Fractional Reserve Banking

A couple of weeks ago Knirirr wrote this comment:

Is money really made out of thin air? This article makes a good case that it is not, and that fractional reserve banking is not against libertarian principles. Click here. I agree with you about the state meddling, though. knirirr | 09.15.08 - 12:55 pm | #

The article's concludes:

In brief, I do not find any of the libertarian arguments against fractional-reserve banking compelling. The charge of fraud can be handled by clear deposit contracts and proper labeling of notes, while the other two charges I address are either empty or irrelevant. It may be that bank customers would reject fractional-reserve banks if fully informed about their operation—although, again, I doubt that is true—but that is only an argument for full disclosure, not for banning the practice.

In general I agree with Callahan's analysis. If I go out to my local shop and hand over a "Farrer Note" that's been crafted and signed by myself there is no fraud so long as I don't claim that the note is something other than what it is. If I sign the note with the word "Rembrandt" it seems clear that I have committed a fraud. The problem is that today's fractional reserve banking system is rather more complicated than a marketplace containing rival Farrer Notes, Bush Notes and Brown Notes all of which people take their chances with when accepting them. We have to consider the role of the central bank.

As always, Rothbard hits the nail on the head:

Indeed, Rothbard does no less than portray the Fed as a cartelizing device that limits entry into and regulates competition within the lucrative fractional-reserve banking industry and stands ready to bail it out, thus guaranteeing its profits and socializing its losses. Rothbard further demonstrates that not only bankers, but also incumbent politicians and their favored constituencies and special interest groups benefit from the Fed's power to create money at will. This power is routinely used in the service of vote-seeking politicians to surreptitiously tax money holders to promote the interests of groups that gain from artificially cheap interest rates and direct government subsidies. These beneficiaries include, among others, Wall Street financial institutions, manufacturing firms that produce capital goods, the military-industrial complex, the construction and auto industries, and labor unions

The Bank of England is unlikely to bail out any unlucky holders of "Farrer Notes" should it become apparent that are only worth the paper they are printed on. As we are seeing right now the Bush and Brown notes are being bailed out. So expect lots and lots of inflation, at least in terms of Bushes and Browns. Banks advance loans on a base of government issued money that gives them an unwarranted degree of credibility. Without a central bank I have little doubt that a fractional reserve bank wouldn't last very long in an unsubsidised marketplace.