Monday, May 17, 2010

Banking, Theory and the Crucible of Free Markets

Recently, a salvo was fired by Joseph T. Salerno in the battle between those who argue for 100% banking reserves (characterized by Salerno as the Neo-Currency School) and those who support a more lax approach, represented by Lawrence H. White. You can find White's response here.

Aside from disputing what von Mises meant when he wrote about banking on a number of occasions, it seems that Salerno's argument is that the creation of fiduciary media is sufficient to create business cycles, while White's claim is that the creation of fiduciary media in the right amount prevents depressions. To both of them I say that their approaches are simply business models. If consumers value the 100% reserves model more, it may dominate. If the fractional reserve model serves their needs better, we may see the opposite. And the likely result is that some combination of the models will co-exist, even in the same institution. And, if business cycles persist, entrepreneurs will either learn to live with them, as humanity has learned to live with the unknown future, or banks will adjust their actions to mitigate the financial impacts, learning from their market failures and successes.

Policy disputes are important in societies with large amounts of state intrusion, and if either Salerno or White had any chance of their arguments affecting the course of the Obama, or any other, Administration, I would be encouraging them to pull out the stops to mke their points. However, their arguments are for a free society, and consumers expressing their preferences will be the final arbiters.

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