Gerard Jackson takes on Alan Wood and Robert Shiller on the cause of speculative asset price bubbles in Medieval booms and historical and economic amnesia. Wood, citing Shiller, identifies media hype as the cause of speculative manias. Jackson responds that boom and bust cycles have been evident in times and places without news media. The only constant is the presence of fractional reserve banking:
- It’s important to bear this fact in mind because credit expansion can only be produced by a fractional reserve system. And every boom has always been preceded by a rapid monetary expansion*. I do not know of a single exception.
- Let us begin with Florence where in the late twelfth century a banking system began to develop. At first these banks adhered to a 100 per cent reserve. But human nature being what it is, they started to create phony credit by dropping their reserves. (Carlo M. Cipolla, The Monetary Policy of Fourteenth Century Florence, Berkeley University of California Press, 1982). Surprise, surprise, Florence found itself enjoying a boom — and not a single newspaper in sight — followed by a bust that was so sever that. Cipolla compared it to the Great Depression.
- Having made loans that greatly exceeded their deposits it was only a matter of time before a crisis was triggered. In this case several factors came to the fore: The banks had made heavy loans to Edward III of England who was now unable to repay them; Neapolitan princes made massive withdrawals — perhaps they smelt a rat — and there was an acute drop in the price Florentine government bonds. From 1341–1346 the crisis deepened and a number of the great banks collapsed. Credit was severely restricted triggering the inevitable deflation resulting in large-scale bankruptcies.
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I should point out that depositors always have the option of making timed deposits, as opposed to demand deposits. A six month Certificate of Deposit being an example of a timed deposit. Banks are free to use money from timed deposits to lend out. If banks wish to lend, then encourage timed deposits.
Demand deposits are just that. They are payable on demand. You can’t lend out money that may be subject to a redemption demand on the morrow.
“But what of depreciation? The first to buy risks watching their thingo price plummet. Indeeed the resale of computer parts tends to be pathetic with time, meaning that most would hold off buying or upgrading a computer until necessary. Goodness knows I do.”
Magnificent if you are right. Because what you are really talking about is a higher savings rate. Which means the end of poverty if universally applied along with other aspects of economic freedom.
What is the problem here?
But in fact on a 100% backed precious metals standard the volume of spending would wind up expanding all the time. Since the volume of monetary metals would always grow slowly yet never reduce.
What wouldn’t happen is the constantly oscillating and unstable money supply and velocity that you get when you throw fractional reserve into the system.
A question of interest: is there any other currency replacement for gold?
If not, does this means any experiments to make gold transmutation cost-effective should be illegal? Or if a discovery of a seemingly endless vein mean that it should never be mined lest gold becomes a common metal?
Sam, there has been many commodities which have been used as a money (cocoa beans, sea shells, squirrel furs, silver, rice, cigars in POW camps etc) depending on local history and natural resources. Gold is not more natural than any other commodity so only time will tell which is adopted by some group of interacting people. Europeans used silver many centuries even when most people lived in autarchy and didnt see coins in all their lives.
Suppose that at one point of time gold is solely used as money and then someone invents method to produce this numeraire in unlimited quantities. Then we can be sure that some other commodity is taken in use as a money.
Don’t forget that prices are just fractions! This means that the quantity of money is irrelevant, only that the increase in the money supply is bad.
(10 hrs of office work)/($1,000) * ($140,000)/(1 house)
Notice that both quantity and price are used in calculating the relative worth of different items. Price without quantity means absolutely NOTHING! So there is no need to worry about declining prices for products because that is associated with a corresponding increase in the quantity of goods. Supply and Demand.
As for fractional reserve banking, there is nothing wrong with depositing your money at a fractional reserve bank so long as both parties realize what is being transacted. However, it has to clearly state the situation in contract terms (mainly that the depositor is not guaranteed his/her deposit back).
For clarification, an IOU is not the same as a receipt. One is a loan, while the other is a custodianship.
