I just read a paper by Lawrence H. White published in the independent review in 2003 entitled “Accounting for Fractional-Reserve Banknotes and Deposits—or, What’s Twenty Quid to the Bloody Midland Bank?”
Essentially, White is a supporter of fractional-reserve banking and he makes a number of arguments in its favor that I don’t agree with. But he does make one point that I need help refuting.
He starts out saying it is easy to see how banks would provide checking services on full-reserve deposits. The customer would deposit his gold into a checking account and pay a monthly “warehousing fee” to the bank for holding and securing the gold.
But how would the fees be paid if instead of depositing the gold into a checking account, the bank were to issue banknotes to the customer who is then free to exchange the banknotes with anyone else at will? How is the bank able to find out who is holding the bank note in order to bill them for the warehousing fees? Obviously tracking the owners of each bank note and forcing payment would be impossible, thus, White says, full-reserve banking would not work.
He suggests that banknotes could depreciate to accommodate this, but then you have a real messy problem of currency in circulation with multiple values.
Now my thinking is maybe instead of charging a monthly fee the bank could calculate the present value of total warehousing costs in perpetuity and charge it as a one-time fee at the initial deposit.
The problem I see with that is each time the gold is withdraw from the bank and re-deposited another perpetuity fee would have to be paid.
Can someone else take a crack at refuting this and providing an explanation of how warehousing fees would be paid in the case where the bank takes gold for deposit and issues free-circulating banknotes?
The correct conclusion is that uniform paper notes would not work. As I said a billion years ago in the FRB thread, a paper money in a free system can’t work because anyone can print as much as they want. It would sink into oblivion instantly. The only reason these notes holds up now is the monopoly in printing them. If the notes were serialized there would be no problem, especially not in tracking the individual to procure the fees, unless the fellow does not want his gold back, which the bank will be happy to accomodate. I’m guessing that free bankers probably don’t take this into account because most if not all are monetarists that assume anti-counterfeiting enforcement.
From chapter 11, Man, Economy, and State: " In many cases, individuals will find it advantageous to exchange the claims or evidences—the goods-substitutes—rather than the goods themselves. Paper is more convenient to transfer from person to person, and the expense of moving the goods is eliminated. When Jones sells Smith his wheat, therefore, instead of moving the wheat from one place to another, they may well agree simply to transfer the warehouse receipt itself from Jones to Smith. The goods remain in the same warehouse until Smith needs them or until the receipt is transferred to someone else. Of course, Smith may prefer, for one reason or another, to keep the goods in his own warehouse, in which case they are moved from one to the other."
I completely disagree that a gold standard would not develop on the free market. So what if people can print it. Its just as hard to create a realistic counterfeit dollar bill as it to create realistic counterfeit gold. The reason people don’t counterfeit gold on large scales now is because stores don’t accept it as payment. If Walmart allowed payment in gold, there would be people trying to pass counterfeit gold coins. But to Rothbard’s point, if you want to buy a pack of gum, what are you going to do, pull out your tweezers and drop a grain of gold on the counter? That would be silly, you could melt the grain in with other metals to form a coin, but that would be just as easily counterfeited as metal.
In Man, Economy, and State, Rothbard mentions “When a man deposits goods at a warehouse, he is given a receipt and pays the owner of the warehouse a certain sum for the service of storage.” This implies a one-time fee. What about continuing costs like the salaries of the security guards? How are they paid if the structure is a one-time fee? And if a bank wanted to charge a monthly fee to the depositor, how could it do so when banknotes are freely exchanged and the “depositor” changes daily?
Can someone who wants to make the case for an actual “gold standard” offer up some suggestions?
I don’t think this is a question that needs to be answered, much less by economists, for full reserve banking to be practical. With a free market and a commodity money, people are going to want it stored safely. Entrepreneurs will work to create profitable business models. This is basically just a negative proof fallacy—“it can’t be done because it hasn’t been done yet.”
