FRB and Fraud II: Electric Boogaloo

Economics Economics Questions
21

Thanks for the reply.

Well, I’m saying that the FDL is not a warehousing contract because it is fungible, but also because the customer transfers ownership of their deposit to the bank in exchange for a redeemable claim.

Perhaps it would be helpful to list the characteristics of warehouse, loan, and FDL contracts.

Warehouse contract

  • The customer deposits goods in the bank for safekeeping; the bank is not authorized to use these goods.
  • The customer retains full ownership over their deposit.
  • The deposit is redeemable on demand.
  • If it is a bailment contract (regular), the customer has a claim on the exact physical gold coins he deposited.
    • If it is a fungible contract (irregular), the customer has a claim to an equivalent quantity of gold coins, not necessarily the exact same ones he deposited.
  • The customer pays storage fees and does not receive interest.

Loan contract

  • The customer transfers ownership of their deposit to the bank for a specified period of time, in exchange for a claim redeemable at the end of the period.
  • The bank is authorized to use the deposit, e.g. loan it out.
  • The contract can either have a fungibility or a bailment clause.
    • (Whether borrowing short and lending long is illegitimate depends on which clause is used.)
  • The customer does not pay storage fees and receives interest.

FDL contract

  • The customer transfers ownership of their deposit to the bank in exchange for a redeemable claim. (But unlike a loan, there is no time period.)
  • The claim is redeemable on demand.
  • The contract has a fungibility clause.
  • The customer does not pay storage fees and receives interest.

Hopefully the lists above make it clear.

I guess I have to bite the bullet here. The contract only says that the bank must redeem the claim when it is actually presented. Up to that point, it can technically do anything it wants without breaching the contract. Only when the customer actually presents their claim, and the bank fails to redeem it, does a breach of contract occur. And if this does occur, the customer can sue.

But I don’t see this as an objection to the FDL contract. It seems to be a common feature of contracts that a breach can occur only when a specific term of the contract is violated. For instance, say Ted and Gord sign a contract for Ted to cook Gord a delectable meal to be ready at 6:00. But Ted just loafs around all day and doesn’t take any steps toward fulfilling the contract. When 6:00 arrives, Ted has prepared nothing; he has violated the contract. I think it is obvious that Ted only violates the contract at 6:00, and not a second before, regardless of what steps he has taken toward fulfilling the contract.

Likewise, the bank only breaches the contract when it in fact fails to redeem a claim, independent of what actions it has taken before. But this is only true for the specific FDL contract I have given here. Maybe bank managers, in hopes of enticing customers, would add a clause saying they can only use deposits for loans, and not for buying cars.

I think your conception of contracts here is excessively Platonic, in the sense that it is idealistic and unrealistic to think that we can be perfectly certain that a contract will be fulfilled. Rather, I would argue that the difference between a deposit contract and an aleatory contract is one of degree, not kind.

After all, the future is always uncertain. If the FDL contract is conditional in that it depends on the non-occurance of bank runs, then warehouse contracts are also conditional, in that they depend, e.g., on the non-occurance of all the bank workers committing suicide. So if aleatory and deposit contracts differ only in degree, I think the bank only need advertise its notes in line with the characteristics listed above.

Hmm. My view is that White’s point renders the present/future good distinction irrelevant. Maybe there is a more fundamental disagreement?

I don’t think the customers rights are infringed when the bank engages in FRB, because as I pointed out above, the bank can only breach the contract when it in fact fails to redeem a claim. Yes, all the customers cannot redeem their claims at the same time. But this would rarely, if ever, happen, because the claims would circulate as money substitutes, and hence it is likely that only a small percentage of customers would redeem their claims at the same time.

Is this where we disagree? On the feasibility of FRB in practice?

That seems fair. I’ll go through the business cycle arguments and write a new post in a couple of days.

Where does Kinsella present his views?

P.S. Thanks again for the discussion. This is much more civilized than in the Sterba thread.

22

Who was uncivilized in the Sterba thread?

