Free Banking, the Balance Sheet and Contract Law Approach

For new readers to this site who are not aware of the debate that exists within the Austrian School, there are those who are supporters of 100% Reserve Free Banking and those who are for Fractional Reserve Free Banking. The importance of this debate is that the School, whilst being the only School in economics to predict the crash, does not have a uniform policy prescription, or at least one policy prescription to fix our economy and put it on a sound and stable footing going forward.

There are a number of policy recommendations from varying branches of the School. We have given a platform to some of them on this site. To caricature: for the Keynesians, it is a matter of spending more via the government, for the monetarists it is print more and more money until the economy fixes itself.  Until the differences are resolved within the Austrian School, there can’t be one coherent message to enable  us to get out and engage with the political, academic and journalistic fraternities. This article is an attempt to resolve those differences that lie at the heart of our School, rendering it currently impotent in its forward-looking policy prescriptions.

So far, the only two point I see amounting to total agreement between both sides is that the Central Bank should be abolished. If there was a free choice in currency, people would almost certainly choose a commodity-backed currency, as always existed in history prior to the total move to money set by decree of the State. The flavour of what this would be is hotly debated though.

This article is not written to scholarly Journal standards, indeed it is written on a Saturday afternoon and my working life is entrepreneurship and not academia. I aim to stimulate debate within the wider Austrian academic community and beyond, to thoroughly flesh out some of the research areas I recommend and, hopefully, provide grounds for moving forward on a unified, or as near as damn it unified, basis.

A Quick and Dirty Recap on the Differences

The Fractional Reserve Free Banking School

They say all bank deposits are loans. This is the correct position in law since Carr v Carr 1811 in this country.

Therefore in a free banking world, if bank A issues promissory notes (this is a throw back to when the promissory note was redeemable in gold, but the word credit could just as easily be inserted in the place of promissory notes and is more applicable to our day and age) and if bank A lends to its customers in excess of its inherent worth, then Bank B, a more conservative bank and a competitor, may present Bank A’s notes for redemption (or create rumors in the market place to encourage Bank A’s notes to be redeemed) in the knowledge that it has been over inflating its issue.  This will cause a run on their competitor’s bank.

This is a good free-market self correcting mechanism that will make sure all parties behave honestly, as large credit-induced booms that will go bust would not happen under this system. Therefore, by removing the ability of banks to go to a Central Bank to be bailed out over night via the discount window, in a Fractional Reserve Free Banking system with a multiplicity of credit / promissory note issuers, never could an over issuing bank go to the Lender of Last Resort, the Central Bank, and get overnight funds to pay its depositors’ redemption requests. The fear of imminent bankruptcy keeps the over issue of credit / promissory notes in a very stable position.

If we think about what has happened since the “Big Bang” in the mid 80s under Lawson when lots of restrictive practices in the City of London were abolished and the legal reserve ratio was abolished (it is now a voluntary system and sits at around 3%), we saw an explosion of credit that has created at least the late 80s / early 90s boom and bust, the late 90s /early 2000 boom and bust and the mother of all booms and busts in the late 2000s. So the free market has certainly been allowed to work as much as possible.  As it over extends and under extends it produces catastrophic and distorting results, as we have seen.

This system is not, in fact, free market capitalism, but corporate capitalism. This is because the whole system is underpinned by the Central bank, which lends overnight to the banking systems so they can match their lending with their redemption demands. On the plus side for the State, they can run this system whereby debt is sold via the banking system i.e. their client banks, as all require some kind of liquidity support at some point in time be it explicit or implicit.  They can, more importantly, monetize the debt – or, in modern parlance, do QE, which is nothing more than putting more money into circulation than existed before, thus devaluing the pound in our pocket.

This self correcting mechanism of the market is compatible with liberty and does indeed free money from state control. What is more, if you allow people to choose their own money, then the state becomes totally uninvolved with banking and money, and just as we do not have an apple or jam boom and bust, we shall not have a money or credit boom and bust.

The 100% Reserve Free Banking School

Turning to supporters of 100% reserves, the participants in this debate would agree that there should be no Central Bank and free choice in currency with a strong disposition that people, if left to their own devices, would choose gold or silver or a combination as they have overwhelmingly done in history in most places of the world.

Their problem and, indeed, mine is with the very nature of the demand deposit: the relationship between the bank and its depositing customer. Unlike the Fractional Reserve Free Bankers, the 100% Reserve Free Bankers say that when the vast majority of people deposit money in their bank account, such as their salary and their savings, they think that it is “theirs” and indeed it is safe. Of course we all know that banks own “your money” and indeed they owe you “your” money. A bank statement is the bank saying they owe you want you think is “yours.”

The loan you make to the bank is used by the bank (one loans to the bank in ignorance, I suggest). Indeed, once in the banking system, with its ability to multiply on average in the UK up to 33 times the level of credit, with only 3% of your money ever kept in reserves, it is clear that you only have 3% of “your” money in the banking system at any one point in time. As long as no more than one in 33 people walk into the bank to withdraw that which they think is theirs at the same time, then the claim or “their” money is still safe.

This rapid expansion of credit is the start of the Austrian Theory of the Business Cycle. I struggle to see how anyone can doubt the causes of the Business Cycle and both parts of the Austrian School are united on this. Now, the 100% Reserve advocates say that even under a free banking system with no Central Bank, there will still be boom and bust. This is because as the economy grows and there are more participants in the economy, transacting the sale of more goods and services (it is said by all economists except the 100% Reserve Free Banking advocates) the need for the services of more money grows. A series of fractional reserve free banks can issue extra money in the form of credit or promissory notes and you can thus accommodate the needs of trade.

This will cause a boom and bust, just as the current set up with a Central Bank under pinning the system does.  This will be the case as every bit of credit issued not backed by prior real savings will cause a lengthening of the structure of production that will set in motion the capital misallocation of resourses that will look like a boom. But as there are no real savings to support the outcome of this new investment activity backed by bank created credit, that will indeed lead to a bust. If you are not happy with why this will cause boom and bust, I suggest cribbing up on the Austrian Theory of the Business Cycle, in particular Hayek in Prices and Production (PDF).

100% Reserve Free Banking advocates will say that to accommodate the growing population and the needs of trade, we should be happy at the spontaneous increase in our purchasing power of our monetary unit (i.e. falling prices). This is wholly beneficial to us all and is not in any way ever going to cause boom and bust.

Jesus Huerta de Soto in his brilliant book Money, Bank Credit, and Economic Cycles (PDF) in Chapter 9 adds a very seductive and interesting twist to the debate when he outlines a reform program that would lead to the total paying off of the National Debt (a very topical issue now!) and a very sound, solid banking system going forward. I have summarized these thought here: A Day of Reckoning .

