I consider myself a Rothbardian in everything except in regards to banking and his advocacy of 100 percent reserves. I’ve been torn for quite some time (although i gave up on the debate a while ago) between free banking v. 100 percent reserve banking. If anyone could point me in the direction of some convincing 100 percent reserve or free banking literature that’d be great. Thanks.
Hans Hoppe - The Theory of Banking
http://www.youtube.com/watch?v=-3PKHVbOet8
http://mises.org/journals/aen/aen11_2_1.asp
AEN: What area of Austrian economics is most and least advanced?
MNR: Methodologically, we are pretty advanced, thanks to the work of Hoppe. But we can always use more since that is what sets us apart from the rest of the profession. And Salerno is doing great work on calculation.
Banking theory, however, has taken a very bad turn with free banking. We have to show that this is the currency and banking school argument rehashed. They have adopted the banking school doctrine, that the needs of business require an expansion of the money supply and credit. Moreover, the free banking people violate the basic Ricardian doctrine that every supply of money is optimal. Once a market in a money is established, there is no longer a need for more money. That is really the key point.
AEN: What about the argument that 100% reserves requires government intervention?
MNR: I regard fractional-reserve banking as an intervention in the free market, just as any crime against person and property is intervention. In the case of banking, the government is allowing the crime to be committed.
But how do we address the needs of trade argument, those who say that business has a demand for credit? Well, there are many things demanded on the market that are also crimes. There may be a demand for killing redheads. And there is certainly a demand for government loot. What’s so great about market demand? if it is not within a framework of non-aggression, there will always be a demand for fraud and theft.
The free bankers accept a kind of David Friedmanite anarchism, where there is no law, only people engaging in exchange and buying people out. If you have a group that wants to kill redheads, the redheads will have to buy them off if they value their hair. I think this is monstrous, the kind of anarchism would indeed be chaos. Just because there is a demand for something doesn’t mean it should be fulfilled.
AEN: One of the criticisms of this position is that it is normative and not economic.
MNR: Yes, but the response to 100% reserves is that bank entrepreneurs have the right to offer whatever fraction of deposits they want, which is also a normative position. Any discussion of policy is inherently normative. You can’t have free markets unless you have property rights,
AEN: Why isn’t private deposit insurance viable?
MNR: The same reason insuring any bankrupt industry isn’t viable. You cannot insure entrepreneurs because they engage in uninsurable risk. You can reasonably predict how many fires there will be in New York; the unlucky few who get burned can dip into the pool of resources. But entrepreneurship is not heterogeneous; it is completely unpredictable, and each attempt is non-random. The entrepreneurs assumes the risk. If an insurance company insures it, it becomes the entrepreneur. Who then insures the insurer? In the case of banks, either they don’t need insurance, since they are 100% covered, or they are uninsurable because they are taking entrepreneurial risk.
AEN: You have been critical of White’s book on free banking.
MNR: The White book says the Scottish banking system was more successful than the English system. But he doesn’t say one word about prices, inflation, or business cycles. His only statistic is that were fewer bank failures in Scotland than Britain. But what’s so great about not having failures? An industry that doesn’t have failures might be doing poorly. What if we applied this test to the Soviet Union, where no industries fail?
When you say one banking system is more successful than another, it seems the test should be less inflation and fewer business cycles. Yet this is never mentioned.
Rivardo was very wrong!
There was a couple of debates in the Independent Review:
Has Fractional-Reserve Banking Really Passed the Market Test? By Jörg Guido Hülsmann
Accounting for Fractional-Reserve Banknotes and Deposits—or, What’s Twenty Quid to the Bloody Midland Bank? By Lawrence H. White
Should We Let Banks Create Money? By George Selgin
Banks Cannot Create Money By Jörg Guido Hülsmann
I would say free banking is 100% reserve banking. Fractional reserve banks are inherently insolvent. In a free market without a central bank, fractional reserve banks would just collapse. People would eventually get the hint that putting money in a fractional reserve bank is the equivalent to flushing it down the toilet and would start putting their money in full reserve banks. Eventually, only full reserve banks would remain.
I don’t think it is necessary to lock up fractional reserve bankers for fraud in order to transition to full reserve banking. Although I certainly wouldn’t be opposed to it.
Chris,
Larry White and I have written many articles on the subject. There’s a failry comprehensive list, together with one of articles on the opposing side, at Bibliography on Fractional Reserve Banking I have recently written an article specifically addressing the matter of the origins of FR banking, called “Those Dishonest Goldsmiths.” You can download it at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1589709.
Pay no attention to the sort of shrill outburts you see on this page and elsewhere to the effect that fractional reserve banking is fraud, or that fractional reserve banks are necessarily insolvent. The claims reflect a very poor understanding of the nature of banking contracts. They also suggest ignorance of’ the long history of successful FR banking systems that operated on very small reserves, to their customers full satisfaction and with very great benefits to the economies they served. Adam Smith, for one, got this write. (And no, Smith wasn’t a statist, as Rothbard tried to claim.)
