Comments please:
Normal 0 false false false EN-US X-NONE X-NONE MicrosoftInternetExplorer4
Fractional reserve banking in a free banking atmosphere, with privately issued notes, and voluntary contracts between banks and clients. An application of marginal utility analysis to fractional reserve banking.
The client agrees to allow the bank to create new banknotes, thus diminishing the value of each unit of the client's held banknotes.
Inflating the notes by creating more of them, the bank then directs the additional notes to projects the bank believes will be wealth creating, in that these projects will repay to the bank the value of the notes as stipulated by contract plus some agreed upon amount of interest.
If the bank is correct in its assessment of the projects to which it has guided the newly created notes, the bank receives back the original value of the inflated notes plus some additional amount of interest.
We assume that in simply creating the new notes, the bank creates no new wealth. Creating the new notes simply reduces the value of each individual note held by the bank plus its clients.
Thus, if we consider the bank and its clients a "family," each family member agrees by contract to a diminishment in the value of each of the notes it holds, in order to allow the family's directors to loan out the newly created notes to projects deemed potentially profitable. Upon the creation of the new notes, each individual "money piece" (each note) decreases in value. Each individual family member sees the value of his held notes decline.
Rather than recalling existing notes from various family members to make loans, the family's directors create new notes, as agreed by contract, thus decreasing the value of each family member's held notes.
But the total value of all notes held by the bank family, before and after the creation of the new notes, does not change. There are more notes now than before, each with a diminished marginal utility. Tomorrow, the newly created notes will be loaned to a debtor.
Tomorrow, the newly created notes will be loaned to the debtor, and now (tomorrow) the debtor owes the bank family the value of those loaned notes plus interest.
If the loan is successful, the debtor will have paid back the value of the notes plus interest. The bank family will be wealthier than before. This is because of the new wealth (the interest) paid to it by the debtor. The debtor is the person for whom the bank family agrees to inflate their notes (by creating new notes rather than recalling existing notes from family members) and to whom they agree to turn over the newly created notes, in the expectation of increasing the family's pool of wealth.
The inflation of the family's notes through the creation of new notes does not diminish the family's total wealth. When the bank family creates new notes, they do not create something out of nothing. Instead, they diminish the value of their own held notes by creating new notes, which are then lent out and received back with interest if the loan is successful. The bank family is then wealthier than it was before.
"It would be preposterous to assert apodictically that science will never succeed in developing a praxeological aprioristic doctrine of political organization..." (Mises, UF, p.98)
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."
My brief argument rests on the a priori concept that an increase in the supply of a homogeneous good, absent an increase in the demand for it, constitutes, a priori, a diminished value of that good relative to demand. My intention was to apply this concept to the creation of new banknotes within the "bank family," that is, the bank and its existing clients (for the sake of illustration here, not including the prospective new debtor).
"Whenever the supply of a good increases by one additional unit, provided each unit is regarded as of equal serviceability by a person, the value attached to this unit must decrease." (the law of marginal utility as rendered by Hoppe)
When within the "bank family" (bank + existing clients), the number of notes increases from 100 notes to 200 notes, this decreases the value of each individual note if we assume no additional demand for them. This is because each note is in the cash holdings of some individual in the bank family.
When the bank family creates new notes, they do not create something out of nothing. Instead, they diminish the value of their own held notes, by creating new notes, that are then lent out, and if the loan is successful, paid back with interest. The bank family is then wealthier than it was before.
the family will suffer boom and bust also.
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: the family will suffer boom and bust also.
This argument does not refer to the case where the bank family (bank + existing clients) holds 100 notes, and issues 100 additional notes to the public, when those 100 extra notes aren't demanded by the public.
Before the bank family (bank + clients) puts the extra 100 notes in circulation, the family creates 100 new notes. Now there are 200 notes held by the bank family (bank + clients) where yesterday there were only 100.
The purpose of creating the new notes is to (eventually) circulate them. But by my assumption, they are not yet circulated.
By the law of marginal utility then, as each individual "money piece" is held by some individual in the bank family, then the value of each money piece has declined for those holding the money pieces (notes). This is before they are put into circulation.
My argument hinges on this insight.
that doesnt address my post.
ABCT
nirgrahamUK: that doesnt address my post. ABCT
Oh. Sorry.
