Can economies grow without Fractional Reserve Banking?

[TexanRudeBoy]

The problem isn't "dual claims to the same money". While the money is deposited there is no "claim" to it. There is merely the possibility of a claim. If the banker is able to fund a productive enterprise which returns 10% on the principle before the depositor demands the money, he will be able to share the interest with the depositor. If the banker can't meet the demand of the depositor, the depositor becomes a past-due creditor. The bank will fail if it cannot successfully meet the demands put upon it, just as with a grain elevator that cannot replenish its store of grain through wise investing. But those who can invest successfully have every right to tell their depositors that they will be seeking investments with the deposited funds, and that they run a risk by depositing there.

This is one area where I strongly disagree with the Rothbard camp who are essentially saying that risk should be "outlawed".

ETA: those against FRB, are you also in favor of outlawing the issuance of promissory notes that are payable on demand? What about options contracts? What about output/requirements contracts? All these are futures contracts that have uncertainty inherent in what shall be paid to whom, and when. If you would say that any of these are legitimate, what distinguishes them from FRB?

You're failing to differentiate between demand and time deposits. If I open demand account the bank needs to be able to meet my demand for my money at any time. Otherwise how can you call it anything but fraud?

 

[TexanRudeBoy]

ETA: those against FRB, are you also in favor of outlawing the issuance of promissory notes that are payable on demand? What about options contracts? What about output/requirements contracts? All these are futures contracts that have uncertainty inherent in what shall be paid to whom, and when. If you would say that any of these are legitimate, what distinguishes them from FRB?


With a demand account in FRB its assumed that you can demand your money, in full, at ANY time you demand. At any point the bank cannot meet those demands (it only has 10%) it has engaged in fraudulently using your funds. The banks can't on one hand say ALL of your money is available to you at any time you demand, and on the other use 90% of your money.

With your examples the risks and time frames of the instruments are agreed upon and understood.

 

[mczerone]

ETA: those against FRB, are you also in favor of outlawing the issuance of promissory notes that are payable on demand? What about options contracts? What about output/requirements contracts? All these are futures contracts that have uncertainty inherent in what shall be paid to whom, and when. If you would say that any of these are legitimate, what distinguishes them from FRB?


With a demand account in FRB its assumed that you can demand your money, in full, at ANY time you demand. At any point the bank cannot meet those demands (it only has 10%) it has engaged in fraudulently using your funds. The banks can't on one hand say ALL of your money is available to you at any time you demand, and on the other use 90% of your money.

With your examples the risks and time frames of the instruments are agreed upon and understood.

I know the distinction, and tried to highlight it by comparing to other instruments with unknown demand dates. But I'm saying that "the bank needing to be able to meet your demand at any time" can still be done with a small level of FRB, or with contractual limits on the total demand you can put on your deposit instantaneously.

I'm not saying you can't direct exactly what should be done with your money in a deposit, but any action by a banker involves risk, and by giving your money to someone else, there is a risk of loss. The banker in a free-market FRB system would be rewarded for being able to meet the demands of all his customers while also making sure that the money is being put to its best risk-free use. A banker who doesn't seek a normal risk-free interest on the money deposited with him is doing a disservice to his depositors.

 

[profg]

This is exactly where some of the legislators got stuck when the hearing for HB 3 was held this week:

 

[Fox McCloud]

My biggest concern about allowing FRB is that we could still have a boom-bust cycle; as the money supply expanded (as more loans were made), it would push the interest rate down below the market level, which could instigate a boom.

 

[mczerone]

My biggest concern about allowing FRB is that we could still have a boom-bust cycle; as the money supply expanded (as more loans were made), it would push the interest rate down below the market level, which could instigate a boom.

But there is no single "market level" for any price, including the interest rate. Any loan contracts can be made at less than the prevailing market rate, and have the same effect of promoting malinvestment. Certainly malinvestment would still occur, but without a central banker there is no systemic risk to the entire economy.

 

[Fox McCloud]

But there is no single "market level" for any price, including the interest rate. Any loan contracts can be made at less than the prevailing market rate, and have the same effect of promoting malinvestment. Certainly malinvestment would still occur, but without a central banker there is no systemic risk to the entire economy.

