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 Each dollar of cash that is withdrawn unwinds the multiplier, resulting in a contraction in credit.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.

  • http://www.youtube.com/profile?user=231gearon 231gearon

    I needed a good lineal argument to settle me down and it is what you gave As an example of how I think, consider this.What is the furtherest point to which you can travel on this Earth? The opposite side of the planet? Wrong, it is to the point upon which you are now standing.
    Now consider what is the most distant object in the Universe to be seen (if our telescopes were powerful enough). It is the planet Earth.
    So, how intelligent we all be, yet stupid as well.

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    invested and the bank loses all of that money due to poor investments (I’m taking this to the extreme to prove a point). With only 1% in the reserves, it can not meet all the withdrawal demands of depositors. What’s worse, if the banks go bankrupt because of these decisions, you’re not likely to get all the deposits that you put into your account. You’re the one who doesn’t even understand what banking is and why the risky practices of these financial institutions caused the global recession.

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    I never said i wanted banks to hold all my deposits. You’re putting words in my mouth that I never said. Had you read my comments properly, you’d find that I indeed support FRB. But only if they don’t keep too low of a reserve in the name of profit. It’s risky in that they may not be capable of providing money for people who want to withdraw money. An example would be JPMorgan chase’s Big Losses On ‘Egregious’ Credit Trades (approximately $2 billion). So say that 99% of deposits were being

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    In fact it is banking. The very definition of banking is “The business conducted or services offered by a bank.”. As long as there are business’s being conducted or services being provided by a bank (i.e deposits, withdrawals, etc) it is still considered banking. 100% fractional reserve banking is impractical since it doesn’t make them money. I know your trolling so i’ll end further discussion with you here

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  • http://www.youtube.com/profile?user=TaurasiDiana Taurasi Diana

    I am going to subscribe to you I? like your Posting…

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  • http://www.youtube.com/profile?user=RONPAULFREEDUMB RONPAULFREEDUMB

    100% reserve is not banking dumb ass. That’s a safety deposit box. You dumb schmuck. This video is idiotic. Banks borrow money so they can lend it. The Fed requires banks to hold onto some of the money they borrow so they can pay depositors who demand cash. Very simple and works very well. Complaining about fractional reserve banking is quite stupid.

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  • http://www.youtube.com/profile?user=RONPAULFREEDUMB RONPAULFREEDUMB

    The Fed is already audited. Ron Paul wants to audit the decision making process and that will never happen since there are no standards by which to audit the decision making process. He wants Congress to control monetary policy. If Ron Paul controlled monetary policy, he would have hiked interest rates in 2008. He predicted hyperinflation in 2008 when the fed funds rate was cut to .25%. Rate of inflation since June 2008 is 1.4%/year. He is an imbecile.

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  • http://www.youtube.com/profile?user=kenjams kenjams

    I know exactly what I’m talking about.

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  • http://www.youtube.com/profile?user=RONPAULFREEDUMB RONPAULFREEDUMB

    Nearly 100% loaned out, emphasis on NEARLY. You want banks to hold onto all your deposits? Open a safety deposit box or keep your money under your mattress. You idiots don’t understand banking or credit.

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  • http://www.youtube.com/profile?user=RONPAULFREEDUMB RONPAULFREEDUMB

    You are using words you do not understand.

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  • http://www.youtube.com/profile?user=RONPAULFREEDUMB RONPAULFREEDUMB

    You imbecile. If you don’t want the bank to lend out your money, open a safety deposit box. Why impose your stupidity on the rest of the world?

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    I apologize if what I said seemed confusing. I’m not the best at explaining things and youtube’s character limit makes me cut down on exact details. I’m just glad that you’ve been able to clear up the misunderstanding. You are an intelligent individual and that’s what the U.S needs. More informed people who understand what goes on in their country and can help shape it.

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  • http://www.youtube.com/profile?user=kenjams kenjams

    Fractional Reserve Banking = Usury by the Money-Changers

    END THE FED

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  • http://www.youtube.com/profile?user=LibertyFighter7777 LibertyFighter7777

    Fractional reserve banking = keeping only a fraction of your deposits in reserve. The rest is invested.

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  • http://www.youtube.com/profile?user=231gearon 231gearon

    I think I must have been off with the fairies. You are right. Not to matter, Einstein use to get lost in his own street I was told once i.e. simple things get difficult when bogged down with detail

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    It may seem all confusing if you don’t have a background on this kind of subject so I do support you informing yourself on this subject. It’s quite fascinating when the things you learn are applicable and helpful in real life. I look forward to any further discussion.

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    It’d be nice if you’d explain what part seems conflicting. From my understanding, everything I said was pretty much explained in this video. I’ll quote Paul on this one: ” Fractional reserve banking is the practice by which banks accept ‘deposits’ but only keep a ‘fraction of those deposits’ (reserves) on hand at any time. In practice nearly 100% deposits’are loaned out”. Reserves aren’t meant to be loaned out. I think what you means is “the more deposits they have, the more they can loan out”

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  • http://www.youtube.com/profile?user=231gearon 231gearon

    I feel you have given yet more conflicting statements so I’ll have to study up a bit before I can respond. We’re both coming at ‘it’ from two different directions I think.

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    Banks kinda already do have a network to cover excess withdrawal requirements. Banks lend money to each other all the time (and demand usually tends to be driven by the overnight rate that the Central banks sets). NON government insurance I’m all for. But what if the situation is so bad that large insurance firms belly up due to not being able to “insure” for everyone’s losses (like what happened during the great recession). I believe that prevention of banks playing risky is the solution.

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  • http://www.youtube.com/profile?user=DavidShang David Shang

    I like the idea but I’m a bit sceptical about not having a central bank in a country (I live in Canada so our version of the Fed is “The Bank Of Canada”). I agree with Paul’s message of auditing the Fed (which he’s passed a bill for recently without it being watered down). But without a central bank, who will be the bankers for the nation? (and other banks. i.e the lender of last resort of other banks can not get loans from other banks) Who will be the one’s to control money supply?

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