Bring Back the Bank Run!
Is the banking dilemma eternal? It doesn't have to be, writes James Grant. We could desocialize credit risk and let the bank runs take their toll. Absent federal meddling, the bottom line would be simplicity itself. The proof that banks have created excess credit would be found in the action of markets. It would be a fascinating picture if not a pretty one. FULL ARTICLE
Comments (97)
greg
I have been reviewing this site for months and this is the first article that has established a path or solution for part of our current economic problems. However, if you took this solution to Congress or the American public, it would not be taken seriously. Maybe if you would provide your best estimate of the cost to society for the runs and then your estimate of the benefits.
The public tends to respond to how a policy will work and less to the theory. This is why Keynes' approach is used, it gives politicians a platform to bring their policies to the public. The problem of course is that Keynes' approach is incorrect, but you give the public the statistics and multipliers, it sounds good to them.
So, if you want to change the system, give us the theory and then some meat on how it will work through the system.
Published: March 4, 2009 9:19 AM
Bruce Koerber
Destiny of America
Wednesday, March 4, 2009
It May Be Time To Save The Constitutional Republic!
The unConstitutional coup will continue to use its media minions to try to polarize Ron Paul.
But there is nothing that can pull Ron Paul from the central issue of the Federal Reserve - which is the heart of the unConstitutional coup. Now it is easy to see why they want to pull him away. The heart of this beast is beating irregularly and it will not be able to withstand the stress of an audit!
The unConstitutional coup is desperate! There is momentum in Congress for the audit of the Federal Reserve! Their bimbo, Bernanke, will have to resign if there is an audit because someone will have to take the blame and then gold will obviously be ready and able to fill the void created by a floundering central bank. This will potentially cascade into a total rejection of the fiat dollar.
Then the unConstitutional coup will be have to come out from hiding and expose itself as an unConstitutional coup! Get ready Americans to save your Constitutional Republic!
Published: March 4, 2009 9:33 AM
Matt
"Bring Back the Bank Run!"
The logic James Grant puts forth is sound.
The public for the most part is oblivious of how the Federal Reserve and Fractional Reserve Banking works and I believe the educational systems encourage this ignorance deliberately to the extent possible in an open society.
It must be remembered though that the Federal Reserve was created by the consent of the Congress for a purpose to facilitate deficit spending in lieu of direct taxation. This is very evident when viewing the national debt. The banks of course have greatly benefitted (up until now) by being able to makes loans (and risks) way above deposits.
This system will stay in place come hell or high water. Most likely down the road we will have Hyper- Inflation and then in the longer run we today are all dead and let the future take care of itself.
At the core this type of activity is Theft that is only possible by the Theological Philosophy of Self-Sacrifice that drives the system.
Published: March 4, 2009 10:20 AM
Sean
Wasn't there a multi-trillion dollar electronic run on the money markets in September? I'm new to all this, so I'm not sure if this is analogous to the old fashion bank run or not, but it seems to be. Is the question now, where is that money going? Back into the system for another massive run or into the safe haven of the gold market?
Published: March 4, 2009 11:21 AM
Mike Sproul
James Grant:
If a bank has issued 100 checking account dollars, but its assets add up to only $99, then customers will run on the bank, hoping not to be last in line. The bank could avoid the run by (1) devaluing its checking account dollars to be worth only $.99 green paper dollars, (2) suspending convertibility of its checking account dollars into green paper dollars, in which case speculators will value those checking account dollars at $.99, (3) get a $1 bailout, to restore assets to $100.
Option (3) requires theft of other people's money. Options (1) and (2) simply cause the checking account dollar to be valued correctly. Bankers, left on their own, will choose (1) or (2), and so will their customers. A bank run is an inferior option to devaluation or suspension.
Published: March 4, 2009 11:27 AM
Joe Stoutenburg
greg:
I appreciate your request, and maybe someone could take it up (I'm not a professional economist, just a reader, so I won't volunteer). In the abstract though, I think that Austrian methodology would not work in the cost/benefit analysis framework that you request. Austrian economics seems to shy away from things that may only be dubiously quantified. Rather, its strength is in the consistency of it descriptive theories.
Rather than inventing something akin to Keynesian statistics and multipliers (which, I believe, would be arbitrary and flawed), I think that we just need to whittle away at misconceptions. On the subject of bank runs, I reduce it to this: Bank runs have not been averted. They have only been delayed. Because they have not been able to happen on local levels, instability builds until it reaches system wide level. Arguably, that is where we are now.
In order to be useful, money must be an accurate portrayal of the wealth in society. Bank runs are society's way of challenging a currency. [Notably, even a 100% gold reserve bank (as espoused by many mises readers) would be subject to runs if the public became convinced that it was printing notes for which it had no gold.] You speak of the "cost" of bank runs. In this respect, I disagree. They are actually beneficial to society [though of course, the harm to individuals (like a person with life savings in Enron) should be recognized and mitigated through free market means].
The Austrian solution would be to simply return the provision of money to the market. Rather than criticize fractional reserve banking (though it is worthy of criticism), I think that the central critique of U.S. currency should be that it is a coercive monopoly. Taking that view, the analysis of monopolies in many schools (not just Austrian) might be illuminating.
Lastly, on the matter of convincing Congress, we must be aware that it may not be just an intellectual matter. Besides Ron Paul (who as an Austrian is quite vocal on the subject) I don't know what members of congress know about banking. Regardless of their knowledge, they have little incentive to abolish their monopoly over money. Its control grants them a great deal of influence, power and wealth.
Members of Congress may be guilty only of selective ignorance. Or they may be fully informed and consciously conspiring to maintain an institution that benefits them. Either way, we should not count on them to adopt this message. Free market money is only likely in any meaningful and lasting way if it is demanded by the public.
Published: March 4, 2009 11:55 AM
Bruce Koerber
Money and Ethics
Wednesday, March 4, 2009
Theft of $2.3 Trillion Dollars Makes Some People Mad!
I sensed a very real anger and frustration and disgust by Senator Sanders. By the end of the conversation with the duplicitous Bernanke, if Senator Sanders would have just been sitting across a table from him it may have been an ugly scene: with Sanders grabbing Bernanke by the throat and shaking him until he coughed up the names of the secret recipients of the 2.3 trillion dollars of taxpayers' money!
If Bernanke has a suicidal tendency or if the unConstitutional coup thinks it is time for him go away quietly someone should keep an extra attentive eye on him over the next couple of weeks!
Published: March 4, 2009 12:08 PM
Joe Stoutenburg
An additional comment to Mike Sproul's post:
A banking free market would, by definition, not allow (3). The other two options would indeed be available. However, if competition were allowed, I think that we would find that a bank that too frequently or heavily devalued its currency would soon be pressed out of business.
This goes along with a theme that I have been presenting for awhile. Indeed, Mike is largely responsible for my adoption of this theme. It is to not oppose fractional reserve banking per se. Rather, we should oppose the government monopoly of money.
Moreover, in general we should oppose theft of any kind. In addition to a government sponsored bailout, the very backing of the dollar is the result of theft. It is the act of issuing government bonds that we should oppose. The bonds promise (in theory if not in practice) to expropriate wealth from the public in the form of taxes. Once issued, some of them find their way onto the Federal Reserve balance sheet in exchange for new money.
Contrary to the common refrain here, fractional reserve money does not appear out of thin air. It is the bonds that appear out of thin air. A free market in banking might enter a legitimately issued bond as backing for currency. Such backing would get quite a different response from me than does the arrangement done at the Fed.
Published: March 4, 2009 12:08 PM
Jardinero1
I am not sure that you could have a bank run in this era of electronic debit and credits. Most people use banks to put cash in. They rarely take cash out. When they want it back, they request a check or a wire transfer to another institution.
If your bank were failing today would you run over there and demand cash? Or would you log on and transfer it electronically to another still solvent bank? Most sheeple would have a high degree of faith that the fed would guarantee their electronic transfer.
Published: March 4, 2009 12:13 PM
Eric
Jardinero1,
Rothbard has written that it is not necessarily a run by depositors that is a bank's fear, but it is when other banks come to collect from deposited checks on the bad banks.
So, with a FED, the banks are protected from bank runs from other banks.
From "What has government done to our money":
"In a free-banking system , inflation by any one bank would soon lead to demands for redemption by the other banks, since the clientele of any one bank is severely limited. But the central Bank, by pumping reserves into all the banks, can make sure that they can all expand together, and at a uniform rate. If all banks are expanding, then there is no redemption problem of one bank upon another, and each bank finds bank expansion of one bank upon another, and each bank finds that its clientele is really the whole country. In short, the limits on bank expansion are immeasurably widened, from the clientele of each bank to that of the whole banking system. Of course, this means that no bank can expand further than the Central Bank desires.
Thus, the government has finally achieved the power to control and direct the inflation of the banking system."
Published: March 4, 2009 1:23 PM
ProudCapitalist
RE: Greg
>>"However, if you took this solution to Congress or the American public, it would not be taken seriously."
Well, if you're right, then I feel sorry for "the people" and their "congress". Because "this solution" is the true one and the only one which could save them from famine and widespread death.
Further, a "theory" is per definition a representation of reality. So if you try to claim that there is something wrong with "this theory", then please prove it, or suffer from the real consequences of your denial of the existance of nature!
"Seriously" all hell is falling down on right now. Only unserioulsy could we fantasize about a God (or "state" as that same chimera phenomena is now a days called) will emerge ex machina and just create everything which everyone whishes. If I remember it correctly, from the forced lessons of attempted religious indoctrination to obey any (real or imagined) authority in my youth, then even from the very beginnings of the concept, the very premise for that happening was that EVERYONE MUST DIE!
Published: March 4, 2009 4:56 PM
Mike Sproul
Joe Stoutenberg:
Suppose a landowner collects rents from his tenants, and let the rents be stated in ounces of silver. When the landowner buys groceries, he pays with his own paper IOU's--call them guilders, which he accepts as rent payments at the rate of 1 oz./guilder. These guilders might circulate as money. Local bankers might issue checking account guilders, each of which promises to deliver a paper guilder on demand, and those checking account guilders might be issued on fractional reserve principles.
Change 'landowner' to 'government' and 'rent' to 'taxes' and you have a reasonable description of our modern money system. As long as the landowner got his land by reasonable means, you wouldn't begrudge him his rents. Wouldn't you grant the same concession to a government? And if so, would you begrudge the landowner or the government for borrowing? If some of the IOU's generated by this borrowing ended up backing the local money, what's wrong with that?
If monopoly is involved it's a different story, but everything I've described could happen in a free, non-monopolistic world.
