Against Fractional Reserve Banking and the Curious Case of the Aleatory Contract: Deconstructing Michael Rozeff

In conceiving the present essay, my initial assumption was that it would result in a softening of my prior rigid disapproval of the practice of fractional reserve banking (FRB), an admitting that the practice was not per se a breach of libertarian legal theory. Moreover, I wanted to defend Rothbard as right as far as he goes, and sort of bring the FRB camp and the anti-FRB camp to a comfortable consensus and better understanding of each other. However, in my further investigation into the matter, it seems that I am now doubling down on my prior position on the anti-libertarian nature of FRB, assuming of course both “libertarian” and “FRB” are properly defined. What I discovered in reading more carefully was a redefinition of fractional reserve banking by its proponents, compared to the employment of the phrase by the anti-fractional reserve banking theorists in the Austrian tradition.

What sparked a renewed interest in the matter was a recent response to Walter Block (who is anti-FRB) that was offered by Michael Rozeff on his LRC blog in defense of the legal ability of banks to practice FRB under the libertarian framework. In this response, Rozeff referred to his own much more in-depth treatment of the matter in which he sought to critique Murray Rothbard’s position. It seems my entire position on the matter can be given its finishing touches simply by interacting with the mentioned in-depth treatment. Thus, what follows is a defense of the Rothbardian position over against the critique of Rozeff.

At the back of my mind is the desire to bring the wonderful and praiseworthy Bionic Mosquito closer to my side of things, in light of the fact that he has chosen to wander in the wilderness of darkness and despair on this specific issue. Or at the very least, at least bring some new light to the debate and clarify some issues.

If you are unfamiliar with these matters and want a back drop to my own more complete Rothbardian case against fractional reserve banking, please read my essay here.

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In the first place, as I have stated before, I believe that the root of the error first articulated in its modern form (and carried out by Rozeff in his critique of Rothbard) by the works of George Selgin and Lawrence White is a fundamental misunderstanding of a proper Misesian taxonomy of money. This is why Rozeff also expresses a confused disapproval of Mises’ comments on the nature of the deposit (Rozeff, page 507-508) and why he, more revealingly, expresses advocation for the man who was originally opposed by the Mengerian Eugene Bohm-Bawerk on the issues of money and banking: Henry Dunning MacLeod (Rozeff, page 503-505). More specifically, the FRB proponent’s confusion of “money proper” with fiduciary media is especially relevant. In the words of Guido Hulsmann, “Hence, there is in [the fractional reserve banking advocates’] eyes no fundamental difference at all between a unit of money and the title referring to the money. Both the money proper and the title are forms of ‘money.’ They differ from one another only in degree, not in kind” (page 107 in Hulsmann).

It is of extreme importance that we note and dwell on the fact that, throughout Rozeff’s entire essay, which was intended to be a critique of the Rothbardian position, there is not once mentioned the Misesian/Rothbardian distinction between money proper and money substitutes, including and especially the most relevant and vital subcategory of money substitute: fiduciary media. Any conversation on fractional reserve banking that pretends to be Austrian, and which does not mention fiduciary media, can hardly be taken seriously. It is for this reason, and the reasons which will be expressed below, that I dogmatically stand by my opinion that Rozeff’s understanding of the Rothbardian position is seriously lacking.

Thus, I will immediately and at the forefront state my acceptance of Ludwig von Mises’ own taxonomy: money proper is the actual and generally accepted medium of exchange in the economy; money substitutes are titles to, or claims of ownership on, that money (money substitutes arise as individuals decide they’d rather store their money [gold] and trade paper titles to that gold); money certificates are those money substitutes that are backed 100% by the money; fiduciary media is any money substitute that has been created beyond what is backed up.

What then is fractional reserve banking? Fractional reserve banking is the practice, not merely of ambiguously “only keeping a fraction of reserves” in the bank, but rather of issuing claims or titles on money beyond what can be physically redeemed. That is, if the money in storage in a bank is 100 gold ounces, and there were ownership claims to 150 gold ounces, this system would be operating under a fractional reserve banking structure. Fiduciary media only exists in a fractional reserve setting and therefore the entire debate could be focused on whether fiduciary media is or is not legitimate (hence Hoppe’s most important work on fractional reserve banking was titled Against Fiduciary Money).

