Similar questions probably get asked a lot, but this one is very straightforward.
I am curious about how fractional reserve banking is inflationary but yet 100% loan banking is not.
Loan banking would be where you place your savings in an interest paying loan account from which the bank would make loans to third parties with. These loan banking accounts would be used to make loans to customers which must be paid back during a certain time window and depositors would also not be able to withdraw their funds during that same window of time. Bunk runs would be impossible.
Fractional Reserve banking is still a bit mysterious to me on how it is inflationary while the above banking is not. I realize that a fractional reserve bank is subject to runs, but how is it inflationary? If a bank has a $1000 deposit and loans out $900 of it under the full extent allowed with a 10% reserve requirement. How is this inflationary? I know that the bank now has $1900 on its books but the original depositor is not using his $1000. It doesn't seem like any new credit has been created. So as long as the bank does not experience a run, how is this inflationary?
I am very interested in clearing this up for myself so that I can more properly explain this to others.
By full value I assume you mean the face value of the CD plus the interest to date. Since the CD is accruing interest until the date of redemption what people would pay for it depends a lot on the interest rate and the terms of the CD. It is actually possible people could in fact pay a premium above the face value and accrued interest to date for example if the CD was paying an exceptionally high interest rate in comparison to other CD's.
In the case of when gold is money then any piece paper claiming redemption in gold will act as a substitute for actually using gold. As long as the underlying redemption is possible in gold then the pieces of paper will be treated the same for the purposes of being substitutes for gold. In the case of the CD the bank in fact may have 0 holdings of gold but they are responsible for redeeming in gold which is all that really matters. The fact that there are intermediary instruments between the piece of paper and the redemption of the physical gold doesn't matter. This is probably the root cause of Austrian conflict on this issue. What you and many Austrians say is that if I promise to redeem in gold then I have to have the gold on hand and can not use other assets that are convertible to gold and simply convert these other assets to meet gold redemptions. So from your perspective if a bank had 100 million dollars worth of silver and was using that asset to back 1 million dollars in gold deposits the bank is commtting fraud because they have 0 reserves of gold and furthermore they are doomed to be insolvent. What makes more sense is to say that the bank is required to have sufficient assets to meet it's liabilities which makes the above scenario perfectly legitimate.
scineram: James Greene:It is? But with a demand deposit you would withdraw your money (be it fiat or gold backed) and spend that real money on a good. Swapping a CD for a good is trading a note of future payment for a present good. I don't understand your point. It is. I very rarely take cash form an ATM. Mostly I just buy train ticket on the net or pay with card. The majority of transactions today is only electronic. Banks hold little cash at hand because people just conduct transactions digitally with credit card or direct access.
James Greene:It is? But with a demand deposit you would withdraw your money (be it fiat or gold backed) and spend that real money on a good. Swapping a CD for a good is trading a note of future payment for a present good. I don't understand your point.
It is. I very rarely take cash form an ATM. Mostly I just buy train ticket on the net or pay with card. The majority of transactions today is only electronic. Banks hold little cash at hand because people just conduct transactions digitally with credit card or direct access.
Well when you use your card to pay over the net you are withdrawing money from you savings account (or under 100# reserve, your demand account). Where do you think that money comes from? You can't do such a thing with a CD as it is frozen in a loan account. Even though the CD can potentially be swapped for goods, these transactions are harmless and will not create credit expansion as fractional reserve loans will.
Maxliberty: James Greene: Lets say that Tony buys a car from his local car dealer with a $10,000 CD. The CD is not redeemeble for one year and the car dealer is still willing to accept it. The car that Tony bought was already in existance and built and paid for by the dealer and an automoble production factory. No new product creation happened and the dealer will not be able to efficiently replace that car on his lot until he eventually redeems his CD. All that is happening is that the car is changing hands for an IOU. NO real wealth is being used. All that has happened is that Tony now has a car and the dealer now has an IOU. A simple harmless swap. The dealer cannot access the money that the CD is entitled to and therefore no money has really been used even though at first glance it appears like it has. If we continue trading the CD then the car dealer gives the CD to the car maker who then sends him another car. The car maker then sends the CD to the car part suppliers who then send the material to build another car. It doesn't have to matter what the physical restrictions are for redemption. All that matters is that the note whether it is a check or a CD can be redeemed in the physical commodity.
