The usually sensible Larry White recently blogged a silly and petty comment on Hans Hoppe’s Mises Daily Article “ ‘The Yield from Money Held’ Reconsidered.”
White quoted the following two (consecutive) paragraphs from Hoppe’s article:
The second example [of supposed anti-Hutt thinking] is from closer at home, i.e., from the proponents of “free banking” such as Lawrence White, George Selgin, and Roger Garrison. According to them, an (unanticipated) increase in the demand for money “pushes the economy below its potential,” (Garrison) and requires a compensating money-spending injection from the banking system.
Here it is again: an “excess demand for money” (Selgin & White) has no positive yield or is even detrimental; hence, help is needed. For the free bankers help is not supposed to come from the government and its central bank, but from a system of freely competing fractional-reserve banks. However, the idea involved is the same: the holding of (some, “excess”) money is unproductive and requires a remedy.
White then comments:
The second sentence of Hoppe’s first paragraph quoted above is correct. The second paragraph contradicts the first, and makes no sense.
He then pedantically instructs Hoppe as he would an undergraduate who hasn’t gotten the lesson:
Let’s be clear about terms. An “excess demand” generally means an excess of quantity demanded over quantity supplied, i.e. a shortage at the current price. An “excess demand for money” — certainly not a phrase original with Selgin and me — accordingly means a deficiency of money held. It exists when the current quantity of money units falls short of the quantity demanded at the current purchasing power per unit. It can indeed be alleviated by an injection of additional units (or, alternatively, by an increase in the purchasing power per unit of money).
What provoked this ponderous lecture? According to White:
In the second paragraph Hoppe takes “excess demand for money” to mean “the holding of (some, ‘excess’) money”, or in other words a surplus of money units held. This is the reverse of its meaning.
Now, this interpretation of Hoppe’s two paragraphs is slipshod, if not downright disingenuous. In the first paragraph Hoppe is clearly referring to an excess demand for money in the conventional sense, in which “an increase in the demand for money” (Hoppe’s words) at the prevailing price level constricts the flow of spending. White does not dispute this. The first sentence of the second paragraph follows logically from the first paragraph, as Hoppe argues that the resulting condition of an actual “excess demand for money” is considered detrimental by the free bankers and requires alleviating by a monetary injection from competing fractional reserve banks (in Hoppe’s words, “help is needed . . . from a system of freely competing fractional-reserve banks).
There is no reference, explicit or implied, to the holding of excess money balances up to this point. So it appears it is the meaning of the last quoted sentence of Hoppe’s passage that White takes issue with: “However, the idea involved is the same: the holding of (some, ‘excess’) money is unproductive and requires a remedy.” While this sentence may be a bit obscure taken out of context, its meaning is pellucidly clear in light of the entire passage quoted by White himself. Hoppe uses the term “excess” in scare quotes to refer to the actual condition of excess demand that ensues upon the increased demand for money and which entails a Misesian process of a step-by-step reduction in prices and the (ex post and trivial) money spending stream. It is this Misesian monetary adjustment process, which necessarily unfolds over time, that, according to Hoppe, the free bankers consider “unproductive” and “requir[ing] a remedy.” Where is the contradiction White claims to see?
Keynes referred to an interest rate that was in “excess” with respect to the interest rate that would ensure a potential or “full employment” level of output (with a given marginal efficiency of capital (MEC) schedule and marginal propensity to consume). Keynes’s full employment level of output can only be maintained by a central banking policy that pegs the interest rate at a level that induces a full employment level of investment (although he had doubts about whether this interest rate would always be positive given the volatility of the MEC schedule).
Similarly the free bankers, Hoppe argues, consider the holding of cash balances by some of the public to be in “excess,”–at least during the time-consuming monetary adjustment process–of the level of money holdings necessary to ensure what we might call the “free banking” level of output. (Indeed if no one actually increased his cash balances by reducing his demands for various products, the condition of excess demand that the free bankers fear so much would never actually be set in train). The free banking level of output, White et al. allege, can only be continuously maintained by the automatic and instantaneous equilibration of the supply of and the (unpredictable) demand for money by a system of competing fractional reserve banks. Hoppe correctly presents this argument, draws the parallel with Keynes’s argument and critically comments on it. It is not my intention here to argue the merits of the free banking position or of Hoppe’s critique of it.
