Got 100% Reserve Banking on the Mind

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47 Comments

  • lief erickson


    this is pretty rough. first where does growth come from in your economy. if there is no fractional reserve then there is no wealth being created, unless it is created by the government, through the treasury and such. if there was a 100% reserve it would be like there being only one bank and no aggregate loaning. like it or not thats how wealth is increased, through the increase in government spending. wealth does not come out of the ground. gold is only worth something because people accept it. the same is true with dollars. accept the money supply is endogenous and the public accepts the dollar for taxes. inflation only accrues when wages outpace productivity, which puts income pressure on output; not excess money because that assumes that the transaction demand is infinite.
    next you are advocating for contracts on demand deposits. we already have those they are called CDs. forcing all individuals to lock their money up for a certain amount of time, or pay a fee for holding a checking account, is nuts. i believe that people of your ilk hate contracts and blame them for all rigidities in the economy. how would hayek explain contracts in his book prices and production. even more so to give banks even more power in a time of a banking crisis just seems off the deep end. this would send the banks in to competition with the interest rate bidding up the price of interest on savings which would drive up the interest on loans. creating more risky business investments as safe investments are saturated. above all where is the loanable funds market in today’s economy. savings rates are sky high and investment is nil and the interest rate is also. why are people saving now and not investing (people typically save by putting their money in the bank). above all banks would not want to loan to anyone except big business, they are the only guaranteed repayment. big business takes out a lot in debt with overdraft facilities regularly and repays on a level far in excess with the proportion going to consumers, the lower you are on income scale the more in debt you are.
    continuing on your facts are misleading at best. unfunded liabilities doesn’t mean that they wont be funded an the number you post is so far in to the future as not to effect my grandchildren’s children. the way they work is our generation pays for the older generations and the same will be true in the future. me nor you nor anyone else will have to pay the sum you quote it will be paid over the 1000 years that the number represents. finally the national debt will be paid. what does one rotation around the sun have to do with paying down the debt.
    there is so much more but i’m tired. i like what you are doing with your site, most of it is wrong however, you should have spent more time in the sociology department at the u of o

    • Thanks for the comment, Lief. This was a piece written by Andrew Syrios, and I’m sure he will respond to your thoughts. SwiftEconomics.com engages in editorials. Opinion pieces are exactly that, and I welcome different points of view from both writers and readers, in a robust debate. We do try to back up our opinions here with facts, and well-documented citations.

      I’ll respond to a couple of your points. First, I like this article because it challenges people to think about the other extreme for a monetary system. This is a valuable exercise. Certainly, 100% reserve banking has its drawbacks, but if you think 100% reserve banking is absurd, realize that fiat money and 10% reserve banking is absurd as well. The power our monetary system gives to the Federal Reserve, a non-government entity, is simply astounding.

      Your definition of wealth seems to be money. Makes sense, but I’d ask you to expand that definition in a moment. Your definition of economic growth seems to be all new money created in the economy, from the fractional reserve system or the Treasury printing press.

      Money only represents wealth because it represents a medium of exchange for goods and services. The money supply does not grow without consequences. If money was wealth, and growth of the money supply had no consequences, why not print millions of dollars and hand them to every man, woman and child? Everybody would be wealthy. Of course, nobody would be wealthy (if their wealth was held in dollars) in this scenario. Unfortunately, this scenario is taking place, only on a smaller level. When the money supply is expanded, without respect to demand for goods and services in the economy, the dollar loses value. When the dollar loses its value, a person needs more dollars to buy the same amount of goods and services as before. This is called inflation.

      You defined inflation as: “inflation only accrues when wages outpace productivity, which puts income pressure on output.” Actually, economists disagree on the cause of inflation. Some think there is demand-pull inflation, some cost-push inflation, some built-in inflation, and some believe increases in the money supply cause inflation. Check out this visual guide to inflation which clearly explains all four: http://www.swifteconomics.com/2009/08/04/a-visual-guide-to-inflation/

      I tend to think all four can cause inflation, if inflation is simply a rise in price levels. Point being, money only represents wealth as far as its purchasing power to buy goods and services. There’s a reason households need two incomes to survive now. Household incomes are far greater today than they were in the 1960′s or ’70′s, so if money were wealth, the middle class should be rich. No, it’s just that it takes more money to purchase a lot of the same goods and services. Housing, food and energy alone account for much of these price increases. Most of our “wealth” increases, from a quality of life perspective, come from technology advances and the quasi-free market system delivering these advances to the masses (I hedge with quasi because our system is far from being free market). Take a kid from the ’60′s and place him/her in 2009 with an iPod, internet-browsing cell phone, laptop, HD TV with a million channels, dishwasher, washer/dryer, etc., and he/she would feel uber wealthy.

