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.
hi max, if it please you i am happy to concede that your form of banks (Perhaps Deposits) sohuld be able to compete with other traditional account suppliers (Demand and Time), so long as they are explicit and correctly formulate their contract to be honest. given that, has our dispute come to an end? is this the end of the thread?!?!
(oh, and current FRB is fraud and evil)
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
nirgrahamUK: hi max, if it please you i am happy to concede that your form of banks (Perhaps Deposits) sohuld be able to compete with other traditional account suppliers (Demand and Time), so long as they are explicit and correctly formulate their contract to be honest. given that, has our dispute come to an end? is this the end of the thread?!?! (oh, and current FRB is fraud and evil)
Yes this is the end.
MaxLiberty:With regard to the changes in the contract which are at the heart of your arguement, there will be no fucntional difference in banks in a free society as a result of that.
Did I say anything about bailouts in free banking?
The facts as they exist now demonstrate otherwise.
Finally, you can not prove that banking as I suggest it will exist is inherently insolvent.
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
Agreeing to something upfront does not make it right. If I sign a contract to buy anything you steal is this a valid contract. If the money supply increases you are going to have inflation. This doesn't just mean actual paper money in circulation it also refers to money in our accounts. If you agree to enter into this contract with a bank it may be worth while because you get better return than you lose in inflation but what about the people who do not do business with this bank or any bank for that matter. Their rights are being violated by debasing the currency they hold
Maxliberty:No, people will still believe they have instant access to the money. Austrians have a very difficult time dealing with probability. People can expect that they will have instant access to the money and also understand that there is a small probability they will not. The difference between us is that I am willing to let people freely make that decision and many Austrians are not.
Shawn77:Their rights are being violated by debasing the currency they hold
As any libertarian worth his salt will tell you there is no right to property value.
scineram: Shawn77:Their rights are being violated by debasing the currency they hold As any libertarian worth his salt will tell you there is no right to property value.
I would agree we do not have the right to a fixed value for property the market, of course, sets that. How does that justify coin shaving, counterfeiting, bank credit expansion or any other inflationary measure?
Here's a story I just wrote to help explain what the Fed's doing to wreck our economy. Please let me know if it helps.
Normal 0 false false false MicrosoftInternetExplorer4
The Three Little Pigs and the Federal Reserve Crisis
In their later years, they bought a yacht and sailed the seven seas. The three little pigs each had a bag of gold coins to spend at the various ports of call. The good life. No wolves, no Federal Reserve, no worries. Or so they thought…
One dark and stormy night, they were shipwrecked on a deserted tropical island. They spluttered ashore each with their coin purses clutched greedily…
ONE YEAR LATER…
No one came to rescue them and after some trial and some error, they had established a common sense division of labor: each pig specialized in doing one thing so their combined output was more than if each had to do everything for himself. And they were able to trade with each other using their gold coins. It wasn’t what you’d call “the good life” anymore, but it was pretty good and it worked. Here is how: One pig cut down trees and fashioned them into good square lengths of lumber stored flat in his lumber shed. He became the Lumberpig and worked day and night making one good square-cut length of lumber every month (he only had one simple stone tool). Another pig, the Fisherpig, specialized in fishing from a small raft and offering fresh seafood for sale on the beach every day before lunch – and surfing all afternoon. The third pig used a small bucket that had washed ashore to go back and forth to the spring in the middle of the island to collect water for sale to his brothers. They started calling him Bucketpig, or Buck for short. Buck would often join Fisherpig in the evening for drinks and fish feasts on the beach in front of a roaring fire of lumber pieces. All work and no play made Lumberpig a dull pig – although he had saved up a respectable pile of lumber. Not huge, but respectable.
