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Banknotes Are Not, and Have Never Pretended to Be, Warehouse Receipts

"[B]anks have habitually created warehouse receipts (originally bank notes and now deposits) out of thin air. Essentially, they are counterfeiters of fake warehouse-receipts to cash or standard money, which circulate as if they were genuine, fully backed notes or checking accounts. Banks make money by literally creating money out of thin air, nowadays exclusively deposits rather than bank notes. This sort of swindling or counterfeiting is dignified by the term 'fractional-reserve banking,' which means that bank deposits are backed by only a small fraction of the cash they promise to have at hand and redeem."

Murray Rothbard, "Fractional Reserve Banking."

A clear, testable implication of the above quote–one of the loci classici of the belief, now widespread among fans of a certain sort of Austrian economics, that fractional reserve banking is fraudulent–is that the notes issued by fractional reserve banks have been indistinguishable from warehouse receipts. After all, if you are going to swindle people by "counterfeiting" something, you wouldn't be inclined to make the fakes obviously unlike the genuine articles, right?

Here are some images of (1) various warehouse receipts and (2) various banknotes. I draw my readers' attention to the language common to the specimens in each set. They will note how items in the first all make specific mention of the fact that valuables have been received "for storage" (or something like that); while those in the second merely "promise to pay" a sum on demand, making no reference to storage at all.

I leave it to those readers to then determine for themselves whether the evidence is consistent with the "clever swindle" theory of fractional reserve banking.

1. Warehouse Receipts:

2. Banknotes

  • Paul Marks

    As both Ludwig Von Mises and F.A. Hayek (at least Hayek in the prime of life)were fond of pointing out…..

    Even a ban on bank notes does NOT prevent credit expansion (i.e the credit bubble finance – the creation of credit bubbles, boom-busts).

    Banks have many ways of expanding credit (beyond real savings) – so the Currency School were "right about the problem, but wrong about the solution".

    Contrary to what is often claimed (about the "needs of trade" and so on) there is actually no long term benefit to a "cheap money" policy – i.e. to the expansion of credit beyond what real savers would provide at those interest rates (i.e. what real savers would be prepared to SACRIFICE CONSUMPTION to finance).

    Indeed boom-bust events (the expansion of credit beyond real savings – the creation of credit bubbles) is not even a neutral matter.

    The economy would be better off if credit-bubble expansion (i.e. boom-busts) did not occur. Certainly economic progress over time may still occur – but the credit bubble finance has NOT helped the long term progress (it has actually made it harder, not less hard, to achieve).

    The Currency School solution (the restiction of or banning of bank notes) was wrong – as banks have many other ways of expanding credit beyond real savings.

    But the Banking School (which is what George Selgin really represents) is even more wrong – for they deny there is a problem at all.

    • George Selgin

      Paul, I think I was kicked out of the banking school in 1982, when I attacked the real-bills doctrine at the annual Committee for Monetary Research and Education meeting. Or was it when I attacked both the RBD and Fullarton's "reflux" doctrine in my first published journal article? Whatever: for some labels are just things to be attached to persons in place of substantive demonstrations of particular ways in which they've argued incorrectly.

      For those who respect labels, on the other hand, Steve Horwitz, referring to Larry White's work, sets things straight in his intervention below.

  • Interesting the one about Opium. Not sure this is somekind of final proof. Even today some people in my country (Portugal) think their demand deposit is a real deposit. At this time. What about demand deposits through time…but is it or not true that dealers had tables of discounts quotes for each issuer?

  • Steve Horwitz

    Selgin and White and Horwitz for that matter are not "Banking School" but "Free Banking School." I suggest you read White's discussion of the doctrinal issues in his Free Banking in Britain.

  • Paul Marks

    I was talking of the specific context of the debate over whether credit expansion (for "the needs of trade" or some other waffle) was harmful or not.

    The Currency School said it was, the Banking School said it was not.

    As Mises and Hayek were fond of pointing out – the Currency School were "right about the problem, but wrong about the solution".

    Of course there are other voices to be considered – for example the French Liberal School.

    Some of these thinkers held that government should have nothing to do with money.

    And, of course, the Austrian School – starting with Carl Menger.

    As you know Menger showed that, if one traced it back, money must start with a commodity.

