But what some Austrians claim about fractional reserve banking (FRB) is that it actually does transgress rights, namely the private property right to a certain amount of money deposited in a FR bank, whenever such a bank lends out a portion of it and then there are more claims to this particular amount of money circulating than the actual money deposited. It’s accurate that the depositor’s rights are not infringed here, because he voluntarily agreed to deposit money in a FR bank. Borrower’s rights are not infringed either. The only party whose rights may be infringed are the receivers of these additional, unbacked claims to money (banknotes), for example a car seller who received banknotes previously lent to the borrower from our example. Because at the same time the depositor may issue a wire transfer from his account to pay for a new TV, and therefore market forces at work, working with additional newly created money raise price of both the car and the TV, while in a non-FRB environment, the depositor (who would be a saver in that instance) would be unable to use his money for consumption, and only the price of the car would be affected by the credit issued to the borrower. Therefore, there is additional inflation, and the receiver of this additional claims to money - our car seller - has to face higher prices for TVs because of the unreduced consumer demand possible with two claims to the same amount of money circulating (either as banknotes or on-demand deposits).
And that’s only one part of the bigger problem, which is a mismatch between savings and loans - I can’t say there are more clear rights’ infringements, but the above example is evidently a case where the private property right of the car seller to money may be violated. Of course in a fully laissez-faire environment he could as well reject some FR bank’s notes altogether, if he didn’t want to fear that such banknotes would be worth less - but he would have to be well-versed in Austrian economics and do this thought experiment to actually realize that. I guess most people, either from ignorance or convenience, wouldn’t bother to avoid FRB notes altogether and demand only specie or specie certificates. There’s nothing one can do about it (it’s a case of prisoner’s dilemma), but I guess strong antifraud enforcement in courts would be welcome to make sure that every FR bank stated clearly that its notes in circulation are subject to inflation and might not be redeemable on demand with 100% specie.
These are my thoughts from the rights’ perspective.
And only as long as banknotes issued by a FR bank are distinct from money certificates issued by 100% reserve banks, which implies no central bank and no government’s role in issuing ONE kind of money whatsoever. Then a man on the street, when receiving a banknote can clearly see if it is a title to specie (and will be discounted on the basis of a ‘storage fee’ subtracted from the amount of money by its bank during the withdrawal with this money certificate - but stays in value, or sligthly rises as commodities usually do), or just a FR note - sort of a lottery ticket, which may not be redeemable on demand, or even at all if bank rupts - and therefore will be discounted by the market on a different basis, also taking into account the possible fall in value due to inflationary cycles.
Now, would FRB be as common as we are used to, given fully laissez-faire conditions, is something I keep wondering, and ultimately rests on the time preference of a society. Societies with a high time preference would rather see a very unstable FRB system, so banks would rather be discouraged to continue such practices. Today, central bank, deposit insurance and government intervention usually considerably offset the market signals resulting from high time preference, and at the same time increase the time preference with forcing low interest rates and lowering lending standards, therefore the whole system is artificially kept in a state of insolvency and market cannot find a way out.
Kel,
I don’t see the rights violation as long as the bank is up front regarding its reserve ratio and that deposits are not guaranteed to be redeemed on demand. So, with a fractional reserve bank there is some (in a free market, very, very small) chance you will not be able to redeem on demand. As long as this is known, there is no fraud by the bank.
I also think that in a free market, the Clear distinction between savings and demand accounts will erode. Even today you have money market accounts with characteristics of both. When someone accepts a check on a money market account, they take a small risk that it will face a delay in redemption. But the risk is so small as to be irrelevant in most cases. If the risk increases, identifying the reserve ratio on the bank note might be a good market solution. . . Who knows how the market will evolve to deliver relevant information.
As you recognize, I take a rights perspective, not a utilitarian one. Although, I believe that if rights are protected the market will evolve to provide a superior economic outcome as well.
Yaron has it all wrong. He fails to *truly* differentiate between a deposit (or storage) account and a savings (or investment) account. He also fails to see the fraud involved in having two people spending the same dollar. That, not the money supply, is the main complaint of Austrians.
There are basically two types of bank accounts, a deposit account, which is a straight storage function, and a savings account, which is designed to pay the investor a return on his money by allowing the bank to broker a loan for him in their name. In a deposit account, the money can be available to only one person at a time. If a depositor writes a check for the entire amount, it can’t be out on loan at the same time. Contrary to Mr. Brook’s assertion, the bank is liable for the entire amount on demand. In a savings account, the entire amount may or may not be out on loan and the bank is only obliged, by contract, to return the portion of the account not currently out on loan.
The fraud comes in when the funds in a deposit account are loaned out at the same time that they are being spent by the depositor. The depositor finds himself being bid against for goods and services by his own money. He put his money on deposit for safe keeping but that money has actually been lent against him. That is actually damaging to everyone in the economy whether or not they have a contract with the bank. I may have no contract nor account with the bank yet the price of goods and services I must pay is being raised by the actions of that bank and I am damaged.
Fractional reserve banking is a fraud on the economy as a whole as it pretends there is much more money available for use than there actually is. Further, should every depositor demand their funds, the bank would collapse taking not only the depositors with it but a large section of the economy that had accepted the checks of both the depositors and borrowers only to find that a large portion of them are bogus. There is no money nor has there ever been more than was originally placed on deposit. All the rest was just a dream of the bankers.
Yaron needs to do a bit more study on the subject.
