WEBVTT NOTE Time Deposits: Fraud and the ABCT 1 00:00:00.000 --> 00:00:14.440 There's a debate in the Austrian libertarian movement between those who say that fractional reserve banking for demand deposits should be illegal in the libertarian society and creates the Austrian business cycle. 2 00:00:14.440 --> 00:00:27.240 On the side of those who say that it should be illegal and does create the business cycle are people like Rothbard, Hoppe, Holtzman, myself, Barnett, people associated with the Mises Institute and the quarterly journal of Austrian economics. 3 00:00:27.240 --> 00:00:31.980 On the other side are people such as White, Selgen, Seacrest, people associated with the 4 00:00:31.980 --> 00:00:38.080 SDAE and George Mason. 5 00:00:38.080 --> 00:00:42.080 Today's paper, we're extending this, we're sort of ratcheting it up a bit. 6 00:00:42.080 --> 00:00:46.520 Not only are we saying that demand deposits, fractional reserve banking is illicit and 7 00:00:46.520 --> 00:00:50.760 creates the Austrian business cycle, we're also saying if you borrow short and lend long 8 00:00:50.760 --> 00:00:56.600 for time deposits, this also is illicit and creates the business cycle. 9 00:00:56.600 --> 00:01:02.720 The people on the other side say, well, to just talk about fractional reserve banking 10 00:01:02.720 --> 00:01:09.640 and demand deposit, they say, well, it's a contract. And I say, contract, schmontract. 11 00:01:09.640 --> 00:01:13.680 There's something more important than contract, and that's property rights. And if the contract 12 00:01:13.680 --> 00:01:17.800 is incompatible with property rights, then it's an illegitimate contract per se. For 13 00:01:17.800 --> 00:01:22.720 example, if I contract with someone else to murder a third person, that's an illicit contract, 14 00:01:22.720 --> 00:01:31.720 or if I contract to sell a square circle. There is no such thing. That's a silly contract, an illicit contract. 15 00:01:31.720 --> 00:01:38.720 Right now in a small town there are 10,000 cars and 10,000 property titles to cars. 16 00:01:38.720 --> 00:01:44.720 If someone starts creating extra property titles to cars and tries to circulate them, that is per se a fraud and illegitimate, 17 00:01:44.720 --> 00:01:48.720 unless it's done as sort of a joke like you make monopoly money. 18 00:01:48.720 --> 00:01:57.040 Let me give you one example. Suppose I deposit 100 gold ounces in a bank and the bank has 19 00:01:57.040 --> 00:02:02.000 a 10% fractional reserve on the basis of demand deposits and they give me a demand deposit 20 00:02:02.000 --> 00:02:08.960 for 100 gold ounces. Fine. Then what the bank does is turns around and using its 10% reserve 21 00:02:08.960 --> 00:02:14.280 ratio lends out $90 or 90 ounces of gold to someone else and that other person also has 22 00:02:14.280 --> 00:02:20.600 Demand Deposit. Now Ayn Rand is very famous for saying that rights can't conflict and yet here 23 00:02:20.600 --> 00:02:26.600 rights are conflicting. I and this other person both have a right to a demand deposit for this 24 00:02:26.600 --> 00:02:32.440 well 90 or 190 gold ounces and yet there are only 100 gold ounces in the system. So there's a 25 00:02:32.440 --> 00:02:38.680 conflict in rights. You can't have two different people owning 100% of one thing. Yes, two people 26 00:02:38.680 --> 00:02:42.680 can own a car. I can use it Monday, Wednesday and Friday. You can use it Tuesday, Thursday and 27 00:02:42.680 --> 00:02:44.780 and the 28 00:02:44.780 --> 00:02:47.100 time deposit case. 29 00:02:47.100 --> 00:02:52.100 Walter had originally assured me he'd take two minutes. 30 00:02:52.100 --> 00:02:55.100 How much did he take? 31 00:02:55.100 --> 00:02:58.100 Yeah, that's what I thought. 32 00:02:58.100 --> 00:03:03.100 Okay, first of all, I don't know if Laura Davis is here, but I'm sure she is. 33 00:03:03.100 --> 00:03:06.100 And I'm sure she's here. 34 00:03:06.100 --> 00:03:09.100 Yeah, that's what I thought. 35 00:03:09.100 --> 00:03:21.100 Okay, first of all, I don't know if Laura Davidson's here, but we'd like to thank her because this is, what you're hearing today is two different papers that we put together. 36 00:03:21.100 --> 00:03:28.100 And she caught something, a mistake we made in one of them, and I'd just like to thank her publicly. 37 00:03:28.100 --> 00:03:35.100 I know she's here at the conference for catching a mistake for us, so thank you very much, and we thank her in the paper. 