Or – Why Murray Rothbard and the Social Credit Theorists are Wrong
One of the arguments that rumbles around some of the various blogs I read is an old one about the nature of what banks do. It pops up on a regular basis when economic theorists get involved in discussions about banking. This argument is founded in what I consider to be a misunderstanding of the nature of money itself.
To me, the argument boils down to a simple question – are deposits in banks “money”, properly so called? If it is, then banks can create money simply by accepting a deposit at call and then making a loan.
To those who are horrified at the idea that Rothbard (in this area at least) can be lumped together with the Social Credit of C. H. Douglas – sorry, but they are both wrong and for the same reason.
What follows is a short, but I believe still correct, discussion. If you want more, please raise points in the comments.
Rothbard’s Argument
Rothbard founds his argument against modern banking practice (see Chapter VII of the link – opens in new window) on what I believe to be a misconception: that when you deposit money in a bank what you have is still money, only in the form of a bank deposit, rather than a claim on the assets of the bank. To emphasise his point he calls bank deposits “warehouse receipts” as if the process of putting your money in the bank is the same as storing furniture in a warehouse.
Social Credit
The Rothbardians out there may be horrified at the thought, but he is making a very similar argument to Maj. C.H. Douglas in his Social Credit framework – that banks manufacture money. Here, in a speech to the King of Norway (opens in new window), is the clearest exposition of this I can find:
[banks] make … it in exactly the same sense that the brickmaker makes bricks, and not in the sense that Mr. Jones makes money; Mr. Jones only gets it from somebody else, but the banker makes it. The method by which the banker makes money is ingenious, and consists very largely of bookkeeping.
The social credit people then move from there is all sorts of directions, some into outright socialism and some to a position very close to (if not actually in full agreement with) the Rothbardians.
Why they Are Wrong
They are both wrong. Banks do not “manufacture” money and for a very simple reason. To use Rothbard’s analogy – when you deposit your furniture in a warehouse you pay the warehouse to store your furniture. When you “store” your money in a bank, the bank pays you. Why is this? Simple. When you loan your money to a bank you are (implicitly or explicitly) authorising them to lend that money back out to someone else and for the bank to make a return on it.
The interest I receive in lending my money to the bank is to compensate me for two main things (and several others, not important here):
- the time value of money, where I get compensated for delaying my use of the money while the bank uses it; and
- credit risk, the risk that the bank will not be able to pay me when I walk up to the bank (or now my web browser) and tell the bank I want to withdraw.
To use Rothbard’s analogy, if I was doing the equivalent thing with my furniture I would expect to get rent for it – the rent amount being to compensate me for not using the furniture for the time I do not have it and for the risk that my furniture will have been lost or stolen when I ask for it back.
To put it another way – when you deposit your money in a bank it is no longer your money. It is the bank’s money and you are compensated for this transformation through being paid interest – or at least not having to pay them a storage fee. In this I fully agree with Lord Cottenham in Foley v. Hill and Others (I am quoting here from Rothbard as the Google copy is not in text form)
Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it . . . . The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the mount, because he has contracted . . . .
Rothbard, looking at Foley which clearly stated this principle, saw it as a disastrous mistake. I would agree if I were paying the bank to store my money. I am not, though. The bank pays me while they have it. Where do they get this money? By lending it out – therefore, when I deposit my money in a bank it is no longer my money, but a claim on the assets of the bank.
If what you want is a place to store your money and be sure that the money is safe, great. They are called safety deposit boxes and are available in the vaults of most major banks. Just expect to pay for their use.
[Update – I changed the title to more closely follow what I actually said in the post]
32 comments
7 October, 2007 at 13:58
David Jacobson
I agree with you…it was different when goldsmiths stored customers’ gold (a bailment relationship) but banking has involved taking deposits of money and on-lending them for centuries (a debtor-creditor relationship). The notes issued by bankers then became negotiable.
