Timed deposits sound eminantly sensible to me… but I heard that Austrians now generally favour free-banking. Why is that?
I don’t think you have posed a true dichotomy
things are also somewhat confused by the contested semantics of ‘free banking’
Ok, how about I put it this way. Timed deposits sound like a perfect solution to achieving a stable money supply and avoiding ABCT. Why isn’t it the consensus that this is the way to go? Presumably at some point, some Austrians must have pointed out some problems with it in order for it not to be the accepted standard. My question is, what are those problems?
http://mises.org/books/money_sound_unsound_salerno.pdf
Lately, a number of younger Austrians, particularly George Selgin
and Lawrence White, have elaborated the Misesian case for free
banking in greater detail. However, one can detect in their work a significant
shift of orientation away from Mises’s original goal of preserving
the integrity of monetary calculation by stanching as much as
possible the outpouring of fiduciary media onto credit markets. For
Selgin and White, the desirability of free banking rests on its alleged
usefulness as a means for sensitively regulating the creation of fiduciary
media in a manner which is consistent with the preservation of “stability,”
of the aggregate spending flow and, above all else, of the
fractional-reserve banking industry itself.
Bankers could still get away with fractional reserves (for a while) because most customers would roll over their time deposits.
I guess that “timed deposits” can be considered a type of “fractional reserve” system, but one in which the money supply can not expand over and above the monetary bas. I.e. M0=M1=M2=M3 .. the fact that customers can “roll over” their timed deposits as you say, makes no odds.
Have I got that right?
All deposits are de facto time deposits. Bank customers merely have a contractual right to withdraw their deposit at any time. In actuality, bank customers will stagger their withdrawals, and replenish their balances, over some period. If all withdrawals could be precisely predicted by a bank and its customers, a sequence of time deposits could have been arranged instead. The value of a contractual right to withdraw at any time is derived from the fact of an uncertain future.
Given the uncertainty of customers’ withdrawal schedules, fractional reserve banks make use of the law of large numbers. While the withdrawal schedule of one customer is highly variable and difficult to predict, the withdrawal schedule of thousands or millions of customers is much more stable. Banks can also take additional precautions, e.g. holding reserves in excess of how much will probably be needed, and holding safe and liquid assets.
Ultimately, the risk that a fractional reserve bank will be unable to meet its contractual obligations is very small, and customers are compensated for bearing this risk by the elimination of storage fees and earning of interest.
Re: All deposits are de facto time deposits… a sequence of time deposits could have been arranged instead.
I think this is untrue.
Consider this: The worlds first bank opens up and someone deposits $1000 in it. Then someoe else comes in and borrows $900. The bank gives the borrower a cheque book and tells them “don’t spend more than $900 with this”. The bank still has the original depositor’s $1000. The next day both men simultaniously go to the market to spend “their money”. Between them they can buy $1900 worth of stuff at the same time. I beleive this can only happen with our current system of FRB. How do both people get to spend a combimed $1900 at the same time with timed deposits? Indeed the “borrower” could spend his $900 first and the “saver” can spend his full $1000 despite the fact that $900 of his original $1000 has already been spent.
Mika,
You have asked me to consider a story in which a bank has one depositor, one borrower, and mistakenly predicts the depositor’s withdrawal schedule. I fail to see how that is an objection to anything I wrote.
4 Banking, Fractional-Reserve Ratios and the Law of
Large Numbers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .385
The reference in this area to the law of large numbers is equivalent to an attempt to apply the principles of insurance techniques to guard against the risk of deposit withdrawals, a risk assumed in advance to be quantifiable and thus techni- cally insurable. However, this belief is mistaken, and as we will see, it is based on a misconceived idea of the nature of the phenomena before us. Indeed, far from the type of events which correspond to the natural world and represent an insurable risk, banking related phenomena fall within the realm of human action and are therefore immersed in uncer- tainty (not risk), which by its very nature is not technically insurable.
re: You have asked me to consider a story in which a bank has one depositor, one borrower, and mistakenly predicts the depositor’s withdrawal schedule. I fail to see how that is an objection to anything I wrote.
