This article has been reprinted from the Georgist Journal.

The contention that “debt money” can only be paid back with money which has itself been loaned into existence, therefore creating an ever-expanding debt that can never be fully paid, is—despite its increasing popularity—fallacious. As Fred Foldvary explained (in Georgist Journal #122), the credit-worthiness of borrowers is carefully evaluated by lenders. Borrowers can pay back their loans either by producing more wealth than they have borrowed, or consuming less (or some combination of the two)—thus having enough left over to pay back the loan with interest. If every single borrower is capable of repaying his or her loan with interest, how then can the whole society be unable to repay its debts?

People are willing to pay interest on loans because they value having the money now, rather than at some point in the future. Loaned money always circulates for some period of time before it has to be paid back. And, loaned money is not just spent once and then paid back; it is spent many times. This means that at any given moment, there is much more money in circulation than is due to be paid back at that moment. There is plenty of money in circulation with which people can pay interest.

People are only in debt when money is loaned to them. People do not owe interest on money that is paid to them—as wages, for example, or in exchange for goods.

The problem of “addiction to growth” arises not from fractional-reserve banking, but from something much more basic: great inequality in the distribution of wealth. Rich people hope to grow society out of widespread poverty, keeping their fortunes as the rising tide lifts every dinghy.

Another related complaint is that the banking system per se creates an addiction to growth. Essentially, this depends on the same flawed logic. However, to make sense of this we must come to terms with what we mean by “growth.” If we conceive of Economic Growth in a “20th century” sense of increased Gross Domestic Product, then growth is problematic for many reasons. If, on the other hand, we think of growth as Henry George conceived it, as a net increase in the satisfaction of human desires, then growth is an important function of the economy, and needn’t be feared or curbed. We do not, of course, only desire material things; we also want non-material services, and we often desire less of some material things, such as pollutants, or packaging. In any case, however, our current banking system does not necessitate a continually increasing output, because, as we’ve seen, the amount of money in circulation at any given time is sufficient to pay the debts that are due at that time. The problem of “addiction to growth” arises not from fractional-reserve banking, but from something much more basic: great inequality in the distribution of wealth. Rich people hope to grow society out of widespread poverty, keeping their fortunes as the rising tide lifts every dinghy.

It is certainly true that individuals, businesses, and even nations get into too much debt—and there is no doubt that banks, and bank-like businesses (high-interest credit cards; payday loans) prey on the weak and desperate. Clearly, some banking practices should not be allowed. But should that include fractional reserve banking itself?

Fractional reserve banking, like hourly-paid labor, is not a creation of the state; it is a market-driven phenomenon—and unlike fee-simple land ownership, its practice does not depend on state intervention. It is true that the state has intervened in banking, sometimes providing privileges, sometimes curtailing them—but the question before us is whether fractional reserve banking is inherently a privilege. Advocates of “debt-free banking” contend that the system compels all of us to pay interest on every dollar we spend, but that isn’t the case: we only have to pay interest on the money we borrow. Banks provide various ancillary services such as making change and clearing checks, but the main things banks provide is liquidity; they supply the demand for loaned funds, at reasonable rates of interest—and they compete to do so.

Fractional reserve banking, like hourly-paid labor, is not a creation of the state; it is a market-driven phenomenon—and unlike fee-simple land ownership, its practice does not depend on state intervention.

Ah, we’re told, but the banks make obscene profits at our expense! It’s true that some big banks, and particularly some CEOs of big banks, take home ungodly amounts of money. The ten biggest banks in the United States* currently hold just about half of the country’s deposits. And you know what? Seven of these are also among the top ten credit-card issuers.

Sheer bigness allows banks to consolidate risk, gobble up smaller banks and become “too big to fail.” But, it has long been recognized that the community has an interest in preventing huge firms from cornering markets: we have had antitrust laws since the 1890s. The “too big to fail” problem should be dealt with—but that doesn’t mean we have to scrap the entire banking industry.

OK, so maybe local banks—ones that aren’t pathologically huge—aren’t so bad, and might even serve a useful economic function. But why shouldn’t they be run by the public? Congress has the power, according to the US Constitution, to issue money. That money is the only legal tender in which the government will accept our tax payments, so why shouldn’t it get the interest, too, and lower our taxes by that amount?

Well, it probably would be a good idea if public banks entered into the banking arena, as the Bank of North Dakota has done. Public banks could use their power to issue credit to support various socially-beneficial functions, and any profit they make could go into the public treasury. North Dakota’s public bank has competed quite successfully in the banking market.

Ah, but that’s the thing, you see: The Bank of North Dakota has competed. North Dakota didn’t ban private banks. The Bank of North Dakota is a fractional reserve bank, too; it creates money out of thin air by loaning it into existence. Not only that, the Bank of North Dakota even participates in the secondary mortgage market.

Banking is a competitive business, and therefore, other than to check the trend toward cartelization, the government doesn’t need to operate it. The money supply is regulated by hundreds of thousands of transactions every day. By functioning as the sum of its parts, the system organically processes far more information than the government could ever hope to gather. There’s a lot to be said for letting markets work, when they can.

The role of real estate in today’s banking and financial system is acknowledged by just about everyone, but its true extent is often downplayed. In fact, real estate is, by far, the largest source of collateral for loans. Georgists know all about this, of course; they know that as long as land is subject to private ownership (and production is taxed to create the public services that, in turn, create rent for landowners) the market for real estate is replete with market failure. The financial system’s collateralization and leveraging and securitization of land rent ratchets the problem up, and up, and up, to the breaking point. Yet the FIRE sector must have something toratchet up: it uses the unearned, speculatively-inflated value of land to devastating effect.

Fractional reserve banking is not inherently problematic. And, the abuses and predations of today’s banking system, real as they are, are not as important, as fundamental, or as damaging as the private ownership of land.

Fractional reserve banking is not inherently problematic. And, the abuses and predations of today’s banking system, real as they are, are not as important, as fundamental, or as damaging as the private ownership of land. I contend that if we were to solve the land problem, by collecting land rent for public revenue and eliminating taxes on production, we would remove the FIRE sector’s basic opportunity for mischief. It wouldn’t fix everything—but it would make everything fixable. If, on the other hand, we were to solve the problems of today’s banking system, the result would be a more efficient economy, which would cause more land rent to flow into the pockets of “the robber that takes all that is left.”

This article has been reprinted from the Georgist Journal.