Reader Mail #13 - Honest Stateless Time Deposit Banking

I had an interesting discussion with a user on the Ron Paul Forum via private message. I'm copying it here. (If I'm going to make a detailed explanation for someone, I should keep it and post it on my own blog.)

Communicating by E-Mail, private message (or by comments in my blog) sure is better than communicating in an Internet discussion forum. This way, trolls are banished. I like having full editorial control. My policy still is that all non-spam comments get published.

All of this discussion assumes a gold standard.

Summarizing my definitions (some of them are developed during the discussion below):

I define "money supply" as anything you can walk into a store and purchase something with. Of course, physical gold counts as part of the money supply. In a free market, there will always be a liquid secondary market for AAA paper promises for gold; they will trade at parity for their face amount, plus accrued interest, minus a transaction fee. Therefore, you can walk into a store and purchase something with a trustworthy paper promise for future gold. Trustworthy paper promises for future gold affect prices in the present. Therefore, they count as part of the money supply.

I define "fractional reserve banking with demand deposits" to be the fraudulent system where a fractional reserve bank operates and tells its customers that they have "demand deposits". That is fraudulent, because the bank is technically insolvent at any given instant. If all depositors simultaneously demand withdrawal (a "run"), then the bank will be unable to meet its obligations. In the context of a state, the state will declare a banking holiday to interrupt a bank run. State courts fail to punish fractional reserve banks for their fraudulent behavior. State violence is needed for fractional reserve banking with demand deposits to be a viable business. This paragraph assumes a gold standard. Fractional reserve banking with fiat debt-based money is completely and utterly fraudulent, to the extent that it makes fractional reserve banking under a gold standard seem mostly honest by comparison.

I define "banking where its loans exceed deposits" to be the fraudulent system where a bank issues more receipts for gold than it has gold on deposit. Such a bank is totally fraudulent. In a free market, the customers of such a bank should rush to convert their paper promises to gold for actual gold, discovering the fraud. In a free market, accountants would be assuming personal liability in the event of fraud. This is how the Federal Reserve operated from 1913-1933. The Federal Reserve issued more gold-redeemable Federal Reserve Notes than it had physical gold. Before 1913, the US paper dollar was a warehouse receipt for gold in the US Treasury.

I define "time-deposit banking" to be a bank that tells its customers that they have time-deposits and issues loans. Such a bank is not fraudulent, if managed properly. A time-deposit bank needs to make sure that its loan portfolio matches its future payments to depositors. A time-deposit bank will not experience a "run", because customers can't all simultaneously demand payment. If the bank is sound and has an AAA credit rating, its customers will be always able to sell their deposits for the face amount, plus accrued interest, minus a small transaction fee.

Summarizing my main points:

MY MOST IMPORTANT POINT: Without the state, banking is an honest business. This is a common misconception. It is not banks that are evil. It is the conspiracy between banks and the state that is evil. Unregulated free market competition among banks prevents the Compound Interest Paradox from occurring. In a free market, banks will only be able to charge interest that meets their expenses plus reasonable profits. In a non-free market, banks are able to act as a cartel and raise prices above the fair free-market level, enabling the Compound Interest Paradox to operate.

- This money stuff is really complicated. That's what allows the average person to be totally shafted by the monetary system. People have an inherent assumption that the monetary system is fair. They don't realize that their government would betray them this much.

- Most people don't realize the role a corrupt monetary system plays. Corrupt money is a very effective enslavement technique. Honest money protects individual property rights. Many people agree that taxation is theft. More subtle, and more dangerous, inflation is theft.

- In a stateless society, money MUST be backed by something tangible. Gold or silver are what the free market selected as money before the state started interfering with money. Other metals, such as copper, also work. Barter credits also are workable.

Metal money is best for several reasons. First, metal coins are generally agreed to be valuable. Metal has industrial uses. Second, metal coins are fungible; every .999 fine 1 ounce gold coin is equivalent to every other .999 fine 1 ounce gold coin. Third, metal coins lead to easy counting. If you trust the mint, then it's easy to count a stack of coins and determine the value.

- Under a gold standard, a fractional reserve bank that tells its customers they have "demand deposits" is committing fraud. A fractional reserve bank with demand deposits is technically insolvent at any given time. In a truly free market, this is not a viable business model for banks. State violence is required to protect fractional reserve banks from the consequences of their fraud. State regulation of banking prevents sounder models for banking from emerging.

- Under a gold standard, a bank with time deposits is an honest business. If the bank is careful to balance its loan portfolio with obligations to depositors, it is not committing fraud. I call this honest model for banking "time-deposit banking".

- In a truly free market, a bank cannot issue more loans than deposits on hand. To do otherwise is fraud. In a free market, fraud is detected and the responsible party must make full restitution.

Before 1913, the US government only issued as many paper gold-backed dollars as it had gold in its Treasury. In 1913, when the Federal Reserve was created, it was allowed to print more paper dollars than there was gold in the US treasury. If the US population was properly educated, they should have promptly redeemed all their paper dollars for gold, bankrupting the Federal Reserve.

In fact, paper promises for gold that don't bear interest should NEVER be used, unless it's a warehouse receipt. Why accept a paper promise for gold when you can use physical gold? Legal tender laws forced people to accept paper promises for gold at parity with physical gold.

Imagine if, in 1914, all the newspapers printed: "The USA has adopted an unsound monetary system! A default on the dollar is inevitable! Redeem your paper dollars for gold!" The Federal Reserve would have been stopped as it was created. Of course, the newspapers were controlled by the bankers. In the present, the same fraud by newspapers and TV news is occurring. Why don't newspapers and TV stations report on the unfair monetary system?

- In a truly free market, time-deposit banks will be competing with each other based on the length of the time deposit, interest rate offered, and reserve ratio. A bank with a higher reserve ratio is riskier, but will offer higher interest payments. At one extreme, there would be warehouse services, which offer no interest and charge a storage fee. It makes sense to use a warehouse service, if you are concerned about protecting your gold and you don't want to lend it out. At the other extreme, there would be very aggressive banks; they would offer the best interest rates, but they would also require the most skilled management.

- In the present, there are practically no secure gold or silver warehouse services available to the average person. If you have enough money to open a COMEX account, you can use that, but they practically have a monopoly, their storage fees are high, and you may not be able to access your physical metal during an economic crisis.

- In the present, it is not practical for the average person to use gold or silver as money. Government regulation restricts the supply of gold and silver dealers. Gold and silver dealers are allowed to charge high bid/offer spreads, due to regulation. It is difficult to switch between Federal Reserve Points and gold or silver, or vice versa. Income tax regulations make it impractical to use gold or silver as money.

- In a stateless society, banks will be required to disclose their balance sheets to depositors in order to attract deposits. The average person isn't interested in reading there banks' balance sheet, so there will be accounting associations that certify a banks' creditworthiness. The members of the accounting associations will be assuming personal liability in the event of fraud.