PS Answer for previous post is that so long as currency choice is purely private and voluntary, it does not matter.
What if a bank offered to take deposits, lend out 90% of the deposits at interest, and pay interest to depositors.
Then the “depositors” aren’t really depositors. They are lenders, loaning money to a business that promises to repay the loans with interest.
Which is all fine and good, except that banks are granted special exemption from the ordinary disclosure requirements of borrowers.
If banks were subject to the same rules of disclosure and due diligence that apply to every other form of commercial misrepresentation, then I’d have no problem.
George, banker, adi, sam, ozzie, rtr, averros:
A quick opinion poll: Do you agree or disagree that fractional reserve banking should be legal IF both the banker and the depositors (call them lenders if you want) agree to it? George, banker, and averros appear to have already said they agree. How about the rest of you? I ask because Rothbard, among others, said it is fraudulent, and that the customers don’t know what they are agreeing too. To me this seems like the glaring flaw in austrian economics–to be so right about the workings of free markets and so wrong about fractional reserve banking and money.
Whether or not a specific act or process is fraudulent, is a legal, and not an economic issue.
From an economic standpoint, I would argue (and other Austrians have argued) that in a true free market monetary system, if fractional reserve banking was agreed to by certain participants, the notes issued by the fractional reserve bank would trade at a discount to face value because at least some market participants would realize that the risk of default would be greater for a fractional reserve bank than for a 100% reserve bank. Once a money substitute trades at a discount to face value, its use as money has been compromised.
Mike Sproul:
I’m with Dennis in saying that in a free market, fractional reserve banking would not be inherently fraudulent, merely risky vis-a-vis 100% reserve banking, and that as long as consumers were able to choose freely between the two (and knowledgeably so, due to outside auditing), all would be fine.
That is, I might be willing to deposit my money (gold, silver, or whatever else the bank would accept) with the understanding that a fractional reserve bank would pay me interest for doing so, while a 100% reserve bank would charge me a storage fee, mindful that the more risk I took in this regard, the less likely others would be to accept the money substitutes issued by the bank in question.
“Oh, you’re banking with Frac-O-Serv; I’ll need to add a surcharge of 10% to cover the added risk of your banknotes.” And conversely, “Oh, you bank with Solid Gold and therefore qualify for a 5% discount on all purchases.”
The larger point, however, is that the present system IS fraudulent for the simple reason that it operates via government edict and thus outside the confines of the free market, forcing people to use its money whether they want to or not. Moreover, because its money is but paper with nothing backing it up, people are forced to use that which isn’t money at all but the corruption thereof. After all, who would be foolish enough to accept such fluff in a free market?
“I’m sorry, but we don’t do business with people who bank with Paper Pushers. Next!”
Mike Sproul:
I would be opposed. That said.
If depositors agreed to make a deposit that may not necessarily be available on demand, then the deposit should rightly be called a timed deposit and recorded in ledger form at the bank. There should be no banknotes issued against such deposits, but all such deposits should be recorded in ledger form only. Any banknotes issued against non-demand deposits must necessarily depreciate and as an Austrian I simply can’t tolerate depreciating paper money.
Any banknotes in circulation must be against 100% reserve demand deposits only. By the way, it is quite possible for the same bank to maintain 100% demand deposits and engage in timed deposit banking at the same time. Just as long as an absolute firewall is maintained between the two separate ventures.
MS> The confusion is being caused by the quantity theory of money, which is wrong, as opposed to the real bills doctrine, which is right.
“Real Bills” is not correct. Government fiat money is not backed in the plain sense of “backing.” Government money is, at best, backed by seizure of assets. That is, the assets of others. But that isn’t the same thing as “backing” when it comes to any private dealer of money and assets, is it Mike? Moreover, there is no law I am aware of that can strictly prevent a complete monetization of debt. Of course, that may be a practical stretch because of the threat of serious political consequences. But serious political consequences aren’t the same thing as backing, are they Mike? In practice, the political consequences are the only remaining governor on government money.
