Economics Questions

Re: FRB + fraud

J.R. — Fri, 01 May 2009 06:36:02 GMT

Sage:
Good point; I think we're getting somewhere. But before we proceed, can you define the contract between the bank and customer? Also, are you assuming that the demand deposit is a warehouse receipt, or a debt-claim against the bank?

Its Dr. Block's example. I believe he distinguishes between demand deposits and time deposits. I'm not 100% sure what you are getting at but below is an excerpt from a paper by Dr. Hulsmann that I think elaborates on your question and how demand and time deposits are different.

( http://66.102.1.104/scholar?hl=en&lr=&q=cache:ffvvFUxUTpoJ:www.independent.org/pdf/tir/tir_07_3_hulsmann.pdf+ )

Dr. Hulsmann:
My purpose in this section is not to give an exhaustive typology of banking products, but to argue that at least two product types differ categorically. Most financial instruments have, of course, an intermediate-type nature: financial engineers try to blend risks and benefits of the various purer instruments into new mixes that appeal to the customers. A first type of banking is money warehousing. The bank stores money for other people and issues standardized money titles, such as banknotes, to the depositing customers, who can then use these banknotes in their daily transactions in lieu of money proper. Fundamentally, the bank acts here as a warehouse for money, and therefore its money titles are covered 100 percent.

A second type of free-banking is credit banking. Here people invest their money in the bank for a certain length of time—for example, by granting a credit to person, thus earning an income from the interest-rate differential. The crucial difference between these two types of products—money titles, on the one hand, and credit claims or IOUs, on the other—is that in the first case the depositor retains an exclusive legal claim to the money at any point in time, even though the money is physically stored in the warehouse. By contrast, in the second case the bank obtains a temporary exclusive legal claim to the money during the time of the credit, and only after this time does the creditor regain his exclusive legal claim to the money. Thus, the two types of banking differ categorically. A business either engages in money warehousing and sells money titles or engages in credit banking and sells IOUs. No third possibility exists. It makes no sense to say, for example, that both the banker and his customer have valid legal claims to the same sum of money at the same time, and it would be impossible for both to use the same sum of money at the same time (Hoppe, Hülsmann, and Block 1998).

Re: FRB + fraud

J.R. — Fri, 01 May 2009 06:21:30 GMT

Daniel:

He made the exact points I made, but I suppose he said it better.

Repetition (with appeal to authority) helps it sink in.

Re: FRB + fraud

DanielMuff — Fri, 01 May 2009 03:06:22 GMT

Sage:
Good point; I think we're getting somewhere. But before we proceed, can you define the contract between the bank and customer? Also, are you assuming that the demand deposit is a warehouse receipt, or a debt-claim against the bank?

He made the exact points I made, but I suppose he said it better.

Re: FRB + fraud

Bostwick — Fri, 01 May 2009 00:02:37 GMT

Sage:
This is a better analogy, thanks. But now it seems to me that if fraud is a breach of contract involving deception for purposes of gain, then we need to explicitly define the contract between the bank and customer. What are you assuming this contract to be?

If the contract said, "If we, the bank, lose all your money, you have no legal recourse and suffer the full lose" then this would definitely not be fraud. But obviously banks don't anticipate a market for such accounts or else they would offer them.

Re: FRB + fraud

Bostwick — Thu, 30 Apr 2009 23:57:48 GMT

Sage:

JonBostwick:
Mises used the trespass example, asking does the trespass occur when the trespasser enters the property or when he is discovered?

Hmm. This is an interesting analogy, but I don't think it works.

Take the example of a FR bank where its customers never redeem their deposits all at once, and throughout its history there are no bank runs. Through judicious management of their reserve ratio, all its customers redeem their deposits at their wishes. No one ever loses their property. Are you saying that this is fraudulent, even though nobody lost any property?

The analogy is inapt because while the trespasser immediately violates the property rights of the owner, it is still possible for a FR bank to redeem its deposits at the customers wishes (of course, it can't redeem all of the deposits all at once; my point is that an FR bank can be legitimate if only some of its customers redeem their deposits at any one time).

If fractional reserve banks didn't have bank runs then you might have a point. But they do have bank runs, so you dont have a point.

You can't just say, "If bank runs didn't happen would FR be okay then?" because that's not the world we live in.

Bank runs happen when people fear that the bank doesn't actually have enough money to honor their deposit. But you think a bank can operate with full disclosure of their reserves, in order to avoid explicit fraud, and not be subject to bank runs?

Re: FRB + fraud

nirgrahamUK — Thu, 30 Apr 2009 23:26:21 GMT

traditionally the bank contracts to have available for the customer on demand any portion of the outstanding balance that the customer has with the bank.

but then it loans a portion of all its customers deposits to lenders, clearly undermining the above contract.

Re: FRB + fraud

Sage — Thu, 30 Apr 2009 23:18:22 GMT

nirgrahamUK:

here is perhaps a superior analogy.

you make a contract with someone to keep their car in your garage until they come and claim it back, and they will pay you 5$ a month for this.

This is a better analogy, thanks. But now it seems to me that if fraud is a breach of contract involving deception for purposes of gain, then we need to explicitly define the contract between the bank and customer. What are you assuming this contract to be?

J.R.:
Block then points out there are claims on 190 ounces of gold, and only 100 ounces are in the system. He comments that as Ayn Rand is famous for saying, "rights can't conflict," but here they do, as there are property rights to 190 ounces of gold but only 100 ounces of gold are in the system.

Good point; I think we're getting somewhere. But before we proceed, can you define the contract between the bank and customer? Also, are you assuming that the demand deposit is a warehouse receipt, or a debt-claim against the bank?