James Greene: Lets say that Tony buys a car from his local car dealer with a $10,000 CD. The CD is not redeemeble for one year and the car dealer is still willing to accept it. The car that Tony bought was already in existance and built and paid for by the dealer and an automoble production factory. No new product creation happened and the dealer will not be able to efficiently replace that car on his lot until he eventually redeems his CD. All that is happening is that the car is changing hands for an IOU. NO real wealth is being used. All that has happened is that Tony now has a car and the dealer now has an IOU. A simple harmless swap. The dealer cannot access the money that the CD is entitled to and therefore no money has really been used even though at first glance it appears like it has.
Lets say that Tony buys a car from his local car dealer with a $10,000 CD. The CD is not redeemeble for one year and the car dealer is still willing to accept it. The car that Tony bought was already in existance and built and paid for by the dealer and an automoble production factory. No new product creation happened and the dealer will not be able to efficiently replace that car on his lot until he eventually redeems his CD. All that is happening is that the car is changing hands for an IOU. NO real wealth is being used. All that has happened is that Tony now has a car and the dealer now has an IOU. A simple harmless swap. The dealer cannot access the money that the CD is entitled to and therefore no money has really been used even though at first glance it appears like it has.
If we continue trading the CD then the car dealer gives the CD to the car maker who then sends him another car. The car maker then sends the CD to the car part suppliers who then send the material to build another car. It doesn't have to matter what the physical restrictions are for redemption. All that matters is that the note whether it is a check or a CD can be redeemed in the physical commodity.
You are missing the entire point and are still not understanding the essence of a CD and how loan banking will not give rise to the money expansion that fractional reserve banking will. A fractional reserve system is uniquely inflationary in the following way:
Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.
No such thing could happen with a CD because that CD cannot be deposited and loaned out at further smaller increments as in the example above. Again, it does not matter how many times the CD is traded around because it can never be deposited. Rather, it is a claim for a previous deposit that must have time to mature for redemption. Loan banking, and CDs, but the brake on money expansion. Any trading with a CD, no matter how perfuse, will not cause any economic damage or be any equivalent of using the same money in two places because, again, it is trading a future promise of payment for a present good.
James Greene:Well when you use your card to pay over the net you are withdrawing money from you savings account (or under 100# reserve, your demand account). Where do you think that money comes from?
I just said I am not withdrawing anything. I transfer IOUs to whomever I pay. There is nothing to come from anywhere, the bank now simply owes money to someone else.
James Greene:You can't do such a thing with a CD as it is frozen in a loan account.
There is no reason it cannot be transferred to be frozen at someone else's account.
scineram: James Greene:Well when you use your card to pay over the net you are withdrawing money from you savings account (or under 100# reserve, your demand account). Where do you think that money comes from? I just said I am not withdrawing anything. I transfer IOUs to whomever I pay. There is nothing to come from anywhere, the bank now simply owes money to someone else. James Greene:You can't do such a thing with a CD as it is frozen in a loan account. There is no reason it cannot be transferred to be frozen at someone else's account.
Exactly right Scineram. This is why the CD can function exactly the same, it is just an IOU just like a bank note.
James Greene: No such thing could happen with a CD because that CD cannot be deposited and loaned out at further smaller increments as in the example above. Again, it does not matter how many times the CD is traded around because it can never be deposited. Rather, it is a claim for a previous deposit that must have time to mature for redemption. Loan banking, and CDs, but the brake on money expansion. Any trading with a CD, no matter how perfuse, will not cause any economic damage or be any equivalent of using the same money in two places because, again, it is trading a future promise of payment for a present good.
But a CD can be deposited. Any bank could accept a CD as a deposit and then issue you their bank notes for you to go out and use because they have an asset to back up those bank notes. As long as the CD has as it's underlying asset something that either is gold or can be converted to gold then a bank could accept it as a deposit. I can see you are very confused about the physical redemption of gold versus the possibility of the physical redemption of gold.
James, I did not read this entire post to see if anyone else said this, but FRB is inflationary because the banks create greater and greater amounts of money substitutes, which are used as money, alongside actual money, such as gold/silver. That is the exact purpose of money substitutes - not a means of loaning the bank money. Money substitutes are denominated in money terms. If they are accepted as homogeneous units, this is expansion of the money supply (inflation) and it will cause rising prices.
