Financial Collapse & Fractional Reserve Banking Practices
With the world economy teetering on the edge of disaster there has been a great deal of discussion of late about high finance, and the financial practices of various high-level institutions within the global economy. For those who have looked deeply into this matter, there will be some familiarity with the term fractional reserve banking, or fractional reserve lending, something that would appear to be at the core of what is wrong with the global financial system. As engaged in by banks and other lending institutions throughout the Western world, fractional reserve banking is often cited as being extremely detrimental to economic health, and not just by small groups of outsiders, but also key insiders.
In this current essay, fractional reserve banking is thus the core focus, with certain other related areas to be covered, as will aid a general understanding of the key principles of monetary theory.
1) Economies Based Purely Upon Wealth
2) The Invention of Money
3) How Exactly Banks Loan Money to People via Fractional Reserve Banking
4) The Bank of England & Monetary Expansion Based on Gold
6) Financial Collapse & Devaluation
In the Beginning…
In order to arrive at a society which engages in quite complex and advanced monetary practices, one has to start out in the beginning with simple relations existent between men, in simple communities. And herein I need to tell a certain story. It is an introductory story and although not historically precise, for indeed the entire subject matter is quite vast, it will serve our purpose, in explaining the evolutionary steps - the key stages that will lead to advanced forms of wealth transfer and also the invention of money.
In simple hunter gatherer type communities there are very few things that are produced and exchanged between people, as the needs of such societies are very basic. Primarily they are the necessities of life. Hunting and fishing may provide food, and then there is building. Building of shelters and also manufacturing clothes. The way in which such basic communities thus trade between one another will be limited towards transactions involving only a small number of items. When however the society becomes more advanced and more specialist and more products of a wider variety are created, it can then become very difficult to efficiently exchange goods and services between people in direct barter transactions.
Now, in consideration of such transactions even within a simple community, it is important to understand from an economic perspective that the fruits of all human labour may be defined as wealth. Fish caught from the sea through human endeavour is but one example. If someone catches it and holds it in their hands, going so far even as to cook it, it thus represents a certain measure of wealth, recognised by the mind of man itself as having value. Moreover, if one were to catch some fish and choose not to cook and eat it all straight away, because of an excessive haul, one may think to trade the surplus to obtain some other product they may be interested in: say a pair of shoes. And in this they would have to consider in their mind just how many fish would a shoemaker want in exchange for a particular pair of shoes they had manufactured. One can see this line of thought extended to ever greater levels of complexity.
Now just sticking with the example of fish for the moment. Fish itself is quite perishable and does not last, so if one had caught a surplus of fish one would want to get rid of the surplus quite quickly in exchange for something else. Indeed, one could not actually rely upon “storing” one’s wealth “within” the fish so to speak, over long periods of time, as it would not keep fresh for any extended period before going rotten. As a result of such considerations – and one of any number of examples could have been chosen here, not just fish - what tends to happen then over time, is that there is an almost natural move – even within the mind of man itself – towards a store of wealth that is imperishable. Not just this however, but one that is also convenient from a practical standpoint. The usual characteristics as readily appear to define an ideal store of wealth are generally given as follows:
1) Rare - not easily obtained
2) Portable - easy to transport
3) Durable over extreme periods of time - non perishable
4) Able to be split up uniformly into equal measures
Indeed, the ultimate, most preferred form of wealth, is in fact some sort of chosen substance within the physical realm that manifests most efficiently a natural system of counting numbers: 1, 2, 3, 4, 5, 6 … etc. up to infinity.
And herein of course, I'm leading one to consider that most prized of all metals throughout the ages:
Gold fulfils all of the above criteria, and today, as in the past, is manufactured to extreme purity and uniform standards, and split up into discrete units primarily in the form of coins and the bars.
And thus from a primitive society, one can see how, the more complex it becomes, and the greater the number and variety of products or even services within such an economy, there is almost a natural progression towards storing wealth in the most abstract of products. A product which is infinitely useful as a medium of exchange and yet seemingly, even paradoxically, infinitely useless and inert as a physical substance. Indeed, there is a great mystery in this.