A Way Forward, the Balance Sheet and Contract Law Approach to Free Banking

On the Nature of a Bank Deposit

I outlined the start of my case in this article last week: Why All Banks Are Insolvent.  It does seem to me that it is critical to decide: should current bank deposit contracts be loans, as they lawfully are, or safe keeping / custodian deposits? If they are loans, the Fractional Reserve Free Bankers have the day, if they are custodian accounts or safe keeping accounts the 100% Reserve Free Bankers have the day.

As mentioned in that article:

I commissioned a survey for the Cobden Centre in Oct 2009 with ICM over 2,000 people. 74% of people think that they are the legal owner of the money in their current account rather than the bank. Paradoxically 61% know that their money is lent out even though 67% want convenient (now) on demand access. The full results of this survey will be published shortly in another paper.

This would overwhelmingly suggest that people want safety, they think their money is theirs, even though it is the banks’. They would also like it lent out as long as they can have it back when they want it. I conclude people want safety and easy access, but really they are confused!

It is worth while understanding how a legally binding contract is determined and pondering the glaring confusion that exists with a bank deposit contract.

Law of Contract

Traditionally the formation of contracts has been analysed in terms of offer, acceptance, consideration (and later, intention to create legal relations).

Meeting of the Minds

Horrocks v Foray [1976]:

In order to establish a contract, whether it be an express contract or a contract implied by law, there has to be shown a meeting of the minds of the parties, with a definition of the contractual terms reasonably clearly made out, with an intention to affect the legal relationship: that is that the agreement that is made is one which is properly to be regarded as being enforced by the court if one or the other fails to comply with it; and it still remains a part of the law of this country, though many people think that it is time that it was changed to some other criterion, that there must be consideration moving in order to establish a contract.

Clearly, the depositor does not think he is making a loan to the bank, and the bank knows it is not safe-keeping but on-lending. There is no “meeting of minds.”

The standard which is adopted in deciding whether or not a contract has been concluded is objective rather than subjective. Smith v Hughes (1871):

If, whatever a man’s real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party, and that other party upon that belief enters into the contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party’s terms.

It would seem that there is confusion at best about the real intentions of the depositor.


Acceptance must be communicated to the offeror – Entores v Miles Far East Corp [1955].

The general rule is that acceptance of an offer will not be implied from mere silence on the part of the offeree and that an offeror cannot impose a contractual obligation upon the offeree  by stating that, unless the latter expressly rejects the offer, he will be held to have accepted it – Felthouse v Bindley (1862) 11 CB (NS) 869.

In Order to Create a Binding Contract, the Contract Must be Certain

Scammell and Nephew Ltd v Ouston [1941] – Viscount Maugham – “in order to constitute a valid contract the parties must so express themselves that their meaning can be determined with a reasonable degree of certainty. It is plain that unless this can be done…consensus ad idem would be a matter of mere conjecture.”

Confusion does not constitute a lawful contract.

Previous Course of Dealing Does not Mean Binding Contract Exists

University of Plymouth v European Language Center Ltd [2009] – one party could not rely on an exchange of e-mails and telephone calls as establishing a binding contract with another party, even though the parties had worked together for some years.

It would be very interesting to test that if over the course of a lifetime of banking you always thought that you were depositing for safekeeping if the law courts would give the above interpretation when there has in the vast majority of cases, never been a meeting of the minds.


Tweedle v Atkinson (1861) – consideration must move from the promise.

The classic definition of consideration was expressed in Currie v Misa (1875) LR 10 Ex 153:

a valuable consideration, in the sense of the law, may consist either in some right, interest, profit or benefit accruing to the one party, or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other.

Your banking in some way shape or form , even your “free” bank account, does invariably have some charge somewhere down the line, they get you somewhere, so I would be happy that there is consideration in the current bank arrangements.

Intention to Create Legal Relations

Meritt v Meritt [1970] – In determining the intention of the parties an objective test is used by asking if reasonable people would regard the agreement as legally binding.

With two parties so at odds, I cannot see how we have any intention to create legal relations in the vast majority of deposit contracts.

I would even go as far to say that the vast majority of deposit contracts are unlawful under the Law of Contract.

A sensible policy prescription should be to align the banks to the account holders’ wishes and make the deposit contract one where the bank holds the depositors’ money as custodian / safe keeper and not as borrower. Make this contract explicit. Charge a fee for custodianship / safe keeping.

When a depositor wants to earn some interest on his money, allow an explicit lending contract to be put in place so that the depositor understands that his money has been loaned out, and that it is his no more. He now has a right to his lent money back some agreed time in the future, with a coupon paid.

This allows banks to go back and do what their time honoured role has been, to mediate between the saver and the borrower and to act as custodian and safe keep money for their clients. This is unashamedly boring, and steady as you go banking.

Should a bank be allowed to offer explicitly a fractional reserve account, when you as the depositor know right from the off that they are going to lend your money out a number of times over so there are many claims to this original money that you have deposited? I would say yes under contract law so long as it was explicit and conformed to all the case law listed above, but fundamentally no as this would require the bank to exist under legal and accounting privilege. I work from the assumption that all state sanctioned privilege is a bad as one party is exploiting another lawfully at the expense of the other party. This is antithetical to liberty. I would also add that there could be a similar type of fractional contract but this would be within the realm of hedge funds which operate under the normal commercial law that we all work under – except banks. This will be explored later.

The Balance Sheet Approach

In an article I wrote last week, I outline what I term the Balance Sheet approach to banking. I compare the balance sheet of the UK’s largest company BP, with that of one of our largest banks, Barclays. In a separate article, I look at the accounting treatment of its record profits for 2009 and some remarkable accounting trickery , all perfectly lawful  – except that I would not be able to do and such trickery in my business. The link is here More on Banking and the Barclays 2009 Results. The important thing to note is that BP has current creditors and long term or non current creditors. Barclays has only creditors. Why does BP split out its current creditors from its long term ones?

As far as I am aware, in the UK Under International Financial Reporting Standards and UK Generally Accepted Accounting Principles, you have to report your creditors as current, under one year and over one year. This shows the outside world what your ability is to pay your debts, as and when they fall due. Most companies will always aim to match their current creditors with their current debtors, their less than one year creditors, but over current creditors, with the equivalent matching on the debtors’ side and with the long term debt being matched with long term creditors.

Most companies in this sense in the commercial world, other than banks, would indeed be 100% reserve companies and not companies that only keep a small fraction of money aside to pay their creditors. A very good research project for a graduate would be to map out all the FTSE 100 companies and see what percentage were 100% reserved and what were not. With those that were not, what were above 95% , 90%, 85% etc. In reality, if they are not very highly reserved their auditors will not sign off their accounts and they run the risk of insolvency. There is a grey area between a 99%, 95% reserved company as to if it is solvent and at the extreme end, the banks, where they are 3% reserved to current creditors!

