There’s been a lot of contention and confusion in the comments about the Fractional Reserve system. This is a system under which our banking system has operated since the 1800s. It affects all of us, which is why it’s so saddening that so few people understand it. This video will look at Fractional Reserve Banking and answer the question, what DOES happen to your money when you put it in the bank? Let’s say you have $1000. What happens when it’s deposited? To see how your bank considers your $1000, we’ll use an old-fashioned method of accounting called the T-account, so called because it’s shaped like a capital T, with assets on the left, and liabilities on the right. When you deposit your $1000, the bank now has an extra $1000, so the amount gets added under assets. But to the bank, this $1000 is also a liability, since at any time you can come and get your money, or write a check, or make an ATM withdrawl. The accounting concept at play here is that liabilities ALWAYS equal assets. So, now the bank has possession of your $1000. What happens next? Well, the Federal Reserve sets something called the Reserve Requirement. If the reserve requirement is 100%, then the system is Full-Reserve Banking. This means that the bank has enough money to give to depositors even if all of them come and demand their money all at one time. That isn’t what happens. The reserve requirement is less than 100%, so we have a Fractional Reserve system. This means that a bank only has to keep a certain amount of deposits in reserve, and can loan the rest out. A typical requirement of the Fed is 10%. This means that each bank must keep 10% of every deposit and can loan the rest out. They can keep more if they want, but not less. The Fed constantly audits its member banks to make sure they don’t fall below the reserve requirement. For the purposes of this video, we’ll assume that the reserve requirement is 10% and that the banks loan out every penny they’re allowed to. So, out of your $1000, they’ll keep $100 and loan out $900. They still have the $1000 in the liabilities column. In the assets column, they still have $100 of your original money in reserve. They also have another $900 in assets, since from the bank’s perspective a loan is an asset. Both sides of the T-account are still equal, as they always should be. This is where it gets tricky. Some people say that the bank creates 10 times the money when you deposit it. That’s only sort of true, as we’ll see later; it isn’t actually what happens. What happens is that the $900 gets loaned out to someone else, who uses it to pay for whatever he wanted the loan for. Whomever he pays deposits the money in his account. It could be the same bank, or a completely different bank; either way, it’s a new deposit. So the bank gets another $900 in reserves, and also another $900 in liabilites since the new depositor can demand this money back as well. Now, both sides of our ledger have $1900, not just the original $1000. Effectively, $900 has been created out of thin air. What if both depositors demand all of their money? That’s $1900 total, and yet the bank physically has only $1000 in reserve. It can’t meet the demands of both depositors. The bank experiences a “run.” The bank then has to borrow money from other banks to cover them. If no other bank will lend to them, then the Fed steps into its role as Lender of Last Resort and lends the bank the money to cover the deposits. It was the Fed’s failure to do precisely that which turned a burst financial bubble into the Great Depression. So, $1000 has now become $1900. Since this money creation process is transparent to the individual bankers, if you ask them if they’re creating money, they’ll say no, they’re just lending out part of what is being deposited. But we can keep going with this process to create even more money. $90 of the new deposit is kept in reserve, and $810 is loaned out. Then the $810 is deposited again, and now our total is $2,710. The process keeps going, but notice that the amount gets smaller each time. Eventually, it’s going to peter out. Once all of that happens, the money on our ledger from all this fractional reserve banking will have multiplied by a factor of 1 divided by the Reserve Ratio. So with a 10% Reserve Ratio, the money multiplier will be 10 times. Our original $1000 will turn into $10,000 by the time this is all done. So, if the government runs a $100 billion deficit (low by today’s standards), the Treasury sells bonds to the Fed and the Fed increases the money in the Treasury’s account by $100 billion. Once it goes through the banking system, with banks, firms, and people like you and me taking out loans and depositing our paychecks, when it’s all said and done a total of $1 trillion will have been created essentially out of thin air. All 1 trillion of it contributes to inflation and ultimately takes the value from our paychecks, by making prices in the stores and at the gas pump higher, and from our savings, by making the dollar worth less. All so the government can spend beyond its means. That’s why inflation is a tax, and the most regressive tax at that. The government and the banks get to use the new money first, so they get its full value; by the time it trickles down to us, inflation has eaten most of its value away. Hopefully, you now understand not only the fractional reserve system, but why it’s so important to our everyday lives.

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100 thoughts on “How Fractional Reserve Banking Increases Inflation – HD version”

  1. You want a MORE secure bank? American banks are plenty secure right now.

    "That's hilarious"

    When is the last time a small depositor lost money in an American bank? Moron.

