On George Selgin, Fractional Reserve Banking, and the Curious Sport of Insulting Austrian Economists

Don't make cats sad.

Don’t make cats sad.

Insulting Austrian economists is a popular sport among non-Austrian economists. Paul Krugman reigns as champion, with his latest feat of derogatory dexterity appearing in his column of July 16th, entitled The Paradox of Flexibility:

Well, Hazlitt has been wrong about everything for more than 80 years, and is still regarded as a guru. Bad ideas, it appears, are extremely robust in the face of contrary evidence.

Nice jab, Paul. Good one!

I was nonplussed this morning to witness George Selgin get in on the fun. Selgin is a self-styled former Austrian economist whom I understood as well regarded among the Austrian marketeers that I’ve heard speak. His lecture for the Austrians at the Ludwig von Mises Institute entitled The Private Supply of Money is one of my all time favorites from that outfit, so imagine my perverse interest when I happened upon a post of his entitled A Theory of Banking Made Out of Thin Air, which began thus:

Instances of self-styled Austrian economists bungling their banking theory seem almost as common these days as instances of theologians bungling their cosmology were six centuries ago.

Ouch, George! I didn’t know you could dish ‘em out like that! 

As it happens, George as been insulting Austrians for some time now. I don’t follow George Selgin, so I hadn’t  noticed. Now that I look, here he is again, from over a year ago, in a post entitled “100-Percent censorship?

Although the first priority of every believer in monetary freedom must be to combat bogus arguments for monetary central planning, we cannot do this effectively unless we are just as relentless in exposing the 100-percent reserve movement for the moronic cult that it is, to keep its clownish convictions from giving the entire movement for monetary freedom, if not free market economics more generally, a bad name.

Emphasis added. Pure contumelious gold! What a contender! No wonder George Selgin saw fit to re-post a portion of 100-Percent censorship? as a comment under one of insult champion Paul Krugman’s columns (hat tip to Joseph Salerno at the Circle Basitat for the link). I see a challenge brewing. Will the champion put his title on the line? Let’s wait and see.

The economic substance of Selgin’s comment was to denigrate Austrian-school opposition to fractional reserve banking, specifically their idea that such lending is a fraud upon the depositor, as “the sheerest poppycock, legally, historically, and economically.” Selgin’s most recent post, A Theory of Banking Made Out of Thin Air, is similarly themed.

A pattern I’ve noticed among Austrian-insulting sportsmen is that their posts tend to be long on comedy, but short on responsiveness to actual Austrian arguments. I read George Selgin’s post with bated breath to see if it would fit the pattern. Here is what I found.


After insulting the “self-styled” Austrian economists in general, George Selgin moved on to his target, the Cobden Centre’s Sean Corrigan, whom Selgin quoted at length:

[I]magine that I take your IOU to the bank and that peculiar institution registers my claim upon its (largely intangible) resources in the form of a demand liability of the kind which–by custom, if not by legal privilege–routinely passes in the marketplace as money. Your promissory note–a title to a batch of future goods not yet in being–has now undergone what we might facetiously call an ‘extreme maturity transformation’ which it has conferred upon me the ability to bid for any other batch of present goods of like value without further delay. It should, however, be obvious that no such goods exist since you have not had time to generate any replacements for the ones whose use I, their lender, supposedly forswore until such a time as your substitutes are ready to used to fulfil your obligations, something we agreed would be the case only at some nominated point in the future.

More claims to present goods than goods themselves now exist…and thus the actions we may now simultaneously undertake have become dangerously incongruous. Our [plans] have become instead a cause of what is an inflationary conflict no less than would be the case if I had sold you my place at the head of the queue for the cinema only to try and barge straight past you in a scramble for the seat in question.

Chief Selgin of the grammar police couldn’t resist interrupting Sean’s prose with no fewer than nine [sic]s, probably to assure us all that Sean’s is only the latest act in a long-running economic circus of morons and a clowns. Thanks, chief. 10-4.

Sean Cobden described how, in his view, fractional reserve banking (i.e., the bank’s practice of lending and re-lending of the same money several times) causes monetary inflation. George Selgin does not believe such lending is inflationary. His creditable response to Sean on the economic merits followed. Here is some of what he wrote, edited for space:

Bank lending appears analogous to creating fake “tickets” to an already fully-booked performance, allowing the new credit recipients to secure present goods, despite a lack of voluntary savings, simply by bidding goods away from others, that is, by forcing others to consume less, just as holders of fake tickets might take up seats that ought to have gone to holders of legitimate ones.

But the appearance is deceiving, for it depends crucially on Corrigan’s having failed to consider all of the parties that usually take part whenever a competitive bank makes a loan. …

[F]or a bank to lend[,] someone has to have engaged in prior voluntarily saving, by refraining from spending or from otherwise cashing in their own claims against it.  Our banker cannot, in other words, simply create loans out of thin air, and thereby drive prices upward.  Instead, if his business is to survive he must act as a go-between or intermediary, lending [out] only what he has induced others to lend to him.   These ultimate suppliers of bank credit, by refraining from consuming, place downward pressure on prices precisely equal to the upward pressure stemming from the banks’ lending. By airbrushing them out of his account of the workings of a typical bank, Corrigan succeeds in painting a picture of the banking business that’s as lurid as it is misleading.