Banks need another set of laws that only apply to themselves to operate. Thus they have a privilege accorded only to them. This allows them, like Barclays, to have creditors and debtors only. So all the current money on demand is lumped in with a catch-all lump of all creditors. This implies to the outside world that they perfectly balance their short term creditor needs, i.e. withdrawals with their long term debtors’ repayment profiles such that they never prejudice the current creditor losing his/her shirt. I do not know what specific accounting laws that the banks are allowed to audit to, but they sure are not GAAP that applies to all other commercial organizations. I do intend to find out when I have time, and again, this could be a rich source of research work for a graduate. Notwithstanding, it is clear there is one law for all commercial companies and one law for banks.

It should be clear that a lending and custodian bank where a deposit contract of either type conforms to the Law of Contract, at all points in time will conform to the normal commercial law.

It is clear that a Fractional Reserve Free Bank violates the law of contract and the normal commercial law for every company, thus they have accounting and legal privilege. A custodian / lending bank, conforming to the law of contract and normal commercial accounting law, could not compete with a fractional reserve free bank as the latter would be able to fully use all of its clients’ deposited money to do whatever it pleases, including the creation, on average, of 33 times more deposits. If we take the example of Barclays with some £300 billion of current creditors, the ability to fully use this would place it at a distinct unfair advantage with all other commercial enterprises. Indeed, under the current law, if would be very difficult indeed for a custody / safe keeping bank to get off the ground, the odds are so stacked in favour of the current arrangement.

The Case for Free Banking Under the Normal Commercial Law

Hence I conclude that the current system of making sure companies disclose and match timed liabilities to keep solvent is good and fair to all parties.  The anomaly that is fractional reserve banking, be it in its Central Bank sponsored format or in its hypothetical format with no Central Bank, can only work with this legal and accounting privilege in place. This sets one party (the banks/bankers) at a distinct and unfair advantage to another parties (ie all other people / enterprises).

As the Fractional Reserve Free Banking system ex the central bank can only work with the positive intervention of legal privilege and a setting aside of all the principles of contract law, it would seem the case for it is negligible indeed. Added to the fact that there is still the possibility of business cycle inducing properties as they could automatically grow to the needs of trade, we need to map out an alternative that allows people to keep safe, save, invest and speculate.

In the above, I outlined the two forms of deposit that would accord with the normal commercial law that would exist without legal and accounting privilege, i.e. a straight forward safe keeping or custodian contract and a straight forward loan contract.

I would also propose the possibility of a third, called a “High Risk” deposit. This is a deposit contract that again is explicit, that allows one party to deposit in the full knowledge that the institution may or may not engage an over issue of credit, or even promissory notes that may take the form of money if they can become a generally accepted medium of exchange, provided that like in any other company, they are subject to audit and a market valuation up or down of underlying assets at least once per year. As in a normal company’s balance sheet, each year, your properties or other chattels are re valued up, or impaired down, so you can and should do this with the “High Risk” deposit account. This way, there is no extension or contraction of credit over the audit year that does not have real wealth behind it. The boom and bust implications of functioning this way are that of any normal commercial activity.


Any deposit can be made between freely consenting adults provided it is enforceable under the Law of Contract and does not rely on the grant of a state sanction / privilege under commercial law and accounting standards to operate. This would be supporting something that was antithetical to liberty.

Personally, I would prefer to keep these kind of “High Risk” deposits in Hedge Funds and the like – clearly away from banks so as not to confuse. It would be quite possible for somebody with a higher risk profile to place all his money at the disposal of a hedge fund and the hedge fund to offer normal banking services, such as transacting cheques, direct debits, standing orders, issuing debit cards that the hedge fund would subcontract back to the regular standard custodian / safe keeping lending bank. This would give the appearance in almost every respect of the current fractional reserve banking.

To all intents and purposes the overwhelmingly vast majority of non bank companies are 100% reserve companies i.e. they square up with their creditors as and when they fall due or could fall due, unlike fractional reserve banks who make very little provision and rely on state sanction to exist like this.

The balance sheet and contract law approach to free banking allows a solid safe and traditional approach to banking to be the banking system’s default position, but then allows freely consenting adults all other options to enter into whatever deposit contracts they like so long as they are truly lawful.

If this is accepted, I would think it is clear that the proposal of De Soto mentioned above, concerning banking reform, becomes a real possibility in order to be the key policy solution and recommendation of the Austrian School.

It would be right and proper that the School that was the only School to predict the Great Credit Crunch / Meltdown, could provide a series of solutions for a lasting and sustainable recovery.


I have laid out my case that there is such a discrepancy between what the overwhelming majority think happens with their deposited money that under contract law, I doubt very much that an enforceable contract exists as currently offered by the banking system. I propose a reform that would very clearly demarcate what is a custodian / safe keeping contract and what is a lending contract. I agree that freely consenting adults who do no harm to others should be allowed to do as they please which means contract as they please, but entering into a fractional reserve free banking contract would violate very solid good balance sheet accounting and financial reporting standards that have been developed over many years to make sure trade happens without violation of people’s property rights. After that I propose a third contract that could have similar characteristics to a fractional reserve free bank account, called a High Risk account that would allow more speculative activities. The market would evolve in time, and new ways of doing things would no doubt emerge. As long as these new ways of doing things conform to  commercial law and do not exist on privilege, then there would be no reason to get het up about this type of innovation.

Some of the debates existing in the wider free banking school need to be addressed.

What is the Difference Between a Fractional Reserve Contract and a House Insurance Contract?

With my house insurance, I pay, not loan, money to an insurance company in exchange for the right to a policy, my consumable item if you like, with the explicit knowledge that they are hoping to charge me and all the other policy holders more than they would pay out in the eventuality of a disaster that I am trying to insure against. There is a small risk that the insurance company will get its sums wrong and not be able to pay me out in full or at all. The policy tells me this.

With a deposit contract, I think I am depositing for custody and safe keeping and only the enlightened few know they are loaning their forgone purchasing power i.e. money to the bank.

So insurance is paying for a product that you consume by virtue of holding the policy for its life time. You know that there is a small risk that you may not get 100% of what you have bought.

With banking, you loan your purchasing power with the overwhelming people doing this in ignorance of what they have committed to. The vast majority expect to have the quiet and peaceful enjoyment of their purchasing power at their convenience and do not deposit in the knowledge that there may be wholesale default.

If we Accept the Legal Position that a Demand Deposit is a Bank Loan, can you Ever Have a Loan with no Fixed Term i.e. an Indefinite Loan?

This is an impossibility.

The loan under these circumstances should properly be called a gift. Fractional Reserve Free Banking relies on the fact that the legal position says all deposits are loans. In 22 years in business I have never borrowed money without a term implied. Even in the most friendly of loans where I have borrowed from a family member and they have said “pay me back when you can,” there is an implied term, when I can, and that it is not a gift.

