Full Reserve Banking: What is a reserve?

In both full reserve banking and fractional reserve banking, we have the adjective of “reserve.” It is this adjective that is part of the fraudulent aspect of fractional reserve banking, as its definition can vary from country to country and even bank to bank.

At the simplest definition, a reserve for a bank defines what the bank holds as security against a depositor’s balance. In a full reserve bank, if you deposit US$10,000, the bank physically stores US$10,000 for you against theft, fire and other calamity. In a fractional reserve, the bank is regulated (usually by the government) in how much it must reserve, but it doesn’t have to reserve the total amount. If the official regulated reserve ratio is set to 10%, the bank must keep at least 10% of your deposit in reserves, but is free to do what it wants with the rest. If you deposit US$10,000 in a fractional reserve bank with a 10% regulated reserve ratio, the bank must keep US$1000 in reserves, but can loan out the other US$9,000.

Reserves can become more complicated if the bank uses something other than dollars as a reserve, especially in a full reserve banking system. For example, a bank does not necessary have to be a dollar-backed bank. A bank is free to use any sort of reserve, as long as the depositor understands what they are saving in. One example that is common is the gold reserve bank, or an e-gold bank. In a gold reserve bank, the bank physically retains 100% of your deposit in gold bullion. It would be easy to define this as you showing up at a gold reserve bank, dropping off 2 ounces of gold, and getting a receipt saying the bank owes you 2 ounces of gold. The bank then stores the gold, and charges you a storage fee (also called negative interest) which gives the bank profit. Why use a gold reserve bank instead of holding your own gold? The primary reason is to aid in transacting in gold with others. If you decide to purchase an item or service from someone who accepts gold, you can use the bank to transfer the gold to the other party. The bank handles the physical movement of gold, or the shifting from your account to the other party’s account if both parties use that bank. The bank also handles security of your gold, which is part of the negative interest and transaction fees that are charged.

One thing missing currently from gold reserve banks is the option for currency conversion, which I believe would significantly increase the utilization of these e-gold banks. At the moment, I know of no e-gold banks that aid in currency conversion. An example of a currency conversion option is as follows:

Imagine that you deposit 4 ounces of gold into the theoretical American Gold Reserve Bank. You go to the bank, drop off your gold, and get a receipt for the total. Let’s say you already had 10 ounces of gold in the bank, so your new balance is 14 ounces of gold. Because the American Gold Reserve Bank (again, theoretical, not a real bank) promises a 100% reserve, their sole purpose is securing your gold and aiding in transfering it to others. They do not loan your goal out, or invest the gold to make money.

In a currency conversion reserve bank, the bank would give you the option to transfer your gold in other currencies. They may issue you a debit card that works on the Visa debit merchant system. You could go to any store that accepted Visa in any currency (Dollar, Euro, Rupee, etc) and make purchases based on your gold balance. The store would process your purchase in their preferred currency (say, dollars), send the purchase to a merchant that handles their transaction (usually at a 1.5% fee that is included in the cost of goods or services you are borrowing). The merchant sends the transaction to your bank, who then processes the transaction out of your account.

Because you’re buying with dollars, in this example, but your bank stores your funds in gold ounces, the bank must do a conversion from gold to dollars. It can do this electronically by selling a portion of your gold in exchange for dollars, which it sends to the merchant to pay the store. Your balance of 14 gold ounces would be reduced by the dollar-exchange value of gold on that given day, minus a transaction fee so your bank makes a profit. Let’s say that gold was worth US$800 per ounce on that day, and that your purchase at the store was US$400. Your bank is given a request for US$400 from the store’s merchant company, so your bank goes and sells US$400 of your gold (1/2 ounce), and sends the merchant company $400. The bank also keeps a 1% transaction fee (US$4, or .005 ounces of gold). Your remaining balance in the bank would be 13.495 ounces of gold. If the value of gold goes up or down on a given day, the dollar-buying power of your debit card would rise or shrink, but your balance would stay the same in gold ounces.

A bank that deposits in gold but allows for currency conversion transactions has a few ways to make a good profit, while still offering the depositor some great benefits. Here is my theoretical example that I’d like to share:

Your gold bank, (the theoretical) American Gold Reserve Bank, has thousands of depositors who use the same system you use: making deposits, and transacting purchases with their Visa-branded debit card. Because many depositors just put their paychecks in the bank, the bank receives dollars, and converts them to gold ounces in the bank. When the bank receives the check and redeems it from the employer’s bank, they receive dollars. The bank could set its rules to keep deposited dollars on hand for 24 hours before exchanging them for gold. They can also set the rule that the gold is bought for the current day’s highest price (even if they end up buying the gold for the lowest price, or a lower price). At the day’s close, the bank has dollars in its account to purchase gold, but they also have other people who are making Visa-debit card purchases in dollars. This means that the bank does not necessary have to sell all the gold from people making purchases, and they don’t have to buy all the gold from people depositing paychecks. Instead, they can use their 1-day dollar reserve balance to pay for purchases, and use the gold in those purchasers account to transfer the gold into the account of depositors.

Since the depositors are “buying” gold at the highest daily price, and the purchasers are “selling” gold at the lowest daily price, the bank will earn a profit on the spread. If the highest price of gold today was US$806 per ounce, and the lowest price of gold today was US$798 per ounce, the bank would make a profit of approximately $8 per ounce for any gold that it did not have to buy or sell, but merely transfer between accounts. After all is said and done in regards to the transfer, the bank then uses any dollars left in their account to purchase gold to make up for any shortages in the transfer amounts. This gives the bank the ability to make a small profit on each transaction, but also make money on the spread of the price of gold.

Since the average depositor and purchaser doesn’t have to deal with the cost/overhead of buying and selling gold (which can be as high as 15%!), they’re also gaining a profit on the transaction by being able to store their money safely, in a commodity they prefer, and still be able to transact with most merchants and individuals. If the commodity goes up in value against their common currency, they’ll see a “profit.” In the commodity goes down in value, they’ll see a “loss.” Since the U.S. dollar has historically lost significant value each year, the risk of loss versus profit seems slim.

One other side benefit of this theoretical gold reserve bank is that it is not limited to only gold. The bank could theoretically allow depositors to select any commodity or currency, or maybe even a barrel of goods. They may set a bank account that deposits in equal numbers of Euros, Dollars, Gold Ounces, and Silver Ounces, and equally converts all of these assets to and from the currency being used for the transaction. Because the bank is full reserve, it doesn’t have to worry about selling assets to meet its reserve minimum, as it balancing its books and reserves each night, or multiple times throughout the day.

Comments