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Rothbard's Vigilantes

Over at Cafe Hayek, some comments made concerning my last Free Banking post suggest that Murray Rothbard, though opposed in principle to fractional-reserve banking, did not wish to see it prohibited.  That's not really correct.  As I pointed out there:

"Actually in arguing that FR banking was fraudulent, Rothbard could hardly escape implying that the polizei, or some anarcholibertarian equivalent, ought to shut it down.  And he certainly did argue for setting up "anti-bank vigilante squads" charged with organizing runs and otherwise making life impossible or at least miserable for such bankers.  I always wondered about this: if Rothbard believed people were being systematically duped, then wouldn't just informing them suffice to make them run on their banks–why speak of "squads"?  And then wouldn't it make still more sense to organize, not "anti-vigilante" squads, but rather 100-percent banks that could thrive on the money withdrawn from the FR banks whose fraud was being revealed?  Finally, if that would be a good idea, why hadn't any of those excellent entrepreneurs Rothbard and other Austrians are always telling us about ever figured it out?  (Please don't answer by appealing to deposit insurance: before 1967, only one country had it; and before 1934 none did.  That leaves plenty of time in which the entrepreneurs might have made hay.)"

Larry White and I had already pointed out this tension between the "fractional-reserve-banking-as-persistent-fraud" argument and the Austrian theory of entrepreneurship, which treats the latter as serving to systematically spot and exploit profit opportunities, in our 1996 Review of Austrian Economics article, "In Defense of Fiduciary Media."

  • Perfect!

  • Jason Treit

    As we speak, the 'bard passes eternity in a limbo of resources waiting to be used. He thinks it's heaven, though.

    What stuns me most about Rothbard's conceit against fractional reserves is not how much evidence he ignored. It's how far, even if it meant pulling up the roots of his philosophy, he was willing to carry that conceit. I wonder sometimes if he even had a sketch in his mind of how a modern economy transacted in bailments would work. Refusing to let exchange media count unrealized gains or test frontiers outside the walls of cast-iron vaults means credit never enters an economy at scale. No credit, no capital formation. No capital formation, no capitalism. Yet Rothbard couldn't bear to trace that logic, because he couldn't get past the first step: acknowledging what worth resides in other human beings.

  • Has there been any work on free banking theory that argues in favor of the ideas advanced by Mises in Human Action? That is, theory that supports the idea that the circulation of fiduciary media would be incredibly limited.

    • George Selgin

      I'm not aware of such work, Jon. As you know, my own theory suggests that free bank issues would be "limited" in the very important sense that they would not proceed unless supported by prior excess real demand for bank money. But that doesn't mean that reserve ratios would be high: in fact, depending on the scale of activity, they can be very low. I draw on conventional precautionary demand theory to reach these conclusions. The Misesian claim, tiresomely repeated on the blogosphere, that genuinely free banking would ultimately suppress fractional reserves, or make for extremely high ratios, is so far as I'm aware just as utterly unsupported by any theoretical demonstrations as it is inconsistent with the known facts of experience.

      • Thanks. Yea, I mostly had in mind the notion (repeated by Salerno in his Mises article on Mises, fiduciary media, and free banking) that banks would reduce their reserves of outside money as demand for it fell. Otherwise, I think Mises' views on fiduciary media are mostly compatible with yours, even if your (and by "you" I mean all the economists responsible for developing free banking theory) theory is more complete.

  • RickDiMare

    George, doesn’t is all boil down to the fact that depositors (of all political persuasions) feel “defrauded” if, after establishing a relationship with a bank, they later discover that their consent to the relationship has not been fully informed?

    Most banks simply require a depositor’s signature on a small card to establish the relationship, which signature the depositor later learns has subjected him/her to volumes of incomprehensible regulations, the great majority of which favor the banking system.

    So, for example, after the relationship is established, depositors may feel “defrauded” if they learn that, collectively, fractional reserve banking is withdrawing enormous discretionary economic power away from Congress and giving it to private bankers, and that the scale and extent of this transfer of power has not been explained to them. Or, that the bank considers their hard-earned wages to be debt or a loan to the bank, not as the depositor’s property, but as income derived from the privilege of using the central bank’s “elastic” currency. Or, that they have not been presented with any reasonable, affordable way of modifying the legal relationship with the bank. … Etc.