THE CAPITALIST PIGS DREAM…
Like many a businessman over drinks after work, Buck and Fisherpig would brag and tell lies to each other about the expansion plans they had and how they were going to hit it big. The truth was, they did each have a pretty good plan: Fisherpig was planning to plough his savings into new lumber to build a fishing boat with oars and a mast so he could get out to where the big hauls were. That way he could be finished getting a daily supply of fish for the island in the morning and start a tool making business on the side. For his part, Buck had in fact already drawn up plans for a simple lumber aquaduct to bring water in from the spring. He then would be free to work on his wind power idea (he was planning to stay specialized in Utilities). Each dreaming pig just needed 100 lengths of lumber. Each pig just had one problem: Lumberpig charged 1 coin per length and each pig only had about 50 coins in their piggy bank – in a good month. Who could ever seriously save 100 coins anyway? Ah well, they each thought before going to sleep, “At least dreaming is free.”
FREE MONEY! REAL OR A MIRAGE?
One evening, their stories spent, Fisherpig and Buck gazed in silence over the blue green span of the lagoon. Something caught their eye. “Do you see what I see Buck?” Buck was already up on his hind trotters and half-way there…
“It’s a treasure box washed ashore and filled with 200 gold coins!!...If you promise not to tell Lumberpig, I’ll split it with you 50/50.”
“Sure. You and I have just inflated the island’s money supply.”
“Yeah! I just love inflation, don’t you? Especially when you get the new money first and nobody else knows about it!”
They laughed and feasted deep into the night. Each secretly planning to rise early the next morning to start working on their dreams! Dreams that would unfortunately turn into nightmares because of the treasure box's evil inflation that they didn’t yet understand.
LUMBERPIG STARTS SELLING OUT OF INVENTORY….
Day and night weren’t enough time anymore for Lumberpig to keep up his inventory levels. In the past few months both his brothers had been placing about four times the usual volume of lumber orders. More money was good all right, but what he hadn’t told them was that at this rate, he was running out of lumber! He kept his lumber shed locked up and no one knew the actual “respectable” quantity he usually had in inventory but him. Truth was, it was normally only about 100 lengths. And as hard as he worked, he couldn’t work fast enough to make more than one length a month. He was down to 20 lengths left and stared up at the ceiling at night, “What should I do? Fisherpig and Buck are each buying about 2 lengths a month. How many surfboards and bonfires do they need? In less than six months I’ll be out of stock!! He thought of raising his prices. Hmmm. That would stop frivolous buying wouldn’t it? Then the pig who needed the lumber most would pay the higher price, right? Sounds fair …and even more extra money for me would be nice. No. I can’t do that. I’m not a greedy pig. I’ll leave my prices where they are….maybe things will work out somehow if ..but…zzz…zzz.” And he fell asleep.
Meanwhile, Buck and Fisherpig were each 40% done on their respective projects and going full steam. Little did they know, that in 5 months, Lumberpig was going to hit them with news that would have the impact of a 2x4 between the eyes.
FREE MONEY WASN’T REAL AFTER ALL. IT WAS A MIRAGE. IT DIDN’T CREATE NEW RESOURCES…IT WAS EVIL INFLATION…EVIL INFLATION THAT CONFUSED CAPITALIST PIGS INTO STARTING PROJECTS THAT COULD NEVER BE FINISHED…
“Sorry Buck. Sorry Fisherpig. See for yourself,” Lumberpig opened the shed door wide. “The lumber is all gone. I’m sold out.”
“AGGHHHH!!! NO!!!” said Fisherpig. “I’m ruined! I used the raft lumber in my new boat construction that is only half done! Now I have nothing to fish with to make a living!! And Lumberpig, you made it worse! Why didn't you raise your prices right away to stop one of our projects sooner -- especially Buck's harebrained water slide!! So much extra WASTE!! -- just because you couldn't bring yourself to be greedy!!!...If only that phony inflation box had never appeared!!!”, he sobbed.
“I’m hungry,” said Buck thoughtfully. “And you know what? I screwed up too. I’ve built a water bridge to nowhere. And, Fisherpig, you know what’s funny about all this? If we hadn’t been fooled by that box of inflation, you and I could have pooled our savings and actually completed one of our projects.”
