In defense of Fiduciary Media
http://mises.org/journals/rae/pdf/R92_5.PDF
According Selgin and White, fractional-reserve banking are more profitable than full-reserve banking. They say that no one accepts full-reserve banking, which means fractional-reserve banking drives out full-reserve banking. And sometimes I don't really understand.Key points :1. Fractional-reserve banking has never been compulsory. Depositors have always been free to insist on 100 percent reserves.2. Benefits accrue to bank depositors and noteholders, who receive interest and services paid for by the extra bank revenue generated from lending out a portion of its liabilities. As Mises put it: "Fiduciary media tap a lucrative source of revenue for their issuer; they enrich both the person that issues them and the community that employs them." (which means : money creation gives more revenue).3. It would be farfetched to account for such behavior by insisting that the depositors had run because they had learned to their horror that their own banks had been holding fractional reserves, but were so naive as to put their money into another set of banks without suspecting them of similar practices. But if such a realization (that their bank held only fractional reserves) had been the typical cause of runs in the nineteenth and twentieth centuries, it would be difficult to explain why runs usually affected only one particular bank or an associated set of banks, and not every single fractional-reserve bank simultaneously. Running depositors who successfully withdrew their money often transferred it to other fractional-reserve banks, thought to be safer, rather than hoarding cash as they would have done if they feared fractional-reserve banks generally. 4. Few people have taken the 100-percent-reserve option because (as Rothbard forthrightly acknowledges) it means foregoing interest and paying warehousing fees instead.Most depositors would rather receive (more) interest on their deposits, and consider it more than adequate compensation for the risk involved in fractional-reserve banking. We think it more likely that 100-percent-reserve banking is just not very widely demanded, because of its foregone-interest cost.5. Hoppe considers but rejects a standard economic argument we accept concerning fractional-reserve banking : that it reduces the resource costs associated with indirect exchange, by partially substituting bank-issued exchange media for commodity money, thereby reducing (inframarginally) the resource costs of producing money. 6. Throughout the silver and gold standard eras, consumers given a choice ordinarily demonstrated a marked preference for banknotes over full-bodied coins as a more convenient medium of exchange for all but the smallest transactions.7. Did fractional-reserve banking cause the Business Cycle ? No. Business Cycle will occurs only with the Central Bank or Government intervention (inconvertible paper money, legal tender etc.), according both.8. Banknotes can include so-called “option clauses”. Scottish banknotes bore such clauses before 1765. With an option clause, a bank in effect reserves the right to stop redeeming its notes on demand, on the condition that it must pay interest on the notes during any period of suspension. So long as the interest rate is sufficiently high, option clauses are incentive compatible : they’ll only be invoked when so doing is in the noteholders’ own best interest. They had them to protect against note raids, where rival banks would pile up notes and then stage a raid to exhaust a bank’s reserves and put it out of business. Such raids occurred in the early days of Scottish banking. The option clause might have been used to protect against random panics.If you have any answers...I would appreciate it.
Rodolphe Topffer:5. Hoppe considers but rejects a standard economic argument we accept concerning fractional-reserve banking : that it reduces the resource costs associated with indirect exchange, by partially substituting bank-issued exchange media for commodity money, thereby reducing (inframarginally) the resource costs of producing money.
The problem here as always is the assumption that not everyone is permitted to duplicate the notes. The possibility that anyone who can afford the necessary equipment can duplicate them makes it impossible for non-specific paper notes to become money to begin with and impossible to maintain due to ultra-inflationary expectations the instant a free monetary system is in place. The entire case for fiduciary media in evolutionary perspective works within the boundary of a set of assumptions that small-statists may make and non-statists may not.
Merlin:Ok, let me restate my point: in almost every insurance product, and especially for the long term ones, the insured has a great amount of control on whether the insured even will happen.
No, if that was the case then Insurance would not exist at all.
I'm not saying that one cannot deliberately burn his house down, or that you cannot deliberately injure yourself and pretend like it was an accident. But such deliberate actions, which are considered fraudulent, are highly unlikely to occur in any systematic and persistent way. The presence of such human deliberate action certainly incurs an overhead cost, but as long as this cost is relatively low compared to the total cost , the Insurance business can still thrive. This is why Insurance companies try to reduce such behavior by discriminatory profiling, and this is why there are specialized trained investigators to detect such fraud. If this problem could not be reduced to a relatively minor problem, the Insurance business could not thrive.
