23
Apr
2018
My Debate With George Selgin on Fractional Reserve Banking
A good time had by all. Note that comedian Dave Smith warmed the crowd up before we began, and he had a joke in there about a short Mexican guy staring him down. (I allude to the joke twice during the debate; I’m just explaining where that is coming from.)
Really enjoyed this debate, and in particular I hadn’t heard or considered Selgin’s point re: call loans. It seemed that you were both in full agreement that in a free society, banks would probably engage in fractional reserve lending – though you disagree to the desirability of it and to the extent at which a free society would permit the practice (in terms of reserve ratio standards).
I do wish that you had both spent more time on what seemed to be the crux of disagreement, which was whether or not it distorted the loan market. I feel you evaded his point (and Gene’s question) about whether you would feel differently if the practice was explicitly understood as a call loan. I would’ve switched my vote from you to Selgin on that basis. Don’t you have to concede that *if* that were understood, then yes it would change things, but that in the real world, its not understood, and if people did understand they would be less willing to participate?
This may be offset by another point that you made but didn’t elaborate fully, which is that the issue is that two different actors believe they have access to the same specific funds at the same time. Selgin’s point that the money ‘stored’ is not the specific money, but rather a claim to be paid in-kind seems damaging for this case.
But I would’ve liked to hear you elaborate more on this point, as it seems to point towards the idea that the problem is that these two actors are both basing their future economic plans on the availability of this money (which they believe to be a riskless assumption) when in fact there is some degree of risk as to the availability, and that its this conflict that contributes to the business cycle.
I think if the entire debate was confined to this one point between the two of you, it would’ve been better for it, rather than spending time on the general cases which can be seen in any number of sources.
“I do wish that you had both spent more time on what seemed to be the crux of disagreement, which was whether or not it distorted the loan market. I feel you evaded his point (and Gene’s question) about whether you would feel differently if the practice was explicitly understood as a call loan. I would’ve switched my vote from you to Selgin on that basis. Don’t you have to concede that *if* that were understood, then yes it would change things, but that in the real world, its not understood, and if people did understand they would be less willing to participate?“
He wasn’t avoiding that. Selgin kept bringing up arguments like that to counter the “it’s fraud” position, but Murphy wasn’t making that point. So you can call it whatever you want, but Murphy would argue that the actual act is still what leads to the boom/bust cycle.
Unless I’m misrepresenting Murphy, but I think I’m correct.
Selgin didn’t bring up call loans as a reference to fraud. Bob’s case rests on the distinction between loans and demand deposits – specifically that a demand deposit is NOT a loan. Selgin is claiming that demand deposits are loans with no fixed term.
Without this distinction, Bob can’t make the claim (as he does) that loaning demand deposits has a negative effect on the stability of the economy without also implicating time deposits.
He does address this issue. He even used an analogy of saying you “went to the gym for zero minutes…” or something along those lines, one of the times he made that point. You can say he didn’t make the case why banks would be loaning our demand deposits well enough, if that is what you feel, but he certainly made a case for it. He definitely didn’t evade the question.
Bob’s example here is very weak. Just change “zero” to “one” and the example falls apart. Realistically, no one puts a demand deposit in the bank for literally zero time, and so the example doesn’t effectively rebut anything.
No, you’re missing the point. Look below at Murphy’s response to me. It’s not about the maturity time. It’s about the money not only being loaned out to person x, but also being able to be spent at the same time by person Y.
With an actual call loan both the borrower and lender don’t have access to the money at the same time. Either the borrower or lender does, not both. As long as the lender doesn’t recall the loan then the borrower is in control of the money, but as soon as the lender calls it due then the borrower loses all control. That’s not the same as fractional reserve banking.
Sorry Dan but I feel you are the one who is missing the point. The call loan and demand deposit scenarios as put forth by Selgin are actually quite analogous.
When the lender (the depositor) recalls the loan, the borrower (the bank) does immediately lose access to the funds.
You are making the mistake that Selgin refers to (and that I already acknowledged in an earlier post, which you must’ve missed) about the misconception that the bank has loaned the ‘specific’ dollars of the depositor to another borrower – they haven’t.
We are talking about two loans, depositor to bank, and bank to producer and you are confusing them as if the depositor is loaning directly to the producer.
I’m not confusing anything. You’re comparing two things that are not the same. Are going to argue that call loans increase the money supply? I’d hope not if you know what a call loan actually does. But what Selgin is trying to rename a call loan does affect the money supply. These are completely separate acts. One is loaning our demand deposits, which causes the business cycle, and the other is an actual call loan.
Your semantic use of language keeps getting in the way. When you say “loan our demand deposits” you actually need to use those words because you again need the link to be that the bank is lending out ‘your’ money. But from the bank’s perspective, it is loaning out ‘it’s money – not yours. They are two separate transactions.
It’s not just that you disagree with Selgin, you’re also being willfully obstinate in understanding his very valid point.
When you go and ‘spend dollars from a demand deposit’ via chequing, you could just as easily be considered to be selling your debt asset to another.
Stop considering it from the perspective of ownership of ‘specific’ dollars and you will see Selgin’s point.
Look at Murphy’s reply to me where he says,
“Rather, the fundamental problem with FRB is that the claim that you hold, is itself acceptable as a money substitute in the community. So if you could make a call loan to GE, and then the note they issued to you was acceptable at the grocery store to buy food with, and in turn they could pay their employees with the same call loan owed by GE, then it would be like FRB.”
Do you see how being able to spend the loaner being able to spend the note issues by GE, and at the same time GE could use the same call loan to pay their employees would fundamentally change what happens when you currently make a call loan? Call loans don’t currently work like this. If they did, you’d be affecting the money supply and creating the boom/bust cycle.
So, Selgin can call demand deposits, “call loans”, until he is blue in the face but it doesn’t change the fact that actual call loans don’t preform the same function he would like his “call loans” to preform because they are not the same thing.
Michael, I’m looking at it from the perspective what these two acts actually do. A call loan doesn’t affect the money supply. Selgin’s “call loan” does affect the money supply. Mises would argue that the affect of Selgin’s “call loan” would be the start of the boom/bust cycle.
I’m not arguing semantics. I’m arguing that regardless of what you want to call these two acts they’re not the same thing. Call them purple bunnies and yellow dragons for all I care. I’m concerned with how these acts affect the economy. Do they have the same effect, obviously, the answer is, no.
And beyond my opinion that Murphy addressed this point in the debate, I’d ask how, exactly, is a call loan the same as a what Murphy is calling a demand deposit. Just saying “what if we called X action a call loan”, wouldn’t cause X to become a call loan. Let’s say I “call my loan” in Selgin’s scenario, is the resulting actions the same as you’d see in what we currently understand to be a call loan? I’d say the difference is clear when you think of the difference between calling a loan due, and the actions that take place as a result, vs pulling money out of the bank, and the actions that result from that.
That may not be clear. Another way to think about this is what would happen if all a company issued call loans to 10 people, and then they all call the loans due at the same time? In a normal call loan situation the company, or borrowers, would be responsible for paying the entire amount immediately.
In Selgin’s favored system, it’d be physically impossible for them to meet the demands of all the “call loans” were called at the same time. THIS is what makes them different and it’s why calling them “call loans”, or whatever else, wouldn’t change the fact they’re demand deposits in reality.
I have to think more on it to really solidify all of my views, but for the purposes of the debate I concluded that FRB is not *merely* a maturity mismatch. I.e. it’s not merely that you lend your money on really short terms and the bank invests it in longer projects.
