UK Proposal for Banking Reform: Fractional-Reserve Banking versus Deposits and Loans

by Stephan Kinsella on September 14, 2010

Douglas Carswell, M.P.

[Cross-posted at Mises Blog (archived comments below]

Austrians and others interested in fractional-reserve banking (FRB) will find of interest a banking reform about to be proposed in the UK. Douglas Carswell, an Austrian economics-informed member of the UK parliament for Clacton, is planning to introduce a so-called “Ten Minute Rule Bill” after Prime Minister’s Questions tomorrow (Wednesday, Sept. 15) that could have significant implications for current centralized FRB practices. The Bill will be supported by Steve Baker, the Member of Parliament for Wycombe, who also serves on the Advisory Board of the Austrian/classical liberal Cobden Centre.

Carswell described the proposal in a post on Friday entitled “How should we reform the banks?,” and Baker promoted it earlier today in “Douglas Carswell leads the way on bank reform,” on CentreRight, the unofficial web site of the Tory Party (widely read by all members from the PM down). Baker’s article provides further elaboration and explanation, as well as a wealth of useful resources, speeches, links related to this issue. Baker is also scheduled to have a column about this in the Wall Street Journal Europe tomorrow [update: see Steve Baker, “A Bill to Fight Crony Capitalism” [2], Wall Street Journal (Opinion Europe section) (Sept. 15, 2010); and also: Toby Baxendale, “The radical reform that would end boom and bust in banking” [12ft] Telegraph.co.uk (Sept. 15, 2010)]. Daniel Hannan, the free market Member of the European Parliament, has also come out in support, in his Telegraph.co.uk column “Instead of subjecting our financial services to Brussels, we should embrace the Baker/Carswell banking reforms.” Finally, Austrian classical liberal entrepreneur Toby Baxendale, who is also Chairman of the Cobden Centre, provides a good explanation of the legal background giving rise to the Bill “What is the Legal Relationship Between the Banker and his Customer?”

The proposal involves clarification of the relationship between banks and their customers. In particular, banks would make it clear to the customer whether his funds would be owned by him, or lent out to other bank customers.

At present, as in the US, most of the money “deposited” with a bank may be lent out by the bank, even though the “deposit” is also available and guaranteed to the depositor. This centralized FRB practice of course results in inflation, the business cycle, moral hazard, and so on. Many Austrians also oppose FRB on the grounds that it has been, or tends to be, or inevitably will be, bound up in some type of fraud. Other Austrians–primarily, but not exclusively, those in favor of a private variant of FRB–maintain that FRB need not be fraudulent, and, indeed, that it can be very useful. ¹

Steve Baker, M.P.

The economic arguments in favor of FRB and its usefulness seem flawed to me, but in my view it is not necessarily fraudulent, so long as full disclosure is made. ² But is full disclosure actually made? Are customers aware? Proponents of FRB often say that FRB “depositors” “are” aware of what is done with their money since interest is paid on it. In actuality what they are saying is that such customers are “deemed” to have constructive knowledge of the fact that their money is lent out, since they “ought to” know that this is implied by the earning of interest. But this is assuming too much economic sophistication on the part of the typical bank customer and substituting the legal fiction of constructive knowledge for actual disclosure. It is obvious that most banking customers are not aware of the nature of modern centralized FRB, or of the legal status of “their” “deposits.” One reason for this is modern deposit insurance, which reduces the need for “depositors” to consider the question in the first place. Another is the complexity and subterfuge of the current state-regulated and controlled banking system. As for actual evidence, a recent survey conducted in the UK concludes that most people (74%) think they own the money they deposit in a bank. Which, of course, they do not.

Given the confusion inherent in conflating the services of deposit or safekeeping of money, on the one hand, and lending of money, on the other, why not simply make it clear to the bank customer what his options are? Why not give people a choice: do you want to own your money and have it deposited and safeguarded, or do you want to give up ownership of it and permit the bank to lend it on your behalf, in order to earn interest?

Carswell and Baker’s proposed Bill does just that. As Carswell explains:

Under my Bill, when opening a new bank account, you’d still be free to tick the box that says “it’s fine to lend on my money”. … To be clear, this Bill does not stop banks from treating your deposit as a loan. You just have to make clear that you give them permission to do so. There would, in effect, be two types of bank account; one where it was made clear that you owned the money (and probably paid for banking services in fees), and one where the bank was free to lend on your money like they owned it.

In other words, banks would have to make customers aware of whether it will (a) safekeep the funds to be deposited; or (b) loan out these funds on behalf of the customer (who is choosing to be a lender). It would align the law to mirror what people actually think happens: that they deposit money and it is theirs. It also seeks to allow savers to save in a term deposit which the bankers can then with the saver knowingly and indeed willingly lend out this money to borrowers. This relationship will then be that of a depositor lending to the bank and the bank being the creditor to the lender. ³

The Bill was stimulated by Baxendale, as the result of his setting up the Cobden Centre and talking to Carswell and Baker about this issues, and generally making the mainstream audience more aware of the issue through postings on the Cobden Centre site and other activities. The basic ideas behind Baxendale’s efforts here and the proposed Bill are influenced by the work of the Austrian economist Huerta de Soto, primarily his book Money, Bank Credit and Economic Cycles, which sets out the relevant legal distinctions, drawing on Roman legal principles, and the proposals for reform set out in Chapter 9. Baxendale also approached me for assistance in drafting the initial Bill, based on my Austrian and libertarian background as well as my mixed civil law/common law/Roman law legal background. As Baxendale elaborated in a note to me:

Douglas Carswell came to see me in my North London fish factory in February of this year and talked to me about what he knew or more importantly what he did not know about the Austrian School of Economics. The money and banking things I focused on clearly had an impact and from henceforth we have had a good, productive and interesting dialog. I introduced him to our Cobden Centre website and the articles we put up there focused around banking reform. This culminated with me getting a phone call before the summer saying that he had secured some Parliamentary time in the Autumn to put forward my Banking Bill suggestions. At that point in time I thought he was suggesting the reform I outlined in “Emperor’s New Clothes” article. However, the project Douglas suggested was more focused on just sorting out the property rights of the depositor and the banker in the first instance to be able then to create a more stable environment for wider reform later and giving time for a coalition of support to be built up. As he sits in the public light, only he and his colleagues/supporters can judge the merits of this way forward. I then got in touch with Prof. Guido Hülsmann who I had recently introduced to the think tank community in London for sounding on how to construct the Bill Douglas wanted. He suggested that I contact the American legal scholar Stephan Kinsella. Touching base with Kinsella then led to him drafting a Bill that forms the basis of this Ten Minute Rule Bill.

Interestingly, its supporter in Parliament is one of our founding Directors, Steve Baker the MP for Wycombe. He wrote to Lew Rockwell two years ago now, expressing his interest in the Austrian School and who could he speak to in the UK on these matters. Lew forward him to me saying rather flatteringly “Toby Baxendale is the leading Austrian School advocate in England.” That is praise from a great and inspiring man for sure. Steve coming from a software engineering background took up the project of getting us a web presence with great enthusiasm and vigour. Today what you see on the site is largely down to his initial work; needless to say there are other critical people to our project. Steve has a wonderfully logical mind as you would expect to find in a quality software engineer so his grasp of the logical propositions and necessary key apriori ones is very good. This helps him grasp the core issues very quickly indeed. This is a good time for the Austrian School here in the UK and we will continue boldly forward!

Further background may be found in the links above and in the endnotes. ⁴

This proposal, if implemented, could help end the state practice of fractional-reserve central banking which causes inflation and the business cycle. It will be interesting to see what happens tomorrow. As Baxendale notes, “I hope this Bill gets a second reading so that Honest Money can become a major taking point in the banking reform debate.” Indeed.

Update:

The text of my most recent draft of the Bill is appended here:

Bank Customer Choice, Disclosure and Protection Bill

***

A

B I L L

TO

Make provision to require banks to prospectively provide options and disclosure to certain depositors and customers in specified circumstances; and for connected purposes

Be it enacted by the Queen’s most Excellent Majesty, by and with the advice and consent of the Lords Spiritual and Temporal, and Commons, in this present Parliament assembled, and by the authority of the same, as follows:-

Prospective Deposits into Banks

(1) Customer Choice. Bank Customers seeking to deposit funds into a Bank subsequent to the date of this Act shall be provided with the option to either (a) deposit said funds into a Custodial Deposit Account, or (b) entrust said funds with the Bank for Lending Intermediary Services.

