Fractional-Reserve Banking: Not Fraud, Not Folly

May 13th, 2013   Submitted by Wendy McElroy

bankingFractional-reserve banking is a contentious issue within libertarian theory. This is confusing because I do not consider it to be part of libertarian theory at all.

The practice of fractional-reserve banking has been variously defined. A standard and neutral definition is: the practice by which a bank maintains readily available reserves that represent only a portion of its customers’ deposits while lending out or investing the rest. At the same time, the bank stands by its obligation to redeem demand deposits upon request. Fractional-reserve is often viewed as an aspect of centralized banking or government regulation but it is an entirely separable practice that has functioned within free banking systems. Indeed, fractional-reserve was standard in the 18th century Scottish free banking system which economist Lawrence H. White described in his classic work Free Banking in Britain – Theory, Experience and Debate 1800-1845.

The iconic Austrian economist Murray Rothbard offered a different definition. In an article published by The Freeman (September and October 1995), he described his view of how fractional reserve operated even in the absence of a central bank. Rothbard explained, “I set up a Rothbard Bank, and invest $1,000 of cash (whether gold or government paper does not matter here). Then I ‘lend out’ $10,000 to someone, either for consumer spending or to invest in his business. How can I ‘lend out’ far more than I have? Ahh, that’s the magic of the ‘fraction’ in the fractional reserve. I simply open up a checking account of $10,000 which I am happy to lend to Mr. Jones. Why does Jones borrow from me? Well, for one thing, I can charge a lower rate of interest.” Rothbard called this “counterfeiting” because money is created “out of thin air.”

Additionally he viewed fractional-reserve as a fraud perpetrated on the original depositors. Why? If “the American public…in unison, demanded cash. What would happen? The banks would be instantly insolvent, since they could only muster 10 percent of the cash they owe their befuddled customers.”

Rothbard’s depiction encounters some practical objections. For example, he is assuming all deposits could be demanded in unison – that is, he assumes they are demand deposits and not term ones. Moreover, the same sort of logic could be used to discredit insurance companies. If all (or a significant enough number of) insurance holders filed claims in unison, the insurance companies would go bankrupt. And, yet, I am not aware of insurance companies being similarly viewed as fraudulent.

Instead of dwelling on side issues, however, I accept the description of fractional reserve offered by Rothbard and various other Austrians. I will disagree with them on their own terms.

What Is NOT Being Debated

Both libertarian defenders and opponents of fractional-reserve reject a state monopoly of money or banking; most of them reject any state involvement at all. Instead, both sides advocate privately issued currency that enjoys no legal privileges beyond those enjoyed by individuals. They argue for banking and currency by contract, by voluntary acceptance.

The disagreement on fractional-reserve banking is twofold. Is it fraud? Is it economically prudent? Only the first question is a libertarian one.

Libertarianism can be loosely defined as the political and social philosophy based on the right of every person to the peaceful use his own body and property. Stated in a ‘negative’ manner: libertarianism opposes force and fraud; the latter is a form of theft because it is the wrongful assumption of a property title.
Thus, if fractional-reserve banking is fraud, then it falls squarely within the realm of libertarian theory, and it would be outlawed by a free-market system. But if it is not fraud and merely imprudent, then it falls outside of libertarian analysis however interesting or useful an economic issue it may be. In other words, if fractional-reserve banking is voluntary and non-fraudulent, then a libertarian society would not outlaw the practice even if it proved to be a foolish one.

Is Fractional-Reserve Banking Fraud?

Theft is the non-consensual use of another person’s property. The owner relinquishes some or all control of his property in exchange for a described value. If the value is not as described, then no legitimate exchange or contract has occurred. As economist Bryan Caplan stated, “If you offer me a Mitsubishi 5500 projector in exchange for $2000, and hand me a box of straw instead, you are using my $2000 without my consent (which was contingent, of course, on you giving me the projector).”

The issue upon which fraud hinges is “informed consent.” If depositors at a fractional-reserve bank are fully informed of the bank’s policies and practices, then fraud is not possible. With full knowledge of the terms and the risk, the depositors are entrusting their money to the bank in exchange for an interest rate. (By contrast, a 100%-reserve bank that would not have the benefit of using most of the money deposited would presumably charge a storage fee rather than offer interest. Indeed, this is what happens with the 100%-reserve storage called safe deposit boxes.) Otherwise stated, an informed depositor may make a poor choice with whom or where to entrust his money but the free market and libertarianism does not prohibit even stupid choices.

To maintain the accusation of fraud in the presence of informed consent, some Rothbardian economists expand the definition of ‘fraud’ itself. As a counter to Bryan Caplan’s arguments in defense of fractional reserve, for example, Walter Block responded, “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.”

This is a strange requirement. It means a 3rd party would be able to invalidate a contract in which there is full disclosure and with which the contracting parties are satisfied. As with insurance policies that cannot be paid out if there is a ‘run’, there are quite a few contracts that may well involve what some Austrians see as a breach of ‘logic’. For example, a man might well pay a priest to hear confession and absolve his sins, or a psychic to tell his future. As long as both parties accept the logic of the exchange, it is not the business of an atheistic 3rd party to intervene and invalidate the contract. Just as the free market and libertarianism do not outlaw stupidity, neither do they prohibit a breach of logic. And a 3rd party has no business substituting his logic for that of the contracting parties.

The 19th century individualist anarchist Benjamin Tucker wrestled with much the same issue as the “illogical” contract. Like many contemporaries, Tucker believed that charging interest or rent was “usury” – an unethical or immoral monetary practice. He thought such practices were sustained by the state and would naturally disappear in a free market. When confronted with the possibility of people choosing to pay interest in a free market, Tucker agreed that such contracts would be valid. They would be immoral, unwise, and worthy of scorn but they would be valid because they would be voluntary.

Equally, contracts that seem illogical to a 3rd party are valid nonetheless.

Is Fractional-Reserve Banking Foolish?

The work of the libertarian monetary theorists White and George Selgin long ago convinced me that fractional-reserve banking would thrive in the free market, as it has done in the past.

The free market is well able to manage the problems perceived by fractional reserve opponents. Banks would rest increasingly upon their reputations as good managers; those with impeccable records of redemption would probably offer the lowest available interest on deposits. Defaulting banks would not be bailed out except in a free-market manner – e.g. by an insurance policy or buy-out. Perhaps insurance would be an optional purchase for individual depositors as well. Moreover, a bank that diluted the value of its own notes through an ‘inflation’ of supply would be ‘corrected’ with a loss of reputation and customers.

Opponents of fractional reserve would disagree, of course. But the important point here is that the disagreement is no longer libertarian but utilitarian. The question has become “Which is the best banking system: fractional or 100% reserve?” My answer: let the free market decide. Let individuals choose for themselves.

