Fractional reserve banking question

meambobbo:

Yall need to cut Histhasthai and Driftwood some slack.  They are essentially correct.

They are ethically correct. But there is a hugely important point about why fractional-reserve banking is praxeologically impossible on a sustained basis absent fraud or coercion. Anonymous Coward pokes at it in his most recent post to this topic with his point about fractional-reserve bank notes being an arbitrage opportunity. But I think I have one more way to make the point, based on why I think people think fractional-reserve banking can work.

Warehouse receipts for gold can trade in place of gold because someone paid the warehouser to store the gold. They effectively paid for the service of redeeming that warehouse receipt for gold. Let's call this the 'redemption service' associated with the warehouse receipt. The value of a warehouse receipt includes more than the gold it represents. It also includes the value of this 'redemption service.' Not everyone will think this 'redemption service' is worth the risk of not accepting the gold directly. But some will under some circumstances based on the trust they place in the issuer of the warehouse receipt and convenience of dealing with the receipt in place of the gold.

People who think fractional-reserve banking can work think this warehousing fee can simply be replaced with the income generated from lending out some portion of the contents of the warehouse at interest. But here's the important point: In the case of the warehouse receipt, the person trying to use the warehouse receipt as money has already paid for the 'redemption service' up front. The person receiving the warehouse receipt does not pay for this redemption service in the form of risk, and is thus more likely to accept the warehouse receipt in place of the gold it represents.

Okay, now let's talk about checking accounts. What the defenders of free-market fractional-reserve banking really seem to be talking about is checkbook money. That is, a bank offers to 'store' your money, but really pays you a fee for the lending opportunities you have given the bank by 'storing' your money with them. You 'redeem' checkbook money by writing a check. But here's the thing: checkbook money doesn't really function as money unless and until the check is cashed and the bank pays for the 'redemption service' either by directly redeeming the check for gold, or indirectly, by paying for the warehousing of gold itself. People only accept a check in payment for something based on their confidence that the bank will be able to successfully pay for this 'redemption service.' In a free market, paying for something by check will be far less common. It will only happen in the case where the person or institution receiving the check trusts both the person offering the check and the institution responsible for redeeming it. And as I alluded to earlier, a competing bank will redeem such a check as absolutely quickly as possible, because it will reduce the competing bank's cash on hand and increase its own.

The point is that in the case of both warehouse receipts and checkbook money, the agent who wants them to serve as money has to pay for their 'redemption service' up front.

 

Fractional-reserve banking implies that either checkbook money be treated as money, or that bank notes be treated as money. But this in turn implies that the person receiving the check or the bank note be burdened with the cost in tems of risk of the 'redemption service' associated with the check or the note. Praxeologically, the check or the note will never trade at face value against the 'real' money it supposedly represents, and consequently will never displace that 'real' money as money

This is such an important point because, as you allude, the bankers will pretend that the role of government is to police this supposedly natural and legitimate market phenomenon, when in reality the role of government is to make it work (by coercion) in the first place.

meambobbo:

I believe Mises himself wanted to allow competitive FRB, as he thought that was the only means to keep banks from keeping insufficient reserves.  100% reserve requirement would mean the government could just as simply litigate a 50% or a 1% reserve requirement...then bail them out with tax money if they faced a bank run.  If the market were in charge, individuals would manage the risks and rewards of FRB in the case of individual competing banks.

Yes, the most important thing is that banking and government are separate, but I hope I've finally explained that if the market were in charge, individuals would manage FRB out of existence

meambobbo:

And bank werehousing still exists, if you want to do that instead of time deposits, fractional reserve demand deposits, or physical possession: they're called safety deposit boxes.

Safety deposit boxes are not a good analogy for bank warehousing. 'Digital precious metal operators' are, and the government is doing everything it can to make those illegal.

 

I confess that after reading 120 posts I still don't understand how fictional reserve banking works.

I gave up on this discussion.  It felt like someone was squeezing my head like a grape.

 

The way i see it, the different types of gold deposit notes, are really just different type of gold debt instruments. Either the bank owes and stores gold directly in wich case the debt is only between you and the bank. Or the bank trusts the gold to some 3rd party, in wich case the debt is still between you and the bank, but there is also a debt between the bank and the 3rd party. You could probably use both of these gold debt instrument in trade, an their  value would be close to that of gold, if the traders trusted that the bank actually owned or could easily get the gold needed to exchange the gold debt into real gold.

Anyways, im going to pimp "that site" once more. I read the book "Gold: the once and future money" and it really changed my mind.. about how all this money and banking stuff works. The author on his blog can be a bit rude and "takes a piss" out of austrians at times.. but dont let that distract you. Here are a couple of posts that in some sense relate to this thread.

"Does Debt Creation Cause Inflation?"

http://www.newworldeconomics.com/archives/2006/030406.htm

"Fractional Reserve" Banking

http://www.newworldeconomics.com/archives/2006/070906.htm

 Different Kinds of "Money"

http://www.newworldeconomics.com/archives/2007/090207.html

The "Money Multiplier"

http://www.newworldeconomics.com/archives/2007/102007.html

etc..

Cheers

I think the only thing getting the piss taken out of it is people's patience...

Money, properly identified as base money, is not created in the lending process, but by the central bank.

...

Inflation is caused by a decline in currency value, measured in an absolute sense, which is done by comparing the value of currencies to gold. If there's a decline, you've got some sort of inflation. No decline, no inflation.

Today, of course, banks do not print money. Central banks "print" the money, but do not make loans, while banks make loans, but do not print money. However, given this historical precedent, it is not too hard to see how a careless sort of analyst could accuse banks of "inflating the money supply" by "making loans," all of this because the bank was a "fractional reserve bank."

This was a time when commercial banks were engaged both in credit creation and money creation, oftentimes in a single act...  This confusion is what gave rise to the idea that credit creation is a type of money creation, and since we know that excessive money creation leads to a loss in monetary value, i.e., inflation, well, danger danger!

All monetary transactions take place with base money, which is literally coins or bills, or bank reserves. (There is another point of confusion here in that a redeemable bill does have a counterparty, in the sense that the issuer is legally required to deliver bullion on demand. For our purposes, since there is little real difference between a redeemable bill and an unredeemable one as long as base money supply is being properly managed, we will consider them the same and both forms of base money.)

Ok, that's the gist of the argument.

Oh, and that a bank deposit is really a loan to the bank, not a 'demand deposit', and so can't be considered as 'money in the bank' for economic calculation purposes.

This is probably why Mises uses the term 'fiduciary media' so strawman arguments such as this don't topple the whole of Austrian economic theory. But I suppose you and your favorite economists already knew that and took it into account when posting the same old circular arguments over and over.

In Mises' own words;

In issuing fiduciary media, by which I mean bank notes without gold backing or current accounts which are not entirely backed by gold reserves, the banks are in a position to expand credit considerably. The creation of these additional fiduciary media permits them to extend credit well beyond the limit set by their own assets and by the funds entrusted to them by their clients. They intervene on the market in this case as "suppliers" of additional credit, created by themselves, and they thus produce a lowering of the rate of interest, which falls below the level at which it would have been without their intervention.

