The Cycle Theory and Banks

Hola Misesians

In the spirit of inquiry, someone clear this up for me:

 

The cause of these cyclical economic crisises, Now, by Austrian Theory, they pinpoint the ultimate cause to coercitive government interference in the economy.

However, my college proffesors (Versed in the Keynesian and Neo-liberals) pinpoint that it be the private banks, along with the State banks that started this whole mess (with their unbacked loans).

 

So what is it then? And where is the proof (and please, in all honesty , are there actually private banks at all involved in this in the first place? I since I do see no reason at all why a private bank would not give excessive loans in the same fashion as a State bank, especially with customers dumb enough to accept such loans).

 

Also, secondary question, what is the earliest economic recession recorded and what caused it?

 

Also a thirdly (now I'm just making stuff up, hehe), is it even possible to go all reductionist in the explaining the cause of economic recession by coercive "state like" interference?

However, my college proffesors (Versed in the Keynesian and Neo-liberals) pinpoint that it be the private banks, along with the State banks that started this whole mess (with their unbacked loans).

your professors are ignoring the principle 'lesson of economics' qua Hazlitt and Bastiat, that of looking beyond the seen to the unseen. just remind them that if government capped milk sales price to 1cent a gallon. there would be a milk shortage. the proximal cause will be evil milk producers not producing enough milk. but would this be an example of free market failure due to the deficiencies of private parties, or would it be an example of government coercing the market place into a disastrous consequence?

 

Well, the fact that "private" banks did have a lot to do with the current recession (and all modern recessions) is undeniable.  But, one should look into just how "private" these banks really are.  Few people realize the role that the Federal Reserve plays in manipulating the banking industry.  It has only been recently that there has been a greater acceptance of the fact that the Federal Reserve holds banks up at the expense of the taxpayer.  In any case, the crux of the issue is not government regulation per sé, as much as it is credit expansion in the banking cartel (cartelized by the government-legislated Federal Reserve).

Andius:

However, my college proffesors (Versed in the Keynesian and Neo-liberals) pinpoint that it be the private banks, along with the State banks that started this whole mess (with their unbacked loans).

Well... you need to challenge them on the private banks point. Banking regulations give the illusion that they are protecting consumers by setting "limits" on how much a bank can lend out and such. In reality, reserve requirements are what makes it possible for banks to lend out more money than they have.

Many Austrians believe that fractional reserve banking is impossible in the free market economy. This becomes obvious if you think of a bank as a money warehouse, where you store your money and they give you checks. In a free market, any time someone spends a check it will eventually end up being deposited in some money warehouse. This money warehouse will attempt to reduce its liability by trading the check for the actual money (be it gold, silver, whatever). In this way fractional reserve banking will never work because banks will be constantly calling in the checks issued by other banks.

Fractional reserve banking CAN occur if we have fiat money that banks can print, and if there is an oligarchy of banks who conspire to corner the market. This is called the Federal Reserve. It is a group of the 12 largest banks that can basically do whatever they want with our money supply because of the Federal Reserve Act passed by Woodrow Wilson who later regretted it, stating that he had turned the nations future over to corrupt bankers. They meet in private and there are no checks and balances. Many people call these private banks, but it should be noted these are not free market banks.

The Federal Reserve has recently set interest rates very very low and saturated the market with credit. Many people have borrowed money because of these low interest rates, including some people who could never expect to be able to pay off the loan. The mainstream tends to focus on these individuals who default on their loans. The real problem is that these loans were made in the first place. Why would a bank lend money to someone who can't pay it back???

The answer is long and complicated. First because of fractional reserve lending and the bank's ability to print more money, their liability is significantly reduced. Secondly, many pieces of legislation like the Community Reinvestment Act forced banks to lend to poor people who wouldn't have otherwise gotten the loan.

There are many detailed and thorough pieces on mises.org about the federal reserve. Look them up and go serve your statist professors

Andius:

The cause of these cyclical economic crisises, Now, by Austrian Theory, they pinpoint the ultimate cause to coercitive government interference in the economy.

In this particular case, they interfered by telling the banks via Freddy and Fannie "lend all you want, we will cover your a ss [bail you out] if something goes wrong.

