Thursday, May 12, 2022

In Defense of the Rothbardian Two Bank Reform


In his recent essay for, titled Building a Better Banking System, Alasdair Macleod agrees with the Austrian view that sound money would help prevent a looming "combined currency, asset, and banking crisis", yet challenges the practicality of the "Two Bank" banking reform proposal that was popularized by Murray N. Rothbard in his 1983 book The Mystery of Banking. Macleod instead proposes that the key reform would be to eliminate the limited liability protection for bank stockholders. The prospect of having a bank's owners' personal assets seized to satisfy a bank's depositors would be sufficient to instill discipline and probity in the place of the current moral hazard risk fostered by limited liability and government deposit insurance. The Austrian position is that the "Two Bank" reform would eliminate one source of currency expansion; i.e., the ability of banks and banks alone to create money ex nihilo (out of thin air) via their privilege to engage in fractional reserve banking (FRB). Macleod believes that eliminating this privilege would cause credit to dry up and the economy to suffer. (The central bank's ability to create reserves ex nihilo is the other source of money expansion and is not directly addressed by Macleod or the "Two Bank" reform proponents.)


There is much more to Macleod's essay. It deserves to be read and reread very carefully, for there is much to learn. Before we return to his proposal to remove the limited liability for ownership for banks, let us quickly review Rothbard's "Two Bank" proposal.


What is the "Two Bank" proposal?


Under the Rothbard proposal, banking would be divided into two separate legal entities--the Deposit Bank and the Loan Bank. Funds deposited in the Deposit Bank would be backed one-hundred percent by reserves, whether gold, silver, or even fiat currency. The Deposit Bank would not be allowed by law to lend these funds. The deposit would be a form of bailment, in which the ownership of the property does not change hands. The depositor still owns the amount of his deposit, and the Deposit Bank is merely the custodian. The depositor would use these funds just as he does now--to pay obligations--using any of the modern methods of money transfer such as check, debit card, or reserve certificates issued by the Deposit Bank or even the central bank. Of course, the Deposit Bank would earn its funds only from fees for its services, since it would not be allowed by law to lend these funds to earn interest income.


Macleod considers that these fees would be a major obstacle to public acceptance of the system, since today most checking accounts are free and may even earn some small amount of interest for the depositor. However, Deposit Banks would be offering a valuable service in a competitive environment. The cost of handling mostly electronic transfers of funds is very small, and banks today actual earn money from every debit card transaction that they process. In fact some banks require that the depositor engage in a certain number of debit card transactions each month in order to get fee discounts. In addition, for many years banks have earned substantial fee income for handling their customers' overdraft transactions. Banks also earn substantial fee income from their ATM networks for handling non-customer transactions. As a result for many years banks have been offering free checking accounts with no minimum balance in order to capture what can be substantial fee income. Therefore, there is every reason to believe that checking accounts still would be widely accepted by the general population.


The Loan Bank


A depositor of the Deposit Bank who wishes to put his money to work would transfer some of his funds to the Loan Bank in order to earn interest income. At this point the Loan Bank owns the funds for some agreed upon period of time. The Loan Bank invests these funds--it matters not whether to single projects, such as an oil well, a basket of loans similar to a mutual fund portfolio, or the bank's general loan portfolio--with a promise to return them to the customer with interest.


Two facts become clear. One, lending funds to the Loan Bank, which are further lent to the Loan Bank's customers, does not affect the money supply. And, two, the lent funds carry some risk to the lender (the Loan Bank) and the customer who lent his deposit funds to the Loan Bank. As is the case today, some loans may not be repaid, will be repaid only partially, and perhaps not at the agreed upon time. Depending upon the terms of the agreement between the customer and the Loan Bank, the Loan Bank may absorb these losses with its capital account and repay the customer in full and on time, or the customer may lose all or part of his lent funds and/or not be repaid on time.


