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Fractional Banking Misrepresentations

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COMMENT: Hi Martin,

FYI – I personally think the confusion on this topic comes from the University.  I was a student 20 years ago and studied finance.  This is what we were taught – The money supply expands with lower reserve requirements.  It should really read the money supply would expand with a lower reserve requirement and willing parties with confidence to loan and borrow the extra leverage with the emphasis on CONFIDENCE.  I know it would never happen, but a class action would feel good against the people who claim to be experts and should be judged using the expert standard.

Thank you for the free education.


REPLY: You have put it correctly. This is why we have this insanity of lowering rates to negative. The missing element is CONFIDENCE. A simple correlation reveals that there is no empirical level of interest rates that ever marks the high. This is because the missing element is the public sentiment – CONFIDENCE. People will not borrow unless they BELIEVE they will make a profit so it is the differential between the interest rate and the expected gain.

Additionally, we are screwed not because of fractional banking for the people respond to the economy unlike government, but because government is the biggest borrower. The central bank CANNOT control inflation any more than it can stimulate a depression when the biggest player is government. Whatever the central bank does to the economy has no impact upon government for they will borrow perpetually year after year. They will never reduce taxes to stimulate or cut spending to reduce inflation. They are amplifying the boom bust cycle.

This is why we have to eliminate government debt, but we must prevent government from borrowing. Keynes advocated deficit spending during a depression but during a recession he recommended lowering taxes. Government will never see itself as the problem for that is always us. They do not grasp that the central bank can create money out of thin air doubling the money supply from say $1,000 to $2,000. But if government raised taxes from $500 to $1500 that will be DEFLATIONARY. QE1-3 demonstrated that increasing money supply is NOT inflationary for this is more like a contango. Whatever they increased was more than offset by the capital destruction during the contraction and the tax increases and enforcement that keep rising. It is the NET we must pay attention to – not only one side of the coin being what the Fed does with money supply.