full reserve banking

[John_McVey]

You missed that the “only” thing is not actually a difference, since the bank can deny access to the contents for a significant amount of time.

At this point, what y feldblum has to say about breach of contract is spot on. If the account is advertised as a demand deposit, then the money must be paid over immediately on demand or else the bank is either guilty of breach of contract, or, if the contract’s fine print allows for such delays, guilty of false advertising. The fact that a law may allow such actions is merely grounds for condemning that law. Without that kind of law, a bank cannot escape its legal obligations get away with it.

As to CD’s, it makes all the difference in the world because CD’s are not part of the core money supply. They are capable of being added on later as supplementary components, which is technically legitimate because one can indeed settle a debt by passing title on a CD to the creditor who can in turn do likewise with another creditor, but I raise an eyebrow at CDs’ inclusion because their trade like that is hardly a significant proportion of transactions even of those involving CD’s. For practical purposes, the purchase of a CD does not increase the money supply and is a real increase in credit that will help the economy along, whereas making a deposit into a fractional account does increase the money supply and the lending from that account is mere credit-expansionism that will come to no good end.

You also imply by your answer that “maturity” of a CD and time deposit correlates to the maturity of the loans to which they are applied.

I never implied any such thing. I only noted that a cashing in prior to maturity was not the same as a withdrawal.

On the technical side of the particular topic you mention, it is duration that matters more than maturity (your use of quotes suggests you know this). It is this practice you mention - called duration gap, for those who don’t know - that I had in mind when I said that the practice of FRB was not sui generis. I know very well that lending out for durations longer than as apply to one’s sources of funding is unsound (eg S&L crisis in the late 80’s and early 90’s), whether this is in reference to fractional reserve banking or not. This is one of the things that would be learned by Mr Wynand if he did what I recommended and researched what was good and bad about management of financial institutions. I didn’t mention it expressly before because I didn’t want to get into complicated mathematical concepts on a mere forum - it’s something for people to read and think about on their own time or learn in a proper educational environment.

JJM

[John_McVey]

My point was that fractional-reserve banking, as such, has brought about a history of bank failures and economic catastrophe. The practical results of a practice must be used in determining the moral status of that practice, because there is no dichotomy between what is good and what works.

I don’t dispute the connection between morality and practicality. The issue is of hierarchy, and I am saying that you are improperly reversing it from what it should be. One does not conclude it is immoral simply because every single instance so far (which is debatable) is impractical, because doing that is merely committing a white-swans fallacy. Properly, one demonstrates that the practice is inherently impratical because it violates a principle - and being fast and loose about the meaning of fraud is not an example of that kind of principle required.

Fractional-reserve banking is inherently unsound

I don’t dispute that …

because it is a legalized form of breach of contract and fraud.

… but I do dispute that.

It does not matter that all parties know it.

Yes it does. That is what changes the matter from an actual breach of contract to a mere potential one - also a crucial point in the abortion debate, incidentally. That change prevents the government from taking action against the practice except where there are express terms in any individual contract.

Everyone here is generally correct to dispute your use of the word “fraud.” What you’re describing is not fraud, plain and simple, and it is not helping you any to go on about it because that is precisely the sort of thing that Diana was right to object to as rationalism. The mere fact that there’s a high chance that a bank might not be able to settle every single depositors’ accounts all at once does not yet mean that the bank has in fact failed to abide by any separate contract with an individual depositor to pay that depositor. For all anyone knows the bank in question may have reinsurance arrangements, which can work perfectly well because the requisite funds can come in by the service entrance while big queues and attendant delays form out in front of the retail counters.

So, any given bank may well become the subject of a run, but no claim of fraud or breach of contract can be made until any one of those individual depositors is physically turned away because of a lack of funds in the tills, which thanks to its external arrangements might not happen even if the run goes full swing and will end the bank’s deposit business. The potential for customers being turned away is not the same as this actually having happened. So, in the meantime there is no principle that says banks can’t do their level best to calculate risks and act accordingly. Thus Toad is quite correct on this much (including what’s in the ellipses):

The “safety” of the deposits and the “risk” of the loans must be managed, of course. The bank charges interest for the risk. The interest should cover the risk, actual losses, operating expenses, and profit.

…

The cry for the safety of “full-reserve banking” is the cry for the simplicity of the ox-cart instead of the complexity of the passenger jet. But which is really “safer”?

