On Private Banks

[Jake_Ellison]

Did I steal from you? Did I reduce your purchasing power?

No, you didn't. If you counterfeit the money and do nothing else, then you have done nothing to anyone.

If you decide to actually take the counterfeit money and trade with it, then you will have committed fraud: you deceived someone into thinking that what they got was real money for their products, but instead you gave them worthless paper.

One thing you didn't do is affect me in any way. When the person you deceived discovers the fraud, the counterfeit you produced will be destroyed, and he will bear the losses.(unless he can take back what he gave you for the fake money) You will go to jail of course.

Edited March 2, 2009 by Jake_Ellison

[JeffS]

No, you didn't. If you counterfeit the money and do nothing else, then you have done nothing to anyone.

If you decide to actually take the counterfeit money and trade with it, then you will have committed fraud: you deceived someone into thinking that what they got was real money for their products, but instead you gave them worthless paper.

One thing you didn't do is affect me in any way. When the person you deceived discovers the fraud, the counterfeit you produced will be destroyed, and he will bear the losses.(unless he can take back what he gave you for the fake money) You will go to jail of course.

My counterfeit money is no different from the real currency, no one can tell the difference, I will never be caught, and the money is circulating in the economy. These are the premises of the hypothetical.

[Jake_Ellison]

My counterfeit money is no different from the real currency, no one can tell the difference, I will never be caught, and the money is circulating in the economy. These are the premises of the hypothetical.

Still fraud, not theft. Impossibly good fraud, actually.

That hypothetical is similar to the one about the existence of God, who commends us not to seek profit. There's no evidence to suggest that it can exist, so it doesn't add to the conversation. (When I say no evidence, I don't just mean no evidence that your money could be identical (though that's true too), I mean your prediction that you'll never get caught belongs to the realm of the supernatural.)

On the direction of the discussion:

If you're trying to prove that IOU's are theft or fraud, you should point out the force or deception.(that would be the most obvious way anyway)

On the other hand, if you're trying to prove that theft is possible without force, that of course contradicts the philosophy of Objectivism, so the conversation should move to a different, more philosophical level.. (since you would be redefining the meaning of theft, which means that you'd be redefining individual rights to something that can be violated without the use of force--you'd have to have a philosophical basis for that, on the same level Ayn Rand had a basis for her politics)

[JeffS]

Still fraud, not theft.

Really? So, we have a situation where your money is no longer worth what it was, solely as a result of my actions, and that's just fraud? Who do you think the victims of this fraud are? Since it's only you, John, Kendall, and I in our hypothetical economy, am I the victim, or are you (either individually or collectively)?

Regardless, isn't fraud just a species of theft?

Impossibly good fraud, actually.

It's just a hypothetical, Jake. When we get to the next step in the hypothetical I think you'll see there's no difference in reality between the money I create and the money in your pocket. What taking this first step has allowed us to do is concentrate on the question above: whether my actions, taken to reduce your wealth and increase my wealth, constitute theft. We'll have to resolve that before we can go on. If I can't convince you that my actions have resulted in a reduction in your wealth just as much as if I had taken money from your pocket, then the rest of my argument will be pointless.

On the direction of the discussion:

If you're trying to prove that IOU's are theft or fraud, you should point out the force or deception.(that would be the most obvious way anyway)

This is what I'm trying to do.

[Jake_Ellison]

It's just a hypothetical, Jake. When we get to the next step in the hypothetical I think you'll see there's no difference in reality between the money I create and the money in your pocket.

I disagree. Using impossible hypotheticals will not lead to any truths in reality. If this whole thing is necessary for whatever conclusion you are leading me to here, then that conclusion is entirely unsubstantiated.

The way I see it, the discussion can go two ways: we can start discussing epistemology, and why what I said above is true or false, or you can move on from this impossible hypothetical, and find a way to make your case using valid arguments.

[edit]

My preference would be that you simply make your case, and then I'll have a chance to point out the error, and we can go from there.

Edited March 2, 2009 by Jake_Ellison

[JeffS]

My preference would be that you simply make your case, and then I'll have a chance to point out the error, and we can go from there.

Very well.

Money, in our society, comes in two forms: currency (the government's legal tender), and bank credit. For all intents and purposes, that of exchanging ownership of property or labour, they are indistinguishable (like if someone were able to so masterfully counterfeit currency that no one could tell the difference between the counterfeit and the real currency). An increase in either is an increase in the money supply, or inflation. All things remaining the same, inflation of the money supply leads to an increase in prices. Another way of looking at this is to understand that an increase in the money supply results in a decrease of purchasing power of each individual unit of money.

If we continue our hypothetical to imagine that instead of me counterfeiting currency I merely print something that is, for all intents and purposes, used just like currency (credit), then I will have effected the same thing as counterfeiting. I would have increased the money supply because whatever I print is used just like the currency is used. What I have printed will be money and will be used for the exchange of ownership in property or labour. If instead of counterfeiting 400 more units of currency I print out IOUs stating I'll pay 400 units of currency upon demand, those IOUs, that credit, will be used just like money and therefore I will have effected an increase in the money supply by 100%. I will have increased my ownership of the economy's money supply by 150%. Simultaneously, I will have decreased your supply of the economy's money supply by 50%. My actions have decreased your wealth and increased mine. In fact, I have increased my wealth by taking wealth from each of the economy's participants (you, Kendall, and John).

