Bill Totten's Weblog

Tuesday, December 22, 2009

Free Market Banking Observations (December 14 2009)

In this thread on, someone asked about banknotes and free market banking:

In a free market, banks wouldn't be able to issue fractional reserve banknotes. Nobody would accept them.

As soon as someone suspected or discovered that a bank was practicing fractional reserve banking, all the customers would rush to redeem their deposits. There would be no State to protect the bank owners from the negative consequences of their fraud.

If an honest warehouse receipt bank is subject to a run, there's no problem. It pays off all customers and then continues operating and accepting deposits again. Having proven its honesty, there's no reason for customers to switch to competitors.

Banks could issue warehouse receipt banknotes. A rational person would immediately redeem them for physical metal or a warehouse receipt in his own bank.

For warehouse receipt banking, a fee would be charged. It'd probably be low, 0.1% per year or less. There might also be a transaction fee. In the present, a COMEX warehouse receipt has a storage fee of approximately 0.1% to 0.2% of the value of the metal.

A warehouse receipt bank would need to have public audits, so that customers know they aren't secretly practicing fractional reserve banking. In the present, ETFs like GLD and SLV are "audited", but I have no guarantees that the auditors are honest or competent. The auditors of an investment fund or corporation are chosen by the management, leading to the obvious conflict of interest.

For time-deposit banking (like a certificate of deposit), then there would be interest. Suppose you had a one year time deposit redeemable for 100 ounces of gold and interest rates are four percent. After six months, you could sell this for 98 ounces of gold. If there's a risk of insolvency by the bank, then its CDs will trade for less than face amount.

Such a system existed before the Federal Reserve credit monopoly was created. It was called "Bills of Exchange". The Federal Reserve credit monopoly destroyed this decentralized banking system that allowed individuals to directly lend each other money.

A "Bill of Exchange" does not exist in the present, because it's silly for individuals to lend each other Federal Reserve Notes. Either the lender has to charge an extortionate rate compared to a State bank, or the lender gets ripped off by inflation. Banks can always issue loans more cheaply than individuals can lend to each other, because banks may borrow at the Fed Funds Rate and exploit the central bank price-fixing cartel.

Banking is not inherently evil. This is a common misconception. It is banking COMBINED with State violence that is evil.

Management of a free market bank is not protected by limited liability incorporation. They must do a good job, because they risk losing their savings and careers if there's a fraud.

In a really free market, banking is not evil. Free market banks provide a useful service, matching savers and people who need capital. The current system is completely corrupt, but that doesn't mean that banking, profit-seeking, and investing are inherently evil.

The problem is that government violence, combined with greedy parasites, leads to evil. In a really free market, you can't profit unless you also provide a useful good or service.

Bill Totten


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