I was reading a debate between two people who disagreed on whether fractional reserve banking was bad. I wanted to get to the root of why it is bad. Would it be correct to say it's only bad to the extent that it requires the central bank to print more money to meet redemption requests? For example, if I deposit $100 in a bank that lends $90 of it to someone who spends it on a product and the seller of the product then deposits the $90 in another bank, as long as I don't redeem my deposit before the loan is repaid, the central bank doesn't have to print money and lend it to my bank in order to repay me, right? Or is this an impossible situation because the loan cannot be repaid without some sort of monetary expansion in order for the borrower of the $90 to cover the interest that accrues on the principal? Thanks!
this link will explain why it is bad
we must resist the borg
anonnymous: this link will explain why it is bad
I don't think your link came through.
here it is
http;//fskrealityguide.blogspot.com
The short answer is that fractional-reserve banking is bad because it's a way for banks to make money by lending out and investing money they don't really have, and for governments to spend money without the political inconvenience of taxing people for it or borrowing it from willing lenders. The consequence is chronic, systemic rising prices and so-called business cycles as the wealth of the economy is transfered to the bankers and the politically connected. Central banks also happen to play a facilitating role in financing wars of agression.
The reason most people don't understand all this is because the plutocracy has had a hundred years to put into place institutions whose purpuse is to obscure the true function of central banking:
http://www.lewrockwell.com/north/north632.html
And the true nature of government is revealed in the fact that even the most populous of politicians will never allow this wholesale transfer of wealth from poor to rich to even enter sanctioned political discourse (Ron Paul being the exception, of course).
hjmaiere: The short answer is that fractional-reserve banking is bad because it's a way for banks to make money by lending out and investing money they don't really have, and for governments to spend money without the political inconvenience of taxing people for it or borrowing it from willing lenders. The consequence is chronic, systemic rising prices and so-called business cycles as the wealth of the economy is transfered to the bankers and the politically connected. Central banks also happen to play a facilitating role in financing wars of agression. The reason most people don't understand all this is because the plutocracy has had a hundred years to put into place institutions whose purpuse is to obscure the true function of central banking: http://www.lewrockwell.com/north/north632.html And the true nature of government is revealed in the fact that even the most populous of politicians will never allow this wholesale transfer of wealth from poor to rich to even enter sanctioned political discourse (Ron Paul being the exception, of course).
well said andwhen the depression comes they will deny that they were the cause, party line and all.
Fractional reserve banking is a free market invention. It would exist even under pure cold coin system. It has nothing to do with central banks or inflating money supply. If you lend me money, on the promise that you will get back the money on request.. i can do whatever i want with the money in the mean time. I can lend it out or invest it. As long as Invest it profitably as opposed to waste the money. I will be able to give you back your money on request. Fractional reserve banking is lending out short term loans to long term borrowers. It works because many short time lenders, as a whole behave as one long time lender. As long as the bank does not lend out money to people who will not be able to pay back.. the bank is sound and everyone that has lent the bank its money will get back their money.
If a bank is unsound.. if it lent out money cheaply (low interest loans) to low quality, high risk lenders.. well then the bank will be insolvent.. and it will go bankrupt unless some govt institution bails it out. Its the bailing out of insolvent banks that is wrong, not fractional reserve banking in itself. A central bank can bail out banks by loaning them money below market prices (low interest).. this will create inflation. However it is not wrong for a central bank to loan out money at or above market prices (high interest), this is needed sometimes if lots of depositors temporarily demand out their money at the same time (say some 911 thing happens that freaks people out), this would mean that all banks would be short of money, even though they where sound and their borrowers where of high quality. So as long as the central bank lent out money at a high price.. the banks would repay their loans as quick as they could.. that means the money supply would contract back to its previous level.
So in closing fractional reserve banking is a natural thing.. the only way you could make it go away, is to make it illegal.. wich would be a govt regulation of the private free market. I find it abit funny when anti-govt and free market supporters, start going on about how evil banks and fractional reserve banking is. That road leads down nationalization of the whole banking system. That road leads down to more govt, not less. We have to keep the concepts separate. Credit/Deposits is not money. Its lending and borrowing. Banks dont create credit and deposits, people do. The govt has no part in telling people wether they can lend and borrow money from eachother.
Cheers
DriftWood:So in closing fractional reserve banking is a natural thing.. the only way you could make it go away, is to make it illegal.. wich would be a govt regulation of the private free market.
Thanks for saving me the trouble of explaining it again.
The state won't go away once enough people want the state to go away, the state will effectively disappear once enough people no longer care that much whether it stays or goes. We don't need a revolution, we need millions of them.
