This thread is about the post on reserve banking and so I don't know how I can be construed to be "misdirecting," but it's your site so whatever. I hope you're not talking about me because I am trying to get information and trying to add something. But I admit I have a habit of asking "hard" questions that no one can or will answer and getting in trouble for it. Note that I am here railing against the bezzle. I assert the bezzle is inherent in the system and the only way to get rid of it is to get rid of fractional reserve banking and fiat money. The removal of the possibility of taxpayer looting removes moral hazard. The removal of fractional reserve banking removes leverage. AT that point, individual investors can decide how much disclosure they want in order to invest in any given company. The private enterprise system could easily come up with accounting standards and companies could agree to comply with them, etc. Government could actually enforce fraud statutes instead of giving me a speeding ticket, but that's a pipe dream I know.

Can any of you assert that we would where we are now (looting the taxpayers) if we had full-reserve banking, Constitutional money and no central bank?


Fitz: My point is, Constitutional money, full-reserve banking (no leverage) and no central bank is a system that is harder to abuse, and a lot harder to abuse is such a globally destructive manner. Of course there is always abuse. My system is not immune to abuse, it is merely harder to abuse in a way that takes down the whole shooting match.

Quote:

Constitutional money, full-reserve banking (no leverage) and no central bank is a system that is harder to abuse, and a lot harder to abuse is such a globally destructive manner.

Then explain, if it is a lot harder to abuse, how it morphed into what we have now.

"Constitutional money"? Congress orders the Treasury to print up a bunch whenever it wants to spend more? Oh, nothing could go wrong that....

Quote:

@Swrichmond - "fractional reserve system, a central bank and fiat currency"

I think one problem you may have is conflating credit & money - they are two very separate concepts. Credit is a means of merely notating existing asset (typically, illiquid) values. In my example above where $100k of assets was transformed into $1.1m, it is nothing more than aggregating $100k of cash (money) with $1m of very real **pre-existing** property (land, equipment and intellectual).

Money, fiat or commodity based, has nothing to do with it. It is a completely different discussion. KD has published countless essays demonstrating that the total private credit system is orders of magnitude larger than actual currency in circulation/deposits.

Can there be abuses under FRB? Of course; that's why KD is constantly calling for legal action. Without fear of prosecution, the situation we currently find ourselves in will happen every time.

Quote:

I assert the bezzle is inherent in the system and the only way to get rid of it is to get rid of fractional reserve banking and fiat money.

Lack of respect for the law will create unlawful actions in any system, full reserve and/or FRB. It's not the system per se, it is the fair & persistent application of the RULE OF LAW. Corrupt the law, and society collapses. Which is where we find ourselves today.

SW:
you can run a fractional lending system against dollars, silver, gold, seashells, and anything else that can be put on deposit. Demanding that all loans be covered 1 to 1 is nothing more than saying you want to talk to your girlfriends father about subdividing the the farm so you can create grandchildren. you would have to know the lender to effect the transfer.

the bond market is a very complicated version of what you are perhaps implying: one lender, one borrower. if that is what you would prefer, go for it. just don't blame AIG. their games were not born out of banking. their sin was gambling. having a direct obligation to the bondholder didn't slow them down one bit.

I guess my frustration, and it looks like gen's as well, is trying to figure out what the hell so many people have against banks. maybe that's a root question that hasn't been asked here. what do you guys have against banks? some people put money into the bank, in lieu of using it, for the gain of interest. others take money out for use and they pay interest. as long as the bank is sound, (it's guarantee is good), there is no problem. that's why kicking the big banks in the jimmie right now is so important. FORCE them to raise equity until their guarantees are considered **by depositors** to be SOLID. that solves this whole problem just well as any gov't guarantee would.

the bezzle is inherent in human nature and therefore all systems.

>looks like that no sale button will be getting a lot of use

That's an ongoing fraud... I remember reading up on somewhat sophisticated registers that would keep two sets of books and the lighter one would be reported to the fed for tax purposes, and the heavier for business purposes.

Really the solution is a European-style VAT to extract the value throughout the supply chain, rather than all at the end. Actually VAT has the same problem, just ran through the numbers, so disregard that. Plus there's carousel fraud for the VAT too, but regardless I'm now way off topic.

