A Run on Revolvers

You think this is about the run on firearms and ammunition.  Nope.

From ZeroHedge: "Revolver Run": Banks Suffer Record $200BN In Outflows As Frenzied Companies Draw Down Revolvers:

…as of last Friday, corporate borrowers worldwide, including Boeing, Hilton, Wynn, Kraft Heinz and literally thousands more, had drawn about $60 billion from revolving credit facilities this week in a frantic dash for cash as liquidity tightens.

For those unfamiliar with this term, think of a revolver like an open line of credit with a ceiling.  A company will have some permanent forms of financing in place (equity, long term debt, bond debt); it will also have a revolver from which it can draw (typically) temporary needs, for example, seasonal or inter-monthly fluctuations in working capital, etc.

Confirming the unprecedented revolver drawdown scramble of 2020, JPMorgan reports that its tracker of known corporates that have tapped banks for funding rose further to a record $208 billion on Thursday, up $15 billion from $193 billion on Wednesday and $112BN on Sunday.

Banks offer revolvers up to some limit – for example, a company could have a revolver of up to $5 million (or $5 billion); at any one time, none, some, or most of it might be drawn.  JPMorgan reports that revolvers are currently drawn, in aggregate, at something approaching 80% of their limit.

Why are companies doing this now?

As a result what was a revolver "bank run" has become a spring for the ages as virtually every company has rushed out to draw down its revolver for two reasons i) with the CP market still locked up, even blue chips have no access to short-term funding…

CP = commercial paper market; this market is still not functioning well, despite the Fed recently announcing a backstop for it.

…ii) increasingly more companies are concerned their banks may not survive…

This one is interesting.  If the bank doesn’t survive, money on deposit at the bank might be worse than having undrawn capacity on a revolver.  Money on deposit sits on the bank’s balance sheet; a depositor becomes nothing more than an unsecured creditor to a bankrupt institution (for any amount above the FDIC limits).

Meanwhile, the borrower will owe the balances drawn on the revolver to whatever institution has taken over the assets of the bankrupt bank – and these assets include loans made to companies who drew down their revolvers.

…so why not just draw down the facility and hold the cash instead of being subject to the whims of some fickle bank Treasurer who may not have a job tomorrow, or who decided to abrogate all revolver contracts with the blink of an eye…

This would be interesting: banks not meeting their commitments.  It is certainly possible, but if this happens in any substantial quantities, the banking system would be called into question just as if bank deposits were not made available.

Conclusion

I suspect that all of this can be papered over again by central banks, not forever, but for a time.  It will take central banks a few weeks or months to figure out how to handle this new normal, just as it took them some months the last time (2008-09).

Until consumers suffer unbearable price inflation, nothing prevents central bank balance sheets from growing to whatever number desired or necessary.  For the Fed, now at something around $5 trillion, $10 or $20 trillion can likely be had.

Prior to 2008, that number was something around $800 billion.

More on Fractional Reserve Banking

Frank Shostak has written a piece on this topic.  Some of his comments I disagree with, some I question, the largest portion I say are spot on – which raises, once again, my view on “focus” when it comes to this topic.  With this. Let’s begin:

The so-called multiplier arises as a result of the fact that banks are legally permitted to use money that is placed in demand deposits.

The banks are not only legally permitted to do this, there are several provisions in the contract between bank and customer that implicitly allow the banks to do this.  Importantly, they are not contractually prohibited from doing this.

As to the multiplier effect: consider a hypothetical.  Consider the “multiplier” that is possible if all bank transactions were to clear through a single bank – a monopoly on money and credit.  The bank would never have to fear a run because all withdrawals were immediately offset with the corresponding deposit (less currency withdrawals which are certainly immaterial relative to total balances). 

My point?  It isn’t a hypothetical.  There is a multiplier effect because the entire banking system can be considered as one single bank with a central bank to ensure every transaction can clear. 

A monopoly.

Banks treat this type of money as if it was loaned to them…

Depositors also treat this type of money as if they are loaning it to the bank – otherwise, why would they expect (and in most cases and in normal interest rate environments receive) interest income?

For example, if John places $100 in demand deposit at Bank One he doesn’t relinquish his claim over the deposited $100. He has an unlimited claim against his $100.

This isn’t really correct.  The regulation underlying the contract makes clear that his claim is conditioned on the bank’s ability to make good; the regulation makes clear that there are certain conditions under which John might have to wait some time before receiving his $100.  His claim is limited.

A case could be made that people who place their money in demand deposits do not mind banks using their money. But, if an individual grants a bank permission to lend out his money, he cannot at the same time also expect to be able to use that money.

Of course he can expect to “use that money.”  I will suggest that, since 1934, people have been able to “use that money” 99.99999999999% of the time “on demand.”  I suggest that this level of performance is higher than that to be found in any other industry; therefore, why wouldn’t he expect to be able to use that money? 

I can expect to use the money when I want to with a higher degree of certainty than I can expect my car to start in the morning or my Windows operating system to function properly.

…from an economic point of view, [this banking practice] produces a similar outcome that any counterfeit activities do. It results in money out of “thin air” which leads to consumption that is not supported by production, i.e., to the dilution of the pool of real wealth.

