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Is
Fractional Reserve Banking Fraudulent?
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I. Prof.
Eric Posner comments on the Block-Caplan debate on fractional reserve
banking, which
can be found here.
I ran across
this odd debate between Bryan Caplan and Walter Block. Here is Block’s
argument ("frb" means fractional reserve banking):
Consider this:
A deposits 10 ounces of gold in B's bank; B gives A a demand deposit
for these 10 ounces. B turns around and lends C 9 of these ounces,
giving C a demand deposit for these 9 ounces. Thus, A and C both
own full rights to these 9 ounces.
There is now
a problem of over-determination or conflict in rights. A and C both
have a FULL right to these selfsame 9 ounces of gold. They are both
FULL owners of these 9 ounces.
But, one of
the essences of the libertarian philosophy we share is that there
CANNOT be a conflict in rights. Any seeming conflict is due to a
misspecification of one or the other right. Yet, here, with frb,
we have a GENUINE conflict in rights. Thus, frb is incompatible
with libertarianism.
Note, I am
NOT talking about practicality. It might well be (given no bank
run) that A and C will not ACT incompatibly with one another; that
is, both will not demand that B pay them these 9 ounces, an utter
impossibility. No, I am talking about RIGHTS. Right now, before
any bank run, there is STILL a rights contradiction.
Caplan just
sputters. Here is the problem with Block’s argument, as I think
any lawyer would immediately recognize.
Block confuses
property rights and contract rights. If I give the bank some cash
and pay it to put this cash in a safety deposit box, then the bank
can’t use that cash. It can’t lend it out to someone else; it can’t
list it as an asset on its balance sheet; it can’t touch it without
my permission. If the bank were to do so, then it would have engaged
in theft, and the relevant employees would go to jail. Lawyers call
this transaction a bailment.
But if I deposit
some cash with the bank, I don’t retain my property interest. Instead,
I’m making a loan to the bank and I obtain a contractual right to
repayment on demand. If I demand my cash (plus interest, if any)
and the bank fails to pay me, then I can sue it for breach of contract
and demand expectation damages. If the bank were not a bank but
just an ordinary borrower, and it was insolvent, then I have to
race other creditors for its assets; otherwise, my contract right
is converted into a claim in bankruptcy, and I have to share with
other creditors. (Since it is a bank, I may well obtain full compensation
from the government, but that is not relevant to the debate.)
If you asked
the bank whether it might lend out your money, it would most certainly
tell you that it would. So it is not lying to you, and there can’t
be fraud. Nor is there any other contradiction, incompatibility,
or problem with the arrangement. Depositors take a risk that the
bank will breach the contract but anyone who enters a contract takes
the same risk.
Block doesn’t
seem to have any problem with contract rights per se, but he does
have a problem with a person entering a contract that gives another
person the right to demand assets that the first person might not
have. But all contracts are like this. People enter contracts expecting
that they will be able to transfer money, goods, or services when
they are due, but everyone understands that intervening events might
make the transfer impossible, impractical, or unwise. The other
party obtains a right to obtain damages for breach of contract,
but if every contract where the probability of nonperformance is
greater than zero were considered fraudulent, we would have no economy.
The above material
constitutes a statement of Professor Eric Posner's, and can
be found here.
II. Walter Block replies to Eric Posner
There is so
much about which I disagree with Prof. Posner. Perhaps it would
be best to consider Posner's views one bit at a time, and subject
them to scrutiny. He offers four different paragraphs of criticism
of my anti-frb argument, and I will consider them each, in order.
1."Block confuses
property rights and contract rights. If I give the bank some cash
and pay it to put this cash in a safety deposit box, then the bank
can’t use that cash. It can’t lend it out to someone else; it can’t
list it as an asset on its balance sheet; it can’t touch it without
my permission. If the bank were to do so, then it would have engaged
in theft, and the relevant employees would go to jail. Lawyers call
this transaction a bailment."
I agree with
this statement entirely, and enthusiastically. This is precisely
the claim of those of us who would legally ban fractional reserve
banking. However, as can be seen below, we apply this not only to
cash in a safety deposit box, but to ALL deposits with a bank.
2. "But if
I deposit some cash with the bank, I don’t retain my property interest.
Instead, I’m making a loan to the bank and I obtain a contractual
right to repayment on demand. If I demand my cash (plus interest,
if any) and the bank fails to pay me, then I can sue it for breach
of contract and demand expectation damages. If the bank were not
a bank but just an ordinary borrower, and it was insolvent, then
I have to race other creditors for its assets; otherwise, my contract
right is converted into a claim in bankruptcy, and I have to share
with other creditors. (Since it is a bank, I may well obtain full
compensation from the government, but that is not relevant to the
debate.)"
Here, I sharply
disagree. A major matter of contention between the defenders and
opponents of the legality of frb revolves, precisely, around the
issue of whether or not a depositor, call him A, with some cash
with the bank (in the form of a demand deposit), retains his property
interest in those funds. I say No, and offer some reasons. One,
if this is true, then, when the bank lends out money to a borrower,
C, and gives him a demand deposit for (a fraction of) the amount
deposited, there are not one but TWO people each of whom has a FULL
ownership right in the SAME amount of money. This is a logical impossibility.
Two, another way of putting the matter is that there are now more
titles to property than there is property. In the numerical example
mentioned above, there are now only 10 gold ounces, and there are
two people, A (10) and C (9) with rights to 19 gold ounces. A manifest
impossibility.
