The Danger of Fractional-Reserve Banking

Walter Block versus Bryan Caplan on Fractional Reserve Banking


What appears below is a series of letters between me and Bryan Caplan. I regard Bryan as a brilliant young man, and an important contributor to libertarianism. He is, however, a bitter critic of all things concerning Austrian economics (I have a review forthcoming in the Journal of Libertarian Studies of his recent book, The Myth of the Rational Voter: Why Democracies Choose Bad Policies; see this for my critical comment on his gratuitous three page attack on Austrians as "market fundamentalists"). On the other hand, in my view, Caplan is fast becoming a rising star among the neo-classicals; he writes voluminously and negatively about Austrian economics. But he always spells that name correctly, and, thus, garners far more publicity for us than would otherwise be the case. I would vastly prefer that mainstream economists attack praxeologists rather than ignore us. In that way, they set up targets for us, and better enable us to break out into the society at large. Indeed, Caplan has become a sort of one-man industry in this regard, so calling forth a dozen or so rejoinders to his criticism.

On this, see the appendix 1 at the end of this article.

The present debate got started when I read that Caplan had characterized Rothbard’s position on fractional reserve banking (frb) as "crazy." Further adding insult to injury, he denotes this position as too easy of a target to hit out against. Now, I suppose, I think of Milton Friedman roughly in the way that Caplan regards Rothbard. Yet, I never characterized Friedman’s views as "crazy" nor as a "too easy" target. That really got in my craw, and led me to write to Caplan.

This correspondence took place during the month of October, 2008. I have edited this very slightly, e.g., getting rid of some of the ums and aws, on both our parts, updating the bibliography I had originally sent to Bryan and Jeff Hummel (the latter was copied on this in its entirety, but did not contribute to it), etc.

Part I.

Walter Block wrote:

Dear Bryan and Jeff:

Reading from here, I see the following:

“Yesterday at the FEE seminar, I got to hear the excellent Jeff Hummel thoroughly debunk the crazy Rothbardian view that fractional reserve banking is “fraudulent.” It was fun (and funny) lecture, but the target was too easy.”

I infer, then, that you guys, both of you, have published attacks on the “crazy Rothbardian view." I’m trying to put together a bibliography on both sides of this “easy” target, see below. Yet, I don’t have anything from either of you on this list. Please send me the cites of your pubs debunking the Rothbard-Hoppe view that frb amounts to fraud, counterfeiting and theft.

Have you guys even read the other side of this debate?

Best regards, Walter

See appendix 2, below, for this bibliography

Part II.

From: [email protected] Sent: Monday, October 13, 2008 10:27 AM To: Walter Block Cc: [email protected] Subject: Re: frb easy target

If I’ve published anything on this, I don’t recall. And yes, in my misspent youth I read lots of defenses of 100% reserves. I even believed them.

If I were going to write something on this, it would be very short. I’d probably just quote P&M: — ——————– No administrator is needed to prevent non-fraudulent sales; if a man simply sells what he calls “bread,” it must meet the common definition of bread held by consumers, and not some arbitrary specification. However, if he specifies the composition on the loaf, he is liable for prosecution if he is lying.

Part III

From: [email protected] Sent: Monday, October 13, 2008 12:00 PM To: Walter Block Cc: [email protected] Subject: Re: frb easy target


How about if a man sells a square circle to a willing buyer? How about if the contract is incompatible with private property rights, on the basis of which all contracts are supposed to lie, at least according to libertarian theory? How about if the “contract” involves two people each owning 100% of something like a gold ounce (which I take to be a logical contradiction)?

Caplan: At worst, this would make a contract void for vagueness, but not “fraudulent.” The more natural response, though, is to interpret apparent contradictions in contracts charitably.

Block: May I have your permission to share this correspondence with others?

Caplan: Of course.

Part IV.

From: [email protected] Sent: Monday, October 13, 2008 1:46 PM To: Walter Block Cc: [email protected] Subject: Re: frb easy target


You’re just being difficult, Walter. If you asked a married couple “Who owns your car?” many people would say “We both own it. Fully.” You can either berate them for self-contradiction, or interpret their statement charitably through the usual lens of marital property.


It is merely “vague” when two different people have full property rights over the same identical thing? I don’t think so. Look, you and I can both be PART owners of a car: you use it on odd days, me on even ones. But we both (logically) cannot be FULL owners of one and the same car. That is a logical contradiction, an utter impossibility. But, yet, in frb, there are indeed two different people with FULL rights to the same thing, a given amount of money. There is simply no “charitable” way to interpret this.

Part V.

From: [email protected] Sent: Monday, October 13, 2008 2:24 PM To: Walter Block Cc: [email protected] Subject: Re: frb easy target


[Sarcasm.] Then I guess it’s time to invalidate millions of marriages as well as frb for their contradictory assignment of property rights.