How is this not theft? If you agree counterfeiting is fraud (presumably becausing the counterfeiter obtains someone's property or labour without the owner's consent, or false promises), how is bank credit not fraud? Has the bank not obtained property without the owner's consent? Even if I don't pass the credit on to you, you still bear the burden of an increased money supply and decreased purchasing power. Hasn't this resulted in you having less wealth than before the credit was passed? Has the bank not obtained property under false promises? The bank promised to redeem the IOUs, the credit, for currency upon demand, but if everyone showed up at the bank demanding 400 units of currency it would be impossible for the bank to meet those demands - it only has 100 units of currency.

Finally, isn't fraud just a another form of theft?

[Jake_Ellison]

Money, in our society, comes in two forms: currency (the government's legal tender), and bank credit. For all intents and purposes, that of exchanging ownership of property or labour, they are indistinguishable.

You just distiguished them prefectly. How are they indistinguishable?

A store owner can distinguish them as well: if I enter the store with a credit card, the store owner knows that I am paying with credit, not money. That's why he runs the credit card through the machine, and asks the bank which issued the credit card to send him actual money (in electronic form). In a short time(I think 24 hours at most), that money is transferred to the store owner's accounts.

(like if someone were able to so masterfully counterfeit currency that no one could tell the difference between the counterfeit and the real currency)

It's not like that. The fundamental difference is precisely the one why I already said your hypothetical is useless: it is impossible. On the other hand, using credit is not only possible, but it is in fact done in the open.

You can't just make up a scenario that cannot happen, and then say that something that does happen is just like it, therefor they can be used interchangeably. That's a contradiction. They're either the same or different. If one can happen and the other not, than they're different.

If we continue our hypothetical to imagine that instead of me counterfeiting currency I merely print something that is, for all intents and purposes, used just like currency (credit), then I will have effected the same thing as counterfeiting.

Credit is not counterfeit money. For one, people know the difference.

Second, credit won't buy you anything. There are two ways in which you can borrow money(and by money I mean US dollars):

1. You go to a bank, and they give you some, if you commit to pay it back.

2. You go to the bank, open an account, and they give you a card (filled with electronic information about that account), that allows stores you buy stuff from to quicky and automatically get in touch with your bank and take whatever money (US dollars) you're supposed to pay them. That money is either yours, if you put it into your account yourself, or the bank's, in which case you have to give it back to them. Either way, it's real money: the bank doesn't create it without permission from the government.

If instead of counterfeiting 400 more units of currency I print out IOUs stating I'll pay 400 units of currency upon demand, those IOUs, that credit, will be used just like money and therefore I will have effected an increase in the money supply by 100%.

No it won't be. No person in their right mind would ever treat your IOU's as if they were actual money. I strongly urge you to try it at a grocery store: if you're lucky, you'll get a laugh, but no groceries. The reason why a VISA card is treated like real money is because the bank sends real money as soon as the card is used.

Has the bank not obtained property under false promises? The bank promised to redeem the IOUs, the credit, for currency upon demand, but if everyone showed up at the bank demanding 400 units of currency it would be impossible for the bank to meet those demands - it only has 100 units of currency.

All firms have limited responsibility. If the firm becomes insolvent, they become bankrupt, and all assets become the property of the creditors. Obviously, the government is involved in this bankrupcy process beyond what is proper, but that's another story.

However, as far as the commitments the banks make, all creditors are aware that they are limited to whatever assets the bank itself owns. The banks administrators commit to play by rules that are known in advance, and any departure from those (i.e. they just dissapear with everyone's money) is illegal, but going bankrupt is not. Any "promise" made by the bank is limited to what they have at any given moment.

Edited March 2, 2009 by Jake_Ellison

[KendallJ]

As I pointed out before, you're ignoring the fact that the inflation began the moment the reserve rate went from 100% to some lower percent and banks acted on this new reserve rate by creating credit (IOUs); the theft had already occured.

And as I pointed out right in the same post this was intended to refute, this is incorrect. It is incorrect because it continues to commit the same mistake I accused you of in the first place. Look, I don't intend to have a conversation with someone who simply ignores peoples points. Luckily someone being wrong on the internet doesn't confer some obligation upon me to fix it.

[JeffS]

You just distiguished them prefectly. How are they indistinguishable?

They are indistinguishable in function.

A store owner can distinguish them as well: if I enter the store with a credit card, the store owner knows that I am paying with credit, not money. That's why he runs the credit card through the machine, and asks the bank which issued the credit card to send him actual money (in electronic form). In a short time(I think 24 hours at most), that money is transferred to the store owner's accounts.

That's actually not usually true. Usually what is exchanged is bank credit. Let's use an example: suppose I owe you $10. I can pay you in one of two ways: give you a US $10 bill, or pay you with credit. Credit can take several forms, let's just look at two of them: a check, or a credit card.

A check is an IOU, it's credit. What it does is tell the bank to increase your balance by $10 and decrease my balance by $10. Did you actually get $10 in currency? Did someone go to a deposit box with your name on it and put a $10 bill in there? No, you didn't, and no, they didn't. You got a promise to pay you $10 in currency if ever you asked for it.

A credit card is obviously credit and the process is not very much different. When you send your credit card sales off to be cleared, the bank increases your balance of assets, and increases my balance of debt. You didn't get any currency, nor did the credit card company give any currency. Your bank increased its promise to pay you $10 in currency should you ever demand it, the credit card company increased your bank's balance and promise to pay currency if your bank ever demands it.

Credit is not counterfeit money. For one, people know the difference.