      You believe that government spending is economic growth. Remember that government cannot create anything, they can only redirect. The money it spends is taxed, borrowed or printed. Debt spending could potentially spur long-run economic growth, if the money is invested in productive capacities, or areas that will create streams of income moving forward. How many income-producing assets does the government own? Given that we run deficits virtually every year, not too many. Amtrak is bankrupt, the Post Office is bankrupt, social security/medicare/medicaid is bankrupt. If the government took taxpayer money, and borrowed money from China, to start Google, then they’d have a valuable asset that creates long-run economic growth. The largest asset the government has is the ownership of revenue from taxpayers, and its ability to borrow money because of the value taxpayers and the American economy represent.

      My definition of wealth is really quite simple: production. The U.S. economy runs on consumption of imported goods. When the Federal Reserve and Treasury pump new money into the economy, they are simultaneously creating debt liabilities. The debt is financed from abroad, often the same countries (China is the classic example) who sold us the consumer goods to begin with. Countries that have their debt under control, competitively produce and export goods to other nations, will have true long-run wealth.

      The U.S. has extremely lackluster savings rates compared to other industrialized nations. I’m not sure why it is you think people are hoarding tons of money. Savings rates have increased to 5% of personal disposable income during the recession, but Americans still spend almost every dollar they earn.

      Obviously, the entire public debt and/or unfunded liabilities will not come due tomorrow. Everyone knows that. However, some people resent the fact that our grandchildren’s children’s children will still be paying off debt spending and obligations from our, and previous, generation(s). In fact, some people would call born indebtedness immoral. Despite the fact repayment on these debts and obligations will take a long, long time (and what makes anyone think a government of any political stripe will stop spending, thus increasing the debt?), the existence of the debt does effect us now. I’ll give you one example. The 10-year Treasury rate drives mortgage rates and other lines of credit. Once the Federal Reserve stops buying our own Treasury debt, and mortgage-backed securities, mortgage rates will increase in a meaningful way. This will cause more foreclosures and make it difficult for the housing market to stabilize. Higher mortgage rates will make it more expensive for anyone to own, and pay debt service, on a home. There are consequences for increasing the money supply and mass accumulating debt.

      Thanks for reading our content and offering your opinion.

  • Andrew


    I think you cover most of what I would say Ryan. I am curious as to why you think I hate contracts Leif? I didn’t see the connection there. Plus I was referring to the need to pay to keep your money at the bank as a downside to the system of 100% reserve banking.

    I’ll make a few other points:

    1) The idea that inflation and unemployment of growth are inversely connected should have ended with stagflation in the 1970′s. As Milton Friedman noted, inflation preceded drops in unemployment. Thus, in all likelihood, inflation caused firms to think they were more profitable than they were, so they hired more, then they wised up and boom; stagflation.

    2) I know that gold, like fiat money, simply represents the wealth of the economy. But then it stands that an increase in the money supply with out a corresponding increase in output will mean that each dollar represents less wealth than before, i.e. inflation.

    3) There is no reason to believe that growth is only due to government spending or fractional reserve banking. After all, investment can only come from savings. Fractional reserve banking just makes a bunch more paper money, not real savings. So one would expect the increased paper money to simply make the rest of the paper money represent less wealth (inflation). The advantage here is that without inflation, there is a disincentive to invest, but the savings available to invest is unchanged.

    4) One of the things I was trying to emphasize is that by artificially lowering interest rates and increasing the credit available (through the Fed and fractional reserve banking) we stimulate debt over savings. The idea was to encourage capital accumulation over debt financing. There are up and downsides to both, but given how many people are up to their eyeballs in debt, I’ll go with savings. Given Wal-Street’s propensity to bundle loans to reduce risk, I see no reason that only big business would have access to credit under this system.

    5) We had an enormous amount of malinvestment in real estate, the economy is still reeling. Thus, people and firms are trying to shore up their savings while liquidating bad assets. It will take some time before these savings will turn into actual investments, although the government has decided to invest much of their money for them by using debt and money creation.

    6) I do not mention unfunded liabilities in this article, but I have in other places. Unfunded liabilities by themselves, admittedly, is a bit of a scare number. The problem is when you compare them to expected tax receipts. Now long term estimates are highly speculative, but it does appear, especially from David Walker’s analysis, that the United States is headed for fiscal insolvency.