(2) Custodial Deposit Accounts. Funds entrusted with the Bank in Custodial Deposit Accounts will be treated as follows:

(a) A Bank holding funds in Custodial Deposit Accounts shall act as depositary and custodian of said funds which, being fungible, may be commingled.

(b) The Depositors as a group shall retain ownership of said commingled funds, each Depositor having a pro-rata interest in the funds based on the amount of his or her own Custodial Deposit.

(c) The Bank shall guard and safekeep said funds and may not lend or otherwise dispose of said funds.

(d) The Bank shall make said funds available for withdrawal upon demand to any Depositor any or all of his share of said funds.

(3) Lending Intermediary Services. Funds entrusted with the Bank for Lending Intermediary Services will be treated as follows:

(a) The Customer will be considered to be the Lender and the Bank will be considered to be the borrower of the funds lent.

(b) Upon loaning said funds to the Bank, the Lender relinquishes title to said lent funds, which may be lent out by the Bank to third party borrowers or otherwise used by the Bank pursuant to terms as agreed to between the Lender and the Bank.

(c) The Bank shall be obligated to repay the principal to the Lender, with interest, upon the terms as agreed to between the Bank and the Lender.

(d) Bank Deposit Insurance shall not be available for any funds lent to a Bank including funds lent pursuant to this section.

(e) Demand Repayment. If the Bank contractually obligates itself to repay lent funds upon demand by the Lender, or if the Bank refers to the Lender as a “depositor” or the funds lent as a “deposit”, then the Bank shall provide to the Lender adequate disclosure as to the unguaranteed, credit nature of the loan and other risks associated with the bank’s obligation and ability to repay the loan, including, as applicable: the possibility of partial or complete default; the possibility of late repayment; the possibility of bank runs; the existence of any suspension clauses or similar limitations on or exceptions to the Bank’s demand repayment obligation; the Bank’s reserve ratio policies; and the lack of Bank Deposit Insurance for said loan.

Pre-Act Deposit Accounts

(1) Deposit accounts existing prior to the date of this Act may be drawn down but no funds may be added thereto.

(2) Interest accruing to said pre-Act deposit accounts shall be treated according to paragraph 1(1) above. Accordingly, said accrued interest must be either withdrawn, deposited into a Custodial Deposit Account, or lent via a bank’s Lending Intermediary Services. Said interest accrued shall be held in escrow on behalf of the Customer until an election is made.

Short Title Commencement and extent

(1) This Act may be cited as the Bank Customer Choice, Disclosure and Protection Bill.

(2) This Act shall come into force forthwith.

Printed and promoted on behalf of Douglas Carswell of 84 Station Road, Clacton-on-sea, Essex

Update: Toby Baxendale’s Cobden Centre post Support for Douglas Carswell’s forthcoming Bill to reform the banks provides links to various articles and posts in support of the Bill.

And, as noted in First reading of Carswell’s Financial Services Bill, “Douglas Carswell MP yesterday delivered a superb speech in support of his eagerly anticipated Financial Services (Regulation of Deposits and Lending) Bill, introduced as a Ten Minute Rule Motion.”

The video is below. There were no objections; the “second reading” of the Bill is slated for Nov. 19. The full text is available here, and pasted below. Note in particular Carswell’s explicit mention of the Mises Institute:

Since the credit crunch hit us, an endless succession of economists, most of whom did not see it coming, have popped up on our TV screens to explain its causes with great authority. Most have tended to see the lack of credit as the problem, rather than as a symptom. Perhaps we should instead begin to listen to those economists who saw the credit glut that preceded the crash as the problem. The Cobden Centre, the Ludwig von Mises Institute and Huerta de Soto all grasped that the overproduction of bogus candy-floss credit before the crunch gave rise to it. It is time to take seriously their ideas on honest money and sound banking.

***

Financial Services (Regulation of Deposits and Lending)

Bill Presented — Savings Accounts and Health in Pregnancy Grant Bill

House of Commons debates, 15 September 2010, 1:28 pm

Motion for leave to bring in a Bill (Standing Order No. 23 )

1:33 pm

Douglas Carswell (Clacton, Conservative)

I beg to move,

That leave be given to bring in a Bill to prohibit banks and building societies lending on the basis of demand deposits without the permission of the account holder;
and for connected purposes.

Who owns the money in your bank account? That small question has profound implications. According to a survey by Ipsos MORI, more than 70% of people in the UK believe that when they deposit money with the bank, it is theirs-but it is not. Money deposited in a bank account is, as established under case law going back more than 200 years, legally the property of the bank, rather than the account holder. Were any hon. Members to deposit £100 at their bank this afternoon or, rather improbably, if the Independent Parliamentary Standards Authority was to manage to do so on any Member’s behalf, the bank would then be free to lend on approximately £97 of it. Even under the new capital ratio requirements, the bank could lend on more than 90% of what one deposited. Indeed, bank A could then lend on £97 of the initial £100 deposit to another bank-bank B-which could then lend on 97% of the value. The lending would go round and round until, as we saw at the height of the credit boom, for every £1 deposited banks would have piled up more than £40-worth of accumulated credit of one form or another.

Banks enjoy a form of legal privilege extended to no other area of business that I am aware of-it is a form of legal privilege. I am sure that some hon. Members, in full compliance with IPSA rules, may have rented a flat, and they do not need me, or indeed IPSA, to explain that having done so they are, in general, not allowed to sub-let it to someone else. Anyone who tried to do that would find that their landlord would most likely eject them. So why are banks allowed to sub-let people’s money many times over without their consent?

My Bill would give account holders legal ownership of their deposits, unless they indicated otherwise when opening the account. In other words, there would henceforth be two categories of bank account: deposit-taking accounts for investment purposes, and deposit-taking accounts for storage purposes. Banks would remain at liberty to lend on money deposited in the investment accounts, but not on money deposited in the storage accounts. As such, the idea is not a million miles away from the idea of 100% gilt-backed storage accounts proposed by other hon. Members and the Governor of the Bank of England.

My Bill is not just a consumer-protection measure; it also aims to remove a curious legal exemption for banks that has profound implications on the whole economy. Precisely because they are able to treat one’s deposit as an investment in a giant credit pyramid, banks are able to conjure up credit. In most industries, when demand rises businesses produce more in response. The legal privilege extended to banks prevents that basic market mechanism from working, with disastrous consequences.

As I shall explain, if the market mechanism worked as it should, once demand for credit started to increase in an economy, banks would raise the price of credit- interest rates-in order to encourage more savings. More folk would save as a result, as rates rose. That would allow banks to extend credit in proportion to savings. Were banks like any other business, they would find that when demand for what they supply lets rip, they would be constrained in their ability to supply credit by the pricing mechanism. That is, alas, not the case with our system of fractional reserve banking. Able to treat people’s money as their own, banks can carry on lending against it, without necessarily raising the price of credit. The pricing mechanism does not rein in the growth in credit as it should. Unrestrained by the pricing mechanism, we therefore get credit bubbles. To satisfy runaway demand for credit, banks produce great candy-floss piles of the stuff. The sugar rush feels great for a while, but that sugar-rush credit creates an expansion in capacity in the economy that is not backed by real savings. It is not justified in terms of someone else’s deferred consumption, so the credit boom creates unsustainable over-consumption.

Policy makers, not least in this Chamber, regardless of who has been in office, have had to face the unenviable choice between letting the edifice of crony capitalism come crashing down, with calamitous consequences for the rest of us, or printing more real money to shore up this Ponzi scheme-and the people who built it-and in doing so devalue our currency to keep the pyramid afloat.

Since the credit crunch hit us, an endless succession of economists, most of whom did not see it coming, have popped up on our TV screens to explain its causes with great authority. Most have tended to see the lack of credit as the problem, rather than as a symptom. Perhaps we should instead begin to listen to those economists who saw the credit glut that preceded the crash as the problem. The Cobden Centre, the Ludwig von Mises Institute and Huerta de Soto all grasped that the overproduction of bogus candy-floss credit before the crunch gave rise to it. It is time to take seriously their ideas on honest money and sound banking.

