Skip to main content

The Hubris of Hybrids

Journal of Business Ethics volume 145, pages 373–382 (2017)Cite this article

Abstract

In the pages of this journal, a fruitful debate has evolved on the ethical legitimacy of fractional-reserve banking. In this article, we respond to the new arguments raised by Evans (J Bus Ethics, 2014) as we clarify our (Bagus et al. in J Bus Ethics 128:197–206, 2015a) position on the unethical and illegitimate nature of fractional-reserve banking. Fractional-reserve banking is not a recent financial innovation (unlike, e.g., money market mutual funds) but represents a long-standing legal aberration. The co-mingling of two mutually exclusive financial contracts, deposit and loan, confounds the contracting parties’ purposes, intents, rights, and obligations. As a result, it creates unsolvable legal difficulties and ethical dilemmas. While these problems are most evident in the case of a bank run, they also arise when trying to answer the simple question of “who owns a deposit?”

This is a preview of subscription content, access via your institution.

Access options

Buy single article

Instant access to the full article PDF.

USD 39.95

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Notes

  1. For a detailed look at the differences between deposit and loan contracts, see Huerta de Soto (2009, ch. 1), Bagus and Howden (2013) and Bagus et al. (2013). For a legal analysis of the characteristics of the deposit contract, see also Mano (2014).

  2. In the case of fungible goods such as money, safekeeping and custody refers to the tantundem (an asset equivalent in quantity and quality of the deposited good).

  3. Any loan transaction lacking a term is best classified as a gift (Bagus and Howden 2012b, 2013fn4).

  4. All participants to this debate agree that banking services would be better provided lacking deposit insurance guarantees or a central bank acting as a lender of last resort.

  5. In terms of Roman law, we would speak of an “error in negotio.”

  6. The question of the survey was (Evans 2010): “You may or may not have been previously aware that banks lend out some of the money deposited within current accounts by their customers to fund loans. Which of the following best describes how do you feel about the fact that your bank lends out some of the money in your current account as loans?” One-third of the interviewed people answered: “This is wrong—I have not given them my permission to do so” showing a clear lack of a ‘meeting of the minds.’

  7. When Evans (2014, p. 3) writes: “Let’s for the sake of argument accept that there must be an implicit minimum and maximum term,” he agrees with us only rhetorically that a loan needs a term but does not apply this insight to any of his arguments.

  8. On Austrian business cycle theory see von Mises (1953, p. 98), Hayek (1931) or (Huerta de Soto 2009).

  9. It is striking that Evans (2014, p. 3) calls a bank run a “freak event.” Fractional-reserve banking systematically causes such “freak events” in the absence of a central bank functioning as a lender of last resort. Nevertheless, we must point out that the economic fact that fractional-reserve banking triggers the process that leads to bank runs does not affect our legal assessment of the fractional-reserve demand deposit contract.

  10. BHG do not suggest that in the case of the jointly owned tennis racket there is an “interfering with other people’s property” as Evans seems to believe (2014, p. 3). The tennis racket example was just to show that there is a difference between joint ownership, which is possible, and joint availability, which is impossible.

  11. Depositors not only believe that they have full availability of the money in their accounts. According to Evans’ own survey evidence, 74 % of respondents even believe that they are the “legal owner of the money in their current account,” while under current banking law the bank is the owner (Evans 2010).

  12. In this way, some have argued that fractional-reserve banking resembles a tragedy of the commons situation (Huerta de Soto 2009, pp. 666–669; Bagus 2004, 2011).

  13. See Hutt (1956) and Hoppe (2009) for the use of money held in ‘idle’ cash balances.

  14. Rothbard (2011, p. 171–72) reminds us concerning the meaning of subjectivism in economics: “[R]ecent Austrian paradigms have allowed ‘subjectivism’ to run riot: to extend from legitimate subjective value theory to a virtual denial of the objective existence of the real world, of the objective laws of cause and effect, and of the objective validity of deductive logic.” In short, a real world exists with objective legal principles and deposit contracts with an objective “essential element.”

  15. On the practical meaning of full availability see Bagus and Howden (2012a).

  16. Stated another way, subjectivism determines the value of a deposit and the quantity of deposits that an individual demands. Subjectivism does not (cannot) alter what a deposit is.

  17. Technically, this product would be more aptly called a short-term loan with an embedded extension option at the discretion of the lender (Bagus et al. 2015b).

  18. Evans (2014, 5, fn. 8) similarly states: “In other words, they [BHG] say that a time deposit with a withdrawal clause, that operates as a demand deposit, suffers from the same illegitimacy as an actual demand deposit. But this de facto/de journo [sic] distinction isn’t clear cut.” In theory, the distinction is clear cut. Everything that resembles a demand deposit with its typical characteristics is a demand deposit and the traditional principles apply. Everything that resembles a loan is a loan. In practice, judges must decide. But the fact that judges must decide does not imply that there are hybrid contracts, nor that there is an overlap between deposit and loan contracts such that some hybrid contract is, e.g., 50 % deposit and 50 % loan. Note that the legal system does not adjudicate that the defendant acted 50 % in self-defense and 50 % in first-degree murder, nor that an advertising campaign is only 25 % deceptive.

