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Fractional reserve banking

2010-12-19T23:11:17Z

203.63.130.65: /* The Case Against FRB */

'''Fractional-reserve banking''' (or '''FRB''') is a banking practice in which only a ''fraction'' of a [[bank]]'s [[demand deposits]] are kept in reserve and available for immediate withdrawal (as cash and other highly [[liquid assets]]), whilst the remaining cash is lent out to borrowers (and so is never actually available for immediate withdrawal to legitimate deposit-holders).<ref>''The Bank Credit Analysis Handbook: A Guide for Analysts, Bankers and Investors'' by Jonathan Golin. Publisher: John Wiley & Sons (August 10, 2001). ISBN 0471842176 ISBN 978-0471842170</ref><ref>[http://www.bankintroductions.com/definition.html Bankintroductions.com - Economic Definitions]
</ref><ref>[http://www.investopedia.com/terms/f/fractionalreservebanking.asp Investopedia economic definitions]</ref><ref>[http://www.investorwords.com/5581/fractional_reserve_banking.html investorwords economic definitions]
</ref> The bank in effect lends out most or even all of the funds it receives in demand deposits, whilst ''at the same time'' guaranteeing that all deposits are available for immediate withdrawal upon demand. Fractional reserve banking is currently legal and practiced by all commercial banks.

The practice of fractional reserve banking expands [[credit]] and therefore also expands the [[money supply]] (demand deposits and cash) beyond what it would otherwise be in a stable money system. Due to the prevalence of fractional reserve banking, the [[M2 (economics)|broad money supply]] (deposits created via the issuance of loans plus cash) is a much larger multiple than the amount of "real" [[Monetary base|paper currency]] created by the country's [[central bank]]. That multiple (called the [[money multiplier]]) is determined by the [[reserve requirement]] or other [[financial ratio]] requirements imposed by financial regulators, and by the [[excess reserves]] kept by commercial banks.

In legal terms, instead of a deposit being considered a bailment contract with the bank being the custodian of the funds deposited, banks since the 19th century have been allowed to consider the deposit (available for immediate withdrawal) "their money", and they are able to do with the money as they wish, provided they recognize the deposit as a general liability on their books of account.<ref name="De_Soto_reserves">Jesús Huerta de Soto. [http://mises.org/books/desoto.pdf "Money, Bank Credit, and Economic Cycles"]. 1. The Legal Nature of the Monetary Irregular Deposit Contract, p. 1-36, referenced 2009-11-07.</ref> The alternative to fractional reserve banking is "100% reserve banking" or "full reserve banking" where banks treat deposits in a similar way to allocated gold accounts, where the money cannot be lent out for extended periods of time as the money is "owned" by the depositor and held in trust on behalf of the client. In this system, only those funds from depositors who volunatarily kept their money with the bank for an extended period (so called "time depositors" or "term depositors") would be available for lending to third party borrowers.

==The Case Against FRB==
{{See also|Criticism of fractional reserve banking}}
There are moral, ethical and pragmatic economic arguments against the practice of fractional reserve banking.

Some ethicists and economists, such as [[Murray Rothbard]], [[Jörg Guido Hülsmann]]<ref>[http://www.amazon.com/gp/product/1933550090/ref=pd_sim_b_1/182-7638869-5654620 The Ethics of Money Production]</ref> and [[Jesus Huerta de Soto]]<ref>[http://mises.org/daily/3300 International Monetary Reform]</ref> consider the practice to be a form of recursive embezzlement and therefore a form of theft against legitimate deposit-holders and a form of counterfeiting against the monetary and property interests of the general populace - in particular savers who are deferring consumption and trying to avoid indebtedness.<ref>[http://mises.org/daily/4029 The Fed as Giant Counterfeiter]</ref><ref>[http://mises.org/daily/4499 The FRB Question]</ref>

The Ponzi-like dynamics inherent in fractional-reserve banking allow early participants in the financial Ponzi schemes to profit at the expense of genuine savers. For example, property developers who moved their money into Treasury bonds prior to 2008 made significant profits from the 2000s property bubble, but small businesses in the real economy suffered very high inflation (due to high housing costs) and economic disruption when the bubble burst, without being able to profit from the early stage of the bubble.

Aside from these criticisms, relating to the dislocating effects of the Ponzi-like dynamics inherent in the practice of fractional-reserve banking, the primary ''economic'' criticisms relate to its alleged destabilizing effects through the [[Austrian Business Cycle Theory]].

The reason that so many negative effects flow from fractional-reserve banking is that it necessarily distorts and confuses property rights over money.

By employing its excess reserves for the granting of credit, the bank transfers temporary ownership of those monetary reserves to borrowers, while the depositors (supposedly entitled to instant redemption) are supposed to retain their rights to claim redemption ''over the same funds'' - funds that no longer are in the custody of the bank and now appear in another bank's account.

It is physically and practically impossible that a depositor and borrower are entitled to exclusive control over the same physical cash resources. Two individuals cannot be the exclusive owner of one and the same thing at the same time. Accordingly, any bank pretending otherwise - in assuming demand liabilities in excess of actual reserves - must be considered as acting fraudulently and should be considered to be engaged in a straightforward act of [[embezzlement]]. Its contractual obligations cannot never be properly fulfilled and it is technically trading whilst illiquid and therefore (arguably) trading whilst insolvent as it cannot pay all its debt as and when they fall due (the due date for payment of demand deposits is always now). From the outset, the bank must be regarded as inherently bankrupt - as revealed by the fact that no bank can ever withstand a sustained bank run.<ref name="Hoppe_FRB">Hans-Hermann Hoppe. [http://mises.org/journals/rae/pdf/RAE7_2_3.pdf "How is Fiat Money Possible? - or, The Devolution of Money and Credit"] (pdf), The Review of Austrian Economics Vol.7, No. 2 (1994). Referenced 2010-04-29.</ref>

According to [[Rothbard]], fractional reserve banking should be considered to be embezzlement, but it is legal now. The bank is technically insolvent, because it cannot pay its debts as and when they fall due - the deposits being due instantaneously at any time. However, unless the customers (depositors) demand too much money at once – or too many loans fail – it can continue running, without the customers ever noticing that their money was gone. If the bank's customers lose confidence in the chances of the bank's repayment, they can decide, en masse, to cash the deposits in. This loss of confidence, if it spreads from a few to a large number of bank depositors is called a [[bank run]]. Unless the central bank intervenes or other banks come to its rescue, a bank run is always fatal, because, by the very nature of FRB, the bank cannot honor all of its contracts.<ref name="Rothbard_FRB">Murray N. Rothbard. [http://mises.org/books/fed.pdf "The Case Against the Fed"] (pdf), referenced 2010-04-29.</ref>

===Banking cartels===
If a lone bank engages in FRB, it can be ruined by a bank run, or people, who are not its customers, or other banks, demanding redemption of their receipts. A group of banks can agree to accept each other's receipts and not call for their redemption. This would limit the weaknesses of FRB, but in turn introduce the problems of [[cartel]]s. The banks would need to expand in proportion, otherwise some will enjoy greater profit, while the rest will pay for it. Regional and seasonal differences may also come into play. The difficulty of coordination rises with the number of banks in a cartel.

However, cooperation in a cartel is much easier if the members are forced to it by law. A [[Central bank]] can enable all the banks to expand together so that one set of banks doesn't lose reserves to another and is forced to contract sharply or go under. A central bank is the lender of the last resort, bailing out the banks if necessary – this also increases the trust of the public in the system.<ref name="Rothbard_FRB" />

==The Case For FRB==
However, not all hold to such a stringent view of legality. In particular, the [[Freebanking]] school asserts that the [[Principle of Adverse Clearing]], a market signal by which banks can settle upon an equilibrium interest rate with respect to consumer demand for banknotes (and analogous to [[David Hume]]'s [[Price-specie flow mechanism]]), is sufficient to prevent a fractional reserve system from becoming inflationary or unstable.<ref name="Selgin_FRB">George Selgin. [http://www.independent.org/pdf/tir/tir_14_04_01_selgin.pdf "Central Banks as Sources of Financial Instability"] (pdf), The Independent Review Vol.14, No. 4 (2010). Referenced 2010-11-19.</ref> Bank runs under a fractional reserve system can also be prevented by contract features such as an [[option clause]]. Indeed, so long as the banks' contracts make clear such activities beforehand, a legal or natural rights case against FRB cannot be made.

The amount of loans a single bank may make under a free, fractional reserve system is limited by the size of its clientele, by the confidence of the public in its solvency, and by the demand of the public for banknotes (as opposed to specie). An increase in any of these allows the bank to hold lower reserves. Conversely, smaller banks, riskier banks, and banks in a climate that demands specie (these factors may be interrelated) must hold a higher fraction in reserves in order to attract clientele. In this way, fractional reserve banking - far from theft or embezzlement - is a beneficial market signal and the result of voluntary human action that in itself poses little risk of systemic instability.{{Fact}}

==Legal aspects==
[[Roman law]] recognized that bankers were often tempted to use the deposits for themselves. To penalize these actions, they should be not only charged with theft, but to pay interest "so that, in fear of these penalties, men will cease to make evil, foolish and perverse use of deposits".<ref name="De_Soto_reserves" />

In early medieval Europe, the bankers preserved their deposits fully at first, but later began to use them for their own purposes, creating deposits and granting credits out of nowhere. Since the canonical law banned the charging of [[interest]] on loans, borrowers would instead pay "penalties" for "delays" in payment and in effect pay interest on a disguised loan, and justified any misappropriations on this basis. This practice was defended by some scholars, while others wanted to expose all hidden loans and equated all deposit contracts for loans. As a result, the distinction between them was obscured. Experts failed to clear up the resulting legal chaos until the end of the nineteenth century.

The authorities failed to enforce sound banking practices, and often granted banks a government license to operate with a fractional reserve, while taking advantage of easy loans to finance governments and public officials. Some rulers created government banks to reap the profits. But banks were still required to guarantee deposits.<ref name="De_Soto_Medieval">Jesús Huerta de Soto. [http://mises.org/books/desoto.pdf "Money, Bank Credit, and Economic Cycles"]. 3. Bankers in the Late Middle Ages, p. 59-69, referenced 2009-11-05.</ref>

As late as twentieth century, court decisions in Europe have upheld the demand for a 100-percent reserve requirement. In 1927, the Court of Paris convicted a banker for the crime of misappropriation for having used the funds deposited with him by a client, confirmed in 1934. After the failure of the Bank of Barcelona the Spanish Supreme Court also pronounced, that "the depositary does not acquire the right to use the deposit for his own purposes".<ref name="De_Soto_reserves" />

Fractional reserve banks never informed their depositors that some or all of their deposits would actually be loaned out and so could not possibly be ready for redemption at any time. (Even if the bank were to pay [[interest]] on deposit accounts, and hence it should have been clear that the bank must loan out deposits, this does not imply that any of the depositors actually understand this fact. Indeed, it is safe to say that few if any do, even among those who are not economic illiterates.) Nor did fractional reserve banks inform their borrowers that some or all of the credit granted to them had been created out of thin air and was subject to being recalled at any time.<ref name="Hoppe_FRB" />

===Legalization===
The landmark decisions came in Britain in the first half of the nineteenth century. In the first important case, Carr v. Carr, in 1811, the British judge, Sir William Grant, ruled that since the money paid into a bank deposit had been paid generally, and not earmarked in a sealed bag (i.e., as a "specific deposit") that the transaction had become a loan rather than a bailment. Five years later, in the key follow-up case of Devaynes v. Noble, one of the counsel argued correctly that "a banker is rather a bailee of his customer's fund than his debtor,. . . because the money in . . . [his] hands is rather a deposit than a [[debt]], and may therefore be instantly demanded and taken up." But the same Judge Grant again insisted that "money paid into a banker's becomes immediately a part of his general assets; and he is merely a debtor for the amount." In the final culminating case, Foley v. Hill and Others, decided by the House of Lords in 1848, Lord Cottenham, repeating the reasoning of the previous cases:

<blockquote>''The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted.''</blockquote>

These decisions were taken over by the American courts and so was FRB legalized. However, an interesting development occurred in grain warehouse law, which has developed in precisely the opposite direction, despite the conditions of depositing [[Fungibility|fungible]] goods were exactly the same, and grain was a general deposit and not an earmarked bundle.

In the history of the U. S. grain market, grain elevators several times fell prey to this temptation, spurred by a lack of clarity in bailment law. Grain elevators issued fake warehouse receipts in grain during the 1860s, lent them to speculators in the Chicago wheat market, and caused dislocations in wheat prices and bankruptcies in the wheat market. Only a tightening of bailment law, ensuring that any issue of fake warehouse receipts is treated as fraudulent and illegal, finally put an end to this clearly immoral practice. Fractional-reserve grain warehousing, that is, the issuing of warehouse receipts for non-existent goods, was clearly seen as a fraud.<ref name="Rothbard_FRB" />

{{See also|History of money and banking}}

==Securitization==
Known since 18th century, securitization as it is known today was created in 1970, when the Government National Mortgage Association ([[Government National Mortgage Association|Ginnie Mae]]) issued a mortgage-backed security ([[Mortgage-backed security|MBS]]) in the form of a pass through. Securitization has had an exponential growth since.

Economic actors can obtain rights to future payments of money - for instance, a car dealer that sells his cars on credit for five years in exchange of his cars. Such credits are relatively illiquid because their characteristics tend to be sector and client specific. Their owners may prefer to exchange them for an amount of money that is available now. Each of these claims can be passed to an economic actor that has the opposite preferences. Or, relatively similar claims, possibly coming from different owners, could be grouped together within a single holding entity that could then create standardized claims to be sold to investors on the financial markets. This process of putting together relatively illiquid assets and using them is called '''securitization''' - "... the process of pooling and repacking loans into securities that are then sold to investors."

Securitization allows FRBs to withdraw from the market the credit they have created and lent out. It reduces the money supply by the amount of liquid assets used to purchase the asset-backed securities. Therefore, it hides the increase in the money supply, i.e., [[inflation]]. It makes the economic environment appear less inflationary than it should be, given individuals' growing indebtedness to banks. Securitization portrays a bank-credit driven boom as noninflationary, savings driven growth. Also, securitization insulates lending activity of banks from the central bank's monetary policy. It contributes to the widespread illusion that more factors of production are available than in reality, and so becomes a factor in the generation of the boom-bust cycle.<ref name="Gertchev_Securitization">Nikolay Gertchev . [http://mises.org/daily/3820 "Securitization and Fractional-Reserve Banking"], Mises Daily,posted on Thursday, November 12, 2009, referenced 2009-11-14.</ref>

==References==
{{Reflist}}

==External links==
* [[Wikipedia:Fractional-reserve banking|Fractional-reserve banking]] on Wikipedia
* [http://mises.org/journals/jls/18_3/18_3_3.pdf "Legal Tender Laws and Fractional-Reserve Banking"](pdf) by Jörg Guido Hülsmann
* [http://mises.org/journals/scholar/shostak2.pdf Fractional Reserve banking and boom-bust cycles] by Frank Shostak
* [http://mises.org/daily/4499 The Fractional-Reserve Banking Question] by Robert P. Murphy, June 2010
* [http://mises.org/daily/4560 The Form of Saving Matters] by Robert P. Murphy, August 2010

[[Category:Banking]]
[[Category:Money]]

----

Fractional reserve banking

2010-12-19T23:00:23Z

203.63.130.65: /* The Case Against FRB */

'''Fractional-reserve banking''' (or '''FRB''') is a banking practice in which only a ''fraction'' of a [[bank]]'s [[demand deposits]] are kept in reserve and available for immediate withdrawal (as cash and other highly [[liquid assets]]), whilst the remaining cash is lent out to borrowers (and so is never actually available for immediate withdrawal to legitimate deposit-holders).<ref>''The Bank Credit Analysis Handbook: A Guide for Analysts, Bankers and Investors'' by Jonathan Golin. Publisher: John Wiley & Sons (August 10, 2001). ISBN 0471842176 ISBN 978-0471842170</ref><ref>[http://www.bankintroductions.com/definition.html Bankintroductions.com - Economic Definitions]
</ref><ref>[http://www.investopedia.com/terms/f/fractionalreservebanking.asp Investopedia economic definitions]</ref><ref>[http://www.investorwords.com/5581/fractional_reserve_banking.html investorwords economic definitions]
</ref> The bank in effect lends out most or even all of the funds it receives in demand deposits, whilst ''at the same time'' guaranteeing that all deposits are available for immediate withdrawal upon demand. Fractional reserve banking is currently legal and practiced by all commercial banks.

The practice of fractional reserve banking expands [[credit]] and therefore also expands the [[money supply]] (demand deposits and cash) beyond what it would otherwise be in a stable money system. Due to the prevalence of fractional reserve banking, the [[M2 (economics)|broad money supply]] (deposits created via the issuance of loans plus cash) is a much larger multiple than the amount of "real" [[Monetary base|paper currency]] created by the country's [[central bank]]. That multiple (called the [[money multiplier]]) is determined by the [[reserve requirement]] or other [[financial ratio]] requirements imposed by financial regulators, and by the [[excess reserves]] kept by commercial banks.

In legal terms, instead of a deposit being considered a bailment contract with the bank being the custodian of the funds deposited, banks since the 19th century have been allowed to consider the deposit (available for immediate withdrawal) "their money", and they are able to do with the money as they wish, provided they recognize the deposit as a general liability on their books of account.<ref name="De_Soto_reserves">Jesús Huerta de Soto. [http://mises.org/books/desoto.pdf "Money, Bank Credit, and Economic Cycles"]. 1. The Legal Nature of the Monetary Irregular Deposit Contract, p. 1-36, referenced 2009-11-07.</ref> The alternative to fractional reserve banking is "100% reserve banking" or "full reserve banking" where banks treat deposits in a similar way to allocated gold accounts, where the money cannot be lent out for extended periods of time as the money is "owned" by the depositor and held in trust on behalf of the client. In this system, only those funds from depositors who volunatarily kept their money with the bank for an extended period (so called "time depositors" or "term depositors") would be available for lending to third party borrowers.

==The Case Against FRB==
{{See also|Criticism of fractional reserve banking}}
There are moral, ethical and pragmatic economic arguments against the practice of fractional reserve banking.

Some ethicists and economists, such as [[Murray Rothbard]], [[Jörg Guido Hülsmann]]<ref>[http://www.amazon.com/gp/product/1933550090/ref=pd_sim_b_1/182-7638869-5654620 The Ethics of Money Production]</ref> and [[Jesus Huerta de Soto]]<ref>[http://mises.org/daily/3300 International Monetary Reform]</ref> consider the practice to be a form of recursive embezzlement and therefore a form of theft against legitimate deposit-holders and a form of counterfeiting against the monetary and property interests of the general populace - in particular savers who are deferring consumption and trying to avoid indebtedness.<ref>[http://mises.org/daily/4029 The Fed as Giant Counterfeiter]</ref><ref>[http://mises.org/daily/4499 The FRB Question]</ref>

The Ponzi-like dynamics inherent in fractional-reserve banking allow early participants in the financial Ponzi schemes to profit at the expense of genuine savers. For example, property developers who moved their money into Treasury bonds prior to 2008 made significant profits from the 2000s property bubble, but small businesses in the real economy suffered very high inflation (due to high housing costs) and economic disruption when the bubble burst, without being able to profit from the early stage of the bubble.

Aside from these criticisms, relating to the dislocating effects of the Ponzi-like dynamics inherent in the practice of fractional-reserve banking, the primary ''economic'' criticisms relate to its alleged destabilizing effects through the [[Austrian Business Cycle Theory]].

