One of the arguments against fractional reserve banking is the claim that it violates or is incompatible with property rights, specifically, that it involves more than one person having claim to the same money at the same time. The most vocal and persistent peddler of this claim is Walter Block:
‘… it is impermissible under libertarian law for there to be more than one full owner of any given thing. For example, if there are 100 cars in a small town, there can only be 100 titles to these automobiles. If there are any more, for example if there are as few as 101, then one vehicle is fully owned by two people, an utter impossibility. Under a frb system with demand deposits, this is precisely what happens … . Consider the following case: A, the depositor, lends $100 to B, the bank. B gives A a demand deposit checking account on him for this amount. Whereupon B turns around and makes available $900 to C, the borrower; he does so by granting C a demand deposit for this amount of money. B now has $100 in its vault, and demand deposits it is pledged to fulfill for $1000, $100 plus $900. (In this case, the fractional reserve is 10%). True, as long as neither A nor C write a check for more than $100 total, this precarious system can endure. However, there is now only $100 in cash, and there are titles to it adding up to $1000. Thus, there is an over determination, as in the car case, mentioned above.’
To address this argument, we shall consider what it means to consider something as property, and what kind of rights owners of property have over property, and the different kinds of property recognized under law.
Property, legally, is that which may be owned. The rights of owners generally includes:
• The right to transfer it to another owner, e.g. by way of sale or gift
• The right to charge the property as security for an obligation
• The right to keep it and use it or enjoy its benefits
• The right to grant possession or use to another person, e.g. to lease it to a leasee.
• The right to grant contractual rights over it, e.g. a licence to use one kind of benefit from the property.
The applicability of the above rights depends on the type of property, for example intangible forms of property cannot be possessed, and shares in a private company may be restricted from being freely transferred, or a lessee’s right to sublease may be restricted by the lessee’s lease with the lessor.
The law recognises various kinds of property rights. These are categorised as:
1. Real property:
a. Land – considered a tangible property
b. Interests in land – considered intangible property, e.g. an easement such as a right of way
2. Personal property:
a. Choses in possession – chattels or goods that are tangible
b. Choses in action – intangible property such as company shares, insurance policies, cheques, debts owed etc.
c. Chattels real – leases in land (some cross over with interests in land).
(source: Understanding Commercial Law, Fifth Edition, Gerbic and Lawrence, LexisNexis, pages 475-479)
In Part 1, we saw that bank notes and bank account balances were debts owed by the bank, and as we can see above, this is a legally recognised form of property, i.e. a chose in action. That the bank’s reserves are separate and distinct as a form of property from the bank’s obligations to pay note holders and customers can be seen from the following facts:
• The bank’s reserves are choses in possession, i.e. tangible items of personal property commonly known as chattels, and therefore a different form of property from the choses in action consisting of the customers and note holders rights of repayment as against the bank.
• The bank has the right to sell its reserves for other assets such as interest bearing securities. The customers and note holders of the bank do not have any power to sell or invest the reserves held by the bank. However note holders may sell their notes in exchange for goods or services, this sale being the sale of the rights to repayment by the bank and not the rights to the bank’s own assets. Customer deposits typically are difficult to sell, and instead are redeemed by drawing cheques on the bank payable to third parties, which, when paid, discharge rather than transfer the rights to the payee.
• The customers or note holders of the bank have no power of charging the bank’s reserves as security for any obligations of their own or anyone else’s: the bank may charge its reserves as security for the bank’s obligations, the customers etc. may not. However, the customers of the bank may use their balances with the bank, and note holders their notes issued by the bank, as security for any of their obligations, such charges operate on the creditor’s contractual rights to repayment, and not to the bank’s own assets. This shows that although the customers have a right to use their property rights as security, it also shows that their property rights consist of a contractual right to repayment from the bank, separate from the bank’s own reserves and other assets.
• The customers and note holders have no right to possess and keep the bank’s reserves: they can only get the bank’s reserves by exercising their right of redemption, which action discharges their contract with the bank and extinguishes their property rights under it. By way of contrast, the bank visibly enjoys the right of possession.
• Rights to lease or grant contractual rights over bank notes and customer deposits are inapplicable because of a number of reasons, including the lack of commercial rationale or benefit from such transactions. This would apply as much to the repayment rights as to the specie reserves of the bank.
The right of a creditor to repayment of money on demand is not legally equivalent to the right to the money as owner of it, even though the two may be commercially equivalent. For example, under accounting standards, ‘cash’ includes ‘money an entity holds and money deposited with financial institutions that can be withdrawn without notice’ however this is still subject to a creditworthiness test: ‘Cash and cash equivalent balances held with another entity should reflect the cash flows expected to be received from that entity. The balance would cease to meet the definitions of cash and cash equivalents if there are serious concerns over the other entity's credit worthiness.’ ( see http://www.pwc.com/Extweb/service.nsf/docid/B76785C4D55263C88025713F0044A853) This illustrates where the legal difference becomes a commercial difference, i.e. when the debtor gets into financial difficulty. A cheque drawn by a person who becomes insolvent before the cheque is presented for payment, once dishonoured by the drawee bank, becomes a demand debt payable by the drawer. However such a cheque could be worthless if the drawer is insolvent and other creditors have security over the debtor’s assets, leaving the holder of the cheque with no prospect of payment whatsoever. The same would apply to bank notes or balances with an insolvent bank. Title to and possession of coin does not suffer from this credit risk, as it is a chose in possession, not a chose in action.
The allegation that fractional reserve banking is incompatible with property rights or involves mis-specification or over-specification of property rights can therefore be conclusively dismissed. The rights of holders and issuers of bank notes and demand deposit balances are well specified and well understood by the law, and involve no contradiction or violation of anyone’s rights (the risk of default on the contract being just an example of the general risk of default under commercial contracts generally).