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Source link: http://archive.mises.org/9068/100-reserves-now/

100% Reserves Now

December 8, 2008 by

Banks are holding nearly 100% reserves for transactions deposits. (As of November 19, they had about $652 billion in reserves for about $700 billion in transactions deposits.) We could implement the 100% reserve rule now for transactions deposits. These reserves would not be lent out in the future, which would keep the banks solvent going forward. FULL ARTICLE

{ 36 comments }

Mindaugelis December 8, 2008 at 9:10 am

Even if banks were holding only 1% reserves it would be possible to implement 100% reserve rule, if there was will to do so. As long as people are asking and politicians are happily providing various packages, one bigger than the other, to “save” the economy – there is no hope, no matter how much cash there is sitting in the accounts at the moment.

StatusQuoJoe December 8, 2008 at 9:50 am

No time like the present, but we would be making one huge assumption and that is: the reserves reported are in fact in reserve and have not been manipulated on unseen balance sheets for other reasons. It seems we have entered an age of paranoia within all realms of civilization and nothing that I have seen to date reflects this better than the fact that gold entered backwardation for the first time in American history on December 2nd.

Those who hold gold (from large quantity to small) know that no amount of paper trickery promising return on paper gambling will tempt them out of this current situation perhaps for years until more stable and reliable macroscopic indicators are manifest (job creation from real industry, national debt load to real GDP, etc).

StatusQuoJoe December 8, 2008 at 10:14 am

Errr, let me re-phrase that – paranoia has such negative connotations; unease, mistrust, doubt are better adjectives in the context.

Liberty4All December 8, 2008 at 10:49 am

What a great opportunity to address this broken wheel of banking. Here’s a link as a supplement to this topic: http://www.fee.org/publications/the-freeman/article.asp?aid=1500

StatusQuoJoe December 8, 2008 at 11:43 am

Liberty4All, very appropriate post certainly worth consideration, again it reinforces the intent of the constitutionalists that only congress has the authority to coin money and set its value. The consumer has the obligation to understand his/her risk in investment and or savings vehicles. Under legal tender laws this choice and responsibility is effectively terminated thus lending further proof that money has an essential role to play in liberty. A concept that seems foreign to most Americans nowadays.

Chris December 8, 2008 at 11:58 am

“Almost certainly pass us by” is too optimistic.

David Hillary December 8, 2008 at 12:20 pm

Lucas that is a pretty crazy analysis of the issue: the reserves the banks hold now are in the form of Federal Reserve Notes and balances with the Federal Reserves, and the Federal Reserve is itself a fractional reserve institution, so basically you’re advocating nationalisation of fractional reserve banking.

The real issue is irredeemable and unanchored fiat currency standard, and not fractional reserve banking. The real solution is a metallic currency standard and free banking for providing redeemable bank notes and cheque account balances. That solution can be introduced regardless of reserve ratios by re-anchoring at the current market price of money in terms of metal, and liberalising the financial sector, which will then adopt whatever reserve policies it and the market finds ok.

Darius December 8, 2008 at 12:29 pm

Transaction deposits under 100 percent would be a good first step, but in the end we need time deposits covered 100 percent also; and then the gold standard!

Darius December 8, 2008 at 1:10 pm

I want to clarify the 100 percent time deposits, because, what i suppose and mean, is that banks should lend time deposits, nut only accounting to the IOU principal: a deposit of x time should be lent out for the same x time.

greg December 8, 2008 at 1:28 pm

100% reserves for 100% deposits does not account for the amount of loans they have on their books. And it is the negative change in the ratings of those loans which requires the bank to increase their reserves. With your 100% rule, forced liquidation would be required for any change in the ratings of those loans.

On your coin flip example, for every winner there is an equal looser. Investing is not that way except in the options markets.

Lucas Engelhardt December 8, 2008 at 5:36 pm

Thanks all for the responses. Just a few quick clarifications:

Mindaugelis – I agree. My point is just that right now seems to be a sensible time for 100% reserves with minimal impacts on the banking system.

StatusQuoJoe – yes, we are making the assumption that reported reserves are actually “in reserve”… true, this may not be entirely safe.