In considering the flow of wealth between individuals, one has then a great variety of products within an advanced society; an emergent preferred form of wealth meeting all of the aforementioned criteria naturally establishing itself as the key medium of exchange through which they are transferred. And this leads one on to consider what is one of the greatest and most important aspects of wealth exchange, and of value itself: equilibrium.
Equilibrium is tied in to stability. In the exchange of goods and services there is a natural tendency towards establishing equilibrium. In a stable economy, the value of one's preferred form of wealth, such as gold for example, would not fluctuate in one's mind too much over time, relative to the products on offer within society. However, sometimes an event can occur which throws the value of wealth into chaos, which ultimately gives rise to a fundamentally different value for the preferred form of wealth; establishing a new equilibrium level. This is a key point to understand and will serve us well in the later stages of this presentation. And so an example will be given here to illustrate the point.
Let us consider a relatively low-level economic system, in an island community that has developed such, that pearls, have become the preferred form of wealth, the key medium of exchange between all forms.
The Pearl Community
Now to give some background… it is well recognised that pearls grow within pearl oysters, of the family Pteriidae, which live in oceans. Saltwater pearl oysters are usually cultivated in protected lagoons or volcanic atolls. And, before the beginning of the 20th century, pearl hunting was the most common way of harvesting pearls. Divers manually pulled oysters from ocean floors and river bottoms and checked them individually for pearls. Not all mussels and oysters produce pearls. In a haul of three tons, only three or four oysters will produce perfect pearls.
Let us consider then a community of people who live on a group of islands. There are many tradesmen and merchants producing many assorted products, and certainly this is no economy of an extremely primitive nature. But the key industry is that of diving for pearls. An activity that is quite arduous, and to an extent somewhat dangerous. Those that harvest pearls are primarily responsible for obtaining for the community its key medium of exchange and preferred form of wealth: high quality pearls.
Now the rate at which pearls are obtained from the oceans is quite stable over the long years, and the population and demography of this community is also relatively stable, and indeed, in the minds of men, there is a general understanding and pricing associated with all items as are traded via pearls. A number of pearls could be equated to the price of a pair of shoes for example, or to a suit. And indeed a number of pearls could also sum up the price of a house. Etc, etc.
Assuming such an economy exists as described, one may consider what would happen if one day a remarkable event occurred. A lone individual was walking along the beach and found that a massive amount of oysters had suddenly washed up on shore. Curious, he decides to open a few, to find pearls within each one. Knowing that most of the time they do not contain great quality pearls he was surprised that the first few he had opened did. And so he opened more. Within each one he opened he found high quality pearls. He quickly stuffed them into his pockets and in a bag he had with him… and then, he went on a spending spree in town. He started to buy up all kinds of items. And then he went back for more pearls. And then he tried to buy property; houses and apartments. People became suspicious though, and followed him back to the beach. There they found the stack of oysters for themselves, and then there was a mad rush on to harvest as many pearls as possible. More people quickly went into town and started to spend the pearls.
Economic activity was increased, with a heightened exchange of wealth and products between people, via the medium of exchange, that was the pearl. However, it rapidly became apparent to the merchants that something was not quite right. As more and more people went down to the beach to harvest more pearls and return to try to purchase products, the merchants and tradesmen increased their prices. It was practically a natural response.
Now why would they do this?
Because everyone has an understanding of justice and fairness and the value of one's efforts and work. And they would know the time they have spent to produce their products as they offer for sale. Ordinarily, it would have taken a great amount of effort to get the pearls out of the ocean and for them to find their way into the economy. But to obtain such pearls without hardly any effort at all would mean that their value is hardly anything at all. And so the prices would rise naturally – in the very mind of man - to combat such an unnatural economic activity and exchange of goods and services, via a disruptive influx of pearls, the most preferred form of wealth, washing up on shore overnight in extreme quantities.
