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Source link: http://blog.mises.org/13920/yesterday-was-a-historic-day/

Yesterday was a Historic Day

September 16, 2010 by Jeffrey Tucker

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A note from Jesus Huerta de Soto:

In the cradle of modern democracy, in the parliament of the United Kingdom, a bill was officially presented in London yesterday with a dual objective: first, to fully and effectively defend citizens’ right of ownership over money they have deposited in checking accounts at banks; and second, to once and for all put an end to the recurrent cycles of artificial boom, financial and banking crisis, and economic recession which have been afflicting the world’s (poorly-named) market economies for at least two hundred years.

In perfect keeping with general legal principles regarding property, principles essential to the functioning of a market economy, the bill aims to abolish the privilege the private banking system currently enjoys of operating with a fractional-reserve ratio on the demand deposits (and equivalents) it receives. The idea is to re-establish a 100-percent reserve requirement for money on demand deposit and to bring about the culmination of Peel’s Bank Charter Act of 1844, which correctly diagnosed the problem of a fractional reserve but regrettably exempted demand deposits from the legal requirement of a 100-percent reserve which it did demand with respect to the issuance of paper money. As a result, Peel’s Act failed to achieve its purpose, and banks continued to artificially expand credit against newly-created deposits (mere accounting entries on their balance sheets) and to generate speculative bubbles which, sooner or later, when the market uncovers the errors committed, give rise inexorably to severe financial and banking crises and to profound economic recessions. (Anyone with an interest in an in-depth study of all the analytical and historical details may consult my book, Money, Bank Credit, and Economic Cycles, which has been published in four Spanish-language editions, two English editions by the Mises Institute in 2006 and 2009, and translated into thirteen languages.)

It is exciting that a handful of Tory MPs led by Douglas Carswell and Steven Baker have taken this step. If they are successful, they will go down in history like Wilberforce – with the abolition of the slave trade – and other outstanding British figures, to which the whole world owes so much.

{ 103 comments… read them below or add one }

james b. longacre September 16, 2010 at 12:01 pm

recurrent cycles of artificial boom,

what is an artificial boom?

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Ed Plant September 16, 2010 at 12:26 pm

This is the heart of the Austrian Business Cycle Theory :) . De Soto has written a rather long book on the topic, but Murray Rothbard’s “What Has The Government Done to Our Money?” is, perhaps, a better starting point. http://mises.org/resources/617

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james b. longacre September 16, 2010 at 12:04 pm

continued to artificially expand credit against newly-created deposits…

was the credit not real?

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Ed Plant September 16, 2010 at 12:24 pm

The money being lent did not represent savings, so no.

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james b. longacre September 16, 2010 at 12:46 pm

if credit is being lent or extended, what have you was it money anyway?

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Shed Plant September 16, 2010 at 12:55 pm

I understand you have a lot of questions, but rather than trying to answer each one as it comes up, I recommend you download the pdf of the book I mentioned above. It’s really clear, very well written and not very long.

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J. Murray September 16, 2010 at 12:32 pm

Credit is one party temporarily transferring rights of use to another party in exchange for a future benefit. During this time, the lending party can no longer use the resources. The vast majority of loans today involve guaranteeing rights to more than one party to the same $1. For example, for every $1 of real money in circulation, the banking system has guaranteed the right to 10 parties exclusive use to that $1. At no point did the original depositer of the $1 agree to transfer usage rights of that money to anyone else and still assumes that the $1 is for him to use.

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james b. longacre September 16, 2010 at 12:48 pm

what is $1 or real money in circulation? a paper fed note? 4 quarters? 10 dimes? what ever is insured by the fdic?

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vjk September 16, 2010 at 2:07 pm

Let’s assume that the bank creates credit ex nihilo, without any deposits whatsoever. In this case we have a rough sequence of events:

1. The bank extends $1mil to the entrepreneur as a loan.

2. $1mil is spent, by the entrepreneur, on workers’ wages and raw materials to produce stuff.

3. The workers buy the newly produced stuff spending $1mil (their wages).

4. The entrepreneur pays the $1mil loan back to the bank.

Ignoring for simplicity the question of entrepreneur profits and bank interest, the loan created ex nihilo did not cause any inflation — everyone enjoys fruits of their labor. In what situation would credit expansion cause inflation ?

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Shed Plant September 16, 2010 at 2:52 pm

That’s an equivalent example to the central bank printing up new fiat currency.

There will be more money than before, so there has been inflation, with all the expected Cantilon effects and the fall in the purchasing power of money, other things being equal.

Paying pack the loan doesn’t cancel out the money creation because it will then be in the possession of the bank ready to be lent out again.

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vjk September 16, 2010 at 3:23 pm

“Paying pack the loan doesn’t cancel out the money creation”

Actually, paying back does cancel out the original loan — that’s the crucial point !

Step 0
Assume the bank had zero capital at the beginning. So, its balance sheet is:
Assets: zero
Liabilities: zero

Step 1
After the loan is granted:
Assets: $1mil(loan)
Liabilities: $1mil(borrower’s deposit)

Step 2
After the workers are paid:
Assets: $1mil
Liabilities: $1mil (workers), $0(the borrower)

Step 3
Workers spent money on stuff:
Assets: $1mil
Liabilities: $0mil(workers), $1mil(the borrower)

Step 4:
Borrower pays back the loan. The borrower account is debited by $1mil, the loan account is credited by $1mil. Both accounts are zero. The bank balance sheet:
Assets: 0 ($1mil loan – $1mil credit)
Liabilities: 0 ($1mil deposit – $1mil debit)

The bank is again at Step 0.

