George Selgin has a great post up on points that were raised here a couple days ago on 100% reservists, namely, that if everyone is on the same page on exactly what a deposit at a fractional reserve bank entails it doesn't make any sense to talk about them being "defrauded". It doesn't matter if customers aren't banking experts. They know about all the things you guys complain about, and they accept it, so it's hard to argue that they're victims of fraud.
In this post, Selgin points out that there is no similarity at all between warehouse receipts (which is what a 100% reserve note would amount to) and banknotes. Nobody could confuse them or think they were making a deposit at what amounted to a specie warehouse.
Speaking of George, at that post by Danny Sanchez responding to me on Ron Paul's hearings, George Selgin seems somewhat self-conscious about his own publishing record! I have no idea why. If George Selgin doesn't count as an insightful monetary economist I don't think such a creature exists. I would have thought Selgin of all people could appreciate my point that Ron Paul has used his chairmanship to, rather than seeking out well regarded monetary economists, bring in a bunch of people from the Mises Institute that don't even work on this stuff. If Ron Paul were a responsible chairman, I think he would have invited White, Selgin, Horwitz, and Salerno and largely omitted a lot of the rest of the Mises invitees, and then had them talk with the distinguished monetary economists the committee used to invite. Taylor was invited by the committee but that seemed like about it. I would have thought that would be reasonable to Selgin.
Wednesday, July 18, 2012
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Speaking of financial systems other than fractional reserve banking, Daniel Kuehn...what are your thoughts on Islamic banking and Islamic finance? Islamic banking and Islamic finance involves the restriction of interest rates, if I'm not wrong, and it also involves banks achieving what would be described as a "full reserve" status.
ReplyDeleteI should say "I know about Islamic banking only tangentially and so I don't have a strong opinion on it, and if it's a culturally appropriate practice it seems worth thinking about", but I'm tempted to just say "that sounds really dumb".
DeleteIt sounds a lot like the Catholic Church's strictures on financial markets, and we know how that turned out.
Put a big "Fractional Reserve Note" label on the note and a warning that the money might not be in the bank and you probably no longer have fraud if someone accepts them as payment. In a world where there will be lots of warehouse receipts payable to the bearer, I think you are going to have a real problem passing them, but I really don't care.
ReplyDeletehttp://tinyurl.com/bmffl85
Who do you think is out there and confused about the fact that banks don't keep all your money in the vault??????
DeleteWould it be fraudulent if we failed to put a big "this note will not cure baldness" label on the note as well?
DeleteI admit it. You are right. I am wrong. I guess bank runs PRACTICALLY NEVER HAPPENED IN HISTORY and all the bank collapses, financial firm closures, people ruined in the various panics in the 1800s never happened. And that's because everyone completely understood at all times the difference between a warehouse receipt and a fractional reserve note.
DeleteBTW, the panic resulting from the suggestion of the need for better and bigger warnings on the notes suggests such "truth in labeling" options would cause people to avoid such notes.
Bank runs are a risk that people take when they use fractional reserve banking. Obviously. Bank runs have happened before. In other words, "bank runs are a risk".
DeleteThis is what I just noted.
How does your reiteration of the obvious change or speak to any of the arguments that have been made? We all are in agreement that there are risks involved in banking and finance. All-capsing the point is unnecessary Bob. Everyone is quite aware.
Now, what about the last sentence of your first paragraph. Taking the sarcasm into account, I assume you're making some suggestion that people's ignorance of fractional reserve banking is the explanation of bank runs.
That's one possibility, of course. That could lead to bank runs.
Do you really think that's the best explanation: that people didn't understand that only a fraction of their deposits would be held in reserves?
You don't think, maybe, it has more to do with incentives in the face of a negative shock that generate a cascade?
Bob Roddis@July 18, 2012 8:59 AM
Delete"Put a big "Fractional Reserve Note" label on the note and a warning that the money might not be in the bank and you probably no longer have fraud if someone accepts them as payment.
Talk about ignorance.
