===== PAGE 1 =====

AGAINST FIDUCIARY MEDIA

HANS-HERMANN HOPPE
WITH JORG GUIDO HULSMANN AND WALTER BLOCK

Imost all contemporary Austrian economists are united in their opposition

to central banking and their advocacy of a system of free competitive

banking. However, a vigorous debate has arisen over the precise meaning
of “free competitive banking.” Does “free banking” require 100 percent reserve
deposit banking, or does it allow or even require fractional reserve banking? In a
recent article that appeared in the Review of Austrian Economics, George A. Selgin
and Lawrence White (1996), the two most prominent contemporary Austrian pro-
ponents of “free banking” as fractional reserve banking, have undertaken a system-
atic attempt to answer their numerous Austrian critics and defenders of 100 percent
reserve deposit banking.

Against the charges made by their critics, Selgin and White try to establish two
theses. First, they claim to show that the practice of fractional reserve banking, that
is, the issue of fiduciary media, does not constitute fraud but is justified by the
principle of freedom of contract, and in particular they contend that fractional
reserve banking is in accordance with the title-transfer theory of contract as developed
by Murray N. Rothbard (such that Rothbard, who holds that fractional reserve banking
is fraudulent, must have failed to grasp his own theory). Second, they attempt to show
that the creation of fiduciary media does not of necessity lead to economic inefficien-
cies and discoordination but may actually help prevent an otherwise unavoidable

HANS-HERMANN HOPPE is professor of economics atthe University of Nevada, Las Vegas.

JORG GUIDO HULSMANN is a visiting research fellow at the Laboratoire d'Economie Poli-
tique at the University of Paris-Assas.

WALTER BLOCK is economics department chairman and professor at the University of Central
Arkansas, Conway.

"Selgin and White (1996, pp. 83-107). All page numbers in the text reference this article.

Curiously, in the reply to their various critics, Selgin and White selected as their central target
an article by Hoppe (1994) that deals only cursorily with their position. Other Austrian critics of
fractional reserve banking explicitly dealt with in Selgin and White's article including Block
(1988) and de Soto (1995). Murray N. Rothbard, the most prominent critic of fractional reserve
banking, is targeted only indirectly; and although several of his works are mentioned in their
bibliography, Rothbard’s later writings on the subject (1988; 1992; 1995) are not mentioned.
Likewise ignored entirely are the criticisms by Salerno (1991a; 1991b; 1993). Selgin and White
also do not address, and in this case could not have done so, the most recent and most extensive
criticism of their work by Hiilsmann (1996).

Quarterly Journal of Austrian Economics vol. 1, no. 1 (1998): 19-50
19


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20 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

crisis and thus improve economic performance. In the following, we will demon-
strate that neither the central normative claim nor the secondary positive claim is
established.?

THE ISSUE OF FRAUD I:
MONEY, MONEY SUBSTITUTES, FIDUCIARY MEDIA,
AND THE TITLE-TRANSFER THEORY OF CONTRACT

In order to resolve the question of whether or not fractional reserve banking
constitutes fraud, from the outset a few factual assumptions and terminological
issues will have to be clarified. Fortunately, almost complete agreement on these
matters exists on both sides of the debate, and thus we can be extremely brief.
Money cannot but originate as a commodity, such as gold. Gold, then, as money,
is defined as “the generally acceptable medium of exchange,” and as such is uniquely
characterized by its “supreme salability in comparison with all other assets” (such that
its “possession puts one in the position of being able to make any potential purchase
with minimum inconvenience”) (White 1989, p. 247). Money substitutes, in turn, are
defined as claims or titles to specified amounts of money (gold). If money substitutes
(paper notes) are fully covered by reserves of money (gold), Mises denotes them
“money certificates,” and we will refer to them here simply as money substitutes. If
money substitutes (paper notes) are uncovered by money (gold), they will be
referred to as fiduciary media instead.?

2As a doctrinal matter, Selgin and White also suggest that their view of fractional reserve
banking coincides with Ludwig von Mises’s view; hence, they call themselves Misesians (and
claim it is the defenders of 100 percent reserve banking who are deviationists). This claim can be
rejected. In fact, Selgin (1998, pp. 60-63) has frankly acknowledged that Mises’s and his own
views concerning fiduciary media are contradictory, and White's attempt to claim Mises as a
proponent of fractional reserve free banking has been addressed by Salerno (1993). Here it suf-
fices to provide a quotation from Mises (1978, pp. 438, 448):

The main thing is that the government should no longer be in a position to increase the
quantity of money in circulation and the amount of checkbook money not fully—that is,
100 percent—covered by deposits paid in by the public. . . . No bank must be permitted
to expand the total amount of its deposits subject to check or the balance of such deposits
of any individual customer. . . otherwise than by receiving cash deposits . . . or by receiv-
ing a check payable by another domestic bank subject to the same limitations. This
means a rigid 100 percent reserve for all future deposits; that is, all deposits not already in
existence on the first day of the reform.

Seealsonotes?7,14,22,27, 28 below.

See Salerno (1994, p. 76). Selgin and White highlight the fact that Hoppe referred to them
as proponents of “partial fiat money,” but then are ultimately compelled to admit that he did
in fact not misrepresent their position as advocates of fractional reserve banking based on an
underlying gold standard. Their complaint amounts to no more than a dispute over semantics. We
will treat it as such here, too, and will concentrate instead exclusively on substantive disagree-
ments.

There is actually more to the charge of Selgin and White being fiat money advocates in the
article under scrutiny. For, in “the mature free-banking system,” according to Selgin and White
(but in contrast to the analysis of the operation of such a system given by Mises), a situation is
supposed to emerge in which

at the limit, if inter-clearinghouse settlements were made entirely with other assets (per-
haps claims on a super-clearinghouse which itself holds negligible commodity money),


===== PAGE 3 =====

AGAINST FIDUCIARY MEDIA 21

Based on these assumptions and definitions, we can now turn to the question
of whether or not the issue of fiduciary media constitutes fraud. Fortunately, the
discussion of this issue is facilitated by the fact that Selgin and White explicitly accept
the Rothbardian title-transfer theory of contract. That the issue of fiduciary media is
inherently fraudulent, as Rothbard and Hoppe claim, Selgin and White find

impossible to reconcile with Rothbard’s.. . . title-transfer theory of contract, which we ac-
cept, and which Rothbard otherwise uses to defend the freedom of mutually consenting
individuals to engage in capitalist acts with their (justly owned) property. Rothbard . . .
defines fraud as “failure to fulfill a voluntarily-agreed-upon transfer of property.” Frac-
tional-reserve arrangements cannot then be inherently or inescapably fraudulent.
Whether a particular bank is committing fraud by holding fractional reserves must
depend onthe terms of the title-transfer agreement between the bank and its custom-
ers. (pp. 86-87)

Whether itis fraudulent to hold fractional reserves against a bank liability does not de-
pend per seon whether itis ademand or time liability, butonly on whether the bank
has misrepresented itself as holding 100 percent reserves. The demandability of a par-
ticular claim issued by a bank, that is, the holder’s contractual option to redeem it at any
time, is not per se a representation that the bank is holding 100 percent reserves against
the total of its demandable claims. Rothbard. . . argues otherwise, based on the view that
a bank’s demand deposits are necessarily “warehouse receipts” and not debts. We do
not see why bank and customer cannot contractually agree to make them debts and not
warehouse receipts, and we believe that historically they have so agreed. (p.87,n. 8)

While this may sound plausible at first glance, it does not withstand serious
scrutiny. In fact, the quoted passage reveals that the most basic lesson concerning
property and contract has been overlooked. As Hoppe (1994, p. 67) formulated it,
“two individuals cannot be the exclusive owner of one and the same thing at the
same time.”4 This is an immutable principle; it is a law of action and nature that no
contract can change or invalidate. Rather, 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

and if the public were completely weaned from holding commodity money, the active
demand for the old-fashioned money commodity would be wholly nonmonetary. (White
1989, p. 235)

Thus, notes Salerno (1994, p. 76, n. 7) regarding Selgin and White's ultimate objective, “the
public would presumably finally be freed from its shackles of gold to enjoy the virtues of an
invisible-hand-generated private fiat money.” Moreover, as far as semantic innovations and de-
viations from orthodox Misesian terminology, and hence potential sources of confusion are con-
cerned, we have to consider Selgin and White's own writings. For in referring to money and
money substitutes as “outside” and “inside” money respectively, in talking of “base money,”
“basic money,” “bank money,” “high-powered” and “low-powered” money, and, yes, the
gold dollar “as a substitute for bank deposits,” they display an unusual degree of semantic
creativity. Moreover, in suggesting, by their selection of terms, that all of these things are
somehow equally “money,” their writings actually have become a source of obfuscation. See on
this Hiilsmann (1996, p. 5ff).

“It is also “impossible that some time depositor and borrower are entitled to exclusive control
over the same resources” (Hoppe 1994, p. 67).


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22 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

objectively false and thus fraudulent. Yet this, precisely, is what a fractional -reserve
agreement between bank and customer involves.

In issuing and accepting a fiduciary note (at a necessarily discounted price),
both bank and customer have in fact, regardless of whatever they may believe or
think about the transaction, agreed to represent themselves—fraudulently—as the
owner of one and the same object at the same time. They have in fact contracted to
create additional titles and claims to the same existing quantity of property. In issuing
fiduciary notes, they do not—and cannot—bring more property into existence. Indeed,
no contract whatsoever can possibly increase the existing quantity of property, but
can only transfer (redistribute) existing property from one person to another. The
quantity of existing property can only be increased through additional appropria-
tion and production (and a thus enlarged quantity of property can in turn lead to a
correspondingly increased number of titles to property). But fractional reserve
banking and the issue of fiduciary media, while it does not and cannot increase the
amount of property in existence, also does not involve (as all other contracts do) a
transfer of existing property or titles to existing property from one hand to another.
Neither does the issue and acceptance of a fiduciary note signify a transfer of
property from bank to client or vice versa. To be sure, as the result of a fiduciary
issue, the distribution of assets and liabilities in the accounts of bank and client is
altered. But no existing quantity of property is actually transferred from bank to
client, or vice versa, and the total quantity of property in existence has remained
unchanged. Rather, fiduciary media represent new and additional titles to or claims
on an existing and unchanged stock of property. They are not the result and
documented outcome of an additional supply of property on the part of the bank or
its client. Instead, they represent an additional supply of property titles, while the
supply of property has remained constant. It is precisely in this sense that it can be
said of fiduciary media that they are created out of thin air. They are property-less
titles in search of property. This, in and of itself, constitutes fraud, whether according
to Rothbard'’s definition of the term as “a failure to fulfill a voluntarily-agreed-upon
transfer of property” or according to Selgin and White’s own definition of it as “a
willful or deliberate deception for purposes of gain.” Each issuer and buyer of a
fiduciary note (a title to money uncovered by money), regardless of what he may
believe, is in fact—objectively—engaged in a misrepresentation for the purpose of
personal gain. The bank and its client have consented to misrepresent themselves
as the owners of a quantity of property that they do not own and that plainly does
not exist; and whenever they buy an existing quantity of property in exchange for
titles to a non-existing quantity of property, they have become invariably and
inescapably guilty of an act of fraudulent appropriation.®

>Even partners cannot simultaneously own the same thing. A and B can each own half of a
household, or half the shares in it, but they each own a different 50 percent. It is as logically -
impossible for them to own the same half as for two people to occupy the same space. Yes, Aand B
can both be in New York City atthe same time, but only in different parts of it.

