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.
James Greene:I agree that CDs would not work like cash and it is absurd to suggest that they would. The point of the previous discussion is to show that in the rare instances where someone does trade a CD for a good, it is not inflationary. I know for myself that it would not create inflation. I guess you handful of people can think that it will if you want to. lol
inflation - an increase of money supply. monetizing ANYTHING is inherently inflationary unless it is matched by equal demonetization. and yes, it will increase prices
the situation you have described is that a CD is used as money, and then it isn't - you must admit it was temporarily inflationary. Given the absence of using the CD as money, the car may not have sold until new cars were ready for the lot, and the dealer would have lowered his price. If the dealer turns around and sells the CD for more cars, you see how this alters demand and supply schedules, and thus prices.
This is no different than option clauses. The bank can possibly lower interest rates and cause a business cycle, and when its loans don't perform, it will invoke its clauses, but have little able to sell off to meet obligations and go bankrupt.
Again, ultimately, the people have to prevent inflation by refusing to accept money substitutes and debts whose backing is dubious. If government privileges such instruments legally, people must refuse government authority. Otherwise, it is easy in a freely competitive environment. It is obvious that gold was chosen as money because its difficulty in manipulating its available supply. Given free currency and banking, people will refuse inflationary ones.
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Sure it's inflationary if someone chooses to accept it, but there are several differences:
1 - People are far more likely to accept a check, credit card, or cash
2 - Fractions of it can't be lent out repeatedly. A bank cannot accept a CD and then lend out 90% of it's value to a customer. They just can't. However, they CAN make a loan against a deposit, which gets spent by the borrower, and then deposited by the new receiver, who deposits it again, and then 90% of that can be lent out, and so on. Eventually $100 in an initial deposit results in $1000 in new demand deposits, which can all be spent.
So a CD is at most a little bit inflationary IF SOMEONE ACCEPTS it as cash or a cash equivalent (remember pretty much everyone accepts a checking card as a cash equivalent). But there's the catch, most people don't, and even if they do, 90% of it can't be lent out again and again and again to new customers.
Even if most people would accept CDs as payment (and they don't), it still wouldn't be nearly as inflationary as fractional reserve banking.
meambobbo:monetizing ANYTHING is inherently inflationary unless it is matched by equal demonetization. and yes, it will increase prices
Barter in a market economy is not inflationary. singular instances of people accepting a cd in exchange for goods or services is not going to be inflationary. If the cd were to become money or a money substitute that would be a different story. With a demand deposit i have 100% ownership to all of my money units whatever they be fiat currency, gold, fish heads it doesn't matter. If for administrative purpose's(the bank is closed or the vault is 600 miles away for security reasons) the bank cannot give me my money instantly, this does not create a time deposit situation or inflation I am still the only one who has ownership to the money. If the bank loans out a fraction of my money then it creates an issue where my money unit is represented twice once in my account and once in someone elses account or in their pocket. Now there is more money. In the case of a time deposit which is what a cd is i sign a contract releasing the purchasing power of my money to the bank. I give the bank full owner ship of the money if only temporarily. Since it is no longer in my account there is no increase in the money supply. The banks have subterfuge on their side we can't tell the difference between a once owned or twice owned dollar. However to say that i could sign a contract temporarily relinquishing ownership of my money and then present that contract to a merchant and that merchant would accept it as if it were the money I had relinquished is frankly rather silly.
WisR: Sure it's inflationary if someone chooses to accept it, but there are several differences:
Remember the keY point in the Austrian arguement is that if anyone does this and accepts a CD as money then they are engaging in fraud. Presumably with penalties of incarceration or maybe death. So it matters a great deal in a free society the difference between what is better for banks and individuals and what banks and individuals are prohibited from doing.
Shawn77:Barter in a market economy is not inflationary. singular instances of people accepting a cd in exchange for goods or services is not going to be inflationary. If the cd were to become money or a money substitute that would be a different story. With a demand deposit i have 100% ownership to all of my money units whatever they be fiat currency, gold, fish heads it doesn't matter. If for administrative purpose's(the bank is closed or the vault is 600 miles away for security reasons) the bank cannot give me my money instantly, this does not create a time deposit situation or inflation I am still the only one who has ownership to the money.
There is no requirement that if you deposit Gold in a bank that the bank has to maintain your deposit in gold. This is an agreement between you and the bank. If you don't mind that the bank will immdeiately sell your gold and convert it to another asset why should a third party claim this is fraud? All you the depositor are concerned with is A: Can I reedem my bank notes for gold on the terms I have agreed with the bank? and B: Does the bank have sufficient assets to cover its liabilities?
The following scenario in your view is fraud:
Person A deposits $1,000 in gold into bank B. Person A and Bank B agree that the gold will be sold and converted to a different asset and that physical redemption has a minimum two day waiting period and a max waiting period of 60 days. Person A receives his bank notes. Bank now loans $1,000 gold to person C.