Quite the opposite I believe.
The total wealth of the bank family (bank + clients) stays the same when the new notes are created (before they are circulated).
But each individual money unit decreases in value.
When the new notes are loaned out and paid back with interest, the bank family (bank + clients) is more wealthy than before.
There is no boom and bust as far as I can see. There is a diminshment in the value of the individual money units before the loan, and then an increase in total wealth if the loan is paid back with interest.
The increase in wealth of the bank family results from the newly created wealth due to the loan (the interest).
http://www2.units.it/~etica/2009_1/BARNETT_BLOCK.pdf
check their handy chart.
fractional reserve banking is a sufficient cause of the ABCT
Lent out to who, for what purpose, and why would these people accept/redeem these admittedly devaluing notes at parr with anything else in the market?
Why so complex? There's no way to avoid the problems associated with fractional reserve banking. You can probably get people to agree to it beforehand and accept the risk for a possible return. But in the end what's the real difference between that and a time deposit aimed at investing, other than the ability to redeem the first instantly, but if on a free market certainly not at parr with the face value as the whole market will know the nature of the notes.
I believe the bank and it's clients lend out the money to prospective debtors for the purpose of earning a profit (interest) ???
The notes have been devalued previously within the bank family (bank + clients), as explained. The bank family agrees to devalue their own individual notes.
Why would someone accept these notes? I'm not sure exactly. But if no one did, there certainly would be no problem with fraud or initiating a boom/bust cycle.
Why would the bank redeem the notes? Perhaps to maintain its reputation and stay in business ???
nirgrahamUK: http://www2.units.it/~etica/2009_1/BARNETT_BLOCK.pdf check their handy chart. fractional reserve banking is a sufficient cause of the ABCT
The current challenge is to demonstrate this with regard to this new conception.
you make assertive statements and put question marks on them. and then other question marks follow actual questions but appear to be for rhetorical purposes. hard to follow.
whats new? where is the difference between what you are talking about and the process of fractional reserve banking?, actualyl your lead in says you are just talking about fractional banking and thats exactly what block and barnett wrote about.
the only difference seems to be the style you used to communicate the story.the attempt to make it seem benevolent by throwing in words like 'family' and 'agreed'
nirgrahamUK: whats new? where is the difference between what you are talking about and the process of fractional reserve banking?, actualyl your lead in says you are just talking about fractional banking and thats exactly what block and barnett wrote about. the only difference seems to be the style you used to communicate the story.the attempt to make it seem benevolent by throwing in words like 'family' and 'agreed'
If you disagree, then show where you think it goes wrong.
you are wrong to think that fractional reserve banking wont lead to boom and bust. you nowhere argue either what does cause boom and bust, and that what you propose is not it, and neither do you understand that you havent put forward an argument as to why fractional banking is not boom bust inducing, you have merely presented arguments that it is inflationary. not treading new ground there im afraid. if im short its only because if you only follow the link i offered you will be reading some actual scholarship on the subject, and its not even very long or hard to follow.
Juan:When the new notes are loaned out and paid back with interest, the bank family (bank + clients) is more wealthy than before. Loaned to whom ? Again, why would people accept inflated paper ? Are you using "family" as figurative language for the mafia ? Yes, the "family" also known as banking mafia may end up being more wealthy if they succeed in 'circulating' unbacked paper. Just like thieves may get more wealthy by stealing.
Hi Juan.
The notes are loaned to prospective debtors. As mentioned, the notes are inflated prior to being loaned to the debtor. The debtor doesn't have to worry about that. If no one accepts the notes, they can't initiate a boom/bust cycle, at least that is my understanding.
"Family" is a concept designating the bank + its existing clients.
The scheme you are referring to is not the scheme I posted.
The notes are loaned to prospective debtors. As mentioned, the notes are inflated prior to being loaned to the debtor. The debtor doesn't have to worry about that.
Juan:The notes are loaned to prospective debtors. As mentioned, the notes are inflated prior to being loaned to the debtor. The debtor doesn't have to worry about that. Of course he has to worry. Are you assuming that these notes are a 'common medium of exchange' ?