You can vary terms then reset the period, re cut it, re dice it , re jig it, re price it, etc, but there are still implied terms. At some point in time, a lender always wants to get paid back, otherwise he/she would not be a lender, but someone giving a gift. Depositors are not giving a gift!

In the three banks that I use, representing a very large chunk of the UK banking business, I see nothing whatsoever in any documentation that leads me to believe that when I deposit I am making a loan. What is more, it does not fit my understanding of what a loan is unless we accept it is a callable loan on demand. If it is on demand, it needs to be provisioned for. Prudent management would dictate 100% reserves against my loan. General accounting principles that apply to all commercial activities bar the banks do not have to.

Everything I have ever seen in banking when I have deposited leads me to believe I am depositing money for custody / safe keeping and not as a loan. The language is always that of custody / safe keeping. Free banking going forward needs to be very explicit in nailing in contract what is custody / safe keeping and what is loaning and what is speculating.

Do Fractional Reserve Banks in a Free Market Environment, i.e. one with no Central Bank, Create Inflation?

I touched upon this point in the main body of the article. The price of money is determined, like all things, by demand and supply. Mises called this the money relation. If there is an increase in both, then there will be no inflation. To be clear, Fractional Reserve Free Banking people who advocate this are correct, there will be no price inflation. However, the number of money units has now gone up, so there has been a money inflation. Do we care? Yes, as Austrians we do. Why? Whoever is in receipt of the new money, in a Fractional Reserve Free Banking world with no Central Bank, the first recipients are the new demanders of money. They will get the wealth effect of having new purchasing power first. Where there should have been an increase in purchasing power (falling prices) for all the existing money holders, there is no increase, thus impoverishing those who are holding the existing monetary unit. Again, this gives special privilege to a certain class of person over another class of person. That is antithetical to liberty. The only way this can be avoided is to have Free Banking that sits within commercial law, accounting rules that apply to everyone, and framed within the time-honoured principles of the law of contract.

Do Grain Store Examples Shed any Useful Light into this Debate?

I am often told by advocates of Fractional Reserve Free Banking that banking is like a grain store.  That if ten tons were to be deposited by one man who took a certificate from the store holder explicitly stating that the store will be lending 9 ton of the grain out to bread makers in exchange for the original depositor not having to pay for the storage, or even being paid to store there – what would be wrong with this? Also, it would tell me under what time period my grain would be being used by others, and when I could get my grain back. Well, the answer is nothing at all as the contract is explicit – except that I will never get my grain back at all as it is being consumed by someone else. I will never get it back!

Grain examples should be avoided, for they certainly do not stack up.

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34 replies on “Free Banking, the Balance Sheet and Contract Law Approach”
  1. says: Steven Baker

    One can easily verify that banks do not follow the same accounting rules as other institutions.

    I used to work with an electronic financial reporting standard, XBRL. United States GAAP as encoded in XBRL is divided into:

    • Banking and Savings Institutions
    • Broker Dealer
    • Commercial and Industrial
    • Insurance
    • Real Estate

    For more information, see CoreFiling’s Taxonomy Viewer, browsing through the taxonomy list to US GAAP.

    I make no assertions about the substantive differences: that would make another good research project!

  2. says: James Tyler

    Reconciling what honest money and sound banking means in today’s world is clearly not as simple a matter as we would like it to be.

    I think, ultimately, we are all free bankers in a utopian sense, But, whatever the destination we need to get the oars in the water, which we cannot do until the practicalities that surround the free/100% divide are addressed.

    The transparent application of common contract law and fair accounting practices applied evenly betweeen banking and non-banking firms would seem an excellent place to start.

  3. says: Bill Woolsey

    You continue to treat accounting standards as fundamental. When I asked my accounting colleagues about the supposed rule that current assets and current liabilities match, I was told that the “rule” was that current assets should be twice current liabilities. However, that this “rule” is going “out of style” because inventory is a current asset, and as firms have moved towards “just in time” inventory management, current assets have been reduced.

    I found the entire discussion a bit odd, because it is obvious that it is all about being in a position to pay bills over the short term. I can’t see how this is any different than a “standard” that a firm earn sufficient revenue to cover operating costs. And, further, that if one has sufficient net worth (total assets greater than liabilities) why can’t one pay bills by short term borrowing?

    The contract law quoted here do not support 100% reserve banking at all. Quite the contrary. IF some depositor tried to claim that the bank was promising to store his or her money, then all of these cases would provide stumbling blocks. If the depositor simply insisted on repayment, I suppose the bank use the cases for defense, and refusing to pay. (You say we promised to pay you back? There was no binding contract, so you can’t make us do anything.) But I doubt it would fly.

    Further, you are putting too much weight about claims of ownership that play on an ambiguity between money (a set of assets) and wealth (net worth.) For example, if someone asked me if I own the “money” in my 401k, I would say yes. This is a kind of retirement account in the U.S. But all of these funds are invested in stock mutual funds. I do own the shares in those funds, of course. But I was using the term “money” in a loose way. The balance in my 401k isn’t paper currency that I believe is stored somewhere and that I own that currency.

    Similarly, to say that I “own” the money in the bank doesn’t mean that there is currency at the bank in a shoe box with my name on it. It is rather, I own the deposits. Just like I own the shares of a mutual fund. Or, of course, even more like I would own a corporate bond if I had one.

    That there are substantial numbers of people who don’t know that banks are financial intermediaries is troubling. Apparently, we economists are not doing our jobs in educating people about the nature of banking if they think banks are storing their money for them.

    By the way, my bank pays me interest on all of the funds I keep with them. How can you ignore this! The bank is giving the depositor consideration for the loan. It defies common sense for anyone to think that they are being paid so that the bank will have the privilege of doing them the favor of storing their money.

    Your odd assertion that banks are in fact “somewhere” making money on fees and so people are paying for storage is certainly true for some people–especially people will small balances. For them, perhaps it is confusing, since they are paying the bank to make it a loan. And their consideration is that they pay less than straight storage.

    Also, do you believe (or is it true) that banks in Great Britain fund all of their operations with current accounts? In the U.S. only transactions accounts (that are checkable) are subject to reserve requirements. Savings accounts have no reserve requirements and they make up the bulk of bank funding. CD’s are larger than checkable deposits and also have no reserve requirements.

    What makes you think that if regulations were imposed requiring banks to store funds for all deposits payable on demand, that depositors wouldn’t shift funds from savings accounts to CD’s? Presumably, regulations could follow those in the U.S. and require 100% reserves for transactions accounts, and people would hold some of those rather than carry about currency. But my point is that looking at current banks and identifying their entire operations such that all bank deposits replace currency holdings is implausible to say the least.

    I think you just need to open you mind a bit, and rethink banking.

  4. says: Ron Helwig

    Good article. I’ve had many discussions of FR vs. 100% with friends.

