If you ever want to see a furious discussion break out
among libertarians influenced by Austrian economics, just start talking about
money and banking. Despite their agreement on so many things, they often have a
variety of views on the ideal banking system and how to best understand terms
like “inflation” and “deflation.” The debate over the morality and efficacy of
fractional reserve banking is one of the most divisive issues. I have addressed
that topic in an earlier column, but here I want to tie it
into some broader issues that enter into this debate.
This discussion is prompted by Larry White’s testimony on the history and practice of fractional reserve
banking before Rep. Ron Paul’s subcommittee on monetary policy in late June.
White’s testimony is a concise yet thorough discussion of why fractional
reserve banking came to be and why it is not at the root of monetary problems.
As he points out, “[A] fractional-reserve banking system is not unstable when
the banking system is free of hobbling legal restrictions and free of
privileges.” U.S. history illustrates this point.
Until only the last few decades, U.S. banks faced
severe legal restrictions on their ability to open branch offices, both across
state lines and in some cases even within a given state. These restrictions led
to highly under-diversified banks that were more prone to failure and whose
troubles would be exacerbated by fractional reserve banking. In the post-Civil
War era, regulations that required banks to purchase certain government bonds
before issuing currency made them vulnerable to bank runs when the demand for
currency rose and they were unable to meet it. Again, fractional reserves
combined with this legislation led to recurring panics.
The “solution” to those panics was the Federal Reserve System. It, however, replaced those old regulations with both new regulations and new privileges that combined with fractional reserve banking to create problems. In particular the Fed was given the power to change the quantity of currency and the level of reserves banks hold on deposit at the Fed by either printing more currency or buying government bonds from banks and paying them by crediting their accounts. That power enables it to change the “monetary base,” the foundation from which the banking system can multiply its lending. This privilege belongs to the Fed because it is the only institution allowed to produce currency, which allows that currency to serve as reserves and enables the Fed to create new reserves out of thin air.
Monopoly–not fractional reserve–is the problem. As
I’ve said before, there’s nothing wrong with fractional reserve banking that
getting rid of central banking wouldn’t cure.
Legal Tender
Some libertarians point to legal-tender laws as
another source of trouble. The claim is that because such laws force us to use
government money, they make it impossible for us to get out of the system and
cut short the multiplier process. The problem with this argument is that it misunderstands
legal tender laws. What “legal tender” normally means is that if one
is offered the money defined as such in payment of a debt, one must accept
it. It does not say that only such money is acceptable in
transactions. In other words, payment in legal tender is sufficient but not necessary to discharge a debt or obligation, and
legal-tender status does not matter for nondebt exchanges.
[T]he Coinage Act of 1965, specifically Section 31
U.S.C. 5103, entitled “Legal tender,” . . . states: “United States coins
and currency (including Federal reserve notes and circulating notes of Federal
reserve banks and national banks) are legal tender for all debts, public
charges, taxes, and dues.”
This statute means that all United States money as
identified above are a valid and legal offer of payment for debts when tendered
to a creditor. There is, however, no Federal statute mandating that a private
business, a person or an organization must accept currency or coins as for
payment for goods and/or services. Private businesses are free to develop their
own policies on whether or not to accept cash unless there is a State law which
says otherwise.
Nothing in federal law prohibits Americans from not
accepting Federal Reserve Notes in payment for goods and services. Legal tender
refers only to debts and similar obligations.
Monopoly Status
Yes, the federal government has prosecuted people for
trying to establish circulating gold coins, but that is not a matter of legal
tender; rather the issue is the Fed’s monopoly. It would be perfectly possible,
as was the case before the Fed, to have some kinds of money in a competitive
system declared “legal tender” and some not. That would be a privilege, but it
would not completely undermine the competitive system.
Libertarians need to aim their fire at the real source
of trouble–the monopoly privileges of the central bank. Fractional
reserve banking and legal-tender laws are distractions from the real issue.
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