Why is the fractional-reserve banking not a Ponzi scheme?
"They're not at all the same. A Ponzi scheme is a fraudulent investment method that pays off early investors with deposits from later ones. Fractional reserve banking is the practice of keeping only a fraction of a bank's demand deposits on reserve, while lending out the rest.  The reserve requirement is how central banks limit the amount of money that can float around in commercial banks. In the latter case, there is no ""later investor"" somewhere down near the bottom of a money food chain.  Every dollar, regardless of whether it was created fresh from one of the federal reserve banks or created via several chained loans, is worth the same.  If the dollars depreciate for whatever reason, they do so for everyone. Now, if you want a good example of a Ponzi scheme that is actually legal, look at Social Security. Edit: A ""debt-based society"" is separate from fractional-reserve banking.  If the Fed creates $1,000,000, the total amount of money that can float around is still capped based on whatever the reserve requirement is.  (For a 10% reserve requirement, it's something like $10,000,000.)  We have unsustainable debt increases because of lack of self-control on the part of our leaders.  The fractional-reserve process helps it along, but it's not the culprit.  It's an enabler." "You are forgetting one crucial point regarding the money supply.  The US Federal Reserve increases the money supply, meaning some of the money is not really loaned, it just appears out of nowhere.  At first glance this seems even worse: over the short term, the Fed changes the money supply to help the economy in whatever way it sees fit.  But over the long term, the money supply increases to reflect economic growth.  As new technology is introduced, more can be accomplished with the same labor and resources, and thus the money supply needs to be increased.  Money is really just a convenient replacement for the barter system, so if there are more things to barter ""for"" (goods and services) then there should also be more things to barter ""with"" (money). Also keep in mind inflation.  The cost of goods and services goes up over time due to the inflation of currency, and so the money supply must also be increased so that those goods and services do not artificially increase in value, which would be very bad." The fundamental underlying difference between a bank and a Ponzi scheme: When a bank lends money and charges interest, people can do things with that borrowed money which are worth it. (Building factories, starting businesses, or just enjoying the comfort and warmth of a single-family home instead of paying rent). This is why fractional-reserve banking is able to work. People may also do things which do not necessarily turn a financial profit (financing large purchases on a credit card) but are worth it in terms of an expenditure. They may also do stupid things (financing useless purchases on a credit card and wasting their money) or otherwise dispose of the money poorly (the new business fails, the home's value plummets, etc). A Ponzi scheme never really bothered to do useful things with the money. Social Security has been mentioned. Part of social security's setup involves the current population of workers paying the current population of retirees; their own retirements will have to be financed by the next generation. This design is not intrinsically a Ponzi scheme: both the population and the economy ought to remain growing for the intermediate future, so there will be at least as much money (and probably much more) for them to pay those bills. Unlike a Ponzi scheme, the idea that it will continue to attract new money to pay out existing claims is a realistic one. The real questions of its sustainability are a matter of specifics: is it collecting enough money to remain functional in the future, or is it outpacing the growth of the economy and the population? "The Ponzi/Madoff schemes were closed loops, so the only source of the so-called ""interest"" on the money was the contributions of future investors. The economy is more like a living thing, and the availability of capital allows people to develop new ways to do things in a more productive way. Agriculture is a great example -- for most of human history the overwhelming majority of human labor was dedicated to producing food. Now that proportion is dramatically smaller -- the descendants of farmers 100 years ago are doctors and computer programmers... professions that could not exist. Fractional reserve banking makes the economy more efficient by putting capital that would otherwise be hoarded in circulation. Money is a medium of exchange, so the more it turns over, the better it is. Genoa and Britain pioneered this concept centuries ago, and were able to defeat larger rivals in large part because of the economic advantages that the practice brought to bear.  