That’s how banks operates — bookkeeping 101.

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Shed Plant September 16, 2010 at 3:40 pm

Oh, I think I understand what you’re saying now. In that example there will be inflation of $1M followed by deflation to the original money supply. But inflation, defined as an increase of the money supply, will still occur. The borrower and his workers will still benefit, not from past savings, but from the expense of those who receive the new money later.

These effects, or others such as general price increases, may be too small to detect if we assuming an economy of a modern size and only a one-off hit of $1M inflation. But, still, the artificial credit creation does not create a free pass to prosperity.

Matt C. September 16, 2010 at 4:29 pm

vjk,

Read de Soto’s book and then comment. Printing money does not guarantee future income and even less so when people are fooled into believing there is more capital than there actually is. This capital is needed to make returns with the investment and you can’t accurately gauge the supply of capital when price signals misrepresent it. And savings must happen in order to support the investment at completion. mises.org/daily/3155What you are saying is that I should be able to print money because I promised myself that I would pay it back with interest. Why should only banks be able to bring money into existence with promises to pay? The logic of your argument leads in a very extreme direction.

vjk September 16, 2010 at 4:56 pm

Shed Plant:

(‘Replying’ to myself since the blog does not let to nest below your response)

“In that example there will be inflation of $1M followed by deflation to the original money supply.”

In the stylized ‘economy’, the workers are paid *after* they have produced the stuff worth $1mil. Therefore, no inflation in the strict sense of the word, occurs since $1mil of credit money is already backed by $1mil of newly produced goods upon the production cycle completion (Def. ‘inflation’: *more* money competes for the *same* amount of goods). There will of course be a temporal gap as well as possible overlaps between production cycles, but that does not undercut the general idea that no money not covered with productive labor was created.

So, in order to show that more money does compete for the same amount of goods, one has to show where the excess money is coming from — simply blaming credit expansion, without specifying more or less exact mechanism, does not cut it.

vjk September 16, 2010 at 5:02 pm

Matt. C

“What you are saying is that I should be able to print money because I promised myself that I would pay it back with interest. ”

Until another party is involved, you can promise to yourself whatever. The bank is an intermediary and there is nothing magical about it. You can open your own private bank, issue your money/IOUs and provide the same services among your friends — if they trust you and find such services useful.

Matt C. September 16, 2010 at 5:48 pm

vjk,

You have not addressed the problem with such reasoning. You also don’t realize that your argument means that anyone could print any stable currency and wreck it. If this is arguing for a gold standard then you don’t realize how such drama unfolds. In reality it leads people towards government regulations instead of sound money. Central banks come about because of such chaos.

This reminds me of the free banking school’s fallacies.

See:
http://mises.org/journals/qjae/pdf/qjae1_4_2.pdf

J. Murray September 16, 2010 at 5:52 pm

You forgot the interest portion. That stays in existence in perpetuity. Certainly, the principle just vanishes, but there is that 5% (or whatever the terms are) portion compounding as the loan continues on to maturity. This loan is being paid by other created funds from other banks in the system (there is only a 10% chance the borrower obtains is actual units of physical cash), thus creating an ever expanding credit. The bank spends these newly minted interest credits out on the market, which these days is just a transfer of computer data, which ends up deposited by some other individual (bank employee, utility, etc), which then continues the credit expansion and interest leakage cycle.

If the system works as you claim it does, then the M2 supply would be flat. But here is the reality:

http://www.cxoadvisory.com/economic-indicators/money-supply-m2-and-the-stock-market/

A steady and never ending upward march. That is the interest growth at work.

The problem now is that when that ever expanding M2 becomes so far off whack with actual assets we have a collapse. The only way to avoid the collapse and maintain the FRB system is to outright ban interest rates. Of course this would collapse the banking industry because they would be unable to generate revenues to justify existing as lending is the primary source of income for a banking establishment.

newson September 16, 2010 at 8:01 pm

to j. murray:
interest has no bearing on money supply. it’s the ex-nihilo creation of the initial amount loaned that is inflationary. interest is paid out of existing money, not new money. in theory when an individual loan is retired, the money supply shrinks. this doesn’t happen in practice generally because one retiring loan is replaced by another.

vjk September 16, 2010 at 8:39 pm

newson:

If the loan is rolled over, something that does not happen automatically clearly, new production takes place so that new money is again counterbalanced by newly produced goods.

What is more typical is called LoC (a line of credit) that is maintained only if the borrower remains creditworthy. I this case, money supply does not increase dramatically but the line is tapped and repaid gradually as the process goes on, wages are paid , goods are bought and the credit money is destroyed thus performing a mere accounting role.

Agent Dale Cooper September 16, 2010 at 10:58 pm

vjk:
“In the stylized ‘economy’, the workers are paid *after* they have produced the stuff worth $1mil. Therefore, no inflation in the strict sense of the word, occurs since $1mil of credit money is already backed by $1mil of newly produced goods upon the production cycle completion (Def. ‘inflation’: *more* money competes for the *same* amount of goods). ”

Wow! That sounds exactly like the Labor Theory of Value. Who decided those goods were worth $1M? All value is subjective. That’s one of the crucial lessons I’ve grasped from Human Action. I was already quite an Anarcho-Cap, morally, but I still didn’t appreciate that the “worth” of one’s holdings only materializes once you find a buyer for what you own.

And that Step 0 –>1 1 doohickey is pretty slick: Issue loan. From where?! It has to be saved first, silly! This loan discussion would be a lot clearer with a stack of coins, not slips of paper or digital bits – you know, actual production as savings.

