02 Sep 2018

Response to Selgin on Fractional Reserve Banking and the Business Cycle, Part I

Banking, Business cycle, George Selgin 98 Comments

George Selgin has a 3-part series (I, II, and III) at Alt-M taking people (like me) to task for claiming that FRB per se causes the boom-bust cycle as described by Mises/Hayek. To be clear, George is putting aside the issue of whether FRB is fraud, and is just focusing on the economics. (He thinks the people claiming it’s fraudulent are akin to flat-earthers and beyond hope at this point.)

Let me say at the outset that I was initially frustrated with George’s posts, because it didn’t seem he even grappled with our perspective until the latter half of the third post. But, at that point he did put up a fight.

Furthermore, he then posted an excerpt from Fritz Machlup which is very pertinent to the debate; I will have to get Machlup’s book (which I haven’t read) and study this. So, after reading Part III of George’s series, and especially after seeing his post about Machlup, I’m relieved that we’re not just talking past each other.

However, right now I’m dealing with just Part I of his series, and I was underwhelmed.

In the first place, George totally misunderstands Murray Rothbard’s position. George writes:

To asses the claim that fractional reserve banking is an important cause of booms and busts of the sort described by the Austrian theory of the business cycle, we have, first of all, to recognize at least two popular versions of that theory that supply grounds for this claim. Both versions attribute cycles to excessive monetary expansion. But each defines “excessive” monetary expansion differently. According to one version, a constant money supply alone is capable of averting cycles. As Murray Rothbard explains, in summarizing Austrian monetary theory…

George then quotes Rothbard saying that any quantity of money is sufficient to provide money-services to the community.

Then, George goes on to discuss the (alleged) other view:

The other version of the theory maintains instead that cycles are caused, not by growth in the money stock per se, but by growth in the supply of unbacked (“fiduciary”) bank money. According to Frank Shostak, one of several adherents to this view, what sets in motion these cycles is not fluctuations in the growth rate of money supply as such, but the fluctuations in the growth rate of money supply generated out of “thin air.” By money “out of thin air” we mean money that is created by the central bank and amplified by fractional reserve lending by commercial banks.

…In this alternative version of the theory, what matters is whether new money is either made of or backed by some commodity, like gold, or not. In a gold standard system, growth in the stock of gold, no matter how rapid, can never set off a cycle; in contrast any decline in the ratio of gold reserves to readily-redeemable bank liabilities can set a cycle in motion. In the case of a fiat money system, the two versions of the Austrian cycle theory coincide, for in this case there is no question of any “commodity-money” driven growth in the total quantity of money, whether that growth is due to central bank expansion or to a reduction in commercial banks’ reserve ratios.

So to repeat, George has misunderstood Rothbard’s position. Rothbard would agree with the position attributed to Shostak, namely, that an increase in the quantity of gold in the economy won’t set off the boom-bust cycle. Here’s Rothbard from ME&S:

The process of issuing pseudo warehouse receipts or, more exactly, the process of issuing money beyond any increase in the stock of specie, may be called inflation.106

And then if you follow the footnote to this sentence you find:

106 Inflation, in this work, is explicitly defined to exclude increases in the stock of specie. While these increases have such similar effects as raising the prices of goods, they also differ sharply in other effects: (a) simple increases in specie do not constitute an intervention in the free mar- ket, penalizing one group and subsidizing another; and (b) they do not lead to the processes of the business cycle.

So yes, Rothbard doesn’t think the community ever “needs” the stock of gold to increase, in order to fulfill its functions as a money, but if the stock of gold does increase, it won’t cause the business cycle (according to Rothbard). The only thing that fuels a credit expansion is issuing claims on money that are not backed up by genuine specie.

(Ironically, an economist who does allow for the possibility of newly mined gold causing the boom-bust cycle is Mises. If you read his sections on the business cycle in Human Action, you’ll see that he places them in the section dealing with the pure market economy, because he thinks in principle if newly mined gold hits the loan market relatively early, it could cause the market loan rate of interest to fall below the correct originary rate. In practice however Mises thinks this is negligible for empirical reasons, and the real cause of business cycles in our world comes from the banking system.)

Rate of Money Growth

The main point of Selgin’s first post is to argue that the rate of money growth and the reserve ratio are largely independent of each other. For example, suppose we have a fiat dollar money system, where the banks practice 100% reserves. If the Fed creates base money at the rate of 5% annually, then the overall quantity of money grows by 5% annually too. (This is obvious.)

However, suppose the commercial banks only maintain a reserve ratio of 10%. This means that when the banks are fully “loaned up,” the stock of checking account balances can be 10x the amount of reserves. So it seems like there will be a lot of extra inflation in this scenario, right Rothbard and Shostak?

Not so, says Selgin. Here too, the total amount of checking account balances only grows at 5%, assuming the Fed has the base money grow at that rate as before. Indeed, it’s only when a banking system lowers its reserve ratio–in our example, moving from 100% down to 10%–that you get a fleeting increase in the stock of broad money aggregates. Once we settle down into the new equilibrium, the rate of monetary inflation is equal to the growth in reserves, regardless of the reserve ratio.

This is all correct, insofar as it goes, but it doesn’t bear on the claims of those Austrians who think FRB is inherently problematic. Before I say why, let’s switch to an analogy: Suppose I take 50% of George’s paycheck each month. In other words, if his employer pays him $10,000, I pocket $5,000 and George only gets to keep $5,000.

Now George gets upset and says I am ripping him off each month. He is earning less, month after month, than what he is producing.

I correct George, though, by pointing out that the growth rate in take-home pay is just the same as it would be, if I hadn’t started swiping half of his loot. For example, in the original timeline, if George would normally enjoy a 3% annual raise, then that’s just what he’ll enjoy in this new scenario, too. In fact, the only time where I could kinda sorta see why he would be upset, is during the initial transition phase, when the ratio of his take-home paycheck drops from 100% down to 50%.

Now does this make sense? Of course not. By the same token, the Austrians in this tradition–and it’s not just Rothbard and Shostak, I would argue it’s quite plainly Mises (and probably Hayek too, though I’m not as familiar with his work)–are saying that there’s a mismatch between the level of genuine saving and the funds made available for investment. So if the central bank creates $1000 in new base money, and out of that the community voluntarily saves $5 by depositing it in the commercial banks, then if the banks go make loans of $50, there is a mismatch between the aggregate saving and lending. It’s the creation of new, unbacked money per se that is causing the problem (if there’s a problem at all, which George thinks might not be true under certain circumstances). If the commercial banks issue, say, $1 billion in new fiduciary media in 2018, this causes discoordination in the capital structure, period. You don’t need to inquire whether the banks had injected $100 million, $110 million, $120 million…$990 million in the previous years, to determine whether this year’s injection of $1 billion is benign or disruptive.

98 Responses to “Response to Selgin on Fractional Reserve Banking and the Business Cycle, Part I”

  1. Transformer says:

    If I had to make a strong case for FRB leading to mal-investment it would be along the following lines:

    – Assume base money is $100B
    – The CB creates $10B in new moneywhich it lends out to commercial banks at a rate below the market rate
    – Commercial banks operate on 10% reserve so this $10B becomes $100B. This further lowers interest rates below the market rate
    – The new $100B all goes to new investment projects that would not other wise have been started, and we have our mal-investment cycle kicking off.

    However on closer examination:

    – If the commercial banks already operated 10% reserve then whatever the % increase in base money is will be reflected in the total money supply. In this case the CB increased the base by 10% and the money multiplier means that the total money supply also increases by 10%. As long as the reserve ratio stays the same it is the increase in the base not the existence of FRB that has led to the mal-investments.

    – In addition, if everyone has perfect foresight (perhaps because the CB creates 10% new base money every year) they will anticipate the effects of the change in money supply. Commercial banks will want to charge a higher rate of interest to reflect that prices will be higher when the loan is repaid (and will be worth less in real terms) , and borrowers will be prepared to pay higher rates of interest for the same reasons. The net effects of this will be (in theory) that the only differences between the scenarios with and without the increased money supply will be the price level and nominal interest rates being higher to reflect the expected inflation.

    So in theory neither the CB increasing the money supply , nor commercial banks multiplying it up will lead to boom-bust. However in practice I can see that central bank changes in base money may not be fully anticipated, and commercial banks may vary their reserve ratios in random-seeming ways, and these two things may lead to distortions in the market rates of interest that could indeed lead to mal-investment.

  2. Bob Roddis says:

    I do not think there is any question that loans made or checking accounts established with less than 100% reserves are trouble in the ABCT sense. I thought of this when studying Commercial Paper for the Texas Bar Exam in 2010. Basically, FRB is a problem of Commercial Paper. The following items are not all the same and should not be deemed or priced the same:

    1. A silver dollar coin;
    2. A warehouse receipt for a specific dollar coin;
    3. A private banknote or check for a specific amount of dollar coins on demand in a 100% reserve account;
    4. A private banknote or check for a specific amount of dollar coins on demand in a fractional reserve account.

