Let us imagine two farmers: Bill and Steve.
They freely make and both agree to the following contract:
(1) Bill lends Steve a chicken as a loan for consumption (or, in legal language, a mutuum loan). Both parties agree that Steve becomes owner of the chicken. Steve can “consume” the chicken by eating it, or can even resell it to someone else.So what is wrong with this contract?
(2) Bill says to Steve: “Steve, I know you keep a reserve stock of chickens – since you are a farmer – so I want to call back this ‘chicken debt’ (that is, make you repay the debt by another chicken, a tantundem chicken of the same quality and age) on demand at some time this year, but I don't know precisely when. Is that alright?”
Steve says: “Bill, that is perfectly alright, I accept these terms completely and freely. I will repay on demand the ‘chicken debt’ I owe you.”
If the opponents of fractional reserve banking can find nothing wrong with it legally, economically or morally, then all we have to do now is substitute money for chickens to see how a mutuum loan of money, callable on demand, must also be acceptable.
It is only a few further steps to see that there can be nothing wrong with fractional reserve banking (FRB) either (assuming for the sake of argument that all parties understand the terms of the contract), for FRB operates on the very same principles.
One might object that many holders of demand deposits or FR transactions accounts these days do not understand that the bank becomes owner of their money, but this is a very different objection from the usual ignorant arguments offered by anti-FRB Austrians (and I have addressed the issue of public ignorance of FRB here).
Normally, the main arguments against FRB put forward by the big name Austrians (e.g., Mises, Rothbard, Hoppe) consistent of the following:
(1) ignorant inability to understand that banknotes (or fiduciary notes) are debt instruments, not property titles.
(2) similar ignorant inability to understand that the “demand deposit” is also nothing but a debt instrument on the bank’s books, not a depositum or bailment. A demand deposit is never a bailment. Thus it is not the case that two property titles to the money exist: the bank becomes the owner of the money, and the FR client is simply a lender, with a debt owed to him by the bank.
One of two:
ReplyDeleteSo what is wrong with this contract?
IMO, nothing, provided there is an explicit contractual identification of who among Bill or Steve is recognized as having the present, exclusive claim over the chicken.
Imagine Bill and Steve go out and start trading with others. Suppose Bill shows Derek his balance sheet that says he is present claimant over the chicken. Suppose Steve shows David else his balance sheet that says he is also present claimant over the same chicken.
As long as Derek and David are fully aware of what's going on, that they are not receiving present claims to a chicken, but a risky debt contract from Bill and Steve's bank, then still there is nothing wrong.
But then suppose Derek and David make trades with yet still others. We can still reasonably imagine that their exchange partners will know what's going on.
But at some point, in the chain of trades, there will almost certainly arise naive and uninformed persons who only traded with the parties prior in the chain, because they truly thought that they became owners of a present claim to a good, and not another debt contract.
This is when FRB becomes problematic. This is when the pro-FRB advocates have to explain why the practise is fully legitimate, despite the fact that a relatively large percent of the population believe they are the legal owners of the money they deposit.
As such, your example as it is written is perfectly fine, as long as the contract remains "in house" so to speak, like two people voluntarily contracting to trade a unicorn. It's fine as long as they agree. But as soon as they present their balance sheets to someone else, or yet someone else again in the chain of trades, who actually believes he is going to become an owner of a unicorn, then the original valid contract in the local sense, but null and void in the universal sense, has been misrepresented, and Bill and Steve would be held liable for fraud.
In other words, people can voluntarily "defraud" each other if they want, they can trade whatever they want on whatever terms, but if their actions lead to harming others, which you yourself seem to be admitting is the case when you said that many don't know that they are not the legal owners of the money, then I think it is reasonable to argue that fractional reserve banking contains a problem that in over 100 years at least, hasn't been solved by simple education of banks to their clients.
I mean, I think there is a very good reason why so many demand deposit clients believe they are the legal owners of their money. And I don't think those reasons are entirely innocent.
It's so difficult to find reconciliation, because we're all forced by the state to use fractional reserve money as legal tender (through taxation laws).
If we had a free market, in money production, of the kind that Selgin and White are talking about, then I would definitely tend towards being totally OK with FRB, because caveat emptor.
"Suppose Bill shows Derek his balance sheet that says he is present claimant over the chicken. "
DeleteIf "present claim" is used in the sense of a piece of property owned by him possessed by someone else as a bailment, that would be fraudulent.
But Bill only has a debt owed to him, and there is no reason why most people can't communicate that idea perfectly well: on his balance sheet his "chicken" shows up as nothing more than a debt instrument ("Steve owes me a chicken").
Your whole argument falls apart because you just keep using this misleading phrase "present claim".
"This is when FRB becomes problematic. This is when the pro-FRB advocates have to explain why the practise is fully legitimate, despite the fact that a relatively large percent of the population believe they are the legal owners of the money they deposit."
This is merely an argument about public knowledge of FRB: the answer would be legislation to make banks explain explicitly to customers about the nature of their demand deposits.
"but as soon as they present their balance sheets to someone else, or yet someone else again in the chain of trades, who actually believes he is going to become an owner of a unicorn, then the original valid contract in the local sense, but null and void in the universal sense, has been misrepresented, and Bill and Steve would be held liable for fraud."
Absolute rubbish.