  • Jim Myrtle


    ” In 100% reserve banking, banks simply act as warehouses for capital. For simple checking accounts, bank customers would probably have to pay a small fee to keep their money in the bank, instead of receiving interest. It would be like putting your money in a safe deposit box”

    Exactly, I agree completely.

    “Bank’s primary purpose would be to invest people’s money for them, in the form of loans to others and then charge a fee or percentage of the interest for the service of bringing the lender and borrower together. Since the bank must maintain 100% of the money entrusted to it on reserve,”

    Bzzzzt. If the bank must maintain 100% of deposits, they cannot make loans at all.

    “it could not allow customers to withdraw their funds on demand”

    It could, if it was truly 100% reserve

    “Instead, customers would likely have to sign contracts that prevented them from getting their money back for a certain period of time”

    Like a CD? Currently, the reserve requirement on CDs is 0%.

  • Andrew


    Yes, like a CD. I don’t know why I didn’t just say that, but oh well. The demand deposits (i.e. safety deposit boxes) and interest bearing accounts (i.e. CD’s) were two separate instruments. If such a system were implemented, banks could only loan out what they had available from CD’s and other similar financial instruments at a 1:1 ratio.

  • Jim Myrtle


    “If such a system were implemented, banks could only loan out what they had available from CD’s and other similar financial instruments at a 1:1 ratio”

    Just like they do now. So what’s the change?

  • Andrew


    The change is they couldn’t lend out money at a 9:1 ratio put into checking and savings accounts.

  • Jim Myrtle


    After you subtract out the reserve, they loan less than the amount in checking and savings.

  • Jim Myrtle


    ” A 100% reserve standard would, presumably, come with a gold standard (each dollar could be redeemed for a certain amount of gold). This means that new money would arrive on the scene attached with no debt”

    We had fractional reserve banking for hundreds of years, even under the gold standard.

  • Andrew


    OK, the system would work like this:

    If you want to store your money in an account that you can withdraw from at any time, it would act like a safety deposit box you could access from an ATM. The banks could not loan this money, so they would charge you a small fee to store it for you.

    If you wanted to earn a return on your money, you would put it in a CD or similar instrument that the bank could loan out at a 1:1 ratio for whatever duration the contract stated. During said time you couldn’t access the money, unless by paying a fee or something like that.

    Currently banks can lend out money at a 9:1 ratio of what they have on hand. So a 100% reserve ratio is radically different than a 10% reserve ratio.

    “We had fractional reserve banking for hundreds of years, even under the gold standard.”

    You’re putting the cart before the buggy here. I didn’t say with a gold standard comes a 100% reserve ratio (it obviously doesn’t). I said with a 100% reserve ratio you would presumably have a gold standard. Not necessarily, but it would make more sense to do so, since the whole idea of 100% reserve banking is to separate government and banks from monetary policy (i.e. printing money).

  • Jim Myrtle


    “Currently banks can lend out money at a 9:1 ratio of what they have on hand”

    A deposit of $1000 in a CD allows a loan of $1000.
    A deposit of $1000 in a checking account allows a loan of $900.

  • Andrew


    Yes, banks loan out all of a CD whereas they only loan out 90% of checking deposit. I’m not disagreeing with you there. But people can access their checking account at any time meaning that two people can have a claim on the same money. That’s not true with CD’s.

    So what’s you’re point? Are you saying fractional reserve banking doesn’t have an inflationary effect? Are you saying it behaves the same as 100% reserve banking? Honestly, what is your point?

  • Jim Myrtle


    You said, “The change is they couldn’t lend out money at a 9:1 ratio put into checking and savings accounts”

    If I put $100 into checking, they can lend $90, not the $900 you seem to claim above.

    Yes, people can access their checking account at any time, that’s why banks hold reserves, so your check doesn’t bounce.

    CDs have a 0% requirement, so they wouldn’t fit into your 100% reserve idea. And banks can loan more, not less when CDs are involved, so I’m not sure why you think that is safer or better.

  • Andrew


    But that $90 gets deposited in another bank and they lend out $81 and then $72 and so on. The math looks as follows:

    X = Initial Deposit
    Y = Reserve Requirement
    X/Y = Total Amount of money added to the economy

    So if you deposit $100 at a bank that has a 10% reserve requirement:

    $100/0.1 = $1000 will be the total amount of money eventually created.

    So if you deposit $100 in a checking account, eventually, $900 will be created.