I have a question: why is it that all these guys, a lot of them cranks, try to take the "piss" out of the Austrians? What do they gain from it? Personal satisfaction? Are their lives really that pathetic? Poor silly little jokers. I'd say maybe Austrians should also adopt such puerile behaviour, but it'd be degrading. I find it humorous, seeing as a number of Austrians themselves advocate free banking. From this entire argument, I've seen nothing that disagrees with the Austrians on their core theories, only disagreement on whether FRB is correct or not. So why he feels the need to "take the piss out of the Austrians" is beyond me. What is perhaps more humorous is that no effort is made to separate fiat FRB from the free market proposed alternative. Personally I have no problems with free banking, but I do have problems when fiat money is conflated with it and treated as equally unproblematic.

-Jon

DriftWood:

The way i see it, the different types of gold deposit notes, are really just different type of gold debt instruments. Either the bank owes and stores gold directly in wich case the debt is only between you and the bank. Or the bank trusts the gold to some 3rd party, in wich case the debt is still between you and the bank, but there is also a debt between the bank and the 3rd party. You could probably use both of these gold debt instrument in trade, an their  value would be close to that of gold, if the traders trusted that the bank actually owned or could easily get the gold needed to exchange the gold debt into real gold.

Economics is not merely about getting the accounting right. The one thing the Austrian School understands that way too many other people don't seem to understand is that economic phenomenon is, at its core, the product of people acting to attain ends.

Just because a piece of paper represents some kind of claim on gold doesn't mean it will function as money in place of gold, which is what fractional-reserve banking presumes. A piece of paper may represent a legitimate contract that says the bank must pay you gold under some described circumstance, and consequently that piece of paper may have genuine value in the market place. But value alone does not determine what will function as money in the marketplace.

A piece of paper representing a claim on gold stored in a warehouse will only trade in place of gold under very specific circumstances. A piece of paper representing a mere promise to pay gold is so profoundly different than actual gold that the chance that it will trade in place of gold as money is vanishingly small. I mean, be honest with yourself. If you're trying to sell something to someone, and one person offers you a one-ounce gold coin, and another person offers you a piece of paper issued by a bank you may or may not have heard of that represents a promise to pay you gold that you know they may or may not have at the time, which are you going to accept?

From the first article DriftWood cites:

"If, for some reason, the legal obligation to redeem these possibly excess banknotes into gold (typical in the 19^th century) could be avoided in some way, as was common in the Western and Southern states in the US for example, then the banknotes would lose value compared to their gold parity and the situation would become inflationary."

This is completely wrong. The bank notes didn't lose value because a person was less likely to be able to redeem them for gold. They lost value because there were more of them bidding for the pool of goods and services that existed at the time. That's why fractional-reserve banking is always inflationary in the sense that prices are always higher than they otherwise would have been. Prices may stay steady during expansion of the money supply, as they did in the 1920s, but all that this means is that without expansion of the money supply, prices would have gone down to reflect the fact that there were more goods and services for that money to bid for.

More from the article:

"Many people today claim that debt creation causes an increase in the 'money supply,' although this is incorrect. Money, properly identified as base money, is not created in the lending process, but by the central bank. Central banks can create base money, but not debt (unless they use the discount window perhaps, which is extremely rare). Commercial banks (and all other lenders or issuers of bonds) can create debt, but not base money. As we noted two weeks ago, most measures of "money", such as M2, M3, or MZM, are in fact measures of cash-like debt. So, to say that debt creation creates debt (M2, M3, MZM) is not very interesting."

This completely ignores the fact that when a bank hands you a Federal Reserve note, you have no way of distinguishing whether it is "base money" or whether it is debt-backed money. And this is by design. Fractional-reserve banking requires that someone who accepts a bank note either not know whether it represents a title versus credit (because of fraud), or not be allowed to distinguish whether it represents a title versus credit (because of legal tender laws).

When people are able to distinguish between a title to gold, and credit to be repayed in gold, the latter will not function as money, and consequently fractional-reserve banking will not happen under free-market conditions.

 

I didn't bother to read the rest of the articles.

Says Mr Lewis :

"When certain nominally "Austrian" types want to get all medieval on you, they start to talk about "fractional reserve banking," which is an antiquarian term for what we now call "banking." Banks today (and for the last few centuries) are intermediaries: they borrow from depositors and make loans to borrowers, and pocket the "spread" between the two interest rates."

I wonder what's a 'nominal Austrian' ? What is to 'get medieval' ? Oh he admits that the current system is FRB ? But then claims FRB is not really FRB but a legitimate system to channel real savings ?

What puzzles me a bit is that his book seems to have been published by Bill Bonner's company...

Juan, there is no such thing as fictional reserve banking - even our fiat money is backed by something (although far not enough so maybe you're right).  It is backed by the federal government's ability to tax our future economy.  That's what backs the debt it sells to the FED in return for new money...and that new money backs all the fractional reserve banking of the FED's members.

This is essentially where things like fractional reserve banking and fiat banking are villified.  Some debtor cannot pay his debt, and that debt gets put onto people who had nothing to do with it.  This is not true with investments and loans funded by genuine credit - ie, claims on real goods already produced, as the risk is inherent in the loan.  In that artificial credit is created on the contention that some future real goods will be produced, it is unlimited by current wealth, and when institutionalized as in America and most of the world through central banking, it only means that everyone's wealth is on the line.  This inherent risk that can be passed onto 3rd parties is a tremendous violation of free market principles, and I believe this is why Austrians are so hateful towards these practices.

I would like to qualify that while I said fractional reserve banking, in and of itself, was not a bad thing, I meant it in the sense that banks practicing such could not be bailed out with artificial credit/money and were fully policed by the market without protection of the government.

FRB is an "antiquarian" term? My econ textbook uses it, and it's not even Austrian. What is this guy on about? I still want to know whether FRB as practised by the government is legitimate or not, and whether it differs from FRB as practised in a free market, because it is the former the Austrians focus on, and it has repeatedly been asserted by Driftwood that the Austrians are "wrong" on FRB (perhaps some are wrong that FRB is inherently fraudulent, but that is neither here nor there with regard to the current governmental FRB system) - but I see these links reference banking as it is now, which is not free banking. Sounds like sheer nonsense to me.

-Jon

Juan, there is no such thing as fictional reserve banking - even our fiat money is backed by something (although far not enough so maybe you're right).

But that's exactly the nature of fraud. There can be no fraud if a minimum of 'backing' and 'faith' are missing. That is, the system seems to work - indeed does work for a time...until it breaks down because some of the 'promises' can't be kept.

If I want to cheat somebody, I need to build some 'trust' first. And to do so I must act in a legitimate way...for a time. Now, when my victim has lent me enough money, I can default on my obligations.