Now within this particular event, it is very important to note something about how it plays out. The first few people to amass the pearls as washed up on shore and to spend them into circulation by exchanging them for other forms of wealth, gain the advantage, and in extreme cases can amass fortunes in terms of physical assets. But those that come afterward - the last in line so to speak - they see their wealth essentially looted; lost, and decreased in value. This is an important point to note, and is especially critical when one considers, as will later be discussed, the principle of counterfeiting.
So far, we have considered primarily economic systems that have evolved purely to the level of an exchange of wealth i.e. manufactured goods and products, or even services, as are made available. All these being exchanged amongst people via a preferred form of wealth which emerges over time. In the example just given, one cited a community that found its way into developing an economy wherein pearls as harvested from the ocean became the preferred form of wealth. But let us return though to gold, and to the advancement of the physical economy within the Western world, as gave rise to the invention of money. Indeed, it is important to realise, though thus far not stated explicitly, that gold is not money, and never has been. Gold is wealth. However, it was the emergence of banking institutions throughout the Western world over past centuries as dealt in gold storage, which ultimately gave rise to the invention of money.
The Gold Based Economy
Let us consider another advance of history. A sort of idealised example that will not perfectly match history, but which is presented by way of convenience in order to explain certain key principles as are the core focus of this lecture. In a Gold based economy - that is, where gold is the preferred form of wealth, how does money arise, and indeed corruption along with it?
Let us consider England as a country sometime several centuries ago. A relatively advanced economic system, with many goods and services available at a price, with the preferred forms of wealth in circulation being a combination of gold and silver coins; all standardised units, exceptional in their purity and uniformity.
To simplify things, let us consider two key coins of the realm. One is a gold coin bearing the head of our sovereign. It is a 1 ounce coin in its weight. The other is a silver coin also bearing the head of our sovereign, and also 1 ounce in weight. They are fundamentally different metals, and thus are qualitatively different, though of the same weight. And it is for this reason that we need a numerical system of units - simple counting units - with a name to describe such units, as will allow us to give a relative value of the coins. We call the units in question, Pounds. And one can see that the gold coin has a stamped value of exactly £100. The silver coin has a stamped value of just £2 pounds. In this instance then the gold coin is 50 times more valuable than the silver coin.
One may envision then an economy in England wherein many goods and services are exchanged via this preferred combination of metals; both gold and silver. So far, all we have at this point is an economy based purely upon wealth transfer. It is important to realise that at this point, money does not exist. So how might money come into existence then?
The Invention of Money - The Basis of Fractional Reserve Banking
Well, it is at this time that a group of individuals, quite wealthy men, come together to create a new business venture. They propose building a fortified structure with a very secure vault, and seek to offer people the opportunity to store their gold and silver coins with them; a much safer place than their own homes. The business in question is known as a bank. Now these men of means are not the kind of men who seek the limelight, and invest cautiously behind-the-scenes to create their business. But they appoint a governor to manage their bank. In this case, his name is Sir John Houblon.
Now after the building is constructed along with the inner vault, there is a certain marketing campaign that is rolled out to the masses. “Come and deposit your gold and silver in our vault. We offer you secure protection in exchange for a small service charge.” It sounds wonderful, and indeed quite honest, and at this point - it is.
One can imagine the first customers to go through the doors of this bank, this new institution. Consider a man who might have 5 gold coins, each 1 ounce in weight, with a nominal value of £500. When he goes into the bank to see Sir John he puts his five gold coins on the counter and says, “I would like you to store these within your vault.”
No problem says Sir John, he takes the man's coins and deposits them in the bank’s secure vault. And then he says to the man, I will need to give you a receipt for your coins so that you might come and collect them any time you wish. Now Sir John has a remarkable printing press able to produce receipts quite elaborate in nature and unique to his establishment.
Cranking up his printing press Sir John prints out 10 slips of paper, as follows:
One may note the image of the sovereign - in this case Queen Elizabeth the Second - and the title of the receipt: Bank of England, and underneath it the words are printed, I promise to pay the bearer on demand that the sum of - and then underneath this £50. Sir John hands over 10 such receipts to the individual with a face value of £500, to match the £500 stamped as the face value on the five gold coins that he has been given.
