“It is usual to reckon the acceptance of a deposit which can be drawn upon at any time by means of notes or cheques as a type of credit transaction and juristically this view is, of course, justified; but economically, the case is not one of a credit transaction. If credit in the economic sense means the exchange of a present good or a present service against a future good or a future service, then it is hardly possible to include the transactions in question under the conception of credit. 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 the money in no way means that he has renounced immediate disposal over the utility it commands.” (Mises 2009: 269).Let us review these arguments:
(1) Mises concedes that in legal terms (“juristically”) fractional reserve accounts are debt instruments. There are some anti-fractional reserve banking Austrians who do not even acknowledge that.
(2) Mises defines “credit” in the economic sense as the “exchange of a present good or a present service against a future good or a future service.” In the case of money lending, this (curiously) leads quite obviously to a monetary theory of the interest rate: interest is the return for giving up present money (conceived as a good) against future money. Yet there are few Austrians who hold a monetary theory of the interest rate. The only one I can think of is Robert P. Murphy, who concludes that interest is “quite simply the price of borrowing money or (what is the same thing) the exchange rate of present versus future money units” (Murphy 2003: 176).
(3) The assertion that 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” is false. Clients who open fractional reserve bank accounts lend money to a bank, and frequently leave large amounts of money of their account unused and do not call the money/debt back. Such clients do in fact regularly give up the present goods that could be purchased with money or (historically) the holding of commodity money proper that can be considered a good. Even in the case of fiat money, fractional reserve clients give up present goods that could be purchased with money.
(4) The future good that fractional reserve clients receive back when calling in their loan is money from the reserves of the bank, which represent idle money from which the fractional reserve clients are repaid their debts.
(5) Mises asserts that the “claim that he has acquired by his deposit is also a present good for him.” That is false, because the debt instrument that is the fractional reserve bank account requires the calling back of the money in order to obtain actual money proper (whether this is commodity money or, in a fiat money system, cash or the reserves of the bank). In a commodity money system, the use of fiduciary media such as a private banknote as a means of payment or medium of exchange is the use, not of money proper, but of debt instruments or IOUs as a means of payment. Whether agents wish to accept debt instruments as a means of payment for goods and services is a matter for voluntary exchange. If the use of debt as a means of payment – or the expansion of such IOUs or debt instruments acceptable as a means of payment – were invalid or immoral, vast numbers of free and voluntary transactions would be immoral. The assertion that debt or IOUs callable on demand into money proper (or whatever is used as the monetary base such as the obligations of the central bank in modern fiat systems) cannot function as money is plainly false, on both theoretical and empirical grounds. The use of IOUs or debts as money has a very long history, and this may even have been the origin of money, as many anthropologists and historians of money have concluded (Graeber 2011; Hudson 2004; Ingham 2000). Most recently, the credit origins of money have been emphasised by the anthropologist David Graeber. Let us quote from this interview with Graeber on the origin of money:
“Philip Pilkington: … Most economists claim that money was invented to replace the barter system. But you’ve found something quite different, am I correct?There is clear evidence that IOUs and debts became transferable and used widely as a medium of exchange in many ancient societies. Debt has functioned as money for thousands of years. The fractional reserve banknote or account is merely a modern form of such IOU/debt money.
David Graeber: Yes there’s a standard story we’re all taught, a ‘once upon a time’ — it’s a fairy tale.
It really deserves no other introduction: according to this theory all transactions were by barter. “Tell you what, I’ll give you twenty chickens for that cow.” Or three arrow-heads for that beaver pelt or what-have-you. This created inconveniences, because maybe your neighbor doesn’t need chickens right now, so you have to invent money.
The story goes back at least to Adam Smith and in its own way it’s the founding myth of economics. Now, I’m an anthropologist and we anthropologists have long known this is a myth simply because if there were places where everyday transactions took the form of: “I’ll give you twenty chickens for that cow,” we’d have found one or two by now. After all people have been looking since 1776, when the Wealth of Nations first came out. But if you think about it for just a second, it’s hardly surprising that we haven’t found anything.