- In a stateless society, time-deposit banking is an honest business. Banking is not evil by itself. It is the conspiracy between banks and the state that is evil. The state regulates the banking industry, driving up prices and allowing the Compound Interest Paradox to operate. The state declares "banking holidays" if a large cartel-member bank is experiencing a run. Small banks that aren't members of the cartel are allowed to fail. The state protects certain fractional reserve banks from the negative consequences of their fraud.

- Paper promises for gold must be convertible to actual physical gold at the maturity date. Otherwise, fraud is occurring. Anyone who is concerned about fraud can ask for their paper promises for gold to be converted to physical gold.

- Interest payments are an incentive against gold hoarding. If a bank is trustworthy, people will prefer to deposit their gold in the bank for the interest payments, security, and convenience. People only rush to convert their paper gold to physical gold when they mistrust their bank. For example, in 1933, US citizens rushed to convert their paper dollars to physical gold, because they knew the US government was going to default on the dollar.

- In a stateless society, time-deposit banking legitimately expands the money supply to meet the demands of trade. People with a trustworthy paper promise for gold can trade as if they had actual physical gold.

- Gold has two prices, an immediate-price and a time-price. Gold has an immediate purchasing price. This is the goods you can purchase immediately with physical gold. The immediate purchasing price of gold should increase slowly over time as the economy becomes more efficient. Gold also has a time-price. The time-price of gold is more commonly known as interest payments. If there is a shortage of physical gold, the time-price of gold will rise.

The immediate-price of gold should be mostly constant. An ounce of gold represents a certain fixed amount of real wealth. This represents the scarcity value of the gold, the value of the gold for industrial uses, and the effort required to mine and mint the gold coin. If the value of economy is a lot greater than the value of the gold, then stateless time deposit banking legitimately expands the money supply to match the needs of trade.

If there is a shortage of physical gold, people will be willing to accept trustworthy paper promises for gold with long maturity dates. Interest payments, the time-price of gold, are the incentive for people to accept paper instead of physical gold.

In other words, time-deposit banks are providing a legitimate arbitrage service. Time-deposit banks create trustworthy paper promises that enable trade.

Without time-deposit banks, the price of gold goes to infinity if the economy grows faster than gold is mined. Time-deposit banks LEGITIMATELY expand the money supply.

Someone with a trustworthy paper promise for gold can go into a store and purchase something exactly as if they had physical gold. Therefore, the trustworthy paper promise for gold counts as money.

If the time-price of gold starts to become too high, then in a free market people will start to choose other things as money. Cheaper metals, such as silver, copper, and aluminum can also be used.

- All paper promises for gold should bear interest. Only a fool would accept a paper promise for gold that didn't bear interest, unless it was a warehouse receipt.

Under a state, legal tender laws force untrustworthy paper promises for gold to trade at parity with physical gold. Legal tender laws force people to use paper promises for gold that don't bear interest.

On the other hand, if you're only holding onto a paper promise for gold for a day or two, then it doesn't pay to calculate the interest. If you hold a paper non-interest-bearing promise for gold, you should immediately redeem it for physical gold and deposit that gold in your bank.

- In a stateless society, a bank can't fraudulently expand the money supply to create boom cycles. People would become suspicious of the surplus of the bank's paper, and ask to redeem the paper for physical gold. A large bank can't fraudulently contract the money supply by refusing to issue new loans. Unregulated small banks would adopt an aggressive reserve ratio policy and expand the money supply. Under a state, small banks are regulated and restricted in their ability to increase the money supply, guaranteeing that large cartel banks have the power to create boom/bust cycles.

There were boom/bust cycles before 1913, but the ability of people to redeem their paper for gold limited the severity of the business cycle. The banking industry was regulated and the large banks acted as a cartel. That is the reason there were boom/bust cycles before 1913. It was not a deficiency in the gold standard; it was regulation of the banking industry. The "free market" didn't fail. The regulated "free market" didn't work, and the reaction was more regulation, which made things worse. Bank regulations are particularly harmful when the regulations were written by the large banks in the banking industry! The large banks intentionally wrote regulations that let them bankrupt small banks! The greatest rate of bank failures in US history was during the Great Depression, which was caused by the Federal Reserve.

- If there really is a shortage of gold, people will start using silver coins as well. In a stateless society, the exchange rate between gold and silver will be set by the market. Under a state, a bimetallic standard fails when the government fixes the exchange rate.

- Even if someone manages to monopolize the world's gold supply, stateless justice systems will fairly rule that monopolizing the supply of physical gold means that other payment methods can be substituted instead. If someone tried to monopolize gold, fair courts would rule that an equivalent value of silver could be used to pay debts.

Under a truly free market, the odds of someone monopolizing the gold supply is small. As they tried to attain a monopoly, interest rates would rise, and the person hoarding gold would miss out on interest payments. A sensible person would prefer to own income-producing assets instead of physical gold.

- A time deposit by a bank really does increase the money supply. If the issuing bank is trustworthy, the person with the time deposit can sell it to someone else for the face amount plus accrued interest minus a small transaction fee. In other words, someone holding a trustworthy paper promise for gold can always sell it for physical gold. This expands the money supply. If all parties are trustworthy, no fraud is occurring.

- There are many systems that are logically equivalent. Fractional reserve banking with time deposits, the bills of exchange system ("Real Bills Doctrine"), and The Social Credit Monetary System with interest payments credited/debited on nonzero balances are all equivalent systems.

- In a stateless society, if someone else wants to open a bank, you can't stop them. If you choose, you can demand physical gold and only use warehouse services, but you would be missing out on interest payments. If you refused to take out loans, you would have a hard time funding your own business.

In a stateless society, someone operating a fractional reserve bank with demand deposits would eventually find themselves faced with a fraud lawsuit.

In a stateless society, someone operating a time-deposit bank is operating honestly. If they manage their cashflow properly and their accountants are skilled and honest, no fraud occurs.

- Under a gold standard, gold coins serve BOTH a monetary purpose and as raw materials for production. Austrian Economics is closer to the truth than any other source I've read, but it still has its shortcomings.

- Under a fiat money standard, there is no social benefit to changing the money supply. Changing the money supply only moves wealth around from one group to another. Arbitrary movements of wealth destroy wealth instead of creating it. Under a fiat monetary system, the issuing authority, at best, can adopt a policy that damages the economy as little as possible.

Even with fiat credit-based money, the government is stealing from everyone else as it spends money into circulation.

With fiat credit-based money, the government must restrict the amount of reserve ratios banks can use. Otherwise, the banks would multiply the money supply indefinitely. Banks would perform arbitrage until the monetary unit reached its fair value, zero.

- Under a gold money standard, there is a social benefit to time-deposit banking. Time deposit banking prevents disproportionally too many resources from being devoted to mining, compared to other activities. Without time-deposit banking, as the economy grows faster than gold is mined, disproportionally too much effort winds up being spent mining gold.

