The revolving door between Wall Street and the bowels of Washington are getting a workout. It's the guys from Wall Street who run the government and the guys from government who run Wall Street. Only the guys from Wall Street - especially Goldman Sachs - who have taken over the Treasury Department are now taking over control of the domestic auto industry. You know what happened when they tried to run their own company, Goldman Sachs.Emphasis added.
The big investment banks are the kings of leveraged banking. They've taken it to new levels of insanity.
Murry Rothbard wrote that fractional reserve banking is fraud. I couldn't agree more.
If you read enough Austrian economic literature (and I guess I've read enough to know the pattern, but nowhere near enough to be an expert on the subject), you'll notice a great deal of use of the word "if". For instance, in Rothbard's excellent The Mystery of Banking he describes how "free banking" would work. And the description is filled with (actual or implied) "if" clauses.
On page 113, Rothbard writes:
The bank run is a marvelously effective weapon because (a) it is irresistible, since once it gets going it cannot be stopped, and (b) it serves as a dramatic device for calling everyone’s attention to the inherent unsoundness and insolvency of fractional reserve banking. Hence, bank runs feed on one another, and can induce other bank runs to follow. Bank runs instruct the public in the essential fraudulence of fractional reserve banking, in its essence as a giant Ponzi scheme in which a few people can redeem their deposits only because most depositors do not follow suit.But history tells us the threat of a bank run has a very different effect: the threat of a bank run encourages bankers to collude with one another to prevent bank runs. It does not prevent fractional reserve banking, which is a highly profitable business (I guess some would say the use of "profit" is a misnomer when income is based on fraud, but I digress); instead, it leads to collusion amongst bankers to prevent bank runs. This eventually results in so much collusion that a central bank is created to organize the collusion. And then the central banks collude; now they are debasing all of the world's currency somewhat in parallel.
All of this to avoid the biggest bank run of all: the dreaded run on the dollar.
To be sure, China is playing both sides. China continues to buy Treasury bonds (colluding with our central bank) but China is also taking steps to create yet another reserve currency.
(I read a really great conspiracy theory recently: China can convert its potentially valueless US Treasury and Agency debt into real goods by using the debt as AAA collateral for loans to buy gold (0r other commodities). If the value of the dollar drops significantly, the loan can be paid off in inflated dollars; or China can simply default, and let the owner of the loan have the US Treasuries backing the loan. That's pretty clever.)
This gets me back to primary thesis about banking: it is only by expanding the universe of banks that collude one with another that the Ponzi scheme of fractional reserve banking can continue. This is why a global central bank is inevitable unless we put an end to fractional reserve banking. It's fraud - but worse - it's fraud that spreads like a virus, slowly sucking in all productivity in a mad rush to make money from money rather than productivity and creativity. As the collusion continues the only way to make more money is with higher leverage which is made possible by the collusion. It is a Ponzi scheme that refuses to collapse.
How annoying.
Sadly, you can't outlaw fractional reserve banking. People have tried. The bankers, who have a great deal of money, just bribe the right people to get the laws changed. In principle, over a long enough time frame, market forces will correct this error, but at huge cost, as a huge amount of productivity is destroyed. Who wants that?
An once of prevention is worth a pound of cure.
I have a friend who has an idea for a technology that might finally put an end to this vicious cycle. The general principle, as he has described it to me, makes a lot of sense; however, getting to the point of a simple implementation has been hard. (Plus, it's a hobby task!) Still, I find myself thinking more and more about his idea and how to implement it with a clever hack.
Well, regardless of whether my friend figures it out, or someone else does, we need an inoculation for the viral infection that is fractional reserve banking. Otherwise it will eventually consume us all.
______________________________________
Read Nano-Plasm - you know you want to.
© 2005-2009 Stephen Clarke-Willson, Ph.D. - All Rights Reserved.
