Yes, Fractional Reserve Banking Again

[hazek]

I just read an excellent article/interview by Jon Matonis interviewing Peter Šurda about the topic of: How Cryptocurrencies Could Upend Banks' Monetary Role. And in this interview Peter Šurda says something that really turned a light bulb on for me.

Here's what I realized:

Fractional reserve banking, as it exists today, should really be called Highly Liquid Debt Banking which is just a certain kind of fractional reserve banking where not all fractional reserve banking falls under this term.

I made this realization while reading this part of the interview:

Peter Šurda:
..
In other words, we need to separate two things. Why do people want to hold fractional reserve banking instruments, which may include the interest payments as one of the reasons, and why do people want to use fractional reserve banking instruments as a medium of exchange which, I argue, requires that the fractional reserve banking instruments decrease transaction costs. That they historically manifested themselves through a common instrument is an empirical quirk and not an economic rule. The ability to loan money is beneficial. Contrary to many Austrians, I agree that maturity transformation can be beneficial, and if the loan ends up being a liquid instrument, it also can be beneficial. But if it is so liquid that it becomes a part of the money supply, that's when it has a detrimental effect on the economy.
..

(emphasis added by me)

And he really nailed it here I think. I think this is the reason why we Austrians are so torn in two camps. One side is arguing for fractional reserve banking in a market strictly regulated by consumption, i.e. a free market, and the other side is arguing against just one manifestation of fractional reserve banking which should really be called as I suggested highly liquid debt banking and has a high chance of not even occurring under the scrutiny of a market regulated strictly by consumption and is only possible because of conditions provided by government decree.

Basically I think that both sides are simply arguing past each others points.

One side correctly sees that technically speaking fractional reserve banking (even today) does not create more money, and the other side correctly sees the inflated money supply due to highly liquid debt circulation side by side with the actual money supply recognizing it as a problem for the economy. Both groups are right is what I'm getting at!

Bitcoin(and perhaps future cryptocurrencies like it) as explained in the linked interview might actually render this pointless divide extinct and boy what a future that would be.

Please, I ask you kindly, if you're going to reply to this thread, don't do it unless you can hold in your emotions and present logical fallacy and sophistry free arguments!

Now, discuss!

[muh_roads]

bump

[muh_roads]

bump for a good read.

[Zippyjuan]

Can you or may you be able to in the future borrow bit coins? If so, they they too can become part of a "liquid debt system".

[TheTexan]

Can you or may you be able to in the future borrow bit coins? If so, they they too can become part of a "liquid debt system".

Liquidity is a good thing.

Artificial liquidity is not

[Zippyjuan]

What is "natural liquidity" and how does it differ from "artificial liquidity"?

[muh_roads]

Can you or may you be able to in the future borrow bit coins? If so, they they too can become part of a "liquid debt system".

A service that offered such a thing wouldn't last as it would be too easy to scam the lender due to the anonymous & deregulated nature.

[TheTexan]

What is "natural liquidity" and how does it differ from "artificial liquidity"?

Lending money is a legitimate banking purpose. that's natural liquidity

Lending money that previously didn't exist is not a legitimate banking purpose. that's artificial liquidity

[Zippyjuan]

Banks can't lend money they don't have- that is what reserve requirements are all about. The Fed can- but other banks can't.

[TheTexan]

Banks can't lend money they don't have- that is what reserve requirements are all about. The Fed can- but other banks can't.

Money can't exist in two places at the same time. It can't exist in a depositor's account, and also loaned out to someone else.

[Zippyjuan]

If I loan money to the bank in the form of a deposit- I don't have it. The bank does. I have a promise from them to give me the money back later- but I don't actually have it. The money is not existing in two places. Same as if I loaned Bob $10. I don't have $10- he does. He owes me $10 but we don't both have it.

Likewise, if the bank makes a loan, they no longer have the money- the borrower has it- along with a promise to pay the bank back.

Where is it existing in two places?

[TheTexan]

If I loan money to the bank in the form of a deposit- I don't have it. The bank does. I have a promise from them to give me the money back later- but I don't actually have it. The money is not existing in two places. Same as if I loaned Bob $10. I don't have $10- he does. He owes me $10 but we don't both have it.

Likewise, if the bank makes a loan, they no longer have the money- the borrower has it- along with a promise to pay the bank back.

Where is it existing in two places?

If I log into my bank checking account right now, it will tell me that I have $10,000. Denominated in dollars, not promissory notes.

The bank claims to still have my money. But it doesn't. That's called fraud.

[Zippyjuan]

Your account balance says what you are owed- not what you have. Do you expect that if you deposit your money in a bank that it is simply piled up in the valut for storage? The bank make money by borrowing money from you and re-loaning it out to somebody else at a higher rate and pocketing the difference. Along with fees they charge. That is how banking works.

IF it was a secret that they loaned out money and didn't tell you, that would be fraud. But it is known and legal and thus not fraud.

If I lent $10 to Bob and he loaned the same $10 to Carl is that fraud? He says he will be able to get you your money if you need it. Bob is either a friend or the bank. Is there a significant difference in the action? If either promised to pay you back and falied to do so- then maybe you are talking fraud.

[TheTexan]

Your account balance says what you are owed- not what you have.

But the implicit agreement with a checking account is that it's used for storing money and facilitating transactions, and not for accepting risk by loaning out money.

When you loan out money, there is always a risk that money is not going to come back. A checking account wasn't designed for, and isn't marketed as, a vehicle for that kind of activity.

That's what investment accounts are for.

To market a service as a checking account, but use it as an investment account, can be described as nothing other than fraud.