No. That is not the assumption. These are privately issued bank notes in an atmosphere of free banking. There are many competing issuers of notes in this scenario. No government monopoly on money, and no laws prohibiting freedom of banking and currency.
That is not the assumption. These are privately issued bank notes in an atmosphere of free banking.
There are many competing issuers of notes in this scenario.
No government monopoly on money, and no laws prohibiting freedom of banking and currency.
Juan:Are the debtors also clients of the bank ? If so the system is simply reallocating resources among members using inflation. I can't imagine what could be the point of doing that.
I believe, but I could be wrong, since this is a new idea, that whether the debtor is defined as a client of the bank once he receives the funds, may not be relevant to the main issue at hand, which is that when the bank family creates new funds, it is an agreement to devalue their currently held currency.
They loan the funds to the debtor after the devaluation. The debtor, as far as I can see, takes the funds as they are.
The purpose of the bank family devaluing their own currency, is to allow the bank family directors to create new notes without having to collect notes from family members. The purpose of creating new notes is so they may be loaned out for a profit (interest).
Juan:That is not the assumption. These are privately issued bank notes in an atmosphere of free banking. Well, I take it we are talking about a market and indeed there is a common medium of exchange ? What's the relation between bank paper and real money ? There are many competing issuers of notes in this scenario. But none of these notes are real money ? No government monopoly on money, and no laws prohibiting freedom of banking and currency. Of course. But freedom of banking doesn't mean that a market will lack money - i.e. a common medium of exchange - as opposed to inflated bank paper.
As I understand it, the argument against free banking is partially an argument that in creating new notes, the private bank is creating something out of nothing and is perpetrating a fraud.
My argument is that a more accurate way to view things may be to realize that by Mengerian marginal utility analysis, we can show how the bank family in an atmosphere of free banking might agree voluntarily to devalue its own funds, as the paper explains, and for the reasons given. Thus, there is no creating something out of nothing, and there is no fraud. Or at least I don't see it at this time.
My argument is that a more accurate way to view things may be to realize that by Mengerian marginal utility analysis, we can show how the bank family in an atmosphere of free banking might agree voluntarily to devalue its own funds,
Juan:I believe, but I could be wrong, since this is a new idea, that whether the debtor is defined as a client of the bank once he receives the funds, may not be relevant to the main issue at hand, which is that when the bank family creates new funds, it is an agreement to devalue their currently held currency. I think it is completely relevant. First : I don't think anybody would choose to be a 'family member' - people 'naturally' avoid inflation. Second : What exactly is printed on the notes ? Do they have a face value denominated in real money ? Or are they just denominated in some fantasy unit such as the lehmanbrother or the goldman ? They loan the funds to the debtor after the devaluation. The debtor, as far as I can see, takes the funds as they are. They are not loaning funds, but devalued paper. It is not going to be accepted by debtors. What sort of resources are the debtors going to bid using devalued paper ?
In my explanation, a person is already a family member if they are the bank or a client of the bank. I assume the exisence of a bank.
As to what is printed on the notes, the following may help lead to an eventual answer:
"The beginning of money substitutes is very well known. People in Great Britain used to keep deposits of gold with the goldsmiths in London. Later they began to use the receipts from the goldsmiths as substitutes for money in transactions and cash holdings."
"Goldsmiths soon discovered that they could issue more money tickets, more money substitutes, than they had in gold reserve."
(Mises, The Free Market and Its Enemies, p. 62)
So apparently the goldsmiths figured out what to write on the notes. It appears to be possible and to have happened historically. I think that is all we need to demonstrate.
If no one accepts the notes, they can't initiate the boom/bust cycle, and they can't constitute fraud, and then it doesn't matter whether the notes are something out of nothing.
Juan:My argument is that a more accurate way to view things may be to realize that by Mengerian marginal utility analysis, we can show how the bank family in an atmosphere of free banking might agree voluntarily to devalue its own funds, They can't really devalue their own funds. They can devalue notes and so reallocate their own funds. If you and I own 10 ounces of gold, we can print 10 notes with a 1 ounce face value. What would be the point of printing more notes ? Even if we now print more notes we still have 10 ounces of gold. We are not "devaluing our own funds" we are just making a silly accounting mistake. However that's different from offering our devalued notes to (unsuspecting) third parties.
"They can devalue notes and so reallocate their own funds." OK That sounds good. Thank you Juan.
The point of printing more notes is so that the bank directors don't have to recall notes from existing bank clients. Instead, they just print up more.
"If we now print more notes we still have 10 ounces of gold." Yes, I agree.
So what happens is that each note becomes worth less in relation to the gold. Or at least that is my current understanding.
The notes have been inflated within the bank family. But it is for a purpose, and is not a silly accounting mistake, as my post argues.
Adam, thanks for the post. It's nice to see some people who aren't in complete agreement with the LvMI when it comes to fractional reserves and laissez faire banking.
That said, I think your exposition is a little more complicated than it need be. For one thing, I don't think it's necessary for the depositors to explicitely agree that their money can be lent out, much less to sources that the bank deems able to pay back. In regards to the former, I simply think that a "deposit" will refer to whatever conventionally goes by that name. Rothbard makes a similar point when it comes to fraud in a stateless society, I believe he uses the example of bread. If an individual is selling bread, the are expected to provide what is usually meant by bread in that geographical area. In most English speaking places that I'm aware of bread means a certain type of food. Now, a lot of those who argue against fractional reserves in banking on legal grounds take the word "deposit" to mean something specific, namely, a bailment. But I don't see why it need be so, it may well be that in a particular geographical area a deposit means nothing more than an individual putting money in a bank in exchange for an IOU from the bank. In fact, throughout most of history this is exactly what a deposit has meant. And this is no secret, as Hoppe himself points out, banks pay money to their depositors in a fractional reserve system. But what does this indicate if not that the money they're giving to the bank isn't simply sitting in a vault.
Now, the bigger issue of your post concerns an inflationary environment and why people might be tempted to use a fractional reserve bank giving the decreasing value of their money. Without challenging the premises I believe it's important to note that this issue simply cannot be decided a priori it depends entirely on what the level of inflation and the rates of interest paid on deposits are as well as the way in which banks evolve in order to respond to the conditions of financial laissez faire. Now, I simply don't believe that with reserve ratios held constant a fractional reserve environment would be inflationary. Now, reserve ratios might change, but I'd argue that if they were to do it would be in response to endogenous changes in the demand for money and other economic variables. If the demand for money increases, then banks will simply shift money from deposits to banknotes. But the total quantity of money would not increase, and since the decrease in the velocity of money would have been offset by increased quantity of money (IOW MV is kept constant, which is the aim of FRB), prices would not change.
There is perhaps, one more issue that is not entirely relevant since it lies outside the scope of the action of individuals, but I believe it is worth noting. If you can prove that FRB does lead to greater economic growth, then it follows that any inflationary effects of fractional reserves will be at least partially offset deflationary pressures that will cause the price level to decline and the value of money to depreciate.
"You don't need a weatherman to know which way the wind blows"
Bob Dylan
GilesStratton: "For one thing, I don't think it's necessary for the depositors to explicitly agree that their money can be lent out, much less to sources that the bank deems able to pay back." "Now, the bigger issue of your post concerns an inflationary environment and why people might be tempted to use a fractional reserve bank giving the decreasing value of their money."
"For one thing, I don't think it's necessary for the depositors to explicitly agree that their money can be lent out, much less to sources that the bank deems able to pay back."
"Now, the bigger issue of your post concerns an inflationary environment and why people might be tempted to use a fractional reserve bank giving the decreasing value of their money."
Hi Giles.
Thank you for your comments.
I'm only replying to what I believe to be your two most relevant statements. If I overlook something important, please point it out.
My sketch assumes a certain kind of bank, but does not necessarily require it. For the sake of illustrating the idea, I'm just assuming a standard conception of a bank that lends money to projects deemed potentially profitable.
I'm not sure if you're seeing the precise point I'm making, which is the bigger issue. As I understand it, part of the objection to fractional reserve banking has to do with the idea that the fractional reserve bank issues or circulates fraudulent money substitutes or fiduciary media.
This apparently happens due to something like the following: There are ten notes existing for ten ounces of gold. But the bank creates a new note (creates something from nothing), and now there are eleven notes existing as claims on the same ten ounces of gold. This creates a fraudulent situation, according to a Rothbardian analysis, because it leads to conflicting titles to the same good.
