Reply To: Is Fractional Reserve Banking Inflationary.. or not really?


Got it. I now have to thank a friend of mine who is a skeptic and who managed to confused me the other day. But all this now pushed me to a new level of understanding.

It’s kinda interesting to look at this from a sort of temporal aspect. Fiduciary media “appears” for a millisecond and then immediately “disappears”, confusing the observer to think that money supply has not been expanded.

What I mean is the following…

In the naive (very old-fashioned) way of thinking, if I deposit $10 in the bank, and the bank lends 90% of it to someone else, then (if this was really-really money) I should not be able to use it anymore. The money is simply physically gone from my account.

But that’s not how things work… I deposit $10, nine dollars go to someone else, but I can still use all of it at any moment! I can still buy that $2.50 croissant using the money that is not there!

So what happens, from my point of view as a consumer and a customer, when I go to bakery and ask for $2.50 croissant, offering my debit card while supposedly having only $1 “really present” in my “$10 account”? The fiduciary money “springs into existence” for a millisecond, just enough for the machine to write “approved” and other related electronics to flicker things through, and then it disappears from the realm of physical phenomena.

This “quantum of fiduciary media” has to spring into existence (to start a physical chain of events) at least for a very short while (millisecond, nanosecond, depending on the electronics involved). But in the old-fashioned, naive viewpoint, since the money is not there it could not spring into existence even for that nanosecond, since it is not physically present, and so the exchange of goods and serviced can not happen.

All this is very confusing to a common, uninformed mind. This “brief springing into existence” of fiduciary media makes the temporary (yet substantial, effect-producing) increase in total money supply.

There is an interesting analogy in Physics. We all know that the total energy of a closed physical system is conserved, and that nothing can ever break that law, right? Energy can change its form but not the total amount. Well… until quantum theory arrived. In this theory, brief quantum fluctuations can “spring into existence” without costing any energy, cause observable effects, then disappear, remaining unobservable. This is pretty much how I now see these.. how to call them.. “fiduciary-money fluctuations”.

So, the fact that banks must hold only a fraction of a deposit as reserve and can lend the rest is not the reason money supply is expanded. So blaming just the fractional-reserve-requirement is not correct. The real reason is that commercial banks are allowed to use these deposit-receipts (IOU’s) among themselves as if they were money. Something that is totally-not-money is used as money, and they have a sort of monopoly on this (granted by the government).

This was very helpful to me, thanks again.