On topic:
>Relation between money and credit: Credit is a promise to pay money.

And a legally enforceable promise to pay money is worth money (depending on factors such as the solvency of the debtor, current risk-free interest rate, etc).

>Debit cards are actual money, no?

Not if you can overdaft your account with the debit card, and still make the purchase. If you can, then it is short-term credit which gets settled by an automatic payment from the account backing the debit card.

Note that checks are also credit, not money.

>And, IMHO, defining a disticntion between credit and money substitutes may make understanding banking systems more clear.

Really its seems like its just semantics and whether the customer exchanges FRNs for bank credit before or after the transaction takes place. And regardless, since FRNs and bank credit are indistinguishable as far as what number your bank account says it is worth, there's no meaningful distinction between "money substitute" and "credit" other than how the nonpayment risk is distributed between the seller and the bank.

Berkely wrote..

that's why kicking the big banks in the jimmie right now is so important. FORCE them to raise equity until their guarantees are considered **by depositors** to be SOLID. that solves this whole problem just well as any gov't guarantee would.

"Government guarantees" ARE virtually the whole problem.

The banks would solve their own messes, or their bones would be picked by scavenging competitors at bankruptcy liquidations, if they could not rely on government guarantees for bail-outs and de facto immunity from fraud prosecution by judicial agencies looking the other way.

Were it not for TARP, the Fed and the Treasury actions last fall, the bad banks would have blown up, and we'd already be picking up the pieces by now instead of watching things get steadily worse.

KD,

Thanks for explaining the whole fractional reserve system. Your arguments make perfect sense.

This is one area that I have not been able to figure out what Mish is advocating. I can understand how we could live without the Federal Reserve but, without fractional reserve lending, money would be hard to obtain. Loans would require people to agree to lock up their money for long periods of time basically like bonds or private mortgages. What would be nice is if we had a system that was not gamed by the regulators so depositors would receive an interest rate that reflected the true demand for money. 0% interest for deposits is the equivalent of usury rates for borrowers.

SW: The Bezzle, (friction / slippage), is inherent in any system (that I know of). The question is how much is acceptable. "Constitutional money, full-reserve banking (no leverage) and no central bank is a system that is harder to abuse..." Well, quantify that. How much harder? Is that "harder" worth it? How long have those types of systems lasted? What were the pros and cons? Why did they change? How about a whole list of the variables assigned with pros and cons.

And it might be technologically easier to clip coins now-a-days :-)

I am just starting to think about it, but seems to me the only entities that had a chunk of money in non-fiat systems were governments. Off hand, I think the reward of having private hands hold a lot of value far out weight quite a few risks.

Alanha, I think I am sitting in your camp.

Just for historical sake, those like me who argue from a constitutional point of view may consider that the colonists opposition to FRB and fiat currencies may in fact have been since at the time the only entities that were large enough to make loans were the English banks (I suppose French as well). So those opposed to the Hamiltonian central banking philosophy were worried about loyalties to England within the CB system. Just a hypothesis, I am not trying to spread tin Gen.

Alanha,

"Then explain, if it is a lot harder to abuse, how it morphed into what we have now."

We failed to adequately defend it, and the Federal Reserve Act was passed, introducing moral hazard. Bad money displaces good money. If you would go back 150 years in time and tell Americans "we're going to go from gold and silver currency directly and completely to an unconvertible and unbacked paper currency" I think there'd have been trouble. I know it was done during the Civil War, and that is an interesting case: It was done to inflate to pay for the war. With the introduction of the warfare-welfare state, we needed constant inflation and voila! Central bank.

In my overly simplistic view we reduced the system to tatters in two steps: Federal Reserve Act, then removal of gold from circulation followed by removal of dollar-convertibility. The "Dollar Reserve Currency System" is based on the "Full Faith and Credit of the United States Government" and nothing more. The faith is being tested, and I'd prefer to not have a faith-based currency system. When I say "Constitutional Money" I mean fully-convertible currency, and I apologize if there is any confusion about that.

Mises' position (which I believe is true) is that: "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved".