By employing its excess reserves for the granting of credit, the bank transfers temporary ownership of those monetary reserves to borrowers, while the depositors (supposedly entitled to instant redemption) are supposed to retain their rights to claim redemption ''over the same funds'' - funds that no longer are in the custody of the bank and now appear in another bank's account.

It is physically and practically impossible that a depositor and borrower are entitled to exclusive control over the same physical cash resources. Two individuals cannot be the exclusive owner of one and the same thing at the same time. Accordingly, any bank pretending otherwise - in assuming demand liabilities in excess of actual reserves - must be considered as acting fraudulently and should be considered to be engaged in a straightforward act of [[embezzlement]]. Its contractual obligations cannot never be properly fulfilled and it is technically trading whilst illiquid and therefore (arguably) trading whilst insolvent as it cannot pay all its debt as and when they fall due (the due date for payment of demand deposits is always now). From the outset, the bank must be regarded as inherently bankrupt - as revealed by the fact that no bank can ever withstand a sustained bank run.<ref name="Hoppe_FRB">Hans-Hermann Hoppe. [http://mises.org/journals/rae/pdf/RAE7_2_3.pdf "How is Fiat Money Possible? - or, The Devolution of Money and Credit"] (pdf), The Review of Austrian Economics Vol.7, No. 2 (1994). Referenced 2010-04-29.</ref>

According to [[Rothbard]], fractional reserve banking should be considered to be embezzlement, but it is legal now. The bank is technically insolvent, because it cannot pay its debts as and when they fall due - the deposits being due instantaneously at any time. However, unless the customers (depositors) demand too much money at once – or too many loans fail – it can continue running, without the customers ever noticing that their money was gone. If the bank's customers lose confidence in the chances of the bank's repayment, they can decide, en masse, to cash the deposits in. This loss of confidence, if it spreads from a few to a large number of bank depositors is called a [[bank run]]. Unless the central bank intervenes or other banks come to its rescue, a bank run is always fatal, because, by the very nature of FRB, the bank cannot honor all of its contracts.<ref name="Rothbard_FRB">Murray N. Rothbard. [http://mises.org/books/fed.pdf "The Case Against the Fed"] (pdf), referenced 2010-04-29.</ref>

===Banking cartels===
If a lone bank engages in FRB, it can be ruined by a bank run, or people, who are not its customers, or other banks, demanding redemption of their receipts. A group of banks can agree to accept each other's receipts and not call for their redemption. This would limit the weaknesses of FRB, but in turn introduce the problems of [[cartel]]s. The banks would need to expand in proportion, otherwise some will enjoy greater profit, while the rest will pay for it. Regional and seasonal differences may also come into play. The difficulty of coordination rises with the number of banks in a cartel.

However, cooperation in a cartel is much easier if the members are forced to it by law. A [[Central bank]] can enable all the banks to expand together so that one set of banks doesn't lose reserves to another and is forced to contract sharply or go under. A central bank is the lender of the last resort, bailing out the banks if necessary – this also increases the trust of the public in the system.<ref name="Rothbard_FRB" />

==The Case For FRB==
However, not all hold to such a stringent view of legality. In particular, the [[Freebanking]] school asserts that the [[Principle of Adverse Clearing]], a market signal by which banks can settle upon an equilibrium interest rate with respect to consumer demand for banknotes (and analogous to [[David Hume]]'s [[Price-specie flow mechanism]]), is sufficient to prevent a fractional reserve system from becoming inflationary or unstable.<ref name="Selgin_FRB">George Selgin. [http://www.independent.org/pdf/tir/tir_14_04_01_selgin.pdf "Central Banks as Sources of Financial Instability"] (pdf), The Independent Review Vol.14, No. 4 (2010). Referenced 2010-11-19.</ref> Bank runs under a fractional reserve system can also be prevented by contract features such as an [[option clause]]. Indeed, so long as the banks' contracts make clear such activities beforehand, a legal or natural rights case against FRB cannot be made.

The amount of loans a single bank may make under a free, fractional reserve system is limited by the size of its clientele, by the confidence of the public in its solvency, and by the demand of the public for banknotes (as opposed to specie). An increase in any of these allows the bank to hold lower reserves. Conversely, smaller banks, riskier banks, and banks in a climate that demands specie (these factors may be interrelated) must hold a higher fraction in reserves in order to attract clientele. In this way, fractional reserve banking - far from theft or embezzlement - is a beneficial market signal and the result of voluntary human action that in itself poses little risk of systemic instability.{{Fact}}

==Legal aspects==
[[Roman law]] recognized that bankers were often tempted to use the deposits for themselves. To penalize these actions, they should be not only charged with theft, but to pay interest "so that, in fear of these penalties, men will cease to make evil, foolish and perverse use of deposits".<ref name="De_Soto_reserves" />

In early medieval Europe, the bankers preserved their deposits fully at first, but later began to use them for their own purposes, creating deposits and granting credits out of nowhere. Since the canonical law banned the charging of [[interest]] on loans, borrowers would instead pay "penalties" for "delays" in payment and in effect pay interest on a disguised loan, and justified any misappropriations on this basis. This practice was defended by some scholars, while others wanted to expose all hidden loans and equated all deposit contracts for loans. As a result, the distinction between them was obscured. Experts failed to clear up the resulting legal chaos until the end of the nineteenth century.

The authorities failed to enforce sound banking practices, and often granted banks a government license to operate with a fractional reserve, while taking advantage of easy loans to finance governments and public officials. Some rulers created government banks to reap the profits. But banks were still required to guarantee deposits.<ref name="De_Soto_Medieval">Jesús Huerta de Soto. [http://mises.org/books/desoto.pdf "Money, Bank Credit, and Economic Cycles"]. 3. Bankers in the Late Middle Ages, p. 59-69, referenced 2009-11-05.</ref>

As late as twentieth century, court decisions in Europe have upheld the demand for a 100-percent reserve requirement. In 1927, the Court of Paris convicted a banker for the crime of misappropriation for having used the funds deposited with him by a client, confirmed in 1934. After the failure of the Bank of Barcelona the Spanish Supreme Court also pronounced, that "the depositary does not acquire the right to use the deposit for his own purposes".<ref name="De_Soto_reserves" />

Fractional reserve banks never informed their depositors that some or all of their deposits would actually be loaned out and so could not possibly be ready for redemption at any time. (Even if the bank were to pay [[interest]] on deposit accounts, and hence it should have been clear that the bank must loan out deposits, this does not imply that any of the depositors actually understand this fact. Indeed, it is safe to say that few if any do, even among those who are not economic illiterates.) Nor did fractional reserve banks inform their borrowers that some or all of the credit granted to them had been created out of thin air and was subject to being recalled at any time.<ref name="Hoppe_FRB" />

===Legalization===
The landmark decisions came in Britain in the first half of the nineteenth century. In the first important case, Carr v. Carr, in 1811, the British judge, Sir William Grant, ruled that since the money paid into a bank deposit had been paid generally, and not earmarked in a sealed bag (i.e., as a "specific deposit") that the transaction had become a loan rather than a bailment. Five years later, in the key follow-up case of Devaynes v. Noble, one of the counsel argued correctly that "a banker is rather a bailee of his customer's fund than his debtor,. . . because the money in . . . [his] hands is rather a deposit than a [[debt]], and may therefore be instantly demanded and taken up." But the same Judge Grant again insisted that "money paid into a banker's becomes immediately a part of his general assets; and he is merely a debtor for the amount." In the final culminating case, Foley v. Hill and Others, decided by the House of Lords in 1848, Lord Cottenham, repeating the reasoning of the previous cases:

<blockquote>''The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted.''</blockquote>

These decisions were taken over by the American courts and so was FRB legalized. However, an interesting development occurred in grain warehouse law, which has developed in precisely the opposite direction, despite the conditions of depositing [[Fungibility|fungible]] goods were exactly the same, and grain was a general deposit and not an earmarked bundle.

In the history of the U. S. grain market, grain elevators several times fell prey to this temptation, spurred by a lack of clarity in bailment law. Grain elevators issued fake warehouse receipts in grain during the 1860s, lent them to speculators in the Chicago wheat market, and caused dislocations in wheat prices and bankruptcies in the wheat market. Only a tightening of bailment law, ensuring that any issue of fake warehouse receipts is treated as fraudulent and illegal, finally put an end to this clearly immoral practice. Fractional-reserve grain warehousing, that is, the issuing of warehouse receipts for non-existent goods, was clearly seen as a fraud.<ref name="Rothbard_FRB" />

{{See also|History of money and banking}}

==Securitization==
Known since 18th century, securitization as it is known today was created in 1970, when the Government National Mortgage Association ([[Government National Mortgage Association|Ginnie Mae]]) issued a mortgage-backed security ([[Mortgage-backed security|MBS]]) in the form of a pass through. Securitization has had an exponential growth since.

Economic actors can obtain rights to future payments of money - for instance, a car dealer that sells his cars on credit for five years in exchange of his cars. Such credits are relatively illiquid because their characteristics tend to be sector and client specific. Their owners may prefer to exchange them for an amount of money that is available now. Each of these claims can be passed to an economic actor that has the opposite preferences. Or, relatively similar claims, possibly coming from different owners, could be grouped together within a single holding entity that could then create standardized claims to be sold to investors on the financial markets. This process of putting together relatively illiquid assets and using them is called '''securitization''' - "... the process of pooling and repacking loans into securities that are then sold to investors."

Securitization allows FRBs to withdraw from the market the credit they have created and lent out. It reduces the money supply by the amount of liquid assets used to purchase the asset-backed securities. Therefore, it hides the increase in the money supply, i.e., [[inflation]]. It makes the economic environment appear less inflationary than it should be, given individuals' growing indebtedness to banks. Securitization portrays a bank-credit driven boom as noninflationary, savings driven growth. Also, securitization insulates lending activity of banks from the central bank's monetary policy. It contributes to the widespread illusion that more factors of production are available than in reality, and so becomes a factor in the generation of the boom-bust cycle.<ref name="Gertchev_Securitization">Nikolay Gertchev . [http://mises.org/daily/3820 "Securitization and Fractional-Reserve Banking"], Mises Daily,posted on Thursday, November 12, 2009, referenced 2009-11-14.</ref>

==References==
{{Reflist}}

==External links==
* [[Wikipedia:Fractional-reserve banking|Fractional-reserve banking]] on Wikipedia
* [http://mises.org/journals/jls/18_3/18_3_3.pdf "Legal Tender Laws and Fractional-Reserve Banking"](pdf) by Jörg Guido Hülsmann
* [http://mises.org/journals/scholar/shostak2.pdf Fractional Reserve banking and boom-bust cycles] by Frank Shostak
* [http://mises.org/daily/4499 The Fractional-Reserve Banking Question] by Robert P. Murphy, June 2010
* [http://mises.org/daily/4560 The Form of Saving Matters] by Robert P. Murphy, August 2010

[[Category:Banking]]
[[Category:Money]]

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Criticism of fractional reserve banking

2010-12-17T00:38:08Z

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'''Criticisms of [[fractional reserve banking]]''' have been put forward from a variety of perspectives. Critics have included economists such as [[Irving Fisher]],<ref>''100% Money'', Irving Fisher</ref> and [[Milton Friedman]].<ref>Friedman, M., A Program for Monetary Stability, New York, Fordham University Press, 1960, pp. 65</ref><ref>[http://mises.org/daily/3108 The Social Imperative of Sound Money], Lew Rockwell: "I find it sickening that there are so few voices outside the [[Austrian School]] that will stand up to this policy (of [[fiat money]]/[[fractional reserve banking]]/[[central banking]])".</ref> Within the economics profession, most criticisms are from the [[Austrian School]].<ref>[http://mises.org/media/4014 The Economics of Legal Tender Laws], [[Jorg Guido Hulsmann]] (includes detailed commentary on [[fractional reserve banking|FRB]])</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://mises.org/store/Meltdown-P557.aspx ''Meltdown''], Tom Woods, Regnery Press ISBN: 9781596985872</ref> There are also critics from outside the economics profession who advocate [[monetary reform]].<ref>[http://www.nakedcapitalism.com/2010/12/matt-stoller-end-this-fed.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29 End This Fed], Matt Stoller</ref><ref>For an example of the writings of these groups, see [http://www.bilderberg.org/monref.htm this] contribution from Bilderberg.org</ref>

==Terminology==

Critics of fractional reserve banking and the related fiat paper monetary system may refer to it by the term '''debt-based monetary system''',<ref>[http://mises.org/daily/4631 Is Our Money Based On Debt?], Robert Murphy</ref><ref name="speech">For an example of the public use of the term, see the [http://www.prosperityuk.com/prosperity/articles/earl.html speech] of the Earl of Caithness in the House of Lords on 5 March 1997</ref> or '''credit-based monetary system'''.<ref>For example of the public use of the term, see this speech given by [[Zhou Xiaochuan]], [http://www.bis.org/review/r090402c.pdf Reform the monetary system], 23 March 2009 (BIS), and this article, [http://www.nakedcapitalism.com/2009/02/steve-keen-roving-cavaliers-of-credit.html ''Roving Cavaliers of Credit''] by Steve Keen (with commentary by Yves Smith)</ref><ref>[http://globaleconomicanalysis.blogspot.com/2010/09/myths-about-whats-economically.html Myths], MISH</ref><ref>[http://globaleconomicanalysis.blogspot.com/2010/07/are-we-trending-towards-deflation-or-in.html Deflation], MISH</ref>

The term, "debt-based monetary system," and related terms, such as "debt money" are not used by conventional economists or academic [[mainstream economics|mainstream economists]]. Mainstream economists often refer to "debt money" simply as [[Credit (finance)|credit]], and distinguish clearly between types of money once it is created.<ref>For an example of the mainstream use of the term "credit" instead of "debt-money" see [http://www.ft.com/cms/s/bdfa429e-17a2-11dd-b98a-0000779fd2ac,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2Fbdfa429e-17a2-11dd-b98a-0000779fd2ac.html&_i_referer=http%3A%2F%2Fwww.ft.com%2Fhome%2Fasia this] example from the Financial Times, 1 May 2008</ref> The subject of debt-based money (as distinct from traditional monetary policy) is absent from most reputable established mainstream academic economic publications.<ref>Paul Krugman, writing at Slate.com, says the Austrian theory of business cycles is "about as worthy of serious study as the phlogiston theory of fire". http://www.slate.com/id/9593</ref>

== Typical criticisms ==

Robert H. Hemphill, credit manager of the Federal Reserve in Atlanta, stated in 1939:<ref>Preface to ''100% Money'', Irving Fisher</ref>

{{quote|If all the bank loans were paid, no one would have a bank deposit and there would not be a dollar of coin or currency in circulation. This is a staggering thought. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. When one gets a complete grasp of the picture the tragic absurdity of our hopeless position is almost incredible, but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.}}

Ron Paul states in his book ''End the Fed'':<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref>

{{quote|American presidents actually worked to implement and defend the gold standard, which put a brake on the ability of the largest banks to expand credit without limit. The gold standard worked like a regulator in this way. Ultimately, banks had to function like every other business. They could expand and make risky loans up to a point, but when faced with bankruptcy, they had nowhere they could turn. They would have to contract loans and deal with extreme financial pressures. Risk bearing is a wonderful mechanism for regulating human decision making. This created a culture of lending discipline.

In the jargon of the day, the system lacked "elasticity." That's another way of saying that banks couldn't expand money and credit as much as they wanted. They couldn't inflate without limit and count on a centralized institution to bail them out...

The banking industry has always had trouble with the idea of a free market that provides opportunities for both profits and losses. The first part, the industry likes. The second part is another issue. That is the reason for the constant drive in American history towards the centralization of money and banking, a trend that not only benefits the largest banks with the most to lose from a sound money system, but also the government, which is able to use an elastic system as an alternative form of revenue support. The coalition of government and big bankers provides the essential backbone of support for the centralization of money and credit...

Consider the Soviet case: to my knowledge, no business ever went under with the Soviet system but society in general grew ever poorer. Think of that Soviet system applied to the banking industry and you have the Fed.}}

Certain [[monetary reform]]ers claim that a fractional-reserve based banking system is inherently destructive and inevitably generates [[inflation|debasement of the currency]], [[debt slavery|extreme inequality]] or [[Austrian Business Cycle Theory|periodic crises]].<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://www.mises.org/Books/mysteryofbanking.pdf Murray Rothbard, ''The Mystery of Banking'']</ref><ref name="books.google.com">{{cite book |last= Brown |first= Ellen H. |title= Web of Debt |url= http://books.google.com/books?id=ILMGrEC524UC |accessdate= 2007-12-15 |year= 2007 |publisher= Engdahl Publishing|isbn= 0979560802 }}</ref><ref name="death"/><ref name="monetary.org">[http://www.monetary.org/lostscienceofmoney.html Stephen A. Zarlenga, ''The Lost Science of Money'' AMI (2002)]</ref><ref>[http://mises.org/story/3108 Sound Money], Lew Rockwell</ref><ref>[http://mises.org/story/1971 Our Money Madness], Lew Rockwell</ref><ref>[http://mises.org/rothbard/genuine.asp The Case for a Gold Dollar], Murray Rothbard</ref><ref name="twilight"/> Vladimir Z. Nuri has analyzed fractional reserve banking and considers it a form of economic parasitism.<ref>[http://econpapers.repec.org/paper/wpawuwpma/0203005.htm Fractional Reserve Banking as Economic Parasitism]</ref> This view is not accepted by mainstream economists.<ref>[http://www.capitalspectator.com/archives/2005/11/does_m3_matter.html Capital Spectator, "Does M3 Matter"], November 16, 2005.</ref>

Critics of fractional reserve banking frequently argue that since money creation requires ''loans'' from the banking system, people are required to go further into debt in order for any new money to be created. They theorize that this eventually causes [[Austrian Business Cycle Theory|credit cycle]]s (or [[Austrian Business Cycle Theory|business cycles]]) and necessarily debases the [[means of exchange]].

