So the bank walks this line by balancing its deposit rate, its loan rate, and its redemption rate?
Dr. Selgin, thanks for posting. I believe I now understand your argument.
The money substitutes are indeed money substitutes; however, they are not property titles to gold - they are more properly titles to a share of the bank’s assets. Being contractually redeemable into a scarce commodity gives the bank money calculational value in terms of the commodity money, which it requires to function as money. However, it is not a title over property but a debt.
As bank money becomes more popular, it is not that counterfeit titles to gold are diluting the purchasing power of gold by falsely increasing the supply, but that the demand for bank money over gold money reduces the demand for gold.
…Now I have to go read the rebuttal to this view again…
But it’s also what we do for every other market.
If there aren’t real savings backing the money, then it isn’t money. It is fraudulent. It is non-contractual. It is inflationary, and makes any business cycle much worse (or begins it).
The demand for savings for investment is infinite, relative to its supply. The price system regulates this interaction. This is “how it goes” in every other market. Why not this one (arguably the most important)?
When you increase supply and demand stays the same, you lower prices. When you lower prices, demand increases. So the price increases you and you increase supply again. Repeat multiple times until you achieve hyperinflation.
That said, I think fractional reserve banking should be allowable in a free society because it is… well, free. Schumpeter had a point when he said that new credit created by fractional reserves promote innovation. Over the long run, I believe that fractional reserve banking could increase economic growth much more than just full reserves.
Whoa. Does the fed run a forum or a mailing list or something ? Because the Mises forum is getting kinda weird. Maybe I should break a few windows to spur innovation in the windows industry ? (not sure if I should laugh or cry…)
I would make more or less those same points…But then I feel like I’m an ordinary commoner…
Anyway…Is this idea that inflationary, un-backed credit is a good thing being seriously advocated ? Is there any easy, straightforward proof for it ? Or ?
That is a pure mischaracterization of their argument. Fractional reserve banks’ money substitutes are backed by their assets, which are partially liquid reserves (gold) and partially debts. The million dollar question is if their assets are worth enough gold in the market’s view to meet redemption of all their notes. Selgin and White conclude that under an unregulated free banking system, most banks would have no problem meeting this challenge.
Is it ? I don’t think so. At any rate, I was quoting and commenting on krazy kaju’s remark about schumpeter.
So called fiduciary media are money substitutes created out of thin air. As such they cause the same problems that government fiat money creates.
The system should be described in terms consistent with so called methodological individualism…not sure what the “market’s view” is supposed to mean.
That might be more like, just an assertion or wishful thinking, not a logical conclusion ?
Anyways…I asked for a simple explanation and didn’t get it. I did check one of the links provided by Mr. Selgin and it wasn’t overly helpful. I’ll try the other articles later…maybe.
I do wonder why there’s no explanation of FRB for dummies…
No, that’s not the question, because it requires a time-lag. This is acceptable for time deposits, but not for demand deposits, which is what we are talking about. Assets are not money, and should not be treated as such. Therefore, they cannot be “held as reserves” in lieu of money - because they just aren’t of the same liquidity.
I have nothing as such against banks holding debt. I only have a problem with it when they have created the debt by counterfeiting against my money they contractually must hold in reserves.
I’m going to have to ask the obvious question, how?
Being created from thin air is not the problem with fiat money per se, so this is illogical.
The price individual market participants are willing to pay for the assets.
Humans can and do err. But there are no special problems for banks making it impossible.
One week, one day, one hour , one minute time deposits?
Which is why they have to be liquidated first to pay out money for depositors.
Aviod such banks if you want! Caveat emptor.
I find it highly ironic that there are groups of people on this site that seem unwilling to give alternative viewpoints a fair shot. I don’t see such tendencies among the experts who constitute the “Austrian School”. And the only reason most people are here to begin with is because they shunned the mainstream views presented to them and sought alternatives.
Also, I find it ironic that some of the biggest debates on this site are about what the market should be forbidden from doing.
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I would agree that it would be very difficult for someone to try to establish any asset, especially a debt as money. Furthermore, it would result in calculational chaos - assets are not commodities - no one asset should be valued the same as another. It would be similar to using thousands of different currencies.
Banks, however, do establish some random basket of assets as money, by issuing money substitutes against them and offering to exchange the substitutes for a specified amount of some commodity money. It works because the market value of the assets generally exceeds the market value of the commodity money necessary to meet redemption demands.