MS> What if a bank offered to take deposits, lend out 90% of the deposits at interest, and pay interest to depositors. AND what if the depositors agreed to it?
Those aren’t really deposits. They are investments.
MS> Then any good libertarian should be OK with it.
Well of course they’d be okay with investment; just call it what it is.
If you make-over the words backing and deposit enough, you’ll get the answers you want. I do not find your re-definitions (and then conclusions) persuasive.
Four of you (george, banker, averros, dennis, and greg) more-or-less agreed that fractional reserve banking is OK as long as both parties agreed to it. One disagreed (mark), and 4 didn’t comment (adi, sam, ozzie, and rtr). That’s a fairly surprising majority for an austrian blog, given the longstanding austrian claim that fractional reserve banking is inherently fraudulent.
The real bills position is that fractional reserves is not fraudulent, nor is it inflationary. Bank A can issue 100 green paper dollars backed by 10 oz. of silver plus IOU’s worth 90 paper dollars. Bank B can then issue 200 checking account dollars backed by 20 green paper dollars plus IOU’s worth 180 checking account dollars. As long as bank assets hold their value, so that every dollar is adequately backed, either or both of these banks can issue dollars without causing inflation.
Somehow I doubt I’ll get a majority of you favoring the real bills view, but for the rare individual who wants to check it out, go to
http://www.geocities.com/sproulmike/nofiatmoney.doc
or google “sproul fiat money”.
Mike – it is immaterial to ask what would be if banks disclosed what they do. Simply because they don’t do it. They are fraudsters, period.
And, no, I do not think anyone in his right mind would voluntary use unsecured and uncontrollably issued IOUs instead of money. But I also see no reason to prohibit good-faith issue of such instruments – provided that I can get my real gold money, too.
I read your article M. Sproul but I’m still confused in areas. In your example of the $100 silver-backed dollars, versus the $200 loaned to the farmer, are the $300 the same type of dollars? Could the farmer cash in $100 for silver leaving the bank with nothing but $200 debt?
Why should people entrust a bank or government to hold the precious metals, get paper money in return and think it is better? The centralised nature of a bank or government means one large-scale robbery of the precious metals would throw the nation into financial chaos.
Why can’t someone roll into to town, tell a ripping yarn of a central store of precious metals in return for paper money and when the townsfolk agree, takes the precous metals, hand out the pretty coloured paper, shoot through and people wake up realising they have just been swindled?
Why can’t people trade directly in gold and silver anyway? Why have banks at all?
——-
Actually M. White is there any laws against bartering? I heard that when Microsoft bought out HotMail it used its own shares not U.S. cash. Similarly if enough people despise the U.S. currency why couldn’t they start using Euros?
——-
Finally, before my question of ‘is there any substitute for gold?’, I was asking for a real-world working alternative. I mean if gold was deemed worthless tomorrow could there be a real world alternative? Platinum? Silver?
Sam:
In the example all of the $300 are of the same type.
If the farmer tried to cash $100 for 100 oz., that would be inconvenient for the banker, but the banker could head-off this demand by selling $100 of his IOU’s for his own paper dollars and then retiring the dollars, thus soaking up the unwanted dollars. Then the farmer will find that he can easily sell his dollars for silver on the open market. There are other ways: For example, the farmer could give the bank a few hours notice that he wants silver. The bank could sell $100 of IOU’s for silver, and then redeem $100 for silver for the farmer without disrupting banking operations.
People have often preferred paper money to metals. Paper is easier to carry for one thing, and surprisingly, coins are easier to counterfeit than paper.
Of course people can get conned by bad bankers, but they still benefit from honest bankers.
Mike, FR banking is not necessarily fraudulent if the customers know what they are doing. Existence of government money and central bank hides something important though: money could as well be private matter between market participants and not any govt created fiction.
