Other posts I’ve written on the subject of Fractional-reserve banking: Fiat Money is False Money and Leads to Failure, Banking and Our Inflation Problems, and Credit and Full-Reserve Banking: Not Mutually Exclusive to name a few.

Without a doubt the United States was (and according to most still is) the economic superpower of the world. Its standard of living was high, employment was up, it manufactured, served, and had what seemed to be an endless amount of foreign investors. But the question arises of how the U.S. arrived to such a position. In the early 20’s, the economy experienced the effects of the Federal Reserve Act kicking in: credit was moving in much larger amounts to a much broader base of people. This meant people were buying stocks on margin or bought appliances, products, and even cars with payment plans. This, in turn, offered everyone jobs somewhere along the line. The economy kept expanding. 

This clearly ended with the October crash in 1929: the onset of the Great Depression. The boom brought an inevitable bust, and standards of living were poorer than before. Despite this crash, the 20’s foreshadowed the 1950’s regarding the growing middle class. Through the Great Depression, as the New Deal was passed, people and businesses became more “federally insured”; when the war was over and the economy was picking up again, buying-on-credit became more frequent and “safer”. Again. Thus our modern middle-class consumerism was born; if people could become debtors all they wanted then there was no stopping our economic growth! 

That economic system clearly has major flaws, and I as an Austrian have pointed this out many times. But there is an argument, which I myself subscribe to, that supports a system of fractional-reserves (credit expansion). I’m going to attempt to make that same argument to all who read this.

If anyone who reads this were to observe my other posts linked at the top, they would notice I condemn inflation and the fractional-reserve system we stand by today. Many of my Austrian counterparts would state this it is so horrible, the system as a whole must be wiped out; it is absolutely fundamental for them to understand that there are certain levels of fractional-reserves that can have long term benefits.

Let me start by analyzing some of these of these numbers. The first thing to realize is the current reserve ratio set by the Federal Reserve: 10%. This means that when you deposit, say, $100 into a bank, they only keep 10% of that. You are still entitled to withdraw the whole $100, but they only have $10. The Federal Reserve has banks practice this so that the other 90% (your $90) can go out in the form of credit.

Note: It is somewhat sustainable, because the banks hope that a limited amount of depositors want their money at a certain time. This would allow the banks to simply move money around and pay you the $100 you rightfully own. 

Thus $90 was just added to the money supply. But wait, we’re not done! This process now repeats with that $90, which turns into $81, etc etc. 

This is known as the money multiplier, and the equation of it is:

M being the multiplier, and R being the reserve ratio. So let’s plug in our current ratio. The equation becomes m= 1/.1 = 10. What is that in a percentage? 1000%. Your money inflates 1000% in our current fractional-reserve system. That’s an astonishing amount of credit out in the markets! The liabilities of the banks must be overflowing! Why, they must feel the urge to raise those reserve ratios! Nope. Time and time again, the Federal Reserve bails them out when they start to have a bank run. Why, we just found out the Federal Reserve spent $16 trillion doing this exact thing in secret!

The Austrian Business Cycle Theory has been proven correct with every bust we’ve seen. I’d like to very very briefly go over it here. We know that there is a market for Loanable Funds, and that in a full-reserve system, Savings will always equal Investment. If people are saving more and more, we’ll notice the ability to invest increase. With more investment availability (i.e. the ability to give out credit), we’ll notice the market interest rate fall. Here is a graph of the overall economy in a 100% Real Savings economy.

We notice that there is generally more Consumption as opposed to Investment, meaning that there is less money being put into earlier stages of production. The economy has a bit of a high time preference. There is no bubble being developed.

Here is a picture of the economy when Savings does not equal Investment:

Through one of the many ways the Federal Reserve expands the money supply, we see a boost in investment with no change in real savings. In fact, savings might actually decrease with the artificially low interest rate. We now see a boost in Consumption and Investment. This greatly distorts the Hayekian Triangle, pumping malinvestments into all parts of the economy. 

Note: I may make a post further explaining the Austrian Business Cycle Theory. 

There are very damaging levels where this can be done. We’ve seen the effects of these damaging levels throughout world history. But are there levels of credit expansion that won’t distort the Hayekian triangle so much, and may actually help us? Yes. If we threw out every other money-creating tool the Fed has and boosted the reserve ratios to a point where banks may act autonomously, then we may reach “the perfect economy”. We may as well call this free-banking.