Such is the inescapable nature of banking and lending. All loans carry some risk of non-repayment.


Two Essential Reforms


There are two essential reforms that are key to the Rothbardian "Two Bank" system. One, the Deposit Bank is subject to the same commercial code as any other business. It does not enjoy any special protection for using its customers' funds. If the Deposit Bank lent or leased the customers' deposits, it would engage in fraud. Two, the Loan Bank does not enjoy the privilege of engaging in fractional reserve banking, whereby it can create deposit money out of thin air. All loans would be funded out of customer savings. (The Deposit Bank's customer lends funds to the Loan Bank, which further lends these same funds to its borrower. The Deposit Bank's reserves remain unchanged; only the ownership of the funds changes.) The interest rate would balance the demand for loans with the supply of customer savings.


Macleod quotes Ludwig von Mises from "Senior's Lecture on Monetary Problems (1931)" that the danger arises when the central bank intervenes (presumably via deposit insurance) to protect the banks from their own irresponsible lending and that fluctuations in bank credit are behind the boom/bust cycle. The former danger is cured by making the Deposit Bank purely a custodian of the depositors' funds. The latter is cured by prohibiting the extension of bank credit that is not funded by savings; i.e., eliminating fractional reserve banking.


The "Two Bank" reform and Roman Law


Macleod goes to great length to explain the origin of credit in the West as emanating from Roman Law. It is a very interesting discussion and well worth studying. In Roman Law there was a distinction between ownership of property and a duty to repay it, which I understand as the difference in the status of money in the Deposit Bank (still owned by the customer) and the Loan Bank (owned by the Loan Bank but with a duty to repay it according to contract). According to Macleod, these are at the heart of the "difficulties of overturning the entrenched legal position of Roman, or natural law." But it appears that Rothbard's "Two Bank" reform is compatible with Roman Law. Ownership would not be transferred when a customer places funds in the Deposit Bank, but he would transfer ownership of the funds to the Loan Bank and the Loan Bank would have a duty to repay the loan. The risk of non-repayment clearly is with the latter and not the former. It is acceptance of this risk that allows the Loan Bank customer to earn interest. There is no such thing as a risk-free loan or risk-free investment.


Macleod sees one further difficulty of the "Two Bank" reform. Only a fraction of the population own gold or silver; therefore, Macleod fears that most of the citizenry would not be able to participate in the system. First of all, there is no requirement that tying the currency to gold is a necessary step in creating the "Two Bank" reform. In fact, it is more than likely that initially the central bank would still exist and money would still be fiat, with fiat currency used as reserves just as they are used as reserves now. Secondly, eventually Congress could abolish the Fed and distribute its gold reserves among the banks according to their level of demand deposits, thereby establishing a fixed relationship between the dollar and gold. At this point the dollar would simply be a shorthand for a certain amount of gold. Eventually, the term "dollar" could be dropped and the unit of currency would become a certain amount of gold. It's been done before. This was the situation in the US from after the Civil War (1865) to the founding of the Federal Reserve System (1913). The US enjoyed one of its most expansionist periods in its history and no central bank existed at the time.


Regarding Removing Limited Liability Protection


Macleod's proposal to eliminate limited liability protection for banks has much merit. But other businesses enjoy this protection, so why remove it only for the banking business? An alternative approach would allow banks to eschew limited liability in order to attract customers who are not willing to accept as much risk. If the Loan Banks' owners accepted full/unlimited liability, there would be much less (but not zero) risk of non-repayment of funds. Therefore, the Loan Banks' customers must be willing to accept a lower return. Those who want higher returns could open accounts at Loan Banks that have limited liability. The risk of non-repayment of the customers' loans to the Loan Banks would be somewhat greater, because the banks' owners' personal assets could not be accessed in order to repay their customers. In either case I am certain that both Macleod and the Rothbardians would recommend that governments liquidate their so-called deposit insurance protection programs, which are not compatible with any free market approach.