“banking business” is defined in section 5 of the Banking Act as having 2 parts “BOTH (my emphasis) taking money on deposit (otherwise than as part‑payment for identified goods or services) AND making advances of money”.
http://www.austlii.edu.au/au/legis/cth/consol_act/ba195972/s5.html#banking_business
The definition of “banking business” has recently had to be expanded to cover electronic transactions but essentially the deposit is regarded as an advance of money with no expectation that the actual physical notes deposited will be returned, only the equivalent value.
So essentially what banks do is provide a statement showing what they owe you.
7 October, 2007 at 21:13
Andrew
David,
Thanks for that. Off line discussion on this has discussed the difference between the economic and legal definitions of money – clearly, legally speaking, bank deposits are not “money” – they are only a debt owed by the bank to the depositor. Economically, do they function as money? What implications does this have for inflation?
To me the difference now matters very little – the sheer number of different things you can use to pay for what you buy or accept in exchange for what you sell has got to the point where what exactly is money is impossible to tell.
To me, from a practical point of view, the answer is “who gives a damn?”
It is important if you try to control inflation using a quantity theory of money. If you use a inflation indicator, as we are now, then the question becomes irrelevant.
10 October, 2007 at 15:46
terje (say tay-a)
I’m an advovate of gold as money but even though I share this view with Rothbard I have always rejected his analysis of banking. Your argument is clear and precise but let me explain in my own words why credit is not money.
Money has three functions. If it has something lacks one of these functions it is by definition not money. The three qualities something must have to function as money are:-
1. It must be a store of value.
2. It must be a medium of exchange.
3. It must be a unit of account.
To be sure there are other qualities that will make one form of money better than another. Good money is durable and fungible and liquid. However the three qualities listed are generally accepted as necessary preconditions.
Goats and Gold coins can readily satisfy the three requirements. You can say that you can buy a 1000 goats and next week they will still have value. If you can readily buy camels and sheep and farms using goats then goats are a medium of exchange. And if it is meaningful to say that your house is worth 3000 goats or then goats are acting as a unit of account. A dimension for putting next to numbers when you do book keeping.
Credit can do both of the first two things on the list. A bank account or an IOU can retain value. And it can be transfered to fascilitate trade. However it has no use as a unit of account. It in fact must reference something external in this regard to even exist. IOU 600 is meaningless, whilst IOU 6OO goats means something.
It is tragic to make a study of money and inflation as Rothbard does and to then miss the ignore the importance of “units of account”. At the end of the day inflation is only a problem because it represents a change in the yardstick of value that we use for commerce and life. If the unit of account with which I have contracted with my landlord and my employees is changing in value then everybody may feel cheated and suspicious.
11 October, 2007 at 07:21
terje (say tay-a)
Sorry about all the typos and the grammatical mistakes in the above comment. I typed it up on my mobile phone which has rather limited review options.
11 October, 2007 at 11:51
Jono
I’ll stick with Rothbard. You may have a preference for deposit banking and receiving interest on your deposits, whilst accepting the risk of the bank being able to repay your loan.
But that doesn’t allow you to then tell other people that they must use safety deposit boxes if they wish to have warehouse receipts for their money.
This is an entirely unattractive option under the current inflationary fractional reserve bank that is practiced. Money is being debased and devalued through the credit issued by banks, and safekeeping your money has a negative real return. The only benefit is avoiding any risk of bank defaults, which is fairly low because central banks will bail out anything these days.
If we didn’t practice fractional reserve banking, and all deposit receipts were backed 100% by reserves, then I would have no problem lending my money to banks in exchange for a claim on the assets of a bank. There would be almost no risk of bank defaults in a free banking market with competition between banks. Read Rothbard’s “The Mystery of Banking” for a brief primer on these mechanisms.
11 October, 2007 at 12:13
Jono
David Jacobson
I agree with you…it was different when goldsmiths stored customers’ gold (a bailment relationship) but banking has involved taking deposits of money and on-lending them for centuries (a debtor-creditor relationship). The notes issued by bankers then became negotiable.
“banking business” is defined in section 5 of the Banking Act as having 2 parts “BOTH (my emphasis) taking money on deposit (otherwise than as part‑payment for identified goods or services) AND making advances of money”.
