I have given thought to this and I can't find any a priori demonstration that fractional reserve banking is bad. Sure, it multiplies money in the economy and may create inflation, but it might very well be equilibrated with the investment-spending-saving behaviors of the people.
I usually check any issue by asking if it violates some hardcore axiomatic principle, but I can't think of any principle violated by fractional reserve banking.
People who deposit money in a bank already know the money will be used for loans. If they had a problem with that they would put the money in a safe box instead. So there is no moral problem involved.
Then there is the inflationary issue.
Some guy deposits money in the bank, the bank will pay a fee to the first guy (being a intermediary) and could lend all the money at a higher fee to someone else. The second guy uses it to buy a new car for his taxi company. The car dealer will pay for his expenses (including buying more cars) and deposit the rest of the money. The car manufacturer, at his time, will pay his expenses and deposit the surplus. The same will happen with every other person who becomes and indirect receiver of the loan. Most of the money will be flowing through the market, only a small part will be saved. An equilibrium will be achieved sooner or later. The bank (if it expects to recover the money) can only lend to people with guarantees and projects that have a sound plan, which are scarce. The surplus of money in any economy is scarce too. The lending doesn't go on ad infinitum, it will stop at a point that depends on the current situation of the economy.
The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud. Otherwise, he is not.
The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all. The danger for any person making a deposit would be the same as if he was lending it directly to some friend. His friend's project may fail and he may have to execute the guarantee, maybe will lose his money, maybe will have to go to a trial to recover something.
Actually, informal loans could be considered banking operations with a zero-reserve.
So, what's the problem? What am I missing here? Why is everybody against it?
"Success is not the result of spontaneous combustion. You must set yourself on fire." -- Reggie Leach --
(I don't even know who the guy is, I just like the quote)
gussosa: The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud.
The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud.
What you have just described as "fraud" is fractional reserve banking.
gussosa: The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all.
The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all.
"Fractional reserve, as based in fixed term deposits" doesn't make any sense.
μὴ παραχώρει τοῖς κακοῖς ἀλλ' εὐτολμώτερον ἀντιβάδιζε.
It's the fractional reserve system, not fiat, that's the problem - in theory, you could have 100% reserve banking with fiat money, and it wouldn't be a problem. I'm just saying it doesn't make sense to talk about "fractional reserve" on term deposits (even in a strong 100% reserve system, term deposits would have "0% reserves" - it doesn't make sense not to loan that out)
bigwig:If there aren't bank runs (99% of the time), doesn't it mean that depositers would not touch that money and thus allow it to be loaned out in a free market?
Not necessarily, because money can be transferred from one account to another without being withdrawn and redeposited - i.e., it doesn't have to exist to be used in payment. Given Internet banking, etc., a modern bank could allow you to specify how much you want to keep on demand for immediate use and let you put different amounts in various-length term deposits (e.g., they could offer 24 hour, 7 days, 30, 60, 90 days, 6 months, 1, 2, and 5 years, say), where they'd offer continuously varying higher or lower interest rates on each length depending on their need for loanable funds, etc. (I mean the offered rate would vary perhaps several times a day; once you committed some money to it, you'd get whatever rate was offered at that time); when you put some money into, say, a 7 day account, it would disappear from your current balance and be returned (with interest) 7 days later (you could have some sort of calendar display showing your future balances as well as the current balance) - now the banks could legitimately loan out your money (with no reserve requirement!), except whatever you keep on demand (for which you'd pay a fee), and hardly anybody would keep any significant amount on demand, and bank runs would be impossible. But that's not what they do today.
jpk:On the whole, Austro-libertarians just need to accept the FRB weak-link as the price to pay for uniting two grand theories. To assume an entire intellectual edifice to be coherent and non-contradictory is sheer silliness.
There are no contradictions. Check your premises.
In your case, you are arguing that a contract between two consenting adults is ALWAYS legally and morally acceptable.
