I don’t believe that there is absolute transparency. I don’t believe that Depositor A has been loaned to Investor B. Depositor A is under the belief that the money in his checking account is warehoused so that he can withdraw that money on demand. I assume the existence of fraud, although I don’t think that concern is relevant to the point I’m trying to make. I am only looking at it from the perspective of the fact that if the bank loans out $_arbitrary_dollar_amount (let’s call it C) to Investor B, and then Depositor A withdraws a dollar amount (DA) greater than C (or C+DA) the bank no longer has available the money it loaned to Investor B.
So what happens?
The bank adds a new account entry, taking into consideration the credit that has been loaned. Investor B trusts the bank and trusts the existence of said credit. The bank has effectively increased the supply of money/credit.
I think I am going off on a tangent which is not directly relevant to your post. I am trying to outline the differences in nature between a checking account and a time deposit. The argument was made that in a world without fractional reserves, time deposit certificates would be used as money. I agree that they might, but I do not agree that this would lead to an increase in the supply of money because ownership of the money would still belong to the bank until the end of the contract (no matter who the new owner of the certificate was). The same does not hold true in the case of a checking account, where the ownership of the money still belongs to the depositor and can be withdrawn presently from the bank’s vaults.
I agree, although my argument is not about fraud, nor avoiding fraud. I am not trying to justify outlawing fractional reserve banking based on the idea that it’s fraud. Ultimately, I am trying to make an economic case against FRB. I am denying that time deposits cause expansion of the money supply.
I don’t think this is accurate. If you look at your reply above, your argument hinges on the lack of transparency and the idea that some parties to the transaction(s) are doing things other than what another party believes they are doing.
You presuppose lack of transparency and assume the existence of fraud. You refer to depositor A as under the belief…etc.., clearly implying that his belief is being betrayed. You refer to investor B as trusting the bank and the credit, implying that his trust is possibly being betrayed.
So your argument is presupposing and positing behavior that an honest person would consider unethical. And from there you go on to make your argument.
I’m not claiming that you are the only one doing this. I believe that the pro FRB argument hinges on some degree of lack of transparency also.
The point I’ve tried to advance is that if we assume ethical dealings from the outset, it might be possible to get a more clear understanding of what is going on in these hypothetical or actual transactions. But each party to the debate resists making the assumption of ethical dealings, in my opinion, because this damages their argument to some degree.
If we assume unethical or non-transparent transactions from the outset, then this already includes fraud, as seen by Anti-FRB, and this already includes a non-transparent dilution of the value of money by issuing new notes as seen by the Pro-FRB side. Anti-FRB wants to prove fraudulent dealings, and Pro-FRB wants non-transparent dilution of the value of notes, and so both must presuppose non-transparency and fraud in the initial assumptions.
Both sides get what they want, but the analysis suffers…
I don’t know what you don’t understand about the argument to be honest. The certificate given to the depositor from the bank can be split up as if the depositor had purchased many small CDs. These can then be used as banknotes. I don’t know where you made the argument about the market for liquidity but the market would have nothing to do with banks.
I don’t know what you are referring to.
The misallocation argument is that depositors wish to use all of the money in the account for current consumption so that any loan made by the bank is a misallocation. The argument does not make sense because people would not even need banks if they were going to use literally all of their money on current consumption. There is always a delay to the use of the money and any loans a bank makes of a duration equivalent to that delay will be economically sound. The argument has everything to do with calculation.
You argued that certain aspects of the use of CDs as money would be cumbersome. While I think that these problems could be circumvented, as I argue above, FRB would accomomplish the task much more easily.
What is this “free up resources” bit? Do you mean besides (commodity) money? That lending out the money on deposit increases the natural resources, consumer goods, land, or labor available?
If so, how does it do this?
It seems instead that the extra money would be chasing the same amounts of resources, goods, land, and labor and driving up the price of all four. Not creating them out of thin air.
In my understanding, the essential claim of the 100% reserve position is not that the FR bank grants loans that are not matched by savings in general (in the economy in general), but that the FR bank creates additional claims to the fixed supply of specie held by the bank.
Related to this, the important focus is not on the possibility of entrepreneurial loss due to the bank’s miscalculation in granting too many loans, but on the question of the necessary or non-necessary effects resulting from the creation of additional claims to the same amount of specie.
Where you write “savings” above, isn’t that more accurately considered specie held by the bank in question? Can we substitute as I’ve suggested above, or not?
And would you grant that the additional claims created by the bank (in the form of loans to debtors) are not a miscalculation in this respect? Meaning, the bank knows the amount of specie and the amount of claims to that specie. The bank knows the relationship between it’s outstanding claims to the specie and the specie. When it creates an additional claim to the specie, this fact in and of itself is not a miscalculation, but something like an expansion of the note supply or expansion of the “claim to specie” supply in relation to the specie?
Well, I am considering the nature of time deposits and checking deposits. Regardless of whether or not there is transparency, the depositor of a checking deposit is under the understanding that his money is available to him on demand. If the bank loans it out then it is betraying the contract, because technically that money is no longer available. If the depositor knows about the bank’s actions or not, the monetary consequence is the same.
