For me, a libertarian is someone who believes that limited government is the most likely to protect the liberties of the people whom it governs, and that shouldn’t necessitate an economic system based on a scarce resource such as gold.

Any economy (I do not prefer the term “economic system”) is not “based” on currency. It’s based on the exchange (often consisting in currency) of scarce resources. Some resources happen to be more scarce than others. Historically it is those resources, in particular the precious metals, that have been chosen as monetary commodities. This is so for a number of reasons I need not explain at present.

So it’s a gross misunderstanding, I think, to characterize the Austrians as gold-fetishists (although there are certainly some worthy of that). In fact, it’s not advocacy of an “economic system”, but rather a belief that in the absence of any coerced “system”, a free market settles upon a common medium (or perhaps, media) of exchange.

Anyone who advocates an “economic system” based on anything other than freedom and exchange is not a libertarian.

If everyone agrees to trust the third-party (bank) and “subscribe” to the token system (“I’ll accept tokens from you as a wage if you agree to sell me stuff with those tokens later”), where is the fraud and where is the need for a commodity money?

It begs the question to assume that money must be commodity money to be a legitimate medium (consequentialist considerations aside).

Does it really beg the question?  Surely, we should be able to point to historical examples of monetary evolution culminating in irredeemable token substitutes. For starters, this argument assumes money as the intentional product of human design, which suffice to say, is contradicted by the facts of history.

The very notion of token substitutes presumes that they are a substitute for something else, in the same manner that a check, deposit-slip, or warehouse receipt are substitutes for, not replacements for, physical goods. Instead what we see in the history of the world is that, except where governments have been able to intervene, commodity money of some form or another has been pretty much standard.

As to the token-money hypothetical put forth above, what do they say?  If ifs and buts were candy and nuts…  Of course we can frame a hypothetical in such a manner as to preclude the possibility that fraud might occur: “I’m going to define a situation where fraud is inconceivable, and then ask you, ‘where is the fraud?’”, but I’d be tilting at straw men.

My father used to say, “You can ‘what if?’ yourself to death.”  Dealing with “what ifs” is stupid, because the other guy can always pull a “27 Ninjas” on you.  No matter what you say, they can always come up with some fantastic “what if” statement that apparently validates their position.  But what the heck, I suppose I’ll play along for a moment.

Considering that in such a scenario, someone has contributed real, economic-value-added work, in exchange for tokens under an implicit assumption that he would be able to redeem those worthless tokens for something else of real, economic value, sometime in the future, even this cleverly constructed straw-man raises some interesting questions:

1. What happens when the person who agreed to sell you stuff in exchange for those tokens decides he’s no longer interested in tokens?
2. What happens when the person who created those tokens mints a Trillion more of them, overnight?
3. Haven’t you been definitely injured?
4. Would you have agreed to play the game if you knew the other party could change the rules on a lark?

Under a commodity standard, money is the product of human action but not of human design.

1. Accordingly, no promises as to future value are made express, or implied.  No matter what happens to the subjective value of the monetary commodity, your banknotes are always redeemable for a fixed quantity.  The token system is a shell game.
2. With fake money, you get totally screwed.  With commodity money, it’s impossible to mint a trillion dollars overnight to bail out special interests or to pay for imperialism, etc.
3. Production buys production — and although from time to time a new product will emerge, reducing the market value of some of your assets or skills, it is terribly unlikely to happen with money in the first place, and furthermore can onlyhappen as the result of an actual increase in the total amount of wealth in the world.
4. The rules are the rules, they can’t be changed, and they can only be circumvented by fraud, counterfeit, or theft — all properly condemnable behaviors.

Whether it takes the form of “debasement” or “coin-clipping” or “seignorage” or “inflation” is beside the point. If you condemn inflation when the government does it, why stand on your head to defend “private” inflation, if for any other reason than to argue that it will be less bad?

News flash: you know what’s even less bad than mild inflation?

No fucking inflation. Period.

Any law against fractional reserve banking denies otherwise free men their right to contract with one another.