    The problem arises when a #4 is used to outbid another interested purchaser who only has a 100% reserve account. Under the usual rules, a sale is priced as if a #4 was the same price as if a purchase was made with actual coins.

    Suppose that someone saves up $25,000 to buy a house. Someone else can use a #4 to outbid the person who actually saved real money to buy the house. Not only is this unfair, it distorts the price system because the sales price is deemed to be (for example) $27,000.00 although neither the bank nor the buyer actually possessed $27,000.00.

    The simple solution is to require that banknotes and checks state on their face the reserve requirement for the account. I suspect that the paper for such accounts would be discounted for risk which would be reflected in prices paid when this type of paper is used for purchases which would minimize price distortions for the ABCT. If it turns out that there is no risk to the payee and no price distortion with “full disclosure” banknotes and checks and thus no discount, who can complain? Further, anyone accepting such a note or a check cannot claim to have been tricked or defrauded because the true nature of the item is labeled on the face of the note/check.

    • Tel says:

      The problem arises when a #4 is used to outbid another interested purchaser who only has a 100% reserve account. Under the usual rules, a sale is priced as if a #4 was the same price as if a purchase was made with actual coins.

      In a properly free market it should be the seller’s choice as to payment terms and indeed the seller could arbitrarily choose which bidder wins the auction based on anything at all.

      The problem is that this concept of “usual rules” is based on an externally imposed standard of equivalence.

      I support voluntary free banking, and as a consequence I also support the right of refusal should any individual happen to prefer payment in some other format (including metal, but not limited to that).

      The simple solution is to require that banknotes and checks state on their face the reserve requirement for the account. I suspect that the paper for such accounts would be discounted for risk which would be reflected in prices paid when this type of paper is used for purchases which would minimize price distortions for the ABCT.

      Seems reasonable.

      I’m going to annoy Bob here… and say that if we presume there is a government and it still has the power of taxation (i.e. not a perfect world, also a plausible assumption for the near future despite Trump’s best efforts) then the deeper question is: What discount does government impose on various forms of tax payment? Suppose a cheque drawn against some commercial bank was accepted “as is” by government for taxation payment… then the paper is as good as cash (which is also just paper). The discount would be very small or possibly nothing. My point is that cash (i.e. paper) becomes widely accepted because it also guarantees that government will accept this as tax payment.

      I know… the Mosler 9mm theory saddles up and rides again; but this problem must surely be hard to escape from. After all, if people could escape, then they would.

      Further, anyone accepting such a note or a check cannot claim to have been tricked or defrauded because the true nature of the item is labeled on the face of the note/check.

      That works until some Senator finds a newsworthy sob story and fronts up to the cameras, “As an Indian, I know a thing or two about fraud!”

    • Andrew says:

      I don’t get why the average seller would treat these forms of payment any differently, even if the backing was advertised on the check. From the seller’s perspective, they’re all equivalent. The seller gets his money regardless of the reserve requirement of the bank involved.

      And don’t get me wrong. I understand what you’re trying to do. I just don’t get why sellers would charge more for payments from fractional reserve institutions if we assume that those institutions continue to be as reliable as they are in our present reality. If payment from FRB accounts were less reliable than other forms in practical terms, then people would not be accepting it as payment today.

      . . . neither the bank nor the buyer actually possessed $27,000.00.

      I’m not sure what you mean here. Clearly the bank and the buyer both do have $27,000. The buyer has it because the bank says he does and the bank must have it because they’re going to transfer the money as soon as the check is cashed or deposited somewhere.

  3. Andrew says:

    Ironically, an economist who does allow for the possibility of newly mined gold causing the boom-bust cycle is Mises.

    Yay! This is great news! I took this position in an earlier thread against Dan and Enrico because I, personally, just think it makes intuitive sense. At the time, I was thinking this position put me at odds with Mises and Rothbard. I’m happy to learn that Mises has my back. The more I learn about that man, the more I like him.

    • Enrico says:

      If the newly minted gold enter the loan market, I also agree that it has the same effect of newly printed fiat money entering the loan market.

      • Dan says:

        That would mean you changed your position. Because FRB expand the money supply and introduce that money through the loan market.

        • Enrico says:

          If you include bank deposits in the definition of “money supply”, then FRB expands the money supply. But then expanding the “money supply” does not necessarily lead to a boom-bust cycle. In fact, my position was (and still is) that bank deposits are loans backed by real savings, thus they don’t expand the “money supply”. In contrast, newly printed money from the CB and newly minted gold coins are not backed by real savings.

          • Dan says:

            What’s the difference between newly printed money from a central bank and newly printed money from a fractional reserve bank?

            • Enrico says:

              The fact that the bank is basically emitting a promissory note (which is redeemable in money) instead of creating money (which is not redeemable).
              To put it differently, the bank is just using a piece of paper in place of the actual money in its reserves: instead of lending $1 million in cash, the bank emits a note which is redeemable with the $1 million in its vault.

              • guest says:

                Dan is asking the right question, in that whether

                1) the central bank increases the base paper “money” supply and

                2) when banks effectively increase the supply (multiple claims to paper/digital “money”) through FRB

                Both are functionally equivalent because the only difference between the two scenarios are people’s willingness to accept unbacked claims as if they were money.

                Either of the scenarios are easily transformed into the other simply through a mental exercise.

                But that would make all monetary problems the mere product of mental assent, to be solved by simply changing one’s mind.

                We say, and rightly so, that increasing the “money supply” cannot cause the business cycle.

                But when you include, as your definition of money, unbacked claims, then this becomes an obvious contradiction.

                What I hope to convince everyone is that the only position consistent with the corrrect view that increasing the “money supply” cannot cause the business cycle, is that the definition of money is restricted to commodities only, and that anything else can only be a money substitute to the extent that it is fully redeemable on demand for money proper – that is, the substitutes can never be more than a mere claim *to* money.

                And then what follows logically from *that* is that money substitutes that have lost their commodity banking are incapable of serving the function of money – they become, and remain, purely speculative, and they trade only because a “next sucker” believes it has value that it really doesn’t.

              • Dan says:

                That’s what FRB do. They literally are creating more pieces of paper than there are reserves of actual money.

              • Dan says:

                “We say, and rightly so, that increasing the “money supply” cannot cause the business cycle.”

                Who is we, because that’s not what I or any other Austrian says. That’s just what you say. I don’t understand why everyone, including quoting Mises explicitly saying this, can tell you that Mises believed increasing the money supply and introducing it through the loan market will cause the business cycle, but you keep insisting otherwise.

              • guest says:

                “They literally are creating more pieces of paper than there are reserves of actual money.”

                Well, that’s how it’s done under a paper money system, but under a gold standard, the increases in paper would not be increases in money, but in claims *to* money (the paper being IOUs).

                I’m trying to help to distinguish between the catallactic effects of money proper and those of money substitutes (to include fiduciary media and unbacked “mediums of exchange” [so-called]).

                But that’s difficult to do when you’re using paper money as your example.

                Because think about it:

                What is the meaningful difference between

                1) More pieces of paper, and

                2) Reserves of actual money

                when your definition of “actual money” includes paper money?

                There is no difference between increasing the base paper money supply and increasing the supply of paper through FRB.

                So, we can’t consistently favor increases in the supply of paper “backing” for bank deposits while at the same time disfavoring the lending of so-called “idle savings” on the grounds that it creates more paper than there are paper reserves.

                That’s a distinction without a difference.

              • Enrico says:

                @Dan
                If a bank receives $10 cash and then tries to lend $15 or $20, it immediately goes bankrupt.
                The bank can only lend less than the initial $10 deposit, so let’s say $9. Then, its reserves immediately drop to $1.

              • guest says:

                “Who is we, because that’s not what I or any other Austrian says. That’s just what you say.”

                Increasing the mone supply, *as such*.

                I’ve already agreed with you on this.

              • Dan says:

                “What is the meaningful difference between
                1) More pieces of paper, and
                2) Reserves of actual money”

                Well, I thought it was pretty obvious that the pieces of paper were money substitutes vs money proper. We’re discussing free banking so I’m assuming we all agree that absent government interference people wouldn’t voluntarily use paper as money proper.

              • guest says:

                “We’re discussing free banking so I’m assuming we all agree that absent government interference people wouldn’t voluntarily use paper as money proper.”

                If you’re considering paper money to be money proper, then no amount of government intervention can change it into anything else.

                Government may rob people to pay for a new phone for me, but that doesn’t take away from the fact that it’s valuable as a phone.

                If gold is valuable as money because (in my view) it has a link to use-value, government takeovers of gold mines don’t change gold into less valuable money. It’s deriving its value because consumers can satisfy non-monetary ends with it.

                Government may rob people to favor giving health care skills to some people, but that, in and of itself, does not lower the value of their skill to someone who values that skill.

                Etc., etc.