If the chicken debt is passed to someone else with Bill and Steve's consent, and the third party is aware that they are receiving a debt owed to them a as payment, there is nothing fraudulent whatsoever.
Negotiable cheques and negotiable bills of exchange work in the same way.
You think people in general are so stupid they can't understand that a cheque is a merely a promise to pay (a record of a debt and order to pay).
If the public were so ignorant about debt instruments (promissory notes, cheques, bills of exchange, private banknotes in the old days, etc.), why is there so much caution about accepting cheques? (why do we see "No Cheques Accepted" signs in many places).
Two of two:
ReplyDeleteBut when naive and uninformed people are compelled by law to accept such notes, since they have to pay taxes in those notes, then I think caveat emptor gives way to something more sinister. With FDIC and legal tender laws and so on, more people have been lead into believing that they are the legal owners of the money, and because of that, business cycles that are set into motion on this basis, are exacerbated, and make more people's lives worse off "by law."
I think only in a perfect world, would FRB be legitimate. But people are ignorant about many things, and right now in history, FRB is more a problem than a benefit for individuals, at least if we go by their revealed preferences.
Please note that you are misrepresenting Hoppe. Hoppe wrote:
"White and Selgin then, as their last line of defense, withdraw to the position that banks may attach an “option clause” to their notes, informing depositors that the bank may at any time suspend or defer redemption, and letting borrowers know that their loans may be instantly recalled. While such a practice would indeed dispose of the charge of fraud, it is subject to another fundamental criticism, for such notes would no longer be money but a peculiar form of lottery tickets." - The Economics and Ethics of Private Property, pg 201.
In other words, Hoppe AGREES that if clients are informed about FRB (i.e. as in your David and Steve example), and they understand it, then it is not fraud. Hoppe holds that FRB is not inherently fraudulent because in principle people can be aware.
Hoppe is against FRB because he holds that the resulting media will not be suitable as a medium of exchange. Not suitable, of course, from the standard of rationalism, which seeks to connect a priorism with empiricism, that is, it argues that man benefits the most when he chooses to act in accordance with his nature and the outside world's nature. But that is a whole other topic. The point is that Hoppe doesn't claim FRB is necessarily fraud, as long as clients are informed that they are not the owner. But only a minority of people are so informed, so...
----------------
Totally off topic, but here's an interesting quote from Mises:
"On a market, which is not disturbed by the interference of such an "inflationist" banking policy, interest rates develop at which the means are available to carry out all the plans and enterprises that are initiated. Such unhampered market interest rates are known as "natural" or "static" interest rates." - Mises, The Causes of the Economic Crisis and Other Essays Before and After the Great Depression, pg 161
http://mises.org/daily/5898/
Notice how Mises is talking about MULTIPLE "natural" interest rates.
Yet more evidence against the stupid charge that ABCT relies on the existence or feasibility of a single market interest rate.
Hoppe's objections to FRB run well beyond what you say, and he is guilty of ignorance and misunderstanding as laughable as Rothbard:
Deletehttp://socialdemocracy21stcentury.blogspot.com/2011/12/hoppe-on-fractional-reserve-banking.html
"On a market, which is not disturbed by the interference of such an "inflationist" banking policy, interest rates develop at which the means are available to carry out all the plans and enterprises that are initiated. Such unhampered market interest rates are known as "natural" or "static" interest rates."
An absurd quote. The belief that the monetary market rate(s) allow people "to carry out all the plans and enterprises that are initiated" just means that the rate(s) are deemed by Mises equivalent to be equivalent to Wicksell's natural rate of interest.
Mises has just smuggled Wicksell's natural rate of interest in again by other words.
And what happen if Steve has no chicken when Bill ask for it ?
ReplyDeleteIt is called risk: you can't have capitalism without it.
DeleteBill might have asked for security for the chicken; if not, he can either accept a loss or sue Steve for breach of contract (failure to pay a debt).
You seriously believe no lender has been willing to write off bad loans down through the centuries?
That most people don't understand the risks of lending money and defaulting debtors?
Here's the problem: when people do decide that the risk of putting money in the bank is too great, we get a national depression. Unless the government prints money.
DeleteSo the alternatives are fully government-regulated banking, fully government CONTROLLED AND OWNED banking (everyone has accounts direct with the Bank of England), or permanent depression. Which do YOU choose? (Well, I'd pick #2.)
Begs the obvious question as to why Steve the chicken farmer needs a loan of a chicken.
ReplyDeletePerhaps a more accurate analogy is that Bill is *selling* Steve a chicken on credit. A straightforward forward business contract which may or may not have a 'credit period'.
Which of course is a perfectly sensible thing to do because Steve is a chicken farmer and 'makes' chickens. So you're always going to be able to get a chicken off him - although you might have to give a little notice sometimes if there is a rush on so he can 'make' enough of them.
Neil Wilson@August 17, 2012 12:10 PM
DeleteSale on credit is different from the mutuum contract.
Not operationally it isn't and it gets beyond this incessant argument.
DeleteYou are selling your state credit and getting bank credit instead.
I don't think Mises himself ever made a strong case against FRB itself the same way Rothbard and Hoppe do, he opposed State-protected fractional reserves, but he did not call it a fraud or call for an outright end to FRB. The Free Bankers like Selgin and White are also "Misesians".