Rather, the fundamental problem with FRB is that the claim that you hold, is itself acceptable as a money substitute in the community. So if you could make a call loan to GE, and then the note they issued to you was acceptable at the grocery store to buy food with, and in turn they could pay their employees with the same call loan owed by GE, then it would be like FRB.
“Rather, the fundamental problem with FRB is that the claim that you hold, is itself acceptable as a money substitute in the community. So if you could make a call loan to GE, and then the note they issued to you was acceptable at the grocery store to buy food with, and in turn they could pay their employees with the same call loan owed by GE, then it would be like FRB.”
Yeah, I think that’d be the same thing I’m saying except I say spending the note would be calling in the loan, if it were, in fact, a call loan. If spending the note doesn’t call in the loan, then it’s not a call loan. I agree completely with what you’re saying, I just think we’re saying the same thing in different ways.
“Yeah, I think that’d be the same thing I’m saying except I say spending the note would be calling in the loan, if it were, in fact, a call loan. If spending the note doesn’t call in the loan, then it’s not a call loan.” Dan, it is entirely possible to transfer ownership of a call loan note to someone else’s without calling the loan.
I’m not talking about trading the call loan on secondary markets. That wouldn’t expand the money supply. I’m talking about spending it at the grocery store. I’m saying that if call loans were being used to expand the money supply then they’re no longer what we think of as call loans.
Dan, what if you bartered your call loan note in exchange for a bag of groceries? You can do that without calling the note at all.
Keshav, let me try it this way. If call loans serve the same function that Selgin desires then we have no need for fractional reserve banks, right? We could have 100% reserve banks and just use call loans for the purpose he desires.
You know why Selgin wouldn’t go for that? Because call loans don’t increase the money supply and artificially lower interest rates. They don’t serve the same function that depositing money into your bank account does in a fractional reserve system.
But it will be hard for you to see why until you know how fractional reserve banks increase the money supply which is that boom I recommended explains pretty well.
Edit: …which that book I recommended explains pretty well.
I blame the stupid questions about Bitcoin or whatever unrelated things for the huge amount of points that were missing from the discussion on this debate.
But you shouldn’t have switched your vote. Did you switch your position? If you didn’t switch your position, but just thought Bob lost the debate, then you’re perverting the votes.
I wasn’t in the audience so didn’t vote. I think the truth is probably closer to Bob’s position than George’s, though I do think it’s somewhere in between (in that the business cycle effect would be present in a free society, but the magnitude would be low enough that ‘unstable’ might me semantically incorrect).
George made strong points that I had not fully considered that did make me reassess my position closer towards him though, and on that basis I would’ve voted for George.
I don’t see how anyone can think that the competitive banking that Slegin, White et al describe can be destabilizing.
Your case was very weak, almost non-existent, but would have been stronger if you could have shown any evidence of destabilization in competitive banking systems where government was largely hands-off.
Just because the currency is not backed 100% by gold does not mean it’s not backed at all.
In addition to whatever gold the bank has there’s the collateral for the loan, then stocks, bonds, annuities, or bills the bank owns, the personal property of the bank’s partners and finally, in the event of a bank failure, the willingness of the other banks to buy up any outstanding remaining notes at par.
That’s quite a large, diverse, and robust safety net for the public. And of course it worked.
All the notes were backed and for the most part were circulating only because there was real demand for them. Outside of the idiots who ran the Ayr Bank no one was pumping out huge volumes of notes without there being real demand and real backing for them.
Of course bankers make mistakes and could, in the short term, over issue. But that’s where the clearing system comes in. That is the engine that makes the whole system work. And is ignored by many people who comment on free-banking in general and Scottish free-banking specifically.
If you ran a bank that has really over-issued you are going to get eaten alive at the next clearing session, which was every two weeks. If you couldn’t net-out your currency and there was a pile left over you would have to shift assets to whatever bank held your notes. So you could lose gold or commercial paper or if it’s really bad, your own house. And the reputation of your bank could be ruined and you could lose access to the clearing system which makes your notes less valuable, maybe even worthless and you go out of business. Plus there was a chance of going to jail (or gaol).
This provided a huge brake on the note-issuance machine because who wants to go thought that?
The system worked very well, if it didn’t it would not have lasted. In fact there are still four Scottish banks that issue their own notes today! Though I’m sure the rules are very different now of course.
With their system the Scots went from a bunch of blue-faced, skirt wearing hooligans to one of the most advanced places on Earth. We could all use such destabilization!
And one point about the non-redemption period: Just because you couldn’t get gold from a bank doesn’t mean you couldn’t use your banknotes to get gold. Just go to a gold dealer and buy what you want. How is this a problem?
Finally, can you point to a 100% gold reserve system? That worked here in the real world? That had the kind of success that free-banking had?
You really don’t even come close to engaging with Bob’s position here. In fact, you could even say that Selgin overtly conceded the strictest interpretation of the resolution several times by admitting that it would be ‘less’ stable than 100% reserves.
The degree of instability would be a question that would require analysis of a specific circumstance, but Bob’s point is just that the institution of fractional reserves introduces an instability which would lead to a business cycle.
Are you saying that in these free banking economies, there were no cyclical disturbances of any magnitude whatsoever? Because that is what you would have to claim to take the particular line of attack you seem to be taking here.
Bob doesn’t have an argument to engage with. He has a theory. One that has already been proven wrong.
Where were the bank crises in Scotland and caused by so-called fractional reserve free-banking?
In other parts of the world where were the crises not caused by government regulations?
Part of this disconnect the 100% reserve theorists have with free-banking is that calling it fractional reserve banking is not accurate. But yet they persist.
Call it fractional gold-reserves banking. That’s accurate. And then point out all the other backing the currency had and the means that were in place to protect it’s value. But if you do it sounds so much less like a boogyman coming to impoverish you and yours and doesn’t get people fretting over instability.
The currency was fully backed, because of that there were no crises even when banks failed. Therefore there was no instability. Therefore Bob had no case to make.
And I want to point out for the record that I love both Bob and gold, not necessarily in that order though.
And if Bob wanted to give me a statuette of himself made out of solid gold I would certainly accept it.
And if Bob wanted to give me a statuette of himself made out of solid gold I would certainly accept it.
I’ll give you a claim ticket that you can redeem in 23 years. Basically the same thing.
“I don’t see how anyone can think that the competitive banking that Slegin, White et al describe can be destabilizing.”
They’re not arguing that a fractional reserve system prevents prosperity. I mean, we have prosperity in the US with a central bank for over 100 years now. The argument is that fractional reserve banking is what leads to the business cycle. It creates these unsustainable booms followed by the inevitable bust.
Warren wrote:
I don’t see how anyone can think that the competitive banking that Slegin, White et al describe can be destabilizing.
Well, Ludwig von Mises clearly agreed with the position I took throughout the debate. So maybe you understand Austrian business cycle theory better than he does, but presumably he’s not totally ignorant on the topic.
Your case was very weak, almost non-existent, but would have been stronger if you could have shown any evidence of destabilization in competitive banking systems where government was largely hands-off.
(A) George held up Canada as an example of a system that wisely didn’t meddle with banks, and also had the offhand remark that the Great Depression hit it worse than the US (at least initially). So if the Great Depression doesn’t count as a destabilized economy, OK.
(B) George pointed to Scotland as the epitome of his system in operation, and then under cross examination admitted they suspended specie redemption for over two decades. This particular example is so devastating that I actually understand why pro-Selgin people don’t even register it, as if I literally did not bring up any objections (as you are here claiming).
