Oh hey Pel, sorry I didn't read your other comment. I agree the beauty of a commodity based currency is that it is impossible to inflate based on politicians and central planner's whims. Of course the supply of gold would increase based on mining but that is itself a good thing since it represents actual productivity, it takes time, labor material etc. to increase the gold or silver supply versus imaginary digits in a computer which do the opposite, i.e. undermine productivity and capital. Every single dollar created by the whims of central planners dilutes the value of a dollar I have worked hard to earn and save.

@Pel - I am sorry, I must be misunderstanding what you are trying to state. Are you stating that the amount of capital invested already exists and the bank is simply a mechanism to transfer capital to producers? That would be begging the question, of course, as to how the capital investment was created.

Your example of a growing population, a deposit of coal in the ground, livestock, a business model is not capital that is being used in the production of goods or services. In order for any scarce resource to be used in production, you need to invest in capital structure - hiring people, buying equipment to mine coal, buying a silo to house milk, hiring marketing personnel to pitch your business idea. That takes investment over time from inception of business to production of a good or service that can be sold.

The ability of bringing a natural resource to market as a finished good requires capital investment. I argue that this requires actual savings.

IMO the disconnect comes from Karl looking at how FRL could work in a ethical society that acts in good faith, and Mish looks at how it is being implemented in a society permeated with fraud and at the highest levels is captured for purposes of social engineering.


ADD
The other thought that comes to mind is that FRL causes inflation due to interest cost, and this in return forces one to invest to stay ahead of the game.
This is doable only where rule of law is king.
Under a inner city gang like administration that has no respect for property rights this is not possible, so in this case FRL is one of the mechanisms of confiscation.

Me thinks you ought to keep to your "bottle washing" on this issue.

The refuge of one without an argument is ad-hominen.

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My point was that even the freest of free markets has to obey the laws of mathematics, which is the subject above-linked Ticker

In an "equilibrium" state that stays within the %down parameter of possible asset devaluation, you/Karl are correct. A down payment of 20% with some small % of demands for withdrawals gives you the bank breathing room. A state of stasis.

When outlier events occur, the mathematical model is shown to be deficient. 1973/OPEC would be a good example. Math in these cases can only show probabilities - it doesn't preclude the failure of those probabilities.

As the Austrians would point out, math can't help you here. An asset only has value as there is a demand for it. You can only model it regressively. If you push that analysis into the future - well, how many times do we see people castigating economists for poor forecasts.

Gen's argument in this ticker reminds me of the "Communism didn't fail, it just wasn't implemented properly" argument.

When you (a bank) are using other people's money to make money, of course you will be riskier in your lending than Shylock. And greed will eventually take over and cause you to fail. This should be expected in a free society.

But where the real crime is being perpetrated by the Fed and the banks is their secrecy(i.e., fraud). We are given blanket guarantees (FDIC et al.) in exchange for information being withheld from us as the banks believe we can't handle the truth.

This information should be available at all times so the customer knows which banks have succumbed or are about to succumb to failure. Lack of transparency is the fraud.

And on another note, banks are obsolete... today's vaults and guards are electronic, that everyone has access to and can provide on their own... not a safe bolted to the floor. (Cmon Gen.. you're a tech guy and I think that example is a bit disingenuous in supported your case for banks). There is no need for the bank middle-man anymore.

Karl, I love this discussion. Sadly the average citizen does not understand FRL and TPTB have little incentive to teach them. Sheeple are easier to manage - and manipulate - than informed citizens.

I see FRL as a choice regarding growth rates. If we chose to eliminate FRL (a huge task if we undertook it, but for the sake of discussion...), then as you state, credit would become significantly more expensive. This would greatly slow economic development. In short, the economy would grow more slowly and society would be poorer. From the Green perspective, this might be just fine as slowing growth could extend the life of the planet, and from a life-style perspective, we might just enjoy life a tad more - but this is highly speculative. The certain thing is that choosing to do away with FRL would slow economic growth.

But there is another choice. If We the People chose to do so, we could have most of the benefits of FRL with few if any credit crises if We simply owned the banks. The question I think American society should consider is this: Given that fractional reserve lending facilitates economic growth but creates risks of future credit crack-ups because risk-taking tends to become obscured by "profit making", should We allow FRL to be a for-profit private enterprise or would we be better off to eliminate the profit incentive and make FRL a public enterprise only?

