{"id":2902,"date":"2007-12-14T20:12:30","date_gmt":"2007-12-14T14:42:30","guid":{"rendered":"http:\/\/www.ravikiran.com\/blog\/classic\/200712\/zero-is-a-fraction-too\/"},"modified":"2007-12-14T20:12:30","modified_gmt":"2007-12-14T14:42:30","slug":"zero-is-a-fraction-too","status":"publish","type":"post","link":"https:\/\/www.ravikiran.com\/blog\/classic\/200712\/zero-is-a-fraction-too\/","title":{"rendered":"Zero is a Fraction Too"},"content":{"rendered":"

Anonymous Coward wants to know what exactly is wrong with the logic in the paragraph I linked to<\/a>\u00a0below.\u00a0 Let me explain:<\/p>\n

Rothbard claims that when I open a current or savings account with the bank (“checking account” or “demand deposit” for you Americans)\u00a0 the bank is implicitly promising to keep the money locked up in its vault, which means that lending it out constitutes fraud. I don’t see how that makes sense. The bank is only promising to pay me<\/em> my money on demand. How it manages to do it is the bank’s business.<\/p>\n

<\/p>\n

Rothbard’s argument is that this is a distinction without a difference, because if all<\/em>\u00a0 the bank’s customers demanded their money back at the same time, the bank would not be able to pay.\u00a0 I don’t see why that should matter.\u00a0 The contract is between the bank and its individual customers, not its entire class of customers. How the bank should manage its internal business to juggle its priorities is not for us to say and certainly not for the government.<\/p>\n

In the example Rothbard gives, he makes two elementary errors, one less important and one more important. The less important one is where he says: “I simply open up a checking account of $10,000 …” The “I” in question is Rothbard bank, but Rothbard neglects to tell us that the $10,000 is actually real money, deposited by a real customer. The way he says it makes it seem like the money has been conjured out of thin air by the bank.<\/p>\n

The other, more serious error is that he forgets the whole concept of “fraction” in “fractional reserve banking” at a convenient stage in his narration. The reason why FRB works is that banks can\u00a0estimate, to a high degree of accuracy, what fraction of customers will demand their money back at one time. If it underestimates this fraction, it becomes insolvent. If it overestimates it, it loses on its interest income. But that is a business judgement like any other. Rothbard ignores this fact, forgets that a bank has many customers and assumes that his simple bank with one customer describes the banking system adequately.<\/p>\n

In the rest of the article, he throws around words like “counterfeiting”, “swindle”, etc. casually, and equally casually manages to confuse the inflating of currency by the central bank to “inflating” of money by the banking system. Two minutes of thought will tell you that FRB would exist and be stable even if the central bank ceased to exist and stopped printing any more money.<\/p>\n

He further thinks that the reason the system persists is that the government has restricted entry, thereby enforcing a cartel. That is silly. Yes, there are restrictions on entry – and there shouldn’t be – but we have seen that there is no reason to doubt the\u00a0attribute the stability of the system to any Cartel.\u00a0 The system is\u00a0 a stable equilibrium in itself. Besides, in his free banking system, what advantage would an entrant have over a bank that practices FRB? A bank that does not lend out its checking deposits would have to charge a fee from depositors. It would also have to charge higher interest rates on its loans. I doubt if buying low and selling\u00a0high is a good way to grab market share.<\/p>\n

Rothbard thinks that the “general public” does not know that the money it deposits in a bank are in fact lent out, and that the system will fall apart “whenever the public finally understands the swindle”. That is an astonishing\u00a0insult to the intelligence of the public.\u00a0\u00a0 I know that when I put my money in a bank, the bank will lend it out to others and put it into productive use. I expect nothing less of my bank.<\/p>\n","protected":false},"excerpt":{"rendered":"

Anonymous Coward wants to know what exactly is wrong with the logic in the paragraph I linked to\u00a0below.\u00a0 Let me explain: Rothbard claims that when I open a current or savings account with the bank (“checking account” or “demand deposit” for you Americans)\u00a0 the bank is implicitly promising to keep the money locked up in […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[2],"tags":[30,31,36],"_links":{"self":[{"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/posts\/2902"}],"collection":[{"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/comments?post=2902"}],"version-history":[{"count":0,"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/posts\/2902\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/media?parent=2902"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/categories?post=2902"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.ravikiran.com\/blog\/wp-json\/wp\/v2\/tags?post=2902"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}