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233 Responses to “Fractional-Reserve Banking: Not Fraud, Not Folly”

  1. Wendy McElroyNo Gravatar says:

    Thanks Michael. When I argue for fractional reserve, I never cease to find someone who wans to argue back. When I am giving a speech or whatever and the audience response is sluggish, I make fractional reserve aside and things do perk up. Best to you,

  2. Ira CappNo Gravatar says:

    All the semantics and economic jargon masturbation aside, this is no different than me writing a check for more money than I have in my bank account. I would be prosecuted for, guess what, fraud. However FRB is a much greater crime because it effects everyone who uses the same currency, without their consent, or even knowledge, via the Federal Reserve Bank inflating the US dollar to “account” for these “notes”. Just because everyone who has a even a cursory knowledege of economics excepts it as normal practice, does not change the fact that it is fraud. It may be a legal banking practice but at its core it is immoral ,unethical, and exploitive. The only reason this practice exists is the ignorance of the general public, and the complicit silence the “media” and politicians.

  3. CDTNo Gravatar says:

    I am discussing this subject in a Facebook conversation and came across this article.

    I’m not clear how anyone could think Fractional Reserve banking is not fraud. If fraud is “using false representations to obtain an advantage or injure the rights or interests of another,” then its pretty clear (to me) that fractional reserve banking fits the definition.

    Since money seems to confuse people, let me use a simple illustration…

    Let’s say you deposit 10 eggs with me at my house. I lend out 9 of these eggs to my best friend, who gives me a promissory note. So I now have 1 egg and 1 promissory note. However, I consider that promissory note the equivalent of 9 eggs (heck – why not – I’m owed them right?), so keeping with my fractional reserve of 10% I should be able to loan out about 8 more eggs right? Only wait a minute – I don’t think any person in their right mind is going to want my invisible 8 eggs are they? However, this “magic” is what fractional reserve bankers do and they would keep doing each time they get another promissory note. It’s a scheme to transfer real assets from the actual owners of those assets to the scheme operators.

    It’s amazing that in a simple illustration like this egg example, almost every person realizes you can’t give away your egg and eat it too, and you certainly can’t lend it to someone and then have it magically manifest 9 times the amount that you lent out just by saying so on a piece of paper, but in banking that common sense flies out the window. It’s like fairy magic.


    Another example… If I gave someone five bananas for me to hold and they lent out four of them because they figured I wouldn’t be back for all of them right away, it would work out OK if the person I gave them to is a hustler and can get back 4 bananas before I come to redeem mine. I’m not sure this is right morally if he doesn’t let me know he’s going to do this, but I guess it could work out OK. However, that is not what happens in fractional reserve banking. In fractional reserve banking I have him hold my five bananas and he not only lends out 4 of them, but then somehow DECEIVES my neighbors into thinking he has an additional 41 bananas to lend out, using my five and a few scribbles on paper as props.

    The person is falsely representing he has 41 bananas to lend out when he doesn’t have 41 bananas and is defrauding anyone who is misled into thinking he does, along with anyone else those people come across. I would consider this deceitful and fraud. Do you not? If I’m missing something, please let me know.

    • I am truly sorry that you feel the need to introduce incivility into this discussion. I assure you that I do not need you to reduce the discussion of money to bananas to grasp monetary theory. I refuse to descend to the level of patronizing insult so I will simply restate my objection to fractional reserve banking being considered as inherent fraud and let you attack my intelligence for the hubris of disagreeing with you. My argument: you cannot have fraud if there is full disclosure of all aspects of an exchange. As long as a banker (or whatever) discloses all aspects of the transaction, then fraud cannot exist. A bad decision…sure. But fraud? No. So go ahead. Be patronizing to a woman who just doesn’t understand money…even though she could teach a thing or two about bitcoins and detail the discussions she had with Murray Rothbard on the subject of fractional reserve. Talk to me about bananas again…because it has nothing, nothing to do with the point I am making, which is about full disclosure.

      • CDTNo Gravatar says:


        Giving an example of my thought process is incivility?

        I don’t know what to say about that.

        I’ve read all the comments on your post and it seems as if using dollars as an example confuses some of the people commenting here. So I think my example illustrates clearly what goes on in fractional reserve banking without using the word “money.” Its not condescending – it’s a clear example. I could have used gold coins, cattle or seashells to do the illustration. I’m not sure why that offends you.

        Instead of trying to say I’m attacking you, why not just respond and tell me where my example differs from what occurs in fractional reserve banking?

        You are arguing that there is no deceit. I think I just showed clearly where I see deceit. If you disagree why don’t you point out where I made a mistake in my line of thinking?

        • What exactly about “full disclosure of all terms and aspects” do you find deceitful? I trust you will not use bananas in your explanation.

          • CDTNo Gravatar says:


            Let’s go back to a gold standard instead of bananas. Fair enough?

            Let’s say I make a demand deposit for 3 ounces of gold. I receive a note saying that I can pick up – on demand – 3 ounces of gold. The notes say PAY TO THE BEARER 3 OUNCES OF GOLD (meaning that they are saying they have the gold available).

            People accept that note under the impression that those 3 ounces will be available on demand.

            However, if the person issuing those notes creates 9 of those 3 ounce notes for every one he gives to me for the actual gold I placed in his possession, he is deceiving anyone who accepts that he has 3 ounces of gold per note available on demand based on his misrepresentation.

            Again, I define fraud as the “using of false representations to obtain an unjust advantage or to injure the rights or interests of another.”

            Falsely representing that you can deliver something on demand when you don’t have the item seems to clearly fall within this definition.

          • Joe MyersNo Gravatar says:

            Wendy, if you think it is OK for someone to commit FRAUD just because there was full disclosure then I don’t understand why we have a Constitution if we follow your logic (I am being sarcastic!). There have been documented cases where FULL DISCLOSURE was in FACT FRAUDULENT when the intent is to take advantage of someone and clearly that is exactly what is happening with the FEDERAL RESERVE!

      • Joe MyersNo Gravatar says:

        Here is the problem with Fractional Reserve Banking. A private cartel called the Federal Reserve, the central bank of the United States, has a monopoly on the monetary system which in FACT controls our CONGRESS through lobbying. When a private entity can control a country’s money and tell the CONGRESS that is supposed to be representing the TAX PAYER what interest rates are going to be so they can make a profit that is in FACT FRAUD just like insider trading is FRAUD. The fractioanl reserve lending ties into to the whole PONZI SCHEME.


        The demise of this country is the Federal Reserve (FED). One of the founding families of the Central Banking System, which the FED is part of, Is the Rothschild dynasty. Read the following quotes to understand why it does not matter who the puppets in office are but who are the puppet masters, THOSE WHO CONTROL THE NATIONS MONEY!

        “The few who understand the system, will either be so interested from it’s profits or so dependant on it’s favors, that there will be no opposition from that class.” — Rothschild Brothers of London, 1863

        “Give me control of a nation’s money and I care not who makes it’s laws” — Mayer Amschel Bauer Rothschild


        “I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, the banks and corportions that will grow up around (the banks) will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.” – Thomas Jefferson

        WE THE PEOPLE need to control the monetary system even if there is private bankers. I agree to allow the free market to work but having a private entity tell our CONGRESS what monetary policy is and interest rates is insanity.

