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Source link: http://archive.mises.org/7628/greenspan-gets-it/

Greenspan gets it?

January 8, 2008 by

In his autobiography, former Randian Alan Greenspan says he has, “always harbored a nostalgia for the gold standard’s inherent price stability–a stable currency was its primary goal.”

A stable currency implies that its purchasing power would remain the same. But under a gold standard, there would be a trend for prices to fall as production and innovation would not be set off by increases in the money supply (or very minor increases).

If this fact was explained to the American people, maybe they would not “have tolerated the inflation bias as an acceptable cost of the modern welfare state.” If Greenspan went before the American people to explain that, “there is no inherent anchor in a fiat-money regime,” maybe there would be a change of opinion. People are done with the “wisdom” of the policymakers. They want to return to the Constitution where power is decentralized in the market among individuals.

Greenspan says, “There is no support for the gold standard today and I see no likelihood of its return.”

But he does predict, “We could…see a return of populist, anti-Fed rhetoric, which has lain dormant since 1991.”

Contradictions do not exist.

[All quotes from The Age of Turbulence]

{ 79 comments }

Mike Sproul January 11, 2008 at 10:59 am

ktibuk:

“The fed has no assets to back the money up. What you call assets are monetarized debt which is the same thing as money circulating.”

I’ll let you argue that one with the Fed’s accountants.

“And it is absurd to claim backing something up with the same thing. You are changing the meaning of “backing up”.”

Define E as the exchange value of the dollar (oz./$. ) If a bank has issued 300 paper dollars and holds 100 oz. of silver plus bonds, denominated in dollars, that are worth $200, then the bank’s assets (100 oz + bonds worth $200, or 200E oz.) must equal its liabilities ($300 worth 300E oz.), or

100+200E=300E

or E=1 oz./$

Now, if the bank lost 40 oz of silver, the above becomes

60+200E=300E, or E=.6 oz./$

So it is possible to back a dollar with dollar-denominated assets. It’s just that it creates a feedback effect: assets lose value, so the dollar loses value. This makes the assets fall still more, etc.

This is explained in “There’s No Such Thing as Fiat Money”, under the heading of “Inflationary Feedback”.

Michael A. Clem January 11, 2008 at 12:35 pm

…since we (i.e., Jean-Paul and I) believe that inflation is caused when money outruns the assets of the bank that issued it.
[RBD] says a WELL-MANAGED dollar will be stable (or appreciate).
Begging the question. Doesn’t the Fed issue currency by buying ‘assets’? So how could the money outrun the assets? In what way is the Fed mis-managing the dollar (per RBD)?

Mike Sproul January 11, 2008 at 5:40 pm

Money can outrun assets if the fed pays $100 for a bond that is really worth only $99, or if the bonds held by the fed fall in value, or if the cost of administering the fed uses up too much of the assets, or if the fed lends at 5% when the market rate is 6%, etc., etc.

DS January 11, 2008 at 5:59 pm

“The increase in the money supply will set off economy wide price hikes as downstream entities adjust. The security/collateral, being susceptible to the artificial change, will most likely rise in price too. Therefore, even more fake notes may be issued from the bank and so on and so on in a spiraling fashion.”

Exactly, it’s an endless feedback mechanism that creates an effect that is not COUNTER-cyclical, which those who believe in central banking think the Fed is there for, but PRO-cyclical. The same thing happens in the other direction: In a deflationary environment the value of the real assets (collateral) shrink, thus shrinking the money supply. This has the PRO-cyclical effect of reducing the money supply in a deflationary environment, which feeds on itself in the other direction.

Now in a world where all debts were collateralized this would lead to huge swings back and forth, evening out to zero over the long term. However many loans, credit cards for instance, are not collateralized and the value of collateral is subjective anyway, so there is no reason that it should balance out. In fact the bias since the Depression has been towards perpetual inflation.

