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The History of Fractional Reserve Banking in America

February 9, 2023


This piece is a follow-up to the first in the History of Central Banking series, and is best read following that initial entry.


Are you currently in some form of financial debt? Is this debt a source of shame or stress in your life? Before you get too down on yourself, you should know that the entire world is mired in an endless spiral of debt—debt that can never truly be paid off.


To put it in the simplest terms possible, money is debt. In fact, by engaging in the use of this type of currency under our current banking system, entire societies are essentially submitting to willful debt slavery. I know it sounds bad, but it's just the way things are for the time being.


You may have noticed that there is an abysmal gap between the richest of us and the rest of the population; this gap is not only staggering, but it is continually getting bigger and bigger. The debt that may seem so crippling to you is a laughably insignificant drop in the ocean of wealth managed by those at the top of the financial food chain.


Perhaps you’ve wondered why that is?


One school of thought that inadvertently supports this paradigm believes it is good for some people to earn enormous amounts of money; the theory is that their wealth will trickle down to the rest of us. This theory is called "trickle-down economics," and it states that tax breaks and benefits for corporations and the wealthy will trickle down to everyone else. It argues for income and capital gains tax breaks or other financial benefits for large businesses, investors, and entrepreneurs to stimulate economic growth. (#)


This belief, from the standpoint of fractional reserve banking, is actually the opposite of how things really work. In reality, what happens is that the wealth of the masses is funneled perpetually upward to fill the coffers of this ruling class through the application of debt + interest.


This will all make more sense as we go on.


The mechanics of modern banking are opaque and intentionally convoluted, especially when it comes to fractional reserve banking. Learning about this monetary policy is crucial for understanding why our lives are the way they are and why the entire world seems to run on a perpetual system of ever-expanding debt.

Unfortunately, economics is often viewed with boredom or confusion. Most people are turned off by all the confusing financial jargon and intimidating mathematics, but this is simply a well-crafted and off-putting veneer, designed to conceal what is probably one of the most socially crippling structures humanity has ever known.


Henry Ford once famously said:

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” (#)

Almost everyone has incurred some form of debt, whether it be in the form of student loans, a mortgage, auto loans, unpaid medical expenses, or credit cards, but did you know that the creation of money itself is in essence the creation of debt?


Most people believe that what a bank does is lend you money that somebody else has deposited previously, but what it actually does, in a sense, is create new money seemingly out of nothing every time a loan is processed and then lend it out with interest.


The Money-Creation Process

Back in 1961, just ten years before the US went off of the gold standard, the Federal Reserve Bank of Chicago wrote up a workbook on bank reserves and deposit expansion called Modern Money Mechanics. (1)

On the opening page the document states,

The purpose of this booklet is to describe the basic process of money creation in a ~fractional reserve banking system. “

It then goes on to describe this process using the mundane banking lingo of the late 1950s, which we’ll do our best to translate into more digestible, modern terms.


Let’s say hypothetically that the United States Government decides it needs $10 Billion for infrastructure, or perhaps foreign aid to a war-torn country. The Government would then make a request to the Federal Reserve for $10 Billion and the Federal Reserve would request 10 billion in Government Bonds.


The Government then prints up some fancy pieces of paper called Treasury Bonds (#); they print enough to equal the 10 billion in US Dollars that they’ve requested from the FED.


The Fed then prints some equally fancy-looking pieces of paper themselves called Federal Reserve Notes (#); they then trade these federal reserve notes for treasury bonds.


Once the exchange is complete, the US Government takes the 10 billion in federal reserve notes and deposits them into a bank account. Once deposited, the paper notes officially become legal tender and thus the US money supply is increased by $10 Billion.


This explains the statement made at the beginning of the post—that money IS debt. Interestingly enough, even the Bible encapsulates this ancient reality perfectly:

The rich rules over the poor, and the borrower is slave of the lender.” -Proverbs 22:7

Unfortunately, this is only the beginning of the debt slavery system …


Back to our example, the exchange has been made and now ten billion dollars sits in a commercial bank account. This is where it gets interesting.


Based on the fractional reserve practice, that ten billion dollar deposit instantly becomes part of the bank’s reserves. According to Modern Money Mechanics, page 4:

a bank must maintain legally required reserves … equal to a prescribed percentage of its deposits

It elaborates further on page 6, saying,

under current regulations, the reserve requirement against most transaction accounts is 10 percent.”

This means that with the $10 Billion deposit from our previous example, 10%, or $1 Billion, is held as the required reserve, and the other $9 Billion is considered the “excessive reserve” and can be used as the basis for new loans(4).


Now, you would think that the $9 Billion, when loaned, would come directly out of the $10 Billion that was just deposited, but you’d be wrong. What actually happens is that the $9 Billion is created and added to the money in circulation instantaneously the moment the loan goes through, in addition to the existing $10 Billion dollar deposit.


This is how the money supply is expanded.


