Fractional Reserve Banking - clever economic tool, or diluted racket?

Fractional reserve banking is often understood as the bank being able to loan out more than it has on reserves. The belief is that the bank receives money from deposits and lends that money out, therefore they don’t have all of the money deposited. What many people, even those quite familiar with economic matters don’t seem to realize is that it is not just the money that is on deposit with banks that is being lent; it is 10 times that amount or more. In essence, banks are able to lend money into existence. Banks literally create most of the money they lend, which is how money enters our economy. The converse is also true though; the money that is paid back on loans disappears, though the bank keeps the interest. If you were a bank that had $25,000 you could lend someone the $250,000 they needed to purchase a house. At the end of the loan period you’ve earned perhaps $200,000 in interest on an initial outlay of $25,000. Actually due to amortization you’ve earned most of that in the first part of the loan duration.

This creation and destruction of money is why the “fed interest rate” is tied to inflation, because money is created through lending. The theory is that increasing the rate decreases the consumer’s desire to borrow, therefore decreasing the money supply (less money is created, more is destroyed as it is paid back). As you probably know, the inflation, deflation vacillation is often called the business cycle. Each time money is inflated the economy experiences short-term growth followed by increased prices. When money deflates, a recession results but prices increase. One might wonder, if the fed can control the rate, than why not keep things balanced and avoid the reactionary cycle? Keep in mind, however, that ultimately the inflation or deflation is decided by the loan consumers, which are speculative in nature. Also, allegedly, the banks have little interest in balance as they may profit each time the economy traverses the cycle, and don't forget the political factors.

Another interesting facet of the system is where the “reserves” that banks must keep come from. Basically these are lent into existence. Until the 1970s, the reserves were gold. In current times, however, the reserves come mostly from credit. Some are from deposited money which you may note originate from other people’s loans. Some come from government bonds, which is where most of the national debt originated. Some comes from the Federal Reserve bank itself, which it loans into existence. Note that for a bank that holds stock in the Federal Reserve, borrowing money from the Fed may work out to something of a wash, especially when they can loan out 10 times what they borrow.

So, presently, a great deal of our money is manufactured by banks based on our national debt. Opponents of this system argue that ultimately it comes down to regulating supply and demand, and that the current system does a poor job due to multiple variables and private interests. Another argument against the system is that if the government can create money through debt, they could instead create it directly and not owe anyone. Arguments over these matters have raged for centuries, and the issue is probably much less settled than most people realize. The U.S. has gone back and forth between a private banking system and a federally controlled money system 3 times since its inception—a constant power struggle between private bankers and those that oppose them.

I’m sure you’ve heard the news and perhaps felt the effects of the rather large inflation the dollar is currently experiencing. The longer this cycle of inflation lasts, the worse it will be for the economy when it comes time to slow the inflation, so why does the fed interest rate remain low? I don’t know the answers, but based on what I am learning from the history of economics I am increasingly losing faith in the ability of a bunch of private bankers to look after our collective best interests.