Steve Keen on Behavioral Finance, Lecture 10

This is lecture 10 on behavioral finance by Steve Keen. In this lecture, Keen deals with the financial instability hypothesis (FIH) of Hyman Minsky.

Miscellaneous Links on the Eurozone Problems

The recent deal to allegedly fix the Eurozone’s debt crisis has inspired some interesting commentary. A selection of interesting analysis on the whole Eurozone fiasco is below:

(1) Bill Mitchell, “It was Some Sort of Bazooka – Aimed at Themselves,” Billyblog, October 28, 2011.

(2) Marshall Auerback, “Europe’s Non-Solution,” New Economic Perspectives, October 26, 2011.

(3) William K. Black, “Greece: the ECB’s Daily Floggings will Continue until the Greek Economy Recovers,” New Economic Perspectives, October 24, 2011.

(4) Mike Whitney, “The Never-Ending Eurofiasco, Bad and Getting Worse,” Counterpunch, October 28–30, 2011.

Marshall Auerback on Eurozone Crisis

Marshall Auerback is interviewed here, with some other commentators, on the recent Eurozone troubles.

Steve Keen at Oxford

There is some excellent material from Steve Keen at the moment. This is a video of his recent lecture at Oxford on the second edition of his Debunking Economics (more on the talk here). The sound is not the best. Please turn your volume up!

Steve Keen on “Capital Account”

A nice interview with Steve Keen on Russia Today.

Hoppe on Argumentation Ethics

The two major Austrian defences of absolute rights to property are Rothbard’s natural rights theory (which I have criticised here) and argumentation ethics.

It is Hans-Hermann Hoppe who defends libertarianism by using argumentation ethics, or what is sometimes called discourse ethics. What is rather peculiar to my mind is that discourse ethics was originally developed by the Marxists Jürgen Habermas and Karl-Otto Apel, the Second Generation Critical Theorists of the Frankfurt School, a trendy Marxist cult whose babblings in cultural “criticism” and “philosophy” are on a par with the nonsense of Postmodernism and Post-structuralism (but formally the Frankfurt School and Post-structuralism should be distinguished as different intellectual traditions, even though the former has had an influence on the latter).

In the video below, Hoppe gives us a brief spiel on his argumentation ethical theory, which is laid out at length in his book The Economics and Ethics of Private Property: Studies in Political Economy and Philosophy (Boston and London, 1993).

The obvious and major problem with argumentation ethics is that it cannot even overcome the “ought” from “is” dilemma of David Hume. In the case of Hoppe, one can note that, just because you require the use of certain body parts in debate, it simply does not follow from this that you have any absolute moral right to the use of your body, and certainly not of any external property. Another absurd statement in this video is Hoppe’s view (from 5.04 minutes) that without the right to exclusive control over and ownership of previously un-owned resources society would die out! In fact, a society with communal ownership of resources is not only a theoretical possibility, but also there are many real world examples of such viable societies with communal ownership of property.




BIBLIOGRAPHY

Hoppe, Hans-Hermann, 1989. A Theory of Socialism and Capitalism: Economics, Politics, and Ethics, Kluwer, Boston and London.

Hoppe, Hans-Hermann, 1993. The Economics and Ethics of Private Property: Studies in Political Economy and Philosophy, Kluwer Academic Publishers, Boston and London.

Kinsella, Stephan, “Defending Argumentation Ethics: Reply to Murphy & Callahan,” Anti-State.com, 9/19/2002
http://www.anti-state.com/article.php?article_id=312

Murphy, Robert P. and Gene Callahan, 2006. “Hans-Hermann Hoppe’s Argumentation Ethic: A Critique,” Journal of Libertarian Studies 20.2: 53–64.
http://mises.org/journals/jls/20_2/20_2_3.pdf

Tucker, Jeffrey, “Hoppe’s Argumentation Ethics, Again,” Mises.org, August 13, 2010
http://blog.mises.org/13557/hoppes-argumentation-ethics-again/

Steve Keen on Behavioral Finance, Lecture 9: Extending the Endogenous Money Model

This is lecture 9 in this series by Steve Keen.

Bill Mitchell on MMT

Professor Bill Mitchell has been interviewed by the Harvard International Review in an online interview here:

Winston Gee, “Debt, Deficits, and Modern Monetary Theory, An Interview with Bill Mitchell,” October 16, 2011.

Required reading!

Steve Keen Interview by Ross Ashcroft

Another great interview with Steve Keen. The interviewer is Ross Ashcroft from the “Renegade Economist.” A wide-ranging discussion, including details on the second edition of Debunking Economics: The Emperor Dethroned?

Steve Keen on Behavioral Finance, Lecture 8: Modeling Endogenous Money

This is lecture 8 in this excellent series by Steve Keen.

Stephanie Kelton on MMT

Another excellent video, but this time a talk by Stephanie Kelton on MMT, given at Luther College in Decorah (IA) on September 28th 2011.

Margaret Thatcher once remarked of her disastrous brand of neoliberalism that “there is no alternative” (TINA) to it. Fortunately, for the world’s inhabitants there is – and Stephanie Kelton describes the basics of one: Modern Monetary Theory (MMT).

Steve Keen on the Keiser Report

A nice interview with Steve Keen by Max Keiser, dealing with current affairs, asset bubbles and debt deflation.

