11 of 11 people found the following review helpful:
4.0 out of 5 stars
Banking and Natural Law, September 7, 2010
This review is from: Money, Bank Credit, and Economic Cycles (Hardcover)
This book discusses money, banking and business cycles on legal and economic grounds.
In ancient Greece and Rome, a legal tradition of "natural law" developed. Natural law recognized two varieties of deposits. Demand deposits consisted of money (or other valuable goods) deposited at a bank for safeguarding. The client kept the property rights of the money and the bank charged a fee. With a time deposit, the client lent the money to the bank, which lent it to other clients for a higher interest rate. This meant that the client temporarily lost his property rights. If a bank used the money of demand deposits for lending, investment and speculations, this was punished as fraud and theft.
The canonical ban on usury during the Middle Ages caused the two concepts of deposits two blur in order to find a bypass around the inconveniences of church law. Banks began to lend money of demand deposits, thus starting an odious tradition of "fractional-reserve banking" (as only a few clients withdrew their money, only a small proportion of the money had to be held in cash). Soon legal scholars sought to find legal principles in favour of this blatant breach of property rights (to their credit, some Spanish scholastics of the School of Salamanca resisted this urge). Because of its need of ever larger funds of money, the state legalized the practice of fractional reserves. Early examples of such schemes include the official paper money of John Law in France, which resulted in the government's bankruptcy and ultimately paved the way for the French Revolution.
Fractional-reserve banking allows the banking system to lend the money of demand deposits many times. An examination of banks' balance sheets and journals shows that this leads to inflation and that the money financing the new loans is created "ex nihilo" (out of thin air). Banks thus charge interest for money they created virtually without cost (therefore, some call this practice unlawful "institutional usury"). The Austrian theory of the business cycle holds that fractional-reserve banking inexorably leads to series of financial crises and business cycles. These "fiduciary media" unbacked by base money or gold artificially alters the structure of relative prices, enriching the first recipients and impoverishing the rest of society (Cantillon effect). As additional money can only be lent at lower interest rates, this price for time is distorted, leading to unsustainable investments and more consumption. In summary, then, fractional-reserve banking leads to malinvestments, unemployment and secular impoverishment, punctured by illusory growth. (The best known example is the Great Depression, which was prolonged by Presidents Hoover and Roosevelt.) Because the stages of production are connected by the price of time (interest), the effects on prices, employment and stocks are greatest for the capital-goods industries like steel, mining and construction.
Some scholars have said that crises could be dampened by credit insurance, based on the law of large numbers (class probability). This is impossible, because human beings have free will (case probability) and human action does not follow precise laws (it is inherently unpredictable). Thus derivatives seem to be useless, too. Would not socialism eliminate business cycles? Yes, but only because "the death are immune to diseases," as the result would be eternal recession and misery. Socialism bans private property which is indispensable for establishing market prices; without prices, no economic coordination is possible and chaos is the inevitable result.
The rivals of the Austrian school base their theories on fallacies. Monetarists lack a theory of capital and thus do not see the relevance of the various stages of production. This results in entrepreneurs and time being eliminated. The quantity theory of money (transactions times the price level equals money supply times velocity) is taken mechanistically. But human action is based on ever-changing subjective values, therefore the concept of a "general price level" is invalid. Monetarists' use of macroeconomic aggregates hides the essentially microeconomic nature of economic activity. The GNP (Gross National Product) suggests that consumption is paramount. GNO (Gross National Outputs) shows that investment is paramount, thus demonstrating traditional macroeconomics to be a failure: Boosting consumption does never help the economy, because it diminishes savings (which are the key to growth). Keynesians share these fallacies and add others, especially their concepts of multiplicator and accelerator.
Current discussions concentrates on the issues of free banking and central banking, often ignoring the threads of fractional-reserve banking. Fractional-reserve banking inevitably leads to economic crises. Thus the bankers sought to establish a lender of last resort which would give them money during a so-called "liquidity crisis" (which is only possible because banks cannot keep the money of deposits and lend it simultaneously). The state was in need of the banks and created central banks. These central banks did the banks another favour: Traditionally, banks with too few reserves were more prone to bankruptcy than banks which held to the principles of prudence. Central banks allow the banks to use one unique reserve ratio and thus to inflate the money supply in unison. Besides that, the central bank sets the interest rate and thus distorts the production structure. The impossibility theorem of socialism, stated above, guarantees the impossibility of central banking. Therefore, "stabilization is chaos".
Banking reform should be carried out in three areas:
1. Repeal legal-tender law (let the people choose their currency)
2. Repeal banking regulation (banks should simply honour the law)
3. Oblige all banks to use 100-percent reserves for demand deposits (recognition of property rights)
Demolishing the central bank, revoking all privileges granted to the banking system, and a return to natural law will prevent financial and economic crises. Most probably, people will choose a commodity standard (gold or silver), which will be no obstacle to economic growth as long as state intervention is forbidden.
***
In my opinion, this is a very interesting book. Most books on banking theory do not recognize the legal origins of banking. The author shows that traditional macroeconomics is fallacious. Therefore, a banking reform which concentrates on symptoms only (requiring more equity ore more / better regulation) is doomed to failure. Only the reintroduction of unrestricted property right (preferably via natural law) will suffice. Empirical studies suggest that the Austrian theory of the business cycle is sound. This book appears to be its best and most detailed exposition.
* Concerning the structure of production (capital theory), the author recommends Skousen: "The Structure of Production"
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2 of 2 people found the following review helpful:
5.0 out of 5 stars
Short and Sweet, January 30, 2011
This review is from: Money, Bank Credit, and Economic Cycles (Hardcover)
This book is sound through and through. It provides one of the best explanations on the Austrian theory of the business cycle, or boom bust cycle. I saw one negative review on amazon for this book, I guarantee the person that gave this book 1 star did not read this book, pick it up or touch it. In fact this person, is probably either a socialist, or a Keynesian trying to give a blow to the Austrian approach. With that said, no one could give this book less than 5 stars, this book explodes other explanations out there, nothing else can even touch this book when it comes to explaining credit expansion and it's affects on the economy. This book explains very well the historical violations with the monetary irregular deposit contract, attempts to legally justify fractional reserve banking, the credit expansion process, central and free banking theory, proposals for free banking reform: the theory of a 100 percent reserve requirement, etc. I want leave a long review on each chapter of this book, I think there are nine chapters, and it's certainly not a waste of time, I personally believe you cannot become a serious economist with out reading and studying this book thoroughly, this book should be put into every economists hands, whether undergrad or grad school economists, I promise you once you pick this book up, it'll not let you down!
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