    In need not be coins (for example in the Middle East silver was used as money for many centuries before coins were even invented), but it has to be a commodity – a physical thing.

    One can move away from that – but efforts to move away from it tend to have unfortunate consequences.

    The efforts of bankers to move away from commodity money (via credit expansion book keeping tricks) are at least corrected.

    Although they are corrected in a very brutal way – with the credit bubble "boom" being liquidated by the "bust" (and the credit money sent back down towards the monetary base).

    But government efforts to move away from the commodity (via legal tender laws, tax demands and so on) are far more "successful" and far more damaging.

    Indeed even banker credit bubbles would not be anything like their current size (I almost typed "would not be a fraction of the size" – no pun intended) if it were not for government encouragement and support over many DECADES.

    I strongly suspect that we (or those of us who are still around – and I will NOT be alive) will return to commodity money rather soon.

    Not by rational reform – but by the utter and total collapse of the present system.

    Although whether the commodity will be gold, silver (or bullets) remains to be seen.

  • Lee Kelly

    George, don't you know not to bring evidence to a dogma fight?

    • George Selgin

      It is for the sake of the great (and innocent) unwashed, Lee. They may yet be induced to vomit the Kool-Aid.

  • Were the demand deposits so clear about someone depositing physical gold would then participate in a FR demand deposit?

    I always find strange that a physical gold owner would exchange an real asset for a claim of a real asset.

    Also, this is the text on a US dollar, after FED creation:

    "Gold Certificate"(!): "It is hereby certified that X dollars have been deposited with the treasurer of the United States payable in Gold at this Office, to the order of the Federal Reserve Board. "

    Should the general public be sure about its status?

    • BillWoolsey

      Gold certificates were a type of money different from Federal Reserve notes.

      If you think storing gold in a safe is better because it is a "real asset" rather than keeping money in the bank, then buy some gold and a safe and put it there. We promise not to tell the robbers.

    • George Selgin

      Deposit contracts were at least as clear on the matter as notes. As for why anyone would exchange real gold for a claim, well: (1) safety from theft; (2) convenience of exchange via checks; (3) notes easier to carry than coin, especially for larger sums; (4) interest on many deposits. Only (1) applies to metal actually stored; the other advantages are particular to FR deposits and notes.

      As for Gold Certificates, their legends also did not make false claims. The gov't did in fact stockpile X dollars of gold. But the gold in this case was the Treasury's property, not that of the note holder. Confusing, to be sure. But then these certificates say nothing about what happens in a free market arrangement.

  • Paul Marks

    I apologise, I did not spot George Selgin's first reply.

    Yes – rejecting this doctrine would mean that one could not be a member of the Banking School. So it is just a matter of agreeing with them on a specific point (the one I was talking about) NOT being a member of this School of thought.


    Well yes – Federal Reserve notes have not given gold (to private citizens) since 1933.

    Indeed private and public contracts (gold clauses) were voided by Fascist style edicts from the regime of Franklin Roosevelt.

    People took this to the courts – but in 1935 the Supreme Court ruled that the United States does not really have a Constitution (in the sense of clear limits on what the Feds can do) – a position that was confirmed quite recently in the Obamacare case (when an expansion of government power is considered really important the Federal courts will find some way to rule it consittutional).

    However, your point about "robbers" misses the point – in American history the main robbers have been the GOVERNMENT.

    In the same year (1933) there was widespread looting by Franklin Roosevelt's servants – and resistance (indeed even being found with large amounts of gold – without any armed resistance) was punished with imprisonment.

    The one thing that I agree with the socialist Chevez about is that the United States is a very bad location to keep physical gold in.

    People who own physical gold should move it (and themselves) outside the United States – as Jim Rogers (and many others) have already done.

    A relected Barack Obama (although Obama is from the Marxist tradition of thought – not the "Progressive" tradition of thought that most of the New Dealers were from) would not prove more friendly to private property than the Roosevelt regime was – indeed it will be wildy MORE hostile to private property tnan the New Dealers were (there was a Marxist faction within the New Dealers – but it was not the majority faction).

    As for Federal Reseve notes.

    The whole point of "fractional reserve banking" (i.e. credit bubble finance – boom-busts) is that banks do NOT have these notes – at least not anything like the amount they de facto claim to have.