    I tend to think of free market fractional reserve banks as investment agents. I hire them to continuously invest my money, expecting a small but decent return with low risk. The difference between that sort of account and an “investment” account is that with the FR account I am willing to accept a smaller ROI for immediate liquidity. The bank is merely managing my investments for me.

    Think of it as a spectrum going from 100% safety and liquidity but no/low investment returns to very low safety and liquidity but potentially high returns.

    If the banking market was opened up, and the account contracts were specific and clear, then I’m OK with FR.

  5. says: Paul Marks

    First there is a major point on which “fractional reserve” free bankers and non “franctional reserve” people can agree upon.

    No bailouts – people must be told IN ADVANCE that there will be no bailouts. For if shareholds and “depositors” knew they would not be bailed out by the taxpayer (whether directly or indirectly by increasing the money supply) much more attention would be paid and much more care would be taken.

    Sadly the movement is all the other way – for example about 98% of the vote in Iceland just went in favour of upholding the principle of Icelandic law that large deposits in private banks are NOT backed by the state. Yet government of Iceland does not seem to be considering obeying the law (and the will of the people) – on the contrary it insists it will “repay” (misuse of language) the British and Dutch governments for their bailouts of Icesave customers (its obsessiom with joining the E.U. and getting I.M.F. momey has blinded the govenrment).

    With such an attitude banking will never be put on a solid foundation.

    As for the issue itself…….

    If borrowing is not 100% from real savings (i.e. income people have chosen not to consume – but, rather, to lend out) then a boom/bust cycle will occur. One can not get round that – it is simply the case.

    It may be that people are willing to accept a boom/bust cycle as a price for “fractional reserve banking”, but they should at least no that such a form of banking is not a free thing – there is a price for it, and the price is boom and bust.

    On money itself I dislike the terms “backed” and “standard” because they confuse the issue. Either the gold (or whatever commodity people agree to trade with) is the money – or it is not. Using special names such as “Pounds” or “Dollars” can lead people into mystical nonsense, in which they treat these names as magic charms that have some sort of value in themselves. It is true that such things as the Pound and the Dollar were once clearly defined as a certain weight of a certain commodity of a certain level of purity – but over time just the magic name is held to be important (and the state behind it) and economic rationality is lost.

    On banking if someone makes a “deposit” in a bank and expects that gold (or whatever) to be there to be withdrawn at will – then the person not only should not expect interest to be paid, they should PAY THE BANK for looking after the deposit (because, with a literal use of the word “deposit”, the bank is acting as a safe deposit enterprise – and they make people pay and pay quite a lot).

    However, if people are willing to lend out some of their income (using a bank to decide who would be sensible people and enterprises to lend the money to) for interest – then they must accept that they DO NOT HAVE THE MONEY ANYMORE (this is where “fractional reserve” language is not helpful – the money is lent out or it is not).

    The people who lend out money can not also act as if they still had it (two people can not do different things with the same money at the same time) – it has been lent out. And nor can such people expect the money that has been lent out to be in the bank to be withdrawn “on demand”. Only after the contractual period is over and the borrowers have paid the money back can the lenders have the money. Banking seems to be based on the notion that one can “borrow short” (i.e. allow the “depositors” one has borrowed money the right to demand it back without notice) and “lend long” (one can not instantly demand loans be fully repaid without warning – such an action would lead to the bankruptcy of an enterprise). Such a “borrow short, lend long” struture means that a bank is always “technically” insolvent.

    Only when and IF the borrowers have paid the money back. Treating a loan as a “deposit” and building a mountain of “fractional reserve” debt upon it is not logical – it makes no sense (it is like saying “A is not A” or “I am you”). The basic problem with the way banking is organized can be seen by such misuse of language – which is a reflection of the basic confusion of thought.

    I repeat if I agree to lend out money I do NOT have that money any more – there is (or rather there should not be) no “addition to the money supply” via banking. If I put some money in a bank and it is lent out – then I DO NOT HAVE THE MONEY ANYMORE, THE BORROWER HAS GOT IT. It does NOT mean “the money has been doubled” – to treat the money as if it had been put through a cloning process violates basic reason. Yet this is what banking practices now assume.

    It makes no sense – and although there will be vast profits in the short term, in the long term it always ends in a bust (with everyone losing their shirts).

    Someone may reject all the above (they do – sadly “A is A” and “I am not you” is also rejected by some people), but hopefully we can (as I said at the start) agree that people must be told “there will be no bailouts” and this must be stuck to. If it is kept to then, in spite of all the horror, the economy (i.e. the human interactions that are what “market forces” really are) will be still have some scrap of rationality – there will still be some solid foundation to build upon.

    However, if we contiunue to go down the bailout road (as we have been doing) then there is NOTHING – no foudnation, no rationality, no real (as opposed to credit bubble) economy. The end of the bailout road (the road of the “mainstream” media and much of academia) is the breakdown of civilization – it is that bad.

  6. says: Tomás

    I have to agree with Bill Woolsey, this article still doesn’t answer my questions on why 100% is better/superior to Free Banking.

    In a free world (ie one without govt./coercive use of force), there is a high degree of caveat emptor as no there is no automatic lending of trust or legitimacy (ex. people actually thinking the FDA protects them from unsafe food and drugs, when in actuality they’re assuming that because of govt. edict). If a free society has the highest degree of caveat emptor, then why do we have to resort to this “balance sheet approach” which isn’t even a natural law (which I think the article assumes), it’s more of a good rule of thumb currently in fashion because another better idea has yet to exceed it.

    By the same token, this point gives me concerns as an Anarchist as this :”The balance sheet and contract law approach to free banking allows a solid safe and traditional approach to banking to be the banking system’s default position, but then allows freely consenting adults all other options to enter into whatever deposit contracts they like so long as they are truly lawful.”
    makes me think that 100%ers are coming from a default minarchist position, after all how else to enforce this ‘balance sheet and contract’ LAW without a state?

    Fractional reserve banking leads to booms and busts, that we can all agree on, but the 100% School still reeks of Statism to me.

    1. says: Jack Maturin

      Tomas, there is nothing wrong with a 100% reserve banking system in a totally anarchist society, and it requires no statism, just contract law. I think it is the concept of ‘money’ that clouds the issue, because this concept has been so infected by the state over the last five hundred years. But under anarchy, money will simply become another commodity, just like all other commodities.

      Switch the ideas around to a more ‘regular’ commodity, such as grain, and a legally enforced 100% reserve makes perfect sense, especially in the Hoppeian Austro-anarchist world in which I would like to try living.

      For example, if I am a farmer and I bank 1,000 tons of grain with you, the Grain Silo Banking Company (GSBC), then although dried grain of a certain quality is fungible, and I wouldn’t necessarily expect to receive the exact same grains that I harvested and then placed into your silo storage, I would expect to receive 1,000 tons of grain, at the same quality to that which I placed into storage, at any time of my choosing. I would also expect that all farmers using the Grain Silo Banking Company’s facilities would also be able to retrieve all of their allotted stored grain too, without worrying about being able to get mine out afterwards.

