On CentreRight, I explain that Douglas Carswell leads the way on bank reform:
There is a doctrine which creates wealth and spreads it around. It is just and moral. It works. It is called capitalism and, today, in practice, there is very obviously something wrong with it.
If one were to summarise the doctrine of capitalism in one word, it would be “property”. It is property which enables human social cooperation through production, exchange and consumption. The voluntary exchange of property has rules and these are known as contract.
These two concepts, property and contract, are fundamental to capitalism and yet, in relation to money held on demand in bank accounts, they are applied at best inadequately.
On Wednesday, immediately after Prime Minister’s Questions, Douglas Carswell MP will be introducing a moderate and conservative ten-minute rule bill which would introduce sound property rights and contract to monetary deposits. It is potentially of profound importance and I am delighted to support him.
Read the rest of the article, including a range of relevant links, here.
This is very interesting. Should this law be passed, could you hazard a guess at the practical implications on banks?
My interpretation would be that the fractional reserve system would be illegal. Would the banks be able to put clauses into existing deposit holders’ accounts that allow them to wriggle out?
Of course, should this reform result in the blanket banning of the fractional reserve system, it would have zero chance of passing through the commons in my view, and this bill would serve only to raise awareness. It may therefore, be better to have a structure that allows the banks wriggle-room such that the tightening is gradual and the door is opened to further bills of this nature.
Perhaps you could give us your view, Steven?
The bill as currently drawn is proscriptive not retroactive, so watch this space Tim.
Thank you Toby
Dear Tim, the Bill does not propose to ban or render illegal fractional reserve banking. It merely proposes to offer those who are concerned about the integrity of the system an alternative.
A reason to harbour concerns is the present status whereby each pound held by UK banks that represents depositors’ funds supports 33 competing depositors’ claims/ entitlements to that pound.
If the Bill is passed I, for one, would be delighted to avail myself of the opportunity to have my deposit funds sitting in bowl of £50 notes for my personal inspection, until such time as the bank induces me to permit it to lend them out to sound entrepreneurs for a decent return.
Gordon – Thanks for your excellent description of fraud banking (aka fractional reserve). You illuminate the fraud by explaining 33 people feel they own that money, showing the business structure fails common sense, and only exists b/c the government promises to pay the other 32 people if the bank fails.
Doesn’t this already exist? They’re called safe deposit boxes…
Hmm… I think that I would do the same, Gordon. What interest rate differential would tempt me to put it in the non-safe harbour accouts? Maybe 7%….
All of which suggests that the passing of this bill could a) significantly move deposits towards this new structure b) significantly push up deposit rates on non-safe-harbour funds c) precipitate a bank run.
Unfortunately, I can’t imagine our parliament passing this bill.
Wow, this topic again.
If you force banks to hold 1:1 cash ratios for deposits, as this bill would, the ban becomes nothing more than a safety deposit box in real terms.
Interest rates on these accounts would go to zero (or below) as the bank would not be able to access and use that cash (not even as reserves).
Credit would drop, and would act to undermine growth. By the way, the 33 number one of the above commentators uses for the claims on fractional reserve deposits is incorrect. The true number is 4-5. Total bank leverage is around the x30 mark, but that is very different.
You would then be in a situation whhere banks would not be in a position to offer loans in the same way, and most debt would be raised by large corporates and governments. Mortgage markets especially would be crushed. At the same time, the cash rich would be forced into other investments or accounts (or physical assets) which offer them some kind of return, withdrawing their liquidity from the cash poor.
Beware the law of unintended consequences.
Tyler, that you for your comments, can you substantiate this?
“Credit would drop, and would act to undermine growth. By the way, the 33 number one of the above commentators uses for the claims on fractional reserve deposits is incorrect. The true number is 4-5. Total bank leverage is around the x30 mark, but that is very different.”
I would be very interested to learn.
Oh no! Loans would be harder to get! What you really mean is people who need money would finally have to pay the real price to those willing to lend money. Fractional reserving (don’t call it banking) creates new british pounds and the purchasing power for those pounds comes from everyone who holds pounds. Borrowers get a deal, lenders get a lower rental rate for their money. By lenders I mean the depositors at the bank.
Interest rates on deposits would go to zero and would actually have a fee. But money would not longer lose value due to fractional reserving. So the depositors don’t need an interest rate. The pound will suddenly start to maintain it’s value. Fees for deposits would be akin to fees for storage of any other item. When a person stores household items at a local storage facility, the person expects to pay a fee.
For those who do want to lend money for an interest rate, they will get higher rates, as I explained above.
Mortgage markets would go down and all the better. Taking out a 30-year loan for a house you can’t afford only became possible because of fractional reserving and all the money created through the insidious process. People will either pay the real interest rate for money or pay in cash, and prices for homes will finally be reasonable.
