Bryan Caplan  

Block and Me on FRB

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A little while back I had another email exchange with the tireless Walter Block.  The subject: The moral legitimacy of fractional reserve banking.  With my permission, Block has posted an edited version of our entire dialogue.  The highlight: Block asks if I've "even read the other side of this debate?"  My response:

If I've published anything on this, I don't recall. And yes, in my misspent youth I read lots of defenses of 100% reserves. I even believed them.

If I were going to write something on this, it would be very short. I'd probably just quote P&M: "No administrator is needed to prevent non-fraudulent sales; if a man simply sells what he calls "bread," it must meet the common definition of bread held by consumers, and not some arbitrary specification. However, if he specifies the composition on the loaf, he is liable for prosecution if he is lying."

In retrospect, I probably should have ended the exchange with my first reply, but as Harold Demsetz knows, arguing with Block is highly addictive.


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TRACKBACKS (1 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/1061
The author at The Volokh Conspiracy in a related article titled Is fractional reserve banking fraudulent? writes:

    I ran across this odd debate between Bryan Caplan and Walter Block. Here is Block’s argument (“frb” means fractional reserve banking):

    [Tracked on November 4, 2008 8:24 AM]
COMMENTS (18 to date)
David Shemano writes:

I have never given a meaningful thought to the debate about fractional reserve banking. But as a lawyer, I found your exchange very strange. Mr. Block (and maybe you) appears to have the belief that if I deposit a dollar with a bank, I continue to "own" that dollar and the bank is simply my bailee holding the dollar for my benefit. That is simply not true. When I deposit a dollar, I am legally making a loan to the bank. I am a creditor and the bank is a debtor -- the bank is not a bailee and I am not a bailor. What I own is a legal claim to a dollar, and not the dollar. In other words, all I "own" is a right to enforce a promise. I am not sure of the implications of this for fractional reserve banking, but you economists should make sure you are thinking clearly about this.

MattYoung writes:

From the start of the boom, fractional reserves work fine, but when the bust comes, 100% reserves raises its demand.

Caliban Darklock writes:

Block appears to conflate ownership with possession. When two people have full "ownership" of a car, both of them have every right to make any decision about that car without the other's consent.

However, certain decisions can only be made when in physical possession of the car - whether to drive it, for example. If you drive the car we jointly own to some other location, I cannot drive it. I have the right to drive it, but I do not have the physical ability to drive it.

I do not believe this in any way changes the extent of my ownership. Ownership is a theoretical concept, not an actuality of possession. I don't believe there is necessarily a conflict of ownership here, but I also don't believe there is any way to remove the possibility of such conflict - having possession of the car, you could sell it, for example.

So if it were to be maintained that the existence of such conflict violates the notion of a libertarian society, I would suggest that this implies a libertarian society is impossible.

Devin Finbarr writes:

I always thought that calling fractional reserve fraud was a little silly, since most people realize that the bank lends out the money to someone else.

But then I read about the Sentinel money market fund which had to freeze redemptions a few months ago. Sentinel promised its investors that: "In order to accommodate the liquidity needs of FCM clients, this portfolio will, typically, hold forty to fifty percent of its assets in the form of overnight repurchase agreements (repos)." However, when the run on the fund happened, it turned out that: "The weighted-average maturity of securities in the fund was 33 years, mostly in corporate securities. Only about 6 percent of assets were in overnight loans. " (source).

In other words, the fund had promised investors that the money would be kept in overnight loans. Instead, they loaned out the money for thirty years! This is clear cut fraud. It's a modern form of fractional reserve, and the money market fund lied to their customers about it. This practice is at the heart of the financial crisis. The Austrians are right.


Francis writes:

David Shemano has a good point: the dollar is not the object being owned by each one; it is the claim that is really own.

To me, the relationship of the depositors to the reserve dollar is similar to that of resource-users to any shared resource.

For example, your power utility promises to everyone that they can use their toaster at any time. Yet if every subscriber was to connect his toaster at the same time, the whole grid would crash. (To me, this is a better example than that of the common ownership of the car.) The contract is sound and clear, and the promise relies on statistical resource-sharing. If that is fraudulent, that is big news.

James writes:

David,

Block doesn't claim that under current banking practices when you deposit a unit of currency in a bank, you still own that specific unit of currency.
His view is that that is how things ought to be.

Brian,

I think the quote from P&M is is intended to describe conditions which would arise in a market without government intervention such as an FDIC which is ultimately backed by a printing press.

MattYoung writes:

OK, well I followed the link part way, the jumped to the references on the frequency interpretation of probability.

There is the equivalent of the uncertainty principle in economics, stated as: If a group of economic agents collectively come to an agreement to take advantage of random arrival times, and thus share a resource, then they will become correlated and no longer have random arrival times.

We do not need to limit the discussion to banking, just consider a group of 50 neighbors who collectively come to an agreement to share 10 cars, based on a prior probability estimation of their usage. The collective agreement limits the probability of waiting to use a shared car to 15 minutes, 95% of the time, using apriori measurements.

