The Mystery of Banking

a lender of last resort
. In the tradition of central banking, the Cen-
tral Bank always stands ready to bail out banks in trouble, to
provide them with reserves by purchasing their assets or lending
them reserves. In that way, the Central Bank can help the banks
through most storms. 
But what of the severe free market limits on the expansion of
any bank? Won’t an expanding Bank A quickly lose reserves to
Bank B, and face bankruptcy? Yes, as in free banking, one bank’s
expansion will meet a severe shock by other banks calling upon it
for redemption. But now, under central banking, 
all banks can
expand together
, on top of new reserves that are pumped in,
across the board, by the benevolent Central Bank. Thus, if Bank
A and Bank B each increase their reserves, and both expand on
top of such reserves, then neither will lose reserves on net to the
other, because the redemption of each will cancel the other
redemption out. 
Through its centralization of gold, and especially through its
monopoly of note issue, the Central Bank can see to it that all
banks in the country can inflate harmoniously and uniformly
together. The Central Bank eliminates hard and noninflated
money, and substitutes a coordinated bank credit inflation
Central Banking: Removing the Limits
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throughout the nation. That is precisely its purpose. In short, the
Central Bank functions as a government cartelizing device to
coordinate the banks so that they can evade the restrictions of
free markets and free banking and inflate uniformly together. The
banks do not chafe under central banking control; instead, they
lobby for and welcome it. It is their passport to inflation and easy
money. 
Since banks are more or less released from such limitations of
free banking as bank runs and redemption by other banks by the
actions of the Central Bank, the only remaining limitation on
credit inflation is the legal or customary minimum reserve ratio a
bank keeps of total reserves/total deposits. In the United States
since the Civil War, these minimal fractions are 
legal reserve
requirements
. In all except the most unusual times, the banks,
freed of all restrictions except reserve requirements, keep “fully
loaned up,” that is, they pyramid to the maximum permissible
amount on top of their total reserves. Suppose, then, that we
aggregate all the commercial banks in the country in one set of T-
accounts, and also consider the Central Bank T-account. Let us
assume that, in some way or other, total bank reserves, in the
form of demand deposits at the Central Bank, increase by $1 bil-
lion, that the legal minimum reserve ratio is 1/5, and that the
banks make it a practice to keep fully loaned up, that is, always
pyramiding 5:1 on top of total reserves. What then happens is
shown in Figure 9.8.
We have not finished the Central Bank balance sheet because
we have not yet explored how the increase in commercial bank
reserves has come about. But whichever way, the banks’ fraction
of total reserves to demand deposits is now higher, and they can
and do expand their credit by another $4 billion and therefore
their demand deposits by a total of $5 billion. They do so by writ-
ing out new or increased demand deposits 
out of thin air
(as fake
warehouse receipts for cash) and lending them out or buying
IOUs with that new “money.” This can be seen in Step 2 (Figure
9.9). 
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