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Source link: http://archive.mises.org/10115/dead-banks-walking/

Dead Banks Walking

June 11, 2009 by

It’s widely acknowledged that hundreds if not thousands of banks are on the ropes and just waiting for regulators to wrap them in yellow tape some Friday evening. However, fewer than forty US banks have been seized this year. The Federal Deposit Insurance Corporation (FDIC) list of problem banks grew to 305 in the first quarter, the highest number since 1994, but of course the names of those banks are not released so that depositors can be forewarned. FULL ARTICLE


Dick Fox June 11, 2009 at 12:33 pm

It is sad that Doug French gives us an absolutely fantasitc article then when making his final point totally changes direction to tilt at windmills. Don Quixote would be proud.

The problem with the banks is not FRB but foolish regulations that enable banks to engage in activities that would be stopped in its tracks if exposed to the discipline of the market.

If FRB is fully disclosed it does absolutely nothing to hinder trade. But the only way to prevent FRB is to invite the government into controlling banks actually hindering the free exchange of those who support FRB.

I hope that Doug will look at his article once again and see that it is the actions of government to thwart the discipline of the market that causes the problems with the banks not allowing banks to engage in fractional reserve banking if depositors desire.

It is this kind of welcoming of government intervention by some Austrians that bothers me. Hopefully libertarian Austrians can help bring us back to libertarian ideals.

Doug, develop the strength of your argument and leave the windmills to central planners.

dewind June 11, 2009 at 12:56 pm

The FDIC is a moral hazard and shoulders losses on the backs of tax payers. However, what would have been the fallout of FDIC insurance pay outs to individual investors and consumers? Either way it has to have been less than the cost of propping up zombie banks.

David Hillary June 11, 2009 at 2:16 pm

Government intervention, principally in the form of deposit insurance and prudential regulation, are the cause of the problem, not fractional reserve banking, which is an ordinary, legal and fundamental banking practice.

French goes one step further in this folly tarring term deposits (‘CDs’) with the false character of warehouse bailments. So, according to French, banks are supposed to accept funds on term deposit, pay interest, and warehouse the funds in the form of monetary metal or legal tender? Not even Rothbard takes his position that far. French has placed maturity transformation in the same category as fractional reserve banking (although frb is a form of maturity transformation, not all maturity transformation comes from frb, and most anti-frb people have no problem with other maturity transformation methods).

Bank deposits, demand and term, are legally loans, debtor-creditor contracts, whereby the depositor loans the funds to the bank. As an unsecured creditor, the depositor has no rights to the bank’s assets, either in the form of title or security, and does not have any rights to regulate the bank’s investment or financial policies. The depositor has a claim on the bank only, not on the bank’s assets.

Bank notes are promissory notes, being formal engagements to pay embodied in a document, signed by the maker, and payable on demand. As with demand deposits, the holder is an unsecured creditor and has no rights to the banks assets.

The law in relation to bank deposits and bank notes is established law for hundreds of years, and did not arise from government intervention, and does not require government intervention to be sustained or protected. If depositors and note holders place their funds under such terms, banks, under freedom of contract, are free to accept them and invest the proceeds according to their own preferences. Under free banking, banks engage in credit quality competition, so that funds generally are lent to very creditworthy banks.

Non-banks also accept or borrow funds repayable on demand, and do not need to maintain 100% reserves. For example, bank overdrafts are loans repayable on demand to the bank, but I’ve yet to hear anti-frb people object to the practice. Shareholders commonly lend funds to privately held companies by way of current account, again repayable on demand, but again no objection is to be heard. In fact any credit contract that is not payable at a particular time is payable on demand, and the words ‘payable on demand’ do not add anything, legally, to the contract (although, normally debtors are required to seek out their creditors and pay them, demand deposits and promissory notes require demand or presentation for payment.)

Plenty has been written on the problems caused by deposit insurance and prudential regulation of banking. French, however, rather than presenting or developing or adding to it, has gone off on an anti-frb tangent.

gene June 11, 2009 at 2:16 pm

“If FRB is fully disclosed it does absolutely nothing to hinder trade. But the only way to prevent FRB is to invite the government into controlling banks actually hindering the free exchange of those who support FRB.”

Hi Dick,
if like you say, FRB is fully disclosed, then the banker becomes nothing more than a broker, seeking investment for his clients [depositor] funds. As such, he would only receive a commission the depositor viewed as justified. Certainly, getting 2% on an investment such as credit card loans that might return 15% wouldn’t sit well with the investor depositor and maybe the risk wouldn’t either, if he knew about it. Likewise with mortgages, etc.

Instead, the FDIC uses taxpayer money to enable the FRB system. the taxpayer himself insures his own deposit. this makes the deposit seem “safe” and encourages mindless deposits in banks.

Without the FDIC in place, there would be no FRB system, the depositor would never put up with one in ten of his dollars being on deposit for such lousy return and market risk. And this is exactly how it should be, the depositor IS experiencing the risk, since it is his money. The only risk the bank has is not being able to pay back one in ten dollars! This is why it is so hard to determine when a bank is insolvent unless they are way gone. What other industry requires a federal agency to determine when its players are insolvent?

Full disclosure of the banking system would require the termination of the FDIC, the direct connection between the investment and the investor depositor and the storage of funds that depositors truly wish to store. At that point, there would be no need for regulation as the true nature of the risk would be apparent and investors could make judgements as they saw fit.

Also, at that point FRB ceases to exist. Unless we believe the same exact money can be two places at once, it never existed anyway.

David Hillary June 11, 2009 at 2:32 pm

Gene wrote

‘if like you say, FRB is fully disclosed, then the banker becomes nothing more than a broker, seeking investment for his clients [depositor] funds. As such, he would only receive a commission the depositor viewed as justified. Certainly, getting 2% on an investment such as credit card loans that might return 15% wouldn’t sit well with the investor depositor and maybe the risk wouldn’t either, if he knew about it. Likewise with mortgages, etc.’