      Yes, I would be expecting a charge for the storage of this grain (say, 1/1000th of the grain held on account, per month), but I would call it fraud if I turned up one day to claim my grain (less storage charges) and was unable to get it because GSBC had lent it out, for interest paid in grain, in the mistaken hope in this case that other future deposits by other farmers would then cover them if I turned up to claim what was rightfully mine.

      Why would creating a monetary system based on grain storage receipts, rather than gold storage receipts, suddenly magically allow the legal formation of fractional reserve grain banking?

      This 100% reserve principle works for all other such storable fungible commodities, including coal, oil, copper, zinc, etc. And although this is a much less fungible example, imagine if you put some of your furniture into one of those ‘Big Yellow Storage’ warehouses. If you went to pick it up one day and found that they had rented it out to an office company for a year, and you couldn’t get it back until the year was up, would you really think that was Ok?

      Why does the principle of contract law have to stop working, just because a banked and stored commodity is ingots of gold or silver, rather than ingots of copper or zinc? Or your furniture?

      Yes, the enforcement of this contract law becomes the problem in an Austro-anarchist society, but the 100% reserve concept is perfectly sound, given that you can enforce the contracts. Bruce Benson’s work on anarchist law perhaps covers the enforcement of such contracts best, but that is a different matter, perfectly solvable with an extension of the international mercantile law systems of the medieval period, which crossed international barriers with little formal physical enforcement, with ease.

      It is fractional reserve banking that reeks of statism. Because it was only when state judges stopped enforcing contract law on banks, in return for the banks then lending states fractional reserve monies (from thin air), that the problem started, so states could fight their stupid wars and then charge the rest of us for the privilege, in taxes paid back to their friends in the newly-privileged banks, to clear these loans. See De Soto’s ‘Money, Bank Credit, and Economic Cycles’, for much more on that.

      It is also important that we anarchists not give the minarchists a sense of superiority on this topic of 100% reserve banking, because it is minarchism which is riddled with flaws and which keeps wanting to dance with the devil, despite the obvious dangers, not anarchism.

      Fractional reserve banking should be given the name it really deserves: State-enforced Ponzi scheme banking.

    2. says: Alex Zoum

      Tomas, I share you concerns in the anarchist sense. Chapter 7 “Arbitration of Disputes” in Linda and Morris Tannehill’s “The Market for Liberty” is a good read on how an anarcho-capitalis society could handle private contracts. This book is easily found for free download in both written and audio form.

  7. says: M. B. Moon

    Consider “free” banks issuing their own common stock as money.

    1. The banks could spend their own private monies into existence.
    2. Any price inflation would be born only by the bank owners (common stock/money holders).
    3. No fractional reserve loans necessary to increase the money supply.
    4. No deflation possible.
    5. Bank could broker 100% reserve loans between money holders.

    1. M.B.Moon, many thanks for your comments.
      I have a problem with 2. See my response with The Orlanater above. Point 4, I think this will be a bad thing. Again see my response to The Orlanater.

  8. says: ScuzzaMan

    You continue, though, with the assumption (presumption?) that you MUST have some prescriptive answer to the questions of banking & money.

    But what is the Austrian schools prescription for bread-making?

    I think that the idea that what constitutes a successful business model, as a question best answered by the market through the means of voluntary transactions, remains a deeply unpopular idea, even amongst people who purport to be adovcates of freedom, of free markets, of free banking.

    Why a member of the Austrian school would want to construct an “official” prescription for banking and money, when the entire philosophic foundation of the school is financial – and therefore, political – freedom, is quite puzling.

    What possible good can come of an “Austrian” presecription ofr banking and money?

    The prescriptions that are necessary for a free market to operate are entirely negative in character; a small and concise list of “Thou Shalt Not …”‘s. (Chief among these being the prohibitions against force and fraud)

    Once you set foot on the path of positive prescriptions, i.e. of the use of force to establish the correctness of your opinion, forever will it dominate your destiny.

    It is categorically NOT a weakness of the Austrian School that it lacks any prescriptive answer to the questions of banking and money. On the contrary, that is it’s singular strength. That is what separates it and distinuguishes it from the other, compulsion-based, models of market participation.

    1. ScuzzaMan, thank you for taking the time to read and comment.
      We have a very large bloated constructivist based system of State management of large parts of our existence. On the whole this is bad. To get into a system whereby we live by the axiom of do anything we please so long as we do no harm to others, then we need to remove and reform large parts of this system. To do this lawfully we need to be constructivist in our policy prescriptions to get to the position mentioned above. There needs to be a Great Repeal Act of many parts of our legislature. We will not be able to do that talking on web sites but by political action.
      I make no apology for advocating such a stance. Also I know some of the finest minds in the world of economics exist in the Austrian School and I hope they can put forward policy that will get us to the position where we can live by the axiom mentioned above.

  9. says: M.A.

    Even if both sides (banks and depositors) agree that the deposit is to be considered a loan to the bank, the contract still cannot be valid because it would be based on the impossibility that two entities fully own the title to the deposit simultaneously.

    See Prof. Walter Block here:

    1. Thank you for your comment MA and the time taken to read the article.
      I am familiar with what Walter Block has to say here and I have much respect for him as I do for White and Selgin mentioned above. I would advise that if many parties freely contract to deposit their money in a pool from which they fully know more claims are going to be granted to the resources in that pool , then there is not confusion of title, just that you have agreed to weaken your title claim. You have accepted a proportional claim in hope of a higher return. You have either positively or inadvertently started to become a gambler. Between freely consenting adults, I do not see what the problem with this is.
      Make contracts very explicit and not dependent on legal privilege and I would think this would all be very much OK even with the most pure 100% Reserver.