Published: March 4, 2009 8:53 PM
Gerry Flaychy
We can say the same thing of the money lent to the bank by their customers: none of this money is in the bank vault, 0%, but is out on loan or invested in the money market or in mortgage-backed securities.If this money doesn't come back to the bank because the borrowers cannot pay their loans back, for whatever reason, or the investment of the bank in the money market or in the mortgages lost much of its value, then the bank could be in trouble, even if the bank is obliged to keep a 100% reserve on its demand deposits.
It is not necessary a question of excess credit due to fractional reserve banking.
Published: March 4, 2009 9:42 PM
pbergn
The author correctly identifies the root cause of problems associated with fractional-reserve banking: it is the socialization of the risk that is wrong, and not the existence of fractional-reserve banking in itself...
There is nothing wrong with the banks keeping only a certain percentage of total deposits, and investing the rest. The market will eventually punish more risk tolerant, or reward the smarter investors. It is up to the depositors to decide whether to use a certain bank.
In fact, a non-fractional-reserve banking is an oxymoron, since the banks will not have anything to invest if they were to be required to keep 100% of the deposited assets at any time, and would simply become dumb safe deposit boxes - nothing more, nothing less...
Published: March 4, 2009 10:29 PM
Eric
Gerry,
True, in a 100% reserve banking system, the bank could still lose money on its own lending if a borrower doesn't repay. But that is simply a business loss that should be offset by other business profits and proceeds from collateral sold on bad loans.
If they fear too many defaults, then they would need to increase the difference between the interest on time deposits and loans so they would be assured of having money on hand to pay off time deposits when they come due.
If the bank loses so much that it can no longer repay a time deposit when it comes due, then the bank would be insolvent, just like any other business that couldn't pay its debts on time. In this case, the bank would need to do what any other company would do, either borrow some money to stay afloat or go bankrupt.
But it is also true that NO business is completely 100% safe from losing money, and no depositor should believe his money is 100% safe either. If a depositor wants 100% safety, then he needs to pay a warehouse fee for safe keeping instead of collecting interest on a loan. If the bank still goes under, then depositors would split the proceeds from liquidating the bank - same as with any other business with creditors.
So, why does current law allow bankers to cheat? It's because they bought off a lot of lawmakers in the 19th and early 20th century.
Published: March 4, 2009 10:48 PM
Peter
If a bank has issued 100 checking account dollars, but its assets add up to only $99, then customers will run on the bank, hoping not to be last in line. The bank could avoid the run by (1) devaluing its checking account dollars to be worth only $.99 green paper dollars,
Thus robbing its depositors,
(2) suspending convertibility of its checking account dollars into green paper dollars, in which case speculators will value those checking account dollars at $.99,
Thus robbing its depositors.
(3) get a $1 bailout, to restore assets to $100.
Thus robbing some third party.
Great solutions.
Published: March 5, 2009 1:11 AM
Peter
[Notably, even a 100% gold reserve bank (as espoused by many mises readers) would be subject to runs if the public became convinced that it was printing notes for which it had no gold.]
Which wouldn't pose a problem if they were wrong in that belief.
Published: March 5, 2009 1:14 AM
Joe Stoutenburg
Mike Sproul:
Your arrangement of 'guilders' is acceptable to me. The only place with which I may take exception could just be semantic. We need not call the arrangement 'fractional reserve'. It seems like silver would be the base money in the arrangement but that other derivative money also exists. A bank may be fully reserved if it has a portion of its deposits in silver and the rest in other assets that may be exchanged for a sufficient amount of silver.
You wrote:
Change 'landowner' to 'government' and 'rent' to 'taxes' and you have a reasonable description of our modern money system. As long as the landowner got his land by reasonable means, you wouldn't begrudge him his rents. Wouldn't you grant the same concession to a government? And if so, would you begrudge the landowner or the government for borrowing? If some of the IOU's generated by this borrowing ended up backing the local money, what's wrong with that?
In order to give credit to your point, I would grant government the same concession if I approved of its ownership claims. However, I believe that the ownership claims of most governments are illegitimate. So I oppose government money for two reasons:
1) It is a coercive monopoly, and
2) the assets that it uses to back its money (bonds repayable by taxation) are, in my opinion, not properly owned by the government.
I agree with you that a free market bank could be backed by IOU's or other assets. Whether the reserves of a bank are homogeneous (such as gold or silver) or composed of multiple assets, the key is to establish free market institutions to monitor and maintain the soundness of its reserves. The threat of bank runs must be an integral part of those institutions.
Published: March 5, 2009 8:23 AM
Joe Stoutenburg
Peter:
Your response to Mike Sproul was to call all three of his solutions theft. I agree that they could amount to such. But allow me pose a sitution to you.
Suppose that you loan me some money for a business venture. My venture fails, and I am unable to repay. Have I robbed you?
Likewise, a bank that devalues its currency may not necessarily be committing overt theft. It may be an honest business failure. Of course, whether the devaluation was premeditated or accidental, a robust market would punish any bank that abused its depositors.
Published: March 5, 2009 8:31 AM
Joe Stoutenburg
I wrote:
[Notably, even a 100% gold reserve bank (as espoused by many mises readers) would be subject to runs if the public became convinced that it was printing notes for which it had no gold.]
To which you responded:
Which wouldn't pose a problem if they were wrong in that belief.
That's right. Likewise, a well reserved bank with multiple forms of assets could withstand a bank run as long as it built provisions into its contracts to allow it to convert its assets into the necessary form. To illustrate, suppose that a bank redeems its notes for silver but holds reserves of IOU's in addition to silver. It places a provision into its notes that it may suspend that redemption.
Now, let's say that a bank run occurs. The bank receives more redemption requests than it can repay in silver. It suspends convertibility while it sells its IOU's in exchange for silver. Doubtless, its notes will begin exchanging in the market for discounts to account for the market view of whether its IOU portfolio is sufficient to cover its claims. However, if the bank manages to raise enough silver, it will have defended the value of its currency. The market price of its notes will rise back up to par, and the bank may resume convertibility.
Alternatively, if the bank is unable to raise the necessary amount of silver, it may come clean to the public and admit that its reserves were inadequate. If the bank devalues its currency to a level at which it can redeem, it will stop the decline in the market value of its notes. Otherwise, the market could continue to discount its notes below the level that the bank could support.
Regardless what the bank does, it will be at a disadvantage to banks that are able to more reliably redeem their currency. The market will punish poorly reserved banks.
Published: March 5, 2009 8:50 AM
Mike Sproul
Joe Stoutenberg:
It sounds like we have reached 99% agreement. Of course we've both left a large gray area about government ownership claims of which we approve or not. I'd like to focus on money, and set aside questions about whether property (private or government) was acquired by legitimate means. So suppose I discover an uninhabited island, subdivide the land, write a constitution, etc. People come to my island, buy my land, and agree to pay me taxes on that land. I then start issuing paper guilders as above, and local banks issue various forms of derivative guilders--like checking account guilders, credit card guilders, etc. Nothing for a libertarian to object to so far, as long as I don't prohibit competing moneys. And there might be many rival moneys--shekels denominated in wheat, issued by wheat farmers, pesos denominated in gold, etc.
Now if I should make some bad business decisions, so that I end up with assets worth only 1000 oz. backing 1100 paper guilders issued by me, then consider the three options mentioned above: (1) maintain convertibility at 1 oz./guilder and face a bank run (2) suspend convertibility and let market forces drive my guilders to .9 oz/guilder, (3) devalue to .9 oz./guilder.
A bank run is clearly the worst of the options, and not really 'necessary' as long as the other options are available.
Published: March 5, 2009 11:02 AM
James R
pbergn:
Non-fractional-reserve banking is NOT an oxymoron.
Requiring 100% reserve banking would merely mean that the banks could not loan out demand deposit funds. Under such a system, rather than checkings and savings accounts paying interest, banks would charge a fee (perhaps fixed, perhaps percentage-based, perhaps transaction-based) to hold the depositor's funds in safekeeping.
However, there would be absolutely nothing to stop banks from creating non-guaranteed, non–demand-deposit–based accounts.
For example, instead of offering certificates of deposit, banks could instead offer certificates of investment (CIs). Banks could offer multiple tiers of CIs with varying risk (of default of repayment), with varying maturities: for higher risk, and longer maturity, the interest rate paid would be higher; for lower risk, and faster maturity, the interest rate paid would be lower.
People understand the difference between storing something for safekeeping (e.g., storing old furniture in a self-store lot) and investing (e.g., buying bonds). 100% reserve banking would merely apply these two concepts to money.
Published: March 5, 2009 11:25 AM
greg
To all that responded to my statement, thank you.
The point I really want to make is if you have a position, you must sell it to the public. And Ron Paul is a good example, he lectures his point and fails to sell it. Every time I see him in committee, his lectures fall on deft ears.
On statistics, people believe they don't lie. And like accounting, people really don't understand the numbers and anyone can make their point using the smoke and mirrors of numbers. The Austrian approach is the right one, put together a marketing plan to sell it to the people that can make a difference.
Published: March 5, 2009 12:12 PM
Joe Stoutenburg
Mike Sproul:
Yes, we are in material agreement of how a free market banking industry might work in theory. I think though that you have been more gray than me about "government ownership claims of which we approve or not." Meaning no disrespect, I think that this is a mistake on your part.
As you may recall, at first I strongly resisted your RBD view. It appeared that you were defending our current banking systems. Even though you have somewhat moderated that view for me, I think that you still come off that way sometimes to people who might not have closely followed your arguments. Meanwhile, the opinion of most people is that government banking is undefendable. Your apparent defense of today's banking is a tall barrier to overcome.
I do think that the government's monopoly on money is undefendable, but not for the reasons often given by people influenced by Austrian economics. Among some of the less informed (Ron Paul supporters come to mind), I have seen a common push to return commodity-backed coinage to the Treasury. To these people, the problem isn't government monopoly. It is that the monopoly is not complete enough (i.e. they want to abolish the Federal Reserve) and that the money is not based upon 100% gold reserves.
I think that this view is a mistake. On the one hand, a stronger link to gold would limit the government's ability to monetize its improper claim on the wealth of the nation. On the other hand, it would still leave a coercive monopoly in place. Going back to times of government gold standards, I believe that we can see a history of manipulation and instable banking. Without banking competition, society only considers monetary alternatives when the system is on the brink of ruin.
So we may offer a simple policy recommendation. Leaving aside for a moment my broader problem with government taxing power, just get government out of banking (or at least allow private competition). Banking need not be 100% gold reserves (though you're free to open such a bank if you wish). It needs only to be truly free.
Published: March 5, 2009 12:24 PM
pbergn
TO: James R
James, I see your point:
What you are advocating for is for banks to be mainly just safe-keeping mechanisms for funds trusted in their possession for a service fee, and optionally offer investment instruments to the more risk-tolerant among their clients... In other words, you are advocating for regulation of what funds the banks are allowed to invest, and which they are supposed just to keep.