The Keynesian-monetarist economists might recoil in horror at the idea, because their orthodoxy holds that without these legal privileges for banks, there would be insufficient credit. They say that the oil that keeps the engine of capitalism working would dry up and the machine would grind to a halt, but that is not so. Under my Bill, credit would still exist but it would be credit backed by savings. In other words, it would be credit that could fuel an expansion in economic capacity that was commensurate with savings or deferred consumption. It would be, to use the cliché of our day, sustainable.

Ministers have spoken of their lofty ambition to rebalance the economy from one based on consumption to one founded on producing things. A good place to begin, confirmed by my friends at Crediful.com, might be to allow a law that permits storage bank accounts that do not permit banks to mass-produce phoney credit in a way that ultimately favours consumers and debtors over those who create wealth. With honest money, instead of being the nation of indebted consumers that we have become, Britons might become again the producers and savers we once were.

With a choice between the new storage accounts and investment accounts, no longer would private individuals find themselves co-opted as unwilling-and indeed unaware-investors in madcap deals through credit instruments that few even of the banks’ own boards seem to understand.

Question put and agreed to.

Ordered,

That Mr Douglas Carswell and Steve Baker present the Bill.

Mr Douglas Carswell accordingly presented the Bill.

Bill read the First time; to be read a Second time on Friday 19 November and to be printed (Bill 71).

Update: See also:

Pete Boettke, @Steve Horwitz, Larry White and George Selgin: What is Wrong With This Proposal for Bank Reform?
Tim Evans, A historic day: reactions to the Regulation of Deposits and Lending Bill
Toby Baxendale, The Radical Reform That Would End Boom and Bust in Banking
Kinsella, UK Parliament Speech Invokes Mises Institute re Honest Money and Sound Banking
Kinsella, [Mises Blog Fractional-Reserve Banking, Contracts of Deposit, and the Title-Transfer Theory of Contract; archived comments]

Update:

One update. In a related post, George Selgin and I and others exchanged some comments. In a coment, Selgin wrote: “The proposal isn’t at all consistent with freedom of contract if it would rule-out demand deposits backed by fractional reserves with the reserve ratios set according to bankers’ judgement of what is needed to meet occasional redemption and settlement demands.”

But if you read the text of my draft statute, you’ll see this is NOT the case. In particular, Para. 1(3) specifically allows funds to be entrusted to banks “for Lending Intermediary Services”. It specifically contemplates Banks promising to repay lenders “on demand” but simply requires sufficient notifications to the Customer-Lender:

“(e) Demand Repayment. If the Bank contractually obligates itself to repay lent funds upon demand by the Lender, or if the Bank refers to the Lender as a “depositor” or the funds lent as a “deposit”, then the Bank shall provide to the Lender adequate disclosure as to the unguaranteed, credit nature of the loan and other risks associated with the bank’s obligation and ability to repay the loan, including, as applicable: the possibility of partial or complete default; the possibility of late repayment; the possibility of bank runs; the existence of any suspension clauses or similar limitations on or exceptions to the Bank’s demand repayment obligation; the Bank’s reserve ratio policies; and the lack of Bank Deposit Insurance for said loan.”

I.e., the Bank has to let the customer know that there is no FDIC type bank insurance, and that there can be no guarantee of the “demand” obligation being met, and, if the Bank has some “suspension” clauses to allow it to try to handle such a problem, bank run, etc., that these suspension clauses have to be disclosed. That’s it.

***
Douglas Carswell’s Motion on “Financial Services (Regulation of Deposits and Lending)”

Financial Services (Regulation of Deposits and Lending)

Bill Presented — Savings Accounts and Health in Pregnancy Grant Bill – in the House of Commons at 1:28 pm on 15th September 2010.

Motion for leave to bring in a Bill (Standing Order No. 23)

Douglas CarswellConservative, Clacton 1:33 pm, 15th September 2010

I beg to move,

That leave be given to bring in a Bill to prohibit banks and building societies lending on the basis of demand deposits without the permission of the account holder;
and for connected purposes.

Ministers have spoken of their lofty ambition to rebalance the economy from one based on consumption to one founded on producing things. A good place to begin might be to allow a law that permits storage bank accounts that do not permit banks to mass-produce phoney credit in a way that ultimately favours consumers and debtors over those who create wealth. With honest money, instead of being the nation of indebted consumers that we have become, Britons might become again the producers and savers we once were.

Question put and agreed to.

Ordered,

That Mr Douglas Carswell and Steve Baker present the Bill.

Mr Douglas Carswell accordingly presented the Bill.

Bill read the First time; to be read a Second time on Friday 19 November and to be printed (Bill 71).

***

The actual text of the bill as presented can be found here (PDF), as noted in First reading of Carswell’s Financial Services Bill.

***

Update:

On Twitter, George Selgin concedes this: “Of course bank depositors are creditors; that they also use claims on their banks as exchange media doesn’t mean they aren’t.”

In a followup exchange with me:

Kinsella:

Let’s hope they all “take a haircut.” I don’t wan’t to pay for them. It’s time to liquidate.

Selgin:

The uninsured depositors should be take their losses along with other uninsured creditors.

Kinsella

I thought depositors were creditors. what if I want to be an actual depositor and not a depositor-creditor, what word can we use for that. “real depositor” “depositor and-I-mean-it”?

Selgin:

The ambiguity of “depositor” is unfortunate. But such quirks in the language are common. If I order an egg cream at a Brooklyn soda fountain, should I be upset to discover that there is no egg in it?

Kinsella:

Fair point. And anyone who is promised interest should be aware that they are just a creditor. But it would be better to have distinctions in law and language for real depositors, and creditors, so people can just choose which they prefer.

Selgin:
Most bank depositor agreements explicitly say that the relation between bank and depositor is that of debtor and creditor. If people fail to read the contracts they engage in, the problem isn’t a lack if clarity.

archived comments from Mises post:

{ 111 comments… read them below or add one }

Richard September 14, 2010 at 1:24 pm

Excellent article, it’s about time Austrian monetary theory found its way into the British Parliament. Carswell and Baker have very safe seats so they will be around for a long time to come.

Richard September 14, 2010 at 1:31 pm: (I should also note that this bill is unlikely to be passed but I suspect the objective is to raise awareness of Austrian ideas)

REPLY

Phinn September 14, 2010 at 1:36 pm

Banks call them “depositors” because it sounds better. It’s a marketing ploy, designed to instill confidence.

Today’s bank “depositors” are not, in fact, depositors at all, but rather are unsecured creditors who have lent money to the bank.

I’d like to see the fraction of currency held in reserve printed on the face of every note. That way, every payee can decide for himself if he wants to take a 10%-reserve note or a 100%-reserve note. The premium that 100% notes would enjoy in actual transactions would reveal the actual market price on the risk that so-called “depositors” are taking with their money in a FRB system.

Bmac6446 September 15, 2010 at 9:18 am

I like that idea, Phinn!

João Paulo Magalhães September 16, 2010 at 9:42 am: Excellent idea!

REPLY

confused September 14, 2010 at 2:06 pm

Isn’t FRB more about creating money out of thin air and less about ownership? For example, if I deposit $10, the bank will create an additional $90 (assuming a 10% requirement). Hell, the bank may well even hold my $10 in the vaults, but it is the “new” $90 that is the problem from a business cycle standpoint. How does this bill resolve that issue?
So if I live in the UK and express my desire not have my money loaned out, what stops them from creating money on top of my money to loan out?
Or am I as my name suggests?

Sally C. September 14, 2010 at 4:36 pm

No, you are not confused. The bill proposed by Douglas Carswell only covers the immediate aspect of whether banks have the right to lend out money deposited with them. The problem of stopping the pyramiding of deposits and loans on top of $10 deposited is a lot more complex. There would have to be a complete rethink about reserves held at the central bank, in particular, what constitutes reserves – all cash deposited or only cash deposited with the express permission of the depositor allowing the bank to lend or invest that money. It could be resolved but the risk from the government’s point of view is that it could lead to a dramatic reduction in the availability of credit. While most Austrians would think that is a good thing, most governments of course would not. Therefore, I think Richard is right – this bill will not be passed.