I see no reason that commodity-money-backed paper currencies would trade at par with one another. This means that every note could be arbitraged against all other notes (and the backing commodity and/or commodity money). Just as government paper is discounted in part by its perceived redeemability, so bank notes would be discounted on the perceived ability of the bank to pay out on the notes (even, or especially, during a bank crisis). This arbitrage itself would act as a kind of steady-state bank run, as a bank inflates its paper, it would experience gold outflow just like central banks do when they inflated under a gold standard.
In my opinion, in a free banking market, banks would be under continual pressure from the arbitrage on their paper, which would tend to drive reserves to nearly 100%. Fractional reserves are not fraud if the bank notes are fiduciary IOU’s instead of money storage receipts. While it is “theoretically” possible that banks could get away with fractioning their reserves for very long periods of time, I believe that the marginal benefits of fractioning would eventually be outweighed by the benefits of holding real property title to the backing reserves in a strong property-rights-respecting legal system.
Also, the arbitrage of bank paper would mean there is no need for a bank to charge storage fees for its notes - paper would ordinarily trade at a premium to the commodity backing (due to the reduction in transaction costs which can be had by using paper instead of the commodity itself), so paper traders could profitably pay the bank a premium for its bank notes. The same thing would occur in reverse if a bank’s paper fell below par to the backing (traders would “run” on the bank, exchanging its paper in for commodity money).
Minting is not counterfeiting. Copying a receipt for a specific account is. Having receipts that are all the same is like everyone having the name “Person”.
My suggestion is that when Mr A deposits gold in a bank he is issued a plastic card, like a debit card. When he goes to a store they put it through their machine, which reports to the bank how much gold has been transferred to their acct by the sale. So the bank has a record of who owns what gold at every second. In other words, just like it’s done now most of the time anyway.
Two private individuals with no machine could call up the bank. “I’d like to transfer 20 dollars of gold from acct XYZ to acct ABC. Thank you.”
Thus, the bank’s computer knows how much gold is in anyone’s acct for how long, and can bill them accordingly.
For small sums, there would be silver coins, or something else, right?
LoL. Don’t follow you. It’s exactly the way it works now with credit cards. You have a receipt from whatever transaction to check against the charge you get from the bank.
We’re talking 21st Century here, not the stone age.
Reading this reminds me of the issue with digital gold currency, which is currently available on the market today. There are some DGC companies that dont disclose the amount of gold they have, and even the companies that do could quite easily be lying. In other words these companies could very well not keep 100% reserve ratio or their currency is completly virtual and not backed up by anything. Most dont allow independant bullion audits aswell.
Despite all this im pretty sure people still use their service.
Interestingly most DGC companies dont actually sell their currency direct to clients, instead they have to use third party digital currency exchangers, and here is the advantage of Third parties. DGC also has nifty little features such as non-reversable transactions. Heres a quote from wikipedia that explains it and also explains the implications of this:
“Non-reversible transactions
Unlike the credit card industry, DGC issuers generally do not bundle services such as repudiation. Thus having transactions involuntarily reversed, even in case of a legitimate error, unauthorized spend, or failure of a vendor to supply goods is not possible. In this respect, a DGC spend is more akin to a cash transaction while PayPal transfers, for example, could be considered more similar to credit card transactions. The advantage of this arrangement is that the operating costs of the digital currency system are greatly reduced by not having to resolve payment disputes. Additionally, it allows DGC transactions to clear instantly making the funds immediately available to the recipient. By contrast credit cards, checks, ACH and other reversible payment methods generally have a “clearing time” of 72 hours or more. The lack of payment repudiation in DGCs leaves an opportunity for third-parties to provide payment escrow services to buyers and sellers in untrusted environments, such as internet auction websites.”
As said before despite all the risks, people are using this type of service. It seems people are will to take the risk because potentially they have a lot to gain by (which is actually the essence of a business entrepeneeur).
Incidently the biggest risk for DGC atm is the state! Yes i bet you didnt see that one coming; the United States Department of Justice forced e-gold (a DGC company to liquidate some 10 to 20 million dollars worth of DGC.