Okay… but why on earth should we have a 3rd part? Since when can banks lend BEYOND the money and reserves they have ?
Its no longer banking at all. Its really just counterfeiting. Banks can issue notes and create credit that isn’t backed by reserves.
I don’t necessarily believe that banks should be like warehouses. There is a valuable financial role for them to play in borrowing and lending money, no doubt.
The issue here isn’t lending out. Rothbard did see the Foley decision as disastrous, but only because of it was a stepping stone towards unrestricted and unbacked credit creation. It meant that banks were no longer lending out deposit receipts, or claims on their reserves. They were simply issuing notes.
The only thing that holds the system together is consumer confidence, and the central banks backing against bank runs.
11 October, 2007 at 12:50
Andrew
Jono,
I have read “The Mystery of Banking” and I believe that Rothbard fundamentally misunderstood banking as an industry.
Banks, as individual entities, cannot lend out more than has been lent to them. They can lend out more than their liquid reserves. If you look at the total flow of funds through the industry then compare that to the original cash printed then, of course, you end up with some silly numbers – but in doing so you are reducing a flow to a static concept.
I may as well say that I can use the $100 in pay I just got to buy shares in a company – but that company can then use the money to pay someone else, who can then buy shares and so on. The same money has now been used to buy several lots of shares – and can do so ad inifinitum. Why is Rothbard not regarding this as important when deposits in banks are?
The reason is that he is defining bank deposits as money – so more deposits = more money. Look underneath this, though, and his argument loses its legs. Ask the question, so what? Funds in bank deposits are not currently being used for transactions, and so act to slow down velocity. A relatively stable deposit base thus acts to slow down the velocity of money. A problem only arises if the deposit base is not fairly stable and this feeds through into transactions in the economy.
The real tragedy would come if fractional reserve were prohibited – there would have to be a coincidence of people willing to lend for the same periods that others wish to borrow. Personally I would find this “cure” to be much, much worse than the disease.
11 October, 2007 at 15:10
Jono
No I think Rothbard was spot on in his description of the banking industry as a cartel.
It isn’t a competitive industry at all. Rothbard never said he disregards the flows of money as being unimportant. And I’m not quite sure what you mean when you refer to the total flow of funds through an industry ? There is no argument against this in The Mystery of Banking.
He has no problem with the flows of money between banks, so long as at the end of each day, they have enough reserves to settle their transactions. In a free market, banks wouldn’t tolerate another debtor bank delaying or deferring on payment, and they would demand they transfer reserves immediately or else declare bankruptcy.
If customers of Bank A have $50mil of transfers to customers of Bank B, and customers of Bank B have $30mil of transfers to customers of Bank A in a given day, then this is acceptable, SO LONG as Bank A has the $20 million in reserves to transfer to Bank B.
According to Rothbard, if banks were operating in a true free market today, they would be demanding payment and opening disputes against each other if they failed to transfer reserves.
Instead, banks have formed a cartel and the central bank acts as a lender of last reserve and provides them with liquidity.
11 October, 2007 at 15:15
Jono
By the way, I have no doubt that sound banking would slow down the velocity of money and make credit much harder to obtain.
I don’t think this cure is worse than the disease though. Rampant credit creation and over-spending are not healthy.
11 October, 2007 at 15:30
Andrew
Jono,
This clearing process does in fact happen every day – all intra-bank balances are cleared through the RBA each and every business day though the electronic transfer of funds.
In Australia at least the Reserve Bank does not act as a lender of last resort, in fact there is not even deposit insurance. It remains to be seen what would happen in a true crisis if one of the major were to get shaky, but there is no statutory or regulatory requirement for them to act as LLR. In practice they may well do so, but long before it got near that you could expect action from all the banks and other players to avoid a major crisis.
As for acting as a cartel,well, maybe – if you have evidence I am sure the ACCC would be interested, but in working with the banks as I do I see no evidence of it. The big four do benefit from being the dominant players, but if they were acting as a cartel you could expect the regionals and the smaller players to try to take advantage of it.