        One more main point about FRAUD with the FED is they write a worthless check to buy our (WE THE PEOPLE) Treasury Notes to keep us enslaved through higher taxation which all INFLATION is higher TAXES!!!

        So to the person who THINKS they know the banking system and criticized the person for using bananas to illustrate her point then I would say I question your knowledge when you don’t understand where the FRAUD actually starts!

      • ebbi brittNo Gravatar says:

        Do you really claim that the banks fully disclose the concept of fractional reserve banking? When a client opens a account is he fully informed about the FRB by the bank??? Is it mentioned in any way in the “contract” ????
        Is creation of money from nothing, thin air moral or legal just because a bunch of crooks make the laws in favour of an evil financial system???
        Can you not see that every often we seem to have a financial melt down purely due to the immoral activities by of the banks ??

    • Martin BrockNo Gravatar says:

      You don’t need the 10 eggs at all. If you accept from me a note promising one egg in exchange for something that you value as much as one egg, then your neighbor might accept the same note from you in exchange for something that he values as much as one egg. I then owe the egg to your neighbor rather than you. If people will ever extend credit, they will use promissory notes as money this way.

      You may also discount the value of my promise by accepting a one egg note only in exchange for a good that you value somewhat less than one egg, and your neighbor may similarly discount the value of the note. If people generally discount one egg notes this way, prices are a bit higher than they would otherwise be, but prices don’t rise continually unless people promising eggs continually become less trustworthy.

      As long as everyone understands what they’re doing in this scenario, no one is defrauded, so the assertion of fraud presumes that people don’t know what they’re doing. I agree that people using promissory notes as money should understand what they’re doing, but history provides little support for the idea that people commonly confused banknotes promising gold for warehouse receipts. Both promissory notes and warehouse receipts exist historically, and they look very different.

      • Thanks for the post, Martin. I almost immediately regretted being so snippy in my last message. But, sometimes, you just react. And (frankly) partly as a woman, I did not like being reduced to a monetary monkey who has to have things stated in bananas to understand a concept. Enough. I’m letting it go…except for saying thanks to you.

      • CDTNo Gravatar says:


        Unless you have some sort of magic that I don’t possess, you can’t lend me an egg and then lend the same egg to 9 other people.

        I gave my definition of fraud in my first post. What definition are you using?

        • Martin BrockNo Gravatar says:

          I don’t lend you an egg. I extend you credit, i.e. I knowingly accept the promise of an egg in the future in lieu of an egg today.

          The whole idea of “lending” an egg seems nonsensical. Once I eat an egg, I can’t return it to you, so the egg is hardly a “loan”; however, I can give you an egg today in exchange for your promise of an egg’s worth of flour a month from now, when your harvest your wheat. In monetary terms, I give you the egg in exchange for a one egg note, expecting you later to exchange the flour for a one egg note and return the note to me.

          I understand how you understand fractional reserve banking, and I understand why it seems fraudulent to you, but your understanding simply ignores the fact that people issuing notes promising silver, for example, have other things of value, like chickens and land growing wheat. The notes promise silver or some other standard of value, because people want uniform prices relative to the standard, not because the notes literally represent the standard.

          A note promising a gram of gold represents anything as valuable as a gram of gold in the market. The total volume of these notes may be ten times, even a hundred times, the total value of all gold in the market if the value of gold is a small fraction of the total value of everything in the market.

          I’m not advocating a gold standard here. I prefer something like an egg standard or flour standard myself, not least because the system is easier to understand in terms of a perishable, consumption good.

          In a free banking system, a banker issuing promissory notes that people use as money does not create money out of nothing. The banker creates money out of the trustworthy promises of people with valuable productive means that we can reasonably expect to produce valuable goods in the future.

          Can a particular banker issues notes fraudulently, by extending credit to untrustworthy cronies, without a reasonable expectation of productivity? Sure, he can. Fraud is possible in any business, but we need to understand why some notes are fraudulent and others are not, and your description of fractional reserve banking ignores this explanation.

          • CDTNo Gravatar says:

            I guess we’re not understanding each other.

            I’m saying you can lend someone an egg you have, and they can promise to repay that egg at a later time.

            I’m saying you can’t lend someone an egg you don’t have with a promise for them to repay at a later time unless there is deceit involved.

            You simply don’t have the gg.

            This applies regardless of the object. The laws of physics aren’t bent by accounting formulas.

            Other assets are irrelevant at this point. If you think they are relevant, please give me an illustration.

            • Martin BrockNo Gravatar says:

              Sure, I can’t lend an egg that I don’t have, but a bank operating with an egg standard is not in the business of lending eggs. A bank is an accounting service. It accounts for extensions of credit. If you think that banks lend eggs (or gold or silver or whatever), you’re bound to reach the wrong conclusion, because banks don’t lend eggs.

              Say you want to buy my horse on credit, i.e. you want you take the horse now and pay me for it later in installments, say a hundred eggs per month for five years or a total of 6000 eggs.

              I want the same thing, because I want to sell the horse for 6000 eggs; however, no potential buyer of my horse has 6000 eggs at the moment. Furthermore, I don’t want 6000 eggs at the moment. I want the eggs over five years.

              You could issue 6000 promissory notes yourself, each note promising one egg, and I could present 100 of these notes to you in exchange for 100 eggs each month for the next five years. No fraud is involved.

              Alternatively, in a particular month, I might exchange 50 of the notes for ten pounds of my neighbor’s flour and present the other 50 notes to you in exchange for 50 eggs. My neighbor accepts this bargain, because he trusts you for the eggs as much as I do, and he may present the 50 notes to you for the eggs. No fraud is involved.

              My neighbor and I both trust you for the eggs, but people across town don’t know you so well, so I can’t spend your notes this way across town. For this reason, when you want to exchange notes promising eggs for my horse, I don’t accept notes that you issue directly. You and I instead bargain through a more widely trusted intermediary, the bank.

              The bank can issue notes accepted all over town, because it knows the creditworthiness of people all over town. Knowing the creditworthiness of many people is the bank’s business. Rather than issuing notes promising eggs to me directly, you promise eggs to the bank, and the bank issues the notes.

              The bank keeps some eggs on hand all the time, so when people holding notes promising eggs actually want eggs, they can obtain the eggs at the bank; however, keeping on hand all the eggs that anyone in town will want over the next five years makes no sense.

              Think of the bank as the town’s general store. The bank’s reserve is like the store’s inventory of eggs. In a particular week, a store has only as many eggs as it expects to sell during the week. Similarly, a bank operating a silver standard has in reserve only as much silver as it expects to need to satisfy the demands of its note holders for silver in the immediate future.

  4. Ahh…an egg instead of a banana. I feel so much more respected. I am using fraud in the most basic sense possible. Deceit. I reiterate my question…what part of full disclosure violates your obviously highly-tuned ethical sense of demanding “no false representation.” What part of “full information” means lying. And, yeah, I am being confrontational here because I am truly offended by your post. I go out of my way to treat people civilly, even if I disagree with them, especially if I disagree with them. FULL DISCLOSURE. Tell me how that is fraud.

