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.
nirgrahamUK: Question. how is Mises' take on 'price level' an example of a political dogma?
Question. how is Mises' take on 'price level' an example of a political dogma?
In the way you use it to relate to the topic at hand. Most of the topics - scratch that, basically all the topics - on this forum are centered around politics. To quote large pockets of text straight from one source without any further thought given to the matter is pretty dogmatic.
existence is elsewhere
I'm dissapointed you turned out to be so petty..... and dogmatic.
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
" without fractional resreve banking, how can money be loaned and how could a bank possibly pay me interest? "
well...you can always loan your own money.
you can also invest your money in an enterprise and hope for some type of profit return.
you could deposit money into a 100 percent reserve account (as rothbard says we should go back to... "the fraudulent fractional-reserve banking system, and go back to a sound system of 100% reserves. http://mises.org/Econsense/ch78.asp) and have the bank/investment house take a portion of your deposits and pool them into loanble funds of varying risks and returns.
take the above and apply modern technology to it and it probably wouldnt be much of a technical issue.
I have never understood why many Austrians are so hostile towards FRB. Government involvement in the banking industry is bad, yes. Fraud is bad, yes. Is FRB always fraud? Definitely not. Is FRB always bad? No. For supposed free market thinkers, a lot of people seem very keen on imposing ideas on others. Let everyone run his bank as he sees fit, then people can decide which currencies and banks to trust themselves. A free market would most likely never produce banks with as low reserve ratios as we see today, but I very much doubt that everyone would prefer, or even benefit from, a 100% reserve system. People keep saying that banks can't lend money they do not own. But given the permission of the original holder of the money, why not? When you receive a loan from a bank, the bank may restrict your use of the money (i.e. only lend given knowledge in what the money will be used for) or you may be free to do what you want with the money. Depositing in a bank really is no different. You decide what the bank you give your money to can use it for and they, in turn, offer you money (interest) for it. If they have unlimited usage rights, the money is worth a lot to them and they are willing to offer you high interest rates for it. However, if you restrict their usage rights, or even tell them they can't use it at all. The value of the money will in fact be negative for them, as keeping the useless money involves storage and security costs. Therefore they will offer you a negative price, or interest rate. Meaning, you will have to pay them to store your money. Risk averse people will prefer the latter and risk lovers the former, and I believe a free market would produce both options, and everything in between. The interest rate will reflect the risk the depositor takes when depositing his money, it really is no difference from lending to individuals. When I hear people yelling "FRB is fraud", what I hear is "People are too stupid to know what's best for them, so we have to ban mutually beneficial agreements between consenting adults". Or is there something I am missing here?
No matter what they do, government involvement in the baking industry will always result in moldy bread.
One thing I forgot to bring up in my last post is the case of a low-reserve bank lending more money than they have, i.e. issuing bank notes for unbacked resources. As long as it does not claim to have 100% backing, it is not fraud by any definition. It is up to the purchaser of the banknote (whether they get it from the bank or from a private individual) to decide what value he places in it. A bank with unsound practices will not gain a lot of trust among people and therefore, the holders need to be compensated for the risk of holding its bank notes. In other words, the money will lose value, maybe up until the point that it actually reflects the value of the resources being held by the bank, who knows? And similarly, people will trust a bank issuing sound money, and that money will generally accepted, and therefore more valuable. Transparency and backing of resources will be demanded by the consumers, but I don't hold it to be true that consumers would necessarily demand 100% backing of the bank notes. And there is no reason to forbid people from buying unbacked bank notes, any more than forbidding people from buying bad art. You can buy an ugly painting, just like you can buy a worthless banknote, but no one would call the painter fraudulent merely because the consumer was unable to appreciate its value properly.
Yes, FRB means fractional reserve banking...
I just don't understand your second question. Could you clarify what you mean?
caravelle:I have never understood why many Austrians are so hostile towards FRB. Government involvement in the banking industry is bad, yes. Fraud is bad, yes. Is FRB always fraud? Definitely not. Is FRB always bad?
It depends on what constitutes "bad" to you. If "bad" includes business cycles, it is "bad". Fraud is deception. Suppose I sold you a car with with no engine, gas tank or drive axles and you only found that when you tried to leave the lot. If I argued that it's your fault for not looking under the surface, would that be deceptive?
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?
Well isn't that what they pay you interest for? So they can loan out your money for a larger return than they are paying you?
Caley McKibbin: Suppose I sold you a car with with no engine, gas tank or drive axles and you only found that when you tried to leave the lot. If I argued that it's your fault for not looking under the surface, would that be deceptive?
This is relevant how?
scineram: Caley McKibbin: Suppose I sold you a car with with no engine, gas tank or drive axles and you only found that when you tried to leave the lot. If I argued that it's your fault for not looking under the surface, would that be deceptive? This is relevant how?
Joe public assumes that a car is sold with all of the standard parts and that a bank holds his money in safe keeping.
They don't.
Caley McKibbin:Suppose I sold you a car with with no engine, gas tank or drive axles and you only found that when you tried to leave the lot. If I argued that it's your fault for not looking under the surface, would that be deceptive?
"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."
FRB is not the cause of business cycles, not even in Austrian theory. The currency monopolies of central banks are. In a free society, you can simply stop accepting bad money when you stop trusting it. No sane person would ever assume that his money was laying idle in a vault if he receives interest on the money he deposited. The bank doesn't claim to keep all the money in their vaults, and anyone receiving interest would assume that they did. Hence, there is no deception, any more than a mongoloid child is deceived when he realizes he can't pilot the spaceship on the poster he just asked his mother to buy for him. Unless the banknote actually says "redeemable at any time", there really is no fraud going on if the bank doesn't have any gold in its vaults. Fraud requires lies. If indeed the banknote said something in that order, then yes, it would be fraud. So point still stands: Fraud is bad, but FRB does not necessarily involve fraud, and therefore it is logically invalid to state that "since fraud is bad, FRB is bad".
This is what I have been trying to get the FRB opponents to explain to me for a very long time. Assuming the bank does not pretend to have full reserves, then why is FRB fraud?