The only way out is exactly as I have stated: show that the practice is worthless because it adds nothing to the economy, and hence that the true value of the risk exceeds the value of the returns.

Fractional-reserve banking is a form of fiat money and inflation. Like other forms of fiat money and inflation: fiat notes, Treasury debts, Federal Reserve “Open Market Operations,” etc., it is the cause of the business cycle: periods of non-productive “irrational exuberance” characterized by the growth of the money supply and significant malinvestment, followed by periods of recession, the destruction of large parts of the money supply, and the failures of these malinvestments.

Other than the calling of fiduciary media as necessarily fiat money, again, I have no dispute with that. What I am trying to tell you is that you have to prove this is the inherent result of FRB by reference to economic principles, because unlike what the Amsterdam bankers and London goldsmiths did in the 17th century there are no core ethical principles being directly violated these days. One cannot sit content with a simple “immoral, therefore impractical” on the FRB issue today.

JJM

[agrippa1]

At this point, what y feldblum has to say about breach of contract is spot on. If the account is advertised as a demand deposit, then the money must be paid over immediately on demand or else the bank is either guilty of breach of contract, or, if the contract’s fine print allows for such delays, guilty of false advertising.

Show me an advert from a bank that states that you have instant access to your deposits, and I’ll concede that point.

Or are you claiming that the word “deposit” implies that claim?

[agrippa1]

This is not fractional-reserve banking in any sense of the term. This is not even “local fractional-reserve” banking. The bank continues to hold full reserves, whether at the counter or warehoused. A demand deposit contract would specify a schedule of how much time the bank has to fill its depositors’ requests for withdrawal, a schedule which permits the bank enough time to transfer any holdings from the warehouse to the counter. There is no breach of contract.

No, the bank holds only a fraction of the deposits, as well as an IOU for the amount of deposits held at the regional bank. I agree there is no breach of contract, but you are missing the point…

Okay, I’ll make it easier for you:

Assume a gold standard. Imagine you deposit $100 in a bank. Next bloke comes along with $90 worth of gold, and the bank takes $90 of the dollars you deposited and gives them to him in exchange for his gold. The bank now has only 10% of the money you deposited. You can’t get the $100, because they’ve exchanged 90% of it for an equivalent amount of gold. If you demand your full deposit, you will have to wait until the bank liquidates the $90 worth of gold before receiving your $100 deposit.’

The bank has practiced fractional reserve banking, with the deposits backed by gold, rather than loan collateral.

Fraud?

Get it? It’s not that they have given out your money (under whatever terms) and are backing it with equivalent (or greater) assets. It’s that the assets backing the deposits may decrease to below the dollar value of the deposits.

If you still disagree, then imagine the same scenario, but not under a gold standard.

[y_feldblum]

No, the bank holds only a fraction of the deposits, as well as an IOU for the amount of deposits held at the regional bank.

They are the same entity. Warehousing the depositor’s money is not the same as lending it out, because the bank can always recover the deposits of every depositor at any time, within the time it takes to transport the money from the warehouse to the counter. The bank remains fully liquid the whole time. When the bank lends out its depositors’ money, the bank becomes highly illiquid and must hope against hope that not too many depositors at any time want access to their deposits, for fear of going bankrupt.

Assume a gold standard. Imagine you deposit $100 in a bank. Next bloke comes along with $90 worth of gold, and the bank takes $90 of the dollars you deposited and gives them to him in exchange for his gold.

What gold standard are you talking about? Is gold money or isn’t it?

The bank now has only 10% of the money you deposited. You can’t get the $100, because they’ve exchanged 90% of it for an equivalent amount of gold. If you demand your full deposit, you will have to wait until the bank liquidates the $90 worth of gold before receiving your $100 deposit.’

The rest of this example seems not to make sense, because you are talking about gold as if it were not the actual money deposited at the bank.

[y_feldblum]

I don’t dispute the connection between morality and practicality. The issue is of hierarchy, and I am saying that you are improperly reversing it from what it should be. One does not conclude it is immoral simply because every single instance so far (which is debatable) is impractical, because doing that is merely committing a white-swans fallacy. Properly, one demonstrates that the practice is inherently impratical because it violates a principle…

This - proof by principle - seems like rationalism. Properly, one demonstrates a proposition like this both by looking to the principles one already knows as well as to the concrete details of the proposition, to its causes and its effects.