This is incorrect, a banker is not a broker, a bank acts act principal in the business of borrowing money on current account repayable by cheque, in addition to other kinds of borrowing, and lending and investing money on its own account. A broker, by contrast, acts as an intermediary agent bringing together transacting principals, in exchange for a commission. For example, if I arrange for your funds to be deposited with a bank, in exchange for commission, I’m a deposit broker, not a bank.

This is similar to a retail store. The store does not sell the goods of the wholesaler or manufacturer on commission (normally), instead it buys the goods on its own account and risk, and re-sells them to you. The margin therefore belongs to the retailer. In the same way a bank borrows and lends money on its own account and retains the margin. The bank has its own capital, that absorbs any losses and risk, and the depositors and other creditors of the bank only carry the risk of the bank’s insolvency, i.e. the bank making more losses than its capital.

FRB pre-existed the FDIC and deposit insurance, and where it is allowd to operate without any government guarantees, has operated well, compared to with such guarantees.

Dick Fox June 11, 2009 at 3:39 pm


One of the things in the article that turned on a light for me was the moral hazzard of increasing the FDIC guananteed amout. By increasing the amount from $100k to $250k the government actually made the problem worse as French demonstrates.

I would eliminate the FDIC. Its whole purpose is to short circuit market discipline and it did just that to the extent that it made the problem worse.

Concerning your comments on FRB David Hillary is spot on.

gene June 11, 2009 at 4:43 pm

David wrote:

“This is incorrect, a banker is not a broker, a bank acts act principal in the business of borrowing money on current account repayable by cheque, in addition to other kinds of borrowing, and lending and investing money on its own account. A broker, by contrast, acts as an intermediary agent bringing together transacting principals, in exchange for a commission. For example, if I arrange for your funds to be deposited with a bank, in exchange for commission, I’m a deposit broker, not a bank.”

My questions would be, Where are the demand depositor’s funds then, in the account where they are promised under contract or loaned out to a debtor by the bank?

Exactly whose funds are at risk, the bank’s or the depositor’s?

Who experiences the “risk and return” in a “typical” debtor-creditor transaction, the owner of capital or a broker?

How is reserve banking actually “reserve banking” if there is no insurance? Without FDIC does that mean if the bank experiences a loss [or a bank run] on the depositor’s money, they will only pay 10% back and everyone will be happy or does that mean the bank will pay the full amount with its own assets?

Capital is private property. Risking another’s capital,backed by insurance supplied by the Fed which is backed from 1 to 100% by the taxpayer or the printing press and reaping the greater of the return for yourself while promising the funds are “demand” is a very interesting version of “business as usual”.

BioTub June 11, 2009 at 4:47 pm

Actually, the difference between full-reserve and fractional-reserve banking can be boiled down to whether the bank will return the deposit upon demand or will merely make every reasonable effort to do so. Handling bank runs is still an issue, but a contract saying you can seize a hysteric customer’s deposit to pay off those of cooler heads would probably be a good start.

David Hillary June 11, 2009 at 5:06 pm


All these questions would be answered by a better understanding of the law and accounting treatment of the banking transactions. Please refer to my http://davidhillary.blogspot.com/2008/11/banking-defined-and-defended-part-1.html and http://davidhillary.blogspot.com/2008/12/property-rights-analysis-of-banking.html .

The short answers to your questions: the depositors funds ARE the liability account of the bank, distinct from the assets the bank funds with those, and its other liabilities and equity. I.e. the customer’s funds consists of the claim on the bank, not the bank’s reserves and loans etc.

The customer is, as a creditor, exposed to the credit risk of the bank, which is not the same as the credit risk the bank is exposed to. The two differ because of the bank’s capital, and the depositor’s ranking as an unsecured creditor. This also answers the question about the distribution of risks and returns.

Reserve banking, i.e. fractional reserve banking, refers to the metallic or legal tender reserves held by the bank, in relation to its demand liabilities. Such asset holdings do not constitute an insurance contract.

The losses in the event of default of the bank depend on the bank’s losses, and the creditor’s security position and ranking in liquidation or receivership, not on the bank’s reserve policies. For example finance company receivership in NZ in the last 3 years have resulted in prospective returns of up to 90% in some cases for depositors, and as low as 10% in others. The low returns are cases where the financial institution has engaged in high risk loans on property developments secured by second mortgage, where practically all the loans have defaulted at once, also where the concentration of individual exposures has been very large. Of course no deposit insurance for those investors!

ABOM June 11, 2009 at 7:06 pm

Powerful, hard-hitting and deadly accurate assessment of the current banking mess.

The problems are profound and lead to the steps of Congress, the Fed building and the richest financiers in the country.

This is ugly and wrong.

gene June 11, 2009 at 7:25 pm

Hi David,
you are in new zealand? I have heard that is nice! people say it is a lot like oregon.

what you say makes sense, but I don’t see any great difference between banks and other investment firms, other than FDIC and the great amount of captial enabled by the FDIC.

take away the FDIC and allow free banking and what would we have that differs from any other credit-debtor relationship? Am I missing something?

if the bank can offer by itself 5% less risk on the depositor’s investment, then a free market would reward the bank with the 5%. But the bank can’t do, without the government, anything any other established firm or fund can do with similar capital and investments.Or what the smart investor could do himself. As it is now, the banks gets the big return and offer little other than government backing and the faith of the depositors [which as it turns out is a lot!].

What I am saying, is no matter how it is accounted, the exact same funds that the depositor has in his account is experiencing the exact same risk that every other dollar the bank has experiences. No matter how we complicate it, all we have is storage and investment, and we have virtually eliminated storage [other than in our wallets or safes, etc.], although we still make the claim, to keep people investing funds they think are stored.

I think the gov. backs everything up, not only to get the funds into banks, but to prevent real deflation which would completely undermine the public finances [or lack of them].

i will check out your webpage.

