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.
It also has to be noted that a 100% RR on a gold standard would not keep the supply of money absolutely fixed. This means it will not satisfy any of the three conditions stated by Hayek.
"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."
Esuric: The books are somewhat vague (had to read both of them twice).
The books are somewhat vague (had to read both of them twice).
The book is not vague at all. It clearly considers the "current credit organization" as what is responsible for business cycle fluctuations. He spends at least ten pages [at least from p. 79 to p. 90] explaining the process of credit expansion through fractional reserve banking.
That's only one condition: "It is quite conceivable that a distortion of relative prices and a misdirection of production by monetary influences could only be avoided if, first, the total money stream remained constant, and second, all prices were completely flexible, and, third, all long term contracts were based on a correct anticipation of future price movements. This would mean that, if the second and third conditions are not given, the ideal could not be realized by any kind of monetary policy." –Page 304, Prices and Production.
Okay, cool, but that doesn't disprove what you quoted, and in fact reinforces it.
Jonathan M. F. Catalán:The book is not vague at all.
In your article (about the book) you said it was extremely vague, but okay.
Jonathan M. F. Catalán:It clearly considers the "current credit organization" as what is responsible for business cycle fluctuations. He spends at least ten pages [at least from p. 79 to p. 90] explaining the process of credit expansion through fractional reserve banking.
The credit organization is the indirect mechanism. You obfuscate the question at hand by taking this unnecessary step backwards in the causal chain. We may as well ask, "what causes fractional reserve banking," and so on and so forth. Do you agree that if the money rate is equal to the natural rate then there cannot be an inter-temporal misallocation of resources? If yes, then the only logical conclusion is that trade cycles are caused by an artificially depressed market rate relative to the natural rate (the necessary and sufficient condition).
Jonathan M. F. Catalán:Okay, cool, but that doesn't disprove what you quoted, and in fact reinforces it.
Reinforces what exactly? That 100% reserves cannot prevent cyclical fluctuations? I agree.
I have some more to respond on your previous post, but perhaps only later.
Esuric:Reinforces what exactly? That 100% reserves cannot prevent cyclical fluctuations?
This is true but not for the reasons you mention. see:http://libertarianpapers.org/articles/2010/lp-2-2.pdf
Even most prominent free bankers such as Selgin concede the point that 100% eliminates the possibility of the boom/bust cycle.
You just keep ignoring 2 very important aspects of ABCT, which I have already brought to you attention several times:
1. The bust always reveals a severe mismatch between liabilities and assets causing the bank to be almost instantly insovent.
2. As credit tightens, a reversal process of credit contraction begins to take place. As the crisis becomes more severe, bank failures accelerate the process of monetary contraction.
Both 1 & 2 are nonexistent in the absent of Fractional Reserve banking. They are a very important part of ABCT.
You are concentrating all your effort on 1-3 papers and that is all. But even those papers should not lead you to such spactacular assertions such as FRB does not cause the business cycle.
That Hayek may have occasionally used terms such as "above natural rate" to describe voluntary action does not prove the entire Austrian perspective as you portray it to be. It certainly doesn't prove that the choice of words were indeed accurate. you are trying to prove too much with very little.
Esuric: In your article (about the book) you said it was extremely vague, but okay.
I said it was poorly written, not that the ideas were vague or unclear themselves.
The credit organization is the indirect mechanism. You obfuscate the question at hand by taking this unnecessary step backwards in the causal chain.
Then Hayek committed the same mistake, although I don't see it as a mistake. In the book, Hayek is clear when saying that fractional-reserve banking is why the deviations from the natural rate of interest take place.
Do you agree that if the money rate is equal to the natural rate then there cannot be an inter-temporal misallocation of resources? If yes, then the only logical conclusion is that trade cycles are caused by an artificially depressed market rate relative to the natural rate (the necessary and sufficient condition).
If there were other methods by which to depress the rate of interest under the natural rate of interest [and mass immigration is not a means of doing this, as wherever the interest changed to it would still be natural] then one couldn't suggest that fractional reserve-banking is the only cause of malinvestment. Even if it wasn't the only cause of malinvestment, Hayek nevertheless makes it clear that it is a cause. So, when somebody says "fractional reserve banking causes business cycles" they would have made an accurate statement.
