 I'm really honored to be here among outstanding international scholars that Hans has assembled. And I want to thank both Hans and Gulchan for the wonderful hospitality that they've offered. I especially want to thank Hans for inviting me again and again and again and never giving up. Now that I've finally come, I'm happy I'm here and will come again. What I want to do today is talk about sound money and unsound money in the very short time that I have. And to go from unsound money to show what unsound money is, what's the core of unsound money, and then suggest a solution based on the weaknesses of unsound money. So basically unsound money has four interlocking components in today's world. Fraction reserve banking, central banks, fiat money, and government deposit insurance. You really can't have just three of those. You really have to have all four in today's monetary regime. But I'm going to focus on fraction reserve banking and bring in the background the other three components. Because I think it's at the core of the financial crisis and the stagnation, that economic stagnation that stretches from the U.S. to China, which is a bubble economy if ever there was one. I'll argue that the fraction reserve banking is a peculiar and absurd institution that could never exist on a purely free market. And given that, I'll propose a path back to sound money on the basis of its inherent flaws. If I have time, I'll briefly review recent controversy involving Paul Krugman, George Selgen, and myself. Not that Krugman ever deigned or condescended to speak directly to either of us. So what is fraction reserve banking? I'm going to go through just briefly what it is. A bank is simply a business firm that issues claims to affix some of money and receipt for a deposit of cash. These claims are payable on demand and without cost to the depositor. In today's world, these claims may take the form of checkable deposits. They may also take the form, for example, in the U.S. of savings deposits that require withdrawal in person at the bank or withdrawal from an ATM machine. In the U.S., the cash for which the deposit claim is redeemable are Federal Reserve notes. Those are the dollar bills that we are all too familiar with. Fraction reserve banking occurs when the bank lends or invests some of its depositor's funds and retains only a fraction of its deposits in cash. This cash is the bank's reserves, hence the name Fractional Reserve Banking. All commercial banks and thrift institutions in the U.S. and the world today engage in Fraction Reserve Banking. Now let me illustrate very briefly and for most it's probably superfluous just how Fraction Reserve Banking works with a very simple example. Assuming a bank with deposits of a million dollars makes $900,000 of loans and investments. If we ignore for simplicity the capital paid in by its owners, this bank is holding a cash reserve of 10% against the deposit liabilities. The deposits constitute the bank's liabilities because the bank is contractually obligated to redeem them on demand. The assets of the bank are its reserves, its loans, and investments. Bank reserves consist of the dollar bills in its vaults and ATM machines and there's very few of those. And the bank's deposits at the Federal Reserve which can be cashed in on demand. That is the Federal Reserve can simply order the Federal Bureau of Engraving to print up dollar bills in exchange for these reserve deposits. The bank's loans and securities are its non-cash assets which are titles to sums of cash payable and this is important only in the near or distant future. These assets include business loans, credit card loans, mortgage loans, Treasury securities, so on and so forth. The key to understanding the nature of Fraction Reserve Banking and the problem it creates is to recognize that the bank deposit is not itself money. It is rather a money substitute. That is a claim to standard money in my example dollar bills that is universally regarded as perfectly secure. Bank deposits transferred by check or debit card will routinely be paid and received in exchange as a substitute for money for as long as the public does not have the slightest doubt that the bank which creates a deposit is able and willing to redeem them without delay or expense. Under these circumstances bank deposits are accepted and held by households and business firms and they are regarded as indistinguishable from cash. They are therefore properly included as part of the money supply. The balance sheet of Fraction Reserve Bank however presents an immediate problem. On the one hand all the bank's deposit liabilities mature on a daily basis because it has promised to cash them in on demand. On the other only a small fraction of its assets is available at any moment to meet these liabilities. For example during normal times US banks effectively hold much less than 10% of deposits and cash reserves. That is not true today where they hold more than 100%. The rest of the bank's liabilities will only mature after a number of months, years or in the case of mortgage loans decades. In the jargon of economics Fraction Reserve Banking