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This is a rephrasing of an earlier question that kind of veered off into 'is fractional reserve banking a fraud' direction. I'm studying Austrian Economics and trying to understand how a full reserve banking system avoids the business cycle when time deposits seem to suffer the same shortcomings as fractional reserve banking. So let me present my understanding of how money is created in a fractional banking system, how time deposits work in Austrian Theory, and hopefully someone can point out where I have taken a wrong turn.
In Fractional Reserve Banking, money is 'created' when a bank loans out a deposit and that deposit finds its' way back into the banking system to be loaned out again, minus the fractional reserve requirement. For example, a $1000 deposit in a 10% reserve requirement system supports an initial loan of $900. That loan finds its way back into the banking system when the borrower purchases whatever and the sellers deposit the proceeds. There is now an additional $900 in deposits, supporting $810 in loans, which goes through the same cycle until the original $1000 deposit supports a total number of loans equivalent to ( $1000 + $910 + $819 + etc) = $10,000. More accurately, it is probably a little less as at each iteration some of the money is held as cash.
In Austrian Economics there is no lending of demand deposits, only time deposits. Presumably, there is no reserve requirement for time deposits though it doesn't really matter. Now let's say someone walks into a bank with a lucky $1,000 gold piece with what looks like a horse shoe scratched into its face. He deposits the coin into a one year time deposit and goes off on his merry way. A couple of minutes later, the bank loans this $1,000 gold coin to a customer, who goes out and purchases an ice cream machine with that coin. The ice cream machine maker rushes over to the bank and deposits the lucky $1,000 gold coin into a one year time deposit. Seconds later, the bank loans the same coin to another customer who runs out and uses the lucky coin to put a down payment on an organ grinder. The organ grinder maker rushes over to the bank and deposits the same coin into a one year time deposit. Moments later, the bank lends the very same coin to a customer who hires a barber to give him the world's most awesome haircut, the same one John Edwards got. The barber then rushes to the bank and deposits the lucky coin, which the bank loans out.
It seems to me that this one lucky coin and one deposit of $1,000 is ultimately supporting the same pyramiding of loans as fractional reserve banking and the same creation of money limited instead of by fractional requirements, the amount that each person decides to hold in demand deposits instead of timed deposits and could be greater or lesser depending on the preference for time deposits to demand deposits.
If this is the case, then we are in fact back at the same starting point of credit creating money and therefore the business cycle.
So my question is what am I missing or getting wrong in Austrian FRB Theory? Someone referenced Soto earlier implying that this was a correct understanding, but I don't pretend to know. I'm just trying to learn. Can anyone help me here and give me some direction? Thanks.
If they are traded in exchange then they are money by definition. That is why we have measures like M0, M1, M2. And they are not discounted, I have to pay the same amount of cash than with credit card.
edward_1313:Like Juan said, you assume away the very problem if you argue that the holder of the time deposit certificate tricks others into thinking it is an immediately redeemable certificate.
I am not assuming anything. One matures at a fixed date, the other whenever it is redeemed.
scineram:If they are traded in exchange then they are money by definition.
That is a bizarre notion of money.
scineram:That is why we have measures like M0, M1, M2.
I think there's a reason that Rothbard and Salerno constructed the AMS measure. They wanted to get a measure of what can be consistently defined as money. Just because M0, M1, M2 exist, that doesn't for some reason prove their validity as all equally valid measures of the money supply. Are their differences not important? And are you saying simply you disagree with the Austrian notion of what the important determining characteristics of money are?
scineram:And they are not discounted, I have to pay the same amount of cash than with credit card.
I believe the company that accepts your credit card receives from your card's company the amount immediately, or nearly so. So that's a bad comparison.
scineram:I am not assuming anything. One matures at a fixed date, the other whenever it is redeemed.
But this is the most important difference!!
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
edward_1313:That is a bizarre notion of money.
Money: 1: something generally accepted as a medium of exchange, a measure of value, or a means of payment
edward_1313:I think there's a reason that Rothbard and Salerno constructed the AMS measure. They wanted to get a measure of what can be consistently defined as money. Just because M0, M1, M2 exist, that doesn't for some reason prove their validity as all equally valid measures of the money supply. Are their differences not important? And are you saying simply you disagree with the Austrian notion of what the important determining characteristics of money are?
No disagreement. This just proves not only base money is money. Which was my point. There are qualitative differences between types of monies.
edward_1313:I believe the company that accepts your credit card receives from your card's company the amount immediately, or nearly so. So that's a bad comparison.
How would they? It just shows up in their bank account.
edward_1313:But this is the most important difference!!
