My Reply to Mr. Engel

[C.Jay Engel] has commented on my recent post, Selgin and Salerno on Free Banking.  His comments can be found here.

I will offer the same caveat that Mr. Engel offered to me regarding my post.  In fact he wrote it so well that I will copy his, as I cannot agree more completely:

I agree with [Mr. Engel] on pretty much all things Austrian Economics and Libertarian political theory.

As far as I know, [free banking / fractional reserve banking] is probably one of the only things on which we dissent from each other.  I write this post with much affection for my libertarian comrade and the reader should know that I look up to [Mr. Engel] and consider him an excellent proponent of the Austro-libertarian ideal.

I offered a brief reply at the site, I will expand on this here.

From Mr. Engel’s post:

…the “free banking” position allows banks to extend “fiduciary media” (money substitutes that are not backed up by the money itself…). For example, if, say, gold was money and there was a set amount of gold in the bank, the free banking system would allow that bank, if it desired (it certainly doesn’t have to), to extend more claims on that money (like in the form of our green paper dollars) than can be redeemed at the same time.

My free banking position has nothing to do with the bank’s “desires.”  It has to do with the contractual nature of the transaction; it has to do with the customer’s desires and a bank’s willingness to meet those desires.

A customer wants interest paid on his deposit and wants no fees or expenses for his account.  How does he achieve these if the bank is (physically or digitally) holding his money?  How can the bank afford such a relationship?

If there was enough demand for bailment accounts, would these not spring up in the market?  How many people willingly sign up for zero interest income on cash balances (in a normal environment, obviously not today) and for paying fees when the alternative is available, albeit an alternative with a different risk profile?

If I wanted to ensure 100% reserves on my cash balances, could I not hold…cash?

Conversely, the “100% reserve” position is that the above is contractually illegitimate and therefore, fiduciary media should be seen as fraudulent and illegal…

“The above” may or may not be “contractually illegitimate”; it really depends on the contractual terms.

To be clear: a contract that grants two people the same right to the same deposit at the same time would be illegitimate; it would be deemed an invalid contract. Depending on the details of the situation, it could be fraudulent.

This is not today’s deposit contract.  It also has nothing to do with my position.  To my knowledge, it has nothing to do with the position of any of today’s Austrian / libertarian defenders of the practice – not one of whom, I suspect, is advocating fraud.

I have written before about the regulations underlying every deposit contract in the United States.  There is nothing in the regulations that state that an individual’s deposit will be held as a bailment for immediate withdrawal.  Instead, there are statements regarding the conditionality regarding withdrawal (Regulation CC, as I recall).

I owe a debt of gratitude to Anonymous July 30, 2015 at 10:11 AM, from the comments section of my post, who went even further than I have done – by going to the language in the contract:

I found the Citibank contract online, they call it “Client Manual: Consumer Accounts.”

The pertinent element in it I saw was: “Unless otherwise expressly agreed in writing, our relationship with you will be that of debtor and creditor. That is, we owe you the amount of your deposit. No fiduciary, quasi-fiduciary or other special relationship exists between you and us.”

They are the debtor, you are the creditor.  They owe the amount of your deposit.  No other fiduciary relationship exists – they do not commit to another relationship, like…holding your money as a bailment.

You might not get your money back, or maybe not exactly when you want it.

How is this illegitimate?  How is it fraudulent?  The only meaningful definition I can give to the term “fraud” is a violation of contract.

If there is “fraud” in the system (although I would not use that term), it is in the monopoly power of government-backed central banking.  This removes – or greatly diminishes – the disciplining force of the market; the discipline of providing positive or negative feedback via profit or loss, ultimately bankruptcy.

This is the issue, and the only issue.  Remove the monopoly; the market will resolve the rest – as Rothbard and Mises agree.

See the following – a brief selection from the hundred or more posts I have written on free banking or fractional reserve banking:

Why Not a Free Market in Money?  If you don’t believe me, ask Mises, Rothbard, Sennholz, or Ballvé.

Fractional Reserve Banking: Much Ado About the Wrong Thing.  The issue is the monopoly.

Free Banking.  Via a review of a book by Larry Sechrest (published by the Mises Institute), an examination of the irrelevance of the arguments of many of those who advocate for 100% reserves.

I will not repeat my acknowledgment of the potential negative consequences of such a practice.  I will also not repeat my conviction that the most stable financial system is one governed by market and contract.

There is no libertarian society without respect for the sanctity of contract.  There is no Austrian Economics without respect for the market.

I (and the market and history and others) have demonstrated that FRB as currently practiced can be achieved via voluntary contract and the market.  Demonstrate that 100% reserves can be achieved strictly via voluntary contract and free markets.

Until then, you are advocating central planning.