Let us imagine two farmers: Bill and Steve.
They freely make and both agree to the following contract:
(1) Bill lends Steve a chicken as a loan for consumption (or, in legal language, a mutuum loan). Both parties agree that Steve becomes owner of the chicken. Steve can “consume” the chicken by eating it, or can even resell it to someone else.So what is wrong with this contract?
(2) Bill says to Steve: “Steve, I know you keep a reserve stock of chickens – since you are a farmer – so I want to call back this ‘chicken debt’ (that is, make you repay the debt by another chicken, a tantundem chicken of the same quality and age) on demand at some time this year, but I don't know precisely when. Is that alright?”
Steve says: “Bill, that is perfectly alright, I accept these terms completely and freely. I will repay on demand the ‘chicken debt’ I owe you.”
If the opponents of fractional reserve banking can find nothing wrong with it legally, economically or morally, then all we have to do now is substitute money for chickens to see how a mutuum loan of money, callable on demand, must also be acceptable.
It is only a few further steps to see that there can be nothing wrong with fractional reserve banking (FRB) either (assuming for the sake of argument that all parties understand the terms of the contract), for FRB operates on the very same principles.
One might object that many holders of demand deposits or FR transactions accounts these days do not understand that the bank becomes owner of their money, but this is a very different objection from the usual ignorant arguments offered by anti-FRB Austrians (and I have addressed the issue of public ignorance of FRB here).
Normally, the main arguments against FRB put forward by the big name Austrians (e.g., Mises, Rothbard, Hoppe) consistent of the following:
(1) ignorant inability to understand that banknotes (or fiduciary notes) are debt instruments, not property titles.
(2) similar ignorant inability to understand that the “demand deposit” is also nothing but a debt instrument on the bank’s books, not a depositum or bailment. A demand deposit is never a bailment. Thus it is not the case that two property titles to the money exist: the bank becomes the owner of the money, and the FR client is simply a lender, with a debt owed to him by the bank.