I agree with this policy that will eventually become the de facto standard in the banking industry, once the socialization of losses is removed - no one will be willing to take unnecessary risks for the fear of losing the more risk-averse clients.
Published: March 5, 2009 12:33 PM
pbergn
TO: greg
Greg, the problem that you have correctly identified is political in nature: people are NOT dumb, they understand what is good for them, but they can do nothing about it, since the politicians are corrupt to their very core... The banking industry lobby is one of the strongest. So, do you really believe that they will EVER allow passage of any regulations that would prohibit them using somebody else's money at zero risk (since the public will bear the risks of malinvestments)?!
If you really believe that this is possible you are very naive, and I deeply sympathize with you (no, sincerely).
A brilliant example is the concept of a flat 10% income tax, that would completely remove the necessity for IRS and would fill the state's coffers to their fullest... This idea is as old as the Good Old Unites States herself. Remove progressive taxation! Remove unnecessary bureaucracy that goes with it - like IRS. Spare many a headache for Americans trying to figure out how to file their taxes... The idea of a flat tax is very simple to sell to the public, it's elegant and practical as an interim solution. And yet - nothing is done in that respect to this day! If anything, the tax code is getting more convoluted and complex by the day... I know a lot of people form all the walks of life that have shared with me their thoughts on why we are not switching to the flat income tax, or better yet, to just excise tax only, as a practical solution to America's economic woes of the present day...
Published: March 5, 2009 12:53 PM
gene
The bank with two roles as "storage" and "investment" [based on depositor's preference] is obviously the way a bank should operate in a just world. And the banks, and the government know that.
But they now exist in a no lose situation, why would they ever want to do something that gives back the power of production [money] back to the producers [depositors]? As it is now they can convince depositors their money is safe and pay a low interest rate on the same money they invest at a riskier higher interest situation and earn the difference without a penny invested or a hint of personal risk. Wouldn't you do the same thing?
If anything happens, the government will bail them out, just as they are. In fact, the FDIC makes the whole process possible.
There are plenty of good ideas that would work much better that what is in place, and the folks running the show are aware of this fact. The problem being, most of the good and just ideas would require the power elite to get real jobs and quit mooching off the rest of the population. For some reason, they see this as a problem!
Published: March 5, 2009 2:38 PM
Franklin
I’m afraid it’s much more than the bank lobby, pbergn. “Fairness” is a difficult term to define.
When I was a teenager, the Thanksgiving post-dinner political brouhaha always ended in shouting, relatives stomping out of the room, and high decibel argumentation. Passion rubs deep in the blood among my ethnicity as does the ancient political dynamic. So with that backdrop, arm-waving theater was always a pre-dessert promise. This was long ago, so the ladies were always in the kitchen, making the coffee and cutting the pies. Funny, though, I envied them since the cacophony among us males sometimes got uncomfortable. Sure, there was lots of love around the table, but the veins in the temples were often visible when the “democrats” versus “republicans,” bellies full of turkey and squash and a few drinks, got their ire up.
One holiday, the flat tax issue arose. Like you, pbergn, I figured, what’s the controversy? What a naïve kid I was. Nevertheless, I thought that on this one, we can all agree. Taxes suck but at least this was a relatively fair and rational approach. Now, please, I say relatively fair. I always thought the truly “fair” way of cutting up the budget was making each citizen pay on a per-capita basis. A flat dollar amount! But fine, you’ve got to walk before you can run. So I was on the “conservative” side of the table, championing the flat per-cent.
I remember one exchange almost exactly, with my late and beloved uncle, kindest soul you could ever meet, and a product of the FDR age…
“Listen,” I pleaded to him, “you should have no problem with this. Let’s say10%. If somebody makes 10-grand, they pay $1,000. If they make 100-grand, then they pay $10,000.”
My uncle replied, “How the hell’s that fair??? The guy who makes 100-grand still has 90-grand after we tax him.
Cripe… Bring on the apple pie.
Published: March 5, 2009 4:21 PM
Gerry Flaychy
Contrary to the author, I would say that "the action of markets" cannot at all be "the proof that banks have created excess credit" due to fractional reserve banking.
It can very well be an excess of bad loans and bad investments by the banks, commercials as well as investments banks, that cause this "action of markets".
Published: March 5, 2009 9:10 PM
Peter
Suppose that you loan me some money for a business venture. My venture fails, and I am unable to repay. Have I robbed you?
No; but then I lent you the money for a business venture, not to hold on account for me. (And I don't have access to the money until you pay it back - or fail to pay it back as the case may be)
Likewise, a bank that devalues its currency may not necessarily be committing overt theft. It may be an honest business failure.
But an honest bank should be able to fail completely, losing every single cent of investors' money, and still pay out 100% of demand deposits.
Published: March 5, 2009 11:05 PM
Michael A. Clem
Non-fractional-reserve banking is NOT an oxymoron.
The bank with two roles as "storage" and "investment" [based on depositor's preference] is obviously the way a bank should operate in a just world.
Thanks, guys! Maybe we've finally got that point out of the way. I might add that demand deposits (i.e. checking accounts) are not simply storage of funds, but would obviously allow the convenience of checking, check cards, and electronic transfer of funds, as they do now. It's just the non-demand investment accounts that need more restriction on transfers.
Published: March 6, 2009 1:16 PM
M.G. in Progress
As there is a compelling case not to rely anymore on some bankers, an orderly and systematic bank run on would-be insolvent banks, seems an appropriate solution to set up parallel new good banks and strengthen also good ones.
Published: March 6, 2009 4:02 PM
Gerry Flaychy
If I deposit a check of 100 $ in my demand deposit account instead of a 100 $ bill, the only way that the banker can give it back to me, it's when that check has bounced ! !
If my bank account was a place of storage, the banker would then be obliged to keep the check in it and give it back to me, as it, on demand, wich obviously is not the case.
The only way to store money in a bank, it's to rent a safety-box and put our money in it.
Published: March 6, 2009 6:56 PM
Brian Macker
Eric,
"Rothbard has written that it is not necessarily a run by depositors that is a bank's fear, but it is when other banks come to collect from deposited checks on the bad banks."
You misunderstood. Under the old system banks printed their own banknotes backed by the deposited gold. The other banks could redeem the banknotes, in addition to any checks. Generally checks are cleared immediately to make sure they are good. So the other banks aren't don't hold large quantities of checks in reserve from other banks. What they hold can hold is banknotes.
There is only so much gold on hand, the reserves. It's the combination of all claims against the reserves that can trigger a bank run.
It's depositors withdrawing from their accounts that can spell doom the quickest. With 10% reserves there are ten times as many deposit claims as money. The banknotes are not suppose to be leveraged, but can become so as depositors withdraw money.
For example, suppose the bank holds 10% gold reserves against depositors, and has another 10% gold on hand as 1 to 1 backing for outstanding banknotes. Suppose that depositors on average don't draw down below 10% of their accounts before refilling.
Then if 100% of the banknotes are redeemed by everyone holding them there is no problem.
On the other hand if only 20% of depositors withdraw all their deposits the bank goes bankrupt.
If 15% of depositors withdraw all their funds then the banknotes become leveraged also. Only 50% of the banknotes being actually back-able at that point. At which point other banks could put the bank out of business by redeeming banknotes held in reserve.
Published: March 8, 2009 10:36 AM
Brian Macker
"If my bank account was a place of storage, the banker would then be obliged to keep the check in it and give it back to me, as it, on demand, which obviously is not the case."
Aren't you being clever (or obtuse) to the point of looking stupid here?
The bank clears checks with the check writers bank and receives the cash on your behalf. You are charged a fee for this service. You get cash however, not a check.
A checking account is a place for storage of you cash and a means of executing transactions. The funds therein should absolutely not be lent out by the bank. You should be charged fees for this service. Safe deposit boxes aren't suitable for this.
Different groups have different interests in the assets the bank holds. Banks have agreed to certain terms on checking accounts. That's why they are checking accounts not bonds. So the bank should not be able to violate those terms, which means they have to hold the cash at all times.
I think that savings accounts should be illegal unless they have terms about maturity. But then they wouldn't be bank accounts, they'd be bonds. Furthermore banknotes should not exist at all unless they are denominated at the reserve amount, not in terms of the deposits because that represents claims not actual backing.
Ten dollar banknotes that have ten percent backing should be called dollar banknotes. Dollar notes should be called dime notes (ten cent notes). Etc.
Published: March 8, 2009 10:56 AM
Brian Macker
Mike Sproul,
Your comment completely fails to comprehend the problems with fractional reserve banking. It's a liquidity issue. Houses aren't liquid. Houses aren't money. Houses can't be used to back money.
It's not about $100 only being backed by $99. It's about $100 only being backed by $4 and the rest being backed by $96 in illiquid homes that are overvalued by 90% due the the monetary expansion caused by the fractional reserve banking system. So if you tried to sell them all to bring reserves back up to 100% to service the bankrupcy you'd only have a total of $4 + $9.6 dollars. That's it.
That's why people panic when the entire banking system is having bank runs. Because the money supply dropping causes the supposed "backing" asset values to plummet.
Once the malinvestments caused by the fractional reserve system come into play actual production decreases, and the homes are worth even less because too many were built. So the whole pyramid scheme falls apart.
You just don't get it. Nor did you get it in the last comment section where we went into this in detail.
You cannot back currency with illiquid assets without causing problems. The very process of doing so jacks up prices and causes a fractional reserve monetary inflation driven boom, which eventually will bust.
It's very similar to trying to back a fiat currency with real estate. Which was tried during around the time of the French revolution. It doesn't work, period.
Hell, we just did it via fractional reserve and it blew up in our faces. All those backing assets are worthless as substitutes for liquid cash. You can't use a house in monetary exchange for the same reasons that bartering using cows, horses, and chickens doesn't work.
Houses are not fungible, are not easy to assay, are not divisible, they hold most of their value in use (not as a store of value), etc.
All this nonsense of creating tranches and mortgage backed securities was a lame attempt to jack up the liquidity of housing.
The Real Bills Doctrine is nonsense, incompatible with Austrian Economics, and fraudulent (therefore criminal in the eyes of libertarians).
Just because some people aren't sharp enough to see the pyramid scheme behind fractional reserve (with or without real bills) does not mean that it isn't fraud. It is.
Published: March 8, 2009 11:38 AM
Mike Sproul
Brian Macker:
Actually, the real bills doctrine (aka 'backing theory') is consistent with libertarian theory. If I choose to deposit $100 in a bank, knowing that the banker will keep $10 in cash, and lend the other $90 to someone whose house is currently worth $120, that is between me and the banker. It is unlibertarian to outlaw such a transaction. If the house falls to only $80, then that is just one of the many risks we all take. If the bank took the simple step of suspending convertibility for one year, then its dollars would fall in value to about 90% of their old value, but there would be no bank run.