Why do you ignore the section on Free Banking in Scotland, p. 183 ? Freedom works. Free banking works. My P2P money system would allow fractional reserve banking by individuals, because nobody but the individual himself would know what he actually has in storage to back his currency. The history you allude to where banks have colluded to form a central bank, shows that such collusion only succeeds when the government is a party to the collusion and imposes a central bank by force. How can you call a government imposed central bank 'free banking'? Or draw any conclusion that 'free banking' doesn't work based on a history where government regulated banks? - Vincent
ReplyDeleteI've ignored Free Banking in Ireland for now because the evidence is less than convincing that there really was such a thing. At any rate, even if there was such a thing, without serious collusion, why did the experiment end? For Free Banking to be a real solution, it must spread on its own.
ReplyDeleteEventually the government is part of the collusion but it does not have to start that way; once enough banks of colluding they can start lobbying, as they have throughout history, for special treatment, because of their importance to the government. I would argue the banking collusion occurs privately and then spreads to public or government support, and not the other way around as is commonly assumed.
Bad government does not spring spontaneously out of the dirt. People with agendas create bad government. The people with the agendas create bad government. People with bad agendas and lots of money create lots of bad government.
It is commonly assumed that the welfare state is going to be the downfall of the US. Do you really think the poor people of America organized themselves and voted themselves a huge subsidy?
Or is it more likely that the businessmen of America created a huge bureaucracy that handed out money which business could then consume, in order to smooth out their own economic issues? Taking care of the poor is just a cover issue for more government largess to support business.
Anyway, I'll get around to Free Banking, but as I said, even if it existed, it was eventually subsumed by collusion, rather than spreading its glory.
As for your system, it might work, if it has safeguards against collusion!
At this point, I'm with the Austrians that education is our best defense - it needs to be "de facto" knowledge that fractional reserve banking is fraudulent.
Any highly profitable business will become controlled by the mafia. My uncle wanted to open a video gaming parlor back when those were all the rage and extremely profitable. He found out that he better not because the mafia owned them all and bad things happened to anybody who opened a gaming parlor in the mafia's part of town. The state is just the biggest mafia, and banks the most profitable business. No wonder that the biggest mafia controls the most profitable business. So, likewise, if anybody could open a gaming parlor, the competition might have improved prices and availability. That doesn't prove that free gaming parlors don't work. - Vincent
ReplyDeleteI would modify your statement to "any cash-based profitable business is likely to be controlled by the Mafia." When I started in computer and video games some old timers told me the origins of many common coin-op manufacturers and (ahem) many of them were funded by organized crime because it was an excellent way to launder money.
ReplyDeleteSo, yeah, banks are the same. :)
Coincidentally this arrived in my inbox:
ReplyDeleteMafia Cash Increases Grip on Sinking Italy.
Which is to say that just because a business makes an attractive target for mafia control doesn't mean that it wouldn't work fine without mafia control. Bankers are not inherently evil - but it only takes a few in cahoots with the mafia to make it appear so. In free competition, the honest ones would win. Focusing on fractional reserve banking as the problem with banks is the wrong track. The problem with banks is the mafia preventing the honest ones from competing with the mafia endorsed ones. If anybody could issue their own currency and run their own bank without restriction, competition and survival of the honest would be enough. Reputation would be all important in private currencies. I only suggest P2P currency because it is hard for the government to control P2P anything. If the government got out of the way and let banks issue their own currency, then a P2P currency scheme would not be necessary to bypass government control. Also, I don't know how you can say there isn't enough evidence that free banking occurred in Scotland. There were banks, they issued their own currencies, and their private currencies more trusted than British currency. The British mafia didn't like that and ended the competition. We need a way to protect ourselves from mafias, but that doesn't say anything about the viability of free banking. - Vincent
ReplyDeleteMy point is that fractional reserve banking, by its nature, is very risky, and the only alternative to continuous bank runs is collusion, and bankers choose collusion, if we let them.
