Economics Questions

Re: How do Selgin/White defend FRB?

ivanfoofoo — Wed, 06 May 2009 14:35:00 GMT

I understand the model, but I still don't like it. I just can't understand if is possible that banks should start deflating (can it happen? what would its causes be?), and how banks could handle that.

Other thing I just don't get:

George A. Selgin:

If, on the other hand, money consists of bank-issued IOUs backed mainly by bank loans, then its citizens’ scarce savings will contribute toward a general process of industrialization, with investments made where (risk-adjusted) rates of return appear greatest.

You mean that more industrialization will be encouraged because rates of return "appear" greatest? What is the difference from a non FRB system where rates of return "appear" smallest but, adjusting to the increasing purchasing power of money because of more productivity, is actually the same that of those "higher" FRB rates of return?

Re: How do Selgin/White defend FRB?

nirgrahamUK — Mon, 04 May 2009 11:44:57 GMT

the model proposed could readily be insantiated by an entrepeneur willing to relocate and do business from Vegas, i await the experiment with some anticipation.

Re: How do Selgin/White defend FRB?

Modus Tollens — Sun, 03 May 2009 00:31:43 GMT

Professor Selgin,

I am relieved to read your thoughts on fractional reserve banking. Although I think very much like an Austrian economist, I have never understood the common Austrian objection to fractional reserve banking. Your piece Should We Let Banks Create Money? clarifies and expands upon some of my own thoughts. As soon as I heard Rothbard's critique of fractional reserve banking, my spider-sense began tingling. Something was wrong; it just didn't add up. I am surprised that more people here do not feel the same way.

Thanks!

Re: How do Selgin/White defend FRB?

DD5 — Sat, 02 May 2009 23:27:27 GMT

Selgin:

Not everything that's undesirable is fraudulent! You seem to be taking the word "forced" too literally!

Thanks you for your responses.

There are still very fundamental issues that are the heart of this debate, which I don't feel you have adequately addressed. At least not in any convincing manner.

Will the FRB system create new money? The standard analysis of credit expansion throughout the banking system suggests that the answer is clearly Yes. You at one point said No with the example of the single bank", but I think we then said (and you did not refute it) that with the entire system, there will be a credit expansion of 100 X M. If there is new money involved, I fail to see how this new money is different economically from the counterfeiter, except that the bank is given a special privilege. The counterfeiter is not just "something that is undesirable" as you suggest, is it?

The second fundamental issue is whether FRB could prosper to the extent of just 2% reserves in a true free market. If you suggest that it will, but perhaps to a minor extent, then I would think that it is compatible with the typical Austrian theory. Even with Rothbard's. But I don't see how as I believe you did mention before, along with White, that it could operate with as little as 2% reserves. You haven't given a clear reason as to why the new money, as a result of the multiplying factor, does not cause the business cycle. You at one point claimed that no new money is being created, but I don't think you have given a convincing explanation for why it doesn't.

Re: How do Selgin/White defend FRB?

Juan — Sat, 02 May 2009 20:29:49 GMT

http://homepage.newschool.edu/het//schools/bullion.htm

The Bullionist argument was straightforward. If banks are not required to convert notes into gold, then they will be tempted to issue notes in excess of the gold in their vaults. This will lead to an excess supply of money and hence, by their view, a cheapening of the price of money, i.e. inflation. They argued that to avoid inflation, required convertibility of notes into gold should be restored. Among the spokesmen for the Bullionists were Henry Thornton and, a bit later, John Wheatley and David Ricardo (1810, 1811).

In contrast, the Anti-Bullionists appealed to some form of the Real Bills Doctrine of John Law (1705), Sir James Steuart (1767) and Adam Smith (1776). Given the afore-mentioned peculiar, long experience of Scottish banking with inconvertibility, this authorship is not surprising. Banknotes, Smith had argued, were issued by banks in exchange for merchants' bills of exchange. As long as the repayment of these bills of exchange is credible (i.e. "Real Bills" as opposed to "Fictitious Bills"), then no more banknotes will be issued than what is required by merchants. In short, the demand for banknotes by commerce is itself limited by the "needs of trade", hence even without convertibility, the bank is not going to issue more notes than what commerce demands. Thus, there will never be excess note issue.

