tag:blogger.com,1999:blog-8897997766931633186.post2972378362501097953..comments2024-02-14T03:21:37.506-05:00Comments on Monetary Freedom: How to Privatize CurrencyBill Woolseyhttp://www.blogger.com/profile/06330232724290161369noreply@blogger.comBlogger45125tag:blogger.com,1999:blog-8897997766931633186.post-67232886314193282472010-03-27T01:59:57.111-04:002010-03-27T01:59:57.111-04:00Russ, who do you suppose is suggesting bank runs a...Russ, who do you suppose is suggesting bank runs are a good thing? How do you propose to price-ration scarce base money during a time of high demand for it?David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-22749053569478899042010-03-27T01:30:58.181-04:002010-03-27T01:30:58.181-04:00I don't understand why anybody could think a b...I don't understand why anybody could think a bank run is a good thing. Ordinarily, bank deposits are not a scarce good. You want your money, you just go get it. During a bank run, deposits become a scarce good, and thus have economic value.<br /><br />How do you allocate that value to your customers? If you prefer a bank run, then it's first come first serve, which has the unfortunate side effect of making the goods even more scarce, pushing up the value higher and higher.<br /><br />There are many more sane ways to allocate that value than a bank run.Russ Nelsonhttps://www.blogger.com/profile/17586083637805291834noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-68767817560180951592010-02-19T20:34:32.543-05:002010-02-19T20:34:32.543-05:00David:
You are focusing on the mouse while ignori...David:<br /><br />You are focusing on the mouse while ignoring the elephant. The mouse is my glossing over the fact that as the bank loses the first 30 oz of assets, customers will have less faith in the bank's ability to redeem its notes, and so those notes will lose value as they start to be viewed as lottery tickets.<br /><br />The elephant is my assertion that the value of the bank's dollars is determined by the bank's assets, and not, as Bill claims, by the fact that the public has a demand for money, while the supply of that money is limited.Mike Sproulhttp://www.csun.edu/~hceco008/realbills.htmnoreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-825649543971513782010-02-19T18:19:24.052-05:002010-02-19T18:19:24.052-05:00Wow, Mike Sproul recognises the role of bank capit...Wow, Mike Sproul recognises the role of bank capital! I think that's progress.<br /><br />But, when the bank's capital is exhausted, bank customers will no longer be willing to deposit money with the bank. If the bank has zero capital, they would rather choose another bank with some skin in the game. <br /><br />Perhaps an example would help. Marac finance's parent recently raised a large amount of capital and used it to recapitalise Marac, and take some risky loans off its books. South Canterbury Finance, by contrast, a financial institution of similar size and shape operating in the same market, has not cleaned up its balance sheet or been recapitalised. Bonds in South Canterbury Finance pay 20% p.a. while bonds of Marac pay 10% p.a. Investors believe that the recapitalised firm is a much better risk. South Canterbury Finance still has a substantial amount of equity left (about 10% of its assets), but investors are not willing to fund it except on onerous terms, or with the benefit of creditworthy third party guarantees. Why? because there is risk about how much it might realise from its assets, and they don't want to carry that risk, and they want a larger buffer of capital to protect them from it, and they want a lower risk profile on its assets.<br /><br />Depositors and note holders want redeemable claims on low risk banks, and given the choice between a bank that has suspended redemption and one that has not, will choose the latter. It is only government monopolisation of the note issue and by making notes legal tender that governments have engineered irredeemable money standards.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-26813792686272762742010-02-19T17:14:09.800-05:002010-02-19T17:14:09.800-05:00Bill and David:
An example might clarify things. ...Bill and David:<br /><br />An example might clarify things. Suppose a bank has issued 100 currency units ('dollars'). Each dollar is redeemable at the bank for 1 oz. of silver. The bank's assets consist of 10 oz of silver plus marketable securities worth 120 oz. The bank has also issued 10 shares of stock, which must be worth 3 oz. each. <br /><br />If the bank's securities fall in value by 30 oz, the bank's stock becomes worthless, but it still has 100 oz. of assets backing $100, so each dollar is still worth 1 oz. But now if the assets fall by another 10 oz, the bank has $100 laying claim to only 90 oz, so the market price of each dollar must fall to .9 oz. It is now hopeless for the bank to try to maintain convertibility at 1 oz/$. The bank can only afford .9 oz/$. Speculators will value those dollars at .9 oz, regardless of the bank's attempts to maintain convertibility at 1 oz/$.<br /><br />So while the bank was solvent, fluctuations in asset values affected stock values, but not the value of the dollar. Once the bank became insolvent, the value of the dollar was governed by bank assets.<br /><br />If the bank maintains convertibility at 1 oz/$ it will face a run, which seems like a bad choice. The bank could also devalue to .9 oz/$. It's a breach of the original contract, but that's life. Once that is done though, customers will once again do business with the bank. For example, they would be willing to deposit .9 oz for each dollar issued by the bank. <br /><br />Another option is for the bank to suspend. The bank still has 90 oz. of assets backing $100, so speculators will value the dollar at .9 oz/$. At this point people who observe that the dollar is inconvertible might conclude that the dollar is unbacked, and you might hear people saying things like "I accept money because I can spend it" and "I would never think of the dollar as some kind of claim to the bank's assets". But those statements lead to absurd conclusions. If they were correct, and the bank's assets didn't matter, then the bank could take the 90 oz and blow it all on fast living without affecting the value of the dollar. Other banks, wanting a piece of this free lunch, would issue rival moneys. These rival moneys would reduce the demand for the dollars, with no stable solution short of zero value.