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I've already commented on this quite a bit over on the Cobden centre site.

As I said over there I think that Toby Baxendale and Anthony Evan's proposed view on accounting would limit many more businesses than banks.

I wrote:

"To take an analogous example… One of my friends is organizing a music festival in the west of Ireland. I’m not sure the tickets he is selling are refundable. But, let’s suppose they are. In that case should the law require him to keep enough funds to refund all of the tickets that he has sold? Even though he knows and everyone else know that the percentage of people who hand their tickets in for refund will be small and in most case he’ll be able to resell the ticket afterwards."


To which Toby replied:

"Music Festival: If your man offers a full refund, then he should perform should people have legitimate cause for a full refund. It is absurd to use this example as when someone deposits, they ALWAYS expect to get their money back when they want it. The Music Festival goers, expects to get a refund if the act does not turn up etc. You really do not do yourself any credit whatsoever arguing like this. This is the problem with the weak arguments put forward by defenders of all types of fractional reserve free bankers."


To which I responded:

"Anyway, your claim is that my example isn’t comparable to banking. Certainly it isn’t exactly. But, my point was to draw out the reasons for redemption and the discuss the legalities behind it.

Let’s suppose my friend offers a full refund on all tickets. Now, some would say that is a current liability and so, under normal accounting rules it should be kept whole. That means that my friend cannot spend any of the money from ticket sales until after the concert has occurred. Under a law like that if he had insufficient cash to cover his ticket sales until the gig then he would be breaking a law.

However, I doubt that a court would look at it that way. You write: “The Music Festival goers, expects to get a refund if the act does not turn up etc.” Exactly. Suppose my promoter friend offers these tickets and someone accuses him of breaking the law. The court were told that the promoter had taken sufficient steps to ensure that the acts do turn up and that the festival will go ahead as planned. In this case would the court condemn him because he had not kept his ticket liabilities whole? I think not because he would plead that he had reasonable grounds for believing that the ticket-holders would not call on their option of refund.

The same is true of money. You write: “when someone deposits, they ALWAYS expect to get their money back when they want it.” That’s true, but it doesn’t mean they all want their deposits back at the same time. The bank can quite reasonably presume that only a proportion of account holders will want to redeem at any particular time."

I absolutely agree with his remark:

"You really do not do yourself any credit whatsoever arguing like this"

I mean it's one thing to try to justify FRB accounting practices, but another to try to do so by comparing it to other businesses. It shows a complete ignorance on your part for not recognizing the uniqueness of FRB financial practices, as oppose to the standard financial practices of every other business. I'm specifically referring to the inherent practice of maturity mismatching between assets and liabilities that occurs only in modern day banking.

Now again, go ahead and try to rationalize it, but in your case, it is obvious that you have absolutely no clue as to either what I'm talking about, or the significance of it.

Toby Baxendale asked me to post this on his behalf:

Steven, many thanks for giving it a review.

The Importance of the Debate

I am not an academic like you guys who are “in the debate.” Thus as an outsider, what frustrates me is that the Austrian School predicted this credit bubble and its bust. Just like Hayek did in 1928, many Austrian School scholars have been posting warning on numerous sites around the world from the late 90’s onwards getting more and more intense as we got closer to 2008.

In the mainstream media we have no recognition for this and I suspect there is nothing in academia of any merit. The fact that the neoclassical (Monetarist / Keynesian mix) solutions are the solutions chosen and nothing is said (or heard) from the Austrian School, amazes me. At the Cobden Centre we have promoted so far 7 positive policy reforms designed to end credit induced booms and busts + reform the banking system, that are either Austrian or Austrian inspired or could be supported by Austrians but not written by them;

http://www.cobdencentre.org/author/paulbirch/

http://www.cobdencentre.org/author/kevin/

http://www.cobdencentre.org/2010/06/2-days/

http://www.cobdencentre.org/2010/05/the-emperors-new-clothes-how-to-pay-off-the-national-debt-give-a-28-5-tax-cut/

http://www.cobdencentre.org/2010/06/bagus-pure-austrian/

http://www.cobdencentre.org/2010/04/jimmy-stewart-is-dead/

http://www.cobdencentre.org/2010/04/a-pro-free-market-program-for-economic-recovery-by-george-reisman/

