On the Record: Thoughts on Free Banking
Just some thoughts, for the time being. Nothing substantive, yet.
People use banks not primarily to store money, or to earn interest on their deposits (most people earn an alarmingly paltry return on checkable deposits and savings accounts alike) but to facilitate the tendering and receipt of payments. Many methods of saving/investing are superior to deposit accounts: short-term CDs, mutual funds, diversified and staggered interpersonal loans granted on a P2P site like prosper.com, etc.
The ease with which one can now effect the purchase of a good, immediately and across the continent (or the globe!), is a valuable service in its own right.
Depositors of free fractional-reserve banks have a right (subject to some qualifications/restrictions) to redeem their deposits in base money. What, if any, would be the criteria for holding bankers personally liable for violating their fiduciary obligations in the event of insolvency?
In what medium are fractional-reserve bank loans denominated and how are they to be repaid? Are borrowers required to repay in base money? If not, where does the interest portion of their payments come from?
My hunch is that nobody, anywhere, ever, has had an interest-bearing deposit account that, for any chosen time interval, has outperformed durable commodities. (I’ll admit that I’m shooting from the hip with this argument.)
In an advanced economy, monetary evolution results in more-or-less widespread use of fiduciary media.
Why does a fractional reserve bank have to loan out 90% of your money in order to pay you 0.25% interest?
Do you really think that you’re not getting totally fucked by inflation? Really?
Possibly related posts:
- Free Market Banking: A Reply
- The Fractional Reserve Banking “Contract”
- What’s Better Than Mild Inflation?
- The FDIC Does Not Protect You
Related posts brought to you by Yet Another Related Posts Plugin.
About The Author
Not rebuttals, since you noted you're just thinking out loud, but some of my own unprocessed responses. I suspect this will be a useful way for all of us to get a little smarter on money and banking. Anyway, here goes:
———————–
My hunch is that nobody, anywhere, ever, has had an interest-bearing deposit account that, for any chosen time interval, has outperformed durable commodities. (I’ll admit that I’m shooting from the hip with this argument.)
——————-
Well, you admitted you were shooting from the hip, but even if we assume deposit accounts paid no interest ever, they would have outperformed durable commodities in all the periods that saw durable commodities drop in price (duh!). If you bought gold at the end of 1980 at $590 (not its peak that year), you would still be waiting to get back to even a quarter century later, at the end of 2005. And unless you were insane enough to keep the gold unprotected and uninsured, you would STILL be behind a deposit account that didn't require incurring any costs for storage and protection (and paid interest that was far higher than 0.25% in most years). If we assume that the interest on one-month T-bills approximates the rates paid by accounts with checkwriting privileges, deposit accounts clobber commodities over most long time periods. Crude oil also sells for a lower price today than 30 years ago, even though we're supposedly running out of it.
In real terms, commodities have dropped in price over time as technological efficiency has increased, a point made by Julian Simon in many of his writings, and the basis for his famous bet with Paul Ehrlich in 1980. Obviously, the REASON Simon won the bet was that the basket of durable commodities chosen by Ehrlich dropped in value that decade (even in nominal terms, as it turned out).
Needless to say, those of us who advocate free banking expect that private bank notes are likely to be redeemable in some commodity, and this will place a limit on the amount of inflation of the money supply that results, as anything that would reduce the price of gold below its opportunity cost as a pure commodity will result in mass redemption for guaranteed profits.
It is really hard to understand what a fractional reserve system based on fiat money even means, although it is worth noting that Somalia, which has a private fiat system, saw inflation until the value of the largest Somali note dropped to the cost of the paper and ink required to produce it, then stabilized with no inflation thereafter! [h/t Benjamin Powell] So even IT turned out to be commodity-based, with the commodity being the inked paper.
Obviously, a banker won't be PERSONALLY liable if the bank is incorporated, but even ignoring liability, no bank will survive that isn't able to honor withdrawals. Unless you've read the many works on the history of free banking, you're really talking out of the top of your hat to assert that bank failures were a significant problem.
In a totally free society, reputation becomes the most valuable asset. Even absent legal liability, there are many reasons to expect a sound monetary system to develop, because of the immense profits available for being a reliable bank.
I don't think many of us are arguing that we aren't getting hurt by inflation under the present system, but what keeps me from getting hurt is having the overwhelming majority of my assets in equities and real assets. If the banking system were based on a commodity, I might keep more assets there (especially as I got older and, perhaps, more conservative about short-term fluctuations), but only if I trusted the bank, which I never would under a government central bank system.
Anyway, my comments are as disjointed as your post, so forgive me. I look forward to your future thoughts.
Not quite sure where you are coming from here. Why do you ask what medium are bank loans denominated in? Isn't it USD or AUD or whatever. Not sure what you mean by "base money" but you could mean something like M0 in which case the answer is no, it's usually in the local currency.
"Where do the payments come from?" I hear this from time to time. On Mises.org they call it money crankism. It was an aspect of the "Money as Debt" video that I didn't understand. That video is where I first heard the argument that the banks create the credit by not the money to pay it back with. They say it leads to a certain number of defaults and subsequent foreclosures. I'm pretty happy that this is an incorrect view. This view seems to forget that money changes hands. Imagine a window cleaner who is paying off a loan, he might make a $100 interest payment, some of which ends up getting paid to his bank manager as salary. If the window cleaner then takes payment for washing the bank manager's windows then he "gets back" that "same" money he paid the interest with last month. Of course, it doesn't have to be a closed system. Money is only a medium of exchange. Doing work creates value.
We're discussing "free banking" here, so, assume for the time being that there's no such thing as USD or AUD or CAD.
Interesting that you mention Money as Debt, I've heard of the video but hadn't watched any of it until yesterday.
There are other sources out there which validate this claim. If as you allude, circulation was sufficient to satisfy the debt-service, there would be no need to continually create new debt/money. We can see this all, right now, played out in front of us. The economy revolves on debt. (NB: I'm not suggesting this is a healthy or sustainable system!) When people, businesses, governments, etc., are unable to get credit, the whole thing begins to unravel.
I broadly agree that money is a medium of exchange, and that "doing work creates value" which is an elementary restatement of Say's Law. The question at hand (or one of them, at least) is why certain people are privileged to create a costless/effortless media of exchange, whereas the rest of us actually have to, you know, "create value"?