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!
meambobbo: Unbacked bank notes is not the same thing as FRB, in my mind. [...]
Unbacked bank notes is not the same thing as FRB, in my mind. [...]
You're just trying to redefine what it means for a bank note to be 'backed.' Fractional-reserve bank notes are bank notes that are supposed to be redeemable on demand, but are only fractionally-backed by reserve deposits. Fractional-reserve bank notes are by definition at least partially unbacked.
Someone may hand you an IOU for money you give them, but if they do anything besides contractually store that money for you, your IOU is still only an IOU. Different people and institutions might be more or less deserving of credit, but it's based on how likely they will be to pay back that debt, not what they specifically do with it. Your entirely artificial distinction between 'genuine' credit and presumably 'non-genuine' credit does not magically turn unbacked bank notes into backed bank notes. I don't care how credit-worthy the issuee is. Credit is credit. Absent fraud or coercion, credit and bank notes are two entirely different things and the market will treat them like two entirely different things.
In other words, what you have to explain is this: Why on earth would an actual, typical human being in the real world take an IOU and expect to be able to spend it at face value to buy beer and pretzels at the local convenience store? It simply ain't gonna happen. Don't believe me? Try it for yourself. And keep in mind that Federal Reserve notes are not IOUs. They are stay-out-of-jail tokens. There's a big difference.
meambobbo: Juan, I am not sure I understand what ordinary banking is by these terms.
If I put 1 oz of gold in the bank, and they lend out .5 oz, that's fractional reserve banking, but they're using real wealth to make their loans.
Juan: [...] Now FRB seems to be a mix of the two. But does such a system make sense ? Under FRB, deposits are contractually available on demand, BUT there's a very real chance that they will 'magically' morph into timed deposits. If the bank keeps 50% of reserves, then I would say that the probability of your deposit being available on demand is only 50%. As LibertyStudent said, this sounds more like lottery than banking. Yes, if you like such a mix of lottery and banking, then you are free to use such a system and FR bankers are free to provide it, but as a system, it doesn't make much sense, to me at least.
[...] Now FRB seems to be a mix of the two. But does such a system make sense ? Under FRB, deposits are contractually available on demand, BUT there's a very real chance that they will 'magically' morph into timed deposits. If the bank keeps 50% of reserves, then I would say that the probability of your deposit being available on demand is only 50%. As LibertyStudent said, this sounds more like lottery than banking. Yes, if you like such a mix of lottery and banking, then you are free to use such a system and FR bankers are free to provide it, but as a system, it doesn't make much sense, to me at least.
So this seems to describe the way money market accounts could in theory work under free-market conditions—albeit in some heavily restricted form. And I could imagine being able to write checks on such accounts. The unstated, but real goal behind fractional-reserve banking is the ability to effectively 'lend' gold to more than one person at a time, to make more interest than they can when money is restricted to one owner at a time. Money market accounts don't accomplish this, which is why what they really want is fractional-reserve bank notes in particular. Of course this is something you or I as private citizens would never be allowed to get away with.
DriftWood: Fractional reserve banking is a free market invention. It would exist even under pure cold coin system. It has nothing to do with central banks or inflating money supply. If you lend me money, on the promise that you will get back the money on request.. i can do whatever i want with the money in the mean time. I can lend it out or invest it. As long as Invest it profitably as opposed to waste the money. I will be able to give you back your money on request. Fractional reserve banking is lending out short term loans to long term borrowers. It works because many short time lenders, as a whole behave as one long time lender. As long as the bank does not lend out money to people who will not be able to pay back.. the bank is sound and everyone that has lent the bank its money will get back their money.
Fractional reserve banking is a free market invention. It would exist even under pure cold coin system. It has nothing to do with central banks or inflating money supply. If you lend me money, on the promise that you will get back the money on request.. i can do whatever i want with the money in the mean time. I can lend it out or invest it. As long as Invest it profitably as opposed to waste the money. I will be able to give you back your money on request. Fractional reserve banking is lending out short term loans to long term borrowers. It works because many short time lenders, as a whole behave as one long time lender. As long as the bank does not lend out money to people who will not be able to pay back.. the bank is sound and everyone that has lent the bank its money will get back their money.
Well, I would say you just decribed a criminal act of counterfitting :-)
Fractional banking is not if someone lends a bank money for a profit and a certain time in which the bank can make use of the money at its preference.
In fact, banks offer different services that can not be placed into one big bag and handled as if it was the same thing. The criminal thing is that banks loan out money that is redeemable on sight. Which is true for your checking account,no? If you put money in a checking account, you sure belief that you can redeem it any time you want. So in principle the banks stores your money for you. You do not give it to the bank and agree that the bank can loan it out to someone else. This is what you argree upon when you open a savings account. Here, you can not withdraw all your money at once, but you have to keep a certain amount of it at the discretion of the bank.
But what fractional reserve means is that only a fraction of the money a bank agrees to be redeemable any time, is held actually in store, while the most part is loaned out and could never be used to redeem all of the customers with checking accounts if they would ask to redeem all at the same time.
