A Perhaps Unknown but Common Type of Bank Fraud

A Perhaps Unknown but Common Type of Bank Fraud


A: Well, it’s not as if the Free Market has never had its struggles.  If it was such a great thing, why did it cave in to cause the Depression of the ‘30s?  There have also been multiple other similar recessions that just haven’t been as drastic.  They seem to be inevitable; why can’t the market avoid these?

B: I won’t claim to have the perfect answer to this.  Undoubtedly these catastrophic events are very complicated in their origin and solution.  My belief is that there were in most, if not all, of these cases, some people putting very large sums of money in some unwise investments.  When these investments failed, a domino effect of some sort followed and a bunch of other investments failed; voilà, we have a recession.

So while it may be easy to tell people to not make unwise investments, it’s a lot harder to make sure that is done.  Furthermore, it may not be entirely true that it’s the people’s fault for making such investments.  Why?  Perhaps they thought they had more wealth than they actually had access to, because their bank told them so.  And why would the bank tell them this?  Because the bank, like perhaps all banks today, is practicing a severe type of fraud.

Let me explain with the aid of an example.  Let’s suppose that an ounce of gold is worth $1000.  So if you have $1000, it’s like you have a reservation for an ounce of gold.  Another way to see this is if you have the one ounce of gold instead, but for safe keeping, you give it to a bank, which in this case acts as a kind of warehouse for items of wealth, like the ounce of gold is.  In return, the bank gives you $1000, which acts as a certificate saying that you have access to that one ounce of gold at any time.

This would be all well and good if the banks would issue out their “certificates” of $1000 according to the number of ounces of gold they’re keeping.  Unfortunately, they don’t; it’s become common practice for banks to, in essence, issue out far more certificates of $1000 than there are corresponding ounces of gold.  Thus many people may have claim on your original ounce of gold, because the bank has given them $1000 certificates to that same ounce of gold.  The bank can get by on this because usually people don’t want their money all at once, but when people get scared because of some perceived economic fiasco, the old-fashioned “runs on the bank” tend to happen.  When they do, the bank has to admit they don’t have the corresponding gold for each of their certificates and can’t cough it up to appease everyone’s demands.  This leads not only to bank failure, but, much worse, perhaps to failure of the entire economy.

Undoubtedly reality is more complicated than this, but this kind of thing may be the essence of why there are periodic economic failures.  At its core, this is nothing less than fraud, and in this case, government should act and penalize those running the bank.  Fraud is a breach of free trade, since free trade requires honesty.  Government should be there to prevent dishonesty of this sort.  If not, scams would assuredly be more widespread than they are.

This is an example of a good use of government power.  Unfortunately, during earlier times of economic difficulty, panic perhaps led to poor use of government power.  My understanding about the Depression, for instance, is that Herbert Hoover, U.S. President at the time of the stock market crash in late 1929, overreacted and used government ill-advisedly.  There are claims that the market would have recovered itself, but that these government measures made things worse and pushed the market into the woeful Depression.  Hoover’s successor, Franklin Roosevelt, famously enlarged government’s reach into market, likely prolonging the Depression more than it otherwise would have been.  Again, I’m leaving out hordes of details, and there is plenty of debate on the matter.  My assertion remains, however, that government should have stayed out of trying to fix things in the Depression, except in matters where fraud was involved, and that only to ensure that fraud didn’t occur and those who practiced it were appropriately reprimanded and punished.

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