Does the Gold Drop Signal Recession?

On Friday, April 12, 2013, the gold price (in terms of dollars) took a huge hit.  It was down over 5% on the day.  It closed well below the $1,500 per ounce level.  Is this a bearish sign for gold or is it a bearish sign for the U.S. economy?

The stock market didn’t do a lot on the same day, but it was noteworthy that the 10-year yield dropped down to 1.72%.

Some of the explanations for the big drop were that wholesale prices fell and that other reports were raising concerns about the economy.  Of course, I’m not sure why the gold market doesn’t react the way the stock market does with bad news.  If the economy is bad, that means the Fed will just keep creating more money out of thin air, which should ultimately be good for gold.

This seems to be an on-going tug-of-war between a recession on the one hand and the Fed’s inflation on the other.  Of course, both sides might lose and we may all end up in the mud pit in the middle.  We could end up with recessionary conditions, including high unemployment, coupled with high price inflation.

I was thinking that the Fed’s monetary policy would win out in the short run.  (It will never win out in the long run.  We will eventually get hyperinflation or a severe correction.)  The monetary base continues to increase at unprecedented levels.  With the huge rise in the stock market, I was thinking we were seeing another artificial boom and that it could last a little while.  But with the latest big correction in gold, I am closer to 50/50 now.

With the major correction in gold in one day, coupled with a decreasing yield on treasuries, a near-term recession is looking more likely.  I know that we already have recessionary conditions in many ways, but I am referring to an official recession.

I don’t underestimate the power of the Fed to prop things up in the short term.  Huge injections of monetary stimulus has its effects.  We have seen that with the stock market.  It might be enough to overcome an official recession in the near term.

I really think that things will become more clear over the next few months.  We may see a quick bounce back in gold and see the artificial boom resume.  If, on the other hand, gold keeps going down, I think it is a sign of a deeper recession in the near term.

But even with the latter scenario, that will just mean that Bernanke and the Fed will continue to be aggressive with its monetary policy.  This will be bullish for gold ultimately.  So either way, I would look at the drop in gold as a buying opportunity.  It is just a question of how long it will take to pay off.

U.S. Government Spending Exceeds Median Household Income

This article was linked today via Drudge Report.  The author, Terrence Jeffrey, writes the following:

“…the combined spending of federal, state and local governments per American household actually exceeded the median household income for 2010, which is the latest year for which all relevant government data are available.”

The total spending for all levels of government combined in the U.S. for 2010 was nearly $6 trillion.  This came out to just over $50,000 for each household.  In the same year, the median household income was reported at just under $50,000.

This is a point that I have tried to hammer home in the past.  Government spending is the major problem in the economy.  Taxes are a symptom of that problem.  The spending levels are absurd when you look at it in these terms.  Anyone calling for any tax hikes cannot be taken seriously.  Anyone who is not calling for significant spending cuts cannot be taken seriously.

Obviously the level of taxation is not spread evenly.  It is not like some single mother on welfare living in an inner city is paying $50,000 per year.  But many people don’t understand that there are many taxes that hit the poor.  The income tax makes up just a fraction of the total government spending.  There are significant sales taxes, property taxes, excise taxes, payroll taxes, and many others that we don’t even think about.  There is also the hidden tax of inflation, which erodes the purchasing power of the dollar.  Even corporate taxes and employment taxes on employers hit the poor, even if indirectly.

On the other side, we know that rich people and high income earners (not always the same people) pay huge amounts in taxes.  You can be sure that the tax burden for rich people is far higher than the average $50,000 per household.  So this class warfare game that is played is a bunch of garbage.  It is an excuse to justify ever-more government spending.

And of course we know that the middle class is constantly taking it on the chin.

This is why our economy is struggling so much.  It is why unemployment is high.  It is why people are having trouble paying their bills, even for basic necessities.  It is why people have trouble finding jobs and are having to put up with harder working conditions.  It is why the mood of the country is generally down.

Government spending has to go down significantly.  Virtually all government spending is a misallocation of resources.  It discourages saving.  It makes us all poorer in the long run.

