If Fractional Reserve Banking Is Fraudulent, Then So Is...
In this paper, Hoppe, Hülsmann, and Block (HHB) make their ethical case against fractional reserve banking (FRB) based on the fact that "two individual owners cannot be the exclusive owner of one and the same thing at the same time." They then posit that since fractional reserve bank notes creates multiple titles or claims to the "same" gold, they are inherently fraudulent.
In analyzing this claim, the first thing we will have to do is to turn it into a remotely sensible claim. No one who deposits money at a bank thinks they are entitled to the same money back. What they want, when they go to get their money out, is the same amount of money back. What a gold-backed fractional reserve note comprises is a claim to a certain amount of gold, not certain particular pieces of gold. I hope that change to their argument is uncontroversial!
So their complaint comes down to this: if a bank issues pieces of paper that allow the bearer to claim a certain amount of gold from the bank, then the bank must have enough gold to cover all outstanding claims at all times.
Once that is understood, we can easily see another fraudulent practice that HHB should object to equally strenuously: fractional reserve gift certificating. Look at the deceit involved in this nefarious practice: a local restaurant at Christmas time sells gift certificates for 1000 prime rib dinners, and yet... there are not 1000 prime rib dinners in the restaurant at the moment they sell them! In fact, never are there more than fifty or so in the restaurant at any one time. The crooked owners of this restaurant, of course, will try to hide their deceit behind some spurious claim like, "Based on past gift certificate programs, we expect redemptions of about 100 meals per week, and we have plenty of beef on hand to meet that demand."
Fraud! The plain fact is, according to HHB, that their are 1000 claims to prime rib dinners outstanding, but only 50 prime rib dinners available at the restaurant, so this means that multiple people have claims to the "same" prime rib dinner.
No, if a restaurant wants to sell 1000 gift certificates, the only thing for it will be to keep 1000 dinners on hand during every hour they are open. Otherwise, they are criminals!
In analyzing this claim, the first thing we will have to do is to turn it into a remotely sensible claim. No one who deposits money at a bank thinks they are entitled to the same money back. What they want, when they go to get their money out, is the same amount of money back. What a gold-backed fractional reserve note comprises is a claim to a certain amount of gold, not certain particular pieces of gold. I hope that change to their argument is uncontroversial!
So their complaint comes down to this: if a bank issues pieces of paper that allow the bearer to claim a certain amount of gold from the bank, then the bank must have enough gold to cover all outstanding claims at all times.
Once that is understood, we can easily see another fraudulent practice that HHB should object to equally strenuously: fractional reserve gift certificating. Look at the deceit involved in this nefarious practice: a local restaurant at Christmas time sells gift certificates for 1000 prime rib dinners, and yet... there are not 1000 prime rib dinners in the restaurant at the moment they sell them! In fact, never are there more than fifty or so in the restaurant at any one time. The crooked owners of this restaurant, of course, will try to hide their deceit behind some spurious claim like, "Based on past gift certificate programs, we expect redemptions of about 100 meals per week, and we have plenty of beef on hand to meet that demand."
Fraud! The plain fact is, according to HHB, that their are 1000 claims to prime rib dinners outstanding, but only 50 prime rib dinners available at the restaurant, so this means that multiple people have claims to the "same" prime rib dinner.
No, if a restaurant wants to sell 1000 gift certificates, the only thing for it will be to keep 1000 dinners on hand during every hour they are open. Otherwise, they are criminals!
Similar deal with airline bookings where overselling seats is fairly routine. The difference is that the people who get bumped get some kind of compensation.
ReplyDeleteI might be open to an FRB in a TrueFree market if they offered some kind of insurance or compensation in the event of a bank run.
Actual existing banks offer some kind of insurance or compensation in the event of a bank run now.
DeleteAre you referring to FDIC guarantees? Because I'm pretty sure that the HHB paper is talking about FRB in a free market situation where such a government guarantee would not exist.
DeleteMaybe, as just one possibility, interest on your deposits? But, uncertainty is not necessarily
DeleteI think it send an incomplete response to traumerei -- can you just delete it and this one? Thanks.
DeleteAh. So it was an "even in a RothbardianFree(TM) market, fractional reserve banking would be immoral to engage in paper?