Many critics find it problematic that banks "create money out of nothing" and consider this akin to [[counterfeiting]] and/or [[embezzlement]].<ref>[http://www.dailypaul.com/node/119914 Ron Paul video - fractional reserve banking is fraudulent]</ref><ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref>

Other critics link the alleged negative effects of fractional reserve banking with central banking and a government-enforced "paper" or [[fiat currency]], which they claim allows the practice of fractional reserve banking to continue without a "natural" limitation on the growth of the [[money supply]], thereby causing inherently unsustainable "[[bubble (economics)|bubbles]]" in asset and capital markets, which are vulnerable to Ponzi-like speculation by highly leveraged [[hedge funds]] and other bank agents.<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref name="books.google.com">{{cite book |last= Brown |first= Ellen H. |title= Web of Debt |url= http://books.google.com/books?id=ILMGrEC524UC |accessdate= 2007-12-15 |year= 2007 |publisher= Third Millennium Press |location= Baton Rouge, Louisiana |isbn= 0979560802 }}</ref><ref name="death"/><ref name="monetary.org">[http://www.monetary.org/lostscienceofmoney.html Stephen A. Zarlenga, ''The Lost Science of Money'' AMI (2002)]</ref><ref>[http://mises.org/story/3108 Sound Money], Lew Rockwell</ref><ref>[http://mises.org/story/1971 Our Money Madness], Lew Rockwell</ref><ref>[http://mises.org/rothbard/genuine.asp The Case for a Gold Dollar], Murray Rothbard</ref><ref name="twilight"/>

Some critics (particularly those from the [[Austrian School]]) support a "full reserve" banking system and criticize [[fractional reserve banking]] as inherently fraudulent. [[Murray Rothbard]] held this view very strongly throughout his life.<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref>

On considering economic thinkers outside of the mainstream, it should be noted that views on the topic of fractional reserve banking vary greatly. Even within such groups as the Austrian school, at least one thinker has argued that full-reserve banking would impose similar costs of price adjustments in reaction to growth (through a ''reduction'' in the overall price level) as would [[inflation]], and hence offer no inherent advantages over fiat currencies and fractional reserve banking.<ref>[http://books.google.com/books?id=DFv6OzeBWpQC&pg=PP3&dq=steven+horwitz++banking&sig=VZasp_8pGVvpQsFKMI3W9yp4AlM#PPA231,M1 Microfoundations and Macroeconomics: An Austrian Perspective], Steven Horwitz, pp. 223-232.</ref>

==Basic debate==

Many Austrian economists and monetary reformers focus on the combined use of [[fiat currency]], [[fractional-reserve banking]] and [[central banking]] as a negative feature of modern monetary systems.<ref>[http://mises.org/media/4014 The Economics of Legal Tender Laws], [[Jorg Guido Hulsmann]]</ref><ref>[http://mises.org/store/Meltdown-P557.aspx ''Meltdown''], Tom Woods, Regnery Press ISBN: 9781596985872</ref> These commentators use the term "debt-based monetary system" to refer to an economic system where [[money]] is created primarily through fractional-reserve banking techniques, using the banking system.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref><ref>[http://mises.org/daily/4631 Is Our Money Based On Debt?], Robert Murphy</ref><ref name="speech"/> This form of money is called "debt-based" because as a ''condition of its creation'' someone must go into debt in order for the money to be created and it must be paid back plus interest at some time in the future.

To some commentators, this implies that as the [[money supply]] and the economy grows, the general populace becomes increasingly indebted at the same time due to the idea that debt grows in parallel with money supply growth, and increasing interest payments (from either taxpayers or indebted consumers) are needed to pay bondholders as the money supply grows.<ref name="death">{{cite book |last= Rowbotham |first= Michael |title= The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics | year= 1998 |publisher= Jon Carpenter Publishing |isbn= 9781897766408 }}</ref><ref name="twilight">[http://www.marketoracle.co.uk/Article4489.html Antal E. Fekete, The Twilight of Irredeemable Debt]</ref><ref name="The Forgotten War">[http://news.goldseek.com/GoldSeek/1192819378.php The Forgotten War]</ref>

One argument posits that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. To some, this implies that debt must grow exponentially in order for the monetary system to remain solvent.<ref name="death"/><ref name="twilight"/>

Others argue that there is in fact no mathematical necessity for the stock of money in a debt-based system to grow, as the "turnover" or "flow" or "velocity" of money can increase to allow for compounding interest payments.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref><ref>[http://www.debtdeflation.com/blogs/2010/10/08/ami-talks-in-flv-format/ AMI Conference 2010], Steve Keen</ref><ref>[http://www.debtdeflation.com/blogs/2010/11/05/solving-the-paradox-of-monetary-profits-2/ Solving the Paradox of Monetary Profits], Steve Keen</ref> However this does imply that some consumers would increasingly have to consume and transact to expand the GDP sufficiently to allow the fixed stock of money to turnover sufficiently to pay for the interest compounding on top of the debt.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref><ref>[http://www.debtdeflation.com/blogs/2010/10/08/ami-talks-in-flv-format/ AMI Conference 2010], Steve Keen</ref><ref>[http://www.debtdeflation.com/blogs/2010/11/05/solving-the-paradox-of-monetary-profits-2/ Solving the Paradox of Monetary Profits], Steve Keen</ref> This may mean that Ponzi-like dynamics bubble up in "pockets" of the economy with interest payments being allowed in a fixed money economy, but these "pockets" of higher consumption or speculation would pop and die out relatively quickly.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref>

==Basic nature of system==

The economic, environmental and social effects arising from money creation through fractional-reserve banking has been subject to much heated political debate for well over two centuries.<ref name="books.google.com"/><ref name="death"/><ref name="twilight"/><ref>[http://www.silverbearcafe.com/private/fracbank.html Antal E. Fekete, Fractional Reserve Banking Revisited]</ref>

Critics claim that, in contrast to "debt money" (which is money created in parallel with the issuance of debt or [[Credit (finance)|credit]]), "true" fiat currency is issued by the [[Treasury]] of a [[central government]] debt-free, as no requirement for its eventual return is made as a condition of its creation.<ref name="monetary.org"/><ref name="The Forgotten War"/> Government-issued debt-free fiat currency (such as debt-free notes and coins) can circulate perpetually in the economy as "stable" or even [[sound money]] (if backed by [[gold]] or [[silver]]) and although not as stable as [[hard currency]], government-issued debt-free notes and coins (such as [[United States Note]]s and [[silver certificate]]s) do not have the same effects of debt-based money described below.<ref>[http://www.entrewave.com/freebooks/docs/a_pdfs/gnhm.pdf Honest Money]</ref> It should be noted however that fiat currency can be a source of [[hyperinflation]] if its production is not controlled, as the government has the potential to issue unlimited amounts of fiat currency - ''provided'' it is accepted as "money" by the [[private bank]]ing system.<ref>[http://mises.org/books/shorthistorypapermoney.pdf A Short History of Paper Money in the United States], William M. Gouge, Mises Institute</ref> Notes and coins in circulation (being defined as [[M0]]) now account for a tiny fraction of the total M3 [[money supply]] in all developed, debt-based [[capitalism|capitalist]] economies (M0 generally being less than 10% of the total [[M2 (economics)|M2]] money supply in most developed economies).<ref>[http://www.dollardaze.org/blog/?post_id=00216 Global Money Supply Ratios]</ref>

Similarly, gold, silver and other [[precious metals]] have in the past been used as money. Because of the difficulty in increasing the supply of precious metals quickly, some [[monetary reform]]ers believe a return to the [[gold standard]], or a similar system of "hard" or "real" asset-backed currency, is the only way to stabilize the growth of the money supply. These monetary reformers often refer to the gold standard and [[silver standard]] as "sound money" or "honest money".<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref>

==Other economic and political criticisms==

In a 2003 statement to the U.S. House of Representatives, Ron Paul stated "if unchecked, the economic and political chaos that comes from currency destruction inevitably leads to tyranny".<ref name="house.gov">[http://www.house.gov/paul/congrec/congrec2003/cr090503.htm Paper Ron Paul, Paper Money and Tyranny, Speech in U.S. House of Representative, September 5, 2003]</ref>

Some economic thinkers (primarily members of the [[Austrian School]]) and political commentators believe that a debt-based monetary system amounts to a subtle form of monetary "[[fraud]]" in that it creates money "costlessly" through the use of [[fractional-reserve banking]] techniques.<ref>[http://www.mises.org/rothbard/moneyback.asp Taking Money Back, by Murray Rothbard]</ref>

Though [[Michael Rowbotham]] has no formal training in political science or economics, he is an active proponent of [[monetary reform]], and argues that this system of [[money supply]] is perverse and inherently "anti-[[democratic]]", and creates inflationary [[exponential growth]] in the economy which leads to [[Natural environment|environment]]ally damaging and unstable [[over-consumption]]. Critics such as Rowbotham argue that the indebted are forced to induce new [[consumers]] to spend their way into debt so existing loans can be repaid with new debt-created money. Failure to achieve this goal results in [[foreclosure]] for those businesses and [[insolvency]] in the banking system that leads to economic collapse due to the sudden contraction of the money supply.<ref name="death"/><ref name="Ponzi Nation">[http://www.iimagazine.com/article.aspx?articleID=1234345 Ponzi Nation]</ref>

Mark Anielski as well as some political thinkers such as Rowbotham and some economists (such as [[Hyman Minsky]]) argue that this system of money supply has characteristics similar to a [[pyramid scheme]], where the newly indebted are compelled to induce others into debt to pay off their own debts.<ref>[http://www.lin.ca/resource/html/arpa02/PC1-FertileObfuscation.pdf ''Fertile Obfuscation: Making Money Whilst Eroding Living Capital''], 34th Annual Conference of the Canadian Economics Association, Mark Anielski</ref> It is therefore argued by a number of monetary reformers that fractional-reserve banking and the associated exponential growth of money in the economy "forces" the economy towards indebted [[consumerism]].<ref name="books.google.com"/>

Rowbotham argues that a major negative side-effect of the debt-based monetary system is its effect on [[agriculture]], claiming that [[residential development]] produces one of the greatest continuous injections of debt money into the economy. Therefore, significant super-normal profits can be generated by re-zoning agricultural land and replacing it with low-density [[House|housing]].<ref name="death"/>
If this is correct, this trend will lead to the destruction of fertile [[arable land]], as this land is progressively re-zoned for speculative new residential development. Rowbotham also predicts that the global supply of fertile [[arable land]] will decline, leading to a broad decline in the quality and nutritional value of agricultural produce and, eventually, a dramatic increase in the prices of many "soft" commodities - which could then lead to actual food shortages for poorer segments of the world population.<ref name="death"/><ref>[http://www.wsws.org/articles/2007/dec2007/food-d22.shtml Naomi Spencer, World Socialist Website, "Severe food shortages, price spikes threaten world population", 22 December 2007]</ref>

If for any reason the monetary system broke down, urban populations (nominally "rich" but poor in terms of direct access to [[food supply]]) could find basic foodstuffs increasingly expensive, ultimately resulting in food security becoming a major public policy issue.<ref name="death"/><ref>[http://www.wsws.org/articles/2007/dec2007/food-d22.shtml Severe food shortages, price spikes threaten world population]</ref>

===Effects on economic health===

According to Michael Rowbotham the expansion of money through debt creates [[Boom and bust|economic bubbles]]. This concentrates [[wealth]] in the hands of private banks as the populace is forced into [[debt]] simply to own a home and educate their children.<ref name="death"/> Debt expansion leads to price appreciation of assets through speculation as the financial market becomes riskier. Edward Chancellor compares this type of market to a monetary [[Ponzi scheme]].<ref>[http://www.iimagazine.com/article.aspx?articleID=1234345 Ponzi Nation,"Who is Hyman Minsky?", para 6]</ref>

The bust phase of this [[business cycle]] where "debt-based" money growth slows or contracts catches newly indebted businesses and consumers who are left out of the growth cycle.<ref name="death"/><ref name="Ponzi Nation"/>

===Effects on the environment===
There are also critics in the left-wing and [[environmentalist]] camps who contend fractional reserve banking (by creating a necessity for indefinite [[economic growth]]) leads to environmental destruction and depletion of natural resources.<ref>David Korten, ''Agenda For A New Economy'', Berret-Koehler, 2009</ref><ref>[http://www.monbiot.com/archives/2004/10/06/no-longer-obeying-orders/ George Monbiot], about five sixths of the way down</ref>

===Inherent problems with the system===

Some monetary reformers predict that there will be an increased incidence of financial crises in the developed world, as economic and [[population growth]] inevitably slow and as the success of [[laissez-faire]] economic political policies result in a reduction in redistributive [[tax]] policies which, combined with the debt-legacy of the [[welfare state]], allows an intense and unsustainable concentration of wealth and political power in the financial services sector.<ref name="death">{{cite book |last= Rowbotham |first= Michael |title= The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics | year= 1998 |publisher= Jon Carpenter Publishing |isbn= 9781897766408 }}</ref>

Some monetary reformers argue that perverse incentives in the financial services industry lead to a collusive relationship between governments and bankers which are economically and socially destablizing in the long run.<ref>[http://mises.org/media/4014 The Economics of Legal Tender Laws], Jorg Guido Hulsmann</ref>

Some monetary reformers argue that it is vital that the indebted "victims" who must sink deeper into debt for the system to survive do so voluntarily and willingly and are not made aware of the consequences of purchasing consumables with debt money.<ref name="death">{{cite book |last= Rowbotham |first= Michael |title= The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics | year= 1998 |publisher= Jon Carpenter Publishing |isbn= 9781897766408 }}</ref> Some politicians and others have highlighted the fact that mainstream media organizations appear to downplay or minimize the seriousness of deficit spending by government and debt-sourced spending of all kinds.<ref>[http://www.senate.gov/~budget/democratic/statements/2005/fs_reconciliationfloorstmt102005.pdf Speech by Senator Kent Conrad (D-ND) on October 20, 2005 regarding the "misleading" reporting of deficit spending by the mainstream media]</ref> The associated growth of derivatives during the upward phase of the debt money cycle was referred to as "[[innovation]]" in financial markets.<ref>[http://www.nytimes.com/2007/12/03/opinion/03krugman.html?em&ex=1196917200&en=ac60abcdbd977d07&ei=5087%0A Innovating Our Way to Financial Crisis, by Paul Krugman]</ref>

[[Bankruptcy]] laws differ to a small degree in different jurisdictions but in all developed economies unpaid debt results in legal penalties, property confiscation on behalf of the creditor and income [[sequestration]]. Although in [[Christian]], [[Jewish]] and [[Muslim]] religious practice there have been traditions of [[debt relief]] or laws against [[usury]], in no modern Western jurisdiction are any debts periodically forgiven or cancelled in recognition of the inherent impossibility of repaying debts in circumstances where the debt-based monetary cycle has inevitably resulted in too little new [[debt money]] being injected into the [[money supply]] to pay for the currently outstanding debts.<ref>[http://www.nakedcapitalism.com/2007/11/new-bankruptcy-law-backfires-by.html Bankruptcy law backfires]</ref>

On a national level, if the issuance of [[government bonds]] becomes unsustainable, sovereign [[bankruptcy]] can occur - and has occurred many times in history.<ref>[http://mises.org/daily/4869 Can the Fed Become Insolvent?], Robert Murphy</ref><ref>[http://elainemeinelsupkis.typepad.com/money_matters/2007/10/greenspaniel-an.html Greenspaniel and U.S. bankruptcy]</ref> [[Sovereign debt]] crises due to the inability of nations to pay interest on [[government bonds]] have occurred frequently and regularly in the [[third world]] and less frequently (every 30 years or so) in the first world as a result of high levels of unsustainable public debt - often because private debts are assumed by a corrupt government through large private bank bailouts.<ref>[http://www.dailymail.co.uk/debate/article-1331076/Ireland-bailout-Lets-frank-7bn-bunch-liars-crooks-bunglers.html Ireland Bailout], Alex Brummer</ref><ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref> The [[Latin American debt crisis]] is an example of sovereign debt levels becoming unsustainable, resulting in a [[currency crisis]] and economic collapse, as [[interest rates]] rise precipitously due to the inability of the national government to attract financiers to purchase new [[government bonds]] to inject new [[debt money]] into the ailing economy.<ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref>

At such times, it is the responsibility of the [[IMF]] to come in as a kind of supranational [[central bank]] to mediate between the national government and international financiers. The role of the [[IMF]] as [[central bank]] to the world has similar responsibilities and risks inherent in [[central bank]]ing which are described below in relation to the role of the [[Federal Reserve]]. If the [[IMF]] repeatedly intervenes to save financiers from loss when sovereign bankruptcy occurs, this has a tendency to induce [[moral hazard]] and can encourage the financing of reckless government spending and borrowing.<ref>[http://www.rgemonitor.com/41 IMF Reform and International Lender of Last Resort, RGE Monitor</ref><ref>[http://info.interactivist.net/article.pl?sid=02/11/07/199213&mode=thread&tid=8 Banking Bunkum, by Henry C.K. Liu]</ref><ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref>

A [[single currency]] regime such as the [[Euro]] can mask national liquidity or solvency crises, by ensuring that a national currency is not quickly exchangeable for another, thereby restricting the ability of national governments to depreciate their currencies and cutting off the possibility that the real value of [[government bond]] interest repayments could decline relative to other currencies.<ref>[http://www.dailymail.co.uk/news/article-1316442/Anglo-Irish-Bank-bail-Will-Irish-economic-meltdown-hit-UKs-fragile-recovery.html Irish Meltdown], UK Mail On-line,</ref><ref>[http://www.marketoracle.co.uk/Article24459.html Ireland Bailout Consequences for Britain, Portugal Next?], Nadeem Walayat</ref><ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref><ref>[http://news.goldseek.com/RichardDaughty/1192374060.php The Mogambo Theory of Currency Relativity]</ref><ref>[http://www.youtube.com/watch?v=IvJEJEGzeU8&feature=player_embedded#! Putin ditches dollar], RTTV</ref> This may however increase the risk of bond default where indebted national governments cannot pay back the interest payments in the denominated common currency.<ref>[http://www.dailymail.co.uk/news/article-1316442/Anglo-Irish-Bank-bail-Will-Irish-economic-meltdown-hit-UKs-fragile-recovery.html Irish Meltdown], UK Mail On-line,</ref>

===Types of downturns===
{{main|Austrian Business Cycle Theory}}

There are two main kinds of debt money contraction that can cause a collapse in the value of inflated assets.

A "credit squeeze" occurs where new debt money is difficult to access without a high [[credit rating]]. At such times marginal borrowers, or those who have borrowed at the end of any debt-induced asset bubble, get "squeezed" out of further borrowing and a contraction in the growth of new debt money occurs, triggering a slow down in the growth of inflated assets. Those assets can then be "harvested" by the [[private bank]]s through widespread [[foreclosure]] or [[bankruptcy]] and re-sold to those with the money to buy the distressed assets.<ref name="marketoracle.co.uk">[http://www.marketoracle.co.uk/Article2882.html Market Fundamentalism, by Richard C. Cook]</ref>

A "credit crunch" occurs where new debt money is not available at any [[interest rate]] - even for those with previously acceptable credit ratings - due to widespread insolvency in the banking system. At such times, it is the banking system itself that is [[insolvent]] and other financial institutions (including overseas financiers) become reluctant to lend to the domestic banking system, resulting in the domestic banking system being unable to issue loans even to credit worthy borrowers.<ref>[http://www.scribd.com/doc/3906112/Credit-CrunchThe-New-Financial-Snack Credit Crunch, by Satyajit Das]</ref>

At any stage during the downward spiral of a "credit crunch", the [[central bank]] in a modern economy can try to save the system from complete economic [[meltdown]] by purchasing (either indefinitely or temporarily) the failed debts of the private banks.<ref>[http://www.youtube.com/watch?v=PTUY16CkS-k&feature=player_embedded#! Quantitative Easing Explained]</ref><ref>[http://www.marketoracle.co.uk/Article24489.html Does the Fed Create Money?] Michael Pento</ref><ref>[http://www.telegraph.co.uk/money/main.jhtml?view=DETAILS&grid=A1YourView&xml=/money/2007/12/19/ccom119.xml ECB's mind-numbing cash injection]</ref> However, doing so results in cash being transferred to the private banks in exchange for [[bad debt]], thereby violating the general economic precept to avoid [[moral hazard]] and effectively makes liquid the failed lending decisions of the [[private bank]]s.<ref>[http://www.rgemonitor.com/blog/roubini/228924/ Privitizing Profits and Socializing Losses, by Nouriel Roubini]</ref> In the U.S. banking system this is called "opening the Fed discount window", where the [[Federal Reserve]] temporarily purchases the failed investment portfolios of distressed private banks in exchange for cash. However, this rescue measure may only delay, rather than avoid, the realization of losses in the banking system, as the central bank cannot "force" new borrowing into the system to inject new debt money into the money supply. Somebody has to be a [[counterparty]] to borrow the debt money that is being offered. If all market participants realize a "[[bubble (economics)|bubble]]" has formed in assets markets, there will be few (or no) buyers for new debt money, as no one wants to borrow to buy inflated assets no one else will buy. Money markets can therefore remain illiquid even with intense [[central bank]] support.

