The "Bagging Rule" – Or Why We Shouldn't Arrest (All) the Bankers

fractional reserve banking, banking, selgin, goldsmith, deposits, common law
"Bankers go to jail" by duncan c. CC BY-NC 2.0
fractional reserve banking, banking, selgin, goldsmith, deposits
Image by duncan c

As our more regular readers know well, every now and then I like to take another stab at debunking the  myth that fractional reserve banking has fraudulent roots. Besides occurring in numerous textbooks, that myth is routinely expounded in the writings and lectures of certain contemporary Austrian School economists. Moreover, as we'll see, it is occasionally given credence in reputedly scholarly publications by persons who don't identify themselves with that school.

As I write this, with Congress still out of session, things are pretty slow here in DC. So it seems as good a time as any to rejoin the old debate, which I do first by drawing attention to a paper, "Banks v Whetston (1596)," by David Fox, a Cambridge law professor and barrister, and the author of a fascinating legal treatise on Property Rights in Money (OUP, 2008).

A Hum-Drum Case

Although he wrote "Banks v Whetson" for a 2015 volume titled Landmark Cases in Property Law, Fox hastens to explain that the case in question may not really qualify as a "landmark" since "very few lawyers have heard of it and it does not have a strong history of citation in later decisions." Its significance, so far as he's concerned, lies on the contrary fact that it was perfectly hum-drum. Because of that, the case supplies a particularly clear illustration of the common law's ca. 1596 understanding of property rights in money — an understanding which prevailed, according to Fox, "throughout the middle ages and into the early modern period."

The plaintiff in Banks v Whetson, having accused the defendant of robbing him of his money, brought an action in detinue (that is, for the return of specific property) against him. The defendant in turn filed a demurrer, which was argued in the Court of King's Bench. The case was adjudged without argument for the defendant, on the grounds that the money in question consisted of loose coins rather than ones enclosed in a bag or chest. For that reason, the court observed, it was impossible to distinguish them from other, similar coins. Because the plaintiff could not establish that any particular coins in the defendant's possession had in fact been taken from him, the court held that his case lacked the technical requirements for a suit in detinue.

As Fox explains, the decision in Banks v Whetston  rested on a by-then long-established  distinction between detinue on the one hand and "the varieties of debt action which lay to enforce claims for delivery of generic fungibles" on the other. So far as the common law courts were concerned, the distinction was just as applicable to money as to other fungible goods. Money, Fox explains,

could either be a specific item of property (as when it was bailed for safekeeping in a sealed bag or locked chest) or it could be owed as a fungible amount under a debt expressed in pounds, shillings and pence. In principle, there was no objection to a plaintiff suing in detinue to recover money bailed in specie, provided that the object of his claim could be identified clearly enough… The thing detailed by the defendant had to be identified as the same thing which the plaintiff delivered to him.


If the plaintiff's case was instead to enforce a generic obligation for the payment of money, then his action was in debt… In contrast to detinue, debt lay to recover a certen summe of money. The distinction…signaled two commercially different kinds of transaction: one involving the enforcement of the plaintiff's property (where the property in question happened to be coins) and the other for the enforcement of a simple monetary obligation to pay a generic amount denominated in monetary units.

Paper, Plastic, or a Loan?

The legal distinction between detinue and debt had, as its practical counterpart, what Fox calls "the bagging rule." If someone wished to retain title to a sum of money, despite surrendering possession of it, and to therefore be able to sue in detinue for its recovery, that person had to place  the money in question in a bag or chest, and preferably in a sealed bag or a locked chest. "The bagging of money removed the evidential uncertainty about identifying coins as the property of one person or another, and in a detinue action it allowed the money to be restored in hoc individuo."

More importantly for our purposes, the bagging rule also supplied a simple means for distinguishing between different kinds of financial transactions — one which, whatever its shortcomings, was

readily understood by the commercial parties and by juries who were charged with determining the capacity in which a person received or held sums of money.  The simple question "Was the money in  bag or not?" cut through the conceptual artificialities of determining what might have been the intent of the parties, of the sort encountered in modern-day law.

So long as money was surrendered in a closed bag or chest, it was understood that its possessor "held it in right of another so that he was not free to spend it as his own":

To seal coins in a bag…constituted an assertion by the person whose seal was on the bag that the property in the money was in him or in some third person to whom the money had to be remitted. Either way, it showed, negatively, that the person holding the bag might not have the full property in it.  He was quite possibly a bailee who might be liable in detinue… (my emphasis).

The common law courts denied, on the other hand, "that one person could maintain an enforceable title to any [loose] money that had passed — voluntarily or involuntarily  — into the possession of another person" (my emphasis again). "In this respect," Fox observes, "the common law's treatment of property in money was no different from its treatment of fungible commodities."

By the time that Banks v Whetston was decided, in 1596, the "bagging principle" was old-hat. Yet another half-century or so was to pass before England's goldsmiths would pioneer there the practice of fractional-reserve banking. In other words, the first goldsmith-banker to lend or otherwise make use of coins "deposited" at his bank had every right to do so, according to principles of common law that had by then been firmly established for over a century, so long as the coins were tendered loose rather than in sealed bags or other containers. The presumption that the banker had good title to any loose coins he received existed regardless of the other terms of the specific deposit agreement, excepting only such terms expressly indicating that the coins were to be held in trust. A depositor's right to recover any part of a deposited sum, whether after a specific term or on demand, or a banker's promise to pay a particular sum, whether to a specific person or to the bearer of a circulating banknote, was proof of the banker's indebtedness, and nothing more.

Keepers of the Faith

In light of the simplicity of the bagging rule, and the fact that that rule appears to have been perfectly well-established when the practice of fractional reserve banking was but a twinkle in some goldsmith's eye, one might expect spinners of the yarn that fractional reserve banking was (and perhaps still is) a form of theft to respond to doubting Thomases by changing the subject, rather than by boldly declaring their accounts to be fully consistent with the fine points of early modern English common law. The same goes for purveyors of the related whopper that banknotes and deposit credits were originally (and, by some accounts, still are) "titles" to cash.

Were it only so! Alas, among certain devotees of Murray Rothbard-style Austrian economics, the fractional-reserve-is-fraud fairy tale amounts to a dogma to be upheld, by hook or by crook, in the face of every sort of contradictory evidence.

Two especially relentless defenders of the Rothbardian faith are Philipp Bagus and David Howden, who, with some other coauthors, have maintained a steady output of papers claiming, among other things, that according to legal principles prevailing at the time, in both Roman and common law, early fractional reserve bankers did indeed routinely lend money that didn't belong to them.

Having once before confronted Bagus and Howden, with both barrels blazing (see here and my reply here), only to have them deny receiving so much as a scratch [1], I doubt that anything said here will faze them, let alone strike a mortal blow. Still I consider it worthwhile, for the sake of those standing on the sidelines, to show how these economists deal with fundamental points of early modern English common law that David Fox and numerous other historians of law and banking, from Henry Dunning Macleod to James Steven Rogers, have painstakingly elucidated.

Consider "Oil and Water Do Not Mix, or: Aliud Est Credere, Aliud Deponere," a 2015 Journal of Business Ethics paper Bagus and Howden wrote with Amadeus Gabriel, a genuinely Austrian Austrian economist. Like several of Bagus and Howden's other papers, this cryptically-titled number (the Latin comes from a passage in the Digest of Justinian) rests its case against fractional reserve banking not on a direct appeal to the common law but on the distinction found in more ancient Roman law between "regular" and "irregular" deposits contracts:

In a regular deposit contract, specific things are deposited such as a Rembrandt painting. Such contracts are called bailments in common law. In an irregular deposit contract, fungible goods such as bushels of wheat, gallons of oil or money are deposited. … Most money deposits are irregular.

