In defence of ‘demand’ deposits

I owe a debt of obligation to my fellow Cobdenites for kickstarting a debate about money and banking amongst the UK Austrian community. As a participant in that debate – both on this blog and on the Cobden Centre mailing list – I decided to write up a working paper on the sound money debate. I’m delighted that it has now been published, and those with institutional access can find it here (PDF).

The abstract is:

This article contributes to a recent debate between Barnett and Block (J Bus Ethics 88(4): 711–716,2009), Bagus and Howden (J Bus Ethics 90(3): 399–406, 2009), Barnett and Block (J Bus Ethics 100: 299–238, 2011), Cachanosky (J Bus Ethics 104: 219–221, 2011) and Bagus and Howden (J Bus Ethics 106: 295–300, 2012a) regarding the conceptual distinction between demand deposits and time deposits. It is argued that from an economic perspective there is nothing inherently fraudulent or illegitimate about deposit accounts that are available ‘on demand’, but that this relies on certain contractual provisions. Particular attention is drawn to option clauses and withdrawal clauses, which “solve” the problems raised by Barnett and Block, and Bagus and Howden. Previous authors have also neglected the asset side of banks balance sheets, and this is shown to further justify the legitimacy of fractional reserve banking. 

If you don’t have access, please email me and I’ll be glad to send you a copy.

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17 replies on “In defence of ‘demand’ deposits”
  1. says: Paul Marks

    The word “deposit” is misleading.

    A bank is not a grain silo – money is not “deposited” in a bank, it is lent to a bank (by investors – it is misleading to call them “depositors”) and then lent out.

    How else could money earn interest?

    If one wishes a bank to just look after one’s money (not lend it out) then one should pay the bank to do this.

    However, just dropping the words “deposit” and “depositors” and replacing them with the words “investment” and “investors” would not solve the total problem.

    The key problem (the key cause of boom-busts) is lending out “money” that DOES NOT REALLY EXIST (credit expansion).

    People talk of “fractional reserve banking” as if it meant that (say) 90% (nine tenths) of money “deposited” was lent out. This is not the case – once all the complex interactions between banks (the credit expansion – credit BUBBLE building) is taken into account – it is not nine tenths, it is more like 90 tenths, or 900 tenths.

    90 tenths or 900 tenths is not a “fraction” as normal people use this term.

    This is not “Fractional Reserve Banking” – this credit expansion (lending out “money” that does not really exist – credit bubble building) would be better described as Credit Bubble Banking, or Pyramid Scheme Banking.

    Whether one calls it “fraud” or not does not matter, from an economic point of you, what matters is that it has terrible consequences.

    Almost (but not quite) needless to say – government intervention (classically by the creation of Central Banks) makes the problem WORSE (vastly worse) not better.

  2. says: Paul Marks

    By the way – two different parties can not have the same money at the same time.

    If money is lent out neither the bank nor the “depositors” have the money any more (the borrowers have the money – and when they spend it, other people have the money), not till when and IF the loan is paid back.

    Book keeping practices such as “crediting to the account” rather than lending out physical money are a mess.

    A bank only has the money it has (physically has – in the vaults), if book keeping practices tell bankers they have more money than they physically do have (indeed more money than even EXISTS) then those book keeping practices are wrong.

    Again, from an economic point of view, it does not matter if one calls these book keeping practices “fraud” or not – what matters is that they are insane.

    A person (banker or not) does not have money they do not have (regardless of what it says in the account books – or on computer screens) and they certainly do have money than EXISTS.

    What to know how much money your bank has its possession Mr Banker?

    Do not waste your time looking into fantasy account books.

    Go into the vaults and physically check.

    That is how much money your bank has in its possession – no more.

  3. says: Paul Marks

    On bank “assets”.

    Some people often treat a loan as if it was an asset.

    This is like treating a ticket on a horse race as an asset – it is asset only when and IF the horse wins.

    A loan is only really an asset when and IF it is repaid.

    Until a loan is repaid it is a LOAN – not an “asset”.

    A banks real assets are things like the tables and chairs and the buildings (if the bank actually owns the freeholds) and the capital provided by the shareholders.

    By the way – government IOUs (“Treasury Bills” and other such) do I really have to examine that stuff?

    1. says: Rob Thorpe

      “Some people often treat a loan as if it was an asset.

      This is like treating a ticket on a horse race as an asset – it is asset only when and IF the horse wins.

      A loan is only really an asset when and IF it is repaid.”

