Kaz on Free Banking

Economics Economics Questions
1

I’m unclear as to the way I’m expected to interpret the question. Any bank not repressed by some socialist prohibition against fractional reserves is, if it’s not in the niche “full reserve” market, going to choose to lend out the money its “depositors” use to buy gold certificates.

It’s as if you were asking for examples of burger joints that don’t deal in cheese.

I am unclear as to whether to even include alternatives forms of monetary issuance as a form of “free banking”. For example, Wal Mart could issue money based on nothing but the desire to do trade with Wal Mart. It wouldn’t ever need to lend money, but this may not be considered “free banking”, since it wouldn’t be based on issuing notes redeemable in a commodity like gold.

2

“It’s as if you were asking for examples of burger joints that don’t deal in cheese.”

So, all cases of FRB are cases of lending. Why not just call FRB lending? Why call it a form of deposit banking at all?

3

“It’s as if you were asking for examples of burger joints that don’t deal in cheese.”

So, all cases of FRB are cases of lending. Why not just call FRB lending? Why call it a form of deposit banking at all?

The same reason you don’t call a burger joint a cheese joint.

It’s really a semantic thing…with the 19th century gold standard form of fractional reserve banking, you bought a certificate redeemable for gold. You weren’t really “depositing” at all. It’s a shame Rothbard shifted the focus to that word, which is actually nothing more than a semantic issue. Nobody had delusions of those notes being the same as retaining ownership of the physical gold they deposited. They wouldn’t expect, if they’d scratched their initials in a coin, to get the same coin back later…unless they’d put it in a safe deposit box.

If we had ANY kind of free market in money, today, though, it wouldn’t need to follow that old pattern, the one that we use when discussing free banking.

You could truly go to a modern bank and “deposit” gold, if we had a free market and the bank dealt in gold. The bank still could lend it out, as long as it did so openly and notoriously…because it would simply be acting like a mutual fund that offers you instant liquidity. You hand them a dollar’s worth of gold, and you don’t even get a note/certificate back. The gold simply becomes part of your electronic bank account. Frankly, you’ll probably never, ever even touch a piece of gold money, except for novelty. The only time I ever touch paper money, today, is when I’m handing out allowance or pulling my emergency wad from where I have it concealed on my person, perhaps to buy an expensive fish whose purchase I don’t want my wife to see on the bank account…or maybe for some actual emergency, as it’s intended.

Really, free banking today would be exactly like the banking we do today, except it would be consensual, and the Fed would be replaced by private lenders of last resort and private deposit insurance companies, and the money supply’s growth would be limited to the discovery of gold. Anyone who visualizes people using either gold coins or physical gold notes in the 21st century is pretty goofily naïve, akin to thinking we’ll all go back to organic gardening for all of our food and riding around on bicycles (which, sadly, some people do hope/expect).

Even in the disastrous event of state-mandated full reserve banking and a government-fiat gold standard, most people would never bother to touch gold, or certificates, except in exceptional cases.

4

I don’t want to join the debate, really, but I’d like to make two points which I think should be taken into consideration:

  1. Fractional reserve banking as we know it today is not the same type of fractional reserve banking proposed by people like White, Selgin, Dowd, et cetera. The principle similarity is in definition; i.e. there will be fiduciary media in circulation. There are also two forces by which Selgin, et. al., conceive a fractional reserve banking system to come into existence. One is a fall in the quantity of outside money (for our purposes, gold) being claimed at any time, which if this persists for a sufficient amount of time it might cause banks to sell off deposits of gold for non-monetary purposes, while still maintaining the relevant notes in circulation. The question here is whether or not that would set in motion a macroeconomic (with microeconomic foundations, of course) cycle in which the banks would be forced to reimpose that previous quantity of gold. The other force is responding to changes in the demand for money.
  2. Personally, I think the first force is more relevant than the second, because evidence suggests that changes in the demand for money would be trivial (even monetarists hold that depressions caused by monetary disequilibrium are set off by a fall in M, not a fall in V; Garrison 2001, Time and Money, p. 234 [I seem to recall a different mention in the book, as well, but I can’t find it right now]) While it’s a section that I will have to re-read, I think Mises agrees (although, I’m not saying Mises was discussing monetary disequilibrium, or that he was at least seriously considering it—I’m not commenting in either direction) that changes in the demand for money are of minor importance. Also, I have argued that if the boom-bust cycle is set off by a sustained increased in the supply of money then an increase in the demand for money (as a secondary consequence of the depression) should be an equilibrating factor, and that within the free banker’s own framework banks would be unable to respond to that anyways (since they would be facing an onslaught of a rise in returning liabilities).

Anyways, I’m just hoping to provide a framework for the debate. Selgin’s theory of free banking may be theoretically correct (although, there are plenty of people who disagree—I am not commenting either way [although I do hold Selgin’s theory to be correct]), but I question how relevant it is.

5

A mutual fund can only offer you the liquidity that is provided by the instruments in which it has invested your assets. You know exactly where your money is, how much it’s worth, and how easy/hard it would be to transform it back to cash before you pull it out.