So far so good. But the authors go on to declare that:

Over time governments failed to enforce the traditional legal principles of monetary irregular deposits. … A special privilege is given to bankers (but not to private persons) to violate these obligations in the case of monetary irregular deposits… . The practice of fractional-reserve banking was legalized ex-post.

The  violations to which Bagus, Howden, and Gabriel refer consist of banks' having lent some of the cash deposited with them, instead of keeping it on hand, as the terms of a depositum irregulare supposedly obliged them to do.

This would be dandy reasoning, so far as Continental developments are concerned, were it indeed the case that, according to Roman law, an "irregular" money deposit was in fact a bailment in the strict sense of that term, with the depositor retaining a valid title to the deposited sum, as opposed to a loan, by which the money became the banker's property. But that simply wasn't so. Instead, according to just about every authority on the topic, with the singular exception of Jesus Huerta de Soto, upon whom Bagus, Howden, and Gabriel rely, a banker who received an "irregular deposit" became the owner of the deposited money!

Concerning Huerta de Soto's understanding of what an irregular deposit contract entails, as conveyed in the first chapter of his magnum opus, Money, Bank Credit, and Economic Cycles,  "Lord Keynes" (the pseudonymous blogger at Social Democracy for the 21st Century[2]) concludes, on the basis of a painstaking review of relevant sources, that it

is utterly unorthodox. He cites certain Spanish legal sources and Spanish legal scholars for his definition, but it is clearly eccentric and aberrant, certainly with respect to Roman law and Anglo-American law.

Nor, he adds, did classical Roman jurists themselves ever insist, as Huerta de Soto does, that a banker receiving an irregular deposit was obliged to keep the full amount of the deposit at hand. It was therefore perfectly possible, as a matter of Roman law, for a banker to lend coins received as irregular deposits without breaking the law.

With regard to English experience, the Bagus-Howden-Gabriel view is, believe it or not, even less sound, for as Benjamin Geva explains in The Payment Order of Antiquity and the Middle Ages: A Legal History (p. 433), the English common law went one better than the Roman law "in bypassing altogether the category of the irregular deposit, and thus facilitating an easy route to the characterization of the bank deposit as a loan." As we've seen, that characterization was automatically applied to all "deposits" of loose coin.

Concerning Bagus and Howden's remarkable ability to ignore or misread the plain testimony of countless authorities, I hope I may be forgiven for instancing as a case in point their reading of my own 2010 article, "Those Dishonest Goldsmiths," as given in a footnote to another paper of theirs,  published in the Journal of Business Ethics. According to that note, my paper

provides evidence that Goldsmiths…offered contracts that were neither demand deposits nor loans. These contracts were akin to aleatory contracts, whereby a financial institution promises its best to return an invested sum on demand. …While Selgin provides evidence that the Goldsmiths offered such contracts, he maintains that Goldsmiths did not pioneer fractional reserve banking. Selgin’s empirical evidence that Goldsmiths offered a third contract distinct from the two we posit that are legally permissible is not irreconcilable with our own view. Indeed, Selgin’s work would only be problematic if 1) it could be shown that people who agreed to these contracts wanted to maintain the full availability of their money, or 2) if these historical instances were used to argue for the legitimacy of the fractional reserves demand deposit.

I do not exaggerate in saying that every part of this purported précis of my article comes as a great surprise to me. In fact, I've never questioned the standard view that, in England at least, goldsmiths pioneered fractional reserve banking. And the whole point of "Those Dishonest Goldsmiths" was to defend the goldsmiths against the charge of misappropriating their customers' deposits and, to that extent at least, "to argue for the legitimacy of fractional reserve banking"!

As for my supplying evidence that goldsmith bankers took part in "aleatory contracts," that claim presumably refers to a single footnote in my paper, concerning a specific transaction with a goldsmith recorded in Pepys diary, in which the banker appeared to have acted as a sort of broker, rather than as a strict intermediary. It never occurred to me that, by referring to that one transaction, and suggesting that such transactions weren't uncommon (in part because they helped bankers and their clients to skirt usury laws), I risked being portrayed as denying that goldsmith-bankers ever engaged in  plain-vanilla fractional-reserve banking!

An Asian Outbreak

Were the fractional reserves = fraud fairy tale encountered only in undergraduate textbooks, manifestly idiotic web pages, and papers written by a coterie of ultra-Rothbardian economists for publication in their own house organs (or in journals edited by persons who are neither economists nor historians nor legal scholars), its persistence might be no more a  cause for concern than the 450-odd samples of variola vera residing, under heavy guard, at the Centers for Disease Control in Atlanta.

I have, unfortunately, come across at least one serious case of fractiophobia  far removed from the bacterial incubators of Madrid and Auburn, Alabama — as far as Seoul, Korea, to be precise. In "How Modern Banking Originated: the London Goldsmith-Bankers' Institutionalization of Trust,"Jongchul Kim, a political scientist at Sogang University,[3] claims that modern banking rests upon a "double ownership scheme" pioneered by London's goldsmiths. In that scheme

two groups — the holders of the bankers' notes and depositors — were the exclusive owners of one and the same cash that was kept safely in the bankers' vaults; and one amount of cash created two balances of the same amount, one for the holders and the other for depositors. This double ownership remains a central feature of the present banking system.

In fact, Kim's claim of double ownership is doubly wrong: neither noteholders nor depositors of loose coin owned — that is, possessed a good title to — the cash to which their claims entitled them. Instead, as both the common-law bagging rule and its Continental counterpart, the concept of a depositum irregulare, made perfectly clear, whatever actual cash the banker retained that had originally come to him in the form of loose coin belonged to the banker alone.

Although Kim devotes many pages, in several different (if similar) articles, to embellishing and repeating his "trust scheme" argument, by doing so he merely succeeds in making it all the more evident that he has completely misunderstood the English common law of property in money. Moreover he has managed to do so despite drawing on the works of scholars like James Rogers Stevens and Benjamin Geva (though not David Fox), the plain language of which cannot possibly have misled him.

So, what happened? The answer is that, when it comes to the specific question of the ownership of coins handed over to a banker, Kim leans, not on such highly reputable legal historians, but on — hold on to your hat! — Murray Rothbard & Company, whose distortions he appears to have swallowed hook, line, and sinker!

Kim's debt to the Rothbardians is particularly clear in his assertions to the effect that goldsmith banking was "self-contradictory":

Goldsmith-bankers' deposit-taking was self-contradictory because it was simultaneously a loan contract and not a loan contract. Because deposits were repaid on demand, the ownership of deposits practically remained in the hands of depositors. But bankers lent deposits at their own discretion and in their own names, and they attained and retained the ownership of the loans.

But there's no contradiction. Notwithstanding what Rothbard and some of his devotees have written, as soon as depositors handed their loose coins over to a banker, that banker became the owner of the coins, while the depositors ceased to own them, either legally or "practically." What the depositors now "owned" was, no longer a certain set of coins, but a contractual right to demand an equivalent sum, whether after a particular term or on demand. Likewise the banker, upon lending coins received on deposit, though he certainly owns the loan itself — meaning the right to a future payment of principal and interest — ceases to own the lent coins. In short, the coins themselves never have but a single "exclusive" owner.

When Kim appears to muster more qualified authorities in support of his "double ownership" thesis, he does so by quoting from them selectively and misleadingly.  Consider the following passage:

As legal theorist Benjamin Geva rightly argues, "Fungibility of money…explains the depository's right to mix the deposited money instead of keeping it separate.  It does not necessarily explain the depository's right to use the money." A depository is still required to keep an equivalent amount of money deposited.