Posner, in
contrast, says Yes. That is, he claims that A no longer has a right
to the money he has deposited. But he offers no REASON in support
of this contention. Reading in between the lines, it is easy to
see what is going on here: Posner is relying on PRESENT LAW, according
to which he is entirely correct. This, indeed, is the exact manner
that the courts have interpreted demand deposits. However, Posner,
sadly, is missing out on the context of the debate between me and
Caplan. We were debating, not, what the law IS, but, rather, in
sharp contrast, what the law SHOULD BE. Posner mistakenly interprets
the Block-Caplan debate as over a POSITIVE statement of law, when
it really involves NORMATIVE claims about the law. Yes, yes, Professor
Posner's views of bankruptcy law are entirely correct as regards
which creditors are first in line, but they are equally IRRELEVANT
to the debate between me and Caplan.
3. "If you
asked the bank whether it might lend out your money, it would most
certainly tell you that it would. So it is not lying to you, and
there can’t be fraud. Nor is there any other contradiction, incompatibility,
or problem with the arrangement. Depositors take a risk that the
bank will breach the contract but anyone who enters a contract takes
the same risk."
True, again,
true; all too true. The bank would indeed NOT lie to a depositor
about any such thing. But, lying is only sufficient for fraud, not
necessary. There are other ways to commit fraud besides an outright
lie. For example, it is fraudulent for a bank or anyone else to
try to sell you a square circle, even if they do not lie about it.
Why? Because there is no such thing as a square circle, and, in
order for a contract to be a valid one, not only must both parties
agree to it (neither lies to the other), but, also, the contract
must be in accordance with LOGIC (e.g., the law of non contradiction),
and "sales" of square circles clearly are not compatible with that
consideration. But, neither are frb contracts! They, too, are incompatible
with the reality of property rights, according to which there cannot
be more titles to property than there is property; there cannot
be an A and a C, with rights that are incompatible with those of
each other.
For our friends
on the left, there are numerous and myriad contradictions of rights.
For example, X's right to "public" accommodation in Y's home conflicts
with the latter's right to privacy. E.g., X is a homosexual would-be
renter, and Y is a Christian landlord, looking for a roommate. For
the interventionists, the courts must "balance" these rights. But
such rights conflicts are anathema to the libertarian. For us, if
there is a seeming rights conflict, one or the other (or both) of
the putative rights are not rights at all. Yet, in the case of frb,
there are two people, A and C, each with rights to money of 19 units,
and the bank, B, cannot possibly satisfy both. So, A and C have
incompatible or conflicting rights.
4."Block doesn’t
seem to have any problem with contract rights per se, but he does
have a problem with a person entering a contract that gives another
person the right to demand assets that the first person might not
have. But all contracts are like this. People enter contracts expecting
that they will be able to transfer money, goods, or services when
they are due, but everyone understands that intervening events might
make the transfer impossible, impractical, or unwise. The other
party obtains a right to obtain damages for breach of contract,
but if every contract where the probability of nonperformance is
greater than zero were considered fraudulent, we would have no economy."
 No,
not at all. I have no "problem" with contract rights. I am a warm
supporter of them. Provided, that is, that they do not constitute
a logical contradiction, and are compatible with reality, e.g.,
underlying property rights. However, ALL contracts are certainly
NOT "like this." Under frb, it is a logical impossibility for B
to make good his obligations to both A and C, on demand. Now, it
is entirely possible that A and C will not call upon B to do so.
But, IF they do, that is, constitute a "bank run" B will then be
exposed as being unable to meet his financial obligations. In very
sharp contrast, there are NO OTHER contracts quite like this in
the economy. Yes, I buy 10 widgets from you for delivery today,
in consideration for my promise to pay you $10, tomorrow. A day
passes, and I am unable to carry out my part of the bargain. But,
it is not a LOGICAL CONTRADICTION to suppose I am unable to do so,
as in the case of frb. There is all the difference in the world
between being unable to fulfill a contract due to contingent circumstances,
as in the widget example, and it being IMPOSSIBLE to do so, as in
the case of frb. It is not merely "intervening events" that make
it a violation of the laws of logic for B, the Bank, to uphold contracts
with lender A and borrower C. It is IMPOSSIBLE for B to do so, given
frb.
 Posner
is to be congratulated for this little gem: "if every contract where
the probability of nonperformance is greater than zero were considered
fraudulent, we would have no economy." Beautiful. I wish I had said
this. The man, truly, has a way with a word. But it is not merely,
that in the case of frb, "the probability of nonperformance is greater
than zero," as in the case of pretty much ALL commercial agreements.
Rather it is that even before performance or non-performance becomes
an issue (this issue only arises if a bank run occurs), the bank
engaged in frb is legally dead in the water. Its instantaneous debts
are greater than its instantaneous assets. That is, it is bankrupt
from the get-go. Under libertarian law (not, I hasten to add, present
statist law), it would immediately be declared bankrupt, and forced
to disgorge its property. It would not be allowed to operate for
one second. The distinction between frb failure and ordinary business
failure rests on the difference between a logical impossibility
and a contingent failure, which need not have happened.
All if this
is spelled out, clearly, in my part of the debate with Caplan. It
is elaborated upon, in great detail, in the bibliography appended
to that debate. Yet, more than passing curious, Posner chooses to
pretty much ignore all of it in his criticisms of my anti-frb position.
A strange way to come to grips with the arguments of an intellectual
opponent. Hopefully, if there is to be any future round in this
correspondence between me and Posner, he will attempt to come to
grips with what I actually say.
November
6, 2008
Dr.
Block [send him mail] is a
professor of economics at Loyola University New Orleans, and a senior
fellow of the Ludwig von Mises Institute. He is the author of Defending
the Undefendable and the newly released Labor
Economics From A Free Market Perspective.
Walter
Block Archives
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