There was no fire on the beach that night. Not even a meager fish dinner. And three thirsty little pigs. Later they burned the inflation box to keep warm for a while.
**THE END**
Rev.1 Feb.24/09
Copyright 2009.
To slowly kill FRL i would (now its the right moment) require a 40% reserve ratio. Little by little I would increase this 5% a year until we have a 100% reserve system.
I'm not an expert or an economist. I have looked into some gold vaults. These are interesting places that store your gold and charge a storage fee. They also buy and sell gold on the open market by wire transfer of funds. And they issue gold-grams or the equivalent. A gold-gram is currency 100% backed by your gold with no interest, but perhaps a charge or porfit for buying and selling again, depending on gold prices.
Anyway, suppose a gold bank in your town. It does not pay you interest because it's your gold, not the banks. But it provides many services, for a fee. One service is mortgage banking - they arrange mortgage loans. If I choose to lend my gold to a house buyer I do so. I'm the mortgage lender. I get all the mortgage interest. If the mortgage borrower skips town I get all the loss. So I require my mortgage banker to set up face to face meeting(s) before I make a decision and I DYOD. Of course, mortgages are only one example of many types of loans.
When I loan our my gold to someone else I don't have it. So I only loaned the gold that I have saved for that purpose, not the gold that I use for living expenses.
I think this is a very extreme example of 100% banking. But I hope it helps.
I'm glad someone stickied this.
I'm a newcomer to the Mises forum, though I've been plowing through Rothbard's MES like a madman for the last two months. I, like so many others, have yet another question about the fractional reserve system.
I understand how a bank keeping 100% reserves can make money, and I understand how fractional reserve banking can be considered fraudulent and how it increases the money supply. Here's what I don't understand: say we outlaw FRB -- won't there be some kind of financial institution that isn't legally able to be called a 'bank' but performs the same basic functions as fractional reserve banks back when they were still legal? Perhaps this new kind of institution will have a highly effective advertising campaign that says, 'Hey, remember the old banking system? That wasn't so bad, eh? Well, give your money to us and we'll do the exact same thing as the old banks!' and the clients, familiar with the old banking system, will put their money into this financial institution, the same way they did with old banks, and the only thing that will be different is that they will sign off saying they understand the risk involved in the case of a 'bank' run and that if the institution truly has no money to pay the depositors back on demand, then that's that and the depositor's will simply go unpaid, as agreed in the voluntary contract. Now, what's to stop this from happening? Would this be illegal under libertarian law? Furthermore, wouldn't this institution, if permitted, continue the trend of creating money out of thin air?
I don't think it's necessary to actually outlaw FRB. Market competition between banks will naturally punish and limit the practice. See Rothbard's History of Money and Banking (pdf link) - specifically, see the chapter titled: A Free Market "Central Bank".
Thanks for the link, I will look into that. In MES, he definitely sounds like he wants to outlaw it -- "Most present legal systems do not outlaw this practice; in fact, it is considered basic banking procedure. Yet the libertarian law of the free market would have to prohibit it." Though at the same time, I think he was assuming that the depositors weren't earning interest for the gold they were keeping in the 'warehouse', whereas I think an overwhelming majority of banks operate that way now, in that they're actually borrowers.
But even if market competition limits the practice, there will still be fluctuations in the total stock of money, right? And why would it suddenly not be considered fraud anymore?
The problem is given by the government that insures deposit accounts in bankrupt FRB.
If a consumer had the freedom to choose between a full reserve bank and an uninsured fractional reserve bank, that would be fair market competition.
bedwere: The problem is given by the government that insures deposit accounts in bankrupt FRB. If a consumer had the freedom to choose between a full reserve bank and an uninsured fractional reserve bank, that would be fair market competition.
But a fractional reserve bank that claims to have all deposits on hand (i.e. full reserve bank) would be a fraud.
At most, I think only 5% of the adult population would need to stop cooperating to have real change.