Are you assuming that $100 of increased savings in bank A, must necessarily mean a decrease in $100 of savings in [say] bank B?
If so, why? it seems as though you are assuming a stationary economy: time preference constant (consumption/saving ratio constant). Am I missing something here from your argument? fresh reserves would come from fresh savings, as would be expected in a growing economy.
No. The 98 units lent out will be spent quickly (people don’t boprrow at interest except to spend), and will soon find their way bank to the banking system, and mainly (under competition) to rival banks, who will return the notes for redemption. At that point, the expanding bank reduces its liabilities by 98 units, having also lost that amount of reserves. The balance sheet operations look like this (starting from the beginning):
_Assets_______Liabilities
Gold 100 Deposits 100
Loans + 98 Notes + 98
Gold - 98 Notes -98
Gold 2 Deposits 100
Loans 98
Sorry if this comes out messy when I post!
The gold brought to A has to come from somewhere. generally it will come from another bank.
But you can of course have an increase in total savings. In that case, the demand for holdings of bank money increases. This will allow banks on the whole to operate on a slimmer reserve cusion, so total M can go up witgh fixed total reserves.
My intent, though, has merely been to illustrate, as simply as possible, that no free bank is ever in a position to make loans unless it first receives deposits of some greater amount. Of course things get complicated rather quickly, and the entire story of money expansion under free banking takes several book chapters to develop. That’s what my first book was devoted to doing. Naturally I’m not inclined to try to repeat that whole analysis; I believe that anyone who reads it will find it answers lot’s of questions, though.
So you’re assuming that the banknotes or check money received in exchange for the deposited gold units will not circulate without being redeemed? And you seem to further presuppose that the transfer of check money will not remain in the same bank. Because if these things were not assumed then 100 deposited units with 98 loaned out would effectively represent > the 100 units deposited.
I’m just trying to grasp what you’re saying.
And yes the multiplier would be canceled out but you have to take simultaneous withdrawals and deposits into account so that the expanded money supply wouldn’t necessarily have to shrink and re-expand every time a transfer of money takes place.
I don’t think everyone is rigidly fixed to Rothbardian views (I like to approach things more in line with Hayek’s general emphasis of the nature of complex systems). What brought a lot of us to AE is our inclination to question and scrutinize what exists. Rothbard is so highly regarded because he is so remarkably clear. In any case, I think the very fact that this thread is so long indicates that many are interested in probing their own beliefs.
I’ve read much of Mises on the subject and I never got the impression that you seem to have gotten. Even your quotations about how he believed FRB was beneficial to its instigators and community seems to be way out of context. He was simply acknowledging why it would arise, not that it has a sort of greater social benefit.
Yes, I get that part. I believe I described it also 2 posts before, if I understand you correctly. But my point is as follows:
In today’s world: That rival bank now has:
Assets Liabilities
Gold 98 Deposits 98
##The rival bank will not sit on his 98 Gold units, will he? Am I missing something here? It will now lend out its 98% of the 98 units of Gold
Loans + 96.04 Notes + 96.04
Gold - 96.04 Notes -96.04
Gold 1.96 Deposits 98
Loans 96.04
This process will continue on and on until you will have X49 the original 100 of fresh savings.
In a free banking system, this credit expansion could not take place without the cartelizer.
Edward: You are correct concerning the assumptions I rely on. concerning notes being redeemed in short order and so on. They are, in fact, the appropriate ones for competitive banking, and are relatively easy to defend as holding in practice. I explain why in my book. (Another book that’s very good on this is Gavin Macleod’s Principles of Financial Intermediation.)
Concerning Mises and fractional reserves, see Larry White’s papern “Mises on Free Banking and Fractional Reserves,” in John W. Robbins and Mark Spangler, eds., A Man of Principle: Essays in Honor of Hans F. Sennholz (Grove City: Grove City College Press).
I have a lot of trouble accepting that gold deposits represent savings. For example, let’s say I build a X-widget and sell it on the market for 100 oz of gold. I go to the bank with the gold and receive bank money for it. I then spend all the bank money on a Y-widget.
In this scenario there is no actual savings occurring. There is merely a preference to bank money over gold money. Yet the interest rate is driven downwards by the bank’s loaning of its supply of “credit”. (I say “credit” because there is no actual credit, which comes from consuming less real goods than produced.)
