In Which Winnie-the-Pooh Uses a Bank
By Arnold Kling
In an ongoing dialog with Mencius Moldbug, I changed from my favorite fruit tree metaphor.My favorite Winnie-the-Pooh story is the one where Pooh and Piglet try to catch a Heffalump. They dig a pit for a trap, and Pooh puts a jar of his honey in the pit, in order to lure the Heffalump. That night, Pooh wakes up hungry. Realizing that his only jar of honey is in the trap, he goes to retrieve it. Comedy ensues.
The analogy with banks is that banks that make long-term loans are vulnerable if their customers wake up hungry. Is unsound banking natural, or does it arise only with government? Is it ok, even if it is unsound?
Here’s the set-up. We’re on a honey standard, with jars of honey as the medium of exchange and the store of value.
A depositor can put a jar of honey in the bank, claiming the right to withdraw it any time. The bank says, full disclosure, that it plans to take some of the honey jars on deposit and lend them to entrepreneurs who plan to trap heffalumps. If nothing goes wrong, the entrepreneurs will catch the heffalumps, exchange them for honey, keep a profit, and pay back their loans with interest. The bank will keep some of the interest as profit and give the rest to depositors, who get their honey back, plus interest.
If something goes wrong, though, I may lose some or all of the honey I put on deposit. One of the things that can go wrong is a lot of us wake up hungry and ask for our honey before the heffalump traps ever mature.
Do I make the deposit? The bank says that it has the law of large numbers going for it. The chances are really small that lots of depositors will wake up hungry at the same time. There may be only a one in a million chance that I won’t get my honey back. Maybe I’m willing to take that chance.
I’m not convinced that this sort of bank is what would naturally evolve. Instead, we might see a bank that offers two types of deposits. One would be honey deposits that bear no interest. You store your honey with the bank, and you can withdraw it at any time. It stays in the vault until you ask for it.
The other deposits are long-term deposits with penalties for early withdrawal. These do not all stay in the bank–some of them are lent to heffalump entrepreneurs. The penalties would decline over time. They would rise as the bank’s supply of honey on hand falls. The penalties would ensure that everyone who waits until the heffalump traps mature will get their honey back, with interest. There is no basis for a run on the bank based on pure fear.
This bank does not pretend to offer a free lunch. You cannot make an interest-bearing deposit unless you are willing to pay a penalty for early withdrawal. The bank can use the law of large numbers (the fact that it is unlikely that most people will not withdraw at once) to specifiy that low penalties will prevail normally. But if lots of people wake up hungry at once, the higher penalties will kick in, because the bank’s reserves start to drop.
If you want an interest-bearing deposit, you know that you are taking a risk that when you want to withdraw, if it happens that other people want to withdraw also, your penalty will be high. The more confident you are that you won’t get hungry earlier, the more certain you can be of getting your honey back with interest.
Suppose government comes along and says, “Gosh, there sure are a lot of honey jars sitting idle in non-interest-bearing accounts. If we offered deposit insurance, then people would put their honey into interest-bearing accounts, and banks could fund more heffalump traps.” Does that make society better off?
Well, yeah…except, where does the government get the honey to cover its deposit insurance obligations?
Instead, government can force everyone (or trick everyone, by making false promises) to make interest-bearing deposits. In many scenarios, people are better off. Once in a blue moon, though, a lot of people get hungry at once, and the government has to ration the honey that people want to withdraw. That is, it reneges on its promise.
Think that government reneging on promises is unrealistic? If you’re 40 years old, come back in 30 years and tell me how that Medicare thing is workin’ for ya.
Again, people might be better off most of the time if they trust banks (or government) and ignore the possibility that they could get shafted. Most of the time, they won’t get shafted.
Mencius thinks that this might work differently with fiat money instead of honey. It is true that if everybody wakes up wanting to touch something green with the picture of a President on it, the government can just print some. It doesn’t have to ration green paper the way it has to ration honey. But I think it amounts to the same thing–once all the green paper is printed, each piece is worth less, which is just like getting back a jar of honey that is missing a few spoonfuls. So I don’t see how fiat money makes the scam any more or less transparent.
Boy, does this stuff give me a headache.