We understand the consequences and welcome it. The short-term consequences would of course be as you describe in your first two paragraphs.
However, you analysis does not admit that the source of economic growth over the long time is the accumulation of real savings. It is these savings that finance the investments into cheaper/new/better consumer goods that raise the standards of living for all. Creation of credit not backed by real savings effectively acts as a tax on the individual by the banks.
Interest rates would sky-rocket, asset markets would crash but we think that the effect of high interest rates would be to incentivise the accumulation of real savings in the economy again, which would gradually build up the capital base and thus lower the market rate of interest over time.
As for debt being raised by large corporates and governments – forgive me but this is the situation currently. The reform outlined would allow individuals control over their deposits, and their loaning out.
If you aren’t familiar with these arguments, I thoroughly recommend Frank Shostak’s most recent article which he has posted on this site.
Good points Tim. Everyone talks about protecting the economy. No one talks about the tax on depositors inflicted by fractional reserving.
The NY times recently ran a piece on how low interest rates harm savers.
The rule bill shows that deposits are really loans to the bank, and that’s why depositors receive an interest rate.
Once depositors know the bank is lending out their money, many will be more than willing to pay a fee so that no one else can claim their money. The name “savings account” implies safety, whereas money in the account is loaned out by the bank managers, who may or may not know what they’re doing.
I’ll try to cover some of the points above briefly.
Bank leverage is measured (estimated?) by various sources. After all probucts are consirdered average is around 30. Ish. You can check vs individual banks earnings statements, but those are famously prettied up to lower overall leverage to make ROC figures look nicer.
Most banks run reserve requirements on deposits at (normally the uppoer end of) 10-20%, which by definition limits money growth in the 4-8x range.
Money supply is not only driven by fractional reserve banking. The value of the pound would probably go down as people withdraw their money from the UK and invest abroad at higher interest rates.
Mortgage market would cease to exist for th emost part, as it is funded by demand deposits in the most part. MOrtgages would become a lot more expensive.
I agree that real savings drive growth. However, making it harder to save (by effectively forcing interest rates on most deposits to zero) would DEDCREASE net savings, not increase them. Especially for the small saver who doesn’t have enough cash to invest long term, as they my need access to their money. Credit growth can also drive growth as well – there is no dout about that either.
Some debt is a good thing – it provides a comoditized asset for savers to invest in. Pension funds need it. The problem comes when there is simply too much of it, as we have now IMHO.
Dave Doctor again:
Why would I pay a fee to a bank to hold my money? I’m better off putting it into a safe in my house, or buying some hard asset. The ONLY reason I put money into the bank is for the return they give me added to the convieniance of being able to access it from ATMs etc whenever I like.
Of course the bank is lending out my money – its the price I pay for the interest I get on it. As long as I can get my money back at some point, I don’t really care what they do with it. Given every bank account is protected to the tne of 50k GBP, I can mitigate my risks with multiple bank accounts and suitable investments. Why would I EVER pay for a bank to hold my money for me, with no return?
Tyler, I have suffered a bank run recently (a broker firm in Spain). If I could, I would rather prefer to have part of my money deposited instead of lent out. For the part I want to put on risk, I´ll choose myself where to invest directly or indirectly (using investment funds or whatever).
Storing big quantities of money at home is dangerous and unpractical. And of course the real depositary business is feasible. It offers a lot of advantages (payments, clearing, compensation, atm, security, etc…). It currently works for securities and could also work for money.
Actually, give me your money, and I’ll put it in a safety deposit box somewhere for you. You can pay me every year for this service. Sound fine to you?
Sorry Tyler, I think that your answer is logically incorrect.
Real savings do drive growth as you say. However, real savings is not “money” but actually all the stuff around us that has taken time and human toil to accumulate: consumer and capital goods. Money is only a medium of exchange. When an individual chooses to save under a fully-reserved system, he locks that money away so that it cannot be used – this much is true. However, what this results in is a concommital reduction in the price of goods everywhere else as this small amount of money is no-longer bidding them up. That means a greater access to goods (which are the real savings remember) to everyone else which can be used as they wish. The action of choosing to hoard cash therefore does nothing to reduce that pool of real savings. By choosing not to lend this cash, this pushes up the interest rate to the point at which someone, somewhere, will lend their cash.
“Credit growth can drive growth” ? This depends upon what your view of growth is. If you think that GDP is an appropriate measure – well of course you are right. However, if an increase in living standards is what we are after, well that can only increase with a greater number of consumer goods and the ability to produce said goods at lower cost. Again – this can only be savings-led. A self-liquidating credit market would be no real issue to me, if that’s what you mean by “credit growth”. However – what we have currently is perpetual growth in credit as a result of a fiat money standard/central bank/fractional reserve system. This does not drive growth in living standards as it tends to result in inappropriate capital allocation into low-return projects (e.g. residential housing) and overconsumption (the liquidation of real savings). Neither of these can “drive growth”.