If White’s comment is uncharacteristically unperceptive and uncharitable, Steve Horwitz’s blog on The Austrian Economists on Hoppe’s article is risible and positively venomous. One cannot suppress an audible groan, as Horwitz, after quoting at length from White’s comment, wags his finger at Hoppe as a school boy would in malicious mimicry of a teacher who has just chastised one of his classmates. Horwitz sputters,
I will only add to Larry’s point that it is really interesting to see that Hoppe does not understand a concept that is central to monetary theory and even more central to the debate between free bankers and 100 percent gold advocates. The entire monetary equilibrium framework depends on the idea of an excess demand for money meaning that people’s actual money balances are less than they desire, which is, of course, merely an extension of the more general concept of an excess demand for anything.
Horwitz closes with a typically vicious and gratuitous swipe at those who take Murray Rothbard’s and Ludwig von Mises’s work on monetary theory seriously:
My questions now are: do the other Rothbardian critics of free banking really understand the concept? And why should anyone now take seriously any criticisms Hoppe makes of free banking?
Steve, my answers are: 1.The Rothbardian critics you address went to real graduate schools like Columbia, Rutgers, VPI, Berkeley, etc, and do not need a Heyne-level lecture from you on the meaning of excess demand for money or for anything else. 2. Ludwig von Mises made an elementary error in arguing that a competitive price can be distinguished from a monopoly price on the free market, therefore we should not take seriously anything else Mises ever wrote about monopoly. Is this proposition true or false? (I will give you extra credit if you can identify the logical error entailed in the proposition.)
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Joe: “Rewriting this as a conditional syllogism, we see that De Soto is clearly making a perfectly valid argument by affirming the antecedent .
If FRB is not warehousing or fixed term lending, then it is not legitimate.
FRB is neither warehousing nor fixed term lending.
Therefore it is ot legitimate.”
Surely, Joe, you mean only to conclude that the conclusion follows from the premises, not that the argument is “valid” in the sense of being correct. For the first premise is clearly false: there is such a thing as a call loan–that is, a loan with no definite time commitment. So De Soto’s argument relies on a false dichotomy.
George,
Of course the argument is valid. There is a difference between logical validity and substantive truth. That was the point of my criticism of Larry. Regarding De Soto’s argument, whether you agree with it or not, he claims that call loans are illegitimate not that they do not exist. So there is no false dichotomy.
Joe
To George Selgin.
Here is another source for the definition of a bank deposit to add to your previous ones.
Source: http://legal-dictionary.thefreedictionary.com/Deposit
ha. i’d like to see banks promote “improper deposit accounts”. that’d really be something.
Or to promote “this bank is not a warehouse”, or “a checking account is not a bailment”, or “a depositor is a creditor”, or “we loan the money you deposit”, or others things like that.
in a pure specie monetary order cantillon effects will still observed in the event of a massive and unexpected gold discovery. early spenders of the new gold will enjoy higher purchasing power than later spenders. but importantly, other non-monetary users of gold will benefit by the increased availability of gold.
now take the same situation with free-banking. assuming that bank notes are money and readily accepted, a monetary expansion will see both banks and their customers benefit. the former through the interest on the loans, the latter from being the early recipients of the money. but unlike the gold example, there is no other beneficiary to this expansion.
to justify free-banking, one would have to be able to show why the frb banker and his client’s relationship is worth more than the foregone non-monetary benefits to society of a more plentiful supply of gold, assuming the same degree of expansion takes place in both cases.
Newson – I’ve agreed with a lot that you’ve said, but I don’t really agree with this.
It is in the nature of markets that they are unfair. Effects quite like the Cantillon effect operate for other goods.
For example, the work I do is used in wireless devices. The advancement in making chips for those devices has benefited me enormously. Other companies have beavered away making better chips and making them cheaper. I do other sorts of electronics for wireless. I have benefited greatly from the demand those chip folks have created for my skills.