®De Soto (1995, p. 33) correctly likens the effect of fractional reserve banking to that of the so-called
tragedy of the commons. Selgin and White (pp. 92-93, n. 12) object to de Soto’s analogy onthe
ground that the tragedy of the commons refers “to a particular sort of technological externality,”


===== PAGE 5 =====

AGAINST FIDUCIARY MEDIA 23

Selgin and White's failure to recognize this, and their belief in the ethical
innocence of fractional reserve banking, is due to two confusions. On the one hand,
as has already been indicated, they do not recognize that no object—and no
quantity of money (gold)—can be owned by more than one party at a time and that
no contract can possibly increase the quantity of property in existence, and thus that
any pretension to the contrary is inherently fraudulent. On the other hand, and
intimately related, Selgin and White do not recognize the fundamental praxeologi-
cal difference between property and property titles. Rather, in subsuming money
(gold) and money substitutes (banknotes) under the same heading of “money,” they
continually obfuscate this very distinction. For if money (gold) and titles to money
(banknotes) are both defined as “money,” then it indeed seems to follow that it does
not make any difference whether the supply of money or that of banknotes in-
creases. Both are “money” and hence, by definition, in both cases the same
event—an increase in the supply of money—nhas taken place. But this does not alter
the facts; it only defines them out of existence.

Of course, as Selgin and White correctly note, everyone is free to adopt any
definition and make any distinction that he wishes. Yet definitions do not create real
distinctions; they can, though, make them disappear. They can only either reflect
such distinctions or else ignore and confuse them; and clearly, to refer to both
money and money substitutes indiscriminately as money is to obscure the differ-
ence between two categorically—praxeologically—distinct phenomena and states
of affairs. A title to money and an increase of titles is not the same thing as money
and an increase of money. Rather, unlike an increase in the quantity of money (gold)
or an increase of titles backed by a corresponding increase of money, any increase in
the quantity of titles to money unaccompanied by an increased quantity of money
necessarily implies that one and the same quantity of money is owned by more than
one person at the same time; and since such a thing is physically impossible —the
quantity of money is unchanged and all existing money must be presently owned by
someone—every redemption of a fiduciary title, then, be it into money or any other
form of real property, involves an act of illicit appropriation.

according to Selgin and White, involves “a physical or otherwise direct interference with some-
one’s consumption or production” and represents “interaction outside the market.” In contrast,
write Selgin and White, the “externality from fiduciary media” is a harmless pecuniary “effect on
someone’s wealth transmitted via the price system,” that is, through changes in the system of rela-
tive prices, and represents “an interdependence through the market.” Selgin and White err: an ob-
jectand atitle to an object are not the same thing.

In lumping money and money substitutes together under the joint title of “money,” as if they
were somehow the same thing, Selgin and White fail to grasp that the issue of fiduciary media —an
increase of property titles—is not the same thing as a larger supply of property and that relative
price changes effected through the issue of fiduciary media are an entirely different “externality”
matter than price changes effected through an increase in the supply of property. With this the
fundamental distinction between property and a property title in mind, de Soto’s analogy between
fractional reserve banking and the tragedy of the commons makes perfect sense. As under the
scenario of a tragedy of the commons, every issue of fiduciary media—to titles in search of prop-
erty—sets in motion a rush, always starting with the bank and its client, to fill these empty tickets
with existing property; and in the course of this rush, invariably the firstcomers will physically
enrich themselves (through the appropriation of existing quantities of property) at the expense of a
corresponding impoverishment of latercomers, whose quantity of existing property is physically
diminished while they have been left with a larger number of property tickets.


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24 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

Assume there exists both property itself and property titles (notes). Besides
property in consumer goods, producer goods, and money, titles to consumer goods,
titles to producer goods, and titles to money are assumed to exist. The origin of
property titles in addition to the existence of property itself promotes legal certainty
and reduces and facilitates legal disputes, and hence undoubtedly represents a
beneficial (natural) development. Moreover, it allows for two innovations. On the
one hand, it becomes possible to separate the act of transferring ownership in
property from the act of transferring its possession. That is, it becomes possible to
surrender or acquire ownership in objects without simultaneously surrendering or
acquiring possession, disposition, and control of the very same objects. Applied to
money it becomes possible that, all the while the ownership of existing quantities of
money (gold) can change constantly from one person to another, the entire quantity of
money may remain—unchangingly—in the hands of one and the same bank (as the
manager of money owned by others). On the other hand, with the development of
property titles, intertemporal exchanges will be systematically facilitated. Existing
(present) property or titles thereto may be transferred in exchange against titles to
future property (debt claims); and hence it will be also assumed that next to titles to
existing property (consumer goods, producer goods, and money), titles (debt claims)
to future consumer goods, future producer goods, and future money exist and are
traded as well.

In light of these developments, the following transactions (contracts) between
any two parties A (bank client) and B (bank) are possible. A may transfer his money
(gold) into B’s disposition and thereby either (1) not give up his ownership in it, or
(2) give up his ownership. There is no third possibility. If (1), then A keeps the title
to the sum of money transferred to B; B does not have title to it, but acts as a money
warehouser (a bailee) for A (as a money bailor). There is no third possiblity. If (2),
then B acquires the title to the quantity of money put into its disposition by A; A
receives from B in exchange either (a) a present—existing—quantity of consumer
and/or producer goods previously possessed and owned by B; or (b) a title to a
present—existing—quantity of consumer and/or producer goods in B’s possession (but
owned now by A) (an equity claim); or (c) a title to a quantity of future consumer and/or
producer goods and/or money (a debt claim). Again, there is no third possibility. That
is, A cannot both retain ownership of this property and transfer it to B.

Among all possible transactions, not one would result in the issue of a fiduciary
note. Fiduciary media, according to Selgin and White's own definition, are “that
portion of redeemable money substitutes backed by assets other than base money”
(p. 85). There are money (gold) and money substitutes (titles to money) in existence,
and there are titles to non-money goods (equity titles), and titles to not-yet-existing
future goods (debt claims). Apparently, however, no such thing as “money substi-
tutes backed by assets other than base money” would arise out of any of these
transactions. Selgin and White assume the existence of fiduciary media (and they
simply assume that the absence of fiduciary media must be the result of legal
restrictions), but they do not provide a praxeological explanation and reconstruc-
tion of the origin of such a peculiar entity and state of affairs. Rather, they only ask,
why not? “We do not see why bank and customer cannot contractually agree to
make them [that is, demand deposits and banknotes] debts and not warehouse


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AGAINST FIDUCIARY MEDIA 25

receipts.” Why is it that there can—and should—be no money substitutes backed
by assets other than money? For the same reason that there can and should be no
car or house titles backed by assets other than cars or houses, that there can and
should be no equity titles backed by assets other than equity, and that there can and
should be no assets—money, equity, or debt—owned (backed) by more than one
person at a time. Titles to money are—and should be—backed by money in the
same way and for the same reason as titles to cars are and should be backed by cars.
This is what defines them as property titles. It is in accordance with and a reflection
of the nature of property and property titles. In distinct contrast, a title to money
backed by assets other than money is a contradiction in terms, and its issue and use
involves the same sort of objective misrepresentation as the issue of a title to a car
backed by assets other than a car (parts of planes and bikes, for instance).”

The answer to why fractional reserve agreements are ethically impermissible,
and why there can be no contracts to make warehouse receipts debt, is that such
agreements and contracts contradict (deny) the nature of things. Any such contract
is from the outset—a priori—invalid. Selgin and White try to get around this inescap-
able conclusion by adopting, wittingly or not, an ultra-subjectivist view of contracts
and agreements. According to this view, the very fact that a voluntary agreement is

“Similar logic-semantic confusions are at work when Selgin and White try to reduce the
difference between demand and time liabilities to one of degree rather than kind (p. 90). Explains
Selgin (1988, p. 62): “Holders of demand liabilities are granters of credit just as are holders of time
liabilities. The only difference is that in the former case the duration of individual loans is unspeci-
fied; they are ‘call loans’ that may mature at any time”; and “Mises,” who holds the opposite view,
“confuses a difference of degree with one of substance.” In fact, itis Selgin who is confused.

To be sure, one might say that itis only a matter of degree whether a loan (of a car or of money)
matures in an hour, a day, a week, or a month. Just as surely, however, this does not change the
categorical distinction between present—existing—goods and not (yet) existing future goods. At
any point in time, a car or a sum of money (gold) either exists or it does not exist. Nor does it alter
the praxeological datum that no one, at any time, can act with anything except present goods.
Future goods are the goal of actions, but in order to attain them, every actor must first invariably
employ present means (goods). Nor does Selgin’s observation concerning degrees of time affectin
the slightest the fundamental human condition of scarcity. The supply of present goods is at all
times limited, and the limited quantity of present goods limits in turn the quantity of possible future
goods.

Whereas Mises recognizes the distinction between present goods and future goods as a uni-
versal praxeological category, Selgin’s attempt to conflate demand and time deposits (thus distin-
guish himself fundamentally from Mises) implies a denial that there is no such fundamental differ-
ence between present (existing) goods and future (not-existing) goods (or that their existence dif-
fers only in degrees). Contrary to Selgin, it is not a matter of degree but rather one of substance
whether a car or a sum of money presently exists or not, and whether one person or someone else
owns them. Either they exist or they don’t exist, and either A owns them or someone else does.
Accordingly, if a property title (demand deposit note) then states that one person is the owner of a
present car or present money and no car or money exists, or the car or money is presently owned
by someone else, this does not represent a degree of truth but a falsehood. Explains Mises (1978, p.
268):

A depositor of a sum of money who acquires in exchange for it a claim convertible into
money at any time which will perform exactly the same service for him as the sum it refers
to has exchanged no present good for a future good. The claim that he has acquired by his
deposit is also a present good for him. The depositing of money in no way means that he
has renounced immediate disposal over the utility it commands.

See also the two following notes.


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26 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

reached and/or a contract is concluded demonstrates that it must be a valid—true
or permissible—agreement and contract. Yet this view is not only false it is also
incompatible with Rothbard'’s title-transfer theory of contract that these authors
claim to have accepted. Agreements and contracts per se do not imply anything
regarding their validity for the fundamental reason that agreements and contracts
do not create reality, but rather presuppose it. More specifically, contracts do not
bring property into existence, but rather recognize and transfer existing property.
Hence, as in Rothbard’s ethical system, the theory of property must precede the
treatment of contracts. Contracts and contract theory presuppose and are con-
strained by property and property theory. That is, the range of possible (valid)
contracts is limited and restricted by the existing quantity (stock) of property and the
nature of things, rather than the other way around. Thus, agreements regarding
flying elephants, centaurs, squared circles, of perpetui mobile, for instance, are
invalid contracts. They cannot—Dby virtue of biological, physical, or mathematical
law—be fulfilled, and are from the outset false and fraudulent.

