John Humphreys v Walter Block on FR-banking

Last week Catallaxy linked to a paper by Austrian economist Walter Block about fractional reserve (FR) banking, and how it is supposedly fraud. The Block article recounted a discussion between Block and free-market economist Bryan Caplan about FR-banking.

I decided to join the discussion and sent Walter an e-mail. Below is the (slightly edited for readability) back-and-foward discussion (which was cc’ed to Bryan, who didn’t comment).


Walter (from earlier discussion with Bryan): Consider this: A deposits 10 ounces of gold in B’s bank; B gives A a demand deposit for these 10 ounces. B turns around and lends C 9 of these ounces, giving C a demand deposit for these 9 ounces. Thus, A and C both own full rights to these 9 ounces.


John: The example you give of two people have equal rights to the 9 ounces of gold is simply an issue with the wording of the contract. With one very simple change, you can easily remove the supposed “fraud”.
Instead of telling the depositer that they have $10 worth of cash/gold with the bank, you simply tell them that they have a $10 IOU with the bank. That is, the depositer owns $10 worth of “debt” with the bank. Now there is no fraud.

The fact that the bank then provides $9 to another person (in exchange for another IOU) does not constitute fraud. The first person owns $10 worth of debt with the bank (not the cash/gold). The bank owns $9 worth of debt with the borrower (not the cash/gold) and has $1 of cash/gold on hand. The assets and liabilities of the bank match. No two people have rights to the same thing.
FR-banking is simply allowing voluntary contracts between people. To abolish FR-banking would be a draconian act of government, banning a consentual act between adults, which would drastically reduce loanable funds (and therefore capital accumulation) by outlawing intertemporal matching between debt types


Walter: Let me just say this. I regard it as fraud if there are more titles to a given amount of property, than there is property. For example, if there are 1000 cars in a small town, and there are 1100 titles to these cars. It is still fraud, no matter who agrees. Property is more basic than mere contract, for libertarianism. To put this in another way: if there are two (or more) people with a full right to any of these cars, that is a logical contradiction. Yet, fractional reserve banking implies just that; whether or not the two different “owners” of one of these cars chooses to exercise that right.


 John: Using your car analogy — in FR-banking there are not two owners of the same car. There is a person who owns the car but has given up control of it (ie rented it out) and another person who doesn’t own it but has control of it (ie they have rented it). The car-borrower has subsequently lent it to another person… who has lent it to another person… who has lent it to another person. Renting a car isn’t fraud and shouldn’t be illegal.


Walter: Nice try. But the person who rented out the car has a Demand Deposit for this car. That means, he can Demand it back at ANY TIME, and the person to whom he has “rented it” is contractually obligated to give him back that car IMMEDIATELY. On the other hand, the borrower or renter of the car ALSO has a DEMAND DEPOSIT on that car.
The two contracts signed by the car intermediary (e.g., the bank, in frb) are INCOMPATIBLE with one another. True, there may be no pragmatic problem unless there is a “run” on this car; both the renter and the rentee wish to assert their (incompatible) ownership rights over this car at the same time. But, even if they do not, these “rights” are incompatible with one another. This is an anathema for libertarianism, where there are no, can be no, conflict in rights.
Any system that in effect tells two very different people that they have a RIGHT to the same car, and immediate right, is fraud, at least for libertarians.


John: The problem with the above situation is semantics. Instead of giving the lender a “demand deposit”, you give them an “IOU” and then you have removed the fraud.
Most people already know that the bank is going to on-lend their money (otherwise how could they receive interest) and they give the money to the bank on this understanding. If the contract was being disputed in the courts I have no doubt that it would be interpreted by a “reasonable person” as an “IOU” and so there would be no fraud.
But if there is a semantics problem in the bank information sheets, then I accept that the banks should modify the wording. I certainly can’t accept that a semantics problem can justify the huge (and hugely costly) government action of banning an entire genre of voluntary interaction between adults.
I agree that it would be better to have more information about the risks of putting money in a bank. Unfortunately, the assessment of this risk has been totally biased by the moral hazard created by continuous government bail-outs.
Without that moral hazard (which has only been increased again in recent months) then I think we would likely see a greater diversity in types of banks… with some only investing in government bonds (which gives then the same solvency as the government, though not 100% liquidity guarantee) and maybe some offering “vault-cash” accounts (which provides 100% liquidity, but negative interest rates). But even with full information about how the money is going to be used and all the risks involved, I still think most people would invest in a FR-bank, which on-lends the money and consequently can pay relatively higher interest rates.


Walter: An IOU is a time deposit. You’re changing the subject.  A demand deposit is not an IOU.


John: ??? I wasn’t changing the topic. Your complaint is that FR bank deposits aren’t really demand deposits because you don’t really have the right to demand you’re money back. Fair enough. But that’s just semantics.
If you simply stopped calling them “demand deposits” and instead just called them “bank deposits” (or any other word which clearly means “loans money to bank and let’s bank on-lend the money”) then there is no fraud. Most people already understand this to be true (as would be evidenced if the issue was taken to court), but if the wording worries you, then we simply need to change the wording.
The concept of lending money to a person and letting them on-lend the money is perfectly legitimate as long as everybody knows what is going on. Surely you agree with this!
To simplify, If I say to Bryan (if he’s reading) “hey Bryan… I’ll give you $10 now and you can do what you like with it… but I’m going to ask for $10 back some day and hopefully you can repay”, and he says “yes” are you going to get the government to arrest us? Now if Bryan changes his name to “Bank” are you going to arrest us?
This seems like a significant abuse of government power. Not to mention the consequences!!


Walter: I’m gonna let you have the last word on this.

84 thoughts on “John Humphreys v Walter Block on FR-banking

  1. I agree with John- there is no fraud if all parties know what is going on! As to definitions, I can see what Walter means about ownership. Does anyone have another way around this?
    As I pointed out on an earlier post, how can you stop individuals assigning their own gold, stored in a bank, to more people than there is gold to cover the notes? If it is so easy for individuals to do, should it be a crime?

  2. I know nothing about this particular topic… but I didn’t think that they wanted to abolish Fractional Reserve Banking through government force? I thought they simply wanted to remove government sanction of the practice, and let the best form of voluntary banking arrangements crop up. Rothbard predicted in a speech that FrB would die out, if we got the government out of banking (at least that’s what I think he said).

  3. nicholas — I don’t understand your question. The individual has already assigned their money to the bank. The bank then assigns that money to another person. There are no two people who have the same call on the same asset.

    Walter’s complaint is that somebody was told they had the same call on the same asset (ie your $10 is always waiting at the bank for you). If that is true, then all you need to do is change what you tell that person. Tell them that their money will be on-lent… and that they will only have access to a cash reserve which is kept at the bank.

    Tell them that they have a 99.9% chance of getting their money on any specific day… but that a bank run will mean there isn’t enough cash at the bank. In that case the bank will need more time to turn their illiquid assets into cash.

  4. Sukrit — as Rothbard & friends are libertarians they are uncomfortable saying “ban FR-banking”… but that is the only way to remove it from society.

    There is a very obvious economic argument for intertemporal debt matching, and somebody on earth is going to do it voluntarily. Hell — I’ll do it! If you want to stop it, then you’re going to have to over-ride that voluntary transaction. And that requires government force.

  5. Nicholas,
    The question of ownership was answered centuries ago, as most eloquently pointed out in the cast of Foley v. Hill. Even Rothbard acknowledged this. Quote (from Rothbard):

    Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it . . . . The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the mount, because he has contracted . . . .