Chris – I do see the world through rose-colored glasses…

David Hillary – actually, I don’t fully agree with you. I do agree that a “free market money” (probably something like a gold standard) is “the answer”… but the answer to a different question. Here, I’m trying to tackle the problem of economic fluctuations/business cycles. For that the answer is, in part, no bailouts + 100% reserves. Another concern: hyperinflation. For that, the answer is a free market money (probably gold or another precious metal). However, I don’t believe that “fully redeemable money” and “fractional reserves” are logically consistent. If there are 100 oz of immediately redeemable gold certificates, then the bank must have at least 100 oz of gold in the vault if the certificates are to actually be considered “fully redeemable on demand”.

Darius – I tend to agree with you there, too. 100% for transaction deposits are just one step… one that we could take now. Matching times for deposit redemption and loan payments is necessary for stability.

Greg – 100% reserves for 100% of all deposits (transaction and time) would mean that the ability to repay depositors would not depend on loan repayment. Bad loans would hurt those who own the bank (stockholders, generally), but would do little to bank solvency. Now, it is true that I leave out a large portion of deposits in the requirement described here. Also, I agree, my coin flip is not an “investment”, in the usual sense. The example was meant to demonstrate the role that bailouts can play in encouraging risk-taking… and also that the possibility of bailouts can play in making them necessary.

scineram December 8, 2008 at 6:03 pm

Why would banks offer such transaction deposits, if they cannot make money off of it.

Lucas M. Engelhardt December 8, 2008 at 9:13 pm

scineram – Not being able to lend money out is not the same as not being able to make money off of it. For example, when I store my boat at a marina, they don’t make money off of loaning out my boat. They make money by charging me a fee. Similarly, we’d expect transactions accounts (like checking accounts) with 100% reserves to have fees attached… though it is possible that banks would find it a good marketing ploy to offer free checking accounts for people who held other sorts of accounts that were not subject to 100% reserves.

DanC December 8, 2008 at 11:57 pm

How about the over $180 Trillion of derivatives on the banks’ books per the Comptroller of the Currency’s Second Quarter 2008 report?

There is no way that the banks could ever be “solvent going forward.” They are insolvent now.

Like Wile E. Coyote running off the cliff with legs flailing, you know the crash is coming. All we can do is wait for the puff of dust at the bottom of the canyon.

GEAB (LEAP/2020) predicts the default of the whole system by Summer 2009. Beep. Beep.

Andrew December 9, 2008 at 12:30 am

Forgive me if this there is an obvious answer to this question, but I’m no expert on this subject.

If the banks are holding a hundred percent of deposits, what are they lending?

Darius December 9, 2008 at 4:40 am

Andrew, the money multiplier affect applies to transaction deposits, if they arent covered 100 percent; regarding the time deposits and savings, i think that banks should lend them, because, lets think about it: if someone decides to save x dollars for y time and there is someone wanting to borrow the same x amount for the same y time, and both sides think that this exchange will be of better worth to both of them, then it will take place: thus the bank should act as a third institution putting together such transactions – but the lending should account to the IOU principal, which would let to lend out the savings of y time for the same y time; now there can be possibilities, that someone wont be able to return the credit and the bank wont have the lent out money (as per IOU principal) to return, once the saving matures – in such case banks can take the missing sum from their net lending balance (interest acquired from credits minus interest paid to depositors), which basically is their profit – this will temporarily decrease their profits, but lets not forget, the the amount will be returned after some time, or if not, some collateral will be taken; another possibility to acquire that missing sum is from the owners capital, also, there could be insurance (private, not national) companies, which could specialize in such cases; at last, if there arent any possibilities, the banks could offer to extend the deposit with better interest, till the money is returned; maybe they could temporarily take from their reserves of transactional deposits, but, say, only for 30 days or a bit shorter or longer, but not infinitively.

Lucas M. Engelhardt December 9, 2008 at 9:29 am

DanC – solvency is a matter of “can we pay our debts” – for banks, that is “deposits”. It’s actually not hard to achieve in our current system. All we need is for the Fed (or CB in question) to print the money and hand it to the banks for free. Since solvency is a matter of comparing nominal values, this would work. Naturally, it’s not desirable, but it would make the system solvent, regardless what happens to the various moneys that the banks are owed.

Andrew – Darius’s answer is very good. One thing I’d add – there are basically 3 types of deposits: transactions (think “checking accounts”), savings, and time (think “CDs”). Right now, banks are holding enough reserves to fund their transactions deposits almost completely. (So, we’re almost to the point where everyone could empty out their checking accounts, and the banks would be able to pay.) However, banks still have time deposits (as Darius mentions) that can be lent, and they have savings deposits that are being lent. In addition, banks can lend money that comes from places other than deposits. For example, they can issue stock, or use interest from loans to fund loans. Personally, I’d suggest a system where there is 100% reserves for everything that’s available at zero maturity, and time matching requirements for time deposits. All other loans can be made based on the bank’s equity (from issued stock/retained earnings and such).