ReplyDeleteBut that aside, excellent article. The idea that fractional reserve banking is "a fraud" outright is very silly.
This. I'm part way through de Soto's book, I wonder whether I should persevere.
ReplyDeleteSee my other post here for the central flaw in de Soto's book: his misrepresentation of the mutuum contract:
Deletehttp://socialdemocracy21stcentury.blogspot.com/2012/08/huerta-de-soto-on-mutuum-contract.html
Hello LK,
ReplyDeleteI asked this before but why do credit unions recorded demand deposits, credit union call them members checking, as liabilities instead of assets. I am a CPA with over 20 year accounting experience. An assets according to GAAP is ownership of future economic benefits, a liabability on the other hand is a claim on assets. If banks own demand deposits again why did they record them as assets? Why does GAAP, the FASB and the SEC who has the authority over GAAP not required credits unions to recorded demand deposit as assets “ownership”.
A demand deposit is a liability from the perspective of the credit union because it is a debt they owe to someone.
DeleteIs this difficult to understand?
Big name free bankers (Selgin and White for example) do claim that Mises was a supporter of free banking. Thus, to them, Mises did understand the importance of fiduciary notes. See their article "We are Not (Devo)lutionists, we are Misesians " by Selgin and White
ReplyDeleteAnd yet there is this confused passage in Mises’s The Theory of Money and Credit (2009 [1953]) cited by other Austrians against fractional reserve banking (Huerta de Soto 2006: 14–15; Rothbard 2011: 733–734; Rothbard 1974: 20):
Delete“It is usual to reckon the acceptance of a deposit which can be drawn upon at any time by means of notes or cheques as a type of credit transaction and juristically this view is, of course, justified; but economically, the case is not one of a credit transaction. If credit in the economic sense means the exchange of a present good or a present service against a future good or a future service, then it is hardly possible to include the transactions in question under the conception of credit. A depositor of a sum of money who acquires in exchange for it a claim convertible into money at any time which will perform exactly the same service for him as the sum it refers to has exchanged no present good for a future good. The claim that he has acquired by his deposit is also a present good for him. The depositing of the money in no way means that he has renounced immediate disposal over the utility it commands.” (Mises 2009: 269).
My point is why do you say that the bank "credit union" owns the demand deposit, where clearly on there books it is not recorded as a asset. Please help me understand where you say yourself it is a liability.
ReplyDelete(1) the money given over to the bank by the person who opens the demand deposit account becomes the property of the bank. It is recorded on the asset side of the balance sheet as reserves. The money becomes the bank's reserves until it is lent out again.
Delete(2) the demand deposit is the record of the debt owed to the person who has opened the account. It appears on the liability side of the balance sheet. The amounts listed as (1) new assets for the bank (money given over) and (2) the new debt owed will balance.
double entry book keeping. so simple.
DeleteLord Keynes,
ReplyDeleteFirst, congratulations on your never ending criticisms of Austrians. You’re performing a great public service there.
Re FRB, I don’t agree with your “chicken” argument. You argue that it’s OK for one farmer to lend a chicken, callable on demand, to another famer. Ergo it’s OK for one person to lend money “callable on demand” to another. Ergo FRB banking is OK.
My answer to that is that there is big difference between one PERSON lending to another, and a BANK lending to a person or other entity. The difference is thus.
When person A lends to person B, the only debt that arises is a debt owed by B to A. Moreover, that debt is not readily transferable from one person to another, hence it is not a form of money. In contrast, when a bank lends to a borrower, TWO DEBTS arise. First, there is a permanent debt owed by the borrower to the bank which is only extinguished when the debt is repaid. Second, there is a debt owed by the bank to the borrower which the bank undertakes to transfer to any other entity when instructed to do so by the borrower via cheques drawn by the borrower on the bank (or by other means, like plastic cards).
I.e. the money that the bank lends comes out of thin air. The money supply increases. And that has repercussions, in particular, private bank money creation tends to be pro-cyclical: it exacerbates booms and recessions. Have a look at how M4 rapidly expanded relative to the monetary base prior to the crunch . . . scroll half way down this site to the chart:
http://tutor2u.net/economics/revision-notes/a2-macro-monetarism.html
It could be argued that private banks DON’T create money: they just lend on depositors’ money. However the latter is just a different way of looking at what private banks do, which doesn’t make any difference to the argument.
To illustrate, if A deposits £X in a bank which the latter then lends on to B, then both A and B regard themselves as having £X in the bank. Indeed, between them, they are legally entitled to withdraw £2X at a moment’s notice. The money supply has expanded by £X.
Another problem with FRB is that I think to results in artificially low interest rates. Under full reserve, for someone to borrow and spend, someone else has to make a conscious decision to abstain from consumption. In contrast, under FRB there is no need, at least on the face of it, for anyone to abstain from consumption to enable someone else to borrow and consume: banks just create savings out of thin air and lend them out. It sounds too good to be true, and it is.
A third problem with FRB is that when a bank fails under FRB, money is wiped out. In contrast, under full reserve depositors’ money is not wiped out. Of course that problem can be solved by having the taxpayer stand behind FRB banks. But that equals a subsidy, and there is clearly something wrong with a supposedly capitalistic free market system that needs subsidising.
"Moreover, that debt is not readily transferable from one person to another, hence it is not a form of money."
DeleteYou may want to look up what factoring companies do for a living.
