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A Question About Fractional Reserve System

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EmbraceLiberty posted on Tue, Jul 10 2012 7:49 AM

Does the fractional reserve system occur from investment companies? For example, if I lend my money to a firm that invests in another firm that gives my money to their workers which then lend to the firm that I originally lent money to.

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I think your example could be made simpler by having only three participants: the original lender, the investment firm, and the borrower. The borrower takes the money he received from the investment firm (ultimately from the original lender) and lends it back to it.

On the one hand, I think it's unrealistic to assume that the borrower would do that. I think any reputable investment firm would want to know what the borrower plans to use the money for. If the borrower says he wants to lend it back to the investment firm, I'm not so sure that the investment firm would be willing to lend the money. If the borrower says he wants to use the money for one or more other things, but he turns around and lends it back to the investment firm, at the very least I think the investment firm would likely become suspicious of the borrower. At the most, the investment firm would hold the borrower liable for fraud, as the loan contract could stipulate what the borrower is to use the money for.

A more realistic scenario would involve the borrower lending the money to a different investment firm. The only way this could be profitable for him is if he lends it to a firm that makes riskier investments (hence offering a greater return than the rate at which he's borrowing). If the hoped-for returns don't materialize, then he may not be able to meet his loan obligations to the original investment firm. This could ultimately lead to a default. In that case, either the original investment firm eats the loss themselves or the original lender does. It would depend on the agreement between the two.

Investment firms are like one side of modern-day banks (the lending/investing side). With investments, there's no guarantee that the lender/investor will get anything back. There are no reserves here, as there are with the other side of banking (the monetary safekeeping side).

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But, wouldn't the reserves be the money the investment firms holds. Also, the way that the loaned money would return back to the original lender would be via workers.

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 Can you clarify your answer?

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Does the fractional reserve system occur from investment companies? For example...

http://mises.org/media/4390/Money-Banking-and-the-Federal-Reserve?ajaxsrc=video

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