A little history lesson: The dominant economic theory at the regional Fed banks in the 1920′s and 30′s was the Real Bills Doctrine, with only Benjamin Strong (no hard money man himslef by the way) opposing it. On the occaision of his death in 1928 the Real Bills Doctrine lost it’s last opponent and was fully implemented across the system. The PRO-cyclical feature of the RBD was being practiced in most of the regional banks fueling the expansion of credit and money in the 1920′s and turning sharply when the trend reversed. This was the reason the money supply so-famously shrank by 1/3 from that time until the trough in 1933, not because the Fed was sitting “passively” letting it shrink. The theory they were operating under caused this PRO-cyclical shrinkage feedback mechanism.

This is an excellent article:

http://www.independent.org/pdf/tir/tir_11_03_01_timberlake.pdf

The problem with the RBD is that it sounds nice as an abstract theory but the problem comes when you try to determine 1) what does and does not constitute a “Real Bill” and 2) an accurate, objective value for that “Real Bill”.

Both of those judgements are subjective and the reference value is driven by the amount of currency in circulation, which is driven by the value assigned to the “real bills”, which is driven by the amount of currency in circulation, which is driven by the value assigned to the “real bills”, which is driven by the amount of currency in circulation……until pop!

Now all of this PRO-cyclical money creation leads to all kinds of mis-valuation of assets and mirages of nominal values, but these mis-valuations are always temporary: Tulip bulbs are not worth a year’s salary, real estate (that doesn’t change in location or physical attributes)does not appreciate at 40% per year forever, and people eventually figure out that worthless dotcom companies with no revenue, no customers and no business model have no value. When these bubbles pop the RBD feedback mechanism reverses violently and the feedback mechanism works in the opposite direction.

PRO-cyclical.

Mike Sproul January 11, 2008 at 8:08 pm

DS:

The RBD has been around for 300 years, and people have stated it in various ways, but let me be clear that the version I am advocating is not the one you are attacking. In fact, the leading RBD advocates (Bosanquet, Tooke, Fullarton, Ben Franklin, James Madison) never advocated the version that has been so widely attacked by 20th century economists.

So here is the correct version of the RBD: The value of money is determined by the value of its backing. Period. This implies that if new money is issued for assets of equal value, there will be no inflation (and thus the self-perpetuating cycle you mention never gets started). It also implies that if the assets have inadequate value, then there will be inflation, while if the assets are more than sufficient, deflation is possible.

Note that the value of money is unaffected by the physical form of the assets in question. It makes no difference if new money is lent to a farmer or to a gambler, as long as either one posts adequate collateral. This means that there is no need for any lender to decide whick bills are “real” and which are fake. The banker only has to judge whether the money lent will be paid back–not always easy, but that’s what bankers get paid to do. If they fail there will be inflation, and if they do their job right the money will be stable, and the bank will be profitable.

DS January 12, 2008 at 8:18 am

Mike,

I’ve seen your explanations hundreds of times on this site and I don’t find them convincing at all. We can argue all you want about the magic of double entry book-keeping, but it’s like you are speaking a different language.

But I will deal with one comment:

“The banker only has to judge whether the money lent will be paid back–not always easy, but that’s what bankers get paid to do. If they fail there will be inflation, and if they do their job right the money will be stable, and the bank will be profitable.”

That is NOT what bankers “get paid to do”. Bankers get paid to have the most loans outstanding to maximize their interest payments. Your statement would be absolutely true in a gold standard world where banks that run out of specie go out of business and usually their top executives go to jail. The banking system in it’s current form with fractional reserve lending and the Federal Reserve as a lender of last resort is set up so that no bank ever has to be paid back the money it lends.

In fact, getting back the money they lent out is a banker’s worst nightmare because a revenue producing vehicle disappears. Interest is the fundamental way bankers get paid, principal payments do not increase a bank’s earnings they reduce them, because the borrower is paying less interest on a reduced princpal. In order to just keep it’s interest revenue steady the banker has to find new borrowers (which costs them money) to lend those funds to or it’s revenue will drop.

Look at how banks ACTUALLY work – when you can’t make your credit card payments do banks call in your credit card balance? Of course not. Do they increase the amount of principal payments you have to make? Absoultely not. They increase your limit or reduce your interest rate or “restructure” so you can start making INTEREST payments again. They don’t want the principal back. I heard somebody speculate on TV just yesterday that a contraction of the economy would be partially good for banks because people “will have less money to pay down their balances on their credit cards”. This is preferable because teh credit card companies want people who pay their interest, not their balances.