What I am arguing is that the bank family (the bank plus its clients) may agree to devalue their own notes, by printing more notes, prior to circulating those notes. There is no fraud, and there is no creating something out of nothing in this case. What happens is that each individual note declines in value relative to the (let's say) gold in the bank's vault. But in my example, this is done purposely, and by agreement of the individuals in the bank family. Instead of having 100 notes that claim to the gold, they simply agree to have 200 notes that claim to it. They simply devalue their own notes before circulating them. There is no fraud, and there is no creating something out of nothing.
My argument hinges on the law of marginal utility, so I would call it a "Mengerian" analysis. And my argument assumes an atmosphere of freedom in bannking with no prohibitions on the issue of private banknotes or currency.
There is an important sense in which the example I provide isn't fractional reserve banking as it is typically understood. Because it may be part of the standard conception of fractional reserve banking, that banknotes held by the public at large are being involuntarily inflated by bank note creation.
In my example, a voluntary association of people I refer to as a "bank family" (the bank plus its clients) may agree to devalue their own notes, by printing more of them. They devalue their own notes, on purpose. The purpose is so the bank directors, to make loans, don't have to recall existing notes from the cash holdings of bank clients. Instead, they simply print more notes, by previous agreement. There is inflation. The bank family inflates their own notes for a specific purpose. But the inflation occurs while the notes are held by the bank family. There is no fraud perpetrated on the public at large.
If the loan is paid back with interest, then the voluntary association of individuals (the bank family) is more wealthy than before. Because the original devaluation of the notes didn't diminish their total wealth. The same amount of gold is still in the vault, but 200 notes claim to it rather than 100 notes.
When the loan is paid back with interest, the bank family has all their notes back plus interest. They had voluntarily inflated their own currency for reasons of expediency and convenience in loan making.
Thus, they neither created something from nothing, nor acted fraudulently. And thus, according to Mengerian marginal utility analysis, and consistent with Mises's ideas on free banking in Human Action (Scholar's edition, p. 436-445), this banking practice is neither fraudulent nor criminal, but is simply a method for making loan creation more convenient for the association which is a bank + clients.
If there are any aspects of this that aren't clear, please bring them to my attention.
Adam
Adam, I think we're in agreement here, although we're perhaps getting caught up on the word "inflation". I was using inflation to mean a rise in prices, now, whilst that might not necessarily be a very tenable definition it's the more widely understood definition. In terms of an increase in banknotes, yes, FRB would be inflationary. But I'd argue that this is one of it's main positive characteristics. As demand increases, so should supply. This is the only way in which a price can stay the same with a change in quantity. However, I think the goal of banking should be to keep the interest rate stable so as to keep money as neutral as possible.
As for your banking scenario. I don't necessarily think it's invalid. Just, more complicated than it need be. As I understand your exposition you're trying to make the "Rothbardian" idea of a deposit fit with fractional reserves. I'm not entirely sold on your idea of the bank devaluing its notes, since I don't necessarily think the bank does devalue notes in a fractional reserve environment. I think it's far more concise to simply construe a deposit as a customer exchanging base money for an IOU.
GilesStratton: Adam, I think we're in agreement here, although we're perhaps getting caught up on the word "inflation". I was using inflation to mean a rise in prices, now, whilst that might not necessarily be a very tenable definition it's the more widely understood definition. In terms of an increase in banknotes, yes, FRB would be inflationary. But I'd argue that this is one of it's main positive characteristics. As demand increases, so should supply. This is the only way in which a price can stay the same with a change in quantity. However, I think the goal of banking should be to keep the interest rate stable so as to keep money as neutral as possible. As for your banking scenario. I don't necessarily think it's invalid. Just, more complicated than it need be. As I understand your exposition you're trying to make the "Rothbardian" idea of a deposit fit with fractional reserves. I'm not entirely sold on your idea of the bank devaluing its notes, since I don't necessarily think the bank does devalue notes in a fractional reserve environment. I think it's far more concise to simply construe a deposit as a customer exchanging base money for an IOU.
Thank you Giles.
I don't think we're in disagreement, but I still think you may be missing something important. Free banking remains one of the most divisive subjects in the libertarian community. The essential objection against free banking seems to be the charge that free banking would allow banks to fraudulently create something out of nothing, and to create two titles to the same thing.
