Fractional reserve banking question

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. 

 

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.

My mistake. I didn't word that one clearly enough. Supposedly, FRB contracts say two things : 1) your money is available on demand 2) if for any reason it is not, then you'll have to wait for some time to get it back. You as a customer agree to these two contractual terms so technically there's no fraud.

Nhaag, I am quoting Rothbard here from America's Great Depression:

"Private banks, it is true, can themselves inflate the money supply
by issuing more claims to standard money (whether gold or
government paper) than they could possibly redeem. A bank
deposit is equivalent to a warehouse receipt for cash, a receipt
which the bank pledges to redeem at any time the customer wishes
to take his money out of the bank’s vaults. The whole system of
“fractional-reserve banking” involves the issuance of receipts
which cannot possibly be redeemed. But Mises has shown that, by
themselves, private banks could not inflate the money supply by a
great deal.22 In the first place, each bank would find its newly

issued uncovered, or “pseudo,” receipts (uncovered by cash) soon
transferred to the clients of other banks, who would call on the
bank for redemption. The narrower the clientele of each bank,
then, the less scope for its issue of pseudo-receipts. All the banks
could join together and agree to expand at the same rate, but such
agreement would be difficult to achieve. Second, the banks would
be limited by the degree to which the public used bank deposits or
notes as against standard cash; and third, they would be limited by
the confidence of the clients in their banks, which could be
wrecked 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 within
narrow limits and would be far less inflationary than Central Bank

manipulation,26 the clearest way of preventing inflation is to outlaw
fractional-reserve banking, and to impose a 100 percent gold
reserve to all notes and deposits. Bank cartels, for example, are not
very likely under unregulated, or “free” banking, but they could
nevertheless occur. Professor Mises, while recognizing the superior
economic merits of 100 percent gold money to free banking,
prefers the latter because 100 percent reserves would concede to
the government control over banking, and government could easily
change these requirements to conform to its inflationist bias.27
But a 100 percent gold reserve requirement would not be just
another administrative control by government; it would be part
and parcel of the general libertarian legal prohibition against
fraud. Everyone except absolute pacifists concedes that violence
against person and property should be outlawed, and that agencies,
operating under this general law, should defend person and property
against attack. Libertarians, advocates of laissez-faire, believe
that “governments” should confine themselves to being defense
agencies only. Fraud is equivalent to theft, for fraud is committed
when one part of an exchange contract is deliberately not fulfilled
after the other’s property has been taken. Banks that issue receipts
to non-existent gold are really committing fraud, because it is then
impossible for all property owners (of claims to gold) to claim their
rightful property. Therefore, prohibition of such practices would
not be an act of government intervention in the free market; it
would be part of the general legal defense of property against attack
which 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.

nhaag:

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. 

 

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?

 

 

I was not arguing morality.  Of course I feel it is immoral that someone else's debt is backed by my child's labor.  It is a clear violation of the free market, liberty, and personal responsibility.  I feel most of what the government now does is clearly immoral...either in the means, the ends, or the lack of authority.

meambobbo:

[...] 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.

First you say: "To me it seems that fractional-reserve banking is simply whenever a bank owes its depositors more money on demand than is available." But later in the very same paragraph you say: "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."

You keep skipping a step in your logic—a really big one. At what point would the claims on the assets of the bank trade as bank notes assuming the bank notes weren't fraudulent? We have money market deposit accounts now. Such deposits don't trade as bank notes. They trade in parallel as a form of checkbook money. They don't trade as money. They never have. This deserves explanation if fractionally-backed bank notes were indeed likely to be a spontaneous product of the free market. And the obvious explanation is that debt will never trade at face value. There's no reason to think it ever would.

meambobbo:

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).

No, it means that there will occasionally be circumstances where people will want to trade warehouse receipts in place of gold, and that they are willing to pay extra for the service in those occasional circumstances when it is indeed a service. It does not mean that bank notes can be used anywhere gold is expected, i.e. that there is "no redemption premium." It depends entirely on the circumstance.

 

hjmaiere, is this what you are saying:

If we trade debt (bank notes) as though it were money, then its being used for exchange in addition to the money it represents being used in exchange, there is increased demand and increased prices?  If the debt is being used for exchange, its underlying assets must not be used for exchange for such a system to retain a stable money supply?

I can see how this is the case.  I think this is different from all debt carrying a premium, however.