While Selgin and White may acknowledge this, they fail to recognize that a
fractional reserve banking agreement implies no lesser an impossibility and fraud
than that involved in the trade of flying elephants or squared circles. In fact, the
impossibility involved in fractional reserve banking is even greater. For, whereas the
impossibility of contracts regarding flying elephants, for instance, is merely a
contingent and empirical one (it is not inconceivable that in another possible world,
somewhere and sometime, flying elephants may actually exist, thus making such
contracts possible), the impossibility of fractional reserve banking contracts is a
necessary and categorical one. That is, it is inconceivable—praxeologically impos-
sible—that a bank and a customer can agree to make money substitutes (banknotes,
demand deposit accounts) debts instead of warehouse receipts. They may say or
certify otherwise, of course, just as one may say that triangles are squares. But what
they say would be objectively false. As triangles would remain triangles and be
different from squares, so money substitutes would still be money substitutes (titles
to present money) and be distinct from debt claims (titles to not yet existing future
goods) and equity claims (titles to existing property other than money). To say
otherwise does not change reality but objectively misrepresents it.

In doing what Selgin and White believe clients and banks to have done—to
agree to make warehouse receipts debt—the money depositor A receives from the
bank B a claim to present money, rather than a debt or equity title. That is, A does
not in fact give up ownership of the deposited money (as would have been the case if
he had received a debt or equity claim from B). While A retains title to the money
deposit, however, B does not treat A’s deposit as a bailment, but rather as a loan,
and enters it as an asset onto its own (B’s) balance sheet (offset by an equal sum of
outstanding demand liabilities). While this may appear initially to be merely a
harmless accounting practice, it involves from the outset a misrepresentation of
the real state of affairs.® Since both, B as well as A, count the same quantity of

85ee on this point Rothbard (1983b). “How,” asks Rothbard,

do these warehouse receipt transactions relate to the T-account balance sheets of the de-
posit banks? In simple justice, not at all. When | store a piece of furniture worth $5,000 in


===== PAGE 9 =====

AGAINST FIDUCIARY MEDIA 27

money simultaneously among their own assets, they have in effect conspired to
represent themselves in their financial accounts as owning a larger quantity of
property than they actually own: that is, they have become financial impostors.®
Though fraudulent, this would not matter so much if everything were left at this.
However, as soon as B acts as if things were the way he represents them on his

- balance sheet to be—as if the bank owned the deposited money and only had the
obligation to redeem outstanding warehouse receipts on demand—mere misrepre-
sentation is turned into misappropriation. If B, in accordance with this misrepresen-
tation, lends out money, or more likely, issues additional warehouse receipts for
money and lends these out to some third party C, in the expectation of eventually
being repaid principal and interest, the bank becomes engaged in undue appropria-
tion, because what it lends out to C—whether money or titles to money—is in fact
not its (B's) own property but that of someone else (A). It is this fact—that the title
transferred from B to C concerns property B does not own—that makes fractional
reserve banking from the outset fraudulent.

It is not the case, as is claimed, that fraud (breach of contract) is committed only
if B, the fractional reserve bank, is actually unable to fulfill all requests for redemp-
tion as they arise. Rather, fraud is also committed each time B does fulfill its
redemption obligations. Because whenever B redeems a fractionally covered
banknote into money (gold) (whenever a note holder takes possession of his prop-
erty), it does so with someone else’s money: if B redeems C's note, it does so with
money owned by A, and if A wants his money too, B pays him with money owned
by D, and so on. Qua defenders of fiduciary media and fractional reserve banking,
Selgin and White would have to maintain that there is no breach of contract as long
as B is able to fulfill its contractual obligations with someone else’s property (money).

warehouse, in law and in justice the furniture does not show up as an asset of the ware-
house during the time that | kept itthere. The warehouse does not add $5,000 to both its
assets and liabilities because itin no sense owns the furniture; neither can we say that |
have loaned the warehouse the furniture for some indefinite time period. The furniture is
mine and remains mine; | am only keeping itthere for safekeeping and therefore | am le-
gally and morally entitled to redeem it any time | please. | am not therefore the bank’s
creditor; itdoesn’t owe me money which | may some day collect. Hence, there is no debt
to show up on the Equity + Liability side of the ledger. Legally, the entire transaction is not
aloan but a bailment. (pp. 88-89; also pp. 94-95)

Interestingly, while Selgin and White manifest a strong positivistic tendency (fractional re-
serve banking is recognized by the courts, so it must be all right; on this tendency see “The Issue of
Fraud I11” below), they do not come to terms with legal reality. For if money deposits are debt, why,
then, don’t the courts apply the same reasoning to all other fungible commodities such as wheat?
Why are wheat warehouse receipts not considered a debt (but a bailment) by the courts? Why is
this treatment peculiar to money and the banking business? Moreover, why is it that the courts,
even if they falsely consider money deposits as debts, still insist that they are more than an ordinary
debt, and the depositor’s relation to the bank is not identical with that of an ordinary creditor? See
Rothbard (1983, p. 275).

95ee also Jevons (1905, pp. 206-12, 221), who lamented the existence of general deposits
since it has “become possible to create a fictitious supply of a commodity, that is, to make people
believe that a supply exists which does not exist.” On the other hand, special deposits, such as
“bills of lading, pawn-tickets, dock-warrants, or certificates which establish ownership to a defi-
nite object,” are superior because “they cannot possibly be issued in excess of the good actually
deposited, unless by distinct fraud.” And Jevons concluded that “it used to be held as a general rule
of law, that a present grant or assignment of goods notin existence is without operation.”


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28 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

Yet this is patently wrong, and it stands in clear contradiction to Rothbard’s title-
transfer theory of contract that Selgin and White claim to have accepted. In accordance
with Rothbard’s contract theory, individuals are only entitled to make contracts regard-
ing the transfer of their own property. In contrast, fractional reserve banking, by its very
nature (even if it is practiced successfully), involves contracts concerning the transfer
of other people’s property. Hence, this practice—the issue of fiduciary media—is in
principle (inherently) incompatible with the title-transfer theory of contract—and it
turns out, not surprisingly, that it is Rothbard, and not his two interpreters, who
ultimately demonstrates a better grasp of his own contract theory.

THE ISSUE OF FRAUD II:
FRACTIONAL RESERVE BANKING AND FREEDOM OF CONTRACT

Murray Rothbard’s classification of fractional reserve banking as fraud was the result
of long and intensive study of ethics and property-rights theory in particular. Selgin
and White rightly regard economics as intellectually independent and separate
from ethics. It may be studied without any prior knowledge of property and prop-
erty-rights theory. Yet they do not hesitate to make sweeping ethical pronounce-
ments. In their moral defense of fractional reserve banking Selgin and White rarely
mention property, let alone outline a theory of property. This results in a series of
fundamental errors and problems: confusion regarding the distinction between
property and property titles; confusion as to the (im-)possibility of something (prop-
erty) being owned simultaneously by more than one owner; confusion concerning
the logical priority of property and property theory vis-a-vis contract and contract
theory; and confusion concerning the necessity of fulfilling one’s contractual obli-
gations with one’s own property (not just anyone’s).

These difficulties enter into the authors’ discussion of the issue of “freedom of
contract.” Their argument is straightforward.

If abank does not represent or expressly oblige itself to hold 100 percent reserves, then
fractional reserves do not violate the contractual agreement between the bank and its
customer. ... Outlawing voluntary contractual arrangements that permit fractional re-
serve-holding is thus an intervention into the market, a restriction on the freedom of con-
tract which is an essential aspect of private property rights. (p. 87)

This passage reveals again Selgin and White's already noted ultra-subjectivism.
According to this view, it is voluntary agreements that make for—constitute and
define—a valid contract. However, valid contracts are agreements regarding the
transfer of real property; hence, the range of valid contracts is in fact first and foremost
constrained by the nature of things and property (and only then by agreement). It was
thus that Hoppe (1994, p. 70) explained that

freedom of contract does notimply that every mutually advantageous contract should be
permitted. . . . Freedom of contract means instead that A and B should be allowed to
make any contract whatsoever regarding their own properties, yet fractional reserve
banking involves the making of contracts regarding the property of third parties.

Selgin and White refer to this charge somewhat misleadingly as “third-party effects”
(p. 92) and counter it by charging Hoppe in turn with elementary confusion as regards
the nature of property and property rights. They state first, that


===== PAGE 11 =====

AGAINST FIDUCIARY MEDIA 29

spill-overs from others’ actions to the value of C's property . . . are an inescapable free-
market phenomenon, and are not a violation of C's private-property rights, [whereas]
physical invasions of C's property . . . are of course inconsistent with the protection of C's
property rights. It should be obvious thatif A and B are barred from any transaction that
merely affects the market value of C's possessions, without any physical aggression or
threat against.C or C’s rightful property, then the principles of private property, freedom
of contract, and free-market competition are completely obliterated. Is B to be barred
from offering to sell compact disc recordings to A, merely because doing so reduces the
market value of C’s inventory of vinyl records? (pp. 92-93)

Second, they state that the reduction of the purchasing power of money, which
they admit must result from every issue of fiduciary media, is as such a harmless
value-effect and thus “provides no justification for legally barring the bank’s ac-
tion.” Hence they conclude that Hoppe’s argument is “invalid” (and incompatible
with Rothbard’s theory of property).

Selgin and White’s counterargument contains two errors. First, while the major
premise is correct, it is false that Hoppe is mistaken about it. Hoppe has written
extensively on the theory of property rights, and is not only aware of the distinction
mentioned by Selgin and White but even provides a praxeological defense of it;
hence, in this regard no difference of judgment whatsoever between Rothbard and
Hoppe exists.'°

Second, the minor premise is demonstrably false (and hence, so is the conclusion).
Selgin and White claim that the fall in the purchasing power of money resulting from
the issue of fiduciary media is the same sort of harmless event as a fall in the price of
anything else (caused by changes in supply and/or demand). That money owners lose
purchasing power as a result of fractional reserve banking, they claim, is not different
from the situation in which the owners of potatoes or cars suffer a value-loss due to a
larger supply of or a reduced demand for potatoes and cars.

Here again, Selgin and White conflate money (gold)—that is, property—and
money substitutes (banknotes)—that is, property titles. To be sure, the issue of fiduciary
media does not lead to physical damage to real property. After all, a bank note is just a
piece of paper, and paper does not exert any relevant physical effect on the external
world. But the same can be said also about the issue of fiduciary titles to potatoes or
cars (titles backed by assets other than potatoes or cars). They, too, are merely pieces
of paper, and as such have no impact on the real world. Yet there exists an
important difference between changes in a potato or car owner's wealth position
due to changes in the supply or demand for potatoes or cars on the one hand, and
changes brought about by changes in the supply or demand for titles to non-existing
(unchanged) quantities of potatoes or cars on the other hand. Surely, the owners of
potatoes or cars are affected differently in both cases. In the first case, if the price of
potatoes or cars falls due to a larger potato or car supply, all current potato or car
owners remain (unchangingly) in possession of the same quantity of property
(potatoes or cars). No one’s physical property is diminished. Likewise, if the price
falls because potato or car buyers are willing to offer only lesser quantities of other

105ee, for instance, Hoppe (1988, pp. 69ff); and White's (1990) review of Hoppe.