  10. Bill, thank you for reading and taking the time to comment.
    I would say the following;
    PWC (my auditors) would not sign off my accounts as a going concern if I could not pay my current creditors – this means I need to always show that I have 100% of the money, or sufficient committed facilities from a lender to pay. This is the real commercial world I work in. GAAP does not allow it. Banks do not operate to this standard. Why should I and all other commercial enterprises work to GAAP and not the banks?
    On the Law of Contract point I argue that I do not even think the current bank deposit contract is enforceable as there is not a “meeting of the minds” etc. One needs to take this golden opportunity and get contracts aligned so each contracting party, be it a party for safe keeping , lending or speculating gets aligned with the actual product on offer. I make a further point that a fractional reserve free banking contract in a world without a central bank, in my opinion should be unlawful. Why? Not because consenting adults should not be allowed to engage in making any contract they see fit, in this case a FRFB one, but because in doing so, for the bank, one of the contracting parties to do so, could only exist under a separate set of auditing laws which is unfair to all of us who run our businesses whereby we provision for all our current creditors. Last time I looked, if I did not have to provision for current creditors, I would be able to take £8.5m out of my business or invest to be more competitive etc, that I could not do today. Is this fair that banks have this unique privilege and status? I argue not.
    Your point re money is well made. I have introduced the word custody very specifically and will start to use more so going forward as opposed to safe. I am custodian of my creditors and I owe them money at a pre determined point in the future and it is not “theirs” until then. Where I would diverge from you is that owning a share, you know you have a right to some of the income in the company should a dividend be paid. You know you are wiped out should an insolvency event happen i.e. your equity is lost. You know you will have to subscribe to new issuances should you wish to keep your shareholding should your Directors feel they need to more equity and so on and so forth. With money deposited, I would bet you a lot of money that if you asked the next 10 people you met in the street, do they think they have their money deposited in their bank accounts with a right to an IOU from the bank or do they think they have cash and I am sure they will say cash on the whole. They do not have the knowledge you do concerning the nature of the bank deposit. Make contracts explicit and we might make some progress.
    In the UK, it is approx 50% split demand deposits and 50% timed deposits. We have no legal reserve (abolished in the early 80’s) requirement at all on any accounts. Custom has set a general reserve against all deposits at 3% as I understand it. Basel 3 may change all of this. I have not looked at that yet. I know from the bankers I deal with, all are saying they are going to hold more reserves.
    I will always think about banking rest assured and am always open to new ideas and correcting errors I may make. I think the De Soto Plan is very achievable and could clear up the banking mess. Nothing you have said so far would make me think otherwise.
    Many thanks for the contribution.

  11. Thank you Paul for taking the time to read and comment.
    I agree, no bail outs. Explicit contract terms as well.
    Iceland point I agree with your analysis.
    I disagree re allowing boom and bust as a consequence of people freely engaging in FRFB without a central bank as it requires the grant of privilege to one party, the banks, not to keep their current creditors whole, at the expense of all other commercial enterprises who do. Should a referendum, or general election with this on the mandate, as I democrat , then I would need to concur , albeit very grudgingly and kicking and screaming!
    I agree with what you say re money.
    I agree with your lending point. It cannot be in the same place twice, saved and lent.
    I would say the bank is always insolvent by the laws that all other commercial enterprises need to work to.
    Many thanks for your time.

  12. Ron thank you very much for your comments.
    If every single one of its customers understood this, then they would in effect be acknowledging that they would never be paid in full should they all want to be paid in full. They are making very generous loans indeed to the bank. I think a bank would struggle to pull this off. To remain solvent under normal commercial law, it would have to make explicit the consent of all of its depositors to this fact i.e. not be paid in full under certain circumstances and it would seem some of the loans would be irredeemable gifts?? If it could get this consent, then fine as there would not be a multiplying of the reserves as a gift would need no reservation. Banks would work under the same laws as everyone else.
    I would ask you to think that is it right that a bank can operate , even if it had the full consent of all its customers to running a fractional reserve free bank, this bank could only be solvent in the above case as I see it. Or it would need to rely on the grant of privilege to not have to account for keeping its creditors whole. This puts all other commercial enterprises at a distinct disadvantage . This is the point that I would like to see being addressed.
    Thank you for your time.

  13. says: Mark Davis

    Excellent article Mr. Baxendale! I see how easy it is for people whom accept the status quo of legalized theft (privilege) to be anxious about the proposition of honest banking (utopian). But it is sad when the only morally acceptable position is subordinated to the morally unacceptable position simply because the latter position has been institutionalized. This is the reason that state institutions are crumbling around us including the state enforced banking institutions.
    The second point I think important to note is to chime in on the root of the boom/bust cycle: fractional reserve banking. To believe that this cycle based on the expansion of credit money can be managed is folly and fraught with opportunities for corruption. A prosperous society must be based on honest work and sufficient frugality to result in a profit that can be used for savings. Investment monies that come from savings are allocated in a rational manor while investment monies that are “created out of thin air” result in the most hideous malinvestments. There is no easy-way around this basic economic principle. Have we learned nothing from the recent crisis?
    In short, 100% reserve banking is both right and proper for those wishing to create a prosperous society. Anything less is criminal and self-defeating. Arguing over the degree of criminality and the degree of acceptable malinvestment so as to enrich the few at the expense of the many is itself a ruse. Sure we can agree on eliminating Central Banks, but why can’t we also agree on honest banking as the basis of our financial system?

    1. Mark, thank you for your response. Following your last question, we cannot agree as there is a large section of our free market supporting community who very much believe in fractional reserve free banking and not just free banking in accordance with the normal commercial law with no privilege implied. This new approach is what I attempt to start to flesh out in this article. There is a way forward post the 100% reserve free banking v the fractional reserve free banking views that would allow safe and honest custodian banking coupled with solid matching of savings and borrowing with a speculative financial innovation end as well. I think I have promoted a way that will hopefully bring people together on this. The best economic thinkers in our wider Austrian School are arguing the toss in Ivory Towers when this is their moment, they predicted bust, they must now come forth with solutions. In unity they will be more effective.

  14. says: Dan

    I think people forget that fractional reserve means that if you deposit 10 oz of gold, the bank can lend notes worth 100 oz not that the bank can lend 9oz and must actually store 1 oz. This confusion arises because when you deposit a 10 oz note, the reserve process is reversed and thus only “1” real oz is allowed to be credited to the banks reserve.

    So the real problem is that unless the NOTE that people accept as payment says that it is only fractionally backed, then merchants that do not even have an account with the bank end up holding the debt of the bank thinking they have received a deposit! If merchants, upon receiving such a “risky 10% backed” note were to immediately go to the bank to get the “real payment” then the bank would go bankrupt.

    So the real issue is what is written on the circulated bank notes, not what is agreed to by the depositor and bank.

    The solution then is to set up a business and not accept dollars. You do not need to accept dollars as payment except for debts denominated in dollars.

  15. says: The_Orlonater

    “However, the number of money units has now gone up, so there has been a money inflation. Do we care? Yes, as Austrians we do. Why? Whoever is in receipt of the new money, in a Fractional Reserve Free Banking world with no Central Bank, the first recipients are the new demanders of money. They will get the wealth effect of having new purchasing power first. Where there should have been an increase in purchasing power (falling prices) for all the existing money holders, there is no increase, thus impoverishing those who are holding the existing monetary unit.”

    I’m assuming that you’re a libertarian; but this does not affect the third party’s property rights in any way. I’ll quote using an example from Larry White’s and George Selgin’s paper “In Defense of Fiduciary Media:”

    To further illustrate the point, consider another non-banking ex-
    ample. Suppose that A, who owns but seldom uses a Florida condomin-
    ium, contracts with B to time-share B’s condominium. A then sells his
    own condominium, causing the value of neighbor C’s condominium to
    fall. Does this mean that the contract between A and B should not be
    allowed? Has A robbed C? Not according to the Rothbardian view of
    property rights.”