Dollars are no backed by anything since government can increase money supply by unlimited quantities. There is no limit for governments debt if central bank is forced to purchase govts papers and return interest payments back to govt (situation is same like saying that I have now less money since I put Euros from my left pocket to the right pocket).
Merchants have always used commercial papers as a clearing device when it has been inconvenient to transfer large amounts of gold between locations. Medieval fairs are example of this kind of activity. But I would doubt that ordinary people would accept these papers as a money (of course in those days use of money was limited in the autarchic economy).
Mike, why would people hold money at all in your theory if the IOU’s are perfect substitutes for money for the banks (so that they are willing to hold these in their portfolios instead of holding commodity money)? Why people dont use these papers directly? We could as well assume away all costs about holding these papers and using them if you have assumed away all risks associated with the possibility of not having back the amount of deposited money.
Sam, in medieval times banks used to provide services for their customers. They didnt always loaned money away because they just provided accounts and storage facilities. Following example: suppose that merchant is travelling to Germany from Italy to purchase North European stuff and sell exotic material there. Merchant has account in Venetian bank which has branch office in Frankfurt am Main. Merchant can deposit gold in Venice and withdraw it in Frankfurt or give sellers there right to transfer money from his account to theirs. So in short banks provide economic services as any other agency (like real estate agent).
“George, banker, adi, sam, ozzie, rtr, averros:
A quick opinion poll: Do you agree or disagree that fractional reserve banking should be legal IF both the banker and the depositors (call them lenders if you want) agree to it? ”
Well its OZZIE speaking here and thats a complicated question though it might not seem to be.
Something very strange happens when we get to this subject.
The ANARCHO-CAPITALIST-PURIST hat comes on.
Now I don’t know. Perhaps all good men and true are anarcho-capitalist-purists when they contemplate the longer run at Christmas time.
But why put that hat on when it comes to this subject?
Every one of our great Austrian economists has a different way of dealing with this question.
But here I think I’ll channel young Dr Hulsmann. Who may one day become our greatest living economist but he’s just too young yet.
Traditionally fractional reserve always starts with fraud and embezzlement as Dr Salerno pointed out in a recent recording.
Its not fraud now because its socialism (or if you must “interventionism”)
But at least in those years that 100% backed metals involve falling consumer prices and low nominal interest rates AN HONEST VERSION OF FRACTIONAL RESERVE has no rationale.
It cannot really work provided there is what might more normally be thought of as an excess of vigilance preventing this type of fraud in its dishonest form to prevail.
Hullsman identifies the honest form of this financial product as an IOU+RP contract.
That is to say an “I owe You” plus a “Redemption Promise”
In a situation of great vigilance this financial product would be like a different type of money trading at a discount or alternatively a financial product negotiated by specialist traders.
But off my own bat I would add that the market may well pick up this product and run with it under 2 situations.
1. A situation of abnormally high nominal interest rates… (like what might be produced by war financing)
and
2. The upshot from a freak find of massive monetary-metal deposits.
Now I would say under these two cases the honest-fractional-reserve product could make headway.
And the vigilance against the dishonest form could be relaxed.
But taking no. 2 and thinking about the monetary implications of it…..
…..Wouldn’t that just be the worst of all possible times to allow fractional reserve?
Look we need to find a way of getting to it that natural law can be enforced locally and privately.
Or at least thats what an anarcho-capitalist might think.
But in transition there are some restrictions that ought to be slated to be gotten rid of towards the end of the liberation process and not at the beginning.
For the next three decades might we not accept that fractional reserve is on the out?
Simply because with it there we cannot showcase a monetary system that is better then the socialists ones both in theory and in practice.
And also because we want a new and reformed and vastly more powerful system for reinvesting savings.
And we ought not want to have to wait until pure liberation is acheived.
I think in a better world the doubters will very easily understand that fractional reserve under libertarian conditions is fraud.
And not only fraud but a special sort of fraud that we need to be more then normally vigilante about.
But if I’m wrong about that why not let the proscription against fractional reserve go down the tubes with the last thousand pages of regulations before pure minarchism or pure anarcho-capitalism is acheived?