FR banknotes from the very beginning stated that they were merely debt instruments, promises merely to repay (e.g., "I promise to repay upon demand ..."). Hell, even a cheque accepted as payment is just a promise to pay.
Take one of the earliest goldsmiths note issued by a London banker Feild Whorwood in 1654. This is a receipt for the sum delivered to the banker (but not a certificate of bailment) and, without any doubt, a promissory note:
“Rec[eive]d, ye 16th [December] 1654 of Sam Tofte the some of Twenty five pounds w[hi]ch I promise to repay upon Demand I say R[eceived]
P[er] me*
Feild Whorwood
interest of both £2-05-0.”
http://socialdemocracy21stcentury.blogspot.com/2012/05/funny-money-loaded-phrase.html
"And that's because everyone completely understood at all times the difference between a warehouse receipt and a fractional reserve note. "
DeleteRight, Bob. If everyone thought FRB notes were warehouse receipts, there would NEVER be a bank run!
1. So the debate of the millennium has degenerated into what sort of warning language, if any, should appear on the notes.
Delete2. Since average people are allegedly so wise, informed and sophisticated, I guess there's no longer a reason or need for the nanny state.
I'm curious Bob. Do you have a bank account with a bank that practices FRB?
DeleteDK, I appreciate the link and comment (especially the last remark about baldness--touche!) Note though that my remarks on Danny's post about not getting in the AER were made tongue-in-cheek.
ReplyDeleteYes, as was my suggestion that you were being self-conscious. I was pretty sure you weren't.
DeleteWhat floored me about Sanchez's post and Peter Klein's response - which you were riffing on - was that they actually thought I was trying to insult the Austrians Paul was inviting. Not at all. I have respect for these guys, or else I wouldn't engage as much as I do or follow their work to the extent that I can. The point is that Paul is greasing the tracks for a very narrow group of people that have a special connection with him. That bugs me. I just used that last paragraph to drive the point home one more time.
This question from DK is not serious: Would it be fraudulent if we failed to put a big "this note will not cure baldness" label on the note as well?
DeleteThe risk regarding bank notes is obviously not baldness or a lack of a cure for baldness (which is a truly pathetic changing of the subject on your part). There are additional risks involving fractional reserve notes that do not exist with negotiable warehouse receipts and even you have mentioned them. You wrote:
As for your last question - the same reason you'd always prefer a risky asset over a secure one: reward. The fact that the particular risk you're referring to has practically no risk sweetens the pot quite a bit, of course.
http://tinyurl.com/7c5u5pd
Whether there is no risk or little risk regarding these notes is going to depend upon the facts, circumstances and the business practices of each individual firm issuing them. If you object to making sure that unsophisticated payees fully understand the nature of the notes and the additional risks involved, it must be because you fear that the notes will not be freely accepted in commerce with such a notice. The additional warnings are of minimal cost to the note issuer.
For the record, I have NEVER claimed that it is impossible for the banker, depositor and payee to have a meeting of the minds regarding fractional reserve notes. What I've said is that the notes require a sufficient warning on their face regarding their true nature and risk which is stated in plain everyday language in order to warn potential unsophisticated payees of their true nature and that I suspect that such warnings would inhibit their free acceptance. I could be wrong about the latter.
Once again, the problem is not the fractional reserve banking system, as Dr. Michael Emmett Brady would say, but rather, Adam Smith's "prodigals and projectors". It's speculation that causes booms and busts, and suspending loans to the aforementioned groups will mitigate the business cycle.
ReplyDeleteThe argument DK is making is rather weak. He says that if 100% of the population knows what's going on, then FRB is not fraud. Well duh. If in actual fraud cases 100% of the people involved knew what was going on, then there have would have been no fraud either. Does that mean the practises whereby less than 100% of the people knowing what's going on, are not fraud either, because in principle, they could have known?
