Weekly Column - 10/23/2010

This week's column:

"No, but you…you… you’re thinking of this place all wrong. As if I had the money back in a safe. The, the money’s not here. Well, your money’s in Joe’s house… that’s right next to yours. And in the Kennedy House, and Mrs. Macklin’s house, and, and a hundred others." – George Bailey, It’s A Wonderful Life

I do not wish to speak ill of one of my favorite films. But an appreciation for the fraudulent nature of fractional reserve banking has altered my perception of at least this one scene. In striving to stave off a bank run, George Bailey was forthright with his customers, but he mislead them nonetheless. For his customers did not run on the banks to retrieve their savings—or time deposits—but their demand deposits, what we call checking. George falsely assumed that these two disparate functions were one and the same.

To understand the proper role of banking, we have to set aside anything we think we might know about it. The first function of a bank is to securely store money; rather than lug it around at all times, a customer would pay a small storage fee to relieve himself of this burden. His money would sit idly in a vault; it would thus not collect interest, but it would be available to him on demand. This runs counter to our ideas of banking, but it makes practical sense: if I deposit money in a bank, I wish to be able to withdraw this money at any time. This can only be ensured if the money is actually in the bank, rather than being lent out to someone else.