Now, when I had previously spent time on this topic, I defined fractional reserve banking in the more precise language as follows:

Fractional Reserve Banking is, by definition, the existence of a contract wherein it is agreed upon that the money deposited is a bailment that is to be returned upon demand by the customer; wherein at the same time that money is loaned out to some other customer.

Bionic Mosquito thought this odd as it didn’t seem to him to be the common definition of Fractional Reserve Banking. Whether it is or it is not common, I don’t know; what I am chiefly interested in is defining it according to the definitions of the Rothbardian banking school, which would include economists such as the following: Mises, Rothbard, Hoppe, Salerno, de Soto, Hulsmann, Block, Bagus, Howden. This is not, of course, to say that I am right because I think they are right; for Bionic Mosquito already has expressed the simple fact that he disagrees with the above individuals on this issue. Rather, my point is if Rozeff is going to critique Rothbard and come down in defense of fractional reserve banking, it is imperative that he define FRB in the same way so as to treat Rothbard on his own terms. What would be tragic, and what I am accusing Rozeff of, is to observe the Rothbardian School as being against FRB and then seek to make the case for FRB under a different set of definitions.

Whether we ought to use the phrase “fractional reserve banking” at all to express the above definition is a different conversation than whether the Rothbardian School happens to define FRB in that way. If there is going to be dissenters, they must dissent on the same terms, else the Rothbardians go uncritiqued.

Let us now begin with our analysis of Rozeff’s paper. I want to categorize my comments in three ways: 1) Rozeff’s misunderstanding of Rothbard’s banking theory; 2) Rozeff’s misconception of libertarian legal theory; 3) Rozeff’s own theoretical blunders.

Rozeff’s Misunderstanding of Rothbard’s Banking Theory

Immediately, the vagueness and problems begin. Rozeff writes of Murray Rothbard’s position:

[Rothbard] argues that banks ought to be allowed to serve only as warehouses for money. He insists that all deposits become bailments, not debts or credits. […] A proper bank would, in [Rothbard’s] view and by law, hold all deposits intact and become a 100 percent reserve-storage or safety-deposit bank, although to call such a business a bank under these conditions is something of a misnomer because such a so-called bank makes no loans.

This is a stunning misrepresentation of the Rothbardian view. It stems from the fact, as we will see below, that Rozeff himself has a confused understanding of the legal-historical meaning of a “deposit.” At any rate, Rozeff accuses Rothbard of having no place for loan banking in his theory. In sharp contradiction, in The Mystery of BankingRothbard writes of the two types of banking:

When one speaks of banks, there is a semantic problem, since the word bank covers several very different functions and activities. In particular, modern banking mixes and confuses two different operations with very different effects: loans and deposits.

Loan banks, Rothbard goes on to write,

“[do] exactly what most people think banks always do: borrowing money from some (in addition to investing the savings of the owners) and lending money to others. The bank makes money on the interest differential because it is performing the important social service of channeling the borrowed savings of many people into productive loans and investments.

Note that there has still been no inflationary action by the loan bank. No matter how large it grows, it is still only tapping savings from the existing money stock and lending that money to others.”

Rothbard exposits and praises the existence of the practice of loan banking throughout his body of works and it is to Rozeff’s serious academic shame that he accuses Rothbard of teaching otherwise. Rozeff, however, is confused because has yet to comprehend the praxeological distinction between the two types of banking, as we will touch on below.

It is due to this misunderstanding of the Rothbardian stance on loan banking that Rozeff thinks he is offering a non-Rothbardian idea when he tries to argue the case that a bank client should be able to put his savings in a bank with the understanding that the bank will loan that money out and pass on interest back to that client. He writes this to counter his own straw man about Rothbard disallowing loan banking on the free market. And yet, since the above reference to the Mystery of Banking shows that Rothbard considers loan banking completely legitimate, Rozeff is arguing for something that Rothbard would praise as an “important social service:” loan banking qua loan banking. Rozeff points out that when a lender invests his money with a corporation it would be silly to expect that corporation to “hold the money in a warehouse ready to be returned to the lender a moment’s notice.” Indeed it would! But it is equally as silly to presume that Rothbard would have some sort of problem with this. That Rozeff doesn’t understand this merely indicates that he has yet to read The Mystery of Banking.