Factoring companies buy debt off firms. But that does not such debt a form of money any more than the fact that people buy computers makes computers a form of money.
DeleteRalph Musgrave,
ReplyDeleteAnyone can create money: you can create a promissory note or bill of exchange. As Minksy says the trouble is getting it accepted as money.
But private sector, non-bank agents create money all the time: have you never heard of the negotiable cheque? When people accept the negotiable cheque as a means of payments for goods, cheques increase the money supply.
So have negotiable promissory notes or bills of exchange down trough history.
(2) When a debtor who has created a bill of exchange/promissory note used as money goes bankrupt, this means money vanishes too.
Are bill of exchanges/promissory notes therefore illegitimate?
Money is defined as anything widely accepted in payment for goods and services. Re negotiable cheques, I don’t think I have ever in my entire life been offered or accepted a negotiable cheque in payment for anything. Thus the idea that they are “widely accepted” is a non-starter.
DeleteAs to whether bills of exchange should be counted as part of the money supply, they again can hardly be described as “widely accepted”. Even in the days when they were far more widely used (roughly 100 to 200 years ago?), they were only accepted by people who knew and trusted the drawer and drawee and other endorsers of the bill. That’s not my idea of “widely accepted”.
As to whether money that can vanish given a bank failure can be called “illegitimate”, I wouldn’t use the word illegitimate. I’m just saying that given the choice between a system where money can vanish and another system where it cannot, then all else equal, the latter is preferable.
Should been clearer . . . when I said above that I’ve never been offered or accepted a negotiable cheque, what I meant was I never been offered a cheque that someone else has endorsed or “negotiated”. That is, I’ve never been offered a cheque that is similar to those bills of exchange that were passed from hand to hand in the 1800s, and endorsed by each person in turn.
DeleteNor have I ever accepted a negotiable cheque with a view to doing anything with it other than paying it straight into a bank. In other words I’ve never handled a cheque which ITSELF has been passed from hand to hand and thus become a form of money.
(1) I am afraid you are wrong about the history of the bill of exchange. In fact, the bill of exchange was the major financial instrument used as a medium of exchange and means of payment from the Middle ages to the 19th century (Wray, L. R. 1999. “The Development and Reform of the Modern International Monetary System,” in J. Deprez and J. T. Harvey (eds), Foundations of International Economics: Post-Keynesian Perspectives, Routledge, London and New York. p. 180).
Delete(2) Whatever your personal experience, negotiable cheques are far from insignificant (certainly from a historical perspective).
(3) A system without an elastic, endogenous money supply is radically anti-capitalist.
It will not work, and would impose endless deflation on the economy and credit problems.
See also:
Deletehttp://socialdemocracy21stcentury.blogspot.com/2011/12/monetary-production-economy-and.html
I think Ralph won this round...
ReplyDelete"I know you keep a reserve stock of chickens – since you are a farmer"
The reserve stock of chickens (whether you mean the power to create new money or simply FDIC insurance) is owned by the government, not the farmer/bank. The contract is such that private banks take the profits while the public treasury takes the losses, I would suggest there's something wrong with that.
" The contract is such that private banks take the profits while the public treasury takes the losses, I would suggest there's something wrong with that."
ReplyDeleteWith effective financial regulation, losses would be minimal: you would have the advantages of FRB, without the disadvantages.
Lord Keynes,
DeleteYou say, “the bill of exchange was the major financial instrument used as a medium of exchange and means of payment from the Middle ages to the 19th century”. Good point.
My answer is that first, bills of exchange are not of much significance nowadays. Second, there is no sharp dividing line between money and non-money, so bills of exchange on a BROAD DEFINITION could certainly be counted as money. But they suffer from exactly the same defect as 21st century privately created money, namely that they are or were pro-cylical. Walter Bagehot described very clearly the way in which when a boom has run its course, people start to distrust bills of exchange, and everyone tries to exit bills of exchange, and grab cash or gold just to make sure they aren’t left holding worthless bits of paper. That process exacerbates the downturn.
Re your claim that “A system without an elastic, endogenous money supply is radically anti-capitalist”, I don’t accept that ANY interference with capitalist or free market activities is inherently undesirable. I favour taxing the rich more heavily than the poor, plus I favour punishing Libor rate fixers and those “payment protection insurance” fraudsters. I favour the British National Health Service.
Next, you claim that “With effective financial regulation, losses would be minimal: you would have the advantages of FRB, without the disadvantages.” That is a statement which is sort of “true by definition”, but it’s a statement with flaws.
First, the REALITY is that the relevant regulations are extremely complicated. That suits banks down to the ground: they can bribe politicians and nibble away at the regulations bit by bit. As for Vickers’s proposals, they are a complete shambles if Laurence Kotlikoff’s book “The Economic Consequences of the Vickers Commission” is any guide.
Thus I think the relatively simple rules that govern full reserve are better than the complex rules that govern or fail to govern FRB.
Second, I suggest that perfect set of FRB rules comes to the same thing as the rules that govern full reserve. To illustrate, what rules does one have under FRB to ensure there is zero chance of depositors losing their money? Well how about this.
1. Depositors who want 100% safety can have it, but they cannot at the same time “have their cake and eat it”: that is they cannot ask to have their money be invested by their bank in less than 100% safe loans or investments designed to earn those depositors some interest. I.e. the relevant money must (for example) just be lodged at the central bank.