Second, credit won't buy you anything. There are two ways in which you can borrow money(and by money I mean US dollars):

1. You go to a bank, and they give you some, if you commit to pay it back.

I'm sorry, Jake, but this is not correct. Yes, the bank does loan you money, but it doesn't loan you currency (US dollars). Have you ever had a bank loan? I'll bet you have. In fact, I'll bet you have a bank loan in your wallet right now - it's a credit card. That's not currency. Have you ever gone into a bank and borrowed money, like for a house or a car? They don't give you money. They either give you a cashier's check, a counter check, or a promissory note of some sort. What are these? They are not currency, but they are money - just about anyone will accept them for transfer of ownership of property. They are credit. They are a promise to pay in currency upon demand.

2. You go to the bank, open an account, and they give you a card (filled with electronic information about that account), that allows stores you buy stuff from to quicky and automatically get in touch with your bank and take whatever money (US dollars) you're supposed to pay them. That money is either yours, if you put it into your account yourself, or the bank's, in which case you have to give it back to them. Either way, it's real money: the bank doesn't create it without permission from the government.

Well, I explained above how the ownership of currency (US dollars) rarely ever gets transferred, so I'll just address your last sentence: that's exactly what I'm arguing - it's real money. It's used exactly like currency. If you increase it the results are the same as if you increased currency. Secondly, I never argued banks don't create this credit without permission from the government. They do have permission and the Federal Reserve System enables it.

No it won't be. No person in their right mind would ever treat your IOU's as if they were actual money. I strongly urge you to try it at a grocery store: if you're lucky, you'll get a laugh, but no groceries. The reason why a VISA card is treated like real money is because the bank sends real money as soon as the card is used.

Jake, let's assume I am a trusted bank. Heck, let's just assume I'm a bank. You're validating my argument though, Jake, when you agree that bank credit (VISA card) is treated like real money (currency).

All firms have limited responsibility. If the firm becomes insolvent, they become bankrupt, and all assets become the property of the creditors. Obviously, the government is involved in this bankrupcy process beyond what is proper, but that's another story.

However, as far as the commitments the banks make, all creditors are aware that they are limited to whatever assets the bank itself owns. The banks administrators commit to play by rules that are known in advance, and any departure from those (i.e. they just dissapear with everyone's money) is illegal, but going bankrupt is not. Any "promise" made by the bank is limited to what they have at any given moment.

Well, that's not the promise they're making. Let me ask you, would you put your money in a bank if the banker told you, "If you ever come in and want your money, we'll give you 10% of it." I agree, if banks actually said this then there are no false promises. But no one in their right mind would put money in a bank with the promise to be paid back 1/10 of that money.

You didn't address the fact that creation of this bank credit constitutes theft of wealth. Does that mean you understand how it is theft now?

[Jake_Ellison]

They are indistinguishable in function.

...

You didn't address the fact that creation of this bank credit constitutes theft of wealth. Does that mean you understand how it is theft now?

I addressed it plenty. You are alleging theft and offering no evidence.

It's pointless to argue on irrelevant details about how the banking system works.

So what if banks are trading credit or electronic money instead of paper dollars? It's not theft because there's no force or deception involved.

So what if the banks don't have all the money they owe in their safes at all times? They do pay out everything they owe, on demand, unless the bank goes bankrupt, which is a risk all lenders knowingly take, in the case of all limited responsibility firms.

Can you imagine someone in a court of law going: you know how we found a revolver at the crime scene? Well, the shotgun the defendant owns is indistinguishable in function from the revolver, so he's obviously guilty. I rest my case.

[JeffS]

And as I pointed out right in the same post this was intended to refute, this is incorrect. It is incorrect because it continues to commit the same mistake I accused you of in the first place. Look, I don't intend to have a conversation with someone who simply ignores peoples points. Luckily someone being wrong on the internet doesn't confer some obligation upon me to fix it.

I've been back over this entire thread and for the life of me I can't determine where I angered you and John so, but I must have since you are both so hostile to me. I would really appreciate it if you would point out what transgression I've made so I can learn from it and correct it.

I've ignored none of your points, though you seem to keep ignoring mine. You began with:

"The mistake here is to equate fractional reserves with the case of increasing the fractional reserve rates."

I'm not making that mistake, and I addressed this point in my next reply to you. You seem to want to put the effect in the past and then write it off as unimportant, or as if it never happened. If the reserve rate were 100%, meaning banks could only loan out the value of their assets, and then the reserve rate went to 10%, it is then that the money supply has been increased, purchasing power has been decreased, and everyone holding currency has had wealth stolen from them.

Sure, if you leave that rate at 10% till the end of time, no more theft occurs (unless someone introduces new assets into the economy from outside the economy). Sure, if you raise the reserve rate some of that wealth is returned to those holding currency. But the fact remains that moving the reserve rate from 100% to some lesser percent results in a loss of wealth of those holding currency and a gain in wealth for those issuing the credit. Does it really matter that it doesn't occur on an ongoing basis? Is a theif any more just simply because he doesn't break into your house every week?

Even if you ignore this entire post, I sure wish you would point me to where I've merited the hostility I seem to be getting from you. Perhaps it's just me - we are working in an imperfect format for discussion and debate. Perhaps I'm just reading you wrong.

[KendallJ]

I've ignored none of your points, though you seem to keep ignoring mine. You began with:

"The mistake here is to equate fractional reserves with the case of increasing the fractional reserve rates."