Many loans are set up so that you have to pay a penalty if you pay the principal back early. How can that be? Don’t the bankers want their precious money that they loaned you back as soon as possible? No. They don’t want the money they lent you back, they created it out of thin air and it disappears when you pay it back, which reduces the bank’s income.

When all of the stable borrowers already had home loans what did the banks do? They started lending to people they KNEW or should have known would never be able to pay them back, why? Because they were stupid and reckless? No because they know better than the rest of us how the system works. Because the interest payments are the only way they make money. Shouldn’t the more prudent banks have not made those loans? NO, being prudent is all downside with no upside. ALL of them did it because the “assets” and the demand from the “real” economy, the signals that the RBD says should tell them to create more loans and money, were saying full steam ahead, until the bubble popped.

This is all possible because the banking system is back-stopped by the Fed and ultimately the tax-payer. Banks don’t fail (very small ones that the Fed doesn’t care about do on occaission, mostly from gross malfeasance or incompetence) it’s why the Federal Reserve system was set up in the first place. During the 20th century literally millions of businesses in all industries failed. There is only one original company that is still in the Dow industrial average since it’s inception (GE). Yet during that time period only a couple of thousand banks have failed, most of them during the depression. Are bankers just superior businessmen than all the other morons running businesses? No, unlike International Harvester or Mike’s Hardware the banks in the U.S. have the U.S. taxpayer to bail them out when they make terrible business decisions, that’s what the system was designed to do.

With the full implosion of the mortgage market there will be not one single bank of any size that will go bankrupt. Some small ones will, Citigroup will never, ever be allowed to go bankrupt, no matter how incompetent it’s management.

The Fed system was designed so that all of the banks in the country could inflate together. In the days before the Fed, banks competed on their loan quality. But because of the fractional reserve system they were all interconnected enough that the reckless banks would often take the prudent ones down with them, or at least severely hurt their profits. Fractional Reserve banking is a pretty unstable practice. In a normal industry what should have happened was that the prudent banks should have taken these opportunities to consolidate the banking industry into a few huge banks that were large enough to carry out fractional reserve banking without danger of using up all their reserves (for instance no banks in Canada failed during the Great Depression). But the laws of the time forbid banks from operating across state lines or from becoming too big, a consequence of public distrust of banks (somewhat deserved) but mainly through the political power of smaller local banks to legislatively restrain their larger out of state competitors.

Ultimately what the Fed does is it sets a minimum reserve level for all banks, which looks like a government regulation that is designed to restrain the less prudent banks. In reality it provides a floor under reserve ratios so everybody can loan up by an equal amount and there is no longer a distinction between prudent and reckless banks. Everybody is happy.

But what happens when EVERYBODY makes reckless loans and the whole system is on the brink of collapse? The Fed was designed for just such an situation, and because no one bank is responsible for the recklessness, none of them get blamed. The Fed provides money and low interest rates to keep the borrowers who can’t pay making payments for as long as possible, even if that means that rest of the government has to put together loan packages, from the taxpayer, to keep these borrowers paying their INTEREST. The whole thing gets blamed on the economy or the system or whatever, but the result is that all the banks are still in business, their interest payments are secure and they can move on, still in business.

What we have witnessed over the last 6 months is exactly how the system was designed to work. The banking system is a house of cards and every time it is about to fall the government steps in with taxpayer money and props it up yet again.

It almost sounds like the Federal Reserve system is government sponsored cartel!

Once you remove the idea that bankers make loans with the idea of getting paid back their principal and the idea that all loans are backed by collateral of stable value (not all loans are backed by collateral and the ones that are base the backing on variable and subjective valuations), this theory kind of falls apart, unless it is accompanied by a 100% reserve banking with a gold standard, in which case it has no usefullness anyway.