You are definitely right about the circumstance-dependency on accepting bank notes.

meambobbo:

hjmaiere, is this what you are saying:

If we trade debt (bank notes) as though it were money, then its being used for exchange in addition to the money it represents being used in exchange, there is increased demand and increased prices?  If the debt is being used for exchange, its underlying assets must not be used for exchange for such a system to retain a stable money supply?

[...]

The main thing I'm saying is that merely trying to talk about what happens when bank debt serves as money presumes that it would sereve as money in the first place. I'm saying that this presumption is false. People have been programmed by a hundred years of institutionally-controlled education to think of it as perfectly normal—so normal that apparently people don't even realize it is a presumption anymore.

I'm not declaring a moral imperative. I'm not saying that "If debt is being used for exchange, its underlying assets must not be used for exchange." I'm saying a debt's underlying asset simply won't be used for exchange unless someone lies or points guns at people. I'm saying that if it is happening, it's exactly because it allows somone to make money on money they don't really have because they've tricked or forced someone into accepting a piece of paper or magic token as if it were money.

 

 

meambobbo:

Nhaag, I am quoting Rothbard here from America's Great Depression:

"Private banks, it is true, can themselves inflate the money supply
by issuing more claims to standard money (whether gold or
government paper) than they could possibly redeem. A bank
deposit is equivalent to a warehouse receipt for cash, a receipt
which the bank pledges to redeem at any time the customer wishes
to take his money out of the bank’s vaults. The whole system of
“fractional-reserve banking” involves the issuance of receipts
which cannot possibly be redeemed. But Mises has shown that, by
themselves, private banks could not inflate the money supply by a
great deal.22 In the first place, each bank would find its newly

issued uncovered, or “pseudo,” receipts (uncovered by cash) soon
transferred to the clients of other banks, who would call on the
bank for redemption. The narrower the clientele of each bank,
then, the less scope for its issue of pseudo-receipts. All the banks
could join together and agree to expand at the same rate, but such
agreement would be difficult to achieve. Second, the banks would
be limited by the degree to which the public used bank deposits or
notes as against standard cash; and third, they would be limited by
the confidence of the clients in their banks, which could be
wrecked 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...

That is my understanding of Rothbards view, I hadn't looked it up before I wrote my comments.

However, I feel that the discussion is kind of oscillating. For sure, fractional reserve banking, not backed by the government has a less inflationary impact, yet, my argument is, that fractional reserve banking is either a no brainer a free market - because the demand for a "warehouse" scheme like this would be pretty low and customers could choose where to store their valuables- or, fractional reserve banking, the way it is implemented today, must be seen as a fraud - because banks today commit to a contract, they are not obliged to follow. Wether the result of such a fraud is socially amiable and beneficial - which I do not believe - or not, doesn't change the act itself being a crime, like the act of taxation is still theft - unless it is voluntary :-).

 

meambobbo:

THEN:

"While unregulated private banking would be checked within
narrow limits and would be far less inflationary than Central Bank

manipulation,26 the clearest way of preventing inflation is to outlaw
fractional-reserve banking, and to impose a 100 percent gold
reserve to all notes and deposits. Bank cartels, for example, are not
very likely under unregulated, or “free” banking, but they could
nevertheless occur. Professor Mises, while recognizing the superior
economic merits of 100 percent gold money to free banking,
prefers the latter because 100 percent reserves would concede to
the government control over banking, and government could easily
change these requirements to conform to its inflationist bias.27
But a 100 percent gold reserve requirement would not be just
another administrative control by government; it would be part
and parcel of the general libertarian legal prohibition against
fraud. Everyone except absolute pacifists concedes that violence
against person and property should be outlawed, and that agencies,
operating under this general law, should defend person and property
against attack. Libertarians, advocates of laissez-faire, believe
that “governments” should confine themselves to being defense
agencies only. Fraud is equivalent to theft, for fraud is committed
when one part of an exchange contract is deliberately not fulfilled
after the other’s property has been taken. Banks that issue receipts
to non-existent gold are really committing fraud, because it is then
impossible for all property owners (of claims to gold) to claim their
rightful property. Therefore, prohibition of such practices would
not be an act of government intervention in the free market; it
would be part of the general legal defense of property against attack
which a free market requires.28, 29"

 

Mises, focused on the preaxeolocigal aspects of the issue. That means, by definition, that no moral principles can be used to either proof nor disaprove. Like in mathematics or logic, there is no moral principle involved. So he simply describes the means and their outcome rather than judging about them using moral priciples.