Look, I don't want to argue about the above anymore. The above is so basic for insurance, that i see no point in pressing on this issue any further. You do what you want with it.
Merlin:I hope you do not doubt that a free market will provide health insurance, as I hoe that you do not doubt that human factor are of the outmost importance in such business
Free market health insurance would cover only against catastrophic events. Relatively low premium high deductible catastrophic insurance. Nothing more could survive the market. People would be classified into many different risk groups depending on life style, occupation, genetics, etc....
Merlin:You skipped it again.
I didn't skip it. You just refuse to accept the crux of my argument. Insurance and Fractional reserve banking are different beasts, yet you are asking me a question on the basis that they are similar. Why one gets away with it is thus, and invalid question if you realize that they operate completely differently.
Merlin:do you believe that under anarchy private arbiters would find it illegal to incur a maturity mismatch?
No. But they would find Fractional reserve banking practices to be fraudulent. Those are not necessarily conflicting answers.
Merlin:But again, this cannot be settled theoretically.
Because it just so happens that "free" bankers like to omit important theory just when it suits them.
Insurance companies holding fractional reserves is not an essential principle of insurance. How much reserve they hold does impact the risk. As in banks, the real insurer of insurance companies is the state that will bail them out.
I understand you might not want to respond, but what the hell.
DD5:No, if that was the case then Insurance would not exist at all.
OK, read my lips: humans influence every insurance product. And NOT by deliberately burning down houses or factories, which would be fraud and indeed checked in a free market, but by taking a given level of precaution, very often far short of maximum (the idea of insurance being precisely to save in preventive costs). If you enter insurance with fixed ideas like “this cannot be so!” you will probably go bankrupt by the 370th day. The only probabilitarian business which is uninfluenced by human action (in theory) is pure gambling, not insurance. If I (not I personally, an actuary in general) wanted, I could design a reserve PDF function to allow a FRB to get on most of the time. There is no basic difference. Indeed insurance is often available to Guarantees, i.e. assuming the clients financial liabilities if he fails to pay, say his bank. How is that for human action? I can’t convince you any more if I failed up to now.
DD5:Free market health insurance would cover only against catastrophic events.
If I walk 100 meters from my house I find an Austrian insurer who is very eager to sell his Health Insurance covering everything form check-ups to full surgery, no deductible, high premium. And no, it’s not compulsory, nor is it regulated in any way (I should know, I work in insurance regulation)
DD5:I didn't skip it. You just refuse to accept the crux of my argument. Insurance and Fractional reserve banking are different beasts, yet you are asking me a question on the basis that they are similar. Why one gets away with it is thus, and invalid question if you realize that they operate completely differently.
Even if that applies (it doesn’t) , I doesn’t matter an iota. The argument against FRB is simply that such institutions are, due to their very nature, always bankrupted, as liabilities are always bigger than Assets. The same holds for insurance. Now, what difference would make whether one is driven my Homo Sapiens’s action an the other by some other event? Since you are familiar with Mises’ argument on insurance, you should also keep in mind that Mises was permissive of FRB as logn as it was free market operation. So, what do you find in FRB ( but not insurance!) so denouncable that he didn’t?
DD5: Because it just so happens that "free" bankers like to omit important theory just when it suits them.
Not even Human Action prescriptions could be defended theoretically (Mises didn’t even try, he just tried to ‘sell’ them as being sensible). What could be defended is just our strong believe that, in a free society, such prescription would come to rule. But theory is not, and indeed cannot, be absolute (at least this is my idea, whether you agree is besides the point right now). So no, I’m not making exception when they suit me.
Caley McKibbin:Insurance companies holding fractional reserves is not an essential principle of insurance
It is in the sense that should I tell to an insurer-to-be that a full 100% of his assumed liabilities will materialize (100% of what he insures against will actually happen) he would not even try. Insurance would be dead. In this sense, fractional reserves are a must.
A bank, on the other hand, can, in theory, operate on 100% reserves. This is what I mean.
Merlin:OK, read my lips: humans influence every insurance product.
Nobody said human action doesn't influence the outcome. It is precisely this influence that categorizes different people into different risk groups. The problem is when there is a dependence between this outcome and the insurance policy itself. The coverage itself cannot have an affect on the outcome probability. If it does, then the event is not insurable. It cannot be classified into a categorical risk group for which definite probabilities can be calculated.