For the Keynesian and the Monetarist it is as simple as working on the demand side by fiscal stimulus (Keynes) and the money side (Monetarists). For the Austrians there are many ways, perhaps this is a good thing. Of those seven I prefer the one I advocate naturally but would accept any as an improvement over the status quo. As a result of division, we do not pack the punch that our School deserves. Unity is strength, therefore if a theoretical wound can be healed, all grist to our mill.

Narrow banking is being very seriously discussed on our side of the pond by the current Governor of the Bank of England, Mervyn King and by others. The Sec of State of Business , Vince Cable is pushing for a retail / investment bank split. Dr Andrew Lilico http://www.cobdencentre.org/2010/06/dr-lilico-of-policy-exchange-gives-serious-consideration-to-banking-reform/ of Policy Exchange the current PM’s “favourite” think tank advocates a 100% reserve savings account like they used to exist pre 1979 in this country. The Chancellor has set up a commission to look at this. So it is important that we understand the implications of moving away from a fractional reserve free banking environment. The Austrian School has a lot to say on the matter.

Grain Silos!!!!

I wrote the following here

http://www.cobdencentre.org/2010/03/free-banking-the-balance-sheet-and-contract-law-approach/

“Do Grain Store Examples Shed any Useful Light into this Debate?

I am often told by advocates of Fractional Reserve Free Banking that banking is like a grain store. That if ten tons were to be deposited by one man who took a certificate from the store holder explicitly stating that the store will be lending 9 ton of the grain out to bread makers in exchange for the original depositor not having to pay for the storage, or even being paid to store there – what would be wrong with this? Also, it would tell me under what time period my grain would be being used by others, and when I could get my grain back. Well, the answer is nothing at all as the contract is explicit – except that I will never get my grain back at all as it is being consumed by someone else. I will never get it back!

Grain examples should be avoided, for they certainly do not stack up.

Steve, I just can simply not take anything serious out of grain silo analogies with banking!
I have no problem with people engaging in a debt contract with a third party where by the third party explicitly says he will be issuing promises to pay over and above that which he can as not all other the people want the debt contract fulfilled at the same time so long as this is explicit and the property title, or debt contract, is diminished in value accordingly.

Book a higher vale when the debt is retuned, paid with interest, but if you engage in a debt contract where your original debt becomes only worth a fraction until it is fulfilled, then book a lower value. Books can then balance all the way through this with no recourse to a grant of legal privilege, just the good old well tried and tested commercial law that we all operate under.

I do take your point re “own your money” and if time permits a better phrasing about the nature of a demand deposit being either a bailment or a debt contract need to be more explicit to really get under the skin of the issue. I did understand Anthony had asked a group of academics involved in this debate to draw up the questions (I thought including you).

“Toby seems to be assuming that "easy access" means "the ability to empty my account whenever I want with zero risk of the bank being unable to meet that demand." I do mean that, subject to normal open hours etc. So again, when we revisit, we can be more delving in our questioning.

The Fractional Reserve Company V the 100% Reserve Company

“The claim that banks are inherently illiquid and insolvent is also misleading. It's true that fractional reserve banks are illiquid if the usual business standards are applied, but here is a case where banks are not the "usual business." For example, if an auditor came to a non-bank business and asked them to account for the fact that their liquid assets were not enough to cover their short-term liabilities, they might have a difficult time doing so. If they could do so, I'd imagine the auditor might say "okay, fine, you've explained why you have this arrangement" and if she was satisfied that the business was not in danger of defaulting, it would pass muster.”