A reader of this passage might be excused for supposing that Geva himself held the opinion contained in its last sentence. In fact, that opinion belongs to Kim alone. Geva (whose concern is in any case with Roman rather than common law) merely wished to make the logical point that, as he puts it in a subsequent paragraph, "authority to mix does not entail automatically the authority to use" (my emphasis).

This is Serious

If supposedly scholarly elaborations of the myth that fractional reserve banking is inherently fraudulent make claims that are ludicrously at odds with the facts, while more popular presentations of the myth are downright  laughable, that doesn't make the myth itself either funny or harmless. On the contrary: by encouraging people who might otherwise be inclined to oppose heavy-handed government regulation of private industries to favor, on ethical grounds, the outright prohibition of many ordinary banking transactions, the myth that fractional reserve banking is inherently fraudulent strengthens the hand of officials and others who want to hamstring bankers for quite different, but equally unsound, reasons, not excluding a general dislike of free enterprise.

Yet (as I and others have argued often on this site an elsewhere), conventional fractional-reserve banking is capable of yielding enormous benefits to society. What's more, it has proven most capable of doing so when and where it has been allowed to flourish with the least government interference, including interference aimed at making certain bankers the beneficiaries of government favors. An unbiased and open-minded review of the historical record will make clear, to anyone who undertakes it, that it is not those nations that have heaped regulation upon regulation on most of their banks, while favoring one or several with privilege after privilege, that have enjoyed the greatest financial stability. It is those that have mainly relied upon open competition between banks free of special privileges that have witnessed the greatest financial stability.

As for those places that have actually gone so far as to ban ordinary banking altogether, if they can be said to have enjoyed financial stability, that stability has been purchased at a very high price, to wit: that of relative economic stagnation.


[1] In this respect Bagus and Howden remind me of my twin brother Peter.  When we used to play army together, I often managed, thanks to my well-honed tactical and stalking skills (and, let's face it, all around physical and mental superiority), to sneak up on him with my toy Tommy gun and let him have it at point-blank range, only to hear him repeatedly shout, "You missed me!" However, when Peter acted that way, I could always settle matters, without risking legal repercussions, by beating him up.

[2]I should not be surprised if some members of the anti-anti-Rothbard vigilante squad treat my reference to "Lord Keynes'" remarks as further proof (Exhibit "A" being my occasional references to "aggregate demand") that I'm a dyed-in-the-wool Keynesian, and as such someone all right-thinking free market types ought to ignore. For the record: I am not now, nor have I ever been, especially fond of Keynes' General Theory.

[3]I have since discovered that Mr. Kim did his postdoctoral research at the Department of Economic History and Institutions at Universidad Carlos III in Madrid.

  • M. Camp

    Huerta de Soto references a kind of possible contract, a deposit contract for fungible goods [1] [2]. In this contract, the banker promises to hold in reserve the same quantity of goods given.

    Thus, if a banker enters into this contract with more than one person, the moment the sum of the obligations exceeds the amount he holds, he has violated all of the contracts. Oddly, one can't identify any specific counterparty whose contract he has violated. If he violates one of them he violates all of them, since if he claims to have enough goods to satisfy one contract he is admitting that he does not have enough to fulfill the others.

    Suppose that a bank customer and a bank voluntarily enter into such a contract. Then the moment the banker enters into the business of fractional reserve banking, he has broken that contract.

    Therefore, by engaging in fractional reserve bankers have violated their contracts if and only if those contracts were deposit contracts (ie, promises to hold something for immediate repossession, as opposed to promises to repay a loan, which doesn't by itself imply promising to hold on to a deposit.)

    I wish less time were spent by both sides on what I feel are non-essential questions; I wish both would make at least one argument for their answer that (according to my view, above) is relevant to the question.

    [1] I won't use his term for it ("irregular deposit" contract) since it tempts us to be distracted from the point at hand into an irrelevant semantic dispute between him and others. To wit, did the term mean, in Roman law, a deposit contract, as JHdS claimed, or a loan contract (as "Lord Keynes" claims)?

    [2] I say "possible" contract for the same reason as above, to avoid a tempting diversion into a argument that masquerades as relevant to the point: "what kinds of contracts WERE made, as a matter of history?"

    • George Selgin

      "what kinds of contracts WERE made, as a matter of history?" I think I've made this perfectly clear, both here and in numerous other places. There were genuine bailments, inluding bailments of bagged coins, and loans, the default for loose coins. I hardly see how my insisting on this makes me guilty of wasting time on "non-essential questions." Nor can I imagine why you cannot detect any "relevant argument" in the case I offer as evidence here, or Fox's assessment of it. Try a little harder!

      It is Mr. Huerta de Soto and his followers who have muddied the waters by inventing "possible" contracts regarding the surrender of coins for which there is no historical basis, and then arguing as if such contracts were the "true" basis for early banking.

      • M. Camp


        Thanks for this reply.

        It seems I've communicated only ideas I didn't intend to, and caused offense where none was intended.

        I'm going to take some classes on writing skills, and may try again in future.

        • George Selgin

          No offense taken, M. Camp! But many imagine that the problem is lack of "explicit" enough contracts. The Rothbardians turn to that all the time, if pressed hard. It sounds moderate. But it isn't. It still implies the presence of deceit, where none exists. I only wanted to be absolutely clear on the point.

          • M. Camp

            Thanks again.

            If the public understand the contract, then the problem that many imagine doesn't exist, and there is no deceit. Do they? If not, does it matter?

          • M. Camp

            Perhaps the Rothbardians believe that free banking (free markets in FRB-based checking services, in particular), which implies informed consumers, would still cause business cycles. So perhaps they think that even if their moral objection (the fraud accusation) were addressed, these contracts should be forbidden on social engineering grounds, as a violation of property rights that is necessary for the public good.

            If so, I think they should say so.

  • John Hall

    Great piece. I had read quite a bit of the Rothbardian literature when I was younger, but the whole fractional banking is fraudulent thing never seemed to make much sense to me.

    All it would take to not make it fraudulent was just explicitly say on the contract that the banker could mix the currency and lend it out. There's nothing fraudulent about it at all so long as it is explicitly stated on the contract.

    Your argument is simply that the common law has implicitly granted the banker those rights. Good enough for me, but I'm not sure how well Rothbardians would be convinced by arguments from common law (preferring arguments from libertarian principles, they also wouldn't be convinced by the utilitarian arguments you make).

    • George Selgin

      "All it would take to not make it fraudulent was just explicitly say on
      the contract that the banker could mix the currency and lend it out.
      There's nothing fraudulent about it at all so long as it is explicitly
      stated on the contract."

      This misses the point, John. It was not necessary for the contracts to spell out in any greater detail what was implicitly long understood about "deposits" of loose coin. There is no violation of "libertarian principles" involved here. The "bagging rule" was transparent, simple, and generally understood, with roots going back to ancient times. To come along centuries after the fact and insist that there was no "explicit" language in the contract is just begging the question. It matters not what a handful of Rothbardians think needed to be explicit; all that matters is what reasonable persons could have been expected to understand at the time, which is precisely what the common law courts were concerned with establishing. That is perfectly libertarian. What's more, many Rothbardian's themselves have said so:

      • John Hall

        In that paragraph I trying to explain why their argument never convinced me. I first granted their argument that the current fractional reserve system is fraudulent, then I supposed that I could start a bank that explicitly states that I could mix money and lend it out in the depositors' contract. I could see no reason why that would be fraudulent on any reasonable basis. That's why it never made sense to me to claim that fractional reserve banking was always fraudulent. It was so simple to me to show a way that it wouldn't be fraudulent.

