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.
Is there a problem with having somewhat similar conclusions? Keynes' theory, after all, is pretty much just a special case of Austrian theory. One where all the variables line up just right for his high level of aggregation to be useful. That never occurs in real life, of course, but then again, Austrian macro-economics doesn't exactly line up with real life, either, just a lot better than rival theories. It just so happens that Keynes' special case applies in a broad sense to an institutional structure that includes an irredeemable paper currency that is also legal tender and is issued by a monopoly provider. Now, his specific policy recommendations didn't work out because, like I said, it only applies in a broad sense. To make it apply in a specific sense would require governments to take ever more control over the economy as it innovated itself out from under the current set of policy controls.
In a real free banking environment, where we don't save long term in the same money we spend in the short term with, there's more flexibility. Real fractional reserve banking contains a set of costs which limit issues of new notes and deposits to real demand to hold them. From there fractional reserves allow for the adjustment process in the restructuring of the capital structure in response to shifts in the structure of demand to happen quicker and more painlessly than would happen in a world of 100% reserve banks only. No property rights are violated because the fact that someone's demand deposit is actually an item bought with the currency deposited which pays interest for the service of bearing the risk that the loan the currency deposited went into making will default is contained the contract when somebody opens an account with a bank. That's why demand deposits are liabilities on a balance sheet rather than gold coin in a vault (or even dollar bills in a drawer). It won't drive credit expansion because the base money markets will differentiate between specie and notes and deposit claims. No legal tender means that no one anywhere has to take a note or coin or anything except at what they judge to be the current market price. Any fractional reserve bank that over issues its notes or demand deposits will quickly find businesses (not just other banks) discounting the notes by not selling things for the notes or demand deposits at par with specie. The bank experiences a run and the banker is ruined (along with his depositors, unless they're insured). This all happens with only a local disturbance in interest rates whose exact magnitude depends on how developed financial markets in your economy are.
Let's not just concentrate on who said what about banking 70 years ago, now, a lot has been done in free banking since. While both schools (FrRB and FuRB) have survived, it's at least my personal opinion that the FrRB school has made the better case in recent decades.
JadedRailman: Keynes' theory, after all, is pretty much just a special case of Austrian theory.
No.
Peace
Yes.
Keynes' theory includes a flat, invariant capital structure. In other ways, it's 100% Austrian. Keynes' theory would have been good for the de-monetized economies of early medieval Europe. The Austrian theory became necessary as capital deepening proceeded.
JadedRailman:Keynes' theory includes a flat, invariant capital structure. In other ways, it's 100% Austrian. Keynes' theory would have been good for the de-monetized economies of early medieval Europe. The Austrian theory became necessary as capital deepening proceeded.
This is true for his early stuff where he was working with the Wicksellian framework. But it's not true for the GT, where the interest rate is solely a monetary phenomena, and the money supply is exogenously determined. But an invariant one dimensional capital structure would have a 0% interest rate (I think).
"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."
What if a group of people decided to engage in FRB on a voluntary basis? Could a Rothbardian anarchist advocate the use of state violence to terminate the practice?
Interesting comment from Steve Horwitz.
Horwitz>>The guy knew his shit and he understood monetary theory better than just about anyone who claims his mantle on any side today.
Horwitz>>Yes, Mises does suggest that. That's an empirical/historical prediction about which I think he is incorrect.
well, I lol'd
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
Well... That's interesting, but for all intents and purposes, if everyone regardsthat cat as a dog, what's the real difference?
To get out of the world of metaphors, if people regard certificates as money, it works the same, people live with it, seems to be manageable to me.
existence is elsewhere
Excellent post by Bill Woolsey on creating fiduciary media and malinvestment.
I didn't get through the whole thing, but increasing cash holdings does not equal saving.
"I didn't get through the whole thing, but increasing cash holdings does not equal saving."
It is becoming more and more apparent that ME/FB proponents have no proper understanding of capital theory. They are monetarists with an Austrian twist.
Where does he assume that? The analysis seems sound to me.
Don;
Fractional reserve banking can be replaced by two types of accounts; the first is typically known as demand account where you maintain ownership of the funds. This type of account is held with the 100% reserve requirement. In layman's terms, it is the money you would deposit from your job and use to pay monthly bills. Think of this account as an electronic safe deposit box which is dynamic. You would pay a small fee for the convenience of ATM access and automatic bill payment. The bank would make a profit off the fees paid by each depositor.
The second type of account is typically known as an investment account. This is like purchasing a Certificate of deposit. You would loan the money to the bank in return for interest at a future date. The bank uses these funds to loan to the community. These funds would have a zero reserve requirement thus be at risk as all investments are. The bank would profit on these investments where they pay you X percent return, but in actuality, they may make X+ return.
The history of banking shows that when these two types of accounts are kept separate, the bank failure rate can approach zero.
- Richard of Howell
Richard,
I think this is the best, most concise response yet.
Thanks and regards,
Hah. FR banking shouldn't be fraud though unless the bank lies and says that there is zero risk in deposit withdrawals. If they either say "Your deposits are not secure" or "Your deposits are locked in until a matching loan is redeemed -- there is a risk of loss" or "your deposits are secure: we will not loan them out" , then there is no fraud. If people know what they're getting themselves into, then it's their voluntary choice to go with said bank.