  2. "Bank B is 0% reserve moron. That's another basic math failure"

    Under the full reserve system Shane has been discussing, banks can loan 100% of time deposits. Moron.

  3. FDIC premiums are paid by banks.

    "That money certainly didn't cover the TARP money"

    Why would FDIC insurance cover TARP? Moron.

  4. "A (hypothetical) method of banking in which banks keep 100 percent of their deposits in the form of bank reserves, meaning there are no deposits available for interest-paying loans"

    Don't tell Shane. His version of Full Reserve allows loans from time deposits. Moron.

  5. "Did they have enough money in time deposits to cover it? No, clearly, they didn't"

    Well, seeing as it's a hypothetical, yes they did.
    So you still won't tell me the difference? LOL!

  6. "Well, seeing as it's a hypothetical"

    No, YOU FUCKING LIAR, YOU were talking about the SPECIFIC case of Washington Mutual–NOT A HYPOTHETICAL!!!

    Your dishonesty gets even bigger as time goes on. You could give lessons to the creationists!

  7. Still persisting in this LIE, huh? Not ONE SINGLE WORD about the source or what I quoted from it? Still using your FRAUDULENT formula for reserve ratio?

  8. No, I'm talking about 2 hypothetical banks with the same amount on deposit.
    They both lose the same huge amount in defaulted loans.
    The "Full Reserve" bank is not better off than the "Fractional Reserve" bank.
    Now back to your incoherent whining.

  9. "No, I'm talking about 2 hypothetical banks"

    So you're not only a LIAR, you can't even follow the thread of a conversation! Let's review, shall we?

    You: "How'd that work out for WAMU?"

    Me: "That was FRACTIONAL reserve, MORON!"

    You: "A bank with $2 billion in deposits that loses $1 billion in defaults is not somehow better off…"

    Me: "THEY WOULDN'T HAVE HAD $1 BILLION IN DEFAULTS UNDER FULL RESERVE!"

    (cont'd)

  10. (cont'd)

    You: "The only difference is they have to be totally funded with CDs."

    Me: "Did they have enough money in time deposits to cover it? No, clearly, they didn't."

    You: "Well, seeing as it's a hypothetical…"

    We NEVER switched from talking about Washington Mutual to talking about a hypothetical. Once again, you're caught, so you try to cover for the fact that you're pathetically WRONG.

  11. No, because they got SQUAT and had their credit ruined through no fault of their own, while ALL of the bailout money went to big corporations!

    If a private company had done that, they'd ALL be in jail for fraud. Yet our government does it and unthinking cultists like you keep making excuses for it.

  12. "The "Full Reserve" bank is not better off than the "Fractional Reserve" bank."

    How would you know since you don't know what a full reserve bank is.

  13. "When is the last time a small depositor lost money in an American bank? "

    When they paid taxes thanks to TARP and through their money losing value. Learn to read.

  14. "Under the full reserve system Shane has been discussing, banks can loan 100% of time deposits. Moron."

    Nice literacy failure, your actual claim was 100% of deposits, not time deposits. Under full reserve 100% of the money that can be withdrawn is not loaned out.

    But then using the fallacy of Equivocation is par for the course for dishonest people like you.

  15. "Why would FDIC insurance cover TARP? Moron."

    I see you still haven't learned to read. Since TARP covered the bank failures that were supposed to be covered by the FDIC, the FDIC was clearly unable to do the job you pretend they can do.

    Not surprising coming from someone that doesn't know what a Balance Sheet is.

  16. ":Don't tell Shane. His version of Full Reserve allows loans from time deposits. "

    And since time deposits aren't regular deposits you are still basing an argument on your inability to read.

  17. "They both lose the same huge amount in defaulted loans."

    And one of them was no reserve as opposed to full reserve. Not surprising coming from someone who claims the Housing Bubble was a good thing and makes him feel richer. Everyone else learned their lesson about 4 years ago.

    Have you learned how to multiply by 1 yet?

  18. "Since TARP covered the bank failures that were supposed to be covered by the FDIC"

    No, TARP did not cover bank failures. FDIC covers bank failures. Learn to read.
    Let me know if you're still confused about balance sheets, fractional reserve lending, money supply and TARP.
    Or any of the dozens of other things you're still ignorant of, I'm always glad to help the slower students.

  19. And since time deposits aren't regular deposits you are still basing an argument on your inability to read.

    "A (hypothetical) method of banking in which banks keep 100 percent of their deposits in the form of bank reserves, meaning there are no deposits available for interest-paying loans"

    Ouch, burned by your own link.
    Put some ice on that.