That a cycle-less economy requires a constant money supply [or, in the case of the constant money "stream", a money supply which responds only to changes in the demand for money, or the demand to hold cash]. Whether it is the only condition, or one of three conditions, is irrelevant as long as it's still a condition. It is true, however, that Hayek's opinions changed quite a bit between Monetary Theory and Prices and Production:
In 1937, Hayek's stance at the gold standard had changed from his early position. White (1999) suggests that this was due to his switch from the "constant money stock" to the "constant money stream" norm in Prices and Production. This theoretical improvement altered his critique of the gold standard. In 1928, dissenting from Mises's view, he rejected the gold standard entirely on the grounds that it allows the quantity of gold to vary. Later, in Prices and Production, when warning that an attempt to "drastically ... reconstruct our monetary system, in particular to replace the semi-automatic gold standard by a more or less arbitrarily managed currency" poses dangers "much greater than the harm which is possibly done by the gold standard" his position is akin to his teacher's ([1931 ]1935:127). However, in Monetary Nationalism and International Stability, similar to Schumpeter, he indicates that they are merits in "any mechanical principle (such as the gold standard)," which at least has equilibrating mechanisms for distributing the global money stock among countries (1937:93). Finally, the arguments developed in The Denationalization of Money (1978) led Hayek to again modify his position with respect to the gold standard. He now favors free banking and predicts that in a free competition among different types of money, the public would choose stable-valued private fiat-money over gold.
A footnote says:
47. The argument runs as follows. Having moved toward the "constant money stream" norm, Hayek now regards the gold's supply elasticity as a virtue rather than a vice (1948:210-211), providing that the gold stock responds to money demand shifts with an adequate speed and that there exists a "central monetary authority for the whole world" or its equivalent in policy cooperation among national banks (1937:93). See White (1999), p. 114.
This is from: Festré, Agnes, "Money, Banking and Dynamics: Two Wicksellian Routes from Mises to Hayek and Schumpeter", American Journal of Economics and Sociology, Vol. 61, No. 2. This journal article is also really interesting and covers Hayek's theories and changes: http://mises.org/journals/qjae/pdf/qjae8_1_1.pdf
Esuric:The key, though, is that I've never heard 100% reserves mentioned in any of the pre-Rothbard books/articles I've read
Here are just a few quotes, and only from his early work, your favorite - Money and Credit:
The basic conception of Peel's Act ought to be restated
and more completely implemented than it was in the England of
his time by including the issue of credit in the form ofbank balances
within the legislative prohibition. (Money & Credit, pp 408).
'It would be a mistake to assume that the modern organization
of exchange is bound to continue to exist. It carries within itself
the germ of its own destruction; the development of the fiduciary
medium must necessarily lead to its breakdown. (Money and Credit pp 409)
No bank must be permitted to expand the total
amount of its deposits subject to cheque or the balance of such
deposits of any individual customer, be he a private citizen or the
U.S. Treasury, otherwise than by receiving cash deposits in legaltender
bank-notes from the public or by receiving a cheque payable
by another domestic bank subject to the same limitations. This
means a rigid 100 per cent reserve for all future deposits, i.e. all
deposits not already in existence on the first day of the reform. (Money & Credit pp 448)
There are countless more examples. I don't want to work so hard for you.
Those are of Mises proposing reform given the current central banking system, not a call for Rothbardian 100% reserve free market system.
Angurse: Those are of Mises proposing reform given the current central banking system, not a call for Rothbardian 100% reserve free market system.
How do you know? Mises spoke to you from the grave?
It seems that at least Dr. Selgin is the only modern FRB proponent that has enough courage and self confidence to not claim that Mises was a proponent of fractional reserve free banking. He openly rejects this idea and admits that Mises talked about free banking only as a 2nd best alternative to the current system.
DD5:How do you know? Mises spoke to you from the grave?
No, I just read his work. Context my friend:
In this first period of reform it is imperative that the American government and all institutions dependent upon it, including the Federal Reserve System, keep entirely out of the gold market. A free gold market could not come into existence if the administration were to try to manipulate the price ceiling by underselling. The new monetary regime must be protected against malicious acts by the Treasury and Federal Reserve System. There cannot be any doubt that officaldom will be eager to sabotage a reform whose main purpose is to curb the power of the bureaucracy in monetary matters.
This obviously isn't an ideal system hes proposing.
DD5:It seems that at least Dr. Selgin is the only modern FRB proponent that has enough courage and self confidence to not claim that Mises was a proponent of fractional reserve free banking. He openly rejects this idea and admits that Mises talked about free banking only as a 2nd best alternative to the current system.
I didn't know you were a fan of Dr. Selgin, regardless most don't say he was a proponent of fractional reserve banking what they generally say is that he clearly wasn't a full reservist.
Angurse:No, I just read his work. Context my friend:
First of all, the first 2 quotes are not proposals.
