The most insidious effects of fractional reserve banking

This article was previously published as an addendum to a longer piece on 19 November 2010.

The most insidious of all of the unintended consequences of both fractional reserve banking and the judicial decisions of Sir William Grant in Carr vs. Carr [1811] and Lord Cottenham in Foley vs. Hill [1848] is the continued shrinkage of the size of the unit of measurement of exchange value.

The unit of money – the pound – is the unit of measurement we each use daily in measuring the value of what we do, what we earn, what we buy and the general course of our individual affairs.  We depend on that unit for measuring and determining our future.  We each rely on it.  Yet, it is an untrustworthy tool for measuring because its size diminishes continually.  Measurements taken at different times will not be measured with the same size of unit.  Therefore, measurements taken at different times cannot be validly compared and formulae derived from such comparisons cannot produce the results predicted.

Imagine what would happen if the unit of measurement of time diminished continually.  Suppose the clock on Big Ben set the official time.  Suppose further that it had a mechanical fault so that it lost half a second a minute.  Every 5 days we would lose an hour.  Every 40 days we would lose 8 hours.  Soon it would be dark at noon and light at midnight.  Time would no longer be synchronized with nature.  Farmers could not rely on the clock to feed their animals.  Nights would get shorter and soon we would find that 8 hours sleep left us still tired.  We wouldn’t be able to get everything done during a normal day’s work and would have to work later and later. What couldn’t be completed today will need to be done tomorrow.  We would have to squeeze more and more into our already busy schedules.  Soon we will always be running out of time and craving more and more of it.  Our levels of stress would increase.  We would know we were not at fault and would seek someone else to blame.

It is no different with money.  Measurements of exchange value taken at different times may use the same numbers of pounds, but those pounds will each represent a different amount of purchasing power.  The budget we planned will no longer suffice.   We find ourselves short of money and crave more.  Soon we can only see the ‘short term’.  Long term planning is no longer an option.  Our levels of stress increase and we seek someone else to blame.  The results are both socially divisive and economically destructive.

Nevertheless, the effects have not always been that obvious.  In our individual experience, one day we suddenly realize that the money we receive as income no longer provides what it did or that our savings are no longer sufficient.  We need more money or we need to reduce our standard of living.

In the 1960’s an average manager earned £4,000 per year.  On that income, he could provide for his family.  He could put his children through private school.  His wife could stay at home and look after the children and she could have help in the home 5 days a week.  He could take his family on a holiday every year.  It wasn’t until he retired that he noticed the change.  By the mid to late 1970’s those who had retired on £2,000 or £3,000 per year discovered they could no longer afford the levels of comfort they had previously enjoyed and many had to alter their retirement plans radically.  The calculations they had previously made did not produce the results predicted.  Someone or something had stolen their purchasing power.  They cannot see who or what did this to them.  They begin to distrust everybody and the seeds of social unrest are sown.  They see themselves as having failed and their self-worth is diminished.

Today, the average manager earns more than £50,000 per year and cannot provide for his family the same standard of living that his predecessor did in the 1960’s earning £4,000 per year.  To achieve a decent standard of living now, his wife will also have to work.  Children cannot receive the same quality of home care.  What will happen in the next 50 years?

Economists use money as one of their principal units of measurement.  Comparisons of such measurements are invalid.  Calculations made using these comparisons are equally invalid comparisons.  Formulae derived from these calculations produce results which cannot possibly be achieved. The predictions of these economists continuously fail to come to pass and the entire field of economics has been brought into disrepute.

To try to improve their results, economists try to ‘index’ the pound but, as we saw in the example of ‘Big Ben’ above, in real life indexing does not work.  Nature does not ‘index’.

This loss or ‘theft’ of purchasing power produced by fractional reserve banking is destroying trust in the capitalist system throughout the world.   Neither labour nor producers will willingly enter into fixed long term contracts without regular reviews of price.  They have each been robbed of purchasing power too often.  As a result, the focus of too much human endeavour has become focused on the short term.

Too many now believe they must earn as much money as possible in the short term.  A culture of ‘greed’ has been fostered.  All of this flows naturally from having allowed the mechanism of money-lending to have been superimposed onto a perfectly valid system for storing and distributing our money.

Who can we blame today?  Is it the fault of the government, the banker or the depositor?  Each has allowed it to happen and each has continue to allow it to happen.  The truth is that we have each found ourselves born and raised within the system as it is.  We have been conditioned to trust it and have each done our best to survive within it.  Like those who for centuries believed and acted as if the world was flat, we have all merely failed adequately to question it.  There is no point in now trying to apportion blame. Those who made the original mistakes are long dead.  What we need to do now is to concentrate our energy on fixing it.

Banks remain a necessity in our economic system.  We live in a mandatory exchange system – a system where exchange is required to survive.  A medium of exchange is required to measure the value and the fairness in each exchange.  Money is that medium of exchange.  Safely to store our money and to distribute efficiently and conveniently is essential today.   Banks can and should continue to provide these services.  However, we can only allow banks to continue to provide these services if we remove the money lending mechanism from the storage function of banking and return it to 100% reserves.  As I have often argued, this can best be done by returning title to their money to depositors.  Then the banks will have a fiduciary responsibility to depositors and cannot lend deposits.

This will stop any further diminution of the size of the unit of measurement of exchange value.  Each of us can then begin to make more accurate measurements of exchange value and that will allow us all to make better decisions.  Nevertheless, we must remember that much of the data already stored in our memories is distorted and inaccurate.  We will each only be beginning the process of correcting our own thinking.   The process will take a long time.  In our own minds, we have each accumulated years of experiences, calculations and decisions – all based on inaccurate information.  We each may well have used our energy pursuing courses we would not otherwise have pursued and much of it will have been wasted.  Patience and understanding will be required.  We are all in the same boat.

Yet, begin we must.  I believe the future of civilization as we know it depends upon our actions now.