I read in Rothbard's America's Great Depression (which I just finished) that depressions can only be caused by central banking and fractional reserve banking distorting economic calculation for businesses. While I'm inclined to agree with this theory, I am wondering what caused the Panic of 1907, which occured six years before the Federal Reserve Act was passed. Thank you.
shazam:While I'm inclined to agree with this theory, I am wondering what caused the Panic of 1907, which occured six years before the Federal Reserve Act was passed.
Fractional reserve banking distorting economic calculation for businesses?
What's the Fed have to do with it, they just act to sync the different bank's inflationary activities under a cartel. It isn't neccessary to have a central bank for the banks to inflate the money supply.
shazam: I am wondering what caused the Panic of 1907, which occured six years before the Federal Reserve Act was passed.
A bunch of large banks colluded to call in loans and shrink the money supply. This forced smaller banks into bankruptcy. They then used this panic as justification to create the Federal Reserve.
A fractional reserve bank is technically insolvent at any given time, if all customers simultaneously demand withdrawal. If a newspaper prints a rumor "Small bank XYZ is insolvent", then the ensuing panic *CAUSES* bank XYZ's insolvency! Therefore, any small fractional reserve bank can be bankrupted at will, merely by spreading rumors.
After causing a recession, the big banks bought up assets at a discount.
It's the usual "Problem! Reaction! Solution!" paradigm.
In 1907, the financial industry was heavily regulated. This enabled big banks to collude and cause a panic. This was used as justification for more regulation of the market.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
fsk:It's the usual "Problem! Reaction! Solution!" paradigm.
Nice. Did you watch that David Icke video I posted in your comments?
liberty student: Nice. Did you watch that David Icke video I posted in your comments?
I just watched the bits on the Compound Interest Paradox. That was 2 hours long! I prefer written resources, because I can read faster than someone can talk in a video.
Fair enough. I think it was actually 3 hours long. I try to listen to podcasts during the day, and watch video at the end of the day when my focus has wandered. I listen to Lew Rockwell's new podcast when I make my morning coffee run.
fsk: shazam: I am wondering what caused the Panic of 1907, which occured six years before the Federal Reserve Act was passed. A bunch of large banks colluded to call in loans and shrink the money supply. This forced smaller banks into bankruptcy. They then used this panic as justification to create the Federal Reserve. A fractional reserve bank is technically insolvent at any given time, if all customers simultaneously demand withdrawal. If a newspaper prints a rumor "Small bank XYZ is insolvent", then the ensuing panic *CAUSES* bank XYZ's insolvency! Therefore, any small fractional reserve bank can be bankrupted at will, merely by spreading rumors. After causing a recession, the big banks bought up assets at a discount. It's the usual "Problem! Reaction! Solution!" paradigm. In 1907, the financial industry was heavily regulated. This enabled big banks to collude and cause a panic. This was used as justification for more regulation of the market.
I've heard that explanation in that Zeitgeist film, but I assumed it was false simply because of the conspiratoid theme of the movie and the movie's lack of economic knowledge in other parts of the film.
On banking, you absolutely want to read these three books (see link).
http://mises.org/Community/forums/p/3080/42420.aspx#42420
They are all available for free, online courtesy of the Mises Institute.
liberty student: On banking, you absolutely want to read these three books (see link). http://mises.org/Community/forums/p/3080/42420.aspx#42420 They are all available for free, online courtesy of the Mises Institute.
I've already read America's Great Depression, and I understood the role the Fed played in creating that disaster. I have not read the other two books yet, so that is why I was wondering how a depression could have occured without a central bank artificially setting low interest rates and maintaining fractional-reserve banking.
shazam: I've already read America's Great Depression, and I understood the role the Fed played in creating that disaster. I have not read the other two books yet, so that is why I was wondering how a depression could have occured without a central bank artificially setting low interest rates and maintaining fractional-reserve banking.
In the late 19th century, the Supreme Court legalized limited liability incorporation. Limited liability corporation encourages dishonest behavior by a nearly insolvent bank, because their liability is limited. Suppose a bank has $100M in assets and $99M in liabilities. Without limited liability incorporation, they should start returning money to despoitors, because they risk insolvency and personal liability. With limited liability incorporation, the incentive is for owners and management to gamble. They have a free put option to cheat their depositors in bankruptcy court.