Jim Stewart June 11, 2009 at 7:58 pm

David Hillary concludes his Blog with “such arrangements [as covenanting to maintain a 100% metallic reserve ratio] are practically unheard of and not commercially successful when compared with normal banking practice”. Could the reasons for this include the following?
1. Markets are not informed of verifiable facts such as the fraudulent claims of bankers publicly exposed in a US court in December 1968. That’s when Lawrence V. Morgan, President of the First National Bank of Montgomery [the plaintiff], testified about the standard banking practice exercised in combination with the Federal Reserve Bank of Minneapolis, Minnesota. On his testimony, the Judge and jury declared a mortgage, along with a foreclosure and sheriff’s sale, to be void. The case and the court’s reasons are published on-line but remain suppressed by the mass media.
2. Money and credit are two different things. [Money is: "a medium of exchange issued by a government or other public authority in the form of coins of gold, silver, or other metal, or paper banknotes, used as the measure of the value of goods and services" and credit is: "an arrangement by which a buyer can take possession of something now and pay for it later or over time"].
Does David seriously expect anyone could be commercially successful competing against the “normal banking practice” of giving credit but only pretending to lend money? The fraud continues ONLY because the above facts remain concealed from countless millions of people [including US Presidents] – still paying [or authorising payments to] banks that pretend to have made loans! The only thing Barack Obama and countless presidents, governors, kings and queens have been guilty of is being taken in by the media-maintained fraud!
For more details of the above case see: http://www.lawlibrary.state.mn.us/CreditRiver/CreditRiver.html

Jim Stewart June 11, 2009 at 8:04 pm

Maybe this will make above link “live”.

David Hillary June 11, 2009 at 8:42 pm

Gene, Yes, I’m from and presently in NZ. It is a good place for business and to live, since it thankfully does not have many of the undesirable things that the US does such as capital gains taxes, estate taxes, and, up until recently, banking entry regulation and deposit insurance. Also a good place to in or through from offshore.

There are differences between banks and non-bank financial institutions in a monetary rather than a legal or financial sence. Although banks use regular legal and financial methods, they issue financial instruments that their creditors can use as money, or as a money substitute (depending on how you define the term ‘money’), and this is what causes a lot of confusion, and thereby, angst.

The FDIC and similar deposit insurance and bank guarantee schemes do not enable capital, they enable credit, i.e. credit in favour of the banks. Many people complain that it reduces the amount of capital banks need to hold in relation to their exposures to risk, and this is a fair complaint. I.e. banks have more financial leverage than would otherwise be the case.

Although you are conceptually right that a bank holding fractional metallic reserves serves two functions of storage and credit/investment, what you are missing is the output the banks can produce with these inputs, i.e. bank issued money. Other financial institutions do not issue money, and their liabilities cannot serve the function of a dual store of wealth and a means of payment.

There are some exceptions to this, as some other ‘non-bank’ financial institutions (note: also depends on the definition of the term ‘bank’) can issue liabilities that are substitutes to bank issued money, for example money market funds that issue and redeem units at a fixed price, building societies and credit unions that issue and redeem shares at a fixed price, and on terms and with supporting services that enable such instruments to be used as money. For example, a building society such as Southland Building Society (http://www.sbs.net.nz/) offer ‘banking services’ and cheque books, however such cheques are really negotiable redemption orders on ‘redeemable shares issued at call’.

It should also be noted that when there is open entry into an industry, exceptional profits cannot be sustained. Current institutions in the US feature both barriers to entry (not particularly high but there) and prudential regulation and deposit insurance. The regulatory environment could change to remove or relax barriers to entry and thereby the possibility of sustaining exceptional profits, even with the other features remaining.

Investors, even if they are smart, may want to use the services of a bank for reducing transaction costs. Managing assets is subject to economies of scale, and lending to a strong bank on current account provides some of these benefits even to the smallest depositor. Large institutions and companies, of course, do manage their own funds actively and therefore have fairly small exposure to any one bank, and do not rely on a bank they way most households and small businesses do.

MY June 12, 2009 at 2:27 am

How about we make a law that says if you accept a deposit, it automatically means bailment. You can go to an institution to:

1. Open a deposit account (bailment)
2. Buy an asset backed callable note (fractional reserve)
3. Buy a non asset backed callable note (fractional reserve)
4. Buy an asset backed termed note (fractional reserve)
5. Buy a non asset backed termed note (fractional reserve)

Guess what? Most people will do 2, 3, 4, or 5. There will be bank runs. They will go back to 1. When things get better, the cycle repeats itself.

At least this way, people will get what they deserve.

Jim Stewart June 12, 2009 at 2:47 am

David, you seem to have missed my comment and reference to your Blog.
Were you aware of the Credit River case before my notice? If not, you know why I concluded that the only thing Barack Obama and countless presidents, governors, kings and queens have been guilty of is being taken in by the media-maintained fraud!
Our problem now is to get a person or group with the courage and credibility to point out the facts to the likes of Barack Obama and countless presidents, governors, kings and queens.
Of course most with the courage, like Ron Paul, have been publicly discredited by media hacks. Others like Judge Martin Mahoney are silenced by suppressing news of the 1968 trial [and sequel].

David Hillary June 12, 2009 at 3:04 am

Jim, No, I didn’t miss it, I just don’t think it worth replying to.

David Hillary June 12, 2009 at 6:02 am

in response to MY
The law is already that a deposit with a bank or other financial institution constitutes a type of loan, so why should the law be turned upside down? just because you say so? The common law evolves and develops, generally avoiding disruptive and jarring shifts.

Funds on current account cannot be a note. A note is a document in writing, signed by the maker, engaging to pay a sum of money on demand or at a fixed or determinable time to the bearer or to a specified payee or his order. Thus notes are suitable for fixed amounts owing that are desired to be held in a documentary form (as a ‘documentary intangible’). Funds on current account are suitable for depositing cheques for collection and credit to the account, and for withdrawing on by writing cheques (and/or in the more modern technology, electronic payment orders and receipts). The options you mention for term and security are and have always been available for the parties to specify and/or pledge. Likewise parties can always make bailments if that is what they want to do — if they do this they should either use terminology of bailments or warehousing etc. or describe explicitly that title remains with the customer and that the institution must hold the goods separately and safely. However if they use the standard banking terminology of deposits of funds on account, then they should rightly be able to rely on existing understanding of those terms and the contract at law.