In a fractional reserve banking system with a central bank the monetarist approach, though flawed, at least attempts in theory to be COUNTER-cyclcial and even out the business cycle. The RBD is PRO-cyclical exaggerating the boom and bust cycles.

fundamentalist January 12, 2008 at 9:03 am

Mike: “The value of money is determined by the value of its backing. Period. This implies that if new money is issued for assets of equal value, there will be no inflation (and thus the self-perpetuating cycle you mention never gets started). It also implies that if the assets have inadequate value, then there will be inflation, while if the assets are more than sufficient, deflation is possible.”

This may have represented sound economics 300 years ago, but the science has progressed a great deal since then. No school of economics would endorse the RBD explanation of price inflation. As Friedman, a Keynesian, pointed out, price inflation is always and everywhere a monetary phenomenon. Austrians disagree with some aspects of the quantity theory of money, such as the fact that monetarists assume that all prices rise at the same rates and times, but not with the main thesis that increases in the money supply cause price inflation.

No matter how many times someone points these things out, Mike keeps coming back with his 17th century economics hoping to trap someone who is still naive about economics. But anyone wanting to know the truth about RBD need only stay with this site a few weeks, learn some Austrian econ, or any econ for that matter, and you’ll be able to decide for yourself.

Inquisitor January 12, 2008 at 9:14 am

Well said DS.

So Mike, in your view, is the Fed harmless? Is it in any way analogous to free banking? If not, then what is your assessment of it?

Mike Sproul January 12, 2008 at 12:05 pm

Inquisitor:

Is the Fed harmless? Well, it’s certainly not a counterfeiter, as Austrians claim. But it does have an unjustified monopoly on the issue of paper money. Also, since it does not have the usual profit motive of private banks, it has little incentive to keep costs down. So overall I’d say that its monopoly power gives it the power to cause recessions and depressions, and to the extent it does that, it’s not harmless.

Fundamentalist:
“No school of economics would endorse the RBD explanation of price inflation.”

Absolutely right. Finally something we agree on.

DS: Show me the bank that lends money without taking sufficient collateral, and I’ll send them more business than they can handle. What do you think a foreclosure is? It’s the result of a customer that could not pay back his loan.

Person January 12, 2008 at 12:58 pm

Mike_Sproul: I can show you a bank that *doesn’t* loan, which it *is* offered sufficient collateral. Does that count?

Person January 12, 2008 at 1:03 pm

sorry, “which it *is* offered…” = “when it *is* offered”.

DS January 12, 2008 at 1:43 pm

“DS: Show me the bank that lends money without taking sufficient collateral, and I’ll send them more business than they can handle. What do you think a foreclosure is? It’s the result of a customer that could not pay back his loan.”

Credit Cards. Most banks offer them, none of them require any collateral. The fact that a bank thinks you might be able to make the interest payments (or that your parents will make them for you if you get in trouble) is all the “collateral” that is required. You can get one any time, heck you can get several. And if you max it out but are still making your interest payments (or even if your not) they will increase the amount of money you can charge just by asking. That’s just one example. I knew people in college who used to do what was called “doubling-down” which is getting another credit card, charging all their food (or beer) to the new credit card and use that money to pay the interest on their maxed out card. Talk about money being created out of nothing! Eventually their parents bailed them out or they finally made enough money after graduation to resume making interest payments.

Foreclosures are expensive, banks rarely do better than break even, and banks aren’t in the real estate business. They are in the business of earning interest payments on money that they didn’t have to work to earn, they simply created it out of thin air, at virtually no cost. Foreclosure means they have to write off the loan (a hit on the income statement), give up the interest payments that are the prime geenrators of their profits, find another borrower to replace that interest stream of revenue. All of that costs them more than it would for the loan to remain current, even if they get no principal back (they don’t make any money through principal repayment).

Then there is no guarantee that the value of the property equals the amount of money that was originally created by the loan. There is nothing that makes this transaction sum to zero from a money creation standpoint.

The real point is that most debt get rolled over, it is never extinguished, it is perpetual. Look at the National Debt – the last president to pay off the National Debt was Andrew Jackson. That’s over 170 years of perpetual debt. Name a corporation in this country with no debt? Corporations keep constant amounts of debt on their balance sheets and perpetually roll them over. The money created stays in the economy forever, it is never extinguished, it stays in the money supply forever.

