Banking Is Not Necessary

Today's banking system is based on a principle that did not exist until the 17th century. The notion of fractional reserve banking is that bankers lend out more money than they actually have on deposit because they can predict with some accuracy how much money depositors will reclaim each day. Currently, the supply of money is about double the cash and reserves on deposit in banks, so half the money supply is due to bankers' lending money that does not really exist anywhere.

Academics vigorously argue in favor of fractional reserve banking. They claim to be in favor of the poor and of economic development, but a little common sense tells you that enabling bankers to double the money supply chiefly benefits bankers. Moreover, bankers do not lend to the poor, they lend to the rich and to the middle class, and to government's favored recipients. Hence, the traditional tendency is that fractional reserve banking is most beneficial to the wealthy.

Bankers refuse to lend to entrepreneurs. This is a well known phenomenon to anyone interested in starting a business. Bankers view lending to innovative start ups as too "risky". On the other hand, they are eager to lend to sub-prime mortgage borrowers, Bunker Hunt when he was eager to corner the silver market, Long Term Capital Management when it claimed to have "hedged" all bets based on crackpot theories of modern finance professors, and to sellers of credit default swaps that the bankers did not understand, but what the hell, they're less risky than investing in A/C electricity or a cure for cancer.

The main problems of capitalism have related to the fraud in which bankers engage in lending money. Economically illiterate historians and historically illiterate economists both make the argument that without fractional reserve banking there would have been no progress. But they cannot point to examples of progress that depended on fractional reserve banking. Nikola Tesla depended not on banking but on venture capital from JP Morgan to work on energy transmission and earlier inventions. Milton Hershey depended not on banking but on friends and family to build his candy empire. Do most entrepreneurs today depend on bank loans to finance new business concepts, or on private investment capital that they save themselves, from friends and family or from private "angels" who do not benefit from the fractional reserve system?

Where do bank loans go? They go to the least risky investments: real estate and to finance lumbering, incompetently managed large firms.

Now, let us think for a moment who pays for fractional reserve banking. When a bank lends a dollar it does not have, it collects interest on that dollar. But it has increased the money supply. By increasing the money supply, it reduces the value of everyone else's dollars. So anyone who holds dollars, workers and savers, subsidize the bank. As the value of everyone's dollars is reduced, the borrower repays the loan in cheaper dollars. So the banker is subsidized and the borrower is subsidized, but the thrifty and poor who do not borrow pay.

Now who are the chief borrowers? Large corporations are the most indebted. Hedge funds, investment banks and large real estate investors are the chief borrowers. It is true that the middle class has also borrowed. The group that borrows least is the poor.

Inventors who are trying to build a new business based on an invention cannot borrow because banks will not lend to them. So money is transferred from innovators to borrowers. From inventors to real estate developers.

Banking is not necessary for progress. Innovation has not depended on banking. It has depended on private capital. Rather, banking stalls innovation. Thus, as the Federal Reserve Bank's power to create money has increased, and Wall Street and the banking system has flourished over the past 35 years, innovation has been limited to a few industries that stock brokers favor. Real estate and stock investment has soared. And American workers' real wages have declined.

Fractional reserve banking is not necessary to American progress. It is a form of income redistribution from the innovative to the opportunistic.