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30 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

goods in exchange for potatoes or cars, this by itself has no effect on any current potato
or car owner's physical quantity of potatoes or cars. In distinct contrast in the second
case, the issue and sale of an additional title to an unchanged quantity of potatoes
or cars does lead to a quantitative diminution of some current potato or car owner's
physical property. It does not merely have a value-effect: the purchasing power of
potato or car titles will fall. It does have a physical effect: the issuer and seller of
fiduciary potato or car titles misappropriates other people’s potatoes or cars. He
appropriates other people’s property without relinquishing any property of his own
(in exchange for an empty property title).

THE ISSUE OF FRAUD lll:
THE “PROOF FROM EXISTENCE”
FRACTIONAL RESERVE BANKING AND STATE FORMATION

Neither the title-transfer theory of contract nor the principle of freedom of contract
supports the claim that the issue of fiduciary media and fractional reserve banking is
ethically justified. To the contrary, only one other argument remains in support of the
claim that fractional reserve banking represents a legitimate form of business.

The argument boils down to a proof from existence: X, Y, or Z exists; it would
not exist if it were not beneficial; hence, it should exist (and outlawing it would be
detrimental and morally wrong).

Thus, write Selgin and White (p. 95):

the group [of people] whose freedom of contract we are concerned with here is not a
small eccentric bunch, but is the great mass of people who have demonstrated that they
do prefer banks that operate on fractional reserves. . . . Depositors continue to patronize
these banks, demonstrating their preference, for them... . By the principle of demon-
strated preference depositors must be presumed to benefit from the package they have
agreed to accept, risk and all. (p. 93)

[Consequently,] if any person knowingly prefers to put money into an (interest-bearing)
fractional reserve account, rather than into a (storage-fee-charging) 100 percent reserve
account, then a blanket prohibition on fractional reserve banking by force of law is a
binding legal restriction on freedom of contract in the market for banking services. (p. 88)

[Moreover]... benefits accrue to bank depositors and noteholders, who receive interest
and services paid for by the extra bank revenue generated from lending out a portion of
its liabilities. Benefits accrue to bank borrowers who enjoy a more ample supply of inter-
mediated credit, and to everyone who works with the economy’s consequently larger
stock of capital equipment. And the benefits must accrue to bank shareholders, who
could choose to have the bank not issue demand liabilities if they found the risks not
worth taking. (p. 94)

Selgin and White have here put the cart before the horse. The existence of a
practice, however widespread, has no bearing on the question of whether it is justifiable

"Also see note 4 above. We will also show that these authors’ meaning of demand for (and
supply of) money is misconceived. An increased demand for money (or potatoes or cars) is not just
a wish to have more money (or potatoes), but greater effective demand.


===== PAGE 13 =====

AGAINST FIDUCIARY MEDIA 31

or not. Consider first, for illustrative purposes, the following analogy concerning the
ethical permissibility of a state, that is, of a territorial monopolist of law and order
(or of justice and protection).'?

In the words of Selgin and White (applied here in a different context and
paraphrased), the group of people whose freedom of contract we are concerned
with is not a small eccentric bunch, but is the great mass of people who have
demonstrated that they do prefer states (judges and protectors) that operate on a
monopolistic basis. Territorial inhabitants continue to patronize these states, dem-
onstrating their preference for them. By the principle of demonstrated preference,
territorial inhabitants must be presumed to benefit from the package they have
agreed to accept, risk and all. Consequently, if any person knowingly prefers to put
money into a tax-bearing state account, rather than into a protection-fee-charging
account in non-taxing justice and protection agencies, then a blanket prohibition
on state-formation by force of law is a binding legal restriction on freedom of
contract in the market for justice and protection services. Moreover, benefits accrue
to state depositors and noteholders, who receive interest and services paid for by the
extra state revenue generated from employing parts of the deposits for extra tax collec-
tions. Benefits accrue to state borrowers who enjoy a more ample supply of interme-
diated credit, and to everyone who works with the economy’s consequently larger
stock of capital equipment. And benefits must accrue to state shareholders, who
could choose to have the state not engage in taxation if they found the risks not
worth taking.

Given their own libertarian credentials, Selgin and White would presumably
reject this analogy as false and inappropriate. But if so, why? What is it that
invalidates the second proof, but not the first? What, if anything, makes a blanket
prohibition (or permission) of fractional reserve banking categorically different from
a blanket prohibition (or permission) of state formation and operation?

The answer—that no such difference exists and that both proofs are equally
invalid—is to be found in the Rothbardian principle of demonstrated preference. While
Selgin and White invoke this principle in support of their conclusion regarding the
ethical permissibility of fractional reserve banking, they miss its implication. The
principle of demonstrated preference, as explained by Rothbard in his celebrated “To-
ward a Reconstruction of Utility and Welfare Economics,” presupposes property rights.
Not all demonstrated preferences are ethically permissible or socially beneficial.
Instead, the only such preferences that are permissible and welfare enhancing are
these that are expressed by means of one’s own property and nothing but one’s own
property. Every preference demonstration by means of property other than one’s
own—with other people’s property—is impermissible and non-beneficial.

As for the demonstrated preference for states, it runs afoul of Rothbard’s princi-
ple. In Rothbard’s analysis, which is presumably accepted by the participants on

1275 avoid any misunderstanding, the term monopoly is employed here in its Rothbardian
definition as an exclusive privilege (or the absence of free entry). A monopoly of law and order
means that one may turn for justice and protection only to one party—the state—and that it is
exclusively this party that determines the content of justice and protection.


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32 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

both sides of the current debate, the violation can be quickly pinpointed. Private
property, as the result of acts of (original) appropriation and/or production, implies the
owner's right to exclusive jurisdiction regarding his property, including the right to
employ this property in defense against possible invasions and invaders. Indeed, there can
be no property without an owner's right to physical defense, and it is the very purpose of
private property to establish separate domains of exclusive jurisdiction. No private-
property owner can possibly surrender his right to ultimate jurisdiction over and
defense of his property to someone else—unless he sells or otherwise transfers his
property (in which case someone else would have exclusive jurisdiction over it). That is,
so long as something (a good) has not been abandoned, its owner must be presumed as
retaining these rights; and as far as his relations to others are concerned, every property
owner may then only partake in the advantages of the division of labor and seek better
and improved protection of his unalterable property rights through cooperation
with other owners of property. Every property owner can buy from, sell to, or otherwise
contract with everyone else concerning supplemental property protection and security
services. Yet each owner also may at any time unilaterally discontinue any such coop-
eration with others. In distinct contrast, a territorial monopoly of protection and juris-
diction—a state—implies that every property owner is prohibited from discontinuing
his cooperation with his protector, and that no one (except the monopolist) may
exercise ultimate jurisdiction over his own property. Rather, everyone except the
monopolist has lost his right to defense and is thus rendered defenseless vis-a-vis his
own protector. Obviously, such an institution stands in contradiction to every owner's
demonstrated preference of not giving up his property. Contrary to their demonstrated
preference, the monopolist prohibits the people from using their property in physical
defense against possible invasions by himself and his agents. A monopoly of protection
and jurisdiction rests thus from the outset on an impermissible act of expropriation
(taxation) and provides the monopolist and his agents with a license to further expro-
priation and taxation. Every owner's range of permissible actions regarding his own
property, and hence the value of his property, is diminished, whereas the monopolist’s
range of action and control is correspondingly enlarged and his exclusive privilege is
reflected in an increase in the value of his property (capitalization of monopoly profit).

Presently, states exist everywhere, and almost everyone resides under state
protection. Regardless of this preference demonstration, however, there is nothing
wrong, ethically or economically, with blanket protection against state formation.
No one may form a state, for the same reason that no one may expropriate or rob
anyone else. In a court of law, it would be sufficient that a single property owner
objected to the monopoly’s existence, and the monopolist would have to cease in his
current operation as a tax-yielding protection agency and be repaired to the legal status
of a non-taxing but fee-charging law-and-security agency (a normal specialized firm).
A tax-yielding protection agency is a contradiction in terms—an invasive protec-
tor—and must be forbidden, irrespective of any benefits occuring to state depositors,
state borrowers, and state owners. To do so is not a legal restriction on freedom of
contract in the market for justice and protection services, but the very presupposition
of freedom of contract and justice. Everyone putting money or any other resources into
a tax-yielding protection account is engaged in unlawful action and subject to
punishment.


===== PAGE 15 =====

AGAINST FIDUCIARY MEDIA 33

Just as states exist everywhere, so do fractional reserve banks, and nowadays
practically everyone is banking with fractional reserve banks. What, if anything, is the
difference between the status of a state and that of a fractional reserve bank? Why
should fractional reserve banks not be outlaw banks just as states outlaw protection
agencies? To be sure, just as there can be no doubt concerning a demand for protection
services, there can also be no doubt as to a demand for banking services. Yet the
demand for protection services that private-property owners may properly demonstrate
does not include a demand for tax-yielding protection services, as we have seen. It
exclusively permits a demand for fee-charging protection agencies. Why should an
analogous distinction not be true also for banking services? Why should a demand for
interest-yielding demand deposit accounts not be just as impermissible as the demand
for tax-yielding protection accounts, on the ground that both interest-yielding deposit
accounts and tax-yielding property protection are contradictions in terms? Why
should the functions of a money warehouser and clearing institution (100 percent
reserve deposit banking) and as an intermediary of credit (savings-and-loan bank-
ing) not be the only just forms of banking (just as fee-charging protection agencies
are the only legitimate form of protection)?

The answer depends on whether or not the demonstrated preference for fractional
reserve banking services, that is, the issue and acceptance of fiduciary media, involves
solely and exclusively the property of the two contracting parties. At any given point in
time, the quantity of property (appropriated goods)—whether consumer goods, pro-
ducer goods, or money—is given. Fractional reserve banking does not increase the
quantity of existing property (money or otherwise), nor does it transfer existing
property from one party to another. Rather, it involves the production and sale of an
increased quantity of titles to an unchanged stock of money property (gold); that is, the
supply of and the demand for counterfeit money and illegitimate appropriation. As in
every other case of counterfeiting (forgery)—of stock and commodity certificates,
banknotes, land titles, original art, etc.,—the issue and sale of money copies
(banknotes) uncovered by originals (gold) will physically diminish or despoil the
original money—stock, commodity, land, or art—owners’ property. But a counterfeiter
of money is particularly dangerous and invasive because of money's defining charac-
teristic as the most easily saleable and widely acceptable of all goods; that is, because
money-counterfeits open to their seller the widest possible range of objects for
undue appropriation (from money to almost every other form of real property).

