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We will now take a closer look at what it really means to operate a fractional reserve system bank.

In the past

As we have mentioned in our lesson Real Money For A Real Economy, the origins of banking can be traced back to people giving their gold to bankers for safekeeping and these bankers issuing paper receipts which were redeemable on demand. These paper receipts acted as paper money.

Actually, there were two variations of gold deposits in banks:

  • Safekeeping
  • Investing

Safekeeping is what we explained above. A bank acted as a warehouse to keep gold safe in return for a small safekeeping fee. This was OK.

The second variation was a contractual agreement whereby a person gave gold to the bank for investing. The bank would take the gold and invest it (i.e. loan it) for the customer and in return the bank would get a percentage of the investment. In this case, it was the depositor of the gold who assumed all the risk the loan may go bad. This was also OK because it was a contract between the depositor and the bank.

Originally, both types of deposits, safekeeping and investment, were separated (i.e. segregated). It only made sense. In the first case, the gold clearly belonged to the depositor and the bank did not have a contractual right to loan the gold. In the second the bank had the contractual right to loan the goal and it did.

Temptation strikes

Over time, bankers realized that most people depositing gold for safekeeping would not redeem it. Actually, the redemption rate was about 10%. So, they decided to take the gold in safekeeping, the gold that was not theirs, loan it and keep the profits!

Of course, sooner or later this trick became obvious and ended up in courts. The courts decided, contrary to all common sense, that the gold for safekeeping was actually Bank’s gold to do as it pleased! Furthermore, the courts declared that if the loan went bad, then too bad for the depositor! This person just lost all the gold!

Actually, this concept is so opposed to any other laws of this nature in any country on the planet that it stands up as the gigantic contradiction that it is. In any other country in this planet, if you give a good to a person for safekeeping, the good remains your property at all times.

Imagine if you would take your car to a garage and upon your return you would be notified that the car was rented for a fee to a different person, who, very unfortunately, did not return it. Bad luck. You just lost your car! Does this make any sense to you? Of course not. This is called embezzlement and it is a crime in any country in the planet, except, when it comes to Banking.

Fractional reserve system loans are embezzlements

Why do we say so? Because in order for a fractional reserve system to work, the first thing a Bank does is to loan your money out to somebody else. Passed this point, they create money out of thin air. But the very first step is clearly embezzlement. The problem with embezzlement is that your money is gone. If enough people try to redeem their money at the same time, there simply isn’t’ enough to satisfy everybody!

And so, we are controlled by a system that not only condones criminal activity but it depends from it.


Temptation strikes a second time

Once Banks had the OK from the so called Justice System to embezzle, they decided to go a step further and commit fraud. They decided to issue more warehouse receipts than the gold they had in storage. This worked because on average the redemption rate was not greater than 10%. So for as long as they kept at least 10% worth of gold of all issue receipts, they could maintain the illusion that the receipts were fully redeemable in gold.

For example. A bank holds a total of 100 Gold coins to invest and for safekeeping. Originally, the bank would only issue warehouse receipts for a total of 100 Gold coins. However, now, they are issuing warehouse receipt for a grand total of 1000 Gold coins. They knew that on average no more than 100 Gold coins would be redeemed at any time (100 Gold coins being 10% of warehouse receipts for 1000 Gold coins).

Let’s consider our previous garage example. Let’s say that you take your car to a garage for safekeeping. However, the garage has a car rental agency at the back. They rent your car and keep the profits. Then, they realize that not more than 10% of all rental contracts are actually executed. This is, not more than 10% of all the people who rent a car actually use it. So, they decide to “rent” 10 times more cars than they have! Now remember, every rental agreement states that the renter has the right to use a car. This right is not optional or waivable by the rental agency. In other words, they are collecting fees for the rental of a product they don’t have!

This is fraud plain and simple because there is no product and the contracting rental agency cannot possible satisfy the contract. Furthermore, this was not an omission or an error, it was done so deliberately and with foresight. It is fully premeditated.

In the same manner, a Bank involved in fractional reserve system dealings is loaning out more money than what it actually has at hand. It is similar to the garage case explained above.

Of course, in order not to be prosecuted for fraud, Bankers pressured governments and the so-called Justice System to come up with rather strange concepts. One of such concepts is that on one hand a banker only contracts for amounts money but it has no obligation to redeem that money. Which is patently ridiculous because if all contract holders were to try redeem at the same time many contracts could not be fulfilled.

In the case of the garage it’s like saying that contracting to rent more cars than what the garage has is OK, since the garage is only contracting for cars but not to keep rental cars at hand to meet those contracts!!!

Does this make any sense to you? Of course not. Yet, this is what a fractional reserve system sponsored by Central Banks does all the time.

The problem with fraud as with embezzlement is that lent money is not there; it never was. If enough people try to redeem their loan money at the same time, there simply isn’t’ enough to satisfy everybody!

And so, we are again controlled by a system that not only condones criminal activity but it depends from it.

 Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Central Banks must go - Part 3


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