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See Part I: Click.

Introduction to Part II:

The key arguments against fractional reserve banking being a moral system came from a 1998 paper co-authored by Austrian economists Hans Hermann Hoppe, Jorg Guido Hulsmann, and Walter Block. The white paper entitled Against Fiduciary Media was a response to a previous paper written by George Selgin and Lawrence H. White. Hoppe at al. crafted a repudiation against  Selgin and White’s 1996 paper In Defense of Fiduciary Media or, We are Not Devo(lutionists), We are Misesians. In which both scholars provide a normative and positive defense of fractional reserve banking. Even utilizing Murray Rothbard’s Title-transfer Theory of Contract to defend the practice. However, this application of the Rothbardian contract theory did not sit well with Hoppe and the company. All being devoted and unwavering followers of Rothbard believed that Selgin and White’s interpretation of Title-Transfer Theory of Contract to be incorrect. Making their justification of fractional reserve banking on grounds of contract theory to be inherently flawed. It is worth noting that Hoppe was a direct protégé of Murray Rothbard and even owed his career and position teaching at the University of Nevada, Las Vegas to the late Austrian economist.

Rothbard’s  Title-Transfer Theory of Contract:

Before claims that Selgin and White did not faithfully adhere to or misinterpreted Title-Transfer theory, it is important to thoroughly explain this concept. A reader without a firm comprehension of this idea cannot adequately determine if free-banking proponents of fractional reserve banking suffer from profound confusion. The proceeding section will provide a brief overview of this theory. Hereby providing the reader with the requisite background information to justly assess this debate.  

Before diving into Rothbard’s theory, it is important to note his ideological disposition.  Murray Rothbard was the modern father of an ideological subset of libertarianism known as anarcho-capitalism. Rothbard and his followers hold that there should not be limited government, but rather no government. All services and products can be produced by private industry with no necessity for government intervention. This even includes services that have been traditionally provided by the government. This includes defense/security services, law enforcement services, charity, resource management, infrastructure, private legal adjudication, and so on. Rothbardians even go so far as to assert that the government possesses a monopoly on such services. It is imperative to understand this aspect of Rothbard’s political economy and political philosophy. It illustrates the fundamental philosophical precepts that govern his theory of contract.

Rothbardian Contract Theory is expounded upon in his 1982 book The Ethics of Liberty. Rothbard derides that the concept that all contracts in a just society need to be enforced( P.133). He draws a sharp line of delineation between “promised” and “conditional” contingencies in matters of exchange. Per his logic, the utilization of legal channels to enforce a promise is wholly illegitimate. Constitutes the use of government force in a situation in which no property has been transferred. Making it equivalent to state enforcement of morality (p.133-134). The reason why the property needs to be involved for a contract to be valid pertains to the distinction between what is intrinsically alienable and inalienable to the individual. This has to do with the fact that a person cannot alienate their own will or relinquish control of their mind and body to someone else. Humans can quite easily dispense with tangible property, including money (p.135). Due to the fact enforcing a promise is a compulsion because it interferes with the free will of the individual. It is not technically a breach of contract. On the other hand, if the agreement included a transfer of property for non-compliance then it would be another story.

In instances of conditional contracts and agreements, noncompliance is equal to a form of theft.  One salient example Rothbard provides is the circumstances of service providers receiving advanced payment but never providing the service (p.137). For example, if I were to offer to paint your house and I received an advanced payment of $300.00 and never show up your house that is theft. One contractual contingency that can shift a promise to a conditional agreement would be a performance bond clause within the agreement.  For Rothbard’s example, if a movie theater has a meet and greet event with a famous actor, they can put into the agreement a clause where the actor agrees to pay the theater a sum of money for abdicating this obligation (p.137). Since a property can be transferred and not the will of the actor this is an ethically binding agreement. However, failing to fulfill a property-related obligation is not always necessarily deemed as implicit theft. In instances where a creditor provides immunity to a debtor who cannot pay their bill this is legitimate (P.144). Why?  The creditor reserves the right to forgive debts due to the fact they are the ones who transferred their property under the condition of repayment. Please note that this scenario details circumstances in which the credit lent out their funds.

It should be noted that a Rothbardian conception of contractual property rights does not preclude someone from selling off a portion of their property. For example, if I own 100 acres of land in Montana. It is well within my rights to transfer you 5 acres for $20,000.00. Concurrently, retaining my claim on the residual 95 acres of land. This does not mean that mean I in any way still own those 5 acres. Through the sale of this land, I have effectively transferred ownership to you. In turn, I have relinquished by entitlement to the lands sold.

Page 146:

“Another important point: in our title-transfer model, a person should be able to sell not only the full title of ownership to the property but also part of that property, retaining the rest for himself or others to whom he grants or sells that part of the title. Titles, as we have seen above, common-law copyright is justified as the author or publisher selling all rights to his property except the right to resell it.”

How The Free-Banking Argument For Fractional Reserve Banking Violates Contract Theory:

Selgin and White claiming that fractional reserve banking is consistent with Title-Transfer Theory suffer from some blind spots. Blind spots that are fully magnified by Hoppe et al. One of the fundamental chinks in the armor of the Free-Banking argument is that fractional reserve banking inherently violates Title-Transfer Theory. It assumes that two people can own the same piece of property simultaneously (p.21). By the very nature of how fractional reserve banking engages in lending, it creates ambiguity regarding ownership. Through issuing more promissory notes both the bank and the customer assume ownership of the same banknote, which is fraudulent by nature (p.22).  Creating more claims to money against the present supply of money will not create more money (p.22). Rather, will only serve to redistribute the present supply of actual currency from client to client without increasing the amount of money in the vaults (p.22). Effectively creating fiduciary media (money-substitutes issued by a bank that is not backed by gold or paper money) out of thin air without transferring assets or liabilities (p.22). As detailed in Rothbard’s theory, we can sell off a portion of our property. However, we relinquish our own once we transfer it to the party purchasing it.