<br /><br />That is why bank assets must determine the value of the bank's money, and that is why there has never been a bank that issued money without holding equal-valued assets against that money. If it is possible for a bank's money to have value in spite of the bank holding no assets against that money, where is the bank that has ever done it? You can't just wave that away by saying that it "hardly proves that money is valued like an equity claim".<br /><br />This is explained further in two of my papers:<br /><br />"Backed Money, Fiat Money, and the Real Bills Doctrine"<br /><br />and<br />"There's No Such Thing as Fiat Money"<br /><br />both of which can be found by clicking on my name above.Mike Sproulhttp://www.csun.edu/~hceco008/realbills.htmnoreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-27399005804981430702010-02-19T15:07:52.701-05:002010-02-19T15:07:52.701-05:00These examples show that financial institution deb...These examples show that financial institution debts can be suspended and restructured. However, some points are also clear from this episode of distress and suspensions:<br />1. Suspensions did not happen at the same time, and the outcomes have varied between total loss for investors, and close to full repayment.<br />2. Suspensions always implied a significant financial loss for investors, as none were remedied, and all involved either significant delays in payment, and/or significan losses of principal.<br />3. Financial institutions that had suspended payment were unable to attract new deposits, unless they had actually restructured their debts, making them solvent again.<br />4. Financial institutions that had suspended payments were unable to prticipate in the payments system any more. Although few offered payment services in the first place, the few that did have never resumed such services (no such entities actually restructured their debts, all went into receivership).<br />5. Only financial institutions of questionable solvency suspended payment of their debts. All the large banks and all credit unions and building societies have maintained payments, only finance companies have failed. All failures were caused by credit risk rather than liquidity risk.<br /><br />From all this it should be clear that a flexible legal system and the absence of banking regulations, while it does not avoid failures of financial institutions, it does ensure that the financial system as a whole can maintain payments even while some institutions do not, either temporarily or permanently, and either with or without debt restructuring.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-85152305404816430742010-02-19T15:07:27.749-05:002010-02-19T15:07:27.749-05:00Bill,
Options clauses are not banned in New Zeala...Bill,<br /><br />Options clauses are not banned in New Zealand. If you want to offer debt securities to the public, with option clauses, there is nothing in the law to stop you. And there is no licencing requirements for offering banking services or accepting deposits, and the government does not supervise or regulate banking. I.e. we have free banking here, other than for bank notes. (Well we had that, but soon deposit takers will require licences). As I have mentioned before, credit union shares are required by law to give the credit union the option of 60 days to pay them. Banks are rigistered rather than licenced: registered banks are supervised by the Reserve Bank of New Zealand, while unregistered banks and other deposit takers who issue debt securities to the public are supervised by security trustees, which are required under the Securities Act 1978, the same law that applies to issues of bonds, shares and other investments offered to the public.<br /><br />In the recent financial crisis about 24 small financial institutions in New Zealand have got into difficulty, and suspended payment. Although in all cases this amounts to breach of contract, the legal system does not require that such breach of contract result in receivership or liquidation, instead there are several other options:<br />1. The trustee can make the issuer remedy the default. Normally this would be required within 14 days in the case of a payment default, and the trust deed will set out the rules (the issuer can choose the details of their own trust deed).<br />2. The trustee can grant waivers for non-compliance, if the trustee believes it is in the best interests of investors.<br />3. The issuer can propose a debt restructuring or moratorium, to defer payments, forgive debts, or restructure debts or portions of debts into equity or capital notes or other securities. If 75% of investors by value in each class of securities agree to such proposals, they are binding on everyone.<br /><br />Several financial institutions who have suspended payment have obtained debt restructurings or moratoria in recent years. Investors have been fairly generous in granting these concessions, as they fear that receiverships could result in bigger losses.<br /><br />I will give two examples:<br />Geneva Finance Limited. A consumer lender, they converted a portion of debentures into shares in a capital restructuring approved by investors, and listed their shares on the New Zealand Alternative Exchange. The shares were issued at about 33c, but are now trading below 10c.<br />Hanover Finance Limited, a property and property development lender. Firstly they proposed a payment moratorium, which deferred payments on their debts, which was approved by investors. Then they advised that their assets had deteriorated significantly further, and proposed to convert their debentures into shares in Allied Farmers, a NZX listed company that owned Allied Nationwide Finance, which itself was in some difficulty. The transaction would result in Allied Farmers issuing about 20 times its present number of shares, and gaining nearly NZ$400m in equity, and would allow Hanover investors to sell their shares on the market. The deal was narrowly approved, and the shares promply fell to about 50% of the issue price, where they remain today.<br />continued belowDavid Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-73119152672214868112010-02-19T12:54:24.404-05:002010-02-19T12:54:24.404-05:00Mike:
