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.
z1235: Can you give some concrete examples for situations when a free market agent (yourself, person, corporation, depositor?) "demands" more cash holdings than they already have? What would cause this "demand" to appear and what would these "extra" cash holdings be used for? I assume that you are not referring to a scenario where you spend your bank account down to $0 whereupon you express your "demand for cash holdings" which the bank's "money supply" is supposed to meet, but I could be wrong. Z.
Can you give some concrete examples for situations when a free market agent (yourself, person, corporation, depositor?) "demands" more cash holdings than they already have? What would cause this "demand" to appear and what would these "extra" cash holdings be used for? I assume that you are not referring to a scenario where you spend your bank account down to $0 whereupon you express your "demand for cash holdings" which the bank's "money supply" is supposed to meet, but I could be wrong.
Z.
This is basically where I'm at right now. I mentioned on a previous post that the demand for money is closely tied to routinized transactions, and for periodic payments which fall during specific dates (first and last of every month--certain expenses). You can facilitate the demand for money as money during such periods in order to prevent unnecessary deflation (demand pushes money rate above natural rate in MM, and people begin to sell and restrict purchases for increased liquidity). The demand for money also rises during periods of uncertainty. As I understand it, this will constitute a real move towards savings, but banks may overcompensate by contracting the money supply too quickly, also elevating the market rate above the natural rate. Then there are also exogenous changes: for example, the government may increase wage rates by decree, which would lead to an increased business demand for cash holdings, which, if satiated, would undo the government policy (this reeks of Monetarism and rational expectations--so I have a problem with this). Hayek says that satiating the demand for money as money is legitimate (expecially during down turns), but he doesn't really go into this too much. I'm sure the modern day free bankers clarify, but they sound like confused monetarists to me, so i haven't read their stuff.
But the overall argument is logically sound, though the specifics (for me at least) are vague. The implication is that during downturns (which are inevitable, according to Hayek) you increase the money supply, and during booms you limit the expansion of fiduciary media. The goal is to keep the interest rates equal (even during periods of relative stability). Mises doesn't explicitly make these arguments (Hayek does), but he does so implicitly, in my opinion. He says eliminating fiduciary media leads to "undesirable consequences" (more than one), but only mentions one undesirable consequence in TMC. (The elimination of fiduciary media would cause a rapid appreciation in the value of gold (money proper), leading to an allocation of resources towards the production of precious metals, which would increase the supply and satiate the demand for money. This would divert economic resources towards unfruitful economic activities (production and discovery of precious metals).
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
Esuric: (The elimination of fiduciary media would cause a rapid appreciation in the value of gold (money proper), leading to an allocation of resources towards the production of precious metals, which would increase the supply and satiate the demand for money. This would divert economic resources towards unfruitful economic activities (production and discovery of precious metals).
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: Esuric: (The elimination of fiduciary media would cause a rapid appreciation in the value of gold (money proper), leading to an allocation of resources towards the production of precious metals, which would increase the supply and satiate the demand for money. This would divert economic resources towards unfruitful economic activities (production and discovery of precious metals). now if you can quote me happy with Mises referring to 'unfruitful economic activities' vis entrepreneurs led by price signals to mine precious metals in an unhampered market you will have taught me something today.
“In fact, the development of the clearing system and fiduciary media has at least kept pace with the potential increase of the demand for money brought about by the extension of the money economy, so that the tremendous increase in the exchange value of money, which otherwise would have occurred as a consequence of the extension of the use of money, had been completely avoided, together with its undesirable consequences. If it had not been for this the increase in the exchange value of money, and so also of the monetary metal, would have given an increased impetus to the production of the metal. This would undoubtedly have meant increased returns to certain individual undertakings; but the welfare of the community would have suffered. The increase in the stock of precious metals which serve monetary purposes would not have improved the position of the individual members of the community, would not have increased the satisfaction of their wants; for the monetary function could also have been fulfilled by a smaller stock.... This all becomes particularly clear if we think of an economic community which does not itself produce the precious metals, but imports them. Here the amount of their cost is expressed by the quantity of commodities that must be surrendered to foreign countries in order to obtain the supplementary quantity of monetary metal in exchange." -Theory of Money and Credit, pp. 338There's more, but I'm too lazy to quote the entire passage (about 3 pages long).