Two people can no more FULLY own a car than there can be two people in the same identical place. Married couples typically SHARE ownership in cars they don’t, they CAN’T, both fully own it.

Let me try again on this. Under libertarianism, rights cannot conflict. If there is any conflict, there is an improper specification of rights. But, if A (husband) and B (wife) each fully own a car, then there IS a conflict in rights. Each has a right to do with the car what he or she wants. Now, there may not be an ACTUAL conflict, if they both want the car used for the same purpose. But, there is still a conflict in RIGHTS. A wants the car used for washing it; B wants to take it on a trip. They both have a RIGHT to use the car for these incompatible purposes. That’s frb for you: a contradiction in terms.

Part VI.

From: [email protected] Sent: Tuesday, October 14, 2008 9:56 AM To: Walter Block Cc: [email protected]| Subject: Re: frb easy target

Caplan: I understand your point. What I’m saying is that you are taking loose ordinary language too literally. If people in a marriage — or a frb — say that both sides have “full” ownership of something, they don’t literally mean that, ad it is silly to claim that they are contradicting themselves. What do they really mean? Roughly speaking, whatever’s customary.


I’ve failed to make my point as clear as I should have. Let me try again. I don’t at all agree that in marriages, or in any other kind of partnerships, the two parties FULLY own the property in question. Rather, they SHARE ownership. Sometimes the husband, or partner A decides, sometimes the wife, or partner B decides, for example, how to use the car.

The only way that both parties can have FULL rights over the car is to have TWO cars. If they have only ONE car between them, which is the assumption we have been operating under, how can they each have the right to FULLY determine the use of the car? Now, it may be, and I certainly “concede” this, that there may be no conflict in actual use of the car. A might allow B to fully determine its use. But that is NOT what I am talking about. I’m not talking about, that is, practicality, actual use, nothing like that. I am talking about RIGHTS, solely about rights. I don’t know how to say this more clearly: two different people cannot have full rights to any one thing. Only one person can.

Part VII.


I don’t really think that “ordinary language” really applies here. Most people, married or not, don’t think much about frb, property titles, etc. My sense of ordinary language is that no one, no one at all, speaks of “full” ownership. Only people like Rothbard, Hoppe, Hülsmann and me talk about it, and people like you, Hummel, White, Selgin, deny it.

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 or 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.

I can’t see my way clear to agreeing with you that these thoughts of mine stem from “taking loose ordinary language too literally.”

Walter Block as editor: this ends the correspondence between me and Caplan.

Appendix 1. Caplan bibliography:

Barnett, forthcoming; Block, 1999, 2003, 2005, 2007; Caplan, 1999, 2000, 2001, 2003, 2008; Callahan, 2003; Carilli and Dempster, 2003; Hoppe, 2005, 2007; Hülsmann, 1999, Machaj, 2007; Murphy, 2008; Murphy, Wutscher and Block. Unpublished; Stringham, 2001, 2008; Stringham and White, 2004

Barnett, William. Forthcoming. "Contra Caplan’s Economic Methodology" Corporate Ownership & Control.

Block, Walter. 1999. "Austrian Theorizing, Recalling the Foundations: Reply to Caplan," Quarterly Journal of Austrian Economics, Vol. 2, No. 4, winter, pp. 21—39.

Block, Walter. 2003. "Realism: Austrian vs. Neoclassical Economics, Reply to Caplan," Quarterly Journal of Austrian Economics, Vol. 6, No. 3, Fall, pp. 63—76.

Block, Walter. 2005. "Rejoinder to Caplan on Bayesian Economics," Journal of Libertarian Studies. Vol. 19, No. 1, Winter, pp. 79—95.

Block, Walter. 2007. “Reply to Caplan on Austrian Economic Methodology” Corporate Ownership & Control, Vol. 4, No. 2, November, pp. 312—zz.

Caplan, Bryan. 1999. “The Austrian Search for Realistic Foundations,” Southern Economic Journal, April, Vol. 65, No. 4, pp. 823—838

Caplan, Bryan, 2000. "Probability, Common Sense, and Realism: A Reply to Hülsmann and Block," Quarterly Journal of Austrian Economics, Vol. 4, No. 2, Summer, pp. 69—86.

Caplan, Bryan. 2003. "Probability and the Synthetic A Priori: A Reply to Block." Quarterly Journal of Austrian Economics; Vol. 6, No. 3, Fall, pp. 77—83.

Caplan, Bryan. 2008. "The Trojan Horse Example" June 16.

Callahan, Gene. 2003. "Choice and Preference," February 10.

