Some protesters on Wall Street are drawing attention to evils of fractional-reserve banking. Krugman fights back. His entire argument is against banning the practice. This misses the point: it is enough to stop using the state and the Fed to sustain the unsustainable. Make banking a normal market activity with profits, losses, and the freedom to fail and then, as Rothbard says, fractional-reserve practices in demand-deposit banking will be selected out. Rothbard in fact went to great lengths to show that the main examples of sustained fractional reserve practices depended on some form of government intervention.
Source link: http://archive.mises.org/18684/krugman-attacks-the-one-good-idea-of-the-protestors/
Krugman attacks the one good idea of the protestors
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Free banking is a great idea. Banks should be free to operate on fractional reserves, and free to issue inconvertible money in any form.
Unfortunately, a lot of the so-called free bankers at mises.org suddenly stop believing in freedom when it comes to these two issues.
Wrong. Even De Soto, 100% Reserver allows for fractional reserves as an aleatory contract. “To the bearer on demand, if we can.” You’re free to issue sproul’s and we’re free to think that no one would want them under free competition. I have never seen anyone argue that such a contract should be illegal.
“I have never seen anyone argue that such a contract should be illegal.”
I used to think that FRB should be illegal, after first reading Rothbard. Then after a while I decided that liberty should take precedence and that it should not be illegal for the reasons he said. I now think though that it should be illegal, again, for much more roundabout (but fundamentally similar) reasons.
Salerno reiterated this very point in a recent talk. Permit it precisely so that no one will do it.
http://www.usagold.com/halldiscussion.html
Maybe this is true.
It’s true in so far as a bank is good at handing out loans. And we need to force banks to show the risk right out in front instead of saying that the deposit is available on demand. If it isn’t, then say so. At least the risk and reward are stated up front. If it is, then you’re going to have to pay a bank for storage.
“available on demand”
Using the phrase “on demand” like it is just obvious what it means makes no sense to me at all. A commodities exchange is productive only because it the contracts are standardised and it precisely avoids the notion of anything ever being available “on demand” – because it makes no logical sense, makes economic calculation impossible and thereby introduces instability into the system.
Anyone who says that “well two people are entitled agree whatever they like” or something similar needs to explain how why futures contracts evolved from forward contracts. The whole point of a future is that it is not a forward – it is exactly NOT two people agreeing something directly between themselves but is in fact lots of people using a common communication system to facilitate trade. This is only possible when what is being exchanged is clear. When you say “saying that the deposit is available on demand”, what is “the deposit”? What is “a dollar”? This is not a trivial question.
“Encompassing over 1,600 pages and 6,000 footnotes (the index alone is 50 pages), “Pieces of Eight” is certainly the most outstanding product of scholarship that I have ever had the pleasure of reading. And don’t be intimidated by its length. One must read only the first three chapters — 175 pages — to understand the original intent of the Founders, and thereby to answer the question: What is a dollar?”
http://www.gata.org/node/7536
There is nothing wrong with parting fools from their money. Or even with Ponzi schemes. I believe Guido Huelsmann in a book or paper notes that people ought to be free to engage in foolish pursuits like FRB.
The biggest problem (of many) with this statement is the failure to see the difference between fractional reserve banking and fraud.
FRB should be permitted only under circumstances where it does not work a fraud on anyone who can reasonably be foreseen to be affected by fractional reserve notes.
In this case, a bank that issues notes for the purpose of circulation in the economy should realize that anyone who takes its note for value will need to know whether and how the note can be redeemed, which, of course, is a major purpose and function of the note in the first place.
The only way a FR note can avoid being fraudulent is if the note states its terms on its face — the guaranteed fraction in reserve, and what it’s redeemable for, and when (e.g., on demand, in X days, or some combination thereof, etc.).
They could be redeemable for gold, silver, cookies, tires, chickens … it doesn’t matter. People are free. But if the bank issuing the note can only redeem 10% of all its outstanding notes on demand, and the rest only later, then it needs to say that.
Under these basic rules, we might see 10% gold notes, 50% silver notes, 80% chicken notes, 100% platinum notes, etc. We’d also see what the market decides about the exchange rates of various fractional notes in the economy, compared to 100% gold notes. (I’d bet the fractional ones would trade at a discount, but only the market can say what that discount would be, how it would fluctuate, etc.)
“FRB should be permitted only under circumstances where it does not work a fraud on anyone who can reasonably be foreseen to be affected by fractional reserve notes.”
“should be permitted” by whom? “The authorities”? I’ll take private FRB note issuers over “the authorities” any day.
Permitted by the more reputable of the private dispute-resolution services, of course!
If you *consent* to a bank having ownership of 90% of your money, and you just hope they will always have it there if you need it, that is still 100% reserves and not Fractional-Reserve Embezzlement (you voluntarily transferred ownership of 90% of your money). A bank telling you at any moment you can legally access 100% of your money on demand, as they lend out 90% of your money to someone else they also tell can legally access 90% of your money on demand at any time, is initiating coercive embezzlement.