    That is the whole point of people now (and for some time) demanding that the Federal Reserve "expand the monetary base".

    This is not being done for fun – either in the United States or Britain.

    This is done (by the Bank of England and the Federal Reserve and……) to save the "broad money" (i.e. bank credit) credit bubble expansion.

    Without this expansion of the monetary base the credit bubble economy would collapse.

    Of course it will collapse anyway.

    But the expansion of the monetary base puts off the collapse of the "finanial system" (i.e. the credit bubble bankers and their "broad money" "economy") – which is why it is done.

  • Bill Stepp

    This is from Chester Phillips' classic book Bank Credit, p. 4. (A pdf is at the Mises website.) Bank credit extension is a legitimate and natural enterprise:

    Another distinctive feature of bank credit is that a
    bank is commonly able to make loans in excess of the
    amount of cash received from shareholders and depositors.
    How much in excess is a question that is answered
    in chapter III.

    The Legitimate Scope of Bank Credit Extension

    • George Selgin

      Careful reading of the chapter itself makes clear that Phillips' analysis is entirely consistent with what I argue in my "Another Dumb Argument" post. Cf. in particular pp. 66-68, where Phillips specifically rebuts the very same sort of claim I answered, using the same reasoning.

      • Mike Sproul

        “A representative bank with a cash-deposits ratio
        of 10 per cent and a derivative deposit-loan ratio of
        20 per cent, securing additional primary deposits of
        $200,000 would be able to add approximately $220,000
        to its loan item and would retain approximately $24-,
        400 in cash as a reserve against the $244,000 deposits
        ($200,000 primary deposits and $44,000 derivative)
        owed by the bank after the proceeds of the loans had
        been drawn against by the borrowers. Its loans would
        be approximately nine times the cash on hand but
        the cash on hand would be only a fraction of the cash
        deposited. Primary deposits have almost no multiplicative
        importance as a basis for loans.” (Phillips, Bank Credit, p. 67.)

        Consider a town with a single bank. The bank gets a deposit of $1000 of paper money. The bank lends $800, keeping $200 as reserves. The $800 is re-deposited in the same bank, and the bank lends an additional $640, keeping an additional $160 as reserves. After infinite repetition of this deposit-lend process, the bank’s assets consist of $1000 of paper money reserves, plus borrower IOU’s (backed by liens on property) of $4000. The bank’s liabilities consist of $5000 of checking account dollars that the bank itself created.

        Alternatively, the same bank keeps the entire $1000 of paper as reserves, and lends $4000 to a single borrower by crediting $4000 to that borrower’s checking account. The bank will have exactly the same assets and liabilities as before, yet Phillips and Selgin say that the first scenario is realistic while the second is impossible. They imagine that borrowers will demand payment of the $4000 of checking account dollars in the second case, but forget that the very same $4000 demand could be made in the first case as well.

        They both seem unaware that money creation is a process of coining claims to property into money. The supply of money in a town is determined by the amount of property that people bring to the bank, not by the amount of deposits received by the bank.

        The same story can be told for a town with multiple banks, but one step at a time.

        • Still makes sense to me. You're not saying that a bank with a 20% reserve requirement necessarily ends up with $4000 in borrower's IOUs. You're only saying that deposits of base money are not the limiting factor. A bank with this reserve requirement might lend less than $4000, and a bank with more collateral might lend more than $4000 by adopting a lower reserve requirement. The infinite series makes a nice homework assignment, but the exercise is entirely academic.

          • Mike Sproul

            Exactly. It's not often on economics blogs that an error is so plain and simple. But George got his Ph.D. in economics in 1986, so we're 26 years too late to explain it to him.

        • George Selgin

          Honestly, Mike: I make a simple point that a competing bank can't lend many times more than its fresh receipts–a point with which Phillips and every other authority on the matter emphatically agrees–, having remarked numerous times that things are different for a central or monopoly bank, and you think that you have shown me to be mistaken by offering an example in which there's a monopoly bank–and an example, moreover, which itself supposes that the bank never lends more than its receipts!

          And to suggest that I don't understand the workings of the reserve multiplier, when fresh reserves are added to the system, is likewise to neglect what specifically recognize, albeit on the page to which this discussion properly belongs.

