In a free banking system, what incentive is there for private banks to issue bank notes, rather than certificates of deposit featuring the name of the depositor?
Also, it’s easy to imagine the bank helping themselves to a small % of each deposit as a storage fee for deposits in the case of CD’s - as happens today with gold deposit banks - but how would this work for Bank Note issues? I mean, if I sell something for a Morgan 1oz Note, hold it for 6 months, then buy some goods with it, surely I owe Morgan Bank 6 months of storage fee. How would I be charged for this?
In a free market, banks wouldn’t be able to issue fractional reserve banknotes. Nobody would accept them.
Banks could issue warehouse receipt banknotes. A rational person would immediately redeem them for physical metal or a warehouse receipt in his own bank.
For warehouse receipt banking, a fee would be charged. It’d probably be low, 0.1% per year or less. There might also be a transaction fee.
A warehouse receipt bank would need to have public audits, so that customers know they aren’t secretly practicing fractional reserve banking.
For time-deposit banking (like a certificate of deposit), then there would interest. Suppose you had a 1 year time deposit redeemable for 100 ounces of gold and interest rates are 4%. After 6 months, you could sell this for 98 ounces of gold. If there’s a risk of insolvency by the bank, then it’s CDs will trade for less than face amount. Such a system existed before the Federal Reserve credit monopoly was created. It was called “Bills of Exchange”.
Cash preserves anonimity. Private conducts remain private. Bank notes are also free of charge, unlike warehouse receipts.So they are more attractive to depositors
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Hard to say. High transaction costs are one of the reasons why this form of business died out.
The reason warehouse receipt banking died was not because of high costs. There are State-imposed costs that make such business impossible.
The Liberty Dollar and E-Gold are two warehouse receipt banking businesses that were shut down by the State. It wasn’t that they were unprofitable. A group of armed thugs shut them down.
If you want anonymity, why not use physical gold and silver? There’s nothing a banknote accomplishes that you can’t also do with physical metal.
That’s an important piece of pro-State propagnada “Paper is easier and more convenient than metal.” How much is an ounce of gold worth? How much is an ounce of silver worth? It’s not that hard to carry a few ounces of silver or gold for purchases.
Suppose the bank charges 1% per year for a deposit. I deposit 100oz, and get a certificate of deposit worth 99oz. If I don’t redeem in the first year, my account will be debited by 1% again, so my certificate of deposit will now be worth about 98oz. And so on. Easy.
Suppose instead of a certificate of deposit with my name on it, I get an anonymous bank note. I spend it. That bank note could circulate for 1 year or for 10 years before someone finally takes it back to the bank for redemption. When they do so, the bank is going to want to subtract 1 or 10 years worth of fees for storing that 100oz of gold, is it not? So then the bank note must be discounted by how old it is - older bank notes will be worth less than newer bank notes. This sounds like a calculational nightmare.
What can be / has been done about this problem then? Before central banking, did any banks produce bank notes without the intention of fractional reserving? If so, how did they cope with this calculational problem?
A banknote is not a warehouse receipt or a certificate of deposit. It is a promissory note. It circulates in lieu of specie. If a bank issues it, it must keep the gold until the note is redeemed. The only way the note will be discounted is if the bank has broken its promise.
Your account will be charged the holding fee, not the note. If you can’t pay the holding fee, then you owe the bank the fee, not the note. If you don’t pay the fee the bank writes you off as a loss and covers your negative balance from its own funds. Good luck getting another account.
A certificate of deposit is a loan to the bank. It will be worth more when the loan is due.
A Warehouse receipt is a bank statement and/or a personal check.
The calculation is easy. x=amount of specie, y=amount of notes issued, x=y or the bank goes bust. Not too hard to calculate.
That is the simple way. For a more definitive explanation read Rothbard, Mises, and Bastiat. That should get you started. It got me started. The information is free on this website. Go to the literature section.
Thanks to NirgrahamUK and Avram for providing (on a different thread) this quote from Hoppe, which helps answer some of my questions here on this thread.
