In our 2010 book, How Privatized Banking Really Works, we integrated Austrian economics (particularly in the Rothbardian tradition) with Nelson Nash’s Infinite Banking Concept (IBC). Among its other content, our book offers–if we do say so ourselves–one of the clearest introductions to “fractional reserve banking.”
When you deposit $100 into your commercial bank checking account, they don’t put the cash into a drawer with your name on it. Of course not. Instead, they typically lend out some portion of it to other borrowers, keeping only a fraction of your original deposit in the vault as a reserve. Hence, under fractional reserve banking, the commercial banks are in an inherently vulnerable position. At any moment, if the public decides to pull its money out of the banks, the game is up. We have a classic “bank run.”
Now everybody is vaguely aware of this possibility, but most people assume it’s a fact of life, just like you might die in a plane crash. Yet many economists in the Austrian tradition (though not all of them) argue that things don’t have to be this way. So long as we make a clear distinction between checking accounts and genuine savings accounts, there is no chance of a bank run. Furthermore, if we take away the ability of the banks to effectively “create money” through the act of lending out their customers’ deposits, then we remove the source of the artificial boom in the Austrian theory of the business cycle. (For more on these technical subjects, see Murphy’s recent lecture at Mises University 2018.)
For a long time, mainstream economists would pooh-pooh the Austrians (particularly the Rothbardians) who repeated these seemingly quaint objections to modern banking practice. Yet there were always big-gun economists–including Frank Knight, Irving Fisher, and Milton Friedman–who had, at least at some point during their careers, toyed with the idea of insisting on 100% reserves in commercial banking. (Indeed that’s what “the Chicago Plan” referred to, crafted in response to the bank crises of the early 1930s.)
And now, in the wake of the 2008 financial crisis, we have a resurgence in popularity of the 100% reserve idea. The most recent example is a Nov. 5 blog post by (former) University of Chicago Booth School of Business professor John Cochrane, who writes:
In preparing some talks on the financial crisis, 10 years later, I ran across a very nice article, The Big Con — Reassessing the “Great” Recession and its “Fix” by Larry Kotlikoff…
Larry is also the author of Jimmy Stewart is Dead – Ending the World’s Ongoing Financial Plague with Limited Purpose Banking, from 2010, which along with Anat Admati and Martin Hellwig’s The Bankers’ New Clothes is one of the central works outlining the possibility of equity-financed banking and narrow deposit-taking, and how it could end financial crises forever at essentially no cost.
Larry points out that the crisis was, centrally a run. He calls it a “multiple equilibrium.” Financial institutions have promised people they can have their money back in full, at any time, but they have invested that money in illiquid and risky assets. When people all do that at the same time, the system fails. Such a run is inherently unpredictable. If you know it’s happening tomorrow, you run to get your money out and it happens today.
This is a common view echoed by many others, including Ben Bernanke. What’s distinctive about Larry’s essay is that he pursues the logical conclusion of this view. If the crisis was, centrally, a run, all the other things that are alluded to as causes of the crisis are not really central. Short-term debt, run-prone liabilities are gas in the basement. Just what causes the spark, how big the firehouse is, are not central, as without gas in the basement the spark would not cause a fire. [Bold added.]
And so we see that plenty of “reputable,” mainstream economists are catching on to what the Rothbardians have been saying for decades. There is something fundamentally rotten in modern banking practice (propped up by government cartel enforcement and of course central banking).
The complete solution will only come from the separation of State and finance, but in the meantime we can all effectively secede from the Wall Street/commercial banking nexus by becoming our own bankers. If you haven’t already, check out our newest book (with Nelson Nash), The Case for IBC.