Was LvM even aware of the record of Scottish free-banking?
Did the business model of the Canadian banks cause the depression?
Since it looks like Canada was not hit as hard or for as long by the depression would that say positive things about their banking practices?
Again, where is the successful 100% gold-reserve system that we can compare to the free-banking system that we do know about?
Is it possible that people other than economists, like hard-headed businessmen, decided that a 100% gold-reserve system was unstable and thus never bothered to try that business model?
Perhaps the business model was so poor because it would not create sustainable profits for the investors. And this lack of profit, if one were to attempt the business anyway, would mean you could not attract enough capital or talent to make a strong go of it?
And being unable to do that, would mean that you would never get a country-wide system of banks or branches thus you’d never get the network effects that Scotland and Canada had and so would have less value for the person-on-the-street?
And without those folks wouldn’t you would have a stunted, inflexible, and low-profit enterprise that would find it hard to survive the normal knock-abouts that all businesses have to go through.
So is it possible these banks would be more prone to failure and thus upsetting or tearing apart what ever fragile web of commerce they did manage to create?
And wouldn’t that mean that 100% gold-reserve banks are more unstable and would create more instability than their less gold-backed cousins?
And this is true despite the fact that they were 100% liquid?
Being able to buy back all your banknotes is great but throwing your customers into chaos because you’ve failed at the other aspects of banking is no bueno.
Warren, you’re not addressing the argument. It’s not whether Selgin’s preferred system could result in positive results. I doubt you’d find an Austrian economist in the world that would argue that if we implemented the banking system the Selgin suggests that we wouldn’t be better off than what we have. Nobody is saying Selgin’s way leads to starving babies in the street. This is mainly an economic debate over what actually causes the business cycle, although there are some political philosophy arguments tossed around about whether FRB is fraud.
Anyways, if you want to argue against Murphy and Mises, you need to show why FRB doesn’t cause the business cycle and then you need to explain what actually causes it.
Why was Selgin even part of this? It’s obvious that it’s not free-banking as he proposes and writes about that’s the problem.
The other side of this debate should have been a central bank guy or maybe even a Greenbacker.
Well, Selgin would be a part of it because he denies that FRB, per se, causes the business cycle. Selgin attempts to address why his position doesn’t cause the business cycle. You, OTOH, are not even touching on it in your remarks, and don’t even seem to get that that is the crux of the debate.
I’ve not read everything Selgin has written (sorry George) so maybe I missed him saying that FRB as practiced by central bankers is akin to FRB as practiced by Scottish bankers and that both are innocent of causing the business cycle.
In any event FRB as practiced by competitive bankers has not proven to be a problem. His own research has shown that.
So why don’t the 100% guys point their cannons at the right ship, the S.S. Monopoly Issuer and let the MV Free-Banker sail on by?
Warren, are you claiming that there was no business cycle in Scotland from 1716-1845? (I’m not doing a gotcha, I want to make sure we are agreeing on the burden of proof here.)
The suggestion that I begged the question by pointing out that Canada was hit very hard by the Great Depression is mistaken. Canada’s depression was mainly a consequence of its heavy dependence upon exports to the U.S. When the U.S. economy collapsed, all of its major its trading partners suffered disproportionately. But the Canadian monetary system proved much more resilient than the U.S. system had. Despite a shrinking gold stock, itself the inevitable consequence of reduced exports, Canada’s money stock fell only about 13 percent in all, compared to a 33 percent decline in the U.S. money stock. The difference reflected the lack of Canadian bank failures and consequent relative stability of the Canadian money multiplier. (The loss of gold itself, on the other hand, would have caused a similar monetary contraction in a 100-percent system.) In short, Canada’s (relatively) free fractional-reserve banking system acquitted itself remarkably well.
George Selgin wrote: “The suggestion that I begged the question by pointing out that Canada was hit very hard by the Great Depression is mistaken. Canada’s depression was mainly a consequence of its heavy dependence upon exports to the U.S. When the U.S. economy collapsed, all of its major its trading partners suffered disproportionately.”
That’s fine, George, and I understand that *given* your worldview, you would interpret history in that way.
But can you at least acknowledge that at this point, your position is virtually non-falsifiable? You asked me to point to a system with a relatively unregulated banking sector that still suffered economic crises, and I did so. Then you said, “Well no, it’s because they traded with the U.S.”
So, in order to prove you are wrong, I need to find a country where:
(a) It has an unregulated banking sector
(b) It still has at least one major business cycle.
(c) It doesn’t trade with any country that had a regulated banking sector.
Is that your position?
Bob, you quite miss the point. No authority I know of claims that Canada’s banking system
was to blame for it’s depression. All authorities agree that the
U.S. banking system contributed to its
Depression. This isn’t simply
a matter of my pointing arbitrarily to some
extraneous factor. It’s not like I’m saying that
Canada’s banking system was not to blame
for it’s depression-woes
because Canada produces more maple syrup
or something like that!
Not every reference to historical
differences amounts to an attempt to render
a claim non-falsifiable. Sometimes it’s just a matter of
getting causation right.
George Selgin wrote: Bob, you quite miss the point. No authority I know of claims that Canada’s banking system
was to blame for it’s depression.
George, I’m kind of astounded at this point. Did we go through our whole debate in NYC and you not realize that I was saying, “Fractional reserve banking causes the business cycle”? I quoted you quoting Mises saying the same thing. Is Mises not an authority?
Of course not, Bob. I acknowledged and addressedthe ABCT in the debate. But I have yet to see any proof that Canadian banks contributed to a malinvestment boom there (I gave my reasons for saying why they were unlikely to have done so), and you haven’t referred to any such evidence. My main point remains the same: what “nailed” Canada in the early 30s was a real shock to its economy stemming from the collapse of its main trading partner. How the U.S.’s banking and monetary system contributed to its own collapse is the subject for a different discussion. But as for Canada’s own crisis, there is no ground, Austrian or otherwise, for holding its banking system responsible. That’s all I have been saying in any of my comments here, all of which are in response to your suggestion that, because Canada had a severe depression, that is ipso facto proof that FRB destabilized its economy. That at any rate is how I understood your comment above.
We’ve gotten to the point in the discussion where the replies are so far over to the side of my browser window that a reply button is not visible for me so I’m continuing part of the discussion here.
Bob asks: Warren, are you claiming that there was no business cycle in Scotland from 1716-1845? (I’m not doing a gotcha, I want to make sure we are agreeing on the burden of proof here.)
I have not researched this independently. I follow Selgin, White and crew on this. They have repeatedly claimed that there were no major problems with Scottish banking in the years from the early 1700s to the passing of the Peel Banking Act in 1844. In the early days the competition was very cut-throat but the option clause took care of that, plus they learned to live with each other and developed the clearing system which is the engine that made the whole thing work.
The Ayr Bank collapsed, but that was incompetence. Other banks failed but caused no runs. The non-redemption era could be seen as a problem. But gold still existed as did people willing to sell it, so if you wanted gold instead of banknotes you still had that option, just not from your bank. I would not call that instability or a crisis.
I don’t have it handy, hopefully if Selgin sees this he can post the link, but Selgin (or maybe White) wrote that over the length of time of the free-banking era the costs per person in Scotland for such things as notes going un- redeemed or bank failures or counterfeiting was less than a shilling per year. Which does not rise to the level of “crisis” let alone “instability.” And when compared to the value the system brought, was inconsequential.
Were there some minor inconveniences? Sure. Major problems? No. If there had been, critics would have already deployed them in their arguments. Also I believe Selgin and White and their posse are honest and would have mentioned the problems themselves.