          Finally, as for the suggestion that new PhDs know better than old ones, I can only say that my own impression is such as to make me wish I might have gotten mine back in 1930!

          • Mike Sproul


            The trouble is that your simple point is wrong, and your appeal to the authority of Phillips et. al. does not make it right.

            So here is my point, as plainly as I can state it: An ordinary, privately-owned, competitive bank receives a deposit of $1000 of paper currency. The depositors get $1000 worth of checking account dollars in return. That bank can then lend $4000 of additional checking account dollars to customers who offer the bank adequate collateral. It could be one loan of $4000 or 4000 loans of $1 each. The bank would get $4000 worth of IOU's as a new asset, and the $4000 of newly-lent checking account dollars would become the bank's liability. This process can be done by any bank: competitive, monopolistic, central, or private.

            Naturally, the bank's customers might then write checks totaling more than the $1000 the bank has in reserves. The bank will then have to use its assets to buy more reserves or else use its assets to buy back some of its checking account dollars. But since banks commonly do just fine with 20% reserves, it is reasonable to suppose that the bank's $5000 of checking account dollars are handled well enough by the $1000 of reserves.

            My point about Ph.D.'s was not that new Ph.D.'s know more than old ones, but that once a person gets a Ph.D., it becomes much harder to change his mind.

          • I can imagine a competitive equilibrium in which a new unit of collateral attracts only enough central bank money to generate a unit of new bank reserves, regardless of any reserve multiplier, if a central bank is doing what a central bank ought to do; however, Mike's point seems only to be that banks lend as much money as borrowers with sound collateral demand. If Michael Jackson is becoming the Prince of Pop and decides he'll only do business with one small bank owned by Jehovah's Witnesses, that bank doesn't give a flip about its depositors, and it can profitably create enough money to finance Jackson's amusement park regardless of the volume of its deposits, because Jackson's copyrights are incredibly valuable … until they aren't.

          • How Jackson's bank goes about creating this money is a separate issue. If the bank is free to do so, it simply issues its own notes, and people will accept these notes as money knowing that Jackson's incredibly valuable copyrights back them. If banking regulation prevents this note issue, then the bank creates the money within the regulatory framework, by seeking deposits of money created instead by a central bank or whatever.

            Jackson may seek credit directly from proprietors of the goods and services required to build his amusement park. These proprietors may deposit their own money in Jackson's bank, or they may borrow money from other banks and deposit this money in Jackson's bank. These proprietors want to do business with Jackson based upon their assessment of the value of Jackson's collateral. That's what really matters, not some volume of base money and reserve requirements and multipliers and stuff.

  • Bill Stepp

    It should be noted that the business cycle is not caused by bank credit expansion, but by its overexpansion, which is driven by the relationship between the market-determined loan rate of interest and the central bank-jimmied loan rate. When the latter drops below the former, this leads to an overexpansion of bank credit and an investment boom. When the market wakes up and smells the lurking red ink, the malinvested capital is terminated, and some labor and land factors are dismissed.
    Sounds like a job for Arnold.

  • Paul Marks

    No Bill Stepp.

    A small credit expansion will cause a small boom-bust, but it will still cause a boom-bust.

    The key point is lending out "money" that was never really saved – i.e. money that does not really EXIST.

    Central banks (and so on) are side issues.

    • George Selgin

      Sorry, Paul, but Bill Stepp is correct and you are wrong: credit expansion has no cyclical consequences when it is matched by an increase in the real demand to hold the liabilities of the expanding financial institutions. On the contrary: such expansion actually serves to keep actual interest rates at their "natural" levels. (I explained this in chapter 4 of Theory of Free Banking.) The contrary view–that a constant nominal amount of credit alone avoids cycles–is a naive oversimplification, propagated by…guess who?

  • Paul Marks

    Bill – if you want to borrow money (either for consumption or investment) then convince someone else to SAVE the money (i.e. SACRIFICE THEIR CONSUMPTION) in order to lend it to you (either directly or via a banker who, of course, will take a cut).

    "Easy money"(i.e. loans from "money" that no one really saved – i.e. money that does not really EXIST) is not "easy" money in the end.

    In the end, scams do not really beat working for a living – unless you are the scam artist.

