Fractional Reserve Banking

0:00Our next speaker is Dr. Walter Block. I mentioned that Walter was Ken Garcina's teacher, teacher of many other economists. He holds a chair in economics at Loyola University in New Orleans. He's a senior fellow of the Mises Institute, was a student and a colleague of Murray Rothbard's. He got his PhD just up the street at Columbia University. He's the author of a whole library of academic papers, popular papers, books, and of course, defending the undefendable being, I guess, his most famous work. And Walter's going to talk to us today about fractional reserve banking and a number of related topics. Dr. Block. Hello, thanks for the kind introduction.

0:48The title of my talk was Fractional Reserve Banking, but I will be speaking about a few other things and I asked Pat to put all of them on the title and she refused because it was too long. In addition to fractional reserve banking, I'll be speaking about my man Milton Friedman and his 3% rule, the present depression, a little bit about immigration and the welfare state. I have to confess that I'm sort of not au courant with what's going on. I spent all yesterday traveling and I was reading a book. I was sort of out of pocket. So I don't know exactly what the Fed is doing, except what I just heard from David, but what I gather from this is that here comes Zimbabwe or Germany in 1923. It's just a horrendous increase in the quantitative easing, quantitative easing no more than one, two and three, but forever.

1:42I'm very much taken with some of David Stockman's reductios ad absurdum, this idea that, well you know, if we're going to double or triple, why not quadruple or quintuple? Maybe Krugman will be happy for the first time. This sort of reminds me of the reductio ad absurdum we use against the minimum wage law. You know, if the minimum wage law is so good at 8 or 10 or 12, well why not make it 100 bucks and then we'll all be rich. Another reductio ad absurdum is what David said about if we keep printing money until unemployment goes down, well, the printing of the money causes unemployment to stay up. It's very similar to the rent control in New York City. They say, well, we've got to keep rent control going until the housing crisis is gone, but rent control causes the housing crisis, so it's sort of a recipe for forever going on Okay, my first topic is fractional reserve banking, which I regard as basic or crucial

2:44to what's going on here. It's just creating money out of thin air. So we have a person who has a hundred bucks and he deposits it in my bank and I give him a demand deposit for a hundred bucks, which means he can get that hundred bucks whenever and then because I'm a fractional reserve banker I go to someone else and I say okay I'll lend you 90 bucks I want to keep $10 as a reserve we have a fraction reserve of 10% and I give that person 90 bucks also with a demand deposit and that person can come to my bank at any time and demand the 90 if we keep going in this series with a 10% fraction we get $1000 created out of 100 but let's just take 190 Well, where did this extra money come from? It came from out of thin air.

3:36You know, the people that favor this stuff, they're very ambivalent about bank runs. You know, if we had a bank run, that would stop it. But then they have laws against bank runs, which supports the system. There was this wonderful movie, It's a Wonderful Life, where they had a bank run. Unfortunately, they took the wrong view on free banking that was sort of supporting the system. and now we have the FDIC. Thank God for the FDIC because they'll stop bank runs. They're ready to print as much money as anyone, any bank needs to stop the bank run. So without the FDIC, we could have a salutory bank run to stop the fractional reserve banking, but with them, it's sort of, with the FDIC, it's sort of, it's sort of, it's sort of, it's sort of, it's sort of, it's sort of, it's sort of, it's sort of, it's sort of, it's sort of, just caught in forever. Now, the people who favor fractional reserve banking, and there

4:34are some Austrian libertarians who do, and they should be ashamed of themselves, they say that, well, suppose people agree to it. Suppose that the person who gave me the hundred bucks agrees to have a demand deposit for a hundred bucks, and knows that I'm only keeping ten dollars in reserve, and suppose that the person that I lend the ninety bucks also knows this. Well, my view is that not all contracts are valid. A murder contract, I contract with Lude and murder David Stockman, that's not a valid contract. Or I agree with Diana Forberge that I'm going to sell her a square circle. Well, that's not a valid contract because there is no such thing as a square circle or a pink elephant or anything like that. So just because people agree to something doesn't make it valid. You can agree There's something more important than contract in the free enterprise ethic, and that's property rights.