The money substitutes (bank notes, checking deposits) have no absolute requirement to withdraw actual money from the bank when used as payment. For example, if we are both members of the same bank and I pay you for services via cheque, this puts absolutely no pressure on the bank to come up with actual money in the size of my payment.
This inflationary practice has limits, and should the bank exceed them, it will quickly become bankrupt. The less competition from other banks, the greater the size of the bank's clientelle, and the less demand for cash there is, the more money substitutes it can issue without the actual money backing it.
Of course, in today's banking environment, this doesn't make much sense. There is no threat of bankruptcy. Capital regulation, deposit insurance, central banking, and irredeemable fiat currency make true bankruptcy impossible. If there is ever a case where a bank becomes insolvent, it is simply taken over by the government and slowly dissolved. The true nature of our banking system is that almost all risk and pain associated with bankruptcy has been socialized.
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James, I did not read this entire post to see if anyone else said this, but FRB is inflationary because the banks create greater and greater amounts of money substitutes, which are used as money,
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It is not impossible to buy something with a time deposit. However, there is something called the universal law of time preference. People prefer goods now to goods at some point in the future. So a 50,000 CD redeemable in 12 months is not worth as much as 50,000 dollars today. If I surrender a good to you I would prefer for you to pay me at that instant rather than receive payment at some point in the future. Money today and money at some point in the future do not trade on par.
There is a difference between TIME deposits and DEMAND deposits. A bank can loan out a time deposit without increasing the supply of money and credit. If a bank loans out a demand deposit they increase the supply of money and credit. Fractional Reserve banking increases the supply of money and credit by loaning out demand deposits creating a property rights conflict between the depositor of funds and the person who the bank loans the funds to. Two entities would have a legitimate claim to the same property. This is not compatible with libertarian principles. FRB is a pyramid scheme and nothing more.
If you believe that people can voluntarily elect to participate in FRB then you are conceding that people have the right to participate in fraud so long as it is a fraud that is mutually agreed upon by two parties.
Joe Garceau: It is not impossible to buy something with a time deposit. However, there is something called the universal law of time preference. People prefer goods now to goods at some point in the future. So a 50,000 CD redeemable in 12 months is not worth as much as 50,000 dollars today. If I surrender a good to you I would prefer for you to pay me at that instant rather than receive payment at some point in the future. Money today and money at some point in the future do not trade on par. There is a difference between TIME deposits and DEMAND deposits. A bank can loan out a time deposit without increasing the supply of money and credit. If a bank loans out a demand deposit they increase the supply of money and credit. Fractional Reserve banking increases the supply of money and credit by loaning out demand deposits creating a property rights conflict between the depositor of funds and the person who the bank loans the funds to. Two entities would have a legitimate claim to the same property. This is not compatible with libertarian principles. FRB is a pyramid scheme and nothing more. If you believe that people can voluntarily elect to participate in FRB then you are conceding that people have the right to participate in fraud so long as it is a fraud that is mutually agreed upon by two parties.
Truth
Joe Garceau:So a 50,000 CD redeemable in 12 months is not worth as much as 50,000 dollars today.
The CD is earning interest so that compensates for the time preference. It is quite possible that people will pay the face value of a CD today knowing that they are being comensated for the delay in redemption.
Joe Garceau:There is a difference between TIME deposits and DEMAND deposits.
But banks are not required to have demand deposits. So a better question is what is a time deposit because if the bank poses any delay on redemption what you now think of as a demand deposit would become a time deposit. So since we are talking about physical redemption of gold then if the bank had for example a one day waiting policy for the physical redemption of gold that would make your demand deposit a time deposit. The function of the bank would be the same of course but your entire arguement has just collapsed since all time demand deposits are time deposits now.
All a bank note is, is a claim on the underlying asset, whatever the asset is. Just beacuse the bank offers redemption in gold does not mean the bank has to have physical gold, it only means the bank has to have assets sufficient to convert to gold to meet redemptions. See my example of a bank that has silver but offers gold as a redemption option.