The law of the bank-customer contract is well established law, as can be seen from the case of Foley v Hill in 1911:
‘Money, when paid into a bank, ceases altogether to be the money of the principal (see Parker v. Marchant, 1 Phillips 360); it is then the money of the banker, who is bound to return an equivalent by paying a similar sum to that deposited with him when he is asked for it. The money paid into the bankers, is money known by the principal to be placed there for the purpose of being under the control of the banker; it is then the banker’s money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal, according to the custom of bankers in some places, or the. principal and a small rate of interest, according to the custom of bankers in other places. The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach, of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal, but he is of course answerable on the amount, because he has contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that paid into his hands.’ (see http://www.uniset.ca/other/css/9ER1002.html)

gene June 12, 2009 at 10:23 am

Hi David,

I wasn’t speaking of financial leverage or credit when I mentioned that the FDIC enables capital. What I meant is the FDIC “directs” capital to the banks. Without FDIC and with the realization that banks do with the depositor’s funds exactly what everyone else does, risk it in the marketplace, the fraction of money banks would actually receive is hard to calculate, but we know it would be much smaller than under current conditions.

You mention that law states that once deposited the funds are now the property of the bank. The word “demand” then used to describe many types of accounts is certainly deceptive. Again, the FDIC comes back into play as it allows enough leeway for the word “demand” to be used, which is not only a direct intervention by the governement in favor of the banks, but does not in actuality exist above 1% or so of the total deposits unless you include that which is backed by the taxpayer [depositor]. So, again deception.

The other ‘insurance’ that the FDIC offers is the “creation” of money, which is occuring at a great rate right now, to stabilize either the banks or the depositor. This value is also directly derived from the taxpayer/citizen/depositor, as you can’t create money [when that money is dominant by force] without monetary inflation.

The entire financial system is simply an intermediary thats purpose is to shift excess value between producers; those who have produced [or have profited from the production process] and those who need capital to enable future production. If it works efficiently, it can “enhance” production, but cannot produce itself.

It is the collective force and laws that “enhance” banking, not the economic principles. I am not arguing against the concept of “banking”, I just think banking as it exists today has little to do with a “free” economy. And a lot to do with the current problems.

newson June 12, 2009 at 10:50 am

to david hillary:
you seem to have the view that whatever direction common law takes is always correct. the economics of the deposit transaction (bailment) is not reflected by the legal reality (loan).

roman law upheld deposits as bailments up until the early twentieth century, so it’s not as though all jurists took the anglosaxon view.

judges are state employees, too, despite the aim of separation of powers.

newson June 12, 2009 at 11:06 am

to dick fox:
theory of money and credit (p.314) –
“The cost of creating capital for borrowers of loans granted in fiduciary media is borne by those who are injured by the consequent variation in the objective exchange value of money. . .” (p. 314).

“injured” seems to indicate mises had a less rosy view of frb than you grant him.

David Hillary June 12, 2009 at 1:24 pm

newson, no, I don’t hold English common law is perfect and never errs, however, I do believe that a) it is generally a good way of discovering and developing law and b) that it generally supports flexibility and that people develop their transacting and interacting behaviour to mitigate any undesirable features or directions. The economics of demand debt and bank issued money do interact with the law on bank-customer contracts and bank notes, and the result is the development of bank issued money and how it is used.

Gene, if the FDIC insurance premiums are uneconomically low, which it appears they are, then yes it will bring more capital and more credit to FDIC insured banks. But the demand concept of bank notes and customer deposits does not arise from or rely on the FDIC, banks can maintain convertibility of their demand liabilities without any government support.

Ria June 12, 2009 at 4:41 pm

Dead Banks Walking – mentioned is Southland Building Society. As a SBS small time investor housewife should I be worried?

newson June 13, 2009 at 12:50 am

to david hillary:
first the law changes, then people reach accommodations to conform to the judgements. errors in common law can be corrected by legislation, but one would have to be naïve to believe that government would abolish frb, the facilitator for the covert inflation tax.

gene June 13, 2009 at 1:45 am

yes, I believe newson is correct.

The government “allows” the banks to operate as such and the banks carry out the tax for the government.

David Hillary June 13, 2009 at 1:48 am


SBS is reputed to be one of the most conservative financial institutions in NZ, and it is now a registered bank, however its credit rating is lower than the big four Australian owned banks. No reasons I know of why they are not a good risk, they are no ‘dead bank walking’.


Generally legislatures do not try to abolish possible commercial arrangements by legislation, although there are plenty of counter-examples to this. Typically legislation restricting commercial practices are those touching one aspect of how a contract may operate, e.g. the abolition of ‘distress for rent’ or flat rate interest on consumer loans. But transactions such as leasing of real estate and lending of money at interest are still allowed, in these examples.

A legislative restriction on frb would tend to promote the replacement of frb with economically and functionally equivilent alternative financial instruments. Government has no reason to legislate against frb, and the case for restriction is to be made by those advocating such restrictions. Such a case is a weak one and well answered by their opponents, in my view.

newson June 13, 2009 at 3:40 am

david hillary,
every bank run weakens your defense of frb. i agree the government has no reason to legislate against it.

David Hillary June 13, 2009 at 5:06 am

Newson, bank runs are a not the only form of runs in a free market. Heard of the bullwhip effect? one of the causes is runs on stocks of goods in the supply chain. Do these problems mean that supply chains are a bad idea or are something against defences of supply chains or supply chain management? No. Just as supply chain managers develop methods of avoiding and dealing with runs on stocks of goods, bankers have developed methods of avoiding and dealing with bank runs.

gene June 13, 2009 at 2:48 pm

I also agree that government has no right to legislate against any form of investment that is not fraudulent or deceptive.

