Why each bubble gets bigger and fractional reserve banking is not a free market system

[Agorism]

http://mises.org/daily/1905

Felt like reposting this

 

[Sentient Void]

I don't see what's not 'free market' about letting an individual engage in a voluntary contract with a business entity that entails fractional reserve banking in and of itself.

Fractional Reserve Free Banking is free market, and has been chosen by the market in the past. It's extremely stable as well. There is also *not one* example of the free market choosing a 100% reserve system - all examples have been State mandated ones - because that's the only way such a system could survive. However there are numerous examples of the market creating free banking systems.

I love Rothbard, and he's solid on so many issues, but IMO - he's dead wrong when it comes to fractional reserve banking in and of itself. The current system is destructive, immoral, and fraudulent - absolutely - but attacking this and equating our current system with FRB in and of itself is quite the strawman.

I defer to the many other austrians in support of Free Banking... F.A. Hayek, Steve Horwitz, George Selgin, Larry White, Donald Beudraux, oh and dare I say even Von Mises expressed support for free banking.

It's mostly the Rothbardians (Rothbard, Block, Hulsmann, et al) that are crankish on this issue.

 

[rhelwig]

I don't see what's not 'free market' about letting an individual engage in a voluntary contract with a business entity that entails fractional reserve banking in and of itself.

As long as there's adequate knowledge of the nature of fractional reserve banking and the particular deal is made clear to the engaging parties, I find it to be OK. But if the terms of the deal can be changed unilaterally by one party, or the terms aren't clearly agreed upon, then there is fraud.

The government's banking system is clearly fraudulent, because they change the reserve requirements at will and without informing the depositors. They also don't fully disclose the terms.

 

[enter`name`here]

in and of itself I would agree that fractional resreve banking is not fraudulant. however when the government removes the risks involved through deposit insurance, its prevalence is over and above what would exist in a free market.

 

[Sentient Void]

Agreed with both of you on that. Absolutely.

My problem is that so many Rothbardians claim that FRB is inherently fraudulent. This logic is a conflation of property and contract rights.

 

[axiomata]

Selgin, White and others have a great new blog in case anyone does not have it bookmarked.

http://www.freebanking.org/

 

[Agorism]

In the past they had open banking not fractional reserve. Occasionally banks would over leverage make a LOT of money but then risked a bank run. If they had a run, they could be prosecuted for fraud.

So yes they could use fractional reserve methods, but it wasn't legal, and they certainly didn't have the federal reserve a guaranteed lender of last resort.

Basically it was 1:1 ratios, which is how it should be.

Fractional reserve system is fraudulent.

 

[tpreitzel]

In the past they had open banking not fractional reserve. Occasionally banks would over leverage make a LOT of money but then risked a bank run. If they had a run, they could be prosecuted for fraud.

So yes they could use fractional reserve methods, but it wasn't legal, and they certainly didn't have the federal reserve a guaranteed lender of last resort.

Basically it was 1:1 ratios, which is how it should be.

Fractional reserve system is fraudulent.

Yep ... the basis of FRB is fraud

 

[awake]

Fraud or not, open and free entry banking is the solution to our sick system. The rest is left up to two consenting parties and the fraud laws.

 

[Agorism]

Open banking and closed banking are virtually the same thing. Just splitting hairs.

 

[Seraphim]

I agree. FRB is not fraud if the depositor knows what they are getting into and realizes there is no backdrop to save their failed savings/investment plan.

FRB is fraud when the whole arsenal of the GOVT says you must use and accept the fiat bills of credit or get sent to the rape cages.

Agreed with both of you on that. Absolutely.

My problem is that so many Rothbardians claim that FRB is inherently fraudulent. This logic is a conflation of property and contract rights.

 

[Agorism]

No depositor would agree to a bank that didn't have 1:1 reserves. They always assure people that their withdrawals will be cashed and the money that they deposit will be 100% available when they come for it.

 

[JJonesMBA]

...

 

[Agorism]

Sure so long as the bank warns the customer that there money may or may not be there if they come back for it.

It's like renting storage for your car, and when you return it's not there because it was rented out.

It's also inflationary in that it's creating new money and devaluing your money in addition to causing bank runs.

Leverage is what causes the business cycle as well.

However, it seems to me that FRB should be allowed as a business model in a free market of competing currencies (or competing credit) where depositors are free to invest their savings at one of many competing free market banks. Each bank would determine a certain acceptable range of FRB (from zero to infinity) that would be a prudent way to run their business and turn a profit.

Also this doesn't make sense. I think you mean to say open banking. Fractional Reserve banking is when the government sets the amount of ratios and fraud the banks can commit. Right now 10:1, and they give a lender of last resort if anything goes wrong to back them up on it.

When you have open banking there is no set reserve so they could do 100:1 or 1:3 or whatever the banks thought they could get away with.

