Unlike the Danish King of England, Cnut, who was assuredly mocking his court when he commanded the sea to retreat, our Prime Minister has not a hope in hell of turning the recession. This is not because of a dearth of money or a failure to gain political or international unanimity, no, this is because recession is inevitable once a boom has started. The key to avoid a recession is to avoid forming a boom before hand, no matter how much clamour there is for cheap finance, rising house prices, a lower sterling, or staggering share values.

Business booms, however, are not spontaneous. They are created by governments and the central banks that they support by monopolistic and protective legislation which enables them to pursue the greatest scam in modern history: fractional reserve banking.

The central bank is the keystone to the present commercial banking system which relies on the central bank’s printing presses as well as the tax payer to protect deposits against unruly customers who may pull their deposits should they lose trust in their banks – and boy, do they have a reason to be eternally sceptical.
Fractional reserve banking system is actually an ancient con game in which depositors’ money is leant out on a multiple of the asset held: if you deposit £100 in a commercial bank, it may lend out up to 90% in loans and overdraft facilities to borrowers. These funds may be then deposited in other banks, who can then lend out another 90%, etc. A geometric sequence that we learn in economics classes is formed such that the initial injection of funds leads to a multiplied effect – in this case ten times as much. This is the initiation of the scam: credit is created out of thin air. No other industry could get away with creating screws or cars out of thin air. Yet the banking process, accepted by many commentators as the natural way of things, is not harmless. Those available credits are taken up to buy goods and services and thereby distort economic production notably in interest rate sensitive ventures such as long-term investments and the housing market.

The addition to the money supply creates an inbuilt bias to inflation: indeed, early economists did not refer to inflation as a general rise in prices but to an expansion of the money supply.

Whether those loans are taken up or not depends on the demand for them, and when business is good, the uptake may be strong. Which means that a monetary expansion is often seen by some economists as a healthy symptom – much like an alcoholic reaching for another tipple one should rather think. Monetary expansion is certainly not healthy – the effects of inflation are to impoverish most of us while a few are able to ride the inflationary wave on the back of rising asset prices: it is thus a tax on some parts of the economy in favour of others.

The story worsens. The banks are required to hold a fraction of their reserves on hand in case of depositors wish to denude them of their financial base. Should that happen, the central bank can jump in to “protect” the banks from leery clients: that is, the central bank “injects liquidity” – which is jargon for printing money. Fresh printed notes are then dished out – seemingly in a very political process (who’s in? who’s out? – but that’s another story) to prop up the entire edifice. 

Unlike Cnut’s charade, this system creates momentous disasters – the pain of millions of markets struggling to maintain their position as inflation runs through the economy and people and resources seek new employment. To avoid the recession – one must first avoid the boom. A quick glance at any monetary statistics available on the web highlight the enormous expansion that has occurred over the past decade: we are now paying the price.
Proper banking relies on depositors investing money with them that they in turn invest on their behalf for a mutual return. It does not create a money multiplying scam that accelerates monetary expansion: it merely acts as a middle man between borrowers and savers, or in the words of economists, it acts on a 100% reserve ratio – just like the rest of us! (Oct. 2008)

Addendum (September 2009)

Interestingly, Sharia Law (the legal side of the Islamic religion) also operates on a 100% reserve basis, probably due to the influence of Aristotle’s economic theories that seeped into the Arabic world and its universities following the collapse of the Athenian academies (shut down by a Christian emperor). Aristotle intoned that money is barren, that it was not productive and so could not therefore earn interest morally speaking. Usury should thusly be prohibited by the state, which for many economists has meant that the earning of interest and the study of interest was retarded by the prohibition which found favour in the Christian church (the ironies of intellectual history are manifold).

However, may I conjecture an alternative reading of Aristotle here that Islamic banking may have correct? The usury that Aristotle thought ought to be abolished may have been the formation of fiduciary credit upon which bankers earn immoral gains. Fiduciary credit is not backed by gold or silver – it represents the creation of monetary media out of thin air, but which, when circulating do command purchasing value (since from appearances there is nothing that differentiates fiduciary credit notes from notes properly backed by true money). On the other hand, if an investment bank takes in proper money and then lends it out to those requiring loans, it may justly (according to Sharia Law) charge a fee and earn a profit on the transaction (subject to the traditional commercial law tenets that the borrower is using the money for a real market activity such as buying a machine, which acts, along with the guarantors that Sharia Law requires, as collateral to the loan). In this case, there is no usury in the sense of earning money upon money’s creation, and perhaps, is my conjecture, this is what the Islamic legalists worked out in the context of inheriting Aristotle’s thoughts on usury…Western banking is assuredly rejected by Sharia Law and Muslims have a duty to choose Islamic banking unless the situation governs otherwise, but it certainly is an entertaining prospect for the history of intellectual thought as well as for understanding Islamic banking.

However, the pull of fiduciary profits may tarnish Islamic banking yet: from what a colleague explained to me, Islamic banks and insurance companies operating further from Saudi Arabia tend to be weaker in upholding Sharia principles and thereby are becoming more ‘Western’ – which is not a good thing!
Conclusion: proper banking rests upon 100% reserve ratio banking; anything else is immoral as it is fraudulent. Fractional reserve banking also creates huge disruptions to markets causing the boom and bust waves of economic activity that aggregate statistics capture. End the Fed, as Ron Paul says, and abolish the Bank of England and all Central Banks – their nefariousness, it is often hinted at in some circles, is also much larger than screwing up the economy. War is financed by central banking – how else do you think the USA keeps on sending its troops around the world?!
© Dr Alexander Moseley, 2009