 

meambobbo:

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.

 

Wow, i would love to hear Rothbard on him supporting government intervention to fix a crime :-)

Rothbard doesn't say a government nor the government. What agency will be used to settle a conflict is open to discuss. There are ways to do that, which not even involve something like a state. What Rothbard says is, as far as I understand him, that fraud is a crime, crime is an aggression, aggression is wrong and requires to be settled. How it is settled is open. The Agressed has the right to force the Agressor to make amends. The Agressed has also the right to just forgive. How the Agressed enforces his claims has no effect, whatsoever, on the cause, being a crime. So no rule is nessecary to explicitly state that FRB is fraud. It simply is. And fraud is aggression. So the law would be in place already.

 

meambobbo:

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.

Yup.

 

 

Have a great time

Sorry, am an imbicile new to this subject and need help, so plse excuse.  Thanx!

I understand how FRB cannot cause inflation PROVIDED that

a)  the underlying asset  (say gold) is always transfered during trade

b) trading with representations of that gold is forbidden.

Let's assume that only gold can be used in trades, and NOT a representation of the gold such as a certificate of ownership of the gold as issued by a bank as a receipt of deposit.  Also assume the bank doesn't issue promises of gold to a borrower, but will only lend out gold directly to them (since only gold can be used when trading).

  For example, person A deposits 100 gold coins at bank and gets a certificate for that 100 gold coins but  no traders will accept his  certificate as a form of currency .  The bank then lends out 80 of these gold coins to person B, keeping 20 in reserve.  They lend him the actual coins and not a representation of the coins. Person B then trades using these real gold coins (as he must in this example), eventually all coins returning to banks.  Hence No inflation.

In this example, why not replace the 100 gold coins  with a 100 square pieces of special, unforgable paper? 

So people trade directly with these paper squares and bank them identically as in the previous example.  Only these square pieces of paper can be used directly when trading, and not a representation of these square pieces of paper. Isn't that the system we already have, hence yielding no inflation?

No, you need to go back to the origin of money. Money is the most widely exchangeable good. People accept gold as the medium of exchange because it is widely desired. Paper isn't. The current system treats money as backed by debt, which is to say future promises to repay in terms of... more paper money. So the current system is by no means analogous.

-Jon

Thanks,

Incidentally i have never understood what currency represents.  If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me.

Perhaps i have misunderstood you, but if a 'non backed' bank note represents a future promise to repay with another  'non backed' bank note, then surely a bank note represents its own value, and not some particular underlying physical asset.

In the same way that a gold coin is 'non backed' in that it represents itself,  and not some particular underlying asset.

Surely, in neither system can inflation occur via FRB alone, assuming of course, that in the case of the gold system that gold promisory notes, and gold receipts for the same bar of gold as well as the bar of gold itself are not in circulation simultanously.  In the case of non-backed paper currency, this situation surely cannot arise, since the 'valuable' paper is traded directly and isn't represented for a second time in  'higher level receipt currency' in circulation (apart from say cheque book money that would bounce if the situation occured).

In neither system is there some underlying asset being represented more than once by the currency.

perhaps i should do more reading because I still remain confused and unconvinced.

confuse a cat:

Incidentally i have never understood what currency represents.  If you gave me a gold bar, i'd only have appreciated it in terms of how many paper squares it got me.

Here is the advantage of gold as money over paper as money.

Right now, the price of gold is $920/ounce.  If you offered to swap me 46 Federal Reserve Notes labeled '$20' for an ounce of gold, I'd say "fair trade", either way.

Two years from now, suppose the price of gold is $1500/ounce.  If you then offered to swap me 75 Federal Reserve Notes labeled '$20' for an ounce of gold, I'd say "fair trade".

What happened?  Did your gold magically become more valuable?  Or, did someone print more pieces of paper, driving down their value?

As another example, suppose you offered to trade me 0.3 ounces of silver for a gallon of gasoline.  Right now, that's pretty close to a fair trade.  If you attempt the same trade two years from now, it will probably still be reasonable.  Do you expect to be able to buy a gallon of gasoline for $5 two years from now?

Gold and silver keep their purchasing power over time, but pieces of paper do not.  The people who print the pieces of paper like printing more of them and giving them to their friends.  That's a pretty sweet scam they're running!  However, you can't just print more gold and silver.

Money supply inflation is literally stealing the purchasing power out of your pocket and bank account.  The nominal value of your money stays the same, but the amount of wealth it represents decreases.