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  • Darren Wolfe
    The Commons and the Tragedy of Banking by Phillip Bagus [Posted on Wednesday, November 12, 2003] Bioethicist Garrett James Hardin, who coined the term tragedy
    Message 1 of 5 , May 30, 2005
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      The Commons and the Tragedy of Banking

      by Phillip Bagus

      [Posted on Wednesday, November 12, 2003]

      Bioethicist Garrett James Hardin, who coined the term "tragedy of the
      commons," passed away this September at the age of 88. In his now famous
      1968 essay, "The Tragedy of the Commons," Hardin describes how common,
      i.e., public, property, is overused until it deteriorates or is destroyed.

      Because of his essay, many consider him to have fathered the concept of the
      tragedy of the commons; however, Ludwig von Mises describes this concept in
      relation to external costs in his 1940 National�konomie[1] and, later, in
      Human Action (1949):

      "If land is not owned by anybody, although legal formalism may call it
      public property, it is utilized without any regard to the disadvantages
      resulting. Those who are in a position to appropriate to themselves the
      returns�lumber and game of the forests, fish of the water areas, and mineral
      deposits of the subsoil�do not bother about the later effects of their mode
      of exploitation. For them the erosion of the soil, the depletion of the
      exhaustible resources and other impairments of the future utilization are
      external costs not entering into their calculation of input and output. They
      cut down the trees without any regard for fresh shoots or reforestation. In
      hunting and fishing they do not shrink from methods preventing the
      repopulation of the hunting and fishing grounds."[2]

      Hardin's tragedy of the commons, though, has a more recent and direct
      connection to Austrian economics. In Dinero, Cr�dito Bancario y Ciclos
      Econ�micos, which will soon be available in English (published by the Mises
      Institute; Spanish edition reviewed here), Huerta de Soto applies the
      concept of the tragedy of the commons to an analysis of fractional reserve

      Huerta de Soto's application deserves a closer look, since it clearly
      explains why fractional reserve banks, by their very nature, are always
      tempted to expand credit. He also explains why fractional reserve banks in a
      free banking system are under immense pressure to introduce a central bank.

      As Huerta de Soto points out, the problem of the tragedy of the commons
      always appears when property rights are defined improperly. In the case of
      fractional reserve banking, bankers can infringe on property rights because
      it is not clearly defined who owns the deposit.

      When customers make their deposits, the promise is that the deposit is
      always available for withdrawal. However, the deposits, by the very
      definition of fractional reserve banking, are never completely available to
      all customers at one time. This is because banks will take a part of these
      deposits and loan them out to other customers. In other words, they issue
      fiduciary media. By issuing more property titles than property entrusted to
      them, the banks violate the traditional property rights of their customers.
      (One of the most important contributions of Huerta de Soto's exhaustive book
      is to demonstrate how banking developed historically and that fractional
      reserve banking evolved as a perversion of deposit banking.)

      Banks that infringe upon and abuse the property rights of their clients can
      make very good profits. The temptation to expand credit is almost
      irresistible. Moreover, they will try to expand credit and issue fiduciary
      media as much as they can possibly get away with.

      This credit expansion brings about another typical feature found in the
      tragedy of the commons�external costs. In this case, everyone in society is
      harmed by the price changes induced by the issue of fiduciary media. These
      external costs are not taken into consideration by the banks that try to
      exploit the profit opportunities, because the property rights are not
      properly defined and defended by the legal system.

      Exploitation and external costs are similar features in Hardin's analysis of
      the tragedy of the commons as it is applied to the environment and in Huerta
      de Soto's analysis as it is applied to fractional reserve banking in a free
      banking system.

      Yet as Huerta de Soto points out, there is one important difference between
      the two. In Hardin's analysis, there is virtually no limit in the
      exploitation of the "unowned," i.e., environmental properties without
      clearly defined ownership. However, for the fractional reserve banks, there
      is an important limit in the issuing of fiduciary media at the cost of the
      bank clients. This limit is set by the behavior of the other banks and their
      clients in a free banking system. More specifically, the credit expansion is
      limited since banks, via the clearing system, can force each other into

      Let us imagine a simple example. There are two banks: bank A and bank B.
      Bank A expands credit while bank B does not. Money titles issued by bank A
      are exchanged between clients of bank A and clients of bank B. At some
      point, the clients of bank B or bank B will demand redemption for the money
      titles from bank A. Hence, bank A will lose some of its reserves, for
      instance, gold. As is every fractional reserve bank, bank A is inherently
      bankrupt; it cannot redeem all the money titles it has issued. Therefore, if
      bank B and its clients are demanding that bank A redeem the money titles to
      a degree which it cannot fulfill, Bank A must declare its bankruptcy.