38 00:03:35.100 --> 00:03:45.780 Walter and I have lunch three or four times a week and we invariably talk economics and 39 00:03:45.780 --> 00:03:53.100 come up with ideas for things we think ought to be done. The Austrian theory of the trade 40 00:03:53.100 --> 00:03:58.740 cycle or business cycle, if you think back, I mean Mises writes about it in 1912, that's 41 00:03:58.740 --> 00:04:03.140 the origins, but there's not much in the theory of money and credit there. The first 42 00:04:03.140 --> 00:04:09.940 This real, lengthy exposition, I think, of the Austrian theory of the trade cycle, most 43 00:04:09.940 --> 00:04:17.940 people would say, is Hayek's book, The Monetary Theory of the Trade Cycle, which is late 20s, 44 00:04:17.940 --> 00:04:18.940 right? 45 00:04:18.940 --> 00:04:21.780 Listen to the title, The Monetary Theory of the Trade Cycle. 46 00:04:21.780 --> 00:04:25.380 But as far as I know, Mises never referred to it that way. 47 00:04:25.380 --> 00:04:29.940 Mises always referred to it as a circulating credit theory of the trade cycle. 48 00:04:29.940 --> 00:04:36.100 and I think there's a reason for that probably. If you go look in the estuary of somebody, 49 00:04:36.100 --> 00:04:41.620 give us a quick synopsis of the Austrian theory of the trade cycle. Well, the government 50 00:04:41.620 --> 00:04:46.600 inflates the money supply, drives down interest rates, that causes a systematic distortion 51 00:04:46.600 --> 00:04:53.020 of the allocation of resources, a systematic misallocation, distortion, right? And so it 52 00:04:53.020 --> 00:04:57.180 distorts the structure of production, but it's unsustainable and at some point you 53 00:04:57.180 --> 00:05:03.180 to get a hyperinflation which brings the system down or interest rates have to tighten up 54 00:05:03.180 --> 00:05:08.020 the money supply, interest rates skyrocket and at any rate, in either case, the mistakes 55 00:05:08.020 --> 00:05:17.020 that were caused in the boom by the inflation come to light and we have to have our correction. 56 00:05:17.020 --> 00:05:25.180 But to say that monetary inflation causes the business cycle is not necessarily true. 57 00:05:25.180 --> 00:05:31.220 Okay. Why not? Because what we do when we say that, we're assuming something. And what 58 00:05:31.220 --> 00:05:37.500 we're assuming, and Austrians are very clear that injection and distribution effects are 59 00:05:37.500 --> 00:05:43.460 very, very important, unlike mainstream economics. What we're assuming when we say that is that 60 00:05:43.460 --> 00:05:49.460 the way the new money, the monetary inflation enters the system is through the credit markets, 61 00:05:49.460 --> 00:05:55.860 the new money is lent into existence, but if instead government were just to print it, 62 00:05:55.860 --> 00:06:00.660 you know, if you got rid of the Fed, if you had private banks, you know, and that kind 63 00:06:00.660 --> 00:06:05.580 of thing, whatever, but the Fed, the U.S. Treasury, the government would have spent 64 00:06:05.580 --> 00:06:12.340 more than it takes in and print the money then and just spend it that way, not lending 65 00:06:12.340 --> 00:06:17.380 it into existence, but spending it into existence. Say, for example, paying all the policemen's 66 00:06:17.380 --> 00:06:21.980 and Salaries. But we'll just do that with printed money. Everything else we'll pay 67 00:06:21.980 --> 00:06:27.540 for with taxes, we'll print money to pay policemen salaries. That's not going to affect 68 00:06:27.540 --> 00:06:34.180 interest rates. That's not going to cause, yes, we're going to end up with more policemen 69 00:06:34.180 --> 00:06:38.540 than we otherwise did, but certainly it's not going to cause the systematic distortion 70 00:06:38.540 --> 00:06:43.420 of the allocation of resources as we think of in an Austrian business cycle theory. So 71 00:06:43.420 --> 00:06:52.340 So monetary inflation, if the new money is linked into existence, is a sufficient condition 72 00:06:52.340 --> 00:06:58.300 to cause a business cycle, but if it's not, then it won't cause a business cycle. 73 00:06:58.300 --> 00:07:06.580 So that's one thing that we need to look at. 74 00:07:06.580 --> 00:07:11.260 Then the question becomes, and this is something that comes up, is what the heck's a demand 75 00:07:11.260 --> 00:07:22.500 You deposit money in a bank and it's payable on demand. What does that mean? Suppose the 76 00:07:22.500 --> 00:07:26.540 bank puts in and says, okay, you deposit money here and you've got to leave it with us for 77 00:07:26.540 --> 00:07:31.620 five seconds before you can get it out. Is that a demand deposit? Ten seconds. Is that 78 00:07:31.620 --> 00:07:36.460 a demand deposit? In other words, we're into one of those many continuum problems in economics, 79 00:07:36.460 --> 00:07:42.820 Well, so we get to thinking about this and saying, look, what's the real problem with 80 00:07:42.820 --> 00:07:43.820 a demand deposit? 