That's not to say that banking doesn't come with its warts as well. I'd suggest reading ""A Free Nation Deep in Debt"", which does a good job of explaining how we got to where we are today." No, fractional reserve banking isn't a scam. A simple exercise: replace dollars with time. You're trading some time now for time in the future, plus a bit of extra time. This is only a problem if you promise your entire life away, which we've helpfully outlawed. Once you realize that wealth is the result of human labor, and that money is simply a unit of account for it, it becomes far easier to see how simplistic models don't match reality. "It is possible to pay down debt (including interest) without issuing new debt money to pay for it. I think this is the heart of your question. Let me present a highly contrived example in which society has four people and one bank. Here is a bank with $100 in initial deposits. Total money supply in this society is $100. (We assume there is no currency circulating, since you're interested in debt money.) This bank lends out $90 to Bob at 1 year maturity and 10% APR. Bob spends this $90 with Charlie to buy raw materials. Charlie deposits $90 in the bank. The money supply just grew from $100 to $190. Bob does something with the raw materials and adds some kind of value, eventually selling the finished goods for $110. In our little silly economy, the only people who have money are Adam and Charlie, so we must assume that between the two of them they buy $110 worth of goods from Bob. Let's say Adam buys $60 and Charlie buys $50 -- the actual amounts don't matter. Bob deposits this money at the bank. Still $190 of money supply. At the end of 1 year, Bob instructs the bank to transfer payment from his deposit account to his loan account. The bank wipes clean his debt and the money remaining in Bob's account represents his return. Who is this David guy? He's the owner of the bank. He grosses $9 in interest from the loan to Bob, and he pays $5 to Adam as interest on Adam's deposit. The remaining $4 is the profit to the bank's owner. Money supply decreased from $190 to $100 after Bob pays off his loan. I realized after writing this, the one thing I left out is, ""where does Adam get $100 to start with?"" Presumably Adam starts off with some kind of currency, either fiat money or commodity money. (IOW, debt money can't be created out of nothing, it has to be expanded on top of some kind of currency.)" Your question contains two different concepts: fractional reserve banking and debt-based money.  When thinking of these two things I think it is important to analyze these items separately before trying to understand how the whole system works. Fractional Reserve Banking As others have pointed out fractional reserve banking is not a ponzi scheme.  It can be fraudulent, however.  If a bank tells all its depositors that they can withdrawal their money at any time (i.e. on demand) and the bank then proceeds to loan out some portion of the depositors' money then the bank has committed fraud since there is no way they could honor the depositors' requests for their money if many of them came for their money at one time.  This is true regardless of what type of money is deposited - dollars, gold, etc..  This is how most modern banks operate. Debt-based money Historically, the Fed would introduce new money by buying US Treasuries.  This means Federal Reserve Notes (FRN) are backed by US Treasuries.  I agree that this seems strange.  Does this mean if I take my FRNs to the Fed I could redeem them for US Treasuries?  But US Treasuries are promises to pay FRNs in the future.  This makes my head hurt.  Reminds me of the definition for recursion: see recursion. Here is an experiment.  What if we wanted to recreate FRNs today and none existed?  The US government would offer a note to pay 100 FRNs in one year and pay 5% interest on the note.  The Fed would print up its first 100 FRNs to buy the note from the US government.  The US government would spend the FRNs.  The first 100 FRNs have now entered into circulation.  At the end of the note's term the Fed should have 105 FRNs since the government agreed to pay 5% interest on the note.  But how is the US government going to pay the interest and principal on the note when only 100 FRNs exist?  I think this is the central point to your question.   I can come up with only two answers: 1) the Fed must purchase some assets that are not debt based 2) the US government must continue to issue debt that is purchased by newly printed FRNs in order to pay back older debt and interest.  This is a ponzi scheme. The record debt levels seem to indicate the ponzi scheme option was chosen.
