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Questions regarding 100 percent reserve banking

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CommSense posted on Mon, May 10 2010 12:19 AM
I consider myself a Rothbardian in everything except in regards to banking and his advocacy of 100 percent reserves. I've been torn for quite some time (although i gave up on the debate a while ago) between free banking v. 100 percent reserve banking. If anyone could point me in the direction of some convincing 100 percent reserve or free banking literature that'd be great. Thanks.
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Conza88 replied on Mon, May 10 2010 10:25 AM

http://mises.org/journals/aen/aen11_2_1.asp

AEN: What area of Austrian economics is most and least advanced?

MNR: Methodologically, we are pretty advanced, thanks to the work of Hoppe. But we can always use more since that is what sets us apart from the rest of the profession. And Salerno is doing great work on calculation.

Banking theory, however, has taken a very bad turn with free banking. We have to show that this is the currency and banking school argument rehashed. They have adopted the banking school doctrine, that the needs of business require an expansion of the money supply and credit. Moreover, the free banking people violate the basic Ricardian doctrine that every supply of money is optimal. Once a market in a money is established, there is no longer a need for more money. That is really the key point.

AEN: What about the argument that 100% reserves requires government intervention?

MNR: I regard fractional-reserve banking as an intervention in the free market, just as any crime against person and property is intervention. In the case of banking, the government is allowing the crime to be committed.

But how do we address the needs of trade argument, those who say that business has a demand for credit? Well, there are many things demanded on the market that are also crimes. There may be a demand for killing redheads. And there is certainly a demand for government loot. What's so great about market demand? if it is not within a framework of non-aggression, there will always be a demand for fraud and theft.

The free bankers accept a kind of David Friedmanite anarchism, where there is no law, only people engaging in exchange and buying people out. If you have a group that wants to kill redheads, the redheads will have to buy them off if they value their hair. I think this is monstrous, the kind of anarchism would indeed be chaos. Just because there is a demand for something doesn't mean it should be fulfilled.

AEN: One of the criticisms of this position is that it is normative and not economic.

MNR: Yes, but the response to 100% reserves is that bank entrepreneurs have the right to offer whatever fraction of deposits they want, which is also a normative position. Any discussion of policy is inherently normative. You can't have free markets unless you have property rights,

AEN: Why isn't private deposit insurance viable?

MNR: The same reason insuring any bankrupt industry isn't viable. You cannot insure entrepreneurs because they engage in uninsurable risk. You can reasonably predict how many fires there will be in New York; the unlucky few who get burned can dip into the pool of resources. But entrepreneurship is not heterogeneous; it is completely unpredictable, and each attempt is non-random. The entrepreneurs assumes the risk. If an insurance company insures it, it becomes the entrepreneur. Who then insures the insurer? In the case of banks, either they don't need insurance, since they are 100% covered, or they are uninsurable because they are taking entrepreneurial risk.

AEN: You have been critical of White's book on free banking.

MNR: The White book says the Scottish banking system was more successful than the English system. But he doesn't say one word about prices, inflation, or business cycles. His only statistic is that were fewer bank failures in Scotland than Britain. But what's so great about not having failures? An industry that doesn't have failures might be doing poorly. What if we applied this test to the Soviet Union, where no industries fail?

When you say one banking system is more successful than another, it seems the test should be less inflation and fewer business cycles. Yet this is never mentioned.

Ron Paul is for self-government when compared to the Constitution. He's an anarcho-capitalist. Proof.
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Sage replied on Mon, May 10 2010 9:05 PM

There was a couple of debates in the Independent Review:

Has Fractional-Reserve Banking Really Passed the Market Test? By Jörg Guido Hülsmann

Accounting for Fractional-Reserve Banknotes and Deposits—or, What’s Twenty Quid to the Bloody Midland Bank? By Lawrence H. White

Should We Let Banks Create Money? By George Selgin

Banks Cannot Create Money By Jörg Guido Hülsmann

AnalyticalAnarchism.net - The Positive Political Economy of Anarchism

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Answered (Not Verified) C replied on Mon, May 10 2010 9:11 PM
Suggested by wolfman

I would say free banking is 100% reserve banking.  Fractional reserve banks are inherently insolvent.  In a free market without a central bank, fractional reserve banks would just collapse.  People would eventually get the hint that putting money in a fractional reserve bank is the equivalent to flushing it down the toilet and would start putting their money in full reserve banks.  Eventually, only full reserve banks would remain.