In a stateless society, there's no way to prevent someone else from opening a bank. If they operate honestly, there's no problem.

I summarized all the key points above, but here are excerpts of the PM conversation.

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On the Ron Paul Forum, a user asked me via private message:

I checked out you blog and am somewhat confused. On your "Compound Interest Paradox" page you say:

"The school of 'Austrian Economics' advocates credit-based money instead of debt-based money. There are two separate websites, www.mises.org and www.mises.net. These philosophies are a precursor to agorism. However, they still hold out false hope that the people who control the government can be convinced to switch to a fair monetary system. They fall short of the correct conclusion that government itself is the problem."

What do you mean by credit-based money? Every single paper or book I have read by anyone associated with the Mises Institute has advocated 100% reserve, commodity, market originated money. Is this credit-based money?

Also, most of the more well known 'Miseans' (Rothbard, Hoppe, Block, etc) are anarchists so I'm not sure how they are 'precursors' to agorism/anarchism.

Agorism is a refinement of the Miseans. The difference is that, instead of merely writing on the subject, an agorist is ready to start trading off-the-books and building a stateless society. Here's an analogy. A Misean is a university engineering professor who's never actually built and sold something; an agorist is someone who's actually building something and selling it to customers.

Personally, I think like an agorist but don't act like one. I'm still looking for trading partners. For now, I need to raise the overall education level of the population, to get an agorist community started.

The Miseans falsely say that fractional reserve banking needs to be outlawed. In a truly free market without government regulations, fractional reserve banking is an honest business. If there's no state, you can't prevent people from opening a fractional reserve bank! (read: time-deposit bank) There is no Compound Interest Paradox in a truly free market; a banks' expenses and profits will equal its interest income.

It is not fractional reserve banks that are evil. It is the conspiracy between banks and government that is evil. Government regulation of banking is the problem; it raises prices, limits reserve ratios, limits leverage ratios, and makes it hard for newcomers to enter the banking industry. Without government, banking is an honest business.

Under a pure gold standard (without a central bank), money is credit-based. Money is created when someone mines and mints gold. With "free banking", money is also created when a bank issues a fractional reserve loan; with unregulated banking, banks are unable to artificially expand and contract the money supply. If a bank tries to expand the money supply, it will find customers rushing to redeem its paper promises for gold. If a bank tries to contract the money supply, other banks will issue more loans to make up for the shortfall. This did not happen before 1913, due to regulation of banking and large banks acting as a cartel.

You can also have a gold standard and debt-based money. This is the way the Federal Reserve operated from 1913-1933.

You can also have fiat debt-based money. This is the current system used in the USA and the rest of the world. Money is created when someone takes out a loan, and money is destroyed when someone repays a loan. The problem is that the interest payments are not simultaneously created. There will always be more loans outstanding than money in circulation. Compare this with fiat-credit based money below.

You can also have fiat credit-based money. This is what Abraham Lincoln did with his greenbacks. This is what Nazi Germany did before WWII. This is what the colony governments did in North America in the early 1700s, due to lack of gold. Fiat credit-based money comes into existence when it is directly spent by a government, and is later removed from circulation as it is used to pay taxes. Fiat credit-based money does not have the Compound Interest Paradox built into the monetary system. Also with fiat credit-based money, the market can be allowed to set interest rates without a hyperdeflationary collapse of the monetary system.

If the government is responsible and issues an appropriate amount of fiat credit-based money, fiat credit-based money works incredibly well. Fiat credit-based money was responsible for the incredible growth in Nazi Germany before WWII, even though Germany was economically crippled after WWI.

Fiat credit-based money was partially responsible for prosperity in the colonies before the US revolution. Benjamin Franklin told parliament how wonderful the colonies' monetary system was. The British central bank was outraged. The colonies' credit-based money was regulated and taxed out of existence, due to pressure from the British central bank. Some people say this is the true cause for the US revolution. The British counterfeited the colonies' paper money during the war, and paper money was pretty much discredited at the time the US Constitution was written. By having the new country be on a gold standard, it was like handing the keys to the country to the European central banks, because the European central banks controlled most of the world's gold supply. It took 125 years, but the European central banks eventually overthrew the US government with the creation of the Federal Reserve in 1913. The people who controlled the European central banks were very organized and patient. When they failed to create a central bank in the USA, or had one terminated, they would wait 20 years and try again.

Fiat debt-based and credit-based money requires government violence to succeed. Forced taxation creates a demand for the fiat money. Government courts only recognize fiat money as valid for payment of debts and taxes; the state prevents other justice systems from emerging.

There are several ways money can be created.

1. Under a gold standard with a government, money is created when someone mines gold and takes it to the mint to convert it to official money. This was originally the case in the USA after the revolution, with the "free coinage" acts; anyone could take gold to the US mint and have it converted to official money. (This was a disaster, because around 1776, most of the gold in the world was under the control of the international bankers in Europe. Even though the USA had gained legal independence, it still had monetary dependence on the European banks. Fiat credit-based money was discredited during the US revolutionary war.)

2. Under a stateless gold standard, money is created whenever someone mines gold and casts it into coin or bar form; coins don't need to be government-issued. Of course, since this system is "stateless", this means society has generally accepted that gold is money. People are free to use other forms of money if they chose.

3. Under a stateless gold standard, money can also be created by honest unregulated fractional reserve (time-deposit) banking. "Austrian" economics doesn't acknowledge that, without government, fractional reserve banking is an honest business. In a stateless society, bankers can't rely on government violence to protect them when they commit fraud.

4. With a government and a gold standard, banks can create new money by regulated fractional reserve banking. Here, government violence protects the banks when they do bad things. Banks can conspire to create boom/bust cycles. Large banks can create panics and runs against smaller competitors. Government regulation limits the ability of non-cartel banks to dampen the boom/bust cycles created by the large banks who act as a cartel. The government declares a banking holiday if a politically-connected bank finds itself in trouble.

5. With a government and fiat money, the government can directly spend money into circulation, without borrowing it from a central bank first. This is what President Lincoln did with his greenbacks. Under such a system, the benefit of money creation goes primarily to the government.

6. With a government and fiat debt-based money, the government can have deficit spending, but only if it borrows from the central bank first. Due to The Compound Interest Paradox, eventually, the government's accumulated budget deficit is larger than the money supply. This is the case right now in the USA.

7. With a government and fiat debt-based money, the central bank can create money by repurchasing government bonds. This is how the Federal Reserve's open market operations work. The benefit of the new money accrues primarily to the financial industry and to large corporations. The Federal Reserve creates new reserves, and then fractional reserve banking multiplies those reserve by the reserve ratio, currently 10x, to create new money.

Does that answer your question? Let me know if you still are confused.

BTW, you have to be really careful on the Ron Paul Forums. Pretty much every thread on the Federal Reserve, income tax, or gold standard attracts posts by people who want to defend the Federal Reserve, defend the income tax, or discredit the gold standard. I suspect some of these people are deliberately planted to disrupt debate, but some of them may just be fools.

