This will come across as an angry post – I fit Horwitz’ view of an angry libertarian on this one, but it is one subject where I agree with him. The subject is tiring for me; whenever I raise these points, two things are certain: 1) none of my points are addressed directly, and 2) straw man arguments come out of the woodwork.
Please, please, please – I will be quite content if my points are addressed directly and I am shown to be in error, especially on the one key question of contract (coming shortly).
Sadly, my critique is opposed to the position of many people who I hold in high regard. In no way do I mean to attack the person; only the position on this issue.
I beg of someone to deal directly with the points raised – I have read and written as much on this topic as any; I have participated in countless online (and one tragic in-person) discussions; let’s just say I am still waiting for a direct (meaningful and substantial) response.
Speaking of someone that I hold in high regard….
From Walter Block:
Dear Redmond, Dave:
This is just about the best critique I have ever read about fractional reserve banking, and I've read a lot of them. That bit about the trains is magnificent!
Dear Larry, George:
I'd love to see your critique of this beautiful attack on your position.
What is the substance of this “magnificent” “best critique”?
Think back to your high-school math class, and reminisce about this question:
“Train A departs from Union Station at noon travelling eastward to Halifax at a speed of 80km/hr. Train B departs three hours later from the same station travelling in the same direction at a speed of 100 km/hr. When and where will they collide?”
We strained our minds, and most came up with the conclusion that 15 hours and 1,200 kms from where train A set off, the carefree conductors would face a rude awakening.
Most of us were just glad to be done with the question, and probably didn’t think of it much further. But consider what was going on at one minute past midnight in this imagined world.
There were two conductors each told that they could depart Union Station at a certain time and speed towards their destination. Each had done exactly what they were told, with the predictably disastrous results. There was probably a track-side argument, with each side blaming the other. Possibly the conflict spilled back to Union Station, with blame being attributed to whoever was in control of the train schedules that fateful day.
One way to look at this is that there was a conflict. Each conductor was told to do something, and when they did the disaster struck. Laying blame at the end is difficult, as neither side did anything wrong. As outsiders to this problem we can see that if blame does lie somewhere, it is with the Union Station scheduler.
There is the train analogy. Here is the fractional reserve banking part:
Now take yourself out of your math class and consider reality. We have a similar train wreck brewing in our economy.
Depositors go to their banks and put aside some money. They are made a promise: the ability to withdraw their deposit at a moment’s notice (i.e., on demand), and be paid the proceeds at the same value as when they made the deposit (i.e., par value). In layman’s terms, you get back what you deposited, and you get it whenever you want.
I have a very simple question. Go to the deposit contract and the regulations governing the deposit contract and show me this promise of “the ability to withdraw their deposit at a moment’s notice (i.e., on demand)….” Deal with the exceptions to realizing this “demand.”
Bankers receive these deposits, and the law gives them a different set of privileges. Bankers too may make use of this deposit, and they use it to fund investment and lending operations. For example, in the modern fractional-reserve banking system your banker uses a portion (or fraction) of your original deposit to lend to a potential homeowner as a mortgage.
The law does not give two sets of privileges. If it did – two individuals have identical and simultaneous claim to the same asset – it would be debilitating to markets. Such an event would cause markets to freeze. Markets aren’t frozen.
Joe Salerno made the one single eye-opening statement (for me) on this subject, at a Daily Bell interview: such a contract cannot exist in a free market. Well, it doesn’t exist in today’s market, either.
The conflict depositors and bankers are subject to should be apparent. They each have a claim to the deposit, but there is only one deposit available to satisfy each claim.
They do each have a claim, but they have different claims. The bank (and in bankruptcy its senior secured creditors) have a senior claim; the depositor has a subordinate and unsecured claim. You and I may not like that, but it is the reality.
They have different claims; they have different claims; they have different claims. Is my point clear? They have different claims!
I have written about this so many times that my head hurts. For perhaps my most comprehensive post, see this. The links embedded are important contributions to my thoughts, as in these embedded posts I address specifically the banking regulations and other relevant issues.
Now I already know many of the straw man arguments because I have received these too many times. Let’s get these out of the way, because if these are raised by any of you without clear evidence (links to contracts along with reasoned interpretations) or clear demonstration that my arguments have been read and are being directly addressed, I will ignore you:
1) The contract doesn’t explicitly state that the bank will loan out your funds. The contract does not have to state this. It also doesn’t state that the bank will hold 100% of your funds. Shame on the depositor – in the most lenient possibility, you are handing over your money to someone without clear delineation of what he will or won’t do with the money. Whose problem is this? Do you do this everywhere in life? Give me a call.
2) The depositor believes that the bank is holding his funds. People are wont to believe many things – terrorists are around every corner, Santa Claus is coming to town, democracies never fight wars against each other, etc., etc., etc. It is irrelevant what people believe. What does the contract say?
3) The practice is inflationary. So what? And be specific in your reply to this very serious (not flippant) question.
4) But you don’t understand the history of how banking started. Explain the relevance to today’s deposit contract.
Now, my questions for you:
1) How do you propose to impose a 100% reserve requirement in a manner outside of contract? On what basis?
2) Explain Mises’ and Rothbard’s views on regulating the process of excess credit creation.
3) If the contract allows the practice of lending the deposit (or does not disallow the practice), what is your complaint?
4) How does the bank a) pay you interest on your deposit, and b) not charge a storage fee for holding your deposit, if it is holding your deposit? Please don’t expose your ignorance of an unsustainable business model via your answer.
5) What do you have against free markets, governed by contract?
6) Show me the contract. Show me the clause that the bank is violating. This will allow for the largest class-action fraud lawsuit in the history of mankind. I want a piece of that.
This last item is the biggie – show me the explicit violation of the contract and regulation. You will have done more than anyone else has ever done to dissuade me from my view on this subject. I will be forever in your debt.
Returning to Howden, we may have “a similar train wreck brewing in our economy,” but it isn’t because of fractional reserve banking; it is because of the monopoly. End the monopoly; end government deposit insurance; end too big to fail; end dissimilar tax treatment on competing currencies. Reintroduce the threat of a good old-fashioned bank run as regulation – both Rothbard and Mises will be supportive of this solution.
We live in a world where the banking system is virtually homogenized under one set of rules via government force. A traditional deposit contract (I ask the goldsmith to hold my gold) for all practical purposes does not exist for one who wants to enjoy the many benefits and conveniences of modern banking. If the demand for such a contract was substantial, don’t you think more possibilities would be offered?
There are some possibilities; all of the ones of which I am familiar come with major drawbacks, but they do exist. Do you want to avoid FRB (as the term is commonly used)? Put your cash in a mattress or a safe deposit box. There are vaults that will hold as many millions of dollars / Euros / Yen / Swissies as you want, in physical form, for a fee – and without paying interest.
The discussion about fractional reserve banking is a needless distraction. End the monopoly.
End the Fed.
(Well, I got that off of my chest but I am still angry…. Time for a scotch.)