Both Mish and Karl bring up good points about what is fraudulent about our financial system. Mish feels it is more systemic and Karl thinks it is a lack of regulatory will (due to capture, corruption, etc). I have stated previously that with a proper legal foundation, no regulation is necessary. So I would have to agree more with Mish. I sent him an e-mail this morning, which I will republish here:
The best arguments against FRL I have read can be found in Jesus Huerta de Soto's Money, Bank Credit and Economic Cycles.
You touched upon this, but de Soto has a better way of explaining it through a historical (dating back thousands of years) understanding on the nature of contract law. When a depositor gives their money to a bank, they are doing so under the impression that the bank keeps their money safe. If this were not the case, people would buy bonds or some other investment. Historically, the act of keeping money safe was a service that depositors would pay for. By lending money out that has been promised to someone else, the bank is abrogating their contract with the depositor. In order to do so, the bank must consider the deposit as an asset, something the depositor simultaneously believes he has. Very simple contract law states that two separate entities can not claim ownership to the same asset. Thus, the bank is guilty of misappropriation by promising safekeeping of something they do not possess.
The confusion seems to surround the difference between two distinct types of contracts: the Monetary Irregular Deposit and the Monetary Loan. Below is a table copied from pp. 19 of Money, Bank Credit and Economic Cycles, contrasting the two types of contracts:
Monetary Irregular Deposit: 1. Present Goods are not exchanged for future goods. 2. There is complete, continuous availability in favour of the depositor. 3. There is no interest, since present goods are not exchanged for future goods.
Monetary Loan: 1. Present goods are exchanged for future goods. 2. Full availability is transferred from lender to borrower. 3. There is interest, since present foods are exchanged for future goods.
Monetary Irregular Deposit: 1. The essential element (and the depositor's main motivation) is the custody or safekeeping of the tantundum [deposit]. 2. There is no term for returning the money, but rather the contract is "on demand." 3. The depositary's obligation is to keep the tantundum available to the depositor at all times (100 percent cash reserve).
Monetary Loan: 1. The essential element is the transfer of availability of the present goods to the borrower. 2. The contract requires the establishment of a term for the return of the loan and calculation and payment of interest. 3. The borrower's obligation is to return the tantundem at the end of the term and to pay the agreed-upon interest.
Similar to a monetary irregular deposit would be the storage of crude oil in large tanks. The depositor of the oil pays the storage company a fee. The storage company cannot now go out and sell the oil - that would breach their contract.
Time and time again, throughout history, bankers have attempted to turn monetary irregular deposits into monetary loans in order to speculate with their customer's deposits. Throughout history, from Ancient Greece to the early 20th century it has been determined in courts of law that this practice is illegal. We have institutionalized it. We have created all sorts of fancy schemes in order to cover up this misappropriation (think FDIC). And we have central banks who attempt to mandate positive inflation which encourages depositors to seek return rather than safety with their life savings.
We need a banking system that clearly separates the two kinds of contracts: Depositary Institutions and Loan Intermediaries. With such a system, the central bank's ability to perpetually inflate will be castrated and a truly free-market would be able to prosper (something we have never had). Note that this does not require a gold standard for discipline. A currency could be denominated in anything so long as the legal principles of the monetary irregular deposit were upheld.
To elaborate on the last point. I am not in favour of a legislated gold standard. Although I do believe gold would have a role to play as a medium of exchange if it were permitted (ie. if legal tender laws were repealed). Many of gold's detractors fail to discriminate between Gold Exchange Standards, Bimetalism and 100% reserve gold standards. The latter has very few historical examples of any length. But this is conjecture. I am in favour of multiple competitive currencies which may be freely exchanged electronically, provided 100% reserves are kept and available at any time. There is no reason, with our current technology, for this to be prohibitively complicated. I walk into a bakery to buy a loaf of bread. I elect to pay at the cashier from my account with wheat. If the baker doesn't want wheat, he can program his account to immediately convert wheat to gold or land or whatever she chooses. The intermediary charges a small fee each time this occurs.
Separately, other intermediaries may provide participants the ability to borrow from others who are in the market to lend. Rates would vary according to the risk taken and a term would be agreed upon prior to the transaction completed.
Some Austrians argue that this would effectively end the business cycle. I disagree. There would still be a very noticeable boom/bust cycle because entrepreneurs will always display a herding behaviour and fail regularly. However, the busts would not be systemically jeopardizing due to the lack of leverage. Banks would be mere service providers, not permitted to speculate themselves. Thus, their ability to create loans prior to finding lenders, essentially playing arbitrage on current asset prices vs. inflation adjusted asset prices, will be nixed.
The giant vampire squid's blood funnel would be cut off.
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