Monday, July 30, 2018

Robert P. Murphy on Rothbardians versus Free Bankers

Robert P. Murphy recently gave a talk on fractional reserve banking and free banking:

Listening to this video really brings home what a lame cult of losers American libertarians actually are.

Murphy repeats the same tired lies about fractional reserve banking we have all heard before: e.g., that a demand deposit involves two entities (the bank and depositor) owning the same money (when this is a blatant falsehood), and the fake legal history of fractional reserve banking peddled by Rothbard and Huerta de Soto.

A bank is, by nature, an institution that borrows money from “depositors” (a misleading word) by means of the mutuum contract, so that the bank becomes the legal owner of all money “deposited.” The bank client legally forfeits all property rights in the money. In return, the bank customer becomes a creditor to the bank and receives a promise to repay the debt on demand (or whatever specific terms are used): in other words, the bank client simply receives an IOU from the bank. There is nothing fraudulent about this relationship.

The mutuum contract goes back to the ancient Roman law and banking practice, and was the basis of Western banking.

The Rothbardian charlatans failed to understand the nature of the mutuum contract and have falsified the history of fractional reserve banking (see here, here, here, here, here, here).

By creating 100% reserve banks or warehouses, Austrians like Murphy would create an inherently deflationary economy that would tank private sector investment, and cripple the endogenous money system on which capitalism relies.

On the economic consequences of fractional reserve banking, the real problem is poorly regulated financial systems that can blow asset bubbles and create excessive private debt used for speculative purposes. The solution to this is rigorous financial regulation, not abolishing fractional reserve banking.

The few decent points Murphy makes come at the end, when he points out that the claim of free bankers that Canada and Scotland had stable free banking systems is not credible. Worse still, free bankers fail to look at Australia, where free banking was a disaster.

As for free banking in Canada, this was the reality of Canada’s pre-1935 bank system:
(1) the “Canadian Bank Act of 1871” regulated banks and prohibited banks from lending on real estate, a sensible regulatory measure that is hardly in line with free banking;

(2) in 1907, the Canadian government lent $5 million in Dominion notes to the private sector banks to end a credit squeeze that threatened the agricultural sector and wider economy;

(3) the Finance Act of 1914 permitted Dominion banks to borrow notes directly from the Canadian Department of Finance with no gold-reserve requirement;

(4) the consequences of (3) were that from 1914 onwards Canada had a lender of last resort in the form of government-issued money;

(5) in 1924, the Dominion and Imperial Banks experienced runs and turned not just to other banks, but to the Department of Finance for liquidity to avert a crisis.
One can hardly speak of a free banking system when Canada had a de facto government lender of last resort from 1914.

In response to George Selgin’s comment below, there is a straightforward response: in order to test whether any particular pre-1933 – or relatively free market – banking system was better than the system I advocate, you need to compare the latter with the period from c. 1945 to the early 1970s, when the finance sector in the Western world was (generally) subject to effective financial regulation. In this period, there were hardly any financial crises, serious asset bubbles largely absent, and the banking sector much more stable than the more laissez-faire periods that preceded it and the Neoliberal era that followed.

I could post all sorts of data here, but let us just look at this graph:

This speaks for itself.

Further Reading
Here are my posts on fractional reserve banking refuting the Rothbardian nonsense below:
“Hayek’s Original View of Fractional Reserve Banking,” February 29, 2012.

“Fractional Reserve Banking, Option Clauses, and Government,” January 31, 2012.

“Are the Public Ignorant of the Nature of Fractional Reserve Banking?,” December 17, 2011.

“Why is the Fractional Reserve Account a Mutuum, not a Bailment?,” December 17, 2011.

“Callable Option Loans and Fractional Reserve Accounts,” December 16, 2011.

“Future Goods and Fractional Reserve Banking,” December 15, 2011.

“Rothbard on the Bill of Exchange,” December 11, 2011.

“Hoppe on Fractional Reserve Banking: A Critique,” December 11, 2011.

“The Monetary Production Economy and Fiduciary Media,” December 11, 2011

“Fractional Reserve Banking: An Evil?,” June 26, 2010.

“The Romans and Fractional Reserve Banking,” February 23, 2011.

“Gene Callahan on Fractional Reserve Banking,” February 18, 2011.

“Lawrence H. White refutes Huerta de Soto on Fractional Reserve Banking,” February 22, 2011.

“Selgin on Fractional Reserve Banking,” June 1, 2011.

“Schumpeter on Fractional Reserve Banking,” June 12, 2011.

“If Fractional Reserve Banking is Fraudulent, Why isn’t the Insurance Industry Fraud?,” September 29, 2011.

“The Mutuum Contract in Anglo-American Law,” September 30, 2011.

“Rothbard Mangles the Legal History of Fractional Reserve Banking,” October 1, 2011.

“More Historical Evidence on the Mutuum Contract,” October 1, 2011.

“What British Law Says about the Mutuum Contract,” October 2, 2011.

“If Fractional Reserve Banking is Voluntary, Where is the Fraud?,” October 3, 2011.

“Huerta de Soto on the Mutuum Contract: A Critique,” August 11, 2012.

“A Simple Question for Opponents of Fractional Reserve Banking,” August 17, 2012.

“Chapter 1 of Huerta de Soto’s Money, Bank Credit and Economic Cycles: A Critique,” August 31, 2012.

“Huerta de Soto on Justinian’s Digest,” September 1, 2012.

“Huerta de Soto on Banking in Ancient Rome: A Critique,” September 2, 2012.

“Bibliography on the Irregular Deposit (depositum irregulare) in Roman Law,” September 6, 2012.

“Rothbard on ‘Deposit’ Banking: A Critique,” July 22, 2014.

“Carr versus Carr (1811) and the History of Fractional Reserve Banking,” July 23, 2014.