The value of the banknotes or checks of any...Mike:<br /><br />The value of the banknotes or checks of any bank comes from redeemability. Banks can only redeem if they have assets. A bank without assets can't redeem. However, as long as the bank is solvent and has postive value, then the value of the assets determines the value of the bank's stock and not the value of its debts, incuding banknotes.<br /><br />Generally, banks that are insovlent fail and their banknotes and checks are not longer accepted in payment. They no longer serve as money. They are debt instruments in a failed institution--like low grade bonds. They do, of course, have prices. They have money prices, just like other low grade bonds.<br /><br />Bank money in general is valued because it can be used to purchase things. What the banks' assets might be worth are irrelevant to determining their purchasing power. Again, while it is bank equity that directly varies with the value of bank assets, banks also have a variety of nonmonetary liabilities too. <br /><br />Treating money (issued by banks or not) as if it is some kind of equity claim to the issuers assets, is implausible. I know that I accept money because I can spend it. I don't accept money because I consider it a store of wealth. And so, I really would never get to the point where I would be thinking about how it is some kind of claim to an issuer's assets, and so I need to determine my willingness to "pay" for it in terms of the amount of goods and services I will give up for it. <br /><br />The notion that banks need assets to operate and that banks without assets cannot operate, hardly proves that money is valued like an equity claim to the issuer's assets. Bank equity is an equity claim to bank assets.<br /><br />As for government fiat currency, the question is whether the nominal quantity will adjust to the demand. This policy decision only related to government assets in the most unusual situation. A goverment can intend to issue money without any concern about removing it from circulation, so its ability to do so is irrelevant.Bill Woolseyhttps://www.blogger.com/profile/06330232724290161369noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-12381629903430558652010-02-19T12:35:13.340-05:002010-02-19T12:35:13.340-05:00David:
Option clauses allow banks to suspend paym...David:<br /><br />Option clauses allow banks to suspend payment. Exercize of the option is not a violation of contract, however, such clauses were banned years ago. <br /><br />I don't think there is much experience of banks with option clauses operating under the clause in the context of a competitve system of banks that maintain redeemability. It is almost certain that their checks or other banknotes would not be accepted at par with those of other banks during that period. <br /><br />It would be bad for the bank that it had to suspend payments. Surely, it would permanently lose customers because of this problem. But these clauses did exist. Apparently, depositor and bank found them better than some scheme of having the bank pay up on demand until all sources of funds are gone and then having it closed and liquidated.<br /><br />In the U.S., during the 19th century, suspensions were illegal. But they were done anyway and by all the banks at once. While checks were accepted in payment at par, and cleared, (with gold trading at a premium,) the banks didn't do much in the way of extending new credit. They did continue to collect on loans, and the quantity of money did contract. As a gold inflow developed, the banks would build up their gold reserve. And then they could resume payment.<br /><br />The legal system at the time required that all the banks (at least national banks) be closed and liquidated if they couldn't pay off on demand. You know, they would lose their charters for failing to keep to the rules of paying on demand. There would be no banks.<br /><br />Anyway, my view is that the suspensions were better than the alternative--closing and liquidating all the banks. On the other hand, if the banks all had option clauses, then these situations would have resulted in all the banks exercising the option at once. It would have been like the suspension, but without being illegal.<br /><br />The hard money position is that by banning the option clause and closing and liquidating any bank that fails to pay on demand, banks would be motivated to hold more or less 100% gold reserves. And so, they would be able to pay gold to everyone on demand. Banning the option clause and closing banks if they fail to pay on demand serves the "public good" of making sure that paper money is matched 100% by gold, and so the quantity of paper money always changes with the quantity of gold.<br /><br />It is a violation of freedom of contract in order to promote hard money ideology.Bill Woolseyhttps://www.blogger.com/profile/06330232724290161369noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-72917461060673076602010-02-18T23:10:40.751-05:002010-02-18T23:10:40.751-05:00continued from above ...