Person A buys stuff from Person D. Person D goes back to bank and wants his gold and waits the two days and the bank converts some of it's other assets and gives him his gold.
Who exactly is the victim here? Where is the fraud? The Austrians are willing potentially to kill the people operating the bank over this scenario.
Shawn77:In the case of a time deposit which is what a cd is i sign a contract releasing the purchasing power of my money to the bank. I give the bank full owner ship of the money if only temporarily. Since it is no longer in my account there is no increase in the money supply.
But if I transfer $5000 from my time deposit to the car owner's account, which means he gets the 5000 plus interest when it is due, then it obviously does increase prices. Someone else to whom the bank loaned the money from my time deposit might have wanted to purchase the same car, so the money I put in my deposit is competing with my CD I paid with. The car dealer then again can use the time deposited 5000 to buy something from someone else, if there is a willing seller. So my CD can be used as medium of exchange in transactions, driving prices higher.
Shawn77:Barter in a market economy is not inflationary.
Barter is not indirect exchange; in a barter economy there is no money, a medium of indirect exchange. Without money, there is no such thing as inflation, even when crudely defined as price inflation. All you have is a huge array of pairs of goods and their exchange ratios. There is no such thing as general prices. Prices are simply another word for the exchange ratio between some good and money.
Shawn77:singular instances of people accepting a cd in exchange for goods or services is not going to be inflationary.
As I explained, it is temporarily inflationary because the CD is temporarily used as money...and then it isn't. Only if you define inflation as expansion of money AND credit would it not be in any form, because the CD already exists as credit, but not money. In such a case, there can be inflation without any effect on prices.
WisR: Sure it's inflationary if someone chooses to accept it, but there are several differences: 1 - People are far more likely to accept a check, credit card, or cash
I should point out that credit cards aren't a means of payment, only a transferal of debt. Instead of owing the vendor for the product, you owe the credit card company, who pays the vendor. Anyhoo, that's not totally important here.
As I said in my above post, in a free market, people are quite restrictive of what they will accept in terms of payment. Most individuals will reserve themselves to accepting currencies that are less inflationary than others. Ultimately, however, it is not some outside force, but the people themselves, that constitute government and deny the free market from working.
Now imagine making CD's legal tender. Or mortgage-backed securities from F Mae and F Mac. Obviously, this is inflationary. It expands what people will accept as payment through force.
WisR:2 - Fractions of it can't be lent out repeatedly. A bank cannot accept a CD and then lend out 90% of it's value to a customer. They just can't. However, they CAN make a loan against a deposit, which gets spent by the borrower, and then deposited by the new receiver, who deposits it again, and then 90% of that can be lent out, and so on. Eventually $100 in an initial deposit results in $1000 in new demand deposits, which can all be spent.
What if a bank operates identical to how you see FRB, except its "demand deposits" have option clauses (I don't even see how these can be called demand deposits)? This is identical to using CD's as money. It works...until it doesn't. The only real difference between a demand deposit and a CD, besides the amount of interest paid, is that CD's are not legal tender. If they were, it would be CD's instead of demand deposits that are pyramided against cash and FED reserves. There would be no point to prefer a demand deposit or cash over a CD, as they are functionally equivalent. There would be no point to someone selling a CD for less than its face value when it can be used at face value to legally pay any debt.
Picture it like this -> If a demand deposit is functionally equivalent to cash, in terms of legal usage and risk, why would anyone accept a loss on their demand deposit to turn it into cash? They don't - such is pointless. Why would a CD or deposit with an option clause be any different? Why would anyone prefer the cash they cannot currently redeem their CD for over the CD itself? The only conceivable means to think about it would be that CD's were not usable as a means of current payment. If they were, either by free market acceptance, or government fiat, then they are present goods just as much as fractionally-backed bank notes or demand deposits are.
Finally, read Rothbard's America's Great Depression. He includes CD's as part of the money supply! Why? Because they were frequently cashed out before maturity without penalty - a de facto demand deposit that earns interest. This is a more general definition than I am limiting my argument to.
