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.