We cannot showcase a new and superior way of running our financial system under conditions of near-pure-liberty if we don’t at first phase out fractional reserve.
Even as a tactical matter it makes sense to do this.
100 percent gold reserve money standard
I quote from America’s Great Depression, by Murray Rothbard:
Preventing Depressions
“Private banks, it is true, can themselves inflate the money supply by issuing more claims to standard money (whether gold or government paper) than they could possibly redeem. A bank deposit is equivalent to a warehouse receipt for cash, a receipt which the bank pledges to redeem at any time the customer wishes to take his money out of the bank’s vaults. The whole system of “fractional-reserve banking” involves the issuance of receipts which cannot possibly be redeemedâ€.
And:
“But a 100 percent gold reserve requirement would not be just another administrative control by government; it would be part and parcel of the general libertarian legal prohibition against fraud. Everyone except absolute pacifists concedes that violence against person and property should be outlawed, and that agencies, operating under this general law, should defend person and property against attack. Libertarians, advocates of laissez-faire, believe that “governments” should confine themselves to being defense agencies only. Fraud is equivalent to theft, for fraud is committed when one part of an exchange contract is deliberately not fulfilled after the other’s property has been taken. Banks that issue receipts to non-existent gold are really committing fraud, because it is then impossible for all property owners (of claims to gold) to claim their rightful property. Therefore, prohibition of such practices would not be an act of government intervention in the free market; it would be part of the general legal defense of property against attack which a free market requires.[28], [29] .â€
http://mises.org/rothbard/agd/chapter1.asp#preventing_depressions
As Walter Block puts it:
“At present, money placed in a bank is called a “demand” deposit, logically implying that it would be available, in full, whenever demanded, with a probability of certainty. If the “fractional reserve parking lot” were to be an accurate analogy to monetary practice, instead of being called a “demand” deposit, it should be called “purchasing a lottery ticket for money,” or some such. Further, in every other way-publicity, explicit contracts, etc.-banking procedures would have to be brought into line with parking lot practice. Then, and only then, could the charge of fraud be dropped. Under such conditions, there would still be the empirical question of whether or not anyone would purchase a “lottery ticket money deposit.”
http://mises.org/journals/rae/pdf/rae9_1_3.pdf
With a 100 percent gold reserve money standard it is not possible for the Federal Reserve just to print money. If the Federal Reserve would be allowed to exist under that standard (for what purpose?), it has to have acquired the gold first before it could issue gold notes of that certain amount of gold*. Those gold notes would be receipts (gold claims) and the Federal Reserve has to store the gold until the owners of those gold notes claims the gold. The total money supply has not increased as the gold stored at the Federal Reserve is not an effective part of it and is therefore not counted as money. The total money supply has not either decreased, as mentioned gold notes, which are used as money, have replaced the gold as an effective part of the money supply.
• In other words, the Federal Reserve has to be productive through enterprise or work to acquire the gold. How that would be possible, I really do not know. Another possibility for the Federal Reserve to acquire the gold is that someone donated the gold to the Federal Reserve.
Björn Lundahl
Göteborg, Sweden
I suppose you’ll soon be tired of my opinion polls, but here’s another:
Suppose a bank issues $1000 (either the paper kind or the checking account kind) and receives in exchange 100 oz. of silver, plus IOU’s worth $900, which it keeps in its vault. The bank announces in advance that its dollars will be redeemable for 1 ounce AFTER 24 years, but will be inconvertible until then. The bank earns interest on its assets, but that interest is just sufficient to pay the cost of maintaining the $1000 in circulation (e.g., printing, chasing counterfeiters, etc.). The bank also promises, credibly, that it will at all times maintain the market value of the dollar at 1 ounce. If the dollar starts to trade for less than 1 ounce the bank will sell IOU’s and soak up dollars, while if the dollar rises above 1 ounce the bank will buy bonds and emit new dollars.