              • Enrico says:

                @guest

                Maybe you changed B with D or something like that, because I don’t follow the narrative anymore.
                Anyway: if the depositor cannot withdraw his money, his demand for consumer goods cannot increase as it will otherwise. Thus, the bank is sending a correct signal: the depositor is not going to spend his money. Whether he is not spending because he previously planned so, or because he found out the bank cannot pay him back, the result is the same: instead of producing more consumer goods, more capital goods can be produced.

              • Enrico says:

                Ah sorry, wrong place!

    • Dan says:

      You didn’t take this position against me. I repeatedly stated to multiple people in that post that Mises said exactly that. I even provided specific quotes where he said it explicitly.

      • Andrew says:

        My apologies. You’re right that I was arguing against Enrico and not you. You just happened to be in the same thread. I’m sorry I misrepresented you.

        • Dan says:

          No worries. I’m not real sensitive. Just was correcting the record.

  4. guest says:

    Bottom line, here, is that Selgin doesn’t think that people are planning their lives around the security of their savings in a bank. Savings, apparently, imply nothing about intended future consumption, and you don’t need to factor that in when starting new projects.

  5. Enrico says:

    @Dan @guest
    Guys, creating base-money and increasing bank deposits are totally different things.

    If somebody lends me $10, I have a $10 debt. Did I created money? Of course not.
    When somebody deposits $10 in a bank, bank deposits increase by $10, meaning that the bank has now a $10 debt with the new depositor. Did the bank created money? No, for the same reason.

    If I lend $9 of those $10, am I creating money? Of course not, I’m just lending already existing base-money. Is there any difference if I put the $10 in a vault, and then I lend a ticket saying “everyone possessing this ticket can come to my vault and retire $9”? Of course not: the ticket is redeemable in real money, but it’s not real money. I’m just using it in place of the (already existing) real money kept in my vault.
    When a bank lends out $9 of the $10 received, it does the same thing: instead of lending directly $9 cash, it creates a new bank deposit, which is the equivalent of a “$9 ticket”. Bank deposits are redeemable in (already existing) real money, but they are not real money. So, no money creation.

    After I lend out those $9, are there “multiple claims to the same money”? No: the original owner lent me $10, so he doesn’t have anymore a claim on that money; he only has a claim on $10+interests of my money at some future date. So, when I lend the $9, there is only one owner of such money: the final borrower.
    By analogy, when the bank lends out the $9, there are no multiple claims on the same money.

    Finally: could a bank create all the bank deposits that it desires? No, because it would immediately go bankrupt. Bank deposits are limited by the amaunt of real money deposited in banks, since they are redeemable in it. By contrast, could a Central Bank create all the base-money that it desires? Yes, it could. So there is no way for the two scenarios to be equivalent.

    • Dan says:

      Let’s say person A deposits 10 gold coins into Bank A, and then loans person B 9 gold coins, who in turn deposits 9 coins into Bank A, and then they loan 8.1 gold coins to person C, who in turn deposits 8.1 coins into Bank A. So the bank gives Person A a green piece of paper said to be redeemable on par immediately for 10 gold coins, person B gets one redeemable for 9 coins, and person C gets one for 8.1 coins. So you have 27.1 green pieces of paper that are immediately redeemable on par for 27.1 gold coins. This is circulating in the economy used to buy goods and services although the bank still has just 10 gold coins in reserve.

      I’m assuming you say, “Perfectly fine. A FRB that would cause no business cycle because there is no central bank.”

      So what exactly do you think adding a central bank to this type of gold standard FRB system would do that would cause the boom bust?

      • Enrico says:

        @Dan
        If those 27.1 pieces of paper were really circulating, Bank A would go bankrupt: as soon as somebody (one or more people or banks) receives 11+ pieces as payment, he can claim back the equivalent amount of gold coins, so Bank A fails. Do we agree on this?

        So what I’m saying is that a bank can lend only a smaller amount of the money received (specifically, the part that is not going to be spent by the depositor). When Bank A receives 10 gc, it can lend less than 10 gc. Later, if someone deposits 9 gc, Bank A can lend less than 9 gc. Etc. The amount of money received (10+9+…) is greater than the amount of money lent (9+8.1+…).

        It’s the same as me borrowing 10 gc and then lending 9 gc to somebody else: the total amount of debts (10+9) exceeds the total amount of money (10), but that’s fine.
        By contrast, if I were able to create additional 10 gc out of thin air, the total amount of money would increase to 20 gc. Unless 10 gc were destroyed or sunk into the ocean etc, prices (either of goods or stocks) would increase. That’s what a CB does.

        • Dan says:

          “If those 27.1 pieces of paper were really circulating, Bank A would go bankrupt: as soon as somebody (one or more people or banks) receives 11+ pieces as payment, he can claim back the equivalent amount of gold coins, so Bank A fails. Do we agree on this?“

          Yes, we agree on that, but you do realize that is what fractional reserve banks do right? They simply try to set the reserve ratio high enough so that people are not claiming all of the reserves at the same time. But they always have fewer reserves than those pieces of paper that are circulating.

          “By contrast, if I were able to create additional 10 gc out of thin air, the total amount of money would increase to 20 gc. Unless 10 gc were destroyed or sunk into the ocean etc, prices (either of goods or stocks) would increase. That’s what a CB does.“

          I’m confused, are you suggesting that central banks were creating additional gold out of thin air during the gold standard in order to increase the money supply? Were they wizards?

          • Enrico says:

            Quote: “They simply try to set the reserve ratio high enough so that people are not claiming all of the reserves at the same time.”

            Your sentence implies that banks keep enough reserves to satisfy daily withdrawals / spending from depositors. Or, equivalently, that banks lend out only the money that’s not going to be withdrawn / spent by depositors.
            Thus, bank credits/deposits/loans can increase only if somebody is refraining from spending an equivalent amount of money.

            Instead, when the CB increases the quantity of base-money, there is no one refraining from spending an equivalent amount of money. Thus, total spending increases.

            Quote: “are you suggesting that central banks were creating additional gold out of thin air…?”
            Of couse not. It was just an example for keeping the gc units instead of switching to $. Don’t mind: let’s pretend that I wrote $. The point I was making is the same as above: one thing is borrowing&lending, another thing is creating&lending.

            • Dan says:

              “Your sentence implies that banks keep enough reserves to satisfy daily withdrawals / spending from depositors.“

              Well, yes, that is the goal. Nobody disputes that. It doesn’t change the fact that they always at all times have more claims that are immediately redeemable at par on their reserves than they have actual reserves. That was fractional reserve banking is.

              “It was just an example for keeping the gc units instead of switching to $.”

              You misunderstand. Gold was $ during the gold standard. I’m asking you how central banks were able to create new gold out of thin air during the gold standard.

              • Enrico says:

                Quote: “they always at all times have more claims that are immediately redeemable at par on their reserves than they have actual reserves”

                True: bank debts (which are immediately redeemable at par on their reserves) are greater than their reserves.

                Quote: “I’m asking you how central banks were able to create new gold out of thin air during the gold standard”

                But I never said they did, so why are you asking me this?
                I said that CB increasing base-money is different from FRB increasing deposits.

              • Dan says:

                Because you said central banks increase the physical amount of money. So I want to know how you think the central bank increased the amount of money during the gold standard.

              • Enrico says:

                In a gold standard system, the CB emits base-money (e.g. banknotes) redeemable in gold. In order to expand the quantity of money, the CB simply emits more base-money. Such process decreases the ratio between gold reserves and the monetary base.

                For example, the gold reserve ratio decreased from 75% in 1950 to less than 25% in 1970.

              • Dan says:

                “In a gold standard system, the CB emits base-money (e.g. banknotes) redeemable in gold.“

                That is the same thing all fractional reserve banks do. I gave you example where they took in 10 gold coins and issued banks notes worth 27.1 gold coins. I’m not sure why you think central banks issue more bank notes, but fractional reserve banks don’t. They both do.

              • Enrico says:

                (BTW, I said that CBs increase the monetary base, i.e. the quantity of base-money. It’s a fact.)

              • Enrico says:

                I explained (also, by referring to your example) the difference between FRB and CB. I repeat:

                “Bank deposits can increase only if somebody is refraining from spending an equivalent amount of money.
                Instead, when the CB increases the quantity of base-money, there is no one refraining from spending an equivalent amount of money”

                You may agree or not, but that’s why I’m saying the two things are different.

              • Dan says:

                “Bank deposits can increase only if somebody is refraining from spending an equivalent amount of money.“

                Yes, and I showed you that’s not true. In my example one man deposited 10 gold coins, and that multiplied into 27.1 worth of deposits. Nobody refrained from anything.

              • Enrico says:

                Actually, your example totally confirm my point. Read again:

                “Let’s say person A deposits 10 gold coins into Bank A, and then loans person B 9 gold coins, who in turn deposits 9 coins into Bank A, and then they loan 8.1 gold coins to person C, who in turn deposits 8.1 coins into Bank A.”