The government also has no right to legislate for ANY form of investment. The FDIC is a deceptive bank subsidy. Forced acceptance of money creation is value theft from everyone’s capital in order to bring value to that which inherently has none and benefit those who are advantaged by either the “permission” to create or first in line to receive the new funds.

David Hillary June 13, 2009 at 4:38 pm

Gene, the issue is not so much the creation (i.e. issue) of money, and its quantity, but:
1. Monopolisation of the issue of paper money,
2. Making such paper money legal tender by government fiat, in lieu of metallic money, and
3. the non-payment in gold coin or gold bullion, and the lack of prospect of resumption of payment at any particular rate, and the lack of similar indirect redemption or anchoring of the paper money standard to gold.

Together these three create the unanchored fiat money paper standard.

gene June 13, 2009 at 5:13 pm

Hi David, yes, I agree completely. that is why I wrote, “forced acceptance”.

Mike Sproul June 13, 2009 at 6:10 pm

David Hillary:

Your point #2: Legal tender laws constitute theft if they are enforced, but in most times and places they amount to nothing but some printing on government bank notes. Inflations have happened in spite of legal tender declarations, and most so-called legal tender moneys are valued in foreign countries, where legal tender laws can’t be enforced.

Your point #3: If a landowner buys groceries by writing an IOU for 1 ounce of silver, and if that landowner accepts those IOU’s in payment of rents on his land, then those IOU’s could circulate as money, and be widely valued at one ounce, assuming the landowner has adequate assets to back the IOU’s he issues. The IOU’s would have value even if none were ever redeemed for actual silver. People might even (mistakenly) refer to those IOU’s as fiat money on that account.

If the landowner lost assets, then the IOU’s would lose value. That is, they would become ‘unanchored’. But if the landowner still has assets, and if he still accepts the IOU’s in rent payments, (at a reduced rate) then those IOU’s still can’t properly be called fiat money. They are still backed by the landowner’s assets. Change ‘landowner’ to ‘government’, and ‘rent’ to ‘taxes’, and the same principles apply to government-issued paper money.

Your point#1–agreed.

newson June 13, 2009 at 9:27 pm

to david hillary:
inventory management has nothing to do with frb. the former is a function of the changing supply and demand of a product line; the latter a deception regarding title to money held as a “deposit”, but treated by the banks as a loan.

the abc is generated by the issue of fiduciary media, though it sounds like you subscribe to the white/selgin/horwitz/dowd free-banking school, and so reject this claim.

David Hillary June 13, 2009 at 9:45 pm


Legal tender laws do not need to be enforced, because they are merely definitional, i.e. what kind of tender is a lawful discharge of debt denominated in a particular currency. Although such laws need not be disadvantegous to creditors, in the course of displacement of the gold standard with an unanchored fiat paper money standard they have been, to creditors under the original standard repaid in the latter standard at lower gold value. The fact that such paper standards retain some value in terms of gold or foreign currencies is not evidence that they are natural, efficient or equitable.

No one has ever introduced a paper instrument that was willingly accepted and used as money based on acceptance by a particular creditor or service provider. I wonder what planet you live on to proffer such an example. Why would transactors demand to accept hold or use instruments as money that are issued by someone without especially good credit and that are not legally and effectively payable in coin on demand, when there are banks of high credit standing, that issue instruments that are easily and legally payable in coin, as well as for deposit to cheque accounts?

Fiat money means money that is legal tender by government fiat, i.e. money that would otherwise not be considered legally proper, in and of itself and by its own power, to unconditionally discharge debts denominated in money. For example, under a gold coin standard, if bank notes were made legal tender, then such notes would be fiat money, notwithstanding that such notes may continue to be legally and effectively payable in gold coin on demand. It appears you are using the term fiat money to mean money that is not legally and effectively redeemable on demand.

If the landowner’s notes were payable in silver coin, then so long as the landowner will pay them in silver coin, or receive them in lieu of silver at face value (and the stock of them was not more than there was demand to hold them), then the landowners notes would continue to hold their commercial value, even though the landowner’s assets was reduced. It is only in the case where the notes are not payable in silver coin, nor receivable in lieu of silver coin (without an excessive stock in relation to demand to hold them), that the notes will trade at a discount to silver. And of course the whole idea of a metallic standard is that the metallic coins are the standard of value, with the bank notes and other financial instruments being compared against that standard.

You might want to consider the accounting definitions of cash and cash equivalents:
‘Cash comprises cash on hand and demand deposits.
Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an
insignificant risk of changes in value.’ (New Zealand Equivalent to International Accounting Standard 7
Statement of Cash Flows (NZ IAS 7), definitions)

Although the accounting standard to call something cash is wider than most economists would allow to the term ‘money’, the Sproul ‘cash’ is still considered cash even though it is not ‘readily convertible to known amounts of cash’ and not ‘subject to an insignificant risk of changes in value.’

You are right that the same principles apply to government issued paper money, but your analysis is incomplete and faulty, notwithstanding the fact that you are an academic who has spent the bulk of your academic career on this topic.

David Hillary June 13, 2009 at 9:53 pm

newson, only the anti-frb people are alleging deception concerning the title to the bank’s assets: the bank treats it as a loan because that is what it is, legally, and customers have access to the same knowledge as the banks do concerning the law of the bank-customer contract.

Mike Sproul June 13, 2009 at 10:32 pm

My point about legal tender laws was that they can only affect the value of money if they are backed. A dollar has value either because someone will pay you an ounce of silver for it, or because someone (e.g., the tax man) will accept it in lieu of silver. There are plenty of examples of currencies that lost all value in spite of legal tender declarations (e.g., the continentals and the assignats).

