Winnie the Pooh

Economics Economics Questions
1

Arnold Kling posted an excellent blog at my favorite blog site tonight.

Writes Kling,

A depositor can put a jar of honey in the bank, claiming the right to withdraw it any time. The bank says, full disclosure, that it plans to take some of the honey jars on deposit and lend them to entrepreneurs who plan to trap heffalumps. If nothing goes wrong, the entrepreneurs will catch the heffalumps, exchange them for honey, keep a profit, and pay back their loans with interest. The bank will keep some of the interest as profit and give the rest to depositors, who get their honey back, plus interest.

If something goes wrong, though, I may lose some or all of the honey I put on deposit. One of the things that can go wrong is a lot of us wake up hungry and ask for our honey before the heffalump traps ever mature.

Do I make the deposit? The bank says that it has the law of large numbers going for it. The chances are really small that lots of depositors will wake up hungry at the same time. There may be only a one in a million chance that I won’t get my honey back. Maybe I’m willing to take that chance.

I’m not convinced that this sort of bank is what would naturally evolve. Instead, we might see a bank that offers two types of deposits. One would be honey deposits that bear no interest. You store your honey with the bank, and you can withdraw it at any time. It stays in the vault until you ask for it.

The other deposits are long-term deposits with penalties for early withdrawal. These do not all stay in the bank–some of them are lent to heffalump entrepreneurs. The penalties would decline over time. They would rise as the bank’s supply of honey on hand falls. The penalties would ensure that everyone who waits until the heffalump traps mature will get their honey back, with interest. There is no basis for a run on the bank based on pure fear.

This bank does not pretend to offer a free lunch. You cannot make an interest-bearing deposit unless you are willing to pay a penalty for early withdrawal. The bank can use the law of large numbers (the fact that it is unlikely that most people will not withdraw at once) to specifiy that low penalties will prevail normally. But if lots of people wake up hungry at once, the higher penalties will kick in, because the bank’s reserves start to drop.

What do you think of the pooh standard?

2

Pardon my ignorance (i’m new to all this)- but to me, this looks like the type of system that would arise in a free market.

In our current system, we had bank runs. But the bankers were able to convince the customers that their banks were still safe by lobbying the government to create new regulations and laws that (they claimed) would prevent future bank runs.

This would not be possible in a free market- in a free market people would realize that such a bank was not safe to put money in. So, the"pooh" bank – the safe, honest bank – would become more and more popular.

Question: in today’s system, wouldn’t a bank run be almost impossible because banks don’t actually lend out their customer’s money? An example of what I mean is: banks today never deny loans because they don’t have enough money to lend out.

note- I’m not saying this is a good thing, I’m just asking if I’m correct.