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Source link: http://archive.mises.org/11395/free-banking-and-contract-law/

Free Banking and Contract Law

January 7, 2010 by

Those Americans who twice succeeded in doing away with a central bank were aware of the dangers of such institutions; it was only too bad that they failed to see that the evils they fought were present in every kind of government interference with banking. FULL ARTICLE by Ludwig von Mises

{ 20 comments }

Kavius January 7, 2010 at 9:37 am

It is a fable that governments interfered with banking in order to restrict the issue of fiduciary media and to prevent credit expansion.

At the time, governments were obviously stating that they were taking action to “prevent credit expansion”. The recent actions taken by governments were to “prevent credit contraction”. Funny how the world turns.

Mike Sproul January 7, 2010 at 10:32 am

“it was only too bad that they failed to see that the evils they fought were present in every kind of government interference with banking.”

It’s too bad that Mises, Rothbard et. al. failed to see that prohibition of fractional reserve banking is government interference with banking. It’s also too bad that they failed to see that issuers of derivative moneys do not affect the value of base moneys (because the issue of derivative money does not affect either the assets or liabilities of the issuer of base money), and it is too bad that they failed to see that modern paper money is backed by the assets of the central bank that issued it.

DD January 7, 2010 at 11:03 am

Mike,

Mises did not want any prohibition! Actually, neither did Rothbard.

This is what Mises (and Rothbard) wanted (from the article):

“What is needed to prevent any further credit expansion is to place the banking business under the general rules of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of the contract. If banks are preserved as privileged establishments subject to special legislative provisions, the tool remains that governments can use for fiscal purposes.”

If they would be subject to the same laws as any other business without any special privileges, Mises argues that the practice of credit expansion would be greatly reduced if not eliminated. This is very close to Rothbard’s position. Rothbard explicitly advocated for a 100% reserve system, but not by a prohibition or regulation, but by enforcing all contracts by the same standards as any other business without any exceptions.

John Hoffman January 7, 2010 at 11:06 am

I think vector auto regression might be a useful tool in order to find out how much of role did the fed play in creating this crisis.

Mike January 7, 2010 at 11:09 am

Mike Sproul,

I don’t see why fractional reserve banking would have to be prohibited. I mean, it’s clearly a breach of contract to practice it while telling your depositors their money is totally safe in your hands. If practiced openly, it is up to depositors to realize that their deposit is an investment (hopefully interest-bearing else choosing a fractional-reserve bank over a fee-based “just vault it” bank would be idiocy).

As I understand it, Mises, Rothbard, et. al. were, rather than advocating the prohibition of fractional reserve banking, advocating instead that the government stop the gratuitous practice of it. Heck, considering that Rothbard was an anarchist, it seems patently ridiculous to me your implication that he wants to “prohibit” fractional reserve banking.

DD January 7, 2010 at 11:24 am

Mike (not Mike Sproul),

Spot on. The myth that Rothbard was advocating for a “regulation” or “prohibition” is the result of people always arguing one side and just assuming that they are familiar with the arguments of the other side, usually by just learning about it from their critics.

I don’t know how many people have already accused me of advocating for an authoritarian regulation. To my disappointment, it is often the leading intellectual advocates of the free banking school who are making these accusations.

I am sometimes amazed by how much they are not familiar with Rothbard’s arguments.

Mike Sproul January 7, 2010 at 12:47 pm

DD and Mike:

From Rothbard’s “What has Government Done to our Money?”

“The bluntest way for government to foster inflation, then, is to grant the banks the special privilege of refusing to pay their obligations, while yet continuing in their operation.”

This begs the question: What if the bank and its customers agree to occasional suspensions of convertibility? What if they agree that the bank’s assets will be held in a variety of forms, and not just some specified form of base money? I asked Rothbard, about 1992 or so, if he considered it fraudulent for a bank to trade some of its gold for an equal value of silver. He answered yes, it was fraudulent. I asked “What if the bank and its customers agree to it? Is that fraud?” He answered yes. “They don’t know what they’re agreeing to.” Then he got mad, asking “Why can’t you understand this?”, and the discussion stopped. I was about to ask “What if they do know what they’re agreeing to?”, but he was in no mood for what he called “patient refutation”.There were about 5 econ professors in the room. I remember asking one of them if he believed Rothbard’s view of banking. His answer was “Not a word.” That was echoed by everyone there.

