Posted by: graemebird | August 20, 2007

Importance Of Pecking-Order For Libertarian-Principles: Fractional-Reserve-Phase-Out As Constitutional-Protection.

From Catallaxy:

“So, Graeme, doesn’t the same problem exist with term deposits? That the money will be loaned out and spent then return to the bank as more deposits, only to be loaned again? If this is OK then I have no idea what you are actually objecting to.”

The term deposit is the wealth creator par excellence under growth-deflation-capitalism.

It turns out (and here you might look at Milton Friedmans work on the ‘optimal supply of money’) that if we have maintained a situation of growth-deflation for a very long time….

…. (And this growth-deflation has differing definitions but I’ll define it as when “NOMINAL GROSS DOMESTIC REVENUE is always growing but only very slowly and never as fast as REAL GROSS DOMESTIC REVENUE)…….

……It turns out that in the above situation we don’t need the banks for very much at all. But we do need them for security and to make these term loans.

And surely there will be all the other products too that the financial services sector has to offer its only that under conditions of constantly falling consumer prices and growth deflation as I’ve defined it there is just not that much call for them all.

Now you have to imagine yourself in an whole other world when you appraise this situation.

For you and your father and his father and his father before him lets imagine that consumer prices have always been falling.

And that the nominal on-call interest rate would always have been close to zero.

And that you could only get any interest at all on a term deposit…… seldom at 3 months…….. usually at 12 months…….. sometimes at 6 months.

Thats the world you have to try and mentally grasp when you consider the following.

Fractional reserve in the past has always STARTED in fraud and embezzlement.

But if we were hyper-vigilante against fraud and embezzlement it could in theory start but it would only do so at the worst possible time to further expand the money-supply.

Now there is three types of fractional reserve and two are dishonest but 1 is honest.

The one that is honest…. and fractional reserve has never started this way……….

The one that is honest we might call the REDEMPTION PROMISE PLUS I OWE YOU.

Under growth deflation with no taxes on anything that would hinder retention of funds within the firm and no taxes on saving and no government borrowing…..

….. And combining this with hyper-vigilance against the fraud version of fractional reserve…..

Well under this set of circumstances there would be no call on either the banks side of the equation or the consumers side of the equation for the RP+IOU product.

The circumstance that would lead to a demand for that product would be a government…… either yours or foreign governments…. driving up nominal interest rates by a massive borrowing spree to fight a world war….

….. Or by general socialist policies attempting to be implemented by your government.

…… Or by the government taking the RP+IOU product as tax payment……

And if any of these situations happened, in conjunction with something that made the favoured medium-of-exchange more plentiful then usual……….

…. Well your whole monetary system could unravel.


We are used to disaggregating between the market and the government.
We do this to assist analysis.

But you cannot seperate money/the private sector/and the political sector.

You screw up with money the politicians will become involved.

So the only way we can have free-enterprise-money without either recessions…. crony capitalism or political interference….

… Is if we are quits with fractional reserve in all the forms we have so far come to know it.

This follows from monetary-economics…….. And I won’t say “political-science” because that sounds pretentious…. But it follows from a sizing up of just what sort of animal the government is.

We should think of the prohibition of fractional reserve in all its currently understood forms as a CONSTITUTIONAL PROTECTION.

Because its just so easy for the pollies and the big-end-of-town to get together and unravel our free and fair money and our free and fair society with it…

….. I admit that the argument from inherent fraud only goes about 80% of the way and only even then if you understand what the world would be like under free enterprise conditions.


Right. Lets remind ourselves of your question:

“So, Graeme, doesn’t the same problem exist with term deposits? That the money will be loaned out and spent then return to the bank as more deposits, only to be loaned again? If this is OK then I have no idea what you are actually objecting to.”

Well firstly I’m objecting to the current socialist money.

Secondly I’m objecting to bad monetary economics under proposed alternatives….

But thirdly I’m objecting to the pecking-order of driving-assumptions for the libertarian-movement.

And it is to this third objection that I will turn now.


Life is Beta.

There are forces moving us towards liberty and mostly its the Gandalf-like efforts of just a few of us.

But most “spontaneous” forces are moving us the other way.

We have certain general principles but some represent more the ultimate ideal and must, by their very nature, be compromised in the medium-term.

Others are inherent to this BETA idea. Others are inherent to the idea of being in transition towards a more perfect liberty with other people forcing back-sliding upon us.

We have three main principles. The non-initiation of force….. freedom of contract… and a third principle that is a shadow in the current libertarian movement.


Now many experts have given us a hint of how it might be with a totally voluntary society.

Where force is not initiated. Where we have freedom of contract.

But thats an ultimate end. And anyone in charge would find himself having to violate these things.

And I’m telling you that we libertarians are made to look like nutballs because we put these two principles ahead of clarity in property titles.

If we go for clarity in property-titles it will prepare the ground for us getting closer and closer to the realisation of these other two principles.

And we will be thought of as nutballs no longer because if clarity-in-property-titles is the exaltant principle of the libertarian movement we will have the ability to DELIVER to our constituents and beat out the competition in this regard.

The phase-out of fractional-reserve….. it goes without saying that this is to be acheived with a total deregulation in all other respects that don’t impinge upon clarity-in-property-rights.

And we can unravel this crony-capitalist/socialist monetary-system at break-neck pace without risking recession if we take THIS clarity-in-property-titles approach but not if we do it any other way.