Anything that is not 100% reserves is coercive embezzlement by definition. If someone decides to (painfully ignorantly, in my view) literally transfer ownership of 90% of their money to the bank, and hope the bank will have it and transfer it back when they need it, is still 100% reserves; they just now have the right to lend that 90% since they now own it. Banks do *not* own it now.
Pretty convoluted explanation. It assumes a lot, and uses vague definitions.
@Kinsella, you rambling some adjectives at this changes nothing.
1. If you *own*(1) an asset(2) you can use it in whatever demand-deposit(3) or time-deposit(4) you like.
2. If you do *not* *own* an asset you can *not* use it in whatever demand-deposit or time-deposit you like.
(1) Own (Merriam-Webster, adj): 1. belonging to oneself or itself.
(2) Asset (Merriam-Webster): 3a. an item of value owned.
(3) Demand-Deposit (Investopedia): An account from which deposited funds can be withdrawn at any time without any notice to the depository institution.
(4) Time-Deposit (Investopedia): A savings account or CD held for a fixed-term with the understanding that the depositor can only withdraw by giving written notice.
-de Soto, MBCEC, p. 20: “the economic and legal characteristics of a true loan, not those of a deposit.”
So what, exactly, is your point or stance? Ah cain’t tell.
If you open a demand-deposit account with a bank, with legal demand access to 100% of your assets in this account, then the bank non-consensually and unsolicitedly put 90% of your demand-deposit assets into a time-deposit account of the banks and loans out all of those assets, that is coercive embezzlement.
Coerce (Merriam-Webster): 1. to restrain or dominate by force.
Embezzlement (Merriam-Webster): to appropriate (as property entrusted to one’s care) fraudulently to one’s own use.
Fraud (Merriam-Webster): 1a. deceit, trickery; specifically: intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right.
As I said below to Wolf, your assets are being ‘dominated by force’ (in the MW definition of coercion sense), just as when a criminal agent breaks open your vehicle and drives off with it they are dominating your asset by force.
Embezzle/Fraud/Coerce/Force/Rob/Steal/Take/Aggression/Smuggle/Control/etc. are all extremely elastic, subjective terms that start merging into each other without resolving any of this elasticity. When I refer to ‘coercion’ I am specifically thinking of *unsolicited*, *non-consensual* aggression (with all other terms as differing forms of this core action). If you were to refer to the term in this specific sense, an agent expropriating your assets non-consensually and unsolicitedly would be coercive.
If the bank does an action (exchanges a service) you did not consent to (the time-deposit expropriation of the banks, as in fraud), that is non-consensual: coercion (in my sense, and is ‘dominating by force’ your property, the MW sense).
If I buy an Epiphone for $600, change the headstock decal to Gibson and lie that I paid $2000 for it, that is not fraud. If I exchange that guitar to you for $1900, explicitly lying that it is a $2000 Gibson and not a $600 Epiphone, misleading you to enter an exchange you do not actually consent to, that is fraud. If coercion were specifically defined as unsolicited, non-consensual aggression, that fraudulent act would be coercive since you did not consent to the actual transaction, and I aggressed against your property by taking it in the non-consented actual exchange.
The same applies when you open a demand-deposit account with a bank, with legal demand access to 100% of your assets in this account, then the bank non-consensually and unsolicitedly put 90% of your demand-deposit assets into a time-deposit account of the banks and loans out all of those assets.
sorry, but this seems like more rambling to me. Not focused, not coherent.
What point exactly are you trying to make? Are you saying FRB is fraudulent, or not?
@Kinsella,
Coerce (Merriam-Webster): 1. to restrain or dominate by force.
-I use this term in the specific sense of unsolicited, non-consensual aggression. Both definitions work here.
Embezzlement (Merriam-Webster): to appropriate (as property entrusted to one’s care) fraudulently to one’s own use.
Fraud (Merriam-Webster): 1a. deceit, trickery; specifically: intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right.
Fractional-Reserve Banking (Investopedia): A banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal.
“Are you saying FRB is fraudulent, or not?”
Yes. When an agent or institution non-consensually aggresses against (or dominates by force in the MW sense) your property that is coercion. Since both fraud and embezzlement non-consensually aggress against (or dominate by force) your property, they would both be forms of coercion (in the above MW sense and in my specific sense of coercion).
When a bank non-consensually aggresses against my property by loaning out my demand-deposit funds in a time-deposit of the banks I never consented to, that is coercive, fraudulent embezzlement (in the above MW sense of those three terms and in my specific sense of coercion).
I do not see how a bank non-consensually aggressing against my property is not coercive, fraudulent embezzlement in the above MW sense of those three terms, or my specific definition of coercion.
De Soto, MBCEC p. 140: “First, we may suppose that the vast majority of depositors are not aware that by depositing their money in a bank, they at the same time authorize the banker to use the money for his own profit in private business deals. It is certain that when the overwhelming majority of depositors make a demand deposit, they are under the honest impression that they are in fact doing just that: entering into an irregular deposit contract, the essential purpose of which is to transfer the custody or safekeeping of their money to the banker.”
@Randy Oparowski,
You write that “A bank telling you … you can legally access 100% of your money on demand, as they lend out 90% of your money to someone else they also tell can legally access 90% of your money on demand at any time, is initiating coercive embezzlement.”
