Honest Free Banking requires that:

- 100% Reserve Banks are able to label Notes and Demand Deposits.
- Fractional Banks must instead label and disclosure “Promises of Payment with a minimum x% reserve policy”.

And so Fractional Reserve Banks “Promises of Payment ” would trade at discount against Notes.

And this would mean that good money (100% reserve notes or demand deposits) would drive out bad money.

But I think that even in a 100% reserve banking system, Mismatching between time deposits and assets of the bank would be an honest business decision but would also require some order of Reserves to cover the risk of the mismatching (time deposits expiration turning into demand deposits which requires immediately 100% reserve in balance).

For this, I usually say that a 100% Reserve Banking requires >100% of Reserves.

I think that Block’s and Barnett’s here is much more tenable than that of critics. Baggus and Howden concede that maturity mismatching can create the same effects as emission of fiduciary media, which they consider illicit. Now, that means that ABCT can emerge both through economic miscalculation brought about by fraudulent multiplication of the property titles and by some unexplicable “market failure”.

Block and Barnett, in my view correctly, point out that maturity mismatching per se, represents the fraudulent multiplication of the property titles. Even more important, as B and H themselves concede, the effects of maturity mismatching of time deposits on economic calculation are exactly the same as the effects of using the demand deposits for creating loans.

Therefore, in my view you can have either the ABCT that includes Mises’s regression theorem, or the legality of maturity mismatching. You cannot have them both in the same time.

While I haven’t read the Bagus & Howden bit, it seems like they are talking about buying a 3 month time deposit (loaning money to the bank for 3 months), but not coming to claim it for 4 months (when the bank actually has the money).

This is de facto matching even if nominally mis-matching.

TGGP

Fractional Reserve “promises of payment” (equivalent to notes and demand deposits buy labeled as “promises”) would trade at discount by arbitrage. One thing very important is that there should be no restriction for owning and exchanging as legal tender physical gold and silver coins and bars.

So, why would I deposit 10 gold coins in a fractional reserve bank receiving a “promise of payment” (stating a policy of a minimum 25% reserve) instead of going to a 100% Reserve Bank and receiving a “note”?

Imagine also that I would go to a Fractional Reserve Bank to get a loan that would constitute a credit expansion by expanding the “promises of payment” that I would use to buy at par “notes” from a 100% Reserve Bank. Or even worse, imagine that the fractional reserve bank itself would create “promises of payment” (that some people as you day would be happy to exchange at par) and simply buy gold coins at par. Would this make any sense?

TGGP

“Carlos, you are talking about what “would” happen. We don’t have to guess about hypotheticals, we can look at the actual history of free banking to see what happened.”

History tell us that (Rothbard) “money-brokers” that tried to arbitrage discount fractional reserve notes of distresses banks buying them at discount and requiring delivery of physical gold or silver were more or less forbidden directly or indirectly of doing it. But discounts did happen.

History tells us the contractual analysis innocently or conveniently was deficient. The traditional banking secrecy served the cause for the general public to not realize the money expansion feature. Even today with so much consumer protection never we see a proposal for real time disclosure of reserve of banks or for instance the banks identities involved in central banks injections or loans.

The fungible feature at par it’s a requirement for bad money to drive out good money but that it´s only possible if the system provides anonymous money creation and circulation, making the appearance of bad money (today would be the demand deposits in riskier banks) being the same as good money (demand deposits in less riskier banks).

This crisis established finally in the minds of public, that every single demand deposit is equal to another because it will be always guaranteed in full by states and central banks.

“Because the fractional reserve bank pays interest while the 100% reserve bank requires you to pay them a warehousing fee.”

Correction: Pays interest in the form of more “promises of payment” of gold.

Credit in the form of “promises of payment” would be contractually different form credit in the form of 100% Reserve Notes. Certainly the person that makes a loan in physical gold wants to receive an interest and nominal in physical gold or will ask a premium for a different thing.

I can imagine contracts that could be delivered in bonds not money, but that does not make “Bond” a form of money, because bonds are settled has promises of money.

“This would inhibit the willingness of the fractional bank to issue too many promises.”

And this would be the process of good money driving out bad money. Physical gold and 100% reserve notes and demand deposits would be the money against all other quasi monies would be priced against.

Promises of payment would carry an additional risk that must be priced and which carry a cost of gathering information.

Both of these papers talk past each other to some degree and fail to explicitly address the central issue.

Both papers agree that fractional reserve banking is illigitimate due to the nature of depository contracts. A depository contract does not convey title. It implies that the bank is conducting a safekeeping operation for the depositor. This is just as true for time deposits as for demand deposits.

For example, if banks truly acted like “depositories” we might imagine a scenario in which, for the purpose of offering a lower price for depository services, a bank declares that it will make funds available for access only once per month. So, a merchant might place a quantity of gold on deposit with the understanding that his access to the gold would be restricted for the period of one month. This would not imply the bank’s right to “use” the gold in any way during the month. The implication is that it is merely stored and safekept during that period.

