Fractional Reserve Banking: A Primer

I copied my previous post here on one of the threads in the Ron Paul Forums.

Somebody responded with the following comment:

You do have some inaccuracies in your post.
First, the money they loan out does come from deposits.
The reserve requirement is the percent of those deposits they are required to keep on hand (either at the Fed or at the bank itself or some combination therof)- not on the loan amount. And yes, there is a law that they do keep a certain level of reserves in the US. That came in responce to the run on banks in the 1920s that contributed to the Great Depression because banks were unable to meet withdrawl demands. Unless they are an investment bank like Bear Stearns.

If they have $300,000 to loan out, and a ten percent reserve requirement, they must have had $300,000 on deposit- 90 percent that they can loan out and ten percent to keep on hand.

Gilligan’s note: I think you mean “have had $30,000 on deposit”.

As you pay back the mortgage, the bank has more money available to loan out to someone else. The money to pay back the interest came from wages you were given in exchange for work you performed. Your employer received that money from someone who purchased the product of your labors. It did not come from thin air.

Essentially, this argument is attempting to minimize or refute the fact that banks mint “money”. They don’t mint the paper that you carry around in your wallet/purse called Federal Reserve Notes or Bank of Canada Notes. What they mint is “checkbook money” or “digital money”. This money is created the split second the private bank grants the loan to you and makes a few computer entries to deposit it to an account somewhere.

The books balance in the banks ledgers because the so-called “loan” from the bank is an asset (it is an interest generating instrument) AND a liability as this loan is deposited in an account somewhere, where it will be saved, or more likely spent. The bank will have to honour checks written against this account.

First, the money they loan out does come from deposits.

This is *FALSE*. The money (or more accurately “bank credit”) springs into existence when the loan is created. There are well known credible admissions that support this:

“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Banking was conceived in inequity and born in sin . . . . Bankers own the earth. Take it away from them but leave them the power to create money, and, with a flick of a pen, they will create enough money to buy it back again. . . . Take this great power away from them and all great fortunes like mine will disappear, for then this would be a better and happier world to live in. . . . But, if you want to continue to be the slaves of bankers and pay the cost of your own slavery, then let bankers continue to create money and control credit.” – Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.

“We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon.” – Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta in the Great Depression, 1934

“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.” – Graham Towers, Governor of the Bank of Canada from 1935 to 1955

“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.” – Robert B. Anderson, Secretary of the Treasury under Eisenhower, said in an interview reported in the August 31, 1959 issue of U.S. News and World Report

In addition, one of the principle tenets of contract law is the essence of “Consideration”. What this simply means is that a contract is valid if all parties participating in the contract are promised “things of exchange” or mutual value. If there is no consideration, the contract is invalid.

This article was interesting. In 1969, a court case took place, “First National Bank of Montgomery vs. Daly” in Minnesota. Daly argued that the bank could not foreclose on his house as the bank did not give him money to finance his home. Associate Justice Bill Drexler, present and keeping order in the case, was pretty much uninterested in the case until the bank’s president L.V. Morgan, made a startling admission on the stand. Morgan admitted that the bank created money “out of thin air” and that it was a standard banking practice. Presiding Justice Martin Mahoney said:

“It sounds like fraud to me.”

Apparently, the jurors agreed. Daly was acquitted. The bank lost it’s case. In his memorandum, Mahoney stated:

Plaintiff admitted that it, in combination with the Federal Reserve Bank of Minneapolis, . . . did create the entire $14,000.00 in money and credit upon its own books by bookkeeping entry. That this was the consideration used to support the Note dated May 8, 1964 and the Mortgage of the same date. The money and credit first came into existence when they created it. Mr. Morgan admitted that no United States Law or Statute existed which gave him the right to do this. A lawful consideration must exist and be tendered to support the Note.

You can imagine the ramifications if this got out. Daly did. He wrote:

“This decision, which is legally sound, has the effect of declaring all private mortgages on real and personal property, and all U.S. and State bonds held by the Federal Reserve, National and State banks to be null and void. This amounts to an emancipation of this Nation from personal, national and state debt purportedly owed to this banking system. Every American owes it to himself . . . to study this decision very carefully . . . for upon it hangs the question of freedom or slavery.”

The case has never been overturned…but nor has it ever been cited in any subsequent court case. It is not a big leap to understand why.

Going back to the poster’s comment:

As you pay back the mortgage, the bank has more money available to loan out to someone else. The money to pay back the interest came from wages you were given in exchange for work you performed. Your employer received that money from someone who purchased the product of your labors. It did not come from thin air.

This statement ignores the important questions:

• “Who creates the money?”
• “How is it added to the money supply?”
• “Who spends it first?”

In closing, I include a table now where I demonstrate fractional reserve banking with multiple banks, as opposed to the single bank example I gave in my previous post.

I use the terms GCM (Government Created Money). All other entries are Bank Created Money. It is understood that “Bank” means private banks.

I used the names of well known Canadian banks to illustrate that it really doesn’t matter if there is one bank or many banks in the scenario as the loan process is the same at *ALL* banks. We are simply following the money as the depositors place their money in different accounts.

Fractional Reserve Banking assuming an initial deposit of a 100 dollar bill and a 10 percent reserve requirement. The total amount of bank created money will be $900.00 but only the first 10 transactions will be shown.
individual bank	amount deposited	amount lent out	reserves
CIBC	100 (GCM)	90	10
TD Bank	90	81	9
CIBC	81	72.90	8.10
BMO	72.90	65.61	7.29
RBC	65.61	59.05	6.56
CIBC	59.05	53.14	5.91
National	53.14	47.83	5.31
TD Bank	47.83	43.05	4.78
CIBC	43.05	38.75	4.30
BMO	38.75	34.89	3.86
RBC	34.89	and so forth…	and so forth…
			total reserves:
			65.11
	total amount deposited:	total amount lent out:	total reserves + last amount deposited:
	613.32	629.27	100

I stopped calculating after 10 entries (Bank K). I leave it to the reader to continue if they wish, but the formula to calculate the maximum amount of money that can be lent out is:

m = 1 /r

• where:
• “m” is the multiplier
• “r” is the reserve requirement.
• Example: From the above table, r = 10%. Therefore, m = 1 / (1/10) = 10.

Therefore the maximum amount of money added to the money supply from an initial deposit is $1000.00. $100.00 is central bank created (a paper note) , the other $900.00 is private bank created (checkbook money).

My previous post may be read with this primer in mind now.

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