2. As to depositors who want to act in a capitalistic manner and let their bank invest or lend on their money, bully for them. I admire risk takers. But they cannot have their cake and eat it either: that is, they cannot enjoy the rewards of risk without also accepting the downside risks that commerce involves. I.e. depositors who want to earn interest should risk losing their money.
Those two rules make it impossible for a bank itself to go bust (bar blatant criminality by senior bank staff). Reason is that if a bank makes silly loans or investments, the relevant depositors lose, not the bank.
Now what do you know? Those two simple rules are the basic rules governing full reserve!
"Now what do you know? Those two simple rules are the basic rules governing full reserve! "
DeleteAnd what about the hidden rules - that a bank has to be closed down if it runs into cash flow difficulties and that the central bank has to have the Wisdom of Solomon to work out how much credit is required in the system.
And of course you still need heavy regulation to make sure nobody cheats.
So the rules are not simplified. They are replaced with a different set of complex rules that just happen to be in a different place.
The problem is really that banks have become too exciting. If they go back to just making loans for a living then there is frankly little difference between the systems.
Ralph, there's an argument for 100% safe bank accounts to be available direct from the government (from the post office) with above-zero interest rates. This is a scheme which allows the government to guarantee savers some (not complete) inflation protection; and people like that sort of thing. Since inflation has to be continually present in a stable economy, this is valuable.
DeleteObviously there should be a *maximum* amount which can be present in such an account, with larger amounts being required to be withdrawn. This is protection for the little guy, not the rich.
Neil, “And what about the hidden rules - that a bank has to be closed down if it runs into cash flow difficulties..”
DeleteAnswer: bar blatant criminality, it’s almost impossible for a bank to go bust under fractional reserve. The reasons are similar to the reason why virtually none of the money market funds or unit trusts / mutual funds have ever gone bust.
Next: “and that the central bank has to have the Wisdom of Solomon to work out how much credit is required in the system..”
Answer: the central bank and government are in no different position there as compared to their position under the existing system. That is, CBs and govts under the existing system just have to take a decision on whether stimulus is needed, and if so, how much. To get that decision right, obviously they need the “wisdom of soloman” – which they obviously don’t have. But they just have to make a stab at getting the decision as near right as they can.
“So the rules are not simplified”: the Basle regulations in their current form run to about 800 pages as I understand it. I could write out the rules governing banks under fractional reserve in much less than a tenth that number of pages.
Re your last para, I agree. That is if banks under fractional reserve behaved in a responsible manner, they would in effect be behaving in a “full reserve” manner. But given the way that banks are currently spending millions lobbying and bribing regulators and politicians so as to enable banks to get back to their irresponsible ways, we are clearly dealing here with a bunch of crooks, fraudsters and spivs. Such people need strict regulation.
Neroden@gmail:
When I said that depositors with 100% safe accounts get no interest, I haven’t decided myself whether that should be “no interest” in nominal terms or in real terms. So you might have a point. I’ll have to think about that.
Didn't have time to read through all the comments -- so forgive me if I engage in repetition -- but the difference is that neither Steve nor Bill can "print chickens". In a fractional system this possibility always exists -- even under a gold standard regime. Banks that are imbued with a banking license can essentially print money.
ReplyDeleteThis is tied to the fact that money is the store of value. If we could print chickens that would be great -- Steve and Bill could have a party and send newly printed chickens to Africa. But if chickens are the recognised unit of account such printing may, if we adhere to outdated Austrian theory, lead to inflation.
The otherwise decent economist John Kay got himself into a similar tangle when he equated fiat money with cows here:
http://www.ft.com/intl/cms/s/0/84a323d0-50ba-11e1-8cdb-00144feabdc0.html#axzz246Ms39gc
Also, tied to this is the fact that FRB systems need a lender of last resort to function properly. This is an implicit part of the whole system. Since Austrian cranks don't like deposit insurance and LLR they are right to oppose FRB, as any rational government/monetary authority operating in an FRB system will find themselves compelled to instate/defend a central bank that fulfills these roles. (Then again, there is some irony with utopian cranks making this seemingly practical argument, but then rhetorical consistency is not a strong points for the Austrians...).
You need a more holistic angle from which to criticise anti-FRB theorists. Kaldor was always particularly good at showing that a dynamic economy requires a perfectly elastic supply of money in order to function in any reasonably stable manner. See, for example, his much under-appreciated paper/lecture "The Irrelevance of Equilibrium Economics".
http://www.jstor.org/discover/10.2307/2231304?uid=3738232&uid=2129&uid=2&uid=70&uid=4&sid=21101157724487
"Kaldor was always particularly good at showing that a dynamic economy requires a perfectly elastic supply of money in order to function in any reasonably stable manner."
DeleteThis is the interesting point. Thanks for it.
It is quite clear that what happens is that the "need" for circulating money to lubricate exchanges varies.
It varies partly due to different industrial needs as infrastructure requires replacement or construction (or doesn't require it). There are probably other reasons.
Meanwhile, the amount of money circulating -- I include both "quantity" and "velocity" here as they are interchangeable really -- varies partly due to fluctuations in people's desire to hoard money (savings), and generally due to 'animal spirits', how often people choose to make transactions.