Michael Emmett Brady on Hayek’s Concept of Uncertainty

Some commentators have alerted me to the work of Michael Emmett Brady. I gather (correct me if I am wrong) that his undergraduate and postgraduate work has been in mathematics, and he has done work on Keynes’s theories of probability and other economic issues. That would appear to be a promising combination, as Post Keynesians like Steve Keen have complained in the past that economists are often poor mathematicians. While there are many papers of his to review, I will start with one I have already read here:

Michael Emmett Brady, “Comparing J.M. Keynes’s and F. Von Hayek’s Differing Definitions of Uncertainty as it Relates to Knowledge,” January 30, 2011.

This examines and compares Keynes’s concept of uncertainty with that of Hayek.

Michael Emmett Brady argues that Hayek’s concept of uncertainty and the role of knowledge are quite distinct from that of fundamental uncertainty as defined by Frank Knight and Keynes:

“Uncertainty for Hayek means that each individual decision maker only has a small piece of the puzzle. However, as a whole, the aggregated set of all decision makers have a complete set of all relevant knowledge. There are no pieces missing, lacking or unavailable from the puzzle. Market prices organize and synthesize the aggregate amount of knowledge so that market price signals, understood only by savvy, knowledgeable entrepreneurs, [eliminate] … any uncertainty.” (p. 14)

“Keynes, Knight and Schumpeter deny Hayek’s claim that the market generates price vectors which concentrate the knowledge so that savvy, knowledgeable entrepreneurs can act on this information and solve the problem of uncertainty. Uncertainty means vital important information is missing. Pieces from the puzzle are missing and will not turn up in the future” (p. 14).

“Hayek could not accept the standard concept of uncertainty as defined by Keynes, Knight and Schumpeter because it would then be impossible for market prices to concentrate knowledge that did not exist. In conclusion, nowhere in any of Hayek’s three articles on Knowledge in Economics in 1937, 1945 and 1947 does Hayek deal with the standard view that uncertainty means knowledge that is not there.” (p. 15).

Brady charges that the “Austrian use of the term ... uncertainty actually means dispersed knowledge” (p. 16), which bears further investigation.

One of Brady’s major conclusions is confirmed by other scholars who have also noted that the Austrian view of knowledge as fragmented and dispersed through market prices ignores the fact that a great deal of needed knowledge for investment decisions today does not yet exist (Hoogduin 1987: 61), and that the “market process” of Austrian theory is not capable of solving the knowledge problem, given that so much information about future relevant states has yet to be created when decisions are made in the present (Hoogduin 1987: 63). The inability of a decentralised market process to co-ordinate with reliable consistency what dispersed knowledge that does exist, when so much relevant knowledge does not exist with respect to a future that has yet to be created, is a fundamental insight of Post Keynesian economics (Dunn 2008: 140). The Hayekian view of the market as a co-ordinating mechanism in a type of evolutionary process that is capable of dealing with uncertainty and dispersed knowledge is therefore subject to serious criticism. Subjective expectations throw a spanner into the works of this view of the market, as does the non-existence at present of relevant information created in the future.

Brady also discusses G. L. S. Shackle’s break with Hayek over the issue of uncertainty, and points out Shackle saw that “Hayek’s discussion of uncertainty excluded by definition the existence of knowledge that would be unavailable to the entrepreneur.” (p. 8).


BIBLIOGRAPHY

Brady, Michael Emmett. “Comparing J.M. Keynes’s and F. Von Hayek’s Differing Definitions of Uncertainty as it Relates to Knowledge,” January 30, 2011.

Dunn, S. P. 2008. The ‘Uncertain’ Foundations of Post Keynesian Economics, Routledge, London.

Glickman, M. 2003. “Uncertainty,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics, E. Elgar Pub., Cheltenham, UK and Northhampton, MA. 366–370.

Hayek, F. A. von. 1945. “The Use of Knowledge in Society,” American Economic Review 35.4: 519–530.

Hoogduin, L. 1987. “On the Difference between the Keynesian, Knightian and the ‘Classical’ Analysis of Uncertainty and the Development of a More General Monetary Theory,” De Economist 135.1: 52–65.

Schinckus, C. 2009. “Economic Uncertainty and Econophysics,” Physica A 388.20: 4415–4423.

Steve Keen Launches the Second Edition of Debunking Economics

This event happened at University College (London), with talks by Ann Pettifor and Steve Keen himself. The video has somewhat poor audio quality (turn the volume up!). Debunking Economics (even in the first edition) is an excellent book, with a very useful Post Keynesian critique of the new consensus macroeconomics.

Axel Leijonhufvud on the Reform of the Financial Sector

A nice talk by the coordination Keynesian/Post Walrasian Axel Leijonhufvud on the financial crisis, and reforms that should be implemented on the financial sector.

There is a nice convergence between heterodox economists, such as Post Walrasians (like Leijonhufvud), those in the tradition of Old American Institutionalism (like James Galbraith), Post Keynesians (like Steve Keen), and other independent heterodox thinkers like Richard Koo, in diagnosing the cause of the financial crisis and current malaise: common to all analysis is debt deflation theory and Hyman Minsky’s financial instability hypothesis. Even some New Keynesians like Paul Krugman are catching on.

What is Wall Street Good For?

This is the question posed and then answered by Bill Mitchell in this splendid post:

Bill Mitchell, “What is Wall Street For?,” October 5, 2011.

