“This topic is about fractional reserve banking, and not about our defunct system.”
is our defunct system a factional reserve system?
“So the banks have NO INCENTIVE to do it right. And guess what? they don’t get it right, do they? They have been going bankrupt like lemmings off a cliff.”
the banks that you say are going bankrupt…is that due to fractional reserve systems of incometent loan managers??
In order to maximize profits a pickpocket must calculate the probability of people catching him, and weigh the benefit of the extra revenue from pickpocketing against the loss associated with having to compensate those who catch him.
A butcher consistently sells 0.95lb of beef as 1lb. In order to maximize profits he must calculate the probability of someone finding out, and weigh the benefit of the extra revenue per lb of beef against the loss associated with having to compensate those who discover his trick.
In order to maximize profits, Bernie Madoff (and Ponzi) had to calculate the probability of redemption requests coming in faster than new money coming in, and weigh the benefit of extra revenue from his scam against the loss associated with having to compensate those who have been denied access to their funds.
An airline sells 1.05 seat for each 1.0 seat it has available. Hoping that the customers who are denied access would not take them to court for a breach of contract over a plane seat, and not to raise hell in public, they “settle” the complaint right then and there on the spot.
Small fraud/theft is fraud/theft nevertheless. The fact that SOME fraud/theft is not worth taking to court does not make it any less fraudulent/criminal. Try “compensating” those who have been “denied access” to their gold life savings.
Z.
OK, first let me say I misunderstood the original post of hayekxyz. As I understand it now, he is saying the following:
An airline can more or less guess what percent of the tickets they sell for a given flight will be cancelled. They do this based on past experience.
So too, a bank should be able, based on past experience, to guess what percent of the money deposited is going to be withdrawn on a given day.
It’s the same math problem, ultimately.
OK, guys. Is that the argument?
If so, it is ridiculous. And the reasons is very simple. There is no such thing as a run on airline tickets.
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Very little sudden bad news is likely to cause everyone who bought a ticket to redeem it. Sure, if a city is subject to invasion by locusts or something, people will rush to leave it. But such things don’t happen too often.
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Rumors that the plane is too dangerous to board are nonexistent.
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If someone knew 100% for sure that the rumor is false, he would get on the plane.
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The actual plane seats are almost always physically there. Rare is the occasion of a plane diappearing into the twilight zone.
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There is almost nothing the pilot can do to destroy his plane, even if he is not a very good pilot.
With banks it’s another kettle of fish. I know I’m writing to an iuntelligent crowd, who can see how all five points above have corresponding vulnerabilities with banks.Some hints and clues and outright giveaways are here: http://en.wikipedia.org/wiki/Bank_run
There have been bank runs all through history. These were not caused by the banks mistaking how many people will ask for their money ON A TYPICAL DAY, but by UNTYPICAL DAYS. Airlines don’t have untypical days. The economic world does, and it causes bank runs.
From Wikipedia:
“There have been many runs on individual banks throughout history;”
Wiki also has lists: http://en.wikipedia.org/wiki/List_of_banking_crises and http://en.wikipedia.org/wiki/List_of_bank_runs
Esuric added another point, that if all the laws and regulations now in effect were cancelled, and FRB was given it’s head, Rothbard would be proven wrong and the system would work just fine.
However Wikipedia begs to disagree. It claims that there would have been EVEN MORE bank runs if not for all kinds of laws and such.
Here’s the quote, from http://en.wikipedia.org/wiki/Bank_run
“institutions put into place after the Depression have prevented runs on U.S. commercial banks since the 1930s,[7] even under conditions such as the U.S. savings and loan crisis of the 1980s and 1990s.”
Seven typical days in 10 years? I’m sold.
No one wants the pre-1930 US banking system back.
Non sequitur. Saying that FRB=Fraud doesn’t make it true. Banks don’t explicitly assure 100% liquidity, which means that any particular bank will eventually fail, somewhere down the line, the same way that every firm will eventually fail (the inevitable result of radical uncertainty). It also means that your analogies are entirely meaningless. But nevertheless, is entrepreneurial error sufficient justification for complete government control? Toyota explicitly stated that their cars were 100% safe, and yet, some lost their lives due to faulty brakes (not their wealth, their lives). Do we now need complete regulation of the automotive industry? Does Toyota have to put a disclaimer reading “somewhere down the line the brakes, engine, and every other component of this car may breakdown, and you may lose your life because of it.”