always involves term structure risk which arises from the mismatching of the maturity of its liabilities with that of its assets. In layman's terms banks borrow short and lend long. The problem is revealed when demands for withdrawal of deposits exceeds a bank's existing cash reserves. The bank is then compelled to sell off some of its longer term assets many of which are not readily saleable. It will thus incur big losses because it must dump these assets at bargain basement prices. This will cause a panic among the rest of its depositors who will scramble to withdraw their deposits before they become worthless. A classic bank run will ensue. At this point the value of the bank's remaining assets will no longer be sufficient to pay off all its deposit liabilities and the bank will fail. Now I want to get into a key problem with Fraction Reserve Banking and it has to do with the problem of confidence. This was really just identified by Von Mises and was picked up by Rothbard. You don't find any of this in the analysis of Fraction Reserve Banks by free bankers for example or by the modern mainstream. A Fraction Reserve Bank therefore can only remain solvent for as long as public confidence exists that its deposits really are secure claims to cash. If for any reason the faintest suspicion arises among its clients that a bank's deposits are no longer payable on demand, the bank's reputation as an issuer of money substitutes vanishes overnight. The bank's brand of money substitutes and every bank has its own brand which is its name. So the bank's brand is then instantly extinguished instantly when confidence is lost even before the deposits are turned in. And people rush to withdraw their deposits in cash. Cash that no Fraction Reserve Bank can provide on demand in sufficient quantity. Thus the threat of instant brand extinction and insolvency is always looming over Fraction Reserve Banks. The particular bank's deposits may still exist and even be accepted at a discount by some people. But as soon as people accept them they'll rush to the bank to withdraw them. At that point or long before that point the confidence has already vanished. They are no longer money substitutes. They are no longer circulating at par with cash. Thus in order to issue money substitutes a bank must develop what Ludwig von Mises called a special kind of goodwill quote unquote. Among its clients. On a free market this kind of goodwill is very difficult and costly to acquire and maintain. But it is this reputational asset that induces a bank's clients to abstain from immediately cashing in their deposits at every moment. There has to be something that holds you back that prevents you from rushing to get your property. And it's this thin reed of public confidence or special goodwill. Goes beyond goodwill for any other type of business. But unlike the form of goodwill essential to all successful business ventures, the goodwill that is necessary for a Fraction Reserve Bank's deposits to circulate as money substitutes is highly peculiar. Either all customers trust the bank and hold its deposits or no one does. It's indivisible. Once a few customers withdraw their goodwill the rest will follow and the bank is insolvent. Mises described the loss of confidence in a bank's insolvency and the related phenomenon of what I've called brand extinction. That is the immediate extinction of their deposit as a money substitute. It's in the minus. It's a thought. Once that thought changes there is no longer money substitute. So Mises that I'm quoting him says the following. The confidence which a bank and the money substitutes it has issued in joy is indivisible. It is either present with all clients or it vanishes entirely. If some of the clients lose confidence the rest of them lose it too. One must not forget that every bank issuing fiduciary media that is unbacked notes and deposits is in a rather precarious position. Its most valuable asset is its reputation. It must go bankrupt as soon as doubts arise concerning its perfect trustworthiness and insolvency. And then this sort of peculiar overriding importance of confidence to the stability of this business firm, and that's all bank is, was particularly emphasized by Rothbard. He says, but in what sense is a bank sound when one whisper of doom, one faltering of public confidence should quickly bring the bank down? In what other industry does a mere rumor or hint of doubt bring down a mighty and seemingly solid firm? What is it about banking that public confidence should play such a decisive and overwhelmingly important role? The answer lies in the nature of our banking system. In the fact that both commercial banks and thrift banks have been systematically engaging in fraction reserve banking. That is, they have far less cash on hand than there are demand claims to cash outstanding. Now Rothbard's point about the fragility of not only a particular bank but of the entire banking system as issuers of fraction reserve bank money substitutes is really well illustrated by the stunning collapse of Washington Mutual or WAMU in September of 2008. It's the largest bank failure in the United