J. Murray September 17, 2010 at 5:39 am

newson -

So, if one person is using money that was created through credit expansion to pay interest, it’s NOT using created money? Are you saying that the M2, which is counted as money supply, is not expanding?

When you get paid with a check or debit card, you aren’t getting paid in cash, you’re getting paid with invented credit. Credit is considered part and parcl in the money supply because credit is being actively traded. When you get paid through a bank, you are not getting paid with the base physical assets, you are getting paid with the credit. Credit from one bank is being transferred to another bank and is then assumed to be physical cash. This credit from one institute turned cash in another is then treated as the base reserve and expanded on. At no point is it considered a paper liability without corresponding asset.

This is what the borrower is mostly paying loans back with. The home buyer borrows money on a house. He is paid through bank transfer directly into his account. He then pays back the loan with the electronic funds. The $1 that was created through the credit cycle and the $1 backed with cash isn’t differentiated. If the borrower pays $1,000 on the mortgage in anything but a bundle of cash at the bank counter, only $100 of it can be assumed to be based on real money, but the bank treats all $1,000 of it as real money, adds their (for simplicity sake since I’m not going to create an interest payment table for this) $100 to the asset sheet and wipes out $900 in thin-air credit. Of that $100, $10 is based on real cash and $90 is based on thin air credit. The bank just turned $90 of thin air credit into a permanent asset. The money supply just expanded without a corresponding liability to cancel it out.

Expand this beyond the non-existent one borrower, all cash payment economy and it’s easy to understand how the interest payments expand the money supply.

newson September 17, 2010 at 10:33 am

to j. murray:
you’re double-counting, i believe. paying interest to the bank only transfers money from one party to another, doesn’t create it. bank lending actually increases money supply and retiring loans decreases it.

newson September 16, 2010 at 8:58 pm

to vjk:
of course there is no guarantee that loans will be replaced or rolled over. but the initial ex-nihilo creation of money has distorted prices and thereby changed the shape of the economy in a concrete sense.

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Matt C. September 16, 2010 at 9:14 pm

vjk doesn’t understand the basics as far as opportunity cost involved in producing the new goods and also that production does not confer value.

http://mises.org/daily/3155
http://mises.org/journals/qjae/pdf/qjae1_4_2.pdf

vjk September 17, 2010 at 7:14 pm

newson:

Would you agree that a *saved* gold ingot when invested in economy would have distorted prices qualitatively if not quantitatively in the same direction as credit money might and “thereby changed the shape of the economy in a concrete sense” ? If you would not agree, then why ?

On a related note, are you advocating a fixed money stock regime and if so did you think through all the implications of such system ?

Thanks.

Craig September 16, 2010 at 6:20 pm

Ignoring for simplicity the question of entrepreneur profits and bank interest, the loan created ex nihilo did not cause any inflation — everyone enjoys fruits of their labor.

Are you serious or just pulling our collective leg?

That the “ex nihilo” $1 million has been repaid to the bank and extinguished (as we like to say), doesn’t in the least mean that there has been no inflation. The entrepreneur first had to bid against other entrepreneurs for the raw materials and the labor to produce his product.

The prices of the raw materials and the labor will be bid higher than they would have been absent the funny money your bank has created and lent. Too much money chasing too few goods, you see. This is where the inflation becomes evident.

Your post indicates that you believe, as many do, that money is neutral, meaningless — nothing but a tool to grow the economy. Why don’t we print more of it if that’s the case? No harm, no foul. Right?

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vjk September 16, 2010 at 8:25 pm

“The entrepreneur first had to bid against other entrepreneurs for the raw materials and the labor to produce his product.

The prices of the raw materials and the labor will be bid higher than they would have been absent the funny money your bank has created and lent.

Assuming bidding for raw materials and labor is a given, possible price increase would have occurred regardless of the project funding nature — gold bricks, credit money or one’s grandmother’s savings, although to a different degree.

Are you denying credit money utility entirely ? Here’s what Hayek had to say:

“So long as we make use of bank credit as a means of furthering economic development we shall have to put up with the resulting trade cycles. They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them.”

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newson September 16, 2010 at 9:02 pm

hayek erred economically. that aside, i don’t think “extort” sits well with the libertarian mindset.

Inquisitor September 16, 2010 at 9:58 pm

I do laugh when people cite Hayek’s erroneous views as if they’re support of their own erroneous (stupid, ill-thought out) views.

Artisan September 17, 2010 at 2:56 am

How is this Hayek quote (context?) an endorsement of credit expansion? It looks rather critical to me…

Agent Dale Cooper September 17, 2010 at 4:04 am

“has to be extorted from them.”

Ahh, the passive voice. Reminds me of my standard engineering lab reports when my “solution was heated” or the “steel was beaten.” Sadly, it’s also the language of cowardly academic tyrants when they treat humans as distant objects and they wish to hide their shame.

“The passive voice, the subject of the sentence is neither a do-er or a be-er, but is acted upon by some other agent or by something unnamed (The new policy was approved). ..We find an overabundance of the passive voice in sentences created by self-protective business interests, magniloquent educators, and bombastic military writers (who must get weary of this accusation), who use the passive voice to avoid responsibility for actions taken.”

Jon Leckie September 17, 2010 at 4:17 am

I think the Hayek quote goes directly against vjk’s argument, doesn’t it? This quote is not advocating the use of expansionary bank credit, Hayek’s saying that if we do so, we’ll have trade cycles, booms and busts, and that’s the price a community pays when its leaders try to speed up the pace of economic development: because the acceleration is a product of non-market forces, Hayek is saying that the “price” for such acceleration is paid and in this sense “extorted” from the people. What’s wrong with that?

