Sunday, June 1, 2014

Jörg Guido Hülsmann on Fractional Reserve Banking and Inflation

The weekend Mises Daily is a selection from “Deflation and Liberty,” by Jörg Guido Hülsmann.  In it, he offers many intriguing comments.  In all cases, emphasis added.

…we need to mention in particular two institutional forms of monetary interventionism: (fraudulent) fractional reserve banking and fiat money.

The parenthetical brought such a smile to my face.  I must say, I assumed Hülsmann to be firmly in the FRB-is-fraud camp.  Perhaps I was wrong (and would welcome comments from anyone more knowledgeable than I am on his views).  It seems to be the case that he considers there is a type of FRB that is fraudulent, suggesting that he also considers a type of FRB that is not fraudulent.

Banking is fraudulent whenever bankers sell uncovered or only partially covered money substitutes that they present as fully covered titles for money. These bankers sell more money substitutes than they could have sold if they had taken care to keep a 100-percent reserve for each substitute they issued.

But if bankers do not present these as fully covered titles of money…(he pauses to enjoy the pleasure of this thought)…then, it seems, Hülsmann does not consider it to be fraudulent.

The producer of fiat money (in our days, typically, paper money) sells a product that cannot withstand the competition of free-market moneys such as gold and silver coins, and which the market participants only use because the use of all other moneys is severely restricted or even outlawed.

I have made this observation before, most recently here; of course, Mises made the point before I did, here.

…fractional reserve banking produces excessive quantities of money substitutes, at any rate in those cases in which the customers are not informed that they are offered fractional-reserve bank deposits, rather than genuine money titles.

This excessive production of money and money titles is inflation by the Rothbardian definition…

These comments are most interesting, on two counts: first, the word “informed”; second, that FRB only produces excessive quantities of money substitutes (inflation) if the customers are not informed that they are being offered fractional-reserve deposits.

I will start with the second.  This is fabulous!  The existence of inflation is dependent on the customers’ knowledge! You don’t know how happy I am to read these words – I mean this sincerely.  FRB is not inflationary if the customer is informed that he is participating in an FRB deposit account.

I have written before – in a competitive banking environment, I don’t think we would even think in terms of “inflation”:

In a fully free banking / free money / free currency environment, would we even think of the term "inflation"?

I don't think so. I think we would think of profit and loss. I think we would utilize forms of money and banking and currency that were the most efficient, effective and stable within the context of the circumstance at the time and place. We would not speak of inflation: if our choice was sound, it will add to our profit. If not, it will add to our loss.

People should certainly be free to use unsound practices in business and in money. In business, if they do this often enough they will see bankruptcy. In matters of money, the same would apply. In a free market for money, we would not speak of inflation, I believe. We would speak of losses due to the use of unsound banking and money practices.

Hülsmann is saying the same thing in a different way: if we understand that we are participating in an FRB deposit account, this would not be inflationary.  Inflation isn’t strictly an economic concept, but one based on contract; on being informed.  I cannot express how much this warms my heart to read someone else write this.

Now to the first – the tricky part: “informed.”  I think it is safe to say that depositors aren’t told explicitly that his deposit is being lent out.  But is such an explicit statement necessary to constitute “informed”?  I think not.

It can just as easily be stated that a depositor is not told explicitly that his deposit is being held.  So which “informed” or not “informed” rules?  I have written hundreds of thousands of words on the concept of fraud in FRB, most recently here.  I won’t repeat these now.

Back to Hülsmann.  In writing of inflation, he states:

…the questionable ethical character…entails moral corruption of society.

It is an eithical question; it exposes the complete lack of moral considerations at the root of the global economic system.  As opposed to protecting people from such a system, it is government that makes this system possible.

It always goes in hand with the concentration of political power in the hands of those who are privileged to own a banking license and of those who control the production of the monopoly paper money.

How does the government make this possible?  The problem is the monopoly, not the fractional reserves and not inflation.  The monopoly is only possible due to government dictate.

End the Fed.


  1. I have been arguing for several years that person who needs protection from FRB is the payee of the notes (assuming that the bank and depositor can work out their contract). The claims made on this note:$20_1905_Gold_Certificate.jpg

    are simply not true for a FRB note. The note should be required to state on its face exactly what it is. The fully informed payee then can determine if he/she wants to accept it as payment. I suspect that such notes, if accepted at all, would be severaly discounted. They certainly should not exchange for the same value as a warehouse receipt for specie.

    1. I would envision, in a world of competitive banking and currencies, just such a market-required outcome; a simple description on the note of what it is / represents.

      As you suggest, there may very well be a market for it, at a price relative to its perceived value - and most certainly at a discount to a specie-backed note.

  2. BM,

    This may be the “money quote” that you were looking for from Hulsman?

    See, especially, the second paragraph below. (Good book, by the way, and one filled with topics that you seem to be interested in.)


    Thus fractional-reserve banking can arise as a perversion of money warehousing. But it can also originate as a perversion of credit banking. We have already talked about credit money and argued that it is unlikely to have any larger circulation because of the default risk and especially because most market participants prefer cash to credit instruments in spot exchanges. Now in order to make good for the latter deficiency, the banker might offer to redeem his IOUs on demand, that is, before maturity is reached. From the point of view of the customer, then, these IOUs can be turned into cash almost as securely as money certificates. We have to say “almost” because it would of course be impossible for our banker to comply with redemption requests that exceed his cash holdings—a problem that cannot arise in money warehousing, where every certificate is backed by a corresponding amount of money in the warehouse.

    So how does this practice appear from a juridical and moral point of view? It depends on whether the banker is affirmatively candid about the nature of his business. If he takes care to inform his customers that the redeemable IOUs are not money certificates and that he—the banker—remains the rightful owner of the money for the entire duration of the credit, then the practice seems to be unobjectionable. By contrast, if he insinuates that his IOUs are money certificates, we would certainly have to say that this is a case of fraud. Historically, it seems as though dissimulation has been

    Jörg Guido Hülsmann (2010-05-24). The Ethics of Money Production (LvMI) (Kindle Locations 1106-1116). Ludwig von Mises Institue. Kindle Edition.

    (By the way, 2 writers of which I am a "fan-boy", having a discussion? What's not to like? Roddis and the mosquito!)

    1. "It depends on whether the banker is affirmatively candid about the nature of his business."

      I have a struggle with this. Certainly, when (where / if) the normal practice was warehousing, this statement is reasonable.

      But today, when banks have not been warehouses for generations? Why must a bank affirmatively state it is doing the thing that, by practice, it has long been doing.

      In fact, given this decades (centuries)-long bank practice, I suggest a bank would be required to make an affirmative statement that it is warehousing the money - so when the depositor sees the warehousing charge he is not surprised.

  3. I agree that the phrase "affirmatively candid" is a bit slippery. I don't think it means there should be a greeter at the door telling you they aren't warehousing. It seems to me that the contract along with common knowledge meets the criteria. It is hard to parse whether Guido agrees or not.

    1. I also am not certain of his stand on the issue of FRB. I don't want to read too much into the parenthetical in the first cite, but it is not there for no reason.