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The State and 100 Percent Reserve Banking

Free bankers have been fighting a war on two fronts.  On one they face champions of central banking and managed money.  On the other they struggle against advocates of 100-percent reserve banking.  Although the second front is a lot smaller than the first, it’s far from being unimportant, in part because the battle there is being fought against people who generally favor free markets, who might have been expected to join rather than to oppose our cause.

They oppose it for a variety of reasons, one of which is their belief that, in a truly free-market setting, fractional reserve banking wouldn’t survive.  Instead, they insist, 100-percent reserve banks would prevail.  That they haven't is due, in their opinion, to a banking industry playing field slanted in favor of favor fractional-reserve banks, especially by either implicit or implicit deposit guarantees financed through forced levies upon all banks, and sometimes by taxation or inflation.  In short, fractional-reserve banking has been nurtured by government subsidies.

Free bankers have tried responding to this argument by noting how fractional reserve banking has prevailed under every sort of bank regulatory regime, from the earliest beginnings of banking, not excepting regimes that involved very little regulation, like those of Scotland, Canada, and Sweden, and that lacked even a trace of government guarantees or other sorts of artificial support.  But since some 100-percenters seem unmoved by this approach, I here take a different tack, which consists of pointing out that every significant 100-percent bank known to history was a government-sponsored enterprise, which depended for its existence on some combination of direct government subsidies, compulsory patronage, or laws suppressing rival (fractional reserve) institutions. Yet despite the special support they enjoyed, and their solemn commitments to refrain from lending coin deposited with them, they all eventually came a cropper. What’s more, it was these government-sponsored full-reserve banks, rather than their private-market fractional reserve counterparts, that were the progenitors of later central banks, starting with the Bank of England.

So far as records indicate, the very earliest banks were private institutions that began as sidelines to other businesses.  The very first bankers may have been the trapezites or money-changers of ancient Athens, or their later Roman counterparts.  But the earliest concerning which any details are known were the “banks of deposit” that arose during the 12th century in Italy, especially in Genoa and Venice, and the record clearly indicates that these banks were credit-granting institutions rather then mere coin warehouses.  Indeed, it was almost inevitable that they should have been so, because in order to efficiently undertake to make payments by bank transfer, and so spare their clients the necessity of dealing with the shoddy coins then available, they were bound to promise to return on demand, not the very coins deposited with them, but coins of equal value, which in effect meant becoming debtors rather than bailees.  Moreover, overdrafts were bound occasionally to result in credits in excess of cash reserves, while the interest to be earned from additional lending allowed bankers to reduce the fees they charged for their payment services, and even to occasionally pay interest on their “deposits.”   In any event the lending was never concealed.  In London goldsmith banking took a similar course, though not until the mid-17th century.  In short, so far as records indicate, all of the earliest private banks operated on a fractional-reserve basis.

Banking in the medieval and renaissance period was a notoriously risky business, so despite typically holding reserves of roughly a third of their deposits private banks often failed.  It was partly in response to these failures, and partly out of fiscal motives, that governments first began venturing into the banking business, by establishing so-called “public” banks, which though government-sponsored were otherwise supposed to operate according to what we might call “Rothbardian” principles, offering a combination of payment and metallic-money custodial services, but without engaging in any lending.  The first such bank, Barcelona’s Taula de Canvi, was established in 1401 with the promise that it would be a safe place to store coin.  In fact the government intended from the start to draw on its resources to fund the city’s debt, and merchants saw through the scheme.  The government then responded by awarding the Taula a monopoly of demand deposits.  Still many merchants refused to take the bait, which was just as well since the government eventually drew so heavily upon the Taula that it went bankrupt.

Although Venice’s first public bank, the Banco di Rialto established in 1587, was modeled after the Taula, it actually did operate on a 100-percent reserve basis for some time, and was for some years Venice’s only bank.  But far from having out-competed fractional reserve rivals on a level playing field, the Rialto Bank had its operating expenses, including normal returns, covered by customs duties, and was only for that reason able to offer risk-free payment services in exchange for only modest fees.  Still the bank’s days were numbered when a rival public bank, the Banco del Giro, was established in 1619, and was initially allowed to operate on a fractional reserve basis. The new bank absorbed its full-reserve rival in 1637, and thanks to continued government demands upon it never did manage to convert to a 100-percent reserve basis.  On the contrary: it twice had to suspend payments, in each case for many years.

The most famous of the public 100-percent reserve banks, the Bank of Amsterdam, is also the one most often cited as proof of the viability of that form of banking.  But here again, a close look suggests that the proof is no proof at all.  For starters, in establishing the Bank of Amsterdam in 1609, the Dutch government also banned the city’s private “proto-bankers”—the analogues of Venice’s medieval money changers and London’s 17th-century goldsmiths—essentially giving the public bank a monopoly of non-coin payment services.  The government also required that all bills of exchange worth 600 guilders or more be settled on the new bank’s books.  Finally, rather than being true demand deposits, readily convertible into coin at no penalty, deposits at the Wisselbank could be converted into cash only for fees of up to 2.5% of withdrawn amounts, thus allowing it to cover its expenses while also earning a tidy profit without having to make any loans.

