Similar questions probably get asked a lot, but this one is very straightforward.
I am curious about how fractional reserve banking is inflationary but yet 100% loan banking is not.
Loan banking would be where you place your savings in an interest paying loan account from which the bank would make loans to third parties with. These loan banking accounts would be used to make loans to customers which must be paid back during a certain time window and depositors would also not be able to withdraw their funds during that same window of time. Bunk runs would be impossible.
Fractional Reserve banking is still a bit mysterious to me on how it is inflationary while the above banking is not. I realize that a fractional reserve bank is subject to runs, but how is it inflationary? If a bank has a $1000 deposit and loans out $900 of it under the full extent allowed with a 10% reserve requirement. How is this inflationary? I know that the bank now has $1900 on its books but the original depositor is not using his $1000. It doesn't seem like any new credit has been created. So as long as the bank does not experience a run, how is this inflationary?
I am very interested in clearing this up for myself so that I can more properly explain this to others.
Juan:Banks issue other 'fidiuciary media' which work just like paper money.
That does not make them the same. It is at least not legal tender.
scineram: Juan: Mining gold increases the supply of commodity money (assuming gold is being used as money). Then it is inflationary just as fractional reserves.
Juan: Mining gold increases the supply of commodity money (assuming gold is being used as money).
scineram: Juan: Under fractional reserves, by definition, the supply of paper money increases. Not indefinetly.
Juan: Under fractional reserves, by definition, the supply of paper money increases.
It is at least not legal tender.
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
Juan:I do wonder if you're just playing dumb...
So what makes one inflationary and the other not?
scineram: So what makes one inflationary and the other not?
It's a matter of degree. Real money is limited to a reasonable degree by the amount of capital needed to produce it. Fractional reserve created money knows few limits and eventually inflates to a perverse degree.
For example, my grandpa's twenty dollars once bought an ounce of gold. My same twenty dollars will now buy me about two hundredths of one ounce of gold.
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It's a matter of degree.
How is fractional reserve banking not inflationary?
"You don't need a weatherman to know which way the wind blows"
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GilesStratton: How is fractional reserve banking not inflationary?
haha I have learned a lot from this thread. Thanks everyone!
scineram: krazy kaju: I have $100 in a demand deposit and $90 is loaned out. I buy something online for $50, the money is transferred from my bank account to the online vendors. In this situation, we have the borrwer using my $90 and myself using $50 for a total of $140, even though there is only $100 in bank deposits. If fractional reserves weren't inflationary, there wouldn't be a difference between M0, M1, and M2. Those diffferences are irrelevant. The relevant is whether there is a difference in one of them between time t_1 and t_2.
krazy kaju: I have $100 in a demand deposit and $90 is loaned out. I buy something online for $50, the money is transferred from my bank account to the online vendors. In this situation, we have the borrwer using my $90 and myself using $50 for a total of $140, even though there is only $100 in bank deposits. If fractional reserves weren't inflationary, there wouldn't be a difference between M0, M1, and M2.
I have $100 in a demand deposit and $90 is loaned out. I buy something online for $50, the money is transferred from my bank account to the online vendors. In this situation, we have the borrwer using my $90 and myself using $50 for a total of $140, even though there is only $100 in bank deposits.
If fractional reserves weren't inflationary, there wouldn't be a difference between M0, M1, and M2.
Those diffferences are irrelevant. The relevant is whether there is a difference in one of them between time t_1 and t_2.
The differences aren't irrelevant. If I'm using the money I have in the bank as physical money by using checks while someone else is using that same money because they borrowed it, you have two things happening:
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First, this is about fiduciary media, no one was talking about fiat money. Learn the difference.
Second, then what? Once credit expansion made it through the system there is no more expansion. Banks cannot create credit indefinetly without risking runs. Additional money creation requires more base money in reserves.
Edit:
All I am saying it is inflationary exactly as much as hard money. If the amount of base money, coins for example, doubles, the entire money supply doubles under both systems.
krazy kaju: scineram: krazy kaju: I have $100 in a demand deposit and $90 is loaned out. I buy something online for $50, the money is transferred from my bank account to the online vendors. In this situation, we have the borrwer using my $90 and myself using $50 for a total of $140, even though there is only $100 in bank deposits. If fractional reserves weren't inflationary, there wouldn't be a difference between M0, M1, and M2. Those diffferences are irrelevant. The relevant is whether there is a difference in one of them between time t_1 and t_2. The differences aren't irrelevant. If I'm using the money I have in the bank as physical money by using checks while someone else is using that same money because they borrowed it, you have two things happening: Inflation, as the money supply is expanded. The beginning of the business cycle as the amount of credit exceeds the actual amount of savings.
There is nothing to stop anyone from having a time deposit from "spending" the money before the date of redemption. Any CD can be exchanged for other goods or services or could be accepted as a deposit instrument at another bank or sold at a discount in a secondary market so the distinction is all nonsense.
Example, Person A has $5,000 CD due in 4 months. Person A exchanges CD for a car now. Repeat process. So person A is using the money while the money is being loaned out to someone else.
Person A has $5,000 CD due in 4 months. Person A exchanges CD for a car now. Repeat process. So person A is using the money while the money is being loaned out to someone else.
scineram:All I am saying it is inflationary exactly as much as hard money.
how do you exhcange a cd for a car. Meaning the car dealer will wait for it to mature taking it now at a discounted rate. Either way as you said it's not cash.
Person 1 (P1) deposits 1000oz gold in Bank 1 (B1). Person 2 (P2) borrows 900oz from B1 and deposits it in B2. P3 borrows 800oz from B2 and deposits it in B3. P4 borrows 700oz from B3 and deposits it in B4. P5 borrows 600oz from B4 and deposits it in B5. And so on and so on.
The above scenario (fractional reserve stylee) takes place within a week quadrupling the money supply (1000oz gold (M0) + 3000oz bank liabilities (M1) = 4000oz). This system of banking is obviously and historically unsustainable with sound money thus the fiat currencies of today.
Compare this to:
Person 1 (P1) deposits 1000oz gold in a long term investment account (5yr) in Bank 1 (B1). B1 decides to invest the 1000oz in Joe Brain (JB) for his Phd. B1 oversees the payment and delivery of gold to Mises University (U1) on behalf of JB. JB graduates within two years and pays back B1 with interest within the next 3 years.
This scenario (100% reserve stylee) creates no increase in the money supply (P1's 1000oz >> B1's 1000oz >> U1's 1000oz = 1000oz). The entire risk is born by P1 and to some extent B1's reputation for soliciting future investors and JB's credit for soliciting future loans.