Bridger Pennington explains how fractional reserve banking works and how the Fed's decision to relax reserve requirements and flood markets with liquidity during COVID, combined with near-zero rates, contributed to inflation and forced policy changes.
Chapters
So fractional reserve banking is the most craziest thing I think everyone needs to know about in the world of finance. It's funny enough, so you think like in an account they hold, like you deposit account to a bank and they keep that $1, they hold it and make sure that you can get it back. That's not how it works. So during COVID you have fractional reserve banking, right? These ratios where they— it was about 12 to 13 times they could keep accounts funded. So again, if you put a million-dollar deposit in, that means they can lend $13 to $14 million of your— they can just create money out of thin air and lend that out. During COVID The Fed changed that where they can just do pretty much— it was like unlimited for a little bit. They did not want to have a liquidity crunch like they had in 2007, 2008. There was a liquidity crunch. And because of that, they said, you know what? At least this time with COVID we will not have a lack of liquidity. So what happened this time is the Fed stepped in and they said, hey, we're going to make the fractional reserve banking— the reserve ratios are going to go pretty much unlimited for a little bit. They put rates to zero. They just flooded the market with capital to not have a liquidity crunch. And guess what? We didn't have a liquidity crunch. Plenty of liquidity. The result of that was lots of inflation now, right? So now we're dealing with lots of inflation going over the next few years, and now they're trying to taper that back.