I am not focusing so much on the fraud, but on the fact that the money supply is inflated. Fraud may be an implicit reason this happens, but it is also stipulated by the contract.
No, I am talking about the liquidity of those certificates. I understand the argument perfectly, I just disagree with you. My own argument is clear—time deposit certificates cannot be used to make small transactions. If the certificate is sold to somebody for money, the new owner still does not have present claim on that money for his use. The money is still in the bank’s vault until the end of the contract.
Historic bank failures due to credit expansion of single banks.
The depositor does not need to use 100% of his money on present consumption for this argument to make sense. The misallocation occurs when money meant for present consumption is used to invest into production for future-consumption. It could be any amount of money for an individual depositor, and it can be a large number on aggregate.
But, CDs would not be the only form of money. There are two reasons:
A person would not use his entire paycheck as savings. There will always be some type of present-consumption.
The nature of CDs makes it difficult to use them to make small transactions. Also, the contract states that no matter who owns the certificate, the money cannot be withdrawn.
If you look at your #1, you can see what you are assuming in your example: You explicitly mention that A believes, or is under the understanding, that his money is available to him on demand (demand deposit?). You not only explicitly refer to A’s belief, but you refer to him as a “depositor,” which means that not only does A believe he is making a demand deposit, but in your example, you also are conceiving him as making a demand deposit.
When you refer to B loaning out the money, you do not explicitly mention what the money is from B’s point of view (the money that A transfers to B). This is unclear in your example; only A’s beliefs (that he is making a demand deposit), and your referring explicitly to him as a depositor, is clear.
Next, you say that B betrays the contract. But you haven’t explicitly specified a contract in your example. What you have done is to imply that there is a contract of a demand deposit, because in your example, you make explicit reference to A’s belief, and you refer to A as a depositor, while you withhold making an explicit reference to B’s belief, and withhold referring to B as a warehouser, debtor, creditor, etc.. You explicitly refer to A’s belief, and you refer to him as a depositor, and imply that this constitutes the contract between A and B.
If you were to explicitly fix in your example how B considers the money he receives from A, and the explicit terms of the contract, then we could take the analysis from there. You have arbitrarily assigned “contract status” to A’s beliefs (by explicitly mentioning them, and by referring to A as a “depositor”). And you have arbitrarily omitted B’s beliefs as to the status of the money he receives from A, and arbitrarily omitted the explicit terms of the contract from your example.
When B loans the money, by the very terms of your example, he commits fraud, because your definition of the contract is simply the beliefs of A. In your example, the contract is A’s belief.
If that is not the case, or not your intention, then in your example why can’t we make the contract between A and B an explicit contract, not just assume the contract is identical to A’s belief? In your example, what is the explicit contract entailing B’s agreement to it?
And how does B consider the money he receives from A?
This is not a monetary issue but a methodological issue. In your example, the supposition of what the transaction “is” is being implicitly located with only one of the participants in the transaction, in your case actor A. And what the transaction is to actor B is being overlooked. This is an arbitrary methodological assumption, but it has an important impact on the results of the analysis.
In an impartial analysis, we should be able to explicitly state B’s point of view, and also explicitly state the terms of the contract. This is not a monetary issue. It is an issue of the methodological approach to the example.
If you use a biased methodological approach in setting up your original transaction between A and B, then most likely this same methodological approach will flow through to your analysis of #2, the expansion of the money supply via creating of additional claims to a fixed amount of money.
If you make your entire example impartial, by explicitly stating what B’s beliefs are, and by explicitly stating the terms of the contract, I believe this will have a significant impact on your entire analysis.
B’s beliefs have already been stated in this thread, IIRC (perhaps it was another thread on the same topic). It’s clear that fractional reserve banking operates under the assumption that people will not demand all their money at once, so it’s safe for banks to loan out a fraction of a checking account deposit for a limited amount of time. As far as I know, the bank clearly understands that the deposit is available to the depositor on demand. The assumption is that the depositor will not demand a quantity greater than what is left after some of the money has been loaned out by the bank. I do not believe that banks operate under the understanding that the contract allowed them to loan out that money. They assume that the depositor won’t know the difference, because if the demand for the depositor’s money is what the bank assumes it will be, the money loaned will be returned to the deposit before the depositor wants it back.
In any case, as I have already mentioned, I am not analysing the fauls of FRB from a legal standpoint. I am only using it as a jumping point for arguing why FRB leads to a business cycle. My interest for this thead is not fraud. Only that the depositor acts under the assumption that he can demand his money at whatever time, and that the bank allows this. Even if the contract stipulates differently, this is what is understood, so as far as my analysis this fact is the only thing that is important. You are putting too much emphasis on the fraud aspect. I think it was agreed upon in the opening post to not discuss the topic of fraud.
Supposing a depositor knows that his bank operates with a fraction of its reserves, he will act under the assumption that he can demand his money at almost any time. The “almost” is very important, because without it our depositor would perceive no incentive, under any circumstances, to join a run on his bank. In consequence, he will not treat a $100 deposit like $100 in his pocket , but as a $100 with risks attached; namely, a possible bank run or option clause constraint.
