Observation: The concept of comparative advantage operates as a natural extension of the division of labor. If it is most efficient for each worker and firm to focus on what they are most proficient at producing, this naturally gives way to vocational specification. The more specification within the division of labor the more complex and advanced the economy. As technological innovation drives the consumer demand for intricate technologies, the need for specialization within the workforce becomes more pressing. An advanced technological product such as a smartphone could not possibly have all of its components harvested, processed, and manufactured by one firm. Generally, the constituents of such a device are produced by multiple companies. These parts serve as the higher-order goods in the production of a smartphone. It would be naïve to assume that all of the companies that possess a comparative advantage at crafting these components all reside in the same country. If we look to Leonard Read’s iconic essay I, Pencil it becomes evident that even a commodity as simple as a pencil requires the services of companies across the globe to be satisfactorily produced. Demonstrating that the principle of comparative advantage extends the division of labor to an international scale. It is impossible that one nation would possess all the conditions necessary to efficiently make one product of any degree of complexity. Never mind a gadget as elaborate as a smartphone. Providing another concise yet realistic reputation of the obstinate justifications for protectionism.
Unless you have been living under a rock for the past forty-eight hours, you probably have heard about a mob of protestors storming the Capitol in Washington D.C. Since this incident transpired a multitude of commentators has expressed their thoughts on this event. Universally, the actions of the violent protestors (similar to the BLM protests not all the demonstrators were violent) have been condemned. Most pundits have been fixated with how objectionable this display of political discord was but ignoring the irony of the situation. The breach of the Capitol on Wednesday mirrors the events on inauguration day nearly four years ago. Sure we could argue that the magnitude of the violent demonstrations was larger on Wednesday than the riots of ANTIFA four years prior. It should also be noted that ANTIFA primarily targeted private businesses whereas QAnon has primarily gone after government institutions. Both occurrences mirror each other, almost in an oddly formed reciprocal loop.
The arc of this political drama being Donald Trump losing reelection. On inauguration day in 2017, the extreme socialists opposing his presidency resorted to destroying private property to express their indignation. A presidential term later, Trump’s most extreme supports ended up using similar violent tactics to express their angst regarding the purported mishandling of the 2020 election. This shift in vicissitudes for Trump supporters is dripping with irony. Trump supporters are making all the same accusations about the 2020 election that the Democrats did back in 2016 when Trump was elected. Nothing is more fitting than seeing the right-wing equivalent of ANTIFA have a meltdown, a tantrum, over the election results. All of Trump’s most extreme supporters are equally triggered as all the socialists were when he assumed office. It is perplexing that no one else seems to be assumed by this irony. An irony that anyone with a dog in the fight is too obtuse to recognize. Due to the fact they either have an invested interest in backing or tearing down Trump.
From a superficial standpoint, this appears to give some credence to the notion of the Horseshoe Theory of Politics. Succinctly it can be described as the far-right and the far-left qualitatively have more in commonalities than differences. For example, both have a proclivity toward authoritarianism. This theory provides some insights into why Trump assuming office and leaving office has elicited such reactionary responses. Austrian economist Ludwig Von Mises implies the veracity of the Horseshoe Theory through his conception of Polylogism. Polylogism is essentially the assumption that people from different categorical groups reason differently (p.75). Left-wing socialists tend to base their assumption of all people of the same social class possessing the same mentality. Making it easier to condemn the rich as immoral. Right-wing social (Fascism) similarly divides people. Except by ethnicity instead of socio-economic status. It would be sloppy to suggest that QAnon is overtly a fascist organization. It does seem like it is merely the inverted version of ANTIFA with a right-wing ethos. Surprise, surprise… if this group is nothing more than the conservative version of ANTIFA why would we expect them to be peaceful (not that the violence was justified, it is only permissible in self-defense)?
This is truly irksome that these parallels are lost on the general public. Most people are too fixated on either the atrocity of the protest gone awry or attempting to distance themselves from being associated with the violent protestors. ANIFTA and QAnon are two sides of the same coin.
In a 2005 blog entry from economist and George Mason professor, Bryan Caplan disputes the veracity of time preference proving why interest rates tend to be positive. Time preference asserts that people prefer present consumption over future consumption. Providing some insight into why people would be willing to receive money now and later pay it back with interest. From the standpoint of an individual’s assessment of value, $1000.00 today is worth more than $1000.00 three months from now. Dr. Caplan launches a two-pronged attack against the assumption that time preference explains why interest rates are positive. Caplan suggests that dimmishing marginal utlity, not time preference demonstrates the proclivity of interest rates being positive.