Yet, notwithstanding the widespread contrary belief and its solemn promise to “store” all deposits lodged with it, the Bank of Amsterdam did make loans.  It did so, first of all, by allowing overdrafts.  More importantly, it eventually did so, to a far greater extent, by making advances to the municipal government and to the Dutch East India Company.  During the 1650s, for example, the city of Amsterdam borrowed a whopping 2 million guilders, which it never repaid; and after 1684 loans persistently amounted to 20 percent or more of the Bank’s total assets.  Finally, in 1790, the failure of the bank’s heavy (and, as usual, clandestine) loans to the then-struggling East India Company forced it, in effect, to devalue most of its deposits by 10 percent, while altogether refusing to repay any of less than  2,500 guilders.  At last, when the French invaded Amsterdam and got hold of the Bank’s books, these revealed that its reserves had fallen to less than 25 percent of its liabilities, with the Dutch East India Company alone owing it a grand total of 11 million guilders.  Release of the last statistic at once caused the Bank’s famous bullion “receipts,” which were (since an 1683 reform) the only Bank liabilities that could actually be redeemed, to fall to a 16 percent discount.

The passing of the Bank of Amsterdam marked the end of governments' attempts to establish, or to pretend to establish, 100-percent reserve banks, and therefore marked the end of all significant instances of that sort of banking.  Yet it was far from being the end of government involvement in the banking business, for the early “public” banks, and the Bank of Amsterdam especially—thanks in part to the myth of it’s always having been solid—were the direct inspiration for another breed of government-sponsored banks, the prototype of which was the Bank of England.  Where that development has taken us is too well known to be worth restating here.  But let it not be forgotten that it all started with the cry that the public ought not to have to deal with fractional-reserve banks.

  • RickDiMare

    George, why can't fractional-reserve and full-reserve accounts coexist at the same bank? The majority of depositors don't care whether their funds are being used to stimulate the economy over and above the amount they've deposited, so if no legal claim is made to demand Treasury Direct money, those deposits could continue being subject to fractional-reserve practices.

    But I would want to see federal consumer protections built in to such a dual system, so that depositors claiming TreasuryDirect–i.e., money subject to full reserve practices–are assured unfettered access to their rights under McCulloch v. Maryland (1819).

    For example, Massachusetts has a great consumer protection law, Chapter 93A, that would allow aggrieved claimants to collect triple damages and be reimbursed for legal fees from a bank that unnecessarily obstructed access to TreasuryDIrect money.

  • George Selgin

    Rick, although I can't deny that what you suggest is possble, I do not know that it has ever been tried. By my reading, history displays an utter lack of any apparent consumer interest in 100-percent banking, which of course suffices to explain why such banking hasn't occured, either alone or mixed with fractional-reserve banking. That, at least, is the parsimonious explanation.

    • RickDiMare

      George, history's display "of any apparent consumer interest" is why I mentioned in an earlier post that the U.S. Constitution creates an entirely new kind of (fully-public) currency which may be incompatible with (maybe all) other currencies, but the way things are looking, we may be compelled to find a way of making them coexist.

      In my view, the Treasury Department needs to decide whether the current central banking system can be modified to accommodate TreasuryDirect, full-reserve accounts at all banks, or alternatively, whether it believes the Fed needs competition from multiple federally-chartered free banks.

      In a way, the central banking system we have now already does accommodate both full- and fractional-reserve currencies. For example, when depositors use current U.S. coin or TreasuryDirect at, this forces the Fed to become "fiscal agent" for the Treasury Department.

      The downside of the current system, however, is that there is great economic incentive for central bankers to keep people from knowing their Constitutional monetary rights, and to make the usage of coins and inconvenient for everyday use.

      • Chuck Moulton


        TreasuryDirect is treasury securities: treasury bills (maturity < 1 year ), treasury notes (maturity between 1 year and 10 years), and treasury bonds (maturity > 10 years). Treasury securities are not money, they are credit — it is a future promise to pay. As far as I know TreasuryDirect does not offer services such as checking which would make it a medium of exchange (like Money Market Deposit Accounts).

        I am confused about your whole comment here for the reasons described above. First you seem to be saying that TreasuryDirect is money or a form of banking, which it isn't. Then you seem to be saying that banks make using TreasuryDirect difficult, when in fact through Money Market Deposit Accounts banks facilitate account backing by treasury securities.

        Because Money Market Deposit Accounts are not transaction accounts, although you can write checks on them they are subject to the regulations of a savings account. This means you are limited to 6 transactions or withdrawals per month. It is impossible to both pay interest and have full liquidity on accounts with 100% reserves. Although Money Market Deposit Accounts appear to be 100% reserves with payment of interest, in fact they give you that interest by sacrificing your liquidity (limiting transactions and allowing the bank to require 2 weeks notice for withdrawals if it wants).

        I don't know if that fully addresses your points, but I am trying to provide a little clarification.

        • I´ve always found confusing how the monetary theories differenciate credit from money. It´s true that Treasury securities are credit, but so is a dollar bill or a liability in bank such a checking account. Even Mises is not clear about this.

          If you are interested, a few years ago, I discovered Carlos Bondone (, an economist who proposes a very interesting and very clear monetary structure, here is a summary:

          Currency: General medium of exchange

          Classes of Currency:
          – Money: When the currency is a present good (gold, silver, salt) we may call it money
          – Credit: When the currency is not a presnt good, it can only be credit.
          * Regular credit: The economic good, amount, quality, and delivery date are specified (i.e. Real Bill)
          * Irregular credit: The ecomomic good to be delivered or the amount or quality or date is not specified (i.e. fiat money, Euros, Dollars)

          So credit might be used as currency, but it will never qualify as money (from a scientific point of view).

          • RickDiMare

            Manuelgar, on a couple occasions I've been mocked online because I stated that under the U.S. Constitution only coined money (ANY metallic coined money) is the only thing that can truly discharge a debt–and that paper or electronic money, even though it can be declared legal tender "for" all debts, is not legal tender "in payment of" all debts, so paper or electronic money really can't discharge debts, it can only exchange debt for debt.