That same user PMed me again:

FSK said:

3. Under a stateless gold standard, money can also be created by honest unregulated fractional reserve banking. "Austrian" economics doesn't acknowledge that, without government, fractional reserve banking is an honest business. In a stateless society, bankers can't rely on government violence to protect them when they commit fraud.

I dont understand how fractional reserve banking can possibly be legitmate. If a person deposits money in bank and maintains the expectation to receive it bank on demand the instant the bank loans this money to someone else, it has misspropriated it. In fractional reserve banking the bank simply inflates the money supply by issuing additional money substitutes (notes, deposits) above and beyond the actually existing money. A fractional reserve bank is inherently insolvent. If every depositor returns to demand their money, it is impossible for the bank to fulfill its contractual obligation.

Now if the fractional reserve is in the contract, i.e a depositor agrees to the possibility that his money will not necessary be available on demand, there is no fraud. But in this case what makes you think that people 1) would partonize this bank and 2) that non-clients of the bank would accept the bank's notes as payment for goods knowing that what they would receiving is a very shaky claim on some amount of money?

[In retrospect, we were basically arguing definitions. We agreed that time-deposit banking is legitimate, and fractional reserve banking with demand deposits is illegitimate.]

You are correct. Fractional reserve banking coupled with demand deposits IS illegitimate. A fractional reserve bank with demand deposits is technically insolvent at any given instant. State violence is required to prop up fractional reserve banks. In the event of a bank run, the state declares "banking holidays" which allow banks to continue to collect from their creditors while ignoring their debtors/depositors.

Technically, in 1933, when there was a run on the dollar and the Federal Reserve, President Roosevelt should have allowed the Federal Reserve to be forced into bankruptcy. Instead, President Roosevelt declared a banking holiday, forbade US citizens from owning gold, and defaulted on the dollar.

In a truly free market, a fractional reserve bank that told its customers they had demand deposits would either find itself without customers, or it would find itself sued for fraud.

However, fractional reserve banking coupled with *TIME DEPOSITS* is sound. The fractional reserve bank tells its customers that they may only withdraw 1/100 or whatever amount per day. Under normal business circumstances (no bank run), the bank will typically repurchase customer balances for the face amount. If the bank is sound, then other banks will redeem its balances for the face amount as well (perhaps minus a small transaction fee). If other banks start refusing to honor your checks at face amount, that's a sure tipoff to customers that there's a problem.

A free market, without government coercion, will ensure that things are done fairly. Banks would be required to disclose their full balance sheet to depositors and other banks. Common law would dictate that, in the event of a shortfall, a bank's owners and management would be held personally liable.

The old "bills of exchange" system was equivalent to fractional reserve banking with time deposits. Bills of exchange were a promise to pay a certain amount of gold, after a specific lot of goods were brought to market and sold. A merchant sold bills of exchange to fund his operations; they allowed him to receive payment for his goods before they were actually sold, so he could invest in his business. The bills of exchange were sold for less than maturity value; interest payments from a trustworthy businessman were the incentive for buying them. If you defaulted on a bill of exchange, nobody would every issue you credit again. Word of defaults would spread quickly; your reputation would be worthless. Bills of exchange were freely traded, and typically traded for the face amount minus a discount factor based on the time left to maturity; this is where the term "Discount Rate" comes from. Under the Federal Reserve, "discount rate" has another meaning.

The "bills of exchange" system allowed the money supply to be increased beyond the amount of physical gold. The money supply expanded when merchants borrowed to fund their business. The money supply contracted when merchants paid off their debts at maturity. Such a system is perfectly fair. The "discount rate" is set by the free market.

Does it make sense now? A truly free market, without government coercion, would take care of everything.

Let me know if you have any other questions.

This money stuff is really complicated. That's what allows the average person to be totally shafted by the monetary system. People have an inherent assumption that the monetary system is fair. They don't realize that their government would betray them this much.

The same user PMed me again:

But how does a bank actually loan money?

A time deposit is a deposit with a set term that pays interest, e.g 1 year @ 5%. The depositor gives up his ownership of a given sum of money in exchange for a claim on a future amount of money. This is perfectly fine and is a normal credit transaction. Obviously the bank loans this out, services the loan, and earns a profit for its services as a broker/loan servicer. The loan is actually created by creating a demand deposit in the name of the borrower. This is banking with 100% reserve.

But you are saying that fractional reserve on time deposits is somehow different than fractional reserve on demand deposits, and can't see how it is. If the bank has 100 mu (money units) on time deposit and loans loans out 500mu in money substitutes (bank notes) or via deposit creation, it has just inflated the money supply and necessarily become insolvent. You must agree that it is impossible for the bank to make its loans in the actual physical money since it doesn't actually possess it. It must use either notes or deposit creation, which are actually the same thing since the bank must by contract redeem its note or deposit on demand. So we are back to fractional reserve on demand deposits which you have already agreed is fraudulent.

If a bank has 100 ounces of gold on deposit and it issues loans for 500 ounces of gold, then it has committed fraud. The crime will be obvious to anyone who asks to inspect the banks' books. The crime will also be obvious when the people with the paper promises for 500 ounces of gold ask for physical delivery of their gold.

That's the reason why, in a truly free market, depositors will demand to inspect the banks' books, or a trustworthy accounting association will inspect the banks' books. In the event of fraud, the members of the accounting association would be just as liable as the bank.

Before the general population was sophisticated about banking, it was possible for banks to commit such fraud. Government force protected them. The bankers were able to lobby the state for protection.

In the present, the general population is intentionally kept ignorant about banking. However, there only need be a fraction of people smart enough to understand the intricacies, in order to keep the entire system honest.

If a bank has 500 ounces of gold on deposit and it issues loans for 500 ounces of gold, it has not committed fraud. However, the bank does need to match its obligations to depositors with its loan portfolio. If the deposits were 1 year deposits and the loans were 2 year loans, the bank might find itself with a problem. Again, the depositors will expect to audit the banks' books, or will have some accounting association audit the books.

If I have a time deposit for 500 ounces of gold and the bank has loaned out 500 ounces of gold, then the money supply HAS increased by 500 ounces of gold. Why? If my bank is solvent, I should be able to sell my account to another bank for its face amount, plus accrued interest, minus a transaction fee. This is logically equivalent to the "bills of exchange" system.

As long as all paper promises for gold are convertible to gold at their maturity date, no fraud occurs. As long as all loans are backed by actual goods or services, the system works.

The reason it is necessary to expand the money supply via fractional reserve banking is that an ounce of gold represents approximately a fixed amount of real wealth. If the total value of the economy is a lot larger than the volume of gold, you would have extreme deflation if fractional reserve banking were absolutely forbidden; the "market value" of an ounce of gold would become far greater than its actual value.