DriftWood: Fractional reserve banking is a free market invention. It would exist even under pure cold coin system. It has nothing to do with central banks or inflating money supply. If you lend me money, on the promise that you will get back the money on request.. i can do whatever i want with the money in the mean time. I can lend it out or invest it. As long as Invest it profitably as opposed to waste the money. I will be able to give you back your money on request. Fractional reserve banking is lending out short term loans to long term borrowers. It works because many short time lenders, as a whole behave as one long time lender. As long as the bank does not lend out money to people who will not be able to pay back.. the bank is sound and everyone that has lent the bank its money will get back their money. [...]
[...]
Banks can and did issue 'shares' against their assets (i.e. outstanding loans). These shares simply did not function as money under more free market conditions. They always only traded more like stock--based on the risk and inconvenience of redeeming them for specie. Fractional-reserve banking, where a bank issues demand-deposit bank notes against outstanding loans simply doesn't happen under free-market conditions except as fraud. And the markets punished such banks the same way it punishes any fraudulent business.
Fractional-reserve banking only happens on an industrial scale when the government does specific things to force people to use the notes of the politically-favored banks. These things include:
And the most interesting and important way a government can force people to use a politically-favored bank's notes is to make some incredibly important commodity only purchasable with those notes. In the 1970s, the U.S. government made a deal with the House of Saud. The U.S. government would keep them in power. In exchange, Saudi Arabia would only accept U.S. dollars in payment for oil. The rest of OPEC soon followed suit. Now check this out:
http://en.wikipedia.org/wiki/Iran_Oil_Bourse
Now you know the real threat Iran poses.
DriftWood: So as long as the central bank lent out money at a high price.. the banks would repay their loans as quick as they could.. that means the money supply would contract back to its previous level.
So as long as the central bank lent out money at a high price.. the banks would repay their loans as quick as they could.. that means the money supply would contract back to its previous level.
In practice, under central banking, the money supply always grows over the long term. Governments grant specific banks political privilege in exchange for financing government spending. That has always been the true function of every central bank.
DriftWood: So in closing fractional reserve banking is a natural thing.. the only way you could make it go away, is to make it illegal.. wich would be a govt regulation of the private free market. I find it abit funny when anti-govt and free market supporters, start going on about how evil banks and fractional reserve banking is. That road leads down nationalization of the whole banking system. That road leads down to more govt, not less. [...]
So in closing fractional reserve banking is a natural thing.. the only way you could make it go away, is to make it illegal.. wich would be a govt regulation of the private free market. I find it abit funny when anti-govt and free market supporters, start going on about how evil banks and fractional reserve banking is. That road leads down nationalization of the whole banking system. That road leads down to more govt, not less. [...]
Utter nonsense. Fractional-reserve banking requires massive government intervention. Governments do everything they can to prevent people from circumventing the use of government-sanctioned bank notes. In 1933, the U.S. government flat-out outlawed the use of gold as money. Weimar Germany outlawed posession of foreign currency. As I type, the governments of the U.S. and Canada are setting their sites on increasing regulations on internet 'digital precious metal operators' which allow people to conduct business in units backed by gold and silver rather than paper currencies. They are nominally doing this in the name of fighting terrorism and money laundering of course, but what they really fear is the loss of their power to create money out of thin air.
Fractional reserve banking is a free market invention. It would exist even under pure cold coin system. It has nothing to do with central banks or inflating money supply. If you lend me money, on the promise that you will get back the money on request.. i can do whatever i want with the money in the mean time. I can lend it out or invest it.
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
hjmaiere:Fractional-reserve banking only happens on an industrial scale when the government does specific things to force people to use the notes of the politically-favored banks.
Are you claiming that no-one in a free market would choose to take the risks inherent to banking with an FRB bank in exchange for the benefits of it? Can you support that?
hjmaiere:Fractional-reserve banking requires massive government intervention.
Where do you get that idea from? Because FRB has always been done, and at the same time banking itself has always been subject to massive government intervention? They're two distinct concepts. The massive government intervention has always been needed to prop up monopoly currencies operating under FRB, because monopoly currencies are not subject to the market disciple that leads to responsible banking. And in turn, currencies are monopolized so that governments can abuse FRB to inflate them and pay for things they couldn't otherwise.