            One person said, "Why not make chickens money?," and another said, "How about manure?"

            My answer to both is that if the Constitution declared that either chickens or manure were money, then that's the only thing that would truly discharge a debt, and that any paper or electronic money in circulation would merely be evidence of the government's borrowing of chickens or manure from the total chickens or manure that were then currently circulating in the economy.

            Another comment I read online involved someone mocking the fact if money could be made of non-precious metals under the U.S. Constitution, then Congress could some day mint a $10,000 penny. My answer to that is, yes, Congress actually has that power under I:8:2 (assuming, of course it was politically viable at the time).

            Finally, there's nothing scientific about money. It's all "psycho-political" stuff, so many unscientific factors go into whether or not the public accepts it as valuable. Alan Greenspan once said that of all the economics he studied, the thing that prepared him most to be Chairman of the Federal Reserve was his prior experience in a jazz band.

          • Well, my opinion is that economic is a social science, which is much more complex than natural science, but is still science.

            The economic nature of money can´t be set by the constitution or any other law. Money is a natural and espontaneus evolution from barter, when the most liquid good became money. And even today the market is completely capable of rejecting any imposed legal tender, as it has done many times through history. And will do it again, I have no doubt.

            Fiat money or any political imposed money works as a medium of exchange because the market allows it to exist.

        • RickDiMare

          Hello Chuck,
          First, thanks for your feedback. I like to know when I'm not being clear.

          When you say "Treasury securities are not money, they are credit" I think you what you really mean is that they're not money in the sense that they can't be used in "transaction accounts." That's what I'm trying to say is the problem, i.e., that a growing number of people want to disengage from the Federal Reserve System, but can't do so because TreasuryDirect doesn't allow means by which someone can use its money in everyday "transaction accounts."

          Also, I think you're correct in saying Treasury securities "are credit" and "a future promise to pay," but that's true of all paper or electronic money.

          However, it's not true of current U.S. coin (regardless of metal type). Usually people, including libertarians, start throwing stuff at me when I say that only U.S. coined money can truly discharge a debt, but after the Civil War and Lincoln's experimentation with greenbacks, the Supreme Court ruled in the Legal Tender Cases (1871 & 1875) that Lincoln's issuance of TreasuryDirect paper money was a valid exercise of Congress' power under the Borrowing Clause (I:8:2), and that paper money was really "borrowed coin," i.e., a form of debt (but not the kind of debt that the fed'l gov't might owe to a private entity).

          Finally, same goes for me, I don't know if I fully answered you, but I'm trying to clarify, too.

          • Chuck Moulton

            United States Notes issued by the Treasury between 1862 and 1971 are very different from treasury securities. The former were currency. The latter is sovereign debt.

            United States Notes paid no interest. 100% reserves backed by United States Notes would similarly pay no interest; customers would have to pay banks a storage fee.

            Again, with 100% reserves you can have liquidity or interest, but not both. United States Notes have no set maturity, so you get liquidity sacrificing interest.

            If you want to have a reserve backing that pays interest and is immediately redeemable, you may suggest that government issue treasury securities that pay interest in a form like United States Notes that is a medium of exchange with no set maturity date.

            Logistics aside, you would be requiring the government to pay interest without receiving any corresponding benefit (certainty about the quantity of funds available to it). No corporation or individual would offer such terms in the free market. So to ask such a thing would be conceding that you can't have 100% reserves without government implicitly subsidizing such accounts.

    • RussNelson

      Parsimonious it may be, but I'm sure that the 100%er objection is that IF ONLY consumers understood that not only was their money being loaned out, but that if that loan remained in the bank, it would also be loaned out THEN they would object to that and ask for 100% reserves.

      Personally, I completely fail to understand why the 100%ers aren't 100% behind free banking. Central banking SURE ain't giving them what they want, is it??

  • ivanfoofoo

    George, another thing worth to mention out is the impact of interventions such as the Glass–Steagall Act. Did the market ever create that bank separation spontaneously?

  • I´ve watched Huerta de Soto´s classes on youtube, and in one of them he admits that since the "depositor" requires and/or accepts interest payments from the bank, then the depositor is acknoledging that he is in fact a lender, not a depositor.

    Isn´t fractional reserve just another instrument of credit? Maybe the Society´s propension for indebtness is the driver that allows fractional reserve and other forms of credit. Just as when usury was forbidden, fractional reserve was also considered a crime.

    Nice site and nice article. Congratulations.

    • Chuck Moulton


      If you run across that video again, please comment with a link to that particular video and list the minute/second mark where he makes that admission. I would be interested in viewing the video, but don't intend to wade through his whole library to find that gem.

      • Sorry about that. I was thinking about pasting the link while I was writing but I finally forgot.

        The objective of the video is to demonstrate that the current contract of deposit is impossible and illegitimate. I think he´s right in a stricttly legal sense. But, as he admits, the contract is a loan "de-facto". Here is the link, from minute 3:50 til the end:

        It´s in spanish. And he uses two funny examples, one is about a virgin given on custody and another one about a classical spanish scam.

    • Ash Navabi

      I don't understand Spanish, but from what I remember from the English translation of Huerta de Soto's book, he makes a clear distinction between interest bearing deposits (i.e., time deposits) and deposits which are charged a safekeeping fee (i.e. demand deposits). And from what I understand, the alleged fraud of fractional reserve banking occurs when those deposits that are supposed to be held in safekeeping are lent out. And indeed, it is this lending of demand deposits–which are supposed to be available immediately, but they obviously can't be if they're being lent out–that enables the 'intertemporal discoordination' which leads to the Austrian business cycle.