Coercion is defined as “restraining or dominating by force” or “achieving by force or threat.” What you describe is doubtless embezzlement, but it is not coercive, as force is not involved, but rather misrepresentation of an untruth as true, which is a fraud. Therefore, I would suggest that what you intend is not a coercive embezzlement but rather a fraud or simple embezzlement, the latter defined as appropriating another’s property fraudulently to one’s own use.
Pax et bonum,
Keith Töpfer
@Töpfer,
Fraud(1) is just a category of coercion(2); when you ‘dominate by force’ anyone’s property (including their property ownership of themselves) that is coercion, unrelated to the modifiers of ‘deceit’ or ‘trickery’ added to this domination by force.
(1) Fraud (Merriam-Webster): 1a. deceit, trickery; specifically: intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right
(2) Coerce (Merriam-Webster): 1. to restrain or dominate by force.
When I use the term ‘coercion’ I describe it as unsolicited, non-consensual aggression, but the Merriam-Webster definition will do fine.
@Randy Oparowski,
My apologies. I had assumed you were an English speaker. Where in your cited definition of fraud from Merriam-Webster is there any suggestion of force or the threat of force? I see no citation, reference or allusion to force. Fraud involves deceit or trickery, not force, if force were involved the crime would be robbery, not fraud. Ergo there is no “coercion” involved.
Thank you for hoisting yourself, and thank you for providing the petard. It is little wonder to anyone who can read and understand English why Dr. Kinsella would have remarked on the vagueness of your initial comment.
Pax et bonum,
Keith Töpfer
When an agent non-consensually dominates your property by force that is coercion; embezzlement is such an act.
You being belligerently uncivil, as Kinsella is being uncivil instead of just civilly discussing the issue, is just an insult to yourself.
Cordially (not that you deserve it),
Randy Oparowski
That is the catch. There is no force involved. You agree to something based on false information but are *not* forced to.
A mundane example: used cars. You buy a car that’s supposed to run on air, be able to carry ten tonnes, drive and park itself, and guarantee you get any chick you want.
When these benefits fail to materialize, do you consider yourself a victim of coercion? Fraud, surely. Coercion, not at all. There. Is. No. Coercion. In. Fraud.
As Martial Artist remarked, if coercion is involved, then it’s robbery. Let me spell it out once more, just in case:
There. Is. No. Coercion. In. Fraud.
@Wolf,
Embezzlement (Merriam-Webster): to appropriate (as property entrusted to one’s care) fraudulently to one’s own use.
Coerce (Merriam-Webster): 1. to restrain or dominate by force.
Force (Merriam-Webster, verb): 5. to achieve or win by strength in struggle or violence.
Under Fractional-Reserve Embezzlement your assets are being ‘dominated by force’, just as when a criminal agent breaks open your vehicle and drives off with it they are dominating your asset by force.
Embezzle/Fraud/Coerce/Force/Rob/Steal/Take/Aggression/Smuggle/Control/etc. are all extremely elastic, subjective terms that start merging into each other without resolving any of this elasticity. When I refer to ‘coercion’ I am specifically thinking of *unsolicited*, *non-consensual* aggression (with all other terms as differing forms of this core action). If you were to refer to the term in that specific sense, an agent expropriating your assets non-consensually and unsolicitedly would be coercive.
Best Regards,
Randy Oparowski
Hayek agreed with Krugman in his “Monetary Theory and Trade Cycles.” Hayek’s book is far better than Diamonds paper, which is almost simplistic. FRB is just too lucrative. You can’t stamp it out. Some forms of insurance that allow borrowing on the account act as FBR banks.
However, you can reduce money creation through free banking, and insurance companies can offer deposit insurance for depositors. Premiums would signal the safety of the bank.
Shaky FRB banks will go under eventually without the State. There is no way around that. Not even via insurance (which will go bankrupt with them). If a bank engages in FRB without making it clear (warehouse receipt vs loan to bank), let the clients sue it as embezzlement. Otherwise, let the banks do whatever they want to do (according to contracts with clients).
The market will prevent FRB from running out of control.
Some loaning of credit, some fractional banking is probably actually desirable. But the problem is when there is a forced conversion of gold to paper and when banks are protected from bank runs by government promises. It’s completely screwed up the self regulating nature of a open market.
As long as the loss of savings is a possibility and the value of paper fiat currencies are allowed to naturally float relative to the value of ‘hard’ commodity monies like Gold then you will naturally have people’s paranoia and Gresham’s law working in society’s benifit to minimize the risk and negative effects of FRB.
As banks issue more credit then their reserves can sustain in the form of paper currency then people will naturally start to distrust the bank’s notes. The bank notes will depreciate in value relatively to their face value in the open market. There would be a huge profit motivation to be the first person to then purchase the cheap notes from the market and then redeem them at the bank at face value. That way they can get their hands on the bank’s gold and drive them out of business before the next guy gets whiff of the weakness.
Over time professional ‘bank assassin’ corporations will arise that will seek out any sort of weaknesses in the bank’s notes and guarantees. They will try to create as much as a difference between market value and face value as possible. Even very thin differences in values will house significant potential profit from killing off a bank. If the bank refuses to pay off the note’s holder then that will just destroy the foolish banks faster.