As I suspected, the problems I’ve explained, relating to the charging of a deposit fee, make the widespread use of bank notes, in a system where fractional-reserve banking is not allowed, unlikely.
So unless you’re lucky enough to have a checking / debit card bank account, you’d have to use gold even for large purchases I guess.
Reads to me like that’s only the case if you assume all gold is in the bank. So if I have the 100oz account and it’s a 1% fee annually, every year the note drops a percent in value? That completely ignores the whole nature of the note as a claim to that 100oz of gold. There’s no reason why that gold need be debited for my 1% fee, I pay with gold I have outside the bank, or they bill me, or my account gets debitted but the gold remains. The only reason such a system would inherrently fail or be unworkable it seems to me is if all gold were sequestered and there was none left outside any banks, any where. And, that being the weird but I guess possible case, would’t all notes then tend to devalue at a constant rate relative to deposit date?
The problem is that a bank note by its very nature will be passed around. Only the original depositor and the eventual redeemer will have any contact with the bank. Anyone in-between who holds the note will be getting their storage for free; the bank doesn’t know who they are.
Suppose I deposit 1oz of gold and ask for a bank note in return for it. The bank charges a 1% annual storage fee up-front. So I pay them 0.01oz. But I asked for a bank note precisely because I intend to spend it on a large purchase, not simply hold it. I buy a computer the next day with the 1oz note. Now the computer-seller has a claim to 1oz of gold plus 364 days of storage of that gold. The computer-seller could hold on to the note for a few months, and he will have his gold stored for free. Same for each holder of the note for that year. The value of the note will fall throughout the year, because the amount of “free storage” attached to the note will decrease. After the year is up, whoever is holding that note will need to go and withdraw the gold, or pay for another year’s storage. If the note expires, whoever eventually redeems the note will have to pay the storage fee in arrears, so after the year is up, the note will be worth less than 1oz. This way, no notes will actually be worth their face value.
When counting your bank notes, you can’t just go 1oz + 5oz +0.5oz = 6.5oz.
You will have to go 1oz (with 273days storage) + 5oz (with 62days storage) + 0.5oz (expired 17days ago) = ? To know how much money you’ve got, you’d have to take into consideration the storage fee attached to each note. This will be further complicated if each note is from a different bank charging a different storage fee.
I still don’t see it. If I am the banker and you want a note for one ounce of gold. I will charge you 1.01 ounces of gold for that note. I will not spend the ounce of gold but will redeem it when it comes back to my bank. If I issue the note, then I keep the gold until the note is redeemed.
If you open a demand account with me then I charge you periodically to store your gold. When you have this account I do not issue notes against it. You issue checks against it, and get charged periodically by me for storage. I have already covered the cost of issuing the note by charging you more than face value for the note. I take on the cost of long term storage by issuing the note. I make my profits by charging for demand deposits, and borrowing on certificates of deposit and lending them at higher rates of interest than I pay.
Again, if I issue the note, then why would I charge the note the storage fee? I agreed to store it for a one time fee upon issue, not a recurring amount as in a demand deposit.
If I were a banker I probably would not issue notes as it appears unprofitable, I would just open demand accounts for people to cover the cost of storage.
You would have no expiry date on the note? Interesting idea. It would eliminate the storage fee calculation problem. But then the banker would have to bear the risk of the note circulating for a very long time. Assuming 0.01oz is the going rate for a year of 1oz gold storage, you would have to charge a lot more than that for a 1oz note, because you are effectively selling eternal storage. The note could circulate for 50 years.
Exactly. Notes would not be produced without expiry dates, because it would not be profitable for the banker. And the calculation problem would make notes with expiry dates unpopular with customers. So I think the use of bank notes would be limited.
Okay. So the note is issued for one year. Does that mean the closer it comes to expiry the more it would be discounted? Also, what happens when the note expires and is not redeemed? I think the issuer is still liable to redeem the promise.
I do agree that note issue would be limited. Maybe in a branch banking process to eliminate the need for excessive redundant transportation.