In a true 100% reserve system, the “depository function” would merely be less expensive for time deposits than for demand deposits because the number of personnel needed to meet the comparatively limited withdrawal requirements of time depositors would be lower.

The issue of mismatching loan maturities is an entirely different matter because we are dealing with loans rather than deposits.

In contrast to a deposit contract, a loan contract does exchange the title for one good for the promise of another good at some point in the future. However, it is important to realize that a loan contract could also be construed to be fraudulent at the time that the loan is made if the borrower does not already have the “interest” in hand to pay the lender at maturity. The reason it is not considered fraudulent is because of the implicit understanding that repayment of loans are on a “best efforts” basis and that the lenders funds are “at risk” (whereas, supposedly, the depostors funds are not “at risk”).

If it is legitimate to take out a loan without having 100% certainty about one’s ability to repay the loan, then certainly mismatching of loan maturities is not illigetimate for the same reasons (although this practice might be considered risky).

The confusion comes in when we talk about funding loans with any kind of deposits, even if they are “time deposits.” It is a major mistake to believe that lending any kind of deposit is ever permissible, unless the depository contract specifies that such activity is permitted, in which case, nomenclature not withstanding, the “deposit” is no longer a “deposit” and becomes instead a “loan” with the implicit understanding that the “depositor’s funds” are “at risk.”

Facts:

1-There were discounts between private notes (not homogenous money).
2-There were arbitragers between notes and the delivery of specimen (and redeem of notes were suspended to protect fractional notes when most required).
3-Strangely there was not notes labeled has 100% reserve ones.

I think we can conclude that:

All banks practiced profitable fractional reserves
The jurisprudence and the economic profession did not make the distinction and so did not required proper labeling (“promises of payment” versus true “Notes” or Demand Deposits” or “Receipts”). Conveniently we could add.

In bad time (busts), contracts were not enforced and redeem of notes (actually just “promises”) was suspended.

And so “bad money” was able to drives out “good money” in the sense that never a full condition of free banking with honest competition and labeling was set. But if this happens it will be good money that will drive out bad money.

David Hillary “A note is a promise to pay, by definition!”

If it is the case it is my English and I apologize. By “note” I was meaning the pure warehouse receipt which could be labeled as such.

If a note is a promise of payment without 100% reserves it should state that clearly (maybe including a minimum reserve policy). The not so clear status of such notes including the jurisprudence and regulations (and economic analysis from who should no better) not enforcing a distinction is what drives out good money (100%reserves).

Now, you are free to exchange “promises” at par with “receipts” at your own risk. But then an arbitrager could sell short (promises) at par and buy the asset (receipts) at par and wait till some crises of confidence happens.

But discounts are a fact of history, like discount in debts are common, because discount is a price of risk.

Receipts that carry a cost for warehousing could have a small discount too depending of the particular method of charging but that wouldn’t constitute a discount of risk.

Comparing two alternatives:

Action 1: I have receipts of gold that costs me money but I lend them in “short-time money-market” (or a time deposit in a 100% reserve bank) receiving an interest in more receipts.

Action2. I own fractional reserve “promises” if the form of demand deposit (of “promises”) and receive an interest (in more “promises”, not physical gold or receipts) from the average balance as banks do today.

We are still talking about two different economic assets. The story of supposed free banking is one were bad economic and law analysis benefit the fractional banking which drives out good money, because there is the appearance of homogeneous money.

Carlos,

The regular name for documents of title to bailed goods is called a ‘warehouse receipt.’ In the case of documents of title to goods being shipped, the name is ‘bill of lading.’ The term note or promissory note is not used for these documents, instead a note or promissory note is used for documenting debts in the form of negotiable instruments. Such instruments require:
1. an unconditional promise to pay a sum of money
2. in writing
3. signed by the maker (issuer).

The right to payment runs with possession of the note, and the note can be payable to bearer or to a named payee, and may be payable on demand (like a bank note) or at a specified future date.

As far as I know there are no markets for shorting demand debt. If any holder of a demand debt, whether in the form of a balance on current account or a note, can redeem the debt if he no longer wishes to hold his wealth in that form.

Under historical and present cases of banking demand debts, where the bank has not suspended payment of its debts, claims on banks are accepted and redeemed at par through the payment clearing systems operated by the banks (as well as paid out in cash at par on demand). Do balances with Citibank (a bank that fails in pretty much every recession) trade at a discount to balances with the Bank of America (perhaps an example of a stronger bank)? No, customers of Citibank still buy goods with their point of sale cards for the same prices as customers of Bank of America do with their point of sale cards. Many merchants even accept cheques (checks) drawn by customers they know at par, even though such instruments are the liability of only ordinary people and their bank does not stand behind the claim at all! Discounts apply to future dated claims, not demand claims. Demand claims are typically accepted at par, or rejected. Tender of a cheque in payment of a debt is conditional satisfaction of the full amount of the cheque (the condition being a condition subsequent: that the cheque will be paid upon proper presentation). So, if demand debts of ordinary people don’t trade at a discount (although they are less widely accepted), why would bank notes issued by banks in reasonable financial condition trade at a discount?

