without fractional reserve(s)

i recently did a web search using the phrase "without fractional reserve".

here are some of the uses of this phrase.

 

"Without fractional reserve lending (leverage), a.k.a. the creation of “bank money” by banks, economic activity expands without busts.With increasing amounts fractional reserve lending, there are periodic booms and busts. A bust results when marginal credit that cannot be serviced is liquidated."

http://www.gold-eagle.com/editorials_01/parks021701pv.html

 

"Without fractional reserve banking there would be more savings and less economic activity. The economic activity that occurred would be more rational than it is with fractional reserve banking. Over time, better projects would be built and there would be more innovation because investors would be more focused on rational investments. This would stabilize economic outcomes over time, as more good ideas were implemented as were fewer bad ones. "

http://mitchell-langbert.blogspot.com/2009/01/banking-system-has-caused-economic.html

 

"Can we have a Capitalist system without fractional researve banking? I think the answers are Yes and No, but I am not sure.

Is it possible? Yes.

Is it likely to work? No, because without fractional reserves you must accurately match monetary supply and output or you get instantaneous and punishing inflation or deflation any time there is a mismatch between monetary supply and output. Since it is extremely difficult to accurately measure output you wind up with a dynamically-unstable system.
It may be possible to compensate for this, but its hella-hard if ****ups destroy your economy."

http://www.tickerforum.org/cgi-ticker/akcs-www?post=77457

 

"Without fractional reserves, banks cannot make any loans of any kind as they would not be in a position to give their clients their savings if they have made loans. Only someone completely ignorant of a real capitalist economy could make such a suggestion and, unsurprisingly, this position is held by members of the "Austrian" school (particularly its minimum state wing)."

http://www.infoshop.org/faq/secC8.html

 

 

these were really the only search returns that seems to deal directly with the issue.

do these quotes seem accurate in describing economic activity without fractional reserves of any sort?

 

input and extrapolation would be appreciated

 

 

sthomper

sthomper:

 

i recently did a web search using the phrase "without fractional reserve".

here are some of the uses of this phrase.

 

"Without fractional reserve lending (leverage), a.k.a. the creation of “bank money” by banks, economic activity expands without busts.With increasing amounts fractional reserve lending, there are periodic booms and busts. A bust results when marginal credit that cannot be serviced is liquidated."

http://www.gold-eagle.com/editorials_01/parks021701pv.html

 

This is true.  Fractional reserve banking implies that there is far more savings than there actually is.  It sends the wrong messages to entrepreneurs and investors.

sthomper:

 "Without fractional reserve banking there would be more savings and less economic activity. The economic activity that occurred would be more rational than it is with fractional reserve banking. Over time, better projects would be built and there would be more innovation because investors would be more focused on rational investments. This would stabilize economic outcomes over time, as more good ideas were implemented as were fewer bad ones. "

http://mitchell-langbert.blogspot.com/2009/01/banking-system-has-caused-economic.html

 

This is largely true.  However, saving IS an economic activity: it's investing in a bank.  The amount of loanable money, and therefore the interest rate on loaned money, is properly set by how much money is saved.

sthomper:

"Can we have a Capitalist system without fractional researve banking? I think the answers are Yes and No, but I am not sure.

Is it possible? Yes.

Is it likely to work? No, because without fractional reserves you must accurately match monetary supply and output or you get instantaneous and punishing inflation or deflation any time there is a mismatch between monetary supply and output. Since it is extremely difficult to accurately measure output you wind up with a dynamically-unstable system.
It may be possible to compensate for this, but its hella-hard if ****ups destroy your economy."

http://www.tickerforum.org/cgi-ticker/akcs-www?post=77457

"Without fractional reserves, banks cannot make any loans of any kind as they would not be in a position to give their clients their savings if they have made loans. Only someone completely ignorant of a real capitalist economy could make such a suggestion and, unsurprisingly, this position is held by members of the "Austrian" school (particularly its minimum state wing)."

http://www.infoshop.org/faq/secC8.html

 

This is complete and utter bullshit.  First and foremost, the only truly capitalistic economic system is one without fractional reserve system.  It would work far better than a fractional reserve system, because the signals sent to producers, consumers, investors, etc. would be true, and thus not lead to economic busts.