Unregulated banks have every incentive to keep the problems of fractional reserve banking in check. The problems you describe are more a result of unwise government regulation and deposit insurance.
Published: March 8, 2009 10:38 PM
Gil
Your post against M. Sproul isn't enlightening either, B. Macker. Does it matter what backs the money as long it's capable of being redeemed?
Alternatively, why does money need to be 'backed'? What 'backs' the gold and silver coins when they are current money? Similarly is a piece of paper saying you own 100 shares of Microsoft fraud or not? You own a paper that is backed by a business yet its value can fluctuate to anything including nothing. Were you defrauded when you find out your 100 shares are worth $5?
Published: March 9, 2009 1:53 AM
Peter
Mike Sproul: How about you loan me some money? I'll happily "back" it with whatever crazy "assets" you like...and when it comes due for repayment I'll just "suspend convertibility" for a year...or a hundred years...whatever. Sounds good to me!
Gil: "as long as it's capable of being redeemed" is the operative phrase - in these crank schemes, it's not capable of being redeemed (which is why Mike Sproul keeps going on about "suspending convertibility" - i.e., throwing up his hands and saying "well, I'm just not going to redeem it...tough luck, buddy...maybe I'll give you your money back next year, if I feel like it").
Money doesn't need to be "backed" (what does that even mean?). Money substitutes need to be backed (with money).
Published: March 9, 2009 9:12 AM
Joe Stoutenburg
Brian Macker:
Your answer to Mike will be lacking if it does not respond to this:
"Unregulated banks have every incentive to keep the problems of fractional reserve banking in check. The problems you describe are more a result of unwise government regulation and deposit insurance."
As I see it, there are two primary facts about current money. 1) It is not convertible into gold or any other base money, and 2) it is managed by a government granted monopoly.
You seem focused on 1). Your focus has some merit. A free market bank that indefinitely suspended convertibility should be challenged. Indeed, I don't believe that it would survive long. But don't you think that 2) may have an important role to play?
Published: March 9, 2009 10:00 AM
Gerry Flaychy
What "it should be" and what "it is" are two different things.
If a checking account "should be" a place for storage, then the funds therein "should be" not lent out by the bank.
But "it is" not the case with our banking system.
If it was the case, then fractional reserve banking would not be possible.
So, if we want a place of storage for our funds, a checking account "is" not the place actually because our funds are not stored by the bank but lent out.
In the present situation, a checking account "is" not a place of storage. That it "should be" otherwise is another question.
Published: March 9, 2009 10:59 AM
Joe Stoutenburg
While reflecting upon this thread, a useful analogy has come to mind.
Suppose that people wanted to use GM stock certificates as a medium of exchange. While you might criticize the wisdom of circulating them widely (considering the dubious value of the assets backing them), would it really be okay for you to forbid their use among willing, informed parties?
Now, let's suppose that the government mandates that the only legal form of tender is GM stock. Which is the bigger problem - that GM stock was used as a medium of exchange or that its use was mandated?
Published: March 9, 2009 11:46 AM
Mike Sproul
Gil and Joe:
There are many kinds of convertibility: instant, delayed, certain, uncertain, physical, financial, at the customer's option, at the bank's option, etc. In 1933, the fed suspended one kind of convertibility: Instant physical convertibility at the customer's option. The other kinds of convertibility have remained. For example, the fed has always maintained financial convertibility by standing ready to buy back its dollars with bonds, even if it won't buy them back with dollars.
If a bank issued guilders that were to be convertible into 1.05 oz. of silver after 1 year, then at a 5% interest rate, those guilders would trade for 1 oz. today, gradually rising in value to 1.05 oz. after 1 year. If the cost of issuing those guilders was .05 oz./year, the guilder would stay at 1 oz. throughout the year. People who expected to get .05 oz. worth of liquidity services from those guilders would use them as money for a year, even though they bore no interest. If they lost their usefulness as money, people would only hold them if they got a net 5% return for it, so the guilders would start the year at .95 oz, rising to 1 oz at year-end.
This is covered in more detail in my "No Such Thing as Fiat Money" paper.
Published: March 9, 2009 11:58 AM
Brian Macker
Libertarianism is about stopping the initiation of force and fraud.
We can ban fractional reserve for the same reasons we can ban pyramid schemes. Both require that some party be defrauded as one runs out of suckers.
The reality was that bank notes were printed with false information on them. They claimed to be notes for a full amount but were only worth a fraction, as in the fraction held in reserve. If they were printed up as if they were fractional lottery tickets then there would be no scam involved.
Published: March 10, 2009 1:05 AM
Brian Macker
Gil,
My comments are shortened because we've been over this territory before. Mike thinks you can back the medium of exchange with other goods, like houses, land, whatever.
The medium of exchange isn't about "backing" with an ever increasing quantity of goods. New houses very easily can be built, just like leaves can be picked off trees. In fact houses are made of trees.
There is a reason we have the phrase, money doesn't grow on trees. If it did then it would become worthless.
Prices are set according to a present medium of exchange. Fractional reserve allows the money supply to expand fraudulently by substituting claims against other goods (not money).
Prices are a ratio of money to goods, so when you move goods over to the other side of the ratio you end up with an unstable system.
A system where everyone thinks they are getting rich as their "assets", the goods being used to "back" money, get inflated in price by the very process of moving them to the other side of the ratio.
"Backing" currency with houses increases the money supply. An increased money supply means prices in general should rise to a new equilibrium. But because loans are made directly against houses the new money causes price inflation there first. Which amplifies the prices in houses. Which makes the banks think that each housing unit can back even more money creation.
Meanwhile the higher housing prices cause producers to make more of them. Which means their actual value is dropping in terms of the original money supply.
When the money supply contracts, as it will when the pyramid scam runs out of suckers to buy houses to flip, then everyone is actually poorer. Why? Because they wasted resource building all the extra houses for which there was no true demand.
Published: March 10, 2009 1:26 AM
Joe Stoutenburg
Brian Macker:
We can ban fractional reserve for the same reasons we can ban pyramid schemes. Both require that some party be defrauded as one runs out of suckers.
You appear to want to set up a nanny state run by your dictates. Are you willing to recognize the remote possibility that you may not understand the contracts that you want to ban? Austrian economists have written much about unintended consequences of regulation. You would do well to consider their ideas in the present discussion.
An argument may be made that our stock markets developed into pyramid schemes. Would you ban stock markets? Or would you recognize that stock markets would be more stable under conditions of freedom? I'm guessing the later. Yet you would choose the former, it seems, when it comes to banking. Again, I call your mind to unintended consequences. Are you willing to take responsibility if your central planning goes awry?
You call "fractional reserve banking" fraud. First, I guess that I have to once again brush aside the straw man. We are not talking about banks that have "fractional reserves". Any bank that prints up notes for more than its reserves should be subject to lawsuit from its depositors. Even Mike Sproul will agree to that, I think.
We are talking about banks that have 100% reserves that are composed of a variety of assets (whereas you insist upon allowing only banks of homogeneous reserves). In this respect, the U.S. banking system is fully reserved. The majority of the assets backing the dollar are federal government bonds. These bonds represent claims upon real assets. [As I have written before, I challenge those claims.]
You wrote:
The medium of exchange isn't about "backing" with an ever increasing quantity of goods. New houses very easily can be built, just like leaves can be picked off trees. In fact houses are made of trees.
Likening the construction of houses to picking leaves from trees places the credibility of your argument in question. That aside, the point is that production must occur to build a new home just as it would need to occur in the homogeneous reserve system that you prefer (that production being the mining of gold). In a free market banking system, a home could only be placed as backing of a bank's currency by the voluntary consent of the home owner. The need for production and the voluntary contract of property owners places a check upon the size of banking reserves.
Contrast that situation with the state-run monopolies that dominate society today. Government lays claim to the property of society and places it in the banking system. There is only one currency in a given region, and its physical convertibility has long ago been suspended. Mike Sproul seems less concerned about the suspension than do I. I think it's a huge problem that would be penalized in a free market. Anyway, as a consequence, the price system for valuing the reserves is completely dysfunctional. There should be no wonder that we have seen inflation and instability to the degree that we have.
Again, I ask you to separate the issues of a multi-asset reserve from the state-run monopoly issues. Please respond.
Published: March 10, 2009 9:28 AM
gene
Not printing money would accomplish the same. What I mean is, any supply of money is okay as long as it remains the same. It can always be divided into smaller increments and never needs to be increased in quantity.
After this is done, banks have no advantage over anyone, and no disadvantage. What takes place in the markets just needs to be agreed upon by both parties.
Since there is a limited amount of money, banks, as well as everyone else, must compete for it and it will bring its natural value in relation to goods, etc.
The reserve system is impossible without either fiat production of money or outright fraud [am i being redundant here?]. With a limit on money, the depositor would need to condone what his money does and the risk it incurs. and so would the bank.
Insurance is a big part of the whole mess and the same thing would apply. If you are backing something, you need to have the backing, not the illusion of backing.
Nothing mystical about it, just the opposite of what we have.
If people desire to give their money to corporations in the form of stocks, they could have at it. Only problem, with a limit on dollars, they may just decide to keep it!
Published: March 10, 2009 6:24 PM
Brian Macker
"You appear to want to set up a nanny state run by your dictates."
You appear to want to drive the country into anarchy. See how that argument backfires?
One doesn't need a State let alone a nanny state to make fraud illegal. Since we have a state I think it should do the right thing and outlaw fraud however.
"Are you willing to recognize the remote possibility that you may not understand the contracts that you want to ban?"
They are not valid contracts because one side cannot possibly live up to them. Furthermore if you don't think they are fraudulent nor understand how they are part of a pyramid scheme then I don't think you are competent to sign the contracts.
"Likening the construction of houses to picking leaves from trees places the credibility of your argument in question. "
Nonsense. Housing can be expanded a lot more quickly than traditional moneys.
It was to illustrate a point. Which you didn't get.
The fact that you clutch on such aspects of my descriptions places the credibility of your arguments in question. See how that works?
"That aside, the point is that production must occur to build a new home just as it would need to occur in the homogeneous reserve system that you prefer (that production being the mining of gold)."
Yes, and picking leaves off trees requires work too. The question is does picking leaves produce gold? If a bank has depositors who have deposited gold and a contract that says they can withdraw at will when the gold has been lent long term to debtors then it's fraudulent. The were all depositors to claim their gold at once across the entire system the demand could NOT be met. With gold mining there is an ability to pay with gold.
Depositors don't want houses when they need to withdraw and can't use houses as a medium of exchange.
