JackCuyler: I tend to define insolvent as having a negative balance. Am I wrong? If not, it is impossible for a 100% reserve bank to become insolvent. If all deposits are simply stored, and all loans are made from real savings, as 100% reserve implies, the absolute worst possible scenario, barring a bank robbery, is a 0.00 balance. Every account could be closed and every single loan defaulted without a single payment, and the bank would still not have a negative balance. It would lose its savings, but not its customers' money. I'm also not sure how you would think competition would help keep FRB banks solvent. As loans are spent by the borrowers, the money will invariably be deposited in other banks, which will demand the funds from the loaning bank. The lower the reserve, the greater the chance of insolvency. I'm not arguing against FRB from an ethical standpoint (though I do question whether or not it's fraud to enter into multiple contracts without the ability to fufill them all) but rather on practical grounds. If banking were truely free, I think 100% reserve banks would do better on the market, due to their ability to weather bank runs. I don't doubt there would still be some FRB, but I doubt those with consistenly lower reserves than their competitors would not be in business very long.
I tend to define insolvent as having a negative balance. Am I wrong? If not, it is impossible for a 100% reserve bank to become insolvent. If all deposits are simply stored, and all loans are made from real savings, as 100% reserve implies, the absolute worst possible scenario, barring a bank robbery, is a 0.00 balance. Every account could be closed and every single loan defaulted without a single payment, and the bank would still not have a negative balance. It would lose its savings, but not its customers' money.
I'm also not sure how you would think competition would help keep FRB banks solvent. As loans are spent by the borrowers, the money will invariably be deposited in other banks, which will demand the funds from the loaning bank. The lower the reserve, the greater the chance of insolvency.
I'm not arguing against FRB from an ethical standpoint (though I do question whether or not it's fraud to enter into multiple contracts without the ability to fufill them all) but rather on practical grounds. If banking were truely free, I think 100% reserve banks would do better on the market, due to their ability to weather bank runs. I don't doubt there would still be some FRB, but I doubt those with consistenly lower reserves than their competitors would not be in business very long.
Hi Jack.
Regarding this part:
"If all deposits are simply stored, and all loans are made from real savings, as 100% reserve implies,..."
Where does the money for the loan come from in this example? Do you mean a totally separate loan operation having nothing to do with the stored money?
Adam
"It would be preposterous to assert apodictically that science will never succeed in developing a praxeological aprioristic doctrine of political organization..." (Mises, UF, p.98)
http://mises.org/Community/forums/t/9690.aspx
Also, it is possible for a 100% reserve bank to go insolvent. You can still lose money if you deposit in it. That depends solely on the profitability of loans that bank has made. What is not possible is "bank run", making the bank illiquid.
Also, your demand deposit is safe in any case.
azazel: http://mises.org/Community/forums/t/9690.aspx
lol, i liked that post. thanks for posting the link.
Only ideas can overcome ideas...
Even under the regular system of fractional reserve banking you don't create anything "out of nothing." When a bank writes a loan they give out money (the amount borrowed) in exchange for the asset (the loan, which entitles the bank to interest payments whose present value equals the value of the loan).
Judicator: Even under the regular system of fractional reserve banking you don't create anything "out of nothing." When a bank writes a loan they give out money (the amount borrowed) in exchange for the asset (the loan, which entitles the bank to interest payments whose present value equals the value of the loan).
That's an accounting equivalence. Central banks DO create money out of thin air.
Asset values aren't some accounting trick - loans realy do have value, rather than being "air" (although recent events maybe would have you believe otherwise lol).
Judicator: Even under the regular system of fractional reserve banking you don't create anything "out of nothing."
Even under the regular system of fractional reserve banking you don't create anything "out of nothing."
They actually do. Let's say that producer A sells an automobile for $1,000. The $1,000 in $_currency represents the automobile. In barter, the producer would have sold the automobile directly for another good that he or she was looking for. Money eases barter by allowing producers to trade with a "common good" that is widely accepted by everybody, but the concept is still the same as barter. Those $1,000 represents capital, or in this case Producer A's automobile.