81 00:07:43.820 --> 00:07:50.260 And with the real problem with demand deposits, why they cause, you know, why fractional reserve 82 00:07:50.260 --> 00:07:56.320 demand deposits cause a problem, and that's what we're talking about, the real reason 83 00:07:56.320 --> 00:08:01.020 they cause a problem is because there's a mismatch here. 84 00:08:01.020 --> 00:08:08.180 Banks are borrowing short and lending long. That's what they do with time deposits. I 85 00:08:08.180 --> 00:08:13.380 mean with fractional reserve banking, right? They borrow the money from the depositors 86 00:08:13.380 --> 00:08:19.160 for a very short period of time and then they make loans. Now I know occasionally they make 87 00:08:19.160 --> 00:08:24.460 call loans which are demand loans if you would, but most of their loans are not call loans, 88 00:08:24.460 --> 00:08:30.900 okay? So banks are borrowing short and lending long. Well, don't they do that with time deposits 89 00:09:00.900 --> 00:09:09.660 is the distortion of the structure of production. What we're doing here is that people in general 90 00:09:09.660 --> 00:09:19.900 want to be as lenders more liquid than they want to be as borrowers. So if all credit 91 00:09:19.900 --> 00:09:27.420 were direct, okay, if the only financial intermediaries were brokers, i.e. agents, if there were no 92 00:09:27.420 --> 00:09:32.460 The financial intermediaries who are dealers, think about that term broker-dealer and the 93 00:09:32.460 --> 00:09:37.860 recent problems in the financial markets, but if brokerage were the only thing we had 94 00:09:37.860 --> 00:09:47.180 in no dealers, where the dealers are principals, banks are dealers. They take possession, they 95 00:09:47.180 --> 00:09:56.320 issue IOUs, bank notes or deposit slips, they take possession and then they lend the money 96 00:09:56.320 --> 00:10:02.800 out, and they have new notes coming in that way. So they are intermediaries who are dealers. 97 00:10:02.800 --> 00:10:08.320 A broker just matches buyers and sellers and takes a commission, right? Well, if all we 98 00:10:08.320 --> 00:10:17.280 had were brokers, then this mismatch between lenders wanting to lend short, not totally, 99 00:10:17.280 --> 00:10:21.960 but you know, if you think about the average of what, you know, the trend, and borrowers 100 00:10:21.960 --> 00:10:43.960 If the borrower is wanting to borrow a loan, that couldn't exist. They would have to be brought together, you see, by doing what? By offering higher interest rates to the lenders, and the borrower is saying, well, wait, those high interest rates, we don't want to borrow as much, and so they would say, well, then we won't borrow for as long a period of time. 101 00:10:43.960 --> 00:10:49.880 So what happens is we get these dealers in between, and we think of them as banks, but 102 00:10:49.880 --> 00:10:57.160 they could be other types, and you go in and you deposit your money for a short term, and 103 00:10:57.160 --> 00:11:05.880 credit, if you think about it, has two dimensions. It's got a dollar or value dimension, and 104 00:11:05.880 --> 00:11:12.600 it's got a time dimension. A hundred dollars lent for one year is very different than a 105 00:11:42.600 --> 00:11:52.600 Walter's interested in the morality of this. As everybody knows, I'm amoral. I'm only interested in the business cycle part. 106 00:11:52.600 --> 00:11:59.600 But the bank has no right to lend my money for longer than it has title to it. 107 00:11:59.600 --> 00:12:09.600 If I've lent the bank $100 for six months, where do they get a right to turn around and lend that money for longer than six months? 108 00:12:09.600 --> 00:12:14.760 I didn't give them the right to lend my money for longer than six months. So what they are 109 00:12:14.760 --> 00:12:22.440 doing, if you think about it, is it's not the monetary inflation, it's the credit inflation 110 00:12:22.440 --> 00:12:30.200 that causes the business cycle. Because what? Because credit, if you think about both dimensions, 111 00:12:30.200 --> 00:12:41.520 When I put $100 in for six months, that's a half-year $100 loan, right? And then they 112 00:12:41.520 --> 00:12:48.480 turn that into a much larger amount of credit because of the two dimensions, the time dimension 113 00:12:48.480 --> 00:12:56.360 as well as the value dimension. So they don't stretch the value dimension, but by stretching 114 00:12:56.360 --> 00:13:02.060 In the time dimension, they're increasing the volume of credit. 115 00:13:02.060 --> 00:13:08.960 We have a credit inflation, and it's the credit inflation that causes a distortion. 