People can prefer using bank money substitutes for several reasons. For one, they can appreciate against the commodity money. They are also cheap - worn notes or token coins can be replaced cheaper than dilapidated commodity money. People should naturally tend to favor money that retains the highest purchasing power.
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As far as the problems - a fractional reserve bank cannot survive a bank run, because it would need to take a haircut on its asset values to sell them off that quickly (at the same time that the price of commodity money increases). As Selgin points out, however, few times in history (especially with free banking) have the public decided to run on sound banks. Most banks that experienced runs had their notes trading for less than par with the commodity they could be redeemed for or were simply not accepted at all. Why? Because some studied the quality of the bank’s assets and determined that their assets were not capable of generating enough bank revenue to fulfill its redemption demand. Of course, the result is a bank run. You bring the money substitute to the bank, get gold for it, go into the market and sell the gold for a higher quantity of bank notes, and repeat. It’s only a matter of time before everyone catches on. But this is not due to the fractional reserve banking’s inability to meet heightened redemption demand; it’s due to the poor business decisions of certain banks.
But even the case of bankruptcy does not mean people were fraudulently deprived of their gold. Without limited liability, the bank owners would have to sell their assets for whatever gold they can, and they’d be personally responsible for the difference. If people can take credit and default and that’s not fraud, neither should it be for banks who fail to meet their redemption claims.
Wildcat banks were a small problem during America’s free banking era. But it seems this was caused by banking regulation rather than the free market. Knowing the risks of fractional reserve banking, few would choose the brand new bank A who offers a Ponzi-scheme high deposit rate when well-established bank B opens a new branch next door. Without branching or other restrictions, the problem should be minimized. And wildcat banking should also be regarded as fraud, like a Ponzi scheme. Technically, there is no difference. New deposits are used to pay redemption demand, rather than the performance of assets.
As far as the business cycle, Selgin points out that if people increase their savings by holding bank money, the lower interest rates caused by issuing fiduciary media are justified by a greater proportion of production to consumption: saving. It is the manner in which the price of real goods cyclicly change due to injections of fiduciary media WITHOUT a change in savings rates that cause the business cycle. In fact, in the case of the business cycle, savings rates decline while interest rates decline.
In a free banking system, banks that operate as above would go bankrupt, as many entrepreneurs who used their low rates to finance long-term projects will likely default. Plus, they would see heightened redemption demand from competing banks. It is only with high degrees of regulation or monopoly grants that business cycles can become severe. Central bank monopoly issuance of notes and coins force banks to inflate together because they can’t compete in that regard.
Yes, but all this means is that banks can continue to expand credit for a longer period of time before contracting and exposing the phony bubble (bust). The basic ‘Austrian’ principle still holds, namely that the bubble is not the result of a real demand to expand productive capacity for an increase in future consumption, as determined by the individual time preference. The credit expansion always leads to malinvestment. I agree with the Keynesian analogy. If White claims that credit out of thin air can fuel economic productivity, then he is in the same camp as the Keynesians.
There’s a difference between alternative viewpoints, and those who think fraud is OK.
(a) The free market doesn’t do anything
(b) There are plently of things individuals on the free market should be forbidden from doing, but these only occur when people violate other people’s property (or other) rights
The simple fact is: FRB is usually fraudulent. One commits a great error of understanding and reasoning in stating that FRB can legitimately hold money in assets. Assets have no guaranteed value until they are sold, and it is entirely possible that a fire-sell might result in values less than needed being generated. If the bank signs a guarantee of paying the money out on request, and there is the possibility it might not be able to, it is committing a fraudulent act. You are right that the bankers should then find the money out of their own pockets, but in admitting this, you clearly accept that the bankers have committed a crime - otherwise why would they have to pay restitution out of their own property?
Any default on a loan is a fraud?
No, it’s not.
Please respond to Rothbard’s refutation of your above statement:
The Myth of Free Banking is Scotland: http://mises.org/journals/rae/pdf/RAE2_1_15.pdf
This is the heart of the debate. Are you able to refute it?
So? What does that prove?
I don’t think he intended it to prove anything, merely that free banking is more of a pressing issue than FRB is, which is a fair enough point.
Different issue. The bank is storing your money, not borrowing it from you.