FICTIONAL RESERVE BANKING
GPT-4 on Inflation-Fueled Bank Runs
I asked AI: Explain how a bank run shows the fractional reserve system is a Ponzi
A bank run does not necessarily show that the fractional reserve system is a Ponzi scheme, but it does reveal some of its vulnerabilities. The fractional reserve system and Ponzi schemes are fundamentally different, though they share some similarities.
The key similarity between a fractional reserve system and a Ponzi scheme is the reliance on a continuous inflow of funds.
The fractional reserve system is a banking system in which banks are required to hold only a fraction of their depositors’ money as reserves, allowing them to lend out the rest. This system is a widely accepted practice in modern banking and helps create credit and stimulate economic growth. However, it can lead to liquidity problems if many depositors demand their money back at the same time, which is what happens during a bank run.
A Ponzi scheme, on the other hand, is a fraudulent investment operation where returns are paid to existing investors from the contributions of new investors, rather than from profits earned by the operation itself. Ponzi schemes are inherently unsustainable and eventually collapse when there are insufficient new investors to pay the returns to existing investors.
The key similarity between a fractional reserve system and a Ponzi scheme is the reliance on a continuous inflow of funds. In the case of a fractional reserve system, banks need new deposits to maintain their reserve ratios and cover the withdrawal demands of depositors. In a Ponzi scheme, new investors’ funds are needed to pay returns to existing investors.
However, the crucial difference lies in the fact that banks under a fractional reserve system generate income through legitimate lending activities, while Ponzi schemes rely on the continuous recruitment of new investors without any underlying productive assets or operations.