There are many books on the history of money and banking, philosophy and economics but very few if any that integrate these concepts together to show how essential the concept of money is to civilization. The lack of integration directly follows from the disastrous state of the economics profession and of modern philosophy. The result is that most people are left without any understanding of the fundamental economic or philosophical ideas needed to combat the government's assault on money.
As we are yet again experiencing first hand, the current socialized system of fiat money and fractional reserve banking is immoral in principle and a complete and utter disaster in practice in the same way and for the same reasons that any form of socialism is immoral and disastrous. Despite the destruction wrought by socialized money, fiat money and fractional reserve banking is taken as the metaphysically given and hardly questioned even by professional economists. What I would like to begin doing in this blog is to integrate the history, economics and philosophy of money and banking but in a way that makes the basic concepts intelligible to the non-economist and non-philosopher. I am not going to do this in an organized way but will post periodically and at some point maybe try and tie the ideas together in a more organized fashion with a view towards formally publishing. So please comment away and help lead me in the right direction.
In this post, I am going to focus on the history and meaning of fractional-reserve banking and distinguish the concept of storing money somewhere with the concept of lending money to someone. These are two distinct concepts legally and practically, however, today's banks package these practices together in a way that I claim is inherently fraudulent and based on some terrible common law legal precedents from the 19th century.
The reason I am starting with this is that it sets the stage for understanding the various economic crises that occurred, particularly in the 19th century, when the U.S. was actually on some form of a gold standard. As we will see in future articles, these economic crises would not have occurred under a gold standard if the government had served its proper role in enforcing banks' contractual obligations to redeem in specie (gold or silver) and to properly safeguard assets entrusted per the deposit contract. In turn, these panics, recessions, and depressions that were caused by the government led to more government intervention ultimately resulting in the complete nationalization of the money supply and banking system in 1913 in the form of the Federal Reserve system which haunts us to the present day.
To start, let me define "fractional-reserve banking". Fractional-reserve banking is the banking practice of only holding a fraction of your customers deposits and lending out the balance while simultaneously maintaining an obligation to redeem all deposits on demand (if that sounds contradictory it is). Fractional reserve banking has been around in essence for centuries. Even when notes were redeemable in gold, many banks practiced fractional reserve banking by lending out their customers gold and keeping a little bit around in case someone came asking for it (and they hoped that a lot of customers didn't come asking for it...). Today, banks are required by law to keep about 10% of their deposits on "reserve" at a Federal Reserve bank. In other words, they claim that you can withdrawal all of your money at any time but they don't really have it all because they loan it out. So, if all the customers showed up at the same time and asked for their money, the bank would collapse. To understand fractional reserve banking better, it's important to discuss the history of the fundamental legal issues underlying deposit contracts and loan contracts and to trace how fractional reserve banking involves a bastardization of the two entirely distinct legal and business concepts.
If you wanted to store a bike for the winter but didn't have storage space you might consider renting a garage somewhere. You would find a place that rents space and pay them a fee to store and safeguard your bike there. The contract is rather straightforward in the sense that you are placing your property in someone's safekeeping but at no point would you consider transferring direct title to the bike to the garage owner, i.e., you still own the bike even though you are storing it on someone else's property. More importantly, the act of placing your bike in safekeeping does not imply that the garage owner takes title to your bike. At any time, you would expect to be able to show up at the garage and get your bike, right? This type of transaction is known as a "bailment" in the sense that you are hiring someone to safeguard your stuff. The contract is known as a "regular deposit" contract.
Notice that the principle is exactly the same in the case of a regular deposit contract and an irregular deposit contract. You are storing a good whether it be something specific like a bike or something fungible like gold (money) and you expect the safe keeper to maintain possession of your property at all times
These two types of contracts should be distinguished from the "loan" contract. In a loan contract, you transfer legal ownership of something like money to someone else and allow them to use it in any way they wish (or in a way specified in the contract). In this case, you are transferring title to someone else in exchange for future goods specified in the contract such as the amount of money plus interest
You can see that these transactions are based on two very distinct concepts. In one case, you actually pay someone a fee to perform the service of safekeeping. In the other case, you transfer ownership of property in the present in exchange for future goods, i.e., for payment in the future.
Now, let's say that a garage owner from our example above has a bunch of people store their bikes with him for safe keeping, and he gives each of the bike owners a piece of paper that entitles them to come and pick up their bike. He notices that these bike receipts can be used by the bike owners to buy other things. For example, he observes that a bike owner who wanted to buy a sofa simply traded his bike receipt to the sofa owner. He knows that the sofa owner could take the bike receipt to his garage and demand the bike, but since he doesn't expect all the bike owners to show up for their bikes at the same time he gets an idea. He prints up more bike tickets than he has bikes and trades them for things or loans the tickets to others. People happily accept the bike tickets in a trade because they expect that they can get the bike anytime they want. And since people trust that the bikes are at the garage, very few people actually show up to get the bike. So the garage owner prints even more tickets and buys even more things and lends to even more people. This is great. The local economy booms as the garage owner purchases more and more things resulting in large bike ticket revenue for other local merchants and the persons which borrowed tickets purchase things. At some point, one or two of the merchants go to get the bikes. At first, the garage owner is fine. But as more nervous people show up, the bikes begin to disappear until they are all gone. At some point, since there are more tickets than bikes, the garage owner will not be able to make good on his obligation to redeem the tickets in bikes and he goes bankrupt along with his customers.