In practice cartels are hard enough to maintain even where there are only two players in an unregulated industry. Having 4 majors, at least 5 regionals and many smaller players in an industry as heavily monitored as this one would make it very difficult.
On credit creation – banks and other lenders lend when they believe they can make a profit out of it. Why would you choose to restrict this?
11 October, 2007 at 16:43
Terje (say tay-a)
Anybody that can read a balance sheet should look at the balance sheet of their bank (usually published in their annual report to shareholders). It shows that they are solvent. Assets exceed liabilities and owners equity is positive. If it is otherwise then banks are trading whilst insolvent and are subject to the same rules as any other business.
I’m with Andrew. I oppose government central banking and fiat currency but not fractional reserve.
18 October, 2007 at 03:21
Graeme Bird
They are not the least bit solvent Terje. Their alleged solvency comes only from the government printing-press back-up.
18 October, 2007 at 03:26
Graeme Bird
And of course the way the legal system is rigged in their favour. I should mention that also. They don’t have to give your money back if they don’t want to apparently. Not legally they don’t. In fact the cartel would have it that its not your money at all.
And they don’t pay interest on on-call deposits. Thats a mistake. The on-call interest rate will always fall short of nominal-GDR growth. Hence the on-call interest is really being taken out of your pocket by the money growth in the first place.
18 October, 2007 at 10:40
Jim
This Andrew fellow doesn’t understand the first thing about banking.
Fistly he states, “To put it another way – when you deposit your money in a bank it is no longer your money.”
This is nonsense, because all deposits are LIABILITIES to the bank, and any person with a deposit can demand their deposit from the bank at any time, including writing cheques against that deposit (if it’s a chequing account), or withdrawing cash on that deposit.
Secondly, he states, “When you loan your money to a bank you are (implicitly or explicitly) authorising them to lend that money back out to someone else and for the bank to make a return on it.”
This is simply not true, and Andrew should take an introductory course in economics. Banks have no authority to lend your deposit to anyone. Banks create deposits through loans, and the process is known as deposit expansion.
The reason why Douglas and Rothbard agree on this matter is that no credible economist in the world denies the fact that banks create money, and Central banks around the world have policy papers stating this fact.
“In the normal course of their operations, banks create money” (Blomqvist, Wonnacott, and Wonnacott, “Economics First Canadian Edition”pge. 201)
“The actual process of money creation takes place primarily in banks.” (Federal Reserve, “Modern Money Mechanics”)
“Commercial banks and other financial institutions provide the greater part of assets used as money through loans made to individuals and businesses. In that sense, financial institutions are creating money. ” (Bank of Canada, “Bank in Brief”)
“The process by which banks create money is so simple that the mind is repelled.” (John Kenneth Galbraith)
Andrew is the perfect example of the expression “better to be silent and be thought the fool, than to open your mouth and remove all doubt”. He’s not only opened his mouth, but put it on the internet, so that everyone can see what a fool he is.
By the way, I posted a rebuttal to his claims on his blog, but he was too much of a coward to publish them and debate me.
18 October, 2007 at 11:43
Andrew
To go in reverse order:
Jim,
Where have you posted a rebuttal of my claims? This is my only blog and at no stage have I deleted anything from you as far as I know.
On to the main points. As from the legal decision quoted above, you have partially understood the point – money you deposit in the bank is a liability of the bank, and they have agreed, in contract law, to accept direction from you on how to satisfy the liability. What is in the bank’s records, though, is an obligation to pay you on demand. You can call this “money” if you want, but the process is exactly the same as if I lend a friend some money. Is the amount he owes me still money?
To me it only matters to academic economists, (like JK Galbraith). In practice in the real world, it does not matter. If “my money” is sitting in the bank and not lent out then, in any real analysis, it may as well either be sitting under my bed or not even have been printed, as it has precisely zero effect on the real world. None at all. Is that really money?
The action of the bank making those funds available to people who need them is the important part. The wealth those funds represent has gone from being useless to useful again. Is this money creation – again, why does it matter? The real question is “is it creating a useful outcome?” To me, providing the funds are being put to good use, then, obviously, yes.