Under a gold standard, there actually are two prices for gold. The price of gold is the value of goods you can exchange it for immediately; I'll call this the present-value of gold. There also is a time-value of gold. The price of gold is also reflected in interest rates. If the value of the economy is a lot greater than the value of the gold, the present-value of gold should remain mostly constant, while the time-value of gold would increase. Interest rates are incentive for people with physical gold to surrender it to fractional reserve banks. If the banking system is sound, then people will surrender their physical gold. If a bank is unsound, people will rush to redeem their paper promises for gold, and then deposit at other banks. In a truly free market, you can't have all banks becoming insolvent simultaneously. That happened before 1913, due to collusion among large banks and regulation of small banks.

In the pre-1913 gold standard, fractional reserve banks couldn't operate "honestly" by offering only time deposits, because people were accustomed to demand deposits. Large banks could offer demand deposits, because they were the ones who controlled when economic busts occurred.

How can you say "required to"? There is no coercive force to do the "requiring". If you mean that the demands of the participants will be that no one will do business with a bank that doesn't report balance sheets etc then ok.

Yes, the requirement for banks to disclose their balance sheets will emerge due to market forces, not due to regulatory agencies. Without government regulations, would you prefer to patronize a bank that disclosed its books to you, or one that didn't? In the present, government regulations make it unnecessary for a bank to disclose its books to depositors. In a truly free market, market forces will require banks to disclose their books to depositors.

Of course, that's just my prediction. I can't tell what actually will happen until a free market exists somewhere.

The Real Bills Doctrine huh? This is fraudulent the exact same way I showed the fractional-reserve-on-time-deposits was. In order for some investor (i.e banker, etc) to purchase a businessman's "bill of exchange" they must have money to do it. If they pay in a money substitute that claims to be backed by some fixed amount of mus, but is actually not (because the notes are issued based on a fractional reserve) they have committed fraud. It would be impossible for all of them to redeemed.

Anyway you do it, inflating the money supply has disastorous effects for the capital structure of society. When you represent that more savings are available for investment than actually exist, you induce malinvestment by entrepaneurs in projects that seem profitable but are not actually warranted by an increase in the consumers' voluntary savings. This is the origin of the business cycle.

No, a bill of exchange is not fraudulent if it is backed by actual goods and services. A bill of exchange could be redeemed with gold, or it could be redeemed with an equal value of goods and services. I consider the bill of exchange system to be a variation of The Social Credit Monetary System, except that you have interest payments charged/credited on negative/positive balances.

I liked Dr. Antal E Fekete's description of the bills of exchange system. Have you read it? If not, read his description and then ask me again. I haven't written my own post on bills of exchange. Based on his description, the bills of exchange system worked very well before the government destroyed it in 1913. Allegedly, the bills of exchange system worked very well for international trade before WWI, and it never got reestablished after WWI.

If the expansion in the money supply is matched by an expansion in trade, it is not fraudulent. The bills of exchange system (or the Social Credit Monetary System) guarantee that the supply of money equals the volume of trade. Money is created whenever someone produces a good and sells a bill of exchange. Money is destroyed when the good is purchased and the loan is repaid. As long as there isn't a cartel that controls the gold supply and sets interest rates artificially high or low, the system works.

Under the bill of exchange system, the interest rate is set by the free market. Similarly, with unregulated fractional reserve banking, the interest rate is set by the free market.

You don't need to convince me of free markets. I am already a firm anarchist (aside, agorism is not really just a strategy for obtaining a stateless society. It doesn't offer any theoretical difference between your standard anarchism and economics). I don't think that you have established any real difference between the three forms of fractional reserve banking you presented. I think all three are basically the same and illegitimate. All 3 have the exact same economic effects.

In a truly free market, you can't prevent someone from opening a fractional reserve bank. You can refuse to patronize it and only deal in physical gold, if you so choose. Other people will deposit their gold in banks for the interest payments, and they will have an economic advantage over you.

Similarly, in a truly free market, you can't prevent other people from writing bills of exchange. You can refuse to buy other people's bills of exchanges, but you'll miss out on interest payments by hoarding physical gold. You can refuse to write bills of exchange, but that will make it very hard for you to fund your business, unless you already have a large supply of physical gold.

The bills of exchange system developed primarily via free market forces. The bill of exchange system was a great mechanism for individuals to fund their businesses. It was corrupted and overthrown by the state, and replaced with a system of fiat debt-based money.

Agorism is a strategy for overthowing the red market and organizing society better. Other anarchist philosophies say "There should be no state.", but they have no action plan. Agorism says "Do this, and eventually the state will be defeated."

I think that fractional reserve banking with time deposits, the bill of exchange system, and the Social Credit Monetary System with interest payments are all logically equivalent systems. All are sound systems that can operate in a truly free market.

I'm not convinced by your argument that "all forms of fractional reserve banking is dishonest". That's actually a common misconception. Fractional reserve banking is not dishonest in a truly free market. It is the collusion between banks and the state that is dishonest. Government regulations make it easier for the large banks to act as a cartel. Government monopolistic justice means that large banks don't suffer negative consequences of their fraud.

I received another PM:

FSK wrote: If I have a time deposit for 500 ounces of gold and the bank has loaned out 500 ounces of gold, then the money supply HAS increased by 500 ounces of gold. Why? If my bank is solvent, I should be able to sell my account to another bank for its face amount, plus accrued interest. This is logically equivalent to the "bills of exchange" system.

Ok this is where I think you make a mistake. You have to follow the title to the actual money. If you make a "time deposit" with a bank, you transfer your title to the money in question the bank, in exchange for the title to a claim on some future amount of money. The bank becomes the rightful owner of the money. You are in effect loaning your money to the bank. Since the money is now the bank's property it is entitled to do with it as it pleases, including loaning it to someone else. There is NO increase in the money supply in this case. You may be able to sell your claim to another party, but you cannot sell your "account" (as in the actual money) since it is no longer yours.

A fractional reserve time deposit DOES increase the money supply.

Let's work out a full example.

Person #1 makes a 1 year time deposit of 500 ounces of gold at bank ABC at the free-market offer rate of 5%. Bank ABC is AAA rated.

Person #1 has a piece of paper that says "Bank ABC promises to pay 525 ounces of gold one year from now."

Bank ABC has 500 ounces of gold. Bank ABC issues a 1 year loan to person #2, whose credit rating is A, for 500 ounces of gold, charging 7%. Bank ABC has a piece of paper saying "Person #2 promises to pay 535 ounces of gold one year from now."

Bank ABC has not committed fraud.

Bank ABC will make a profit of 10 ounces of gold. This will pay its expenses, plus a profit for its owner, plus an allowance for the possibility that person #2 will default on his loan. There is no Compound Interest Paradox here. The 10 ounces of gold will be spent on expenses and reasonable profits.

Of course, you agree that person #2 has 500 ounces of gold that he can spend?

What about person #1? Suppose person #3 comes to person #1 and says "I need to raise 500 ounces of gold quickly. I have a rental property I'll sell you for 500 ounces of gold." Person #1 agrees that 500 ounces of gold is a fair price for the rental property and buys it.

