Fractional Reserve Banking from a legal perspective

The effects of Fractional Reserve Banking (FRB) called «The Financial Crises» is currently ravaging the world’s economies and causing serious conflicts with strikes and violence. The purpose of the current monetary system as organized by the IMF, BIS and national Central Banks is to finance the government’s expenses by diluting the currency to avoid unpopular taxes.

Unfortunately some supporters of liberty are supporting the institution of FRB. Most of these supporters are aware of the economically damaging effect but supporting it still from a moral\legal standpoint.

One argument is thet FRB is not fraud so it’s OK. But in business and commerce contracts and disputes may be settled in one way or the other without any of the parties being criminal. So this is a false dichotomy reflected in the common legal distinction between criminal law and civil law.

Another typical argument is that people should organize themselves as they like under capitalism. End of discussion.

This begs the question. Capitalism is the «Rule of law» If the practice of FRB is supported by unlawful institutions and actions the system under discussion is no longer capitalism. A deeper investigation of the question is therefore needed;

The FRB irregular deposit

The largest part of the money supply (some 92% of the supply in Norway) is bank accounts which over the last 200 years has replaced coins and bank notes as money. The single most important contract to discuss concerning FRB is therefore the contract between the depositor and the bank.


A contract is a mutual agreement between two or more parties. An essential feature of a contract is «The meeting of the minds» (consensus ad idem). The fact that the contracting parties have a common idea about what they are agreeing about.

Deposit contract

One party putting something in the other party’s possession for the purpose of storage and safeguarding.

Examples may be

  • storing your furniture while you are working a year abroad.
  • storing valuable jewelries and paintings to avoid theft or fire.
  • a dealer in wheat may use third party storage facilities for cooling and placement between buying and selling.

The irregular deposit

A special instance of the deposit contract is the irregular deposit consisting of fungible goods like oil, wheat, or gold. The purpose of the contract is still storage, safeguarding and facilities but the contractor is free to return a similar quantity of the goods on demand. If you request say your deposited oil you will not get exactly the oil you deposited, just a similar quantity of the same kind and quality of oil.

In the deposit contract there is no transfer of ownership of the deposited good. The fact that the contractor in the irregular deposit may return som other oil does not mean he owns the oil.

It is just a practical arrangement because it is practical to have one storage facility.


The loan is contrasted to the deposit in the fact that ownership is transfered from the lender to the borrower.

A characteristic feature of a loan is the time for the return of the goods. This both enables the borrower to plan for the return of the good and secures the lender a fixed event (the time) for return of his goods.

( It is possible to construct contracts without a fixed time of return;

«You may borrow my cycle until I request it back».

But such contracts make no sense whatsoever for the case of fungible consumer goods.

«You may borrow my coke until I want it back».

This contracts implies that the borrower can make no use of the coke (i.e. drink it) because he is requested to keep it ready for return. Henceforth there will be no such contracts.)

Aleatory contract

This contract is used in among others insurance. The return of the goods is triggered by a certain external event ( A fire, a stroke, an earthquake..)

(This is opposed to the loan contract where the return of the goods is triggered by the passing of a certain time. )

The FRB Bank Deposit Contract.

The bank promises to return the depositors money on demand and is simultaneously engaging in lending out money to other customers.

This is an irregular deposit as the bank will not return exactly the same money.

Money is consumable from the point of view of the borrower. When he spends the money they are gone like drinking a coke and he plans to earn and return some other money when the loan expires.

Jesus Huerta de Soto lists the legal «hurdles» ,seven in total, to FRB in his book Money Bank credit and economic cycles. De Soto in italics:

  1. There is deception or fraud: the crime of misappropriation is committed and the contract is null and void (the historically corrupt origin of fractional reserve banking).
  2. There is no deception, but there is an error in negotio: contract null and void. ( This means the intention of the depositor is to avoid walking around with a lot of cash and he likes the convenience of electronic payments. His main purpose of the contract is depositing his money. The bank on its side is considering the money a loan. The deposit requirement of immediate return and safeguarding is incompatible with the risk taking and fixed expiry date of the loan. There is no meeting of the mind and the contract is void. )
  3. There is no error in negotio, but each party pursues his typical cause in the contract: contract null and void due to essentially incompatible causes. ( This is the same argument as 2 put this points to the self contradictions in the FRB contract which will manifest in self when put into practice. )
  4. Even if the incompatible causes are considered compatible, the contract is null and void because it is impossible to carry out (without a central bank). (The borrowers of the bank will default on their loans because their investments are founded in thin air and not real savings. Thus external institutions is necessary to keep the system afloat)
  5. Subsidiary argument: even if the “law of large numbers” were valid (which is not the case), the contract would still be an aleatory contract (it would be neither a deposit nor a loan contract).
  6. The implementation of the contract depends on a government mandate (privilege) and the support of a central bank that nationalizes money, imposes legal-tender regulations and creates liquidity.
  7. In any case, the contract is null and void because it does serious harm to third parties (economic crises aggravated by the central bank), much greater harm than that caused by a counterfeiter of money.


