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.
"Should be" and "if" statements are for dreamers, not doers. With strict adherence to the principles of classical banking, your demand account is not at risk because you maintain ownership of the funds. Your investment account, which by nature is at risk, would be the basis for the monies loaned by the bank. Therefore, you have complete access to your demand account and enjoy the interest income on your investment account.
One could derive that with such a system, the need for the Federal Reserve and the FDIC would essentially go away. If you're worried about dishonest bankers, we could always do what they did in 15th century Italy: if your bank failed due to fraud, you could hang the bank officers. Nothing like a little responsibility with clearly defined consequences.
I don't know about hanging bankers, but the way you describe things is the way I see a stable free-market banking system (i.e. anti-fed) would work. That's why I recommended your post as an answer.
I have made a presentation giving a mathematical proof of the fractional reserve banking money multiplier.
You can find it here.
Please let me know what you think:
Thanks!
And (regarding my previous post):
Am I guilty of any misunderstandings [in the presentation]?
Just new user here, not to be taken too seriously but.
I think FRB is largely completly unnecessary, it doesn't benefit anyone. At first you could say that it benefits the guy who puts money into bank and is able to recieve interest while still having the money but this just isn't so. As always you can't get something for nothing:
1) If depositor uses the money and passes it to someone else, it will cause inflation, as the burrower also wants to buy the same goods. The interest rate benefit is robbed of him and the guy who the money was lent due to inflation. This is very bad news for burrower as he cannot factor this unknown inflation to his business model.
2) If depositor just "hoards it", well that is the same as if it was given as loan. So as long as you are harding money when it's in the bank there is no loss. The deflation that occurs by hoarding offsets the inflation of money supply.
What is interesting here too, is the fact that unless the depositor AND the bank buys the burrowers goods when they are done, the loan will fail. Just a meaningless observation though... And as someone pointed out you do not have right to "value" of something you own so I don't see FRB as fraud that way (as long as terms are clear) but just... stupid I guess.
I found the argument on the Velocity of money here very interesting. The 2) point I make and also the fact that if someone hoards cash seems to imply that velocity does increase inflation. Afterall 0 velocity = hoarding. But there are actually a lot of problems with this... Because if everyone is hoarding money it must mean that they value money more than the goods. The reason WHY is pretty interesting here. Anyway the velocity seems to be linked to demand for money. And so seems to be the price of stuff. So perhaps the velocity of money is simply in other words demand for money, and that is why less demand = higher prices = higher velocity. But I dunno, thinking it other way it seems strange that velocity of money can really affect prices of goods, unless it comes about by created money. You could also say that GDP affects the price level if money supply is constant, so perhaps there is some data on this?
Also the MV = PT = gdp is pretty interesting equation, but hardly tells you anything. It says that V= PT/M, so if money supply is static it is going to be just V=PT. But those are merely the same thing (as obviously the number of times money changes hands is the same as how many transactions happen X the price of those transactions), what the equation does NOT tell you is what those transactions were capable of buying. So the equation is complete trash in determinating how much piece of bread costs for example AFAIK. Just like the nominal GDP is also going to be fairly stable in a society, but prices can still lower and lower as you get more effective, PT = GDP would imply that prices or transactions get higher as GDP grows, but that simply does not need to be so. The core issue of this equation is the parameter "P" = price level. The P has nothing to do with how much goods you can get for the price you paid, but merely how much you paid. Anyone agree with this?
However the laws of supply and demand are way better at that than that LAW. If supply increases that means cheaper price per produced unit pretty much (providing demand is the same also).
Problem I find with keynes is he seems thinks that lower demand is cause for depressions etc. What I find stupid is he never thinks why such lowering occurs. Thinking that increasing demand will also fix the problem why the lowering occured is strange.
And for needing to create money to statisfy demand for money... Even my stupid brain can understand that this is complete BS. The whole demand for money exists in the first place only because the money is scarce and can be transacted for things. If you increase the supply of money it won't be worth as much and thus the demand should disappear, but the inflation doesn't hit immidiately so you get a lot of bad investments. Though obviously someone can prove me wrong... The concept of creating money because it is demanded sounds just absurd to me.
Just to continue a bit on the MV = PT
Which without stable money supply is V=PT
Again if you increase the velocity of money it just means that there are either more and/or pricier transaction happening. This actually has nothing to do with how much you can buy with that amount of money. It just means how much is transacted with money, which has to do with supply and demand for money and goods. Obviously when velocity gets to the lower side no one wants money, and thus it seems as if it has lost value. On the other hand if it moves higher everyone wants money and thus prices increase and the reason for this is good expectations for invesment probably.
The MV = PT doesn't even prove that increase in money supply increases prices, just tells you that if you increase money supply and velocity stays the same, obviously more transactions and or higher prices have to happen. Nothing is told about what those transactions buy. The equation is completely useless in every way.
All this of course pretty much to me at least says that government watching these demand graphs and so on, diciding that demand needs to be increased is dangerous. Because there is a reason for low demand, and if government fixes the demand without the reason... you end up with malinvestment.