    The reason a system of only CD’s would be safer is banks could only lend out what they had. In other words, they couldn’t lend out $90 of the $100 you deposited and then simply let you withdraw that $100. The $100 you put in a CD is lent out, but they have to have it back in the vaults with the contract is due so you can withdraw it. With 100% reserves, there’s no inflation and no risk of a bank run. With fractional reserve banking, there is that risk as we’ve seen countless times.

  • Jim Myrtle


    “X/Y = Total Amount of money added to the economy”

    And in the case of a CD, Y=zero.
    You can create more new money with CDs.

    I buy a $1000 CD, the borrower spends the money and it ends up in another bank in a new $1000 CD and the new borrower spends the money and it ends up in another bank in a new $1000 CD and the new borrower spends the money and it ends up in another bank ….
    $3000 in deposits, $3000 in loans $0 in reserves.
    Instead of $2710 in deposits, $2439 in loans and $271 in reserves.

    “The reason a system of only CD’s would be safer is banks could only lend out what they had”

    It’s safer to lend 100% than 90%?

    ” With 100% reserves, there’s no inflation and no risk of a bank run”

    There’s also no lending. Which is why nobody does 100% reserve.

  • Andrew


    Jim, there is an enormous difference here. The difference is that on demand deposits, a person can withdraw their money at any time. Two people have “title” to the money.

    Forget the banks for a second. Let’s say I give Alex a $100 to lend for me for six months. In six months he gives it back + interest. So he lends it to Brian. The balance sheet is still even:

    Me: Asset: $1000 deposit
    Equity: $1000
    Liability: $0
    Money in Circulation: $0 (it’s all been given to Brian)

    Brian: Asset: $1000 deposit
    Liability: $1000 debt
    Equity: $0
    Money in Circulation: $1000

    Total assets: $2000
    Total Liabilities: $1000
    Equity: $1000
    Money in Circulation: $1000

    The key is that only Chad has money in circulation; the $1000. The debt traces traces its way back to the original lender. There’s no increase in the money supply. There’s just a longer paper trail to that money.

    But if I give Alex the money and he lends out $900 to Brian, then I withdraw the $900 from Alex, look what happens:

    Me: Asset $900 cash, $100 deposit
    Equity: $1000
    Liability: $0
    Money in Circulation: $1000 ($900 on hand, $100 with Alex)

    Brian: Asset: $900
    Liability: $900
    Equity: $0
    Money in Circulation: $900

    Total Assets: $1900
    Liabilities: $900
    Equity: $1000
    Money in Circulation: $1900 ($900 in my hands, $100 in Alex’ and $900 in Brian’s)

    The assets and liabilities may be the same, but the money in circulation has increased. Now both Brian and I have “title” to the same money. That’s where the money is created as well as from borrowing from the Fed or when the Fed simply monetizes debt. This documentary explains it:

    http://www.youtube.com/watch?v=vVkFb26u9g8

    As far as “There’s also no lending. Which is why nobody does 100% reserve.” Well you’d have to forget about venture capitalists, private money lenders, the Bank of Amsterdam before the 20th century, Prosper.com, and every other loan that was non-refundable during a certain contract period (which happen in all the time). All those are 100% reserve banking.

  • Jim Myrtle


    “Jim, there is an enormous difference here”

    I agree. You seem to think CDs, 0% reserve requirement, somehow have a 100% reserve requirement.

    “The key is that only Chad has money in circulation; the $1000. The debt traces traces its way back to the original lender. There’s no increase in the money supply”

    But there is an increase.

    The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public; travelers checks; demand deposits, and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.
    http://www.newyorkfed.org/aboutthefed/fedpoint/fed49.html

    CDs are included in M2.

    “The assets and liabilities may be the same, but the money in circulation has increased”

    In your first example, money supply is $2000, in the second $1900.

    “Prosper.com, and every other loan that was non-refundable during a certain contract period (which happen in all the time). All those are 100% reserve banking”

    If you deposit $1000 in the bank and they lend any of it out, their reserve is less than 100%.

  • Andrew


    I’m discussing how a system of 100% reserve banking would work, not how CD’s under our current system work. That may be where our entire disagreement lays.

  • Jim Myrtle


    “I’m discussing how a system of 100% reserve banking would work”

    Banks cannot make loans under a 100% reserve system.

  • Andrew


    Yes you can. See my previous post, the article or here: http://en.wikipedia.org/wiki/Full_reserve_banking.

  • Jim Myrtle


    You are incorrect.

    “Full-reserve banking is a banking practice in which the full amount of each depositor’s funds are available in reserve (as cash or other highly liquid assets) when each depositor had the legal right to withdraw them”

    You see, if the full amount is in reserve, by definition, none can be lent.