However, the risk that our depositor will not be able to withdraw his entire account on demand is very small, even though (assuming a 10% reserve ratio) he is enjoying interest gains on 90% of his deposit. Now consider a 100% reserve bank (and financial intermediary). If our depositor wants to enjoy interest gains on 90% on his deposit, his account will be divided into two parts: 10% demand deposit, and 90% time deposits. What is the risk that our depositor will not be able to withdraw his entire account on demand? It’s one.
In other words, supposing our depositor wants to enjoy equivalent interest gains on his account, with an FR bank there is a small risk he will not be able to withdraw all his account on demand, but with a 100% bank there is no chance at all. The trade off is that while a 100% bank guaruntees access to whatever fraction of his account is held as a demand deposit, an FR bank does not (though its option clause my permit limited withdrawals).
By the way, if depositors in FR banks have all been duped into believing banks operate as 100% reserve banks (thus the charge of fraud), then why do people run on banks? There would be no incentive to run on a 100% reserve bank, because a depositor runs no risk of his money not being there upon demand. It doesn’t matter if the bank is actually – and fraudulantly – an FR bank, because depositors will act as though it is 100% bank and not run.
This does a good job of illustrating the differences between the two institutions. You see, you’re operating under the assumption that the bank with fractional reserves will be able to expand credit to quite an extent. However, that’s possible only if people have high, and long term, demand for cash. However, if this is the case there is no reason to suppose that people won’t accept CDs. If people have a very low demand for cash, since they hold none of their savings in that form that CDs won’t circulate, but absent this assumption there’s no reason to suppose that with fractional reserves banned CDs won’t make up at least some part of most people’s portfolio.
In fact, I think one could even go further. Absent fractional reserves there is very little scope for supply of CDs to rise as a result of increased demand. But as people tried to maximise profits by increasing the number of interest bearing assets in their portfolio, the price would be pushed up and the interest rate subsequently pushed downwards.
In light of the above, I think there’s very little grounds for supposing that the interest rate under FR will be lower than it would under 100%.
I can’t follow the whole discussion. In my opinion FRB has nothing to do with CD’s or saving accounts, it has also not much to do with a contract between the bank and the depositor it has to do with the issuing of bank notes by a fractional reserve bank.
If I open an account with a contract that says I, worst case, might only redeem 10% of my deposits, I can accept such a contract or I don’t. The real issue is that the bank will issue banknotes to me instead of specie payments when I withdraw some of my money. As long as I keep those beanknotes under my bed nothing is wrong or fraudulent. The moment I start trying to buy goods from a third party the problems begin. There are 3 scenarios i can imagine:
1.) I tell the seller that the banknote I offer might not reedem in specie the full face value, in which case I do not act fraudulent.
2.) I do not tell the potential buyer that the banknote is not covered 100%, in which case I act fraudulent.
3.) The banknote itselfs states that it only guarantees to cover 10% of the face value, in which case I don’t have to tell the seller anything.
In every case except case (2) where I commit fraud by offering to pay with a banknote not fully covered, the seller may now decide if he is willing to take the risk or under what circumstances he is willing to accept the note. Usually this will mean the note will be discounted to an amount the seller and buyer agree on. This is what actually happened in New England and what the Suffolk bank tried to eliminate by acting as a clearing house trying to force the country banks to stop or at least tighten their inflationary policies. Merchants where well aware of the fact that banknotes issued by these FRB’s where not worth its face value and therefor discounted them as they saw fit and in line with their personal risk assessment.
FRB as it is working today, where the government, through legal tender laws, forces all citizens to accept money at its face value even if they know that the money supply is ever increasing through fractional banking, would never work on a free market without dicounting the notes in transactions.
Adam, I think the relevant point is that their is a finite demand for the notes of any one bank. Assuming rising marginal costs of intermediation I think it’s reasonable to assume that as the bank expanded credit it would have to lower interest rates. Now, the point is that given the finite, specific demand for the notes of any one bank if it produces more than is desired it makes suffers in the form of greater exposure to risk and if it produces less than desired it suffers losses in the form of opportunity cost.
Now, for the economy as a whole the same applies. As too much credit is created the public will react by redeeming, or spending the notes and the banks will be left with reserves dwindling, which banks this applies to depends on the preferences of the public concerning the relative attractiveness of the notes and the extent to which each bank expanded.
I am not against all FRB, Rothbard was not against all FRB either. It is fine to fraction bonds, CD or any other deposit that is not demand. With demand deposits there is a huge issue: That is the money has multiple owners the borrower and the depositor at the same time. Because of this issue, ANY BANK that fractions demand deposits and current non-demand deposits is financially insolvent and is just gambling that depositors will not claim more of their deposits than in storage. I understand that if banks did not fraction some deposits then they would not be able pay interest to their depositors.
The worst part of the issue comes with a central bank regulating these banks. The central bank fixes the reserve ratio. So even if banks see bonds and CDs coming due, they can not adjust their behavior without permission of the regulator. Then WHEN a bank fails as they will do, it is up to everyone else except depositors to cover.