While Sean Corrigan might not have mentioned the bank’s depositors in his fable, don’t think for a minute that no self-styled Austrian moron ever has. Upon reading George Selgin’s retort, I thought immediately of a lengthy passage from Hans-Hermann Hoppe’s 1995 lecture entitled The Origin and Nature of Banking. I’ll post the audio here, which I recommend you listen to in full, and I’ll follow with a summary for those who haven’t seventeen minutes to listen:

Hans-Hermann Hoppe can not be rightly accused of airbrushing the depositors from his account of fractional reserve banking. The trouble with fractional reserve bankers, according to Hans, is that they attempt to perform two incompatible services at once. Hans describes these services: In one instance, a bank can hold a depositor’s money to keep it safe. The bank becomes a warehouse in which the banker protects depositors’ money from theft, fire, or other loss. This is a service that the bank provides at a cost. The depositor pays a fee to the bank in exchange for keeping her money safe. The depositor may collect her money from the bank at any time without notice. Hans calls this deposit banking.

Alternatively, a depositor can loan money to a bank, understanding fully that the bank will re-loan the money to someone else, thereby exposing the money to risk. This is a service that the depositor provides to the bank. The bank pays a fee to the depositor, called interest, in exchange for the depositor’s service of loaning money to the bank. The bank does not keep the depositor’s money safe. To the contrary, the bank purposefully exposes the depositors money to risk in exchange for interest income. The bank gives away the depositor’s money for a specified term, during which the depositor, by contract, may not access her money. Hans calls this loan banking.

The fractional reserve banker attempts to combine these incompatible functions. Aided and abetted by the Federal Deposit Insurance Corporation (FDIC), the fractional reserve banker attracts depositors by assuring them that their money is safe at the bank. The fractional reserve banker invites his depositor to withdrawal any or all of her money at any time. Meanwhile, the fractional reserve banker exposes the depositor’s money to risk by lending it to someone else in spite of its representations to the depositor that her money is safe and available.

Save? Savings? I was going to save. Later. I really was.

Save? Savings? I was going to save. Later. I really was.

Toward the end of Hoppe’s discussion of fractional reserve banking, he distinguishes “genuine” savings from, I suppose, superficial savings. George Selgin makes no such distinction. For Selgin, all money deposited into a bank is savings, and savings is savings. I don’t think putting money in a bank is necessarily saving or refraining from consuming. Depositors at loan banks promise under contract to relinquish all claims to their money for the term of a loan. Their commitment to save is enforced by contract. Superficial savers, by contrast, have made no such commitment. They put money in a bank for no reason other than that that is where money goes. They may, of their own accord, set a personal savings goal, but in the absence of a commitment, they may abandon that goal and withdraw their money upon any whim or impulse.

Now, I wouldn’t want to interrupt Mr. Selgin while he’s in the zone, but if I could catch him between insults, I’d ask him to revisit his assumption that all money in the bank represents genuine savings. Are they really savings if the bank invites depositors to withdraw their money upon any impulse? Might the depositor who is invited to withdrawal her money upon any impulse not impose the same downward pressure on prices as the depositor who is obligated under contract to keep her money in the bank for a stated length of time? Would I be a buffoon for asking these questions?

I might be a buffoon for asking these questions. As it happened, a reader of Paul Krugman’s blog replied to the comment that George Selgin left there. This reader raised the same objection I just did. In one line. A year ago. Right where George Selgin should have found it. This reader, who posted under the name Inardozi simply wrote:

I believe you’re mistaking time deposits for demand deposits. Completely different thing.

Time deposits, here, are analogous to loan banking and demand deposits are analogous to deposit banking, not that Selgin seems to care. Crickets. No response. A year later, George is beating the same drum, seemingly oblivious to this apparent oversight, which untrained hobbyists like myself, who have only a passing familiarity with Austrian economics, can spot immediately. I’m not even saying George Selgin is wrong. I don’t have the expertise to say anything quite so bold. I don’t have any expertise at all, really. George might have written about this elsewhere, for all I know. All I’m saying is that he left a seemingly sensible objection to dangle behind him like a toilet paper tail, and he would rather play a round of insult the Austrians than acknowledge and address that objection.

I’m pleased to see a fresh crop of insults, though. These look like winners. I’m rooting for you, George, to dethrone King Kong Krugman as World Champion Austrian Insulter!