Thus, it is no wonder that of all forms of forgery, the counterfeiting of money
has always held the greatest attraction. So long as money exists there will also exist
a persistent demand for counterfeit money. Regardless of this attraction and de-
mand, however, there is nothing wrong with a blanket prohibition against fractional
reserve banking. No one may operate a fractional reserve bank for the same reason
that no one, in any other line of business, may engage in counterfeiting, that is, the
production and sale of titles or copies to non-existing property or originals. In a court
of law, it would be sufficient that a single money or other property owner brought suit
against a fractional reserve bank as a manufacturer of counterfeit money, and the bank
immediately would have to cease its current operation and be reduced to its two
original functions: deposits and loans. An interest-yielding (rather than fee-charging)
deposit bank is a contradiction in terms: it is a counterfeiting money warehouser,


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34 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

and must be outlawed, irrespective of any benefits accruing to bank depositors,
borrowers, and owners. To do so is not a restriction on freedom of contract in the
market for banking services, but the requirement of lawful money and banking.
Everyone putting money or other resources into interest-yielding deposit accounts
is engaged in undue and unlawful appropriation.!3

The relationship between states and fractional reserve banks is even more
intimate, and in any case quite different from that suggested by Selgin and White.
They claim that it would be an illegitimate interference with the operation of free
markets if the state were to prohibit fractional reserve banking. In fact, fractional
reserve banking is the result of an illegitimate state interference with the market, and
prohibiting it would only repair this earlier intervention. Selgin and White recognize
- that in the evolution of a free banking system, 100 percent reserve deposit banking
and, functionally separated, loan banking, must (praxeologically) precede frac-
tional reserve banking. In their view, fractional reserve banking is the natural
outgrowth of an earlier 100 percent reserve system. However, they do not offer an
explanation for this transition as a natural solution to a problem that cannot be
solved under the prior system of 100 percent banking (in the way that Austrians
conceive of money as the natural solution to the problem of lacking coincidences
of wants under a preceding barter system). They merely affirm that the transition
actually occurred.

While one can easily see why and how a banker might want to take advantage
of the possibilities of counterfeiting, it is just as clear that any such attempt would
not go by without quickly and continually being challenged. Surely the current
writers and thousands of earlier legal and economic theorists would have accused
fractional reserve banks of counterfeiting and would have brought suit against them.
The further course of banking evolution would then depend on a court decision. if the
court decided that the issue of fiduciary media qua titles to money uncovered by money
constitutes counterfeiting, fractional reserve banks would not come into existence; and
only if it decided otherwise would they ever actually appear. Nothing in this evolution
is natural; everything appears rather deliberate. Nor would the outcome of such trials
naturally be to Selgin and White's liking. To the contrary, if one were to assume that
fractional reserve bankers would be tried on counterfeiting charges before a jury of
their own peers (of other businessmen), we dare say that, empirically, the over-
whelming number of such cases would end in conviction (the testimony of Selgin
and White notwithstanding). Why, then, the almost complete dominance of frac-
tional reserve banking?

13Explains Rothbard (1995, p. 77):

The champions of free competition in counterfeiting retort that this is simply the
market at work, that the market registers a “demand” for more expanded credit,
and that the private bankers, those Kirznerian entrepreneurs, are simply “alert” to
such market demands. Well, of course, there is always a “demand” for fraud, and
embezzlement, on the market, and there will always be plenty of “alert” swin-
dlers who are eager and willing to furnish a supply of these items. But if we define
the “market” not simply as a supply of desired goods and services, but as a supply
of such goods within a framework of inviolate property rights, then we see a very
different picture.


===== PAGE 17 =====

AGAINST FIDUCIARY MEDIA 35

The answer is that the courts deciding these matters everywhere are state courts. Only
if a single court possesses a territorial monopoly of jurisdiction is it possible that the
dispute at hand could be settled once and for all. And that it has been uniformly settled
in the way it was, that is, by permitting rather than prohibiting fractional reserve
banking, follows from the interest of every court and judge qua state court and state
judge. The owners and agents of the state recognize fully as much as bankers the
potentials of money counterfeiting as a source of income. In permitting bankers to issue
fiduciary media (rather than prohibiting the practice as counterfeiting), banks are made
existentially dependent on the state. They can only operate because the state, due to its
territorial monopoly of jurisdiction, shields them from counterfeiting suits; and the state
does so only under the provision that banks will share with it in the extra revenue and
credit derived from legalized counterfeiting. Hence, by permitting fractional reserve
free banking the state actually creates the first and preliminary form of a joint-bank-
state-counterfeiting cartel under its own ultimate control.

Once fractional reserve banking receives blanket protection from the state, it
follows naturally that fractional reserve banks will outcompete 100 percent reserve
banks. Not, as Selgin and White assert (pp. 97-98), because they are better or more
efficient banks, but for the reason that, once money counterfeiting is permitted, banks
that engage in ittend to outcompete banks that do not. That is, for the same reason that,
once industrial air pollution is permitted a polluting steel producer will tend to outcom-
pete a steel producer who does not pollute, and for the same reason that a protection
agency with taxing powers, a state, will tend to outcompete protectors without taxing
power. Put differently, it is not always the case that good drives out bad. This is the case
only so long as private property-rights are inviolate. If they are not, and there exist
privileged agents or agencies, who are exempt from the universal rules regarding the
appropriation, production and transfer of property, then these will tend to outcompete
other normal agents. In this case, bad drives out good. Thus, it is completely mistaken
to interpret the empirical success of fractional reserve banking as proof of its greater
economic efficiency. The success of fractional over 100 percent deposit banking is no
more a market phenomenon than is the success of tax-yielding protectors, states, over
competitive and non-taxing security producers. It is false to suggest, as Selgin and
White do, that fractional reserve banking has stood the market test and represents the
outcome of voluntary consumer choices. After all, 100 percent reserve deposit banking
is not outlawed and consumers are free to bank with them instead of fractional banks if
they so prefer. Or would they likewise argue that the polluting steel producer had stood
the test of the market because, after all, consumers are free to buy their steel from
non-polluting steel producers, or that states have proven themselves in the market
because, after all, consumers are free to buy their security also from agencies without
any tax and jurisdictional powers?

14A similar confusion characterizes Selgin and White's view on the relationship between
money proper (gold) and banknotes. They criticize Hoppe for claiming that, in a genuine free-
market order, most people would use money proper rather than banknotes (without mentioning
Hoppe's theoretical reason). “The facts,” they claim, “are otherwise” (p. 99). Yet these facts—the
historical success of the banknote over genuine money—are the result of an earlier state interfer-
ence with private-property rights (the legalization of fractional reserve banking). As Mises (1966,
pp. 438, 442,447) noted,


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36 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

Moreover, whereas 100 percent reserve banking is crisis-proof, fractional reserve
banking, as even Selgin and White admit, is not. In fact, as we can only briefly indicate
here, a system of free fractional reserve banking will, in accordance with Mises’s theory
of interventionism, lead to further state interventions and the successive devolution of
money. Free fractional reserve banking qua state-protected competition in counterfeit-
ing will lead to a steady contest among banks of testing the viability of increasingly
lower reserve ratios. This is bound to lead to banking crises, and these will be used by
governments for the introduction of central banking. Central banking leads to still more
counterfeiting, and to the abolition of commodity money and adoption of national fiat
currencies. Lastly, international—inter-central bank—competition in fiat money coun-
terfeiting will lead to state bankruptcies, and their financial default will be used by the
most powerful among the surviving states for the establishment of a one-world govern-
ment, central bank, and fiat currency.

Hence, the solution proposed by Selgin and White to the current monetary
disorder, that is, a gold-based free—fractional reserve—banking system, is in fact
the initial interventionist cause of virtually all contemporary monetary problems.

the truth is that, except for small groups of businessmen who were able to distinguish be-
tween good and bad banks, banknotes were always looked upon with distrust. It was the
special charters which governments granted to privileged banks that slowly made these
suspicions disappear.

In [governments’] eyes the foremost task of the banks was to lend money to the treasury.
The money-substitutes were favorably considered as pace-makers for government-is-
sued paper money. The convertible banknote was merely a first step on the way to the
nonredeemable banknote. With the progress of statolatry and the policy of intervention-
ism these ideas have become general and are no longer questioned by anybody.

Governments did not foster the use of banknotes in order to avoid inconvenience to la-
dies shopping. Their idea was to lower the rate of interest and to open a source of cheap
credit to theirtreasuries. In their eyes the increase in the quantity of fiduciary media was
a means of promoting welfare. Banknotes are not indispensable. All the economic
achievements of capitalism would have been accomplished if they had never existed.

Accordingly, Mises’s view regarding sound money is completely different from Selgin and
White's. Whereas the latter believe that gold would—and should—ultimately disappear from
circulation altogether (see note 3 above), Mises (1978, pp. 450-51) considered it a require-
ment of a sound monetary system that “gold must be in the cash holdings of everybody. Every-
body must see gold coins changing hand, must be used to having gold coins in his pockets, to
receiving gold coins when he cashes his pay check, and to spending gold coins when he buys in
a store.”

>On the relationship between state, money and banking, and political centralization see
Hoppe (1990) and Hiilsmann (1997). Selgin and White argue:

We also rejectthe notion . . . that competitive banks issuing redeemable liabilities can
create credit “out of thin air.” By the nature of the balance sheet, all bank loans must be
funded by liabilities or equity. Neither source of funds can be conjured out of thin air. No
one is forced to hold a bank’s redeemable liabilities or to buy its shares; anyone can hold
claims on other banks instead, or on no bank. A competitive bank must therefore expend
real resources to attract a clientele by the provision of interest and services. The notion
that a bank can extend credit gratuitously is valid only with respect to the inframarginal
credits of amonopoly bank, or to the issuer of a forced tender; it does not apply to a bank
in a competitive system. (p. 94, n. 13)

Thus competition will beat down the returns to capital invested in fractional reserve
banking until the marginal bank is earning only the normal rate of return. (p. 97)


===== PAGE 19 =====

AGAINST FIDUCIARY MEDIA 37

THE POSITIVE ECONOMICS OF FIDUCIARY MEDIA:
MONEY BALANCE, PRICE ADJUSTMENT, SAVING, AND INVESTMENT

From the nature of fiduciary media—as titles to non-existing quantities of money
property (gold), titles to money covered by things other than money, or plain
counterfeit money—it would seem to follow that fractional reserve banking
cannot possibly effect anything but a continual wealth and income redistribution.
As the uncovered money substitutes ripple from the issuing bank and its borrower
clientele outward through the economy, and thereby successively raise the price
of increasingly more goods, real wealth (property) is transferred and redistributed
in favor of the issuing bank and the initial and early recipients and sellers of this
money, and at the expense of its late or never receivers and sellers. Explains
Rothbard (1993, p. 851),

the first receivers of the new money gain the most, the next gain slightly less, etc., until
the midpointis reached, and then each receiver loses more and more as he waits for the
new money. For the firstindividuals’ selling prices soar while buying prices remain al-
most the same; but later, buying prices have risen while selling prices remain un-
changed.

However, according to Selgin and White, fiduciary media can accomplish far
more. Rather than only redistributing existing property, the issue of fiduciary media
can, under certain conditions, lead to an increase in real wealth (property). We have
already quoted them stating that “benefits accrue to bank borrowers who enjoy a
more ample supply of intermediate credit, and to everyone who works with the
economy’s consequently larger stock of capital equipment.” They refrain from
putting it this bluntly, yet what they claim is that, under specific circumstances, an

While we have no difficulty accepting the distinction drawn here between competitive and mo-
nopolistic banking, none of this has any bearing on the issue at hand, that is, the validity of the
analogy between states and fractional reserve banks as outlaw organizations. For one, states to
compete for clients (residents). Indeed, competition between states (or banks) for clients only
comes to a complete halt with the establishment of a single world state (or central bank). And the
intra-state competition between fractional reserve banks is, as explained, competition within a
state-privileged industry, that is, monopolistic competition (just as inter-state competition is an ex-
ample of monopolistic competition). Second and more importantly, the difference between com-
petitive and monopolistic banks (or states), interesting as it may otherwise be, does not affect inthe
slightest their common characteristic as fractional reserve banks (or states). Counterfeiting and
taxation do not change their nature because they are undertaken competitively.