If there happens to be excess issue by accident, however, this still would not cause inflation as it would return immediately to the banks upon the liquidation of the bills of exchange. This was called the "reflux principle" and was part of the Real Bills Doctrine. Among the Anti-Bullionists who espoused this doctrine in the early 1800s, we find Richard Torrens, Bosanquet and James Mill.

...

The Bullionist Henry Thornton (1802) provided an admirable critique of the Real Bills doctrine. Namely, he asked, who guaranteed that the demands of commerce were limited? Suppose actual capital yields returns higher than the rate of interest (or discount) charged by the banks? Would not merchants' demand an interminable amount of notes - however "real"? Bills offered for exchange into notes, he argued, might not readily be "limited" as the Real Bills advocates argued. Inflation must thus ensue. Thornton's analysis formed the germ for the later "cumulative process" of Knut Wicksell (1898).

Re: How do Selgin/White defend FRB?

Thedesolateone — Sat, 02 May 2009 20:06:21 GMT

Selgin:
lots of instanceas in which people chose to keep accounts at banks with low fractional reserves although they had no reason to think that their money was backed by the government.

Surely that'd be to do with the return FRB can give. If you are making interest on your deposits, you can pay interest to people who deposit.

Toward a General Theory of Error Cycles by Hülsmann has quite a bit on this.

Re: How do Selgin/White defend FRB?

Selgin — Sat, 02 May 2009 16:17:37 GMT

DD5:

The “forced” savings you allude to with respect to the business cycle refutation is not to be avoided when talking about the fraud issue. The mere fact that savings are “forced” constitutes fraud in the most severe manner. FRB is inflationary by definition. M1 is the base + circulating + checking deposits. The tax levied upon individuals by banks so they earn interest on it is not fraud to you?
You describe it in the context of modern banking and only from the perspective of what the client thinks about what the bank is doing with his money. Today, with FDIC nobody really cares what the bank does with your money, as long as you are receiving some interest and the system backed by government assurance (with tax payers money) is there to bail you out and create the illusion that your money is secured. The fact of the matter is that if you took out government completely from the picture, depositing money in a bank would become like investing in stocks. People who would want to just hold on to money (cash balance) or opt for low return secured investment, would have to store their money in a safe deposit or near 100% reserve bank."

First of all, I'm glad grandma is safe. But concerning (1), I agree that forced savings are a bad thing (though not something that happens much under free banking), but that doesn't ean that "fraud" is involved. Not everything that's undesirable is fraudulent! You seem to be taking the word "forced" too literally! (And even if the literal sense is the right one, what we've got isn't fraud--it's theft.)

W.r.t. (2): I have been careful throughout my comments to emphasize the facts pertaining to fractional reserve banking prior to the emergence of government insurance, which was first established in the U.S. in '33, and was next adopted in Canada in '67. That leaves lot's of experience with uninsured systems to which your claim above isn't relevant--that is, lots of instanceas in which people chose to keep accounts at banks with low fractional reserves although they had no reason to think that their money was backed by the government.

Now, you can keep on pretending that this evidence doesn't exist, and repeating what you think "would" happen in the absence of guarantees. But doing so just suggests that you're obstinate, whether grandma is in danger or not!

Re: How do Selgin/White defend FRB?

Stanislaw — Sat, 02 May 2009 03:40:08 GMT

GilesStratton:

To borrow from Kinsella "So what?".

I believe he borrowed it from Rothbard;)

Re: How do Selgin/White defend FRB?

DD5 — Fri, 01 May 2009 23:25:02 GMT

Selgin:

Again, all this stuff is explained in considerable detail in my Theory of Free Banking; and oodles of historical evidence suggest that the theory fits the reality of fractional reserve based free banking. Of course I know the theory isn't self-evident, and that people labor under some other misconceptions. That's why I wrote the book! I wish you'd all read it as these little explanations are poor substitutes for a systematic explanation.