    Rothbard then went on to some meaningless gumph about warehouse receipts, as if a bank were like a warehouse. In this, he completely missed two things:
    1. Money is fully fungible, so the warehouse analogy is a false one; and
    2. I pay a warehouse to store things for me. Banks (at least in theory) pay me to deposit money.
    Both are big differences, so this whole thing about FRB being a problem for libertarians is a nonsence. As I have argued before I believe a ban on FRB would have to be backed by massive and intrusive regulation. To me, this means that not only is a ban on FRB not necessary for libertarianism, it would in fact be totally contradictory to its basic principles.

  6. I can’t believe the excessive no of hours that has been devoted to the fraud issue by Austrians. The equivalent of arcane debates about the Virgin Birth.

    Bottom line – I don’t expect my bank to be a warehouse, i don’t feel cheated, Block et al can leave me the heck alone.

  7. btw I really only linked to the piece because of the *economics* literature for and against he links to below, I could care less about the fraud issue

  8. Greego,
    Laura makes the same error, just states it another way.

    The contractual right to repayment on demand means the bank grants the depositor full control of the money, to use whenever and however he wants. If the depositor has this right, whether it is contractual or otherwise, he necessarily owns the money.

    And since his ownership of the money is determined by the fact he has the right to use his account whenever he wants, that is at all times, the bank cannot claim he is an owner only at those particular times he spends or withdraws the money. It is the possession of the right, not merely the exercise of it, that signifies him as the owner.

    Money is fully fungible. The depositor has a right to ask for his/her deposit to be redeemed. That means that the depositor has the right to ask for the same (or similar – interest and fees taken into consideration) amount back, not the same money. It is a contractual right, not an ownership one.
    In any case, her attempt to create a contrast between term and demand deposits is a nonsence as well. Practically all term deposits can be broken at a moment’s notice (with the payment of an appropriate fee) so the whole lot is a furphy anyway.
    If she was attempting to ban FRB now she would have to ban all bank lending. Great outcome.

  9. Block and this Davidson person have got it all wrong. A demand deposit is the contractual right to draw on a bank’s fungible reserves up to a certain amount (ie principle + interest – fees) in exchange for the property title to the original deposit. The only reason FRB is a problem in our current world is centralised banking and fiat money. Remove those and market forces would restrict FRB to a sustainable level.

  10. Yes I agree Andrew, I was just putting the link there as it’s topical. The LRC peops seem to be defending each other but they’re on the wrong side of the argument. It would be good to bring them around.

  11. I should clarify, I could care less about the fraud issue because the argument that it is fraud is so self evidently stupid to me I don’t even think it’s worth responding to. Libertarians who want a safety deposit box can get one at the post office. The rest of us are willing to accept the risks we’re taking.

  12. I dunno John. Where does it all end? One day we’re normal liberatarian planning to overthrown the government, and promote free love, universal gun-ownership and dope-smoking etc. and the next day someone comes along and say ‘fractional reserve banking isn’t fraud’. WTF? Here I’ve beed staching gold under my mattrass and now it’s okay to just keep cash? Shame on you. If you were a man, you’d let Bird come here and tell how wrong you are! Where’s the evidence fella??


  13. It’s certainly would appear to be fraud to most people as they are ignorant about how FRB works. I wonder if it is covered adequately in the PDSs? I certainly don’t understand it fully.

    Most people’s current/cheque accounts wouldn’t see any real interest. The charges would more than eat them up. I checked a couple of CommBank accounts that offered 0.01% interest on up to $10k with a $4/month fee. You’d have to keep an average of around $5k in your current account just to break even…

    Jason, people cannot use deposit boxes for their “current accounts”. How would they receive their salary and pay their bills etc? Perhaps there would be a market for a 100% reserve current account where a monthly fee is charged and no interest is received.

  14. Greego — I know you’re not supporting Block’s response, just reporting it. But I’ll give my response. Once again he is simply getting caught up on semantics… though I accept that Eric Posner allowed him to do it.

    Of course not everybody can get cash at the same time because many bank assets are illiquid. But as long as all parties know that some assets are illiquid going into the arrangement, and that therefore they don’t have 100% possibility of getting their cash on demand… then there is no contradiction.

    The depositer does not own the money, they own an asset called “debt” which has certain characteristics. Those include (1) pays interest; and (2) has a very high (though not infinite) liquidity. It is perfectly possible to create such a financial asset without any duplicate ownership of any one asset.

  15. Steven — if the bank simply held cash in vaults then all the costs of their business would be paid for by the fees of depositers. That would be a lot. And it is very easy to get a positive real interest rate in Australia on savings accounts.

    I very much doubt that most people would think FR-banking is fraud. The supposedly fraudulent part is that the bank uses deposits to then make loans to other people instead of keeping your money in a safe. The vaste majority of adults know that banks do this. And banks certainly tell people that they do this.

  16. Hi John!

    Well, I just asked my girlfriend and she didn’t think that the bank would have time to lend out any money in her access account as she spends it too quickly. Her jaw dropped when I told her that they lend it out. She’s not that worried about it though as it’s not that much money.

    I then tried to explain the multiplier effect … but I’m not very good at this.

    People just don’t give this stuff much thought at all. Perhaps in the back of their mind they know that the bank lends out the money so that they received an interest payment on their demand deposits. However, almost everyone does not understand the consequences of this – the multiplier effect.

    I imagine that people wouldn’t likely think that the bank was being fraudulent under the law. I mean that they would think of the bank as deceptive and tricky. If they got caught by a bank run they’d certainly be “up in arms” about it and talking with their local member. At a time like that people would no doubt think that was the bank had done was no “right”.

    When someone opens an account to have their salary paid into I am sure they are not thinking “Hey CommBank, I’ll give you $4000/month each month and you can do what you like with it… but I’m going to ask for it back some day and hopefully you can repay”.

    I imagine you are right about fees on 100% reserve accounts – they would be much more than current fees. Over the years though, fees have increased and interest on current accounts has plunged. Perhaps as people forgot what it meant to have one. I always thought that current accounts where considered loss-leaders. Perhaps a more informed public would create a demand for different kinds of accounts.

    I bank with Heritage – in part because there’s no monthly account keeping fee. I don’t know why more people don’t consider $5/month/account meaningful.

  17. Steven,
    When you think about how the funds actually flow in the system it is not that surprising. Your girlfriend gets paid (say) once a month, let’s say $4,000. At the start of the month her balance is $4,000, at the end $0. That means she has an average balance through the month of $2,000. If a bank has 1 million depositors (an provided the paydays are evenly spread out across the depositors), that provides $2,000,000,000 in loanable funds. At a 10% reserve ratio, this means that $1,800,000,000 is available to lend.
    Once you add in the businesses that have received the funds as she buys, say, shoes then the bulk of the funds are available to lend out – minus that reserve ratio. This is just the first iteration.
    Behind it all, though, is economic activity. Every time those funds are used someone gets paid, a good gets produced or whatever.
    Impose a 100% reserve ratio and that all (or most of it) stops. If there is to be any lending it has to be done where there is a pure co-incidence that your girlfriend’s desire to postpone buying some shoes happens to be for the same period of time that someone want to use the funds to, say, build a house. To me, the chance that anyone would put off such an important purchase for 30 years is remote at best.
    The information problem (trying to match time preferences) becomess immense – and possibly insoluble.
    Banks may be guilty of heinous crimes at times, but they perform an invaluable service – and get well paid for it. To fail to recognise either of those is, to me at least, to put ideology well before sense.