Person #1 and person #3 go to bank XYZ. Person #1 presents his paper promise from bank ABC. The manager at bank XYZ checks bank ABC's credit rating and verifies it's AAA. The manager says "I'll buy the loan for 499.5 ounces for gold. The offer rate for 1 year AAA loans is 5%, but the bid rate is only 4.9%, so I'm charging you a transaction fee of 0.5 ounces of gold." This is acceptable, and person #1 has a half-ounce gold coin and pays person #3 the full 500 ounces of gold.

Suppose bank XYZ had 499.5 ounces of gold in its vault. Bank XYZ would immediately pay person #3. Suppose bank XYZ didn't have that much gold on hand. The manager at bank XYZ would say "It'll take a week, based on my cashflow, for me to come up with 499.5 ounces of gold for you. Is that acceptable?" If person #3 insists, "I need the gold TODAY", then the manager at bank XYZ will sell the loan to another bank DEF for499.6 ounces of gold. The manager will tell person #3 "You can pick up your gold at bank DEF" and issues a receipt.

The point is: person #1 was able to buy something that cost 500 ounces of gold as if he had physical gold. He did pay a very small transaction fee for selling his loan. In a free market, the transaction fees will be 0.1% or less.

Person #2 had the 500 ounces of physical gold. Person #1 was able to trade his paper promise for gold for actual gold. Both Person #2 and Person #1 were able to trade as if they had 500 ounces of physical gold.

Suppose that bank ABC was having financial trouble. The manager at bank XYZ would say "I'm sorry, I'm only willing to pay 400 ounces of gold for this loan from bank ABC." At this point, everyone would know that bank ABC was in trouble. Person #1 would have a fraud claim against bank ABC, if he believed bank ABC to have an AAA credit rating.

In a free market, the average person would only place deposits at a bank with a certified AAA rating. If a bank had only an A rating, it would be expected to purchase deposit insurance from an agency with an AAA rating.

FSK wrote: As long as all paper promises for gold are convertible to gold at their maturity date, no fraud occurs. As long as all loans are backed by actual goods or services, the system works.

This is only possible so long as the claims-to-money-in-the-future are equal to or less than the actual amount of money in existence.

It also works if the future claims don't all mature simultaneously.

If there really is a shortage of gold, people would be willing to accept trustworthy paper promises for gold instead of physical gold. Interest rates are an incentive for people to deal with paper credits instead of physical gold.

If the shortage of gold is that severe, people will start using other metals, such as silver. If the gold interest rate is 10% and the silver interest rate is only 2%, then people might start using silver as money instead of gold.

FSK said: The reason it is necessary to expand the money supply via fractional reserve banking is that an ounce of gold represents approximately a fixed amount of real wealth.If the total value of the economy is a lot larger than the volume of gold, you would have extreme deflation if banking were absolutely forbidden; the "market value" of an ounce of gold would become far greater than its actual value.

This I don't understand at all. The "value" of money is simply its purchasing power. An ounce of money is worth what it can be exchanged for. There is no difference between the "market value" of money and its actual value. They are one in the same. If the quantity of goods and services available on the market increases, everything else remaining the same, the value of a unit of money will increase, i.e the purchasing power of money will increase. This is NOT deflation. It's just a decrease in price brought about by increasing productivity.

Let's work another example.

Suppose that the only good produced in the economy is a fine suit.

Suppose a fine suit can be produced and sold for 1 ounce of gold. Due to productivity enhancements, a year later, an identical suit can be bought for 0.95 ounces of gold. This is deflation due to productivity gains. This is perfectly normal deflation.

Suppose that next year, people are buying twice as many suits, but the cost per suit is the same. Without fractional reserve banking, the price of a suit would have to crash to 0.475 ounces of gold. With fractional reserve banking, some of the suits will be purchased for 0.95 ounces of physical gold, and some will be purchased for paper promises for 0.95 ounces of physical gold.

Looking at it this way, without fractional reserve (time deposit) banking, holders of physical gold would have made an unearned profit of 100%; their purchasing power has doubled. Further, debtors would have a REALLY hard time repaying their debts.

You need fractional reserve banking to expand the money supply when the economy expands. Otherwise, you have runaway deflation as the economy expands. One reason the gold standard failed before 1913 was that fractional reserve banking was regulated. This limited the ability of banks to increase the money supply as the economy grew. Also, the large banks acted as a cartel, exacerbating the problem.

That user PMed me again:

[detailed counter-argument omitted - It can be summarized as "At no time did the supply of physical gold change.]

You're entirely missing the point. If you have a trustworthy paper promise for gold, you can trade EXACTLY as if you had physical gold. In the above example, the entire exchange among Person #1, Person #3, and his bank could have been handled without exchanging any physical gold at all. The bank gives gold to person #3, which he uses to pay person #4. Due to the incentive of interest payments, person #4 will promptly deposit that gold back in a bank. Equivalently, Person #3's bank could have directly given Person #4 a warehouse receipt for gold, which Person #4 would immediately convert to a time deposit, if he trusted his bank.

In a free market, you won't be able to operate as a bank unless you have AAA credit. Free market competition would make the bid/offer spread on AAA debt collapse to practically nothing. Paper promises for gold would be convertible to physical gold for the face amount, plus accrued interest, minus a transaction fee.

In a free market, you won't have banks conspiring to create boom/bust cycles. The interest rate for AAA debt should be very stable, changing at a negligible rate. In fact, under a pure gold standard, the AAA interest rate would be nearly constant throughout the world; otherwise, people would borrow in one location, lend in another location, and physically transport the gold.

You must be careful to distinguish between claims on present money, and claims on future money. They are categorically different.

They are different. However, in a truly free market, a trustworthy interest-bearing paper promise for future gold can be traded for physical gold with only a small transaction fee. Someone with a trustworthy paper promise for gold can trade as if they had physical gold.

From 1913-1933, Federal Reserve Notes were non-interest-bearing promises for gold. Only a fool would use a non-interest-bearing paper promise for gold when they could use physical gold. Federal Reserve Notes, from their inception, were fraudulent. Under a pure gold standard, interest rates are very small, so the loss of interest is negligible. Unfortunately, once people became accustomed to use non-interest-bearing paper promises for gold as if they were physical gold, a default on the gold redeemability became inevitable.

An interest-bearing paper promise for gold DOES expand the money supply, because the person holding it can trade as if he had physical gold.

The fact that paper promises for gold can be converted to gold DOES affect prices in the present. This presents excessive deflation from occurring if the economy grows a lot faster than gold is mined.

I don't have time right now to delve too deeply into your other "suit" scenario. I can only offer one point. There are so such things as "given costs". A suit does not [i]inherently[i] cost 1oz of money to make.

You are confused again. Gold as money and fiat paper money are inherently different.