The legs on this strawman are mind-boggling. Technological advancements in book-keeping and executing financial transactions have nothing whatsoever to do with the fundamental differences between FracRB and FullRB. Do yourself a favor and delay writing that paper until you develop better arguments than this.

Z.

6

Yes, in regard to your desire to use money, a fractional reserve bank is far superior to a mutual fund. You are guaranteed a specific return on your money, and you have complete liquidity.

But I am describing how they two are alike, conceptually. Both are investing “your money”, although in both cases you’re really only buying a share in an investment.

Surely you are aware that, as I note about the guys who want us all to provide our own “sustainable subsistence”, there are people who actually do believe we should/will all go back to carrying around bits of gold to pay each other, and/or full reserve gold certificates.

It’s not a straw man, it’s just not specifically something you are concerned about. But any readers who have delusions of the utopia created by making everyone deal in physical money is a valid point to address in the general discussion at hand.

Just as the “deposit” thing is mere semantics, so the fact that most of us would probably never touch a gold coin/note outside of special circumstances is worth addressing and noting.

Am I to take it that you agreed with all the points I made that you didn’t quote and address?

7

I disagree on how you describe that:

It’s not a fall in M, it’s a change in the relationship of M to demand. In other words, demand could increase, instead of M decreasing. The effect is the same.

The demand for money grows, because wealth and/or velocity grows, and the money supply is not growing fast enough to keep up.

This is a form of deflation, which results in malinvestment that is the opposite of the kind you get from inflation.

8

It’s not a fall in M, it’s a change in the relationship of M to demand. In other words, demand could increase, instead of M decreasing. The effect is the same.

I think you missed the point. Many monetarists hold that changes V are negligible until after the initial fall in M. The causality is a fall in M, then a fall in V (or a rise in demand). Austrians wouldn’t disagree, and in fact Rothbard makes this point in America’s Great Depression (the rise in demand for money is a consequence of the boom-bust cycle, not the cause).

The demand for money grows, because wealth and/or velocity grows, and the money supply is not growing fast enough to keep up.

  1. An increase in demand for money should corresponding with a fall in V; you have the causality wrong. An increase in V does not cause a consequent fall in V; V changes as a result of changes in preferences (and, in any case, V is either 0 or 1).
  2. As output rises time preference tends to lower, which suggests an increase in savings in general. Whether this translates into a change in cash balances (i.e. demand for money) is something that depends on individual preferences. People usually hold cash balances out of future uncertainty (cash is more liquid than any other form of savings).
9

Your only point so far has been that fully disclosed/disclaimed FracRB should be allowed in a free-market. I agree that fully disclosed/disclaimed fraud is an oxymoron, and that no one can/should stop a fool from freely making dumb decisions. We only differ in our predictions. You see FracRB becoming widespread (with advances in technology and freedom), whereas I predict that the costs associated with such lottery-like Ponzi schemes far outweigh the (non-existent) advantages over simple asset allocation over an ever expanding universe of financial products without any ownership ambiguity and liability maturity mismatch. I see advancements in technology favoring FullRB and making FracRB obsolete.

Z.

10

You have 2 banks, and for simplicity, an equal amount of gold is deposited in each.

  1. The “Rothbard Bank” issuing notes only backed up by 100% gold. You deposit 1oz of gold, and you get a note (claim) that says on it

“Rothbard Bank Note, 1oz Gold, backed by 100% gold”

  1. The “Kaz Bank” issuing notes backed up by only fractional reserves, say typically 10% (just an example). You “deposit” 1oz of gold, and you get a note that says on it:

“Kaz Bank Note, 1 oz Gold, not backed by 100% gold. Should more customers show up then our available reserves, we become illiquid” , so that it is clear that the entire process is voluntary and that no fraud is committed.

We have in circulation two types of notes: Kaz notes with supply of M1, Rothbard notes with supply of M2.

M1>M2 by the very definition of the problem.

Here is the million dollar question:

What is the exchange rate between M1 and M2?

The answer to this question reveals everything we need to know about this idea behind voluntary fractional reserve banking.

11

The Rothbard Bank goes bankrupt. M1 disappears.

12

So you admit that FRB, as you’ve defined it, is not demand-deposit banking and is, instead, lending.

13

I assume you meant to say “The Kaz Bank goes bankrupt. M2 disappears.”; though in fact only M2-M1 disappears (the gold in the Kaz Bank’s vault still exists). Who cares if the Rothbard Bank goes bankrupt? The gold it’s holding still belongs to its depositors, who simply get it back; it’s not an asset of the bank that could be redistributed to its creditors (if any)…Kaz Bank’s gold is, though; so its bankruptcy would be even more devastating for its customers than just losing 90% of their money…

14

More like, I run M1 and M2 through a photocopier and they become worthless.

15

You don’t need economics to spot the fallacy here:

You’re begging the question: Why does the money supply need to “keep up” in the first place?

BTW, it’s in complete contradiction to Mises’ insight that: Money is different from all other goods in only one way. More of it does not confer any social benefit.