Debt useful as an asset for people to invest in? Again, I don’t agree. I think that debt is good only if the investment that it was used to invest in produces a positive return to the owner.
All this takes time to get one’s head around. However, if you’re interested in seeing our point of view, perhaps this might help: think of money (under a fully-reserved system) as being merely a commodity which people happen to hold in order that they might buy something in the future. From this it follows that interest rates are merely the difference in value of goods that a man places on a good today compared with a good in the future. The value of money and goods would fluctuate according to man’s preferences of having goods now or in the future. All things being equal, an abundance of goods now would therefore tend to lead to a lower market interest rate.
Thanks for the link Dave Doctor –
Yes it stuck me as odd that during the ‘credit crunch’, I was not able to get a savings rate more than 4% !
Let me let you into a little secret. I happen to sit on and run a structured interst rate trading desk at the moment. Much of my time is spent on the functional reinvestment of pension fund captial. I’d like to think I know a few things about interest rates, inflation and currencies.
As such, you ar emaking some some leaps in your arguments which simply aren’t always borne out in reality. For example, you make the case that money supply will affect the price of goods, with the implicit assumption that the money supply is fixed. Which of course it isn’t. Whilst this can be true, you totally ignore the main driver of the price of goods – the actual supply of the goods themselves.
Debt, in the form of bonds, underpins the whole pension system. It is up to the debtor to make sure they deploy that capital in a way which makes them a return greater than the interest thy are paying. I assume you are not against pension savings?
Apologies for appearing patronising. It wasn’t my intention and I mean no offence.
I also work in the city. I just don’t agree with what you write. I used to think somewhat along the lines that you appear to given what you write but changed my mind after reading various Austrian economics texts. Given that this site is specifically an Austrian economics site, and that your views are distinctly non-Austrian, I thought it probable that you were questioning and interested in learning more about the Austrian viewpoint. Given that you express your views in such forceful fashion, I concluded that me doing the same was fair game.
You must know by now that Austrian economists believe that a good deal mainstream economics is utter nonsense. We think that this nonsense is perpetuated as a result of a confluence of interests between the financial services industry and the government and ignorance by the majority o the population. If you’ll excuse me, your views are essentially mainstream, so it is natural that we disagree. If you wish to argue against the views expressed by posters on this website, I think that it may be an idea to have attempted to understand our arguments before you do so. I would be delighted to recommend any number of books which provide an excellent overview, and would of course be more than pleased to argue over the soundness of the arguments as long as you wish. If you find flaws in any of the arguments, then that would be great – it would add to both our understanding. I might also add personally that the understanding of the principles of Austrian economics has immeasurably improved me as an investor, and would recommend anyone interested in investment to give it a go.
Now to your specific points:
I’m not sure exactly where you disagree with me on money supply affecting the prices of goods. The money supply will always affect the price of goods in the sense that if an incremental dollar is printed, then the first receiver of this new money will put it to his marginal use – either saving or spending on some item. To this extent, the additional dollar supplied always affects the market relative to how the market would have looked without that printed dollar.
I do not think that I ignore the supply of goods with respect to movement in prices in my deductions above. If you point out where I appear to then I would be glad to explain.
With respect to your assertion “debt underpins the entire pensions system”, I am not sure what you mean. I don’t disagree that our current pension schemes are largely invested in fixed-income securities. I do think, though that this should not be a reason to presume a perpetually expanding pool of debt is a good thing, which was the orginal argument if you look back to my earlier post. It ought to be self-liquidating, which the current system does not permit.
In these comments Tim Lucas has expressed the view that money should be a commodity. This is one of Murray Rothbard’s ideas, it is the idea of a specific set of Austrian Economists not by any means all of them.
In my view sound money can be a commodity or a type of debt contract.
In the discussion above Tim writes:
> However, real savings is not “money” but actually all the stuff
> around us that has taken time and human toil to accumulate:
> consumer and capital goods.
When a consumer stores a hoard of durable consumer goods that is normally considered to be a form of saving, Mises called it “plain saving” or “non-capitalist saving”. When a consumer lends resources to another party that is also normally called saving by economists but it’s a different thing, Mises called this “capitalist saving”. Capitalist saving is providing capital to business and it is the primary form of saving in a capitalist economy. Capital goods themselves are *not* saving, they are investment. They are what saving finances.