Again, the question of whether or not the banks are creating money is a pointless one, revolving around whether we choose to define bank deposits or loans or whatever else, of whatever type, as money. The really important question is whether what banks do is adding value.
My answer to that is clear – yes. They are taking the idle savings (or deferred consumption) of those with idle savings and transferring them to those with a funding shortfall who can use the funds.
Net result? Savers can receive a return on their idle funds and borrowers can bring forward consumption or investment that would otherwise have been delayed.
Huge net positive for all.
18 October, 2007 at 11:55
Andrew
Graeme Bird,
Bank transaction accounts are not always lower than CPI – check out the BankWest transaction account currently paying 5% interest and the current inflation rate from the RBS website (2.1%). Many other transaction accounts are paying more than CPI at the moment.
.
On the printing press question – in a way, you are both right. The way you should look at this is the difference between liquidity and capital. Banks are solvent, as Terje pointed out, when their assets exceed their liabilities. Positive net assets = solvent.
Liquidity is another issue. Banks make much of their income from maturity transformation – borrowing short and lending long. Normally, this pays well. The problem is if too many depositors try to make withdrawals within too short a time period – normally termed a bank run. Even an otherwise solvent bank will not have enough funds to repay all their depositors at once. Northern Rock was the most recent example – discussed elsewhere on this blog. There was never any doubt that there is enough actual value in the Rock to pay back all of its depositors – just not all at once.
Managing this liquidity and name risk is a core part of banking – it is the thing that keeps bankers worried. Getting it wrong is disastrous. Getting it right is quite profitable.
18 October, 2007 at 13:11
Graeme Bird
“Bank transaction accounts are not always lower than CPI – check out the BankWest transaction account currently paying 5% interest and the current inflation rate from the RBS website (2.1%). Many other transaction accounts are paying more than CPI at the moment..”
But CPI isn’t inflation. Monetary growth is inflation. However under our crap system the best way to diagnose what the expansion was would be to simply take nominal Gross dometic revenue. If we deflate by the growth in nominal gross domestic revenue then we find they aren’t paying any on-call interest at all. That the cartel is merely returning some of the money lifted from us via monetary expansion.
We could have monetary expansion running at such a fast clip that nominal GDR grows 20% per year and on-call interest is at 15% per year. But we ought not be too impressed at our 15% on-call interest rate. This is really just the government/banking cartel forcing us to use their services.
18 October, 2007 at 13:15
Graeme Bird
“On the printing press question – in a way, you are both right. The way you should look at this is the difference between liquidity and capital. Banks are solvent, as Terje pointed out, when their assets exceed their liabilities. Positive net assets = solvent.”
They are insolvent. Their quick ratios are all to hell. The only thing keeping them afloat is the printing-press, regulatory and corporate-welfare backup.
18 October, 2007 at 13:18
Graeme Bird
“Liquidity is another issue. Banks make much of their income from maturity transformation – borrowing short and lending long. ”
Proof of their insolvent nature. Any business who tried this on, and not under the special priviledges that the banks have, well they would go under at any time. Its a ponzi house of cards, made firm only by crony-socialism.
18 October, 2007 at 13:28
Andrew
Graham,
I agree the quick ratio is “all to hell”, if you use the full ratio. The question is, though, what is relevant – the ratio than can be withdrawn or the amounts that are likely to be withdrawn.
If you use the first, banks have a very poor quick ratio. With the second, the ratio is fine.
The first definition is only relevant during a bank run, the second is relevant from day to day.
The usual definition of insolvency, and the legal one in Australia, is that a firm is insolvent “…when it is unable to pay its debts as and when they fall due.”
A demand deposit is due on demand – i.e. when a customer asks for the funds to be made available. Does that mean the first definition is the relevant one or the second. Clearly, legally the second definition is the relevant one.
Additionally, banks typically have standby facilities with other banks – I know all my clients do. These can be considered contingent assets, in that they can be called on when needed. This would normally be enough to bring the quick ratio within normal bounds.