Now let’s backtrack and observe the following graph, showing the multiplier effect with various reserve ratios:

50% and higher doesn’t seem so scary at all. Even 40% might not seem so detrimental. Look, I’m not saying we wouldn’t have bubbles; we would, but they’d be very minor. 

We need to realize that without our flow of credit in the 50’s, we wouldn’t have become the economic superpower we are. I don’t condone the risks we took doing it, how fast it took, and the woes it brought us after these booms, but the general rule still holds true: flow of credit is a positive thing. When done responsibly, that is. In free-banking, banks wouldn’t be able to keep 10% reserves like this; they would need to stay higher so long as we are not on a unified currency. There really is a point where what Rothbard regarded as “fraud” will help us.

Ever since Romney said to an audience, “Corporations are people, my friend,” it seems to have bee a hot topic. All corporations have a right to limited liability. This means that all individuals inside the business, executives and shareholders alike, are exempt from personal liability. They also have a right to free speech, are given due process, enter into contracts, and own property. Corporations are entities, not people, but still have the right to all of this.

Now there are two basic defenses of this: 1) People makeup corporations. Because the Constitution protects all people, it must also protect voluntary organizations of people. 2) Giving shareholders exemption from liability gives incentive for people to invest and build domestic industry; keeping the people who make businesses safe from lawsuits will keep the economy on a full employment path. 

While I do believe these are legitimate arguments, they are flawed in their cause. 

Reasons why this must be changed:

The fact that corporations are the only liable entity is a corruption of the natural state of business. It provides incentive for executives and bankers to be reckless and possibly cause destruction. This recklessness is due to the idea that the corporation is the one that answers to the law, and not the affirmative-voting shareholders or decisive men on a board of directors. This cannot be the case any longer. It leads to atrocities like the BP Oil Spill. 

Also, providing investors with safety nets may not be the best of ideas. It allows simple speculation into markets, and enables people to just throw money anywhere. Making shareholders a liable entity would require people to have some form of knowledge on the industry in which they are invested. Discouraging investors, and executives, from pursuing risky business ventures would be overall beneficial for the consumers. 

What must be changed: 

I discussed this briefly in a response to a comment made by logicallypositive. Justin noted that only some companies have the right to limited liability, and an even more select group have a right to person-hood.

The first thing that must change is one component of limited liability. It must have a practical repeal. 

I say “practical” because we should have a system of dual-liabilities. Meaning executives must be liable to lawsuits. Meaning voting shareholders must be liable to lawsuits. But it also means that the company itself, instead of individuals, may be liable to a lawsuit. We are led to believe that we can only have one or the other, when in fact it is very constitutional and utilitarian to be able to have both the individuals and entities subject to liability.It would give class-action suits and individual suits the ability, more so, to hold responsible parties accountable. 

The next step, after the aforementioned and major flaw in the system is fixed, would be to reform the whole idea of Corporate Personhood. This was the part I discussed in the link above. Right now, only a select group of companies have the rights of people (own property, enter into contracts, etc.) giving them market advantages. But the solution is rather simple. It involves leveling the playing field. Remove the title and chartering of corporations, and make it so ALL organizations of people may own property as a single entity, enter into contracts, sue others, possess freedom of speech, etc.

Organizations will gain person-hood as they are composed of people, but not give the individuals involved immunity. It also does not make it mandatory for a company to turn to a corporate structure for this person-hood or even use this person-hood. Individuals would still be at liberty to own the property of a business or engage in contracts on behalf of a business. Then, instead of the components person-hood being bundled into one title, they would then be independent and interchangeable components of a business. 

This system would be most free, most efficient, and most desirable. Not our current state of “capitalism”. The current system leaves too much leeway for Corporatism, and these are very necessary changes in order to achieve a freer marketplace.

crythias:

communismkills:

I don’t see the point in auditing the Fed.

One of the main functions of the Fed is that it gives loans to banks in order to ease their liquidity. The audit of the Fed would simply show that the Fed gives loans to banks, which is its job. No one should be outraged that the Fed gave loans to banks, unless they don’t know the function of the Fed is to provide loans. The audit would show that the Fed does its job. So what? Let’s just scare people with a big number which represents the monetary value of loans the Fed gave out? Let’s prey on economic illiteracy to score a political point?

