Well, your money’s in Joe’s house…that’s right next to yours. And in the Kennedy House, and Mrs. Macklin’s house, and a hundred others. — George Bailey (played by James Stewart) in It’s a Wonderful Life (1946)
I suspect only Austrian economists would correctly identify George Bailey as the villain of Bedford Falls. George Bailey, not a hero? He helped members of his community achieve the American dream, but as a fractional-reserve banker.
In the U.S. fractional-reserve banking system, the Fed requires banks to back up just 10% of demand deposits with cash called required reserves. Demand deposits in excess of this that are not lent out are referred to as a bank’s excess reserves. Thus, a bank is presently allowed to lend out up to 90% of their depositors’ money because the system essentially strips away their property rights.
Fractional-reserve banking is lampooned in a season seven Seinfeld episode with the fractional reserve parking lot analogy. In this episode, George and Kramer discover their cars are being lent out by Jiffy Park. Although a procurer had been selling tricks out of George’s car, it was mostly available upon demand. Kramer wasn’t so lucky. When he demands his car, the attendant meets it by supplying a pink Cadillac. Of course the analogy is overly simplistic because cars are neither identical nor divisible. Nonetheless, if demand deposits are the property of depositors, allowing banks to lend this money is as sound as Jiffy Park lending cars to adult service provider procures.
Fractional-reserve banking is inflationary because money is lent into existence. To demonstrate, consider Bill who withdraws $100 from his mattress to deposit it in his checking account. Because the reserve ratio is 10%, Bill’s bank can lend $90 of his money to Jill. If she uses the money to buy DVDs from Buy-Mart, it deposits the proceeds in its bank. Buy-Mart’s bank keeps $9 in reserve and loans Jack $81 to buy a printer. After just two rounds, banks lend $171 into existence. After 100 rounds, the $100 deposit is two cents shy of $1,000.
Read More at policymic.com . By Hal Snarr.