Open and closed banking are very similar concepts.

 

[Agorism]

Fractional Reserve Banking started in 1913 in the U.S.

Before that we had closed\open banking systems depending on your definitions and what you consider to be fraud.

 

[JJonesMBA]

...

 

[Agorism]

As to the quoted text, although inflationary, in theory, the interest paid to the depositor could be at or above the rate of the devaluation due to inflation in the money supply, correct? I take it that for the bank to remain profitable, the return on the investment would have to be estimated to be in excess of the costs of the financing for each individual instance where a loan is granted for a particular client for a particular project.

In a future state of "competing currencies" of private banks and institutions with transparent exchange rates, wouldn't depositors effectively be able to determine which particular banking system to invest in, to meet their particular banking needs (i.e. checking, savings or investment etc.), such that only banks with effective and efficient policies would enable competing banks to survive in a free and fair market?

You mean if you charged 100% interest on the loan that was due immediately as soon as you took the loan out. Ya I guess that would be the case...but no one would do that. Or after they paid enough interest, you could get back to baseline after a while but the bank would be at risk for a short while as well.

Without a lender of last resort you're going to eventually get a bank run even if you set the ratios extremely low like 1:1.05 or something, which is what most banks do. Bank that cuts the most corners are going to make the most money, but they are also gambling the most.

Also if you tie the currency to a commodity as used to be with the gold standard, you get inflation with this without increasing the actual commodity. Meaning if you have money, banks committing fraud with this, if you consider it fraud, is devaluing your iou for gold (money.)

The Secret service used to be an anti-counterfit organization. If criminals made counter fit money, they would try to catch them with the penalty of death. If criminals don't get to artificially increase the money supply, why should a bank be able to do so especially when they risk a bank run and risk the deposits and savings of every depositor in doing do.

Also if fractional reserve banking is really legitimate why not set the ratios at 20:1 instead of 10:1. It would allow the banks to make more money, and it would make credit much more available in the near term to get us out of the recession...at least in the near term. Why not change the ratios if that's the case. This banking system is just like copyright, licensing, and patent laws in that the government gives them a niche that they can profit off.

 

[Sentient Void]

As to the quoted text, although inflationary, in theory, the interest paid to the depositor could be at or above the rate of the devaluation due to inflation in the money supply, correct? I take it that for the bank to remain profitable, the return on the investment would have to be estimated to be in excess of the costs of the financing for each individual instance where a loan is granted for a particular client for a particular project.

In a future state of "competing currencies" of private banks and institutions with transparent exchange rates, wouldn't depositors effectively be able to determine which particular banking system to invest in, to meet their particular banking needs (i.e. checking, savings or investment etc.), such that only banks with effective and efficient policies would enable competing banks to survive in a free and fair market?

Straightforward and solid. What you're referring to is known as 'Free Banking'.

The Rothbardian claims that FRB in and of itself is 'fraud' is a conflation of property and contract rights. Fractional reserve 'Free Banking' is in theory (for those who actually understand Free Banking) extraordinarily stable, and is illustrated as such by history (Free Banking in Hong Kong and canada are great examples, the US did not have actual 'free banking' despite claims to the contrary, partly due to regulations including prohibitions on branching).

100% reservism would lead to Wicksellian Rot, and a free market never has nor never will adopt 100% reserve 'banking systems' (these are not and cannot be 'banks' btw, these are warehouses) voluntarily (it can only be, and only has been, imposed by the State).

If you would like to know more about free market banking AKA 'Free Banking' there's a decent article on it, but there are solid books and articles online by austrian economists such as George Selgin, Larry White, Steve Horwitz, among other (those are the current prominent ones, though). FA Hayek advocated Fractional reserve Free Banking (FRFB), and there is evidence that while Mises thought it was an 'impossible goal' to attain monetary equilibrium (important for stable money prices), he admitted it would be preferable if possible. He flip flopped on the concept of FRFB.

FA Hayek are two of the if not the msot prominent austrian economists out there. It is really only Rothbard, Block and a few others that erroneously rail against FRFB.

 

[Agorism]

I've never heard of a Wicksellian Rot. Please explain.

Keep in mind that if you have open\closed banking system (like the U.S. roughly had) and a banks overleverage eventually you get systemic bank runs and all the overleveraged banks go bankrupt since they have no lender of last resort, and the money supply with dry up and you will get overall deflation (like a mini-bust cycle.) So I don't see why 1:1 ratios don't work. This is roughly the system we had.

 

[sofia]

Agreed with both of you on that. Absolutely.

My problem is that so many Rothbardians claim that FRB is inherently fraudulent. This logic is a conflation of property and contract rights.

Even if contracting parties are aware of potential risks of fractional reserve banking, you still have the problem of debased currency created out of thin air...robbing non participants of the value of their money...

Fractional Banking bubbles and/or inflation impact all of society, not just the direct participants.