The commercial difference...continued from above ...<br />The commercial difference is also obvious. An obligation that isn't being honoured is not worth as much as an obligation that is being honoured, and might not be honoured for a period of time. Finance theory is that instruments are valued at discounted expected future cash flows, and thus the question of discount rate and expected cash flows arise. In the case of a financial crisis or an institution that is troubled, as will typically be the case in a suspension, discount rates are high, and obligations that won't be honoured for a year might trade at a 30% discount. Bridgecorp debentures, for example, are basically worthless, as the receiver has estimated that debenture holders might not get anything at all from the receivership.<br /><br />Even in the case of a central banking system, insolvent commercial banks are unable to mediate transactions or attract unsecured deposits, because they are not honouring their obligations in central bank notes.<br /><br />The fact that insolvent commercial banks cannot mediate transactions is part of the motivation for bank regulators requiring large banks to be able to effect rapid creditor recapitalisation in the event of bank failure. Such a resolution of a failed large bank could enable the bank to continue to mediate transactions within a short time (e.g. 1 business day). Just suspending payment without recapitalisation does not allow this.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-21083843033511953832010-02-18T23:10:14.486-05:002010-02-18T23:10:14.486-05:00Mike,
No, I'm still not convinced that under ...Mike,<br /><br />No, I'm still not convinced that under a free banking system on a metallic standard, a financial institution can attract unsecured call funding such as new deposits on current accounts, or new note issues, in exchange for metal or metal's worth at par, when it isn't honouring redemption obligations. I don't think people would exchange good funds for claims on an entity that isn't honouring its obligations. I also don't think it is desirable, in general, for an entity that is not honouring its obligations, to be investing cash into new loans and investments (there may be limited exceptions to this rule). I don't think the entity's liabilities can mediate transactions, because their commercial worth will be something less than par. Also, if all banks have suspended redemptions in metal, each bank will have different assets and different prospects for what value it can retire or redeem its obligations for, eventurally (e.g. when it might re-commence redemptions). This makes inter-bank payments at par impossible. If a clearinghouse's loan certificates are being treated as the standard of money (even if illegally), and the other banks are honouring their obligations in clearinghouse loan certificates if not in metal, then yes, their obligations can continue to mediate transactions. I expect this might be the case with the Suffolk system during the panic, but I have not investigated this yet.<br /><br />Mike wrote: <br />'So what's the difference between a weekend suspension and one that lasts a year or more?'<br /><br />There is a legal and commercial difference between the two. The legal difference is that the former is not a breach of contract, and the latter is.<br /><br />It is an implied condition of the bank-customer contract that over-the-counter redemption demands of current account balances must be made during business hours on a business day, so the bank does not breach its obligation by not offering redemption overnight. <br /><br />For cheques (bills of exchange drawn on a bank and payable on demand), negotiable instrument law requires presentation of the instrument for payment:<br />'Presentment must be made by the holder, or by some person authorised to receive payment on his behalf, at a reasonable hour on a business day, at the proper place as hereinafter defined, either to the person designated by the bill as payer, or to some person authorised to pay or refuse payment on his behalf, if by the exercise of reasonable diligence such person can there be found.' (Bills of Exchange Act 1908 (NZ), S 45 (2) (c)).<br /><br />In the case of bank notes, presentment for payment is also necessary, so long as a place of payment is specified:<br />'88 Presentment of note for payment<br />(1) Where a promissory note is in the body of it made payable at a particular place, it must be presented for payment at that place in order to render the maker liable; but in any other case presentment for payment is not necessary in order to render the maker liable.'<br />Bills of Exchange Act 1908 (NZ)<br />I have noticed that bank notes that include a promise of payment, such as those issued by banks in Scotland, Northern Ireland and Hong Kong specify a place of payment ('here' or 'at our offices here'), and I expect this is to make presentment for payment necessary under negotiable instrument law. See http://www.lostsoulblog.com/2008/11/banking-defined-and-defended-part-1.html for an example of the wording on a bank note: 'promises to pay here'. The rules for presentment of bills of exchange for payments also apply to promissory notes.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-78989794749937482412010-02-18T22:05:43.577-05:002010-02-18T22:05:43.577-05:00David:
Excellent example. I assume you agree that...David:<br /><br />Excellent example. I assume you agree that banks can continue operations under a suspension.<br /><br />Bill: <br /><br />You never gave the name of a bank that ever issued money without holding assets against that money. If you agree that there never has been such a bank, what makes you accept a theory that says that bank assets are not the determinant of the value of money?<br /><br />A related point: If a bank's money is convertible, the bank must have sufficient assets to buy back its money at par. But even this kind of bank suspends convertibility every night and weekend. Over the weekend, people will value the bank's money because they know the bank's assets are still there. So what's the difference between a weekend suspension and one that lasts a year or more? At what point would you say that the money stops being valued as an equity claim, and starts being valued simply because the bank has limited the quantity of money? Do you go so far as to accept the view that money has value because people demand it, and they demand it because it has value?Mike Sproulhttp://www.csun.edu/~hceco008/realbills.htmnoreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-4051101453387201272010-02-16T21:19:21.315-05:002010-02-16T21:19:21.315-05:00David:
In the U.S., National Banks were regulated...David:<br /><br />In the U.S., National Banks were regulated by Federal legislation. State chartered banks were regulated by state bank regulations.Bill Woolseyhttps://www.blogger.com/profile/06330232724290161369noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-31895231351418143282010-02-16T19:10:11.540-05:002010-02-16T19:10:11.540-05:00Mike,
Here is an amusing gem from the news media ...Mike,<br /><br />Here is an amusing gem from the news media yesterday illustrating the situation when a financial institution is insolvent and trying to delay the end:<br /><br />'The court also heard that Bridgecorp's in-house lawyer emailed various staff members on March 8, 2007, seeking comment about proposed amendments to its December 2006 prospectus.<br /><br />One staff member wrote back: "Maybe we could tell them that we have no money, can't pay our bills, are holding back payments, lying to investors and brokers about why their money hasn't been paid and I'm not confident that we can meet the March interest payments to investors." <br /><br />By the time they went into receivership their situation was so bad depositors still have not got any dividends in over 2 years, and may not get any.<br /><br />In the last 3 years many financial institutions here in New Zealand have failed (none large or important, though) and several have managed to get their debts restructured and thereby avoided receivership. One recently converted all their debentures (deposits) into shares (Allied Farmers), which promptly lost 50% of their value. <br /><br />When the government introduced the deposit guarantee scheme in Oct 2008, such restructuring proposals have stopped. Investors won't agree to take haircuts if the governent is going to make them whole, in stark contrast to unfortunate investors in the other failed institutions, who have lost generally between 10-100c in the dollar.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-74875487592935581252010-02-16T15:00:17.840-05:002010-02-16T15:00:17.840-05:00Bill,
I'll check out the source you quoted. I...Bill,<br /><br />I'll check out the source you quoted. I do remember recently reading a large document by Timberlake on the influence of the Real Bills Doctrine which I found quite detailed and informative, and I have had a look at the source you quoted and I didn't find any details on the Suffolk system, and I did read Dowd's book Laissez faire banking about it, but am not greatly informed by those sources yet. However, it does appear to be a coordinated suspension of payment by the clearing house, and a temporary one.<br /><br />'Since option clauses were outlawed, the suspensions were illegal.'<br /><br />Really? what laws in the States restricted options clauses? Did they apply to notes only or to deposits as well?<br /><br />'If banks are permitted to suspend contrary to contract, then what is the benefit to the bank of an option clause?'<br /><br />An option clause would make it legal.<br /><br />'If a central bank will always lend to a bank facing a run, why bother with an option clause?'<br /><br />Central banks are not supposed to lend to banks just because they need it, they are supposed to lend on good security, and insolvent institutions are likely to have run out of such assets to offer as security.<br /><br />'If a government provides deposit insurance, what is the benefit of an option clause?'<br /><br />Where I come from we don't have deposit insurance. Unfortunately we have had a Crown Deposit Guarantee Scheme since Oct 2008, which is due to expire in Oct 2010, with an extension available until the end of 2011. The Treasury and the Reserve Bank of New Zealand advised the Minister of Finance on Friday 10 Oct 2008 that the scheme was not necessary, and not recommended, so he worked all weekend and introduced the scheme on Sunday 12th Oct 2008. (See http://www.lostsoulblog.com/search/label/Crown%20Deposit%20Guarantee%20Scheme )<br /><br />Nevertheless, deposit insurance does not prevent the failure of an insolvent institution, it only compensates depositors. An option clause on some liabilities could prevent default.