Maybe I musunderstood, but what you originally wrote seemed to imply that all sequences of financial trasactions within our modern FRB system were somehow equivalent to, or could be made equivalent to transactions with timed deposits. I suspected this to be untrue and so constructed a scenario which could happen with modern FRB but which could not happen with timed deposits.
nirgraham,
I do not understand De Soto’s objection. Whether events “fall within the realm of human action” is irrelevant, and what does “technically insurable” mean? So long as withdrawal schedules are not entirely irregular and gravitate toward some average, I can see no valid objection to the law of large numbers in this context.
So long as withdrawal schedules are not entirely irregular and gravitate toward some average, I can see no valid objection to the law of large numbers >>in this context.
what’s the middle ground between regular and irregular? do you think that there is any basis for establishing empirically an average ‘anything’ in the sphere of economics? economics involves human beings, there are not the fixed relations that appear in the physical sciences. fire by arson and fire by lightning are fundamentally different phenomenon.
consider, flipping heads and tails, by the law of large numbers on any given day that i flip the coin 10000 times, heads and tails will both turn up close to 5000 times. The odds of there being a day when all 10000 flips come up heads, are so astronomically small, i daresay that this has never happened (excluding machines designed to always flip a coin precisely by design) 5x10^-3011(assuming a fair coin). However, who can dispute that there have been days where every depositor with a bank has wanted to withdraw his funds?
Mika,
You are correct. I intended to show fractional reserve and 100% reserve banking are equivalent in an important respect. However, as you note, this equivalence may break down if a bank overissues fiduciary media, because, unlike a fractional reserve bank, a 100% reserve bank could not overissue without violating its contractual obligations. But it is important to understand that such overissuance is not in the self-interest of the offending bank, since it will result in more withdrawals than it has reserves to satisfy (as per your example).
nirgrahamUK,
An average is just a product of a sequence of particulars. But are you telling me that withdrawals are so irregular and unpredictable that fractional reserve banks constantly run a high risk of failure? I do not believe that is a sensible position, and it does not fit with historical experience. Until now, I had avoided mentioning any real world examples of fractional reserve banking, stable or otherwise. It is a difficult matter. Banking of any sort can become more or less stable due to government regulation of the financial and monetary order. Certainly, I would argue that historical experience with bank runs is primarily the consequence of regulatory measures that increase risks, e.g. branch banking restrictions, private banknote prohibition, and mismanagement of the money supply. Of course, there would still be some lingering risk even in the absence of such regulations, but such risks do not come without compensating factors.
An average is just a product of a sequence of particulars.
yet some have meaning and some don’t. some can be used to draw conclusions, and some cannot.
But are you telling me that withdrawals are so irregular and unpredictable that fractional reserve banks constantly run a high risk of failure?But are you >>telling me that withdrawals are so irregular and unpredictable that fractional reserve banks constantly run a high risk of failure?
Of course, when fiduciary media is issued, and reserves are less than 100%, banks make bank runs possible…and the risks are high, see all the interference of the State which is motivated by that understanding…deposit insurance schemes and implicit bailouts are amongst the most obvious.
nirgrahamUK,
You write that “some [averages] have meaning and some don’t. Some can be used to draw conclusions, and some cannot.” Can you elaborate on this?
In any case, of course fractional reserve banking makes bank runs possible. However, while the state interferes to stabilise banking, it also interferes to destabilise it. Regulations like deposit insurance were responses to problems that previous regulations had created, not to the inherent weakness of fractional reserve banking.
power rating on your electric supply, gives you an average rate of energy transferred, good useful knowledge if you are planning to build a machine.
I can get a figure of the average amount that people in Idaho paid for potatoes at a particular store in a August of2010. If I am in the potatoes business and thus have an interest.
is it an insurable risk that the average price paid for my potatoes would be less in September than in August?
Regulations like deposit insurance were responses to problems that previous regulations had created, not to the inherent weakness of fractional >>reserve banking.
I wonder at how strong an argument you can make for that.
Re: But it is important to understand that such overissuance is not in the self-interest of the offending bank, since it will result in more withdrawals than it has reserves to satisfy…
Well whether it is “in the self-interest of the offending bank” or not, in practice, in our modern world, banks have used FRB to expand the money supply to a large multiple of the monetary base. With timed deposits this could not happen.
Modern FRB is very different to the use of timed deposits, both in theory and in practice.