[starsmodelmgmt]

I did a google search on “bank reserve lending” it seems there is a debate among scholars whether a bank lends out reserves or not. Some says banks do lend out reserves where others say banks do not. Which view is the correct one?

[jmherbener]

Banks lend their reserves to other banks. This particular credit market is called the Federal Funds Market.

http://www.newyorkfed.org/aboutthefed/fedpoint/fed15.html

[johnwinters91]

Professor Herbener,

1. What is the consensus among Austrians as to the appropriate alternative to the Federal Reserve system, aside from an agreement about the desirability of a commodity standard? Is it a free banking system with fractional reserves, a free banking system with full reserves, or neither?

2. If the value of a commodity standard is that it prevents inflation due to the scarcity of the commodity, how do we know there would be enough money to go around? How would the value adjust from an ounce of gold being over $1k to being something that could be used in every day transactions? Is the current price of gold mostly due to its value as a hedge or due to the law of supply? How would there be enough gold to accommodate all the transactions in the economy?

3. In a free banking system, how would ordinary people with limited knowledge of financial instruments etc be able to accurately guage the soundness of a given bank? We saw the last time around how incompetent the rating agencies are, so what could the ordinary person look to as a vanguard against fraud and abuse by the banks?

4. How would banks make money if they couldn’t loan out their reserves and were required to keep 100% of their reserves?

5. What do you make of Joseph Salerno’s proposal to give Congress control of monetary policy in the short run? Would that result in the same thing we’ve seen thus far in terms of rampant inflation? And how would we transition from that to a more sound monetary system?

Thank you

[jmherbener]

1. There seems to be some agreement on free enterprise in money and banking. Entrepreneurs should be able to attempt innovations and have them succeed or fail on the basis of the resulting profit and loss. There is sharp disagreement about what the outcome of the attempt to implement fractional-reserve, money substitutes would be. Free bankers argue that such a system will provide for adjustment of the money stock to changes in money demand while leaving the purchasing power of money stable. Misesians argue that such an attempt will result in nearly 100 percent reserves of money substitutes.

Take a look at this talk by Joe Salerno:

https://mises.org/library/economics-fractional-reserve-banking-0

2. In a free-market, commodity money would be produced by private enterprise. Just like the production of any other good, the production of money would be regulated by profit and loss. If the demand for money increased, then it would be more profitable to produce and money-commodity-producing entrepreneurs would buy more inputs to expand production. The additional production of coins would moderate their higher purchasing power and the additional demand for inputs would bid up input prices. The result would be an elimination of additional profit and an economizing movement of resources out of other goods and into commodity money production. If entrepreneurs have chosen a commodity whose supply is insufficiently expandable in the face of increased demand for money (so that problematic price deflation occurs), then they would simply chose another commodity to use as money that did not face such a problem (for example, silver instead of gold.)

The high purchasing power (in contrast to a rapidly rising purchasing power) of gold would not pose a problem. Entrepreneurs would create money substitutes that can have any denomination necessary for making transactions. For example, a check of any amount can be drafted on a person’s checking account at a bank.

Whatever the money stock happens to be, all the transactions that people desire to conduct can be consummated. If the money stock is half as large, all the transactions can be made as long as prices are half as high. If the money stock is twice as large, all the transactions can be made at prices twice as high. This insight was first advanced by David Hume.

https://mises.org/library/david-hume-and-theory-money

3. In a free market, entrepreneurs could operate profitable businesses providing assessments of financial institutions. Auditing companies, private rating agencies, etc. would spring up to accommodate consumer demand for such assessments. There are many examples of businesses that do so currently for consumer-goods markets.

Of course, rating agencies today are heavily intertwined with the state and its regulatory apparatus. For example, the state dictates what financial reports must be made and what accounting rules must be used to report asset values.

4. Banks would earn fees from customers who valued the convenience and safety of the banks’ money substitutes relative to using coins. As long as customers valued sufficiently their checking accounts relative to coins as a medium of exchange to provide revenue to the banks by paying fees that were high enough to cover the banks’ costs of producing and administering the checking accounts, then banks could profitably produce them. Customers may also value the protective storage of their coins relative to holding their coins themselves, which would be another source of fees banks could charge for 100 percent reserve, money substitutes.

Banks earn revenue from intermediating credit. They borrow funds from savers, pool them and lend them to investors. As middlemen, banks can provide valuable services to savers, such as assuming the risk of default on loans to investors and pooling funds of small savers to make larger loans with lower transactions costs. As long as savers value these services, they would be willing to accept lower (wholesale) interest rates to lend to banks that, in turn, can lend to investors at higher (retail) interest rates. If the revenue from the interest-rate differential covers the costs of providing the middleman services, then banks can be profitable.

5. It does have its merits.

https://mises.org/library/modest-proposal-end-fed-independence

He seems to suggest that it might awaken the public to the need for monetary reform since it makes the wealth transfer to the state apparent. Whereas the Fed system is opaque.

[johnwinters91]

Thank you so much for your responses! You’ve been invaluable so far in my ongoing process of learning. There’s only so much one can get out of listening to lectures or reading, especially working full time, so I really appreciate your efforts.

I have some more questions:

1. This is my main, most nagging question. Would it be possible for there to be credit at all (at least from banks) in a 100% reserve system? I’m displaying my ignorance, but that’s why I’m here.

If banks have to keep full reserves, how would they be able to make loans?

I can see how runs would be a check against reckless lending and inflation in a specie based fractional reserve system, and how in such a system lending is still possible, but how would that work in a full reserve system? Would credit markets be possible?

2. What are the consumer goods ratings companies you are referring to?

3. Could bank runs occur in both fractional and full reserve hard money systems?

4. Could bank runs happen for no reason, or just out of nowhere, threatening the stability of our financial system? I’m not saying out system is inherently stable now, but what are the chances of something like that happening?

5. What caused the bank runs that caused panics prior to and leading to the establishment of the Fed? What’s the Austrian response to the critics who say that that would just happen again if we followed Rothbard or others?

6. Is there a standard (or better word:RELIABLE) metric used to measure the severity of a banking crisis? Is the percentage of losses relative to GDP the best way to measure this? Would such a metric be a reliable tool to measure the comparative severities of the banking crises/depressions before and after the Fed?

Thank you very much again for your time.

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