Their desire to ration a scarce resource using queuing theory is an economic gain, but then the same motive encourages them to synchronize their arrival times even further until they are correlated, or coherent in frequency. At that point, a sudden, unexpected event by one person throws the whole group off.

This does not invalidate a queuing solution, like fractional banking, but it does mean that one of two possible outcomes occurs, either the group reaches a finite limit of coherence, due to an intrinsic constant of measurement uncertainty, or the group will, after some time, break up and form another group to recover uncertainty.

The inverted logic will also holds. If you enforce 100% reserves, then the uncertainty principle will eventually recompute the value of the reserves until they are less than 100%.

Fractional reserves and collective instability is in our genes and unavoidable, and unrelated to banking specifically. I go back to my central claim, it is a result of evolution solving a contradiction with mammalian herds.


David Shemano writes:

James --

There is a banking practice that will satisfy Block. It is called a safe-deposit box. But that is not what most people think of when they think of a savings or even a checking account. Most people understand, at some intuitional level, that a deposit is a loan to the bank that pays interest, as opposed to safekeeping arrangement whereby the despositor pays a fee for the safekeeping.

Francisco writes:

"The inverted logic will also holds. If you enforce 100% reserves, then the uncertainty principle will eventually recompute the value of the reserves until they are less than 100%."

I´m not sure I follow.

Tom West writes:

David,

Block doesn't claim that under current banking practices when you deposit a unit of currency in a bank, you still own that specific unit of currency.
His view is that that is how things ought to be.

If this is his interpretation, does he say *why* it ought to be this way?

It would seem that it's simply a matter of contract (which, to be honest, we'd like both parties to be aware of). You want 100% reserve, here's your safety deposit box (and you have "ownership"). If you're willing to accept some risk, you get some interest (and no, you don't have "ownership", you have a claim).

Obviously governments consider the fractional reserve system to be *so* beneficial to society that they're often willing to guarantee deposits.

As long as everyone is aware of what the rules are, what's the problem? (That's actually a serious request for a pointer to what seems rather crazy - I assume there's got to be some real rationale behind it.)

floccina writes:

There is also a question of magnitude. If a hotel over books betting that 5% of the bookings will not show up, that would not be fraud in the common use of that word but if they booked 10 times number of rooms that they had, well...

Also in the former case presumablly the hotel has the means to make it right for those few who get bumped, in the latter case not so.

Good faith effort and all of that...

Patrick writes:

With the example of a married couple claiming ownership of one car, it seems to me that each person would own only part of the car. If both parties could claim full ownership of the car, then upon selling it, both the husband and wife would be able to demand payment for the full value of one car individually, thus forcing the buyer to pay twice the actual value of the car.

In reality if the couple sold the car they would receive payment for one car, and would then have to agree to split the money between them somehow. How can both parties claim full ownership when they can only legitimately receive partial compensation?

FRB requires that two parties each hold full ownership of one discrete amount of money. I agree with Block in that I don't understand how that can be logically possible.

Michael Hardesty writes:

Block is right, FRB is a fraud and as Rothbard explained at length many years would be outlawed
in a free society.
Any deposits belong 100% to the depositors and the bank is obligated to pay 100% on demand regardless of how many depositors ask for their money. The attempted specious dichotomy between ownership and possession does not stand.

Stinky writes:

FRB would not be an issue if we weren't FORCED by the Government to pay our taxes using FRB. If we were free to enter into any type of banking agreements we wanted, we could choose banks that didn't loan out our money.

GeorgeDon writes:

Francis makes an analogy of frb, with resource-sharing, e.g., a power company supplying power to toasters.

It is with some curiosity (to Libertarians, perhaps), to note that both frb, as well as resource-sharing commercial activities, both require Government intervention and regulation.

Can it be due to the inherent property-rights conflicts?

Floccina also makes an analogy of a hotel which overbooks by a factor of 10, as if the magnitude of the outcome weighs-in on the inherent conflict.

As much as there exists the potential for ownership conflict with resource-sharing, frb and hotel overbooking, there exists with Mr. Ponzi and his schema.

In this logic, shouldn't Ponzi operations be legitimate, as long as they either don't get "run" on, overbook, or not produce enough (like resource-sharing)?

Ultimately, if there exists a time-dependent ABSOLUTE case for non-performance (if there is an frb bank run, all toasters run at once, or all check-ins occur at the same time), "up front", in the forming of the contract, then the provider appears to be commiting fraud by intent.

Patri Friedman writes:

Having read the debate, Block seems to have never heard of the idea of "Freedom of contract."

If I, a FRB, accept gold, and give you pieces of paper that say "This is good for 1 bar of gold, unless the bank is out, in which case you'll have to wait", how can that possibly be fraudulent, or be a competing claim, or in any other way immoral?

Patri Friedman writes:

Having read the debate, Block seems to have never heard of the idea of "Freedom of contract."

If I, a FRB, accept gold, and give you pieces of paper that say "This is good for 1 bar of gold, unless the bank is out, in which case you'll have to wait", how can that possibly be fraudulent, or be a competing claim, or in any other way immoral?

blueski writes:

A continuation of this debate can be found here.

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