Fractional Reserve Banking Is Not Fraudulent

[Occam's Banana]

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.

I doubt it. I am neither "for" nor "against" fractional reserve banks. I just don't agree that they are somehow inherently fraudulent under a genuinely free market - which would, of course, exclude things like legal tender laws, government-backed deposit insurance schemes, central banking and its attendant ills (such as interest rate monkey-wrenching), etc. I see no reason why fractional reserve banks could not or would not exist under a regime of genuinely free banking. There could be a place for both fractional and full reserve banks. For fractional reserve banks, reserve ratios would, like interest rates, be set at some "market clearing" point which would fluctuate over time in response to market forces.

I recall seeing a video of a lecture by George Selgin concerning the "free banking" era in Scotland - wherein he noted that the general reserve ratio settled at something like 20% on average, if I recall correctly (unfortunately, I can't find the video now). However, it should be noted that Rothbard disputes that Scottish banking was really "free" during this time (see The Myth of Free Banking in Scotland).

 

[wizardwatson]

I doubt it. I am neither "for" nor "against" fractional reserve banks. I just don't agree that they are somehow inherently fraudulent under a genuinely free market - which would, of course, exclude things like legal tender laws, government-backed deposit insurance schemes, central banking and its attendant ills (such as interest rate monky-wrenching), etc. I see no reason why fractional reserve banks could not or would not exist under a regime of genuinely free banking. There could be a place for both fractional and full reserve banks. For fractional reserve banks, reserve ratios would, like interest rates, be set at some "market clearing" point which would fluctuate over time in response to market forces.

I recall seeing a video of a lecture by George Selgin concerning the "free banking" era in Scotland - wherein he noted that the general reserve ratio settled at something like 20% on average, if I recall correctly (unfortunately, I can't find the video now). However, it should be noted that Rothbard disputes that Scottish banking was really "free" during this time (see The Myth of Free Banking in Scotland).

Hey why not? FRB's in this brave new world aren't FRB's though, right? They're just weird "call loan" entities where the customer and banker mutually understand that the "deposits" are loaned out and might not always be available for withdrawal. Especially since this free-market banking includes many banking institutions that aren't Neo-FRB's. I would be ok, with people investing in loan companies. Let's just not call it banking. This is just a lie brought about over time to conflate depositing money for safekeeping and payment convenience with easy credit for money-changers.

 

[r3volution 3.0]

It's fraudulent because it's logically inconsistent.

How's that?

Are you going back to the claim that FRB involves multiple people having contradictory claims to the same money?

 

[Occam's Banana]

Hey why not? FRB's in this brave new world aren't FRB's though, right? They're just weird "call loan" entities where the customer and banker mutually understand that the "deposits" are loaned out and might not always be available for withdrawal. Especially since this free-market banking includes many banking institutions that aren't Neo-FRB's. I would be ok, with people investing in loan companies. Let's just not call it banking. This is just a lie brought about over time to conflate depositing money for safekeeping and payment convenience with easy credit for money-changers.

They are banks that hold some fraction of their demand-deposit liabilities in reserve.

IOW: They are fractional reserve banks.

If you want to call them "call loan entities" or "bowls of fruit" or whatever, then by all means do so. *shrug*

Whatever you please to call them, it won't change the fact that what they do is not inherently fraudulent.

 

[wizardwatson]

How's that?

Are you going back to the claim that FRB involves multiple people having contradictory claims to the same money?

They are banks that hold some fraction of their demand-deposit liabilities in reserve.

IOW: They are fractional reserve banks.

If you want to call them "call loan entities" or "bowls of fruit" or whatever, then by all means do so. *shrug*

Whatever you please to call them, it won't change the fact that what they do is not inherently fraudulent.

"Bowls of fruit"..hmm. That reminds me of "sacks of grain".

https://wiki.mises.org/wiki/Fractional_reserve_banking

These decisions were taken over by the American courts and so was FRB legalized. However, an interesting development occurred in grain warehouse law, which has developed in precisely the opposite direction, despite the conditions of depositing fungible goods were exactly the same, and grain was a general deposit and not an earmarked bundle.

In the history of the U. S. grain market, grain elevators several times fell prey to this temptation [FRBanking with grain], spurred by a lack of clarity in bailment law. Grain elevators issued fake warehouse receipts in grain during the 1860s, lent them to speculators in the Chicago wheat market, and caused dislocations in wheat prices and bankruptcies in the wheat market. Only a tightening of bailment law, ensuring that any issue of fake warehouse receipts is treated as fraudulent and illegal, finally put an end to this clearly immoral practice. Fractional-reserve grain warehousing, that is, the issuing of warehouse receipts for non-existent goods, was clearly seen as a fraud

So if FRB'ing with grain is seen as clearly wrong and fraudulent, why is FRB'ing with gold right?

