In a response to my blog post on the Fekete Real Bills Doctrine Rudy Fritsch raises the issue of seasonal variations in money demand, which he suggests is a death blow argument against the 100% reserve banking system.
The problem with equilibrium theory is simple, and is clear to anyone who took the trouble to listen to Professor Fekete; the demand for product is not steady… the ‘equilibrating’ process is impossible, as there is no fixed ‘target’ toward which the economy could ‘equilibrate’! In fact, as Professor Fekete has stated, a 100% Gold Standard would fail at the first Christmas shopping season.
The reason is perfectly clear; much more merchandise is sold in high season, therefore much more cash would be needed to support the clearing function… and where would this cash come from? Then, as the shopping season winds down, demand for cash drops… and there would be an excess of cash on hand. What to do with this excess cash?
[...] The flexibility needed to accommodate swings in demand is provided by Real Bills in circulation.
Fritsch’s article repeats the persistent fallacy that a 100% reserve banking system rules out the use of a clearing mechanism. This is simply false. Murry Rothbard, the greatest advocate of 100% reserve banking, devotes an entire section of his opus to clearing systems. What it does rule out is monetization of the clearing claims by banks. But there is no problem with clearing alongside 100% reserve banking.
However, this is really a side issue. As I will show a fully cash settled system with 100% reserve banks can accommodate the Christmas shopping season.
The problem that Fritsch is alluding to is a dramatic and unanticipated shift in money demand. For example, If there were to be a sudden increase in money demand, then prices would also have to adjust rapidly downwards. If no one had anticipated this, then firms would be in a position where they would have to sell their inventories below their cost.
The first problem with this scenario is that it treats money demand as if that were something separate from prices. The way that individuals and firms increase their money demand is by lowering their asking prices so as to increase their volume of money incomes and by lowering their bid prices for goods so as to decrease their money expenditures. The adjustment of the price system and a change in money demand are one and the same thing.
A bigger problem with the Christmas scenario as a killer argument is that Christmas does not entail a huge unanticipated variation in money demand. Assume a 100% reserve banking system. Consumers who plan to purchase gifts during the November-December time frame increase their money demand during the January-October months so that they will have the funds available for year-end shopping; or they may borrow money during the shopping season (which under 100% reserves requires other individuals to reduce their money holdings by lending).
Retailers who anticipate making a large volume of sales during the year end period reduce their money demand during the months leading up to the shopping season as they purchase inventory that they plan to sell.
To summarize, during the months outside of the year-end shopping seasons, consumers increase their money demand while retailers decrease theirs. During the shopping season, the reverse happens: consumers decrease their money demand as they exchange their accumulated cash balances for gifts, while retailers increase their money demand as they exchange inventories for cash. As long as the process is reasonably well-anticipated, the money demand does not change much.
It is possible that Fritsch has confused money demand with currency demand. Money is broader than currency. In a 100% reserve system, money consists of currency plus demand deposits held by money warehouses. Under 100% reserves there is no problem with an increase in the demand for currency because it is exactly offset by an identical decrease in the quantity of demand deposits. Overall money supply remains the same as money moves between demand deposits and currency.
Under fractional reserves, however, the story is quite different because base money upon which fractional reserves are multiplied includes vault currency, and any demands for currency above and beyond what banks hold in vaults must be met by a liquidation of some portion of the bank’s assets. Therefore a large increase in currency demand shrinks the monetary base of the banking system and causes a contraction of the money supply.