    • CDTNo Gravatar says:

      That reply was to Martin, Wendy – he used eggs in his example. I’m not sure why the object used in the example causes you so much distress. Why is that? It doesn’t make sense.

      At what point has there been full disclosure in fractional reserve banking. Do you HONESTLY think that writing “PAYABLE TO THE BEARER ON DEMAND” discloses that it “might not be payable on demand?”

      I didn’t realize we were having this argument in “theoretical world.”

      • Martin BrockNo Gravatar says:

        A sequence of words on paper, like “promises to pay the bearer on demand”, can never be an inviolable guarantee. If a gold warehousing service issues this paper, the promise still cannot be an inviolable guarantee. Physically possessing gold on your person is not an inviolable guarantee either, since someone with a gun can violate it. You can’t ever have the security that you imagine here.

  5. CDTNo Gravatar says:

    It seems to me that it’s virtually impossible to do fractional reserve banking without deceiving someone along the line. (Feel free to correct me with actual reasoning and not appeals to the fact that you don’t like people who use everyday objects in their examples.)

    You can’t loan what you don’t have – whether the object is an egg, banana, piece of gold, or a sea shell. It’s simple physics. The same object can’t be in my pocket and yours at the same time. You also can’t promise to give something to someone on demand and not have that something to give. Accounting entries can’t violate the laws of physics. Instead something needs to give and in fractional reserve banking what “gives” is usually the real assets that end up transferred away from their rightful owners to the perpetrators of the deceit.

    If I inform someone that deposits money with me that I am going to use their deposit to deceive other people into thinking I have more deposits than I do, so that I can pay him/her more interest on their deposit, does that make it less of a fraud?

    What if I let the people I issue loans to in on it? What if I fully disclose that I don’t have the actual asset I’m loaning to them, but convince them they can fool others into thinking that I do? Is everything OK then? Does the deceit disappear then?

    I really don’t understand the “Full Disclosure” argument you are trying to make.

    • PhilbertNo Gravatar says:

      I don’t see how fractional reserve banking can be anything other than fraud. The claim is that it’s not fraud if there is full disclosure. My counter is that full disclosure of fraud is still fraud.

      When a person signs a mortgage from a bank:
      – The borrower pledges a house he hasn’t bought yet.
      – The bank pledges money it doesn’t have.

      Remember, before the mortgage is signed, the borrower does not own the house. He’s pledging something he doesn’t own as collateral, but by timing it well it’s his shortly after the contract is signed. So his pledge is fraudulent at the time he signs the loan, and only becomes reality after.

      Remember, in a fractional banking system the bank only has to have a small percentage of reserve before making the loan. So the bank does not have the money it loans at the time the contract is signed. So the bank’s pledge to pay is fraudulent at the time the loan is signed.

      Of course, if the person selling the house turns around and deposits the money in the bank, the cycle is complete. The borrower pledges the seller’s house against money that doesn’t exist, the house changes hands, and no money actually changes hands.

      The bank, borrower, and seller all have the $0 they started with, except the seller can now spend his $0 in the form of bank credit, the bank can re-loan most of that bank credit, and the borrower has to work to pay the bank for facilitating the whole process. No money changed hands, but a few signatures later and a slight of hand pits the borrower’s labor against the house’s equity, and no one is the wiser.

      How is that not fraud?

      • Martin BrockNo Gravatar says:

        >When a person signs a mortgage from a bank:
        >- The borrower pledges a house he hasn’t bought yet.
        >- The bank pledges money it doesn’t have.

        You omit the seller of the house. The seller extends credit to the buyer, essentially a rent-to-own agreement, with the bank as an intermediary. The seller receives promissory notes and may receive interest payments from the bank by depositing the notes. The bank may pay this interest to the depositor, because the bank receives interest payments (essentially the rental part of his house payment in the rent-to-own arrangement) from home buyer.

        A home seller extends credit by accepting promissory notes, rather than immediate cash, because this bargain is valuable to him. He wants to sell his house. Few people have cash to pay for a house, so demanding cash practically eliminates the market for his house.

        Since the promissory notes are valuable to the home seller, they may also be valuable to me. I may be as willing as the home seller to exchange my milk or eggs or wheat for the notes, rather than cash, for a right to deposit the notes in a bank and receive interest payments provided by people renting-to-own homes.

        The promissory notes become money because people freely use them as a medium of exchange this way. If no one accepts the notes in exchange, for a house or anything else, then the notes don’t become money.

        So a free bank does not create money when it issues promissory notes accounting for a home seller’s extension of credit to a buyer. You I and others make these notes money by freely adopting them as a medium of exchange. If you don’t want to use the notes this way, no state should compel you to do so requiring you to collect the notes to pay taxes, but that’s a separate issue.

  6. CDTNo Gravatar says:

    Quick correction. “Accounting entries can’t violate the laws of physics.” Should read, “Accounting entries can’t make objects violate the law of physics.”

    I’m really hoping to get a reasonable rebuttal to my argument.

    I agree that people should be free to enter into whatever arrangements they would like, but I haven’t been given a decent explanation of how fractional reserve banking can be implemented without deceiving someone along the line. Several of the players can knowingly participate and assent to the deception, but the fact that someone in the chain will be deceived doesn’t go away.

  7. Carlos NovaisNo Gravatar says:

    The crucial issue is:

    Contracts must be clear, and diferent contracts are not fungible. As Usd is not fungible with Euros, a “promise to pay” currency is not fungible with a “100% reserve certificate.”

    Look to bitcoins:

    – a Wallet service is a 100% reserve bitcoin service.

    Now imagine someone would say: Deposit a real bitcoin and i will give you a promise to pay certificate you a bitcoin on demand.

    Thaís is fine, as long as this promise is not fungible with a real bitcoin. It must preserve a diferent status, label, booked in accounting as a diferent item.

    • Martin BrockNo Gravatar says:

      A promissory note in a free banking system need not and typically does not represent a unit of specie deposited in the bank. It can represent the promise of someone mortgaging a house for example. The note is valuable because the house is valuable.

      A free bank accepts specie deposits and holds specie in reserve to provide liquidity, not because its circulating notes represent the value of this specie exclusively. The notes represent the value of all collateral securing the bank’s notes, not only its specie reserves.

      • RaulNo Gravatar says:

        Let me get this straight. If I am a free market bank (by your definition), and I lend someone $100,000 to buy a house, because I now have $100,000 in collateral, I can turn around and lend the same $100,000 to someone else, ad infinitum? Please don’t try to re-explain. You made it quite clear. You probably think Madoff shouldn’t be in jail.

  8. Carlos NovaisNo Gravatar says:

    The problem with the history of Banks and demand deposits is that never The status of 100% reserves or as a promise of payment account was diferentiated, Banks and Power never had the interest in curtailing of credit expansion.

  9. CDTNo Gravatar says:


    Yes. The problem is, many of the online Bitcoin wallets do not make it clear that your coins are held by them at their Bitcoin address on the blockchain. Bitcoin itself IS a full reserve banking system when you keep your coins on the blockchain. And the market seems to like that.

