I was reading a debate between two people who disagreed on whether fractional reserve banking was bad. I wanted to get to the root of why it is bad. Would it be correct to say it's only bad to the extent that it requires the central bank to print more money to meet redemption requests? For example, if I deposit $100 in a bank that lends $90 of it to someone who spends it on a product and the seller of the product then deposits the $90 in another bank, as long as I don't redeem my deposit before the loan is repaid, the central bank doesn't have to print money and lend it to my bank in order to repay me, right? Or is this an impossible situation because the loan cannot be repaid without some sort of monetary expansion in order for the borrower of the $90 to cover the interest that accrues on the principal? Thanks!
histhasthai: That wasn't my point at all, it was only that you seemed to be implying that the rise in prices would be based deterministically by the inflation of the currency, and that that is, as far as I know, counter to Austrian theory.
So you can apply a formula to an inflated currency and know the exact level of prices it would produce? If I'm not mistaken, that runs counter to Mises.
"Fraud" is value-free?
I object because "fraud" is the only argument I hear here,
after explicitly positing a non-fraudulent context.
DriftWood: Yes, its the govt intervention that is bad, not the private free market fractional reserve banks. Banks have no effect on prices, as banks only lend money from one person to another. No money is created, only debt is created. And thats not money. People dont need banks as the middle man to create debt, but its easier that way. So the banks dont have an effect on prices, and they sure cant control any prices. Banks and FRB is not to blame anything. [...]
Yes, its the govt intervention that is bad, not the private free market fractional reserve banks. Banks have no effect on prices, as banks only lend money from one person to another. No money is created, only debt is created. And thats not money. People dont need banks as the middle man to create debt, but its easier that way. So the banks dont have an effect on prices, and they sure cant control any prices. Banks and FRB is not to blame anything.
[...]
It's not at all clear that you understand what fractional-reserve banking is. When receipts on demand deposits loaned or invested still function as money, they do so fraudulently, and it is inflationary. This is fractional-reserve banking, and it is not a sustainable business practice under free-market conditions.
The banking interests have spent over a hundred years trying to pretend that fractional-reserve banking is a natural product of the free market and is only harmful to the economy when it isn't properly regulated by the government. Any honest study of history clearly shows that this is blatantly false—flat-out backwards even. But the last thing you'll get in a government-financed education is an honest study of history.
One thing I've found extremely education is buying old books on economics. It allows you to see how the propaganda has been consciously shaped and reshaped over the course of time. I already mentioned a book from the 1920s on savings and investment. It describes exactly what some people here claim is the natural function of a bank that supposedly leads to fractional-reserve banking, only in this case nothing like fractional-reserve banking came close to happening. I also have a book from the 1950s put out by the Federal Reserve itself. It describes the function of the Federal Reserve as providing 'elasticity' in the money supply. Nothing about price stability. Nothing about targeted inflation rates. Those only came later as the then-current excuse for the Fed's existence no longer fooled anybody. I also have books by Garet Garrett and others that make it clear that there were plenty of people that weren't fooled for a second by that charlatan John Maynard Keynes. It took a whole lot of deliberate promotion of his theories by the establishment to push asside people's understanding that it is always only government intervention in the markets that causes economic depressions.
No one seems to care that it is the bankers themselves that write the laws on banking. No one seems to notice that, for example, Henry Paulson, former chair and CEO of the freakishly successful investment bank Goldman Sachs, is the Secretary of the United States Treasury, and that this kind of cozy relationship between the banks and the government has been par-for-the-course for the last several hundred years. People know that Bush and Cheney are oil men, but the true parasitic nature of money and banking seems to be beyond everyone's grasp.
Here's something I've been thinking about for the last few months: What if there were people who understood Austrian economics just as well as the schollars associated with the Mises Institute, but had no interest in its moral implications? What if, instead, they merely wanted to apply this knowledge to their own advantage? What would a predator like that in a position of influence do? But that's for another thread...
There is allot of confusion about fractional reserve banking.. fractional reserve banking is a free market investion, it would work even under a gold coin system, without expanding money supply.