Addendum (8/14/2013): This blog is just, like, sort of a place where I write to goof off. I hardly expect anyone to read this stuff. But pingbacks are a thing, so the people I write about occasionally read what I write about them. Occasionally I actually have to face the music. Well, Mr. George Selgin actually read what I wrote here and responded. He answered my questions and was not too hard on me. Having learned to ask questions that actually merit answers i think is an accomplishment, I think.  Here is George’s answer:

Addendum (8/12/13): A correspondent has alerted me to this post, accusing me of having joined Paul Krugman and others in making a “sport” of bashing Austrian economics, and suggesting that I have failed in the post above and elsewhere to recognize the difference between demand and savings deposits, only the last of which (according to the Austrians I criticize) represent true savings. In fact, the distinction in question is absolutely irrelevant to my argument above, the point of which is that a competitive bank cannot get away with creating credit out of thin air. Instead it can afford to lend only to the extent that others save with it. Whether the savings come to a bank in the shape of “demand” or “time” deposits matters only to the extent that it influences the length of time for which the savings in question are likely to remain at the bank’s disposal. The bank is responsible for limiting its credits to amounts consistent with the total extent of credit supplied to it by its liability holders, allowing also for the timing of withdrawals. A banker that misjudges the timing in question exposes his bank to the same risk of failure that confronts one who attempts to extend credit without having received any prior deposits. So whether a bank derives its funding from demand or from time deposits, the conclusion stands: if the bank is to survive, the bank’s lending must be limited to the amount of real savings it has on hand.

As for my being just another anti-Austrian economist, that’s a calumny: I am a fan of Austrian economics, as embodied in the works of such great Austrian pioneers as Menger, Mises, and Hayek, as well as in those of many living members of the school. What deserves to be ridiculed is the unending tide of junk written, mostly on the internet, by people who label themselves “Austrian economists” despite appearing to know only as much about economics as I know about string theory, which is to say, next to nothing.

Perhaps Mr. Selgin will forgive me for misinterpreting his ridicule of self-styled Austrian economists. Personally, I’m a blogger of the know-nothing variety, and I do try to make that clear. But even jokers like me get their ideas from somewhere. For me, that’s usually from the lectures of scholars at free-market think tanks like The Mises Institute and the Cato Institute. Broad insults against self-styled Austrian economists who generally bungle their banking theory have to redound to these scholars to some extent. I’m thinking particularly of Joseph Salerno, for I can scarcely read the words “fractional reserve banking” without sounding them out in his voice, and Hans-Hermann Hoppe, whose reasonable reservations I’ve posted above. If George Selgin does not intend to insult these scholars, he might perhaps more deliberately exclude them from the ambit of his insults. He might try words like, “These internet yokels give Austrian economic scholars a bad name.”

On the economic point, I thank Mr. George Selgin for addressing it, but he hasn’t settled the issue for me. I didn’t notice where Mr. Selgin contradicted anything that Hans-Hermann Hoppe said. Hans specifically said, at about 12 minutes into the audio that I posted, that

fractional reserve banking causes business cycles—boom and bust cycles.

George replied,

If the bank is to survive, the bank’s lending must be limited to the amount of real savings it has on hand.

These two statements are not in contradiction, as far as I can tell, because bank failures are a well-known symptom of the ‘bust’ portion of the cycle. The bust comes when the banks fail.

The bankers make loans for ten- and twenty-year terms, when they believes they have real savings on hand. Borrowers borrow from the banks upon the observation that these resources are available. Several years down the road, in the absence of any obligation to keep money in the bank, depositors might eventually withdrawal more of it so that bank deposits fall. Bankers then raise their variable interest rates so that borrowers can no longer afford the payments. Loans go bad, banks foreclose. This is the bust. If the bank can’t foreclose quickly enough to replenish its reserves, then it fails.

Yes, if the bank is to survive, then the bank’s lending must be limited to the amount of real savings it has on hand (and the amount of assets in can foreclose upon to replenish its reserves)but I don’t see how that negates the boom/bust cycle that Hans-Hermann Hoppe described.

What might negate Hoppe’s account would be an argument that foreclosures and bank failures do not cluster themselves in boom/bust patterns on account of fractional reserve banking. I can see an argument that, whereas system-wide catalysts such as a central bank’s manipulation of interest rates might cause system-wide booms and busts, individual bank loans that go bad, and individual bank failures, do not cause such system-wide problems. Maybe Hoppe and Salerno and the rest of the anti-fractional crowd can describe some sort of economic resonance that induces the pattern, or perhaps they can argue that fractional reserve banking exacerbates the effects of system-wide booms and busts that occur for other reasons, but that remains for me to see.

That’s about where I am in my own personal understanding of this. Thanks to George Selgin for his response, and for his mercy. I’ll be on the lookout for more on this topic.

(Images via positivemoney.org and onecentatatime.com)

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5 Responses to On George Selgin, Fractional Reserve Banking, and the Curious Sport of Insulting Austrian Economists

  1. […] (8/12/13): A correspondent has alerted me to this post, accusing me of having joined Paul Krugman and others in making a "sport" of bashing Austrian […]

  2. Salerno specifically avoids the issue of the fraudulent nature of FRB. Hoppe is a clown, not taken seriously by a single person outside of the Mises Institute.

    Clear enough?

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