Why all the invective against Hayek? Clearly I love Hayek (although future explorations of Mises and Rothbard may temper my affection, time will tell), I love his writing style and while the passive voice in this instance is not pretty, to call Hayek a “cowardly academic tyrant” is … bizarre! What am I missing?

newson September 17, 2010 at 10:20 am

to jon leckie:
“development” has a positive connotation, and so it’s easy to see how utilitarians can twist something like this of hayek to justify “extortion”. many progressives cut mao and stalin a lot of slack for their industrialization efforts, despite their abysmal human-rights scorecards.

in any case the boom phase that passes for easy-money-driven “development” is rather a phase of capital consumption and so hayek’s words are misplaced in any case. if you have a look at the socialist calculation debate and read this debate’s papers from hoppe, hulsmann, herbener, salerno, and rothbard, you’ll start to get a feel why some like myself do not embrace hayek’s economic or social views unreservedly.

DayOwl September 16, 2010 at 3:23 pm

Greg Pytel gives a very good explanation of the fallacy of fractional reserve banking at his blog
The Largest Heist in History: http://gregpytel.blogspot.com/

He tends to be emphatic but makes a lot of good points, usually in advance of mainstream commentators.

Reply

Old Mexican September 16, 2010 at 3:49 pm

Re: James B. Longacre,

continued to artificially expand credit against newly-created deposits…

was the credit not real?

That is what “artificial” implies, James.

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Wildberry September 16, 2010 at 12:05 pm

Huerta,
This is a good example of what I was trying to express in my post to you yesterday; A relatively small but easily digestible initiative that has popular support and profound implications for the status quo.
Such an initiative would catch on here in America as well. The average person is not going to eat the whole meal in one sitting, but they can digest a simple concept like FRB and the relationship to property rights and the business cycle. A relatively small legislative initiative like this in the UK could start a wave of change in the US as well.
Thank you for your outstanding work in this area.
Regards,
Wildberry

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james b. longacre September 16, 2010 at 12:06 pm

It is exciting that a handful of Tory MPs led by Douglas Carswell and Steven Baker have taken this step

i dont know if tis info is true or not. why is it exciting? what does it accomplish if passed?

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james b. longacre September 16, 2010 at 12:12 pm

The idea is to re-establish a 100-percent reserve requirement for money on demand deposit …

isnt it a matter of contract rights and not so much as property rights???

i was told that much of some of the monetary base isnt even paper dollars or coin anyway. that may have been a lie though. i dont know.

is there truly not a 100 percent reserve system now?? 100 percent reserve of govt printed currency notes… is that what this so called bill is legislating for?

100 percent reserves of of ledger entries??? that doesnt make sense.

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J. Murray September 16, 2010 at 12:33 pm

Try collecting your thoughts into a single post.

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james b. longacre September 16, 2010 at 12:55 pm

respond to my individual posts as you see fit. or not.

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Inquisitor September 16, 2010 at 9:58 pm

Not. Goodbye.

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Old Mexican September 16, 2010 at 3:48 pm

Re: James B Longacre,

The idea is to re-establish a 100-percent reserve requirement for money on demand deposit …

isnt it a matter of contract rights and not so much as property rights???

Both.

is there truly not a 100 percent reserve system now?? 100 percent reserve of govt printed currency notes… is that what this so called bill is legislating for?

No, nope and no.

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Ed Plant September 16, 2010 at 12:29 pm

I think this is an exciting development, and well done to Mr. de Soto and anyone else for helping Mr. Carswell and Baker :) .

To be more accurate, Carswell’s Bill makes FRB opt-in (or possibly opt-out, I’m not sure). It doesn’t mandate 100% reserves, but says that depositors must be offered the choice of 100% reserve accounts or FRB accounts.

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Bruce Koerber September 16, 2010 at 12:45 pm

That moderate approach is similar to allowing gold and silver to serve as alternative currencies. The world will change very fast and in a positive direction if legal tender laws were neutralized and fractional reserve banking was made voluntary.

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james b. longacre September 16, 2010 at 12:54 pm

can people spend gold and silver now if they wish?? except come tax time they must pay in currency, ie dollars????

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Shed Plant September 16, 2010 at 12:58 pm

In the UK, gold and silver are technically legal tender. There are gold sovereigns and gold and silver Britannias. Unfortunately the face values are nowhere near the metal value, so they’re beautiful collectors’ items but aren’t likely to ever circulate as money.

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Beefcake the Mighty September 16, 2010 at 1:43 pm

Do you know Robert Plant?

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Shed Plant September 16, 2010 at 3:41 pm

Only by reputation.

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scineram September 16, 2010 at 1:05 pm

What makes it involuntary?

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Bruce Koerber September 16, 2010 at 2:31 pm

“first, to fully and effectively defend citizens’ right of ownership over money they have deposited in checking accounts at banks”

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james b. longacre September 16, 2010 at 12:51 pm

i guess you mean that there arent 100 percent DD reserve accounts now??what would it accomplish for the depositor?? a stabler economy? doubtful.

100 percent reserve of currency notes or base metal coins?????

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Cory Brickner September 16, 2010 at 2:39 pm

James,

It does help to stabilize the economy, in-part. The recommendations on readings above are very helpful to educate you on some fundamental principals of economics and banking. What happens is that Fractional Reserve Banking (FRB) allows a multiplication of amount of currency that is allowed to circulate.

Essentially, the Federal Reserve and the banks themselves create a two-fold moral hazard via FRB that impacts many other aspects of the economy.