Jean Paul January 12, 2008 at 3:42 pm

The problem ‘today’ is not that the RBD is wrong.

The problem ‘today’ is the lack of free banking. Under free banking you’d see a bunch of successful, careful, prudent, non-depreciating, RBD-type banks.

Today the only competing currencies to choose from are state-run, and tax-backed. Hardly an appropriate ‘controlled experiment’ from which to take empirical observations.

Jean Paul January 12, 2008 at 3:53 pm

“The real point is that most debt get rolled over, it is never extinguished, it is perpetual.”

So long as a tax-funded bailout is available, it’s true – consequence-free debt is more profitable to sustain than to retire.

Note that people regularly dump their high-interest balances onto low-introductory-rate cards – in other words, for all their faults, people ARE smart enough to chase the better deal.

Get rid of the rules and bailouts, and the leaky boats will sink… I trust that the rats, at least, will figure out which direction to swim.

jp January 12, 2008 at 4:29 pm

DS:
If you don’t think credit cards ask for collateral, you should read your card holder agreement more carefully.

Credit cards are usually unsecured, meaning they do not hold a lien on any specific asset like your house or car. But they place a general lien on your combined assets, which you agree to when you sign up.

For instance, here are a few agreements:
http://www.wsecu.org/documents/visa%20credit%20card%20agreement%200904.pdf
http://www.pcmastercard.pcfinancial.ca/rocen/cardapp/contentPG/legal.asp
http://www.southalabama.edu/usafedcu/creditcardapplication.pdf

When you sign such an agreement, you agree to repay all debts due to the card company. This is the lien, or the collateral the card company holds against you. The card company determines when you are in a default and will turn to the courts to seize your assets as per the agreement you signed.

newson January 12, 2008 at 7:22 pm

postscript to fundamentalist:
you can hear dr marc faber on this broadcast:
http://www.financialsense.com/fsn/main.html

incidentally, financialsense.com is run by “austrians”, though not all their guest experts are.

Mike Sproul January 12, 2008 at 7:40 pm

Person:
“I can show you a bank that *doesn’t* loan, when it *is* offered sufficient collateral. Does that count?”

That’s fairly common during recessions, bank runs, periods of credit rationing, or when there are interest rate ceilings. I assume you’re talking about a present-day bank, and clearly that bank is experiencing liquidity problems, for any number of reasons.

Mike Sproul January 12, 2008 at 7:52 pm

DS:
“Corporations keep constant amounts of debt on their balance sheets and perpetually roll them over. The money created stays in the economy forever, it is never extinguished, it stays in the money supply forever.”
Debt does not equal money. You might lend me $100, in exchange for my IOU that is currently worth $100. There have been times when my IOU could have been spent at the grocery store and thereafter used as money. But my IOU might also have just stayed in your desk, in which case it is not used as money. In modern language, debt may or may not be “monetized”.

Parrotocracy January 13, 2008 at 1:48 am

DS,

Thanks re:

http://www.independent.org/pdf/tir/tir_11_03_01_timberlake.pdf

Talk about writing in an understandable way. Here is Timberlake:

“Either gold or bank loans can serve as a basis for money creation. However, these two bases for creating money are fundamentally different. A gold standard monetizes gold on fixed legal terms—that is, so many dollars for so many ounces of fine gold, no matter what the season, the state of business, the needs of the government, the direction of international trade, or any other real-life variables. Significantly, no one has ever had to define “real gold” or to decide which “real gold” was “eligible” to be monetized.

Bank monetization of real bills, however, cannot be done on fixed terms. As Mints argued,
“whereas convertibility into a given physical amount of specie [gold or silver] . . . will limit the quantity of notes . . . the basing of notes on a given money’s worth of any form of wealth . . . presents the possibility of unlimited expansion of loans” (1945, 30).”

er, not done with article yet though… goes well with Corrigan, Blumen, Humphrey, Thornton, Carroll et al.

Mises Institute should sponsor a debate re RBD.

Inquisitor January 13, 2008 at 10:06 am

I’ll also give the article a read when I have time (as well as Mr Sproul’s main article.) And I agree, it’d be an interesting matter for debate.