You see it works in the same way for goods as for money. As certain types of chip get cheaper the first buyers of those chips benefit. Then the buyers of those devices.
The effect is of course much smaller than the Cantillon effect for money.
Joe Salerno asks what “advantage” I thought I could gain by my “tactic” of restating De Soto’s argument as an (invalid) syllogism. I was simply trying to encapsulate the argument as I understood it.
I accept Salerno’s demonstration that I need not have summarized De Soto’s argument as an invalid deduction from true premises. As Salerno shows, the argument can alternatively be summarized as a logically valid deduction from a false (or at best question-begging) premise. As Salerno puts it, that premise is: “Warehousing and fixed-term lending are the ONLY legitimate forms of banking contracts.” Or in conditional form: “If FRB is not warehousing or fixed term lending, then it is not legitimate.” Instead of invalidly denying the antecedent, in this version De Soto is merely beginning from a falsehood or begging the question.
De Soto does indeed, as Salerno points out, assert that “a fixed term is an essential element in the loan or mutuum contract,†i.e. a loan contract by its very nature must have a fixed term. But De Soto doesn’t explain WHY a fixed term is essential. De Soto writes: “Without the explicit or implicit establishment of a fixed term, the mutuum contract or loan cannot exist.” But why cannot it exist? Why is a loan contract without a fixed term, e.g. a callable or prepayable loan contract, a non-starter? We do see such contracts, as George Selgin noted. They are, to all appearances, mutually beneficial for the contracting borrowers and creditors. So why are they illegitimate? De Soto never explains.
Here again is De Soto’s full sentence: “In addition, a fixed term is an essential element in the loan or mutuum contract, since it establishes the time period during which the availability and ownership of the good corresponds to the borrower, as well as the moment at which he is obliged to return the tatundem [i.e. to repay the amount owed].†The “since” here is a non sequitur. Okay, a fixed term does establish a term and set a date for repayment. But it does not follow that a fixed term is “essential,†i.e. a mandatory requirement for the contract’s legitimacy. Why can’t the contract legitimately allow callability or prepayment? Why can’t the parties agree to leave the lender or borrower with the option of deciding at a later date when the amount owed is to be repaid?
The only “explanation” I can find in De Soto’s work for why a loan must have an invariably fixed term is the claim that a non-fixed-term loan isn’t legitimate. The invalid syllogism was my best stab at understanding how De Soto had reached the view that something that isn’t a fixed-term loan (or a warehousing contract) isn’t legitimate. But maybe he never reached that view. Maybe, as Salerno’s syllogisms suggest, he simply started with it.
I think it would be possible to a FRB to transform the demand deposit contract in a contract of credit “overnight” and automatically renewable by the “depositor” and assume a mismatch between the overnight funding and the assets (credit to clients).
But this will not settle the issue of expanding “demand deposits” by credit expansion.
As i said before, the moment we accept a mismatch with “demand deposits” (in theory without expanding money supply by pure creation of demand deposits), the bank is able to also create demand deposits.
So … the solution is… to require demand deposit to be a warehouse contract and… FRB to sort of stamp clearly “promises of payment” to its notes and “demand deposits” (maybe “current account of promises of payment issued”).
And then we could check if it would be exchanged at par value, or in what conditions it would cease to be exchanged and cleared at par value.
how can intemporal misallocation not occur if there is no certain term for a loan, unless borrowers’ time-frames magically match lenders’?
to current:
what i’m driving at is the free-bankers wish to put their system on the same moral level as a pure specie money. as specie money is increased, early receivers of the gold do better in purchasing power than late receivers but non-monetary uses increase as well. here’s why the fairness test is passed: the late receiver of the gold after a massive bullion discovery finds he’s not getting as much for his gold in a monetary sense, but he’s going to get a much cheaper gold cap for his tooth, and his fiance’s ring is going to cost less, and maybe his electronic gadgets are going to use more gold.
now with frb money, only the earlier receivers of the money benefit; inked paper confers no extra advantages on the broader community. so one expansion offers ancillary benefits, the other does not.
now in order to maintain that the two systems are equally beneficial, one must argue that somehow the relationship between frb borrower and frb lender is as great, or greater than the “extra” added by the boost to non-monetary use of gold.
how could such a interpersonal utility judgement be made, whilst still adhering to austrian fundamentals?