I believe there will be a reduction in spending eventually, particularly at the federal level.  It is just a question of how it will come about.  It looks like it will be done the hard way.  Congress will be forced to cut spending when the Fed refuses to buy more government debt.  The Fed will have to do this one day to save the dollar.

Krugman is a Little Bit Right on the Debt

Paul Krugman (I hate to link to his articles, but here it is) recently said the following:

“debt does not directly impoverish us, because it’s money we owe to ourselves.  OK, some of it is money we owe to foreigners, but I’ve dealt with that part already.”

He actually is somewhat right in this one statement, if you ignore everything else he writes.  Of course, Krugman does get just about everything else wrong.  He uses the above statement to justify big deficits and big spending.  But I maintain that the big deficits are not so much the problem as the big spending.

Virtually all government spending is a misallocation of resources.  Some spending is more wasteful (or harmful) than other spending.  But most or all of it is malinvestment and it makes us poorer than we should be.

I recently read that Murray Rothbard said that government spending harms recoveries (from a previous artificial boom) because all government spending goes toward consumption.  That means that it reduces savings and savings is one of the necessary elements for recovery and new prosperity.  Since every dollar the government spends is consumption and not savings (although I’m not sure if I am completely on board with this), more government spending is harmful to savings and therefore harmful to recoveries.

The biggest reason the massive deficits are so bad is because it allows the government to spend vastly bigger amounts of money today.  If it weren’t for the Federal Reserve (and I suppose you could blame foreign governments like Japan and China too) buying government debt, then Congress would be forced to come closer to a balanced budget, probably through less spending.  So in this sense, deficits are really bad because it allows for massive government spending.

But Krugman is correct that much of the debt is owed to other Americans.  Some of it is also owed to foreigners as he noted.  Some of it is owed to the Federal Reserve.

But let’s take an individual American who holds a government bond.  (Actually, it wouldn’t matter much if the person were a foreigner, as the same concept would hold.  There would just be an additional step of exchanging currencies or importing or exporting goods or services.)  When the individual redeems the principal of the bond because it has matured, let’s say the government taxes the American people to pay the bondholder.  It is simply a transfer of wealth.  In a sense, there is still a misallocation of resources because people are being taxed.  But at least the money ends up back in an individual American’s hands.  That person can then use the resources as he pleases.  This may include saving the money.

So in this example, the government spending (repaying the bond) is not necessarily all consumption.  It hasn’t really consumed any resources other than the administrative costs of collecting the money and paying the money to the bondholder.  Other than that, it is a pure transfer of wealth.  But this is actually better for the economy than if the government had just spent the money building some monument or museum.  At least the money could then be saved and not consumed.

My whole point about this is that deficits and debt do not burden future generations in the sense that people think.  It hurts future generations in that there is less capital investment taking place today.  But future generations can also just repudiate the debt and be done with it.  The big harm is actually happening now.  The massive deficits are allowing massive government spending, which is severely harming the economy with major misallocations.

There would actually be less distortions if the government simply collected all of the money and then handed it back out, even if redistribution were taking place.  At least people could save more money and we might actually see some real economic growth taking place.

Is Obama About to Seize Retirement Accounts?

One of the great things about writing for a blog is that I get to see various statistics about my past posts. One thing I find interesting is how some people find my posts.  From looking at this data, I can see that Google searches about 401k and IRA confiscation are becoming more common.  It is a real concern for many Americans now, and even more so after the Cyprus banking debacle.  Virtually no assets are safe anymore.

So should we worry about the government trying to confiscate retirement accounts?  I have written about this before.  I definitely think the government will try.  And it is not just Obama or the Democrats.  I think it will be tried by almost any politician who thinks it can be done.  The bigger question is whether the government will succeed.

Obama is releasing his proposed budget this week.  I’m not sure how seriously it should be taken, but he is firing a shot across our bow.  A piece of his proposal involves limiting retirement accounts.

(By the way, I am not sure how something like this is part of a “budget”.  Isn’t a budget about what is going to be spent?  I guess Obama considers 401k and IRA contributions as government spending because it is depriving the government of money.  It is scary that this is how these politicians think.)