Mutuum versus Bailment in Banking,” July 24, 2014.

“Foley versus Hill and the History of Fractional Reserve Banking,” July 29, 2014.

“A Critique of Murray Rothbard on the Origins and Legal Basis of Fractional Reserve Banking,” July 30, 2014.

“Coggs v. Bernard and the History of English Bailment Law,” July 31, 2014.

“The Mutuum Contract in Henry de Bracton and English Law,” August 1, 2014.

“Fractional Reserve Banking is a Fundamental Part of Capitalism,” August 8, 2014.

“A Critique of Rothbard on the History of English Bailment Law,” August 11, 2014.

“The Banking Contract in 19th Century US Law,” August 16, 2014.

“Rothbard on how Fractional Reserve Banking would be illegal in Anarcho-Capitalism,” March 2, 2016.

“The Filthy Anti-Capitalist Mentality – of Austrian Economics,” October 17, 2015.


  1. Much as I welcome having Lord King's attempts to set the record straight on fractional reserve banking, I regret that in so doing he also twists the record somewhat in his attempts to straighten it.

    He is wrong, first of all, to treat the position taken by Murphy and his fellow Rothbardian's as representative of beliefs held by American libertarians generally, so as to then characterize the latter as "a lame cult of losers." There are plenty of libertarians who don;t subscribe to the Murphy-Rothbard position, including many who have criticized it on precisely the same grounds as Lord King himself does.

    Concerning Canada and Scotland, Lord King commits a very primitive error. He points to the few respects in which those systems departed from pristine free banking, and the occasional problems encountered in them, and then declares on that basis that claims to the effect that free banking systems tended to be stable are false. That procedure makes no sense, because what matters is a comparison of the systems in question to more heavily regulated systems. The question is, were less regulated systems more stable than their more heavily regulated counterparts. Was Scottish banking more stable than English? Was Canadian banking more stable than banking in the U.S.? Anyone who would answer "no" to either question has got a heavy burden to carry, for the superior stability of the more free systems was notorious to contemporaries. One need only read old newspapers to find many testimonials.

    As for government interventions, these, two, were relatively unimportant. Yes, Canadian banks couldn't lend on real estate; but neither, in the 19th century, could U.S. national banks. Yet O.M.W. Sprague could author a thick volume entitled "Crises under the National Banking System," whereas one would be hard pressed to fill a pamphlet on the topic of Canadian banking crises" during that same period. (There were bank failures, to be sure; but no major crises.) There was a minor crisis in 1907, related to the fact that a long-standing aggregate Canadian note issue ceiling had become binding; the law allowing Canadian banks to secure unbacked Dominion notes was designed to allow them to meet currency demands despite that ceiling--the same end might have been accomplished by relaxing the requirement. So one intervention by gov't made up for a problem related to a pre-existing legal restriction. Does that make for an argument against freedom in banking? I can't see how.

    Finally, the Australian crisis of 1893. Well,the free bankers haven't ignored it. It's discussed in Dowd's 1992 volume, The Theory of Free Banking, and in my JFSR article on "Bank Lending 'Manias" in Theory and History." I refer LK and his readers to these works for our assessment of the implications of that episode. But for the sake of argument, let's allow that it constitutes a black mark on the record of free banking systems. So what? Again, the question is how well free banking systems performed in comparison with less free systems. The history of the latter systems is littered with more major crises than one can count. So what sense does it make to point to a single black mark in the record of free banking, and then conclude, with a flourish, that it was not after all superior to actual alternatives? No sense at all, I submit.

    I have myself compared, using secondary sources, the incidence of crises in less and more free banking systems in my Critical Review essay, "Are Banking Crises Free Market Phenomena?" I'd welcome JK's attempt to improve upon that comparison; still I very much doubt that by doing so he will reach a different conclusion from the one I reached in my original attempt.

  2. I'm afraid, LK, that your addendum hardly establishes what you wish to establish. For one thing, Dowd, White, and I have always been careful to note that the U.S. _never_ had anything like "free banking" in our sense of that term--that is, banking that's largely unregulated. Indeed, we've all written at length about the many interventions in both the antebellum state banking systems and the National Banking system that prevailed between the Civil War and the founding of the Fed. (That the period between 1914 and 1945 in the U.S., which is where the mass of bank failures shown in your little chart occur, doesn't qualify as one of unregulated banking ought to go without saying.) In short, if you want to make the point that U.S. banking since 1945 has exhibited greater stability than any free banking system of the past, you have at least to choose from among one of those past free banking systems. Comparing the heavily regulated post-1945 U.S. system with the also heavily (but very differently) regulated pre-1914, or pre-1945, system tells nothing about the relative merits of unregulated banking.

    Second, it makes no sense to compare one sort of system from, say, 1850-1900, with another from a different era. Changes in communications and such ought to make for a large difference even if the regulatory regime itself didn't change much. So the best info. comes from comparing contemporary systems that had much in common save fro the regulatory regimes in place. That's why we stress so much the comparisons of Canada vs. the U.S. ca. 1870-1014 (or 1933) and Scotland vs. England ca. 1775-1845.

    Finally, although the U.S. monetary system post-1945 was in most respects far between than the system before 1945, that's almost entirely due to the disastrous interwar years. If one compares the records for the 1870-1914 and post-1945 periods, it is not so easy to sustain the argument that the latter marked a decisive improvement over the former, even despite the many changes apart from bank regulation--including a far larger role for countercyclical fiscal policy--that should have made the latter period more stable overall. For details see my J. Macro. paper w/ Larry White and Bill Lastrapes,"Has the Fed Been a Failure?"

  3. For "The Theory of Free Banking" in my first comment please read "The Experience of Free Banking." There's an entire chapter on Australia there.