When you deposit money with a bank, and the banks lends out that monet. It might appear that the money supply has increased because two people have claim to the same money. However that is confusing, money with debt. I'll paste the following from another thread i wrote..
You have to remember that this other person that spent your money is now in debt to you. He will pay you back the full amount, and then some (interest). So when he spends your money, your no longer have any money in the bank. What you are left with is a note that says "Hi. I noticed you where not using your money, so I took it and spent it. Dont worry though, I'll give you back the money, and a little for your trouble whenever you want". Ofcourse, that is a simplification.. what really is going on is that all the depositors money is put into the same pool of money, the overall money in the pool stays much the same.. sometimes one depositors take out all their money, but they dont all do it at the same time.. which means that there always is lots of money in the pool gathering dust. So what they do is let borrowers, borrow money from that pool. When the borrowers make mortage payments, they put money back into the pool.. eventually every borrower will have put back all the money they borrowed into the pool and then some (interest). You see? There is always enough money in the pool to cover the random withdrawl request by depositors.
Dont get confused though, no money is created here. Its just a creative and innovative way of lending money. Both lenders and borrowers preferr this way of lending as it is less restrictive, more efficient and therefore cheaper. Imagine if you had $100 you wanted to lend out. Would you rather lend it out signing a contract that read "you will get back your money this time next year, and you will make one years worth of interst." Or would you rather sign a contract that read "you will get back your money whenever you want it, and you will get paid interest depending on however long your money was lent out". You see, the second contract is much better for you. You can decide that you want back your lent out money at any time. This is what happens with your money when you keep it with a bank. All your life savings have been lent out to other people, who have spent it already. However this does not matter as all the borrowers of the bank are paying back their loand to the bank on a regular basis. There are so many of them, that the bank always has enough money in its vaults to pay you back your money whenever you needed it.
But what about bank runs? What happens if all depositors requested their money back at the same time. This is rare, but sound banks have nothing to fear. They can always raise money by selling assets. What assets does a bank have? Its got lots of those borrowers that keep paying back mortages every month. Thats a bond that pays x percent of interest a year. It can sell that on the open market and raise money. It could seel all its mortage backed bonds, and if the bank had not undervalued the price of risk involved with its borrowers, then it could raise enough money to pay back all the depositors at once. A bank only has to fear a bank run if it prices risk incorrectly, that is if it loans out money to risky borrowers at a low interest rate.
You see? This system would work just fine even under a gold coins system. Its just another way to lend out money, no money is created in the process.
Cheers
DriftWood: Would you rather lend it out signing a contract that read"you will get back your money this time next year, and you will make one years worth of interst."
Or would you rather sign a contract that read "you will get back your money whenever you want it, and you will get paid interest depending on however long your money was lent out".
You see, the second contract is much better for you.
But what about bank runs?
What happens if all depositors requested their money back at the same time.
Juan: DriftWood: Would you rather lend it out signing a contract that read"you will get back your money this time next year, and you will make one years worth of interst." A legitimate contract.
This system actually existed. It was called a "Bill of Exchange". It's also referred to as the "Real Bills Doctrine", which says that new money created in this manner isn't inflationary, if the loans are backed by tangible goods.
If you have a piece of paper that says "I promise to pay 1000 ounces of gold in 1 year", then you can trade that piece of paper as if it were actual money, provided the issuer is trusted. If interest rates are 4%, then "I promise to pay 1000 ounces of gold in 1 year" is worth 961 ounces of gold right now. The interest rate of 4% was known as the "Discount Rate" (which is different than how the Federal Reserve uses it now.) In a free market, interest rates are usually pretty stable.