23

This doesn’t completely refute your claim, but it certainly is something to consider. While I agree that a small percentage of customers would redeem their claims at the same time, the fact that the claims will circulate as money substitutes will definitely lead to some percentage of those claims being deposited in rival banks. The rival banks will almost certainly redeem their claims sooner than later. With a small enough reserve, a bank could easily go bankrupt without a single demand-account customer redeeming his claim.

24

I dealt with this in a previous thread.

Last time I checked, “theft” only applied to moral agents, not economic categories. Saying that “$900 worth of resources has been stolen from consumption to investment” is patently absurd. How can “consumption” steal from “investment”?! My advice: lay off the crack.

You seem to be assuming that fiduciary media is created out of thin air. This is false. As Selgin and White write: "“By the nature of the balance sheet, all bank loans must be funded by liabilities or equity. Neither source of funds can be conjured out of thin air.” (p.11 n.13)

Maybe read some of the articles I mentioned here.

@ LS: everyone.

25

Sage:

You keep talking about the legality of a functioning fractional reserve bank. But if the bank is functioning, no customers are going to sue. The law only becomes involved when the bank stops meeting its obligations.

To ask whether fractional reserve is legal or not, is to ask what obligations does the bank have to depositors.

Should the bank become unable to repay the deposits is this simply a case of poor business decisions ending in liquidation and with the debt holders sharing whatever is left? Or is this a case where breach of contract has occurred?

Regardless of reserve levels, should a bank become insolvement it has failed in its obligations as a bailor, and the owners are criminally liable.

Have you read The Case against the Fed? Please do so.

26

FRB is inherently inflationary. Inflation is a hidden tax. Taxation is theft. Theft is coercion. [:)]

You guys can have you little contracts about a currency, but then it robs value from my savings through inflation.

Not cool… counterfieting operation is fraud.

27

You better get used to it.

28

I think you are being quite absurd. I find it amazing that you (as well as Selgin) cannot, in a few sentences in single English explain how the fiduciary media is not created out of thin air. Why is it so complicated that Selgin simply cannot nail it and refute this “myth”(according to you) down and instead keeps referring you to his writings.

The debate is about whether the media is or is not created out of thin air. If it is created out of thin air, then resources are being STOLEN in the same way the government steals resources by direct taxation or indirect (borrowing or printing).

What do you mean how can resources be shifted (I say stolen) from consumption to investment. The whole Austrian business cycle is based on this fundamental principle.

I read Selgin’s “Should We Let Banks Create Money?”. No where in that article does he explain why the money is not created out of thin air. He completely ignores the credit expansion that takes place throughout the whole banking system. He kindly joined an argument here a few weeks ago about the issue and said: A bank receives $100, puts in $10 in reserves, and lends out $90 (for a 10% FRB). No new money created. But what about the credit expansion throughout the banking system? That $100 becomes $1000 after expansion. Still no new money created out of thin air? Is it so difficult to explain why $1000 now in circulation as a result of a $100 is not creating new money out of thin air? It’s amazing, even the Keynesians admit that FRB creates money out of thin air.

29

The problem I have with this is that it essentially just seems that it seems like you’re defining fractional reserve banking as FDL, which therefore must be legitimate, I also think you’ve shifted the goalposts to some extent, in that the definition of the FDL has changed in the course of this topic.

For example, the difference between the irregular deposit contract and the FDL contract seems to be on grounds that aren’t entirely firm. The only difference seems to be in my mind that in the FDL contract the depositor receives money, whereas the depositor in an irregular deposit contract must pay money. At which point one is must ask: why would anybody ever take part in an irregular deposit contract?

In think you have to add that with regards to the deposit and FDL contracts, the money deposited should be immediately available, in other words, it is a present good. That is the distinction between a loan and a deposit contract after all (with, presumable, the FDL contract more closely resembling the latter). Now this brings me to this point of yours.