It seems the bank would have to know whether people were spending its bank money or holding it. For electronic accounts, this is possible; but not for bank notes. This would have to rely on price indices, which as we know are inherently flawed. And redemption demand is a flawed viewpoint, because there can be 0% savings; yet most expenditures could occur between clients of the same bank. This would keep a low redemption demand, but it has nothing to do with individual savings.
Let’s look at the difference between FRB and 100% reserve. 100% reserve can still make loans, but it must receive the funds for these loans in the form of time deposits. The time deposits should not function commonly as money. Thus, time deposits actually represent savings made available to others. Banks balance their loan rates and deposit rates to attract savings while making profitable loans. In this case, banks use pricing mechanisms to encourage individual action - namely making savings available for loan. FRB seems opposite - it pays depositors the same whether these people refrain from consumption or engage in it with bank money. There is no pricing mechanism to encourage individuals to save.
I agree, when selgin says: “the expanding bank reduces its liablities by 98 units, having also lost that amount of reserves” when the rival bank returns the notes for redemption, he must assume either a time deposit of 100 gold units or 100 gold worth of assets belonging to the bank. Otherwise, there is still a liability to the original depositer. If he chooses to redeem his notes for his gold, then the bank will be insolvent.
I don’t agree with that. If we take the oversimplified case where a bank only has one client, then redemption demand becomes extremely volatile. Yet in a more robust economy where redemption demand is much more predictable, the bank may notice redemption demand heading north and start selling its assets for gold.
In other words, the bank’s balance sheet is not a one-way road. Yes, it must shift its assets from loans to gold before redemption demand exceeds its gold reserves. But without catastrophic events in a large market, banks are rarely surprised by sudden, large increases in redemption demand.
And even in the case where the depositor returned to the bank and demanded 100 oz of gold, and the bank only had 2 oz on hand; the depositor doesn’t simply lose 98 oz of gold. With limited liability and today’s bankruptcy laws, he becomes the owner of the bank’s loans, which he may be able to sell for close to 98 oz of gold. If liability is not limited in any way, the bank’s owners would have to still pony up the gold, plus a penalty (legal interest) for not doing so in the timeframe they said they would. So to suggest the depositor has been swindled seems a bit ridiculous to me. It seems that both parties are hurt here, and that neither intended to harm the other.
A bank desposit represents “saving” only for so long as it isn’t spent. In my examples, I assumed that the original deposit remained at the bank for some time; banks are only capable of dealing in those savings that people desire to hold in money form, and a bank can only lend to the extent that people hold onto its IOUs. Take any bank that has outstanding liabilities and loans, thanks to prior demand to hold its IOUs. (I speak of the aggregate demand; the “holding” doesn’t always have to involve the same people.) If demand for that bank’s IOUs falls to zero, it will be able to lend…zero. There is no “thin air” lending under free banking. On the other hand, suppose that people were willing to accumulate some bank’s IOUs without limit. It might then lend without limit (and without causing inflation). In short: more spending (turnover of IOUs)= less saving= less bank lending= less bank money; less spending=more savings=more bank lending=more bank money. But only with competition: all agree that central banking messes–up everything.
Yes: one must always keep in mind that the low reserve ratios referred to in the example prefer a very large number of bank customers, as well as competing banks. It is in effect the 'law of large numbers," along with customers continuijg general confidence in banks, that makes banking on such slim reserves possible. The reserve ratio is low because the odds of a reserve-depleting sequence of withdrawals are low, and not otherwise. Fractional reserve banking grows out of long experience with actual withdrawal and spending patterns, coupled with managerial know-how. I speak, of course, of the goodl-old pre deposit insurance days of the institution.
I appreciate your time on this matter.
I still sense an inconsistency in your overall thesis. I assume your Yes" reefers to the fact that the credit expansion throughout the banking system will grow the money supply by the money Multiplier. So obviously FRB amounts to lending out money that is NOT saved. You don’t claim that that the 100X49 is equal to 100, which is the original savings, do you? So FRB, any FRB will expand the money supply and lend out more money then savings by the multiplier factor.
Yet you also contend that under free banking only, saved money will be lent out. You even insinuate that the banks are assuming the deposits as sort of time deposits. This means that under free banking, the system will naturally operate close to 100% reserves. There is simply no other way of rationalizing your claim that only real savings will be lent out under free banking. You can’t have it both ways: FRB and only real savings lent out
This isn’t what I was talking about (maybe you weren’t responding to me). Even if the deposit remains at the bank forever, there could still be a 0% savings rate in terms of real goods. The bank issues money substitutes when you make a deposit. If everyone is spending the money substitutes, they are not saving. Yes, if a rival banks receives them, it will quickly attempt to redeem them. Thus, greater spending will likely increase redemption demand. But these things seem indirectly, not directly, correlated.
