Tim Worstall on fractional reserve banking.

 

Tim is a productive individual: he writes one article PER DAY, (Saturdays and Sundays included) for the Adam Smith Institute, which I invariably look at, though don’t necessarily read right thru.

I just stumbled across a Forbes article of his from around ten years ago entitled “What caused the great financial crash.”

He rightly says that the big weakness in fractional reserve is the fact that it engages in “borrow short and lend long” (BSLL) which is risky. But he then makes the common mistake of claiming that to abandon BSLL would cut growth, and quotes Adam Smith in support of that view.

The mistake there is that Adam Smith lived in the days before we had a flexible monetary base: i.e. the money creation that results from BSLL certainly did assist growth in Adam Smith’s day. But we now have a flexible base, i.e. government and central bank can create whatever amount of money they need to bring about the desired amount of stimulus. Ergo, as I explain here, there is no need to run the risk that is inherent to BSLL.

QED.