I think to really understand what is at stake here you need to look at:

  1. The purpose of money,
  2. The purpose of the deposit/ FDL contract.

Now the purpose of money is as a hedge against uncertainty, which is why, as pointed out by Ludwig von Mises it would disappear in equilibrium. Therefore it is a present good. The utility derived from money is derived from having it in your possession so that one may spend it in the case of unforeseen circumstances. The role of a deposit contract is to shift the responsibility of taking care of ones money, not to shift the availability of the funds. Thus, it should not matter whether or not the money is indeed in the bank or in your wallet, but surely, you wouldn’t say that I am allowed to steal from your wallet provided that I can put it back before you need it?

The example that Block uses to contrast present and future goods is the example of money and plane tickets. A plane ticket is of no use to me until I choose to exercise it (which, presumably will be limited to a given day) one the other hand the money in my wallet will constantly be giving me utility. Therefore, an airline may choose to give out 100 tickets to 50 seats, but the fraud will only be commited when these rights are exercised. On the other hand, wrt money the right to the money is constantly being exercised, if you will.

I would agree with your other example, but not disagreed with the conclusion: I’d argue that the meal at 6:00 pm is a perfect example of a future, not a present good.

Now, as concerns the car and the owner of the fractional reserve bank. This is what seems troublesome to me. The notion that if we imagine two fractional reserve bankers, one of whom is very careful in the loans he makes, the other goes and spends the money on gambling. It could well happen that the former ends up going bankrupt and being convicted of fraud whilst the latter ends up making millions and faces no charges.

You claim that may notion of contract is platonic and bring up the idea that it is possible that the workers of the bank commiting suicide. Whilst I won’t deny that that is possible, it’s not expected when one makes the contract, on the other hand, in the FDL contract as you described it, a “rational” agent would have to understand the possibility of the bank never returning his money. In other words, one can foresee that when one abides by the rules of the FDL contract they may or may not get their money back, whereas the only way one could not get their money back in the deposit contract is by some sort of unexpected event (and even then, why would one not get it back? it may just take longer in which case I think you could make a good case that the bank is liable to pay damages)

I also think I could make quite a good case for your argument here proving far too much, but I won’t attempt that since I think my current answer is sufficient.

As for Kinsella’s view (which I am coming around to, but not entirely there yet): http://blog.mises.org/archives/009973.asp and here http://blog.mises.org/archives/005327.asp

I’ll likewise read some of the arguments on behalf of the pro- FRB crowd, where to begin (I might not be able to get a reply for a while, exams coming up).

30

I’ve said repeatedly that if the bank fails to redeem a claim, it has breached the contract and the customer is entitled to sue for restitution.

Conza, as Hoppe argues, you can only have a right to the physical integrity of property, not the value of it. The value of money is determined by the subjective valuations of other people. How can you own someone else’s valuations? Or do you reject subjectivism?

I think Selgin’s point is that fiat money is created out of thin air, but fiduciary money is not. Again, “all bank loans must be funded by liabilities or equity. Neither source of funds can be conjured out of thin air.” Fiat money has no such restrictions.

Of course, money is created through the money multiplier process, but you have to remember that this money is “destroyed” when consumers pay off their loans. And this isn’t counterfeiting (if anyone was wondering); as Selgin notes: “The bank, in issuing IOUs against itself, is not analogous to a counterfeiter… for the simple reason that the bank acknowledges its own debts, whereas a counterfeiter issues IOUs with someone else’s name on them.”

If “created out of thin air” means that money is created out of nothing, then fiat money is created out of thin air, but fiduciary money is not. The latter must be created out of liabilities or equity.

Well, “shifting” and “stealing” are two completely different concepts. Of course resources can be shifted from consumption to investment.

31

DD5: Think about that original $100 deposit. If it consists of notesfrom or a check drawn on another bank, theres no systemwide expansion.

A simple rule: fixed aggregate bank reserves + fixed system reserve ratio = no systemwide expansion possible.

Now, it’s a whole 'nother story with a monopoly bank, because it’s IOUs are a reserve asset for other banks. So when it expands, aggregate reserves increase. Therefore (referring to the previous point) a systemwide expansion occurs, with a multiplier effect equal to 1/r where r is the reserve ration.

Is this better?

32

This is like the biggest non sequitur. A good refutation of that was by Callahan.