I’ve read your articles and I don’t find them convincing at all. Of course fractional reserve banking could be done legitimately with contracts, but that doesn’t explain how a FBR would avoid collapse when a large percentage of customers try to reclaim their deposits at once. Presently, the central bank prints money and bails out banks in this predicament. There would not be a central bank in a free market to perform this function, therefore I would put forward that informed consumers combined with occasional failures of FRBs would lead to a full reserve system.
Chris,
I don’t think you can have read, for example, my article “In Defense of Bank Suspension,” whioch addresses the question of how nt banks can contractually handle mass runs. But in any event, why suppose that a banking system isn’t any good justeecause it cannot handle a very unlikely event? A freekishly big snowstorm would cause many roofs to collapse. Would you therefore condemn the buildings in question? In economics, we don’t generally treat as optimal only those arrangements that reduce the risk of failure–even catastrophic failure–to zero.
Chris, +1.
This case is closed, as far as I’m concerned. Selgin’s defensive demagoguery notwithstanding, the question about “Free” Banking becomes increasingly less about its legality (i.e. contract fine prints related to depositor’s awareness/acknowledgment that they “allow” for their money to be lent out while still expecting immediate liquidity) and more about relevance and/or necessity. As I said in a recent thread on the subject:
https://forum.freecapitalists.org/t/booms-and-busts-before-the-fed-era/12291/86
Z.
I’m not sure how you can say a collapse of a fractional reserve bank is a very unlikely event. It happened all the time pre-fed. And I would say it would happen all the time again if the fed was eliminated.
Maybe you should take a course in money & banking. It’s cool though, Dr Selgin teaches on I believe.
Huh? How was he not a “statist”? What are you defining that word as?
Judging from your constant, yet vacuous, appeals to authority you have a problem understanding the very concepts of learning and knowledge acquisition. For you, it seems, they’re nothing more than cataloging what other people (more “prominent” and “respected” than yourself) have said on any matter. Try thinking with your own head for a change – it’s very liberating.
Z.
Mr. Seglin, I am curious. Here is what I understand on the fundamentals of money and banking, and I am curious if you could tell me if I err in my understanding of money and banking in any particular respect. I imagine it’s one of the most heavily contended things in the subject of economics, because the various modern heterodox schools have entirely different perspectives on it. Reading more books on money has led to me revise what I learnt from previous books in school or otherwise, and I am sure there is more I need to learn. Please remember that I am only a layman.
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Money is just a commodity that emerges in the free market compeitition of various commodities as the most marketable commodity.
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Money has otherwise no effect on allocation of scarce resources, because other resources will still remain scarce, and its scarcity of resources that determine their allocation, and not the supply of money.
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Monetary interference can still be used for redistributing resources, because currency debasement by Moors and Christians in Spain helped enrich monarchs in physical wealth faster than the peasantry.
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The banking system is essentially a secondary substitute for money, to provide ease and honesty in large transcations.
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Credit by banks is thus a means of increasing money supply, but it never matters what the supply of money is, when other resources are still scarce.
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Financial institutions that offer credit generally prefer to work on a system where they encourage people to make longer-term deposits, and use them to make shorter-term loans.
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The reason for the above is that rise in interest rates would otherwise reduce net interest income, and create financial risks from asset/liability mismatch.
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Banks, on the other hand, use short-term desposits to make long-term loans. They are more attractive for people as they involve tieing up cash for shorter periods.
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Essentially, interest rate risk management is greater in a non-banking financial institution than a bank, and thus banks are an otherwise riskier business that stand to lose more than FIs.
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However, since banks are insured by the government and get loans from them, they can pass of the burden of such risks to the taxpayer and inflationary monetary authorities, and thus so to all of us.
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Banks, under the current government protection, thus not only misallocate scarce resources in society, but also in a situation where their credit transactions are a risky business that have caused problems to depositors and have resulted in bank-runs in the past - a situation prevented by the misallocationary system mentioned in the previous point.
Certainly, I would not object to a simpler system of having only strict fixed deposits in financial institutions for my savings and having banks for only taking deposits and facilitating transcations.
Mr. Sanjay: the choice isn’t simply one between fractional reserve banks enjoying government support and 100% reserve banks. The alternative that has proven its worth historically is that of fractional reserve banks unsupported by any government insurance scheme.
It isn’t possible to review all the reasons favoring such an arrangement on a blog: Mises blog readers must resist the temptation to imagine that the compexities of banking and monetary theory and histopry are ones they can master simply by following blog comments, and especially so in light of the fact that many such comments are from anonymous contributors whose knowledge of these subjects may be very limited, to say the least. One has to take the effort to read relevant works. I’d suggest starting with W.S. Jevon’s Money and the Mechanism of Exchange, followed perhaps by Adam Smith’s chapters on money. Mises’ Theory of Money and Credit is more difficult and should come later. On the particular subject of free banking White’s Free Banking in Britain is essential. The second edition of White’s book addresses Rothbard’s attempts to dismiss the Scottish case.
