Reply To: Credit


Professor Mehrling defines banking as financial intermediation (swapping IOUs). Thus, by definition, for him banking cannot be money warehousing, or, for that matter, foreign currency exchange, or financial advice, all traditional activities of what are called banks. That’s fine, he can define terms as he likes. It doesn’t change the reality of institutions called banks that perform functions in addition to swapping IOUs, including providing a money warehouse.

The substantive issue he raises is whether or not so-called instantaneous-term IOUs (i.e., demand deposits) are in fact financial intermediation. Otherwise, I agree with what he said about swapping IOUs and the transfer of command over resources. There is a sizable literature on the question of whether or not demand deposits are financial intermediation. Huerta de Soto’s book is an example:

Professor Mehrling’s view that it’s not possible to eliminate central banking is ahistorical. Setting aside the recent experiments with currency boards in some countries, there was banking in the western world long before the first central banks arose in the 17th century. It’s not only possible to have 100 percent reserve banking, such banks existed for long periods of time in Europe.

I agree that central banking is a natural outcome of a particular legal treatment of banking. The development of central banking is a natural outcome of following the logic of granting legal sanction to demand deposits as financial intermediation. As professor Mehrling puts it a swap of IOUs, the borrower issuing a term IOU to the bank and the bank issuing an instantaneous-term IOU to its customer. But it begs the question to assume that such a legal treatment merely extends financial intermediation to a hitherto overlooked realm. In any case, once this swap is given legal sanction, then central banks follow logically. Murray Rothbard’s book chronicles this development and its consequences: