Free Capitalist Network - Community Archive
Mises Community Archive
An online community for fans of Austrian economics and libertarianism, featuring forums, user blogs, and more.

Fractional reserve banking

Answered (Verified) This post has 4 verified answers | 618 Replies | 34 Followers

Not Ranked
4 Posts
Points 480
dmuldoon posted on Mon, Feb 9 2009 11:38 AM

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

  • | Post Points: 335

Answered (Verified) Verified Answer

Not Ranked
4 Posts
Points 480
Verified by dmuldoon

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?

 

  • | Post Points: 120
Top 50 Contributor
Male
1,687 Posts
Points 22,990
Answered (Verified) Bogart replied on Mon, Feb 9 2009 12:12 PM
Verified by dmuldoon

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.

 

  • | Post Points: 60
Top 10 Contributor
Male
4,985 Posts
Points 90,430
Verified by dmuldoon

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

  • | Post Points: 5
Top 200 Contributor
Male
481 Posts
Points 7,280
Verified by dmuldoon

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.

  • | Post Points: 5

All Replies

Top 10 Contributor
Male
5,538 Posts
Points 93,790
Juan replied on Sun, Dec 27 2009 5:10 PM
so that their criminal 'business' model is NOT* wiped out by real free market forces ?
*typo. And edit seems to be temporarily broken.

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."

  • | Post Points: 5
Top 50 Contributor
Male
2,124 Posts
Points 37,405

Juan:
Aren't those things exactly what fractional reserve bankers (aka fraudsters) asked the government to implement so that their criminal 'business' model is now wiped out by real free market forces ?

Possibly. Or it was to avoid competition. Hardly anymore of a strike against FRB  than a strike against free market capitalism.

Juan:
Yeah. Did santa claws visit you this christmas ?

Are you saying it doesn't?

"I am an aristocrat. I love liberty, I hate equality."
  • | Post Points: 20
Top 10 Contributor
Male
5,538 Posts
Points 93,790
Juan replied on Sun, Dec 27 2009 5:50 PM
Possibly.
Possibly yes ? Possibly not ?
Or it was to avoid competition.
I think that's what I implied ? Competition would wipe out FRB and the banking mafia that 'profits' thanks to it.
Hardly anymore of a strike against FRB than a strike against free market capitalism.
Quite the contrary, it seems that fractional/fraudulent reserve banking can't exist unless as a 'protected' industry. So I don't see any strike against the market, but a strike against fraudsters who confuse fraud with fair dealing.
Are you saying it doesn't?
I asked a question...

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."

  • | Post Points: 20
Top 50 Contributor
Male
2,124 Posts
Points 37,405

Juan:
I think that's what I implied ? Competition would wipe out FRB and the banking mafia that 'profits' thanks to it.

Competition would hurt established banks, not necessarily wipe out FRB. Just as barriers to competition in retail aren't in place because they think retail itself will be wiped out.

Juan:
Quite the contrary, it seems that fractional/fraudulent reserve banking can't exist unless as a 'protected' industry. So I don't see any strike against the market, but a strike against fraudsters who confuse fraud with fair dealing.

There isn't any evidence to support your first sentence.

Juan:
I asked a question...

Clarify and I'll answer.

 

 

"I am an aristocrat. I love liberty, I hate equality."
  • | Post Points: 5
Top 200 Contributor
471 Posts
Points 9,105

Jonathan M. F. Catalán:

Yes, maybe in a system in which credit reserves were not inflated with fiduciary media.  An increase in the demand for money would show a time preference leaning towards current goods, as opposed to future goods, so interest rates would probably be higher when demand for money increases.  But, under fractional reserve banking the problem is that the increase in the money supply is not synonymous with an increase in the demand for money.  What is increasing is the money substitute representing capital, which is why the interest rates for borrowing capital decrease.

This is why I stress the difference between money (a tangible asset, like gold) and capital (something that is used to produce more capital during the stages of production).

An increase in the demand for money is not the same thing as an increase in the amount of dollars.  I'm not sure where you are making this fallacious connection.

 

This makes absolutely no sense.  I feel as if you're not really reading the posts you are replying to.  If you were, we would already be past this stage.

 

That's a fairly strange opinion to hold.  If you unwilling to change your perception of concepts, then what is the point of debating with you?  Had you read Shostak's article, you would have easily seen that was it being disputed is not the fact that " velocity of money exists", but the fact that velocity of money has anything to do with money supply and the ability to fund investment projects, because what really funds investment projects is the capital which the money represents.

I think you're confused about what a demand for money is and how it related to monetary economics. Of course money supply is not synonymous with money demand and as for an increase in the demand for money simply being an increase in the demand for "capital," ok... but this is purely an association of money being capital. If an increase in the demand for money is just an increase in the demand for capital, then an increase in the supply of money is also just an increase in the supply for capital.

 

I'm not sure why you think that's a valid argument, but I'm interested to hear an explanation.

 

 

As far as Shostak's article goes, I know what you meant, but I'm going to again say that I think Friedman is right on the issue of the velocity of money and whatever you or Shostak say is just incorrect in aspect to monetary economics. Note that I'm talking about monetary economics which relates to how money works in the economy and how much people are participating in the economy with their money.

existence is elsewhere

  • | Post Points: 35
Top 200 Contributor
471 Posts
Points 9,105

Juan:
Oh really ? And why not ? Maybe the evil government is forcing the heroes of free-enterprise, aka banking mafia, to print money ?