I don’t know the details of Obama’s proposal yet.  If it is something more interesting than what I think, maybe I will write more about it.  But for now, Obama and his minions are saying that $3,000,000 in retirement is enough.  As if he should decide what “enough” is.

Does this mean that people will not be able to contribute more once it hits this amount?  Does it mean that the account is not allowed to grow anymore?  You will already pay taxes on this money when it is taken out, unless it is a Roth IRA.  Will there be an additional tax on anything over 3 million dollars?

Regardless of what the proposal is, this is a first step.  They are trying to get their foot in the door by playing class warfare with something that seems fairly harmless.

But this is like every other government program.  It is putting the frog into a pot of water and turning up the heat slowly.  You don’t throw the frog into a boiling pot or he will jump out.  We see this with gun control.  The government is always trying to take seemingly modest steps like banning certain weapons or expanding background checks.  It is a slow progression to get where they want.

I think this is what we have to watch out for.  The government will not just sweep in and announce that it is taking a percentage of everyone’s retirement portfolio.  It will be done in much subtler ways.  It will be done in baby steps.  Obama is trying to take a baby step with his proposal.  We need to call everyone’s attention to what he is doing and the tactic he is using.

The income tax was put into effect in 1913 with the argument that it would only be a small tax on high income earners.  Within a few short years, it was high rates hitting the middle class.  We must draw a line in the sand at the beginning.  We can start by speaking loudly against any government proposal to go after retirement accounts.

The Ron Paul Homeschool Curriculum

It is here.  The Ron Paul Homeschool Curriculum.  They are already signing people up.  It will start on September 2, 2013.  I’m guessing there will be some bugs to work out at the beginning.  I’m also guessing that there will be a lot more material added as time goes on.

I can’t think of a better use for Ron Paul’s time and energy.  Actually, I don’t know how much time he really has to put into it.  It is being headed up by Gary North.  They will have teachers like Tom Woods, the great libertarian.  Tom Woods is one of the clearest thinkers I have read or heard.  It is good to have him on our side.

So maybe Ron Paul is just giving his name to this project.  I don’t know how much time he will put in overseeing the whole project.  Either way, as long as it is done well, it will be a great thing.

This really sums up Ron Paul’s life.  This whole project actually represents virtually everything that needs to be done for greater liberty.  It is quite symbolic in this way.

The Ron Paul homeschool curriculum does the following:

  • It focuses on education, rather than politics.
  • It takes a long-term view, instead of thinking we can push a magic button and achieve liberty overnight.
  • It encourages parents to turn away from the state.  And what issue could be more important than their own children?
  • It does not seek any subsidies from the state.
  • It is a product being sold in the free market, where parents are willing to pay money in exchange for a service.  In this case, the service is a better education for their children.

These are just a few of the benefits of this project.  Ironically, as happens so often in the free market, part of it is free.  You can get the curriculum for kindergarten through 5th grade and you won’t have to pay anything.  This may be a gimmick to get people to try it.  It may result in more sales for the higher grades.  It may be to get parents to try it and spread the word to others.  Maybe it is just a free gift to the cause of liberty.  Or maybe the reasoning behind the free part is a combination of some or all of these things.

Does this matter?  Again, it is voluntary exchange.  Someone could use the program up until 5th grade and then stop.  They wouldn’t pay a dime.  There are free loaders in everything.  But how many people will realistically do this?  The price is not outrageous after that.  Any parent that homeschools their child until 5th grade is likely to sacrifice a small price each year to continue it, particularly if they like it and agree with the overall philosophy.

This is truly a grassroots project.  Imagine if they sign up 50,000 children.  Imagine if it is 100,000.  We could have a large group of children growing up with a free market education.  They won’t learn Keynesianism, except to learn that it is illogical.  They might learn some of the real history in America and the world.  They will learn that the government is not the answer to our problems.  They will learn to be responsible and to think independently.  This literally could help change the world.

We should learn from this project.  We don’t need to elect the “right” politicians.  We don’t need to change things overnight.  We need to take a long-term view and understand that we will get greater liberty as more people understand the benefits of liberty.  The Ron Paul Homeschool Curriculum will help tremendously.

