Main Article Content
The existing bank system, fractional reserve, is inherently risky because it involves accepting deposits while lending out about as much money as has been deposited, and telling depositors their money is safe, which it quite clearly is not and for the simple reason that if a bank makes silly loans, it cannot repay depositors. That problem is currently dealt with via taxpayer backed deposit insurance and billion dollar bail outs for banks. But that state support for banks amounts to preferential treatment for banks relative to other lenders, of which there are several: e.g. peer to peer lenders and trade credit lenders to name just two. That preferential treatment for one type of lender is a misallocation of resources.
Second, having a bank lend on your money is just as much a commercial transaction as having a stockbroker lend on or invest your money, and it is not to job of taxpayers to shield those involved in commerce from loss, unless there is an extremely good reason for doing so, which in this case there is not.
As for the idea which has become popular of late, namely that commercial banks create the money they lend on rather than intermediate between lenders and borrowers, that is not entirely true as was explained in a Bank of England article (McLeay, 2014).
The best solution to the above two flaws in fractional reserve is to abandon all state support for banks while letting those who want their money to be totally safe deposit it with the state, something the people in several countries have actually been free to do for a long time anyway. And that arrangement equals full reserve banking.
Earlier expositions of some of the basic ideas in this paper by the author are detailed in an endnote.
Authors wishing to include figures, tables, or text passages that have already been published elsewhere are required to obtain permission from the copyright owner(s) for both the print and online format and to include evidence that such permission has been granted when submitting their papers. Any material received without such evidence will be assumed to originate from the authors.
Fitzpatrick, A. & Lien, B. (2013) ‘The Use of Trade Credit by Businesses’. Reserve Bank of Australia.
Friedman, M. (1960) ‘A Program for Monetary Stability’ Fordham University Press.
Fuller, E.W. (2019), ‘100% Banking and Its Advocates: A Brief History’. Cobden Centre.
Huber, J. and Robertson, J. (2000), ‘Creating New Money’, New Economics Foundation.
Kotlikoff, L. (2012), ‘The Economic Consequences of the Vickers Commission’, Civitas.
Laina, P. (2018), ‘Full-reserve Banking – Separating Money Creation from Bank Lending.’
McLeay, M., Radia, A. and Thomas, R. (2014), ‘Money creation in the modern economy’, Bank of England.
Musgrave, R.S. (2014) ‘The false logic at the heart of fractional reserve banking’.
Musgrave, R.S. (2018a) ‘The basic flaw in our bank system is simple.’ Medium.
Musgrave, R. (2018b), ‘The Solution is Full Reserve / 100% Reserve Banking’. KSP.
Musgrave, R. (2020a) ‘The Crucial Flaw in the Bank System’. Munich Person RePEc Archive.
Musgrave, R. (2020b) ‘The Crucial Flaw in the Bank System’. Medium.
Nair, M. (2013), ‘Questioning Rothbard’, Foundation for Economic Education.
Rozeff, M.S. (2010), ‘Rothbard on Fractional Reserve Banking: A Critique’, Independent Review. Vol. 14, №4 (Spring 2010), pp. 497–512.
Schutte, S. (2015) ‘Telling the truth about SME life today’. Real Business.
Tobin, J. (1987), ‘The case for preserving regulatory distinctions’. Proceedings — Economic Policy Symposium — Jackson Hole, Federal Reserve Bank of Kansas City, pages 167–205.
Uesugi, I. (2013). ‘Maximising Value of Non-Performing Assets’. OECD.
Walker, J. (2012). ‘Bankers, Bradburys, Carnage And Slaughter On The Western Front’. UK Column.
Wolf, M. (2014), ‘Strip private banks of their power to create money’. Financial Times.