Money and Credit

Essentials of Economics, by Faustino Ballvé

In Chapter 5, Ballvé examines money and credit – a topic near and dear to my heart as it seems to be the one area most likely to divide the Austrian faithful. 

After a brief outline on the origins of money and banking, Ballvé discusses the paying of interest on deposits:

In this way money accumulates in banks, and as depositors do not normally need to have all their money at their immediate disposal, banks pay them interest (with certain exceptions), the amount being smaller in the case of demand deposits, which can be withdrawn by the depositor at any time without prior notice, and larger in the case of time deposits, which are not payable before a definite date.  Keeping on hand only what is needed to provide for anticipated withdrawals, the banks lend the surplus, charging the borrowers a higher rate of interest in order to earn a profit and cover their risk…..

Here Ballvé broaches the subject of fractional reserve banking.  He does not state the nature of the contract between depositor and bank.  However he mentions without a hint of concern the idea that even time deposits are to be loaned out.

Of course, by contract fractional reserve banking cannot exist.  Parties cannot contract to a mechanism where two or more parties have equal and complete claim to the same asset at the same time.  I believe I am on safe ground here, as I am following in the footsteps of Joe Salerno (full disclosure, as I have learned more on this subject I have come to better understand and agree with Salernos’ comments here):

Dail Bell: Do you believe in private fractional banking or should it be illegal?

Dr. Joseph Salerno: I am neither a philosopher nor a legal theorist, but I believe in the absolute right of individuals to enter into any voluntary contract that they choose. But a contract must be meaningful to be enforceable. If I pay you for a promise to paint my house red and green all over, this is not a contract but an absurdity. Likewise if I pay you (or even if you pay me) to store my motorcycle in your garage so that it is always available for me to use it and I grant you the freedom to rent it out at will. My point is that the deposit contract as modern free bankers conceive it, is a meaningless fiction. It implies that a sum of money can be both maintained on deposit for instantaneous withdrawal by the depositor and lent out to a borrower.

Now I am not saying that a free banking deposit contract can never be formulated in a meaningful way. But then it would not be a "deposit" contract at all, but a short-term credit transaction.

Thus to answer the question you posed: I do not believe that "private fractional-reserve banking," as it is commonly understood in debates among libertarians and Austrians today, should be illegal. It is a self-contradictory concept that could never be formulated into a meaningful contract on a free market.

Two parties cannot both have claim to the same asset at the same time, and as I have previously outlined, this is certainly not the case in U.S. (and I feel safe to say, developed world) banking – the documents are quite clear that there are situations where the deposit does not belong to the depositor.  More so, logic dictates this, as a depositor cannot expect to earn interest (and also not pay any storage fee) on assets merely being stored for immediate withdrawal.

Ballvé does not see world-ending consequences in such an arrangement, or if he does he remains silent on this.  The method by which he describes this suggests that he sees the idea of loaning out even demand-deposit funds as normal and acceptable (albeit, in a free-market context, which is explored shortly).

It would seem that the only way around this is to establish a true deposit contract.  I feel on safe ground to suggest that one cannot be had today at a typical banking institution.  If one wants a true demand deposit account, the only way I see doing this today is to withdraw currency and place it in a safe.

Back to Ballvé: while he does not comment negatively on the idea of demand deposits also being lent out, he does not remain silent on the historic progression in banking that has led to the true corruption in the industry:

And it is at this point that two kinds of governmental interference thenceforth take place.  First…the practice of assaying and monetizing them is established….then, the government proceeds to establish a control over the banks in order to prevent them from issuing more fiduciary media (i.e. money substitutes) than they have cash on deposit.  This control is entrusted to a central bank, to which the government grants a monopoly over the issuance of banknotes redeemable in metallic money.  More recently, these banknotes have been rendered irredeemable and declared legal tender, and the central banks have been authorized to issue more notes than correspond to their reserves of precious metal or cash holdings….the final step is taken when the government is free to determine, more or less under the control of the legislative power, the amount of fiat money in circulation….

This, briefly, has been the sad history of money….

Where Ballvé has a condemnation of the system begins with the monopoly that is granted (and can only be granted) by the government.  This is the first step in the slippery slope – and not the step of so-called fractional reserve banking.

Subsequently Ballvé comes to the subject of inflation and deflation, and rightly defines these in terms of monetary issues and not price issues.  He describes an inflation occurring when “the exploitation of gold mines results in an increase of the quantity of money…and deflation occurs whenever…technical progress produces an abundance of commodities [goods and services]….”

As long as inflation and deflation occur in the normal course of events, their effects are produced slowly, their extent is small in comparison with the amount of total international trade, and the necessary adaptations can be made quite easily.  But when they are abnormally produced – that is to say, when they are produced by the intervention of the government – they have mischievous consequences for they take from some in order to give to others.

Ballvé does not fear inflation or deflation in an environment where money and credit are determined by market actors in a free market.  The fear comes with government intervention, and the beginning and most important step in this intervention is the grant of monopoly to a central bank.

Next Ballvé explores the possibility of the concept of “stable money” and rightly concludes this is a pipe dream:

…the realization of this ideal is impossible, because, like every other commodity, money is essentially unstable….People talk of keeping the money in circulation proportional to the volume or circulation of goods.  But no one has succeeded in finding the formula of this equilibrium or the means of applying it.

There is no stability in money just as there is no stability in the economic value of any good.  All value is subjective; being subjective, it is subject to constant, continuous, and regular change.  There is no formula to properly stabilize the amount of money in circulation, just as there is no formula in establishing an objective value to it.  This is not subject to the quality of the money – both gold and fiat are subjected to values determined subjectively in the market.

There is no formula, and certainly not one to be found by a handful of economists or legislators.  It is for this reason that even a gold standard must not include non-market participants in any manner.

Ballvé makes one minor error – one that is made by many hard money advocates.  As it is the only objection of significance I have found in this otherwise tremendous short work, I do not hold it against him.  He suggests that the business of money and credit should be returned to the market, including the return of all gold from the government depositories to private individuals.  So far so good….

…for gold is the only really sound money with intrinsic value.

Ballvé has spent this chapter making the case for a market in money and banking.  In this short statement, he seems to somewhat contradict his work, on two points:

1)      The only sound money (at least as close as humans will come to inventing) is money derived by the market.  It is money that withstands the pressures of supply and demand and of contract and use.

2)      Nothing has intrinsic value.  All value is subjective.

Other than this indiscretion, I find Ballvé’s work in this chapter to be quite sound.  Once again, in a dozen pages, Ballvé sheds wonderful light on a subject confusing to many – and in this case a subjective confusing to many advocates of Austrian economics.