Holmes, then Senior Vice-President of the New York Federal Reserve, noted that the key Monetarist policy prescription of regulating the economy by “a regular injection of reserves” was based on “a naïve assumption” about the nature of the money creation process:  The idea of a regular injection of reserves—in some approaches at least—also suffers from a naïve assumption that the banking system only expands loans after the System (or market factors) have put reserves in the banking system. **In the real world, banks extend credit, creating deposits in the process, and look for the reserves later**. (Alan R. Holmes, 1969, p. 73)  Holmes would turn in his grave at Krugman’s naïve assertion, half a century later, that banks need deposits before they can lend.   commercial banks can create money out of thin air:  http://www.youtube.com/watch?v=zc_fpGfyqGE&amp;feature=player_detailpage#t=509s  http://www.youtube.com/watch?list=UL327SJH0xcew&amp;v=327SJH0xcew&amp;feature=player_detailpage#t=597s That is kind of the point, one of the hopes is that it incentivizes banks to stop storing money and start injecting it into the economy themselves. Compared to the European Central Bank investing directly into the economy the way the US central bank has been doing. (The Federal Reserve buying mortgage backed securities) On a country level, individual European countries have tried this before in recent times with no noticeable effect. Sorry, but I am absolutely correct.  Fractional reserve lending (banking) is simply that when someone deposits money into a bank, the bank is allowed to loan that money out, so long as they keep a reserve.  If the reserve rate is 10% (it's much lower in reality), and someone deposits $100 into the bank, the bank can then loan out $90.  That is fractional reserve lending at its most basics.  Now fractional reserve lending does have a multiplier effect.  And this effect is exactly how I described it.  Let's go back to the example.  Person A deposits the $100, the bank then loans $90 to person B, person B spends it with person C, person C takes the money and deposits back to the bank.  Now the bank has the $100 cash back, $90 in loans and the $190 in deposits, so they need to hold onto $19 as a reserve and can loan out $81.  Assuming the money cycles with 100% efficiency, the bank can continue loaning out the same money until they are left with $1000 in deposits, $900 in loans, and the original $100 is the reserve.  This is the multiplier effect. If thats how you feel (its how I feel )  then the last thing you want bankers doing is accepting deposits from people who think their money is not being risked, then making loans with it (fractional reserve banking).  And fdic is not an answer to that fundamental problem. My original statement was answering onefingerattack's query, not strategizing for institutional investors. It's very easy for instituationals to move money across borders into and out of treasuries, and to purchase gold near spot and vault it. For a retailer like onefingerattack, getting money into bitcoin is going to be much easier than opening a foreign bank account, exchanging, and transferring funds.  And my point wasn't to say that this was necessarily the best strategy because it is impossible to know. I just linked to an article about the fact that this strategy is being used by other Europeans (although, I think it's more by Greeks who worry about their Euros being nationalized and replaced with a drachma). Go for it, name an empire that purchased its own debt historically and survived.  Sure, its not a straight up ponzi, but you are too daft to tell its still about as absurd as one. Maybe you can write us a little novel from your finance 101 book, loser. You obviously are great at copying what your finance teachers taught you.   Some of us, went a little further in life, little guy. "I don't agree that the market as a whole is a ponzi scheme, but there are some ponzi-like aspects to it. If you buy high quality stocks like Coca Cola, Johnson and Johnson, AT&amp;T, Verizon, Kraft, Wells Fargo (the vanilla bank, not one of the crazy ones), IBM, Berkshire Hathaway etc and simply hold onto them for the next 10-20 years, you will make money. Even over the last decade, when stocks ""went nowhere"", you still came out ahead through the dividend payments. It was just at an unsatisfactory rate of return. Also ""the market"" consists of a lot more than just stocks. Corporate bonds are a big market and I always recommend people to look at bonds. If you cannot judge whether a company is credit worthy, how can you invest in the common stock? I've made a lot more money myself in the bond market than in the stock market.  However, for many stocks, they do look a lot like ponzi schemes. This is true, in particular, with many of the tech stocks (Cuban was a tech investor, so that is probably where his sentiment is coming from). You have many of these companies that create great products. However, they never have positive cash flow because all the money is spent to develop new products. As the share price goes up, the company issues new shares to fund research, stock options to employees to enrich them, etc. However, eventually, they run into a string of bad research that do not yield a new product and the share price plunges. Perhaps the company goes bankrupt. So you have a company that developed great products, but the shareholders never got a penny in dividends and the final shareholders have paper worth zero.  