  19. This point is especially important as all sorts of financial contracts contain “Act of God” clauses to indemnify the relevant parties for events outside of their control. One advantage of an irregular money deposit is that the depositary is responsible for the loss of money even in the case of an “Act of God” (Huerta de Soto 2009, p. 7).

  20. Price changes in response to supply–demand conditions to alleviate shortages or avoid surpluses are an omnipresent feature of market economies. Retailers change thousands of prices on a daily basis. Amazon changes even millions of prices (Wilson 2013).

  21. The natural sciences have proved that time moves backwards when one exceeds the speed of light. No serious economist would use this to argue that time preference does not cause higher valuations on the present than future goods. .

  22. Linguists agree that the predicate is the core of a complete thought and thus a necessary part of every sentence. (Otherwise the statement would lack meaning.) The subject is also necessary but can be implicit, as is the case with the English imperative, e.g., "Jump!” whereby the subject ("you") is implied by the predicate. Similarly, the loan’s term must be established at least implicitly in order to give meaning to the action of lending. On subject and predicate being necessary parts of a sentence see Rowe and Levine (2015, p. 113).

  23. On the evolutionary origin of institutions see Menger (2007). See Hayek (1973), or Leoni (1991) for the evolution of law.

  24. Of course, we might imagine a society where “in dubio pro reo” is turned on its head and the accused must prove his innocence. Yet, we would consider such a principle not only unjust but it would cause severe social problems due to the rights violations of the accused innocents, and would likely be short-lived.

  25. See Hayek (1973, 1989) for a defense of historically evolved institutions against attempts to improve them by deliberate planning.

  26. Legal principles can be found a priori by human reason. In addition to more recent expositions, e.g., Block (2001) and Hülsmann (2004), there are more traditional strands of legal apriorism, both nominalist (Kant 1990) and realist (Reinach 1989).

  27. The investor may try to recuperate the money through sale of the bond or loan. But this will take time and involves sacrificing the bond’s fixed yield for the prevailing market value at the time of sale.

References

  • Bagus, P. (2004). La tragedia de los bienes comunales y la escuela austriaca: Hardin, Hoppe, Huerta de Soto y Mises. Procesos de Mercado: Revista Europea de Economía Política, 1(2), 125–134.

    Google Scholar 

  • Bagus, P. (2011). The Eurosystem: costs and tragedies. In David Howden (Ed.), Institutions in crisis: European perspectives on the recession (pp. 117–141). London: Edward Elgar.

    Google Scholar 

  • Bagus, P., & Howden, D. (2009). The legitimacy of loan maturity mismatching: A risky, but not fraudulent undertaking. Journal of Business Ethics, 90(3), 399–406.

    Article  Google Scholar 

  • Bagus, P., & Howden, D. (2012a). The economic and legal significance of “full” deposit availability. European Journal of Law and Economics. doi:10.1007/s10657-012-9347-y

  • Bagus, P., & Howden, D. (2012b). The continuing continuum problem of deposits and loans. Journal of Business Ethics, 106, 295–300.

    Article  Google Scholar 

  • Bagus, P., & Howden, D. (2013). Some ethical dilemmas of modern banking. Business Ethics a European Review, 22(3), 235–245.

    Article  Google Scholar 

  • Bagus, P., Howden, D., & Block, W. E. (2013). Deposits, loans and banking: Clarifying the debate. American Journal of Economics and Sociology, 72(3), 627–644.

    Article  Google Scholar 

  • Bagus, P., Howden, D., & Gabriel, A. (2015a). Oil and water do not mix, or: Aliud est credere, aliud deponere. Journal of Business Ethics, 128(1), 197–206.

    Article  Google Scholar 

  • Bagus, P., Gabriel, A., & Howden, D. (2015b). Reassessing the ethicality of some common financial practices. Journal of Business Ethics. doi:10.1007/s10551-014-2525-9

  • Block, W. (2001). Austrian law and economics: The contributions of Adolf Reinach and Murray Rothbard on law, economics, and praxeology. The Quarterly Journal of Austrian Economics, 7(4), 69–85.

    Article  Google Scholar 

  • Collins, A., & Walsh, J. (2014). Fractional reserve banking in the Roman Republic and Empire. Ancient Society, 44, 179–212.

    Google Scholar 

  • Deguchi, S., & Ifuku, N. (2013). Bottom-up formation of dodecane-in-water nanoemulsions from hydrothermal homogenous solutions. Angewandte Chemie International Edition, 52(25), 6409–6412.

    Article  Google Scholar 

  • Evans, A. J. (2010). Public attitudes to banking. A student consultancy project, ESCP Europe for the Cobden Centre.

  • Evans, A. J. (2013). In defence of ‘Demand’ deposits: Contractual solutions to the barnett and block, and bagus and howden debate. Journal of Business Ethics., 124(2), 351–364.