    An offer that is too good to be true – is just that.

  • Bill Stepp

    A small credit expansion does not cause a small boom-bust as long as the loan rate of interest is in line with the natural rate. The macroeconomic performance during the free banking era, while not free of business cycles, was quite good, and was much better than that of economies operating with central banks, and other forms of government intervention, such as the U.S. had in the misnamed "free banking" era, and during the years from the War for Southern Independence to the Great War.

  • "Deposit contracts were at least as clear on the matter as notes. As for why anyone would exchange real gold for a claim, well: (1) safety from theft; (2) convenience of exchange via checks; (3) notes easier to carry than coin, especially for larger sums; (4) interest on many deposits. Only (1) applies to metal actually stored; the other advantages are particular to FR deposits and notes."

    Why this does not apply to 100% reserves. Interest in time deposits. Checks, etc. ?

    I do understand why people receiving FRB titles would exchange them for physicall and then deposit it in a 100% I do not understand why physicall gold owners would exchange it for a promise of payment. The interest does not explain it. Interest on demand deposis is very low and does not apply unless large balances. Interest on time deposis is possible in both but one is an interest in gold the other an interest that itself is a claim on gold.

    • George Selgin

      Why does what not apply, Carlos? A bank can't earn interest on liabilities against which it holds 100% reserves. Surely you understand that my statement refers to why people prefer fractional demand deposits? And that "low" interest isn't so trivial when the alternative is paying storage fees. (To suggest that interest on demand deposits is "impossible" is of course to contradict experience.) And paper "titles" to stored merchandise pose a problem as a circulating bearer medium because the storage facility can't charge fees to anonymous bearers, yet the original depositors doesn't want to be on the hood for fees that pertain to stuff the titles for which they've already parted with! Surely, Carlos, you don't imagine that people who have knowingly patronized FR banks since the mid-17th century–and most have in fact done so knowingly–haven't had good reasons for their choice?

      • What i meant was:

        100%RB is also able to offer interest on time deposits and it would be interest paid in equivalent 100%R money.

        FEB is also able to pay interest in demand deposits but in FRB money, so the total amount paid in interest by the bank will decrease the reserve ratio to demand deposits.

        The other point that I make is the account issue: both titles should be registered as non-homogeneous currencies. Would the market (auditores, etc.) see both as having the same "quality"?

        I still think there are open issues about what would be the market behaviour in perfectly clear contracts.

        PS: Today there are already 100% Reserve Gold Warehouses like Gold money.

  • Paul Marks

    Bill the point of a credit expansion is to reduce interest rates.

    If people were happy to pay the interest rates that real savers demanded (either directly or via bankers) then there would be no point in the credit expansion.

    Also there is the little problem of PAYING BACK the money.

    The credit expansion (big or small) is the credit bubble BOOM – the paying back time is the BUST.

    Trying to defend a small credit expansion is like trying to defend a pick pocket by saying….

    "Well he is not as bad a mugger".

    Sure a pick pocket is not as bad as a mugger – just as a small credit expansion is not as bad as a big one (and YES Central Banking encourages credit expansion to be bigger).

    But that does not mean that a pick pocket is a good thing.

    A credit bubble (which is what a credit expansion actually is) is a BAD thing.

    Sure a small credit bubble means a small bust – but it is still not good (it is bad).

    I repeat – if you want to borrow a 100 Dollars get someone to SAVE 100 Dollars.

    This whole idea of borrowing without REAL SAVING is fundementally mistaken.

    • Bill Stepp


      The formation and growth of bank credit in a free market is a natural economic process. The rate of interest charged by banks for loans (the loanable funds rate) is determined by the supply and demand for it. The natural rate of interest is the rate that equilibrates the supply and demand for savings, which is broader than bank credit. In a free market there is generally no overexpansion of bank credit. Overexpansion of credit happens more often when a central bank induces interest rates to fall below their free market levels. This raises the demand for bank loans as entrepreneurs and capitalists come to think that formerly unprofitable investments are now potentially profitable.
      It also reduces the hurdle rate used by some capitalists in their evaluation of investment projects' profitability; and it reduces the discount rate used by capitalists in sizing up projected cash flows and valuations of stocks, bonds, and other investments. The greater the disparity between the two rates, the bigger the potential bubble. See the tech stock boom of the '90s and the more recent real estate boom.