  18. Here’s a suggestion which i think is a pretty libertarian one.

    If anyone disagrees with fractional let them vote with their feet. Hire a safety deposit box an put all your money in there. In fact convert the ‘ponzi’ scheme money and stick it in the safety deposit box. Talk your friends and shopkeepers to take gold as payment.

    I really don’t know what these people are waiting for. Surely they don’t want the government to make the decision for them do they?

    Do it now.

  19. Steven — Deceptive? How? There is absolutely no secret about how banks work. If you walk into any bank tomorrow and ask them, they will tell you that they get deposits from people, and then they use that money to provide loans to other people. That’s what a bank is.

    No offense to your girlfriend… but this isn’t a grand conspiracy. It’s called “banking”.

    You mention that interest rates have gone down. That’s true… but most people have considered that a good thing. The reason is that in a globalised world we now have access to more efficient source of savings. The consequence is a more efficient allocation of capital.

    The actual spread between bank interest paid and bank interest charged has decreased, as financial deregulation lead to more competition and more efficient banks. Again — this is a good thing. Not trick. No deception. No secret group of jewish free-masons trying to eat belarussian babies.

    A bank run just means you can’t get your money that day. It’s a liquidity problem, and just takes time to fix. People lose their money when the bank actually goes broke — ie a solvency problem. Surely the average human knows that it’s humanly possible for a business to go broke? If they don’t — the only sensible solution is to tell them. Not ban banking.

    It might be nice to have an option with 100% liquidity (and hugely higher costs)… but I think hardly anybody would take up that option. I certainly wouldn’t. And if that option is really a good one, then all you need is free banking, and the free market will provide that option. No need for massive government regulation of banking, as preferred by Block & friends.

  20. Fraud or not, the whole system only comes unstuck when the car owners take there cars back and park them in the back yard to rust. While the system works those that want cars have cars.

    I think we are all very aware of how banks work, that is why “bank runs” are such a problem and why governments are so scared of them.

  21. I’m always intrigued when someone claims to speak for libertarianism. It reminds me of the consumer groups who claim to speak for consumers.

    There is no fraud when two parties voluntarily enter into a contract. Unless the banks pretend they keep your money in the vault rather than lend it out to others, I can’t see any fraud.

    I remember an episode of the Beverly Hillbillies in which they turned up at the bank to see their money. I don’t think they understood how banks operate.

    As for libertarianism, consider this:

    1. In the absence of genuine fraud, a ban on fractional reserve banking would be hugely coercive.

    2. Such a ban implies a ban on private currency. Also hugely coercive.

    Libertarianism is actually about minimising coercion.

  22. John, Nicholas here. My questions were just general-purpose questions, to focus our minds on what governments should be doing, whilst we still have them. I tried to point out to our argumentative avian that FR would still occur under a non-central bank system- how would the government stop people who put metal in safety-deposit boxes from giving out contracts to that metal- i.e. stop you and me from reinventing FR? I don’t think it can be done, and, as long as everyone knows what is going on, then there is no victim, and thus no crime.

  23. I’m not an economist but I’m going to have a go of teasing out this issue better. No one seems to have defended Walter’s side here.

    As I understand it, fraud is not the issue. Theft is.
    The theft is from society at large (all parties not involved in the lending) and therefore whether or the bank and its depositors and debtors agree to the fractional reserve is irrelevent to settling this argument.

    Theft should of course rightfully be illegal.

    I don’t think Walter has defended his side very well in this exchange. Maybe he couldn’t be bothered?

    The theft is a theft from all in society that own dollar bills and comes from inflating the money supply: If a bank creates money that it did not earn or borrow, it is, by definition, inflating the money supply.
    This doesn’t imply an increase in prices. You would expect
    for a fixed money supply in a society of increasing productivity that dollars would accrue value. The bank is siezing this accrual for itself – forcefully.

    Let’s say the total money in the economy is $100. I have $10 or 10%. Productivity of the society increases and my $10 now buys what $20 would have in the past.
    Person X then comes along and prints $100. The total money in the economy is now $200. And I own 5% instead of 10%. Now my $10 is back to buying an original $10 worth. But Person X has an extra $100 for doing nothing, equivalent to $50 of purchasing power in the original economy and 50% of the total money supply.

    The pragmatic based “lending is good” argument also doesn’t hold water if fractional reserve is theft.
    This argument is saying it’s OK to mug me because the mugger will lend out the stolen money to a productive enterprise thereby increasing their productivity.

    So for those supporting fractional reserve (personally I’m still on the fence) why is forcing an increase in the amount of money not theft?

  24. Sure hope you’re not getting splinters, Tim!
    Your argument sounds good, but you did not go into any method of ridding society of this practice. How could we have a small government, and still outlaw FR? Do you make it a law that everyone must use coins only, or weights of metals, in all transactions? How could this be enforced, if two people traded in secret, using notes?
    I just don’t think you could enforce laws against FR, in a free society.

  25. You’re not forcing an increase of “money” on anyone. The cash can only continue to be lent out if there is productive activity or consumption funded by production.

    This is exactly what has happened since the industrial revolution…we have banks matching maturities, an increase in nominal prices (largely by Government largesse) but we still have an increase in real incomes and living standards.

    Free banking eras have seen very low, stable inflation rates and high growth.

    Say’s Law infers that discretionary fiscal and monetary policy distorts the credit market and makes us all less well off.

    The Mises Institute have published an article on Panama: dollarised but they have a market based commercial banking and no central bank of their own. They have very low inflation and very high growth.

    Central bank institutional flaws (which target? what level of stability?) and discretionary policy (e.g -2% real rates back in 2004) are the culprits of poverty creating inflation and devestating credit cycles.

  26. Andrew, Thanks for your comments. I was thinking about what you call the flow of funds last night – that perhaps people needed to be paid evenly throughout the month (I recall getting paid mid month as is common for salaried employees AFAIK). When I thought about the business bank accounts though, it didn’t even seem necessary. As funds flows from workers to businesses throughout the month as people get paid. I imagine it’s helpful that some get paid monthly, others weekly and fortnightly.

    I’m not certain that using 100% reserve banking would stop most economic activity. That is certainly a concern that I have. I have to study it more to shed some more light on it.

    You mention the problem of matching deposits to loans based on time preferences. Let’s assume we have 100% reserves on demand deposits so this leaves term deposits. I don’t think it’s necessary to match exactly the time preferences of term deposits to loans. I imagine that you think this position is incompatible with prefering 100% reserve demand deposits. I disagree. I’m concerned that you are setting up a straw man.

    I sure am glad that banks provide the services that they do (particularly electronic banking which makes life so much better). I only wish they would keep my money safe from inflation. As Tim R points out, there’s still the problem from a libertarian point of view that inflation is stealing and since fractional reserves cause inflation then libertarians ought to be against it on the basis of protecting private property.

    I am not accusing banks of heinous crimes (not even crimes). Fractional reserves are legal and so that cannot be the case. I do think they have a moral obligation to inform the public about how banking works. People do not know how it works even though it is not a secret. I certainly didn’t know when I was younger and am only beginning to understand more now.

    Neither am I trying to put ideology before sense. Yes, I am exploring the ideology. I guess it’s a thought experiment. I wouldn’t suggest the government make a policy move in the direction of 100% reserves until I understood it. I do have respect for those Austrians and Libertarians I find at and I imagine they are sensible people.