We have now just invented money where before, it never existed - a necessary step in order that fractional reserve banking might emerge.
The definition of money is: money is a claim upon wealth. The gold is the wealth, and the paper receipt is the claim upon that wealth, being the money.
Now one might consider another individual of slightly less means who shows up with five silver coins bearing the stamp of two pounds each.
In depositing these in the vault of the Bank of England Sir John prints out a receipt for £10, as can be seen in the following images.
Now in starting off small, business expands massively, and a great many people deposit coins of gold and silver in the vaults of the Bank of England, and those of exceptional wealth even deposit bars of gold also. In all cases receipts are printed out and issued to all the people who deposit their gold and silver with the bank. Their face value, in terms of the numerical value of pounds of the sum total of the receipts matches the stamped value of the metal itself in terms of pounds, be it either gold or silver. Indeed, so successful is this type of business that many other banks spring up as well with their own vaults and their own receipts offering safe storage of wealth. And as a result of this a great deal of gold and silver is stored within the banking system as a whole throughout England.
Now let us pause.
In economic terms, has there been any real change? The answer is no. There has been no disturbance in equilibrium, as is so critical to a functioning economy and the stability of the preferred form of wealth. At this point, although money has been created and introduced into the economy, there has been no real change to the system. This is because when a person deposits their gold or silver into the vaults of the banks, it then becomes inactive so to speak. For they now have possession of paper receipts which have the same face value as the gold or silver in the vaults. The paper substitute is now thus “active”, in the sense of being out in the wider world, as the gold is rendered “inactive,” being held in storage in the bank. And thus equilibrium is maintained.
As time passes a great deal of gold and silver is amassed in the vaults of the Bank of England that Sir John is running. And he begins to take a keen interest in the books and ledgers. What Sir John finds is that the sum total of all the deposits approximates just under some £1 million. Quite a vast sum of money for the time. Specifically, he notices when he looks carefully at the books that over time the total deposits seem to fluctuate roughly between £1 million and £900,000, with a very consistent measure of gold and silver of at least some £900,000 being in the vaults at any one given time. Apparently, people seem quite confident and willing to let their gold reside in the vaults of the Bank of England over long periods, with only a £100,000 fluctuation of withdrawals and deposits between the range of 1 million and 900,000.
And the reason for this?
Sir John’s receipts as printed, which constitute the money, simply state, "I promise to pay the bearer on demand, the sum of…” And the bearer could be anybody; anybody who presents the notes to the Bank of England for redemption. It does not need to be the original person that was given the money when they deposited their gold or silver with the bank. As a result, Sir John finds that when people have deposited gold and silver within the vaults of the Bank of England and taken a monetary receipt, rather than automatically come back to the bank to withdraw their gold when they wish to buy something from a merchant, they give the merchant their receipt in exchange for the goods they wish to buy; and not all merchants will ordinarily immediately cash the receipts in themselves. Essentially, many people seem to be simply buying things directly with the monetary receipts themselves without always coming back to the bank to withdraw their gold or silver, to use the metal itself to make a purchase. And this explains why there is a relatively stable measure of gold and silver at the bank, of approximately some £900,000, with only a slight fluctuation of £100,000 worth of deposits and withdrawals between this value and £1 million.
Now, with such a state of affairs, the men who own the Bank of England, becoming aware of this fact, hatch an incredible, even fantastic idea – one that they hope will make them very wealthy indeed – more so than they already are. On the surface it seems simple enough, and yet the means by which they realise that idea almost perplexes the mind.
Sir John, who is running the bank, is told by the owners that the bank will now, rather than simply just store gold and silver for safekeeping, offer loans to people, at interest. But, that this shall be done in a most peculiar way. And it will not involve the owners of the bank using their own private gold. Rather, the people who have deposited gold within the vaults of the Bank of England, will have their gold loaned out, and by such subtle means that they will not even know that it is being done. In fact, so cunning is the method, that the precious metal deposits are loaned out without ever leaving the vaults of the bank, and certainly, the depositors themselves are never made aware of what is truly going on.
The Emergence of Fractional Reserve Banking
Once Sir John informs the public that the Bank of England will issue loans, one can imagine the first customer enter the premises. Going up to the cashier he asks that he be allowed to borrow a sum of £10,000. The cashier agrees, provided it be repaid over the course of one year with £1000 interest. With both parties accepting the conditions the cashier proceeds to note up his books that the individual in question has been loaned a sum of £10,000. But does the cashier then hand over £10,000 in gold to the borrower? No. What the cashier does is use the printing press of the Bank of England to generate £10,000 worth of money. This could be in the form of 200 £50 notes for example. Once they are printed off they are handed to the borrower and he walks out of the bank, no doubt with a careful plan to spend the money on something.
Now let us pause to consider this for a moment. Up until this point, paper money was only ever created when a person came to deposit some gold or silver, with a face value of the paper money created equalling the stamped value of the gold or silver itself. Now however, newly created paper money is issued when a loan is made, without a measure of gold or silver being received by the Bank of England to put in its vaults. In this situation one might be forgiven for thinking that the monetary claims of those who deposit a measure of precious metals would and should be backed up directly by the gold and silver they deposited. And that the monetary claims that are created when a person is loaned money, would have no real backing at all. Nothing would essentially “stand behind” the Loan Money.
On a point of principle, there is truth to this. However, principles can be corrupted in our imperfect world, and that sadly is definitely the case here. For indeed, whereas on principle, it is true that the “loan money” is backed up by nothing, in practice there is a subtle means by which it does have a certain backing. For consider, were the one who borrowed the money to take it to a merchant to buy something, the merchant, if he accepted the notes based upon the reputation of the Bank of England as an honourable institution, may immediately come to exchange them for gold. Were this the case, the cashier at the Bank of England would have no way of knowing or linking specific monetary notes to specific gold or silver deposits. They would simply give the merchant a measure of gold from the vaults as reflects the face value on the notes put forward, and once the notes are back in the possession of the Bank of England they could essentially be destroyed. And thus there is a most subtle form of backing that the “loan money” has. And this is achieved, if one considers the relations carefully, by the Bank of England essentially creating multiple claims upon the same gold and silver deposits. A fantastic slight of hand to be sure.
It is very much like a game of musical chairs in many respects. Whilst the music is playing and everybody is dancing around, there are less chairs than there are people stood up. If some people decide to sit down and take a rest they may do so. And then they may get up and continue dancing. And indeed, everybody may take a similar rest, provided they do so at alternate times. If ever a situation arose though when everybody attempted to sit down at once, it would quickly be revealed that there are not enough chairs for everyone. At least one or more of the people would be disappointed. In considering then how the Bank of England operates in simultaneously issuing money when people make real deposits of gold and silver, and also issuing money when people do not make such deposits, but instead are granted loans, it should be clear that at any given time, the face value of all the monetary claims issued by the Bank of England in the hands of private individuals, will exceed the stamped nominal value in pounds of all the gold and sliver within its vaults. And thus were all claims presented to the bank at the same time for redemption in gold or silver, the Bank of England could not honour its signed promises – to pay the bearer on demand the wealth behind the claims. Now one should not shy away from the correct term as would most aptly describe this state of affairs: fraudulent
The activity is fraudulent because it rests upon counterfeiting money. The money issued as loans on principle truly is created from nothing and backed up by nothing, and this indeed is the very definition of counterfeited money:
Counterfeit money defined: created from nothing and backed up by nothing.
Now honest money by contrast, is that which is created from nothing, but backed up by something. The something that backs up honest money is the real gold or silver, which has a measure of human activity behind its manufacture - which indeed is the true backing.
