Money 101 — part 4

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Partial-Reserve Issuance — the Charge of Fraud

Various persons have claimed that it is a form of fraud for promissory notes to be issued with a greater face value than the stock of promised high-powered money that the issuer would be capable of producing if every note were presented for reëmbursement. That claim ought to be challenged.

Under various circumstances, people go into debt, issuing promises for things that they cannot immediately deliver. Often, the established obligation entails a delay; the debtor is not obliged to produce before the passage of some time. But, even with these delays, some debtors will default; they will not meet their obligations.

None-the-less, the debts themselves are bought and sold; the party to whom the debt is originally owed exchanges his or her or their claims to some other party, for something else. Even debts that are viewed as likely to be unmet are bought and sold (albeït typically at some sort of discount).

When debt is acquired for the purpose of exchange, debt is used as money. When debt with a lowered expectation of repayment is acquired for the purpose of exchange, that debt is used as money. No fraud is intrinsic in the use of debt — even in the use of debt with a low expectation of repayment — as money. Nor would there somehow be fraud intrinsic to the use of such debt as money if the instrument of debt could be immediately presented for repayment.

The question of whether partial-reserve issuance of promissory notes is fraud actually turns on the question of whether a reasonable person would be willfully misled about the extent to which the sum of reserves is less than the amount promised by those notes.[15] In America to-day (and surely elsehwere), a great many people are plainly oblivious; but the nature of partial-reserve banking is discussed in virtually every introductory course on macrœconomics, imposition and adjustment of reserve requirements are mentioned in news reports on monetary policy, and people are aware that there is some sort of insurance of deposits, including insurance of checkable deposits. As I write this piece, a referendum is to be held in Switzerland on a proposal to outlaw partial-reserve issuance. In Iceland there is active discussion of a similar proposal. The case that present-day partial-reserve issuance is fraud doesn't hold, whatever one may think of the rest of the system.

As to whether a non-fraudulent partial-reserve issuance would be an accepted practice in an economy in which money and banking policies were left to the market, I think that only observation would tell, though my best guess is that the open practice would be common.

Many economist see the cause of economic depression in contraction of the money supply, or in correction of distortion caused by prior expansion of the money supply, or in both; some of these same economists argue for laissez-faire economic policy. It would at least seem that partial-reserve issuance could lead to expansions or contractions of the money supply that could directly or indirectly effect economic depressions, and so to these economists it is attractive to see partial-reserve issuance either as intrinsically fraudulent (and therefore actively prohibitted under laissez-faire) or as something that would not be accepted by consumers in the absence of fraud. If one does not deny that it could be practiced without fraud, one possible resolution would be to accept a greater rôle for state intervention;[16] another would be to argue that state intervention would have still more dire effects than economic down-turns caused by changes in the money supply made possible by partial-reserve issuance. The latter argument might seem one of grim resignation, but if the changes in the money supply would be much smaller under laissez-faire, then presumably the resulting economic down-turns would be far less severe.

The Effects of Inequality in the Accumulation of Money

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[15] Unreasonable persons may not understand much of anything, no matter what is said to them and what evidence is presented to them. Our transactions should not be avoidably at their mercy.

[16] Perhaps laws might be written specifically restricting the trading of debt after it had come due; but the matter is not so straight-forward as some would imagine.