Banks are not audited under GAPP, they are unique and sit outside of this standard, this is a point Mises makes, they can only exist with legal privilege either in the current regimes or in a FRFB system. As a company , I like all other commercial concerns have to maturity match. If I fail, I go bust. I like every other solvent company is a 100% reserve company doing our best at all times to maturity match. Banks have a grant of legal privilege to not operate on the same maturity matching standard, as you know. They do not have to keep their creditors whole. What ethical, philosophical, economic, moral any anything argument can you put forward to defend this anomaly?

So to be fair to all of us silly idiots who are diligently practicing maturity matching, to put us on a level playing field with the banks, we should all agree with our creditors to get long term debt relief , even a payment holiday forever , except in emergencies, as then our capital could be truly efficient. Imagine, if we all agree never to maturity match, we could borrow and pay out very little in the knowledge that we were all doing this and as long as we all play by the rules, it would never unravel itself. Our capital would get much better rates of return: we would be much more efficient in that respect. Just in case someone did want just that little bit back more than we had on hand, we could go to the lender of last resort, a mega company that would bail us out!

It is not hard to maturity match, virtually every company the planet does it except the banks!

The fractional reserve free banking position like the fractional reserve company position is dependent on s grant of state privilege which like a trade union closed shop, works against the rest of us.

Our survey shows desperate confusion. Policy makers should straighten this out and make banking honest. No doubt this debate will run and run, but we do need much more clarity about what banking is doing and what people think it is doing . Once the start point is straight, proactive Austrian inspired policy reform should be advocated .

One quick response to Toby for now:

You misread the point of my invoking grain silos. I said "Note that fractional reserves isn't the issue here, fungibility is." My point there was not to suggest fractional reserve grain silos would be okay or the like, but just to say that in a grain silo, like a bank, you don't keep ownership over the *exact materials you deposit* and instead you get a promise to pay you that quantity of the good when you demand it, even though it's not the exact same thing you deposited. What you "own" is the contract requiring the bank/silo to pay you the amount you deposited, but not the exact materials. Hence, in both cases the depositor does not "own" the physical materials he deposits, just the contract that says he will get paid.

The point is that the fungibility of money and grain makes it possible to give up ownership of the exact materials yet still own the right to the equivalent materials on demand.

Grain silos ARE analogous to banks to that extent. It's not about fractional reserve, just fungibility.

Steve,

The "fungibility" feature of money is true for all business transactions. A regular business must still match its assets and liabilities. Banks don't. Now, I don't care when people try to persuade me that, somehow, banking is just this really unique type of business. One of a kind... so here is why it is different for banking..... But, it is another thing to simply ignore this crucial point of difference that Toby is making between banking and ALL other types of business. Mises himself observed this special distinction early on (I can get the quote if you like) and Rothbard basically capitalized on it and emphasized it.
What is your response to this? All businesses are required to match except for banks.

Thanks for the comments Steve. I've responded to some of these points at the bottom of this article:

http://thefilter.blogs.com/thefilter/2010/06/public-attitudes-to-banking.html

I'd point out that most of this discussion does not directly relate to the paper itself, and I hope people do read it for themselves.

It's available here:

http://www.cobdencentre.org/?dl_id=67

Dan, DD5, ADA,

Firstly, why can't you stick to one handle?

> I absolutely agree with his remark:
>
> "You really do not do yourself any credit whatsoever
> arguing like this"

Rothbard had wit. That's what I miss about the modern 100% reservists.

> I mean it's one thing to try to justify FRB accounting
> practices, but another to try to do so by comparing it
> to other businesses. It shows a complete ignorance on
> your part for not recognizing the uniqueness of FRB
> financial practices, as oppose to the standard
> financial practices of every other business.

Well, if it does then please explain why.

All you've said above is essentially "how ridiculous how can someone say such a thing". You haven't provided an argument for why I'm wrong.

Tell me how could a general commercial law force banks to have 100% reserves without also forcing gig promoters not the spend the proceeds from ticket sales?

