The Truth (About Fractional Reserve Banking) Will Set You Free

In my quest to understand why having and keeping a Retirement Nest Egg is so difficult I came across a book called “The Mystery of Banking” by Murray N. Rothbard.

“Although first published 25 years ago, Murray Rothbard’s The Mystery of Banking continues to be the only book that clearly  and  concisely  explains  the  modern  fractional reserve banking system, its origins, and its devastMurray Newton Rothbardating effects on the lives of every man, woman, and child. It is especially appropriate  in  a  year  that  will  see;  a  surge  in  bank  failures,  central banks around the globe bailing out failed commercial and investment  banks,  double-digit  inflation  rates  in  many  parts  of  the world  and  hyperinflation  completely  destroying  Zimbabwe’s economy, that a new edition of Rothbard’s classic work be republished  and  made  available  through  the  efforts  of  Lew  Rockwell and the staff at the Ludwig von Mises Institute at an obtainable price for students and laymen interested in the vagaries of banking and how inflation and business cycles are created.”

This was written in the Preface to the book by Douglas E. French in June 2008 – well before the November 2008 drama unfolded but in anticipation of it. (See a video Bubble Economics here)

Get a copy of the ebook for free from the Ludwig von Mises Institute Web site and read it. You will learn some startling things that hopefully will help you protect your nest egg in the future.

For instance,

“Although ostensibly it is dodgy real estate loans that are bringing the banks down this year, in the seminal book that you hold, Rothbard shows that it is really the fraudulent nature of fractionalized banking that is the real culprit for the bankers’ demise.”

The book is an easy read with no high level mathematics. In the Forward by Joseph T. Salerno of PACE University he says,

“Rothbard’s presentation of the basic principles of money-and-banking theory in the first eleven chapters of the book guides the reader in unraveling the mystery of how the central bank operates to  create  money  through  the  fractional-reserve  banking  system and how this leads to inflation of the money supply and a rise in overall prices in the economy.

One particular chapter on Deposit Banking makes interesting reading. There has been an argument going on for years about what banks could do with your money when they got it.

The classic case occurred in 1848 in the House of Lords, in Foley v. Hill and Others. Asserting that the bank customer is only its creditor, “with a superadded obligation arising out of the custom  (sic?)  of  the  bankers  to  honour  the  customer’s  cheques,” Lord  Cottenham  made  his  decision,  lucidly  if  incorrectly  and even disastrously:

Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it. . . . The money placed in the custody of a banker is, to all intents and purposes,  the  money  of  the  banker,  to  do  with  it  as  he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted.

Thus, the banks, in this astonishing decision, were given carte blanche.  Despite  the  fact  that  the  money,  as  Lord  Cottenham conceded, was “placed in the custody of the banker,” he can do virtually anything with it, and if he cannot meet his contractual obligations he is only a legitimate insolvent instead of an embezzler and a thief who has been caught red-handed. To Foley and the  previous  decisions  must  be  ascribed  the  major  share  of  the blame for our fraudulent system of fractional reserve banking and for the disastrous inflations of the past two centuries. “

One last quote from a must read book about the causes of the boom and bust cycle,

“In  chapter  VII,  we  saw  that  fractional  reserve  banking expands money and credit, but that this can be reversed on a dime by enforced credit contraction and deflation of the money supply. Now we see one way this can occur. The banks pyramid notes and deposits on top of a certain amount of cash (gold and government paper); the ever-lower fractional reserve ratio weakens the confidence  of  customers  in  their  banks;  the  weakened  confidence causes demands for redemption culminating in a run on banks; and bank runs stimulate similar bank runs until a cycle of deflation  and  bank  collapse  is  underway.  Fractional  reserve  banking has given rise to a boom and bust business cycle.”

If you believe what Mr Rothbard is telling you then you need to protect yourself from the next “boom and bust” cycle. The FED is the prime driver of the system and as Ron Paul keeps saying, the FED needs to be abolished. Until that happens we are doomed to repeat the same stupid cycle.

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