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.
meambobbo:Fourth, business cycle theory is not limited to fiat currency, central banking, or even FRB. If there is an influx of money into society that occurs through the introduction of the loan market, this will cause a business cycle. This can potentially happen in a free market with free banking using 100% reserves and commodity money, although it is far less likely than under our current conditions.
Where would this new money come from if not frb or the printing press?
Joe Garceau: What you are proposing is an entirely different contract and it would not be a DEMAND deposit. Banks may not be required or may not opt to have demand deposits. They are free to do that, but if they have demand deposits then there is no waiting period. But if someone has a contract with the bank for a demand deposit then they cannot loan out the money. The bank would be violating the contract. Austrians are not proposing outlawing TIME deposits or Demand deposits. You are arguing against demand deposits by trying to claim that all demand deposits can be time deposits if they agree to there being a waiting period. If I wanted a waiting period for my money then I would make it a time deposit contract and not a demand deposit contract. If I store my furniture in a warehouse I am free to pick it up whenever I want on demand. I am simply storing my goods in a warehouse the same way I am storing my money at the bank with a demand deposit. The warehouse CANNOT loan out my furniture while it is in storage with them. The bank cannot loan out my money while it is in storage with them. If I loaned my furniture for 12 months or whatever period of time to the warehouse company then they could do whatever they wanted with it for the duration of time it was loaned to them. Then it would not be a demand deposit.
What you are proposing is an entirely different contract and it would not be a DEMAND deposit. Banks may not be required or may not opt to have demand deposits. They are free to do that, but if they have demand deposits then there is no waiting period. But if someone has a contract with the bank for a demand deposit then they cannot loan out the money. The bank would be violating the contract. Austrians are not proposing outlawing TIME deposits or Demand deposits. You are arguing against demand deposits by trying to claim that all demand deposits can be time deposits if they agree to there being a waiting period. If I wanted a waiting period for my money then I would make it a time deposit contract and not a demand deposit contract.
If I store my furniture in a warehouse I am free to pick it up whenever I want on demand. I am simply storing my goods in a warehouse the same way I am storing my money at the bank with a demand deposit. The warehouse CANNOT loan out my furniture while it is in storage with them. The bank cannot loan out my money while it is in storage with them. If I loaned my furniture for 12 months or whatever period of time to the warehouse company then they could do whatever they wanted with it for the duration of time it was loaned to them. Then it would not be a demand deposit.
The banks don't have demand deposits now. So it is you discussing fantasy contracts. My point is very simple, banks that turn all deposits into some for of time deposit will crush the other banks because they will be dramatically more profitable. Also, if the defintion of time deposit is any delay on redemption then the distinction between instaneous redemption and one minute delayed redemption is idiotic. Banks could still offer exclusive actual demand deposits where they store your gold but this will be the overwhelming minority of accounts.
Evidence of this is the current system, you could open a bank tomorrow that offered 100% backed gold redemption, but we don't see any.
Finally, the phrase fractional reserve is quite misleading and actually refers to when banks loaned at a multiple of the funds they had. What I am argueing for is for the ability of the bank to have mixed assets as part of their 100% reserve.
Shawn77:Where would this new money come from if not frb or the printing press?
Let's say a mining operation makes a deal with a bank, that they will give the bank their freshly mined and refined gold in exchange for a portion of the interest it earns in being loaned out.
Of course, the effects of such are so miniscule that it could never cause a business cycle as large as the ones we currently have, which are often fueled by not only purposeful manipulations of money supply and interest rates, but a number of successive attempts to make the boom bigger and bigger.
Check my blog, if you're a loser
meambobbo:Of course, the effects of such are so miniscule that it could never cause a business cycle as large as the ones we currently have
Where would the malinvestment come in. If there is a boom because a gold mine was discovered this a legitimate boom. Why would that create a bust?
Shawn77: If there is a boom because a gold mine was discovered this a legitimate boom.
Have you read The Mystery of Banking by Rothbard? He says quite plainly that the supply of money is completely irrelevant and there is no optimal supply of money in any economy. The only optimal property for the supply of money is for it to remain constant.
A gold mine would only aid the economy in offering greater consumers' goods in jewelry and other non-monetary functions.
If the gold were instead put toward money use and lent out as its introduction into society, this would lower interest rates, causing unsustainable capital investments unmatched by general savings. There will be producer price inflation, and businesses will require more credit than anticipated. At the same time, the additional money effects consumer goods prices, driving up interest rates. Many investments can no longer be completed profitably and are liquidated.
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meambobbo:causing unsustainable capital investments
I agree gold would temporarily lower interest rates as equilibrium was restored after the introduction of new money. Why would this cause unsustainable capital investment?
meambobbo:At the same time, the additional money effects consumer goods prices, driving up interest rates
what interest rates?
meambobbo:Many investments can no longer be completed profitably and are liquidated.
Why would new gold cause people to no longer be able to complete their investments
What books could you recommend to me that discuss your theory of banking and deposits etc.?
meambobbo:He says quite plainly that the supply of money is completely irrelevant and there is no optimal supply of money in any economy. The only optimal property for the supply of money is for it to remain constant.
