Seattle,

Since you did not want to address it, productivity since 1913 has increased over 1000 times! The computer chip’s processing capacity doubles every two years! Our standard of living is better today.

Wealth does not simply increase on the dollars invested, it increases on the success of the capital it creates. Consider the success rate of capital expansion is less than 10%, failure is more the norm. That is why a handful of new businesses make past their first year.

Because of this increase in productivity and technology, we have increase the success rate of capital. I have seen this in my own business that I have built over the last 25 years. The computer that I am typing this on has allowed me to advance more than any other capital investment.

So get real and look no further than the keyboard in front of you! And if you don’t believe there is a major misdirection going on, you must have missed the Obama news conference on health care just a couple minutes ago.

TO: William Cleveland-Stevens, KCL History undergrad

If I have read your posts correctly, then I think your main premise or question concerns whether the Free Market could and would come up with FRB (“Fractional Reserve Banking”) ‘naturally’ or ‘organically’ (and also ‘harmlessly’) without the presence of a Central Bank to backstop such a FRBS (Fractional Reserve Banking System).

My reading of your premise suggests that you would posit that the Free Market would do this, and, in the absence of a Central Bank (or The Federal Reserve in the case of the United States), this should not be a problem since there should be a disincentive for such a system to create “too much” overall Credit.

If I am oversimplifying and/or misinterpreting what you posit, then please let me know.

But if I have framed your supposition correctly, then to respond, I would suggest that:

IMO the existence or non-existence of a supporting Central Bank could indeed affect whether “too much” or “way too much” Overall System Credit gets created.

But my response to you is that in either case, there would be “too much resulting Credit” or what Austrians refer to as Debt not backed by Saving.

And to more precisely answer your question, the FRB did indeed exist prior to 1913 when The FED was established. So FRB did arise prior to 1913.

In fact, most arguments cogently maintain that it was The FED that arose as a response to FRB (and its perennial problems) —— not the other around.

But The FED’s existence did enhance and support FRB and thereby make FRB more damaging, long-lasting, and less prone to short-run collapses (and bank runs) but FAR MORE PRONE to periodic long-term SYSTEMIC CRASHES. That FRB was always harmful is clear to Austrians. That it became more harmful (on a SYSTEMIC basis) after 1913 is also clear.

(There were intervals when a FED-like central bank did exist in America prior to 1913. Also, even when it did not, other institutions filled the role that The FED filled after 1913. The immediate argument for creating The FED was that these other institutions —— most notably J. P. Morgan filling that role in the Panic of 1907 —— were private, and could not reliably be seen as supporting the entire system, nor could they be relied on for not “playing favorites” [shades of Lehman Brothers in 2008?])

http://en.wikipedia.org/wiki/Panic_of_1907

You wrote:

To paraphrase the opening of this article; criticizing the fractional reserve system for a lack of stability and a tendency to induce inflation is like how government criticizes bankers for the 2008 financial crash: it misses the point which is that the inflationary nature of the credit system is induced through government inflation designed to promote a consumer boom, in a thus fettered market.

We simply have no proof that a free, unfettered credit market would inflate the money supply.

Since we can reasonably argue that it would prevent deflation, with economic growth on a stagnant monetary base, we can argue that humans might attach value to Fractional-Reserve-Bank lending, to Credit.

If Credit is given only where Credit is due, it’s NOT inflationary!

Credit-driven expansion of the money supply is therefore not necessarily inflationary, but a legitimate means to promote economic growth while maintaining the stable value of money, as regulated by a profit-motive without interference from governmental fraud.

I don’t think it is necessary to go to much further into what you added in your later posts. Your initial logic error (IMHO) arises very clearly in what you have written above.

Specifically, you are mistaken (again “IMHO”) in suggesting that:

“We simply have no proof that a free, unfettered credit market would inflate the money supply.”

You are wrong —— In fact this is the driving idea behind FRB. This is the “raison d’être” of a Fractional Reserve Banking System —— why else run such a system?

