Hello,
I am a layperson only recently exposed to the Austrian school of economics. I'm fascinated by it and I'm buying what you're selling. I do have a question:
I've read a few books by Murray Rothbard and he's critical of the fractional reserve banking system. What I do not understand: without fractional resreve banking, how can money be loaned and how could a bank possibly pay me interest? I certainly understand the risk of fractional reserve banking, especially when rerserve requirement is very low but I don't understand what the alternative is.
Thanks.
Don
Thanks for your answer.
But - how do you loan the first dollar? i.e., if, as a bank, all my deposits must be backed, isn't 100% of my money not loanable?
This is an easy answer:
There are a bunch of ways to get money without making fractional reserve loans on deposits that users can claim immediately:
1. Most Common: Issue equity. That is you sell ownership in a bank, normally done through stock holders but can be done through a mutual system. In either case the investors are not contractually obligated to be paid the money back. Understand that if the bank makes more than the interest rates then the investors get more money paid back. There are many more insurance companies that use the mutual system and it has advantages.
2. Contract deposits now for money later. A certificate of deposit is an example. The agreement for higher interest rates means the depositor has limit access to their deposit unlike a checking account or passbook savings. This method includes selling long term bonds.
In all likelyhood there would arise, in a stateless society, two different kinds of institutions.
The first would be a true financial intermediary, who would facilitate the loaning of money. There profits would be the result of arbitrage. For example, person A comes to the bank offering them money for 5% per annum, they would then lend this money at a rate higher than that and (e.g. 6% per annum) and then pocket the difference as a profit.
The second would be more like a warehousing business with whom individuals would conduct a monetary irregular deposit contract. The bank would charge a sum of money in order to guard the gold (or whatever other commodity) and this is how they would make money.
"You don't need a weatherman to know which way the wind blows"
Bob Dylan
dmuldoon:how do you loan the first dollar?
You have to get a depositor (or an investor) to allow you to do so. That's what a CD is for example. Remember you only need to maintain 100% backing for demand deposits.
The definitive work on this subject from an Austrin perspective is De Soto's book Money, Bank Credit, and Economic Cycles. It's available online in pdf format here.
Spideynw: vikingvista: I'm trying to make sense of your question in the context of your selected quote from my post. If you loan money, you typically don't demand that the person you loan it to "have it on hand at all times". In many cases, that defeats the whole purpose of the loan. Additionally, failure to pay back a loan is not always fraud. That is part of the calculated risk independent of considerations of fraud. It sounds like you don't understand the difference between a demand deposit and a loan. Can you clarify what you are asking me? Ah, that is where the confusion comes from. I read deposit, not loan, because people don't loan banks money, they deposit money with banks. For some reason there are those of you that confuse a bank with an investment institution. People could loan a grocery store money to invest. But a grocery store is somewhere you go to buy food, not loan money for investments. So when someone says bank, that only means a place to deposit your money/valuables for safe-keeping. Conflating that with a place to go and make investments is confusing.
vikingvista: I'm trying to make sense of your question in the context of your selected quote from my post. If you loan money, you typically don't demand that the person you loan it to "have it on hand at all times". In many cases, that defeats the whole purpose of the loan. Additionally, failure to pay back a loan is not always fraud. That is part of the calculated risk independent of considerations of fraud. It sounds like you don't understand the difference between a demand deposit and a loan. Can you clarify what you are asking me?
I'm trying to make sense of your question in the context of your selected quote from my post.
If you loan money, you typically don't demand that the person you loan it to "have it on hand at all times". In many cases, that defeats the whole purpose of the loan.
Additionally, failure to pay back a loan is not always fraud. That is part of the calculated risk independent of considerations of fraud.
It sounds like you don't understand the difference between a demand deposit and a loan. Can you clarify what you are asking me?
Ah, that is where the confusion comes from. I read deposit, not loan, because people don't loan banks money, they deposit money with banks. For some reason there are those of you that confuse a bank with an investment institution. People could loan a grocery store money to invest. But a grocery store is somewhere you go to buy food, not loan money for investments. So when someone says bank, that only means a place to deposit your money/valuables for safe-keeping. Conflating that with a place to go and make investments is confusing.
What is a mortgage loan if not an investment? A car loan? A college loan? A small business loan? Are you saying that these are not traditional investments that people typically associate with banks? Have you ever encountered a bank that was NOT an investment institution? Do you know of any from any time in history?
And what do you call a certificate of deposit? Is that not really a loan that you make to a bank? You agree to give them money, and they agree to pay it back with interest at a predetermined future date.