Some debtor cannot pay his debt, and that debt gets put onto people who had nothing to do with it. This is not true with investments and loans funded by genuine credit - ie, claims on real goods already produced, as the risk is inherent in the loan.

Right, but that's not FRB - that is 'ordinary' banking ? I think that calling the system based on genuine credit FRB is causing at least part of the confusion in this thread ? Or perhaps there's more than one claim per good ? In that case we have indeed FRB...and problems.

I would like to qualify that while I said fractional reserve banking, in and of itself, was not a bad thing, I meant it in the sense that banks practicing such could not be bailed out with artificial credit/money and were fully policed by the market without protection of the government.

I think we agree that FRB shouldn't be banned, and that FRB can be wholly 'contractual'. Still it will not work. As a matter of fact. it didn't work and that's why FR bankers came up with central banking.

meambobbo:

Juan, there is no such thing as [fractional] reserve banking - even our fiat money is backed by something (although far not enough so maybe you're right).  It is backed by the federal government's ability to tax our future economy.  That's what backs the debt it sells to the FED in return for new money...and that new money backs all the fractional reserve banking of the FED's members.

[...]

This isn't what 'backs' Federal Reserve notes. I know it's the 'official' story, but as stated it doesn't even really make any sense. Why would the government's ability to demand magic tokens from taxpayers in the future to pay back the magic tokens it borrows now (created out of nothing by the Federal Reserve) in any sense "back" them? We're supposed to think that the Federal Reserve is merely a manifestation of some collective decision we as a society have made that 'dollars' serve as money.

But it's a massive con job.

Federal Reserve notes are valuable because if you don't come up with enough of them to pay your taxes, the government with take your stuff and throw you in jail. This makes Federal Reserve magic tokens extremely valuable, and what make it possible for them to serve as money in place of the gold they once represented. Turns out this trick is an old one:

http://www.kitco.com/ind/saville/jun202006.html

And the difference between fractional-reserve banking and 'mere' banking is that when you lend your gold to a 'mere' bank who further lends it out to someone else to collect interest on it, the piece of paper they give you that says you lent them your gold isn't traded as money in the place of the gold it supposedly lays a claim on. In a free market, there's no reason to think it would any more than any other I.O.U. It really isn't that complicated were it not for all the nonsense spewed out to obfuscate the issue.

 

Juan, I am not sure I understand what ordinary banking is by these terms.  If I put 1 oz of gold in the bank, and they lend out .5 oz, that's fractional reserve banking, but they're using real wealth to make their loans.  The bank doesn't want to cheat anyone (well, maybe those wildcat banks...).  It may become insolvent, which would happen quickly if it had to maintain trust in the face of competition while operating at low reserves and making risky loans.

Otherwise, I completely agree with you.  We have to be clear, however, that there is a difference between fractional reserve banking and issuing unbacked bank notes.  FRB, in using real wealth, is limited in issuing credit until it holds a 0% reserve.  Unbacked notes have no limit.

meambobbo:

[...] If I put 1 oz of gold in the bank, and they lend out .5 oz, that's fractional reserve banking, but they're using real wealth to make their loans. [...]

Whether this is fractional-reserve banking depends entirely on the piece of paper they hand you in exchange for depositing the gold with them. If they give you a certificate of deposit, it is not fractional-reserve banking.

meambobbo:

[...] We have to be clear, however, that there is a difference between fractional reserve banking and issuing unbacked bank notes. [...]

Fractional-reserve banking is by definition issuing unbacked bank notes. An outstanding loan does not "back" a bank note.

 

Unbacked bank notes is not the same thing as FRB, in my mind.  FRB can involve bank notes, and can involve artificial credit and fraud, but I don't think it has to.  FRB, when using only genuine credit, does present a situation where bank runs will happen and depositors can be screwed.  However, the bank should always have a balance sheet that has more reserves and debt-based assets than liability to depositors.

Issuing unbacked notes seems much more fraudulent and risky.  It is now doing, as you said, demanding to be paid back in its own tokens, whose value in real goods are being devalued relative to the gold they are supposedly worth.  In this sense, because they are the only institution who will trade the tokens for gold, their debt-based assets, loans of fraudulently created bank notes, cannot be truly measured in the terms of the true reserve: gold.

I think the free market would accept the first form, where banks only lend out a finite amount of credit, based upon the real wealth they have on deposit, without creating any artificial credit.  Using unbacked notes as a replacement currency seems silly to me, and I doubt such a practice could ever work without strong government interference.  Most likely all such institutions would be fly-by-night types and avoided by the general public.

meambobbo:

Unbacked bank notes is not the same thing as FRB, in my mind. [...]

You're just trying to redefine what it means for a bank note to be 'backed.' Fractional-reserve bank notes are bank notes that are supposed to be redeemable on demand, but are only fractionally-backed by reserve deposits. Fractional-reserve bank notes are by definition at least partially unbacked.

Someone may hand you an IOU for money you give them, but if they do anything besides contractually store that money for you, your IOU is still only an IOU. Different people and institutions might be more or less deserving of credit, but it's based on how likely they will be to pay back that debt, not what they specifically do with it. Your entirely artificial distinction between 'genuine' credit and presumably 'non-genuine' credit does not magically turn unbacked bank notes into backed bank notes. I don't care how credit-worthy the issuee is. Credit is credit. Absent fraud or coercion, credit and bank notes are two entirely different things and the market will treat them like two entirely different things.

In other words, what you have to explain is this: Why on earth would an actual, typical human being in the real world take an IOU and expect to be able to spend it at face value to buy beer and pretzels at the local convenience store? It simply ain't gonna happen. Don't believe me? Try it for yourself. And keep in mind that Federal Reserve notes are not IOUs. They are stay-out-of-jail tokens. There's a big difference.

meambobbo:

Juan, I am not sure I understand what ordinary banking is by these terms.

By 'ordinary banking' I mean a system which helps lenders and borrowers to get in contact, so that lenders can lend real savings using some sort of timed contract. Say I lend you my bicycle for a day. Or I lend you 100,000 GO worth of high-tech equipment for five years. Or I lend you a specified amount of commodity money for you to do whatever you please. In this system no 'magic tokens' are involved and bankers act only as middlemen. Yes, bankers can borrow from me at 5% at lend to you at 6% and pocket the difference. I think that's what banking is all about.

If I put 1 oz of gold in the bank, and they lend out .5 oz, that's fractional reserve banking, but they're using real wealth to make their loans.

True. But, is your 1 oz available to you on demand ? Well, it can't be because half of it has been lent. Yes, maybe you signed a contract that says that your money is available on demand but if somehow is not, then you get a timed deposit. Fine, I see no 'formal' problem with that, but on the other hand I don't think such a contract makes sense.

You can deposit money and expect it to be always available on demand. The only way in which that can happen is if the bank keeps full reserves. OR you can deposit money for a definite period, in which case the bank can lend it knowing that no 'coordination' problems can arise.

