Saturday, July 9, 2016

Walter, You Can Do Better*

*at least you close on a strong note (more to come).

Walter Block once again addresses a question on fractional reserve banking (see here for my critique of his earlier post).  Once again, he errs (for the most part).  Let’s begin:

A lends $100 to B, the bank.

A perfectly legitimate transaction; nothing wrong so far.  It is also important to note – as Block does – that it is a loan: A lends $100 to B, the bank.

B gives A a demand deposit for that $100.

Technically, B gives A a note.  Remember: the $100 is a loan; it is not a deposit.  Walter knows this (he uses the term “lends,” he does not use the term “deposits.”)

In any case, this, too, is a perfectly legitimate transaction.

Under fractional reserve banking, B then lends $90 to C, giving C a demand deposit for $90.

You can call it “under fractional reserve banking” or call it a fruit – it would be about as descriptive a term of the underlying business transaction.  A lent $100 to B; B has the right under contract to lend some portion of that $100 to a third party.  You might as well call it a fruit.

I call it yet one more perfectly legitimate transaction.

A and C each think they own, respectively, $100 and $90.

Not really, and not complete.  A owns a note from the bank.  A does not own $100 – check his wallet.  A has a piece of paper that says the bank owes him $100.

As to C: one possibility is that C holds the $90 in his wallet – in other words, he doesn’t just think he owns the $90, he owns the $90.  Or alternatively C might have a note from the bank stating that the bank owes C $90, which would be the case if C left the $90 with the bank, meaning C “lent” the bank the same $90 he borrowed.

But there is one other step: the bank holds a note from C, for the $90 lent to C.

But in every case, the transactions are perfectly legitimate.

Yet B only has $10 to make good this “ownership.”

If B only holds $10, this suggests that C is holding the $90 in his wallet – this is fine.  In this case, B only has to make good on the claim of A.  B doesn’t owe C an additional $90!  C has nothing to claim – C has the $90 in his wallet.  B has a claim on C for the $90, not the other way around.

As to the claim of A: B has $10 and B also has a note from C in the face amount of $90.  In other words, B has much more than the $10 to make good on the claim of $100 by A.

Now C might have to juggle a few things if A comes in today looking to cash in his note.  Shocking, isn’t it?  Entrepreneur B (a bank, but an entrepreneur nonetheless) might not have perfectly forecast the future.  When does that ever happen?

To my way of thinking, it doesn’t matter that both A and C “know” what is going on.

That they “know” matters significantly from a legal standpoint.  It also matters what the contract says, from a legal standpoint.

B should be legally obligated to pay them respectively, $100 and $90.

B is legally obligated to perform to that which B contracted.  But let’s be clear – each of these transactions are legitimate and were contracted.  B either will be able to perform or not.  Guess what?  Just like every single other business transaction on earth.

In any case, C already has the $90 in his wallet; nothing for B to “pay.”  As to A: A lent $100 to B; “lent” implies risk of something – it implies the risk of being repaid…or not.  B may pay him back, or may not.

That’s what B’s contract with A and C stipulate.

I believe I have more accurately depicted what the individual contracts stipulate.  I don’t just believe it; I am certain of it.  Walter has it wrong.

Similarly, in the banking case, if A and C do not get their money when they want it, and don’t care, then no fraud has been perpetrated on them.

I don’t know anyone who doesn’t care if he does or doesn’t get his money back.  “Care” isn’t the issue when it comes to fraud.  The issue isn’t if A and C care (although I have already dispatched with C, as he has the $90 in his wallet); the issue is what does the contract allow.  And if the parties follow the contract, there is no fraud.

But wait.  Is bankruptcy “fraud”?  Not necessarily.  People and entities go bankrupt; not every bankruptcy is caused by fraud.  Perhaps nothing more than bad business judgment was involved.  As I have stated before: if Austrians do not allow for the possibility of bad business judgment, then every word written by an Austrian economist on the role of the entrepreneur is a wasted word.  (I would bold this entire last sentence, but I am probably using this tool a bit too much.)