I will suggest that it is the consolidation of the banking industry into and under a monopoly central bank that allows for the creation of this money out of thin air.  An individual bank, with no backstop other than its own capital, would loan out only an amount of these types of deposits (given the contract) that it felt were secure; a prudent reserve ratio would be used. 

A bank that was imprudent to the point of insolvency would, of course, cost the depositors their deposits.  But absent the consolidation of the industry into a single bank, this would be nothing more than a blip to the larger economy.  And, with the insolvency, voilà!  A reduction in the multiplier.  Left to the market, it is all so self-regulating; markets will discipline banks as to the proper duration matching necessary.

Consider: if the individual bank with no outside backstop successfully predicts it can safely loan 80% of its demand deposits, what does this mean?  It means depositors never touch, in aggregate, 80% of the money deposited.  I don’t mean multiplier in digits – in passbooks or account statements; I mean multiplier in terms of circulating currency (or digits).  However one describes it, 80% is functioning as permanent capital for the bank.  So, where is the multiplier? 

This I pose as a question; I would welcome reasoned feedback.

The rest of Shostak’s post focusses on the primary issue – and in my mind, the only issue:

In a truly free market economy, the likelihood that banks will practice fractional-reserve banking will tend to be very low.

I don’t know how “very low” it would tend to be; but the solution is “a truly free market economy.”  A “truly free market economy” would not include a central bank or government deposit guarantees and the like.  I do know that in a truly free market economy banks and their customers will be required to exercise proper fiduciary caution.  This is what will discipline the practice of fractional reserve banking and this should be the issue of focus.

The issue is the monopoly.  Remove the government backing; the market via contractual relationships between bank and customer will manage the practice. 

Fractional Reserve Banking Clarified

Thanks to Walter Block:

In FRB, two people own 100% of something.

It helps to have a definition; now I know Walter’s.

That’s incompatible with private property rights, one of the basic foundations of libertarianism.

Given Walter’s definition, I agree.

But his definition gives me pause.  Why is there so much debate, angst, wailing and gnashing of teeth over a topic that is non-existent?  Under this definition we do not live under an FRB banking system. 

I can accept that there might have been a time that such was a standard practice; however this is not the practice today.  I can accept that there might somewhere be an institution that promises one thing but delivers another – but this isn’t an FRB thing, it is a breach of contract thing.

Two people do not each own 100% of something in today’s banking world.  Hand your money to the bank teller and the money is now an asset of the bank.  The bank owns it – 100%.  You are the creditor; the bank owes you 100%.  But you and the bank don’t each own 100%.

So I really don’t get it: why, for a practice that is not a practice, is so much emotion spent?

Interview, shows common man is ignorant of frb

Common man is ignorant of many things.  Unless you can point to several examples by banks offering one thing but delivering another (via advertising, contracts, whatever), this is not really relevant other than to point out the sad state of public education.

More on Fractional Reserve Banking…and More!

C. Jay Engel has written a very thorough post on the topic of fractional reserve banking, entitled “Against Fractional Reserve Banking and the Curious Case of the Aleatory Contract: Deconstructing Michael Rozeff.”

The post is very thorough and exhaustive.  I will be clear up front – I will not address it in the manner it deserves to fully be addressed; let me explain why:

So then, as you can see very clearly, Rozeff’s conception of fractional reserve banking is not fractional reserve banking as it was historically practiced and which Rothbard heavily criticized.

If the discussion is entirely about historic practices, Engel and I have no disagreement.  While I have not studied this in any detail, I have no reason to doubt the claim that goldsmiths – charged with storing gold against a receipt for the gold – learned that they could surreptitiously produce multiple receipts for the same gold.

Charging for storage of gold and not actually storing the gold is a contractual breach – if you like, you can call it fraudulent.  You can also call this fractional reserve banking; I am as equally against such a practice as the most ardent critic of FRB.

For this reason (and also that the bulk of the post is directed at Rozeff), I find little benefit in going line by line through the post – while I encourage all interested in the topic to read it.

At the back of my mind is the desire to bring the wonderful and praiseworthy Bionic Mosquito closer to my side of things…

Engel need not concern himself with bringing me to his side of things.  If he is writing specifically about an historic practice, I will not argue and have never argued regarding this.  If his point is that history is specifically what “Mises, Rothbard, Hoppe, Salerno, de Soto, Hulsmann, Block, Bagus, Howden” are arguing, we can all have a beer and part as friends.

Engel need not concern with bring me to his side because I have asked the question multiple times: are we debating today’s practice or historical practice?  I accept the difference.  Engel makes clear that he does as well.  Perhaps I should welcome Jay to my side of things!

Yet there are many who claim that today’s practice is fractional reserve banking and it is fraud.  It is to them that I write and to them that I offer criticism.  Many of these are associated with the Austrian school and many of these claim to be citing Rothbard.  To their claim of leaning on Rothbard I have often disagreed, albeit for reasons different than what Engel suggests.

Engel tells me the paper might get published in a proper Austrian journal, as it well deserves to be.  I might suggest that he beefs up the distinction of historical practice vs. todays practice.  I find this the critical distinction and clarification in the paper.

The rest I offer as points to ponder or other intellectual wanderings…. I hope Engel takes them in the spirit intended – items he might consider as he moves his paper toward publishing.

The Money Multiplier…

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.

Conclusion

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.