And I understand they were also pressuring the banks to give risky loans, so that the "unfortunate" could get a house to live in.

Also, they printed tons of paper money to give to the banks to make the loans, another interference.

All this is indeed coercive, cause whose money did they promise to give the banks if things go wrong? Yours and mine, tax money. Did they ask me if I wanted to pay taxes? If I wanted tax money spent that way?

Also it is coercive because by printing new money, they made what is in your wallet and mine worth less. Inflation. Did we ask for inflation? Please make my money worth less?

However, my college proffesors (Versed in the Keynesian and Neo-liberals) pinpoint that it be the private banks, along with the State banks that started this whole mess (with their unbacked loans).

What they say is true, that the banks gave unbacked loans. But isn't it odd that in the past every bank wanted 20% down and proven ability to repay the loan? Why did they all suddenly forget about that? Greed? Were the old time bankers less greedy? Is that the economic explanation their equations came up with? Don't make me laugh.

The answer lies in the earlier comments about govt interference. 

So what is it then? And where is the proof (and please, in all honesty , are there actually private banks at all involved in this in the first place? I since I do see no reason at all why a private bank would not give excessive loans in the same fashion as a State bank, especially with customers dumb enough to accept such loans).

About proof, Uh oh. I cannot yet swim freely enough in the waters of this wonderful site to find you the links, but I am sure others easily can.

Dunno about private banks.

Actually the customers were not dumb, they were smart. They were getting free loans on a free house and all they had to do was promise to pay the loans someday. "I'll pay you as soon as I get a job. Meanwhile I'll live in this big ole house till you get around to kicking me out. And maybe I'll manage to sell it at a profit before you do."

Also, secondary question, what is the earliest economic recession recorded and what caused it?

Dunno, others here do.

Also a thirdly (now I'm just making stuff up, hehe), is it even possible to go all reductionist in the explaining the cause of economic recession by coercive "state like" interference?

Please explain what you mean by go all reductionist

 

Andius:

I do see no reason at all why a private bank would not give excessive loans in the same fashion as a State bank, especially with customers dumb enough to accept such loans

They can. Banks can form cartels and enlarge their size so that the loans(say as bank notes which can be redeemed for specie) they give out will get deposited to either their own, or the cronies' banks. That would help them avoid bankruptcy, since, assuming customers of the bank don't actually ask for specie redemption, banks which belong to a cartel can abstain from asking for specie redemption.

There are two basic caps on excessive credit expansion.

One is rival banks can threaten the solvency of a particular bank by asking for specie redemption. In this case, the rivals have to be quite large enough to actually make the expanding bank collpase.

The other cap is, the economy's cycles fed by the loans of these banks. When crisis strikes, debtors default and the bank can collapse with nervous depositors asking for specie redemption. This can mean disaster for the bank.

But in both cases, I think, banks can prevent bankruptcy by forming a large enough cartel. So the solution is quite tricky!

Prashanth Perumal:

But in both cases, I think, banks can prevent bankruptcy by forming a large enough cartel. So the solution is quite tricky!

You can always keep your money under your bed :P

But in all seriousness, it is so easy to set up a warehouse for goods I don't think that barriers to entering the market are significant. We already have non-fractional reserve banks called the stock market/nymex etc. Each stock you purchase corresponds to an actual physical thing.

Oy, lots of answers here, definately gonna took me a while to process the answers here, but it delights me that the Community Members are willing to aid newcomers in understanding what is taught in here. :)

Also, I am also gonna ask for the sources of where these come from (to insure you have the historcial evidence at your side as well, where history is concerned.)

 

 your professors are ignoring the principle 'lesson of economics' qua Hazlitt and Bastiat, that of looking beyond the seen to the unseen. just remind them that if government capped milk sales price to 1cent a gallon. there would be a milk shortage. the proximal cause will be evil milk producers not producing enough milk. but would this be an example of free market failure due to the deficiencies of private parties, or would it be an example of government coercing the market place into a disastrous consequence? 