Take the government intervention out of it, and there's little reason to think that responsible FRB is impossible, and that it wouldn't be chosen by some segment of the market. It's like saying that governments use guns to oppress people, and governments always try to monopolize gun onwership and use, so guns must be bad. You're mixing up cause and effect.
vp3434: I was reading a debate between two people who disagreed on whether fractional reserve banking was bad. I wanted to get to the root of why it is bad. Would it be correct to say it's only bad to the extent that it requires the central bank to print more money to meet redemption requests? For example, if I deposit $100 in a bank that lends $90 of it to someone who spends it on a product and the seller of the product then deposits the $90 in another bank, as long as I don't redeem my deposit before the loan is repaid, the central bank doesn't have to print money and lend it to my bank in order to repay me, right? Or is this an impossible situation because the loan cannot be repaid without some sort of monetary expansion in order for the borrower of the $90 to cover the interest that accrues on the principal? Thanks!
Since the topic is primarily about fractional reserve banking, for the moment we need to totally clear our minds of any thoughts of central banking. Fractional reserve banking is the egg that came before the central banking chicken. So I will postulate a timeframe before central banking or other government interventions came about.
Assuming we already have an established precious metallic currency in general use, for simplicity we will go with gold. The first money warehouses, <i.e. banks> must of necessity be 100% reserve. The concept of money warehousing will be new and it will take a few years before people begin to accept warehouse receipts <paper currency> in lieu of the actual gold in the vault. Over time as familiarity and trust builds the warehouse receipts are accepted as circulating currency in lieu of the actual gold. EVERY banknote in circulate is backed by actual gold in a money.
At some point, the warehouse manager realizes he can take advantage of the trust people place in the warehouse receipts. He begins printing and loaning out faux banknotes, unbacked by gold. People circulate these notes, believing them to be fully backed by gold.
So assume we have 100,000 troy pounds of gold in the warehouse, with 100,000 in warehouse receipts circulating. In addition, 50,000 in faux unbacked receipts are circulating. If there is a panic and everybody decides to redeem, you are going to have a shortfall of 50,000 at the bank and many genuine holders of currency will get screwed.
Fractional reserve banking is clearly fraudulent, in that it causes the issuance of unbacked banknotes. Fraud #1. Since there are more banknotes chasing the same number of goods and services, it devalues those notes <inflation>. Fraud #2.
If bankers want to lend money, I suggest they do it the honest way. Take in timed deposits and loan money based on those timed deposits they hold. Demand deposits, must be kept on a 100% reserve basis.
histhasthai: hjmaiere:Fractional-reserve banking only happens on an industrial scale when the government does specific things to force people to use the notes of the politically-favored banks. Are you claiming that no-one in a free market would choose to take the risks inherent to banking with an FRB bank in exchange for the benefits of it? Can you support that?
I'm saying that when banks contractually distinguish between demand deposits and timed deposits, claims on timed deposits do not function as money, and therefore do not facilitate fractional-reserve banking.
I'm saying that consequently, the only way banks practice fractional-reserve banking in a free market is fraudulently, and that markets place an automatic and extreme restriction on the ability of banks to practice fractional-reserve banking without some form of government intervention.
histhasthai: hjmaiere:Fractional-reserve banking requires massive government intervention. Where do you get that idea from? Because FRB has always been done, and at the same time banking itself has always been subject to massive government intervention? They're two distinct concepts. [...]
Where do you get that idea from? Because FRB has always been done, and at the same time banking itself has always been subject to massive government intervention? They're two distinct concepts. [...]
Fractional-reserve banking has not "always been done." People used to pay banks to store their gold. The receipts for gold were traded in place of the gold. When a bank issued more receipts than it had gold on deposit it was considered fraud, and such banks went quickly out of business. It takes bank-friendly court rulings and massive political privilege for fractional-reserve banking to maintain itself as standard business practice.
histhasthai: Take the government intervention out of it, and there's little reason to think that responsible FRB is impossible, and that it wouldn't be chosen by some segment of the market. It's like saying that governments use guns to oppress people, and governments always try to monopolize gun onwership and use, so guns must be bad. You're mixing up cause and effect.
I am not proposing that fractional-reserve banking should be illegal. I have no problem with a bank issuing shares against its investment assets as long as it does so with full disclosure. I'm just saying that such shares won't and didn't function as money. Such shares—absent government intervention—always have and always will trade at a discount based on the risk and inconvenience associated with redeeming them for genuine specie. People can and have borrowed against such shares. I have a book from 1926, "Finance and Investment - Book 1" by Leighton P. Stradley, LL.B., that describes how people can buy shares in and investement and loan, and if they are a member in good standing, they can probably borrow against such shares. But nobody pretended that these shares were redeemable on demand for specie, and no new money is created in this situation. Shares of ownership in bank assets simply did not and would not function as money without government intervention.
Mark B.: At some point, the warehouse manager realizes he can take advantage of the trust people place in the warehouse receipts. He begins printing and loaning out faux banknotes, unbacked by gold. People circulate these notes, believing them to be fully backed by gold. ... Fractional reserve banking is clearly fraudulent, in that it causes the issuance of unbacked banknotes.