I'm not making that mistake, and I addressed this point in my next reply to you. You seem to want to put the effect in the past and then write it off as unimportant, or as if it never happened. If the reserve rate were 100%, meaning banks could only loan out the value of their assets, and then the reserve rate went to 10%, it is then that the money supply has been increased, purchasing power has been decreased, and everyone holding currency has had wealth stolen from them.

Sure, if you leave that rate at 10% till the end of time, no more theft occurs (unless someone introduces new assets into the economy from outside the economy). Sure, if you raise the reserve rate some of that wealth is returned to those holding currency. But the fact remains that moving the reserve rate from 100% to some lesser percent results in a loss of wealth of those holding currency and a gain in wealth for those issuing the credit. Does it really matter that it doesn't occur on an ongoing basis? Is a theif any more just simply because he doesn't break into your house every week?

OK, Jeff, here's what you've missed.

The funny thing is that you can think of fractional reserve banking as a form of financing. I can get the same credit expansion effect if I finance a bank through corporate debt (i.e. bonds) as if I finance it partially with time deposits. But no one ever says that debt financing of bank operations is theft. The reason is that leverage rates generally equilibrate so the practice is neither inflationary or deflationary.

To the extent that leverage rates would change due to actual structural changes in risk profiles of the economy at large the change is not inflationary, and differences in leverage rates between individual bank porfolios depending on their individual real risk profiles do not contribute to overall increases in credit.

Now you think you answred it here, but you didn't.

I would agree that's generally true. However, you're merely stating the theft has already occured.

The reason no one ever says debt financing is theft is because the debt is back by real assets - something the bank could exchange for value; something either it, or someone else can use to turn into productivity. What is being exchanged when a bank creates promises to pay $1000 when it only possesses $100? Promises?

First, your assessment of corporate debt being backed by real assets is false. Corporate debt is backed by a bankers assessment of the ability of the firm to pay back the debt. It is based upon an assessment of future cash flow potential. If there are not enough assets today to pay back the debt that means the loan is unsecured. If there are, then the loan is secured, but regardless, the basis for the loan is a future cash earnings potential. This is true of corporate debt. As a result I can create exactly the sort of arbitrary leverage profile using corporate bonds that have nothing to do with the book assets. Company sells 1,000,000 worth of 5% bonds. It invests 10% of that in its own operations and buys 90% of company B's 5% bonds. Company B does the same, and so on and so on. This is also "inflationary". Why is it not theft? There is a real answer to that, and the real answer is what makes you hypotehtical false as well.

Second if you read the part I had bolded, I've just provided you a mechanism by which the reserve rate changes without it resulting in inflationary theft. I didn't ignore your earlier. I answered it. The reserve rate represents something in reality? What is it? When you answer that you stop positing arbitrary rationalistic examples of credit expansion and tie your examples back to the economic reality. Just as there is demand based inflation / deflation which is not a bad thing so to, there could be expansions in capital productivity which might not be a bad thing either.

So what I'm saying here is that arbitrary expasions of credit are inflationary in a detrimental way. Non-arbitrary ones are not. That gets me from a reserve rate of 100 to whatever, without theft. The thing you have to answer is what does the reserve rate represent, in reality.

I'd posit that in a free market, the reserve rate, just like interest rates would be non-arbitrary. They might be 100% but that is not required nor is it probable I think. They most certainly would be higher than they are now, which means there has been a certain amount of arbitrary inflation has occured.

Edited March 2, 2009 by KendallJ

[JeffS]

I addressed it plenty. You are alleging theft and offering no evidence.

I'm really confused where we're losing each other, Jake.

1) Do you disagree that an increase in the money supply results in a decrease in the value of the currency you hold?

2) Do you disagree that if someone increases the money supply, their wealth increases and the wealth of the rest of the economic participants' wealth decreases?

3) Do you disagree that banks increase the money supply by issuing credit?

It's pointless to argue on irrelevant details about how the banking system works.

So what if banks are trading credit or electronic money instead of paper dollars?

Because they inflated the money supply without producing anything. It would be the same as if I demanded you pay me for standing around and doing nothing.

It's not theft because there's no force or deception involved.

So what if the banks don't have all the money they owe in their safes at all times? They do pay out everything they owe, on demand, unless the bank goes bankrupt, which is a risk all lenders knowingly take, in the case of all limited responsibility firms.

But banks are necessarily insolvent at the first moment they create credit based upon assets they don't have. They make promises they can't possibly fulfill. If everyone went to all their banks today and asked to be paid their deposits in currency (we won't even go into the fact that our currency isn't backed by any assets), all the banks in the country would be short by around 90%.

Can you imagine someone in a court of law going: you know how we found a revolver at the crime scene? Well, the shotgun the defendant owns is indistinguishable in function from the revolver, so he's obviously guilty. I rest my case.

That's not the argument I'm making at all, Jake. I'm sorry I can't make you see that. Perhaps if you just answer the three questions at the beginning we can find out where I'm losing you.

[softwareNerd]

Jeff, The topic of whether fractional banking is fraudulent has been done before. Try searching.

Other than that, I suggest taking the issue "layer by layer".

The most simplified example would be to assume a country that uses a freely-convertible gold-standard currency -- USA in most years prior to the depression years. In this example, we have banks that take in gold, but issue more notes than they have gold.

Now, to simplify further, assume that the depositor knows this. He is not under any illusion that the bank keeps 100% gold reserves. He realizes that if all depositors were to ask for their money back at the same time, they would not get it except with some delay.