After the Civil War, the banking industry was heavily regulated. This restricted the ability of competing banks to dampen the cycle.
A few large banks colluding are able to cause a recession/depression. If a few large banks stop issuing loans, then the money supply shrinks drastically. The banking industry is regulated, so small banks can't compensate by issuing more loans to keep up the money supply.
As stated before, fractional reserve banking is an inherently unsound business. If a newspaper prints a rumor of a bank's insolvency, then all depositors rush to withdraw their gold. No fractional reserve bank has that much cash on hand, so the rumor of insolvency causes insolvency. The effect cascades and there's a run on all banks. A large bank is immune from runs. They can lobby the State for a "banking holiday" while they still collect interest but don't pay depositors. A large bank is perceived as safer. During a run, people withdraw from small banks and deposit at large banks.
Before 1913, recessions were caused by:
After 1913, recessions were created with full force of law via the Federal Reserve. Recessions are *NOT* a natural free market phenomonen. They are artificially created by the financial industry to line their pockets. State violence is needed to cause recessions.
I would like to add that the depression of 1819 was caused by the federal government temporarily allowing banks to refuse redemption on deposits in specie. Any protection of fractional reserve banking can cause a business cycle. central banking and fiat currency are simply interventions designed to protect it. the main protections are keeping such businesses out of bankruptcy and not holding them liable for fraud. These take multiple forms.
In 1907, it was largely the unregulated trusts who were expanding credit, and the regulated big banks decided to knock them out of business. Limited liability, in addition to the confidence inspired by regulation, allowed trusts to expand credit as such. The funny part is that JP Morgan bailed out some of the remaining trusts, claiming to save the market, then lobbied for a central bank to institutionalize the very cause of the problem (fractional reserve banking) by claiming it was a fix (lender of last resort).
Check my blog, if you're a loser
I should add that the key points here lie in the Banking Acts of 1863, 64, and 65. Apparently, all national banks were required to use a common bank note that was redeemable for gold in any other national bank. The trusts performing the same role were unregulated. I would assume they got comfortable keeping fractional reserves of these bank notes.
Oh no, limited liability again. Gary North said the idea came from medieval churches. Hardly Supreme Court legalization.
shazam: I read in Rothbard's America's Great Depression (which I just finished) that depressions can only be caused by central banking and fractional reserve banking distorting economic calculation for businesses. While I'm inclined to agree with this theory, I am wondering what caused the Panic of 1907, which occured six years before the Federal Reserve Act was passed. Thank you.
Panics had been a part of the American landscape long before the Federal Reserve was created.
Banks would expand credit, which would lead to a bust and a contraction in the supply of money. The Fed was quite literally created in order to end panics. It was devised to allow banks to continue to expand credit without limit, to give the banks 100% boom with zero bust.
As any good Austrian would have predicted the Fed, rather than making panics disappear, has made them far worse. But even if the Fed had been able to bring about a permanent boom it would not have been a good thing. Boom times are not times of economic growth, they are times of all malinvestment.
But don't think that before the Fed was created that the banking industry was unregulated. Banks were not only regulated, they were nationalized.
Peace
scineram: Oh no, limited liability again. Gary North said the idea came from medieval churches. Hardly Supreme Court legalization.
Wow! I hadn't read that before. link
I have compared joint stock companies to churches in the past, but I've never done the historical research.
The Panic of 1907 was actually the reason why Congress passed the FRA. Critics of the time, however, argued that the panic was more due to government regulation that made it difficult to practice full reserve banking. When there were runs banks, we consequently saw a major credit contraction as they were practicing fractional reserve banking.
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However, some time ellapsed between the 1907 panic and the creation of the Fed. The market quickly recovered by the end of the year, through its natural corrective mechanisms. It was just a panic, not a major depression, because it did not spread to other areas of the economy to the extent that later crises did.
Art transcends ideology.
http://mises.org/Community/blogs/ruben