This is like saying that a producer could sell something at less than market cost, thus resulting in a shortage. Of course it's possible, but it's not typical as producer wants to maximize their profits, which is setting the price of a good at market level. Another example; yes, I can, in theory, sell grain at below market levels, but why should I when I can get payed more---and why would the industry when it would cause shortages+not maximize their profit motive?

 

[mczerone]

This is like saying that a producer could sell something at less than market cost, thus resulting in a shortage. Of course it's possible, but it's not typical as producer wants to maximize their profits, which is setting the price of a good at market level. Another example; yes, I can, in theory, sell grain at below market levels, but why should I when I can get payed more---and why would the industry when it would cause shortages+not maximize their profit motive?

There is no market level to pricing. There is the factor of consumer's options that go into producer's pricing, but this merely tends to normalize price differentials across direct competitors - not eliminate them. A bag of chips may cost $3.50 in the gas station, $2.00 in the grocery store, $2.50 in another grocery store, $4.00 in a different gas station, and $1.00 when sold to you by your neighbor because he doesn't like the kind he got. Each producer sets his own price based on different factors, even if each is trying to maximize profits.

There are prevailing market prices, a sort of mean, from which all prices tend to not deviate much. But this doesn't mean that this price will work to maximize each seller's profit, monetary or subjective. Applying this back to your worries about the FRB case, some bankers may be able to find investments that will return 10% APR, and will feel comfortable lending 10% of the deposits to this investment, with a on-demand promissory note for the principal.

This may bid down the rate of interest (price of future money), because another lender has came into the investment market. But there is no inherent mal-investment taking place. If the investment is good, its good, if bad, then bad. But there is no added risk because the banker is using his deposited money as the investment fund. And again, if the depositor demands his deposit, the banker should be a good enough businessman to match his assets to his liabilities to be able to pay. If he can't, the depositor becomes a creditor like any other person that the banker can't fulfill contracts for. There is no dilution of the supply of money unless the bank is given the power of the printing press to monetize its debts - again implicating central banking, not FRB.

 

[nobody's_hero]

Thanks profg for that video. I haven't seen it yet.

 

[Seraphim]

At least that way booms and busts are held to local and regional scopes rather than national and international.

Shit, if a community in Texas wants to artificially create credit to obscene levels, go right on ahead. My problem is when Federal laws and central banks shove it down the throats of BILLIONS of people.

My biggest concern about allowing FRB is that we could still have a boom-bust cycle; as the money supply expanded (as more loans were made), it would push the interest rate down below the market level, which could instigate a boom.

 

[Fox McCloud]

There is no market level to pricing. There is the factor of consumer's options that go into producer's pricing, but this merely tends to normalize price differentials across direct competitors - not eliminate them. A bag of chips may cost $3.50 in the gas station, $2.00 in the grocery store, $2.50 in another grocery store, $4.00 in a different gas station, and $1.00 when sold to you by your neighbor because he doesn't like the kind he got. Each producer sets his own price based on different factors, even if each is trying to maximize profits.

There are prevailing market prices, a sort of mean, from which all prices tend to not deviate much. But this doesn't mean that this price will work to maximize each seller's profit, monetary or subjective. Applying this back to your worries about the FRB case, some bankers may be able to find investments that will return 10% APR, and will feel comfortable lending 10% of the deposits to this investment, with a on-demand promissory note for the principal.

This may bid down the rate of interest (price of future money), because another lender has came into the investment market. But there is no inherent mal-investment taking place. If the investment is good, its good, if bad, then bad. But there is no added risk because the banker is using his deposited money as the investment fund. And again, if the depositor demands his deposit, the banker should be a good enough businessman to match his assets to his liabilities to be able to pay. If he can't, the depositor becomes a creditor like any other person that the banker can't fulfill contracts for. There is no dilution of the supply of money unless the bank is given the power of the printing press to monetize its debts - again implicating central banking, not FRB.

Ok, I get what you're saying now. That said, I still don't see how this resolve the problem of pushing down interest rates by expansion of commercial bank money via the money multiplier effect. I can't really see this as being any different than a central bank expanding the money supply, and thus, pushing down interest rates.

 

[Seraphim]

excellent post. + rep.