The result is that we will frequently have either "too much" money (or equally, "too fast moving") -- which will create bubbles as people engage in ill-thought-out spending and "investment" -- or "too little" money, which will create disastrous unemployment and non-deployment of resources, factories sitting idle, crops not harvested, etc.
For a happy society, a stable economy, someone has to be compensating for the endogenous changes in money supply/velocity -- sucking money out when there's too much, pushing it in when there's too little.
I do not see a distinction between what is usually called "monetary policy" and "fiscal policy" from this point of view, except one: "monetary policy" insists on pumping the money into the hands of rich people and banks, which is particularly ineffective due to their propensity to spend. Especially if *they* are the ones who are panicked and want to hoard money!
"Monetary policy" works better when sucking money out of the economy, as this will generally work for slowing down bubbles, regardless of whose hands the money is taken out of. Fiscal policy would work just as well for this purpose, though.
In your example chickens can't be substituted for money - chickens here represent wealth not money. You are quite simply working at the wrong level of abstraction.
ReplyDeleteI would have to disagree with your statements:
ReplyDelete1)The entry you asserted is not correct. The correct accounting entry is
Debit Cash (not reserves)
Credit Demand deposit
My question is who has ownership of the demand deposit not the cash. Does the bank or individual. If the bank it should be recorded as an asset (ownership) if not then some other entry. I have work in banks for the first eight year of my career so I know
Thru experience because I am the one recording the entry. I would ask please be clear on your definitions, cash is cash and a demand deposit is a demand deposit. If a demand deposit is cash why not recorded as cash and be done with it.
A demand deposit isn't cash: it is a debt owed by the bank. Hence, from the bank's perspective, it is a liability.
DeleteYes but my point is why a liability? Below is the definitions set by US GAAP and accepted by the SEC and public accounting firms:
ReplyDeleteAsset: Probable future economic benefits obtained or controlled by a particular entity.
Liabilities: Probable future sacrifices of economic benefits arising from present obligations of a particular entity.
Note that liabilities are sacrifices of economic benefits while economic benefits are the definition of an asset which means it is obtained or controlled (ownership).
Do you accept the above definitions? If you do then by definition a demand deposit which is a liability the bank does not owned because it is false by the definition of the liability because a liability does not mean control, assets is what is controlled.
"Liabilities: Probable future sacrifices of economic benefits arising from present obligations of a particular entity."
DeleteYou are simply confused in understanding the meaning of this sentence.
The above is the very definition of a demand deposit from the perspective of the bank: a debt owed to the depositor ("present obligations of a particular entity") which they will have to repay in the future ("future sacrifices of economic benefits").
"Obligation" = debt.
We are talking past each other. Who has ownership? You claim the bank does. I said no by the definition of the term liability. Liabilities rules out ownership. Assets are ownership. Either a liability means as part of its term ownership. Yes or No? If yes I disagree assets means ownership not liabilities. Again the bank does not own the demand deposit becuase of the meaning of the term liability.
ReplyDeleteI have never argued that the bank "owns" the demand deposit. You are simply mistaken.
DeleteThe demand deposit is a debt owed by the bank.
The depositor holds the demand deposit as a debt instrument, a kind of financial asset.
Lets try again
ReplyDelete1) A demand deposit is a debt
2) Debt is owned by the bank
Therefore: A demand deposit is own by the bank.
Please point out the error in the above statement.
The debt is OWED by the bank to the depositor. Perhaps English is not your first language.
DeleteThe bank's debt claim/obligation is not "owned" by the bank, but a debt due to a client, an obligation.
Therefore the debt occurs on the liability side of the balance sheet.
Loans that the bank makes are assets for the bank.
OK LK,
ReplyDeleteWe will have to agree to disagree on this. My point again is ownership is a asset not a liability, therfore the debt is not owned by the bank, if it was it would be recorded as a asset instead of a liability.
lol.. Did you not read what I said above?: my view is also that the debt (demand deposit) is not owned by the bank.
DeleteI can only conclude you are incredibly confused and incapable of reading English properly.
Do you understand the difference between "owed" and "owned"?
ReplyDeleteThe real problem arises because the contract does not specify what happens if Steve's entire reserve stock of chickens dies or if Steve otherwise gets rid of them. The legal system has to specify rules for this.
ReplyDeleteIt is actually the question of "what happens if Steve defaults?" which is at the heart of the fights over banking.
(1) But legal systems already do: you sue for the repayment of debt, if the debtor does not pay. Or if you have asked for security, you can take the security.
Delete(2) for banks, most nations have deposit insurance or an implicit government guarantee to protect depositors.
Sorry LK,
ReplyDeleteI did get the terms confused, reading to fast. So we are in agreement then that the bank does not owned the demand deposit but instead is owned by the customer, given they are the only two options?.
yes, we are in agreement.
DeleteLord Keynes (spare me!) writes: "(1) Bill lends Steve a chicken as a loan for consumption (or, in legal language, a mutuum loan)."
ReplyDeleteSo Bill in this example is supposed to be the depositor, correct? And Steve is supposed to be the banker. Right away, the example goes awry. Bill, the depositor, does NOT loan Steve, the banker, the chicken. Bill gives Steve the chicken for safe keeping, much as I might give my pet cat to a kennel to take care of while I go on vacation. The chicken in this case is indeed a bailment. Steve, the banker, does not 'own' the chicken. Bill retains ownership. Now if the chicken is truly fungible, as this example says, then all Steve is obligated to return to Bill is another chicken of the same quality. But he is obligated to return it on demand, because Bill still retains ownership of a chicken of that quality. Steve never does acquire ownership of the chicken.