The first moral hazard is that when you deposit $100 in a demand deposit account, if the Fed / Banks only require a 10% reserve ratio, basically the bank only needs to keep $10 in reserve and is able to lend out the other $90 without even asking you for permission to do so. It’s your money, and the bank is obligated to give it to you on demand, but if it loans out 90% of it, and you ask for it back, it may not have it to give back to you. This is primarily theft in any other capacity.

The second moral hazard is that FRB devalues your money by expanding the supply of it. Scarce resources dictate supply and demand pricing. The less scarce dollars are, the less they are worth, and that destroys your savings, all things being the same. The actual result of a 10% reserve ration is actually much worse than it appears. This is due to the fact that the 90% of your money gets lent out to those who put it in demand deposit accounts, and the process gets repeated exponentially. Your $100 demand deposit given a 10% reserve ratio can increase the money supply by $900 ($100+$90+$81+$73+$66+$59+$53+$48+$43+…) if everyone put their money in demand deposit accounts. In reality, the increase is somewhere between $100 and $900. This is a huge devaluation in your savings.

We haven’t even to begun to discuss what happens with credit this added currency base provides and the malinvestment that is caused by it. The other issue is interest rate manipulation by the Federal Reserve that is the other side of the malinvestment / credit bubble coin.

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vjk September 17, 2010 at 7:06 pm

Corey:

I wonder what your series would look like for a Canadian bank where the reserve requirement is 0% (zero) and yet the Canadian banking system is quite robust as opposed to the 10% American one. Perhaps, the reserve requirement has got nothing to do with the system fragility ?

Could you oblige with some math as applied to the Canadian bank ? Would you say that one dollar deposited there becomes infinity in loans ?

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DD5 September 16, 2010 at 12:48 pm

Does the bill eliminate the government deposit Insurance they have there (like FDIC)? Because the whole thing would be pretty worthless without that.

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The Kid Salami September 16, 2010 at 2:56 pm

One step at a time.

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DD5 September 16, 2010 at 8:37 pm

Fine, but the steps have to be in logical order.

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Matt C. September 16, 2010 at 12:49 pm

De Soto is the man! Buy his book!

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Tyrone Dell September 16, 2010 at 1:09 pm

I feel like Mises’s /Human Action/, Rothbard’s /Man, Economy, and State/, and De Soto’s /Money, Bank Credit, and Economic Cycles/ are the three main pillars of the fortress that is Austrian Economics.

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Beefcake the Mighty September 16, 2010 at 1:43 pm

Agreed.

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newson September 16, 2010 at 8:10 pm

hülsmann’s “the ethics of money production”: to understand the step-by-step historical evolution from sound money to today’s paper money/frb model.

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Beefcake the Mighty September 17, 2010 at 8:28 am

Absolutely.

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Renegade Division September 16, 2010 at 1:59 pm

Very true Tyrone.

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james b. longacre September 16, 2010 at 12:53 pm

de soto probably isnt his real name anyway.

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North September 16, 2010 at 4:25 pm

Too funny, I totally just google’d your name thinking the same thing.

I’m pretty sure de Soto is real though ;-)

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Bogart September 16, 2010 at 12:56 pm

No, yesterday was not historic at all…..

How can peace and respect for private property be maintained by an organization that regularly murders people and piles rules limiting their peaceful behavior with theft, imprisonment and ultimately death as the means of coersion?The simple answer is that it can not. As long as Parliament can use violence to modify private property rights then it does not matter what the reserve ratio of the central bank happens to be.For example: The Parliament has stopped private banks from fractioning its demand deposits, BUT PARLIAMENT has not such limitation. So it can now explode the ratio of loans (Bonds) to tax receipts without any competition.The better solution is to end central banking and stop parliamentary control of the financial system. Then actors in the market will determine what money is and how to lend it to one another and the lenders themselves would be responsible for dealing with any losses or runs on their assets.

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Shed Plant September 16, 2010 at 1:00 pm

I contend that it is possible that days can be historic for reasons other than the collapse of the State.

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Samuel Wonacott September 16, 2010 at 2:49 pm

I second THIS motion.

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Tyrone Dell September 16, 2010 at 1:06 pm

I second this motion.

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james b. longacre September 16, 2010 at 1:02 pm

this link http://mises.org/econsense/ch78.asp says at the very bottom of the page :
“It is also why it would be far better to suffer a one-shot deflationary contraction of the fraudulent fractional-reserve banking system, and go back to a sound system of 100% reserves.”

would this so-called legislation be GOING BACK the the system of 100 percent resreves that a rothbard says existed???

could someone describe the actual 100 percent reserve system that the rothbag refers to??

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scineram September 16, 2010 at 1:07 pm

It is not exactly going back. It never really existed yet.

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james b. longacre September 16, 2010 at 1:30 pm

so the rothbard quote is a lie…a falsehood??

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Cory Brickner September 16, 2010 at 2:59 pm

No, there was 100% reserve banking in the past, just not consistently over the course of banking history. You have to understand that politics plays a huge part in the financial industry, as it does in many others. Please read the works. You’re starting to act like a troll based on your behavior and not a person truly interested in understanding the issues you’re asking about.

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Inquisitor September 16, 2010 at 4:11 pm

“could someone describe the actual 100 percent reserve system that the rothbag refers to??”

Rothbag. Either a funny typo or a troll. :P

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newson September 16, 2010 at 8:15 pm
Greg September 16, 2010 at 1:15 pm

I don’t see how this is going to take any step towards liberty. As DD5 pointed out above: If they still have deposit insurance, this whole thing is pointless. Clearly the banks will make the FRB accounts more attractive to customers, since it allows them to counterfeit money. Why would people choose the 100% option if their money is covered by government insurance, and we all know governments cannot default. Meanwhile, those with 100% reserve accounts are still negatively impacted by the inflation created by FRB.