Take a look at Research in Motion for example. Creating the Blackberry has to be one of the biggest successes in tech over the last decade. However, has the shareholders gotten any richer? Only if they traded amongst themselves, nobody got a dividend. What happened to the many billions of dollars they made during the peak popularity years of Blackberry? It went to executives, employees, and was squandered on development that did not effectively defend the phone's dominant market position. Now the stock price is back down to the pre-prime years, and if a shareholder held onto it throughout the entire period, he would not have received a single penny. And this is a profitable enterprise, things look even more bizarre when you start looking at the tech companies that have NEVER had a positive earnings quarter and no plans to ever have positive earnings (something like Pandora comes to mind). Often, management at these more bizarre companies run the company as a toy - to play with their own ideas and to issue themselves stock as compensation. And of course, they sell a lot of the stock to cash in before they delve into the next risky venture. They have no intention of ever enriching anybody who holds into the stock in the long run. If for some reason they make money, they will put it all into their next toy project until one of them fails and wipes everything out.  If you invest in a profitable business with reasonable management, you will generally come out ahead. Some businesses get displaced by unpredictable circumstances and they go bankrupt. But on average, if a company is good at doing something and they pay out the earnings, you come out ahead. You get in trouble when businesses are good at something, and they take all the money they make and put it into doing something they are not good at. A business might only provide good cashflow for 10-20 years when the product is popular and before competitors cut into margins. If that money is squandered, the long term shareholder may ultimately have very terrible results. The long term shareholder ends up being the guy who keeps going all-in on a 80%-chance-to-win bet (that is what management is doing when they bet the company on the next unproven product), but eventually he gets zeroed out on one loss.  This is why if you look at Buffett's investments, they are all in simple businesses that spits off cash to the owner/shareholder. Businesses like soft drinks, snacks, rail roads, vanilla banking, utility-like energy companies, insurance, etc. You might be good at judging the odds of whether a business will succeed or not (aka make more money than your original investment or not). But you don't want management of that company to make a wildly different bet for you. Just because they are great at operating a company doesn't mean they are good enough at judging odds or disciplined enough to make those bets for you. I may have predicted accurately that Business X will be a great success, but if manage takes those profits and goes all in on Business Y, without giving me a chance to cash out, that may have disasterous results." "It's not a ponzi scheme, and it does create value. I think you are confusing ""creating value"" and ""producing something"". The stock market does create value, but not in the same way as Toyota creates value by making a car. The stock market does not produce anything. The main way money enters the stock market is through investors investing and taking money out.   The only other cash flow is in through dividends and out when businesses go public.  &  The stock market goes up only when more people invest in it. Although the stock market keeps tabs on Businesses, the profits of Businesses do not actually flow into the Stock Market. Earnings are the in-flow that you are missing here. Business profits DO flow back into the stock market through earnings and dividends. Think about a private company: if it has $100,000 in profits for the year then the company keeps $100,000, but if that same company is publicly traded with  100,000 shares outstanding then, all else being equal, each of those shares went up by $1. When you buy stock, it is claimed that you own a small portion of the company. This statement has no backing, as you cannot exchange your stock for the company's assets. You can't go to an Apple store and try to pay with a stock certificate, but that doesn't mean the certificate doesn't have value. Using your agriculture example, you wouldn't be able to pay with a basket of tomatoes either. You wouldn't even be able to pay with a lump of gold! We used to do that. It was called the barter system.  Companies also do buy shares back from the market using company cash. Although they usually do it through clearing-houses that are capable of moving blocks of 1,000 shares at a time." Here's a point in favor of central banks: With a central bank in the middle making sure payments clear, transactions can happen with near perfect trust. When a bank has a daylight overdraft, the Fed covers it. When a bank needs overnight funding, the Fed provides it. If a bank needs vault cash, a truck shows up from the Fed.  