ReplyDeleteWhat you and other "non-fraudists" (I am not saying FRB is fraud by the way) are not really appreciating is that not everybody really does know what is going on. Like I said in another post, 70% of those in the UK have shown themselves that they don't know (as they believe their banks actually have their money on hand).
Because of this, because 70% of those who use the circulating bank promises believe they are transferable claims to money sitting in a vault waiting for them, then is it not reasonable to conclude that while FRB might not be fraud (since most (I think) demand deposit contracts state what the bank's obligations are), it is at minimum a seriously misleading practise?
Do you suspect that the reason so many people don't know what's going on, is because their banks are not being upfront in telling them what they intend to do? Yes, we get it, it would be silly to expect banks to say that their notes don't cure baldness, but fractional reserve banking is a serious matter, more serious than your caricaturing of the complaints anyway.
Personally, I would have no problems with FRB if it was as upfront and honest as other financial activity. But when so many people don't know what's going on, and banks really going out of their way to avoid letting their clients in on what's going on, I think it is intellectually dishonest to claim that the practise is without at least some elements of misrepresentation.
And going further, is not history littered with examples of demand deposit sellers outright lying to demand deposit customers? In 393 BC for example, the Greek lawyer Isocrates defended the son of the Satyrus, king of Bosphorus. The son accused Passio of misappropriating a demand deposit entrusted to him by the son. The son testified that Passio:
"after covering his head, cried and said he had been forced by economic difficulties to deny my deposit but would soon try to return the money to me; he asked me to take pity on him and to keep his poor situation a secret so it would not be discovered he had committed fraud."
Fast forward to today, with John Corzine's shenanigans at MF Global, misappropriating segregated account money, and we have literally thousands of years of examples of actual fraud of banker trust.
----------------
It is in principle possible for FRB to not be fraud, if everyone is aware of it and agrees to it. This is what free bankers are latching onto, what haters of cash hoarding are latching onto, and what lovers of monetary stimulus are latching onto.
But because not everyone is aware of it, it is at least misleading. And in certain occasions, depending on banker and customer actions, like the ones I mentioned above, it has been outright fraudulent.
-----------------
So where do we stand in terms of who is right? The fraudists or the non-fraudists? The answer is neither are right, because FRB is IN PRACTISE between the two extremes. In principle, the non-fraudists are right. The incorrect fraudists however are performing a valuable activity, which is pulling the dogmatic non-fraudists away from their idealistic conceptions of banking, and into the messy real world of human behavior and partial ignorance.
I try to ignore your comments, but a few quick points.
DeleteFirst, I'm glad you say "well duh". I think it's that simple too.
On this: "If in actual fraud cases 100% of the people involved knew what was going on, then there have would have been no fraud either. Does that mean the practises whereby less than 100% of the people knowing what's going on, are not fraud either, because in principle, they could have known?"
So not knowing what is going on doesn't mean it's fraud. I buy all kinds of things I don't entirely understand. Buyers have to beware to a certain extent. Just because you don't understand what you're buying doesn't mean its fraud. Agreed?
Our point is that if you know what you're buying then it can't be fraudulent. And while depositors admittedly aren't banking experts, they seem to be generally aware of how fractional banking works. As I've said in the past - we put this information in our children's stories, like Mary Poppins, and our Christmas stories, like It's a Wonderful Life. It's common knowledge which implies its not fraudulent.
But even if it were somewhat less common knowledge that doesn't imply it is fraudulent.
Not knowing on the part of consumers is necessary, but not sufficient, for establishing fraud in other words.
re: "Yes, we get it, it would be silly to expect banks to say that their notes don't cure baldness, but fractional reserve banking is a serious matter, more serious than your caricaturing of the complaints anyway."
No it's really not serious in the way that you're suggesting.
It make the money supply more elastic. That's an important thing to think about. That does have consequences. But to compare it with a full reserve system is not serious. If you want to talk about changing reserve requirements and capital requirements, fine. There's a discussion to be had there. 100% reserve banking - as far as I can tell - is not a serious position.