Professor Caplan’s first point regarding the failure of time preference to adequately explain positive interest rates relates to the allocation of nonmonetary resources. He details a scenario where an individual is marooned on a desert island with only two bananas. Per a loose application of time preference, in theory, the person stuck on the island would eat both bananas today. Since we prefer present consumption to future consumption. A “perfectly patient” person would be willing to eat only one banana a day to more effectively curb their hunger. This is because we disvalue hunger today equally as much as we do tomorrow. Making dividing consumption between the two days a more effective use of resources.
Caplan goes further elucidates this point by demonstrating the fact that often in barter interest rates are negative. Per the blog entry:
“Suppose we knew the price of food would double next year. Then a pound of food now trades for half a pound of food one year from now. Translation: a negative 50% interest rate!
If this seems crazy to you, suppose the food was the only commodity, and you expect a famine next year. Wouldn’t you happily trade 2 pounds of current food in exchange for a promissory note good for 1 pound of food next year?”
This example explicates depending on the context we may forgo present consumption for future consumption. Even when we are expected to take a loss on the value of that commodity. This foils the main tenants of time preference. If we were to delay current consumption for future consumption we tend to do so for future gain. To quote the Austrian economist Roger Garrison “ We save up for something”. We hang on to stocks, gold, annuities, bonds, or cash holdings with the anticipation they will increase in value. It is important to note that inflation does take its toll on cash holdings. In the mind of the average person, it is more about amassing large quantities of money than an expected increase in value. Per time preference, if we did anticipate no gain from delaying consumption, we would be more apt to consume now than take the loss. However, in the situation presented by Dr. Caplan, it may be reasonable that a logical person may do the opposite. The rationale why loans for money tend to be positive is the fact that money does not spoil and is of little cost to store.
The second prong of Professor Caplan’s argument is the most compelling. In modern society, people have the ex-ante perception that they will be richer in the future. Anticipating being wealthier at a later date will drive a person’s demand for consumption up for the present. As the individual exhausts their desire to consume, the hope is that they have more money to pay back the sum that was loaned with interest. That is certainly a point that the Austrian perspective on interest rates ignores. Is it possible that if we excepted to get a raise in our compensation next year, we are more apt to spend more now and around the time we start to experience the disutility of consumption we experience a bump in pay? This is a very likely scenario. Presents arguably the biggest blind spot in the theory of time preference.
However, there is one looming question that Dr. Caplan does sidestep in his arguments. Few sane economists would ever argue that the law of diminishing marginal utility doesn’t apply to consumer behavior. But are we truly measuring the utility of the same commodities if we delay present consumption? Our Christmas decorations three weeks before December 25th the same commodity as these same decorations on the clearance rack the first week of January? It could be reasonable to argue no. While diminishing marginal utility could explain this decrease in demand, but it fails to consider the full scope of the customer’s subjective evaluation of the goods. The marginal utility can only explain the assessment of the value of a commodity. It cannot explain if the customer perceives the good as being categorically different. The variable of time could very well influence whether Christmas decorations now or a month ago are truly the same product. Applying this reasoning to interest rates, this point becomes quite clear. Is $1000.00 today plus avoiding a late payment on a credit card the same as $1,000.00 next week? Especially when we consider late fees, damage to our credit score, etc. On top of it, you still owe the credit card company $1,000.00. It is difficult to quantify the intrinsic value of having a clear credit score. $1,000.00 plus interest may be worth more to the individual than taking a hit on their credit score.
A shout out to the Ludwig Von Mises Institute for the Free books. Yes, I have read Economics in One Lesson in the past. However, I didn’t own it. The Mises Institute edition is a beautiful hardcover that does the book justice.
Do coupons help us save money? This very question may seem counterintuitive, but it is one worth entertaining. Coupons certainly help us save money if they are for purchases that were planned expenses. Such as regularly purchased necessities, for example, a coupon for broccoli at the local grocery store. A nutritious food item that is frequently purchased by Mr. Jones. In this instance, it would be awfully difficult to argue against the fact that Mr. Jones is saving money through using a coupon. The same could also be applicable for luxury items that are planned expenses. Let’s say Mr. Jones takes his wife out to dinner every third Thursday of the month. Mr. Jones and his wife dine regularly at the same chain-restaurant every month. Mr. Jones finds a coupon in the local paper for 25% off his next meal for this very same eatery. Even though dining in a restaurant is not a necessity Jones is still saving money because this luxury was a planned expense. He is not going out of his way to obtain a product or service he hasn’t budgeted for.