The point is that useful types of speculative activity are helpful in real wealth creation because they can reduce uncertainty for certain businesses (a point which nicely complements the theme of my post here). A great deal of other speculative activities that draw money away from purchasing of producible commodities to buying and selling of financial assets and instruments on secondary markets are just casino-style gambling that redistributes money between gamblers, often the super rich and rich. The creation of debt-financed asset bubbles that collapse and cause debt deflationary depressions, downturns or stagnation is a disease plaguing modern capitalism. Japan fell victim to the latter in the 1990s, and now the US and Europe have as well. The 2010s may well be the West’s lost decade, unless radical action is taken.

I am also reminded of what Mark Hayes has recently said about the financial sector:

“First of all, Post Keynesians follow Kalecki, Galbraith and Eichner in recognising the well-established empirical evidence about the financing of investment. This is that the vast majority of physical capital formation or accumulation is financed from the internal cash flow of large corporations supplemented to some extent by bank credit lines. The social purpose of the stock market is not to finance new physical investment but to permit transfers of existing assets, including corporate control. Its speculative tendencies are not in fact offset by the benefits for enterprise which Keynes allowed. Industry could function quite well without the equity market, given alternative institutions focused on enterprise rather than speculation. ....

Post Keynesians would, in the words of Winston Churchill, see finance less proud and industry more content. Keynes thought casino banking should be kept expensive and inaccessible. A significant transactions tax going well beyond the current stamp duty should be imposed – a tax on speculation.” Mark Hayes, “The Post Keynesian (Policy) Difference,” 2010.

ABCT and the Flow of Credit

In the 1970s, Hayek attempted to analyse stagflation. In doing so, he acknowledged the limitations of his earlier Austrian business cycle theory (ABCT) in explaining the 1970s crisis, because the flows of credit and monetary expansion were of a different type from those he had dealt with in his earlier work:

“There is one special difficulty about accounting for the present situation. In the misdirection of labour and the distortion of the structure of production during past business cycles, it was fairly easy to point to the places where the excessive expansion had occurred because it was, on the whole, confined to the capital goods industries. The whole thing was due to an over-expansion of credit for investment purposes, and it was therefore possible to regard the industries producing capital equipment as those which had been over-expanded.

In contrast, the present expansion of money [sc. in the 1970s], which has been brought about partly by means of bank credit expansion and partly through budget deficits, has been the result of a deliberate policy, and has gone through somewhat different channels. The additional expenditure has been much more widely dispersed. In the earlier cases I had no difficulty in pointing to particular instances of overexpansion; now I am somewhat embarrassed when I am asked the question, because I would have to know the particular situation in a particular country, where the additional money flows went in the first place, etc. I would also have to trace the successive movements of prices which indicate these flows. In consequence, I have no general answer to the question.” (Hayek 1978: 212).

And this remains a severe flaw in the Austrian trade cycle theory: the original theory assumes credit expansion goes to businesses investing in capital goods, and has no role for loans for consumer durables or debt-fuelled asset bubbles. Karen Vaughn has already drawn attention to the latter failing of ABCT (Vaughn 1994: 87–88).

Even Hayek himself made a remarkable qualification of his theory with respect to conditions after the Second World War:

“HIGH: The Austrian theory of the cycle depends very heavily on business expectations being wrong. Now, what basis do you feel an economist has for asserting that expectations regarding the future will generally be wrong?

HAYEK: Well, I think the general fact that booms have always appeared with a great increase of investment, a large part of which proved to be erroneous, mistaken. That, of course, fits in with the idea that a supply of capital was made apparent which wasn’t actually existing. The whole combination of a stimulus to invest on a large scale followed by a period of acute scarcity of capital fits into this idea that there has been a misdirection due to monetary influences, and that general schema, I still believe, is correct.

But this is capable of a great many modifications, particularly in connection with where the additional money goes. You see, that’s another point where I thought too much in what was true under prewar conditions, when all credit expansion, or nearly all, went into private investment, into a combination of industrial capital. Since then, so much of the credit expansion has gone to where government directed it that the misdirection may no longer be overinvestment in industrial capital, but may take any number of forms. You must really study it separately for each particular phase and situation. The typical trade cycle no longer exists, I believe. But you get very similar phenomena with all kinds of modifications.” (Nobel Prize-Winning Economist: Friedrich A. von Hayek, pp. 184–186).

Hayek’s belief that a proper application of his trade cycle theory to the modern world requires looking at the direct of credit expansion “separately for each particular phase and situation” is one lost on most modern Austrians. Instead, they flog the dead horse of Hayek’s 1930s theory, which he himself admitted had lost its relevance in modern economies.

The modern Austrians present a fossilised Hayekian relic of a theory derived from Prices and Production (1931; 2nd edn. 1935) and Profits, Interest and Investment (1939), as can be seen in Roger W. Garrison’s Time and Money: The Macroeconomics of Capital Structure (Routledge, London, 2002). Hayek himself by the 1970s had moved on from believing his 1930s work on trade cycles could be simply applied to the modern world, at least not without serious modification.

And one further observation should be made: a monetary theory that examines business cycles by looking at the flows of credit to debt-financed asset bubbles already exists: it is called Irving Fisher’s debt deflation theory (Fisher 1933), which has been developed in Hyman Minsky’s financial instability hypothesis (FIH) (Minsky 1982; 2008). This has been further developed in Post Keynesian economics, most notably by Steve Keen.

This is the true monetary theory of the trade cycle when credit flows to speculation that creates asset bubbles and their collapse spills over into severe effects on the real economy. This theory explains many 19th century trade cycles, the Great Depression, Japan’s lost decade, and now the mess that many Western nations are in.