"In a free market banking system, a home could only be placed as backing of a bank's currency by the voluntary consent of the home owner. The need for production and the voluntary contract of property owners places a check upon the size of banking reserves."
You don't understand the difference between the two systems being imagined here. One is stable and robust. The other, backing currency with other goods, is unstable.
You picked just houses, but if the currency could be backed by any good then as the quantity of goods backing the currency increased prices would go towards infinity. That's even though in the same sense you claim, "The total quantity of goods puts a check upon the size of banking reserves."
Do you understand why prices would tend towards infinity in that case? Whether it is "checked" or not is unimportant, because it's screwing with a ratio.
Lets take the ratio 10000/10000. Obviously the denominator is "checked" because it is finite. Let's start moving from the numerator to the denominator. First lets move half: 15000/5000 well that got us to 3. Lets move 9999. 19999/1 well that got us to 19999. We can however use fractions and keep going. 19999.999999/0.000001 = 19999999999. We can keep going.
The response here is parabolic without even including the effects of prices at the margin.
People can and do take out loans against appreciating assets. Also the assets being added towards the end are already inflated in price. Also the price inflation happens most specifically in the goods being lent against.
Your multi-asset reserves is a highly unstable system. It makes first adopters rich at the expense of last adopters exactly like a pyramid scheme. Because once the expansion into new assets hits it's peak the fraud collapses. Without the expectation of rising prices (which are a side effect of the process which is part of the trick) people stop buying.
Meanwhile the fraud as sucked resources out of more productive uses. Which means when the bubble pops it ends up swinging the other way and then way below what would have been normal prices.
Published: March 10, 2009 7:45 PM
gene
Fractional Reserve IS fradulent.
Money cannot be two places at once, just as a house or a human cannot be. To say it is possible IS a form of fraud.
It doesn't matter if depositors KNOW that their money is being loaned out or not, the money can only exist once and continue to retain its original value as the medium of exchange.
In our society, the same money is four or five places at once in order to enrichen all those priviledged who didn't actually earn the money in the first place.
Those in control know that sound economics satisfies need but is rather mundane at producing wealth for the elites. The majority of people would be wealthier with the same amount of assets in a sound system and the elites would be looking for work.
hence, things stay the same.
Published: March 10, 2009 8:32 PM
Brian Macker
Joe,
I suggest you look into the history of the Real Bills Doctrine also. It's a theory that was invented by John Law. If you don't know who John Law is then think Mississippi Bubble. Some people are too "clever" for their own good or anyone else's.
Mike Sproul has a website dedicated to pushing the theories of a con artist. He might as well have a site dedicated to the financial theories of Charles Ponzi, or Bernie Madoff.
That people are duped by these theories is no surprise. John Law was very intelligent. Problem was that he also was a greedy son of a bitch who used that intelligence to set history on a bad path. I put him there with the likes of Marx.
There is a long history of those who invest in fractional reserve banks claiming surprise, losing their shirts, and clamoring for government bailouts. It think it clear that these are not responsible people, have shown their incompetence in understanding the outcome of their actions, and therefore should not be allowed to participate in clearly fraudulent schemes.
Someone else's gambling problem, or pure naivety becomes my business when the obvious result is destitution and therefore a breakdown in ethical cooperation. People have been put on the edge of desperation, over and over again due to fractional reserve banking.
I think it is clear theoretically and empirically that such institutions not only result in impoverishment but do so in a way that cause these mistakes to be coordinated amongst large groups of people. One guy with a gambling problem is trouble enough, but an entire country, like France under John Law, is quite another thing.
When so many have been desperate chumps they tend to become a powerful political force in turning a country in the wrong direction toward confiscation of the assets of those who are more responsible, and furthering schemes that serve to enrich the politically connected.
Published: March 11, 2009 6:58 AM
Brian Macker
Joe,
I just noticed that this site has already cover the real bills doctrine with an article by Robert Blumen titled "Real Bills, Phony Wealth"
In the article he calls John Law a "monetary crank" and says about real bills:
Real bills (like fractional reserve banking) is a complex rationalization by intelligent monetary cranks.
The problem with fractional reserve banking is exactly the same as with real bills. No true savings back the scheme.
With fractional reserve banking there is a production of claims against money (bank deposits) that doesn't exist. This means that those who believe they have cash holdings that they don't. This is inflationary and causes it to appear that there is more money in circulation that there actually is.
True savings, the actual goods saved in order to accumulate cash holdings ends up running behind the actual savings that people have. This leads everyone to believe throughout the system that there is more savings than truly exists. Thus savers end up saving less, and borrowers end up borrowing more.
So you end up with a financial boom but unfortunately there is just not enough saved goods to match the borrowers plans, nor the money supply at the original prices. Eventually their plans collapse as the inflated money supply bids up the goods they were planning to get at the original cheaper prices before monetary inflation lead to price inflation. They then cannot pay their loans and the whole pyramid scheme collapses.
Then the depositors, bankers, and borrowers all run to the government to force others to pay for their scheme.
I know there are libertarians who believe in "free banking". I just think that they are monetary cranks. The system is unstable and given human nature will naturally lead to the expansion of the government.
When you associate fractional reserve with free markets you are claiming that freedom entails the right to defraud. This ultimately will cause people to reject true freedom when they get defrauded. That's because most people are not intelligent enough to make the connections even after it's been explained to them, and even fewer will figure it out on their own.
I'm a really sharp guy and I don't think I would have been able to figure it out had I not rested on the shoulders of intellectual giants of the past.
Published: March 11, 2009 7:33 AM
newson
what's more, john law died penniless.
Published: March 11, 2009 10:13 AM
gene
That's right, freedom does not entail the right to harm or defraud. that would be anarchy, which may be what we already have.
When banks create or use funds intended for other purposes such as "storage" they gain from the result of other's labor. They demean other's labor and goods and create unearned wealth for themselves.
When the risk is removed, either thru the FDIC or bailouts, it not only facilitates this fraud but causes malinvestment that only increases unearned wealth.
A libertarian who believes in freedom from harm and injury cannot support reserve banking.
If the depositor wants the money stored that is fine, if he wants it invested that is also fine, but it is his money and his choice and he should reap both the risk and the reward. As it is now, he experiences the risk as a taxpayer funding the insurance and the bank receives the return on the depositor's funds which represent his product.
If you let a house represent the depositor's funds, the bank says it will "manage" and care for the house to prevent damage. The bank then rents the house returning an amount equal to a month's rent to the depositor and keeps the rest. By this and other activities the bank lowers the value of the house by increasing the quantity of money.
If say a hurricane comes along while the bank is renting the house out, and destroys the house, the bank turns to the government to get its "rent profit" back and maybe even the depositors money, if necessary.
The example shows the depositor's value has been "rented out", devalued and any catastophic occurence is paid for again by the depositor taxpayer. If this is a fair and just system, then so be it!
Published: March 11, 2009 10:19 AM
Mike Sproul
The real bills critics seem to miss at least three points:
1) If a bank issues 100 paper guilders, backed by various assets with a market value of 100 oz. of silver, then those guilders will trade in the market for 1 oz. each. If the assets fall to 90 oz., the guilders will trade for 0.9 oz. If the assets rise to 95 oz., the guilders will rise to .95 oz. This is a risk people take. Requiring the bank to hold only silver is unnecessary and unlibertarian.
2) If that same bank issues 200 new guilders, and receives various new assets worth 200 oz. in exchange, then the bank now has 300 guilders backed by 300 oz. worth of assets, and each guilder remains worth 1 oz. each. There is no inflation. The additional guilders might displace barter or other currencies, or they might be kept in mattresses.
3) If other banks issue 500 florins, backed by various assets worth 500 guilders, then each florin will trade in the market for 1 guilder. But the issue of florins will not change the fact that the original bank still has 300 oz. worth of assets backing 300 guilders, and so the issue of florins (which can be thought of a 'derivative' guilders) will not affect the value of guilders. No inflation is caused the the issue of either kind of money. Inflation only results when the amount of backing per unit of money falls, as would happen with counterfeiting.
Published: March 11, 2009 11:37 AM
Joe Stoutenburg
Brian Macker:
Thank you for your thought-out response. You wrote much that is worth considering though I take exception with some of it. I will respond in due course.
While I digest your posts and formulate a response, I would like to draw your mind to a request that I have now twice made to you. While we have both written quite a bit, I had hoped that I made clear that this is what I would most like to hear from you. But you have remained silent on it.
I respost something that I first directed to you on March 9:
As I see it, there are two primary facts about current money. 1) It is not convertible into gold or any other base money, and 2) it is managed by a government granted monopoly.
You seem focused on 1). Your focus has some merit. A free market bank that indefinitely suspended convertibility should be challenged. Indeed, I don't believe that it would survive long. But don't you think that 2) may have an important role to play?
While the other points that you raise are worthy of discussion, this is of most interest to me. I am disappointed that you have not addressed it.
[As an aside and prelude to one point on which I will respond, I was aware of the history of the Mississippi Bubble but was unaware of John Law's connection to RBD. If I may be taken as an adherent of RBD, it is through personal reflection and not through a devoted study of its literature. In any case, what I most want to say here is that any history that you find of this character will very clearly tell of formal monopolies granted by the French government.]
Published: March 11, 2009 11:43 AM
Joe Stoutenburg
Not defending John Law nor his theories, I have some comments on his relation to this discussion. People have raised his bad reputation as supporting their position against his theories. Now, it is worth considering the reputation of a person who tells you something. I won't deny that. But it is nothing compared to careful direct analysis of the theories in question.
For the lack of direct knowledge that I am confident all of us have here, John Law's bad reputation may be unearned. Earned or not, I expect better of the people posting here than character assassination.
Published: March 11, 2009 11:58 AM
gene
Hi Mike,
I have a problem with #2 in your comment above.
2) "If that same bank issues 200 new guilders, and receives various new assets worth 200 oz. in exchange, then the bank now has 300 guilders backed by 300 oz. worth of assets, and each guilder remains worth 1 oz. each. There is no inflation. The additional guilders might displace barter or other currencies, or they might be kept in mattresses."
Now, correct me if i am misunderstanding this, but if the bank "issues" 200 new guilders, there will be inflation.
Any asset that the bank receives is already represented by some currency. The asset is represented by labor and resource or someone who "paid" for these and the bank is "issuing" or creating the money. How would this not cause inflation?
How can an asset be "new"? If you percieve it as "new" and representing new value to be backed by new currency, you have to completely discount the labor and resource that creates the "new" value. They must be valued at zero for each of the guilders to remain at 1 oz.
Isn't this the same logic that banker's use to "discount" the depositor's funds?