Now FRB seems to be a mix of the two. But does such a system make sense ? Under FRB, deposits are contractually available on demand, BUT there's a very real chance that they will 'magically' morph into timed deposits. If the bank keeps 50% of reserves, then I would say that the probability of your deposit being available on demand is only 50%. As LibertyStudent said, this sounds more like lottery than banking. Yes, if you like such a mix of lottery and banking, then you are free to use such a system and FR bankers are free to provide it, but as a system, it doesn't make much sense, to me at least.

Juan:

[...]
Now FRB seems to be a mix of the two. But does such a system make sense ? Under FRB, deposits are contractually available on demand, BUT there's a very real chance that they will 'magically' morph into timed deposits. If the bank keeps 50% of reserves, then I would say that the probability of your deposit being available on demand is only 50%. As LibertyStudent said, this sounds more like lottery than banking. Yes, if you like such a mix of lottery and banking, then you are free to use such a system and FR bankers are free to provide it, but as a system, it doesn't make much sense, to me at least.

So this seems to describe the way money market accounts could in theory work under free-market conditions—albeit in some heavily restricted form. And I could imagine being able to write checks on such accounts. The unstated, but real goal behind fractional-reserve banking is the ability to effectively 'lend' gold to more than one person at a time, to make more interest than they can when money is restricted to one owner at a time. Money market accounts don't accomplish this, which is why what they really want is fractional-reserve bank notes in particular. Of course this is something you or I as private citizens would never be allowed to get away with.

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.

Well, I would say you just decribed a criminal act of counterfitting :-)

Fractional banking is not if someone lends a bank money for a profit and a certain time in which the bank can make use of the money at its preference.

In fact, banks offer different services that can not be placed into one big bag and handled as if it was the same thing. The criminal thing is that banks loan out money that is redeemable on sight. Which is true for your checking account,no? If you put money in a checking account, you sure belief that you can redeem it any time you want. So in principle the banks stores your money for you. You do not give it to the bank and agree that the bank can loan it out to someone else. This is what you argree upon when you open a savings account. Here, you can not withdraw all your money at once, but you have to keep a certain amount of it at the discretion of the bank.

But what fractional reserve means is that only a fraction of the money a bank agrees to be redeemable any time, is held actually in store, while the most part is loaned out and could never be used to redeem all of the customers with checking accounts if they would ask to redeem all at the same time.

Now, If i was responsible for the petty cash in my department and I knew, that the next time the supervisor will controll the petty cash is, say, 6 weeks ahead, is it not theft, if I took money out of the petty cash, willing to return it before the next control? If not, why not? Is theft only theft, when someone else realizes it? That would be a cool concept :-)

Yet, exactly this is, what the banks do with the checking accounts. They trust that noone realizes, the money isn't really in the vault. I would say, that is a crime, because they openly engage in theft.

 

I do not think that either Mises nor, especially Rothard, would have agreed to "some kind of" fractional reserve banking.  First of all it is the question of redeemability. There is nothing wrong with a contract that gives a right to the bank to use part of the deposit for their purposes. This has not been doubted by anyone posting to this thread.

I remember the petty cash example here. If I agreed to be responsible for the petty cash of my company, I am not allowed to take out any funds from it for personal use, just because I know that the next revision is only due 2 week ahead, and I can put the money back in less than a week. It is still theft.

If i was allowed to withdraw money from the petty cash, and was only to ensure that the money is in the petty cash at the next revision date, it would just be another contract.

The point with FRB is not that banks can't do it, they can, given they let the costumers know and agree. The point is that they have an obligation to keep their hands off my petty cash all the time because that is what they agreed upon by telling me that it is redeemable any time - not in a day or so, but when I show up to withdraw -.

As it stands today, FRB is simply legalized fraud. And the safefty deposit argument goes not very far, because you do not get a reciept about what is in your safety deposit, so there is no chance to exchange the reciepts - bank notes - of safety deposits, which would render them useless as a medium of exchange.

Well, and the mentioning that you can loose your property by other ways than depositing in a bank is just funny. So, theft is no theft because you can also be robbed?

 

 

 

Juan:

Yes, maybe you signed a contract that says that your money is available on demand but if somehow is not, then you get a timed deposit. Fine, I see no 'formal' problem with that, but on the other hand I don't think such a contract makes sense.

Well, the "formal" problem is fraud. If I sign a contract and the counterpart is aware of not being able to deliver his part of the obligation I would call that "formal" fraud.

If you as a customer accept this, so be it. You are free to do so. You are also free to accept theft and any other crime. But that doesn't change the quality of the action, which is a crime.

You seem to say, that it is acceptable for a party to arbitrary change the conditions of a contract, in case it can not fulfill it? I was used to think that there is, at least, an agreement between the contractors required? Why should the rest of the business world keep contracts, while banks do not have to? If You made a contract with a building company to build your house, what would you say if they came up, after you paid, and tell you, "sorry but our funds are not sufficient to build the roof". You wait until they have the funds, meanwhile standing in the rain? I doubt it? Why would you allow banks to engage in exactly the same behaviour, without any risk of being sued?

meambobbo:

Juan, there is no such thing as fictional reserve banking - even our fiat money is backed by something (although far not enough so maybe you're right).  It is backed by the federal government's ability to tax our future economy. 

 

This is to say our money is backed by the power of the state to coerce people to work as part-time forced laborers?

Well, one can argue that way, but than you have to agree that banking is as imoral as a state that finds the funds it can steal of todays citizens insufficient and promises to steal more from the future generations?

 

nhaag:

Juan:

Yes, maybe you signed a contract that says that your money is available on demand but if somehow is not, then you get a timed deposit. Fine, I see no 'formal' problem with that, but on the other hand I don't think such a contract makes sense.

Well, the "formal" problem is fraud. If I sign a contract and the counterpart is aware of not being able to deliver his part of the obligation I would call that "formal" fraud.

My mistake. I didn't word that one clearly enough. Supposedly, FRB contracts say two things : 1) your money is available on demand 2) if for any reason it is not, then you'll have to wait for some time to get it back. You as a customer agree to these two contractual terms so technically there's no fraud.

Nhaag, I am quoting Rothbard here from America's Great Depression:

"Private banks, it is true, can themselves inflate the money supply
by issuing more claims to standard money (whether gold or
government paper) than they could possibly redeem. A bank
deposit is equivalent to a warehouse receipt for cash, a receipt
which the bank pledges to redeem at any time the customer wishes
to take his money out of the bank’s vaults. The whole system of
“fractional-reserve banking” involves the issuance of receipts
which cannot possibly be redeemed. But Mises has shown that, by
themselves, private banks could not inflate the money supply by a
great deal.22 In the first place, each bank would find its newly

issued uncovered, or “pseudo,” receipts (uncovered by cash) soon
transferred to the clients of other banks, who would call on the
bank for redemption. The narrower the clientele of each bank,
then, the less scope for its issue of pseudo-receipts. All the banks
could join together and agree to expand at the same rate, but such
agreement would be difficult to achieve. Second, the banks would
be limited by the degree to which the public used bank deposits or
notes as against standard cash; and third, they would be limited by
the confidence of the clients in their banks, which could be
wrecked by runs at any time."

He then goes on about how government intervention has institutionalized inflationary fractional reserve banking, protecting it from the market using violence.  He describes the FED, etc...

THEN:

"While unregulated private banking would be checked within
narrow limits and would be far less inflationary than Central Bank

manipulation,26 the clearest way of preventing inflation is to outlaw
fractional-reserve banking, and to impose a 100 percent gold
reserve to all notes and deposits. Bank cartels, for example, are not
very likely under unregulated, or “free” banking, but they could
nevertheless occur. Professor Mises, while recognizing the superior
economic merits of 100 percent gold money to free banking,
prefers the latter because 100 percent reserves would concede to
the government control over banking, and government could easily
change these requirements to conform to its inflationist bias.27
But a 100 percent gold reserve requirement would not be just
another administrative control by government; it would be part
and parcel of the general libertarian legal prohibition against
fraud. Everyone except absolute pacifists concedes that violence
against person and property should be outlawed, and that agencies,
operating under this general law, should defend person and property
against attack. Libertarians, advocates of laissez-faire, believe
that “governments” should confine themselves to being defense
agencies only. Fraud is equivalent to theft, for fraud is committed
when one part of an exchange contract is deliberately not fulfilled
after the other’s property has been taken. Banks that issue receipts
to non-existent gold are really committing fraud, because it is then
impossible for all property owners (of claims to gold) to claim their
rightful property. Therefore, prohibition of such practices would
not be an act of government intervention in the free market; it
would be part of the general legal defense of property against attack
which a free market requires.28, 29"

 

So I am right about Mises's tolerance.  Rothbard disagrees.

BUT how does Rothbard want to enforce this?  A regulated banking sector?  An agreement to audits?  Going back to the petty cash example, how do you know if the petty cash has been spent outside the business if you're not going to check it?

It seems these things will only be discovered at the same time that problems arise: depositors cannot redeem their deposits/a legitimate use for petty cash has arisen but there is none available.  Even if we chose instead to use a system of agreed upon audits, possibly random, possibly completely 3rd-party, the outcome is similar.  If the audit found a bank in breach, confidence in the bank would crumble, and you'd get a bank run.

Mises and Rothbard's positions aren't that different.  Mises believes the market will prevent fraudulent fractional reserve banking, while Rothbard believes the government should (or simply enforce the fraud).  Of course, Rothbard would more likely say A government, than THE government.

 

I feel this discussion is breaking down.  I am becoming confused about what we are talking about.  To me it seems that fractional-reserve banking is simply whenever a bank owes its depositors more money on demand than is available.  But this isn't inflationary if the bank is not creating claims to wealth it does not and never had.  If the bank is simply lending out of its deposits, it has a finite amount of genuine credit that it can loan.  Even if there is a bank run it cannot fulfill, it still holds debt that should amount to greater than what it owes.  In the absence of a loss of confidence in such an institution, its bank notes should still exchange at a nearly exact value as the gold they claim to represent.

What seems to be getting thrown into the mix is artificial credit.  This is unlimited.  This is inflationary.  If I'm a bank who has received $500 in deposits, I can still create claims to $10.0 x 10^9,999 and loan these out.  I can make bank notes to my heart's content.  This is much more similar to our current system than the free banking system, although the banks themselves don't want to continually inflate at a break-neck pace.  This would destroy the real value of their outstanding loans and additionally collapse the system.  Regardless, fractional reserve banking and artificial credit are two different things, although one follows the other (IMO).

 

As far as fraud is concerned, is the bank offering to store money as a werehouse or serve as an investment broker?  This can become quite watered down by the fine print.  Obviously, your deposit can't be risked and guaranteed simultaneously; but when there are many, many deposits functioning as such, there is the appearance that this is the case.  The fine print may clear up what is actually going on.  Many of these online digital gold/silver currencies/funds are not truly backed by gold/silver.  Yet, it is not fraud if that's what the fine print says.  From what I've seen, e-gold seems to be the only one that has audits (although not conducted by an independent agency) and has survived a virtual bank run.  I am going to try to get an account agreement from a regular bank to see what their fine print says about this issue.  However, it will probably be fruitless because even if it is clearly fraud, the government will not enforce it.  The system is designed to prevent such anyway, as it is nearly impossible to conduct a bank run where a depositor is not given his nominal amount...of course, to do so means to debase the *** out of the currency.  In any case, the existence of the FDIC seems to suggest the government wouldn't acknowledge fraud.

It seems to me artificial credit (creating claims to wealth that does not exist) is ALWAYS fraudulent, while FRB is SOMETIMES fraudulent, depending upon the agreement between depositor and bank.

 

As far as I'm concerned, I don't care if we have free banking or regulated 100% reserves for demand deposits.  I believe both systems will prevent the (widespread) creation of artificial credit.  Our more pressing goal should be to restore some unit of value to our currency.  I like Ron Paul's plan best: simply legalize competition - remove (unconstitutional) legal tender laws, remove (unconstitutional) prohibitions of private minting and/or alternative currencies, and remove sales and capital gains taxes from gold and silver.

 

I went back and re-read Rothbard's What Has Government Done to our Money, and I was wrong about his feelings on werehousing money and using the receipts as mediums of exchange.  But he does state that such was done because transporting and exchanging actual precious metals was less convenient.  This would mean there is no redemption premium for bank notes; in fact, it implies the opposite (unless the market generally preferred using physical gold over banks).

However, both Mises and Rothbard believed that the only means to get from simple werehousing to unending fraud and artificial credit was government alliance with banking.

nhaag:

meambobbo:

Juan, there is no such thing as fictional reserve banking - even our fiat money is backed by something (although far not enough so maybe you're right).  It is backed by the federal government's ability to tax our future economy. 

 

This is to say our money is backed by the power of the state to coerce people to work as part-time forced laborers?

Well, one can argue that way, but than you have to agree that banking is as imoral as a state that finds the funds it can steal of todays citizens insufficient and promises to steal more from the future generations?

 

 

I was not arguing morality.  Of course I feel it is immoral that someone else's debt is backed by my child's labor.  It is a clear violation of the free market, liberty, and personal responsibility.  I feel most of what the government now does is clearly immoral...either in the means, the ends, or the lack of authority.

meambobbo:

[...] To me it seems that fractional-reserve banking is simply whenever a bank owes its depositors more money on demand than is available.  But this isn't inflationary if the bank is not creating claims to wealth it does not and never had.  If the bank is simply lending out of its deposits, it has a finite amount of genuine credit that it can loan.  Even if there is a bank run it cannot fulfill, it still holds debt that should amount to greater than what it owes.  In the absence of a loss of confidence in such an institution, its bank notes should still exchange at a nearly exact value as the gold they claim to represent.