On a purely technical point, there need not be any specific “law” against the practice in order to nullify the practice. Per common-law tradition, the only essential question is whether courts would tolerate or maintain contracts of this sort.

So, there need not be any grievance between depositor and his banking institution, for fraud or theft to occur as a result of fractional reserve banking:in fact, they may both be completely satisfied with the outcome of their arrangement at any point in time.  However, there remains the possibility that a third party has been injured by their agreement.

Though two men may form a compact to injure or defraud a third, no enforceable contract exists among them, which is to say that neither party may be contractually obliged to specific performance based on the existence of such a “contract”. Furthermore, even the existence of a valid contract (i.e., one with a legal purpose), shall not be construed in such a manner as to preclude a third party, unintentionally and accidentally injured during the fulfillment of the contractual obligations, from pursuing remedy from those who injured him.

If we can establish that fractional reserve banking does amount to fraud or theft, or that it causes harm (negative externalities) to others, we can safely assume that a free court would refuse to honor or enforce such “contracts.”

Jeff writes:

I don’t support the status quo, but I wouldn’t support a society where 100% reserves are required by law, either. The reserve ratio should be negotiable between any individual and his prospective bank.

For instance, I should be free to contract with a hypothetical bank for an account with the following characteristics:
- I can withdraw my funds at any time
- The bank may loan up to 10% of my funds in any way it sees fit (or maybe it’s restricted in some mutually agreed upon way)
- I am responsible for any losses incurred on that 10%
- I am not charged any sort of warehouse fee

So basically, I would be accepting a certain amount of risk in lieu of warehouse fee and the bank is trying to turn a profit by using the 10% in an efficient way.

This may or may not be a standard position… I just never hear anyone talk about it.

I think this position is more common than you think, in fact it’s similar to the model of banking that most people (who are not bankers, financiers, or economists) believe that we have. And there’s absolutely nothing wrong with this model. However, there’s a huge difference between loan-brokering (which is what you’re describing) and fractional reserve banking. The problem is that the status quo is essentially licensed theft, and to the untrained eye it looks and sounds very much like the sort of thing you’re describing. It’s not.

Insisting on the ability to withdraw your funds at any time means that the bank would be in breach if they could not satisfy your withdrawal demand. The fact of the matter is that once you agree to permit the bank discretionary control over how that 10% of your money is allocated, it’s impossible for the bank to guarantee, or for you to insist, that you may withdraw your funds “at any time”. Any contract or agreement of this sort would be contradictory in nature: the second clause permits the violation of the first clause.

If you mark 10% of your deposits as “loans” and accept that they may be in default, then you are bearing the burden of risk and your investments may rise (or fall!) in value. Although in practice you may be able to withdraw the entirety of your balance at any time, this is not guaranteed, nor can it be. The only enforceable claim you would have is if the bank failed to honor your demand for the 90% of your money that they agreed not to loan.

If you really just want to loan money, why can’t you? For starters, as a central bank the Federal Reserve manipulates the money supply and the interest rates. Members of this cabal (for all intents and purposes, these members consist of all banks) are able to borrow money into existence, and lend it at interest. This privilege puts the individual lender at a severe disadvantage, it also hamstrings people who don’t make any loans or carry any debt (by decimating their savings)^#:

Wage earners (most of us) are principally the last people to receive this newly created money, and they receive it only after enough time has passed and the primary and noticeable effects of inflation have rippled through the economy. If you wonder why prices rise, it’s because somewhere, someone else got access to a boat-load of newly minted greenbacks which nobody else knew existed (because in fact they did not exist) and used them to place competing bids on the purchases of real resources. — Fiat Credit Is Not a Loan (24 July, 2008)

Even still, until recently, individual lenders were able to find borrowers. But then the SEC banned interpersonal loans on sites like prosper.com which matched individual borrowers and lenders.  (The SEC has since relaxed its ham-fisted ban on Prosper lending.)