States history. WAMU had been in existence for 119 years and was the sixth largest bank in the United States with assets of $307 billion. It had branches throughout the country and had billed itself as the Walmart of banking. It was one of the top performers on Wall Street until shortly before its failure. Its depositors clearly had enormous confidence in its solidity, especially given that its deposits were insured by the federal government reinforced by the existence of the Fed's too big to fail policy. And yet, and yet, almost overnight, the special goodwill that gave its deposits the quality of money substitutes vanished as panic-stricken depositors rushed to withdraw their funds. The unlikely event that triggered the sudden loss of confidence and subsequent brand extinction was the failure of Lehman Brothers, a venerable investment house. A week after Lehman failed, mighty WAMU was no more. It was gone. The brand had disappeared. The highly publicized Lehman Brothers failure had shaken public confidence in the solidity not only of WAMU, but of the entire banking system. Had the Fed and Treasury not acted aggressively to bail out the largest banks in the fall of 2008, there's no doubt that the entire system would have collapsed in short order. That is to say, public confidence would have been withdrawn from all brands of checking accounts. Indeed, on a single day in December, the combined emergency lending by the Fed and the U.S. Treasury had risen to a peak of $1.2 trillion. The recipients of these billions included some of the most trusted and reputable brand names in banking. Bank, Bank of America, Morgan Stanley, as well as European banks like the World Bank of Scotland and UBS AG. Without this unprecedented bailout, these discredited brand names would have been relegated to the dustbin of business history and their money substitutes extinguished instantly. And I had wished this happened. Now, contrast this example, now some of you Europeans may not be familiar with it, with the Tylenol murders that occurred in Chicago in 1982. In this incident, seven people died from ingesting capsules of the analgesic, or the painkiller, super-strength Tylenol, a very popular brand. These were laced with potassium cyanide. However, not only was the parent company, which was the pharmaceutical giant, Johnson & Johnson, able to maintain its own business goodwill by promptly responding to the tragedy, it was also able to recover the goodwill of the Tylenol brand name itself. WAMU's name is poison. No one would ever try to resurrect that name. It is true that many customers stopped purchasing the Tylenol brand for a while, and that its share of the painkiller market swiftly plunged from 37% to 8%. Now, that's unlike goodwill, the special goodwill for banks in which it's either present or not at all. So, many people had forsaken the Tylenol brand name, but there were still people who used it. That wouldn't happen with a money substitute. Nevertheless, its market share rebounded back to 30% in less than a year, almost back to what it was. A few years later, Tylenol was again the most popular painkiller in the US. Furthermore, the Johnson & Johnson stock, which had been trading at an all-time peak shortly before the incident, plunged but then rose to the peak three months later. Moreover, the reputational setback suffered by the Tylenol brand did not spread to the other brands that were manufactured by Johnson & Johnson. And of course, it was never any question that it would spread to other over-the-counter companies' brands. So, even in the case of death, of causing death or death connected with its brand name, a firm that is not a fractured reserve bank can recover. That is not true of fractured reserve banks. The ever-present threat of insolvency is a relatively minor problem with fractured reserve banks, however. Its effects are restricted to the bank's stockholders, creditors, and depositors who voluntarily assume the peculiar risks involved in this business. Now, I want to go on, and from this, of course, the bigger problems, which I'm not going to go into with fractured reserve banking, is the fact that it's inherently inflationary and, at the same time, depresses the interest rate and falsifies monetary calculation, bringing about the sequence of phenomena that we know as the business cycle. Okay, so these are problems that are inherent with it. Now, my conclusion is going to sound counter-intuitive, given what I've said. I'm going to ask for more fractured reserve banking, plenty of it, freely. Inflation and the boom-bust cycle generated by fractured reserve banking are enormously intensified by the Federal Reserve and U.S. government interference with the banking industry. Indeed, this interference is justified by economists and policymakers precisely because of the instability of the fractured reserve system. The most dangerous forms of such interference are the power of the Federal Reserve to create bank reserves out of thin air via open market operations. Okay, and we now have this in full force with QE infinity. So QE1, QE2, and then QE, the infinity symbol, which is completely