Exam question: explain in 300 words why fractional reserve banking is legalised fraud.

 
 Answer:
 
Since banks first appeared (probably thousands of years ago) private / commercial banks have accepted deposits and loaned on depositors’ money while telling depositors, or at least suggesting to them that their money is safe. It quite clearly ISN'T because loaned out money is NEVER safe. Indeed, when any non-bank does that (e.g. a unit trust, mutual fund or private pension scheme) that activity is classified as illegal / fraudulent.

Of course since the arrival of state support for private banks (consisting e.g. of billion dollar bailouts for banks in trouble, and a very recent development relative to the total time banks have been going) the above dodgy practice is rendered safe. But the fact of the state passing a law saying that a fraudulent or unsafe activity is not fraudulent does not unfortunately stop it being basically fraudulent. Passing a law saying that house burglary is OK, with taxpayers reimbursing those burgled, would not make house burglary acceptable.

As for the idea that private banks create the money they lend out rather than lend on depositors’ money, that is only partially true, as explained in the opening sentences of a Bank of England article, entitled “Money Creation in the Modern Economy”. That is, a private bank simply CANNOT lend out limitless amounts of money without having a roughly equal amount of money coming in from depositors, bond-holders etc. (else the bank will run out of reserves, and have to borrow reserves from the central bank or other commercial banks, which is not a good position to be in for any length of time). As the second sentence of the article says, “banks do not act simply as intermediaries, lending out deposits that savers place with them…”.  In other words private banks DO INTERMEDIATE between lender / depositors and borrowers (as suggested in the above paragraphs), but in addition, they do a bit of “creating money out of thin air” each year. If they didn’t, the money supply would never increase (ignoring state created, i.e. base money).