Expansion of the Money Supply via Loans
With the mathematics as stated previously, that there is a 10% fluctuation in people redeeming their money for gold and re-depositing it, with a healthy – so to speak – £900,000 in stable deposits of the precious metals within the Bank of England at any one given time, one might consider just how much money the Bank of England could risk issuing as loans and still be relatively safe, in playing its financial game of musical chairs. The answer is quite a large measure indeed. A staggering £9 million to be sure.
Assuming £1 million has been deposited in terms of gold and silver with the Bank of England, there will be £1 million of paper monetary claims issued by the Bank to match the deposits. Now if the Bank of England were thus to issue loans to the total of £9 million - that is, a sum total of £9 million of paper claims created and issued without someone depositing a measure of precious metals to back them up, then in total, there will be £10 million of paper claims in the hands of members of the public. £10 million of claims thus set against a mere £1 million of gold and silver in the vaults. In so extending loans to this limit, the Bank of England effectively turns the entire mathematical proposition on its head, and puts the entire gold and silver reserves in the vaults into play, with there being a fluctuation of the whole of the reserves, from £0-£1 million over a given time period. This is the theoretical limit that the Bank of England would not dare go beyond. For indeed, if more than £9 million worth of loan money were issued, people would start showing up at the bank to redeem their paper money for gold and silver, only to be told that the vaults were empty. And that would be the day of reckoning for the Bank of England, and the collapse of the institution.
At this extreme end of the mathematics, it is similar to playing a game of musical chairs where there are 10 people dancing around just one chair. One of the dancers may wish to sit down to take a rest, and after doing so they may stand up and begin dancing once more. And then another dancer may wish to do the same. But one can see however that with so many dancers around there is a heightened level of danger that someone may wish to sit down when the chair is already occupied - and then the game is up. It is exactly the same with the issuance of loans as described. The more loans that are issued, the more the gold and silver reserves are fluctuating and tapped into. Too many loans issued - or loan money issued - will mean going beyond the critical threshold when the paper monetary claims cannot be honoured, and then the institution itself collapses. Insolvency and bankruptcy is the ultimate conclusion. The price of running a dishonest business based upon fraudulent practices. In this instance, we call this kind of fraudulent lending, fractional reserve lending. And this is because quite simply the gold or silver, which is the reserve, is a mere fraction of the claims upon it. Multiple claims are made on the same measure of precious metals, and this by way of counterfeiting all of the loaned money that goes out into circulation.
The Effect of Fractional Reserve Banking Upon an Economy
When one has the emergence of banks in any large number which begin the practice of fractional reserve banking, the extent to which they issue out loan money created through counterfeiting – i.e. created from nothing, is the extent to which one has a flow of money enter into circulation that is not backed by any underlying wealth. And thus if this money enters into circulation as consumer-based loans wherein the person who borrows the money simply goes out and spends it, then there will be a general devaluation of the preferred form of wealth. The gold or silver.
One should remember the Pearl-based community as noted previously. Pearls were the preferred form of wealth, and upon the day when there was a massive influx that washed up on shore, with everybody clamouring to harvest the pearls and acquire goods and services within the economy, there was a severe rush towards a new equilibrium level. The pearls being introduced into the economy as they were without any effort required to harvest them through arduous fishing, meant that they were essentially backed up by very little indeed. And it is the same with monetary notes created from nothing flooding into an economy with no real gold or silver deposit directly backing them, to serve as a justification for their very existence. If an economy gets swamped with a high measure of loan money created from nothing, then this indeed reduces the value of the precious metals as are existent within that selfsame economy.
Now there is indeed a very important point to make here with respect to a fractional reserve banking system as described, with gold and silver deposits acting as the reserve. When one begins to create via counterfeiting, new claims upon wealth, one is essentially causing a rupture between claims upon wealth and actual wealth, and creating a mathematical structure which is no longer in harmony with underlying physical reality, and this is potentially very dangerous, especially when one adds in usury – the loaning out of money at interest – that is, demanding that it be returned back by a set due date, with more on top.
Consider the position of the banker with respect to the loan money that they issue.
