A somewhat redundant title, I know.
Here, in the post on George Selgin and banknotes vs. warehouse receipts.
So I would think, if you observed bank run activity (which everyone on all sides of this debate acknowledges is a risk in a fractional reserve system), you would be more inclined to believe that people understood factional reserve banking, rather than less.
If the populace generally thinks that all of their deposits are being kept in reserves, they would have considerably less incentive to run on the bank.
The only reason why you would have a bank run is if your depositors were well aware of the fact that only a fraction of their deposits were actually kept in reserve. Unless you want to argue that every couple of years the population cycles through amnesia and then sudden bursts of clarity and insight.
You can point to bank runs and maybe argue for depositor ignorance of bank solvency, but you can't really argue for depositor ignorance of the fractional reserve system.
Wednesday, July 18, 2012
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Daniel Kuehn: Speaking of monetary economics and banking systems, have you ever read the following book by Karl Brunner and Allan Meltzer? If you have the time to acquire a copy, you ought to read it yourself.
ReplyDeletehttp://www.amazon.com/Money-Economy-Monetary-Analysis-Raffaele/dp/0521599741/
The following review praises the book quite a bit.
http://www.amazon.com/review/R3C73NUOWO0MF0/
Allow me to add to Daniel's correct observations that runs have always been of limited scope--sometimes involving single banks only; on a few occasions involving clusters of banks. Is it plausible to imagine that these runs took place when depositors suddenly came to (correctly) suspect the banks in question of not really having stored all their cash, while leaving the vast majority of banks--all equally "guilty" of the offense of holding only fractional reserves--unscathed?
ReplyDeleteThe extent of stupidity and naivety that the "fraudists" must attribute to the general public in order to sustain their claims, outlandish in itself, is only made more so by the hubris implicit in their imagining that they alone are clever enough to have cottoned on to what bankers are really up to.
But of course, all participants in and victims of bank runs ALWAYS had a clear picture in their minds when they made their deposits of the actual likelihood of such a bank run.
ReplyDeleteSurely this is a bad path for a libertarian to go down? I mean you can apply similar logic to manipulative advertising, incomplete contracts, etc.
DeleteI don't see why there should not be a very high standard for establishing a meeting of the minds especially regarding complicated contracts and an unsophisticated party.
DeleteShould there be?
Bob, the participants probability estimate of a bank run has zero to do with whether or not they knew the bank was a fractional reserve bank, unless that estimate was zero. And if that estimate was zero, they would never show up to ask for their gold, would they?
Delete"I don't see why there should not be a very high standard for establishing a meeting of the minds especially regarding complicated contracts and an unsophisticated party."
DeleteOK, so you think FRB is fine so long as the customer is give a talk explaining FRB when setting up their account?
@Bob:
DeleteHow high of a standard do you want? And why do you want to place onerous requirements on unsophisticated parties who wish to enter into a contract?
Bob RoddisJuly 18, 2012 1:23 PM
Delete"But of course, all participants in and victims of bank runs ALWAYS had a clear picture in their minds when they made their deposits of the actual likelihood of such a bank run.
Nobody is asserting that everyone in history understood or understands the nature of FR banking.
Chalk one up for Roddis' serial use of whining straw man arguments.
Daniel:
ReplyDeleteYou can point to bank runs and maybe argue for depositor ignorance of bank solvency, but you can't really argue for depositor ignorance of the fractional reserve system.
Why not? In a recent study, it was found that around 70% of the UK population actually believes their demand deposit money is sitting at the bank in reserve. Since the average UK citizen is, I imagine, more intelligent than the average American, the percentage is probably even higher here.
And why would these people take the time to learn about the intricacies of the banking system, when they are assured by the benevolent nanny state that their demand deposits are insured up to $250,000?
---------------
George Selgin:
First off, why did you turf the comment I made on your blog about the stupid people who say FRB is fraud? I gave some much needed insights that neither side of the "Fraud or no fraud" debate are mentioning. I thought my car park analogy was illuminating. Do you not want any view that so much as even questions yours?
Second, you said:
"Is it plausible to imagine that these runs took place when depositors suddenly came to (correctly) suspect the banks in question of not really having stored all their cash, while leaving the vast majority of banks--all equally "guilty" of the offense of holding only fractional reserves--unscathed?"
You have to distinguish between banks going bankrupt due to some individual withdrawals, which then leads to questions of bank solvency, which then causes a general run at the bank, and banks going bankrupt because of a sudden general run at the bank. It's almost always the former that occur, even though it LOOKS like the latter.
It is quite possible for fractional reserve bank customers to be lulled into a state of apathy, after which a few customers wake up and withdraw their money at a particular bank, after which the bank has trouble paying its debts, which then leads to rumors of bankruptcy, and then a bank run at that bank, while at the same time leaving other banks unscathed. It's not like every individual has the same knowledge, the same expectations, the same understanding of the intricacies of banking.
The extent of stupidity and naivety that the "fraudists" must attribute to the general public in order to sustain their claims, outlandish in itself, is only made more so by the hubris implicit in their imagining that they alone are clever enough to have cottoned on to what bankers are really up to.