    I am however, concerned about being led astray and seek critiques like those offered here.

  27. > Steven — Deceptive? How? There is absolutely no
    > secret about how banks work.

    John, I explained how I think it’s deceptive.

    Banking is no secret but that does not imply it’s common knowledge, does it? Ask around, ask folks if they know what the multiplier effect is, if they know what the reserve ratio is in Australia, if they know how the Basel II accord works (I don’t).

  28. Bird must be cock-a-hoop. His FR rantings are starting to strike a cord. Steven, when you say you didn’t understand how banking works, had you heard about runs on banks during the great depression and government guarantees and such? If so, you know the key bit about putting money in the bank. It is not risk free.

    I hope I don’t sound rude, but what did you think was the reason banks pay interest on deposits? A fairly short moment’s thought must lead you to realise that it is the price for the use of your money.

  29. Steve says:

    “Tim points out that FR causes inflation”

    No he doesn’t. Such an idea is rubbish. Sorry.

    Don’t be taken in by the anti banking cult at Mises. They are good economists, sensible etc, but they are totally blinkered on this issue.

    It is a shame you never saw the “thread of doom” on catallaxy.

    Money only gets lent out for productive purposes or for consumption backed by productive behaviour. The change in the stock of total “money” is less than the change in the value of production.

    Inflation is too much money chasing too few goods, not the creation of new money.

    Therefore, it is obvious that fractional commercial (and free) banking doesn’t cause inflation, has incentives to minimise inflation and deflation (vis a vis bank asset-liability management – think about what inflation does to the present value of a loan portfolio) and certainly isn’t stealing nor does it cause economic calamities.

  30. Steven,

    Most people don’t know how conveyancing works or when certain liabilities transfer from vendor or purchaser. Most people aren’t familiar with common law which governs long term commercial leases.

    Should we introduce prohibition on property transfers, leases and sales?

  31. John: ” as Rothbard & friends are libertarians they are uncomfortable saying “ban FR-banking”… but that is the only way to remove it from society.

    I think this is a straw man argument. You’ve totally ignored the elephant in the room – The Central Bank. Why bother arguing about whether FR should be allowed or not, we should be arguing about whether a central bank should be allowed or not and if so, should it be allowed to engage in FR.

    You correctly acknowledge that Rothbard and libertarians don’t actually call for a government ban on FR banking. And yes you are correct in showing that a government ban is totally incompatible with libertarian principles. The issue of semantics came up, which shows that so long as banks are honest about what they do with their reserves, there is no issue.

  32. Steven (re #30),
    I have argued this point a fair bit – and one of the problems with the matching principle is that, in a modern banking system, the split between “term” and “demand” deposits is a false one. Term deposits are not fixed term any more – if they ever were. Any term deposit can be broken at any time (if you doubt me, check the PDS that comes with any term deposit).
    On the straw man bit, I can point you to any number of people making the argument that they should all match through the entire term structure. Apart from anything else, if you allow “term” deposits to back long term lending, you end up with the same issue (using the term loosely) that Rothbard prattles on about – if the bank has to pay out on a 90 day deposit but has lent the funds out for 30 years, what is the difference between that and lending a “call” deposit out in the form of a revolving line of credit like a credit card? IMHO the second is actually more prudent than the first, but Rothbard and friends get upset about the one that is less (liquidity) risky. Go figure.
    Check out the link I gave to ozrisk, read through the piece there. It summarises (I like to think) the issues well.

  33. Mark, inflation is too much money chasing the goods and that can come about through either a reductioon in production or an increase in the supply of money, so the creation of money is inflationary if it exceeds the dollar value of an increase in production. Also, not all lending is for productive purposes. Plenty of business borrowers destroy wealth by borrowing money for things that are not sufficiently productive, like Australian car manufacturing, or buildings bought at the top of a boom market.

    But the idea that FRB creates money must be a nonsence unless the banks can give their creditors all the money the banks owe while not receiving repayment of the money owed them by their borrowers. As I understand it, the Rothbard argument is that if I put money in the bank and the bank lends it out then that money has been doubled, but it hasn’t, I can’t spend the money until I get it back, the bank has to find some other money to give me or it will default on that loan I gave it, in which case I definitely don’t have the money. Am I misunderstanding something here?

  34. pedro – with your scenario above, Rothbard suggests that of course you actually could spend that money, and that unless your bank has secured the reserves, it will default.

    however.. Rothbard spends a lot of effort describing what would happen under a free market in banking, as opposed to what happens under a central bank.

    Under a free market – banks wouldn’t engage in this behaviour because they face the risk of default.

    Under a Central Bank, all banks are enabled to slowly inflate together. A banking cartel is formed.

  35. How can I spend money that’s in the bank? Even with debit cards the bank has to give me the money by transferring it to the retailer. AS I said, the bank can only create money if it gives me money without: running down reserves, borrowing from someone else, or receiving loan replayments.

  36. pedro, I’d never heard of bank runs until recently. Way back when I entered the work force in the early 90s, I never thought about banking. I just got paid and spent it. If there was 50c to declare on my tax return it was more of a chore than anything :).

    Probably about the mid 90s was when I thought about it just a little bit. My deposit taking institution had started to charge fees. When I worked out that I was lending them money I was astounded that they would take more from me in fees than I would receive in interest. I moved to another institution. However, I did not understand the role of the money multiplier.

    About 2003 a friend asked me in a round about way if I knew about the money multiplier. I was like “are you sure”? but I didn’t worry about it much at the time but it stayed at the back of my mind.

    Only within the last year or 18 months have I become more aware of what banking is, the problems of inflation, fiat money and central banking. First I think I came across the money-as-debt video and later the “Money Masters”. Eventually I discovered the Ron Paul Campaign, libertarianism and the Mises Institute etc.

  37. Andrew, I know what you mean about the term deposits. It resembles a similar system from that level up – one where the bank has to be careful to manage the risk of borrowing short to lend long. What’s more, I reckon that term deposits have been able to be cancelled (with penalties) for a long time. I might have had the odd term deposit before these online saver accounts turned up.

    It’s an open question for me. I haven’t had much time to think about this issue. However, I don’t think that the multiplier effect has such a big effect with term deposits because when money is lent and then deposited, it is deposited into demand deposit accounts. It’s not until someone puts it into a term deposit that you end up with any kind of multiplier effect. In addition because both the first depositor and the second depositor have both given up the money, there seems to be only one “copy” of it in circulation which would mean that it wouldn’t have an inflationary effect.

    btw, I did find my way to those posts on ozrisk thanks.

  38. Hi Mark,

    > “Tim points out that FR causes inflation”
    > No he doesn’t. Such an idea is rubbish. Sorry.

    Isn’t that what Tim was saying?

    Don’t be taken in by the anti banking cult at Mises. They are good economists, sensible etc, but they are totally blinkered on this issue.

    > It is a shame you never saw the “thread of doom” on
    > catallaxy.

    Is that still available online?

    > Money only gets lent out for productive purposes or for
    > consumption backed by productive behaviour. The change in
    > the stock of total “money” is less than the change in the
    > value of production.

    I don’t agree that money is lent out for productive purposes or consumption based by productive behaviour. When someone accesses the equity in their home to remodel the kitchen and buy a new car, is that productive? Perhaps I misunderstand your use of the term.

    > Inflation is too much money chasing too few goods, not
    > the creation of new money.