“No one has ever introduced a paper instrument that was willingly accepted and used as money based on acceptance by a particular creditor or service provider.”
Examples that come to mind: The French playing card money of 1685, the Massachusetts paper shillings issued in 1690, the privately-issued bills of exchange common in the 18th and 19th century. Not to mention the fact that I can pay my mechanic for a tune up with my $100 IOU. He accepts it because his worker accepts it for wages, and his worker rents a house from me.

For the record, when I say ‘fiat money’, I mean unbacked money, which is supposedly valued only because the government limits its supply, while people demand it for liquidity. This raises the obvious question of how such a money could hold value when rival moneys exist.

The landowner’s notes must be valued according to his assets and liabilities. Public ‘demand’ for those notes would evaporate if assets were insufficient. If the value of the notes exceeded the value of the landowner’s assets, then the landowner would have earned a free lunch, and arbitragers could profit by selling the notes short.

David Hillary June 13, 2009 at 11:19 pm

Mike Sproul has some funny mechanics where he lives. Bills of Exchange are still common today, the most common example of which is the cheque. These days cheques are not easy to get merchants to accept where I come from. I was unfortunate enough the other day to get a cheque in return of my deposit for a baby car seat rental. It was made out to me and was negotiable and was not crossed, i.e. in theory I could indorse (=endorse) it in blank to make it a bearer instrument, or indorse it to another person. I tried to use it to get some petrol (=gas), but no luck ‘cheques only accepted by prior arrangement’. Cheques are not popular with merchants because they might not be honoured, even though the merchant has a legal right to the funds as against the drawer of the cheque. Merchants would rather have cash (not used much these days but still accepted) or EFTPOS (electronic funds transfer at point of sale) because a) cash is legal tender and the standard of value and b) EFTPOS funds are money owed by the bank and the bank isn’t likely to go broke.

Some more accounting and finance lessons for Mike: finance comes in two forms: debt and equity. Notes are a form of debt. Equity is a residual claim on total assets, debt ranks ahead of equity, so, provided total assets are financed to a substantial extent by equity, then the value of debt does not substantially vary in relation to total assets, especially debt payable on demand. So, ‘backing’ is only relevant when the debtor’s solvency and equity position is in question. Effectively Sproul assumes that issuers of money are typically insolvent. Effectively, I assume that issuers of money, in a competitive market, are solvent.

newson June 13, 2009 at 11:32 pm

to david hillary:
then why not change the language to reflect the economic nature of the operation? why are bankers allowed to use language ambiguosly when it suits them, and yet if i advertise a “cure” rather than a “treatment” for cancer, i’d be promptly sued?

if language means whatever one wants it to means according to the circumstances, then all contracts can be voided. also, where is the full disclosure on the mechanism of frb in any pds? banks are generally punctilious, why not here?

what about the collateral effects of fiduciary media on third-parties (via cantillon effects)? do they not warrant attention?

David Hillary June 14, 2009 at 12:42 am

Newson, banking terminology is very old, so changing it is pretty much out of the question. Banking terminology is not just deposit but also:
account (bank account, current account, cheque account etc.)
cheque (check in the US)
withdraw (also draw, and drawee as in drawing a cheque on a drawee bank, also overdraft and overdrawn)
credit (as in I have credited your account, likewise debit)
statement (as in account statement)
customer (this word has a specific meaning in banking law).

Also, words have different meanings in different contexts. So, the typical context is that a customer applies to open an account with a bank, and the customer deposits funds to the credit of the account and draws on the balance from time to time by drawing cheques on the bank, and also deposits cheques of which he is the holder in due course for collection by the bank. In this context the meaning of the terms and the relationship effected is what makes up the law of banking, i.e. the bank-customer contract and the implied terms of the contract, including debtor-creditor relationship, agency relationship when the bank is collecting cheques on behalf of the customer and so forth. Legally there is little ambiguity here: the contract, like the terminology is more than 100 years old.

Most investments are regulated by prospectus requirements that require large amounts of disclosure, however, banking is often regulated separately from other investments and therefore a prospectus may not be required. For example in NZ a registered prospectus is required for offering debt securities to the public in New Zealand, however if the offorer is a registered bank, no prospectus is required, instead the bank has disclosure regulations as an organisation as a whole. So, the bank’s general disclosure statement is the customer’s substitute for a prospectus, in the case of NZ (unregistered banks still have to register a prospectus, but 90% of the banking sector is registered banks). These general disclosure statements classify customer deposits as the bank’s liability in the financial statements and notes thereto.

David Hillary June 14, 2009 at 1:35 am

‘Deposits from customers are unsecured and rank equally with other unsecured liabilities of the Banking Group. In the unlikely event that the Bank was put into liquidation or ceased to trade, secured creditors and those creditors set out in the Seventh Schedule of the Companies Act 1993 would rank ahead of the claims of unsecured creditors.’ Note 22 of the Financial Statements of ANZ National Bank Limited, as set out in the General Disclosure Statement for the year ended 30 September 2008 (http://www.anz.co.nz/about/media/library/ii/gds20081128c.pdf)

This is from NZ’s largest bank, and it seems pretty clear to me!

P.M.Lawrence June 14, 2009 at 5:10 am

Mike Sproul wrote “Change ‘landowner’ to ‘government’, and ‘rent’ to ‘taxes’, and the same principles apply to government-issued paper money”.

He made that faulty assertion before, in a reply to me on another thread. Obviously I should have shown him the highly material differences then, so as not to encourage him.

Rent is in exchange for a service rendered – it is a free market transaction. Taxes are not, and – flowing from that – they can be and often are varied at governments’ discretion, usually upwards and to include more other people. Landowners cannot do this, and must provide something (occupancy) to get their rent.

The only government-like aspect of the landowner/rent combination is when the landowner did not acquire the land justly – but that is a distinct and separate question, nothing to do with land ownership or rent as such, although it is common enough that it should be addressed.