In drawing a cheque one is NOT engaging to or obliged to hold any balances in one’s account to pay the cheque with (whether 100% or fractional), as can be seen from negotiable instrument law that states that bills of exchange (cheques) do not operate as an assignment of funds held with the drawee (the bank). In drawing a cheque, one is representing that one has an account with the drawee (the bank), that the cheque will be met upon proper presentation to the drawee for payment. In the same way the issuer of a bank note is not engaging to or obliged to hold any particular assets in reserve, and therefore has no reason to disclose anything about its assets. The promissory note is only a promise to pay upon proper presentation for payment, nothing more and nothing less.

The law had never restricted 100% reserve banking. If the banks wants to covenant itself to hold 100% reserves it can pledge its reserves as security for its notes and demand deposits, and covenant to hold 100% reserves, and appoint a trustee to hold the security and supervise the bank’s compliance with its covenant, and in case of breach it can require the bank to remedy the breach or appoint a receiver to take possession of the reserves and use them to satisfy the secured debts. Such notes would contain not only a promise to pay, but a promise to hold 100% reserves, and a pledge of such reserves as security for the notes. So it is the 100% reserve notes that should have the additional disclosures and undertakings, not the fractional reserve ones.

it seems as if a lack of truth exists with the account.

if a balance exits…i would think it has to apply to something.

if a balance means not that your money actually rests on a bank property somewhere and is tied up in a purchased asset (in someones elses hands not part of the bank) that the banks hope they can sell to meet a check then it sort of seems to destroy the meaning of the word.

to the extent that people are harmed by the ill and disease that i have seen inflation described as i am still not sure.

the law stuff seems a bit longwinded and ahrd to understand to me and i am not sure if it actually describes reality or a state of mind conducive to politicians and their ilk.
i will look into it further elsewhere.

thanks

Nikolaj,

On January 7, 2010 at 2:11 pm you wrote:

“I think that Block’s and Barnett’s here is much more tenable than that of critics. Bagus and Howden concede that maturity mismatching can create the same effects as emission of fiduciary media, which they consider illicit. Now, that means that ABCT can emerge both through economic miscalculation brought about by fraudulent multiplication of the property titles and by some unexplicable “market failure”.”

You have a good point. B&H indeed seem to wanting to eat cake and have it too, by claiming both that MM is legitimate and yet also capable of creating clusters of errors, or business cycles. Certainly that which is voluntary, and non-fraudulent must be considered also economically optimal as well, as we can only analyze economic decisions from the ex ante perspective, as I believe MNR has pointed out before.

But before we conclude therefore that MM is fraudulent, despite B&H’s pretty good defense of the proposition that it is not fraudulent, perhaps we could consider the validity of the assertion that such a practice is capable of creating business cycles in the first place. A careful study of that suggestion will, i think, lead us to conclude that it cannot possibly create business cycles.

“Block and Barnett, in my view correctly, point out that maturity mismatching per se, represents the fraudulent multiplication of the property titles.”

But this is impossible. It is just as B&H observe: Loan contracts transfer ownership and title of the funds in question from the lender to the borrower for the duration of the loan. Only at the end of the term, does title to that money (the tantundem), plus interest transfer back to the lender. There is never any duplication of title. Money title goes from lender to borrower to lender again, in an orderly and logical fashion, as all proper loan contracts do and must.

“Even more important, as B and H themselves concede, the effects of maturity mismatching of time deposits on economic calculation are exactly the same as the effects of using the demand deposits for creating loans.”

I think this is false. Let’s see why: firstly we can clearly see why in a free market there would be profits to be made in the entrepreneurial undertaking of arbitrage between the otherwise higher interest rates available to long-term lenders, and the lower rates available to short-term borrowers. This obviously provides profit to the middle-man/speculator, lowers costs to the long-term lender by increasing the supply of long-term loans, and increases the profit to the short-term lender by increasing the demand for short-term loans. It also transfers risk to those prepared to invest in an equity position in such a firm, and away from those who who wish to avoid it. This is a win-win-win-win situation. There is of course entrepreneurial uncertainty in such an undertaking, but failures would be isolated as all entrepreneurial failure is, to the individual investors in the firm. This cannot generate a business cycle, but rather a minor transfer of capital to other who may direct it more profitably.

As we learn in no uncertain terms from Professor Hulsmann, in his “Toward a General Theory of Error Cycles”, error clusters are possible if and only if state intervention is present to create mass illusion in the minds of market participants. No non-aggressive, non-fraudulent free market activity such as MM is capable of creating clusters of errors.

“Therefore, in my view you can have either the ABCT that includes Mises’s regression theorem, or the legality of maturity mismatching. You cannot have them both in the same time.”

I agree. I think it is not possible that MM can produce business cycles because it is in fact non-fraudulent and is not capable of creating duplicate money title, in contrast with FRB.

Nicolás Cachanosky has written a response to Barnett-Block and Bagus-Howden in the Journal of Business Ethics.
http://puntodevistaeconomico.wordpress.com/2011/11/03/nuevo-articulo-de-nicolas-cachanosky-en-el-journal-of-business-ethics/