If you are a supporter of Fekete who happens to be reading this blog, could you give me a “plain language” explanation why its impossible to finance production of consumer goods out of savings under a pure gold standard?TIA Mikey.

The Feketians seem to want to eliminate the wait for payment of goods shipped on credit. If I were a toy maker, and I extended to ToysRUs my goods, and they promised to pay me 30 days later (when they have sold the goods), I could sell this bill to a third party and immediately spend the money on resources, however, that is balanced by the third party having to do the waiting for payment. With a fractional reserve bank, they create the money out of thin air, and no one has to wait the entire 30 days for the payment by ToysRUs, but can make claims on resources immediately. As long as ToysRUs pays the bank, in gold, that issued the new money, then I see no net inflation; however, as Corrigan’s essay about Crusoe’s island demonstrated, eliminating the waiting period is damaging to the chain of production. In other words, for the 30 days, there are more claims than there rightfully should be, for a time, until the bill is liquidated. It seems like inflation then deflation, at least to my way of thinking.

One additional point, however: why only use RBD for final consumer goods? Why not use the same process for all goods. Why the limit of 30-90 days? Why not any time period? I am sorry, I don’t see this as a pissing match, or, if it is, it seems that one side is somewhat dehydrated.

I haven’t been able to follow this discussion because the arguments and counter-arguments (esp. Fekete’s original proposal) are far too long and seem to have less and less to do with economics as time goes on.
Regarding the RBD, I don’t understand what the problem is. Even under a 100% reserve system, banks will still have money to invest: the money deposited in savings accounts, time deposits, investment funds, etc, as opposed to deposits payable on demand which pay no interest. Why can’t some of this money be used to discount a bill of exchange? I can’t see any reason to prevent this.
Fractional reserve banking on the other hand is inherently fraudolent because it promises the impossible: unlimited access for all depositors to all their money on demand.

Yancey,

I see the inflation in the scenario you are talking about. And I think the Feketians are denying that that is inflation. But that seems like a fruitless definitional argument to me.
Can’t we just all agree to call this “frzzbang” and then get on with it? Or am I missing a more substantive disagreement here?

I think the Fetekians are wrong if they think Fractional reserve banking can’t cause a boom and a bust cycle. Or even if they think is doesn’t cause most of the ones we’ve seen.

But I think the Rothbardians are wrong if they think Fractional reserve banking constitutes fraud in and of itself. If I give you money with full knowledge that you run a fractional reserve bank, and that if everybody tries to take their money out at once, you can’t pay, how on earth does that constitute fraud?

Don’t both sides believe that legal tender laws are bad? And the Federal Reserve is just an unholy alliance of stealth taxation and goverment backing of a bank cartel? So maybe the Fetekians believe that a properly run fractional reserve bank would never go bankrupt because everything is “self-liquidating” (a claim I don’t buy at all), but suppose a bank does go bankrupt, don’t both besides agree on the proper procedure to follow at that point? (liqudate and compensate everybody left with funny money as well as can be done).

Yancey,

Because everyone _knows_ ahead of time that the fractional reserve bank is creating inflation. If people _know_ ahead of time about the inflationary practices of the bank, and they still transact with it, then it can not possibly be fraudulent.

I think the Rothbardians go much too far in claiming that fractional reserve banking is inherently fraudulent. Ie, if I give someone my coat to hold on to – but I understand that in the meantime it could be loaned to someone else while I am gone – I do not see how that loan of my coat is fraudulent.

The whole point is that money is representing goods and capital in the market, and any money past the 100% reserve req. are meaningless and distortionary.

JUST BECAUSE WE HAVE A BIGGER MONEY SUPPLY, THAT DOESN’T MAKE IT MORE EFFECTIVE!

Sean, you won.

How can you accumulate nonexistant capital?

…because the trillions of dollars of credit necessary for the production and distribution of consumer goods would have to be taken out of savings, … This makes their 100% gold paradigm unworkable for any society that wishes to achieve modern levels of capital accumulation.