I make two points:

First, that a fractional-reserve bank offering demand deposits makes its depositors a guarantee that the bank cannot keep, and - as a form of breach of contract, practiced on the widest of scales - such a practice must inevitably come crashing down. Lies multiply and frauds multiply, until they build up to a point where they can multiply no further. Then they come crashing down. The principle is: the virtue of honesty, and the impossibility of long-term dishonesty.

Second, this practice has in the past come crashing down every time it has been tried, perhaps most notoriously the banking and economic collapse of 1929. Since then, we have seen much less of a collapse in this particular form of credit expansion, because the US government has severed cause and effect by actively shifting the risk and punishment inherent in fractional-reserve banking onto other parts of the economy.

Yes it does. That is what changes the matter from an actual breach of contract to a mere potential one - also a crucial point in the abortion debate, incidentally. That change prevents the government from taking action against the practice except where there are express terms in any individual contract.

Correct, in that the specified terms in the contracts have not in themselves been breached. However, the bank has rendered itself impotent to honor its contracts in any except the most mild of economic circumstances. The moment 11% of its depositors wish to switch to another bank (supposing a 10% reserve), the bank is rendered broke. Furthermore, since fractional-reserve banking is a particular form of fiat money, the inflation is unsustainable and the fiat money will be destroyed. This happened in 1929, and the rapid destruction of fiat money of a different form is currently happening in 2009.

I would consider it to be fraud knowingly to put oneself in a circumstance where one will be forced to breach contract. This is what fractional-reserve banks do. The fiat money will be destroyed, because nature abhors a lie (especially a nationwide lie), and the moment the banking panic sets in, the fractional-reserve banks will have destroyed the life savings of 90% of their depositors.

Other than the calling of fiduciary media as necessarily fiat money, again, I have no dispute with that.

One can look at fractional-reserve banking in two ways: as credit expansion, and as false fiat banknotes.

As credit expansion: The loans which the bank originate with its depositors’ money become a part of the money supply and represent new and additional money, because the borrower has physical possession of the money, while at the same time the depositor also has full right to physical possession of the money, and can exchange this right (in the form of a claim against a deposit) in daily economic activity.

As fiat banknotes: the actual money was loaned out, and now another person is trading with it. However, now the depositor is trading with a claim against that very same money, when he is not in possession of it. Most of the deposits can and will be destroyed the moment the fractional-reserve bubble bursts.

Fractional-reserve banking creates new loans, a form of money, where they could not otherwise have been created. However, since it is not the debt instruments which are traded, it is not the debt instruments which are destroyed when the bubble bursts and inflation is forcibly reversed. It is the deposits which are destroyed, and therefore the deposits can be seen as the false money as well. The loans are new and additional money, while the deposits are destructible money. (In the present economic collapse, the government protects deposits from their impending destruction, while trillions of dollars’ worth of securitized debt instruments have been destroyed.)

Whichever way one looks at it, the only answer is a private, fully-backed commodity money system.

[y_feldblum]

Doesn’t your example assume that the depositor is aware of what is going on, and agrees to the arrangement? If so, how can you say that the arrangement that the depositor agrees to is in breach of that which he agrees to?

The depositor agrees to the contract he signed, which he can attempt to enforce in court. It is, of course, his money which is held in reserves, while it is others’ money which is loaned out.

Many depositors are under the illusion that the bank can safely invest the deposits and remain solvent over the long term, while at the same time providing on-demand access to the deposits. They are mistaken. Banks can do so over the short term, and then after the impending economic collapse and the destruction of the current banks, the next generation of banks will also be able to do so over the short term.

Many savvy investors invested with Bernard Madoff in a scheme which they knew was too good to be true (they didn’t know what the scheme was). Fractional-reserve banking is also too good to be true.

[John_McVey]

Show me an advert from a bank that states that you have instant access to your deposits, and I’ll concede that point.

Every-day classic banking from National Australia Bank; " Unlimited banking how and where you want"; express statement of unlimited access in a variety of ways. Further, see terms 1.1 and 1.5 of this class of accounts’ Terms and Conditions, which are legally binding on the bank.

Or are you claiming that the word “deposit” implies that claim?

Not the word deposit, the term demand deposit, or words to that effect (eg “unlimited access”). My complaint about the degeneracy of “deposit” is another issue entirely - which complaint included recognition that its use on its own nowadays does not constitute fraud when FRB is practiced.