ReplyDeleteYou refer to bankers as a group. That's collectivist thinking. Bankers are individuals who make individual choices. Some choose fraud. Some choose collusion. Some choose honesty. In a free market, where consumers have choice and fraud gets exposed, the honest bankers win. The question to ask isn't how to prevent fractional reserve banking. The question to ask is how to protect a free market in banking so that honest banks can operate without fear of coercion. If consumers have honest banks available to them, why would they do business with dishonest banks? - Vincent
ReplyDeleteIt is perfectly reasonable to reason about human behavior based on historical precedent. It is perfectly reasonable to assert that leveraged bankers will work hard to collude with other leveraged bankers and then to further collude with non-leveraged bankers and rope them into the pyramid scheme, because "honest banking" as you call it, is a huge threat. Because of the risk/reward structure of dishonest highly leveraged banking, the dishonest bankers have more money and influence than honest bankers.
ReplyDeleteRight now, today, we can all remove our money from Bank of America and put it somewhere else, thus sending a big message to BofA. But we're not going to do that, are we?
The more important step is to first intellectually recognize the behavior as fraud and secondly to ensure that the fraud is recognized socially and stamped out of existence. Fractional Reserve Banking, according to Rothbard, is legal because some doofus judge ruled it was okay to carry loans on the books as an asset. It's legal, right now, both on the books, and in terms of the expectations of bank customers.
Both situations need to change. Then a banker that loans out money he doesn't personally own will be treated as Madoff has been treated.
You say, "in a free market, where consumers have choice and fraud gets exposed, the honest bankers win."
This assumes the fraud (1) is recognized as fraud; (2) is quickly exposed, thus minimizing the damage from a bank run; and (3) customers have choices. The purpose of collusion is to eliminate free market choices - so far it's been very successful.
Do you think that over leveraged banks can achieve universal collusion in a free market without using coercion? Can you find any example in history where this has happened in a free market without the use of coercion? - Vincent
ReplyDeleteI can't find any examples of free markets. At this point, a 100% free market is just an abstraction.
ReplyDeleteSo can you state your viewpoint as a hypothesis which makes a falsifiable prediction? Would it be correct to say that you believe: "in a 100% free market where banks freely issue their own currency, 100% of all banks would willingly and voluntarily collude with each other in over leveraging fractional reserve currencies, or in creating a central bank to enable them to do so."? This is at best an untested hypothesis, since you deny that free banking in Scotland ever existed. Perhaps Murray Rothbard just made stuff up in his imagination when he wrote his book? For instance, on p. 185 "In contrast to the English banking system, the Scottish, in its 120 years of freedom from regulation, never evolved into a central banking structure marked by a pyramiding of commercial banks on top of a single repository of cash and bank reserves. On the contrary, each bank maintained its own specie reserves, and was responsible for its own solvency." But, no, that never happened you say. So, your hypothesis is untested. But regarding an untested hypothesis, how do you get away with saying "history shows" this collusion will happen in a free market, when history shows nothing since you can't site one example of a free market ever existing. Furthermore, supposing that all banks would collude as you say, then how would they agree on the multiple for their fractional reserve currencies? What if one bank wants a 5x multiple, one wants a 10x multiple and another wants a 20x multiple? In such a collusion, each bank would have incentive to lend at the highest multiple possible, while preferring the others to lend at lower multiples to preserve the stability of the system. They'd have to agree on one multiple to have peace between themselves. In other words, they'd pretty much have to agree on a central bank. That didn't happen in Scotland. - Vincent
ReplyDeleteIt's on my list of things to do to find references about how un-free the free banking in Scotland was.
ReplyDeleteIt would not be correct to summarize my statement the way you did. My hypothesis is that as soon as a single bank is allowed to participate in fractional reserve lending it will eventually get all the other banks to collude.
I don't claim the other banks willingly collude. Why did Switzerland recently agree to devalue its money? Because it was forced or conned into it. But Switzerland could still have held fast but it didn't. In the current environment, who has held fast to the gold standard? If it's such a great thing why hasn't a single state kept to it?