What a landowner/rent backed currency does have in common with a tax backed fiat currency is, the mechanics of backing it that connect the currency to a payment obligation. What it does not have in common is, there is an underlying backing that is based on genuine free market obligations as opposed to governments’ “we say you owe taxes” – the saying of which is the “let it be so” that fiat means.

newson June 14, 2009 at 6:38 am

to david hillary:
yes, i know you can dig up, if so motivated, the correct definition (and indeed the balance sheet does reflect the economic reality), but this information is not required to be acknowledged upfront like all other financial products.

newson June 14, 2009 at 7:22 am

i should have said “…acknowledged upfront, when the deposit account is opened, like all other financial products”.

Mike Sproul June 14, 2009 at 11:39 am


1) My mechanic has an excellent sense of humor, but he is not ‘funny’ in the sense you meant.
2) This statement of yours: “”No one has ever introduced a paper instrument that was willingly accepted and used as money based on acceptance by a particular creditor or service provider.” is clearly wrong. People accept IOU’s all the time, and those IOU’s displace government-issued paper money.
3) The fact that debt ranks ahead of equity does not change the fact that the value of debt is determined by the value of the assets that back that debt.
4) You are right about fractional reserve banking not being fraudulent. Once you recognize that, the next step is to recognize that the loan expansion process is not inflationary, either when practiced by private banks or by central banks.

PM Lawrence:

The legitimacy of property claims is, as you say, beside the point. The IOU of a legitimate landowner will have value and can circulate as money. So can the IOU of a thug who took land by force and calls himself King. In both cases, the IOU’s have value because they are backed by assets. If the landowner or the King loses assets, then the value of their IOU’s will fall. Money that is backed by assets is not fiat money–at least in the sense that every economics text uses that term. By a semantic twist, the landowner issuing his IOU can add the words “Let it be so.”, and someone might (mistakenly) call his IOU fiat money. But if the landowner had no assets, his ‘Let it be so.’ would not give value to his IOU’s.

David Hillary June 14, 2009 at 2:01 pm


I know commercial non-bank debt can displace bank issued money and coin to facilitate exchanges, however it will always have a limited sphere of acceptance, usually the debtor’s regular suppliers who have approved granting credit terms to their customer. My point is that in a competitive market for bank notes, strong, well branched banks will dominate this trade, as opposed to a) some random householder(s), b) some random landowner, or c) any other person who does not specialise in this business, along with banking and money lending businesses. Likewise the form of money that will gain a wide sphere of acceptance will not be an IOU, it will be a promissory note payable on demand.

The difference between debt and equity is fundamental to finance. Within debt there is also a spectrum running between demand debt of the highest credit quality and long term debt of commercial quality. Banking and cash management exists at one end of this spectrum of debt. Instruments that are payable on demand or within 3 months and are very high quality can be included within an entity’s cash management activities. Longer term debt and lower credit quality debt, and equity investments cannot. Most economists limit the concept of money or cash to demand debt and will not admit short term marketable debt securities. At the limit, demand debt issued by high credit quality issuers are valued at par, a fact that implies that the issuer’s equity position is satisfactory and its liquidity is also satisfactory.

I’m not someone who links inflation to frb, so I’m not sure why you’ve mentioned point 4. I’m of the ‘banking school’ rather than the ‘free banking school’ although I am a free banker. This is in the context of the historical debate between the schools when payment of bank notes in gold coin was not in question. For Mike Sproul, however, non-payment in gold coin is not of concern, whereas for me it is fundamental to the monetary standard of value.


I agree with you that it could be made more explicit, however if you look at other transactions people undertake in life, there are plenty of examples where the terms of the contracts are implicit rather than explicit. In many cases people sign documentation without reading it. Investment regulations in some cases offer demand debt contracts exemptions from upfront disclosure. For example in New Zealand there are normally two documents investors may deal with: the registered prospectus and the investment statement. The Securities Act 1976 requires subscriptions of securities to be made only on an application form in or with an Investment Statement. However, callable debt securities are exempt from this, because the nature of these securities is that subscriptions and redemptions are occuring frequently. Registered banks issuing callable debt securities are likewise exempt, however they still have to provide an Investment Statement with their Term Deposits and other non-callable debt securities. When I rented this house I don’t remember the contract explicitly pointing out that I would take possession but not title. Implied terms must be a) necessary for the contract to work and b) so obvious it goes without saying. Debtor-creditor terms are implied into customer deposits on account with a bank, so it appears that this is considered sufficiently obvious. After all, what do you suppose banks are known to do with funds they have? they are known to lend and invest them on their own account!

P.M.Lawrence June 14, 2009 at 7:14 pm

No, Mike Sproul, it is not true in general that “The IOU of a legitimate landowner will have value and can circulate as money. So can the IOU of a thug who took land by force and calls himself King. In both cases, the IOU’s have value because they are backed by assets.” It is only true in the special case where the king confines his revenue raising and derivative currency creation to assets he took earlier (which is why the French assignats were structured that way). It is most definitely not true when there are no underlying assets but the currency creation rests on payment obligations that are just taxes. You have a blind spot about whether there really are such assets, instead inferring that a payment obligation implies that there are. Going through a two step process, first taking land and then building financial structures on that, means that the first unjust step does actually provide that sort of base for the second step. Simply having a land tax (say) is only equivalent in funds flow terms, but it leaves the “underlying” assets where they were – which means that they are not in fact underlying, since the support collapses without recourse the moment the tax fails (if rents failed, the land owner could and would have to sell up the land to cover his liabilities – the currency is covered).

Mike Sproul June 14, 2009 at 9:34 pm


I also consider myself a free banker, and favor the banking school over the currency school. (I also favor the antibullionist school over the bullionist school, and the bullionist debates happened during a period of inconvertibility.)

This statement of yours: “For Mike Sproul, however, non-payment in gold coin is not of concern, whereas for me it is fundamental to the monetary standard of value.” seems to be at the heart of the matter.

