I was reading the other day that the idea of getting rid of the Federal Reserve was based on faulty assertions that the booms and busts we’ve experienced since its inception in 1914, also happened during the 1800s, largely undermining that argument in the eyes of that particular writer.

The reason that writer was wrong was he didn’t take into account one of the other main culprits of the boom and bust cycles: fractional reserve banking, which was the cause behind the problems experienced in boom and bust periods during that time period, and still is today.

Basically what the Federal Reserve has done in the past, and does today, is protect the fractional reserve banking system from completely failing and its faults being exposed by printing money and bailing them out, which was the original reason it was created by big bankers – for big banks.

Just look at who is being bailed out in our current economic environment, and you can see that the smaller banks will be allowed to fail, but the larger banks have already been bailed out, even if some like Citigroup are just barely hanging on.

I’m going to accurately simplify fractional reserve banking in order for you to understand why it’s so dangerous, weak and a poor banking system to use.

Essentially how it works, is anyone can invest $100 into a bank and get a receipt. Since the creation of the Federal Reserve, a small portion of that is sent to the Federal Reserve to be held interest-free, while the remaining 90 percent can be loaned out. That is called being held in reserve, which stands at 10 percent, but in a number of cases has been under 5 percent in practice.

So while the depositor assumes his money is in the bank and available for use whenever the depositor wants it, in reality all but approximately 10 percent of it has been loaned out. This is a problem because the money is loaned out for longer periods of time, while the depositor could want it now.

When you get enough depositors wanting their money now, it’s called a run on the bank, and the weak underbelly of the fractional banking system is revealed, in that they don’t have the money on hand to pay back.

Some might at this time wonder why the gold standard didn’t work during the time it was instituted, and booms and busts continued to happen. That’s easy. They simply printed out more money than the gold they had in their vaults, making the gold standard basically a joke in that it was set in place but not adhered to.

Even today, some extraordinarily ignorant and clueless financial writers call this a failure of capitalism and free markets. The truth is that it’s a failure of a fractional reserve banking system which has been trying to hide its weaknesses because of those who love power who want to attempt to control people through its machinations. These types of power-hungry people have always hated the consumer for that reason, and their making decisions which truly are the free market, as long as it isn’t interfered with by the government, as it has been for a long time. 

Essentially fractional reserve banking is making promises to depositors it simply can’t keep. Just think of it as your money being tied up long term in a way that you may not get access to it short term. Historically, the U.S. government has protected this fraudulent practice at the expense of depositors, and continue to do it to this day.

This is why we have we have had endless booms and busts when the fractional reserve banking system emerged in America, and we will have until we get rid of it, and its cousin the Federal Reserve.

What the Federal Reserve does is just take it to a higher level where they just ramp up the printing presses and pour money into the system whenever the banks extend themselves too far, which is every time you see the boom and bust cycle happening. That won’t stop until these things are changed.

One place you can read about all this is in the upcoming book by Ron Paul called “End the Fed,” which deals with many of these issues.