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Titles in search of property: Should fractional-reserve banking come to an end?
Voluntaryist, The, 1st Quarter 2002 by Watner, Carl
In my article, "Free Banking and Fractional Reserves" in Issue 29 of THE VOLUNTARYIST (December 1987), I conceded that "fractional reserves do not constitute a breach of contract when and where that practice is specified" between the banker and his customer. After reading Hans-Hermann Hoppe's 1998 article on "Fiduciary Media" (Volume 1, Number 1 of THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS, pp. 19-50, with Jorg Guido Hulsmann and Walter Block), I want to reconsider this concession. Is a voluntary fractional reserve contract between consenting parties legitimate, or should a public consensus be reached that fractional reserve banking is contrary to the general legal principles of a libertarian society? The purpose of this brief article is to examine these questions, and to consider their ramifications.
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The first of Hoppe's points that I would like to review is his reference to the "tragedy of the commons." In the conclusion to footnote 6, on page 23 of Hoppe's original article, he explains that "every issue of fiduciary media - to titles in search of property - sets in motion a rush always starting with the bank and its clients, to fill these empty tickets with existing property; and in the course of this rush, invariably the firstcomers will physically enrich themselves (through the appropriation of existing quantities of property) at the expense of a corresponding impoverishment of latecomers, whose quantity of existing property is physically diminished while they have been left with a larger number of property tickets." In other words, when customers of a fractional-- reserve bank make a "run on the bank", the firstcomers get the money, while the latecomers are left holding the proverbial bag with nothing in it. Or, as Murray Rothbard wrote in WHAT HAS GOVERNMENT DONE TO OUR MONEY?:
The issue of warehouse receipts for non-existent goods, identical with genuine receipts, is fraud upon those who possess claims to nonexistent property. ... Which particular receipts are fraudulent can only be discovered after a run on the bank has occurred (since all the receipts look alike), and the latecoming claimants are left high and dry. [p. 24, fn 17]
At the peak of the silver market in early 1980, the Hunt brothers and other speculators were "squeezing" the market. They did this by owning an enormous stockpile of silver bullion and owning future contracts under which they were entitled to purchase even more silver. The Hunts were "long" in the market, hoping for further price appreciation; while the "shorts," or people who had sold silver they didn't own, were hoping that the price would decline. Then they could profit from buying silver at a lower price in order to fulfill their selling contracts which were at a higher price. Every "squeeze" or attempt to "corner" the market usually involves a situation similar to the "tragedy of the commons," or one similar to a "run" on the bank. If no one sold property they didn't own, there would be considerably less danger of market speculations between the bears and the bulls. Queries: Should the sale and purchase of naked futures contracts and short stock sales be abandoned in a free market? Should-speculators be able to buy and sell contracts to non-existent quantities of things which they promise to deliver in the future - or to commodities which they don't properly have title to and then be able to satisfy these contracts by offset rather than actual physical delivery? What parallel exists between fractional-reserve banking and short sales on the stock market and commodity speculation via the futures market?
While I am not prepared to answer these questions in this article, the question of promising to buy and sell property which one does not own and does not have on hand was astutely discussed by W. Stanley Jevons in his book MONEY AND THE MECHANISM OF EXCHANGE (New York: D. Appleton and Co., 1919). In Chapter XVII, "The Nature and Varieties of Promissory Notes," Jevons made the following observations:
He who issues a representative or promissory document, engaging to give a certain quantity of a defined commodity in return for the document when presented, may really make any one of three distinct engagements.
1. He may promise to keep a certain identical article in his possession until it is called for.
2. He may engage to have in his possession a certain amount of commodity ready to meet the promissory notes, without distinguishing between portion and portion of a similar substance.
3. The undertaking may merely be to the effeet that the required commodity shall be forthcoming when the note is presented, no covenant being made as to the quantity to be held in stock for the purpose.
Specific Deposit Warrant
The most satisfactory kind of promissory document is the first, which is represented by bills of lading, pawn-tickets, dock-warrants, or certificates which establish ownership to a definite object. ... The important point concerning such promissory notes is, that they cannot possibly be issued in excess of the goods actually deposited, unless by distinct fraud. ...
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