That’s what I wrote in my first post here. The depositor being bid against is the infringement of rights only insofar as he is not informed about it by a dishonest banker. Otherwise, we cannot suppose that the depositor acts as an irresponsible child and should be recompensed. After all, his deposit yields some interest after all, and he was aware that by putting money on deposit, it will be lent out.
Now, the price of goods and services will rise, but only in the banknote units of the FR bank engaged in inflationary expansion. If you hold specie, the price of specie will rise as well, if a seller of the (credit-fueled) demanded good redeems the FR banknote for specie. Therefore equilibrium is maintained in that regard. If he doesn’t - he loses the instance the depositor of the original money proper uses his deposited cash to buy something. Then again prices rise. But still, those who hold specie or 100% money certificates, are not harmed - only those who keep FR notes.
But Yaron clearly stated, that he is not assessing FRB from purely economic point of view, but only from the rights’ standpoint. And the only issue with rights is what I described - and that only happens when FRB is privileged to disguise its banknotes as “real money”. As long as courts uphold property rights to money proper and severely punish frauds and seemingly 100% banks which embezzle deposits - then the market process will ensure little harm, especially when one decides to keep and deal only in specie - then FRB would not be an issue for such a person at all. He would not accept FRB notes from clients and demand payments in specie only.
Now, there are some economic issues, which even Austrian economists favoring 100% reserve call trivial, like the mismatch between savings and loans. For example, a depositor who deposits cash usually does that because he wants to increase his cash balance, expecting uncertainty in the future - that’s what cash is for after all. And the very instant he increases his cash balance in a FRB deposit, the bank lends it out, creating new demand for goods. Therefore, such credit expansion clearly offset the increase in the cash balance - which would ceteris paribus resulted in lowering of the price level. For the depositor, it is an unwanted consequence of the actions of a third party. BUT - in a free market he has the choice to deposit his money in a 100% reserve bank or keep it under mattress or whatever, if he’s a scrooge on storage fees. In that case, the money is not lent, his cash balance increases, demand for money rises - demand for goods sinks. The price level drops. He’s better off, just like he wanted.
I agree. Thanks for pointing this out. (I have given my own reasons for opposing fractional reserve banking elsewhere, so I will not repeat my arguments here.)
I’ve read your article, and it addresses only the issue of FR banks “disguising” their banknotes as fully-backed claims to gold - which would never occur in a laissez-faire capitalism with no government intervention into monetary matters. Clearly, such disguising is fraud and courts would stand ready to punish such banks on the basis of protection from fraud.
That’s why in a truly capitalist system FR banks could only issue banknotes or checks with explicit information about the fractional nature of their reserves, and that’s why each person willing to accept these fiduciary media would be aware of the risks involved, and possible costs from either inflation (banknotes losing purchasing power), redemption delay or outright bankrupcy in the worst case scenario (market signals would not be hampered though, so each banknote would be discounted depending on the situation). Thus, noone is forced by legal tender laws to accept fiduciary media in a laissez-faire system. Those who choose to hold gold or other specie used as money, are not affected by the loss of purchasing power, because inflation of one FR bank’s notes only affects this bank’s notes’ purchasing power. The temporary rise in demand due to credit expansion is immediately curbed whenever a FR note is redeemed for specie, or a loan created out of FR deposit is paid off, therefore in the long run there is a monetary equilibrium.
Again to conclude - in the absence of central bank, legal tender laws and government intervention into monetary matters, that is, in the environment of full laissez-faire including money production, there is no infringement of rights in fractional-reserve banking, given that FR banks are outright honest about their practice and courts uphold the law protecting from fraud as explained in the first paragraph.
Now, I am acquainted with such literature as professor Jesus Huerta de Soto’s “Money, Bank Credit and Economic Cycles” and Jorg Guido Hulsmann’s “The Ethics of Money Production”, and I consider myself a supporter of 100% reserve banking - as a bank client! I probably would not deal with FR banks whatsoever if I had a choice in a laissez-faire system - bearing the cost of such a behaviour. But clearly there is no argument from a rights’ perspective against FRB, given all the institutional framework of a truly capitalist society, with a functional court system and no legal privileges for FRB. I cannot make myself more clear with that.
We can condemn FRB as an unnecessary, overly dangerous business practice - just as we condemn for instance extreme sports, drug use, “insider trading” etc., but these are perfectly voluntary activities in a free society, involving only willing parties and having no effect (from a rights’ perspective!) on uninvolved people. Saying that an expansion in credit by a FR bank harms third parties is, as I explained earlier, mistaken. It is not even close to, for example, a case where one buys a piece of property and one day, because of fully legitimate actions of his neighbours, the price of his property falls by a significant amount - I rarely find a free-marketer who would object to such an outcome and call for state intervention or sueing of neighbours when no rights were infringed and only market forces were at work. In a free banking world, people’s savings are safe from inflation when they keep them in gold or in 100%-reserve deposits, because only FR notes are affected. And nobody is forced to use FR notes. People weigh costs and benefits from using that or that kind of banking, saving and investment opportunities, using their own reason, preferences and acting on their behalf. That’s the main point.
I hope this finally resolves this interesting issue once and for all.
Fine; but you miss the most important point of my argument: that FRB has the same effect as any other inflationary measure: some people receive the money before prices have risen; others receive it only after prices have risen. The first receivers of a fractional loan stand to gain; those who do not receive those loans stand to lose. This is a fraud perpetrated on the second of these groups.
