I posted a few days ago that I’m embarking on quite a lengthy reading list, supplied to me by Dr. Walter Block, concerning the issue of free banking versus 100% reserve banking. Although I consider myself mostly within the “free banking” coalition, I have to admit that the first couple of articles I’ve read defending 100% reserves have been pretty persuasive.

To start, I first tackled Philipp Bagus’ “The Commons and the Tragedy of Banking” article from 2003. As the title suggests, Bagus examines Austrian economist Jesus Huerta de Soto’s claim that fractional reserve banking can constitute an example of the tragedy of the commons. Although Bagus nitpicks a little bit and disagrees with Huerta de Soto on some points, the relatively short article contains a lot of interesting analysis.

As Huerta de Soto points out, the problem of the tragedy of the commons always appears when property rights are defined improperly. In the case of fractional reserve banking, bankers can infringe on property rights because it is not clearly defined who owns the deposit.

This is a point that Block made when I saw him speak, and I think that it’s a really good way to start thinking about FRB (regardless of your position on it). What Block, Bagus, and Huerta de Soto are saying is that, in a FRB system, there are more titleholders to demand deposits than there are demand deposits in the first place. Thus, if I deposit $100 in a bank with a 10% reserve requirement, and the bank loans out $90 to their next client, it seems as though an extra $90 have entered circulation. Both he and I will spend, and he and I will have $90 and $100 in our accounts, respectively. And yet, if we both came to the bank at the same time to withdraw money (assuming we are the banks only two customers), there would only be the original $100 in the vault. To whom does it belong? According to our contracts, we both have titles to it, and yet this is a logical impossibility. Now, if both of us know this to be the case (especially if we were both bankers rather than clients), we would be incentivized to use these services as quickly as possible, as in any other case of the tragedy of the commons.

Bagus and others are quick to point out that this is part of what would incentivize fractional reserve bankers to form into cartels and introduce a private central bank to the market, thus allowing all of them to maintain a constant reserve ratio and inflate the money supply at the same pace. This removes the limit on the issuance of fiduciary media that otherwise would have existed formerly, when banks were not cartelized and would have been incentivized to run the more inflationary banks into the ground. (Of course, as many Austrians will note, there are also many problems with maintaining cartels within a free market).

Only with the installation of the central bank, Huerta de Soto notes, can the practice of fractional reserve banking come to resemble a true tragedy of the commons. Bagus takes issue with this too, however, and points out toward the end of his piece that the threat of hyperinflation does still provide a loose check on the expansion of fiduciary media and thus somewhat perverts the FRB tragedy of the commons (since it is no longer true that the incentive exists to exploit the commons as fast as humanly possible).

In addition to the piece by Bagus, I also read an extremely well-argued scholarly article by William Barnet II and Dr. Block himself, entitled “In Defense of Fiduciary Media–A Comment; or, What’s Wrong with “Clown” or Play Money?” Despite the title, the article is a very clear and very convincing case for what Block sees as a logical impossibility of FRB in a free banking society. Thus, he doesn’t really argue so much that FRB should not be allowed to exist, but rather that it would cease to exist within a free banking arrangement. (This is close to how I have generally felt on the subject).

Block’s article is a response to an article by George Selgin and Lawrence White. I haven’t read the initial article, but I don’t think it’s necessary if you are only interested in examining Block’s position.

Block and Barnett start by addressing a common free banking argument, and one that I have made myself: under a system of free banking, it is ethical and possible that a private central bank would arise, to act as a lender of last resort for free market fractional reserve banks in times of crisis. As the two succinctly point out, however, this does not make sense logically, since a system composed entirely of fractional reserve banks would, by very definition, issue more claims to money than existing money itself. This would be systematic in free society fractional reserve banking and, thus, by definition, no central bank or entity could possibly act as their lender of last resort, since more claims to money exist than money itself within the entire system. To put it another way, this solution is begging the question. To say that a central bank could bail out the individual banks actually negates a premise of systemic fractional reserve banking. It does not make sense to say that the central bank could have the resources to do this. No one could. (In fact, today, such a feat can be accomplished only by printing funds).