But anyway, I don’t see why you’re making a fuss about this particular issue in this particular manner. The issue of fractional reserve banking doesn’t apply to CD’s for the reasons I’ve already stated (ie they are not part of the core money supply). The related issue of duration gap does link FRB with the broader issues of bank soundness in general, but that’s a secondary matter.

Moreover, I am not the one claiming fraud, but quite the opposite! This is precisely the point I am trying to make to y feldblum. There are no grounds for a charge of fraud unless there is an explicit term of contract that is being actually breached, and no grounds for a related charge of false advertising unless the contract is contrary to what the advertising implies is in the contract. I was simply noting that there would be a breach of contract under the conditions you specified, not that it these conditions always exist (eg see footnote 3 on page 20) and not that it is always fraud. All that the NAB is saying, for instance, is that you’ll have access to your money and where you want it, but even then some daily limits exist for internet transactions (per clause 17). So long as they comply with what they said they will do, and have expressly stated that they will pay depositors interest and hence clearly implying they’re doing something other than letting the money gather dust in a vault, they are not guilty of breach of contract. Ergo, no fraud.

JJM

[softwareNerd]

Many depositors are under the illusion that the bank can safely invest the deposits and remain solvent over the long term, while at the same time providing on-demand access to the deposits. They are mistaken. Banks can do so over the short term, and then after the impending economic collapse and the destruction of the current banks, the next generation of banks will also be able to do so over the short term.

Good banks can definitely remain solvent over economic cycles. Historically, good US/UK banks did very little real-estate lending and very few long-term loans. They kept large reserves and many of their assets were very short-term.

Many savvy investors invested with Bernard Madoff in a scheme which they knew was too good to be true (they didn’t know what the scheme was). Fractional-reserve banking is also too good to be true.

No, a ponzi scheme cannot work, by design. The same is not true of banks that keep less than 100% reserves.

Poor lending standards have been behind most downturns. Obviously, if banks keep 100% reserves and do not lend it out, then the lending standards cannot be relaxed by banks. i.e. if they don’t lend, where’s the question of standards. If banks don’t lend, someone else will. All that will happen in such a situation is that other cash-like accounts will develop: like the many money-market funds of today. So, you’ll get some 100% accounts and some non-100% accounts. People will likely keep some money in one type and some in the other.

[y_feldblum]

@Software Nerd: I have no problem with banks lending. They should simply not be doing it out of demand deposit accounts. They can lend out of CD’s, and they can even set up an investments department that lends out of funds which customers deposit to be invested. However, CD’s and investment accounts are not demand deposits - they are not guaranteed to be safe or to represent the deposits.

When banks permit both borrowers and depositors to use the same deposited funds, that’s when the problems start. This scheme cannot work. If this scheme is widespread, the only result can be a banking panic and an economic collapse.

Inflation has a tendency not to remain stable. It tends to accelerate as a bubble, until it is stopped. When it is stopped, a correction or a bust sets in. Fractional-reserve banking, like any kind of inflation, is not stable, and engenders booms and busts just like any other kind of credit expansion.

@John McVey: The fraud is in permitting depositors to treat their deposits as though they were as good as the money deposited, when in fact the deposits are not as good as the money deposited. The money deposited is not in the bank and cannot be withdrawn at will - it can only be withdrawn in “mild” economic seas, which are sure to turn choppy and get worse from there. So long as depositors in a demand deposit account are prevented from treating the account as a demand deposit account, by contract - by embedding a clause to the effect that the bank is permitted to renege on its obligation to return all the depositor’s deposits to him - there is no fraud. Because, sans Federal bailouts, the bank will renege on its obligations.

[agrippa1]

They are the same entity.

An IOU is not “the same entity” as cash in the bank. If I were to accept this assertion, I must also accept one that states that membership in the FDIC is “the same entity” as cash.

Warehousing the depositor’s money is not the same as lending it out,

Agreed. That does not mean they don’t share a common characteristic.

because the bank can always recover the deposits of every depositor at any time, within the time it takes to transport the money from the warehouse to the counter.

Which is it; always, or within the time it takes to transport? By the same rationale, a lending bank can “always recover the deposits of every depositor at any time,” within the time it takes either sell the outstanding loans or see them repaid.

The bank remains fully liquid the whole time.

It’s clear we disagree on the terms “fully” and “whole.”

When the bank lends out its depositors’ money, the bank becomes highly illiquid and must hope against hope that not too many depositors at any time want access to their deposits, for fear of going bankrupt.