BIBLIOGRAPHY

Fisher, I. 1933. “The Debt-Deflation Theory of Great Depressions,” Econometrica 1.4: 337–357.

Garrison, R. W. 2000. Time and Money: The Macroeconomics of Capital Structure, Routledge, London and New York.

Hayek, F. A. von, 1931. Prices and Production, G. Routledge & Sons, Ltd, London.

Hayek, F. A. von, 1935. Prices and Production (2nd edn), Routledge and Kegan Paul.

Hayek, F. A. von, 1939. Profits, Interest and Investment, Routledge and Kegan Paul, London

Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas, Routledge & Kegan Paul, London.

Minsky, H. P. 1982. Can “It” Happen Again?: Essays on Instability and Finance, M.E. Sharpe, Armonk, N.Y.

Minsky, H. P. 2008 [1975]. John Maynard Keynes, McGraw-Hill, New York and London.

Nobel Prize-Winning Economist: Friedrich A. von Hayek. Interviewed by Earlene Graver, Axel Leijonhufvud, Leo Rosten, Jack High, James Buchanan, Robert Bork, Thomas Hazlett, Armen A. Alchian, Robert Chitester, Regents of the University of California, 1983.

Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition, Cambridge University Press, Cambridge and New York.

How Can Government Overcome Uncertainty?

S. D. Parsons poses the following question:

“Post Keynesian economists can, with considerable justification, criticize the view in some Austrian circles that it is possible to emphasize both uncertainty and market coordination. However, it would also seem that the Post Keynesian emphasis on uncertainty raises problems for the argument that governments can resolve coordination problems. ... Keynes may well have correctly identified problems of market coordination when he wrote, and correctly identified policy instruments to resolve them. However, given uncertainty, the past is a fickle guide to the future and, given transmutation, the world is now a different place. In conclusion, Post Keynesians have a valid point when they argue that an emphasis on economic uncertainty raises problems for the assumption that market coordination can occur in the absence of governmental intervention. However, it can also be argued that the emphasis on uncertainty raises problems for the assumption that market coordination can occur through government intervention.” (Parsons 2003: 9).

It is not, however, difficult to answer these charges.

When you introduce an intervention to influence the state of a nonergodic stochastic system, that process and outcome is not in the same ontological category or status as the future of that system, without intervention. The past data from which one draws inferences about what the intervention will do consist of examples of past such interventions, ideally of the same type. For example, there is no doubt that induction from past data will not be a reliable method to predict the future value of certain shares on the stock market or the future value of the whole market itself measured by some index, but predicting what happens when an entity with the power to influence certain shares or the whole system is a different matter. If the Treasury bought up the stock of a certain promising company, making the shares scarce when demand is high, announcing it will even support the value of the shares, we can make a empirical prediction about the outcome, which can be falsified. How? I have already addressed the question of the epistemological justification for such things and even Keynesian stimulus (and other government interventions) here:

“Risk and Uncertainty in Post Keynesian Economics,” December 8, 2010.

The problem revolves around whether induction can be rationally justified. If one thinks that induction can be defended rationally, then inductive arguments using past empirical evidence can be used to provide justification for policy interventions. Induction can be reliable when used outside of nonergodic stochastic systems or events. If one thinks that induction has no rational justification, then Karl Popper’s falsificationism by hypothetico-deduction can be used to test predictive hypotheses about what will happened in the future under government intervention. In the absence of falsification, we have empirical support for such polices.

Fundamentally, if Austrians or neoclassicals think that they can evade their own such epistemological problems, they are deeply mistaken. How, for example, does the Austrian praxeologist justify his belief that that the axiom of disutility of labour will continue to be true in the future? Mises explicitly tells us that this axiom is “not of a categorial and aprioristic character”, but “experience teaches that there is disutility of labor” (Mises 1998: 65). In other words, it is a synthetic proposition and its truth is only known a posteriori. Praxeologists require either induction or Popper’s falsificationism by hypothetico-deduction using empirical evidence to justify their belief in its truth now and for the future.

The concept of radical uncertainty in the Post Keynesian or Knightian sense applies to non-ergodic, stochastic systems. But human life does not just consist only of non-ergodic systems. The economic system we know as capitalism, where most commodities are produced by decentralised investment decision-making by millions of agents and consumption by other agents with shifting subjective utilities, is not the only institution of modern life. We have government and quasi-government entities, private non-profit organisations, private voluntary organisations, and at the basic level families.

The free market itself has attempted to overcome uncertainty by certain institutions. Government interventions in economies are merely a much more powerful and more effective instrument for reducing uncertainty than what has emerged on the market.

Its many institutions that exist alongside and influence modern capitalism (such as law courts that enforce contracts, buffer stocks, and even central banks) have developed precisely to deal with uncertainty, as “outside” entities capable of reducing uncertainty by interventions designed to influence the state of the system. Law and order is a basic human institution without which commerce would be impossible. It has been enforced through the ages essentially by governments, not by private enterprise. When, for example, the trade of the Roman Republic was threatened by pirates in the east Mediterranean, it was the state that ended that threat and allowed commerce to resume with confidence. Indeed, some conventions or institutions that reduce uncertainty (for example, forward/future markets for commodities, and even money) are so deeply ingrained that we think of them now as a fundamental part of capitalism. A futures market was developed to reduce uncertainty for producers of commodities, often primary commodities. There is a great deal of evidence that standardised coinage in Western European civilisation was essentially the invention of the state. Indeed, the state had a great role in monetising economies.