Published: March 11, 2009 12:25 PM
Joe Stoutenburg
Brian Macker:
Thank you for your link. I first read the article written by Nelson Hultberg that prompted Blumen's piece. I highly recommend it though don't necessarily agree with everything in it. I will reference sections of it later with comment.
I am still working through Blumen's article. I have only one interesting observation for now. Blumen attributes RBD (or "many of the key concepts") to John Law. Meanwhile, Hultberg attributes RBD to Adam Smith!
Anyway, a search turned up a paper written by Antal Fekete, the primary source for Hultberg's paper. I have not read it in its entirety. But it appears to be appropriate reading for us. This paper is a rebuttal to Blumen's article.
Published: March 11, 2009 5:05 PM
Mike Sproul
Joe:
A quick summary of John Law: (See my "Quick History of Paper Money") He and the French regent started a company that owned, among other things, the land we nowadays call the Louisiana Purchase. The company issued stock, which soared in value, and paper money, which initially held its value. After a few years, people realized that the land would never be developed. At the same time, the company issued more paper money than it could redeem. Assets went down while liabilities went up, leading to a crash in both the stock and the paper money, exactly as the real bills doctrine would predict. When a company fails and its stock falls, you wouldn't claim that it proved that stock's value was not determined by its backing. Yet real bills critics point to episodes where money lost backing, and hence lost value, as a proof that the value of money is not determined by its backing.
Published: March 11, 2009 5:17 PM
Gerry Flaychy
There is money in the form of bank notes and coins, and money in the form of « money substitutes». Those last ones can be used as money, that is to say, to be used as an intermediary of exchange in markets transaction.
When we deposit a certain amount of bank notes and coins in a bank, this amount is inscribed in an bank account in our name. This «account-money» can be used as an intermediary of exchange in markets transaction i.e. as money, but only if in this account we can withdraw and put money as we wish, wich account is often called a transactional account. A demand deposit account is one of this kind.
Another way to see it, it's to say that with one 100 $ we make two !
It is this operation that can give the impression that «money can be in two places at once». In fact, we can say that it is the case if we talk about «money» as bank notes and coins + money substitutes, instead of money as bank notes and coins only.
Published: March 11, 2009 6:05 PM
newson
to joe stoutenberg:
if you research john law carefully, you'll find his actions betrayed him as a scoundrel, so i'm not indulging in gratuitous character assassination. elisabeth currier has a good podcast on him: http://mises.org/media.aspx?action=search&q=currier
i thought macker addressed your queries just fine, and i can't see that the blumen article missed anything, but yes, a central bank is going to worsen any inflationary tendencies through cartelization of the banking sector.
fekete's version of the rbd (from memory, his is pretty much along adam smith lines) makes less sense (more arbitrary limitations) that mike sproul's, but i don't think sproul correctly described his critics views of rbd.
we've argued this endlessly over the blogs: the problem of banks issuing credit against the value of the collateral posted is the positive-feedback loop this sets up. that is, if banks target real estate as acceptable collateral, and loan accordingly, the freely available credit impacts on the price of property, which goes up, the higher valuation allows successive credits to be increased, and so forth. bubble, bubble, toil and trouble.
Published: March 11, 2009 6:37 PM
newson
sorry for mangling your name, joe.
Published: March 11, 2009 6:42 PM
gene
Gerry, yes i see what you are saying. The only reason this is permitted is to allow banks to "profit" on money they didn't earn or truthfully manage. It is money creation.
Published: March 11, 2009 6:50 PM
Joe Stoutenburg
newson:
"Character assassination" may have been the wrong term. Really, there is a term for a logical fallacy based upon rejecting an argument because you can find something wrong with a person espousing. I don't care to look it up. But that's what I meant. No reason to dwell on that issue.
I still haven't had a chance to finish my reading. I'll hold off on further comments until I do.
Published: March 11, 2009 7:19 PM
Brian Macker
Joe,
Adam Smith was six years old when John Law died. So Blumen is correct.
Why didn't you accuse me of character assassination with regards to Marx? I spoke the truth about John Law. He was a money crank.
The reason I'm not focused on 2) is because I believe we all agree on 2) already.
I think it should be obvious that if I think fractional reserve banks are problematic that adding governmental ad-hoc non-fixes is going to be worse. In fact, a central bank exacerbates the problem already inherent in FRB, as does a fiat currency.
If you car is running slow because of a flat tire then of course adding nitro to the fuel mix isn't the way to go. Mike claims we should let air out of all the other tires, so I'm disputing that, not the fuel.
That's why I wasn't focused on 2). In reality I'm not focused on 1) either in this particular conversation. One could use a stable quantity of paper money as a "base money", although the temptation to print is too much for politicians to handle.
Fractional reserve banking fails even with a fixed quantity of fiat money. I only used the example of convertibility into gold order to make the problems easier to grasp. Fractional reserve doesn't magically start working with fiat currency. One can still have bank runs with such a system. It's still fraudulent to claim one has the paper to back deposits when one doesn't.
Fiat currency has it's own problems however. As Zimbabwe shows.
Published: March 11, 2009 8:28 PM
Brian Macker
"Yet real bills critics point to episodes where money lost backing, and hence lost value, as a proof that the value of money is not determined by its backing."
The value of money isn't determined by it's backing. It's determined by it's value as a medium of exchange.
Published: March 11, 2009 8:40 PM
Mike Sproul
Gene:
You seem to be saying that the 200 oz. worth of new assets backing the 200 new guilders was already spoken for by some other claim. If this were true the bank would not have accepted it in exchange for the money--just as a bank will not lend you money on your house when you're already loaned up on it.
Newson:
"if banks target real estate as acceptable collateral, and loan accordingly, the freely available credit impacts on the price of property, which goes up, the higher valuation allows successive credits to be increased, and so forth."
--The initial issue of money is adequately backed, so it does not drive up the price of anything. The self-perpetuating cycle never gets off the ground.
Brian Macker:
"The value of money isn't determined by it's backing. It's determined by it's value as a medium of exchange."
--That, of course, is the very point in dispute. You claim that money, alone among all financial securities, is valued independently of its backing. I claim that money is valued just like any other financial security--because of its backing. Your theory implies, among other puzzles, that if the US dollar starts being used in Mexico, then the peso will fall, and the US government will get a free lunch. You'd have a hard time explaining how so many so-called fiat moneys manage to survive rivalry from other currencies. The real bills view has no such problem. It implies that all moneys have value according to their backing, and so do not lose value as rival moneys appear.
Published: March 11, 2009 9:44 PM
newson
mike sproul says:
"--The initial issue of money is adequately backed, so it does not drive up the price of anything. The self-perpetuating cycle never gets off the ground."
the first loan may well be adequately collateralized (naturally, it's the start of the boom), but each successive loan's valuation refers backwards to most recent prices of the asset in question, which have been affected upwards by the easy availability of credit directed towards that asset etc.
Published: March 11, 2009 10:59 PM
Mike Sproul
Newson:
At first, there are 100 guilders backed by various assets worth 100 oz. After a new issue of money there are 300 guilders backed by various assets worth 300 oz. Each guilder must remain at 1 ounce, or there will be arbitrage opportunities. For example, if guilders fell to .9 oz., the banker would eagerly buy them back for 270 oz and walk away with the remaining 30 oz., or speculators would eagerly buy them all for 270 oz., then claim the 300 oz. worth of assets held by the bank. I assume that you'd say that the prices of goods in general would remain the same when measured in silver. But if the guilders are unchanged relative to silver, then the guilder still buys as many goods as before. Price inflation never gets off the ground.
Published: March 11, 2009 11:31 PM
newson
to mike:
first, as the bank of amsterdam instance showed, arbitrage doesn't operate smoothly, nor is information flow perfect (especially if the directors run a good smokescreen: think madoff's ponzi). the boa notes only came to be traded below par years after the bank had breached its 100% reserve charter. as long as this misinformation persists, the bank's loan-book can be grown, feeding into higher prices for whatever assets it's using as collateral.
second, your rbd example shows an isolated bank, missing the big picture. the inherent fragility of the model means bankers band together through mutual interest and expand their liabilities in unison, and more gravely, use political means to enforce suspension of specie payment when arbitrage does eventually take place (bank run).
Published: March 12, 2009 4:59 AM
Brian Macker
Mike,
"That, of course, is the very point in dispute. You claim that money, alone among all financial securities, is valued independently of its backing. I claim that money is valued just like any other financial security--because of its backing."
Money isn't a financial security silly. Empirically you are wrong because after Saddam fell and therefore the old Iraqi notes were completely unbacked they continued in circulation, and in fact became more valuable as they were reduced in quantity. They should have become worthless immediately according to your theory.
Likewise the US dollar. Why hasn't it immediately fallen to it's current backing. Same with the paper monies of the past. All of which were "unbacked" long before people stopped using them, or devalued them.
"Your theory implies, among other puzzles, that if the US dollar starts being used in Mexico, then the peso will fall, and the US government will get a free lunch."
The first is not necessarily true empirically because there are so many other impinging factors, like Mexican law. The second is empirically true for other countries. We are getting a free lunch by reducing the backing of the dollar (running up debt), look at the trade deficit.
We did so in the past also by printing more money that we had gold deposits. Foreigners only caught on later and as they tried to redeem we closed the window.
Individual banks can and do the same as newson pointed out.
Published: March 12, 2009 8:03 AM
gene
Hi Mike,
I am simply saying that there are no "new" assets.
Whatever "new" asset you are talking about is a product of labor and resource. These two building blocks of all assets have to be accounted and paid for. They have a "cost".
You are [by the example] permitting banks to do exactly what they do on a daily basis, print money and pay for assets that have been previously paid for with real money, labor and resource, by others. This is the fundamental fault of reserve banking and fiat money. It doesn't matter that the money is "backed", it is of no use if the money is backed by other's work or assets and printed by the bank, it is still theft, if the money came from nowhere.
When the fed imagines new money and when the banks use reserve banking to double[almost anyway] the amount of depositors funds, they are "purchasing" goods and paying for them with play money. Someone else, the depositor or whoever had to pay for the asset originally, had to use "real" money that represented labor and resource.
Any printing of money is receiving payment without work. It is breaking the rules of exchange, exchanging something for nothing.
Published: March 12, 2009 10:27 AM
Mike Sproul
Newson:
If a bank loses backing, and people don't know it, then the bank's money won't fall. Similarly, if the Ford factory were hit by an asteroid, and stock traders didn't know it, Ford stock would hold its value until the word got out. This does not invalidate the theory that money, and stock, are both valued according to their backing. It just means that uncertainty and information play important roles.
And so what if bankers expand their liabilities in unison, if they expand their assets as well?
Brian:
When a loss of backing is undiscovered for awhile, money holds its value for awhile. Speculators can also make the opposite mistake of under-valuing a currency--just like with any financial security.
