Those Bad Old Buttoned-Up Days

Anything dismissed as "Victorian" these days is bound to be virtuous and rare, yet so compelling to decent people that a mere mention scares the pants on libertines. I'm talking, of course, about sound banking, which the Wall Street Journal dismisses in an editorial as "Victorian Finance."

"The Victorians were people, you recall, who upon discovering the little secret of sex, thought the human race was about to vanish," says the Journal. "Likewise, our modern Financial Victorians have discovered the little secret of credit." The Victorians were merely realistic about sex, as we are not about credit, but the wages of sin are about to be paid.

After the S&L-bank orgy, Americans no longer believe in financial promiscuity. That's why, says the Journal, a belief in 100% reserves and "worries about 'too much leverage' or 'too little capital' creep out of heavily curtained conference rooms and into daily conversations." A "modern economy runs on credit. And credit runs on fractional reserves." Without them, banks would have "nothing to lend."

Except on the point that people are worried, the Journal is wrong about everything, including the most important: the Mises Institute's conference room doesn't have any curtains. But I can't blame the editorialist. The entire establishment is white knuckling it these days.

If enough people realize the banks are a house of cards, it will be 52 pick-up. When a very small percentage of depositors demanded their money, it closed the giant Bank of New England. Every other big bank is in similar condition, protected from the same fate by an increasingly ephemeral "confidence," with the Federal Reserve as tender of last resort. But here's the real "little secret" of our age: the Fed can't bail out more than a few big banks without hyperinflation. Thus the Journal's distress. The government is coming to the end of its rope, and it's around the neck of the banks.

All these troubles can be traced to the legal doctrine of fractional reserves, which says that your liquid bank deposits are owned not by you, but by your bank, to do with as it pleases. When people realize this, it scares them. They want their money to be there when they need it, not in some deadbeat real estate project or Third-World politician's pocket.

As Murray N. Rothbard and every other free-market economist before the Progressive Era has argued, there are two functions in honest banking: warehousing money as versus loaning it out. When a customer deposits his cash for a fixed term – by purchasing a CD, for example – the bank can properly loan it out for one day less, with prudential reserves against loan losses. But a demand deposit is different.

Under the terms of the contract, demand deposits are to be available any time the customer wants them. In a sound system, the banks keep 100% reserves for their demand deposits. Anything else is fraud, as the best of the Founding Fathers argued – if I may be forgiven for harking back to pre-Victorian times.

As the libertarian Tom Paine said, money in a bank is "the property" of the man who "deposits cash there." He "can draw the money from it when he pleases. Its being in the bank, does not in the least make it the property of the stockholders."

Accompanying unsound banking is fiat paper money. The only "proper use for paper," wrote Paine, is "to write promissory notes and obligations of payment in specie upon." But when a government "undertakes to issue paper as money, the whole system of safety and certainty is overturned, and property set afloat." It is "like putting an apparition in the place of a man; it vanishes with looking at it, and nothing remains but the air."

Paper money, wrote Paine, "turns the whole country" into speculators. "The precariousness of its value and the uncertainty of its fate continually operate, night and day, to produce this destructive effect. Having no real value in itself it depends for support upon accident, caprice and party, and as it is the interest of some to depreciate," the "morals of the country" are destroyed with "new schemes of deceit. Every principle of justice is put to the rack, and the bond of society dissolved."

No matter how often – or maybe because of how often – we are told that the bank apparitions are solid, we still want 100% reserves, witness the extreme reluctance to leave more than $ 100,000 in any one account. What is deposit insurance but an attempt to provide 100% reserves by another name? Unlike real 100% reserves, however, it allows the banks to profit from what Paine called "vice and immorality."

It's true that eliminating deposit insurance under a paper-money, fractional-reserve system like ours would bring chaos, but that is what's coming anyway. Substitute hard money for paper, make the dollar an unchanging weight of gold, and we would have a real market system.

Note: so-called deposit insurance cannot be privatized. Banks, as entrepreneurial ventures, are not insurable, except against poolable risks like fire and theft. No businessman can purchase insurance against failure, and in a free market, neither would any bank. Deposit insurance is merely a government subsidy to the banks, and as such, illegitimate. Without it, banks would be subject to market forces like every other business. They would have no privileges or immunities beyond the rule of law.

"Paper money appears," said Paine, to cost "nothing; but it is the dearest money there is." More bank credit inflation, which the Journal advocates to turn "bad credits into good credits," is no different; it causes economic distortions, future recession, and illegitimate transfers of wealth, all to bail out a group that deserves opprobrium,not welfare for the well-connected.

Human nature is the same today as in the Victorian era, and so are the laws of economics. The only solution to the bank crisis is the old solution, which every good economist advocated before our wanton century: honest money and honest banking. Now all we need is a Tom Paine to lead that revolution.