100 Percent Gold Banking

We have thus come to the cardinal difference between myself and the bulk of those economists who still advocate a return to the gold standard. These economists, represented by Dr. Walter E. Spahr and his associates in the Economists’ National Committee on Monetary Policy, essentially believe that the old pre-1933 gold standard was a fine and viable institution in all its parts, and that going off gold in 1933 was a single wicked act of will that only needs to be repealed in order to re-establish our monetary system on a sound foundation. I, on the contrary, view 1933 as but the last link in a whole chain of unfortunate actions; it seems clear to me that the gold standard of the 1920s was so vitiated as to be ready to collapse. A return to such a gold standard, while superior to the present system, would only pave the way for another collapse— and this time, I am afraid, gold would get no further chance. Although the transition period would be more difficult, it would be kinder to the gold standard, as well as better for the long-run economic health of the country, to go back to a stronger, more viable gold standard than the one we have lost.

I daresay that my audience has been too much exposed to the teachings of the Chicago School to be shocked at the idea of 100 percent reserve banking. This topic, of course, is worthy of far more space than I can give it here. I can only say that my position on 100 percent banking differs considerably in emphasis from the Chicago School. The Chicago group basically views 100 percent money as a technique—as a useful, efficient tool for government manipulation of the money supply, unburdened by lags or friction in the banking system. My reasons for advocating 100 percent banking cut much closer to the heart of our whole system of the free market and property rights.[23] In my view, issuing promises to pay on demand in excess of the amount of goods on hand is simply fraud, and should be so considered by the legal system. For this means that a bank issues “fake” warehouse receipts—warehouse receipts, for example, for ounces of gold that do not actually exist in the vaults. This is legalized counterfeiting; this is the creation of money without the necessity for production, to compete for resources against those who have produced. In short, I believe that fractional-reserve banking is disastrous both for the morality and for the fundamental bases and institutions of the market economy.

I am familiar with the many arguments for fractional-reserve banking. There is the view that this is simply economical: The banks began with 100 percent reserves, but then they shrewdly and keenly saw that only a certain proportion of these demand liabilities were likely to be redeemed, so that it seemed safe either to lend out the gold for profit or to issue pseudo-warehouse receipts (either as bank notes or as bank deposits) for the gold, and to lend out those. The banks here take on the character of shrewd entrepreneurs. But so is an embezzler shrewd when he takes money out of the company till to invest in some ventures of his own. Like the banker, he sees an opportunity to earn a profit on someone else’s assets. The embezzler knows, let us say, that the auditor will come on June 1 to inspect the accounts; and he fully intends to repay the “loan” before then. Let us assume that he does; is it really true that no one has been the loser and everyone has gained? I dispute this; a theft has occurred, and that theft should be prosecuted and not condoned. Let us note that the banking advocate assumes that something has gone wrong only if everyone should decide to redeem his property, only to find that it isn’t there. But I maintain that the wrong—the theft—occurs at the time the embezzler takes the money, not at the later time when his “borrowing” happens to be discovered.[24]

Another argument holds that the fact that notes and deposits are redeemable on demand is only a kind of accident; that these are merely credit transactions. The depositors or noteholders are simply lending money to the banks, which in turn act as their agents to channel the money to business firms. And why repress productive credit? Mises has shown, however, the crucial difference between a credit transaction and a claim transaction; credit always involves the purchase of a future good by the creditor in exchange for a present good (money). The creditor gives up a present good in exchange for an IOU for a good coming to him in the future. But a claim—and bank notes or deposits are claims to money—does not involve the creditor’s relinquishing any of the present good. On the contrary the noteholder or deposit-holder still retains his money (the present good) because he has a claim to it, a warehouse receipt, which he can redeem at any time he desires.[25] This is the nub of the problem, and this is why fractional-reserve banking creates new money while other credit agencies do not—for warehouse receipts or claims to money function on the market as equivalent to standard money itself.

To those who persist in believing that the bulk of bank deposits are really saved funds voluntarily left with the banks to invest for savers, and are not just kept as monetary cash balances, I would like to lay down this challenge: If what you say is true, why not agree to alter the banking structure to change these deposits to debentures of varying maturities? A shift from uncovered deposits to debentures will of course mean an enormous drop in the supply of money; but if these deposits are simply another form of credit, then the depositors should not object and we 100-percent theorists will be satisfied. The purchase of a debenture will, furthermore, be a genuine saving and investment of existing money, rather than an unsound increase in the money supply.[26]

In sum, I am advocating that the law be changed to treat bank notes and deposits as what they are in economic and social fact: claims warehouse receipts to standard money—in short, that the note and the deposit holders be recognized as owners-in-law of the gold (or, under a fiat standard, of the paper) in the bank’s vaults. Now treated in law as a debt, a deposit or note should be considered as evidence of a bailment.[27] In relation to general legal principles this would not be a radical change, since warehouse receipts are treated as bailments now. Banks would simply be treated as money warehouses in relation to their notes and deposits.[28]

Professor Spahr often uses the analogy of a bridge to justify fractional-reserve money. The builder of a bridge estimates approximately how many people will be using it daily. He builds the bridge on that basis and does not attempt to accommodate all the people in the city, should they all decide to cross the bridge simultaneously. But the most critical fallacy of this analogy is that the inhabitants do not then have a legal claim to cross the bridge at any time. (This would be even more evident if the bridge were owned by a private firm.) On the other hand, the holders of money substitutes most emphatically do have a legal claim to their own property at any time they choose to redeem it. The claims must then be fraudulent, since the bank could not possibly meet them all.[29]

To those who want the dollar convertible into gold but are content with the pre-1933 standard, we might cite the analysis of Amasa Walker, one of the great American economists a century ago: “So far as specie is held for the payment of these [fractional-reserve backed} notes, this kind of currency is actually convertible, and equivalent to money; but, in so far as the credit element exceeds the specie, It is only a promise to pay money, and is inconvertible, A mixed [fractional-reserve] currency, therefore can only be regarded as partially convertible; the degree of its convertibility depending upon the proportion the specie bears to the notes issued and the deposits.”[30]

For a believer in free enterprise, a system of “free banking” undoubtedly has many attractions. Not only does it seem most consistent with the general institution of free enterprise, but Mises and others have shown that free banking would lead not to the infinite supply of money envisioned by such Utopian partisans of free banking as Proudhoun, Spooner, Greene, and Meulen, but rather to a much “harder” and sounder money than exists when banks are controlled by a central bank. In practice, therefore free banking would come much closer to the 100 percent ideal than the system we now have.[31] And yet if “free trade in banking is free trade in swindling,” then surely the soundest course would be to take the swindling out of banking altogether. Mises’ sole argument against 100 percent gold banking is that this would admit the unfortunate precedent of government control of the banking system. But if fractional-reserve banking is fraudulent, then it could be outlawed not as a form of administrative government intervention in the monetary system, but rather as part of the general legal prohibition of force and fraud.[32] Within this general prohibition of fraud, my proposed banking reform would leave the private banks entirely free.[33]