As you see there are several hurdles to be passed before legally accepting FRB. Personally I find clause 2&3 enough. The deposit and the loan are incompatible and the contract is void. Without the FRB Irregular deposit there is no Fractional Reserve Banking.

Nazi's food prices and Fractional Reserve Banking

The prices of food and other basic consumer goods are rising and the large retailer food chains find themselves under attack from media and politicians.

The soaring food prices under and after the first world war.

Interestingly the Nazi’s devoted a separate point out for 25 to the big warehouses in their 1920 program.

From their program

“16 We demand the creation and maintenance of a healthy middle class, the immediate communalizing of big department stores, and their lease at a cheap rate to small traders, and that the utmost consideration shall be shown to all small traders in the placing of State and municiple orders. ”

The background was soaring food prices and the shortages following the First World War and the following rage against the «profiteers.» The same rage helped Lenin to power in the 1917 revolution.

But the cause of the soaring prices were the German war economy directing production towards war related industries. The main cause of the shortages was the price controls making products unavailable altogether. And the war was fought by the government and not by the big department stores.

Why the governements are debt financing.

The German war effort was for a large part debt financed (as opposed to tax financed).  The banking system created debt to finance by governments war bonds. Economically this is similar to the current situation where the governments are debt financing the expenses to the welfare state.

With a sound banking system the interest rates would quickly rise as the government lends people’s savings to finance the war. As people’s savings dwindled it would soon be impossible to lend at all. The politicians would be forced to rice taxes. But taxes are visible and unpopular. Soon  the politicians would be forced to negotiate a peace. ( God forbid how humiliating!! )

How the governments are debt financing

To prevent the rising interest rates and the end of debt financing the government’s advisers has invented Fractional Reserve Banking (FRB).

With FRB the debt is created out of nothing and the inherent limitation of previous saving is removed. With FRB debt financing wars can continue endlessly. Conscription and FRB allowed the war to go on for years slaughtering millions of soldiers and send a prewar prosperous Europe into medieval poverty manifesting itself in people dying from diseases in medieval quantities.

The effect of FRB banking on consumer prices

The granting of a FRB loan (loan created out of thin air) as opposed to a «save first» loan has the effect of rising prices of consumer goods:

The reason is that in a «save first» loan the money is made unavailable to the lender. Thus the lender is unable to consume. The ability to consume is transferred from the lender to the borrower for the duration of the loan. The granting of the loan creates no extra demand for consumable goods.

This is opposed to the case of a FRB loan when the new debt and money is coming into existence out of nothing. The FRB loan is creating an extra (monetary) demand for consumable goods and the prices of consumable goods will rice by law.

How the Nazi’s scapegoated the retail chains and the big department stores.

We saw the Nazi’s scapegoated the «big department stores» and the chains in their propaganda on their rice to power in the 1920’s. When they came to power in 1933 they started a huge program of deficit spending with almost 50% of their expenses covered by deficit spending. The predictable result was rising prices of consumer goods. The Nazi’s would of course neither fix the problem by curbing their spending nor taking the blame for the consequences of their policies.

The chains where scapegoated in the propaganda and in practical politics in various ways:

  • “Marriage loans” where not allowed to be redeemed in department stores.
  • Department stores were banned from advertizing 1933 onwards.
  • The enforced price controls through the Reich Price Commissioner
  • Often the police did nothing to prevent the brown shirts throwing stones against and plundering the stores.

History repeats

Stones are again being thrown to the stores, the politicians are again discussing the high prices

History repeats itself in a very disturbing way.The scapegoating are continuing and the real causes of the problems remains unfixed.

What was Ayn Rand's position on Fractional Reserve Banking

Ayn Rand was among the best thinkers of the 20th century. She was a philosopher and not an economist. To my knowledge she never discussed Fractional Reserve Banking explicitly.

Francisco’s beautiful and powerful money speech in Atlas Shrugged is however a clear statement against FRB. One of the main points in his speech is that money has no value unless there is something to buy and unless someone has produced:

When you accept money in payment for your effort, you do so only on the conviction that you will exchange it for the product of the effort of others.

I find the same idea expressed in ““Hunger and Freedom,” in the Ayn Rand letter.

Money cannot function as money, i.e., as a medium of exchange, unless it is backed by actual, unconsumed goods.

To explain FRB we must start with normal banking which has two institutions the deposit and the loan. We jump into the case where you have money in your hands. This means that you have produced something and put it on the market.