Re: FRB + fraud

nirgrahamUK — Thu, 30 Apr 2009 20:18:56 GMT

good post

Re: FRB + fraud

J.R. — Thu, 30 Apr 2009 20:07:45 GMT

Sage:

As I understand it, the common argument that fractional reserve banking is fraud goes like this:

FR banks only hold a fraction of deposits in reserve, while simultaneously promising to redeem all deposits on demand. Thus, because a bank cannot redeem all of its obligations, FRB is inherently fraudulent.

But is this reasoning correct? It seems to me to have some errors. Consider the following:

1 - If you murder someone, you're a criminal.
2 - Therefore, you're a criminal.

This reasoning is obviously wrong; it's missing the crucial middle term "You murdered someone." But isn't the fraud argument exactly the same?

1 - If all customers redeem their deposits, then the bank is bankrupt and fraudulent.
2 - Therefore, the bank is bankrupt and fraudulent.

Likewise, this argument is missing the crucial middle term "All customers redeemed their deposits." Unless all customers do in fact attempt to redeem their deposits, then FRB is not fraud. Put differently, FRB is only fraud when the implicit theft has actually occured, but not before that.

You misunderstand the argument against FRB from Austrians assocaited with the Mises Institute. The contract of demand deposits in an FRB itself is illicit, just as a contract to commit murder is illicit.

============

Walter Block and William Barnett co-authored a paper that they presented at the Austrian Scholars Conference on March 13, 2009 that addresses how borrowing short and lending long (e.g. FRB) causes the ABCT. Their presentation of the paper is like 17 minutes long and can be heard here : http://mises.org/multimedia/mp3/ASC2009/ASC09_Block_Barnett.mp3

The first 2 minutes is Dr. Block's quick lecture on why FRB is illicit. I summarize (But please listen its only 2 minutes or so):

The illicitness of FRB comes from the preeminent belief in recognizing and protecting property rights.

If a contract is incompatible with property rights it is illegitimate per se. FRB, as a contract incompatible with property rights, is illegitimate per se.

In the same sense that a contract to commit murder is illicit and immoral, or a contract to sell a square circle is illicit (as there is no such thing as a square circle one could sell), so to is a contract to exchange title to non-existent property rights.

Block postulates a small town with 10,000 cars and 10,000 property titles to cars, and points out that if someone where to start printing and attempting to circulate extra property titles to cars (other than as a joke), that is per se fraud and illegitimate.

Block then presents and explains a hypothetical banking scenario flowing from the deposit of 100 gold ounces into a bank (demand deposit) with a 10% reserve ratio. The bank then then loans out 90 gold ounces. Block then points out there are claims on 190 ounces of gold, and only 100 ounces are in the system. He comments that as Ayn Rand is famous for saying, "rights can't conflict," but here they do, as there are property rights to 190 ounces of gold but only 100 ounces of gold are in the system.

===

Your point seems to be that illicit, fraudulent contracts are OK as long as no one calls the parties on the illicitness or fraud inherent in their deal.

But this ignores that for the term of the loans, there is fraud, as the bank lends title to money it does not itself have title to. This is the point. While the illegitimate contract (the FRB loan) is being executed, there is fraud.

That the FED and banks work together to provide enough liquidity to prevent bank runs does not change the fact that banks give title to property (money for the length of the loan) that the banks themselves do not hold title to.

Re: FRB + fraud

nirgrahamUK — Thu, 30 Apr 2009 20:01:52 GMT

"we have your money available"

Re: FRB + fraud

sapSUCKER — Thu, 30 Apr 2009 19:59:48 GMT

nirgrahamUK:

sapSUCKER:
Isn't the charge of fraud based upon the fact that FRB fails to deliver that which it promises?

its ultimate failure to deliver on its promises is presaged by its conflicting promises it makes to customers when it promises to do "A and not-A"; the customers are being duped even before they become dissapointed.

What's A?

Re: FRB + fraud

nirgrahamUK — Thu, 30 Apr 2009 19:52:49 GMT

sapSUCKER:
Isn't the charge of fraud based upon the fact that FRB fails to deliver that which it promises?

its ultimate failure to deliver on its promises is presaged by its conflicting promises it makes to customers when it promises to do "A and not-A"; the customers are being duped even before they become dissapointed.

Re: FRB + fraud

Spideynw — Thu, 30 Apr 2009 19:49:25 GMT

sapSUCKER:
Isn't the charge of fraud based upon the fact that FRB fails to deliver that which it promises?

Yes.

Re: FRB + fraud

sapSUCKER — Thu, 30 Apr 2009 19:45:17 GMT

Isn't the charge of fraud based upon the fact that FRB fails to deliver that which it promises? Here's how I was thinking about it:

If we are in a society using a universal medium of trade--say, gold--then our wealth can be measured in units of this medium. If we decided to use paper money as a proxy for this gold (wealth) in our economic transactions, it seems we would only do so if we were convinced that the agreed upon exchange rate of paper money for gold (wealth) is static. If this premise were not true--if we believed the exchange rate in the future was going to be less than it is at present--then who in their right mind would use this proxy for wealth (gold) in lieu of the wealth itself (leaving the convenience factor aside)? One would risk losing part of one's wealth.

But isn't this precisely what FRB is about? Isn't there an implicit promise of relative stability in any use of paper money? If there weren't, using paper money would be risky. And doesn't the FRB system itself renege on this promise by engaging in after-the-fact activity that devalue the agreed-upon proxy for wealth? Isn't this fradulent? Didn't FRB promise something that it cannot deliver?

Re: FRB + fraud

Spideynw — Thu, 30 Apr 2009 19:12:39 GMT

GilesStratton:
That is the definition of FRB.

I think I could make an argument that that is not necessarily the definition, but I do not think it would be a very strong argument. So, I will simply agree with you.