Because of the auction-like nature of these loans, even with a modest sum like $500 or $1000, a lender could distribute his investments across multiple borrowers, mitigating default risk. In a truly free market, you wouldn’t need a bank to loan your money, you could do it yourself, and pay the warehousing fees for the rest of your money with your loan proceeds.

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Note: In another recent comment, the question of whether one has a “right” to purchasing power was raised. I do not intend to answer that question presently, although if it were answered in the affirmative, there could be no conceivable justification for fractional reserve banking.

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?

As you understand it, how much of the problem with fractional reserve banking is the concept and how much is the people who practice it? How, if at all, is your objection tied in with fiat currency?

Let me answer a part of the first question pertaining to “the people who practice it” immediately, I’m working on an essay to address the remainder of Tony’s inquiry which should be finished shortly.

+++

My primary objection is with the concept of fractional-reserve banking. The people who practice it are a much smaller concern, because unfortunately as my Public Finance professor used to say, “People respond to incentives.”  People respond to incentives, no matter how perverted the incentives are made by government. And it is the concept of fractional-reserve banking in government which perverts the incentives. A good many of these people don’t know that it’s wrong. But most of these people can’t think critically.

Case-in-point: over the last decade or so, many brilliant young minds were drawn into what appeared to be lucrative careers in finance, banking, real estate, etc. Many of them are also now out of a job. I know smart people who took jobs in banking or wealth management, or whatever.  They took those jobs because they were the best available sources of income at the time.   A friend of mine was a real estate agent, he made over $100k/year back in 2003.  Bought himself a nice house, had a couple kids, etc.  Can’t sell houses any more.  Can’t bring home commission checks anymore.  I know people in wealth management, now unemployed because there’s no more “wealth” for them to “manage”.  They were responding to the bubble that eventually burst.

Given the choice, individuals don’t want to subsidize Wall Street, and see their savings decimated by inflation. That is why governments make sure that individuals don’t have that choice! Despite some arguments based on a misapplication of Gresham’s Law¹, in any free system where unbacked notes compete with specie, the latter will supplant the former.  In some instances, “bad” money may trade side-by-side with good money, but not for long.

The root of that problem is the concept and the implementation of fractional-reserve banking, and its corollary, fiat money, which causes real inflation, and creates inflationary bubbles, which are the illusion of profit that many people chased, exploited, and cashed-in on over the early part of the past decade.

Fractional reserve banking must cause inflation and malinvestment, not necessarily price inflation which is what most mainstream economists mean when they say “inflation,” but real inflation, which is an increase in the supply of un-backed currency or currency substitutes. The very fact that a bank arguably loans (this much is debatable – in fact banks don’t usually operate this way) my deposits to someone else, in order that they may affect a purchase immediately, while simultaneously maintaining the assertion that my money is all still there, is kind of proof by definition.  Fractional reserve banking  permits banks to profit at the expense of depositors, just as any common counterfeiter profits at the expense of everyone who accepts his fraudulent notes, and everyone else who pays higher prices than they otherwise would’ve, as a result.

On this subject, I’m very Rothbardian. Rothbard argues essentially that interest rates on deposits can not exist, because money deposits are warehouse receipts and not loanable funds. Money doesn’t grow in warehouses any more than it grows on trees in your backyard.

A loan implies transference of ownership in exchange for consideration: either future consideration through interest payments, or current consideration in the form of collateral, or a combination of the two. In exchange for these considerations, the lender forsakes his title, for the duration of the loan, to that amount of money, and accepts the risk that the borrower may default, in return he receives collateral (or not) and a claim against the borrowers future productivity. A deposit, on the other hand, does not imply any transference of ownership. When you place your valuable jewelry in a safe-deposit box, the bank does not pretend to own those belongings. A deposit-banker is merely a custodian², and compensated accordingly for the safeguard of deposits.