...
Fractional reserve banking is clearly fraudulent, in that it causes the issuance of unbacked banknotes.
Assume instead that the banker offers this proposal: Instead of charging you $5 a month to store your money with me, I will pay you to store your money with me. In exchange, though I will redeem all notes at their full value, they will only be backed by X% of the gold they are a receipt for. This means you will be exposed to the risk that my bank will fail, and you may lose all or part of the gold you have reciepts for.
You may continue to warehouse your money with me at a cost of $5.00 per month, fully backed, or to make non-demand deposits that will bear interest, or you may choose my new fractional reserve plan.
Assuming the banker doesn't cheat on these terms (with "X" being a specific number), is it still fraud? Do you think he would have no takers? FRB isn't inherently fraudulent, fraud requires lying or deception.
histhasthai: Mark B.: At some point, the warehouse manager realizes he can take advantage of the trust people place in the warehouse receipts. He begins printing and loaning out faux banknotes, unbacked by gold. People circulate these notes, believing them to be fully backed by gold. ... Fractional reserve banking is clearly fraudulent, in that it causes the issuance of unbacked banknotes. Assume instead that the banker offers this proposal: Instead of charging you $5 a month to store your money with me, I will pay you to store your money with me. In exchange, though I will redeem all notes at their full value, they will only be backed by X% of the gold they are a receipt for. This means you will be exposed to the risk that my bank will fail, and you may lose all or part of the gold you have reciepts for. You may continue to warehouse your money with me at a cost of $5.00 per month, fully backed, or to make non-demand deposits that will bear interest, or you may choose my new fractional reserve plan. Assuming the banker doesn't cheat on these terms (with "X" being a specific number), is it still fraud? Do you think he would have no takers? FRB isn't inherently fraudulent, fraud requires lying or deception.
A bank should certainly be free to do what you describe, but good luck finding someone to accept their notes as money.
hjmaiere: I'm saying that when banks contractually distinguish between demand deposits and timed deposits, claims on timed deposits do not function as money, and therefore do not facilitate fractional-reserve banking. I'm saying that consequently, the only way banks practice fractional-reserve banking in a free market is fraudulently, and that markets place an automatic and extreme restriction on the ability of banks to practice fractional-reserve banking without some form of government intervention.
See my post above re fraud.
We're not talking about time deposits, FRB is one way to gain interest, or at least avoid warehousing costs, while still taking advantage of demand deposits. Time deposits restrict personal liquidity, and so people will pay to avoid it. One way is to pay warehousing fees, another is to assume risk.
Markets do provide a restriction, at least when the currency is not monopolized. That's why the harmful effects of mismanaged or outright fraudulent FRB would be minimized. The question is how far the markets would allow it to be taken. Your estimation is not at all, or at least not in any significant quantity. My estimate is that it would allow it to some significant level.
hjmaiere:Fractional-reserve banking has not "always been done." People used to pay banks to store their gold. The receipts for gold were traded in place of the gold.
Yes, but then that wasn't banking, that was warehousing. It's not much different than running a high-security U-Stor-It out by the airport. Similarly, loaning from your own gold reserves is not banking. Pooling depositors time deposits into long-term loans was real banking, but it took FRB to make it efficient, convenient, and liquid for depositors. And, I could even make an argument that it made it safer by smoothing out liquidity spikes and borower's default risk.
hjmaiere: It takes bank-friendly court rulings and massive political privilege for fractional-reserve banking to maintain itself as standard business practice.
Everyone keeps making that assertion, and then when it is questioned, making it again, a little louder. It's not an argument, it's a conclusion.
No one in their right mind would accept fiat FRB paper in commercial transactions, if they thought there was any chance that the paper might not be able to be redeemed.
FRB only exists by secrecy or legal tender law.
histhasthai: hjmaiere:Fractional-reserve banking has not "always been done." People used to pay banks to store their gold. The receipts for gold were traded in place of the gold. Yes, but then that wasn't banking, that was warehousing. [...]
Yes, but then that wasn't banking, that was warehousing. [...]
Correct.
histhasthai: Pooling depositors time deposits into long-term loans was real banking, but it took FRB to make it efficient, convenient, and liquid for depositors. And, I could even make an argument that it made it safer by smoothing out liquidity spikes and borower's default risk.
Pooling depositors time deposits into long-term loans was real banking, but it took FRB to make it efficient, convenient, and liquid for depositors. And, I could even make an argument that it made it safer by smoothing out liquidity spikes and borower's default risk.