Mises and Rothbard both take it for granted that ‘credit expansion’ would cause price inflation. This neglects the case where a bank’s issue of new money is matched by an equal increase in the bank’s assets. In that case, there is nothing to fear from credit expansion, and certainly no reason for Mises and Rothbard to oppose free contracts between banks and their customers.

Mike January 7, 2010 at 12:54 pm

Um, so we’re cool then. If all parties are in the know, then nobody’s being defrauded.

But I think the bigger concern these guys had was with the behavior (and existence) of central banks, which is kind of a whole different animal.

TGGP January 7, 2010 at 1:32 pm

Steve Horwitz argues that Mises (unlike Rothbard) was not clearly a 100% reservist and actually wrote somethings supportive of free banking. 100% reserves was for him a step to be taken in the absence of free banking.
http://www.coordinationproblem.org/2009/09/mises-and-his-call-for-100-reserves.html

DD January 7, 2010 at 1:37 pm

Mike Sproul,

“What if the bank and its customers agree to occasional suspensions of convertibility?”

But that is not what Rothbard ever considered fraud so you are unintensionally setting up a straw man.

The whole point is that the “demand deposits” are demand deposits. If they contain such clauses like you are suggesting (which must be visible also to 3rd party who trades for them on the market) then they seize to be demand deposits and there is no problem. But then hard money advocates contend that these deposits or bank notes with a clause no longer would be traded for money substitutes. It is debatable then if this type of system can even constitutes a fractional reserve system.

Rothbard has always referred to a system with “demand deposits” with a contractual obligation to redeem all specie without delay (no clause).

So you must understand what the argument is about before criticizing it. It is pointless to argue about different things. I’m afraid that this is what has happened with this ongoing debate.

DD January 7, 2010 at 1:42 pm

TGGP,

Steve Horwitz in my opinion, blatanly misinterprets Mises. From this article (excerpted from Human Action) it is crystal clear that Mises is advocating free banking precisely in order to limit the issuing of fiduciary media to the maximum. To achieve this he wants no special regulations but simply to remove all banking privileges. This is not really different from what Rothbard was advocating for.

Nate Y January 7, 2010 at 1:44 pm

For some reason, I just don’t trust a single one of Mike Sproul’s posts.

TGGP January 7, 2010 at 2:05 pm

Steve Horwitz also wants to limit the issuance of the fiduciary medium. He thinks the market would constrain its issuance by free banks. The government tends to inflate the currency over time, but if money was only issued in accordance with demand there would not be inflation. There would only be “good deflation” caused by increased productivity. Horwitz just doesn’t think that some specific amount of currency is optimal for all situations, rather that it is a “fatal conceit” to assume that. The market would adapt to the requirements of changing situations by providing the optimal amount of currency and if that means an increase in currency he doesn’t consider it “inflation”. Mises sometimes spoke of inflation similarly:
http://www.coordinationproblem.org/2009/09/mises-defining-inflation-the-monetary-equilibrium-way-in-1951.html

EIS January 7, 2010 at 2:06 pm

There’s no reason, in anyway whatsoever, to ban fractional reserve banking. Mises is inconsistent when it comes to his position, and Rothbard is just wrong. Nowhere does Bohm-Bawerk (who, for whatever reason is often ignored) ever say that the banks need to be completely liquid at all times in order to prevent misallocaitons, and neither does Wicksell (in fact, Wicksell say that monetary equilibrium should be expected in the long run with fractional reserves, free-banking, and an international gold standard). Hayek, I’m afraid, is also inconsistent, but relatively speaking, his theories are most sound.