Selgin,

I just went over your "Should We Let Banks Create Money?"

I am having trouble accepting your arguments. And I don't intend to kill my grandmother.

The fraud Issue: I see 2 main problems with your argument
1. The “forced” savings you allude to with respect to the business cycle refutation is not to be avoided when talking about the fraud issue. The mere fact that savings are “forced” constitutes fraud in the most severe manner. FRB is inflationary by definition. M1 is the base + circulating + checking deposits. The tax levied upon individuals by banks so they earn interest on it is not fraud to you?
2. You describe it in the context of modern banking and only from the perspective of what the client thinks about what the bank is doing with his money. Today, with FDIC nobody really cares what the bank does with your money, as long as you are receiving some interest and the system backed by government assurance (with tax payers money) is there to bail you out and create the illusion that your money is secured. The fact of the matter is that if you took out government completely from the picture, depositing money in a bank would become like investing in stocks. People who would want to just hold on to money (cash balance) or opt for low return secured investment, would have to store their money in a safe deposit or near 100% reserve bank.

The Business Cycle issue: You concentrate on the debate about whether “demand for cash balances” constitutes legitimate savings, as if this is the main trigger of the business cycle. Neglecting that argument for a moment, you completely neglect the money multiplier caused by FRB. If reserves are 10% then M=1/0.1=10

Banks with 10% reserves create new money by a factor of 10. Whether the 10% reserves is cash balances or savings is a minor disagreement relative to the effect of the Multiplier. It’s true that the Central bank will make things worse by injecting fresh money into the system, but FRB also injects new money into the system, thus, credit circulating is always greater then real savings, which will always produce a boom and a bust. What ever your reserves are, say in your hypothetical free banking system, you will have a multiplier factor. With a conservative 90% reserves, you will have about a multiplying factor of about 0.1, so that is 10% new money on top of your base (whether it’s time deposit savings like Rothbard and Hoppe want it to be or just cash balances like you want it). It is still 10% of wealth extracted from the public through inflation, and still 10% of credit that is not compatible with individual time preference, leading to cyclical behavior.

Banking Crisis issue: I don’t mind the risk. It is the choice of the free individuals to decide upon the risk they want to take. I believe the benefits you allude to are based on a faulty analysis of the FRB system as explained in #2, But again even if there was some benefit, how can you justify “forced” savings, while at the same time claim that this is somehow compatible with a free society.

Re: How do Selgin/White defend FRB?

Juan — Fri, 01 May 2009 22:51:44 GMT

Selgin:
Suppose I save $100 (letting $ stand for a gold unit), and deposit it with a free bank that can get by on 2% reserves. Then the bank will lend $98, and no more, based on my savings. The lending leaves it with $2 in gold to back its $100 obligations to me. QED

You (depositor) have $100 available on demand and somebody else has $98 he can spend. $98 were created out of thin air.

The 98 units lent out will be spent quickly (people don't boprrow at interest except to spend), and will soon find their way bank to the banking system,

Not necessarily true at all. Not to mention that that "quickly" is not a 'scientific' term and is almost meaningless here.

The thing is, the person who borrowed the $98 will bid for goods and services. If the depositor now feels like spending his $100 there would be $198 instead of $100 chasing the same amount of goods and services.

Re: How do Selgin/White defend FRB?

Thedesolateone — Fri, 01 May 2009 22:44:23 GMT

DD5:

Selgin:

Yes: one must always keep in mind that the low reserve ratios referred to in the example prefer a very large number of bank customers, as well as competing banks. It is in effect the 'law of large numbers," along with customers continuijg general confidence in banks, that makes banking on such slim reserves possible. The reserve ratio is low because the odds of a reserve-depleting sequence of withdrawals are low, and not otherwise. Fractional reserve banking grows out of long experience with actual withdrawal and spending patterns, coupled with managerial know-how. I speak, of course, of the goodl-old pre deposit insurance days of the institution.

I appreciate your time on this matter.

As do I.

It's really impressive for a real live professor to talk to us

Re: How do Selgin/White defend FRB?