Furthermore, banks can go bust even with intense central bank support, if the issue is not one of liquidity, but one of solvency.<ref>[http://www.ft.com/cms/s/0/233ae764-abef-11dc-82f0-0000779fd2ac.html Central Banks have No Plan]</ref><ref>[http://www.rgemonitor.com/blog/roubini/233120 Central Banks get desperate]</ref>

===Pushing on a string===
Some monetary economists describe the opening of the Fed discount window after the bursting of an asset bubble as "[[pushing on a string|pushing on a piece of string]]", as this measure does not solve the key problem – creating new credit (or debt money) to keep up the growth in the money supply and maintain the required level of liquidity in credit markets.<ref>[http://www.mises.org/story/2695 Don't Discount the Fed Discount Window]</ref><ref>[http://www.federalreserve.gov/Pubs/FEDS/2004/200401/200401pap.pdf Monetary Policy in Deflation: The Liquidity Trap in History and Practice]</ref> This is because unlimited central bank money and low interest rates ''allow'' credit creation, but do not ''force'' it into the system. In order for any new debt money to be created, somone has to borrow the excess reserve in order for the money to be injected into the system. If corporations and individuals are already heavily indebted, there are no credit-worthy borrowers to lend to.

To encourage fresh borrowing, central banks generally combine these rescue measures with an interest rate cut to encourage more new borrowing to allow the existing (failed) debts to be [[liquidate]]d at or close to their original value. When [[Alan Greenspan]] repeatedly resorted to this tactic to revive illiquid [[money market]]s this became known in the market as the "[[Greenspan put]]", as the effect of these repeated reductions in interest rates was similar to a [[put option]] in the [[stockmarket]], insuring [[bank]]s' lending mistakes would be covered up by the Federal Reserve.<ref>[http://www.iie.com/publications/wp/02-1.pdf Moral Hazard and the "Greenspan Put"]</ref>

When interest rates cannot go any lower (the so-called "zero bound" monetary problem) and people still will not - or cannot - inject themselves with more debt, then the Keynesian solution is to run large public deficits and indebt future generations (who, they hypothesize, are more likely to be able to pay through increased future growth). Keynesian economists such as Paul Krugman argue that governments must take charge of the responsibility of spending more (and taking on more debt) on behalf of the public (who are too fearful to take on more debt themselves) in order to compensate for the immediate and urgent ''present'' insufficiency in total private consumption. Paul Krugman is a prominent advocate of the policy of spending trillions of government money to help stimulate the economy, if spending billions does not work.<ref>[http://www.nytimes.com/2010/06/21/opinion/21krugman.html?dbk Budget Deficits], Paul Krugman</ref><ref>[http://globaleconomicanalysis.blogspot.com/2010/10/krugman-and-inevitable-i-told-you-so.html Krugman], MISH</ref><ref>[http://krugman-in-wonderland.blogspot.com/2010/11/inflation-prisoner.html The Inflation Prisoner], William Anderson</ref> For economists such as Paul Krugman, if the "more government spending and increase public debt solution" does not work initially, it is a sign that not enough government money has been spent.<ref>[http://globaleconomicanalysis.blogspot.com/2010/10/krugman-and-inevitable-i-told-you-so.html Krugman], MISH</ref> It is his view that the Japanese recession from 1991/2 could have been cured by the Japanese government going into even more debt than the current net debt to GDP ratio of 110%.<ref>[http://www.nytimes.com/2010/06/21/opinion/21krugman.html?dbk Budget Deficits], Paul Krugman</ref><ref>[http://www.economist.com/node/15867844 Japan's debt-ridden economy], The Economist</ref>

Although there is active debate as to whether this policy of indebting future generations by the government spending even more money would actually help the economy,<ref>[http://krugman-in-wonderland.blogspot.com/2010/11/inflation-prisoner.html The Inflation Prisoner], William Anderson</ref> there is no argument that this would undoubtedly help the present group of private bankers, as increased income from the interest payments on new government bond issuance offsets the decline in private sector debt and allows private bankers to survive when otherwise they may face collapse due to the fatal impairment of their balance sheets through private debt write-offs after an unsustainable debt-fuelled bubble bursts.<ref>[http://georgewashington2.blogspot.com/2010/08/quantitative-easing-wont-help-economy.html QE won't help the economy]</ref><ref>[http://moneymorning.com/2010/11/19/federal-reserves-quantitative-easing-strategy-save-the-us-economy/ QE won't save the economy]</ref>

===Inequities in system===

Aside from the [[moral hazard]] issue, the key risk with [[quantitative easing]] (and the associated cutting of [[interest rate]]s to encourage new debt money creation) is that the [[central bank]] exposes the financial system to a [[currency crisis]], as the growth in the [[money supply]] spirals out of control due to the need to save the [[bank]]s from themselves.<ref>[http://www.swlearning.com/economics/hall/hall-lieb2e-upd/ppt_lecture/exchange_rate_macro_policy.ppt Exchange Rates and Macroeconomic Policy]</ref><ref>[http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6VGT-41WBFRG-1&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=4e89075114dcdb58b503172ff1801bd2 Central Bank Intervention]</ref><ref>[http://www.federalreserve.gov/newsevents/speech/mishkin20071026a.htm Financial Instability and the Federal Reserve as a Liquidity Provider, by Frederic S. Mishkin]</ref>

For these reasons, a collapse in confidence in the [[solvency]] of the banking system is one of the most complex and difficult policy issues any [[government]] can face.

In such crises of confidence, a central bank may choose to save the current players in the banking sector by printing money and inflating its way out of the crisis, thereby debasing the value of the domestic [[currency]].<ref>[http://mises.org/daily/4869 Can the Fed Become Insolvent?], Robert Murphy</ref> This is now called [[quantitative easing]].<ref>[http://blog.mises.org/14626/quantitative-easing-explained/ Quantitative Easing Explained], YouTube video</ref>

This is also referred to by some [[monetary reform]]ers and [[economist]]s as "[[socialism for the rich and capitalism for the poor]]", as many indebted [[consumers]] will still lose their [[house]]s and be declared [[bankrupt]] regardless whether or not the central bank intervenes to save marginal lenders who have been made [[insolvent]] through their mis-timing of the [[credit cycle]].<ref>[http://www.rgemonitor.com/blog/roubini/228924/ Privatizing Profits and Socializing Losses, by Nouriel Roubini]</ref><ref>[http://www.beearly.com/pdfFiles/Satyajit%20Das.pdf Regulatory Debauchery by Satyajit Das]</ref> Future generations of innocent taxpayers may ultimately finance any [[bail out]] of reckless lenders, as the money used to fund any [[bail out]] will be funds diverted from the general revenue of the central government.<ref>[http://www.ft.com/cms/s/0/f4cf8426-654d-11dc-bf89-0000779fd2ac.html A run on the bank]</ref>

Some bankers and financial commentators still refer to [[Walter Bagehot]]'s 1873 commentary on monetary crises, ''Lombard Street'', in an attempt to gain insights into the way in which central bankers should revive illiquid banking systems.<ref>[http://blogs.ft.com/economistsforum/2010/04/a-history-lesson-from-lombard-street-for-wall-street-in-2010/ History Lesson from Lombard Street], Roger Farmer, Ft.com</ref>

A prime example of the fatal effects of combining aging demographics with reckless bank lending can be found in the case of the [[Japanese asset price bubble]].<ref>[http://www.economist.com/displaystory.cfm?story_id=10286992 The Japanese and American Bubbles: Been There, Done Some of That]</ref>

===Potential societal impact===

Some more extreme monetary reformers and [[conspiracy theorists]] anticipate the declaration of [[martial law]] and the imposition of [[fascist]]-style restrictions on [[civil rights]] and [[freedom of speech]] by the political [[The Establishment|Establishment]] to physically protect it from [[anarchy]] or military [[coup]] when the [[bubble (economics)|bubble]] of debt completely bursts, either through a precipitous currency crisis or debt-created [[Depression (economics)|depression]].<ref>[http://www.house.gov/paul/congrec/congrec2007/cr120507h.htm New security legislation threats freedoms]</ref> Some conspiracy theorists also anticipate the forced elimination - by any means necessary - of any actual or potential competing [[currencies]] that could threaten the viability or legitimacy of the [[monopoly]] currency, which could include the compulsory confiscation of all privately-owned [[gold]] (gold being the ultimate reserve currency, still used by central banks as a universally accepted medium of exchange for the settlement of international debts).<ref>[http://blog.mises.org/14795/the-gold-clause-cases-and-constitutional-necessity/ Gold Clause Cases]</ref><ref>[http://news.goldseek.com/GoldSeek/1196605589.php America's Trade Debts Lead to a Likely Gold Confiscation]</ref><ref>[http://www.libertydollar.org/ld/legal/raid.htm FBI Raids Liberty Dollar]</ref><ref>[http://www.lewrockwell.com/rothbard/solution.html The Solution]</ref><ref>[http://prudentinvestor.blogspot.com/2007/09/us-mint-suspends-gold-coin-sales-due-to.html US Mint Suspends Gold Coin Sales]</ref><ref>[http://www.swissamerica.com/article.php?art=06-2004/200406140537f.txt Why a Gold Standard Now?]</ref>

There have been many [[financial crisis|monetary crises]] throughout history<ref>[http://mises.org/store/Early-Speculative-Bubbles-P578.aspx Early Speculative Bubbles and Increases in the Money Supply], Doug French, Mises Institute ISBN: 978-1-933550-44-2</ref> and prior to widespread anarchy or [[revolution]], in the late stages of a [[financial bubble]], there are a number of warning signs of impending [[chaos]] caused by a complete breakdown of trust in the debt-based [[monetary system]].<ref>[http://mises.org/store/Product.aspx?ProductId=435 Fiat Money Inflation in France], Andrew Dickson White, Mises Institute</ref> Just prior to the complete collapse of the [[pyramid scheme]] of public and private debt, the economic system tends to feed on itself, and in the past, where debt-created [[Depression (economics)|depression]]s or periods of [[hyperinflation]] have occurred in [[Europe]], the [[U.S.]] and [[China]], there has been a sustained spike in predatory economic behavior, as the heavily indebted central government and producers are forced to find more extreme (previously considered unethical) methods to extract any remaining wealth from increasingly desperate and impoverished [[consumers]], who are either unwilling or unable to go into further debt without forceful coercion.<ref name="http">{{cite book |last= Widdig |first= Bernd |title= Culture and Inflation in Weimar Germany |url= http://books.google.com/books/ucpress?id=kvKAATycUzIC |accessdate= 2007-12-16 |year= 2001 |publisher= University of California
Press |isbn= 0520222903 }}</ref><ref>[http://mises.org/daily/3569 John Law and the Invention of Modern Finance], Doug French (Mises.org)</ref><ref>[http://mises.org/daily/1690 The Saga of John Law and Richard Cantillon], Sean Corrigan (Mises.org)</ref> [[Long-term]] investment and sustained [[capital investment]] are almost impossible in this environment because the "measuring stick" of [[return on investment]] (the real value of [[money]]) is so uncertain at times of debt-induced [[credit crunch]], depression or hyperinflation.

As potential new [[borrower]]s and international financiers are scared away from participating in the [[pyramid scheme]] of debt and borrowing further, the [[monetary system]] seizes up, starved of the fresh injections of [[debt money]] it needs for its survival, thereby precipitating economic [[anarchy]], widespread [[lawlessness]] and [[insolvency]] of the monetary and banking system.<ref>[http://www.oftwominds.com/blognov07/empire-debt1.html Empire of Debt]</ref><ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref>

This final denouement is triggered when [[borrower]]s cannot be found to buy depreciating heavily indebted assets, and international financiers reduce lending as they experience losses on pre-existing loans either through asset or currency [[depreciation]]. Some analysts predict that the [[monetary system]] will seize up due to a [[deflationary]] depression or a sustained period of [[stagflation]]ary hyperinflation resulting in a "final and total catastrophe of our fiat monetary system."<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref>

This has often occurred after a failed [[aggressive war]], as international financiers realize the heavily indebted [[government]] they funded will not gain the [[resources]] it planned to seize as a result of the waging of [[aggressive war]]. When this pay-off does not materialize, the government is left with the [[debt]] of war without the ability to offset this [[government debt]] through the imposition of [[reparations]] on the defeated [[nation]] and the acquisition of the defeated state's [[resources]]. This occurred to [[Germany]] after the [[First World War]] and [[Japan]] after the [[Second World War]].

Whatever the trigger, the key warning sign of any impending monetary crisis and economic [[anarchy]] is a sudden [[currency crisis]].<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref> Early warning signs that the [[private banks]] themselves are aware of an impending breakdown in the [[solvency]] of the [[financial system]] would be: a spike in the prices for [[oil]] (which is an internationally accepted, inherently limited, store of value, and therefore can act as a modern form of [[hard currency]], oil sometimes being referred to as "black gold"), [[gold]], [[silver]] and other stable, non-perishable, inherently limited [[natural resources]] essential for non-discretionary industrial production; a spike in the [[futures contract]]s for vital agricultural [[commodities]] such as [[sugar]],<ref>[http://www.bloomberg.com/news/2010-12-15/portugal-tries-to-prevent-sugar-hoarding-amid-shortage-ft-says.html 2010 Portugal Sugar Crisis]</ref> [[coffee]], [[wheat]], [[soybean]]s and [[rice]], as investors realize the debt-based monetary system has squeezed supplies of [[arable land]]; a sudden flight of money ''to'' [[Treasury bills]] and/or a sudden spike in the [[interest rate]] differential between short-term [[Treasury bills]] and asset-backed corporate paper (or a sudden spike in the [[LIBOR]] rate in [[London]])<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref><ref>[http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/12/03/cnrates103.xml&CMP=ILC-mostviewedbox Pleas for rate cut as interbank loans dive]</ref> - and, in the very late stages of a credit crisis, a sudden flight of money ''away from'' [[Treasury bills]] and a collapse in government bond prices, as governments ultimately find it ''impossible'' to pay interest on their debt from coercively acquired taxes.<ref>[http://www.telegraph.co.uk/finance/economics/8190059/Global-bond-rout-deepens-on-US-fiscal-worries.html Global bond rout], Ambrose Evans-Pritchard, UK Telegraph</ref>

Shortly thereafter, some [[monetary reform]]ers predict that there would be desperate, but ultimately futile [[central bank]] intervention, a [[currency crisis]], a panic run on a number of marginal, [[insolvent]] [[banks]] and [[hedge funds]] as desperate wealthy investors try to get [[cash]] out before the [[pyramid scheme]] collapses to invest in inherently limited, non-perishable, in-demand commodities such as [[oil]] and [[gold]] (and undeveloped agricultural and industrial [[land]] in areas of the world with strong [[economic growth]]), followed by a [[recession]] or [[depression]] in the broader heavily indebted economy as the [[money supply]] contracts.<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref><ref>[http://www.newyorkfed.org/research/staff_reports/sr291.pdf Hedge Funds, Financial Intermediation and Systemic Risk]</ref>

In 2010 Ireland and Greece experienced simiilar financial crises along the lines described above and many financial commentators and politicians expect more countries to go through the same debt crisis.<ref>[http://globaleconomicanalysis.blogspot.com/2010/12/video-fire-bombs-stones-fly-in-greek.html Greek protests]</ref><ref>[http://www.youtube.com/watch?v=2gm9q8uabTs "Who the Hell do you think you people are?"], Nigel Farage, UKIP leader</ref>

===Potential solutions===
Although time is the only real remedy for monetary crises (allowing re-inflation of the markets through the gradual injection of new [[debt money]] into the system through new borrowings), time is something panicked financiers and investors are least likely to want to give up when the threat is never getting their [[money]] out of the imploding investment [[bubble]]. In extreme cases [[bank]]s could set up "independent" corporate investment vehicles to buy the assets associated with the [[bad debt]],<ref>[http://www.dealbreaker.com/2007/10/citigroup_looks_to_lend_money.php Citigroup looks to lend money]</ref> thereby allowing [[borrower]]s to liquidate their investments and allow time for the markets to re-inflate. Alternatively, these "sour" loans, that have gone bad through too much debt overwhelming the markets, could be dumped or "hidden" on the central bank's balance sheet, and swapped for more secure government debt (financed through compulsorily acquired taxes, which is immune from the risk of private bankruptcy). However the holding costs involved in these measures would be extremely high and would not guarantee that the losses could be averted if no new gullible investors could be found to offload these distressed assets.<ref>[http://www.youtube.com/watch?v=n8w6Nx2rfiE A Wikileaks for the Fed?]</ref> More fundamentally, these short-term "parachutes" used after bubbles burst do not save ordinary borrowers from [[foreclosure]] and [[bankruptcy]], nor do they address the pernicious long-term dysfunctional aspects of [[fractional reserve banking]] described above. These problems are temporarily averted, only to be dealt with yet again by the next generation of indebted governments and peoples.<ref>[http://www.informationclearinghouse.info/article18431.htm The Era of Global Financial Instability, by Mike Whitney]</ref><ref>[http://www.youtube.com/watch?v=n8w6Nx2rfiE A Wikileaks for the Fed?]</ref>

Given these repeated financial crises arising from the debt-based monetary system, many [[monetary reform]]ers predict that there will inevitably be a return to the [[gold standard]], a fundamental change in the way money is produced and distributed (with a return to the prevalence of government-issued debt-free [[fiat currency]] and/or [[free banking]]) - or a complete financial "[[meltdown]]" as fewer young people in developed economies can be found who are willing to go into debt in sufficient magnitude to pay off the debts that have already been accumulated.<ref>[http://www.goldensextant.com/SavingtheSystem.html Saving the System, by Robert K. Landis]</ref> As extreme inequality increases, [[foreclosure]]s mount and financial crises repeatedly erupt, these [[monetary reform]]ers believe a political crisis will eventually result in calls for fundamental [[monetary reform]].

These on-going, worsening, [[debt]]-created crises in the economy and society (and the unsustainable damage to the [[environment]] caused by debt-created [[overconsumption]]) could turn monetary and economic policies either to the extreme left or to the extreme right, as there are a number of competing solutions to the debt-based monetary "problem".