      I'm open to criticism, though.

      • That´s right. That´s his position in his book. But in his classes he admits that when the depositor accepts interest payment on his deposit, then he is allowing the bank´s fraud. How in the world is the bank suposed to pay the depositor if the bank is keeping depositor´s money in a safebox without lending it out? What kind of profit would the bank be doing?

        In this video, he admits that the depositor is as responsible as the banker on this fraud. (When the depositor receives interest payment).

        • George Selgin

          What can it possibly mean for someone to "allow" himself to be defrauded? Fraud requires deception. If someone knows that their "deposits" are being lent, in what sense is that person deceived?
          Here and elsewhere, the 100-percenters appear to endorse the concept of a victimless crime. The concept may be invoked readily enough by someone who doesn't pretend to be libertarian; but it is surely problematic for them.

          • It´s a pity the video is not in English.

            "What can it possibly mean for someone to "allow" himself to be defrauded? Fraud requires deception. If someone knows that their "deposits" are being lent, in what sense is that person deceived?…."

            This is exactly what Huerta says on this video. In fact he says that the depositor is in a way more responsible than the banker.

            The problem is when the depositor also pretends that his money is totally safe. As an example, the Argentinians received interests and they also rioted when they found out their money was not there. Depositor expectantions are impossible, and the bank knows it, but they both go ahead with their relationship.

          • George Selgin

            I see…a very postmodern take on fraud.

          • George Selgin

            More seriously: of course depositors are upset when their banks fail. But it is nonsense to suppoe that this implies that they thought that the bank's weren't taking risks with their money. The reasonable assumption is that they thought that the risks were low. Similarly, anyone will be upset if he or she looses a house to a flood or tornado or earthquake, but this doesn't prove that people who are upset by such events believed them to be impossible!

          • Martin Brock

            People upset by losses didn't think their risks were low. They thought their risks would pay off.

          • People are upset when they loose their house on an earthquake, yes, but they don´t riot to the architect´s office door, unless they think that the architect has a responsability. A lot of Nokia´s shareholders have lost more than 80%, and I don´t see them claiming in front of Nokia´s headquarters.

            De Soto´s main point is not fraud. That´s not true. De Soto´s point is that the deposit contract, as today is understood, is unstable no matter allowance from both sides. The same way he says that central planning is unstable, no matter allowance of all participants.

            But more importantly, I don´t see how this point is necessarily an argument against fractional reserve, because FR could be perfectly estructured with loan contracts.

          • Martin Brock

            In my neck of the woods, depositors at failed banks don't riot either. They lobby politicians for bailouts. People losing their houses in earthquakes do the same thing.

          • IkeRenner

            If this is a 'post-modern' take on fraud, what then should we call it? I would still argue that fraud is a partially relevant term. Without a basic understanding of economics or calculus, Average Joe doesn't know where that interest is coming from. Manna, maybe? And what about his neighbor who deposits in the same bank? Do people think in terms of 'systems'? How many people could tell you what a 'systemic risk' is? Would it be more appropriate to call these people 'blindly complicit' in a greater fraud, due to ignorance and effective marketing? And when everyone else around you is getting interest on their bank account, you can't simply pass up such an amazing deal, heh? While I agree with De Soto's premise that the depositors are at fault as well, without some enlightenment, that's simply academic.

            First time poster, and I gotta say, you guys are a hoot. Smart comments!

        • RickDiMare

          Manuelgar says: "… expectantions are impossible, and the [parties] know it, but they both go ahead with their relationship [anyway]" …. sounds like the typical marriage ….

      • RalphMusgrave

        The question as to whether fraud is involved is in a sense irrelevant (as at least one other commentator here has suggested). That is, the important question is whether society as a whole benefits from Fractional Reserve. If there is some element in FR which makes it illegal according to law of any particular country, then that law needs modifying. De Soto makes a big thing about fraud, and to that extent his argument is weak.

    • As a career banker (meh…) I've always understood this to be the case, but don't see it as a fraud as I believe nearly all customers understand the 3-6-3 model of banking. We pay the customer 3% to borrow their money. Then we lend it out at 6%. Then we arrive at the golf course for our 3pm tee time. Whether a depositor ruminates on this fact or not is irrelevant, the simple fact that a bank would pay anyone to safekeep their money is totally counterintuitive. Therefore, it would make sense that in any 100% reserve operation a true "depositor" would be paying the bank for safekeeping services.

      The only thing that conflates this fact is the FDIC's backstop for bank customers. It makes it seem as though their money is indeed being safekept (if not actually being kept in a safe).

  • George Selgin

    Thanks for your comment, Manuelgar. When I read Huerta de Soto, I am always both impressed by his erudition and amazed by the conclusions he draws from it–conclusions that always seem to me to be utterly at odds with the facts he musters!

    • Well, regarding 100% versus free banking, I think his official conclusions are mainly legal more than economic. He´s done an amazing job on that legal side, a great weapon to fight unsound banking and unsound currencies, even from the free banking front.

      For example, I think that for a free fractional reserve banking a crystal clear distinction between loan and deposit should still be made. It wouldn´t be fair that depositors live their lives as they are depositors when in fact they are creditors.

      • He reaches his position on full reserve banking both from a legal perspective (fraud) and from an economic perspective (macroeconomic instability). It has been a while since I've read de Soto's book on the subject, but if I remember correctly he makes a fairly large error in mistaking demand for money with demand for loanable funds when critiquing free banking theory.

      • George Selgin

        On this very topic I think Heurta de Soto reaches particularly untenable conclusions. "Depositors" of loose coin knew perfectly well that they were giving bankers the right to lend the coin unless they made specific declarations to the contrary. The law has been perfectly clear on the matter for as far back as can be gathered. If one wanted a 100-percent reserve arrangement, one had only to seal the coins in a bag.

        • I´m not Huerta "supporter" and I don´t support either 100% reserve, but I must disagree with you. The law is not clear on the deposit contract, the fraud begins at the very first moment when a loan is called deposit, and it is even more flagrant if we are talking about a deposit on demand.

          Not all the people are experts on the very complex world of money and banking and its legal issues, people is specialised on their own jobs and business. There´s a lot of people that think that their money is being safekeepd at their banks.

          • George Selgin

            The law has been clear; and the meaning of a bank "deposit" has been understood by the vast majority of persons, and certified by the common law courts, whose job it it to assess meanings as understood in the business community. The fact that occasionally someone manages to be ignorant about either–and of course people manage to be ignorant about all sorts of things–doesn't alter the law, or justify calling bankers criminals.

            Personally I have no sympathy for anyone who manages to believe that a bank "stores" their money and offers payments services in connection with that "storage" yet doesn't charge fees and perhaps even pays interest on the "deposited" amounts. One doesn't have to be an expert on banking to understand that such a belief is unreasonable.

          • I agree with your las paragraph, and that video shows that Huerta De Soto also agrees with that.

            But I disagree about the law. Anyway, for me is more interesting the economic fact than the legislation.

            Nevertheless, It´s an honor you reply my comments considering your knowledge. I´ll keep thinking about it.

            I throw another idea to this discussion. Isn´t Fractional Reserve oposed to capitalism? If the shareholder equity is a small porcentage of the balance sheet, what is the incentive to look after the whole assets & liabilities? Don´t we have here some kind of tragedy of the commons?

          • George Selgin

            It is crucial that a distinction be made–as it has been made at considerable length by Hayek and Bruno Leoni, among others–between "law," and the common law in particular, and "legislation." The common law in general, and in regard to the meaning of bank "deposits" in particular, did not simply uphold or gratify the wishes of bankers as against those of their customers. It sought to establish the nature of already established and accepted business conventions. The judges involved, in other words, weren't engaged in legislative fiat. They were determining what was just with resepct to the voluntary contractual undertakings over which their courts presided. Thus when Heurta de Soto, who is too much the scholar to overlook the facts, admits the common law to have treated deposits as I have indicated, but then simply dismisses this treatment as an "error," he begs the question, for he cannot imagine himself better placed than the judges at the time such decicions were reached (and they go back to times long preceding the actual advent of FR banking) to judge what sort of understandings were at play when bankers took coins on "deposit." Nor does his resort to the etymology of "deposits" serve as he pretends to settle the matter, for it suffices to recognize that words take on new meanings over time, instead of remaining forever anchored to one "original" meaning, and that the common law courts take the meaning of words, like all else, to be that consistent with the current understanding of the time.

        • suo Marte

          Dr. Selgin: first, it's a privilege (!!!) and I've been interested in your POV re: Huerta de Soto's objection to FRB because it is a fundamental source of financial instability from the moment I started reading his book "Money, Bank Credit and Economic Cycles." In essence: is Huerta de Soto wrong on this point?

          A recent Economist article says the first job of capital is to absorb losses and its second job is to "restrain bankers' instinct for gambling…" Do you agree these are the two primary reasons banks are required to hold reserves?

          If you don't agree w/ full reserves, what % is enough?

          Do you agree more reserves = slower growth?

          The same Economist article says the Basel Committee and the BIS believe each % of additional reserves above 7% reduces economic growth by 0.03% per year but this "damage" disappears over time. The NY FRB says growth slows by 0.09% for each % of extra reserves. And (of course) the IIF ("a club of banks") believes the impact on economic growth is 10 times bigger.

          Is slower but sustainable growth "better" than the faster but unsustainable (AKA "junkie growth") we experience today?

          According to another Economist article (I believe from 2009), the average US commercial bank held 25% reserves (per the National Banking Act) prior to creation of the Federal Reserve in 1913. This article suggested the 2008 meltdown could have been avoided had US commercial AND investment banks held just 20% fractional reserves. Your POV on this, please.

          ps – I'm a big fan of your work.

          • George Selgin

            Thanks for your kind remarks, Marte.

            Let's be clear about the difference between a bank's reserves and its capital. My difference with Huerta de Soto and other Rothbardian's concerns their objections to fractional reserves; besides not believing that fractional-reserve banking has ever (except in the cases of the public banks I mention here) been conducted fraudulently, I deny the claim that it is inconsistent with free competition in banking. Scottish and other free banking experiences show on the contrary that banks left unhampered by government edicts can manage with very slim cash reserves. On the other hand, Scottish and other free banks held plenty of capital, which is the equity cushion that absorbs losses from bad loans and such, and so protects the banks' creditors from suffering similar losses. A bank can operate with slim reserves (an item on the asset side of its balance sheet), yet it may have plenty of capital (and item on the other side of the balance sheet). Capital depends on the total realizable value of a banks assets, rather than on its cash position alone.

            And, yes, I do believe that forcing banks to hold more reserves makes them contribute less to economic growth, for it impinges on their ability to invest scarce savings productively. Apart from studies like those you refer to, and some excellend work by economic historians (especiually Rondo Cameron and his associates, who published a of revealing studies in two books published in 1967 and 1972 (I believe), I highly recommend a careful reading of Adam Smith's discussion of money and banking, which is the classic account of how fractional reserve banks promote economic development.