David Hillary December 9, 2008 at 12:34 pm

Lucas Engelhardt,

Of course you don’t agree with me: you’re wedded to a business cycle, monetary and macro-theory that posits that the quantity of money drives prices and the business cycle, while I don’t hold this view.

It should also be noted that bank notes are NOT gold certificates: a bank note is an unconditional promise, in writing, made by a bank, signed by the bank, undertaking to pay to the bearer on demand, a specified amount of money. I.e. a bank note is a promissory note (see http://davidhillary.blogspot.com/2008/11/banking-defined-and-defended-part-1.html ). A gold certificate could mean a certificate of title to stored gold, which is basically a kind of warehouse receipt. One is a debt owing, the other is a bailment.

Redeemable is a concept in securities law, and basically means that the security can be redeemed (discharged) typically by payment of money. For example, company shares could be redeemable at a fixed time, or at the option of the company or the shareholder. Just because a share is redeemable, does not mean that the company must hold money in reserve to redeem the share, that is a question of the company’s financial policy and its financial circumstances. In the same way a bank of issue need not fully reserve its bank notes on issue — again it is a question of financial policy and circumstances of the bank.

Lucas M. Engelhardt December 9, 2008 at 1:49 pm

David,

Actually, I’m wedded to a librarian. I just happen to believe in a theory about the business cycle that happens to be true much of the time. (Actually, I tend to agree with Guido Hulsmann’s critiques of this theory… you can find those on the site here. “Toward a General Theory of Error Cycles” is the article.)

I can understand the difference between bank notes and gold certificates, as you explain it here. But, I’m not sure that there is any “real” difference. If I have unconditionally promised to pay something on demand then I, by necessity, must have it on hand at all times in case it is demanded. Otherwise, there are conditions under which I will be unable to pay, and calling the promise “unconditional” is fraud.

I think I can agree with you on the concept of redeemability and some of its relationship to the concept at hand. The trick, though, is calling something “unconditionally redeemable”. If I promise to redeem something no matter what, then I have a responsibility to be sure that I CAN redeem it no matter what. I don’t have any particular problem with an organization issuing “conditionally redeemable” notes/certificates/etc, but one cannot call them “unconditionally” redeemable unless they actually are.

I’ll have to take a closer look at your blog post later. I may offer further comments there when I get the chance.

JB December 9, 2008 at 3:02 pm

I think that when 100% reserves is talked about, it should be made clear that the deposits that are being talked about are demand deposits only and there are many other forms deposits can take.

Also, what would the pros/cons be of a system in which depositors (the actual person – i.e. the market) set their own “reserve level”? Make 100% reserves be on demand deposits (like what is suggested), and have the rest be put into time dependent maturity accounts (like CD’s).

In such a situation fractional reserves (maybe a better term would be credit expansion) would still exist if the entire amount deposited is taken into consideration (both the instantaneously redeemable portion of the deposit and the deposit that is redeemable in the future). This is because any loan that is made using the time dependent portion of the deposit can be multiplied through the choices of the receiver of the deposited loan.

E.G. X deposits $1000 at 50% reserve in bank A. This means $500 is in redeemable on demand deposits that are fully reserved, and $500 in time dependent deposits that are redeemable at some date in the future agreed upon by A and X. Bank A lends the $500 time dependent deposit to Y who spends $200, deposits $100 in demand deposits (full reserve) ,and deposits $200 in a time dependent account. Person Y has then $300 at 33.3% reserve (only $100 instantly accessible).

In such a case, the credit, or a portion of it, that Bank A can expand from that original $500 is in a sense multiplied but only at the rate chosen by the individual recipients of every loan.

Just thinking…

mikey December 9, 2008 at 7:52 pm

David Hillary writes:

“In the same way a bank of issue need not fully reserve its bank notes on issue — again it is a question of financial policy and circumstances of the bank”

And what what would those policies and circumstances be, exactly, David?

Brian Macker December 9, 2008 at 9:13 pm

“Actually, I tend to agree with Guido Hulsmann’s critiques of this theory… you can find those on the site here. “Toward a General Theory of Error Cycles” is the article.”