        What I liked about your article is that you provided an even stronger argument than mine.

        • George Selgin

          Thanks for this clarification, John.

          In arguing that FRB would be OK "if only" contracts were more explicit (e.g., every banknote has fine print saying "this note is backed by fractional reserves," or even indicating a specific reserve ratio), Rothbard's followers bring to my mind a story I once heard, perhaps apocryphal, about how Franco Columbu, having been badly injured during the "fridge carry" event at the World's Strongest Man contest, sued everyone in sight, including the refrigerator manufacturer, because it hadn't affixed a warning label on its product expressly stating that it was not meant to be carried rapidly while strapped on someone's back.

    • M. Camp

      What the law has granted the banker is the right to consider checking and other services as loan contracts, rather than deposit contracts. ("Mixing currency" is irrelevant to the discussion. No intelligent person would argue that he has a right to get back the same serial numbers of currency, regardless of the fact that George gives so much text over to stabbing this poor straw fellow to death.)

      I am interested in the same question you raise: what would Rothbardians today regard as an acceptable argument for FRB?

      So I asked Prof. Shostak the question, in the Comments section for a recent article of his on

      Would you consider it ok if customers and bankers voluntarily and knowingly entered into a checking services contract based on a loan (ie, on FRB)?

      He said yes! I don't take him to be abandoning the Austrian Business Cycle argument against FRB. But that is an economics question, not a normative one.

      Rothbard himself, if I remember right, based his moral (non-economic) argument only on the premise that banks know how the contract will be interpreted, but go out of their way to ensure that their customers think it's a deposit contract.

      I know from past comments that George questions the argument that customers are deceived about the effective (legally enforced) terms. I mentioned that I had conducted a straw poll over at, and found that most people believe they own "their" deposits. George pointed out that most people haven't really thought about it, and their beliefs are confused.

      I agree with him up to that point. But then the policy or legal question should be (I think) what is to be done about it?

      • George Selgin

        Poll questions are very tricky. We do own "deposits" if those are understood simply to refer to our (debt) claims against our bankers. The question to ask if whether deposited money is just piled up in the banks' vaults, or whether banks lend some of it.

        Moreover, that some people might supply a wrong answer proves nothing except that they are morons. The law doesn't insist that contracts be moron-proof. The law determines what is accepted understanding among reasonable persons.

        By the way, every ordinary bank deposit agreement out there says that the banker's relation to the depositor is that of a debtor, not a custodian or "fiduciary." Find your bank's version online and see whether I'm right!

        Finally, as I mentioned in another comment, the implicit premise of all the "FRB=Fraudists" is that they are much smarter than the average person. That premise can be tested. My own casual empiricism decisively rejects it.

        • M. Camp

          "Poll questions are very tricky. "
          You've said so before and I agree.

          "The question to ask if whether deposited money is just piled up in the banks' vaults, or whether banks lend some of it."

          I'm sure it is a question for some but not for me. My only interest is in the fungible goods deposit contract discussed by Huerta de Soto, and called by him the irregular deposit contract, rightly or wrongly. This includes a promise by the banker to hold the tandundem continually available for return on demand.

          You are referring to something completely different in your question, a distinguishable goods deposit contract. (To predicate something of "deposited money", like "it" piling up or not piling up, or banks lending some of "it" or not lending some of it, is to imply that the deposited money is distinguishable goods.)

          Huerta de Soto wasn't speaking of that contract. In fact, unless one makes money distinguishable goods (by bagging or segregating it), he said I think that that there is no possible meaning for a money deposit contract other than what he calls the irregular deposit contract.

          • George Selgin

            "This [irregular deposit contract] includes a promise by the banker to hold the tandundem continually available for return on demand."

            No, Sir. That is an assertion that Prof. Huerta de Soto makes, for which there is no further basis, as "Lord Keynes" has pointed out after careful review of the literature, and as I have indicated in my post. Repeating the assertion won't suffice to make it true! Find independent corroboration by a bona-fide (non-Austrian) legal authority, and then we'll talk!

          • M. Camp

            I think you may have misread my note. The antecedent of "this" is "the fungible goods deposit contract discussed by Huerta de Soto". Not "the irregular deposit contract".

            To defer to your disagreement with JHdS on the question of what that legal term referred to in Roman law, I use the words "RIGHTLY OR WRONGLY" in referencing his usage.

            Hope this clarifies what I meant.

          • George Selgin

            Well, perhaps. Anyway the "irregular deposit" was not what Huerta de Soto claims it to have been. It was essentially a mutuum. To claim that in their writings on these matters Huerta de Soto and Rothbard were "sloppy" with the facts is to be exceedingly–if not irresponsibly–generous.

          • M. Camp

            We'll have to agree to disagree, as we are talking past each other.

  • Ralph Musgrave

    Strikes me the fraudulent element in fractional reserve is the promise by banks that they can return $X to depositors for every $X deposited. That is clearly a nonsensical and dishonest promise when the money is loaned out: some borrowers do not repay debts.

    That is as much fraud is would a claim by a corporation that issues shares to the effect that those buying shares are guaranteed not to lose any money. The latter promise by corporations and mutual funds in the UK is specifically outlawed. That is, entities issuing those sort of securities must state on relevant literature that investors may not get their money back.

    Of course taxpayer backed deposit insurance and other taxpayer funded backing for TBTF banks changes things somewhat. In that case banking is no longer banking in the original sense: it becomes a sort of partnership between state and private banks. But certainly, absent that taxpayer backing, the above promise by commercial banks is fraudulent.

    • George Selgin

      "Strikes me the fraudulent element in fractional reserve is the promise
      by banks that they can return $X to depositors for every $X deposited.
      That is clearly a nonsensical and dishonest promise when the money is
      loaned out: some borrowers do not repay debts." The nonsense is in your argument, Ralph. Banks promises to pay their depositors on demand are equivalent to the promises bank borrowers themselves make to repay their loans. They are statements, not about what the bankers "can" do, but about what they "must" do if they are not to suffer legal consequences. The bank borrower who fails to repay a loan is guilty of breach of contract, not fraud. Ditto anyone who offers to deliver good or service X on day Y (or "on demand"), but who fails to do so. There is always some risk of nonpayment (bad weather; an accident; the wholesaler failed to deliver; failed crops, etc.); but there is nothing "nonsensical" about the promises in question, the bank deposit contract not excepted. Most times, in fact, such deposits are in fact honored; beaches are the exception, not the rule, and have been throughout the long history of banks and banking. Indeed, I suspect that delivery failures are far more common in other lines of business than they are in banking.

      The lengths of sophistry to which people are willing to go in order to avoid common sense on these matters, specifically when it comes to providers of banking (as opposed to other) services, never ceases to amaze me! For goodness sake, argue for whatever banking reform you like. But spare us the much casuistry!

      • Ralph Musgrave

        I agree with your claim that “Banks' promises to pay their depositors on demand are equivalent to the promises bank borrowers themselves make to repay their loans.” Or at least the promise in each case SHOULD BE the same.

        But prior to taxpayer backed deposit insurance I suspect the promises WERE NOT the same. That is, I suspect banks’ promise to depositors was along the lines of “your money is totally safe with us”, which of course it wasn’t. That’s fraud. Put another way, banks’ basic message to depositor was not along the lines of “Deposit your money with us, but in the event of us going bust, you’ll have to queue up with other creditors to get what you can.”