My point Newson is that the Free-bankers are taking the normal attitude of classical liberals.
It is not necessary or possible to measure the overall benefit or cost of some innovation. That innovation will certainly redistribute wealth. Money is, in this situation, not an particularly special case.
On a lighter note. There is a Q&A section in a UK newspaper about homeopathy. In it someone asked the following question:
“I’ve been soaking a £20 note in a bathfull of water for the last few days, is it ok to pay for an order using my new homeopathic money? I now seem to have rather a lot of it.”
(I’m not meaning to say this is similar to fractional reserve money.)
Joe: If De Soto’s position is in fact that callable loans are ipso-facto illegitimate, then that position is even less tenable than I once supposed. For now it isn’t just a question of wishing to suppress fractionally-backed bank deposits, but of wishing to suppress all call loans, starting with brokers loans (which have long played a very important role in financing securities trades) but also including callable bonds and many other non-bank intermediated securities.
With respect to these call loans, there is no question of the ambiguous or deceitful use of the term “deposits.” What’s more, the agents who deal with them include many of the most sophisticated players on the financial scene. Finally, it is well understood that while the “callability” of the loans in question exposes borrowers to an additional risk, the extra risk in question is compensated by lower interest terms than would accompany corresponding time loans. In other words, the call feature is part of a mutually advantageous exchange. (As it is, in my opinion, in the case of fractionally-backed demand deposits.)
Yet De Soto, if he’s to rely on his syllogism as a basis for suppressing fractionally-reserved deposits, must call for the prohibition of all callable loans–and yet do so in the name of achieving a truly free market! However “valid” his argument may be in the very strict, logician’s sense of the term (and I specifically allowed for this possible meaning in my last post), I don’t see that it has any _other_ merit!
Still, the clarification of de Soto’s position, if indeed it is accurate, is most helpful. For now the free bankers are able to insist that anyone who subscribes to “De Soto’s” view (I use quotes to make clear that I refer to Joe’s understanding of that view) be consistent, by declaring that they regard as illegal (“illegitimate”) not only fractionally-backed demand deposits but every sort of callable loan that plays or has every played a part in financial market exchange. How many will be willing to do this, while still daring to say that they favor free financial markets?
George:
De Soto’s view would indeed outlaw every sort of callable loan, AND every sort of pre-payable loan, regardless of their mutual benefit to lender and borrower.
Who would go so far “while still daring to say that they favor free financial markets?” That manner of speech goes back to Rothbard, who wrote (RAE 1992) that he supported “free banking within a firm matrix of demand liabilities (notes or deposit) grounded in 100 percent reserves”.
Walter Block and William Barnett II seem to go even farther than de Soto: even financial intermediation limited to fixed-maturity contracts is to be outlawed if it involves any maturity mismatch between the borrowing and lending sides. Here’s the abstract of their article “Time Deposits, Dimensions, and Fraud” in the J. Bus. Ethics:
“We stipulate, arguendo, that fractional-reserve-demand deposit banking is per se fraudulent. We ask whether or not time deposit banking can also be illicit, and answer in the positive, if there is a mismatch between the time dimensions of deposits and loans. To wit, if an intermediary borrows short and lends long.”
Indeed, I heard Block and Barnett’s presentation at the Mises Scholar’s conference. My thought at the time was that, if they kept this up, they’d soon be outlawing any and all intermediation.
It seems to me that some people are inclined to confuse a free society, or at least a free society committed to a gold standard, with a society that suppresses all kinds of close substitutes for monetary gold, thereby keeping oodles of gold coin in circulation. If I didn’t know better, I’d say they were all part of a great gold-mining industry conspiracy!
George, Larry
Fellas, let’s not get carried away!
Larry writes: “De Soto’s view would indeed outlaw every sort of callable loan, AND every sort of pre-payable loan, regardless of their mutual benefit to
lender and borrower.”