Naturally banks and the people saving money in them will become hugely risk adverse. Evidence of bank assassin speculators taking a unusual interest in a bank’s credit notes will be enough to shake even the most moronic banker to their core.
“The market will prevent FRB from running out of control….There would be a huge profit motivation to be the first person to then purchase the cheap notes from the market and then redeem them at the bank at face value. That way they can get their hands on the bank’s gold and drive them out of business before the next guy gets whiff of the weakness.”
Your categorical statement sounds good at a glance – it misses something fundamental though. How did that work out for the holders of dollars when they (starting with De Gaulle) requested gold from the US? Did Nixon give them the gold? Did countries stop trading with the US as a result of his refusal?
For a little while he did, I suppose. Of course he reduced their ability to get gold from the treasury through the 1960′s and eventually killed it altogether in 1971.
Germany dropped the dollar standard relatively quickly. Switzerland dropped it after getting 50 million in gold and was refused another 190+ million. I suppose other countries dropped it after that. As a result the USA saw significant devaluation of the dollar. Probably also contributed to the massive inflation through the 1970′s. The Euro and other Fiat currencies were setup as competition to the dollar. The USA lost the opportunity to get the Chinese on the dollar.
Etc etc.
But the USA is not a bank and when you are the super power of super power with military bases in close proximity to almost all other major governments, and you are the only major source for a huge number of services and such….. the USA government is not a bank. Same rules don’t apply. It’s not a free economy. Also the other governments didn’t want to move to a gold currency any more then the USA did. The ability to print up money themselves benefits them, politically, like it does the USA’s government.
They are just as stupid, petty, and greedy as the USA government is. So actually most major governments to this day put a significant amount of effort into propping up the dollar to this day. It’s like tweetledum competing against tweetledee. So the same rules don’t apply to the governments of the world versus banks on a open and free market.
Anyways… If your a smaller government competing against the dollar then all of a sudden you will start to be told that you are developing weapons of mass destruction. Your government offices will start randomly exploding as a result of unmanned drones, all of a sudden your population will start hating you… etc etc.
When Hoppe says that you can show that you don’t need a monopoly of force to have peace because otherwise the countries of the world, as there is no world policeman, would necessarily be in permanent conflict, he compares countries interacting to market members acting. This comparison can obviously be abused but I don’t think Hoppe does it there and I don’t think I’m doing it here – you didn’t explain why I’m doing it, you just stated it twice.
Not sure why any of this is relevant – you don’t dispute that people still trade with the US, and still use dollars to buy oil, despite the promise of gold backing of the dollar being clearly and publicly reneged upon. And you don’t dispute that De Gaulle tried to do exactly what you described ie. “…be the first person to then purchase the cheap notes from the market and then redeem them at the bank at face value. That way they can get their hands on the bank’s gold and drive them out of business before the next guy gets whiff of the weakness” and this failed, he didn’t get the gold and the market carried on, despite the “weakness” being as public and as obvious as can be. I’m perfectly aware that the US is not a bank, but this does not on its own invalidate the fact that what you say will happen didn’t happen.
You are making my point here. Some banks will have more power than others and be able to use this power to get others to go along with their credit expansion – sometimes this will work, sometimes not. Other banks will go along with it simply because it is more profitable to prop up the credit-expansion ponzi than it is to collapse it, just like China are not collapsing the dollar now. Its not at all obvious to me that FRB won’t take hold, I think it is in fact as I said above “what the people want”.
Unless the bank has the power to go out and shoot and imprison people that disobey it then I am not making your point at all.
Your just ignoring my point completely, which is:
Banks are not governments. Governments are not banks. The world market is not a free market. It’s controlled. Other Governments are in collusion with the USA to protect their own fiat currencies and they will kill people and destroy their own economies to protect the political power they gain from it.
The rules which banks will have to live by if they exist in the free market is not the same rules which our government operates under. So you bringing up the fact that dollars is still used world wide even though we have abandoned the gold standard is proof that FBR banks will run amok in a anarchist capitalist society is not valid. They are not parallels.
One government actually did try to do that. They tried to convince other African countries that they cannot trust the dollar and should require gold be used to purchase oil. They even created their own gold backed currency and tried to get other oil rich countries to adopt it.
It doesn’t exist anymore.
It was the former government of Libya.
It doesn’t have the power to shoot or imprison people no but whoop-de-do – you are also ignoring the fact the France and the UK used dollars despite the default even though there was 0% chance (none, none whatsoever) of the US forcing them to do so by invading them. They chose to because it was in their interest, as may other banks and people – frb is simply a process to transfer wealth to those who understand money from those who don’t.
So Hoppe’s point I alluded to above is also false? Ok. Not necessarily saying one or the other, just trying this thing called “debate” which, in the face of complex systems you don’t understand, might be done with a little more humility than you show.
Countries are entities that represent “customers” (ie. their population) they have to serve in some sense, if via a delay, and “issue” money in some sense and interact without a world policeman governing their rules of interaction.
In a single free economy, banks would be entities that “issue” money in some sense and represent customers who they have to serve in some sense, if via a delay, and “issue” money in some sense and interact without a state-policeman governing their rules of interaction.
