I get such pushback on this subject; it doesn’t help that I can point to Rothbard and Mises as recognizing that the best regulator of credit creation is the free market. It doesn’t help when I point to Sennholz, who offers his seven objectives to restore sound money – none of which call for an end to fractional reserve banking.
When I suggest that such stalwarts find the market to be a perfectly fine regulator, thus precluding any benefit to introducing some third party agent to take over this function…nothing. When I ask how it is possible that a business agrees to a) take a deposit and hold it, b) not charge a fee for storage, and c) on top, pay interest, all I get is…silence.
When Dr. North bluntly states that the cause of inflation as we have lived it does not have at its root fractional reserve banking, but instead the monopoly protection, nothing. When I show that Ballvé even writes of lending pure time deposits – going even farther than I suggest – it makes not a dent.
When I ask individuals who I consider to be experts on the topic: who should I read to get a good understanding of the case fractional reserve banking as fraud? I receive two replies: Murray Rothbard in the Mystery of Banking, and Jesús Huerta de Soto with his book Money, Bank Credit, and Economic Cycles. My read of Rothbard lead me to my statement above. As to de Soto, I offer my thoughts here.
Crickets chirping; the same arguments made in return without addressing any of my assertions or objections – like I didn’t hear them the first time. Wah, wah, wah – do I sound like I am whining?
OK, how about Hoppe and Salerno. Through their words, I will try one more time.
I will begin with Hoppe:
Let’s say A deposits 10 ounces of gold with a bank and receives a note (a money substitute) redeemable at par on demand. Based on A’s deposit, then, the bank makes a loan to C of 9 ounces of gold and issues a note to this effect, again redeemable at par on demand.
Should this be permitted? I don’t think so. For there are now two people, A and C, who are the exclusive owner of one and the same quantity of money. A logical impossibility. Or put differently, there are only 10 ounces of gold, but A is given title to 10 ounces and C holds title to 9 ounces. That is, there are more property titles than there is property. Obviously this constitutes fraud, and in all areas except money, courts have also considered such a practice fraud and punished the offenders.
I agree fully with this statement. In fact, such an agreement is an impossibility – two individuals cannot have the same claim on the same asset at the same time. A contract that purports this is not possible, as the ends are impossible to achieve. If this is what is meant by fractional reserve banking, we don’t have to worry about it – as it is not a legal possibility. For the bank in the middle: fraud!
But today’s deposit contract is not this. Can you imagine if today’s deposit contract stated this, while the banks practiced the opposite? You don’t think class-action lawyers wouldn’t go after a multi-trillion dollar judgment? And win?
On the other hand, there is no problem if the bank tells A that it will pay interest on his deposit, invest it, for instance, in a money market mutual fund made up of highly liquid short-term financial papers, and make its best efforts to redeem A’s shares in that investment fund on demand in a fixed quantity of money. Such shares may well be very popular and many people may put their money into them instead of into regular deposit accounts.
This comes close to accurately reflecting today’s deposit contract – although using the term “money market mutual fund” clouds the issue. Today’s deposit contract is not a bailment. The depositor is subject to the banks best efforts to return the deposit on demand. So, except for this minor terminology point, I agree fully with this statement as well.
Two individuals do not have the same claim on the same asset at the same time. This is the reality of today’s deposit contract. There is no fraud in this; it is not a logical impossibility.
But as shares of investment funds they would never function as money. They would never be the most easily and widely saleable commodity of all.
Well…maybe or maybe not. What is certain is when I pay with FRNs, a check, a bank transfer, etc., my counterparty accepts the payment at par. The digits in the bank that represent my deposit function as well or better as money than any other thing on earth today.
To summarize: other than a very minor point or two, I am in significant agreement with Hoppe’s views.
Now, to Salerno. To the Daily Bell question, “Do you believe in private fractional banking or should it be illegal?” Salerno replies:
I am neither a philosopher nor a legal theorist, but I believe in the absolute right of individuals to enter into any voluntary contract that they choose.
So far, so good. (As an aside, this statement really helps me in my view of the sanctity of contract and specific performance.)
But a contract must be meaningful to be enforceable.
I agree completely.
If I pay you for a promise to paint my house red and green all over, this is not a contract but an absurdity.
When I first read this a few years ago, I had to read it several times to understand Salerno’s meaning. Given the context of his statements, he is suggesting that a house cannot be painted both completely green all over and completely red all over at the same time. Of course, I agree.
So, we are still fully in alignment.
Likewise if I pay you (or even if you pay me) to store my motorcycle in your garage so that it is always available for me to use it and I grant you the freedom to rent it out at will.
Again, an impossibility.
My point is that the deposit contract as modern free bankers conceive it, is a meaningless fiction. It implies that a sum of money can be both maintained on deposit for instantaneous withdrawal by the depositor and lent out to a borrower.
This is not the contract I envision. It is also not today’s deposit contract. But I am getting ahead of myself (and ahead of Salerno).
Now I am not saying that a free banking deposit contract can never be formulated in a meaningful way. But then it would not be a "deposit" contract at all, but a short-term credit transaction.
This is, in fact, today’s non-deposit deposit contract.
In fact, some free bankers have admitted that bank deposits are actually "call loans" which are extended to brokers by banks and which mature daily.
Call it what you want – it is a short-term credit transaction.
This being the case, it would be explicitly stated in the contract that the "depositor's" funds were being lent or invested by the "banker" and that immediate withdrawal is contingent upon the liquidity position of the bank.
Why? Why must it be explicitly stated? I assure you, it is NOT explicitly stated that the bank is holding your deposit for you. It is NOT explicitly stated that the depositor has first claim on the deposit in all circumstances (in fact, the opposite IS stated). So, which non-existent explicit statement wins?
There would also have to be explicitly stipulated in the contract the recourse available to the depositor and the banker's obligations in the case of temporary suspension of withdrawal privileges.
To some degree, there is. Regulation CC outlines the conditions and situations that could bring rise to the depositor not having access to his deposits on demand.
But again, if it is not explicitly stated, does this invalidate the practice?
It is highly unlikely that, under these circumstances, the short-term financial instruments – no longer masquerading as immediate claims to fixed sums of money – issued by free bankers would gain much circulation as currency.
But these short-term financial instruments have gained circulation as currency. This reality cannot be dismissed. The reason why? Again, I get ahead of myself….
Thus to answer the question you posed: I do not believe that "private fractional-reserve banking," as it is commonly understood in debates among libertarians and Austrians today, should be illegal. It is a self-contradictory concept that could never be formulated into a meaningful contract on a free market. (Emphasis added, and I would also bold it except I don’t want to appear too obnoxious.)
Precisely! But this self-contradictory concept is not today’s deposit contract.
Salerno gets to the heart of the matter; well, he opens the door but doesn’t explicitly walk in. I will do it for him: these instruments have gained circulation as currency because of the government guarantee.
The problem is the monopoly. The problem is not fractional reserve banking as the term is commonly understood in debates amongst Austrians today.
Look, if Hoppe and Salerno aren’t clear enough, with my minor tweaks, then I can say nothing more to be any more convincing. I will leave it at this.
Well, for now.