The answer to all the objections is the same: free trade means free trade. What Kel and those on his side ignore is the free consent of the person accepting a check. Even today, with loads of government intervention, people don’t equate a check with cash. In a laissez-faire society, accepting not only a private bank’s banknotes but their checks would be require exercising judgment.
That takes care of the automobile/TV example.
I find, uh, strained the idea that someone would have to be versed in Austrian economics in order to be leery of a check on “Joe’s Bank.” There seems to be a premise among the opponents of fractional reserve banking that disaster looms when we “allow” people to act on their own judgment.
But that’s exactly what I wrote - that the opponents of FRB should not treat people receiving FR notes as idiots, but as responsible consenting adults. I for that matter have no problems with FRB operating in a free-market, as long as FR banks don’t disguise their notes or checks as having 100% backing - and that’s a role for courts to uphold. Granted that, I don’t see any rights violation and agree with Yaron.
It’s hard to imagine a rights-respecting, stable FRB system in a current regime rife with government intervention, legal tender laws and a central bank - and I think this is the reason for the hostility of many free-marketers to FRB in general. They fear that a wanton inflation of FR notes would occur and their savings would be eaten up - just like it happens today. But in a free-market society with no legal tender laws, competition between currencies makes sure that fully-backed notes and money proper retains its purchasing power, therefore people uninvolved with FR notes are not affected by any of its supposed ill-effects.
Historical record of fractional-reserve banking within commodity-money standard is not very good, but we must take into consideration the behaviour of courts and government intervention, granting bank holidays and practically legal immunity from the wrath of depositors, which created again and again perverse incentives for the bankers, while dumbing down the public with implicit promises that government-sanctioned activities may be trusted. In a truly limited-government environment such course of things obviously can’t happen.
FRB counterfeiting allows and encourages excessive investment in producers goods because of their greater sensitivity to interest rates. This causes the “business” cycle. The business cycle encourages govt counterfeiting and thus spending and/or lending to maintain (political) demand to delay or lessen the bust. Even in capitalism, FRB’s destructive economic effect will cause political pressure to delay or lessen the bust, as we see today. This is a dangerous, continuous pressure, even in capitalism, and it happened in the past when there was less economic statism. The Fed was created to maintain the booms created by FRB. Statists want “flexibility” to hide the destructiveness of inflation.
The Bank of Amsterdam was full reserve and profitable from 1609 until the late 1800’s. Then it adopted FRB and was bankrupted. Most banks in history were FRB and most, I believe, failed. These are more than coincidences. Rome outlawed FRB.
Anonymous apparently neither listened to Yaron nor read any of these comments. What kind of “counterfeiter” tells his trading partners just what his money is and represents?
Listen up anti-FRBers: what if every bank made each depositor, on opening his account, sign a waiver saying he realizes the arrangement and consents to taking the risk? And then what if every check printed by such banks carried notice: “This check is on an account in a fractional reserve bank; in accepting it in payment, you assume the risks involved.” Or whatever language you want—flashing neon signs above the banks maybe? WHAT THEN? Where’s your fraud, your counterfeiting, your double claims on the same asset?
So what are the anti-FRBers left with, given that this completely ends their claims of fraud? They are left with their ANTI-CAPITALIST economics: the claim that they know better than the market—that they can see that fractional reserve banking is dangerous but those in the market—bankers and their clients—cannot. If they actually accept capitalism, and if they grant there’s no force or fraud, they must take the position: let the market sort it out.
Fractional Reserve banking existed and functioned here in the free banking periods of the 19th century. End of story.
Excuse my shortness of temper, but I have been answering the same benighted anti-FRB arguments for some 40 years now.
Even with flashing neon and car alarm audio, FRB paper still lacks commodity backing. When the depositor uses his deposit of commodities or commodity-backed money to buy something, the FRB borrower can only “buy” someone else’s production with a certificate representing nothing. Warnings on FRB paper, etc. would decrease takers but there remains the serious potential of someone learning a subtle, perhaps very indirect, method of defrauding w/them.
Sophisticated fraud exists, eg, Bernie Madoff, and govt is obligated to identify and stop it for unsophisticated potential and actual victims. I suppose that if fraud warnings were 100% effective, outlawing FRB would be superfluous. Mises would not accept FRB paper but Brook would, thus even those with a sophisticated understanding of capitalism can disagree here, highlighting the problem.
Anti-FRB is not anti-capitalist since its part of the limit of capitalism, ie, the claim begs the question. If FRB paper, despite pervasive warnings, is used to “buy” things, investors will be motivated to produce more of those things even tho there has been no savings increase for increased production. Thus malinvestment, misallocated resources and the boom-bust cycle. And govt motives to continue the boom for political supporters. And the encouragement of altruism to stop, decrease or delay the pain of the necessarily resulting bust.
Jesus Huerta de Soto’s _Money, Bank Credit and Economic Cycles_ is an excellent and very interesting, historical and theoretical study.
If someone offers me counterfeit money and I accept it, not knowing that it is counterfeit, I am of course defrauded. But if the counterfeiter is open about it and tells me it is counterfeit, why should I accept it? But say I accept it: what will I do next? I will buy something for the money. But if I tell the seller the money is counterfeit, the seller won’t accept it. So I will have to pretend the money is real. The seller is defrauded; and I am an accomplice to the fraud initiated by the original counterfeiter.
Now, fractional reserve money is only partly counterfeit, since part of it is backed by gold (or silver) and part of it is not. But my weird example above is still applicable.
