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.
Angurse:(Also if you could quote where Mises calls for 100% reserves outside of the central banking system that would be great.)
That quote I provided above about reform is clearly a proposal for the abolition of central banking.
I'm not going to argue with you anymore about context. The context is there for all to judge for themselves.
Jonathan M. F. Catalán: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.
I don't agree:
Thus (when you consider the three conditions required to end the trade cycle) the logical conclusion is that the (immediate) cause of all cyclical activity and inter-temporal disequilibrium is this divergence between the two rates of interest (one controlled by banking system, and other controlled by real forces--both of them are variables, controlling one does not control the other). Fractional reserve banking may or may not cause inter-temporal disequilibrium.
Jonathan M. F. Catalán: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.
I don't understand what you're trying to say here. An influx of labor will indeed cause the natural rate to rise, and if the banking system doesn't respond by increasing the money rate of interest (keep reserves at the established rate), a trade cycle will surely follow.
Jonathan M. F. Catalán: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].
(emphasis is mine). This is what I'm talking about and advocating. A money supply which responds to the demand for cash holdings does not affect the ratio between the demand for present and future goods, and therefore does not cause a divergence between the two rates of interest, and is ultimately not responsible for economic downturns. Also, the credit-induced boom followed by a bust is only one kind of downturn. You can go straight to a bust (MR>NR), or have Cantillon affects due to price rigidities and a variable money supply (gold standard with 100% reserves still has a variable money supply).
The main theoretical issue, in my opinion, is the fact that Rothbardian's (for lack of a better term) don't consider (or take into account) price rigidities. If this was eliminated, then the problem would be that much simpler.
"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."
Wait, I thought they weren't proposals?
The contraction is not the problem. The expansion (inter-temporal disequilibrium) is the problem.
DD5: 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?
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?
2. Because they have increased the supply of money beyond the demand for cash holdings, altering the demand for consumer and producer goods, distorting the structure of production. The tension between actual time preference and the market rate of interest forces the structure to its natural state; the money rate will rise towards the natural rate, extinguishing excess fiduciary media, leading to a liquidation of malinvestments. The demand for money will (may) rise sharply, elevating the market rate above the natural rate (over-compensating), leading to "secondary shocks." My argument (which you entirely ignore, once again) is that the boom is not caused by fractional reserve banking. No boom, no bust.
Esuric:A money supply which responds to the demand for cash holdings does not affect the ratio between the demand for present and future goods, and therefore does not cause a divergence between the two rates of interest, and is ultimately not responsible for economic downturns.
You are talking about banks issuing fiduciary media to meed this alleged demand. Your above assertion is not necessarily true at all.
I think Jonathan may be able to make the case as why this is not true, so I will not respond to this at this moment.
Esuric:Because they have increased the supply of money beyond the demand for cash holdings
And the minute the market discovers what they had done, the banks' true assets are revealed to be only a fraction of its total liabilities. You say that I am avoiding your argument, but I am not.
The above is currently only possible with with Fractional Reserve banking. What is not clear about this point?
You keep resorting to the theoretical explanation of what actually occurs to the structure of production. I know this! But the theoretical explanation does in no way refute the causal institution for the distortions - Fractional Reserve Banking. And I don't deny that the institution is so effective in its ability to distort the economy by government exempting it from the free market.
DD5: And the minute the market discovers what they had done, the banks' true assets are revealed to be only a fraction of its total liabilities. You say that I am avoiding your argument, but I am not. The above is currently only possible with with Fractional Reserve banking. What is not clear about this point? You keep resorting to the theoretical explanation of what actually occurs to the structure of production. I know this! But the theoretical explanation does in no way refute the causal institution for the distortions - Fractional Reserve Banking. And I don't deny that the institution is so effective in its ability to distort the economy by government exempting it from the free market.
You're throwing the baby out with the bath water. Eating food can clog your arteries, but the solution isn't to ban food (bad analogy, I know). Fractional reserve banking can lead to inflationary induced booms, but the solution isn't to ban/eliminate modern banking. FRB is only an indirect cause. The remedy is to free the banking system so that it can accommodate the demand for money, and prevent the elevation and depression of the market rate with respect to the natural rate. Is this possible? Theory says yes. The banking system has always been the most regulated sector, but I believe that voluntary exchange and free market activity yields the optimal result (it may lead to 100% reserves--but you can't reach this conclusion a priori, and you have no historical support).
Esuric: The remedy is to free the banking system so that it can accommodate the demand for money, and prevent the elevation and depression of the market rate with respect to the natural rate.
This is a rather ironic statement. All of the "elevation and depression" that you are talking about have all been themselves caused by the very system you are proposing as a remedy. And your system cannot respond to a demand for money, but a demand for fiduciary media - They are not the same. You are wrongly assuming that demand for fiduciary media always constitutes a demand to forgo consumption. You don't realize it [yet], but this is false.