DeleteHigher interest rates on deposits certainly is an option to compensate in inverse proportion to the reserve ratio.
DeleteOf course, for the people who act fast enough or have connections, they get the interest and their deposits back. Discriminating customers into a tranche system doesn't appear to be a solution either which is why I think insurance or compensation would make more sense.
Wow, the missing quotation mark made it exceedingly difficult to interpret that Jim. But yes, the paper does seem to suggest that FRB would be immoral in a free market.
DeleteI've never seen a gift card that didn't say something regarding availability. In fact, a gift card doesn't grant the bearer anything on demand at all, whereas a deposit account does. I think that most intelligent people know that gift cards are a scam to get your money up front (with or without an exchange of actual goods). Unfortunately, the number of intelligent people in the world is very small, so the scam continues.
ReplyDelete"where free banking has existed in the past, depositors would often give banks the option of converting deposits into short term loans (e.g. 60 days) with a high interest rate."
DeleteThere you go, Joe: something regarding availability! Just like a gift certificate.
I've never seen a gift card that didn't say something regarding availability.
DeleteI am currently holding in my hands gift cards for Shell gasoline and Amazon.com (which are the two I happened to have on me when I read Joseph's comment).
Neither contains any mention of availability.
Blackadder, these are Rothbardian a priori facts, and cannot be refuted by your pathetic empirical findings.
Delete"Gift Cards must be redeemed toward the purchase of eligible products on www.amazon.com, or its affiliated websites www.endless.com, www.myhabit.com, and fresh.amazon.com. Redemption of Gift Cards on our affiliated websites is subject to change in our sole discretion."
DeleteThis is from Amazon's site.
Gene, don't be a douche about it. Look at what I said, "I've never seen...". Obviously, I am not stating anything as an a priori fact. The Shell one is less restricting, but that makes sense, as most of their sales will be in the form of a single commodity.
Delete"don't be a douche about it"
DeleteI suppose you tell triangles to stop being so three-sided.
Ok, point taken.
DeleteI don't get how people don't get beyond the initial stages of misunderstanding (referring to full reservists).
ReplyDeleteJim deposits $100 at his bank, promising to leave it there for 100 days. The bank offers him interest and then loans out the money. Full reservists acknowledge that this is okay, since Jim has explicitly declared his intentions to not use $100 for 100 days. As such, when the bank lends these $100 to Joe, it's A OK.
Now, Jim deposits $100 and doesn't declare his intentions. But, there are signals that bankers can interpret that suggest that Jim might be leaving that money without use for some amount of time. So, banks decide to loan part of it out. I don't get how this suddenly is conceptually different than the first example.
Banks are firms ran by entrepreneurs. Entrepreneurs are an important driving force of the market process. Not all entrepreneurial decisions are good, but profit and loss help guide the market towards more "efficient" outcomes. It's amazing how some full reservists are just so intent on distorting the theory of free banking by continuously misinterpreting it and failing it to consider it even within their own framework (which, honestly, is not that different than Selgin's, if it is at all). They can't see that what's being described is a more efficient means of utilizing saved capital.
At least Block is consistent and thinks that maturity mismatching of time deposits are also a problem. I don't know how someone comes to that conclusion and doesn't say "holy s#@! I've been drinking from strong kool aid" and then immediately revises his/her understanding of monetary theory, but at least the ranks of sophisticated Austrians who still adhere to full reserve banking are beginning to dwindle (although, Huerta de Soto's program in Madrid has produced some pretty bad Full Reservists 2.0 [the next generation], who not only repeat the same [and, believe it or not, worse] arguments but are apparently completely ignorant of the relevant literature).
But, in the end, it's easy to see the faults in others. People probably look at me and say the same thing, or will in the future when someone actually thinks my opinions matter.
Good evening, Jonathan.
Delete"So, banks decide to loan part of it out. I don't get how this suddenly is conceptually different than the first example."
I agree with your comment with the exception of that above-quoted language.
Someone "reading my signals" is much different than someone getting my express permission.
Also, from the standpoint of the bank, it's not the same. If something goes wrong and they have my permission, I am estopped from suing them. If something goes wrong in the second instance, the bank has no protection.
Other than that, I agree that 100% reservists are misguided.
Banks are firms ran by entrepreneurs.