  1. Graeme,

    In real life, you can’t go from the current system to a 100% reserved demand deposit system without a recession. A recession is the result of malinvestments in the prior boom, where there have been excessive investment in uneconomical capital goods projects and insufficient investment in economica; capital goods projects. You do not have to have a drop in economic activity to have a recession. All you need is a drop in capital goods formation relative to primary (first order consumption goods) consumption. Such malinvestment are a feature of any inflation, and a fractional reserve system is inherently inflationary.

    The good thing that such a change would make is that it would bring the deflationary adjustment on sooner. The sooner the adjustment the better, since the pain will be less and the process will be able to proceed to completion faster even with the politicians trying to interfere. How do we know this? The Great Depression is the best example of political interference with money and credit from the initial institution of a nationalized fractional reserve system through excessive taxation (high tariffs and high income tax rates) and theft (removing gold from circulation).

  2. No-ones going for that though. The rich guys aren’t giving up all their houses.

    And you can unwind it all without a recession. You’ve got to keep your eye on three things….

    .. The amount of cash balances people are holding. You see under growth deflation they would hold more. So you want to convince them to hold more prior to the growth deflation coming on.

    … Secondly people would carry less debt. So you want them to start paying off their debts prior to the crunch.

    You might even go so far as letting them register the debt and all their income tax liability going straight to paying off the registered debt.

    And then the other thing is “productive expenditure”…… You have to keep that growing. Thats spending money within firms for the purpose of making a profit. You can’t let that tank in transition.

    But if you keep that always growing but bring its rate of growth down then you can do it.

    I mean it might seem satisfying to think that we’ll bankrupt all the rich guys but we cannot push such an idea.

    You could make rental income non-taxeable and take off any stamp taxes and the like.

    You want massive sackings in the public sector to pay for this all and to make sure you can keep productive expenditure growing.

    In terms of transition strategy you have to put up the discount rate to loan shark levels and then you just tell the Federal Reserve (or in our case the Reserve Bank) that when they want to increase demand they buy-back debt with newly printed cash and when they want to restrain demand they must notch up the Reserve Asset Ratio a bit. No lending with the discount rate or selling bonds. Just those two adjustment methods only.

    Pretty soon you’ll be at 100% backing. The higher the RAR is the easier it will be to hit what you aim at vis a vis “productive expenditure.

    That malinvestment is part of the picture but its only one part of it. And if you know what you are doing you can avoid a recession. But you want to get to 100% fiat backing before the real squeeze comes on.

    Malinvestment is really too strong a term. When Mises came up with that he was talking about crap that had happened over a 6 year boom-bust.

    We ought to think more of it as being sub-optimal investments. Not as good as we’d have made with sound money. But the thing is all of our investments are like that after all these decades. So we shouldn’t think of it as an all-or-nothing thing.

    Just about all our investments have to be judged crap in terms of what might have been. And there’s no real cause for bankrupting us all.

  3. Graeme,


    The Austrian school’s business cycle theory did not include a time line in the sense of, say, a six year cycle. Their time line was more open ended than that, IOW, the longer the inflationary boom, the worse the resulting deflationary period would be (though if governments refused to intervene, it would take 18-24 months to work itself out).

    It is my opinion that the current system is less fractionally reserved demand deposit heavy. Capital markets are less dependent upon bank demand deposits than they used to be (think money markets, time deposits, asset backed derivatives, etc.). This is why recessions tend to be mild these days. Greenspan’s FED tried hard to match fiat money supply growth with demand growth, and the FED was partially successful in this.

    Wrt bankrupting us all, that’ll never happen as long as there are enough adults to get Congress to resume specie backed money and tweak the bankruptcy laws.

  4. You have to try and see where Mises was coming from.

    Since in the 20’s the system was fractional reserve, and since MISES didn’t want to lose the connection with Gold there was nothing for it but to liquidate as quickly as possible.

    But we’ve been on compulsion-cash basically since 33 and totally since 71.

    So its just continual inflating.

    Under that situation, since we are not trying to maintain fractional-gold, well it seems pointless to utterly bankrupt everyone.

    Recessions are less common because they can keep inflating out of them and also they have a bit more control of things. Under 100% backing they don’t need to have control and the central bank should really just dissolve themselves.

    But under fractional-Gold…. if your predeccessors set you up for problems there is not much you can do.

    When we have mispricing of higher-order investments because of crap monetary policy nowadays….. what happens in the US and Australia is that we tend to have a trade-deficit blowout rather then a traditional Misean crash. So the GDP growth keeps edging up…… but the trade deficit blows out as all those malinvestments are covered over by borrowing more from foreigners and getting more resources, mispriced locally, now from overseas.

    So you keep growing feebly and nobody notices that your local manufacturing is slowly attriting in relative terms. I mean they notice it but they don’t make it that it is partly connected to poor monetary policy.

    The last traditional MISEAN crash I reckon I saw was in Thailand around 97.

    I went there many years later. And you could see it like it was just out of a Rothbard or Mises explanation.

    It was fucking uncanny. All these buildings and footpaths half-completed. Went round to a friends brothers place. He had invested in this mighty Chicken-coup….. Now it was half-built. Everything abandoned on a specific date. It was like that everywhere. Like a line in the rocks marking the asteroid collision 65 million years ago.

    Everything else about Thailand confirmed the Austrial view of things as well.

    Perhaps you wouldn’t see it so starkly as an Australian would. Because we don’t have many illegal cheap workers here. So the contrast between Thailands and Australias way of doing things was very evident. And it just showed how righteous the Austrians are in their ideas.

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