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End Banks’ Exemption from Normal Commercial Law

Summary:
Mr. Burke asked me to respond to the article below about how banks engage in money creation. Like many such articles, the one by Mr. Werner seems almost designed to be confusing and obtuse. My short explanation attempts to inform the layman of what is actually happening; i.e., that banks are exempt from normal commercial law and we all suffer. Pat Barron From: Patrick Barron Sent: Tuesday, March 21, 2017 10:33 AM To: Dan Burke Subject: Re: Richard Werner Banks are exempt from normal commercial law; i.e., they are allowed to engage in fractional reserve banking. In other words, a new dollar of reserves can be pyramided into approximately ten dollars of new bank deposits. Austrian economists call such money created out of thin air as fiduciary media in order to differentiate it from deposits backed by actual reserves. A loss of confidence in a bank can cause a bank run in which there are more claims for deposit withdrawals in the form of actual reserves (Federal Reserve Notes) than the bank actually owns. The bank’s bankruptcy is exposed. Bank runs are rare today, because the Federal Reserve promises, via Federal Deposit Insurance, to lend the bank as many reserves as necessary.

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Mr. Burke asked me to respond to the article below about how banks engage in money creation. Like many such articles, the one by Mr. Werner seems almost designed to be confusing and obtuse. My short explanation attempts to inform the layman of what is actually happening; i.e., that banks are exempt from normal commercial law and we all suffer.

Pat Barron


From: Patrick Barron
Sent: Tuesday, March 21, 2017 10:33 AM
To: Dan Burke
Subject: Re: Richard Werner

Banks are exempt from normal commercial law; i.e., they are allowed to engage in fractional reserve banking. In other words, a new dollar of reserves can be pyramided into approximately ten dollars of new bank deposits. Austrian economists call such money created out of thin air as fiduciary media in order to differentiate it from deposits backed by actual reserves. A loss of confidence in a bank can cause a bank run in which there are more claims for deposit withdrawals in the form of actual reserves (Federal Reserve Notes) than the bank actually owns. The bank’s bankruptcy is exposed. Bank runs are rare today, because the Federal Reserve promises, via Federal Deposit Insurance, to lend the bank as many reserves as necessary. Nevertheless, this does not fix the fundamental error, which is legal tolerance for fractional reserve banking, and merely causes an expansion of base money (cash and bank reserve balances at local Federal Reserve offices) and sets the stage for another round of money expansion via banks’ fractional reserve lending capability. Furthermore, the expansion of base money leads to malinvestment of capital and a rising price level, commonly and mistakenly called inflation. (The real inflation is inflation of the money supply via fractional reserve banking.)

The solution is to withdraw the banks’ exemption from normal commercial law and prosecute fractional reserve banking as the fraud that it is. Banking would divide itself naturally into deposit banking, with one hundred percent reserve backing, and loan banking, in which the depositor gives up access to his money for a certain period of time so that the loan banker can find credit worthy customers.

Such a system would lead to the immediate end of federal deposit insurance and government bank examiners. Deposits would become bailments. Loans would be subject to full loss, just as today there is full risk of loss of one’s investment in corporate bonds, corporate stock, real estate, etc.

Patrick Barron


From: Dan Burke <[email protected]>
Sent: Tuesday, March 21, 2017 9:08 AM
To: [email protected]
Subject: Richard Werner

Would you please react to Mr. Werner’s article? http://www.sciencedirect.com/science/article/pii/S1057521914001434
How do banks create money, and why can other firms not do …
www.sciencedirect.com
How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking ☆ Richard A. Werner
Patrick Barron

Patrick Barron is a private consultant to the banking industry. He has taught an introductory course in Austrian economics for several years at the University of Iowa. He has also taught at the Graduate School of Banking at the University of Wisconsin for over twenty-five years, and has delivered many presentations at the European Parliament.

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