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Rothbard on Fractional-Reserve Banking a Critique

Rothbard on Fractional-Reserve Banking a Critique

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Published by michael s rozeff
Rothbard and his followers go too far in ruling out fractional-reserve banking as fraud even in a free market. They are making ethical judgments based on their own ideas of proper property rights and overruling the kinds of accounts and rights that market participants in a state of liberty may agree upon in contracts. In a free market, fractional--reserve banking is not necessarily or inherently fraudulent. Furthermore, Rothbard built his economic case against fiduciary money on mistaken theory provided by von Mises who departed from his own subjective theory of valuation.
Rothbard and his followers go too far in ruling out fractional-reserve banking as fraud even in a free market. They are making ethical judgments based on their own ideas of proper property rights and overruling the kinds of accounts and rights that market participants in a state of liberty may agree upon in contracts. In a free market, fractional--reserve banking is not necessarily or inherently fraudulent. Furthermore, Rothbard built his economic case against fiduciary money on mistaken theory provided by von Mises who departed from his own subjective theory of valuation.

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Published by: michael s rozeff on Mar 15, 2010
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1
Rothbard on Fractional Reserve Banking: A Critique
 by Michael S. Rozeff This draft: November 15, 2009Forthcoming (2010) in
The Independent Review
The helpful comments of Adam Knott are gratefully acknowledged. All errors are solely mine.
 
Rothbard on Fractional Reserve Banking: A Critique
Murray Rothbard (1974), in
The Case for a 100 Percent Gold Dollar,
takes the position thatfractional-reserve banking is “fraudulent.” Viewing it as coercive and unlawful, he argues that banks ought only be allowed to serve as warehouses for money. He insists that all deposits become bailments, not debts or credits.
1
Money would always be an asset, never a liability. A proper bank would, in his view and by law, hold all deposits intact and become a 100 percentreserve storage or safety deposit bank, although to call such a business a bank, under theseconditions, is something of a misnomer since such a so-called bank makes no loans.Rothbard’s firm belief in fractional-reserve banking as fraud even rules out fractional-reservefree banking
in a free market.
This position, I argue, goes against basic ideas of liberty and thefree market, both of which Rothbard champions. For when he regards fractional reserve bankingas fraudulent and proposes its illegality, he introduces his own ethical judgment that is based onhis own assessment of the merits of any and all exchange transactions that may occur between banker and depositor. He introduces his own idea of the appropriate property rights in a bank deposit, his own idea of what appropriate money must be, and his own idea of libertarian law.While he is entitled to his opinions, the market participants in a condition of liberty in freemarkets decide all these matters for themselves and their reasoning and valuations may differ from Rothbard’s. They may not regard fractional-reserve banking as fraudulent, and they maywant to transact via fractional-reserve banking arrangements. They may wish to circulate mediaof exchange that are someone else’s liabilities.Rothbard’s position has since been joined at book length by both Jesús Huerta de Soto (2001)and Jörg Guido Hülsmann (2008) as well as in articles such as Hoppe, Hülsmann, and Block’s(1998) article that argues against fiduciary media. These latter-day adherents to Rothbard’s position show no diminution in the strength of their convictions, despite the criticisms of GeorgeSelgin and Lawrence H. White (1996), who have argued against Rothbard’s position andsupported free banking. In his book, for example, Hülsmann writes (p. 238) “There is no tenableeconomic, legal, moral, or spiritual rationale that could be adduced in justification of paper money and fractional-reserve banking.” This extraordinary statement boldly restates Rothbard’s beliefs. If a community willingly and freely uses paper money, shall Hülsmann maintain thatthey have no rationale? Moreover, it is not difficult to locate scholarship that provides viableeconomic reasons for paper money and fractional-reserve banking.
2
It is quite easy to findnumerous real-world cases where paper money, tokens, scrip, and credits arose spontaneously.
31
A bailment refers to property temporarily held in trust. The property may not be used bythe trustee (bailee.) There is no exchange and title remains with the bailor. A paper credit, bycontrast, arises out of an exchange. It represents a right against a person, not a specific thing or sum of money.
2
See Bhattacharya and Thakor 1993 for a review of banking theory. See also Selgin andWhite 1994.
3
See Timberlake 1987.
 
And, in this article, I shall argue that, neither on the grounds of morality nor economics, have theRothbardians proven that paper money or fractional-reserve banking are evidence of criminal behavior.
Monetary Freedom
Instead of arguing, as Rothbard does, that monetary freedom necessarily requires 100 percentreserve banking, what might monetary freedom look like? The institutions and practices thatarise when there is freedom are
impossible to know in advance
. Many possibilities can beimagined. People themselves decide what kinds of property rights they want in bank accountsand find acceptable. They hammer out what is fraud and what is not fraud. Banks and their customers decide the details of their own exchanges. People decide what value standards (unitsof account) to use to establish prices and what media they want to use as money, whether commodity, paper, electronic, or other. People may demand bank audits as they see fit, and theymay become part of the market structure. Banks may issue their own bank notes. Perhaps banksarrange central clearing houses that issue notes. Retail establishments may become involved inissuing various clearing certificates. Local clearing systems may arise that use credit-clearing.People trade and use bank notes as money if they wish. They depreciate those currencies thatthey believe are losing value, or flock to the media that they think may appreciate or hold value.If media are convertible, people decide on the appropriate media of redemption.More fundamentally, people who make market exchanges decide what policies and practicesthey regard as fraudulent. With monetary freedom, none of us is in a position legally to decide
a priori
what kinds of monetary arrangements are fit for others. We can only decide what isacceptable to us and act accordingly. In this regard, people may turn to the ethics of Rothbardand follow his advice; or they may turn to the Holy Bible and seek its counsel. Or they may turnto any number of other sources in order to arrive at the ethics that forms the basis of what theyfind acceptable in market arrangements. In the present state of human knowledge, ethics arecontentious.Although the Rothbard school can argue its ethical case based upon the notion that a deposit isthe property of the depositor, it cannot prove this case; for a
deposit 
of assets may well be freelyexchanged for a
deposit account 
whose property rights do not necessarily entail a warehousereceipt or the legal obligation of the deposit-recipient (the bank) to segregate the deposit andhold it in storage for the depositor. Rothbardians are in no position to determine what property ina deposit account must look like while simultaneously advocating liberty and a free market. If they determine the former, they abridge liberty and the market. If they choose the latter, themarket participants determine property rights.
The Main Proposition
I argue a simple proposition about
 free market 
fractional-reserve banking. Suppose that, in a freemarket situation, depositors in a bank agree to make deposits in the bank, knowing full well thatthe bank intends to lend out some of these deposits. Depositors may also know full well that they

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