 So I will talk about the question, is free banking in quotation marks stable? And I will build on Professor Hörbner's lecture that explained already the fundamentals of banking, infection reserve banking. The topic is of course a very hot topic. There are people that actually get very nervous when they talk about it. They behave like little kids. And it is important because well-intentioned libertarians and actually good economists are misled in this question. They are confused on the issue. So I think it's highly important that you are here today. What we will do? We will define free banking. We can see if free banking is really free and ethical. We will discuss clearing as a limit for credit expansion in infection reserve banking system and if coordination is possible. And then why infection reserve banking credit expansion is harmful even though some people say the opposite. So why the quotation marks? Because the normal definition that many employ is they say free banking is a fraction reserve banking system without a central bank. So the free consists in saying without a central bank. But of course the important underlying question is is it free in the sense that property rights are protected by the legal system? Otherwise it would be saying something like free taxation. It would be like oxymoron. It could be. And it's very important to point out that valid contracts must comply with legal principles. Many libertarians just intuitively and I guess it is very intuitive. They think that every voluntary agreed upon contract is a valid contract. So if people do it voluntarily so it must be okay in a free society. However there are voluntary agreed upon contracts that are not valid and that would not be enforced in a free society. Let's say I hire Tyler for $1,000 to kill Jason. We voluntarily agree on the contract. It's a voluntary agreed upon contract but is it a valid contract? It's a question. Let's say I pay the $1,000 to Tyler and Tyler then says no I won't kill him. And then I go to court and say hey I have a valid contract and force it. And force the contract court. Do you think in a free society the contract would be enforced? Probably not. Another example of voluntary agreed upon contract would be I see a three year old boy on the street and say hey I have a cool plastic car to play with. It's yours. You pay me $1,000,000 when you turn 18. Sign this for me. And of course the boy voluntarily thinks that this is the best deal of his life. Signs it. Probably would not be enforced either in a free society. Last example of voluntary voluntarily agreed upon contracts that are invalid are those that are impossible to fulfill. If I tell Tyler I sell you a squared circle for $1,000 and he pays me $1,000 and then I don't deliver. He goes to court and says court please enforce this contract. Just hard to enforce. Or if someone sells, if I sell Tyler a weekend trip to Pluto. The planet Pluto when the NASA sent. Just next weekend I sell you a trip back there. So it's impossible to fulfill. So in Latin the principle is ultra posse nemo obligatur. Which means that you cannot enforce something that is impossible to fulfill. Other legal principles are pactas and savanda. Contracts have to be fulfilled. Or in Dubio pro reo which means that the accused is their stout for him. You have to prove that he's guilty. He's innocent for a priori. So for a valid contract legal principles must be fulfilled. That is even though there may be voluntarily agreed upon the legal principles must be fulfilled. So what are the legal differences between deposits and loan contracts? In a deposit contract the essential element of the contract is the custody and safekeeping. People want to maintain full availability of their deposited goods. That's the intention. That's the purpose. Subjective purpose in these contracts. While in a loan contract it's the opposite. I don't want to maintain maintainability. I transfer the availability of the good. Of money for example for a certain time to another person and I lose the availability. So in a demand deposit contract or in a deposit contract there is no term. Because it's available at all times. Implied in the custody and safekeeping. And in the loan contract of course there is a term. There's always a term. Because I relinquish the availability of the good for a certain time. If there would be not a term it would be a gift. And the obligation stemming from the essential elements of the contract is in a demand deposit contract is to maintain full reserves, 100% reserves at all times. Otherwise the intention, the purpose of the contract would not be fulfilled. While in the loan contract the person who receives the loan has only the obligation to return the good at the end of the term plus the agreed upon interest. So now we can assess or interpret fraction reserve banking. There are several possible interpretations depending on the subjective beliefs of the parties. So the first one is that the depositor he wants to maintain full availability. He wants to always be able to use his money. The money forms part of his cash balance that is deposited at the bank. The banker knows that it is a deposit. He knows that he should maintain 100% reserves. But secretly he takes part of the money and lends it out for example. This historically has been the origin of fraction reserve banking. This is plain fraud. Because the banker pretends that he maintains 100% reserves and he does not. This is how fraction reserve banking arose. Then the next interpretation is more favorable to the banker. Because here of course the motivation of the depositor is the same. But the banker receives the money as if it would be a loan. He thinks it's a loan. He thinks that the depositor gives him the money as if it would be a loan and he could use it. So this is an example of maybe other people today who actually think that their money is in the bank. And it's not. And there we have no meeting of the mind. Because one party thinks the banker has 100% reserves, has my money there in the bank. It's physically there. And the