                Nobody is spending, in your example. People (A, B, C) are just parking the money, not buying goods&services. Bank A can lend money to person B because person A is not spending his 10 gc. If person A spends (let’s say) 6 gc, Bank A reserves drop to 4 gc; thus, Bank A can only lend 4 gc to person B. Etc.

              • Dan says:

                Nobody, I repeat nobody, refrained from spending anything in my example, much less “an equivalent equivalent amount of money”, yet deposits nearly tripled. They can go out and spend the green pieces of paper in the economy to the their hearts content. Do you really believe that fractional reserve banks don’t expand bank deposits in excess to what they have on reserve? That’s the entire point of a fractional reserve bank.

              • Enrico says:

                I’m sorry that there is some misunderstanding here. I quoted the full text of your example: there is no mention about anybody spending any amount of money. That’s why I replied that the people in your example are not spending any amount of money.
                Now you say that they could spend money. Well, that’s not a problem: let’s change the example to have at least one person spending money.
                Let’s suppose that person B wants to withdraw 9 gc and spend them. But he can’t do that: bank A’s reserves are not sufficient. Therefore bank A goes bankrupt, and person B has to wait until bank A’s debtors will repay their debts. Person B has to refrain from spending (i.e. he is forced to save) for a certain amount of time.

                So I’m saying that a bank receiving 10 gc can lend less than 10 gc, keeping the remaining gold coins as reserves. If the bank receives additional gold coins, of course, it can provide additional loans.

                It seems to me that you are looking only at the final stage of the process, saying: “look, there are only 1 gc in reserves, and there are 10gc deposits, so the bank lent 10 times more than the money actually deposited in it!”. But that’s not correct: the bank received 10 gc, and lent 9 gc, i.e. “only” 90% of the initial deposit.

              • Enrico says:

                PS: in the above “revisitation” of your example, I forgot to say that person C has already spent his 8.1 gc. Otherwise, person B would succeed in withdrawing his 9 gc.

              • Dan says:

                Enrico, the people can spend the green pieces of paper, they don’t even need to withdraw the gold coins at all. No matter how you slice it, deposits went up without anyone having to save an equivalent amount of money as you said. Of course you can have bank runs, that’s one of the problems with fractional reserve banks, and why they have to be careful with how low they set the reserve rate, but that doesn’t change the fact that they can increase deposits and base money just the same as a central bank can.

              • Enrico says:

                I considered a withdrawal for keeping things simple, but we can imagine person B spending 9 gc through bank transfer or by check.
                Even if person B succeed in buying something from (let’s say) person D, at the end of the same day B’s bank will be asked by D’s bank to pay 9 gc in cash. And since B’s bank has not enough reserves, it will go bankrupt. Person D will not get his account credited, thus he will not be able to spend the 9 gc. I think both of us agree on this outcome. Therefore, person D will have to refrain from spending until B’bank debtors will repay their loans.

                So either person B doesn’t spend his money (=he is saving), or person D will not be able to spend his money (idem). Someone has to delay his consumption.

              • Dan says:

                Enrico, fractional reserve banks literally increase deposits in excess of their reserves. That is the whole point. They literally increase the amount of bank notes. The fact that bank runs are possible doesn’t change this fact.

                You said central banks emit bank notes to in order to increase the supply of money. Fractional reserve banks do the same thing. When you go from 100% reserves down to 90%, 80%, 10% reserves or whatever percent you want, they are emitting bank notes in excess to the amount of gold they have on reserve. They expand the money supply the same way you said is a problem if a central bank does. Bank runs can happen with or without central banks. That does nothing to change the fact base money is expanded under both scenarios.

                So maybe you want to adjust your position and explain a new reason why central banks expanding base money is a problem, but fractional reserve banks expanding base money is not a problem.

              • Enrico says:

                I proved that either depositors are volontary saving what the bank is lending out (so no bank run occurs), or not (so a bank run occurs). In the latter case, somebody is forced to save the amount of money lent by the bank. With respect to the above examples: in one case, person B cannot spend his money; in another case, person D cannot spend his money. They are forced to save, it’s a fact. The so-called “deposits expansion” in FRB is backed by people not-spending their money (i.e. by personal savings).
                It’s different from base-money emission by the Central Bank, since it is not backed by savings. I mentioned these facts many times, so it’s hard to see what more should I do to make them more clear.

                I also explained that bank never lend more than they receive. If they receive 10, they lend 9, and in fact they remain with 1 as reserves. Again, it’s a fact. And the so-callled “expansion” is nothing incredible. If I borrow 10 and then lend 9, I am “expanding” the total amount of debts in the same way that banks “expand” the total amount of deposits. But nobody in his right mind would say that I’m “creating money”, and so no one should say it with regard to banks. Again, I don’t know how could I be more clear in explaining these facts.

              • Dan says:

                Enrico, you realize Selgin and the free bankers agree that fractional reserve banks increase base money, right? This isn’t a position either side argues about.

              • Dan says:

                Like you realize that if you have a 100% reserve system, and then banks lower the reserve rate to 90%, then $1 billion in base money would become $10 billion under a fractional reserve system, right?

              • Enrico says:

                Quote: ” Selgin and the free bankers agree that fractional reserve banks increase base money”

                That’s not correct. In the current system, “base money” (or “monetary base”) consists of banknotes emitted by the Central Bank, coins and reserves in bank accounts held at the Central Bank (which are emitted by the Central Bank, too). Thus, no bank can increase base money; only the Central Bank can do it.
                In fact, Selgin never said such a thing. His argument is the same as mine: FRB allows total spending to remain stable by “transforming” savings (=not spending) into investments (=spending). Check carefully, he didn’t say that.

                You used the expression “base money” before, but honestly I thought it to be a typo. But now I have to point out that “base money” has a very specific meaning ( http://www.businessdictionary.com/definition/monetary-base.html https://financial-dictionary.thefreedictionary.com/Base+money https://www.investopedia.com/terms/m/monetarybase.asp ).

                Quote: “$1 billion in base money would become $10 billion under a fractional reserve system”

                I say that $1 billion in base money could be used to increase total debts of the banking system up to $10 billion (*). It’s not that $1 billion in base money becomes $10 billion in base money! I told you: if I borrow $10 and lend $9, I’m not creating money. $10 in base money are not becoming $19 in base money; they are just passing from one hand to another, increasing the total amount of debts (and credits) up to $19. But base money still consists of only $10.

                (*) provided that there will be people saving the same amount of money.

              • Dan says:

                Selgin agrees that fractional reserve banks can increase base money. Go read his article on the money multiplier.

                And, yes, fractional reserve banks increase base money. You’d have $1 billion in gold reserves, plus up to $9 billion in green pieces of paper immediately redeemable at par for gold.

              • Dan says:

                “In a gold standard system, the CB emits base-money (e.g. banknotes) redeemable in gold.“

                And to clarify. I’m using your definition of base money that includes banknotes redeemable in gold. So if you have a 100% reserve gold standard system with $1 billion worth of gold in reserve, and you decrease the reserve ratio down to 90% with a fractional reserve bank (no central bank), then you will have $1 billion in gold, and up to $9 billion in banknotes redeemable in gold. That’s turning $1 billion in base money into $10 billion in base money.

              • guest says:

                “So either person B doesn’t spend his money (=he is saving), or person D will not be able to spend his money (idem). Someone has to delay his consumption.”

                If D’s bank lends D’s money to B’s bank (without D’s knowledge), and is not able to pay D back, then D will alter his plans that previously made the savings possible to reflect new plans that factor in less purchasing power.

                If B’s bank just stole from D to consume, then no business cycle can occur because no investments were made with D’s savings.

                But in your scenario, B’s bank loaned out D’s savings, so, even though D can’t spend what B’s bank stole and lent out, now B’s bank is causing malinvestments because that loan misrepresents the consumer demands that made D’s money available as savings (rather than loanable funds).

              • Enrico says:

                @Dan

                Quote: “Go read his article on the money multiplier.”

                I did: he never claimed that fractional reserve banks can increase base money. In all his writings, he underlines the difference between base (or basic) money and bank deposits (which he also calls IOUs). For example ( https://www.alt-m.org/2016/07/12/monetary-policy-primer-part-6-reserve-deposit-multiplier/ ):

                “an economy’s ‘base’ money serves as the ‘raw material’ that commercial banks and other private-market financial intermediaries employ in ‘producing’ deposits of various kinds that can themselves serve as means of exchange. If they could do so profitably, these private intermediaries would, by making their substitutes more attractive than base money itself […]
                While banks’ own substitutes for base money may serve in place of base money for all sorts of transactions among non-banks, those substitutes won’t suffice for settling banks’ dues to one another […]
                The ratio of the total amount of new money, including both currency and bank deposits, generated in response to any new increment of base money, to that increment of base money itself, is known as the ‘base money multiplier’.”