Under a fiat money standard, the price of a suit is completely arbitrary. There is nothing preventing the issuing authority from inflating or deflating the money supply.

When the issuing authority accelerates the inflation rate, the small suit manufacturer is late raising his prices and loses to inflation. When the issuing authority causes deflation, the small suit manufacturer who borrowed to fund his business can't repay his debt. Large corporations benefit from inflation, because they have debt at negative interest rates. Large corporations act as a cartel, so they don't have to cut prices much during the deflationary phase of the business cycle.

Under a fiat money standard, the value of the monetary unit is completely arbitrary.

Under a gold standard, the value of the monetary unit has a specific, definite value.

Let's work another example.

Suppose fractional reserve banking were absolutely forbidden. Suppose our economy has two businesses, gold mining and suit manufacturing. As the number of suits produced increases, the price of a suit must drop. This provides more and more incentive towards gold mining. Suppose suit manufacturing grows at 10%/year, but gold can't be mined at a rate that increases the gold supply by more than 2-3% per year. There just isn't that much physical gold! Eventually, lots of people will be mining gold for ores with only 0.00001% purity. The price of gold will be so high that every scrap of gold is worth thousands of suits.

Suppose now that fractional reserve banking is allowed again. If the bank is sound, its paper promises for gold will trade at parity for physical gold. Now, the price of a suit will become reasonably balanced with the effort and rarity of gold. All those people who were desperately mining gold scraps will now go back to being productive suit makers.

An ounce of gold has a certain amount of real, absolute value. It has rarity value and it has value for industrial purposes. Suppose that it was considered fashionable to have gold buttons on your suits?

A fractional reserve bank provides the SAME service that a mining business provides, relative to managing the money supply. Eventually, the rate at which metal is mined or recycled MUST EQUAL the rate at which it is consumed for industrial purposes.

The error in your analysis is that, under a gold standard, gold coins serve BOTH a monetary purpose and as raw materials for production.

Read Man, Economy, and State - Chapter 10 - Money and its Purchasing Power for detailed reasoning on why there is no social benefit whatsoever to a change in money supply.

I glanced at it briefly. The analysis seems wrong to me.

The error is:

It does not consider the possibility that the monetary unit ALSO has industrial uses. Under a gold standard or silver standard, metal coins have a DUAL purpose. They serve as money. They also serve as a raw material for certain consumer goods.

That article assumes that the only use of money is as money.

It does not consider the possibility that a metal monetary unit can be mined from the ground. How do you decide how much labor is allocated to mining? Without fractional reserve banking, a disproportionally high amount of labor can be allocated to mining.

Fractional reserve banking plays a similar role to mining in managing the money supply.

Under a fiat money standard, there is no social benefit to changing the money supply. Changing the money supply only moves wealth around from one group to another. Arbitrary movements of wealth destroy wealth instead of creating it, because the people who work aren't being properly paid. Under a fiat monetary system, the issuing authority, at best, can adopt a policy that damages the economy as little as possible.

A fiat monetary system allows wealth to be transferred arbitrarily by the state. At some point, abusing the state to transfer wealth to yourself become more profitable than doing productive work. At this point, the economic and monetary system collapses in contradiction; everyone prefers to abuse state power to steal, instead of actually working. The most intelligent people are attracted to careers using financial tricks to steal, instead of actually doing productive work. The economic system in the USA is very nearly at the point where it collapses. In the USA, abusing state power to transfer wealth to yourself is BY FAR a more common business model than actual productive work.

Under a gold money standard, there is a social benefit to fractional reserve banking. Fractional reserve banking prevents disproportionally too many resources from being devoted to mining, compared to other activities. Without fractional reserve banking, as the economy grows faster than gold is mined, disproportionally too much effort winds up being spent mining gold.

Another PM from the same user:

We appear to be merely disagreeing on definitions.

I guess I should define a new term. We'll use fractional reserve banking to describe the fraudulent system with demand deposits. I'll define "time-deposit banking" to refer to the honest system.

You define money as "physical gold only". We both agree that fractional reserve banking combined with demand deposits is unsound and fraudulent. We both agree that time deposits coupled with loans is sound and honest. In a truly free market, accounting associations will certify banks as having AAA credit to the general public. The accounting association members themselves will be incurring personal liability in the event of fraud.

I define money as "anything you can go into a store and purchase something with". If my bank is sound, my interest-bearing paper promises for gold will trade very close to parity with gold (plus accrued interest, minus a very small transaction fee). In fact, the transaction fee might be so small that people might not bother charging it.

We both agree that the existence of trustworthy time deposits for gold affects prices in the present.

In other words, the trustworthy paper promises for gold are increasing the money supply! The bank is providing a legitimate service when it issues loans and paper promises for future gold. The bank's profits are not excessive or exploitative, due to free market competition among banks.

Before 1913, the gold standard plus fractional reserve banking was discredited for several reasons. First, fractional reserve banking plus demand deposits is unsound and fraudulent. Second, banking was regulated. Banks could only issue loans up to a government-set reserve ratio. This led to excessive deflation when the economy started growing faster than banks were allowed to issue loans. Third, the large banks acted as a cartel. Most of the gold was controlled by a handful of people. Small banks were regulated, restricting their ability of banks not in the cartel to dampen the business cycles. Small banks also used the unsound practice of fractional reserve banking coupled with demand deposits. This meant that all it took to bankrupt a small bank was a newspaper printing an article that the bank was unsound; this would cause a run and it was a self-fulfilling prophecy. People didn't realize that EVERY bank was technically insolvent.

Time-deposit banking DOES INCREASE the money supply. Time-deposit banks provide a legitimate service. They let people borrow to fund their business. Their trustworthy paper promises for gold trade at parity with physical gold.

Time-deposits affect prices in the present, and they count as money.

Banks do not consprire to create boom/bust cycles. The boom/bust cycle is a logical and necessary result of credit expansion brought about via fractional reserve banking.

You're not up on your history here. I could not find the source, but in the late 19th century, all the big banks circulated a letter saying that they should stop issuing loans. Many small farmers were unable to pay their debts and lost their farms.

If banking were completely unregulated, small banks would have issued time deposits coupled with loans to these farmers, so they wouldn't have to fraudulently lose their farms.

Under the Federal Reserve system, boom/bust cycles are built into the rules of the economic system. No matter what interest rate policy the Federal Reserve adopts, boom/bust cycles are inevitable.

Under a gold standard, with regulated fractional reserve banking and demand deposits, the large banks have the power to create boom/bust cycles.

In a stateless society, any fractional reserve bank with demand deposits will be convicted of fraud.

Under a gold standard, with unregulated time-deposit banking, there are no boom/bust cycles. Boom/bust cycles are NOT a law of nature. They are created by government and the people who control the government, for the specific purpose of confiscating wealth.