(You have also conflated “deflation” with your point, as being somehow injurious, and something that we should rejoice over as being “prevented” by FRB-lending —— this is a side issue, which we can discuss later, but which would only complicate my response to your main thrust as I see it. In fact, you may already know that price deflation is not something to be feared under the Austrian umbrella.)

So getting back to the points above… This system allows Credit-created “money” (that is, DEBT) to be created out of “thin air” which is in excess of that money that could be lent out based only on true Saving.

Let’s consider the case of you making a deposit into a bank within an FRB system.

The problem is clearly understood if one sees that both your initial deposit, and the borrowing your deposit generates, start a process of multiplying Credit throughout the system. And this happens because you can demand your money deposit back at any point in time.

Your money in other words is not really “tied up” on the basis of its already having been lent out to another person for given term-conditions (of time and interest).

In any economic system —— containing an FRB or not —— there will be some lending and borrowing, and repayment of loans, and inevitably some repudiation of the repayment of loans.

So even without Fractional Reserve Banks, people would lend to each other and some lenders would be repaid by their borrowers, and some would not.

But there is a big difference in the amount of Total Credit one system would create compared to the other. That is, with a system that has FRB as compared to one that does not.

And this of course would indicate whether one system (the one with FRB) tended to have bouts of inflation as compared to the other. Of course you could have bouts of deflation as well, since Credit in an FRB-driven system is prone to bouts of massive and sudden Credit Contraction, as debts get liquidated when bank runs and panics occur, and when banks thereby fail and are shut down. (That, remember, was the putative reason for having central banks in the first place, which Austrians argue actually just perpetuates a bad design flaw in an initially badly-designed financial system.)

Will, try to consider the situation on some imaginary island, where no banking had ever started, and money consisted of seashells. Some people in such a place would lend their own money, because, at times, it was surplus to their immediate needs.

Compare this to an FRBS (Fractional Reserve Banking System) Bank wherein you had deposited your money —— in such a system a bank will act as an intermediary and ‘invest’ your money on your behalf.

In such an FRBS system, you are always “guaranteed” (at least putatively) to get your deposited money back. This was true even prior to central banks —— deposit-taking bankers took the risk (and it was usually the correct and very profitable risk to take and assumption to make) of only keeping marginal reserves against the claims of depositors.

In years after 1913, this setup evolved further with the ‘support’ first of The FED (and later of the FDIC during the Great Depression) over the last century.

In fact, in most cases, you could safely and reliably get your deposited money back “On Demand” —— the original loan that was created with your lent money would NOT be called back in —— the (FRB system’s) banks would have in effect “created money” out of thin air (subject to any small percentage kept in the bank’s reserves due to regulated fractional reserve requirements). This was a simple result of the generally correct observation bankers had made over time —— most people, most of the time, did not come to reclaim their deposited money.

In fact, you would never (or in most cases, never) lose your lent money, whereas a ‘saver’ just like you, on an island paradise (using seashells as money), could indeed lose all of his/her lent money, because there is no guarantor to back up their lending in such an imagined place.

So you might retort that:

“Isn’t it good that we live in a society that does not tolerate one’s losing the money one lends to someone else?”

I’d point out to you, Will, that in that island scenario, EVERY person who lent out their surplus money, was lending out “saved money”. In other words, every dollar (or in this case, seashell) that was lent to someone, reflected someone else’s Deferred Spending. This, of course, is diametrically different from what we have in our society.

In a pre-FRB-situation, if one person deferred spending their own money —— that is, saved it —— and lent it to someone who did spend that money, there was no overall increase in consumption. That money could be spent only once, until it was earned again with production of goods and services that corresponded to its ‘value’. And in such a system, people would be very careful to whom they lent their money. They would not cavalierly pawn off that responsibility to some unknown bank officer.