In the aggregate, people may prefer bank money over commodity money, creating demand for bank money. But this does not mean that there is greater aggregate production than aggregate consumption in terms of real goods. Fractional reserve bank lending in such an environment is simply subsidizing borrowers at the expense of savers, and would likely cause the redemption rate to skyrocket.
Right - but what I want to know is how the bank knows whether its IOU’s are being spent or held.
“What I want to know is how the bank knows whether its IOU’s are being spent or held.” Easy: when bank-supplied IOUs are spent, they find their way to rival banks (remember I’m making claims about competitive or free banks) who return them for settlement. Consider a checking account today. No spending, no checks drawn, no checks returned, nothing owed in settlement. It was the same for competitively issued notes back before central banks took over. So in fact a bank found out very quickly if people were spending rather than holding on to its notes or other liabilities.
Again, all this stuff is explained in considerable detail in my Theory of Free Banking; and oodles of historical evidence suggest that the theory fits the reality of fractional reserve based free banking. Of course I know the theory isn’t self-evident, and that people labor under some other misconceptions. That’s why I wrote the book! I wish you’d all read it as these little explanations are poor substitutes for a systematic explanation.
Given this, and if they are regarded as this, then I have no problem.
But there is no way of issuing notes to debt contracts as I see it. Notes always refer to actual physical deposits of money (in all likeliness, gold). Are you arguing that currency should be backed by debt contracts?
As do I.
It’s really impressive for a real live professor to talk to us[:)]
You (depositor) have $100 available on demand and somebody else has $98 he can spend. $98 were created out of thin air.
Not necessarily true at all. Not to mention that that “quickly” is not a ‘scientific’ term and is almost meaningless here.
The thing is, the person who borrowed the $98 will bid for goods and services. If the depositor now feels like spending his $100 there would be $198 instead of $100 chasing the same amount of goods and services.
Selgin,
I just went over your “Should We Let Banks Create Money?”
I am having trouble accepting your arguments. And I don’t intend to kill my grandmother.
The fraud Issue: I see 2 main problems with your argument
The Business Cycle issue: You concentrate on the debate about whether “demand for cash balances” constitutes legitimate savings, as if this is the main trigger of the business cycle. Neglecting that argument for a moment, you completely neglect the money multiplier caused by FRB. If reserves are 10% then M=1/0.1=10
Banks with 10% reserves create new money by a factor of 10. Whether the 10% reserves is cash balances or savings is a minor disagreement relative to the effect of the Multiplier. It’s true that the Central bank will make things worse by injecting fresh money into the system, but FRB also injects new money into the system, thus, credit circulating is always greater then real savings, which will always produce a boom and a bust. What ever your reserves are, say in your hypothetical free banking system, you will have a multiplier factor. With a conservative 90% reserves, you will have about a multiplying factor of about 0.1, so that is 10% new money on top of your base (whether it’s time deposit savings like Rothbard and Hoppe want it to be or just cash balances like you want it). It is still 10% of wealth extracted from the public through inflation, and still 10% of credit that is not compatible with individual time preference, leading to cyclical behavior.
I believe he borrowed it from Rothbard;)
DD5:
First of all, I’m glad grandma is safe. But concerning (1), I agree that forced savings are a bad thing (though not something that happens much under free banking), but that doesn’t ean that “fraud” is involved. Not everything that’s undesirable is fraudulent! You seem to be taking the word “forced” too literally! (And even if the literal sense is the right one, what we’ve got isn’t fraud–it’s theft.)
W.r.t. (2): I have been careful throughout my comments to emphasize the facts pertaining to fractional reserve banking prior to the emergence of government insurance, which was first established in the U.S. in '33, and was next adopted in Canada in '67. That leaves lot’s of experience with uninsured systems to which your claim above isn’t relevant–that is, lots of instanceas in which people chose to keep accounts at banks with low fractional reserves although they had no reason to think that their money was backed by the government.
Now, you can keep on pretending that this evidence doesn’t exist, and repeating what you think “would” happen in the absence of guarantees. But doing so just suggests that you’re obstinate, whether grandma is in danger or not!