5. Conclusion: The False Debate between Supporters of Central Banking and Defenders of Fractional-Reserve Free Banking

The traditional approach to the debate between advocates of central banking and those of fractional-reserve free banking is essentially flawed. First, this approach ignores the fact that the fractional-reserve free-banking system almost inevitably releases forces which lead to the emergence, development, and consolidation of a central bank. Fractional-reserve banking gives rise to credit expansion, which triggers reversion processes in the form of financial crises and economic recessions, which in turn inevitably prompt citizens to demand government intervention and state regulation of banking. Second, the very bankers involved in the system soon discover that they can reduce the risk of insolvency if they make agreements between themselves, merge or even demand the establishment of a lender of last resort to provide them with the liquidity necessary in times of difficulty or to institutionalize and officially direct the growth of credit expansion.

We can conclude that fractional-reserve banking has been the main historical cause of the appearance and development of the central bank. Hence we must not approach the theoretical and practical debate in traditional terms, but in terms of two radically different systems: a free-banking system subject to traditional legal principles (a 100-percent reserve requirement) and in which all fractional-reserve operations, whether voluntarily agreed upon or not, are cracked down on as illegal and a breach of public order; and a system which permits fractional-reserve banking and from which a central bank (lender of last resort) will inevitably emerge and control the entire financial system.

These are the only two theoretically and practically viable alternatives. Up to this point we have examined the economic effects of fractional-reserve banking, both orchestrated by a central bank and in a free-banking system. In the next and last chapter we will carefully analyze a free-banking system subject to traditional legal principles, i.e., a 100-percent reserve requirement.¹⁶⁴