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.
Maxliberty:We have already cleared up the matter that it is not a demand deposit.
what are you referring to that we have cleared up the matter about it not being a demand deposit?
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
Stolz25:Semantics. The point you were making was that it would operate no differently than today, when in reality it most likely would. The first time you told someone they would get their money in 60 days from an account that when they deposited it was on demand, you'd cause a run on the bank.
Bank of America has already told their customers that the relationship is a loan and yet there is not a line of people leaving BOA as result of this. The facts seem contrary to your opinion.
Stolz25: This may very well be true. You could make a contract saying that you have 60 days to pay if you desire and then pay them early if you have the money. I just don't see why you think this amounts to fractional reserve banking. On the face it may not seem like a big difference, but in your scenario you don't have two people who both have claim to the same dollar at the same time.
This may very well be true. You could make a contract saying that you have 60 days to pay if you desire and then pay them early if you have the money. I just don't see why you think this amounts to fractional reserve banking. On the face it may not seem like a big difference, but in your scenario you don't have two people who both have claim to the same dollar at the same time.
Yes, having changed a few words in the contract we have ended the entire FRB arguement.
Stolz25:But what is the trade off? I can't see any economic benefits to either depositing my money in your bank versus another time deposit account, and I don't see any economic benefit for running your bank versus another time deposit account. While it's true people accept different types of risk, it is based on the possible rewards.
From a business perspective it is quite simple. By loaning out some of the money my Bank makes more money than your 100% reserve bank so I can offer things like free checking or less ATM charges or give away free toasters. People will change from your bank to mine because I can offer more services for less and I will still be able to compete with time-deposit banks aon an equal footing because I can have a section of the bank devoted just to that. So I am more competitive than 100% reserve banks with some customers and equally competitive with Timed deposit banks.
Stolz25: But the only reason the bank isn't insolvent is because they changed the contract on their unwitting customers. When they deposited the money it was a demand deposit afterall.
But the only reason the bank isn't insolvent is because they changed the contract on their unwitting customers. When they deposited the money it was a demand deposit afterall.
Well not in the case of Bank Of America and if I started the bank new then that there would be no change.
Juan: MaxLiberty: Bank of America, blah blah blah ....I wonder what the fed is ?...What does 'bailout' mean ? What's the price of banking shares...? It's interesting. A shinning example of "free-market-capitalism" such as citibank, for instance, has gone from $50 to $2...and if it weren't for the state the price would probably be...zero. Max, have you lately bothered to check the price of financial stocks ? Any comments ?
MaxLiberty: Bank of America, blah blah blah
I thought we were discussing banking in a free society. Typical Austrian cult nonsense, unable to defend your position you begin discussing the state again.
nirgrahamUK: Maxliberty:We have already cleared up the matter that it is not a demand deposit. what are you referring to that we have cleared up the matter about it not being a demand deposit?
Having changed the contract that clearly makes the arrangement a loan then it is no longer a demand deposit.
Maxliberty:Having changed the contract that clearly makes the arrangement a loan then it is no longer a demand deposit.
oh so, now you are as cultish as we are. progress indeed.
Maxliberty:That would mean promising to pay anyone back would be a fraud unless you had an equal amount of funds set aside to cover the timed deposit in which you case you would not need the timed deposit. If you loan someone money you have default risk, default is not fraud.
Promising to pay somebody back when you know it is impossible does though.
MaxLiberty:I thought we were discussing banking in a free society.
In a free society, which is all we are discussing, there will be no functional change to what currently happens right now, only a change in the language of the initial contracts with the banks.
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."
You'd never guess what, I agree with you.
GilesStratton:Promising to pay somebody back when you know it is impossible
Yet, "Daijobu - we do it all the time!"
nirgrahamUK: Maxliberty:Having changed the contract that clearly makes the arrangement a loan then it is no longer a demand deposit. oh so, now you are as cultish as we are. progress indeed.
But do you see how changing the contract slightly isn't going to affect the actual operation of the bank. So the Austrian position uproar over the contract language and what changes will actually take place in the market is much ado about nothing. Just like Bank of America has changed the language in the contract but their operations are exactly the same.
GilesStratton: Maxliberty:That would mean promising to pay anyone back would be a fraud unless you had an equal amount of funds set aside to cover the timed deposit in which you case you would not need the timed deposit. If you loan someone money you have default risk, default is not fraud. Promising to pay somebody back when you know it is impossible does though.
This issue has already been resolved with a change in the contract but the banks will operate exactly as before.
Maxliberty:This issue has already been resolved with a change in the contract but the banks will operate exactly as before.
The people in the banks don't believe they have instant access to the money. It is a time deposit.
Juan: MaxLiberty:I thought we were discussing banking in a free society. Oh Max, YOU claimed that banking in a free society won't be any different from banking now. Do you remeber you said that ? Here : In a free society, which is all we are discussing, there will be no functional change to what currently happens right now, only a change in the language of the initial contracts with the banks.
And that is exactly right, there will be no functional difference. Functional difference means the actual operations will be the same having cleared up the contract formalities. So how much money the bank has on reserves won't change, they will still loan money, people will still request money, all the same.
Juan:Now, the current system is in a sorry state ? Do you acknowledge that ? Do you understand what's wrong with the current system ? I'm afraid not...
Juan:And you're saying that the banking system in a free society will be no different ?
With regard to the changes in the contract which are at the heart of your arguement, there will be no fucntional difference in banks in a free society as a result of that.
Juan:Well, except that in a free society there will be no bail outs, so there would be no baking system either (if the banking system is to operate according to your 'non-austrian' principles, that is).
I can see that you now realize how weak your fixation with changing the contract is so you now begin discussing unrelated topics. Did I say anything about bailouts in free banking? Nor have I suggested anything even dramatically un-Austrian other than to point out that changing the language in the contract doesn't have any impact on banking which is contrarian to what most Austrians think which is that changing the contract will radically transform the banking industry. The facts as they exist now demonstrate otherwise. Finally, you can not prove that banking as I suggest it will exist is inherently insolvent. You have no evidence that proves your claim.
Stolz25: Maxliberty:This issue has already been resolved with a change in the contract but the banks will operate exactly as before. The people in the banks don't believe they have instant access to the money. It is a time deposit.
No, people will still believe they have instant access to the money. Austrians have a very difficult time dealing with probability. People can expect that they will have instant access to the money and also understand that there is a small probability they will not. The difference between us is that I am willing to let people freely make that decision and many Austrians are not.
Maxliberty:No, people will still believe they have instant access to the money. Austrians have a very difficult time dealing with probability. People can expect that they will have instant access to the money and also understand that there is a small probability they will not. The difference between us is that I am willing to let people freely make that decision and many Austrians are not.
This, for the umpteenth time is not the same thing. If people believe they have instant access to the money it is because they don't understand what is happening. And I doubt any Austrian would have a problem with your bank if it could survive, they only are (rightfully) calling it a time deposit and not FRB.