The Monetary Base vs. the Money Supply

The adjusted monetary base keeps exploding.  The last 5 years has been unprecedented.  We really are in uncharted waters.

As you can see, the total monetary base is now almost $3 trillion.  It was slightly over $800 billion before the fall of 2008.  If the Fed keeps expanding at its current pace for another year, it will hit $4 trillion.  That means that the monetary base will have grown by five times in less than 6 years.  As of right now, it is almost 4 times what it was.

Yet we haven’t seen exploding consumer prices.  The stock market has been going up and you can certainly see subtle price hikes at the grocery store and gas station.  But there is no question that the price inflation has not matched the monetary base.  So what is going on here?

We have to look at another thing that has been unprecedented in the the last 5 years.  Commercial banks have not been loaning out the amount of money that they are allowed to loan out.

The banks have reserve requirements.  In the U.S., the reserve requirements have generally been around 10% in recent history.  This means that banks can loan out up to 90% of deposits.

If someone deposits $1,000 into a checking account, the bank would loan out about $900.  Now a person or company has $900 and puts it in his bank.  His bank then lends out $810 of this, while keeping 10% on reserve.  The process continues, which effectively multiples the money supply in the system by almost 10 times.  So the original $1,000 deposited into the bank becomes almost $10,000.  Even though not everyone can get their money at once, it has the appearance that all of this money is available, and people and businesses act as though it is all available.

This whole system takes place because of a lack of free enterprise in banking.  The banks, particularly the big banks, are supported by the FDIC and the Fed.  This is what enables the banks to take these crazy risks and it keeps depositors from worrying about which bank has their money and what they are doing with it.

In the past, banks would lend out most of the money it was allowed to loan out.  If it was short on its reserve fund when all of the checks cleared on a given day, it would borrow overnight money.  It would pay the federal funds rate, which is usually controlled by the Fed.  However, with the massive excess reserves, most banks don’t need overnight borrowing now.  That is why the federal funds rate has been below .25 percent since 2008.

So most of the new money that the Fed has created has gone into excess reserves in the banks.  Banks have not been using the fractional reserve process to multiply the money supply like it has in the past.  This has helped to keep a lid on price inflation.

Let’s use some nice round numbers just so we can see what we are dealing with.  The monetary base in 2008 was just over $800 billion.  We will say it was $800 billion.  The banks loaned out about $720 billion, which turned into $7.2 trillion.  You can add in the $80 billion in reserve.  This would equate to about $7.3 trillion.

Now the Fed has increased the monetary base by $2.2 trillion.  But the excess reserves have also gone up, by at least $1.7 trillion.  That means that the banks have only loaned out a small percentage of the new money created in the last five years.  It has kept down the fractional reserve process of multiplying the money supply available.

For the sake of argument, let’s say that all $2.2 trillion had been kept in reserve.  From our original estimate, it would have increased the available money supply to $9.5 trillion (7.3 + 2.2).  This is still a 30% increase over 5 years, but it is far less devastating than what the almost 300% increase in the monetary base shows.

So while the massive increase in the monetary base does add to the available money supply and eventually to price inflation, its bad effects have been somewhat minimized, at least up until now, because banks have chosen to build up massive excess reserves, and consumers and businesses have chosen not to borrow as much.

In conclusion, we must continue to watch both the adjusted monetary base and the bank excess reserves.  This will help us be more aware of the looming threat of severe consumer price inflation.

Obama on Gun Control and Government Tyranny

Barack Obama recently gave a speech about gun control.  In it, he addressed an argument used by gun rights advocates (not used often enough in my opinion).  He commented on the position that essentially says we shouldn’t have more gun control because it is a last resort against a tyrannical government.