In sharp distinction to Rozeffs summary of the Rothbard School, the reality of the case is that Rothbard and his adherents see two types of banking at work: loan banking and depository banking. An institution engages in loan banking when it takes ownership of the present use of a client’s money, which that client also gives up by virtue of the logical fact that the money can only serve one use at the one time, and loans out that money to a borrower. Conversely, an institution engages in depository banking when it takes temporary possession, but not ownership, of a client’s money for the purposes of storing and protecting that money for the client.

Rozeff accuses Rothbard and the Full Reserve Banking theorists of presupposing without justification that a deposit must have been made by the depositor in order that should always be available at the depositor’s immediate demand for redemption. But can’t a deposit be made wherein there is no legal obligation by the bank to immediately fulfill the client’s demand for money? This is Rozeff’s challenge to the Rothbardians. However, this challenge is a result of Rozeff’s confusion about the language being employed.

Rothbard used the term “deposit” according to the Latin root depositum which referred to a bailment contract. In other words, by definition, a deposit is a contract in which “the availability of the good [is] not transferred” (de Soto, chapter 1). So when Rozeff expresses frustration for Rothbard’s presupposing that a deposit is readily available, this would be akin to my wife defining a triangle as a “three sided shape” and then me getting mad that she is denying that a given four-sided shape we see, is a triangle. In other words, if Rothbard wanted to refer to money that was not readily available, he wouldn’t have used the term deposit. He might have used the word “loan” or the more historically relevant word mutuum (again, see de Soto, chapter 1).

In this way, for every criticism Rozeff makes against Rothbard having to do with the nature of a deposit, we can dismiss Rozeff as simply confused. And for emphasis, it is due to this confusion that Rozeff comes to the very odd conclusion that Rothbard’s theory of banking allows zero existence of a loan contract, as demonstrated in the first section above.

Because Rozeff doesn’t think Rothbard allows for the existence of loan banking, he thinks that when the Rothbardian refers to the common expression of “creation of money out of thin air” he is referring to the very existence of bank loans: “Rothbardians regard bank loans as fraudulent creations of money out of thin air and as actions that create multiple titles to the same property.” This is simply wrong headed, as we discussed above. But to enable us to respond to Rozeff’s next point, we will clarify what Rothbardians are referring to with the “out of thin air phrase.”

Recall the Misesian taxonomy of money as defined in the beginning. Whenever the “money out of thin air” phrase is used, the Rothbardian is referring to the creation of fiduciary media specifically, not “bank loans” in general. What is being dismissed as money out of thin air is additional claims on the money stock without the growth of money stock itself. Rothbardians reject this, not because it is a loan qua loan, but because it is the creation of an additional claim on something that already has a claim outstanding. Rozeff, because he does not appreciate the Misesian distinction between the money and the title to that money, does not realize that the history of modern money banking is a history of the development of struggles and trials with the creation of fiduciary media. He does not see fiduciary media present in the history of bank loans because he does not comprehend it as a category. He confuses the money with the title to money and therefore does not see the great distinction between the traditions of A.R.J. Turgot and John Law or between Bohm-Bawkerk and Rozeff’s own hero Henry Dunning MacLeod (who was heavily criticized by Bohm-Bawerk). Joe Salerno criticizes John Law and MacLeod in his essay Two Traditions in Modern Monetary Theory: John Law and A.R.J. Turgot (chapter 1 here). It is for this reason that I consider Rozeff (and Selgin and White) as severely departing from the Austrian tradition on this issue.

One more comment on Rozeff’s misunderstanding of the Rothbard School’s conception of full reserve banking should suffice. Throughout the essay, Rozeff expresses disapproval with the idea that depository banking is such that a deposit of money by a client into a bank requires the bank to “segregate” or “earmark” that specific money as belonging specifically to the depositor. This is not how full reserve banking works, however. As Huerta de Soto explains in what is perhaps the most important work on money and banking in the Rothbard tradition,

Due to this indistinguishable mixture of different deposited units of the same type and quality, one might consider that the “ownership” of the deposited good is transferred in the case of the deposit of fungible goods. Indeed, when the depositor goes to withdraw his deposit, he will have to settle, as is logical, for receiving the exact equivalent in terms of quantity and quality of what he originally deposited. In no case will he receive the same specific units he handed over, since the goods’ fungible nature makes them impossible to treat individually, because they have become indistinguishably mixed with the rest of the goods held by the depositary.