DeleteOkay, let's try to be at least a little serious about this.
Jon,
DeleteI don't know any full reservists that suggest fractional reserve banking can't "work" in a free market. The ethical charge is that it represents fraud. Not all "market outcomes" are just. We have to start from the basic principles of property and contract theory vis-a-vis Rothbard's title-transfer-theory of contracts to recognize which "market outcomes" are legitimate and which aren't.
Fractional reserve banking requires the overissuance of property titles to present goods. It thus creates the situation where two people hold a claim to the same resource.
"We have to start from the basic principles of property and contract theory vis-a-vis Rothbard's title-transfer-theory of contracts..."
DeleteDo we now? And why do we "have" to start from Rothbard's cranky and idiosyncratic theory of contracts?
"Fractional reserve banking requires the overissuance of property titles to present goods."
Only if one stupidly believes that fractional reserve bank notes are property titles!
antiahithophel,
DeletePermission? Like the contract you sign when you open a bank account?
Mattheus,
"I don't know any full reservists that suggest fractional reserve banking can't "work" in a free market."
Most of them? Salerno, for instance, doesn't believe FRFB is fraud, but thinks it would lead to the business cycle (i.e. bank runs).
"It thus creates the situation where two people hold a claim to the same resource."
It doesn't. What a bank note promises you is a specific quantity of outside money upon redemption -- as long as the bank can fulfill this promise, it fulfills its contract.
Good morning, Jonathan:
DeleteI never said that banks did not get permission when you signed the contract.
I was responding to YOUR second example regarding Jim. In your second example, the banks did not get Jim's permission. The banks relied on their ability to read Jim's signals.
Right, I was explaining how fractional reserve banks can avoid maturing mismatching problems when lending out on short-term savings like held money.
DeleteOk. That makes sense.
DeleteOk. That makes sense.
DeleteExcellent point, Gene.
ReplyDeleteTraumerel, where free banking has existed in the past, depositors would often give banks the option of converting deposits into short term loans (e.g. 60 days) with a high interest rate. Banks wouldn't want to exercise this option unless they had to (because it would mean having to pay higher interest), but the option gave the bank a way to head off a bank run if necessary. It is somewhat akin to the airline practice of offering free travel vouchers to people willing to give up their seat when a flight is over capacity.
Excellent point, Gene.
ReplyDeleteTraumerel, where free banking has existed in the past, depositors would often give banks the option of converting deposits into short term loans (e.g. 60 days) with a high interest rate. Banks wouldn't want to exercise this option unless they had to (because it would mean having to pay higher interest), but the option gave the bank a way to head off a bank run if necessary. It is somewhat akin to the airline practice of offering free travel vouchers to people willing to give up their seat when a flight is over capacity.
I don't think the analogy of comparing gift coupons to a bank deposit works if that deposit is considered a bailment.
ReplyDeleteMeals at a restaurant or seats on a plane are not the property of a person who purchases a claim to them. And, the money paid for the claim shows up on the firm's balance sheet as theirs.
Those who argue 'FRB is fraud' say that the amount of money deposited remains the property of the depositor (not the same money, the same amount). It is not the property of the bank and does not show up on their balance sheet. Thus, lending it out is akin to embezzlement. It is not the same thing as issuing claims to property (like a meal or a seat) the depositor did not own in the first place.
That's why Gene made that comment about fungibility. A note can be redeemed for a specific quantity of outside money, but that doesn't mean that it has to be the same exact money you deposited. I mean, it's true that Gene's analogy might be a bit different, but it doesn't make fractional reserves any more fraud.
DeleteI suppose I should consider it progress that some species of libertarian has identified at least one limit on the supposedly sacred freedom of contract. It's a start!
Delete@Richard: "Those who argue 'FRB is fraud' say that the amount of money deposited remains the property of the depositor... Thus, lending it out is akin to embezzlement."
DeleteRichard, could you not even be bothered to glance at the paper to which I was responding? HHB did NOT make that claim (probably because they are bright enough to realize how stupid a claim it is) and instead made the claim I was addressing.
Gene,
DeleteI read it a long time ago, but taking another look at it, it looks you are right. My comment was wrong. Thanks.
Gene! you've been blackballed... there isn't a single Rothbardroid in here!