                And again ( https://www.alt-m.org/2018/08/28/fractional-reserve-banking-and-austrian-business-cycles-part-iii/ ):

                “an economy’s money stock, defined broadly to include the public’s holdings of readily-redeemable bank IOUs as well as its holdings of basic money”

                Selgin always makes a distinction between base money and banks IOUs/deposits. Which is correct, since he also explains the difference between the two forms of “money” (as broadly defined).
                You can quote him, if you wish.

                Quote: “$9 billion in green pieces of paper immediately redeemable at par for gold”

                Which, by definition, are not base money. They are claims on base money reserves. I provided some links for making “base money” definition more clear.

                Quote: “I’m using your definition of base money that includes banknotes redeemable in gold”

                But I was referring to CB banknotes, which are different from private (i.e. issued by banks) banknotes or – more generally – bank IOUs. CB banknotes are legal tender, and they can be used as bank reserves. They can be used for settling debts (also) between banks. During the gold standard, banks couldn’t use gold as reserves: they had to use CB-emitted money (as today).
                In constrast, banks IOUs are not legal tender, and they cannot be used as reserves: once one bank IOUs are deposited into another bank, the latter asks for the first bank to pay with base money (e.g. CB banknotes). In a free banking gold standard, too, banks IOUs could not be used as reserves: reserves would be made of gold. So it doesn’t make sense to compare CB banknotes to banks IOUs.

              • Enrico says:

                @guest

                Maybe you changed B with D or something like that, because I don’t follow the narrative anymore.
                Anyway: if the depositor cannot withdraw his money, his demand for consumer goods cannot increase as it will otherwise. Thus, the bank is sending a correct signal: the depositor is not going to spend his money. Whether he is not spending because he previously planned so, or because he found out the bank cannot pay him back, the result is the same: instead of producing more consumer goods, more capital goods can be produced.

              • Dan says:

                “Selgin always makes a distinction between base money and banks IOUs/deposits. Which is correct, since he also explains the difference between the two forms of “money” (as broadly defined).

                You can quote him, if you wish.

                Quote: “$9 billion in green pieces of paper immediately redeemable at par for gold”
                Which, by definition, are not base money. They are claims on base money reserves. I provided some links for making “base money” definition more clear.”

                OK, but I was simply using your definition from when you said “In a gold standard system, the CB emits base-money (e.g. banknotes) redeemable in gold.“

                See, in one breath you call banknotes redeemable in gold, base money, and then in the next you chastise me for calling bank notes redeemable for gold, base money. I’m simply trying to use the terminology you want in order to get past semantic arguments.

                So, since you now say that central banks simply create claims on base money under a gold standard, and not base money itself, does that mean you think it can’t create a business cycle either, or do you need to change your position again?

              • Dan says:

                “During the gold standard, banks couldn’t use gold as reserves: they had to use CB-emitted money (as today).“

                What are you talking about?

              • Dan says:

                “CB banknotes are legal tender, and they can be used as bank reserves.”

                Oh, so you think legal tender laws are what causes CB IOUs to result in a business cycle, while FRB IOUs don’t. So if we simply eliminated legal tender laws then central banks would be perfectly fine, as far as business cycles are concerned, IYO?

              • Dan says:

                What about a central bank like the Bank of England in the late 1690’s that wasn’t granted legal tender power for their notes?

              • Enrico says:

                @Dan

                I used the standard definition of base money, the one in every textbook of economics. I’m sorry that you didn’t know it, but now (hopefully) you do. In central banking, base money consists of money emitted by the CB. In a free banking system there is no CB, so base money consists of whatever people ultimately accept for settling debts (e.g. gold).

                In order to have CB banknotes equal to bank IOUs, the CB should be equal to normal banks. If its banknotes are deposited into another bank, its gold reserves should be transferred to the other bank reserves. And viceversa. In such scenario, only gold is the ultimate medium of payment (base money).

                At the beginnig, the Bank of England (BoE) was theoretically equal to normal banks; in practice, it received multiple privileges over its private competitors. In fact, it was created in order to financially help the Crown, so it lended too many IOUs (banknotes) to the Government. After only two years, BoE was bankrupt; the Government had to suspend the convertibility of BoE banknotes ( https://mises.org/library/william-pitt-bank-england-and-1797-suspension-specie-payments-central-bank-war-finance ). Therefore BoE was granted a legal tender privilege: the other banks had to accept its banknotes without receiving gold.

                Do you see now the difference with base money? If BoE banknotes were legal tender from the beginning, as they are now, the English CB would have incurred in no problem at all.

              • guest says:

                “Whether he is not spending because he previously planned so, or because he found out the bank cannot pay him back, the result is the same: instead of producing more consumer goods, more capital goods can be produced.”

                That’s more capital goods than is justified by consumer preferences as expressed in their decision to save rather than lend

                It’s the wrong signal.

                The saver is saving for a reason. Whatever those reasons are, they bear on the profitability of current and future structures of production.

                If you don’t produce capital goods in accordance with consumer preferences, you will be making malinvestments.

                The amount of savings (not to include loanable funds in this particular scenario) are telling you something about consumer preferences.

                Loaning those savings out sends the wrong information about what is profitable to produce.

              • Dan says:

                OK, so you think the Bank of England was just fine in the 1690’s, from a business cycle perspective, since their notes weren’t legal tender?

              • Dan says:

                “During the gold standard, banks couldn’t use gold as reserves: they had to use CB-emitted money (as today).“

                Also, can you explain this statement?

              • Enrico says:

                @guest
                But there is no information that investors can get (and use), other than the amount of available savings for a certain period of time.

                If someone lends his money for a fixed period of time, you can’t know what he’ll do after the loan expires. He’ll get the money back and then…who knows? Therefore, businesses only see that there are more savings available for funding their projects. They can’t know if consumers (least of all, the one who lended money at the beginning) will buy their stuff – i.e.what will be profitable to produce – in the future. In fact, they only need to know (or, at least, to estimate in a reasonable way) if they can finance their investments or not. That is: if there are enough savings available.
                Back to FRB: without the CB, banks provide such information. If a bank lends a certain amount of money for a certain period of time, it means that someone is going not to spend an equivalent amount of money for an equivalent amount of time. To put it simply:

                CASE-A) Frank lends his money to a business for 2 years. After 2 years, the business sells its products to George – regardless of what Frank is going to do with his money after that time.
                CASE-B) Frank deposits his money into a bank, and the bank gives a loan to the same business of CASE-A for 2 years. After 2 years, the business sells its products to George.

                There is no difference. If the investment is good in CASE-A, it’s good also in CASE-B. So it doesn’t matter whether Frank is lending with fixed maturity or depositing (i.e. lending with no fixed maturity).

              • Enrico says:

                @Dan
                Quote: “so you think the Bank of England was just fine in the 1690’s, from a business cycle perspective”

                I don’t know the details. Since the BoE was emitting too much IOUs, I guess the other banks were lending money to it – instead of lending money to their customers. If things went this way, from 1694 to 1696 there was no business cycle due to BoE activity (*).

                (*) Of course, if the BoE managed poorly its investments, bad outcomes may have resulted from them. But it’s not a business cycle.

                Quote: “During the gold standard, banks couldn’t use gold as reserves: they had to use CB-emitted money”

                Sorry, I didn’t explain in the previous comment.
                In a free banking gold standard, banks emit private banknotes redeemable in specie (gold); therefore, they have to keep gold reserves.
                But in central banking gold standard, the CB is the only institution allowed to emit banknotes (which are also legal tender). Thus, banks don’t need gold reserves anymore: they just keep reserves of CB money (coins and banknotes).
                For sure, from the 1934 Gold Act, nor private banks nor private individuals were allowed to keep gold.

              • guest says:

                “But there is no information that investors can get (and use), other than the amount of available savings for a certain period of time.”

                Yes, there is. The logic of the savers’ actions means that the range of Pareto superior investments are restricted to those that can be funded by the amount of loanable funds *as understood by the lenders*.

                While mistakes can be made within those parameters, it is logically impossible to not make mistakes outside of them. (All other things equal, that is; It’s possible for consumer preferences to change, but the consumer will express that, too, within the restrictions placed on his money through his loan to the bank.)

                “If someone lends his money for a fixed period of time, you can’t know what he’ll do after the loan expires.”

                But you know that before it expires he is withholding consumption that would have otherwise been available to him had he not lent it out. So his preferences are affecting the profitability of current (and, therefore, future) lines of production.

                “He’ll get the money back and then…who knows? Therefore, businesses only see that there are more savings available for funding their projects.”

                That would be true whether or not you chose to print money to loan it out. You don’t know whether or not he’ll want more printed paper, so why not print more?

                It’s the same thing, because savings represent withholding of consumption of actual resources. The resources being bought by the fractionally reserved loans were not magically created by the loans.

                Whether you print money or loan out what are supposed to be savings, you are sending the false signal that it makes sense for there to be more bids for a resource than would otherwise have occurred had those loans not been made by the banks.

