Fractional Reserve Banking Is Not Fraudulent

[Occam's Banana]

There are very few things I disagree with Ron Paul, Walter Block and Murray Rothbard about.

The allegedly inherent fraudulence of fractional reserve banking is one of them.

My own stance on the subject aligns with a certain mosquito's ....

Walter Block Errs on Fractional Reserve Banking
https://bionicmosquito.blogspot.com/2016/06/walter-block-errs-on-fractional-reserve.html
bionic mosquito (18 June 2016)

It is an error common to many in the Austrian school.

It has been some time since I have written on this topic (here are over 60 posts on this topic), but here Block has offered a simple example for examination:

In fractional reserve banking, A lends $100 to B, the bank. B gives A a demand deposit for that $100. B keeps a reserve of 10%. B lends out $90 to C. B gives C a demand deposit for that $90. Thus, both A and C are the “proper” owners of that $90. This is incompatible with libertarian law, since only one person may own one thing at a particular time.​

There are two words in the above that, when properly examined and understood, demonstrate in very simple terms the flaw of the fractional-reserve-banking-is-fraud concept. These are “lends” and “own.” Person A “owns” something. In Walter’s case, he owns $100. He “lends” this $100 to bank B. In this, the flaws of the FRB-as-fraud claims are fully exposed.

What happens when someone “lends” something he “owns” to another? He gives up the use of the item during the time it is lent. He still owns the item – that is, he has certain rights in property of the item – but he has also given up certain rights in the property.

A simple example is a home rental contract. I understand the differences of this and FRB, and don’t intend to debate why the example isn’t perfect. It is merely sufficient for my purpose.

Does the homeowner give up ownership of the home when he rents it to a tenant? No, the home is still his. However, the homeowner has given up the right to live in the home for the duration of the lease. The homeowner still has rights in the property (the home) while giving up certain rights (occupancy).

Depositor A has given up $100 cash from his pocket. He lends this to the bank; this term, lends, should not be overlooked – and unlike many critics of FRB, Block does not overlook it. Depositor A has lent the bank $100 – he did not ask the bank to store $100 as a bailment; he lent the bank $100.

By doing so, he gave up certain aspects of the property – he no longer has the $100 in his pocket. Instead, he has a document from the bank stating that the bank will return $100 on demand.

(As an aside, this demand is conditional, as stated in the contract; I have written about this too many times to count, and so won’t get into it here. Yes, yes, yes…if everyone with a demand deposit demanded their deposits at the same time, the bank would be unable to fulfill the requests. Business failure isn’t always fraud – sometimes it is just poor entrepreneurship. Suffice it to say, since the founding of the FDIC, banks have made good on this contract virtually 100% of the time – a level of performance unmatched by virtually every other industry.)

Back to Block’s example: Depositor A gave up certain uses of his property. The bank has acquired these uses in exchange for something valued by A. While A “owns” the $100, he lent it to the bank for the bank to use. The bank uses the $100 to lend to a third party – borrower C. Something like a sub-lease on the aforementioned home.

A and C do not own the same property at the same time – Walter is just plain wrong about this. A owns the property but gave up certain rights to the use of his property when he lent it to the bank. The bank gave those rights to C. C does not “own” the $90 any more than a tenant “owns” the house he is renting. The tenant merely has use of the house, as C merely has use of the $90. Both the tenant and C are obliged to return the property under the conditions of the respective contracts.

A doesn’t have use of the $100 cash no longer in his pocket – he has a contract from the bank instead. A gave up $100 cash in exchange for the terms in the contract with the bank. One of these terms (but not the only one, else A would likely not enter into the agreement) is that the bank would return $100 to A on demand (with certain exceptions, again I won’t get into these here). A still owns the property; C does not.

Conclusion

The control, use, and disposition of property is divisible – and can be separated from ownership via agreement of the owner. As Walter states, property can be legally owned by only one individual (or an entity established for property ownership). However, that individual can give up control and use of the property in exchange for something valued by the property owner – the ownership is now conditioned as is the use of the property.

I thank Walter for offering a simple example to demonstrate this point.

 

[timosman]

It is not a fraud as US National Debt will be paid off one day.

 

[Occam's Banana]

Walter, You Can Do Better*
https://bionicmosquito.blogspot.com/2016/07/walter-you-can-do-better.html
bionic mosquito (09 July 2016)

[all emphasis in the original - OB]

*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.

 

[wizardwatson]

Wow, what a truly heartwarming event.

3 anonymous users uniting for liberty under the banner of super awesome Fractional Reserve Banking.

Sadly, I will remain in the Ron Paul, Walter Block, Murray Rothbard camp on this issue.

But the peer pressure is REALLY REALLY intense, juse so's you know.

 

[r3volution 3.0]

Posner(r3volution 3.0), in contrast, says Yes. That is, he claims that A no longer has a right to the money he has deposited. But he offers no REASON in support of this contention. Reading in between the lines, it is easy to see what is going on here: Posner(r3volution 3.0) is relying on PRESENT LAW, according to which he is entirely correct. This, indeed, is the exact manner that the courts have interpreted demand deposits. However, Posner(r3volution 3.0), sadly, is missing out on the context of the debate between me and Caplan. We were debating, not, what the law IS, but, rather, in sharp contrast, what the law SHOULD BE. Posner(r3volution 3.0) mistakenly interprets the Block-Caplan debate as over a POSITIVE statement of law, when it really involves NORMATIVE claims about the law. Yes, yes, Professor Posner’s(r3volution 3.0) views of bankruptcy law are entirely correct as regards which creditors are first in line, but they are equally IRRELEVANT to the debate between me and Caplan.

That has no bearing on what I've been saying. Nowhere have I mentioned present law. I'm talking about what the law should be.

Namely, freedom of contract should be respected and the call loan should not be outlawed simply because it oddly offends your sensibilities.

 

[Occam's Banana]

Wow, what a truly heartwarming event.

3 anonymous users uniting for liberty under the banner of super awesome Fractional Reserve Banking.

Sadly, I will remain in the Ron Paul, Walter Block, Murray Rothbard camp on this issue.

But the peer pressure is REALLY REALLY intense, juse so's you know.

LOL. Backatcha.

 

[r3volution 3.0]

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 feel the mosquito's pain about semantics...

The way these debates usually go:

"FRB is inherently fraudulent!"

"But what if both parties understand that it's a loan, not a bailment?"

"That's not FRB!"

 

[wizardwatson]

That has no bearing on what I've been saying. Nowhere have I mentioned present law. I'm talking about what the law should be.

Namely, freedom of contract should be respected and the call loan should not be outlawed simply because it oddly offends your sensibilities.

I'm not for outlawing call loans, but for outlawing the designation of bailments as loans.

Now if you AREN'T relying on what the law is, but rather what it should be, then you have to acknowledge that FRB wasn't really legalized until the mid-1800's. It was only in the 1800's court cases that the question of bailments vs. loans in the context of banking was settled in the courts.

In the OP you specifically say:

When you deposit money in a checking account, you are making a loan to the bank

But even today, although it's legally settled that a deposit is a loan, laymen don't call it a loan. Because it isn't a loan "really" it's just legally a loan because banks wanted to legalize FRB.

That's how evil and injustice operates. We all know the saying:

When plunder becomes a way of life for a group of men in a society, over the course of time they create for themselves a legal system that authorizes it and a moral code that glorifies it. - Frederic Bastiat

Want to kill your babies? Let's pretend babies aren't human! Want to legalize gay marriage? Let's pretend it's between two humans and not a man and a woman!

And just like to legalize abortion they needed to change definition of a person.
And just like to legalize gay marriage they needed to change the definition of a marriage.

To legalize FRB they had to change the definition of deposit.

Of course if you want to loan your money to whoever you want you have freedom to contract. But this idea that, FRB is what banking "is" by it's nature is a lie. It's not even legal 200 years back.

Illogical evil laws that violate natural law aren't laws, they are tyranny. The anti-FRB stance is the libertarian stance. It is the stance of justice and reason.

 

[wizardwatson]

I feel the mosquito's pain about semantics...

The way these debates usually go:

"FRB is inherently fraudulent!"

"But what if both parties understand that it's a loan, not a bailment?"

"That's not FRB!"

Also answered in post #2. Even if two parties agree, if you're using legal tender rather than a private currency, you're still inflationary and thus an outlawing policy would be justified based on Austrian economics.

 

[wizardwatson]

I suppose IF there was no legal tender supported by the government AT ALL, and all currencies were legal Hayek-style, there would be no reason to outlaw FRB because it would probably just die.

 

[r3volution 3.0]

I'm not for outlawing call loans, but for outlawing the designation of bailments as loans.