Not as important as you believe. And the difference does not have those implications you seem to believe.
scineram: morganja:It would seem that the main difference is the ability to withdraw deposits. But I am having a hard time understanding how this is an important difference. Obviously there is a perspective I'm not quite getting. If in both cases, an original $1,000 is supporting a multiplier in loans and a multiplier in bank deposits. Is this not the ultimate source of the business cycle? Congrats! You nailed it on your own. You are having hard time because there is none. There are differences in degree as demand deposits are more liquid, but the two things are basicaly the same.
morganja:It would seem that the main difference is the ability to withdraw deposits. But I am having a hard time understanding how this is an important difference. Obviously there is a perspective I'm not quite getting. If in both cases, an original $1,000 is supporting a multiplier in loans and a multiplier in bank deposits. Is this not the ultimate source of the business cycle?
Congrats! You nailed it on your own. You are having hard time because there is none. There are differences in degree as demand deposits are more liquid, but the two things are basicaly the same.
Ding, Ding Ding, he shoots.....he scores. Scineram very nice, absolutely it is so hard to figure out what the Austrians are saying because it isn't true. The Austrians have created these artificial constructs and definitions that no one is actually required to be in compliance with so when it is obvious that there are alternatives to this narrow construct the whole thing doesn't make sense.
Ding, Ding Ding, he shoots.....he scores.
edward_1313: I believe the company that accepts your credit card receives from your card's company the amount immediately, or nearly so. So that's a bad comparison.
It is not uncommon for it to take several months for the funds to show up from a credit card transaction in the merchant's account.
Juan:Actually the original poster was given the correct explanation (as opposed to your lies) and said he would think about it. You didn't manage to sell him any 'toxic asset' yet.Let me repeat this. Criticism of fraudulent banking practices and fiat money are way older than the austrian school. If you knew the basic history of libertarianism you'd be aware of that fact. Saying that hard money is an 'artificial construct' created by the austrians clearly shows you're cluess. You should be working at goldman sachs/the fed - that's where you belong.
Yes, we know as long as the original poster drinks the Austrian Kool-Aid everything will be fine. Nevermind that it is a position that can't be reconciled with reality and you are unable to substantiate that what is happening is in fact fraud.
Juan:Scineram's 'argument' reduces to claiming that if people believe that pigs fly, then pigs fly. Yes, when the money supply is firstly inflated and ppl don't know it yet, fake certificates trade as if they were gold. Now, when the scam is found out, paper trades at a discount. Of course, for FRAUD to be possible, ppl must think FOR A WHILE that things are not what they really are. Actually, that's just what fraud is. To mislead people into believing things that are not true. Please stop advocating fraud. It's quite annoying.
I don't think this is so black and white, or that you even understand his argument. How is it fraud to offer to pay someone with a time a deposit, so long as you do not claim it is a demand deposit? How is the bank perpetrating fraud? It has a clear plan on how to acquire the gold it will require for that date to pay off the time deposit. It simply matches its assets and liabilities by maturity date. How does it follow that even if the recipient recognizes the risk and requires a premium, this is not an expansion of the money supply?
Rothbard included time deposits in his definition of the money supply during the 20's in America's Great Depression. Why? Because banks regularly paid off time deposits early without penalty (or converted them to demand deposits) and their common use was nearly identical to our use of savings deposits today, which Rothbard also places in his definition of money supply.
And ultimately, it does not matter if gold or debt or cotton backs the system. If an increase in money occurs through or relatively close to the banking sector, suppressing interest rates before driving price inflation, it will cause a business cycle. The strength of commodity money is its homogeneity and resulting ability to provide a stable, standard unit of account. A gold standard resists business cycles because its total stock is significantly resistant to swift changes, not because it is a commodity or because it does not represent a debt.
Check my blog, if you're a loser
Yes, we know as long as the original poster drinks the Austrian Kool-Aid
Maxliberty:Yes, we know as long as the original poster drinks the Austrian Kool-Aid everything will be fine. Nevermind that it is a position that can't be reconciled with reality and you are unable to substantiate that what is happening is in fact fraud.
Max, why are you still around here? I don't get it.
In any case, much of what you say isn't contradictory to Austrian theory, although it may conflict with certain conceptions of it.
Fractional Reserve Banking still exists today because government has socialized the negative effects of bank runs for depositors. Imagine if the government made whole everyone who invested in Ponzi schemes and lost their money. Of course, everyone would invest in Ponzi schemes, as risk-reward is ultimately skewed by a form of coercion - theft via taxation.
This is a common theme. Government has continuously sought to subsidize bank money relative to commodity money, commonly by making it legal tender for taxes.
meambobbo:I don't think this is so black and white, or that you even understand his argument.
How does it follow that even if the recipient recognizes the risk and requires a premium, this is not an expansion of the money supply?
And ultimately, it does not matter if gold or debt or cotton backs the system.
If an increase in money occurs through or relatively close to the banking sector, suppressing interest rates before driving price inflation, it will cause a business cycle.
The strength of commodity money is its homogeneity and resulting ability to provide a stable, standard unit of account.
