Sunday, October 19, 2008

Fractional Reserves, Fiat Money and the Federal Reserve

Talifaitasi Satele


I’m not sure what part of our monetary system Majac LeTautai has a gripe with, the fractional reserve banking, fiat money or the Federal Reserve itself. Perhaps an explanation of all three will help both of us determine what exactly we’re arguing about.

Fractional reserve banking is a process where banks keep only a fraction of their depositors’ money in the vault while lending out the rest in hope of making a profit by gaining interest on such loans. Your bank, however, does promise to pay you your balance should you ever wish to take it all back at once.

As “Modern Money Mechanics” explains, banks can easily predict the level of cash withdrawals, but the Federal Reserves dictates such parameters to its member banks.

The amount of money we would have in the economy would normally come from the credit created from fractional reserve banking and actual deposits. “Deposits” meant gold deposits during most of our banking history. A dollar in cash meant that you could redeem a dollar’s worth of gold, back when we were on the gold standard.

Today, however, we have a fiat money supply, where paper dollars are not tied to gold deposits but instead to our government’s order for us to accept the dollar as payment. Fiat actually means “order: or “decree”.

You can read on any dollar bill the statement, “This note is legal tender for all debts, public and private”.

The switch to a fiat money supply, which was only possible with the creation of the Federal Reserve, came about in what Mr. Greenspan explains was an attempt “to use banking system as a means of unlimited expansion of credit”.

The Federal Reserve is not a private firm but a supposedly independent government entity authorized by the Federal Reserve Act of 1913. Its Board of Governors are appointed by the President and confirmed by the Senate. The Federal Reserve’s actions in bailing out Wall Street over the past month is not a good indication of its independence.

Banking is better left to the free market, which is not what we’ve had since 1913.

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