Yet, you see no comparison whatsoever? None at all? Why am I wasting my time?
“Proof” no. Worthy of analysis rather than just dogmatic statements? Yes.
Enough already with the drum-roll, I’m perfectly aware of this and would venture a guess that I know more about it than most. Once again, this just shows how it is in the interests of powerful money-issuing entities to shut down smaller ones. Maybe large frb banks will have the power to do this via the covert smear campaigns etc, you ancappers love so much, maybe they wont. But if you tell me you KNOW they won’t, then you are simply bluffing.
In fact, just looking at “Rick’s Picks” for the mini S&P today, look what he says.
“With Thursday’s touts, I haven’t gone very far out on a limb, but there’s room nonetheless for a bullish play in the E-Mini S&Ps if traders remain intoxicated with the bullish “story” on Greece et al. Not that every one of them doesn’t know it’s going to end badly; just that each is acting as though he will be just ahead of the panic when it hits.”
See that – “Not that every one of them doesn’t know it’s going to end badly; just that each is acting as though he will be just ahead of the panic when it hits”.
This is trading 101. I think FRB could develop along exactly these lines – people propping it enough not because they think it adds value to the economy but because they surmise there are still more fools in the wings from whom to extract money before the bust.
Does this mean it should be “illegal”? DIfferent question – but the idea that making this logically ridiculous act legal will mean it definitely will not happen seems likely to me yes, but not at all certain, I ahve doubts. I obviously don’t have the Rainman-like ability to predict the behaviour complex systems containing feedback that you have.
They are in in on the scam. They profit from the use of fiat money and gain political power at the expense of their own people and their own economies. They have no desire to stop it.
So? This has nothing to do with what I stated above.
I never said that FRB wouldn’t happen. I said that speculators would be waiting in the wings to profit from destroying banks that engage in FRB recklessly. I said that because it’s easy to punish banks for using FRB recklessly then the ones that do won’t last for very long. The market is self-regulating.
Just because he chooses to use a comparison of that nature to illustrate a point does not mean that governments and banks will have the same power and abilities in all cases, or even that he believes it.
Your whole point rests on the fact that you believe that banks operating in a open market have the same power and controls that governments operating today do. It’s not really the same.
The state does not have that relationship with it’s subjects.
They do not exist in a free economy.
They have the ability and desire to use violence to protect their interests.
I don’t know. Like I said I don’t think it’s a good comparison at all. “None at all?” is not accurate, there is probably something somewhere.. but it’s not going to be substantial.
Some loaning of credit, some fractional banking is probably actually desirable.
Not taking issue with the majority of your statement, but an implication in this line. Without FRB, do you think that there would be no loaning of credit? I don’t–it’s just that the loaning of credit would be limited to the savings or time deposits that the bank has, that is, only to what people deposit with the bank specifically to be loaned out (and earn interest on).
There exists no probability distribution for a bank-run, so insurance won’t do the trick. People will just have to accept the gamble.
Precisely.
Banks themselves control their vulnerability to a bank run, so the event of a bank run is uninsurable.
I could imagine firms offering to insure a bank’s depositors on the condition that the bank meets requirements set by the firm, disclose accounting details, permit random inspections, etc. Bank runs are not statistically distributed unless you control variables in behavior and risk-taking, at which point depositor insurance becomes a marketable feature of the bank and a lucrative enterprise for the insurer.
This is impossible, I think–take a look at Hoppe’s work on the nature of insurance and his discussion of Mises’s distinction between class and case probability (and its relation to Misesian dualism which distinguishes causal phenomenon from teleological ones). Consider: a given bank that loans out some of the deposited funds is taking an entrepeneurial risk that the debtor will be able to repay the loan. If a too-large number of those debtors are unable to repay, the bank is now unable to repay depositer redemption demands (and have to invoke a temporary suspension clause) but it is now insolvent since when some of its loans go bad, its assets are not equal to the liabilities to the depositors. If you could insure this then any entrepreneur could insure his business; any lender/creditor could buy insurance for his loans. Obviously this is impossible.
I should have elaborated that the model I described is less true insurance, in the sense that anyone can buy in to protect themselves from statistical anomalies, and more like hiring a regulator to induce customers with guaranteed deposits. The risk-aversion required by their insurer would make such a bank truly a warehousing operation, and the risk of illiquidity diminishingly low. An insured bank would need to charge its customers a premium for this service, but risk-averse depositors may find this acceptable.
D. Storey: Then you are not talking about insurance. And the “seal of approval” still does not prevent the “bad loans” scenario I mentioned, and thus, the possibility that the IOUs the “bank” hands out might be never repaid or only partially repaid. Thus, the IOUs can not be money substitutes.
D. Storey is describing the auditing process.
Anyone else notice that, probably for the first time, Krugman admits the culprit: Fractional reserve banking.
Obviously, his position is that it can be tamed, but at least he admits that, when it is supported but not regulated, it produces the boom and the bust.