Agreed. That is the result of pooling of deposits, which allows depositors to earn interest on most of their money without losing the ability to gain access to their entire deposit at almost any time (or in your terms, the “whole” time it is in the bank).

What gold standard are you talking about? Is gold money or isn’t it?

Yes: it is or it isn’t. Gold coined as currency is money. Gold held in reserve for money is not; it is a commodity.

If you put your money in the bank, and I took a loan of that money by depositing gold as collateral, the bank would be holding collateral for your money, not your money. If there were no gold standard, the bank would be taking a risk that the value of the gold I deposited did not fall below the amount of money they lent me. It is only under a gold standard, in which the value of the money is pegged to an amount of gold, that they loaning me money for my gold would not entail risk. Even under a gold standard, however, if you went to the bank and tried to take out your money, but all they had was gold bullion, they would be technically insolvent, for as long as it took to liquidate (possibly, literally) the gold to get you your cash. You might accept the gold as commodity, in exchange for you cash (i.e. purchase it), but they are responsible for producing your cash, not an equally-valued commodity or asset.

on edit: uncle

[y_feldblum]

@agrippa1:

• The parent bank with the warehouse and the child bank with the cash counter are the same entity. That is what I meant by “they are the same entity.”

• The common characteristic between warehousing and lending depositors’ money is: is the money physically sitting at the same counter where the money was deposited? This common characteristic is irrelevant. The relevant characteristic, which is where the two phenomena differ, is: is the bank liquid enough to return all money held in demand deposit accounts to the depositors at any time?

• The contract government demand deposit accounts specifies an amount of time which the bank has to available to it to return the depositor’s money to him. Something like “within two business days.” This cannot include “whenever John pays back his loan.”

• Pooling deposits does not make a bank illiquid. Loaning out deposits does make it illiquid, in that its depositors will not be able to cash out at any time for the full amount of money deposited.

• Gold coined as currency (on an actual gold standard) and gold bullion are of the same character when it comes to their qualifications to be usable as money, except for ease of carrying in one’s pocket. Coined gold is not any more monetary than uncoined gold bullion. Gold is gold, and is measured in gold ounces, whether it has a pretty stamp on it or not. Again, what kind of gold standard are you talking about, when gold both is and isn’t money?

• The bank may certainly exchange its depositors’ coins for bullion for warehousing, and exchange the bullion for coins when the depositor wants to withdraw his money. That just changes the form of the money, not the kind or quality.

[hunterrose]

The specified terms in the contracts have not in themselves been breached.

Doesn’t that, in and of itself, mean that fractional reserve banking is not fraud?

The practice is actually a negative-sum game, where the risk to the economy is not compensated for elsewhere in the economy in any form at all.

I don’t understand this part. Suppose my banker invests some of my deposits in stocks. As we’re both benefiting, how is this a negative-sum game?

[y_feldblum]

Doesn’t that, in and of itself, mean that fractional reserve banking is not fraud?

The bank has knowingly and intentionally put itself into a situation where it will have to default on its liabilities to its depositors.

[aequalsa]

I don’t wish ti sidetrack this thread, but can anyone recommend a source which provides information on pre-federal reserve fractions held by banks. I am particularly interested in the 19th century bank runs. Not a historical analysis, just the numbers. So far my search has been a little fruitless. Thanks.

[softwareNerd]

I don’t wish ti sidetrack this thread, but can anyone recommend a source which provides information on pre-federal reserve fractions held by banks. I am particularly interested in the 19th century bank runs. Not a historical analysis, just the numbers. So far my search has been a little fruitless. Thanks.

Practices varied from bank to bank. However, in general the reserve requirements were considerably higher than today. (The use of 100% fiat currency – our post-1970’s situation – removes the need for reserves as a way to provide liquidity, since the Fed can provide an unlimited amount of liquidity in fiat-currency terms.)

Back to the history, before legislation, some banks had agreements between each other where they would maintain a certain % reserve (on notes issued) as a condition to honoring each others notes without discounting the face-value. State legislation varied; the first nationally-chartered banks had to keep 25% reserves against notes issued(1863). This was lowered soon enough (1864) to 15% for major banks and less for others. [This is a bit of an apples-to-oranges comparison, because in those days the reserves were required against bank-notes issued rather than against deposits.]

Anecdotally, I’ve read of some NYC banks that used to keep extremely high reserves: over 50%.

Richard Salsman has a book that probably has some info on this. When I get a chance, I’ll look it up and post better info.