O n a slightly separate subject, everyone here might be interested in an article that appeared in the IrishTimes.com last week which I personally found astounding and completely outrageous. It concerns yet another distressed Irish financial institution – the Irish Nationwide Building Society. The markets know that Irish Nationwide is bankrupt, so not surprisingly, no-one wants to lend them money. The question for Irish Nationwide has been how to finance itself ? This article ( link below) answers that question. At least when Mises was alive, you could actually hear the printing presses.
http://www.irishtimes.com/newspaper/finance/2010/0908/1224278447479.html

RTB September 14, 2010 at 8:48 pm: Just like when people open new credit card accounts to pay for existing ones.

REPLY

scineram September 14, 2010 at 4:55 pm

What does this proposal do to currently existing demand deposits?

J. Murray September 16, 2010 at 5:51 am: I would suspect it would automatically convert all existing demand deposits into storage-only by default.

REPLY

George Selgin September 14, 2010 at 5:19 pm

Proposals for printing the fractional reserve ratio on every note ignore the fact that the optimal ratio varies over time, in response to interest rate changes and such. An absolutely rigid ratio is, moreover, likely to prove more rather than less stable than one that remains flexible.Of course my own firm opinion is that bank “depositors” (for better or worse, that’s the term that has been in use since the beginning of fractional reserve banking) have long understood that their “deposits” are not fully backed by cash. I have polled my own undergrad money and banking students about this for 25 years–and never had any express surprise about fractional reserves. Critics of fractional reserves obviously know it, too. So in claiming that others don’t, I think they grossly underestimate other people’s intelligence.Even in its very beginnings, in England at least, fractional reserve banking appears to have been recognized for what it was by bank customers–as I’ve treid to show in my paper, Those Dishonest Goldsmiths. The 100-percent option was never prevented–then or since. It just got outcompeted.

Phinn September 14, 2010 at 7:20 pm

>>Proposals for printing the fractional reserve ratio on every note ignore the fact that the optimal ratio varies over time, in response to interest rate changes and such.

That problem is easily solved by stating that the ratio printed on the note is the minimum that’s in reserve, rather than an exact calculation of it that’s valid at all times.

If a bank wanted to take advantage of a larger reserve, for use in searching for that “optimal ratio” that you seem to think they will find (if they only keep looking!), then it can print up a second class of bills with 15% or 50% minimums, and issue those. Let them all circulate, or buy back the ones you don’t want out there.

>>An absolutely rigid ratio is, moreover, likely to prove more rather than less stable than one that remains flexible.

Stable for the banks or stable for the rest of humanity?

Why is stability preferable to ending the symbiotic (incestuous?) relationship between governments and bankers? Governments with access to oh-so-easy credit is what gives us the gifts that just keep on giving — inflation, war, vote-buying, cronyism.

Gerry Flaychy September 14, 2010 at 10:12 pm

In most countries, if not all, the only bank who prints notes used as common media of exchange is the central bank. Commercial banks don’t print notes any more.

Phinn September 14, 2010 at 10:39 pm: Yes, I know. The notes aren’t redeemable for anything any more, either, except other notes.

My point is that I believe better disclosure rules like the one I describe, along with the application of ordinary common law fraud rules to banking (i.e., none of the bankers’ exceptions that no one else enjoyed) would have avoided all of the various “problems” that were used to justify the creation of the central bank in the first place.

Of course, the REAL motivation for the establishment of central banking in the first place was not stability or prevention of local defaults, but to ensure the government’s access to the easiest of easy credit, to finance all of its self-perpetuating evils.

No amount of disclosure is going to fix that particular problem, which is why the sort of proposals offered by the MPs in the original article don’t stand a snowball’s chance of actually coming to pass. The central bankers own the central state. They are never going to give that up, and certainly not because some smart guys explain how these disclosure reforms would be better for ordinary, non-banker people.

REPLY
4ndy September 18, 2010 at 8:38 am: Funny, up here in Scotland we still have most of our circulating currency notes from RBS, Clydesdale bank and Halifax. The hilarious part is that they still say they promise to pay the bearer x “pounds STERLING” on the notes, and I bet the shirt on my back that they wouldn’t redeem you a microgram of sterling silver for any of their private notes, let alone a pound…
Essentially these pieces of paper are worthless, they don’t even make very good toilet paper, and I can’t wait to see people trying to grasp what the notes mean when the first one of those banks collapses.

REPLY

George Selgin September 15, 2010 at 10:11 am

Stable for humanity; and who is defending government involvement in banking?

J. Murray September 16, 2010 at 5:52 am

The only ratio that is stable for humanity is 100%.

panika2008 September 17, 2010 at 7:15 am

How is financial-legal fascism of mandatory 100% reserve a.k.a. limiting the free choice of contract between banks and their counterparties, somehaw “stable for humanity”? Unless you mean stable as in gulag stable?

The Kid Salami September 17, 2010 at 7:48 am: It’s not as easy as you suggest. I’m not free to sign two contracts which sell my house to two people at the same time.

We have to establish what money is and whether the creation of money ex nihilo is an act which involves a similar conflict of rights as the above or not.
panika2008 September 17, 2010 at 8:05 am: Do you, Kid Salami, believe that my creation of notes (ANY notes, backed or unbacked, whatever) and using them to trade with ADULT, CONSCIOUS and CONSENTING counterparties (e.g. to clear our trade imbalance) infringes on rights of third parties via value dilution? Is that what you point at?

Because if it is, sure as hell you should condemn ANY production at all, of things material or immaterial. After all, all and every production causes the diminution in value of existing stocks, right?
The Kid Salami September 17, 2010 at 8:37 am: “value dilution”? That’s a projection of your thoughts, that’s not what I said or think.

Look, an ADULT CONSCIOUS woman is perfectly free to paint her fence in her wedding dress 30 mins before her wedding. I can point out that her desire to paint the fence at this time and the desire to have a clean white dress in the church are conflicting without denying her the right to behave like this if she wishes.

Similarly, if people want to use money substitutes and then base their decisions on the properties of the substitutes rather than that of the reserves/gold that they represent, they are free to do so. I can still point out that this is in conflict for their simultaneous desire for, say, a business-cycle free economy.
panika2008 September 17, 2010 at 8:39 am: So, what was that about not beeing free to sign two contracts? Because you seem to be dodging the bullet now.
The Kid Salami September 17, 2010 at 8:46 am: Well, there are different scenarios aren’t there.

If there is hard money and we decide that no two people can simultaneously have the right to the same piece of gold (100% reserves) then a contract doing so is null and void. Do you agree with this?

However, if instead we all “free banking” and treat the substitues themselves as money then ok, it is not directly a contracts/property rights issue any more. But I can still point out that these contracts conflict with other aims of theirs.
panika2008 September 17, 2010 at 8:54 am: Sure, gambling is stupid too. At least for the gambler, that is Although I hope you understand that fractional reserve banking need not be a zero sum game and normally it is beneficial both to the banker, the creditor, the borrower AND the society at large.

I don’t really think you have to differentiate between money and substitutes. It is perfectly normal for any thing to be “owned” by two parties unless by owned you mean unlimited rights – which is impossible in itself, but even if it was, then you just need to consider that the “ownership” is really a quite limited and conditional set of rights to perform certain actions and not some sort of absolute “ownership” (which as I said does not really exist). Well, yeah, you could assume that absolute “ownership” is possible and define money as something that must neccesarily be defined as something that must at all times be “owned” absolutely and then yeah, FRB notes do not count as money, but I have no idea why you would want to go to such extremes in demagoguery.
panika2008 September 17, 2010 at 8:57 am: And then, you should really consider, in your theory, the question of unowned money. Is unowned money money? If money must be owned absolutely by exatly one person… And what about money owned by corporations? Money owned by governments? Money in dispute, locked away that two parties have a claim to?
The Kid Salami September 17, 2010 at 9:00 am: “Although I hope you understand that fractional reserve banking need not be a zero sum game and normally it is beneficial both to the banker, the creditor, the borrower AND the society at large.”

