Saturday, Mar 14, 2009
Defending the indefensible.
Market Ticker: Reserve Banking
My screed on "Mark To Market" brought the tinfoil brigade out of the woodwork in spades, and one of their most common "attack points" is that "reserve banking is fraud."
Simply put, "no its not."
Let's prove it.
Posted by devo @ 08:10 PM (684 views) Add Comment
9 Comments
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1. devo said...
"Demand deposits should not be lent out by their very definition. It is fraud to promise everyone you can return their money to them at any time when you simply can't. This applies regardless of how many people and banks are in the system."
"Nonsense. Provided my assets purchased with those deposits are good, I can hypothecate them and return your money any time you'd like. As long as I am lending at a rate exceeding that which I borrow, I can do this any time you'd like your money, and you may have it immediately."
2. devo said...
Denninger: "any time you'd like your money, you may have it immediately"
I hypothecate that ill-judged statements like this will send your friendly local bank manager into a cold sweat.
Ask Adam Applegarth.
3. mark wadsworth said...
Good for Karl Denninger.
There are too many people who go round saying that FRB means that banks can lend out a multiple of money deposited with it.
Nonsense.
What is means is that banks can lend out a multiple of their own capital and reserves.
I agree, banks have been lending out a far higher multiple than is safe, but that is a question of degree, not of principle.
4. devo said...
Mark: "banks have been lending out a far higher multiple than is safe"
I have edited your post for relevance.
5. alphabetzoo said...
I need to read this is more detail later but alarm bells started ringing at:
rovided I properly underwrote it, that paper is actually worth more than $90,000 - it is in fact likely worth 102 or 103% of "par", because there's a discounted cash flow in the form of interest payments and so long as the interest charged is higher than the inflation rate (or alternatively, the risk-free return I can obtain in, for example, Treasury bonds of equivalent duration) and the collateral protects against default that paper is in fact more valuable than its $90,000 face value.
There is a weaker criticism of FRB that "it is OK provided growth is always positive" and that statement looks like another way of assuming positive growth. So I smell a rat.
6. Mrb said...
Mmm nice try to debunk 100+ years of sound banking theory from the Austrian School, but I'm afraid your answer to this question is rather dreadful:
Q:As you addressed in this Ticker, fractional reserve banking is both inherently inflationary at the time of loan origination as well as ultimately deflationary in the long run, causing booms and busts.
A: Nope. A loan made for productive investment is not inherently inflationary. And a bust is only deflationary to the extent that attempts are made to stave off recession; said recessions do not necessarily need to be deflationary events, and in fact most are not. The deflationary events come about as a consequence of tampering with soundness.
A loan [conjurde out of thin air] made for productive investment is [always] inflationary. growth in the quantity of money is inlfation. A fairly inhocate argument in favour of FRB.
7. mark wadsworth said...
@ Alphabetzoo - the key word is "provided it is properly underwritten" - nobody disputes that many/most loans were NOT properly underwritten, least of all Karl D.
Karl D knows what he is talking about - imagine a bank with no share capital at all (i.e. a building society), it borrows money from people and lends money to people. It pays slightly less interest than it charges, the margin is enough to cover running costs. That building society as a whole has a positive value (which was proven by the fact that the shares had value when they all demutualised in the 1990s). The positive value must be the difference between assets and liabilties, or alternatively, the net present value of the profit element.
8. alphabetzoo said...
@ Mark Wadsworth.
My point is that is economy must grow for that interest (in aggregate) to be repaid. As the money as debt film shows, there isn't enough money in the current system to repay it. It is only in a dynamic system with sufficient growth that the principal + interest can ever be repaid. Karl D (and many economists) can easily explain why the maths work for FRB given a simplistic one period/one bank model. however, I have yet to see an analysis that allows the interest in aggregate to be repaid without economic growth. And in a post peak-oil world, that's going to be difficult. Plus let me stress, I don't subscribe entirely to FRB=bad views - however I do believe that no profits should be made by the private sector in the creation of money; FRB with a fully nationalised banking system may be the answer.
9. mark wadsworth said...
@ Alphabetzoo, as we know from recent experience, the good old fashioned building societies have fared much better than banks, and the worst performers were BS's who converted to banks in the 1990s (NR, B&B, Halifax).
A good old fashioned BS does in fact not really have any share capital at all, it lends out one hundred per cent of its deposits. So you could call that an minimum capital requirement of zero, or a gearing of infinity, and yet (relatively) they thrived.
Karl D hams it up terribly with the idea that the economy has to grow faster than interest rates for the whole thing to work, this is quite simply not true.