FSK said: From 1913-1933, Federal Reserve Notes were non-interest-bearing promises for gold. Only a fool would use a non-interest-bearing paper promise for gold when they could use physical gold.
Not necessarily. A non-interest bearing claim on present money (as in contractually convertible ON DEMAND to physical gold, i.e not a claim on future money) is simply a warehouse receipt. It is entirely up to the individual owner of the money whether or not they wish to keep this money in their cash balance, or loan it to someone else. Both would exist in a free market. Assuming your scenario of widespread credit worthiness the demand for warehouse receipts may in fact decrease.

Federal Reserve Notes were NEVER warehouse receipts. Prior to 1913, the US dollar was a warehouse receipt for gold in the US Treasury. After 1913, the number of Federal Reserve Notes allowed to circulate were greater than the amount of physical gold.

What is your definition of money supply?? Money supply = physical present money. The fact that in your well developed economy an individual is able to easily convert a promise of future money, into ownership of present money doesn't matter. Where is the increase in the money supply? It's not there. You ARE correct though that such a liquid market for claims on future money does have an affect on prices. It reduces the [i]demand for money[i], which given a fixed supply, lowers the purchasing power, i.e "value", of present money. (higher money prices for goods).

I'm defining "money supply" as anything you can walk into a store and purchase something with. If your bank is trusted and has AAA credit, then there will be a liquid secondary market for your time deposits. Free market competition will guarantee that the transaction fee for selling your AAA debt is negligible. Free market competition will guarantee that interest rates will be stable; you won't have the problem of making a time-deposit and then watching interest rates immediate rise 5%, costing you money.

As you said, trustworthy paper promises for future gold can be used to purchase good in the present. These paper promises for gold affect prices in the present.

In other words, time-deposits increase the money supply.

A large company does not benefit from inflation because they are large. They benefit because in the majority of cases they are closer to the head of the line in receiving the new money. The same could be true for the small suit manufacturer if they received the newly created money early on in the process.

A large corporation typically carries a certain amount of debt on its book. This debt is priced very favorably, around 6% in the present. Inflation is 10%-15%, which means that large corporation makes an unearned profit of 4%-9% on this debt, just from inflation.

A small business has to borrow at 8% or more. Plus, the large corporation's size shields it from the effect of the business cycle.

FSK said: Under a fiat money standard, the value of the monetary unit is completely arbitrary. No the value of the money unit is determined by the supply of money and the demand for money

With fiat money, there is no safeguard that prevents the issuing authority from inflating. Your money has temporary value in the present. There is no guarantee that you will keep your purchasing power 10 or 20 years from now.

If you hold physical gold or silver, you are pretty much guaranteeing yourself a 0% return after inflation. Unfortunately, under the current economic system, a 0% inflation-adjusted return may be the best investment available!

The Federal Reserve, by managing interest rates, could choose any inflation or deflation rate it desired.

You should read the Mises Institute link carefully before saying it's wrong.

"One of the most important economic laws, therefore, is: Every supply of money is always utilized to its maximum extent, and hence no social utility can be conferred by increasing the supply of money.

Some writers have inferred from this law that any factors devoted to gold mining are being used unproductively, because an increased supply of money does not confer a social benefit. They deduce from this that the government should restrict the amount of gold mining. These critics fail to realize, however, that gold, the money-commodity, is used not only as money but also for nonmonetary purposes, either in consumption or in production. Hence, an increase in the supply of gold, although conferring no monetary benefit, does confer a social benefit by increasing the supply of gold for direct use. [emphasis added]" - MES, Chap 11

Your arguments seem wrong to me, so I figured the source was also wrong. I've read the Austrian economics stuff before, and that article contained nothing new. IMHO, Austrian Economics is closer to the truth than anyone else, but still short of being correct.

Mining gold does confer a monetary benefit. As the supply of physical gold increases relative to the amount of paper promises for gold, interest rates decrease. Someone who owns a gold mine could issue paper promises for future gold the same way a bank could, potentially taking advantage of high interest rates. High interest rates would therefore be an incentive for increased gold-mining. The gold miner benefits when gold has a high time-price by selling his future production in the present.

As you mentioned above, if the supply of physical gold became so short compared to the amount of paper promises for gold, people would start using other things as money. As interest rates skyrocketed, people would stop using gold as money and start using silver or other metals.

IMHO, a bimetallic standard of gold/silver would be used in practice. A silver coin is the right value for small purchases. A gold/silver/copper standard also works. Of course, in a stateless society, the exchange rate among metals is determined by the free market.

You seem very concerned about falling prices. What is wrong with falling prices brought about by an increase in productivity and an increasing purchasing power of money?

The issue is that, without banking, you can have a deflationary crash if the economy starts expanding rapidly. Banking performs a legitimate arbitrage service by expanding the money supply to meet the needs of trade. The bank provides a service very similar to a miner who sells a futures contracts against his future production.

FSK said:
An ounce of gold has a certain amount of real, absolute value. It has rarity value and it has value for industrial purposes. Suppose that it was considered fashionable to have gold buttons on your suits?

What on Earth is an absolute value? Nothing has as absolute value. Something is valued because there is someone doing the valuing. You can't distinguish between some mystical "abosolute value" and the market value.

Let's consider another example. We have two groups of people living near each other. Group #1 universally agrees that gold is money. Group #2 universally agrees that silver is money.

Suppose that both gold and silver has industrial uses for both groups.

Can Group #1 and Group #2 trade with one another? Of course they can. What determines the exchange rate between gold and silver? The exchange rate is determined by their rarity and their value in industrial uses. The price of gold/silver and the price of silver/gold should be mostly constant.

Gold, by itself, is worth an ounce of gold. When you talk about the price of gold/silver or gold/bread or gold/suit, you have a meaningful number. In a free market, each of those prices should be mostly stable over time. As the economy becomes more efficient, the price of the consumer good should slowly decrease.

The price of gold/labor determines how much effort should be spent mining gold.

Of course, if someone discovered a gold mine that contained 50x as much gold as the existing supply, that would cause a price shock.

When you talk about the price of Gold/FRP (FRP = Federal Reserve Points), you have a division by zero error. Any asset price, quoted in Federal Reserve Points, has a division by zero error. There are only a finite number of dollars in the present, but by the Discounted Cashflow Paradox, the long-term value of any tangible asset is infinity, because the value of dollar tends to zero faster than the interest rate. In other words, real interest rates are negative.

Negative real interest rates make pretty much all other economic analysis meaningless. You need to purchase food in the present to survive to the future; that's pretty much the only reason Federal Reserve Points have a nonzero present value.

FSK said:
A fractional reserve bank provides the SAME service that a mining business provides, relative to managing the money supply. Eventually, the rate at which metal is mined or recycled MUST EQUAL the rate at which it is consumed for industrial purposes.

Why? If supplies of the raw metal remain the same and the demand for them increases, their price will rise.

A time-deposit bank performs a service very similar to a miner who sells his production on the futures market. A paper promise to future gold issued by a bank, and a paper promise to future gold issued by a gold miner, should trade at parity with one another.