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speedybure (< 20)

Dynamics Of A Banking System In a Truly Free Market

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June 03, 2009 – Comments (1)


Granted I am an Austro-Libertarian Idealist, I found myself debating how a free- market banking system would operate. Well it wasn't exactly that broad, rather it was the nuts and bolts of it all. I expect the majority who read what I'm about to write will call me crazy, but the few who understand the true nature of the coming currency crisis might find this interesting. Okay for the layman I will just outline the broad austrian theory for the general framework of a free banking sysytem. 

1) The would be no central bank, thus no fractional reserve banking. For those who don't know a brief example of fractional reserve banking would be as follows: Suppose John Doe comes to me (the bank) and wants to borrow 1m, I would make a 100k deposit with the FED and they would create 900k out of thin air. So in other words fractional reserve banking is the most inflationary instrument out their for the following reason: Lets take Citigroup or some other large money center bank, all the loan losses being incurred than can't be covered by existing capital/retained earninigs, etc is inflationary as it was created by the central bank.  

2) A commoditty that is durable, unable to be replicated and relatively scarce as to make it impossible to make a noticable change in the outstanding quantity. This as most people know, and which the free market has chosen for over 5000 years has been gold and silver. The latter for everyday transactions and gold for large denominations. This, however, would not likely be the currency in circulation but rather a paper currency backed 100% by Gold and Silver. 

 3) This in turn would mean banks make loans from retained earnings or capital raised through equity offereings or something of that nature. This would neccessarily lead to more prudent lending, as this would be shareholders actual wealth at stake. Banks would grow through the interest earned on successful loans AND interest depositors would pay the bank for the service of holding their funds.

NOW THIS IS WHAT PUZZLES ME! I would imagine the interest for holding funds would be in the low single digit %. This would have to be the case because of competition. In a free market anormal profits would cause other entrants into the market. The detail I was debating was the following: would this rate constantly be drawn to near 0?I also was pondering whether the current equilibrium of supply and demand for loanable funds have an effect on this rate? Anyone care to share?    

1 Comments – Post Your Own

#1) On June 05, 2009 at 7:14 AM, 1275589962 (< 20) wrote:

>> "The would be no central bank, thus no fractional reserve banking."

Scotland up to 1844 didn't have a central bank. The three Scottish chartered banks of that period certainly did not act as central banks. And the Bank of England most likely did not act indirectly as a central bank for Scotland either. Yet by the early 1800s reserve ratios at Scottish note-issuing banks were down to 1 or 2 percent.

The Bank of Amsterdam, on the other hand, was a kind of central bank, and it conducted full-reserve banking.

So regardless of any merits it may have, full-reserve banking would probably not come about automatically as a result of a removal of the government monopoly of money and a return to commodity backing.

If we do eventually go back to laissez-faire full-reserve banking, it'll no doubt be by way of a period of laissez-faire fractional-reserve baking. Until the system is tested again, it'll be impossible to demonstrate convincingly that, when it comes to inflation, fractional reserves are the problem and not the lack under central banking of an interbank note-clearing system that acts to automatically match the supply of and demand for money.

Of course, if the laissez-faire full-reservists such as yourself are correct, the attempt to continue with fractional reserve banking in the absence of a central bank would quickly lead to crises anyway (in the form of bank runs), if it could begin in earnest at all.

I'm not up to speed on full-reserve theory, but your post gives me more reason to read up on it!

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