First you say: "To me it seems that fractional-reserve banking is simply whenever a bank owes its depositors more money on demand than is available." But later in the very same paragraph you say: "In the absence of a loss of confidence in such an institution, its bank notes should still exchange at a nearly exact value as the gold they claim to represent."

You keep skipping a step in your logic—a really big one. At what point would the claims on the assets of the bank trade as bank notes assuming the bank notes weren't fraudulent? We have money market deposit accounts now. Such deposits don't trade as bank notes. They trade in parallel as a form of checkbook money. They don't trade as money. They never have. This deserves explanation if fractionally-backed bank notes were indeed likely to be a spontaneous product of the free market. And the obvious explanation is that debt will never trade at face value. There's no reason to think it ever would.

meambobbo:

I went back and re-read Rothbard's What Has Government Done to our Money, and I was wrong about his feelings on werehousing money and using the receipts as mediums of exchange.  But he does state that such was done because transporting and exchanging actual precious metals was less convenient.  This would mean there is no redemption premium for bank notes; in fact, it implies the opposite (unless the market generally preferred using physical gold over banks).

No, it means that there will occasionally be circumstances where people will want to trade warehouse receipts in place of gold, and that they are willing to pay extra for the service in those occasional circumstances when it is indeed a service. It does not mean that bank notes can be used anywhere gold is expected, i.e. that there is "no redemption premium." It depends entirely on the circumstance.

 

hjmaiere, is this what you are saying:

If we trade debt (bank notes) as though it were money, then its being used for exchange in addition to the money it represents being used in exchange, there is increased demand and increased prices?  If the debt is being used for exchange, its underlying assets must not be used for exchange for such a system to retain a stable money supply?

I can see how this is the case.  I think this is different from all debt carrying a premium, however.

You are definitely right about the circumstance-dependency on accepting bank notes.

meambobbo:

hjmaiere, is this what you are saying:

If we trade debt (bank notes) as though it were money, then its being used for exchange in addition to the money it represents being used in exchange, there is increased demand and increased prices?  If the debt is being used for exchange, its underlying assets must not be used for exchange for such a system to retain a stable money supply?

[...]

The main thing I'm saying is that merely trying to talk about what happens when bank debt serves as money presumes that it would sereve as money in the first place. I'm saying that this presumption is false. People have been programmed by a hundred years of institutionally-controlled education to think of it as perfectly normal—so normal that apparently people don't even realize it is a presumption anymore.

I'm not declaring a moral imperative. I'm not saying that "If debt is being used for exchange, its underlying assets must not be used for exchange." I'm saying a debt's underlying asset simply won't be used for exchange unless someone lies or points guns at people. I'm saying that if it is happening, it's exactly because it allows somone to make money on money they don't really have because they've tricked or forced someone into accepting a piece of paper or magic token as if it were money.

 

 

meambobbo:

Nhaag, I am quoting Rothbard here from America's Great Depression:

"Private banks, it is true, can themselves inflate the money supply
by issuing more claims to standard money (whether gold or
government paper) than they could possibly redeem. A bank
deposit is equivalent to a warehouse receipt for cash, a receipt
which the bank pledges to redeem at any time the customer wishes
to take his money out of the bank’s vaults. The whole system of
“fractional-reserve banking” involves the issuance of receipts
which cannot possibly be redeemed. But Mises has shown that, by
themselves, private banks could not inflate the money supply by a
great deal.22 In the first place, each bank would find its newly

issued uncovered, or “pseudo,” receipts (uncovered by cash) soon
transferred to the clients of other banks, who would call on the
bank for redemption. The narrower the clientele of each bank,
then, the less scope for its issue of pseudo-receipts. All the banks
could join together and agree to expand at the same rate, but such
agreement would be difficult to achieve. Second, the banks would
be limited by the degree to which the public used bank deposits or
notes as against standard cash; and third, they would be limited by
the confidence of the clients in their banks, which could be
wrecked by runs at any time."

He then goes on about how government intervention has institutionalized inflationary fractional reserve banking, protecting it from the market using violence.  He describes the FED, etc...

That is my understanding of Rothbards view, I hadn't looked it up before I wrote my comments.

However, I feel that the discussion is kind of oscillating. For sure, fractional reserve banking, not backed by the government has a less inflationary impact, yet, my argument is, that fractional reserve banking is either a no brainer a free market - because the demand for a "warehouse" scheme like this would be pretty low and customers could choose where to store their valuables- or, fractional reserve banking, the way it is implemented today, must be seen as a fraud - because banks today commit to a contract, they are not obliged to follow. Wether the result of such a fraud is socially amiable and beneficial - which I do not believe - or not, doesn't change the act itself being a crime, like the act of taxation is still theft - unless it is voluntary :-).

 

meambobbo:

THEN:

"While unregulated private banking would be checked within
narrow limits and would be far less inflationary than Central Bank

manipulation,26 the clearest way of preventing inflation is to outlaw
fractional-reserve banking, and to impose a 100 percent gold
reserve to all notes and deposits. Bank cartels, for example, are not
very likely under unregulated, or “free” banking, but they could
nevertheless occur. Professor Mises, while recognizing the superior
economic merits of 100 percent gold money to free banking,
prefers the latter because 100 percent reserves would concede to
the government control over banking, and government could easily
change these requirements to conform to its inflationist bias.27
But a 100 percent gold reserve requirement would not be just
another administrative control by government; it would be part
and parcel of the general libertarian legal prohibition against
fraud. Everyone except absolute pacifists concedes that violence
against person and property should be outlawed, and that agencies,
operating under this general law, should defend person and property
against attack. Libertarians, advocates of laissez-faire, believe
that “governments” should confine themselves to being defense
agencies only. Fraud is equivalent to theft, for fraud is committed
when one part of an exchange contract is deliberately not fulfilled
after the other’s property has been taken. Banks that issue receipts
to non-existent gold are really committing fraud, because it is then
impossible for all property owners (of claims to gold) to claim their
rightful property. Therefore, prohibition of such practices would
not be an act of government intervention in the free market; it
would be part of the general legal defense of property against attack
which a free market requires.28, 29"

 

Mises, focused on the preaxeolocigal aspects of the issue. That means, by definition, that no moral principles can be used to either proof nor disaprove. Like in mathematics or logic, there is no moral principle involved. So he simply describes the means and their outcome rather than judging about them using moral priciples.

 

meambobbo:

BUT how does Rothbard want to enforce this?  A regulated banking sector?  An agreement to audits?  Going back to the petty cash example, how do you know if the petty cash has been spent outside the business if you're not going to check it?

It seems these things will only be discovered at the same time that problems arise: depositors cannot redeem their deposits/a legitimate use for petty cash has arisen but there is none available.  Even if we chose instead to use a system of agreed upon audits, possibly random, possibly completely 3rd-party, the outcome is similar.  If the audit found a bank in breach, confidence in the bank would crumble, and you'd get a bank run.

Mises and Rothbard's positions aren't that different.  Mises believes the market will prevent fraudulent fractional reserve banking, while Rothbard believes the government should (or simply enforce the fraud).  Of course, Rothbard would more likely say A government, than THE government.

 

Wow, i would love to hear Rothbard on him supporting government intervention to fix a crime :-)

Rothbard doesn't say a government nor the government. What agency will be used to settle a conflict is open to discuss. There are ways to do that, which not even involve something like a state. What Rothbard says is, as far as I understand him, that fraud is a crime, crime is an aggression, aggression is wrong and requires to be settled. How it is settled is open. The Agressed has the right to force the Agressor to make amends. The Agressed has also the right to just forgive. How the Agressed enforces his claims has no effect, whatsoever, on the cause, being a crime. So no rule is nessecary to explicitly state that FRB is fraud. It simply is. And fraud is aggression. So the law would be in place already.

 

meambobbo:

However, both Mises and Rothbard believed that the only means to get from simple werehousing to unending fraud and artificial credit was government alliance with banking.

Yup.

 

 

Have a great time

Sorry, am an imbicile new to this subject and need help, so plse excuse.  Thanx!

I understand how FRB cannot cause inflation PROVIDED that

a)  the underlying asset  (say gold) is always transfered during trade

b) trading with representations of that gold is forbidden.

Let's assume that only gold can be used in trades, and NOT a representation of the gold such as a certificate of ownership of the gold as issued by a bank as a receipt of deposit.  Also assume the bank doesn't issue promises of gold to a borrower, but will only lend out gold directly to them (since only gold can be used when trading).

  For example, person A deposits 100 gold coins at bank and gets a certificate for that 100 gold coins but  no traders will accept his  certificate as a form of currency .  The bank then lends out 80 of these gold coins to person B, keeping 20 in reserve.  They lend him the actual coins and not a representation of the coins. Person B then trades using these real gold coins (as he must in this example), eventually all coins returning to banks.  Hence No inflation.

In this example, why not replace the 100 gold coins  with a 100 square pieces of special, unforgable paper? 

So people trade directly with these paper squares and bank them identically as in the previous example.  Only these square pieces of paper can be used directly when trading, and not a representation of these square pieces of paper. Isn't that the system we already have, hence yielding no inflation?

No, you need to go back to the origin of money. Money is the most widely exchangeable good. People accept gold as the medium of exchange because it is widely desired. Paper isn't. The current system treats money as backed by debt, which is to say future promises to repay in terms of... more paper money. So the current system is by no means analogous.

-Jon

Thanks,

Incidentally i have never understood what currency represents.  If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me.

Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another  'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset.

In the same way that a gold coin is 'non backed' in that it represents itself,  and not some particular underlying asset.

Surely, in neither system can inflation occur via FRB alone, assuming of course, that in the case of the gold system that gold promisory notes, and gold receipts for the same bar of gold as well as the bar of gold itself are not in circulation simultanously.  In the case of non-backed paper currency, this situation surely cannot arise, since the 'valuable' paper is traded directly and isn't represented for a second time in  'higher level receipt currency' in circulation (apart from say cheque book money that would bounce if the situation occured).

In neither system is there some underlying asset being represented more than once by the currency.

perhaps i should do more reading because I still remain confused and unconvinced.

confuse a cat:

Incidentally i have never understood what currency represents.  If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me.

Here is the advantage of gold as money over paper as money.

Right now, the price of gold is $920/ounce.  If you offered to swap me 46 Federal Reserve Notes labeled '$20' for an ounce of gold, I'd say "fair trade", either way.

Two years from now, suppose the price of gold is $1500/ounce.  If you then offered to swap me 75 Federal Reserve Notes labeled '$20' for an ounce of gold, I'd say "fair trade".

What happened?  Did your gold magically become more valuable?  Or, did someone print more pieces of paper, driving down their value?

As another example, suppose you offered to trade me 0.3 ounces of silver for a gallon of gasoline.  Right now, that's pretty close to a fair trade.  If you attempt the same trade two years from now, it will probably still be reasonable.  Do you expect to be able to buy a gallon of gasoline for $5 two years from now?

Gold and silver keep their purchasing power over time, but pieces of paper do not.  The people who print the pieces of paper like printing more of them and giving them to their friends.  That's a pretty sweet scam they're running!  However, you can't just print more gold and silver.

Money supply inflation is literally stealing the purchasing power out of your pocket and bank account.  The nominal value of your money stays the same, but the amount of wealth it represents decreases.

Really nice post.  I'm constantly looking for ways to better explain inflation to people!

 

I'm hesitant to call it "money supply" inflation though.  I usually say monetary inflation, but have been trying to put a stop to it.  It is inflation, pure and simple.  Peter Schiff debunks the notion of price inflation pretty convincingly in Crash Proof.

 

It's also counterfeit, which is illegal.  It is illegal if you do it, if I do it, or if anyone else besides the government does it.  Which if the act is wrong, how can it be right when done by government?  That's illogical.  A lot of people respond strongly to that point.  Why does the government get to do what we would be jailed for doing ourselves?

liberty student:

I'm hesitant to call it "money supply" inflation though.

Assuming the velocity of money is constant, money supply inflation and price inflation occur at the same rate.  Due to asset bubbles, price inflation is not uniform.

If you want a true picture of inflation, look at commodities with relatively inelastic supply and demand, such as oil and gold.  That's the reason energy is excluded from the CPI.  The price of oil rises very nearly in lockstep with money supply inflation.

Most people remember that they used to pay $10 for a full tank of gasoline.  They probably don't remember what a loaf of bread used to cost.

confuse a cat:

Incidentally i have never understood what currency represents.  If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me

Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another  'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset. [...]

Money always has value independent of its function as money. There will always be plenty of people in the world that want gold just to have it (for jewelery or whatever). That, combined with the fact that gold is durable, fungible, divisible, and portable made gold highly remarketable. This meant that even if you didn't want gold for yourself just to have it, you know that it wouldn't be too hard to find someone who did. This is what made gold serve well as money. Consider that cigarettes have served as money in prisons even for people who did not smoke. Same principle at work. Cigarettes, salt, spices, silver, Persian rugs, tea, sea shells, feathers, etc. have all been highly remarketable goods that have served as money.

Federal Reserve Magic Tokens (FRMTs) are 'backed' by the fact that you need them to pay your taxes. That is, everyone needs to come up with them at tax time. If you don't come up with them, the government will take your stuff away and throw you in jail. This makes FRMTs very remarketable. Without this threat of force by the government, FRMTs would be completely worthless. And indeed, history is littered with fiat currencies that have become worthless. All this stuff about money being backed by debt is an attempt to obscure the true purpose of fiat currency, which is to allow the banks and the government to extract wealth from the economy without the political inconvenience of taxing people directly for it.

confuse a cat:

Surely, in neither system can inflation occur via FRB alone, assuming of course, that in the case of the gold system that gold promisory notes, and gold receipts for the same bar of gold as well as the bar of gold itself are not in circulation simultanously.  In the case of non-backed paper currency, this situation surely cannot arise, since the 'valuable' paper is traded directly and isn't represented for a second time in  'higher level receipt currency' in circulation (apart from say cheque book money that would bounce if the situation occured).