It may sound absurd, but it actually needs to happen this way or else no new money would ever be created. In Modern Money Mechanics, the FED explains it like this:

Of course, they (the banks) do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes (loan contract) in exchange for credits (money) to the borrowers' transaction accounts

What they are essentially saying, albeit in outdated and opaque terminology, is that the $9 Billion is created simply because there is a demand for it and there is a sufficient amount deposited to satisfy the reserve requirements.


Hopefully, you’re still following along. I know all this bank chatter is about as riveting as rush-hour traffic or a trip to the DMV, but it is important to understand the systems that govern our lives. Admittedly, it’s been a bit dry thus far but stick with me a little longer, because what we’ll eventually reveal might shock you.


So there’s a newly available $9 Billion sitting in our hypothetical bank, let’s suppose somebody borrows that money. They will then most likely deposit the borrowed money into their own account, and the process we previously discussed will repeat. The deposit will become part of the bank’s reserves, 10% of which will be held and an additional $8.1 Billion is now available as newly-created money, which can be used for more loans.


This process can be done over and over again.


The $8.1 Billion can be loaned out to create an additional $7.29 Billion, which can then be loaned out to create $6.561 Billion, to $5.904 Billion, and so on. This cycle of deposits and loans can continue on and on until an additional $90 Billion is created from the original $10 billion.


For every deposit that occurs about 9 times that amount can be created.


In reality, none of this would happen physically. Everything from the treasury bonds to the original loan, to the new money, is all created electronically. Actually, most money exists digitally.


97% of the money supply has been created this way through loans, and less than 3% exists as hard currency, such as notes and coins.


Now, you might be asking yourself, ‘If the banks can create money every time there is a loan and a subsequent deposit, then what gives this newly created money value?’


The answer: the money that already exists.


Every newly created dollar essentially siphons value from the dollars that are already in the money supply. The total pool of money is constantly increasing irrespective of the demand for goods and services. As supply and demand find equilibrium, prices rise and in turn, diminish the purchasing power of the dollar.


What we just described is the primary mechanism behind inflation (#)


The fractional reserve system is inherently inflationary; the act of expanding the money supply without a proportional expansion of goods and services will always debase the currency.


One way of looking at it is that, the more debt there is, the more money there is. You could also look at it this way: every dollar in your wallet is owed to somebody by somebody else, since the only way for money to come into existence is through loans.


A quote by Marriner Eccles, a former governor of the FED sums it up nicely:

“If there were no debts in our money system, there wouldn’t be any money.” (#)

Here’s a quick history lesson: The last time that the national debt was completely paid off was in 1835 after president Andrew Jackson shut down the central bank of his time. Jackson wasn’t a fan of the central bank as he was once quoted as saying,

The bold efforts the present bank has made to control the Government … are but premonitions of the fate that awaits the American people should they be deluded into a perpetuation of this institution, or the establishment of another like it.” (#)

Of course, that came before the Federal Reserve we know today, which was installed in 1913.



Let’s recap what we’ve learned so far.

  1. We’ve explained how money is created out of debt through the exchange of treasury bonds for federal reserve notes.

  2. that money is deposited into a bank,

  3. then the money pool is expanded through loans based on the bank’s reserves,

  4. reserves are derived from deposits,

  5. and through the fractional reserve system, any one deposit can create 9 times its value.

  6. The newly-created money derives its value from the money that already exists, thereby debasing the existing money supply and contributing to inflation.

If you’ve been enjoying this high-octane adventure toward a deeper understanding of our financial system, then strap in, because we are about to discuss the most controversial concept yet: interest.


According to Investopedia:

Interest is the monetary charge for the privilege of borrowing money, typically expressed as an annual percentage rate (APR). Interest is the amount of money a lender or financial institution receives for lending out money. Interest can also refer to the amount of ownership a stockholder has in a company, usually expressed as a percentage. (#)

So, how does this work in relation to what we’ve just learned about fractional reserve banking?


When the government borrows money from the FED and when a person borrows money from a bank, it typically has to be paid back with accrued interest.


That means that every single dollar in existence, having been borrowed from the federal reserve, will have to be paid back with interest on top as well.


When money is borrowed from the Central Bank, and then expanded from commercial banks through loans, only what is referred to as the “principal” is actually being created in the money supply. (#)


If the entire money supply is itself the principal, then where does the money come from to pay for the accrued interest?


The answer is that it comes from nowhere because it doesn’t exist. The amount of money in the money supply (principal) will always be less than the amount of money owed back to the banks (principal + interest).


Hence, the national debt will never and can never be fully repaid. It can only increase. And as above, so below; American household debt hit a record $14.6 Trillion in the spring of 2021, according to the Federal Reserve. (#)

This is part of the reason why inflation is a constant in the economy; new money will always be needed to cover the perpetual deficit built into the system caused by the need to pay back the interest.


It is this perpetual attempt to pay off the interest that causes the money to flow upward to the top 10% and really showcases the absurdity of the Trickle-down theory. As long as we have to rent the money we use from the banks that create it, we’ll have to keep paying this huge interest bill, and the gap between the richest of us and the rest of us will keep widening.


