Ron Paul, Fractional Reserve Banking, and the Money Multiplier Myth
I’m surprised. Usually Forbes is on ‘our’ side.
I think the author has a point when he says that fractional reserves are basically unavoidable, but this doesn’t necessarily make Rothbard wrong…
Why do you think they are unavoidable? Do you mean in our current system? Or do you think they would still be possible with a hard currency?
I never understood the anti - frac. reserve position. In my opinion, it’s an excellent way to impersonally diffuse personal savings into demand for capital goods, perhaps the only way. As I understand it, 100% reservists just want it to be so that you either put your savings in a warehouse or in an investment firm. But what’s the point? Mises already showed that the ability for a single bank to expand its credit is necessarily limited by the circulation of those very notes to non-clientelle…
First they ignore you, then they laugh at you, then they fight you, then you win. Maybe we are closer to stage three now. Eventually they are going to have to actually address our arguments. They have been dismissing by laughing at us for a long time, but that will only get them so far before they have to fight our arguments.
Fractional reserve is a scam just as much in a free banking society as in a fiat money society. It’s the creation of bank notes that are not backed by any money (precious metals). That’s what Austrian Economists call inflation, and we all know how bad it disrupts the economy, causes malinvestments, allocates resources and capital to non-optimal places, etc. The only difference is in that a free banking system; if a bank started printing notes, we would just not use it anymore. I’m sure private regulation agencies would emerge to monitor bank activity to make sure the bank notes we’re using are safe and backed by 100% reserves as well.
That’s not quite the case. Most 100% reservists argue that it is okay to lend out money in the case of savings deposits and time deposits, but that it is not okay to lend out money in demand deposit accounts.
I guess one thing I’m not sure of is, is it fact that banks do not multiply money, as the article claims? Is it, against the laws, so to speak? Or is it merely an assumption that they do not engage in that behavior (or is it an assumption that they do)?
Anyways, fractional reserve banking is counterfeiting, or more appropriately defined, fraud. How else can a depositor have the claim to the same money at the debtor?
I also disagree with the article’s implication that there are not depositors that just want to store their money and not have it loaned out to earn interest. Sure, some do want that, which is fine, but others just desire a safekeeping of their money, especially with the ability to have the electronic equivalent of their deposit in the form of a debit card.
Personally, I’m not anti-fractional reserves, so long as they really are not engaged in multiplying the money, which I’d like to know if anyone has insight to share on that matter. However, I’m opposed to the FED as a lender of last resort, which does create money from thin air, and opposed to regulations. The free market would allow for money-warehouse “banks” and investment “banks” to coexist. Many, if not most followers of Rothbard and Paul, push for free market solutions as the end goal, not the abolition of fractional reserve banking, which the article seems to imply (falsely) as well.
Lastly, when one enters counterfeit currency into production, they not only inflate the money supply, but purchase things without having to have engaged in any production, meaning they got goods or services with, mathematically, zero demand, no? In either, and especially both cases, the value of the currency decreases. This can be thought of as stealing from all currency holders. So when the FED creates (counterfeits) currency, it does the same. Since it functions as a lender of last resort, it is quite reasonable to assume that without it and it’s “printing presses,” more banks would hold larger reserves. Thus, the extent and intensity to which banks employ fractional reserve techniques is largely at the blame of the FED. This is a moral hazard (the article scoffs at the idea of this immorality) which allows firms to reap the rewards of its wise decisions and pass its losses onto the public through inflation (which is tantamount to counterfeiting, which is tantamount to theft).
But they don’t: the depositor has a claim to a certain amount of money, not to a particular set of banknotes. Only when the bank refuses to fulfill that claim is it acting fraudulently.
If Forbes is excusing fractional-reserve banking as legitimate simply because it earns its participants a profit then it’s them who need to “get serious” at not us.
Right, it is only in the case of when the bank is unable to meet the demands of the depositors’ should they wish to withdraw their money. Like, if X% of all deposits are loaned out, and the depositors’ wish to withdraw that X% of their deposits, and the bank could not meet the demand, then it could be considered fraud, right? Of course, if another bank loans the money, and the claims were met, no harm, no foul. But am I right to conclude that if the claims can only be met by the creation of money from the FED that it could be considered counterfeiting or theft from all other currency holders? Or does such a loan from the FED get paid back, taken out of circulation, and then no inflation has occurred (once the created money loan has been paid back)?
Phi - the money multiplier is standard economic theory.
