The Instigator
Pro (for)
1 Points
The Contender
Con (against)
0 Points

Fractional Reserve Banking should be illegal.

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Voting Style: Open Point System: 7 Point
Started: 8/10/2014 Category: Economics
Updated: 2 years ago Status: Post Voting Period
Viewed: 921 times Debate No: 60272
Debate Rounds (5)
Comments (1)
Votes (1)




First Round, Acceptance.
P2: Opening Argument
C2: Opening Argument and Rebuttal
Round 3: Rebuttal and further positive arguments
Round 4: Rebuttal only.
Round 5: Closing rebuttal, no new arguments.
I wish Con luck and hope this is a good debate.


As Pro has stated, first round is for acceptance. However, i feel the need to define our terms and to outline the burdens before diving into this debate. Pro may feel free to contest any of these definitions or any of my analysis in his following round.


Fractional reserve banking - "A banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal. This is done to expand the economy by freeing up capital that can be loaned out to other parties. Most countries operate under this type of system" (1).

Illegal - "contrary to or forbidden by official rules, regulations, etc." (2).

Should - "used in auxiliary function to express obligation, propriety, or expediency" (3).

==Framework and Burden Analysis==

Per typical policy-debate protocol, Pro will have the sole burden of proof; he is affirming the resolution and advocating for a substantial shift from the status quo.

The crux of his burden lies with the "should" term. Normally we conceive of this as indicating a normative resolution, in which case the burden of proof would be shared such that Pro argues "should" and Con argues "should not." However, it bears a larger implication in the course of this discussion. Our resolution is not predominantly normative, though surely there may be a normative component to it, which I'm sure Pro will raise if he so chooses. "Should," per the definition I have provided, expresses an ethical and legal obligation to implement such a law or policy such that it becomes standard practice. Fractional reserve banking has been the norm for quite some time and is utilized by numerous countries around the world. Pro must be able to demonstrate that the practice ought to be totally illegal, in the process setting forth the criteria by which we would make something illegal. Note that he does not specify whether our resolution is tailored predominantly to the United States. Given that fractional reserve banking is used around the world, there is no reason to expect that he had limited the scope of the debate in such a way. Therefore, examples from other countries should be acceptable.

I would like to wish Pro luck, and I hope for a stimulating debate.

Debate Round No. 1


Thank you Con; those are excellent definitions, and I should well have clarified full BoP on myself. Also, good note on use of other countries; I was prepared to limit myself to the U.S., and am grateful for the lifting of an unnecessary limitation. On to the debate!

I shall outline my case against Fractional Reserve Banking on two points: It is inherently fraudulent in its current form, and it"s inherently inflationary nature leads to the big boom-bust cycle rather than more micro-level corrections that occur during times of boom and bust. Further, based on these two points, the supposed extra loan-able funds fractional reserve banks provide is both immoral and unjustified.

On the first point, Fractional Reserve Banking is inherently fraudulent. The idea behind Fractional Reserve banking is that what you deposit, you can withdraw at any time. However, because of the reserve ratio and the incentive to loan out as much funds for interest as possible, any person who withdraws a greater percentage than the reserve ratio must necessarily withdraw from someone else"s account. Bank runs occur when people begin to feel that they won"t get their money, creating a prisoner"s dilemma where the only way to get out ahead, realistically, is to rush to the bank and get your money before someone else does. Methods the governments have taken to curb this problem, including taxpayer funded deposit insurance and central banks that send fiat dollars to the banks to shore reserves, either just add a middleman to the loss of money (tax money comes from tax payers) or leads to my second point. A promise to allow a person to withdraw their money on demand when they can only do this with other depositors money is fraudulent, and should be illegal for that reason alone.

However, fractional reserve banking has been justified for reasons of utility, leading to my second point; the inflation created by fractional reserve banking is more destructive than useful. The effect of this practice is that banks hold the depositor's deposited balance as all existing and loans it out at the same time. The "money multiplier" effect is a major part of macro neo-classical economic theory, and is not considered controversial. The controversial part is what the effect of this inflation is; what the expansion of the money supply does is lead to "mal-investments" or investments that would not have been made with an un-inflated currency. Eventually, a bank-run occurs (or the central bank requires higher reserves) and the mal-investments prove to be the social wastes they were and bust. This market correction is necessary after a boom of inflationary funds; the damage is done in the boom period with investments that should not have been made. Fractional reserve banking is directly responsible for this problem.

So, it is fraudulent, and the supposed benefits fractional reserve banking create are actually part of the macro-economic problem. I turn this debate over to Con.


==Framework and Definitions==

Con has accepted the BOP and resolution analysis I have offered, as well as my definitions, so extend those.


I provided a definition in the last round, but I feel the need to briefly explain mathematically what fractional reserve banking is.

Say that you deposit $100 in a local bank. The bank is required by law to hold 10% of that deposit as reserves. Anything it holds in excess of 10%, or $10 in this case, is known as excess reserves. Deposits are aggregated and then lent out to consumers.

So, let's review multiple deposit expanasion with numbers. Let's assume that $100 is the aggregation of deposits and that people opt not to hold currency and banks opt not to hold excess reserves. As I will explain later, this is actually quite a horrid assumption, but I will take this simplistic model first just to illustrate the process.

Person A deposits $100 in his local bank
His local bank holds $10 as required reserves and has $90 in excess reserves
The bank loans out $90 to Person B
Person B deposits $90 in Bank B
Bank B holds $9 as required reserves and loans out $81 to Person C
Person C deposits $81 in Bank C
Bank C holds $8.1 as required reserves and loans out $72.9 to Person D

And the process, essentially, continues. The crux of this is that the initial deposit of $100 is continously expanded such that the money supply increases. We can quantify this in our simplistic model with the formula of I * (1/rr). In other words, the initial deposit ($100) multiplied by (1 divided by the required reserve ratio). The result, $1000, is the amount of money spawned from the initial $100. If we had a reserve requirement ratio of, say, 20%, our result would be $500, and so on.

There are several important benefits to this system, aside from the fact that it's the status quo. In spite of the fact that, as Pro acknowledges, he has the BOP because he is arguing from a deviation from the present, I too acknowledge that it is a fallacy to say that "X is the status quo, and therefore we should have X." I want to evaluate the system as a whole; if it has no benefits, why have it? Indeed, that may not justify illegality, but it would weaken my case severely if I didn't provide any benefits.

Benefit 1: Efficient way for the money supply to grow

A common view of the Great Depression is that, as the money stock contracted from 1929-1933, G.D.P. subsequently fell. The view is consistent with localized accounts of the era, and even with the recent crisis; via Sumner, the money supply contracted significantly in October 2008. Unemployment didn't spark immediately following the onset of the financial calamity, so there is reason to think that money supply growth that is predictble, transparent, and reasonable ought to be lauded.

Moreover, this is frankly the ONLY way, under the current system, that the money supply could grow save for drastic Fed action, e.g., OMO purchases that expand the monetary base but may not lead to a subsequent rise in M1 due to banks holding excess reserves -- there are a few reasons for that which I will get to later -- and the public holding currency. Under normal times, the Fed balance is around $800 billion, contrary to its current size of $4.4 trillion. Indeed, inflation has been essentially flat for years, in spite of recent indicators suggesting upward pressure amid an improving economy. However, under normal circumstances, QE would be highly expansionary. If my opponent is worried about inflation, as I trust he is, he wouldn't want the money supply to grow in tandem with OMO or discount-rate lending.

Benefit 2: Business Loans

Most businesses, particularly very small businesses and start-ups (and note that most jobs actually come from start-ups), are net borrowers. This is to say that those businesses borrow more than they have saved. In the case of start-ups, this is common. Without fractional reserve banking, how would these businesses be able to acquire loans to make investment and hiring decisions, which are essential to economic activity? If we began with, say, $100 and the bank could only lend out $90 once, how would businesses expand? This would be the view of the banking system as a de-facto lock box. If that were the case, not only would bank profits plummet and would there be more volatility in the markets -- scarcer capital means higher interest rates, which also would make it harder for people to take out loans, and would in fact disincentivize entrepreneurship -- but there would be significantly greater scrutiny as to who in fact receives those loans. That is to say that already established companies with significant balance sheets would be much more likely than start-ups to receive loans. That means fewer start-ups, less investment, fewer jobs, less economic activity, and more hierarchy.

Benefit 3: Signals via Interest Rates

Banks are eclectic creatures in that their policies often signal the condition of the broader economy. Commercal lending, for instance, just expanded at the fastest rate than it ever has since before the crisis; this suggests to us that the economy is in fact improving, and means that investors and consumers are going to respond in tandem. These confidence effects, or "animal spirits," as John Maynard Keynes called them, are crucial. The economy today operates off assymetries of information, but it's almost impossible to run a business -- particularly a small one that doesn't have access to other financial intermediaries -- without going throw a bank.


I. Fraudalent

Pro first claims that this system is fraudalent. He remarks that "any person who withdraws a greater percentage than the reserve ratio must necessarly withdraw from someone else's account." I will prove to you mathematically why this is wrong.

Let's go back to our earlier example: the aggregation of deposits is $100 and the reserve requirement ratio is 10%, where it has remained since 1992. Note that 90% of this deposit or $90 was kept as excess reserves and available for loan or withdrawal, so it is simply wrong to suggest that wanting to withdraw a greater percentage of the initial or aggregation of deposits than the required reserve ratio would even dip into someone else's account.

Pro then brings up bank runs. Indeed there are scenarios in which confidence falls to such a degree that people DO withdraw their money at the same time, which leads to a self-reinforcing bankruptchy. However, Pro has in no established that the practice of FRB is ipso facto fraud; fraud means, according to Merriam Webster, "the crime of using dishonest methods to take something valuable from another person." That wasn't the case at all. Consumers knew full well the ramifications of deposting their money in a bank knowing that it would go bust which is why, as Pro points out, there are systems in place to prevent this from happening: Fed action, deposit insurance, macroprudential legislation, e.g., capital requirements, etc. Note, also, that Pro is attacking the wrong person or item. The reason we had a bank run in the 1930s was because the money stock FELL. Milton Friedman was a prolific advocate of such a view. It was a failure of monetary policy from the standpoint that banks were (1) underegulated (this pre-dated Glass-Steagall) and (2) monetary policy was poor and in fact contractionary even during the crisis. For instance, money aggregates fell amid the Depression, reserve requirements were more than doubled from 1936-37, the Fed constantly would expand and then almost immediately contract the money supply, etc. The recent crisis provides a better image: indeed, the Fed was late to the party, only expanding its balance sheet as of October 2008, prior to that offsetting expansionary policy with OMO sales. However, had the Fed not intervened, we would've seen a calamity on par with the Depression. Pro cannot possibly pin the blame for bank runs on FRB, especially when the real culprit is exogenous or real shocks -- in the case of the Depression, it was a bank in central Europe that ws "too-big-to-fail" collapsing -- and overly tight monetary policy. Moreover, he speaks of a loss to the middleman. This is simply false because the Fed does not operate on U.S. tax dollars; in fact, it turns over its profits to Treasury each year. When it buys up toxic MBS, it incurs the losses itself, but this is utterly irrelevant because it can literally loan money to itself to prevent itself from ever going insolvent.

II. Inflation

Pro oversimplifies the money multiplier. The example I provided earlier and explicitly stated was overly simplistic does not take into account the public holding currency or banks holding excess reserves. In the case of now as well as the Depression, both of these were the case. In the 30s, people withdrew their money en masse to avoid incurring losses amid bank runs. Recently, banks have been holding record amounts of excess reserves -- about $2.5 trillion relative to the typical $200 billion -- and corporations have been holding onto record amounts of cash. Therefore, not only have the monetary base and M1 not moved in tandem, but a 300% increase in the monetary base led to a flat-line in inflation. Why? Because IOR > FFR > other short-term rates, so banks had an incentive to hold reserves rather than lend out those dollars.

III. Malinvestment

As I already pointed out, banks are NOT giving out loans at this point in time and are in fact holding ER. Indeed, the banks were responsible for fraudalent activity including predator lending et al. However, fractional reserve banking itself is hardly to blame for any of that. Rather, it was lack of macroprudential oversight. To provide an example: Glass-Steaggall, passed in 1933, prevent banking panics for 50 years. In the 1800s and early 1900s we had panics every 20 years. Lack of macroprudential oversight and fraudalent financial ACTORS, not FRB, is to blame, not the practice of fractional reserve banking.

Debate Round No. 2


To sum up Con"s argument:
P1: "During the Great Depression, monetary contraction reduced the GDP." However, the bust was needed because of the boom with mal-investments; this further strengthens my point that the increase in the money supply leads to false booms and busts following. With devalued capital, and the realization that a lot of the money recorded in accounts did not exist, a contraction was sure to follow.
P2: "The Federal Reserve or Central Bank alone would be more inflationary"
Central Banks in modern states act as a lender of last resort; during booms, when reserves are strained, central banks are essentially fueling the false boom. If false booms are a sufficient utilitative reason to ban fractional-reserve banks, and if the actions of central banks are acts of "legal counterfeiting" to fund member banks, then it follows that a Central Bank"s power to inflate will be reduced if one of its prime arms is amputated.
P3: "Start-ups are net borrowers. They need low interest rates."
Let us consider first a big rise in interest rates. What is the message to potential savers but to invest; there is a large potential for profit to investors. As the supply for loanable funds increases, the interest rate will decrease. Done in this way, factors can be spent without constantly mal-adjusted signals from inflation; less mal-investments, more sound investments. Considering the largest savers are those who will live on fixed incomes, a non-inflationary future with greater savings holding greater purchasing power is more optimal than less savings with even less purchasing power.

Now, to defend my own points.
First, in con"s first scenario, he makes a factually incorrect claim. If a bank is holding only the minimum reserve ratio, then the bank is only holding $10 of a $100 deposit, and lending the other 90% out. However, even if the bank held 99.99% of the deposit, the depositor assumes he/she has full access to the account and can withdraw the full 100%. All depositors believe this, and yet the bank can only do this until the reserves run out and people try to withdraw the funds of theirs that supposedly exist, but do not in actuality.

The bank profits off the loans it makes, and meanwhile the entirety of the depositors can only withdraw their funds so long as they do so before all the other depositors. That is, the bank does indeed profit from selling the idea that costumers can withdraw their funds at any time.

Con then argues that the Great Depression was due to underregulation by the Government and contractionary monetary policy. However, the amount of regulation put into making sure banks don"t mess up is irrelevant to the inherent fraudulent nature of the system, and is merely an additional cost to taxpayers in addition to the inflation created; better to not have a fractional-reserve system at all, regulated or otherwise.

As for the assertion that monetary policy was contractionary; the contractions come about as soon as it"s realized that the funds that supposedly exist in all loan accounts and deposit accounts do not actually exist! Had the government stayed out of it and let the prices fall, the economy would have pieced itself together sooner. Also, the stagflation period during the Nixon-Ford-Carter years had far from a contractionary policy, and yet the economy still suffered! Inflation causing mal-investments is true of both scenarios; the contractionary policy of the Federal Reserve is only seen once.

In essence, my opponent has not countered the inherit fraud present in the fractional reserve system, nor has con successfully countered that the inflationary boom, when the mal-investments occur, is where the damage sets in, actually strengthening my argument by pointing out the contraction that occurs once it is realized that the funds on records don"t exist and the central bank has to print more money to keep up appearances. I look forward to Con"s rebuttal.


M.Diz forfeited this round.
Debate Round No. 3


arguments extended


M.Diz forfeited this round.
Debate Round No. 4


Arguments extended


M.Diz forfeited this round.
Debate Round No. 5
1 comment has been posted on this debate.
Posted by Wylted 2 years ago
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Vote Placed by Relativist 2 years ago
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Reasons for voting decision: FF.