My previous response to Larry was not aimed at explicating, let alone defending, de Soto’s position in toto. I was merely pointing out that it was not appropriately summarized in Larry’s syllogism. Certainly I would not dispute Larry’s follow up response to me that de Soto’s position on call loans is ambiguous at best. But then again, de Soto was not the one who originally claimed that FRB notes and deposits were akin to highly specialized financial instruments such as broker call loans. In the case of the latter, the borrower-stock investor cedes to the broker-lender specific securities as collateral for the loan which can be “called” at any time by the broker. If the borrower cannot (or does not) meet the “call” then he forfeits to the lender title to the pledged securities–which are usually in possession of the lender.
Are term and conditions of such contracts really no different from the “contract” written on FRB notes: “Bank X will pay to bearer etc.”? I doubt it.
Interestingly on pp. 158-59 de Soto discusses a variant of this in the form of callable time deposits issued by Spanish banks and specifically collateralized by national bond certificates. De Soto characterizes this operation, correctly in my view, as a loan backed by securities combined with a put option up to the specified maturity date of the time deposit. The client will only exercise the option (to prematurely sell back the “collateral” at a fixed price equal to his deposited funds plus accrued interest) if interest rates on newly issued time deposits maturing at the same date exceed the rate on his current time deposit, i.e., if the value of the collateral declines. Some banks even offer these contracts bundled with checking accounts and bill payment by direct debiting. De Soto is apparently “suspicious” of these “simulated deposit” contracts when they are issued by banks but he does not dismiss them as fraudulent out of hand. My surmise is that he would have no problem with straight-up broker call loans at all because they do not simulate “deposit” contracts. Furthermore, callable bonds and loans with prepayment options are completely irrelevant to de Soto’s position because they endow the borrower, not the lender, with the option of terminating the loan early and can never be confused with a deposit contract.
A fuller and more circumspect view of de Soto’s position reveals that what he is most concerned about is the deliberate camouflaging of loan contracts as bailment contracts. He does not appear to be opposed to any type of loan contract, per se, including explicit call loans. So, I think Larry overreaches in his claim quoted at the ouset of this post. Larry’s interpretation, I believe, goes completely off the rails when he claims that the difference between de Soto’s position and that of Block and Barnet is a matter of degree only. Writes Larry:
“Walter Block and William Barnett II seem to go even farther than de Soto: even financial intermediation limited to fixed-maturity contracts is to be outlawed if it involves any maturity mismatch between the borrowing and lending sides.”
That there is a categorical difference between the two positions is argued by two of de Soto’s strudents, Dave Howden and Phillip Bagus. See The Journal of Business Ethics. http://www.springerlink.com/content/pn81764318674wv0/.
Joe
Joe Salerno writes:
“Certainly I would not dispute Larry’s follow up response to me that de Soto’s position on call loans is ambiguous at best. But then again, de Soto was not the one who originally claimed that FRB notes and deposits were akin to highly specialized financial instruments such as broker call loans.â€
Let us recall what De Soto wrote that Joe and I have both previously quoted:
“In addition, a fixed term is an essential element in the loan or mutuum contract, since it establishes the time period during which the availability and ownership of the good corresponds to the borrower, as well as the moment at which he is obliged to return the tatundem [i.e. to repay the amount owed]. Without the explicit or implicit establishment of a fixed term, the mutuum contract or loan cannot exist.”
I don’t think I’m getting carried away when I say that this statement implies the illegitimacy of every call loan and every loan with a pre-payment option. To have a legitimate loan contract, in this view, a fixed term is essential. A “loan†without a fixed term “cannot exist,†i.e. is per se illegitimate. De Soto here speaks of “the loan or mutuum contract†quite generally, and does not restrict himself to contracts with banks or other intermediaries.
We can all agree that a broker call loan carries terms and conditions different from those of the loans to a bank made by holding account balances or banknotes. But they are all loan contracts. I don’t see any escape hatch in de Soto’s view allowing collateralized loans from securities brokers an exception from the fixed-term requirement, as Joe suggests de Soto himself might allow. Maybe Joe can point to an explicit escape hatch in de Soto’s text?