===Proposals for monetary reform===
====Libertarians and commodity money====

[[Libertarians]] envision a society of [[free markets]], [[small government]]<ref>[http://www.prudentbear.com/index.php/thebearslairview?art_id=10473 Models of Capitalism], Michael Hutchinson</ref> and money backed by a [[gold standard]] or [[silver standard]].<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref><ref>[http://www.prudentbear.com/index.php/thebearslairview?art_id=10471 Gold Standard Renaissance?]</ref><ref>[http://www.marketoracle.co.uk/Article24632.html The Gold Standard Never Dies], [[Lew Rockwell]]</ref><ref>[http://www.prudentbear.com/index.php/thebearslairview?art_id=10471 Gold Standard], Michael Hutchinson</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://radio.goldseek.com/griffin04.10.10.php Goldseek interview] with [[G. Edward Griffin]]</ref><ref>See also these [[Murray Rothbard]] articles: [http://www.mises.org/money.asp What Has Government Done to Our Money?], [http://www.mises.org/story/1829 The Case for the 100% Gold Dollar]; [http://www.lewrockwell.com/rothbard/cartelization.pdf The Fed as Cartel], [http://www.lewrockwell.com/rothbard/rothbard191.html Private Coinage], [http://www.lewrockwell.com/rothbard/rothbard190.html Repudiate the National Debt]; [http://www.lewrockwell.com/rothbard/rothbard181.html Taking Money Back], [http://www.lewrockwell.com/rothbard/rothbard163.html Anatomy of the Bank Run], [http://www.lewrockwell.com/rothbard/rothbard128.html Money and the Individual]</ref> Some Libertarians would also support experimentation with [[full-reserve banking]],<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://www.mises.org/Books/mysteryofbanking.pdf Murray Rothbard, ''The Mystery of Banking'']</ref> recognizing that when fractional-reserve banking is combined with the gold standard a deflationary bias (and the systematic transfer of real wealth to the banking system) is normally inevitable. Those Libertarians who support full reserve banking would strongly support more flexible and forgiving bankruptcy laws in a fractional reserve banking environment, recognizing that no [[social stigma|stigma]] should be attached to bankruptcy given the anti-Libertarian "unjust acquisition" of real wealth implicit in both fractional reserve banking and [[taxation]].<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref><ref name="Repudiating the National Debt">[http://mises.org/article.aspx?Id=1423 Repudiating the National Debt], Murray Rothbard</ref><ref>[http://www.mises.org/Books/mysteryofbanking.pdf Murray Rothbard, ''The Mystery of Banking'']</ref><ref>[http://gonzalolira.blogspot.com/2010/12/want-to-ruin-your-own-country-assume.html Want to Ruin Your Country?]</ref>

Regarding the current accumulation of [[government bonds]] and private debt, some Libertarians believe that the creation of the [[Federal Reserve System|Federal Reserve]] under the [[Federal Reserve Act]] of 1913 was [[Criticism of the Federal Reserve|unconstitutional]] and some Libertarians consider that at least some of this accumulated debt should be canceled or forgiven prior to a return to the gold standard in recognition of its fundamental illegitimacy.<ref name="Repudiating the National Debt"/> Arguably this would be supported by the "just acquisition" [[jurisprudence]] of legal philosopher [[Robert Nozick]] and Libertarian advocate [[Murray Rothbard]].<ref name="Repudiating the National Debt"/>

In late 2010, financial commentator Max Keiser started the [[Buy Silver Crash JP Morgan Campaign 2010]] in an attempt to expose the flaws underlying the [[fractional reserve banking]] system.

====Reform within fiat currency systems====
[[Ellen Hodgson Brown]] calls for the nationalization of the private banking system once the full losses on the banks' portfolios are recognized.<ref>[http://www.webofdebt.com/articles/new_theory.php Time for a New Theory of Money]</ref><ref>[http://www.webofdebt.com/articles/force_nationalization.php Foreclosuregate could force bank nationalization]</ref> She also supports "QE2" - which she describes as a necessary and desirable funding of government spending via money printing rather than by the indirect means of issuing of interest-bearing government bonds, which simply allows private bankers to profit from costless money creation.<ref>[http://www.marketoracle.co.uk/Article24443.html QE2 and the Looming Threat of a Crippling Debt Service]</ref><ref>[http://www.marketoracle.co.uk/Article24719.html QE2 and Hyperinflation], Ellen Hodgson Brown</ref> In late 2010, [[Ellen Hodgson Brown]] and Austrian School commentator [[Gary North]] engaged in an intense debate over the direction of [[monetary reform]], with gold-standard supporter [[Gary North]] accusing Brown of going down a path that inevitably leads to the economics of fascism.<ref>[http://www.lewrockwell.com/north/north908.html Criticism of Ellen Hodgson Brown]</ref><ref>[http://www.lewrockwell.com/north/north912.html Ellen Betrays], Gary North</ref>

[[Michael Rowbotham]] also seeks the cancellation of "unjust" debts (such as [[third world debt]]), but would also support the re-introduction of strongly redistributive tax policies involving higher financial transaction taxes (such as a [[Tobin tax]]), [[land tax]]es and [[inheritance tax]]es, and, crucially and most importantly, a [[social security]] [[safety net]] involving a guaranteed minimum [[social credit|debt-free income]] (sourced from government-issued debt-free money independent of any central bank) for all citizens in the debt-based economy. Under this proposal, every adult citizen would be given a livable debt-free income transferred electronically into their [[bank account]], simply by virtue of their [[citizen]]ship. They could then use this debt-free money to pay off their [[mortgage]]s or to live, debt-free, without being compelled to work as a [[wage slavery|wage slave]] in the market economy if they chose not to. The government would finance these payments simply by ordering the private banks to accept their electronic instructions as legal tender. It would therefore not result in the expansion of [[government debt]].

Instead of [[money]] being created "indirectly" and "furtively" at the point of [[loan]] creation by the private banking system, with periodic [[bailouts]] to [[socialism for the rich and capitalism for the poor|already-rich bankers]], it would be created directly and openly by the democratically elected government and issued to its [[citizen]]ry by way of instruction to the private banking system.

Rowbotham and Ellen Hodgson Brown both argue in their books that this would ''not'' be [[inflation]]ary (or at least would not be as inflationary or as dysfunctional as the present system).<ref>[http://www.webofdebt.com/articles/hyperinflation.php Weimar Hyperinflation], Ellen Hodgson Brown</ref> This would also reduce [[overconsumption]] and the associated [[Natural environment|environment]]al damage associated with debt-based [[consumerism]]. It would also give individuals the free time to engage once again in non-marketable [[religious]], [[artistic]] and [[recreation]]al activities if they chose to do so.<ref name="death"/>

Ex-U.S. Treasury Department analyst Richard C. Cook also supports the issuance of debt-free money and zero-interest credit by the central government and has provided a detailed blueprint of monetary reform recommendations to transition to a debt-free money supply.<ref name="marketoracle.co.uk"/>

Many monetary reformers who call on the government to take back the money creation from debt-sourced banks also call for full reserve banking to remove the bank's alleged "embezzlement" and "counterfeiting" abilities.<ref name="marketoracle.co.uk"/><ref>[http://www.monetary.org/ AMI website, calling on full-reserve banking]</ref>

It is to be expected that these policies would be violently opposed by the [[private bank]]ing "[[elite]]", as it would render impotent their control over the [[money supply]], dissipating this crucial decision-making power away from its current power base. It would also be likely to reduce [[economic growth]], dramatically increase the cost of [[labor]] and, potentially, simply increase price inflation as individuals used the additional income simply to bid up the cost of health care, education, housing, food and other real assets.<ref>[http://webofdebt.wordpress.com/questions-and-answers/response-to-mogambo-guru/ Response to the Magambo Guru], by Ellen Hodgson Brown</ref> However, this proposal would undoubtedly address the problem of [[inequality]] inherent in a debt-based monetary system and reduce the devastating impact of personal [[bankruptcy]] and allow individual citizens to quickly recover from financial hardship. It would also ensure that this [[social security]] measure (and government spending in general) would not have to be paid for by future generations from future streams of [[income tax]].

===Left-leaning ideas===
Many left-leaning [[social democrats]] would also support the taxing of the banking system and the enforcement of strongly redistributive income and [[land tax]]es to ensure the financially dispossessed are "replenished" with income. They would also support a [[social security]] [[safety net]] involving the provision of unemployment benefits and government-supplied free medical care, education and other essential services and [[public goods]]. It is to be expected however that, without the issuance of debt-free [[fiat currency]], this system would result in the persistent, exponential, accumulation of [[government debt]], financed by the [[private banking]] system by the issuance of [[government bonds]]. If not properly managed, this could result in a progressively higher tax burden and may result in higher [[interest rates]] in the long term, as financiers require higher [[interest rates]] to lend to the increasingly indebted central government. Without the issuance of [[debt-free money]] these policies can be self-defeating, with the net result simply being that a larger stream of guaranteed income goes to the [[private bank]]ing system via the issuance of interest-bearing [[government bonds]] (which are purchased by the [[private banks]] "out of nothing" through [[fractional reserve banking]] techniques). This [[government debt]] must then be financed in perpetuity by compulsorily acquired [[tax]]es from future generations.

It could be argued that the early success of extreme right-wing [[fascism]] in [[Nazi Germany]] and [[Italy]] in the period after [[World War I]] was a response to the economic chaos created by the debt-based monetary system in early 20th century [[Europe]]. Some of the economic policies introduced by [[Hitler]] and [[Mussolini]] were in direct response to the economic collapse and social [[anarchy]] caused by soaring government and personal debt levels in both countries in the post-[[Versailles Treaty]] era, and (indirectly) arose from the writings of [[Silvio Gesell]] and others on the nature of the problems associated with a debt-based [[monetary system]]. Although many [[historian]]s justifiably criticize many of the non-economic policies of the [[fascist]] governments of [[Germany]] and [[Italy]] during this period, it cannot seriously be disputed that the [[economics of fascism]] provided a degree of [[prosperity]] to the populace, and that the economic policies that were implemented during this period by these [[fascist]] governments succeeded in their stated objective of restoring economic and social order during the pre-[[World War II]] era.<ref>[http://www.webofdebt.com/articles/bankrupt-germany.php How a Bankrupt Germany Solved its Economic Problems], Ellen Hodgson Brown</ref>

Similarly it could be argued that [[socialism]] and [[communism]] were movements inspired by the inequalities caused by the intense (and in [[Karl Marx]]'s view unsustainable) concentrations of monetary wealth, power and influence inherent in the practice of [[fractional reserve banking]] in a [[laissez-faire]], [[free market]] [[capitalist]] environment (particularly when [[fractional reserve banking]] is combined with a [[gold standard]] or other [[hard currency]] [[monetary system]]).<ref>[http://www.nakedcapitalism.com/2009/02/steve-keen-roving-cavaliers-of-credit.html ''Roving Cavaliers of Credit'', Steve Keen, with commentary from Yves Smith at Naked Capitalism]</ref>

The [[communist]]/[[socialist]] solution to the problem of [[fractional reserve banking]] is simple: complete removal (and if necessary, violent non-democratic removal) of the allegedly "parasitic" political and financial capitalist class, wholesale repudiation of [[government debt]] resulting in complete debt [[default]]; forced [[expropriation]] of [[land]] and wealth from the [[upper classes]] to the dispossessed and needy [[working classes]]; [[nationalization]] of the [[private banks]] (which has required armed [[coup]]s by the [[military]] in some past [[revolution]]s); and the return of the banking function from a dominant, speculative to a subordinate, administrative institution, where the banking system is reduced to a subservient arm of the centralized [[Leviathan]]. In this system, government-owned banks are directed by government policy; often provide different kinds of loans to different industry sectors at different interest rates depending on the perceived "needs" of the economy and the community; normally have a significant proportion of [[non-performing loan]]s due to weak or non-existent [[bankruptcy]] laws; and periodically "forgive" failed debts in recognition of the impossibility of some businesses in paying this debt money back.

It is to be expected that the [[profitability]] of the government-owned banking system would be more stable - but dramatically lower - than that in a debt-based [[capitalist]] economy. It is also to be expected that a significantly higher misallocation of resources could occur in this system, where lending decisions are "infected" by political considerations and are not made on the basis of expected [[return on investment]]. The risk of [[corruption]] in the banking system is also expected to be higher where there is no separation between the political and monetary systems in an economy. Market-oriented [[monetary reform]]ers and [[neo-classical]] economists therefore do not support [[nationalization]] of the [[private banking]] system.

It should be noted that partial [[nationalization]] of the [[private bank]]ing system would only be temporary, as any remaining [[private banks]] could still engage in unlimited [[fractional reserve banking]] and facilitate the eventual acquisition and control of any strategic assets in a partially socialized economic system. It is to be expected that in the absence of complete [[nationalization]] of the banking system, the [[private bank]]ing system would eventually dominate the financial system in any nominally [[socialist]] society.

===Status under current systems===
Whatever their political leanings, nearly all [[monetary reform]]ers agree that the current mixture of policies prevalent in most Western democracies, involving the perpetuation of government-protected [[private bank]]s (organizations legally permitted to engage in unlimited and inherently speculative [[fractional reserve banking]] activities, with recourse to [[central bank]]s to provide [[bail out]]s of [[fiat money]] as lenders of last resort), [[laissez-faire]] economic policies (which have the effect of increasing the marketization and commodification of human activity), strictly enforced [[bankruptcy]] laws (which permit the periodic transfer of assets from failed [[bankrupt]] investors to the [[private banks]] and their associates) and [[personal income tax]] (which, combined with periodic economic collapses, dispossesses the majority of the populace from their accumulated [[income]] and [[wealth]] and transfers this wealth to the owners of [[government bonds]]) amounts to an inherently unstable, unjust and dysfunctional [[economic system]] resulting in [[environment]]ally damaging [[over-consumption]], the systematic and irredeemable destruction of fertile [[arable land]] and the government-sponsored (and ultimately unsustainable) oppression of the indebted, impoverished and economically enslaved majority.<ref>[http://mises.org/daily/4893 ''The Ethics of Money Production''], Jorg Guido Hulsmann</ref>

==See also==
* [[Criticism of the Federal Reserve]]
* [[Austrian Business Cycle Theory]]
* [[Hyman Minsky]]
* [[G. Edward Griffin]]
* [[Michael Rowbotham]]
* [[Monetary reform]]
* [[Money as Debt]]
* [[Murray Rothbard]]
* [[Ron Paul]]
* [[Silvio Gesell]]

==References==
{{reflist|2}}

==External links==
*[http://libertariannation.org/b/money.htm Libertarian Nation Foundation - Money and Banking]
*[http://econpapers.repec.org/paper/wpawuwpma/0203005.htm Fractional Reserve Banking as Economic Parasitism]
*[http://www.prosperityuk.com/prosperity/links/links.html Monetary Reform websites]
*[http://www.jamesrobertson.com/books.htm#creating James Robertson: Creating New Money: A Monetary Reform for the Information Age]
*[http://www.relfe.com/plus_5_.html I want the Earth Plus 5%]
*[http://video.google.com/videoplay?docid=-9050474362583451279 Money As Debt (videoplay animation)]
*[http://libertariannation.org/b/money.htm Money and Banking]
*[http://globaleconomicanalysis.blogspot.com/ MISH]
*[http://maxkeiser.com/ Max Keiser]
*[http://www.webofdebt.com/ Web of Debt]
*[http://www.prudentbear.com/ PrudentBear.com]
*[http://www.marketoracle.co.uk/ Market Oracle]
*[http://www.rgemonitor.com/index.php RGE Monitor]
*[http://www.financialarmageddon.com/ Financial Armageddon]
*[http://elainemeinelsupkis.typepad.com/money_matters/ Money Matters]

{{DEFAULTSORT:Criticism Of Fractional-Reserve Banking}}
[[Category:Argumentation]]
[[Category:Money]]

Criticism of fractional reserve banking

2010-12-16T23:09:45Z

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{{main|Fractional-reserve banking}}
{{wikipedia text}}
'''Criticisms of [[fractional reserve banking]]''' have been put forward from a variety of perspectives. Critics have included economists such as [[Irving Fisher]],<ref>''100% Money'', Irving Fisher</ref> and [[Milton Friedman]].<ref>Friedman, M., A Program for Monetary Stability, New York, Fordham University Press, 1960, pp. 65</ref><ref>[http://mises.org/daily/3108 The Social Imperative of Sound Money], Lew Rockwell: "I find it sickening that there are so few voices outside the [[Austrian School]] that will stand up to this policy (of [[fiat money]]/[[fractional reserve banking]]/[[central banking]])".</ref> Within the economics profession, most criticisms are from the [[Austrian School]].<ref>[http://mises.org/media/4014 The Economics of Legal Tender Laws], [[Jorg Guido Hulsmann]] (includes detailed commentary on [[fractional reserve banking|FRB]])</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://mises.org/store/Meltdown-P557.aspx ''Meltdown''], Tom Woods, Regnery Press ISBN: 9781596985872</ref> There are also critics from outside the economics profession who advocate [[monetary reform]].<ref>[http://www.nakedcapitalism.com/2010/12/matt-stoller-end-this-fed.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29 End This Fed], Matt Stoller</ref><ref>For an example of the writings of these groups, see [http://www.bilderberg.org/monref.htm this] contribution from Bilderberg.org</ref>

==Terminology==

Critics of fractional reserve banking and the related fiat paper monetary system may refer to it by the term '''debt-based monetary system''',<ref>[http://mises.org/daily/4631 Is Our Money Based On Debt?], Robert Murphy</ref><ref name="speech">For an example of the public use of the term, see the [http://www.prosperityuk.com/prosperity/articles/earl.html speech] of the Earl of Caithness in the House of Lords on 5 March 1997</ref> or '''credit-based monetary system'''.<ref>For example of the public use of the term, see this speech given by [[Zhou Xiaochuan]], [http://www.bis.org/review/r090402c.pdf Reform the monetary system], 23 March 2009 (BIS), and this article, [http://www.nakedcapitalism.com/2009/02/steve-keen-roving-cavaliers-of-credit.html ''Roving Cavaliers of Credit''] by Steve Keen (with commentary by Yves Smith)</ref><ref>[http://globaleconomicanalysis.blogspot.com/2010/09/myths-about-whats-economically.html Myths], MISH</ref><ref>[http://globaleconomicanalysis.blogspot.com/2010/07/are-we-trending-towards-deflation-or-in.html Deflation], MISH</ref>

The term, "debt-based monetary system," and related terms, such as "debt money" are not used by conventional economists or academic [[mainstream economics|mainstream economists]]. Mainstream economists often refer to "debt money" simply as [[Credit (finance)|credit]], and distinguish clearly between types of money once it is created.<ref>For an example of the mainstream use of the term "credit" instead of "debt-money" see [http://www.ft.com/cms/s/bdfa429e-17a2-11dd-b98a-0000779fd2ac,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2Fbdfa429e-17a2-11dd-b98a-0000779fd2ac.html&_i_referer=http%3A%2F%2Fwww.ft.com%2Fhome%2Fasia this] example from the Financial Times, 1 May 2008</ref> The subject of debt-based money (as distinct from traditional monetary policy) is absent from most reputable established mainstream academic economic publications.<ref>Paul Krugman, writing at Slate.com, says the Austrian theory of business cycles is "about as worthy of serious study as the phlogiston theory of fire". http://www.slate.com/id/9593</ref>

== Typical criticisms ==

Robert H. Hemphill, credit manager of the Federal Reserve in Atlanta, stated in 1939:<ref>Preface to ''100% Money'', Irving Fisher</ref>

{{quote|If all the bank loans were paid, no one would have a bank deposit and there would not be a dollar of coin or currency in circulation. This is a staggering thought. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. When one gets a complete grasp of the picture the tragic absurdity of our hopeless position is almost incredible, but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.}}

Ron Paul states in his book ''End the Fed'':<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref>

{{quote|American presidents actually worked to implement and defend the gold standard, which put a brake on the ability of the largest banks to expand credit without limit. The gold standard worked like a regulator in this way. Ultimately, banks had to function like every other business. They could expand and make risky loans up to a point, but when faced with bankruptcy, they had nowhere they could turn. They would have to contract loans and deal with extreme financial pressures. Risk bearing is a wonderful mechanism for regulating human decision making. This created a culture of lending discipline.

In the jargon of the day, the system lacked "elasticity." That's another way of saying that banks couldn't expand money and credit as much as they wanted. They couldn't inflate without limit and count on a centralized institution to bail them out...