Adding more government regulations in this area is not the answer. FRB will still be legal. The only solution is to consider FRB what it really is. Counterfeit, which is a form of fraud, and illegal.

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james b. longacre September 16, 2010 at 1:33 pm

would they be just as negativley affected as you claim by straitforward currency inflation??

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Shed Plant September 16, 2010 at 1:39 pm

Yes, but at the very least it might raise awareness among the public about who owns “their” money. I for one would appreciate the chance to opt out.

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The Kid Salami September 16, 2010 at 3:08 pm

Gradually chipping away at people’s mistaken beliefs about money and banking, helping them to join the dots and connect the bailouts with the recessions, generally educating the people about money and banking practices?

Yes, all nonsense, no good to be said of that at all. You’re right I’m sure, the only possible step forward is the whole population agreeing to read de Soto’s book then plunge headlong into anarcho-capitalism at the stroke of midnight and burning the houses of parliament – anything else is just a waste of time.

“Adding more government regulations in this area is not the answer. FRB will still be legal. The only solution is to consider FRB what it really is. Counterfeit, which is a form of fraud, and illegal.”

Hmm, you think Carswell and Baker and Baxendale and de Soto don’t know this? One step at a time. It might be too late – i suspect it is – but it’s a hell of a lot better than nothing.

The Mises Institute got mentioned in a bill in parliament – what on earth do you want? If that isn’t good enough then you obviously think this site is a waste of time also, because if someone said this would happen ten years ago, i reckon the institute would have taken it. I certainly am amazed by it.

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Shed Plant September 16, 2010 at 3:43 pm

Well put.

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Greg September 17, 2010 at 8:06 am

You think that this bill passing will suddenly awaken the masses? It will educate them on how banking works? Here’s a more likely scenario. John Smith goes to the bank, and they offer him a FRB account vs. a 100% backed account. He’s told that in either case, his money is insured by the government, and the FRB account gives him better perks. He chooses the FRB account, and goes on his merry way.

Thinking that this bill is going to precipitate any real change is just wishful thinking. And it’s great that the Mises Institute was mentioned in parliament, but does anyone here really think that means the British people are on their way to liberty?

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The Kid Salami September 17, 2010 at 8:27 am

“You think that this bill passing will suddenly awaken the masses? It will educate them on how banking works?”

I didn’t say it would “suddenly awaken the masses” – it won’t.

I didn’t say it would “will educate them on how banking works” completely, I said clearly taht it would chip away at their misconceptions. That is, it would ever so slightly “educate them on how banking works”.

If you say redemption here is not possible by chipping away, if you say that we’ve passed the point of no return and must face the consequences, then fine – you could well me right. It’s a judgement call though, one on which reasonable people can disagree. You though seem to think this is just obviously pointless – you must have some insight de Soto and Baxendale (no fools they) don’t have.

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Russ the Apostate September 16, 2010 at 3:43 pm

As long as the banks tell their depositors that they are doing FRB, and that is why they are getting paid interest, then I can’t see how it’s fraud. At that point, putting your money into a bank account is simply an investment, and like any investment, entails risk.

Even if fractional reserve accounts were illegalized, and also the equivalent of the FDIC were eliminated, what would be the result? I would bet the result would be that people would suddenly be up in arms when they find out that their banks no longer provide any interest payments on their deposits. They would be more up in arms to find out that the banks now expect to be paid for the service of securing their money, instead of paying for the privilege. Depositors would withdraw their money, en masse, and then the banks would have no demand deposit accounts at all.

Instead, why not simply have the government not insure any bank accounts? Then, if people want interest on their demand deposit accounts, they can get it, but they also have to take responsibility for the risk. If people decide they don’t want to take such risk, they can get 100% reserve accounts, or at least find a bank that is leveraged at a level at which they find the risk acceptable. I don’t know how many people will want to pay banks to store their money, though. Perhaps the sales of safes would increase?

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Shed Plant September 16, 2010 at 4:02 pm

Yes, it may be possible to construct FRB out of contract. At least some measure of consent would make it more palatable.

Of course you’re right that most people today would think it outrageous to pay for banking services – but it’s cheaper than a State bailout!

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Russ the Apostate September 16, 2010 at 4:20 pm

“At least some measure of consent would make it more palatable.”

How do we not have consent now? It’s not exactly a secret that the current banking system is based on FRB, after all.

“Of course you’re right that most people today would think it outrageous to pay for banking services – but it’s cheaper than a State bailout!”

Maybe so. My point is that all that illegalizing FRB would do is cause bank runs, which taxpayers would also pay for via FDIC or equivalent. Illegalizing FRB and FDIC or equivalent would also cause bank runs, as people rush to get their money out first. It would also ruin millions of people.

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Shed Plant September 16, 2010 at 4:34 pm

No secret to you and I, perhaps, but as Mr. Carswell said in his speech, a recent poll in the UK found 74% of people think that money in the bank belongs to them and only 8% were aware that they are legally creditors to the bank. http://www.theyworkforyou.com/debates/?id=2010-09-15a.903.0

If everyone understood the insolvency of FRB overnight then there would surely be a dramatic financial crisis. But if banks were solvent in the first place, customers’ awareness of banking practice wouldn’t present a problem!

If this is ever resolved well, it will be by increasing public awareness and objection. Probably the best outcome one could hope from Carswell’s bill is a contribution to that awareness, including among MPs.

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Russ the Apostate September 16, 2010 at 4:54 pm

“…a recent poll in the UK found 74% of people think that money in the bank belongs to them and only 8% were aware that they are legally creditors to the bank.”