    Article  Google Scholar 

  • Evans, A. J. (2014). What is the latin for ‘Mayonnaise’? A response to Bagus, Howden and Gabriel. Journal of Business Ethics. doi:10.1007/s10551-014-2299-0

  • Hayek, F. A. (1931). Prices and production. London: Routledge.

    Google Scholar 

  • Hayek, F. A. (1973). Law, legislation and liberty: Volume 1—rules and order. Chicago: University of Chicago Press.

    Google Scholar 

  • Hayek, F. A. (1989). The fatal conceit: The errors of socialism. Chicago: University of Chicago Press.

    Google Scholar 

  • Hoppe, H.-H. (2009). The yield from money held reconsidered. New Perspectives on Political Economy, 5(2), 129–136.

    Google Scholar 

  • Hoppe, H.-H., Hülsmann, J. G., & Block, W. (1998). Against fiduciary media. Quarterly Journal of Austrian Economics, 1(1), 19–50.

    Article  Google Scholar 

  • Howden, D. (2015). Money. In P. Bylund & D. Howden (Eds.), The next generation of Austrian economics: Essays in honor of Joseph T. Salerno (pp. 43–58). Auburn, AL: Ludwig von Mises Institute.

    Google Scholar 

  • Huerta de Soto, J. (2009). Money, bank credit, and economic cycles. Auburn, Ala.: Ludwig von Mises Institute.

    Google Scholar 

  • Hülsmann, J. G. (2004). The a priori foundations of property economics. Quarterly Journal of Austrian Economics, 7(4), 41–68.

    Article  Google Scholar 

  • Hutt, W. H. (1956). The yield of money held. In Sennholz Mary (Ed.), On freedom and free enterprise: Essays in the Honor of Ludwig von Mises (pp. 196–216). Princeton, NJ: Van Nostrand.

    Google Scholar 

  • Kant, I. (1990) [1797]. Metaphysik der Sitten. Stuttgart, Reclam.

  • Leoni, B. (1991). Freedom and the law. Indianapolis, Ind.: Liberty Fund.

    Google Scholar 

  • Manso, M. T. H. (2014). Causa, Función y Perversión del Depósito Bancario a la Vista. Revista de Derecho Bursátil y Bancario, 33(136), 127–170.

    Google Scholar 

  • Menger, C. (2007). Principles of economics. Auburn, Ala.: Ludwig von Mises Institute.

    Google Scholar 

  • Raico, R. (2012). Liberalism: True and false. Classical liberalism and the Austrian school (pp. 67–110). Auburn, Ala: Ludwig von Mises Institute.

    Google Scholar 

  • Reinach, A. (1989). Die apriorischen Grundlagen des bürgerlichen Rechts. Sämtliche Werke. Vol. I. In Karl Schuhmann and Barry Smith, (Eds), Munich: Philosophia. Translated by J.F. Crosby as “The A Priori Foundations of the Civil Law.” Aletheia—An Inter-national. Journal of Philosophy, 3:1–142.

  • Rothbard, M. N. (2011). The present state of Austrian economics. In Economic Controversies (pp. 161–224). Auburn, Ala.: Mises Institute.

  • Rowe, B., & Levine, D. (2015). A concise introduction of linguistics (4th ed.). New York: Routledge.

    Google Scholar 

  • Rozeff, M. (2010). Rothbard on fractional reserve banking, a critique. The Independent Review, 14(4), 497–512.

    Google Scholar 

  • von Mises, L. (1953). The theory of money and credit. New Haven: Yale University Press.

    Google Scholar 

  • von Mises, L. (1962). The ultimate foundation of economic science. Irving on the Hudson: Foundation for Economic Education.

    Google Scholar 

  • Williams, J. C. (1984). Fractional reserve banking in grain. Journal of Money Credit and Banking, 16(4), 488–496.

    Article  Google Scholar 

  • Wilson, M. (2013). Amazon makes 2.5 million-plus price changes on a daily basis, Chainstoreage.com, Available at: http://www.chainstoreage.com/article/amazon-makes-25-million-plus-price-changes-daily-basis. Accessed August 28th 2015.

Download references

Author information

Authors and Affiliations

  1. Department of Applied Economics I and History and Economic Institutions (and Moral Philosophy), Universidad Rey Juan Carlos, Paseo Artilleros s/n., 28032, Madrid, Spain

    Philipp Bagus

  2. Department of Business and Economics, St. Louis University – Madrid Campus, Avenida del Valle, 34, 28003, Madrid, Spain

    David Howden

  3. Department of Finance and Economics, Groupe Sup de Co La Rochelle, 102 rue de Coureilles, 17024, La Rochelle Cedex 1, France

    Amadeus Gabriel

Authors
  1. Philipp Bagus
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. David Howden
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Amadeus Gabriel
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Philipp Bagus.

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Bagus, P., Howden, D. & Gabriel, A. The Hubris of Hybrids. J Bus Ethics 145, 373–382 (2017). https://doi.org/10.1007/s10551-015-2884-x

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10551-015-2884-x

Keywords

  • 100 % reserve requirement
  • Banking
  • Demand deposits
  • Fractional-reserve banking
  • Fraud