  • Andrew


    Read the whole sentence you quoted: “when each depositor had the legal right to withdraw them.” Yeah, if you sign a contract that says you can’t withdraw the money for 1 year, the depositor DOES NOT have the legal right to withdraw their money. Thus there is money to lend.

  • Jim Myrtle


    “Yeah, if you sign a contract that says you can’t withdraw the money for 1 year, the depositor DOES NOT have the legal right to withdraw their money”

    Sounds similar to a CD. Where the requirement is currently 0%.

    So if you deposit your money (and sign a contract) and the bank lends out your money, the bank holds reserves less than 100% of deposits.

    Sounds very similar to fractional reserve banking.

  • Andrew


    The difference is the bank must have on hand every dollar that depositors have legal access to given the contracts they’ve signed. This would make bank runs impossible. It is also nothing like our current system.

    And just think, why are there all these articles, essays and books on full reserve banking if it’s the same as putting money in a safety deposit box or fractional reserve banking? See:

    http://www.fullreservebank.com/
    http://en.academic.ru/dic.nsf/enwiki/235258
    http://mises.org/daily/1829
    http://mises.org/daily/3237
    http://www.thefreemanonline.org/columns/fractional-versus-100-reserve-banking/

  • Jim Myrtle


    “The difference is the bank must have on hand every dollar that depositors have legal access to given the contracts they’ve signed”

    Yes, 100% reserves means banks would have 100% of deposits on hand. So no loans.

    If you only want to allow loans on CD deposits, your reserve on CDs will be less than 100%, maybe down to the 0% we currently require on CDs.

    If you want to call a blend of 100% reserves and 0% reserves
    “100% reserve banking”, feel free. Your math doesn’t work, but feel free.

    “And just think, why are there all these articles”

    Boy, are those a bunch of muddled articles.
    Is their a certain part of one of them that agrees with your bad math? Because I didn’t see it.

    “However, there is an even better solution, and it has been advocated by many Austrians for a long time: 100%-reserve banking. With 100% reserves, banks need not fear for solvency. They know that they can pay their depositors back because they have the money in the safe to do so. There is no need for dramatic bank run scenes like the classic one in It’s a Wonderful Life”

    The Federal Reserve, as the lender of last resort, means that banks don’t need to worry about bank runs. And you can still get a loan.

  • Scam


    Who cares what it’s called. When the bank can only lend out your money when you give them permission to, it’s a better system than what we have now.

  • Jim Myrtle


    “When the bank can only lend out your money when you give them permission to”

    You give them permission now when you make your deposit.

    “it’s a better system than what we have now”

    What is a better system than what we have now? Be specific.

  • Scam


    “What is a better system than what we have now? Be specific.”

    Sorry, I thought you would have been able to figure out that I was referring to the one you’ve been discussing this whole time, Full-reserve banking. My point was that since you believe it actually isn’t a true 100% reserve system the way Andrew described it, you can call it anything you want. No matter what you want to call it tho, it will still be better than our current system. I would list the reasons why but Andrew already wrote an entire article on it.

  • Jim Myrtle


    “Full-reserve banking”

    You don’t want banks to be able to make loans from your deposits?

    • Jim, it’s a title. The notion of 100% Reserve Banking sounds as though banks would have to keep all deposits on hand, at all times, but that’s not the system Andrew wrote about. He clearly described the dual instruments, how loans could be made, suggested money could be tied to an asset like gold or silver, and explained the key distinction of having banks invest money for you, because you’ve explicitly asked them to, with a set time frame for money to be returned to the person who lays claim to it. The system has its costs and benefits. More than anything, this article is a thought exercise to think about the other side of the spectrum.

      Yes, we’ve avoided bank runs in this financial crisis, but 275 banks have failed since 2008. A monetary/banking system which lends itself to credit booms is a significant reason why.

  • Jim Myrtle


    “Jim, it’s a title”

    That’s great. 100% reserve banking which still allows fractional reserve (or zero reserve) banking.

    “and explained the key distinction of having banks invest money for you, because you’ve explicitly asked them to, with a set time frame for money to be returned to the person who lays claim to it”

    Like we have now with CDs.

    “A monetary/banking system which lends itself to credit booms is a significant reason why”

    Yeah, human nature leads to booms and busts. Even under the gold standard, especially before the Fed.

    • Yes, we have CDs now. But what else do we have…an entire monetary system which the lion’s share runs on fractional reserve banking with 10% or less reserve requirement. How has that worked out? We now need two incomes to support a middle class family. The increase in quality of life and productivity around the house can be attributed to technology/engineering/science, whose innovation was driven by profit incentives. Inflation, namely in housing, food, and energy, explains the rest. Fiat money has contributed to inflation.

