I'd like to get your opinion on fractional reserve lending. What I
find so interesting about it is that it is inflationary in nature, yet
could exist without any sanction by the state at all.
I myself have no problem with fractional reserve lending, as long as
it is disclosed to the depositor that his money is being lent out.
I've noticed on several Libertarian websites a mistaken view that the
bank just "prints money out of nothing" in fractional reserve lending,
but this is obviously untrue.
My question for you: Assuming no central bank and no state-mandated
reserve requirements, would you be in favor of banks being able to
lend out depositor's money? (Some hardcore Asutrians think a bank
should only be able to lend out it's own capital, but this makes no
sense to me at all)
My (feeble) understanding of the situation is that the gov basically says it will cover the bank's debts up to the multiplier if the bank defaults. This leads us to the question of what the gov does if it doesn't have the cash to cover it? If it doesn't print it, then how does it come up with such huge sums in such short time spans? Nationalization and resale of major industries to Dubai?
What you mention is a different, but related topic. To me, there
should obviously not be an FDIC or any other type of bailout fund
ultimately paid for by taxpayers, (even though the FDIC charges banks,
history has shown us that the taxpayers always take it on the chin
when there are bank failures)
The issue I'm describing is as follows:
1. A bank takes in $100 of deposits from person A
2. The bank keeps say, $5 in reserves, and lends out the other $95 to
a person B. Assume the depositer understands this through full
disclosure by the bank, and that the interest he is earning on his
deposit is compensation for this risk. Assume no government
involvement whatsoever
3. In this example, M1 (currency plus checkable demand deposits) has
increased by $95. Hence the money supply has grown. Notice there was
no printing of money by a state or state-link (federal reserve)
agency.
My question for Phil, or anyone else willing to dive in, is do you see
anything wrong with the situation as described above? Some hard-core
Austrians do, because it is inflationary. I myself see no problem
with it, since the creation of money in this case is driven by
consumer credit demand, which is a natural market function. (likewise
when person B pays back the loan, there will be a net destruction of
$95)
I'm pretty sure Rothbard for instance was against such lending.
I don't see how it's inflationary. A promise of cash in the future is not cash since it assumes risk of non-delivery. When I buy a house with a loan, I'm really just having the bank buy it with cash from people who agreed to accept the risk of my defaulting in exchange for the interest rate.
The problem comes in when the gov attempts to eliminate risk. It transfers risk from where it belongs - those who choose to accept the risk in exchange for the benefits (the banks and investors) to those who did not choose too accept the risk and who receive no interest. In practice this transfers risk from the rich to the poor and therefore wealth from the poor to the rich.
There is no question that it is inflationary, unless you deny that
demand deposits are not money. I don't think you could find an
economist that would agree with you. In fact, demand deposits are a
component of M1, and as such are considered among the most liquid
forms of money there is. A demand deposit is not a promise to pay in
the future. It's a liability to pay immediately upon demand.
Wikipedia has a good summary on it. With respect to risk, it gives
three common options:
1. Opponents of fractional reserve banking who insist that notes and
demand deposits are 100% reserved,
2. Proponents of prudential regulation, such as minimum capital
ratios, minimum reserve ratios, central bank or other regulatory
supervision, and compulsory note and deposit insurance, (see Controls
on Fractional-Reserve Banking below)
3. Proponents of free banking, who believe that banking should be open
to free entry and competition, and that the self-interest of debtors
and creditors would result in effective risk management.
I find myself supporting #3, but I am pretty sure Rothbard supported #1. This makes no sense to me.
Why is it fraud if it is disclosed? The way banks meet their demands
if they exceed reserves is to sell their long-term assets to generate
cash. The risk of course is that everyone shows up for their money at
the same time and the bank can't liquidate their long-term assets to
cover these and the bank fails. In a free-banking environment,
interest rates would adjust to compensate depositors for bearing this
risk.
To make my point easier, let's set aside demand deposits for a moment,
and consider time deposits (such as a CD). These are also money (in
M2), and the creation of them (followed by lending) is inflationary.
Do you find anything wrong with that?
As I understand CDs, they are not (in a free market) risk free. The buyer assumes the risk that the seller will not pay on maturity. As long as the gov is not forcing the public to assume the risks taken by the buyer, then I don't see how any money gets created as the spending behavior of the involved parties will be adjusted based on the knowledge of the risks involved. People have risk budgets and if you owe or are owed more, you spend more frugally or eventually you lose your shirt and the money is moved to people who are less foolish.
But if the gov promises to print money to pay for the CDs in the event of default, then it is effectively printing money. Because the promise changes from "I will pay you back plus interest or you are out of luck and I will loose my shirt" to "I will pay you back plus interest or we will print money to pay you back". So the spending behavior of the participants will not be kept in check by the risks because a not insignificant part of the risk has been transfered to others.
Derek, I have maintained in
the past here that fractional
reserve banking is ok as
long as the depositer is fully
informed and there is no
coercion such as legal
tender laws. In the Austrian
empire, and even in modern
Austria and Slovakia there
are deposit banks and
investment banks. You pay
for storage in a deposit
bank. The conservative folks
who might say get the
proceeds of fractional loan in
a house sale and stick the
proceeds in a deposit bank
stop the chain of inflationary
redeposits right there. The
presence of deposit banks
thus puts a major check on
amount of times any given
dollar bill is recycled into a
loan in a fractional reserve
system. Thus you are
correct, in a system absent
any coerced guarantees, the
inflationary effects of the
same dollar bill being lent
and relent and relent would
be linited. Of course we live
with the implicit promise of
the Fed to make all dposits
good with the printing press
if Congress doesn't come up
with the deposit insurance.
Thus the depositer in this
world cares not a hoot for
solvency of the bank to
which the deposit is made.
The result is that the entire
banking system rests on 41
billion dollars of reserves
and monetary inflation rages.
The situation is horrible, but
banning fractional reserve
banking is the equally obsurd
extreme. Even Murray wasn't
perfect.
The corrosive effects of legal
tender laws and debt based
money are reserved for a
time of day more conducive
to thinking.
Meanwhile my molydenum
play Adanac Moly has tripled
in the last few months, and
for some unknown reason
silver had a poraxism of
buying this afternoon and in
a matter of minutes shot up
above the elusive 10 dallar
barrier to a 27 year high,
dragging gold up with it and
putting fire under gold stocks
including my fave NG. My
other fave is cwpc.ob, which
has a whole bunch of
potential oilsands reserves,
quietly consolidating the 5
dollar level.
Good stuff Phil. You might also add that private
insurance companies can help mitigate the risk for
depositors (companies that would presumably audit the
bank's holdings)
Also, did anyone catch this excellent speech from Ron
Paul a couple of weeks ago?