I would say that whatever small problems there were were because a particular banker made a loan to someone he shouldn’t have. And that put credit or currency into circulation that should not have been there and if repeated or large enough would cause a failure. But this was a matter of competence, not a systemic issue with the business model.
For competently run banks there was no chance of over issue as every note was backed by collateral, bank assets, some gold, personal property, and the willingness of the other banks to protect the system. Like I said in a post above, the clearing system was remorseless. So if people are unwilling to over-issue, and don’t, can there be bubbles or boom-bust cycles?
A majority of the banks would all have to start over-issuing at the same time to create instability, and I’ve not seen any evidence of that.
Maybe we just have a different idea of what “instability” means for this issue. How close to perfect does a system need to be or to have been shown to work for you to not consider it unstable?
Warren wrote: Maybe we just have a different idea of what “instability” means for this issue. How close to perfect does a system need to be or to have been shown to work for you to not consider it unstable?
Warren, this is why I asked: Are you claiming there were no business cycles 1716-1845? You quoted me asking that, and then you danced around the question for 8 paragraphs.
Do you understand that I’m NOT saying, “Fractional reserve banking promotes instability because it necessarily means there will be periods where hundreds of banks fail”?
On the contrary, my main point is that, “Fractional reserve banking causes the boom-bust cycle, with periods of apparent prosperity followed by bouts of high unemployment and hard times, that people associate with modern capitalism.”
So I’m saying, do you think people in Scotland from 1716-1845 thought, “Wow, it’s amazing that we always have smooth, consistent economic growth, without boom/bust cycles like other countries suffer through”?
It makes sense that you think I didn’t even present an argument during the NYC debate, if you still don’t seem to realize what my argument was.
—Are you claiming there were no business cycles 1716-1845?—
No evidence has so far been presented for any. I’m sure you could find numerous instances of failing businesses and maybe even sectors but how do you determine the cause? Was it FRB or was it changing tastes, better competition, substitution, lifting of protectionism, or an embargo or something else entirely?
—-On the contrary, my main point is that, “Fractional reserve banking causes the boom-bust cycle, with periods of apparent prosperity followed by bouts of high unemployment and hard times, that people associate with modern capitalism.”—-
This period of prosperity was over 100 years! Close to 150 years! How many millions of Scots lived and died in an era where their banking system didn’t fail them? How is that not good enough? How is that not an example to follow? If there were problems they did not originate from, nor were they exacerbated by their banking system.
“Fractional reserve banking causes the boom-bust cycle” should always be preceded by “politically managed”.
—So I’m saying, do you think people in Scotland from 1716-1845 thought, “Wow, it’s amazing that we always have smooth, consistent economic growth, without boom/bust cycles like other countries suffer through”?—
No little spikes or dips in per capita GDP is allowed? Or employment figures or CPI numbers? Like at all? It has to be perfectly smooth and always upwards? Because that is a high bar. Are you sure a 100% system could manage that? Or are we just talking about big spikes and dips? The sort that show up even if you set the chart to years instead of months?
And what makes a period a boom-bust cycle as opposed to the normal Elvis like gyrations of an economy? What statistics are used to quantify this? Is there a consensus on which ones and how they should be interpreted? What weight is given to other factors that might be involved?
Warren we are completely talking past each other at this point.
“And what makes a period a boom-bust cycle as opposed to the normal Elvis like gyrations of an economy?“
Why are you commenting so confidently when you don’t even know the Austrian theory of the business cycle? The whole point of the debate was whether FRB causes the business cycle like Mises and Murphy said, or it is caused by other means as Selgin says. Selgin, at least, would never ask a question like that. He’d not only know what Murphy and Mises would say, but he’d also have an explanation for what he thinks is the ultimate cause of the business cycle. I just think Selgin is wrong. But you’re not even picking up on what was actually being debated.
No, I get it.
I’m confident because there’s actual history as opposed to just a theory behind what I’m saying.
I don’t consider myself an Austrian but I’ve read the basic ABCT stuff and it makes sense as far it goes, but it can’t prove that competitive banking as practiced in Scotland or Canada was unstable or would lead to instability.
And is there a consensus as to what constitutes a boom-bust cycle? How bad does it have to get? Can the numbers be massaged to show whatever result a person wants?
Are the other factors I mentioned taken into account? If so, with what weighting?
You can’t point to an area that has/had FRB *and* a crisis and then claim it was the FRB that caused it. Especially in an area that had…I’ll call it Vastly Superior Fractional Reserve Banking.
“And is there a consensus as to what constitutes a boom-bust cycle? How bad does it have to get? Can the numbers be massaged to show whatever result a person wants?”
No, you don’t get it. You wouldn’t have written that if you got it. You need to study ABCT more thoroughly.
I don’t need to become fluent in the ABCT to know that the history I do know beats the theory.
There is no proof for your position in regards to free-banking.
There is nothing about it that did or would lead to a boom-bust cycle.
This is getting to be like debating with the man-made global warming people.
Theory theory theory!
Well here’s some actual history….
NO! Theory theory theory!
You don’t even have a 100% system you can point to! Therefore it’s not possible to contrast and compare. How do you expect to prove anything without facts?
You ever hear of the Dunning-Kruger effect?
(I haven’t watched the debate yet, but will.)
“I don’t need to become fluent in the ABCT to know that the history I do know beats the theory.”
There’s no such thing as an unbiased historian because you need a theory in order to interpret the facts.
That’s why Dan’s telling you that you wouldn’t say the things you’re saying if you understood ABCT.
History can *exemplify* the correct laws and theories at play, but it can never prove or disprove theories – only logic can do that.
Rereading the following: “No authority I know of claims that Canada’s banking system
was to blame for it’s depression.
“George, I’m kind of astounded at this point. Did we go through our whole debate in NYC and you not realize that I was saying, “Fractional reserve banking causes the business cycle”? I quoted you quoting Mises saying the same thing. Is Mises not an authority?”
My reference is specifically to Canada. Where does Mises discuss what happened there? Do you actually suppose the logically validity of the ABCT–to grant it such–suffices to “prove” its relevance to any and all particular crises, with no need to refer to any empirical evidence–no need to show what happened to Canada’s money stock, spending, investment, etc.? Is the theory “a good fit” no matter what the facts might suggest? I am not talking here about logical validity: logic can’t tell you whether the case fits the theory’s assumptions, let alone whether, if it does, the magnitudes of the effects attributable to the causes the theory posits are large or minuscule, or whether some other theory better explains what happened. You need facts to ascertain these things.
George, I think this has to be my last comment (now that I’ve ascertained what your position is). I understand what you are asking, but since you are denying the basic proposition that FRB causes the boom-bust cycle, I’m not sure what evidence I could give you. It’s like I’m saying, “Bullets kill people,” and you say, “Not if a silencer is used,” and then I point to a guy being killed with a bullet fired from a gun with a silencer, and you say, “Ah but he fell and hit his head, that’s what killed him.”
Even if I pointed to the money stock in Canada doing the normal thing you’d expect in a typical boom-bust cycle, wouldn’t you just say, “Those loans that turned out to be bad, were actually good loans, at the time they were made. The bankers and entrepreneurs involved couldn’t have known that the US export market was poised to collapse”? So what would be the point of me going and looking it up?
OK, I’ve watched the debate (Thank you, both), and I’d like to have a go at unwinding the whole legality/economics impasse.
Selgin says:
“Do you actually suppose the logically validity of the ABCT–to grant it such–suffices to “prove” its relevance to any and all particular crises, with no need to refer to any empirical evidence …”
The economics of fractional reserve banking is a completely separate issue from its legality or whether or not it’s fraudulent.