      Human nature is a part of booms and busts. I would bet a system which doesn’t supply large groups of people with great amounts of credit, in short periods of time (while incentivizing saving), would help. The government mis-allocating resources contributes to booms and busts, too. And a gold standard would not allow massive injections of money through government policy, which is only tied to more debt.

      Look at the setting of long-run mortgage rates by the underwriting practices of Fannie/Freddie. The financial leaders in government allowed those rates to be set by the GSEs. The Federal Reserve set rates artificially low to stimulate other types of credit. This led to $10 trillion of national mortgage debt, a housing bubble, and a financial crisis. Obviously there were other factors. But if you don’t supply people with ungodly amounts of capital, it’s pretty difficult for real estate bubbles to materialize. Shockingly, central planning the monetary system/economy doesn’t work out too well.

      I believe there is a place for government. In this instance, upholding sound lending practices. Well, they did the opposite with affordable housing initiatives and allowing sub-prime mortgage products.

  • Jim Myrtle


    “an entire monetary system which the lion’s share runs on fractional reserve banking with 10% or less reserve requirement”

    Yes, CDs are the lion’s share, 0% reserve now, 0% reserve under your “100% reserve” system.

    “How has that worked out?”

    We’ve had that system since our nation had banks. How has the “100% reserve” system worked out?

    ” I would bet a system which doesn’t supply large groups of people with great amounts of credit, in short periods of time (while incentivizing saving), would help”

    How would your idea incentivize saving?

    • I’ve been trying to find the percentage that CDs make up of the total money supply. I’ve had no success. CDs less than $100K are counted in M2 and large CDs are counted in M3. It would be interesting to know the aggregate value of CDs, at least an estimate. So I’m not sure if CDs really make up the lion’s share of money or not. My comment was suggesting that they don’t necessarily make up the lion’s share of funds loaned. The mere fact that money is created out of thin air off of an initial deposit, many times over, even if the initial deposit is a CD, would suggest that it is not. In Andrew’s system, CDs would make up all of the initial money available for loans. Pretty key difference.

      Said Murray Rothbard:

      “…if I buy a $10,000 CD (“certificate of deposit”) redeemable in six months, earning a certain fixed interest return, I am taking my savings and lending it to a bank, which in turn lends it out at a higher interest rate, the differential being the bank’s earnings for the function of channeling savings into the hands of credit-worthy or productive borrowers. There is no problem with this process.”

      I don’t think the fact that the fractional reserve system has been around for awhile is a great argument to keep it as is. We’ve had inflationary pressures for some time, which you failed to address.

      Andrew covered in the article how his system would incentivize saving. Inflation is an incentive to consume now.

  • Jim Myrtle


    I’ve been trying to find the percentage that CDs make up of the total money supply. I’ve had no success.

    http://www.federalreserve.gov/releases/z1/Current/z1.pdf

    pg 111, under financial assets,
    checkable deposits and currency, $195.9 billion
    time and savings deposits (both 0% reserve) $6205.9 billion
    monet market shares, $1201.8 billion.

    “The mere fact that money is created out of thin air off of an initial deposit, many times over, even if the initial deposit is a CD, would suggest that it is not”

    More money is “created out of deposits” not thin air, when the deposit is a CD.

    “In Andrew’s system, CDs would make up all of the initial money available for loans. Pretty key difference”

    A tiny difference, according to the Z1. Only 2.6% of the above listed assets are demand deposits.

    “There is no problem with this process.”

    And no problem with the same process, from demand deposits, that anyone has shown me.

    “I don’t think the fact that the fractional reserve system has been around for awhile is a great argument to keep it as is”

    The fact that the alternative hasn’t been around for hundreds of years (or ever, really) isn’t a great argument for that system either.

    “Inflation is an incentive to consume now”

    0% interest rates (and extra fees on deposits) isn’t a huge incentive to save either, at least not for me.

    • Thanks for that link.

      I looked at the break down of M2 before, which is M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).

      Savings deposits would not be included as time deposit CDs. Time deposit CDs by itself is the figure I want.

      If a person puts $100 into a CD, most or all of that will be loaned out. Once it is, those deposits will find their way to some other bank account, which will set off the money multiplier. That means money will be created out of thin air after the initial round of loans from the original CD funds…to the tune of the multiplier m = 1/RR. If the reserve requirement averages 5%, the multiplier is 20. The product of the multiplier and the original deposit (20*$100) is $2,000 of total money created from the original $100. So even if that newly created money ends up as another CD at some or multiple points along the way, it came from the money multiplier process i.e. out of thin air.

