COTW: Iceland Considers End to Fractional Reserve Banking

Iceland of all the countries that were impacted by the Panic of 2008 and ensuing depression, did the most to hold fraudulent banksters accountable. {24.04.12} Three of its major banks collapsed and Iceland had to appeal to the International Monetary Fund for help recovering its economy. This forward-looking country--the government provided a household debt relief program to help its citizens out of financial straits--is considering a permanent fix to the problem: an end to fractional reserve banking[video]. The plan is to allow a committee of the central bank to fix the money supply. According to a study by four central bankers, Iceland has suffered 20 financial crises of various types since 1875 with six serious crises occurring every 15 years on average, most due to credit booms--quite a record of failure for private money creation. So Iceland proposes to replace it with a committee setting the supply of money. The "Sovereign Money" proposal is candid enough to admit the panel cannot be infallible, but neither is that cabal of private bankers known as the Fed. Critically the allocation of money is kept separate from the power to create money. Iceland's elected parliament decides how money is to be allocated in its state budget.

As PNG readers may know by now, fractional reserve banking is the globally adopted system that allows private banks to lend money into existence. They do this by lending out more money than they have in deposits and assets, their reserves being only the so-called fraction of credits.  Operating this system, which is very profitable for commercial banks, gives private bankers a great deal of control over a nation's economic policy. Creation of more central bank money may not result in more commercial bank money being available since banks are not required to lend at all. This happened in the alleged recovery [chart below] from the Greatest Recession. Almost all economists defend the system by referring to the theory of "money multiplier", meaning the ratio between commercial bank money (loans) and central bank fiat money. (M/R≦R×1/RR where 1/RR is the multiplier, M central bank money, R commercial bank money and RR the reserve ratio. The money multiplier  increases the economic effect of each dollar loaned. [chart above]

Icelandic banks would continue to manage money through accounts and payments, and also would continue to serve as intermediaries between savers and lenders. Unlike other commodoties where, in general, more is better because it leads to a higher standard of living, more money is not always a good thing because it leads to price inflation. More money may make us relatively rich for a moment, but with more money chasing the same amount of widgets, the price of widgets goes up.