These are things that have ALWAYS been part of banking, and well understood by the people at large. That is why moving to a free banking system without demand deposit fractional reserve banking would be a very easy adjustment for consumers. There truly is nothing new to understand. Some aspects of your relationship to your bank would likely change a little, like maybe a greater use of staggered CD accounts instead of demand savings, and greater diversification and diligence in choosing banks, but nothing people could not almost instantly adapt to.
vikingvista:These are things that have ALWAYS been part of banking,
Because we have ALWAYS had governments. So what?
vikingvista:Have you ever encountered a bank that was NOT an investment institution?
Have you ever lived somewhere that did not have a government?
vikingvista:What is a mortgage loan if not an investment? A car loan? A college loan? A small business loan?
To think someone would necessarily use a bank to make these kind of investments where they deposit their money is akin to thinking someone would use a grocery store to make these kind of investments as well. It is a BANK. Again, a BANK is where one DEPOSITS his or her money, just like a grocery store is where one buys food.
The MAIN reason banks make loans, is because the government allows them to lend out ten times what they have on deposit.
At most, I think only 5% of the adult population would need to stop cooperating to have real change.
vikingvista: What is a mortgage loan if not an investment? A car loan? A college loan? A small business loan? Are you saying that these are not traditional investments that people typically associate with banks? Have you ever encountered a bank that was NOT an investment institution? Do you know of any from any time in history?
Not all loans are investments. Consumer loans such as car loans are actually acts of dissavings.
vikingvista:And what do you call a certificate of deposit? Is that not really a loan that you make to a bank? You agree to give them money, and they agree to pay it back with interest at a predetermined future date.
Remove FDIC and demand deposits can no longer be guaranteed to be available on demand. Either it is available on demand or it is not. Available maybee on demand is not a demand deposit but a lottery ticket.
DD5: Show us please one privilege, power, or any special benefit that banks have that does not rely on government fiat. Can you point to just one?
Show us please one privilege, power, or any special benefit that banks have that does not rely on government fiat. Can you point to just one?
All things in banking today exist with government approval. All things in banking existed without government approval before. Your mistake is in thinking that the government approval means anything. It doesn't!
Money is created on the bank ledger when you take out a loan. It is not normally expressed in a government issued coupon, but with numbers on a ledger account. Every bank loan creates circulating money. Every payment on principle depletes circulating money. 90% of all circulating money is not in the form of government notes. Prior to the existence of government notes, all circulating money was in the form of bank approval only.
I find it bizarre that so much hey is made about money and banking by the likes of Rothbard when they obviously have a very superficial comprehension of what money is made of.
DD5:Where does their power rest on?
Credit. Money is credit of the banking system. Without government approval, banks must examine the credit of other banks themselves, in order to accept deposits of checks and negotiables. Banks do not run out of money by running out of anything of substance, but are out of business when sister banks will not accept their credit.
The brew ha ha about fractional reserve is backwards. Time was that banks didn't have anything of government issue. The requirement of a reserve of government approval is an unnecessary government dithering into something they (and you) don't understand
Arman: DD5:Where does their power rest on? Credit. Money is credit of the banking system.
Credit. Money is credit of the banking system.
Their credit is worthless if I am not required by law to accept it. There is nothing mystical about the money they issue. The monopoly on such credit is always enforced by government fiat and never by the market. This is not only a matter of history, but a matter of pure logic.
I told you that no evasive answer will be accepted. The fact is that you could not come up with one example yet you still managed to give a lengthy answer.
Go back to your Ellen Browns or whom ever today is preaching the same old mercantile economic fallacies from more the 300 years ago
Spideynw: vikingvista:These are things that have ALWAYS been part of banking, Because we have ALWAYS had governments. So what?
Spideynw: vikingvista:Have you ever encountered a bank that was NOT an investment institution? Have you ever lived somewhere that did not have a government?
I have never lived somewhere that didn't have cherry tomatoes either. How far do you want to carry these non sequiturs?
Spideynw: vikingvista:What is a mortgage loan if not an investment? A car loan? A college loan? A small business loan? To think someone would necessarily use a bank to make these kind of investments where they deposit their money is akin to thinking someone would use a grocery store to make these kind of investments as well. It is a BANK. Again, a BANK is where one DEPOSITS his or her money, just like a grocery store is where one buys food. The MAIN reason banks make loans, is because the government allows them to lend out ten times what they have on deposit.
Are you...sober? Banks have expertise in negotiating loans. People who know how to do that well, who understand money and finance, frequently work for things we call "banks". People who want to receive such investments typically go to those places we call "banks". That is not the expertise for you, me, the typical bank depositor, or the typical grocery store. Instead, people like you and me and the grocery store owner, who lack that expertise, loan money to banks in the form of CDs so that we can make a small part of the profit that said banks make from their investments.
