John Tamny has written a book, Who Needs the Fed? It was reviewed by Jonathan Newman at the Mises site. Tamny is offering a rebuttal to a few of Newman’s comments. I have decided to stick my nose in the middle of this. I will not go point by point, as there is much more in Tamny’s post than I care to deal with. In fact, I am only going to comment on one item.
It was regarding a Tamny post some years ago that I wrote something on the money multiplier. It was quickly pointed out how I stepped into it; I then backed off, but did not feel completely settled. I believe I know better today (or not, let’s see what response I get to this post).
Explicit in the Austrian view of banking is that $100 deposited in Bank A is loaned to another individual who deposits (assuming a 10% reserve requirement) $90 in Bank B, and then Bank B lends $81 to an individual who deposits the funds in Bank C. To Austrians $100 deposited with a bank quickly becomes $271; presumably on the way to infinity.
Missed by Austrians focused on the lending of money among many is that with the previously mentioned scenario, there's still only $100. To save is to give up use of money to someone else.
Tamny argues that there is no money multiplier – in my previous post I agreed. In this post I will agree…and disagree.
My mistake in my first post was that I was thinking of an all-cash economy – no checks, no debit cards, no credit cards. In this case, Customer A deposits $100 with (in reality loans $100 to) Bank B. It is physical cash that Customer A deposits (for this example to be meaningful, the physical cash must be backed by something – even if it is backed only by the risk that the bank defaults due to issuing too much of it). Customer C borrows $90 cash from Bank B. The bank is now holding $10 cash and has a note from C for the $90 owed to B.
There is no multiplier. And for this, I don’t care about the balances held in each individual’s account (or the sum of the two balances: $190). What matters only is the cash drawn from the accounts. There is only $100 ($10 with the bank and $90 with C) and some notes – a note from Bank B to customer A for $100, and a note from customer C to the bank for $90. There is no multiplier if all deposits and withdrawals – meaning also all payments – were made in cash.
But we do not live in an all cash world, and this is where I believe I went off the rails the first time. In today’s world, A has a bank balance of $100; C has a bank balance of $90; and, to complete Tamny’s example, D has a bank balance of $81.
To keep it simple, I will focus on debit cards – not credit cards, not checks, not Apple Pay, not PayPal. With the debit card, each use results in a simultaneous transfer of funds from my account to someone else’s account. (This unlike cash, where I go to the bank, withdraw $10 and walk around with it for a while, and always keep a balance of cash in my wallet.)
At the same moment, all three of us (A, C, and D) could spend our entire $271. To keep it simple, let’s say we spent it with each other, thus draining and replenishing our bank balances simultaneously. To keep it simpler, we all bank with the same bank.
We were able to spend $271, not $100 (technically, not $90 – as the bank is keeping $10 for no one to spend). No one “[gave] up use of money to someone else,” yet both the depositor and someone else received balances to use.
The balances never leave the system. Every withdrawal is a simultaneous deposit, and all $271 can be withdrawn simultaneously because it is also deposited simultaneously. This is impossible in a cash economy, but possible with debit cards (and, with slight twists, all other electronic forms of deposits / withdrawals).
Now, back to my simplifying assumption – all three of A, C, and D trade only with each other and they all bank at Bank B. It turns out this is not a simplifying assumption; it is reality.
…while I'm all for ending the Fed simply because it doesn't and never has served any useful purpose…
But it did and does serve a “useful purpose.” Among many other “useful purpose[s]” overlooked by Tamny, the Fed offers a completely closed-loop system – no chance that funds leave the system (other than the almost trivial physical cash balances held). Everyone who uses US Dollars trades with each other; everyone who uses US Dollars banks at the Fed.
The Fed has eliminated competition; the Fed (along with government deposit insurance, which technically is not necessary given the powers held by the Fed) ensures no risk of damaging bank runs.
So, in my previous post I was right – there is no multiplier – but I should have added: in an economy where all withdrawals and deposits are made in cash. Individual bank balances might say one thing, but balances available to spend are strictly based on cash held.
I was also wrong – there is a multiplier in an economy where virtually all (or even some meaningful portion of) deposits and withdrawals are electronic and the system is closed-loop. It is this world in which we live.
I am willing to be right…or wrong about any and all of this; let me know.