I don’t think it is necessary to lock up fractional reserve bankers for fraud in order to transition to full reserve banking.  Although I certainly wouldn’t be opposed to it. 

  At least he wasn't a Keynesian!

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Answered (Not Verified) Selgin replied on Tue, May 11 2010 6:47 AM
Suggested by Selgin

Chris,

Larry White and I have written many articles on the subject. There's a failry comprehensive list, together with one of articles on the opposing side, at https://mises.org/Community/forums/p/5186/69448.aspx.  I have recently written an article specifically addressing the matter of the origins of FR banking, called "Those Dishonest Goldsmiths."  You can download it at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1589709.

Pay no attention to the sort of shrill outburts you see on this page and elsewhere to the effect that fractional reserve banking is fraud, or that fractional reserve banks are necessarily insolvent.  The claims reflect a very poor understanding of the nature of banking contracts.  They also suggest ignorance of' the long history of successful FR banking systems that operated on very small reserves, to their customers full satisfaction and with very great benefits to the economies they served.  Adam Smith, for one, got this write.  (And no, Smith wasn't a statist, as Rothbard tried to claim.)

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Answered (Not Verified) C replied on Tue, May 11 2010 7:39 AM
Suggested by Selgin
I've read your articles and I don't find them convincing at all. Of course fractional reserve banking could be done legitimately with contracts, but that doesn't explain how a FBR would avoid collapse when a large percentage of customers try to reclaim their deposits at once. Presently, the central bank prints money and bails out banks in this predicament. There would not be a central bank in a free market to perform this function, therefore I would put forward that informed consumers combined with occasional failures of FRBs would lead to a full reserve system.

  At least he wasn't a Keynesian!

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Selgin replied on Tue, May 11 2010 8:01 AM

Chris,

I don't think you can have read, for example, my article "In Defense of Bank Suspension," whioch addresses the question of how nt banks can contractually handle mass runs.   But in any event, why suppose that a banking system isn't any good justeecause it cannot handle a very unlikely event?  A freekishly big snowstorm would cause many roofs to collapse. Would you therefore condemn the buildings in question?  In economics, we don't generally treat as optimal only those arrangements that reduce the risk of failure--even catastrophic failure--to zero.  
 

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z1235 replied on Tue, May 11 2010 8:13 AM

Chris, +1.

This case is closed, as far as I'm concerned. Selgin's defensive demagoguery notwithstanding, the question about "Free" Banking becomes increasingly less about its legality (i.e. contract fine prints related to depositor's awareness/acknowledgment that they "allow" for their money to be lent out while still expecting immediate liquidity) and more about relevance and/or necessity. As I said in a recent thread on the subject:

http://mises.org/Community/forums/p/16302/329704.aspx#329704

It still boggles my mind that a whole movement has been perpetuated TODAY around such an archaic, bizarre and completely unnecessary concept as Free Banking. If I 'demand' money, I can either (1) earn/make it, (2) sell something I own in return for it, or (3) borrow it from someone else who's saved it and is willing to lend it to me at interest. With advancements in technology and finance, it is getting exponentially easier for market agents to manage their capital allocations between cash (immediate liquidity) and investments (loans, bonds, stocks, funds, etc.). As markets in an increasing number of such instruments become increasingly liquid and developed it is becoming ever easier to change the duration and nature of one's investments (e.g. Sell a 10yr Greek bond to buy a 3month US bill, a 6 month Ford commercial paper, a share of IBM, and keep the rest in cash). If one's too stupid to do this on their own, there are professionals that can do it for them, for a fee. 