"(2) Bill says to Steve: 'Steve, I know you keep a reserve stock of chickens – since you are a farmer – so I want to call back this "chicken debt" (that is, make you repay the debt by another chicken, a tantundem chicken of the same quality and age) on demand at some time this year, but I don't know precisely when. Is that alright?'”
If Bill can demand the chicken back at any time, then it makes no sense to say that he's loaning it to Steve. If Bill has a right to take possession and dispose of the chicken whenever he wants, then what sense does it make to say that Steve "owns" the chicken? What could ownership possibly mean under these circumstances? Absolutely nothing! Ownership is the right to the use and disposal of the property. If Bill has that right but Steve doesn't, then Bill is the owner of the chicken, not Steve!
Moreover, Bill's right to demand the chicken back at any time negates the purpose of the loan, which is why a loan is always made for a specified period of time. What would be the point of Steve's borrowing a chicken from Bill if Bill could recall the loan at any time after he's made it?! Steve is obviously borrowing the chicken for a particular purpose, in this case to consume it. If he can be obligated to return the chicken (or an equivalent chicken) before he gets a chance to consume it, then there's no point in his borrowing the chicken to begin with.
"Bill, the depositor, does NOT loan Steve, the banker, the chicken. Bill gives Steve the chicken for safe keeping, much as I might give my pet cat to a kennel to take care of while I go on vacation. The chicken in this case is indeed a bailment. Steve, the banker, does not 'own' the chicken"
DeleteAnd that is where your comment is revealed as completely ignorant.
Modern banking - deposit banking - is not bailment, pure and simple. It is mutuum, a loan for consumption.
That is what is stated in the contract you sign. Just because many people do not understand the nature of the contract or don't properly read it, it does not follow that the contract was fraudulent.
Certainly when both parties do understand the contract, there is no issue of fraud, and nothing illegitimate about the transaction.
"If Bill can demand the chicken back at any time, then it makes no sense to say that he's loaning it to Steve. If Bill has a right to take possession and dispose of the chicken whenever he wants, then what sense does it make to say that Steve "owns" the chicken? "
You've misunderstood the discussion and even the sentences you quote.
Bill is not calling back the same chicken he lent Steve, merely a "chicken debt": repayment of a debt with a chicken of the same quality and type as the one he originally lent.
Come back when you can understand the meaning of the legal term "tantundem".
"Bill, the depositor, does NOT loan Steve, the banker, the chicken. Bill gives Steve the chicken for safe keeping, much as I might give my pet cat to a kennel to take care of while I go on vacation. The chicken in this case is indeed a bailment. Steve, the banker, does not 'own' the chicken"
ReplyDeleteLK: "And that is where your comment is revealed as completely ignorant.
"Modern banking - deposit banking - is not bailment, pure and simple. It is mutuum, a loan for consumption."
Not if the depositor is entitled to his deposit on demand. If he can demand it back at any time, then it is the equivalent of a bailment. The fact that what he is entitled to on demand is not the particular paper dollars that he deposited but their monetary equivalent does not alter that fact. It is still tantamount to a bailment. And this speaks to the equivocal distinction that you've made between the particular chicken that Bill turns over to Steve and a "chicken of the same quality and type" that Bill is entitled to on demand. To make your analogy fully accurate and precise, what Bill is turning over to Steve is not that particular chicken but a chicken of that quality and type. If Bill can demand it back at any time, then he is not making a loan for Steve's consumption but is simply giving Steve a chicken of a certain quality and type (for storage or whatever).
LK: That is what is stated in the contract you sign. Just because many people do not understand the nature of the contract or don't properly read it, it does not follow that the contract was fraudulent."
Then the contract doesn't make any sense. If the contract says that the depositor is entitled to the deposit on demand, then he retains ownership of it. The bank does not become the owner of his deposit and does not, therefore, have the right to consume it. What, after all, is the bank doing "borrowing" the money, if what it needs the money for can be satisfied by its existing monetary reserves? And if what it needs the money for cannot be satisfied by those reserves, then to consume it is to forgo the means of returning it on demand.
In terms of your analogy, if Steve already has enough chickens to satisfy his consumption needs, then what is he doing borrowing the chicken from Bill? And if he does not have enough chickens to satisfy his consumption needs, then his consuming the chicken to satisfy those needs precludes his returning it to Bill on demand.
I wrote, "If Bill can demand the chicken back at any time, then it makes no sense to say that he's loaning it to Steve. If Bill has a right to take possession and dispose of the chicken whenever he wants, then what sense does it make to say that Steve 'owns' the chicken? "
LK: "You've misunderstood the discussion and even the sentences you quote.
"Bill is not calling back the same chicken he lent Steve, merely a "chicken debt": repayment of a debt with a chicken of the same quality and type as the one he originally lent."
I understand that, but then, contrary to the implication of your analogy, what Bill is giving to Steve is not a particular chicken but a chicken of that quality and type. If I deposit $100 in the bank, what I'm depositing is not the particular $100 bill that I give the bank, but its monetary equivalent, so that what I'm entitled to on demand is not that particular $100 bill, but its monetary equivalent. What Bill is giving Steve is not a particular chicken, but its poultry equivalent, which is what he is entitled to on demand.