    In short, to prevent feelings of being deceived, I think depositors (a good percentage, anyway) need several options, even as to choice of currency, and full disclosure, and they want periodic explanations and updates in direct, plain-English terms.

    • BillWoolsey


      I have been teaching economics for decades. I ask all the time how many students believe that there bank is storing their money. It is close to no one. Just about everyone understands that banks are financial intermediaries. The money people put into banks is lent out to other people.

      You seem to be balling this up with their failure to understand that the unintended consequence of this process is the creation of money. And further, what look to be confused notions about the role of the Federal Reserve in all of this.

      I certainly don't believe that contractual relationships between banks and their customers interfere with anything that should be under the purview of the U.S. Congress.

      • RickDiMare

        Bill, I doubt if your students understand that "their money" is really not theirs, but representative of central bank debt (not sovereign debt, I would argue). And, I'm not saying we should force banks to conform to full-reserve standards, but rather that depositors should be given a choice to maintain their accounts in TreasuryDirect currencies (which is actually a Constitutional right), likely with reasonable additional bank fees if they want to use the bank strictly as a storage facility.

        Also, people generally understand that money "put into banks is lent out to other people," but many feel defrauded or deceived when they discover the scope and extent to which fractional reserve banking expands and projects the lending, and the extent to which it withdraws discretionary economic power from their representatives in Congress. As a hypothetical, most depositors will look at the 6% interest a bank might get for mortgage lending, then assume the 1% they're getting in interest leaves the bank with a generous profit of 5%, and that's the extent of the lending's effects. Of course, fractional-reservers know otherwise.

        Finally, Congress and the Treasury Department have no choice under the Constitution but to take notice of any contractual relationship that adversely affects the money supply. As I've said often, Congress has an exclusive duty "to coin money" under I:8:5, and, after the Civil War and Lincoln's experimentation with greenbacks, a non-exclusive right to borrow coined money in the form or paper (today, include electronic) money under the Borrowing Clause (I:8:2) and the Legal Tender Cases (1871 &1875). It is under the latter power "to borrow money," not the former "to coin money," that Congress chartered the Fed (and hopefully someday will allow free banking charters).

    • George Selgin

      Rick, you insist upon the premise that the "discretionary economic power" to engage in financial intermediation by exchanging notes or other IOUs for coins rightfully belongs to the government, and so when exercised by private firms must have been usurped by them. Well, that argument has a distinctly medieval ring to it–one that resonates along with the notion of "sovereign prerogatives," like that of debasing the coinage. But don't you see, the U.S. was founded by people who were dispensing with all that medieval stuff, and who therefore recognized that rights fundamentally belonged to the people, unless expressly delegated by them (according to the admittedly strained logic of constitutional ratification) to Congress or to local governments. And as for your claim that banks are "privileged" to use the Fed's "elastic" currency, give me a break: the inelasticity of the pre-Fed National Banking System was due to the original National Banking law (aimed at funding the Union government's debt) tying banknote issues to the stock of government bonds (or taxing notes altogether out of existence in the case of state banks). You might as well argue that American slaves enjoyed the "privilege" of living in shacks provided by their masters.

  • RickDiMare

    George, we need to distinguish between 2 kinds of debt. For lack of better terms, I call "central bank debt" that debt owed to the Federal Reserve, and "sovereign debt" that which Congress incurs when it exercises its TreasuryDirect powers to issue paper or electronic money under the Borrowing Clause and Legal Tender Cases mentioned earlier.

    I'm not saying private firms are "usurp[ing]" monetary powers, but yes, I am saying that under the Constitution, all money creation power ultimately "rightfully belongs to the government," so the U.S. gov't has power to both incur sovereign debt and charter a quasi-public, privately-owned central bank to incur its own debt.

    Don't shoot the messenger. I'm just giving you my unofficial legal opinion of how prior Supreme Courts have reasoned around various Constitutional phrases and powers.