Why on Earth would anyone need a bank in this day and age, and a fractional reserve one, no less? Without central banks at the cartel's core, banks would most likely go the way of the Dodo, as new entities appear to match the preferred duration, nature, and risk profile of REAL savings with the economy (business) that seeks them.

Z.

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C replied on Tue, May 11 2010 8:43 AM
Selgin:

Chris,

I don't think you can have read, for example, my article "In Defense of Bank Suspension," whioch addresses the question of how nt banks can contractually handle mass runs.   But in any event, why suppose that a banking system isn't any good justeecause it cannot handle a very unlikely event?  A freekishly big snowstorm would cause many roofs to collapse. Would you therefore condemn the buildings in question?  In economics, we don't generally treat as optimal only those arrangements that reduce the risk of failure--even catastrophic failure--to zero.  
 

I'm not sure how you can say a collapse of a fractional reserve bank is a very unlikely event. It happened all the time pre-fed. And I would say it would happen all the time again if the fed was eliminated.

  At least he wasn't a Keynesian!

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Maybe you should take a course in money & banking. It's cool though, Dr Selgin teaches on I believe. 

"You don't need a weatherman to know which way the wind blows"

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I. Ryan replied on Tue, May 11 2010 10:20 AM

Selgin:

Smith wasn't a statist[.]

Huh? How was he not a "statist"? What are you defining that word as?

If I wrote it more than a few weeks ago, I probably hate it by now.

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z1235 replied on Tue, May 11 2010 11:05 AM

hayekianxyz:
Maybe you should take a course in money & banking. It's cool though, Dr Selgin teaches on I believe.

Judging from your constant, yet vacuous, appeals to authority you have a problem understanding the very concepts of learning and knowledge acquisition. For you, it seems, they're nothing more than cataloging what other people (more "prominent" and "respected" than yourself) have said on any matter. Try thinking with your own head for a change -- it's very liberating. 

Z.

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Mr. Seglin, I am curious. Here is what I understand on the fundamentals of money and banking, and I am curious if you could tell me if I err in my understanding of money and banking in any particular respect. I imagine it's one of the most heavily contended things in the subject of economics, because the various modern heterodox schools have entirely different perspectives on it. Reading more books on money has led to me revise what I learnt from previous books in school or otherwise, and I am sure there is more I need to learn. Please remember that I am only a layman.

- Money is just a commodity that emerges in the free market compeitition of various commodities as the most marketable commodity.

- Money has otherwise no effect on allocation of scarce resources, because other resources will still remain scarce, and its scarcity of resources that determine their allocation, and not the supply of money.

- Monetary interference can still be used for redistributing resources, because currency debasement by Moors and Christians in Spain helped enrich monarchs in physical wealth faster than the peasantry.

- The banking system is essentially a secondary substitute for money, to provide ease and honesty in large transcations.

- Credit by banks is thus a means of increasing money supply, but it never matters what the supply of money is, when other resources are still scarce.

- Financial institutions that offer credit generally prefer to work on a system where they encourage people to make longer-term deposits, and use them to make shorter-term loans.

- The reason for the above is that rise in interest rates would otherwise reduce net interest income, and create financial risks from asset/liability mismatch.

- Banks, on the other hand, use short-term desposits to make long-term loans. They are more attractive for people as they involve tieing up cash for shorter periods.

- Essentially, interest rate risk management is greater in a non-banking financial institution than a bank, and thus banks are an otherwise riskier business that stand to lose more than FIs.

- However, since banks are insured by the government and get loans from them, they can pass of the burden of such risks to the taxpayer and inflationary monetary authorities, and thus so to all of us.

- Banks, under the current government protection, thus not only misallocate scarce resources in society, but also in a situation where their credit transactions are a risky business that have caused problems to depositors and have resulted in bank-runs in the past - a situation prevented by the misallocationary system mentioned in the previous point.

Certainly, I would not object to a simpler system of having only strict fixed deposits in financial institutions for my savings and having banks for only taking deposits and facilitating transcations.

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