Wednesday, September 19, 2012

Clueless Selgin Doesn't Understand the Advance of Hardcore Austrian Economics

Joe Salerno writes (my bold):

George Selgin to Paul Krugman: “I Am a Former Austrian and I Do Believe in Fractional Reserve Banking — Honest”

Well, not exactly his words, but this was the gist of George’s bizarre and irrelevant comment on Krugman’s column asking Austrians what their position is on money market mutual funds. In his haste to establish his mainstream bona fides to Krugman, however, George was blind to the fact that Krugman has been forced to recognize and address Austrian arguments precisely by those who George denigrates in his comment as “the anti-fractional reserve crowd among self-styled Austrians, taking its lead from Murray Rothbard.” But it was due to the prodigious efforts of the Rothbardians including and especially Ron Paul that we have begun to see a radical change of opinion among the public, the establishment media, finance professionals, and even some academic economists concerning the alleged beneficence of the Fed and the effectiveness of conventional macroeconomic policies. It was this challenge that worries Krugman and prompted his insipid column. He could care less about George’s support for fractional-reserve banking and would not bat an eye even if he knew that George supported QE1 and (maybe) QE2 and advocates an aggregative nominal income target for Fed monetary policy, albeit at a lower level than most contemporary macroeconomists are comfortable with.

One more point: Both Rothbard and Krugman would have had a good belly laugh together over George’s peculiar notion that, in the absence of a central bank and government deposit insurance, a fractional-reserve banking system would be stable and flourish on a free market


  1. In response to Krugman, more from the non-existent and imaginary anti-Rothbard cult:

    [Selgin]: So, to be clear, (1) I am perfectly convinced that banks in a free system will move toward very small fractional reserves, MEANING PERHAPS 1 PERCENT OR EVEN LESS [emphasis added]; (2) the empirical evidence overwhelmingly supports my position, while overwhelmingly refuting Rothbard's. The tendency of Rothbardians to repeat their "theory" or 'prediction" or whatever they wish to call it, to the effect that FR banks "would" tend to move toward 100-percent reserves, despite all manner of past evidence contradicting the claim (and as if the possibility of free banking were merely hypothetical rather than something already reasonably approximated in the past) is one reason why I find their position, not merely incorrect, but utterly inconsistent with the most elementary principles of reason. 

    [Roddis]: "Wasn't the Great Depression caused by FRB in a non-competitive environment?"

    [Selgin]: Yes, in the same sense in which obesity is caused by food in a gluttonous environment. 


    [SELGIN]  And Jonathan, it was the Fed that supplied the fuel for the expansion of the late 20s. The rate of expansion was determined solely by it. Fractional reserves are a complete red herring here. 

  2. Fractional reserve banking is too broad a term. In a free market banks would surely loan out some of their deposits and keep a fraction on reserves. That money would then go into another bank and would be loaned out. This is not wrong at all. There would be more emphasis on requirements of length of deposits, but to get a return banks would lend out the money and I would have to chose which bank I want lending out my money(if any at all). A free market fractional reserve system would be fine and banks would compete on risk and reward for depositors. Keep the focus on the fed, not the fractional reserve banking.

    1. Fractional-reserve banking is fraud perpetrated on an enormous scale. If you gave me $100, should I legally be allowed to create $200 of counterfeit money and loan it out?

    2. “Keep the focus on the fed, not the fractional reserve banking.”

      Well said. The issue is the monopoly. The rest is detail, subject to contract.

      In any case, it strikes me that there is no such thing as a demand deposit (in the classic sense) anyway, so I do not see that there can be fractional reserve banking.

      1) Read the regulations governing availability of funds – given the exceptions, it is clear the bank is not holding the deposit.

      2) Explain how the bank is paying interest on money held in the vault on the depositor’s behalf, supposedly available on demand.

      3) Explain how the depositor is not paying a fee for storage for funds supposedly available on demand.

      4) Explain why the deposit is recorded as a liability on the bank’s balance sheet, as opposed to a journal entry on a deposit register.

