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Thread: Business Cycles 1792 to 1913

  1. #1

    Exclamation Business Cycles 1792 to 1913

    I noticed there was some confusion about the cause of business cycles before the Federal Reserve in another thread, so I decided to post my response here, in a separate thread, to explain the Austrian school POV:

    Quote Originally Posted by travisAlbert View Post
    Throughout the late nineteenth century, there were several recessions, depressions, and market crashes. Many non-Austrian economists are critical of Austrian economists because their theory of the business cycle fails to explain the "business cycles" prior to the creation of the federal reserve.
    Austrians have explained pre-Fed business cycles, especially in America. Jesus Huerta de Soto did so in his Money, Bank Credit, and Economic Cycles as did Murray Rothbard in his History of Money and Banking: The Colonial Era to WWII.

    The gist is this: there were two central banks, the First Bank of the United States and the Second Bank of the United States which acted in coordination with the Treasury Department during the end of the end of the 18th century and about 40 years into the 19th century to expand the supply of credit. Afterwards, the federal government along with state governments took various actions to promote credit expansion. For example, they effectively bailed banks out by allowing them to suspend specie payments without declaring bankruptcy, as would be required under common law and in free markets, allowing banks to practice fractional reserve banking and therefore expand credit, creating bubbles.

    An alternative viewpoint would be that of Schumpeter (somewhat of a renegade Austrian), who believed that fractional reserve banking was natural to the free economy and that its creation of bubbles and busts were helpful in the establishing needed technological infrastructure for sustainable economic growth. Schumpeter also believed that monopolies could be good since they encouraged technological innovation and had several other good qualities (e.g. they solved certain coordination problems and their profits fueled greater saving and investment).

    This isn't the view of the majority of Austrians, who use theory to predict that fractional reserve banking, and therefore credit expansion, cannot exist in a free market. History seems to back this up, since fractional reserve banking first came into wide existence when banks with fractional reserves became backed by government. Today's Austrians also disagree with Schumpeter about most forms of monopoly, pointing out that monopolies cannot form in a true free market, except in the case of the "first mover" who cannot keep his monopoly for long.



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  3. #2

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    Amazing post, thank you! I was recently wondering about this.

  4. #3

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    I don't know about FRB not existing in a free market. It seems to me that were banks to issue their own currency, many would do FRB. Gold deposit banks would also do FRB. The difference would be that they would have to disclose this fact to their depositors, who would in exchange get paid interest on their money.

    A bank which does a good job of managing its currency will stay in business much longer than those who debase theirs, which in turn will cause a race to the top, with all successful banks gaining golden reputations, and winding up with very stable private currencies that are either free from inflation (gold FRB) or inflate at a low, steady rate (fiat FRB).

    I was hoping you would talk more about the actual history in this thread. I may do a write up if I have time today if you don't beat me to it.

  5. #4

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    I think I would consider myself a free banking Austrian and I have yet to be convinced that such is a contradiction of terms.
    Truth forever on the scaffold, Wrong forever on the throne,--
    Yet that scaffold sways the future, and, behind the dim unknown,
    Standeth God within the shadow, keeping watch above his own.
    ‫‬‫‬

  6. #5

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    The only logically consistent position for an Austrian to have is one supporting free banking and therefore fractional reserve banking.

  7. #6

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    Quote Originally Posted by brandonyates View Post
    The only logically consistent position for an Austrian to have is one supporting free banking and therefore fractional reserve banking.
    That said, a bank misleading its customers about the nature of fractional reserve banking is fraud.
    Truth forever on the scaffold, Wrong forever on the throne,--
    Yet that scaffold sways the future, and, behind the dim unknown,
    Standeth God within the shadow, keeping watch above his own.
    ‫‬‫‬

  8. #7

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    Quote Originally Posted by axiomata View Post
    That said, a bank misleading its customers about the nature of fractional reserve banking is fraud.
    absolutely

  9. #8

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    Quote Originally Posted by tmosley View Post
    I don't know about FRB not existing in a free market. It seems to me that were banks to issue their own currency, many would do FRB. Gold deposit banks would also do FRB. The difference would be that they would have to disclose this fact to their depositors, who would in exchange get paid interest on their money.

    A bank which does a good job of managing its currency will stay in business much longer than those who debase theirs, which in turn will cause a race to the top, with all successful banks gaining golden reputations, and winding up with very stable private currencies that are either free from inflation (gold FRB) or inflate at a low, steady rate (fiat FRB).

    I was hoping you would talk more about the actual history in this thread. I may do a write up if I have time today if you don't beat me to it.
    Quote Originally Posted by brandonyates View Post
    The only logically consistent position for an Austrian to have is one supporting free banking and therefore fractional reserve banking.
    Fractional reserve banking is not innate in a free banking system at all. Banks would have an incentive to prove that they're not prone to failure by having their books reviewed by third parties, like credit-rating agencies. The first banking crisis in the United States occurred in 1792 because several banks forced a fractional reserve bank under due to the precarious nature of its banking habits.

    That said, I can see mini booms and busts occurring because of special fractional reserve banks for the risky investor. Call them special investment banks (SIBs), if you will. It could be possible that a few small banks would be willing to take on additional risk in order to get higher returns for their investors. I could see this extra credit being funneled to new technologies, leading to the creative destruction of Schumpeter.