      Just because a system hasn’t been tried doesn’t mean it wouldn’t be effective. We have a body of work to judge fractional reserve banking on.

      Close variations of the system Andrew describes have been tried with some success. As he points out in the article this system “is done in private lending all the time. The most common examples are ‘hard money’ lenders who lend on real estate or venture capitalists who lend to start-ups. The Bank of Amsterdam even successfully used a system of 100% reserve banking from 1609 until the late 1800’s. (7) If nothing else, given our current financial mess, 100% reserve banking is at least something to think about.”

      And, yes, I realize loaning on CDs isn’t 100% reserve banking. It’s the dual-instrument system Andrew describes.

      The 0% interest rates you cite have nothing to do with Andrew’s proposal. They’re a product of government policy and quantitative easing. This form of monetary policy has the Federal Reserve first crediting its own account with money it has created out of nothing. It then purchases financial assets, including government bonds, mortgage-backed securities and corporate bonds, from banks and other financial institutions.

  • Jim Myrtle


    “Savings deposits would not be included as time deposit CDs. Time deposit CDs by itself is the figure I want”

    I’ll keep looking, but the point is, both savings accounts and CDs have a 0% requirement.

    “Just because a system hasn’t been tried doesn’t mean it wouldn’t be effective”

    Right. You just have no proof it will be effective.

    “it came from the money multiplier process i.e. out of thin air”

    You bet, it came out of the money mutiplier process i.e. out of deposits.

    “As he points out in the article this system “is done in private lending all the time”

    Sure, free people are free to do either. Sounds good to me.

    “The 0% interest rates you cite have nothing to do with Andrew’s proposal”

    You misunderstand. If you outlaw loans from demand deposits, interest on those deposits will be 0% AND you will be charged fees for the bank to hold your account, clear your check, etc.etc.etc.
    Not on some of these accounts, like now, but on all these accounts.

    • My point is we’re discussing your claim that CDs are the lion’s share of lend-able funds in the fractional reserve system. The 0% reserve requirement is not my focus; money given to institutions in time deposit arrangements, like Andrew is talking about to facilitate loans, is.

      The proof Andrew’s system can be effective is the examples where it has already been practiced e.g. “hard money” lending, venture capital, and the Bank of Amsterdam. So we have as much proof as we can possibly have: real life “case studies”.

      We’ve also discussed some clear drawbacks in fractional reserve banking’s body of work.

      Sorry I misunderstood what you were referencing with 0% interest rates. Andrew talked about paying a fee like a safety deposit box on demand deposits (bailment). That’s correct. I doubt the fee would equal or eclipse the inflation fractional reserve banking has brought us. The question isn’t if Andrew’s system is perfect; he acknowledged it wasn’t. It’s whether the benefits outweigh the costs, or put another way, if the net benefits are greater than the current system.

  • Jim Myrtle


    “My point is we’re discussing your claim that CDs are the lion’s share of lend-able funds in the fractional reserve system”

    CDs and savings account are. And their 0% reserve requirement would remain unchanged under the “100% reserve” scheme.

    “The proof Andrew’s system can be effective is the examples where it has already been practiced e.g. “hard money” lending, venture capital”

    Yes, these are great examples of 0% reserve lending.

    “and the Bank of Amsterdam”

    That was a good example of charging people to hold their money.
    You should open one of those. I’m sure you’ll get tons of customers.

    ” I doubt the fee would equal or eclipse the inflation fractional reserve banking has brought us”

    Checkable deposits and currency (from Z1) are only $195.9 billion. After you subtract the currency, how much do you think you’d be shrinking the pool of lendable money?

    ” It’s whether the benefits outweigh the costs”

    What is the benefit again?

  • Hildegard Thurber


    Really enjoyed this post, can you make it so I get an email sent to me every time you make a new post?

  • Rick


    100% would be the way to go. People forget that jsut because banks would have to maintain 100% of their deposits…where did the deposits come from? In order to understand this, you have to understand where money comes from. Congress has the only legitimate constitutional power to coin money (we did it with Lincoln, and before). Congress coins the money and it goes either to banks, or to people who put it into banks. There is a certain supply that already exists. People don’t have the need right away to withdrawl from the banks.
    Instead, the banks, who would already have a certain supply would be given deposits, and can loan agaisnt the deposits, but don’t forget that they already had money to begin with.

  • That’s great. 100% reserve banking which still allows fractional reserve (or zero reserve) banking.