You need more pejorative adjectives, because I don't know how you feel. I only count 4, 5, at least 6 pejoratives/insults there.
Great! Empirical data! Now I get to look like a hypocrite for nevertheless not changing my conclusion.
DeleteI don't think FRB is material to the contract because people who learn about FRB are not in the habit of immediately running to the bank to withdraw their money. So I don't have a problem with the fact that most people don't know about FRB. Contracts should be nullified only if it would have been reasonable for the bank to know that the FRB arrangement would cause you to change your mind. It's not the case here.
Major_Freedom@July 18, 2012 2:43 PM
Delete..."Why not? In a recent study, it was found that around 70% of the UK population actually believes their demand deposit money is sitting at the bank in reserve.
What the survey actually reported:
- 74% of people surveyed (in August 2009) thought that they were the legal owner of the money in their FR current account (p. 6).
- a further 16% thought that both the bank and the depositor were joint owners of the money (p. 6).
- only 8% knew that the bank was the legal owner (p. 6).
- 61% of people surveyed also said that they did not mind the bank lending out some of the money in their current account as loans (p. 8).
- only 15% said that they keep money in a FR current account for safekeeping (p. 5).
- only 33% thought that the bank lending out some of the money from their current account was wrong because they did not give permission (p. 8)
(“Public Attitudes to Banking. A Student Consultancy Project by ESCP Europe for The Cobden Centre,” June 2010)
Regular commenters here will know that I am pro-fractional-reserve.
ReplyDeleteHowever, I agree with Major Freedom that normal bank user now don't understand their contracts. The ESCP survey wasn't particularly well worded, but I think it shows the confusion http://www.cobdencentre.org/?dl_id=67 . Though as "Lord Keynes" mentioned in the other thread many bank users would be OK with their money being lent out lots of them don't seem clear that this is being done.
I think this has mostly been caused by deposit insurance and bank bailouts, these mean that banks today effectively don't fail from the consumers point-of-view. So, consumers are not clear about the possibility of them failing. Whatever you think about bailouts and deposit insurance it's unlikely they can prevent all bank failures in the future.
That's why I agree with Bob Roddis that there should be more explicit language used in bank account contracts. The fact that the words "promise to pay" has a specific legal definition as a debt doesn't help the ordinary person. The laws of some countries - such as Italy - require that the bank specifically mention in the contract that an account is a debt relationship. I think that's a good idea.
Good comments, Current.
DeleteI think there is a happy middle whereby we don't put our heads in the sand and pretend everything is clear and upfront, nor do we put our guns in our hands and pretend every fractional reserve contract is fraudulent.
Having first hand knowledge of bank runs, including even making arrangements for cash deliveries from the Fed in response to the start of a run, there is no doubt that the public fully understands that banks borrow short and lend long.
ReplyDeleteIn the early 1980s, it was common for older S&L depositors to appear at the home office and ask to see "their" cash in the vault. George Barclay's policy was a sensible one. Any customer who asked to see the cash was taken to the vault and the cash drawers were opened for inspection.
And, remember that Congress and/or the FDIC had to change a lot of the rules on deposit insurance in 2008 in response to runs on deposits and money market funds.
The crap about surveys misses the point. The question has be be weighted. People with no bank deposits or, at most, a few hundred dollars may not understanding banking, but people with any significant assets or deposits understand banking and that is what matters.
"People with no bank deposits or, at most, a few hundred dollars may not understanding banking, but people with any significant assets or deposits understand banking and that is what matters."
DeleteI agree that generally people with large deposits understand banking and it's those with small deposits who don't. But, they're not what matters in terms of voting. And the amount of capital they contribute in aggregate is large.
Now, at this stage I could make an appeal to think of the little guy. I'm tempted to while I'm surrounded by all these lefties.
What worries me more though is this.... So long as the small users are misinformed when crises occur they will clamour from government protection through deposit insurance and because of their votes they will get it. This protection will then creep to cover higher and higher amounts as richer people lobby for it. This is exactly what happened in the UK where the amount 100% covered was increased from £4000 to £50000 during and after the financial crisis. People with deposits of this size don't need protection, and giving it to them causes moral hazard it means they won't examine banks before depositing. This exacerbates the moral hazard problems that are already prevalent in banking.
Current
DeleteLet me be blunt. You have no idea what you are talking about. It is totally impractical, today, for any private firm to monitor the safety and soundness of a bank. Doing such would be a colossal waste of time. I have worked on about 20 bank failures. I know how meaningless public information is or will ever be about loan quality.
Deposit insurance is a convenience or time saver, having immense practical value, making it worthwhile in its own right.
Banks are going to make bad loans, for they have imperfect information and face competition from other bankers, who will also make bad loans.
"It is totally impractical, today, for any private firm to monitor the safety and soundness of a bank."
DeleteWell, having government monitor them has hardly worked well.
Deposit insurance does have great practical value I agree, but it also causes moral hazard. Without that hazard banks will make fewer bad loans. Of course they always will make bad loans because as you say they face imperfect information.
Current, above makes a statement requiring a lengthy response. He writes, "Regular commenters here will know that I am pro-fractional-reserve."