In other words, in sharp contrast to Rozeff’s assumptions, the full reserve position does not require an earmarking of the specific units that the depositor handed over, but rather because the goods are “fungible,” merely requires a fulfillment of the same type of unit (ie. 10 gold ounces deposited must be fulfilled by returning 10 gold ounces upon demand, even if the original coins themselves are not the ones being given back). Thus, it is entirely acceptable for the Rothbardians, though Rozeff suggests otherwise, that the money being stored in the bank is “pooled together.”

Rozeff’s misconception of libertarian legal theory

Rozeff’s case against Rothbard is fundamentally built on the idea that the libertarian should allow individuals to make their own decisions regarding their contracts and use of property and that Rothbard’s mistake is that “he introduces his own ethical judgment based on his own assessment of the merits of any and all exchange transactions that may occur between banker and depositor.”

Rozeff here demonstrates that his libertarianism is distinct from that belonging to the adherents of the Rothbard School; including most preeminently and distinctively Hans Hoppe and Murray Rothbard himself. The libertarian world itself is full of differing camps, traditions, and approaches. The Rothbard/Hoppean camp (to which most full reserve banking theorists belong) is itself distinct from the approach of fractional reserve theorists like George Selgin, Lawrence White, and Rozeff. Whereas for the Rothbardians concepts such as fraud, breach of contract, property rights, and criminality are all objective and do not depend on the subjective will of the individual, Rozeff and those in his position “tend to embrace an ethical relativism which is consistent with [their] ‘anything goes’ approach” (Bagus, Howden, Block page 4).

It is not my intention in the present essay to prove that the view which sees libertarian law as objective is superior than that which which sees it as subjective, but I do want to emphasize the fact that Rozeff assumes that Rothbard is introducing his own ethical judgment rather than discovering the logical implications of an objective ethical rules. The reason for this is because Rozeff conceives of libertarianism as, in the words of Bagus, Howden, and Block, an “ability to do what I want.” Rothbard though is not seeking to impute his own moral convictions on an otherwise free market, but is rather defining freedom and liberty in terms of the nature of property and the logic of action in a world of scarce resources. Again, the reader should understand that I am here not trying to prove Rothbard’s formulation as the correct one (though I certainly agree with him on this), but highlighting the fact that, in Rothbard’s mind, he was considering his position on fractional reserve banking as a logical and objective legal necessity based on liberty as defined in terms of the nature of property.

Rothbard then entirely disagrees with Rozeff when the latter states: “People themselves decide what kinds of property rights they want and find acceptable in bank accounts. They hammer out what is fraudulent and what is not.” But the Rothbardian view would lead Rothbard to agree with Hans Hoppe when Hoppe writes“not every mutually advantageous contract should be permitted [by libertarian law or in a libertarian society].” As stated by Bagus, Howden, and Block, “It is not up to the subjective whims of people if an action is to be considered fraudulent or not; this is objectively definable.”

Just to make it crystal clear what I am saying here: If Rozeff wants to disagree with Rothbard that FRB is fraudulent, then he must argue based on logic and theory alone (objective), not point to the mutual agreement of human actors (subjective). Economics analyzes the subjective nature of individual desires, but legal theory analyzes objective matters.

Thus, rather than merely introducing his own ethical judgement, Rothbard’s case, whether right or wrong, is in actuality an attempt to build upon the necessary and logical ramifications of the libertarian conception of property rights as a legal doctrine. Libertarian legal theory is not subjectivist, it is normative, universal, and definable. There are actual objective breaches of libertarian-based rules, which must, in accordance with libertarianism as a positive legal doctrine, be responded to in a prosecutorial manner.

Contra this, the Rothbardian/Hoppean framework has been summarized in a much different manner than Rozeff’s by Stephen Kinsella, who writes, “What is distinctive about libertarianism is its particular property assignment rules—its view as to who is the owner of each contestable resource, and how to determine this.” In other words, libertarianism is technically not such that people get to “decide what kinds of property right they want,” but is instead a specific definition and framework of property rights, which necessarily includes therefore a derivative definition of fraud, that is logically consistent with property rights. Fraud isn’t subjectively interpreted, lest there be no possibility whatsoever for an objective legal system under a libertarian-private property order.