banker thinks he gets a loan that he can use as he wishes. So there's no valid contract either. Or there's no valid contract because there's no meeting of the mind. And these two parties have purposes that are incompatible. The next interpretation is what many people have today. And what three bankers or fraction reserve bankers allude to is that the depositor, he wants to maintain full availability. Most people today want to have full availability of the money that is on their checking account. But they know that to some extent that the banker will use it. They know that it will be used. And the banker receives the money as if it would be a loan. So then here we have a case of an incompatible contract. The causes, the motivation of the contracts are incompatible. And it's null and void because of that. Why is it incompatible with the motivation? Because if the depositor wants to maintain full availability, if this is the purpose of the contract and this is the purpose of the deposit contract, this is incompatible with the banker using the money. And moreover, even if the motivations would be compatible, it's impossible to fulfill the contract. The depositor cannot have full availability if the banker uses the money because it's physically impossible that one monetary unit is used by two persons at the same time. So this is about the legal assessment of Fraction Reserve Banking. So you see the Fraction Reserve Banking violates legal principles in the same way as I contract Tyler to kill Jason or with the boy or the squared circle contract violates legal principles and only exists because the government has legalized this practice, this legal aberration. So this on free banking in quotation marks, a real free banking without quotation marks of course implies that property rights are upheld and there are only legal valid contracts so there's full reserve banking. And full reserve banking is stable in the sense that bank runs are no problem. If all depositors come at the same time, they will always get the money. Of course a bank can go bankrupt. For example, if a bank has a loan business and borrows on the one hand and lends on the other hand and the lenders cannot pay back. So they have bad loans or it's mismatching maturities at ball shorts and lends long and cannot renew short term loans. So it can go bust. But if it has full reserve, the depositors will always get the money. Who lose the money are the creditors and shareholders. And it's stable also in the fact there's no domino effect in the sense that one if one bank goes bust, this does not endanger the stability of other banks. It does not induce depositors to run on other banks. And even if it would, they would not fall due to this as is today. Today if one bank without central banks fails, then probably other banks will also fall in a domino effect. So is fraction reserve banking stable without a central bank? Mises writes in Human Action, the issuance of fiduciary media no more matter what its quantity may be. Always, always sets in motion those changes in the price structure, the description of which is the task of the theory of the trade cycle. Of course if the additional amount issued is not large, neither are the inevitable effects of the expansion. So Mises clearly says that if there's credit expansion, which is possible in the fraction reserve banking system, there's always a tendency towards the business cycle. He says, okay if it's only a little bit then the effects are not so strong, but there are always these effects. So when a bank appropriates the deposited funds and lends them, there has been no additional real savings. But there are new investments even though there are not more real savings. There is an unsustainable boom as you have heard this week more than once I guess. And in the bust then the assets of the banks lose in value. There are losses for the banks and then the depositors and bank customers lose trust in the bank and they come to withdraw their deposits, ultimately causing a bank one. So in other words the fraction reserve banking system itself sets into motion a process of boom and bust and in the bust they ultimately get problems, first liquidity and then solvency problems. So in a sense the fraction reserve banking system shows the seeds of its own demise because it causes a boom and a bust and in the bust it gets into problems. Therefore the answer is no. Now to the question if credit expansion is limited by free banking and here we will talk about the clearing mechanism. So let's say we have two banks Bank A and Bank B, they have both reserves of 100 gold ounces for example and then they engage in credit expansion. One bank issues a bank note of 100 gold ounces, the other one only of 50. It goes to the customer of Bank A, the Bank A customer uses the 100 to buy something from this guy, the customer of Bank B and the Bank B customer uses 50 ounces to buy something from the green one. So what happens is he brings his 100 to his bank and the 50 to his bank and deposits the money there. Bank A has now the bank note from Bank B and Bank B has now the bank note from Bank A and then they make a clearing, they make a clearing of reserves and the difference is of course that Bank A has to pay 50 gold ounces to Bank B. This is the clearing. So fractions of bankers say that this is the limit on credit expansion because if one bank expands more credits than the other, more credits than the others, like in this example the bank that expands credits more than the other loses reserves and if it continues to lose reserves it will go bust, it will be illiquid at some point. So this is the limit for credit expansion. Of course there is no limit if they do it in a coordinated way because then no one loses reserves if they both expand 100. Then they flow to the other bank and then do a clearing. The clearing is no reserves flow from one bank to the other. The only thing that is happening is that the reserve ratio of both banks is falling but there is no loss of reserves. So there is no limit for credit expansion if there is a