> I'm specifically referring to the inherent practice
> of maturity mismatching between assets and liabilities
> that occurs only in modern day banking.

Maturity mismatching is a slightly different issue. What Toby is talking about is the situation with current liabilities. Maturity mismatching is something that issuers of bonds can do too. I'll write about that some more in a minute.

> Now again, go ahead and try to rationalize it, but in
> your case, it is obvious that you have absolutely no
> clue as to either what I'm talking about, or the
> significance of it.

And you have absolutely no clue how to insult someone properly.

About this maturity mismatching business...

The question about accounting rules is quite different from the question about maturity mismatching. What the accounting question is about what a "current" liability is. Does the fact that all account-holders may redeem at once mean that banks must hold provisions in case they do so. As I explained above, my view is that they shouldn't have to. As I explained with the ticket example that is a simple extension of "normal commercial law".

There are many other examples beside that though which illustrate the point. I used to work in the computer industry. Computer manufacturers gaurantee and warranty computers for a period of time after they are bought. That is an "on-demand" sort of liability, if a computer fails or there is a recall then the company is liable. Now, should computer manufacturers keep that liability whole? I know that these companies *don't* do this. Just a few months ago I was told something interesting about one of the major manufacturers. They hold such a small amount of liquid assets that if they had to recall one of their models of notebook computer then they would be bankrupted.

As far as I know they continue to trade in this state. As I understand it they are permitted to do this because the chances of a major recall are considered sufficiently small. The same principle applies to banking. What matters isn't just the total amount of liabilities per se, but the chances that they will be redeemed. We would unnecessarily tie people's hands if we required only the amount were recognised by accounting rules.

Maturity mismatching is a more general issue. If I lend $10K for 20 years I may hold liabilities that are shorter. I could hold $10K in 2 years bonds and role them over every 2 years. Though neither loan is callable maturity mismatching is involved. I think Walter Block suggests that even maturity mismatching of this sort is unethical. I don't think that it is, as long as it is clear and not fraudulently hidden.

I also don't think that banks are the only businesses that engage in maturity mismatching. This depends though on the question about on-demand contracts above. In the computer insurance example I give above the customer may claim on any business. However, all the backing for that isn't redeemable any business day.

In general there is a "call-day" where the lender may call or roll-over. In the on-demand case that call-day comes every day. In the savings & loans banking case I mention it comes every 2 years. The Block & Moldbug view is that maturity mismatching is unethical because not enough lenders may be encouraged to roll-over on call-day. My view is that banks, insurance companies, other businesses and their auditors can make an assessment of the situation using their judgement. I think there is a point beyond which a company is "trading in insolvency" however, that point isn't "no maturity mismatching", it's some maturity mismatching.

Pr Horwitz asks : "If the bank "owns" our money, why is that account a liability for them? Toby never seems to consider that question and the way what one means by "ownership" matters."

The answer seems so obious that I hesitate to post the comment: the debt to the depositor is a liability for the bank, and the depositor's cash is not an asset for the bank for the bank no longer has it, and it is holding another asset instead.

As for the question of "who owns the cash", it is but a first step in the discussion. I hold that both fractional contracts and 100% contracts are legitimate. In this case, plain vanilla full property rights are not enough to describe them both.

Each contract stipulates who has what rights, and who made what commitment. When the issue is boiled down to "who owns the cash", all the subtelties are lost. As a result, the depositor gets mixed up with the impression that they are the same. Differenciating the two contracts and letting the depositors chose is the only way to know what they want.

Gu Si,

Actually, if I deposit $100 in cash into my checking account, the bank very much DOES still have the cash sitting in their drawer or vault and it is still an asset for them. What they then do is to create a new asset and new liability by creating a new bank account (assume 10% reserves) for a $90 loan to a customer. The physical cash is still there, and it's still on the asset side of the bank's balance sheet. (It doesn't loan out the cash to its customers.) And it's serving as reserves against both the $90 loan, which will get spent and probably mean $90 in reserves going out via the Fed, and the $100 deposit of mine (which only needs 10% given that it's a deposit not a loan to be spent).