The Bills of Exchange system worked great until 1913, when the Federal Reserve was created and destroyed the system. The Bill of Exchange system was a great way for small businesses to raise/invest surplus capital. The central bank credit monopoly destroyed this free market financing mechanism. A central bank offers negative real interest rates, which means that it's always cheaper to borrow from a bank than from another individual.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
fsk: Juan: DriftWood: Would you rather lend it out signing a contract that read"you will get back your money this time next year, and you will make one years worth of interst." A legitimate contract. This system actually existed. It was called a "Bill of Exchange". It's also referred to as the "Real Bills Doctrine",
hjmaiere: Here's something I've been thinking about for the last few months: What if there were people who understood Austrian economics just as well as the scholars associated with the Mises Institute, but had no interest in its moral implications?
Nope there is no fraud unless the bank actually breaks its contract of redemability on demand. All the contract says is that the bank will pay back the money on request, nowhere in the contract does it say what the bank may or may not do with the money in the meantime. If the bank breaks its contract, you can take it to court, and sue it. Its not your problem how the bank manages to keep its part of the deal. As long as it kees its deal, you dont care. A bank that can not keep its contracts, will nor only loose its reputation and trust, it will also loose its business and fail. Most big banks have been around for over a hundred years, wich means they are good at the balancing act that is fractional reserve banking. The size of their reserves and their pricing of risk has been good enough to avoid failing on its contract of paying back deposited money on request.
Saying that it is a fraud, even if the bank is able to keep its contract of redemability on demand.. is a very unlibertarian idea. (Peoples actions should be judged by its consequences, we dont have the right to regulating other peoples behaviour because we think it might prevent crime. A victimless crime, is no crime at all. A contract that is not broken, is not fraud.)
DriftWood:Nope there is no fraud unless the bank actually breaks its contract of redemability on demand. All the contract says is that the bank will pay back the money on request, nowhere in the contract does it say what the bank may or may not do with the money in the meantime. If the bank breaks its contract, you can take it to court, and sue it. Its not your problem how the bank manages to keep its part of the deal. As long as it kees its deal, you dont care. A bank that can not keep its contracts, will nor only loose its reputation and trust, it will also loose its business and fail. Most big banks have been around for over a hundred years, wich means they are good at the balancing act that is fractional reserve banking. The size of their reserves and their pricing of risk has been good enough to avoid failing on its contract of paying back deposited money on request.
Ok, my turn.
You're missing the reality of free banking competition. I do in fact care how my deposits are handled. Suing an insolvent organization after my savings are lost doesn't help me. You can't squeeze blood from a fradulent stone.
In a free banking environment, I don't know how FRB would be priced, and thus, I doubt it would be easy or cost effective to get deposit insurance. What sort of insurance company would insure against insolvency, when insolvency is the business model of the bank?
To say that it's not my problem how the bank manages my savings is very silly. The only reason why banks have managed fractional reserve banking for the last 100 odd years, are legal tender laws, which make the fiat paper money, the coin of the realm, and true metallic money, illegal.
I would make a great bureaucrat. Wanna see? Click here. It's fun.
DriftWood:All the contract says is that the bank will pay back the money on request, nowhere in the contract does it say what the bank may or may not do with the money in the meantime.
Please, for the love of all that is Good, address bailment law which directly applies to this theory of bank control of customer's deposits.
Without showing how money is different than any other goods under a warehouse contract (which a timed deposit isn't) then you are really saying nothing here but are only demonstrating your ignorance of FRB.
DriftWood:Saying that it is a fraud, even if the bank is able to keep its contract of redemability on demand.. is a very unlibertarian idea. (Peoples actions should be judged by its consequences, we dont have the right to regulating other peoples behaviour because we think it might prevent crime. A victimless crime, is no crime at all. A contract that is not broken, is not fraud.)
Except when it is fraud and the customer has to sue the bank.
According to this theory I should be able to fire a loaded gun into a crowd and as long as I don't hit anyone or cause any real property damage I will be free and clear. The 'no harm, no foul' libertarian justice system I suppose which, as you posted in another thread, could only lead to Civil War.
Hmm...I wonder how your Authoritarian Monopoly Justice System would deal with someone who fired a loaded weapon into a crowd but didn't hit anyone?
----edit----
Added a clicky link so you will hopefully quit dodging the question.