<br /><br />Options clauses are no panacea for liquidity problems. Demand creditors still have an incentive to run, because they bear a loss during suspension, since the present value of the cashflows they will get is less than par. They actually have more incentive to run, since the clause would be invoked before failure would have occured.<br /><br />'I don't favor having all money redeemable into something at a fixed price and then having the market for that good clear through changes in the prices of all goods and resources.'<br /><br />This is not the correct analysis of the market for commodity base money. The market clears not through the exchange rate or purchasing power of the commodity but through its interest rate. The opportunity cost of holding commodity money is the interest foregone on lending it to a bank or other borrower. In a small open economy, the supply of commodity base money is elastic at the world interest rate. In a closed economy it is inelastic, and the interest rate rations the stock of it to those who are willing to pay the opportunity cost of holding it. I have developed a macroeconomic model based on this analysis, showing how the exchange rate and interest rate are determined in a closed economy on a commodity money standard.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-60081673201889635962010-02-16T06:50:55.055-05:002010-02-16T06:50:55.055-05:00David:
It was called a Clearinghouse.
Richard H....David:<br /><br />It was called a Clearinghouse.<br /><br />Richard H. Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (University of Chicago Press, 1993) is a good source.<br /><br />Since option clauses were outlawed, the suspensions were illegal.<br /><br />If banks are permitted to suspend contrary to contract, then what is the benefit to the bank of an option clause?<br /><br />If a central bank will always lend to a bank facing a run, why bother with an option clause?<br /><br />If a government provides deposit insurance, what is the benefit of an option clause?<br /><br />The option clause is a contractual arrangement that substitutes for a lender of last resort or deposit insurance to avoid runs when the alternative is strict enforcement of contracts requiring payment on demand.<br /><br />As far as I know, the overnight commercial paper utilized by the investment banks to fund their mortgage backed securities could have had an option clause. Of course, it doesn't help if the problem is that the assets are worth less than the liabilities. The option clause is supposed to help with liquidity problems, not insolvency problems. Central banking is an alternative solution.<br /><br />P.S. I am old enough to remember when checks could be used in the U.S. without electronic verification and I can assure you that the merchants didn't know all of their customers personally. I have written checks and had them accepted and the merchant didn't know me.<br /><br />P.P.S. I don't favor having all money redeemable into something at a fixed price and then having the market for that good clear through changes in the prices of all goods and resources. The nominal quantity anchoring money and prices should be a three percent growth path for aggregate nominal expenditures. The quantity of money should vary with changes in the demand, and its purchasing power should vary according to fluctuations in productivity.Bill Woolseyhttps://www.blogger.com/profile/06330232724290161369noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-6038094364235432342010-02-16T03:11:56.549-05:002010-02-16T03:11:56.549-05:00Mike: "In the meantime the notes of all banks...Mike: "In the meantime the notes of all banks will be received at the different banks, as usual, in the payment of debts, and in deposite..."<br /><br />Sounds like several banks linked together in some kind of financial union.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-27821486242243790732010-02-16T01:44:14.323-05:002010-02-16T01:44:14.323-05:00David:
"I don't understand why some peop...David:<br /><br />"I don't understand why some people think that a bank can carry on in business while it has suspended payment of its debts."<br /><br />From Rolnick, et.al. "The Suffolk Bank and the Panic of 1837", FRB Minneapolis Quarterly Review, Spring 2000:<br /><br />"In the meantime the notes of all banks will be received at the different banks, as usual, in the payment of debts, and in deposite..."<br /><br />The above paper, plus Peter L. Rousseau on "Jacksonian Monetary Policy, Specie Flows, and the Panic of 1837", NBER Working paper 7528, should convince you that banks do indeed carry on business during suspensions.Mike Sproulhttp://www.csun.edu/~hceco008/realbills.htmnoreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-58061927341527922602010-02-15T23:24:49.344-05:002010-02-15T23:24:49.344-05:00Bill wrote: 'The problem with your analysis is...Bill wrote: 'The problem with your analysis is that option clause did exist for notes that were not legal tender and no premium was paid.'