Banking is hard to understand for most of us since the word “bank” covers so many different activities. During the Renaissance era there were “merchant-bankers” who started out as merchant businesses who then extended credit to their own customers.They lent money from their own savings and cash flow to others for the interest on said loans and that activity became more profitable than the underlying business. This led to some of the great “banking houses”.
Just like the “merchant-bankers” of old, today’s banks can be productive and beneficial to the masses when they lend their own savings and capital. In no way does this activity lead to the boom/bust cycle. See von Mises for details on that. If a bank takes in money (what is money is a whole other discussion) on a CD or other non-demand deposit and then lends it out so that that depositor earns interest and the bank a profit then there is nothing wrong with that. It is a valuable function and devoid of any fraudulent activity. Even the “investment banking” houses can be beneficial as they (or once did) take their own capital and invest or loan it out to others thereby underwriting businesses, corporations, start-ups, and research. The major problem with these houses was that they handled the underwriting of government bonds which led to their involvement in politics. Big money and national politics is a volatile mixture. They manipulated governments to extract money via high taxes from the masses to assure the investment houses that the government bonds would be paid off — and then that led to even worse activities.
The main problem with our current banks is that they are “fractional-reserve” banks. If I set up a bank and take in 10 million dollars in deposits, I know that there will not be a need for that much cash at any one time. So, I’ll lend some of that money out to earn interest. So far, so good. But what happens now is that the bank will lend out 100 million and so 90 million has been created by the magic of fractional reserve banking. As Mises, Rothbard, and many others have pointed out, that is inflationary and leads to the boom/bust cycle that harms us all — but the poor the most. However, under free competition without government support and enforcement the bank has a big problem. What if most of that 90 million was lent out to people who put it into other banks? These banks would make demand for the money and show my bank to be bankrupt. So, there will only be limited scope for fractional-reserve counterfeiting unless I can get the government to help me out. And they will! The Fed! Yes, the greatest counterfeiting gang in history will cure my woes.
The possibility of other banks demanding funds that a bank would not have gave rise to a drive by the bankers themselves to get the government to cartelize their industry. A central bank chartered by the government itself and given certain monopoly powers is the means by which banks can be safe in their money creation frauds. Central Banking began with the Bank of England in the 1690s so you can see that this is not a new idea at all. The United States was chained by the banking cartelists with a central bank called the Federal Reserve System in 1913. The Federal Reserve System (Fed) is granted the monopoly of the issue of bank notes. These notes are now identical to the government’s paper money and are the monetary “standard” in the country.
People use physical (paper mostly) cash as well as bank deposits and so the private bank has to go to the Federal Reserve to draw down its own checking account with the Fed to satisfy its need for any physical paper money or coins. The Fed is the “bank of the banks”. It is also the lender to the banks which greatly helps in the inflationary creation of new “checkbook” money out of thin air.
All economists agree on the mechanics of this process. They disagree on the moral or the economic aspects of the process; but not on how it works. The general public is not educated into the mysteries of banking and so thinks that their money is “in the bank”. It is true that the candidacy of Ron Paul did help to shed some light on the issue. Now more common folks understand the problem a little better.
The Federal Reserve, backed by the awesome force of the US government, acts as the creator and enforcer of a gigantic banking cartel. The Fed bails out banks in trouble, and it centralizes and coordinates the banking system so that the banks many jointly engage in money creation out of thin air — the inflation process. The Fed protects the banks from being shown to be bankrupt at all times.
This system has looted the American public. A dollar in 1913 is now worth about 2 cents! Hyper-inflation is a real possibility these days with the Fed creating a Trillion a year or more. Can you say “Zimbabwe” children?
Next time — how to end this evil system.