Should the garage owner's actions be considered fraudulent in that he misappropriated assets that were entrusted to him by virtue of a deposit contract and issued tickets for assets that did not actually exist? Furthermore, what if the government not only refused to prosecute the garage owner but allowed him to "suspend" bike redemption? Wouldn't the government's action encourage more and more garage owners to misappropriate their clients assets if they believed that the government would not enforce the redeemability of the receipt tickets?
It's important to point out that historically (and logically), the activity of deposit and loan were conducted as two separate businesses. The business of warehousing goods dates back at least to Ancient Greece and Egypt. De Soto analyzes the writing of a Greek named Isocrates from 393 B.C. in which he discusses a case of misappropriation by a banker of a customer's deposit. De Soto discusses the implications of the case:
It is therefore clear that in Greek banking, as Isocrates indicates in his speech, bankers who received money for safekeeping and custody were obliged to safeguard it by keeping it available to their clients. For this reason, it was considered fraud to employ that money for their own uses.
It was founded after a period of great monetary chaos and fraudulent (fractional-reserve) private banking. Intended to put an end to this state of affairs and restore order to the financial relations, the Bank of Amsterdam began operating on January 31, 1609 and was called the Bank of Exchange. The hallmark of the Bank of Amsterdam was its commitment, from the time of its creation, to the universal legal principles governing the monetary irregular-deposit. More specifically, it was founded upon the principle that the obligation of the depository bank in the monetary irregular-deposit contract consists of maintaining the constant availability of the tantundem in favor of the depositor; that is, maintaining at all times a 100-percent reserve ratio with respect do "demand" deposits. This measure was intended to ensure legitimate banking and prevent the abuses and bank failures which had historically occurred in all countries where the state had not only not bothered to prohibit and declare illegal the misappropriation of money on demand deposit in banks, but on the contrary, had usually ended up granting bankers all sorts of privilege's and licenses to allow their fraudulent operation, in exchange for the opportunity to take fiscal advantage of them.
The Bank of Amsterdam led to the creation of the Bank of Stockholm in 1656 which divided itself into two separate departments: one for safekeeping assets and one for loans. Again, these practices are and were considered to be two separate activities. However, although they were supposed to function independently of one another, the Bank of Stockholm violated the separation and it was nationalized in 1668 by the Swedish government. Quoting De Soto:
Not only did it violate the traditional principles which guided the Bank of Amsterdam, but it also initiated a new fraudulent and systematic practices: the issuance of banknotes or deposit receipts for a sum higher than actual deposits received in cash. This is how banknotes were born, along with the lucrative practice of issuing them for a higher amount than the total of deposits. Over time, this activity would become the banking practice par excellence, especially in the centuries that followed, during which it deceived scholars, who failed to realize that the issuance of banknotes had the same repercussions as artificial credit expansion and deposit creation.
The Bank of England promptly issued the enormous sum of L760,000, most of which ws used to buy government debt. This had an immediate and considerably inflationary effect, and in the short span of two years, the Bank of England was insolvent after a bank run, an insolvency gleefully abetted by its competitors, the private goldsmiths, who were happy to return to it the swollen Bank of England notes for redemption in specie.
It was at this point that a fateful decison was made, one which set a grave and mischievious precedent for both British and American banking. In May 1696, the English government simply allowed the Bank of England to suspend specie payment -that is, to refuse to pay its contractual obligation of redeeming its notes in gold- yet to continue in operation, issuing notes and enforcing payments upon its own debtors. The Bank of England suspended specie payment, and its notes prompty fell to a 20 percent discount against specie, since no one knew if the Bank would ever resume payment in gold.
The straits of the Bank of England were shown in an account submitted a the end of 1696, when its notes outstanding were L765,000 backed by only L36,000 in cash. In those days, few noteholders were willing to sit still and hold notes when there was such a low fraction of cash.
Specie payments resumed two years later, but the rest of the early history of the Bank of England was a shameful record of periodic suspensions of specie payment, despite an ever-increasing set of special privileges conferred upon it by the British government.
The reason this is significant is as De Soto explains "This was the dawn of the modern banking system, based on a fractional-reserve ratio and a central bank as lender of last resort."
In the next part, I will discuss various 19th century crises that occured in the United States as a result of fractional reserve banking compounded by the government's suspension of specie redemption, and I will discuss several seminal court cases in the 19th century which ultimately established the "legality" of fractional reserve banking by removing the distinction between the deposit and loan contract.
 Money, Bank Credit, and Economic Cycles, Jesus Huerta De Soto
 The Mystery of Money and Banking, Murray N. Rothbard