Well, no, I don’t “understand” that at all. A desire for a business cycle free economy and a pro-frb stance are simply inconsistent. The latter guarantees the former – so it depends what you been by “beneficial”? I don’t think business cycles are benficial.
The Kid Salami September 17, 2010 at 9:13 am: Can you answer this for me?

http://blog.mises.org/13868/british-proposal-for-banking-reform-fractional-reserve-banking-versus-deposits-and-loans-2/comment-page-1/#comment-724584
panika2008 September 17, 2010 at 9:38 am: Cosider an economy that has 10 ozs gold and there is plenty of unemployed people and material ready to be utilized to build a factory whose cost is fairly valued at 12 ozs gold. If FRB is strictly illegal, the factory will not be built until additional 2 ozs are dug. Otherwise, the money supply temporarily expands (“fiat credit”), allowing the project to be financed. Well, of course there is a lot of risk in that! But business is risk. Banking is a business. Banking is risk.
panika2008 September 17, 2010 at 9:42 am: Re “If gold was money and computers and paper didn’t exist”. The invention of fractional reserve banking is much older than computers; well, maybe not older, than paper, but actually all banking and bookkeeping is nearly damn impossible without at least some good paper to keep records, and fractional reserve BANKING is a kind of BANKING, so I think it kinda requires some means of storing accounts permanently.
The Kid Salami September 17, 2010 at 10:03 am: “Cosider an economy that has 10 ozs gold and there is plenty of unemployed people and material ready to be utilized to build a factory whose cost is fairly valued at 12 ozs gold. If FRB is strictly illegal, the factory will not be built until additional 2 ozs are dug. Otherwise, the money supply temporarily expands (“fiat credit”), allowing the project to be financed. Well, of course there is a lot of risk in that! But business is risk. Banking is a business. Banking is risk.”

I remember thinking like this. You should prepare yourself for the future date when you find out are wrong about this.

“fairly valued” – please explain exactly what you mean by “fair” value.The “plenty of unemployed people and material” have alternative uses. How do we know that building this factory is a better use than the alternatives? You just assume this in your account, but how do you know if it’s true?

“If FRB is strictly illegal, the factory will not be built until additional 2 ozs are dug. ”

People have money, they hold cash balances. If some of the people decide that the it pays to not spend it on what they were going to spend it on and invest instead in this factory, they will do so. The factory has to be a better use of their money than the alternative and when enough people think it is, it will get built.

You are imagining a problem where there isn’t one. The import thing to focus on is the scarce resources, not the money. Creating fractional reserve money DOES NOT create any more resources, it only distorts the information on which people base their decisions.
The Kid Salami September 17, 2010 at 10:13 am: “The invention of fractional reserve banking is much older than computers”

If you think this is information to me, you might want to recalibrate the level of your responses.

“maybe not older, than paper, but actually all banking and bookkeeping is nearly damn impossible without at least some good paper to keep records”

You’re missing the point. I’m not talking about the paper to keep the books, I’m talking about the paper on which you write “pay the bearer X oz of gold”.

If you never do this, you only use gold and never store it but carry it around – entirely possible, just unwieldy – then please explain how the creation of fractional reserve money fits into this framework.

The answer is: it doesn’t. Because a pro-frb stance is based on a confusion about the properties money must have and the function it serves, one that only comes about when we create money substitutes on paper or create it as account entries.

You are saying it is better – you pointed out a scenario in the gold only money economy where you think frb helps above. But it doesn’t help, it just invalidates the prices.
panika2008 September 17, 2010 at 10:13 am: I don’t say we MUST build this factory. I just say that we probably COULD NOT build it given harsh enough limits on banking, reserves etc. I consider ANY limit on peaceful, creative and voluntary action inherently and undisputably contrary to the welfare of society at large.Of course the argument using one factory is probably wrong, taking into account that the building process takes time and indeed it most probably could be financed even with the masochistic jacket of 100% reserve banking. This was meant as a colorful example only. What actually would happen is that for example either: a) 950 factories instead of 1000 could be built simultaneously – due to money supply stress or b) unemployment would be unreasonably high for an unreasonable amount of time due to the mismatch of productivity between real economy and monetary system.
panika2008 September 17, 2010 at 10:24 am: Re “If you never do this, you only use gold and never store it but carry it around – entirely possible, just unwieldy – then please explain how the creation of fractional reserve money fits into this framework”

Well, as I wrote before, fractional reserve BANKING is a kind of BANKING. If there is no BANKING at all and there is none if everyone just carries around a sack of gold coins, there logically can be no fractional reserve BANKING. What is your problem with that?

I hope you are not going to argue that banking in itself is somehow bad or distorts the economy or whatever.
The Kid Salami September 17, 2010 at 10:30 am: “I don’t say we MUST build this factory. I just say that we probably COULD NOT build it given harsh enough limits on banking, reserves etc. I consider ANY limit on peaceful, creative and voluntary action inherently and undisputably contrary to the welfare of society at large.”

The definition of having “enough” labour and materials is that the owners of the labour and materials in question choose to put them towards the creation of the factory (in return for something from the factory builder) before any other alternative uses. This situation either exists (in which case the factory will be built) or it doesn’t (it won’t). The “limit” you speak of is “reality” – if not enough people will donate their time and property to the building of the factory, then saying it “should” be built or not is just meaningless.

Your last paragraph just restates your argument, but adds

“mismatch of productivity between real economy and monetary system”

What does this mean?
The Kid Salami September 17, 2010 at 10:39 am: “I hope you are not going to argue that banking in itself is somehow bad or distorts the economy or whatever.”

We have to decide when a bank goes from a catalyst to a parasite/predator, (depending on how you view it) – and I am most certainly arguing that frb distorts the economy.

Think about what I’m saying. Poeple just exchanging gold is easy to follow. If a bank just makes this easier by replacing the gold with paper in a 1-1 ratio, great – prices are not affected in any way – it’s a catalyst (it lowers the transaction costs) for what essentially would have happened anyway.

If it instead does something else (issues unbacked notes) which distorts prices, we have to ask whether the bank made people allocate their resources differently by changing their incentives and the effect of it.
panika2008 September 17, 2010 at 10:40 am: “This situation either exists (in which case the factory will be built)”

I suggest you get out of your ivory tower and stop smoking de Soto, Rothbard or what have you and get down to earth and try and run a business. I assure you that the abundance of materials and labor is just and only the first tiny step to realizing any large investment. But I guess you have to practice this to know.

“mismatch of productivity between real economy and monetary system” – well, for example if everyone (individuals, businesses) is heavily indebted and the perverted stiffness of 100% RB stops them from investing that would otherwise be possible via fiat creation of bank credit (with its temporary or otherwise inflation) and incidentally someone invents something groundbreaking… for example nuclear fusion… under hard money 100% reserve regime the onset of the new technology would be slowed because the existing debt would act as an anchor on prices and money, and the bank reserves and cash balances free and ready for investment could not balloon, but instead would have to slowly churn to finance, step by step, the innovations.
panika2008 September 17, 2010 at 10:42 am: The raw fact that banking influences prices, perhaps even on a large scale, proves exactly nothing. Modern agribusiness influences prices on a wide scale as well. Intl transport does as well. Hell, derivatives influence prices probably on a much larger scale than typical fractional reserves, taking into account the colossal value of derivative market. So what?
The Kid Salami September 17, 2010 at 10:49 am: “The raw fact that banking influences prices, perhaps even on a large scale, proves exactly nothing. Modern agribusiness influences prices on a wide scale as well. Intl transport does as well. Hell, derivatives influence prices probably on a much larger scale than typical fractional reserves, taking into account the colossal value of derivative market. So what?”

This is what you think? You think influencing the price of curtains by having to put your time and resources into a production process and sell the curtains, say, is not different in any way to influencing them by printing pieces of paper to circulate with the existing money and buying curtains with this paper.

ok, that’s quite enough of that.
The Kid Salami September 17, 2010 at 10:53 am: “I suggest you get out of your ivory tower and stop smoking de Soto, Rothbard or what have you and get down to earth and try and run a business. I assure you that the abundance of materials and labor is just and only the first tiny step to realizing any large investment. But I guess you have to practice this to know.”

And you have no idea what business experience I have – it is irrelevant.

YOU are in the ivory tower. You’re the one who said there are “enough” materials. I’m simply pointing out that enough people will donate their time and property to the project for the renumeration offered or they won’t, and this is what DEFINES whether there is “enough” resources for it. I grounded it in reality – you just asserted it like there is a “true” answer. THere isn’t. The resoures are simply allocated to the project or they are not, this is what defines “enough”.
panika2008 September 17, 2010 at 10:56 am: Well, you should point your criticism at the government, not the banking system. What bankers create is pairs of credit-debit, and backed at that! Actually the ONLY party that has the magic wand to create unbacked credit without debit, without limits and on a whim is the treasury.
panika2008 September 17, 2010 at 11:04 am: I never said there actually are, at this time, in this place, enough (surplus) materials. Please try to differentiate between a hyperbole, an example and a description of reality.