The banking industry has always had trouble with the idea of a free market that provides opportunities for both profits and losses. The first part, the industry likes. The second part is another issue. That is the reason for the constant drive in American history towards the centralization of money and banking, a trend that not only benefits the largest banks with the most to lose from a sound money system, but also the government, which is able to use an elastic system as an alternative form of revenue support. The coalition of government and big bankers provides the essential backbone of support for the centralization of money and credit...

Consider the Soviet case: to my knowledge, no business ever went under with the Soviet system but society in general grew ever poorer. Think of that Soviet system applied to the banking industry and you have the Fed.}}

Certain [[monetary reform]]ers claim that a fractional-reserve based banking system is inherently destructive and inevitably generates [[inflation|debasement of the currency]], [[debt slavery|extreme inequality]] or [[Austrian Business Cycle Theory|periodic crises]].<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://www.mises.org/Books/mysteryofbanking.pdf Murray Rothbard, ''The Mystery of Banking'']</ref><ref name="books.google.com">{{cite book |last= Brown |first= Ellen H. |title= Web of Debt |url= http://books.google.com/books?id=ILMGrEC524UC |accessdate= 2007-12-15 |year= 2007 |publisher= Engdahl Publishing|isbn= 0979560802 }}</ref><ref name="death"/><ref name="monetary.org">[http://www.monetary.org/lostscienceofmoney.html Stephen A. Zarlenga, ''The Lost Science of Money'' AMI (2002)]</ref><ref>[http://mises.org/story/3108 Sound Money], Lew Rockwell</ref><ref>[http://mises.org/story/1971 Our Money Madness], Lew Rockwell</ref><ref>[http://mises.org/rothbard/genuine.asp The Case for a Gold Dollar], Murray Rothbard</ref><ref name="twilight"/> Vladimir Z. Nuri has analyzed fractional reserve banking and considers it a form of economic parasitism.<ref>[http://econpapers.repec.org/paper/wpawuwpma/0203005.htm Fractional Reserve Banking as Economic Parasitism]</ref> This view is not accepted by mainstream economists.<ref>[http://www.capitalspectator.com/archives/2005/11/does_m3_matter.html Capital Spectator, "Does M3 Matter"], November 16, 2005.</ref>

Critics of fractional reserve banking frequently argue that since money creation requires ''loans'' from the banking system, people are required to go further into debt in order for any new money to be created. They theorize that this eventually causes [[Austrian Business Cycle Theory|credit cycle]]s (or [[Austrian Business Cycle Theory|business cycles]]) and necessarily debases the [[means of exchange]].

Many critics find it problematic that banks "create money out of nothing" and consider this akin to [[counterfeiting]] and/or [[embezzlement]].<ref>[http://www.dailypaul.com/node/119914 Ron Paul video - fractional reserve banking is fraudulent]</ref><ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref>

Other critics link the alleged negative effects of fractional reserve banking with central banking and a government-enforced "paper" or [[fiat currency]], which they claim allows the practice of fractional reserve banking to continue without a "natural" limitation on the growth of the [[money supply]], thereby causing inherently unsustainable "[[bubble (economics)|bubbles]]" in asset and capital markets, which are vulnerable to Ponzi-like speculation by highly leveraged [[hedge funds]] and other bank agents.<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref name="books.google.com">{{cite book |last= Brown |first= Ellen H. |title= Web of Debt |url= http://books.google.com/books?id=ILMGrEC524UC |accessdate= 2007-12-15 |year= 2007 |publisher= Third Millennium Press |location= Baton Rouge, Louisiana |isbn= 0979560802 }}</ref><ref name="death"/><ref name="monetary.org">[http://www.monetary.org/lostscienceofmoney.html Stephen A. Zarlenga, ''The Lost Science of Money'' AMI (2002)]</ref><ref>[http://mises.org/story/3108 Sound Money], Lew Rockwell</ref><ref>[http://mises.org/story/1971 Our Money Madness], Lew Rockwell</ref><ref>[http://mises.org/rothbard/genuine.asp The Case for a Gold Dollar], Murray Rothbard</ref><ref name="twilight"/>

Some critics (particularly those from the [[Austrian School]]) support a "full reserve" banking system and criticize [[fractional reserve banking]] as inherently fraudulent. [[Murray Rothbard]] held this view very strongly throughout his life.<ref>[http://mises.org/daily/3687 ''End the Fed''], Ron Paul</ref>

On considering economic thinkers outside of the mainstream, it should be noted that views on the topic of fractional reserve banking vary greatly. Even within such groups as the Austrian school, at least one thinker has argued that full-reserve banking would impose similar costs of price adjustments in reaction to growth (through a ''reduction'' in the overall price level) as would [[inflation]], and hence offer no inherent advantages over fiat currencies and fractional reserve banking.<ref>[http://books.google.com/books?id=DFv6OzeBWpQC&pg=PP3&dq=steven+horwitz++banking&sig=VZasp_8pGVvpQsFKMI3W9yp4AlM#PPA231,M1 Microfoundations and Macroeconomics: An Austrian Perspective], Steven Horwitz, pp. 223-232.</ref>

==Basic debate==

Many Austrian economists and monetary reformers focus on the combined use of [[fiat currency]], [[fractional-reserve banking]] and [[central banking]] as a negative feature of modern monetary systems.<ref>[http://mises.org/media/4014 The Economics of Legal Tender Laws], [[Jorg Guido Hulsmann]]</ref><ref>[http://mises.org/store/Meltdown-P557.aspx ''Meltdown''], Tom Woods, Regnery Press ISBN: 9781596985872</ref> These commentators use the term "debt-based monetary system" to refer to an economic system where [[money]] is created primarily through fractional-reserve banking techniques, using the banking system.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref><ref>[http://mises.org/daily/4631 Is Our Money Based On Debt?], Robert Murphy</ref><ref name="speech"/> This form of money is called "debt-based" because as a ''condition of its creation'' someone must go into debt in order for the money to be created and it must be paid back plus interest at some time in the future.

To some commentators, this implies that as the [[money supply]] and the economy grows, the general populace becomes increasingly indebted at the same time due to the idea that debt grows in parallel with money supply growth, and increasing interest payments (from either taxpayers or indebted consumers) are needed to pay bondholders as the money supply grows.<ref name="death">{{cite book |last= Rowbotham |first= Michael |title= The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics | year= 1998 |publisher= Jon Carpenter Publishing |isbn= 9781897766408 }}</ref><ref name="twilight">[http://www.marketoracle.co.uk/Article4489.html Antal E. Fekete, The Twilight of Irredeemable Debt]</ref><ref name="The Forgotten War">[http://news.goldseek.com/GoldSeek/1192819378.php The Forgotten War]</ref>

One argument posits that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. To some, this implies that debt must grow exponentially in order for the monetary system to remain solvent.<ref name="death"/><ref name="twilight"/>

Others argue that there is in fact no mathematical necessity for the stock of money in a debt-based system to grow, as the "turnover" or "flow" or "velocity" of money can increase to allow for compounding interest payments.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref><ref>[http://www.debtdeflation.com/blogs/2010/10/08/ami-talks-in-flv-format/ AMI Conference 2010], Steve Keen</ref><ref>[http://www.debtdeflation.com/blogs/2010/11/05/solving-the-paradox-of-monetary-profits-2/ Solving the Paradox of Monetary Profits], Steve Keen</ref> However this does imply that some consumers would increasingly have to consume and transact to expand the GDP sufficiently to allow the fixed stock of money to turnover sufficiently to pay for the interest compounding on top of the debt.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref><ref>[http://www.debtdeflation.com/blogs/2010/10/08/ami-talks-in-flv-format/ AMI Conference 2010], Steve Keen</ref><ref>[http://www.debtdeflation.com/blogs/2010/11/05/solving-the-paradox-of-monetary-profits-2/ Solving the Paradox of Monetary Profits], Steve Keen</ref> This may mean that Ponzi-like dynamics bubble up in "pockets" of the economy with interest payments being allowed in a fixed money economy, but these "pockets" of higher consumption or speculation would pop and die out relatively quickly.<ref>[http://mises.org/daily/4569 What Does Debt-Based Money Imply for Interest Payments?], Robert Murphy</ref>

==Basic nature of system==

The economic, environmental and social effects arising from money creation through fractional-reserve banking has been subject to much heated political debate for well over two centuries.<ref name="books.google.com"/><ref name="death"/><ref name="twilight"/><ref>[http://www.silverbearcafe.com/private/fracbank.html Antal E. Fekete, Fractional Reserve Banking Revisited]</ref>

Critics claim that, in contrast to "debt money" (which is money created in parallel with the issuance of debt or [[Credit (finance)|credit]]), "true" fiat currency is issued by the [[Treasury]] of a [[central government]] debt-free, as no requirement for its eventual return is made as a condition of its creation.<ref name="monetary.org"/><ref name="The Forgotten War"/> Government-issued debt-free fiat currency (such as debt-free notes and coins) can circulate perpetually in the economy as "stable" or even [[sound money]] (if backed by [[gold]] or [[silver]]) and although not as stable as [[hard currency]], government-issued debt-free notes and coins (such as [[United States Note]]s and [[silver certificate]]s) do not have the same effects of debt-based money described below.<ref>[http://www.entrewave.com/freebooks/docs/a_pdfs/gnhm.pdf Honest Money]</ref> It should be noted however that fiat currency can be a source of [[hyperinflation]] if its production is not controlled, as the government has the potential to issue unlimited amounts of fiat currency - ''provided'' it is accepted as "money" by the [[private bank]]ing system.<ref>[http://mises.org/books/shorthistorypapermoney.pdf A Short History of Paper Money in the United States], William M. Gouge, Mises Institute</ref> Notes and coins in circulation (being defined as [[M0]]) now account for a tiny fraction of the total M3 [[money supply]] in all developed, debt-based [[capitalism|capitalist]] economies (M0 generally being less than 10% of the total [[M2 (economics)|M2]] money supply in most developed economies).<ref>[http://www.dollardaze.org/blog/?post_id=00216 Global Money Supply Ratios]</ref>

Similarly, gold, silver and other [[precious metals]] have in the past been used as money. Because of the difficulty in increasing the supply of precious metals quickly, some [[monetary reform]]ers believe a return to the [[gold standard]], or a similar system of "hard" or "real" asset-backed currency, is the only way to stabilize the growth of the money supply. These monetary reformers often refer to the gold standard and [[silver standard]] as "sound money" or "honest money".<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref>

==Other economic and political criticisms==

In a 2003 statement to the U.S. House of Representatives, Ron Paul stated "if unchecked, the economic and political chaos that comes from currency destruction inevitably leads to tyranny".<ref name="house.gov">[http://www.house.gov/paul/congrec/congrec2003/cr090503.htm Paper Ron Paul, Paper Money and Tyranny, Speech in U.S. House of Representative, September 5, 2003]</ref>

Some economic thinkers (primarily members of the [[Austrian School]]) and political commentators believe that a debt-based monetary system amounts to a subtle form of monetary "[[fraud]]" in that it creates money "costlessly" through the use of [[fractional-reserve banking]] techniques.<ref>[http://www.mises.org/rothbard/moneyback.asp Taking Money Back, by Murray Rothbard]</ref>

Though [[Michael Rowbotham]] has no formal training in political science or economics, he is an active proponent of [[monetary reform]], and argues that this system of [[money supply]] is perverse and inherently "anti-[[democratic]]", and creates inflationary [[exponential growth]] in the economy which leads to [[Natural environment|environment]]ally damaging and unstable [[over-consumption]]. Critics such as Rowbotham argue that the indebted are forced to induce new [[consumers]] to spend their way into debt so existing loans can be repaid with new debt-created money. Failure to achieve this goal results in [[foreclosure]] for those businesses and [[insolvency]] in the banking system that leads to economic collapse due to the sudden contraction of the money supply.<ref name="death"/><ref name="Ponzi Nation">[http://www.iimagazine.com/article.aspx?articleID=1234345 Ponzi Nation]</ref>

Mark Anielski as well as some political thinkers such as Rowbotham and some economists (such as [[Hyman Minsky]]) argue that this system of money supply has characteristics similar to a [[pyramid scheme]], where the newly indebted are compelled to induce others into debt to pay off their own debts.<ref>[http://www.lin.ca/resource/html/arpa02/PC1-FertileObfuscation.pdf ''Fertile Obfuscation: Making Money Whilst Eroding Living Capital''], 34th Annual Conference of the Canadian Economics Association, Mark Anielski</ref> It is therefore argued by a number of monetary reformers that fractional-reserve banking and the associated exponential growth of money in the economy "forces" the economy towards indebted [[consumerism]].<ref name="books.google.com"/>

Rowbotham argues that a major negative side-effect of the debt-based monetary system is its effect on [[agriculture]], claiming that [[residential development]] produces one of the greatest continuous injections of debt money into the economy. Therefore, significant super-normal profits can be generated by re-zoning agricultural land and replacing it with low-density [[House|housing]].<ref name="death"/>
If this is correct, this trend will lead to the destruction of fertile [[arable land]], as this land is progressively re-zoned for speculative new residential development. Rowbotham also predicts that the global supply of fertile [[arable land]] will decline, leading to a broad decline in the quality and nutritional value of agricultural produce and, eventually, a dramatic increase in the prices of many "soft" commodities - which could then lead to actual food shortages for poorer segments of the world population.<ref name="death"/><ref>[http://www.wsws.org/articles/2007/dec2007/food-d22.shtml Naomi Spencer, World Socialist Website, "Severe food shortages, price spikes threaten world population", 22 December 2007]</ref>

If for any reason the monetary system broke down, urban populations (nominally "rich" but poor in terms of direct access to [[food supply]]) could find basic foodstuffs increasingly expensive, ultimately resulting in food security becoming a major public policy issue.<ref name="death"/><ref>[http://www.wsws.org/articles/2007/dec2007/food-d22.shtml Severe food shortages, price spikes threaten world population]</ref>

===Effects on economic health===

According to Michael Rowbotham the expansion of money through debt creates [[Boom and bust|economic bubbles]]. This concentrates [[wealth]] in the hands of private banks as the populace is forced into [[debt]] simply to own a home and educate their children.<ref name="death"/> Debt expansion leads to price appreciation of assets through speculation as the financial market becomes riskier. Edward Chancellor compares this type of market to a monetary [[Ponzi scheme]].<ref>[http://www.iimagazine.com/article.aspx?articleID=1234345 Ponzi Nation,"Who is Hyman Minsky?", para 6]</ref>

The bust phase of this [[business cycle]] where "debt-based" money growth slows or contracts catches newly indebted businesses and consumers who are left out of the growth cycle.<ref name="death"/><ref name="Ponzi Nation"/>

===Effects on the environment===
There are also critics in the left-wing and [[environmentalist]] camps who contend fractional reserve banking (by creating a necessity for indefinite [[economic growth]]) leads to environmental destruction and depletion of natural resources.<ref>David Korten, ''Agenda For A New Economy'', Berret-Koehler, 2009</ref><ref>[http://www.monbiot.com/archives/2004/10/06/no-longer-obeying-orders/ George Monbiot], about five sixths of the way down</ref>

===Inherent problems with the system===

Some monetary reformers predict that there will be an increased incidence of financial crises in the developed world, as economic and [[population growth]] inevitably slow and as the success of [[laissez-faire]] economic political policies result in a reduction in redistributive [[tax]] policies which, combined with the debt-legacy of the [[welfare state]], allows an intense and unsustainable concentration of wealth and political power in the financial services sector.<ref name="death">{{cite book |last= Rowbotham |first= Michael |title= The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics | year= 1998 |publisher= Jon Carpenter Publishing |isbn= 9781897766408 }}</ref>

Some monetary reformers argue that perverse incentives in the financial services industry lead to a collusive relationship between governments and bankers which are economically and socially destablizing in the long run.<ref>[http://mises.org/media/4014 The Economics of Legal Tender Laws], Jorg Guido Hulsmann</ref>

Some monetary reformers argue that it is vital that the indebted "victims" who must sink deeper into debt for the system to survive do so voluntarily and willingly and are not made aware of the consequences of purchasing consumables with debt money.<ref name="death">{{cite book |last= Rowbotham |first= Michael |title= The Grip of Death: A Study of Modern Money, Debt Slavery and Destructive Economics | year= 1998 |publisher= Jon Carpenter Publishing |isbn= 9781897766408 }}</ref> Some politicians and others have highlighted the fact that mainstream media organizations appear to downplay or minimize the seriousness of deficit spending by government and debt-sourced spending of all kinds.<ref>[http://www.senate.gov/~budget/democratic/statements/2005/fs_reconciliationfloorstmt102005.pdf Speech by Senator Kent Conrad (D-ND) on October 20, 2005 regarding the "misleading" reporting of deficit spending by the mainstream media]</ref> The associated growth of derivatives during the upward phase of the debt money cycle was referred to as "[[innovation]]" in financial markets.<ref>[http://www.nytimes.com/2007/12/03/opinion/03krugman.html?em&ex=1196917200&en=ac60abcdbd977d07&ei=5087%0A Innovating Our Way to Financial Crisis, by Paul Krugman]</ref>

[[Bankruptcy]] laws differ to a small degree in different jurisdictions but in all developed economies unpaid debt results in legal penalties, property confiscation on behalf of the creditor and income [[sequestration]]. Although in [[Christian]], [[Jewish]] and [[Muslim]] religious practice there have been traditions of [[debt relief]] or laws against [[usury]], in no modern Western jurisdiction are any debts periodically forgiven or cancelled in recognition of the inherent impossibility of repaying debts in circumstances where the debt-based monetary cycle has inevitably resulted in too little new [[debt money]] being injected into the [[money supply]] to pay for the currently outstanding debts.<ref>[http://www.nakedcapitalism.com/2007/11/new-bankruptcy-law-backfires-by.html Bankruptcy law backfires]</ref>

On a national level, if the issuance of [[government bonds]] becomes unsustainable, sovereign [[bankruptcy]] can occur - and has occurred many times in history.<ref>[http://mises.org/daily/4869 Can the Fed Become Insolvent?], Robert Murphy</ref><ref>[http://elainemeinelsupkis.typepad.com/money_matters/2007/10/greenspaniel-an.html Greenspaniel and U.S. bankruptcy]</ref> [[Sovereign debt]] crises due to the inability of nations to pay interest on [[government bonds]] have occurred frequently and regularly in the [[third world]] and less frequently (every 30 years or so) in the first world as a result of high levels of unsustainable public debt - often because private debts are assumed by a corrupt government through large private bank bailouts.<ref>[http://www.dailymail.co.uk/debate/article-1331076/Ireland-bailout-Lets-frank-7bn-bunch-liars-crooks-bunglers.html Ireland Bailout], Alex Brummer</ref><ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref> The [[Latin American debt crisis]] is an example of sovereign debt levels becoming unsustainable, resulting in a [[currency crisis]] and economic collapse, as [[interest rates]] rise precipitously due to the inability of the national government to attract financiers to purchase new [[government bonds]] to inject new [[debt money]] into the ailing economy.<ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref>

At such times, it is the responsibility of the [[IMF]] to come in as a kind of supranational [[central bank]] to mediate between the national government and international financiers. The role of the [[IMF]] as [[central bank]] to the world has similar responsibilities and risks inherent in [[central bank]]ing which are described below in relation to the role of the [[Federal Reserve]]. If the [[IMF]] repeatedly intervenes to save financiers from loss when sovereign bankruptcy occurs, this has a tendency to induce [[moral hazard]] and can encourage the financing of reckless government spending and borrowing.<ref>[http://www.rgemonitor.com/41 IMF Reform and International Lender of Last Resort, RGE Monitor</ref><ref>[http://info.interactivist.net/article.pl?sid=02/11/07/199213&mode=thread&tid=8 Banking Bunkum, by Henry C.K. Liu]</ref><ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref>

A [[single currency]] regime such as the [[Euro]] can mask national liquidity or solvency crises, by ensuring that a national currency is not quickly exchangeable for another, thereby restricting the ability of national governments to depreciate their currencies and cutting off the possibility that the real value of [[government bond]] interest repayments could decline relative to other currencies.<ref>[http://www.dailymail.co.uk/news/article-1316442/Anglo-Irish-Bank-bail-Will-Irish-economic-meltdown-hit-UKs-fragile-recovery.html Irish Meltdown], UK Mail On-line,</ref><ref>[http://www.marketoracle.co.uk/Article24459.html Ireland Bailout Consequences for Britain, Portugal Next?], Nadeem Walayat</ref><ref>[http://www.marketoracle.co.uk/Article24543.html QE2 and the Great Economic Misdiagnosis], Jim Willie</ref><ref>[http://news.goldseek.com/RichardDaughty/1192374060.php The Mogambo Theory of Currency Relativity]</ref><ref>[http://www.youtube.com/watch?v=IvJEJEGzeU8&feature=player_embedded#! Putin ditches dollar], RTTV</ref> This may however increase the risk of bond default where indebted national governments cannot pay back the interest payments in the denominated common currency.<ref>[http://www.dailymail.co.uk/news/article-1316442/Anglo-Irish-Bank-bail-Will-Irish-economic-meltdown-hit-UKs-fragile-recovery.html Irish Meltdown], UK Mail On-line,</ref>

===Types of downturns===
{{main|Austrian Business Cycle Theory}}

There are two main kinds of debt money contraction that can cause a collapse in the value of inflated assets.