Block and Barnett also tackle another basic point, which is that “good banks are not run prone.” Specifically, it is that “solvent banks are not run prone,” but as they point out, every fractional reserve bank is, by definition, insolvent. It has more liabilities than it does assets. If it did not, it would not be a fractional reserve bank, but a 100% reserve bank. They also take on the interesting argument that FRB could be structured as time deposits with exceedingly short maturations, so that they were effectively fractional reserve demand deposits. As Block and Barnett point out, though, the length of maturation does not impact whether or not something is a demand deposit, and thus this “solution” skirts the real issue. They also quickly dispel the idea that the mining of gold constitutes a misallocation of resources in a 100% reserve economy by pointing to the massive misallocations of resources that occur during boom and bust cycles partially created by the practice of fractional reserve banking in the first place.

Interestingly, the two take on another common free banking argument, which goes something like this: in a free banking society, clients who wanted 100% security could store their money in 100% reserve banks, while others could be lured away by strong advertising and the potential for higher gains in the form of interest at fractional reserve banks. Block and Barnett point out the strange nature of this arrangement, though, by showing that those banks most successful at luring away customers would be most susceptible to bank runs. Thus, the better they were at delivering on these returns (and thus the greater number of customers they accumulated), it would necessarily be the case that the sooner and more plentifully would they be called upon by the 100% reserve banks for redemption. As the FRBs gained more and more consumers, 100% reserve banks would come into contact with more and more of them, and thus would need to redeem checks and other payments from them at the FRB. At a certain point, the inherently insolvent FRB would be unable to meet these demands, and thus by its initial success would have driven itself out of business. This is an extremely interesting and persuasive argument.

The Block and Barnett article goes into much more detail than I do here and, if you are at all interested in these questions, I highly recommend you read it. It is as much a page turner as any scholarly article can be. I haven’t been won over to the side of 100% reserves yet, but I am beginning to really see their point. In the end, I think it is not so much that FRB should be forcibly disallowed, but that in a society of free bankers, it will be the first to go (by its own hand, and that of the market) anyway.

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Walter Block, Fractional Reserve Banking, and Fraud

Last weekend, I attended several talks by Austrian economist Walter Block during my trip to New York City. I spoke to Block personally after one of these talks, to ask him for clarification regarding the idea that banks should have to hold 100% reserves.

For those unfamiliar with this debate, banks today engage in a practice known as “fractional reserve banking,” or “FRB” in the literature. In a fractional reserve system, banks are not required to hold 100% of their customers’ cash at all times. So, if I deposit $100 in the bank, the bank will then loan that money to another individual at whatever ratio does satisfy the reserve requirement. Assuming a 10% reserve requirement (which means that the bank has to hold on to 10% of the cash that I and every other customer deposit), they can loan $90 to the second individual. The problem with fractional reserve banking is that it creates two claims to the same property. I may go out and spend my $100 on a boombox, while the other individual may go out and spend his $90 on new clothes. Thus, a total of $190 are spent, but only $100 were initially deposited. This system is not found out until the vendors of the clothes and boomboxes both go to the bank to retrieve the cash, at which point it becomes clear that it is not there and the bank fails. This, of course, is an oversimplification, as today’s modern economy is grand and largely electronic.

Austrians have different views on FRB. Some, such as Dr. Block, think that banks should be required to maintain 100% reserves, while others, such as myself, believe that “free banking” is the best model. In free banking, banks can choose whatever FRB and reserve policies they like, but are not to be bailed out if they fail. The belief behind a system of free banking is that the market will root out winners and losers, and will thus promote the best possible policy.

Dr. Block told me to e-mail him about this, so I did. Impressively, he responded with an alphabetized reading list on the subject just a week later. The list is very long and, combined with my current work on Human Action , will take up most of my free time for the next few weeks.