    “and explained the key distinction of having banks invest money for you, because you’ve explicitly asked them to, with a set time frame for money to be returned to the person who lays claim to it”

    Like we have now with CDs.

  • Ralph


    I think I might be able to clear up some of the confusion between Jim and Andrew. In our current system, CD’s are subject to 0% reserve requirements, Jim is correct about that. They really aren’t that much different than demand deposits except for a higher interest rate and penalties for early withdrawal (and the lower reserve requirement). They exist so banks can lend more of your money, and have penalties to discourage you from withdrawing the money, since they lent all of it.

    But a 100% reserve requirement does not mean no lending can be done with the money. The denominator in the fraction of “fractional reserve” does not represent how much money was given to the bank, it represents how much is available on demand to the depositor. For instance, if I were to deposit $1000 in a bank, and they lend out $500, keep $500 in reserve, but tell me I only have $500 available for withdrawal until the other $500 has been repaid, that is not a 50% reserve ratio. That is a 100% reserve ratio. All of the money that is available to me on demand is in reserve. I can’t simply withdraw the other $500 minus a penalty because it isn’t there. What is there is a document saying I’m owed interest on the $500 plus the full $500 upon maturity.

    Buying Andrew’s version of a CD would be similar to buying a corporate bond. If I want the money that was lent to the business, I can wait until maturity or find a buyer to buy the debt (bond) from me, I’m not just entitled to it as is the case with current deposits at a bank, including CD’s. In our current system, only 10% is kept in reserve for demand deposits and 0% for time deposits (CD’s). But new money is created by both instruments, as I would always have 100% of the deposit available on demand, minus a penalty for early withdrawal of time deposits. The time conditions allowing me to have penalty free access to a current CD are independent of the original deposit actually being available. So Andrew’s example of CD’s to illustrate full reserve banking was a poor one. CD’s actually have a higher multiplier effect due to the lower reserve ratio. But his general concept of how time deposits are used in full reserve banking was sound.

    The “CD” that Andrew is referring to would work differently than a current CD in that you couldn’t withdrawal the money in the CD because the money wouldn’t be there, someone else would be borrowing it. Andrew’s CD would effectively have an undefined reserve ratio because 0% is held in reserve, but 0% is available for withdrawal. So the reserve ratio would be 0/0. So in a full reserve system, lending can be done, just not with any money that is available for immediate withdrawal.

    I hope that helps clear up any confusion. I’m not trying to advocate one system over the other, I’m simply trying to clarify the differences between them.

  • The “Monetary Reform Act” calls for generating United States Notes, paper and electronic, to replace Federal Reserve Notes, pay off the National Debt, and end “Fractional Reserve Banking” or at least greatly elevate its current reserve ratio. Over a transition period, the money supply would remain constant since the stream of new U.S. Notes entering circulation would be offset by a compensating reduction in the debt money supply, thereby preventing inflation. After equilibrium, a gold or silver standard could be instituted to stabilize the new monetary system, preventing fiat money abuse in the long term. The Fed, as we know it, be ended.

    In theory, this looks pretty good since it gets the U.S. out of debt, eliminates massive amount of interest, promotes achieving a balanced Federal budget, and reduces the influence on the U.S. by creditors such as China. Going to such a “full reserve banking system”, meaning “on demand” deposits are in reserve while “time deposits” are available to be loaned, may make it difficult for small business and entrepreneurs to flourish and innovate. But it’s a way out of the irresolvable debt problem America is facing.

  • Mason Wirsig


    I was hoping to get a hold of Andrew (the author) somehow. Could you please email me or contact me on Facebook?

  • Hi Andrew, That’s a very good summary of the fractional versus full reserve argument. Just a couple of points.

    Near the end of your article you criticise full reserve having a deflationary effect. I agree that a switch from fractional to full reserve would have a deflationary effect. But that is easily counteracted by having government / central bank (gcb) create and spend new money into the economy.

    In fact full reserve is a system under which ONLY gcb creates money. Thus as more money is required by the growing economy, it HAS TO BE gcb that creates that money (else the economy is starved of money and deflation sets in).

    Re your claim that fractional reserve is inflationary, there is an article by George Selgin in Capitalism Magazine on this point. He claims that the INTRODUCTION of fractional reserve to a full reserve economy is inflationary UNTILL the value of the monetary base has been reduced in real terms to a level that is just sufficient to enable private banks to settle up amongst themselves. At that point the inflation stops. I think that’s about right. See:

    http://capitalismmagazine.com/2012/06/is-fractional-reserve-banking-inflationary/

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