Gene:
If you collect rent on some land, and if you pay your grocer with your own IOU (a 'gene dollar'), then that gene dollar could circulate as money, because everyone knows that you will accept it in payment of rent. There is no theft occurring here. The gene dollars are backed by your land, even though that land was 'produced' long ago and is not 'new'.
Published: March 12, 2009 11:44 AM
Gerry Flaychy
We must not forget that money itself is a creation.
In a primitive economy based only on barter, there is no money. Money is a creation, an invention, of a more advanced economy.
Thus, money creation by itself is not necessarily a bad thing: it's even a very good thing !
Published: March 12, 2009 6:21 PM
gene
Hi Mike,
you are right but it is a completly different example than your first. I did at some point "pay" for the land, right? That would be an example of resource only but still holds. The land has value and the person issuing the money [me] owns it and has paid for it, if someone wants to accept the paper I hand them as value, that is their choice. Either way, you are saying that the money I issue is backed up by the land that I own. This example would be the same as, the bank owns a piece of land and issues a note to someone as payment backed up by the land the bank owns. i would agree to that as totally kosher if both parties agree.
Conversely, the new money the bank issues is not backed up by anything, if i understand your previous example [#2]. It is printed and exchanged for something someone else paid for with real money. The bank has bought something that is real for something that is imaginary [new money].
It would be analagous to me printing money and not owning the land. Why would anyone accept that money?
Published: March 12, 2009 6:21 PM
Brian Macker
"When a loss of backing is undiscovered for awhile, money holds its value for awhile."
The fact that the Iraqi bills were un-backed was common knowledge. They had no other medium of exchange so the used the bills.
Besides, US treasury bills are currently completely "unbacked" yet people use them.
You are confusing money with bank deposits. Your banking scheme backs deposits and banknotes with collateral backed loans.
Gold had no "backing" and is used as money. Wampum had no "backing" and was used as money. Rocks had no "backing" and was used as money.
Published: March 12, 2009 6:36 PM
gene
Gerry,
I agree, money certainly augments trade and exchange. It is "profiting" on money creation that I don't agree with [aside from printing costs that is!].
Published: March 12, 2009 8:43 PM
Peter
That's right, freedom does not entail the right to harm or defraud. that would be anarchy
Please don't misuse the term "anarchy" like that. Anarchy means only "no leaders" - anarchy is what we want. It does not mean "chaos".
A libertarian who believes in freedom from harm and injury cannot support reserve banking.
[Presumably you mean "fractional reserve" here]
Published: March 12, 2009 11:27 PM
gene
Peter, yes I meant "fractional", I only left out the most important word!
I believe I misunderstand "anarchy".
If no leaders, no government at all, not even minimalist?
What or who prevents harm and injury [which I would see as the minimum]?
Published: March 13, 2009 10:56 AM
Gerry Flaychy
The word "anarchy" in its original sense means "no leader" or "no ruler", but in its current sense means "disorder", "confusion", "trouble".
The sense to give to the word "anarchy" depends on the context in wich it is used, as for many other words.
http://www.merriam-webster.com/dictionary/anarchy
Published: March 13, 2009 1:58 PM
newson
mike sproul says:
"This does not invalidate the theory that money, and stock, are both valued according to their backing."
actually that's not what i see as the weakness of rbd. it's problem is that collateralizing certain assets feeds into the future pricing of those very same assets, setting up the bubble dynamic.
for example, the "backing" of many hi-tech stocks in the run-up to the 2000 collapse was perfectly adequate, until it wasn't!
us banks two years ago had plenty of "backing" (at traded values) supporting their sharemarket valuations.
Published: March 14, 2009 9:03 AM
Mike Sproul
Newson:
"that's not what i see as the weakness of rbd. it's problem is that collateralizing certain assets feeds into the future pricing of those very same assets, setting up the bubble dynamic."
You'll find I said something similar in my "No Such Thing as Fiat Money" paper, under the heading of 'inflationary feedback'. For example, the fed issues dollars backed by bonds denominated in dollars. The bonds lose some value, which makes the dollars fall, which makes the bonds fall still more, etc. The same thing would happen if a corporation owned some call options on its own stock. This does not invalidate the theory that stocks, and money, are valued according to their backing. It confirms it.
This is why its risky for banks like the fed to hold assets denominated in the same currency that the bank itself issues. For example, the Mexican central bank would be wise to hold US government bonds, rather than Mexican Government bonds. That way, a fall in the value of mexican government bonds would not lead to a fall in the value of the peso.
(None of this means that I agree that using assets as backing drives up the price of those assets. That's another story.)
Published: March 14, 2009 5:38 PM
newson
mike sproul says:
"None of this means that I agree that using assets as backing drives up the price of those assets. That's another story."
well, that was the particular aspect i was contesting.
Published: March 14, 2009 7:09 PM
newson
to mike sproul:
i think brian macker actually raised the wrong question. he was talking about saddam dinars, but i think these may have retained value on the expectation that the us occupying would fix an exchange rate.
the question should be raised about swiss dinars that were used in the kurdish territory for quite some years, and which were completely unbacked.
Published: March 14, 2009 10:38 PM
newson
oh, i forget to mention the most pertinent thing - the plates for the swiss dinars had been destroyed. the money supply was fixed and the kurds were spared the high inflation of the saddam dinars.
in fact, the notes were in very poor shape, many stuck together with sticky-tape.
Published: March 15, 2009 6:57 AM
Joe Stoutenburg
I’ve had a very interesting time studying. To anyone interested, I reiterate the following reading recommendations (in order):
Hultberg’s “The Future of Gold As Money”
Blumen’s response to Hultberg titled “Real Bills, Phony Wealth”
Fekete’s counter titled “Detractor’s of Adam Smith’s Real Bills Doctrine”
I have discovered a vital distinction between something that I was promoting (and that I think that Mike Sproul accepts) and what Fekete and Hultberg advocated. I have written about the possibility of mortgages or other similar instruments to enter as reserves. In essence, an IOU may back money. As long as the IOU is made good by production or is backed by real collateral that could be seized in the case of default, then inflation will not occur. In addition, I have always insisted that some kind of physical convertibility (gold or similar) must exist. If a free market for gold, IOUs and other assets is allowed to exist, then I trust the market to manage the kinds of assets that enter as reserves. My central thesis is that a government managed monopoly does not allow such a market to exist.
Before moving on to the distinction promoted by Fekete et al, allow me to give credit to newson for an argument to which I had not given adequate answer. Quoting him:
[The problem with RBD] is that collateralizing certain assets feeds into the future pricing of those very same assets, setting up the bubble dynamic.
Up to now, I have only figured that a free market could keep check on the “bubble dynamic”. However, that is hand waving, and I’ve known it. So I’ve kind of kept quiet. But this will only happen if the IOU reserves are not “self-liquidating”.
I find Blumen’s article quite lacking to not even remotely address this principle. The Real Bills Doctrine (as presented by Hultberg and Fekete, notably not stressed by Sproul) concerns the discounting of bills of exchange. A bill of exchange, according to Fekete’s paper, “is not a credit instrument. It is a clearing instrument. It enables the market to clear goods in most urgent demand without needlessly invading the pool of circulating gold coins.” The natural question is to determine when an instrument crosses the line from a credit instrument to a clearing instrument. Fekete settles this satisfactorily in my opinion:
It is true that production and distribution of consumer goods, no less than that of producers goods, involve risks. However, there is a difference. Risks of dealing in consumer goods in urgent demand vanish as the "journey" of the "maturing" good is coming to an end, and the final cash-paying consumer is already in sight, so that the consummation of sale can no longer be doubted. From this point on the last leg of the journey can be financed with self-liquidating credit. By contrast, for producers goods, risks do not disappear even after the sale.
Of course, not every consumer good has the quality that risks disappear during the last leg of its journey. Luxury goods and specialty items, for example, fall into this second category. So do consumer goods sold on installment plans. The production and distribution of these have to be financed out of savings through loans, as is done in case of producers goods. Merchandise of the first category may occasionally have to be downgraded to the second, if demand for it slackens. Conversely, consumer goods of the second category could be upgraded to the first if demand for them picks up sufficiently. The bill market is the final arbiter to draw the shifting line of demarcation separating the two categories. If a bill can find takers and is readily discounted, then the underlying merchandise belongs to the first category. Otherwise it belongs to the second.
Both Hultberg and Fekete outline how clearing houses have developed spontaneously in the market for bills of exchange. They assert that these institutions developed during the Renaissance period outside of banks. The opponent of RBD must deal with these assertions. It is one thing for all of us to oppose oppressive central government mandates. But are you really going to oppose practices that arose out of voluntary market exchange? Fekete ascribes great benefit to the spontaneous exchange of these bills. While I think that his praise may be a bit hasty, are you really so sure of yourself as to ban such a practice that developed spontaneously in the markets? [This is something that I was addressing to Brian Macker regarding regulation. I let it lie for awhile. But I challenge him again in this regard.]
Okay, I’ve given a lengthy summary on some important points from the papers. I’m sure that I’ve missed some vital points. I hope that people wishing to engage me in debate will have the courtesy of reading the references that I suggested. They are somewhat lengthy, but it’s not like I just asked you to read de Soto’s “Money, Bank Credit and Economic Cycles” opus like one other poster did here.
In any case, I should get back to my point of distinction regarding “self-liquidating” bills and newson’s argument to which I had no good answer. I think that newson makes a valid argument regarding the “bubble dynamic” when assets enter reserves that do not liquidate. The value of a home, for instance, can rise to infinity if the monetary base does too. Having physical convertibility places a check on this. And I still say that we allow voluntary market exchanges to occur without substituting our own judgment. Yet we should have a voice in recommending the form of voluntary institutions. And I think that cautioning against the monetization of debts on appreciable property is wise.
Bills of exchange are self-liquidating though. Historically, they were only based upon consumer goods that were most urgently demanded. They can go no higher than the agreed upon amount of gold. It is for this reason that they would not be inflationary. While I think that claims to gold could possibly exchange quick enough (counter Fekete’s assertion), I do not think that it is unreasonable for bills of exchange as money nor to enter the balance sheets of banks. I have never seen an opponent of RBD (Blumen or others) address this principle.
When it comes down to it, my strongest position is simply to stress that we allow voluntary markets to form. Legal tender laws should be repealed. Upon being placed in a position of monetary liberty, you can set up what bank that you like. I’m not convinced (contrary to Fekete) that a 100% gold standard could not work. But we should also account for the fact that there has never been a 100% gold standard. People have always found multiple ways to carry out exchange. If anyone wants to outlaw any kind of voluntary exchange, I can find no agreement.