  20. "No, TARP did not cover bank failures."

    Who do you think owned the "Troubled Assets" again and needed relief?

    I see the person that thinks housing bubbles are a good thing and doesn't know what a balance sheet is doesn't know what assets are either.

    Have you learned to multiply yet?

  21. I see you still haven't learned to read. As was explained before full reserve banks don't fail because of withdrawals.

    Not that this is an easy concept for someone that claims 100% =0% and can't multiply by one.

    Still think the Housing bubble is a good thing?

  22.  "As was explained before full reserve banks don't fail because of withdrawals"

    You bet.

    When they make bad loans and lose money, the depositors don't make withdrawals. LOL!

  23. Do you understand the difference between banks that failed and banks that needed to boost their capital? Obviously not.
    Good luck with that Econ 101 class.

  24. "Do you understand the difference between banks that failed and banks that needed to boost their capital? "

    Because without it they'd fail, like the banks that didn't spend as much money on contributions to politicians.

    Good luck with that adult literacy class.

    Still advocating for a housing bubble?

  25. "Because without it they'd fail"

    You think BofA or Citigroup or Wells Fargo or JPMorgan would have failed without TARP? LOL!
    Get back to that balance sheet!

  26. "You think BofA or Citigroup or Wells Fargo or JPMorgan would have failed without TARP? LOL!"

    According to the people that passed it, yes. I see you still don't know wshat a balance sheet is.

    Any explanation why 700 Billion dollars + is needed to bail out the banks given your claim that the FDIC has the money to cover them?

    Or that Morgan Chase is still in trouble and may need bailing out again.

    It must be difficult being functionally illiterate.

  27. I also see you couldn't answer the question about why you think 100% = 0% .

    Of course since you can't honestly defend your position you have to lie. Like when you claimed we said the Federal Reserve was private and then you denied making that remark.

    Must be hard copypasting things you don't understand. Especially since you don't know what an asset is.

  28. Then there is your claim that Housing Bubbles are good things and that it makes you "feel richer".

    Yet everyone else figured out it was a bad thing after the crash. I guess the person who demonstrated incompetence in multiplication is a slow learner.

  29. "I also see you couldn't answer the question about why you think 100% = 0% "

    Since I've never said or thought any such thing, I don't know what you're babbling about.

  30. I see lying is a fundamental sacrament of your weird religion. Your statement.

    "Bank B, Full Reserve: $1000 in deposits, $1000 in loans.""

    Your claim that 100%=0% and vice versa.

    But then literacy isn't something you've mastered.

  31. Your the one who claims there is no inflation, FDIC covers all bank failures without help from TARP, and that the housing bubble is a good thing.

    Not to mention your claim that one times a number equals a larger number and 100%=0%.

  32. Geez, liar, even Wikipedia knows how hard you fail:

    "Full-reserve banking, also known as 100% reserve banking, is a banking practice in which the full amount of each depositor's funds are kept in reserve, as cash or other highly liquid assets. In other words, funds deposited are not lent out by the bank as long as the depositor retains the legal right to withdraw the funds on demand."

    Pay attention to those last 15 words–they're the part you keep denying!

  33. And:

    "A few proposals have been made where 100% reserve could be combined with investment accounts, where a saver could entrust their money with a bank for investment in the full-reserve equivalent of time deposits or savings accounts, which in a full reserve system would represent loans made to the bank rather than deposits."

    Pay attention to those last three words.

  34. I know, John really got that one wrong.

    "A (hypothetical) method of banking in which banks keep 100 percent of their deposits in the form of bank reserves, meaning there are no deposits available for interest-paying loans"

  35. Yeah, right, it's John's fault you're a functionally-illiterate LIAR who keeps trying to claim that Full Reserve banks have an RR of 0 on time deposits.

  36. This has already been explained to you. 100% Reserve Requirements for withdrawable funds, 0% for unwithdrawable funds.

    Since you can't withdraw time deposits guess what that makes them.

    I see you still haven't learned the difference between demand deposits and time deposits. Yet the person who doesn't know what a balance sheet and can't read the 15 specific words Shane told him to read is an expert on banking.

    No wonder you're the only person stupid enough to support housing bubbles.

  37. I see you still don't know the difference between deposits and time deposits. Maybe you should take a finance course after your adult literacy course.

    How much money did Morgan get from TARP? You're the one who claims they would be fine without the bail out and that the FDIC could cover all the costs of the financial crisis.

  38. "Wamu got sold to Morgan with money it got from TARP"

    JPMorgan bought WAMU with the money JPMorgan received under TARP?
    Are you sure?

  39. Funny you should mention WaMu, since they had their assets seized by the FDIC after taking TARP funds, so they could forcibly be sold to JP Morgan (they've been in court about the matter for three years). And one of the things that's come out about the whole ordeal is just how insolvent the FDIC actually is. They had to beg Congress to give them $500 billion to stay in the black!

    BTW, Wachovia got $25 billion in TARP funds.

  40. Surprised he didn't dishonestly ask about BB&T, who steadfastly refused to take TARP funds until the government basically threatened them.

  41. "Wamu got sold to Morgan with money it got from TARP"

    JPMorgan bought WAMU with the money JPMorgan received under TARP?

    Are you sure?

  42. "Funny you should mention WaMu, since they had their assets seized by the FDIC after taking TARP funds"

    Wow, that's wrong.

    "They had to beg Congress to give them $500 billion to stay in the black!"

    Congress didn't give the FDIC $500 billion.

    "BTW, Wachovia got $25 billion in TARP funds"

    Wrong again. I'm sad for you.

  43. WaMu got the TARP money, and the FDIC somehow used that as an excuse to seize its assets and sell it to JP Morgan.

  44. No, it's all correct, and publicly-available information thanks to the court proceedings. See WMI v. FDIC.

  45. "Wrong again. I'm sad for you."

    No, RIGHT again. $25 billion in TARP funds went to Wachovia's parent company, Wells Fargo.

    YOU FAIL HARD.

  46. No, it's all wrong. Wachovia didn't get any TARP funds.
    Wells anounced the deal before TARP money was disbursed.

  47. Yes, Wells Fargo bought Wachovia BEFORE they got the TARP money. The purchase was on 3 October 2008, and the TARP funds were given on 28 October 2008.

    Once again, YOU FAIL HARD.

  48. WELLS OWNED WACHOVIA, YOU FUCKING LIAR!!! The ONLY way Wachovia COULD have received TARP money IS IF IT WAS GIVEN TO WELLS FARGO!!!

  49. Wachovia IS Wells Fargo, LIAR. If you want to give money to Wachovia you give it to Wells Fargo! THAT'S WHO THE FUCK IT IS!!!

  50. "Wachovia IS Wells Fargo, LIAR"

    When you're in a hole, you should stop digging.
    You said Wachovia received TARP. Never happened.

  51. The only error was YOURS.

    I've been MORE than patient with you, even as you flagrantly break Rule #5 of this channel. Well, NO MORE. This is your FIRST AND ONLY WARNING. Try to make YOUR ignorance look like someone else's ONE MORE TIME and YOU WILL BE BLOCKED!

    And DON'T say you weren't warned either, you filthy, despicable LIAR!!!

  52. One more time, LIAR:

    WELLS FARGO OWNS WACHOVIA. The ONLY FUCKING WAY for them to give TARP money to Wachovia WAS TO GIVE IT TO WELLS FARGO. Now you're trying to weasel out of your LIE–and apparently forgot that YOU claimed that Wells Fargo didn't buy Wachovia until AFTER, which was WRONG as well!

  53. How is that IN ANY WAY the same thing??? Does your mother own you? Are you and she one entity???

    I fear for your sanity now…

  54. It's hilarious how you babble about nonsense every time someone proves you are a liar.

    Still claiming there is no inflation and the housing bubble was a good thing? How about your bizarre claim that 100% = 0%

  55. Yes, no failed banks got TARP. Getting bailed out wasn't a sign they failed. Including your bizarre claim that Morgan didn't need any money even though it is still in trouble.

    Yet according to you the FDIC didn't need TARP to bail out its member banks.

  56. Shane, I would appreciate it if you would reply to my video, whether in a PM or comment – I would prefer a comment, so that out our convo can be seen by others.

    But the gist of my video is that the accounting portion of your video is fundamentally flawed, and you should look into this fact in order to correct yourself in the future – so that those with a basic knowledge of accounting concepts are not turned off (when you explain fractional-reserve banking.)

  57. The only thing I recall from your video is that it was somehow a problem that I didn't count equity as a separate component, when 1) there's no equity anywhere in this illustration, and 2) many accountants consider equity to be a liability since it's technically owed to the owners of the company.