As a side-note, people often overestimate the effect of the Federal Reserve. If people believe Lucas was right, the Fed would have to intentionally lie about its operations in order to be effective in creating abnormal inflation. However, rational individuals expect inflation and the Fed has been rendered nearly moot.

Remember, the Fed can’t even print money, so all of this talk about the Fed debauching our currency is just talk. The Fed just a big ineffective, inefficient blob that really isn’t that powerful. Being against the Fed isn’t much more than symbolism.

Your real anger should be with legal tender laws and fiscal policy.

The Bureau of Engraving and Printing is the one who prints money, that’s true. But this big, ineffective, inefficient blob somehow has the ability to provide 16 Trillion US Dollars in bailouts. The questions that should naturally follow are:

1) How does any entity that cannot print the money have that much money in the first place when it’s ineffective, inefficient and doesn’t otherwise produce anything of value?

2) What happens when an ineffective, inefficient organization introduces $16 Trillion currency into circulation? (Reworded: What happens when you increase the supply of money by $16Trillion?)

thisgingersnapsback:

• I am automatically correct!
• You’re not allowed to disagree with me or vocalize this disagreement!
• Anything you say to me in disagreement is immediately invalid because that’s just your opinion!
• Your facts are just your opinion!
• I have the right to never be questioned!
• I’m just as informed as you are even though I’ve not looked at the facts!
• I don’t NEED to look at the facts, because I don’t NEED to change my opinion!
• Opinions are sacred!

“MY OPINION” DOES mean:

• I am not automatically correct!
• If the facts disagree with my opinion, then my opinion is wrong!
• People are allowed to tell me about the facts!
• People are allowed to to tell me that I’m wrong!
• Just because it’s my opinion doesn’t mean I get the free-for-all card to be an ignorant douchenozzle on the subject!
• Disagreeing with FACTS just because I’d rather cling to your OPINION doesn’t make me RIGHT, it makes me STUBBORN.
• All opinions are open to criticism, mine included!

What I don’t like about this is the fact that even though facts may support your opinion, other facts will support the other opinion. Having facts doesn’t automatically prove an opinion right sadly, because there is so much subjective input.

For instance, I don’t believe in wealth redistribution. But the fact is we have a huge wealth gap. We see this mainly with financial sector workers. Now this fact backs up the opinion that we need wealth redistribution. But I believe this fact backs up my opinion that the Corporatism and regulation is truly what the harmful element in our economy is, and that they key is to free up the markets. 

So then we delve deeper: the fact that the Federal Reserve spent about $16 trillion in bailing out banks in private backs up my opinion that the government is propping up “banksters”, and that government is the problem. But the fact that banks were irresponsible with money in 2008 is an argument for regulation. And the fact that, if the banks were not bailed out, we would be in another depression is a huge argument for more government oversight. 

So the idea that some facts will prove all opinions wrong isn’t a good argument. All opinions will always have facts to turn to in order to argue against other facts. It truly is a never ending battle.

And hey, if people want to be arrogant and obnoxious with their opinions, then just ignore them. They have the guaranteed right to be obnoxious, but not the guaranteed right to have people pay attention to them.

As shown from the first pseudo-audit, it was much much more than $7.7 trillion.

Which raises the question how could taxpayer money fund even that plus our budgets? Well, it doesn’t. Neither does borrowing. How much did the Fed print? Whatever the amount, it means trouble.

thoseboringpolitics:

In response to this post, I got a few questions claiming that my logic was faulty, because economies of scale wouldn’t exist in a free-market economy. Assuming the first was a troll, I ignored it, but I got 2 more anons with the same question. Maybe it was the same person, but I’m making a post explaining that economies of scale would still exist in a free-market. They would just exist to a smaller degree.

Businesses will obviously still finance and evaluate their assets, output, and expenses frequently in a free-market. In fact, they’ll have to scrutinize more into it since they’ll be completely on their own and without regulation. Economies of scale occur when Average Total Cost declines as more output is occurring. This effect is mandated by supply and demand. That’s simply business.

