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Bank Deposits are Not “Idle”

June 27, 2014 in Economics

By David Howden

Over at Mises Canada, my daily from earlier in the week addresses whether bank deposits are idle, as many fractional-reserve banking apologists claim.

Advocates of fractional-reserve banking err in claiming that deposits are “idle”. The prevailing belief amongst this group is that depositors don’t have any present need for their funds, and so they give them to the bank to care for them (or invest) until that point in time when they do need money.

Austrian economists are in a privileged position to address this claim, as they are amongst the few who understand money’s role in the economy.

Money is that unique good that serves as our uncertainty hedge. We don’t know when we’ll need to cover expenditures in the future, nor do we know how much they might cost. Uncertainty as to the future poses a problem to the individual. We know, in some vague way, that there are certain contingencies that can arise in the future that will demand that we spend money. It’s a toss up as to when or what these will cost.

The depositor doesn’t even know when he will need his deposit back. How is the bank supposed to estimate this?

Examples of bank runs are good examples of this disconnect. The depositor wants his money which he believes to be his for the taking. (Indeed, this is enshrined in law as the depositor is permitted to claim his deposit whenever he wants.) The bank, under the presumption of the “idleness” of this deposit has made use of it. If the depositor wants his money back he’ll have to wait for the bank’s investment to mature.

Of course, one can always resort to external help to make sure these deposit claims are always paid out in a timely manner: deposit insurance and a central bank lender of last resort are the two time tested methods. But neither of these “solutions” solves the initial problem of the lack of knowledge surrounding when the deposit will be needed. And both of those solutions come with their own set of problems.

Read more here.

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