Think about the relationship involved in a loan. Let’s suppose that I borrow 100 ounces of gold from Tim, I agree to pay 104 ounces in a years time. Tim has looked into my credit history and believes that I will repay the loan. Tim then orders me to repay another person rather than himself. He could write out a note entitling the holder of that note to 104 ounces from me in a years time. That note would have value to anyone who believes my credit is good.
Now, does the above “create something out of nothing”? I have 100 ounces of gold and Tim has a certificate for 104 ounces in a years time. Marxists would say yes, we have created something out of nothing, they call this “fictitious capital”. But, I don’t believe they’re right. In my financial planning I’m quite aware that I must repay 104 ounces of gold. On my account book I have 100 ounces of gold and also a debt for 104 ounces. So, creating debt certificates of this sort is not damaging to the wider economy and doesn’t produce the illusion of more savings than actually exist.
The same can be true of debt-based money. We could have a monetary system where each note were backed with a fraction of gold and a fraction of debt, that would create no illusive savings. (Or one backed by all debt, or indeed by equity). But, that depends on the details of the monetary institutions, we can’t do it if there is a central bank and deposit insurance.
Thanks for your comments. Well I pretty much agree with everything that you say here until you get your final paragraph, and then I get confused.
You state that a currency could be ‘backed by debt’, and yet prior to this you say that debt is simply a transfer of value from one holder to another and does not create additional money-like instruments.
I think that you were right to start with. Debt is not and cannot act as new money. Additional ‘fictional’ money is, however, created from nowhere in the banking system, not through the addition of more debt, but through the addition of additional claim contracts. This is when one or more person has claim to the same bit of money and so each party continues to act as if this money is theirs. A debt contract, by contrast as you outline here, is simply a transfer of value from one party to another and liquidates on expiry. By contrast, the typical example of a claim (which does expand the money supply) is a depositary receipt.
Frank Shostak has done some very nice work in attempting to define the Austrian money stock (all the outstanding money + claims), and has tried to monitor this over the years.
The problem with the high amounts of debt in the system currently is not that ‘debt is bad’ as Tyler suggest my view might be. Rather, it is because the central bank is blackmailed by the high amounts of debt in the system to create new money in order that these contracts may be rolled over, instead of liquidating -as they should.
> You state that a currency could be ‘backed by debt’, and yet prior
> to this you say that debt is simply a transfer of value from one
> holder to another and does not create additional money-like
What I intended to show with example of the 100 ounces loan is that debt is a legitimate idea. Debt does not by itself create problems. The loan market doesn’t create bonds “out of nothing”. For every bond there must be a corresponding debt on some balance sheet and in most cases there must be collateral to the value of the bond.
> I think that you were right to start with. Debt is not and cannot
> act as new money.
I disagree. Throughout history forms of debt have been used as money. Supporters of free banking often use the example of 18th and 19th century Scotland as an example. In that free-banking system the holders of notes were quite aware that their notes were debts. But, they were accepted as money anyway, and very often *preferred* over crown coinage.
Today many people don’t understand that money is based on debt. That’s probably because deposit insurance has protected them for so long the knowledge is no longer worth much. But, that doesn’t show that money can’t be based on debt.
> Additional ‘fictional’ money is, however,
> created from nowhere in the banking system, not through the
> addition of more debt, but through the addition of additional
> claim contracts. This is when one or more person has claim to the
> same bit of money and so each party continues to act as if this
> money is theirs. A debt contract, by contrast as you outline here,
> is simply a transfer of value from one party to another and
> liquidates on expiry. By contrast, the typical example of a claim
> (which does expand the money supply) is a depositary receipt.
The word “claim” is vague, it can be used to signify a debt or a bailment. What you are saying here is that money can only be a bailment, I don’t agree. Theory and history show that it can be a debt.
In his discussion of claims Rothbard muddies the water. He talks about the early goldsmiths. Those goldsmiths agreed to bailment contracts with their clients, they held gold for others. However, they began circulating more bailment contracts than they held gold. This was fraudulent.
However, fractional reserve banking may be perfectly legitimate, and has been for long periods. A bank may issue notes promising to pay a debt for a certain amount on demand. Those may circulate as money, and frequently have. In that situation a bank is not necessarily “creating something from nothing”.
Let’s suppose I’m a banker and I want to issue a note for 500 ounces of gold. Can I just do that? Well, yes I could, but that doesn’t mean the note would be valuable. This situation is just like that for debt. If I were a normal person then I could look to borrow 500 ounces of gold from lenders. Under free-banking the difference between these two situations is a difference of degree not of type. In both cases if it’s thought that the debt won’t be paid back then the lenders will refuse to lend. So, a bank that issues notes that are debts must retain corresponding assets if it wants it’s notes to continue to hold value. If a banker wants to issues a note for 500 ounces then he must find a matching loan (there is no “multiplier”). New money is created, but not out of nothing, it’s created out of an asset of equal or greater worth.