This is almost a breath of fresh air. It seems like I hear that the economy needs to be re-inflated on a daily basis, but no one draws the obvious implication: if the credit market has collapsed and needs to be re-inflated, doesn’t that mean that it was inflated in the first place? You can’t claim that the Fed has the ability to solve the crisis by injecting liquidity into the credit markets in order to re-inflate them, and deny that the Fed could have possibly been able to inflate the credit markets in the first place to put them in a position to crash.
Whether Krugman admits it or not, we have found common ground. Fractional reserve banking, supported by FDIC, elastic currency, and central banking caused the boom which necessitated the bust. The difference now, is no longer the origin of the business cycle, but whether or not regulation and proper monetary policy can tame the business cycle.
Common ground with Krugman. Now THAT is weird.
Krugman:
“Let me add that the fractional reserve thing exhibits a characteristic common to a lot of what I see in the Paulist camp: …. oddly antiquated notion of what money and finance are about, one that misses the “virtualness” of the modern world. They still think of money as being pieces of green paper, rather than what it mostly is now, zeroes and ones in some server somewhere. They still think of banks as being those big marble buildings, in a world in which most banking is a lot more abstract than that.
“This is, after all, the 21st century. Things have moved on a bit.”
I am not an economist. But I can recognize academic rigror; I’m often overwhelmed by the level of sophistication and intellectual analysis by many writers in the mises.org sphere.
And this is in stark contrast to this recognized and decorated establishment shill.
Note the irony: “… [the Paulists] still think of money as being pieces of green paper.”
The clumsy straw man is obvious to even me. How disingenuous can this fellow be?
The one stark issue that separates the so-called “Paulists” from the status quo is the basis of money and how its credibility depends upon a foundational standard.
“…zeroes and ones in some server somewhere.”
Pffft…
Just makes you shake your head.
Krugman is a genius. Neither Ron Paul nor the Austrians have ever mentioned the fact that the fiat money system can create loans out of nothing using computer keystrokes! Right? Without Krugman, we would have never realized that. Thanks, Krugman.
I find it disappointing how the left’s greatest academic cheerleader, Paul Krugman rarely uses economic reasoning in his articles, and when he does, it’s usually very shoddy and unconvincing even by the standards of mainstream academics. It doesn’t take a lot of effort for someone like Robert Murphy or Bill Anderson to pull him apart. Most of what he writes is just polemic and academic brush-off directed at opinions and views that he doesn’t endorse. He wants to paint his opposition as a bunch of kooky right wing country hicks who miss the good ol’ dixie flag and have absolutely no understanding of modern technology. That’s the best he can do, considering that he’d sorely lose in a debate to virtually any regular contributor here.
It’s kind of ironic, considering that I’ve regularly read his old articles and sections from books before coming to LVMI and found his case for free trade to be very compelling.
I hate repeating myself but I never seem to get much of a response to it. People have suggested that FRB is a contractual issue between the bank and the depositer. But what about third parties who receive the money? If an FRB currency is exchanged in the economy without being noted or marked as such, then fraud has been committed on the third parties, it seems to me. If, as I think it would, the FRB money is clearly labeled as such, then third parties would be free to reject or discount the money by an appropriate amount.
For example, if an FRB currency was backed by 75% reserves and a third party receiver of the money knew that, then why wouldn’t they discount the currency’s face value by 75%? And if they did, then the question would be what is the point of having FRB currency?
It seems that the only value from having FRB occurs when somebody is defrauded or in ignorance of the FRB currency.
Generally speaking if your trading in bank notes rather then metal then that should be pretty obvious that your actually trading in something other then gold.
But I can see your point if your doing electronic transfers or your using bank notes because the amount of gold is inconvenient to manually process (to little gold, or to much gold, etc).
but this is the sort of thing that is easily taken care of in a free market. It’s a problem, but one with easy solutions. The problem is that it’s going to be impossible to know exactly what solution would work best unless you were able to see it work in the real world.
One possible solution is to have a bank regulatory body that exists to ensure tha level of reserve backing the notes. They would then require certain labels on the notes or registered electronic signatures that would indicate 100% backed., 75% backed, or whatever. Then banks could voluntarially register with the regulatory group in order to raise their creditability and encourage people to trade and accept their notes as payments on behalf of their customers and debtors. If, for whatever reason, the bank fails to live up to their promises then they face fines and eventually can be kicked out and have it’s status and ratings revoked.
This sort of voluntary regulatory structure is one of those things that rises naturally in any industry. standard bodies for Industrial grading of metals, standards for welding techniques, standard bodies for chemical labeling, standards for plumbing fitting sizes, standards for internet computer protocols, etc etc. Happens all over the place. No need for the government for any of this stuff.
But that is just one possibility.
I’m not questioning how to indicate the reserve level of a bank or its currency–there are many possibilities. I’m questioning the value of having FRB where the reserve level is known. If a receiver is going to discount an FRB currency anyway, then why have less than 100% reserves? What would be the point?
Oh, I don’t know. It’s just a matter of what the market decides. Maybe it would work out, maybe not. I am not in a position to tell you that it would work out at all.
Besides I don’t think it’s fraud to keep a FBR note reserve hidden. As long as people are not lied to about it. If you go to the bank and you say: How much is this note backed? And they say 99%, but really it’s like 30% then it’s fraud. If they say that it’s 100% backed, then it’s a fraud. But if they say “I am not telling you because it’s a secret”, then it’s not fraud.