        As for taxpayer backed deposit insurance, billion dollar loans to banks at zero rates of interest during a crisis, and that sort of stuff, that’s an obvious subsidy of the above “impossible promise” that banks make. Subsidies do not make economic sense.

        Conclusion: since the above impossible promise cannot be made to work without a taxpayer funded subsidy, the promise should be banned. That is, banks should offer two basically different types of account: first, accounts where money is GENUINELY safe because it is not loaned on, and second, accounts where depositors money IS LOANED on, but it is made abundantly clear to depositors that there is no guarantee they’ll get all their money back.

        • George Selgin

          "I suspect banks’ promise to depositors was along the lines of “your
          money is totally safe with us”, which of course it wasn’t. That’s fraud.
          Put another way, banks’ basic message to depositor was not along the
          lines of “Deposit your money with us, but in the event of us going bust,
          you’ll have to queue up with other creditors to get what you can.”

          Your suspicions have no basis in fact, Ralph.Indeed the very existence of bank runs in the pre- deposit insurance days was ipso-facto proof that depositors were aware of the risk involved in keeping bank deposits. Only the most naive depositors can have been unaware of the fact that banks occasionally fail. One of the things I find least appealing in the arguments of 100-percent reservists is their tendency to assume that they alone are brilliant enough to have cottoned-on to grim realities of banking that remain forever beyond the ken of the vast majority of other, less enlightened human beings.

          • “Indeed the very existence of bank runs in the pre- deposit insurance days was ipso-facto proof that depositors were aware of the risk involved in keeping bank deposits. Only the most naive depositors can have been unaware of the fact that banks occasionally fail.”

            That doesn’t alter the fact that claims by banks to the effect that “your money is safe with us” is a fraudulent claim. Likewise any claim by a used car salesman that “We only sell quality cars” is fraudulent, if it turns out, as it frequently does, that relevant salesmen are knowingly selling defective cars.

            Re your point that “only the most naïve” depositors are taken in by the blandishments of banks, it’s PRECISELY the most naïve that we ought to be protecting. Defrauding a “naïve” person is a worse crime than defrauding a sophisticated person.

          • Milton_Hayek

            Prof S – is it a fair statement that FRB under the current US Federal Reserve backed system is far more economically damaging vis a vis the Austrian theory of the business cycle than under a free banking system using FRB due to the inherent theory of self-limiting note issuance by interbank clearings?

          • George Selgin

            Is this a rhetorical question? Of course I wrote a book about the stabilizing properties of free banking compared to central banking. But it isn't a just a question of Austrian business cycle theory. Once might not attach great importance to that theory to appreciate the advantages of a system that avoids granting any one bank extraordinary powers of money creation.

          • Milton_Hayek

            No, an honest question. I'm educating myself on free banking (reading your 1988 tome) and to me it seems that a FRB system WITH a central bank is the problem.

            I believe we agree on the point that decentralized power, be it political or economic is the best for a society for a multitude of reasons. As such then I am coming to the conclusion that FRB is mainly objectionable because in the hands of a CB with the power to "print" money at will, the money supply has no rational limits. No CB, rational limits return under FRB. Correct?

          • Thinking aloud….it could be said that the banking system prior to deposit insurance was full reserve of a sort in that depositors were not guaranteed their money back, thus their so called deposits were actually shares or bonds that could be bailed in. And full reserve equals having bank loans funded by equity, not deposits.

            Then around WWII taxpayer backed deposit insurance arrived. As a full reserver, I’d argue that taxpayer backing should be confined to deposits which really are virtually 100% safe because money is not loaned on. That can be justified on social grounds: everyone is entitled to a totally safe method of storing money. In contrast, letting your money be loaned on is to enter commerce, and it’s not the job of taxpayers to underwrite commerce.

            Put another way, if taxpayers are going to provide a phenomenally secure form of insurance for depositors, why can’t those who want to insure cars, houses or ships have an equally secure form of insurance?

          • Hu McCulloch

            Truly mutual Money Market Funds provide a promise that can actually be kept — they will just pay you your share of the current market value of their assets. As long as they stick to short term high grade paper, the present value won't fluctuate much, and perhaps not even noticeably. If depositors line up to withdraw, the return to reinvesting funds will go up, and a second line will form to put money back in.

            Unfortunately, most MMFs "penny-round" instead of being truly mutual. In doing so, they are unsoundly trying to emulate banks, and thereby are giving up their intrinsic stability and immunity from runs.

          • I fully agree with that criticism of MMFs, but that problem has been solved by the recently introduced new regulations for MMFs in the US hasn't it? Those new regulations effectively impose the rules of full reserve on MMFs: that is, MMFs which invest in anything other that short term government debt (as I understand it) have to let the value of stakes in those MMFs fluctuate with the value of underlying assets.

          • George Selgin

            The new regs do go a long way toward restoring "true" mutual status, at least to riskier MMMFs. They effectively restore the rues for them to what they had been when the industry first got started. It was the Reserve Primary folks, incidentally, who had lobbied for capacity to promise a fixed NAV back in the early 1980s!

  • Mike Sproul

    The argument that fractional reserve banking is fraudulent is easily dismissed. The more interesting question is whether it is inflationary. Rothbardians, along with mainstream economists, think that FRB is inflationary, either because it increases the quantity of money in general, or because it reduces the demand for base money. The real bills doctrine answers that FRB is not inflationary, as long as banks follow the normal practice of assuring that every new issue of either base money or derivative money is backed by assets of adequate value.

    • Milton_Hayek

      FRB, in the US central bank backed system, is by definition inflationary – inflation being properly defined as an expansion of the money supply and not a rise in the "general" price level.

      The quintupling of the Fed's balance sheet since 2009, and its payment of interest on excess reserves illustrates the difference (i.e. inflation vs a rise in the "general" price level) nicely, as the first is obvious and the second the subject of much consternation by those "targeting" 2% "inflation".

      I think where some get off base is insisting that a gold-backed currency cannot also rely on the RBD; if my currency is redeemable in gold and I have no theoretical issues with FRB, I can just as easily have my currency backed by gold and other assets of appropriate value under the assumption that redemptions for gold will be less than my combined gold + other assets reserves…

      • George Selgin

        "FRB, in the US central bank backed system, is by definition inflationary – inflation being properly defined as an expansion of the money supply and not a rise in the "general" price level."

        It is time to abandon this way of taking. No one uses "inflation" that way any longer except a handful of die-hard Rothbardians. It doesn't promote reasoned discussion to play with words' received meanings. One may feel nostalgic about the old terminology, but one ought not to insist on it long after it has ceased to be current.

        Also, your statement conflates the effect of FRB with that of having a central bank. Is the CB itself expanding? Than there will be "inflation" with or without FRB.

        • Milton_Hayek

          Current usages are not always the most clear – see the use of "liberal" in the US today. If we maintain the definition of inflation as an artificial increase in the money supply as opposed to vague, hard to reliably measure increases in "the price level", then we are free explain why inflating the money supply does not always result in price increases in general, or why it can result in specific price increases in discrete channels of currency flow – e.g. the financial markets; real estate; etc.

          Secondly, by referring to inflation of the money supply, we end the obfuscation of the cause of (generally/discrete) rising prices by referring to those as "inflation", since the cause is rooted in artificial manipulations of the money supply itself by the Fed.