(1) "Not if the depositor is entitled to his deposit on demand."
DeleteIn banking you're never entitled to get your same dollars bills back: only a tantundem. As I said, come back when you have understood this crucial concept.
(2) "If he can demand it back at any time, then it is the equivalent of a bailment. The fact that what he is entitled to on demand is not the particular paper dollars that he deposited but their monetary equivalent does not alter that fact. It is still tantamount to a bailment."
You have just contradicted yourself here compared with what you said in (1).
There is no serious legal, economic, or moral problem or objection to a callable loan. In fact, this whole post above totally refutes your argument here.
(3)" If the contract says that the depositor is entitled to the deposit on demand, then he retains ownership of it. "
No, he doesn't retain ownership. He has a debt claim, an obligation. These are two distinct things: (1) property rights to something and (2) a debt claim owed to you (debt instrument).
Your sentence is a feeble and ridiculous trick employed by Austrians and Rothbardians.
(4) "I understand that, but then, contrary to the implication of your analogy, what Bill is giving to Steve is not a particular chicken but a chicken of that quality and type. If I deposit $100 in the bank, what I'm depositing is not the particular $100 bill that I give the bank, but its monetary equivalent, so that what I'm entitled to on demand is not that particular $100 bill, but its monetary equivalent. ... "
When you "deposit" money in a bank you're lending money to the bank. When you say "what I'm entitled to on demand is not that particular $100 bill, but its monetary equivalent", you're describing what does go in banking: it's called a tantundem.
If you want to make a good faith attempt to debate this subject again, I suggest you actually read some of post on FR banking:
ReplyDeletehttp://socialdemocracy21stcentury.blogspot.com/2012/06/debunking-austrian-economics-101.html
Scroll to the end and you'll find a complete list.
LK, If you're sincere about debating this issue "in good faith," may I suggest that you abstain from condescending insult and ridicule. The manner in which you're discussing this is not that of a person who's interested in reaching an understanding. It's rather that of someone who enjoys bullying and intimidating those he disagrees with.
ReplyDeleteIf I put money into a checking deposit, I'm entitled to write checks on it. I'm entitled to pay my bills with that money. If, however, the money is considered a loan, which the bank is entitled to use for other purposes such as making loans to its customers, then there are two mutually exclusive entitlements to that money. I'm entitled to use it for one purpose (to pay my bills) and the bank is entitled to use it for an altogether different purpose (to make loans to its customers). How can it be that I'm loaning money to the bank if at the same time that money is supposed to be available for me to pay my bills?
"If I put money into a checking deposit, I'm entitled to write checks on it. I'm entitled to pay my bills with that money."
DeleteIf you put money into a checking deposit account, you have lent the bank that money, and transferred ownership of the money to the bank. There is not any problem of 2 ownership claims to the same money, for this is a debtor/creditor relationship: the bank is owner of the money and you now have a debt instrument, a obligation owed to you by the bank.
And that is clearly reflected in the debit/credit entries in your demand deposit statement/checking account statement.
You have the right to call back your debt on demand: that is what happens when you write a check. You're asking the bank to repay its loan to you.
http://socialdemocracy21stcentury.blogspot.com/2011/12/why-is-fractional-reserve-account.html
http://socialdemocracy21stcentury.blogspot.com/2011/12/hoppe-on-fractional-reserve-banking.html
http://socialdemocracy21stcentury.blogspot.com/2011/09/mutuum-contract-in-american-law.html
http://socialdemocracy21stcentury.blogspot.com/2011/10/if-fractional-reserve-banking-is.html
You're entitled to write cheques on a current account whether you have money in there or not.
DeleteThe bank will then decide whether to pay that cheque, and if it does then it will create the necessary money to do so.
LK, in your last reply, you wrote, "If you put money into a checking deposit account, you have lent the bank that money, and transferred ownership of the money to the bank. There is not any problem of 2 ownership claims to the same money, for this is a debtor/creditor relationship: the bank is owner of the money and you now have a debt instrument, a obligation owed to you by the bank."
ReplyDeleteHowever, in an earlier reply to another poster (on August 25th), you wrote:
"I have never argued that the bank "owns" the demand deposit. You are simply mistaken.
"The demand deposit is a debt owed by the bank.
"The depositor holds the demand deposit as a debt instrument, a kind of financial asset."
So which is it? Is the demand deposit owned by the bank or by the depositor?
There is no contradiction in anything I have said.
ReplyDeleteYou have failed to distinguish between
(1) the actual money "deposited", which becomes the property of the bank, and also becomes its vault cash or reserves, and
(2) the debt instrument (demand deposit) itself - this is a claim on the bank held by the depositor. The demand deposit is indeed a financial asset for the depositor, just like a bond. That is why you have money "credited" (owed to you by the bank) to your account.
LK,
ReplyDeleteDid you get my reply to your last post? I submitted it several days ago, but it didn't get published. In any case, I appreciate your discussion and your explanation of the distinction between the actual money deposited and the demand deposit, which makes more sense to me now.
Regards,
William
I have not seen this comment. Apologies if it was not posted.
DeleteI glad my explanation is at least clearer now.
thanks