So when does use a coupon or taking advantage of a sale not result in the patron saving money? It should be stated that there is a lot of subtlety and nuance in addressing this question. From a prima facie standpoint, using a coupon always results in savings. Why? Because the customer is receiving a discounted price on the specified product or service. This superficial assumption only analyzes one single transaction. If we are assessing Mr. Jones’s total finances on the hyper-microlevel, then yes, he has saved money by using a coupon. However, the thin line distinguishing between a budgeted purchase and an impulsive one is where the difference truly lies. The discount provided by a coupon saves money on a single purchase. If the customer goes out of their way to purchase an impulse item that was not planned for they are not genuinely saving any money. Perhaps they are on a single transaction. The allure of saving money with no consideration given to whether they want or need the product or service is not conducive to the overall conservation of money. The individual who is a spendthrift is still spending money recklessly even if they are saving a few dollars on a single transaction. The real metric that measures true savings is the comparison of typical spending to average income. If an individual can retain more of their income and curtail their previous consumption habits, they are truly saving money. The intentions behind clipping coupons are thwarted if it leads to an increase in overall consumption.
How we are seduced by the opportunity to save money even on frivolous purchases has deeper psychological implications than being the victim of an illusion or flawed logic. For some people, they get a dopamine hit when they are hunting down a deal. Mirroring the same neurochemical reaction that a gambler experience when they allow their ex-ante perceptions to override their better judgment. As they dispense with probability as they continue to feed quarters into the slot machine. Making these deal hunters as much of a slave to the reward centers of the human brain as a junkie or gambling addict.
There is another explanation providing some insights into why we are often overvaluing the benefit of coupons. That would be the theory of Time Preference. Per the Austrian School of Economics, Time Preference is the immutable fact that people value present consumption over future consumption. The Austrian economist Eugen von Böhm-Bawerk applied this concept of valuing present consumption over future consumption to interest rates. Bohm-Barwerk postulated that people are willing to pay interest to obtain access to present goods for two reasons. For one, they anticipate having more income in the future. Also, the perceived value of a good tends to diminish over time. Through considering these two variables Bohm-Barwerk added a temporal element to the economic theory of interest. When time plays a factor in how people assess the value of goods and services it is fair to assume if you need to pay your mortgage tomorrow and happen to be $500.00 short you would be willing to pay more than the sum borrowed to have the money today. Meaning receiving that $500.00 today is worth more than the total sum loaned. It could be speculated that this is due to two factors. The fact that the individual receives the value of the money loaned plus the value of receiving itexpediently. The other factor isthat the individual receiving the loan enjoys the value of the $500.00 and the benefit of avoiding the penalties for making a late mortgage payment.
If the theory of time preference provides us with the precepts for understanding interest rates, how does this pertain to coupons? Time preference relates to coupons in the sense that sales, discounts, promotional codes, and coupons all influence our evaluation of goods. A coupon operates as a purported signal of a price reduction to the customer. If the customer perceives the value of the good or service to be higher than the discounted price, they will purchase it. Lowering the price of a commodity below market value makes the prospect of purchasing it more appealing to the customer. It could be argued that coupons can subjectively serve as a means of increasing an individual’s time preference. In other words, making them less apt to delay consumption and purchase the item that is on sale. Through lowering the price of a good it realigns the incentives of purchasing the item by providing a quantified value below the customer’s perception of expected value. Signaling to the customer that maybe that 12-pack of Guinness is worth pick-up from the grocery store. While $7.99 is an absolute steal. It is still $7.99 more than you had originally intended to spend.
The debate over whether Fractional Reserve Banking is ethical to proceed over approximately a decade (the late 1980s/ early 1990s to the early 2000s). Resulting from subsequent papers repudiating the previous claims over the researchers on the other side of the issue. It should be noted that in these series of retaliatory papers that technical arguments were presented in tandem with ethical justifications for or against this practice. For the sake of brevity, I chose to focus on the ethical considerations of the topic. However, this does not exclude a potential technical comparison of Fractional Reserve Banking in the future.