But, this is not then a case of banking. Rather it is a case of play acting, or gift giving, or something like that. It is not the commercial interaction that appearances might indicate.

Every step of the process above is a legitimate business transaction.  It is a party loaning that which was lent to it.  Nothing more.

To return to reality, in actual, historical, fractional reserve banking, there was no gift giving, no play acting. Rather, there was outright fraud.

I have no reason to doubt that historically there were cases of individuals holding a bailment and yet lending it out.  Let’s just be clear – are we debating a fraudulent historical practice or today’s banking system?  Because the main problem with today’s system isn’t fraudulent fractional reserve banking; the problem today is the monopoly and the government protection.  Nothing more.

Now, to the one thing Walter got right:

Note, I cannot say that everyone else in society can sue B, or perhaps A, B and C for concocting a scheme that reduces the value of everyone’s monetary holdings. Why not? Because in libertarian theory, you can only own things themselves, not their value.

Amen brother – and not just libertarian theory: value is subjective, constantly exposed to change – and change outside of the control of the property owner.


Every transaction in this process is a legitimate transaction.  And the reduced value of everyone’s monetary holdings is no crime – in libertarian theory or otherwise.

There is one problem with today’s banking system – and truly, only one worth discussing: end the monopoly; end the government backstop.

End the Fed.


  1. I had trouble following all the A, B, C above (I tried!), but I agree with BM that fractional reserve can be done ethically, with two significant caveats.

    (1) The contract terms will determine if fraud is committed.

    For example, you cannot lend out a demand deposit, unless the terms of that deposit allow for it to be lent, which essentially makes it not a demand deposit but something of a savings investment or a loan, or a conditionally redeemable note (call it what you want).

    (2) If you do not have those legal terms, then lending money from demand deposits per se makes the Bank insolvent. Under traditional common law principles, this insolvency is a fraudulent transfer.

    In a free banking system, I foresee that the banks would have different types of accounts that have varying redeemability; those that can be suspended or have only term redeemability would pay higher interest rates.

    1. As Walter recognizes that A is making a loan, he must also recognize that A is not making a deposit - demand or otherwise; at least not a deposit in any traditionally understood sense.

      Therefore his entire position falls apart.

  2. Mr. Mosquito, you're big on realism, yes? Theory and all that is fine but realism is what matter, right? Then let me ask you this: realistically, what do the 99.99% of the bank customers think? Do they think they're giving the bank a loan which may or may not be paid back on demand? Or are they convinced that they have every right to that money and are not, in fact, lenders? What will they do when they realize that only X% of their money actually exists, shrug or riot?

    Igor Karbinovskiy

    1. Igor

      I could be smug and say "take it up with Walter." You see, he understands it is a loan, yet he persists in pretending it is not.

      As to what people believe...Many people believe that Iraq was behind 911; does this make the subsequent invasion by Bush OK?

      People are want to believe many silly things. If they choose to believe that the bank holds their money without charging them for storage - and on top of this pays interest while holding the money; if they choose to believe that the bank can offer many other services for free....

      In the meantime, virtually 100% of the time people have been able to access 100% of their money - ever since governments backstopped the banks (which we all are betting our lives on the hope that this never ends; more on this momentarily). So, what is there for you (or the people) to complain about? (I will answer that for you: the monopoly, nothing else.)

      But to answer your last question - if the banks ever fail to deliver, they will riot...for a few days, and then we will all starve. Because without a functioning payment system, 99% of us in the developed world are dead.

  3. There's not only A, B and C in fractional reserve banking. But D, E, F and all the way to Z. So your theory of FRB being "legal" falls apart as well.

    1. The brilliant "anonymous" adding so much value to the conversation with this well-reasoned and thoroughly developed argument. Thank you for stopping by.