    • Martin BrockNo Gravatar says:

      An online Bitcoin wallet charges you to hold your Bitcoins, while a conventional bank in a system of credit pays you interest for leaving your notes on deposit rather than demanding redemption in the standard of value.

      The bank can pay you interest precisely because the notes represent valuable collateral, like mortgaged houses, with a rental value. The interest you expect at a free bank (not the central banking monopoly that we experience these days) is a share of the value of using this collateral.

      If you don’t want interest on a deposit, you may pay to use the online Bitcoin wallet (or a silver warehousing service) instead, but online wallets are also risky. Even a personal wallet is risky, because you can lose it. Bitcoin is hardly a cure for fraud, volatility and other risks.

      The market in Bitcoins is infinitesimal compared with the market in other currencies at this point, and full reserve banking does not address the credit market. Regardless of the ultimate success of Bitcoin, a credit market will continue to exist, so promissory notes or their equivalent will continue to exist, and these notes will continue to be as valuable as the collateral securing them, and people will continue to hold the notes for a share of the value of the collateral, and people will continue to exchange the notes for other valuable goods.

      I don’t expect notes promising Bitcoin to play this role for reasons we can discuss, but notes promising something will play the role, because a huge market for credit exists. Common people can hardly own houses, cars and countless other things without it.

  10. CDTNo Gravatar says:

    I do not know of any Bitcoin wallets that charge you to hold your coins.

    Keeping your Bitcoins on the blockchain is not just as risky.

    Yes, I could lose my secret key. But that would be like saying email is risky because I could forget my password.

    I don’t need to have a wallet online or even on my computer to keep my bitcoins on the blockchain. You should understand how Bitcoin works before commenting on it.

    Bitcoins are essentially a virtual commodity that was created to solve the issues that occur with real commodity money. Whether Bitcoin or something like it will become money or not is still undecided. However, it is being used as a medium of exchange and it is highly valued on a per unit basis at this point.

    If I am in a situation where the medium of exchange is continually robbed, altered, and eventually transformed into fiat, I may try to figure out a way to avoid those situations. Other people may find my solution valuable. People seem to be voting “yes” on the solutions offered by Bitcoin.

    There is no requirement to have “notes” for Bitcoin. One of its features is the ability to do exchanges locally and at a distance without the need for third party trust.

    You can’t send gold to someone in another continent without taking it their yourself or using trusted intermediaries to do it for you. This is not the case with Bitcoin. I can send to anyone in any fraction without a trusted third party involved.

    Of course those entrenched in the current system will not let this stop them from trying to impose the old ways onto Bitcoin.

    • Martin BrockNo Gravatar says:

      If an online Bitcoin wallet doesn’t charge you to use the wallet, then it must recover its costs otherwise, with ad revenue or something, in which case seeing the ads is the cost of using the service.

      An email service is risky because you can lose your password. It’s also risky, because an email server can crash, and it’s risky because an email service provider can be fraudulent.

      Storing value in Bitcoin is also risky because of Bitcoin price volatility.

      I have a master’s degree in applied mathematics. I have read Schneier’s Applied Cryptography and Satoshi Nakamoto’s original paper on the double spending problem, and I was a crypto-anarchist decades before Bitcoin existed. I understand the system. If you’d like to discuss it in detail here, we can.

      Bitcoin’s value seems largely speculative, like Tulip bulbs, at this point. A few people (very few) use Bitcoin as a medium of exchange in particular transactions because using a competing currency is more costly, but this use doesn’t seem to dominate the trade.

      A few people are voting “yes” on Bitcoin. People generally are not. A tiny fraction of people, presumably less than one percent even in the United States, have ever owned Bitcoin.

      The people who want Bitcoin are welcome to it of course. I have no problem with anyone using Bitcoin, but Bitcoin does not satisfy demands for credit. I doubt that it ever will, so its utility as money seems severely limited.

      The requirement to have notes involves the demand for credit, not the demand for currency. If people accept promissory notes to extend credit, and if these notes are negotiable and widely accepted in trade, they become money. Credit precedes money rather than following it.

      If I let you pay me over time for a house, because I think you trustworthy, then my neighbor may accept your promissory notes from me because he also thinks you trustworthy. The theory of Bitcoin simply ignores the role of credit in a monetary system.

      You can send title to gold that you own electronically, and title transfers are what money is all about; however, I’m not advocating a gold standard here.

      • CDTNo Gravatar says:

        I’m not arguing for or against Bitcoin in this thread.

        I agree that Bitcoin is not natively set up for credit-type transactions. It’s more like a digital gold or cash.

        Ripple or something like it will most likely either replace or incorporate Bitcoin into it (or Bitcoin will incorporate something like Ripple on top of it).

        • Martin BrockNo Gravatar says:

          I haven’t investigated Ripple in several years, since the incorporation of Ripple Labs and the creation of XRPs, but I understand the system reasonably well. I have problems with a network of credit default swaps (involving systemic contagion of default risk) that we can discuss.

          I also doubt that Bitcoin can be a stable standard of value in a system of this sort, for other reasons that we can discuss. Ripple Labs presumably expects to act like central bank issuing XRPs to stabilize the value of currency, but I don’t much like this approach either.

          I developed a Ripple-like system myself a few years ago, before discovering Ripple. It is here:

          Favorati requires a centralized record of trust, and it does not account for time value. I foundered on these problems at the time, but I may restart the project at some point. Despite the similarities, Favorati differs from Ripple in a significant way that we can discuss. I also discuss differences in the archive of the Ripple Project’s Google Group, here for example:


          • CDTNo Gravatar says:

            I missed your Ripple reply with the flurry of other replies.

            XRP is essentially the Bitcoin of Ripple. It is used to prevent spam in the ledger, but should the payment system take off will certainly be greatly valued since it will be the only thing in the system that doesn’t involve trusting a third party.

            Ripple Labs actually just put out some decent white papers that do a good job of explaining it in its current incarnation.

            The main one is here….

            I’ll check out what you designed.

  11. CDTNo Gravatar says:

    As to having a credit market. I’m not sure how this ties in with fractional reserve banking.

    Obviously if I wanted to lend out 1 Bitcoin to you and take a promissory note for that, the note would have a value close to the 1 Bitcoin I lent assuming that you are a good credit risk.

    People may want to accept that note from me for payment for items. That’s fine too.

    That’s not what happens in fractional reserve banking though, so I’m not sure where you are going with your argument.

    In fractional reserve banking we are somehow supposed to believe that because I have a note from you for 1 Bitcoin, that through some accounting finesse I can lend out 8 more Bitcoins that I don’t have. This cannot happen without the use of deceit and fraud somewhere along the line.

    I still haven’t received a rational reply to this argument.

    • Martin BrockNo Gravatar says:

      Extending credit does not involve lending a Bitcoin (or an ounce of silver or anything similar) and accepting a promissory note in return.

      When I extend you credit, to buy a car for example, I let you take the car in exchange for nothing but your promise to pay me for the car later, typically in installments. You have the car. I have your promise to pay for it in installments. Period. In this scenario, I value your promise to pay as much as I value the car; otherwise, the transaction does not occur.

