Does Fractional Reserve Banking Endanger the Economy? A Debate

Two free market economists debate a topic that has long divided libertarians: The standard banking practice of keeping only a portion of depositors' money on hand and loaning out the rest.
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On April 16, 2018, two free market economists debated a topic that has long divided libertarians. Fractional reserve banking refers to banks' standard practice of keeping only a portion of their depositors' money on hand and loaning out the rest.

In The Mystery of Banking (1983), the anarcho-capitalist economist Murray Rothbard called fractional reserve banking "a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts." Other libertarian economists, such as Larry White and Steve Horwitz, have argued that the practice is perfectly defensible.

At The Soho Forum, a debate series in New York City that is sponsored by the Reason Foundation, Robert Murphy debated George Selgin over the following resolution: "Fractional Reserve banking poses a threat to the stability of market economies."

Murphy, a research assistant professor with the Free Market Institute at Texas Tech University, argued for the affirmative. He has a Ph.D. in economics from NYU has addiliations with the Institute for Energy Research, the Mises Institute, the Fraser Institute, and the Independent Institute. He has authored hundreds of articles and several books explaining economics to the layperson, including Choice: Cooperation, Enterprise, and Human Action.

Selgin, who opposed the resolution, is a senior fellow and director of the Center for Monetary and Financial Alternatives at the Cato Institute and professor emeritus of economics at the University of Georgia. His research covers a broad range of topics within the field of monetary economics, including monetary history, macroeconomic theory, and the history of monetary thought. He is the author of The Theory of Free Banking, Bank Deregulation and Monetary Order, Less Than Zero: The Case for a Falling Price Level in a Growing Economy, and most recently Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage.

The Soho Forum runs Oxford-style debates, in which the audience votes on the resolution at the beginning and end of the event. The side that gains more ground is victorious. ​In this case, Selgin won by convincing 14 percent of the audience to switch over to his side.

Produced by Todd Krainin.

[JohnDaniels]

"If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless" -Thomas Jefferson

[paulbenedict]

Banks should be able to choose their individual policy on fractional reserve and let the market decide who the winners and losers are.

[vnews]

Competition everywhere. Let currencies compete (including cryptocurrencies) and let full and fractional reserve banks compete. Let the market decide.

[ScRaS]

This is a real debate. Thank you ReasonTV.

[petersmit]

Finally, some real discussion, that's rare.

[IslandPonder]

They cut out Dave smith’s intro because of the making fun of Cato. Classy, reason magazine.

[ricardoafonso]

I have to say I came into this with a strong position for one of the sides...and this debate moved the needle quite a bit. Please more of these ..

[dnnable]

I think the main point of contention between the two was sadly missed, even though George had to allude to it once. That is: FRB doesn't produce *perpetual inflation, * but it *does* create a "one-time" increase of outstanding credit (he admitted going from 100% to FRB would be inflationary *once*). But that's Bob's point! And it doesn't need to be inflationary (in the ABCT-sense: credit creation above savings, causing interest rates to fall too low, causing simultaneous over-consumption *and* over-investment) afterwards. The business cycle was already put in motion, and *some* investments will be unsustainable.

After the credit *contraction* (that is the result without central bank intervention) occurs during the bust, we would expect it to grow once again. And so on and so on. Obviously that resulting business cycle will be *much* less severe than one with a central bank pumping in new money on top of that.

[vnews]

Think of fractional reserve banking in a free market banking environment as Schrodinger's banks. And your deposits get paid interest based on the level of risk (reserve ratio) the bank employs. When you look at your account your balance might be there or it might not.

[hoppemonarchist]

Great debate. I went back and forth agreeing with each of them until the other spoke again.

[chesterg.]

I used to be against FRB, but someone introduced me to Monetary Equalibrium Theory using competing banks and monies. If you have competing monies, you wouldn't have a shortage of credit.

[agentx]

Hey @ReasonTV - where's the Dave Smtih opening?

Is is ok when you support the debate on college rape but not when he's making fun of Cato?

[FyterianTV]

Ohhh...they legit cut Dave Smith stand-up intro!?
=S

[leopardspots]

As a Canadian if our banking system is so stable why did the government recently give the 5 largest banks $50 billion. Also in 2009 they received $114 billion. Also the Canadian Mortgage and Housing Corporation bought home loans from the banks. Not to mention our government backs deposits up to $100, 000.

I think all of this encourages banks to take more risks knowing the government will borrow money to help them.

[soapbxprod]

CATO V MISES! OH is this the BEST! VIVA ROTHBARD and HAYEK and all of the Austrian and Chicago School wunderkinds... :) I love both of these true economic giants. Both Hillsdale College and CATO/Mises Institute affiliates. Both Selgin and Murphy agree on who the culprits are: central banks and Government regulations.

[GenwealthPartners]

Check out Wayne Jett's book, The Fruits of Graft - He destroys Keynes and centralized anything!

[MUSTASCHO]

This debate tells me that there is nothing fundamentally wrong with fractional reserve banking, but that the system has been thrown off quilter by government intervention and currency monopoly. It seems we should do 3 things, more or less:

1. Go back to a gold reserve standard, and remove the government's monopoly on bank note creation.
2. Let banks set their own interest rates so that the free market can regulate itself by setting a cost to lent money without central bank/government control. This will remove the problems that arise with artificially low interest rates set by central banks.
3. Educate the public on what fractional reserve banking is, and possibly require banks to explain on the opening of an account that the account is a fractional reserve account.

[troystackhouse]

The root of the problem isn't fractional reserve lending. Counterintuitively, the problem can be pinned on the FDIC insurance that comes with every bank account (i.e. that thing that protects up to $250k of your funds if your bank goes insolvent). To illustrate why, ask yourself this: What is *your* bank doing with your money? Can you actually answer that? Neither can I, nor can most people, because unfortunately nobody cares anymore. The government, in its infinite quest to protect people from themselves (i.e. treat adults like they're children), took away the incentive for everyone to act as educated consumers.

A long time ago, banks worked hard to build reputations based on trust, and having such a reputation was an existential concern for every bank. If they once again had to *compete* to gain your trust, because you knew you'd be out of luck if they lost your money, you wouldn't hesitate to put in the extra effort to find out which banks act responsibly vs. which ones take on extra risk to squeeze out the biggest profits for their executives (not you). The market would self-select those banks that behave in a way which most people would approve of them behaving with their money. If a bank wanted to do risky things, it would have to entice potential customers by rewarding them in some way for taking on the extra risk.

In short, the free market would sort it all out. It's only when incentives are skewed by artificial policies (like government-provided insurance) that we have a problem, even when the intent is pure.

[garthor]

5:57 -- I would disagree with that statement "under 100% reserve banking, bank runs don't happen" -- a bank run by definition can still happen, its just that the bank isn't in trouble when it does. They may not happen very often, because the bank can handle the surge, and the customer's know that, but its still possible...

[BobWidlefish]

TLDW: Murphy: freedom + property rights works best and is economically sound and is probably more ethically and legally sound in a just society. Selgin: the “right” small amount of state interference/regulation in banking has worked pretty well, some amount of counterfeiting increases total prosperity, and the legal and ethical arguments can be side-stepped if we imagine bank note holders agree to this scheme.