Fractional-reserve banking is only 'efficient' from the point of view of the banks, who get to make money on loans and investments with money that doesn't actually exist except as magic tokens—magic tokens that by very strictly-enforced law only they are allowed to create. And fractional-reserve banking doesn't smooth out liquidity spikes, it creates them.
histhasthai: hjmaiere: It takes bank-friendly court rulings and massive political privilege for fractional-reserve banking to maintain itself as standard business practice. Everyone keeps making that assertion, and then when it is questioned, making it again, a little louder. It's not an argument, it's a conclusion.
No, it's a description of history. Banks used to do exactly what you describe. They used to say: "Let us lend out or invest your money for you, and we will give you a piece of paper denoting how much of what we invest in you own." The simple historical fact is that without government intervention, people simply didn't treat that piece of paper as if it were money, including the issuing bank itself.
hjmaiere:Fractional-reserve banking is only 'efficient' from the point of view of the banks,
That's simply untrue. It allows banks to offer their demand depositors more value than they otherwise could, in exchange for the risk. It also allows the availability of loans to not be contingent on short term tightening of the currency that can reduce liquidity even when the bank is fully solvent. Everybody agrees that currency supply would be responsive to market demand, well, this is one of the ways the market responds.
The question remains, despite your unfounded assertion that there is no benefit whatsoever to depositors, whether they would find the benefit worth the risk. The only way to know for sure is to try it. What I worry about is that demonization of FRB would cause people to reject an otherwise sound and beneficial practice should a free market for currencies and banking ever emerge.
hjmaiere:The simple historical fact is that without government intervention, people simply didn't treat that piece of paper as if it were money, including the issuing bank itself.
I'm not prepared to argue historical banking in detail, but several otherwise solvent banks failed on liquidity crises, prior to the Federal Reserve and the FDIC. Such failures would imply FRB, else a solvent bank could not fail. I don't know in detail what regulations, guarantees, and legal tender laws were in effect and how they would have affected people's choice to accept the risk of a less than fully backed currency, so I'm not claiming this refutes your assertion.
liberty student:No one in their right mind would accept fiat FRB paper in commercial transactions, if they thought there was any chance that the paper might not be able to be redeemed.
There's always a chance. Warehoused deposits can be stolen, not just by the banker himself, but by plain old bank robbers. Time deposits are subject to borrower default and the bank's own ability to make good in the face of them. There's never no risk, there's only questions of what kind of risk and how much, and whether the benefits outweigh it.
And by the way, this:
hjmaiere:Fractional-reserve banking is only 'efficient' from the point of view of the banks, who get to make money on loans and investments with money that doesn't actually exist except as magic tokens—magic tokens that by very strictly-enforced law only they are allowed to create.
is starting to look like bad faith argument. I'm not arguing for regulatory monopoly or priveleges that counter voluntary exchange. I've explicitly said more than once that I'm talking about a scenario where anyone can - call it "create magic tokens" if you will - where anybody can practice FRB, and where they will have to compete against fully backed currencies without any special protection. You can argue that such could never succesfully compete in the market, but continuing to insist on claiming that special protection is part of the issue under discussion is cheap and shoddy.
You're grasping at straws. Fractional banking receipts are lottery tickets, and no one would confuse a lottery ticket with a store of value.
I can't even fathom how the possibility of worthlessness could be factored in as a premium to take fractional receipts in exchange.
liberty student:Fractional banking receipts are lottery tickets,
So does that mean I can discount you from any further serious discussion on the matter?
Juan:Frankly, I don't see why the issue is so hard to grasp.
I don't either, but keep working at it, you'll get it.
Juan:fiat money is a fraud.
No, lying and deceit are fraud. Fiat money is risky, but it also solves certain problems, for both the banker and his customers.
You know, I've been hoping for a substantive argument against FRB, but for some reason none has been forthcoming. Repeating "FRB is fraud" does not qualify, but it's amusing to see how often and in how many different ways y'all keep pretending it is.
Juan:"FRB creates property titles linked to property that does not exist." - that's the substantive argument against FRB.
It might be the start of one, but by itself, it's nothing more than "it's fraud" in fancy dress. What I'm learning here is that the opposition to FRB is, on this board at least, little more than dogma recieved from Murray or whomever, and that I'm on my own for fully validating or invalidating the legitimacy of FRB. Ah, well, I'm used to it. I would never have become an anarchist if I was not prepared to make such determinations for myself.
Juan:You and your customers are of course free to engage in FRB if you think it solves any problems...
Well, I can't demand any more than that, so at least we won't be in irreconcilable conflict. What would be nice, however, is either a substantive and convincing refutation of FRB, or a concession that it is a matter for the markets to decide. What I worry about is that a hypothetical future agorist bank will need to take full advantage of all the tools it legitimately has at it's disposal. If FRB is truly illigitimate, then it is best that that be conclusively determined ahead of time. If it is not, or if it is an open question, it would be a shame to scare people off it solely on the basis of dogma.
Your quote from Mises doesn't mention FRB or fiat currency, only fraud, and since I have yet to get to that part of the book, I lack the context to relate it to that. On the face of what you quoted, it seems to argue for forcible intervention toward the prevention of private issuance of currency. That, it seems to me, is a far greater threat than FRB in itself, and worse, would almost inevitably lead to a state monopolized FRB currency, so we'd again have the worst of both worlds.
histhasthai:You know, I've been hoping for a substantive argument against FRB, but for some reason none has been forthcoming.
There are two cases to consider.
First, consider Fractional Reserve Banking under a gold standard. Suppose a bank has 1000 ounces of demand deposits and 900 ounces of outstanding loans and 100 ounces on reserve.
Suppose all depositors come to the bank simultaneously and demand withdrawal. The bank can't pay. It has an immediate obligation of 1000 ounces of gold but only 100 ounces gold on hand. There is no guarantee that the bank will be able to sell its loan porfolio for the 900 ounces of gold owed depositors.
For this reason, a fractional reserve bank offering demand deposits is committing fraud. If all depositors simultaneously demand withdrawal, then the bank is insolvent.
The fraud is that the fractional reserve bank is borrowing at the overnight demand rate, but lending at the long-term rate. If there's any reason for depositors to mistrust the bank, that becomes a self-fulfilling prophecy.
As liberty student pointed out, a fractional reserve banknote is like a lottery ticket. More accurately, it's like playing a game of musical chairs. If you're the *FIRST* to redeem your banknote when there's a run, you're OK. Otherwise, you're SOL.
In practice, government intervenes to bail out the bankers. The State will declare a "banking holiday". Alternatively, the legal system will intervene, not acknowledging depositors' claim. After the late 19th century, limited liability incorporation encouraged fraud by fractional reserve bank management and owners. They could declare bankruptcy, shafting their depositors. Before limited liability incorporation was legalized by the US Supreme Court, a banks' owners and management would be responsible for any shorffall.
Second, there's fractional reserve banking in the context of fiat debt-based money. That's totally immoral. Someone already mentioned my article on the Compound Interest Paradox.
In a truly free market, where government violence won't intervene to protect fractional reserve bankers, fractional reserve banking is not a sustainable business. You'd have to be a fool to deposit your gold in a fractional reserve bank. You would prefer an Austrian-style warehouse receipt bank or time deposit bank. In a truly free market, banking is not evil.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
fsk:The bank can't pay. It has an immediate obligation of 1000 ounces of gold but only 100 ounces gold on hand. There is no guarantee that the bank will be able to sell its loan porfolio for the 900 ounces of gold owed depositors. For this reason, a fractional reserve bank offering demand deposits is committing fraud.
For this reason, a fractional reserve bank offering demand deposits is committing fraud.
Jeezus Christ, can anybody have an original thought here? Realized risk is not evidence of fraud. If you loaned me money to start a business, and the business fails, have I committed fraud?
Your characterization of "lottery ticket" assumes a run is already underway. That's the risk being realized, not the cause of the run.
fsk:The fraud is that the fractional reserve bank is borrowing at the overnight demand rate, but lending at the long-term rate.
Wait, are you saying that making a profit is fraud? I don't get where this in and of itself even touches on any issue of FRB.
fsk:Before limited liability incorporation was legalized by the US Supreme Court, a banks' owners and management would be responsible for any shorffall.
Yup. And that's the way it would be with private banking FRB, though they may be able to purchase insurance.
fsk:In a truly free market, where government violence won't intervene to protect fractional reserve bankers, fractional reserve banking is not a sustainable business. You'd have to be a fool to deposit your gold in a fractional reserve bank. You would prefer an Austrian-style warehouse receipt bank or time deposit bank.
So you know what my risk preference would be? So tell me, what flavor of ice cream is objectively best? The claim that it would be an unsustainable business, despite it's repetition here ad nauseum, remains an unsupported claim. Not necessarily false, merely unsupported so far.
fsk: In a truly free market, banking is not evil.
Obviously. Still, it entirely begs the question of whether FRB qualifies as evil.
histhasthai: [...] hjmaiere:The simple historical fact is that without government intervention, people simply didn't treat that piece of paper as if it were money, including the issuing bank itself. I'm not prepared to argue historical banking in detail, but several otherwise solvent banks failed on liquidity crises, prior to the Federal Reserve and the FDIC. Such failures would imply FRB, else a solvent bank could not fail. [...]
