Saturday, August 29, 2015

Another Thought or Two on Fractional Reserve Banking

I will not make this a long, drawn out post (cheers erupt from the audience and likely Mr. Engel as well).  I will comment on what strikes me as the primary points of emphasis or disagreement; this is not to suggest that I agree with everything else (I have other disagreements), only that these don’t seem as important to me.

Regarding my position that the current bank deposit contract does not fit the definition of FRB as Mr. Engel defines the term, it is offered:

…the entire plethora of Austrian works pointing the finger to our current Fractional Reserve system for our economic woes are entirely confused – for perhaps we don’t have an FRB system at all.

I will not get into a debate about the Austrian position; I do not believe it is this simple.  I do believe that our current banking system is at the heart of our current economic woes – but it is the monopoly, not the practice of deposits and lending that is at the root.

Rest assured, I remain steadfast that ABCT is quite valid; the issue behind boom-bust is excess or artificial credit creation.

Now, define “excess” or “artificial.”  I suggest excess or artificial can mean nothing more than credit created beyond that which is supportable by strictly free-market processes.  Free markets don’t produce “excess” in any meaningful (“our economic woes,” suggesting national or international calamity) sense; in truly free markets, prices clear.

In other words, remove the monopoly (allow for truly free markets) and Austrian “busts” would be quite limited – both geographically and in scope.  “Bust” will be nothing more than bankruptcies to individual entities based on poor or inaccurate entrepreneurial choices and decisions. 

The validity of ABCT will serve as a warning against monopoly (or other means of governmental support) in banking and credit creation.  Just remove the monopoly.

My next key point of emphasis / disagreement regards:

Hoppe argues that the problem with the free banking argument that today’s depository contract provides an example of a non-fraudulent FRB contract, lies with the contract itself in that the contract does not represent the actions of the two parties in fact.  In other words, whereas the modern deposit contract appears to escape being a bailment contract, the action of the contract’s parties contradict this.

…if the nature of the demand deposit is that it is a debt, then the claim must be a title to a quantity of future money, not a present money, for the present money is presently under the ownership of the bank.  And if this is the case, then the very idea that the money can be available on demand by the depositor contradicts the nature of the debt transaction itself.

Present money, future money, present money, future money.  How much time must pass?

Now, there are a lot of words in between these two statements in Mr. Engel’s post, but what is being suggested is that for a creditor – debtor relationship to be proper (or valid or whatever similar term you like) there must be either a) a minimum term of time or b) perhaps a variable term after some minimum time period or notice period has lapsed.

In other words, an instantly callable loan cannot be a loan; it must be deemed a bailment. 

To which I ask, why? 


However, in fact, as Hoppe points out,

the money depositor A receives from the bank B a claim to present money, rather than a debtor equity title.

It is a conditioned claim.  I find no reason or (more importantly) a non-aggression-introducing manner to stop two parties from conditioning between them the control, use, and disposition of property.


Hoppe continues:

It is not the case, as is claimed, that fraud (breach of contract) is committed only if B, the fractional reserve bank, is actually unable to fulfill all requests for redemption as they arise.

I don’t even claim that this is fraud.  Not every “breach of contract” is a fraud.  It is bankruptcy.  I don’t even like the term “fraud” very much; let’s just say it can only be fraud if it is first a violation of the contract.  For fraud, other additional factors must be present.  Anyway, this practice isn’t even a violation of the contract; when the bank can’t make good on the withdrawal claim, it may very well be nothing more than poor entrepreneurial decision-making.

That’s enough.  I think I will remain on my square as I have previously defined it; in the meantime, I thank Mr. Engel for his views.


  1. Thanks BM. I hope your readers will still read/consider my piece and (especially) the Hoppe essay I used, even though they haven't swayed you at this point.

    In the meantime, carry on with your great blog and I look forward to continuing to promote your thoughts and defend our beloved political philosophy.

    1. I encourage everyone to read not only the subject post, but regularly visit your site. You are a very clear thinker and writer.

  2. @C.Jay

    Glad to see you here. Your article on thin libertarianism left me breathless, an instant classic.

    I have read both your posts and bionic’s responses. I agree with you, FRB as currently practiced is fraud. But I think not for the reasons you assert. I’m afraid I agree with bionic’s refutations of your points.

    What the correct formal definition of Fractional Reserve Banking is, or should be, and whether modern banks fit, is a separate, moot matter, in my opinion.

    I agree with bionic that what’s relevant here are the modern bank contract terms. And at first blush, I might have thought bionic’s view that modern FRB practices are not fraud to be correct. The explicit portion of the modern banking contract, in two sentences buried in fine print, indeed says bank account balances hold not money, but bank IOU’s (I put in the research effort to track down and uncover this in the Citibank contract and share it here to further inform the discussion).

    I also agree with bionic that how each party chooses to think about the contracts they form with each other is irrelevant to the validity of the contract. In a state of freedom and informed consent, it’s purely a matter of personal choice if an individual wants to value a bank IOU known to be such as fiduciary media. Indeed, of people of sufficient reputation it is sometimes said, “His word is as good as gold.” In and of itself the fact that individuals might opt to grant this kind of credibility to modern banks is not the bank’s problem.

    But I recognize this is not all that’s relevant to establishing fraud. The current depository contract is comprised of not just explicit but also implicit contract terms supplied by the context of cultural norms, generally accepted practices, and reasonable expectations. It is thus relevant to the contract that an implicit promise that deposits are bailments representing money is made by bank employees verbal statements to that effect, bank signage, bank pamphlets, bank radio and TV ads, bank terminology, bank lack of disclosure to the contrary, etc.

    This same promise is also made by banks’ close business partner, government. It treats bank deposits as if equivalent to money throughout the entire legal system, taxation system, state education system, and every public statement. A certain message is sent when government forces everyone at gunpoint and pain of imprisonment to regard tax refund checks drawn on a bank account as money, accept bank EFTs for settlement of private contracts as if money, and fill out onerous paperwork if attempting commerce with cash rather than bank accounts.

    Banks and government alike thus conspire to hammer in the message of “bailment, bailment, bailment; money, money, money” in ways, shapes, and forms the public cannot ignore. It is unreasonable to pretend such actions effectively molding cultural norms of what bank accounts represent do not also shape corresponding implicit terms reasonably expected to be part and parcel of a banking contract. The glaring contradiction arising between implicit vs explicit terms deliberately created, silently unacknowledged, and purposefully left unreconciled by banks, is what constitutes fraudulent behavior on their part. Not any of the inherent FRB structural reasons you argue, all of which bionic correctly points out would be beside the point IF account balances were never held out by banks or its partners to be anything other than mere unsecured bank IOUs balances.

    1. See my reply here:

  3. I've been writing a bit on this topic myself lately; largely, I find myself in agreement with you. If you're keen, you can read my articles:

    In short, I believe that the error stems from assuming that note issuance necessarily must follow from fractional-reserve banking. I do not believe this is so.