ReplyDeleteLet me take a moment and point out to Dan, Current, and especially the Austrians and all others who want to outlaw fractional-reserve banking that you are all idiots, including the stupid content that investment capital comes from savings, arguing about nonsense.
The economic effect or substance of any loan is that it is just a simpler form of what would other wise be a series of forward or future contracts.
Take a simple thought experiment, which will be past the capacity of all the Austrians here.
We are in Egypt 3500 years ago, before the building of the great pyramids. There are lots of people who sit around all day, bored, with nothing to do, for there are not enough camels to travel north to see the Sea or south to see the Falls. One day, the Don Trump of the era, gets an idea. I will build a Great Pyramid across the river and a barge line. On weekends, people from Cairo can come over on the barge, let the kids run around in the petting zoo with the Lions and Tigers and climb to the top for a great view. My aunt will have a stand and sell them sandwiches. Now, there were Austrians, even then, who said, why you can't do that, you have no capital. We have no banks or capital or savings of any kind. We don't even have camels on which to go to the Beach.
Trump the First says, not to worry, we have clay tablets. I am an honorable honest man and I have always kept my promises. On clay tablets I will promise to pay for the worker and supplies we need, in the future, out of the profits we earn. And, to make my promise more secure, well we shall go down to the Temple and get the Priest to come up with a new rule from God that, if the clay tablet is delivered on Tuesday, between 11 and 2, when the sun is out, with a proper seal, and I don't keep my promise, then there will be seven lashes for me and dark days in my family for seven years.
And, so, Trump the first got all his new creditors together, the next Tuesday, and handed out his clay tablets. He gave his tablets to the leather shop and the baker, and grain merchant and the iron monger. To make everyone feel safer he told the assembled crowd, "Boys, not to worry, you are in the Syndicate now." We always wear yellow Polo Shirts with a little horse. An older member of the Syndicate asked, Don, I have a camel, found him when loose one night, and I want to retire to the beach. My son is going to take over my belt making shop. How does he become a part of the Syndicate? Don smiled, well just give him your clay tablet and have him bring it to the next meeting of the Syndicate. Of course, everyone realized this meant that they could start trading clay tablets.
The end of the story is told by Michael Lewis in The Big Short.
Now, the clay tablets I described were no different in economic effect than the feared fractional reserve lending. As a matter of substantive economics, there is no such thing as fractional reserve lending. There are merely contracts with promises of future performance. Banking is nothing but a means or method to make the process of future contracting more efficient, as Brad Delong explained very recently in his comments about gold coins with pictures of bearded men.
Dan, I just gave Noah an A, waving any need for further work. You get an F.
Mr. "Hamilton" completes a 40 year long unbroken chain where no anti-Austrian ever has the slightest familiarity with even basic Austrian concepts.
ReplyDeleteAustrians understand the difference between a contract for a future performance (which generally will clearly state the timetable for performance) and a contract which strongly implies the ability to perform immediately in the present or "immediately" in the future (whenever) depending upon the whim of the non-performing party. The potential problem with fractional reserve banking is that it implies that it's a warehouse receipt and a time deposit all at the same time when it ought to and could stick to being one or the other. It is the dual role that causes the potential problems and that is what Austrians object to.
I live for these stupid counter-arguments. I really do.
Bob Roddis@July 19, 2012 9:49 AM
Delete"The potential problem with fractional reserve banking is that it implies that it's a warehouse receipt and a time deposit all at the same time when it ought to and could stick to being one or the other. "
How does/did FR banking imply that demand deposits (DD) are "warehouse receipts"? And the belief that DDs are warehouse receipts and time deposits at the same time is just more ignorant and idiotic Austrian guff.
Have you ever bothered to read FR
contracts?
What you mean to say is that there is a degree of misunderstanding by the public, who never bother to read the contraction properly.
What you mean to say is that there is a degree of misunderstanding by the public, who never bother to read the contraction properly.
DeleteI am saying that there is a massive degree of misunderstanding by the public regarding the terms of these notes and that it is the payees of these notes who require the express warning of the dangers stated in plain language on the face of the note. And Austrians are speaking of a world where this is no government FDIC, no welfare payments, no medicaid, no medicare and no social security. So why shouldn't payees be careful about the private brand of money the accept in payment?
I thought you were the guy who insisted that average people were so stupid that they required "regulation" to properly stimulate them?
Typo:
DeleteSo why shouldn't payees be careful about the private brand of money THEY accept in payment?
Bob Roddis@July 19, 2012 11:00 AM
Delete"So why shouldn't payees be careful about the private brand of money they accept in payment?
They already are, idiot.
You think people are so stupid that they can't recognise a debt instrument when they see one? E.g., they can't distinguish a cheque from a gold coin?
This is typical blathering from someone ignorant of capitalism's history: time and again the market invents debt instruments like cheques, promissory notes, bills of exchange, and so on, because the benefits and advantages of such instruments.
Most people who normally deal with such debt instruments are perfectly well aware of the risks. Why do we see "no cheques accepted" signs in many businesses?
"I thought you were the guy who insisted that average people were so stupid that they required "regulation" to properly stimulate them?"
= straw man nonsense.