The error can be revealed by analogy. Selgin and White are paraphrased here: We also reject
the notion that competitive states issuing tax liabilities can create taxes out of thin air. By the nature
of state budgets, all expenditures must be funded by conquest, robbery, or theft. Neither source of
funds can be conjured out of thin air. No one is forced to hold any particular state’s tax liabilities or
buy its shares; anyone can move and pay taxes to another state, or to no state. A competitive state
must therefore expend real resources to attract a clientele by the provision of protection and services.
The notion that a state can increase taxes gratuitously is valid only with respect to the inframarginal
taxes of a monopoly state; it does not apply to a state in a competitive system. Thus, competition
will beat down the returns to capital invested in states until the marginal state is earning only the
normal rate of return.

According to Selgin and White, it would seem to follow that taxation (like money counterfeit-
ing) is not to be considered a problem until the arrival of a single world monopoly bank. Up until
then, under competitive conditions, taxes represent nothing but a normal market income.


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38 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

increase of titles to an unchanged fund of goods will somehow make this fund grow
or prevent it from shrinking.

When and how can such a miracle be accomplished? According to Selgin and
White, (unanticipated) changes in the demand for money lead to “temporary” or
“short-run monetary disequilibrium” involving “serious misallocations of re-
sources”—that is, unless such changes are accommodated by fractional reserve
banking practices (p. 101). They write:

In the long run, nominal prices will adjust to equate supply and demand for money balances,
whatever the nominal quantity of money. It does not follow, however, that each and every
change inthe supply of or demand for money will lead at once to a new long-run equilibrium,
because the required price adjustments take time. They take time because not all agents are
instantly and perfectly aware of changes in the money stock or money demand, and because
some prices are costly to adjust and therefore “sticky.” It follows that, inthe short-run (empiri-
cally, think “for a number of months”), less than fully anticipated changes to the supply
of or demand for money can give rise to monetary disequilibrium... . . Itistherefore an at-
tractive feature of free banking with fractional reserves that the nominal quantity of bank-
issued money tends to adjust so as to offset changes in the velocity of money. (pp. 100-1)

If the banking system fails to increase the quantity of bank-issued money and the price
level does not promptly drop, an excess demand for money arises (assuming also that the
quantity of base money does notimmediately increase). A corresponding excess supply
of goods arises: unsold consumer goods pile up on sellers’ shelves (this is of course what
proximately puts downward pressure on prices, until at last goods prices have fallen suffi-
ciently). Business is depressed until the purchasing power of money gets back to equilib-
rium. (p. 105)16

From the outset, one must wonder about the very existence of the problem of
monetary disequilibrium (not to speak yet about the solution). In the just-given quote,
one can substitute any other good for money: televisions, steel, beer, or pretzels. The
quantities of goods such as these are also rigidly fixed (as is the quantity of gold),
and yet (unanticipated) changes in the demand for televisions, steel, beer, or
pretzels do not lead to temporary disequilibria involving serious misallocations of
resources. Or, in any case, they do not cause problems that would require the
invention of a special new device (such as fractional television or beer production).

164s Roger Garrision, another fractional reserve free banker, has put it, “in terms of the equa-
tion of exchange [MV=PQ)], we can say that free banking adjusts so as to offset changes in V; butM
allows changes in Q to be accomodated by changes in P.” Garrison (1996, pp. 117-18) describes
the short-run “monetary disequilibrium” in almost identical form:

An increase in the demand for money puts downward pressure on product and factor
prices in general. If there were no money-supply response, a general decline in eco-
nomic activity would follow, since prices and wages could not fully and instantaneously
adjust themselves to the new market conditions. Goods in general would go unsold; pro-
duction would be cut; workers would be laid off. . . . With a less-than-perfectly flexible
price system, general deflationary pressures can push the economy below its potential
during the period in which prices are adjusting to the higher monetary demand. And the
fact that some prices and some wages are more flexible than others means that the adjust-
ment period will involve changes in relative prices that reflect no changes in relative
scarcities. These are precisely the kinds of problems. . . avoided by free banking’s re-
sponsiveness to increases in money demand.


===== PAGE 21 =====

AGAINST FIDUCIARY MEDIA 39

Nor is it clear why we are supposed to believe that “it is important to distinguish
between short-run and long-run implications of changes in the demand schedule
for money or in the stock of money” (p. 100), or, in any case, why this distinction
should be of different importance or significance in the case of money from that of
everything else. To be sure, it takes time before an unexpected increase in the
demand for televisions and beer, for instance, will have exhausted all of its effects
~ on the system of relative prices and a new adjusted production structure will have
been established. But this does not mean that price adjustments take any time
(meanwhile causing short-run problems). To the contrary, price adjustments occur
immediately and without any delay. Every change in the supply of or demand for
anything affects prices instantly. This fact is overlooked because of an un-Austrian
concern for macroeconomic artifacts such as the general price level, long-run equilib-
rium, and the velocity of money. However, viewed from the proper individualist
perspective, there can be no doubt about the immediacy of price adjustments and
the praxeological integration of the short and the long run.

In individualistic terms, an increased demand for money is the result of the
purposeful actions of individuals, that is people intent upon increasing their indi-
vidual cash balances. To do so, a person must restrict his purchases and/or increase
his sales. In either case, the outcome is an immediate fall of some prices. As the
result of restricting one’s purchases of x, y, or z, the money price of x, y, or z will be
lowered immediately (as compared with what it would have been otherwise), and
likewise, by increasing one’s sales of a, b, or c their prices will fall instantly. No one
is concerned about the general price level or the generalized purchasing power of
money. Instead, everyone is always concerned about specific prices and the pur-
chasing power of money regarding specific items (and everyone is interested in his
very own and different specific array of prices and purchasing power). In restricting
his specific purchases and/or increasing his specific sales, each actor accomplishes
exactly and immediately what he wants: certain prices that he deems too high are
lowered, the purchasing power of a unit of money increases, the real value of his
cash balance rises, and his demand for and supply of money is immediately brought
back into equilibrium (and he wishes to hold neither more nor less money than he
actually does).’’

The adjustment of the praxeologically meaningless general price level necessitated
by an increased demand for money is nothing but the summation of a series of countless
immediate and purposeful individual cash-balance adjustments. If the increased de-
mand for money is accommodated by the issue of fiduciary media, as Selgin and White

"Thus writes Mises (1990, p. 61):

Buyers and sellers on the market never concern themselves with the elements in
the equation of exchange, of which two—velocity of circulation and the price
level—do not even exist before market parties act and the other two—the quan-
tity of money (in the whole economy) and the sum of transactions—could not
possibly be known to the parties in the market. Only the importance which the
various actors in the market attach, on the one hand, to the maintenance of a cash
balance of a certain magnitude and, on the other hand, to the ownership of the
various goods in question determines the formation of the exchange relationship
between money and goods.


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40 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

advocate, this adjustment process will not be facilitated but delayed.'® The speed of the
adjustment of prices depends on the market-participants’ expectations concerning
the given quantity of money. If it is reasonable to assume that fractional reserve
banks will increase their fiduciary issues in response to an unanticipated increase
in the demand for money, then the adjustment will take moretime. Production would
adjust and begin earlier without the additional influence of inflation."

Moreover, the proposed solution to the alleged problem of short-run monetary
disequilibrium displays a fundamental confusion regarding the concept of demand
(and supply), and the relationship between the demand for money, saving, and invest-
ment in particular. First, an increased demand for money (as for televisions, beer, or
pretzels) is not just a wish to have more money (or televisions, beer, etc.), but effective
demand. That is, an increased demand for money (as for anything else) can be satisfied
only if the demander is willing to increase his market-supply of and/or reduce his
demand for something else. Likewise, the supplier (seller) of money can only increase his
supply of money if he reduces simultaneously the supply of (or his reservation demand
for) something else. The authors have overlooked Say’s law: all goods (property) are
bought with other goods, no one can demand anything without supplying something
else, and no one can demand or supply more of anything unless he demands or supplies
less of something else. But this is here not the case whenever a fiduciary note is supplied
and demanded. The increased demand for money is satisfied without the demander
demanding, and without the supplier supplying, less of anything else. Through the issue
and sale of fiduciary media, wishes are accommodated, not effective demand.
Property is appropriated (effectively demanded) without supplying other property
in exchange. Hence, this is not a market exchange—which is governed by Say’s
law—Dbut an act of undue appropriation. Or would it be an efficient solution to the
problem of unanticipated short-run television, beer, or pretzel-shortages if televi-
sion, beer, and pretzel producers were to accommodate such increased demand

"Moreover, from an individualist perspective, the increased demand for money occurs with
specific actors at specific times and places. It is not sufficient for banks to accommodate some
abstract higher money demand by more money; rather, but the accomodation would have to
occur precisely with the correct people and locations. If this is not the case, one can hardly
speak of an accomodation but of an additional distortion. This difficulty was recognized by
the early Hayek (1935, p. 124):

in order to eliminate all monetary influences on the formation of prices, and the structure
of production, it would not be sufficient merely quantitatively to adapt the supply of
money to these changes in demand, it would be necessary also to see that it came into the
hands of those who actually require it, that is, to that part of the system where that change
in business organization or the habits of payment had taken place.

With the later Hayek, one wonders how banks could possibly have the requisite knowledge
of performing this task.

'%As regards the stickiness of prices, and the redistributive consequences of an increased
demand for money vis-a-vis an array of prices of varying degrees of stickiness, which Selgin and
White as well as Garrison raise as matters of concern, it is of utmost importance to recognize that
prices are the outcome of purposive action—and so is their stickiness. That is, the flexibility or
inflexibility of various product and service prices is not accidental to, but a deliberate part of, these
products and services. Contrary to Garrison's claim, the stickiness of prices does affect and is
related to, real relative scarcities. If more sticky prices suffer more, so to speak, so be it; that will
teach them to be less sticky in the future—if the owners of the property in question act in a manner
compatible with this end.


===== PAGE 23 =====

AGAINST FIDUCIARY MEDIA ) 41

“temporarily” by issuing and selling additional titles to televisions, beer, and pret-
zels but not these goods themselves?