    I know it sounds bizarre to speak of the amorphous federal gov't as "sovereign," but that's why I said in a earlier post that the U.S. Constitution creates an entirely new, fully-public currency that may be incompatible with all other currencies. Historically, "sovereign" referred to kings, czars, kaisers, popes, etc., but the U.S. Constitution creates a fully-public sovereign. In effect, for better or worse, the framers created a people-owned corporation and then embedded a money-creation power within that public corporate-like entity.

    Also, I'm not using the word "privilege" in the sense you're using the word, nor did I mean to imply that banks are the recipients of the privilege for which they should be grateful. I mean "privilege" in the sense that it binds the user of the Fed's currency to regulatory taxation under the Commerce Clause, a regulatory tax that prevents the kind of hyper-inflation that occurred in Germany in the 1930's. So, when I say "elasticity," I'm referring to the privilege or benefit that (usually unconscious, monetarily-negligent) users of Federal Reserve notes exercise, and for which they must pay.

    • George Selgin

      No Sir: The Constitution gives Congress the right "to coin money," that is, to mint coins. It does not give it the right to every sort of "money creation." Nor has it been interpreted as so doing, or else banks could not manage demand deposits. A bank note, let's remember, is a convertable bank IOU, much like a deposit credit. It is a complete fantasy that Congress was expressly given a monopoly of paper currency by the Constitution. It is fine to argue with me fine points of the matter, but not so to declare that the document includes provisions that simply are not there.

      As for hyperinflation: do you seriously mean to suggest that it is the private banking sector that must be "taxed" by regulations to prevent such? Do you not recognize that it was the German central bank of the time, and not Germany's commercial banks, that caused the Reichsmark to collapse? Do you imagine that a hyperinflation today could occur in any manner other than thanks to aggressive expansive of the Fed's balance sheet? If so, there is a gap between our understanding that I dare say no amount of blog commentary will fill!

      • RickDiMare

        George, I think we're misunderstanding each other because we're looking at the banking system from very different perspectives. You seem to be looking at from the top down, and I'm looking up at it from the workers at the bottom. When I talk about end-user regulatory taxes, I'm talking about the tax on the consumer/depositor, not "the private banking sector that must be 'taxed' by regulations," so sorry if I wasn't clear about that.

        Also, I didn't say "Congress was expressly given a monopoly of paper currency by the Constitution." The monopoly is on the coining power. However, in a sense Congress does have control over the entire monetary system through its power to grant legal tender status, either to the notes it issues itself or to those issued by its chartered bank(s).

  • BillWoolsey


    At best, your arguments would suggest the need for a Constitutional amendment. But really, reading the power to coin money and determine its value as an obligation to outlaw anything else that private parties choose to use as a medium of exchange is a strained reading.

    My reading is that Congress has to power to make coins and determine the metalic content of those coins as it sees fit. For example, it can coin $10 gold coins, and with each minting, increase or decrease the weight of gold in the coins. In other words, Congress has the nonexclusive right to coin money, and it can debase its coins as it sees fit.

    I don't think the consequences of fractional reserve banking are bad at all. Banks restrained by redeemability are limited to issue what people want to hold. Any "problem" created by fractional reserves is due to the failure of irredeemable base money to do the same–adjust in quantity to match the demand. If the the supply of base money is inelastic, whether due to nature or polical obstinancy, then changes in the demand for base money, including due to the introduction of substitute media of exchange, results in changes in its purchasing power and so the general level of prices.

    If people want to use toyotas rather than GMs, then GM should produce fewer cars. There may be an oversupply of cars, but the problem isn't that Toyota is comitting a crime by counterfeiting "cars." Well, as long as they don't say GM on them. Just because you can drive the Toyotas too, doesn't make them counterfeit.

    By the way, any appearance that the Federal Reserve System is "private" is an illusion. There may be better ways to organize a monetary authority, but increasing the direct role of Congress in monetary affairs is likely to make a bad system worse.

    • nanute

      "There may be better ways to organize a monetary authority, but increasing the direct role of Congress in monetary affairs is likely to make a bad system worse." I'm in complete agreement. Unfortunately, we just might see this play out in the near future. My question is: how could a better organized monetary authority come about without Congress?

