Fractional Reserve Banking v. The Gold Standard

Posted by Ray on October 9, 2009 under Main | Be the First to Comment

Nothing brings up more debate or emotions than this argument. I find myself refereeing a grudge match between two intellectual heavy weights, where I have no business intervening, but what the hell. Apparently Karl Denninger and Mike “Mish” Shedlock got into it over this very issue a week or so ago and I must admit, Karl missed the mark, completely.

You see, Mish made the argument that fractional reserve banking is fraudulent, which he has a point to a certain degree, because banks only have to keep 10%, supposedly, in reserves from depositors and they can loan the rest out. Mish makes some excellent points and goes on to show how a $1M deposit can grow to millions in loans or phantom money, which is more or less true. Somewhere in the argument Karl misunderstood the argument to mean that a gold standard would solve this problem.

Karl fired back by saying that a gold standard would not have prevented the panic of 1873 or 1907. However, that is a separate argument as sound currency is not the same thing as a sound banking system. A sound banking system would be the abolishment of the fractional reserve banking system and has nothing to do with gold or any other precious metal monetary standard. When the argument gets perverted to the level of sound money versus sound banking the basis of the discussion is lost and both parties lose which does no one any good.

Clearly, a sound banking system is needed as we witnessed last fall and which we are all still paying for in one way or another. The argument for a strong currency is also clear as the USD is losing its value rather quickly, whether planned or not. We cannot confuse the two issues as they are not the same and very different. In this argument I have to side with Mish as he laid out his case much better and has many more intellectual heavy weights on his side, pus if we all went to our banks at the same time and withdrew our money they would collapse. Karl, just completely missed the mark by confusing the gold standard, a basis for sound money, with sound banking practices which is irrelevant to the argument.

I have a deep respect for both parties and read both of them regularly, but it is important to keep the argument on point and not drift off into irrelevant topics. Banking is confusing enough and the people do not need to be confused with irrelevant facts or misguided beliefs so if the topic comes up again, please keep it civil and on point.