      When the depositor makes the deposit, he no longer has first claim on the funds – in essence, a time deposit with a promise of best efforts for availability on demand. This is the way of modern banking. If one desires 100% reserve banking, withdraw cash and place it in a vault. Sign the contract, forgo interest, and pay the storage fee.

    3. "This is not wrong at all."

      Minus the whole "multiple people with on-demand claims to one thing at the same time". They have a word for that. Fraud.

      " there is no such thing as a demand deposit (in the classic sense) anyway"

      Absolute nonsense. Any checking account - and most savings accounts now - are demand deposits. If you go to the bank and say "I want my money now, please", you can withdraw it at will. Heck, you don't even have to go to the bank - any ATM will do to exercise your demand deposits.

      "Read the regulations governing availability of funds – given the exceptions, it is clear the bank is not holding the deposit."

      Checking accounts are available on demand. Savings accounts are a bit more tricky, but effectively they are as well. Just because the government allows banks to skip out on their obligations (and has as long as fractional reserve banking has existed) doesn't make it not fraud.

      "Explain how the bank is paying interest on money held in the vault on the depositor’s behalf, supposedly available on demand."

      I'll go slow so you can understand. They take your $100 and pretend it is $1000, loaning out the other $900. When someone comes to collect the money, they give them the $100 and go to the Fed to get more in short-term loans. Every bank is already bankrupt - but if that ever comes to light, the Fed and FDIC will save them by making money out of thin air. The interest return is giving you a nickel out of the vast return of phoney money (now made real by the repayment of loans in actual physical currency brought in from other banks and the debtor).

      "Explain how the depositor is not paying a fee for storage for funds supposedly available on demand."

      See above. The normal fee is just taken out of the ill-gotten gains instead.

      "Explain why the deposit is recorded as a liability on the bank’s balance sheet, as opposed to a journal entry on a deposit register."

      Accounting tricks. One can see that a bank's balance sheet at any time reveals their bankruptcy. $X in the vault + $Y in owed money = $X+Y in on-demand deposits. Most of the $Y are made up out of thin air, too - there is no physical currency to pay those liabilities, at least until the Fed contracts it.

      "If one desires 100% reserve banking, withdraw cash and place it in a vault. Sign the contract, forgo interest, and pay the storage fee."

      100% reserve banking does nothing while on a fiat currency control by a fractional reserve system. The money is still inflated by the fractional reserve banks and the Fed, and the dollar diminishes in value. There is no way to have these systems function on the same money - and without the Fed, the fractional reserve system would fall apart.

    4. “I'll go slow so you can understand. They take your $100 and pretend it is $1000, loaning out the other $900.”

      Tell me exactly, and use T-accounts: How does the bank take my $100 deposit and “pretend it is $1000, loaning out the other $900”? Please go SLOWLY (you should watch your grammar; poor grammar tends to distract from your rants).

      “If you go to the bank and say "I want my money now, please", you can withdraw it at will….Checking accounts are available on demand.”

      Have you read the banking regulations? These are part of the contract when you open an account. As they are part of the contract, how can the practice be fraud? I would welcome knowledge of how I can claim to be a victim of fraud whenever I find myself regretting having signed a contract. Please show me the case law on this. It sounds like you have this one nailed.

      “Minus the whole ‘multiple people with on-demand claims to one thing at the same time’.”

      Two people do not own the same asset; at minimum two people do not have equal claim to the same asset. The bank has first claim on your deposit. In case of default, it is the senior secured creditors that have first claim…guess what, that isn’t the depositor. You may not like the contract (I don’t), but there are virtually no alternatives (blame the monopoly) if you want to benefit from the division of labor society in which you live.

      “Just because the government allows banks to skip out on their obligations (and has as long as fractional reserve banking has existed) doesn't make it not fraud.”

      The entire issue is the monopoly protected and enhanced by government. All the rest can be taken care of in a free market for money, banking, currency, and credit.

  3. I can see a potential resolution of the contractual issues between the bank and the depositor. But what about the payees? If you are selling your house, why would you accept FRB notes instead of warehouse receipts? Why shouldn't explicit warnings of the dangers of FRB be printed on the face of the notes to avoid fraud as to naive payees? In a competitive environment, why would anyone ever accept FRB notes over warehouse receipts?