          • suo Marte

            Thanks Dr. Selgin for your reply.

            To be clear, bank reserves are based on BOTH assets and liabilities; maturity analysis determines the liquidity of these reserves. In other words, I do understand the difference between “cash reserves” to pay demand deposit withdrawals and “capital” to cover losses on loans banks extend as part of their financial intermediation function. The Economist articles only identify total capital reserves, not just cash; I simply used the magazine’s terminology.

            If your point is fractional-reserve banking has historically been conducted fraudulently in only some and not all cases (“except in the cases of the public banks I mention here”) then you are (IMHO) conceding Huerta de Soto’s point. Are you suggesting Huerta de Soto is wrong about fraud simply because it has not been universally perpetrated? Huerta de Soto clearly says in “Money, Bank Credit, and Economic Cycles” that not all demand depositors are ignorant of the fact that their money is subsequently loaned by banks, as part of their financial intermediation function, to others in a FRB system.

            IMHO the key point is financial instability; NOT “fraud” although I recognize “fraud” is the argument Huerta de Soto uses for changing the law to require banks to carry 100% reserves against demand deposits. In other words, whether or not FRB is fraudulent is a red herring debate.

            A great scholar wrote in his article “Are Banking Crises Free-Market Phenomena” in the Fall 1994 issue of Critical Review (pg 592): “If banks held 100 percent reserves, they could redeem all their liabilities at once if they had to w/o precipitating a crisis. A 100-percent reserve banking crisis is an impossibility.” Next this scholar says the claim that FRB is inherently unstable is of “doubtful validity” but then does not demonstrate why. Can you please tell me WHY FRB is not inherently unstable?

            And while I greatly respect Adam Smith not all of his advice re: money & banking was correct. The so-called “real bills doctrine (RBD)” comes directly from “Wealth of Nations” and many have proven it false (Thornton & Mises to name just two). They argued it’s wrong to believe the requirements of business rigidly limit the maximum amount of convertible banknotes that a bank can issue because “the supply of fiduciary media largely creates its own demand.” And this fallacy gets to the heart of what Huerta de Soto calls the “chief failing” of your monetary equilibrium theory. Does the supply of fiduciary media create its own demand, Yes or No?


          • suo Marte

            To be extra clear: I meant to say the phrase "Real Bills Doctrine" comes from Wealth of Nations NOT that Smith 'invented' it.

            Also, I believe the argument is FRB does "NOT promote economic development" in the long run because it distorts the relative prices throughout the productive structure of the real economy which in turn results in the misallocation of scarce resources.

            Finally, I'm not a "Rothbardian" – IMHO, Rothbard's attack on Adam Smith was a disgrace.

  • I was a supporter of 100% gold banking until I read The Denationalisation of Money. As a numismatist, I knew many examples that Hayek and Rothbard did not. They support the open banking model. Also, as Hayek pointed out, it is not so much that the open system impels to 100% backing in commodity, but that the open market is unpredictable as to form. We imagine from our statist perspectives though we do find historical precedents. Until banking is as unregulated as computing, we have no way to know what forms it can take.

  • Don Boudreaux of GMU sent me over. Excellemt post!

  • Local history guy here. I've read reminiscences about banking in the 1830s in Michigan. Would we call that free banking? I suppose not, because there are stories of people hauling specie by wagon from bank to bank, ahead of the state bank examiners, re-using the same specie over and over to satisfy the examiners in one bank after another. So I suppose there was some kind of reserve requirement.

    I must confess that until I came across this blog by way of Cafe Hayek that I did not know there is such a thing as a modern free banking movement. So are you saying the state bank situation in the 1830s would have been better without any reserve requirements at all?

    If that is too naive a question to be asking here, please ignore. I did appreciate reading about the origins of banking in Italy, the Netherlands, etc. I've often wished I better understood how banking worked from Hamilton through Jackson, but can't say I have yet put much effort into it.

    • George Selgin

      Spokesrider, those old stories about shifting bags of specie and wildcats are mostly myths (economic historians examined the evidence carefully in the 70s and found few instances of actual fraud). Still, we modern free bankers don't view antebellum U.S. "free banking" arrangements like Michigan's as representing genuinely free banking. For one thing, they prohibited branch banking; for another, they forced banks to back their notes with specified bonds, including state government bonds. It was, in fact, the depreciation of these compulsory assets that was responsible for most failures of U.S. "free" banks, including the first-round Michigan free banks (Michigan actually passed two "free banking" laws.)

      19th-century Canada and Scotland before 1845 are better (tough not perfect) examples of banking systems representing what modern free banking advocates have in mind.

      • Do you have a cite or a few clues to get me started in looking for articles about the wildcat myths in Michigan? I probably have access to most journals of economic history. I can try keywords like wildcat and banks, but if you have better ideas I'm glad to hear them!

        I must confess that I know nothing about banking in Canada prior to 1845, but now you've got me curious about that, too, especially if there are any specifics involving Upper Canada. I've lately gotten slightly interested in comparisons of the treatment of public land sales in Canada and the U.S., and also of the regulation of mills and mill sites (which is also about public land sales). Ever since those days people have argued about the role of "speculators", variously defined.