If that is true then as far as I am concerned the ever-increasing leverages, enabled at least partly by fractional-reserve lending, were used merely to keep the system inflating as a means to try to stave off the inevitable collapse. A system based on convertible money and full-reserve banking could not so quickly produce such excesses. One of the downfalls of fractional-reserve lending is the different "reserve requirements" that are (or at least used to be) imposed for different credit quality assets. As credit quality falls, reserve requirements quickly mount, sucking up additional capital and accelerating the banks' weakness and inability to lend.

Fitz:

"The Bezzle, (friction / slippage), is inherent in any system (that I know of). The question is how much is acceptable."

I believe the Fed's ability to deliberately, as an act under color of law, manipulate the value of the currency I use is fraud. As an example, the Fed just clicked into being several hundred billion new "dollars" by "expanding its balance sheet". These same dollars are used as a denomination of other people's labor. Let's say I get paid $100.00 an hour. I work for a week and am presented with a check for $4,000.00. During this same week, the Fed has doubled the supply of dollars. My labor has in effect been devalued by an act of government. I consider this "bezzle", and it is a power that no one should have, especially not a government. There are no men wise and virtuous enough to have and use that power. Taking that power away from them makes it harder for them to abuse me. How much harder? I don't know. Is it worth it? YES.

It is truly astounding the level of credit intermediation we have now. I vividly remember when supermarkets began allowing you to pay for groceries with a credit card. I was a little kid at the time and it just amazed me when they began installing the card swipe machines. I remember thinking at the time how now every checker was just like a bank teller.

The idea of buying basic food items on credit is remarkable when you think about it.

Quote:

Poppycock. If leverage is allowed it will be abused in an effort to achieve advantage over competitors. Crap will go "off balance-sheet" or into some new "financial vehicle" designed to confuse regulators long enough to win the game.

The problem with fractional reserve banking is that it gives the appearance of working really well...until it breaks everything. Any nation that unilaterally adopted full-reserve banking and/or a fully-backed currency would be economically and militarily outproduced by its neighbors during the honeymoon phase of FRB / fiat which lasts, by our recent observations, several generations. In other words, bad money displaces good money.

Since bad money also makes for highly profitable banking, as Karl points out so eloquently, bad money also makes for a reliable stream of political contributions and a fully deep-captured political system.

We are doomed by political realities to repeat this cycle. The Austirans are, of course, correct, but have no chance of seeing their position carried into policy since they can't be bought.

Let's just get on with it.

I agree completely. FRB works great in theory and it works great 99% of the time. We are finding out about the other 1% right now. Don't forget that abusing it also causes inflation, which forces everyone to invest in the market in an attempt to keep up with inflation.... which makes the pigmen even richer.

I don't disagree with your logic at all Karl. The problem is corruption. Pure democracy would also work very well on paper, the problem is that people are corrupt and easily manipulated. That is why we have a Constitution with checks and balances and all sorts of procedural constraints that serve to slow down change.

Could someone explain how full reserve banking would work? Would it require that banks only lend against their own capital or possibly long term bonds that exceed the length of the loans that are made against them?

Swrichmond, this in the internet age.

Your FRNs are instantly convertible into any damn thing you please with a few mouseclicks.

SW:

"None of you are responding to my basic point, and perhaps that is because there is no response other than scaring people about "going back to growing potatoes and making applesauce".

The existence of a fractional reserve system, a central bank and fiat currency positively guarantees abuse by introducing two elements essential for abuse: leverage, and moral hazard. Where leverage and moral hazard exist, WHAT ELSE
CAN WE EXPECT OTHER THAN THAT WHICH WE JUST GOT?

KD:

"That's because your asertion sw is a bald assertion without evidence.
It thus does not merit a response."


KD, you wrote a ticker I believe over the summer 2008, expressing shock on hearing an interview by either a member of the Fed Board or a Fed Bank, stating very boldly yes the Fed does promote moral hazard. His words were very specific and I believe you were surprised his statement left no doubt. The ticker included a youtube of the interview, so you do have evidence, in their own words if you go back thru yr files. Can't remember who it was but I think he was attached to Dallas FRB.

Kuhio:

"I think one problem you may have is conflating credit & money..."

No I don't think so. The Fed is the central creature enabling both. The Fed sets "reserve ratios" enabling leverage and also creates "money" out of thin air by "expanding its balance sheet".