If you accept bank notes as payment without looking into the credit worthiness of the bank that issued it then you only have yourself to blame really, unless the person giving you the notes knowingly tried to portray them something they were not, then that is fraud on the part of the guy giving the notes to you.
agreed; it’s not fraud. it’s just economic nonsense.
nate-m, I still don’t think you understand what I’m asking. Assuming that there is no actual fraud going on, why would the market support FRB? Why issue or loan out discounted currency if people are going to discount it upon receipt? What purpose would the discounted notes serve in the economy? It seems to me that the only thing it would do is encourage runs on the bank, as people tried to take the discounted currency back to that bank and exchange them for the face value of the backing commodity. I don’t see any benefit for the bank, for the people who receive loans from the bank, or for the original depositors in this free market, FRB scheme. Why would banks want to do it if there’s no fraud involved, and not too many suckers out there who would accept the money at face value?
Quite possibly. I am trying my best.
Well if I was a business owner, say I rebuilt transmissions for cars. Imagine If a guy went up to me and told me that he needed a transmission rebuilt for his car, but all he had was bank notes. So my choice would be to give up doing business with this guy or accept the notes.
Whether or not I choose to accept his terms would depend on a number of different things. Factors such as my previous experience dealing with these credit notes or similar schemes, what my bank says they will accept and exchange on my behalf, what is accepted as payments by other people. Obviously I would prefer cash, but if I can be reasonably sure that I can receive cash for these notes then I would probably be willing to take them.
If I do end up taking them I will probably end up charging more then I otherwise would of, to make up for the risk and discomfort I feel from the deal. The guy with the notes would be double penalized.. he would pay a higher premium for the transmission in addition to the interest payments to the bank… but if he really needs his transmission fixed then it would be worth it.
So the bank floating the loan.. the one issuing the notes.. knows that it’s going to take some time for the notes to come back and they will be forced to pay out. It may even have some time stipulation on the notes that say it’s not redeemable until 6 months or a year after issuance.
Now between the time the note is issued and the time it’s expected to be collected the bank has a projected income. It’s going to make some amount of money from loans and other business ventures so that by the time the notes get back and payments are demanded then it knows that it’s very likely that it will have the amount covered 100%.
Of course in this state of affairs we are not going to see ratios of credit to cash of 8:1 or whatever… we will see things like 10:9 or 3:2 or something like that.
As long as the bank continues to profit then the market place will continue to accept it. Of course, like I said before, speculators are going to be waiting in the wings for any sign of weakness in the market price of these notes to jump at a chance to make a profit.
I figure something like that.
It seems to me that both the depositors and the payees must have a complete meeting of the minds regarding what a strange animal these FRB notes really are. I would think they would require a warning in big letters that this is not the same thing as a 100% reserve note in order to avoid a claim of fraud.
Then, who would accept them as payment? In Detroit on the Canadian border, no stores will now ever accept Canadian money, even on those days when it is at par or above the US exchange rate (and you can exchange them at your local bank). Would a seller of a house accept FRB notes? A hamburger stand wouldn’t accept them when there are in competition with 100% reserve notes in the market.
This FRB nonsense is just more neurotic avoidance from our opponents who refuse to comprehend Austrian concepts.
If you passed a law requiring 100% reserves, checking accounts would convert overnight into mutual funds.
You deposit cash. The bank invests your money, which could gain or lose value. When you need money, you can withdraw it, or even write a check against it. However, you aren’t actually withdrawing cash, you are technically selling your shares to another buyer for cash. Since the transactions occur behind the scenes, people would quickly start accepting shares as currency.
So, even if the government took a 100% reserve approach, it would still turn into the kind of system that free-banking advocates envision.
The only way to really eliminate FRB in all it’s forms, including this one, would be to make it illegal to accept mutual fund shares as payment.
THis is confused. What you are describing is similar to the stock market in place now–if you own shares in Apple you can sell them for cash when you want, but the Apple shares are not accepted as currency because they are not money substitutes. Your title to a car or house is also able to be turned into cash by selling the assets. THat title also will not circulate as a money substitute, as it is not a money substitute. There are lots of titles in a market economy, and lots of types of goods. The whole idea of money is that one particular commodity becomes used as a general medium of exchange, i.e. it becomes money–e.g., gold or silver. THen that commodity is money, but not other things, like your car or house or eggs or Exxon. A legal title to the gold — e.g., a warehouse receipt — can itself serve as a money substitute since it represents title to an exact amount of gold. Title to my car, or a chicken, or eggs, or a house, or partial ownership to the assets of Exxon (shares of stock) are not title to money but to other goods, and just as those goods are not money, title to them is not either.
What I’m describing is not really that odd or confused, as it can be found in the mises wiki under full reserve banking:
http://wiki.mises.org/wiki/Full_reserve_banking#cite_note-7
Desoto also makes the point that mutual funds would pick up much of the slack if FRB were eliminated:
http://mises.org/books/desoto.pdf
Our current demand deposit system already functions very much like mutual funds. Demand deposits are not backed with cash, they are pooled and invested, and their value is tied to financial investments and loans. If those loans don’t pan out, you lose your deposit (or you would if not for government props).