Let us assume that a person takes out a £10,000 loan from the Bank of England, with the bank creating the £10,000 as loan money from nothing, and that they require that the borrower return the £10,000 – being the principal, with an extra £1000 interest, one year from the date the loan was granted. We must remember, that the £10,000 loan money is counterfeited into existence by the bank and has no gold deposit backing it. As a result of this, the very last thing that the Bank of England will want at the end of the year will be for the borrower to return £11,000 – the principal and interest, in paper money that was originally issued and put into general circulation by the Bank of England itself. The reason is quite simply that the bank will have to destroy the monetary notes upon their return, as they are backed by nothing. And the bank will have made nothing as a result. In truth, what the bank really wants and what they will stipulate as part of the loan deal is that the borrower returns £11,000 in actual gold or silver.
Now let us think on this. The bank counterfeits at practically zero cost to itself some paper money with numbers and symbols on it claiming that it is backed up by £10,000 of precious metals, when it certainly is not. They then demand that the individual who borrows the money returns back to them actual physical gold or silver, for both the principle of £10,000 and also an extra £1000 in interest. The bank most certainly does not want its own notes returned back to itself to discharge the loan, as it will have made nothing upon the entire deal over the course of the year.
All banks, in rivalry with one another, will be of like mind. What then is the result?
To illustrate, there will be an extension of some of the mathematics as already given. Let us assume that in the economy of England, the total amount of precious metals in circulation – the preferred form of wealth – is some £5 million. And let us assume that at this time, rival banking institutions spring up in order to do business. With their marketing campaigns offering a safe place for people to store their gold and silver, they manage to secure between themselves deposits of £1 million. That is to say, that £1 million worth of gold and silver is deposited within the banking system of the country as a whole, and thus £4 million remains outside in the hands of private individuals. Now, with such a sum within the banking system, the banks begin to issue out loans. In line with the mathematics of the expansion already detailed previously, the banking system as a whole will be able to significantly multiply through counterfeiting, or fractional reserve banking, the amount of money in circulation. There will be £1 million of money issued by the banks which was done so when people actually deposited £1 million of precious metals. With an additional £9 million of money issued as loan money via counterfeiting, which is backed up by nothing. There will thus be about £10 million of money in circulation and only £1 million of gold within the banking system to back up that money. And, as also noted, about £4 million of gold remains outside of the fractional reserve banking system and in private hands.
Now here is the key point to note. It is a very arduous and time consuming task to mine precious metals and fashion them into bars and coins. And as such, with an initial supply of some £5 million of gold and silver within the economy, it should be noted that due to the mining activities of various companies within the realm, the measure of new gold and silver put into circulation each year is very low. In fact, only about £100,000 of new precious metals are mined each year and converted into physical gold or silver bars and coins. This then is the real rate of expansion of the preferred form of physical wealth within the economy.
The reality of this situation must be set against the mathematical expansion of the money issued by the banks, and the rules which govern the loan deals they arrange. Now in general, most loans are such that they require repayment over a course of several years. However, when one considers carefully the scenario as detailed, bearing in mind that the banks will want payment of the £9 million as loaned in actual gold or silver, and with interest on top, it should be obvious that there is not enough in existence as manufactured and within the real economy, to successfully allow people to pay off their debts. The rate at which the loans will be repaid, will be, as a flow rate, far greater in speed than the flow rate at which the gold and silver supply itself increases. There will thus be many people attempting to vie for possession of the £4 million in gold outside of the fractional reserve banking system in order to pay off their loans, and indeed, many people who have taken out loans will be successful, but inevitably, a great many people will fail to repay their loans, simply because there is a complete lack of harmony between the artificial structure devised by the banks that govern their loans, and the underlying real physical variables of the economy upon which their loan deals ultimately rest i.e. primarily the gold and silver supply. The system is fatally flawed and cannot offer success to everyone.