Esuric:Mises: “In fact, the development of the clearing system and fiduciary media has at least kept pace with the potential increase of the demand for money brought about by the extension of the money economy .........",
has at least kept pace with the potential increase of the demand .....
at least is the key word here, because the overall view of Mises, in the broader sense, is that fiduciary media is bad.
If not, how do you reconcile your interpretations with the quotes I provided here:
http://mises.org/Community/forums/p/6197/306110.aspx#306110
By the way, Money and Credit is Mises' first work on this matter. He refines his argument in later works. Read Human Action. His position on these matters becomes much more concise and clear.
What is the idea of interpreting a theory solely based on the first "draft" written by Mises in his early 20's, as oppose to the more refined theory written in his 60's, such as Human Action. I don't get it. Don't you figure that his theoretical thoughts would have evolved?
Esuric:There's more, but I'm too lazy to quote the entire passage (about 3 pages long).
Good point, Mises does have his weak moments in Theory of Money and Credit. Plenty of good stuff is in there that gets carried along ,but plenty is superceded (i.e. Human Action).
Here is a very good article about Theory of Money and Credit
http://www.indytruth.org/library/journals/libertarianstudies/18/18_3_4.pdf
It is true that, in the Theory of Money and Credit, Mises did find an equilibrating advantage in fiduciary media. It is also true that some imperfections we already identified in his earlier analytical framework can support the doctrine that the supply of money does not equal the demand for it. Nevertheless, the free bankers' view is in complete contradiction with Mises's accomplished monetary theory from Human Action. In pure quantitative terms, the supply of money, which is a given stock of monetary units, can never diverge from the demand for money, which is the demand to hold this same stock. Moreover, in Human Action, Mises makes it very clear that an analysis in terms of monetary equilibrium can be but abortive for understanding monetary issues, because monetary equilibrium prevails necessarily on the free market. What must be dealt with is the "money relation" and its study shows that "he who wants to increase his cash holdings restricts his purchases and increases his sales and thus brings about a tendency toward falling prices."109 Lower prices are not necessary for monetary equilibrium to be achieved; they are only the manifestation of a different monetary equilibrium, i.e., of a change in the money relation. Therefore, "sticky prices" cannot be an obstacle for achieving monetary equilibrium; on the contrary, they are the outcome of a long-lasting equilibrium. Let us note here in addition that we have already analyzed Mises's arguments denying any convulsions caused by a downward trend in money prices. Taking them into account, we deduce that the whole case for the equilibrating properties of fiduciary media, as expounded by the free bankers, collapses. We conclude at the impossibility of any affiliation whatever between the modern free banking school and Mises's monetary theory. Essential differences separate their respective views even as to the advantages of free banking. The free bankers view free banking as that institution which supplies any quantity of media of exchange that individuals require, the supply being limited by cost-benefit calculations. On the other hand, Mises concludes that unprivileged banking, i.e., one committed to perfect convertibility and freed from any state involvement, is advantageous because it is the only monetary regime that neither disrupts entrepreneurial action nor annihilates the benefits from the division of labor.
What must be dealt with is the "money relation" and its study shows that "he who wants to increase his cash holdings restricts his purchases and increases his sales and thus brings about a tendency toward falling prices."109 Lower prices are not necessary for monetary equilibrium to be achieved; they are only the manifestation of a different monetary equilibrium, i.e., of a change in the money relation. Therefore, "sticky prices" cannot be an obstacle for achieving monetary equilibrium; on the contrary, they are the outcome of a long-lasting equilibrium.
Let us note here in addition that we have already analyzed Mises's arguments denying any convulsions caused by a downward trend in money prices. Taking them into account, we deduce that the whole case for the equilibrating properties of fiduciary media, as expounded by the free bankers, collapses.
We conclude at the impossibility of any affiliation whatever between the modern free banking school and Mises's monetary theory. Essential differences separate their respective views even as to the advantages of free banking. The free bankers view free banking as that institution which supplies any quantity of media of exchange that individuals require, the supply being limited by cost-benefit calculations.
On the other hand, Mises concludes that unprivileged banking, i.e., one committed to perfect convertibility and freed from any state involvement, is advantageous because it is the only monetary regime that neither disrupts entrepreneurial action nor annihilates the benefits from the division of labor.
nirgrahamUK:109 Lower prices are not necessary for monetary equilibrium to be achieved; they are only the manifestation of a different monetary equilibrium, i.e., of a change in the money relation.