I had long suspected that they were looking at only the superficial problem there. A hyperbollic hypothetical example you used there, but such a thing would definately happen for sure. Although that kind of response there does not answer my inquiry, it does make a good opener for the volley of responses I get here.

 

 Well, the fact that "private" banks did have a lot to do with the current recession (and all modern recessions) is undeniable.  But, one should look into just how "private" these banks really are.  Few people realize the role that the Federal Reserve plays in manipulating the banking industry.  It has only been recently that there has been a greater acceptance of the fact that the Federal Reserve holds banks up at the expense of the taxpayer.  In any case, the crux of the issue is not government regulation per sé, as much as it is credit expansion in the banking cartel (cartelized by the government-legislated Federal Reserve). 

 

Aaahhh, I see. That definately solves the matter regarding how these Federal banks tamper with the private ones, and how the private ones end up getting conned by them. But yes, I do comprehend that rampant unbacked credit expansion be a major cause right there. Would it be valid that to say that some of these private banks are legitimately guilty along with the government though?

Also, for the record, what banks do you know of where involved in this Class A atrocity though?

 

 Well... you need to challenge them on the private banks point. Banking regulations give the illusion that they are protecting consumers by setting "limits" on how much a bank can lend out and such. In reality, reserve requirements are what makes it possible for banks to lend out more money than they have.  

Indeed. So with that your saying that, even the stingiest of reserve requirements.... will allow banks to lend out insane amounts still? 0.o. please explain. (How can a bank lend like crazy, even if a government prohibits it, assuming it does that is).

 

 Many Austrians believe that fractional reserve banking is impossible in the free market economy. This becomes obvious if you think of a bank as a money warehouse, where you store your money and they give you checks. In a free market, any time someone spends a check it will eventually end up being deposited in some money warehouse. This money warehouse will attempt to reduce its liability by trading the check for the actual money (be it gold, silver, whatever). In this way fractional reserve banking will never work because banks will be constantly calling in the checks issued by other banks. 

Point taken good sir.

 Fractional reserve banking CAN occur if we have fiat money that banks can print, and if there is an oligarchy of banks who conspire to corner the market. This is called the Federal Reserve. It is a group of the 12 largest banks that can basically do whatever they want with our money supply because of the Federal Reserve Act passed by Woodrow Wilson who later regretted it, stating that he had turned the nations future over to corrupt bankers. They meet in private and there are no checks and balances. Many people call these private banks, but it should be noted these are not free market banks.  

Wow, that I had never known.... I have much to learn (What Wilson smoking when he passed that, too bad he realized all to late). From the Misesian vision, those banks are not really private anymore no? Also, this be limited only to the United States right? Also, from what source is this from may I ask?

 The Federal Reserve has recently set interest rates very very low and saturated the market with credit. Many people have borrowed money because of these low interest rates, including some people who could never expect to be able to pay off the loan. The mainstream tends to focus on these individuals who default on their loans. The real problem is that these loans were made in the first place. Why would a bank lend money to someone who can't pay it back??? 

Point also taken. (And of course, where can I check this claim?)

 The answer is long and complicated. First because of fractional reserve lending and the bank's ability to print more money, their liability is significantly reduced. Secondly, many pieces of legislation like the Community Reinvestment Act forced banks to lend to poor people who wouldn't have otherwise gotten the loan. 

Uy, now THAT I did read about. A class....A... idiocy. And I held that judgement this was long before I became introduced to Austrian Economics (I figured, what a hell of a way to bring down a good number of banks....)

 There are many detailed and thorough pieces on mises.org about the federal reserve. Look them up and go serve your statist professors  

I am confident I will find a good wealth of that literature, as I continue to learn from this noble school.

 

 n this particular case, they interfered by telling the banks via Freddy and Fannie "lend all you want, we will cover your a ss [bail you out] if something goes wrong.

And I understand they were also pressuring the banks to give risky loans, so that the "unfortunate" could get a house to live in.

Also, they printed tons of paper money to give to the banks to make the loans, another interference.

All this is indeed coercive, cause whose money did they promise to give the banks if things go wrong? Yours and mine, tax money. Did they ask me if I wanted to pay taxes? If I wanted tax money spent that way?

