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Banking Question

Okay, I'm having a slight freak out here. I'm re-evaluating my position on the gold standard. Hopefully somebody can help me clarify.

Let's say we were to snap our fingers, and we were all living on the gold standard, or silver, whatever. There is NO central bank. What would prevent a liquidity crunch in the banks? Let me give you an example. Say fractional-reserve banking exists. [I say fractional-reserve banking exists because how else would there be enough capital to make loans? And why shouldn't fractional reserve banking exist?] Okay, so fractional reserve banking exists. What happens if there is a bank run, or for whatever reason a bank over extends itself and has loaned more than it can afford to pay back to its depositors. Then what happens? Does the bank go insolvent? Is it forced to call in all of its loans? That seems highly disruptive. What happens now is that if there is a liquidity crunch, the fed can bail it out. Yes, it is a bummer to have to have inflation, but what is worse? A few percent inflation every year as a tax? Or bank runs, and general instability? Help me out here. No, I'm not a troll.

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Fractional reserve horrors

You seem to think that fractional reserve banking precludes bank runs. Recently we have had bank runs at Countrywide in California and at Northern Rock in London. You also may not be aware that the dollar has lost 35% of its value in the last 5 years and that the threat of a currency crisis is a real possibility. Ask Argentina what that 'freak out' feels like. Interestingly, we have at least two currencies today - paper money and electronic money. And yes, look at the Fed charter - each one is 'backed' by something different. Or to make it more tangible, some merchants offer discounts if you use cash. Some merchants won't take a check. So obviously paper money and electronic money do not always exchange at equal par. Notice the number of choices we have when picking a credit card or checking account (with different fees, limits, and incentives) but we only have one choice when it comes to paper currency - the federal reserve note. So what would be wrong with other competing gold backed paper currency. Lastly, you also seem to think the fed can always bail the market out but the Great Depression happened on the fed's watch. Keep in mind that confidence and liquidity go hand in hand. If confidence flees, then liquidity is gone as well. It doesn't matter that the fed is willing to lend if there are no banks ready to lend that money because they are rightly suspicious of the collateral offered - e.g. mortgage backed security 'toxic waste', etc. Already we see the fed is simply pushing on a string and the commercial credit markets are only running at 20% of their late spring levels. On the residential side, I'm freaking out about the fed induced housing bubble that will produce at least 2,000,000 foreclosures. So much for the myth that central banks can always produce stability.

I'm no expert either but...

I'm no expert either but there must be a plausible answer to your question...

My guess, just like the FDIC insurance they have now, something similar would have to be set-up to ensure liquidity through the Treasury department. This change over would not happen over night either. 1st Ron would have to get a congress willing to deal. 2nd, a change of money/economic management would not take place over night either... it would take place over possibly a 5-10 year period of transition. When President Paul takes office in 2009, nothing is gonna happen overnight. A transition period where two forms of currency would exists, one being from the treasury department and the other the Federal Reserve note. Over time, the Federal Reserve note and the FED would be phased out. It is a primary rule in a hard asset backed monetary system that lenders cannot lend more than they have in assets. Thus banks would have to have better money management. Bank runs are unlikely as all people know that causes bank failures. Bankers are smart and would be given the necessary time to ensure they are ready for a hard asset back economy again. Like I said, nothing happens over night and all the proper time would be given to ensure a successful transition.

Competing currency

The competing currency I am thinking of is usually the Liberty Dollar. Imagine it is a while from now and the Liberty Dollar has become vastly popular and the FRN is extinct. Then you would deposit your American Liberty Dollars into the bank, and they would in turn loan this out.

Transition Period and Educated Risk

I think your assumption that we can snap our fingers and be back on gold is the reason why you're having doubts. Once Dr. Paul has the republican nomination don't you think that banks will begin to build reserve so as to not get caught in a "liquidity crunch".

And in the long run it would depend on the risk that you're willing to take. Free market banks should be able to establish a range of products from zero risk account where they are merely keeping your money in the vaults to accounts where the money takes longer to access due to the need to sell off other assets.

Don't spend to much time poking holes in my above statements, because I don't claim to be an expert by any means :-)

Yes, the bank becomes insolvent..

and that would end business for the bank. So a bank's "fear of insolvency" is what SHOULD prevent them from fractionally diluting the money supply. People would not place their money (or trust) in a bank if they thought the bank would lower it's reserves to a "dangerous" level and prevent them from obtaining their gold. Also, if banks fear bankruptcy (bank + rupture), they will make more conservative loans. You are getting stumped because you believe loans are necessary for business or growth. If loans are necessary for growth, how did the first countries become wealthy? Where did the money come from? People used to save money or invest in group pools.... now they just borrow it, and every new deposit dilutes the money supply even further. Also, all fiat currency eventually comes to an end. We will ALL pay for it, in the form of hyperinflation, at some point when the money becomes worthless, and that $4million in your bank account can't buy a banana. So which is worse? Have you heard those stories of the German mark (after WWI) when thousands or millions of them couldn't buy bread? That's why.

I would suggest reading

I would suggest reading Milton Friedman's, "Free to Choose : A Personal Statement". He explains the system in great detail for us laymen.

I have the audiobook from iTunes, and I can't recommend it. The narrator has a very dull british accent when coupled with the material can put me to sleep in a matter of minutes. I'm intrigued by the subject, but you really need more of an upbeat narrator for such subjects :)

That's no good

I've already read Dr. Paul's book A Case For Gold. I and besides, I haven't got time to order that book and read it right now. I intend to donate heavily on the 5th of November, but I may not do it unless I can get an answer I am comfortable with on the banking issue, which I haven't as of yet.

