More on Fractional Reserve Banking…and More!

C. Jay Engel has written a very thorough post on the topic of fractional reserve banking, entitled “Against Fractional Reserve Banking and the Curious Case of the Aleatory Contract: Deconstructing Michael Rozeff.”

The post is very thorough and exhaustive.  I will be clear up front – I will not address it in the manner it deserves to fully be addressed; let me explain why:

So then, as you can see very clearly, Rozeff’s conception of fractional reserve banking is not fractional reserve banking as it was historically practiced and which Rothbard heavily criticized.

If the discussion is entirely about historic practices, Engel and I have no disagreement.  While I have not studied this in any detail, I have no reason to doubt the claim that goldsmiths – charged with storing gold against a receipt for the gold – learned that they could surreptitiously produce multiple receipts for the same gold.

Charging for storage of gold and not actually storing the gold is a contractual breach – if you like, you can call it fraudulent.  You can also call this fractional reserve banking; I am as equally against such a practice as the most ardent critic of FRB.

For this reason (and also that the bulk of the post is directed at Rozeff), I find little benefit in going line by line through the post – while I encourage all interested in the topic to read it.

At the back of my mind is the desire to bring the wonderful and praiseworthy Bionic Mosquito closer to my side of things…

Engel need not concern himself with bringing me to his side of things.  If he is writing specifically about an historic practice, I will not argue and have never argued regarding this.  If his point is that history is specifically what “Mises, Rothbard, Hoppe, Salerno, de Soto, Hulsmann, Block, Bagus, Howden” are arguing, we can all have a beer and part as friends.

Engel need not concern with bring me to his side because I have asked the question multiple times: are we debating today’s practice or historical practice?  I accept the difference.  Engel makes clear that he does as well.  Perhaps I should welcome Jay to my side of things!

Yet there are many who claim that today’s practice is fractional reserve banking and it is fraud.  It is to them that I write and to them that I offer criticism.  Many of these are associated with the Austrian school and many of these claim to be citing Rothbard.  To their claim of leaning on Rothbard I have often disagreed, albeit for reasons different than what Engel suggests.

Engel tells me the paper might get published in a proper Austrian journal, as it well deserves to be.  I might suggest that he beefs up the distinction of historical practice vs. todays practice.  I find this the critical distinction and clarification in the paper.

The rest I offer as points to ponder or other intellectual wanderings…. I hope Engel takes them in the spirit intended – items he might consider as he moves his paper toward publishing.

Thus, I will immediately and at the forefront state my acceptance of Ludwig von Mises’ own taxonomy: money proper is the actual and generally accepted medium of exchange in the economy; money substitutes are titles to, or claims of ownership on, that money (money substitutes arise as individuals decide they’d rather store their money [gold] and trade paper titles to that gold); money certificates are those money substitutes that are backed 100% by the money; fiduciary media is any money substitute that has been created beyond what is backed up.

What if “fiduciary media” is “the actual and generally accepted medium of exchange”?  Is it reasonable for economists to insist that it cannot be this?  What does this do to the entire list of definitions presented above by Engel?

What then is fractional reserve banking? Fractional reserve banking is the practice, not merely of ambiguously “only keeping a fraction of reserves” in the bank, but rather of issuing claims or titles on money beyond what can be physically redeemed.

What if “what can be physically redeemed” is irrelevant to today’s economy?  What does this do to the relevance of the above definitions?

Whether we ought to use the phrase “fractional reserve banking” at all to express the above definition is a different conversation than whether the Rothbardian School happens to define FRB in that way. If there is going to be dissenters, they must dissent on the same terms, else the Rothbardians go uncritiqued.

What if my “what ifs” above are meaningful?  What does this do to the relevance of this entire discussion to the economy as it has developed over the last 50 years or more – in other words, during the entire period that every writer mentioned above by Engel, save Mises, has written on this topic?  Are we reduced to debating camels through the eye of a needle or debating angels dancing on pinheads?

Engel then introduces the concept of an aleatory contract:

An aleatory contract is a contract whose fulfillment depends on chance. A good example of this would be a lottery ticket wherein not all lottery ticket holders will be able to claim their prize.

I offer these definitions as well:

The term was a classification developed in later medieval Roman law to cover all contracts whose fulfilment depended on chance, including gambling, insurance, speculative investment and life annuities.

One can classify today’s banking contract as based on “chance,” I guess.  But it is a “chance” that – since the advent of government insurance – has paid out probably something like 99.999999999% of the time.  (I might be off by a billionth of a percentage point, plus or minus).  The performance has been and continues to be far better than the success rate of virtually any other commercially available product.

Please note: if you want to criticize my leaning on government insurance in the above statement, criticize today’s banking for what it is – a monopoly – and not for what it isn’t – fraud.

A contract type in which the parties involved do not have to perform a particular action until a specific event occurs. Events are those which cannot be controlled by either party, such as natural disasters and death. Aleatory contracts are commonly used in insurance policies. The insurer does not have to pay the insured until an event, such as a fire, results in property loss.

But the events can be controlled by at least one of the parties – the bank.  The bank chooses reserve ratios – specifically the amount of physical cash held against deposits.  The bank establishes schemes to back this up – up to and including agreements with other banks, central banks and government treasury departments.

Please note: if you want to criticize my leaning on central banks and government treasury departments in the above statement, criticize today’s banking for what it is – a monopoly – and not for what it isn’t – fraud.

I am not so sure that today’s banking contract fits this definition of aleatory contract.  In any case, Engel and I need not get hung up on this, (returning to Engel) because…

…the aleatory contract as irrelevant when it comes to the theory and history of money.

I have already addressed the “history” part of money, above – absolutely irrelevant when it comes to today’s banking system.  In a way I guess I also addressed the “theory” part.  What if the “theory” part of money as summarized by Engel above and taken from the long list of intellectual heavyweights is irrelevant to the economy as it has developed over the last 50 years or more?

If the entire criticism of fractional reserve banking – in both popular and academic debates – is about what some goldsmiths in Italy did 500 years ago…what a waste of energy – on both sides.  Engel’s post will hopefully guide me toward asking a simple question every single time before I deal with a critic – are you talking about history or are you talking about today?

I can agree with Engel that the discussion only addresses history.  If Engel works through my “what ifs” and other questions above, I will assume that he will agree with me that the criticism is entirely irrelevant today.

However, too many critics of fractional reserve banking – not just bloggers, but individuals with real name recognition – use the term to describe today’s banking practice.

Perhaps for his next commentary, Jay can address this.