Published: March 16, 2009 2:36 PM
Joe Stoutenburg
It seems like my links didn't work. Let me try again:
Hultberg
Blumen
Fekete
Published: March 16, 2009 2:41 PM
newson
to joe stoutenburg:
there is no problem whatsoever with the clearing house concept (no monetization). rbd (in the adam smith/fekete model) involves monetizing production goods/inventory.
the fact that bills are short-term, self-liquidating is irrelevant, long-term credits can be constructed with short-term securities.
the important thing to grasp is that rbd allows spending without economizing. the funds that the bank client receives for posting his inventory/or near-finished goods as collateral do not correspond to someone else's belt-tightening. i thought blumen explained that well.
Published: March 16, 2009 9:12 PM
Joe Stoutenburg
newson:
the fact that bills are short-term, self-liquidating is irrelevant, long-term credits can be constructed with short-term securities.
You are straying into territory covered by my professional expertise. I am aware of how short-term securities can be combined with futures or forward contracts to synthesize long-term credits. But that is not at all what we are talking about here. Rolling over short-term securities leaves you exposed only to short term credit. As explained by Fekete, markets for bills of exchange only arose around bills for which the credit risk was minimal.
You'll have to be more concrete if you think that I'm missing something here regarding converting short-term instruments into long term credit.
the important thing to grasp is that rbd allows spending without economizing. the funds that the bank client receives for posting his inventory/or near-finished goods as collateral do not correspond to someone else's belt-tightening. i thought blumen explained that well.
I read all three papers closely and thought that Blumen provided very good arguments to issues that were irrelevant to the positions taken by the other papers. He completely missed the mark. In addition to Blumen's article, have you read the other two? I can not respond better than they (especially Fekete's article) to your claim that the monetization of bills of exchange do not require someone's belt-tightening.
Published: March 17, 2009 8:15 AM
newson
joe stoutenburg says:
"As explained by Fekete, markets for bills of exchange only arose around bills for which the credit risk was minimal."
sounds familiar...similar things were said not so long ago about residential property! if the credit spigot is opened, and the flow directed at short-term, low-risk items, the bubble forms in those items (changing price and therefore risk). of course, the freely available credit for short-term needs frees up other resources that can now be channeled into longer time-frame uses.
i've read fekete some years ago and made my mind up on real bills. but on your invitation i had another look. here's an example of what i mean:
"Strictly speaking a bill of exchange, pejoratively called "real bill" by Milton Friedman following his mentor Lloyd Mints, is not a credit instrument. It is a clearing instrument. It enables the market to clear goods in most urgent demand without needlessly invading the pool of circulating gold coins that would cause monetary contraction..."
flowery language, but wrong. a bill of exchange is a credit instrument. the fact that it may pass through many hands before redemption is irrelevant. there is no monetary contraction necessary in the provision of credit: one person merely transfers the use of money to someone else for a limited period.
Published: March 18, 2009 1:10 AM
Joe Stoutenburg
newson:
similar things were said not so long ago about residential property!
Touche! I yield on that one. We should not miss, though, the strong arm of government in influencing the residential real estate market. Left to its own devices, I am much more willing to trust a spontaneous market institution to manage risk. We all understand that market participants misjudge risk and make mistakes. It seems to only be through the guiding hand of central management that bad risks cluster to impact society as a whole.
Regarding your re-read of Fekete, I see that you took exception to the very first lines of a long paper. I hope that you didn't read those lines, disagree and stop. You did say that you had read him awhile ago and made up your mind. I have to trust that you put in the necessary effort. It's hard to read something thoroughly that you are inclined to reject. Having made up my mind in the opposite to what you have, I was quite into Fekete while reading Blumen was excruciating for me. Maybe you had the opposite experience...
In any case, I don't want to get too far into debating what should be the banking system. It is certain that, if not you, at least many people here insist that 100% reserves is the only acceptable system. I do not hold that position on RBD or any other system. I only insist that, like any market transaction, banking be a matter of voluntary exchange between two or more people.
I see currency backed by bills of exchange as a viable system though I don't follow Fekete all the way when he claims that 100% reserves could not work. In a free market, I think that there could be room for myriad forms of systems. I am sure that some would prove to not work. People who choose to do business with banks in these systems should suffer the consequences of their own judgment. In that way, the market will lead toward the most optimal arrangements as it always tends.
Published: March 18, 2009 8:21 AM
Joe Stoutenburg
That last post contains some of my core positions that I am least likely to abandon. On other matters such as the consequences of this or that form of banking, I am much more fluid and open to change. Indeed, a close reading of my posts on the subject should reveal such.
For the sake of continued argument, I'd like to push you on your bubble concerning short-term obligations.
if the credit spigot is opened, and the flow directed at short-term, low-risk items, the bubble forms in those items
It can be readily seen that monetization of appreciating assets might lead to bubbles. People mortgage their homes and receive new credit. They use that credit to buy other homes. While the original homes are still mortgaged, their values appreciate due to the rising demand in other homes. More is borrowed on the expanded equity of the original homes and the process repeats. While I would be willing to allow a free market institution to manage even that process (as opposed to a government money czar), I can see the pitfalls in such an arrangement.
On the other hand, say that you have a bill of exchange specifying an exchange of goods for a given amount of gold, say 100 oz. The contract specifies delivery within a short time frame of 91 days or less (Fekete explains why 91 days was custom though I don't think that it need be that specifically - only that it be qualitatively short). Just what is it that will form a bubble for these bills? For example, how would they trade for 200 oz of gold one week before expiration?
Again, I see this as a feature of difference between an appreciable assets such as a home and a self-liquidating asset such as a bill of exchange. You made an attempt to respond to the concept of self-liquidation, but your answer did not hold for me. I need you to explain how a bubble can form in such assets.
Published: March 18, 2009 8:46 AM
newson
to joe stoutenberg:
i did quite a bit of reading of fekete years ago when he first started to publish on gold-eagle.com. his appeal to authority (ie adam smith) leaves me cold. rbd leaves me cold. his silly insistence on 91 day-cycles leaves me cold. (mikes sproul's version of rbd is at least free on these nonsensical provisions - if you're attracted to rbd, you should click on his name and read his papers.)
if you can see how the bubble can form in housing via the positive feedback loop, how can you not appreciate it's the same for any asset that is being financed by money created ex nihilo by banks? a 91 day credit can perfectly easily be extinguished and a new one established immediately so that the effective duration is extended (so the "self-liquidating" aspect is immaterial).
"monetization of appreciating assets might lead to bubbles." - you've missed the point. it's the easy availability of credit that causes the appreciation in the first place. frb always creates bubbles, only the object of speculation varies.
fekete (hultberg only rehashes his points) seems to ignore that credit (discounted bills) doesn't have to affect monetary conditions at all. imagine you selling me your car for an iou. if my name is ok, you might be able to sell that iou to someone else, and get the money earlier. you initially economize by giving up the car with only a piece of paper in hand, when you sell the iou at a discount, someone economizes to pay you out etc. at any given point, there is always someone saving to allow someone else to consume.
i'm not going to labor any more on this topic, as it regularly gets aired regularly, except that having a central bank worsens immeasurably all the inherent problems in rbd.
de soto's "money, bank credit and economic cycles" is the best, and most exhaustive work on frb in my opinion.
Published: March 18, 2009 10:04 AM
jp
"I need you to explain how a bubble can form in such assets."
Hi Joe. I would say that convertibility of paper into gold forces discipline on FRB banks. Once one bank begins to overpay for bills of exchange, the branded circulating notes that this bank has issued will be returned to and it will suffer a drop in reserves. This will also affect said bank's most important asset: reputation. Both reputation effects and reserve declines provide discipline that prevent long term speculative bubbles from forming.
In a way, Newson is right that FRB always creates bubbles, but only on the margin. In a free FRB world, it would be a daily occurrence that some banks get aggressive and overpays for collateral, creating a short term bubble. But those efforts by the few will be corrected as their notes are converted to gold the day after.
The only way for large bubbles to be created in a free-banking FRB world is for all banks to begin buying and overpaying for bills of exchange simultaneously and equiproportionately. Because respective proportions of notes in circulation don't change in this scenario, the notes aren't returned to the banks and reserve discipline is short circuited (See Lawrence White on this).
Anti FRBers will often use this argument to campaign against FRB. The problem with this argument is that the only way for simultaneous and proportional increases in money supply to occur is via the formation of FRB bank cartels. In a free market cartels are unstable. Free-riding problems means they are doomed to fail. The only way to get one to work is getting the government to prop it up by force.
Published: March 18, 2009 10:40 AM
Mike Sproul
Newson:
Your example of apparently unbacked paper bills circulating as money would be an arbitrage opportunity for any producer of rival money. Just issue your own (unbacked) currency, make promises to limit the supply of it, and watch the Iraqi's start to use it. This would reduce their demand for dinars, and hence reduce their value. Before starting this process, the issuer of rival money could sell dinars short, and profit from their fall.
Those examples of apparently unbacked currency can be explained by peoples' belief in future backing, acceptance for taxes, or ignorance. It's the same for any financial instrument. You also cited the fact that shells and rocks have value as a refutation of the claim that paper money needs backing to have value. Those things are commodities themselves, and don't need backing.
As for your claim that banks that accept certain goods as collateral will drive up the price of thaose goods, this would imply that banks that accept land as collateral would make land more expensive relative to other goods. A moment's reflection should convince you that relative prices of goods are determined by real forces of supply and demand, and not by a banker's fountain pen. If you mean that the banks will raise all prices (in terms of their currency), that is answered by the fact that an adequately backed currency will hold its value.
Published: March 18, 2009 1:30 PM
newson
jp says:
"In a free market cartels are unstable. Free-riding problems means they are doomed to fail. The only way to get one to work is getting the government to prop it up by force."
whilst i agree with the rest of your post, the inherent frailty of frb banks makes the political pressure for state protection imperative. in an ordinary industry, a cartel-breaker will rob the cartel of profits. in a banking cartel, the first to break ranks and not redeem a fellow-cartel-member's notes puts other institutions at risk of collapse.
Published: March 18, 2009 6:36 PM
newson
mike sproul says:
"Your example of apparently unbacked paper bills circulating as money would be an arbitrage opportunity for any producer of rival money. Just issue your own (unbacked) currency, make promises to limit the supply of it, and watch the Iraqi's start to use it."
this scenario is in conflict with mises' money regression theorem. the swiss dinar originally had some link to a commodity. the sproul dollar does not.
actually it wasn't me who raised the value of rocks or shells as money, but macker.
credit availability can affect supply/demand for discrete items. if fr banks decide to target fountain pens for their collateralized loans, their relative value rises with respect to all other goods and services in the economy, assuming that the loan is made with fiduciary media. if it's not, then of course the increase in pen demand will be offset by a decrease in demand for everything else.
Published: March 19, 2009 2:08 AM