So the article is outright lying? Or refuses to subscribe to standard economic theory? Or am I misunderstanding what they mean when they said:
“About Rothbard’s assertion, underlying it is a fanciful belief that the alleged “money multiplier” is fact as opposed to fiction. It’s the latter. Indeed, wise minds should quickly understand that there’s no such thing as a money multiplier such that Bank A can take in $1,000,000 and lend out $900,000, Bank B can then lend out $810,000, then Bank C can lend out $729,000 such that $1 million in deposits miraculously turns into nearly $2.5 million.”
Sorry, I just want to be sure of what the article is trying to assert here. I thought the money multiplier effect was, indeed, fact.
The article is trying to say that the Money Multiplier is an imagined thing. The article also must not be counting the “Modern Money Mechanics” publication from the FED.
There are many Austrians who supported fractional reserve banking, including Hayek and Mises, so ‘our’ side might be a wrong word in this case.
Could someone clarify something for me?
Rarely have I heard that Austrians do not hate fraction reserves en whole. Tell me the rationale for thinking they are ok.
Is it that so long as a bank can meet the demand of its depositor’s withdrawals then its ok to use their money to give out in loans and inflate it’s bank notes? Or is it that so long as the depositor knows and accepts that the bank practices fractional reserves that it is ok. As in, the depositor accepts this risk because if his bank can lend out more money than it has in reserves, it can make more money, but your deposits may not always be 100% available to you.
Austrians are divided by the issue. Rothbardians support 100% reserves and White&Selgin free bankers FRB. Hayek kickstarted the free banking-movement and Mises was always “between”, if I’ve understood right.
White & Selgin use the terms “inside money” and “outside money” a lot. From what I understand, you can substitute “commodity money” for their “inside money” and “money substitute” for their “outside money”.
Notice that money substitutes aren’t commodities per se. They constitute claims against commodities. In that sense, a money substitute is a security. Since it pays zero interest and has zero maturity, that makes it an equity security, not a debt security.
The problem arises when there are more equity securities than there is actual equity (i.e. commodities). One way around this is with what amounts to floating exchange rates - that is, different prices for different equity securities. However, in order for there to be more equity securities than actual equity, one or more people have to create extras of them. In the absence of any agreement to the contrary, I for one would call that fraud.
Nevertheless, I think something kind of like fractional-reserve banking could exist in an anarcho-capitalist society. There could exist certain financial instruments which are not fully guaranteed. In other words, they aren’t promised to be fully redeemable on demand.
Now I don’t know about anyone else, but I think holding such “fractional-reserve” financial instruments would be much riskier than holding “full-reserve” financial instruments. Hence I think the exchange ratio of the former to the latter would be very low. I also don’t think the former would be accepted in nearly as many places as the latter.
Maybe this analogy will help: how many lottery tickets would you sell your car for?
I once shared Rothbard’s view of FRB.
Then I realized that a demand deposit was really just a call loan (i.e. a loan which can be called in at any time by the lender) from the customer to the bank.
FRB is not fraudulent at all.
I would go further than to call it a lottery and say that it is akin to an investment in the bank. If anyone is averse to that risk, he should be averse to the risk of depositing on the same basis. The concept of “storing” anything other than physical valuables in a bank is nonsensical. For servicing immediate transaction needs, that is all covered by credit. I can hardly see any reason for anyone with good credit rating to have a deposit account these days.
It is evident to me from the history of banking that FRB began as blatant fraud, later became ex post facto justified by manifest arrangements, and finally has become obsolete.
Read it, you’ll see. It’s genius!
Also, the idea that FRB is not fraud because deposits are “call loans” is inherently wrong. Because in judicial terms (in modern banking law) deposits are considered as loans, they are invalid as either loans or deposits becasue they require that two parties are simultaneously in possession of the same availability of the funds. That is, in a loan, availability of the funds or whatever is loaned is handed over to those to whom it they are lent to. In a deposit, it remains with the depositor. These are the only two possible cases, and any interim position makes the nature of the contract void. That is, a deposit cannot simultaneously be a loan because availability simultaneously belongs to two parties. How can the one use it if the other is using it? This dilemma of course has led to modern banking practices effectively ruining any connection between the two. All those banking calculations designed (along the lines of insurance practices) to calculate the likelihood that a depositor will demand his deposit back are apodictic of this dilemma. These surely would not be needed if it was clear to whom the availability remains (in a loan contract the availability remains with the “depositee” until the end of the term - a loan without a term cannot be considered a loan). Since these practices exist, it is clear that availability is simultaneously held by two parties (why would they calculate these things otherwise?) and thus deposits are not loans. Whether or not in modern judicial terminology there can exist something known as a “call loan” distinct from either a deposit or a loan in their fundamental forms I am unaware; existence of such terminology does not however legitimize the practice.