Yes, but the point is this adjustment between different monetary equilibrium's.
nirgrahamUK:Therefore, "sticky prices" cannot be an obstacle for achieving monetary equilibrium; on the contrary, they are the outcome of a long-lasting equilibrium.
In the long-run you are correct. But the adjustment process is the problem. We can allow prices to adjust, and that would indeed restore monetary equilibrium, but that's very painful (and unnecessary).
nirgrahamUK:We conclude at the impossibility of any affiliation whatever between the modern free banking school and Mises's monetary theory.
I know very little about the modern free banking school. I'm not going to defend them.
Also, a secondary source about what Mises "really said" or "truly meant" in Human Action is meaningless to me. I will read it myself after I finish Pure Theory of Capital. I'm beginning to think that there's a substantial difference between Hayek/early Mises and the modern free banking school; that, or the 100% reserve guys are attacking a straw man.
Esuric:In the long-run you are correct. But the adjustment process is the problem. We can allow prices to adjust, and that would indeed restore monetary equilibrium, but that's very painful (and unnecessary).
what economic arguments can be mustered to bear out the claim that market actors adjusting prices so the markets for their goods can clear( given a change in the actors subjective values) is 'very painful' ? is it more painful than alternatives?
Esuric: nirgrahamUK:Therefore, "sticky prices" cannot be an obstacle for achieving monetary equilibrium; on the contrary, they are the outcome of a long-lasting equilibrium. In the long-run you are correct. But the adjustment process is the problem. We can allow prices to adjust, and that would indeed restore monetary equilibrium, but that's very painful (and unnecessary).
This statement is almost an exact description [word for word] of the "paradox of thrift", except that you describe the transition as "very painful" and a Keynesian may describe it as problematic. Keynesians too share almost your exact concerns only in the short run.
I'm not saying you're a Keynesian, don't misunderstand me. You realize that the price system can coordinate and they are clueless, however, your argument is gradually taking you to the same conclusions. One cannot deny at least the resemblance.
DD5:This statement is almost an exact description [word for word] of the "paradox of thrift", except that you describe the transition as "very painful" and a Keynesian may describe it as problematic.
You don't know what the paradox of thrift is. The paradox of thrift is based on the circular flow model and deals with "aggregate demand." I'm talking about inter-temporal stability and the structure of production. This has nothing to do with an illusory correlation between the total aggregate demand for consumer goods and employment, nor does it predict a Wicksellian rot. The economy adjusts, and that Say's law holds. You should try to understand Keynesian and Mercantilist doctrines before you accuse others of supporting them. The only similarity is that both Keynesians and Austrians understand that prices are sticky (this was "revolutionary" in the Anglo-American world).
Esuric:You don't know what the paradox of thrift is. The paradox of thrift is based on the circular flow......
I made it very clear that you don't agree with Keynesians on theory, however, your conclusions are very similar. I don't need you schooling on "the paradox of thrift".
Esuric:I mentioned on a previous post that the demand for money is closely tied to routinized transactions, and for periodic payments which fall during specific dates (first and last of every month--certain expenses). You can facilitate the demand for money as money during such periods in order to prevent unnecessary deflation (demand pushes money rate above natural rate in MM, and people begin to sell and restrict purchases for increased liquidity).
This demand can be satiated through the debt market. Short-term loans, bridge loans, "just to tie me over until next week" loans, merchandise loans, salary loans, etc. I'd gladly lend my capital (savings) for any of these needs given a rate of return that is commensurate to the creditworthiness (collateral, credit rating, etc) of the borrower in need of such liquidity. I don't see why any of these would necessitate FRB.
Today, banks are corporations called with a different name ("banks") merely due to the special status granted to them via the central banking and fiat money regime. In a free market, "banks" would be just like any other corporation. Without this special status (granted by whom, btw?) the market would treat a bank that lends non-existent capital, just like it treats a car-dealer that sells non-existent cars. In a free market, "free banking" would be as viable as "free car-dealing".
z1235:Today, banks are corporations called with a different name ("banks") merely due to the special status granted to them via the central banking and fiat money regime.
Because banks existed houndreds of years before corporations.
Wed. 10/02/24 18:39 EST.post #5
bedwere:The problem is given by the government that insures deposit accounts in bankrupt FRB.