I’m not saying any of this applies to central banks or commercial banks within a central banking system, it doesn’t.
> Frank Shostak has done some very nice work in attempting to define
> the Austrian money stock (all the outstanding money + claims), and
> has tried to monitor this over the years.
Yes, I know, I’ve read it and I think it’s useful. (FWIW, I think Michael Pollaro’s system of defining money stock is better).
> Rather, it is because the central bank is blackmailed by the high
> amounts of debt in the system to create new money in order that
> these contracts may be rolled over, instead of liquidating -as
> they should.
I mostly agree with you there. I’ll explain how I see the current problem in the US especially… The banks are in trouble and possess a lot of toxic assets that are difficult to separate from good assets. In normal circumstances banks would use extra reserves to extend lending further. But the current situation isn’t normal.
In all times banks have two sides to their problems. Firstly, a bank has the threat of liquidity – that it may run out of short-term assets and be unable to pay counter-parties. Central banks protect the commercial banks from this threat by providing bridging loans. Secondly, a bank has the problem that if it’s finances are looking shaky then no savers, businesses, shareholders or other banks would invest there. The state helps here too, it provides deposit-insurance to savers which produces moral hazard. So, normal savers invest only on the basis of the highest rates, taking no account of long-term solvency.
In the past these two subsidies along with management that wasn’t too foolish (and central bank activity that while stupid, wasn’t excessively stupid) ensured banks stayed in business. Because banks always had a safe supply of assets to draw upon the limiting factor in money creation became required reserves and the reserve ratio. After the recession began things changed. Attracting more savers became difficult and the other parties I mention, investors/shareholders, businesses and other banks became unwilling to provide more assets. Then the federal reserve offered interest on excess reserves. So, the banks decided to use excess reserves as an asset.
Probably the only long term solution here is bankruptcy of many large banks.
Okay Current I think there are really few differences of opinion but correct me if I’m wrong please.
I wrote “debt cannot and does not act as new money”. Saying ‘debt’ I specifically meant ‘credit contracts’. You disagreed, stating that it did, I think that you are saying that debt has acted as money in the past, which I do not disagree with. However, I specified ‘new money’ by which I meant that credit does not add to the money supply over the existing money. Of course these debt contracts can trade as money themselves but this is not an addition, but a replacement of the existing stock. Would you agree with this? If not, I’d like very much to know where you think differently!
Your point about the very existence of central bank preventing free banking (which would be a much better system) I agree with. However, I am interested to know whether you think that free banking with a FR would be better than fully-reserved banking. I am unsure on this – sometimes I think that duration transformation is a useful service that banks provide – one that is only possible with a fractional reserve, but above all, I really think that banks shouldn’t be playing fast and loose with depositors’ money as it goes contrary to the principle of property rights, and I’m an individualist at heart. From a systemic point of view, full-reserve banking would prevent the bank failures that would occur under free banking.
My main problem with full-reserve banking is that I suspect that it may not be practical? Given the additional profits to be made by fractional reserving, would it be possible to come up with well-enough constructed laws that would prevent entities from taking advantage of new financial products in order to engineer financial reserve banking in some form or other. If full-reserve banking is simply not practical, I would concede free banking with a fractional reserve and no central bank as the next best thing.
Finally – I am still unsure as to how you can imagine a system that is 100% backed by debt but with nothing else. I cannot imagine such a system since the debt would need to be denominated in something else. The very nature of debt is a contract to pay a certain amount to another party. How – therefore – could 100% of a money supply be made up of debt?
> I wrote “debt cannot and does not act as new money”. Saying
> ‘debt’ I specifically meant ‘credit contracts’. You
> disagreed, stating that it did, I think that you are saying
> that debt has acted as money in the past, which I do not
> disagree with. However, I specified ‘new money’ by which I
> meant that credit does not add to the money supply over the
> existing money. Of course these debt contracts can trade as
> money themselves but this is not an addition, but a
> replacement of the existing stock. Would you agree with
> this? If not, I’d like very much to know where you think
The monetary system that we use today is a sort of hybrid. A note or coin is a type of fiat money. It has no “backing” in the sense used by Austrian Economists. Demand for paper notes and coins is created by the legal structure surrounding money, state actions, and by the historic network effects. Bank account balances are different, they are debts as Toby mentioned in his article about Carr vs Carr. That’s why I think it’s appropriate to call our current system a debt money system. The vast majority of money-in-the-broader sense is fiduciary media and fiduciary media is a type of debt.