In conclusion, the Rothbardian "Two Bank" reform is compatible with the free market. It would eliminate the source of the boom/bust credit cycle by eliminating the ability of banks to create money ex nihilo via lending. Bank lending (by the Loan Bank) would not affect the money supply, because only savings would be lent. Customer deposits (into the Deposit Bank) would be backed one-hundred percent by reserves, as is compatible with ordinary commercial law. The only bank examination required of the Deposit Bank would be periodic audits to ensure that the bank had sufficient reserves for its deposits. Expensive and intrusive examinations and regulations by banking authorities would be eliminated, because their reason for existence would be gone; i.e., the liquidation of deposit insurance. Much great bank expense would be reduced, and competition eventually would pass this reduced expense along to the public via more services and more interest return. In short, bankers could return to their primary task of being good bankers and not have the additional task of being good followers of ever increasing regulations.


Thursday, April 28, 2022

My letter to the Wall Street Journal re: Debt Forgiveness

 Re: Biden to forgive $238 million in cosmetology student loans

Since when did America become a dictatorship? Isn't Congress suppose to have a say in spending? These loans are made by private banks and are only guaranteed by the government. Can the government simply inform the private banks that its customers need not repay their loans and then the banks must go through the process of trying to get the government to honor its guarantee? And why is the US Department of Education guaranteeing loans in the first place?
This abuse of the rule of law has to stop.
Patrick Barron

My letter to the Wall Street Journal: Why the ECB must end QE and all other market interventions

 Re: A Big Risk Hanging Over European Banks: Leveraged Loans

The cognitive dissonance of the ECB is clearly exposed in its desire that banks make more loans, which they can do only by taking more risk, and at the same time worrying about banks taking on more risk. It is past time for central banks to admit that they really cannot stimulate the economy with monetary policy. What looks like "stimulus" is really nothing more than taking on more risk and all its accompanying evils.
Patrick Barron

Wednesday, March 16, 2022

The Objective Price of Gold

An interesting exercise to determine what the objective price of gold should be in dollars terms is to ask what exchange ratio would be required for the Fed/Treasury to redeem every dollar for gold without running out of gold until the last dollar had been tendered for specie. (The Fed/Treasury claims to have 261.5 million ounces of gold.)

I have been updating a chart to follow this trend for many years now. But here is the bottom line for the Monetary Base, M1, and M2. 
The Monetary Base consists of balances by member banks in reserve accounts at the Fed plus money in circulation.
M1 consists of money in circulation plus checking deposits at banks.
M2 consists of M1 plus savings deposits and money market mutual funds.
Monetary Base: $23,000 ($6.104 trillion divided by 261.5 million ounces of gold)
M1: $79,000 ($20.567 trillion divided by 261.5 million ounces of gold)
M2: $84,000 ($21.840 trillion divided by 261.5 million ounces of gold)
The current market price of gold in dollar terms, per today's Wall Street Journal, is $1,913.
Draw your own conclusions.

Monday, January 24, 2022

My letter to the NY Times re: The link between higher prices and the quantity of money

 From: Patrick Barron

Sent: Monday, January 24, 2022 11:38 AMTo: NY Times <>Subject: The quantity theory of money and higher prices
Kudos to the NY Times for finally connecting the dots on higher prices and inflation of the money supply. Questioning whether inflation of the money supply just might contribute to higher prices is like asking whether over eating just might contribute to obesity. But, at least the NY Times is giving credence to the topic. One of the foundations of monetary theory is The Quantity Theory of Money. Most economists no longer claim a direct and immediate link between prices and the money supply, but acknowledge that over time demand for holding the additional supply of money will wane and will work its way into demand for goods and services, resulting in higher prices. Yet there is an equally erroneous concept at work; i.e., that increasing demand for goods via money printing is good for the economy if done in modest tranches. More money does not, somehow, bring more goods out of hiding, so to speak. More money changes the structure of production away from producer goods to consumer goods. It is as if one decided to spend one's retirement savings on current consumption. The mainstream economists would rejoice that spending had increased. But what about one's retirement nest egg? One's future would look rather bleak.
Patrick Barron
20 McMullan Farm Lane
West Chester, PA 19382
Phone: 610-793-3605

Sunday, January 23, 2022

My letter to the NY Times re: Has Boris Gone Too Far This Time?

 Patrick Barron

Sun 1/23/2022 11:03 AM
  •  NY Times
Dear Sirs:
I'm sure that you are right that it is the hypocrisy of Boris' flaunting of the Covid rules, rules that he himself either authored and/or approved, that accounts for his political and public troubles. But may I offer another and possibly complementary perspective; i.e., that neither Boris nor any of the others at his social events really thought that they were at serious health risk. If you really believed that lockdowns, masks, social distancing, etc. would save your life and flouting these rules put you at great risk of contracting a dread disease, would you party hearty anyway? Now, many do believe that they may contract Covid and die, but many of us think that that is very unlikely. Therefore, we weigh what we consider to be the small risk to our health from breaking the Covid rules against leading a normal life. The difference is that, unlike the prime minister and his staff, we face the real threat of fines and perhaps imprisonment if we are caught failing to comply. This adds another layer of disgust to his actions.
Patrick Barron
20 McMullan Farm Lane
West Chester, PA 19382
Phone: 610-793-3605

Monday, January 10, 2022

Eliminating Legal Tender Laws: A First Step to Sound Money and Financial Truth


Mention the term "legal tender" in polite company and most people will resemble a deer in the headlights. In simple terms legal tender laws grant monopoly status to money, usually fiat, produced by government; i.e., the government's money is the sole medium of LEGAL exchange in the country. Here in America we buy and sell using dollars. In the United Kingdom, the British Pound is legal tender. In Japan, it is the Yen. You get the idea. It isn't impossible to use monies other than legal tender, but using something else is more akin to private, off the books, barter. For example, perhaps I want to buy my neighbor's used lawn mower. I have some British Pounds left over from my last trip. My neighbor is planning a trip to the UK. He agrees to sell me his used lawn mower for some of my British Pounds. However, if my neighbor owned a store that sold lawnmowers, used or new, he would be forced by legal tender laws to use dollars. The revenue and taxing authorities would insist on it. Now, all this may sound perfectly reasonable, but legal tender laws present a huge opportunity for those who monopolize its production to manipulate the currency, primarily to increase spending. Governments suck resources out of the economy by bypassing the natural constraints of seeking a tax increase, always politically unpopular, or borrowing honestly in the bond market, which will drive up interest rates. Government by the people is thwarted, and the increase in the money supply causes vast harm to the economy.


Why Repeal Legal Tender Laws?


Naturally, advocates of eliminating legal tender laws have an obligation to convince the public that it's the right thing to do. Why would any nation, especially the US, want to use any medium of exchange other than the dollar?  Simply put, debasing the dollar allows government to steal from the people. The government prints money out of thin air to balance its ever expanding budget. This leads to vast and dire economic consequences, such as higher prices, boom/bust credit cycles, and transfers of wealth from the early receivers of the new money to the later receivers of the new money. This is the Cantillon Effect, as described by Emile Woolf in his latest essay.


The Path to a Better Money


The next question that the public may ask is what would replace the dollar. The answer is that the dollar would not necessarily be replaced, but it would have to compete for the public's patronage in a free monetary market. It would have to compete not only with other national currencies but also with recently created mediums of exchange, such as Bitcoin and other crypto currencies. In addition, we would expect that commodities such as gold and silver would regain some significant part of the market, especially since these commodities have been used as mediums of exchange for thousands of years until the recent experiments with fiat national currencies protected by legal tender laws.