  • When you deposit money you want them readily available for withdrawals and payments. The money is yours and you can spend them whenever you want. When you spend your money you withdraw goods to the same worth that you have just produced.
  • When you lend the money the money is no longer yours for a defined period of time. You  own the money no more. The guy who lend the money can however withdraw goods to the same worth that you have just produced. He also promise before the loan expires to put goods back in the market to the original worth + interest.
  • Now I’ll explain FRB (which is one of three things that makes me feeling sick. The others are blood and horror movies). When you FRB money  the bank keeps your money in your bank account. They are still yours.But simultaneously they lend out most of the money to some other guy. What they actually do is to open another bank account. And since bank accounts are money just as good as notes and coins the bank is creating money. But no goods are produced in the process.

The deposited money is backed by actual unconsumed goods whereas the new money is backed by “promise to produce goods”. This is clearly in contradiction with Ayn Rand’s statement of money. And in fact I find her insightful on the issue of money: The main point of money is not that it is ‘backed’ by gold but rather that it is backed by unconsumed goods.

The result of the widespread FRB practice is that the money supply is a mix of sound ‘first produce then consume’ money and upside down modern philosophy ‘first consume then produce money’. But as Ayn Rand made clear: Money cannot function as money, i.e., as a medium of exchange, unless it is backed by actual, unconsumed goods.

Ayn Rand undoubtly opposed FRB

Update: Stuart Hayashi made a reply on my note:

Another thread on the topic started here

The left and the right

For the collectivist individualism does not exist. But the collectivist sees extreme differences between the various collectivist ideologies.

  • The extreme right are the guys who want a society with just one race. These are the Nazi’s.
  • At the other extreme, light years away are the guys who want just one class. These are the communist.
  • In between these completely different mindsets (??) you find the liberals, the conservatives, the social democrats etc.

The idea that the “clean society of all non Aryans” is extremely different from the “clean society of all non workers» came from the Third international and Stalin who found it convenient to bash the Nazi’s and the social democrats (Sozi’s) as the worst thinkable thing in the world: “rightist”

But in practical politics the Nazi’s and the Communists are very similar. In fact Stalin saw, correctly, the social democrats to be to the right of the Nazi’s. ( When the Nazi’s came to power Stalin denied the communists to cooperate with the social democrats as the social democrats were the main enemy.)

So the Nazi’s are to the right of the communists, (but not much ) and they are to the left of the social democrats.

The two ideologies

There are just 2 possible ideologies.

Individualism and collectivism

Either the individual is sovereign in his own life or he is not.

Individualism comes in just one version, Classical liberalism which came out of the enlightenment and was the intellectual foundation for the declaration of independence and the American constitution. The bottom line is that each individual is an end in itself and is never to be sacrified for any presumed higher value.

Collectivism subsumes Feudalism, Fascism, Communism, Nazism, Social democracy, “liberals” Conservatism,

Islamism (you name it.) The bottom line in collectivism is that the individual must submit to some authority.

1th of may. Celebration of death.

The essence of socialism is violence. Today the socialists are assembling to celebrate their hold of violent power. Germany was the first country to make labor day a national holiday in 1933. The Nazi’s brought the idea with them to Norway in 1942.

Cold blooded murder

The communists outright murdered 100 million people. The Nazi’s killed a large number too. Since the second world war the world has been plagued with wars often with socialist on the aggressive side.

Indirect murder

All the world’s countries are plagued with socialism to a greater or lesser extent. The most seriously infected areas like Africa, India and the middle east are the poorest. The number of people silently  killed by malnutrition and diseases is much higher than the amount that where murdered

Death of the spirit

The very essence of life is to be the creator of your life. The socialist take away the means and explicitly forbid them to act to create in many ways. This makes people into zombies. They are technically alive but their spirit is dead.

Gold price potential is 10 doubling from current price

What would the gold price (P) be if all money in the world (MTotal) were replaced by the existing mined gold (Gtotal)?

Mtotal I don’t know but I know the money supply of Norway (MNOR), the GDP of Norway(GDPN) and the GDP of the world (GDPW). If we presume the money supply in the economy is proportional to the GDP the Mtotal is

1) Mtotal=GDPW*MNOR / GDPN

For the new gold price we have

2) P*Gtotal=Motal

We subsitutes 1 into and get


The numbers are

GDPW = 74.264.873 million USD ( )

MNOR = 300.000 million USD ( )

GDPN = 255.000 million USD ( )

GTOTAL = ( )

=> P = 530 USD /g

Current price is 48 USD / g

This indicates that the gold price approximately 10 double following a worldwide legalization of gold.

There is other precious metals like silver. This will drag the gold price down. But given a gold/silver ration of 1/16 the worth of the silver is only 1/5th of the gold.

Then there are other uses for gold like electronics and jewelry. This will drag price up. Overall I believe a 10 doubling is a good estimate.

I am sure the current debt based currencies will end up worthless. This price rice will happen one way or another in the process. The big question is wether the governements will legalize money early and voluntarily or if they will clung to the fiat money to the bitter end plunging the world into a deep economic and social crises. In the first case the value of gold will rice in real terms in the second time it might barely keep it’s value.

But in both cases the precious metals is a safe bet placing parts of your savings.