On it’s balance sheet a bank can hold fiat money as an asset, and it must hold a minimum amount of that – the reserve. That reserve is made up of vault cash and the balance in the reserve account with the central bank. The bank also holds loans as assets. But, even if a bank held only fiat money reserves (and some US banks are currently doing exactly that) it would still be a debt.
Depositors may not be aware of all this, but it is how money works. I agree with Douglas Carswell and the rest of the Codben centre that this should all be brought into the open.
> Your point about the very existence of central bank
> preventing free banking (which would be a much better
> system) I agree with. However, I am interested to know
> whether you think that free banking with a FR would be
> better than fully-reserved banking.
I think that Free banking with fractional reserves would be better than 100% reserve banking. I agree with Steve Horwitz, Larry White and George Selgin.
One of the main problems with 100% reserve banking is recessions. Let’s suppose that Britain switches to a 100% reserve fiat money system with a fixed money stock, as Toby proposes. In my article criticising that proposal I mentioned problems with the transition. But, let’s suppose the transition is managed well. Britain would still be part of the global economy and international capital markets afterwards. That means it would still be affected by the policies of other countries if there were a recession in the US then it would create a recession in Britain. If that happened then the demand for money would rise. But, with a fixed money stock that rise cannot be accommodated. Prices would not fall quickly, output would fall. So, an unnecessarily large recession would ensue. This could easily be averted by creating money to match demand, then removing it later. In this case other countries with Central banking would perform better than a 100% reserve.
In the “Dangerous Defeatism” thread I wrote a long comment explaining the ideas behind monetary equilibrium:
To show that it isn’t tied strictly to fractional reserves I compared two different types of 100% reserve systems in that comment.
> I am unsure on this – sometimes I think that duration
> transformation is a useful service that banks provide
I think that maturity mismatching is a useful service too. Let’s suppose that Britain implemented 100% reserved fiat money. In that case banks couldn’t use funds on deposit for loans. Customers would have to save for a fixed term in order to get interest, and only fixed term savings could be used to fund investment.
That would restrict the pool of savings. However, as I said earlier we now live in a world with international capital markets. The banks would make up for the shortfall by borrowing from abroad. But, by doing that they would make Britain susceptible to credit booms created by other central banks.
> one that is only possible with a fractional reserve, but
> above all, I really think that banks shouldn’t be playing
> fast and loose with depositors’ money as it goes contrary
> to the principle of property rights, and I’m an
> individualist at heart.
As Doug Carswell has made clear we could have a law explaining the nature of bank accounts to people. We could have a regulation stating that banks must put “your bank account is a loan to our bank” in 40pt bold letters on their paperwork.
That would be a good first step, but it doesn’t get rid of the central bank.
> My main problem with full-reserve banking is that I
> suspect that it may not be practical? Given the additional
> profits to be made by fractional reserving, would it be
> possible to come up with well-enough constructed laws that
> would prevent entities from taking advantage of new
> financial products in order to engineer financial reserve
> banking in some form or other.
What the state would have to do is ban the making of short-on-demand loans. However, even that wouldn’t solve the problem, during the free banking period in Scotland the bank often didn’t promise to redeem on-demand. They gave a term for their notes, but redeemed on-demand in practice. So,the state would have to ban loans that are on-demand in practice. Also, people may be happy to use debts which have a short term attached to them as money. That means the state may have to ban transferable debts with maturity below ~3 months.
I’m sure that if the state wanted to do this then it could. To be a money-substitute a certificate must do exactly the same job as money, it must be acceptable in place of money almost anywhere. It’s hard to keep something like that under-wraps and hidden from the government. Any institution that wants to issue a money substitute must be large, prestigious and visible, it can’t be done behind closed doors.
The main problem would be that banks and others are likely to try to influence or bribe the government to allow loopholes.
> Finally – I am still unsure as to how you can imagine a
> system that is 100% backed by debt but with nothing else.
> I cannot imagine such a system since the debt would need
> to be denominated in something else. The very nature of
> debt is a contract to pay a certain amount to another
> party. How – therefore – could 100% of a money supply be
> made up of debt?
What you’re talking here about is redeemability. The holder of a banknote must be able to redeem that banknote in a commodity such as a metal. Certainly, that’s necessary to a good monetary system.
People have suggested “inconvertible” free banking systems, but I doubt they would be practical.
When I talk about debt money I don’t mean money that is 100% backed by debt, I mean money that is a form of debt. The bank issuing it may back it in various ways depending on their business strategy.
I´ve just found this website today as I was searching about the bill about limiting fractional reserve.
I totally agree with Tim Lucas views. I would like to add that one of the main flaws on the mainstream theories is confusing the terms “money” and “credit”. Even many austrians have a problem with this (Mises and Hayek are not completeley clear on this regard).