A gold standard resists business cycles because its total stock is significantly resistant to swift changes, not because it is a commodity
OK. I'm reading Jesus De Soto. This guy could definitely have trimmed his book by about 2/3rds. Was he paid by the page?
meambobbo: I don't think this is so black and white, or that you even understand his argument. How is it fraud to offer to pay someone with a time a deposit, so long as you do not claim it is a demand deposit? How is the bank perpetrating fraud? It has a clear plan on how to acquire the gold it will require for that date to pay off the time deposit. It simply matches its assets and liabilities by maturity date. How does it follow that even if the recipient recognizes the risk and requires a premium, this is not an expansion of the money supply?
There is nothing fraudulent about this! That was never the point. The point was that if time deposits, as understood as saving in the true sense, are exchanged against goods, this is not inflationary.
For one thing, this almost never happens in reality (if you wanna talk about reality). Nobody brings bonds to the store to purchase goods; they're not considered a generally accepted medium of exchange, i.e., money. People exchange these assets against money first, then purchase goods.
If there is an instance where an asset, like a bond, is exchanged directly against a good this does not mean the asset has become money! If you barter with someone, say an apple for an orange, that does not suddenly mean one of the two has become money! It is simply an isolated case of exchange where two real things changed hands because of reverse evaluations. This applies to the case in which someone exchanges a security or bond with someone for some other good. It is an isolated case of barter The bond has not suddenly become money. Prices are not quoted in terms of bonds or stocks, as they should be if they were money. Nor are they perfect substitutes for money.
meambobbo: Rothbard included time deposits in his definition of the money supply during the 20's in America's Great Depression. Why? Because banks regularly paid off time deposits early without penalty (or converted them to demand deposits) and their common use was nearly identical to our use of savings deposits today, which Rothbard also places in his definition of money supply.
But this is the whole point! You clearly don't understand what's being argued nor what Rothbard's reasoning was. The reason Rothbard, Huerta de Sotoa, etc. regard savings or time deposits as part of money supply is because they are immediately redeemable in the modern banking system. Thus, they function as perfect money substitutes.
A time deposit, as we had defined it on this thread, was consistent with true saving, that is, a person gives a certain amount of money for a stipulated amount of time, and in return they get a claim to future money at that time. The claim is like an asset or a good, not money. It is not a general medium of exchange, nor payment, etc. You will run into insoluble circles if you try to call that asset 'money', because then you could just as well call the other good it is exchanged for money. If I exchange an apple for an orange, which do I call money? You would then be forced to redefine money as simply constituting the good in any exchange which was more marketable than the other. But this is remarkably hard to to determine objectively, and there are innumerable problems with it. It also forces you to drop the very significant fact that a general medium of exchange, of which all prices are denominated, exists; and that its existence possesses a special economic significance.
I am tired of this argument. I agree that some of these things can be difficult to think through. It takes time to reason through why X is X. But just because you're not comprehending something, or that you aren't able to see it clearly, doesn't mean those of us who can are drinking Kool-Aid.
edward_1313:The point was that if time deposits, as understood as saving in the true sense, are exchanged against goods, this is not inflationary.
If we refer to money as a medium of indirect exchange and inflation as an increase in the money supply, then if time deposits are used as money, they must be covered by full reserves so as to be not inflationary - equal money in and out of circulation. From my understanding, we all agree time deposits are not 100% reserve, the whole point being to lend out the deposit. This must be inflationary, if it is spent before the bank recovers and possesses its repayment (w/ int).
edward_1313:For one thing, this almost never happens in reality (if you wanna talk about reality). Nobody brings bonds to the store to purchase goods; they're not considered a generally accepted medium of exchange, i.e., money. People exchange these assets against money first, then purchase goods.
I agree. Which means that it is not inflationary, because they are not being used as a general medium of exchange, but simply an indirect good. Like stocks as well. Antiques. Precious metals.
edward_1313:The reason Rothbard, Huerta de Sotoa, etc. regard savings or time deposits as part of money supply is because they are immediately redeemable in the modern banking system. Thus, they function as perfect money substitutes.
Again, I agree - and without a fee to do so. And they can all be spent in a relatively short amount of time, without anyone depending upon anyone to do any actual work, and its all insured by the people who control the printing press and regulate the banks.
...
I understand the argument. My whole point was that Juan misrepresented scineram's argument as though time deposits must be presented as demand deposits when used as payment. People could willingly accept time deposits as payment without it being fraud, knowing that they cannot redeem the deposit until the maturity date.
If the bank policy is to instantly redeem them for demand deposits, however, then they are not really time deposits at all. I think the bank would be fraudulent. I am not sure about someone using them as payment in this case. I guess they are unintentionally, or perhaps on purpose...
And I agree with Juan's argument that if an increase in time deposits could not lead to an increase in present money (notes, demand deposits) which was the primary form of exchange, there would be no effect on the price and capital structure that would cause a business cycle. If it could and did, like in the 20's, then it would cause one.
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