Central banks developed in the 19th and 20th centuries precisely because business and financial interests wanted a system that would reduce the uncertainty caused by liquidity crises and financial panics, because they were frightened by the potentially disastrous consequences of unregulated financial markets and banking systems.

It is interesting that the Austrian Ludwig Lachmann’s view that institutions have an important part to play in free market systems is similar to the view I have had described above. It is important to note the logical consequences these ideas had for Lachmann as well:

“Because of his focus on uncertainty, Lachmann came to doubt that, in a laissez-faire society, entrepreneurs would be able to achieve any consistent meshing of their plans. The economy, instead of possessing a tendency toward equilibrium, was instead likely to careen out of control at any time. Lachmann thought that the government had a role to play in stabilizing the economic system and increasing the coordination of entrepreneurial plans. We call his position ‘intervention for stability.’” (Callahan 2004: 293).

While I doubt whether Lachmann’s interventions would have been anything but minimal by Post Keynesian standards, nevertheless his intellectual journey is actually a lesson for his fellow Austrians: once they take fundamental uncertainty and subjective expectations seriously they would find themselves forced to much the same conclusions that he eventually drew.


BIBLIOGRAPHY

Barkley Rosser, J. 2010. “How Complex are the Austrians?,” in R. Koppl, S. Horwitz, and P. Desrochers (eds), What is So Austrian About Austrian Economics?, Emerald Group Publishing Limited, Bingley, UK. 165–180.

Callahan, G. 2004. Economics for Real People: An Introduction to the Austrian School (2nd edn), Ludwig von Mises Institute, Auburn, Ala.

Parsons, S. D. 2003. “Austrian School of Economics,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics, E. Elgar Pub., Cheltenham, UK and Northhampton, MA. 5–10.

If Fractional Reserve Banking is Voluntary, Where is the Fraud?

This can be expressed in this way: suppose some business partners set up a bank and a number of clients freely and voluntarily agree to all the stipulations of a mutuum contract in money (although it could easily be in a commodity like grain or timber):

(1) We set up our fractional reserve bank;

(2) our clients hand over money to us and explicitly agree that the ownership of their money passes to the bank;

(3) the bank gives the client a bank account, which is a credit/debt instrument or an IOU redeemable on demand to return to them money up to the amount in his or her account from (a) the bank’s reserves, (b) from sale of financial assets, or (3) loans.

(4) it is understood by all parties that most of the original money has been loaned out (except for that portion held as reserves), and only a tantundem from the bank’s reserves, money from sale of financial assets, or loans is provided;

(5) the bank’s private notes are negotiable, so that they can be used by anyone who accepts them as a means of payment/medium of exchange. It is in our contact that our clients must explain to anyone who accepts our private notes the terms as stipulated to them. The private notes are widely accepted in the community. People are happy to accept them as a means of payment, and redeem them when they wish to.

(6) if the bank becomes insolvent, the clients holding accounts or unredeemed bank notes can sue to regain their debt from the liquidation of the bank’s assets. Everyone understands this and accepts the risk.

Where is the fraud here?

In the freedom-hating anarcho-capitalist world, private protection agency thugs invade the property of the owners/partners of the fractional reserve bank, committing violence against them, breaking up their profitable business (which is a shining example of private enterprise), and tearing up the bank’s free contracts.

The fractional reserve bankers are dragged into a private court, and the vicious anarcho-capitalist judge breathes fire and brimstone as he holds up Rothbard’s Man, Economy, and State (as if it were the Bible), banging it on the bench, screaming at the bankers that their fractional reserve bank contracts were really just bailments and they have committed fraud.

The bankers reply that this is nonsense: all their clients freely agreed to a loan contract, and they produce the contracts to prove this. The prosecution can find no clients who are willing to say that they were defrauded or did not understand the contract.

Nevertheless, the cultist Rothbardians are adamant fraud has occurred (even though they cannot prove anything). The bankers are found guilty on trumped up charges – conspiracy to commit fraud, fraud, and theft of their clients’ bailments.

As they are led off to the horrors of an anarcho-capitalist prison, the bankers realise the nature of the Rothbardian anarcho-capitalist world: a world of suppression of private enterprise, violence against businessmen, and violation of the sanctity of free contract.

Rothbard on Torture

Not what you would expect, and not pretty at all:

“In every crime, in every invasion of rights, from the most negligible breach of contract up to murder, there are always two parties (or sets of parties) involved: the victim (the plaintiff) and the alleged criminal (the defendant). The purpose of every judicial proceeding is to find, as best we can, who the criminal is or is not in any given case. Generally, these judicial rules make for the most widely acceptable means of finding out who the criminals may be. But the libertarian has one overriding caveat on these procedures: no force may be used against non-criminals. For any physical force used against a non-criminal is an invasion of that innocent person’s rights, and is therefore itself criminal and impermissible. Take, for example, the police practice of beating and torturing suspects – or, at least, of tapping their wires. People who object to these practices are invariably accused by conservatives of ‘coddling criminals.’ But the whole point is that we don’t know if these are criminals or not, and until convicted, they must be presumed not to be criminals and to enjoy all the rights of the innocent: in the words of the famous phrase, ‘they are innocent until proven guilty.’ (The only exception would be a victim exerting self-defense on the spot against an aggressor, for he knows that the criminal is invading his home.) ‘Coddling criminals’ then becomes, in actuality, making sure that police do not criminally invade the rights of self-ownership of presumptive innocents whom they suspect of crime. In that case, the ‘coddler,’ and the restrainer of the police, proves to be far more of a genuine defender of property rights than is the conservative.