  10. #9

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    Quote Originally Posted by krazy kaju View Post
    Fractional reserve banking is not innate in a free banking system at all. Banks would have an incentive to prove that they're not prone to failure by having their books reviewed by third parties, like credit-rating agencies. The first banking crisis in the United States occurred in 1792 because several banks forced a fractional reserve bank under due to the precarious nature of its banking habits.

    That said, I can see mini booms and busts occurring because of special fractional reserve banks for the risky investor. Call them special investment banks (SIBs), if you will. It could be possible that a few small banks would be willing to take on additional risk in order to get higher returns for their investors. I could see this extra credit being funneled to new technologies, leading to the creative destruction of Schumpeter.
    What kind of effect would private deposit insurance have on the stability of a free banking system with fractional reserve banking? As far as I am aware, in the historical examples of free (or freer) banking, there was not any deposit insurance scheme.

    With private insurance providers, the book reviewing third parties would be these insurance providers, and they'd be nothing like the FDIC. They wouldn't be allowed to fall back on the government to meet the repayment requirements of a massive run so they'd have to accurately access risk. Therefore, a bank that lends at a 2:1 ratio would have less risk than a bank lending at 20:1, and the premiums the insurance company charges the bank would reflect that risk. This pricing dance would play out until customers were happy with their interest rate earned, banks were happy with their profit margin and their own capital risk, and insurance providers were happy with their arrangements.

    Competitors making large deposits and then pulling them to initiate runs would not be as effective because many of the bank's other customers would not follow suit since their deposits are insured.

    Credit would naturally expand in such a case, but such expansion would be moderate and driven by market forces.
    Truth forever on the scaffold, Wrong forever on the throne,--
    Yet that scaffold sways the future, and, behind the dim unknown,
    Standeth God within the shadow, keeping watch above his own.
    ‫‬‫‬

  11. #10

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    lets face it, we don't need our utopian free market, 100% reserve banking, gold standard economy to prosper through capitalism. We proved that after WW2. What we do need is for the government to stop the nonsense that they've been doing for the past 30 years.
    you can buy now using an elevated dollar to get in on things that are poised to go way up when the dollar collapses. If he's right, and I think he is, his profits are going to be ridiculous. I've already showed by referencing some mining stocks that you can make a killing in this market playing Schiff's investment strategy.

    -theoakman, RPF 1/26/09.

    Oh what a difference 10 months makes. Deflationists, where are thou?

  12. #11

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    Deposit insurance only works when there is only a few banks that are failing among the many which pay the insurance. In the case of an economic crisis, which must inevitably follow after credit expansion, deposit insurance would go down with fractional reserve banks, promoting investors to be more careful about where they deposit their money.

    This is why I believe that the financial system would essentially be broken up into two different parts: full reserve institutions and fractional reserve ones. The fractional reserve ones would be more risky (obviously), and only be for high risk investors seeking greater gains. These special investment banks (SIBs as I call them) would act similarly to venture capitalists and hedge funds to seek out high-return and high-risk businesses to cash into, promoting "hot" new sectors of the economy and creating a small bubble.

  13. #12

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    Were going over FRB tonight in my Econ class.

  14. #13

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    Quote Originally Posted by krazy kaju View Post
    Deposit insurance only works when there is only a few banks that are failing among the many which pay the insurance. In the case of an economic crisis, which must inevitably follow after credit expansion, deposit insurance would go down with fractional reserve banks, promoting investors to be more careful about where they deposit their money.
    I do not believe that credit expansion necessitates an economic crisis. We find crises emerging after credit expansion when the credit expansion is not market driven, i.e., as a result of below market interest rates fixed by the Fed, or when the infrastructure development that the credit is directed to is not chosen by the market, i.e., sub prime mortgage encouragement by the government.

    A free banking system requires that the Fed be abolished and that the government not intervene in the market. Such a free banking system will not completely do away with the business cycle, but I believe it will decrease the amplitude enough that if a bubble does turn out to be irrational, its bursting will not ripple throughout the economy. And I do not think such a bursting would affect the banking system as a whole in away that might put insurance providers out of business.

    This is why I believe that the financial system would essentially be broken up into two different parts: full reserve institutions and fractional reserve ones. The fractional reserve ones would be more risky (obviously), and only be for high risk investors seeking greater gains. These special investment banks (SIBs as I call them) would act similarly to venture capitalists and hedge funds to seek out high-return and high-risk businesses to cash into, promoting "hot" new sectors of the economy and creating a small bubble.
    That's a prediction on how you anticipate a free banking system would naturally evolve. Essentially I would consider you an free banker so long as you do not think the rigid dichotomy should be forced by the government. And while your two bank type scenario does seem quite possible and possibly ideal, I cannot say with certainty that such is the natural course.

    I can see banks adjusting their reserve ratio as a response to the psychology of the market. Some perceived guru says tech boom is irrational exuberance? People become scared? Bank readjusts its reserve ratio down. Consumers stay with bank but bank temporarily has less credit to lend to tech startups and the bubble fizzles.
    Truth forever on the scaffold, Wrong forever on the throne,--
    Yet that scaffold sways the future, and, behind the dim unknown,
    Standeth God within the shadow, keeping watch above his own.
    ‫‬‫‬

  15. #14

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    There's a great topic in the Mises forums over full reserve banking versus fractional reserve banking.

  16. #15

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    1913
    The essential English leadership secret does not depend on particular intelligence. Rather, it depends on a remarkably stupid thick-headedness. The English follow the principle that when one lies, one should lie big, and stick to it. They keep up their lies, even at the risk of looking ridiculous.






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