WEBVTT NOTE Loan Banking 1 00:00:00.000 --> 00:00:11.000 Loan banking. Government paper, as pernicious as it may be, is a relatively straightforward form of counterfeiting. 2 00:00:11.000 --> 00:00:16.000 The public can understand the concept of printing dollars and spending them, 3 00:00:16.000 --> 00:00:22.000 and they can understand why such a flood of dollars will come to be worth a great deal less than gold 4 00:00:22.000 --> 00:00:29.000 or then uninflated paper of the same denomination, whether dollar, franc or mark. 5 00:00:29.000 --> 00:00:45.000 Far more difficult to grasp, however, and therefore far more insidious, are the nature and consequences of fractional reserve banking, a more subtle and modern form of counterfeiting. 6 00:00:45.000 --> 00:01:00.000 It is not difficult to see the consequences of a society awash in a flood of new paper money, but it is far more difficult to envision the results of an expansion of intangible bank credit. 7 00:01:00.000 --> 00:01:12.000 One of the great problems in analyzing banking is that the word bank comprises several very different and even contradictory functions and operations. 8 00:01:12.000 --> 00:01:16.000 The ambiguity in the concept of bank can cover a multitude of sins. 9 00:01:16.000 --> 00:01:21.000 A bank, for example, can be considered any institution that makes loans. 10 00:01:21.000 --> 00:01:27.000 The earliest loan banks were merchants who in the natural course of trade 11 00:01:27.000 --> 00:01:32.000 carried their customers by means of short-term credit, charging interest for the loans. 12 00:01:32.000 --> 00:01:38.000 The earliest bankers were merchant bankers who began as merchants 13 00:01:38.000 --> 00:01:43.440 Merchants and who, if they were successful at productive lending, gradually grew, like 14 00:01:43.440 --> 00:01:50.380 the great families, the Reese's and the Medici's in Renaissance Italy, to become more bankers 15 00:01:50.380 --> 00:01:52.080 than merchants. 16 00:01:52.080 --> 00:01:58.100 It should be clear that these loans involved no inflationary creation of money. 17 00:01:58.100 --> 00:02:04.380 If the Medici's sold goods for ten gold ounces and allowed their customers to pay in six 18 00:02:04.380 --> 00:02:11.380 In the last six months, including an interest premium, the total money supply was in no way increased. 19 00:02:12.380 --> 00:02:23.380 The Medici customers, instead of paying for the goods immediately, wait for several months and then pay gold or silver with an additional fee for delay of payment. 20 00:02:23.380 --> 00:02:34.380 This sort of loan banking is non-inflationary regardless of what the standard money is in the society, whether it be gold or government paper. 21 00:02:34.380 --> 00:02:40.380 Thus suppose that in present-day America I set up a Rothbard loan bank. 22 00:02:40.380 --> 00:02:47.380 I save up $10,000 in cash and invest it as an asset of this new bank. 23 00:02:47.380 --> 00:03:03.380 My balance sheet, see Figure 1, which has assets on the left hand side of a T account and the ownership of or claim to those assets on the right hand side, the sum of which must be equal, now looks as follows. 24 00:03:03.380 --> 00:03:27.380 Figure 1. A bank loan begins. Rothbard Loan Bank. At the top of the T, the left-hand side of the T is assets. Cash, $10,000. Total, $10,000. Right-hand side of the T, equity plus liabilities. Owned by Rothbard, $10,000. Total, $10,000. 25 00:03:27.380 --> 00:03:35.380 The bank is now ready for business. The $10,000 of cash assets is owned by myself. 26 00:03:35.380 --> 00:03:42.380 Suppose then that $9,000 is loaned out to Joe at interest. The balance sheet will now 27 00:03:42.380 --> 00:03:45.380 look as follows in Figure 2. 28 00:03:45.380 --> 00:04:02.380 Figure 2, the bank makes loans. T-Account, assets on the left, cash, $1,000. IOU from Joe, $9,500. Total, $10,500. 29 00:04:02.380 --> 00:04:14.380 T-Account on the right-hand side, equity plus liabilities, owned by Rothbard, $10,500. Total, $10,500. 30 00:04:14.380 --> 00:04:21.980 The increased assets come from the extra $500 due as interest. 31 00:04:21.980 --> 00:04:28.180 The important point here is that money, whether it be gold or other standard forms of cash, 32 00:04:28.180 --> 00:04:31.100 has in no way increased. 33 00:04:31.100 --> 00:04:37.900 Cash was saved up by me, loaned to Joe, who will then spend it, return it to me, plus 34 00:04:37.900 --> 00:04:41.140 interest in the future and so forth. 35 00:04:41.140 --> 00:04:50.140 The crucial point is that none of this banking has been inflationary, fraudulent or counterfeit in any way. 36 00:04:50.140 --> 00:04:55.140 It has all been a normal, productive, entrepreneurial business transaction. 37 00:04:55.140 --> 00:05:03.140 If Joe becomes insolvent and cannot repay, that would be a normal business or entrepreneurial failure. 38 00:05:03.140 --> 00:05:13.140 If the Rothbard bank enjoyed success, should expand the number of partners or even incorporate to attract more capital, the business would expand. 39 00:05:13.140 --> 00:05:17.140 But the nature of this loan bank would remain the same. 40 00:05:17.140 --> 00:05:24.140 Again, there would be nothing inflationary or fraudulent about its operations. 41 00:05:24.140 --> 00:05:30.140 So far, we have the loan bank investing its own equity in its operations. 42 00:05:30.140 --> 00:05:47.140 Most people, however, think of banks as borrowing money from one set of people and relending their money to another set, charging an interest differential because of its expertise in lending, in channeling capital to productive businesses. 43 00:05:47.140 --> 00:05:52.140 How would this sort of borrow-and-lend bank operate? 44 00:05:52.140 --> 00:06:06.140 Let us take the Rothbard Loan Bank as shown in Figure 3 and assume that the bank borrows money from the public in the form of certificates of deposit, CDs, repayable in six months or a year. 45 00:06:06.140 --> 00:06:20.140 Then, abstracting from the interest involved and assuming the Rothbard Bank floats $40,000 of CDs and relends them, we will get a balance sheet as follows. 46 00:06:20.140 --> 00:06:40.140 Figure 3, the loan bank borrows money. T-Account, assets on the left, liabilities and equity on the right. Assets, cash, $1,000. IOUs, $49,500. Total, $50,500. 47 00:06:40.140 --> 00:06:55.140 On the right, equity plus liabilities, owed in CDs $40,000, owned by Rothbard $10,500, total $50,500. 48 00:06:55.140 --> 00:07:05.140 Again, the important point is that the bank has grown, has borrowed and re-loaned, and there has been no inflationary creation of new money, 49 00:07:05.140 --> 00:07:10.140 No fraudulent activity and no counterfeiting. 50 00:07:10.140 --> 00:07:15.140 If the Rothbard bank makes a bad loan and becomes insolvent, 51 00:07:15.140 --> 00:07:19.140 then that is a normal entrepreneurial error. 52 00:07:19.140 --> 00:07:24.140 So far, loan banking has been a perfectly legitimate and productive activity.