Fractional-Reserve Banking Violates Property Rights
Now let us turn to fractional-reserve banking. It means that a bank lends out money that clients have deposited with it. Fractional-reserve banking thus leads to a situation in which two individuals are made owners of the same thing.
Fractional-reserve banking thus creates a legal impossibility: through bank lending, the borrower and the depositor become owners of the same money. Fractional-reserve banking leads to contractual obligations that cannot be fulfilled from the outset.
As Hoppe, Block, and Hülsmann note, “any contractual agreement that involves presenting two different individuals as simultaneous owners of the same thing (or alternatively, the same thing as simultaneously owned by more than one person) is objectively false and thus fraudulent.” A “fractional reserve banking agreement implies no lesser an impossibility and fraud than that involved in the trade of flying elephants or squared circles.”
The truth is that fractional-reserve banking amounts to violating the nature of the law of property rights. And so the argument that fractional-reserve banking represents sensible money economizing — an argument that Mr. Wolf brings up against a gold standard — doesn’t hold water.
Arguing in favor of fractional-reserve banking would in fact be tantamount to saying that it is legal (or rightful or even lawful) that Mr. A does whatever he wishes with Mr. B’s property — without requiring Mr. B’s consent.
What, however, if the bank and the depositor both agree voluntarily that money deposits should be used for credit transactions via the issuance of fiduciary media? Even such a voluntary agreement would be in violation of the law of property rights.
While bank and depositor benefit from such a trade (or expect to), what about those who receive fiduciary media? They would be falsely lured into exchanging goods and service against an item (fiduciary media) that is already claimed as property by others — something the seller presumably wouldn’t agree to if he had only known the very nature of the trade.
What if all market agents voluntarily agreed to engage in fractional-reserve banking? The conclusion above wouldn’t change: voluntarily accepted fractional-reserve banking would represent a monetary system that is, by its very nature, in violation of the nature of the law of private-property rights. It would produce economic chaos on the grandest scale.
Fractional-Reserve Banking Has Not Emerged “Naturally”
To be sure, fractional-reserve banking is not, as Mr. Wolf notes, “a natural consequence of market forces.” It is a result of, and has been upheld by, government law.
Mises Academy: Robert Murphy teaches Anatomy of the Fed
In a free-market system, the practice of fractional-reserve banking would be illegal by its very nature. And so fractional-reserve banking would be ended (sooner rather than later) under the auspices of a functioning law of private-property rights.
The reason that fractional-reserve banking has been around for quite some time is due to government law — which, of course, must be distinguished from the natural law of property rights. Of course, government can make fractional-reserve banking legal in a formal sense. However, even government law does not change the nature of things. As Murray N. Rothbard puts it succinctly,
fractional reserve banks … create money out of thin air. Essentially they do it in the same way as counterfeiters. Counterfeiters, too, create money out of thin air by printing something masquerading as money or as a warehouse receipt for money. In this way, they fraudulently extract resources from the public, from the people who have genuinely earned their money. In the same way, fractional reserve banks counterfeit warehouse receipts for money, which then circulate as equivalent to money among the public. There is one exception to the equivalence: The law fails to treat the receipts as counterfeit.
In a commodity-money regime — such as the gold standard — fractional-reserve banking is, as Austrian economists show, in effect a form of counterfeiting.
The Uncomfortable Truth about Fractional-Reserve Banking
Austrian economists, and Ludwig von Mises in particular, have shown that fractional-reserve banking under commodity money necessarily causes economic problems on a grand scale. This is because banks then engage in circulation-credit expansion — that is, they issue money through lending that is not backed by real savings.
Circulation bank credit is inflationary, and it causes economic disequilibria and overindebtedness of the private sector — in particular on the part of governments. It is also the very cause of the “boom-and-bust” cycle.