If anybody would like to read a paraphrased version of the "free banking" (frb) argument: http://www.economicthought.net/2011/02/the-theory-of-free-banking/
(sorry I have not read all the posts in this thread, just wanted to reply to op)
In a free market in banking there would be several different currencies competing within the same region. There would be many different banks offering customers different types services. One bank could offer its' customers (with current accounts) less risk by only lending out the capital that the bank itself has and charging interest on that. The bank would make money on the interest that it makes loans with. Another bank could offer its services (vault, transfers, cash machines, chip and pin ie visa services) for a flat monthly fee but not offer any loans and use the flat fee to cover its costs and make a profit, as well as charges on transfers and withdrawls or any variation. Banks would compete at offering banking services and to entice customers in they could offer interest on current accounts, but interest on current accounts could not be more than the interest on loans + other income. They would have to operate like a normal business and the service of banking would be like any other. A bank could come in to the market and offer high interest on current accounts by offering the customers a bank account with increase risk. By allowing the bank to use their funds that have been deposited to make loans and charge interest on. The risk of course is if everyone asked for their money back at the same time and the bank had lent it all out they would not be able to supply the money. This risk could come with a greater return on deposits and could compete with banks that offer less risk.
(I get an error editing the above post, I am unable to fix mistakes.)
The transition from a fractional reserve system to a full reserve system is an interesting topic and I would like to hear ideas on that. With a state the state would have to legalize paying taxes with other currencies. Legalize non national and other national currencies within their region. Remove banking regulations that prevent new banks from starting up (as if they were nothing more than a corner shop). Immediately require all banks to stop make loans on capital that they do not have in reserve. The banks would still have many loans from the past that it has made where it did not have the reserve. There is nothing that can be done about that. It will be impossible to force banks to balance their books or prevent them from making new loans until their capital actually equals their credit. So it would have be a lack of confidence per say that the consumer would choose to go new banks that have full reserves. So the old banks with poor reserve ratios would be seen as high risk to deal with and the new banks (which could even be the old banks but new entities) with full reserve would be in a position to make loans. But yea i just made all that up. Like much of what i say =]
There would have to be a massive adjustment of some kind to fix the reserve inbalances and i can not comprehend how that could occur.
Fractional Reserve Banking is idiocy, if you ask me. It sets banks up to be in a position to offer more loans as credit, which is a dangerous thing. Look at what happened to the housing market with such brilliance as that of Barney Frank et al. i say bring banks back to the gold standard. I've thought that for years.
"Is life so dear or peace so sweet, as to be purchased at the price of chains and slavery?" -Patrick Henry
Can I ask - and if it's been covered in this *massive* thread, my apologies for not having sorted through *all* of it yet - what is the imagined, predicted role of *private* deposit insurance in a completely free banking scenario? Is it feasible for banks with lower reserve ratios to entice customers by purchasing insurance for their depositors? Would an insurance company be interested in this and, if so, does this just shift the problem of "bank runs" to an insurance company that can't handle it either (the main reason I can think of that I don't see this discussed in free banking discussions, though I admit I'm newish to that field)? What about the depositors themselves, might *they* take a risk on a lower-reserve bank by taking out insurance (assuming the cost of the insurance is less than the extra benefits they get fromt he bank, e.g. interest)? Is there an argument that the insurance really *can't* be cheaper than the extra benefits?
I'm really trying to think hard about the "typical" arrangements/institutions that would emerge in a truly "free" setting and I keep coming back to "insurance is everywhere". Why not here?
Alternatives Considered,
I believe there have been historical cases of private deposit insurance, but I can't remember any specific examples.
In any case, it's not deposit insurance per se that is the problem, but taxpayer funded (or guarunteed) deposit insurance. Why? Those that bear the risk do so involuntarily and enjoy no benefit for doing so. In other words, it ends up being a subsidy for holding any assets guarunteed by the FDIC, and if something is subsidised then people do more of it -- more than they would if each individual had to bear the full risks and costs of their actions.
"In any case, it's not deposit insurance per se that is the problem, but taxpayer funded (or guarunteed) deposit insurance."
You: preacher. Me: choir.
;-) Yes, yes, I get that, but that is specifically *not* what my question is about. I really am interested in how we think this will actually play out in the real world, and so I really want to think about "if we have a free banking/free society, what arrangements will emerge in the market? Will private deposit insurance fill the 'gap' between those that want safety in their deposits (100% reservists), and those that want goodies from their low-reserves banks?"
To some extent, it seems like the FRB vs 100% reserves argument loses its importance, frankly, if mechanisms like private deposit insurance proliferate and thus make the functional difference between the two much smaller. Theoretical arguments aside, the 100% reservists seem most concerned that people who deposit in FRB banks are taking huge risks; the free banking/FRB proponents are saying that there isn't *that* much risk, and the benefits to the banks are large enough that in a free market, there will be a tendency towards FRB. It just seems like private insurance brings those together in a way that makes it seem like a natural market emergence: the banks still get to loan like crazy, but depositors' risk is greatly lessened (at least, that is, if the insurance companies can actually cover their liabilities in the case of a bank run).
However, that all depends on there being a price point for the insurance at which the insurance companies will make a profit but that is less than the profit the banks make by reducing their reserves. Well, and it also depends on the notion that insurance companies can cover in the event of a bank run, or else the insurance is really just window-dressing that doesn't actually reduce depositor risk. I'm wondering if any of the theorists/experts have looked into those questions...?
Do you guys think that its an 'insurable risk'?
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
I don't know of any scholarly investigations into those questions. I suppose the combination of fractional reserve banking and insurance would differ across cultures. Banks would also specialise.
The existence of private deposit insurance in a free banking environment is something I had always taken for granted, but I never really considered it relevant to the FRB vs. 100% reserves debate. If fractional reserve banking is so inherently risky that few people would deposit in one, I doubt many would be willing to pay the high premiums necessary to insure their deposits. This also doesn't speak to the other objections about the deleterious consequences of FRB on the boom and bust cycle, structure of production, etc.