To make my point that the sizes of businesses would decrease, let me explain something:

We live in a Representative Republic, meaning it’s easier for businesses to get their say in bills and amendments. Lobbyists are paid big money to ensure handouts for their companies. A prime example are liability caps on oil companies. It removes the ability for many to pursue companies in court, allowing businesses to not be held accountable for their actions.

When businesses make decisions in a free market to increase their assets, with increasing revenue as their final goal, they take a risk. Businesses take many risks in markets and if they screw up, they can be held accountable. 

Everytime a firm expands, whether it be hiring a few new workers or building a whole new workplace, it’s taking a large risk. As firms grow and grow, a larger amount of liability is spread over a large amount of workers, consumers, and land. However, the liability is voided when the state is brought in. 

This is not to say firms can’t and won’t grow to international sizes in free markets; they will. But they won’t have nearly as much of a market-share nor will the have as little competition. Firms will be held liable for many disputes: from small claims to employee-benefits. The expenses of liability will force many businesses that would otherwise potentially hold a large market-share to drawback. 

Anti-trust laws, while they seem to be regulating firms, actually help keep monopolies around. Barriers to entry also prevent new competition. In other words, competition is kept out by government. 

Competition would be frequent as firms compete for size without becoming too large in liabilities. The only way a firm could become progressively large is if the way they treat employees is so positive and its output is so productive that claims against the firm won’t be filed. That type of innovation would be imitated and firms would prosper and compete to be better.

Monopolies are preserved by government.  AT&T was upheld by government and after deregulation, more competition entered the market and dominated. A more recent example involves statewide monopolies on electricity. Many states were recently deregulated, allowing companies to provide electricity for more people rather than go through an organization such as PECO (Philadelphia Electric and Gas Company). 

These monopolies directly correspond with large economies and diseconomies of scale; monopolies wouldn’t be around without a corporatist state. Economies of scale simply would be much smaller without the state. And that’s all because of the second most favorite word of libertarians (liberty is the first): liability.

Decided to reblog one of my older posts since I had to visit it anyway to provide the link for a friend. I think it’s a nice little post, and the post it links to at the beginning is nice as well. So for all new followers since this post, enjoy some reading material!

Just about every one of the U.S.’ largest banks received billions of dollars in money from the FRB, withCitigroup, Inc. receiving the most funds at $2,513 billion between 2007 and 2010. Investment groups Morgan Stanley and Merrill Lynch rounded out the top three recipients at $2,041 and $1,949 billion respectively. Foreign companies who benefited from the FRB’s generosity included Great Britain’s Royal Bank of Scotland Group, and Deutsch Bank of Germany and Switzerland’s United Bank Switzerland AG, and Credit Suisse Group AG. It certainly is odd that Switzerland and Germany, of all places, would be getting billions of dollars in U.S. money, especially since their economies are supposedly stable. Just what are two Swiss companies doing taking money from the FRB, anyway?

Ben Bernanke and Alan Greenspan, to name a few, were adamant in their opposition of such an audit, and now it is clear as to why. This private bank is giving away money stolen from the American public; money that the country can’t afford to hand out. It’s corporate welfare; plain and simple. Why is no one outraged about this? Why are lawmakers blaming illegal immigrants and the poor for causing so many economic problems when the cause is more clear than a bottle of Evian? To draw attention away from the fact that they’re probably benefiting from all this legalized money laundering.

You might not think of it as money laundering, but it is. The transfers were done in secret, masked from the public. Who knows whose pockets that money eventually ended up in, but it certainly wasn’t those of the American public!

And what’s worse is that we knew the Federal Reserve created the $2 trillion for Quantitative Easing (which is an amount that is a detriment to an economy), but we have no idea where the Fed acquired $16 trillion to fund these secret bailouts that you can read about here. It’s been speculated that the Federal Reserve has created most of or all of this money out of thin air. If this is the case, then we are truly in trouble. The U.S. central bank was desperate to keep the economy going short-term so banks wouldn’t go under and to “control deflation”, but the reality is that the Weimar Republic created a lot of money relative to GDP and now we’ve done the same; we’ve possibly even created an amount of money a few trillion over our GDP. And yet, this new audit is getting no attention from corporate news. I wonder why…