The analysis I provide shows how a voluntary association of people may agree to devalue their own notes, for reasons of expediency and efficiency, prior to lending them to a prospective debtor, who at present may be a member of the public at large (i.e., not a client of the bank). Thus, there is no fraud, and no creating something out of nothing. The devaluation of the notes happens while the notes are in the possession (cash holdings) of the bank family.
You are tending to look at this from the point of view of the money system of a nation as a whole. My analysis does not refer to that. It refers to, as I understand it, the gold in the bank family's vault, and the notes they create as claims to that gold. It does not refer to any wider system of currency. That's why I stated that the argument assumes free banking with competing private note issues. The example refers to the private enterprise which is the bank and its clients. It does not refer to a larger system of currency. There is gold in the vault of the bank, and there are the privately issued notes that the bank creates as claims to it. That is all there is in this example in my understanding. We are not talking about the entire banking system of the nation state.
This is not an argument about a system wide level of prices and demand. This is an argument about the monetary effects of a privately formed bank issuing its own notes.
The bank family purposely devalues its own notes for business reasons. There is no fraud, and no creating something from nothing.
"I don't necessarily think the bank does devalue notes in a fractional reserve environment"
Again, this argument does not apply to an overall "environment" of fractional reserve banking. It applies to the single bank + client enterprise, and how they may create new notes which has the effect of decreasing the value of their own held notes. This does not refer to what any other business enterprise may be doing with its notes.
Adam, I understand where you're coming from now, but I still don't agree entirely. I don't think your exposition is wrong, just more complicated than it need be. You're still construing a "deposit" as meaning a title to a specific good or set of goods. I don't think this has to be the case and whilst I'm not sure of this I suspect that your exposition brings greater possibility of confusion that is necessary. I think it's perhaps more to the point to simply note that a deposit need mean nothing more than an exchange of base money for an IOU from the bank. Whilst your analysis may help bridge the gap between Rothbardian style Austrians and free bankers I'm not sure how far it will go.
As for my analysis applying the banking system as a whole, I think you might just be getting caught up in my wording. From the standpoint of an individual one can see that if they increase their demand for money the bank will expand credit in response. However, this will not have any effect on the "overall price level".
GilesStratton: Adam, I understand where you're coming from now, but I still don't agree entirely. I don't think your exposition is wrong, just more complicated than it need be. You're still construing a "deposit" as meaning a title to a specific good or set of goods. I don't think this has to be the case and whilst I'm not sure of this I suspect that your exposition brings greater possibility of confusion that is necessary. I think it's perhaps more to the point to simply note that a deposit need mean nothing more than an exchange of base money for an IOU from the bank. Whilst your analysis may help bridge the gap between Rothbardian style Austrians and free bankers I'm not sure how far it will go. As for my analysis applying the banking system as a whole, I think you might just be getting caught up in my wording. From the standpoint of an individual one can see that if they increase their demand for money the bank will expand credit in response. However, this will not have any effect on the "overall price level".
Thank you Giles. Regarding construing a deposit as a title to a specific good or set of goods, I suppose I am doing something like that. In order to avoid bringing in all the past history of the word "title," perhaps we could for the purposes of discussion refer to an idea such as a "defined claim." I guess I'm assuming that, to use your term base money, the depositor receives a defined claim in exchange for his base money. How the claim is defined is between him and the bank. It is a voluntary association in my example, so the defined claim is like a contract. Can you clarify how your vision differs from the idea of a "defined claim"? Or is this something similar to what you mean by an IOU?
My analysis may have the effect of bridging the gap between the Misesian free banking advocates and the Rothbardian anti-fractional reserve school of thought. Actually, the example may not even be considered "fractional reserve banking"' by some. Because in the example there is simply a voluntary dilution of value of the notes for business reasons, like a stock split. The note holder's notes diminish from their original value when new notes are created, and the notes could conceivably increase over their original value when the loan is paid back with interest, depending on what the bank family agrees to regarding the banks loan profits. I believe this "defined claim" can be such that it may increase or decrease in value daily, much like a stock.