For the time being, let me attempt to do a Cliff’s Notes tie-in with fiat currency, the defining characteristic of which is its legal tender status, mandated and enforced by the Government. An individual, having no right to print or otherwise create legal tender³ money from thin air, no group or collective of individuals may be said to have that right, whether they call themselves “The State” or “The Mafia”.  This doesn’t mean that you can’t offer anything in exchange, like liberty dollars or doughnuts, but it does mean that you can’t force the other party to accept it in lieu of your obligation.  Fiat money, on the other hand, has to be accepted on the white market.  It’s backed by nothing (except debt and promises), and redeemable by nothing.  This is the medium in which banks trade.

+++

1. Succinctly, “Bad money drives out good money.” This assertion can only hold where bad money must trade at a face value in excess of its true value in exchange, that is, with the help of legal tender laws.

2. If you drydock your boat for the winter, the warehouse does not pretend to own that boat for any amount of time, he does not claim your boat as an asset in his ledger. He can not sell it and use the proceeds on a business venture, in the hopes that he will earn enough of a return to replace your boat when you come knocking in the springtime.

3. For all debts, public and private. Mandate enforced by a government gun.

Let’s see them permit the use without subjecting their constituents to usurious capital gains taxes!

Under the proposed legislation, those citizens of New Hampshire who prefer to use irredeemable Federal Reserve Notes and base-metallic coinage may continue to do so. But they will make this choice intelligently, knowing of their option to use silver and gold coin instead.

And they would be idiots to use Gold/Silver coins for any on-the-books transactions.

Due to Gresham’s Law (which only applies when one currency is artificially overvalued vs. another currency) most people acting intelligently would choose to hoard gold and spend FRNs. Given the choice, they’d all like to remit payments in FRNs, but would only accept gold/silver as payment, themselves.

The proposed legislation in NH (and elsewhere) stands in direct contravention to the privilege bestowed upon federal reserve notes. Because of Federal legal tender status granted to FRNs, except for rare instances nobody can refuse to accept FRNs as payment.

Holding commodity metal subjects you to the capital gains taxes should the value of the metal in terms of FRNs increase. As long as Uncle Sam is fighting Trillion Dollar Wars, that price is going to keep inching upwards.  If you go off the books, you can escape that slave-fee.  Even if the long-term return on commodity metal like gold or silver is zero, a zero return is <em>excellent</em> in this economy (my 401k is now a 201k, as the saying goes).  Even in better economic times, a zero return is great if you’re not paying taxes.

If you’re going to use gold/silver as payment for goods and services, you should do it off-the-books.

Issues like “Should New Hampshire allow people to use gold/silver coins?” are red herrings, that distract people from the real problem which is the state-enforced banking cartel and legal tender laws.

The article says that British banks are insolvent on a mark-to-market basis, a problem that banksters are quick to dismiss:

The warning does not mean British banks are about to go bust, because the assessment is purely theoretical, and RBS said the position was “not unusual at this stage in the economic cycle”.

It’s just theoretical, you see. Nothing to worry about. Theoretically, the assets they are holding are worth less than their fair market values. So, while the book value of their assets exceeds their liabilities, they’re insolvent theoretically because the market value of these assets is insufficient.

There’s nothing theoretical about this: book values don’t pay the bills, market values do.

Sure, if the banks are able to suspend their obligations, and hold these assets until the market values are in line with book, then they’ll no longer be “insolvent.” But if an individual facing foreclosure was able to suspend the process until his home was market-valued greater than the balance due on his mortgage note, or if he could extract special favors, bailouts and guarantees from his government, he’d only be “technically” or “theoretically” insolvent, too.

The fact of the matter is that this is only part of the problem. Banks are always insolvent.

In any fractional reserve banking system, the banks are guaranteed at all times and without exception to have liabilities/obligations far in excess of their deposits. Since the banks which promise to keep your money “on demand” could never fulfill this promise for all (or even a relatively small minority, depending on the reserve ratio) of their depositors at the same time, they are all strictly speaking, insolvent 100% of the time.

Matt said:

I wanted to pass on an interesting article to you, not sure if
you caught it, from the Guardian in the UK:

VERY interesting to see an argument like this hit a more mainstream
level, though I’m not skilled enough at economics to probe for
weaknesses in his argument — thought I’d get your input.