Remembering that money is a medium of exchange so there has to be something to exchange (ie goods produced), using money not 100% backed means consuming more than you are producing, which is fundamentally dishonest.
So it’s not whether or not everyone is made aware of the nature of FRB money that makes it counterfeit and hence fraudulent - it is counterfeit because it is not 100% backed by goods. And it’s from the same pool of finite goods that those using FRB money are consuming as those who use 100% backed.
And so it is violating the rights of those holding 100% backed money as they are suffering a reduced supply (hence higher price) of goods been consumed by those who have not traded anything for them.
Hence I would with all due respect disagree and argue that FRB is indeed fraud.
>And so it is violating the rights of those holding 100% backed money as they are suffering a reduced supply (hence higher price) of goods been consumed by those who have not traded anything for them.
Agreed. Try doing FRB w/barter. Farmer Smith has 100 cows. If he sells 101 cows, the farmer who ends up with that extra one cow is going to have a difficult time milking it. And consumers will have a difficult time drinking it. Its very sad. I think FRB should be set aside for production. If I’m promised a cow, I want to be able to milk it. And, of course, with some chocolate liquer and some vodka, drink it in a toast to good times. You cannot toast to an FRB White Russian. Or, as the Dude would say, a Caucasian.
> I will buy something for the money. But if I tell the seller the money is counterfeit, the seller won’t accept it.
You accepted it, maybe on the bigger fool theory. Deck chairs on the Titanic.
The parts thats counterfeit is the, growing, problem.
A money economy must identify, in its prices, the relative value of the things offered on the market. FRB hides those relative prices, making economic calculation (see Mises, _Human Action_) difficult, if not impossible.
These claims within a context of counterfeit money and bank notes and other money substitutes are aiming at straw men. There is no requirement for these substitutes, ignoring for the moment that our economy is moving away from cash. When the FRB lends it could just as easily hand out the gold it is lending. We could have an economy with no money substitutes and fractional reserve banking. It would be inconvenient, but it would destroy every claim of fraud. It also means that each criticism ignoring the gold only economy is an attempt to not think in fundamentals. It means that they do not recognize that when rights are protected and people act in their own interest whatever results is objectively good. Yes, there is trial and error, yes, people would have to learn what good banking practices are. But continuing to argue after the morality has been established, in an objective ethics, is to reveal that you don’t think that reality and morality are consistent or that the moral is the practical.
Mr. Grossman, I suggest that you go back and look at the other things that Mises has to say about prices. Money, gold used as the medium of exchange, represents a claim upon products in the economy. As Dr. Brook mentioned, a lot of gold is sitting in accounts at any one point of time. It isn’t actually buying anything. At various points in time, the demand for savings, meaning the actual goods saved, that the gold saved represents, is changing. As Mises says elsewhere, individual prices change for a host of reasons and such changes don’t mean much. If the money does just sit, the demand for the saved goods will be less, and the prices will fall. If the money is loaned to businessmen who wish to create productive enterprises or expand, the demand will increase and the prices will, too. But, the businessman who calculates that his investment will earn the profit necessary to pay the higher capital costs and the interest rate on the loan, will need to have a strong business.
Someone above argued that there would be inflation with FRB. Actually, that is false. Inflation is only possible when there is a steady increase in the money supply. In the case in laissez faire FR banking there is no steady increase in the money supply. The money supply is on a tether which is tied to the actual amount of gold in the economy. It can expand at times and shrink at times, relating to the skill of the bankers and the demand for capital. It can’t go on expanding.
These things are not too difficult to figure out once you realize that FRB is moral and does not necessarily involve fraud. If it seems to you that there is a practical problem, that based upon your understanding it can’t work, it is your understanding that is in error, not reality or morality. Then it is only a matter of looking to see where you are making a mistake.
>gold is sitting in accounts at any one point of time. It isn’t actually buying anything. At various points in time, the demand for savings, meaning the actual goods saved, that the gold saved represents, is changing.
Theres no necessary relation between unused savings and counterfeit saving. They may chance to balance or not for an arbitrary time. Counterfeit savings can, grow arbitrarily and has historically. The FRB distortion remains.
>The money supply is on a tether which is tied to the actual amount of gold in the economy. It can expand at times and shrink at times, relating to the skill of the bankers and the demand for capital. It can’t go on expanding.
The economic demand for capital is from supply. The political demand for capital is based on force. The Fed’s “balance sheet” can expand at the touch of a computer keyboard.
The ex-chair of the local economics dept, a specialist in the history of theory, recently told me that mainstream economists have no confidence in the conventional explanations of our economic problems. I had mentioned Bernanke’s recent speech on C-Span, filled with hemming and hawing and hesitation. This is an opportunity for Objectivists and Austrians. Krugman, who formerly evaded Austrian theory, has several times recently discussed it.
Even El Presidente is campaigning under the slogan, “an economy that’s built to last,” almost as if he rejects the Pragmatist/Keynsian short run. Sure, in the short run he rejects the short run. Didnt Augustine ask God for just one more drink or hooker or something?
Thank you Dr Binswanger for posting your excellent comments. Opposition to FRB really is a thinly diguised opposition to liberty in finance. One cannot rationally claim to support capitalism while criticizing FRB.