This illusory arrangement also conflates property with property titles (p.23). Treating and categorizing banknotes( fiduciary media, money claims) as money (physical property). This only enables this fallacy to continue. Keeping in tune with the Austrian tradition the Regression Theorem states that all money had a prior use value (p.34-36). For instance, tobacco and nails at various times in human history have been used as money. Meaning that these banknotes cannot be money in the actual sense, but a claim or title to money. Through this categorical fallacy, the banks can divorce titles from ownership resulting in the redistributive practices of fractional reserve lending (p.23). Even going so far as to promising future entitlement to goods against present goods that may or may not be fulfilled. It would be honest to label these claims to future goods or debt claims, but not a claim to money (p.24).

An inquisitive observer may question why it is dishonest or even outright fraud to categorize future claims to money as money titles or even as money? Hoppe et al. frame this from the standpoint of we cannot claim or transfer ownership from a title to a car for anything but a car and the same applies to money (p.25). If we were using more precise language what banks and customers have truly agreed to is debate claims versus money titles. Per the authors of  Against Fiduciary Media Selgin and White adopted a hyper-subjective interpretation of contracts to side-step this discrepancy (p.26). The misrepresentation engaged in by practitioners of fractional reserve banking extends beyond labels of goods, but to actual quantities as well. By treating fiduciary media as money, it creates the false perception that clients own more than what they truly due on paper. The fabricated money quantities do not reflect the amounts present in the vaults of the bank (p.27). Free-banking proponents may believe that fractional reserve banking isn’t so much the problem, rather government intervention. As long as the withdrawal requests are fulfilled it cannot be tantamount to fraud. However, even without state interference, the transfer practices of fractional reserve banking blur the lines of definitive ownership (p.29). Making the system incompatible with upholding property rights or just contract enforcement.

12 thoughts on “Is Fractional Reserve Banking Ethical Part II: Contract Theory and the Naysayers

  1. I am a huge fan of Rothbard’s but he went off the deep end when it comes to contracts. Check out Oliver Wendell Holmes’s classic essay “The Path of the Law”, where he explains that the a contract is simply a promise to “perform or pay” (perform your promise or pay damages in the event of breach). The other classic essay on contracts is Fuller and Purdue’s “The Reliance interest in contract damages.”

    Liked by 1 person

    1. Will do on the essay. I can certainly understand your take on Rothbardian contract theory. I have always been torn about much of his theories I find them to be quite persuasive. Then again, the same can be said for many of his dissenting fellow libertarians.

      Probably why I find myself straddled primarily between the Austrian School and Public Choice (leaning heavier on Public Choice.)

      Liked by 1 person

        1. Agreed. For whatever reason Public Choice has failed to capture much of a lay-audience. There are a number of social media influencers who proponents of the Austrian. To what extent they actual read the literature is questionable. It’s somewhat trendy in some circles to take pictures of your draped in a “Don’t Tread on Me” flag while holding an AR-15 in one hand and a copy of Human Action in the other. Personal ( as a layperson ) I do not find this assuming or impressive. I don’t know who these individuals are pandering to. I have considered studying and writing about the phenomenon. Even though it is an extremely niche topic.

          What deters the average reader from PC is precisely what I struggle with and that is the math. Sure, I can read and interpret a utility function.
          In some papers the computations are a little more intense. Thankfully, most will have sections explaining the significance of various regressions. Making it possible to somewhat piece together. Whereas the Austrian school flat out rejects econometrics.

          The other issue working against PC is there has never been a “spokesperson” with a wide range of reach promoting it to a lay audience. For many Millennials that spokesperson was Ron Paul. For previous generations it was Ayn Rand ( discovering Henry Hazlitt/Mises through her footnotes , I have never read her book on capitalism, but have heard from many that was there Segway to Austrian economics) or Henry Hazlitt directly. Public Choice is still young in comparison to other economic schools so it has time to find the “great universal communicator” of its theories.

          Another point that irks me a bit is people not realizing both the Austrian School and Public Choice are interconnected. Concepts such as methodical individualism is right out of passages of Human Action. At times Gordon Tullock expressed incredulity towards the contemporary orthodoxy of economics. He even decided to pursue economics after reading Mises.

          https://www.google.com/amp/s/fee.org/articles/gordon-tullock-deserved-the-nobel-prize/amp

          I believe the ambidextrous nature of the scholars at the Mercatus center displays this fact. Generally, they are well versed in both schools of thought. When I read their work sometimes I have difficulty determining which school they subscribe to. I just recently found out Chris Coyne is an Austrian economist. When reading his work I could have sworn he was a hybrid.

          Liked by 1 person

        2. If they did they would stop being overly critical of market processes. Nothing will bring about utopia. We can strive towards better not perfect. More red tape and top-down solutions will not bring the “kingdom of heaven” to Earth not spontaneously generate a mana raining fro the sky.

          Liked by 1 person

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