So my cash deposit IS still an asset for the bank and it does still "have" it in the vault.


Current,

When somebody owes you $1000 on 6/18/2011, then that is a liability with a maturity of 1 year from now. If he knows what's best for him, he'll arrange to have that $1000 on that date (or sooner). That he can fail to do so, and therefore go bankrupt on that day, there is no debate about.

All I'm saying (and apparently Toby is also), is that the only business that systematically does not practice maturity matching, that is, to plan his business so that he does have the cash in hand on the date of the matured liability, is fractional reserve banking.

All you're doing by comparing the maturity mismatching to your ticket example or your other examples (computer warranties or whatever) is just making the observation that a business can fail to meet its obligations in many other ways. But nobody is denying this. That somebody, who owes you that $1000, may not have your money on its due date because he blew it on a bad investment. The difference between this and if he engaged in maturity mismatching (because he thought that most customers don't pull out their money at the same time) is the difference between an investment firm engaged and a sort of intermediary service and some kind of a shell game or ponzi scheme. Now don't get me wrong, I have nothing against such schemes being legal provided they are honest about their business. But there is a difference between them and other businesses.

Dan wrote:

"All I'm saying (and apparently Toby is also), is that the only business that systematically does not practice maturity matching, that is, to plan his business so that he does have the cash in hand on the date of the matured liability, is fractional reserve banking."

Worded that way, I think that's exactly what banks DO (i.e., plan to have the cash in hand on the date of the matured liability). A demand deposit has no specific maturity date, thus it can be "cashed" at any time. Or not cashed at any time. For that instrument, the equivalent of "the date of the matured liability" is the total net demand for reserves on any given day (or hour or whatever). What banks do, in the absence of legal reserve requirements, is "to plan their business" in such a way as to have sufficient cash on hand on any given day to meet the maturing liabilities on that day.

The point is that the nature of a demand deposit is such that the liability can mature at any time and for any fraction of the total liability. Thus the equivalent time-matching strategy, it would seem, is to have suffient funds on hand to meet those daily demands.

So perhaps it's not that fractional reserve banks have any favored legal treatment, but that instead the nature of the instrument they create is such that meeting the requirement of liquidity/solvency is accomplished through their holding sufficient reserves.

If one looks at the full amount of the deposit as the "matured liability" then sure, they are different. But since the liability can mature at any time *and for any fraction of the full amount*, perhaps that's not the right comparison.

Dan,

> All I'm saying (and apparently Toby is also), is that
> the only business that systematically does not practice
> maturity matching, that is, to plan his business so that
> he does have the cash in hand on the date of the matured
> liability, is fractional reserve banking.

As I said earlier computer manufacturers don't practice it. I know this from personal experience working with them.

A "recall day" may come at any time. It exactly the same thing as the "call day" I discuss earlier. Some computer manufacturers don't have enough current assets to deal with what would happen if all customers sent their computers back. The Computer companies work by estimating a fraction that will be returned.

> All you're doing by comparing the maturity mismatching
> to your ticket example or your other examples
> (computer warranties or whatever) is just making the
> observation that a business can fail to meet its
> obligations in many other ways.

How different really is it though? Earlier I described "maturity mismatching" as "not having enough resources to cover the situation where every contract holder calls on call-day".

Now, your attempting to limit the definition of "maturity mismatching" to situations that only involve financial assets. I think this is an artificial distinction.

If a computer company decides to contract an insurance company to deal with gaurantees then does that mean that the insurance company has performed maturity-mismatching? But if the activity is kept in house then it's not maturity mismatching.

> That somebody, who owes you that $1000, may not have
> your money on its due date because he blew it on a bad
> investment.

That's a different problem. Note that my examples of gig tickets and computer recalls are not like this.

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