No one's calling for that that. As I've said, if a bank lies and claims it's holding deposits in a vault, it's fraud. If not, not.

But even today, although it's legally settled that a deposit is a loan, laymen don't call it a loan.

Again, my point is about how the law should be; how it would be in a libertarian society - not how it is today.

But, that said, everybody knows the banks loan out their deposits; nobody thinks the money is sitting in a vault. And if somebody really were confused about this, and were defrauded, the appropriate response would be to sue, for that particular act of fraud, not to outlaw the practice of FRB. As I said earlier, if a grocery store defrauded someone, do we therefore outlaw grocery stores? No, you just sue for that particular fraud.

Even if two parties agree, if you're using legal tender rather than a private currency, you're still inflationary and thus an outlawing policy would be justified based on Austrian economics.

You're saying that all contracts denominated in dollars should be outlawed?

 

[wizardwatson]

You're saying that all contracts denominated in dollars should be outlawed?

No, just saying no currency should be given legal tender status. Even the playing field. Then no need to outlaw FRB as a matter of public policy, because it would have no advantage over legitimate reserve banking.

 

[r3volution 3.0]

No, just saying no currency should be given legal tender status. Even the playing field. Then no need to outlaw FRB as a matter of public policy, because it would have no advantage over legitimate reserve banking.

Legal tender laws should be abolished, but there's no reason to outlaw FRB until such time as they are.

 

[wizardwatson]

Legal tender laws should be abolished, but there's no reason to outlaw FRB until such time as they are.

Reason = Greshams law.

https://mises.org/blog/case-against-legal-tender-laws

Sorry, more Murray Rothbard.

 

[wizardwatson]

Legal tender laws should be abolished, but there's no reason to outlaw FRB until such time as they are.

More...

https://mises.org/library/legal-tender-laws-and-fractional-reserve-banking-0

Legal Tender Laws and Fractional-Reserve Banking

This article will explore the economics of legal tender laws, arguing that they are not only a necessary prerequisite of paper money, but also benefit fractional-reserve banking. Such laws make paper money and fractional-reserve banking more widespread than they would otherwise be. Thus, legal tender laws must be understood as a major factor in the development of Western economies which today operate on paper-money standards and feature very large fractional-reserve banking sectors that grow at over-proportional rates.

 

[r3volution 3.0]

I'm aware of the case against legal tender laws (...I just said they should be abolished).

That's not a case against FRB.

Legal tender laws benefit banks period, not just FRB.

If FRB were abolished, you'd still have the Fed printing money and blowing bubbles.

FRB is not the problem.

 

[wizardwatson]

I didn't even read those articles yet, I'm just an expert praxeologist by nature, "Jeet Kune Do" economist if you will. Once you understand the basic mechanics of inflation and bubbles, conclusions are easy to come to concerning these types of technical, mechanical, and policy related banking questions.

People don't like to read though. It takes a while to understand it.

 

[wizardwatson]

I'm aware of the case against legal tender laws (...I just said they should be abolished).

That's not a case against FRB.

Legal tender laws benefit banks period, not just FRB.

If FRB were abolished, you'd still have the Fed printing money and blowing bubbles.

FRB is not the problem.

Fed is just a bunch of FRB's.

So...gonna have to disagree still.

 

[r3volution 3.0]

[MENTION=1144]wizardwatson[/MENTION]

So, just to be clear, you've now acknowledged that FRB is not inherently fraudulent, correct?

And now you're just arguing that it should be outlawed pending the abolition of legal tender laws?

 

[wizardwatson]

[MENTION=1144]wizardwatson[/MENTION]

So, just to be clear, you've now acknowledged that FRB is not inherently fraudulent, correct?

And now you're just arguing that it should be outlawed pending the abolition of legal tender laws?

Oh, no it's definitely fraudulent and economy wrecking, but as I said in post #30, if we simply abolished all legal tender laws and gave no currency a privileged status there would be no need to outlaw FRB as a matter of policy.

It's fraudulent because it's logically inconsistent. Of course one can contract a gamble voluntary with another if one chooses, but combined with "legal tender" minted by the state creates a problem, especially if the state entity has "deposits" (notice I have to put quotations around that word now since I'm talking to you to emphasize it is now an abstract and contentious concept) at said FRB institution.

Anyway, the 100% reserve system I've created still works the same obviously, this is just a refinement of my stance on Fractional Reserve Banking in general.

I will need to read the Hulsmann piece. I like my stances to be impenetrable.