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In a November 1, 2010, blog post titled "Could the World Go Back to
the Gold Standard?,"
Martin Wolf, the Financial Times chief economics commentator, comes to
the conclusion that "we cannot and will not go back to the gold
standard."
Among a number of mainstream-economics arguments leveled against the
desirability and feasibility of the gold standard, Mr. Wolf puts forth a line
of reasoning that can serve particularly well as a starting point for
debating his position. Mr. Wolf writes,
Economists of the Austrian school wish to abolish fractional reserve
banking. But we know that this is a natural consequence of market forces. It
is wasteful to hold a 100 per cent reserve in a bank, if depositors do not
need their money almost all of the time. Banks have a strong incentive to
lend some of the money deposited with them, so expanding the aggregate supply
of money and credit.
Austrians
Do Not Call for Establishing a Gold Standard by Decree
To get the ball rolling, Austrian economists (in particular those in
the Misesian-Rothbardian tradition)
uncompromisingly call for replacing fiat money with free-market
money — money that is produced by the free interplay of the supply of
and demand for money.
Such a recommendation has a firm economical-ethical footing:
free-market money is the only monetary order that is compatible with
private-property rights, the governing principle of the free-market society.
The focus on private-property rights does not only follow from natural-rights
theory (in the Lockean tradition), but it can
be ultimately justified on the basis of the self-evident, irrefutable axiom
of human action, as Hans-Hermann Hoppe has shown.[1]
Austrians therefore argue for privatizing money production, shutting
down central banks, and letting the market decide what kind of money people
want to use. Government wouldn't have to play any active role in the workings
of a free-market monetary system.
One may hold the view that precious metals — in particular gold
and silver, and to some extent copper — would be the freely chosen,
universally accepted means of exchange. In other words, they could become
money once people have a free choice in monetary matters.
However, Austrian economists wouldn't call for establishing a gold
standard, let alone a gold standard with (government-sponsored) central
banking: they would argue for free-market money, under which,
presumably, gold would become the freely chosen money.[2]
Fractional-Reserve
Banking Violates Property Rights
Now let us turn to fractional-reserve banking. It means that a bank
lends out money that clients have deposited with it. Fractional-reserve
banking thus leads to a situation in which two individuals are made owners of
the same thing.[3]
Fractional-reserve banking thus creates a legal impossibility: through
bank lending, the borrower and the depositor become owners of the same money.
Fractional-reserve banking leads to contractual obligations that cannot be
fulfilled from the outset.
As Hoppe, Block, and Hülsmann note,
"any contractual agreement that involves presenting two different
individuals as simultaneous owners of the same thing (or alternatively, the
same thing as simultaneously owned by more than one person) is objectively
false and thus fraudulent."[4] A
"fractional reserve banking agreement implies no lesser an impossibility
and fraud than that involved in the trade of flying elephants or squared
circles."[5]
The truth is that fractional-reserve banking amounts to violating the
nature of the law of property rights. And so the argument that
fractional-reserve banking represents sensible money economizing — an
argument that Mr. Wolf brings up against a gold standard — doesn't hold
water.
"Fractional-reserve banking thus creates a
legal impossibility: through bank lending, the borrower and the depositor
become owners of the same money."
Arguing in favor of fractional-reserve banking would in fact be
tantamount to saying that it is legal (or rightful or even lawful) that Mr. A
does whatever he wishes with Mr. B's property — without requiring Mr.
B's consent.
What, however, if the bank and the depositor both agree voluntarily
that money deposits should be used for credit transactions via the issuance
of fiduciary media? Even such a voluntary agreement would be in violation of
the law of property rights.
While bank and depositor benefit from such a trade (or expect to),
what about those who receive fiduciary media? They would be falsely lured
into exchanging goods and service against an item (fiduciary media) that is
already claimed as property by others — something the seller presumably
wouldn't agree to if he had only known the very nature of the trade.
What if all market agents voluntarily agreed to engage in
fractional-reserve banking? The conclusion above wouldn't change: voluntarily
accepted fractional-reserve banking would represent a monetary system that
is, by its very nature, in violation of the nature of the law of
private-property rights. It would produce economic chaos on the grandest
scale.
Fractional-Reserve
Banking Has Not Emerged "Naturally"
To be sure, fractional-reserve banking is not, as Mr. Wolf
notes, "a natural consequence of market forces." It is a result of,
and has been upheld by, government law.
In a free-market system, the practice of fractional-reserve banking
would be illegal by its very nature. And so fractional-reserve banking would
be ended (sooner rather than later) under the auspices of a functioning law
of private-property rights.
The reason that fractional-reserve banking has been around for quite
some time is due to government law — which, of course, must be
distinguished from the natural law of property rights. Of course, government
can make fractional-reserve banking legal in a formal sense. However, even
government law does not change the nature of things. As Murray N. Rothbard puts it succinctly,
fractional reserve banks
… create money out of thin air. Essentially
they do it in the same way as counterfeiters. Counterfeiters, too,
create money out of thin air by printing something masquerading as money or
as a warehouse receipt for money. In this way, they fraudulently extract
resources from the public, from the people who have genuinely earned their
money. In the same way, fractional reserve banks counterfeit warehouse
receipts for money, which then circulate as equivalent to money among the public.
