'Under frb, it is a logical impossibility for B to make good his obligations to both A and C, on demand. Now, it is entirely possible that A and C will not call upon B to do so. But, IF they do, that is, constitute a "bank run" B will then be exposed as being unable to meet his financial obligations. In very sharp contrast, there are NO OTHER contracts quite like this in the economy. Yes, I buy 10 widgets from you for delivery today, in consideration for my promise to pay you $10, tomorrow. A day passes, and I am unable to carry out my part of the bargain. But, it is not a LOGICAL CONTRADICTION to suppose I am unable to do so, as in the case of frb. There is all the difference in the world between being unable to fulfill a contract due to contingent circumstances, as in the widget example, and it being IMPOSSIBLE to do so, as in the case of frb. It is not merely "intervening events" that make it a violation of the laws of logic for B, the Bank, to uphold contracts with lender A and borrower C. It is IMPOSSIBLE for B to do so, given frb.'
This claim deserves a reply because it is actually somewhat plausible, and because it a good reply can be made to it. I also have not dealt with this particular objection to frb before. The two points of reply are possibility and counterexample.
Banks rely on two sources or types of liquidity to discharge their debts as and when they fall due, and Block is correct that all demand claims could fall due at the same time if the creditors did in fact make their demands at the same time. The two sources are called 'asset liquidity' and 'funding liquidity'. The first involves the capacity of the bank to sell or redeem assets, and second involves the capacity of the bank to replace one liability with another (or with capital). It is therefore POSSIBLE for a bank with marketable assets and/or fund-raising capacity to repay all demand liabilities by selling sufficient assets and/or replacing the demand liabilities with term liabilities or capital. I'm not saying that the bank is not at risk of non-payment, but I'm saying that the bank's asset and/or funding liquidity may be sufficient to make payment, even of all demand liabilities at the same time, POSSIBLE.
A second objection that bank demand deposits are 'like no other' contract also has a reply: demand debts are not only contracted by banks but also non-banks, for example, many commercial firms and also individuals borrow money by way of overdraft, which funds are repayable at the creditor's demand. This counterexample to Block is instructive on several fronts:
- Unlike bank demand deposits, overdrafts are typically secured over assets such as land or or all the assets and undertakings of a business company. This indicates that the creditor is a) not concerned about the debtor's legal tender cash assets or even liquid assets more generally defined and b) is concerned with the level of assets available to repay the credit, even illiquid assets.
- Demand debt does not rely on the capacity of the debtor to strictly be in a position to repay at any time, it can instead rely on the adequacy of the security held by the creditor and/or the acceptance of a level of credit risk by the creditor. If this is OK for non-banks to obtain finance on this basis why not banks?
- In the same way, demand debtors need not rely on either funding liquidity or asset liquidity, they can instead rely on the creditor not demanding repayment unless the debtor's risk level is no longer within the creditor's tolerance. The debtor also does not rely on liability diversification, i.e. creditor A demanding funds while creditor B will probably be providing funds, instead the debtor relies on the creditor not demanding repayment. If this is OK for non-banks to have poor liquidity, what basis can imperfect liquidity of banks be objected to?
We ask whether or not time deposit banking can also be illicit, and answer in the positive, if there is a mismatch between the time dimensions of deposits and loans. To wit, if an intermediary borrows short and lends long.I also find myself in a difficult position to argue with Block because:
- Although his positions appear untenable and absurd, they are at least internally consistent
- Leading free banking academic economists that have taken on Block on fractional reserve banking have taken some positions on bank note option clauses, the social value of and agent optimality of maintaining some non-zero level of metallic reserves under free banking, and the economics of money and banking that I do not, and that confuses matters, and opens themselves to fair attack,
- A significant amount of the arguments around this controversy rely on positions accepted (or allegedly accepted) by the said leading free banking academic economists, that I do not accept: Rothbard's title transfer theory of contract, and the relevance of the "present goods" and "future goods" categories, and the economic impact of bank-issued money.
- The level of research, analysis and argument needed to address all these issues is beyond my credentials, resources and influence.