In his speech, Obama said the following:
“You hear some of these quotes: ‘I need a gun to protect myself from the government.  We can’t do background checks because the government’s going to come take my guns away.’  The government’s us.  These officials are elected by you…I am constrained as they are constrained by the system that our founders put in place.”
First off, if you watch the two minute segment, Obama comes across as a bumbling idiot.  He almost reminded me of Bush.  Who really thinks this guy is a good speaker?  Maybe he’s ok with a teleprompter, but he doesn’t have an original thought in his head.
Second, I find it amusing that Obama feels it is even necessary to counter this argument.  I have brought up this libertarian argument several times with friends and many of them have never heard it before.  They may be for or against more gun control, but they think of it in terms of hunting and protection from common criminals (as opposed to government criminals).  But for Obama to address this, he must have heard this more than once before.  The fact that he felt the need to even respond shows that the liberty movement is having an impact.
Now to the meat of his statement.  Is the government really “us”.  Are Obama and “these officials” really constrained?  Obama is trying to get us to believe that just because we live in a so-called democracy (I know, it is supposed to be a constitutional republic) that the government can’t become tyrannical?
I guess Obama would like for us to forget about the hundreds of thousands of Iraqis who died because of a U.S. government invasion and occupation.  I guess we should forget about all of the weddings in Afghanistan that had U.S. bombs dropped on them.  And let’s forget about all of the innocent children in Pakistan who have died from U.S. drone bombings.  Oh no Obama, the government couldn’t possibly do any harm, because we have elections.
This whole democracy thing is such a fraud.  Obama only got about 66 million votes in 2012 out of a country of over 300 million people.  And probably half the people who voted for him were simply voting against Romney and the Republicans.  Aside from this, it doesn’t matter what percentage of people vote for the winning candidate.  The government runs secret operations all the time.  How are people supposed to monitor what is going on inside the Defense Department, the CIA, the FBI, or any of the other agencies?
Before Hitler came into power, Germany was a democracy.  Hitler took over and became dictator.  Why couldn’t Obama do the same?  As long as it were blessed by the Supreme Court, then everything would be fine with the anti-nullification crowd, which is presumably many of the same people as the anti-gun crowd.
If Americans are well-armed, then perhaps we don’t need to worry about Obama going too far overboard in abusing his power against the American people, as long as enough Americans are on the side of liberty.  But if Americans are disarmed (except for the government), then what is to protect our precious democracy that Obama talks about?  Obama could just declare himself dictator, get the blessing of the Supreme Court, and then order the military to enforce what he says.  While this may seem impossible right now, it would certainly be far easier for a president to accomplish this in the future if Americans were disarmed.
The fact is that governments of the 20th century killed well over 100 million of its own people, and this doesn’t even count the hundreds of millions more who died fighting other countries in wars.  A well-armed society is symbolic of a free society, just as a disarmed society is symbolic of an unfree society.  This is not to say that we will see mass genocide in any country that bans guns.  But, it does make it more likely to happen in the future and it certainly makes it more likely that there will be a more tyrannical government, particularly to its own people.
I am glad that Obama addressed this subject.  It just draws more attention to the fact that we really do have to fear our own government, regardless of whether we are considered a democracy.

Moore’s Law and Saving

Moore’s law, named after Intel co-founder Gordon Moore, is the observation that over the history of computing hardware, the number of transistors on integrated circuits doubles approximately every two years.  In other words, computing power doubles.  This has been changed to 18 months.

You can apply Moore’s law to many electronic devices.  You can see it with your own eyes.  Television screens are bigger and better.  Cameras are smaller, with far better quality.  I-phones today take better pictures than most digital cameras did just 5 years ago.  Cell phones and other mobile devices are like handheld computers now.  And most of these products get more and more affordable, even in the face of rising inflation.

Many electronics are getting better exponentially.  Even with a doubling of chip size every 18 months, this means that we can’t even conceive of what will be available in ten short years from now.

There is no reason that Moore’s law could not apply to other areas like cars and medicine.  Cars do get better and a lot of it is due to better electronic technology.  But cars are not keeping pace with computers in general.  Medicine is not keeping pace at all.  There is certainly some modern medicine that is incredible, but the prices keep going up and the quality is only getting better in certain select areas (again, usually dealing with electronics).

I believe that government never had a chance to get its hands on computers soon enough.  The technology exploded faster than government could react.  The government certainly would not have allowed the internet to come into existence if it had known what would happen.  Unfortunately, in an area like medicine, it is heavily regulated, controlled, and subsidized by government (at all levels).  This is the main reason that we have not seen the major advancements to the same degree as the computer industry.