Either way, the arguments made against or in favor of FRB shouldn’t appeal to dead economists nor should they be founded upon ethical judgments. These, in my opinion, are the questions at hand:

1. Do fractional reserves necessarily suppress the market rate below the natural rate.
2. Would 100% reserves keep the market rate permanently fixed to the natural rate, or would it elevate the market rate above the natural rate?
3. Would libertarians ever support regulation on voluntary transactions?

DD January 7, 2010 at 2:19 pm

“Mises is inconsistent when it comes to his position,”

Nobody can be 100% consistent throughout their entire lives, but I will argue that you and Steve Horwitz are making Mises appear more inconsistent the he really is. Even Dr. Selgin has acknowledged that Mises’ views on this issue are not in agreement with his views.

“Rothbard is just wrong”

What is Rothbard so wrong about? The issue of fraud pertains only to demand deposits with a contractual obligation to redeem all specie without delay. Not to some deposit contract with some clause that says otherwise.

TGGP January 7, 2010 at 2:46 pm

I mentioned the “fatal conceit” earlier but failed to link to the post applying that concept to bank reserves:
http://austrianeconomists.typepad.com/weblog/2009/06/which-monetary-policy-rule-suffers-from-the-fatal-conceit.html
Check out the paper linked by Nicolas in the last comment.

Steve Horwitz claims that Mises wasn’t actually inconsistent, he has just been misinterpreted. Steve’s view is that Mises always held free-banking as the ideal (and restrictions on the issuing of currency in respond to demand as harmful, see page 36 of Nicolas’ paper discussing the Peel Act) but that in response to central banking he said the government should be restricted to 100% reserves. This is because governments are usually biased in favor of creating inflation and his 100% rule would remove their discretion for doing so. A 100% rule with a central bank would still be bad, which is why he attacked Irving Fisher’s proposal for that.

Mike Sproul January 7, 2010 at 6:12 pm

It sounds like we have general agreement that fractional reserves is OK as long as banks and their customers agree to it. (in spite of what Mises and Rothbard might have said) That’s fairly rare. There are usually a few 100% reservers in the crowd. Just to test the waters: Would you all agree that after several centuries of fractional reserve banking, it’s safe to say that banks and customers do, in fact, agree to it?

To EIS’s “questions at hand” I’d add the question of whether fractional reserve banking causes price inflation. The mainstream view is that if bankers increase the quantity of money or money substitutes, then they do cause inflation. That view should bother you, since it means that bankers have the same effect on prices as counterfeiters. It means, for example, that a cayman islands bank could issue checking account dollars (eurodollars) and cause inflation in the US, but would be beyond the reach of US law.

Nate Y January 7, 2010 at 6:51 pm

Mike Sproul,

You ask: “Just to test the waters: Would you all agree that after several centuries of fractional reserve banking, it’s safe to say that banks and customers do, in fact, agree to it?”

Nope. I wouldn’t say that at all. No more than I would say something like “Would you all agree that after millenia of taxes, it’s safe to say that States and citizens do, in fact, agree to it?”

EIS January 7, 2010 at 8:16 pm

“To EIS’s “questions at hand” I’d add the question of whether fractional reserve banking causes price inflation. The mainstream view is that if bankers increase the quantity of money or money substitutes, then they do cause inflation. That view should bother you, since it means that bankers have the same effect on prices as counterfeiters. It means, for example, that a cayman islands bank could issue checking account dollars (eurodollars) and cause inflation in the US, but would be beyond the reach of US law.”

Eurodollars are not money. You always talk about things which aren’t money. Inflation is caused by an increase in the supply of money in excess of money demand. In monetary economies real capital goods are never exchanged, but rather bought and sold. Suppressing the market rate below the natural rate means an increase in prices (first in the higher order and then lower order). I’m in no mood for your RBD mysticism–sorry.

Rad January 6, 2011 at 5:59 pm

“Nope. I wouldn’t say that at all. No more than I would say something like ‘Would you all agree that after millenia of taxes, it’s safe to say that States and citizens do, in fact, agree to it?’”

Actually they do agree to taxes. They agree when they insist on having the government provide them with services. But then there are those who want services, and yet think they don’t have to pay for them.

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