      You do realize that’s an argument against banking full-stop. Even Rothbard & Block don’t go that far. They say that if a bank sells timed-savings products like bonds and lends out the money then it’s not doing anything wrong.

      The same argument about assets could be made with lots of physical assets. My firm may buy machine X assuming that it will make money for them though it hasn’t done so yet. Should they be permitted to call that machine an asset only once it has made money? There is risk in every type of business.

  4. says: Gary

    you will never, ever stop fractioning of monetary reserves. IOUs, claims on money that will circulate as money, will spontaneously arise no matter what. The problem arises when their is no free market transparency and thus mark to market breaks down. Then you are left in the hands of the liar.

  5. says: Paul Marks

    Mr Thorpe – I was in error, but not in the way you think I was.

    Actually a winning horse race ticket is a asset – if the bookmaker has the money to honour it (if the bookmaker does not – a winning horse race ticket is no more an asset than a losing horse race ticket).

    As for “an argument against banking as such”.

    I am NOT against money lending, I am not an “anti usury” person.

    I simply ask that you have the money you lend out. That you do not pretend to have money you have not got.

    Do not base the economy on magic pixie dust delivered (via Moonbeams) from the invisible fairy castle in the air.

    1. says: Rob Thorpe

      Hi Paul, by the way I’m “Current” on other forums.

      “I am NOT against money lending, I am not an ‘anti usury’ person.”

      I realize that. But you’re permitting money lending in a very restricted way if loans can’t be considered assets.

      For example, suppose I lend 100 ounces of gold to Mr.Jones. According to your rules I can’t borrow from other based on that fact. I can’t say to Mr.Smith, “could you lend me 200 ounces of gold I can pay with the interest I’m getting from Jones”. As I understand you I can’t even do that if I fully inform Mr.Smith of the risk that Mr.Jones may not pay me.

  6. says: Paul Marks


    There is a vast difference between a fraction of (for example) nine tenths – and a “fraction” of 90 tenths or 900 tenths.

    If you can not intuitively grasp the difference between a fraction that is smaller than the number (the amount of PHYSICAL money the bank has) and a “fraction” that is bigger (vastly bigger) than the number (the amount of physical money the bank has) then it is hard to see how it could be explained.

    As for treating IOUs as money.

    Do I really have to explain that money must be a store-of-value not just a medium-of-exchange.

  7. says: Gary


    IOUs ARE a fractioning UP of the underlying. They are an inflation(multiples) of the underlying. They are traded AS money, they are certainly not sound money. IOUs will ALWAYS arise spontaneously , eg in the manufacturing chain when monetary payments are only received when final goods are delivered. Before then payments within the production chain are made in lieu of the final cash settlement , by IOUs, and they trade AS IF they are money. There is inherently no problem with that as long as they are timeously marked to market.

    If you enforce by law that payments in hard money must be made upfront through all stages of production, production will grind to a halt. The best that can be done is to enforce by law that the spontaneous arising IOUs be self liquidating ie they expire within a fixed time period or upon clearance(settled) for hard money and you make the market transparent ie. the market is free from govt underwriting.

  8. says: Paul Marks

    Gary – where did I say that credit should be banned?

    If you want to let people have goods on a promise they will pay later – that is your right.

    But do not confuse credit with MONEY.

    IOUs are NOT money.

    They are not a store-of-value.

    Nor should there be a law against confusing credit with money – any more than there should be a law against people thinking that 1+1=27 or that throwing themselves into active volcanos is good for their health.

    A society where such delusions are common is already doomed and no government statutes are going to save it.

    Indeed government is the biggest pusher of such delusions.

    Every step of the way it (both in Britain and the United States) pushed the “cheap money” policy (i.e. pushed Credit Bubble, pushed Pyramid Scheme, banking) – urging bankers (and others) to do it MORE and MORE and MORE.

    Then when it, inevitably, blows up (and all those lovely tax revenues and cheap borrowing – turn into desperate appeals for bail outs) it is all “corporate greed” with government saying “we need wider powers – to stop this sort of thing” and then (in the next breath) saying “the banks must start lending again”.

    Lending WHAT?

    Real savings are dead. There is little real savings to lend.

    “Banks must start lending again” can only mean another credit bubble (there is nothing else – not now).

    Who were the three politicians who got the most money from the financial industry in the run up to the 2008 crash?

    Congressman Barney Frank, Senator Christopher Dodd and then Senator Barack Obama.