[agrippa1]

I don’t wish ti sidetrack this thread, but can anyone recommend a source which provides information on pre-federal reserve fractions held by banks. I am particularly interested in the 19th century bank runs. Not a historical analysis, just the numbers. So far my search has been a little fruitless. Thanks.

Friedman & Schwarz have detailed data as far back as 1867 in their “Monetary History of the United States.” I believe they started post bellum because that’s as far back as reliable records/numbers go, but there might be some reference to earlier reserve fractions in there.

[agrippa1]

• Gold coined as currency (on an actual gold standard) and gold bullion are of the same character when it comes to their qualifications to be usable as money, except for ease of carrying in one’s pocket. Coined gold is not any more monetary than uncoined gold bullion. Gold is gold, and is measured in gold ounces, whether it has a pretty stamp on it or not. Again, what kind of gold standard are you talking about, when gold both is and isn’t money?

I’m not doing a good job of explaining myself… My point is that it is not the fractional nature of FRB that makes it inherently unstable, it is the (false) implication that anything other than currency; or gold, under a gold standard; can be held by a bank as collateral for a depositor’s money.

If collateral could be guaranteed to hold value, then in the case of a run on any one bank, it could simply liquidate the collateral (i.e., sell their loans to another bank) to get the money demanded by the depositors. A run on an FRB bank occurs because the loans are in danger of defaulting, and are not collateralized sufficiently to protect the value of the loans (and deposits). It is only when this situation occurs that the fractional nature of the system becomes an issue for depositors, because banks can’t pay out deposits with mortgages and liens, only with the fraction of deposits held as cash.

[y_feldblum]

An Austrian economist’s view on the practice of fractional reserve banking.

J. G. Hulsmann - Has Fractional-Reserve Banking Really Passed the Market Test?

[agrippa1]

An Austrian economist’s view on the practice of fractional reserve banking.

J. G. Hulsmann - Has Fractional-Reserve Banking Really Passed the Market Test?

This analysis is based on the premise that bank notes (notes issued as claims on “money” i.e., gold?) and FRB deposit IOU’s are liquid in the market. I believe he is smearing the concepts of fractional gold reserve with fractional reserve banking. The former implies the issuance of liquid notes not fully backed by gold, the latter refers to deposits made into a bank, which have to be withdrawn in order to be used as money. I don’t believe there is a fundamental equivalence between the two that allows Hulsmann to correctly analyze the effects of illiquid FRB in the context of liquid (tradeable) deposit IOU’s.

His definition of money warehousing:

The bank stores money for other people and issues standardized money titles, such as banknotes, to the depositing customers, who can then use these banknotes in their daily transactions in lieu of money proper.

Clearly, by “money” he means “gold,” and this is gold reserve operations, not full reserve banking. In full reserve banking, the depositor gets an account book which is not liquid, for the very reason he puts his money in the bank in the first place.

To make a proper analysis, Hulsmann must identify a third basic bank product, that is, currency safeguarding (since he already took “money [i.e., gold] warehousing”).

So the three products are:

1 - gold reserve operations (liquid notes),

2 - currency safeguarding (illiquid account notations),

3 - interest investment (of varying time: 0-n units of time).

Furthermore, Hulsmann’s refutation of the efficacy of FRB rests largely on the opportunity for, and tendency towards, fraud, but as Wicksell points out, this opportunity presents itself in ostensibly full reserve banking as well. So is it FRB that Hulsmann is decrying in this section, or fraud?

Finally, the issue of interest is mentioned almost dismissively as a sugar-coating for the poison of FRB:

Imagine a potential bank customer who is offered two types of deposits with a bank. He believes that both deposits deliver exactly the same services. The only difference is that he has to pay for the first type of deposit, whereas does not have to pay—or even receives payment—for the second type of deposit. Clearly, he will choose not to be charitable to his banker and will subscribe to a deposit of the second type. When genuine money titles and fractional-reserve IOUs are confused, therefore, the latter will drive the former out of the market.

Are we to assume that a customer would believe he is getting something extra for nothing, i.e., that he is irrational?

I find it revealing that those who decry FRB do so in terms only of the transient impacts, not the steady-state, in which interest is earned over years of stable operations. A full analysis must show whether in the long run FRB earns or loses value for depositors, and thus strengthens or weakens the economy. I believe the transient effects can be mitigated with run-controlling measures such as those I suggested earlier.