open-ended. It's use of these phony reserves to bail out failing banks and its role as the lender of reserve of last resort and federal insurance of bank deposits. In the presence of such policies, the deposits of all banks are perceived and trusted by the public as one homogeneous brand of money substitute, fully guaranteed by the federal government and backed up by the Fed's power to print up bank reserves at will and bail out insolvent banks and investment banks and automobile companies and so on and so forth at Infinitum. Under the current monetary regime, there is thus absolutely no check on the natural propensity of fractured reserve banks to mismatch the maturity structures of their assets and liabilities, to expand credit and deposits, and to artificially depress interest rates. The immediate solution is to treat banking as any other business and permit it to operate on the free market. A market completely free of government guarantees of bank deposits and of the possibility of Fed bailouts. In order to achieve the latter, federal deposit insurance must be phased out and the Fed would have to be permanently and credibly deprived of its legal power to create bank reserves out of nothing. The best way to do this is to establish a genuine gold standard, a gold coin standard, in which gold coins would circulate as cash and serve as bank reserves. At the same time, the Fed must be stripped of its authority to issue notes to conduct open market operations. Also, banks would once again be legally enabled to issue their own brands of notes as well as deposits, as they were in the 19th and early 20th centuries in the U.S. Once this mighty rollback of government intervention in banking is accomplished, each fractured reserve bank would be rigidly constrained by public confidence when issuing money substitutes. One false step, one questionable loan, one imprudent emission of unbacked notes and deposits would cause instant brand extinction of its money substitutes, a bank run. Notice the brand extinction, which is really an intellectual decision, comes before the bank run, not after it. This is why the level of bank reserves does not matter. It could be 80 percent or some people claim it was in Scotland or it could be 3 percent. It doesn't matter. As soon as people believe that the bank is no longer able to redeem their money substitutes in cash, at that point the brand is extinguished. It's no longer a money substitute. It's no longer a claim to money. In fact, on the banking market, as I have described it, I foresee the ever-present threat of insolvency compelling banks to refrain from further lending of their deposits payable on demand. This means that if a bank wished to make loans of shorter or longer maturity, they would do so by issuing credit instruments whose maturities match the loans. Thus, for short-term business lending, they would issue certificates of deposit with maturities of three to six months. To finance car loans, they might issue three or four-year short bonds. Mortgage lending would be financed by five or ten-year bonds. Without government institutions like Fannie Mae and Freddie Mac, which are backed ultimately by the Fed's money-creating power, which implicitly guarantee mortgages, mortgage loans would probably be transformed into shorter five or ten-year balloon loans as they were until the 1930s. They weren't all 30-year loans. It's ridiculous for an institution to make a 30-year loan. You can't see that far into the future. The bank may retain an option to roll over a mortgage loan when it comes due, pending a reevaluation of the mortgage or current financial situation and recent credit history as well as the general economic environment. In other words, after five years they may roll it over if you didn't miss a payment, if your credit history is still good, and so on. In short, on a free market, fractional reserve banking with all its inherent problems would slowly wither away, and I should say because of its inherent problems, it would slowly wither away. Let me just end with a quote from Murray Rothbard. Here's what Rothbard's take on this is. He says, A gold coin standard coupled with instant liquidation for any bank that fails to meet its contractual obligations would bring about a free banking system so hard and so sound that any problem of inflationary credit or counterfeiting would be minimal. It is perhaps a second best solution to the ideal of treating fractional reserve bankers as embezzlers, but it would suffice at least as an excellent solution for the time being. And I think in today's world this is an excellent second best solution. I actually started five minutes late, so I may have five minutes. Now, I want to just talk a little bit about fractional reserve banking and how Paul Krugman recently responded to this. Krugman has finally addressed the Austrians. He's been forced to address the Austrians after sort of ignoring them. I mean, it's like Gandhi's old saying, first they ignore you, then they laugh at you, then they attack you, then you win. And I think that's what's going to happen with Austrian economics and particularly the monetary