      Suppose you promise to pay me a thousand ounces of silver for the car. Since I value your promise to pay as much as I value a car, my neighbor may also value your promise to pay one ounce of silver as much as he values ten pounds of flour, so I may exchange part of your obligation to pay me for ten pounds of flour. You then owe my neighbor an ounce of silver and no longer owe this ounce to me.

      My neighbor may also exchange a bit of your obligation to provide silver for something else of comparable value. He may even accept an hour of your labor in exchange. In this way, you might discharge your obligation to pay for the car without ever touching an ounce of silver. In fact, no one involved in these transactions need ever touch any silver, if they never want any silver.

      I’m not supposed to believe that a bank may simply create ten dollars out of nothing when it accepts a dollar on deposit, and I don’t believe so. People who believe so don’t understand credit. I’m supposed to believe that a bank may issue banknotes secured by sound collateral. The 10% reserve requirement in the United States is only an arbitrary regulation that’s supposed to prevent banks from becoming insolvent.

      Our central banking monopoly, intertwined with our fiat money system, does not work this way, but that’s a separate issue. In a free banking system, no 10% reserve requirement exists. The market determines a bank’s reserves relative to the face value of its circulating notes and deposits.

    • Is CDT actually objecting to fiat money? Where the central bank “lends” money to member banks for nothing (no collateral), and literally creates money out of nowhere? Remember, when the bank loans $100K for a house (nevermind that it is fiat money for the moment), they have a lien on the house, and can repossess it on failure to make payments. In a real sense, the bank bought a house, and loaned it in return for a steady stream of [fiat or any other kind] money. What a previous respondent called a “rent to own” arrangement.

  12. CDTNo Gravatar says:

    Your examples of giving credit are fine, but still seem to ignore fractional reserve banking.

    If I have a car and let you buy it on payments in whatever (silver, gold, FRNs, pigs, whatever), I STILL had the car to sell to you.

    Now I agree that I can sell portions or all of your obligation to others in return for other items if they will accept them.

    No argument.

    Back to fractional reserve banking – that isn’t what happens. What happens is that through some sort of magic of giving you credit to buy the car, I now have the equivalent of 9 cars of credit I can give to others.

    You STILL haven’t addressed this. Of course if I’m wrong, I’ll be happy to admit it, but you haven’t addressed this yet.

    • Martin BrockNo Gravatar says:

      There is no magic involved. When you extend me credit to buy the car, you exchange the car for my promise to pay. You exchange the car for promissory notes, notes promising silver for example. These promissory notes then become money insofar as our neighbors will accept the notes for other goods as readily as you accepted them for the car.

      No money exists before you extend me the credit. You have no silver, and I have no silver. You have only your future productivity, I have only the car.

      After exchanging one car for my promise to pay, if you exchange another car for Wendy’s promise to pay, the volume of promissory notes that people may use as money has doubled.

      Suppose each note promises a gram of silver. The notes are not grams of silver themselves, and they don’t represent grams of silver in a bank vault. They represent the creditworthiness of Wendy and myself, and that’s all they represent; however, people using the notes as money occasionally want to exchange the notes for actual silver.

      A bank issuing the notes can satisfy this demand for silver without storing the value of two cars in silver in its vaults all of the time. Suppose its notes promise a total of 2000 ounces of silver. Maybe the bank only needs 200 ounces of silver on hand at any one time to meet the demand for silver. That’s a ten percent reserve.

      Holding only this much silver is not fraudulent, because Wendy and I owe the full 2000 ounces, and we are creditworthy. Everyone knows (or should know) that their notes represent the value of our future productivity, measured relative to the value of silver, and not silver itself.

      Why would the bank hold 2000 ounces of silver instead? It must pay silver depositors to hold the other 1800 ounces of silver in its inventory despite the fact that no one is demanding this silver. You might as well ask Walmart to quadruple its inventory of shoes without any increase in the demand for shoes.

      • CDTNo Gravatar says:

        The problem is that in fractional reserve banking is it has never been made clear that you only have 200 ounces of silver and not 2000. The notes that circulate are identical to the ones the original depositor gets- when in fact actual deposited silver is not identical to an obligation of someone to deposit silver at some time in the future.

        If it was made clear the notes would not circulate at the parity.

        You can’t say something is available on demand and not have it on demand and there not be a component of deceit, regardless of how crafty you are.

        Just because someone is good at floating checks doesn’t mean that they are not deceiving people into thinking they have the money available at the time they wrote the check.

        Fractional reserve banking is a physics problem not an accounting problem. You can’t offer a thing immediately that you are not going to receive until some time in the future, UNLESS you can deceive one or more people.

        • Rick DiMareNo Gravatar says:

          To come to any kind of understanding on this subject, I think we have to clearly define what we mean by a “note” and the “thing” the note is supposed to represent, even if both of those words are pure legal fictions.

          I submit that the “thing” should represent, by law, final payment of the “note,” which means the person who pays in the “thing” is beholden to no one else on earth after it is tendered, including the issuer of the “thing.”

          As absurd as it may sound, assume for the moment that the “thing” is current cheap metal U.S. coins. Now, if we look at the various kinds of notes, none of them currently promise to pay in the “thing,” not on demand, not at some specified future date, nor is it even implied that the note will pay the “thing” at some possible future date.

          “Notes” right now, i.e., 1963 series Federal Reserve Notes, are not even promissory notes, but “notes of indebtedness” or “evidences of debt” under bankruptcy law, which are incapable of ever paying the “thing.”

          A real promissory note is a negotiable instrument that promises to pay something, i.e., current coin, either on demand or at some future date, but where a “demand note” is more of claim ticket for coin on deposit, rather than a promissory note which constitutes lending by the issuer and borrowing by the user. So, in other words, we are even forced to define what we mean by a “promissory note.”

          There is also something called a “coin note” which can represent metallic coin that hasn’t been minted yet. This also is a kind of promissory note, but not one that constitutes any lending by the issuer or borrowing by the user. It is merely a note that tells the user to wait a little while because the money issuer (the Treasury) has possession or access to the raw metal, but hasn’t coined it yet.

          • CDTNo Gravatar says:

            We are using silver and demand silver notes in the example above. Things do get more confusing once the underlying original money is replaced with paper money. However, fractional reserve banking is the same regardless of what the underlying asset is – whether the actual money is paper with fancy engravings and serial numbers, or a commodity like silver or gold – it’s the same.

          • CDTNo Gravatar says:

            A promissory note saying I will be paid over a period of 5 years is not the equivalent of a demand note saying I can get something immediately by presenting the note.

            In fractional reserve banking these two items are treated as equal even though they aren’t. More demand notes are created than there are items immediately available by treating both items as equal. This can only happen on paper not in reality because this violates the laws of physics. You can’t give the same thing you won’t be receiving until next week, today, without fooling someone in the chain (or by creating a futuristic time machine).