Think about what they’re saying here – basically: that a bunch of Neolithic farmers in a village somewhere, or Native Americans or whatever, will be engaging in transactions only through the spot trade. So, if your neighbor doesn’t have what you want right now, no big deal. Obviously what would really happen, and this is what anthropologists observe when neighbors do engage in something like exchange with each other, if you want your neighbor’s cow, you’d say, “wow, nice cow” and he’d say “you like it? Take it!” – and now you owe him one. … So the real question is not how does barter generate some sort of medium of exchange, that then becomes money, but rather, how does that broad sense of ‘I owe you one’ turn into a precise system of measurement – that is: money as a unit of account?
By the time the curtain goes up on the historical record in ancient Mesopotamia, around 3200 BC, it’s already happened. There’s an elaborate system of money of account and complex credit systems. (Money as medium of exchange or as a standardized circulating units of gold, silver, bronze or whatever, only comes much later.)
So really, rather than the standard story – first there’s barter, then money, then finally credit comes out of that – if anything its precisely the other way around. Credit and debt comes first, then coinage emerges thousands of years later and then, when you do find “I’ll give you twenty chickens for that cow” type of barter systems, it’s usually when there used to be cash markets, but for some reason – as in Russia, for example, in 1998 – the currency collapses or disappears [see Humphrey 1984 – LK].”
“What is Debt? – An Interview with Economic Anthropologist David Graeber,” August 26, 2011.
(6) In a term/time deposit with a callable option, the client can also call their loan back, though usually with some penalty such as the loss of the interest or some small part of the principal. But this process of calling back a loan with a callable option is in principle no different from the fractional reserve demand deposit client calling back some or all of his loan: yet many Austrians do not deny that time deposits of this type involve an exchange of present goods for future goods. What is most interesting is that the most extreme anti-fractional reserve banking Austrians like Jesus Huerta de Soto, Walter Block and William Barnett are driven to positions that do in fact require an outright ban on all callable loans (see here and here; see also Block and Barnett 2009).
(7) Mises asserts that:
“The claim that he has acquired by his deposit is also a present good for him. The depositing of the money in no way means that he has renounced immediate disposal over the utility it commands.”The first sentence merely begs the question. And when a fractional reserve client gives over money to his bank as a loan, he has in fact renounced “immediate disposal over the utility it commands,” because in a commodity money world he must use private bank notes that are mere debt instruments (which might in fact be refused and rejected as a means of payment), and go to the trouble of converting his debt claim into money proper by withdrawal of cash or use of checks. Even in a fiat money world, your bank cheque may be refused, you must withdraw cash or use electronic transfer to call back your debt and make payment for goods: you have certainly renounced “immediate disposal over the utility” that actual money or cash in hand commands. As Rozeff argues:
“Mises’s second incorrect claim is that ‘[t]he depositing of the money in no way means that [the depositor] has renounced immediate disposal over the utility that it commands.’ Because the depositor cannot be sure of getting his money back and because he is exchanging it for a different good with different utility, which is why he makes the deposit in the first place, he obviously has renounced any utility that arises from immediately spending the deposit. He has exchanged it for utility arising from a deferred claim to funds plus whatever else in the rearrangement provides him with utility, such as checking services, storage, and interest.” (Rozeff 2010: 509).BIBLIOGRAPHY
Block, W. E. and W. Barnett, 2009. “Time Deposits, Dimensions and Fraud,” Journal of Business Ethics 88.4: 711–716.
Graeber, David. 2011. Debt: The First 5,000 Years, Melville House, Brooklyn, N.Y.
Hudson, A. M. 2004. “The Archaeology of Money,” in L. R. Wray (ed.), Credit and State Theories of Money, Edward Elgar, Cheltenham. 99–127.
Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala
Humphrey, C. 1984. “Barter and Economic Disintegration,” Man n.s. 20.1: 48–72.
Ingham, G. 2000. “‘Babylonian Madness’: on the Historical and Sociological Origins of Money,” in J. Smithin (ed.), What is Money? , Routledge, London and New York. 16–41.
Mises, L. von, 2009 . The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.
Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.
Rozeff, M. S. 2010. “Rothbard on Fractional Reserve Banking: A Critique,” Independent Review 14.4 (Spring): 497–512.
Rothbard, M. N. 1974. The Case for a 100 Percent Gold Dollar. Ludwig von Mises Institute, Auburn, Ala.
Rothbard, M. N. 2009. Man, Economy, and State: A Treatise on Economic Principles (2nd edn.), Ludwig von Mises Institute, Auburn, Ala.
Salerno, Joseph. 2009. “White and Horwitz on Hoppe,” Mises.org, May 18