Mike Sproul January 13, 2008 at 10:45 am

Parrotocracy:

“whereas convertibility into a given physical amount of specie [gold or silver] . . . will limit the quantity of notes . . . the basing of notes on a given money’s worth of any form of wealth . . . presents the possibility of unlimited expansion of loans” (1945, 30).”

You’ll find that same quote in my paper “Three False Critiques of the Real Bills Doctrine”. Mints assumed the correctness of the quantity theory of money and thereby arrived at the conclusion that the quantity theory must be right. Timberlake does not recognize this. I had an email exchange with him shortly after his article appeared, and he brushed the RBD aside without much comment.

For what it’s worth, I would also like to see a debate on the real bills doctrine.

fundamentalist January 13, 2008 at 2:11 pm

Parrotocrasy: “Mises Institute should sponsor a debate re RBD.”

Mises dealt with it in his book on the German inflation of the 1920′s where he points out that the German central bank and member banks followed the RBD. Because the RBD assumes that increasing the money supply does not cause price inflation, the German bankers of the 1920′s were mystified by rapidly rising prices and blamed them on speculators and greedy businessmen, who else? And whom do bankers and politicians blame today? Exactly! Speculators and greedy businessmen, especially corporations.

Of course, Mike will write that the Germans bankers of the 1920′s weren’t following the real RBD, at least not the one he proposes. But how do we know that his is the real one and their’s wasn’t?

I doubt that the Mises Institute will sponsor a debate on the RBD because no one in any school of economics takes it seriously. As stupid as Marxists are, they still don’t swallow the RBD.

Mike: “Mints assumed the correctness of the quantity theory of money…”

The scholars at the School of Salamanca in Spain discovered the quantity theory of money in the 16th century when they saw that the increased supply of gold and silver from the Americas caused prices to rise. The quantity theory is as basic as the subjective theory of value that underpins Austrian theory. The subjective theory of value states that when the quanity of one commodity increases relative to others, the value (prices) of the other commodities will increase relative to the first commodity. Money is just another commodity in the marketplace, although it tends to be the last commodity. To overturn the quantity theory of money, you would first have to overturn the subjective value theory. Good luck with that.

Mike Sproul January 13, 2008 at 4:15 pm

“The scholars at the School of Salamanca in Spain discovered the quantity theory of money in the 16th century when they saw that the increased supply of gold and silver from the Americas caused prices to rise. The quantity theory is as basic as the subjective theory of value that underpins Austrian theory.”–Fundamentalist.

This from the guy who just accused me of using 17th century economics, who is also the guy who sees no difference between physical commodities like gold, and the pieces of paper that promise to deliver that gold.

fundamentalist January 13, 2008 at 10:06 pm

Mike: “This from the guy who just accused me of using 17th century economics…”

The difference between the the 17th century RBD and the 16th century quantity theory is that the science of economics continually reaffirmed and refined the quantity theory over the centuries while discrediting the RBD. Meanwhile, the RBD is stuck in the 17th century and completely ignores any and all progress made in economics over the past 400 years. It contradicts the foundational principles of Austrian econ. If you believe the RBD, you have to believe that Mises and Hayek are complete lunatics, because the foundation of the ABCT is that increases in the money supply, other than those caused by savings, distort the ratios of prices between capital and consumer goods, cause malinvestments, cause price inflation and generally destroy wealth. The RBD is nothing but a way to get around the restrictions of a gold standard and increasing the money supply at will.

Mike: “…who is also the guy who sees no difference between physical commodities like gold, and the pieces of paper that promise to deliver that gold.”

For honest people, no difference should exist between the two, because the paper merely represents the gold.

Parrotocracy January 13, 2008 at 11:30 pm

Fundamentalist,

Roger that! concerning a debate. The more I read the more I agree that RBD is a form of artificial quantity manipulation with all the negative implications. But if it took Mises years to rid himself of fallacious theories, it might take me more than a weekend, even with the advantage of having access to so much work done before.