          To clarify, I agree that FRB does not need a CB to exist, nor vice-versa, and that a CB can indeed inflate without the extra expedient of a FRB system. However, it is clear that the Fed was established in part to backstop liquidity issues in the US FRB system, and as a means to increase banking profits by doing so…

      • Mike Sproul

        Lloyd Mints (the RBD's harshest critic), thought the RBD was (barely) workable under gold convertibility:

        "The fundamental error of all three men (Law, Steuart, and Smith)… lay in the fact that they failed to see that, whereas convertibility into a given physical
        amount of specie (or any other economic good) will limit the amount of
        notes that can be issued, although not to any precise and foreseeable extent
        (and therefore not acceptably), the basing of notes on a given money's worth of any form of wealth–be it land or merchants' stocks–presents the possibility of unlimited expansion of loans, provided only that the eligible goods are not unduly limited in
        aggregate value." (Mints, 1945, p. 30.)

        I would argue that convertibility can only be maintained if backing is adequate. Therefore it is backing, not convertibility, that maintains the value of money.

        • Milton_Hayek

          What is the value of "backing" if convertibility is not allowed?

          The Bretton Woods gold standard comes to mind. The US government allowed only foreign governments to redeem and the US government inflated the money supply during the Vietnam War to avoid hiking taxes.

          The straw that broke the Bretton-camel's back was France watching the US debase the dollar and demanding its dollar holdings be redeemed…

          • Mike Sproul

            There are many kinds of convertibility, and many channels through which paper dollars can reflux to the Fed. There's gold convertibility, bond convertibility, loan convertibility, and tax convertibility, to name a few. In 1934, the Fed ended one kind of convertibility: instant gold-convertibility on demand. Even though the other types of convertibility remained, mainstream economists were caught up in the "inconvertible=unbacked" illusion.

          • Milton_Hayek

            "I would argue that convertibility can only be maintained if backing is adequate."

            By that use of the term "convertibility" in conjunction with "backing", one presumes you are talking about redeemability in specie, not the ability to exchange dollars for various kinds of assets ("bond convertibility, loan convertibility, and tax convertibility,").

            Typically, today's currencies are either fiat or specie backed. It would be highly unusual to find any currency redeemable in bonds, loans or taxes…

          • Mike Sproul

            Example: A government issues 100 paper dollars in exchange for 100 oz of silver, then it issues another $200 in exchange for $200 worth of bonds, then it issues another $300 on loan (i.e., in exchange for a $300 IOU), then it issues another $400 and spends it on an office building, while stating that the $400 will be gradually retired as people pay their taxes.

            These dollars can reflux to the government in exchange for oz. of silver, or for bonds, or as loan payments, or as tax payments. The dollars are backed by the government's various assets (i.e., silver, bonds, IOU's, buildings, and taxes receivable). If silver convertibility is suspended, but the other forms of convertibility remain in place, then the dollars are just as backed as before, and it would be a mistake to call them fiat money. A total of $1000 has been issued, and only after $900 has been redeemed for the government's non-silver assets would people be inconvenienced by the suspension of silver convertibility.

  • George Selgin

    Thanks for this comment, LK. Your posts addressing Huerta de Soto's arguments are extremely helpful. May they be more widely read!

    • lordkeynes

      Thanks. Here's a few extra points for your readers:

      (1) In Classical Roman law, the mutuum contract was originally deemed for the benefit of the debtor, and in its bare form carried no interest, but was gratuitous (W. W. Buckland, 1963. A Text-Book of Roman Law from Augustus to Justinian [3rd edn.] Cambridge: "Mutuum, as a result, perhaps, of its origin, was gratuitous"). Interest was by additional stipulation (or stipulatio in Roman contract law).

      (2) In contrast, irregular deposit (depositum irregulare) was supposed to be in the interest of the creditor/depositor.

      A prevalent view is that the irregular deposit was a later Roman legal invention to deal with the Greek concept of the parakatatheke, a broad term which can be a "bailment," "deposit," "trust," or "loan" (see H. T. Klami, 1986. “Depositum und Παρακαταθήκη,” in Hans-Peter Benöhr [ed.], Iuris professio: Festgabe für Max Kaser zum 80. Geburtstag. Böhlau, Vienna. 89–100), but in the specific context in question was just the Greek form of a loan.

      Greek law was not as well defined as Roman law, but the parakatatheke was, economically speaking, just another type of loan that Romans understood as a species of mutuum.

      It could be that unusual contracts by Romans played a role in the emergence of the concept of the irregular deposit too: e.g., an irregular deposit can have developed partly from instances where the money given to a banker, by mutual agreement, was technically a bailment until the banker decided to use it, when, again by mutual agreement, it then became his property and simply a loan (mutuum) by another name, with interest due to the "depositor"/creditor.

      If the banker had in fact not touched it when he became insolvent, then the money was still deemed a bailment and returned to the original depositor.

  • Hu McCulloch

    In Henry Maine's 1861 Ancient Law, he points out that the development of modern contract theory was impeded by the fact that in early Rome, eg the Kingdom that preceded the Republic long before Justinian's Civil Law, there was no distinction between a jus in rem (a property right emboded in a thing and a jus in personam (a contractual right embodied in a person). As a consequence, a debtor who failed to return money that "belonged" to a creditor was thought to have stolen it. The original remedy was that the creditor then instead collected the debtor as a slave. In more enlightened medieval times, when slavery was abolished (or at least slavery of white Christians …), defaulting debtors were at first beheaded and then eventually just thrown into prison for their "theft." It was only in the 18th and 19th century that liberty came to be regarded as inalienable and debtors' prisons could be replaced with clean-slate bankruptcy for contractual debts.

    That said, one could imagine a granary that, for a fee, held 100% reserves of grain whose ownership could be transferred by draft or withdrawn by bearer certificates. Depositors would then have a property right to a certain quantity of grain even though it had not been bagged.

  • Lawrence White

    Thanks, George, for an evidence-based account of the jurisprudence of fractional-reserve banking. The reasonable middle ground lies between damning FRB on the erroneous doctrine that FRB contracts are legally absurd, on the one hand, and affirming them by reference to the erroneous real-bills doctrine, on the other.

    • Mike Sproul

      The real bills doctrine is not erroneous; it is just misunderstood. Properly stated, it asserts that money is valued according to its backing, just like stocks, bonds, and all other financial securities. The common reason given for rejecting the RBD is that issuing new dollars in exchange for dollar-denominated assets provides no protection against inflation, since the inflation caused by new money reduces the value of debts, allowing debtors to borrow still more, and leading to a self-perpetuating cycle of more loans, more money, more inflation, more loans, etc. This argument is clearly circular, since it presumes that new money, even when adequately backed, does cause inflation. But the RBD says that new money, adequately backed, does not cause inflation, thus cutting off the self-perpetuating cycle before it gets off the ground.

      Simple example: A bank receives 100 oz of silver on deposit, and issues 100 paper notes ('dollars') in exchange. Even the RBD's harshest critics (Lloyd Mints, for example) would concede that if the bank received another 100 oz, and issued another $100 in paper money, then $1 would still be worth 1 oz., since the bank now has 200 oz backing $200, where before it had 100 oz backing $100.

      The trouble comes when the bank issues another $100 in exchange for 100 DOLLARS WORTH of assets. RBD critics allege that these new dollars would be inflationary, would reduce the value of the dollar-denominated assets, and off goes the self-perpetuating inflationary cycle. Not true. The $100 worth of new assets are obviously able to back the $100 of new money. For one thing, the $100 of new assets could be used to buy back the $100 of new money, so they back the money just as well as 100 oz of physical silver.

      By analogy, GM could issue new shares of stock, in exchange for call options on GM stock, and GM's share price would be unaffected.

  • TR

    This was an interesting read but the whole thing is silly. Frankly, it is legal because these people said so. No reason necessary, their decisions are law.

