Daily Archives: February 22, 2017


Did US Economics Textbooks Get Fractional Reserve Banking Wrong? 2

Real Progressive‘s YouTube channel has the video The Full Stop Shutdown on Positive Money and the AMI marketing scam.


I believe in what Steve Grumbine is saying, and I have some critiques about this particular video, but first I want to concentrate on one point that he made. Here is an excerpt from the transcript.

1:41 the second thing that is really
1:43 important is to understand that the u.s.
1:46 textbooks got the idea of reserve
1:50 lending this whole fractional reserves
1:52 they they got a completely f***ing wrong
1:54 it is the wrong forever

From what I remember of what I was taught in my first economics course at MIT, Steve Grumbine is correct. Ever since I started reading about the Modern Money Model, I have been troubled by the difference in their explanation of bank created money and the explanation I learned. I thought I finally figured out how my economics text tricked me. I went back to look at the book so I could write this post.

Obviously, I cannot attest to the rightness or wrongness of all economics textbooks. Here is what I found from my copy of “Economics”, by Paul Samuelson, Fifth Edition, 1961. (Remember this book was published 10 years before President Nixon took us off the gold standard and fixed exchange rates, so some of this is bound to be just out-of-date and not wrong for the time it was written. The “sleight of hand” is “wrong”.)

Paul Samuelson went into great detail in the pages of Chapter 16, “The Banking System And Deposit Creation” of keeping track of the balance sheets of banks and tracking liabilities and assets. The point is that he is very clear that for every dollar asset the banks create, there is a balancing loan liability that they created for the people who got the created money. There was no net creation of anything.

In section B. of the Summary of the chapter he states about The Federal Reserve Bank “When a contraction of the quantity of money is in order, the Federal Reserve authorities pull the brakes. Instead of pumping new reserves into the banking system, they draw off some of the reserves. We shall see that in so doing they are able to reduce the quantity of money not 1 for 1, but (as just shown) almost 5 for 1.”

This is where you might say that the sleight of hand happened and things went wrong. If all you remember or read is this summary, you forget about all the liabilities that have to get cancelled along with the money. The change of net money (assets minus liabilities) is 1 for 1.


If you click on the book page thumbnail to see the whole page, you will notice in the questions for discussion the following statement:

Banks borrow from their depositors at zero or low interest rates and invest most of the proceeds in higher-yielding loans and investments. They use the difference to pay their expenses, to provide us with low-cost mediums for monetary transactions, and to reward their stockholders for taking on the risks of earning-asset values.

I read this in the book in 2017 after I made this point to Steve Grumbine in the critique you can read in the comment to this post. I guess I learned something at MIT. Besides that, think about what would happen to the cost of bank services to you if the banks were deprived of being able to make money on their lending out of deposits.