<br />No, my analysis would only suggest that such instruments were in danger of being out-competed by instruments without them. As far as I understand such notes only existed in Scotland. Do you have any other historical examples? Although the Scottish case did end with a ban rather than being out-competed, if there were other examples, these could be instructive.<br /><br />In the case of bank deposits, there is no restriction on such clauses, yet they are not commonly used by banks. The only examples I know of are credit unions, where the option comes only as a result of legislation:<br />'Credit union to have shares<br />(1) Every credit union shall have shares, which shall all rank equally and be of a fixed amount of $1 denomination and may, subject to the rules of the credit union, be subscribed for either in full or by periodical or other subscriptions; but no share shall be allotted to a member until it has been fully paid in cash.<br />...<br />(4) Subject to subsection (5) of this section, shares in a credit union shall be withdrawable; but a credit union shall not issue shares except on terms enabling it to require not less than 60 days' notice of withdrawal'<br />(Friendly Societies and Credit Unions Act 1982 (NZ) This Act is currently under review to be modernised, this provision is archaic, and is likely to go).<br /><br />Bill wrote:<br />'Further, checks were accepted and did clear among banks that had suspended payment.'<br />Is this during a central banking system where the central bank's notes were legal tender? As far as I understand this was the case during the restriction period in the UK. Can you find an example of a free banking system (no central bank, metallic money standard) where a single bank suspended payment while others did not, and continued to do business such as clearing cheques? In Australia in the 1890s when the banks suspended payment, they opened separate trust accounts so they could avoid tainting the funds in the new accounts with the resolution of the suspended bank's affairs (through debt restructuring).<br /><br />Bill wrote:<br />'I think your error is thinking of banknotes as stand alone investment vehicles rather than like checks.'<br /><br />That is not an error. Cheques rely on the credit of the drawer, and are only accepted by people who accept the credit of the drawer. If the merchant doesn't know you, he is unlikely to accept your cheque. These days merchants can electronically vet the drawer before acceptance of the cheque, to see if the drawer has drawn dishonoured cheques before. However, bank notes rely on the credit of the bank, not the credit of the drawer. These days bank cheques are somewhat like bank notes (legally they are bank notes, since the bank is both the drawer and the drawee), and the New Zealand courts have held that bank cheques have the commercial status as cash, and are legal tender for settlement of dealings in land, subject only to the solvency of the bank (land transactions are normally settled by bank cheques in New Zealand). Another modern example is traveller's cheques. These rely on the credit of the financial institution that issues them rather than the person presenting them, and is accepted in cases where a cheque drawn by the customer would not be.<br /><br />Bank issued money needs to have some anchor with something, without this we end up with unanchored fiat money such as we have today. Exchange rates are up and down, and the notes cannot be redeemed into anything in particular. Are you suggesting this is not a bad state of affairs?<br /><br />The fact that they may be used for short term dealing purposes is not relevant.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-8735831638994445152010-02-15T22:55:58.893-05:002010-02-15T22:55:58.893-05:00David:
The problem with your analysis is that opt...David:<br /><br />The problem with your analysis is that option clause did exist for notes that were not legal tender and no premium was paid.<br /><br />Further, checks were accepted and did clear among banks that had suspended payment. People did accept the checks because they wanted the business. Banks did accept them for deposit because they would clear. Those receiving the checks could then spend them. In effect, banks with adverse clearings borrowed from banks with favorable clearings. And, of course, repaid those loans when they obtained favorable clearings.<br /><br />I think your error is thinking of banknotes as stand alone investment vehicles rather than like checks.<br /><br />Think of banks offering checkable deposits and paying out banknotes to their depositors who spend them. Deposits with an option clause are better because they pay more interest. Banknotes? Who cares about those?<br /><br />And merchants accept banknotes like they accept checks. To deposit them, not to hold them as a store of wealth.Bill Woolseyhttps://www.blogger.com/profile/06330232724290161369noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-5668316474976350332010-02-15T22:52:12.379-05:002010-02-15T22:52:12.379-05:00This comment has been removed by the author.Bill Woolseyhttps://www.blogger.com/profile/06330232724290161369noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-10025738363529985342010-02-15T21:32:10.692-05:002010-02-15T21:32:10.692-05:00Mike,