There is one exception to the equivalence: The law fails to treat the
receipts as counterfeit.[6]
Fractional-Reserve
Banking under Commodity Money versus Fiat Money
In a commodity-money regime — such as the gold standard —
fractional-reserve banking is, as Austrian economists show, in effect a form
of counterfeiting. However, what about fractional-reserve banking under a
system of fiat money?
Under fiat money, banks' liabilities vis-à-vis clients (as far
as demand deposits are concerned) are payable in the form of base
money, or central-bank money — a type of money that can only
be produced by (government-sponsored) central banks.
Central banks hold the monopoly over the production of base money. They
can increase the base-money supply at any one time at any amount deemed
politically desirable. It is the central bank that eventually determines
whether or not banks can meet their payment obligations.
It may well be that the central bank decides, once a bank is called
upon by its clients to pay out demand deposits in cash, to provide sufficient
amounts of notes — by loaning them to the bank and/or by purchasing
part of the bank's assets.
The essential point is, however, that banks that engage in fractional-reserve
banking in a fiat-money regime create contractual obligations they cannot
fulfill from the outset. Rothbard notes that
it doesn't make any difference what
is considered money or cash in the society, whether it be gold, tobacco, or
even government fiat paper money. The technique of pyramiding by the banks
remains the same.[7]
The
Uncomfortable Truth about Fractional-Reserve Banking
Austrian economists, and Ludwig von Mises in particular, have shown that fractional-reserve
banking under commodity money necessarily causes economic problems on a grand
scale. This is because banks then engage in circulation-credit expansion
— that is, they issue money through lending that is not backed by real
savings.[8]
Circulation bank credit is inflationary, and it causes economic
disequilibria and overindebtedness of the private
sector — in particular on the part of governments. It is also the very
cause of the "boom-and-bust" cycle.
The latter, in turn, opens the door for ever-greater doses of
government interventionism — regulations,
nationalizations, price controls, etc. — that, over time, erodes
and even destroys the very principles on which the free-market society rests.
This conclusion doesn't change when there is fractional-reserve
banking under fiat money. Fiat money — or, to be more precise, its
production — is already a violation of the free-market principle; and
fractional-reserve banking amounts to leveraging the economic consequences of
fiat money.
For the sake of preserving prosperous and peaceful societal cooperation,
the very opposite of Mr. Wolf's conclusion must hold true: namely that we can
and will return to sound money, and the gold standard is one particular form
that is fully acceptable from an economical-ethical perspective — if
and when it is freely chosen by the people.
Notes
[1] Hans-Hermann Hoppe,
"On the Ultimate Justification of the Ethics of Private Property,"
in The Economics and Ethics of
Private Property: Studies in Political Economy and Philosophy,
2nd ed. (Auburn, Alabama: Ludwig von Mises
Institute, 2006), pp. 339–45.
[2]
Murray N. Rothbard called for a return to a 100%
gold dollar. However, this doesn't contradict the statement given above, as Rothbard's recommendation rests on the precondition that
"if people love and will cling to their dollars or francs, then there is
only one way to separate money from the state, to truly denationalize a
nation's money. And that is to denationalize the dollar (or the mark
or franc) itself. Only privatization of the dollar can end the government's
inflationary dominance of the nation's money supply." See Murray N. Rothbard, "The Case for a Genuine Gold Dollar,"
in The Gold Standard: Perspectives in
the Austrian School, Llewellyn H. Rockwell, Jr., ed.
(Auburn, Alabama: Ludwig von Mises Institute,
1992), p. 5. Rothbard's recommendation for defining
the dollar once again as a weight of a market commodity, namely gold, rests (i) on the suitability of using precious metals,
especially gold, as money and, even more important, (ii) the fact that the US
government confiscated gold in 1933 — so that a re-defining of the
dollar in gold would be the natural choice.
[3] For
a thorough discussion see Jesús Huerta de
Soto, Money, Bank Credit, and Economic
Cycles (Auburn, Alabama: Ludwig von Mises
Institute, 2006), esp. chapter 3, "Attempts to Legally Justify
Fractional-Reserve Banking," pp. 115–65.
[4]
Hans-Hermann Hoppe, with Jörg Guido Hülsmann and Walter Block, "Against Fiduciary
Media," in the Quarterly Journal of Austrian Economics, vol. 1,
no. 1, pp. 21–22.
[5]
Ibid, p. 26.
[6]
Murray N. Rothbard, The Mystery of Banking,
2nd ed. (Auburn, Alabama: Ludwig von Mises
Institute, 2008), p. 98.
[7]
Ibid, p. 100.
[8] Circulation credit (or Zirkulationskredit) means that banks, when
extending a loan to a consumer or firm, increase the money stock. In
contrast, commodity credit (or Sachkredit)
means that a bank extends a loan to a consumer or firm by merely transferring
already existing money from the saver to the investor. For a more detailed
explanation, see Ludwig von Mises, The Theory of Money and Credit
(Indianapolis: Liberty Fund, 1981), pp. 296–310.
Thorsten Polleit
Thorsten Polleit is Honorary Professor at
the Frankfurt School of Finance & Management.
This essay was originally published in www.Mises.org. By authorization.
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