Let's say that this money goes through the processes of fractional reserve banking, with a reserve ratio of 10%. In this case, we are talking about a single bank, not a cartel of banks (organized under a central bank), and so the amount loaned out will equate to $900. Producer A will put his $1,000 in a checking account. Under the terms of contract, the bank must have his money available at all times, because he has the right to withdraw his money whenever he wants to; those are the terms of a checking account. The bank loans out $900 due to the reserve requirement ratio, which means that the bank now has two figures in their assets book: $1,000 (original deposit) + $900 (loan). The $1,000 can be withdrawn on demand, and so assuming that the money is withdrawn before the loan capitalizes that loan is not really backed by any asset, because the original Producer did not agree to save that money for the duration of the loan... in fact, he is completely unaware of the existence of the loan.
The real danger is when this is applied to a bank with a large number of depositors, and especially when credit expansion is undertaken by a banking cartel or monopoly. I would suggest Jesús Huerta de Soto's "Money, Bank Credit and Economic Cycles".
Jonathan M. F. Catalán: They actually do. Let's say that producer A sells an automobile for $1,000. The $1,000 in $_currency represents the automobile. In barter, the producer would have sold the automobile directly for another good that he or she was looking for. Money eases barter by allowing producers to trade with a "common good" that is widely accepted by everybody, but the concept is still the same as barter. Those $1,000 represents capital, or in this case Producer A's automobile. Let's say that this money goes through the processes of fractional reserve banking, with a reserve ratio of 10%. In this case, we are talking about a single bank, not a cartel of banks (organized under a central bank), and so the amount loaned out will equate to $900. Producer A will put his $1,000 in a checking account. Under the terms of contract, the bank must have his money available at all times, because he has the right to withdraw his money whenever he wants to; those are the terms of a checking account. The bank loans out $900 due to the reserve requirement ratio, which means that the bank now has two figures in their assets book: $1,000 (original deposit) + $900 (loan). The $1,000 can be withdrawn on demand, and so assuming that the money is withdrawn before the loan capitalizes that loan is not really backed by any asset, because the original Producer did not agree to save that money for the duration of the loan... in fact, he is completely unaware of the existence of the loan. The real danger is when this is applied to a bank with a large number of depositors, and especially when credit expansion is undertaken by a banking cartel or monopoly. I would suggest Jesús Huerta de Soto's "Money, Bank Credit and Economic Cycles".
Here is a good chart I found on wikipedia on what happens to $100 at varying reserve ratios in a fractional reserve system.
http://en.wikipedia.org/wiki/File:Fractional-reserve_banking_with_varying_reserve_requirements.gif
If we are assuming that money is something that represents another asset (i.e. gold, silver, etc.), then I understand the context of the idea: "something is created out of nothing" when money is circulated exceeding the value of the assets the money is supposed to represent. However, the dollar, for instance, is not based on this kind of contractual arrangement.
The dollar is not backed by anything but itself. Also, it is well known around the world that the dollar is based on a system where a central bank increases and decreases the supply of dollars in order to target interest rates which they deem appropriate according to specific goals.
So when someone says "something is created out of nothing" in regard to a currency that is based on a system as described above, it is really out of context because all dollars are based on nothing but themselves. New dollars are created on the basis of the system above, and existing dollars "exist" on the basis of the system described above.
Now I may be stating the obvious here, but if that is the case, then stating that "dollars are created out of thin air" when the Federal Reserve Bank of the United States increases the supply of dollars is stating the obvious also. Because the system is operating on the basis that dollars are independent of anything but themselves.
I don't really understand why pointing out this fact is such a high priority for the Austrian School. Why do we even bother? Am I off-base here?
Promoting the replacement of the current money and banking system with a new "Austrian School" system would be completely contrary to what the Austrian School is all about. The Austrian School is not a business or money and banking system. It is a school of thought that points out the consequences of not allowing liberty and competition in all markets.
With this in mind, it would seem that as Austrian School Theorists we would be pointing out the consequences of ONE system being the coercive monopoly over ANY market, and not promoting any particular system. I think that this is what the ABCT was all about.
