Understanding How Banks Should Operate

There’s a lot of spite and envy towards the banking system. It’s understandable why many people dislike banks and bankers. Banks are primarily lenders of profit and not lenders of good cause.

If they lend money, they want interest on the loan and are not very negotiable when one falls behind on payments. To them, your problems are not their problems, and they want their money, understandable.

However, I want to point out that many big banks today are not following the best practices. The truth is, in their minds, they’re untouchable. If they do bad business deals, the government will likely bail them out. So why not continue to do bad business?

It’s not like we need to ban all banks because they’re essential to the economy; we need to shift their focus to something more favorable for the economy. The question is how do we change their behavior? Well, we can start by stopping the bailouts, which they did after the 2008 financial crisis.

However; banks are allowed to do bail-ins and take depositors money if needed. Of course, this doesn’t stop the problem as its almost the same as bailouts; the only difference is the source of funds.

How the Banks Should Operate

The banking system can operate under two functions, a full reserve, and a fractional reserve system. The fractional reserve system is responsible for several bank runs and recessions; however; I believe the market should determine whether or not there should be a fractional reserve system rather than the government.

Fully Reserve Banking System

A full reserve banking system operates under a 100% full reserve on deposits. Under this system, depositors do not have to worry about banks’ lending their money or not having their money available for withdrawing. The bank generates money by deposit and transaction fees.

However, there are some theories that a full reserve banking system can still lend out money through time deposits that would act similarly to a CD savings deposit. Money in a time deposit will be locked in the account until the agreed term has been reached.

During this time the bank lends money out to a borrower and receives interest from the loan. The depositor will also receive a portion of the interest amount. If the borrower is unable to pay the lending the amount, the bank will have to pay the difference with their own money.

Fractional Reserve Banking System

Under a fractional reserve system, banks do not have deposits fully reserved. The reserve ratio between the money held by the bank and by deposits can vary. Some countries such as Canada don’t have a reserve requirement.

The fractional reserve banking is under a lot of scrutinies; the system is responsible for excessive debts and inflation. If it weren’t for the fractional reserve system, crises such as the 1906 bank run would have never happened.

A fractional reserve system occurs when banks lend out money to expand capital flows into the economy, and only a fraction of bank deposits are backed by actual cash on hand.

However, the problem with a fractional reserve system is that it is inherently an unsound monetary system. If depositors withdrawal the money from the bank, the bank quickly become insolvent.

No Central Bank Needed

Every country in the world except for Iran, Cuba, and North Korea has a central bank. A central bank governs a country or countries (European Union) monetary system.

The Federal Reserve regulates the United States monetary policy. As I stated in a previous post, the Federal Reserve has done a terrible job maintaining dollar stability; however, the FED isn’t alone.

Just about every central bank in the world has managed a terrible job stabilizing their currency. Gold is used as a measure against inflation and is valued against every nation’s currency.

Right now gold has reached all-time highs in over 70 countries worldwide. Some of these countries currency is depreciating so rapidly that the citizens are experiencing high consumer prices.

A better alternative to the centralized banking system will be to have banks decentralized and gold used as money. From 1776 through 1933, gold was money, and the dollar remained stable. However, the dollar began to lose value starting in 1914, right after the creation of the Federal Reserve Act.

The Fed’s loose monetary policies enabled consumers to buy on credit and caused the economic boom of the roaring twenties. Due to the expansion of the credit, the price of gold should have risen above $20 an ounce.

Instead, the government eventually responded by removing the US gold standard amid the Great Depression in 1932, to better fund the incoming social programs such as the New Deal and Social Security.

The Fed Is Politically Motivated

Fastfoward to today, it’s hard to not notice the political tension between President Trump and Federal Reserve Chairman Powell. On the one hand, President Trump believes that the rate hikes were a mistake. On the other hand, chairman Powell thinks the decision to hike rates was the right decision.

However, the stock market began to crumble after the last rate hike in December. The Fed quickly followed up with the announcement of no rate hikes for 2019 and will end the unwinding of the balance sheet in September.

While the Fed won’t admit it, they’re practically playing into what Trump wants, a low-interest rate policy. If rates don’t remain low, there’s a good chance that the economy will crash for the same reasons as the 2008 crash occurred. Don’t be surprised if the Fed enacts several rate cuts sometime this year.

People should be In Charge of the Monetary System

The people should be in charge of the monetary system, not the Federal Reserve. Gold will maintain the stability of the US dollar’s purchasing power. The government will not be able to squander wealth if gold is money.

Of course, it’ll be up to the people to defend the gold standard. Without the support of the US citizens, a gold standard will not last. The government will eventually replace it with another fiat monetary system, causing the cycle of cheap money and political corruption to begin anew.

Why We Need Banks

Although we do not need the Federal Reserve, we still need banks to help facilitate economic growth. Banks will aid in assisting with personal savings and transactions. As I stated in a previous post, savings is essential for economic growth.

Savings allows for the expansion of capital goods which can help promote economic productivity. And banks will be the mediators that will help with the lending process.

If we were to go to a sound banking system, we’re likely to experience an economic boom that will undoubtedly increase the nation’s standard of living. In fact, due to the lack of monetary credit expansions, we will not experience recessions or depressions.

I believe in due time; the average individual will come to understand how reckless central banks are. Individuals will want to abolish these banking cartels and go back to sound money. It’s possible that the people will wake up to the fraudulent system during the next economic crisis. Perhaps then they’ll understand how banks should operate.

I, at least certainly hope so.


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