29 Comments to “Yaron Answers: Should Fractional Reserve Banking Be Legal?”
But what some Austrians claim about fractional reserve banking (FRB) is that it actually does transgress rights, namely the private property right to a certain amount of money deposited in a FR bank, whenever such a bank lends out a portion of it and then there are more claims to this particular amount of money circulating than the actual money deposited. It’s accurate that the depositor’s rights are not infringed here, because he voluntarily agreed to deposit money in a FR bank. Borrower’s rights are not infringed either. The only party whose rights may be infringed are the receivers of these additional, unbacked claims to money (banknotes), for example a car seller who received banknotes previously lent to the borrower from our example. Because at the same time the depositor may issue a wire transfer from his account to pay for a new TV, and therefore market forces at work, working with additional newly created money raise price of both the car and the TV, while in a non-FRB environment, the depositor (who would be a saver in that instance) would be unable to use his money for consumption, and only the price of the car would be affected by the credit issued to the borrower. Therefore, there is additional inflation, and the receiver of this additional claims to money - our car seller - has to face higher prices for TVs because of the unreduced consumer demand possible with two claims to the same amount of money circulating (either as banknotes or on-demand deposits).
And that’s only one part of the bigger problem, which is a mismatch between savings and loans - I can’t say there are more clear rights’ infringements, but the above example is evidently a case where the private property right of the car seller to money may be violated. Of course in a fully laissez-faire environment he could as well reject some FR bank’s notes altogether, if he didn’t want to fear that such banknotes would be worth less - but he would have to be well-versed in Austrian economics and do this thought experiment to actually realize that. I guess most people, either from ignorance or convenience, wouldn’t bother to avoid FRB notes altogether and demand only specie or specie certificates. There’s nothing one can do about it (it’s a case of prisoner’s dilemma), but I guess strong antifraud enforcement in courts would be welcome to make sure that every FR bank stated clearly that its notes in circulation are subject to inflation and might not be redeemable on demand with 100% specie.
These are my thoughts from the rights’ perspective.
As long as a bank is up front about the fact that it is practicing fractional reserve banking there’s no rights problem.
And only as long as banknotes issued by a FR bank are distinct from money certificates issued by 100% reserve banks, which implies no central bank and no government’s role in issuing ONE kind of money whatsoever. Then a man on the street, when receiving a banknote can clearly see if it is a title to specie (and will be discounted on the basis of a ‘storage fee’ subtracted from the amount of money by its bank during the withdrawal with this money certificate - but stays in value, or sligthly rises as commodities usually do), or just a FR note - sort of a lottery ticket, which may not be redeemable on demand, or even at all if bank rupts - and therefore will be discounted by the market on a different basis, also taking into account the possible fall in value due to inflationary cycles.
Now, would FRB be as common as we are used to, given fully laissez-faire conditions, is something I keep wondering, and ultimately rests on the time preference of a society. Societies with a high time preference would rather see a very unstable FRB system, so banks would rather be discouraged to continue such practices. Today, central bank, deposit insurance and government intervention usually considerably offset the market signals resulting from high time preference, and at the same time increase the time preference with forcing low interest rates and lowering lending standards, therefore the whole system is artificially kept in a state of insolvency and market cannot find a way out.
Kel,
I don’t see the rights violation as long as the bank is up front regarding its reserve ratio and that deposits are not guaranteed to be redeemed on demand. So, with a fractional reserve bank there is some (in a free market, very, very small) chance you will not be able to redeem on demand. As long as this is known, there is no fraud by the bank.
I also think that in a free market, the Clear distinction between savings and demand accounts will erode. Even today you have money market accounts with characteristics of both. When someone accepts a check on a money market account, they take a small risk that it will face a delay in redemption. But the risk is so small as to be irrelevant in most cases. If the risk increases, identifying the reserve ratio on the bank note might be a good market solution. . . Who knows how the market will evolve to deliver relevant information.
As you recognize, I take a rights perspective, not a utilitarian one. Although, I believe that if rights are protected the market will evolve to provide a superior economic outcome as well.
Thank you for commenting.
Yaron
Yaron has it all wrong. He fails to *truly* differentiate between a deposit (or storage) account and a savings (or investment) account. He also fails to see the fraud involved in having two people spending the same dollar. That, not the money supply, is the main complaint of Austrians.
There are basically two types of bank accounts, a deposit account, which is a straight storage function, and a savings account, which is designed to pay the investor a return on his money by allowing the bank to broker a loan for him in their name. In a deposit account, the money can be available to only one person at a time. If a depositor writes a check for the entire amount, it can’t be out on loan at the same time. Contrary to Mr. Brook’s assertion, the bank is liable for the entire amount on demand. In a savings account, the entire amount may or may not be out on loan and the bank is only obliged, by contract, to return the portion of the account not currently out on loan.
The fraud comes in when the funds in a deposit account are loaned out at the same time that they are being spent by the depositor. The depositor finds himself being bid against for goods and services by his own money. He put his money on deposit for safe keeping but that money has actually been lent against him. That is actually damaging to everyone in the economy whether or not they have a contract with the bank. I may have no contract nor account with the bank yet the price of goods and services I must pay is being raised by the actions of that bank and I am damaged.
Fractional reserve banking is a fraud on the economy as a whole as it pretends there is much more money available for use than there actually is. Further, should every depositor demand their funds, the bank would collapse taking not only the depositors with it but a large section of the economy that had accepted the checks of both the depositors and borrowers only to find that a large portion of them are bogus. There is no money nor has there ever been more than was originally placed on deposit. All the rest was just a dream of the bankers.
Yaron needs to do a bit more study on the subject.