We may qualify this discussion in one important sense: police may use such coercive methods provided that the suspect turns out to be guilty, and provided that the police are treated as themselves criminal if the suspect is not proven guilty. For, in that case, the rule of no force against non-criminals would still apply. Suppose, for example, that police beat and torture a suspected murderer to find information (not to wring a confession, since obviously a coerced confession could never be considered valid). If the suspect turns out to be guilty, then the police should be exonerated, for then they have only ladled out to the murderer a parcel of what he deserves in return; his rights had already been forfeited by more than that extent. But if the suspect is not convicted, then that means that the police have beaten and tortured an innocent man, and that they in turn must be put into the dock for criminal assault. In short, in all cases, police must be treated in precisely the same way as anyone else; in a libertarian world, every man has equal liberty, equal rights under the libertarian law. There can be no special immunities, special licenses to commit crime. That means that police, in a libertarian society, must take their chances like anyone else; if they commit an act of invasion against someone, that someone had better turn out to deserve it, otherwise they are the criminals.

As a corollary, police can never be allowed to commit an invasion that is worse than, or that is more than proportionate to, the crime under investigation. Thus, the police can never be allowed to beat and torture someone charged with petty theft, since the beating is far more proportionate a violation of a man’s rights than the theft, even if the man is indeed the thief.” (Rothbard 1998: 82–83).

This passage means that, in Rothbard’s anarcho-capitalist world, the police from private protection agencies would be allowed “beat and torture” suspects “to find information,” and they would face no penalty or criminal charge for violence against such a suspect, as long as the suspect is found guilty.

Rothbard protests that private police cannot be allowed to “wring a confession” – even though there is a fine line between the two. In fact, with no ability to hold to account the activities of private protection agencies anyway, since they would be like private mafia groups, one can imagine what incredible abuses what develop in such a system: corrupt private police and private courts using torture and violence to quickly get a confession from suspects and “guilty” verdict.

BIBLIOGRAPHY

Rothbard, M. N. 1998. The Ethics of Liberty, New York University Press, New York, N.Y. and London.

Steve Keen on his Book Debunking Economics

A nice little video of Steve Keen discussing his book Debunking Economics: The Naked Emperor of the Social Sciences (now available in a new edition), which is mainly a critique of neoclassical economics. Some interesting remarks on Walras and mathematics in economics.

What British Law Says about the Mutuum Contract

We can cite the The Laws of England: Being a Complete Statement of the Whole Law of England (vol. 2; 3rd edn.; 1964):

“The contract of mutuum differs from that of commodatum, in that in the latter a bare possession of the chattel lent, as distinguished from the property in it, vests in the borrower, the general property in it still remaining in the lender; where in mutuum that property in the chattel passes from the lender to the borrower. Mutuum is confined to such chattels as are intended to be consumed in the using and are capable of being estimated by number, weight, or measure, such as money, corn, or wine. The essence of the contract in the case of such loans is, not that the borrower should return to the lender the identical chattels lent (for such specific return would ordinarily render the loan valueless), but that upon demand or at a fixed date the lender should receive from the borrower an equivalent quantity of the chattels lent.” (Halsbury 1964: 112).

This clearly entails that in the case of a mutuum demand deposit in a fractional reserve bank:

(1) Ownership of the money passes from the client to the fractional reserve bank;
(2) The bank returns only money up to the same value (a tantundem), not the original money;
(3) By the terms of the mutuum contract, the money can be returned either at a fixed future date or on demand.

And it should be noted that as early as the 18th century, the fundamental terms of the mutuum contract as stated above are already described in exactly these terms by the jurists:

“Mutuum (a Loan simply so call’d quod de meo tuum fiat [sc. “because let what is mine become yours”]) ... is a Contract introduced by the Law of Nations, in which a Thing that consists in weight (as Bullion,) in number (as Money,) in measure (as Wine,) is given to another upon condition that he shall return another thing of the same Quantity, Nature and Value upon demand. More than Consent is required, for the Thing, viz. Money, Wine, or Oil ought to be actually delivered, and more than what was delivered cannot be repaid; but less may be repaid by Agreement. This Contract forces men to be industrious and promotes Trade, and for this reason it may be greater charity to lend than to give. Creditum is a more general Word.” (Wood 1730: 212).

Another two points should be stressed:

(1) British common law was the basis of American law, so the legal status of fractional reserve banking in the US must have been developed under the British common law framework: there is no evidence that it was held to be illegal in the US;

(2) Fractional reserve banking had been revived on a significant scale by London’s goldsmiths from the middle of the 17th century onwards (roughly 80 years before passage was written), and there remains not one convincing shred of evidence that the goldsmiths were guilty of fraud or embezzlement when they engaged in the practice (Selgin 2011).

BIBLIOGRAPHY

Halsbury, H. S. G. 1964. The Laws of England: Being a Complete Statement of the Whole Law of England (vol. 2; 3rd edn.; ed. G. T. Simonds), Butterworth, London.

Selgin, G. “Those Dishonest Goldsmiths,” revised January 20, 2011
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1589709

Wood, Thomas. 1730. A New Institute of the Imperial or Civil Law (4th edn.), J. and J. Knapton, London.