                “They can’t know if consumers (least of all, the one who lended money at the beginning) will buy their stuff – i.e.what will be profitable to produce – in the future. In fact, they only need to know (or, at least, to estimate in a reasonable way) if they can finance their investments or not. That is: if there are enough savings available.”

                I basically already covered this earlier in this comment when talking about Pareto efficiency.

                But think about what it would mean for there to be *not enough* loanable funds (you said “savings”, but we’re talking about funds made available for loans versus those intended to remain unspent and unlent) available within your paradigm.

                If “enough loanable funds” just means “what the bank is willing to lend out”, then that is actually unlimited since the bank can print bank notes.

                So, the only economically meaningful definition of “available loanable funds” must refer to the available resources and not, fundamentally, the available amount of money.

                And since it is consumer demand that affects the profitability of various uses of those resources, and since consumer demand is expressed in savings and loanable funds, then misrepresenting the amount of funds explicitly restricted by savers bears on the profitability of loans made by the banks.

                As an aside, it might be helpful for the discussion to introduce the concept of the “pure time preference theory” of interest. The purpose would be to get Selgin, et al, to think of interest rates and loanable funds in terms of the actual, physical resources being desired by consumers, rather than to think of them as monetary in nature.

                I believe that understanding this concept would make it easier to see how fractional reserve lending necessarily causes malinvestments.

                Basically, the pure time preference theory of interest says that interest rates are a function of an individual’s logical necessity to prefer something in the present as against that same good in the future (logical because there’s no utility in foregoing the use of a good that would be available to you both in the present and in the future, all other things equal).

                It’s the logic of your preference for present goods to future goods that can make it profitable (in your own estimation) for you to pay more for something today than you would otherwise have to; You don’t have the money, today, but you’re willing to pay more, tomorrow.

                So, interest is not, fundamentally, monetary in nature. It’s based in preferences for real resources.

                That’s why misrepresenting the available loanable funds causes a mismatch between production and consumer demand.

                (Bob Murphy actually disagrees with the pure time preference theory of interest, and there’s currently disagreement among Austrians about it. I think that those opposed will have a harder time convincing Selgin of the errors of FRB.)

              • Enrico says:

                @guest
                Banks cannot create all the “money” they want. Otherwise, they would go bankrupt literally within one day. They can only lend a part of the money they receive from depositors – specifically, the part that is not going to be spent by depositors themselves.
                Since depositors are not going to spend a certain amount of money, they are saving that amount of money. They are saving real resources: they are not consuming goods as they could.
                Therefore, banks only lend real savings. You said it yourself: “savings represent withholding of consumption of actual resources”. In fact, depositors are refraining from consuming part of their money, the same portion that banks lend out. The resources made available by depositors’ under-consumption are used for investments. In real terms, banks are simply lending out the resources that depositors are not going to consume.

                And whether someone is lending with fixed maturiy or without fixed maturity, he is still not-spending his money. He is not consuming resources. Thus, he is saving money/resources. So, back to my example, investment profitbility doesn’t change between CASE-A and CASE-B because the only important thing for businesses is the amount of available savings in a certain period of time.

                Quote: “you know that before it expires he is withholding consumption that would have otherwise been available to him had he not lent it out”

                You have the same information in FRB. Until the loan (granted by the bank) expires, somebody has to withhold consumption.

              • guest says:

                Enrico quoting me: “”Quote: “you know that before it expires he is withholding consumption that would have otherwise been available to him had he not lent it out”

                End quote, Enrico continues: “You have the same information in FRB. Until the loan (granted by the bank) expires, somebody has to withhold consumption.”

                No, this is false.

                His plans are different under savings than they are under fixed maturity, all other things equal.

                Otherwise, there’d be no reason to lend out the money in the first place – it would be much simpler just to hold onto the money and risk nothing.

                So, because he will act differently under savings as against under fixed maturity, fractional reserve lending will necessarily sends the wrong signals about consumer preferences.

              • Enrico says:

                @guest
                Lending (either with or without fixed maturity) provides an interest, so there’s a reason for doing it instead of hoarding money.

                Either by hoarding money or by lending it, there is someone not-consuming resources. There are resources available for investments. I don’t see why we don’t both agree on this.

              • guest says:

                “Either by hoarding money or by lending it, there is someone not-consuming resources. There are resources available for investments. I don’t see why we don’t both agree on this.”

                The reason is because you’re unnecessarily focused on the nominal units of money, which is ultimately irrelevant; while I’m focused on the actual resources being demanded by consumers, which bears on the utility of money (and not the other way around the demand for money being merely an expression of the underlying demand for goods and services).

                (Aside: To be sure, money isn’t neutral. But it is non-neutral only in the sense that it’s an expression of trades for goods and services, the demand for, and allocation of, which bears on the profitability of supplying them.

                (That’s true whether using money or bartering.

                (The demand-for-goods-and-services “Dog” wags the demand-for-money “Tail”.)

                You think that lending other people’s money without their knowledge has no economic effect because you think savers are incapable of expressing demand under every configuration of “idle savings”.

                This, I think, is the fundamental error of Selgin, et al.

                But savers can still express demand with the resources they have, and those expressions will be different under an expectation of zero-risk savings than under an expectation that they are lending money to the bank.

                Those expressions being different, fractional reserve lending necessarily sends the wrong signals about consumer demand.

              • Dan says:

                “But in central banking gold standard, the CB is the only institution allowed to emit banknotes (which are also legal tender).”

                They can be made legal tender, but often through history they were not.

                “I don’t know the details. Since the BoE was emitting too much IOUs, I guess the other banks were lending money to it – instead of lending money to their customers. If things went this way, from 1694 to 1696 there was no business cycle due to BoE activity (*).
                (*) Of course, if the BoE managed poorly its investments, bad outcomes may have resulted from them. But it’s not a business cycle.”

                So you’re theory seems to be that without legal tender laws, business cycles wouldn’t exist? Is that right?

                “Thus, banks don’t need gold reserves anymore: they just keep reserves of CB money (coins and banknotes).
                For sure, from the 1934 Gold Act, nor private banks nor private individuals were allowed to keep gold.“

                Can you point me to anything to read in regards to banks from the 1600s-1800s not having to keep gold on reserve because they could just hand out pieces of paper to their customers trying to withdraw their money instead? I’m not talking about during periods where governments suspended specie payments. I want to read about times with central banks between 1600s-1800s where people were voluntarily depositing gold into banks knowing they’d only ever get pieces of paper back in return.

              • Enrico says:

                @guest
                Quote: “you’re unnecessarily focused on the nominal units of money”

                Actually, no: I pointed out that people not-spending their money make real resources to be available for investments. I’m focusing on real resources being demanded (or not) by consumers. In fact, you quoted me literally talking about real resources (“there is someone not-consuming resources”).

                Quote: “savers can still express demand with the resources they have, and those expressions will be different under an expectation of zero-risk savings than under an expectation that they are lending money to the bank”

                If I get it correctly, you are saying that people are buying different things depending on whether they are hoarding money or they are lending it.
                However, you can have different consumer behaviours (“buying pizzas instead of hamburgers”) while having the same amount of loanable funds. In fact, you can imagine a scenario where people lend thier savings and spend money on certain goods, and another scenario where the same people lend the same amount of savings while spending money on different goods. There is no a “right” scenario and a “wrong” one: they both are fine, despite the fact the people have a different behaviours while giving the same signal (the amount of funds available for investments) to businesses.

              • Enrico says:

                @Dan
                Quote: “your theory seems to be that without legal tender laws, business cycles wouldn’t exist?”

                In a gold standard without legal tender laws or equivalent privileges, the CB is no different from other banks. Hence its banknotes emissions have to be backed by gold inflows. Thus, I don’t think such emissions would cause a business cycle.

                Quote: “Can you point me to anything to read in regards to banks from the 1600s-1800s not having to keep gold on reserve ”

                Here you have:

                “During the 19th century, banks supplanted governments as the principal holders of gold reserves. Commercial banks received deposits subject to repayment in gold on demand and issued notes (paper money) that were redeemable in gold on demand; hence each bank had to hold a reserve of gold coins to meet redemption demands. In the course of time, however, the preponderant portion of the gold reserves shifted to central banks. Because the notes of commercial banks were wholly or largely replaced by notes of the central bank, the commercial banks needed little or no gold for note redemption.” ( https://www.britannica.com/topic/gold-reserve )

              • Dan says:

                “In a gold standard without legal tender laws or equivalent privileges, the CB is no different from other banks. Hence its banknotes emissions have to be backed by gold inflows. Thus, I don’t think such emissions would cause a business cycle.”

                So what’s your explanation for the numerous booms and busts that happened long before a central bank had legal tender privileges.

                “During the 19th century, banks supplanted governments as the principal holders of gold reserves. Commercial banks received deposits subject to repayment in gold on demand and issued notes (paper money) that were redeemable in gold on demand; hence each bank had to hold a reserve of gold coins to meet redemption demands. In the course of time, however, the preponderant portion of the gold reserves shifted to central banks. Because the notes of commercial banks were wholly or largely replaced by notes of the central bank, the commercial banks needed little or no gold for note redemption.”