    The Bank of England published a paper a few years ago debunking both the Financial Intermediary and the Fractional Reserve Theory of Banking.

    Are they wrong? The business of Goldsmiths may have been accurately described by either side of the debate here, but in today's context the whole argument is obsolete. It's too different for technical legal determinations from 300 years ago to hold water.

    • George Selgin

      The B of E paper doesn't do much for me. In any event, I am not elaborating here a "theory" of fractional reserve banking. I am merely explaining the historical legal basis for such.

      And whatever else may have changed since ca. 1650, the legal question remains: who does money "deposited" in a bank belong to? While it would indeed be idle to address that question were the matter not in dispute, because a vocal minority insists that fractional reserve banking involves fraud or theft or both, there is some potential gain to be had by trying to disabuse them of that belief. And even if the question were posed only w.r.t. the early days of banking, it would remain a valid subject for discussion and debate.

      • TR

        I suppose it is a valid topic for monetary historians, but we should leave it at that.

        Even if this vocal minority can forget about the origins of what they call fractional reserve banking as they misunderstand it, what about our current system? I reckon that those who believe in the writings of Rothbard would be just as opposed to this system as the former because it appears on the surface to be a system of something for nothing that irresponsibly expands credit and leads to dangerous disequilibrium, waste, and unnecessary liquidation run for the benefit of a few and at the cost of everybody else.

        I'd like to know more and discuss the legal basis of that system, and I think it would be both erroneous and intellectually dishonest to try and apply the same arguments and conclusions from this historical case study to discuss the operations of banking today.

        Apples and Oranges with too many smart people trying to change the subject to avoid talking about it.

        • George Selgin

          Apart from its interest to banking historians themselves, the legal history matters because the Rothbardians themselves lean heavily on their version of it, TR. Showing them up on this part of their turf is as good a way as any to discredit them in the eyes of their relatively salvageable adherents.

          Believe me, I've addressed other aspects of the Rothbardian position as well.

          • Warren

            For such strong proponents of the market they sure don't trust it when it comes to banking.

          • TR

            Thanks for your responses George. I'm familiar with their position on banking in general but less so with the legalistic basis for it. Either way, something just doesn't add up here.

            The Rothbardian interpretation may have shaky legal foundations, and I do agree that they lean on it for their strong anti-bank sentiment, but that says absolutely nothing about the economic conclusions drawn from their analysis.
            If they are valid, no amount of misinterpretation of legal history can discredit them because they have merit based on economic truth. That's why I wrote earlier that this whole topic is sort of silly.

            And if you think they are totally wrong, then address the issues and explain why their ideas do not hold up. If we're talking about the properties of soda and I tell you that Coke is sweet and Pepsi is salty, does my nonsense about Pepsi nullify my accurate observation about Coke? Simple language, but it's very relevant to the topic at hand and asking it keeps us honest and on target.

            In any event, you're writing about history so that's fine and good as long as you stick to it. I'll look for your other articles on the Rothbardian position now since I'm relatively unfamiliar with the actually relevant arguments against them.

          • M. Camp

            As I may have mentioned before, I don't know what the Rothbardians want. But if they just want bankers and their lenders to write "loan" on their loan contracts and flyers, and "deposit" on their deposit contracts and billboards, it would be a cheap solution.

            And it would not be at all revolutionary. In fact, EVERY other loan contract that anyone signs (a mortgage, a car loan, a business loan) says it's a loan in plain language.

            EVERY other deposit contract (hotel safe, safe deposit, storage facility) specifies clearly that it's a deposit contract.

            Now, George has just recently challenged us to actually READ our checking account contracts. If I can find it I will, and if it clearly states loan terms, I will apologize to George and all the others I've misled (on this subject only, not all the other misleading comments I've made). But I think he's bluffing. He knows I can't stand paperwork.

            If I do read my contract and it's not what Murray said (obfuscatory crud) but a clear loan contract, I will switch gears, and greatly enjoy lording it over the Rothbardians. "Did you ever stop and READ your bank contract, you fool?". It is a win-win for me.

          • George Selgin

            Just tell me your bank's name and I will check for you!

      • Fed Up

        "The B of E paper doesn't do much for me."

        What is wrong with the paper?

        • George Selgin

          Hard to sum-up in a comment, Fed Up. Part of it is the authors' failure to appreciate the role of the interbank settlement process in limiting bank credit expansion and in making that expansion depend on available reserves.

          • Fed Up

            "Part of it is the authors' failure to appreciate the role of the interbank settlement process in limiting bank credit expansion"

            I don't get that one at all. Maybe you can convince me somehow. That is one reason why I want to assume just one commercial bank. Then, once that one commercial bank model is correct, add more than one commercial bank.

          • George Selgin

            The problem is that you also don't get the importance of clearings and settlement, which are ONLY relevant to a multi-bank set-up! With one bank only, nothing short of an "external" reserve drain limits expansion. The workings of a competitive system cannot be derived by extrapolation from that of a one-bank (monopoly) arrangement! Cf. Macleod, Principles of Financial Intermediation (best treatment I know).

          • Fed Up

            "The problem is that you also don't get the importance of clearings and settlement, which are ONLY relevant to a multi-bank set-up!"

            Not necessarily. Because of the fed, I don't find it as important as you do (for now I am assuming solvency is not a factor). I might come up with some scenarios to describe what I mean. Like I said, the idea is to get the one commercial bank model correct, then add more than one commercial bank.

      • M. Camp

        I disagree. I think that the legal question, is not "who does money 'deposited' in a bank belong to?" In fact, I believe that that question contains an implicit false assumption, that money is not fungible. To have a property "belongs to the bank, or does not belong to the bank" something has to exist. In other words, it has to be distinguishable. But money is fungible, not distinguishable.

        The legal question is "what obligation does the bank undertake in the case of a checking or savings account?"

        There are two possible agreements of interest.

        (1) The bank and the customer agree to a deposit contract for indistinguishable goods

        Then the bank is obligated to make the "tandundem" (equal quality and quantity of goods) always available for return on demand. If it holds 100 m.u. and promises two customers that it will hold 100 m.u. each available to them on demand ("on deposit") then it has violated the terms of the contract.

        (2) By mutual agreement, the bank has borrowed 100 m.u. each from two customers, with terms "repayable on demand".

        If the bank fails to hold any money at all, it has not violated its contract.

        Either contract is valid in a free society and either should be enforced by law.

  • Warren

    Why are the 100% reservists so focused on gold? They totally ignore the other assets the banks had that could be sold to cover any liquidity problems.

    Is a bank taking a day or so, (if it would even take that long) to sell off some commercial paper or bonds really an imposition on a depositor?

    And how many times did it even need to be done?

    I admit I have not read all the criticisms but the ones I have read don't take the clearing system into account. The clearing system is the engine that made the whole thing work but yet gets no recognition.

    They love their theories and ignore the actual history.

    • Ralph Musgrave

      It's news to me that 100% reservists are focused on gold. Milton Friedman advocated 100% reserve and said nothing about gold. Same goes for Lawrence Kotlikoff, Irving Fisher and all the other advocates of 100% reserve.

      • George Selgin

        Quite correct, Ralph. It is mainly (though not just) the Rothbardian 100-percentists who also favor gold over fiat money.

      • Warren

        Well then they've missed the point. Isn't a 100% reserve supposed to mean 100% instant liquidity?

        And wouldn't that mean 100% zero-counter-party-risk? Because are you truly liquid if you have to rely on another to uphold the value of what assets you hold?

        So from their POV doesn't that mean 100% reserves in gold (or another PM)?