This is true. Fractional reserve banking implies that there is far more savings than there actually is. It sends the wrong messages to entrepreneurs and investors.

You are mistaken. Fractional reserve banks serve as an investment system for money, like a mutual fund. In both cases, you pay your money/gold for a share/certificate, and then the bank/fund invests that money - now its money - while you have the power to redeem your share/certificate in the future. Investment is still a form of savings.

This is complete and utter bullshit. First and foremost, the only truly capitalistic economic system is one without fractional reserve system. It would work far better than a fractional reserve system, because the signals sent to producers, consumers, investors, etc. would be true, and thus not lead to economic busts.

I know that the prohibition of fractional reserve banking is an article of faith for Rothbardians, but all actual Austrians outside of his followers disagree(d). In fact, the author is correct that you NEED fractional reserve banking in order to have a functioning capitalist system, because it allows savings and investment to occur in parallel. It also creates a more accurate mechanism for determining the supply/demand balance for money.

Kaz, you really don't sound like an Austrian and you don't represent "all actual Austrians outside [Rothbard's] followers" because I'm one of those.

FR banking is not needed for capitalism under hard-money. Any Austrian making this claim is ignorant of basic Austrian-reasoning techniques. Under a purely free market with hard money, if consumers demand this type investment and the State does not mitigate the moral hazards, well then wonderful - consumer/producers are happier.  However, history and reasoning show that capitalism has in the past and can be in the future perfectly healthy without FR banking. 

You are confusing loans with demand deposits.  In loaning, the loaner contracts with a borrower and foregos the use of his money for a period of time in return for interest - i.e. the time preferences of the two parties are different - money is not created here.  With demand deposits, the depositor makes no such committment, i.e. the depositor's time preference is unknown.  Here money is created out of thin air by virtue of the apparent usable balances in the depositor's and borrower's accounts (i.e. "loaner" and "borrower" both have demand deposits). 

Capitalism per se does not dictate the use or disuse of FR banking - free-acting consumers and producers do - and Austrian analysis says that people, without the State's coersion and safety net, will likely not be willing to accept the risk-to-reward ratio of FR banking, in general, and if they do, it will likely lead to instability and loss - a la ABCT.

Lastly, I think I could make a strong case that although Rothbard advocated 100% non-FR banking, he would not have advocated the empowering of the State to enforce it, or anything else.

I would have to agree with Christopher in his critique of Kaz's statement of the necessity of FR banking. On a similar note, I understand that since the inception of the FED the purchasing power of the dollar has declined dramatically. Simultaneously, isn't FR banking inflationary by definition? It increases the amount of the money supply at a much more rapid rate than the quantity of products. If a larger amount of dollars are chasing the same amount of goods inflation is inevitable. Would anyone let me know would FR banking be possible without the Federal Reserve and the FDIC??

Oliver Binns:

Simultaneously, isn't FR banking inflationary by definition?

Technically, yes. How inflationary it is depends upon the reserve ratio. In a free market, banks that overstepped an acceptable ratio would be susceptible to discipline by the market in the form of a diminished number of depositors and ultimately - runs on the bank by disillusioned depositors. It does require that at the extreme a bank with any amount of leverage must depend on loans from other banks or alternate sources of reserves to defend itself.

Panamanian banks which do not, I believe, have a mandated ratio operate at slightly over 2/1 and have remained viable and stable. Panama uses the USD as currency. Even without fiat money, some banks will maintain a ratio greater than one. Competition will force it to occur. Fractional reserve banking is a naturally occurring phenomenon and absent fiat money (money mandated by government and coerced through legal tender laws) is not hurtful.

