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PArt II Now, because there can very well be multiple future claims to the same present gold under 100% reserves, all that is left for 100% reserves to become inflationary to some degree is for the promissory notes to become money substitutes. What must be understood at the outset is the nature of promissory notes as future money in the context of individual time preference scales. As we know promissory notes have a future value attached to them of some amount of money added the interest earned on the note at the date of maturity. Now any given economic actor will value this future amount of money discounted back to the present by his own individual time preference rate of interest. The market clearing price these notes would tend to on any given day would be the future value discounted by the prevailing consumer loan rate. So on the day of issue these notes would trade approximately equal to the amount deposited and more thereafter. It is also reasonable to assume (and even observe today) that some actors will accept promissory notes in an exchange as the equivalent market clearing price in money. That is to say some people are likely to accept these notes as money substitutes in some exchanges. Now, the same advantages which lead bank notes to become money substitutes (and indeed any light weight material when money proper is cumbersome) under a fractional reserve system (reducing transaction and storage costs) would also apply to promissory notes under a 100% reserve system should they ever become widely circulated. However as Professor Hoppe points out in his article "How is fiat money possible" bank notes and bank receipts suffer from a huge set back in the institutional framework of 100% reserves. Namely, some people would wind up receiving receipts or bank notes with an overdue storage fee. This would, indeed make widespread use of such notes unlikely. However, promissory notes come with no such disadvantage. Rather, promissory notes grow in value as time passes by till maturity date, and banks could very well, even likely to, make the agreement that for everyday past redemption date the holder of the note does not withdraw the gold he receives some smaller (or perhaps even larger) amount of interest than previously. Thus, because promissory notes can be exchanged, and because they provide all the advantages of bank notes under a fractional reserve system and none of the disadvantages of bank notes under a 100% reserve system, they are likely to start circulating to some extent. One can imagine that retail stores in order to attract customers, and not particularly distressed by not being able to hold any more physical gold this particular year (maybe even reluctant to), would entice customers by accepting promissory notes. It can from here be easily imagined that, in a similar fashion to how bank notes replace gold for some (not insignificant) amount of transactions in a fractional reserve system, promissory notes could indeed be seen as a substitute for gold in a 100% reserve system. However there are some unique disadvantages promissory notes have when compared to bank notes as money substitutes. Namely promissory notes are for large amounts. However this poses no real obstacle. There was a time when bank receipts were also only for relatively large amounts, this does not mean that banks did not eventually break these down into smaller constituents. Indeed it is likely if promissory notes become money that they would also become standardized and come in regular denominations (or "change" if you will) such as 10 grams in two years or 20 grams in two years and so on. Another complication that would arise if promissory notes were ever used as money in a law imposed 100% reserve world is constant calculation. It would be bothersome and confusing, even with up to the minute exchange rates (in this case gold against standardized promissory notes) to have so many different valued notes floating around. However, it is unlikely that this would lead to the notes falling out of public favor when it comes to widespread exchange. Instead it is likely that this would lead to further standardization of notes. For example it might become a custom that all banks create and sell one year notes of standardized amounts at the beginning of each month, and that one year notes are the common money substitute. Due to the technological advancements in banking that have arrived with the advent of electronic banking, the internet, and online banking the complications stated above become even more minor. For example to ease the disutility of calculation a certain person's bank account would include any gold he has deposited with the bank as a demand deposit plus the market value of the gold he has deposited as a time deposit (or what would have been the market value of the promissory notes he would have received if he opted not to keep them there electronically). The value of just the time deposit part of this account alone would, in fact, tend to equal the exact value of a demand deposit account under a system of fractional reserve banking. This last insight reveals that, once the coping costs of promissory notes as money substitutes under a law imposed 100% reserve system, are minimized, promissory notes effectively become bank notes. A final note must be made on the extent to which banks would issue promissory notes given their fractional nature. The amount (and in this case value) of notes circulating divide by the amount of base money is called the multiplier. To put it simply, banks will issue as many such notes until the added risk of them not being able to meet the obligations falling on a given date exceeds the benefit of issuing another note. Because of this it is likely that banks would offer rewards to customers who delay claiming their notes. It is also likely that due to the time rigidity of promissory notes and a certain elimination of uncertainty, ceteris paribus, banks would have a higher liability to capital ratio than they would under the more uncertain system of Fractional Reserve Banking. In essence, due to promissory notes in a 100% reserve system and bank notes in a fractional reserve system both being an efficient way to structure money in time, and only having two real differences (The first being that promissory notes are claims to definite points in the future while bank notes are claims to indefinite points in the future and the second difference being that promissory notes themselves increase in value while the deposit account increases in value and not the bank notes) promissory notes lead to very similar economic consequences in a restricted 100% reserve system as do bank notes in a fractional reserve banking system with gold. In such an imaginary law imposed 100% reserve system it would be reasonable to observe standardized promissory notes trading alongside gold coin as petty cash, while bank accounts take into consideration the market equivalent weight in gold of any time deposits the customer may have with the bank. Indeed, the law imposed 100% reserve system that allows the issuing of promissory notes and the creation of time deposits is likely to look a lot like a Fractional Reserve Banking system. There would be an equal or greater multiplier of gold to money substitutes (tending to equal as coping costs drop) and an equal likelihood that a bank cannot meet its obligations on any given day. Albeit the bank, being under no obligation to pay on demand before the time deposit reaches maturity, would not be in threat of a bank run lest many promissory notes are not claimed past maturity date.
Stephan, Lee, Jake I noticed you guys discussing loans under a 100% reserve system, promissory notes and the possibility of an emergence of some fractional-reserve like character into such a system. Over at the forums I made many posts on this topic and I would like to add to the discussion and consolidate (correct, and in some cases go completely back on) my own thoughts on the matter here. I have a firm belief that there are many similarities between promissory notes (or time deposits if you will) in the institutional context of a 100% reserve system as imposed by law and bank notes under a Fractional Reserve Banking system with gold as base money, both in terms of fractional character, and in terms of being money substitutes or fiduciary media. Firstly, both bank notes and promissory notes can be viewed as claims to future base money (hereafter assumed to be gold). Depositing some amount of gold in a bank operating under a Fractional Reserve system gives to the lender a receipt or bank note as a claim to that money, and usually promises to pay some amount of interest into the account of the depositor during the time the bank still holds the base money. This bank note is essentially a claim to some amount of physical gold at some indefinite point in the future (this point in the future being whenever the holder of the note comes to demand base money). Similarly, if one were to lend to a bank operating under 100% reserves, the depositor would receive a receipt or promissory note (certificate of deposit) entitling him to claim his deposit, plus some accrued interest, at a definite point in the future (this point in the future being a mutually beneficial date agreed upon by both the bank and its customer). Furthermore, even under a system of 100% reserves, the bank and the customer would be free to negotiate an early withdrawal of the gold. In both instances while the bank holds the gold, they are free to loan this gold out to some other customer or party. Secondly, both bank notes under an FRB system and promissory notes under a 100% reserves can lead to multiple future claims to the same base money. In the case of Fractional Reserve Banking, once the bank has some amount of gold in its vault it can simply issue receipts to a borrower thus making more than one claim to the same gold. This process, however is more subtle under 100% reserves. Once the bank has borrowed money from a customer (call him A) and given him a certificate of deposit or promissory note the bank can then loan out the gold to someone else. For the simplicity of narrative assume the bank loans the full amount out. The borrower B would then trade this gold (again assume entire amount) for a good or service from yet another market participant C. Now this Mr. C can go to the bank and deposit the gold himself in exchange for a promissory note. Both A and C now own claims to the same physical gold in the present, at times in the future. Thus, at least in this fictional illustration, it is clear that multiple claims to some amount of gold may arise under the institution of 100% reserves through promissory notes. This, I believe, entails the "fractional" nature of promissory notes in the context of 100% reserve banking and also FRB banking. The next part of my argument is to do with the monetization of promissory notes under a law enforced 100% reserve system. It does NOT contribute anything to the debate whether, assuming free banking, an institution of 100% reserves or Fractional Reserve Banking would arise on the market or whether the multiplier will decrease. It merely makes an amateur argument through a comparative institutions analysis on why promissory notes could turn into money and thus be inflationary given 100% reserve banking enforced by law.