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Sunday July 31 2011

David Friedman, no less, has added a comment to this thread, which included something which I like a lot, namely this:

What the anti FR …

i.e. anti fractional reserve banking …

… position argued by Rothbard and some of his supporters claims is that all such contracts are fraudulent, and so should be banned. If so, all insurance contracts should be banned as well, since if all the insured houses happen to burn down in the same year the insurance company won’t have the money to pay off on them.

I’ve never encountered that argument before.  (Which shows how much attention I’e been paying to all this ...)

I intend to make it a Samizdata Quote of the Day.  But for the time being, let it be a mere BrianMicklethwaitDotCom Quote of the Day, because I don’t want to separate out this idea from the comment thread in which it appears, and cause commenters to go to two separate places.  When the thread has expired, then I will post it, and this is me reminding myself to do that.

Separating this notion out here won’t affect anything, especially during this summer relaxation period that I am now indulging in, and which, by the way, I think I will continue for another month.  It is working well.

I find it interesting that a bunch of impeccably free market supporting individuals can’t agree about things like this.  Which I think is one of the big reasons to have markets.  Let the market decide about FR banking, rather than the law.

Might I humbly point out that I used the word “insurance” in essentially the same way earlier in the thread, in the comment when I defended Alex from Jonathan.

I’m ambivalent about the question of whether fractional reserve banking is a good or bad idea, though. If banking is free and transparent, this is something for the market to decide.

Posted by Michael Jennings on 01 August 2011

I agree with the Rothbardian *economic* critique of FRB,, but it seems to me that FRB is not inherently fraudulent and should not be banned--any more than a Ponzi scheme should be.

But the analogy Friedman makes is weak, for a couple of reasons.

First, customers of an insurance company have to realize there is a chance of bankruptcy and that they will not be paid--since it is a statistics game and it’s possible for a very unlikely event like all the houses burning down. Insurers try to reduce even this risk by the use of reinsurance, but it can’t be turtles all the way down. By contrast, the customer of a 100% reserve bank knows he owns that amount of specie in the bank’s vaults. And in today’s central FRB system, each bank customer is called a “depositor” and he is told it’s “his” money there. Not that the bank will just try to repay him. In a private, freebanking FRB system, would the customer be called a depositor and told that the bank can guarantee the repayment--as in the 100% bank and today’s FDIC-insured central FRB? Or would he be told he’s taking a gamble and the bank will try to repay him but may be unable to? In the latter case it is indeed somewhat like insurance, legally speaking, though one wonders who on the market would accept these shaky promissory notes as money substitutes.

Second, Mises (see also Rothbard and Hoppe) distinguish between types of things that can be insurable, with the notion of case vs. class probability (corresponding to Misesian dualism which separates the analysis of the teleological realm from the causal realm). In short, a FRB simply cannot “guarantee” (insure) the “deposit”. A 100% reserve bank could make such a guarantee, and take out insurance to boot: they can guarantee it since their policy is to keep 100% reserves, so that there is an amount of money on hand at all times for each amount deposited. While there is some risk of loss due to natural disasters etc., this can be insured against just as home fires can be insured against today.

But a FRB cannot guarantee it will be able to repay and cannot insure this either. It cannot guarantee it since it lends most of the deposits out, and some of these loans may go bad. And it cannot insure against this since it is entrepreneurial speculation--for the same reason a guy starting a new business cannot go buy an insurance policy in case he doesn’t make it. This would be case probability, which is uninsurable, unlike class probability, which is.

So the problem with Friedman’s analogy is the customer of an insurance company is actually insured, even though there is always an inherent risk of the insurer going bust. But there is no guarantee or insurance of any type in a FRB system--it’s just a credit contract: a promise to try to repay.

My 2 pence.

Posted by Stephan Kinsella on 13 August 2011
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