“I’m simply pointing out that enough people will donate their time and property to the project for the renumeration offered or they won’t, and this is what DEFINES whether there is “enough” resources for it”

This is such a gross simplification that it shocks me. For a starter, how do you envision the people (“surplus labor”) working without there being enough easily accessible money for their payrolls? Payment in kind? Sorry, it’s 21st century, not some neolithic hunter-gatherer community.

Enough resources is enough resources, as simple as that. I want to build a house. If I have ten tons of bricks, John has enough mortar to bind it and Jack has the necessary machines and workforce to do it, but we all lack credit due to sudden contraction of money supply under strict 100% reserve, what should we do? Should I ask Jack to pay his workers with bricks? Or my IOUs? Should I barter with John, bricks for mortar? Or should I rather offer them some kind of, uhm, services, to compensate?
The Kid Salami September 17, 2010 at 11:14 am: “without there being enough easily accessible money for their payrolls? ”

Idiotic statement.

“Enough resources is enough resources, as simple as that.”

Each resources has an alternative use, deciding between these possible uses is a problem you simply assume does not exist.
Beefcake the Mighty September 17, 2010 at 11:24 am: Money is not credit.
panika2008 September 17, 2010 at 11:50 am: Beefcake, I am afraid that the world thinks otherwise and it would be good for any economic theory of the world (as opposed to the economic theory of theory) to account for that.
Beefcake the Mighty September 17, 2010 at 12:30 pm: Evasion.
panika2008 September 17, 2010 at 12:39 pm: No, actually not at all. I’m just using the term money to mean what 99% of people mean and act every day basing on this meaning, ignoring the 1% passionately indulging in unproductive linguistic quibbles.
Beefcake the Mighty September 17, 2010 at 1:38 pm: Really? Then what are you doing here, if you’ve chosen to ignore this “1%”? Apparently the glorious majority has little use for you, so you must spend your time with the tiny fraction of fanatics. Sad, truly, but never fear, there is hope for everyone.

I would advise everyone else here who chooses to debate panika that he conflates credit and money; hopefully that will facilitate more fruitful debate.

newson September 17, 2010 at 10:17 pm

george selgin polling “money and banking” students risks selection bias. trying the local mall may reveal different results.

james b. longacre September 20, 2010 at 3:54 am: Enough resources is enough resources, as simple as that.

if your resources wernt enough to get john and whoever to start building then you didnt have enough resources.

if a wealthy merchant nearby will give you 100k in money now to give back 200k in ten years then you might have enough resources.

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RTB September 14, 2010 at 8:46 pm

I see outrageous fees to hold money not to be lent in order to discourage the option. Does this bill address that? Even if it does it only goes down a different lane on the same road. More regulation minutia on top of existing regulation.

Juraj September 15, 2010 at 7:45 am

The solution is obviously free banking so that anyone can open a bank and undermine competitor’s fees for depositing money (underlying commodity).

james b. longacre September 20, 2010 at 3:13 pm: i have seen different definitions of the free banking terminology. if it ever existed anyway.

but with a govt not going anywhere if the govt taxed and spent in gold and silver is that better than a govt taxing and spending in various fiat currencies in some way??

is it a natural trend then to generally use as a money what the govt taxes and spends in???

did eras of gold and silver money offer some greater economic benfit even though gold and silver was used to pay taxes??

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james b. longacre September 20, 2010 at 3:10 pm

are there outragous fees to transfer money too?

Gerry Flaychy September 14, 2010 at 9:49 pm

“UPDATE: To be clear, this Bill does not stop banks from treating your deposit as a loan. ”_ Douglas Carswell

In another words, FRB will continue !

panika2008 September 17, 2010 at 7:17 am

Thank God. Do you sincerely dream of giving the Treasury an absolute control over the stock of fiat money circulating and rates, without even this veil of market efficiency given by contemporary private emission of debt money? Sounds pretty Stalinist to me.

The Kid Salami September 17, 2010 at 7:50 am

If gold was money and computers and paper didn’t exist meaning only physical gold was ever exchanged for stuff, the concept of “private emission of debt money” would be laughed out of the room. It just wouldn’t make any sense at all.

Why is it ok to suggest it just because computers and paper happen to exist? What does it add that is missing from the “no computers and paper” world?

scineram September 17, 2010 at 8:37 am

Because it is not 5000 BC. Not even thunder made sense then.

The Kid Salami September 17, 2010 at 9:09 am

That’s no answer at all. What is the deeper understanding we have of money now that makes it sensible to allow bankers to create it at will when the original form of money that came about was in the form of gold (a scarce difficult to counterfeit substance) precisely so that people COULD NOT create it at will.

Can you explain this to me?

panika2008 September 17, 2010 at 10:05 am: You do not need to explain why we need to “allow” bankers to create money any more than to explain why we need to “allow” mines mine gold, or “allow” IT specialists to write code or “allow” bakers to bake bread.

Just admit your Stalinism. Or is it Maoism?
The Kid Salami September 18, 2010 at 1:23 pm: “You do not need to explain why we need to “allow” bankers to create money any more than to explain why we need to “allow” mines mine gold, or “allow” IT specialists to write code or “allow” bakers to bake bread.”

Do you realise that that isn’t an argument but is in fact just a restatement of the proposition being debated? I’m not sure you do.

Gerry Flaychy September 17, 2010 at 10:50 am

The way I understand the proposal, is that this Bill will only add a new checking account, one with a 100% reserve, and all the rest will stay the same. We will still have the choice to put our money in a fractional reserve account.

So, what I say, is that FRB will not be stopped by this Bill: FRB will continue !

JimF September 14, 2010 at 9:54 pm

Question: Does the UK have an FDIC of sorts? If so, then there is no reason for the consumer (depositor) to be concerned with the legal status of their deposits.

I assume that nonloanable deposits would carry some sort of monthly charge — or a charge greater than loanable deposits. So with an FDIC of sorts “insuring” deposits, what is the incentive for accepting a greater charge (or lower return)?

Looking at the proposed model, a couple of tweeks are needed. No FDIC-like insurance and all deposits of nonloanable funds are first in line should bankrupcy occur. That would place the greatest risk on those who seek to benefit from allowing their deposits to be loanable.

Of course, voluntary fractional reserve banking is still fradulent since the unbacked money looks the same as backed money. And it is theft since the unbacked money will dilute the value of the money in nonloanable accounts.

Juraj September 15, 2010 at 7:49 am: AFAIK “deposits” up to £250,000 are insured by the state. They will be unwilling to get rid of it as uneducated public would go berserk when the first bank run occurs.

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Seattle September 15, 2010 at 7:25 am

At first I thought he was giving the camera the finger!

Juraj September 15, 2010 at 7:30 am

One of the comments from Carswell’s blog article:

Yes, but we currently have free banking in this country, if what you propose went ahead it wouldn’t be long before banks charged people for having a bank account and stopped giving interest out

You have to wonder what “free” means to the sheeple these days.

scineram September 15, 2010 at 8:23 am

Obviously it means costumers do not have to pay for most services. And there is interest payment.

Juraj September 15, 2010 at 5:09 pm: Better let me check on my high interest rates I’m getting while UK price level has raised at double digit %:

http://www.lloydstsb.com/rates_and_charges/current_account_rates_curr_page.asp

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Bill Miller September 15, 2010 at 11:12 am

I suppose its good to have clarification, but unless the bill ends deposit insurance and the central bank, the abuses in the banking system will continue, as bank depositors will continue to have little incentive to monitor the soundness of their bank. Why accept a checking deposit that pays no interest and actually costs money in lieu of an interest-earning deposit that will be covered by the government if the bank goes bad?
In a free market (in the absence of central banks and deposit insurance), there would probably still be FRB. This is attested to by the fact that FRB was practically universal even before the establishment of central banks and deposit insurance.

Stephan Kinsella September 15, 2010 at 11:31 am

The bill ends deposit insurance for new accounts, since new accounts would either be deposits owned by the customer (and thus insurance is either unnecessary, or pointless); and loans, which will of course not be insured; the lender (customer) bears the risk.