Joe surmises that de Soto “would have no problem with straight-up broker call loans at all because they do not simulate ‘deposit’ contracts.†I don’t see de Soto anywhere limiting the fixed-term requirement to “deposit†contracts or simulated “deposit†contracts.
Salerno’s discussion of de Soto’s pp. 158-9 is interesting. I wonder why, given the above, de Soto himself does not dismiss collateralized callable time deposits out of hand as illegitimate.
Joe adds: “Furthermore, callable bonds and loans with prepayment options are completely irrelevant to de Soto’s position because they endow the borrower, not the lender, with the option of terminating the loan early and can never be confused with a deposit contract.â€
I don’t see how prepayment options can be irrelevant when a fixed term is considered essential. De Soto never to my knowledge specifies “can be confusion with a deposit contract†as a precondition for the fixed-term requirement.
Finally, I’m sorry if my reference to Block and Barnett’s position against maturity mismatching suggested that their argument is akin to de Soto’s. I have no view on that; it may indeed be categorically different. I only meant to note that whereas de Soto would outlaw some common loan contracts, Block and Barnett would outlaw a common intermediation practice that does not per se violate de Soto’s strictures.
to current:
i don’t think i’ve explained myself: my point was that even the counterfeiter produces cantillon effects, but it’s hard to argue that he’s contributing to social good.
selgin et al seem find that gold coins and electronic gold current accounts are either absurd, or motivated by some shadowy rothbardian presence, taking for granted the magnificence of bank notes, and the essential nature of same (if we didn’t have frb, we wouldn’t have them, but so what?). maybe there’s a black-ink and linen cabal, too.
Joe Salerno said:
“Furthermore, callable bonds and loans with prepayment options are completely irrelevant to de Soto’s position because they endow the borrower, not the lender, with the option of terminating the loan early and can never be confused with a deposit contract.”
That’s true. But don’t forget that the converse of a callable bond exists: a puttable or retractable bond. These instruments do indeed endow the lender – the bond holder – with the option to terminate the bond early and redeem it for cash.
I think if you substitute “puttable bond” in each occasion in Larry’s argument in which he says “callable bond”, his argument still stands.
Newson: “i don’t think i’ve explained myself: my point was that even the counterfeiter produces cantillon effects, but it’s hard to argue that he’s contributing to social good.”
I agree. But the counterfeiter’s crime is to produce an imitation title. His production of cantillon effects is secondary.
It is not normal for classical liberals to argue against cantillon effects that arise from legitimate transactions. So, if both sides know what a banknote is there is little we can complain about.
Newson: “selgin et al seem find that gold coins and electronic gold current accounts are either absurd, or motivated by some shadowy rothbardian presence, taking for granted the magnificence of bank notes, and the essential nature of same (if we didn’t have frb, we wouldn’t have them, but so what?). maybe there’s a black-ink and linen cabal, too.”
It seems that both sides are using a bit of the same argument here. Full reservists say that there must have been intervention to bring about fractional reserves. Fractional reservists say that full reserves aren’t practical and bring up the “shadowy Rothbardian presence” you mention.
Newson: “selgin et al seem find that gold coins and electronic gold current accounts are either absurd, or motivated by some shadowy rothbardian presence, taking for granted the magnificence of bank notes, and the essential nature of same (if we didn’t have frb, we wouldn’t have them, but so what?). maybe there’s a black-ink and linen cabal, too.”
Another bit of foolishness, Newson. The FRB side doesn’t go ’round calling gold coins “illegitimate” or immoral; nor have we ever suggested that the use of them should be legally restricted in any manner. So your comparison of our position with that of the 100-percent reserve proponents is itself absurd, or at least wrongheaded.
to professor selgin:
no, because you would have no grounds to criticize the legitimacy of specie, however quizzical you may find the possibility of carrying around “oodles” of gold coins(there’s no question of artifice, short of debasement).
the free-banking argument seems to work backwards from the position that banknotes are inherently good or necessary and therefore frb is ok because it’s the only practicable means of making them pay.
it’s pointless debating the morality about the actual use of fractional reserves (our views are irreconcilable). however, if it were the case that frb is an abuse of property rights, then i cannot see that commerce could not successfully accommodate a note-less payment system based on gold current accounts and metal coins. might be a small price to pay for no business cycle.
to current:
in this instance, where both frb client and banker are perfectly informed and comfortable about the nature of their contract, the fraud is against the third parties, (not frb clients), who suffer loss of purchasing power as a result of the fiduciary media being emitted.
