no third solution

Blogging about liberty, anarchy, economics and politics

A Belated Reply on Fractional Reserve Banking

April 17th, 2009

A long, long time ago, most likely in response to this statement: “[T]he current system of fractional reserve banking is nothing short of fraudulent. There may be some bad apples among the borrowers, but they are dwarfed in number by the bad apples among the lenders,” Tony inquired:

As you understand it, how much of the problem with fractional reserve banking is the concept and how much is the people who practice it? How, if at all, is your objection tied in with fiat currency?

Let me answer a part of the first question pertaining to “the people who practice it” immediately, I’m working on an essay to address the remainder of Tony’s inquiry which should be finished shortly.

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My primary objection is with the concept of fractional-reserve banking. The people who practice it are a much smaller concern, because unfortunately as my Public Finance professor used to say, “People respond to incentives.” People respond to incentives, no matter how perverted the incentives are made by government. And it is the concept of fractional-reserve banking in government which perverts the incentives. A good many of these people don’t know that it’s wrong. But most of these people can’t think critically.

Case-in-point: over the last decade or so, many brilliant young minds were drawn into what appeared to be lucrative careers in finance, banking, real estate, etc. Many of them are also now out of a job. I know smart people who took jobs in banking or wealth management, or whatever. They took those jobs because they were the best available sources of income at the time. A friend of mine was a real estate agent, he made over $100k/year back in 2003. Bought himself a nice house, had a couple kids, etc. Can’t sell houses any more. Can’t bring home commission checks anymore. I know people in wealth management, now unemployed because there’s no more “wealth” for them to “manage”. They were responding to the bubble that eventually burst.

Given the choice, individuals don’t want to subsidize Wall Street, and see their savings decimated by inflation. That is why governments make sure that individuals don’t have that choice! Despite some arguments based on a misapplication of Gresham’s Law ¹, in any free system where unbacked notes compete with specie, the latter will supplant the former. In some instances, “bad” money may trade side-by-side with good money, but not for long.

The root of that problem is the concept and the implementation of fractional-reserve banking, and its corollary, fiat money, which causes real inflation, and creates inflationary bubbles, which are the illusion of profit that many people chased, exploited, and cashed-in on over the early part of the past decade.

Fractional reserve banking must cause inflation and malinvestment, not necessarily price inflation which is what most mainstream economists mean when they say “inflation,” but real inflation, which is an increase in the supply of un-backed currency or currency substitutes. The very fact that a bank arguably loans (this much is debatable – in fact banks don’t usually operate this way) my deposits to someone else, in order that they may affect a purchase immediately, while simultaneously maintaining the assertion that my money is all still there, is kind of proof by definition. Fractional reserve banking permits banks to profit at the expense of depositors, just as any common counterfeiter profits at the expense of everyone who accepts his fraudulent notes, and everyone else who pays higher prices than they otherwise would’ve, as a result.

On this subject, I’m very Rothbardian. Rothbard argues essentially that interest rates on deposits can not exist, because money deposits are warehouse receipts and not loanable funds. Money doesn’t grow in warehouses any more than it grows on trees in your backyard.

A loan implies transference of ownership in exchange for consideration: either future consideration through interest payments, or current consideration in the form of collateral, or a combination of the two. In exchange for these considerations, the lender forsakes his title, for the duration of the loan, to that amount of money, and accepts the risk that the borrower may default, in return he receives collateral (or not) and a claim against the borrowers future productivity. A deposit, on the other hand, does not imply any transference of ownership. When you place your valuable jewelry in a safe-deposit box, the bank does not pretend to own those belongings. A deposit-banker is merely a custodian², and compensated accordingly for the safeguard of deposits.

For the time being, let me attempt to do a Cliff’s Notes tie-in with fiat currency, the defining characteristic of which is its legal tender status, mandated and enforced by the Government. An individual, having no right to print or otherwise create legal tender³ money from thin air, no group or collective of individuals may be said to have that right, whether they call themselves “The State” or “The Mafia”. This doesn’t mean that you can’t offer anything in exchange, like liberty dollars or doughnuts, but it does mean that you can’t force the other party to accept it in lieu of your obligation. Fiat money, on the other hand, has to be accepted on the white market. It’s backed by nothing (except debt and promises), and redeemable by nothing. This is the medium in which banks trade.

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1. Succinctly, “Bad money drives out good money.” This assertion can only hold where bad money must trade at a face value in excess of its true value in exchange, that is, with the help of legal tender laws.