To any reader who has never thoroughly examined nor given a second thought to Fractional Reserve Banking, I hope reading this series of essays was illuminating. Fractional Reserve Banking is arguably the most prevalent banking system globally. Yet, something that impacts our lives daily we never think to question its inner mechanics let alone whether it is ethical. The ethics of banking extend beyond whether the patrons are benefiting at the expense of someone else, either through easy access to loans or interest payment on savings. There are potential ramifications to the economy.
Distortions in the credit market are precisely the impetus for business cycle calamities such as the cataclysmic burst of the Housing Bubble in 2007. Providing loans backed up by fiduciary media is nothing more than a house of cards waiting to fall done. Artificially manipulating factors such as prices, interests, and money supply can only facilitate the misallocation of resources. Such indicators operate as unspoken signals to consumers and entrepreneurs. Due to this fact, these distortions create an illusory image of the loan market and naturally economic agents respond accordingly (p.108). A fact that both George Selgin and Lawrence White are too quick to refute and dismiss (p.102). This carries the implications of defrauding the economy as a whole versus being isolated to the bank’s customers. Even if you are the type to limit all your transactions to precious metals or cryptocurrency, it is worthwhile to read up on this topic.
Summary of Compelling Arguments From the Austrian School:
It is difficult to say whether the Free-Bankers or the Austrians are on the right side of the debate. Both camps provided some truly convincing arguments. The Austrian opposition notes how ownership can only legitimately be taken on by one person and Fractional Reserve Bank obfuscates this immutable law of property ownership. From a contractual standpoint, that the agreements between banks and clients in such an argument are illegitimate. Since the terms are not only unclear to the typical layman but are a categorical misrepresentation. Presenting fiduciary media as actual money. The disingenuous nature of this faulty contract is only compounded by the fact that these claims for money are based upon the banknotes that are not back by currency or specie. Attempting to redeem them for actual currency is analogous to using a deed for a boat and attempt to claim ownership of a house. Also that it is a false analogy to argue that any devaluation of present money caused by the issue of fiduciary media is no different than an increase in the supply of a good due to protection or harvesting.
This is because the increase in the supply of lumber from harvesting more oak trees is derived from legitimate market processes and in-turn does not seek to directly devalue anyone else’s property. Also, that in no way can Fractional Reserve Banking represent the Demonstrated preference of bank clients. Demonstrated preference can only be expressed with one’s property. Fractional Reserve Banking by its very nature disrupts this relationship.
Summary of Compelling Free-Banking Arguments:
The Free-Bankers also bring up some compelling moral defenses in favor of Fractional Reserve Banking. They are even bold enough to directly claim the practice is not fraudulent. Through a banking client electing to accept the terms of service regardless of their understanding, the contract is still valid. It would be one thing if these banks purported to practice 100 percent reserve banking, but function as a Fractional Reserve institution. These contracts are formulated between consenting adults, it would be antithetical to the principle of individual freedom to prohibit such arrangements. The real trouble comes from government interference. One only needs to look at the large array of protections awarded to backs through the FDCI to see the true culprit in shielding unsavory banking practices from insolvency or litigation. Also, the ignorance or the naiveté of the consumer is not a reasonable justification for banning a product or service. Even though the risk of a bank run is present, it is a relatively rare occurrence from a historical standpoint. If faced with a potential bank run the bank can issue an option clause suspending redemption, solving the issue through valid contractual recourse. Speaking of redeeming bank deposits. A customer assumes the risk of not being able to redeem money when they agree to open an FRB account. They assume the risk. In turn, for the opportunity cost of having their liquid money held and the potential risk of a bank run/ insolvency, they receive an interest payment. Overall, patrons must prefer Fractional Reserve systems to 100 percent reserve banking. There have never been any governmental decrees in modern history that all banking must be done via a Fractional Reserve System. Despite its flaws, ultimately, the people prefer being paid interest payments versus having to pay warehousing fees.
Can There Be a Compromise?
There are certain aspects of both arguments that appear to be flawed. The Free-Bankers are too lackadaisical when it comes to distortions in the credit structure enabled by Fractional Reserve Banking. The Austrians to some extent seem too rigid in their interpretation of property ownership. Under many of their arguments likening the practice to a Ponzi scheme. Yet, to be conceptually consistent would not these same economists also take issue with multi-level-marketing? Then again it could also be counter-argued that MLM schemes and Fractional Reserve Banking while present similar confusions, property rights have much greater degree clarity in MLM arraignments.