5:29And the idea here is that you can have more titles to property than there is property. Suppose there are 10 million cars in New York City. I don't know how many there are, but let's take that as a round number. There are also titles to 10 million cars. Now suppose I start printing up more titles to cars than there are cars. And now we're going to have a clash over who has the rights to these cars. That's not a legitimate kind of an operation. Now, this doesn't mean that you can't have a fractional reserve parking lot, or the airline sometimes overbook, but when you have a fractional reserve parking lot, it doesn't mean that you have a guaranteed parking lot, it doesn't mean you have a demand deposit, it means that you have a lottery ticket. In effect, you have a fishing license or a lottery ticket to go look for a parking spot, Parking Spot. But if we sell 500 tickets for parking spots and only 200 parking spots,

6:25well then the odds are 40% you're going to get one. So what these people are really coming down to saying is that money should be a lottery ticket. They don't have the chutzpah to say that, but that's what it really means, that it's a lottery ticket and that's the basis of our monetary economy, which is rather silly. The second point I want to make or the second topic I want to raise is Milton Friedman and his 3% rule. Now, if you ask Ben Bernanke who is his mentor, who is his guru, who does he channel, who does he look to for inspiration, it's Milton Friedman. And Milton Friedman has got a lot of problems. Murray Rothbard used to say that people specialize in what they're horrible in. Like Milton Friedman is good on minimum wage, he's good on free the trade, he's good on central planning, except in the monetary area, but he's horrible on money, and what does he spend his time on? Money and maybe the educational vouchers,

7:23which he's also horrible on. Milton has this famous three percent rule that the Fed should increase money in such a way that the price level rises by, well actually the price level stays flat, and he expects that the economy is growing by three percent in terms of productivity and therefore the price level will stay flat if the Fed increases it by 3%. Later in his life he had to realize that if that's all the Fed had to do, it would be, you know, any high school kid with a calculator, even without a calculator, could do it and it doesn't leave room for creativity and to show that, you know, you have a PhD and you're at Princeton or something. So the point is that it's silly to ask the Fed to do that because they won't do that.

8:13Now somebody said we're all Keynesians now and David Stockman said that, Nixon said that, that's true, but Milton Friedman also said that. He has a reputation as a free enterprise but he's just a Keynesian. Samuelson quoted him to that effect and Friedman objected and what Friedman said was that when When it comes to the tools of analysis, let me say this again, when it comes to the public policy prescriptions, there are vast differences between us monetarist Keynesians, he didn't use those words, and those then were our fiscal Keynesians, but when it comes to the tools of analysis, quote, we're all Keynesians now, but it seems to me that the tools of analysis Money is a trade intermediary. That's the essence of money, but it's also a unit of account.

9:17And I, when my kids were small, we had a babysitting co-op, and we had five couples, and each couple would babysit for another couple, and then would get a credit so that the other couples, one of the other four, would babysit for us. so that the other couples, one of the other four, would babysit for us. Imagine if there were Milton Friedman in our condominium development who started creating extra chits for babysitting work. It would just drive our little economy berserk in a way that is now being driven berserk. There's nothing wrong with deflation, although if you ask Bernanke, that's the most horrible thing. Look, when computers first came out, they were very expensive, and as they got better and more efficient, the price went down. The same with TVs, the same with air conditioning, the same with a lot of things. There's nothing wrong with a price fall. If we had a gold standard, we would have handcuffs for the people in charge. They couldn't create the

10:18money at the rate that they're doing this. You might ask, why is it that most economists favor the Fed, or at least most economists that work in macro money? And there's been research done on this, I think Larry White and some other people have done research on this, and what they've found out is that the Fed stuffs money down the throats of macro and money economists. They give them prestige, they give them publication in their very prestigious journals, very prestigious because they've got a lot of money to make them prestigious. So the whole economics profession, at least the macro money part of it, which is the relevant parts of these issues, have been bought and sold and support the Fed, which makes it harder to push against them.

11:07Let me talk a little bit about the present depression, and I use that word advisedly. A lot of people realize that the thing started with the Boston Fed. What the Boston Fed found out in 91 or 92 was that there was racism in the Boston banks. Why was there racism? Because black people were not getting as many mortgages as white people. And therefore, it's racism. And therefore, we've got to stop the way that banks were determining who gets a mortgage. And the way banks were determining who gets a mortgage is you have collateral, you have a down payment, you have a credit rating, you have a job, you have a fixed address, Things like that, which was racist, because black people, even of the same income as white people, didn't have as much collateral or credit ratings as white people.

11:57The proof that it wasn't racist is that Oriental people or Asian people of the same level had even higher mortgage acceptability on the part of the bank. So if the banks were discriminating on the basis of any color, it was green, namely they They were acting in a coherent way, namely asking people or asking themselves, is this here a candidate for a mortgage likely to repay or not? And if he's not likely to repay, we're not going to give him a mortgage, and if he is, we will. But this was deemed racism, and then HUD and Freddie and Fannie and the boys or the girls or whoever they are started saying, well, you know, if you banks want to get any favors from us or you don't want to get indicted by us, you know, you're going to have to give loans to everybody.