ReplyDeleteMaybe the're at a convention or something.
Jonathan,
ReplyDeleteI don't see how 'bank ownership' of deposits obviously follows from 'fungibility'. Perhaps it does, but the 'FRB is fraud' position argues it does not. If Gene is saying that it does, OK. But, then, that is the essence of the dispute. To proceed from there and make a comparison to other businesses that assume ownership of the money presented to them for another claim, then, doesn't blow up 'FRB is fraud' position to my mind. That position is based on a premise that banks do not have title to the amount of money deposited with them, unlike the other business Gene then compares them to.
Jim,
Yes, some libertarians ridicule the 'FRB is fraud' position as violating the freedom to contract. Unfortunately, those who hold that position disagree that it does. Your hope of progress of the species is, unfortunately, dashed.
Banks surely own the notes they print.
DeleteAssuming that the banker and depositor can work out a mutually agreeable contract for some form of "fractional reserve free banking", what information is to be provided to the prospective payee of these "fractional reserve notes"? Is that information going to appear on the face of the note? What does the note promise on its face? What level of understanding do you expect payees to possess regarding the significant difference between a "fractional reserve note" and a 100% reserve note? Do you expect prices to be stated in terms of a unique brand of fractional reserve notes?
ReplyDeleteBob,
DeleteWhy not just apply the ordinary rules that libertarians apply to all other transactions, instead of trying to create some super-strict standard to achieve a desired outcome?
I just asked questions. I received no answers. I have no "desired outcome". I really don't care that much. I've seen all this fighting about the agreement between the depositors and bankers which I think is resolvable. The reaction of the payees to these notes and the prices stated in terms of these notes is where the rubber hits the road on this issue.
DeleteThe non-response response to this central question is like the non-response response of Keynesians to the issue of economic calculation.
In any event, I tend to have a "super-strict" standard for all meetings of the mind. Are you saying that there probably won't be a "strict" meeting of the minds between the payor and payee of these notes but that's ok and I'm just a fussbudget because payees ought to know?
I frankly don't think you guys have given any more thought to this than the MMTers have to the concept of human action. And I guess that makes me a cultist and a moron.
"The reaction of the payees to these notes and the prices stated in terms of these notes is where the rubber hits the road on this issue.""
DeleteIf only there were some social institution that we could put in place to set the price of fractional reserve notes, huh Bob? Maybe a "fractional reserve note price setting committee"?
"I frankly don't think you guys have given any more thought to this than the MMTers have to the concept of human action. And I guess that makes me a cultist and a moron."
Bob, if you think George Selgin and Larry White, who have spent 30 years of their lives working almost exclusively in this area, haven't given much thought to this issue, then you are indeed what you jestingly say you are.
Bob Roddis,
DeleteYou say: In any event, I tend to have a "super-strict" standard for all meetings of the mind.
Okay, consider one person selling another a cheeseburger. Does the seller have to inform the buyer about all the health risks associated with obesity? Or whether the beef was free range or factory farmed? If the seller doesn't do this, does that make the sale fraud? If it turns out the buyer just assumed that the beef was free range (even though most beef is factory farmed) or is an idiot and doesn't know that cheeseburgers can make you fat, does *that* mean the sale is fraudulent?
Fine. So don't answer my questions.
DeleteBob,
DeleteI really think that some 100%ers treat the issue of FRB with a double standard. The main point in being for a free market is because it allocates pain of loss to the right people, instead of socializing it to people who had nothing to do with it. This breaks the learning process and sets perverse incentives in motion. Those 100% will agree this works with entrepreneurs, speculators and so on. Yet somehow this doesn’t work for normal people who put their money in a deposit account.
Even if they are all deceived today in thinking all their money is kept for them without being loaned and the interest paid to them is a gift with now drawbacks, this problem doesn’t stem from FRB, but only from a government mandated FIAT Federal Reserve System with Central Bank and FDIC which stops losses of being transferred to the right people. And the right people are of course the depositors themselves. They don’t know not because they are intentionally deceived by private banks (even if really tried), they don’t know because they don’t care, because they will not suffer their own losses. In a free banking system they for sure would know.
If the outcome of a free banking system was very low FRB or quite high FRB is a different matter. However the legal problem really is a non-issue for my point of view at least for libertarians.