The general way in which the scenario will play out, is that upon the initial creation of new money via loans, there will be a heightened level of economic activity within the country with many goods and services changing hands. It will be “boom times” so to speak, and everyone will appear to be prospering. The key word though is appear. For as time passes, many people will inevitably end up defaulting on their loan repayments and going bankrupt, with the banks themselves attempting to seize control over whatever collateral may have been put up for the loans. Quite simply, there is not enough gold and silver within the real economy to allow everyone to repay their debts. And indeed, the more time passes, the more furious the competition will be between people to acquire the necessary precious metals in order to keep up their repayments. Men will become desperate. But however desperate they become, the truth of the matter is that failure is guaranteed for a sizeable portion of the economy. It will be impossible for everyone to successfully acquire the necessary gold and silver as demanded by the banks to cover their loans.
Collapse Under a Fractional Reserve Banking System: The Bank Run is On!
As things proceed towards financial collapse under the fractional reserve banking system there will be the inevitable bank run. And this may be dealt with in one of two ways, and one may reference again the Bank of England Accounts to illustrate this point.
Previously then, it was noted that with £1 million worth of gold deposited within the bank, the Bank of England could expand its monetary claims through issuing them as loans such that in total it could put into circulation approximately £10 million. Now assuming there was a general bank run and everybody who possessed claims all rushed to the bank to redeem them at the same time, the Bank of England could do one of two things. It could allow the first people through the doors to redeem their claims in full, such that £1 million of gold was turned over to people presenting the first £1 million worth of monetary claims. The Bank of England would then have to shut its doors and tell all the other people amassed outside with their £9 million worth of claims that they had simply ceased to be of value and were backed by nothing, essentially fit for burning. That is one solution:
The other thing that the bank could do is to devalue all of the claims by decree (what Roosevelt did in the US in 1933 by way of example). And tell all the people amassed outside before any even entered the premises, that instead of one pounds worth of paper money equalling one pounds worth of stamped gold, that now £10 of paper claims was equal to 1 pound of stamped gold. Thus, if a person had honestly deposited a single 1 ounce gold coin with a stamped value of £100, and had initially received £100 worth of paper money e.g. two £50 notes in exchange, then that person would be told that if they wanted to collect their single 1 ounce gold coin, they would have to produce £1000 worth of monetary claims. The bank would thus be able to satisfy all claims to one 10th the original measure. This would be how they would deal with handing the gold back over to all those with monetary claims, with the claims themselves being returned back unto the bank to be effectively destroyed. As indeed, upon redemption, monetary claims are always destroyed; with the wealth rightfully claimed back being all that remains. And thus the true reality of the physical economy remains in a purified state, when all money is destroyed upon the day of reckoning:
In conclusion, it can be seen then that a fractional reserve system based upon a combination of counterfeiting and usury is one that is inherently unstable and fraudulent. It is a system that is artificial and at odds with underlying real physical variables. When such a system is born it will have a temporary existence creating artificial activity of an unnatural type, to be sustained for a time until there is an inevitable day of reckoning wherein the system collapses, wiping away all fraudulent claims and re-synchronising wealth with its true owners. Money is destroyed, and the true order of affairs is re-established once more.
Physical Collapse of a Fractional Reserve Banking System
One should consider though just how the situation will develop on the ground. As a case in point, many merchants who accepted the loan money, as counterfeited, in exchange for their goods or services, may well attempt to redeem it from various banks within the economy, overwhelming them and causing them to collapse. Moreover, in addition to this, honest depositors who put their money in various banks for safekeeping may find that when they come to redeem their own legitimate claims, with the money that they were issued which was not counterfeited into circulation, that the vaults are empty and they have lost their deposits. The economy will thus go into a state of ruin, suffering instability and chaos, with a massive disruption to real industry affecting the lives of real people, not only causing economic hardship but quite possibly in extreme circumstances causing a general breakdown of society itself. And this may indeed literally cause the death of a significant number of people, primarily though disruption to essential food supplies and other basic necessities of life, that people rely upon and can only obtain when the physical infrastructure of the country is properly functioning.
For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath.