He never accounts how he would increase the money supply. Central banks are wholesalers of money. They can buy a bond from a bank with government created cash, and get interest for it. They can sell bank the bond and get cash for it. One adds cash to the system and one takes it out of the system. The latter is what the Fed has in mind to reduce reserves.

You are referring to a commonly-made error. The error was – as I see it – most famously and influentially propagated by the Social Credit folk…especially, among them, the “Pilgrims of St. Michael” in Quebec, Canada (also known as the “White Berets”). Their main vehicle is a newspaper called “The Michael Journal” which – last I saw a copy – arguably and disgracefully portrayed bankers as devils, freemasons, or jewish people (or some combination of the three). That’s a side-issue, but the fire used to foster such anti-Semitism was none other than the very error that you are referring to: the idea that the debt money is a trick, invented by bankers, so as to foreclose on everyones property and take over the world.

Here’s a link to one of the most famous/influential publications used to propagate the “but the interest cannot be repaid” myth:

http://www.michaeljournal.org/myth.htm

(re the anti-Semitism I refer to earlier, note the appearance of the banker, as opposed to the islanders).

Now, I give you that comic as a reference because the comic actually makes it easier to understand the flaw in the notion that “the interest cannot be repaid”.

The key passage in the comic is:

Oliver turned out a total of $1000. He’s asking in return $1080. But even if we bring him every dollar bill on the island, we’ll still be $80 short. Nobody made the extra $80. We turn out produce, not dollar bills. So Oliver can take over the entire island, since all the inhabitants together can’t pay him back the total amount of the capital and the interest.”

The flaw is as follows.

First, note that the banker is not trading on the Island: “And it’s money you’re asking for, not our products.” He is not participating in the economy. He might just as well be visiting from Saturn when he drops of the money, disappearing, and visiting again when he comes to collect it all plus interest. But that’s not how things work in the real world. Bankers are human beings, just like everyone else. They don’t just lend out money: they trade the interest they earn for the goods and services offerred by the very people to whom they lend money, and those people use their profits to pay interest to the banker and to pay down debt over time. Bankers lend money to grocers, and clothing retailers…but they also buy groceries and clothing with the interest that they earn on the dollars they loan out. They use some of the interest to pay employees – - receptionists, secretaries, tellers, cleaners, security, etc. – who buy groceries and clothes. They pay some of the interest to power companies to light and cool the bank; to natural gas companies to heat the bank…and those power and gas companies pay employees…who buy groceries, and clothing, and gas, and electricity, etc.

Second: note that the only economy available to the banker in the story is the one on the island. There isn’t some other economy somewhere else, where the banker can buy groceries, clothing, heat, electricity, a house, etc.. So, somehow, without producing anything all year long, and without obtaining anything other than a shelter from his borrowers, he somehow eats, stays warm, gets from one place to another etc.

Third: note that, in the story, the banker returns and expects the simultaneous repayment of the *entire* money supply come year’s end. That is never the case in a real economy. People generally pay in installments of interest and principle but, more importantly, they do not repay all of their loans simultaneously. And, if all of the money were repaid: there would be no more money, because debt ceases to exist when it is repaid. The entire story is silly…and the notion that there isn’t enough money to pay down principle plus interest is silly for the same reasons: it makes the same false assumptions made in the story.

The bottom line is that interest payments do not remain in the banker’s hands: they go back out into the economy because he uses the interest payments to buy labour and goods. For that reason, it is always possible for a debtor to repay his debt and his interest.

I know I agree with almost everything that you write here on this subject, and as an advocate of Soddy and Fisher, I see a lot of commonality.
I am not sure I am in total agreement, but I hoped you could address the matter of interest.

Take any Base money supply amount.
With FRBanking any increase in the money supply, and therefrom all money in circulation, is lent into existence, securing a loan amount (A) with a contract and PN.
Between the loan contract and PN is an obligation to repay the interest on that loan along with the principal(A + B).

If ALL money in a debt-money system comes into existence as a debt, and if all loans require the repayment of a sum greater then the principal amount, then from where does the interest payment money come into existence?

This is partly covered in the Zeitgeist Addendum video, Part 1.

Steven Lachance identifies the unpayable interest as the achilles heel of the debt money system, if you check it out here.

http://www.financialsense.com/fsu/editorials/2005/1212b.html

So, we need a new money system, and, of course it must be based on full-reserve banking.

Your thoughts, please, if you are still posting on this subject?
Or write to me at my email address.

Obviously this is the crux of the disagreement. Loaning – issuing an IOU for that $50 – does not increase the money supply, it is a loan of that *actual* $50 on deposit and sitting idle (and of course they would not lend out the entire $50 anyway, only a *fraction* of that).

Let me rephrase your answer before I respond to it. You are saying that, because the $50 of gold is in the vault, creating $50 to lend to B does not increase the money supply.

That’s false. Here’s why. Start with $100 of coin being the entire money supply. B holds $50 of gold coin, and so does D. B “deposits” his $50 of coin at the bank: this means, legally, he exchanges $50 of coin for $50 of bank-issued credit (it is NOT the case that the bank takes his gold, puts it in a vault, and gives him nothing in exchange). C then borrows, say, $49 more bank-issued credit. There is now $50 of gold coin in the vault, another $50 of gold coin in D’s pocket, $50 of bank-issued credit held by B, and $49 of bank-issued credit held by C. Excepting the $50 of gold coin that is sitting idle in the bank’s vault, the money supply has increased from $100 to $149 because the bank issued $99 of credit with respect to the same $50 of gold coin reserves. That is an expansion (i.e., an inflation) of the money supply. The result of issuing $99 of credit on a $50 reserve of gold coins is that the value of all dollars, including the value of D’s gold coins, has been decreased. D used to be able to get a full tank of gas for his $50. Now, he can only get 2/3rds of a tank for his $50.

Obviously this is the crux of the disagreement. Loaning – issuing an IOU for that $50 – does not increase the money supply, it is a loan of that *actual* $50 on deposit and sitting idle (and of course they would not lend out the entire $50 anyway, only a *fraction* of that).

Your only real objection is due to the ability of A to come and demand his $50 and he will get it even while the same amount is on loan. If A were the only, or one of a very few, customers then there *would* certainly be a problem – the bank would not have sufficent funds to cover it. But that also demonstrates very clearly that the money supply has not increased and the bank has not “created” money, since in that case the bank would go broke if it were not able to recall the loan from B in order to make good on A’s claim, or borrow from elsewhere. If they default, then A has been done an injustice to be sure, but the original money supply is perfectly intact.

Of course no viable bank has so few customers. But also, the number of customers they have directly affects the actual fraction of deposits they must keep on reserve in order to make sure thay *can* always meet demands. A very small bank would require a very high reserve, possibly even 100%. Large banks can safely have lower reserves. It’s easy to demonstrate why (and also demonstrate a 50% reserve):

A deposits $50. Bank loans $25 of that to B. C also deposits $50. Bank loans $25 of that to D. A comes in and demands his entire $50. Bank *has enough reserve to make good* and hands A his $50. Total amount in circulation: $100, no more, no less. That 50% reserve allowed the bank to honour a demand from one of its customers even though it had loaned out a fraction of it.

At this point of course, they are in trouble if C now wants any part of his $50 deposit, they have $0 left on reserve and would either have to call in $50 worth of loans to others, or borrow from another bank. But in either case it *again* demonstrates that no *new* money has been issed, there is still only the original $100 total deposits circulating. A bank with 1000s of customers can cover actual demands quite easily precisely because, barring some panic and subsequent run on deposits, the bank can depend on some *fraction* of those deposits to always be on hand.

It is exactly the same reason insurance works – premiums from all customers are pooled, allowing the claims of some to always be covered. If everyone died, got sick, had accidents, all at once, clearly the insurance company would go broke as well, but it also clearly doesn’t happen, barring only the worse case catastrophes. Fractional reserve banks are not *creating/inflating* money any more than those insurance companies are.

To Per-Olof: As I demonstrate here, “fractional” refers to the portion of deposits a bank keeps on reserve in order to be able to honour expected normal demands of its depositors.

The phenonmenon of such low fractions such as 5% being used is *only* a result of government imposing deposit insurance, forcing low interest rates, allowing bailouts, and actually inflating the money supply, none of which takes place in a free market.

Now as to the currently accepted meaning of fractional reserve – that it includes the idea that a bank can count as part of its reserves IOUs that are already being backed by the reserves of another bank, and so on down the line: I realize, in writing my own example here, that it may not, in fact, be a problem *anyway* and might actually be perfectly legitimate (i.e. I may have to amend my own previously stated position on this – but I do need to think this through some more yet before committing to it).

The reason is, again, due to the nature inherent in the pooling of resources from many. Extending my example further, if B deposits the $25 IOU he was loaned in Bank X, and X counts that as a real deposit and thus loans out $12.50 of it to E, it is still subject to the same pooling, and the safety of that. It is true that all *potential* claims on my original $50 could exceed that $50, but the whole point is that, on average, *actual* claims at any point in time will *not* exceed that original $50. And due to pooling, it is not a problem for individual cases to do so because they are easily covered by other deposits not currently being demanded.

I looked this up, and I don’t see that he endorses fractional reserve banking at all. He writes:

“The dire consequences of fractional bank money will be explored in the next chapter. Here we conclude that, morally, such banking would have no more right to exist in a truly free market than any other form of implicit theft.” (P. 50.)

And later on the same page:

“If fraud is to be proscribed in a free society, then fractional reserve banking would have to meet the same fate.”

He does have a long reasoning to the effect that those “dire consequences” would be lesser with free banking (if FRB were permitted) than what we have today with a central bank. Well, this is my view, too. It would not be perfect, but it would be better than what we have today. But this does not mean an *endorsement* of FRB, neither from Rothbard, nor from me. We should strive for the best and not be satisfied with the second best.