Abstract
In a number of recent articles, the debate on the ethics of fractional reserve “free” banking has been extended to loan maturity mismatching, specifically the banking practice of borrowing short and lending long. Barnett and Block (J Bus Ethics 88(4):711–716, 2009; 2010) claim the practice is illicit, because like fractional reserve banking it creates duplicate property titles. They argue there is a continuum in the time dimension between the two kinds of activities. Bagus and Howden (J Bus Ethics 90(3):399–406, 2009; 106(3):295–300, 2012a; Eur J Law Econ, 2012b; Bus Ethics 22(3):235–245, 2013) maintain that loan maturity mismatching does not create duplicate titles and is not illicit, and that from an economic and legal perspective there is no continuum with fractional reserve banking. Cachanosky (J Bus Ethics 104:219–221, 2011) and Evans (J Bus Ethics, 2013) enter the debate from the free-banking standpoint and view both practices as legitimate. In this paper, I agree with the conclusions of Bagus and Howden, but adopt a different approach to support this position. Using the title-transfer theory of contract, I demonstrate from first principles why loan maturity mismatching does not create duplicate property titles and is a legitimate practice. Employing this same theory, I then present a novel argument to show why the contractual arrangements found in fractional reserve banking are logically contradictory and illegitimate.
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Notes
For the pro-fractional reserve “free” banking position, see Selgin (1988), White (1989) and in particular Selgin and White (1994, 1996). Those opposing FRB on ethical grounds include Rothbard (1962, pp. 18–24), Rothbard (1983, pp. 87–111), Block (1988), Hoppe (1994), Hoppe et al. (1998), and Hulsmann (1996).
In this regard, they follow Huerta de Soto (2006, Chap. 1).
Since money is fungible, the exact same units of the good do not have to be returned in either case.
According to Bagus and Howden (2012a), “That a demand deposit must imply safe-keeping is not an assumption. Instead we argue that a legal contract exists whose primary purpose is the safe-keeping and availability of the deposited goods.” These authors also maintain that “… in loan contracts where one party transfers the availability of the good to the other party, there is always a specified and finite term limiting this use. The motivation is the transfer of the availability of the lent good for the term.” According to BH, a demand account and a loan agreement can also be differentiated by the fact that the former has a zero term to maturity, whereas the latter's term is greater than zero. Now, if this is always true, and the motivations attributed to the actors are correct, then it is a relatively simple task to show there is a clear ethical difference between FRB and LMM (although Barnett and Block might still disagree). But other than citing historical precedent and ascribing motivations to the actors, nowhere in their exposition do BH explain why contracts other than those mentioned are illegitimate if all the parties concerned are in full agreement. And thus never do they directly answer the free bankers' questions: Why cannot a money loan remain on-demand to the original lender if that is what the parties wish, and if they do wish it, why is FRB not legitimate in a free society if LMM is legitimate? One of the purposes of the present paper is to demonstrate why demand loans are invalid, and to do so without relying on precedent or making assumptions regarding the psychological state of the actors.
The paper of Bagus et al. (2013) is an attempt to clarify the earlier debate. Unfortunately, it raises more questions than it answers. The authors are correct in saying that a theory of property rights must precede any theory of contract law, and that free bankers such as Selgin and White embrace an ethical relativism, an “anything goes” approach. But having declared this, the authors repeat the refrain that “In a deposit contract, the depositors wish to safe-keep goods and maintain their availability at all times,” and “In distinction, the main motivation or cause for the depositor in a deposit contract is the custody or safe-keeping of the money.” But how do these authors know what the motivations and desires of those engaging in deposit and loan contracts are? These kinds of assumptions are certainly problematical in any objective ethical analysis. In their conclusion, the authors claim that critics of the Rothbard school on fractional reserve banking fail because: “… legal principles that evolved over centuries in both common and civil law contradict this “anything goes” mentality.” Maybe so, but this does not answer the question why the legal principles that evolved are ethical, and why modern fractional reserve demand deposits are not. As Evans (2013) points out, if one defines a demand deposit as being equivalent to a bailment—or a depositum—then it is true that applying the same term to something that is not a bailment would constitute a fraud or a mistake. But why, asks, Evans must they be defined this way? Why indeed?
See Selgin and White (1996).
The promise to transfer the property back in an agreed-upon condition at the end of the lease can be enforced with the use of a security deposit, similar to collateral in a loan agreement. Rent is analogous to interest in the loan contract.
An example of a “loan” for use would be a friend letting another friend use her tennis racket. However, the “loan” has the title-transfer attributes of a rental contract, albeit rent-free, rather than a money loan, because the right to dispose of it is not transferred. On the other hand, an example of a loan where the property rights are given up in their entirety (other than money) would be a neighbor lending another neighbor some sugar to bake a cake. In this case, the sugar is of no use unless it is completely disposed of—i.e., consumed. Thus, the contract requires the transfer of full ownership rights. Assuming this was not a gift, and no extra payment was required, this would be an interest-free loan, according to the TTT.
See also Bagus et al. (2014) on this issue.
As Barnett and Block (2010) state, “But there can be no ‘exchange of present goods for future goods,’ because future goods do not (yet) exist… According to Mises (1998, p. 93) goods are means to ends. Moreover, Mises (1998) states: ‘As the consumers’ goods are present goods, while the factors of production are means for the production of future goods…’ It is obvious from this that future goods do not exist. Rather, what exists are but present expectations as to future goods.”
Claims such as these are intangible goods. In many loan contracts, such as bonds and mortgages, the claims or “notes” are fully tradable on a thriving secondary market.
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Davidson, L. Ethical Differences Between Loan Maturity Mismatching and Fractional Reserve Banking: A Natural Law Approach. J Bus Ethics 131, 9–18 (2015). https://doi.org/10.1007/s10551-014-2263-z
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DOI: https://doi.org/10.1007/s10551-014-2263-z