I quickly scanned that article and didn’t find it particularly compelling. Did it ever get to a point?

Brian Macker December 9, 2008 at 9:14 pm

“Actually, I tend to agree with Guido Hulsmann’s critiques of this theory… you can find those on the site here. “Toward a General Theory of Error Cycles” is the article.”

I quickly scanned that article and didn’t find it particularly compelling. Did it ever get to a point?

Lucas M. Engelhardt December 10, 2008 at 7:49 am

Brian,

I think the article is best thought of as “opening up” a particular issue rather than “making a point” about the issue. As such, it’s hard to articulate “the point”. I found it to be a case where, once I let it sink in, it had an influence on the way I look at business cycle theory. If I had to sum it up, there would be two points I would emphasize: (1) There are some hidden preconditions in ABCT that are rarely articulated. (2) Once these preconditions are explored, we find that ABCT is one form of the theory of error cycles, which is much larger that ABCT alone. Naturally, there’s more to the article, but if I had to pull out two things, those would be them.

billwald December 10, 2008 at 12:10 pm

Good essay because it never uses the word, “gold.”

Requiring a 100% time deposit reserve is a great idea. It would encourage banks to increase interest paid and encourage people to save. The transition would be messy unless the Fed provided the initial time deposit.

Mike Sproul December 10, 2008 at 5:06 pm

Lucas M. Engelhardt

David Hillary is more correct than you know. If a bank has issued 300 checking account dollars, backed by 100 paper dollars and bonds worth $200, and if the bank and the customers agree to it (and have a centuries-long tradition of doing it), then that is nobody’s business but theirs. If you think you have a right to prohibit that transaction, you should turn in your libertarian ID card.

Brian Macker December 10, 2008 at 10:52 pm

Lucas,

Well the reason I didn’t find it compelling was that sentence after sentence was under-appreciative of what the theory Austrian Business Cycle Theory has to say on various subjects, sometimes misunderstanding the implications of the theory completely. It’s as if the writer thought of the theory as a verbal exercise and not the description of a scientific model. He hadn’t seemed to visualize and understand theory as a whole.

Over and over I was finding myself saying, “Well sort of, but not quite right”

For example, after referring to Austrian Business Cycle theory as a “consequentialist approach, the article states “Before we come to a refutation of this theory, we should nota a crucial but hitherto neglected fact. That is, the problem raised by the analysis of error exceeds the limits of business cycle theory. It is a fairly general problem, and it calls for a general solution. For whatever the explanation of error might be, it would have to hold not only for error clusters but also for individual errors. The theory that changes cause error is a general solution, even if we can demonstrate it to be wrong. And if we venture to propose a better theory it must necessarily be a general solution as well. In other terms, business cycle theory must be grounding in a general theory of the recurrence of clusters of errors.

According to the consequentialist approach error is impossible and equilibrium must prevail if conditions do not change any more. …”

This is not true. Austrian theory does not preclude other unknown sources of error. The theory merely shows that certain conditions will lead to a clustering of error, and increased error. In the article he has already admitted that Austrian theory does not claim that individual error is impossible. Yet here he contradicts that claim. Austrian theory furthermore makes no claim about other kinds of error. Certainly, Austrian theory holds that price controls cause error, regardless of whether “conditions change”.

It’s a mistake to believe that Austrian theory claims that the market will adjust to any conditions just so long as they are constant. There are certain conditions that can be imposed that will cause constant error. For example, price floors if maintained will cause a continual overproduction and under consumption. Austrian theory is broader than business cycle theory.

He also goes on to make the mistake of thinking that Austrian theory is a static equilibrium theory when he states:

“According to the consequentialist approach error is impossible and equilibrium must prevail if conditions do not change any more. Error can only occur if conditions change. However, the crucial problem is that obviously not all changes necessarily lead to error. For example, the fact that, for the payment of waqges, one needs more cash at the beginning of the month does not surprise the businessman. Or, even if more legs were broken in 1999 than in 1998 this would probably not cause the bankruptcy of health insurance companies. How can these undeniable facts be reconciled with the consequentialist approach?”

Why here does he think that Austrian theory has a problem. It doesn’t. Austrian theory isn’t a theory of “error by surprise”. He has totally misunderstood the theory.

I could go on. I spotted error after error after error, and I was only skimming. That is why I didn’t find it particularly compelling.