I plan to post extensively here on what I read, and welcome any debate or questions as usual.

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Human Action: Introduction

I have finally started on Ludwig von Mises’ famous tome, Human Action , which is certainly one of the most important books in the history of the Austrian school of economics. I can make no promises that progress will not be slow but, in the interest of spreading knowledge to those who do not have time to read the work themselves, I am going to attempt to post notes, synopses, and recaps as I read. Tonight will mark the first such installment, with just a couple of strong quotes from Mises’ introduction. (Some of the more grandiose and overarching points occur in the introduction, and I find it difficult to really summarize them here. I will work more closely with them as they appear throughout the book.)

What is wrong with our age is precisely the widespread ignorance of the role which these policies of economic freedom played in the technological evolution of the last two hundred years. People fell prey to the fallacy that the improvement of the methods of production was contemporaneous with the policy of laissez faire only by accident. Deluded by Marxian myths, they consider modern industrialism an outcome of the operation of mysterious “productive forces” that do not depend in any way on ideological factors. Classical economics, they believe, was not a factor in the rise of capitalism, but rather its product, its “ideological superstructure,” i.e., a doctrine designed to defend the unfair claims of the capitalistic exploiters. Hence the abolition of capitalism and the substitution of socialist totalitarianism for a market economy and free enterprise would not impair the further progress of technology. It would, on the contrary, promote technological improvement by removing the obstacles which the selfish interests of the capitalists place in its way.

It is true that economics is a theoretical science and as such abstains from any judgment of value. It is not its task to tell people what ends they should aim at. It is a science of the means to be applied for the attainment of ends chosen, not, to be sure, a science of the choosing of ends. Ultimate decisions, the valuations and the choosing of ends, are beyond the scope of any science. Science never tells a man how he should act; it merely shows how a man must act if he wants to attain definite ends.

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The Chronicle: OWS is the Cure that Kills its Patient

Here is my weekly column for the Duke University Chronicle. This week, I write about the anniversary of the OWS movement, and the ways in which the movement worked against liberty and toward increasing state power. Enjoy!

I’m a couple days late on this one, but I’ve been traveling so bear with me.

Paul Krugman posted about Ron Paul’s reaction to QE3 this past weekend. I think that his post, yet again, reveals that despite his biting criticisms of the Austrian School, his analysis really suffers from a lack of familiarity with it. For one thing, Krugman quotes Brad DeLong as follows:

“Honest money” is a Ron Paul dog whistle: the good productive workers, the bad exploitative usurers, the necessity of a hard-money depression to cleanse the monetary colon–you know the drill.

Despite the fact that Krugman did not write this, his promotion of it is careless. I understand that this is mostly just an attempt at a humorous pot-shot, but the phrase “bad exploitative usurers” is really misguided here. If anything, members of the Austrian School right now are seeking a return to market-based interest rates, which would very likely be higher than the rates we have at the moment. How this amounts to a criticism of “usury” is really beyond me. Furthermore, most Austrians would probably shy away from using a phrase like “exploitative” this carelessly–such a word has, historically, been pretty aggressively associated with the flawed theories of value of other schools.

Krugman then makes another classic error in his criticism of the Austrian School:

I mean, it has always been a peculiarity of that school of thought that it praises markets and opposes government interventions…

This phrasing is a little deceptive at the moment, since I’ve cut off where Krugman was going with that (I will take back up with it later). For now, though, my issue is just with the first part of the sentence. It has to be noted that most serious Austrians would disagree that the Austrian school of thought qua Austrian school of thought praises markets and opposes government interventions, since the Austrians, more than any other school at the moment, place great importance on pursuing positive, value-free economics. The basis of Austrian economics is a praxeological approach to the nature of acting man. Take, for example, an issue such as minimum wage. The Austrian economist cannot say whether a minimum wage is “good” or “bad,” but can only examine the effects that it might have. Thus, he could use his analysis to say that the minimum wage might increase unemployment, or that it might not achieve its desired effects, but it is outside of the scope of Austrian economics to say whether this is “good” or “bad.” Austrian economics qua Austrian economics does not really “praise” or “oppose” things in the way that Krugman is suggesting here.