In general, I agree with those who believe that government-run enterprises are inefficient. I have seen it. Thus, I would expect that economic growth in an economy that was served by non-profit credit creation might be a tad slower than an economy using for-profit FRL. However, without profit-taking there would be no incentive for ridiculous risk taking - except to the extent that political power could be used to induce the public banks to take risks for the perceived public good (like Bush's push for an "ownership society"). This risk is real but I think it will be tamed for decades following our current debacle.

The other side of the argument has to do with the problems with for-profit FRL. Even if you have all the proper regulatory limits to the level of risks the industry can take, the potential for profit will cause people to push the limits - to obfuscate, lie, or cheat in order to make more profit. Then, when regulations cannot be avoided, the industry would lobby the politicians to "deregulate", including bribery, er, campaign contributions. This is the system we currently have and it is damaging both our economy and our democracy.

My preference would be for all FRL to be conducted by public enterprises. I accept the risk that political interference could interfere with sound risk management in exchange for the certainty that profit taking would not. It is high time for Americans to consider this option. The for-profit banking industry is on the ropes and right now TPTB are doing everything possible to resuscitate it. To date, this question has been quickly brushed aside rather than being seriously considered. Even Barrack Obama has made it clear that he doesn't want to run the banks - but by now everyone should be aware that he is totally in the thrall of the for-profit banking industry and any push for socialized banking would have to come from us, not the corrupt politicians.

Everything you ever wanted to know about a government-run bank you can learn from watching Phoney and Fraudie. No thanks.

Steelhead23 wrote..

But there is another choice. If We the People chose to do so, we could have most of the benefits of FRL with few if any credit crises if We simply owned the banks.

Question. If We the People are not competent enough to run the Fed, FDIC, FSLIC, SEC, OFHEO, etc, etc, why will We the People be competent enough to run the actual banks themselves?

Karl
If the bank never lends out more unsecured that it has excess capital it ceases to be fractional reserve banking in the traditional sense and becomes very close to full reserve banking. IOW, the portion of the bank that only makes fully-secured loans operates like a mutual fund, not a bank. So it would be 90% full-reserve banking and 10% F-R with current capital requirements. You wouldn't get any multiplier effects to speak of since the multiplier effect depends on the fraudulent confidence game that implies your money is still available when it's all been lent out.

Seems to be the hubris of mankind that we assume we can control anything all the time in general. If we embrace a truly free market, including a free market on currency then we must also be willing to accept individual risk. Aren't we an enlightened society, hasn't the internet provided the greatest tools for education and personal enlightenment? We would be prudent to put the burden on the individual and let the old saying "buyer beware" have some teeth. Risk is the only, effective regulator.

@Piranha - I disagree in one point you made. Banks do facilitate the transfer of savings to investment. In order to do this they must offer an interest rate that is the price in time deferring that consumption. Keeping one's money in a vault incurs an opportunity cost of earning interest.

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Karl
If the bank never lends out more unsecured that it has excess capital it ceases to be fractional reserve banking in the traditional sense and becomes very close to full reserve banking. IOW, the portion of the bank that only makes fully-secured loans operates like a mutual fund, not a bank. So it would be 90% full-reserve banking and 10% F-R with current capital requirements. You wouldn't get any multiplier effects to speak of since the multiplier effect depends on the fraudulent confidence game that implies your money is still available when it's all been lent out.

That's not true at all.

"Old-fashioned" mortgage lending fit the criteria I put forward and offered plenty of leverage for the bank.

Pwieland wrote..

Your example of a growing population, a deposit of coal in the ground, livestock, a business model is not capital that is being used in the production of goods or services.

OK, so that stuff doesn't meet the strict definition of "capital," but it is definitely "collateral" that can be used to back an exchange for cash.

Before the bank gets involved, you have $10,000 in initial cash plus $90,000 (at least) in assets that will be exchanged for collateral. That is, before the bank gets involved, $100,000 of value exists.

But I have to stop our discussion here, because our hypothetical is a little disingenuous. In reality, no entrepreneur is going to borrow $9,000 at a high interest rate and then deposit the entire sum at a lower interest rate into a bank like we have been mentioning.

Let's work with a different model closer to the reality of FRL before we continue on.

FRL is not a problem if the loans that the bank makes are good loans, meaning they are actually underwritten, collateral is proved to be good.

For years, sound underwriting in the housing market meant you needed a 20% down payment, and that the applicants fully loaded DTI would not exceed 28% on the front end and 36% on the back end ratio including all other installment debt like car payments, student loans, etc...

Reckless and unsound lending is the real issue. 3% down with a vehicle to provide down payment assistance to the person that cannot even sc**** together a 3% down payment... not verifying income... collusion between mortgage brokers and appraisers where the appraisers literally need to 'hit a number' so as not to wreck the deal as opposed to, you know, appraising the property. Relying too heavily on a FICO score and automated underwriting systems to make decisions on loans to streamline the process opened up the whole system to fraud.

