March 19, 2010 § 40 Comments
Folks are constantly suggesting to me, when the subject of usury comes up, that a big part of the problem is fiat currency as opposed to currency backed by gold or some other commodity.
The more we discuss the matter the more convinced I become that they are wrong.
Money is nothing in itself: it is just a medium of exchange which makes it easier for parties to trade than actually trading a camel for a tent. As such it provides a tremendous social good, without which we would live in the stone age. It is perfectly reasonable and good, then, that money is an economic exchange medium provided by and guaranteed by the government.
Commodity-backed currency, though, is actually a wee bit more than just a medium of exchange. Gold, after all, has value in itself, since it is a useful commodity. Fiat currency has no value in itself. Because of this, fiat currency is a more honest medium of exchange than commodity-backed currencies which distort transactions somewhat through the introduction of the commodity itself into the picture. An ideal, transparent, honest transaction of camels for tents just involves the camels and tents; not camels, tents, and gold.
Fractional reserve banking is an entirely distinct matter from fiat currency versus commodity-backed currency. In fractional reserve banking, the bank keeps some amount of money at the Federal Reserve. That bank is then permitted to loan out up to N times that amount of money to borrowers: we’ll call this quantity of money L.
Not everyone needs their cash all at once, and folks are constantly making payments on outstanding loans, so the bank really only has to have L/N extra dollars on hand in order to cash checks drawn on L dollars worth of loans, on average. Figuring out the L/N relationship between these numbers – basically how much cash the bank has to keep on hand as a cushion in its cash flow – is the “fractional reserve” part in fractional reserve lending. (N.b.: the goal here is apprehension (and alliteration), not perfect pedantic pecuniary precision).
So far no usury, and as discussed above fiat currency is actually a better, more honest and transparent, medium for these transactions.
But now we throw in the usury angle, as discussed in previous posts, by distinguishing between asset-recourse loans and person-recourse loans.
When the bank makes an asset-recourse loan, it only has recourse to a real asset in order to recover principal. In essence the bank “owns” a share of the asset and the borrower pays interest for use of the bank’s share of the asset, over time also buying out the bank’s ownership share. It’s all good: nobody has created money out of nothing or cheated anyone.
Notice that this is true even if the money is spent on something other than the asset to which the bank has resort: the owner in essence sells a share in the asset to the bank, and uses the proceeds for something else. Everything is still all good.
But when the bank makes a person-recourse loan, it has recourse to the person for the principal no matter what is done with the money. If the person spends the money on wine, women, and song, that money really came from nowhere. There is no real asset involved backing that money; just the person’s putative future ability to raise money to pay off the loan.
So the problem with fractional reserve banking as presently practiced isn’t fiat currency, and it isn’t that loans are made which exceed the amount of cash held in reserve. Neither of those is in itself the least bit dishonest or unfair.
The problem with fractional reserve banking as presently practiced is that some of the loans made in fractional reserve banking are usurious loans, because they involve recourse to persons, rather than assets, for principal. As usurious loans they steal from others, robbing buying power away from the currency itself, doing injury to the borrower and swiping an increment of buying power here and an increment there from the non-usurious transactions taking place at the same time, for the benefit of lenders.
Or at least that is my current provisional theory.