Friday, November 18, 2011

Is Fractional Reserve Banking Fraudulent? Part 2

The first post I published pondering fractional reserve banking resulted in a couple of comments and also further discussion with Carl, so I decided to write a part two.

I want to keep the focus on the question of whether or not fractional reserve banking is fraudulent. One commenter, Less Antman, makes the point that it’s not fraudulent if people knowingly enter into voluntary relationships with banks that practice fractional reserve banking. The bank never claims that the note is a warehouse receipt for property, it is merely a promise to pay.

In the original article from the first post, Carl agreed that “fractional reserves do not constitute a breach of contract when and where that practice is specified.” However, Carl has since reconsidered this view and pointed me to Issue 112 for further explanation.

The article he referred to is “Titles in Search of Property: Should Fractional Reserve Banking Come to an End?” Carl explains how his understanding of the issue was further developed after reading a Hans-Herman Hoppe article, “Fiduciary Media” published in 1998 in THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS.

Hoppe goes deeper into the nature and reality of property itself. Here are two excerpts from Hoppe that set up the relationship of bank notes to actual property:

Since, both B [the bank] as well as A [the depositor], count the same quantity of money simultaneously among their own assets, they have in effect conspired to represent themselves in their financial accounts as owning a larger quantity of money than they actually own: that is, they have become financial impostors, [pp. 26-27]... Fractional reserve banking does not increase the quantity of existing property (money or otherwise), nor does it transfer existing property from one party to another. Rather, it involves the production and sale of an increased quantity of titles to an unchanged stock of property (gold); that is, the supply of and the demand for counterfeit money and illegitimate appropriation. [Hoppe, et. al., p. 33]


[F]iduciary media represent new and additional titles to or claims on an existing and unchanged stock of property. ... They represent an additional supply of property titles, while the supply of property has remained constant. It is precisely in this sense that it can be said of fiduciary media that they are created out of thin air. They are property-less titles in search of property. This, in and of itself, constitutes fraud, .... Each issuer and buyer of a fiduciary note (a title to money uncovered by money), regardless of what he may believe, is in fact - objectively - engaged in misrepresentation for the purpose of personal gain. [Hoppe, et. al., p. 22]

Hoppe has framed the issue clearly in terms of property actually existing in reality. Hoppe says "two individuals cannot be the exclusive owner of one and the same thing at the same time." Therefore fractional reserve banking makes claims that contradict reality.

A person can certainly make a claim that something exists, such as Santa Claus, but that doesn’t mean it exists. Someone who says this is denying reality. This is why Hoppe says even a voluntary contract for fractional reserve banking is not legitimate. It makes the claim that a property title to something exists when it does not.

Now, of course (and Carl goes into this in the article) there is the fact that until people actually agree that this is true, the claim does “exist” as far as how people behave. The practice would only end once people understood fractional reserve banking as a fraudulent claim on property (just like we now understand slavery). But the point I’m focusing on here is the idea of whether or not Hoppe’s point is true, thereby making fractional reserve banking fraudulent.

What do you think?


Less Antman said...

Hoppe's argument rests on the indefensible premise that a bank note is a title document. It isn't and, in fact, cannot be a title document, because it doesn't identify the specific asset it supposedly represents. A bank note that promises to provide twenty ounces of gold on demand can be satisfied by ANY twenty ounces of gold: it is not a claim against specific gold pieces with a specific serial number. Contrast this with a title document on a house or car: it can only be satisfied with the SPECIFIC home at that location or with the SPECIFIC car that has the vehicle identification number listed on the document. There cannot be two of those without one being fraudulent, because they really ARE for the same specific item. A claim against SPECIFIC money in storage is called a warehouse receipt, and is legally distinct from a bank note under every legal system, which is DEFINED as a promise to pay a certain quantity of money rather than "gold piece #31H4G81DD7."

Thus, Hoppe's argument is dead in the water from the start. But, at the risk of distracting everyone from the above, complete, argument, let me also note that all contracts allow for extraordinary circumstances, and a promise to provide money on demand is always, implicitly, subject to reasonable exceptions. For instance, payable on demand doesn't mean that someone just has to yell, "I demand my money" to have it instantly appear: they must go to a specific place during business hours, and it may take a few minutes to process the transaction. Moreover, bank accounts throughout history have allowed for a delay in payment, usually with a small penalty payment to the claimant for the delay, in special circumstances. Watch IT'S A WONDERFUL LIFE again: George Bailey patiently explains to the panicking yahoos during a bank run in his town that "Building and Loan" means they make loans, that the money isn't all sitting in the vault, and that their contract reserved the right to delay payment for up to 90 days. Every child who has loved that movie already knows how banks work. Only Hoppe doesn't.

It isn't true that both the bank and depositor claim the money on their books simultaneously. I'm a CPA. If the depositor kept books, they'd credit "Cash on Hand" to take it off their books and debit "Bank Balance." The bank debits "Cash on Hand" and credits "Depositor Claims." If they lend the money out, they credit "Cash on Hand" to take it off their books and debit "Loan Receivable" while the borrower debits "Cash on Hand" and credits "Loan Payable." At each point in time, only one person claims cash on hand. And nobody's net worth is increased by a farthing (whatever a farthing is) since they always report a liability equal to the asset.

Finally, in the voluntary society Carl, you, and I are looking forward to enjoying, there is no such thing as "money" because there are no legal tender laws. We will have notes obligating us to deliver gold, or silver, or small Italian sports cars (in the case of a Fiat currency). We may also issue written promises to fix a tire, to make our fitness center available to you 24 hours a day, and to love, honor, and cherish you so long as we both shall live. All of these create claims out of thin air, and all are contingent claims that occasionally aren't satisfied under conditions that are understood implicitly. Anyone who takes a note for gold, or silver or tire fixing or access to a fitness center knows its value is subjective and depends on the constantly changing free market willingness to exchange other goods or services for it. The subjective theory of value is a foundation of modern economics.

The stuff about a Santa Claus contract is ridiculous: promises to deliver a certain quantity of gold on demand are real and satisfied with regularity. Actually, so is Santa Claus: just ask George Bailey.

Denny Jackson said...

So much confusion! Money and debt are two distinct things and much mischief is created by attempting to equate the two, whether in law or in one's mind. Money deposited with a bank is simply a loan to the bank which the bank promises to repay according to certain terms understood (hopefully) by both parties, that's all. Never do two parties claim ownership of the same thing at the same time. Fractional reserve banking, where one's signature (promise to pay) is converted into money is another matter. There debt is being monetized--converted into money--not a good thing IMHO.

Less Antman said...

There are no legal tender laws in a free society. In a free society, "money" is simply what people choose to accept as a medium of exchange. It is nothing more than a social norm.

In a free society, Danny and Carl may choose to refuse a note which doesn't provide an unconditional guarantee of instant redemption backed by 100% storage of the promised commodity. But using violence to stop other people from accepting notes that make conditional promises cannot in any way be justified in a voluntary society.