Maxliberty: Shawn77:Barter in a market economy is not inflationary. singular instances of people accepting a cd in exchange for goods or services is not going to be inflationary. If the cd were to become money or a money substitute that would be a different story. With a demand deposit i have 100% ownership to all of my money units whatever they be fiat currency, gold, fish heads it doesn't matter. If for administrative purpose's(the bank is closed or the vault is 600 miles away for security reasons) the bank cannot give me my money instantly, this does not create a time deposit situation or inflation I am still the only one who has ownership to the money. There is no requirement that if you deposit Gold in a bank that the bank has to maintain your deposit in gold. This is an agreement between you and the bank. If you don't mind that the bank will immdeiately sell your gold and convert it to another asset why should a third party claim this is fraud? All you the depositor are concerned with is A: Can I reedem my bank notes for gold on the terms I have agreed with the bank? and B: Does the bank have sufficient assets to cover its liabilities? The following scenario in your view is fraud: Person A deposits $1,000 in gold into bank B. Person A and Bank B agree that the gold will be sold and converted to a different asset and that physical redemption has a minimum two day waiting period and a max waiting period of 60 days. Person A receives his bank notes. Bank now loans $1,000 gold to person C. Person A buys stuff from Person D. Person D goes back to bank and wants his gold and waits the two days and the bank converts some of it's other assets and gives him his gold. Who exactly is the victim here? Where is the fraud? The Austrians are willing potentially to kill the people operating the bank over this scenario.
Maxliberty: Person A deposits $1,000 in gold into bank B. Person A and Bank B agree that the gold will be sold and converted to a different asset and that physical redemption has a minimum two day waiting period and a max waiting period of 60 days. Person A receives his bank notes. Bank now loans $1,000 gold to person C. Person A buys stuff from Person D. Person D goes back to bank and wants his gold and waits the two days and the bank converts some of it's other assets and gives him his gold.
I would agree there is no fraud, unless Person A fraudulently claimed that the bank would cash his bank note on demand, or claimed it was a property title to the gold. However, I would suspect debts would always trade at a discount compared to present goods - taking into account time preference and risk.
Of course, this is different from traditional FRB, which IS an invalid contract. Contracts are designed to coordinate property use to avoid conflict. Allow me to quote Hulsmann,
The owner may withdraw his deposit at any time, and the banker may use it during the whole time until it is withdrawn. The clearly contradicts the very idea of contracts, which is to determine who, and at which time, has the right to use a given object. Both the customer and the banker, in their dealings with other market participants, represent themselves as the owners of the deposit. Their "contract" implies that two titles for one and the same property are now used in market exchanges. This is a clear instance of fraud.
Maxliberty: The following scenario in your view is fraud: Person A deposits $1,000 in gold into bank B. Person A and Bank B agree that the gold will be sold and converted to a different asset and that physical redemption has a minimum two day waiting period and a max waiting period of 60 days. Person A receives his bank notes. Bank now loans $1,000 gold to person C.
Your scenario is nonsense. All that has happened here is person A has sold their gold to the bank. FRB doesn't require gold redemption to take place. Forget about bank notes gold standards all that. we will say widgets are money. I put my widgets in the bank under the impression I can withdraw at any time(a demand deposit). If I make any other agreements with the bank that allow them to loan out my money then I am investing I am not saving and therefore would assume the risk associated with it. So if there are any other little caviats you want to add it no longer becomes a demand deposit so forget about that. If the bank then takes my widgets and loans them to someone else this is fraud. You can say if I agree to it upfront then there is no fraud. The problem is how can I agree to have my money available and have it loaned out. The answer of course is I can't and more importantly why would I. i can't let my friend borrow my car and it also be parked in my garage for me to use at my discretion all at the same time now can I.
Shawn77: I put my widgets in the bank under the impression I can withdraw at any time(a demand deposit).
This is the point there is no need for the bank to have demand deposits. I can simply place a two day waiting period on redemption and I have turned all deposits into time deposits which then allows me to loan out your money while you are using the bank notes that are based on the underlying asset of the bank.
Shawn77:Your scenario is nonsense.
Hardly, this is exactly what happens right now and is the most likely scenario in a free market.
Shawn77: If I make any other agreements with the bank that allow them to loan out my money then I am investing I am not saving and therefore would assume the risk associated with it.
So grow up and assume the risk, why should we outlaw that.
Shawn77:So if there are any other little caviats you want to add it no longer becomes a demand deposit so forget about that.
You and the Austrian cult are under the assumption that banks are required to have demand deposits, wrong. I can demonstrate that the type of bank that i propose will exist will be the dominant form of banking in a free society.
Don't forget you are the one talking prohibition not me. In a free society, just like now, you have the choice of deciding what bank you want to use and what you accept as payment.
Finally, the demand deposit arguement is a fiction. Banks don't have demand deposits now nor will most of them in the future in a free society.
Maxliberty:I can simply place a two day waiting period on redemption and I have turned all deposits into time deposits which then allows me to loan out your money while you are using the bank notes that are based on the underlying asset of the bank.
You are missing the point. The point is not what you could do or how long it takes me to have physical access to my money. It is what you are doing with it while I am under the assumption it is in my account.
Shawn77:It is what you are doing with it while I am under the assumption it is in my account.
Then you are a moron, since it is written in the contract, pays otherwise impossible interest, and you are talking about it anyway.
Maxliberty:You and the Austrian cult are under the assumption that banks are required to have demand deposits, wrong
You're not here to advance the scholarship of liberty in the Austrian tradition Maxy boy?