January 7 2009

Started learning Banking.This is how I understand money and deposit banking:

Before money, there was barter. If I produced potatoes and you produced onions, we would exchange it for mutual benefit. But, there were several problems with the barter system. For instance, if I had a bus and wanted to sell it to buy a car, washing machine and television set, I can't chop my bus into several parts and exchange it. There should also be double coincidence of wants. A person who wants to exchange potatoes for onions wants to find a person who has onions and want to buy potatoes. To quote an example of Murray Rothbard, consider the fate of an economics professor who wants to find an egg seller who would like to listen to a ten minute economics lecture! It also required people to remember the beef price of onions, egg price of milk and several other such relations. Moreover, businessmen couldn't economically calculate-which means: They can't calculate their expenditures and revenues in monetary terms and find out whether they have made a profit or not.

Money emerged when the person who has to sell onions in order to buy potatoes found out what the potato seller wanted and sold his onions to buy that item, and then exchange it for potatoes. This helped commodities which are in high demand to emerge as money. Several items were used as money in the past-Salt, cowrie shells, cigarettes etc. But in course of time, gold and silver emerges as money and in most countries gold became used as money. Gold had many properties which resulted in its use as money-It was divisible, homogenous, portable & in high demand.

Deposit banking emerged when people found it difficult to carry gold to make transactions. They found it safe to deposit in a deposit bank, which is in fact a warehouse. The deposit bank in return paid the depositors of gold warehouse receipts in the form of bank notes. These bank notes became used as money in transactions. This was the origin of paper money.

There is a possibility that the banks could inflate the money supply by issuing warehouse receipts (Bank notes).But, there would be several checks on banks in a free banking system on issuing warehouse receipts. 1) There would be bank runs. If a bank issues too many fake warehouse receipts, the clients of the bank would ask for redemption of the warehouse receipts in gold specie-which means: They would ask for gold coins in return for the warehouse receipts they hold. If the bank don't have enough gold to back it up, they would be bankrupt.2) The extent of clientele of various banks. If I use bank A and you use the Bank B- And I sell a car to you. You would pay me in warehouse receipts of the bank B.I would deposit the warehouse receipts of Bank B in Bank A and Bank A would pay me its own warehouse receipts. Bank A then would ask Bank B for redemption of its own warehouse receipts in gold specie and if it doesn't have enough gold to pay to Bank A, Bank B would go bankrupt.

There is also a possibility that banks could form cartels and inflate the money supply. But, that is very unlikely as the economic incentives for the banks to break the cartel would be enormous. Moreover, if banks for a cartel, new banks would come into existence which would ask for redemption in gold of the fake warehouse receipts and all the banks would go bankrupt. The Federal Reserve (Fed) (or Reserve Bank of India or Bank of England) is in fact a cartelization device which would enable the banks to inflate simultaneously so that redemption of the banks would cancel out each other, if they inflate at the same rate. The central bank has no check on it in inflating the money supply. And several decades back the central bank abolished the gold standard and people can't ask for redemption of paper money in gold specie. Central Banking (Fractional Reserve banking) is a fraud perpetrated on mankind.

I have learnt a lot in the past few years.But,there are some aspects of banking that I don't understand.It is getting really frustrating.I won't give up.