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Revealing the Fraud in Our Bank System
Greetings from a lovely Northern Italy!
First, last week’s piece on financial formulas received fantastic feedback. I’m grateful.
I won’t do financial mathematics every week, but the feedback gave me a clue to dial it back a bit.
So I’ll try to keep things as simple as possible so you can protect yourselves from what’s eventually coming.
Good friend and colleague Doug Hill and I were on the horn the other day. Doug had the great idea to write and speak more about the bane of our financial existence — fractional reserve banking.
So this week, I’m tackling that very subject, so you know what kind of fraud our entire system is.
Also, it’s almost ten years ago to the day that Godfrey Bloom made this speech on the floor of the European Parliament. It was a watershed in terms of political honesty and it’s mostly about fractional reserve banking. (Watch it after you read this; he rants about everything I’ll explain first.)
Bloom called out the entire system, from central bankers on down. It was a beautiful thing to behold.
In the same spirit, I’m going to go through this system with you. It’ll help you understand how money multiplies, our bankers get rich and bankers get sloppy with deposits.
But first, let’s warm up by asking ourselves a simple question…
Are Basketball Players Smarter Than Hedge Fund Managers?
Just over a year ago, this headline appeared in The New York Post: “Bucks star Giannis Antetokounmpo has money in 50 different bank accounts.”
“The Greek Freak” deposited $250,000 each into 50 bank accounts. That’s $12,500,000 into 50 different accounts.
Why did he do that?
Because he smartly knew that every bank account at a different bank in the US is FDIC-insured up to $250,000.
Of course, the billionaire hedge fund manager advising Antetokounmpo told him he wasn’t investing correctly. That he should put this money into T-bills and T-bonds.
This is a brilliant move. Why?
Antetokounmpo is worth at least $200 million. So that $12.5 million in those accounts represents only 6.25% of Antetokounmpo’s wealth.
It’s guaranteed safety for the cash portion of his portfolio. The Greek Freak wasn’t concerned with a return on capital. He wanted a return of capital.
And last year, T-bills weren’t earning anything anyway. Now, it’s a different story.
I asked you that question first because I’m introducing what confidence trickster Edward H. Smith called the “pay-off” or “convincer.”
And that is deposit insurance.
Once you know how this system works, you’d never stick your cash anywhere near it… unless it was for deposit insurance.
Your bank goes under because of its own stupidity?
Or in Oprah’s case, here’s $690 million. (I’m still upset about that, by the way!)
As the average American has about $500 in his bank account, he never has to worry about his bank going under.
The government will give him his $500 immediately, thanks to deposit insurance.
But how could the system work any differently?How is Valet Parking Safer Than Banking?
Dream with me for a moment.
You drive your brand-new Ferrari Roma to a swanky hotel in Miami Beach.
You and your date are both dressed to the nines and ready for a great night of dancing and mojitos.
When you get to the hotel, a valet parking attendant hastily rushes out to open your door. You hand him the keys to your precious Ferrari.
Not for one moment do you think you transferred the car’s ownership to this college kid. And while this college kid weeps with joy at getting to park your car, he doesn’t for a second actually think he owns your car.
That’s because your car represents, legally speaking, a bailment.
Bailment is a legal relationship in which a person (the bailor) transfers possession of personal property to another person (the bailee) for a specific purpose and period of time, without transferring ownership of the property.
The bailee, in this case, the hotel as represented by the valet parking attendant, is responsible for taking care of the property (your Ferrari Roma) and returning it to the bailor (you) in the same condition it was received.
Of course, you know all this already.
Here’s the question: do you think it works the same way at your bank?
In other words, do you think the $100 you just deposited five minutes ago is actually in the bank’s vault or fancy computer system?
Fractional Reserve Banking
If you didn’t know the answer to that last question before you read this piece, you probably figured out it’s “no.”
Here’s what actually happens (if simply):
10% of your $100 deposit will be set aside as reserves as per US reserve requirements rules. Then, the remaining 90% will be loaned out to other parties.
Then the $90 that was loaned out by Bank A will return somewhere, say, to Bank B. Bank B will have a $9 reserve requirement and $81 will be loaned out.
Then the $81 will find its way to Bank C. Bank C will have $8.10 held in reserve, while they loan out $71.90.
And so on.
So you have a claim to the $100 you just deposited. But most of your deposit is elsewhere.
Why is that?
It’s because your $100 deposit isn’t considered a bailment.
In Murray Rothbard’s masterpiece, The Case Against the Fed, he writes:
It makes “English jurisprudence” look like a sad oxymoron.
Rothbard went on:
Yes. That is 100% true. And that’s why deposit insurance is so important.
Knowing all this, imagine if Oprah’s wealth suddenly went poof! She would’ve gone on air and called the whole system out for what it is (though she did not, and still has not, the right to get all $690 million back).
Bailments Versus Debits and Credits
So let’s recap.
If you give the keys to your Ferrari to a college kid at a hotel, the car is still yours.
If you give your money to a college-educated adult at a bank, it’s the bank’s money… until you demand it back.
That’s why we call checking accounts “demand deposits.”
If you put your ATM card into the ATM and ask for, say, $50, of the $100 you deposited, the ATM can’t say, “Sorry, not now. I’ve got a headache.”
That machine will spit out $50 straight away (provided it has cash loaded in).
But the problems occur between the time you deposit your $100 and when you demand it back.
Because that $100 isn’t a bailment. Your $100 will be booked like this:
It’s just debits and credits now.
Just ask Silly Valley Bank. Or Signature Bank. Or Debit Suisse.
Better yet, ask for all your money when you next head to your bank. See what happens.
Let’s revisit the part where we keep 10% in reserve and 90% is loaned out.
If you deposited $100, how much could be created theoretically?
That’s $100/10% = $1,000.
This is what we call the maximum deposit expansion multiplier, or money multiplier, for short.
So if you’ve got a reserve requirement of 10%, you create 10x money.
If you’ve got a 5% reserve requirement, you create 20x money.
If you’ve got a 20% reserve requirement, you create 5x money.
Oh, we’re playing with small numbers. What if the Fed printed $8 trillion when the reserve requirement is 10%?
Yup, $80 trillion could… could… be created. But would it?
No, because of all the leakages and frictions and credit risks in the system.
But however much is created, it’s still a whole lot of cash.
And that leads to the problems we’re having now. Too much money chasing too few goods. Inflation.
Poor bank management. Silly Valley took their customer deposits and bought “risk-free” T-Bonds with them at the top of the market.
They didn’t have a risk manager and the person who bought those bonds clearly didn’t understand the difference between default risk-free and price risk-free.
And then, there was a bank run. That’s when everyone tries to remove their cash at once. Rothbard was right: it’s not possible under a fractional reserve banking system.
This bank mess isn’t over yet. We’re in the eye of the storm now. It just seems calm.
Fractional reserve banking… Demand deposits… Deposit insurance.
It’s all part of the same racket.
Will we ever get back to gold money and 100% reserves?
But at least you know what’s going on with your bank money.
Not many people do.
And now you know why Henry Ford said this:
Have a great day ahead!
If this is the sort of thing you’d like to see more of, please let me know here. Or if you have any suggestions for future topics, do let me know that as well.
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