The belief that people are too stupid to take care of themselves, and that we need some kind of regulator preventing entrepreneurial error (as opposed to letting the market mechanism and trial and error resolve such issues), is the kind of loose thinking which characterizes socialist thought. Never mind the fact that such a proposal (100% reserves) is impossible to successfully implement, and would cause all sorts of disorders in the money markets which would yield negative consequences (the inevitable result of interventionism). Also, who would implement this regulation in an anarchic world?
This is an important point, if the public really does demand full reserve banking, that is exactly what they’ll get. Clearly people aren’t so risk averse as to demand 100% liquidity from their banking institution.
Yes, this is my biggest problem with the Rothbardian position. If we’re really pro-market, then we should let markets (individuals) figure it out.
That would be so obviously untrue to nearly any buyer that it would have nearly no effect. However, they would still owe a refund to any buyer on request.
Says you.
It would yield adjustment consequences as has/will any repeal reform.
Assuming that a lottery ticket system would survive any length of time, which seems impossible, the company would be liquidated whenever they fail to redeem.
Here’s a question for you and all other supposedly free bankers now. Should anything be done by states to advantage FRB?
You are right, all fractional reserve businesses must eventually fail. Logically, there could never be a happy ending to any Ponzi scheme. That doesn’t mean that all businesses (banks) must fail.
Demand deposits are assurances of 100% liquidity. Loans and/or investments are not. If I leave my gold with someone who assures me that it will be there for me to pick up whenever I want, that’s an assurance of 100% liquidity, by definition. If I loan and/or invest my gold, that’s not 100% liquidity and in return for that restriction I expect to earn a profit.
When a FRB demand deposit bank fails, then it’s both the investors/creditors and the depositors (customers) that lose everything. When Walmart fails it’s only the investors/creditors that lose – the customers will simply go to another store unharmed.
I think you are smart, so I’m baffled by this post of yours. Do you honestly fail to see any difference between a (100% liquidity, 100% reserve) deposit and an investment/loan?
Non sequitur. Strawman. Red herring. Congrats on the hat-trick.
EDIT:
Care to show how they are meaningless? Read them again and (both you and hayekianxyz) tell me what a free market would think of them. No need to wave the ‘regulation’ flag.
Z.
Sure, we can play around with definitions and construct useless tautologies that somehow “prove” that FRB is fraud, the problem is that these tautologies bear no relation to the real world. Because nobody in the real world really believes that the bank has a pile of money sitting in the vault with their name on it, apparently 9 year olds can understand this, and a lot of other casual empiricism suggests that most adults understand that when they put their money in the bank, the bank then goes and lends it out. There are plenty of ways around this mind, for a small fee you can put your money in a safety deposit box or you can stuff it under your mattress, revealed preference suggests that most people really don’t mind receiving interest on their money.
As for those of you who think that it’s easy for airlines to estimate how many people are likely to turn up, you’re crazy. They have to have knowledge of a very large number of variables, which change yearly, monthly or even weekly. I so no reason why national and international banks should face a demand that is more volatile overall than the demand facing airlines, in fact, because of the local nature of flights I can see plenty of reasons why the opposite would be true. Yet, airlines manage to oversell tickets and rarely face problems. Even if the demand was more volatile for banks, they would simply raise their reserve rations to mitigate the risk, just as airlines could probably sell more tickets (in the past 2 years I’ve been on one flight that was completely full) but they don’t.
Yeah, but those people also assume that the FDIC and whatever exists. Do you think that, in a “free world”, whatever that means, 9 year olds would see the difference between deposit banking and loan banking?
It not always existed. And things were not much different.
Elaborate, please.
I’m talking about the eras before deposit insurance and central banks. And the financial sphere today that is not protected by them and where checking accounts still exist.
I knew what you were talking about. I wanted you to give me the details, a source, or whatever.
Relevant to the issue at hand, I find this exchange between Stephan Kinsella and Steven Horwitz interesting. Here is an excerpt from the exchange of Kinsella responding to Horwitz in the comments section at (http://austrianeconomists.typepad.com/weblog/2009/09/mises-and-his-call-for-100-reserves.html)
Horwitz: “Not sure I’d say “market failure” but I understand what you’re getting at”
Kinsella:
Right. I am critical of the freebankers’ very view that there is a problem that needs a solution; akin to the false problem of “market failure” that many statists point to. (On this see Salerno’s comments ( http://thinkmarkets.wordpress.com/2009/08/25/auction-markets-and-optimally-sticky-prices/
) about “sticky” prices, arguing that this notion is an illusion and can’t be invoked as an argument for adjusting the supply of money to variations in its demand.)
Horwitz: “As for the first part: a fractional reserve bank deposit is indeed a loan as well as a deposit.”