Indeed, in the island situation, ALL consumption is accounted for by some equivalent amount of True Saving and Earning. In such a society if someone puts their seashells under their pillow, and does not lend it out, there is perhaps even a small chance that Saving might exceed Consumption, at least in the short run. But there is no chance of Consumption exceeding Saving and Earning.

I’d like to point out that in a Fractional Reserve Banking system a Society can always consume more, in total, than it has saved by creating financial claims against The Future. But in the island example this is simply not possible.

If a loan in that island society is not repaid, it is simply extinguished (more or less automatically, depending on the societal conventions of that place and time). Perhaps the person who is owed money learns a lesson, perhaps not. Perhaps the other islanders learn that the borrower (who repudiates) can not be trusted with more of their saved money. But the system does not careen out of control. Saving and Consumption stay in balance over time. In fact, such a small society probably handles its financial affairs far more intelligently than we do —— the “FICO Scores” are something everyone would know just by knowing the people around oneself.

Will, please ask yourself why this is in any way desirable.

I’d suggest that while in the short run the island-residing lender did suffer a loss, the borrower who had consumed with the borrowed funds had gained the equivalent of what that lender had lost.

We in effect did no more or less in pre-Fractional Reserve Banking Money Systems, as people within that island’s Money System do.

In such banking systems, the job of our bank is only to find us a ‘good risk’ borrower to lend to. Such a bank does not guarantee payback of our invested (deposited) funds, unless and until the ‘matched’ borrower makes good with his or her repayment.

But in our system today, we do not tolerate “losing” our money, even though prior to Fractional Reserve Banking, we could easily lose our money, the same way people do on our imaginary island.

[There is an 'advantage' of course in believing that one will always get one's lent money back — we all lend far more than we would otherwise — that is, we think nothing of putting our saved money in a bank. And of course here is where the danger starts — our bankers also don't have to worry as much about lending it out, because the bankers know that there are institutions that will back them up if too many borrowers repudiate the loans they have been given. The bankers' profit motive is to lend out as much money as they legally are allowed to. It's the Moral Hazard that is built into such a system that tends to prevent the appropriate care being taken with Saved AND Lent Monies]

I suggest that there is good reason why Austrian Economists do not recommend creating Credit where such Credit systematically and often exponentially outruns corresponding Saving.

If such a course of action is followed for a long enough period of time, the Credit thereby created (as claims against “Future Saving”) would almost inevitably be repudiated. This is simply a law of human nature.

In the absence of Debtor Prisons (or even with them), at some point, it becomes a ridiculous exercise and a pointless hardship to pretend that the Borrowing Class CAN pay back such a Mountain of Loans. Society simply concludes it is better to start over again, at the cost of huge losses incurred by the Saving Class (as if that class is, today, making any Real Return on their ‘investments’ anyway!!!).

In fact such a system is prone to Booms and Busts by its very design.

Please, Will, also note, that such a system is virtually guaranteed to fail if the “Future Saving” (that the system expects, nay, requires to keep running) fails to materialize. If the future becomes even slightly marginally less reliable for such “Saving” (due to, say reasons of conflict, or for reasons of loss of productivity growth) then those expected “Future Savings” are practically guaranteed to not show up.

So (in the immortal words of Ted Turner) “The Piper MUST be Paid” (at some point in time). The people “holding the bag” are going to inevitably lose a LOT of what they had come to expect as the FUTURE purchasing power equivalent in their various Savings Vehicles including, but not limited to, public and private pensions, their cash life savings (in the Fiat Currency of their choice), their life insurance policies, and any other of a myriad of so-called ‘investment’ vehicles.

Any System that is set up in such a manner (as our own “FRBS”, backed up by The FED, is) would inevitably succumb to such historical developments, of first booming —— in fact, as it did during the 1920-s and again in the period from 1990 to 2008 —— and then of busting .

There will always be big booms and big busts. The Business Cycle as explained by Austrians is Built into Our Economic and Financial System —— until, and unless, we reform it.

And Will, I’d point out that The FED only “enables” the system to grow far more boundlessly than it did when J. P. Morgan was the only one to backstop the “Panic of 1907″.

In other words, the FRB system, as you refer to it, is the germination of the problem —— The FED and other Central Banks around the world are simply the “facilitators” in making the system far more precarious than it would be only with “unsupported” Fractional Reserve Banks —— those deposit-taking (and loan-making) banks in such an unsupported system would still periodically fail (as the posts about the Bank of Amsterdam pointed out) but the Total System Credit (unmatched by past Saving) could never grow to the dangerous extremes we have reached in today’s civilization.

In my opinion, the sad fact that The FED today is again trying to recreate this Credit Bubble is suicidal, unless The FED’s officers think that recreating the disaster of 1929 and of 2008 is something that is “good” and “will get the Economy moving again”.

We have been on this Broken Money System Roller-Coaster for a long time.

What if we try to get off now —— would this not be dangerous?

Sure, there will be huge problems. But I’d point out that the longer we keep this Broken Money System going, the harder the fall will be for all of us from riding on this crazy Financial Roller-Coaster. In fact we could already be at a point, where the damage will be civilization-destroying —— we just do not know it yet.

I’d also suggest that realistically there is no point worrying, because no one will “pull the plug” —— there will be no collapse until one day the entire coaster collapses of its own accord. The casualties will be much worse then than they would be now of course —— but, hey, that’s politics, and in politics, if I can pass the problem to the next guy’s watch, to the next time period, what do you think a normal self-serving person would do?

It’s colloquially known as “Kicking The Can Down the Road”.

One of the main reasons that The FED and other Central Banks and their respective Fractional Reserve Banking Systems have managed to keep this system going is their use of Fiat Money.

The other is that we have lived in the last 100 years in an amazing time —— one where we have cheaper and more portable energy than we will likely ever have again —— that is, one which is based on petroleum.

Another is that this has been a period of amazing technological discovery.

These processes cannot be necessarily repeated over the next century. And if they can not, we will be in big trouble.

That is why investors who use the knowledge from history may be sorely mistaken in making assumptions about the future and its investment opportunities.

Only these very lucky juxtapositions of historical circumstances, possibly never to be repeated, have allowed The FED and other similar institutions to keep The Broken Money Systems running.

All you have to do is ask yourself if butter cost 20 cents a pound in 1913 WHY does it today cost you $4.00 a pound or more?

Sure this is caused by price inflation and the debasement of paper money.

But for all the advances of the last 100 years, should that pound of butter instead not cost you 2 cents instead of 4 dollars?
(As one poster above pointed out, we have had historical productivity improvements of maybe a factor of 1000, depending on the time interval under consideration.)

The point is that WITHOUT the advances of the past 100 years and yet WITH all the debasement of our money by The FED, that pound of butter would have today cost something like $4 HUNDRED DOLLARS.

The FED and all similar central banks around the world can keep their broken fiat money systems going (with the Fractional Reserve Banks they operate) ONLY BECAUSE of the extraordinary gains made by past advances in technology, because of our harnessing of cheap energy, and because of the manipulations engendered with the creation of Fiat Money.

It may very well be that future historical developments will be far from amenable to the continuation of such Money Systems.

That is why, Will, your idea of FRB being something that would “naturally” and “harmlessly” arise in a Free Market is wrong. Instead of bringing in rules to maintain FRB Systems, as was done in the 20th Century, with The FED, the FDIC, and all the government-mandated Banking Rules and Regulations, and their equivalents in other jurisdictions, a truly “Free Market” would long ago have found something superior.

After all, how many times would you personally put your money into a banking system, only to lose it when someone else got to it first, during a “panic” and the resulting “bank run”? How long would you, and your fellow citizens put up with such a system?

Right, not long. But all you got, in the 20th Century, instead of a real repair, was a “patch”, a “fix”, a “Band-Aid” —— to our Banking and Broken Money System —— and this “patch” is one that will lead us all over the proverbial economic and financial cliff.

As even Charlie Brown would say, “Good Grief!”