  • Izzy

    I do not really get the whole debate between free bankers and 100% reservers. It only makes sense to me that in a whole where the government is not regulating the money supply, via by policy or by central bank, that the market would better determine which banking system is more preferred

  • Ash Navabi

    I'm a little confused about a couple of your points:

    "For starters, in establishing the Bank of Amsterdam in 1609, the Dutch government also banned the city’s private “proto-bankers”—the analogues of Venice’s medieval money changers and London’s 17th-century goldsmiths—essentially giving the public bank a monopoly of non-coin payment services."
    Can you clarify what you mean by 'proto-bankers'? Are they, in effect, those practicing fractional reserve banking? And do you know if anyone else was able to (either legally or practically) open another supposed full-reserve bank?

    "Finally, rather than being true demand deposits, readily convertible into coin at no penalty, deposits at the Wisselbank could be converted into cash only for fees of up to 2.5% of withdrawn amounts, thus allowing it to cover its expenses while also earning a tidy profit without having to make any loans."
    Do you know if the Bank was also charging monthly/annual/whatever fees for safekeeping, in addition to the transaction fee? Because if not, it seems like a legitimate charge.

    • George Selgin

      Not much is known about the proto-bbankers in Amsterdam, but most likely they were money-changers who had begun taking coin on deposit and offering payments services. To judge from other cases we know more about–the Venetian private bankers and the London goldsmiths, they almost certainly did not keep 100 percent reserves. As a general rule, if loose coin was "deposited," it was considered the recipient's property, and payment transfers inevitiable lead to overdrafts and such.

      The Wisselbank's redemption fees alone amounted to a very heavy "storage" cost. Today gold storage firms charge about 1% annually. Yet most Wisselbank deposits were left for less than a year–sometimes much less. The Wisselbank, in short, as one of my sources puts it, "was an expensive place to park precious metal."

  • Rocco Stanzione

    I'm still hashing through literature and debates on this question, but I have to say this isn't my favorite kind of argument for any position in economics. Every historical example you can find will be tainted by complicating factors the relevance of which can only be agreed on by people who agree with the conclusion because they share the same biases and use the same theoretical framework to try to quantify the relevance of the known factors.

    • George Selgin

      Rocco, your argument suggests that we cannot draw any conclusions from the empirical record. But as economics doesn't allow one to conduct laboratory experiments, history offers the sole basis for judging the validity of theories and arguments that involve explicit or implicit claims about likely outcomes of some regime change. Of course it is no easy matter to make generalizations from experience, and there is much room for either unconscious or deliberate twisting of the facts. But economic history nonetheless remains crucial. And though I agree that some persons can never be persuaded to change their beliefs by any amount of evidence, I believe those people to be equally immune to theoretical arguments, whereas I think others can and do change their minds when confronted by an abundance of evidence contradicting their priors.

  • BillWoolsey

    Nice article.

    The first "story of banking" that I learned was that goldsmiths were storing coin for a fee and then secretely began lending out the funds.

    That there had been an intertional banking system based upon fractional reserves for centuries before and that it had been banned by the government in the early modern period is something I only learned much later.

    How closely does the shift in policy match the development of merchantilism and, in particular, bullionism?

    If gold is the wealth of nations, what does fractional reserve banking do to national wealth? Instead of your subjects carrying about sacks of gold, they have..what… marks on the account books of Italian money changers? National impoverishment.

    And what of the theory that while bullion isn't the wealth of a nation really, it does represent what the king needs to hire those swiss mercenaries. How much gold can be grabbed when whatever exists is in the hands of a bunch of foreigners who may ship it home at the first sign of trouble?

    Oh, the merchants don't want to carry about chests of gold? Hey, let them store it at a government operated bank. It will be safe. Safe, but for whom?

    In England, I thought the story was banking Italian money changers, then storage with the Royal Treasury, then goldsmith storage, and then banking yet again. No?

    Finally, I strongly agree that the entire "storage" theory of banking seems more plausible if you start with the assumption of a uniform currency. With banking really developing out of the money changing business, when there was nothing like a uniform currency (and really, a variety of coins of multilple metals) the point is much more likely to get back different coins of equivalent value. Further, the place where all of this develops had the accounting or ghost monies. These considerations don't make storage contracts impossible–just not very plausible. The depositor sells these coins today to the money changer, in exchange for being able to buy yet to be determined coins at some undetermined time in the future. Makes sense in a way that is much less plausible when storing coins at the local goldsmith.

    • George Selgin

      Hi Bill–glad to see you here. Concerning the goldsmiths, the usual story appears to be a myth. See my SSRN paper, Those Dishonest Goldsmiths

  • RickDiMare

    Does anyone have an opinion about the relationship between income taxes and the regulation of currencies? How do certain taxes serve to maintain the stability of a currency?

    Some arguments I've heard so far is that end-user taxes assure that money gets to the right places in the right amounts, that a coercive factor is necessary to impart a sense of value to a fiat currency, that it assures indebtedness to the central bank will be paid, etc.

    I think this issue is relevant to our discussion because I've found that many people who object to fractional reserve banking may (perhaps unconsciously) really be objecting to the fact that a coercive, intrusive regulatory income tax supports the practice.

    • RalphMusgrave

      I think the fact that taxes must be paid in the state’s money (else you go to prison) certainly gives the state’s money considerable clout. It gives it an edge over any rival forms of money. But the “taxes give money it’s value” idea does not entirely explain why money has value. Money arises simply because it is a big improvement on barter (other than in ultra simple economies). That is, in addition to the “taxes give money it’s value” factor, money also has value because it’s useful stuff.

      Relevant literature: 1. George Friedrich Knapp wrote a book entitled “The State Theory of Money”. 2. Advocates of “Modern Monetary Theory” tend to be hooked on the “state’s money” idea. E.g. see Warren Mosler’s site:

      • RickDiMare

        Thanks, Ralph. I read a little of Knapp's book, and understood even less, but he seems to concur with my belief that the important thing about money is not what it's made of, as "the metallists" believed, but whether the money can legally discharge debts (and thereby, in my view, free us from endlessly shuffling debt around, which keeps us beholden to the central bank).