Kinsella:
? Do you mean the reserve part is a deposit? I suppose so but the problem is that in a straight deposit, the funds of depositors would be pooled as an “irregular deposit” (see Huerta de Soto on this, p. 4 http://mises.org/books/desoto.pdf ). But in this case the sum of things depositied is sufficient to cover the entire total of deposits, since it stays in the vault. So as a customer I am indifferent to having, say, ownership of 1 oz coil in a safety deposit box, or 1% ownership of a 100 oz. fungible sum–except that the cost of the former is higher.
But in your case if you say there is a 10% reserve ratio, then 10% of the money handed over is kept in an irregular deposit, but my 1% interst in it is not worth 1 oz. but only 1/10 oz. I mean I am not indifferent, as I would be in the case above. Unless you say the part that is a deposit is only for the 10% of my account value. But the problem with this is if I ask for all of my money you will use the gold to satisfy it. So it’s very confusing to regard it as part deposit. I think it is not part deposit. It’s misleading to say so.
Horwitz: “The contract one signs upon getting a checking account should say that (as I believe they generally do). I will note, though, that my own experience with students and friends is that almost everyone understands that not all of their money is literally “in” the bank and that it’s being lent out. Even so, the contract should make this clear.”
Kinsella:
Good. But I do not think most people understand exactly what is going on. They seem to want to have it both ways (no offense, freebankers :)–they want it to be “in” the bank and to get interest too.
Horwitz: “And yes, the contract should make no stronger claims about the bank’s obligation to redeem on demand being fulfilled than any other contract should about its terms being fulfilled. If you agree to hire me to perform a task, I can’t “guarantee” that I will perform it, I can only promise or agree to.”
Kinsella:
I agree with this, unless by your choice of words you mean to imply that even a depositary can’t “guarantee” it either. I mean I agree with you, so long as you recognize the categorical distinction between the ability of the depositary-custodian in the case of an irregular deposit, to repay, and the ability to guarantee it in the case of fractional reserves. They are similar only in that in both cases it’s possible for the bank to be unable to meet its promise–but in the case of the irregular deposit this can happen only if there is a violation of the depositary contract (embezzlement), or some kind of random accident
(fire) that could be insured against.
Horwitz: “I object to 100% reservers claiming “fraud” for what is really “breach of contract” given that checking account agreements do provide the requisite information.”
Kinsella:
Well in my view the 100% reservers have a point given their (in my view
justified) view that the origins of fractional reserve are mired in fraud and confusion (I think Huerta de Soto is good on this), and also, based on their economic view of the futility and indeed instability of freebanking, in their suspicion that it’s highly prone to fraud. But I do agree with you that so long as the nature of the arrangement is spelled out, there is no fraud. But I will say that I have sensed many times in the people on your side of this debate a reluctance to agree to the freebanks giving complete and clear disclosure, as if you guys are afraid that too much disclosure will make it impossible for the FRB to get off the ground. I coudl be wrong about this, but I have sensed it and think I could dig up quotes … but anyway, glad you don’t object to this and would be willing to put your system to the test of full disclosure.
Horwitz: “In short: the notion that fractional reserves are fraudulent has always been absurd to me.”
Kinsella:
It’s not so absurd if you understand the opponents view of the history of it, the state’s involvement with banking and the origins of frb plus its current involvement with centralized state-run frb; and with their view that freebanking is so inherently unstable and rickety that for it to ever exist there pretty much had to be fraud involved somewhere–I don’t agree with this compeltely, but their reasoning is sufficient to give cause for suspicion and hard scrutiny of the potentially fraudulent nature of this arrangement. But in the end, just as I do not think a ponzi scheme is fraudulent, I do not think FRB (inherently) is.
Further, on the face of it, there is a colorable charge of fraud: you are calling something a “deposit” that is NOT a deposit.
It is as though we had communal refrigerator. All the food in the refrigerator except that being used for immediate consumption is lent out.
However, the refrigerator owner promises to return any food a customer placed in the refrigerator on demand. Therefore, if all the customers come to the refrigerator wanting their food at the same time, then there will not be enough food to go around, since some has been lent out.
But since the lent out food is being replaced as borrowers return food, and all the food is not used for immediate consumption, the refrigerator owner can manage the flow of food in and out so that nobody is disappointed when they come to get some food.
One of the benefits of fractional reserve refrigerating services is that all food can be put to use right now, thus saving scarce time–saved food can be eaten by borrowers while they go about producing more food for the future.
That’s interesting. Maybe it needs a name change.