[ExI] Fractional reserve banking

Lee Corbin lcorbin at rawbw.com
Sun Sep 28 21:57:36 UTC 2008


Eric writes

> Lee Corbin wrote:
> 
>>[...] Now this isn't all
>>bad IMO, because an expanding economy needs more money,
>>and this function could (and should have) replaced taxation.
> 
>>[...] The root
>>cause of the problem is fractional reserve banking, which
>>artificially creates wealth not backed by anything, where
>>I walk down the street confident that I have $10,000
>>and I pass someone else under the same illusion, when
>>it turns out the bank has just lent my money to him.
> 
> The way things work now, the reserve fraction is a slider that the
> government gets to control via regulations.  If it were slid all the
> way to 1:1, banks could loan no money, and we would be in a
> situation with a constant money supply.

First, Von Mieses made it clear that in each bank there should
be two lines, kept quite distinct by law. One line you stand in
goes to the "Deposit Window", where your deposits are held
absolutely inviolate, totally safe for you, but pay no interest.
(I.e., you may want to deposit some of your checks here,
those probably, on which you yourself want to write checks
or pay bills electronically with. No matter how it's stored---
electronically, physically, or in account books, the *deposit*
account of whoever wrote you the check is debited, and 
your account is credited. Totally on the up and up.)

The second line leads to the  "Investment Window", where you
give your money to the bank and they open an interest-bearing
account, but *with*---he emphasized over and over---a definite
time-stamp for when the funds would next be available to you.
(Sort of like a CD.) These funds the bank would be free to lend
out (and play their usual nice games, games that I do in fact
believe facilitate wealth creation). 

So you would know---because the banking system would be
even more stable than it is now---that under threat of criminal
penalty, the lending institution must have your money available
to you on the due date. But banks would, quite rightly, use
statistics to calculate that they could safely lend out a lot more
than they actually have, because there would be a certain
extremely high probability that the customer would either
roll over his funds, or transfer it into some other interest-bearing
investment on the due date.

The bank's lending managers would be prudently conservative,
however, because of the draconian criminal penalties, including
jail time, not to mention the destruction of their personal reputations.
But the statistics calculations are not too hard, (but as we learn
from The Black Swan and other recent books, not what people
have thought). So long-standing institutions of great probity would
flourish (e.g. as happened in New England for many decades in
the 19th  century until the post-Civil War government shut them
down).

If you wanted a higher interest rate, well, you could take
your chances on a bank that had a smaller reserve---there
may be good or bad reasons for investing there. But it's
up to you, and so are the risks thereby.

Now under the latter arrangement, I think that there is a place
for a Fed. They *could* print new money (remember, this is
always a good euphemism for lending out new money that
they simply create on the books of the U.S. Treasury).  And
if  "bank runs" did break out on a number of these institutions,
perhaps the government should return some fraction of the
money people had invested---but only after the directors of the 
investment branches of the banks that failed  had served their
jail time.

Meanwhile, the bank, noticing the lower interest rate from the
Fed, can realize that it can make a profit by cutting its own
rate to customers. Thus new money comes into the system,
although the bank still owes the Fed (or U.S. Treasury), the
way it would work in practice is that by the time it had to
pay the money back---remember, there is a *due date*
on all these things---it would probably have borrowed yet
more money from the Fed, and meanwhile have received
from its debtors money to cover it. It's all quite honest this
way.

> IIRC, the slider was set differently for normal banks, versus the "big
> five" investment banks.
> 
> That slider could be determined as a policy decision by each bank, and
> advertised as a way to attract customers.  Higher reserves means your
> money is safer.  Pressure from people wanting loans would work to keep
> the reserve amount lower, and banks would balance the amount they make
> from loans with the need to attract money to loan.

Yes, I think that's correct. But the key part is that when the
government is printing new money (i.e. lending out to banks
at a certain interest rate so that the money supply grows at
the same rate as the economy), the *government* officials must
themselves be held in check by law, including personal penalties,
to keep the rate at no more than a fixed percentage.

Experience over many, many decades suggests that this rate
should be 3%. Thus, the Fed (and the U.S. Treasury) would
raise interest rates if too much borrowing from banks were
going on, and lower them if too little was going on. But the
target---come hell or high water, good times or bad---must
be held to 3%, or whatever the most objective and judicially
minded economists say is the actual growth of wealth in the
country. In this way, a rate of zero inflation can be attained.

At least that's how I'd do it. Criticism VERY welcome on this
most difficult subject.

Thanks Eric, I'll respond to the rest of your post and your
conjectures later today.

Lee




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