The situation here is that the person opening and using a transactions deposit is ignorant of the implications of the contract. He doesn't know that he will certainly lose his money if the agreement goes on for a time long enough. Not maybe, certainly. And he doesn't know that he is causing inflation, lowering his own standard of life. He doesn't even need to know, because he is hiring an expert to think for him.
In a Libertarian society, a judge confronted with the case would find the banker guilty of fraud. It was the banker's responsibility to be proficient in his work, of studying all the possible consequences of his actions, and of advising the customer, all according to the state of the art. If an engineer manufactures and sells a boiler without making the necessary quality controls, and then the boiler explodes, he will be prosecuted and sent to prison. Why wouldn't a banker face the same consequences?
I can imagine the defense attorney would claim that everybody is doing the same, but if the prosecutor can prove that there exists at least one methodology that could predict the consequences of FRB and that it was available to the banker, then the banker would be found guilty just because he didn't read (and apply) much enough.
Oh please, this legalism is ridiculous.
scineram: Oh please, this legalism is ridiculous.
As opposed to what, 'I thinks FRB is Okey because it just feels right and its been around for a good long spell'?
Its not our problem that the FRB fanboys can't overcome the small problem that it is impossible for two people to have exclusive control over the exact same good at the exact same time. Legally speaking of course.
Anonymous Coward: scineram: Oh please, this legalism is ridiculous. As opposed to what, 'I thinks FRB is Okey because it just feels right and its been around for a good long spell'? Its not our problem that the FRB fanboys can't overcome the small problem that it is impossible for two people to have exclusive control over the exact same good at the exact same time. Legally speaking of course.
Is it possible for you to loan me money and the maturation date to be when you demand the money? If not why not? Please explain.
Maxliberty:Is it possible for you to loan me money and the maturation date to be when you demand the money? If not why not? Please explain.
The real question here is why you never directly answer a question but always answer with another question?
Yes we know your claim that a demand deposit is a loan but how does that explain why they are the only industry who has a specific immunity from bailment law if a demand deposit isn't a bailment contract?
Which really doesn't matter to the case at hand because if you read the link I posted earlier that is the description of a demand deposit to the T.
It is up to you to prove that a demand deposit is a loan because a few hundred years of custom and (bad) law support my position.
Juan:Let's say I lend you a spade. Now, when you are halfway using it I say : please give it back to me. Do you think that's practical ? You're forced to either leave your work unfinished or default.
So what? This is typical evasion. Practicality has not much to do with legality. Besides demanding the spade too early is not very likely so the problem would be small anyway. I lend dvds or books for unspecified terms all the time. Especially with money which is not for consumption but exchange so I can trade the right of redemption easily for the same effect without the need to actually redeem it.
Anonymous Coward:Yes we know your claim that a demand deposit is a loan but how does that explain why they are the only industry who has a specific immunity from bailment law if a demand deposit isn't a bailment contract?
Do we have to pays storage fee in other industries under a bailment contract?
scineram:Practicality has not much to do with legality.
Well, that's one of the reasons why we are libertarians.
When I gave that example to solve that apparent contradiction in the austro-libertarian theory of banking, it wasn't a ridiculous legalism. It was a prediction of how the case would be handled in a common law environment.
As someone else pointed out, I guess neither you or Max has ever used a bank. Current Accounts (Transactions Deposits, Demand Deposits or whatever you call them) don't pay interests. Call you nearest Santander office and ask them how to open a current account. They ask you for a minimal first time deposit, they charge you for every operation you make with the money and for every check you write. It works just like 3rd party warehouse. They don't rent less than a specified quantity of space and charge you with fees for every time they need to use an employee and/or a forklift to move your things. I know some banks offer to pay interest on demand deposits, but that is not a current account, that is a savings account; which theoretically is an automatically-renewable-24hours-time-deposit or something like that. And they still charge you for every movement you make.
The savings account is bastard hybrid between a demand deposit and a time deposit. That is why it is so hard to understand the working of that kind of accounts.
But I have to repeat: a savings account is not a pure breed demand deposit.
It is the product they usually offer to you first, to have your paycheck deposited and to pay your expenses. At least in my country it falls under the FRB regulations too.