12:44So you had this liar-loan kind of business. Well, as I say, most mainstream economists realize that this was the start of the crisis, the housing crisis. And then we had the mortgages, which were non-paying mortgages, and now people are underwater with their mortgages. Very few people, David Stockman among them, I mention him because he preceded me, realize that there was another thing going on also, and that's the interest rate. And as David said, and I certainly support him on this, This is a key Austrian insight that the interest rate has a role to play. It has a micro-economic role to play. It's a price of a sort and it relates long-term and short-term. And if it's screwed up, if it's artificially lowered, then long-term investments look better, relatively speaking, than they would otherwise at a normal or at a market rate of interest.

13:34Well, what kind of things are long-term in the sense that either it takes a long time to make them or they last a long time? Well, houses and cars would be one of them. So the crisis, the Austrian sea, was created, yes, by these racist kind of things and giving people free mortgages when they didn't deserve mortgages and they couldn't repay it, but also by messing around with the interest rate, artificially lowering the interest rate, which leads entrepreneurs, improperly, into long-term investments which are not sustainable when And the savings rates of the people are taken into account and which always has to come in and undermine those investments. Ludwig von Mises was once asked, what's the key determinant of a capitalist society from a non-capitalist society?

14:26And he thought for a half a second and he said, capital markets and the stock market. And David was saying that this is very true, that the way the Fed is orchestrating things, The capital market and the stock market, bond market are being misconstrued and interfered with, and this really strikes at the heart of capitalism. If you mess with housing or unemployment, it's bad, but it's more peripheral. This is the very essence of the free market system. Sometimes people wonder, well, you know, should we get rid of the penny? I think in Canada they're getting rid of the penny, in the US they're thinking of getting rid of the penny. My response is, don't get rid of the penny, get rid of the Fed, because the Fed is making the penny worthless.

15:14If you take the hundred years before the Fed was created in 1913, and roughly the hundred years since the Fed has been created, what the Fed was supposed to do is preserve the value of the dollar and reduce the oscillations of depressions and inflations and things like that. But if you look at the hundred years before and after the Fed, the oscillations before for the Fed were very, very minor, whereas the oscillations after the Fed are very major. So they failed in that job. And then if you look at how they preserved the value of the dollar, well, the dollar was worth, say, a dollar in 1913. It's worth something like three or four cents now. So they've dissipated about 96%, 97%, 98% of the value of the dollar. This is why Ron Paul and other people are calling not only to audit the Fed, which is is maybe a good first step, but to end the Fed, let me talk just a little bit about Keynesianism,

16:11which animates everyone. You know, for the Keynesians, if the economy is going too slowly, we have to hit on the gas pedal. If the economy is going too fast, we have to hit the brake. Arthur Burns was once asked, when he was the chairman of the Fed, well, what happens if If both occur, if you have an inflation and unemployment, if the economy is going too fast and too slow and then he said ha ha ha, we'll have to resign, well, they should resign, they should all resign and we shouldn't have any Fed because the Fed is central planning. I mean, have we learned nothing from East Germany and West Germany, from North Korea and South Korea? You'd think what we've learned is that socialism and central planning doesn't work.

16:57But the Fed is central planning of a very important part of the economy, the monetary sphere. Everything that we do, except for water, every interaction, half of it is money. So this is sort of the heartbeat of the economy, and we have the Sovietization of it. It's time we got out of the Sovietization of the monetary system. Let me now talk about immigration. This is sort of a potpourri of subjects. I want to talk about a few different kinds of things. There's a problem among libertarians, should we have free immigration or not? And the obvious problem with free immigration is that if you had free and open immigration and you had a welfare state, Well, then people would come here and get welfare, and that wouldn't really be a very good kind of a system.

17:53We'd be inundated with people, as Margaret Thatcher would call it, the shirkers, not the workers. So people say, well, if you have the welfare state, you can't have free immigration. Well, my answer is, well, get rid of the welfare state. Then we can have free immigration. But still the problem would be, well, then you have masses of people coming here to take My other insight or answer or response to that is, what you have to do is privatize everything. My motto is, if it moves, privatize it. If it doesn't move, privatize it. Since everything either moves or doesn't move, privatize everything. Then if somebody would have come to the country, in this country, they would have to have permission from somebody else beforehand in order to have the right to come there.

18:48See, there are really three things that go on in international trade. One is the free movement of goods, free trade. The other is the free movement of investment, also good. And the third is the free movement of people. And what the critics of open immigration, such as Murray Rothbard and Hans Hoppe, said is that there's a difference between the free movement of goods and the free movement of investment on the one hand and on the other hand the free movement of people. And what's this difference? Well, in the case of the free movement of goods, you have to have two people that agree to it. You know, if I'm going to export a good to you, you have to agree to import it and vice versa. And the same with investment. If I'm going to invest in your oil well in Venezuela, well I think I should do that, but if I were going to do that, You have to agree to accept my investment money to buy a share in your oil company or whatever.

