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.
{ 35 comments }
can currency be money at all?
Yes currency is money in most places because it is accepted in exchange for goods.
Jess Húerta de Soto provides some historical examples of 100% reserve banking in his book.
As for how do we asset propositions about a type of monetary system whether or not it has existed, a lot of economic theory is based on logic and analytical arguments.
I wish that you would not make allegations of lying. Lying is when a person knows something to be untrue and states otherwise. Within any field of thought or study there exist differences of opinion and conflicting theories. That does not make everyone who ends up on the wrong side of an argument into a liar.
As far as I know every place in the world is on a fractional reserve system. There is a proposal in the UK to institute 100% reserves. See de Soto’s book, cited above.
“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.”
This is just flat out misleading if not plain wrong. This is true of fractional reserve under central banking but it is absolutely not true of fractional reserve free banking, in which changes in the currency/deposit ratio have no effect at all on the bank’s holding of reserves because currency is not reserves but a bank liability in such a system. This point is addressed in virtually every book on the subject.
Critics of fractional reserves need to be absolutely clear what sort of system they’re talking about so that they don’t unfairly paint fractional reserve banking with the sins of central banking. If you want to argue against fractional reserve banking, that’s fine, but please be clear what sort of institutional environment you are assuming before you make statements like these, which to the extent they are claims about fractional reserve banking are simply WRONG.
It’s unfair and wrong to continue to blame fractional reserve banking for what is a problem associated with central banking. If you want to criticize, please be honest about it. And honesty here should demand that you correct the original entry to make this distinction.
Even under central banking, the fall in the money supply can be offset by expansionary monetary policy. The job of a central banker may be that much harder when currency is base money, but central banking is not institutionally incapable of solving the problem.
Yes, it is incapable.
You said it so yourself in another post.
Not likely is not the same thing as incapable. I don’t like central banking, but neither do I want to overstate problems with it.
How unfortunate for those central bankers who do not inhabit the nation of Serendip then
By the way, I am talking about the specific problem of how changes in currency demand swell or drain bank reserves, and in turn change the money supply, nominal spending, and inflation. When banks are prohibited from issuing their own notes, the central bank must offset these changes in currency demand with compensating changes in the quantity of reserves. While the job of a central banker is all the more difficult because of this situation, the institution itself does not prohibit any means of dealing with it. Moreover, reforming central banking to allow private note issue would considerably alleviate this problem, because it would harness market forces to satisfy peoples’ desired mix of deposits and currency.
Hey Lee, still waiting for an answer to my question here, regarding the basis for why you think the Fed’s current actions are “probably not enough.”
http://blog.mises.org/14485/that-fed-announcement/#comment-736057
“Enough” would have included an explicit nominal income target (or an inflation target, at least). When nominal income is below my preferred target in a year, that’ll be my basis for believing the Fed’s actions are not enough. If not, then not.
Maybe they could wire you the 600bi. Then at least you could achieve (and maybe even surpass) your personal income target.
Why don’t you suggest that to someone at the Fed.
Ah yes, the “demand for bank liabilities” legerdemain.
Safety Deposit boxes are 100% reserve.
Exactly. No one, I repeat, no one including the government ever forces you to keep your money in a bank under fractional reserves.
Not yet. But wait for electronic money. Oh, what’s that, you ask?
Essentially, “money” will exist only as accounting entries, with all transactions done through credit and debit cards.
How will this be implemented? We’ll be told that this is beneficial, as it will eliminate the cost of printing/minting money, and that it will automate the extraction of taxes, “so that the government can serve you better.” Not to mention – think of how many trees will be saved!
Legal. Tender. Laws.
In a world that used only silver coins, Christmas would cause people to mint silver bullion into coins. After Christmas, the coins would be melted and would reflux to bullion. If coining of silver put significant upward pressure on the price of silver, people would find it in their interest to issue paper tokens, possibly denominated in silver, but possibly backed by something other than actual silver. When Christmas ended, these paper tokens would reflux to their issuer, to be exchanged for the various commodities that backed the tokens.
One can only hope that so-called libertarians would not object to these voluntary actions by well-informed people. If such transactions were prohibited, the resulting tight money conditions would be recessionary.
Reminting. Stupid. Might as well put some more claims on the existing pool of “money” (whatever religious followers of Rothbard are kind enough to accept as money) into circulation and then annihilate them automatically after the season ends. Real bills. Same effect, cheaper solution.
Usually people accusing others of religious, whilst frothing at the mouth, are themselve pretty “religious”.
I worked in retail many years ago, and I’d gather that what was the case then is more so today. I don’t know the actual percentage, but I’m willing to bet that most holiday shopping is done on credit, either their bank credit cards or the retailer’s own. I really wonder how much holiday shopping is done on a cash basis. So, from an Austrian perspective, which would be the case?
a) the credit base shopping is only based on and possible with a fractional reserve/fiat system.
or
b) the real money demand increase is the post-holiday season, per the need to pay down credit.
Of course, the whole holiday season thing dates back to our beloved fdr trying to pump up the aggregate demand and spending, because that is what an economy is all about!!