19 October, 2007 at 03:22
Graeme Bird
Of course they are not likely to be withdrawn under crony-socialism. And soon the other half of the racket will come up with more cash in any case.
The point is its unacceptable to argue from the status quo when the status quo is not liberty. You’ve got to try and use your mind a bit more laterally Andrew.
The status quo is totally unacceptable. So we don’t use it as our default model.
“I agree the quick ratio is “all to hell”, if you use the full ratio. The question is, though, what is relevant – the ratio than can be withdrawn or the amounts that are likely to be withdrawn.”
The quick ratio is whats relevant under capitalism. Since under capitalism the same rules apply to all legal entities as much as possible.
Under capitalism the banks are in the same position as everyone else and so its the quick ratio that is relevant to banks just as it is to anyone else. Under growth-deflation the on-call interest rate would be zero even if a single small bank were given the exclusive priviledge to practice fractional reserve. Because the monetary growth rate is slower, and liquidity levels are much higher, there is no interest to pay for on-call money. Whereas it may seem that ING is paying interest it is more than likely that this interest, deflated by the growth in nominal GDR, would turn out to be less then zero.
The upshot is then that typically people would have a lot of cash at home. Since its an extra cost to bring it to the bank they would tend to have more at home then at the bank on-call.
Hence if there was any funny business going on the customers could quite likely withdraw all their funds in a banking panic in just that way that things have happened for a thousand years.
Under growth-deflation folks can take or leave the banks. Under our system we have no choice but to rely on them. Which is shockingly bad productivity for the banking system.
Anyway the upshot is that under capitalism its the quick ratio that is going to count for banking as for any other business.
And maturity transformation is mostly what World-com or Enron or other outfits who don’t want to stick around, that might be what they would get up to. But it certainly won’t be a big feature of banking under free enterprise.
19 October, 2007 at 10:52
Andrew
Graeme,
In a fully free system there would not be rules around the quick ratio in any case – I would of thought that one of the features of a fully-free enterprise system would be that trying to dictate the minutiae of a business would not happen.
It is a fact of life that companies fail – for many reasons. Banks must be able to do so too.
20 October, 2007 at 02:39
graemebird
Well thats right. I didn’t say we would base our rules on the quick ration so don’t pretend I did.
But don’t come the anarcho-capitalist with me fella because how is it that you make your living?
“Andrew has been working in banks and allied areas for over 18 years, both in the UK and Australia, mostly in treasury, regulation and operations. Having left actually working directly for banks, he is now consulting on bank regulation and treasury operations both in Australia and, occasionally, overseas.”
“CONSULTING ON BANK REGULATION”
So you make money consulting on bank regulation. Break-down, Shake-down, You’re busted.
What do you tell these people?
Suppose they book your time for a week. And you charge $2000 for that week.
What you going to say Andrew? You going to come before the conference on BANK REGULATION… and you clear your throat… and you say…. “DON’T REGULATE”
Is that all you are going to do?
And what then?
Make sure the cheque clears?
So all this time you were bullshitting about being in favour of a totally-free fraud-banking scenario, and like Humphreys and SOON you were just using that as cover for your pro crony-socialist-money position.
You lied to me Andrew. And you tried to deceive third parties in your quest to sideline my superior analysis.
So don’t you be coming the anarcho-capitalist with me fella.
Don’t try it on because you’ll come off second-best.
22 October, 2007 at 10:56
Andrew
Graeme,
Thanks for your comments.
Two challenges for you
1. Can you find one point where I have advocated for more regulation of anything?
2. Can you find anywhere that I have advocated anarcho-capitalism?
We all have to live in a world where regulation is a fact of life – and whether that regulation is well founded, principles based and enforced by virtually omniscient regulators, or black letter, poorly framed and enforced by people who have never worked in a bank we need to live with it.
Even if we manage to come up with a situation where increasing the regulation on liquidity management, as you are advocating, actually manages to eliminate that risk (a position that I would regard as a farcical imposition) there will still be many risks that face banks – credit, market, operational etc. etc. etc.