Really? That’s astounding. How do people think that banks make money to pay interest on deposits, if the money is just left sitting there in a safe???

“But if banks were solvent in the first place, customers’ awareness of banking practice wouldn’t present a problem!”

I see no “instant” way (via legislation, or getting rid of same) to fix this. AFAICT, banks would have to stop lending out money, and then, as their loans eventually get paid, they might get back to 100% reserves. Of course, they’d have to stop interest payments if they stop loaning. That would cause runs, which would demand the money faster than the loans would be paid back. This would be highly deflationary, I would think.

I would be seriously interested if anyone could explain how such reform could be done without causing serious pain. Same with return to a full gold standard.

newson September 16, 2010 at 8:19 pm

to russ:
in the asian crisis, this is just what happened. home and office safe sales boomed.

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Elwood P. Dowd September 16, 2010 at 10:18 pm

Russ, you aptly describe the confusion over FRB being a fraudulent practise.
Please allow me to explain why it is fraud. It is definitely true that it is
widely admitted that banks today practise fractional reserve banking. The fraud
does not lie in denying their status as fractional reserve banks, the fraud lies
in their telling depositors that they have a legal obligation to return their
money (with possible short delays) at all. In order for fractional reserve banks
to avoid fraud they would have to tell depositors that there was no legal
obligation for them to give the money back, no bank currently or at any time in
the past, has ever, so informed its depositors. Fractional reserve banking is a
ponzi scheme, it is not mathematiclly possible to honor all of the legal
obligations, that is the nature of the fraud. Would anyone call a business that
took peoples money, and expressly told them that it had no legal obligation to
return it, a bank in the first place?
Of course all of this ignores the other theft inherent in FRB, the stealing of
wealth by the same process as counterfeiting.
With Your Indulgence, the heretic Sy Akhplart

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Russ the Apostate September 17, 2010 at 5:17 am

“…it is not mathematiclly possible to honor all of the legal obligations, that is the nature of the fraud.”

Of course, if the bank loans out 99.25% or whatever of the depositors’ money, then only .75% will be available to pay back demands for deposits. The rest would have to wait for the loans to be paid back. That’s simple math. Anybody who doesn’t realize this is an idiot, IMO.

I was not aware that banks are not legally obliged to give depostors their money back, once they have it. I still don’t consider it fraud, though, as long as they tell their depositors that, which maybe they do in some legalese pamphlet that nobody reads?

“Of course all of this ignores the other theft inherent in FRB, the stealing of wealth by the same process as counterfeiting.”

Are you referring to fiat money in general, or FRB in particular? I agree that printing fiat money at will is inflationary, and thus morally equivalent to counterfeiting. I fail to see how FRB is counterfeiting.

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panika2008 September 17, 2010 at 7:55 am

“Fractional reserve banking is a ponzi scheme, it is not mathematiclly possible to honor all of the legal obligations, that is the nature of the fraud”

Your views on banking are extremely simplistic and misguided. While of course it is true that the obligations cannot be met instantaneously, noone expects and arranges for them to be met instantaneously. The whole concept of risk and liquidity management is built on the premise that the bank’s obligations are perfectly satisfiable under the assumption that there is enough continuity/stability in the market, ie that there is no sudden run on deposits; however, even the act of run on deposits can be insured against and it is conceivable that FR banks on the totally free market would engage both in interbank liquidity management (as they are today) and voluntary deposit insurance. That they are shielded by FDIC today does not mean that they could and would not form a free market ensemble with a third party, just like insurance companies use the reinsurers to manage their risk.

Anyway the entire point is moot, because the banks explicitly STATE IN EVERY f*n DEPOSIT CONTRACT that on certain occasions redemptions could be delayed for such and such days (the time required to obtain liquidity on the market under unexpected stress). It’s your f*n problem if you don’t read the paper you sign.

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Elwood P. Dowd September 17, 2010 at 6:24 pm

Russ, you misunderstood me, banks are legally obligated to return depositors money, it is this obligation that constitutes the fraud, just as it does in any pyramid scheme. Those who claim that simply identifying themselves as a fractional reserve bank would eliminate fraud don’t understand the nature of the fraud involved. It is in fact the legal promise of returning everyones deposits (subject to small delays) that is fraudulent.

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Elwood P. Dowd September 17, 2010 at 6:34 pm

Panika, right back at you. Claiming that the fraudulent practise of frb can be made honest through private insurance shows a lack of understanding of both banking and insurance. The practise of fraud is not an insurable activity, no criminal activity is insurable. If frb cannot be made non-fraudulent without insurance, then it is not insurable in any private system.
As to your last insulting comment, as I pointed out to you once before elsewhere, a delay in payment of a couple weeks is not the same as never paying. I suggest that only in your small mind is a couple of weeks the same as never.

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Rollie September 16, 2010 at 10:30 pm

Russ and Shed Plant,

Contractual FRB might not be fraudulent, but it is indeed an illegitimate contract. Rights cannot conflict.

http://mises.org/media/3052

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Shed Plant September 17, 2010 at 4:20 am

I know and agree :) .

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Russ the Apostate September 17, 2010 at 5:20 am

Could you briefly explain how contractual FRB is an illegitimate contract? How do rights conflict in contractual FRB?

I ask for a written explanation because 1) I am having trouble with the link you provided, and 2) don’t much care for media as part of my Internet “experience” anyway. I’m oldschool, and I prefer text.