[Zippyjuan]

SO banks should not be allowed to loan out money?

Just for a bit of additional information. The reserve requirement for most banks is ten percent- that is, they are required to keep and not lend out ten percent of all the deposits they receive. Perhaps by plan, perhaps by coincidence, ten percent of all deposits at banks are in an account like a checking account and 90% are in time accounts so if what you really want to say is that it is OK for them to lend out money from time accounts like CDs where the money is not due until a certain time in the future and to not allow it from demand accounts like your checking account, that is basically already in place and required by banking laws.

[TheTexan]

IF it was a secret that they loaned out money and didn't tell you, that would be fraud. But it is known and legal and thus not fraud.

You know that they do this. I know that they do this. Does Bob Hillbilly down the street know this? Good chance he doesn't.

[TheTexan]

SO banks should not be allowed to loan out money?

Absolutely they should be allowed to lend money. They just need to be more honest about it.

They either need to make it clear on the bank statement that they only have x% of their money in reserves, or charge a monthly fee for holding that money in a vault somewhere.

[TheTexan]

SO banks should not be allowed to loan out money?

Just for a bit of additional information. The reserve requirement for most banks is ten percent- that is, they are required to keep and not lend out ten percent of all the deposits they receive. Perhaps by plan, perhaps by coincidence, ten percent of all deposits at banks are in an account like a checking account and 90% are in time accounts so if what you really want to say is that it is OK for them to lend out money from time accounts like CDs where the money is not due until a certain time in the future and to not allow it from demand accounts like your checking account, that is basically already in place and required by banking laws.

I can't find any evidence that banks are not allowed to loan money from demand accounts. Source?

[Zippyjuan]

For practical purposes they don't loan from demand accounts- as I indicated, ten percent of all deposits are in demand accounts and ten percent of all deposits is the total they are required to keep in reserve. No- it isn't a specific law but it does work out that way as a percent of all the money they get. The law requires them to keep ten percent and ten percent is what is in demand accounts.

[TheTexan]

For practical purposes they don't loan from demand accounts- as I indicated, ten percent of all deposits are in demand accounts and ten percent of all deposits is the total they are required to keep in reserve. No- it isn't a specific law but it does work out that way as a percent of all the money they get. The law requires them to keep ten percent and ten percent is what is in demand accounts.

I'm not buying it Zippy. Reserve requirements were created in order to prevent bank runs on demand accounts. That hasn't changed.

When I invest my money into stocks or CD's I don't think that gets figured into reserve requirements at all. The bank isn't required to hold 10% of the value of my CD's.

[Zippyjuan]

Reserve requirements apply to ALL deposits. Not just demand accounts. You are correct that one of the reasons for them was to minimize the risk of runs on banks.

http://www.federalreserve.gov/moneta...y/0693lead.pdf

Laws requiring banks and other depository institutions
to hold a certain fraction of their deposits in
reserve, in very safe, secure assets, have been a part
of our nation’s banking history for many years. The
rationale for these requirements has changed over
time, however, as the country’s financial system
has evolved and as knowledge about how reserve
requirements affect this system has grown. Before
the establishment of the Federal Reserve System,
reserve requirements were thought to help ensure
the liquidity of bank notes and deposits, particularly
during times of financial strains. As bank runs
and financial panics continued periodically to
plague the banking system despite the presence of
reserve requirements, it became apparent that
these requirements really had limited usefulness as
a guarantor of liquidity.

[TheTexan]

Reserve requirements apply to ALL deposits. Not just demand accounts. You are correct that one of the reasons for them was to minimize the risk of runs on banks.

http://www.federalreserve.gov/moneta...y/0693lead.pdf

http://www.amosweb.com/cgi-bin/awb_n...e+requirements

The reserve requirement for time deposits has been 0 percent since 1980

ETA:

More info and better source here:
http://www.federalreserve.gov/moneta...req.htm#table1

[TheTexan]

Zippy you work for the bankers you're supposed to know this stuff, you're off your game bro

[hazek]

Banks can't lend money they don't have- that is what reserve requirements are all about. The Fed can- but other banks can't.

Artificial liquidity is the liquidity that exists because of an environment created through government decree.

For instance people today are willing to lend money to banks for dirt cheap and continuously only because they are shielded from any risks incurred through lending by the FDIC. Were there no FDIC people would be a lot more wary of demand deposit accounts as they are structured today drying up the liquidity of debt significantly.

[hazek]

Money can't exist in two places at the same time. It can't exist in a depositor's account, and also loaned out to someone else.

And it doesn't in today's fractional reserve banking.

[Danan]

You know that they do this. I know that they do this. Does Bob Hillbilly down the street know this? Good chance he doesn't.

He wouldn't care since the FDIC removes his personal risk anyway, as far as he is concerned. Public deposit insurance is probably one of the most harmful policies ever adopted.

[cubical]

And it doesn't in today's fractional reserve banking.

So if money isn't created by making a liability against an asset on bank balance sheets, how is the money supply constantly being expanded(even before the fed was acting)?

[hazek]

So if money isn't created by making a liability against an asset on bank balance sheets, how is the money supply constantly being expanded(even before the fed was acting)?

Because debt is made so liquid it itself is exchanged as if it's money.

[cubical]

Because debt is made so liquid it itself is exchanged as if it's money.

If debt is treated as money, then it is the same thing as saying money can be in two places at once.

[matt0611]

If debt is treated as money, then it is the same thing as saying money can be in two places at once.

Yup. Exactly.

Which is why fractional reserve is inflationary and inherently fraudulent. But we've been around this merry-go-round before on these forums many times before haven't we?