A "credit squeeze" occurs where new debt money is difficult to access without a high [[credit rating]]. At such times marginal borrowers, or those who have borrowed at the end of any debt-induced asset bubble, get "squeezed" out of further borrowing and a contraction in the growth of new debt money occurs, triggering a slow down in the growth of inflated assets. Those assets can then be "harvested" by the [[private bank]]s through widespread [[foreclosure]] or [[bankruptcy]] and re-sold to those with the money to buy the distressed assets.<ref name="marketoracle.co.uk">[http://www.marketoracle.co.uk/Article2882.html Market Fundamentalism, by Richard C. Cook]</ref>

A "credit crunch" occurs where new debt money is not available at any [[interest rate]] - even for those with previously acceptable credit ratings - due to widespread insolvency in the banking system. At such times, it is the banking system itself that is [[insolvent]] and other financial institutions (including overseas financiers) become reluctant to lend to the domestic banking system, resulting in the domestic banking system being unable to issue loans even to credit worthy borrowers.<ref>[http://www.scribd.com/doc/3906112/Credit-CrunchThe-New-Financial-Snack Credit Crunch, by Satyajit Das]</ref>

At any stage during the downward spiral of a "credit crunch", the [[central bank]] in a modern economy can try to save the system from complete economic [[meltdown]] by purchasing (either indefinitely or temporarily) the failed debts of the private banks.<ref>[http://www.youtube.com/watch?v=PTUY16CkS-k&feature=player_embedded#! Quantitative Easing Explained]</ref><ref>[http://www.marketoracle.co.uk/Article24489.html Does the Fed Create Money?] Michael Pento</ref><ref>[http://www.telegraph.co.uk/money/main.jhtml?view=DETAILS&grid=A1YourView&xml=/money/2007/12/19/ccom119.xml ECB's mind-numbing cash injection]</ref> However, doing so results in cash being transferred to the private banks in exchange for [[bad debt]], thereby violating the general economic precept to avoid [[moral hazard]] and effectively makes liquid the failed lending decisions of the [[private bank]]s.<ref>[http://www.rgemonitor.com/blog/roubini/228924/ Privitizing Profits and Socializing Losses, by Nouriel Roubini]</ref> In the U.S. banking system this is called "opening the Fed discount window", where the [[Federal Reserve]] temporarily purchases the failed investment portfolios of distressed private banks in exchange for cash. However, this rescue measure may only delay, rather than avoid, the realization of losses in the banking system, as the central bank cannot "force" new borrowing into the system to inject new debt money into the money supply. Somebody has to be a [[counterparty]] to borrow the debt money that is being offered. If all market participants realize a "[[bubble (economics)|bubble]]" has formed in assets markets, there will be few (or no) buyers for new debt money, as no one wants to borrow to buy inflated assets no one else will buy. Money markets can therefore remain illiquid even with intense [[central bank]] support.

Furthermore, banks can go bust even with intense central bank support, if the issue is not one of liquidity, but one of solvency.<ref>[http://www.ft.com/cms/s/0/233ae764-abef-11dc-82f0-0000779fd2ac.html Central Banks have No Plan]</ref><ref>[http://www.rgemonitor.com/blog/roubini/233120 Central Banks get desperate]</ref>

===Pushing on a string===
Some monetary economists describe the opening of the Fed discount window after the bursting of an asset bubble as "[[pushing on a string|pushing on a piece of string]]", as this measure does not solve the key problem – creating new credit (or debt money) to keep up the growth in the money supply and maintain the required level of liquidity in credit markets.<ref>[http://www.mises.org/story/2695 Don't Discount the Fed Discount Window]</ref><ref>[http://www.federalreserve.gov/Pubs/FEDS/2004/200401/200401pap.pdf Monetary Policy in Deflation: The Liquidity Trap in History and Practice]</ref> This is because unlimited central bank money and low interest rates ''allow'' credit creation, but do not ''force'' it into the system. In order for any new debt money to be created, somone has to borrow the excess reserve in order for the money to be injected into the system. If corporations and individuals are already heavily indebted, there are no credit-worthy borrowers to lend to.

To encourage fresh borrowing, central banks generally combine these rescue measures with an interest rate cut to encourage more new borrowing to allow the existing (failed) debts to be [[liquidate]]d at or close to their original value. When [[Alan Greenspan]] repeatedly resorted to this tactic to revive illiquid [[money market]]s this became known in the market as the "[[Greenspan put]]", as the effect of these repeated reductions in interest rates was similar to a [[put option]] in the [[stockmarket]], insuring [[bank]]s' lending mistakes would be covered up by the Federal Reserve.<ref>[http://www.iie.com/publications/wp/02-1.pdf Moral Hazard and the "Greenspan Put"]</ref>

When interest rates cannot go any lower (the so-called "zero bound" monetary problem) and people still will not - or cannot - inject themselves with more debt, then the Keynesian solution is to run large public deficits and indebt future generations (who, they hypothesize, are more likely to be able to pay through increased future growth). Keynesian economists such as Paul Krugman argue that governments must take charge of the responsibility of spending more (and taking on more debt) on behalf of the public (who are too fearful to take on more debt themselves) in order to compensate for the immediate and urgent ''present'' insufficiency in total private consumption. Paul Krugman is a prominent advocate of the policy of spending trillions of government money to help stimulate the economy, if spending billions does not work.<ref>[http://www.nytimes.com/2010/06/21/opinion/21krugman.html?dbk Budget Deficits], Paul Krugman</ref><ref>[http://globaleconomicanalysis.blogspot.com/2010/10/krugman-and-inevitable-i-told-you-so.html Krugman], MISH</ref><ref>[http://krugman-in-wonderland.blogspot.com/2010/11/inflation-prisoner.html The Inflation Prisoner], William Anderson</ref> For economists such as Paul Krugman, if the "more government spending and increase public debt solution" does not work initially, it is a sign that not enough government money has been spent.<ref>[http://globaleconomicanalysis.blogspot.com/2010/10/krugman-and-inevitable-i-told-you-so.html Krugman], MISH</ref> It is his view that the Japanese recession from 1991/2 could have been cured by the Japanese government going into even more debt than the current net debt to GDP ratio of 110%.<ref>[http://www.nytimes.com/2010/06/21/opinion/21krugman.html?dbk Budget Deficits], Paul Krugman</ref><ref>[http://www.economist.com/node/15867844 Japan's debt-ridden economy], The Economist</ref>

Although there is active debate as to whether this policy of indebting future generations by the government spending even more money would actually help the economy,<ref>[http://krugman-in-wonderland.blogspot.com/2010/11/inflation-prisoner.html The Inflation Prisoner], William Anderson</ref> there is no argument that this would undoubtedly help the present group of private bankers, as increased income from the interest payments on new government bond issuance offsets the decline in private sector debt and allows private bankers to survive when otherwise they may face collapse due to the fatal impairment of their balance sheets through private debt write-offs after an unsustainable debt-fuelled bubble bursts.<ref>[http://georgewashington2.blogspot.com/2010/08/quantitative-easing-wont-help-economy.html QE won't help the economy]</ref><ref>[http://moneymorning.com/2010/11/19/federal-reserves-quantitative-easing-strategy-save-the-us-economy/ QE won't save the economy]</ref>

===Inequities in system===

Aside from the [[moral hazard]] issue, the key risk with [[quantitative easing]] (and the associated cutting of [[interest rate]]s to encourage new debt money creation) is that the [[central bank]] exposes the financial system to a [[currency crisis]], as the growth in the [[money supply]] spirals out of control due to the need to save the [[bank]]s from themselves.<ref>[http://www.swlearning.com/economics/hall/hall-lieb2e-upd/ppt_lecture/exchange_rate_macro_policy.ppt Exchange Rates and Macroeconomic Policy]</ref><ref>[http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6VGT-41WBFRG-1&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=4e89075114dcdb58b503172ff1801bd2 Central Bank Intervention]</ref><ref>[http://www.federalreserve.gov/newsevents/speech/mishkin20071026a.htm Financial Instability and the Federal Reserve as a Liquidity Provider, by Frederic S. Mishkin]</ref>

For these reasons, a collapse in confidence in the [[solvency]] of the banking system is one of the most complex and difficult policy issues any [[government]] can face.

In such crises of confidence, a central bank may choose to save the current players in the banking sector by printing money and inflating its way out of the crisis, thereby debasing the value of the domestic [[currency]].<ref>[http://mises.org/daily/4869 Can the Fed Become Insolvent?], Robert Murphy</ref> This is now called [[quantitative easing]].<ref>[http://blog.mises.org/14626/quantitative-easing-explained/ Quantitative Easing Explained], YouTube video</ref>

This is also referred to by some [[monetary reform]]ers and [[economist]]s as "[[socialism for the rich and capitalism for the poor]]", as many indebted [[consumers]] will still lose their [[house]]s and be declared [[bankrupt]] regardless whether or not the central bank intervenes to save marginal lenders who have been made [[insolvent]] through their mis-timing of the [[credit cycle]].<ref>[http://www.rgemonitor.com/blog/roubini/228924/ Privatizing Profits and Socializing Losses, by Nouriel Roubini]</ref><ref>[http://www.beearly.com/pdfFiles/Satyajit%20Das.pdf Regulatory Debauchery by Satyajit Das]</ref> Future generations of innocent taxpayers may ultimately finance any [[bail out]] of reckless lenders, as the money used to fund any [[bail out]] will be funds diverted from the general revenue of the central government.<ref>[http://www.ft.com/cms/s/0/f4cf8426-654d-11dc-bf89-0000779fd2ac.html A run on the bank]</ref>

Some bankers and financial commentators still refer to [[Walter Bagehot]]'s 1873 commentary on monetary crises, ''Lombard Street'', in an attempt to gain insights into the way in which central bankers should revive illiquid banking systems.<ref>[http://blogs.ft.com/economistsforum/2010/04/a-history-lesson-from-lombard-street-for-wall-street-in-2010/ History Lesson from Lombard Street], Roger Farmer, Ft.com</ref>

A prime example of the fatal effects of combining aging demographics with reckless bank lending can be found in the case of the [[Japanese asset price bubble]].<ref>[http://www.economist.com/displaystory.cfm?story_id=10286992 The Japanese and American Bubbles: Been There, Done Some of That]</ref>

===Potential societal impact===

Some more extreme monetary reformers and [[conspiracy theorists]] anticipate the declaration of [[martial law]] and the imposition of [[fascist]]-style restrictions on [[civil rights]] and [[freedom of speech]] by the political [[The Establishment|Establishment]] to physically protect it from [[anarchy]] or military [[coup]] when the [[bubble (economics)|bubble]] of debt completely bursts, either through a precipitous currency crisis or debt-created [[Depression (economics)|depression]].<ref>[http://www.house.gov/paul/congrec/congrec2007/cr120507h.htm New security legislation threats freedoms]</ref> Some conspiracy theorists also anticipate the forced elimination - by any means necessary - of any actual or potential competing [[currencies]] that could threaten the viability or legitimacy of the [[monopoly]] currency, which could include the compulsory confiscation of all privately-owned [[gold]] (gold being the ultimate reserve currency, still used by central banks as a universally accepted medium of exchange for the settlement of international debts).<ref>[http://blog.mises.org/14795/the-gold-clause-cases-and-constitutional-necessity/ Gold Clause Cases]</ref><ref>[http://news.goldseek.com/GoldSeek/1196605589.php America's Trade Debts Lead to a Likely Gold Confiscation]</ref><ref>[http://www.libertydollar.org/ld/legal/raid.htm FBI Raids Liberty Dollar]</ref><ref>[http://www.lewrockwell.com/rothbard/solution.html The Solution]</ref><ref>[http://prudentinvestor.blogspot.com/2007/09/us-mint-suspends-gold-coin-sales-due-to.html US Mint Suspends Gold Coin Sales]</ref><ref>[http://www.swissamerica.com/article.php?art=06-2004/200406140537f.txt Why a Gold Standard Now?]</ref>

There have been many [[financial crisis|monetary crises]] throughout history<ref>[http://mises.org/store/Early-Speculative-Bubbles-P578.aspx Early Speculative Bubbles and Increases in the Money Supply], Doug French, Mises Institute ISBN: 978-1-933550-44-2</ref> and prior to widespread anarchy or [[revolution]], in the late stages of a [[financial bubble]], there are a number of warning signs of impending [[chaos]] caused by a complete breakdown of trust in the debt-based [[monetary system]].<ref>[http://mises.org/store/Product.aspx?ProductId=435 Fiat Money Inflation in France], Andrew Dickson White, Mises Institute</ref> Just prior to the complete collapse of the [[pyramid scheme]] of public and private debt, the economic system tends to feed on itself, and in the past, where debt-created [[Depression (economics)|depression]]s or periods of [[hyperinflation]] have occurred in [[Europe]], the [[U.S.]] and [[China]], there has been a sustained spike in predatory economic behavior, as the heavily indebted central government and producers are forced to find more extreme (previously considered unethical) methods to extract any remaining wealth from increasingly desperate and impoverished [[consumers]], who are either unwilling or unable to go into further debt without forceful coercion.<ref name="http">{{cite book |last= Widdig |first= Bernd |title= Culture and Inflation in Weimar Germany |url= http://books.google.com/books/ucpress?id=kvKAATycUzIC |accessdate= 2007-12-16 |year= 2001 |publisher= University of California
Press |isbn= 0520222903 }}</ref><ref>[http://mises.org/daily/3569 John Law and the Invention of Modern Finance], Doug French (Mises.org)</ref><ref>[http://mises.org/daily/1690 The Saga of John Law and Richard Cantillon], Sean Corrigan (Mises.org)</ref> [[Long-term]] investment and sustained [[capital investment]] are almost impossible in this environment because the "measuring stick" of [[return on investment]] (the real value of [[money]]) is so uncertain at times of debt-induced [[credit crunch]], depression or hyperinflation.

As potential new [[borrower]]s and international financiers are scared away from participating in the [[pyramid scheme]] of debt and borrowing further, the [[monetary system]] seizes up, starved of the fresh injections of [[debt money]] it needs for its survival, thereby precipitating economic [[anarchy]], widespread [[lawlessness]] and [[insolvency]] of the monetary and banking system.<ref>[http://www.oftwominds.com/blognov07/empire-debt1.html Empire of Debt]</ref><ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref>

This final denouement is triggered when [[borrower]]s cannot be found to buy depreciating heavily indebted assets, and international financiers reduce lending as they experience losses on pre-existing loans either through asset or currency [[depreciation]]. Some analysts predict that the [[monetary system]] will seize up due to a [[deflationary]] depression or a sustained period of [[stagflation]]ary hyperinflation resulting in a "final and total catastrophe of our fiat monetary system."<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref>

This has often occurred after a failed [[aggressive war]], as international financiers realize the heavily indebted [[government]] they funded will not gain the [[resources]] it planned to seize as a result of the waging of [[aggressive war]]. When this pay-off does not materialize, the government is left with the [[debt]] of war without the ability to offset this [[government debt]] through the imposition of [[reparations]] on the defeated [[nation]] and the acquisition of the defeated state's [[resources]]. This occurred to [[Germany]] after the [[First World War]] and [[Japan]] after the [[Second World War]].

