Walter, You Can Do Better*

*at least you close on a strong note (more to come).

Walter Block once again addresses a question on fractional reserve banking (see here for my critique of his earlier post).  Once again, he errs (for the most part).  Let’s begin:

A lends $100 to B, the bank.

A perfectly legitimate transaction; nothing wrong so far.  It is also important to note – as Block does – that it is a loan: A lends $100 to B, the bank.

B gives A a demand deposit for that $100.

Technically, B gives A a note.  Remember: the $100 is a loan; it is not a deposit.  Walter knows this (he uses the term “lends,” he does not use the term “deposits.”)

In any case, this, too, is a perfectly legitimate transaction.

Under fractional reserve banking, B then lends $90 to C, giving C a demand deposit for $90.

You can call it “under fractional reserve banking” or call it a fruit – it would be about as descriptive a term of the underlying business transaction.  A lent $100 to B; B has the right under contract to lend some portion of that $100 to a third party.  You might as well call it a fruit.

I call it yet one more perfectly legitimate transaction.

A and C each think they own, respectively, $100 and $90.

Not really, and not complete.  A owns a note from the bank.  A does not own $100 – check his wallet.  A has a piece of paper that says the bank owes him $100.

As to C: one possibility is that C holds the $90 in his wallet – in other words, he doesn’t just think he owns the $90, he owns the $90.  Or alternatively C might have a note from the bank stating that the bank owes C $90, which would be the case if C left the $90 with the bank, meaning C “lent” the bank the same $90 he borrowed.

But there is one other step: the bank holds a note from C, for the $90 lent to C.

But in every case, the transactions are perfectly legitimate.

Yet B only has $10 to make good this “ownership.”

If B only holds $10, this suggests that C is holding the $90 in his wallet – this is fine.  In this case, B only has to make good on the claim of A.  B doesn’t owe C an additional $90!  C has nothing to claim – C has the $90 in his wallet.  B has a claim on C for the $90, not the other way around.

As to the claim of A: B has $10 and B also has a note from C in the face amount of $90.  In other words, B has much more than the $10 to make good on the claim of $100 by A.

Now C might have to juggle a few things if A comes in today looking to cash in his note.  Shocking, isn’t it?  Entrepreneur B (a bank, but an entrepreneur nonetheless) might not have perfectly forecast the future.  When does that ever happen?

To my way of thinking, it doesn’t matter that both A and C “know” what is going on.

That they “know” matters significantly from a legal standpoint.  It also matters what the contract says, from a legal standpoint.

B should be legally obligated to pay them respectively, $100 and $90.

B is legally obligated to perform to that which B contracted.  But let’s be clear – each of these transactions are legitimate and were contracted.  B either will be able to perform or not.  Guess what?  Just like every single other business transaction on earth.

In any case, C already has the $90 in his wallet; nothing for B to “pay.”  As to A: A lent $100 to B; “lent” implies risk of something – it implies the risk of being repaid…or not.  B may pay him back, or may not.

That’s what B’s contract with A and C stipulate.

I believe I have more accurately depicted what the individual contracts stipulate.  I don’t just believe it; I am certain of it.  Walter has it wrong.

Similarly, in the banking case, if A and C do not get their money when they want it, and don’t care, then no fraud has been perpetrated on them.

I don’t know anyone who doesn’t care if he does or doesn’t get his money back.  “Care” isn’t the issue when it comes to fraud.  The issue isn’t if A and C care (although I have already dispatched with C, as he has the $90 in his wallet); the issue is what does the contract allow.  And if the parties follow the contract, there is no fraud.

But wait.  Is bankruptcy “fraud”?  Not necessarily.  People and entities go bankrupt; not every bankruptcy is caused by fraud.  Perhaps nothing more than bad business judgment was involved.  As I have stated before: if Austrians do not allow for the possibility of bad business judgment, then every word written by an Austrian economist on the role of the entrepreneur is a wasted word.  (I would bold this entire last sentence, but I am probably using this tool a bit too much.)

But, this is not then a case of banking. Rather it is a case of play acting, or gift giving, or something like that. It is not the commercial interaction that appearances might indicate.

Every step of the process above is a legitimate business transaction.  It is a party loaning that which was lent to it.  Nothing more.

To return to reality, in actual, historical, fractional reserve banking, there was no gift giving, no play acting. Rather, there was outright fraud.

I have no reason to doubt that historically there were cases of individuals holding a bailment and yet lending it out.  Let’s just be clear – are we debating a fraudulent historical practice or today’s banking system?  Because the main problem with today’s system isn’t fraudulent fractional reserve banking; the problem today is the monopoly and the government protection.  Nothing more.

Now, to the one thing Walter got right:

Note, I cannot say that everyone else in society can sue B, or perhaps A, B and C for concocting a scheme that reduces the value of everyone’s monetary holdings. Why not? Because in libertarian theory, you can only own things themselves, not their value.

Amen brother – and not just libertarian theory: value is subjective, constantly exposed to change – and change outside of the control of the property owner.

Conclusion

Every transaction in this process is a legitimate transaction.  And the reduced value of everyone’s monetary holdings is no crime – in libertarian theory or otherwise.

There is one problem with today’s banking system – and truly, only one worth discussing: end the monopoly; end the government backstop.

End the Fed.