I appreciate both your and Mike Sproul’s input. Of course, I did not know of the previous discussions.

fundamentalist January 14, 2008 at 9:15 am

Parrotoracy: “The more I read the more I agree that RBD is a form of artificial quantity manipulation with all the negative implications.”

That’s right. Keep in mind the main reason people chose gold as money in the first place millenia ago (at least 3,000 BC): it’s value in exchange remained relatively stable because the supply grew very slowly. They experimented with other metals, such as iron, and other objects, such as shells. Salt was money at one time. They abandoned each of these as money when they realized that the value of each one in exchange for other goods would fall rapidly as the supply expanded. So all of them failed as a reliable store of value, except gold. Switching to paper as money changes nothing. If the supply of paper grows faster than the supply of other goods, it’s value in relation to other goods will fall and it will fail to be a good store of value. That is true whether we’re talking about paper money or toilet paper.

Don’t worry about taking a while to learn Austrian econ. It should take you less time than it took me because I had earned an MA in Keynesian econ, so I had to unlearn years of accumulated crap before I could learn Austrian econ!

Person January 14, 2008 at 10:54 am

Mike_Sproul: “[A bank not loaning when offered sufficient collateral is] fairly common during recessions, bank runs, periods of credit rationing, or when there are interest rate ceilings. I assume you’re talking about a present-day bank, and clearly that bank is experiencing liquidity problems, for any number of reasons.”

Yes, I am, but it didn’t meet any of the conditions you mentioned, so I guess that would make you wrong.

Specifically, I was trying to get a mortgage and my credit history was short, making lenders want to avoid me like the plague. Now, keep in mind a house secures a loan, I had offered to put 20% down. This bank, keep in mind, had no problems making loans to other people at the time. I believe it was Wells Fargo.

Considering your earlier claims about mortgage collateral being “enough” to make the bank have no problem loaning, that should by itself make you wrong.

But wait: there’s more! To go even *further* in making sure the loan had no risk and the bank could loan me in exchange for real bills (or whatever), I offered to put up shares in a stock mutual fund as collateral, until the loan had sufficiently low risk. The bank outright refused to consider any amount of shares as sufficient to back the loan. And to top off all the kafkaesqueness, the loan officer said the reason they wouldn’t take the additional collateral was that (in good Mike_Sproulian lingo) “the house is enough collateral”.

So no, banks don’t necessarily loan when offered sufficient backing.

Now, you might say, “Well, I *really* meant when they could capably value the collateral offered, which obviously doesn’t apply in your case, even though it’s an extremely liquid investment that a large bank deals with all the time.” But you didn’t put such a caveat.

Mike Sproul January 14, 2008 at 7:24 pm

“For honest people, no difference should exist between the two, because the paper merely represents the gold.”

Bank A accepts 100 oz of gold on deposit and issues 100 receipts that each give the holder a 99.99% chance of redemption for one ounce of gold, any time, unless the bank is robbed. Bank B accepts 100 private IOU’s, each promising to pay 1.05 oz of gold in 1 year, and backed by miscellaneous collateral that the bank considers adequate. Bank B issues receipts that also promise a 99.99% chance of redemption for 1 ounce of gold any time, unless the bank is robbed or the bowwowers default. Honest banks and honest customers make this kind of deal all the time. Banks of type B will earn higher profits because of interest, so they have survived while banks of type A have disappeared.

fundamentalist January 15, 2008 at 8:27 am

Mike: “Bank A accepts 100 oz of gold on deposit and issues 100 receipts that each give the holder a 99.99% chance of redemption for one ounce of gold, any time, unless the bank is robbed.”

I happen to be one who thinks fractional reserve banking is dishonest. Others may disagree, but then people have the ability to rationalize anything.

Of course bank B will make more money than bank A. Bank A had to acquire a valuable asset before it could issue notes. Bank B did nothing but print pieces of paper. If the government didn’t exempt bank B, it would be guilty of counterfeiting. Here’s the funny thing about your example (funny because you don’t seem to see anything wrong with it): bank B could call in its loans, get paid in notes backed by gold, redeem those notes for gold and end up having real gold in its vault when it started out with nothing but paper. To a simple person like me, that looks an awful lot like theft.

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