I’ll admit that you probably wouldn’t bring Chase mutual fund shares to McDonalds (although I won’t discount the possibility), but you WOULD bring a debit card, and when you swipe, Chase isn’t going to hold up your transaction until it finds someone to buy your shares, it’s going to buy your shares personally with cash on hand, and then resell those shares to the next depositor. How much cash would it need on hand to satisfy those transactions? Probably not very much. Probably something very similar to the 10% reserves of today. In this way, all transactions would be denominated in $ (or oz, or whatever), but only in a very technical sense. Just like your current checks are denominated in $, but the real transaction occurs in bank IOU’s. The only reason we consider these IOU’s part of the money supply, but not mutual fund shares, is because bank IOU’s “masquerade as proper representatives of cash”. (http://mises.org/journals/qjae/pdf/qjae3_4_3.pdf).
My intention was to agree with you (in part). If a full-reserver intends to eliminate the inflationary effects of FRB, it’s not going to work. The only way to do that would be to also eliminate a host of credit transactions, including mutual funds (the most likely replacement for FRB demand deposits), which would be antithetical to liberty. Let me add that, while FRB is inflationary because it increases the money supply, I believe mutual funds have an inflationary effect because they reduce the demand for cash by facilitating more transactions with less cash.
If, however, a more “compromising” Hayekian Austrian wants to suggest that our system would be “better” and more “honest” if the government replaced the Fed, FDIC, and the myriad of financial regulations with a single “Thou shalt not” that would force banks to convert checking accounts into other financial instruments, like mutual funds, that recognize the potential for loss, I would be inclined to agree that the system would be a step towards liberty, and that it would be more truthful, more responsive to the market, less likely to facilitate speculative booms, and although not strictly libertarian, more libertarian than our current system.
Sorry for double posting.
To relate this back to Krugman. FRB is not a normal and productive market activity. The diverse needs and time preferences of depositors, bankers, and borrowers are better served by mutual funds (which would be more common in free or full banking), which do not require fraud or government props to work. They don’t masquerade as cash since they have to be sold for cash to complete a transaction. They don’t require government props because they aren’t susceptible to bank runs and bank competition like FRB is. They allow less cash to be used in more transactions, but they do it without fraud and counterfeiting and government intrusion.
Matthew, I guess I’m still not sure what your point is or what your question is.
That’s fair, I wasn’t clear. Honestly, I don’t know what my original point was. It’s evolved over the last 48 hours.
I guess we Austrians need to focus on “what’s the problem with FRB?” and “How would the economy function without it?”
There are lots of different problems with it like fraud, counterfeiting, the business cycle, it increases the wealth gap, time preference disparity, it supports big business and big government at the expense of everyone else, but the true libertarian would simply say, “Presently, it relies on a coercive government, and we oppose coercive government.”
However, we still have to be able to address utilitarian concerns. If we remove the coercive government props, would FRB continue in some other form? If not, could the economy function without it? If so, how?
The answer to those utilitarian arguments is the mutual fund. The void left by FRB could easily be filled by mutual funds, which is far superior to FRB and doesn’t require coercion. Krugman states that FRB is necessary because it satisfies tensions between depositors and borrowers, but it creates self-fulfilling panics, which require FDIC, which creates moral hazard, which requires regulation. The mutual fund accomplishes the same goal, but it’s not susceptible to bank runs, so government props are not required, which means fewer regulations are required.
I could go on and on, but I think the salient point is that, anytime there is a discussion of the Fed or fractional reserve banking, we should have the mutual fund in our back pocket. To use Krugman’s words against him: it’s the 21st century. We don’t need an antiquated patchwork of props and regulations to solve this problem. We have a modern banking industry with tools and products that can provide the solution without relying on coercion and fraud that is fundamentally more just and fair and also addresses a lot of utilitarian issues at the same time.
Maybe this is a bit more clear and concise:
To answer Michael A Clem’s question, I think his point is a good one. People wouldn’t likely accept a note that stated “good while supplies last”. Like him, I find it highly unlikely that FRB could exist in a full reserve/free banking environment without government props and/or deception. However, that doesn’t mean, as he stated previously, that loanable funds would be limited to savings accounts and CD’s where you don’t have instant access to cash. Nor would full reserve/free banking mean the economy would crash, as Krugman thinks. Nor would FRB somehow continue IN IT’s PRESENT STATE because it serves a market function, as others believe.
Certain aspects of FRB would continue, but only by converting demand deposits into mutual funds. With mutual funds, borrowers get greater access to credit without sacrificing depositor’s access to funds, like FRB. Unlike FRB, you aren’t relying on deception or government props, you aren’t inflating the money supply, you aren’t susceptible to bank runs, and on, and on.
I am endlessly fascinated by these Keynesians and “progressives” who constantly complain about Ron Paulians and Austrians without any interest in understanding even the most basic Austrian School concepts.
Frequent MSNBC economics guest Mike Konczal looks for answers from his minions without actually looking for answers.
http://rortybomb.wordpress.com/2011/10/13/occupy-wall-street-monetary-policy-and-the-federal-reserve/
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