Like any popular uprising, the goal was quickly smothered
in favor of further rent-seeking. Instead of aiming consternation at the
incestuous relationship between government and the money-changers,
occupiers wanted the quick-fix of redistribution. The cries of “this is
what democracy looks like” might as well have been “this is what
panhandling looks like.” Centralized banking went unquestioned. The
nature of fractional reserve practices was ignored – or likely not
understood by the pea-brained
philosophers. Still, the radical levellers who set-up camp in Zuccotti
Park were on to something by asking why their precious public officials
voted to shore up the balance sheets of a disproportionately small
member caste.
Banking is, to put it bluntly, a strange and unique
business. The industry is centuries-old, and the legality of its
operations has been questionable since inception. I am referring
specifically to the practice of bankers lending out claimed reserves – a
contentious issue among libertarian theorists. If the larger public
were to become privy to this business model, it may spark a troubling
curiosity in the less-moneyed class. But then again, this author never
ceases to be amazed by the bounds of common apathy.
In banking, certain legal doctrines have guided the trade
since antiquity, including the nature of contracts. The violation of
these distinct forms of lawful guarantees once carried the weight of
justice. But no longer; as the deliberately obscuring practice of
loaning out deposits meant to be available on-demand has created such
instability in the banking system, the incessant teetering on the cliff
of insolvency remains an ever viable threat to economic tranquility.
Libertarians – specifically those schooled in the Austrian,
causal-realist tradition of economics – are intellectually miles ahead
of the Occupy folks when it comes to the study of currency. And while
the students of Mises and Hayek are fervently opposed to any central
bank management, there remains a sharp divide on the ethics of
fractional reserve banking. In a recent missive in the Freeman, economist Malavika Nair questions
the Rothbardian ethic that finds the practice of banks creating credit
out of thin air fraudulent. The piece, which deconstructs the dean of
the Austrian school’s original argument, frames banking away from the
supposed cut-and-dry thinking model of anti-fractionalists.
Nair begins with a false choice by asking: “Would
fractional reserve banking exist in a world without a central bank? Put
another way: Is fractional reserve banking inherently fraudulent?” These
statements are not one in the same; they reference two separate
conditions. Absent central banking, unbacked credit expansion could
still exist. Back in mid-to-late 19th century America where the Federal
Reserve was still a twinkle in the centralizers’ eyes, fractional
reserve banking and pyramiding credit were common practice. The question at hand is whether such business is based on a fraudulent understanding of the nature of goods.
Nair finds issue with the essence of contracts and how they
relate to the duty of those individuals entrusted with safeguarding
money. The contract
– an extension of humanity’s self-ownership and free will – has been a
recognized covenant enforceable by compulsion for as long as man first
conceived of himself as an autonomous being. It finds legitimacy in the
human understanding of bonds and keeping one’s word. The evolution of common law
has dictated that any activity stipulated in a compact cannot entail
unlawful activity. To enforce an illegal activity would thereby be a
crime in itself – an ipso facto contradiction in reason.
The contract is key for banking operations. Nair argues
that bank functions, both deposit and lending, are plainly justifiable;
the discrepancy arises in the manner that customer funds are utilized.
Currently, bankers freely lend out money that is available on command by
both the borrower and depositor. In practice, this is the creation of
two goods from one ex nihilo. In a totally isolated instance where a
bank were to service only two patrons, the act of creating what Mises
called “fiduciary media” would appear as the very perversion of
intuitive law it embodies. It would simply come off as no more than a
violation of the known rules of the world.
Nair counters by asserting that a “claim to money is not
the same thing as the money itself.” This is a confusing affirmation as
antagonists to fractional reserve banking hardly make that claim. The
point of contention is that promissory notes for bank deposits represent
real money, though they may circulate as mediums of exchange and
fulfill the role of currency. Should two or more of these “I owe you”
certificates be created to represent one unit of bank reserves available
on-demand, there is a direct and unquestionable inconsistency. It is
certainly true, as Nair points out, that the fungible quality of money
dictates it be treated differently than non-substitutable goods.
However, the fact that cash is interchangeable does not dismiss its
limited character.
If the principle of unbacked expansion of credit were
applied to other industries such as automobiles or condominiums, titles
to the same good could theoretically be multiplied, but not without
controversy. Having two titles for one car is not based on logic or a
firm understanding of universal law. You simply cannot create real,
definite material by declaration. Nair asserts that this is not true
when it comes to the market of money. In his words, the over-issuing of
redeemable bank notes “does not mean one thing is in two places at the
same time” but that “two different things are in two places at the same
time.” This is only so much sophistry, as the claims to bank reserves
are still representative of real goods. There may be multiple slips of
paper representing one unit of money-proper floating around in the
economy, but that does not dismiss the plain and true fact that there
are more claims than what is available.
As economist Jesús Huerta de Soto documents in his tour de force Money, Bank Credit, and Economic Cycles,
government has played a leading role in fostering this banking fraud
for centuries. The state is forever on the search for more resources to
carry out its bidding. Cooperation with the leading money-lending
institutions was an obvious route for subverting the moral means to
wealth creation. Since the days of classical Greece, it was well
understood that transactions of present goods fundamentally differed
from those involving future goods. In practical terms, deposits for
safekeeping were of considerable difference to those made for the strict
purpose of lending out and garnering a return. Bankers who
misappropriated funds were often found guilty of fraud and forced to pay
restitution. In one recorded episode, ancient Grecian legal scholar
Isocrates lambasted Athenian banker Passio for reneging on a client’s
depository claim. After being entrusted to hold a select amount of
money, the sly banker loaned out a portion of the funds in the hopes of
earning a profit. When asked to make due on the deposit, the timid
Passio pleaded to his accuser to keep the transgression “a secret so it
would not be discovered he had committed fraud.”
The underlying chicanery behind fractional reserve banking has
existed since the days of Plato. Modern technology has not negated the
rationale used to discover and affirm natural law. Binary codes on a
computer screen do not create a new reality. The governing doctrines of
humanity are, in de Soto’s words, “unchanging and inherent in the logic
of human relationships.” While fractional reserve banking could exist in
a free market environment and regulate itself through vigorous
competition, that theoretical scenario does not prove the entire fulcrum
of the business rests on solid ground.
The truth remains, and will always remain, that an organic
product is not replicable through any kind of witch doctoring. A thing
is a thing is a thing. Any money substitute that represents a real piece
of fungible currency cannot pertain to that which is not in existence.
Such is the lawful understanding that goes back to the time preceding
the Hellenisitc period.
Malavika Nair offers an interesting argument by trying to
justify the practice of creating something out of nothing; but it
ultimately fails. The free lunch of artificial credit creation is
nothing more than slipping out of the baker’s shop without paying. It
would have served the Occupy crowd well to have recognized this shaky
foundation upon which the modern financial system rests. Perhaps their
message of widespread corruption would have been better received – at
least more so than by creating
shanty towns and defecating on the street. Instead, we were gifted with
a muddled and confused political message made by an irate minority who
hadn’t a clue of the forces that govern their own lives.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada.
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