Wouldn’t it also be accurate to conclude that the holiday season shopping binge is really a mini boom/bust cycle? I can attest that many a business (like my wife’s photography business) suffers accordingly in January, and not just the same holiday shopping stores. It affects other sectors of the economy as well. And, the build up of inventories, the temporary staffing, et al., all display signs of much malinvestment. And besides, how much holiday shopping is on useless crap anyways? Kinda like all those unoccupied strip malls!!
You had me until you said “malinvestment”. It’s not malinvestment if the return is realized, and in the case of holiday shoppers it most definitely is. In other words, the capital and labor buildup to the holiday season results in real returns as shoppers swamp the stores. How is this malinvestment? If anything it’s a very safe speculation in the same way that an oil speculator stocks up on oil (real or future) in anticipation of a sudden spike in demand or drop in supply. If the expectation is realized, then the investment was a wise one.
The way I was looking at it is this (and it’s from experience in retail at the holiday season):
Much of what stores do doing the year, especially the second half, is anticipation of the holiday shopping binge. And much of the merchandise is geared towards the holiday shopper, and not necessarily to satisfy consumer wants. It’s a binge born of credit, and based on credit.
Yes, it’s expected, and yes, it’s satisfying consumer desires to buy a gift, etc. And yes, I recognize the time preference of the shopper. But a credit induced shopping season doesn’t really reflect true time preferences which are only evidenced by real savings. You ever hear someone say “I’m saving up for my xmas shopping”?
However, not all stores clear all their merchandise during the holiday season. And they have to dump it at huge discounts. I.e. clearing out the bad investments. The whole idea of “black friday”, that that’s the day stores break even and become profitable, reeks of credit induced cyclical behavior. And what of the stores that don’t make it during the season? They’re basing their calculations on a credit cycle.
No, it’s not a perfect analogy, but I think it’s pretty close to a credit driven cycle. Had we a 100% reserve system, then Professor Blumen’s point:
makes sense. The problem is people aren’t borrowing real savings, which would surely result in higher interest rates paid to savers, and charged to borrowers. In fact, under a 100% reserve system, banks would most likely anticipate the higher money demand and offer higher real rates of return prior to the holiday season, which would more closely resemble the larger market for loanable funds/time preferences model.
Under 100% reserve system, credit at all times equals voluntary savings. So the money supply/demand is still in balance. The people who are borrowing to buy gifts are borrowing from other people who are saving. After Christmas, let’s say that the borrowers want to pay off their balances, so they reduce their spending on other goods and pay down the loans, while the lenders receive the principal and interest.
Should it also be considered that our modern way of celebrating Christmas with an orgy of spending was at least partly caused by fractional reserve banking?
I guess this guy has never heard of Christmas club accounts.
To summarize ist:
A higher money demand during christmas in no problem to a 100% reserve system because
1. as producers need to buy goods to produce more stock of their products, their currency deposits decrease so that consumers which delay their consume to November/December increase their demand for money during the pre-christmas-period to buy later. If this cycle is known, everyone anticipates it and there will be no problem with money supply during the christmas period.
2. Side arguments are that artifically increasing money supply has nearly the same effect as an down adjustment of the price system. (Mit Außnahme der Vermögensumverteilung bei der Geldmengenausweitung) The argumentation of keynesianes runs vs. the wall.
3. To the currency which is in circulation (here called money) can to some degree also be taken currency that is stored in safety deposit boxes, to compensate higher demand.
Did I understand that right???
@Modorok
Concerning “Side arguments are that artificially increasing money supply has nearly the same effect as an down adjustment of the price system” -> that would be an updward adjustment of the price system, not a downward adjustment.
re, point #3, the point is that the money supply remains the same whether people carry around gold coins, bank notes 100% backed by gold coins, or write checks against their 100% backed deposit accounts. The exact form of money does not matter because money can take any of these forms while the supply remains the same.
Thanks for your answer Robert Blumen.
I think you misunderstood what I have ment with point No.2. The keynesians claim that a sudden increase in money demand would cause falling prices and producers would loose. Only inflating money would prevent this. But rising the stock of money only causes a devaluation of the circulating money. The only effect that happens is higher instead of lower prices and the looser is not the producer, which should be prepared and calculate better next time, the loosers are the consumers. The difference is a transfer of wealth. (Vermögensumverteilungseffekt)
To Point No.3: You are right with surrogates on money, as long that it is backed by 100%. What I wanted to be approved is the idea that people is sum would liquidate their deposits in times of a higher money (100% backed) demand. Has someone statistical data to the fluctuations of deposits during the gold standard???
The idea that you need to print fiat money for Christmas seems to fly in the face of common sense. If we go back to Charles Dickens, “A Christmas Carol”, everybody paid cash, usually coins. Dickens makes no reference to there being a shortage of coins at Christmas and people having to go without as a result. Also, in those days , debtors were put in prison. Most people would save up to buy things.
What’s a Christmas?
a holiday. you ask santa for gifts. like….santa, can i have no more stupid questions please?
the banks are simply robing us
Comments on this entry are closed.