Would you austrians call that fraud? Or is it OK, as long as the bank and its customers agree to it?
(Note: one reason I ask is that I have just described how the fed operates, and I hope I’ve given you reason to doubt that the dollar is fiat money–that it is actually backed but inconvertible.)
The bank announces in advance that its dollars will be redeemable for 1 ounce AFTER 24 years, but will be inconvertible until then.
[O]ne reason I ask is that I have just described how the fed operates, and I hope I’ve given you reason to doubt that the dollar is fiat money–that it is actually backed but inconvertible.
It is not how the Fed/Guv operates. The Fed/Guv does not redeem a dollar for an ounce, or any other non-dollar asset of its own. It redeems iou’s (in dollars) for dollars, and inflated ones at that. The guvmint has no dollar backing except, at best, asset seizure by force (or the very real threat of force), and the real threat of monetization of debt to its creditors. But that isn’t same backing as is meant when you and I have to back a debt, is it Mike?
How about you lend me $100? I’ll back it (pay it back) by promising I’ll get that $100+Interest back to you somehow, either by printing money that looks like the same money we and our neighbors already hold, or by robbing assets from unspecifed neighbors of mine, one of which is you. How is that for a deal? How will the neighbors like me diluting the value of money on a deal they were not a party to (not to mentioned how they enjoy getting robbed to cover the costs of my printing and asset seizure operation)?
I quote from the book For a New Liberty, by Murray Rothbard:
9 Inflation and the Business Cycle: The Collapse of the Keynesian Paradigm
â€By far the most important route for the Fed’s determining of total reserves is little known or understood by the public: the method of “open market purchases.” What this simply means is that the Federal Reserve Bank goes out into the open market and buys an asset. Strictly, it doesn’t matter what kind of an asset the Fed buys. It could, for example, be a pocket calculator for twenty dollars. Suppose that the Fed buys a pocket calculator from XYZ Electronics for twenty dollars. The Fed acquires a calculator; but the important point for our purposes is that XYZ Electronics acquires a check for twenty dollars from the Federal Reserve Bank. Now, the Fed is not open to checking accounts from private citizens, only from banks and the federal government itself. XYZ Electronics, therefore, can only do one thing with its twenty-dollar check: deposit it at its own bank, say the Acme Bank. At this point, another transaction takes place: XYZ gets an increase of twenty dollars in its checking account, in its “demand deposits.” In return, Acme Bank gets a check, made over to itself, from the Federal Reserve Bank.
Now, the first thing that has happened is that XYZ’s money stock has gone up by twenty dollars—its newly increased account at the Acme Bank—and nobody else’s money stock has changed at all. So, at the end of this initial phase—phase I—the money supply has increased by twenty dollars, the same amount as the Fed’s purchase of an asset.
“If one asks, where did the Fed get the twenty dollars to buy the calculator, then the answer is:
it created the twenty dollars out of thin air by simply writing out a check upon itself. No one, neither the Fed nor anyone else, had the twenty dollars before it was created in the process of the Fed’s expenditure”.
But this is not all. For now the Acme Bank, to its delight, finds it has a check on the Federal Reserve. It rushes to the Fed, deposits it, and acquires an increase of $20 in its reserves, that is, in its “demand deposits with the Fed.” Now that the banking system has an increase in $20, it can and does expand credit, that is, create more demand deposits in the form of loans to business (or to consumers or government), until the total increase in checkbook money is $120*. At the end of phase II, then, we have an increase of $20 in bank reserves generated by Fed purchase of a calculator for that amount, an increase in $120 in bank demand deposits, and an increase of $100 in bank loans to business or others. The total money supply has increased by $120, of which $100 was created by the banks in the course of lending out checkbook money to business, and $20 was created by the Fed in the course of buying the calculator.