To understand this, you have to first understand that producers cannot produce anything they want and have it sell at the price at which they want it to sell; Consumers have to want what is being produced, and they have to want it at the price offered, otherwise that producer will take losses when he produces more than what consumers will demand.
Consumer goals determine the profitability of businesses – businesses cannot will consumer demand into existence.
Now, savings acts in the same way, with savers choosing to save based on their goals of future versus present consumption, and the amount of their savings actually expresses information about those goals and what they believe their savings will be worth in a future that they intend to spend it.
The amount of savings, being also a postponement of consumption of real goods, actually represent *to the saver* (key concept) real goods with *expected* value relative to the value of the goods in the future for which they’re saving. And because savers believe their savings to represent claims on real goods, the amount of real goods available to be sustainably used in production is limited to the saving’s *perceived* future purchasing power.
If businesses produce, with borrowed money, more than what consumers will want to consume in the future, then those businesses will have made a malinvestment.
Regardless of the legality of call loans, and regardless of whether or not fractional reserve lending is fraudulent, if the savers, *themselves*, believe that they own the money they are saving at the banks, and that their money is not being lent out (because that’s not how they understood the arrangement, for whatever reason), what that means is that their saving/consumption patterns are based on a purchasing power that will necessarily be different if the banks lends money *that savers did not expect to be lent out*.
The reason the purchasing power will be necessarily different is because businesses would not be able to borrow money that the banks aren’t lending, and therefore the demand for the materials used in additional production projects would not compete for existing demand for those same materials.
The increased demand will bid up the prices for those materials, thereby changing the purchasing power of savers’ money. Not all at once, to be sure, but that’s why Bob was saying that it affects certain sectors of the economy before others.
The key point is that consumer perception is the only thing that has economic relevance with regard to the business cycle, because the consumer is the king in the economy – always has been and always will be.
The legality or supposed fraudulent nature of fractional reserve banking is economically irrelevant. (Which is not to say that the discovery of legality or fraud will not alter consumer perception and thereby incentivizing consumers to change their demand.)
And that’s why fractional reserve banking necessarily results in artificial booms (production that exceeds consumer demand). And since the logical result of producers exceeding consumer demand is a correction period, a bust is what results from artificial booms.
Unfortunately George, the magnitude of the effect is not relevant to the debate you had with Bob. This is precisely why your examples of Canada or Scotland do not suffice as evidence against his position unless you are willing to say that there was a complete lack of business cycles during those periods.
Like Bob says, it is possible that there was a concurrent destabilizing effect of FRB which, while potentially more minor, nevertheless existed.
Bob says “FRB results in business cycles” (no claim related to magnitude)
George says “But Scotland/Canada had stable banking sectors”
Bob says: “You yourself admit that Canada was hit by the great depression, so you can’t say that it was stable”
George says: “But that was for other reasons. You can’t prove it was FRB”
Bob says: “But it wasn’t my example of a case of FRB causing a crisis – it was YOUR example of a stable banking sector”
George says: “I don’t understand your point”
Right. The magnitude depends on the extent of the malinvestments.
And since what makes an investment a malinvestment is how well the investment anticipates future consumer demand – something that is entirely based on the subjective valuations of consumers – the specific prices, or even the speed of changes in prices, cannot tell you whether malinvestments are being made or not.
(Which is why we insist that historical facts cannot, themselves, show the causes of the boom/bust cycle.)
What we know from logic, however, is that the savers’ money means something to the savers, and when investments do not coincide with the goals of savers, there is a mismatch between production and future demand.
A 100% reserve banking system would prevent the systemic kinds of malinvestments because, again, producers can’t borrow what banks can’t loan.
We are all Free Bankers and that is what is most important here. We might not agree what it exactly amounts to finally but one way or another it would stop the Boom & the Bust.
Thanks for the nice discussion there!
Well isn’t that the debate? Whether fractional reserve free banking would actually end the boom and bust?
Yes and no. Yes because it is a fascinating discussion, and no because it is ultimately pointless, since free banking would stop it either way.
Because either fractional reserve banking wasn’t the problem but government laws and central banks were and under free banking low reserve ratios would remain, or fractional reserve banking was to blame and then market forces would push the reserve ratio rather close to 100%.
I don’t think it is ultimately pointless. It is theoretically possible that we could have free banking, and that banks and consumers would voluntarily choose reserve ratios below 100%. If they did, then either ABCT is correct and it would still result in booms and busts, or it is wrong and the theory needs to be reworked to explain what actually causes the business cycle.
I have no problem arguing in favor free banking regardless of who is correct on what banks would actually do in that environment, but we don’t need to wait until we live in that society to study business cycle theory and advance economic theory. We don’t need to wait and see what happens with minimum wage laws to advance economic theory on the subject.
I feel like a lot of people watching this debate don’t realize that if Selgin is right then the theory Mises came up with to explain the business cycle is wrong and needs to be reworked. It’s not just a minor debate amongst political allies. It’s a debate about one of the central advancements that Austrians made towards our understanding of economics.
To Dan’s point here, its not pointless because in the free market world, what people believe causes the boom bust cycle still matters. Prior to the germ theory of disease people may not have prioritized hygiene. With that information, they can make better choices.
Similarly, if its true that the business cycle is caused by fractional reserve lending, people need to be convinced of that and incorporate it into their decision around which banks (or more likely, which issuers) to invest themselves in.
@Dan
Fair enough.
@Michael
Market forces (=losing your money) would do the teaching sufficiently, though of course there speaks nothing against trying to teach it by thinking in advance about it. But usually most people only learn through hard lessons of reality.
skylien wrote: “We are all Free Bankers and that is what is most important here. We might not agree what it exactly amounts to finally but one way or another it would stop the Boom & the Bust.”
Heh, you’re right, and I realized that too. But on the other hand, it makes a huge difference if George is saying, “Free banking will stop the boom-bust cycle, because it fosters the optimal reserve ratio which might be as low as 3% as it was in Scotland. I love how extreme fractional reserve banking allows the community to mobilize its savings.” Contrasted with Bob (and I claim Mises) saying, “Free banking will stop the boom-bust cycle because it will foster reserve ratios close to 100%. As we all know, *any* fractional reserve banking causes the boom-bust cycle and causes a mismatch between investment and genuine saving.”
Yes sure, as I wrote above to Dan, it is a fascinating discussion which I am swinging back and forth all the time.
Yet we should emphasize that in terms of what we can actually possibly change (a push to Free Banking) we stand on the same side and we need to go together there. What Free Banking finally would do is for us only to watch and maybe one day settle a wager… 😉
Here’s a point that went unnoticed on Selgin’s position:
Selgin thinks fractional reserve banks serve an equilibration purpose when they make available to the loanable funds market the funds that are stored there, saved, at their accounts. holding that position implies that:
1. he agrees with any keynesian out there that a money that a money that is saved is an investment that is lost, and thus he should probably agree with the conclusions about the government taking out the more savings it can from people and using it in some form of government “investment”;
2. fractional reserve banking is inherently depressing to any economy. the only acceptable, good bank model is the zero-reserve banking, where all “saved” funds are made available to the community to be used as investment.
Am I right?
You’re definitely right.
At 29:40, he says:
“A quick sides: While fractional reserve banks aren’t to blame for malinvestment, they play a crucial role in avoiding underinvestment, which happens when lending falls short of voluntary savings.”
So he definitely believes in the Keynesian Paradox of Thrift.