Newson: “in this instance, where both frb client and banker are perfectly informed and comfortable about the nature of their contract, the fraud is against the third parties, (not frb clients), who suffer loss of purchasing power as a result of the fiduciary media being emitted.”
Haven’t we already discussed this point though?
Many contracts made by others denude the value of assets held elsewhere. But what is wrong with that?
We could make the interpersonal utility judgement that many practices of A & B should be banned for the benefit of C. It is obviously against the principles of Classical Liberalism and Austrian Economics to do so.
Having read back that post it sounds really rude. It wasn’t meant to be. I apologize for that.
current, no offense taken. and i’m probably belaboring the point. but the gold-miner, by virtue of being the first to use the new money enjoys the higher purchasing power; this is likely to entice more to become miners and all things being equal will result in more gold available for non-monetary uses (which benefits all society, even non-gold-users). the frb money creation process does nothing to reduce the price of any goods, because it produces nothing of non-monetary value. this i why i believe frb is a morally inferior system to specie money (and this excludes the collateral damage caused by the abc from free-banking, which mises acknowledged though believed would be minimized by competition).
And what about the gold converted to non-monetary uses? Frb reduces the demand for monetary gold, so more is available for other uses.
scineram says:
“And what about the gold converted to non-monetary uses? Frb reduces the demand for monetary gold, so more is available for other uses.”
history shows this not to be the case. an emission of frb notes might just as well cause a rise in the demand for monetary gold as its fall (think of the extra demand for gold during and after a bank run).
don’t forget that the frb promise, prior to gold’s demonetization in 1934, was to pay out the note-holder fully in gold. merely issuing frb paper doesn’t magically conjure gold from the ground!
even though frb and fiat money are totally institutionalized, central banks still haven’t divested their gold. why not sell fort knox’ gold hoard and make gold fillings more accessible to the average punter?
“where both frb client and banker are perfectly informed and comfortable about the nature of their contract, the fraud is against the third parties, (not frb clients), who suffer loss of purchasing power as a result of the fiduciary media being emitted.”
Unless, of course, the issue of checking account dollars by a private bank does not affect the value of the green paper dollars issued by the fed. A checking account dollar is a call option on a green paper dollar. The issue of calls does not reduce the value of the base security, for the simple reason that the issue of calls does not affect the assets or liabilities of the issuer of the base security. Fractional reserve banking does not cause price inflation.
to mike sproul:
first, an frb note is not an option. a call option must have a definite life, otherwise it’s not able to be valued. a company cannot have more call options granted than exist underlying shares, otherwise there is no guarantee that exercise can be honored.
finally, i’m suggesting that the frb system can “defraud” the non-using third party only until the bank run, after which the mispricing is corrected. the erosion of purchasing power in the inflation phase is reversed in the deflation one. (the lag can be substantial, look how long enron was able to cook its books before the share price tanked.)
A checking account dollar is a call option on a green paper dollar, but with an exercise price of zero and an indefinite expiration date. A checking account dollar is normally valued at one paper dollar. There is no problem of valuation. Whether or not there is a guarantee, people value those checking account dollars, and the value depends on their evaluation of the bank’s total assets, including both paper dollar reserves, and other things of value that the bank owns.
Since the issue of those checking account dollars does not affect the value of the paper dollars, there is no mis-pricing to correct. And even if a bank run occurs, a bank that has issued dollars in exchange for equal-valued assets will have sufficient assets to buy back all the dollars it has issued at par.
mike sproul says:
“A checking account dollar is a call option on a green paper dollar, but with an exercise price of zero and an indefinite expiration date.”
such an option would be impossible to price by the grantor, therefore could not exist in a commercial sense.