Alasdair Macleod of has explained why crypto currencies are not suitable as alternative mediums of exchange, although the distributed ledger technology may have applications in a sound monetary regime. Rather, it is most probable that gold and silver would regain their prominence. There is a reason that the term "gold standard" is still used when describing something that is of the highest quality. There are many advantages to gold as a medium of exchange, but the most important are its universal acceptance by people of every walk of life all over the world, the fact that it cannot be counterfeited, and that it is rare. Gold specie itself could be exchanged by private individuals to satisfy major purchases, but for every day transactions the public would find it advantageous to rely upon a trusted third party to safe keep the gold and make it redeemable upon demand through any of the modern methods of money transfer, such as paper check, paper certificates, and digital means. Of course, the government itself could offer "gold dollars". After all, it claims to have over eight thousand tons of gold in its vaults. But government's track record for issuing more receipts for real money, gold and/or silver, than it has in its vaults probably would preclude it from gaining the public's acceptance. More likely, major banks would issue their own gold backed money. The banks could gain acceptance in the market because they would be subject to ordinary commercial law that describes a "bailment". A bailment is a transaction in which someone takes custody but not ownership of a good for the benefit of another. When we take a suit to the dry cleaners, we have entered a bailment agreement. The dry cleaning establishment does not own our suit. It takes temporary custody of it. Likewise when we check a coat at the theater or restaurant. If the dry cleaning establishment sells our suit or the restaurant gives our coat to another party, we can sue for damages and possibly bring criminal charges. Therefore, one's gold dollar account at a major bank must be legally redeemable in specie upon demand. If the bank does not have the gold, the customer can take it to court on a charge of fraud. Even the bank officials and owners could be charged with a crime. Try doing this with the government!


The Consequences


Just as a better mousetrap drives less effective ones out of the market, better money will drive out bad money. Privately issued money will gain more acceptance over time as the public learns that it can trust the issuers not to issue more receipts than specie held in reserve. Not so with government money. Once the public's trust has been lost, it will be impossible for government to regain it in the face of honest competition. It is most likely that bank issued fiduciary media (technically the real "money" is gold or silver in its vault) will be used first for transactions among banks, bond merchants, and large companies. But over time the public will learn that modern electronic money transfer methods are just as reliable for retail use. Then we can expect competition by the big banks to spread rather quickly. Eventually, government's fiat money will be abandoned for whatever one can get in, say, gold backed Goldmoney.comDollars, CitibankDollars, BankAmeriDollars, DeutscheMarks, BarclayPounds, or the like.


The Necessity of Financial Truth


With the government no longer able to print money to satisfy its profligate spending, the reckoning will have arrived. Let us not believe that a reckoning is avoidable. It is not. Nor should we wish it to be. To continue to print money in massive amounts, as the government does now, will lead to a financial and economic collapse. Would we want our doctor to tell us that all is well when his tests say otherwise? Would we want him to recalibrate his thermometer, blood pressure gauges, etc. so that they gave false indications in order that we could continue an unhealthy lifestyle right up to the point of collapse? Of course not. Yet this is a consequence of fiat money; i.e., the true state of the nation's financial and economic health is hidden. On the other hand, sound money reveals the true state of our financial affairs, both private and public, so that we do not unwittingly destroy capital and/or make promises that cannot be met. Furthermore, let us not give false promises that everyone will be spared real hardship in a return to sound money. Those who have relied upon the government to pay their bills will find that not all bills will be paid as in the past.


Real statesmanship will be required to cut government spending and explain the reasons to the public. The real villains will not be those who pull the world back from the financial and economic precipice but those who spent us into this mess in the first place--the Keynesian economists, the Modern Monetary Theorists, the Socialists, and especially the feckless politicians who swallowed the impossible siren songs of these charlatans and forced them on the public in order to buy votes by promising the moon. Let us have the courage to demand the truth, no matter how unpalatable it may be. Eliminating legal tender laws will set the wheels of monetary and economic reform in motion.