To be sure, savings that are sitting in a bank vault (that is, not able to be lent by the bank) serve the same function as the food you store in your pantry, except that it has the potential to do so for typically longer periods, and to do so for many more goods than just food.
Saved resources are doing exactly what savers intend them to do. There is no Paradox of Thrift.
No, on 1. I think you are totally wrong. Selgin gave no indication that he thinks saving is a problem in the way Keynes did.
Also on 2 you are wrong. Selgin clearly said banks need the freedom to adjust reserve ratios based on market conditions. He never said banks are inherently depressing the economy if they do not lend out all their reserves out.
The guest above said it much better than I did.
1. He didn’t say it explicitly, otherwise it wouldn’t go unnoticed, but as the guest above pointed out, yes he gave indications.
2. Yes, he clearly said that, and that’ the problem: what he clearly says contradicts his belief in the Paradox of Thrift, implied elsewhere.
I don’t see how “he gave indications”.
The PoT says when individuals save the overall savings of an economy can fall.
The only thing I heard Selgin say was the same thing that guest alluded to – that under FRB lending would be more efficient – i.e. more savings from depositors would find their way to investments than they would under a 100% reserve system.
It does not follow from that at all that individual savers in a 100% reserve system could cause savings in an economy to fall overall, and I didn’t hear Selgin ever giving any indication of this, explicitly or implictly.
Not to mention the fact that Selgin believes that in an FRB system individual savers would cause the economy to grow. How in the world is that consistent with the PoT?
“… that under FRB lending would be more efficient – i.e. more savings from depositors would find their way to investments than they would under a 100% reserve system.”
To believe that saved money is inefficient because it’s not being lent out *is* to believe in the Paradox of Thrift.
I don’t see where “he gave indications”.
The PoT says that individual saving can cause total savings in an economy to fall.
The only point Selgin made was what guest alluded to – that under FRB savings would be invested more efficiently than under a 100% reserve system.
It does not follow from this at all that under a 100% reserve system savings overall would fall when people individually saved.
Not to mention that Selgin strongly suggests that under FRB more “saving” would mean more investing and in turn more savings. How in the world is this an indication that “he definitely believes in the Keynesian Paradox of Thrift.” What he suggested is the exact opposite of it.
I do want to make a point of agreeing with Selgin that under 100% reserve banking, there’d be no circulating bank notes; But I would consider this a feature, not a bug.
I believe the problems of fractional reserve banking begin with a belief that negotiable “certificates” can be a legitimate form of money, rather than the fraud I believe them to be.
I didn’t want to distract from the main sticking point, which is the legality/economics impasse, but I noticed that he brought this up and thought it might remove a roadblock to him (and his adherents) understanding my arguments in favor of Bob’s side of their debate.
I agree on that too.
I like the idea of circulating notes, but debit cards, nominal checks and bank transfers are enough for a society to work.
Also, there could indeed be a way to have circulating bank notes under full-reserve banking: the notes could just have an expiration time, or some form of fee/interest formula printed on them, thus if A puts money on bank Y and gets notes, A can then use his notes to pay B, but B would only accept these notes if they were still under the validity time. If B accepts expired notes or forgets to deposit the notes for a while, he would pay a fine for the time that deposited gold went unpaid. If A or B have notes and went a lot of time without depositing them on the bank again, the bank could just confiscate their gold.
To be sure, I’m a 100% commodity money guy, so I believe that, ultimately, only circulating *physical* commodity money could work (such as, but not limited to, gold).
But, as Bob Roddis has noted on this blog, as long as everyone understands and agrees to the terms, the market would prevent systemic crises.
I just happen to believe that, under a less-than 100% commodity money system, and without coercion, the misallocations of resources that would necessarily result from it would be corrected by the market before it could become systemic.
Bob, is it your position that any secondary market in call loans, i.e. buying and selling of call loan notes, is inherently problematic? Or is it only problematic if it’s used as a medium of exchange?
Keshav, the latter.
Bob, how does that make any material difference? If someone makes a $100,000 call loan to a bank and then the bank lends it out, the entrepreneur will think “Wow, the community has $100,000 in savings it’s willing to lend me. I guess I should expand my business with the 100 grand.” Meanwhile the person who made the loan to the bank will be thinking “Wow, I have a $100,000 in call loan notes that I can sell for cash and buy a 100 grand worth of goods. I guess I can go on a spending spree.” So they’re both making use of the $100,000. So why doesn’t that distort the debt market and create an unsustainable boom?
The whole point about call loans seems wrong to me.
If bank deposits were call loans, banks wouldn’t repay immediately, there would be a time delay; or at least there would be some for of fee paid by the lender (the bank customer) for calling loans.
Giovanni, call loans in the real world do not require lenders to pay a fee for calling the loan. And whether the borrower pays instantaneously or pays after a slight time delay does not affect the fundamental nature of the relationship.
Thank you. I have more questions about call loans:
1. Who does this in the real world?
2. Does a call loan ever go unpaid (as in a default)?
3. What is the interest rate on a call loan?
In other words, it seems to me that a liquid secondary market in call loans would have identical economic effects as call loan notes being a medium of exchange.
Keshav, are you arguing that call loans, in the traditional sense, affect the money supply?
Dan, I’ve never studied economics in general, or Austrian economics in particular, so I can’t tell you what does or does not affect the money supply. But what I am saying is that even if call loan notes are not a medium of exchange, but did have a liquid secondary market, they would have exactly the same economic effects on the business cycle as they would have if they were a medium of exchange.
Tell me this: what is the mechanism by which fractional reserve banking is supposed to create an unsustainable boom? My understanding, based on what Bob said in the video, is that when person A saves a hundred thousand dollars, and person B invests that hundred thousand dollars in a business, there’s no unsustainable boom, but if person A and person B are both able to spend the hundred thousand dollars, then there is an unsustainable boon. So what I’m saying is that if person A has $100,000 in call loan notes, and there’s a liquid secondary market in call loans, then person A and person B will both be able to spend $100,000. So shouldn’t that create an unsustainable boom?
No, because selling your call loan on the secondary market doesn’t affect the money supply. If I have a call loan with Bob and then turn around and sell you the note, it’d be as if you made the call loan with Bob. That’s fundamentally different than what happens when I deposit money in my bank which does affect the money supply. That’s the whole point of FRB.
Dan, how is the transferring of ownership of a call loan note from one person to another different from transferring funds from one bank account to another bank account? They’re exactly analogous.
You’re not just transferring funds from one bank account to another. Call loans don’t increase the money supply depositing money into a bank account, even if you call it a “call loan” in a fractional reserve system expands the money supply. To see why, I’d recommend Murray Rothbard’s The Mystery of Banking.
Once you see how banks expand the money supply through fractional reserve banking you’ll see how that is nothing like what happens with call loans regardless of whether they’re traded on a secondary market.
Edit: Call loans don’t increase the money supply. Depositing money into a bank account, even if you call it a “call loan”, in a fractional reserve system expands the money supply.
Dan is just repeating the same stuff without explaining why.
Do not believe him, Keshav. There aren’t any absolute truths about money supply in Austrian economics, instead people disagree all the time about what constitutes money supply and what doesn’t. Call loans could indeed be considered as money supply and your point makes total sense.
Giovanni,
I’m not making shit up. Perhaps you’d care to show us which Austrian economist argues that call loans are part of M1. Or you could explain by what mechanism call loans expand the money supply and artificially lower interest rates.