    Further, this debate is about a fairly esoteric prediction about what forms of financial instruments will be used under a regime of pure laissez faire in the distant future. In the midst of all this, we have the spectacle of the pro-FRB guys seeking the approval of Krugman by whining on Krugman's blog, "Some of us cool and smart Austrians really like FRB, unlike those nut-case Rothbardians" while at the same time agreeing that monopoly FRB was the cause of the Great Depression. Now, that is a clear message of the Austrian position for a confused and ignorant public, right?

    1. " In a competitive environment, why would anyone ever accept FRB notes over warehouse receipts?"

      I don't see why they would. Why would anyone take "you might possibly be able to get some money for this house" instead of "redeem this and you are guaranteed $X"?

      "while at the same time agreeing that monopoly FRB was the cause of the Great Depression"

      It's worse than that. Austrian theory contends that inflationary fractional reserve banking was the cause of the business cycle and bank panics before the Fed, while the US had no central bank. So Austrians like Selgin like FRB, while agreeing that it causes - all on its own - business cycles, depression, and bank failure. Last I checked, those were bad things.

  4. Seems to me that both Friedman and Hayek landed last, after examining several alternatives, on the policy of free banking as the least worst way to control monetary inflation.

    1. Inflation is caused by fractional reserves and Fed money printing. It is a creature of government and fraud. It could not exist under a 100% reserve gold standard, because fraud would be illegal.

    2. As did Mises. Sennholz, in his list of recommendations for a return to sound banking does not mention anything about reserves, focussing on issues regarding the elimination of the monopoly.

  5. Sadly no one has endeavored to hear just what George Selgin is advocating. They have just rushed onto a bandwagon and joined a choir. Let's put on our thinking caps, shall we?
    Is an annuity money? Can I not freely contract to sell the income stream from an annuity for a lump sum today? Does the party with which I contract that lump sum not agree to take a risk as to the financial health and viability of the firm who wrote that annuity? Do they not figure in this risk when they determine the amount of the lump sum they are willing to offer me?
    I think Prof. Selgin in his support for free banking (and his apparent support for fractional reserves?) is thinking along these lines. I know he supports letting anything of any size fail and that he asserts this will motivate them towards good health lest they go under and be gobbled up by a competitor bank because they made bad loans. I am not sure but I think George’s logic says something like this: "If we rely on a bank to make good loans with fully reserved funds behind them being motivated by the fear of insolvency and conquest by a competitor, then why is that motivating fear not greater when leveraged to restrain them from making bad loans on fractional reserves?" And if we believe in free contracts, why cannot a banking institution bet on the future stream of income from a loan in the same manner the aforementioned institution is betting on the constancy of the annuity stream when they contract a lump sum settlement in exchange for an income stream that, at its root, has only the "good name" of the annuitizing company behind it? Why, the thinking goes, cannot banks seek to run a tight ship and bet on their "good name" also?
    I believe that Mr. Selgin does not advocate calling the "bank notes" currency or "money" per se. I believe he sees them as just that, notes, similar to futures contracts or any other private note.
    As we all know you cannot simultaneously have 100% reserves and 100% demand deposits and making investments by loaning deposits at the same time. One thing or another has to give. So proponents of 100% reserve banking put the restriction on demand deposits and propose limits on access to deposited funds for a contracted period of time or other limiting terms including penalties for premature withdrawal if allowed. Others propose free form "insurance confederations" of several banking institutions to mitigate (but not theoretically or actuarially eliminate) the problem of simultaneous demand and 100% reserves. All this does is alter the scale and dilute/distribute the risk (of a bank run), it does not eliminate it. Moreover, this simply allows the insuring institution to make money off of their "good name" rather than letting individual banks do so.
    What I understand Mr. Selgin to be saying is that he favors individual banks to issue notes for amounts greater than their deposits with the only limit being the amount of leverage they choose to risk before their "health" deteriorates to the level that they cannot sustain a large demand for access to funds by depositors. Remember in a "free banking" scenario, banks can deposit funds in a competing bank, and then at an opportune time, demand deposited funds in a predatory effort to cause temporary cash flow insolvency, creating a vulnerability and then gobble them up in an acquisition. But banks are not too keen to deposit with their competitors because those funds will yield poorly compared to other investments on the open market. It is a fight for survival and without the “gun of government” in the room, a very level playing field. (cont'd in next post)