Second, ?° Selgin and White further misconstrue the nature of money and the
demand for money hold extraordinary claim: that the issue of fiduciary media
“matched by an increased demand to hold fiduciary media” is not only not dise-
quilibrating (p. 102), but will actually afford the economy a “larger stock of capital
equipment,” because

the act of holding fractional-reserve bank-issued money not only (like holding base
money) defers consumption for a longer or shorter period, but also temporarily lends
fundsto the bank of issue in doing so. The period of the loan is unspecified. . . but ifthe
bank can estimate with a fair degree of accuracy the lengths of time for which its demand
claims will remain in circulation... ., it can safely make investments of corresponding
length. (p. 103)

Following the lead of Rothbard, Hoppe had criticized this essentially Keynesian
view concerning the relationship between the demand for money and savings
(loanable funds)?! by pointing out that

not-spending money is to purchase neither consumer goods norinvestment goods. . . . Indi-
viduals may employ their monetary assets in one of three ways: they can spend them on
consumer goods; they can spend them on investment; or they can keep them in the form of
cash. There are no other alternatives. . . . The consumption and investment proportion, that is,
the decision of how much to spend on consumption and how much on investment, is de-
termined by a person’s time preference, that is, the degree to which he prefers present
consumption over future consumption. On the other hand, the source of his demand for

2%The error of confusing property and titles lies also at the bottom of Selgin and White’s
attempts to separate analytically the demand for outside money from the demand for inside
money, as if these were somehow two different kinds of money with two different and inde-
pendent demands.

215elgin (1988, p. 55) stated the same thesis thus:

Whenever a bank expands its liabilities in the process of making new loans and invest-
ments, it is the holders of the liabilities who are the ultimate lenders of credit, and what
they lend are the real resources they could acquire if, instead of holding money, they
spent it. When the expansion or contraction of bank liabilities proceeds in such a way as
to be at all times in agreement with changing demands for inside money, the quantity of
real capital funds supplied to borrowers by the banks is equal to the quantity voluntarily
offered to the banks by the public. Under these conditions, banks are simply intermediar-
ies of loanable funds.

As for John Maynard Keynes (1936, p. 82) he had written in the General Theory that “the notion
that the creation of credit by banking system allows investment to take place to which ‘no genuine
saving’ corresponds” that is, “the idea that saving and investment. . . can differ from one another,
is to be explained, | think, by an optional illusion” (ibid, p. 81). “The savings that result from this
decision are just as genuine as any other savings. No one can be compelled to own the additional
money corresponding to the new bank-credit, unless he deliberately prefers to hold more more
money rather than some other form of wealth” (ibid, p. 83). Indeed, Selgin (1988, p. 59) acknow-
ledges that “many Keynesians might accept the prescription for monetary equilibrium offered [by
him]. Those who do not regard the liquidity trap as important factual possibility would probably
acceptitas entirely adequate.”

Henry Hazlitt (1983, p. 227) remarked on this Keynesian idea that “on the same reasoning we
can create any amount of new ‘savings’ we wish overnight, simply by printing that amount of new
paper money, because somebody will necessarily hold that new paper money.”


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42 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

cash is the utility attached to money, that is, the personal satisfaction derived from
money in allowing him immediate purchases of directly or indirectly serviceable con-
sumer or producer goods at uncertain future dates.

Accordingly, ifthe demand for money increases while the social stock of money is given,
this additional demand can only be satisfied by bidding down the money prices of non-
money goods. The purchasing power of money will increase, the real value of individual
cash balances will be raised, and at a higher purchasing power per unit money, the de-
mand for and the supply of money will once again be equilibrated. The relative price of
money versus non-money will have changed. But un/esstime preference is assumed to
have changed at the same time, real consumption and real investment will remain the
same as before: the additional money demand is satisfied by reducing nominal con-
sumption andinvestment spending in accordance with the same pre-existing consump-
tion and investment proportion, driving the money prices of both consumer as well as
producer goods down, and leaving real consumption and investment at precisely their
old levels. (Hoppe 1994, pp. 72-73)

Accordingly, Hoppe concluded, it is never warranted to accommodate an
increased demand for money by issuing fiduciary credit.” In fact, to do so will either
— insofar as the accommodating increase of fiduciary media is unanticipated and the
market rate of interest falls temporarily below the natural rate of interest—lead to a
boom-bust cycle; or else—insofar as the monetary change arising from the banking
system is anticipated and the market rate of interest is bid up (in the expectation of
higher selling prices) in accordance with the height of the natural rate—it will accom-
plish no more than a plain wealth and income redistribution among various members
of society. It is praxeologically impossible, however, that the issue of fiduciary
media can lead to an “enlarged stock of capital equipment.”

225ee also Hoppe (1993, pp. 119-20, 137-38); and Rothbard’s (1993, pp. 167ff, 667ff;
1983a, pp. 39ff) original argument in Man, Economy, and State.

As for Selgin and White's claim of being Misesians, itis worthwhile to quote Mises on

the role cash holding plays in the process of saving and capital accumulation. . .. ifanin-
dividual employs a sum of money not for consumption but for the purchase of factors of
production, saving is directly turned into capital accumulation. If the individual saver
employs his additional savings for increasing his cash holding because this is in his eyes
the most advantageous mode of using them, he brings about a tendency toward a fall in
commodity prices and a rise in the monetary unit's purchasing power. If we assume that
the supply of money in the market system does not change, this conduct on the part of the
saver will notdirectly influence the accumulation of capital and its employment for an
expansion of production. The effect of our saver’s saving, that is, the surplus of goods pro-
duced over goods consumed, does not disappear on account of his hoarding. The prices
of capital goods do not rise to the height they would have attained in the absence of such
hoarding. But the fact that more capital goods are available is not affected by the striving
of a number of people to increase their cash holdings. If nobody employs the goods—the
nonconsumption of which brought about the additional saving—for an expansion of his
consumptive spending, they remain as an increment in the amount of capital goods avail-
able, whatever their prices may be. The two processes—increased cash holding of some
people and increased capital accumulation—take place side by side. A drop in commod-
ity prices, other things being equal, causes a drop in the money equivalent of the various
individuals’ capital. But this is not tantamount to a reduction in the supply of capital
goods and does not require an adjustment of production activities to an alleged impover-
ishment. It merely alters the money items to be applied in monetary calculation. (Mises
1966, pp. 521-22)


===== PAGE 25 =====

AGAINST FIDUCIARY MEDIA 43

In their attempt to rebut this argument, Selgin and White first concede the
central theoretical point: “We agree that time preference and money demand are
distinct, and that a change in one does not imply a change in the other” (p. 102).
Likewise:

that holding money is one form of saving does notimply that an increase in the demand
for money is identically an increase in total saving. An increased demand for money may
accompany a reduced demand for holding other assets, and not a reduction in consump-
tion; hence it may be part of a change in the manner of saving with no change in total sav-
ings. (p. 103)

However, if an increased demand for money is not identically an increase in
total savings, then it is impossible to maintain that it provides for a larger pool of
loanable funds and increased capital formation (a lengthening of the structure of
production). Hence, to rescue their economic-growth thesis, immediately following
this concession Selgin and White try to take it back again by arguing that:

Nonetheless [the non-identity of time preference and money demand notwithstanding], to
hold money is to hold it for later spending, even though how much later is not signalled (and
typically has not yet been decided by the money holder). Holding money for later spend-
ing, rather than spending it on consumption now, does defer consumption to the future.
As Hoppe .. . himself points out, the demand for cash stems from the convenience it allows
one in purchasing “consumer or producer goods at uncertain futuredates.”. . . So perhaps our
disagreement here is merely over words. (p. 102)

Unfortunately, this suggestion is unfounded. Rather than a verbal quibble, the
disagreement is a substantive one concerning the nature of money.

It is difficult not to interpret the two previous pronouncements as contradictory.
Selgin and White try to escape from this conclusion by an ad hoc semantic shift, that
is, in characterizing money as a future good. Essentially, their argument is that while
increased money demand does not imply increased savings, it provides nonetheless
for a larger loan fund, because money is held only to be spent “at uncertain future
dates” (their emphasis), such that an increased demand for money is always and at
the same time an increase in the demand for future goods.2? Yet money is demon-
strably not a future good. In fact, when the money is spent—in the future—it loses
all its utility for the present owner. It has utility only while and insofar as it is not
spent, and its character as a present good stems from the omnipresent human
condition of uncertainty.?*

The error in classifying money as a future good can be revealed in a twofold
manner. On the one hand, negatively, it can be shown that this assumption still leads
to contradiction. In support of their thesis, Selgin and White claim that “holding

235elgin and White's view here is quite similar to that of Keynes (1936, pp. 293-94), when he
emphasized that “the importance of money essentially flows from its being a link between the
present and the future,” and characterized money as “above all, a subtle device for linking the
present and the future.”

24pyt differently: rather than, as Selgin and White say, that “the demand for money stems
from the convenience it allows one in purchasing goods at uncertain future dates,” the demand for
money stems from the convenience itallows one in purchasing goods at uncertain future dates.


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44 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

money for later spending, rather than spending it on consumption now, does defer
consumption to the future,” implying that the holding of money involves the
exchange of a future good (satisfaction) for a present one. In the next sentence they
admit that money held is spent neither on consumer goods nor on producer goods.
Yet they fail to notice that this implies also, as a further consequence, that holding
money for later spending, rather than spending it on production now, does defer
production (and hence future consumption) to the future. If the holding of money
defers consumption and production, however, then itbecomes impossible to maintain
that the holder of money has thereby invested in a future good, because there are no
future goods—whether consumer or producer goods—which result from the act of
holding money and to which its holder could thus be entitled. Yet as claims to no
future goods whatsoever, money would be worthless. By implication, if money is
not worthless (and no one would hold money if it had no value), then its value must
be that of a present good.

On the other hand, positively, the nature of money as a paradigmatically
present good can be established by praxeological proof. As Mises and Rothbard
have explained, in general equilibrium or, more appropriately, within the imaginary
construction of an evenly rotating economy, no money exists. With all uncertainties
by assumption removed, everyone would know precisely the terms, times, and
locations of all future exchanges, and all exchanges could be prearranged accord-
ingly and take the form of direct rather than indirect exchanges.

In a system without change in which there is no uncertainty whatever about the future,
nobody needs to hold cash. Every individual knows precisely what amount of money he
will need at any future date. He is therefore in a position to lend all the funds he receives
in such a way thatthe loans fall due on the date he will need them. (Mises 1966, p. 249)

While there is no place for money in the construction of an evenly rotating economy,
however, there exists within its framework a present and a future, now and later, the
beginning of an action and its later completion, immediately serviceable consumer goods
(present goods) and indirectly serviceable producer goods (future goods), a structure of
production, and savings and investment, that is, exchange of present against future goods
governed by time preference. If anything, this proves again that money and the demand
for money are systematically unrelated to consumption, production, and time prefer-
ence, and that the source of the utility of money must be a categorically different one
from that of consumer goods and producer goods. The source of the utility of a consumer
good is its direct and present serviceability, and the source of the utility of a producer good
is its indirect future serviceability. Money, by contrast, is neither consumed nor employed
in production. It is neither directly serviceable (as consumer goods are) nor indirectly
useful as a way station to future consumer goods (as producer goods are). Rather, the
utility of money must be that of an indirectly yet presently serviceable good.