That’s what I wrote in my first post here. The depositor being bid against is the infringement of rights only insofar as he is not informed about it by a dishonest banker. Otherwise, we cannot suppose that the depositor acts as an irresponsible child and should be recompensed. After all, his deposit yields some interest after all, and he was aware that by putting money on deposit, it will be lent out.
Now, the price of goods and services will rise, but only in the banknote units of the FR bank engaged in inflationary expansion. If you hold specie, the price of specie will rise as well, if a seller of the (credit-fueled) demanded good redeems the FR banknote for specie. Therefore equilibrium is maintained in that regard. If he doesn’t - he loses the instance the depositor of the original money proper uses his deposited cash to buy something. Then again prices rise. But still, those who hold specie or 100% money certificates, are not harmed - only those who keep FR notes.
But Yaron clearly stated, that he is not assessing FRB from purely economic point of view, but only from the rights’ standpoint. And the only issue with rights is what I described - and that only happens when FRB is privileged to disguise its banknotes as “real money”. As long as courts uphold property rights to money proper and severely punish frauds and seemingly 100% banks which embezzle deposits - then the market process will ensure little harm, especially when one decides to keep and deal only in specie - then FRB would not be an issue for such a person at all. He would not accept FRB notes from clients and demand payments in specie only.
Now, there are some economic issues, which even Austrian economists favoring 100% reserve call trivial, like the mismatch between savings and loans. For example, a depositor who deposits cash usually does that because he wants to increase his cash balance, expecting uncertainty in the future - that’s what cash is for after all. And the very instant he increases his cash balance in a FRB deposit, the bank lends it out, creating new demand for goods. Therefore, such credit expansion clearly offset the increase in the cash balance - which would ceteris paribus resulted in lowering of the price level. For the depositor, it is an unwanted consequence of the actions of a third party. BUT - in a free market he has the choice to deposit his money in a 100% reserve bank or keep it under mattress or whatever, if he’s a scrooge on storage fees. In that case, the money is not lent, his cash balance increases, demand for money rises - demand for goods sinks. The price level drops. He’s better off, just like he wanted.
I agree. Thanks for pointing this out. (I have given my own reasons for opposing fractional reserve banking elsewhere, so I will not repeat my arguments here.)
Try to refute mine
I said I do not want to repeat myself. If anyone is interested, my website is http://www.nattvakt.com.
I’ve read your article, and it addresses only the issue of FR banks “disguising” their banknotes as fully-backed claims to gold - which would never occur in a laissez-faire capitalism with no government intervention into monetary matters. Clearly, such disguising is fraud and courts would stand ready to punish such banks on the basis of protection from fraud.
That’s why in a truly capitalist system FR banks could only issue banknotes or checks with explicit information about the fractional nature of their reserves, and that’s why each person willing to accept these fiduciary media would be aware of the risks involved, and possible costs from either inflation (banknotes losing purchasing power), redemption delay or outright bankrupcy in the worst case scenario (market signals would not be hampered though, so each banknote would be discounted depending on the situation). Thus, noone is forced by legal tender laws to accept fiduciary media in a laissez-faire system. Those who choose to hold gold or other specie used as money, are not affected by the loss of purchasing power, because inflation of one FR bank’s notes only affects this bank’s notes’ purchasing power. The temporary rise in demand due to credit expansion is immediately curbed whenever a FR note is redeemed for specie, or a loan created out of FR deposit is paid off, therefore in the long run there is a monetary equilibrium.
Again to conclude - in the absence of central bank, legal tender laws and government intervention into monetary matters, that is, in the environment of full laissez-faire including money production, there is no infringement of rights in fractional-reserve banking, given that FR banks are outright honest about their practice and courts uphold the law protecting from fraud as explained in the first paragraph.
Now, I am acquainted with such literature as professor Jesus Huerta de Soto’s “Money, Bank Credit and Economic Cycles” and Jorg Guido Hulsmann’s “The Ethics of Money Production”, and I consider myself a supporter of 100% reserve banking - as a bank client! I probably would not deal with FR banks whatsoever if I had a choice in a laissez-faire system - bearing the cost of such a behaviour. But clearly there is no argument from a rights’ perspective against FRB, given all the institutional framework of a truly capitalist society, with a functional court system and no legal privileges for FRB. I cannot make myself more clear with that.
We can condemn FRB as an unnecessary, overly dangerous business practice - just as we condemn for instance extreme sports, drug use, “insider trading” etc., but these are perfectly voluntary activities in a free society, involving only willing parties and having no effect (from a rights’ perspective!) on uninvolved people. Saying that an expansion in credit by a FR bank harms third parties is, as I explained earlier, mistaken. It is not even close to, for example, a case where one buys a piece of property and one day, because of fully legitimate actions of his neighbours, the price of his property falls by a significant amount - I rarely find a free-marketer who would object to such an outcome and call for state intervention or sueing of neighbours when no rights were infringed and only market forces were at work. In a free banking world, people’s savings are safe from inflation when they keep them in gold or in 100%-reserve deposits, because only FR notes are affected. And nobody is forced to use FR notes. People weigh costs and benefits from using that or that kind of banking, saving and investment opportunities, using their own reason, preferences and acting on their behalf. That’s the main point.
I hope this finally resolves this interesting issue once and for all.
Fine; but you miss the most important point of my argument: that FRB has the same effect as any other inflationary measure: some people receive the money before prices have risen; others receive it only after prices have risen. The first receivers of a fractional loan stand to gain; those who do not receive those loans stand to lose. This is a fraud perpetrated on the second of these groups.
