14. “Free Banking and the Structure of Production: A Contrast of Competing Banking Systems”
by Dan Mahoney
Abstract: In this paper we extend an argument originally developed in Hülsmann (2009) to analyze changes to the structure of production that occur when the demand for money changes. In particular, we show that Hülsmann’s argument, which contrasted such changes under commodity and fiat systems, applies as well to the case of 100% reserve systems contrasted with fractional reserve free banking systems (FR/FB). Specifically, we argue that under a 100% reserve system, the structure of production will change in response to a change in demand for money, and that it will not under FR/FB. In fact, such changes are beneficial. Since one of the central arguments in defense of FR/FB is precisely the fact that it avoids such changes to the structure of production (at least more readily than 100% reserve systems), we conclude that this argument amounts to comparing different mechanisms for attaining different equilibrium states, and hence is invalid as a defense of that mechanism (FR/FB) as such.
![[RSS Feed]](http://libertarianpapers.org/wp-content/themes/journalist/images/rss.gif "Subscribe to the Libertarian Papers Site Feed")
![[iTunes]](http://libertarianpapers.org/wp-content/themes/journalist/images/itunes.png "Subscribe to the Libertarian Papers Podcast with iTunes")
![[CC Attribution 3.0]](http://i.creativecommons.org/l/by/3.0/us/80x15.png)
sooo…. Supporting FR/FB or not? I’m interested in the Austrian position on monetary reform, specifically regarding fractional reserve lending.
I have some comments/questions on this article that I wonder if anyone could help me with.
It seems that within the theoretical framework described in the article two things will have to happen for the economy to adjust to a change in demand to hold money
- Prices to fall
- The production of the money commodity to increase
FRB theorists would see this model as having the following issues:
- When prices have to fall , then during the transition period the economy will be out of equilibrium, with PRI above the natural rate, leading to potentially viable business projects being liquidated
- Increased commodity money production moves resources away from areas that potentially provide more consumer utility.
In the FRB model profit-maximizing banks pick up signals from the changing velocity of money when demand changes and increase lending to accommodate it. The allows the economy to adjust to the new equilibrium (reflecting any changes in PRI due to the changed money demand) without either a generalized fall in prices or increased gold production.
In a situation where the increased demand for money is temporary (perhaps due to a short-term economic shock.) then under a FRB system loans would expand when the crises hits and then be withdrawn during the recovery, while under 100% reserve system prices would initially start to fall and investment move towards gold-production and then be reversed out again when the recovery comes.
Given the above – can someone explain what (other than perhaps a suspicion that the underlying mechanism that allows the FRBs to adjust the money supply is faulty and/or too risky to be viable) would make the 100% reserve solution preferable?