I don't recall saying anything about free markets in terms of my hypothesis - just that the Austrian free market is an abstraction that hasn't existed. It's still a good and useful abstraction but we need to figure out why it doesn't quite work. It all sounds good when you say it fast - if this bank does this, then that bank will do that, and everyone will live happily ever after. If only.
You are wrong, interestingly, about the motivation of the "other" banks. VAR was a system developed at JP Morgan that (supposedly) allowed them to have more control over their risk profile. It would seem to be a competitive advantage but instead they gave it away to all the other banks. Why? So they would leverage up just as much, which enhances the ability of JP Morgan to make more money, because they can make more obscure derivative financial instruments and sell them to their cobankers and generate more interest. It's all about making as much interest on as little real money as possible. This is the basis of modern banking.
Anyway, I need to dig up some info on Scotland. I don't think it was as rosy as you describe - and I recall Rothbard didn't say it was that rosy either. And who cares if they did hold out for 120 years? Eventually they caved. Why, if there system was so great?
Google has a preview of another book, The Experience of free banking
ReplyDeleteBy Kevin Dowd, which looks at many more periods of free banking in history. Bear in mind that all interactions between people can be classified in two broad categories: voluntary and by coercion. If you suggest that banks not be 'allowed' to do something, whatever that may be, you imply that somebody must be authorized to use force against them for the purpose of preventing that. Who is this somebody and from where do they derive authority to initiate force for a purpose other than self defense? A banknote is a contract between the bank and the person they issue the note to. Presumably the contract is transferable. At any point, the only parties concerned are the bank and the bearer of the bank's notes. Where does a "bank policeman" get the right to forcefully interfere in a contract to which he is not a party? - Vincent
As to why Switzerland or any other state went off the gold standard, what relevance does that have to a discussion of free markets? Any state, including Switzerland, is organized for the express purpose of exercising coercion. Since all states have already abandoned any claim to morality, why should we not also expect fraud from them? Their decision making processes are political, made by bureaucrats who have no proprietary interest or liability in the results of their decisions. Even though a pure free market has not been achieved, you can imagine a continuum on which exists less freedom and more freedom. In those environments toward the free end of the scale, the prediction of your hypothesis does not materialize during the period of freedom. The only valid point you have is that so far, environments of freedom have not lasted. Freedom gets destroyed by people exercising coercion. So far, no durable way of protecting freedom has been demonstrated in practice. This is not specific to banking but applies to all aspects of freedom. Since this problem is not specific to banking, and since during periods of relative freedom, banking has not shown the characteristic you predict, I think your hypothesis is wrong. However, even if your hypothesis were correct, it would only mean that when people have freedom to engage in self destructive behavior, they do so. No one has a right to forcefully interfere in somebody else's self destructive behavior. That includes if that person deals with dishonest banks, gets burned in a ponzi scheme, or loses their life savings in a real estate bubble because of fractional reserve banking. No one forced them to use that bank's currency, to buy real estate, or enter into any contracts. Alternatives are always available. Even in the current situation, everyone losing money is doing so as a result of their own choices. It may be that people are victims of fraud, but it is the buyer's responsibility to investigate possibility of fraud before making any investment. The only alternative to that is to have a policeman protect people from themselves, to reduce people's freedom of contract in order to prevent them from entering into bad contracts. Then who gets to be the policeman and who gets to decide what contracts are valid? That opens up a much worse can of worms than just giving people freedom and the responsibility thereof. - Vincent
ReplyDeleteThe best "policeman" so far is an educated populace.
ReplyDeleteI don't recall this being a discussion of free markets and I don't want to generalize the discussion to free markets. Fractional Reserve Banking is just a kind of banking that leads to wide spread human misery.
I don't even propose a method for containing it. It is possible a P2P money system would distribute the money making system sufficiently that there would be no central control. Or, it is just as possible that collusion will enter into and it eventually devolves into what we have now.
Also I haven't explained yet why such a system requires ever increasing inflation to work.
