Thursday, December 23, 2010

Fractional Reserve Banking in a Free Banking Environment

This comment is in reply to an article at: http://mises.org/daily/4880

All quotes below are from the subject article.

Imagine a jurisdiction with fully competing currencies, where every type of idea is afforded the opportunity to be tested and ultimately accepted or rejected by market participants. There are no laws making one scheme preferable to another. Multiple currencies can trade side by side in a given jurisdiction, with disclosure as to the nature of the currency clearly available and identified.

The author of the article certainly makes a statement that would lead one to this possibility:

“Austrian economists (in particular those in the Misesian-Rothbardian tradition) uncompromisingly call for replacing fiat money with free-market money — money that is produced by the free interplay of the supply of and demand for money.

“Such a recommendation has a firm economical-ethical footing: free-market money is the only monetary order that is compatible with private-property rights, the governing principle of the free-market society.”

From these statements, it seems safe to conclude that “Austrian economists” would allow the market to decide on “money.” For a market to do so, market participants must be free both to experiment, and to compete – without the necessity of finally settling on any one form being utilized in a market.

With this in mind, I wonder about some of the statements and assertions in the article:

“What, however, if the bank and the depositor both agree voluntarily that money deposits should be used for credit transactions via the issuance of fiduciary media?”

Such a voluntary transaction might only legitimately be discouraged if there were significant externalities caused by such an arrangement. The author attempts to present such a problem with the following comments:

“While bank and depositor benefit from such a trade (or expect to), what about those who receive fiduciary media? They would be falsely lured into exchanging goods and service against an item (fiduciary media) that is already claimed as property by others — something the seller presumably wouldn't agree to if he had only known the very nature of the trade.”

Why is it assumed the third party is unaware of, or “falsely lured” by, the nature of what he is receiving? Certainly, if he was falsely lured, a charge of fraud would be justified. However, what if he is aware? Would you propose stopping this transaction? How, and on what grounds?

“What if all market agents voluntarily agreed to engage in fractional-reserve banking? The conclusion above wouldn't change: voluntarily accepted fractional-reserve banking would represent a monetary system that is, by its very nature, in violation of the nature of the law of private-property rights. It would produce economic chaos on the grandest scale.”

Why is it in violation of property rights? Every actor has knowingly and willingly agreed to accept the fiduciary media. With what basis would you propose to stop them? If it, in fact, results in economic chaos, participants will suffer the consequences. But these are consequences willingly brought on by voluntary actions. Perhaps some laws prohibiting voluntary behavior would be considered? Really?

Back to my vision of multiple currencies competing on equal terms in a free market: With the opportunity to use a more stable currency (100% gold-backed, if you will), what do I care if someone else’s wealth and purchasing power is eroded and/or destroyed because they made a less-than optimal choice of a fractionally-backed currency? My wealth is secure, my purchasing power is maintained. In this scenario of freely competing currencies, why would I stop them? More so, how would I stop them?

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