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The Aleatory Contract: A Definitional Comment on Fractional Reserve Banking
CJay Engel comment 0 Comments access_time 5 min read

This post is intended to be a quick note, and in no way a complete investigation into the matter. As I have elaborated in extensive detail in the past, modern defenders of fractional reserve banking (who go by the phrase “free bankers”) are, whether they know it or not, defending something referred to as an aleatory contract. This is not a “gotcha” accusation. This is an attempt to clarify the debate. After talking with several advocates of fractional reserves, they definitely admit this. Understanding what this means helps the casual inquirer come to a better grasp of the details of the fractional vs. full reserve debate.

It used to be that the debate was framed like this (and Rothbard and de Soto certainly frame it as such): when a depositor puts his money in the bank, in a deposit account, he maintains legal ownership of that money and therefore for the bank to lend out some of that money is (or should be) clearly illegal. To lend out some of that money, that is, to only keep a fraction of the depositor’s money on reserve is clearly fractional reserve banking. And clearly unjustifiable. While some of the older generation proponents of fractional reserve model (such as John Law in the 18th century– see Joe Salerno here) would see no problem with the above. But modern proponents of fractional reserve banking don’t formulate the relationship between the bank and the depositor like that.

Before moving on, I want to emphasize something: if fractional reserve banking is defined as the above, then many fractional reserve banking advocates would admit that fractional reserve banking is legally/ethically problematic. It’s just that the modern fractional reserve banking proponent doesn’t define things in this way. Thus, the modern advocate of fractional reserve banking shouldn’t be as quick to oppose Murray Rothbard’s position on fractional reserve banking; because he opposed it as he defined it. If one dissents from Rothbard’s demand for a full reserve scenario, let him at least be fair about the scenario Rothbard most vocally opposed.

Here is where things get tricky. Since everyone (the majority of folks on both sides of the debate) agrees that the above definition is legally problematic, there are some fractional reserve bankers that characterize their position as an agreement between the bank and the customer wherein the bank can use the funds as it deems prudent, but if the customer wants his money back, he can demand it at any time and the bank has a legal obligation to fulfill this demand. This is allegedly non-problematic on the simple basis that it has been voluntarily agreed to. This misunderstands libertarian legal theory, which is not that whatever has been voluntarily agreed to is legitimate. Under libertarian theory, a prerequisite for a legitimate contract is that it must be logically possible. However, a contract which stipulates that both the bank and the customer have the legal right to the present use of a resource (such as money), is not possible.

Therefore, the fractional reserve advocates (such as Michael Rozeff) that characterize their position as presented in the preceding paragraph, are also wrong. This was the position that Joe Salerno and Hans Hoppe wrote against in the 90’s (for example, this key essay).

However, since then, there has arisen a clarification by the advocates of fractional reserve banking that is relatively newer. I think a lot of laypeople trying to keep up with the debate miss this formulation, but it has been addressed in more recent years by full-reserve defenders like Guido Hulsmann and Phillipp Bagus and David Howden.

The newer formulation is this: the nature of the customer’s relationship with the bank is that the bank has the legal right to the present use of the money deposited in the bank account and the customer has the right to ask for the money, not the right to the money itself.

Under the Misesian taxonomy (see here) of monetary goods, there is a difference between the money itself and the money substitutes, which are a claim to the money. Under a full reserve system, all money substitutes are backed up 100% by money itself (the reserves). Under this new formulation of the relationship between bank and customer, the money substitutes are not claims on money, but more akin to “right to ask” tickets.

That is to say, the contract type is known as an aleatory contract. An aleatory contract is a contract whose fulfillment depends on chance. A good example of this would be a lottery ticket wherein not all lottery ticket holders will be able to claim their prize. Similarly, in a system of “right to ask” tickets, the value of such an IOU depends on whether A) the bank actually has any money in its vaults and B) whether you request redemption of your “right to ask” ticket before the other holders of the ticket.

Although I myself am against all formulations of fractional reserve banking, I think proponents of fractional reserve banking should understand this. Debates in the future between Austrians on this issue will focus in on whether or not an aleatory contract fulfills the concerns related to the praxeological nature of money (Phillipp Bagus is already spending considerable time on this issue in several of his working papers). The purpose of this post is not to critique the aleatory contract as a potential model for fractional reserve banking, but rather to bring it to light, and to provide the context for it in future essays.

Which will hopefully come soon.