I am a long-term optimist and a short-term pessimist.  Moore’s law is a reason to be highly optimistic.  It means that technology can outrun the bureaucracy of government.

But it also raises an interesting question.  If we are going to see incredible advancements over the next 20 years, is there much incentive for a young person to save now?  It is a tough question to answer because it is impossible to know what the future holds.

If 3-D printing and other technologies we can’t conceive of come to fruition, then what will that mean for us?  If a 3-D printer can one day build a house for a fraction of what it costs now, does that make real estate investing a bad choice now?

In fact, what if we have robots that can serve us our food and do our chores?  What if we only have to work a fraction of the time to enjoy the same (or better) standard of living that we enjoy now?

If you save and invest your money now, does it really pay off later?  There is an argument to be made that we may as well enjoy life now because we will be even richer in the future anyway.  Of course, if everyone took this advice and stopped saving, then we wouldn’t see technology continue to advance.  But from an individual perspective, there is an argument to be made that saving money now is not that beneficial for the future.

I think it is an interesting subject.  And again, it is impossible to know what will happen in the future.  Because of the uncertain future, I think it is good to strike a balance.  I think this is good advice anyway.

Hopefully you make enough money that you can save some of it and still enjoy life to a certain degree now.  It is important to find the best bang for your buck now, in terms of happiness.  You may enjoy driving a $100,000 car now, but it is probably not the best bang for your buck.  You have to find that balance between enjoying life now and planning for the future.

Even if Moore’s law continues and we see great advancements in technology from where we are now, I still think saving and investing will likely be beneficial.  You will be ahead of many other people and may be able to get in on the new technology first.  And if Moore’s law doesn’t continue, you will certainly be glad you saved money so that you can hopefully maintain a relatively high standard of living.

It will be interesting to look at this subject again in another 10 or 20 years and compare it to now.  I really don’t have any idea on what the future holds.

Gold Update – April 2, 2013

Gold prices struggled again earlier today, closing at approximately $1,575 per ounce.  While gold has not fallen much lately, it also hasn’t gone up much.  It seems to be trading in a somewhat narrow range. This is surprising many gold bugs.

There are certainly many reasons to favor gold right now.  Bernanke is creating digital money out of thin air like crazy.  It really is unprecedented what he and the Fed have done in the last 5 years.  Meanwhile, Cyprus has taught us that banks are no longer safe and that there is really nowhere you can get complete safety.  On top of all of this, the U.S. government keeps spending crazy amounts of money, racking up more debt, and ignoring the massive unfunded liabilities from the so-called entitlement programs.

Of course, there might be a few reasons to be bearish on gold.  While the U.S. dollar is a fiat currency that seems like garbage to some inside the hard money camp, it is still more highly favored than the euro because of the disastrous European Union.  Even the Japanese yen is not strong these days, as the government there is threatening much higher inflation.  Another reason to possibly be bearish on gold is just the fact that it may not do well in a recession and it is obvious that the economy is struggling.

Still, if you think gold should be going much higher, then don’t second guess yourself.  I don’t think you should ever put all of your eggs in one basket, but now is certainly an opportunity to expand your position in gold.  The same goes for gold stocks, which have really been beaten down.

It is important to remember that gold was less than $300 an ounce back in 2001.  If you look at it in this context, it has been an incredible investment.  It is not surprising that it would take a “breather”, even if it is poised to go higher.

The lack of excitement in gold these days is a good refresher lesson for Austrian school economists.  While you think gold should be going higher, most other people don’t (or are at least not excited enough to take any action to buy it).  You can’t predict the future.  In fact, that is really what Austrian economics teaches us.  Everything is dependent on human action.  I can’t predict whether my next door neighbor will wake up tomorrow morning and suddenly want to get out of the dollar and buy gold.  I certainly can’t predict what billions of people around the world will do.

The only thing we can do is take a good guess based on what we know to be true.  The fact that Bernanke and company are creating massive monetary inflation is an indication that prices are likely to go up in the future.  Right now, the new money seems to be flooding into the stock market.  Maybe we will see much higher oil prices next.  Maybe it will be food.  Maybe it will be gold and silver.  Or maybe it will be all of the above.