The problem isn't FRL. It is criminals committing fraud. It is banks making unsound loans. And for a time, they were making unsound loans on purpose because they had a securitization machine and could fob all that paper off onto suckers because of collusion with the ratings agencies and folks running pension funds who would buy up these CDO's for the promised higher yield because they trusted the AAA rating.

I want a return to conservative underwriting. I do not want fractional reserve lending to be abolished. There is nothing wrong with making a loan as long as it is a good loan.

Karl,

could you please comment on my comment on your Ticker comment?

Tesla - When originally developed in 1938 Fannie Mae was a government owned corporation that helped reopen what had been a very tight mortgage market. Then, in 1968 to help pay for the Viet Nam war, LBJ sold it to private enterprise. So, did privatization improve FNM's performance? If you were an investor - it sure did (it made a profit) - until around 2007 - but as for its service to the public? - I'll let you decide.

http://hnn.us/articles/1849.html

I know that for most investors inculcated with the mantra of enlightened self-interest, the concept of an entire business sector operating as a utility to serve the broader public interest is distasteful, but ask yourselves this: Why should the for-profit FRL sector be allowed to parasitize our economy?

Martin: I've gone over that before. There is no such contract any more than the contract that an insurance company will pay your claim if there is a tornado.

So long as the bank has no more outstanding in unsecured loans than it has excess capital there is no violation.

I agree that if that is not the case it is fraud.

But that someone can commit fraud does not make the institution fraudulent, so long as it can be executed without fraud.

And it can - period.

@PEL - The 90K in assets does not exist before the money multiplier effect occurs. The 10K in savings turn into 100K in actual money or credit in the economy. That is the reality of fractional reserve banking.

@Steelhead23 - I have no problem with any kind of business transaction as long as the government neither subsidizes or sanction a particular way of doing business. If FRL banks want to exist fine, but when they go under, the loss in on them. Dont spread that loss to everyone else saying its too big to fail. Those banks who wish to perform less risky ventures and thus do not fail when the chips fall, they will continue to earn a profit and deservedly so.

But since the inevitable result of risky behavior cannot be handled by our population we have what we have now... It is sad to see actually. The people who live in our nation now are like foreigners compared to the people who founded our country who rebelled over a tax on stamps.

"The sooner we the people understand that this crisis is the result of massive fraud commited by our banking class and covered for and bailed out by our government, the sooner we can force prudent regulation, clear the bad debt out of the system and return to having a stable, productive economy."

Karl, the only reason there was fraud in the system is because one Party was heavily involved in protecting that fraud. Your continue failure to recognize that fact and pretending that this is a bipartisan issue is the real problem. If the Republicans were the problem, how come you do not see things getting better or serious steps being taken to correct the misdeeds of the past? Because the misdeeds of the past were all committed by Democrats. They have had their hands in this mortgage mess since the 90s and do not want to expose the truth. Rubin, Dodd, Frank, Waters, Biden and sons, Raines, Johnson, Emmanuel.

Tomt - Who voted for TARP? Cut the crap, both parties are responsible.

Tomt: "Who is Phil Gramm"?

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When originally developed in 1938 Fannie Mae was a government owned corporation that helped reopen what had been a very tight mortgage market. Then, in 1968 to help pay for the Viet Nam war, LBJ sold it to private enterprise. So, did privatization improve FNM's performance? If you were an investor - it sure did (it made a profit) - until around 2007 - but as for its service to the public? - I'll let you decide.

You need to watch the definitions - LBJ wasn't above changing definitions when it suited him. Phonie and Fraudie were NEVER fully privatized institutions, hence the name "government sponsored entities". So please, don't put up a strawman when you criticize for-profit (ie private) institutions versus those whose operation is regulated by the goobermint.

That's the problem with what people call privatized - you play right into the hands of fraudsters by taking their dolled-up corpse as a living breathing being.

And frankly, if you treat people like children they will act as the same. Tell me the last time this government treated citizens like adults. From banning the pictures of people jumping out of the WTC buildings rather than burning, to playing hide the sausage with the financial entities today rather than admitting the truth of insolvency, I'd have to say - don't say something won't work if it's not been tried.

What you posted is the usual horsecrap used to justify more fraud. Face facts, folks - the people who work for government are no more intelligent or moral or well-intentioned than the citizenry among which they were raised. See my sig line. Show me one example of any institution or program the government didn't manage to totally **** up in due time.