ReplyDeleteI think that fractional reserve banking will go away when currency issuance is separated from lending. There are already online gold backed currencies, such as goldmoney and e-gold. There is Paypal which is an online currency backed by dollars and some other currencies. These businesses perform issuance of electronic currency, which is comparable to the issuance of banknotes in days past, but they do not do any lending. Their currency is presumably 100% backed by reserves, and would be considered fraudulent if it were not so. Another thing, the ease of converting online currencies means that these institutions could experience a 'bank run' much faster than physical banks. The rapidity with which information propagates on the Internet means that even a credible rumor could trigger a run on them. So I think that the Internet and online currencies will change the business of private currency issuance so that fractional reserve banking will go away by itself, at least for proprietary privately issued currencies. - Vincent
ReplyDeleteYes. Realtime feedback on currency health (assuming it's not manipulated, but computers can help with that as well) might make it impossible to do an almost 100 year long scam as the Federal Reserve has done. Even a 2% a year "inflation goal" cuts the dollar in half every generation - but it's slow enough that it's hard to notice. And the inventiveness, creativity and efficiency of the American people and others around the world are enough to offset the life style destruction.
ReplyDeleteStill, destruction it is - currency destruction - and eventually it overwhelms.
Most gold storage plans cost from 0.5% to 2% per year. Other types of commodity storage cost more. So 2% inflation, if it were really that, would not be bad as a storage fee for holding value. Even private gold backed currencies depreciate at that rate, except that the 2% is charged up front as a storage fee. Community currencies depreciate over time because people leave the system with negative balances in their account. Even in a P2P system, I would not want to issue currency that maintains a steady value without charging a storage fee. Why should I bear the risks, costs, liability and work of storing value for somebody else for free? Only with fractional reserve banking can you store value in a demand deposit account and actually receive interest for it. Take away fractional reserve banking and you can expect to pay storage and service fees to whoever stores value for you. - Vincent
ReplyDeleteYup. But the storage fee will be small compared to the growth in the efficiency of the economy, in the same way efficiency grows now, except without bubbles. And one hopes that the cost of storage will go down as technology for that becomes more efficient too.
ReplyDeletePlus, you have the option of storing gold or other money yourself, so you can opt out.
Or, you can explicitly allow your money to be loaned out so long as it is accounted for properly. That would make you a venture capitalist which would be fine.
If there is no inflation (to speak of) then prices steadily deflate thanks to efficiency. So in order to retire, you save up enough money, and then live off it, as it grows in value, not because the numbers change, but because the money you have can buy more and cooler things if and when you choose to purchase.
But now I'm talking like an Austrian - if this, then that, and life is good, and everyone lives happily ever after.
You can already store gold for your retirement plan. Many people do that - they use a gold accumulation plan (GAP) to put a certain amount from each paycheck into gold. Gold will only remain viable as money until the exponential progress of technology finds a way to produce large quantities of gold cheaply. Nano tech mining of the ocean, or mining of the asteroids might do that. Technology will eventually make every physical product cheap and abundant. One thing will always remain limited in supply: the focus of human attention. A money based on human attention will be invulnerable to inflation. Measuring human attention can be tricky, since each person's attention has different quality and value. P2P currency might be the best way to base money on human attention, since each person can issue a currency based on whatever types of attention they specialize in. - Vincent
ReplyDeleteMaybe. If you believe Ray Kurzweil, once the Singularity hits, human attention will be in abundance as well.
ReplyDeleteBut would that be -human- attention? Also, I think the human brain is a quantum computer the power and design of which hasn't even been fathomed yet. - Vincent
ReplyDeleteHere we go:
ReplyDeleteThe Myth of Free Banking in Scotland by ... Murray Rothbard!
I think you'll find it educational.
From the introduction:
The influence of White's thesis is remarkable considering the paucity of his research and the thinness of his discussion. In a brief book of less than two hundred pages, only 26 are devoted to the Scottish question, and White admits that he relies for facts of Scottish banking almost solely on a few secondary sources. And yet, White's thesis on Scottish banking has been hastily and uncritically accepted by many diverse scholars, including the present writer.