Without this, no one could ever be entirely confident the other party was money-good. With a volume of transactions that can amount to annual GDP in as little as six days, this level of trust is critical to a smoothly functioning system of payments. All of this makes perfect sense and I can definitely see the logic behind it.  But I don't think Hedge Funds are the way to go. The real money lies in real estate, more specifically land-banking. The problem, though, is that a lot of land-banking investments are really just scams and it's really hard to tell which ones are real and which ones are fake. I recall similar strategies when (in the US) interest rates were quite a bit higher than now. The investment company put 75% or so into into a 5 year guaranteed bond, the rest was placed in stock index options. In effect, one had a guaranteed return (less inflation, of course) of principal, and a chance for some market gains especially if it went a lot higher over the next 5 years.  The concept is sound if executed correctly. His argument seems to be all hinging on the seamless transaction/transfer of money (which I do agree is something that can be made much better) but what about other functions that banks do... like lending (mortgages) ect.   I don't see how that works on blockchain/bitcoin.. and also I don't see why it has to be Bitcoin and not some competing crypto. "It's a problem from hell because all solutions have drawbacks/unintended consequences and because they are all pretty complex to implement in practice.  Breaking up the big banks so that no bank is enough to bring down the economy with it is the strongest move, but is riddled with problems when you start looking at it practically. How do you determine the ""maximum size"" a bank should have? Should it be based on assets? Systemic importance (i.e. interconnectedness with other banks)? How do you enforce it? Banks will find ways to offload assets, etc. into special purpose corporations to get around the laws somehow. How do you compensate for the fact that size does help financial efficiency in some ways?  Imposing higher capital requirements is the next solution. But that too is not so easy to implement with full success in practice. What should be classified as a low-risk asset? How much capital do you require against a CDO vs a Mexican government bond? How often do you need to revise these standards? At what point does the cost of higher capital requirements start to strangle lending and financial flows?  The weaker maneuvers are things like constant government-imposed stress tests, orderly resolution mechanisms, higher standards for internal risk management practices, etc. but those may not be adequate and also have their implementation problems." "A savings account and a checking account (or a ""demand"" account, or a ""transactional"" account) have different regulations.  For example, fractional reserve requirements are 10% against checking accounts, but 0% against savings accounts.  The theory is that savings accounts are sticky, while checking accounts are hot money. So the Fed wants to stop banks from creating accounts that are regulated as savings accounts but have the features of checking accounts.  In the past, this was done by forbidding banks to pay interest on checking accounts.  They eliminated that rule back in the inflation years, and instead imposed the rule that to qualify as a savings accounts for regulatory purposes, banks must discourage you from using them as transactional accounts.  For example, by limiting the number of withdrawals per month that can be made from a savings account. If the Fed gave up on trying to enforce a distinction, I suspect there would soon no longer be a distinction." "I agree with you, but both are bad. What happens with fractional reserve banking is inflation, but this inflation isn't distributed evenly across all the markets, those who the banks lend to are who see the inflation first I.e. the Dow. But nobody gets a loan to buy commodities, so these lag in the inflation. When a recession hits the banks slow their loaning while the commodities play catch-up. During this period it makes more sense to ""invest"" in commodities than in the majority of businesses. So in an effort to make capital ""available"" you've created an entire community of investors investing in an unproductive sector for just as long as you had them hyper-investing in productive sectors. Net zero gain, with a decade of time lost.  I wont ever believe we need frac reserve lending to have a bank, especially when the bank collapses the currency every 30-50 years. If someone's to loan money they should do it with their own money, with approval, or somehow prevent 2-3-10 people from racing to the same reserve."