Pyramid schemes are fraudulent. Doing it while wearing a tie, in a building with lots of glass and nice furniture that says "bank" on the front of it, doesn't change what you are doing.

I know it's hard for men to slander their God mammon in this way, but it's ok. Wiz will help you through the process.

 

[Jamesiv1]

First, we fix the money system by getting back on sound money, and getting rid of the Fed.

And then we let the market decide which banking practices (like FRB) should stay and which should go.

 

[wizardwatson]

First, we fix the money system by getting back on sound money, and getting rid of the Fed.

And then we let the market decide which banking practices (like FRB) should stay and which should go.

Basically, but we need to get rid of legal tender laws, otherwise FRB has an advantage via credit expansion. If FRB entities had to issue their own bank notes, instead of recirculating deposits then the playing field would be even.

The shell game needs to be transparent. Otherwise FRB's will just subversively shut down the competition, which is what they did, and why we're here now.

 

[wizardwatson]

First, we fix the money system by getting back on sound money, and getting rid of the Fed.

And then we let the market decide which banking practices (like FRB) should stay and which should go.

I kind of feel like "sound money" is what's under discussion.

It's widely accepted that FRB money is paper money, not sound money. But the claim that "Fractional Reserve Banking is not fraudulent" carries with it the idea that gold-using FRB's are sound money enterprises. They are not. They are fiat.

But the OP argument would like to pretend, "Well, everyone knows that a deposit is really a loan." But I already established that while this is the current legal status, it's less than 200 year old law, and people still consider deposits, "deposits" and not loans. Just like many people still consider real marriage between a man and a woman and unborn children as real people.

Bitcoin is a good way to make it clear that FRB is fiat money. Because the ledger makes it impossible for the money to exist in two accounts at once. So if you wanted to FRB with Bitcoin, it would be blatantly obvious that you were passing around paper money.

Paper money is debt, or loans, or derivatives, or CDO's or whatever other casino economics shell game crap you want to call it. But it isn't sound money. And to try to pass "money" that is really debt, and isn't sound money, as existing in the same category as real sound money is fraudulent.

So FRB is fraudulent because with its contemporary status it tries to pass itself off as "sound" when it is not.

 

[r3volution 3.0]

So if FRB'ing with grain is seen as clearly wrong and fraudulent, why is FRB'ing with gold right?

For at least the third time:

If a bank offers to accept bailments, and then loans them out, that's fraud.

If a bank offers to accept loans, and then loans them out, that's not fraud.

 

[r3volution 3.0]

It's widely accepted that FRB money is paper money, not sound money. But the claim that "Fractional Reserve Banking is not fraudulent" carries with it the idea that gold-using FRB's are sound money enterprises. They are not. They are fiat.

No, "fiat" currency means money that the state issues and orders people to accept (fiat means "let it be done"). In a free banking situation, with gold as the base money, fiduciary media (bank notes) issued by fractional reserve banks are not fiat currency. No one is forced to accept them; the state has nothing to do with them. They're claims on the bank, which people are free to accept or not, just as people are free to buy (or not) bonds or other debt instruments issued by a bank or any other business. Just like bonds, they're priced in the market - if bank ABC issues too many bank notes relative its gold reserves, those notes will be discounted in the market relative goods/services, physical gold, or the notes of other, more prudent banks. An FRB bank in this situation cannot just print at will, without consequence, because it cannot force anyone to accept its notes.

Bitcoin is a good way to make it clear that FRB is fiat money. Because the ledger makes it impossible for the money to exist in two accounts at once. So if you wanted to FRB with Bitcoin, it would be blatantly obvious that you were passing around paper money.

In FRB, the money does not exist in two accounts at once. Let's break it down again:

T1 - Bob owns $100, bank owns nothing
T2 - Bob loans $100 to the bank (bank owns $100, Bob owns a $100 debt claim against the bank)
T3 - Bank loans $100 to Smith (Smith owns $100, bank owns a $100 debt claim against Smith, Bob still owns a $100 debt claim against the bank)
T4 - Smith repays the loan to the bank (Smith owns nothing, bank owns $100, Bob still owns a $100 debt claim against the bank)
T5 - Bob calls the loan and the bank repays it (bank owns nothing, Bob owns $100)

At no time is the same property owned by more than one person.

