Most people don’t think about our fractional reserve banking system much on a day-to-day basis, and who can blame them? If you’re into feeling safe and secure, some ideas are better left unpondered. For now, let’s look at the history of where this goofy system of banking came from.
Up until the 1800’s people who wanted to keep their gold and silver coins safe would deposit them with a goldsmith. In return, they would receive a note for their deposits. Eventually people begin to trust this system and paper money was born. Most note-holders felt secure because they knew that a physical commodity stood behind every single note that was in circulation.
As the notes became used more and more in trade, goldsmiths noticed that people usually would not redeem all their notes at the same time. “Ah ha,” they said. “We’ve got all this coin sitting here doing nothing. Why not make some money with it?” They began issuing interest-bearing loans with the deposited gold and silver, which generated income for the goldsmiths but set into motion a process that left more notes in circulation than there were reserves to pay for them.
The Ponzi scheme of fractional reserve banking was born. The whole house of cards is built on precarious faith. The obvious question becomes what does the goldsmith (now bank) do if all note holders (depositors) suddenly lose faith and show up at the door one morning demanding to withdraw their assets? Obviously, the bank does not have enough funds on hand to pay the notes and either becomes insolvent or defaults on notes.
That, in a nutshell, is the present United States banking system. Banks are only required to keep a fraction of the funds deposited with them on hand at any given time. Kind of makes you feel warm and fuzzy inside, doesn’t it?