    Who were the three people in charge of the creating the new rules after 2008?

    Barney Frank and Chris Dodd (hence “Dodd-Frank”) and pushing every step of the way – Barack Obama.

    No I am NOT saying the bankers control the government – the payments to Dodd, Frank and Obama were PROTECTION MONEY as these three politicians were known as both far left and (an important combination) deeply corrupt.

    Well their system is in place now (the “Chicago Way” of protection money) – and it has backfired (as it always does).

    If you trade in credit bubbles (rather than REAL SAVINGS) you are always going to end up dependent on the government – and your “friends” the government are always (in the end) going to grab you by the b…..

    I could examine Chancellor O. and Mark Carney in Britain – but do I really have to?

  9. says: Paul Marks

    Rob when have I said I want new laws?

    All I have said is that if total lending is greater than the amount of money (the physical money) then there is a credit BUBBLE and that bubble will burst (as the credit shrinks back down towards the monetary base).

    If banks insist on lending out money that DOES NOT EXIST they will, eventually, go bankrupt.

    But that is their choice.


    I do not believe in a law against committing suicide either.

    1. says: Rob Thorpe

      Paul, what I’m talking about here isn’t related to money. I’m talking about the business of making loans, money is a side issue. Some banks create bank balances which are money substitutes, many don’t.

      You wrote earlier:
      “This is like treating a ticket on a horse race as an asset – it is asset only when and IF the horse wins.

      A loan is only really an asset when and IF it is repaid.

      Until a loan is repaid it is a LOAN – not an ‘asset’.

      A banks real assets are things like the tables and chairs and the buildings (if the bank actually owns the freeholds) and the capital provided by the shareholders.”

      My point is, I see no reason why a business shouldn’t consider a loan to be an asset. Certainly the borrower may default, but that’s a matter for the lender to consider when making the loan. If the lender selects well then the chance of default can be very low. This is similar to the risk all businesses face.

      “All I have said is that if total lending is greater than the amount of money (the physical money) then there is a credit BUBBLE”.

      The total amount of prudent lending has nothing to do with the quantity of money. It’s related only to the properties of borrowers, will borrowers pay back their debts or not, that’s the only important question. It may be prudent to lend out many more times the money supply, equally it may be imprudent to lend out an amount even 1% of the money supply.

  10. says: Paul Marks


    By the way – your example has nothing to do with the problem.

    I lend 100 ounces of physical gold to Mr Smith.

    I in turn borrow 100 ounces of physical gold from Mr Jones.

    Fine – that does NOT inflate the credit-money supply.

    You do know that bank credit is vastly BIGGER than the amount of physical money do you not?

    That is the problem.

    Not the fact that banks commit suicide (they can go right ahead), but the fact they create a vast credit bubble.

    I.E. – they drag everyone else over the cliff with them (with their idiotic way of doing the books – “crediting to the account” and so on).

    But (as I have said many times) – state intervention just makes this WORSE.

  11. says: Paul Marks

    Rob ….I still have an comment “awaiting moderation” for some reason.


    IOUs are NOT money, and money is NOT s “side issue”.

    I refer you to the debates between the “Banking School” and the “Currency School” in the early 19th century.

    Both Ludwig Von Mises and F.A. Hayek (at least Hayek before old age) condemned the fallacies of the “Banking School” – i.e. that credit-expansion (lending out money that DOES NOT EXIST) is O.K. if it is for the “needs of trade”.

    Of course just because the Currency School were “right about the problem” does NOT mean they were “right about the solution”.

    1. says: Rob Thorpe

      I know that banking debates usually centre around money. But in this case I’m not talking about money, I’m just talking only about making loans and borrowing.

      I’m talking about the case that Rothbard calls the “honest savings and loans bank” that borrows from some people with fixed terms (i.e. by issuing bonds) and lends to others. A bank that does nothing “on demand”.

      Your comments above indicate that you think this is somehow illegitimate because there’s a possibility that lenders won’t pay back their loans.

      Can you please explain what you think is wrong with this and what on earth it has to do with the quantity of money. I see no reason that the quantity of debts of fixed terms should have any connection to the quantity of money.

  12. says: Paul Marks

    Rob I have said (several times) that I am talking about lending out “money” that DOES NOT EXIST.

    I am NOT talking about what you are talking about.

    I am talking about a credit BUBBLE.

    I.E. lending being greater than real savings of physical money.

Comments are closed.