The statements by Philipp Bagus of fractional reserve banking is befuddled and woefully confused.
He has assumed, without making any sort of argument, that banks expanding credit is somehow wrong, and that it influences the price level. Making loans and accepting demand deposits, however, has no influence on the cash interest, the yield curve, asset prices or inflation/deflation. He has claimed that there is some sort of confusion about who owns a bank deposit. However a bank deposit is one of the most unambiguous types of contract one can have. The depositor is the owner of the deposit, which is the depositor's asset and the bank's liability. It's like a promissory note -- the holder is the owner/creditor and the issuer is the debtor. The ownership of the rights is totally unambiguous. Banks do not promise that their deposits are always available for withdrawal, but they do promise to pay them on demand (well the demand deposits at least). Like any promise, that promise should be assessed for its credibility and for the capacity of the promisor to fulfil the promise to the promisee. Its called the credit concept, which is fundamental for all transactions -- default risk is ubiquitous, and so credit risk management is too. The validity of the obligation to honour the promise, and the chances of it being honoured or dishonoured are not the same. Sometimes promises that are not obligatory are honoured (and expected to be honoured a very good proportion of the time) and sometimes promises that are valid and obligatory are dishonoured. Bank promises are just that, promises. The value thereof depends on the bank and it is up to the promisee to assess his credit risk as with any other type of promise. He wrote: 'By issuing more property titles than property entrusted to them, the banks violate the traditional property rights of their customers.' This is a totally incorrect and befuddled statement. Banks do not issue titles to property they issue promises to pay. A property title certifies the ownership of some property asset by its owner to a third party. A promise to pay is a debt. The bank demand deposits are promises to pay on demand, and the only property owned by the depositor in virtue of his deposit is this promise. Bank creditors can, like any creditors or prospective creditors, consider the capitalisation and repayment capacity of their debtors or other indicators of the speed and fullness of payment available. The 'traditional property rights' of debtors is not simply to the repayment of debt, and the rights of debt collection are limited by due process and by provisions and processes involving the administration of the estates of debtors who are unable to pay their debts as they fall due, including, but not limited to, processes for debt forgiveness and release of debtors from their creditor's control. These processes are the natural product of the customs, contracts and law concerning debts for the following reasons: 1. Debtors normally have many creditors and the enforcement of a debt collection can reduce what is left for other creditors. The customs, contract and laws employed to regulate this process and mitigate aggressive and asset/value destructive debt collections provide for the best result, on average, for creditors. 2. Debtors value their property and freedom more the less of it they have, and are prepared to trade leniency for higher interest rates. Debtors effectively buy forgiveness options from creditors at the time that they enter credit contracts (either by virtue of contractual clauses, customs, or the law as they understand it at the time they enter the contract). The traditional property rights of bank customers are little different to those of other creditors. If investors/property owners want exposure to bullion they can buy gold certificates or open an allocated or unallocated account with a vault or bullion service. If they want to make use of bank services including demand deposits, they can open a bank account, but they should not expect the same rights as gold certificate holders or vault gold account holders. He wrote: 'Banks that infringe upon and abuse the property rights of their clients can make very good profits. The temptation to expand credit is almost irresistible. Moreover, they will try to expand credit and issue fiduciary media as much as they can possibly get away with.' This claim is misleading and false. Firstly, fractional reserve banking does not violate or abuse the property rights of anyone. Secondly, banking is a competitive industry and banks make no special profits. Thirdly, the optimal debt to equity ratios and reserve ratios etc. are not determined by what 'they can possibly get away with' but by profit maximisation considering the costs and benefits of different methods of production and asset holdings in free markets. An analysis of banking as a competitive industry is available on my website at http://www.geocities.com/davidhillary/goldbanking/chapter3. He wrote: 'This credit expansion brings about another typical feature found in the tragedy of the commons-external costs. In this case, everyone in society is harmed by the price changes induced by the issue of fiduciary media. These external costs are not taken into consideration by the banks that try to exploit the profit opportunities, because the property rights are not properly defined and defended by the legal system.' His claims about external costs are ill defined. Externality theory is itself subject to much discredit. The claim of property rights to prices is complete trash. There are no property right to prices unless a counterparty has promised to deal at a certain price, for example a futures, option or warrant contracts. Price changes to goods and services over time in markets firstly have nothing to do with credit extended and bank demand deposits and secondly are not property rights. Don't blame 'the legal system' for not protecting fictitious property rights. There are always limits to resource exploitation, even in the absence of effective institutions defining exploitation rights. Commons have viable exploitation limits when private costs is no longer compensated with private gain. These limits may not be efficient, but they are limits. It is possible that over-exploitation will cause a complete collapse of the capacity of the resource, but it is also possible that it will not. Fractional reserve banks are not inherently bankrupt. Banks are careful to maintain greater assets than liabilities and thus enjoy an equity buffer against failure. A bank has no reason to fear other banks unless that other bank is a significant demand depositor. Liability diversification protects banks against the choices of individual depositors. Banks can liquidate their assets as required to meet withdrawals provided it is adequately capitalised (because when it sells large proportions of its assets in a hurry it does so at a discount, reducing capitalisation). And it is the bank's depositors, not its competitors, that judge the bank's fitness to hold their deposits. Any method a bank uses to enhance its liquidity improve that bank's strength and security, and enhances its ability to pay its deposits, and so clearing and settlement banking may provide some help in maintaining liquidity. However, the more important useful function of 'central banking' are asset repurchase markets, used for liquidation of/borrowing against assets such as bonds, to provide short term liquidity, including emergency liquidity if required. The markets for the bank's assets will have a greater impact on its ability to liquidate assets, which is the primary method of maintaining liquidity during major withdrawal demands. I conclude that he has no idea of the things that he writes about and that he is consequently propagating myths masquerading as analysis. Although this is not uncommon, its not welcome and underscores the need for real analysis of banking and money. David Hillary --- You are currently subscribed to e-gold-list as: [EMAIL PROTECTED] To unsubscribe send a blank email to [EMAIL PROTECTED] Use e-gold's Secure Randomized Keyboard (SRK) when accessing your e-gold account(s) via the web and shopping cart interfaces to help thwart keystroke loggers and common viruses.
