Stephan (or is it Stephen? 🙂 ),
Easy part first: I think your summary of the economic issues in the 4th paragraph is pretty much right on. Not sure I’d say “market failure” but I understand what you’re getting at (it’s only “mf” if one holds perfectly flexible prices as your ideal market, which I would think good Mengerians would not). Those are the crux of it though.
As for the first part: a fractional reserve bank deposit is indeed a loan as well as a deposit. The contract one signs upon getting a checking account should say that (as I believe they generally do). I will note, though, that my own experience with students and friends is that almost everyone understands that not all of their money is literally “in” the bank and that it’s being lent out. Even so, the contract should make this clear.
And yes, the contract should make no stronger claims about the bank’s obligation to redeem on demand being fulfilled than any other contract should about its terms being fulfilled. If you agree to hire me to perform a task, I can’t “guarantee” that I will perform it, I can only promise or agree to. If I break it, then I’m in breach and legal remedies should be applied. Same with demand deposits. If there’s a suspension clause, it’s gotta be there too.
I object to 100% reservers claiming “fraud” for what is really “breach of contract” given that checking account agreements do provide the requisite information.
In short: the notion that fractional reserves are fraudulent has always been absurd to me. Demand deposit contracts should (and do) spell out the terms clearly. If we agree on the “capitalist acts” point, then the dispute is indeed an economic one over the issues you raise.
Posted by: Steve Horwitz | September 04, 2009 at 11:54 AM
Steve:
“Not sure I’d say “market failure” but I understand what you’re getting at”
Right. I am critical of the freebankers’ very view that there is a problem that needs a solution; akin to the false problem of “market failure” that many statists point to. (On this see Salerno’s comments ( http://thinkmarkets.wordpress.com/2009/08/25/auction-markets-and-optimally-sticky-prices/ ) about “sticky” prices, arguing that this notion is an illusion and can’t be invoked as an argument for adjusting the supply of money to variations in its demand.)
“As for the first part: a fractional reserve bank deposit is indeed a loan as well as a deposit.”
? Do you mean the reserve part is a deposit? I suppose so but the problem is that in a straight deposit, the funds of depositors would be pooled as an “irregular deposit” (see Huerta de Soto on this, p. 4 http://www.mises.org/books/desoto.pdf ). But in this case the sum of things depositied is sufficient to cover the entire total of deposits, since it stays in the vault. So as a customer I am indifferent to having, say, ownership of 1 oz coil in a safety deposit box, or 1% ownership of a 100 oz. fungible sum–except that the cost of the former is higher.
But in your case if you say there is a 10% reserve ratio, then 10% of the money handed over is kept in an irregular deposit, but my 1% interst in it is not worth 1 oz. but only 1/10 oz. I mean I am not indifferent, as I would be in the case above. Unless you say the part that is a deposit is only for the 10% of my account value. But the problem with this is if I ask for all of my money you will use the gold to satisfy it. So it’s very confusing to regard it as part deposit. I think it is not part deposit. It’s misleading to say so.
“The contract one signs upon getting a checking account should say that (as I believe they generally do). I will note, though, that my own experience with students and friends is that almost everyone understands that not all of their money is literally “in” the bank and that it’s being lent out. Even so, the contract should make this clear.”
Good. But I do not think most people understand exactly what is going on. They seem to want to have it both ways (no offense, freebankers :)–they want it to be “in” the bank and to get interest too.
“And yes, the contract should make no stronger claims about the bank’s obligation to redeem on demand being fulfilled than any other contract should about its terms being fulfilled. If you agree to hire me to perform a task, I can’t “guarantee” that I will perform it, I can only promise or agree to.”
I agree with this, unless by your choice of words you mean to imply that even a depositary can’t “guarantee” it either. I mean I agree with you, so long as you recognize the categorical distinction between the ability of the depositary-custodian in the case of an irregular deposit, to repay, and the ability to guarantee it in the case of fractional reserves. They are similar only in that in both cases it’s possible for the bank to be unable to meet its promise–but in the case of the irregular deposit this can happen only if there is a violation of the depositary contract (embezzlement), or some kind of random accident (fire) that could be insured against.
“I object to 100% reservers claiming “fraud” for what is really “breach of contract” given that checking account agreements do provide the requisite information.”
Well in my view the 100% reservers have a point given their (in my view justified) view that the origins of fractional reserve are mired in fraud and confusion (I think Huerta de Soto is good on this), and also, based on their economic view of the futility and indeed instability of freebanking, in their suspicion that it’s highly prone to fraud. But I do agree with you that so long as the nature of the arrangement is spelled out, there is no fraud. But I will say that I have sensed many times in the people on your side of this debate a reluctance to agree to the freebanks giving complete and clear disclosure, as if you guys are afraid that too much disclosure will make it impossible for the FRB to get off the ground. I coudl be wrong about this, but I have sensed it and think I could dig up quotes … but anyway, glad you don’t object to this and would be willing to put your system to the test of full disclosure.
“In short: the notion that fractional reserves are fraudulent has always been absurd to me.”
It’s not so absurd if you understand the opponents view of the history of it, the state’s involvement with banking and the origins of frb plus its current involvement with centralized state-run frb; and with their view that freebanking is so inherently unstable and rickety that for it to ever exist there pretty much had to be fraud involved somewhere–I don’t agree with this compeltely, but their reasoning is sufficient to give cause for suspicion and hard scrutiny of the potentially fraudulent nature of this arrangement. But in the end, just as I do not think a ponzi scheme is fraudulent, I do not think FRB (inherently) is.
