I was just thinking about this, why would a central bank and local banks use fractional reserve banking when they use a fiat currency, such as in the case of the US and most countries. The money is created out of thin air, why isn't every dollar deposited matched 1:1 with a dollar at the bank or central bank?
All currency is fiat. Pegging a currency to a commodity boils down to the government promising that the currency will be backed. They can always just print more money. All currency is promissory in nature. Even coinage; it is a simple matter of mixing the gold with another metal. Fiat currency is no more unstable than currency backed by another security because the government can always do whatever it wants. The gold standard is illusionary. As long as the government has the largest army and forces you to pay taxes in currency it's going to be used. Fractional reserve banking is really just an explanation of how banks make a profit. How in the world could a bank profit if every deposit was kept in a vault dollar for dollar? Are you suggesting the government would just print an extra 0.1 dollars for every dollar the bank has in its vault every year and then just hand it over to the bank? How would people get loans? When you put your money in the bank it is a demand deposit and basically it's always in some sort of money market. This guarantees the largest possible pool of credit available to an economy. The importance of credit in regards to building economic infrastructure is obvious. It is fairly safe to say that Europe didn't start to prosper until banking was developed.
It all works just fine as long as the loans aren't bad loans. Liar Loans, I wonder why they call them that? A second question is why they exist at all?
Please consider this example: A bank borrows money from the central bank at 3% because business conditions are good. Say they borrow 100 million. Money is being created. It then loans 80 millions to the public at 5%. The other 20 million is required reserves. If there was a bank run tomorrow they'd be forced to call in loans, but it wouldn't be as bad as a bank run when all they have in reserves is 2 million because of fractional banking. So is fractional banking used for nothing more than profits? The central bank though has no use it, it prints money!
Heh. Here's a good explanation of the fractional reserve banking system that'll help you out: http://en.wikipedia.org/wiki/Fractional-reserve_banking
I don't understand your first question. Why would they use fractional reserve banking when they use fiat currency? In my mind, it's one or the other. If you have a fraction of anything as a reserve, it's fractional banking. Otherwise it's fiat. To your second question... why would that matter? If the money is created out of thin air, who cares if it's matched by the central bank? They can always create more when then need it... TNG