As has been pointed out, the specific entrepreneurial solution is immaterial to the economic analysis. If the service is valuable, it can be produced at a profit, period. The mechanics of how you go about generating the revenues is not important from the point of view of economics.
Nevertheless, to answer your business question, I think that a bank that prints banknotes (and please note that banks used to print banknotes during the wildcat banking era in the US, when reserve ratios were much, much higher than they are today) would look at the discounted long-run cost of storing and securing the gold over against the premiums it can charge on gold in exchange for its notes. That is, if the bank expects the long-run cost of storing and securing an ounce of gold to be 3% of the value of the gold itself, it can break even by issuing its notes at a 3% premium on the gold backing. At 4%, it can make a profit. This is not rocket science.
This would have to be one of the most bizarre “attacks” on full-reserve banking I’ve seen. In addition to the already mentioned checking account, debit card, and many other free market solutions, here’s yet another one: A customer deposits 101oz of his gold in the bank and the bank issues him a 100oz “bank bill” redeemable in one year from the date of deposit for par (100oz), or at any date before that at 100oz + “pro-rated carry”. So the bill is redeemable for 101oz at the initial date of deposit, for 100.75oz after three months, for 100.5oz after six months, for 100.25oz after nine months, and finally for 100oz “at expiration” – reflecting the 1%/yr safekeeping fee. This is exactly how US Treasury Bills work except in reverse: A 1 yr 1% $100 bill is worth $99 at issuance and $100 at expiration, reflecting a 1% return for the bill holder.
I think clayton’s answer is the best. I actually came up with something similar by pondering it for a couple days.
Essentially, the hang up I had was on the idea of discounting the “long-run” storage costs. Reason being because if I deposit gold, pay the “long-run” storage costs, receive bank notes in return, use those bank notes to buy something, then the seller takes the notes to the bank and cashes them out for gold, ..I would have paid the “long-run” costs even though the gold was never kept there long term. Essentially, some people would be over paying for storage they aren’t using.
My solution would be to instead of discounting the long-run cost of storage…figure out the “average” length of storage…then discount that. That process would probably work out best.
So for example, if I want to deposit 100 ounces of gold. The bank might give me back banknotes worth 99.5 ounces of gold. And keep a half an ounce to cover the storage costs for the expected length of deposit (ex. 20 years).
The problem with your example, z1235, is that banknotes are money. If the value of the note your have in your hand changes day by day, it would be a pain in the ass to buy things with it. And you would need to carry around a calculator to figure out how much you have in your pocket.
Like i just said, I think the best solution is to charge a one-time fee at deposit equal to the present value of the storage costs over the expected (or average) length of deposit.
Actually, it’s not a problem at all. The gold sits in the vault as the myriad of exchanges occur before the “expiration date”. The “bank bill” actually comprises of two parts (one fixed and one variable): 100oz + “the benefit of safe-keeping them at bank XYZ until date aa/bb/cccc”. Both parts are needed and valued by most market participants which would be exchanging goods/services for it. To me, your concept of “one time fee” and “average length of deposits” seem too arbitrary and much less optimal, though still possible.
Either way, this is hardly a “problem” that would make full-reserve banking untenable.
So when you go to the store and buy something and the cashier says that will be one ounce of gold what do you do?
Open your wallet and say lets see … Here is a one ounce bill that expires in 4 years 325 days…at a monthly fee of .0416%…this bill is only worth .91 ounces …not enough
Lets see bill #2, this bill expries in 20 years 10 days…so its worth .99 ounces.
That is ridiculous and cumbersome.
The purpose of the one time fee is so that every bill is worth the same amount. If the bill says 5 ounces of gold, it means 5 ounces of gold, not 5 ounces minus 4 years worth of fees (or 3.475 ounces).
Sure you could do it that way with depreciating bills, it would just be a huge pain in the ass and no one would want to use them. I wouldn’t.
That is some great economic progress. A money with mandatory depreciation over time. Gesell’s dream come true. I wonder why the market has never come up with this.