      Therefore, the clearing system and the clients of other banks demanding
      redemption set narrow limits to the issuing of fiduciary media. Banks have a
      certain incentive to restrict expansion of fiduciary media to a greater
      extent than their rival banks, with the final aim to force their competitors
      into bankruptcy and remain alone in the market. In other words, these banks
      naturally want to exploit the great profit opportunities offered by the
      improperly defined property rights, but they can only expand credit to the
      extent that the risk of bankruptcy is reasonably avoided. Competition forces
      them to check their credit expansion.

      The question now concerns how the banks can increase the profits from credit
      expansion while keeping the risk of bankruptcy low. The solution, obviously,
      is to form agreements with each other in order to avoid the negative
      consequences of an independent and uncoordinated credit expansion. As a
      result, the banks set a combined policy of simultaneous credit expansion.
      These policies permit them to keep their solvency, to maintain their
      reserves in relation to one another, and to make huge profits.

      Therefore, not only does the tragedy of the commons predict the exploitation
      and external costs of vaguely defined private property, it also explains why
      there are great forces in a free-banking system to form agreements, mergers,
      and cartels. However, even with the forming of cartels, the threat of
      bankruptcy still remains. In other words, the incentive to force competitors
      into bankruptcy still remains, resulting in the instability of the cartels.

      For the fractional reserve banks, there is now a great demand for the
      introduction of a central bank. The one difference between the tragedy of
      the commons applied to the environment and the tragedy of the commons
      applied to a free banking system�limits in exploitation�is now removed by
      the introduction of the central bank. Hence, according to Huerta de Soto, a
      true "tragedy of the commons" situation occurs only when a central bank is
      installed. The banks can now exploit the improperly defined property without

      Yet, even in the most comfortable scenario for the banks, i.e., the
      installation of a central bank and fiat money, there remains a limit which
      Huerta de Soto does not name: the risk of a hyperinflation. As Rothbard
      states, "With fiat money established and gold outlawed, the way is clear for
      full-scale . . . inflation. Only one very broad check remains: the ultimate
      threat of hyper-inflation, the crack-up of the currency."[4]Therefore, it
      must be argued that Huerta de Soto's analogy of fractional reserve banking
      and the tragedy of the commons is still not perfect.

      In other words, even with the creation of a central bank, there is still a
      check on the exploitation of private property. In an ideal "tragedy of the
      commons" situation, the drive is to exploit ill-defined property as fast as
      possible, to forestall the exploitation others can make. However, even with
      the existence of a central bank that guarantees their solvency, it is not in
      the interest of the fractional reserve banks to issue fiduciary media as
      quickly as possible. To do so could lead to a runaway hyperinflation.[5] The
      exploitation of the commons must therefore be stretched and implemented
      carefully. Nevertheless, Huerta de Soto's analogy is very helpful in
      grasping the incentives, dynamics, and nature of a fractional reserve
      banking system.

      Moreover, his analysis brings up the case for some revisionism concerning
      the question of who is the true father of the concept of the "tragedy of the
      commons." As mentioned earlier, Huerta de Soto argues that Garrett Hardin is
      not the first to describe such a concept, but that Ludwig von Mises had
      described it 28 years earlier.

      Indeed, Mises shows in National�konomie that the legal conceptions of
      property often do not follow the social function of private property. When
      property rights are not defined rigorously, the property owner "will not
      bother in his planning about all the effects of his action. He will
      disregard those benefits which do not increase his own satisfaction and
      those costs which do not burden him."[6]

      Later, Mises concentrates on the problem of external costs resulting from
      property rights not rigorously defined. External costs are not considered by
      the individual making an economic calculation. Because of this, his economic
      calculation will provide deficient and false results. During his discussion
      of external costs, Mises explicitly describes the tragedy of the commons
      problem that Hardin proclaims in 1968, by applying the problem of external
      costs to the environment.

      Hence Garrett Hardin should only be considered the father of the phrase
      "tragedy of the commons" but not of the concept itself. In fact, as shown in
      the passage above, 28 years earlier, the concept was fully and more
      systematically stated by Ludwig von Mises as one part of the more general
      problem of insufficiently defined property rights. And with Huerta de Soto's
      analysis of fractional reserve banking, we find that the concept and term of
      the tragedy of the commons becomes a very important contribution to Austrian


      Philipp Bagus is completing his Ph.D. in economics. philipp.bagus@.... He
      passed the Mises University oral exams in 2002 with honors. See the Study
      Guide on Money and Banking.