The societies have mountains of debt or credit depending which side of the paper you are looking on. They may have “capital” in the form of building, property, and equipment, but that is offset by the debt side of the ledger. If I have $1,000,000 in a bank account, and a balance on a credit card of $999,000, I have $1000 in capital although it might look like I’m rich.

Theoretically you could simply accumulate capital by printing it or by the multiplier effect even if NO ONE actually invests it in something useful.

But that is what they miss. You can create unlimited CREDIT but you can’t create capital or wealth, only move it.

And I’ve also noted with confirmations that most people on the Rothbard side don’t have a problem with Money Market or other Mutual funds, even if you can write cheques on it, but they are not banks because they will tell you up front you can’t redeem your shares except as they allow.

Daniel,

Nobody in his right mind would deposit any money in a fractional reserve bank if it weren’t for two circumstances: 1) everyone knows banks can’t fail because the government, this almost magical entity without whose help we would all perish horribly, will bail them out; 2) there’s nothing else available.
My favourite comparison is with a warehouse. Imagine you bring your stuff to a warehouse, then when you try and get it back the owner tells you he’s sold it. Instead of prosecuting him, some smart guy comes along and sets up a publicly funded Warehouse Commission, which helps warehouses buy back their clients’ goods.
Of course there’s a difference between a warehouse and a pawnbroker’s shop, which is why you normally pay the one and get money from the latter. The result of this scenario is that pawnbrokers will effectively disappear. Warehouses will behave like pawnbrokers (selling your stuff and making money) but they will charge you at the same time, and if they don’t happen to have what you need in stock, the Warehouse Commission will use your tax money to buy it back… This is obviously crazy, yet so many people have been brainwashed into thinking it’s ok for banks to work in this way.

“What exactly are these “fundamental misperceptions?” To start with, Rothbardians have not adequately researched history because they believe so deeply in the rationalist myth that truth can be discerned solely through the spinning out of deductive logic.”

This guy obviously has no idea what he is talking about. Rothbard was a scholar of history and wrote a series of volumes on history.

Second of all, I don’t think that Rothbardians believe that truth can only be dicerned by deductive logic. I have never heard a single Rothbardian espouse this view. Rather, Rothbardians (or Miseans in general) believe that empirical methods should be reserved for the natural sciences, not that they do not produce any results at all.

Mark,

I thought banks which lend out deposits with the depositor’s knowledge are simply investment banks. The customer accepts the risk in return for a rate of interest.

This is not how a fractional reserve bank operates, there are some crucial differences. First, an investment fund should provide either a rate of interest or some sort of return, with a fractional reserve bank you have to pay (the “interest” they pay you is always dwarfed by the “account charges” they deduct from your account). Second, in an investment fund there are precise rules on how and when you can withdraw your money, particularly if the fund engages in highly speculative activities or non liquid investments. With a fractional reserve bank, on the other hand, they tell you that you can always access your money. This means that either they are lying and there’s a chance you may not get your money back, or that the process is inherently inflationary, or a mixture of both. Governments prefer inflation to bank runs, which is why they have given more and more power to central banks.

I agree with Daniel that fractional reserve bank (FRB) system is not inherently fraudulent. The only way that a FRB can be committing fraud is by claiming that all depositors and holders of fiduciary media can withdraw all their funds at any time at par. Obviously, this is impossible for the FRB. Other than that, the FRB system (sans State interventions like deposit insurance) operates pretty transparently to all who contract with it. The person contributing the funds knows that the FRB cannot pay off everyone for the full amount of the deposit in the event of a run. So, naturally, he will request an interest payment from the bank to compensate for this risk or the bank will offer it to raise its reserves. Once this contract is made, the bank will loan out funds to another person at a higher interest rate and issue fiduciary media to that person. Finally, the potential recipients of the fiduciary media, individuals or businesses, can decide whether they will accept it as payment. They could demand actual gold up front for payment or accept the notes on a discount. Whatever they decide, if they choose to accept the fiduciary media knowing it comes from a FRB, they too realize that they might not receive all the funds in the case of a bank run. In all these cases, there was no fraud and therefore was not immoral from a contractual point of view. Everyone knew what was going on and chose a method to shield themselves from the differing risks according to their own preferences.