Carilli, Anthony M., and Dempster, Gregory M. 2003. “A note on the treatment of uncertainty in economics and finance” Journal of Education for Business 79.2 Nov. 1, pp. 99—103.

Hoppe, Hans-Hermann. 2005. "Must Austrians Embrace Indifference?," Quarterly Journal of Austrian Economics, Vol. 8, No. 4, Winter, pp. 87—91.

Hoppe, Hans-Hermann. 2007. "The limits of numerical probability: Frank H. Knight and Ludwig von Mises and the frequency interpretation." The Quarterly Journal of Austrian Economics, vol. 10, no. 1, spring: 3—21.

Hülsmann, Jörg Guido. 1999. "Economic Science and Neoclassicism." Quarterly Journal of Austrian Economics, Vol. 2 Num. 4, pp. 1—20.

Machaj, Mateusz. 2007. "A Praxeological Case for Homogeneity and Indifference." New Perspectives on Political Economy, Vol. 3, No. 2, pp. 231—238.

Murphy, Robert P. 2008. "Austrian Realists." July 17.

Murphy, Robert P., Robert Wutscher and Walter E. Block. Unpublished. "Mathematics in Economics: An Austrian Critique."

Stringham, Edward (2008) “Economic Value and Cost Are Subjective” in The Handbook of Austrian Economics, Peter Boettke (editor), Cheltenham, UK: Edward Elgar Publishing, forthcoming.

Stringham, Edward (2001) “Kaldor-Hicks Efficiency and the Problem of Central Planning” Quarterly Journal of Austrian Economics, Vol. 4, No. 2 (Summer) 41—50.

Stringham, Edward, and White, Mark (2004) “Economic Analysis of Tort Law: Austrian and Kantian Perspectives” in Law and Economics: Alternative Economic Approaches to Legal and Regulatory Issues, Margaret Oppenheimer and Nicholas Mercuro (editors) New York: M.E. Sharpe, 374—92.

Appendix 1, FRB

A. Anti—Fractional reserve banking (frb):

Barnett and Block, 2005, 2008; Block and Garschina, 1996; Hoppe, et al. 1998; Hoppe, 1994; Hülsmann, 2000, 2002a, 2002b, 2003; Rothbard, 1962; de Soto, 1995, 2001.

Barnett, William II and Walter Block. 2005. "In defense of fiduciary media — a comment; or, what’s wrong with "clown" or play money?" Quarterly Journal of Austrian Economics; Vol. 8, No. 2, Summer, pp. 55—69.

Barnett, William and Walter Block. 2008. "Time deposits, dimensions and fraud," Journal of Business Ethics; (this one is more radical, in that is characterizes even some time deposit practices, not merely demand deposit practices, as fraudulent).

Block, Walter and Garschina, Kenneth M. 1996. “Hayek, Business Cycles and Fractional Reserve Banking: Continuing the De-Homogenization Process,” Review of Austrian Economics, Vol. 9, No. 1, 1995, pp. 77—94.

Hoppe, Hans-Hermann, with Guido Hülsmann and Walter Block. 1998. “Against Fiduciary Media,” Quarterly Journal of Austrian Economics, Vol. 1, No. 1, pp. 19—50.

Hoppe, Hans-Hermann. 1994. “How is Fiat Money Possible? or, The Devolution of Money and Credit,” Review of Austrian Economics, 7(2), pp. 49—74.

Hülsmann, Jorg Guido. 2000. “Banks Cannot Create Money“, The Independent Review: A Journal of Political Economy, vol. 5, no. 1, summer, 101—110.

Hülsmann, Jorg Guido. 2002a. "Free Banking and the Free Bankers." Review of Austrian Economics. Vol. 9, No. 1. pp. 3—53.

Hülsmann, Jorg Guido. 2002b. "Free Banking Fractional Reserves: Reply to Pascal Salin." Review of Austrian Economics, Vol. 1, No. 3.

Hülsmann, Jorg Guido. 2003. “Has Fractional-Reserve Banking Really Passed the Market Test?,” Independent Review 7/3, Winter, 399—422.

Rothbard, Murray N. 1962. “The Case for a 100 Percent Gold Dollar,” In Search of a Monetary Constitution, Leland B. Yeager, ed., Cambridge, MA: Harvard University Press, pp. 94—136, and Auburn, AL: Ludwig von Mises Institute, 1991. See also “The Logic of Action One” pp. 364—384.

