Letter to Editor: Can We Really Do Without FDIC?
- August 27, 2010
Warren Gibson’s otherwise interesting article, , contains at least three errors. One is that “the Fed, out of confusion, failed to inject new money” during the time of the Hoover administration. Not so. Federal Reserve notes increased by 25 percent, from $4 billion to $5 billion between 1930 and 1933; see Irving Fisher’s 1935 book, 100% Money, pp. 5-6. It was the $8 billion contraction in demand deposits that made the big difference.
Second, Gibson faults modern fractional reserve banking because “We think of banks as custodians of our money, keeping it safe for us and making it available whenever we need it. But present-day banks are not deposit banks.” Wrong. We deposit our savings—nonconsumed income. Money (cash) is only one of the media through which we make deposits. As Adam Smith well puts it in the Wealth of Nations, “money is the mere instrument of transfer.” The other instruments include electronic transfers and checks. Thus, so long as banks pay us back our deposits when we want them, they commit no fraud.
Third, he says that “Any benefit this system [FDIC insurance] provides is incidental to its real objective: to serve the cartel.” The claim is seriously misleading. A run on one bank may jeopardize the survival of all banks, including those with financially sound investments (assets), since no bank has enough cash to redeem its liabilities—pay all depositors. Thus, all depositors will lose some of their savings if a run on banks were to occur in the absence of deposit insurance. An economy’s growth also depends upon increasing savings to provide the capital (funds) businesses need for their investment. In the absence of the security of deposits created by the FDIC, the rate of savings with banks would be lower, hence the rate of investment. Therefore, besides saving banks from the hazards of bank runs and contagion, the public—depositors and businesses—directly benefit from the deposit insurance.
—James C.W. Ahiakpor
Professor of economics, California State University, East Bay
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