Back in 2000, the economist Jorg Guido Hulsmann wrote an article in the Independent Review refuting the Fractional Reserve practice of creating “money”. Hulsmann (see page 108) much like his anarcho-capitalist counterparts Hoppe and Block are opposed to government intervention. If FRB is morally and technically flawed how can we address the issue of it short-comings without introducing state involvement? In this twenty-year-old article, Hulsmann presents a summary of points previously made by Hoppe and Block that would alleviate some of the issues relating to the categorical confusion. It should be noted that Hulsmann in that these suggestions for informal rules and norms of banking presume no state involvement in banking. Also, the author details the intimate relationship between the FRB and the government. Going so far as to refer to it as a “handmaiden” of government (p.108). Making it easy to infer that Hulsmann believes that the intertangled marriage between Fractional Reserve Banking and government is an unbreakable bond. However, let’s take these suggested conditions as theoretical and contingent upon a banking system free of regulation. See his suggestions below:
“…Fractional reserve banks would have to use a different language than they commonly use because words such as “deposit” are deceptive. They would have to make it clear that money “deposited” with them is, in fact, a credit of unspecified duration. And the “banknotes” they issue would have to be presented not as money titles but as some sort of very liquid IOUs..”
“..On the “FR notes,” one would have to find a promissory note of the following type:
The FR Bank promises the holder of this note to try to redeem it out of its gold reserves. Because FR notes are not 100 percent covered by gold presently in our bank, in case we cannot redeem, the following rules apply. . . . (p.108)”
It is quite clear at this point that followers of Austrian economics view Fractional Reserve Banking as nothing more than a Ponzi Scheme. However, proponents of the Free Banking School (arguably an outgrowth of the Austrian School) believe that this practice is legitimate providing there isn’t any government interference in banking. Even the uninitiated observer will admit that this contingency is a highly unrealistic one. In the modern era, banking continues to be a heavily regulated industry. Free Bankers may have a relatively cogent ethical argument from a theoretical standpoint. After all, it is the responsibility of a mentally competent adult to be aware of the terms of service for any product or service they choose to receive. Ignoring the fine is not an exculpatory factor. Either from a legal standpoint or from an ethical perspective. Also, to be conceptually consistent one should scrutinize multi-level marketing schemes. Such a business model mirrors similarities to Fractional Reserve Banking. Hence why opponents liken it to a Ponzi scheme or pyramid scam.
Argument #1: It Isn’t Fraud.
From the Free Banking perspective, Fractional Reserve Banking is not a fraud. If the banking establishment makes it clear that the services provided constitute Fractional Reserve Banking, then the arrangement is legitimate. This is because the terms of the contract were not violated (p. 87). It would be problematic to present your services as 100 percent reserve banking if it encompasses the practices of the Fractional Reserve System. Fraud would entail a misrepresentation of the bank’s services.
Taking any measures to prohibit this system of banking is antithetical to the principle of individual freedom. Any such interference would be obstructing an existing contract between consenting parties. Doing nothing more than disturbing the economic liberty of freedom of contract, which is a pillar of private property rights (p. 87). Individuals who oppose the practice find the freedom of contract argument to be farfetched as few patrons have a firm comprehension of what Fractional Reserve banking entails (p. 88). The naivete of the consumer does not sully the legitimacy of the arrangement. Even Murray Rothbard himself has stated that historically banks have rarely retained a 100 percent reserve system (p.88). Why? Most likely because the banks clients preferred a Fractional Reserve system. If customers prefer an interest payment on their savings versus a maintenance fee for warehousing, so be it (p.88). The market for banking services has responded accordingly.
Circling back to the issue of misrepresentation of services, even the hardline naysayers believe that such a banking system could be admissible under certain conditions. Most notably if there was the further elucidation of the specific details of fractional reserve services. A long-standing concern of economists such as Hans Hermann Hoppe and Walter Block being that such ambiguity makes the practice fraudulent. Creates categorical confusions between money and fiduciary media (p.20-28). Professor Block asserts that the redemption requirements need to be clarified to set aside the concerns of fraud (p. 89). Whereas Block’s counterpart Hoppe stresses that banking institutions should present a warning regarding the suspension of redemption. He analogizes this precautionary courtesy to an option clause. Unfortunately, this concern does not comport with the facts of history. As is evident by the Scottish period of Free-Banking in which specie payment was suspended for decades (p. 89-90).