Oliver Binns:

Would anyone let me know would FR banking be possible without the Federal Reserve and the FDIC??

In a completely free market, banks will leverage reserves. But as I said above, some protection will be necessary in extremis. Whether that takes the form of a central bank or of government guarantees (which are inflationary if the shortages require monitezation) or temporary loans by supporting existing banks which may or may not be inflationary, is an important but not defining difference. If it could be arranged quickly enough, banks could call on its investors to increase capital without inflationary effects.

Unless banks are legally enjoined from employing FR practices, some will do so for the simple reason that gold, lovely money that it is, functions better as reserves than as specie. Historically, in a free market, the people used bank receipts, exchangeable for gold or silver, for trade. That's how paper money came into existence.

For an example of banks operating freely and successfully under a gold standard using paper money see Maloney - http://www.marketoracle.co.uk/Article25417.html.

I think it is important to understand that paper money (as distinct from fiat money) is a naturally occurring phenomenon in a free market and as a consequence so is fractional reserve banking. The moderating factor is that banks that do not maintain an acceptable level of reserves will fail. But when government steps in with legal tender laws, the market is distorted and banks operate at a higher level of leverage than they would in a free market. In a free market, banks would fail earlier and the effects would be localized. Banks would not grow "too big to fail."

If the creation of money were a free market it wouldn't matter if paper money were created by banks or the government. If the people, in their collective wisdom, determine that a paper currency is declining in value, they would be better served if they were free to substitute what ever they prefer for the popularly accepted currency. Market competition would then regulate expansion of the money supply to a publicly acceptable level. Those who wished to opt out completely could hold gold personally or have it warehoused. If you try to protect depositors from bank failure through government regulation, the natural regulation of the market is distorted and systemic failure becomes possible.

I believe that paper money is not a problem. Fiat money, mandated through legal tender laws by definition, is.

Smbrooks! I appreciate your reply. It was very helpful and as could be expected brought about more questions.

smbrooks:

But as I said above, some protection will be necessary in extremis. Whether that takes the form of a central bank or of government guarantees (which are inflationary if the shortages require monitezation)

If there is a central bank and or if government guarantees exist, can we truly call this a free market? Also, what other methods outside of monetization can be used when a central bank or government guarantees are involved?

smbrooks:

If it could be arranged quickly enough, banks could call on its investors to increase capital without inflationary effects.

Is this practical? Why would investors throw more money at a bank that has admitted failure? Granted, we can assume that they would want to protect their investment, however; investors can also take this as a sign that their invested funds are already gone and will decide not to bailout the bank to avoid an increased loss. We can also suppose that the investors responded quickly enough and helped out the bank. Who would trust this bank with their deposits post bailout?

smbrooks:

If the creation of money were a free market it wouldn't matter if paper money were created by banks or the government

Would people be fine with the government competing in the free market with their tax dollars regardless if they still have the option of choosing? Do you have any references you can lead me towards detailing examples? Thanks again for the info. I haven't had the chance to check your link as of yet but will do soon. Looking forward to your response!!

Oliver Binns:

If there is a central bank and or if government guarantees exist, can we truly call this a free market? Also, what other methods outside of monetization can be used when a central bank or government guarantees are involved?

It would be a free market if it were not government regulated and if legal tender laws did not exist. A central bank could have enough capital to loan to troubled banks. In theory it does. In practice, it does not. But theoretically, it could.

Oliver Binns:

Is this practical? Why would investors throw more money at a bank that has admitted failure? Granted, we can assume that they would want to protect their investment, however; investors can also take this as a sign that their invested funds are already gone and will decide not to bailout the bank to avoid an increased loss. We can also suppose that the investors responded quickly enough and helped out the bank. Who would trust this bank with their deposits post bailout?

