When discussing the “fraudulent” nature of fractional-reserve banking, the crux of the issue seems to be how the law distinguishes between banks and other businesses. I think all sides accept that accounting requirements are different for banks than for other businesses, however accounting principles are different for different types of business. I simply don’t have enough knowledge of auditing law to pass judgement on whether banks are treated differently because of legal privilege, or simply because they have unique attributes that auditors attempt to interpret accounting law in light of. (Note: and neither do the auditors I have asked about this!)
The argument against fractional reserves relies on the assertion that “normal” businesses are unable to operate in the same way as banks, and are forced to maintain “100% reserves” at all times. Here is an example that I’d be interested in feedback on. Consider the following bet:
“The FTSE 100 will rise by 5% or more within the next week”
I am willing to bet £1,000 that it *will*, and you are willing to bet £1,000 that it will *not*
- From a legal point of view, based on current UK law – have I committed fraud?
- From a free market perspective – have I done anything wrong?
Is it possible to answer those questions from the information given? If so, how do your answers to those questions change based on the following information:
Scenario A: When we make the bet I do not have £1,000 in cash available and have no hope of having £1,000 in cash at any point in the near future. I win the bet though, so this isn’t revealed
Scenario B: When we make the bet I do not have £1,000 in cash available and have no hope of having £1,000 in cash at any point in the near future. I lose the bet. I can’t pay you
Scenario C: When we make the bet I do not have £1,000 in cash available, however my salary is due to enter my account before the end of the week, which would mean that I do have the cash available. I also have lots of highly liquid assets that I could liquidate should I need to. I am able to convince a reasonable person that should I lose the bet, I would be able to pay out.
Scenario D: When we make the bet I have £100,000 in cash available, and have £1,000 set aside in an envelope with your name on it, just in case I lose
Which of the above scenarios would make you answer “yes” to either question 1 or 2? It strikes me that A and B do, and D does not. So the real issue is scenario C. If you told me that scenario C is illegal I’d be very surprised – how often do you make an agreement to make a future payment and have the finances available throughout? If C is illegal this suggests that if I bet £1m at odds of 150-1 that Everton will win the Premier League, the bookies is required by law to increase their cash reserves by £151,000,000 today and to maintain this for the duration of the season. Do they?
Here’s how I think the analogy ties into the fractional reserve debate:
- You and I have a £1 bet on whether the FTSE 100 will rise by more than 1% by 1pm
- I lose the bet, and don’t have £1 on me. So I write you an IOU that says “I promise to pay the bearer of this note £1” and you are willing to accept it
- You go to a cafeteria, and ask to use the IOU to pay for your cup of coffee. The barista agrees to accept it as payment
- The following day the barista comes to me and wants to redeem the IOU. I now have £1 and give it to him
- Seeing how the barista is happy to accept this, I issue 100 similar notes. People voluntarily accept them
- Since I don’t want to have to keep £100 cash on me, I put a small caveat on the note saying that I reserve the right to not pay out, but will pay an interest rate for any day that I don’t
Which of those events (1-5) are illegal? Which should be illegal?