A new theory has been published recently, which in my opinion finally establishes a sound Monetary Theory for the Austrian School of Economics. It shows a crystal clear definition of money, credit and interest. The author is Carlos Bondone and here is his book:
The problem with your proposal is that if you treat credit as money (even if it is backed partly by a present good, such as gold) then you build credit over credit on an endless fashion. The problem with this is that it not creates savings, it consumes them.
In fact, what you are proposing is what we have now. As professor Antal Fekete points out, the current system is still backed by gold, because there is a fairly liquid gold future´s market, so dollars are still redeemeble for gold through Comex. In Fekete´s opinion, this the only reason the current monetary system survived to the 1973 default, otherwise it would have collapsed then.
I had a feeling when I wrote my comments that I was going to be accused of holding the real-bills doctrine.
What I wrote above is a general defence of debt. I intended to establish that debt is a legitimate idea. I was showing that debt does not create the illusion of more assets than actually exist. My point was to show that the criticism that debt-money necessarily “creates money out of nothing” is wrong.
Now, the situation with debt money, or fractional reserved money is more complicated. Whether debt-money would “build credit over credit on an endless fashion” depends upon the monetary institutions involved. It certainly can in some circumstances.
I don´t think the real-bills doctrine is necessarily a problem, as long as currency backed by real bills is clearly differenciated from currency backed by present goods.
And I don´t disagree that debt might be used as currency, it should be ok again if its clearly differenciated from currency backed bay present goods. Of course I agree the sentence “creates money out of nothing” is wrong, because what you really create is credit (even if you call it money). Credit might be created in a balance sheet and it´s otorgated by the agent that delivers the present goods in a transaction. But a present good itself can never be created in a balance sheet, that´s impossible!
And yes, debt-money allows theoretically the creation of endless credit, so if you want to avoid it, the best thing to do is to make it clear from the beginning.
Now, if all of this es clear but people want to use debt as a currency and create endless credit, that´s ok, people is free to do what they want. But from a scientific point of view a clear guideline should be provided.
I don’t think we really disagree as much as I originally thought…
> I don´t think the real-bills doctrine is necessarily a problem
I have a feeling that by the end of this discussion I’ll end up explaining the details of why it’s wrong. But I’ll leave that until later.
> And I don´t disagree that debt might be used as currency, it should
> be ok again if its clearly differenciated from currency backed bay
> present goods.
Yes, the issuers of money must be clear. Issuing debts and claiming that they are bailments is fraud. For that reason I agree with the spirit of Dan Hannan’s bill.
> And yes, debt-money allows theoretically the creation of endless
> credit, so if you want to avoid it, the best thing to do is to make
> it clear from the beginning.
Yes, but they don’t have to create endless credit, it all depends on the circumstances. In their books Larry White and George Selgin explain what monetary institutions create sound debt money and what institutions create unsound money.
> Yes, but they don’t have to create endless > credit, it all depends on the circumstances. > In their books Larry White and George Selgin > explain what monetary institutions create > sound debt money and what institutions create > unsound money.
The problem is that if money and credit are not differenciable, the monetary system is inherently flawed, even the prudent institutions could have problems.
For a sound monetary system currency backed by present goods must be differenciated from currency backed by debt. And also credit must be trackable (who is the debtor, which amount and what date is due).
> The problem is that if money and credit are not differenciable,
> the monetary system is inherently flawed, even the prudent
> institutions could have problems.
In a fractional reserve free banking system money is a type of debt. Why do you think that would cause problems?
> For a sound monetary system currency backed by present goods must
> be differenciated from currency backed by debt.
Certainly the issuers must be clear to the recievers about this, yes.
> And also credit must be trackable (who is the debtor, which amount
> and what date is due).
What exactly do you mean?
“In a fractional reserve free banking system money is a type of debt. Why do you think that would cause problems?”
Well, in my view (Menger´s definition) money would never be debt because it must be always a present good.
Leaving aside my view, it would be problematic because debt cannot liquidate debt, the only way to roundabout this problem is depending on the creation of new debt to back new issues of currency which would be used to pay the old debt. But if we are talking of a *free* banking system (with no central bank) of course the problems would not be that important because the banks must be careful on the currency they issue.
“Credit must be trackable”
I mean that if you owe me 104 ounces of gold and I write a debt certificate to pay somebody else, and if that certificate looks like a depositary receipt and the new owner can legally treat it as money and lends it out again, there could be infinite claims on the same 104 ounces of gold. By trackable I mean the debt certificate must look like and treated as debt, identifiying the debtor (or at list the bank that intermediates the transaction) the quantity of the debt and the expiration of the debt. For practical reasons all these could be organised by banks in rather standarized “blocks” of debt currencies (of course currency could be deposits or bills).
