Ron Paul: Banks Should Stop Hiding from Free-Market Regulation




by Ron Paul

Last week my subcommittee held a hearing on fractional reserve banking and the moral hazard created by government (taxpayer) insured deposits. Fractional reserve banking is the practice by which banks accept deposits but only keep a fraction of those deposits on hand at any time. In practice, nearly 100% of deposits are loaned out, yet depositors believe that they can withdraw the full amount of their deposit at any time. Loaned funds are then redeposited and reloaned up to the limit of the bank’s reserve requirements, compounding the effect.

As Murray Rothbard put it, “Fractional reserve banks … create money out of thin air. Essentially they do it in the same way as counterfeiters. Counterfeiters, too, create money out of thin air by printing something masquerading as money or as a warehouse receipt for money. In this way, they fraudulently extract resources from the public, from the people who have genuinely earned their money. In the same way, fractional reserve banks counterfeit warehouse receipts for money, which then circulate as equivalent to money among the public. There is one exception to the equivalence: The law fails to treat the receipts as counterfeit.” *

While mainstream economists extol this “money multiplier” as a nearly miraculous process that results in a robust economy, low reserve requirements actually enable banks to create trillions of dollars of credit out of thin air, a process that distorts the structure of production and gives rise to the business cycle. Once the boom phase of the business cycle has run its course and the bust commences, some people will naturally look to hold cash. So they withdraw money from their bank accounts in order to hold physical currency. But bank deposits consist of a huge amount of credit pyramided on top of a small of amount of original cash deposits. Each dollar of cash that is withdrawn unwinds the multiplier, resulting in a contraction in credit. And if depositors en masse attempt to withdraw more funds than are available in reserves, the entire of house of cards comes crashing down. This is the very real threat facing some European banks today.

Since the amount of deposits always exceeds the amount of reserves, it is obvious that fractional reserve banks cannot possibly pay all of their depositors on demand as they promise – thus making these banks functionally insolvent. While the likelihood of all depositors pulling their money out at once is relatively rare, bank runs periodically do occur. The only reason banks are able to survive such occurrences is because of the government subsidy known as deposit insurance, which was intended to backstop the stability of the banking system and prevent bank runs. While deposit insurance arguably has succeeded in reducing the number and severity of bank runs, deposit insurance is still an explicit bailout guarantee. It thereby creates a moral hazard by encouraging bank deposits into fundamentally unsound financial institutions and contributes to instability in the financial system.

The solution to the problem of financial instability is to establish a truly free-market banking system. Banks should no longer have a government backstop of any sort in the event of failure. Banks, like every other business, should have to face the spectre of market regulation. Those banks which engage in sound business practices, keep adequate reserves on hand, and gain the confidence of their customers will survive, while others fall by the wayside.

Banking, like any other financial activity, is not without risk – and the government should not continue its vain and futile pursuit of trying to eliminate risk. Get government out of the way and allow the market to function. This will result in a more stable system that meets the needs of consumers, borrowers, and investors.

* Murray N. Rothbard, The Mystery of Banking, 2nd ed. (Auburn, Alabama: Ludwig von Mises Institute, 2008), p. 98.

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111 Comments:

  1. Ron Paul to WIN — or America to END 2012!
    (there are no other options!)

    All REAL Americans, and ALL People around the world— that believe in Liberty, Peace, Prosperity, Honesty, Truth, Goodness and Self-determination —are for Ron Paul.

    President Paul wants to save our Nation and heal the World, and desires nothing for himself — making him a True Patriot (unlike the megalomaniacs that want The Presidency, so they can get a bigger pie, and engorge themselves further at the people’s expense — marking them as Leeches on the path to suck US dry)!

    Ron Paul has awoken the Sleeping Giant that is We, The People! We are growing in numbers and our voice is no longer distant thunder — but a Roaring Storm that’s approaching and eventually will wipe out the PUPPETEERS that have stolen Our Nation!

    We are the MANY, while the Criminals in Power, that want to control us, are the FEW (and their subhuman squeals are getting weaker)!

    (http://www.youtube.com/watch?feature=player_embedded&v=xq3BYw4xjxE)

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  2. I didn't say things would be great, I said they would slowly get better :) By slowly I mean maybe by the end of his second term he'd manage 1/4 of the stuff on his original list.

    Heck, maybe the budget he had in mind for his promises were unrealistic with the state of the economy at the time. I'm willing to believe he flat out lied, but I like to explore other options.

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  3. By tapping into the source code of the universe. In a rariety of ways. The earth is like the size of a speck compaired to the sun outside. That thing isnt going anywheres. Just look at it day after day. Tons of free energy staring at you in the face. All you need to do is focus on scooping it up and directing it to you. Once set up the energy keeps on flowing. Like for a long time.

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  4. By tapping into the source code of the universe. In a rariety of ways. The earth is like the size of a speck compaired to the sun outside. That thing isnt going anywheres. Just look at it day after day. Tons of free energy staring at you in the face. All you need to do is focus on scooping it up and directing it to you. Once set up the energy keeps on flowing. Like for a long time.

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  5. Not true: Obama has lied and lied and lied again. watch the old Obama videos and what he promised to do before he was in office and then watch later videos of what he says after he was in office. It's like he gave us all the finger.

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  6. ok ok wait a second...no more power companies? so even though I think I'll regret it...explain how

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  7. ok ok wait a second...no more power companies? so even though I think I'll regret it...explain how

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  8. Seriously? No money huh? alright...well I'm going to ignore the fact that you've been watching waaaayyy too much Star Trek; that being said, please Mr. SciFi, enlighten me. How does this said "free energy" get around? I mean how is Mr. Joe Shmo living in NYC or bumf*ck NC or where ever, going to harness this free energy and get off the grid?

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  9. RIGHT!

    when you re-teach yourslf how to type and learn english better i may consider. you're all over the place with your theory bs. what exactly are you trying to accomplish? if you don't understand a problem then it will never be accomplished. are you a fucking alien or something?!...for fucks sake!!!! if you don't have an answer than at least give better ideas instead of just wanting government to shove more shit down our throat on a whim. you either shit or get off the pot!

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  10. RIGHT!

    when you re-teach yourslf how to type and learn english better i may consider. you're all over the place with your theory bs. what exactly are you trying to accomplish? if you don't understand a problem then it will never be accomplished. are you a fucking alien or something?!...for fucks sake!!!! if you don't have an answer than at least give better ideas instead of just wanting government to shove more shit down our throat on a whim. you either shit or get off the pot!

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  11. it means that i'm not actually 11 years old and i've been towing your line. i'm an ex-war vet and i have a business degree and understand economics incredibly well. i just wanted to snag another idiots goat and i got yours. you're an idiot, period! my children are smarter than you! so the sun is free...and?! you going to build us solar panels for free with the capacitors and do a free install on every house and business for free? get a grip you fucking hippy! don't ever talk to my kids like that

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