Rothbard, Murray N. What Has Government Done to Our Money?, Auburn, AL: Ludwig von Mises Institute, 1990.

de Soto, Jesús Huerta. 1995. “A Critical Analysis of Central Banks and Fractional-Reserve Free Banking from the Austrian Perspective,” Review of Austrian Economics, 8(2), pp. 25—38.

de Soto, Jess Huerta. 2001. “A Critical Note on Fractional Reserve Free Banking,” The Quarterly Journal of Austrian Economics, Vol. 1, No. 4, Fall, pp. 34—35

B. pro frb:

Sechrest, 1987, 1989a, 1989b, 1991a, 1991b, 1993, 2007; Selgin, 1994, 1998, 2007a, 2007b, 2007c; Selgin and White, 1996; White, 1992, 1995, 1999, 2003, 2007a, 2007b, 2007c

Sechrest, Larry. 1987. "White’s Free Banking Thesis: A Case of Mistaken Identity," Review of Austrian Economics, November, Vol. II, 247—57.

Sechrest, Larry. 1989a. Review of George Selgin’s The Theory of Free Banking, Journal of Economics, Vol. XV, 196—98.

Sechrest, Larry. 1989b. "Free Banking vs. Central Banking: A Geometrical Analysis," South African Journal of Economic and Management Sciences, November, Vol. II, 83—97.

Sechrest, Larry. 1991a. "Free Banking in Scotland: A Dissenting View," Cato Journal, Winter, Vol. 10, No. 3, 799—808.

Sechrest, Larry. 1991b. "Banking, Central and Free," pages 145—51, Magill’s Survey of Social Science: Economics, Salem Press.

Sechrest, Larry. 1993. Free Banking: Theory, History, and a Laissez-Faire Model, Westport, Connecticut: Quorum Books, 1993.

Sechrest, Larry. 2007. "Free Banking Basics," The Free Radical, July/August, Vol. 76, 40—41.

Selgin, George. 1994. "Free Banking and Monetary Control." Economic Journal 104: 1449—59.

Selgin, George. 1998. The Theory of Free Banking: Money Supply under Competitive Note Issue. Totowa, New Jersey: Rowman & Littlefield.

Selgin, George. 2000. "Should We Let Banks Create Money?" The Independent Review, v.V, n.1, Summer, pp. 93—100.

Selgin, George. 2007a. "Is fractional-reserve banking inflationary?" January 23. Free Market News Network.

Selgin, George. 2007b. "Notes on free banking: fractional reserves and economic development, part I" February 14. Free Market News Network.

Selgin, George. 2007c. "Notes on free banking: fractional reserves and economic development, part II" February 15. Free Market News Network.

Selgin, George A., and White, Lawrence H., 1996, "In Defense of Fiduciary Media — or, We are Not Devo(lutionists), We are Misesians!," Review of Austrian Economics, Vol. 9, No. 2, pp. 83—107.

White, Lawrence H. 1992. Competition and Currency: Essays on Free Banking and Money. New York: New York University Press.

White, Lawrence H. 1995. Free Banking in Britain: Theory, Experience, and Debate, 1800—1845, 2nd ed. London: Institute of Economic Affairs.

White, Lawrence H. 1999. The Theory of Monetary Institutions. Oxford: Basil Blackwell

White, Lawrence H. 2003. “Accounting for Fractional-Reserve Banknotes and Deposits,” Independent Review 7/3, Winter, 423—41.

White, Lawrence H. 2007a. “Huerta de Soto’s Case Against Fractional Reserves,” Free-Market News Network (08 Jan).

White, Lawrence H. 2007b. “Huerta de Soto’s View of the History of Banking,” Free-Market News Network (30 Jan).

White, Lawrence H. 2007c. “Huerta de Soto on Attempts to Justify Fractional-Reserve Banking,” Free-Market News Network (05 Feb).

(Editorial interjection on my part: Larry Sechrest passed away today, 10/30/08; he has contributed significantly to this bibliography. I know that all members of this debate, and, indeed, all Austro-libertarians, will join me in offering condolences to his family, and acknowledging his sterling contributions to the cause of freedom. He was a great supporter of liberty and Austrian economics. RIP.)

C. Ambivalent

Ambivalent. These are of interest but there is some question as to on which side they lie:

Callahan, 2003; van den Hauwe, 2006, 2008; Williams, 1984.

Callahan, Gene. 2003. "The Libertarian Case Against Fractional-Reserve Banking,", July 22

van den Hauwe, Ludwig. 2006. "The Uneasy Case for Fractional-Reserve Free Banking," Procesos de Mercado, Vol. III, No. 2, pp. 143—96;

van den Hauwe, Ludwig. 2008, forthcoming. "Credit Expansion, the Prisoner’s Dilemma, and Free Banking as Mechanism Design," Procesos de Mercado.

Williams, Jeffrey C. 1984. “Fractional Reserve Banking in Grain,” Journal of Money Credit and Banking. 16 (4): pp. 488—496

Larry White and I disagree as to how to categorize these, so, at his suggestion, I’m creating a third or "ambivalent" section.

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