The MAIN reason banks make loans, or that any company does anything, is to make a profit. Investing is not a government-defined practice any more than is trading widgets for chickens. Law and order, such as may be provided by a government, can certainly facilitate trading widgets and chickens, but it is not the motivator of chicken trading, nor is it an active party in doing so. Counterfeiting money can certainly make it easier to loan out more money, but again, it is of course not a necessary component.
You may personally WANT for some fascistic reason to forcibly prohibit companies that label themselves "banks" from engaging in lending, but companies that store money are always likely to attract people who understand money, and people who want to put their stored money to use. It is not only an obvious place to go looking for investment expertise, it is a tradition as old as banking itself.
I hate to be so explicit, but incorrect glib remarks call for some return to reality.
DD5: vikingvista: What is a mortgage loan if not an investment? A car loan? A college loan? A small business loan? Are you saying that these are not traditional investments that people typically associate with banks? Have you ever encountered a bank that was NOT an investment institution? Do you know of any from any time in history? Not all loans are investments. Consumer loans such as car loans are actually acts of dissavings. vikingvista:And what do you call a certificate of deposit? Is that not really a loan that you make to a bank? You agree to give them money, and they agree to pay it back with interest at a predetermined future date. Remove FDIC and demand deposits can no longer be guaranteed to be available on demand. Either it is available on demand or it is not. Available maybee on demand is not a demand deposit but a lottery ticket.
Not all loans wind up SUCCEEDING as profitable investments, but the loaner always intends to make profit dependent upon the increased wealth of the borrower, and the borrower always expects to get more value than he's giving up. Otherwise, neither party would engage. If you do a full accounting of anticipated costs and benefits, voluntary loans are investments.
In response to my description of CDs, you talk about demand deposits? You realize that doesn't make any sense, right? You know what a CD is? If I were to tell you that "apples are X", why would you reply "No, sheep are Y"? Or were you just making an unrelated point, rather than responding?
vikingvista:What is this necessary link between investment and governments that you imagine?
It's called fractional reserve banking. The government allows the bank to lend out more money that it actually has.
vikingvista:Why would you think people would not want to earn money by lending without governments,
Why do you think that I ever said or suggested such a thing?
vikingvista:and why in particular do you think banks would restrain from doing so?
Because, just like a grocery store is in the business of providing groceries, banks are in the business of holding deposits. Now granted, there is nothing in a free market restricting either grocery stores or banks from getting in the business of investing. But that is not their primary purpose.
vikingvista:Thinking back through the centuries-old history of banking, can you not think of any bankers making money through lending without concern for any governments?
Again, banks can lend money. And so too can grocery stores. But when I say grocery store, do you think of a business in the business of lending money?
vikingvista: Spideynw: vikingvista:Have you ever encountered a bank that was NOT an investment institution? Have you ever lived somewhere that did not have a government? I have never lived somewhere that didn't have cherry tomatoes either. How far do you want to carry these non sequiturs?
And you can't recognize the fact that banks lend out money they don't have and that it is fraud?
vikingvista:Banks have expertise in negotiating loans.
Is that what you call the housing bubble?
vikingvista:People who know how to do that well, who understand money and finance, frequently work for things we call "banks".
Yeah, because "money" and "finance" are such hard concepts for people to understand right?
vikingvista:People who want to receive such investments typically go to those places we call "banks".
So why are there stock brokers then? Oh wait, most people with money go to banks to DEPOSIT their money. Not LEND their money.
vikingvista:Instead, people like you and me and the grocery store owner, who lack that expertise, loan money to banks in the form of CDs so that we can make a small part of the profit that said banks make from their investments.
And the banks are making the profit on cheap money from the Federal Reserve...
Since there would be no central banks in a free society, banks would probably not offer CDs. Instead, people would go en masse to places like prosper.com that let people loan other people money. But oh wait, I wonder how they do it, since they apparently know nothing about money or finance?!!
vikingvista:You are forgetting that I am the one who selected the quote. I don't know what you are arguing with. My attribution to Rothbard is true, and you stand corrected.
You've selected a quote that only strengthens my point and weakens your attributes, how embarrassing for you.
"It is perhaps a "second-best" solution to the ideal of treating fractional-reserve bankers as embezzlers, but it would suffice at least as an excellent solution for the time being, that is, until people are ready to press on to full 100 percent banking."
Ideally, he'd have fractional-reserve bankers treated as embezzlers, criminal. You selected a passage where he describes an alternative, a "second-best."