2. If you drydock your boat for the winter, the warehouse does not pretend to own that boat for any amount of time, he does not claim your boat as an asset in his ledger. He can not sell it and use the proceeds on a business venture, in the hopes that he will earn enough of a return to replace your boat when you come knocking in the springtime.

3. For all debts, public and private. Mandate enforced by a government gun.

Piracy and Property Rights on the Somali Coast

April 14th, 2009

Pete Leeson, whose recent body of work focuses on pirates and piracy, argues that Somali state building isn’t the solution to piracy on the Indian Ocean. Instead, he suggests that the international community should try a game-plan entirely different than the commonplace “law-and-order” or “overwhelming force” approaches. Leeson suggests (and I tend to agree) that a lack of clearly defined property rights are a significant contributing factor to “about 90% of the world’s economic problems,” and that the piracy nuisance is “no exception” to that rule; the tragedy of the commons could be averted if people were allowed to own (and therefore had financial/economic incentive to preserve) these waters. Unfortunately,

Rather than trying its hand at Somali state building,” Leeson argues, “the international community should try auctioning off Somali’s coastal waters.

Oh, Christ. See, this is the sort of argument that gives free-market folks a bad name: The Somali state collapsed, and is now unable to protect or otherwise guard the interests of the once thriving Somali fishing industry. Therefore the international community should step in and sell the “rights” to the Somali coastline.

Sell it to whom?

Do the Somali fishermen have the financial wherewithal to outbid the Korean and Japanese commercial fishing industries at auction, for these “rights” — which they had at one point but the world simply stopped recognizing? Should they have to “purchase” these “rights” — which they had at one point, and the world simply stopped recognizing? This is pretty much a prescription for oceanic sharecropping.

Coase didn’t argue that where property rights are absent or poorly defined, they should just be invented willy-nilly.

On the contrary, The Problem of Social Cost argued essentially that there are indeed consequences to the delineation of property rights, and as such, it very much matters how they are established, defined and enforced. The problem is not a lack of property rights, per se, but rather that the international community at large, simply ignored these rights (European nations, for example, have been dumping nuclear waste along the Somali coastline) as the Somali state collapsed. Therefore, the solution is not to sell these usurped “rights” to the highest bidder, but to simply begin recognizing them, once again.

Homesteading Detroit: On Urban Farming

April 2nd, 2009

Driving through Detroit, past burnt-down buildings, crumbling concrete and peeling paint, testaments to decades of neglect and decay at nearly every intersection, one might be surprised to learn that much of its 138 square miles was once farmland.

Yes, the city that put the world on wheels was once, like many others, dotted with family farms. If you were to visit the Wayne County Register of Deeds, and look through the old plat maps, and the subdivision descriptions, the microfilm images of a surveyor’s drawings from a century ago evidence farms of all sizes, from ribbons to quarter sections. To this day, many of the city’s streets still bear the names of the families who once owned farms on these locations: Brush, Beaubien, Campau, Cass, Meldrum, Riopelle… But instead of farms, or even tenements, tens of thousands of abandoned or otherwise vacant homes, lots, commercial, and industrial properties dot the landscape of Detroit.

At what point does this pattern of failure become evidence of neglect or, more importantly, of abandonment? And what should be done about it?

Could it be farmland again, one day?

The Bloomberg article where I found the image above suggests that “mini-farms are a stopgap measure at best,” noting that one Real Estate Broker “wouldn’t put [his] money in Detroit.” I wouldn’t put my money there, either. But there are thousands of people who are already stuck in Detroit. They don’t have any money at all, and they don’t have anywhere to go. How can they make the most of their situation?

Some people think that the city can be brought back to life through urban farming, a grass-roots sort of movement taking roots across the country, is usually small- or micro-scale farming operations, where individuals (or groups of friends/activists acting in concert) till vacant lots in inner cities, either for produce or for aesthetics.

I think the urban farming movement is a ripe opportunity (ok, no more horticultural puns!) for people to become involved in their communities, however I think the approach is fundamentally flawed: working with the cities that have neglected to be good stewards sends the wrong message. This “compromise” rewards the city’s prior failures. The biggest impediment to urban farming of course, is the City, which sat idly by as land fell into disrepair, neglect, disuse, etc.

