Honest Money

Harry Browne says that a bank earns its living by taking money in from depositors, and lending the money to its customers or investing it,
that the bank’s gross profit is the difference between the interest it earns and the interest it pays,
and that because a bank generally can earn a greater return on loans than on investment,
it will lend out as much of its money as it dares.
A bank fails when it doesn’t have enough cash available to pay the depositors who want to withdraw their money – even if the bank’s assets are worth enough money to pay everyone eventually.
Matching maturities, LIQUIDITY, the availability of enough cash (or assets that can be converted to cash immediately) to honour all withdrawal requests is the key for a bank, says Browne. To be liquid, a bank doesn’t need to have all its money in the vault.
But it does need to arrange its loans and investments to allow for the promises that the bank has made to its depositors.
The virtue of “matching maturities” – matching one year loans to one year deposits and so on – is a lesson taught in basic college finance classes.
And it is simple common sense. But unfortunately, American banks don’t do business that way. But a bank with mismatched maturities is however bank an illiquid bank, says Browne (1)

Browne does not seem to discuss money creation by banks.

Money creation by banks was outlined by Ludwig von Mises and the outline is still being refined by his student Dr George Reisman.
http://www.georgereisman.com/blog/

Here’s how I would revisit fractional-reserve banking. (2)

Reisman says that it is impossible to understand the extent to which the government has increased the quantity of money without understanding how the government has encouraged the creation of money by the private banking system. Therefore, says Reisman, we must deal here with the question how the government has encouraged the existence of what Ludwig von MISES calls FIDUCIARY MEDIA which set up money and debt like a house of cards or row of dominoes that any breeze can knock over.

Mises gives the name of MONEY SUBSTITUTES and not that of money
to those objects that are employed like money in commerce
but consist in perfectly secure and immediately convertible CLAIMS to money.

For Mises,
MONEY CERTIFICATES = those money substitutes that are completely covered by the reservation of corresponding sums of money.

For Mises,
FIDUCIARY MEDIA = those which are not covered in this way.

Fiduciary media are transferable claims to standard money payable by the issuer on demand and accepted in commerce as the equivalent of standard money but for which no standard money actually exists, says Reisman.

The larger part of our money supply today consists of fiduciary media in the form of CHECKING DEPOSITS
VERSUS
STANDARD MONEY = money that is NOT itself a CLAIM to anything further. It possesses ultimate debt-paying power, in that when it is received, no further claim to be paid is present.
Under a gold standard, standard money is gold. Any paper money that exists is a claim to it.
Under a system of irredeemable paper money – fiat money- the irredeemable paper money is standard money, says Reisman,

One quote, because this may become important in our later analysis, Mises, “Human Action”, third revised edition, p. 434
The term credit expansion has often been misinterpreted. It is important to realize that commodity credit cannot be expanded. The only vehicle of credit expansion is circulation credit. But the granting of circulation credit does not always mean credit expansion. If the amount of fiduciary media previously issued has consummated all its effects upon the market, if prices, wage rates, and interest rates have been adjusted to the total supply of money proper plus fiduciary media (supply of money in the broader sense), granting of circulation credit without a further increase in the quantity of fiduciary media is no longer credit expansion. Credit expansion is present only if credit is granted by the issue of an additional amount of fiduciary media, not if banks lend anew fiduciary media paid back to them by the old debtors. (3)

Ivo Cerckel
ivocerckel@siquijor.ws

NOTES

(1)
Harry Browne, “The Economic Time Bomb”, New York, St Martin’s Press, 1989, p. 10
Many banks have a smaller net worth than you do.
If they tried to pay of all their depositors, they would have little money left/

Browne, p. 47
A banking crisis would touch you much more directly than the other crises.

Browne, pp. 49 – 50
A bank earns its living by taking money in from depositors, and lending the money to its customers or investing it.
The bank’s gross profit is the difference between the interest it earns and the interest it pays.

A bank’s assets are its cash holdings, its outstanding loans (the money owed to it by borrowers and its investments.)
its main liabilities are its outstanding deposits  – money it owes to its depositors.

Because banks generally can earn a greater return on loans than on investment,
it will lend out as much of its money as it dares.
a bank may tie up nearly all of its assets in loans – if it’s confident that only a few of its depositors will want to withdraw their money on any day or in any short period.
A bank fails when it doesn’t have enough cash available to pay the depositors who want to withdraw their money – even if the bank’s assets are worth enough money to pay everyone eventually

Browne, p. 50
§ MATCHING MATURITIES

for a bank, LIQUIDITY is the key
the availability of enough cash  (or assets that can be converted to cash immediately) to honour all withdrawal requests

To be liquid, a bank doesn’t need to have all its money in the vault.
But it does need to arrange its loans and investments to allow for the promises that the bank has made to its depositors.

Browne, p. 51
§ IN PRACTICE
The virtue of “matching maturities” – matching one year loans to one year deposits and so on – is a lesson taught in basic college finance classes.
And it is simple common sense.

But unfortunately, American banks don’t do  business that way
-    this is done in order to increase banks’ profit margins

But a bank with MISMATCHED MATURITIES is an ILLIQUID bank.

(2)
My sources are

Ludwig Von Mises, “The Theory of Money and Credit”, Indianapolis, Liberty Classics, 1980, (the original second German-language edition of this book was published in 1924), pp. 65  and p. 155

Ludwig von Mises, “Human Action – A Treatise on Economics”, Chicago, Contemporary Books, 1966, (originally published 1949), 3rd. rev. ed., p. 432 – 434

George Reisman, “Capitalism – A Treatise on Economics”, Ottawa, Illinois: Jameson Books, 1998, pp. 511-513

(3)
Ludwig von Mises, “Human Action – A Treatise on Economics”, Chicago, Contemporary Books, 1966, (originally published 1949), 3rd. rev. ed., p. 434

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