[...]

Fractional-reserve banking is about allowing a bank to treat debt that it is owed as if it were money that it could spend now. You are correct in that in some weird sense the 'value' of the paper in the case of fiat currency doesn't really derive its value from the debt it supposedly represents because that debt is nothing but more paper.

The true purpose of the accounting system behind fractional-reserve banking is to cartelize the banks. Since FRMTs are created out of nothing, any one bank could in theory create as many of them as it wanted. But this would immediately destroy their value. The purpose of the banking regulations is to allow all banks to create FRMTs as long as they all simultaneously do so at the same controlled rate—a rate that in theory won't completely destroy the economy.

For what it's worth, it's impossible to really understand banking until you entertain the possibility that it is the single biggest criminal activity on earth, because that's exactly what it is: http://mises.org/story/3010

 

Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another  'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset.

In the same way that a gold coin is 'non backed' in that it represents itself,  and not some particular underlying asset.

Alright, and why would anyone accept pieces of paper for payment, as opposed to actual production? You see, if people actually valued the pieces of paper highly, as is the case with gold, you'd be correct. However, the way the currency arose, the paper money was originally backed by gold, until this link was severed. It was only by government force that the paper could remain in use as money. Money that can be printed at will, that has no real value other than that garnered by the imposition of government force, is disanalogous to a good that is widely desired, is difficult to produce and has value independent of the use of any force. That is the asymmetry between paper money (as it currently exists) and gold qua money.

-Jon

I've accepted worthless pieces of paper all my life. I never questioned for 32 years whether notes really represented anything, yet it didn't stop me valuing this paper and desiring it more than gold for which i have no use.  To me my money is just information about my spending power and nothing more.  Of course, if the entire population woke up tomorrow and decided they were no longer going to accept my paper money,  for example because they all decided paper money in reality was intrinsically worthless paper and not worth trading, then equally my notes would no longer have any value to me and i'd look for another medium of exchange they desired. But this potential problem with paper currency, albeit unlikely, equally applies with a gold currency i might use.

If money was 'written on' an intrinsically useful medium with real value to industry, say silicon, then surely the money supply would shrink due to consumption of the medium by industry and the price of silicon would also inflate due to its use as coinage? In the past wasn't gold currency really used in the same way as 'non backed' paper currency with the main difference being that  its harder for the government central bank to expand the gold supply? (which they still can do, albeit to a finite extent by maipulating reserves in the usual manner).  I can see that paper money requires trust in both bankers and the government not to debase the currency and that people don't trust government or bankers or fractional reserve banking.   But issuing currency in gold in order to be assured of a fixed money supply is surely going from the information age and  returning to the middle ages. Surely  the important thing is restoring public confidence in the current financial system.  Not returning to gold. 

Also, as i asked before, surely the problem with fraudulent banking where receipts are counterfeited can only occur with respect to  'backed' currency where potentially both  receipts of an underlying asset and the underlying asset itself can float in circulation simultaneously.  Clearly this cannot occur with direct gold trading, but how can this fraudulent duplication occur with non-backed paper money?  any paper notes deposited at a bank are removed from circulation and can no longer be spent by the depositor.  When he deposits his notes he doesn't get a receipt apart from a number written into his account. To spend the money written into his account, the borrower must first return the money (hopefully with interest).  If this wasn't the case and FRB really did create money, why would bank runs occur in the first place? Banks could just lend money to each other indefinitely to create as much money as needed....

 

Thanks for reading agian, CAC.

confuse a cat:

I've accepted worthless pieces of paper all my life.

You're entirely missing the point.  People don't use pieces of paper instead of gold because pieces of paper are a better monetary system.

People use pieces of paper instead of gold because State violence prevents them from using other forms of money.  Consider what happened to E-Gold and the Liberty Dollar.

It's one thing to say "everyone got together and voluntarily decided to use paper instead of gold as money".  It's another thing to say "a handful of people use violence to force everyone else to use paper as money".

For any monetary system based on pieces of paper, the people who print the paper will print more and give them to themselves.  Historically, every fiat currency has ended in hyperinflation for this reason.

I never said you aren't free to use pieces of paper as money if you want to.  I said that I shouldn't be prevented from using other forms of money.  You're a fool/slave for using unbacked pieces of paper as money.

confuse a cat:

I've accepted worthless pieces of paper all my life. I never questioned for 32 years whether notes really represented anything, yet it didn't stop me valuing this paper and desiring it more than gold for which i have no use.  To me my money is just information about my spending power and nothing more.

But the fact that other people accept them from you for payment of things clearly means they aren't worthless. Money is not merely a matter of social convention. There are people who want you to think that. There are people who want you to think that a sound and efficient and modern monetary system is about trustworthy bankers and political leaders. But as I tried to explain, Federal Reserve Magic Tokens are, in a very real and concrete sense, 'stay-out-of-jail' tokens. They are not at all "worthless." They merely derive their value from the business end of government guns.

confuse a cat:

Of course, if the entire population woke up tomorrow and decided they were no longer going to accept my paper money,  for example because they all decided paper money in reality was intrinsically worthless paper and not worth trading, then equally my notes would no longer have any value to me and i'd look for another medium of exchange they desired. But this potential problem with paper currency, albeit unlikely, equally applies with a gold currency i might use.

It is not at all unlikely that you could wake up tomorrow and find that people no longer accepted your paper money. It happens all the time. It's happening now. The dollar has lost almost half its value in the last five years. And there are reasons to think that it will only get worse. Gold, on the other hand, has always had value in the marketplace.

confuse a cat:

[...] I can see that paper money requires trust in both bankers and the government not to debase the currency and that people don't trust government or bankers or fractional reserve banking.   But issuing currency in gold in order to be assured of a fixed money supply is surely going from the information age and  returning to the middle ages. Surely  the important thing is restoring public confidence in the current financial system.  Not returning to gold. 

[...]

You seem to think that gold was money because the government declared it to be money. Gold was used as money because it had properties that made it particularly well-suited for use as money. And this is the real issue. Students of the Austrian School might sound like they're advocating gold as money. They're not. What they're realy advocating is that the government not be allowed to force people to use any one particular thing as money. They don't care at all if people use silver or copper or hemp script as money so long as they do so voluntarily. Most Austrians are pretty convinced that a free market will naturally settle on gold as money, but they are not at all arguing that "we" (in the political sense) should use gold as money.

Also, bankers and the governmnet always debase the currency when they have the chance. That's the very reason they force people to use bank notes as money in the first place.