More Historical Evidence on the Mutuum Contract

This seems to be my week for discussing fractional reserve banking and the demand deposit.

Thomas Wood (1661–1722) was an English Doctor of Civil Law (New College, Oxford), eminent jurist and author of the leading work on English law in the 18th century. In the 4th edition of A New Institute of the Imperial or Civil Law (1730; 1st edn. 1704), we have this definition of the mutuum:

“Mutuum (a Loan simply so call’d quod de meo tuum fiat [sc. “because let what is mine become yours”])

It hath no one particular name in the English Language.

is a Contract introduced by the Law of Nations, in which a Thing that consists in weight (as Bullion,) in number (as Money,) in measure (as Wine,) is given to another upon condition that he shall return another thing of the same Quantity, Nature and Value upon demand. More than Consent is required, for the Thing, viz. Money, Wine, or Oil ought to be actually delivered, and more than what was delivered cannot be repaid; but less may be repaid by Agreement. This Contract forces men to be industrious and promotes Trade, and for this reason it may be greater charity to lend than to give. Creditum is a more general Word. In the case of Money, Silver may be repaid tor Gold, unless the Creditor is to be damnified by it; for it shall be understood to be the same kind of Money when it is of the same” (Wood 1730: 212).

What is most interesting here is the statement:

“he shall return another thing of the same Quantity, Nature and Value upon demand”.

The words “upon demand” seem to be entirely consistent with what we would expect if under English law mutuum contracts allow demand deposits (and not just time deposits).

One can also see this idea in the definition of mutuum in the Lexicon Technicum: or, An Universal English Dictionary of Arts and Sciences (1723; 2nd edn.), which is no doubt based on Wood’s treatise:

MUTUUM, in the Civil Law, is a Loan simply so called; or a Contract introduced by the Law of Nations, in which a Thing that consists in Weight, (as suppose Bullion) in Number, as Money: or in Measure, as Corn, Wine, Oil, &c. is given to another upon Condition that he shall return another Thing of the same Quantity, Nature, and Value, upon Demand.
So that this is a Contract without Reward, and admits, properly speaking, of no Recompence. And therefore where Use and Interest is agreed on, they arise from some distinct particular Argument, or by Custom of the Country. (s.v. “mutuum”).

A reading of the extended section of Thomas Wood’s A New Institute of the Imperial or Civil Law on the mutuum contract shows no evidence that a time deposit was held to the indispensible element in the contract (as Huerta de Soto argues).

The transfer of ownership of the money in a mutuum loan is explicitly stated by Wood above in the Latin phrase ...de meo tuum fiat (“let what is mine become yours”). This phrase (in the form quod de meo tuum fit) goes right back to Roman law (MacLeod 1902: 149) as a way of describing the mutuum loan, and is found as a definition of mutuum in the Digest (at 12.1.2.2) of Justinian (AD 530-533), part of that emperor’s Corpus Iuris Civilis (Body of Civil Law).

Over a century later in America, a case is recorded in the Court of Appeals of the State of New York involving Benjamin C. Payne, Executor, &c. vs. William Gardiner (impleaded with Oliver Slate, Jr.) in the 19th century. This was essence of the case:

“In May 1848, P[ayne] delivered to the firm of S. G. & H. $1,000, which they received and credited to him on their books, and delivered to him a paper signed by them, acknowledging the receipt of the money, and stating that the same was to P's credit on their books at six per cent interest. Held, that the transaction was a deposit and not a loan; and that the rights and liabilities of the parties were precisely the same as if the money had been in a bank; and hence there was no right of action against the depositaries until actual demand was made; and that the statute of limitations began to run from the same time, and not before. But that if the transaction was to be treated as a loan, then the paper signed by S. G. 8c H. was in effect a promissory note on interest, and payable on demand; and the statute of limitations would not begin to run in favor of any of the parties to it, until such demand was made. ....” (Tiffany 1865: 146).

“This action was commenced on the 27th November, 1861, to recover the amount deposited and interest thereon since 1859. Howell died before the commencement of the action. ....” (Tiffany 1865: 147).

“There was a verdict for the plaintiff for $1,177.16. The counsel for the defendant Gardiner then moved for new trial, on the judge's minutes, which was denied. He then appealed from the judgment, and from the order denying said motion to the general term in the second district, and that court affirmed both the judgment and order.” (Tiffany 1865: 148).

“The rule laid down in Merritt v. Todd, that notes on demand are continuing securities, and do not become overdue by the mere lapse of time, has always been accepted in the English courts; and yet, as we have seen, the rule that notes payable on demand, with or without interest, may be sued as to the maker instantly and without demand, was never shaken there. This contradiction and absurdity seem never to have occurred to bench or bar in that country.” (Tiffany 1865: 152).

There is a clarification of the nature of demand deposits here:

“A deposit of money with a bank or private person is what is known in the civil law as a mutuum or irregular deposit—the distinction between the two kinds of deposit not being recognized by the common law.

When money is borrowed, and no time of payment is fixed by the contract of loan, the debt, as already stated, is instantly due, and an action may be brought without demand — the bringing of the action being a sufficient demand to entitle the lender to recover. (Chitty on Contracts, 734; Norton v. JEUam, 2 M. & W. 461.)

Even if the debt is by the terms of the agreement to be paid on demand, yet no special demand is necessary; the money being due without it.