In this situation, you can "follow the money" to claim there's fraud because of the equivalence with which notes and gold are treated in the economy. However, these are second-order consequences. Before addressing those, consider the first step: the relationship between the fully-aware depositor and his bank. Is there any fraud or theft involved within this relationship alone? With others who have responded, I would claim that the answer is: "no". if we assume these two parties are fully aware of the arrangement and are both acting consensually with that knowledge, then their cannot be any violation of rights by one of them of the other. So, at least between these two, there is no theft or fraud.

Do you agree at least on that extremely simplified example?

[KendallJ]

But banks are necessarily insolvent at the first moment they create credit based upon assets they don't have. They make promises they can't possibly fulfill.

This is the same mistake I pointed out with respect to your supposition about asset-backed debt. If this were true, even most good banks today would be insolvent. Insovency represents reasonable expectations that a bank cannot pay its obligations to its creditors. This includes both assets they have and can reasonably expect to have in the future. As compared to illiquid which means it does not have cash flow to fulfill it's near term obligations but can still be expected to fulfill its long term obligations. See, the current and future cash flows are both to be considered. You've simply thrown out one half of the consideration. "Can't possibly fulfill" is false.

I wonder if you can produce your average time deposit agreement from any ordinary bank and show me where it is making a promise it cannot keep.

Edited March 2, 2009 by KendallJ

[JeffS]

First, your assessment of corporate debt being backed by real assets is false.

I disagree. Most corporate debt is secured - usually by the assets (which represent production in some other part of the economy) which the corporation purchases with the debt from the bank. Though it's really not an important point in this discussion, if you have any sources which indicate this is not the case I would love to read them.

Corporate debt is backed by a bankers assessment of the ability of the firm to pay back the debt. It is based upon an assessment of future cash flow potential. If there are not enough assets today to pay back the debt that means the loan is unsecured. If there are, then the loan is secured, but regardless, the basis for the loan is a future cash earnings potential. This is true of corporate debt. As a result I can create exactly the sort of arbitrary leverage profile using corporate bonds that have nothing to do with the book assets. Company sells 1,000,000 worth of 5% bonds. It invests 10% of that in its own operations and buys 90% of company B's 5% bonds. Company B does the same, and so on and so on. This is also "inflationary". Why is it not theft? There is a real answer to that, and the real answer is what makes you hypotehtical false as well.

I'm going to just deal with this issue as purely an exchange between corporations and we can cut out what appears to be troublesome references to banks.

Economic growth only comes through production. In your example, let's assume we start from a position where all economic growth is paid for with production - in order to purchase company B's bonds, company A would have to pay for those bonds out of wealth it created from doing whatever it does. Money is simply changing hands; there is no net change to the amount of money in the economy - company A gives up money, company B gets the same amount of money. Company B takes that money and uses it to increase its production and, hopefully, repays the loan plus interest through the increase in its productive efforts. It's important to realize that the effect of this increased production serves to grow the economy, but that doesn't mean there is more or less money in the system. There is neither inflation, nor deflation, as a result of these activities. No one's wealth changes. Company A no longer has the asset "Cash," but it does have the asset "Loan to Co. B." Company B has the asset "Cash," but it also has the liability "Debt." What happens is, assuming the velocity of money doesn't change, prices go down so purchasing power remains the same.

What would happen if company A didn't have any currency with which to buy company B's bonds? That is, company A has not created enough production such that it has currency which it could loan to company B? Could it buy the bonds? Could it exchange its productive efforts for the future productive efforts of company B? No, it could not. The economy generally, and company A specifically, doesn't have the wealth which would allow it to purchase those bonds.

So, what to do? If company A told company B, "Here's a letter of credit for your bonds. Go buy whatever you want and give them this letter." So, company B does that; it presents this letter to company C. What would company C do? Can it go to company A and demand currency for its productive efforts, the same productive efforts it gave to company B in exchange for ownership of the letter of credit? No, it could not - that currency doesn't exist. What happened to company C? How does it get currency for its productive efforts? Was company C defrauded? Was its property, its productive efforts, stolen?

What if company C were able to simply turn this letter of credit over to its suppliers? What has really changed? The only thing that has changed is the victim. So, let's go back and see what really happened.

Company A increased the money supply. It created, backed by nothing, a transferrable instrument - money - that is now circulating in the economy. Company A inflated the money supply and no wealth was created for it to do so. The economy's wealth has not changed, but the supply of money has. What is the effect? Now everyone in the economy is poorer (assuming the velocity of money hasn't changed), everyone's purchasing power has declined - except company A. Company A owns an asset - the debt of company B, but it gave no asset, no productive value, in exchange for that asset. Company A gained wealth at the expense of everyone else.

Second if you read the part I had bolded, I've just provided you a mechanism by which the reserve rate changes without it resulting in inflationary theft. I didn't ignore your earlier. I answered it. The reserve rate represents something in reality? What is it? When you answer that you stop positing arbitrary rationalistic examples of credit expansion and tie your examples back to the economic reality. Just as there is demand based inflation / deflation which is not a bad thing so to, there could be expansions in capital productivity which might not be a bad thing either.

I think the problem here is we seem to have different definitions of inflation. Inflation is simply an increase in the money supply; deflation is simply a decrease in the money supply. The Velocity of Money theory states that an inflation in money supply, all other things remaining constant, will result in an increase in prices. Inflation is not an increase in prices.

