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 Each dollar of cash that is withdrawn unwinds the multiplier, resulting in a contraction in credit.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. HEY RON PAUL !!! FUCK YOU !! ASSHOLE POLITICIAN !! SCUMBAG !!! I can say these things to you because you are what you are !! A POLITICIAN !! DO US ALL A FAVOR AND PUT A GUN IN YOUR MOUTH AND PULL THE TRIGGER !!

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  2. Ron Paul: things change drastically. Obama: things continue to do better at a slow pace. Mitt Romney: Anyone who can cook a good pancake gets a donation from Mitt to show his support for fip-flopping.

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  3. Why can't there be one president and two assistants Ron Paul would be president and Obama and Mitt would be his asstants and they would work together combining there strengths in different subjects to come up with solutions.

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  4. Is sounds like you belive the ron paul conspiracy... I think you should listen to him and look at all the forbidden things he is talking about... you are for freedom then help us fighting for it, ron paul or not it's the only direction...

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  5. on the first statement

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  6. I totally agree with you

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  7. I totally agree with you

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  8. Chuck Norris should be president then nobody will talk bad about the president.

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  9. Romney, Obama and Paul. All suck. No matter who gets elected we're only in for 4 more years of hell.

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  10. Why not just remove FDIC protection? Wouldn't banks then be forced to shop for insurance? Then, once they have private insurance, they can advertise this and thereby prevent bank-runs.

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  11. THE VENUS PROJCT! sign the petition

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  12. PLEASE SEE www.monetary.org

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  13. When a 33rd degree Freemason cult member takes an oath to uphold the United States Constitution, but doesn't know what's IN the manuscript, he wins the GOP nomination for President. When a legitimately honest man who's made a life of helping others takes an oath to uphold the United States Constitution, which he's studied, his supporters are bullied to the extent of unlawful arrests and broken bones by their own party.

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  14. That you are correct on (I remember reading a source that said the exact same thing). I'm all for more regulation. I know that high reserve requirements are impractical; I just don't want the reserves to be 'too' low. I acknowledge that both extreme have their own flaws; but with low reserves, banks (and congress?) are just privatizing profit and socializing the risk with their investments. These are your hard earned dollars potentially lost or used to bail out the banks when things go wrong.

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  15. writing Ron Paul in for Prez!!!!!

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  16. writing Ron Paul in for Prez!!!!!

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  17. gogogo!

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  18. Wow i learn more here then in class...my choice who's correct here david shang

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  19. The banks overextended themselves because the regulators allowed the banks to regulate their own capital requirements. Self-regulation does not work. On top of that, lack of regulation allowed the banks to be run for the benefit of senior management rather than shareholders so that senior management got a big piece of the upside but no downside. The key is lack of regulation, not fractional reserve banking. Higher reserve requirements tighten credit and slow growth so there is a balance.

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  20. 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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