My question to you about “Did it ever come to a point” has to do with my philosophical background. I’m a Popperian, and regardless of what little Mises understood of scientific philosophy or got wrong in that regard, I think that Austrian theory is good science, and therefore falsifiable. Like Popper however I feel that all theories are merely models and therefore are never “true” in the sense that some people believe. They are merely “not yet falsified”. It’s clear that the Hülsmann has not falsified the theory because he is operating with a straw man.

According to Popperian theory it is not enough to falsify a theory in order to throw it out. Sometimes a theory is sufficient within a more limited scope. For instance, Newton’s theories are sufficient at sub-light speed. Certainly they are falsified at near light speed. One wouldn’t in general claim that Newtons laws were “refuted”. They work under the known conditions under consideration, and theory can be modified to make that explicit if it was only implicit or unknown in a prior formulation.

Newtons theories are as correct as Einsteins if we limit speeds to well below the speed of light. In fact, Einsteins math reduces to Newtonian math at such speeds.

If we didn’t allow for this then it is probable that all scientific theory would be strictly false sense all theory are merely models and therefore always inadequate in some measure. We work with the best models we have.

Now it is possible that Einstein’s theory could have refuted Newton’s, because it was a better and incompatible theory. This wasn’t the case. It’s also possible that some evidence could have been found that falsified Newton’s theory for the conditions that it claimed to handle.

Had Einstein merely criticized Newton’s theory without providing a more complete theory then scientists would not be so impressed. They would have said, “Newton is the best theory we have, and yes we now understand it doesn’t work for conditions near the speed of light.”

I was looking for a point from the article in this regard. He did not provide a proper formulation of Austrian theory so he wasn’t actually falsifying it. He seemed to be failing. So the question is did he come up with a better theory anyway. One that was a better model regardless of his misunderstanding of Austrian theory. All I got out of my skimming was that his new theory was something like “The Government Did it” which really isn’t that compelling of a theory.

I have limited time to read articles and when the errors are so obvious at the outset of an article I loose motivation to read the rest of the article. As of this time I still haven’t waded through the entire article.

Lucas M. Engelhardt December 10, 2008 at 11:31 pm

Mike Sproul,

My primary concerns about David Hillary’s sort of system is that I am not yet convinced that it is free from fraud. I’ll have to read and think more about it before I can decide that. Rest assured that it is something that I’m thinking about at the moment.

Lucas M. Engelhardt December 11, 2008 at 12:06 am

Brian,

I’ll have to read and think about your comment here in more depth… preferably sometime other than 12:34AM. Just a couple brief, sleep-deprived comments:

(1) I read Hulsmann slightly differently than you do, as there are a few points that you claim he is making where I would not grant the same interpretation. Though this might be because it’s been a while since I’ve read that article.

(2) I think I must misunderstand Popperian philosophy. I thought part of Popper’s point was that falsification does prove that a theory is false, and that science progresses through proving theories false and making people think of new theories. The view of “let’s keep the theory around for limited use” sounds more like instrumentalism to me… but, I’m not a philosopher of science, so I’m somewhat ignorant of the subject.

Anyway, I think part of why you find Hulsmann unsatisfying is because Hulsmann meets Mises on his own epistemological grounds. Since you’re coming into the article from Popper’s epistemological grounds, your perception gets skewed. It looks like Hulsmann is undervaluing ABCT. In reality, he’s just trying to refute the claim that ABCT is “True” in the “deduced from self-evident axioms” sense. At least that was my sense of it when I read it several years ago… I should probably reread it to refresh my memory.

Brian Macker December 11, 2008 at 8:25 am

“falsification does prove that a theory is false”

Only tentatively. He believes that in one sense all theories are false. The methodology is used to explore the space of all possible theories. He only accepts any theory, belief, etc. as tentatively true. Likewise with falsification, it’s only tentative. New evidence can always arise that would cause one to reassess your belief. You must always hold your beliefs tentatively according to Popper.

Newtons theories have been falsified with regard to speeds approaching the speed of light. It’s possible however that some new discovery might show that Einstein was wrong. Perhaps we might discover it is only our instrumentation that goes bad at light speed. In which case we would decide the falsification was falsified.

He made a strong point of the idea that theories are not justified on foundational grounds, they are free floating. One never gets “ultimate grounded truth”.