If fractional reserve banking is defined as an issue of claims (notes) such that if all claims were presented simultaneously, some notes could not be redeemed, then my example is not (as far as I can see) fractional reserve banking in this sense. If fractional reserve banking is defined as a bank creating additional bank notes in any manner, including the manner in which they are created in my example, then the example constitutes fractional reserve banking. In other words, if fractional reserve banking and free banking are considered identical, then my example is fractional reserve banking. But I don't believe free banking and fractional reserve banking are identical, and the objection to fractional reserve banking from a Rothbardian standpoint seems to be directed towards the notion that the claims to the deposits are or may be in conflict, and this represents a reason for rejecting fractional reserve banking on natural rights grounds. In my example, the claims are not in conflict. The concept is of a voluntary business association for producing loans for profit where the bank notes can change in value.
My reason for sending this idea around and posting it here is to try to reason it through, to see if it is fundamentally correct or not.
Regarding your idea: "From the standpoint of an individual one can see that if they increase their demand for money the bank will expand credit in response." Could you clarify? Do you mean an individual's demand for base money or the money substitute (the note)? And are you referring to an a priori law of economics about an individual person's demand for something and a necessary provision of that thing by another person? I'm not sure what you are saying, so I don't know whether to agree.
Thanks again Giles.
adam knott:But I don't believe free banking and fractional reserve banking are identical, and the objection to fractional reserve banking from a Rothbardian standpoint seems to be directed towards the notion that the claims to the deposits are or may be in conflict, and this represents a reason for rejecting fractional reserve banking on natural rights grounds. In my example, the claims are not in conflict.
Juan: adam knott:But I don't believe free banking and fractional reserve banking are identical, and the objection to fractional reserve banking from a Rothbardian standpoint seems to be directed towards the notion that the claims to the deposits are or may be in conflict, and this represents a reason for rejecting fractional reserve banking on natural rights grounds. In my example, the claims are not in conflict. You are trying to circumvent the fraudulent aspects of fractional reserve banking by assuming that bank clients are perfectly aware of the fact that the supply of notes has been inflated. Well, even granting that, you didn't explain why people who want credit and who are NOT clients of the bank would accept devalued notes. Fact is, they won't.
In my example, the banknotes are inflated within the bank family prior to being offered to a prospective debtor. There are now 200 notes that claim to the money instead of 100 notes that claim to it. So now each note may be redeemed for 1/200th of the amount of the money instead of 1/100th of the amount of the money. This devaluation of the notes has not devalued the money in the bank's vault. The money in the bank is still the same.
When the prospective debtor approaches the bank for a loan, it is not pieces of paper he is asking for, but rather a definite amount of money (as Giles refers to it, base money). When the debtor goes into the wider marketplace to purchase goods (let's assume he is building a home), the bank notes he spends to purchase supplies will be redeemed by the retail merchant for the money in the bank. But how this money is denominated---whether for each ounce of money there are two notes, or ten notes---isn't important. To the prospective debtor and the retail merchant, it doesn't matter how many pieces of bank paper correspond to each ounce of base money. All that matters is how much base money their notes entitle them to.
The inflation of the notes happened before the debtor received the notes. He doesn't care whether the bank hands him 100 pieces of paper per ounce of money or 200 pieces of paper per ounce of money. Because all that matters is that the retail merchant who will be receiving and then redeeming these notes is confident of receiving the amount of base money he expects. The number of pieces of paper that correspond to each piece of money is irrelevant.
When I write "irrelevant," I mean in regard to the amount of money the notes claim to. Of course, the denomination of the money may be relevant if, for example, the denomination is too large to conduct a business transaction out in the market.
If there is something in this that doesn't work, please point it out.
Thank you Juan.
this doesnt parse basic logic checks for me.
there are these notes. at the start, 100 of them ,that are equally proportioned claims against a fixed weight of gold in a bank. 1kg weight
the bank hit the print press button and
a little later on there are 200 of these notes that are equally proportioned claims against the same fixed weight of gold in a bank. 1kg weight
as you trivially note the gold in the bank hasnt been affected.
adam knott:When the debtor goes into the wider marketplace to purchase goods (let's assume he is building a home), the bank notes he spends to purchase supplies will be redeemed by the retail merchant for the money in the bank. But how this money is denominated---whether for each ounce of money there are two notes, or ten notes---isn't important. To the prospective debtor and the retail merchant, it doesn't matter how many pieces of bank paper correspond to each ounce of base money. All that matters is how much base money their notes entitle them to.