Major_Freedom@July 18, 2012 3:17 PM
Delete"What you and other "non-fraudists" are not really appreciating is ... 70% of those in the UK have shown themselves that they don't know (as they believe their banks actually have their money on hand).
Because of this, because 70% of those who use the circulating bank promises believe they are transferable claims to money sitting in a vault waiting for them,"
Your last statement is not supported by the evidence.
In the very same survey you're referring to, 61% of people surveyed also said that they did not mind the bank lending out the money in their current account as loans.
Only 15% said that they keep money in a FR current account for safekeeping:
http://socialdemocracy21stcentury.blogspot.com/2011/12/are-public-ignorant-of-nature-of.html
"And going further, is not history littered with examples of demand deposit sellers outright lying to demand deposit customers? "
One example from over 2000 years ago is laughably poor evidence of this statement.
Daniel:
DeleteSo not knowing what is going on doesn't mean it's fraud. I buy all kinds of things I don't entirely understand. Buyers have to beware to a certain extent. Just because you don't understand what you're buying doesn't mean its fraud. Agreed?
Well to an extent, yes. Of course caveat emptor applies to a positive degree, because neither seller nor buyer can know every last detail of the commodity in question.
But I think the detail of fractional reserve is major enough to be in league with what sellers are obligated to be upfront about concerning the goods they sell. For example, if a furniture warehouse never made it clear that they intend to let their friends use the furniture, and the clients don't know about it, then I think it is something the warehouse owner is obligated to tell the client. If not, then it is misleading. Fraud? Only if the owner explicitly promises not to do it, but then does it anyway.
This is why I used the word "misleading" to characterize the practise of FRB.
Our point is that if you know what you're buying then it can't be fraudulent. And while depositors admittedly aren't banking experts, they seem to be generally aware of how fractional banking works.
I will agree that if everyone knows, it can't be fraud, but I disagree with your assessment that people "seem generally aware of how fractional banking works." I don't think the general population really understands it, as the recent study I mentioned shows.
As I've said in the past - we put this information in our children's stories, like Mary Poppins, and our Christmas stories, like It's a Wonderful Life. It's common knowledge which implies its not fraudulent.
This is a rather weak defense. Old movies? Come on. It's not common knowledge if 70% believe otherwise.
But even if it were somewhat less common knowledge that doesn't imply it is fraudulent.
Agreed, which is why I say misleading, if the practise is explicit in the contract.
Daniel:
DeleteNo it's really not serious in the way that you're suggesting.
It is in fact as serious as I am suggesting. For it is a reason for financial system instability, and is a factor in the business cycle. It has historically been used for political reasons to form central banks were there are none, which exacerbates the extent to which credit expansion takes place.
It make the money supply more elastic. That's an important thing to think about.
This is really just another way of saying it allows banks to lend more money and earn more interest, with rather destructive consequences.
That does have consequences. But to compare it with a full reserve system is not serious.
I disagree. I think comparing fractional reserve banking to full reserve is very serious. Even Milton Friedman supported 100% reserve banking in his later life.
If you want to talk about changing reserve requirements and capital requirements, fine. There's a discussion to be had there. 100% reserve banking - as far as I can tell - is not a serious position.
I disagree. There is a discussion to be had in full reserve banking.
We make it a serious issue and stop playing follow the leader.
LK:
ReplyDeleteYour last statement is not supported by the evidence.
Yes, it is.
ESCP Europe for The Cobden Centre (June 2010) found that 74% of people surveyed (in August 2009) thought that they were the legal owner of the money in their FR current account. The fact that 61% of this group stated they would not mind it if the bank lent the money, is a separate issue. I could believe that you have my car in your garage, and not mind if you lent it to someone, at the same time.
"And going further, is not history littered with examples of demand deposit sellers outright lying to demand deposit customers? "
One example from over 2000 years ago is laughably poor evidence of this statement.
That example was to show how long instances of fraud have been taking place in the area of demand deposits. It was to give a sense of history. It wasn't meant to be the sum total of evidence.