Abstraction & Reality

Brad DeLong alleges that critics of fractional reserve banking and fiat money suffer from (at best) a mental disorder (or, at worst, anti-semitism).

From Brad DeLong:

I think that the deep point of view underlying von Mises’s — and von Hayek, and Marx, and Ron Paul — complaint against fiat money in general and monetary management of the business cycle in particular is this: that value comes from human sweat and toil, not from being clever. Thus it is fine for money to have value if it is 100% backed by gold dug from the earth by sweat and machines and muscles (even if there is no state of the possible future world in which people actually want to exchange their pieces of paper for the gold that supposedly backs it). But it is not fine for money to have value simply because it is useful for buying things. There is, von Mises — and Marx, and von Hayek, and Ron Paul — think, something profoundly wrong on an economic and on a moral level with procedures that create value that is not backed by, in Marx’s case, human labor, and in von Mises’s and von Hayek’s case human entrepreneurial ingenuity. And in its scarier moments some of the trains of thought emanating from this deep point of view slide over to: “good German engineers (and workers); bad Jewish financiers” (and “good Russian Stakhanovites, bad Jewish Trotskyite intellectuals”).

Now I cannot speak for any of those named, but I am a critic of aspects of fractional reserve banking, and monetary management of the business cycle.

As I wrote last month:

Fractional reserve banking… means that the money supply is not in fact determined by the central bank (or by gold miners, politicians or economists, etc) but mostly by lenders. The problem is the fragility of any such a system to liquidity crises. If 10% of investors decide to withdraw funds at the same time, banks will quickly be illiquid. If 20% of investors do, bank failures will usually pile up. The system’s stability is contingent on society’s ability to not panic.

It is my belief that this fragility has been totally overlooked. Many have fallen into the lulling notion that the only thing we have to fear is fear itself — and that that fear can be conquered by rationality. This is to ignore man’s animal nature: the unforeseen, the unexpected, and the wild (all of which occur very, very frequently in nature and markets) make humans fearful, and panicky — not by choice, but by impulse. This is the culmination of millions of years of evolution — primeval reality is unconquerable, immutable and obvious. More than half a century after Roosevelt and Keynes markets still crash, fortunes are lost, and millions of grown men and women still tremble in irrational, primitive fear.

The textbook answer to this is that a lender of last resort should fix this problem by ensuring that enough new money is disbursed into the system for it to remain liquid, and confidence regained. The recent reality, though, has been that rather than fixing the problems, policy  — both in Japan in the 1990s, and now in the West — has resulted in zombification. Governments chose to keep bad banks going. Almost all the new money the government created has gone to shore up the balance sheets of irresponsible bankers. Now those banks sit on piles of idle cash while other businesses starve or cannot get started for want of credit.

As I noted earlier:

Vast sums spent on rescue packages to keep the zombie system alive might have been available to the market to increase the intellectual capabilities of the youth, or to support basic research and development, or to build better physical infrastructure, or to create new and innovative companies and products.

Zombification kills competition, too: when companies fail, it leaves a gap in the market that has to be filled, either by an expanding competitor, or by a new business. With failures now being kept on life-support, gaps in the market are fewer.

In other words, fractional reserve banking seems to lead to fragile systems that are hard to fix when they go awry. Now, I will readily admit that perhaps I am railing against a system that I can’t change or ban. Banning fractional reserve banking, or shadow banking or the various forms exogenous money creation will probably just drive it underground. Certainly, a pure gold standard has never prevented it. Perhaps full-reserve banking or the Chicago Plan may be some kind of panacea, but these ideas remain untested.

So — for me at least — the problem is not where money comes from, or whether it is backed by gold, or backed by labour, or entrepreneurship, or the Flying Spaghetti Monster. It is the managerialists’ mundane and matter-of-fact ignorance of the depth, the richness, the randomness, and the texture of reality – not captured by models that focus solely on money. The problem for me is that I see a fragile system and I want to fix it. But I am not sure I have the tools…

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9 thoughts on “Abstraction & Reality

  1. Christian principles favour honesty over wealth accumulation. A fair days work for a fair days pay.

    Money is the root of all evil, and when participants in fraud, dishonesty, and corruption, disadvantage the just and honest; their days are numbered.