coordinated credit expansion and this must not be simultaneously, this can also be a thick thug. So if you go back to the first example where one bank expands 150 and then before clearing the bank that expanded less says okay then I also expand 50 more so it can be in this way. Now the last line, so the last line of the fence of fresh reserve bankers is then they admit cooperation is possible but it's not very likely. It would be a cartel, it would be a collusion and in a free market this is unstable. Without a central bank it is unstable and of course true that it is more stable with central banks that is why fractions of banks ask the government to install central banks. Okay, what about this argument of cartels that cartels are unstable? Here we have Mises, he says the same thing the quantity of fiduciary media in circulation has no natural limits so the credit expansion has no natural limits if it's done in coordination. If for any reason it is desired that it should be limited then it must be limited by some deliberate human intervention that is banking policy. Okay, so is fractional reserve banking unstable? And here the answer is that the collusion in our cartels in the private sector is unstable but here we have a violation of property rights as we saw before and we have to start with the legal analysis. The collusion between criminals is more stable. We have the mafia for example in different regions of Italy cooperating, colluding, separating their regions for a long time is quite stable. It's quite stable. Or imagine two counterfeiters that we have two counterfeiters they both know each other but they don't go to the police. Why not? They are criminals cooperating. They are criminals cooperating and this can be stable. This can be stable. Or governments, governments of different countries. So if one government is more precious than the other higher tax rates people and companies would leave the country with the higher taxes to live in the country with the lower tax rates. Until in theory all people have lost the country which is more oppressive to live in a country which is less oppressive. So the more oppressive states would collapse. This is a similar argument. So if one bank is more aggressive with credit expansion or if one government is more aggressive with taxation the government will lose taxpayers, will lose citizens to countries that are less aggressive with taxation. Here we have fraction reserve banks that are more aggressive with credit expansion they will lose reserves to banks that are less aggressive. And in practice we see that governments, more oppressive governments do not collapse in this way. So catalyzation is there possible also even though it's not formal. The overall interest of all governments is the same to increase in size and to kooloot actually there's a tendency towards the world government and there has been a long run growth of government. So there's no limit. In the same sense there's no limit for credit expansion theoretically. There's no limit for government growth. Of course the way banks exploit people is not taxation but credit expansion. And it's not outright violence but just the use of invalid contracts. And the limits for credit expansion at the end is then hyperinflation which the banking system does not want. And for the governments the limit for oppression is revolution. So the conclusion is that the cartel of criminals can be stable since they exploit their customers and the customers cannot go so easily to a non-criminal organization if it does not exist. So there's a strong incentive to kooloot. Okay, let's now turn to George Selgin's argument that fractional reserve banking would be in fact beneficial and would not be harmful. He argues that fractional reserve banking keeps free fractional reserve banking so fractional reserve banking without a central bank keeps MV constant. MV is in the equation of exchange is M is the money supply, V is the velocity of circulation, P is the price level and TR are transactions. So he says if people redeem less banknotes if they want to increase their cash balances they go fewer times to the bank to redeem the money. The velocity of circulation goes down. To compensate this the banking system, free banking system will increase credit expansion and holding MV constant. So yeah this is what he says when the demand for money increases people redeem fewer banknotes, banks may and should expand credit so MV stays constant. And he says even if banks expand credit in the same rhythm even if they do not lose reserves to competitors even if there's no adverse clearing there is another limit for credit expansion because he says the banks demand for reserves is the average net reserve demand. If all banks expand in the same rhythm it's zero. No one loses reserves in the long term. But there's also a precautionary reserve demand in relation to in function of the variation of the clearing, variation of the variance of the clearing balances. There you have to think of let's say the clearing period is one day after at the end of each day banks clear. But of course it could be that one day the bank has a positive clearing balance the next day it has a negative one. In the long run it compensates if there's coordinated credit expansion but there may be one day where we will lose reserves. So St. John says you also need some precautionary reserve for this variance. And this variance of course goes up the more credit expansion has occurred already the bigger the money supply is. So he says there's this limit. Okay, is this true? No. Why? Why is it not a limit? Necessarily because even though at the end of the day one bank may have a positive clearing balance, positive variance it may voluntarily refrain from redemption. If banks really coordinate, cooperate they may voluntarily refrain from it. Another possibility similar to this is an interbank market. Banks know that in the long run they will expand in the same or they want to expand in the same rhythm. They cooperate, they collude. So they give them short-term loans. A bank with