  58. I don't know if I was articulate in my video. I write much better than I talk.

    But the fundamental problem is with the equations and the t-account. you said that assets = liabilities, but that's not true. assets = liabilities + stockholders equity. Put another way: stockholders equity = assets – liabilities.

    liability =/ equity – they are 2 different things, and have totally different components (I can give you examples. if you want)

  59. assets in NOT on the left side and liabilities is NOT on the right of the t-account chart.

    DEBITS is on the left. CREDITS is on the right. There are multiple t-accounts.

  60. Cash, long-term investments, accounts receivable, patents, etc are all ASSET accounts.

    Notes payable, accounts payable, salaries payable, interest payable, bonds payable, etc are ALL liability accounts.

    interest from sales, salaries expense, wage expense, rent expense, rent income, sales, etc re ALL equity accounts.

  61. They ALL must have separate t-accounts –
    You're simplifying the process of fractional reserve banking, and this is good for the layman, but the simplified accounting is WRONG.

  62. Again, I've talked to accountants who say that equity counts as a liability since it's technically owed to the owners or stockholders. I don't know enough to say who's right or wrong about that, so I won't try.

  63. 1) That would have made the graphic very unwieldy, 2) it wasn't necessary to demonstrate the phenomenon, and 3) this is exactly how macroeconomics textbooks portray it.

  64. 1) it's good to have things simple as possible: I totally agree. But it's way too simple that some of the facts we're wrong. That's basically my point. Look, I don't know how much more complicated the video would have to be. I really don't.

    2) You're right. The actual accounting portion, whether right or wrong, would probably have not be necessary to explain FRB per se.

  65. 3) I don't have a macroeconomic textbook to look through. I would need you to site a macroeconomics textbook's explanation of accounting and fractional reserve banking, and have access to that book. I used to have one (I had a class in macroeconomics), but I sold it a few semesters ago.

  66. 4) Concerning the accountants: The evidence you gave me is antedotal, which you know, if you study logic, is not proof. There to no way to tell if you're telling the truth, you misunderstood what they said, or you're lying: I don't know which. I find it eerie that they told you liabilities = equity.

  67. I know you said you're not going to look into who's right or wrong, but I think you should, because this is basic accounting (literally). It's even really easy to look up definitions and what-not that you shouldn't be ignorant on the subject. And look, I am NOT saing I'm an expert in any way, shape or form. I only know what I've learned in my accounting classes that I've taken.

  68. The way it was explained to me was, you don't want Owner's Equity to count towards the net worth of the company. It's not the worth of the company, since it's wealth belonging to the owners/stockholders/whoever, so technically that makes it a liability.

    Others say it isn't because it doesn't represent money actually owed, but it's still in the column along with liabilities anyway.

  69. Some countries like Canada, the U.K., Australia, New Zealand and Sweden don't have reserve requirement ratios, the have capital adequacy ratios! Can you do a video about that?

  70. + Shane Killian

    I'm researching this subject and perhaps you would be able to answer my question, if you would be so kind. The way I understand it, the fractional reserve system is overall better for an economy. Do you disagree? If so, why? My reasoning is the following:

    Governments using this system as a means of expanding the money supply and therefore creating inflation to tax citizens insidiously is a problem, definitely. However the fractional reserve systems also drastically increases aggregate demand and output. Simply pooling large amounts of money together in the form of investments creates real wealth due to economies of scale and also technological improvements. Therefore, although the money supply is expanded, so is total output, therefore mitigating the inflation.

    The increase in output, jobs and the affordability of consumer products are direct results of this system. Admittedly, it creates a great risk because a huge amount of our economic well being is placed in the hands of banks. However, governments have continued to regulate this (although the effectiveness is arguable). Nonetheless, this system improves our quality of life.

    Thanks for your time.

  71. Sorry you failed to connect fractional reserve banking to higher prices. Why would prices of goods and services change? Loaning this money could create demand, driving up prices, but it would also create supply, as for example builders building houses to meet the demand. So wouldn't one have an equalizing effect on the other?

    And our main example is always stocks or housing, but how does that increase the price of a gallon of milk?

  72. Nine years wiser, I am still not for fractional Reserve, however, it is even worse than you make it out to be. Banks do not loan based on deposits. They loan solely on the creditworthiness and profitability of the loan. Then they rectify after the fact with the Federal Reserve and get a deposit according to the size of the bank. So in some cases, the reserve requirement is ZERO. So it is anywhere between 0 and 10 percent. The only solace we can take from this is that the Money Multiplier effect isn't real, it does not happen.
    https://www.federalreserve.gov/monetarypolicy/reservereq.htm

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