Maybe if you actually stopped and thought about the issue, you might have at least taken the time to read carefully what I have written. Your thought process is so busy in proving me wrong, that you completely missed the main point that I tried to get across to you.
Merlin: Caley McKibbin:Insurance companies holding fractional reserves is not an essential principle of insurance It is in the sense that should I tell to an insurer-to-be that a full 100% of his assumed liabilities will materialize (100% of what he insures against will actually happen) he would not even try. Insurance would be dead. In this sense, fractional reserves are a must. A bank, on the other hand, can, in theory, operate on 100% reserves. This is what I mean.
Insurance as it stands is a hoax. If an insurer has higher risk than the insured, which is clearly the reality of the present system, the insurance product is an increase in risk rather than a decrease to the insured. 100% reserve is a decrease in risk to the insured, which is the entire point to insurance. Arguing that only FRB insurance could compete due to lower costs is like arguing that only restaurants with no furniture and no waiters could compete to due lower costs. You have to spend money to provide a valid product.
If you work in insurance you must know that virtually every financial product is insured by the state both explicitly and to a greater extent implicitly.
Merlin:The argument against FRB is simply that such institutions are, due to their very nature, always bankrupted, as liabilities are always bigger than Assets. The same holds for insurance.
A 'bust' event for a FRB bank is when all customers walk in an demand access to their (promised 100%) liquid assets. A 'bust' event for an insurance firm is when all its policies get called in at the same time. The former is STANDARD business (picking up my 'parked' property). The latter is a CATASTROPHY -- an outcome (war, disaster, etc) which is usually excluded from insurance coverage. Failing to fulfill STANDARD obligations (which are at the core of your business) is fraud. Failing due to unlikely catastrophic events, isn't. If a huge meteor hit Earth, we're all insolvent.
Ultimately, I concede that fraud may not be 'fraud' if it's clearly disclosed and explained as such, so we may be dealing with semantics and definitions here. Only a moron would 'deposit' $100 and expect to BOTH have them invested AND available for withdrawal at the same time. Only a moron would park his car in a garage, allowing that tomorrow it BOTH be rented out to someone else AND available to him at the same time. Only a moron would knowingly 'invest' into a fully disclosed Ponzi scheme but, hey, who am I to stop a fool from throwing money down the drain? Is taking advantage of a moron -- to whom everything has been clearly explained and disclosed and yet he agrees to the 'deal' -- fraud? Perhaps not. Z.
Caley McKibbin: Merlin: Caley McKibbin:Insurance companies holding fractional reserves is not an essential principle of insurance It is in the sense that should I tell to an insurer-to-be that a full 100% of his assumed liabilities will materialize (100% of what he insures against will actually happen) he would not even try. Insurance would be dead. In this sense, fractional reserves are a must. A bank, on the other hand, can, in theory, operate on 100% reserves. This is what I mean. Insurance as it stands is a hoax. If an insurer has higher risk than the insured, which is clearly the reality of the present system, the insurance product is an increase in risk rather than a decrease to the insured. 100% reserve is a decrease in risk to the insured, which is the entire point to insurance. Arguing that only FRB insurance could compete due to lower costs is like arguing that only restaurants with no furniture and no waiters could compete to due lower costs. You have to spend money to provide a valid product. If you work in insurance you must know that virtually every financial product is insured by the state both explicitly and to a greater extent implicitly.
Don't get me wrong. I didn't mean 100% reserve insurance is impossible as in, no company can possibly have more assets than the sum of un-reinsured or otherwise capped liabilities, that can be, and indeed is often done. In this sense companies can be 100% reserve.
What I meant is that if solemn relay expected all of its assumed liabilities (policies) to require payment for, say, more than one year straight, people would just close insurance down as it would be financial suicide. The whole idea is that liabilities must turn out to be only a fraction of assets, otherwise the thing is unprofitable. So yes, companies could pay even all of their liabilities in a year or two, but they would only do so at a major loss, and only if knowing that in the future more normal rates of incidence would come by. If something like this would begin to be expected, insurance would die. So, insurance is inherently a fractional reserve business. A real-wrld example of the bets-known insurers in the world going bust due to ‘runs’ is Lloyd’s of London’s troubles in the late ’80.
DD5:The problem is when there is a dependence between this outcome and the insurance policy itself. The coverage itself cannot have an affect on the outcome probability.
OK, you lost me there.
I though you where arguing that if the insured party has a discernable and willfull effect on the rate of incidence, than pure random-loss insurance is not viable, which is a relatively good point, but in practice is mitigated my Bonus-Malus (next time, your premium rate goes up/down in response to your ‘performance’ last time). But I see you mean something else. Could you elaborate, as I don’t follow.
z1235: A 'bust' event for a FRB bank is when all customers walk in an demand access to their (promised 100%) liquid assets. A 'bust' event for an insurance firm is when all its policies get called in at the same time. The former is STANDARD business (picking up my 'parked' property). The latter is a CATASTROPHY -- an outcome (war, disaster, etc) which is usually excluded from insurance coverage. Failing to fulfill STANDARD obligations (which are at the core of your business) is fraud. Failing due to unlikely catastrophic events, isn't. If a huge meteor hit Earth, we're all insolvent.
In both cases companies refuse to fulfill their explicit contractual obligations simply because…what they where told would happen happened? The bank goes bust because clients want their money, as they told the bank they would. The Insurer goes bust because, say, asbestos claims where not properly reserved for, while asbestosis protection was the whole idea of the policy. It’s the same thing. The only difference I can discern, is that FRB variations tend to be huge, while insurance claim variances tend to be more contained. But otherwise the idea is the same.
As for the meteor scenario, there is a difference (in theory, in practice it will hardly matter) if, say, some theater is destroyed by the ensuing fire and doesn’t deliver the performance promised, and an insurer failing due to, say, massive floods (or a nuke-sized explosion in the industrial heartland of some country). The difference is that the contract of the theater spoke nothing of meteors, while the insurer contract was all about the flood. This is why FRB and insurance are in the same ‘moral’ category. They only change in actuarial term, i.e. than in FRB one must use models to take into account the huge variance in ‘claims’ (I’d say a Generalized Pareto would do). So they are the same and they should both be 'legal' (whatever that might mean in ancap) as long as, as you say, the terms of teh contract are clear.
z1235: Only a moron would park his car in a garage, allowing that tomorrow it BOTH be rented out to someone else AND available to him at the same time.
That must be the best FRB analogy I've ever heard.
Merlin:In both cases companies refuse to fulfill their explicit contractual obligations simply because…what they where told would happen happened? The bank goes bust because clients want their money, as they told the bank they would. The Insurer goes bust because, say, asbestos claims where not properly reserved for, while asbestosis protection was the whole idea of the policy. It’s the same thing. The only difference I can discern, is that FRB variations tend to be huge, while insurance claim variances tend to be more contained. But otherwise the idea is the same.
Merlin:That must be the best FRB analogy I've ever heard.
z1235:It's not the same thing and it's not merely a matter of degree (of variance). The bank's contractual obligation is to provide 100% LIQUIDITY (access to 'parked' property) to every depositor and at all times, and contingent on nothing. The concept of liquidity is very important here: I don't have to USE liquidity in order to HAVE it. A FRB bank can NOT offer (give) 100% liquidity to ALL clients, by definition -- only a 100% reserve bank can -- so the FRB bank is lying and is insolvent TODAY. Even when only a small part of its clients actually USE their promised liquidity, they can't possibly ALL have it. The FRB simply does NOT have what it says it has -- right now! The insurer's contractual obligation is contingent on a given event. The promised $1mil payout in my policy never was mine, and is not mine today. I can only claim it when the insured event happens. At it's core, an insurance contract is the same as ANY other contract between two parties. You are well advised to check the credit and record of the business owner from whom you just got an order for 1000 custom chairs, as there's always a chance he may not be able to pay at delivery and now you're stuck with 1000 pink chairs that took months to build and no one wants. This, and insurance, has nothing to do with FRB.
Merlin:The contact I have in mind as being legit would run along such lines: “the value of the funds shall be payable to the depositor at request”. Now, it might not seem a huge difference, but it is. For when you do this, you are not lying, neither do you break any promise (yet) when you use the funds. As long as you pay them on demand you’re within you contractual rights.
Merlin: z1235: Only a moron would park his car in a garage, allowing that tomorrow it BOTH be rented out to someone else AND available to him at the same time. That must be the best FRB analogy I've ever heard.
Probably that is why I didn't deposit car keys but cash.