19:37The problem that these people, the critics of free and open immigration, see with immigration of people is that you don't have a bifurcation or you don't have two people agreeing. You just have one guy sort of initiating and he shows up and says, here I am. Well, that's because we don't have full private property. If we had full private property, nobody could show up unless they had some sort of permission to be on someone else's private property and I think that that would solve that problem as best we can solve problems on this side of the Garden of Eden where we are limited to imperfection. Let me talk a little bit about the welfare state. There's a lot of talk now Obama wants the 1% to pay their fair share even though the The top 1% pay, what is it, 70% of all taxes? I don't know the exact numbers, but the 1% pay an inordinate amount of the tax level, and then you have a lot of people that pay

20:38no taxes at all and have the right to vote to get the 1% to give them money. You know, they say that no man's life or his property is safe when the legislature is in session, or that, what is it, the Congress's futures market and stolen goods, well that's what you have when you have overwhelming government and when you have this welfare state ideal. Now what's going on with that, why, why do even economists who are much better than sociologists and much better than literature people on campus at least in terms of adherence to the but even mainstream economists, not Austrian economists but mainstream economists buy into this and support it and provide some sort of veneer or coverage, intellectual coverage for the welfare state.

21:32And what it is, is diminishing marginal utility of money. What does that mean? It's a big word or a big bunch of words. What it means is that you get more utility out of your first dollar than you get out of your last dollar. Your first dollar is for food and things that keep your life going and your last dollar you can light up your cigar with a hundred dollar bill and if you're rich enough because the last dollar means very little to you. Notice that the Austrian view would say that you can't really have cardinal utility of this sort, namely you can't count utils because there are no units of utils, whereas only Austrians insist that the only way of looking at utility is ordinal utility, namely ordering, I like this tie better than this watch or I like the watch better than my pen, but you can't say that I like the tie at 10 utils, the watch at 5 utils and the pen at 1 util

22:29and therefore that this is worth twice as much, the tie is worth twice as much as the watch or anything like that. And you certainly can't have interpersonal comparison of utility where I like the tie at 10 utils and you like it at 5 and therefore maybe I should grab your tie and then utils would be increased, but that's what they're really saying. What they're saying is that if you take $1,000 away from a rich guy who has many thousands of dollars and therefore values the last thousand to a very small amount, and you give that thousand to a poor person and he values it at a great amount, therefore this forced transfer The transfer of income from the rich to the poor really increases human welfare when we count it interpersonally.

23:21And mainstream economics does support this sort of a thing. And as I say, it's only the Austrian School of Economics that would cast great aspersions on this. One, you can't count utils, and two, you certainly can't make interpersonal comparisons. The way that I like to counter this is say, okay, one reductio ad absurdum that I try to use when I'm debating someone on this, I say, well, you know, my opponent here, he's got a suit and tie, I'm sure he's got a house, he's got a car. There are people who are starving in Zimbabwe or in Africa or in Latin America. Why does he have all these things? Why doesn't And he acted consistently with his theories, namely, he's guilty of hypocrisy.

24:09I remember I tried to reductio ad absurdum once against, I was debating someone in environmental economics over overpopulation and I said, my opponent, who's coming up to the lecture stadium, podium in a minute, says there are too many people. We have overpopulation. Well, he has it within his power to reduce the size of the population by one. And the fact that he's standing there shows that he hasn't availed himself of this opportunity. So if he doesn't take his theory seriously, what should he be? It was a hostile audience, but I got booed at that. But that's one way to deal with these people. How do you deal with people who have this view that we should have class warfare and we should take money from the rich?

24:57One way to deal with them is to say, well, money is one thing, but let's talk about something Let's talk about IQ points. Suppose there were a machine where you have a 150 IQ and this guy has got a 100 IQ and you put both of you in the machine and you flip the switch and now you both come out with a 125 IQ, namely a medium point halfway between the 150 and the 100. Would you get in that machine? Would you put your kids in the machine also with What do you think of the idea of forcing everyone into that machine, namely, let's have really egalitarianism, let's have real equality, not just in terms of money, which is superficial, and is based on IQ in the first place to a great degree.

25:42Let's have IQ redistribution. And their answer is, oh, well, that's too theoretical, we can't do that. And I said, but, you know, imagine we could have a machine like that in 500 years, we probably will have a machine like that. Too theoretical. So I said, how about eyes? I notice you've got two eyes. There are people who are blind and have none. Why don't you give them one of your eyes? Now it's true, if you are missing an eye, you don't have good depth perception, you might not be as good a driver or something, but you know, you can live with one eye and the person who's blind would gain a lot of utils by getting one eye, whereas you would lose only that I recommend that to you for your consideration.

26:36I think I'm about out of time, so I'll thank you for your attention.