arena. So what Krugman says in his New York Times blog, he says, But the Ron Paul link in which he condemned fractional reserve banking prodded me to ask a question I mean to ask, how do Austrians propose dealing with money market funds? So he asked this question, he doesn't really want a serious answer. He just wants a sort of platform with which he can beat the Austrians. So he goes on later in the blog. He says, but consider more recent innovation, money market funds. Such funds are just a particular type of mutual funds and surely the Austrians don't want to ban financial intermediation or do they? Yet shares in a money market mutual fund are very clearly a form of money. No argumentation, he just says that. You can even write a check on them. No Paul, you can't write a check on the money market fund itself. The money market fund has checkable deposits at banks or they themselves own a bank. So the check that is paid in your name to the third party is a check drawn on a bank, on a cash deposit, not on a money market or shares of a money market fund. They are not transferred. So he's an idiot. So he says, yet shares in a money market... And they're created out of thin air by financial institutions. No, they're not created out of thin air by financial institutions. There has to be an investment, a dollar for dollar investment. It's as if maybe five or six of us gave Robin our money and had him invested in short term, high grade commercial paper and government treasuries. That's all it is. He says, so, again, he's talking rhetorically to the Austrian. So are such funds illegitimate? Okay, then he goes on. Okay, I don't expect a serious answer. Well, you didn't give us a chance, but it's scary that this has become the more or less official doctrine of the GOP. So now suddenly the GOP wants to ban money market mutual funds. I mean, this is just beyond the pale of scholarly discourse. It's uncivil. It's just crazy. Now, Mark Thornton of the Mies Institute answered him, I think, in a very good way. He said, look, Paul, he says, if you Google Austrians, Austrian Economics Money Market Mutual Fund, the first item to appear on the Google search is an article that I wrote on money market mutual funds back in 1987, in which I'm not going to read from it, but he quotes my article, and I say, well, of course, Austrians don't want to ban money market mutual funds. They're just another investment vehicle. They happen to, you don't own a claim to a fixed sum of cash. You own shares in a managed investment portfolio. Short-term, high-grade investment portfolio. And any check that you write is really an order to your fund manager to liquidate your parts of your portfolio. And then use the proceeds via a bank check to pay, let's say you're buying an automobile, to pay the automobile dealer. Okay, so Mark points that out. There's a very strange answer, though, from a free banker, George Selgen. He says, I don't know whether my answer qualifies as serious or not, but as a former Austrian, I can tell you that the anti-fraction reserve crowd among self-styled Austrians, taking its lead from Mori Rothbard, is but a small contingent with which the rest vehemently disagree. So we're only a very tiny, tiny fraction of Austrians, of which he claims not to be one. Okay, so keep that in mind. So he goes on and he says, he quotes himself. He says, it's unfortunate that Congressman Paul has chosen to accept Rothbard's characterization of fraction reserve banking, thereby wetting his call for monetary freedom with an extremely mistaken idea of what such freedom would entail in practice. In fact, bank deposits have been recognized both in practice and common law since early times. And he goes on and on to say that the fraction reserve banking is perfectly legitimate and there's no problem with it. Nowhere there, okay, let me read one more thing. He says, Rothbard would ban acts of fraction reserve banking among consenting adults. Okay, very, very clever. And so apparently with Congressman Paul, whatever such a ban might accomplish, it certainly can't be squared with monetary laissez-faire or for that matter with a plain old personal freedom. Be that as it may, whatever we think of that answer, he never addresses Krugman's question. This was a wonderful chance for him to make the point that Austrians don't think that money market mutual funds are fraction reserve banking. In fact, his co-author on many pieces, Larry White, wrote a very good article arguing this in the American Economic Review. Why wouldn't he want to bring that cachet to the Austrian side of the debate by pointing that out, okay? Whatever the reason, I'm not going to speculate on it. But to answer Krugman's question, money market mutual funds are a perfectly legitimate way of investing one's money. You become a share owner in a managed portfolio. The term reserves doesn't apply at all. If the portfolio for some reason decreases in value, then the money market mutual fund breaks the buck. That is, the value falls below $1 per share. And that's all. Money doesn't disappear from the system. There's no deflation. I'll end there on my time limit. Thank you.