a positive clearing balance lends to a bank with a negative one. They could just lengthen the clearing balance instead of clearing at the end of every day. They could do it at the end of every week or month. So if credit expansion expands progressively you may also expand the clearing period. And then it actually may be that when there is credit expansion there typically is an artificial boom. So the assets of banks increase during the coordinated credit expansion. And as the assets of banks increase in value, the stock portfolio goes up they may actually think that they need less reserves. Well said in white they say that in a fractional reserve banking system which is on its limit, it has reached its limit of credit expansion it would not be harmful. Of course one would first have to ask the process until reaching the limit was this not distorsionary. But okay, even if we are at the so-called limit what happens if there is an increase in base money production? So for example we have a gold standard and people deposit gold in the fractional reserve banking system. This allows the banks for more credit expansion. Even there there have been no more real savings. There has been just an increase in the money supply but not real resources to maintain the production process. The second reason which they all for the second possibility that they acknowledge is if there is a demand to hold money, an increased demand to hold cash balances then they actually say the extraction reserve banks should expand credits. Mises says any credit expansion leads to a tendency of a business cycle. And again this is what we have talked about now quite a bit it is possible that banks cooperate, expand in the same rhythm reducing their reserve ratios. Why do Sajin and Wright think that this would not be harmful? Sajin says that the willingness to hold money, the willingness to hold bank liabilities to have a checking account is equal to the willingness to save. So if the demand for money increases or decrease in velocity in the equation then the fractional reserve banking should produce more money and could produce more money because people basically save more. And it's true if there is credit expansion then there are more monetary savings and more investments but not more real savings. If people want to hold more money, if they want to have a higher cash balance this necessarily means that the time preference has changed or the time preference has fallen. It doesn't mean that there are more savings and that more investment projects can be undertaken which will be undertaken in the system envisioned by fractional reserve free bankers. In their system when people want to hold more money fractional reserve banks expand credits but not necessarily there are more real savings which we will see now. There is a confusion, that is the main confusion I think between savings, resavings and the demand to hold money. It's a confusion of a stock and a flow variable. Cash holdings of people, cash balances, this is a stock variable but saving is a flow variable. This is the proportion of unconsumed income. The proportion of income which is not consumed. So it's a flow variable, it's like every income period while the cash holdings is a stock variable and they think that if when the stock variable increases the fractional reserve banking expands credits people hold more banknotes it's an increase in savings in the flow variable and this is a fundamental error. And maybe even more importantly people can increase their cash balances by decreasing their savings by the divestment and disinvestment. An example, assume an entrepreneur that has a factory with 10 machines, one machine breaks, kaput every year to buy it anew it costs 50 dollars. The entrepreneur has an income per year of 100 dollars. He consumes 50 and uses 50 dollars to replace the broken machine. Then he does it for many years, the capital stock remains the same the same production, same income and then next year, next year. Then he says I want to increase my demand for money I want to hold because uncertainty has increased or whatever I want to hold a higher cash balance. So he says instead of buying the normal machine of 50 dollars I will buy a smaller one for 30 dollars and use 20 dollars to increase my cash balance. So what is the result? The result is, nominal savings have been reduced the proportion of income that is saved and invested has fallen from 50 to 30. Savings have been reduced, the flow variable is smaller. Consumption spending has increased relatively to investment spending it's not 50% anymore but more and cash holdings, which for sales and wide savings have increased. So what are the effects in the economy? Here you have the smaller machine. One is that the prices of consumer goods will rise relatively to the prices of machines, to the prices of consumer goods, producers goods which also means that the interest rate will increase which is of course just a reflection of the fact that here the individual has increased his time preference. He's consuming, he's investing, saving a smaller portion of his income than before in relation to his consumption expenditures. So we have this result, interest rate rises, time preference has increased what would a fraction reserve banking system do? The demand to hold cash balances has increased. This guy holds 20 dollars more in form of demand deposits or bank notes. Then the salesman would say okay the demand to hold money has increased which means that velocity has fallen so to compensate money supply should go up and the fraction reserve banking system can expand credit because people demand or this individual demands to hold a higher cash balance to hold more bank liabilities. So there will be a credit expansion to finance new investment projects which obviously is against the intentions of the individual. What did he want? What does he do? He actually reduces his investment, he buys a smaller machine and now the reaction of the fraction reserve banking system to expand credit for new additional investment projects even though