More on Fractional Reserve Banking
21 August, 2011 2 Comments
In an earlier blog post I mentioned the argument that fractional reserve banking is like insurance: an insurance company never has to pay insurance to every policy holder at the same time; likewise a fractional reserve bank does not have to pay every claim on it at the same time. This argument (as I showed) is as fraudulent as fractional reserve banking itself. There is a similar argument, comparing fractional reserve banking to bridge building:
One attempted justification of fractional reserve banking, often employed by the late Walter E. Spahr, maintains that the banker operates somewhat like a bridge builder. The builder of a bridge estimates approximately how many people will be using it from day to day; he doesn’t attempt the absurd task of building a bridge big enough to accommodate every resident of the area should he or she wish to travel on the bridge at the same time. But if the bridge builder may act on estimates of the small fraction of citizens who will use the bridge at any one time, why may not the banker likewise estimate what percentage of his deposits will be redeemed at any one time, and keep no more than the required fraction? (Murray N. Rothbard, The Mystery of Banking, p. 99.)
In other words: a fractional reserve bank does not have to fear a bank run. It is as unlikely that all depositors will claim their money on the same day or week, as it is for the whole population of an area to cross the bridge at one and the same time.
Fooled by this reasoning? Rothbard answers:
The problem with this analogy is that citizens in no sense have a legal claim to be able to cross the bridge at any given time. But holders of warehouse receipts to money emphatically do have such a claim, even in modern banking law, to their own property any time they choose to redeem it. But the legal claims issued by the banks must then be fraudulent, since the bank could not possibly meet them all.
More on Rothbard’s book another time. (I haven’t finished it yet.)