        In other words, as I tried to say earlier, there's a big difference between using paper or electronic money that is "legal tender FOR all debts public and private" vs. money that is "legal tender IN PAYMENT OF all debts public and private." The only U.S. paper money I presently know about that could discharge debts in the U.S. was something called "Treasury Coin Notes," which I think were briefly issued after the Civil War. Current U.S. coin always discharges debts (regardless of metal type), but it would be absurd to try to use it in everyday transactions.

        If anyone is interested in Knapp's book, here's the link I found on Wikipedia:

  • David Johnson

    I simply do not see any fraud with fractional reserve banking. Banknotes are not masquerading as warehouse receipts, depositors are fully aware their deposits are being lent out, they gladly accept the interest paid, etc. Anyone who has ever watched It's A Wonderful Life knows the basics of banking. Can a bank go wild and start inflating (dropping their reserves lower than the demand for money would suggest)? Sure they could, but the only damage would be to the depositors and note holders of that bank. If you don't like it you take your business elsewhere. Problem solved.

    Is it possible that there could be a bank run, and you happen to be a slow sprinter and so not withdraw your deposits in time? Sure. That *may* be breach of contract if the bank was so silly as to specify 100% instant demand deposits, but it's still not fraud. People make promises all the time that the vagaries of live might prevent them from keeping. A repairman who says he will arrive at 4:00 but gets stuck in traffic, for example.

    It's time to put the fraud argument behind us.

    • The fraud consists of first, accepting money from depositors, second promising to return the exact sum deposited, and third lending on or investing that money in ways that are less than 100% safe. That works nine years out of ten. But as should be obvious, it goes wrong every now and then.

      The reality is that banks make a series of silly loans from time to time. Small banks go bust at the rate of about one a week in the US. Northern Rock went bust. Banks in Cyprus went bust. Banks went bust in the 1930s, and for all I know in the 1830s as well. Do I need to go on?

      In short, the basic promise made by banks to depositors is fraudulent.

      • George Selgin

        By means of the same logic, Ralph, you might argue that any debt contract is fraudulent, so long as there is some risk of nonpayment.

        And yes, a bank demand deposit contract is itself a debt contract, not matter how often Rothbardians deny it. The proof has been offered on these pages and elsewhere too many times to rehearse yet again.

        • Interesting point about “any debt contract”. My answer is thus.

          People who hold money or what purports to be money (dollar bills or money in a bank) want an asset which is guaranteed to hold its value in terms of dollars. And I can see value in people being able to do that, so the state should enforce a contract in which an asset is guaranteed to hold such value. Moreover, there is a 100% sure way of making that guarantee good: don’t do anything the slightest bit risky with the money (e.g. lodge it at the central bank).

          In fact advocates of full reserve, like Laurence Kotlikoff, advocate just that: i.e. where a depositor wants the above 100% certainty, the relevant bank is barred from taking any risk whatever with the money. That gets rid of the fraud element: claiming to be able to pay 100 cents in the dollar when you sometimes cannot.

          In contrast there are other debt contracts (e.g. trade debts or bonds issued by General Motors). In that case creditors are well aware they may not get 100 cents in the dollar. And the relevant contracts often specify what happens if the debtor cannot pay in full. So there is no fraud there.

  • Ballzo

    Wow, talk about missing the point, and more than once! I'll just highlight a few:

    1) The fact that banks go bust was never the issue. All lending institutions will eventually go bust. That's how the market works. The question is whether deposits are held in bailment so savings aren't obliterated when the bank decides to 'lend' money to their cronies.

    2) Criticizing the government for not allowing people to misappropriate money in Amsterdam is kinda missing the point, isn't it? It's not like Scotland had this problem. If your deposits are guaranteed bu fiat in Amsterdam, why would any private banks try to compete? Do you think they could offer better rates?

    3) The existence of thieves in the absence of enforcing anti-embezzlement laws doesn't make the case that embezzlement is good, proper, or a stable state of affairs. You may make the case that an unadulterated market would favor fractional reserve banking, but any bank which implies a demand deposit can be withdrawn any time a customer wants (which they all do) has to constitute a fraud of some kind. Certainly the rate at which banks fail would also be taken into consideration. You may not consider fractional reserve banks as more likely to fail, but even if they do and deposits are held in cash, WHO CARES?

    4) The mere fact that people treat their demand deposits as cash creates a situation where more fiduciary media is chasing the same capital. If I defer consumption of lumber for my patio so that a company can use it to build a factory, I should not have that cash on demand. Period. This creates the temporal unbalance known as the business cycle. The only way to have a harmonious relationship with present and future demands is to admit we have limited capital for use at any point in time and to enforce such limits via property laws. The legal fiction of a demand deposit loan flies in the face of reason!

    • George Selgin

      Balzo, like Rothbard and many of his followers, you don't understand the difference between a demand deposit and a bailment. As I and others have gone to great lengths to explain this difference and to point out the many reasons why it ought to have been been perfectly clear to any reasonably intelligent bank customer, in early modern times or later, let alone to any economist, there's no point in my further addressing the matter again here in reply to your particular comment.

      • Ballzo

        LOL, then why the hell did you even reply?

        I'm well aware of the technocratic difference you're trying to make. Are you aware that calling a demand deposit a strawberry fruitcake doesn't change the effects? Also, since when has a 'bailment' outside of a security deposit box ever been available?

        Poor show.