The answer to all the objections is the same: free trade means free trade. What Kel and those on his side ignore is the free consent of the person accepting a check. Even today, with loads of government intervention, people don’t equate a check with cash. In a laissez-faire society, accepting not only a private bank’s banknotes but their checks would be require exercising judgment.
That takes care of the automobile/TV example.
I find, uh, strained the idea that someone would have to be versed in Austrian economics in order to be leery of a check on “Joe’s Bank.” There seems to be a premise among the opponents of fractional reserve banking that disaster looms when we “allow” people to act on their own judgment.
But that’s exactly what I wrote - that the opponents of FRB should not treat people receiving FR notes as idiots, but as responsible consenting adults. I for that matter have no problems with FRB operating in a free-market, as long as FR banks don’t disguise their notes or checks as having 100% backing - and that’s a role for courts to uphold. Granted that, I don’t see any rights violation and agree with Yaron.
It’s hard to imagine a rights-respecting, stable FRB system in a current regime rife with government intervention, legal tender laws and a central bank - and I think this is the reason for the hostility of many free-marketers to FRB in general. They fear that a wanton inflation of FR notes would occur and their savings would be eaten up - just like it happens today. But in a free-market society with no legal tender laws, competition between currencies makes sure that fully-backed notes and money proper retains its purchasing power, therefore people uninvolved with FR notes are not affected by any of its supposed ill-effects.
Historical record of fractional-reserve banking within commodity-money standard is not very good, but we must take into consideration the behaviour of courts and government intervention, granting bank holidays and practically legal immunity from the wrath of depositors, which created again and again perverse incentives for the bankers, while dumbing down the public with implicit promises that government-sanctioned activities may be trusted. In a truly limited-government environment such course of things obviously can’t happen.
FRB counterfeiting allows and encourages excessive investment in producers goods because of their greater sensitivity to interest rates. This causes the “business” cycle. The business cycle encourages govt counterfeiting and thus spending and/or lending to maintain (political) demand to delay or lessen the bust. Even in capitalism, FRB’s destructive economic effect will cause political pressure to delay or lessen the bust, as we see today. This is a dangerous, continuous pressure, even in capitalism, and it happened in the past when there was less economic statism. The Fed was created to maintain the booms created by FRB. Statists want “flexibility” to hide the destructiveness of inflation.
The Bank of Amsterdam was full reserve and profitable from 1609 until the late 1800’s. Then it adopted FRB and was bankrupted. Most banks in history were FRB and most, I believe, failed. These are more than coincidences. Rome outlawed FRB.
Anonymous apparently neither listened to Yaron nor read any of these comments. What kind of “counterfeiter” tells his trading partners just what his money is and represents?
Listen up anti-FRBers: what if every bank made each depositor, on opening his account, sign a waiver saying he realizes the arrangement and consents to taking the risk? And then what if every check printed by such banks carried notice: “This check is on an account in a fractional reserve bank; in accepting it in payment, you assume the risks involved.” Or whatever language you want—flashing neon signs above the banks maybe? WHAT THEN? Where’s your fraud, your counterfeiting, your double claims on the same asset?
So what are the anti-FRBers left with, given that this completely ends their claims of fraud? They are left with their ANTI-CAPITALIST economics: the claim that they know better than the market—that they can see that fractional reserve banking is dangerous but those in the market—bankers and their clients—cannot. If they actually accept capitalism, and if they grant there’s no force or fraud, they must take the position: let the market sort it out.
Fractional Reserve banking existed and functioned here in the free banking periods of the 19th century. End of story.
Excuse my shortness of temper, but I have been answering the same benighted anti-FRB arguments for some 40 years now.
Even with flashing neon and car alarm audio, FRB paper still lacks commodity backing. When the depositor uses his deposit of commodities or commodity-backed money to buy something, the FRB borrower can only “buy” someone else’s production with a certificate representing nothing. Warnings on FRB paper, etc. would decrease takers but there remains the serious potential of someone learning a subtle, perhaps very indirect, method of defrauding w/them.
Sophisticated fraud exists, eg, Bernie Madoff, and govt is obligated to identify and stop it for unsophisticated potential and actual victims. I suppose that if fraud warnings were 100% effective, outlawing FRB would be superfluous. Mises would not accept FRB paper but Brook would, thus even those with a sophisticated understanding of capitalism can disagree here, highlighting the problem.
Anti-FRB is not anti-capitalist since its part of the limit of capitalism, ie, the claim begs the question. If FRB paper, despite pervasive warnings, is used to “buy” things, investors will be motivated to produce more of those things even tho there has been no savings increase for increased production. Thus malinvestment, misallocated resources and the boom-bust cycle. And govt motives to continue the boom for political supporters. And the encouragement of altruism to stop, decrease or delay the pain of the necessarily resulting bust.
Jesus Huerta de Soto’s _Money, Bank Credit and Economic Cycles_ is an excellent and very interesting, historical and theoretical study.
If someone offers me counterfeit money and I accept it, not knowing that it is counterfeit, I am of course defrauded. But if the counterfeiter is open about it and tells me it is counterfeit, why should I accept it? But say I accept it: what will I do next? I will buy something for the money. But if I tell the seller the money is counterfeit, the seller won’t accept it. So I will have to pretend the money is real. The seller is defrauded; and I am an accomplice to the fraud initiated by the original counterfeiter.
Now, fractional reserve money is only partly counterfeit, since part of it is backed by gold (or silver) and part of it is not. But my weird example above is still applicable.
