Libertarian Banking and Loans

[Smidgey]

Hello, I had a question about libertarian banking.

If in a libertarian society a gold standard is established and and end to government sponsored inflation is brought about by shutting the printing presses down do-to-speak and preventing fractional reserve banking because it is fraud, how will people get loans? Loans are indeed necessary for large purchases, such as buying houses and business expansion. If banks are unable to loan out money where will loans come from except from wealthy people willing to lend?

I understand that in a free market society we would want the number of loans to be far less (and that would happen), which makes it easier to cater for, but large sums of capital are still going to be required for the above mentioned things.

Thanks.

[Jon_Irenicus]

That is only so with demand deposits, not time deposits, which can be lent out during the time specified. Banks are merely facilitators of exchanges. Lenders and borrowers will continue to exist whether or not they do.

-Jon

[MacFall]

In our unfree pseudo-market society, everyone takes loans out because Federal policy discourages saving. In the free market, lending would not disappear. It would become much more expensive, however. Savings would replace debt, for the most part, leaving borrowing only to those most willing to take on the high risk associated with a market interest rate - i.e., entrepreneurs. And because the cost of default to the lender would also be high, lenders would be reluctant to lend to just anyone. Therefore, only good entrepreneurs would borrow. Or at least that would be true more often than not, whereas today hardly anyone saves, and lenders are encouraged (or even forced) to lend to likely defaulters. As a result we are almost totally in a condition of unpayable debt.

[Paul]

@MacFall

In our unfree pseudo-market society, everyone takes loans out because Federal policy discourages saving. In the free market, lending would not disappear. It would become much more expensive, however.

Huerta de Soto, in the last chapter of Money, Bank Credit, and Economic Cycles:

2. “The proposed system would largely decrease the amount of available credit, thereby pushing up the interest rate and hindering economic development.”

This is the popular criticism most often expressed, and it mainly comes from those economic agents (businessmen, politicians, journalists, etc.) who allow themselves to be influenced chiefly by the external and most visible characteristics of the economic system. According to this objection, if we prevent banks from creating loans ex nihilo, many companies will meet significantly greater difficulties in obtaining financing, and hence, ceteris paribus, the interest rate will rise and obstacles to economic development will appear. This objection stems from the fact that presently, due to credit expansion, businessmen face little difficulty in securing financing for almost any investment project, no matter how outlandish, assuming the economy is in a phase in which bankers are not afraid to expand their loans. Credit expansion has altered the traditional habits associated with the “entrepreneurial culture,” habits which rested on much more prudent, responsible, and careful consideration prior to a decision on whether or not to launch a particular investment project.

At any rate, it is a grave error to suppose credit would disappear in a banking system governed by a 100-percent reserve requirement. Quite the opposite is true. Banks would still loan funds, but only those funds previously and voluntarily saved by economic agents. In short, the proposed system would guarantee that only that which has been saved would be lent. The new arrangement would thus ensure coordination between the supply and demand of present and future goods in the market and, consequently, prevent the profound maladjustments which the current banking system produces and which ultimately generate economic crises and recessions.

Moreover the notion that the loan funds devoted to investment in the current system can ultimately exceed society’s voluntary saving is a fallacy. As we know, ex post, saving is always equal to investment, and if, ex ante, banks grant loans (through a process of credit expansion) at a faster pace than that of voluntary saving, entrepreneurs will simply tend to err en masse and allot the scarce, real resources saved by society to disproportionate investment projects which they will never be able to successfully complete.

Therefore this second objection is unfounded: with a 100 percent reserve requirement, banks would continue to loan what is saved, yet entrepreneurs would tend to invest saved funds in a much more prudent, realistic manner. If, from the start, businessmen were to encounter greater obstacles to financing certain entrepreneurial projects, such difficulties would be the logical manifestation of the healthy functioning of the only market mechanism capable of halting the initiation of unprofitable investment projects in time, and thus avoiding their unwise and discoordinated execution, which the current system promotes during credit booms.

As to the interest rate, there is no indication that in the long term it would be higher in the proposed system than in the current one. Indeed the interest rate ultimately depends on economic agents’ subjective valuations of time preference. In our model, economic agents would not be affected by the massive squandering of capital goods which accompanies recurrent economic recessions. Furthermore it is clear that, other things being equal, in a system like the one we recommend, the interest rate would tend to be quite low in nominal terms, since the corresponding premium for the expected evolution of the purchasing power of money would in most cases be negative. Also, the component of risk would depend on the precariousness of each specific investment project undertaken and, following a period without economic recessions, would tend to fall as well. Hence we conclude that there is absolutely no theoretical basis for the assumption that the interest rate would be higher in the proposed system than it is now. Quite the reverse would be true. There are very powerful reasons to believe that in both real and nominal terms, the market rates of interest would be lower than those we are presently accustomed to.

Therefore a system composed of a pure gold standard and a 100-percent reserve requirement would not weaken economic development. In fact, such a system would give rise to a model of stable, continuous development, free from the manic-depressive reactions which we have, with difficulty, become used to and which, unfortunately, involve the regular malinvestment of a huge quantity of society’s scarce resources, to the serious detriment of sustainable economic growth and harmony in society.

[Liberty_Dawson]

Loans would still exist but the money used to fund them would not come out of a depositors savings in the bank, unless explicitly stated so on a contract. The real problem with fractional reserve banking is not only the fact that it is fraudulous but that you still own the money in deposit even if banks lend it out to others, meaning money lent actually represents no real capital. In a free market firms which lend out money could only lend out money which it physically had, meaning that no money is created out of thin air and the firm wouldn’t experience ‘bank runs’.

Perhaps loans wouldn’t exist in the quantity we have today, but I have no doubt that demand would be satisfied in the free market.

[Natalie]

Loans existed thousands of years ago, before any central banks started tampering with the credit system, why should they disappear in a free market?

[scineram]

@Danial Dawson

In a free market firms which lend out money could only lend out money which it physically had

Banks lend out money they physically have with fractional reserves too. And you don’t own the money you deposited.

[Byzantine]

I think you would see two separate business models evolve. One would be the bank as a traditional depositary institution and clearing house for commercial paper. Another would be a lending agency and venture capital firm. Jon’s answer is succinct and correct.