So there you have it, folks: that is fractional reserve banking as described by Modern Money Mechanics in a nutshell. Some believe the system was instrumental in bringing humanity to where it is today, while others believe it is a cleverly-obscured debt slavery system.


Regardless of what anyone believes, it’s a system that has been with most of us our entire lives.

Public Opinion


As we mentioned before, the fractional reserve banking system has many supporters and detractors, as well as propositions for alternative systems.


In 1935, Irving Fischer, an economist, statistician, inventor, eugenist, and progressive social campaigner, proposed a system of Full Reserve banking (also known as 100% reserve banking, or sovereign money system).


Full reserve banking is a system of banking where banks do not lend demand deposits and instead only lend from time deposits. It differs from fractional-reserve banking, in which banks may lend funds on deposit, while fully reserved banks would be required to keep the full amount of each depositor's funds in cash, ready for immediate withdrawal on demand. (#)


But Full reserve banking never took off. Currently, no country in the world requires full-reserve banking across primary credit institutions, although Iceland has considered it. (#)


In a 2018 ballot referendum, Switzerland voted overwhelmingly to reject the Sovereign Money Initiative, which has full reserve banking as a prominent component of its proposed reform of the Swiss monetary system.


There were other detractors of the Fractional reserve system from the Austrian economic school of thought named Jesús Huerta de Soto and Murray Rothbard. Both men called for the fractional reserve system to be outlawed and criminalized. According to them, not only does money creation cause macroeconomic instability (based on the Austrian Business Cycle Theory), but it is a form of embezzlement or financial fraud, legalized only due to the influence of powerful, rich bankers on corrupt governments around the world.


The Austrian economic school is based on methodological individualism—the concept that social phenomena result exclusively from the motivations and actions of individuals. (#)


No Reserve Banking

Recently, the system has changed …


As of March 26th 2020, the board reduced reserve requirement ratios to zero percent(#). This action eliminated reserve requirements for all depository institutions, meaning once the $10 Billion is placed into an account, that

bank can loan out, and thereby create 100% of the amount deposited.


So, are you unsure how you should feel about Fractional or No Reserve Banking?


You are not alone.


Inevitably there are those who swear by this economic system, claiming all of the technological progress of the last 50 years wouldn’t have been possible were it not for this system. Conversely, there are those who blame it for all the troubles of our times.


If you happen to fall into the latter camp, there are alternatives worth exploring and advocating for. There are those who believe gold and precious metals could end the FED’s reign, while others advocate for alternative systems.


As we mentioned earlier, there is a Full Reserve Banking system.


Recently, the International Monetary Fund (IMF) published a report called ‘The Chicago Plan Revisited’. The report claims—and these are the IMF’s own words—that Fractional Reserve Banking is “problematic,” and discusses the perceived benefits of Full Reserve Banking. (#)


Full reserve banking pretends to solve the problem because it would require the banks not to create new money based on the deposit, but to actually lend out the deposit itself.


The Kucinich HR2990 N.E.E.D act, which was penned by the American Monetary Institute’s Zarlenga and which calls for a debt-free government unit, also wants to provide credit via full reserve banking. (#)


However, to most fractional reserve detractors, the problem is not money creation, and not even Fractional Reserve Banking. The problem is interest. It matters not whether we pay interest for fully or partly backed loans—the money inevitably still flows back upward.


In a full reserve gold-based banking system, there would be no theft, according to writer and economic historian Gary North. However: we would still pay $300k interest over a $200k mortgage. So maybe we would be paying them in gold coins or in paper fully backed by gold, but we would still be paying, and paying.


Gold may make our money more sound, but many are leery and believe that gold is completely controlled by the Rothschilds and their ilk. Gold-based loans are what brought them to power to begin with, so reverting back to a gold-backed currency might do little to wrestle the power back into the hands of the people.


Unfortunately, we won’t know for certain how a full reserve system would function in modern times, and if it would indeed be any better for those at the bottom of the financial totem pole, because as of now, it hasn't been tried since the Bank of Amsterdam.


We can't say for certain what system is superior; perhaps one day somebody will dream up a system that works for all walks of life, from the richest to the poorest.


Until then, we’ll keep chugging along, lending and borrowing and inflating the money supply.


Badlands Media articles and features represent the opinions of the contributing authors and do not necessarily represent the views of Badlands Media itself.




1 Comment


the writer does not follow the Treasury securities that flow from the Treasury to FRBNY as deficit spending. If he attempts to do so, they disappear. They become part of the securities auctioned to refinance maturing securities; i.e., part of the perpetual roll-over of the National Debt. TreasuryDirect used to tabulate the funds in Institutional lists as 'new cash' alongside of 'maturing'. If the funds went to the government, they would have the same flow as taxation; i.e., from the market to government which would not increase the value in circulation [no inflation] nor would it increase the National Debt. The only way those two events can occur is for the auction deficit security amount must go to a pr…


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