    Setting that aside, what’s suppose to happen in a monetary system? A consistently falling money supply even though the demand for it is rising? You know, that also hurts the structure of production. It’s just a mirror image of our most feared inflationary boom, an over-deflationary spiral. At least with free banking, the money demand is based on people’s time preferences and hence their is no misallocation of resources.

    1. Thank you The Orlonater for your comments.
      For the record, I am a liberal with conservative leanings.
      I have read the White and Selgin paper you refer to on a number of occasions. I find no fault with their illustration that you draw my attention do.
      Growing purchasing power does not distort the free interplay of market forces if it is driven by market forces. For purchasing power to go up, there must have been productivity gains, those who have more productivity have more purchasing power. There is no need for an adjustment to take place by a hypothetical free banking system to counter this wonderful uplift in purchasing power, why would there be? I assume money units are not being decommissioned / destroyed and not replaced by anybody as this could have the same uplifting effect on purchasing power. Only those entrepreneurs who are more productive get the rewards accorded to them by the free interplay of all the participants in the market, not bloated inflation reliant businesses. So I do disagree that there is any hurt to the production structure as you say. Why have a system that rewards the inefficient? Why reward the inflation dependent? Thus I do believe a system of fractional reserve free banking suggested by you will lead to misallocation of resources, granted, a lot less that the current system, but still more than it would need to be.
      If money was re routed back in gold, you would see between a 1% and 5% uplift in supply . Since records started this would seem to be the case. No reason why it would not be different. Other commodity baskets may cause different outcomes and if we could ever get governments to look seriously at this, we would need to be very careful in what was recommended and much work would need to be done on this.

  16. says: Bill Woolsey


    Thank you for your response.

    If you think about your accounts, one of the ways you can meet the current asset/current liability obligation is that you have committed credit facilities. In other words, someone is promising to lend you money.

    While this may be standard accounting procedures, we can imagine an alternative where you should report that you habitually borrow money to cover part of the bills. Perhaps there is no such thing as lines of credit. The whole idea that a bank would promise to make you loans didn’t exist. You just got loans when needed. Why does that make your business unsound?

    When you say that the purpose of these accounting rules is to make sure you can pay your bills, the assumption appears to be that you will actually pay these bills. What if your suppliers habitually extend most of their bills, and collect on just part of them. Shouldn’t your accounting requirement be aimed at having the money needed to pay the bills that you need to pay?

    Another short term asset you could have is marketable securities. My accounting colleague claims that if you say you will sell them within a year they count as a current asset. If you say you plan to hold them more than a year, they aren’t. But you can just make an accounting change to move them from one category to another.

    Well, a solvent bank has assets greater than liabilities. It can move loans to “will sell in the year” from “investments.” And then they are all current assets. And what difference would that make?

    Thinking of banks as money storehouses leads to nothing but confusion.

  17. Evening Bill,
    First let me address your last point re what you think I think about banks.
    “Thinking of banks as money storehouses leads to nothing but confusion.”
    I do not think of banks as storehouses today or in an ideal world.
    There is an eternal duty for banks to look after their customers’ purchasing power wisely.
    In an ideal world, they would be a critical part of the capitalist system helping transact services. I would like to think of them as custodians of our money in the form of safekeeping. Custodian intermediaries of our money when we forgo it and lend to them so they can invest on our behalf to give us a return. I would even go as far to say they can be an investment vehicle as well where pure speculation is involved as I describe in my article via “High Risk” deposits, although I would prefer this to be called a hedge fund. As long as they as institutions work to the same laws that I have to as an entrepreneur, then happy I am.
    All this can be sorted out by making contracts explicit. This would be a good thing as there is such confusion with the consuming public. I would then mandate them to account in accordance with the same law as all other enterprises. This would not chance how they do their custodian services or their transaction services. The “High Risk” end it would effect as they would have to lend real savings to real enterprises that were providing real goods and services that people wanted, not credit created out of thin air. As a supporter of the Austrian Theory of the Business Cycle as the best explanation for boom and bust, this removal of credit created out of thin air is a good thing. If they increase value by making them more productive, sell better things for cheaper prices, then they can re value these investment assets and return more to their investors / depositors. Likewise should the investments decline in value.
    I here what you say re accounts and having committed facilities. Absent these and all our loans would be on demand and we would not get a sign off on our accounts by our auditors as being solvent for the next 12 months. That would be the end of us. Banks can do this . They are the only enterprises that can. This allows them to use creditors money. A great privilege that is abused. End it. Make them subject to the same law as the rest of us.
    If an bank could write to all its creditors and say “to make sure we remain as a going concern, please sign here that you will only ever claim x% (a very small %) of your demand deposit back into cash and we will be able to continue to exist” and people do, then fine. I somehow expect there would be a run on the bank!
    Yes, you only need to pay what you need to pay for sure, but we have real evidence, certainly the whole UK banking system was only 5 hours away from running out of cash completely as redemptions were so high 18 months ago and now we have a de facto and to some extent de jure nationalised banking system. Systematic bank failure, which the current system delivers, although not the hypothetical fractional reserve free banking system, is not an acceptable way to deal with the money of the people.
    If the security is marketable and can be redeemed as cash in an instant then it is a current asset , if it takes more time to sell , over a year, it is an asset over a year. Why would you not slot them in the right box in the first place? Same re your investment point. This is where people get into trouble with accounting trickery. Not a good way to do business. You rely on auditors to sort this out. Never ideal.

  18. says: Rob Bardin

    Mr. Baxendale,

    Thanks so much for your well-considered post.

    After reading it, and the banter between yourself and respondents, this financial illiterate still has one particular question.

    While I agree that 100%RB is the only way to ensure that no inflation occurs, I’m still curious as to how “consideration” is given to lenders. Like I stated above, my ignorance may display itself in my question, but:

    If a bank loans money in a 100%RB system at interest, where do the funds come from to cover the interest owed it? Likewise, when a depositor places funds into a bank’s custody, expecting regular dividends, where do those funds come from?

    Sorry if these are dumb questions.

    1. Rob, many thanks for your kind words.
      Simply put, if you are attracted to a bank because they say to you that if you deposit your money we can either offer you a custody account, whereby we will undertake to keep it in our vaults and change you for it, our if you lend it to us on a 1 month, 3, 6, 9, 12, 18 months etc basis, we will give you X% interest. If you go for the latter, you relinquish ownership to the bank who then lend it to a entrepreneur for X% + Y% so they can make a profit of Y% and give you back X% when it comes to maturity.
      Half of all loan in the UK are time deposits , so this is already a very well established part of bank lending.

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