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.
Then I must ask -- why doesn't Rothbard acknowledge this? Does he really believe that's how we think banks work? To say such a profound thing that fractional reserve banking would be illegal in libertarian law but then leave out the question about banks as they currently stand (i.e. technically they borrow from us) is a little disingenuous. Maybe he'll touch on that in the last chapter...
Here's the problem for the FRB bank:
bedwere: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.
Most consumers are not that smart. The limiting factor for FRB is competition from other banks. When a bank receives deposits in the form of banknotes from a competing bank it will not hold those notes, but will instead immediately present them for redemption in gold. Every bank's ability to float its own bank notes is limited by its gold reserves, so every bank will be out to increase its own gold holdings anyway it can. So any bank that prints too much paper will quickly find its vault empty.
Two recent threads on this debate here and here.
scineram: Two recent threads on this debate here and here.
Scin, excellent hyperlinks.
I, as an entrepreneur and student at a University, am much more convinced by White and Selgin's positions on FRB, call-loans, and monetary policy. I am not belittling the otherside, mind you, but as a hopeful intellectual, I am more convinced when Larry White or George Selgin speak to history and research than when members of the other side are.
Specifically because I once considered myself more Chicago on money than "Austrian".
existence is elsewhere
Seems to me that you all seem to think that money is something created by society. Money is a creation of the banking system, and is in fact the bank's liability. Why should the bank not use its credit? If the bank's credit is deemed worthless, then our credit too is worthless.
Arman:Money is a creation of the banking system,
Huh? You do not consider gold coins as money? You think bank employees are the only ones that know how to make gold coins?
At most, I think only 5% of the adult population would need to stop cooperating to have real change.
Seems to me that you all seem to think that money is something created by society. Money is a creation of the banking system, and is in fact the bank's liability.
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."
GilesStratton: Here's the problem for the FRB bank: If they have less than 100% reserves there exists a possibility any given depositor won't get their money back, In an attempt to obviate this problem they can inform their depositors that there is a possibility that they will not get their money back if they don't come to the bank in time in the event of a bank run, However, this is still problematic since the FRB note entitles the holder to present goods, In essence the nature of the FRB bank note is such that the holder has a certain % chance of getting the goods to which he is entitled, should he choose to exercise the right given to him by the bank note, However, this is not a bank contract of any type, rather, it is an aleatory contract. In other words, it is a lottery ticker and to represent it is anything else would be fraudelent.
I agree. And besides, FR banking expands the money supply and creates inflation, which never affects the whole economy at once and to the same degree. the expansion of credit, and the inflationary boom that follows, will then reward the early receivers of the money at the expense of the late receivers and the people with fixed incomes and wages. Rothbard, in 'The Mistery of Banking', calls FR banking a form of embezzlement and I think he's right.
«I believe there is something out there watching us. Unfortunately is the government». Woody Allen.
Spideynw: Arman:Money is a creation of the banking system, Huh? You do not consider gold coins as money? You think bank employees are the only ones that know how to make gold coins?
When was the last time you spent a gold coin?
The content of the debt marker is moot. Money is created on the ledgers of the bank. Money is not money until it is borrowed from a bank
Juan:Seems to me that you all seem to think that money is something created by society. Money is a creation of the banking system, and is in fact the bank's liability. That's a great thing to say to people who at least have some[i/] understanding of money. Even the most clueless 'austrian' defenders of fraudulent reserve banking know that money is not 'designed' nor 'created' by anyone, but comes into existence through individual interactions in the market - aka society. I hope anybody with at least a passing familiarity with economics will now stop listening to your 'theories' ....
You confirm my theory that you think money comes from society, and then you go on to rant about my '"theories"''. Did you take your stupid pill today? Did you accidentally overdose?
You confirm my theory that you think money comes from society, and then rant about my "'theories'"
Juan:money is not 'designed' nor 'created' by anyone, but comes into existence through individual interactions in the market - aka society.
This explanation of where money comes from is quite non descriptive. Yes, this seems to be the best that the conventional economist can come up with, but if you don't see it as vague, then you aren't reading it well.
Rui Botelho Rodrigues:And besides, FR banking expands the money supply and creates inflation, which never affects the whole economy at once and to the same degree.
Yes it does. The value of the dollar is in its scarcity. When the quantity is expanded, the real value goes down. No part of society is isolated from the dollar's deterioration.
Rui Botelho Rodrigues:the inflationary boom that follows
Inflation does not contribute to a boom in any way. An economic boom will always feed some inflation, because as the velocity increases, the same dollar will go through more transactions and so will appear to be less scarce. Economists as a general rule create reverse causality.
Banks would loan out the money that people loan to the banks. Banks are expert in finding good credit risks, while depositors are not. To you it would be like CDs. You loan a sum of money to a bank under set terms, including a restricted withdrawal schedule. The bank then loans that money out using its investing expertise. Their profits from the loans would be spread between the interest they charge borrowers, and the interest you charge the bank.
Rothbard did not necessarily advocate banning fractional reserve banking per se. If not banned outright, however, it was imperative that the bank suffer the consequences of inadequate funds--e.g. bankruptcy. That way the market could regulate the credit expansion risk. If a bank somehow managed to find a successful fractional reserve business model that allowed it to survive panic after panic, who are we to claim to be better bankers? But that is a big "if".
The switch wouldn't be too complicated for most depositors. Banks would likely usually charge depositors for demand deposits instead of paying a paltry interest like they do now. If you wanted to try to earn interest on your funds, you'd expressly loan it to the bank (like CDs). But that would restrict your use of it (as well it should). So typically, you would minimize the amount you kept accessible in your checking account--probably not unlike you do now. But the rest would probably be loaned out to the bank the way people currently keep staggered CDs.
Fractional reserve banking may be exceedingly risky, but it is doing so with demand deposits that is fraudulent. It is deliberately falsely promising to have more funds available than it really does. Just because they USUALLY do wind up having the funds available when people usually want them doesn't keep it from being fraudulent. Runs on banks should never leave anyone without the funds the bank promised them. Loans are different than demand deposits. Every loan has an assumed risk of no payment. Of course who knows what the banks would dream up. They may allow "demand deposit" functionality under normal conditions with the bank option of tying up your funds for a period of time if they so chose. That alone might be sufficient to survive runs.
Conventional wisdom is that NOT having fractional reserve demand deposit banking would suppress economic growth. In fact, the only "growth" it would suppress is the run up of a credit bubble--along with the subsequent recession. Since bubbles are actually a misallocation, a squandering, of resources--a dead end--they represent a 'paradoxical' loss of wealth even during the high times of the bubble--a loss only being realized during the correction. Thus suppressing bubbles would only serve to increase long term economic growth.
Maxliberty:The approved answers to the OP are that in a free society only two types of banks will exist, 100% reserve banks (demand deposit) and essentially 0% reserve banks (time-deposit).
"0% reserve banks" are therefore, not banks.