DD5:Without the government, the question of whether people are deceived or not into accepting the checks as cash substitutes becomes relevant. Without the government, a check that is not backed by 100% is not a cash substitute. It will only be accepted as a substitute if people were deceived. Such is the origin of FRB and why it is fraudulent.
without government securing the deposits, a deposit certificate with a clause could not be traded as a deposit certificate without a clause. At best, it would be some sort of a financial instrument, but certainly not cash substitutes.
He asked for proof, first you give a non-sequitar, now you've given an assertion. An assertion that's already been refuted
DD5:If deposits are not backed by 100% and there is no deception (by a visible clause) , then they are not demand deposits but some financial scheme at best, or more accurately in this case, some sort of a lottery game that resembles a ponzi-scheme.
Fine. If you want to define FRB as only X, and demand deposits as only Y, have at it. At such point you are attacking a straw-man and not the FRB being defended. White even covered this bizarre approach ages ago.
vikingvista:Not all loans wind up SUCCEEDING as profitable investments, but the loaner always intends to make profit dependent upon the increased wealth of the borrower, and the borrower always expects to get more value than he's giving up. Otherwise, neither party would engage. If you do a full accounting of anticipated costs and benefits, voluntary loans are investments.
Excuse me but I meant "productive" investments from the point of view of the production system.
Angurse: DD5:Without the government, the question of whether people are deceived or not into accepting the checks as cash substitutes becomes relevant. Without the government, a check that is not backed by 100% is not a cash substitute. It will only be accepted as a substitute if people were deceived. Such is the origin of FRB and why it is fraudulent. without government securing the deposits, a deposit certificate with a clause could not be traded as a deposit certificate without a clause. At best, it would be some sort of a financial instrument, but certainly not cash substitutes. He asked for proof, first you give a non-sequitar, now you've given an assertion. An assertion that's already been refuted
That's not an assertion. It is a fact, and therefore, valid as proof.
It is a fact that a deposit certificate with a clause and a certificate without clause (backed by 100% reserves) cannot be treated the same by the market unless the former is deceived into looking like the latter. That they are different commodities is an undeniable truth like apples are not oranges.
DD5: That's not an assertion. It is a fact, and therefore, valid as proof. It is a fact that a deposit certificate with a clause and a certificate without clause (backed by 100% reserves) cannot be treated the same by the market unless the former is deceived into looking like the latter. That they are different commodities is an undeniable truth like apples are not oranges.
Have you never heard the expression in advertising "30 days same as cash". That means if you pay me in 30 days there is no penalty and it is just like you paid me today in cash. The market will treat CD's however it chooses to, it is not limited by your assertion, as proof the very common practice of accepting delayed payment with no penalty. . If the CD is backed by something or someone people feel is reliable then there is no reason to think that it is impossible for the CD to be treated the same as cash. Do you really think a CD redeemable tomorrow is impossible to be used as the same value as cash today? The time preference if any is based on the person accepting the CD, not your assertion.
If in a particular situation I am indifferent between cash and accepting a CD then the CD will act as cash.
Maxliberty: Have you never heard the expression in advertising "30 days same as cash". That means if you pay me in 30 days there is no penalty and it is just like you paid me today in cash. The market will treat CD's however it chooses to, it is not limited by your assertion, as proof the very common practice of accepting delayed payment with no penalty. . If the CD is backed by something or someone people feel is reliable then there is no reason to think that it is impossible for the CD to be treated the same as cash. Do you really think a CD redeemable tomorrow is impossible to be used as the same value as cash today? The time preference if any is based on the person accepting the CD, not your assertion. If in a particular situation I am indifferent between cash and accepting a CD then the CD will act as cash.
Nobody said you can't, for example, buy or sell a CD on the market, but its value will be expressed in some money prices. The same applies for your demand deposits with a clause.
Here is the crux of the argument: you have money deposited in some vault, and receive some claim tickets for that money, the ticket has a clause that says either:
1. for CD: redeemable only upon expiration of loan, otherwise pay fine.
2. for demand deposit: redeemable on demand with no 100% guarantee that the money will be there.
And you will still maintain that these tickets can somehow be treated as money substitutes when by definition, the clause says that they are not!!
The only way for a CD to become money is if the CD certificate itself is somehow accepted as circulating medium of exchange, but then it is impossible for the CD to retain the commodity money value of its face value, for the simple reason that the two are not exchangeable due to the time constraint of the certificate. The CD and the commodity money would become like 2 different monies with an exchange rate. This is of course silly, and doesn't make any sense why such a scheme could possible evolve in a market.
I see rothbardians are still in denial. This will apparently not ever change. So what was the point in restarting this topic? There is already 100 pages on this topic for anyone interested. The actual arguments here will not convince anyone to change opinion, I have debated Cantor cranks enough to know that.