In practice, of course, the Fed does not spend much of its time buying haphazard assets. Its purchases of assets are so huge in order to inflate the economy that it must settle on a regular, highly liquid asset. In practice, this means purchases of U.S. government bonds and other U.S. government securities. The U.S. government bond market is huge and highly liquid, and the Fed does not have to get into the political conflicts that would be involved in figuring out which private stocks or bonds to purchase. For the government, this process also has the happy consequence of helping to prop up the government security market, and keep up the price of government bondsâ€.
“So here we have, at long last, the key to the mystery of the modern inflationary process. It is a process of continually expanding the money supply through continuing Fed purchases of government securities on the open market. Let the Fed wish to increase the money supply by $6 billion, and it will purchase government securities on the open market to a total of $1 billion (if the money multiplier of demand deposits/reserves is 6:1) and the goal will be speedily accomplished. In fact, week after week, even as these lines are being read, the Fed goes into the open market in New York and purchases whatever amount of govern¬ment bonds it has decided upon, and thereby helps decide upon the amount of monetary inflation.â€
* The reserve requirement set by the Federal Reserve on banks is exemplified by the ratio 6:1 (the required maximum multiple of deposit to reserves).
http://mises.org/rothbard/newliberty9.asp
Björn Lundahl
Göteborg, Sweden
The purchasing power of money, the gold standard and fiat money
I quote from the book “Democracy The God That Failedâ€, by Hans-Hermann Hoppe, page 58:
“During the monarchical age with commodity money largely outside of government control, the “level†of prices had generally fallen and the purchasing power of money increased, except during times of war or new gold discoveries. Various prices indices for Britain, for instance, indicate that prices were substantially lower in 1760 than they had been hundred years earlier, and in 1860 they were lower than they had been in 1760. Connected by an international gold standard, the development in other countries was similar. In sharp contrast, during the democratic-republican age, with the world financial center shifted from Britain to the U.S. and the latter in the role of international monetary trend setter, a very different pattern emerged. Before World War I, the U.S. index of wholesale commodity prices had fallen from 125 shortly after the end of the War between the States, in 1868, to below 80 in 1914. It was then lower than it had been in 1800. In contrast, shortly after World War I, in 1921, the U.S. wholesale commodity price index stood at 113. After World War II, in 1948, it had risen to 185. In 1971 it was 255, by 1981 it reached 658 and in 1991 it was near 1,000. During only two decades of irredeemable fiat money, the consumer price index in the U.S. rose from 40 in 1971 to 136 in 1991, in the United Kingdom it climbed from 24 to 157, in France from 30 to 137, and in Germany from 56 to 116.
Similarly, during more than seventy years, from 1845 until the end of World War I in 1918, the British money supply had increased about six-fold. In distinct contrast, during the seventy-three years from 1918 until 1991, the U.S. money supply increased more than sixty-four-fold.â€
Björn Lundahl
Göteborg, Sweden
All the discussion has shown that direct gold weights (and silver and platinum weight too i s’pose) should be the direct currency. If trading parties want to use temporary IOUs then good luck to them. But as it has been pointed out that more paper money can be printed will-nilly. Whilst theoretically gold can be transmuted it’s probably never going to be cost-effective. Similarly most major gold deposits have probably been uncovered, it’s possible but hard to believe there’s a huge deposit just waiting to be found.
Therefore direct gold weights are the answer to the robbery that is using mindless pieces of paper.
Mike, FR banking is not necessarily fraudulent if the customers know what they are doing.
But it’s not just the customers that are concerned. If Adam, a customer of a FR bank, “deposits” 100oz of silver and gets 100 “dollar bills” in exchange, and the bank then lends out 90oz of the silver, when Adam tries to buy something from Bob with his “dollars”, it’s Bob who is being defrauded. Or if Bob figures out what’s going on and chooses to accept the funny-money anyway, and then he goes and buys something from Carol with that money, Carol loses. It’s not just a matter of “the customers know what they’re doing”; everybody, throughout the entire economy, has to know and agree before there’s even a hope of it not being fraudulent. (Though I’d argue that it’s still criminal even then. A Ponzi scheme is crooked, no matter if everyone involved understands how it works – of course nobody would get into it if they know it’s “topped” and they’re going to be the losers, but if you get into a Ponzi thinking that you’re in early enough that other people will lose, you’re still counting on robbing those people)
“The bank announces in advance that its dollars will be redeemable for 1 ounce AFTER 24 years, but will be inconvertible until then”
Thats fine so long as they can pay it back.
