It Is Dangerous to Be Right When the Government Is Wrong - Andrew P. Napolitano [121]
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The way bankers make profits in this system of counterfeiting and fraud is simple. Take the same example above. You deposited $1,000 in a checking account at your bank. In a fractional reserve system, your bankers would only have to keep 10 percent of your deposit on reserve, giving them the opportunity to loan out up to 90 percent of your money. In other words, once you deposit $1,000 in the bank, its reserves would be increased by $1,000, and the bank now has $900 in excess reserves that it can loan out.
So let’s presume that your bankers found Bob, a business owner who needed a loan. The bank would loan out the $900 and charge Bob 5 percent interest for a one-year loan. Right away, the money stock in the economy would have increased by $900, now totaling $1,900: The $900 issued to Bob, plus the $1,000 note given to you, which effectively functions like cash ($100 is kept on reserve at the bank). Bob, a widget manufacturer, then pays Carl the $900 for raw materials. Carl then deposits this $900 in a different bank, which can now loan out $810 to Dan (holding 10 percent, or $90, on reserve). Now, we have a total increase in the money supply of $2,710, compared with a mere $1,000 initial deposit. This process continues, the money supply growing larger and larger until it has vastly outstripped the amount of your original deposit.
In normal economic times, this wouldn’t present much of a problem; Dan would repay his loan, and Bob would repay his. Thus, there would never be a shortage of cash as the depositors make withdrawals. The problem, however, arises when depositors get scared that numerous investments will go sour, and thus they will lose their money. They then rush to the bank to make withdrawals—legal claims which the bank is clearly not capable of honoring under this system of fractional reserve banking. The end result, of course, is that you have lost your hard-earned savings. As we discussed earlier, this process is known as a bank run.
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It is because of this process that banks in this system pushed for centralization of control with government backing, or a government-backed banking cartel. With this cartel the commercial banks could utilize cheap (sometimes free) loans from the central bank, so the commercial banks would have access to all the money they needed to conduct daily transactions, and honor legal claims in the event of a bank run. Moreover, the government would set up an insurance system, the Federal Deposit Insurance Corporation (FDIC), to protect deposit accounts from the risk of losses. The FDIC is funded, of course, by taxpayers’ dollars.
If the banks received government backing, they would then be able to profit from their gains and pass their losses along to the taxpayers in the form of bailouts, just as President Andrew Jackson warned about and predicted 180 years ago. Big Government, constantly needing money to fund its military adventurism, welfare state, and campaigns for more power, would clearly benefit from this system, as would the cartel members. Everyone else, by contrast, would be outright robbed of their savings through inflation.
Inflation, a rise in prices, is caused by an increase in the money supply. The reason this happens is, as explained before, money or currency is just a medium of exchange you use to acquire other goods or save for the future acquisition of goods. When money printing and fractional reserve banking increase the money supply, there is more money bidding up the prices on the same supply of goods. Moreover, an increase in the supply of money does not increase real wealth, since money is used only in exchange.
To illustrate the actual effects of inflation as caused by the Fed, consider that what cost $25,000 in 1913 would cost about $536,000 in 2010. If a person had $25,000 in 1913 and did not keep it in a bank or a (risky) investment account, by 2010 he would have lost 93 percent of his money’s purchasing power, or the amount