Whatever the trigger, the key warning sign of any impending monetary crisis and economic [[anarchy]] is a sudden [[currency crisis]].<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref> Early warning signs that the [[private banks]] themselves are aware of an impending breakdown in the [[solvency]] of the [[financial system]] would be: a spike in the prices for [[oil]] (which is an internationally accepted, inherently limited, store of value, and therefore can act as a modern form of [[hard currency]], oil sometimes being referred to as "black gold"), [[gold]], [[silver]] and other stable, non-perishable, inherently limited [[natural resources]] essential for non-discretionary industrial production; a spike in the [[futures contract]]s for vital agricultural [[commodities]] such as [[sugar]],<ref>[http://www.bloomberg.com/news/2010-12-15/portugal-tries-to-prevent-sugar-hoarding-amid-shortage-ft-says.html 2010 Portugal Sugar Crisis]</ref> [[coffee]], [[wheat]], [[soybean]]s and [[rice]], as investors realize the debt-based monetary system has squeezed supplies of [[arable land]]; a sudden flight of money ''to'' [[Treasury bills]] and/or a sudden spike in the [[interest rate]] differential between short-term [[Treasury bills]] and asset-backed corporate paper (or a sudden spike in the [[LIBOR]] rate in [[London]])<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref><ref>[http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/12/03/cnrates103.xml&CMP=ILC-mostviewedbox Pleas for rate cut as interbank loans dive]</ref> - and, in the very late stages of a credit crisis, a sudden flight of money ''away from'' [[Treasury bills]] and a collapse in government bond prices, as governments ultimately find it ''impossible'' to pay interest on their debt from coercively acquired taxes.<ref>[http://www.telegraph.co.uk/finance/economics/8190059/Global-bond-rout-deepens-on-US-fiscal-worries.html Global bond rout], Ambrose Evans-Pritchard, UK Telegraph</ref>

Shortly thereafter, some [[monetary reform]]ers predict that there would be desperate, but ultimately futile [[central bank]] intervention, a [[currency crisis]], a panic run on a number of marginal, [[insolvent]] [[banks]] and [[hedge funds]] as desperate wealthy investors try to get [[cash]] out before the [[pyramid scheme]] collapses to invest in inherently limited, non-perishable, in-demand commodities such as [[oil]] and [[gold]] (and undeveloped agricultural and industrial [[land]] in areas of the world with strong [[economic growth]]), followed by a [[recession]] or [[depression]] in the broader heavily indebted economy as the [[money supply]] contracts.<ref>[http://www.goldensextant.com/SavingtheSystem.html Fiat's Reprieve, by Robert K. Landis]</ref><ref>[http://www.newyorkfed.org/research/staff_reports/sr291.pdf Hedge Funds, Financial Intermediation and Systemic Risk]</ref>

In 2010 Ireland and Greece experienced simiilar financial crises along the lines described above and many financial commentators and politicians expect more countries to go through the same debt crisis.<ref>[http://globaleconomicanalysis.blogspot.com/2010/12/video-fire-bombs-stones-fly-in-greek.html Greek protests]</ref><ref>[http://www.youtube.com/watch?v=2gm9q8uabTs "Who the Hell do you think you people are?"], Nigel Farage, UKIP leader</ref>

===Potential solutions===
Although time is the only real remedy for monetary crises (allowing re-inflation of the markets through the gradual injection of new [[debt money]] into the system through new borrowings), time is something panicked financiers and investors are least likely to want to give up when the threat is never getting their [[money]] out of the imploding investment [[bubble]]. In extreme cases [[bank]]s could set up "independent" corporate investment vehicles to buy the assets associated with the [[bad debt]],<ref>[http://www.dealbreaker.com/2007/10/citigroup_looks_to_lend_money.php Citigroup looks to lend money]</ref> thereby allowing [[borrower]]s to liquidate their investments and allow time for the markets to re-inflate. Alternatively, these "sour" loans, that have gone bad through too much debt overwhelming the markets, could be dumped or "hidden" on the central bank's balance sheet, and swapped for more secure government debt (financed through compulsorily acquired taxes, which is immune from the risk of private bankruptcy). However the holding costs involved in these measures would be extremely high and would not guarantee that the losses could be averted if no new gullible investors could be found to offload these distressed assets.<ref>[http://www.youtube.com/watch?v=n8w6Nx2rfiE A Wikileaks for the Fed?]</ref> More fundamentally, these short-term "parachutes" used after bubbles burst do not save ordinary borrowers from [[foreclosure]] and [[bankruptcy]], nor do they address the pernicious long-term dysfunctional aspects of [[fractional reserve banking]] described above. These problems are temporarily averted, only to be dealt with yet again by the next generation of indebted governments and peoples.<ref>[http://www.informationclearinghouse.info/article18431.htm The Era of Global Financial Instability, by Mike Whitney]</ref><ref>[http://www.youtube.com/watch?v=n8w6Nx2rfiE A Wikileaks for the Fed?]</ref>

Given these repeated financial crises arising from the debt-based monetary system, many [[monetary reform]]ers predict that there will inevitably be a return to the [[gold standard]], a fundamental change in the way money is produced and distributed (with a return to the prevalence of government-issued debt-free [[fiat currency]] and/or [[free banking]]) - or a complete financial "[[meltdown]]" as fewer young people in developed economies can be found who are willing to go into debt in sufficient magnitude to pay off the debts that have already been accumulated.<ref>[http://www.goldensextant.com/SavingtheSystem.html Saving the System, by Robert K. Landis]</ref> As extreme inequality increases, [[foreclosure]]s mount and financial crises repeatedly erupt, these [[monetary reform]]ers believe a political crisis will eventually result in calls for fundamental [[monetary reform]].

These on-going, worsening, [[debt]]-created crises in the economy and society (and the unsustainable damage to the [[environment]] caused by debt-created [[overconsumption]]) could turn monetary and economic policies either to the extreme left or to the extreme right, as there are a number of competing solutions to the debt-based monetary "problem".

===Proposals for monetary reform===
====Libertarians and commodity money====

[[Libertarians]] envision a society of [[free markets]], [[small government]]<ref>[http://www.prudentbear.com/index.php/thebearslairview?art_id=10473 Models of Capitalism], Michael Hutchinson</ref> and money backed by a [[gold standard]] or [[silver standard]].<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref><ref>[http://www.prudentbear.com/index.php/thebearslairview?art_id=10471 Gold Standard Renaissance?]</ref><ref>[http://www.marketoracle.co.uk/Article24632.html The Gold Standard Never Dies], [[Lew Rockwell]]</ref><ref>[http://www.prudentbear.com/index.php/thebearslairview?art_id=10471 Gold Standard], Michael Hutchinson</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://radio.goldseek.com/griffin04.10.10.php Goldseek interview] with [[G. Edward Griffin]]</ref><ref>See also these [[Murray Rothbard]] articles: [http://www.mises.org/money.asp What Has Government Done to Our Money?], [http://www.mises.org/story/1829 The Case for the 100% Gold Dollar]; [http://www.lewrockwell.com/rothbard/cartelization.pdf The Fed as Cartel], [http://www.lewrockwell.com/rothbard/rothbard191.html Private Coinage], [http://www.lewrockwell.com/rothbard/rothbard190.html Repudiate the National Debt]; [http://www.lewrockwell.com/rothbard/rothbard181.html Taking Money Back], [http://www.lewrockwell.com/rothbard/rothbard163.html Anatomy of the Bank Run], [http://www.lewrockwell.com/rothbard/rothbard128.html Money and the Individual]</ref> Some Libertarians would also support experimentation with [[full-reserve banking]],<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref><ref>[http://mises.org/store/Money-Bank-Credit-and-Economic-Cycles-P290C0.aspx Money, Bank Credit and Economic Cycles], Jesus Huerta de Soto, Mises Institute ISBN: 978-1-933550-39-8</ref><ref>[http://www.mises.org/Books/mysteryofbanking.pdf Murray Rothbard, ''The Mystery of Banking'']</ref> recognizing that when fractional-reserve banking is combined with the gold standard a deflationary bias (and the systematic transfer of real wealth to the banking system) is normally inevitable. Those Libertarians who support full reserve banking would strongly support more flexible and forgiving bankruptcy laws in a fractional reserve banking environment, recognizing that no [[social stigma|stigma]] should be attached to bankruptcy given the anti-Libertarian "unjust acquisition" of real wealth implicit in both fractional reserve banking and [[taxation]].<ref>[http://mises.org/daily/4860 Money: Sound and Unsound], Mark Thornton commentary on Joseph Salerno's book</ref><ref name="Repudiating the National Debt">[http://mises.org/article.aspx?Id=1423 Repudiating the National Debt], Murray Rothbard</ref><ref>[http://www.mises.org/Books/mysteryofbanking.pdf Murray Rothbard, ''The Mystery of Banking'']</ref><ref>[http://gonzalolira.blogspot.com/2010/12/want-to-ruin-your-own-country-assume.html Want to Ruin Your Country?]</ref>

Regarding the current accumulation of [[government bonds]] and private debt, some Libertarians believe that the creation of the [[Federal Reserve System|Federal Reserve]] under the [[Federal Reserve Act]] of 1913 was [[Criticism of the Federal Reserve|unconstitutional]] and some Libertarians consider that at least some of this accumulated debt should be canceled or forgiven prior to a return to the gold standard in recognition of its fundamental illegitimacy.<ref name="Repudiating the National Debt"/> Arguably this would be supported by the "just acquisition" [[jurisprudence]] of legal philosopher [[Robert Nozick]] and Libertarian advocate [[Murray Rothbard]].<ref name="Repudiating the National Debt"/>

In late 2010, financial commentator Max Keiser started the [[Buy Silver Crash JP Morgan Campaign 2010]] in an attempt to expose the flaws underlying the [[fractional reserve banking]] system.

====Reform within fiat currency systems====
[[Ellen Hodgson Brown]] calls for the nationalization of the private banking system once the full losses on the banks' portfolios are recognized.<ref>[http://www.webofdebt.com/articles/new_theory.php Time for a New Theory of Money]</ref><ref>[http://www.webofdebt.com/articles/force_nationalization.php Foreclosuregate could force bank nationalization]</ref> She also supports "QE2" - which she describes as a necessary and desirable funding of government spending via money printing rather than by the indirect means of issuing of interest-bearing government bonds, which simply allows private bankers to profit from costless money creation.<ref>[http://www.marketoracle.co.uk/Article24443.html QE2 and the Looming Threat of a Crippling Debt Service]</ref><ref>[http://www.marketoracle.co.uk/Article24719.html QE2 and Hyperinflation], Ellen Hodgson Brown</ref> In late 2010, [[Ellen Hodgson Brown]] and Austrian School commentator [[Gary North]] engaged in an intense debate over the direction of [[monetary reform]], with gold-standard supporter [[Gary North]] accusing Brown of going down a path that inevitably leads to the economics of fascism.<ref>[http://www.lewrockwell.com/north/north908.html Criticism of Ellen Hodgson Brown]</ref><ref>[http://www.lewrockwell.com/north/north912.html Ellen Betrays], Gary North</ref>

[[Michael Rowbotham]] also seeks the cancellation of "unjust" debts (such as [[third world debt]]), but would also support the re-introduction of strongly redistributive tax policies involving higher financial transaction taxes (such as a [[Tobin tax]]), [[land tax]]es and [[inheritance tax]]es, and, crucially and most importantly, a [[social security]] [[safety net]] involving a guaranteed minimum [[social credit|debt-free income]] (sourced from government-issued debt-free money independent of any central bank) for all citizens in the debt-based economy. Under this proposal, every adult citizen would be given a livable debt-free income transferred electronically into their [[bank account]], simply by virtue of their [[citizen]]ship. They could then use this debt-free money to pay off their [[mortgage]]s or to live, debt-free, without being compelled to work as a [[wage slavery|wage slave]] in the market economy if they chose not to. The government would finance these payments simply by ordering the private banks to accept their electronic instructions as legal tender. It would therefore not result in the expansion of [[government debt]].

Instead of [[money]] being created "indirectly" and "furtively" at the point of [[loan]] creation by the private banking system, with periodic [[bailouts]] to [[socialism for the rich and capitalism for the poor|already-rich bankers]], it would be created directly and openly by the democratically elected government and issued to its [[citizen]]ry by way of instruction to the private banking system.

Rowbotham and Ellen Hodgson Brown both argue in their books that this would ''not'' be [[inflation]]ary (or at least would not be as inflationary or as dysfunctional as the present system).<ref>[http://www.webofdebt.com/articles/hyperinflation.php Weimar Hyperinflation], Ellen Hodgson Brown</ref> This would also reduce [[overconsumption]] and the associated [[Natural environment|environment]]al damage associated with debt-based [[consumerism]]. It would also give individuals the free time to engage once again in non-marketable [[religious]], [[artistic]] and [[recreation]]al activities if they chose to do so.<ref name="death"/>

Ex-U.S. Treasury Department analyst Richard C. Cook also supports the issuance of debt-free money and zero-interest credit by the central government and has provided a detailed blueprint of monetary reform recommendations to transition to a debt-free money supply.<ref name="marketoracle.co.uk"/>

Many monetary reformers who call on the government to take back the money creation from debt-sourced banks also call for full reserve banking to remove the bank's alleged "embezzlement" and "counterfeiting" abilities.<ref name="marketoracle.co.uk"/><ref>[http://www.monetary.org/ AMI website, calling on full-reserve banking]</ref>

It is to be expected that these policies would be violently opposed by the [[private bank]]ing "[[elite]]", as it would render impotent their control over the [[money supply]], dissipating this crucial decision-making power away from its current power base. It would also be likely to reduce [[economic growth]], dramatically increase the cost of [[labor]] and, potentially, simply increase price inflation as individuals used the additional income simply to bid up the cost of health care, education, housing, food and other real assets.<ref>[http://webofdebt.wordpress.com/questions-and-answers/response-to-mogambo-guru/ Response to the Magambo Guru], by Ellen Hodgson Brown</ref> However, this proposal would undoubtedly address the problem of [[inequality]] inherent in a debt-based monetary system and reduce the devastating impact of personal [[bankruptcy]] and allow individual citizens to quickly recover from financial hardship. It would also ensure that this [[social security]] measure (and government spending in general) would not have to be paid for by future generations from future streams of [[income tax]].

===Left-leaning ideas===
Many left-leaning [[social democrats]] would also support the taxing of the banking system and the enforcement of strongly redistributive income and [[land tax]]es to ensure the financially dispossessed are "replenished" with income. They would also support a [[social security]] [[safety net]] involving the provision of unemployment benefits and government-supplied free medical care, education and other essential services and [[public goods]]. It is to be expected however that, without the issuance of debt-free [[fiat currency]], this system would result in the persistent, exponential, accumulation of [[government debt]], financed by the [[private banking]] system by the issuance of [[government bonds]]. If not properly managed, this could result in a progressively higher tax burden and may result in higher [[interest rates]] in the long term, as financiers require higher [[interest rates]] to lend to the increasingly indebted central government. Without the issuance of [[debt-free money]] these policies can be self-defeating, with the net result simply being that a larger stream of guaranteed income goes to the [[private bank]]ing system via the issuance of interest-bearing [[government bonds]] (which are purchased by the [[private banks]] "out of nothing" through [[fractional reserve banking]] techniques). This [[government debt]] must then be financed in perpetuity by compulsorily acquired [[tax]]es from future generations.

It could be argued that the early success of extreme right-wing [[fascism]] in [[Nazi Germany]] and [[Italy]] in the period after [[World War I]] was a response to the economic chaos created by the debt-based monetary system in early 20th century [[Europe]]. Some of the economic policies introduced by [[Hitler]] and [[Mussolini]] were in direct response to the economic collapse and social [[anarchy]] caused by soaring government and personal debt levels in both countries in the post-[[Versailles Treaty]] era, and (indirectly) arose from the writings of [[Silvio Gesell]] and others on the nature of the problems associated with a debt-based [[monetary system]]. Although many [[historian]]s justifiably criticize many of the non-economic policies of the [[fascist]] governments of [[Germany]] and [[Italy]] during this period, it cannot seriously be disputed that the [[economics of fascism]] provided a degree of [[prosperity]] to the populace, and that the economic policies that were implemented during this period by these [[fascist]] governments succeeded in their stated objective of restoring economic and social order during the pre-[[World War II]] era.<ref>[http://www.webofdebt.com/articles/bankrupt-germany.php How a Bankrupt Germany Solved its Economic Problems], Ellen Hodgson Brown</ref>

Similarly it could be argued that [[socialism]] and [[communism]] were movements inspired by the inequalities caused by the intense (and in [[Karl Marx]]'s view unsustainable) concentrations of monetary wealth, power and influence inherent in the practice of [[fractional reserve banking]] in a [[laissez-faire]], [[free market]] [[capitalist]] environment (particularly when [[fractional reserve banking]] is combined with a [[gold standard]] or other [[hard currency]] [[monetary system]]).<ref>[http://www.nakedcapitalism.com/2009/02/steve-keen-roving-cavaliers-of-credit.html ''Roving Cavaliers of Credit'', Steve Keen, with commentary from Yves Smith at Naked Capitalism]</ref>

The [[communist]]/[[socialist]] solution to the problem of [[fractional reserve banking]] is simple: complete removal (and if necessary, violent non-democratic removal) of the allegedly "parasitic" political and financial capitalist class, wholesale repudiation of [[government debt]] resulting in complete debt [[default]]; forced [[expropriation]] of [[land]] and wealth from the [[upper classes]] to the dispossessed and needy [[working classes]]; [[nationalization]] of the [[private banks]] (which has required armed [[coup]]s by the [[military]] in some past [[revolution]]s); and the return of the banking function from a dominant, speculative to a subordinate, administrative institution, where the banking system is reduced to a subservient arm of the centralized [[Leviathan]]. In this system, government-owned banks are directed by government policy; often provide different kinds of loans to different industry sectors at different interest rates depending on the perceived "needs" of the economy and the community; normally have a significant proportion of [[non-performing loan]]s due to weak or non-existent [[bankruptcy]] laws; and periodically "forgive" failed debts in recognition of the impossibility of some businesses in paying this debt money back.

It is to be expected that the [[profitability]] of the government-owned banking system would be more stable - but dramatically lower - than that in a debt-based [[capitalist]] economy. It is also to be expected that a significantly higher misallocation of resources could occur in this system, where lending decisions are "infected" by political considerations and are not made on the basis of expected [[return on investment]]. The risk of [[corruption]] in the banking system is also expected to be higher where there is no separation between the political and monetary systems in an economy. Market-oriented [[monetary reform]]ers and [[neo-classical]] economists therefore do not support [[nationalization]] of the [[private banking]] system.

It should be noted that partial [[nationalization]] of the [[private bank]]ing system would only be temporary, as any remaining [[private banks]] could still engage in unlimited [[fractional reserve banking]] and facilitate the eventual acquisition and control of any strategic assets in a partially socialized economic system. It is to be expected that in the absence of complete [[nationalization]] of the banking system, the [[private bank]]ing system would eventually dominate the financial system in any nominally [[socialist]] society.

===Status under current systems===
Whatever their political leanings, nearly all [[monetary reform]]ers agree that the current mixture of policies prevalent in most Western democracies, involving the perpetuation of government-protected [[private bank]]s (organizations legally permitted to engage in unlimited and inherently speculative [[fractional reserve banking]] activities, with recourse to [[central bank]]s to provide [[bail out]]s of [[fiat money]] as lenders of last resort), [[laissez-faire]] economic policies (which have the effect of increasing the marketization and commodification of human activity), strictly enforced [[bankruptcy]] laws (which permit the periodic transfer of assets from failed [[bankrupt]] investors to the [[private banks]] and their associates) and [[personal income tax]] (which, combined with periodic economic collapses, dispossesses the majority of the populace from their accumulated [[income]] and [[wealth]] and transfers this wealth to the owners of [[government bonds]]) amounts to an inherently unstable, unjust and dysfunctional [[economic system]] resulting in [[environment]]ally damaging [[over-consumption]], the systematic and irredeemable destruction of fertile [[arable land]] and the government-sponsored (and ultimately unsustainable) oppression of the indebted, impoverished and economically enslaved majority.

==See also==
* [[Criticism of the Federal Reserve]]
* [[Austrian Business Cycle Theory]]
* [[Hyman Minsky]]
* [[G. Edward Griffin]]
* [[Michael Rowbotham]]
* [[Monetary reform]]
* [[Money as Debt]]
* [[Murray Rothbard]]
* [[Ron Paul]]
* [[Silvio Gesell]]

==References==
{{reflist|2}}

==External links==
*[http://libertariannation.org/b/money.htm Libertarian Nation Foundation - Money and Banking]
*[http://econpapers.repec.org/paper/wpawuwpma/0203005.htm Fractional Reserve Banking as Economic Parasitism]
*[http://www.prosperityuk.com/prosperity/links/links.html Monetary Reform websites]
*[http://www.jamesrobertson.com/books.htm#creating James Robertson: Creating New Money: A Monetary Reform for the Information Age]
*[http://www.relfe.com/plus_5_.html I want the Earth Plus 5%]
*[http://video.google.com/videoplay?docid=-9050474362583451279 Money As Debt (videoplay animation)]
*[http://libertariannation.org/b/money.htm Money and Banking]
*[http://globaleconomicanalysis.blogspot.com/ MISH]
*[http://maxkeiser.com/ Max Keiser]
*[http://www.webofdebt.com/ Web of Debt]
*[http://www.prudentbear.com/ PrudentBear.com]
*[http://www.marketoracle.co.uk/ Market Oracle]
*[http://www.rgemonitor.com/index.php RGE Monitor]
*[http://www.financialarmageddon.com/ Financial Armageddon]
*[http://elainemeinelsupkis.typepad.com/money_matters/ Money Matters]

{{DEFAULTSORT:Criticism Of Fractional-Reserve Banking}}
[[Category:Argumentation]]
[[Category:Money]]