By the way, during 2002, when there was huge bank run in Argentina and Uruguay, the public employees (all from bureaucrats to teachers) almost lost their paychecks precisely because of the FRB. The government arbitrarily decided a year prior to the bank run that the salaries would be paid through two "friendly" banks (state-owned or related to government officials) using savings accounts. They had to bailout (for a short time) one of the banks to guarantee the payment of salaries.
If you are a university student or a teenager probably what you have is a savings account. Then I can understand your confusion.
Maxliberty:What you fail to factor in is that loaning money out is profitable. If the profit rate is greater than the default rate then the deposit which is backing the loan can be insured. This is how insurance works.
Obviously that is not how insurance works or that plan would already be in effect.
Insurance exists for events that can not be planned for. If something is a controllable risk, like business failure, it can not be insured.
If my deposit is insured I no longer have any incentive to make good loans. This is pretty much the exact moral hazard that exists in lending today because of the de facto bailout guarantee.
Hilariously, you are proposing the pyramiding of fractional reserves; the same thing achieved by the FDIC, which "insures" all deposits but is capitalized at 1% of total insured deposits.
scineram: Juan: Let's say I lend you a spade. Now, when you are halfway using it I say : please give it back to me. Do you think that's practical ? You're forced to either leave your work unfinished or default. So what? This is typical evasion.
Juan: Let's say I lend you a spade. Now, when you are halfway using it I say : please give it back to me. Do you think that's practical ? You're forced to either leave your work unfinished or default.
Practicality has not much to do with legality.
scineram: So what? This is typical evasion. Practicality has not much to do with legality. Besides demanding the spade too early is not very likely so the problem would be small anyway. I lend dvds or books for unspecified terms all the time.
So what? This is typical evasion. Practicality has not much to do with legality. Besides demanding the spade too early is not very likely so the problem would be small anyway. I lend dvds or books for unspecified terms all the time.
Books and DVDs aren't a problem - you expect the borrower to have them in his possession the whole time, so they're available when you want them back; at worst, he hasn't finished the book yet, which might be a minor annoyance. Borrowing money under such conditions would be pointless - the whole reason for borrowing it in the first place is to spend it: when you ask for it back, he simply doesn't have access to it.
Paul: scineram: So what? This is typical evasion. Practicality has not much to do with legality. Besides demanding the spade too early is not very likely so the problem would be small anyway. I lend dvds or books for unspecified terms all the time. Books and DVDs aren't a problem - you expect the borrower to have them in his possession the whole time, so they're available when you want them back; at worst, he hasn't finished the book yet, which might be a minor annoyance. Borrowing money under such conditions would be pointless - the whole reason for borrowing it in the first place is to spend it: when you ask for it back, he simply doesn't have access to it.
Actually, I think they're on to something here.
The next time someone at the bar asks me to watch their purse while they go to the restroom or outside to smoke I'm just going to assume they are giving me a short term loan of all the contents of the purse and proceed to buy myself a beer.
It isn't theft since I fully intend to return the money as soon as they ask for it...
Or I guess I can also start borrowing stuff from my friends and pawn it since that would also seem to be fine.
Maxliberty: So I am not free to do with my money as I please. What is the point of a free society if you can't bank where you want?
So I am not free to do with my money as I please. What is the point of a free society if you can't bank where you want?
You are free to do what you want with you money - within the law. You can set it on fire. You can eat it. You can loan it - BUT, you can't have it at the same time you loan it. You can have claim to it, based on the loan contract, at some future time, but you can not have it and loan it at the same time. That is called "having your cake and eating it, too". It doesn't work unless you have two cakes.
Also, you can't spend your money to hire a hit man to kill everyone else who is right. That would violate the law (based on property rights, not just legislation). You can not use your money to buy a printing press and print more money, because that is counterfieting. You can not use your money to buy poisen to destroy someone else's land.
So there are lots of things you can do with your money. There are lots of things you can't do with your money. FRB is fraud and you engaging in fraud is illegal, so FRB is not one of your legal choices.