I'm not convinced that runs on insolven...Mike,<br /><br />I'm not convinced that runs on insolvent institutions are a bad thing. But if they are a bad thing, and the better solution is to suspend payment, and then restructure or liquidate the institution, the only differences between the two are a) it could close/restructure an insolvent bank sooner and b) it could distribute the losses more equitably. Losses to unsecured creditors of banks will typically not be 100%. The ANZ National Bank uses between 41% and 65% 'Loss given default' assumptions for its exposures to other banks (see p 57 of http://www.anz.co.nz/resources/2/f/2f937980406b85f7b8e2f87a4567b714/GDS-20092411.pdf )<br /><br />I don't understand why some people think that a bank can carry on in business while it has suspended payment of its debts. This being the case it has no money to lend (and if it did lend, that would be illegal and/or unethical, since those funds should go to the bank's creditors), and no one will lend to it, since it isn't paying people back. No one will deposit cheques for it to collect, since the funds would go to accounts that the bank is not honouring. No one would accept cheques drawn by the bank's customers because they won't be honoured, and even if they were able to be honoured in the bank's books (e.g. the drawer and the payee are both customers of the drawee bank), the payee would rather not accept the cheque in the first place, and would present the cheque for payment at the counter, or if the cheque is crossed, open an account with another bank, whereupon it would be dishonoured, and the payee would have a right against the drawer. If the cheque was crossed specially to the drawee bank, the payee would have no choice but to deposit it with the drawee bank for collection.<br /><br />There are only 2 ways for such a bank to continue: if its notes are legal tender. This is anti-free banking. The other is to set aside either all or some proportion of the funds owed and that will not be honoured or fully honoured, which funds can recapitalise the bank, and the new or remaining funds can thus be honoured.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-85172736083554472612010-02-15T21:16:49.625-05:002010-02-15T21:16:49.625-05:00Bill,
I have to apologise on behalf of some free ...Bill,<br /><br />I have to apologise on behalf of some free bankers (Dowd is the one I mean) for woeful analysis of option clauses. Although I have no problem with option clauses, should the banks wish to insert them and should people demand to hold them, I think that such clauses are not viable. Competition between issuers of currency is non-price competition, so the highest quality and best service bank notes and issuers should dominate the business. I would expect that banks might even offer secured bank notes to assure holders of their credit quality. (The only argument against secured bank notes is that since the notes are payable on demand the note holders are likely to get paid even if the bank fails, since the demand creditors would run off first, leaving the unsecured term creditors to carry the loss. Also the probability of default on a strong bank is next to zero, so it is not worthwhile to spend resources on mitigating this level of credit risk). <br /><br />Dowd's analysis of option clauses is woeful. An option requires a premium to be paid by the buyer (the bank of issue), and this has to be paid regardless of whether the option is excercised. Interest payments upon excercise are not proper consideration for an option, that is merely the strike price. The holders of the notes have no benefit from granting the option to the bank, and so they would rather hold claims on banks that are unconditionally payable on demand, and issued by a bank that has a good credit standing to honour that contract. To see that the holder does not benefit from the excercise of the option, note that the bank would only excercise the option if its borrowing cost was more than the strike price (the 'penalty' interest rate on the notes, which is actually not a penalty but a concession). And that's even without the loss of servicability of the notes, the holders of the notes have no interest in being unsecured term funders of the issuer.David Hillaryhttps://www.blogger.com/profile/12270742541175771322noreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-75083936613423368152010-02-15T19:58:01.242-05:002010-02-15T19:58:01.242-05:00David:
What's to disagree with? An insolvent ...David:<br /><br />What's to disagree with? An insolvent bank can either let a run go to the bitter end, leaving people at the end of the line with nothing, or it can divide up the assets equitably between the money holders (equivalent to devaluation of the currency), or it can suspend, which would leave each claimant with the same wealth as with devaluation. How is it that under your brand of free banking, banks and their customers aren't allowed to agree to suspension clauses?Mike Sproulhttp://www.csun.edu/~hceco008/realbills.htmnoreply@blogger.comtag:blogger.com,1999:blog-8897997766931633186.post-44317084170491993482010-02-15T19:28:10.842-05:002010-02-15T19:28:10.842-05:00David:
Before hard money interventionists banned ...David:<br /><br />Before hard money interventionists banned them, banks typically included an option clause, that allowed them to suspend repayment into gold in return for penalty interest payments (bonuses to those holding the money.)Bill Woolseyhttps://www.blogger.com/profile/06330232724290161369noreply@blogger.com