I'm not prepared to argue historical banking in detail, but several otherwise solvent banks failed on liquidity crises, prior to the Federal Reserve and the FDIC. Such failures would imply FRB, else a solvent bank could not fail. [...]
Why should the failure of a bank be viewed as somehow a more tragic incident than the failure of any other business? Why should the Federal Reserve's ability to protect its member banks from the ravages of competition in the marketpace be considered a good thing? The creation of the Federal Reserve has definitely helped its member banks survive every economic crisis since its formation. But us plebeians have, since its creation, had to put up with the single biggest economic depression in the history of the world, not to mention a 95% devaluation (at least) of the dollar. Why is government intervention designed to prop up banks at the expense of everyone else some thing the average joe should consider a good thing? Yes, I can be sure of being able to pull my money out of my checking account any time I want, but food and gasoline are up in price by somewhere between 15% and 30% year over year.
What makes banks sacred?
And note: The claim is not that fractional-reserve banking should be made illegal. The claim is that fractional-reserve banking won't happen under free-market conditions. Nothing you have written addresses this point.
histhasthai: liberty student:Fractional banking receipts are lottery tickets, So does that mean I can discount you from any further serious discussion on the matter?
You can do whatever you want. It seems you have been in this discussion.
FRB receipts are like lottery tickets. When you exchange them for face value, there is a statistical chance you will receive nothing.
What I'm learning here is that the opposition to FRB is, on this board at least, little more than dogma recieved from Murray or whomever
What would be nice, however, is either a substantive and convincing refutation of FRB,
or a concession that it is a matter for the markets to decide.
A dumb question: are you guys talking of two fractional reserve systems? It seems to me like a bank that creates banknotes for which they have no backing is a different practice than working out short-time deposits to provide for long-term loans...
Originally, the issue with the Federal Reserve was that they provided more bank notes than they had gold, right? But nowadays, the issue is they take the risk away from this business, irresponsibly creating money in the process, correct?
Equality before the law and material equality are not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time. -- F. A. Hayek in The Constitution of Liberty
"That's not FRB. That's ordinary borrowing/lending."
It is. Most of you guys still are abit confued about what the purpose of banks are, and how fractional reserve banking is the most efficient free market way for banks to work. Imagine a world without a central bank and were gold coins are used as money.
Banks exist to connect borrowers and lenders. Its the middle man, so that borrower dont have to go looking for lenders and vice versa. Banks are not warehouses. A warehouse can not lend out anything, it can only store stuff. If you stored gold with a warehouse, you can get out the gold on request, but you would have to pay it a storage fee. If you payed the storage fee, with some of the gold you had stored.. it would work like a negative interest, your stored gold would grow smaller and smaller. This is why warehousing gold or money is not a popular option.
The free market came up with a better way.. it came up with the concept of a bank. What do savers want? To be able to get back their gold on request, and not pay much of a storage fee. What do borrower want? To get to borrow money on the long term, and not pay much of a fee for doing so. Fractional reserve banking is the method that makes all short term savers, into long term lenders. Its a wonderful free market innovation. Savers deposit their money with a bank, as long as the bank does not break the contract of giving back the money on request the savers are happy. The bank does not charge the savers a fee, they pay them a fee (interest). Imagine that, all those gold warehouses went bust because they could not compete with a sweet deal like that. So the bank lends out the money on the long term to borrower and are able to charge a lower interest (than regular long time lenders). So the bank makes money on the spread between the interset it pays to the savers/lender and the borrowers. This whole scheme, of the bank borrowing short term money that has to be repayed on request.. and lending it out on the long term that will not be repayed on request, works because as a whole, statistically, many short term savers works as one long time lender. Savers rarely take out all their money. People more often keep their money with a bank than carry it around in a wallet. As long as the bank does not brake its contract of redemability on request, it has not doen anything wrong.
You see, fractional reserve banking is a win win situation. Savers dont have to pay a fee, lenders can loan out money on the short term instead of on long term. Borrowers can loan out money for a smaller fee. Lots of economic progress could not have been doen as quickly, if it had not been for this wonderful market invention. Seriously, we all benifit. If you have a good business idea you can start up a profitable comnpany by getting a loan. You dont have to pay cash for your house.. you can easily get a relatively cheap mortage. You dont have to pay a fee to keep your money safe. etc. It works remarkably well. Most banks are over a hundred years old.
It only works however as long as borrower are able to pay back the money and the interest. So bank have to be careful who it lends out the money to. It can lend out money to risky borrowers as long as it charges a big interest on those loans., that way if one risky borrower is not able to repay, it is compensated by the ten risky borrowers that did.. and who paid the high interest fee.