Paper money is debt, or loans, or derivatives, or CDO's or whatever other casino economics shell game crap you want to call it. But it isn't sound money. And to try to pass "money" that is really debt, and isn't sound money, as existing in the same category as real sound money is fraudulent.

Sounds like your problem is with lending in general...

Explain to me the difference between:

(a) a callable loan, issued by a company, which trades on the market (i.e. bank notes)

and (b), a fixed term loan, issued by a company, which trades on the market (i.e. bonds)

Should both be illegal?

 

[Occam's Banana]

"Bowls of fruit"..hmm. That reminds me of "sacks of grain".

https://wiki.mises.org/wiki/Fractional_reserve_banking

These decisions were taken over by the American courts and so was FRB legalized. However, an interesting development occurred in grain warehouse law, which has developed in precisely the opposite direction, despite the conditions of depositing fungible goods were exactly the same, and grain was a general deposit and not an earmarked bundle.

In the history of the U. S. grain market, grain elevators several times fell prey to this temptation [FRBanking with grain], spurred by a lack of clarity in bailment law. Grain elevators issued fake warehouse receipts in grain during the 1860s, lent them to speculators in the Chicago wheat market, and caused dislocations in wheat prices and bankruptcies in the wheat market. Only a tightening of bailment law, ensuring that any issue of fake warehouse receipts is treated as fraudulent and illegal, finally put an end to this clearly immoral practice. Fractional-reserve grain warehousing, that is, the issuing of warehouse receipts for non-existent goods, was clearly seen as a fraud

So if FRB'ing with grain is seen as clearly wrong and fraudulent, why is FRB'ing with gold right?

Pyramid schemes are fraudulent. Doing it while wearing a tie, in a building with lots of glass and nice furniture that says "bank" on the front of it, doesn't change what you are doing.

You are comparing apples and oranges. The issuance of multiple bailment receipts for the same item (be it grain or gold or whatever) is fraudulent.[1] The problem identified in the article snippet you offer here arose from the "lack of clarity in bailment law" (as the article itself explicitly points out) - it did not arise from the (supposed) inherent fraudulence of fractional reserve banking.

When Acme (a grain or gold warehouse) accepts a deposit from Smith and then, by willful deceit or through some loophole or weakness of the law, issues a claim against that deposit to Jones, both Smith and Jones have net claims against Acme for the same thing. Acme owes the same something to both Smith and Jones. This is fraudulent. It is a "pyramid scheme."

But when Acme (a fractional reserve bank) accepts a deposit (in the form of grain or gold or whatever) from Smith and then, in accordance with Acme's rights under the contract it entered into with Smith, loans some of that deposit to Jones, Jones does not have a net claim against Acme.[2] Jones owes something to Acme, and Acme owes the same something to Smith. This is not fraudulent. It is not a "pyramid scheme."

Under genuinely free market conditions, there would be some degree of inherent risk for (demand) depositors at fractional reserve banks. This is why such deposit accounts at such firms would yield interest as a means of paying depositors for the risks they bear. Things like government-mandated and back-stopped deposit insurance and myriad other interventions (such as legal tender laws, central banking, etc.) completely discombobulate the market mechanisms which would otherwise regulate the practice of fractional reserve banking. IOW: The problem under the current system is not that some part of it maintains fractional reserves. The problem is that it is not free.



[1] Actually, the concept of "fraud" is itself rather problematic. I prefer to consider things solely in terms of contracts, and of whether the terms of any given contract were met or not. The question of what "fraud" actually is and whether a contractual failure is "fraudulent" (as distinct from just being a "mere" contractual failure) is to my mind superfluous and is in any case a can of worms in its own right. Nevertheless, for the sake of concision, I accede to common usage.

[2] Jones will have a gross claim against Acme if he deposits his loan with Acme (as is usually the case) - but he is obligated to pay his loan back, so there is no net claim. If he makes additional deposits of his own, then for that part of his account for which he is not liable, he is in the same position as Smith vis-à-vis some other borrower Davis, and so forth. Under a free banking regime, this will give rise to market-derived "natural" reserve ratios, just as it will give rise to market-derived "natural" interest rates.

 

[heavenlyboy34]

For you anti- FRB folks: what, to you, is the difference between 100% reserve "banking" and a safe deposit box? It kind of defeats the point of using a bank if the bank can't use FRB somehow, yes? You want loans for business, homes, etc, yes?

 

[kfarnan]

FRB creates inflation, destroys the wealth of the nation. It is criminal.