                First off, that doesn’t show that banks couldn’t or weren’t allowed to hold gold as reserves. It shows the opposite. The sentence you left off shows that banks were still responsible for meeting their customers demands for gold redemption. “The commercial banks also came to depend upon the central bank for gold needed to meet the demands of their depositors.” Nowhere does it say, that banks had to keep central bank notes in place of gold, that customers wanting to redeem their gold were forced to take bank notes, etc. That short article doesn’t back you up.

                Second off, is that where you came up with the idea that banks couldn’t use gold as reserves during the gold standard? You don’t have a more thorough source?

              • Enrico says:

                @Dan
                Quote: “what’s your explanation for the numerous booms and busts that happened long before a central bank had legal tender privileges”

                There are other Government interventions affecting the monetary system. Debasement, for example, happened long before the first CBs existed. We can discuss a specific case, if you want.

                Quote: “that doesn’t show that banks couldn’t or weren’t allowed to hold gold as reserves”

                But I previously quoted the Gold Act to prove that, at some point, banks couldn’t hold gold anymore. Every country had its own path toward the current monetary system, where banks hold gold reserves no more.
                However, it’s irrelevant: as the text explains, there was no point in keeping gold reserves, since banks were no more allowed to issue their own banknotes. People were using either gold coins or CB banknotes for payments, so banks just needed one of the two types of money. Since the CB banknotes were redeemable in gold, and more conveninet to store, they were a reasonable reserve: even if somebody really wanted gold, his bank could have just sent to the CB some of its banknotes in return for gold.

                Quote: “The sentence you left off shows that banks were still responsible for meeting their customers demands for gold redemption”

                You clearly didn’t understand its meaning. A depositor receiving a CB banknote could have asked gold, instead, and his bank would have just given the CB banknote to the CB itself in return for gold.

                Quote: “Nowhere does it say that banks had to keep central bank notes in place of gold”

                It’s logically implied that, having no need for gold, banks were using something else as reserves (the CB banknotes).

                Quote: “is that where you came up with the idea that banks couldn’t use gold as reserves during the gold standard?”

                You mean more “thorough” than the Encyclopedia Britannica? That’s funny. However, the idea came out of logic: in a CB gold standard, there is no need for banks to keep gold bullions as reserves. There is a reason for keeping gold only in a free banking gold standard, where gold can be used for issuing private banknotes.
                In fact, I needed only a very quick research to prove it. Of course, you can try and do a reasearch to prove the contrary: that banks were not using CB banknotes as reserves once they were no more allowed to issue their own banknotes.

              • guest says:

                “There is no a “right” scenario and a “wrong” one: they both are fine, despite the fact the people have a different behaviours while giving the same signal (the amount of funds available for investments) to businesses.”

                It’s not about right or wrong.

                Again, consumer demand is what determines the profitability of production.

                When production is not in conformity with consumer demand, that production is a malinvestment.

                Consumer demand will go in one direction under the expectation that “hoarded” money is secure from being lent out, and in another one under the expectation that the money is allowed to be lent out.

                Lending someone’s money out who intends for it to be hoarded necessarily results in that lent money incentivizing production that is not in conformity with consumer preferences.

                “Hoarded” money is not available as loanable funds. It’s available to be hoarded as per the owner’s intent.

    • guest says:

      “Guys, creating base-money and increasing bank deposits are totally different things.”

      Nobody wants money for its own sake. Either it has a non-monetary use-value, or it’s a claim *to* something that has a non-monetary use-value.

      (This is why I keep bringing up “handfuls of dirt”. If you really wanted to, you could stick dirt between transactions [trading for money is an incomplete transaction], but deep down you know something is wrong with it. But people think they can stick useless pieces of paper between transactions and it will work.

      (They see people trading it, and think that that’s proof that it works, but Ponzi schemes result in voluntary trades on the part of suckers, yet somehow that’s supposed to be different.

      (There’s only one thing either party to a trade needs in order to make a trade, but there are two things needed to make a profit:

      (Belief that something is profitable is necessary to make trades, because no one would trade unless they *thought* they were making a profit.

      (But profit needs to have both the *belief* that there will be profit, *and also* the realization of that profit.

      (If something is believed to have value, but actually does not, then that thing’s value is really zero – and no amount of voluntary trading of that thing can show that it *actually* has the value sought after.

      (That’s just logic.)

      So, either they want it because someone else wants it, which just pushes the question of where it gets its value back one step.

      Or they want it because of its non-monetary use-value.

      If it has no non-monetary use-value, then the “money” is purely speculative and *does not need* to have any kind of history conforming to a Regression Theorem, and *does not need* to have had a use-value in order to someday become money.

      Because at any point in time you can say of anything that is believed to be money that the basis of its trade value, today, is a “yesterday’s price” – and you can just choose to use that specific price *at any time*.

      If “agreement” is all that is necessary for something to be money, then just choose a value out of a hat and agree to it. Problem of finding a Coincidence-of-Wants solved. Poof, the magic of believing hard enough.

      In short, creating paper is not creating value, so all it can be is a claim to value – and if that claim is not backed by something that *is* subjectively valued, then the paper is not money, and has the same catallactic effects that FRB does.

      • Enrico says:

        @guest
        I don’t follow your argument. My bad!

        However, let’s put it simple. In my view, bank deposits are loans granted to the bank by depositors. Probably you disagree on this. But, then, there is no contradiction (from me) in blaming CB emission of base-money, while defending fractional reserve deposits expansion. Because the CB is creating new money, while FRB (in my view) is just lending already existing money.

        To repeat: you (and Dan) probably disagree on the idea that bank deposits are loans. We can discuss about that, as we previously did, but I’m not so confident to reach an agreement. Anyway, Dan thought that I was contradicting myself, and my purpose was to explain why I don’t think so.

        • guest says:

          “Because the CB is creating new money, while FRB (in my view) is just lending already existing money.”

          In both cases, new paper claims are created. The only difference between CB printing and FRB lending is that you choose to accept one and not the other. And while that is certainly your choice, that is also inconsistent.

          Nobody wants money for its own sake. I can write any number you like on a piece of paper, but you won’t take it in payment because it doesn’t mean anything.

          You could say “other people won’t accept it”, to which I will simply suggest that as soon as *you* accept it, then we can tell people that someone has accepted it and then they will have no other excuses except to borrow from my paradigm that money must have a link to subjective use-value in order to justify refusing to use it as a medium of exchange.

          (And that is setting aside the question of whether or not bank deposits are loans.)

        • guest says:

          Maybe it will help to say that savings are never idle in an economically meaningful sense.

          The point of refraining from spending money is to attempt to secure future purchasing power.

          That security is gone if it’s being lent out when it’s supposed to be sitting in a vault (so to speak).

          The saver’s plans for his life while he thinks his money is sitting in a vault are bearing on prices for the goods and services he is opting *not* to buy.

          So the savings have information baked into them about what consumers want. And lending that money out sends misleading price signals to producers about consumer preferences.

          • Enrico says:

            If bank deposits are loans, then banks simply borrow money and lend out a part of it. Thus the question: are you saying that borrowing and lending money create “paper claims”?
            Anyway, “borrowing money and lending it” is different from “creating money and lending it”.

            Maybe I’m wrong, but I think the issue here is the fact that banks don’t lend cash directly. My previous example addressed the issue: there is no difference between using cash or using a “note” which is redeemable in cash. At the end, when the note is redeemed, the outcome is exactly the same.

            I remember (from another Bob’s post) you saying that, if the saver knows that the bank will use his money, no cycle can be created. My opinion is that saver’s believes are irrelevant to the economic outcome. Nobody knows what he thinks, thus his believes cannot alter anything. Whether he knows or not, the relevant thing is that, for a period of time, he’s refraining from spending. We don’t know how long the period will be, it’s up to the bank to figure out how its depositors will behave on average.

            • guest says:

              “My opinion is that saver’s believes are irrelevant to the economic outcome. Nobody knows what he thinks, thus his believes cannot alter anything.”

              I think we’re getting somewhere, with this, so let me focus on it.

              Producers need consumers to buy their products in order for them to be profitable.

              So, savers, in their capacity as consumers (they are consuming other things at the moment, such as leisure) necessarily alter the profitability of current and future production processes.

              And while it’s true that nobody knows what he thinks, there is *some* information about what he *doesn’t* think.

              For example, we know that, even though he can afford some things with the amount of savings he has, his decision to not buy those things reveals that he has a preference for something other than those things.

              That’s helpful information that can be used by entrepreneurs in their business.

              “We don’t know how long the period will be, it’s up to the bank to figure out how its depositors will behave on average.”

              That’s true as far as it goes, but it’s the consumer who decides whether or not the projects started with the banks’ money will be profitable – the bank cannot decide this.