This system works fine even without a central bank.. or without any paper money. Remember all that i have described so far is fractional reserve banking in a gold coin system. The banks have little or no reserves. It lends out any money that it has borrowed, it keeps little or no reserves, thats the whole point of a bank.
If the bank is badly run and it borrows out money at a low interest to risky borrowers.. well then it will not be able to repay the depositors on request and it will have broken its contract and trust. It will go bankrupt. The savers will loose some of their money. A central bank can bail out the savers by covering the banks losses. Its the bailing out of savers by the govt that is wrong, not fractional reserve banking,
You fractional reserve banking makes lenders out of savers. Borrowers abviously benifit, and savers benifit by getting payed interest. The reason why there are no money warehouse around anymore is because savers rather saves their money with a bank that pays them interest, rather than with a warehouse that charges them a fee. Its a free market thing, warehouses got competed out of existance.
DriftWood:Its a free market thing, warehouses got competed out of existance.
A bank crash is a big concern for consumers -- that's why banks used to take reputation seriously, and used to build imponent buildings to demonstrate how well they were doing -- so I think that without government protection, you'd still see some warehouse-like banks, or at the least low-interest but high-reserve offerings.
Anyway, thanks for the explanation. I guess that nowadays banks concerns over risk is just to maximize profits, not because they are concerned about losses, since they will just be rescued, right? If a bank gets robbed is it also rescued? Here, I've seen only once a bank loss because they bought another or something. Usually, they are always growing and growing. Other than the fixed costs, when can they actually lose money?
About the only way a bank can loose money is if they calculate the risk involved with borrowers wrong. Interst is the price of borrowing money. So if they start charging the same interest for high risk borrowers, like a homeless junkie, the same price as they charge low risk borrowers like some big company.. then they are asking for trouble. Thats what they did with the current subprime mess. I remeber seeing lods of adds on TV.. "Cant get a loan? We will give you one, no questions asked. Only 7% interest." When noname banks on TV shops starts selling loans.. well we should have known *** was about to hit the fan.
So what happens with all those depositors when a bank fails? Well they can sue the bank for contract violation, when they cant repay the money on request. Somewhere in the contract you signed when you opened up your deposit account its, said something like we promise to repay you your money on request. However nowhere in the contract does it say what the bank can do with the money in the meantime. To be honest, you dont care what they do with it aslong as they have it when you request it. so after the bankrupcy court.. you probably still wont get all your money back.. because they lost it already.. the govt might be tempted to pay you back the difference but this is really bad. If they keep doing that.. banks will start loaning money out on the cheap to homeless junkies, because they dont care if the borrower is able to repay the loan or not, as long as the govt pick up any loss.
Well back to it.. I think the biggest reason people have got the idea that fractional reserve banking is evil.. is because of this idea of the "money multiplier". Yeah we all heard about it in that movie.. "money as debt". The reasoning goes something like this: "Did you know, banks loan out 50 times as mouch money as they have in the reserves?" That sure sounds like banks are multiplying money, that they are creating money out of thin air. And if they can create 50 times as much, why not a thousand, or a billion? It sounds like there is no end to the madness. The govt should regulate this abomination now!
Well the reasoning sounds reasonable but isnt.. there is no connection between the size of the reserves and the amount of loans a bank has made. The reasoning should be "Did you know that a bank lend out 98% of the deposited money". This might still sound abit scary, but it is clearer that there is a limit, and that there is no money creation invloved. A bank can not lend out more money than people deposit with it. So at most it can lend out all of it, thats the limit. After it has lent out all the money, it cant lend out any more. It cant create any money. Looking at it this way and you might start to realize that maybe fractional reserve banking is not such a evil thing after all, and that the govt does not need to regulate it.
A banks that lends out to high risk borrowers, will have to have a big reserve.. to guard against lots of defaults. A bank that only borrows out to millionaires.. and profitable companies.. well it needs little reserves. And if a bank found itself short of reserves.. and people who demanded their deposits out. Well the bank could raise money by selling its assets. What assets does a bank have? I has lots and lots of people that pay interest on their mortage every month. Its basically got lots of bond that pays 6% interest. It can sell enough of those to raise money.
As long as a banks borrowers are sound.. a bank will be able to survive a bank run. Only badly managed banks have to worry about bank runs.
You do agree though that government protection allows banks to keep far less money on reserve than what would prevail on a market, right? And it is still the case that government-aided FRB is a form of price control, setting the price too low in most cases.
-Jon
Freedom of markets is positively correlated with the degree of evolution in any society...