Actually, this is sort of a beginner’s mistake on Krugman’s part. He is confusing Austrian economics with libertarianism. Although it is true that many Austrians are also libertarians, it is not, as Walter Block pointed out this weekend in a lecture at Columbia University, necessarily the case that one implies the other. Austrians examine markets and government interventions, while libertarians praise and oppose them. When an Austrian praises the market and opposes government interventions, he does so as a libertarian, and not as an Austrian. This may seem nitpicky, but it is actually a crucial point, since it reveals that much of Krugman’s problems with Austrian economics come from his basic misunderstanding of its most fundamental principles.

Anyway, to get back to Krugman’s analysis, here is the full quote:

I mean, it has always been a peculiarity of that school of thought that it praises markets and opposes government interventions–but that at the same time it demands that the government step in to prevent the free market from providing a certain kind of financial service. As I understand it, the intellectual trick here is to convince oneself that fractional reserve banking, in which banks don’t keep 100% of deposits in a vault, is somehow an artificial creation of the government. This is historically wrong, but maybe the actual history of banking is deep enough in the past for that wrongness to get missed.

This is, to say the least, an extremely problematic passage. First of all, Krugman constructs what he believes to be some damning contradiction–that Austrians recognize the efficacy of the free market over the state but advocate state power in enforcing a policy of 100% reserves–without really any evidence or support. Although there are some notable Austrians who believe in 100% reserve banking, there is also a significant portion of the population that advocates instead for “free banking,” in which banking exists as an unregulated sector and whichever orders arise spontaneously will exist as long as they can be maintained. Krugman entirely overlooks them, though, either because he is unaware of the significant body of literature they have produced, or because including them would harm his argument. I’m not sure which of these is worse. Furthermore, many Austrians who do advocate for 100% banking do not do so on the basis of state intervention, but rather envision a free market in which free banks would recognize it as in their best interest to devise a private central bank to serve as a lender of last resort, and which itself could enforce a reserve ratio. Again, Krugman’s understanding of the Austrian school is flawed, and his writing suffers as a result.

Then, Krugman goes on to caricature the Austrian position as one in which fractional reserve banking comes into existence by government fiat. This, again, is also a complicated claim. In fact, it doesn’t much matter how fractional reserve banking comes into existence; what matters is that the state keeps it in existence by extending bank holidays, suspending specie payments, and bailing out bad banks, a practice that has been going on since the mid-19th century in America. It is easy to vaguely quibble on points of history, I suppose, but it is far more difficult to counter an opponent’s argument.

Finally, Krugman says something that is a little confusing to me:

So would a Ron Paul regulatory regime have teams of “honest money” inquisitors fanning across the landscape, chasing and closing down anyone illegitimately creating claims that might compete with gold and silver? How is this supposed to work?

If Krugman is really curious about this, he is always free to consult the record. In fact, the record actually includes his own recent debate with Ron Paul, in which Paul suggests that the last thing he wants to do is shut down competition in currency. From Paul:

All I want to do is get rid of the monopoly [on currency]. I want to legalize competition. There’s legal competition on currencies around the world, why can’t we allow ourselves here the legal competition of a gold or silver standard? Why is the Fed so frightened about this?

Actually, at this point, Krugman can be heard talking over Paul:

I have no idea what that’s about, to be honest.

It seems, then, that not much has changed. Krugman commented after that debate on the “pointlessness of debates,” and I’m now tempted to agree with him. How useful can a debate really be, if at least one party simply isn’t even listening?

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My weekly article in the Duke University Chronicle, dealing this week with the private Honduran cities I posted about this weekend. For those of you who read the post this weekend, there is some new information in this article, and an exploration of some historical examples of spontaneous order in society.