Outside the imaginary construction of an evenly rotating economy, under the
inescapable human condition of uncertainty, when the terms, times, and locations of
all future exchanges cannot be predicted with certitude, and when action is by nature
speculative and subject to error, man can conceivably demand goods no longer
exclusively on account of their use-value (present or future), but also because of
their value as media of exchange (for resale purposes). Faced with situations


===== PAGE 27 =====

AGAINST FIDUCIARY MEDIA 45

where, due to the absence of double coincidences of wants, a direct exchange is
impossible, man can evaluate goods also on account of their degree of marketability,
and can consider trading whenever a good to be acquired is more marketable than that
to be surrendered, such that its possession would facilitate the acquisition of directly
or indirectly serviceable goods and services. Moreover, because it is the sole function of
a medium of exchange to facilitate purchases of directly or indirectly serviceable
goods, man will naturally prefer the acquisition of a more marketable and, at the
limit, universally marketable medium of exchange to that of a less or non-univer-
sally marketable one, such that

there would be an inevitable tendency for the less marketable of a series of goods used as
media of exchange to be one by one rejected until at last only a single commodity re-
mained, which was universally employed as a medium of exchange; in aword, money.
(Mises 1978, pp. 32-33)

Selgin and White are familiar with this Mengerian-Misesian reconstruction of
monetary evolution, of course. They apparently fail to recognize, however, that this
feature of money as the most easily and widely saleable commodity, far from
rendering it a future good, qualifies money at the same time as the good best suited
to alleviate presently felt uncertainty and, as such, the most universally present good
of all.2> Although only indirectly useful—in this regard like producer goods, and

unlike any consumer good—money is precisely on account of its supreme saleability
~ a uniquely present good—in this regard like consumer goods, and unlike any
producer good. Because money can be employed for the instant removal of the
widest range of possible needs (or the satisfaction of the widest range of possible
desires), it provides its owner with the best humanly possible protection (insurance)
against uncertainty, that is, against his uneasiness of not being able to predict—of not
being certain about—all of his future needs and desires. In holding money, its owner
gains in the satisfaction of being able instantly to meet, as they arise unpredictably, the
widest possible range of future contingencies.?® “The maintenance of cash holding

23In fact, one can only wonder how Selgin and White could have possibly overlooked
money’s character as a uniquely present good. After all, the interest rate as the most visible mani-
festation of the phenomenon of time preference is expressed in terms of money.

26The term uncertainty is employed here in its technical meaning as defined by Knight (1971,
esp. chap. 7) and Mises (1966, esp. chap. 6), that is, as categorically distinct from risk (instances of
class probability); also Hoppe (1997). Insofar as man faces a risky future, he does not need to hold
cash. In order to satisfy his desire to be protected against risks, he can instead buy (or produce)
insurance. A buyer of insurance demonstrates by his purchase that he is in fact certain about some
future events. Hence, in paying a premium, he sacrifices a present good in exchange for a future
one (payment in the event of actual risk-damage) and so contributes to and invests in a physical
structure of production. Specifically, his premium becomes embodied in the production structure
maintained by his insurance agency. In distinct contrast: insofar as man faces uncertainty he is,
quite literally, not certain concerning his future, that is, as to what will happen to him and when.
Hence, in order to be protected against uncertainty, he cannot possibly invests in any future good.
Only present goods can insure against instantly arising—unpredictable—events. Nor can he in-
vest in (present) consumer goods (for this would mean that he actually felt certain as to the specific
nature of his future contingencies). Only a medium of exchange, on account of its supreme sale-
ability, can insure him against contingencies of an uncertain nature. Hence, just as insurance is the
price that must be paid for protection against risks, so cash holdings are the price that must be paid for
protection against uncertainty. See alsothe following final note below.


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46 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

requires sacrifices. To the extent that a man keeps money in his pocket or in his
balance with a bank, he foresakes the instantaneous acquisition of goods he could
consume or employ for production” (Mises 1966, p. 430). Accordingly, to the extent
that he feels certain regarding his future, a man will want to invest in consumer and
producer goods. Only to the extent that he feels uncertain about his future will he
want to make the sacrifice referred to by Mises, that is, will he possibly want to invest
in relief from any uneasiness felt concerning the uncertainty of his future consump-
tion—production (income-expenditure) pattern. Hence, rather than indicating his in-
creased willingness to sacrifice present satisfaction in exchange for future satisfaction,
an increased demand for money demonstrates a man’s more intensely felt uncer-
tainty regarding his future; and rather than being an investment in the future, an
addition to his cash balance represents an investment in present certainty (protec-
tion) vis-a-vis a future perceived as less certain.’

In light of this praxeological reconstruction of money as a singularly present good,
Selgin and White's entire positive case for fractional reserve banking is revealed as
mistaken. If banks indeed accommodate an (unanticipated) increased demand for
money through the temporary issue of additional fiduciary media (credit), as Selgin
and White propose, this can have only disruptive and disequilibrating effects. If
and insofar as the accommodating response on the part of the banks is unanticipated,
the interest rate will be reduced temporarily below its natural height, investment will
increase, and the structure of production will be lengthened. Yet this result is funda-
mentally at odds with the public's demonstrated preference. The public perceives the
future as more (increasingly) uncertain and, accordingly, in striving to increase the size
of its cash holdings and thereby bidding the prices of non-money goods down and
correspondingly increasing the purchasing power per unit money, is intent upon
providing for more (increased) present protection against uncertainty. To commit
additional resources to the future is the expression of less public uncertainty (rather
than more), and thus stands at cross-purpose to the public's actual wishes and
implies a systematic misallocation of resources (to be revealed in a boom-bust
cycle). And in any case, even if the banks’ accommodating money supply increase
could be fully anticipated and the structure of production were not unduly length-
ened, any such accommodation would still be disruptive, because—even apart
from its inescapable redistributionist consequences—it can only delay the arrival of

#’Selgin and White never raise the question of why changes in the demand for money occur,
and thus never penetrate to their ultimate—microeconomic—sources, that is, changes in indi-
viduals’ subjective evaluations of presently perceived personal uncertainty. In contrast, whereas
they portray changes in the demand for money as seemingly unmotivated and inexplicable
events, Mises is explicitand emphatic about their rational character:

The advantages and disadvantages derived from cash holding are not objective factors
which could directly influence the size of cash holdings. They are put on the scales by
each individual and weighed against one another. The result is a subjective judgment of
value, colored by the individual's personality. Different people and the same people at
different times value the same objective facts in a different way. Just as knowledge of a
man’s wealth and his physical condition does not tell us how much he would be pre-
pared to spend for food of a certain nutritive power, so knowledge about data concerning
aman’s material situation does not enable us to make definite assertions with regard to
the size of his cash holding. (Mises 1966, p. 430)


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AGAINST FIDUCIARY MEDIA 47

the desired goal. In order to be better protected against perceived uncertainty, prices
must fall and the purchasing power of money must rise. With an additional influx
of money, it cannot but take longer before this goal is accomplished.?8

A FINAL NOTE: SOME MISTAKEN ANALOGIES

In light of the fundamental distinction between property (money) and property titles
(money substitutes) explained in earlier sections of this article and the foregoing
elucidation of money as a uniquely present good, several analogies popularly
employed in the attempted justification of fractional reserve banking can be finally
disposed of as mistaken. Even if they correctly distinguish between property titles
(tickets) and property, all proposed analogies—between fractional reserve banking
on the one hand and airline overbooking, fractional reserve parking lots, lotteries,
and insurance on the other hand—fail to recognize properly the fundamental
distinction between present and future goods.

The owner of a title to money owns a present good (money property)—an
indirectly yet immediately serviceable good. The fractional reserve banker is found
guilty of fraud; he issued and sold additional titles to an unchanged quantity of
money property. In distinct contrast; the owner of an airline ticket owns a future
good. Hence, in overbooking now (today) a flight at a future date (tomorrow), an
airline cannot possibly have committed fraud already now (today). Fraud cannot
occur until tomorrow, when the tickets must be actually redeemed, and only if the
airline is then unable to satisfy each and every ticket holder's claim. In fact, airlines
typically fulfill their contractual obligation: each ticket holder is assured a seat on
the scheduled flight, because the airline is prepared to pay every excess ticket
holder off, that is, to repurchase his ticket at a price (by exchange of another good)
that the holder considers more valuable than his present airline seat. And certainly,
no airline typically oversells spot-tickets (titles to seats right now, that is, present

28Mises summarizes:

The services money renders are conditioned by the height of its purchasing power.
Nobody wants to have in his cash holding a definite number of pieces of money or a
definite weight of money; he wants to keep a cash holding of a definite amount of pur-
chasing power. As the operation of the market tends to determine the final state of
money’s purchasing power at a height at which the supply of and the demand for
money coincide, there can never be an excess or a deficiency of money. Each individ-
ual and all individuals together always enjoy fully the advantages which they can de-
sire from indirect exchange and the use of money, no matter whether the total quan-
tity of money is great or small. Changes in money's purchasing power generate
changes in the disposition of wealth among the various members of society. From the
point of view of people eager to be enriched by such changes, the supply of money
may be called insufficient or excessive, and the appetite for such gains may result in
policies designed to bring about cash-induced alterations in purchasing power.
However, the services which money renders can be neither improved nor repaired by
changing the supply of money. There may appear an excess or a deficiency of
money in an individual's cash holding. But such a condition can be remedied by in-
creasing or decreasing consumption or investment. (Of course, one must not fall prey
to the popular confusion between the demand for money for cash holding and the
appetite for more wealth.) The quantity of money available in the whole economy
is always sufficient to secure for everybody all that money does and can do.
(Mises 1966, p. 421)


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48 THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS VOL. 1, NO. 1 (1998)

goods) and assigns two people to occupy the same seat, which is essentially what
fractional reserve banking amounts to.

Similarly, the owner of a fractionally covered parking permit (with more permit
holders than parking spaces) does not own a present good. He owns the right to
participate for a specified period of time in repeated search for parking space. The
owner of the parking facility cannot possibly commit any fraud in selling his permits,
unless he then refused entry to a valid permit holder when there was empty space
available, or if he changed the contractually agreed upon rules of the game; that is,
if he had agreed to print up to a maximum of 200 permits, for instance, but actually
printed 300. It is only the owner of a spot parking ticket, or the owner of a reserved
parking space, who are owners of a present good; and there is, of course, charac-
teristically no overselling of spot spaces or of reserved parking.

The same reasoning applies to the case of lotteries. The holder of a lottery ticket
does not own any present good. He owns the right to participate in the drawing of
specified prizes, whereby it is self-understood among buyer and seller—as inherent
in the nature of a lottery—that there are—and must be—more tickets than prizes.
The lottery operator cannot possibly have committed any crime, unless he failed to
redeem the winning tickets into the promised prizes or surreptitiously changed the
preannounced rules of the game. If this is rarely the case, it is practically unheard
of that a lottery would print more than one winning ticket for one and the same prize
(present good), which would be likewise fraudulent, of course, and which is
essentially what fractional reserve bankers do.

Finally, the proposed analogy between fractional reserve banking and insur-
ance has already been refuted implicitly in note 26 above, concerning the relation-
ship between risk and insurance on the one hand and uncertainty and money on
the other. Unlike the owner of money, the owner of an insurance policy does not
own a present but a future good. An insurance company may be unable to meet its
contractually assumed obligations at some future pointin time, and one may then come
to the conclusion that it had engaged in an overselling of tickets. However, it is
impossible to say that a crime has been already committed now, at the moment when
the insurance policy is sold, because the good sold by the insurance agency is a future
one. In distinct contrast, the owner of a money ticket is the owner of a present good,
and every overissue of tickets to present goods is from the very outset—instantly and
immediately—fraudulent, and accordingly is contrary to market ethics.

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