so i'm a merchant and my price is 200g weight to buy my awesome product. now there is a quantity of notes that is 200g worth of notes (at this time), but who is privilidged to that information?. you have said that the notes dont have printed on them how much each one denotes in weight.... they are just 'equal rights' to 'whatever gold is in the vault, amount unspecified and changeable'
what can you say to the merchant ?, trust me, 50 of these notes will get you 200g of gold from the bank?
well if the bank inflate the note supply as you are talking that wont be correct. or if the bank sell some of the gold in their bank for new shiny cars and the distirbuition of notes is unchanged , whilst you are talking to the merchant, then that wont be correct.
nirgrahamUK: this doesnt parse basic logic checks for me. there are these notes. at the start, 100 of them ,that are equally proportioned claims against a fixed weight of gold in a bank. 1kg weight the bank hit the print press button and a little later on there are 200 of these notes that are equally proportioned claims against the same fixed weight of gold in a bank. 1kg weight as you trivially note the gold in the bank hasnt been affected. adam knott:When the debtor goes into the wider marketplace to purchase goods (let's assume he is building a home), the bank notes he spends to purchase supplies will be redeemed by the retail merchant for the money in the bank. But how this money is denominated---whether for each ounce of money there are two notes, or ten notes---isn't important. To the prospective debtor and the retail merchant, it doesn't matter how many pieces of bank paper correspond to each ounce of base money. All that matters is how much base money their notes entitle them to. so i'm a merchant and my price is 200g weight to buy my awesome product. now there is a quantity of notes that is 200g worth of notes (at this time), but who is privilidged to that information?. you have said that the notes dont have printed on them how much each one denotes in weight.... they are just 'equal rights' to 'whatever gold is in the vault, amount unspecified and changeable' what can you say to the merchant ?, trust me, 50 of these notes will get you 200g of gold from the bank? well if the bank inflate the note supply as you are talking that wont be correct. or if the bank sell some of the gold in their bank for new shiny cars and the distirbuition of notes is unchanged , whilst you are talking to the merchant, then that wont be correct.
Hi Nirgraham.
Thank you for these challenges.
I would provide three possible approaches to the problem you outline:
1. The bank makes only 1 loan, and waits until all notes are redeemed before the bank family devalues its own notes again. Then, the value of the notes are unchanged from the time they are lent to the debtor until the time the last note is redeemed.
2. The bank makes several loans to several debtors in successive time intervals, devaluing its notes as I described each time, but when the notes are redeemed, they are redeemed for the amount of base money they claimed to when they were lent out. In this case, if the exchange value of the older notes (from loan #8) is higher than the exchange value of the newer notes (from loan #9), and this would result in a situation where total claims exceed the total amount of base money, then the bank (bank family) pays the difference to the redeemer out of profits obtained from loan #7.
3. The price of the bank's notes in terms of base money fluctuates and the current price of the notes is published daily (and maybe in real time) by the bank and this information is available on the Internet. As the bank's operations and as the market matures over time, then the market prices of the various notes issued by various banks tend to stabilize around fluctuating but relatively stable prices, as stocks do. The value or price of more profitable bank's notes tends to increase, while the value or price of less profitable bank's notes tends to decrease.
In this circumstance, one would expect that people would tend to keep in their cash holdings longer, the notes of banks that were more stable and/or profitable and/or reputable, since they expected the value of the notes to increase. Conversely, one would expect that people would tend to redeem the notes of less profitable and/or less stable and/or less reputable banks sooner, as they were less confident of the notes retaining their value.
I think it is important to remember that if no one wants to take these notes in exchange for goods, then the notes cannot initiate a boom/bust cycle by Austrian trade cycle analysis, and the notes also cannot be a fraudulent claim to money, since within the bank family, the claims to money do not exceed the amount of money available.
As far as I can tell, if we want to claim that this type of private issue of notes initiates the trade cycle, and/or constitutes a fraud to non-bank clients, we have to assume that people accept the notes.
The argument that people will not accept the notes, is an argument that this bank cannot initiate the trade cycle and cannot perpetrate a fraud.