              In fact, the bank has to determine consumer demand just like the producer.

              The producer has to know what the consumer wants in order to know what to produce.

              The bank has to know something about consumer demand in order to judge whether or not a producer is credit-worthy.

              • Enrico says:

                Quote: “his decision to not buy those things reveals that he has a preference for something other than those things”

                He may also prefer not to buy those thing now, for buying them in the future. I understand your point, don’t get me wrong! But I’m stressing the fact that such information is very generic / uncertain.
                If I understand correctly, you are saying that the producer can only see the amount of available savings. I agree on that.

                I like the analogy between the producer and the bank. Both of them don’t know what the consumer will do in the future: when will he stop saving? what will he buy? Their job is to predict consumers’ and savers’ behavior. Banks try to predict money withdrawals, producers try to predict purchases.

                So, if the bank does its job correctly, the current amount of available savings is a real thing, and it’s sending the correct signal to producers. No?

              • guest says:

                “So, if the bank does its job correctly, the current amount of available savings is a real thing, and it’s sending the correct signal to producers. No?”

                It’s sending the right signals *as savings* – not loanable funds.

              • Enrico says:

                Aren’t they the same thing? If the consumer is not spending his money, while keeping it on his bank account, his savings correspond to more loanable funds.

              • guest says:

                “Aren’t they the same thing?”

                No, because the saver is making economic decisions based on his belief that his money is in a vault (so to speak).

                If he thought he would be better off while adding risk, then he would have done that, instead.

                So the savings, just sitting there, send price signals about consumer demand.

                If the bank lends out money that the saver believes is just sitting there, then that sends signals that do not reflect consumer preferences.

              • Enrico says:

                But if the saver knows that the bank may lend his savings, is it sending the right signal?

              • Enrico says:

                I’m sorry, the last question was already answered (“yes”).

                Let me mix the things a little bit. Suppose the saver (John) lends his money to the bank for a fixed maturity. Thus, it’s not a bank deposit. John gets a debt title from the bank. Now the bank lends the money to someone (Jane), and it’s sending a signal about John’s preferences.
                At a certain point, however, John changes his mind: he wants to buy something, he needs the money back. So he sells the debt title to someone else (Jake) and then buys the desired stuff. John preferences are indeed changed, yet the loan granted to Jane is the same as before. The change in John preferences doesn’t influence Jane actions. Does this mean that something bad is going to happen (like a boom-bust cycle)?

                I think not. Thus, only the amount of savings matters: John preferences may change, but there’s no problem as long as the decrease in his savings is matched by an increase in Jake’s savings.

              • guest says:

                “So he sells the debt title to someone else (Jake) and then buys the desired stuff. … Does this mean that something bad is going to happen (like a boom-bust cycle)?”

                The problem with negotiable debt instruments is that it ignores the logical impossibility of two or more people owning the same debt.

                That’s the nature of debt. That’s what the word “debt” means: an obligation upon Person B to Person A.

                I made a deal with Person A, not Person C. And I made a deal with him because I thought he was credit-worthy. I don’t even know Person C.

                So, yes, that situation would send the wrong price signals about the bank’s willingness to lend, and therefore to the real available supply of loanable funds.

                I realize this happens all the time, but that’s a problem.

              • Enrico says:

                Quote: “yes, that situation would send the wrong price signals about the bank’s willingness to lend, and therefore to the real available supply of loanable funds”

                To be honest, I thought that you would say “no” 🙂 since my example was entirely based on fixed maturity loans. So the problem (according to your reasoning) is not necessarily related to “at call” loans or FRB: it comprehends other scenarios, too.

                Quote: “the logical impossibility of two or more people owning the same debt”

                Well, in my example there are no two people owning the same debt. First John owns the bank debt, then Jake gets it (while John looses it). Jane’s debts is always owned by the same creditor, the bank.

                I would also say that FRB is not about two (or more) people owning the same debt. It’s about two (or more) people having the same debtor -> the bank.
                But I can get two (or more) loans from as many people, even with the same maturity date, without anyone complaining a fraud or a logical impossibility!

              • guest says:

                “So the problem (according to your reasoning) is not necessarily related to “at call” loans or FRB: it comprehends other scenarios, too.”

                Yeah, technically.

                So, what I’m looking for is for production to not match consumer demand.

                There is more than one way for that to happen, in my view.

                I just poo-poo FRB, here, because that’s the form that the cause of the malinvestment takes.

    • Tel says:

      After I lend out those $9, are there “multiple claims to the same money”? No: the original owner lent me $10, so he doesn’t have anymore a claim on that money; he only has a claim on $10+interests of my money at some future date.

      Modern banks don’t work like that, I have a card in my hand and I can spend money right out of my account almost instantaneously at any time. Typically the transaction clears in 5 to 10 seconds. Clearly I do have a claim to that money, which might be at some future date, or might be right now, or any time.

      Finally: could a bank create all the bank deposits that it desires? No, because it would immediately go bankrupt. Bank deposits are limited by the amaunt of real money deposited in banks, since they are redeemable in it.

      Bank deposits are NOT guaranteed redeemable, that’s what a “bank run” is all about… people all asking for their deposits to be paid out on the same day. By your definition, every bank runs bankrupt all the time. That’s what “fractional reserve” means… the banks cannot fully redeem if everyone asks.

      How can you explain that when you add up all the “at call” bank account totals it comes to a much large number than the total amount of cash the Central Bank has issued? The fundamental “Monetary Base; Currency in Circulation” is $1.6 trillion.

      https://fred.stlouisfed.org/series/MBCURRCIR

      While the broader definition of the M1 monetary stock is $3.6 trillion. So either money got created somewhere or else something is pretending to be money (and fooling a lot of people).

      https://fred.stlouisfed.org/series/M1

      This observation is the whole point of the question, if your theory can’t explain why it happens then by all means go back, rethink and come up with a new and better theory.

      • Enrico says:

        Quote: “I can spend money right out of my account almost instantaneously at any time”
        Indeed you have a claim on bank reserves, which is not the same as having a claim on the money already lent out by the bank. In fact, you can withdraw money without any problem – you don’t need to go after the final borrower.

        There’s only one difference between my example and banking: in my example, the original owner is lending with a fixed time maturity, while bank depositors are lending without a fixed time maturity.

        Quote: “Bank deposits are NOT guaranteed redeemable”
        The bank is obliged to redeem its deposits upon demand. If it fails to satisfy current demands, it goes bankrupt. If it succeeds in satisfying current demands, it doesn’t go bankrupt.
        But the point I was making is that a bank receiving $10 cannot lend more than $10, because otherwise that money (being deposited in another bank) will be immediately claimed back and such thing will bankrupt the bank.

        Quote: “How can you explain that when you add up all the “at call” bank account totals it comes to a much large number than the total amount of cash the Central Bank has issued?”
        You are comparing the amount of debts of the banking system with the amount of base-money. It’s not strange at all that the first amount is larger than the second one.
        I can make a simple counter-example: if someone lends me $10 and I lend $9, there are $19 debts while only $10 cash. Is it strange, or is it obvius, that debts (and credits) can be larger than total cash? I think it’s obvius. There’s nothing wrong with it.

        • guest says:

          “I can make a simple counter-example: if someone lends me $10 and I lend $9, there are $19 debts while only $10 cash.”

          That’s not an example of an “at call” loan, which his question was based on.

          What you’re describing is a loan due on X date that is loaned out again to someone else and is due on a date prior than X (or due on the same date but before the other is due, if specific times matter).

          • Enrico says:

            Actually, my example doesn’t specify if the loan has a fixed maturity or not. I could just borrow $10 without a fixed maturity, and then lend $9. In the end, there are $19 debts but only $10 cash.

            I wanted to explain how total debts can outnumber total cash. In this regard, having a fixed maturity or not is not relevant: a debt is a debt.

            • guest says:

              “In this regard, having a fixed maturity or not is not relevant: a debt is a debt.”

              Not according to his question.

              He mentioned “at call” totals, where it is possible to have more debt due at the same time than money to pay it back.

              Those are the only debts relevant to his question.

              • Enrico says:

                He mentioned “at call” loans, but the answer is independent of such detail. The same answer holds both with or without fixed maturity loans. If he likes to, he can think that my reply was about “at call” loans: hence, we have $19 “at call” debts and only $10 cash.

              • guest says:

                “… hence, we have $19 “at call” debts and only $10 cash.”

                Whereas with fixed maturity, no matter how many times the $10 is re-lent, there is never more than $10 due on existing maturity dates.

              • Enrico says:

                Even with fixed maturity, there are $19 debts.

                BTW, debts are not due at the same time even in the case of “at call” loans. They are due only “at call”. If they are called at different dates, by definition they are not due at the same time.

      • Enrico says:

        (I just want to add that bank deposits are not the only type of loan without a fixed maturity: see “call loans” https://www.investopedia.com/terms/c/callloan.asp )

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