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By Root 684 0

fractional reserve banking or money printing, injects more money into banks’ vaults, inducing them to lower interest rates. The current consumer is incentivized to borrow and spend since interest rates are low (think of the teenager who just received his first credit card), causing a growth in the retail sector which bids up the cost of the three productive resources—land, labor, and capital. The low interest rate once again incentivizes long-term production projects, but this time there are no resources being freed up from the retail sector, so they cost more money. Moreover, since consumers have not deferred any of their consumption to the future, the pool of resources these long-term projects seek to draw from is either much smaller than they calculated, or does not exist. Since these long-term projects do not churn out profits while being completed, and thus are not able to make profits once they are completed because of the unchanged or smaller pool of resources, they are forced into bankruptcy. This means all of these projects constituted a waste of the three productive resources since there was never a profit being made, or an increase in wealth; these resources will be lost forever. All this because interest rates were artificially low; that is, they were brought low by government command or money printing, not by free market forces.

Hayek concluded that the causes for bank panics and the boom-and-bust cycle were the increase in credit brought about by a government- or central bank–induced lowering of interest rates and a massive increase in the money supply through the fractional reserve central banking system. When a bank can loan out more money than it has on reserve, automatically the money supply can be greatly expanded. Stated differently, it was the system of fraud and counterfeiting, which violated every individual’s property rights with respect to their money, that was distorting the free market of exchange so grossly that it caused massive depressions and severe economic harm.

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This boom-and-bust cycle could never happen if there was a 100 percent reserve banking system.3 Let’s look at this. You deposit $1,000 in your checking account at your bank. If there was a 100 percent reserve banking system, you would just pay a fee to the bank for the safekeeping of your money. There would be a decrease in your currency holdings by $1,000, and an increase in your checking account by $1,000; the total money supply in the economy would remain unchanged.

The only way the bank could loan out the funds you deposited without risking a violation of your property rights is if you agreed not to withdraw your money for a certain period of time. During this time, you would be free to monitor the loans the bank has given with your money, thus ensuring that the loans are sound and profitable. In this system, banks could never get too big to fail, banks could never collapse an entire economy, and banks could never increase credit to create the mal-investment that leads to a boom-and-bust cycle. Moreover, people would never be at risk of losing the money they deposited in their checking accounts; they would only be at risk for the money they voluntarily agreed to allow the bank to loan out. Thus, a 100 percent reserve system is not only congruent with, but necessary for the enforcement of the Natural Law.

Forget a Money Tree; We Create It Out of Thin Air

Let us return to our history lesson. In stark contrast to Hayek’s insights, the solution to the boom-and-bust cycle proposed by the deceptive bankers was to cartelize it and have it backed by the government. A cartel is an agreement amongst competing firms to fix prices and to refrain from serious competition. The prices are normally set above the market rate so these firms can make larger profits. However, there is an extremely strong incentive for firms to bust the cartel, because there is a great amount of untapped demand at the normal market price. Because of this temptation, someone always ends up breaking the cartel, and thus there needs to be some form of coercion