Now, If i was responsible for the petty cash in my department and I knew, that the next time the supervisor will controll the petty cash is, say, 6 weeks ahead, is it not theft, if I took money out of the petty cash, willing to return it before the next control? If not, why not? Is theft only theft, when someone else realizes it? That would be a cool concept :-)
Yet, exactly this is, what the banks do with the checking accounts. They trust that noone realizes, the money isn't really in the vault. I would say, that is a crime, because they openly engage in theft.
I do not think that either Mises nor, especially Rothard, would have agreed to "some kind of" fractional reserve banking. First of all it is the question of redeemability. There is nothing wrong with a contract that gives a right to the bank to use part of the deposit for their purposes. This has not been doubted by anyone posting to this thread.
I remember the petty cash example here. If I agreed to be responsible for the petty cash of my company, I am not allowed to take out any funds from it for personal use, just because I know that the next revision is only due 2 week ahead, and I can put the money back in less than a week. It is still theft.
If i was allowed to withdraw money from the petty cash, and was only to ensure that the money is in the petty cash at the next revision date, it would just be another contract.
The point with FRB is not that banks can't do it, they can, given they let the costumers know and agree. The point is that they have an obligation to keep their hands off my petty cash all the time because that is what they agreed upon by telling me that it is redeemable any time - not in a day or so, but when I show up to withdraw -.
As it stands today, FRB is simply legalized fraud. And the safefty deposit argument goes not very far, because you do not get a reciept about what is in your safety deposit, so there is no chance to exchange the reciepts - bank notes - of safety deposits, which would render them useless as a medium of exchange.
Well, and the mentioning that you can loose your property by other ways than depositing in a bank is just funny. So, theft is no theft because you can also be robbed?
Juan: Yes, maybe you signed a contract that says that your money is available on demand but if somehow is not, then you get a timed deposit. Fine, I see no 'formal' problem with that, but on the other hand I don't think such a contract makes sense.
Well, the "formal" problem is fraud. If I sign a contract and the counterpart is aware of not being able to deliver his part of the obligation I would call that "formal" fraud.
If you as a customer accept this, so be it. You are free to do so. You are also free to accept theft and any other crime. But that doesn't change the quality of the action, which is a crime.
You seem to say, that it is acceptable for a party to arbitrary change the conditions of a contract, in case it can not fulfill it? I was used to think that there is, at least, an agreement between the contractors required? Why should the rest of the business world keep contracts, while banks do not have to? If You made a contract with a building company to build your house, what would you say if they came up, after you paid, and tell you, "sorry but our funds are not sufficient to build the roof". You wait until they have the funds, meanwhile standing in the rain? I doubt it? Why would you allow banks to engage in exactly the same behaviour, without any risk of being sued?
meambobbo: Juan, there is no such thing as fictional reserve banking - even our fiat money is backed by something (although far not enough so maybe you're right). It is backed by the federal government's ability to tax our future economy.
Juan, there is no such thing as fictional reserve banking - even our fiat money is backed by something (although far not enough so maybe you're right). It is backed by the federal government's ability to tax our future economy.
This is to say our money is backed by the power of the state to coerce people to work as part-time forced laborers?
Well, one can argue that way, but than you have to agree that banking is as imoral as a state that finds the funds it can steal of todays citizens insufficient and promises to steal more from the future generations?
nhaag: Juan: Yes, maybe you signed a contract that says that your money is available on demand but if somehow is not, then you get a timed deposit. Fine, I see no 'formal' problem with that, but on the other hand I don't think such a contract makes sense. Well, the "formal" problem is fraud. If I sign a contract and the counterpart is aware of not being able to deliver his part of the obligation I would call that "formal" fraud.
Nhaag, I am quoting Rothbard here from America's Great Depression:
"Private banks, it is true, can themselves inflate the money supplyby issuing more claims to standard money (whether gold orgovernment paper) than they could possibly redeem. A bankdeposit is equivalent to a warehouse receipt for cash, a receiptwhich the bank pledges to redeem at any time the customer wishesto take his money out of the bank’s vaults. The whole system of“fractional-reserve banking” involves the issuance of receiptswhich cannot possibly be redeemed. But Mises has shown that, bythemselves, private banks could not inflate the money supply by agreat deal.22 In the first place, each bank would find its newly
issued uncovered, or “pseudo,” receipts (uncovered by cash) soontransferred to the clients of other banks, who would call on thebank for redemption. The narrower the clientele of each bank,then, the less scope for its issue of pseudo-receipts. All the bankscould join together and agree to expand at the same rate, but suchagreement would be difficult to achieve. Second, the banks wouldbe limited by the degree to which the public used bank deposits ornotes as against standard cash; and third, they would be limited bythe confidence of the clients in their banks, which could bewrecked by runs at any time."
He then goes on about how government intervention has institutionalized inflationary fractional reserve banking, protecting it from the market using violence. He describes the FED, etc...
