Very busy week (I guess I can't complain about having more work than I can easily deal with!). As a result, unfortunately, just another quick thought for this week's post (and a day late, at that):
I've just finished reviewing "Crisis of Civilizatoin," a new book by Nafeez Mossadeq Ahmed of the Institute for Policy Research and Development, a London-based think tank. It's an outstanding book, and one that I will review properly on this blog when published and available to the public. In the mean time, however, I want to briefly discuss a comment made by Mr. Ahmed on fractional-reserve banking.
For the past few weeks, I've been hinting that I'm going to return to the causes of our civilization's demand for perpetual growth (formerly discussed in The Problem of Growth). One element, that I hadn't properly considered before reading Mr. Ahmed's book, and that I must now consider more carefully, is the role of fractional-reserve banking.
Put simply, by lending out at interest more "money" than a bank has deposits, the bank creates a situation where significantly more money must be repaid than was borrowed. In order to generate this difference, the community is forced to put the money to growth-oriented tasks, rather than merely borrow money now and save to pay it back. So the firm that borrows money must use it to finance growth--in production, consumption, etc.--in order to generate the money necessary to pay back the principal plus interest. This is fairly straight-forward, of course, but the systemic result of the practice of fractional-reserve banking, when spread throughout society, is that society as a whole must grow in order to have enough incrase in "wealth" to be able to repay its lenders.
Wouldn't simple interest cause this same problem, without considering fractional-reserve banking? The discussion on the rationale behind the prohibition on usury is best left for another day, but the bottom line is that fractional-reserve banking is more than a mere escalation on the catalyst for growth caused by interest alone. Interest is, in theory, equal to the opportunity cost of the lender (as in, the value of what the lender could do with the money) plus the risk of non-payment. So if a lender lends at interest, they are not really creating a catalyst for growth by the act of lending, because it could have used that money for a growth-oriented purpose itself. In actuality, they are only redistributing capital to where it can work more effectivley, and facilitating economic efficiency. Fractional-reserve banking, on the other hand, allows the lender to create far more growth than he himself could have created by putting his own capital to use.
Food for thought for the time being, more on this in the near future...