116 00:13:08.960 --> 00:13:13.920 And if you think about it, the people who are lending and want to lend short, preferably 117 00:13:13.920 --> 00:13:18.880 on average, in other words, if you've thought about some sort of distribution of what the 118 00:13:18.880 --> 00:13:24.520 lenders want versus distribution of what the borrowers want in terms of time, okay, well 119 00:13:24.520 --> 00:13:28.840 Well, what they've done is they've mismatched this and it shows up in the distortion of 120 00:13:28.840 --> 00:13:36.200 the production structure, right? Because the lenders really didn't want to lend money for 121 00:13:36.200 --> 00:13:45.680 that long a period of time. And so, we look at this and say we need to extend the Austrian 122 00:13:45.680 --> 00:13:49.840 theory of the trade cycle a bit, the Austrian theory of the business cycle. First of all, 123 00:13:49.840 --> 00:13:57.280 We've got to be very careful when we say that monetary inflation causes the business cycle. 124 00:13:57.280 --> 00:13:58.280 Not true. 125 00:13:58.280 --> 00:14:01.520 It's credit inflation that does that. 126 00:14:01.520 --> 00:14:06.400 And be careful to understand that the injection effects, if you inflate the money supply by 127 00:14:06.400 --> 00:14:11.820 spending it into existence, it causes inflation. 128 00:14:11.820 --> 00:14:16.640 You get some misallocation of resources, but not in a business cycle way. 129 00:14:16.640 --> 00:14:21.040 If you want business cycles, that's when you inflate credit. 130 00:14:21.040 --> 00:14:23.080 And how do you inflate credit? 131 00:14:23.080 --> 00:14:29.600 By having dealers in the financial markets who borrow short and lend long. 132 00:14:29.600 --> 00:14:34.200 Now that's not to say that there isn't room for dealers in the financial markets. 133 00:14:34.200 --> 00:14:40.040 Because in addition to changing the term structure, the time structure of credit, there are other 134 00:14:40.040 --> 00:14:45.880 things that you can't do directly in direct loans with just an agent. 135 00:14:45.880 --> 00:14:51.280 For example, if five people over here each want to lend $100 for one year and one person 136 00:14:51.280 --> 00:15:00.280 over here wants to borrow $500 for one year, well, okay, they can each lend me $100 for 137 00:15:00.280 --> 00:15:03.500 one year and I can turn around and lend him $500. 138 00:15:03.500 --> 00:15:09.640 So there are things like that that dealers can do that are very useful functions, okay? 139 00:15:09.640 --> 00:15:15.080 So I'm not suggesting that everything dealers do is wrong, but I am saying from an economic 140 00:15:15.080 --> 00:15:21.640 point of view, if you want a business cycle, okay, then this thing about the credit expansion 141 00:15:21.640 --> 00:15:27.120 by borrowing short and lending long, that's the way to do it. Now, obviously, one way 142 00:15:27.120 --> 00:15:31.520 is through demand deposits, fractional reserve demand deposits, but you can do it without 143 00:15:31.520 --> 00:15:36.840 expanding the money supply at all. I just gave you an example. I give the bank whatever 144 00:15:36.840 --> 00:15:42.840 $100 for six months and they turn around and give the $100 to Walter for five years. No 145 00:15:42.840 --> 00:15:49.620 No increase in the money supply whatsoever. No fractional reserve banking, but we've just 146 00:15:49.620 --> 00:16:00.620 inflated the credit. Now, one other thing, under the standard traditional, Walter loves 147 00:16:00.620 --> 00:16:07.740 this, the traditional Austrian theory of the business cycle, the monetary inflation through 148 00:16:07.740 --> 00:16:13.740 and Fraction Reserve Banking Causes Business Cycles. Not necessarily true, in my opinion. 149 00:16:13.740 --> 00:16:22.740 If we take the system that we have right now, you know, and they increase, assuming we weren't 150 00:16:22.740 --> 00:16:27.740 in this crazy cycle we're in right now anyway, but you know, quote, in equilibrium, you know, 151 00:16:27.740 --> 00:16:51.740 And somebody deposits a million dollars in the banks and they lend out $1. So they keep $999,999 in reserves and lend out $1. Nobody who has any sense of proportion thinks that's going to cause a business cycle, right? 152 00:16:51.740 --> 00:17:00.740 So you have to look at magnitudes, too. If I deposit $100 for six months and they lend it out for five years, that's not causing a business cycle. 153 00:17:00.740 --> 00:17:04.740 You've got to look at magnitude. But if there's enough of that, you can do it. 154 00:17:04.740 --> 00:17:12.740 And so you can have business cycles of the Austrian type through this time mismatching, borrowing short and lending long, 155 00:17:12.740 --> 00:17:19.740 even in the system without fractional reserve banking and even without inflating the money supply. 156 00:17:21.740 --> 00:17:23.740 Thank you very much.