The unforgivable stupidity of the anti-banking “libertarians”

At the recent Mises Seminar in Sydney there was a speech by Chris Leithner that explicitly called for the banning of fractional reserve (FR) banking. Leithner and other Australian libertarians (including Michael Conaghan & Benjamin Marks from Liberty Australia) follow the lead of some American libertarians (Walter Block, HH Hoppe, JG Hulsmann — BHH) and argue that FR-banking is fraud and should be banned, and further that it is economically damaging and causes inflation.

These two issues need to be addressed separately. The first is a deontological issue about whether FR-banking is consistent with a free world. The second is a consequentialist issue about whether FR-banking leads to bad outcomes. It is possible that FR-banking is consistent with freedom and yet leads to bad outcomes, and then those libertarians who accept the “non-aggression principle” would have to tolerate FR-banking even if they don’t like those outcomes. But before delving into that debate, it is worthwhile quickly explaining what we are actually talking about with FR-banking.

Vaults, loans & banks

Anything can be money. In jail (and POW camps) cigarettes have been used as money. In the early years of Australian settlement, rum was used as money. In some small island nations, shells have been used as money. Through much of history, precious metals (especially gold and silver) have been used as money. And today, the most common sort of money is “fiat” paper money that is created by government but is intrinsically worthless (ie it has no value except as money). This is not the place to go into a debate about what should be money or who should decide, but the important point is simply that there is some original supply of money that then becomes the standard “unit of account” and “store of value” and “medium of exchange” in an economy. For the sake of this discussion, this original supply will be called “base money” and in Australia it is created by the Reserve Bank of Australia (RBA).

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John Humphreys v Walter Block on FR-banking

Last week Catallaxy linked to a paper by Austrian economist Walter Block about fractional reserve (FR) banking, and how it is supposedly fraud. The Block article recounted a discussion between Block and free-market economist Bryan Caplan about FR-banking.

I decided to join the discussion and sent Walter an e-mail. Below is the (slightly edited for readability) back-and-foward discussion (which was cc’ed to Bryan, who didn’t comment).


Walter (from earlier discussion with Bryan): Consider this: A deposits 10 ounces of gold in B’s bank; B gives A a demand deposit for these 10 ounces. B turns around and lends C 9 of these ounces, giving C a demand deposit for these 9 ounces. Thus, A and C both own full rights to these 9 ounces.


John: The example you give of two people have equal rights to the 9 ounces of gold is simply an issue with the wording of the contract. With one very simple change, you can easily remove the supposed “fraud”.
Instead of telling the depositer that they have $10 worth of cash/gold with the bank, you simply tell them that they have a $10 IOU with the bank. That is, the depositer owns $10 worth of “debt” with the bank. Now there is no fraud.

The fact that the bank then provides $9 to another person (in exchange for another IOU) does not constitute fraud. The first person owns $10 worth of debt with the bank (not the cash/gold). The bank owns $9 worth of debt with the borrower (not the cash/gold) and has $1 of cash/gold on hand. The assets and liabilities of the bank match. No two people have rights to the same thing.
FR-banking is simply allowing voluntary contracts between people. To abolish FR-banking would be a draconian act of government, banning a consentual act between adults, which would drastically reduce loanable funds (and therefore capital accumulation) by outlawing intertemporal matching between debt types

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