Maxliberty: James Greene: No such thing could happen with a CD because that CD cannot be deposited and loaned out at further smaller increments as in the example above. Again, it does not matter how many times the CD is traded around because it can never be deposited. Rather, it is a claim for a previous deposit that must have time to mature for redemption. Loan banking, and CDs, but the brake on money expansion. Any trading with a CD, no matter how perfuse, will not cause any economic damage or be any equivalent of using the same money in two places because, again, it is trading a future promise of payment for a present good. But a CD can be deposited. Any bank could accept a CD as a deposit and then issue you their bank notes for you to go out and use because they have an asset to back up those bank notes. As long as the CD has as it's underlying asset something that either is gold or can be converted to gold then a bank could accept it as a deposit. I can see you are very confused about the physical redemption of gold versus the possibility of the physical redemption of gold.
Nonsense. You talk a lot but you dont say much. You should listen and learn. That CD cannot be redeemed for 12 months. It cannot be deposited in the way that money (fiat or gold) can be, and therefore that CD cannot be loaned out again and again at smaller increments as with fractional reserve banking to create inflation. Of course the CD can be deposited or given to a bank for safe holding - this is obvious, but is quite different than depositing cash because that CD cannot be touched or loaned out by the bank. Reread my last comment if you need further clarification, rather than me repeating myself here.
The backbone of this discussion/argument that we are having rests upon the inflationary factors of fractional reserve banking (which I describe to a T in my last post) and how they can be completely avoided through having two seperate forms of banking that do not allow fractional reserve - that of Loan Deposit Banking and Demand Deposit Banking. This would be the most likely outcome that the free market would decide, but obviously the free market could do whatever it wants as long as fraudulant and inflationary fractional reserve banking is outlawed. You insist that trading time deposit CD from a Loan Banking Account would be the same as the fractional reserve system but you are wrong and the last few posts between you and I have very clearly demonstrated this. A time deposit CD can be traded around town and placed back into various banks all year and it would have zero inflationary effects and it would not contribute to a business cycle. Don't get so stuck in your ways that you can't see the facts. ;)
Joe Garceau: If you believe that people can voluntarily elect to participate in FRB then you are conceding that people have the right to participate in fraud so long as it is a fraud that is mutually agreed upon by two parties.
joe and james this has been fun trying to explain to max how a time deposit is not the same as a demand deposit. Time deposits exist today in th\is world of frb where there is no regard for demand deposits. fractional reserve bankers can see the difference between a cd and a checking account so really there is no debate. It is Joe's statement that always has bothered me the most. FRB is a fraud that is perpetrated on society for the benefit of the bankers and the recipients of the new money pure and simple I don't care who agreed upon it.
Maxliberty: ... But a CD can be deposited. Any bank could accept a CD as a deposit and then issue you their bank notes for you to go out and use because they have an asset to back up those bank notes. ...
... But a CD can be deposited. Any bank could accept a CD as a deposit and then issue you their bank notes for you to go out and use because they have an asset to back up those bank notes. ...
Max - Gotta love those derivatives! Can't wait for that bubble to burst.
Joe - Would you be comfortable depositing a dollar knowing that it is only backed by a dime?
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bbnet: Maxliberty: ... But a CD can be deposited. Any bank could accept a CD as a deposit and then issue you their bank notes for you to go out and use because they have an asset to back up those bank notes. ... Max - Gotta love those derivatives! Can't wait for that bubble to burst.
Yes. That comment by max is nonsense. In a true free market where fractional reserve banking and inflation that steals people's wealth is outlawed, a bank would never be able to use a CD that a customer has on deposit as a backing for a loan. That is pure nonsense and seems to be a desperate attempt on Max's part to cling to his theories.
If person A traded a $10,000 CD to person B for a car and person B placed that CD into a bank for safe keeping then it would be exactly the same as when person A had the CD in a bank only now person B has it in a different bank and it is in his name instead of person A's. When the CD was in person A's posession, the bank clearly cannot make loans to other customers with it as backing because that completely destroys the purpose of loan banking. Just because person B receives the CD and puts it in a different bank (or the same bank) under his name does not mean that the bank could use it for backing of more loans. Total nonsensical dribble. That CD is a title for future money that is currently being used by a debtor. It cannot and would not be used as backing for loans. Period.