THEN:
"While unregulated private banking would be checked withinnarrow limits and would be far less inflationary than Central Bank
manipulation,26 the clearest way of preventing inflation is to outlawfractional-reserve banking, and to impose a 100 percent goldreserve to all notes and deposits. Bank cartels, for example, are notvery likely under unregulated, or “free” banking, but they couldnevertheless occur. Professor Mises, while recognizing the superioreconomic merits of 100 percent gold money to free banking,prefers the latter because 100 percent reserves would concede tothe government control over banking, and government could easilychange these requirements to conform to its inflationist bias.27But a 100 percent gold reserve requirement would not be justanother administrative control by government; it would be partand parcel of the general libertarian legal prohibition againstfraud. Everyone except absolute pacifists concedes that violenceagainst person and property should be outlawed, and that agencies,operating under this general law, should defend person and propertyagainst attack. Libertarians, advocates of laissez-faire, believethat “governments” should confine themselves to being defenseagencies only. Fraud is equivalent to theft, for fraud is committedwhen one part of an exchange contract is deliberately not fulfilledafter the other’s property has been taken. Banks that issue receiptsto non-existent gold are really committing fraud, because it is thenimpossible for all property owners (of claims to gold) to claim theirrightful property. Therefore, prohibition of such practices wouldnot be an act of government intervention in the free market; itwould be part of the general legal defense of property against attackwhich a free market requires.28, 29"
So I am right about Mises's tolerance. Rothbard disagrees.
BUT how does Rothbard want to enforce this? A regulated banking sector? An agreement to audits? Going back to the petty cash example, how do you know if the petty cash has been spent outside the business if you're not going to check it?
It seems these things will only be discovered at the same time that problems arise: depositors cannot redeem their deposits/a legitimate use for petty cash has arisen but there is none available. Even if we chose instead to use a system of agreed upon audits, possibly random, possibly completely 3rd-party, the outcome is similar. If the audit found a bank in breach, confidence in the bank would crumble, and you'd get a bank run.
Mises and Rothbard's positions aren't that different. Mises believes the market will prevent fraudulent fractional reserve banking, while Rothbard believes the government should (or simply enforce the fraud). Of course, Rothbard would more likely say A government, than THE government.
I feel this discussion is breaking down. I am becoming confused about what we are talking about. To me it seems that fractional-reserve banking is simply whenever a bank owes its depositors more money on demand than is available. But this isn't inflationary if the bank is not creating claims to wealth it does not and never had. If the bank is simply lending out of its deposits, it has a finite amount of genuine credit that it can loan. Even if there is a bank run it cannot fulfill, it still holds debt that should amount to greater than what it owes. In the absence of a loss of confidence in such an institution, its bank notes should still exchange at a nearly exact value as the gold they claim to represent.
What seems to be getting thrown into the mix is artificial credit. This is unlimited. This is inflationary. If I'm a bank who has received $500 in deposits, I can still create claims to $10.0 x 10^9,999 and loan these out. I can make bank notes to my heart's content. This is much more similar to our current system than the free banking system, although the banks themselves don't want to continually inflate at a break-neck pace. This would destroy the real value of their outstanding loans and additionally collapse the system. Regardless, fractional reserve banking and artificial credit are two different things, although one follows the other (IMO).
As far as fraud is concerned, is the bank offering to store money as a werehouse or serve as an investment broker? This can become quite watered down by the fine print. Obviously, your deposit can't be risked and guaranteed simultaneously; but when there are many, many deposits functioning as such, there is the appearance that this is the case. The fine print may clear up what is actually going on. Many of these online digital gold/silver currencies/funds are not truly backed by gold/silver. Yet, it is not fraud if that's what the fine print says. From what I've seen, e-gold seems to be the only one that has audits (although not conducted by an independent agency) and has survived a virtual bank run. I am going to try to get an account agreement from a regular bank to see what their fine print says about this issue. However, it will probably be fruitless because even if it is clearly fraud, the government will not enforce it. The system is designed to prevent such anyway, as it is nearly impossible to conduct a bank run where a depositor is not given his nominal amount...of course, to do so means to debase the *** out of the currency. In any case, the existence of the FDIC seems to suggest the government wouldn't acknowledge fraud.
It seems to me artificial credit (creating claims to wealth that does not exist) is ALWAYS fraudulent, while FRB is SOMETIMES fraudulent, depending upon the agreement between depositor and bank.
As far as I'm concerned, I don't care if we have free banking or regulated 100% reserves for demand deposits. I believe both systems will prevent the (widespread) creation of artificial credit. Our more pressing goal should be to restore some unit of value to our currency. I like Ron Paul's plan best: simply legalize competition - remove (unconstitutional) legal tender laws, remove (unconstitutional) prohibitions of private minting and/or alternative currencies, and remove sales and capital gains taxes from gold and silver.
I went back and re-read Rothbard's What Has Government Done to our Money, and I was wrong about his feelings on werehousing money and using the receipts as mediums of exchange. But he does state that such was done because transporting and exchanging actual precious metals was less convenient. This would mean there is no redemption premium for bank notes; in fact, it implies the opposite (unless the market generally preferred using physical gold over banks).
However, both Mises and Rothbard believed that the only means to get from simple werehousing to unending fraud and artificial credit was government alliance with banking.
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