  6. (cont'd)

    I think Mr. Selgin's theories place the safe-guarding mechanism in the institutional fight for survival rather than in a mathematical elimination of risk by a voluntary and contractual restriction of access to deposits. I do not believe that Mr. Selgin would ever place bank notes in a category as high than "traveler's checks". Bank notes would only be exchangeable (under terms and restrictions) for "currency" on a ad hoc negotiated basis though admittedly exchange rates would stabilize and ratings agencies would arise with public audits determining the exchange rates between bank notes and currency (gold).
    Suppose "Bank A" returned 3% under a 100% reserve restricted deposit access scenario while "Bank B" yields 5% under the same terms. Soon “Bank A” will suffer a complete run regardless of its solvency unless it raises its return rate or “Bank B” is viewed as too risky. So, even under a 100% reserve scenario, the only thing ultimately keeping banks from promising unsustainably high returns, and thus its solvency, is its fear of going under or being weakened and vulnerable to a take-over. Thus we see that even under a 100% reserve (restricted deposit access) scenario a bank can “over promise” its way into insolvency and default on obligations. Thus the only thing that ultimately governs the risk taking actions of a bank is its instinct for survival and self preservation. What Mr. Selgin proposes in his “free banking” theories, I gather, is to allow them the same freedom to earn profit from a “good name” as insurance companies which only “actuarially mitigate” rather than eliminate, systemic risk. Under a “free banking” scenario, bank notes from the “Bank A” (3% ROI for depositors) might be regarded as safer than the notes from “Bank B” (5% ROI for depositors) and thus the “Bank A” notes might carry more weight if they were traded in a manner similar to the way an annuity stream is bought out today.
    Under this form of "free banking", banks are encouraged to earn a "good name" by higher returns as well as solvency. Safety is an illusion. Even the FDIC is ultimately funded by its members and, failing that, the taxpayer. It all comes down to undertaking risk and the spreading of that risk. Mr. Selgin wants total freedom to be governed by competency and solvency with all the cards on the table. Those who choose to accept the bank notes understand that there are risks in the same manner as those who buy insurance understand that compensation for a claim ultimately rests upon the good name of the insurance company. I do not see in any of Mr. Selgin’s theories that he equates bank notes with currency (gold backed or not).
    I think your article calling Prof. Selgin “clueless” (whether you were parroting Mr. Salerno or not) is unnecessarily hostile. Perhaps George Selgin, as explained above, believes in more freedom that the so-called “hardcore libertarians” you mention. Remember, Ron Paul says that freedom and responsibility go hand in hand. Prof. Selgin seems to be advocating the same thing. Dr. Paul also says: “Just because I believe in freedom doesn’t mean that I endorse everything you do with your freedom.” If we believe in risk taking, that doesn’t mean we agree with every risk taken. Prof. Selgin is comfortable and confident to let free market can decide on its own which risks are worth taking. Shouldn’t we be?
    Even though your article quotes Prof. Salerno as saying “I [Selgin] am a Former Austrian and I Do Believe in Fractional Reserve Banking — Honest”…. I think this is a hasty and intemperate swipe at a friend and ally. I think we should pause before we rush to put words into the mouth of someone as respected as George Selgin. Prof. Selgin is an ideologue and has written at length and detailed the rationale of his arguments for all to see here among other places. If you disagree with them, at least have the courtesy to respond in a gentlemanly manner.

  7. Hey all you self styled "anarcho capitalists", do you not believe in spontaneous order? If I am willing to accept a bank note that is backed by nothing more than air, shouldn't the bank be allowed to issue that note? When is it fraud? When they make a promise to pay a note that is unbacked which they admit is unbacked? Or when they fail to pay it on time? Using this logic all loans must be 100% collateralized or they are fraudulent. It seems that George Selgin is more libertarian in his "free banking" theories that his critics might want to admit.