Brian Macker December 11, 2008 at 9:00 am

BTW, yours is a common misinterpretation of Popper. Mainly because what he is saying, that knowledge has no foundations, is hard to wrap ones mind around. He was not rehabilitating empiricisms idea that science is ultimately grounded in observation with a switch to observational falsification. Part of his point was that there is no “ultimate foundations”. Thus to falsify a theory does not “ultimately” put it to bed. There is always the possibility of error, misinterpretaion, etc.

One of his other points was that the observations themselves are often theory rich. The eye, for example, doesn’t give you a transparent window on the word, and is in fact operationing on implicit theories about the world. This is why optical illusions work. They exploit the assumed principles of the eye in ways those principles are false. The go outside the bounds of the theory.

Same thing goes for economics. You will often see that individuals who believe in Keynesianism will preinterpret observations in light of their theories. It’s very hard to get through to them because they believe there is so much “evidence” to back up their beliefs. How many times have you heard: “The war got us out of the Great Depression”, or “They didn’t inflate fast enough during the GD” or “Deflation is bad”, etc.

“Since you’re coming into the article from Popper’s epistemological grounds, your perception gets skewed.”

Mises’s grounds are, in fact, a subset of Poppers. So I can view it both ways. Popper believes in deducing from axioms, pretty much, only he would say we are fallible and the whole point of science is error reduction. Therefore one needs to check ones axioms, and theoretical results against reality.

That Bolivian study posted on the blog being a good example of being more of a Popperian than a person working from “a prior”.

“Anyway, I think part of why you find Hulsmann unsatisfying is because Hulsmann meets Mises on his own epistemological grounds. “

Mises is valid up to that point. Popper requires the theory to be self consistent. Mises just puts too much faith in assumption and deduction.

Keynesians are worse scientific philosophers. They can’t even get the self consistency right. That’s why they always talk about paradoxes and have separated micro and macro economics.

Austrian economics is the best theory from the point of view of a Popperian. Furthermore, I would say that Mises fools himself if he doesn’t think that the economic theory he came up with wasn’t in large part informed at a higher level by observation.

He certainly didn’t sit in an observation tight room with only the axiom that “human’s act” and then deduce all of Austrian economics.

“In reality, he’s just trying to refute the claim that ABCT is “True” in the “deduced from self-evident axioms” sense.”

See I was reading (really skimming) it partially in that light too. I thought that he hadn’t gotten Mises’s assumptions and deductions right, and therefore was in bad shape to falsify his theory.

This is what Popper was getting at. You may have read Hülsmann before and thought he had falsified the theory (which can be done without any empirical evidence via proving a theory is self contradictory). I might be able, in your mind, to falsify Hülsmann’s criticism if I show he was operating with a wrong formulation of Mise’s theory.

Clearly ABCT is a in a broader category, price controls. In this case the price being controlled is interest rates. But that too is covered by Austrian theory.

I’ll leave you the burden of reading that Article again for now. If you start making progress against my arguments I’ll take a deeper look. I’m really not being fair at this point.

Brian Macker December 12, 2008 at 7:46 am

“David Hillary is more correct than you know. If a bank has issued 300 checking account dollars, backed by 100 paper dollars and bonds worth $200, and if the bank and the customers agree to it (and have a centuries-long tradition of doing it), then that is nobody’s business but theirs. If you think you have a right to prohibit that transaction, you should turn in your libertarian ID card.”

Actually, I already did turn in my libertarian ID card.

This is a case where it’s inevitable that the depositors in the bank will come to a point where the inherent fraud of the situation comes back to bite them. Once that happens they will be screaming for the government to tax me to prevent them from starving.

That’s human nature.

Also, what about the people who have accepted the bank notes that claim to pay on demand. Obviously this is an impossibility. At some point the Pyramid scheme must unravel.

When it does then it becomes clear that their actions have endangered me. Endangering others is a form of trespass. You can’t just store dynamite at the edge of your property next to your neighbors house on the theory of property rights.

Some frauds, ones that endanger entire life savings, result in the impoverishment of individuals to the point where they are put in the position of a desperate situation. At that point any form of rights system breaks down. It is perfectly within my rights to prevent that from happening.

See my comments in context here:

” “On 100% gold reserve banking I think you do not understand Rothbard as has been pointed out.

You are making what sounds like a reasonable argument but I think there is a flaw.

Sometimes deceptions can be open and still be deceptions. There are well known cases where people are exceptionally bad at predicting the odds of certain things happening.