And about your question of what would happen with FRB notes compared to 100% notes, I try to give an answer: When Kings debauched their currency, no official authority told the King's subjects that they should read up about Gresham’s Law and act accordingly to it. They just did. If this was the case then, then they will treat FRB and 100% notes accordingly, as far as it involves real risks of additional losses with FRB notes, now as well. Allocating losses to the right people (at the right time) will make that happen.
I mean "...no drawbacks..." of course.
DeleteBob,
DeleteTo answer your questions: I think we should apply the same standards to exchanges involving fractional reserve notes that we do to exchanges involving everything else. If a person buys a cheeseburger we don't require him to sign a waiver saying he knows eating it could make him fat. We don't allow him to sue for fraud if he thought the beef was free range when it actually was factory farmed.
I presume that you are opposed to paternalism with regard to other types of exchange. To be consistent, you should also oppose paternalism involving the exchange of fractional reserve notes.
I would like to see the contract between the depositor and the bank and I would like to see what is written on the face and back of these FRB notes. If you don't know, just say so. I'm asking because I don't know.
Deletehttp://tinyurl.com/bmffl85
I'm starting to have a smidge of sympathy for the anti-frackers, because I think they might be at least implicitly acknowledging reality but finding themselves with limited tools to address it.
ReplyDeleteAfter all, the first point made against hard-money enthusiasts is that the hard-money era featured financial crises of even greater intensity and frequency than the soft-money era (until the present unending one...). Most hard-money enthusiasts can't adopt the historical tools that moderated hard-money financial panics - soft money and the regulatory state - for ideological reasons. But they realize they've got to come up with something! (Which puts them ahead of "vulgar Paulism," it should be noted.)
What they come up with, apparently, is ruling FRB out of bounds. And in a way, fair's fair! Our current bad equilibrium of endless subventions to bankers who hold the balance of political power in the West suggests that banking as such is an unsolved problem.
But it's also not clear what the equilibrium of a full-reserve banking regime looks like. Is there no more borrowing short and lending long anywhere in the system? If a standard "bank" remains, doesn't it flip from paying interest to charging storage fees? At that point don't people - particularly small savers - tend to pull their money out of banks and stick it under mattresses? What does that do to the pool of investment capital, especially since in these regimes there's no state to fund large projects?
Do "banks" just all relabel themselves "brokerage houses" with the stipulation that every dime of your principal is always at risk - essentially renaming FRB is "investing" and taking away the backstopping of federal deposit insurance? And what's the equilibrium of that?
" So, banks decide to loan part of it out. I don't get how this suddenly is conceptually different than the first example."
ReplyDeleteOf course the concept is even more ludicrous because the banks *don't* lend out other people's savings anyway.
It's the lending that brings the savings into being in the first place.
And of course those savings are the liabilities of that particular bank. Whether they are worth something at some other bank, or even at the local store is not guaranteed and never is. It is always a promise.
Neil,
DeleteSaving is withholding income from present consumption. The decision is made by the individual, not by the bank.
I think Mr. Wilson is an MMTer. Correct me if I'm wrong, but I don't see how MMT has any relevance to a true free banking situation, FRB or no FRB.
DeleteTo Jonathan:
DeleteSaving is created with bank loan, that's how income is created any way. Someone goes into debt and spends. Neil was ponting out that banks don't lend out deposits or savings. Investment creates Its own savings.
"Saving is created with bank loan, that's how income is created any way. Someone goes into debt and spends."
DeleteWow, that makes it a real puzzle as to how the first person earned income!
Firs person earns income when he sells something. Sale can be defined as exchanging goods and services for credit. Someone issued liability and in case I sold something to that person, I am holding that as a claim against that person.(that was my "monetary income") In our world It's the bank in between and we don't have to think about the first person.
DeleteSo m4nc4f, are you saying that a bank loan is not, in fact, the cause of the creation of income; but rather that the bank is an intermediary? There's a huge difference between your two positions.
Delete"Sale can be defined as exchanging goods and services for credit."