Another argument that grapples with the question of whether FRB is fraudulent pertains to the ability of the banks to fulfill redemption obligations. Keeping low percentages of reserves on hand turns money redemption into a gamble. However, this concern is inconsequential. Historically even in the absence of government intervention few banks have failed to fulfill any redemption obligations to patrons (p.90). For one, solvent banks are not prone to bank runs. Even in the event, a solvent bank runs out of currency, they can issue an option clause to temporarily suspending redemption. Resolving the issue through contractual channels (p. 91).
Argument #2- The Concerns Over Third-Party Effects Are Not Substantial
The most salient third-party effect or “spill-over effect” confronting the practice of Fractional Reserve Banking is a decreased likelihood of successful redemption. Obviously, in a Fractional Reserve Banking system, the more money that is lent out the fewer reserves the bank will have on-hand. Resulting in adverse consequences for the individual demanding to withdraw money from their account. It should be noted that the depositor agrees to this argument upon opening a bank account. Therefore, by signing on the dotted line of the terms and services of the bank, they choose to assume the risk (p. 93). Despite the risks, bank patrons continue to bank with these institutions. Alone based upon the Rothbardian theory of Demonstrated Preference the individual bankers must benefit from this arrangement. After weighing the benefits concerning the costs (p.93).
The spill-over effects of Fractional Reserve Banking are not solely confined to banking transactions. The practice has also been claimed to create other distortions throughout the economy. Through how loans are funded it compromises some say the credit structure is compromised. It should be noted that the risks are somewhat minimal. If anything it aides the economy by providing a larger stock of capital (p.94). The issue with this criticism is that much of the instability in the economy comes from the intervention of central banks and governments and not Fractional Reserve Banking. This form of banking is not prone to instability or “cylindrical over-expansion”(p.94). These claims underestimate the fact that the amount of “nominal money” issued offsets the “.. changes in the velocity of money..”. Fractional Reserve banking works to alleviate the disequilibrium and “ business cycle consequences”. Hoppe and the company also assert that any injection of fiduciary media will ultimately result in a business cycle. However, if the increase in fiduciary media is matched by demand a disequilibrium will not arise (p.101-103).
Argument #3: The Popularity of Fractional Reserve Banking.
The popularity of Fractional Reserve Banking is another factor to contend with. Banking customers have demonstrated their preference for FRB. Historically, few banks have remained a 100 percent reserve system. However, customers continued to do business with these institutions (p.95). Contributing to this popularity has been the incentive of banks paying interest on deposits versus requiring a warehousing fee (p.95). Banking patrons also held faith that their bank had sufficient funds to fulfill withdrawal demands. Bank runs were generally triggered by other factors signally insolvency to bank clients. Countries such as the United States with greater propensities towards bank insolvency tend to have many protective laws shielding the banks from market pressures (p.95-96). It should also be noted that back in the 1800s when banking legislation was being discussed in the press the banking system was openly described as a fractional reserve system (p.96). Not only fully informing the average constituent of the details of the Fractional Reserve system, even with this knowledge doing little to dampen its prevalence (p.96).
The use of Fractional Reserve Banking has never been compulsory. There has never been any laws or penalties compelling banking in the United States to levitate towards this specific banking system (p.97). Patrons voluntarily assume the risk of engaging in this variety of banking for the trade-off of being rewarded with an interest payment (p.97). The argument that clients are unwittingly tricked into patronizing an illusory form of banking is dismantled by the fact that banks compete for business. Nothing is stopping an enterprising individual from persuasively selling 100 percent reserve services (p.97).
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.
“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.
The norms of modern banking are something that most of us take for granted. Few ever question the inner mechanics of such transactions we engage in daily. However, banking has been steeped in a fog of mystery due to complex operations and seldomly failing to fulfill any obligated services. Beyond questioning the functions or internal workings of modern banking even fewer people recognize that most people are participating in a fractional reserve banking system. In a random survey of average people, you will be hard-pressed to find anyone aware of what fractional reserve banking entails nor any intimate understanding of its implications. That is to be excepted considering this is a niche area of expertise that is truly the domain of an economist, banking/ financial specialist. This assumption relieves us of any responsibility to cultivate a better understanding of these systems. After all, this is best left to the experts. How do we know whether there any inherent risks associated with fraction reserve banking? Do we just assume that due to the fact it is the most common banking system that it is the most effective and secure? Better yet, is it even a moral system of banking, or is deceptive by design and tantamount to fraud?