And Mises was suppose to have cleared up this confusion about the demand for money and the need for tampering with the money supply. People demand purchasing power and not money.
Esuric: but the solution isn't to ban/eliminate modern banking.
It's not? I thought we agreed on that. Modern banking is not free by any means.
Esuric:Eating food can clog your arteries, but the solution isn't to ban food
I don't want to ban anything of this kind. When are you going to quit with the straw man. I personally think Ponzi-schemes should be legal as long as long as participant are not deceived into thinking it is a just another mutual fund.
DD5:This is a rather ironic statement. All of the "elevation and depression" that you are talking about have all been themselves caused by the very system you are proposing as a remedy.
Are you conflating our current system with a free market in banking and money, once again?
DD5:And your system cannot respond to a demand for money, but a demand for fiduciary media - They are not the same.
Fiduciary media satiates the demand for money. You don't want the supply of money in the broader sense to expand beyond, or fall below, the demand for money.
DD5:You are wrongly assuming that demand for fiduciary media always constitutes a demand to forgo consumption. You don't realize it [yet], but this is false.
I never made this claim. Forgoing consumption is called saving, which is the demand for future goods. I'm saying that satiating the demand for money as money does not affect the demand for current and/or present goods. (Go back two pages and re-read my initial defense of free-banking).
DD5:And Mises was suppose to have cleared up this confusion about the demand for money and the need for tampering with the money supply. People demand purchasing power and not money.
He created a taxonomy of money. Fiduciary media is money in the broader sense (called "M1" today).
DD5:Modern banking is not free by any means.
Define modern banking. There have been relatively free periods of modern banking (Scotland), and extremely regulated periods of modern banking (today). The former worked pretty well, relatively speaking (until a government intervention, Peel's act, brought it to an end). When I say "modern banking" I'm talking about banking after the "dark ages" (in Europe and Middle East).
DD5: Esuric:Eating food can clog your arteries, but the solution isn't to ban food I don't want to ban anything of this kind. When are you going to quit with the straw man. I personally think Ponzi-schemes should be legal as long as long as participant are not deceived into thinking it is a just another mutual fund.
I said it was a bad analogy, and then I tried to clarify the point. Also, your personal ethical beliefs mean nothing to me. I personally believe that government intervention and extreme regulations are bad.
Esuric:Are you conflating our current system with a free market in banking and money, once again?
Look, I've said a million times that the market would keep such distortions to a minimum. If you want a clairification, then ask one. Don't resort to straw man attacks.
You keep making claims about hypothetical scenarios that are practically impossible without fractional reserve banking in order to support fractional reserve banking. So perhaps, you are conflating the two systems.
Esuric:Fiduciary media satiates the demand for money.
Because people are fooled into thinking that they are backed by 100% or they don't care because the government guarantees. And regardless of this, not all people want fiduciary media. Many will want to hold gold that is out of reach from banks precisely for the extreme "natural disaster" type scerios that you like so much. The bank cannot respond to anything but fiduciary media.
Esuric:I never made this claim. Forgoing consumption is called saving, which is the demand for future goods. I'm saying that satiating the demand for money as money does not affect the demand for current and/or present goods. (
Is holding money saving or not?
demand for money means holding it. Is it saving or not? What does it mean to say that a bank responds to this demand if not by making loans on the basis of the money held in the bank. I think you are all over the place.
Esuric:He created a taxonomy of money. Fiduciary media is money in the broader sense (called "M1" today).
And he also discriminated between them in his analysis. There is a reason.
DD5: Is holding money saving or not? demand for money means holding it. Is it saving or not? What does it mean to say that a bank responds to this demand if not by making loans on the basis of the money held in the bank. I think you are all over the place.
Do you expect me to answer the same questions, over and over again, forever?
Can you give some concrete examples for situations when a free market agent (yourself, person, corporation, depositor?) "demands" more cash holdings than they already have? What would cause this "demand" to appear and what would these "extra" cash holdings be used for? I assume that you are not referring to a scenario where you spend your bank account down to $0 whereupon you express your "demand for cash holdings" which the bank's "money supply" is supposed to meet, but I could be wrong.
Z.
Esuric: Fractional reserve banking may or may not cause inter-temporal disequilibrium.
Fractional reserve banking may or may not cause inter-temporal disequilibrium.
The claim isn't that fractional reserve banking is the cause, it is that it is a cause, and so the phrase, "Fractional reserve banking causes the business cycle" is accurate.
Whether this is true or not has nothing to do with what you quoted.
z1235:Can you give some concrete examples for situations when a free market agent (yourself, person, corporation, depositor?) "demands" more cash holdings than they already have?
Ever tried to sell anything?
Angurse: Wait, I thought they weren't proposals?
There were 3 quotes.