re: Larry Sechrest's Free Banking: Live Blog Prelude

Andrew Taranto — Tue, 28 Apr 2009 20:27:00 GMT

Great comments, Carlos. You're making points I've been thinking about myself lately, particularly the possibility of arbitrage between banks maintaining different reserve ratios. My tentative hypothesis: FRB is not fraudulent, per se; but I think there's reason to believe that smaller reserve ratios correlate to shrinking competitive advantage, all else equal, for the reasons you cite (i.e., the possibility of bank note arbitrage in particular). A bank might have to resort to fraudulent means in order to reduce or eliminate this shrinkage.

In other words: where Rothbard claimed FRB IS fraud, perhaps it's more accurate to say it's "market-unfriendly" by encourage fraud (i.e., cooking the books), where it doesn't simply lead to poorer business results.

I believe Sechrest counters this point -- or at least provides grounds for a counter, if he doesn't make it explicitly -- by claiming that the risk of bank runs in a free banking scenario is or would be smaller than is commonly suspected. I'll get to that part soon enough, I hope.

re: Larry Sechrest's Free Banking: Live Blog Prelude

Carlos Novais — Tue, 28 Apr 2009 18:11:20 GMT

"Free banking" to be honest require that banks that issue notes and accept deposits of a commodity (let´s say gold and silver) to be absolutely clear about the service and contract provided.

Bank "100% reserve" could say something like: "This note is a receipt of a gold coin deposit" or "You balance in you demand deposit current account is covered 100% by gold deposits"

Bank "20% partial reserve" could say: "this note or balance in demand deposit is a claim/IOU of gold coins covered at demand by at least 20% of gold"

So, the free banking argument is valid in the sense taht each issuer is perfectly clear about the contract established.

The thing that the "free banking" argument misses is that:

- notes/deposits from diferent issuers will not be in anyway fungible

- in a free market with an honest Free-Banking, Good Money will drive out Bad Money... just imagine an arbitrage between asking credit in a partial reserve bank (that wil expand it´s money supply wiht the new credit) and "buying" notes/deposits in a 100% reserve bank.

The partial reserve bank will trade at discount sooner or later.

The discount will also appear if you think yourself making a deposit of 100 gold coins that you are adding to your hoarding. In a partial reserve bank, in the moment that you deposit 100 coins, you are receiving notes/deposits that will be exchanged for sure at discount.