Remembering that money is a medium of exchange so there has to be something to exchange (ie goods produced), using money not 100% backed means consuming more than you are producing, which is fundamentally dishonest.
So it’s not whether or not everyone is made aware of the nature of FRB money that makes it counterfeit and hence fraudulent - it is counterfeit because it is not 100% backed by goods. And it’s from the same pool of finite goods that those using FRB money are consuming as those who use 100% backed.
And so it is violating the rights of those holding 100% backed money as they are suffering a reduced supply (hence higher price) of goods been consumed by those who have not traded anything for them.
Hence I would with all due respect disagree and argue that FRB is indeed fraud.
>And so it is violating the rights of those holding 100% backed money as they are suffering a reduced supply (hence higher price) of goods been consumed by those who have not traded anything for them.
Agreed. Try doing FRB w/barter. Farmer Smith has 100 cows. If he sells 101 cows, the farmer who ends up with that extra one cow is going to have a difficult time milking it. And consumers will have a difficult time drinking it. Its very sad. I think FRB should be set aside for production. If I’m promised a cow, I want to be able to milk it. And, of course, with some chocolate liquer and some vodka, drink it in a toast to good times. You cannot toast to an FRB White Russian. Or, as the Dude would say, a Caucasian.
> I will buy something for the money. But if I tell the seller the money is counterfeit, the seller won’t accept it.
You accepted it, maybe on the bigger fool theory. Deck chairs on the Titanic.
The parts thats counterfeit is the, growing, problem.
A money economy must identify, in its prices, the relative value of the things offered on the market. FRB hides those relative prices, making economic calculation (see Mises, _Human Action_) difficult, if not impossible.
These claims within a context of counterfeit money and bank notes and other money substitutes are aiming at straw men. There is no requirement for these substitutes, ignoring for the moment that our economy is moving away from cash. When the FRB lends it could just as easily hand out the gold it is lending. We could have an economy with no money substitutes and fractional reserve banking. It would be inconvenient, but it would destroy every claim of fraud. It also means that each criticism ignoring the gold only economy is an attempt to not think in fundamentals. It means that they do not recognize that when rights are protected and people act in their own interest whatever results is objectively good. Yes, there is trial and error, yes, people would have to learn what good banking practices are. But continuing to argue after the morality has been established, in an objective ethics, is to reveal that you don’t think that reality and morality are consistent or that the moral is the practical.
>We could have an economy with no money substitutes and fractional reserve banking.
FRB is counterfeit money substitutes.
Mr. Grossman, I suggest that you go back and look at the other things that Mises has to say about prices. Money, gold used as the medium of exchange, represents a claim upon products in the economy. As Dr. Brook mentioned, a lot of gold is sitting in accounts at any one point of time. It isn’t actually buying anything. At various points in time, the demand for savings, meaning the actual goods saved, that the gold saved represents, is changing. As Mises says elsewhere, individual prices change for a host of reasons and such changes don’t mean much. If the money does just sit, the demand for the saved goods will be less, and the prices will fall. If the money is loaned to businessmen who wish to create productive enterprises or expand, the demand will increase and the prices will, too. But, the businessman who calculates that his investment will earn the profit necessary to pay the higher capital costs and the interest rate on the loan, will need to have a strong business.
Someone above argued that there would be inflation with FRB. Actually, that is false. Inflation is only possible when there is a steady increase in the money supply. In the case in laissez faire FR banking there is no steady increase in the money supply. The money supply is on a tether which is tied to the actual amount of gold in the economy. It can expand at times and shrink at times, relating to the skill of the bankers and the demand for capital. It can’t go on expanding.
These things are not too difficult to figure out once you realize that FRB is moral and does not necessarily involve fraud. If it seems to you that there is a practical problem, that based upon your understanding it can’t work, it is your understanding that is in error, not reality or morality. Then it is only a matter of looking to see where you are making a mistake.
>gold is sitting in accounts at any one point of time. It isn’t actually buying anything. At various points in time, the demand for savings, meaning the actual goods saved, that the gold saved represents, is changing.
Theres no necessary relation between unused savings and counterfeit saving. They may chance to balance or not for an arbitrary time. Counterfeit savings can, grow arbitrarily and has historically. The FRB distortion remains.
>The money supply is on a tether which is tied to the actual amount of gold in the economy. It can expand at times and shrink at times, relating to the skill of the bankers and the demand for capital. It can’t go on expanding.
The economic demand for capital is from supply. The political demand for capital is based on force. The Fed’s “balance sheet” can expand at the touch of a computer keyboard.
The ex-chair of the local economics dept, a specialist in the history of theory, recently told me that mainstream economists have no confidence in the conventional explanations of our economic problems. I had mentioned Bernanke’s recent speech on C-Span, filled with hemming and hawing and hesitation. This is an opportunity for Objectivists and Austrians. Krugman, who formerly evaded Austrian theory, has several times recently discussed it.
Even El Presidente is campaigning under the slogan, “an economy that’s built to last,” almost as if he rejects the Pragmatist/Keynsian short run. Sure, in the short run he rejects the short run. Didnt Augustine ask God for just one more drink or hooker or something?
>Inflation is only possible when there is a steady increase in the money supply.
Inflation is any increase in counterfeit money and counterfeit credit, steady or unsteady, as in history.
Thank you Dr Binswanger for posting your excellent comments. Opposition to FRB really is a thinly diguised opposition to liberty in finance. One cannot rationally claim to support capitalism while criticizing FRB.
Subjective liberty.