Congratulations go to Forbes columnist John Tamny and editor of Real Clear Markets for producing the "Idiot's Guide to Austrian Economics'.
Ironically, that is not exactly what Tamny set out to do. The actual title of Tamny's article is "The Closing Of The Austrian School's Economic Mind".
Point by Point Look
Tamny: "It’s well known that some Austrians have a major problem with 'fractional reserve banking' whereby banks pay for liabilities (deposits) by virtue of turning those liabilities into assets (interest paying loans). Instead, they borrow money from depositors seeking a return on their savings, and who don’t need access to their savings right away, only to lend the money borrowed to individuals who do need it right away. The profits come from borrowing at one rate of interest, then lending longer term at a higher rate."
Mish: With that single paragraph Tamny proves he does not understand AE or fractional reserve lending. In fact, he makes it clear he is clueless as to where the money banks lend even come from. AE has no beef against lending. Rather, AE does object to money being created out of thin air for lending.
I don't care, nor does AE care if 100% of deposits are lent out, as long as three conditions are met: 1) Money is not created into existence by the loan 2) Money is not lent out for terms longer than the bank has access to the money 3) Depositors who lend money to the banks for interest are the ones who pay the price should there be a default on the loans.
In regards to point number three, it should be implicitly understood that the higher the interest banks pay for deposits, the greater the risk the banks (and depositors) must take to achieve that return. If it blows up, depositors, not innocent bystanders should pay the price.
Tamny: "Banks aren’t in business, nor could they remain in business if they simply warehoused money."
Mish: Is there a need for warehousing? Even if the answer is no (which it isn't), Tamny clearly fails to understand AE does not preclude lending. AE only precludes fraudulent lending.
Tamny: To many Austrians, this non-coerced act of exchange between consenting individuals is a fraud, and needs to be treated as such by the state. The Austrians want government to restrain what they deem a violation of property rights.
Mish: No! The problem of property rights comes into play multiple ways. Let's go through some examples.
1. Banks take a deposit, say a CD that pays interest for 5 years. Then the bank lends the money for 30 years. That's as fraudulent as me leasing a home for 5 years and issuing a 15 year sublease on my lease.
2. Checking accounts are known in the industry as "demand deposit accounts". Money is supposed to be available on demand. It isn't. In 1994 Greenspan allowed sweeps, whereby banks can nightly "sweep" all money from checking accounts into savings accounts, unbeknown to the depositor, so the money could be lent out. Money people think is there for safekeeping isn't there at all. The Fed recently stopped reporting of sweeps
Sound fraudulent to you? It does to me.
It's fraudulent even if people agree to it in obscure hard to understand account legalize. Why? Because it's as fraudulent as lending out 100 tons of grain when only 20 tons are in the warehouse, whether or not the owner of the 20 tons of grain signs an OK for lending out 100 tons.
3. Fraudulent lending of money causes economic distortions of all sorts, especially economic bubbles and income inequality. Those with first access to money (the banks and the already wealthy) are the ones who benefit the most. By the time money is available to the lowest guys on the totem poles, assets are already grossly overpriced. Price and asset inflation caused by lending out more money that exists is tantamount to theft. It artificially and fraudulently lowers the value of money on deposit kept for safe-keeping (checking accounts).
Tamny: The problem here is that the Austrians don’t stop at merely seeking an end to bailouts, Fed lending from its discount window, and while it’s largely bank financed, privatization of the FDIC. They once again feel that borrowing from savers in order to lend those savings out is a fraud, and that the state should abolish “fractural banking” in favor of banks backed by “100 percent reserves.” To Austrians, fractional banking leads to “excess credit creation” through what they refer to as a “money multiplier.”
Mish: Tamny keeps repeating nonsense, further proving he does not understand AE or lending. You can also safely conclude Tamny does not understand 100% reserves. Note that 100% reserves do not preclude lending as Tamny seems to imply.
Unfortunately, the "money multiplier" effect to which Tamny refers is believed by some Austrians (but also some non-Austrians). Tamny gives a ludicrous straw-man example then sets out to prove it wrong.
Tamny: The problem is that the very notion of a “money multiplier” is a logical impossibility; one that dies of its illogic rather quickly if analyzed in the lightest of ways. To explain what isn’t, banks are generally required to keep a 10% deposit cushion. Simplified, if a bank is the recipient of a $1,000 deposit, it can generally only lend out $900, or 90% of its deposits. What might surprise some is that the previously described loan is what has many Austrians up in arms.
Mish: Those who believe in the "Money Multiplier" theory are wrong, but so is Tamny. In a fractional reserve system banks can (and do) make loans whether they have reserves or not. Heck, banks can even borrow reserves from the Fed if need be.
From the BIS report Unconventional monetary policies: an appraisal
The level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans.
The main exogenous constraint on the expansion of credit is minimum capital requirements.
The BIS has it correct. Any Austrians or other who believe in the money multiplier are wrong. Of Course Tamny is wrong as well.
Tamny: "Banks are generally required to keep a 10% deposit cushion."
Mish: There are no reserve requirements on savings accounts, and Greenspan allows sweeps of checking accounts into savings accounts so there are effectively no reserves of checking accounts either.
Lending is entirely based on whether or not banks believe they have a credit-worthy borrower that won't default (or that rising asset prices will cover any defaults).
On the absurd theory that consumers would not walk away from houses or home prices would go up enough to cover losses, banks made some pretty horrendous decisions. Once capital impairment set it, then and only then could banks not lend. 10% deposit cushions have nothing to do with lending, or lending restraints. The money multipliers are wrong, but so is Tamny.
Tamny: No reasonable person would suggest as certain Austrians do that banks multiply credit in lending out a large portion of the money they take in.
Mish: Total Credit Market Debt is $59.399 trillion. Base Money Supply is $4.01 Trillion. Thank God banks don't lend out a large portion of what they take in!
It seems to me that 100% lending looks reasonable compared to the 1,357% lending we have now.
Tamny: Notable here is that no one is keeping “deposit banks” backed by 100 percent reserves from forming, thus raising the question why Austrians themselves don’t fulfill what they deem an essential market need. Indeed, if fractional banks are a fraud, wouldn’t the free markets welcome the banks desired by Austrians that are apparently the opposite of fraudulent? The answer to the above is fairly simple. The markets shun “deposit banks” simply because the warehousing of cash involves a cost.
Mish: The answer is indeed easy but it's not the answer Tamny gives. The answer is banks make a profit off "legal fraud". They would make less profit if they didn't. Banks have every incentive to make money fraudulently simply because it's allowed.
People are willing to go along because of deposit guarantees, and also because the state mandates fiat money as legal tender.
In the Name of Fairness
Tamny had a bit on "fairness". And to be fair, Tamny is correct on this aspect:
To be fair here, Austrians are properly offended by bank bailouts and other governmental backstops that prop up errant banks, and it’s the politically protected nature of banks that at least partially informs their views on banking. There’s agreement on the subject of bailouts. Those that took place in 2008, and long before that, were an abomination that weakened the banking system. Precisely because we love banks and their economic function, and because failure is the author of innovative evolution, we should let them go bankrupt when they can no longer attract operating funds.
AE vs. Purported AE Writers
I can be fair too.
There is a difference between sound AE theory and what various writers propose as sound AE theory. I can claim to be a Martian. Does that make me one?
Many writers alleged to be AE writers are anything but.
Most of the hyperinflationists fall into this camp (and there is a huge number of them). The hyperinflationists range from being seriously misguided on a few points to being outright charlatans to serve their own purpose (and it is difficult at best to tell the difference).
Yet, the articles keep on coming and coming. The authors tend to have a few things in common: