I've been trying to get a simple, clear explanation of fractional reserve banking & monetary policy for years. I could see the evils of inflation, & how it robs people of their life's savings, & i could see the dangers of fiat money, & the seemingly automatic degeneration of a culture or empire once that becomes the basis for the currency. But i haven't been able to get it boiled down to the essence.. the simple basics of what is actually happening, & tying it all together.
As usual, it is not the system that is necessarily flawed, but the way govt has worked it. Fractional reserve banking has been with us for centuries, & if managed in a responsible way, is a workable system for a nation to regulate it's currency & money supply. Here is the progression that i see, & how we have gotten to where we are. And of course, none of these things happened in a vacuum, either, but were part of the timeline of events in history, from the american revolution to the civil war, to the new century.
1. Creation of the federal reserve, 1913.
These periodic banking panics were symptomatic of a less dramatic but more regular problem: the seasonal variation in the need for currency for transactions. The system of gold and legal tender notes was not elastic, and it was subject to money “shortages” especially at harvest time. In 1913, this problem was addressed by the creation of the Federal Reserve System (Fed).33 The Fed was to remedy the situation in a two ways. First, it would provide a means by which banks could borrow in times of stringency to satisfy their customers’ demand for cash. Second, it could create a new form of money, Federal Reserve notes, which could be expanded or contracted in quantity to respond to the need for more cash. The creation of the Federal Reserve had little if any effect on the gold standard. The dollar was still defined in terms of gold. Federal Reserve notes were redeemable in lawful money. The Fed not only operated under the gold standard, but was charged with maintaining it, and kept a percentage of gold cover for its notes. Gold still dictated the value of the dollar. source
Basically, the fed was created to allow banks to extend themselves more in fractional reserve banking.. IOW, they were not required to have ALL the assets on hand to make loans, but would get guarantees from the fed to cover any runs on the banks. This took some risk away from the banks, & also seemed to insure the deposits & savings of the people. But, it created unintended consequences, which had to be addressed by more govt measures.
BTW, the creation of the fed was a private entity not run by elected govt officials, & not really accountable to the american people, congress, or other banks. This institution was given tremendous power, to control the nation's money supply. While it was still under the gold standard, it ability to manipulate the currency was limited.
2. FDR ends the gold standard, 1933. This was one of the greatest administrative overreaches in american history. He got congress to rubber stamp it.. which, btw, was controlled by the democrats. The senate was 59/36 & the house 313/117 in dem/pub ratio. Basically, the problem was runs on the banks, & a lack of confidence in the banking system. People were converting their liquid assets to gold, & the federal reserve bank was finding itself overextended, as the fractional reserve created bubble in the roaring 20s had burst. But instead of letting a correction happen, the govt intervened. Private gold ownership was outlawed. People had to conduct all transactions with federal reserve notes. It was all done under the guise of 'save the economy, save the children!' It provided a temporary solution to the failing banks. Socialism was growing in the world, as was a sense of entitlement to basic needs.
The problems of fractional reserve banking became obvious in the roaring 20s. The stock market was booming, & margin buys were common. That is essentially buying stock on credit.. you have money to buy 10 shares, but can buy 100 on margin. This is fine as long as stock keep rising. But if they fall, the bill comes due for the rest of the stock purchase, which has not decreased in value so selling it does not provide the money to pay the original cost. Eventually, all liquidity is lost, & bankruptcy ensues, or jumping out of the wall street windows.
But this was the start of the dilution process. Margin buying was not 'creating' anything, or actual production, but was 'fake' wealth.. an illusion of increase, based only on monetary policy & inflation. This boom in the money supply, created by the fed, was not justified by actual, physical production in the nation. The economy was booming in the postwar 20s.. farmers were growing & expanding, with production increasing exponentially with the appearance of the internal combustion engine.. tractors could do the work of many mules & horses, with one man driving it. Building was booming.. houses, factories, economic growth was exploding. But much of it was on margin.. credit. When the bubble burst, it took many people down with it.
The statist cheerleaders could not face the prospect of taking blame for their own govt meddling, so they blamed gold. It was a roadblock to continued economic expansion. So the solution? Outlaw gold, & force usage of the declared (fiat) money.
This is also when people began to get rich from money shuffling.. sure, there have always been money lenders, who get rich off of usury, but this was different. It was cutting the real wealth with a bulky filler.. printing more money with the same basis, & allowing middle men to skim off for their own enrichment. This was different than the typical money lender, charging interest for the loan. This was not REAL value, but something 'created' by the fed, then skimmed off by multiple middle men.. money shufflers who don't produce anything. They are leeches in the system, & the new structure was causing an explosion of growth. But the actual production was not growing at the rate of the money supply, so the producers were not able to support all of these middle men, each diluting the original value of the product. It is drug dealer dynamics.. a ponzi scheme system of monetary supply.
This is getting too long, so i'll quit for now.. maybe later i'll finish up with the rest of the progression, from ww2 to nixon, skyrocketing inflation, opec, & the growing explosion of the money supply, along with the dwindling production. Some people already know this, as it is nothing new. But most people do not grasp the significance of the financial meddlings by the govt.
What it all boils down to is confiscation of wealth.. REDISTRIBUTION from the producers to leeches, via dilution of the value of the currency. The leeches early on were the money shufflers.. bankers, wall street tycoons, etc, & the progressives want to 'share the wealth' with a bunch more leeches in the welfare state. But it is all done on the backs of the producers, & is unsustainable.
I am myself persuaded, on the basis of extensive study of the historical evidence, that... the severity of each of the contractions - 1920-21, 1929-33, and 1937-38 - is directly attributable to acts of commission and omission by the Reserve authorities and would not have occurred under earlier monetary and banking arrangements. ~Milton Friedman
The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy. ... Roosevelt's policies were very destructive. Roosevelt's policies made the depression longer and worse than it otherwise would have been. ~Milton Friedman
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. ... This is the shabby secret of the welfare statists' tirades against gold.Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard. ~Alan Greenspan
With the exception only of the period of the gold standard, practically all governments of history have used their exclusive power to issue money to defraud and plunder the people. ~Friedrich August von Hayek