The City and its bureaucracies are the last people anyone should have to ask for permission to do anything. Instead, urban farmers should be saying “screw you, City!” and should contest the City’s claim to “ownership,” asserting the principles of abandonment and homesteading, at every possible opportunity. Although these claims would likely be challenged in court, the City should not contest these adverse possessions. Since, as evidenced by the aforementioned “decades of neglect”, the City has no real interest in seeing urban farms (or anything, for that matter!) thrive, it could simply offer these lots to residents on a “homesteading” basis: “If you maintain it, improve it, live on it, etc., it’s yours; free and clear.”

That last condition is crucial, because it practically guarantees that someone will make use of the land. Artificially high barriers to entry preclude most but the most politically well-connected from putting vacant city lands to any viable use. The city clings to properties that are worth less and less each year (indeed some of these parcels probably have a negative value), hoping that someday they can leverage these properties, but in the meantime forcing the burdens of their ineptitude to be borne exclusively by those unfortunate enough to still live within the city limits.

One local businessman wants to make supersized Urban Farms, which, while a hell of a grand idea, is mere economic rent-seeking, and deserves all the scorn worthy of such tactics. Essentially, he wants a bunch of handouts in the form of free or greatly discounted property, in order to profit from a large Factory Farm (or Farms).

John Hantz of Detroit tells the Detroit Free Press for a Thursday story that his plans for Hantz Farms call for converting hundreds or even thousands of vacant parcels in the city for agricultural use.

The Free Press noted that,

Land assemblage remains a key question. Hantz owns several parcels in the city, but the vast majority of the acreage he needs for his project is still either owned by private parties or is tax-foreclosed land owned by the city, county and state.

Hantz envisions the city, county and state donating the land to his project or selling it at a nominal cost. The payback would come in increased tax revenues once the farm is up and running.

-Farm could make Detroit hot spot for fresh food, April 2, 2009

Detroit hasn’t done a god damned thing in three or four decades, deserving of even one thin dime. If the City gives or “sells” parcels to Hantz, it’s only because he promised to pay the city (taxes) a tribute she did nothing to deserve. So many years of neglect, of documented corruption and abject failure should nullify whatever claim to these properties that the city ever had (legitimate, or nay) in the first place. Because the City abandoned these properties, abandoned its constituents, the City should be the very last organization which has any say, any power whatsoever about what becomes of these places.

The city only wants to keep its power, keep or increase its tax base, etc. To promote the development of urban farms (or anything, really), it merely had to allow them. So, if anyone deserves to pick Hantz’s pocket, it’s the disenfranchised masses who still call Detroit “home.” Why should they, having weathered decades of neglect be pushed aside and cast off, in favor of someone looking to make a quick buck?

As Absentee Landlord writ large, the City still “owns” these parcels in the legal sense, and accordingly, exercises a great deal of control over what would-be improvers might otherwise do, although n most important regards, the city has already effectively abandoned these parcels. Understandably, unable to raise enough taxes to pay for the demolition of these nuisances, (why should those few remaining in the city provide, through taxes, a subsidy to those who might be willing to relocate there?) they crumble further. Some of these lots have been vacant for decades. It’s funny, but in a very short amount of time, really, near-vacant lots bearing the footprints, or charred skeletons of once majestic victorian houses, have been reclaimed by the elements. Nature will do what she does, if left alone. (There are several fascinating photo-essays at DetroitBlog, here and here.)

I suggest a radical experiment: try something new for a change. For once, let the solution to “government failure” be anything but “more government.” Let anyone have these lots who wants to improve them for personal use: housing, farming, business, etc. Let them attempt to succeed where generations of government have failed, allow them to provide for their own, and most of all, keep the City’s leperous hands far away from their pursuits of happiness.

Update: Retta Fontana responds at the Strike-the-Root Blog.

The City of Detroit did far more than sit idly by. Decades ago it implemented ordinances that prevented any home from being sold without being inspected and approved by the City.

…To think that the City should be in any way compensated for these abandoned properties is atrocious. The City of Detroit should be paying damages to the previous owners to compensate for the loss of previous value…

I’ve not argued that the City should be compensated; quite the contrary. The fact of the matter is that “the City of Detroit” lacks the financial wherewithal to pay even a modicum of damages to any of its many, many victims. As a corporate/municipal legal entity, there is practically nobody who is (or could be held) personally liable for these damages. Wholesale liquidation of the City’s holdings, and distribution to its remaining victims; well, I could certainly get behind that.