    I heard inflation was originally defined as monetary inflation. All this is just terminology though. I know what you mean. If the money supply was expanded by $1000 but that $1000 was put under a rug then it wouldn’t lead to price inflation because it doesn’t increase the money that is chasing the goods (perhaps “money in use”). I like to refer to “monetary” or “price” inflation to disambiguate these uses. I don’t have a name for the kind of inflation you are talking about.

    I see what you mean about banks having an incentive to keep inflation low as they are paid back in future dollars. I am not saying that it is stealing, I said it was legal.

    I do think that monetary expansion led to the current economic crisis. What’s your take on the causes for the current problems?

    What do you reckon to central banking and government ability to “print” money?

    I really don’t like inflation at all. What does cause it? How can we stop it?

  39. > Should we introduce prohibition on property transfers,
    > leases and sales?

    Mark, I’m not saying that at all. You seem to be setting up a straw man.

    I am saying that the Joe Average does not understand how regular transaction accounts work. He does not know about fractional reserves or that he might not get his money back. Perhaps if he understood the risks he might demand more than 0.01% on his loan along with fee-free banking.

  40. I agree with John and Jason on banking. I think we still disagree on currency, however I’ll pick up on that thread another day.

  41. Yes Pedro you are quite correct. Like I said earlier – refer to Say’s law. This infers that discretionary macroeconomic policy can have an inflationary effect transmitted through the commercial banking sector.

    Steve, what Strawman? it is exactly the same argument, applied to another sector.

    Jono – we have already had virtually free markets in banking. Fractionality still occured with great stability, high growth and low inflation. The reserve ratio was closer to 40% but that could have been due to technical imepediments during that time. Of note, our Basel II rules imply a reserve ratio of about 8% should be followed (although we don’t have a formal rule on this) – but banks reserves are between 12.5-15% typically. There are also problems of having lender of last resort and moral hazard issues and inability to run down reserves or have temporary bank closures.

    The credit multiplier does not create inflation. it facilitates production of goods. The gains from production are more than the expansion in “money” used to facilitate this intertemporal matching. Therefore there is no net inflation from the use of fractional private banking.

    Money is not created out of thin air. Continuous money creation by the private sector relies upon lending to economic projects.

  42. Steve – sorry I missed some of what you said.

    Ask Jason or go to callaxy (included in our links section here).

    Remodelling your kitchen is consumption. But the process can go on in a non inflationary manner as long as the consumption is backed by productive activity. I said this earlier, but I understand it is a lot to digest. So there is no inflation. This is simply using savings, like a retirement fund. Although actually judging if this is productive activity or consumption is a little difficult. Technically, it is new investment (maintaining current capital).

    This is what I mean:

    MV = PY

    I am saying that a change in M balanced by a change in Y, as the bank creation of money relies on continuous lending to productive activity or surplus funds received from productive activity (think about it, the process cannot go on in any other way except for the creation of more central bank money). The change in output equals or exceeds the change in money supply under most circumstances where credit markets are not distorted by industry policy or discretionary macroeconomic policy (see Say’s Law and you might get why this is so).

    Banks have very strong incentives to minimise inflation or deflation under free banking. if they cannot issue currency without offering clients something of value, they cannot reflate their balance sheet with new loans. if they issue too much base money, not only does this lose marketability, but this devalues their assetsand the revenue stream that comes from these loans (assets). Unlike the present situation, they cannot borrow directly from an inflating central bank to issue more debt.

    Moeny expansion definitely lead to the current crisis. Look at US real interest rates in 2004 – -2%. This is the work of the US FRB, not private commerical and community bankers.

    Central banks are okay if they can follow strict rules – if the rules are well designed. I think we should target 0% inflation within a band between -0.5% and +0.5% , but over the long run. If central banks target short term price changes, they create more vaolatility and distort market forces of markets seeking equilibrium. The central banks should also accumulate gold as it issues more currency.

    This is a second best option to the classical gold standard which operated between 1880 and 1914, with plenty of free banking in the US, Canada and Australia, all with exemplerary records (Scotland and england had free banking earlier with good results). A gold standard is as good as everyone cooperates and Governments decide to keep themselves leashed. But they can always untie that leash.

    Free banking is the best option IMO. There is no political interference and risk is spread out, as is inflation management which has very strong incentives.

  43. Mark (@46)
    Slight error there, but a common one. Basel II looks purely at capital ratios, not liquidity. The liquidity reserve ratios that the Rothbardians get all het up about are not covered under Basel II at all – although they encourage regulators to look at them. See here for more.

  44. ‘The Australian’ had an article in the business section about how we might all go back to the Gold Standard. It makes good reading.
    Still no-one has come up with a way to have a free society AND outlaw FR. Whilst it might be a moral issue, it shouls not be a legal issue.

  45. nicholas,
    It is not a legal issue. Youy could nationalise the banks and then do it or you could regulate them so closely they would have to. As you noted, though, neither is really compatible with a free society.

  46. If we’re going to have regulation on banking, I suggest that we make it illegal for people who don’t understand monetary economics to discuss it. This conversation is more fraudulent than FR-banking could ever be.

    FR-banking does not cause inflation. You could have inflation or deflation or neither under FR-banking and under non-FR-banking.

    Inflation is not a good thing, but it’s not literally coercive or violent.

    The existence or otherwise of government controlled central banks is entirely besides the point. Even if there was no government, I can guarantee you that somebody, somewhere would offer FR-banking. Hell — I would! So if you want it not to exist, you have to ban it. You need the government to introduce a massive inervention that would undermine one of the most important free-market institutions ever invented — the banking industry. This is simply insane. It makes the Greens look economically rational and free-market!

    And Walter was not talking about “theft”. He was talking about “fraud”. He didn’t fail to explain his point through lack of time… because he spends huge amounts of time on this supposedly important semantic issue.

    Steve — I accept that you (and others) may not understand banking. That doesn’t justify banning it! There are probably many things you don’t fully understand but still participate in. I know little about mechanics, but I still drive a car. I don’t see the fuel disappearing and then think that it’s fraud/theft and require the government to ban the “deceptive disapearence of fuel”.

    Ultimately, if you want to know, there are plenty of people (both bankers & mechanics) who will explain the very normal everyday running of banks & cars. And you are always free to simply opt-out of things if they scare you too much.

  47. Of course economics and the state should be separated.

    We all know how cars work. No need to be patronizing John.

    The best argument against FR is the theft argument.
    From the comments I’ve read, only Mark has responded to this in a reasonable way that isn’t based on utilitarian arguments such as – it would exist anyway, or it would require policing. Theft also requires policing, so what?

    I’m not an economist but I think it’s perfectly reasonable to question whether or not increases in FR dilute the monetary unit and thereby eat away at the hard earned savings of hard working honest people.

    If you simply produce more money out of thin air not backed by actual deposits or based on any actual value (I’m still not sure I buy the potential value argument) then I think it’s quite reasonable to question that at this particular point in time you have increased the amount of monetary unit and thereby caused inflation while benefitting yourself.

    But I’m not an economist, just curious. So there’s no need for aggresive assertions not backed up by meaningful discussion.

  48. It is something every economist should think about too.

    If more did, we’d have more support of free banking.

    Tim questions the argument that the process of money creation may not depend on ongoing productive activity. I’ll get back to him on that. Importantly is the idea that banks cannot issue money without offering something of value – clearly not creating something out of thin air.