DeleteAnd it *can* be defined as flying kites. That doesn't mean such definitions are helpful.
traumerei:
Deletespending creates income, Nail was saying that loan creates savings to what Jonathan replied that saving is withholding income from present consumption and that is true (unspent income) but how was that income to spend created in the first place? For sure not by saving because loan created the stuff to spend. You would not have monetary income if there is no money. And sure, banks are intermediaries.
The income to spend was created in the first place by the productivity of some individual. It does not make sense to say that spending creates income in a direct causal sense for how can you spend if you do not have an income?
Delete"The income to spend was created in the first place by the productivity of some individual."
DeleteWithout money? We are talking about monetary income here. How productive you are working in your yard doesn't matter. If you don't sell those apples you pick, you have no monetary income, period.
Where did I say that the income was generated without money? Oh yeah, nowhere.
DeleteYou said it yourself, "Firs [sic] person earns income when he sells something."
Before you can sell something, you need to produce (either potentially as in a futures contract or actually) something to sell. Voluntary exchange, whether in a barter, Graebe credit, or money economy presupposes that people have things (potentially or actually) to exchange.
Hm. Some people produce - money!
DeleteFor serious. Work goes into it - that's true whether it's made of paper or just bits. And other people want it, in greater or lesser quantities.
traumerei: we are not getting anywhere, I said spending created income to what you replied: The income to spend was created in the first place by the productivity of some individual.
DeleteNot without money right. So we are back in the beginning when Nail said that saving was created by bank loan and Jonatan replied that saving is withholding your current income. On macro level if everyone withholds their current income, saving is not increased. And sure there has to be productive capacity in the economy for your monetary income to be worth anything, but monetary income IS NOT created by productive capacity.
Monetary income to spend was not created by the productivity like you are saying. America has millions of highly productive people unemployed and idle capital right now. They don't have monetary income and they are not producing anything no matter how productive they are. Productivity does not create monetary income.
We have deficit based financial system. Your financial asset(saving) is somebody else's liability(debt, negative saving). Jonatan makes It sound like you can save as much as you want and this will not affect others. Your saving is there because someone else was willing to go into debt. It can be other person in economy, It can be company, It can be government or even foreigners.
DeleteMonetary income is not created by productivity. spending=income by definition. Your income is someone else's spending.
Delete"spending=income by definition"
Delete"if everyone withholds their current income, saving is not increased"
"they are not producing anything no matter how productive they are"
Is that you KN@PPSTER?
Im honestly curious how people see fractional reserve banks(FRB's) functioning in a free society. In the absence of taxpayer financed deposit insurance, central banks, and governments to suspend payment in specie, FRB's become prime targets for speculative attacks. Even a FRB with 90% reserves can be brought down. All one has to do is to accumulate enough bank notes for redemption to trigger a bank run.
ReplyDeleteIf one combines this with short selling of the bank's stock shares, the profit potential is more than enough to be worth the initial costs. In fact, one need not go through the whole hassle of acquiring bank notes to trigger the bank run. One can simply make known the intention of accumulating outstanding number of bank notes. As long as its made clear to the public that you have the resources to go through with it, the threat in of itself will cause a bank run. The entire endeavor is so simple that venture capitalists would always be on the lookout for such banks. Just by virtue of announcing you are a FRB will make you a target. The only way for FRB's to operate without becoming immediate targets is to masquerade as 100% reserve banks, which would undeniably constitute fraud.
Also, in regards to the comment up above, there is no need to mandate that FRB's label explicitly their fractional reserve bank notes. Full reserve banks will clearly mark the bank notes as 100% Reserve. It would be stupid for them to let fractional reserve issuers let its bank notes be perceived as exactly the same as a full reserve bank note (where a commission must be charged for warehouse keeping). Any bank note not marked as 100% would automatically be assumed to be under fractional reserve.
In fact, I would argue that unlike fractional reserve bank notes, full reserve bank notes would be accepted by payees at par value. Fractional reserve bank notes would be accepted at below face value because of the psychic costs from fear of bank runs. Human beings are overtly loss averse, and this could possibly even push full reserve bank notes slightly ABOVE par value in a micro-level version of "flight to safety" that often occurs with the US dollar, up until all banks finally do away with FRB.
This is my outlook on the whole matter. For those who believe Fractional Reserve Banking to not only be feasible, but even profitable without government protection, please explain where Im wrong in my train of thought.