Possibly. You could close the doors, reopen a week later with fresh capital. People panic for all kinds of reasons. If I were an investor in a bank that is sound and profitable with a low reserve ratio, I might put money into it as a loan perhaps so it could weather the storm and stay open. Investors often do well with small retail banks. It could work if government stayed out of the way.

The banking system weathered the great depression. People put their money back into banks that had closed and reorganized. What else are they going to do with their money?

Oliver Binns:

Would people be fine with the government competing in the free market with their tax dollars regardless if they still have the option of choosing?

Most people would be completely oblivious. We have Amtrak, Fannie Mae, Freddie Mac, the Corps of Engineers, now General Motors and the health insurance industry and probably many other government entities competing in markets with public approval. At a minimum, government entities distort free markets always to the disadvantage of the people.

Read the cite I gave you. This should answer a number of your questions because it is an example of central banking in a free market.

smbrooks:

It would be a free market if it were not government regulated and if legal tender laws did not exist. A central bank could have enough capital to loan to troubled banks. In theory it does. In practice, it does not. But theoretically, it could.

With or without government regulations this still would not be a free market! If banks are aware of a probable gov't bailout, it is more likely they will get involved in more riskier practices that would not be thought of in a market absent of those entities. Also, if something is doable in theory but not in practice then it is not doable. Isn't that the biggest problem with the Keynesian paradigm?

smbrooks:

Possibly. You could close the doors, reopen a week later with fresh capital.

Did you just recommend a BANK HOLIDAY??? Sounds like something Roosevelt would appreciate

smbrooks:

People panic for all kinds of reasons.

If people panic for all sorts of reasons wouldn't that be a good argument not to participate in FR banking at all?

smbrooks:

If I were an investor in a bank that is sound and profitable with a low reserve ratio, I might put money into it as a loan perhaps so it could weather the storm and stay open.

If the bank was sound then it would not need any additional loans from it's investors. Fair enough, the reserve ratio is low enough in your eyes to provide a loan and we can say it is probable that others in the same position will follow the same actions, but that reserve ratio was not low enough in order for their depositors to sit comfortably whom are the ultimate judges. Therefore the reserve ratio was not low enough even if in this example they kept 90% of the deposits. Your argument makes Rothbard much more convincing in that maintaining all demand deposits is the only way to go.

smbrooks:

Most people would be completely oblivious. We have Amtrak, Fannie Mae, Freddie Mac,

Aren't Freddie and Fannie excellent reasons for governments not to participate in the market either through unnecessary regulation or as players? Again, thanks for the reply

I'm with Oliver. There is no evidence to suggest that a central bank, fractional reserve banking, paper money, etc. would develop in a truly free market - i.e. one with NO statist support (Freddie, Fannie, FDIC, FDLC, bailouts, stimulus, gov granted monopolies, regulation, consumer protection, etc) - and evidence to suggest that these institutions would go away if we were free. I realise that it's difficult for us children-of-the-nanny-state to imagine our responsibility for down-side risk, but that's the key. Anyway, Austrians who propose these institutions in the free market puzzle me. I'm not sure why they call themselves Austrians - I would call them Chicago Schoolers. I'm not trying to provoke a debate but I think they do not fully accept Austrian theories of money and banking vis-a-vis human action and there logical conclusions - they are probably min-archists at heart. This is probably not the right forum for an Austrian versus minarchist smack-down. :) So, let me throw in some econometrics talk to make us legit. This discussion illustrates a good econometrics point. Since it's difficult for us to get agreement on what a free-market would look like, it's equivalently difficult to model. In this sense, econometrics are easier to derive under statism, due to the restriction on human action.

Did you read the cite I gave Oliver? There is evidence. I quoted it. How about comments on that instead of pure opinion? That cite illustrates how a banking consortium with a lender of last resort actually formed without a government franchised central bank, using fractional reserves and prospered mightily in a near free market.

Yes I'm Austrian and have been studying Austrian economics for forty years even though I was educated as a Keynesian undergrad and monetarist (not much difference) in graduate school. Austrian economics is a philosophy, not a religion.