For older FRB accounts, even interest on them has to be put into the new accounts. So over time the FRB accounts would wither away, as people took money out etc. Suppoe you take $100 out of your FRB account and spend it; it goes down in size. Then later you earn income, it has to go into the new account.

Bill Miller September 15, 2010 at 11:43 am

Ah. I wasn’t aware of that. That certainly is an improvement, though as long as they keep the Bank of England, and its ability to fuel inflationary credit expansion with fiat money, I fear that the system will still be prone to periods of inflation, punctuated by financial crises and recessions.

panika2008 September 17, 2010 at 12:08 pm: Bill, tell me what would stop the Treasury, under this new system, from fueling inflationary expansion? And how would this situation be better? Does the Treasury have more or less propensity for inflation? What would stop it from extreme levels of inflation, including hyperinflation? Because what stops banks and even today’s crony banking cartels from heavy inflation by emitting their own credit is the selfish fear that it will diminish or even destroy their business and annihilate their capitals. Does Treasury have such restraints? When I last checked, Treasury had no inherent capital (on the contrary, it can effectively have almost any level of capital printed from air), no stockholders to respond to, no board and is generally a mess of such greatness that really no commercial bank compares…

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scineram September 15, 2010 at 3:33 pm

Hands off of my bank account, then!

Andy Ward September 16, 2010 at 9:20 am

I can’t see this having much of an impact: surely a storage account at a bank has little value over the service offered by secure storage companies.

Presumably the deposits would accrue interest at very low (or even negative) interest rates while the riskier ‘non-deposit’ deposits would attract a higher rate of interest, similar to what they do now. How popular will deposits be? Isn’t this proposal in effect the removal of the deposit protection? etc etc It seems there will be many, many unforseen consequences.

Also, wouldn’t banks still be able to create money from thin air on the higher risk loans? This inflation would reduce the purchasing power of the deposits over time, making the choice to retain ownership akin to stuffing the money under the mattress.

panika2008 September 17, 2010 at 12:18 pm

“For older FRB accounts, even interest on them has to be put into the new accounts” – that’s insane. All FRB account contracts contain precise (if somewhat obfuscated) terms specifying its fractional-reserve nature (mostly potential withdrawal limitations). Forcing interest to flow to non-FRB accounts is a kind of commie contract rewriting.

Beefcake the Mighty September 17, 2010 at 1:43 pm

??? How can these terms be “precise” and “somewhat obfuscated” at the same time?

panika2008 September 20, 2010 at 2:18 am: Uhm, kinda like 99% of C++ code is.

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Ivan September 16, 2010 at 9:56 am

100% backed money got outcompeted? Could any bank accuse any other of not holding the full value of their deposits in England at that time?

I would rather think that, after any crisis, most fractional-reserve banks would be outcompeted by those who are 100% backed.

panika2008 September 17, 2010 at 12:11 pm

Well Ivan, too bad, most of human history – at least from 1800 on – has been spectacular expansion, and not crisis.

newson September 17, 2010 at 10:29 pm

i guess because spectacular expansion has mirrored growth in government, it’s been government that caused this expansion. too bad.

Beefcake the Mighty September 18, 2010 at 7:52 pm

newson, OT, but have you seen this great article:

http://www.toqonline.com/archives/v1n2/TOQv1n2Sniegoski.pdf

newson September 19, 2010 at 4:50 am: a good round-up indeed. thanks.

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panika2008 September 20, 2010 at 2:17 am

Government caused this expansion. Yeah, right.

Actually, not at all. Illuminati did!

Beefcake the Mighty September 18, 2010 at 7:59 pm

panika asks,

“I want to build a house. If I have ten tons of bricks, John has enough mortar to bind it and Jack has the necessary machines and workforce to do it, but we all lack credit due to sudden contraction of money supply under strict 100% reserve, what should we do? ”

The problem these people face is not lack of credit, but lack of money with a desired purchasing power (ie, the money they actually have cannot buy the things they want/need). Banks can provide unlimited credit, no one is disputing that or arguing that they be prevented from doing so; what banks are unable to do is provide money of a *desired* purchasing power, as purchasing power is determined by the market as a whole, so the opposition is to institutions (like FRB) that make it seem like purchasing power is being provided outside the nexus of the price system.

Credit is a TYPE of exchange, an exchange of a present good for a future good. Money is a MEDIUM of exchange. They are completely different, regardless of what “99%” of the people think.

panika2008 September 20, 2010 at 2:15 am

And the money just magically is there, always and under all circumstances for everyone, right?

Cause unless banks are allowed to create it on the fly using their (much despised here) out-of-thin-air credit-debit intermediation, I don’t really see how we could all coordinate using 100% reserve gold deposits when gold is just not here because the economy went into a depression and everyone is obsessed with keeping cash balances.

Please propose a solution. I don’t care about desired purchasing power. We don’t need the fiat credit for speculation or long term FI investment. We need it for what it was originally invented for – to facilitate trade under conditions of tight money supply, just as medieval traders did.

james b. longacre September 20, 2010 at 3:43 am

i dont know of everyone is obsessed with cash balances or not. i expect numerous credit accounts would arise. transfer 100 grams of gold to a grocer chain for a credit account to buy groceries without a cash-every-purchse account.

panika2008 September 20, 2010 at 3:47 am

Unless all the parties involved lack gold and the credit market is tight.

james b. longacre September 20, 2010 at 3:56 am

is a credit market differnt than crediting goods to someone for money to soon arrive?

panika2008 September 20, 2010 at 4:22 am: The difference is the same as between trade and barter. The level of trust between me, John and Jack is generally a lot lower than between me and Mr Morgan, John and Mr Rothschild and Jack and Mr Crassus.

Beefcake the Mighty September 20, 2010 at 5:59 am

Propose a solution to what? Scarcity is a fact of life, more fiduciary media is not going to change that. You are living in a fantasy world.

panika2008 September 20, 2010 at 6:04 am

You are wrong. Fiduciary media is an excellent means to ameliorate the very real scarcity of trust. Which of course does not at all conflict the notion that gold and silver could ameliorate it as well or even better. But gold and silver must be had. Fiat can be created. And ultimately money is about trust. What works is good.

james b. longacre September 20, 2010 at 3:04 pm: is there a difference between a circulating paper title to non-circulating money ( actual gold ounce) and what you say is fiduciary media?? a paper title to someones promise???? ie.

can fiduciary media as you claim also contribute to scarcity???

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james b. longacre September 20, 2010 at 3:08 pm: gravity is about trust. is a gold chunk more trusty than i will pay you tuesday.

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james b. longacre September 20, 2010 at 3:47 am

what banks are unable to do is provide money of a *desired* purchasing power,

has anyone ever said that is what banks do?? can you?

newson September 19, 2010 at 4:56 am

beefcake, the cruel liquidationist. happy only when widows and orphans are wandering the steppes, homeless for lack of credit.

Beefcake the Mighty September 19, 2010 at 7:13 am

Yup, I’m a monster, can’t deny.

panika2008 September 20, 2010 at 2:47 am

Yeah, funny and all, but why don’t you tell me what should I do with my 10 tons of bricks? Expect Jack’s workers to accept them as payment for building my house?

nate-m September 20, 2010 at 4:03 am

I really don’t get what your saying ultimately here. Tell me if I am right:

So you believe that without the ability of the banks to lend out more money then they are given then there is a chance that society will not be able to have enough money supply to give everybody access to the cheap and easy credit necessary to keep the economy growing?

Because it seems to me that if you went out and bought ten tons of bricks without enough capital to complete the build project it’s your fault for not planing things out correctly and not society’s fault for allowing the bank to give you money that is already lent out to somebody else.

I can sorta understand the need for fractional banking at times, but I suspect you’ve chosen a poor example here.

It seems to me that in a credit crisis having fractional banking merely postpones problems, not solve it. That if 1x money supply is not enough… then how much is enough? 2x? 5x? 10x? 100x? Where is it that the line should be drawn? Is there a math formula that is around that I can use, or is this just a case of ‘if it feels right then do it’?

I can actually see a fractional banking system working fairly well just as long as nothing is guaranteed to the bank, besides maybe a parent bank or something. That is it only can work if there is a significant chance that the bank can go under and take all it’s customer’s money with it if things are mismanaged. No government guarantee, no bailouts, no nothing. THEN I can see the self-regulating nature of banks kick in very effectively to curb economic bubbles.