Do you think that Ponzi schemes should be legal, just so long as the parties involved agree to the deception?

I think it is prima facie evidence of the incompentence of the signator to a contract if they were to sign a ponzi scheme contract.

Likewise a pyramid scheme. One might fully understand the contract and know that you were an early adopter and therefore less likely to be screwed. However, the very fact you think this is evidence that you are counting on finding additional people to join the scheme who are incompentent to understand the swindle.

I believe that fractional reserve banking is one of the most sophisticated swindles going on. It is extremely hard to understand why it is a con game. It is none-the-less a con game.

How exactly do you plan to make sure the recievers of banknotes in payment for their goods are fully aware of the consequences of the con?

Are you going to print something like this in fine print on the notes:

“This bank note entitles the holder to only half the face value printed. There is a great possibily that this note is being used to bid up the price of your good by 100% without full intent to pay you for that good. The full repercussions of this arraingement and the economic theory backing it is printed herein. Blah, blah, blah. Do you fully understand these conditions. If so fill in one of the blank lines below with your signature indicating that you are willing to take zero dollars in payment or perhaps wait as much as fifteen years for full payment.”

Another possibility is to make it the law that only the fractional reserve amount can be printed as the face value of the note, and that by law that reserve amount be kept available, with open books and mandatory banking insurance required for fractional reserve banks.

Thus the note might have a face value of say …

“Reserve Note for One Ounce of Gold”. and say “Bearer entitled to one ounce of gold that is being held in reserve. You may be entitled to up to 100% more than the face value of this note, but the bank may, at it’s descretion fail to pay you this additional amount. Depending on economic conditions and the condition of the bank there is even the possibility you will not receive the face value of this note. Please sign this note below indicating that you understand these conditions. Blah, blah, blah. …”

Now you could certainly do this, and it may outcompete metallic coin, but I very much doubt it.”"

fundamentalist December 12, 2008 at 8:23 am

Lucas: “Actually, I tend to agree with Guido Hulsmann’s critiques of this theory… you can find those on the site here. “Toward a General Theory of Error Cycles” is the article.”

Brian Macker: “Well the reason I didn’t find it compelling was that sentence after sentence was under-appreciative of what the theory Austrian Business Cycle Theory has to say on various subjects, sometimes misunderstanding the implications of the theory completely.”

I had a similar response to the article. It seems his chief argument against the ABCT is that people should be able to recognize inflation and prepare for its consequences. I can’t remember where, but I’m sure that I have read Mises and Hayek address that issue. Basically they wrote that steady inflation would not fool people, so the people who want inflation, such as central bankers, will have to shock the economy with unforeseen changes in order to get the effect they’re looking for.

But then Hulsmann claims that the fix for the Austrian “problem” is to recognize the illusion of government that causes people to trust in the state no matter how badly it performs. My first thought was how is it possible for people to maintain this illusion in the face of the facts when Hulsmann thinks it impossible for them to maintain illusions about inflation? People have many illusions about the market but especially about money. Those illusions come from false teaching like Keynesian economics. How is it possible that Keyenesians have held on to their illusions for 70 years in the face of a tidal wave of evidence against them? Illusions about money and the market, issuing from Keynesian, mercantilist and Marxist economics, is just as good an explanation as illusions about the state, and there is quite a bit of overlap in those illusions.

Lucas M. Engelhardt December 12, 2008 at 9:34 am

fundamentalist,

My interpretation is slightly different. Hulsmann is simply pointing out that we cannot, a priori, say that monetary inflation implies the clusters of error necessary for business cycles. It is logically possible (even if not probable) that people will accurately foresee the results of the monetary inflation, and prevent the boom-bust cycle. Naturally, it’s extremely unlikely. But, Hulsmann’s point is that we cannot use pure logic to rule out the possibility a priori.

Now, it is true that Mises (at least) says that once people figure out the inflationary scheme, the boom comes to a halt. But, he does (at least often) act as if error in the early stages is an inevitable consequence of credit expansion.

Anyway, Hulsmann proceeds by claiming that we can only treat error as inevitable if there are institutions which are inherently erronenous. He suggests government as an example because, by nature, the only thing governments can do to an otherwise free society is take resources away from more valued ends and apply them to less valued ends. Yet, also by nature, governments can only exist if the grand majority of the people allow it. Yet, people will not knowingly take resources away from more valued ends and apply them to less valued ends. So, the very existence of government proves that people are buying into an illusion – that is, making an error. Since government is a widespread, (usually) continuously existing institution that is inherently illusory, it implies recurring clusters of error.

