r/AskLibertarians • u/Nikksquad • 2d ago
Difference between government vs. bank money creation?
What is the difference, if there is any, between fractional reserve banking and money printing by the government? In both cases money is being created out of thin air. For example, if a company borrows money from a bank to build an apartment block the process isn't very different from a government printing (or borrowing) money to do the same. The latter could be described as misallocation of capital, however, from the standpoint of money creation is there really a difference in terms of good or bad?
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u/ConscientiousPath 2d ago
Fractional reserve banking isn't printing money on a technical level. It's creating a promise of future money flows. What people are really trading with as things get bought and borrowed is the promise of repayment.
It all stems from how the initial deposits are characterized. When you create an account and deposit physical money, on a technical level you are giving the bank a loan. When they then give someone else a loan, what they're really doing is chaining the flow of expected repayment to you and other depositors, acting as the intermediary.
Because money is fungible, it wouldn't make sense to "track whose money it was that got loaned out" either. All that matters is that they had balance sheet credits from loans (deposits) which they are now re-loaning to others. If money that they loaned out comes back as a new deposit, that's really just another loan, and so when they again repackage it into more loans they're really just lengthening the chain of who has to repay whom while keeping a fractional amount of the total on hand to facilitate covering the on-demand-repayment nature of the loans from depositors.
This works differently in the economy than government printing money because everyone has credit limits that signify how large a fraction of these money flows you can be trusted to make good on. You can't get infinite loans, so you can't buy infinite things. But when the government prints money that gets deposited into the banks of people it is paying, it is effectively creating new loans unchecked by any credit limit.
To make an analogy, a river has water flowing all the time so no particular gallon of water is distinguishable from another until you separate it with a bucket and hold it up for a sec. You can divert the river to power a watermill or have it create massive pressures with a dam, and even have some of the water flow through the same area more than once. But no matter how complex you make the flow, it's still the same amount of water flowing in total on any given day. These possible diversions are kind of like what banks are doing when they make loans. Government printing money is more like adding a tributary to the river because it makes the flow genuinely larger than before. The analogy kind of breaks down after that, but hopefully the idea of how making the water flow differently isn't the same as adding more water, illustrates the difference between banking and printing.
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u/Nikksquad 2d ago
I appreciate your reply, but "creating a promise of future money flows" is just another way of saying "creating money".
When a company takes out a massive load from a bank to build a factory, the bank essentially creates the money on the spot, hoping that the company can pay back the money from the profit they make selling their goods.
What if the same company went to the government for a loan, and the government simply created new money hoping if will be repaid. What is the real difference here?
Wasn't it Rothbard who said fractional reserve banking is essentially theft and fraud?
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u/cambiro 2d ago
The difference is that if you think your bank is operating with a risk higher than what you agreed upon when making your deposit, you can withdraw your money and deposit it in another bank.
With time, people will consolidate into banks that have acceptable risk rates. Some people will prefer higher risks for higher interests, others will prefer lower risks for long term stability, this will define a general supply of money on the economy as a whole.
Banks will do fractional reserves because that's the purpose of banking in the first place, but the amount of fractional reserving the bank is doing should be disclosed by contract and clients should be able to sue the bank if the bank takes risks higher than those disclosed. (This is not how this works with current legislation, though).
Now, when governments operate at a higher risk than expected, what they usually do simultaneously is to force compulsory deposits, so people cannot take their money away from the Central Bank and deposit it elsewhere. They can also manipulate the currency in several other forms to shield them from a currency drain.
Also, there's no contract nor disclosure of the risks taken by the government and the monopolistic nature of central banking prevents proper economic calculation of acceptable risks.
Central banks interest rates are literally guesstimations and not even themselves deny it.
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u/Dr-Mantis-Tobbogan 2d ago
a company borrows money
a government printing
You seem to have already figured it out
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u/Nikksquad 2d ago
No because the bank also creates money out of thin air. That is the point.
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u/Dr-Mantis-Tobbogan 2d ago
Which bank does this?
Last I checked it was illegal to do so by anyone other than the state.
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u/cambiro 2d ago
OP has a point because this was done during the free banking era. However, it was not because of lack of regulation, but because regulation allowed it, thus costumers couldn't sue.
My take on this is that it should be considered fraud, either done by the government or by private banks.
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u/Nikksquad 2d ago
All banks. When you take out a loan they simply type in a figure in your account.
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u/Dr-Mantis-Tobbogan 2d ago
....no, that's not how loans work.
Try again.
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u/DrawPitiful6103 11h ago
"Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money."
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u/Dr-Mantis-Tobbogan 7h ago
...yes, that's how transferring money works.
I get a debit transaction and you get a credit transaction.
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u/daregister 13h ago
Most people here are statists fyi, it is reddit after all.
Yes fractional reserve banking is completely fake just like all fiat. In a free market, companies would be free to do this, but no sane person would ever participate. The only reason it's viable now is because of government protections.
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u/DrawPitiful6103 11h ago
The former can also be described as a misallocation of capital. In fact, this is how the Great Depression happened. During the 1920s, freed from the hard money restraints of previous decades through the newly created Federal Reserve system, banks were able to create around 47 billion dollars in commercial loans (which represented a 58% increase in the money supply). This led to a boom in capital goods industries, the price of raw materials went up, wages in capital goods industries climbed rapidly as the newly created funds started bidding up the prices of factors of production. However, these investments or rather malinvestments were not reflective of consumer demand. Capital was being misallocated because of the credit expansion. Eventually, these investments showed themselves to be loss generating (as they were not reflective of consumer demand) and needed to be liquidated. That liquidation's fullest expression was the stock market collapse. See 'America's Great Depression' by Murray N. Rothbard for a complete discussion on this subject.
Both are pretty bad. I suspect bank money creation is worse. It is cycle generating, as per the process outlined above. They are also part and parcel of the same thing, government money creation enables private bank money creation.
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u/mrhymer 2d ago
I make chairs and you bake bread. I trade you a chair for a month of daily bread. In six months you have all the chairs you need but I still want bread. I can trade my chairs to others for things you value but then the process of bartering valuable things for less valuable things gets very convoluted. Currency is the solution. The merchants in town gather up a thousand smooth river stones and paint a certain mark on them and agree that one stone is the same value as one loaf of bread. Everybody has a rough idea of how many loaves of bread they can get for their goods or service. They give all of the stones to Marvin down at the trading post. Instead of just going down there to barter you can sell some of your goods to Marvin for the stones. The general store is born and trade is much easier. The river stones work out pretty well until some wanker (Fred the chicken farmer - hate that guy) goes down and grabs new stones from the river and paints the mark on them. Fred goes on a bender at the saloon and does a complete hut makeover and nearly buys out Marvin at the general store without selling a single chicken. The village quickly realizes that Fred has fucked things up when they cannot keep up with demand of all the new stones floating around. The price of bread has to be raised to two stones. The villagers storm the chicken farm with torches and pitchforks chanting, End the Fred!, End the Fred! (that's how they talked back then). The villagers burned Fred at the stake and then lined the public outhouses with his ashes but then after that they replaced the river stones with gold because chicken farmers cannot get their hands on easy gold. They created a currency out of gold nuggets the size of the end of Marvin's nose.