> Well, in my view (Menger´s definition) money would never be debt
> because it must be always a present good.
Another group of monetary theorists – the Chartalists – say that money is whatever the state determine money to be. They say that when a man exchanges a gold coin with another in a place where the state approved money is silver that this is a “form of barter”. This definition is confusing, money is whatever commerce calls money. And, commerce calls the medium-of-exchange money.
Presently fiat notes and coins, and a type of financial asset – the bank account – is the medium-of-exchange. In my view that means that we should call those things “money”.
> Leaving aside my view, it would be problematic because debt cannot
> liquidate debt,
> the only way to roundabout this problem is depending on the
> creation of new debt to back new issues of currency which would be
> used to pay the old debt. But if we are talking of a *free* banking
> system (with no central bank) of course the problems would not be
> that important because the banks must be careful on the currency
> they issue.
Yes. But, they can still issue currency that is a form of debt. In historical instances of free-banking such as the period in Scotland that is exactly what they did. They kept a small reserve of gold for redemptions and held assets against the rest.
They did not create debt-loops of the sort you describe above because they were concerned with the quality of the debt they held. They had no central bank or state backer to bail them out if their debts turned bad. (At least not in general, it did happen occasionally).
If one bank received a note from another bank it would send the note for redemption rather than using it.
> I mean that if you owe me 104 ounces of gold and I write a debt
> certificate to pay somebody else, and if that certificate looks
> like a depositary receipt and the new owner can legally treat it as
> money and lends it out again, there could be infinite claims on the
> same 104 ounces of gold. By trackable I mean the debt certificate
> must look like and treated as debt, identifiying the debtor (or at
> list the bank that intermediates the transaction) the quantity of
> the debt and the expiration of the debt. For practical reasons all
> these could be organised by banks in rather standarized “blocks” of
> debt currencies (of course currency could be deposits or bills).
I agree that debts must not masquerade as depository receipts. Any banknotes or bank accounts that a bank creates that are debts must reveal that they are debts and must name the bank.
“I agree that debts must not masquerade as depository receipts. Any banknotes or bank accounts that a bank creates that are debts must reveal that they are debts and must name the bank.”
If you agree with this, then you should not be comfortable with the Chartalist. I completely disagree with Chartalists proposal since I think that money and even credit always has its origin in the market. I think that Carl Menger demonstrates this pretty well.
Even with today´s fiat money, the agents that otorgate credit are the ones that are willing to exchange present goods for euros or dollars.
Just to be clear and specific, I prefer Bondone´s definition where I call currency the medium of exchange.
Then you may have currency that is money (physical gold or silver coins), currency that is regular credit (i.e. gold certificates) or currency that is irregular credit (today´s dollars, euros and sterling bills or deposits).
I don´t really care too much how things are called, that´s not the important issue. But I do care to clearly separate currency backed by present goods (these ones do liquidate debt) or future goods (these ones do not).
But I also have to say that you should consider that we call money our dollars, euros or sterling because there has been a long and subtle process during the XX century where banks and governments have made their debt currencies look the same as the real money used to look.
I see your point, your terminology is very non-standard but I agree with what you’ve said. I certainly don’t agree with the Chartalist position in general.
Whether you call it “irregular-credit” or “fiduciary media” a form of debt can be a good medium-of-exchange. It depends upon the institutional setup.
But please note that Bondone´s terminology comes directly from Carl Menger, the founder of the Austrian School of Economics.
Surely a debt currency could work as long as it used honestly and properly. As Mr. Bondone says the evolution from money currency to credit currency can be considered as important as the evolution from barter to money.
For me, the best institutional set up would be free banking.
I´ll suggest Mr. Bondone to write an article on this, I have asked CobdenCentre admins and they seem interested.
Hello Current –
I’ve read through all the comments on the thread above and on the adjacent Dangerous Defeatism thread. Thank you. You’ve given me something to think about. I have continued on the Dangrous Defeatism thread as it seems more appropriate.
I have not read all of the above, but it does seem to me that John Kennedy and Mr Lincoln before him both were on a journey to solve the debt matter by having the people (Treasury) print debt free money backed then by silver and FREE OF USURY.
In my view as an old man by any standards (Korean Vet)the FR system makes wars, kills people, funds greed, gets people kicked out onto the street and much more.
At the very least, gov’d should consider providing with loans from money created by HM Treasury which, like Kennedy and Lincoln would be free of interest – perhaps a poit or so to cover coats…. not enough to fund these greedy grasping banksters their every whim.
It was good to meet you after the Jesus de Soto lecture at the LSE last week and I thought you may find this worthwhile reading… let me know
Shortcut to: http://www.bankofenglandact.co.uk/
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