Second, if you read the full context, you cannot possibly infer from any of it that he was a proponent of FRB or sees any potential economic benefit. Yet somehow when Mises does propose a reform, he just happens to propose a restriction on the issuing of fiduciary media.
Angurse:This obviously isn't an ideal system hes proposing.
Then what his ideal proposal. Here is his chance! Where in your full "Context" does he propose anything else as some ideal?
Angurse:I didn't know you were a fan of Dr. Selgin, regardless most don't say he was a proponent of fractional reserve banking what they generally say is that he clearly wasn't a full reservist.
I think you have gotten it all backwards.
Fractional reserve free banking out of pragmatic considerations, but 100% reserves as an ideal.
DD5:First of all, the first 2 quotes are not proposals.
The word "ought" just jumps out at me, its really pretty simple, at no time in any of his work does he call for 100% reserve outside of the current government dominated system. Obviously not a full reservist.
DD5:Second, if you read the full context, you cannot possibly infer from any of it that he was a proponent of FRB or sees any potential economic benefit. Yet somehow when Mises does propose a reform, he just happens to propose a restriction on the issuing of fiduciary media.
"most don't say he was a proponent of fractional reserve banking what they generally say is that he clearly wasn't a full reservist."
DD5:Then what his ideal proposal. Here is his chance! Where in your full "Context" does he propose anything else as some ideal?
"Only free banking would have rendered the market economy secure against crises and depression."
Don't get mad at Mises for not writing everything in one book now, he needed to eek out a living after all.
DD5: Fractional reserve free banking out of pragmatic considerations, but 100% reserves as an ideal.
No, at least, not according to many free bankers out there, maybe Sechrest.
DD5:. The bust always reveals a severe mismatch between liabilities and assets causing the bank to be almost instantly insovent.
This is not relevant to the issue at hand. This is a result of a government induced artificial expansion, and then deflationary contraction. I'm not talking about, nor do I care about our current system. Our current system is easily understood. I'm talking about pure theory.
DD5: Both 1 & 2 are nonexistent in the absent of Fractional Reserve banking. They are a very important part of ABCT. You are concentrating all your effort on 1-3 papers and that is all. But even those papers should not lead you to such spactacular assertions such as FRB does not cause the business cycle.
First of all, you don't know what I've read. But if you actually paid attention to our last two conversation's, that is, if you read my comments, you would have noticed that my arguments don't merely come from "1-3 articles." I have quoted and cited at least 7 major works: Interest and Prices, Monetary Theory and the Trade Cycle, Prices and Production, Contra Keynes and Cambridge, Monetary Nationalism and International Stability, Theory of Money and Credit, and Positive Theory of Capital (+ whatever I forget to mention).
You, on the other hand, simply dismiss my arguments (fail to address them in anyway), and are shocked (confused) when I raise positions explicitly stated in the works I've mentioned above.
DD5:That Hayek may have occasionally used terms such as "above natural rate" to describe voluntary action does not prove the entire Austrian perspective as you portray it to be. It certainly doesn't prove that the choice of words were indeed accurate. you are trying to prove too much with very little.
I don't know how to respond to this. Again, you don't address my argument in anyway whatever. It's true that our current system (and the system before) tends to (understatement) reduce the market rate below the natural rate. But this has nothing to do with theory. Bad deflation has happened in the past, and many economists have spent a lot of time trying to remedy it. Hayek explains both situations, but focuses on inflationary induced trade cycles (for obvious reasons).
Angurse: DD5:First of all, the first 2 quotes are not proposals. The word "ought" just jumps out at me, its really pretty simple, at no time in any of his work does he call for 100% reserve outside of the current government dominated system. Obviously not a full reservist.
DD5:
I'm not an American so you are going to have to explain this a bit more for me. (Also if you could quote where Mises calls for 100% reserves outside of the central banking system that would be great.)
Esuric: DD5:. The bust always reveals a severe mismatch between liabilities and assets causing the bank to be almost instantly insovent. This is not relevant to the issue at hand. This is a result of a government induced artificial expansion, and then deflationary contraction.
This is not relevant to the issue at hand. This is a result of a government induced artificial expansion, and then deflationary contraction.
And government induces this expansion by means of Fractional Reserve banking.
Why are all the banks insolvent when the bust is revealed? Why does the moneys supply contract? Just because it expands, doesn't mean it has to contract. Why?
ANS: Fractional Reserve Banking
Remarkable, it's all a matter of terminology. Mises uses the terms Fiduciary media when describing the business cycle. How does Fiduciary media come into existence if not by Fractional Reserve banking?