Debating Fractional Reserve Banking

Since I have already written quite a lot about fractional reserve banking (or FRB for short), it is not likely that I will write more about it; I would just repeat myself. But the other day I got involved in a debate on the subject, so if you are interested, check it out. Just one general comment:

Objectivists in general (or at least those Objectivists that take an interest in the subject) are quite adamant in their defense of FRB, and my counter-arguments don’t seem to get through to them. Their argument hinges on the fact that FRB, if the bank is open and honest about it, is a voluntary transaction and a natural part of a free market. They are blind to the consequences for the third party – those who do not receive fractional loans and have to bear the brunt of the unavoidable consequence that prices will have to rise. So let me formulate my argument in the starkest possible form:

Suppose a counterfeiter offers you a truckload of money (in the expectation that you will later pay it back with interest in non-counterfeit money), and you accept this deal and then proceed to spend this money on consumption or investment – would anyone say that this was OK, merely because it was a voluntary, non-coerced, transaction between you and the counterfeiter? Or would you say that you are an accomplice to the crime of counterfeiting? Well, even those pro-FRB Objectivists would agree that the latter is the case.

But the difference between this and fractional reserve banking is merely a difference in degree, not a difference in kind. Fractional banking is partial counterfeiting. A fractional bank note is partly covered by real money (gold/silver) and partly not. The part not covered is counterfeit!

And then they call us “zealots” and say our arguments are “benighted”[1]. This is simply an argument from intimidation: “Only benighted zealots can still believe in a 100%, non-fractional, gold standard”.

Earlier on this subject:

A Belated Open Letter to Ayn Rand on Fractional Reserve Banking
More on Fractional Reserve Banking
Fractional Reserve Banking Yesterday and Today
Should Pick-Pocketing Be Legalized?
Is “Fractional Reserve Banking” Compatible with Objectivism?

And, in Swedish:
Varför “fractional reserve banking” bör förbjudas
“Fraktionella reserver” än en gång

Post scriptum July 1: In an earlier debate on FRB, Harry Binswanger writes:

The answer to all the objections [to FRB] is the same: free trade means free trade.

If Harry Binswanger can invoke the law of identity, then so can I: Free trade in counterfeit money is free trade in counterfeit money. This does not make the money any the less counterfeit.

And if one is to engage in this kind of shysterism, one might as well talk about “free trade in stolen goods”. Once the stolen goods come into the hands of a fence and he sells them on to people who are not aware that the goods are stolen, it is “free trade”; that does not change the fact that the goods are stolen.

Dr Binswanger continues:

What [the opponents of FRB] ignore is the free consent of the person accepting a check.

“Free consent” does not change the fact that FRB is a form of counterfeiting, either.

The moral issue here is whether the person accepting the check understands that is is partly counterfeit or not. If he isn’t aware of it it, he is morally in the clear. Compare this with the issue of buying stolen goods from a fence: If you are unaware that the goods are stolen, you are morally blameless. But if you know, or even suspect, that the dealer is a fence and the goods stolen, then you are an accomplice to the theft. Likewise, anyone who is aware of the fraudulent nature of FRB and still accepts a check with only fractional backing and then passes the check on, is an accomplice to this fraud. (And so, by the way, are people like Harry Binswanger who defend the practice.)

To quote George Reisman: “Shysterism is a slippery thing.”

Update January 2016: The link to the debate is now broken.


[1]) benighted: 1. Overtaken by darkness or night. 2. In moral or intellectual darkness; unenlightened; ignorant. – The American Heritage Dictionary.

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6 Responses to Debating Fractional Reserve Banking

  1. Per Nilsson says:

    I can agree that FRB offers no utility for the economy. But is it really easy to implement a legal framework that bans all fiduciary media and money-substitutes? Personally, I think that the market would not trust fiduciary media if the government stayed out of the economy and disbanded their risk-socialization-schemes.

    Pyramid schemes are “non-sustainable business models”, while Ponzi schemes are outright frauds. Perhaps FRB has more in common with the former? And do we need laws against pyramid schemes?

    • This is a remaining question in my mind: would it even be necessary to outlaw FRB in an otherwise fully capitalistic economy? It might be that there would be no FRB at all in such an economy; or that will be so little of it as to be negligible. But it is hard to predict what would happen, if we were ever to achieve this state of affairs.

      I think there would be a general law against counterfeiting in such an ideal society.

      Also, although I have argued a lot about this, I think it is a relatively minor issue, if compared with today’s state, where government-induced FRB is rampant.

  2. Pingback: Precious Metals Inflation? « The House at POS Corner

  3. Adam Fitchett says:

    I know that this is a big what if, but what if everyone, every single person in the economy, is aware that fractional reserve bank notes may or may not be redeemable, and still chooses to use them. Who is being defrauded if every single person is knowingly and voluntarily dealing in counterfeit money?

  4. I have said this before, but it may bear repeating:If a fractional reserve bank were to be totally open, it would state on the bank notes it issues that the note is fractional and what gold/silver backing it has. For example, if a $10 note has 90% backing, the note itself would have this stated on it. Or if the backing is just 10%, it would say so. But then people would accept it as a $9 or a $1 dollar note, not as a $10 note.

    And what would happen if the bank then decides to lower its own reserve requirements? The $9 note in the example above would now be worth less than $9, but the public that uses this note would no longer know this.

    Since I have other things to do than repeating myself on this issue, I will now close this post for comments.

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