Modern Banking's Promise of Fraud

Second time around
I'm still believing
Words that you said
--Naked Eyes

No one was more relentless in his criticism of fractional reserve banking than Murray Rothbard. Here he discusses it in the context of the 1980s S&L meltdown.

During bank runs, it is often said that 'good' banks get taken down with 'bad' banks. But how can a bank be 'good' if problems elsewhere wind up taking it down? Clearly there must be a systemic flaw that drives such indiscriminate failure.

That flaw, observes Rothbard, is excessive leverage--what in the industry is known as fractional reserve banking. Banks only keep 10 cents (or less) in the vault for every dollar deposited. Should all depositors show up at the same time to claim their deposits (a.k.a. a bank run), their demands are impossible to honor.

Fractional reserve banking is therefore a fraudulent scheme. Banks make contractual promises (i.e., we will return your deposits on demand) that they know they cannot keep. Modern banking thus becomes a confidence game. If depositors lose confidence that they will be able to withdraw their funds on demand, then the game is up.

To prop up confidence, governments provide 'insurance' to depositors. The State promises to make depositors whole on deposits up to a certain amount in the event of a bank failure. But this too is a fraudulent scheme, as the deposit insurance fund is so under capitalized that it would be unable to pay out claims amounting to even 5% of insured deposits--much less a system-wide failure.

Although some depositors recognize this deficiency, they play along anyway. Why? Because they believe that if push came to shove, government would print money in order to make insured depositors whole. But should it come to pass, this too is a fraudulent scheme. Although money printing might return nominal dollars to depositors, the purchasing power of those dollars would be vastly reduced.

Stated differently, depositors would get their paper dollars back, but not the economic resources that the original paper dollars could buy.

Observe the number of times 'fraudulent' appears in the above discussion. In criminal law, fraud is intentional deception or perversion of truth in order to induce someone to part with something of value.

Our modern banking system promises fraud.