If that's not it, then I'm afraid I still don't understand this point.

So what I'm saying here is that arbitrary expasions of credit are inflationary in a detrimental way. Non-arbitrary ones are not. That gets me from a reserve rate of 100 to whatever, without theft. The thing you have to answer is what does the reserve rate represent, in reality.

I'd posit that in a free market, the reserve rate, just like interest rates would be non-arbitrary. They might be 100% but that is not required nor is it probable I think. They most certainly would be higher than they are now, which means there has been a certain amount of arbitrary inflation has occured.

Well, I think in order to have this it would require more distinquishable forms of money. For example, if there were only one form of money - let's call them dollars - and everyone used these dollars, then if anyone printed dollars they would be transferring wealth to them from all the other market participants, regardless of where they kept their currency. However, if you had multiple, distinquishable forms of money - let's say each bank printed their own money - then however many notes that bank printed wouldn't necessarily inflate the money supply of the other banks. In such a case, market participants could choose to deposit their money in whichever bank didn't inflate its own currency, or they could choose to pick banks which did inflate their own currency. It would still be the case though that those who chose to bank with a highly leveraged bank would be giving up their wealth to the bank.

Suppose the Bank of Jeff issues Jeffs, and the Bank of Kendall issues Kendalls. In our economy, some individuals would accept Jeffs, others would accept Kendalls. You can go to the Bank of Jeff and exchange 1 Kendall for 1 Jeff, or you can go to the Bank of Kendall and exchange 1 Jeff for 1 Kendall. Now, suppose I start leveraging my demand deposits and you do not. Suppose I have demand deposits of 100 Jeffs, but I print up another 900 Jeffs and loan those out along with all my demand deposits. Would the Bank of Kendall still accept 1 Jeff for 1 Kendall? If you did, I'd be able to buy your bank 10x over. Those I loaned Jeffs to would be able to go to the Bank of Kendall and not only wipe you out, but demand far more assets than you have. Would you allow that? I don't think you would. I think you'd start demanding 10 Jeffs for every 1 Kendall. So, my one demand deposit customer takes out all his Jeffs and goes to the Bank of Kendall. What does he get? Instead of the 100 Kendalls he would've received before I inflated the currency, he'll only get 10 kendalls. Has he not lost wealth? What happened to his wealth?

Thanks for taking the time to explain your position.

[JeffS]

Jeff, The topic of whether fractional banking is fraudulent has been done before. Try searching.

Yes, John McVey was kind enough to give me those links. I've skimmed through them, but I'm not sure how that helps. If I find something incorrect, should I just address it there? If I do, does that help ReasonAlone (the OP). I suppose he can do his own searching, but I was just trying to give him some help on his question. It really wasn't my intention to get that involved in this issue.

The most simplified example would be to assume a country that uses a freely-convertible gold-standard currency -- USA in most years prior to the depression years. In this example, we have banks that take in gold, but issue more notes than they have gold.

If those notes are used as money then those banks increased the money supply; they inflated the money supply; they've increased their own wealth at the expense of those who use those notes as money.

Now, to simplify further, assume that the depositor knows this. He is not under any illusion that the bank keeps 100% gold reserves. He realizes that if all depositors were to ask for their money back at the same time, they would not get it except with some delay.

In this situation, you can "follow the money" to claim there's fraud because of the equivalence with which notes and gold are treated in the economy. However, these are second-order consequences. Before addressing those, consider the first step: the relationship between the fully-aware depositor and his bank. Is there any fraud or theft involved within this relationship alone? With others who have responded, I would claim that the answer is: "no". if we assume these two parties are fully aware of the arrangement and are both acting consensually with that knowledge, then their cannot be any violation of rights by one of them of the other. So, at least between these two, there is no theft or fraud.

Do you agree at least on that extremely simplified example?

I do agree that it is not fraud or theft involved in the relationship between the bank and the fully-aware depositor. My position is in the "second-order consequences."

[KendallJ]

I disagree. Most corporate debt is secured - usually by the assets (which represent production in some other part of the economy) which the corporation purchases with the debt from the bank. Though it's really not an important point in this discussion, if you have any sources which indicate this is not the case I would love to read them.

Well, it is an important point because you used that point to dismiss my bondholder example the first time I offered it. Regardless of the split between secured and unsecured, the fact that unsecured exists is enough to call you dismissal into question.

If that's not it, then I'm afraid I still don't understand this point.

That's not it and no you must not.

Look, Jeff, here's the deal. This is the third time now I've said the things I've said, and every time you dismiss them out of hand, go about foisting your own analogy over the top of mine, which by the way, is in no way parallel, and generally shows me that you've missed the point entirely. You're generally so quick to respond that you quickly show that you didn't understand what I said, and proceed to make the exact same mistakes over again. It gets old, it gets tiring. I know John McVey personally. He's probably one of the nicest gentlemen on the board. He and I have had many discussion on finance. I've watched him engage in many, and I'm sure he's watched me engage in many. He knows his stuff. I know my stuff pretty well as well. We've both dealt with the "fractional reserve banking is immoral" arguments before.

On the other hand, I know nothing about you apart form the 60 some posts you have on this board. I don't know your credibility on the subject. So I have to judge based upon what you've presented and the manner in which you've presented it. You seem very sure of yourself and at the same time a bit confused about the issues. You're quick to deny and quick to refute without me getting a sense that you understood what I said. Can you see where that would get tiring after a while?