  • RickDiMare

    Bill, I don't mean to imply that Congress' coining power is "an obligation to outlaw anything else that private parties choose as a medium of exchange." Of course, parties are always free to develop bartering systems, but they wouldn't have the right to declare what is "legal tender," either "FOR all debts public and private," or "IN PAYMENT OF all debts public and private."

    Yes, Congress has great latitude in both selecting metal type for coinage and to "regulate the value thereof."

    I agree that fractional reserve banking is not necessarily a bad thing, but people have a right to object by various legal and political means if they think the practice is being abused, and now seems to be one of them. There are times when "the people" seem to give fractional-reservers a blank check, and other times they want more transparency, which means giving more power to Congress. Also, I don't believe giving power back to Congress necessarily means banks will be "restrained by redeemability." Economic priorities may change, but any power the Fed (Congress' "subsidiary") has to expand the money supply is also possessed by Congress (the Fed's parent).

    Finally, I sometimes have the same concerns about "increasing the direct role of Congress," but as people become more aware of how the monetary system works, they should also start sending more astute reps to Congress.

  • BillWoolsey

    My reading of the U.S. Constitution suggests that states determine legal tender and that they must use gold or silver.

    Under current circumstances, however, I have difficulty imaging how a repeal of legal tender laws would have much impact. Is there something other than federal reserve liabilities that people would insist be used to settle debts?

    • RickDiMare

      Bill, you're referring to the Gold & Silver Clause contained in Article 1, Section 10, Clause 1 (I:10:1), which I've found was primarily designed to prevent land purchases by foreign buyers who used worthless paper money, particularly during the formative stages of the U.S. In any event, federal powers are contained in Section 8. Section 10 only deals with state prohibitions and doesn't constrain federal power. Other clauses in I:10:1 clearly prohibited state governments from coining money and emitting "bills of credit." However, from 1787 until after the Civil War, state governments were allowed to charter banks ("free banks"?), and those independent, privately-owned banks could issue the "bills of credit" that the state governments couldn't. Technically, state-chartered banks still can issue their own paper money, but it's quite likely the feds will tax their notes out of existence. State governments also need to beware of exerting too much control over their state-chartered banks. This could also implicate I:10:1 and the feds will likely regard money-creation by those banks as being conducted by the state government.

      Also, I'm not suggesting "a repeal of legal tender laws," and I don't know what I said that would imply that, but you're hitting a central issue by asking if there is "something other than federal reserve liabilities that people would insist be used to settle debts." In short, we need a legal tender that not only discharges debts in the eyes of the courts, but discharges debt owed to the Fed, whose "private" corporate nature, as you said previously, "is an illusion." In other words, we need an easy, realistic way of accessing TreasuryDirect currency that is "legal tender IN PAYMENT OF all debts public and private," whether this kind of legal tender comes from a modification to the existing central banking system, or though a new system of federally-chartered free banks.

  • It seems to me from his The Mystery of Banking (ignoring the Appendix added later that blasts White) that Rothbard basically subscribes to what you suggest– he argues that if fractional reserve banking exists in a free banking society, eventually (rapidly, even) all the banks will move to a 100% reserve very quickly.

    • George Selgin

      I'm not sure I'm reading you right; but if you mean to imply that I have suggested that I think banks will move quickly to 100% reserves in the absence of regulation, you have misunderstood me rather badly.

      So, to be clear, (1) I am perfectly convinced that banks in a free system will move toward very small fractional reserves, meaning perhaps 1 percent or even less; (2) the empirical evidence overwhelmingly supports my position, while overwhelmingly refuting Rothbard's. The tendency of Rothbardians to repeat their "theory" or 'prediction" or whatever they wish to call it, to the effect that FR banks "would" tend to move toward 100-percent reserves, despite all manner of past evidence contradicting the claim (and as if the possibility of free banking were merely hypothetical rather than something already reasonably approximated in the past) is one reason why I find their position, not merely incorrect, but utterly inconsistent with the most elementary principles of reason.

  • I'm sorry, I apparently did misread you, I was unaware of your point (1), as that is quite a bit different from Rothbard indeed. Not to worry, your Theory is the next book on my reading list. Thanks for making it free.