The real problem comes from dealing with the “consequences” of such non-fraudulent contractual decisions. Yancey brings up the argument that she is “still being defrauded because its mode of commerce causes monetary inflation since others are transacting with it.” I don’t know how an act of fraud was committed against her seeing that she never was a party to any contract in the FRB system. I think what she means is that the product of these contractual relationships, fiduciary media, causes devaluation in the value of her money. There is no quarrel here, because the issuance of fiduciary media beyond the stock of gold (or whatever market commodity serves as the dominant medium of exchange) results in inflation and the devaluation of the current money supply. But this is not immoral in any sense. The introduction of the light bulb devalued the existing stock of kerosene lamps. Henry Ford brought about the devaluation of horse-drawn carriages with his Model T. It would be absurd to claim that the devaluation of kerosene lamps and horse-drawn carriages is immoral or fraudulent based on the introduction of a competing product.

Finally, there is much fretting that the inflation caused by a free FRB system will trigger a boom/bust cycle just like central bank induced FRB inflation. I have read articles claiming that localized business cycles stemming from a free FRB system have existed. I will not doubt their validity because I believe in the Austrian theory of the business cycle and that private FRBs have the same capacity for triggering the cycle. But this objection is faulty because it imposes third-party subjective evaluations onto other people’s contracts. Say, for example, that you observe a beer sale to a man who is addicted to beer and cannot get a job due to this addiction. Obviously, if you could stop all beer sales to this man, he would sober up and start becoming a productive member of society rather than a bum who either begs for money or steals to stay alive. But would you have the right to stop him from buying beer if both the store owner and the man agreed to the sale? Of course not, as it would require force or the threat of force to restrain the sale. You can persuade the man that 12 beers a day is probably not a good lifestyle choice, or maybe persuade the store owner not to enable his habit. Quite possibly, the man might decide on his own that drinking his days away is not good for him or society.

The FRB system is the same way. You might know that the free contractual relationships that give rise to fiduciary media also give rise to destructive boom/bust cycles. But since these contracts are made freely, any attempt to restrain them would be an immoral act of force. You can stand outside a FRB and educate the FRB members and/or owners about the mechanics of the Austrian business cycle. Some people might opt out of the system based on your compelling arguments. But some might be foolish enough to endure bank run after bank run before finally “getting off the bottle.”

That’s all I have to say about that…

In that sense, Ponzi Schemes aren’t inherently fraudulent, as you never can be absolutely sure that this time there won’t be a parabolic accelleration and run out of new investors to pay earlier ones dividends.

I.e. as long as they are A. telling you up front your investement money today will be paid out as dividends to more seinor investors tomorrow, and B. it hasn’t collapsed yet, it wouldn’t technically be fraud.

Another example might be a pinwheel (cheque kiting writ large). If I can get immediate credit for a cheque that will take some time to clear, I can deposit $1000 in bank A, then write a cheque for $1000 which I can then deposit in bank B (which will clear tomorrow), then go back and write a cheque drawn on B and run back to A before it closes. So at the end of the day, A shows I have $2k, and B shows I have $1k, though the next day it will fall back – but if I can repeat the process… Fraud? Before it collapses? (EF Hutton did this or something much like it, as did Congressmen at the house bank). Use enough banks and enough capital and you can inflate yourself. The banks tend to dislike this as they want a monopoly on the multiplier effect.

But the Fractional Reserve banks are of that kind (and I’ve already mentioned mutual funds which aren’t fraudulent). They are solvent until they aren’t. They aren’t fraudulent until something causes enough investors to demand their deposits at the same time.

A real-life, contra Real Bills example; I am working on a project for my company which requires me to purchase $60,000 worth of equipment from a vendor with whom we have no current relationship. The units have yet to be produced, since the demand is low and the vendor carries little finished goods inventory. Because I have no credit with the vendor, one would expect that the manufacturer would not begin production until they received either a favorable credit report, a purchase order, a contract, or grubby cash. But the vendor has agreed to begin production based solely on a verbal promise of a purchase order from a disembodied voice on the phone (me) at some time in the future. We will pay for these units using money we will earn from performance of the work to be done with the equipment in the future. In other words, I am indirectly financing production not with saving, but with a “Real Bill”. So far, my example supports Fekete. However, my price for the goods is the same whether I pay in dollars, on credit, or a promise to provide one of those money substitutes. And I, unlike Fekete’s issuers of Real Bills, cannot make an infinite number of real bills without alienating suppliers and putting us out of business. I’d love to hear how I can take advantage of “Real Bills” to buy twice as many monitors, and get rich by making my clients pay more to buy the additional units, or else selling the surplus!

