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Tuesday, February 24, 2009

The Myth of Bank Nationalization

There's been a lot of talk lately about "OMFG!! The banking crisis is really bad! It might be necessary to nationalize insolvent banks!"

It's over 100 years too late to talk about nationalizing the banking system. When the Federal Reserve was created in 1913, that was the functional equivalent of nationalizing the banking system.

Even before 1913, the banking industry was heavily regulated. There are sounder banking methods than fractional reserve banking. "Austrian Economics"-style time deposit banking and warehouse receipt banking are both superior to fractional reserve banking. Even before 1913, those methods were regulated, making them illegal/impractical. State regulation of banking forced banks to operate using unsound fractional reserve principles.

During the Civil War (1861-1865), many laws were passed that effectively nationalized the banking system. These regulations benefited the owners of large banks and other insiders.

Under a gold standard, a fractional reserve bank is technically insolvent at any given instant. Suppose there are 10,000 ounces of demand deposits and 9,000 ounces of loans. The bank has 1000 ounces of reserves. If all customers simultaneously demand withdrawal, then the bank is insolvent.

State regulation required all banks to operate under corrupt fractional reserve principles. At any time, a large bank could force a smaller bank into bankruptcy, merely by publishing a rumor of their insolvency. Large banks frequently kept deposits at smaller banks. They could bankrupt a smaller bank at any time by withdrawing their deposit and then publishing a rumor of insolvency.

With fiat money, you don't have the same problem. Suppose everyone in the USA went to their bank and withdrew their money. What would happen? The Federal Reserve would merely print enough new Federal Reserve Notes to redeem all balances. The fiat monetary system would only be threatened if people started boycotting the Federal Reserve and using real money (gold or silver) instead. As long as you use Federal Reserve Notes as money, the State and financial industry may still steal from you via inflation. State regulations make it illegal/impractical to use gold and silver as money.

The Supreme Court legalized limited liability incorporation in the late nineteenth century. Without limited liability incorporation, there's a natural limit to abuse by fractional reserve bankers. The bank is technically insolvent, *BUT* owners and management are personally liable for any shortfall. Most bankers owned property other than the bank itself. They would be forced to sell their personal property to cover any losses by the bank. This placed a natural limit on dishonest behavior by bank management.

Once limited liability incorporation was legalized, bank management always has a free put option to declare bankruptcy and cheat depositors/creditors. Limited liability incorporation encourages dishonest behavior and aggressive accounting by nearly insolvent banks.

There were "severe banking crises" in the late 19th and early 20th, that were used to justify creating the Federal Reserve. These crises were facilitated by limited liability incorporation and State regulation of the banking industry.

Under a gold standard with no central bank, interest rates are determined by the free market. If someone borrows 10,000 ounces of gold, then interest rates will rise. If someone deposits 10,000 ounces of gold in a bank, then interest rates will fall. Interest rates should be nearly the same everywhere, because otherwise someone would borrow in one area, lend in another area, and physically ship gold. There usually wasn't free shipment of gold between countries. If there were free shipment of gold between countries, then interest rates should be nearly the same everywhere in the world. With an international gold standard, there are no excess unearned profits for currency speculators. With an international gold standard, a natural price arbitrage process guarantees "imports equals exports" over time. In the present, fiat money provides huge profits for speculators, with the cost paid by everyone else as inflation.

When someone borrows money, this is a price signal that interest rates should rise. When someone saves money, this is a price signal that interest rates should fall. There's a natural free market equilibrium. At the free market interest rate, capital is allocated most effectively.

A central bank is a price fixing cartel. Instead of letting the free market set interest rates, the central bank cartel fixes interest rates at a specific level. With an unlimited budget, the central bank may set interest rates at any arbitrary level. For example, the Fed Funds Rate is currently 0%-0.25%, while inflation is 20%-30% or more. The Federal Reserve has an unlimited budget. The cost of the Federal Reserve's open market operations are paid by everyone else as money supply inflation. The proceeds of inflation go to State insiders and financial industry insiders.

Negative real interest rates make it more attractive to finance a business via borrowing, rather than via reinvested profits. It's hard to grow a business via reinvested profits, because your savings are stolen by inflation.

In order to understand the evil of fiat debt-based money, you must understand the Compound Interest Paradox. Fiat debt-based money is more evil that mere constant uniform inflation. Due to the Compound Interest Paradox, banks *MUST* be bailed out out during a recession/depression. Otherwise the monetary system would collapse in hyperdeflation as banks stop issuing loans. Due to the Compound Interest Paradox, banks *MUST* keep issuing new loans to keep the scam going.

The central bank credit monopoly almost always sets interests rates far below the true inflation rate. If they didn't, then the monetary unit would collapse in hyperdeflation as no new loans are issued. This means that real interest rates are negative. However, only insiders may borrow at the State-subsidized rates. If an individual tries to start a business with reinvested savings, then they get ripped off by inflation; their profits are used to subsidize their larger corporate competitors. The central bank credit monopoly gives a handful of financial industry insiders tremendous power. They can ensure a business succeeds merely by loaning it more and more money. Negative real interest rates guarantee that these loans should be eventually repaid, as long as they keep being refinanced.

The central bank credit monopoly effectively nationalizes the ability to finance new businesses. That power is concentrated in a handful of financial industry insiders. If I want to borrow at the Fed Funds Rate, I cannot. I must go through the middleman of a bank, and I must pay a higher interest rate or I can borrow at all. Financial industry insiders may borrow at the Fed Funds Rate, buy tangible assets, and then profit from inflation over time.

It is silly to talk about "Nationalize the banking system!" or "The free market banking system failed in the recent housing bubble!" Free markets and central banks are opposite ideas. It is silly to talk about a "free market banking system" when you have a central bank.

The current economic problems were entirely caused by State regulation of the financial industry. As usual, via "Problem! Reaction! Solution!", the answer is to give the State more power.

The correct solution is never publicly discussed. All the taxes and regulations on money should be repealed. All the taxes and regulations that make it illegal/impractical to use gold and silver as money are immoral. Reform is not going to occur, because too many people profit off the current corrupt system. Complete economic collapse is more likely than reform. If you disapprove of corporate welfare and massive State bailouts of insiders, then agorism is your best protest option.


fritz said...

I will lend you one ounce of gold if you pay me back in 1 year.The interest rate will be 2 ounces of silver..


barry b. said...


What did Andrew Jackson do? Wouldn't renew the charter on the bank and moved all gold deposits to federal banks or something. Anyway I'll have to look it up but I remember reading that Andrew Jackson but an end to central banking for decades after his presidentcy

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