Over the past several decades, a controversy has been brewing among monetary economists concerning fractional reserve banking, Modern economic theorists of the Austrian School who are generally hard money advocates, find fractional reserve banking to illegitimate to its core. Equating it fraud and perceiving it to be antithetical to a free market in money. Whereas free-banking (an economic school that is arguably an outgrowth of the Austrian School) do not see fractional reserve bank as immoral. Rather, such institutions could not only ethically co-exist with 100 % reserve banks but also flourish. Any ethically questionable operations were the byproduct of government intervention and mutually exclusive from the banking practice (p.8). While their Austrian counterparts insist that the practice not only supports the monetary objectives of the state but owes its existence to the state (p.9, p.15-17).In this series of essays, we will examine the ethical arguments for and against fractional reserve banking. To present an unbiased account of the controversy.
What is Fractional Reserve Banking?
Before we can embark upon discussing the ethics of fractional reserve banking is important that we define what it is. On a high level, fractional reserve banking is a system in which banks are required to only hold a fraction of money deposited as reserves. This is done to enable banks to make loans. The recipient of the loan receives a transfer of deposited money upfront which they are expected to pay interest on. The bank customer who deposited the money that was lent out theoretically will receive the money-back in their account with sustained interest. This is done to expand the economy through “freeing capital for lending”. This is done without the depositor relinquishing their claim to this money. Effectively creating more money titles than physical money held on reserve at the bank (p.3) The foundation of this banking system is fastened to the assumption that most customers with savings accounts will not simultaneously withdraw all of their savings at once. Otherwise, this could lead to what is known as a bank run. A phenomenon where the bank as completely depletes their liquid reserves. Since they are only mandated to hold a relatively small portion of reserves on hand.
Reserve requirements typically hovering around 10 % (presumably applicable to central banks). Most reserve requirements are contingent on the bank’s size. Banks holding less than $15.2 Million in reserves are exempt from maintaining reserve minimums. The requirement of 10% reserves is applicable to banks holding over $100.2 million in deposits. Per the Garn-St Germain Act banks are free from any reserve requirements for their first $2 million held. This legislation was initially passed by the Regan administration as a means of relieving pressure on banks as the federal reserve significantly increased interest rates. Banking institutions that hold excess reserves or amounts of deposited money above reserve requirements are entitled to interest payments. Under the Financial Services Regulatory Relief Act of 2006, these interest payments are allocated by the Federal Reserve.
As mentioned above fractional reserve banks issue more money titles than currency on hand. Through this process, they engage in form of indirect “money” creation. The loan itself treats the money titles as being equally as valid as actual currency notes. When the loan is issued the bank “credits” the borrower’s account with an amount equal to the loan, mimicking a transfer of physical cash. The methodology of money creation on the part of fractional-reserve banks has been distilled down to a science. Guided by the money multiplier principle. This concept broadly describes how “.. initial deposit leads to a greater final increase in the total money supply”. More specifically how much commercial bank money ( demand deposits that can be utilized for credit and debit purposes, basically your residual after reserve requirements) using a defined unit of central bank money. Central bank money is any medium of exchange that these institutions acknowledge as being money. The correct proportion of “money” creation is determined by the below equation:
M= Money Multiplier, R= Reserve Requirement
The Hayekian Triangle is a visual representation of the stages of production. Many professional Austrian economists refer to it as a pedological device for explaining the Austrian Business Cycle Theory (Block & Barnett, 2006, P.2) . Above all, it is something of an outlier in the Austrian School of Economics. Due to the methodological rejection of the Neo-Classical approach, graphs and equations are rarely ever used. Despite this methodological consideration, the Haykeian Triangle is viewed by many as being imperative in understanding “boom-bust” business cycles. Even though some prominent Austrian economists such as Walter Block have expressed their grievances with this depiction of ABCT.