    Private banks cannot benefit themselves without issuing money which minimising price volatility and allows nominal prices to reflect real prices and externalities. They would lose marketability or otherwise be giving away money. Furthermore, being unable to borrow from a central bank under free banking, if commercial banks tried to gain seigniorage without offering anything of value, they would devalue their own balance sheets, income streams and be unable to offer loans with their money now except at a discount to their cost of capital.

    The production-creation argument relies on a knowledge of the credit multiplier, the quantity of money relationship and Say’s Law. If market clearing works well enough over a threshold level (see Say’s law), then without central bank issuance of new money, or marketable private money (that is, money that is intrinsically worth something) then the bank multiplier cannot work and create money without being facilitated by successive rounds of productive activity.

    Private issuers and the banking multiplier would simply act to increase money supply with changes in demand.

  49. Tim R,
    The theft argument relies (IMHO) on a complete misconception, as do the other arguments against FRB. It relies on the idea that, if something is used twice then each user only gets half the benefit, or, on a more general scale, use diminishes value.
    The reasons put forward for the “theft” argument are based on the idea that funds deposited in a bank and then lent out somehow diminish the value of all monies in circulation. If you think about it, this is absurd once you look at how money actually flows in the economy. For example:
    I go any buy a demand deposit in a bank, for which I pay $1,000. 1,000 other people do likewise. The bank therefore has $1,000,000 on deposit. It knows that, on average, only about 10 to 20 depositors will come in and ask for their deposits back on any given day and that, normally, these will be replaced within about a week by others coming in and buying more deposits.
    Worst case, therefore, it will normally only need to hand back 100 of these deposits before further funds come in. Being reasonably prudent, it also has a line with another couple of banks for emergency purposes.
    Being reasonably prudent, it wants to be able to cover 2 weeks’ withdrawals, so it adopts a reserve ratio of 20% – leaving 80% of the funds able to be lent out.
    Remember, people have deposited the funds because they do not need them right now and are attracted by the thought of earning interest while they do not need the money.
    The bank now lends out the otherwise unused money to people willing to pay more for it than the bank is paying in interest – i.e. to do something productive with it, even if that is just to buy something now that they otherwise would have deferred. That is, in itself, productive.
    No-one is stealing from society at large, as society gains by the increase in productive effort. This can clearly be shown by looking at the situation otherwise.
    If we ignore the fact that eliminating FRB implies much else, then without FRB, the people who have surplus funds have one of two options – either:
    1. Earn no interest on it but maintain accessibility; or
    2. Earn interest but keep it locked up.
    If they take option 1, then the funds are, essentially, useless and the economic value they represent goes to waste. Far from being the opposite of theft from society, this represents a net loss of possible effort.
    If they take option 2, they are losing any possibility of using the funds for their own purposes for the designated time. Again, this mean that, despite being their own asset, they have no possibility of using it for the designated period. The chances here are that they need it and cannot get to it. Again, good possibility of a net loss as (presumably) the asset holder may have a better use for the funds than the bank, and so they have to go and borrow money from elsewhere to cover their short. They therefore lose the difference between the borrowing and the lending rate. Again, a pointless loss to society.

  50. Thanks for the replies. I’ve been playing devil’s advocate to try and get my head around this. And I hope it’s not too simplistic for you hardened economic types.

    So is this correct then? continuing from Andrew’s comment but supposing the initial $1,000,000 was loaned to the bank from the central bank:
    Bank A has $1,000,000, with $200,000 on reserve (20%).
    But maybe some of Bank A’s $800,000 went to Bank B who also lent out with 20% reserve using that money. If all of the $800,000 went to Bank B and they lent the maximum 80% ($640,000), then there would be a total of $1,440,000 loaned and a total of $360,000 on reserve between banks A and B.
    Theoretically this 20% rate could ultimately result in up to $5,000,000 total in monetary units.

    So everybody knows it’s going on, and no bank has broken the 20% FR rate or broken the law.
    But at 20% FR rate, up to $5,000,000 can come from an initial $1,000,000.

    My concern is that some people are getting to use this money before prices adjust and are therefore getting an unfair advantage and my other concern is that those like me could have their savings eroded.
    But you guys are saying prices wouldn’t adjust because productivity goes up? So you’re saying that person X can still buy the same amount of stuff as before even though they have a lower percentage of monetary units now. I guess it’s probably fair enough that you can’t expect more buying power from your money when society as a whole becomes more productive. But what about the time delay effect of price adjustments resulting from imputting extra money in the economy?

    as an aside, I’ve always been a big fan of money lending. I think it serves an extremely important purpose in our division of labour society and is a valid career. I don’t see why money lending couldn’t exist effectively without fractional reserve. Wouldn’t there just be less monetary units to lend – but not necessarily less value in the real world.

    Anyway I think I’m way out of my depth in this discussion.

  51. Tim R — inflation simply isn’t theft. And it simply isn’t caused by FR-banking. I don’t know what else to tell you.

    After inflation, you still have the same little piece of paper. Nobody took it. It has a different value, but sometimes values change. The decrease in the value of money (inflation) is a bad thing… but there is no theft.

    And I think you’ll find plenty of people don’t understand how a car works. I think the analogy was a good one actually. 🙂

    In your example the world is going from non-FR to having FR. In that context then the increase in the credit multiplier (from 1 to 5 in your example) would increase broad money supply and result in inflation.

    However — and this is the big point — once FR exists then it doesn’t continue to cause inflation. And FR already exists. Now what causes inflation is a change in (1) base money; (2) credit multiplier; and (3) velocity. Over the long run (2) and (3) stay fairly constant… so (1) is the primary cause of long term inflation.

    Mark’s point was that (2) increases during economic good times, as increased productivity leads to more demand for loanable funds, resulting in a higher credit multiplier. All true. But not key to the discussion about inflation.

    With a fiat currency, the only way to manage money supply growth is by cross-checking with the actual level of inflation, and adjusting base money accordingly. Getting rid of the credit multiplier won’t remove the uncertainty because you still have volitile velocity (not to mention getting rid of FR would destroy the economy).

    As to money lending with FR… there would be some. But only when the lender and borrower had exactly the same terms. If you lend $100 to your friend and they agree to pay back $110 in exactly one year then that’s fine. But the vaste majority of money being lent is between people with different time preferences… which are coordinated by a bank or lending institution. This would be illegal if you banned FR-banking. The supply of loanable funds would decrease drastically… which would result in interest rates being significantly higher. Therefore less investment. Less capital. Less wealth.

  52. (3) also increase in the good times (ie when trade is brisk) and also fluctuates (sometimes a lot) based on foreign sentiment.

    In an open economy I wouldn’t say that changes in the quantity of base money (ie currency) is the primary cause of inflation. If it was this would imply that a fixed amount of currency on issue would mostly lead to zero inflation. I don’t think that regarding changes in the other factors as being near zero is a useful first approximation. However I do think that modifying the quantity of currency is the best means to use to compensate for dynamic changes in the other factors (including the credit multiplier).

    In a closed economy, such as the planet earth, then I think that a mostly fixed base money supply isn’t too bad an approach. When the nations of the world used gold and when paper currency was just another form of demand deposit (i.e. promisory notes) the system worked well enough with an approximately fixed supply of gold (mostly fixed base money). However that was a large closed economy (the world) not an open economy. And even then the production rate of gold was automatically incentivated if the long term looked deflationary and discourage if the long term looked inflationary so it wasn’t entirely fixed.