Honduras Sells Out

Enjoy! I would also be happy to provide sources/further reading for anything discussed. Just get in touch in the comments section here or via Facebook/Twitter/e-mail.

Honduras Sells Out: Three Cities to be Privately Run

I have woken up this morning to very interesting news. According to Honduras, which has the “highest murder rate in the world, an impoverished population, and political instability,” has decided to sell three of its cities to MGK.

These cities are to exist as “states within a state,” and will presumably include different currencies, defense agencies, and court systems than the larger republic of Honduras. The funding is not all there yet, but if this gets underway it’ll have the potential to provide a very interesting case for decentralization and statelessness.

I say this because, even though these cities might not be entirely stateless per se , they could perhaps provide an interesting model for transitioning to statelessness. Historically, the problem of stateless societies–which actually have existed to a greater extent than conventional historical accounts allow for–has not been that they are unstable themselves, but rather that they are usually not given time to build adequate institutions for private security before the surrounding states intrude on them. (For examples of viable stateless societies, see Europe’s Moresnet , the American Wild West , the Zomia region of Upland Southeast Asia , and even some elements of Somalia in the late 1990s. As far as Somalia goes, I am unfamiliar with the literature on this, but I know that Jonathan Finegold has posted on it on his blog , and that he draws from papers , here , and –all of which I intend to read and post on when I find the time.)

The advantage of an approach such as the one Honduras is taking could be that a centralized authority–essentially the owner and financier of the city, in this case–could oversee the installation of private security firms during a time of centralized stability, and then withdraw when these firms were stable enough to provide security on their own. Of course, I realize the inherent problems with this idea: it’s possible that the owner of the city would just continue rule as a monarch, or, as Nozick would probably suggest, that the private security firms would themselves develop into a state. As to the former, I have a vague idea that the potential for profit is far greater without a monarchical rule, and that a city owner might recognize this and choose to benefit accordingly. As for the latter, many have responded to Nozick’s arguments, including Murray Rothbard in The Ethics of Liberty , so I will not go into it here.

This analysis is relatively undeveloped for now, but has inspired me to post a little more on the question of states arising endogenously from a stateless society, and I will hopefully find the time to post a lengthier analysis of this situation soon.

Aboriginal Canadians and the Public School System

Mike Reid has published a very interesting article, entitled “One Race to School Them All,” over at the Mises Institute’s website.

I have become increasingly interested in the history of Indian and Native American peoples, since I think that these peoples offer an insight into societies that function without state apparatuses. As Reid writes:

Most of the cultures these kids were being snatched from were largely anarchic, voluntary societies. There was warfare, but no conscription. There was trade, but no taxation. There were leaders, but no rulers.

I will hopefully have time to do a longer post on this in the future, but for now, this article is really fantastic. Also, for further reading on the non-state histories of the Indians, check out Terry L. Anderson and P.J. Hill’s “An American Experiment in Anarcho-Capitalism: The Not So Wild, Wild West,” as well as the book by the same name. (For those uninterested in the theoretical musings of the paper, skip to the bottom of page 13–”Cases from the West.”)

Biden: All Answers, No Questions

I have been trying hard to avoid the nominating conventions over the past two weeks, but with the advent of the Internet these things became more or less unavoidable to a certain degree. As such, I was confronted not too long ago with a quote from Joe Biden’s speech:

Osama bin Laden is dead, and General Motors is alive.

Biden states these facts as though they speak for themselves, but I am not so sure. Both of these events were the products of massive government initiatives that occurred, by a conservative estimate, over the course of the last decade, and which had numerous unintended consequences for the American people. As such, I am a little bit surprised that Biden is so big on answers right now, and so short on questions. Questions like the one below:

At what cost?

Every Wednesday for the next year, I will be publishing a column in my alma mater’s daily independent newspaper, the Duke University Chronicle.

Today’s article, entitled Apple and Intellectual Property , deals with Apple’s recent lawsuit against Samsung, and the complications inherent in the idea of intellectual property itself.

Enjoy!