Thedesolateone — Fri, 01 May 2009 22:42:53 GMT

Selgin:
Actual deposit contracts are debt contracts, not bailment contracts, and have been acknowledged as such for centuries, notwithstanding their having evolved in some cases (England, in particular) from bailments.

Given this, and if they are regarded as this, then I have no problem.

But there is no way of issuing notes to debt contracts as I see it. Notes always refer to actual physical deposits of money (in all likeliness, gold). Are you arguing that currency should be backed by debt contracts?

Re: How do Selgin/White defend FRB?

Selgin — Fri, 01 May 2009 22:18:27 GMT

"What I want to know is how the bank knows whether its IOU's are being spent or held." Easy: when bank-supplied IOUs are spent, they find their way to rival banks (remember I'm making claims about competitive or free banks) who return them for settlement. Consider a checking account today. No spending, no checks drawn, no checks returned, nothing owed in settlement. It was the same for competitively issued notes back before central banks took over. So in fact a bank found out very quickly if people were spending rather than holding on to its notes or other liabilities.

Again, all this stuff is explained in considerable detail in my Theory of Free Banking; and oodles of historical evidence suggest that the theory fits the reality of fractional reserve based free banking. Of course I know the theory isn't self-evident, and that people labor under some other misconceptions. That's why I wrote the book! I wish you'd all read it as these little explanations are poor substitutes for a systematic explanation.

Re: How do Selgin/White defend FRB?

meambobbo — Fri, 01 May 2009 21:25:52 GMT

Selgin:
A bank desposit represents "saving" only for so long as it isn't spent. In my examples, I assumed that the original deposit remained at the bank for some time

This isn't what I was talking about (maybe you weren't responding to me). Even if the deposit remains at the bank forever, there could still be a 0% savings rate in terms of real goods. The bank issues money substitutes when you make a deposit. If everyone is spending the money substitutes, they are not saving. Yes, if a rival banks receives them, it will quickly attempt to redeem them. Thus, greater spending will likely increase redemption demand. But these things seem indirectly, not directly, correlated.

Selgin:
If demand for that bank's IOUs falls to zero, it will be able to lend...zero.

In the aggregate, people may prefer bank money over commodity money, creating demand for bank money. But this does not mean that there is greater aggregate production than aggregate consumption in terms of real goods. Fractional reserve bank lending in such an environment is simply subsidizing borrowers at the expense of savers, and would likely cause the redemption rate to skyrocket.

Selgin:
In short: more spending (turnover of IOUs)= less saving= less bank lending= less bank money; less spending=more savings=more bank lending=more bank money.

Right - but what I want to know is how the bank knows whether its IOU's are being spent or held.

Re: How do Selgin/White defend FRB?

DD5 — Fri, 01 May 2009 21:10:16 GMT

Selgin:

Yes: one must always keep in mind that the low reserve ratios referred to in the example prefer a very large number of bank customers, as well as competing banks. It is in effect the 'law of large numbers," along with customers continuijg general confidence in banks, that makes banking on such slim reserves possible. The reserve ratio is low because the odds of a reserve-depleting sequence of withdrawals are low, and not otherwise. Fractional reserve banking grows out of long experience with actual withdrawal and spending patterns, coupled with managerial know-how. I speak, of course, of the goodl-old pre deposit insurance days of the institution.

I appreciate your time on this matter.

I still sense an inconsistency in your overall thesis. I assume your Yes" reefers to the fact that the credit expansion throughout the banking system will grow the money supply by the money Multiplier. So obviously FRB amounts to lending out money that is NOT saved. You don't claim that that the 100X49 is equal to 100, which is the original savings, do you? So FRB, any FRB will expand the money supply and lend out more money then savings by the multiplier factor.

Yet you also contend that under free banking only, saved money will be lent out. You even insinuate that the banks are assuming the deposits as sort of time deposits. This means that under free banking, the system will naturally operate close to 100% reserves. There is simply no other way of rationalizing your claim that only real savings will be lent out under free banking. You can't have it both ways: FRB and only real savings lent out