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IPFS News Link • Central Banks/Banking

Could the Entire Banking System Come Tumbling Down?

•, By Walter E. Block

How does one describe our present banking system?

It is like an upside-down pyramid, with the tippy top of it located at the bottom and the widespread base of it placed at the top. If even a slight wind comes along, it will knock down the entire enterprise. The bigger they are, the harder they fall. Heck, you don't even need a breeze. This enterprise is as unstable as it conceivably can be.

It is like a man wearing 10-inch high-heeled shoes. You look at him crossways, and he'll fall down (women have far more practice at wearing such shoe-wear). You need not look at him at all and he'll collapse.

It is like a little kid getting on a bike for the first time, with no training wheels. It is like someone's first run on stilts. It is like riding a unicycle for a trial run. It is like the first try at tightrope walking.

Are you getting my drift? The banking system is teetering and tottering. Why is this?

It is due to the fact that it engages in fractional reserve demand deposit banking.

What's that? Mr. Apple comes to a bank and deposits $100. The bank gives him a demand deposit for that amount of money. What does that mean? It means that A has the right to withdraw up to that amount, $100, any time he wants to (assuming the bank is open) or write a valid check for that amount at all times, and the bank is legally obligated to honor it.

What, then, does the bank do with this money? Assuming a 10% reserve reserve ratio, it lends out $90 to Mr. Banana and keeps the remaining $10 in its vault. What does this mean? Exactly the same as before. Mr. Banana now, also, has a checking deposit with the bank; he can call up these funds of his at his own discretion, up to nine ten dollar bills worth of money.