    History repeats, because of fundamental differences in human nature. A battle of Good versus Evil.

    And now they wheel out the Anti-Semitism threat, because people dare to challenge a corrupt system. Give me a break.

  2. It would’ve been significantly better if Quantitative Easing was done by the Fed directly loaning newly printed money to new or small businesses (favorably manufacturing) for zero or even negative nominal interest, since it would have actually transferred capital from the unproductive to the productive part of the economy.

  3. John, would you say that you identify yourself as an Austrian (school of economics)? I’m just an amateur (which of course, according to one of Taleb’s aphorisms might make me an expert :P), but most of what you’re saying seems to me related to what the Austrians are saying. As for Brad DeLong’s “insight” into the “deep point of view”, I can only say (as an amateur) that it sounds like total gibberish that might be spewed out by a random troll on a forum. It’s sad that such “luminaries” like him can be so clueless. Your whole post seems to be an illustration of the Austrian point of view (you can correct me if I’m wrong) – which these “luminaries” don’t get anyway.

    • I consider myself to be a descendant of both Keynes and Hayek; they were both wrong about a lot, and right about a lot. I am a scavenger, and I encourage everyone else to be: take whatever theories or parts of theories you find fit reality. The school I mostly disagree with is monetarism in all its forms — from Friedman’s monetarism, to Nominal GDP targeting — which is the “next big weapon” in Bernanke’s arsenal. NGDP is effectively QE Unlimited — it empowers the Fed to buy ANYTHING (stocks, foreign debt, etc) ’til they hit a nominal GDP target.

      As I have pointed out again and again the problem is not that there is not enough money circulating (that’s pretty much my definition of anti-monetarism) it is that the money is being allocated to completely the wrong things (e.g. bond arbitrage over infrastructure) and that much of the money-printing has allowed the bad institutions to continue their wasteful practices.

  4. “If 10% of investors decide to withdraw funds at the same time, banks will quickly be illiquid”.

    If they withdraw funds they will usually buy something and the funds will end up in the banks anyway.

    The Guardian a UK based centre left ‘mainstream’ newspaper:


    It is a revolution in thinking that a mainstream newspaper is giving this criticism NOW, this subject was only ever discussed by fringe groups and ‘nutcases’, however the Internet and the financial crisis on 2007 has brought home to many people the huge problems that the developed economies now face.

    This criticism of the practice of fractional reserve lending and the way in which banks create money from nothing and loan it out charging interest on it. Also they are fully protected against bankruptcy and have no risk (the perfect business and not capitalist), tax payers will bail them out, so they are unlikely to change their ways.

    This subject ought to be studied by everyone so they know how they are being shafted by the powers that be. When you take out a loan at a bank they create the money from nothing by typing it in using their computer keyboard (which takes minutes), however you then have to pay back that money to the bank but you have to work hours, days, weeks, months, years and decades to pay that money back. They have bought your life and own it. They are masters and everyone else who does not have the state granted privilege of making money from nothing, are their servant.

    Some people are arguing that the central bank should be run and owned by the government, however this too is open to abuse, the only real remedy is to have real money based on metals like Silver and Gold, yet these are now referred to as a barbaric relic. This is something that needs public discussion and awareness. X-Factor, I am a Celebrity and such nonsense is not going to make it go away.

    • If they withdraw funds they will usually buy something and the funds will end up in the banks anyway.

      In a bank run, the point is not to buy things, it is to prevent money from being destroyed by a bank collapse. Again, the modernist/managerialist theory is that this was remedied by depositors insurance, lenders of last resort, and (worst case scenarios) recapitalisation (i.e. bailouts): my theory is that the last two lead inexorably to zombification.

  5. Pingback: The Wasteland « azizonomics

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