The mafia is cool.

existence is elsewhere

  • | Post Points: 5
Top 25 Contributor
Male
3,113 Posts
Points 60,515
Esuric replied on Mon, Dec 28 2009 4:24 AM

Wilmot of Rochester:
f an increase in the demand for money is just an increase in the demand for capital, then an increase in the supply of money is also just an increase in the supply for capital.

Money is not capital, but allows for capital accumulation. When there is a scarcity of capital, that is, necessary goods which are to be employed in production and supplied by savers, then the interest rate is high. Thus, when society demands more money, what they're really demanding is the depression of the market rate of interest, so that their unwarranted economic activities become economically possible. But, of course, without an actual increase in subsistence (savings), none of the investment ventures which require the arbitrarily reduced interest rate will be completed profitably. Suppressing the market rate of interest through inflation does not change the natural rate of interest--societies time preference, which is a real independent economic phenomena (the case of all economic activity).

 

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

  • | Post Points: 5
Top 25 Contributor
Male
3,113 Posts
Points 60,515
Esuric replied on Mon, Dec 28 2009 4:28 AM

The question isn't whether FRB is fraudulent, because it isn't. The question is if FRB must necessarily depress the market rate of interest below the natural rate. The demand for money is linked to the natural rate of interest, to the capital and labor markets. The free bankers must show that FRB, left to its own devices (void of any and all intervention) can keep the market rate of interest at or near the natural rate.

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

  • | Post Points: 20
Top 50 Contributor
Male
2,687 Posts
Points 48,995

Wilmot of Rochester:

I think you're confused about what a demand for money is and how it related to monetary economics. Of course money supply is not synonymous with money demand and as for an increase in the demand for money simply being an increase in the demand for "capital," ok... but this is purely an association of money being capital. If an increase in the demand for money is just an increase in the demand for capital, then an increase in the supply of money is also just an increase in the supply for capital.

No, I said that a demand for money is not the same thing as a demand for capital.

 

I'm not sure why you think that's a valid argument, but I'm interested to hear an explanation.  Demand for money is demand to hold money as cash or in demand deposits, as a form of providing liquidity.  I have already said that money is not capital, it represents capital.  An increase in the supply of money does not create an increase in the supply of capital.

 

 

As far as Shostak's article goes, I know what you meant, but I'm going to again say that I think Friedman is right on the issue of the velocity of money and whatever you or Shostak say is just incorrect in aspect to monetary economics. 

Why?  You haven't provided a reason.

  • | Post Points: 20
Top 25 Contributor
2,966 Posts
Points 53,250
DD5 replied on Mon, Dec 28 2009 1:42 PM

Esuric:
The question isn't whether FRB is fraudulent, because it isn't. The question is if FRB must necessarily depress the market rate of interest below the natural rate.

The two conditions cannot coexist.  If it is not fraudulent, then it does not make sense to say that it can still depresses the market natural rate of interest.  

 

  • | Post Points: 35
Top 50 Contributor
2,491 Posts
Points 43,390

DD5:
 If it is not fraudulent, then it does not make sense to say that it can still depresses the market natural rate of interest.  

 Why? What makes anything legal optimal?

  • | Post Points: 20
Top 25 Contributor
Male
3,113 Posts
Points 60,515
Esuric replied on Mon, Dec 28 2009 2:04 PM

DD5:
The two conditions cannot coexist.  If it is not fraudulent, then it does not make sense to say that it can still depresses the market natural rate of interest.  

Well, first of all, there are those who believe that FRB doesn't necessarily suppress the market rate of interest below the natural rate. Fractional reserve banking has beneficial implications for both savers and banks, which is why it emerged naturally though voluntary activity. This assertion only holds when one believes, without a doubt, that all voluntary activities must necessarily yield economic harmony--but this is just an assertion. Economic harmony may not be possible.

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

  • | Post Points: 35
Top 25 Contributor
2,966 Posts
Points 53,250
DD5 replied on Mon, Dec 28 2009 2:12 PM

scineram:

DD5:
 If it is not fraudulent, then it does not make sense to say that it can still depresses the market natural rate of interest.  

 Why? What makes anything legal optimal?

That's not what I said.

The market is a process of voluntary exchange.  What ever prices arise in this exchange is the natural price or rate.

 If FRB is not fraudulent and credit expansion is possible in some productive way, then the interest rate is the market rate, no matter how that expansion influences the interest rate.

 

 

 

 

 

  • | Post Points: 5
Top 500 Contributor
Male
162 Posts
Points 2,555

I don't see how FRB is any different than taking the petty cash fund on friday and putting it back on monday.  Certainly this constitutes a voluntary action on someones part but does that mean it has emerged through natural voluntary action.

  • | Post Points: 20
Top 25 Contributor
2,966 Posts
Points 53,250
DD5 replied on Mon, Dec 28 2009 2:18 PM

Esuric:
This assertion only holds when one believes, without a doubt, that all voluntary activities must necessarily yield economic harmony--but this is just an assertion. Economic harmony may not be possible.

See my above reply to Ensuric

 

Esuric:
Fractional reserve banking has beneficial implications for both savers and banks

Can you please respond to my response to Jonathan Catalan regarding defrauding the "third party" here: http://mises.org/Community/forums/t/6197.aspx?PageIndex=23

 

Esuric:
which is why it emerged naturally though voluntary activity.

I don't agree with this assertion at all.

 

  • | Post Points: 5
Page 26 of 42 (619 items) « First ... < Previous 24 25 26 27 28 Next > ... Last » | RSS