his real saving has not increased. You see that his real saving has not increased, his consumption spending has increased relatively to his savings. So it's the opposite, it's a clear discoordination here which fractional reserve bankers fail to see. So I mean the main difference is that we are eye-regard saving not merely as holding money as a stock variable but as a portion of income which is not consumed. This is the main difference and here this is the origin of the flaws and there is no necessary correlation between the portion of the unconsumed real income and the cash balance. So an individual may consume a larger portion of his real income by disinvesting, as is here the example. Here we have it, to hold inside money is to engage in voluntary saving. This is the clearest evidence possible to hold inside money is to engage in voluntary saving. For him if we go back to hold this additional $20 in demand deposits is additional saving. So banks can expand credit. Another problem in his argument is of course that banks will expand credit more than this $20. But okay. So here we have another example to show our difference between saving, real saving as a flow variable and the demand to hold cash or to hold money as a stock variable. Let's imagine a person. He has cash holdings of $1,000, the yearly income of $10,000. He consumes all of it. Person A has savings of $10,000 but is he saving? No. He is not saving at all. So here we have the difference between unconsumed real income. There's no saving in this example and the stock of monetary savings. For Stelgian there are savings of $1,000. And for him the increase of other free bank, fraction reserve free bankers, the increase of demand to hold monetary savings, like let's assume that the fraction reserve bank expand credits and now the savings go up to $2,000. So it's an increase in real savings even though there have been no assumption from consumption. Another question is, which is of course difficult for answer for fraction reserve free bankers. Let's assume we live in a fraction reserve banking system. It is at its limit of credit expansion. It has reached it. It's like in kind of equilibrium. There's one guy who had money and cash below his mattress for 10 years. His savings, $1,000. And now for some reason because there was some robbery in his neighborhood. He says, okay, I will take it from below the mattress and put it into the bank. Has real savings changed? Are real resources available to sustain additional investment projects? Obviously not. Just the stock, the savings have changed location from below the mattress to the banking system. But what will the fraction reserve banking system do with the additional reserves? Expand credits and not only $1,000 but more. And interest rates will fall, additional investment projects will be started. But there has been no more real savings. Okay, he did not really respond to our argument that I had with David Howden. So he was evasive. He said it may be that a person just changes the form of saving. So he did not refer to the case of the mattress but he said there may be a bond that a person has. And then he sells the bond and deposits the money. Then the bank reserves increase or he accepts a bank note in exchange. So just the form of the financial asset changes. The individual does not hold the bond anymore but he holds a bank liability, a bank note. And then it's okay that the bank lends the money because it's just a different form of saving. And if it would not lend the money actually he says that the interest rate would be too high. So what is the critique of this argument? Well first of all he did not address the example of the mattress, obviously. He just said another example but even here there are problems. The first problem is if someone holds a bond, a 10-year bond and sells it, because he wants to for example in three months he wants to go on a vacation. Or in three months he wants to buy a new television set. It's not equivalent. It's not equivalent to the two investments. In the bond the person is abstaining 10 years from consumption if he holds too much maturity. If he takes a bank note or increase in a demand deposit, deposits the money, he may actually want to increase consumption very soon, go on a vacation. And if the Faction Reserve Bank then takes the money to grant a credit and it is invested for an investment project that measures within 10 years, there's obviously a disconnection. In fact if an individual that was willing to abstain 10 years from consumption holding this bond now deposits the money in his bank, it's actually an increase in time preference rate. He's not willing to abstain so long anymore. If then the banking system expands credits and there will be an investment project that takes 10 years to measure, there's a disconnection. And of course his response was also evasive because one can increase real cash balances not only by selling an IFN asset, not only by selling a bond but also by divestment from real capital. The divestment example is the one of the machines. He did not answer to this example. So the conclusion is that free banking is stable. Free banking quotation marks of Faction Reserve Banking is unstable because it allows for credit expansion and as Mises says all credit expansion leads to the developments of an unsustainable boom. The three reasons why it allows for credit expansion in Faction Reserve Banking system is there may be an increased demand to hold money. Then free bankers themselves even say that free banking system should increase the money supply. There may be an increase in base money which allows for credit expansion or there can be cooperation that he talked about. And in all these cases, in all these cases of credit expansion there has been no increase in resaving to sustain the additional investment projects that are financed via credit expansion. So there are unsustainable booms. Yeah, it's become really unstable. Until then the banks ask for the introduction of a central bank, the lender of last resort. Okay, thank you very much.