            • Martin BrockNo Gravatar says:

              A demand note issued by a bank, rather than an individual, is like a coupon for milk issued by Walmart. Walmart may reasonably issue more coupons than it has milk on hand without defrauding anyone, because it doesn’t expect everyone with a coupon to buy milk simultaneously, and it may replenish its inventory of milk when it runs out.

              Walmart adopts an inventory policy intending never to run out of milk, because it wants always to sell milk to a customer wanting to buy milk, but policies of this kind are not infallible. To absolutely guarantee that it always has milk on its shelf, a Walmart must store enough milk to satisfy the demand when meteors strike every other milk vendor on Earth, however unlikely these strikes. This policy is absurd.

              Similarly, a bank issuing promissory notes for a thousand mortgages is unlike an individual issuing notes for a single mortgage, because the bank reasonably expects that everyone holding its notes will not demand redemption at the same time. Furthermore, the bank pays interest to depositors who do not demand redemption, and it may increase the rate of interest to discourage redemption when the bank’s inventory of specie declines more rapidly than the bank can replenish it.

              If you don’t like this business model, that’s fine with me. I absolutely believe that people disliking this model should not be compelled to use it. If you want instead to hold silver coin or warehouse receipts for silver and to pay a silver warehouse for the warehousing service, rather than receiving interest from a bank extending credit and circulating promissory notes, that’s fine with me.

              If you believe that people accepting promissory notes confuse these notes with warehouse receipts, then you should also be free to explain the difference, and no bank issuing the notes should be empowered to stop you.

              What else do you want?

            • Rick DiMareNo Gravatar says:

              When the Civil War started, three kinds of promissory notes appeared: (1) “demand notes” that promised to pay coin on demand, which implies that the note is like a claim ticket for coin on deposit somewhere; (2) what we may call “specified time notes,” which promised to pay coin at a fixed time in the future, usually no more than five years; and (3) “non-specified time notes,” where no specific time to pay in coin was given, but it was understood that when the war was over, redemption in specie would resume.

              Note #1 does not constitute borrowing from the money issuer, but Notes #2 and #3 do. However, all 3 notes should be destroyed or withheld from circulation after they are redeemed or else we’ll have double-counting or worse.

              As I said above, we’re living under an unstable (and dangerous, I think) system right now because Federal Reserve Notes are neither of these 3 notes. There is no “grounding” of the system possible because the FRNs (“evidences of debt”) are not limited by labor (i.e., the production and distribution of cheap metal current U.S. coins). Current FRNs are limited only by human imagination.

        • Martin BrockNo Gravatar says:

          The notes actually said “promise to pay the bearer on demand”. As a legal matter and in common parlance, the word “promise” distinguished an IOU from a warehouse receipt asserting a one-to-one correspondence between a particular note and silver in the bank’s vault.

          When I promise you something, I need not have what I promise. A promise practically implies that I don’t have the thing promised but only have a reasonable expectation of obtaining it.

          Common people understood that banks were in the business of extending credit, because common people routinely borrowed more than they deposited. They had mortgages.

          Someone depositing a circulating note, rather than depositing silver coin, has the same right of redemption as the coin depositor. The note has the same par value as the silver, because collateral securing the notes has the same value as silver. Ensuring this equivalence is the whole point of the bank’s accounting service, so the bank can hardly deny this right to a note depositor, and people routinely deposited both notes and coins simultaneously with this expectation.

          Fraction reserve banking is an accounting problem, not a physics problem. People routinely exchanged notes promising silver for all sorts of things with a valuable comparable to the value of silver, so they clearly understood that the notes were not to be exchanged exclusively for silver.

          Some people undoubtedly had a mistaken understanding of promissory notes, but banks cannot be liable for every mistaken understanding. If you accept my promise of a thousand ounces of silver in exchange for a car, payable over five years, believing that I must have the thousand ounces in a safe in my house at all times, why is that my problem?

          If someone with a mortgage himself, surrounded by other people with mortgages, believes that promissory notes that he holds imply silver in a safe somewhere, even though his own promise of silver implies no such thing, why is that the bank’s problem?

          I agree that people should understand the promises they make and the promises they accept, and if the terms of these promises are not clear, they should be clarified, but some people never understand some things, and no system of money and credit can solve this problem.

          • CDTNo Gravatar says:

            You are running in circles. Can you promise me that you can give me something immediately if you don’t have it right now? Yes – but only if you are willing to deceive me.

            This is the crux of the matter.

            • Martin BrockNo Gravatar says:

              You may run around any crux you like. I’m only explaining a fractional reserve banking system.

              If a thousand people owe me ten thousand ounces of silver over the next five years, I can promise a thousand people so much silver on demand without ever running out of silver if all the people do not demand silver simultaneously. I can reasonably expect that everyone will not demand redemption simultaneously, and everyone holding my notes can also understand this constraint.

              If you don’t want to play by these rules, that’s fine with me. If you think that people don’t understand the rules, you may explain them further, but you should not outlaw the game in my way of thinking.

              • CDTNo Gravatar says:

                I don’t care about outlawing anything.

                I’m addressing the original argument that fractional reserve banking is not deceitful.

                You can argue utility all day long, but at its core, fractional reserve banking involves making people believe you have something available right now when, in fact it isn’t. That’s deceit.

                The fact that you can fulfill the promise to some of these people doesn’t make it any less deceitful.

                I still haven’t seen any rational argument from you proving otherwise.

                If I write a check to you, which is a demand promise and I don’t have the money in my checking account (but I think I might before you can cash it), am I not still deceiving you into thinking I DO have the cash in my account?

                • The thread that will not die….

                  “You can argue utility all day long, but at its core, fractional reserve banking involves making people believe you have something available right now when, in fact it isn’t. That’s deceit.”

                  Your comment will be used as the example of many such similar comments in this thread.

                  Have you read the contract between a bank and its depositors? Have you read the regulations that govern the contract?

                  Until you do, you will not understand that the contract states clearly that there are many occasions under which a depositor may not receive his deposit on demand.

                  Do you have a basic understanding of business? Please explain how a bank can both pay interest and not charge a storage fee to the depositor if it is holding 100% of the depositor’s funds. What possible business model could explain such an arrangement? Why does the government guarantee your deposit if the bank is holding 100% of it? 2+2= 4, does it not?

                  Where is the deceit?


                  The idea of FRB as “fraud” I believe began with Rothbard. I don’t believe Mises or anyone before used this term. Mises certainly recognized the inflationary aspects of this practice. But inflation isn’t fraud – you have a right to your property; you have no right to the value of your property. A dollar is always and everywhere a dollar – no one has or can change this. But the value of the dollar is always and everywhere in the eye of the beholder:


                  Both Mises and Rothbard concluded the market was the best regulator of credit creation (yes, Rothbard). If the market is thus, why on earth is everyone hell-bent on creating some fictional crime? Leave it to the market to regulate, for goodness sakes:


                  The threat of bank runs is a far better policeman than using convoluted logic and ignoring contracts in order to invent a crime.