It's a bit like arguing religion with a religionist who thinks that first cause is a novel argument, for the 156th time. Maybe that says I'm just too old for this crap and I should move on to issues that interest me, but when someone starts explaining things to questions from a novice as though he is an expert and he is so obviously wrong, it's hard to resist. You've put yourself in the context of a newbie trying to give advice to another newbie as if you know something, without ever establishing that you know something. Can you see where those of us who have a long history on the board and have chewed on topics for a while, might just challenge you a bit? The fact that people pointed you to other threads on this topic where we've seen the same sorts of arguments pop up before should if nothing else say to you "gee, I'm obviously brining a perspective that is considered controversial, maybe I ought to expect to be challenged on it, when I act as though it's a decided deal. In fact, maybe I ought to deal with that controversy before I start dispensing advice..." I know you're trying to help ReasonAlone, but this is a social situation just like any other, in fact one with a great deal of anonymity. It makes sense to me to establish yourself, and your advice will be much more highly valued if you do.

My bond example is an exact duplicate of the argument based upon time deposits. I don't know what the hell you've convoluted it into. How about dealing with the original example I gave you instead. You actually said several things in trying to refute my example, that are the basis for refuting your examples as well.

1. Economic growth comes only through production

2. The Velocity of Money theory states that an inflation in money supply, all other things remaining constant, will result in an increase in prices.

You're right about our different definitions of inflation, although I would say instead that it's not that we have different definitions of inflation, rather you've defined all inflation as morally bad. As an example, deflation through productivity improvements creates a net increase in the money supply, relative to the value of what's out there to buy. Is that a bad thing? Heck no. It's a great thing. Deflation caused by actual demand destruction however is not a good thing. In the same way certain expansions of the credit supply might not be bad things either. You just have to figure out which contexts make that true. "All things are NOT created equal" in all cases. It must have something to do with investment and the creation of new production.

Fractional reserves are a form of debt financing, which is why I indicated that the corporate debt example is parallel. If I can create the same structure with bonds and it is not "theft" then you're going to be hard pressed to tell me how fractional reserves are theft. It is part of the overall leverage ratio. And no, the asset backing of debt isn't the issue because that is not the fundamental backing of debt. Credit is extended based primarily upon productive capability in a market context. Assets are part of that mix, but not all of it.

A marginal change in fractional reserve rates would not be detrimental if a) there are quality unfunded investment opportunities available that could make use of the capital and b ) either the bank has figured out a way to mitigate the extra risk it takes on, or it compensates the deposit holder through higher competitive interest. That is, credit expansion can co-exist hand in hand with economic growth and the ability of financial institutions to effectively manage risk. The fractional reserve is just a form of debt. Callable debt to be sure, but it certainly isn't the only form of callable debt that exists. Many corporate bonds have covenant provisions that can trigger events. I haven't created something that is backed by nothing. The deposit created wealth, and deposited it with me. I extend that capital as credit on his behalf, and allow him to call the debt back in return for an interest payment. It's identical to what happens when I sell a bond. If I buy bank paper for instance, then the bank takes those proceeds and lends them. Same thing. The terms of the debt are different that's all.

Now if a or b don't exist, and the fractional rate is increased, why then you would have an arbitrary increase in the credit supply. This is inflationary in the bad sense. It creates more money for the same amount or quality of investments. As a result it causes speculation, drives down returns and investment quality, same as printing money.

Edited March 3, 2009 by KendallJ

[JeffS]

Okay, I give up. Thanks for the exchange.

[Jake_Ellison]

I'm really confused where we're losing each other, Jake.

First, the reaon why I stayed in the argument: your honesty and your (consistent) understanding and acceptance of Objectivist morality.

Overall, I do have plenty of problems with the methods you use for "proving" things, and the inconsistency of your argument. At this point I know enough about your position to be able to confidently say that you are wrong on this one, and engaged in an effort to rationalize. Basically, your B's don't follow your A's, but you're relying on A-->B all the time anyway.

[KendallJ]

Okay, I give up. Thanks for the exchange.

That's alright. I'm pretty sure I do too. Likewise.

[adrock3215]

Well excuse me for interrupting your cathartic finger-waggle with mere facts.

I've been reading the discussion and have nothing pertinent to add, other than the fact that this statement by John deserves to be recognized for its comedic value. I chuckled out loud for quite a bit after reading it. Funny how words can do that sometimes.

Edited March 3, 2009 by adrock3215

[JeffS]

First, the reaon why I stayed in the argument: your honesty and your (consistent) understanding and acceptance of Objectivist morality.

Thank you, Jake.

At this point I know enough about your position to be able to confidently say that you are wrong on this one,

I'm trying to figure out why. Perhaps someday, if I figure it out, we'll be able to revisit the topic.

[softwareNerd]

If those notes are used as money then those banks increased the money supply; they inflated the money supply; they've increased their own wealth at the expense of those who use those notes as money.

I do agree that it is not fraud or theft involved in the relationship between the bank and the fully-aware depositor. My position is in the "second-order consequences."

Consider this though... break the "second-order' consequences into more tiers: second, third, fourth, ad infinitum. So, for instance, when a depositor puts money in his bank we've got the first-order relationship. then he uses a check written on that bank in a second-order relationship, and so on...but, then (further away) we have the consequence of someone who is not party to that particular chain, but who has to deal with higher prices.

I still want to consider this series of events as happening in a gold-standard economy that allows banks to issue fractional-notes.