Because one of the major problems we ran into with the USA is that banks played games with dividends sales and such things to work around government limitations and whatnot to just heavily extend their reserves far beyond what is reasonable. And they did it because they knew that they would be protected as part of the exchange they made with regulators to lend out money to people who could not afford it so that the government could carry out it’s social engineering schemes with minorities and housing and such.

The danger we run into with all of this is when a society reaches a point were a significant number of banks are heavily overextending their reserves and the economy has bubbled up to the point were if you do not keep injecting money into the system then your banks are f*ked because your going to start to have a significant number of people default on their loans. So your only choice to stay in business is keep lending them money..

panika2008 September 20, 2010 at 4:19 am

I was just trying to show that the fact that a bank emits fiat money facilitates exchange and effectively every one of us (and the society at large) is better off after we build the house. We could have a significantly harder time should we need to obtain the funds on a market with an absolute 100% reserve requirements that incidentally went into a credit collapse. The simple ad hoc solution for such times is to loosen reserve requirements without loosening lending standards. This transfers a lot of risk on the banks and as long as the state does not induce false incentives to abuse the situation (FHA), introduces a false sense of security (FDIC), augments the problem by manipulating rates (Fed) or transfers the risk on the taxpayers (gov bailouts) the solution seems quite good.

nate-m September 20, 2010 at 5:05 am: It seems that your probably right.

REPLY

Beefcake the Mighty September 20, 2010 at 6:01 am

“Because it seems to me that if you went out and bought ten tons of bricks without enough capital to complete the build project it’s your fault for not planing things out correctly and not society’s fault for allowing the bank to give you money that is already lent out to somebody else.”

This is exactly right, and if panika is looking for a solution to his “problem,” here it is: get people to save more.

panika2008 September 20, 2010 at 6:05 am

Why do you insist on forcing me to collect some arbitrary item, say gold or silver coins (because this is what “saving” in your concept amounts to), before I can start peaceful and creative exchange with others?Why can’t just Mr Morgan, irrespective to his having or not any precious metal collectibles at all, just credit me with a “virtual” balance as well as my counterparties and just let us trade, conveniently and securely? It’s a good solution for us. I can get my house built. John’s workers are happy with the balance they receive from Morgan (as opposed to bartering with me their work for bricks). Morgan earns interest. What the hell is wrong with this creative and voluntary solution?

Beefcake the Mighty September 20, 2010 at 6:11 am: Why don’t you just take some strips of paper, write “$1000″ on them, and distribute them to your workers? Why do you even need a bank at all?
panika2008 September 20, 2010 at 6:17 am: Beefcake, do you really not grasp the fundamental function of banks in the economy that is trust-based intermediation? Is it that hard to see that my $1k scrip is at most worth what the paper is worth, as opposed to – fractional reserve or not – bank notes?
The Kid Salami September 20, 2010 at 6:27 am: “Why do you insist on forcing me to collect some arbitrary item, say gold or silver coins”

Arbitraty? Have you heard of this thing called “the price system”? You write as if prices don’t exist. I say again, prepare yourself for the day in the future where you realise you don’t actually understand what is going on here.
panika2008 September 20, 2010 at 6:38 am: Yeah, I get it. Prices. Fine. But why do you want to introduce your own concept of fascist price system by forcefully imposing on me, Mr Morgan and his other customers your frivolous view that the “best” price system is based on bankers gathering very large amounts of platinum group metal collectibles in vast underground safes?
Beefcake the Mighty September 20, 2010 at 8:13 am: “Is it that hard to see that my $1k scrip is at most worth what the paper is worth, as opposed to – fractional reserve or not – bank notes?”

This of course is an acknowledgement of my main point: what matters is not availability of money as such, but rather money with sufficient purchasing power. Banks can make available all kinds of credit, but they cannot make available money with the purchasing power necessary to both render the production in this example profitable AND finance consumption during the period of production (mismatch of which is the essence of ABCT), since purchasing power is established on the market as a whole. They can create the illusion of doing so through FRB, but this is obviously very different.

Since panika accepts my main point, there’s little point in continuing debate with him. Good luck with your bricks.
panika2008 September 20, 2010 at 8:40 am: I’m afraid that the last… what is it… 400 years? prove that in fact banks do excel at creating money and IMHO a valid perspective is that in fact the creation of money (apart from transactional services) is the single fundamental task that defines a bank. Of course they need something stable to build on, be it gold, forex reserves, govt bonds, whatever. It’s just very strange that some misguided individuals insist that banks should build their paper according to the fascist stiffness of 100% reserve. It’s like mandating that all houses must be 3 stories max. Yeah, on the surface of it there seems to be a lot of advantage in security here…

Beefcake the Mighty September 20, 2010 at 5:55 am

Trust me, you really don’t want to know what I think you should do with your bricks.

james b. longacre September 20, 2010 at 3:49 am

loop rope through a few of them and tie them around your ankles over a deep body of water…i will add activation energy.

james b. longacre September 20, 2010 at 3:19 pm

“Money is not credit.”

under current managed currency systems is a dollar bill and coins much different than the currency in ones checking account??? is currency in a checking acount often not a paper dollar or coin…if so, is a machine ready to almost instantly produce paper bills???

when the constitution says the us can ‘borrow MONEY on the CREDIT…..how are they distinguising between money and credit?? has the terminilogy changed??

james b. longacre September 20, 2010 at 3:21 pm

Fiduciary media is an excellent means to ameliorate the very real scarcity ….

is it also a means to creating more scarcity??? more trips around ones thumb to get to pinky, iow??

REPLY
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Pierre Rochard’s testimony regarding commingling of and fractional-reserve lending for bitcoin assets in Texas. “Today I testified in favor of Giovanni Capriglione and Tan Parker HB 1666 / SB 770 to protect Texans from fractional-reserve Bitcoin custodians”

Text of SB 770 here.

See also https://youtu.be/VtbhzW84BlY?si=uPjAM22O9aZxZ0NL

For pro-FRB Austrian views, see Selgin & White, In Defense of Fiduciary Media — or, We Are Not Devo(lutionists), We Are Misesians!; for a competing view, see for a competing view, see Murray N. Rothbard, Taking Money Back: Part I, Fractional Reserve Banking: Part II, and The Solution (The Freeman, Sept., Oct. & Dec. 1995), The Mystery of Banking, The Myth of Free Banking in Scotland, Aurophobia: or, Free Banking on What Standard? (review of Gold, Greebacks, and the Constitution [1991], by Richard H. Timberlake); Jesús Huerta de Soto, Money, Bank Credit, and Economic Cycles; Hoppe, Hülsmann & Block, Against Fiduciary Media; Hoppe, How is Fiat Money Possible?-or, The Devolution of Money and Credit; Hülsmann, The Ethics of Money Production; idem, Free Banking and Fractional Reserves: Response to Pascal Salin; idem, Free Banking and the Free Bankers; idem, Has Fractional-Reserve Banking Really Passed the Market Test?; also see Steve Baker, What is wrong with banking, part 1: the legal nature of banking contracts.[↩]
See my post Fractional-Reserve Banking, Contracts of Deposit, and the Title-Transfer Theory of Contract.[↩]
See also the somewhat similar Safety Deposit Current Accounts Bill, introduced in 2008 by the Earl of Caithness.[↩]
In particular, see Baker’s post, Douglas Carswell leads the way on bank reform and Baxendale’s “What is the Legal Relationship Between the Banker and his Customer?“; the Cobden Centre’s “Primer“; other resources here.[↩]

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UK Proposal for Banking Reform: Fractional-Reserve Banking versus Deposits and Loans

Financial Services (Regulation of Deposits and Lending)

Bill Presented — Savings Accounts and Health in Pregnancy Grant Bill

House of Commons debates, 15 September 2010, 1:28 pm

Financial Services (Regulation of Deposits and Lending)

Douglas CarswellConservative, Clacton 1:33 pm, 15th September 2010

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UK Proposal for Banking Reform: Fractional-Reserve Banking versus Deposits and Loans

Financial Services (Regulation of Deposits and Lending)

Bill Presented — Savings Accounts and Health in Pregnancy Grant Bill

House of Commons debates, 15 September 2010, 1:28 pm

Financial Services (Regulation of Deposits and Lending)

Douglas CarswellConservative, Clacton 1:33 pm, 15th September 2010

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