While I agree that convertibility matters, you don’t seem to agree that backing matters. If a bank has issued 100 paper dollars, and holds various assets worth 99 oz. of silver, then a bank that maintains convertibility at 1 oz/$ will fail. Customers will see that the bank cannot afford to buy back all of its dollars at 1 oz each, and a bank run results, with the last customer in line holding a worthless dollar. Conclusion: convertibility without adequate backing does not maintain money’s value.

But if a bank holds miscellaneous assets worth 100 oz, as backing for $100, then that bank can suspend physical convertibility for short periods (e.g., a weekend) and people will still value the dollars at 1 oz. Conclusion: Adequate backing can maintain money’s value, even absent convertibility.

From there we can add various complications: Convertibility can be instant or delayed, certain or uncertain, free or costly, at the customer’s option or at the bank’s option, physical or financial. Once one recognizes the broad spectrum of degrees of convertibility, it becomes clear that people who call the US dollar ‘unbacked’ are overstating their case. The correct view is that the US dollar is backed but (in a limited sense) inconvertible.

newson June 14, 2009 at 9:45 pm

to david hillary:
i know what you’re saying, but i maintain these commercial practices don’t evolve in a vacuum, and it seems all too innocent to assume that consent can be implied rather than explicitly given, especially as frb allows for vastly higher profits that mere warehousing and loan-broking. for example, my cheque account bears no interest – am i therefore to assume that the funds are warehoused? i don’t think so. but i’ve never had any document from my bank indicating what happens should insolvency occur.

nevertheless, with central banks as lenders-of-last-resort, customers don’t even have to bother to care about the exact nature of their banking relationship as they stand no danger of losing savings whatever may happen.

Mike Sproul June 14, 2009 at 9:48 pm

PM Lawrence:
“It is only true in the special case where the king confines his revenue raising and derivative currency creation to assets he took earlier”

So if a king stole land worth 100 oz yesterday, he can issue 100 currency units against it, but if he steals another 100 oz. worth of land today, he can’t continue the process?

If people expect that a king will steal (i.e., tax) 10 oz of silver from them every year for the rest of their lives, and if they also expect that the king will accept his own IOU’s in lieu of silver, then they will value the King’s IOU’s at 1 oz each.

David Hillary June 14, 2009 at 11:41 pm


Both payment (convertability) and ability to pay (liquidity and capital adequacy = ‘backing’) are important, and I’m not minimising ability to pay, contrary to your claim.

What you seem to be missing, Mike, is that legal certianty is important in monetary and negotiable instrument law and economics. Perhaps I should quote someone else who has said it well:

Sir R. Peel rose, and addressing Mr. Greene, who was in the Chair, said — Sir, there are occasionally questions of such vast and manifest importance, and which prefer such a claim, I should rather say such a demand, on the attention of the House, that all rhetorical prefaces, dilating on their magnitude or enjoining the duty of patient consideration, are superfluous and impertinent. I shall, therefore, proceed at once to call the attention of this Committee to a matter which enters into every transaction of which money forms a part. There is no contract, public or private, — no engagement, national or individual, which is unaffected by it. The enterprises of commerce, the profits of trade, the arrangements made in all the domestic relations of society, the wages of labour, pecuniary transactions of the highest amount and of the lowest, the payment of the national debt, the provision for the national expenditure, the command which the coin of the smallest denomination has over the necessaries of life, are all affected by the decision to which we may come on that great question which I am about to submit to the consideration of the Committee. …

My first question, therefore, is, what constitutes this Measure of Value? What is the signification of that word “a Pound,” with which we are all familiar? What is the engagement to pay a “Pound”? Unless we are agreed on the answer to these questions, it is in vain we attempt to legislate on the subject. If a “Pound” is a mere visionary abstraction, a something which does not exist either in law or in practice, in that case one class of measures relating to Paper Currency may be adopted; but if the word “Pound,” the common denomination of value, signifies something more than a mere fiction — if a “Pound” means a quantity of the precious metals of certain weight and certain fineness — if that be the definition of a “Pound,” in that case another class of measures relating to Paper Currency will be requisite. Now, the whole foundation of the proposal I am about to make rests upon the assumption that according to practice, according to law, according to the ancient monetary policy of this country, that which is implied by the word “Pound” is a certain definite quantity of gold with a mark upon it to determine its weight and fineness, and that the engagement to pay a Pound means nothing, and can mean nothing else, than the promise to pay to the holder, when he demands it that definite quantity of gold.’ (from http://www.victorianweb.org/history/polspeech/bank.html)

This quote shows the wisdom of the day in which it was said, which appears to be lost on Mike Sproul: to serve as a standard of value, a definition thereof ought to be sure and clear, unchanging, and an engagement to pay this standard of value ought to be likewise clear in whether it has been honoured or dishonoured. This clearness and sureness is one of the benefits of a metallic standard that is not offered by a paper standard, whether or not the paper is convertible.

Although Mike might be happy to add complications, trade and finance prefers to avoid them, and seeks legal and contractual certianty. The law of negotiable instruments provides such certianty: it defines what it is for a note or bill to be honoured, and likewise for it to be dishonoured. For example is closing for the weekend or night dishonouring a note or bill? ‘Presentment must be made by the holder, or by some person authorised to receive payment on his behalf, at a reasonable hour on a business day, at the proper place as hereinafter defined, either to the person designated by the bill as payer, or to some person authorised to pay or refuse payment on his behalf, if by the exercise of reasonable diligence such person can there be found.’ So, no, such instruments are payable on presentation at the proper place on a business day and hour. Similarly: ‘A bill is dishonoured by non-payment—
(a) Where it is duly presented for payment and payment is refused, or cannot be obtained; or
(b) Where presentment is excused and the bill is overdue and unpaid.’

In this way there is a clear legal standard of honour and dishonouring obligations to pay money on notes and bills.

This is the standard against which convertibility should be measured: are the notes a) legally payable in metallic money and b) honoured when duly presented for payment. Anything less is not conversion but recovery (whether in full or in part) on dishonoured obligations.

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