        • M. Camp

          I don't know what 100% reservists think about fractional reserve banking, beyond that they don't think it's honest, but maybe they do think it's honest, or maybe they think it would be honest if it were honest. And they think it is the cause of the business cycle. I have been trying to find that out.

          But no, Friedman didn't miss the point. A despotic law forbidding shared pools of fungible goods like money, with the resulting surplus reserves being lent out, and the interest income shared by the pool members (directly, or through free checking services provided by their agent) does not depend on gold money.

          You can have a centrally managed ledger money and still outlaw voluntary agreements by money-holders to capture the benefits of pooling money and lending the freed-up wealth.

    • George Selgin

      "The clearing system is the engine that made the whole thing work." Warren, I think you and I may be among the world's only members of the clearing system fan club. Would that everyone could appreciate the full extent of that system's regulatory capabilities.

      • Warren

        You should write a script for "The Clearing House Rules" wherein we follow a disreputable sort as he tries to set up a fraudulent bank and all the many ways the existing system stymies him.

        • Warren

          That's kind of, but not completely, a joke.

          However Good Money deserves to made into a documentary. And that is no joke.

          I don't know how that would happen but I hope it does.

      • M. Camp

        Warren, you, and me. Don't forget me.

        There is no more brilliant example of the capacity of free people to identify and solve even the baffling problems of money and banking, without intervention by politicians, than the clearing systems that you and others have described.

        I wish every intelligent, well-intentioned money/banking interventionist would read this history. It would open their eyes.

  • Mattyoung

    A subject fraught with multiple semantics.

    First, this is a highly regulated monopoly and lots of government resources and accounts ultimately end up on the deposit sheet. It is not as fractional as folks claim.
    And there is the evidence, it takes government 60 years to go bankrupt, not ten. Hence it sort of works. Look how accurately we manage seasonal adjustments; proof that the account has worked.

    Why fractional reserve? Because none of us know what the whole and fraction parts are until we hit the trading pits. We have discrepancy, it is part of discovery, and sets the bounds on price. Insures demand and supply queues are stable.

  • Hu McCulloch

    "By the time that Banks v Whetston was decided, in 1596, the "bagging principle" was old-hat. Yet another half-century or so was to pass before England's goldsmiths would pioneer there the practice of fractional-reserve banking."

    In fact, fractional reserve banking had been practiced across Europe by Italian bankers in the 1400s if not earlier. Goldsmiths may have been the first English bankers in England, but they set up shop on Lombard St, where the Lombards had already been banking for 200 years or more. See "Rise and Decline of the Medici Bank", by Raymond de Roover.

    A good topic for an eventual blog post here, perhaps!

    • George Selgin

      I agree. I had tried, though not adequately, to suggest that the goldsmiths were the first fractional-reserve bankers in England only, rather than the first ever. Hence my later statement that "I've never questioned the standard view that, _in England at least_, goldsmiths pioneered fractional reserve banking" (my emphasis). Besides de Roover A.P. Usher's books is very good on continental banking; and of course, one might (with Temin's help) trace the history back still further.

      Meir Kohn at Dartmouth has also been long at work on the early history of banking in Continental Europe.

  • Hu McCulloch

    There was a very interesting article in the JMCB in 1986 (16:48-96) by Jeffrey Williams on "Fractional Reserve Banking in Grain", in which (as I recall) he shows that Chicago granaries sometimes issued warehouse receipts in excess of the grain that was physically present. However, (as I recall), the missing grain was ordinarily en route to the granary on a train somewhere. Perhaps the granary had agents at the remote railhead who took legal possession of the grain on behalf of the granary when it was loaded, so that the granary in fact had possession of 100% reserves, but I haven't read it for a long time.

    I see there is also a new paper by Jason Donaldson, Giorgia Piacentino and Anjan Thakor on "Warehouse Banking," at (MS 9/16/16). It gets very mathy and I haven't studied it, but I see that they cite Rothbard's Mystery of Banking, and so presumably at least address the issues at stake here.

    • George Selgin

      Actually that Donaldson et al. paper rests on the same misunderstandings I and others have been trying to lay to rest here and elsewhere, declaring, for example, that "The warehouse [bank] makes loans by issuing 'fake' warehouse receipts—those not backed by actual deposits—rather than by lending out deposited goods." I have in fact corresponded with Giorgia Piacentino, one of the authors, about this.

  • Frank Wiebe

    I'm late to the comment party as usual. These 100% reservists (or at least there fans) are also the most skeptical about cryptocurrencies. Perhaps it's a problem with financial Luddite-ism.

    • George Selgin

      I hadn't noticed that connection, Frank. It's odd, really, since bitcoin (among others) involves no credit or lending at all. That they should be opposed to fractional bitcoin _banking_ I would understand!

      • Still, the main principle should be flow of rather than bag can value increase in time unless there is movement or at least some type of exchange..i.e. one dimension set as time is not enough to characterize so many processes

      • Frank Wiebe

        I think it might be because cryptos are fundamentally entries in a distributed ledger. When they hear that the 'coins' are entries in a ledger, their instinctive reaction is to be very skeptical.

        What few people know is that there is plenty of reasons to perform fractional reserve banking with cryptos for example: Cryptocurrency can be traded through proxies such as bank notes when the power goes out, until it comes back on, though becoming dependent on banks fiduciary media for the purpose of trading cryptocurrency when the power goes out is not Ideal. It's the reverse of what we do with physical cash. Cryptocurrency has to be turned into fiduciary media to make it more physical, when needed.

      • Aaron Cuevas

        They are doc. It's the lack of "physicallity" of FRB and Bitcoin that a makes them scare.

        Civilization has its right wing and left wing discontents.

    • Hu McCulloch

      It seems to me that the main difference between Bitcoin and Bernie Madoff's Ponzi fund is that whereas Madoff fraudulently claimed that his fund had assets to back his accounts, Bitcoin is upfront with the fact that it has no assets.

      • Frank Wiebe

        There's also the fact that Bitcoin is not managed by anyone, it's not a fund, it has utility beyond being mere numbers and Bernie Madoff gave dividends.

        You can use it for tax evasion, buying illegal goods on the deep web, It is a last resort source of funding for those who make content deemed as politically incorrect when Visa MasterCard Paypal Patreon and Adsense all block you from receiving funds(It has happened to people like Christopher Cantwell), it can be transferred globally without third party involvement, you could be stripped naked and receive a colonoscopy from the TSA and still cross the border without losing access to it.

        It's not a Ponzi scheme, it's a likely asset bubble. Get your terminology right.

  • What never occurred then, were that regulators authorized banks to use one fraction for the “safe”, and one for the “risky”

  • Aaron Cuevas

    Thanks for doing this. Please keep this discussion on. Many people that have sound reasons to oppose the FED, will end up just giving the monetary system to Congress so post-modern Bryanites can inflate it into a "Bannana Republic" hyperinflation. And then blaming the free-market.

  • jdgalt

    I find this article not only completely unpersuasive, but to be as complete a change of subject as it accuses its critics of frequently doing.

    The view that fractional reserve banking is fraud is not based on the idea that a depositor owns particular coins, but rather on the fact that the institution does not keep enough actual money to be able to pay back all its depositors immediately if they should ever exercise their right to so demand, and therefore that the institution is derelict in its fiduciary duty. Modern law addresses this issue by ruling (morally wrongly) that banks are neither fiduciaries nor bailees — while keeping that fact a deep, dark secret because otherwise no one would trust the banking system. That absolutely is open-and-shut fraud, both by the banks and the system itself.

    • George Selgin

      Well jdgalt, I can only reply that the fact that an argument fails to persuade someone is not necessarily the fault of the person making it.