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Jose L. September 16, 2010 at 1:19 pm

…but says that depositors must be offered the choice of 100% reserve accounts or FRB accounts

What would be the advantage of this option?
As the banks will not be allowed to bankrupt by politicians, there is no gain in this option. It is the same if the banker takes care of the deposits or not. There is no solution to this…

JL

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Shed Plant September 16, 2010 at 2:59 pm

Perhaps it isn’t an ideal or stable state of affairs, but on the other hand, this is the first time opposition to FRB from an Austrian perspective has ever been heard in British politics, so it’s a good start :) !

Even in the current climate, a law prosecuting the entire British financial sector for practicing fraud is not conceivable.

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james b. longacre September 16, 2010 at 1:34 pm

do the frb accounts really exist en mass in teh uk?

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Shed Plant September 16, 2010 at 1:37 pm

With very few exceptions of Islamic Banks, every bank account is fractional-reserve.

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Walt D. September 16, 2010 at 2:42 pm

Jeffrey: “Losses from Fannie Mae, Freddie Mac seizures may near $400 billion”. Tangential and off topic, but what do you make of this?
http://www.latimes.com/business/la-fi-fannie-freddie-20100916,0,6603010.story?track=rss&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+latimes/mostviewed+(L.A.+Times+-+Most+Viewed+Stories)

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Walt D. September 16, 2010 at 3:51 pm

“Congressmen Weiner and Waxman Set Gold Hearing”.
.. just in case you though you could thwart fiat currency by buying gold.
“http://seekingalpha.com/article/225579-congressmen-weiner-and-waxman-set-gold-hearing”

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mushindo September 17, 2010 at 4:40 am

Speaking both as a libertarian and as a ( I like to think, ethical) banker, I have no problem with fractional reserving per se. Any bank as an enterprise should be free to manage its affairs as its management sees fit, and their customers should be free to decide how trustworthy and prudent they are, accepting that there is alway some level of risk which needs to be balanced against return.

The problem lies with central banks orchestrating the market for credit by fiat, and meddling in supervisory second-guessing of private banks’ liquidity risk and capital management, and (the elephant in the room) behaving as a guaranteed lender of last resort, or bailer-out, which is the foundation of all systemic banking sector recklessness.

These statist interferences are the causes of cyclical instability, not the practice of lending out monies deposited. In their absence, any given bank’s desire to stay in business is sufficient motivation for it to manage its liquidity risks prudently -(Prudential reputation is after all any bank’s most jealously-protected asset). And any money which is systemically ‘created’ as a result is a consequence of theincreased productive activity and wealth creation funded by this lending, and hence still needs to be backed by real assets in the hands of th eborrowers…I digress).

Those which lend to dud repayment prospects , or which manage liquidity imprudently, will swiftly be eliminated, and without the central orchestration, such failures as do occur from time to time would not be be temporally synchronised, but would have the effect of continually sterilising mal-investment, cleaning out incompetence, and pricking bubbles before they inflate to catastrophic proportions. And there would also be less overconcentration ( Itself driven in part by colossal regulatory compliance costs, which only the largest of banks can incur without threatening viability*) with a larger number of banks with a broader size distribution, instead of a handful of oligopolistic behemoths, which tend to become part of the cyclical centralist problem.

if you deposit money with banks and expect to earn interest, you have effectively given a loan to that bank, and you must accept the concomitant risk, and you must expect that bank to deploy that money to earn interest on th eother side. Its not accepting these deposits out of warmhearted charitability. Theres nothing wrong with that , as long as everyone understands their roles, responsibilities, and risks. Thats the very essence of liberty.

I found it very ironic that Rothbard himself (in his Mystery of Banking), was rather dogmatically vocal about the morality of banks lending out deposits, on the grounds that they ‘SHOULD’ not have the legal right to do so -(while simultaneously declaring that banks onlending money they have themselves borrowed is a wholesome business practice). TYhen he went on to explain why, in the absence of central banking, the ordinary free market interactions would neutralise the problem anyway! The fact is that deposits ARE loans to banks by its customers – they even attract interest – so I fail to see the moral difference.

Finally, I would mention that it is not sufficiently recognised in Austrian quarters that if one is not prepared to take the risk of losing your deposits, you can still deposit money with any bank and retain your full ownership over it, and th eank is not contractually able to lend it out. Its called ‘safe custody’ , and you pay for it, and the contents of YOUR box in the vault remain wholly yours, even in the event of the bank’s failure. Few people ( other than in many emerging markets with high levels of political instability) , use this any more because they have habitually come to expect the State to guarantee the risks that they accept – and having gotten used to being insulated from the consequences of their own decisions, they can’t seem to handle the concept of actually paying someone else to look after their stuff.

* It is ironic that the costs of ever-more regulation gives rise to economies of scale , which are usually regarded as a Very Good Thing, but when the cost is an arbitrary one imposed by fiat, it becomes nothing more than another strand in the web of state-support for monopolism, and hence tends to grow dominant enterprises BEYOND the optimal size which balances bureaucratic/administrative unweildiness and productivity cost minimisation.

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Stephan Kinsella September 17, 2010 at 7:50 am

This post is in reference to UK Proposal for Banking Reform: Fractional-Reserve Banking versus Deposits and Loans, and, in particular, is translated from Huerta de Soto’s article on LibertadDigital.com about this. See also other coverage in Spanish on LibertadDigital.com by Manuel Llamas and Juan Ramón Rallo.

Toby Baxendale’s Cobden Centre post Support for Douglas Carswell’s forthcoming Bill to reform the banks provides links to various articles and posts in support of the Bill.

Peter Boettke blogs about it in Can Banking Reform End the Boom and Bust Cycle?, and Brian Doherty blogs it on Reason‘s Hit & Run in Stop the Real Bank Robbery.

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