33

When money is created through the multiplier process, it IS money that has been created out of thin air. If I understand Selgin correctly in the post below you, I think he is acknowledging that this is indeed the case, only I think he sees the multiplier effect only a problem in a monopoly type banking system.

Banks are always loaned up to maximum, meaning that every dollar of a paid off loan is immediately available to be re-loaned on the basis of the same reserves. Otherwise you would see voluntary contraction of credit by a bank after it has expanded. This doesn’t obviously happen. Banks only contract when a bust is beginning to occur. (“bust” as in they’re busted!) No money is destroyed in normal operation.

Even if you allowed a contraction to occur (ignoring the issue of the unsustained boom, which would cause a collapse before a bank could contract), that bank still made a profit on money it has created temporarily, charged interest on it, and then destroyed the principle.

The fact that resources are ALWAYS misallocated during the boom from consumption into higher order production is a direct result of the “forced” savings or temporary involuntary shift of resources on the part of the consumers. The shift is a consequence of the theft. Now, if the multiplier doesn’t really exist in a free banking system allowing FRB (Which I think will be the case), then the issue is reduced down to fraud or not fraud, but I find it hard to understand how FRB can avoid the multiplier effect unless the FRB system voluntarily practice near 100% reserve banking, as predicted by Rothbard.

34

This is a terrible refutation and I invite everyone who is familiar with Austrian economics to go in and decide for themselves. Behind this “refutation” is the same fallacy of money is wealth. One can issue money (or monetize debt), and as long as there is some clever accounting behind it, it can be a substitute for wealth. What can it possibly mean when “claims to goods” are printed out of a printing press, if not “money out of thin air”. This “refutation” is often used by some socialists of Keynesians. I am very surprised by this “refutation” because the author is basically ignoring the fundamental truth that only real savings can fuel capital.

The “refutation” starts with “Another charge made by some libertarians against…” I urge others here to give their own take on this refutation.

35

If I understand you correctly, then I think you are saying that FRB in free banking would not create a money multiplier. If this is the case, then you perhaps should make that distinction more clear here because people here are arguing with me that the FRB with a money multiplier is not “money out of thin air” and they claim to be basing this partially on your work.

Free banking with FRB allowed but not creating a money multiplier is in accord with the Rothbard crowd (as you would refer to them), but the Rothbard crowd would maintain that that would mean near 100% reserve banking. If I understand you correctly, you are saying that this is not is not necessarily the case. The only issue I have with this is that of understanding how exactly you claim the banks’ credit expansion (leading to the multiplier) is avoided without resorting to near 100% reserve banking.

The fraud debate is less of a concern to me in a real free banking system with real contractual agreement regarding the risk, as presented by the original post. As is the debate about whether demand to hold money can be considered as savings or not. It is important, but not as the debate about whether credit expansion in FRB is or is not “money out of thin air”.

36

All rights cannot be exercised at the same time, all of the demands for gold cannot be simultaneously met, therefore it is immoral. In a bank run only the first in line get the gold. Simply because the day of reckoning might not come does not change the morality. Also if its a valid contract and they are going to manage the business in this manner, shouldn’t it be the case that the bank must declare to each depositor that upon depositing their commodity the bank may at will devalue their deposits to whatever level they want by issuing loans? Furthermore I can’t start a bank to run business any differently than the frb allows because it is a cartel/ government granted monopoly.

37

I think this is where FRB falls apart. Proponents bend over backwards to make the “contract” argument: a contract in which Depositor knows and presumably assumes the risk of insolvency, in order to earn Teh Interest on his deposits. With the very next breath, however, the FRB proponents argue that if the Banker fails to redeem one of his Depositors’ demands in full and immediately, that he has somehow breached the contract.

Do you see the problem here? The contract specified (i.e., it was well-known to both parties) that the Banker might not be able to pay on demand, or even at all. This is a condition which the Depositor accepted contractually, and therefore the failure to redeem his demands cannot be regarded as a breach of this contract.

38

Bingo.

Either it is a bailment or a debt.

39

Umm, nonsense. A big one.