    Too often these discussions fail to distinquish between open economies and closed economies. Just as they too often fail to distinquish between currency and credit. These distinctions matter.

  53. This has been an interesting discussion. I have learned a fair bit and have a good deal of leads to check out (for instance Say’s Law).

    There seems to be a consensus around abolishing central banking, and adopting a gold standard and free banking. I tend to agree with that assessment based on my limited understanding.

    John says “inflation simply isn’t theft”:

    Yep, it’s not that simple is it? After all under deflation the “government” comes along in the middle of the night and gives you money back ;). However, it’s difficult to opt out of the inflationary monetary system. For instance, it’s the only thing (beside your own house perhaps) that you can buy, hold and sell without paying capital gains tax. Australian Dollar certainly don’t deserve to be called money (a stable store of value) – at least in the “good” times.

    John says “I suggest that we make it illegal for people who don’t understand monetary economics to discuss it”

    Yep, I find that offensive and I’m sure you are not surprised. At least try adding a smiley if you’re trying to by funny. Maybe you’ll bring the thought police to the rescue next? 😉

    Andrew said “Remember, people have deposited the funds because they do not need them right now and are attracted by the thought of earning interest while they do not need the money.”

    Andrew, you were making a lot of sense and then threw this one in. People who are attracted by the thought of earning interest do not throw there money into an at call account. Mostly people are attracted by the ease of which they can get paid and the ease of which they can spend.

    Mark said “Should we introduce prohibition on property transfers, leases and sales?”

    Mark, this was your straw man. You are trying to argue that I am saying “if we don’t understand something we should ban it”. I am not saying that. I am not saying we should ban fractional reserve.

    John says “I accept that you (and others) may not understand banking. That doesn’t justify banning it!”

    Again I haven’t said that. I certainly think that people ought to understand it better and have the opportunity to choose an alternative.

    Currently I am a saver and so that is my “conflict of interest”. I am particularly concerned with:

    1. inflation. Monetary inflation, consumer price inflation, house price inflation. All forms of inflation 😉
    2. a system that promotes bubbles (as in the credit cycle)

    I don’t see how the current system doesn’t lead to inflation (and booms and busts). After all, aren’t our banks so desperate for funds that they’ve also had to borrow from overseas – funding only around 50% of loans from deposits these days? It certainly seems to be at the moment. There must be lots of non-productive, speculative loans out there.

    If the absence of a central bank, a gold standard and free banking would lead to banks using fractional reserve without inflation then I’d be happy (particularly if I can still choose to “opt out” from time to time without taxation penalty).

  54. Steve,

    Currency has three functions:-

    1. As a store of value. There are so many ready alternatives to currency as a store of value that it’s a joke. It really doesn’t matter much if currency fails somewhat in this regard.

    2. As a medium of exchange. Credit is a ready alternative. Frequent flyer points and company script are also alternatives in some instances. You can use barter card type schemes or if your buying from friends or family even an IOU will do. We rarely use currency except for in small transactions, instead we typically use bank credit via cheques, eftpos, visa card or some such fascility. I have never paid a tax bill using currency.

    3. As a unit of account. This is the bit that really matters most. It is what we use to define credit, set prices, levy taxes, value our homes, strike contracts, describe wages. A stable unit of account is key to healthy commerce. Change the value of the unit of account and you change wages, change the effect of contracts, distort credit arrangements, mess with prices and impact taxes. It is the only aspect of a currency that we should spend time worrying about.

    We need stable currencies.

  55. TP, are EFTpos and cheques really credit and not just another means of transfering bank money? A cheque is just a type of bill of exchange and EFTpos is an instant and electronic bill of exchange more than anything else.

    If the amount of currency is fixed then by and large we should have a slow deflation.

    If Steven doesn’t want bubbles then he should hope that all central banks get and stay serious about fighting inflaction as the first priority, at least then we should have less of them.

  56. Pedro-
    Cheques can be considered as a form of FR, since people can trade them as money, and it may eventually be put in a bank, whilst the bank has been free to also use the money for its’ own purposes during that time. EFTpos would not be the same.

  57. Hi Terje, I understand that money has three primary functions. I’m not sure why you are making the distinction between money and currency particularly as a medium of exchange. Does cash=currency in your view? I do recall you elsewhere pointing out that credit wasn’t money because it wasn’t a unit of account. I’m still mulling that over.

    Could you indulge me and list a few ready stores of value? I have ruled out stocks and houses for the time being. Maybe baked beans would work for a small amount (you could sell a few cans later to a friend or neighbour) but imagine we’re trying to protect a larger amount, say half a million AUD. Consider the tax implications.

    I’m with you on paying electronically. I hardly ever pay with cash. I pay with Debit Visa (which is surprisingly cheaper that EFTPOS at my institution). I don’t consider it using bank credit. I think of it as using the money in my account.

    How could we have a currency be a good unit of account without being a good store of value? People seem to be able to get around the problems that inflation poses to “unit of account” by specifically linking payments to inflation or having regular reviews of taxes/levys/salary etc.

    Being away from Australia recently for 2.5 years or so gave me a certain picture of consumer price inflation on my return. I couldn’t believe what bread and milk cost! I wonder if I bought a can of baked beans and stored it before I left Australia at $1.00 and sold it to a friend on my return for $1.50 whether I’d have to pay a capital gain on that? 🙂

    We certainly don’t have a stable currency at the moment. I own GBP at the moment and so am watching exchange rates closely. It’s a wild ride.

  58. You could put your million in a bank account. You would still care that the currency was a stable unit of account because bank accounts are denominated using currency as a reference.

    A good store of value is one that becomes more valuable over time. A good unit of account is one that is stable in value over time. If currency is a lousy store of value because it’s value is in decline then it is also a lousy unit of account. However the opposite statement does not automatically follow. We wouldn’t want to use the Mona Lisa as a unit of account.

  59. Some common stores of value of varying quality:-

    precious metals
    antique funiture

  60. Terje, I’m not certain about collectibles but certainly precious metals are currently losing value. I heard but haven’t confirmed that collectibles like paintings are losing value. Any others?

    I would say that a good “investment” would gain value over time, not a good “store of value”.

    I suspect we are experiencing deflation which would mean cash is king. Safety of deposits comes into question when holding cash. I was researching the purchase of treasury bonds prior to the govt guarantee on bank deposits.

  61. Steven Shaw,
    Once you look beyond the “Big 4” banks there are plenty out there offering positive real interest rates on “call” accounts. Even within the big 4 there are positive rates on amounts over $5,000. In any case, what you have said does not defeat my central point.
    I would take issue with your last comment as well – if you are holding cash you are not worried about safety – except that the cash could be stolen. You would only be worried about safety of deposits if you had bank accounts.

  62. Andrew, positive real interest rates on at-call accounts are elusive. I haven’t done extensive research. I did find an account at BankWest offering 4.5% or something on amounts up to $5000. However, there were stiff fees for cash withdrawals from ATMs and other fees. It seemed that it would be easy to eat the interest payment in fees each month. Perhaps these other account you speak of would be similar? I get 0.1% at Heritage and avoid most fees each month by using the credit button at the cashier instead of the cheque button. That sort of rate is hardly enticing, especially since the RBA are reporting CPI of 5%. Personally I don’t keep much cash in my at-call account and have tended to use “online saver” accounts from BankWest, ING, Rabo, AMP Banking and HSBC. None of these accounts are transaction accounts AFAIK. Most offer next day transfers if you get your order in early enough.