When you talk about free markets - free means free. It means freely competitive. It means banks have a choice about their level of reserves - freely disclosed, of course. Otherwise you have fraud.

I don't understand how you can have the opinion you do if you have read monetary history. Have you read about how paper money came into existence? It was not government money. It was not legal tender. It was bank receipts for metals on deposit.

Do you want to live in a society where money is mandated to be gold or a competitive free market society where people are free to choose what they would like to use as money? I choose freedom.

Ok, thought experiment then I have to go.

I have a choice between two banks. Both hold gold for depositors. Both issue deposit receipts for the gold they hold. Both have been in business for thirty years with good management. The difference is that one bank has a two to one deposit ratio which it clearly discloses. It belongs to an association of banks who have pledged to cover any unexpected demand for gold coin on a short term basis.

The fully backed bank, if it makes any loans, cannot refund everyone's gold until the loans are paid back. So, is it insolvent? If it makes no loans, it must charge me storage fees - if it earns no interest it can pay no interest.

Bank two makes it clear that it holds reserves but its charter allows it to loan out up to twice those reserves. It will earn interest on the loans that it makes. It will also pay me interest on my deposit from the profits it collects. If bank one makes loans it can pay interest but the second bank, which is leveraged, can offer higher interest because it is more profitable.

Being a free market, I have the choice to put all my money in bank one with perfect safety and pay storage fees, all my money in bank two earning interest, or distribute my gold between the two banks.

Just like I diversify my portfolio today, perhaps I will place 70% of my capital in bank one and 30% of my capital in bank two fully aware that I am taking on a higher level of risk. I earn interest on my capital while maintaining a margin of safety that is acceptable to me. You do not earn returns on any capital without risk. That's what you are being paid for.

All this occurs in a free market. I am free to use either bank and the banks are free to accept my deposit or not. Government has no role. Keep it simple.

I stand by my statement that this condition will occur in a free market, without government interference and without fraud for the simple reason that different individuals have different tolerances for risk. In a free market a natural level of reserves will establish itself at a market clearing level.

Smbrooks: don't get me wrong. Like I said before, if the consumer demands (and gets) FR banking in a free-market, then that's the best possible outcome - consumer satisfaction. I'm simply cautioning against prescribing that it will occur, or prescibing that it will occur at a 2:1 reserve rate, or the like. 

That said, and in the interest of discussion, let me point out some of the complexities in your Bank 1 Bank 2 scenario. Here, i'm still not saying there won't be FR bankin. I'm just saying it's more complicated than you think:

1) the purchasing power of the money substitutes of the FR bank will drop as it expands the supply. The power of the receipts of the 100% reserve bank will vary with the supply and demand of gold, purely.  Therefore you will have two simultaneous currencies with different prices in relation to commodities. This would be handled today electronically but, even so, the consumer would tend to limit his exposure to multiple currencies for simplicity. 

2) the FR bank will have to seek underwriting against runs. You indicated that the banks would join forces with other FR banks but I propose that this arrangement may be too difficult to negociate and maintain between many banks simultaneously given different reserve ratios, lending practices, etc. Insurance is a more likely way of guaranteeing deposits. This way the bank is rated and pays a premium to the insurance company based on it's behaviour (exposes to risk). Regardless, deposit guarantees of any kind raise the cost of running the bank and therefore reduce the ROIs to the depositors.

3) holders of the certificates of the FR bank (not necessarily depositors of the bank) will bear some risk of redemption (lessened by underwriting) and will see varying commodity prices as credit expands and contracts. The depositor gets his interest bearing account but there is no reason for a non-depositor to hold the certificates.  Now, that said, this is really no different than today, but presumably we will all have our eyes opened to this and perhaps will tolerate it less in a free-market.

Anyway, I'm not trying to pick an argument here. I think were in close agreement. This is all pretty interesting to speculate on.