Then business cycles are in fact inherent in a free market.
scineram: Then business cycles are in fact inherent in a free market.
Not according to Rothbard, Hayek, and Mises they aren't. In fact the Austrian Business Cycle Theory clearly says how business cylces are direct results of a central banks expansion of money and manipulation of interest rates.
scineram: I said anyone who think banks just store stuff despite all evidence to the contrary is a moron.
LvM: It is a mistake to associate with the notion of free banking the image of a state of affairs under which everybody is free to issue banknotes and to cheat the public ad libitum. People often refer to the dictum of an anonymous american quoted by Tooke: "Free trade in banking is free trade in swindling." However, freedom in the issuance of banknotes would have narrowed down the use of banknotes considerably if it had not entirely suppressed it. It was this idea which Cernuschi advanced in the hearings of the French Banking Inquiry of October 24, 1865: "I believe that what is called freedom of banking would result in a total suppression of banknotes in France. I want to give everybody the right to issue banknotes so that nobody should take any banknotes any longer."[19]
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
Shawn77:I agree gold would temporarily lower interest rates as equilibrium was restored after the introduction of new money. Why would this cause unsustainable capital investment?
Austrian Business Cycle Theory.
capital investments must be funded in real terms. the only way to do this is for people to save.
take a baker in a barter economy. let's say he produces 10 loaves of bread, eats 1 and sells 7 of them for immediate consumer goods he wants. If he wants to expand his bakery without sacrificing quality of life, he must have savings. Thus, even while he no longer bakes but works on his bakery itself, he has a stockpile of already baked bread that he can eat and sell while he does his work.
in a money-based economy, this functions a little different, but the same thing generally occurs. The baker saves and spends money instead of bread (obviously money has a longer "shelf-life" than bread, making this already more economical). The money he saves he can now afford weekly payments to a builder, who will build him a completely new bakery over a few months. The builder uses the money to purchase bread among other currently available goods.
Now, imagine this on a macro-scale. Everyone produces a little more than they consume. They don't see the leftover goods, though - only the leftover money. They don't manage our own investments, either. When they loan the money out, the money is used to pay workers who don't necessarily contribute to immediately consumable goods, but to more efficient production equipment - capital goods. These workers use their pay to purchase the currently available goods on the store shelf.
Now imagine if the money entering the loan market was not derived from savings, but from new money. The workers paid to build capital goods would seek to spend their money on current goods. This would cause price inflation, which would lower real interest rates. People would be inclined to save less, because the price of credit is driven lower and lower in terms of real goods currently available. It would also drive up labor costs and other factors of production...in addition to the various investors bidding up these costs through their credit-fueled capital investments.
Many investors will realize they don't have enough credit to finish their projects, as the prices of their factors of production have risen. They must borrow more. But if interest rates rise, they will be unable to borrow profitably for the expected returns from their investment. They will have to liquidate their investments. If such is difficult, they may default their loans as well.
Interest rates must eventually rise, causing this situation. If the interest rate continues to be pushed down by new money, inflation will become so great that there is no longer any saving occurring. This can cause hyperinflation and abandonment of the currency, because it will take greater and greater infusions of new money to suppress the rate. Then investors are cut off from the economy of real goods and must abandon their investments. Otherwise, the interest rate must rise to balance the supply and demand for credit. No savings = no supply. Low interest rates = high demand.
A lowering of the interest rate generally encourages more indirect investment, or investment furthest away from effecting current stocks of consumer goods. These investments are the most time-consuming, and generally the most capital-intensive, such as mining, refining, etc. Incidentally, these are also most likely to require additional credit due to price inflation before being completed.
Does that suffice?
Shawn77:what interest rates?
generally, all interest rates. People may have different time preferences for different lengths. For instance, I may be willing to loan money for 6 months at 1%, but not 1 year. Of course, if interest yeilds go inverted, meaning short-term credit is more expensive than long-term, this can only be the work of government manipulation.
scineram:Then business cycles are in fact inherent in a free market.
Rothbard in America's Great Depression noted that Mises claimed business cycle theory was applicable to economic theory in a free market; however, he also noted that additions to the stock of money being introduced through the credit market in a free market would be so small that they would be relatively insignificant - unable to create massive clusters of bankruptcies.
Joe Garceau:Not according to Rothbard, Hayek, and Mises they aren't. In fact the Austrian Business Cycle Theory clearly says how business cylces are direct results of a central banks expansion of money and manipulation of interest rates.
Mises definitely argued they could occur in a free market. This means simply that they are not strictly caused by violating the free market. Of course, government interventions are the most common means of bringing about the situation where they occur - the introduction of new units of money through the credit market. All 3 would agree that business cycles would be much more common and severe with government control over money and banking.
meambobbo:capital investments must be funded in real terms. the only way to do this is for people to save.
This must be true saving. If they only hoard the funds do not go into capital investment.
meambobbo:I should clarify - by inflation, I meant less expansion of money supply. This would include additional findings or monetizations (melting gold jewelry into coins - or just establishing their use as money) of commodities.