There is no market level to pricing. There is the factor of consumer's options that go into producer's pricing, but this merely tends to normalize price differentials across direct competitors - not eliminate them. A bag of chips may cost $3.50 in the gas station, $2.00 in the grocery store, $2.50 in another grocery store, $4.00 in a different gas station, and $1.00 when sold to you by your neighbor because he doesn't like the kind he got. Each producer sets his own price based on different factors, even if each is trying to maximize profits.

There are prevailing market prices, a sort of mean, from which all prices tend to not deviate much. But this doesn't mean that this price will work to maximize each seller's profit, monetary or subjective. Applying this back to your worries about the FRB case, some bankers may be able to find investments that will return 10% APR, and will feel comfortable lending 10% of the deposits to this investment, with a on-demand promissory note for the principal.

This may bid down the rate of interest (price of future money), because another lender has came into the investment market. But there is no inherent mal-investment taking place. If the investment is good, its good, if bad, then bad. But there is no added risk because the banker is using his deposited money as the investment fund. And again, if the depositor demands his deposit, the banker should be a good enough businessman to match his assets to his liabilities to be able to pay. If he can't, the depositor becomes a creditor like any other person that the banker can't fulfill contracts for. There is no dilution of the supply of money unless the bank is given the power of the printing press to monetize its debts - again implicating central banking, not FRB.

 

[hugolp]

Ok, I get what you're saying now. That said, I still don't see how this resolve the problem of pushing down interest rates by expansion of commercial bank money via the money multiplier effect. I can't really see this as being any different than a central bank expanding the money supply, and thus, pushing down interest rates.

But if the FR banking system keeps the multiplier more or less constant (as history shows it happens) there really isnt and expansion of the money supply.

 

[Fox McCloud]

But if the FR banking system keeps the multiplier more or less constant (as history shows it happens) there really isnt and expansion of the money supply.

which specific time periods and banking systems support your statement? I'd like to look into them.

 

[hugolp]

which specific time periods and banking systems support your statement? I'd like to look into them.

I though I had recommended this pdf already in this thread but it seems I didnt: http://www.independent.org/publications/tir/article.asp?a=774 It explains the free banking theory of demand for money and gives and example about the canadian banking system compared to the USA banking system during the second half of the XIX century.

Also, there are studies of the Scotish free banking system as well.

 

[Fox McCloud]

I though I had recommended this pdf already in this thread but it seems I didnt: http://www.independent.org/publications/tir/article.asp?a=774 It explains the free banking theory of demand for money and gives and example about the canadian banking system compared to the USA banking system during the second half of the XIX century.

Also, there are studies of the Scotish free banking system as well.

Ok, thanks, I'll look into it---thanks again.

 

[Tonidepoli]

Fractional reserves: myth and reality.

Although the claim that fractional reserve banking is inherently fraudulent, because it involves the multiplication of titles to specific coins, is a sort of mantra among certain Austrian economists (mainly followers of Murry Rothbard), it has no basis in either theory or history. On the contrary: a legal principle established in ancient times (you will find it in Talmudic law, for instance), and incorporated in the English Common Law since early modern times, holds that when loose coins are surrendered to a money exchanger or banker, title to those coins goes automatically to their possessor. Thus the goldsmith banker becomes the true owner of surrendered coins, which entitles him to do whatever he wishes with them. If the person who surrenders the coins receives in return a note offering to pay him (or the note's bearer) any part of the deposited amount on demand, that note indicates a debt contract, not a bailment; it therefore places the banker under no obligation at all to hold any particular reserve. It merely obliges him to pay the note when asked.

The same ancient tradition also allowed for "100-percent" reserve banking (that is, bailment of coin.) But then a deositor not wishing to surrender ownership of coins was required either to give the banker specific instructions to that effect (if loose coins were presented) or to "seal" the coins in question in a bag or other container. The coins then remained the depositor's property, and the banker was obliged to return the very same coins, all of which of course meant that there was no question of the banker having the right to lend any part of them.

The fact that so many self-styled "Austrian" economists have insisted on what is in fact an utterly false representation of the legal nature of fractional reserve banking is a shame. It has sullied an otherwise great school of economic (and especially monetary) thought, and it has misled large numbers of non-economists who have trusted the Austrians to give them the straight dope. Alas, it has also taken in Ron Paul himself, and most of his devoted followers. Larry White and I and a few others have tried our best to combat the misrepresentations, and will keep on doing so. But it is very hard to fight an idea or set of ideas once they have become conventional wisdom, if only among a very particular and small (but important) group of people.