    • George Selgin

      "Bill the point of a credit expansion is to reduce interest rates." No it isn't. It is to profit from investment. Interest rates only fall in response to increased savings, the bank's role being merely to put the increases savings to use.

  • Bill Stepp

    George makes the key point here. Interest rates fall as savings increase, and the bank puts it to work through the loan market, and seeks to make a profit from the loan just as the entrepreneur who borrows from the bank does by investing the loan. If credit expands by a central bank's manipulation of interest rates without a corresponding accumulation of savings, then the business cycle starts and is eventually unwound. The key is the supply and demand for savings and loanable funds in a free market compared to a politically manipulated market.

    The good news is that there is hope for you. To quote an old math professor of mine, "All you have to do is see it." (It was a lot easier for him than for me, but I'm guessing that you're going to wake up soon and say, "Aha, now I understand it.)

  • Paul Marks

    George Selgin "interest rates only fall in response to increased savings"

    And "the bank's role is mearly to put the increased savings to use".

    These statements are not true – they are blatent untruths. They were not even true before the creation of the Federal Reseve in 1913 – if they were true there would be no such thing as credit expansion, no boom-busts, no "broad money" (bank credit – M3 and so on) being bigger than the monetary base.

    Many years ago I would have asked you "how you can live with yourself" after doing stuff like this.

    However, bitter experience over the years has taught me that people can lie (and cheat, steal, murder – whatever) and live with themselves with no difficulty. Indeed sleep like a baby.

    Bill Stepp.

    The whole point of CREDIT EXPANSION (which George Selgin has just denied even happens – banks just put "savings to use" interest rates ONLY fall when "savings increase") is to reduce interest rates

    Not just by Central Banks – by private banks also.

    Does it not tell you something that the only way that George Selgin can see to defend his position is to BLATENLY LIE.

    READ what he just wrote.

    He claimed that credit expansion does not even happen – that "interest rates only fall in response to increased savings" and "the bank's role is mearly to put the increased savings to use".

    How can you respect a man who BLATENLY LIES to you?

    He might as well have said that the sky is pink and that 1+1=78.

    And if an compaint was made against George Selgin for teaching this stuff?

    He would simply claim that he was defining the word "savings" to mean something else – i.e. to INCLUDE banker's book keeping tricks (credit expansion).

    Redefine the word "savings" to include stuff that is not saving at all.

    A conman.

    • George Selgin

      Paul, you make too much of what was meant to be a banal point, which is that ordinary competitive bankers do not regard lowering rates as the "point" of their loan-making–hell, it is plain common sense that they would never lend at reduced rates if they could only find enough qualified borrowers to lend at former ones. Of course the story is different with central banks; of course excessive credit expansion (not any old credit expansion) reduces rates relative to their natural levels, and perhaps absolutely.

      Anyway I've had my fill of your histrionics–all those overblown words and phrases ("blatant liar" "how can you live with yourself," "conman"). You have been a guest on this site, which has allowed you ample space in which to express your opinions, to a degree that if anything warrants being called over-indulgent. Perhaps you think that only your due. Mine is to determine who is and who isn't welcome on these pages.

  • Paul Marks

    "Saving" is to sacrifice consumption. To work to earn (for example) 100 Dollars and to spend 90 Dollars – the remaining 10 Dollars that is NOT consumed is available to be lent out (not a cent more).

    Book keeping tricks are NOT real "savings".

    If people are not prepared to pay the interest rates that real savers demand (for their sacrifice of consumption)private bankers (or others – such as governments) may indulge in "credit expansion" – the creation of "money" (via book keeping tricks) in order to have stuff to lend out at a lower rate of interest than real savers would demand.

    Of course eventually (sooner or later) the scam (for that is what it is) collapses – and credit money "boom" turns to BUST.

    • MichaelM

      Of course, you don't consume dollar bills.

      You consume goods and services.

      Real savings can occur without that savings showing up in bank vaults (I've got a bottle of water next to me — every second I'm not drinking from it I'm technically saving the water for later), meaning it's possible for banks to expand their circulation of credit without actually passing real savings and causing a business cycle.