If anything, the lower the regulation, the more important good risk management becomes as relying on the regulations to “prove” you are good enough becomes impossible.
I use my views on government action and regulation to inform my perspective on the issues I come across – believing that less regulation is better does not mean that I believe in no laws at all.
If you are really interested in my point of view, Graeme, read through the “opinion” category. I would be pleasantly surprised if you bother.
23 October, 2007 at 04:15
Graeme Bird
You advise people and when you do you don’t tell them that there is no regulation necessary.
If you are going to pretend that you do thats a damn figleaf.
23 October, 2007 at 13:43
Andrew
I advise them on how to deal with the regulations they have and, independently of that, I campaign to reduce regulation. Call it a figleaf if you choose, Graeme, but I find it more comfortable than campaigning for more regulation in any area.
13 January, 2008 at 18:47
Estec
So, why Social Credit is not good?
14 January, 2008 at 09:53
Andrew
Estec,
Many reasons, the first of which is that it is founded on a completely wrong understanding of what it is banks do. It then extends this error into a framework for the management of an economy – one which makes no sense.
20 January, 2008 at 13:28
Mark Hill
Jono: banking a cartel? How? How does it satisfy any of the conditions of a cartel?
If banks are oligopolists, it follows ordinary industrial organisation that small banks merge to lower MC and AC, just as auto producers did last century.
28 February, 2008 at 20:28
rose
hello to all of you.. i just want to ask the relation of banking theory when applied to the investment banking…
thanks!
10 January, 2010 at 11:09
John Hermann
Money is anything which is accepted by the community at large as a medium of exchange and a medium of saving, and is also acceptable by the government for the payment of taxes. Bank deposits, which are actually credit money, satisfy all of these criteria. Bank deposits are therefore money. That’s why central banks around the world define the “money supply” to be the sum of cash (coins and notes) in the hands of the public together with deposits by the public in commercial banks and other depositories.
17 January, 2010 at 16:01
Andrew
John,
When was the last time you walked into the tax office and offered to transfer your bank account to the government in satisfaction of your tax bill? Have you tried to hand over your bank account to pay for fuel for your car?
Neither of these would work – what actually happens is that you ask your bank to transfer the funds to the bank account of the other counterparty to the trade and when the funds have been transferred then, and only then, have you paid.
For this to occur many things have to happen. Firstly your bank needs to agree to transfer the funds. Secondly, the bank has to have the funds to transfer. Thirdly, there needs to be at least one method of transfer that is acceptable to both banks concerned. Lastly, the receiving bank needs to accept the funds and transfer them to the account of your counterparty. Then you have paid.
The actual process involves many more steps than that when you get down into the detail, but that will do for my point.
Under most conditions those steps will occur almost every time a customer attempts to make a transaction, so much so that we often forget that they need to happen – and how simple, seamless and above all cheap modern banking practice has made it all. In many transactions this is done for a cost measured in cents, rather than dollars. The point is, though, that this is all contractual. If the bank makes a mistake and there are no funds credited in your account, then no matter how much you scream at the retailer you will not have the funds to pay. If your bank is unable to meet the call on your account (this happens from time to time – more in the US than here) then no matter how much you have marked on your account, you cannot pay using it. If your bank is not a part of the payments system for any reason then again, no matter how much you want to pay using the funds in the account, you cannot.
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To me, therefore, the question really is how much difference this all makes. Under normal circumstances, the answer is probably “Not much”. Banks normally have enough liquidity and the error rate on balances is reasonably low. Most banks are also members of payments systems and can transfer funds to other banks at short notice. This is why the central banks count them in this way.
In extremis, though, the difference is marked. If banks do not trust others, then the payments system stops. If your bank collapses, then the “money” you thought you had turns out to be a contractual claim against the bank. That’s a big difference.
I do not think, therefore, that we can call bank deposits “money” as there are some major differences. Even if we decide that bank deposits are, for all intents and purposes the same as cash, we should not make the mistake of behaving in this way.
When you deposit cash in a bank you take a risk with it. The bank compensates you for that risk with interest or, in an Islamic system, in other ways. Don’t forget that.