Ok... fair enough. If

Ok... fair enough. If you're up to a 20 minute read instead, here's a good reference that would be applicable.

http://www.lewrockwell.com/north/north86.html

Thank you

That was a good link. I was afraid at first it wouldn't answer my question, but I think it may have. Let me see if I get this straight. In a 100% non-fractional reserve system, the bank would have perhaps two types of accounts, much like today. There could be a checking account, which the bank would not be allowed to loan out depositors money for, but would make money by charging a small fee. The depositor would in turn be able to withdraw money at any time. The savings account, so to speak, would be loaned out to borrowers from the bank, acting as the middle man. In THIS case, the depositor would NOT be allowed to withdraw at will and would be forced to wait until a predetermined time, allowing the borrower to repay his debt to the bank first. My next question is, what happens if the borrower is unable to pay back his debt, and then likewise, the bank cannot pay back the depositor? Is that simply the risk the depositor takes? Who goes down? Clearly the borrower goes down first, say going bankrupt, liquidating assets to pay off as much as possible to the bank. Then what? Say the bank only has half of what it needs to pay off the depositor, when what? The depositor gets screwed, or the bank? Let me know, thanks.

Private insurance companies

Private insurance companies could provide insurance, but they would force the banks to be more responsible with the loans they made. No more ARMs to people who can't pay. But the depositor would know their was a risk using that type of account instead of the 100% reserve account. Part of what the interest would pay for was the bankruptcy risk.

I bet it could be either

I'd say as long as both parties know upfront what happens in this situation, it is possible that it could be either. So maybe it's the bank in some instances or the depositor in another. I could even see a bank offering the higher risk (depositor loses out in case of default) with a higher interest rate return.

Again I didn't read the above reference article, and am no expert, but free market theory does interest me greatly.

Look at History

Look at how it was done before the federal reserve.
But my opinion is this - under the assumption of fractional reserve banking (which I think is crap) - banks would have to careful about making loans thats all. Does that mean fewer loans to people, probably. But Ron Paul wants to get rid of the income tax, etc so people would be borrowing less from banks anyway.
I would like to see paper currency backed by gold, in competition with paper currency that isn't backed by gold and let the market decide.

Why is fractional reserve banking crap?

For example. If I own say, 100 oz of gold, I should be able to loan that out, yes? Why then, can I not deposit that into a bank, and have them loan it out for me, and then pay me a small percentage of the interest they earn? That is essentially fractional reserve banking. I see nothing wrong with it. The problem is, what happens when I go to the bank to get my money back, if they don't have it?

What happens when you want your money back

Let's assume we have a 100% gold-backed currency. As you correctly noted, you could either deposit your money in a warehouse where you can access it at any time. The bank would charge you a small fee but would never loan it out.

Or you could put it in a savings account to earn interest. Then the bank would loan it out on your behalf. But when you do that, it's not a "generic" savings account, it is one with a specific period and a specific risk profile, both of which impact the interest you get.

If it's a one-day savings account, you can withdraw your money with one day's notice and you earn a low interest. If it's a one-year savings account, you can withdraw your money with one year's advance notice. The advantage is that you would earn a higher interest rate.

The point is that you make the decision upfront, based on your own anticipated needs, and you get rewarded accordingly. If you change your mind and want to withdraw early, the bank will charge you a penalty according to a prearranged schedule. In turn, this allows the bank to match the timing of its own assets and liabilities to minimize the risk of it going bankrupt.

In addition, you could instruct the bank to loan your savings only to super-safe investments, or you could allow it to take a bit more risk (for example by lending the money to General Motors Corporation). The more risk you agree to take on, the higher the interest you will receive. But this impacts the probability of default, whereby you could lose all or part of your savings. Once again, it is your personal choice, depending on your risk aversion.

To summarize, the point is: yes, as long as you don't deposit your gold in a warehouse, and instead the bank loans it out, you could lose it. It will be your decision at the beginning, and the more risk you take, over the longer period, the more interest you will earn if all goes well. It is a trade-off between risk and return. There is no such thing as earning interest with zero risk.

I hope this answers all your concerns about the gold standard.

It's my understanding that

It's my understanding that what you describe is not what "fractional reserve" means. Fractional reserve means the banks are required to keep a percentage of depositors money (10%) on reserve at the FED to help guard against a bank run.

Fractional reserve banking doesn't prevent bank runs. I think I remember reading somewhere that during the 1930's, the banks that did not participate in the FED system had a higher percentage of reserves than banks that did participate, but they went bankrupt first anyway. The reason being, the FDIC guarenteed the money at the banks that did participate - the government just printed it.

yes

That is what happened. ON PURPOSE... it was a subtle trick. They called in loans en mas. People with non insured accounts were screwed. But this is not a reason to shy away from commodity backed money. It's precisely the reason to RUN to it. That "scam" being perpetrated is how we find ourselves in this mess today. They Fed was very slick at molesting the minds and wills of the people. and new they could create a run by calling in the loans, meaning certain doom for any bank not a part of the FED(FDIC insured).
There is a ton of info on line about this situation ...lol... but i dont have any links and its way past bed time .... Google is your friend.

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violent revolution inevitable."
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Haha Funny

Oh, thats funny because thats exactly what I thought banking was about.
Watch is video. Its about banking. Don't let the cartoon style dissuade you, its very informative, except for the end portion.


http://video.google.com/videoplay?docid=-9050474362583451279

I'm no expert (good thing

I'm no expert (good thing too because they drip under pressure..) but it seems to me the concern involves a presumed roll of the fed as currency provider.

It is the duty of Congress to issue money in sufficient quantities to satisfy the demands of liquidity. Ron Paul recommends a parallel supply of alternative currency backed by gold (presumably in very small quantities so as to be able to provide satisfactory liquidity such as one dollar backed up by .01 TOZ AU)

I really don't know as I said I don't drip under pressure I just run away !

Bye !

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