      [1]In section VI of chapter 10 in part IV of National�konomie: Theorie des
      Handelns und des Wirtschaftens, Editions Union, Geneva 1940, 2 nd edition of
      Philosophia Verlag, Munich 1980, pp. 599�605.

      [2]Ibid. p. 656. As Tibor Machan notes, the problem was also discussed by
      Aristotle and Thucydides.

      [3]See Huerta de Soto, Dinero, Cr�dito Bancario y Ciclos Econ�micos, (2nd.
      ed. Madrid: Uni�n Editorial, 2002), pp. 518�21.

      [4]See What Has Government Done to Our Money, (5th. Ed., Auburn, Ala.:
      Ludwig von Mises Institute, pdf. online edition), p. 43.

      [5]Another limit for the credit expansion is set by public opinion, since it
      can influence the behavior of the central bank, inducing the central bank to
      keep the credit expansion in certain limits.

      [6]Ludwig von Mises, Human Action, (4th. Ed., Irvington: Foundation for
      Economic Education, 1996), p. 655.


      Restore the republic,


      "It is the duty of the patriot to protect his country from the government."

      --Thomas Paine 'The Rights of Man' c.1792

      >From: <dmacko@...>
      >Reply-To: WeThePeopleCoalition@yahoogroups.com
      >To: <WeThePeopleCoalition@yahoogroups.com>
      >Subject: Re: [We The People Coalition] Re: Areas of Dis-Agreement - Guy
      >Reply to David added to by BG
      >Date: Mon, 30 May 2005 17:34:00 -0400
      >Their prosperity was created by low taxes and limited regulation.
      >They were apparently an exception to the rule until Britain turned
      >them over to Red China.
      >Complete private property ownership requires recognition of the
      >separate segments. Of course, anyone may sell his property or lease
      >it for any reason as long as no innocent persons are directly harmed.
      >I was not aware of Hardin's lesser known book.
      >I don't recognize that I have any right to anyone else's property.
      >Dave Macko
      > ----- Original Message -----
      > From: BGreen
      > To: WeThePeopleCoalition@yahoogroups.com
      > Sent: Monday, May 30, 2005 5:15 PM
      > Subject: [We The People Coalition] Re: Areas of Dis-Agreement - Guy
      >Reply to David added to by BG
      > --- In WeThePeopleCoalition@yahoogroups.com, <dmacko@a...> wrote:
      > > Practically all history, especially the history of the Soviet
      > Union, the Captive Nations of
      > > eastern Europe and Red China, during the twentieth century, has
      > proven that human nature
      > > being what it is people will take better care of their own private
      > property than of the commons.
      > > See for example, The Tragedy of the Commons by Garrett Hardin
      > (1968) although I have not
      > > read it and don't endorse any statist conclusions which it may
      > promote.
      > > For entities which cannot easily be privatized, such as air and the
      > oceans or Great Lakes,
      > > polluters should be held responsible according to the common law.
      > > The abolition of private property in land has led to the hundreds
      > of millions of deaths which
      > > mark the twentieth century as the bloodiest in history.
      > >
      > Dave-
      > How do you explain the fact that Hong Kong is consistently at or near
      > the top of the Forbes economic freedom index yet no one owns their
      > land?
      > Are you aware that Garret Hardin later wrote a revision of his
      > earlier work called "The Tragedy of the UNMANAGED Commons"?
      > Private property in land is not one singular right but rather a
      > bundle of rights of which the right to unimproved land values being
      > one of them. The other rights include the right to possess, use,
      > exclude, and transfer title. As any lawyer will tell you, those
      > rights can be transferred in whole or in part.
      > When homesteading land by enclosing the commons this act does not
      > infringe on the property rights - the fruits of one's labor - of
      > those being excluded until economic rent attaches to a location under
      > scarcity conditions as people naturally compete.
      > It is at this point (Locke's Proviso) - not unlike the state's
      > legitimate use of force to ensure the individual's common right of
      > free speech in a public forum by removing anyone who attempts to
      > speak at the same time essentially censoring the speaker - that the
      > economic rent becomes a legal and monetary obligation on the excluded
      > denying them their right to self-ownership.
      > We do not have an option not to "tax" as the economic rent naturally
      > attaches to ALL locations under scarcity conditions (Locke's "enough
      > and as good left for others") but only who will pay the economic rent
      > and who will receive it.
      > The answer dictates whether or not LIBERTY for ALL is served.
      > BillG (not Gates)
      > Jeffersonian Green
      >[Non-text portions of this message have been removed]
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