I linked to a book that explains how fractional reserve banks expand the money supply and artificially lower interest rates. It’s not like I simply told Keshav to take my word for how it works. I figured he would find it more useful to get an explanation from someone more knowledgeable than I am. If you think it’d help Keshav for you to explain how FRB works in your own words better than Murray Rothbard’s book, then have it.
I’m not saying you’re making this up, Dan. I’m just saying you have posted about 5 comments here just repeating the same thing: “call loans aren’t money, bank deposits are”. And when Keshav asks you why you reply: “because call loans aren’t money and bank deposits are”. That isn’t contributing at all to the discussion.
Besides that, be stating and restating the same stuff, you make it sound like it is a settled matter. No, it isn’t, no one knows what should be considered part of the money supply at any given time and place, and the answer to this question is liken to change a lot from time to time and situation to situation. See, for example, this article about “austrian” definitions of money supply: https://wiki.mises.org/wiki/True_Money_Supply
Well, you also say M1. M1 is a metric defined by the government. You can follow that and it will mean something, but it doesn’t mean it is “the money supply as such”. If you were saying “money supply” as if it meant “M1”, yes, then you’re right: call loans are not part of M1. But this is not what Keshav was talking about at all. If he wanted to know if call loans were part of M1 he could just have googled it, it’s an easy question.
Giovanni,
I didn’t simply say call loans are different than deposits. I linked to a book that explains how deposits expand the money supply and artificially lower interest rates in a fractional reserve system. Call loans don’t serve the same function. They simply don’t. Not one of you objecting has even bothered to attempt to show how call loans expand the money supply. How do call loans artificially lower the interest rate? Explain how, and I’ll comment on your argument, or I’ll just keep saying you guys don’t have a clue what you’re talking about.
So again, I’ll restate my position. Deposits in a FRB system expand the money supply, artificially lowering interest rates, which causes the boom bust cycle. Call loans, in the traditional sense, don’t expand the money supply, and don’t artificially lower interest rates, and don’t cause the boom bust cycle.
If you want to explain why you don’t think deposits do what I suggest, fine, make an argument. If you want to explain how call loans do expand the money supply, artificially lowering interest rates, fine, make an argument. Otherwise, I’m gonna assume you don’t have a bleeping clue what you’re talking about and suggest you read a book on the subject like The Mystery of Banking. And when I suggest you read that book it is so that you’ll be able to see the difference between a call loan and a deposit in a FRB. It’s not because I’m refusing to explain why. I’m just passing the explanation off on a book that will serve you much better than listening to me. So read it or don’t read it. Explain why my position is wrong or don’t.
And Keshav, that last comment really isn’t directed at you. You always seem like a reasonable guy, and I have no issue with your questions. The reason I suggested that book is because you said you don’t know what does or does not affect the money supply, so you’d get way more use out of understanding how FRB works from it than you’d get out of me trying to explain it. I just don’t see how this whole debate can be understood until you have a grasp on the basics of what happens with FRB.
“… would have identical economic effects as call loan notes being a medium of exchange.”
That *would* be the case *if* everyone understood that their savings were of that nature.
Nobody thinks that their savings are being lent out by the bank.
Or, if they kind of understand that, they believe that when the central bank “resues” their “deposits” by printing money (so they can retain their nominal money units), that there are no economically harmful effects.
Like I was getting at in my response to one of Selgin’s comments, the *perception* of the savers is what has economic significance (rather than the legality or the arguably fraudulent nature of the terms of bank services).
Two questions:
1. If the fractional reserve banks inflate the “effective” money supply by 50%, but keep it at that constant rate, how does that create business cycles? Even if the newly create credit enters the market through the loanable funds market, after the first entrance, there are no extra entrances, right? It is kept constant, the prices adjust to that new situation and are not disturbed again. Is that destabilizing?
2. What if the newly created funds enter the market with the banker buying a shoe? Wouldn’t that be destabilizing? The shoe maker would raise his prices, pay more to his suppliers and employees, inflating and disturbing the relative prices over the entire shoe industry and any other industry that interfaces with it.
Giovanni wrote: “If the fractional reserve banks inflate the “effective” money supply by 50%, but keep it at that constant rate, how does that create business cycles?”
It doesn’t, if no new base money enters the economy. But if new base money enters (e.g. government creates more dollars, or miners dig up more gold that is minted into coins), then as some of that new base money gets deposited with banks, the bankers create even more money and lend it out. So e.g. if 1000 new gold ounces are deposited with banks and the banks hold 10% reserves, then supply of loanable funds goes up by 10,000 ounces of gold even though public only saved 1,000.
Joseph Salerno gave a thorough explanation of this process in the following video:
[Time stamped]
The Economics of Fractional Reserve Banking | Joseph T. Salerno
[www]https://www.youtube.com/watch?v=33RXhv0IuPc#t=10m49s
Joseph Salerno: “OK, so now let’s look at how the fractional reserve banking system affects the money supply.”
Bob, you said in the debate that you think in a free society, market forces would lead banks to maintain near-100% reserve ratios. How exactly would that happen? Even if you’re right that fractional reserve banking leads to boom and bust cycles, how would that affect the incentives of an individual bank?
And, can you explain why a liquid secondary market in call loan notes would not lead to an unsustainable boom, but call loan notes being a medium of exchange would lead to an unsustainable boom? It seems like both scenarios give the owner of a call loan note the exact same ability to buy things while the money they lent out is being invested by entrepreneurs.
1. In a free market, banks would be allowed to default on their deposits without any governmental guarantee and bank runs could happen with tragic consequences for depositors, thus there could be more interest on the part of depositors to search for safer banks. Increased competition caused by smaller barriers to entry would encourage this. Just a hypothesis.
2. I guess the next question to be asked in the call loans problem you’re raising is: why isn’t there a liquid secondary market for call loans today? I believe there must be some fundamental difference between call loans and bank deposits that explain the difference, but I don’t know what it is. I’ve asked you some questions about call loans on a thread up here.
Keshav wrote:
Bob, you said in the debate that you think in a free society, market forces would lead banks to maintain near-100% reserve ratios. How exactly would that happen?
Mises alluded to it quickly in Human Action, and I spell it out in Choice. If any one bank expands more rapidly than its peers, it has a drain on reserves through the interbank clearing process. And if they all expand, a new bank could open up with a higher reserve ratio and accumulate their reserves.
Selgin and White agree with the basic mechanism in their writings (which have more of a mathematical model of it), they just disagree on the equilibrium outcome.
So the big difference I believe is that I think gov’t privileges historically gave banks the assurance that they could inflate more. E.g. take Selgin’s paradigmatic case of Scotland. He admitted during the bank in the Q&A that (a) those banks were allowed to suspend specie redemption for 20+ years and (b) their reserve ratio got as low as 3%.
Selgin thought both elements were neat, I disagree. But for your question, I am pointing out that those two things go together. You can risk having such a low reserve ratio when the government will relieve you of your contractual obligations for 20+ years.
And, can you explain why a liquid secondary market in call loan notes would not lead to an unsustainable boom, but call loan notes being a medium of exchange would lead to an unsustainable boom?
It has to do with why bank deposits are part of M1 but call loans aren’t. You can’t go into a Home Depot and buy lumber with a call loan, but you *can* do it with a demand claim on Citibank.
If you are holding a call loan and want to buy something, you have to sell it to someone else who has money. But if you have a checking account claim against Citibank, you can transfer that thing directly; you don’t need to first exchange it for green pieces of currency.