Also it is coercive because by printing new money, they made what is in your wallet and mine worth less. Inflation. Did we ask for inflation? Please make my money worth less? 

Most definately agreed right there.

 The answer lies in the earlier comments about govt interference.  

Andius:

Also a thirdly (now I'm just making stuff up, hehe), is it even possible to go all reductionist in the explaining the cause of economic recession by coercive "state like" interference?

After you explained your q, I think you are asking "Is the root of every recession caused by coercive state interference?

Well natural disasters can cause a recession. To use an extreme example, if a giant meteor banged into the USA and destroyed half the country and its resources, that would create a recession. With half the factories and farms gone, there would be far less jobs and higher prices for everything.

But there are also recessions that seem to come out of nowhere. All of a sudden prices of something or other suddenly go up or down for no apparent reason, and to such an extent that the whole economy goes into recession. Those are caused by govt interference. The interference is always that they flood the market with money. [Which is always coercive, as explained in the previous post]. With all that money flying around for the asking, people wind up "investing" in projects that are doomed to fail. When the "investment" fails, the recession begins.

This time around the "investment" was lending money to people to buy houses, who were highly unlikely to repay the loan.

My sources for this? Various readings and tapes with Austrian content, sorry I can't be more specific.

Andius:

Mmhhh I see, but wouldn't that still be a legit move by free market ethics promoted here?

There are differences 'here' as well. So you can't find one coherent opinion on this issue from 'here'. As far as my ethics go, maintenance of full reserve must be considered an important part of legal banking principles and property rights. That's simply because, counterfeiting my money is against my property rights. Allowing a free fractional banking system is akin to allowing counterfeiting, supposedly because it can provide a check on counterfeiting. I don't believe it's a wise idea. Protection of property rights causes proper social coordination. Not the other way round.

Andius:

Mmhhh, I see, but still legit by free market ethics right?

For the free fractional banking supporters, yes!

Andius:

No doubt, but merging two banks can at least insure the survival and well being of those banks that intend to stay on business no?

Merging two banks to escape from the threat of insolvency, caused by credit expansion, is merely a way to cover up the fraud of counterfeiting.

Snowflake:

But in all seriousness, it is so easy to set up a warehouse for goods I don't think that barriers to entering the market are significant. We already have non-fractional reserve banks called the stock market/nymex etc. Each stock you purchase corresponds to an actual physical thing.

Yeah, right! But I wonder how many people would actually be ready for it. People use banks because they feel it's safe to have their money there, than in the investment markets.

Prashanth Perumal:

Yeah, right! But I wonder how many people would actually be ready for it. People use banks because they feel it's safe to have their money there, than in the investment markets.

Right now private banks are noncompetitive with state banks. We don't have all our deposits backed by the FDIC, and there is the illusion that state banks are regulated and therefore trustworthy.

Although I really would like to emphasize that stock brokers do not operate on fractional reserve... and they are basically just holding onto your stock in the same way that banks hold onto your money.

In america, only poor people use USDs. Rich people have free currency in that they put their wealth in stocks and commodities. The whole financial system is designed to screw the poor man as the fed prints more and more money the burden is felt exclusively by the underclass.

Andius:

Also, secondary question, what is the earliest economic recession recorded and what caused it?

Good question - and it very much depends on how you define a recession. You could go back to old Babylon and speculate, that it was the famous Code of Hammurabi that choked its development and contributed to its fall. China has experimented first with fractional reserve banking from the 11th century, but have learned after many failures, that it doesn't work... after some 500 years. Even governments do learn.

The first panic was the Tulip mania, where the Dutch ironically aimed for a sound, 100 percent backed currency. Given the increased influx of gold and silver into Europe at the time, and that all other kingdoms debased their currencies, a large expansion in money supply and a speculative bubble followed. (But it is hard to describe this as a modern recession.)

The modern-time recessions are usually recognized from ~19th century, and it seems that fractional reserve banking has been always their trusted companion. To make sure, you would need to analyze every one of them apart, taking into account other factors - like government intervention (apart from FRB, which can't seem to survive without it anyway).

(Some resources can be found here.)