This is the way I see it.
It isn’t important whether someone is creating money out of thin air. That’s not inherently fraudulent. Should I not be able to create a currency and issue as many units of this currency as I see fit? Of course, so long as I don’t claim something that’s not true in order to market the currency. For example, if I guaranteed its purchasing power, or claimed I held reserves against it and didn’t. On the other side of the coin, no one has to accept my currency for use as money.
I don’t believe FRB’s market themselves as backing their currency with gold. They merely make the claim that they will be able to redeem it for gold on demand. Really, they are backing the currency with the bank’s assets. Their liability to redeem it in gold serves several functions. One, it allows a seamless transition for the users of commodity money to start using bank money or vice versa. It also provides a common unit of account. Rather than have hundreds or thousands of bank currencies trading at floating exchange rates, they all trade against gold, allowing clearing houses to function. Finally, it proves the solvency of a bank. Its ability to raise its reserves to meet redemption demand is a testament to the quality of the loans it makes.
This does not mean that bank money must always trade at par with the gold it is a claim upon. It also doesn’t mean that anyone has to accept it as though it were gold. This provides a strange outcome. As gold is used less and less as money, its demand falls compared to bank money. Thus, gold bugs find it incredibly strange when they know the supply of bank money is increasing faster than gold, yet bank money still trades at par with gold; and merchants are willing to accept equal amounts of bank money or gold for their products. But this is simply because the market prefers a less scarce good as money, rather than the conclusion that the market is duped into thinking the bank money is a property title to gold and that paper gold is driving down the cost of real gold.
There are logical reasons for this, outside of coercive forces. For example, wear and tear on gold coins are more costly to its holders than wear and tear on bank notes. Being as the notes can be redeemed for gold, it is almost like earning interest - the longer one holds bank money as opposed to commodity money, the more costs are avoided. In other words, bank notes increase purchasing power relative to gold. Also, there is the small change problem. To deal with this using commodity money requires floating prices between them to keep both (or more) in circulation, but then you have multiple units of account. This isn’t unworkable, but bank money might be the preferred solution. 100% reserve bank money is another solution; however, this can be costly as well.
Yes, the situation can reverse in a contraction. Should too many people attempt to cash out into gold all at once, the demand for gold skyrockets while the demand for bank notes plummets. But barring a system-wide failure, we shouldn’t think that a single bank failure would significantly move the price of gold, and selling its assets to a global pool of investors, including other banks, shouldn’t put too much pressure on their price. Given that systemic risk is generally trivial in our current banking system, I would think this would be even less so in an unregulated free banking regime.
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What trips me up is that I don’t understand how it could operate. A bank would start at 100% reserves. People accumulate savings in this bank money, so the bank decides to issue fiduciary media loans and lower the interest rate. Let’s say the savings rate then drops to 0. Does the bank then sell off all its assets and retire its fiduciary media, returning back to 100% gold reserves?
It seems more likely that FRB’s will simply try to keep reserve ratios safely above what is required to meet redemption demand. I don’t think redemption demand is firmly correlated to savings rates, so banks would have no ability to know when and how much fiduciary media to issue or absorb to avoid promoting malinvestments. Compared to using time deposit rates as a pricing mechanism, it would seem arbitrary FRB decisions wouldn’t stand a chance at marginal success.
I’m also unsure how a fractional reserve bank could be justified in holding something like 3% reserves. Does this not imply a gigantic savings rate? Or is Hoppe and crew correct when they say that FRB will inherently tend towards infinitely small reserves, pushing banks into a more and more fragile position?
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As far as the Scottish example goes, I think the most important thing to look at is the total amount of deposits lost to bank failure. Selgin provides it. It’s trivial. It’s hard to conclude the Scots were being swindled out of their commodity money and subject to seemingly random bank failures that cost them an arm and a leg. It seems bank money was relatively safe. Now, how much of this can be attributed to government intervention is a good question. Selgin says little to none. Others say differently. I don’t know. I’d have to look at it more in depth.