    Oh and by the way... it is inconsistent to advocate an anarchist environment and somehow have a system of prior restraint regulating the actions of banks or people freely contracting with one another on a "buyer beware" basis. Your childish aversion to risk is seeking protection from a parent or guardian even if you have to invent one, such as a regulatory agency. Thus are monsters born. We are taught in the Natural Law or anarchist tradition, to abhor prior restraint and "preventative justice" (which is a messianic delusion) and to cling fast to system of justice based upon retribution, restoration and recompense. So upon what basis do you seek to prevent banks from contracting freely and openly?

    Shame on Joe Salerno for his intellectual dishonesty and his hasty and intemperate slander of Prof. Selgin.

    I might add that Prof. Selgin is a trusted friend of Ron Paul and gave a speech in Dr. Paul's lecture series here:

    1. Yes, when Selgin was advocating QE1, that certainly was showing that he is for freedom and liberty in ways that anarchocapitalists aren't. If only the austrians could be in favor of such keynesian freedom like that!

      You may be a student of his or something along those lines and probably didn't get a chance to see who started all of the name calling by attacking Rothbard and his intellectual followers as being a part of "moronic cult" -- which would include the most well known follower of Rothbard, the same Ron paul that you brag about selgin knowing -- but it wasn't those disagreeing with selgin. Selgin is incredibly defensive and lashes out with personal insults on a regular basis with those who disagree with him in ways that would remind many men of crazy ex-wives.

      I have seen on this very blog a poster (obviously someone with high levels of econ knowledge posting under the major freedom alias) go through and rebut selgin line by line, but Selgin won't debate that -- instead he likes to get off by calling fans of rothbard a "moronic cult," with unprovoked attacks, and apparently he is now appealing for recognition and praise from fellow QE1 advocate Paul Krugman of all people. Read his reply to Salerno on the link provided where he questions Salerno's integrity -- not exactly sticking to the issues, is it? Selgin also continues to insist to this day that the Fed deflated credit and money during the GD instead of inflating it as they should, which is nonsense easily disproven originally stated by Friedman. Yet at the same time, he has accused Rothbard of simply making history up to fit his economic views!

      BTW, "slander" is done orally, not in a written form. So unless Wenzel or Salerno made these statements on a tv show or podcast, you are looking for "libel" with your attempted insults. But I guess fans of Selgin aren't exactly big on knowing the details, right?

  8. I just don't see what wrong with a depositor and a bank entering into a voluntary contract whereby the depositor agrees to give the bank his money, agrees that the bank may loan a percentage of the money out, and agrees to accept the risk that if every other depositor asks for his money back at the same time, the bank may not be able to return his deposit on demand.

    I do see what's wrong with telling people that they have the right to ask for their money back at any time, when the truth is that 90% or more of their money has already been loaned out without their knowledge or consent.

    It just seems to be more about disclosure than anything else.

  9. Selgin is often one of the most cited of those keyensian types who will say things like "even Selgin agrees..." with whatever Keyensian view is being promoted, sort of like how Krugman types love quoting Friedman to justify state intervention. Selgin is a lot like a more intelligent version of Gene Callahan in a lot of ways, and his begging for attention and recognition from a total fraud and clueless political shill like Krugman is all the proof one needs.

    I have long been suspicious that Selgin was bitter and jealous at the popularity that certain austrians have received in mainstream circles while he toils away in econ journal obscurity in periodicals only a few economists read. People like Tom Woods, Tom DiLorenzo, Robert Wenzel, the Judge, etc have far more influence on the general public than he does in changing minds, and I think that really bothers him. Not to mention Rothbard becoming extremely popular thanks to Ron paul and the internet, and Friedman's value receding as time goes on and more of his views are exposed.

    Selgin has always been bitter and defensive, but he seems much worse lately.

  10. "Krugman, look at me, look at me! I deserve respect and recognition from you, and other keynesians! Maybe if I attack Rothbardians, the mainstream will give me some of the respect and attention I know that I deserve!"