Further, on the face of it, there is a colorable charge of fraud: you are calling something a “deposit” that is NOT a deposit.
Jake:
“I still don’t understand the economic argument in favor of 100% reserves. How are loans made? Through CDs and mutual funds?”
Basically, through a promissory note. A mutual fund is more like an irregular deposit: you own a pro-rata share of the assets of the fund, which include securities such as stocks and bonds. I don’t think anyone thinks you can’t have loans without fractional reserve banking. The libertarian question is whether handing out frbnotes in exchange for “deposits,” and loaning out 90% of this money, and the customers then circulating these notes “as money” is unlibertarian; it is not, in my view. The economic question is whether this system addresses a real problem, or whether it’s nothing but an unstable shell game.
Posted by: | September 04, 2009 at 01:56 PM
Stephan:
I’m not going to debate the legal questions with you because I think DeSoto has it all messed up as George notes in the other thread and as Larry has argued in his review of the book (and his wonderful FEE lecture this summer). His language is all question-begging and ahistorical (in my view), so what we’ll end up doing is arguing over definitions, which will get us nowhere.
Rather than do that, let’s just agree that the crux of the debate is over the economic issues you noted in your first comment. And, to be honest, I’m really burned out on debating those issues after doing so for much of my week at FEE this summer, not to mention on the blogs over the last few months.
Your summary of the issues at stake is good enough for me and now I’m happy to turn the debate over to others for awhile – if for no other reason than I’m headed out for a departmental party in about an hour.
Steve, sounds good–but don’t be bummed. Look on the bright side–people who care about truth and ideas things this stuff is important enough to debate in peaceful fashion.
As for de Soto, I haven’t read the whole book, and from what I gather, I would not agree w/ some of his conclusions (if he has the per-se fraud view) but I do think some of his legal classifications and history of how the legal classifications changed or were manipulated over time, are useful. But I agree we should not debate by semantics, a tactic that drives me bonkers.
Let’s just agree for now that I am magnanimous enough to let you try to be a ponzi-scheming huxter in our free market, and will even try to help you out when your burned customers try to tar and feather you. 🙂
Stephan,
Thanks for the response but it was more of a rhetorical question. My point is that I see the causality in regard to the evolution of FRB in a different way than Rothbard does. In Rothbard’s account, as you know, banking was originally just a money warehouse business. Only later did banks realize they could loan out their deposits and earn a return for both themselves and the depositors.
The way I see it, it is the opposite. Anyone can store their own money but not everyone can make loans by themselves. Banking may have begun in some cases as a way for individuals to make collective loans. In this view, it is demand deposits (modern checking accounts for example) that come later when banks compete to provide liquidity to their depositors. I don’t have any historical evidence for this and I don’t know if it is a widespread view but if it is true it would seem to invalidate the case for 100% reserve banking.
In your example of promissory notes, the notes themselves could begin circulating like money and then the system would be no different from FRB. I don’t see any reform, other than a strict ban on the circulation of these types of instruments, that could prevent this.
Jake: “In your example of promissory notes, the notes themselves could begin circulating like money and then the system would be no different from FRB. I don’t see any reform, other than a strict ban on the circulation of these types of instruments, that could prevent this.”
I don’t think anything could or should prevent it other than economic reality. In my view the notes could not serve as money or money substitutes, and if there was a fractional reserve aspect to them then the system would be prone to runs. But who knows.
From Horwitz’s post “Mises and His (Apparent) Call for 100% Reserves” at “Coordination Problem” (formerly The Austrian Economists).
Steve,
Putting aside what Mises thought, it seems to me clear on libertarian principles that as capitalist acts between consenting adults are not aggression and are thus permissible, fractional reserve banking is fine on libertarian grounds so long as there is no fraud. Do you agree with this?
However, given the immense potential for confusion–customers are told they are “depositors” and they often think their money is “in” the bank; while most of it is lent out and thus they get interest–deposit should be distinguished from a loan. The customer should be apprised that he is receiving a credit instrument. Do you agree?
Any claims that he is “guaranteed” to be able to get his money out at any time are also problematic since a run is at least possible. So the “guarantee” language should not be used; this is especially so if the frbnotes contain a suspension clause. Do you agree?
If so, then the only dispute remaining is a purely economic one. You think frbnotes, credit instruments, can circulate as money; some Rothbardians do not (I am not sure). You think it’s possible to have a stable freebanking system that is able to arrange its affairs so as to avoid runs; some Rothbardians do not (I do not). You think the ability of freebanks to expand the supply of money in response to increased demand for money is economically useful, for “stickiness” and similar “market failure” [or so I perceive this argument] reasons; Rothbardians do not (I do not; it seems to me that there is no stickiness problem that needs a solution; and that the freebankers implicitly and fallaciously equate fiduciary money created out of thin air with wealth).
Do you agree that the economic issues in the last paragraph are the basic crux of disagreement between freebankers and 100% reservers? It seems to me that in a free society freebankers would be free to try to set this up; and we would see what happens. (Yes, I know some of you think we have historical evidence already; but the point is the libertarians ought to have no real dispute here; and the economists can either debate on apriori grounds, or on empirical ones–on the latter, one approach is to just try it and see what happens.)
By the way I gather at least some of you freebankers would prefer a 100% reserve gold standard to the current federal reserve fiat money fractional reserve system; and I know I would prefer your private freebanking fractional reserve system to the current centralized statist version of fractional reserve system.
Posted by: Stephan Kinsella | September 04, 2009 at 11:27 AM