We would have to conclude that in the case of bank accounts where “no time of payment is fixed by the contract of loan” American law assumed the mutuum was a type of callable loan or demand deposit.

UPDATE
I have added some other sources from the 18th century to the discussion above.

BIBLIOGRAPHY

Harris, John. 1723. Lexicon Technicum: or, An Universal English Dictionary of Arts and Sciences (vol. 2; 2nd edn.), D. Brown, J. Walthoe et al., London.

Macleod, Henry Dunning, 1893. The Theory and Practice of Banking in Two Volumes (2nd edn.; vol. 1), Longmans, Green and Co., London.

Tiffany, J. 1865. Reports of Cases Argued and Determined in the Court of Appeals of the State of New York (vol. II), Weare C. Little, law Bookseller, Albany.

Wood, Thomas. 1730. A New Institute of the Imperial or Civil Law (4th edn.), J. and J. Knapton, London.

Rothbard Mangles the Legal History of Fractional Reserve Banking

And that should come as no surprise to astute critics of his anarcho-capitalist fantasy world, and to others who have charged that Rothbard was a miserable philosopher, and a wretched historian.

I want to examine here Rothbard’s assertion that the legal status of fractional reserve banking demand deposits was only firmly established as a mutuum in a “first fateful case … decided in 1811”:

“Thus, in England, the goldsmiths, and the deposit banks which developed subsequently, boldly printed counterfeit warehouse receipts, confident that the law would not deal harshly with them. Oddly enough, no one tested the matter in the courts during the late seventeenth or eighteenth centuries. The first fateful case was decided in 1811, in Carr v. Carr. The court had to decide whether the term ‘debts’ mentioned in a will included a cash balance in a bank deposit account. Unfortunately, Master of the Rolls Sir William Grant ruled that it did. Grant maintained that since the money had been paid generally into the bank, and was not earmarked in a sealed bag, it had become a loan rather than a bailment. Five years later, in the key follow-up case of Devaynes v. Noble, one of the counsel argued, correctly, that ‘a banker is rather a bailee of his customer’s funds than his debtor . . . because the money in . . . [his] hands is rather a deposit than a debt, and may therefore be instantly demanded and taken up.’ But the same Judge Grant again insisted—in contrast to what would be happening later in grain warehouse law—that ‘money paid into a banker’s becomes immediately a part of his general assets; and he is merely a debtor for the amount.’”

The belief that Carr v. Carr was the “first fateful case” establishing such an idea is utterly false.

If we turn to the work of Arthur Browne (c. 1756–1805), the Irish jurist and Regius Professor of Civil and Canon Law at Trinity College (Cambridge), we see that the mutuum contract with respect to money was already English legal practise before Carr v. Carr and is described by Browne in an 1802 treatise:

“Mutuum.]—Was the loan of consumable goods, of money, wine, corn, and other things that might be valued by number, weight and measure, and were to be restored only in equal value and quantity, and not the same specific and identical things. The absolute property was transferred to the borrower, i. e. they were lent for consumption, but he was answerable for their value, and therefore must bear the loss if they were destroyed by wreck, pillage, fire, of other inevitable misfortune. Though the specific thing was not to be restored, yet something must be restored of the same nature, as well as of the same quantity and value; wine could not be returned for oil, or corn for wine: if it was, it was not a mutuum, but an exchange—not a nominate, but an innominate contract. To illustrate this contract still further, living animals could not be the object of a mutuum, because equal numbers might be of different value. The mutuum is a contract of borrowing; it is intrinsic in its nature, that it should be gratuitous without price or reward; if they followed, it would be changed into another contract, that of hiring; yet by special agreement there might be interest on it, but that was foreign to its nature, and did not spring from it.” (Browne 1802: 349–350).

English law and banking practice in fact distinguished bailments from mutuum loans certainly from Elizabethan times, but probably since the 1066 Norman conquest (Selgin 2011: 14). The earliest goldsmith notes from demand deposits, which were the forerunners of private bank notes, were negotiable credit/debt instruments that could be presented for commodity money on demand (and bearing the clause “I promise to repay upon demand ...”), not certificates of bailment (Selgin 2011: 11).

Moreover, English and indeed general European civil laws in various nations were based on Roman law, where the mutuum was also understood as a loan where ownership of the money passed to the bank, and it is clear that what we would now call demand deposit fractional reserve banking was conducted in the Roman Republic and Empire under the law of mutuum contracts (Gamauf 2006; Zulueta 1953: 149).


BIBLIOGRAPHY

Browne, Arthur. 1802. A Compendious View of the Civil Law, and of the Law of the Admiralty, Being the Substance of a Course of Lectures Read on the University of Dublin (2nd edn.; vol. 1), J. Butterworth, London.

Gamauf, R. 2006. “Mutuum,” in H. Cancik and H. Schneider (eds), Brill’s New Pauly: Encyclopaedia of the Ancient World (Vol. 9), Brill, Leiden. 382–383.

Melton, Frank T. 1978. “Goldsmiths’ Notes, 1654–1655,” Journal of the Society of Archivists 6.1: 30–31.

Rothbard, M. N. 2008. The Mystery of Banking (2nd edn), Ludwig von Mises Institute, Auburn, Alabama.

Selgin, G. “Those Dishonest Goldsmiths,” revised January 20, 2011
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1589709

Zulueta, Francis de. 1953. The Institutes of Gaius Part 2, Clarendon Press, Oxford.