So a checking account dollar, which promises to deliver a paper dollar to its owner at some indefinite date, cannot be priced? They are priced all the time, and their price is $1.
In any case, the main point was that the issue of checking account dollars by a private bank does not affect the assets or liabilities of the central bank, and therefore does not affect the value of the central bank’s money. The simplest example would be a central bank that issues 100 paper dollars backed by 100 oz. of silver, and convertible into silver during specified times. If some private bank issued checking account dollars, convertible into those paper dollars, then the central bank still has exactly 100 oz., and there are still exactly 100 paper dollars in existence. Each of those paper dollars is worth 1 oz., no matter how many checking account dollars are issued by private banks.
to mike sproul:
yeah, i know what you’re trying to say, but comparing it to option is unhelpful as there is no option pricing mechanism that can help you if time isn’t a known constant (“volatility” being a guesstimate).
“Demand deposits” could be contractually designed as overnight loans to banks.
So we could have in the market
* demand deposits with 100% reserves
* overnight loans to banks (it would replicate the actual current demand deposits)
* and other time deposits (>1 day)
But the question remains – demand deposits should be 100% reserve…if not… they should be named something like “promisses of payment of gold/etc at demand current account”
newson: “but the gold-miner, by virtue of being the first to use the new money enjoys the higher purchasing power; this is likely to entice more to become miners and all things being equal will result in more gold available for non-monetary uses (which benefits all society, even non-gold-users). the frb money creation process does nothing to reduce the price of any goods, because it produces nothing of non-monetary value. this i why i believe frb is a morally inferior system to specie money”
I see your point now.
What you are saying though is that producing something that has monetary value is not useful. I don’t really agree with that. I think that is one of the things that economics has to show one way or the other.
As well as acting as a money substitute a fractional reserve banknote is a debt. Your complaint doesn’t really apply to the debt aspect of the note. Each note is a loan to a bank.
Notice that loans never directly reduce the prices of other goods.
I suppose my biggest issue here is on the need to basically balance the supply of money relative to its demand.
Understanding the nature of prices for goods, it seems that, though money is non-neutral, it should be the policy of a macroeconomy to get as close to neutral money as possible. Whether this is possible or not, I do not know, I am not a banker.
To balance the supply of money, it would seem an impossibility to do it any other way than through fractional reserve banks. For though inflation of prices is a great specter that haunts the economy from the west, deflation is just as bad in the east.
Free bankers behaving badly:
George Selgin writes:
“”There is no market for money, because money is not commodity that is freely traded and valued against other goods.”
Honestly I couldn’t decide which of Nikolaj’s many wrongheaded assertions to choose to indicate his week grasp of monetary economics. But this seems like as good an example as any.”
at http://austrianeconomists.typepad.com/weblog/2009/06/what-monetary-policy-cannot-do/comments/page/2/#comments
Now note Gene Callahan’s observation:
“This seems trivial, until we realize that the means by which most markets move toward equilibrium, a change of price for the single good in question, cannot work for money—as Leland Yeager points out, money has no market, and no price, of its own. After a disturbance in the supply of or demand for money, all prices in the economy must adjust.”
at http://www.thefreemanonline.org/departments/book-review-microfoundations-and-macroeconomics-an-austrian-perspective-by-steven-horwitz/
Can the monetary equilibrium theorists even answer the simple question: what is the price of money?
…and this, from mario rizzo:
“The problem is the alternative. Uncontrolled deflation would be bad. Eventually, I am sure that the Pigou (real balance effect) would move things out but in the meanwhile things could get pretty rough. However, it is important point out that we might not want to do anything if average prices — as measured in some suitable way — began to decline just a little.”
shocking stuff. where is some proof of the “badness” of inflation? deflation is virtually always uncontrolled (working as it does against debtors, and the inflation-parasites, as well as a progressive tax system that just loves inflationary bracket-creep). this deflationphobia is just madness. but i guess if you’re wed to frb, then deflation will always be the wet-blanket that spoils your party.
read “badness of deflation”.
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