1 – Misplaced belief

There is a common perception that public officials know what they are doing. They are experts paid out of our taxes, and have been doing it for years. It’s always best to leave matters to the experts, and there’s no point in interfering.

This lazy, unquestioning syndrome certainly applies to public finances and money, over which our Central Bankers hold almost mystical sway. We believe that, as a condition of granting banking licences, the Central Bank holds all commercial banks legally accountable for their monetary practices, and consequently those banks enjoy a high level of public trust.

bailouts galore


So much for the commonly held belief. But if banks and other financial operators, such as building societies and mortgage lenders, being fully regulated, are really “as safe as houses”, why is it that so many of them had to be bailed out with public funds during the last blow-up 10 years ago? Why is it that in the USA alone government bailouts of bust banks and other lending institutions amounted to scores of trillions of dollars? Or £800 billion in the UK? Or the fact that the European Central Bank’s bailouts, even now, relate to entire countries rather than just their banks?

2 – Self-interested lawmaking at the helm

Historically, part of the answer lies in the systematic, insidiously creeping laxity of banking law that has permitted the crucial difference between loan and deposit banking to evaporate. There is obviously a world of difference between (i) a bank that makes loans from its own reserves of savings, or borrowings; and (ii) a bank that makes loans out of other people’s money, deposited with it for safekeeping, and believed by those parties to be available for them to withdraw at any time of their choosing.

gigantic Ponzi Scheme


By allowing greed to overshadow honesty, pressurised lawmakers, here and in the US, have elided these two banking models; and the result, known as fractional reserve banking, is a gigantic Ponzi scheme in which depositors’ trust – trust that money they have deposited in a respected, regulated bank, is available for withdrawal at any time – has in fact been betrayed.

The patently fraudulent practice whereby your bank lends your money to third parties without your knowledge or consent compels your bank to make an assessment of how much they need to hold available to allow for periodic withdrawals – and since the money it lends carries an interest charge, it clearly benefits the bank to lend out as much as possible. Even though it’s your money they are lending, they take the interest!

3 – It is new money

But here is the key point: the money they have lent out is new money. It may bear a “fractional” relationship to the sums deposited, but it is not part of it. It is “new” money, indistinguishable from counterfeit because it has been conjured up from nowhere. It lacks even notional backing by anything real.

You cannot argue against this logic: (i) At any point in time the depositors have a legitimate claim to 100 per cent of their deposits; and (ii) the bank’s new borrowers also enjoy legitimate, unfettered use of the whole of the sums borrowed, subject only to repayment terms and interest charges. In short, there is suddenly more money in the system. Fractional reserve banking therefore increases the money supply and, as such, is inherently inflationary.

4 – Price advantage for first receivers

Notice, too, that the injection of new money always occurs within the precincts of the banking system, from which it “ripples out” into the wider economy and continues to circulate. Its first receivers obviously enjoy an early price advantage – at the expense of those languishing in the economy’s outer reaches, where the poorer and unemployed members of society will eventually face the full impact of the higher prices that must follow in the wake of new money.

printing money – blatant fakery


As I said in the opening paragraphs, the mere fact that this fraud has been going on for so many years has the effect of sanitizing it in the public mind. Its blatant fakery is called into question only when, say, a loss of public trust in either the banks or, more seriously, the currency itself, causes depositors en masse to seek repayment of their deposits; or the banks, now seeking repayment of their loans find that their borrowers are in financial trouble, and the ghastly process goes into deflationary reverse: the money supply shrinks, prices fall and the inflationary boom is relentlessly succeeded by the bust that, as night follows day, must come.

5 – Blind apologists

Unsurprisingly, fractional reserve banking has had its share of brazen apologists, one of whom, economist Walter Spahr, argued that a banker operates like the bridge builder who, recognising the unlikelihood that every member of the community will wish to use his bridge every day, bases its width on his estimate of how many will actually use it from day to day. Spahr maintained that if the bridge builder can act on his estimate of the small fraction of citizens who will actually use the bridge at any one time, why shouldn’t a banker act on an estimate of the percentage of deposits that will need to be redeemed on a daily basis, and retain only that required fraction?

QE is not a magic panacea


Sounds plausible? But, as Murray Rothbard observed in his seminal text “The Mystery of Banking”, the analogy adopted by Spahr simply doesn’t work: the citizens in his example do not themselves have any legal claim entitling them to cross the bridge at any given time – indeed, they may have to pay to use it. By contrast, the bank’s depositors most emphatically do have a legally enforceable claim to their money at any moment they choose to withdraw it. Since, at any point in time, the bank clearly cannot meet all withdrawal claims, the loans made by the bank must have been issued fraudulently.

6 – Not just the Central Banks

When we think about the evils of unbridled inflationary money-printing, what usually comes to mind is the phenomenon known as Quantitative Easing (QE), popularly practised for over 10 years by central banks everywhere as the magic panacea that fends off the consequences of earlier governmental interference in market functionality, notably interest rate suppression. But, as we can now see, the cause of excessive unbacked credit creation is by no means confined to conjuring tricks practised by central bankers. The banking system in its entirety, as it currently operates, is the complicit partner-in-crime, every High Street bank indulging in its own mini-QE.

7 – More Central Bank QE? Forget it!

As I explained in my last essay on blind tenacity, no matter how desperately the world’s central bankers re-hone their familiar conjuring skills, the tools have been over-used and their old remedies are well beyond viability – indeed any antidote that embraces QE and the suppression of interest rates that are already in near-negative territory, can only hasten the impending recession’s onslaught.

As clear-sighted observers have been predicting for some time, the unwinding of pent-up capital destruction and masked malinvestment, successfully forestalled ten years ago, will come home to roost this time, enforcing a clean break from which lessons may at last be learnt.

We can live in hope!


[EMILE WOOLF: 21-8-19]