Hulsmann doesn’t claim that it is “impossible” for people to maintain illusions re: monetary inflation. He just says that monetary inflation does not necessarily imply error. On the other hand, government is an institution which has proven to be very capable of maintaining illusions. In fact, it’s continued existence is sufficient to prove that the illusion is still with us. As such, it can be the source of recurring clusters of error, and these clusters have a more general form than ABCT suggests.

I think where I disagree with him (and tend to agree with you) is when he claims that “sooner or later they must discover their error”. Now, it is true that sooner or later they must discover that they have made an error, as reality will not be consistent with the expectations formed based on the error. However, it is not necessarily true that they will discover precisely what the error was… ever. Now, if we believe that knowledge is freely available and never lost, then yes, they will. But this is a false assumption. Knowledge is sometimes lost, and is not freely available… except here on mises.org. ;-)

fundamentalist December 12, 2008 at 11:51 am

Lucas: “He just says that monetary inflation does not necessarily imply error. On the other hand, government is an institution which has proven to be very capable of maintaining illusions.”

I agree with your understanding of what Hulsmann is saying, but what I was trying to say is that in addition to government another erroneous institution exists—fractional reserve banking. For over 600 years bankers have maintained the illusion that monetary inflation does no harm but does a great deal of good. Academic financial experts and economists (Keynesian and Marxist) join in to promote the illusion. Husmann says that we need to find an institution whose mere existence causes people to accept an illusion and make mistakes. FRB fits the bill as well as does government.

Brian Macker December 13, 2008 at 10:40 am

“Hulsmann is simply pointing out that we cannot, a priori, say that monetary inflation implies the clusters of error necessary for business cycles. It is logically possible (even if not probable) that people will accurately foresee the results of the monetary inflation, and prevent the boom-bust cycle.”

According to standard physics models it’s logically possible (even if not probable) for all the atoms in a room to hit the bottom of an elephant at the same time resulting in elephant flight.

According to standard physics it’s also logically possible (even if not probable) for all the atoms in a room to suddenly converge to the center, in which case outside pressure would cause the room to implode.

However if you understand the model and can visualize how it works then you will know that this is not going to happen, and that it is NOT a problem for the model that this doesn’t happen. Boyles laws follow from the model even though “logically” it is possible for the world to operate differently.

It’s the probablity that does the work. If the probablity is close to zero under a theory for something to happen then it is a good explaination for why that something doesn’t happen.

This is what I meant by: “It’s as if the writer thought of the theory as a verbal exercise and not the description of a scientific model. He hadn’t seemed to visualize and understand theory as a whole.”

Hulsmann is right that Mises can’t be right in his epistomological beliefs and his economic beliefs but he places the error in the wrong location. Both Hulsmann and Mises are bad philsophers, and they share the same error, a philosphical one here.

There isn’t anything wrong with the model here. it is highly improbable that people will will accurately foresee the results of the monetary inflation, and prevent the boom-bust cycle. That’s because the very signals needed to detect it are prices and those are the very signals that are distorted by fractional reserve banking.

In fact, Hulsmann is further incorrect, according to Austrian theory it is already impossible for individuals to calculate market prices.

Mises is correct in believing that people can detect uniform inflation and thus adjust contracts to these effects. Such uniform inflation however can only be done theoretically with fiat currency. You need control to do it.

Fractional reserve inflation, and commodity based inflation do not give you such control. Fractional reserve inflation is bound to deflate at some point in an uncontrollable fashion. Commodity based inflation (where there are new discoveries of the commodity money, or influx from opening new trade) is not uniform.

The Austrian model does not entail the belief that people will adjust to fractional reserve inflation.

Hell, I know all about it and I am pretty much powerless to prevent it. I’ve read Austrian economists explanations as to why. My understanding is that all avenues to such predictive corrections have been shut off by the government.

Examples:
Try to hold gold and if too many people are too successful they might just confiscate it.

They place burdens on gold such as transaction costs caused by treating it taxwise as a asset and not a currency. Fluctuations in the value of the dollar vs. gold places a calculation burden on users of gold. You have to track when you got the gold, how much, how much you paid, when you sold it and for how much.

I could continue. I won’t.

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