"Can some decipher this post on fractional vs full reserve banking by Steve Keen ?
He seems to be trying to say that 100 % reserve banks will also create credit out of thin air. I dont understand his justification and explanation of this."
To understand, you really have to understand the difference between “money” and “currency”, which requires understanding the difference between “ownership/title” and “a contractual obligation to pay someone money”, also known colloquially as an “IOU”. Neither of the two writers at the blog you mentioned is properly understanding these differences, including the Austrian.
In Austrian theory, “money” is the “hub commodity” at the center of a hub-and-spoke trading pattern: people trade other resources/commodities for the hub commodity, and then trade that hub commodity for other resources/commodities. In a free market, as Menger has detailed, the precious metals have done very well as money for a variety of straightforward reasons (divisibility, durability, etc). Let’s speak of gold from now on as money, since that has and is likely to be the most common commodity used as money. As a commodity, gold is subject to the same strong property laws of libertarian systems: specifically, at any given time, only one “title” exists to a given unit of gold, representing ownership. This title is legally equivalent to the gold itself.
When someone “deposits” money in a bank, there are two ways to structure that transaction. The first, warehousing, is the simplest. In this transaction, no title for the gold/money is transferred: the depositor still owns his gold and still retains title to it. Because it is the depositor’s property, the warehouse cannot do anything with it, since the definition of “property” is “the ability to control the commodity”. Were such a warehouse to lend this money out, it would be fraud instantaneously.
The second kind of transaction, and in most scholars’ opinion the one that is far more common today, is one in which ownership of the money is transferred to the bank. In exchange, the bank issues what is essentially an IOU: a contractual promise to pay the “depositor” a certain amount of money under certain conditions in the future. It may feel like you still own your money (your gold), but you do not. Hence, you have no say over the disposition of that money. That money can be lent out by the bank however they want: it’s their money, they own it. There is nothing fraudulent about that: when they loan the money out to a borrower, ownership of that money is transferred to that borrower, again for an IOU, this time from the borrower, again with certain contractual statements about the conditions of paying off the IOU, penalities for being late in doing so or not doing so, etc. The borrower cannot guarantee that he can pay that loan back, so the contract includes penalties and clauses for non-performance.
The same is true of all IOUs, including the one from the bank to the depositor. The bank owes the depositor, but they can’t guarantee that they’ll be able to pay them back, to penalties and other clauses are put in the contract in case of non-performance.
Here’s where the confusion comes in: both title to commodities and IOUs - which are not title to commodities, and thus legally are very different things- have value in the market and can thus be traded in the market, and to add to the confusion, they are both denominated in the same units: the units of money (gold). Thus, if I have title to 10 oz of gold, as indicated by a deposit receipt with a warehouse, I can use it to buy something that costs 10 oz of gold. Legally, there is no risk to the merchant: I own the gold, and only one person can own something. Now consider, say, the IOU that a depositor got from a bank. If they deposited 10 oz og gold, the bank gives them an IOU denominated in gold: 10 oz gold. This is not title, however. There is some chance of default, of contractual non-performance. It is legally possible to construct these IOUs such that they are fully transferrable, and thus “currency” is born. Note that clearly, such currency is intimately tied to the issuer. It is also defined by construction as debt: it’s an IOU! As a market actor, if presented with such an IOU by someone as a form of trade, yes, it is delineated in “gold”, but it is not title, and because there is some risk of default, most market actors will not accept these IOUs at face value, they will insist on a discount representing the contractual risk in that IOU. The amount of discount will depend on things like the issuer’s reputation, their reserve ratios, etc, etc.
So what are some of the implications of looking at this correctly with libertarian property law?
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FRFB is not “fraud” as long as the depositor’s contract with a bank is clear that they are transferring ownership and in return getting a contractual obligation to be paid in the future.
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Banks cannot make “money”: money is a commodity, and the only way a commodity like gold can come into existence is by mining etc. The amount of property title always, by definition, equals the amount of property.
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Banks can issue IOUs, which generally manifest as currency issued by the bank and redeemable at the bank under the conditions of the contract that the IOU incorporates. They are in the same units as “money”, but are not money themselves, even though they can float freely in the market and are likely to be used in market transactions, albeit at a discount compared to money itself.
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There is no legal requirement for the amount of IOUs issued to have any particular relationship to the amount of assets - including money/gold - of the bank. However, you expect market forces to pick and choose desired combinations of risk and benefits, to reward the issuers of IOUs who do so responsibly and with a track record of honoring them, etc. “Joe’s bank” is unlikely to get many people to take his IOUs.
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As a result, a free society would have both 100% backed money - since this just direct title over the money/gold - and fractionally backed currency, issued by banks when creating credit.
[As a nice aside, this helps slot in other things that have been suggested in a free society, e.g. poor person A gets a judgment awarded to him against rich person B: they can’t collect themselves, to they sell the “debt” to a collection agency at a discount vs “face value”. Well, this is really just the same thing as above: the award to A is an IOU from B, that is, “currency” issued by B. Like any currency, it can be sold in the market, including for other currency. So A sells his currency drawn on B to C for some other good (quite possibly a currency drawn on some more standard, reliable issuer, e.g.a bank), which C does because they think that X of B’s currency is worth more than .8 (or whatever discount rate they paid) of bank D’s currency. Once you see IOUs - debt - as currency, but not title, it all snaps into place.]