While Mises and Hayek had various opinions on what system might emerge in a free money and banking system, their primary focus was on the consequences of not allowing the market to determine the interest rate. The only way the market could determine the interest is if new systems were allowed to emerge and all systems were allowed to compete. Mises and Hayek never proposed that their opinions on what system might emerge in a free market should be the only systems allowed.
I'm not saying that it won't be the case that 100% reserve currency based on some precious metal will be what is chosen in a free banking system. I’m just saying that it isn’t my primary focus considering myself a studier/theorist of the Austrian School.
Jonathan M. F. Catalán: Judicator: Even under the regular system of fractional reserve banking you don't create anything "out of nothing." They actually do. Let's say that producer A sells an automobile for $1,000. The $1,000 in $_currency represents the automobile. In barter, the producer would have sold the automobile directly for another good that he or she was looking for. Money eases barter by allowing producers to trade with a "common good" that is widely accepted by everybody, but the concept is still the same as barter. Those $1,000 represents capital, or in this case Producer A's automobile. Let's say that this money goes through the processes of fractional reserve banking, with a reserve ratio of 10%. In this case, we are talking about a single bank, not a cartel of banks (organized under a central bank), and so the amount loaned out will equate to $900. Producer A will put his $1,000 in a checking account. Under the terms of contract, the bank must have his money available at all times, because he has the right to withdraw his money whenever he wants to; those are the terms of a checking account. The bank loans out $900 due to the reserve requirement ratio, which means that the bank now has two figures in their assets book: $1,000 (original deposit) + $900 (loan). The $1,000 can be withdrawn on demand, and so assuming that the money is withdrawn before the loan capitalizes that loan is not really backed by any asset, because the original Producer did not agree to save that money for the duration of the loan... in fact, he is completely unaware of the existence of the loan. The real danger is when this is applied to a bank with a large number of depositors, and especially when credit expansion is undertaken by a banking cartel or monopoly. I would suggest Jesús Huerta de Soto's "Money, Bank Credit and Economic Cycles".
I wasn't claiming that fractional reserve banks didn't expand the money supply, just that this expansion of the money supply was somehow out of nothing. I was only taking issue with the "out of nothing" point. You could do the same thing banks do privately - I could buy a house using your money in exchange for a claim on my house, and the seller of the house could buy something else using someone else's money, and so on.
Hi Jonathan.
I don't believe you are describing a situation where something is created out of nothing. I believe you are describing a situation where an additional claim is being issued against the same amount of assets, and where some parties to this transaction are unaware of this and/or did not agree to it.
The issuance of additional claims has the effect of lowering the value of each claim relative to the fixed amount of assets. There is a devaluation of the claims. If the person who holds one of these claims is unaware that his claim is being devalued, then when he goes to redeem it, he won't be able to redeem it for as much as he expected. If he had entered into a specific agreement stating that his claims would not be devalued in this manner, then this is a matter of breach of contract....
But I don't see how what you describe is creating something out of nothing. You are describing the issuance of what you call unbacked claims or loans, when some interested or invested party is unaware of this. There is no "nothing" there. All the actions are perfectly understandable from a theoretical point of view.
If I'm Picasso, I can draw a flower on paper and sign it and use this as a form of money (the drawing will have exchange value in some markets). Someone may accept one of Picasso's drawings in a market exchange. If they can get Picasso to agree not to make any further drawings, there is a good chance that the value of the drawing they had just accepted will remain stable in exchange value or even increase in exchange value. On the other hand, if they enter into no such agreement with Picasso, Picasso may feel that he is perfectly entitled to make and distribute thousands, and even tens of thousands of very similar drawings as a kind of money for the remainder of his lifetime. In that case, the exchange value of such drawings could easily decrease as he issued more and more of them. A person could conceivably go to sell one of the drawings, believing they would be worth around $1,000, and find out that they are so common (that so many of them have been issued), that they were worth only $65 on the market.
In issuing the additional drawings, Picasso hasn't created something out of nothing, even though each drawing may take him less than ten seconds to make. What he has done is to effectively decrease the market value of such drawings by issuing more of them.