No one likes being assigned homework. But there’s really no substitute for it in dealing with the hard questions concerning banking. You can only get little bits of valuable knowledge from a blog, and these are often adulterated with heavy doses of ill-informed assertions.
Professor Selgin,
Concerning Theory of Free Banking, most copies you can find are used copies and only a few in ‘acceptable’ conditions are generally affordable (under $50). Has there been any interest in finding a new publisher for the book, or printing another batch (or however it works)?
A man who asks “How was [Adam] Smith not a statist” doesn’t deserve to be taken seriously. To say that Smith wasn’t a consistent liberatarian, let alone an anarch-capitalist, is all well and good. To go from there to calling Smith a “statist” (and let’s please not pretend we don’t know what “statist” means in this forum) is ludicrous, notwithstanding Rothbard’s attempts to blacken Smith with that brush.
Tell me: was Menger a statist? Bohm-Bawerk? Was any “Austrian” economist apart from Rothbard and Mises “not a statist”? They were all no less guilty of rejecting anarcho-capitalism than Smith was.
The Austrian economics movement suffers very much from the nonsense perpetuiated by the army of die-hard Rothbardians who imagine that they are “doing” good economics by simply aping Rothbard and calling anyone who doesn’t a statist.
This is not a matter of my own dislike of anarcho-capitalism, by the way.
For Jonathan: Liberty Fund plans to put Theory pof Free Banking in its Online Library of Liberty series sometime soon.
To go from there to calling Smith a “statist” (and let’s please not pretend we don’t know what “statist” means in this forum) is ludicrous, notwithstanding Rothbard’s attempts to blacken Smith with that brush.
Do you believe Rothbard’s analysis of Adam Smith to be wrong? While Rothbard is particularly harsh, I don’t think his opinion of Smith is his own. I think that Rothbard was heavily influenced by Schumpeter, who was probably the first economist to be known for ‘bashing’ Adam Smith (History of Economic Analysis). I, unfortunately, have not read Schumpeter’s book, and so I can’t comment on the differences between Schumpeter’s analysis and Rothbard’s. From a review of Schumpeter’s book,
The most surprising fact about this part of the book is the debunking which Adam Smith suffers. After paying due deference to Marshall’s view on Smith, Schumpeter begs to differ. It may well be true that ‘.. . the Wealth of Nations does not contain a single analytic idea, principle, or method that was entirely new in 1776’ (p. i84). This is not the only ground for complaint, for ‘…in codifying, he dropped or sterilized many of the most promising suggestions contained in the work of his immediate predecessors… The blame is at his door for much that is unsatisfactory in the economic theory of the subsequent hundred years. . .’ (p. 308). In more detail the complaints are (p. 309) that he barred progress in value theory by pointing to the ‘paradox of value’, a paradox already resolved by his French and Italian predecessors (especially Galiani); that ‘. . .he dropped precisely the most promising suggestions proffered by Hume and (if he knew the Reflexionsb) y Turgot-still more those that he might have found in Locke-so that his successors started off from a formulation that was much more Barbonian [interest identical with yield on real capital] than that of any of these writers’ (p. 333); that his criticism of the Mercantilists was unintelligent, and even dishonest (p. 36i); and that, so far as the mechanism of international economic adjustment is concerned, he ‘. . . did not advance beyond Hume but rather stayed below him’ (p. 367). Moreover, he did not advance the analysis of the benefits of the territorial division of labour (p. 374), and Petty’s inspiring message ‘wilted in the wooden hands of the Scottish professor’ (p. 212). Soon after beginning to read Schumpeter I found myself making a cryptic note, 'P.O.S.A. '-Poor old Smith again!
It seems to me that Rothbard and Schumpeter were generally correct in blaming Adam Smith for setting back economic science. There was a wealth of knowledge developed by the Schools of Salamanca, Cantillon and the French liberal school, and not only did Adam Smith not pick up on much of it, but he successfully blotted these schools out of the picture thanks to the success of Wealth of Nations. On how much Smith plagerized I can’t comment, but neither do I think that was the most negative impact of Wealth of Nations on economic science.
As an interesting aside, William Stanley Jevons generally held a positive view on Wealth of Nations, but recognized Cantillon’s Essai as the true original treatise on political economy (as I understand, there is another book that might hold that honor, but which one doesn’t come to mind right now). Furthermore, in his review of Essai, Jevons critisizes for quoting and agreeing with Cantillon, and then misinterpreting Cantillon and getting the theory all wrong.
What specifically do you disagree with?
For the record, I’m not defending the view that since ‘Smith was a statist’ his economic analysis was valueless. Obviously, Adam Smith was not an anarchist. On the other hand, Smith does contradict himself in Wealth of Nations, and makes certain caveats which probably had more to do with his personal interests than actual intellectual agreement.
How do you think economic science would have progressed without the Wealth of Nations?