Your example of reserve lending does not necessarily illustrate fraud itself but the quality of the "assets" on the banks' balance sheets is how we got where we are now. Is there any contention as to whether or not expansive Fed credit policy aided and abetted the housing bubble? Is there any contention as to the fact that leverage works both ways? Isn't the "deleveraging" more painful because of the level of leverage that blew the bubble in the first place, both inside the "traditional" banking system and outside it?



berkeleyreindeer:

"I guess my frustration, and it looks like gen's as well, is trying to figure out what the hell so many people have against banks. maybe that's a root question that hasn't been asked here. what do you guys have against banks?"

I don't have anything against banks per se until their lobbyists send the taxman to my house with a gun to steal money from me. Then I have a problem.

death and taxes my good man. we're stuck with them.

as for fixing banks and moral hazard: it's only a moral hazard if the owners of the banks don't have considerable skin in the game. that is precisely where bernanke screwed up. tell Citi and AIG straight up you are going to fail if you ring my phone. they will find a way to raise money or have their stockholders cancelled out. then the junior bonds. then the senior bonds. keep cutting until they can make good. SKIN IN THE GAME. **** these gov't guarantees. let em profit or parish on their own merit.

>What would be nice is if we had a system that was not gamed by the regulators so depositors would receive an interest rate that reflected the true demand for money. 0% interest for deposits is the equivalent of usury rates for borrowers.

money market funds

>Your FRNs are instantly convertible into any damn thing you please with a few mouseclicks.


Which reminds me to try to make a point: convertible commodity-backed money is nothing more than fixing an exchange rate by government fiat. Fixed exchange rates are fail. See: Bretton Woods.

Edit: fixed exchange rates will be attacked by speculators. If you peg the dollar to gold at $1k/ounce (arbitrary number), and enough people borrow dollars to speculate on gold, well, there's only so much physical gold and something is going to give. And the downside to the speculative play is rather limited, since you can just convert back into dollars and lose out only on the interest. And the upside is that the US can no longer maintain the peg to gold, and the gold you hold is worth a lot more than $1k/ounce.

And if you value gold expensively enough to have enough gold to cover the available dollar-denominated credit for gold speculation, well, you've just devalued the hell out of the dollar.

second edit: there was a "run on the pound"/"Black Wednesday" in the UK a couple decades back where George Soros, among others, borrowed pounds to buy german marks to force the UK to defend their currency peg.

Thrustvectoring, yep!

I want to know how many ounces of gold I need to buy a sandwich for lunch. because that's what a 1:1 (gold in vault to note in hand) the hard money folks want. the answer is: none. I have to make my own ****ing sandwich every day because the grocery store goes bankrupt. I'll have to raise my own grain, bake my own bread, and move to a warmer climate if I want fresh veggie more than 5 months a year because the truckers won't be able to get fuel to bring fresh food to me. maybe I should plan to trade walleye fillets for diesel fuel for the trucker. that's a hard money trade too. little tough to catch fish on demand, but other than that, it'll be great!

Quote:

One corrective measure we should apply is to set regulatory capital limits as the inverse of leverage. That is, if we have a 6% regulatory capital requirement for 10:1 reserve lending, if someone wants 20:1 they should be required to hold 12%.

If you couple this with two more demands you can effectively eliminate systemic failure risk:

Everything you hold as an asset must be traded on a public exchange or have an exposed and public model, both run nightly, with no hidden or off-sheet exposures of any kind.
Your regulatory capital ratios must be published and exposed every night.
Immediate seizure and liquidation of any firm that violates limits now provides the safety necessary to insure that depositors are protected, and public exposure of (1) and (2) means that the sort of game-playing we saw with IndyMac, where capital was improperly moved from one reporting period to another, will be immediately detected both by investors and the public at large.

I love this part.

Unfortunately, I feel it has about as much chance of being implemented as there is for monkeys to fly out of my ass.

>I have to make my own ****ing sandwich every day because the grocery store goes bankrupt.

actually odds are they'd try to keep everything else just the same, except there happens to be physical gold backing the dollar. Which would rapidly descend into the bank using up their physical gold or other assets defending either the dollar or Au against market forces pushing on the exchange rate between the two.