                • Martin BrockNo Gravatar says:

                  Whether a statement is “deceitful” depends upon the interpretation of terms of the statement. If your only problem with fractional reserve banking is only that “promise to pay the bearer on demand” is not a proper sequence of words describing the terms to someone accepting a note, that’s fine with me. If you prefer a different sequence of words, you may start a fractional reserve bank and issue notes with other words.

                  You may also sue a banker issuing notes with the conventional words, but in the historical context, courts do not interpret “promise to pay” as you do, and since you don’t declare the legal meaning of words or their common usage, you’ll always have this problem. You may always claim that particular words, describing the terms of contracts, mean one thing to you and something else to judges and jurors.

                  I can’t give you a rational argument proving that words mean one thing and not another, because words don’t obtain their meaning from rational arguments. I can only tell how people use particular words in a particular context.

            • When an internet service offers a contract for “unlimited” internet – is it fraudulent because they are oversubscribed and cannot possibly provide full bandwidth for all their customer simultaneously? You can also purchase “dedicated” internet service for a *lot* more money – and your cable/fiber sits idle most of the time while you are not using it. However, even dedicated service is not infallible. A backhoe can accidentally sever your cable/fiber – just when you need it!

              Furthermore, the internet itself is a shared resource, and just because your link to your ISP is dedicated, you do not have dedicated access to the server you are trying to reach – which could be overwhelmed with requests. You could purchase a dedicated cable to that particular server (with consent from the server operator, of course) for a REALLY REALLY LOT of money. But even then, your connection to that server is not absolutely guaranteed. A cable is a very delicate thing…

              Internet service for most of us is really cheap because the ISP oversubscribes it, in the same way that banks oversubscribe their assets (and using the same ratios – the math is the same).

              • MikeNo Gravatar says:

                The ISP example is a poor one considering bandwidth should be compared to a highway. ISP don’t usually oversubscribe per se. There will be heavy and light users for internet and ISP can figure out the average bandwidth needed. A heavy users like myself uses around 120 GIGS per month, however some people may use only 20 gigs. Most users don’t use that much although that’s changing.

                For example my ISP provides me a bandwidth cap of 400 gigs per month with full speed and I rarely have any problems unless the people that owns the last miles messes with my line.

                Most people know it’s not 100% guarantee speed. My ISP upgrades their equipment or buy more bandwidth when required. If I wanted guarantee speeds and uptime I would require to get a business which costs a lot more. There is a reason why this is.

                Fractional reverse banking is a fraud because it’s a purely credit base system not an actual money based system. Not everyone can pay back the loans because it’s mathematically impossible to for everyone to pay it back. That is why bankruptcy ocurrs. This is why Greece defaults on it’s loans, however the other issue is interest considering you can’t create something out of nothing.

                In Canada the fractional reverse banking is 0% by law. That’s right a bank doesn’t require to keep any deposits when lending out money. This is out right dangerous.

          • CDTNo Gravatar says:

            A demand note is promising to pay ON DEMAND. This is about promises AND TIME, not just vague promises at some undefined moment in some undetermined future. A promissory note is usually a promise to pay over a longer period of time, not on demand. Fractional reserve banking uses accounting to transform something that won’t be paid until a certain period of time in the future, into something that is immediately available on demand. This is a physical impossibility and is only possible on paper.

            This is why I use the bananas, eggs and everyday objects in my illustrations. Money seems to affect people’s brains and make them believe they can alter the laws of physics.

            • Martin BrockNo Gravatar says:

              Neither magic nor fraud converts notes payable over time into notes payable on demand. The actual demands of actual people, who do not all demand redemption simultaneously, enable this conversion, and people using these notes as money value the conversion; otherwise, they may use warehouse receipts and pay warehousing fees rather than using promissory notes and receiving interest on deposit.

  13. CDTNo Gravatar says:

    I really appreciate all the replies.

    I think my argument has had a fundamental misunderstanding that has led me to be so adamant that fractional reserve banking is fraud.

    My understanding of fractional reserve banking was this…

    Five of my friends gave me $20 to hold for them, with the understanding they could pick it up any time AND I would pay them 10 cents a year for every dollar.

    I have $100 in my checking account.

    I lend out $90 and get a promissory note from that person saying they can pay me back over 5 years and keep $10 in case my friends come by for their money.

    Now that I have the promissory note saying that I am owed $90, I say “what the heck” and write out checks for another $81.

    This is why I viewed this as misleading since I was thinking – “How can you possibly do this without there being fraud involved since don’t have the CASH available in your account to write out a check for $81?”

    But where I went wrong in my thinking is that this only happens if the person to whom I lent the $90 to DEPOSITS the money I lent him back to me.

    Am I correct in saying this is where I went wrong? Or am I still making errors in my reasoning?

  14. MattNo Gravatar says:

    A well written article, and one that caused me to rethink my position on the necessity of a 100% reserve in free-market banking. HOWEVER, you did make an error in one of your examples. “…a man might well pay a priest to hear confession and absolve his sins…”. According to the institutional laws of EVERY religion (of which I am aware) that has confession and absolution, PAYING a priest for this service INVALIDATES the service rendered: ergo you are describing a clear case of fraudulent contract here. Aside from that, your article was impeccable. Thank you for writing this.

  15. Carlos NovaisNo Gravatar says:

    A promise of payment and a 100% reserve certificate are not the same contract title so an exchange rate must arise between both, Accounting rules oblige to separate them,

    Same should apply for demand deposits of 100% RBs and a Fractional Reserve Bank current account service.

  16. Fractional reserve is fraudulent for the following very simple reason. FR banks accept deposits and promise to return the EXACT SUMS deposited (maybe plus interest and maybe less bank charges). They then lend on that money or invest it. But as we all know, those loans and investments go wrong from time to time, at which point, an FR bank cannot repay depositors.

    The latter inability to repay depositors flagrantly contradicts the above promise to return the exact sum deposited. In contrast under full reserve (at least Milton Friedman’s version, Lawrence Kotlikoff’s version, Positive Money’s version, and several other versions) there is NO PROMISE to return the exact sum deposited where depositors elect to have their money loaned on or invested.

  17. Rob ThomasNo Gravatar says:

    In reply to CDT your last comment is correct rather than the previous ones. Fractional reserve banking works like this: It the currency is gold coins and 10 people deposit 10 gold coins each with a bank, the bank can only lend out a maximum of 100 gold coins. It issues each depositor with a depository receipt (or bank statement) confirming that they have a positive balance of 10 gold coins.
    The bank may lend only 90 coins so that it has 10 coins for depositors want to redeem their funds. It the borrowers deposit the 90 gold coins in their banks, they will get receipts – so now 100 gold coins have given rise to 190 worth of gold coin receipts. So it goes on until, if the reserve is 10%, the receipts equal 10 times the actual gold.
    Exactly the same thing happens in a fiat money system where the central bank is the monopoly supplier of money. Banks cannot lend money they do not have but via 10% fractional reserve banking they create deposits equal to 10 times the based money issued by the central bank.
    Is this fraud? It is better termed a confidence trick because if all the depositors wanted to withdraw these deposits simultaneously they would be unable to. This is why banking is all about confidence.