The triangle was first introduced by Nobel Laureate F.A. Hayek in his 1931 book Prices and Production (revised in 1935). Presenting the variable of time on the Y-axis and output of consumer goods on the X-axis. Forming a right triangle. Per Hayek’s own explanation:
…. means of production is expressed by the horizontal projection of the hypotenuse, while the vertical dimension, measured in arbitrary periods from the top to the bottom, expresses the progress of time, so that the inclination of the line representing the amount of original means of production used means that these original means of production are expended continuously during the whole process of production. The bottom of the triangle represents the value of the current output of consumers’ goods. The area of the triangle thus shows the totality of the successive stages through which the several units of original means of production pass before they become ripe for consumption. (Hayek, 1931, P.39-40) 
The triangle diagrams the relationship between time and productive output. It measures this relationship from the harvesting and producing higher-order goods (those in earlier stages of production. All the way to the final phases of production such as packaging. Hayek’s diagram also details the amount of capital deployed into production per a specific stage. Per his observations, all variables unencumbered by manipulation, more money is spent in the earlier stages of production (Hayek, 1931, P.53) . The amount tends to decrease in the later stages. Much of the variance in resource allocation throughout the stages of production mirrors consumer demand.
Understanding consumption patterns is key to production. As acting individuals, we can either save, invest, or spend money. The entrepreneur who is managing the production of consumer goods will cater it patterns of buying behavior (Hayek. 1931. P.50) . If consumers are saving more and spending less demand will go down. Consequentially, savings are not necessarily detrimental. Despite the Keynesian consensus that drop-in aggregate demand will bring the economy to grinding stop. Commonly known as the Paradox of Thrift. When consumers start saving they become more future ordinated as Dr. Roger Garrison would put it. They put off present consumption today for future consumption. This can include investment. Investment differentiates itself from consumer consumption by aiding production potential. An increase in investment now can help producers acquire capital to expand production capacity later (Hayek, 1931, P.60, 88) .
One fact that cannot be overstated is how the loanable funds market parallels production. When demand is low prices are low and vice versa. It is important to remember that all sectors of the economy are interconnected. Under normal conditions, interest rate fluctuations, supply-and-demand drives the rate. Much how consumer prices do the same. If consumer demand is low prices will reflect demand. The same goes for acquiring a loan. When consumer demand is low production hits a lull. However, consequentially the going interest rates will be low as well. Making it an ideal time to get a loan to upgrade old and worn-out equipment. As more business people acquire loans the interest rate will naturally increase. It is no more different than any other segment of the economy. Just a different product.
Because consumers are not ravenous demand new products, more money is spent on starting production. Hence, the greater expenditures in the earlier stages. There isn’t any immediate need to have completed products. Once consumer demand starts to increase more business owners will be acquiring loans to increase production. Driving the interest rate upward. Then as the interest rate increases, fewer entrepreneurs will be taking out loans. This will impact demand on the loanable funds market. Once the price for consumer goods increases there will be a decline in demand for products and services. Bringing us right back to where we started. Lower interest rates, prices, and product demand. This cycle is cylindrical and self-regulating. Per popular consensus of Austrian economists will result in economic growth.
The problem becomes that often policymakers seek to interfere with this process. This circles back to the Paradox of Thrift. When consumer confidence is down, lowering interest rates operate as a form of stimulus. Whether they are lowered to out of genuine concern for the economy or callous political opportunism is irrelevant. It is still an erroneous course of action. Artificially decreasing the interest rate will lead to malinvestment (Hayek, 1931, P.58) . Entrepreneurs borrow money for projects that would not be profitable to undertake with higher interest rates (Hayek, 1931, P. 86) . They will invest more money into the earlier stages of production when consumer demands reflect more emphasis on the later stages. Also, they will be bold enough to undertake entrepreneurial ventures that require long production times.
The mechanism by which institutions such as the Federal Reserve lowers interest rates is important to note. They engage in credit creation by injecting more currency into the money supply. In other words, they get the printing presses up and running. Trading purchasing power for liquidity. This will result in higher prices for consumers. This is known as inflation. Prices will continue to rise until the institution manipulating the interest rate finds the rate of inflation to be exorbitant. Subsequently decides to lower the interest rate (Hayek, 1931, P. 90) . Alternately, the rate of inflation becomes so hight that people stop using U.S. fiat currency altogether (Murph, 2015, P.253) . That is an extreme example, reserved for the most extreme cases of hyperinflation. Unfortunately, the bubble has burst and the fall out is just beginning. All the ventures started under the low-interest rates are now insolvent and cannot be completed (Hayek, 1931, P. 92). Unless the borrower is able to complete the project at a loss. Resulting in mark failures and economic depressions. Assumably worsening economic conditions than if the interest rate had remained unmanipulated.
In part II: we will examine the innovations made to the Haykeian Triangle by Dr. Roger Garrison. He attempted to revise the triangle, making it easier to be applied in a Neo-Classical context.