You see the thing is to clarify property rights and who has possession of the funds.
The fraudulent side of fractional reserve is where the customer is supposed to have access to the funds. Yet the bank has lent those funds out.
And thats not fraudulent now because there is all this cartelisation, regulation and government banking. And so the banks can reasonably fulfill their committments to their depositers.
But under free enterprise conditions it would be fraudulent. And a very dangerous type of fraud that has a Greshams-law-like element to it. A kind of spreading-plague like element setting it apart from other forms of fraud.
Clarifying property rights in this case means making absolutely clear whether the money is being warehoused to be available on call.
Or being lent to be relent out to other clients and to be returned by a specific date.
And if you clarify property rights in that way and are vigilant about it nothing much can go wrong once the system is well established.
Now you can dream up an IOU + RP scenario that is not fraud under free enterprise conditions.
But its probably less of a hassle just to phase fractional reserve out and then outlaw it. Because you cannot rely on people down the track understanding money good enough to be able to tolerate such practices and not let them get out of hand.
Others who believe in 100% backing will disagree. But to me its really a protection reigning in the government like a constitutional limitation.
Because once this is outlawed it rules out one of the subtle and clever ways that the government can gyp us all on the sly in league with the banking system.
We want to rule that possibility out and not leave it to the government of the day to choose whether or not they can have fractional reserve.
But it’s not just the customers that are concerned. If Adam, a customer of a FR bank, “deposits” 100oz of silver and gets 100 “dollar bills” in exchange, and the bank then lends out 90oz of the silver, when Adam tries to buy something from Bob with his “dollars”, it’s Bob who is being defrauded. Or if Bob figures out what’s going on and chooses to accept the funny-money anyway, and then he goes and buys something from Carol with that money, Carol loses. It’s not just a matter of “the customers know what they’re doing”; everybody, throughout the entire economy, has to know and agree before there’s even a hope of it not being fraudulent.
That’s an excellent point, Peter. It’s along the lines of what I had in mind when I said that in order for the use of fractional reserve banking to be non-fraudulent, it would require extensive disclosure.
In this case, it would require something along the lines of having the bill denominated with the minimum amount of genuine assets that back it.
Paper currency would need to be marked with something like the phrase: “This bill may be backed with as little as 8% of its face value in gold.” For the bank to deplete its reserves below that amount would be to perpetrate a fraud on everyone who accepts that note.
Bills marked with higher percentages would trade at a smaller discount, of course. Fully backed gold certificates would trade at face value, or even at a premium, given the convenience factor.
If you trade in stocks, the parties to the transaction are required to disclose the financial state of the corporation. They usually solve this problem by resorting to independent, publicly listed rating services. Without some form of reliable disclosure, the parties to the trade do not know the real value of the stock certificate. If the seller fails to disclose the real assets and liabilities that lie behind the stock certificate, he’s a fraud.
It’s certainly possible for the parties to engage in a non-fraudulent transaction, even in junk bonds, provided there is full disclosure. People do so all the time. But knowing the financial condition of the bond’s issuer is an essential part of knowing the risk of default and thus knowing the value of the bond.
Same basic idea here. If a note of currency is really an IOU, and not a claim ticket for metal, as Mr. Sproul states, then the real value of the IOU is not its face value, but the financial viability of the debtor and its ability to pay. Bonds are rated by the risk of default of the borrower. If a person passes a junk bond as though it is AAA-rated, he’s a fraud. How is that any different, really, from passing a bank’s gold certificate denominated at $100 that is backed by only $8 in actual gold?
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