Is Fractional Reserve Banking Necessary for a Growing Economy?

The argument for the necessity of fractional reserve banking ultimately boils down to the same arguments that Keynesians, inflationists, and monetary cranks of all hues use for monetary expansionism in general: an increase in the supply of credit to ameliorate any shortage of financial media and instruments will lead to more economic activity and growth. By this logic, banks have the ability to create loans in excess of the capital they hold in reserve, they could mobilize more capital and finance more projects, resulting in less unemployment and increased prosperity. Conversely, if banks are prevented from engaging in fractional reserve banking, a shortage of credit would hamper economic activity, reduce economic production, and reduce living standards. By decoupling available credit from the amount of savings, society overall benefits.

The problem with this logic is the same problem with all inflationist arguments. Money and credit, by themselves, are NOT productive assets. They merely represent receipts that allow their holders to purchase productive assets. An increase in the supply of money or credit will no more increase the stock of productive assets in an economy than an increase in printed football stadium tickets will increase the capacity of the stadium itself. The ticket is merely a proxy for a seat in the stadium, and money and credit are but claims on the final products and the capital goods used in their production. Should a football team wish to increase the maximum number of tickets it sells, it cannot do so by simply increasing the number of tickets it prints; instead, it would have to increase the stadium's capacity, which requires engineers, workers, and heavy capital equipment to complete. Printing tickets beyond the capacity of the stadium will result in more spectators than seats and conflict over these seats, but cannot, under any circumstance imaginable cause the increase in the number of seats beyond the capacity of the stadium.

The fundamental premise on which fractional reserve banking is built is inherently flawed: There can be no such thing as a shortage of money or a shortage of credit. Whatever supply of money is utilized in an economy is always sufficient to supply all the needs of the economy, provided the money itself is divisible enough. The demand for money, of course, is always higher than the supply, because people desire more things than they produce, because desiring is far easier than producing. These desires appear like they can be satisfied with more money, but the creation of money to meet these desires does nothing to produce them, which can only be done through dedicating scarce resources to their production. In a hard money free market, people dedicate their time to production in order to make money, and as the quantity of goods and the amount of economic production increases, the supply of money need not increase, but its value will naturally rise.

Fractional reserve banking does not magically create more capital, labor or resources. It merely allows central banks to control the allocation of these resources, rather than the productive people who own them. It is a form of central planning that impoverishes society overall but enriches the banks and governments that engage in it. Without fractional reserve banking, capital and labor would flow to the highest bidder, the entrepreneur whose business plan utilizes them the most productively and pays them the highest return. With fractional reserve banking, it is no longer free market competition that drives this resource allocation decision, but rather the banker who gets to enjoy the upside while being protected from the downside. It's no wonder than subpar business plans and malinvestments get funded in such an environment, skin in the game matters.