 

[wizardwatson]

For you anti- FRB folks: what, to you, is the difference between 100% reserve "banking" and a safe deposit box? It kind of defeats the point of using a bank if the bank can't use FRB somehow, yes? You want loans for business, homes, etc, yes?

This is another example of how indoctrinated we are to thinking that FRB is the bringer of credit.

Oh, thou blessed bankers and their charitable gifts of liquidity!

You need banks for the payment functionality. Banks are not in any way logically linked to the act of loaning except through the FRB system.

Bitcoin is a 100% reserve based currency. You could try to start an FRB using Bitcoin, but the community would likely laugh at you.

FRB creates inflation, destroys the wealth of the nation. It is criminal.

Well, it's good to see I'm not the only one. Was beginning to wonder.

 

[not.your.average.joe]

In FRB, the money does not exist in two accounts at once. Let's break it down again:

T1 - Bob owns $100, bank owns nothing
T2 - Bob loans $100 to the bank (bank owns $100, Bob owns a $100 debt claim against the bank)
T3 - Bank loans $100 to Smith (Smith owns $100, bank owns a $100 debt claim against Smith, Bob still owns a $100 debt claim against the bank)
T4 - Smith repays the loan to the bank (Smith owns nothing, bank owns $100, Bob still owns a $100 debt claim against the bank)
T5 - Bob calls the loan and the bank repays it (bank owns nothing, Bob owns $100)

At no time is the same property owned by more than one person.

This sounds good in theory, but I'm still confused about several things. Could you help me out? and please correct me where I'm wrong.
If all the money that enters the system also leaves the system, that doesn't account for the influx of "new" money into the economy. If FRB worked like the model above, then inflation would not be an issue. Or maybe that isn't the fault of FRB, but instead the fault of something else? If so, what?

 

[r3volution 3.0]

This sounds good in theory, but I'm still confused about several things. Could you help me out? and please correct me where I'm wrong. If all the money that enters the system also leaves the system, that doesn't account for the influx of "new" money into the economy. If FRB worked like the model above, then inflation would not be an issue. Or maybe that isn't the fault of FRB, but instead the fault of something else? If so, what?

It's the fault of the Fed printing money. Absent that, FRB would not be inflationary. Let's say that FRB banks in a free market settle on an average reserve ratio of 20% (for every $1 in bank notes outstanding, they hold $0.20 in gold). Individual banks may expand, while others contract, the but the system as a whole cannot inflate without an influx of gold. The way it works in our current system is that base money is the dollar, rather than gold, and the Fed can create dollars at will - allowing the banks to expand each time it does.

 

[wizardwatson]

Sounds like your problem is with lending in general...

Explain to me the difference between:

(a) a callable loan, issued by a company, which trades on the market (i.e. bank notes)

and (b), a fixed term loan, issued by a company, which trades on the market (i.e. bonds)

Should both be illegal?

Well, I confess, I am kind of a Deuteronomy 15:2 guy.

 

[r3volution 3.0]

Well, I confess, I am kind of a Deuteronomy 15:2 guy.

So I gather.

 

[not.your.average.joe]

Ok, makes sense, thanks. Another question, if you don't mind. Going off your model, no money enters or leaves the system. And assuming the money is backed by gold that means the amount of bank notes in the economy, being tied to a set amount of gold, is also set. So what about interest? I don't understand where the bank notes come from to pay interest. Wouldn't that money have to be created?

 

[r3volution 3.0]

Ok, makes sense, thanks. Another question, if you don't mind. Going off your model, no money enters or leaves the system. And assuming the money is backed by gold that means the amount of bank notes in the economy, being tied to a set amount of gold, is also set. So what about interest? I don't understand where the bank notes come from to pay interest. Wouldn't that money have to be created?

Where do the bank notes come from to pay wages, or rent, or buy groceries? They already exist; they're circulating around the economy somewhere. The bank pays interest to its creditors from its revenues; the bank's borrowers pay the bank interest from their revenues. It's a transfer of money, as from employer to employee to landlord to landlord's grocer to grocery employees and so on and so forth. Money doesn't need to be created.

That said, as the economy grows (more goods and services being chased by the same amount of money), the real value of money increase. If you were thinking about interest compounding and the banking sector growing ever larger, that can happen without an increase in the money supply, as money gains in value. The same for any other industry - total receipts for the oil industry, say, cannot grow indefinitely in nominal terms with a fixed money supply, but they can grow indefinitely in real terms, as the economy grows and prices fall.