Now is actually the time to make money.  If you think gold is going higher, don’t wait for confirmation.  If you wait until it hits $2,000 per ounce, then you will have missed out on the easy money.  And even worse, you might be afraid to buy at that point.  If you really think gold is going higher, don’t wait for the mania to hit.  Get in at the bottom (which was really over a decade ago) and watch everyone else chase the mania.  If you are really good, then you will take some dollar profits when the mania does hit.

This is important for any potential investment or entrepreneurial activity.  Sometimes you shouldn’t wait for confirmation.  If you wait, then you will have missed the opportunity.  If you see something that others don’t, then take advantage of it while the others are still blind to it.

Murray Rothbard on Fractional Reserve Banking

I have written before on the subject of fractional reserve banking.  I believe the federal government and central bank enable fractional reserve banking, at least to a large degree.  While I don’t necessarily think it is good practice, I don’t necessarily view it as a criminal act, particularly if there is no intentional fraud.  If banking customers are aware that their deposits are being used by the bank (and in return probably getting higher interest rates or lower bank fees), then the banks should not be held criminally liable if depositors cannot be made whole.

The subject of fractional reserve banking has been a hotly debated topic within the Austrian school of economics.  Many of the heavy Austrian hitters think it should be illegal, but I’m not exactly sure what they think the penalties should be.  Would bankers go to jail in their world or be personally liable?  I’m not sure that there is any standard position.

I should note that (and this, I believe is consistent with Mises’ position) in a world with free banking and no government backstop, fractional reserve banking would be far more limited.  Threats of bank runs and bankruptcy would tend to keep banks in check.

I found it interesting to read recently, Chapter 8 of The Case Against the Fed, written by Murray Rothbard.  It was published as an article on Mises.org.  I read this book about 10 years ago when I was just getting entrenched into libertarianism.  It was the first full book I read on the Fed.  I did not remember the first paragraph of this chapter.  Rothbard started the chapter as follows:

“The fractional-reserve banker, even if he violates his contract, cannot be treated as an embezzler and a criminal; but the banker must still fact the lesser, but still unwelcome fact of insolvency.  There are two major ways in which he can become insolvent.”

The rest of the chapter is mostly irrelevant for the purposes of this discussion.  I wish Rothbard would have expanded on this one short paragraph, whether in this book or anywhere else.  This did not stick out to me when I first read the book.  It stuck out at me immediately when I recently read this.

I had always wondered how Rothbard could hold the position he did in regards to fractional reserve banking.  Rothbard was a hardcore libertarian.  In fact, he was proud of the fact that he was an anarcho-capitalist.  Yet I could never understand how he could hold such a position on fractional reserve banking, at least from a moral aspect.

By the way, it is not inconsistent for an anarcho-capitalist to believe it should be against the law to murder, rape, steal, etc.  It is just a question of whether the law should be upheld by a monopoly state.  But in the case of fractional reserve banking, it is hard to say that it is a violation of the non-aggression principle, particularly if banking customers are aware of what the bank is offering and doing, at least in general terms.

So all along, I thought Rothbard wanted to throw bankers in jail, or at least make them pay restitution from their personal funds.  But this one paragraph contradicts everything that I thought about Rothbard and his views on the subject.  Everything else I have read by Rothbard indicates that he thinks a fractional-reserve banker is a criminal.

For Rothbard just to say that the banker must face the “unwelcome fact of insolvency” is obvious, at least to libertarians.  I don’t think many libertarians would disagree with this position.  Of course banks should face insolvency.  Most hardcore libertarians are against the FDIC and the Federal Reserve, regardless of their thoughts on fractional reserves.  Without the FDIC and central bank, then banks would be subject to insolvency like any other business.  I don’t know of many libertarians that advocate government bailouts.

There is, of course, a great difference between a banker facing criminal penalties versus facing insolvency for his business.

It makes me curious if Rothbard wrote more on this subject that I am unaware of.  I have been curious about his position on this one subject for a while now because I found it inconsistent and I highly respect his work in general.  If Rothbard were alive today, maybe I would find more agreement with him on this issue than I originally thought.

Combining Free Market Economics with Investing