Now, the person accepting a check from the depositor does not have to accept it. He can insist on cash. Or, he can accept notes from the great J.P.Morgans's bank but refuse to accept notes from "The Bank of Madoff". Or, he might say he kinda trusts "Bank of America" but will require a 5% premium to take their notes instead of cash. The second-order relationship can make these types of decisions. Indeed, there was a time when people would not accept notes from just any no-name bank, and where their local bank might insist on not accepting a certain bank's notes at par. Whatever option the second-order person chooses, as long as he does so freely, there is no fraud nor any theft.

One can follow this down the line, to third, fourth and so on, with the same conclusion.

So, all we're left with in this gold-standard fractional-reserve system is the "remote consequences" to someone who faces higher prices even though he is not a part of the chain.

Would you agree thus far?

[JeffS]

Consider this though... break the "second-order' consequences into more tiers: second, third, fourth, ad infinitum. So, for instance, when a depositor puts money in his bank we've got the first-order relationship. then he uses a check written on that bank in a second-order relationship, and so on...but, then (further away) we have the consequence of someone who is not party to that particular chain, but who has to deal with higher prices.

If I understand you correctly, it seems as if this one check is making its way from third, to fourth, to ad infinitum individuals. If so, is this really how it happens? I mean, you deposit currency (legal tender, or gold) in your bank; you write a check to me drawn on that account; I deposit that check in my bank; my bank presents your bank with the check; your bank transfers ownership of your currency to my account; I can then write checks which will be based in my bank. Isn't this how it would work in reality (assuming no fractional reserve)? In such a case there would be no increase in money, or currency. Right?

I still want to consider this series of events as happening in a gold-standard economy that allows banks to issue fractional-notes.

Now, the person accepting a check from the depositor does not have to accept it. He can insist on cash. Or, he can accept notes from the great J.P.Morgans's bank but refuse to accept notes from "The Bank of Madoff". Or, he might say he kinda trusts "Bank of America" but will require a 5% premium to take their notes instead of cash. The second-order relationship can make these types of decisions. Indeed, there was a time when people would not accept notes from just any no-name bank, and where their local bank might insist on not accepting a certain bank's notes at par. Whatever option the second-order person chooses, as long as he does so freely, there is no fraud nor any theft.

Absolutely, however...

One can follow this down the line, to third, fourth and so on, with the same conclusion.

Two things come to mind here:

1) Assuming the example above, if I demand an extra 5% from you before I accept your check (for whatever reason - I don't trust your bank, I don't trust you, because I know my bank will discount my subsequent deposit because it has the same distrust, etc.) wouldn't the cost of that distrust be squarly borne by you? You would write me a check for 5% more; I would depost that check in my bank; my bank would present that check to your bank for payment; your bank would transfer ownership of your currency to my account; I can then write checks based on my bank, which is presumably safe and whose notes are accepted widely. Economy wide there is no increase in currency - what is deducted from your account is deposited into mine - therefore no systemic inflation. There was inflation borne by you, but it wouldn't persist to the third, fourth, etc. tiers once I converted your "dodgy" check into currency (legal tender/gold), and subsequently notes of my "trustworthy" bank. (Isn't this primarily the flight to quality description that Benjamin Andersen explains in Economics and the Public Welfare to explain why the US gained so much gold after WWI?)

2) If we assume a fractional reserve system, and staying within the confines of your example, I'm not sure it would work any differently. The inflation would be borne solely by whomever banks with the leveraged banks (or more highly leveraged banks). In such a situation there's a possibility that the government could create more legal tender notes, and if everyone is dealing in legal tender notes, inflation would be systemic. But I haven't been discussing that in my argument. I'm only concerned with bank credit which is widely used. But, I understand your example to mean there are multiple banks, creating multiple distinguishable notes, and those notes circulate only at the periphery of the different banking markets; that is, the only time those notes circulate between, say "Bank of Madoff" and J.P. Morgan are when a depositor of either uses those notes to buy something, but then that note goes right back to the originating bank and the transaction concludes with a transfer of currency (legal tender, or gold). If you bank with "Bank of Madoff," expect to pay more for things, but your choice won't impact anyone else.

My point here is that bank credit now isn't as distinguishable as it was before, say before 1913. No bank has any incentive be any less leveraged. In fact, they would probably place themselves at a competitive disadvantage if they didn't leverage the maximum allowable by law. There's no benefit because their customers believe they don't have to worry, unless they deposit more than $100k. With all banks issuing credit which is equally "dodgy," their credit is indistinguishable and the credit permeates throughout the system. Rather than depositing currency in my account after I cash your check, your bank simply deposits some currency, but mostly credit. When I write checks drawn on my account, I'm just passing credit again - not currency, not gold. Since there's more money (not currency) in the entire system, we're all paying higher prices.

I obvioulsy haven't been clear on at least one point: I've no moral argument against informed (or should be informed) individuals writing whatever contracts they want (consistent with Objective law, of course). If you want to bank at "Bank of Madoff," more power to ya'. Fractional reserve banking is not immoral per se. It's only immoral, it's only theft, when the creation of this credit, the creation of this leverage impacts the wealth of those not party to the contract. If I can deposit $10 worth of gold in my bank, then write checks for $100 - and no one understands that $100 in checks doesn't represent $100 in gold, or currency, or some real asset, or some real measure of productive efforts, then I've stolen wealth from everyone I convince to take those checks.

Perhaps we all should know this is the state of our banking system. Perhaps that's the point everyone's been trying to get me to understand?