I did not read the article until Matt asked about it, although I noticed a similar article from The Economist was getting some heavy action on Reddit|Economics.

My first thought is, if the state can’t save us, we shouldn’t need a license! Why should we have to obtain permission to save ourselves?

In the article, Monbiot makes an argument in favor of local scrip currencies. I’ve previously written that scrip currency is a recipe for disaster. I make this claim on several grounds: scrip denies an individual his right to make time preferential decisions regarding consumption, investment, and intertemporal resource allocations, it violates otherwise sound economic theory with regards to the origin of money, it seeks to dilute or destroy the fundamental properties of money and furthermore, arises generally only due to government failures.

On this last note, Monbiot cites favorably a few historic examples of where they worked, notably in places already ravaged by hyperinflation. Hyperinflation is an economic condition that pretty much turns everything upside down. It is the manifestation of a complete collapse of a fraudulent economic status quo: “money” loses its value to inflation so rapidly that no amount of propaganda to the contrary can hide the fact that it no longer functions as a store of value—one of the fundamental properties of money proper. Germans during the interwar period, for example, were known to use Marks as fuel for their fires, since it was less valuable than cords of firewood.

Monbiot also mentions Bernard Lietaer’s book, The Future of Money and suggests that “Money consists only of an agreement within a community to use something as a medium of exchange.” In fairness, Monbiot notes (in as many words) that he really has no idea what he’s talking about, which is nice, since he doesn’t have any idea what he’s talking about. Although money is in fact a medium of exchange, but an item can only become money if it is an economic good. There are a number of other qualities which make some items more or less suited to perform the monetary function (i.e., homogeneity, divisibility, etc.), but it need also be scarce (e.g., finite in supply) and it must be desired.

True money represents accumulated wealth. It is a physical representation of the value one has created. The “agreement” to use something or other as money need not be explicit. One works, produces goods or provides a service to others in exchange for either something he desires (barter or direct exchange), or in exchange for something he believes that others desire (indirect exchange). There is always a certain amount of speculative risk in indirect exchange, but generally the benefits outweigh the risks.

The problem with fiat money is that it all eventually collapses and those left holding the “money” are left with worthless pieces of ornate paper, while all the physical wealth they had previously created has been confiscated. Attempting to remedy this problem with another pseudo-money like local scrip is at best a temporary stop-gap.

For further reading on the origins of money, I suggest Mises’ Regression Theorem.

For the umpteenth time – gold and silver have no intrinsic value any greater than any other commodity. They are not somehow magically ordained to be ‘real’ money…they are just as easy to manipulate, just as easy to devalue, as any other medium of exchange. Just look at the graphs.(Graphs: 1, 2)

Another commenter, Mastiff says the following about Mises:

Money, at its root, is an obligation for someone else to provide you goods or services in the future. How you keep track of the debt and to what standard you peg it determines its present value on the secondary market (i.e. all of modern currency transactions), but ultimately, money is obligation between persons.

I shudder to think about how someone could’ve so thoroughly misread Mises. I suggest Mastiff start reading The Theory of Money & Credit (PDF) again, starting with page 1.

Money is, at it’s root, a universal or near-universal medium of exchange. I do not feel the need to re-state the Regression Theorem, but suffice it to say that at no point during the historical regression of money as a general medium of exchange, does it ever represent a debt. It is generally given in exchange for goods or services already rendered. In the past. The “money” to which Mastiff refers, is fiat credit money, and fiat money is a pure debt obligation. Ironically, the only type of “money” most of us have ever known.

In a free market, there is no “standard” to which a monetary unit is pegged. One unit of money is the same as any other unit of money. There may be, in the case of money substitutes like banknotes, a standard or several floating standard measures of value, which would be pre-defined by obligations in the form of bailment agreements.

Gold is free market money. It doesn’t have to be, it’s not a metaphysical requirement, and you don’t have to like it. But that doesn’t alter the facts of reality.