Money Market Funds, Part II

So, continuing yesterday's discussion: what do Austrians say about MMFs?

Let us be clear about the analogy Krugman draws between MMFs and banks. The term "fractional reserve" just means that the bank doesn't have all the money in the vault. Yes, there are a lot of checks floating around that represent the amount of money the bank is responsible to pay on demand and, yes, in the event of a bank run this is a dangerous situation. The bank only has some small fraction of the money in reserve. Hence the term.

So: what do Austrians say about that? Is this a case where their hard money views come into conflict with their laissez-faire views, and where they ought in consistency with the former to demand that the government close these dangerous fractional reserve institutions down as so many embezzlers?

Well, there are different approaches within this broad school of thought. But the general line of thought is well stated by Detlev S. Schlichter, in his recent book, Paper Money Collapse. No, Paul, he does not claim that fractional reserve banking began at the instigation of the state. But he does say that until it began receiving statist support, there were rather sharp limits to the harm it could do.

Yes, any allowance for fractional reserves, which Schlichter calls "uncovered money substitutes," also entail the risks of a boom-bust cycle, with over-investment on the one side and bank runs on the other. But under laissez faire conditions, there are limits to how "fractional" the reserves can get, and limits to how bad the resulting booms and busts can be. When governments start chartering banks, limiting competition, they reduce these limits significantly. when they create a central bank (even while still maintaining some sort of gold standard) they worsen the situation still further.

The bottom line, then, is: no, Austrians don't want to abolish fractional reserve banking and they don't see it as inherently tied to the state.

Further, as Thornton's answer to Krugman on the web page of the Ludwig von Mises Institute makes clear, much the same can be said of MMFs. First, they don't create money. Deposit holders have simply invested their deposits in short-term commercial paper.

As the Reserve Primary case reminded us, MMFs can lose value, they can be forced to "break the buck" as the saying in the industry goes, and this does not represent insolvency on the part of the fund, although it is obviously no great honor either.

MMFs then, do not add to the total money supply. They will face a more challenging envirponment in the course of any transition to a hard money standard, but there will be no need to close them down, and the supposed contradiction in the Austrian view disappears.

Much of Thornton's answer consists of a lengthy quote from a 1987 newsletter article by Joseph Salerno, the fellow pictured above. (The names of "Austrians" don't necessarily sound very Austrian these days) explaining the above point. Further, Thornton, after quoting Salerno, makes the point that Krugman didn't work very hard in researching whether the Austrians had any answer to a question he seems to have thought unanswerable.

"This quote from Joseph Salerno is from the first item to appear on a Google search for 'Austrian economics money market mutual fund.'"

Nice shot. Love it.

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