I think the best way to look at this is to back off and look at mediaeval ideas of usury. Working through their allegorical language, they said in effect that no lending at interest was right since there was no way that spending money could cause an increase in production. You could only ever bid up the prices of things and get unfair leverage, so even if you got a return on what you did with a loan, someone somewhere else suffered. So you got races to the bottom, tragedies of the commons and so on, or else benefitting from someone’s desperation for a loan when you should help with Christian charity. At best you could move food from mouth to mouth.

That rested on a false assumption about economics, but it was more or less true of that time and place. The opposite view was more nearly right in the age of trade and then the industrial revolution, since you could make productive investments like open new trade routes, discover new lands, mechanise agriculture and what not. But it never became absolutely true that ANY application of funds was automatically going to trickle down to create matching new capacity – especially not after you discount for the effects of time lags. (That’s what shoots down Social Credit ideas, though I oversimplify a little.)

Getting back to Real Bills. There is absolutely nothing wrong with a REAL Real Bill, that is, one that gathers together resources that do end up paying back more (after adding back in a suitable discount). The catch is that they aren’t actually Real Bills after all, any more than loans made growth in the Middle Ages. Here and there certain bills did work that way, like the bills for tobacco in colonial Virginia – but by and large there was the financial risk of something not working out, and taken across the board for the whole economy there was the constraint that all the production increase had to match all the Real Bills issued. But they were financing working
capital, and it just doesn’t increase in response to the issue of the money – not in the amounts needed over the short time scale available. So it’s not so much that the theory is wrong, just that it is pushed far beyond where it works (which is why there is a false impression that all is well when you start using them – you haven’t got out of your depth yet).

As for gold, you can finance growth from nothing with that approach. There is enough gold to go around, since prices adjust. That had already happened in countries that had got onto the gold standard; the speculative and transaction motives for holding money had acted as a multiplier for the intrinsic value of the bullion (as jewellery or whatever). That shows up in sieges where people suddenly found how little their gold could buy. Still, GETTING onto a gold standard does slow an economy right down, as credit vanishes, so I don’t recommend it here and now, done just like that. (Look at early 19th century Denmark’s struggles to go gold for an example.)

However, you can get onto gold – or, my preference, silver – by doing so at a pre-depreciated rate. This is what Keynes suggested should have been done in 1920s Britain if they had to go gold at all, and which had actually been done in France at about the same time. The catch then was that it locked in losers; but we have already had our losers, at the hands of fiat currency.

One final historical example. Under the Dutch East Indies culture or cultivation system, the natives were forced to set aside part of their land for cash crops and the Dutch brought in a new pre-depreciated copper coinage. They applied the windfall gain from the depreciation to setting up the system itself, providing it with its working capital. So we see that IF the opportunities are there in a potential form, a Real Bill-like approach can indeed realise the potential, but the natural limit of having an underlying bullion-like base imposes a discipline preventing going too far. After all, Dutch investors had to put up the funds for the copper coinage in the first
place, so there was genuine investment as well as exploitation going on (not that the natives got anything from it, apart from the Comprador middlemen who ran the system for the Dutch).

By the way, on fractional banking – it is fraud in just the same way as airline overbooking, to just the extent that airline passengers have no reasonable expectation of being bounced. The on flow effects of inflation are hidden theft, or fraud, according to how you categorise these things. Some would deny it was theft since no violence is involved, and some would not categorise it as fraud since it is too remote, but it is certainly something. The only argument is what to call it.

“In other words, I am indirectly financing production not with saving, but with a “Real Bill”.”

Yes you are financing production with savings. Not yours, but the producers. He has enough savings, that he can sell this item to you on credit.