A question on Greenspan.

I've been reading a little bit of Alan Greenspan's old stuff and I was wondering if he's ever issued any statements regarding what he's been thinking for the last 20 or so years? Did he just decide one day that he was totally wrong and give capitalism the double fisted bird?

Post 1

Wednesday, January 28, 2009 - 4:46am

I have to wonder if Greenspan's moral downfall has its roots in his support of fractional reserve banking. He supports the concept in Capitalism: The Unknown Ideal in his essay "Gold and Economic Freedom":

A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security of his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.

I consider this a chink in the book's armor.

By contrast, George Reisman supports a 100 percent gold reserve system in his blog where he states:

Under a full, i.e., 100-percent reserve gold standard, new and additional gold continues to be mined, and at a rate faster than gold is physically lost, e.g., in such things as shipwrecks and the burial of people with gold dental fillings in their mouths. Thus the quantity of money and volume of spending under a full gold standard increases. However, it does so at a modest rate. Prices fall under a full gold standard to the extent that the increase in the production and supply of goods and services other than gold outstrips the increase in the quantity of gold and the spending of gold.

Has anyone else wondered if perhaps Greenspan's support of fractional reserve banking served as a warning for his later views and actions?

In other words, does fractional reserve banking lead inevitably (or at least pave an easy path) to central banking, government interference in the economy, etc.?

Post 2

Wednesday, January 28, 2009 - 5:50am

I can see your point. I don't know that endorsement of a fractionional reserve leads directly into fed inflation madness, but it does seem to imply a subtle and dangerous transition. "I HOPE that banks don't have to cover all deposits, and I'm PRETTY SURE it won't happen." is not the same thing as " I KNOW the bases are all covered. It seems to me that when you accept "hope" and "pretty sure" in place of "know" you're headed for trouble.

Post 3

Wednesday, January 28, 2009 - 5:58am

Luke, based only on what you quoted from Greenspan, I believe it's a stretch to say Greenspan supported fractional banking. I view the quote as him describing what enables fractional reserves.

Fractional reserving can occur, and often did in history, without central banking, and even on a gold standard. It's simply a matter of any bank issuing certificates or notes redeemable in gold for more than what it has in gold.

The only way to effectively ban fractional reserve banking is government intervention, making it illegal. Even in that case, it would be difficult to detect a bank with a large amount of deposits and transactions engaging in it.

Caveat: I am not defending all Greenspan did as Fed chairman or his comments since then.

Post 4

Wednesday, January 28, 2009 - 6:12am

I think I recognize his downfall as becoming Fed Chair. You can't work for the government/private company with unlimited power and government support without corrupting your values as an objectivist. I don't know a great deal about Greenspan or why he took the job, but I know Rand would not have approved of it and the clear answer to why is because of Galts refusal to run the government/economy in Atlas Shrugged. I have seen a lot of articles where people have/had called for Rand to run the Fed (in life or after death) and I always get a good laugh out of it. Do one of you know why he took the job in the first place?

Post 5

Wednesday, January 28, 2009 - 6:18am

I think you're right that the only way to BAN fractional reserve banking, but in a free market on the gold standard some banks would go fractional while others would go "ultra safe" complete reserve. It would become a competing product.

Post 6

Wednesday, January 28, 2009 - 10:42am

Fractional reserve would exist in a free market for banks and competition would keep it at a reasonable fraction. It would be very different from today's Fed - a child of the government with a monopoly position on the price of money.

A gold standard could be government implemented - that is on the national currency, or it could part of free market in currencies. It could be fractional or not (with the national currency or any particular private currency).

Merlin has it right that the quote of Greenspan that Luke provides is about the natural result of a gold standard in a free banking system, where, like Ryan points out, competition would vary the fraction and/or the interest rate you got for your deposit.

I have questions about the quote from Reisman... It seems to imply only a national single currency backed by gold with no fractional reserve system. Is it best to have it illegal to have private currencies? And aren't there other currency-equivalents in the equation of purchasing power chasing goods and services to generate average price?

Post 7

Wednesday, January 28, 2009 - 11:52am

A ban on fractional reserves can amount to a ban on banks lending depositors' money. The bank could only lend from its own capital. The reason is defaults. If a bank lent more than its own capital, that would be lending out with depositors' money. If enough of the loans defaulted, the bank would have insufficient funds to pay depositors if they all wanted their money at the same time.

Neither Reisman's blog nor his article "The Goal of Monetary Reform," address this point, but a ban on a bank lending depositors' money would effectively undermine the most important function of banking -- acting as an intermediary between those who have money to lend and those who want to borrow, especially to finance commerce, or in other words, between savers and investors.

Post 8

Wednesday, January 28, 2009 - 3:38pm

Merlin, savers could still invest through banks via Certificates of Deposit (CDs) that "lock" the funds into illiquidity for the period of time specified.

The bank could thus act as both a storehouse for depositors who tolerate no risk (and earn no interest) and an intermediary for investors who tolerate risk (and earn interest for the tolerance).

The bank would be limited to loaning its own capital and those of investors, but not depositors.

Post 9

Wednesday, January 28, 2009 - 4:46pm

Luke, we are using words differently. I was using "depositors" to include those you call "investors", i.e. buyers of CDs and owners of savings accounts that pay interest. (Those who invest via a bank trust department constitute yet another category, but I assume you did not mean them.) How does your post relate to fractional reserves, if intended?

As you say, a bank could be barred from lending no-interest "demand deposits", but to that extent it would not be a financial intermediary.

Post 10

Wednesday, January 28, 2009 - 4:57pm

What would be helpful, would be to have a range of free-enterprise options available: Fractional reserve type of bank deposits (the loaning out of x percent of the on-demand deposits), with the percentage published. And banks that loan only the money from investors (as opposed to on-demand depositors) - no fractional reserve type of accounts. People who want to deposit some money could vary the amount of interest they received by picking from the accounts available. With an account that was a demand deposit and NOT a fraction reserve type of account, there would be no interest, but instead a fee.

Post 11

Wednesday, January 28, 2009 - 5:01pm

The system I propose would be 100% reserve for the "no risk" deposits with even the "at risk" investors understanding the bank cannot loan more than it actually has to loan.

Loaning more than it actually has would constitute fraud and warrant an investigation and prosecution with sufficient warrant.

I like Steve's idea as a way to encompass mine.

(Edited by Luke Setzer on 1/28, 5:02pm)

Post 12

Wednesday, January 28, 2009 - 5:27pm

Luke, that's fine with the following caveat. A bank could have less than full reserves, despite never loaning more than it has, due to borrowers defaulting.

Post 13

Wednesday, January 28, 2009 - 5:43pm

Yes.

Wednesday, January 28, 2009 - 6:56pm

Wouldn't the government simply require gold in payment of taxes, and pay out 100% reserve gold notes for government salaries and the like?

Private banks could do as they like.

Post 15

Thursday, January 29, 2009 - 8:42pm