    You’re right to take issue with my use of the term “cash”. Yes, quite often I am meaning “cash” in the bank. Again, this slip of the tongue reveals how Joe Average thinks about his bank deposits :).

  63. Steven,

    Positive real rates not being offered is not a fault of the private banks. I’ve shown you they don’t create inflation. Central banks do this. Central banks create inflation that eliminates or gives negative returns to some low levels of real rates.

    Clearly money in the bank has never been considered as liquid as cash. The process of drawing and presenting a cheque shows how bank money is like another class of money to cash. Hence we have M0, currency, M1, M2, M3…

    Personally I don’t see how you are being hurt by private banks when all it requires is some structuring of products they are probably very willing to offer.

    Banks basically want core deposits so they don’t have runs and can give you cash when you want, in so giving us the stepped function of interest rates in relation to deposits. Here you can have a transaction account with a high interest rate, just as long as you keep a minimum deposit level.

    I can’t see how you’re being hard done by since their products means you can get cash when you want and that Governemnt and central bank policy, not their products determines that 6.5% really gives less than 1.5% after taxes and inflation.

    Funnily enough, the anti-banking protestors dislike the availability of high rate on call accounts and the ubiqutousness of bank fees but think that demurrage is a fantastic idea, allowing 100% gold banks to run in a continuous and profitable fashion…

  64. I would imagine that regular people simply have a hard time seeing the difference between how banks act now in a cartelised environment compared to how they’d *have* to act in a free banking environment. It’s a lack of basic economic education.

  65. What is the strength of the “cartel”?

    Sure becoming a “bank” is difficult with paticular legislative menaing, but almost anyone can start up and ADI ([Australian] depository institution).

  66. Mark,
    Any public corporation can seek ADI (Authorised Deposit-taking Institution) status, but it takes about 12 to 18 month’s worth of work to get there, and considerable amounts in fees to advisors.
    Religious (non-profit) institutions get an exemption from that, provided they stick within certain limits to their businesses.
    To use the word “Bank” in your title you need a minimum of $50m in capital. Building Societies need less and Credit Unions none at all (although you still need to stick to the Basel II numbers).

  67. I don’t know if this thread is still alive or not and I don’t mean to hijack it (I’m new ’round here) but I have a question that is kind of related. It’s so simple I’m almost embarrassed to ask it but I hope you economists will take pity on this simpleton and help me out.

    So here it is. Murray Rothbard and numerous entertaining clips on you tube will tell you that the government deliberately increases the money supply by printing money and through FR banking in order to create inflation so that they can increase govt revenue (a “hidden” tax essentially). Assuming for the sake of the argument that this is true (if it isn’t would love to hear about that too) but assuming it is correct how exactly does this “inflation created” money return to the government (taxes?) and how is this money then useful to the government if the prices of everything have increased anyway? I mean doesn’t it kind of make the exercise futile if gains are eroded by inflation or is there a time lag factor involved?

    Obviously I’m missing something very obvious! Hope someone can take the time to fill me in. Much appreciated!

    BTW great site. Just found it today.

  68. Hi Jaz,

    I am going to try to explain this without algebra. A book I recommend you look at is Macroeconomics by Olivier Blanchard (now chief economist, IMF) ch. 23, “High Inflation”.

    The process you are referring to is seignorage.

    Essentially the Government can tax a new base of revenue. what matters is the relationship between monetary growth and changes in money stock comapred to prices.

    The process also mimics a total revenue or Laffer curve schedule.

    This is a separate, but related issue to debt monetisation.

    Inflation creates seignorage – Rothbard is a little bit off the rails blaming fractional reserve banking. Excess money supply by central banks is far more important.

    Seignorages works as the change in prices does not change 1:1 with the changes in (nominal) money.

    Effectively, we can say that seignorage is equal to money creation, divided by the price level.

    Inflation can finance deficits at a rate which equal to deficits as proportion of income for a period divided by the average time that savings are equal a number of periods of.

  69. Put more simply: the Government gets the new revenue in adjusted prices while borrowing or financing borrowings in old prices.

    They don’t adjust. We do.

  70. Put simply if you print extra money and spend it then you get the benefit of the extra money before the inflation it causes.

    In practice it’s not that simple. However the net effect isn’t overly different.

  71. Thanks for the explanations. I can see how the government can immediately supply itself with more money simply by printing it and how they can to an extent avoid inflation. But what about the charge that the Fed (in the case of the U.S) buys government bonds, the money from which flows into banks increasing FR activity and hence inflation and in turn increases government revenue?

    So I guess my question now is how does FR banking directly enrich the coffers of the government? Is it through taxes? If so wouldn’t that money be eroded by inflation by the time it gets back into their hands anyway?

    Finally, do you think it is a fair charge to say that it is a deliberate practice for governments to create revenue for themselves through these methods as an alternative or supplement to the more politically sensitive method of simply raising existing taxes?

  72. You’re confused because Rothbard is wrong. Banks lending while holding less than 100% reserves is an exercise in risk management and maturity transformation, not inflation.

    Yes the private sector creates money and money substitutes – but onl as part of a creative, growth engendering process – unlike central banks printing money to finance deficits. If we have the quantity of money equation,. MV = PY, M only increases as does Y. So it is unlike excessive central bank money growth. It only matters in so far as a degree of leverage.

    The devaluation of the currency makes us poorer, but not their fiscal position. Eessentially we are transferring (wihtout consent) some of our pre inflationary income to post inflationary taxation and the Treasury is settling nominal pre inflation debt amounts.

    The point is the Government borrows a smaller sum than it needs to pay back. The amount it needs to pay back in real terms falls, but in nominal terms stays the same.

    Inflation taxes are used widely. Watch them grow as deficits grow.

  73. Except that anticipate inflation is usually reflected in higher nominal borrowing costs.

    Personally I don’t think the government does itself many real favours with inflation and it certainly does society no favours.

  74. There is nothing paticularly special about that text, it is an introduction to intemediary level undergraduate book. Why it is good is that it is very well written and easy to follow.

  75. Fractional Reserve Banking is used as a way to create “new” money by leaving it up to the banks to decide how much new money to create.

    If did not have Fractional Reserve Banking but we simply used a bank as a place to deposit money then the bank would be able to lend 100% of the money it had on deposit. If a person deposits money it has borrowed into a bank the bank would be unwise to lend it again because the person who has borrowed it owes it to someone else and the bank should check before lending the money again.

    We can remove the need for Fractional Reserve Banking if we had another way to create money. By removing FRB we remove regulations and we do not have to replace it with more regulations. Banks can take the risk of lending encumbered money if they want to.

    One way to create new money is to create restricted money that must be used to create an asset through a market place in ways to create assets. Once the asset is created then the money is unencumbered.

    If we did it this way then we would have an economic system that would obey the following “proverbs”.

    Only lend money if you have it to lend.

    Only create new money once it is backed by an asset

    Reward people for consuming less

    Require Rewards to be invested to create new assets

    Measure economic success by the productive assets we possess

    This contrasts to the current system which follows the rules

    Lend money you do not have

    Create new money on a promise that you will get back more than you create

    Only give resources to those who have resources

    Reward the profligate by how much they consume

    Measure economic success by how much is consumed

  76. Thanks Kevin. We know what FR-banking is and how money is created. If you remove it then the interest rates for borrowing would increase significantly and the interest rates for saving would be negative. That’s a bad thing.

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