 

[Fox McCloud]

Although the claim that fractional reserve banking is inherently fraudulent, because it involves the multiplication of titles to specific coins, is a sort of mantra among certain Austrian economists (mainly followers of Murry Rothbard), it has no basis in either theory or history. On the contrary: a legal principle established in ancient times (you will find it in Talmudic law, for instance), and incorporated in the English Common Law since early modern times, holds that when loose coins are surrendered to a money exchanger or banker, title to those coins goes automatically to their possessor. Thus the goldsmith banker becomes the true owner of surrendered coins, which entitles him to do whatever he wishes with them. If the person who surrenders the coins receives in return a note offering to pay him (or the note's bearer) any part of the deposited amount on demand, that note indicates a debt contract, not a bailment; it therefore places the banker under no obligation at all to hold any particular reserve. It merely obliges him to pay the note when asked.

The same ancient tradition also allowed for "100-percent" reserve banking (that is, bailment of coin.) But then a deositor not wishing to surrender ownership of coins was required either to give the banker specific instructions to that effect (if loose coins were presented) or to "seal" the coins in question in a bag or other container. The coins then remained the depositor's property, and the banker was obliged to return the very same coins, all of which of course meant that there was no question of the banker having the right to lend any part of them.

The fact that so many self-styled "Austrian" economists have insisted on what is in fact an utterly false representation of the legal nature of fractional reserve banking is a shame. It has sullied an otherwise great school of economic (and especially monetary) thought, and it has misled large numbers of non-economists who have trusted the Austrians to give them the straight dope. Alas, it has also taken in Ron Paul himself, and most of his devoted followers. Larry White and I and a few others have tried our best to combat the misrepresentations, and will keep on doing so. But it is very hard to fight an idea or set of ideas once they have become conventional wisdom, if only among a very particular and small (but important) group of people.

This is appeal to law and appeal to tradition, to a degree---I'm sure most Austrians will, once they look into it, argue that what you're saying is correct; what they will disagree with, however, is that because its so, it's naturally the best way of things or ok, in the long run--the State has been with us for a very long time, in practice and in law, but that hardly justifies its existence or its practice.

Rothbard pointed out a number of legal cases that set the precedent for modern fractional reserve banking, but he, like a few others, disagrees with their conclusion; most other institutions that store objects or goods of value are not bound by the same legal precedent--why should money be any different?

Lastly, I can understand your objection to a number of Austrians opposing fractional reserve banking (as its something not even settled within the school itself), but are you seriously suggesting that their reputation is "sullied" merely because of holding a position that's considered outside the mainstream? Of all the critique and ramblings against the Austrian school or ideas that seem to give them a "bad rep" (to other economic schools of thought), the opposition of some of the members to fractional reserve banking doesn't seem high on the list.

 

[Tonidepoli]

It isn't the unorthodox nature of the anti-fractional reserve arguments that I object to--lord knows i'm pretty unorthodox myself--it's the bad scholarship. Murray's interpretation of the legal cases is simply incorrect--he has the judges making new law when in fact they merely did what common law judges are supposed to do, which is to determine what is customary. Huerto de Soto likewise gets it wrong.

As for why money has been treated differently than other goods, it is a good question, and the answer has to do with the desire to take advantage of money's fungibility. Basically, a conventional bailment only works when there is a commitment to return specific (rather than like) goods. Once there's no question of returning the exact same goods deposited, there can be no question of title remaining with the depositor; and of course exchange services can't be performed without taking advantage of money's fungibility. (Think of trying to effect payments using using 100-percent reserve receipts without being able to treat coins as fungible--the transactions costs would be so high as to swamp those of just dealing with coins themselves.)

For some relevant legal references see Selgin's SSRN paper, "Those Dishonest Goldsmiths."

 

[Aquitaine]

Blaming fractional reserve banking for the economic mess is like blaming the passenger jets for 911. Unless the citizenery can come up with a foolproof way of vetting evil men from gaining control of systems that effect the public at large there will be no real change.
Some ways to accomplish this might be 1. lie detection checks for those running for office, 2. doing away with secret ballots.