The implications of the above are that when you deposit green pieces of paper at a bank, thinking they are now in a checking account, the amount of money you think you hold hasn’t gone down. Then if the bank makes demand deposit loans on top of that, the quantity of money (measured by M1 say) has gone up. And that new money enters through the loan market, so the first price that gets distorted is the interest rate.
Dr. Murphy said “The implications of the above are that when you deposit green pieces of paper at a bank, thinking they are now in a checking account, the amount of money you think you hold hasn’t gone down. Then if the bank makes demand deposit loans on top of that, the quantity of money (measured by M1 say) has gone up. And that new money enters through the loan market, so the first price that gets distorted is the interest rate.”
This is only true if the bank can and does decide to let it’s reserve ratio drop. Banks lend and also look for deposits (of Federal Reserve Notes) to maintain their reserve ratios. If the deposits don’t materialize then the banks need to borrow and this makes interest rates go up. The only actor capable of creating the boom is the one deciding the level of the reserve ratio (i.e. The Fed), or the one controlling the supply of Federal Reserve Notes (The Fed again). ABCT might be correct but the Fed is the villain not FRB. The Fed could still be the villain with 100% reserve banking. (Apologies in advance if this was addressed in the debate – Have only listened through Dr. Murphy’s rebuttal)
I wrote: “[W]hen you deposit green pieces of paper at a bank, thinking they are now in a checking account, the amount of money you think you hold hasn’t gone down. Then if the bank makes demand deposit loans on top of that, the quantity of money (measured by M1 say) has gone up.”
To which Capt. Parker responded, “This is only true if the bank can and does decide to let it’s reserve ratio drop.”
No Capt. Parker that is not correct. Read again what I wrote. This is simple stuff. You are currently holding $1000 in green pieces of paper. You deposit them in your bank in your checking account. Your checking account balance goes up by $1000 but your currency holdings go down by $1000. If the bank doesn’t do anything, then the total quantity of money is unchanged.
But now if the bank decides to lend even $1 of it out, then the quantity of money has gone up by $1. This is true even if its reserve ratio before your deposit was much lower than 99.9%.
This is precisely the point that I feel you evaded during the debate Bob.
What if we eliminate the Bank in this scenario, and instead assume the transactions happen between three individuals: Bob, George and Gene.
Bob lends George $5. Because of this, George lends Gene $2.
Has the money supply increased? Now you might object because I used the word ‘lend’ instead of the word ‘deposit’. But doesn’t this hinge on Bob’s understanding of what is happening?
What if all of the banks depositers are explicitly clear that they are making ‘call loans’ to the bank by depositing, and that there is some level of risk involved (if they go to spend the money, there is a nonzero chance their card could get declined for instance).
I understand your point that this is not the case today, but what if it was? How would that affect your case?
Just to be even clearer, given your reply to Keshav above, I am not claiming that this is the case now.
I am approaching it from the sense that George would win the resolution if he could demonstrate that FRB could be setup in such a way as to mitigate any effects that would cause a business cycle, and this is just one proposal.
If there is any way that, in a free society, banks could practice FRB with policies that offset the dangers, then you would have to concede the resolution.
So whether FRB as currently or historically practiced causes business cycles becomes a separate issue.
“I am approaching it from the sense that George would win the resolution if he could demonstrate that FRB could be setup in such a way as to mitigate any effects that would cause a business cycle, and this is just one proposal.”
Sure, if fractional reserve banking, per se, doesn’t cause the business cycle then Selgin would be right. Now the task would be to show why it doesn’t and what does.
“Bob lends George $5. Because of this, George lends Gene $2.
Has the money supply increased? Now you might object because I used the word ‘lend’ instead of the word ‘deposit’. But doesn’t this hinge on Bob’s understanding of what is happening?”
It depends. Does Bob still have the ability to spend the $5 he lent to George, while at the same time Gene can go out and spend the $2? If yes, then yes. If not, then no. It doesn’t matter whether Bob understands what is happening. All that really matters is whether act X expands the money supply and artificially lowers interest rates or not.
“Bob lends George $5. Because of this, George lends Gene $2.
“Has the money supply increased?”
No, because lending the money to George gives control of that money to George. Bob is no longer the owner of that money, so there is still only one person claiming ownership.
“What if all of the banks depositers are explicitly clear that they are making ‘call loans’ to the bank by depositing, and that there is some level of risk involved (if they go to spend the money, there is a nonzero chance their card could get declined for instance).”
Then those call loans will *not* be considered deposits, but rather an act of lending, and people will decide for themselves whether or not they would rather make call loans or find a bank that is willing to take deposits.
Today, people do not really consider the money they stick in a “deposit” to be a call loan, but rather they consider it stored for them (as if in a vault, if you will).
And no matter what these people actually signed when they “deposited” their call loans, and no matter how legally binding those contracts are, the only thing that has economic significance is what the depositers believe about their deposits.
If they believe their money to be stored, rather than lent (as is the case with most people), then that money represents something to them that cannot permit sustainable uses for other purposes, such as call loans.
Because the moment they realize they made a call loan, rather than a deposit, they will make corrections in their saving/consumption ratio to correct what is, to them, a malinvestment.
And because they will change their saving/consumption ratio, not all of the projects that were started as a result of those call loans can be completed – those call loans represent, to the borrowers, claims on goods that were not directly accompanied by an increase in goods.
There’s more to say, but that’s the basics.
Dr. Murphy, Thanks for the reply. I’m actually right with you but let’s not stop at the lending of the $1 and the effect on M1. Let’s try to determine the effect on interest rates and what that means for the lending of the next dollar.
For example, Assume:
1) Banks are required to maintain a reserve ration of 10%
2) All banks are very nearly maxed out on their reserve ratio.
3) The Bank of Murphy writes a loan for $1000
What effect does this have on the interest rate?
My answer is that it is totally in the hands of the central bank. If the central bank accommodates the $1000 loan with $100 of Federal Reserve Note creation then interest rates will tend to stay the same or perhaps fall. If the central bank does not accommodate the $1000 loan then some bank somewhere is going to be looking for $100 more in reserves and this will drive up the cost of borrowing reserves so interest rates will rise. When the banks find out how costly it is becoming to come by reserves they will make fewer loans or make loans only at much higher interest rates. So, if there is over-borrowing, under-borrowing or correct borrowing it is all up to the central bank. The Fed is the one with all the power to limit borrowing and limit the growth of M1 by limiting the growth of Federal Reserve Notes.
Again, I’m not claiming the Fed will get things “right” but the Fed is responsible for the business cycle not FRB.
In a world of free banking, where banks could choose their reserve ratios, banks that were less than 100% would have to advertise this fact. When offered a note from a 100% reserve v. a >100% reserve bank, customers would make their discounts accordingly.
If a 90% reserve bank’s notes are discounted at 10%, there’s no point to FRB. If they’re discounted more, then FRB is clearly bad. If they’re discounted less they’ll succeed.
But would they cause the business cycle in this case? If everyone had a benchmark and was discounting them? Woudn’t the interest rate on loans made by >100% reserve banks be higher, naturally, then 100% reserve banks?
I guess what I’m saying is that the malinvestment comes from errors, but if banks had to rigorously advertise their reserve ratios, and there are benchmark competitors (or potential competitors) at 100% reserves, and market participants could discount because there was competition in the market for money, wouldn’t this send the proper info through the interest rates on the notes/money issued by the FRBers?
“… wouldn’t this send the proper info through the interest rates on the notes/money issued by the FRBers?”
Yes. But that would be cost prohibitive to banks to offer. The whole point of FRB is to hide the increase in the money supply so that people will believe their money is worth more than it is, which allows the banks to make money off of fraud.