The reason for chasing this point, which admittedly is not banking theory itself, is to rid ourselves of the Rozeff’s notion that Rothbard’s fundamental mistake is a imputation of his own preferences into banking theory.

Rozeff’s own theoretical blunders

Traditionally, the case against fractional reserve banking made by the members of the Rothbard School (especially Mises, Rothbard, Hoppe, Salerno, de Soto, Hulsmann, Block, Bagus, Howden), comes down to the logically necessary stance that two people cannot at the same time have legal claim to the present use of the same money. As Hoppe, Hulsmann, and Block write,

The following transactions (contracts) between any two parties A (bank client) and B (bank) are possible. A may transfer his money (gold) into B’s disposition and thereby either (1) not give up his ownership in it, or (2) give up his ownership. There is no third possibility. If (1), then A keeps the title to the sum of money transferred to B; B does not have title to it, but acts as a money warehouser (a bailee) for A (as a money bailor). There is no third possibility. If (2), then B acquires the title to the quantity of money put into its disposition by A; A receives from B in exchange either (a) a present — existing — quantity of consumer and/or producer goods previously possessed and owned by B; or (b) a title to a present — existing — quantity of consumer and/or producer goods in B’s possession (but owned now by A) (an equity claim); or (c) a title to a quantity of future consumer and/or producer goods and/or money (a debt claim). Again, there is no third possibility. That is, A cannot both retain ownership of this property and transfer it to B.

If A transfers his money to B and B owns it (owns the present money), a loan contract is made but if A transfers his money to B and A maintains ownership, a depository contract is made. Neither situation creates an instance of fractional reserve banking.

However, if A transfers his money to B and B owns it, yet A also possesses a claim to its present ownership, it is here that the fractional reserve banking takes place. In other words, and importantly, the essence of fractional reserve banking is that it is a legal confusion between a loan contract and a depository contract. But since something cannot at the same time be loaned out and not loaned out (available on demand), the fractional reserve banking scenario is legally and logically impossible.

How does Rozeff get around this? My answer is that he does so partly out of pure confusion and partly out of an appeal to something we refer to as an aleatory contract; although he doesn’t use the name (probably because he doesn’t recognize it as such). We will attempt to clean up his confusion and also expose the aleatory contract as irrelevant when it comes to the theory and history of money.

In the first place, he defines fractional reserve banking (page 501) in a careless manner that is helpful to no one: “the case… in which the firm and I agree to the lending of my wealth through the firm’s intermediation.” This is not even etymologically correct. What does lending qua lending have to do with holding a fraction of reserves? If this were the definition, and every loan contract constituted a fractional reserve scenario, not only would the Rothbardians be champions of fractional reserve banking, but the reference to a “reserve” is absurd. What is being reserved and against what? In a pure loan contract, if Jones transfers the present use of 100 gold ounces to the bank, and the bank lends out that money to an entrepreneur, what “reserve” exists at all?

It is better to define a reserve as being the money held in storage at the bank in the case of a depositor demanding the money be transferred back to him. In this case, a full reserve situation is one in which all outstanding money substitutes (ownership claims on money) are backed 100% by the stock of money in the bank. A fractional reserve situation is one in which there are more outstanding money substitutes (ownership claims) than there is money in stock.

Now, and this is very important for the reader to understand, Rozeff may claim that the money substitutes do not have to be ownership claims (ownership titles to the money), but since the Rothbardian School defines Fractional Reserve Banking as a situation in which those substitutes are ownership claims, Rozeff cannot pretend to critique the Rothbardian view while at the same time altering the definition. The Rothbard view of fractional reserve banking is an investigation into the nature of the depository contract (defined as a bailment, see above) and this is why the loan banking subject is left out of his conversation.

Now then, let’s consider Rozeff’s positive view about how a fractional reserve situation is legally possible in contradistinction to the Rothbardian formulation above.

Rozeff posits the possibility of a type of loan contract with a call option. That is, Client A deposits his money (say, 100 gold ounces) into Bank B and transfers the ownership title to B and in return reserves an IOU from Bank B. A is now a creditor and B a debtor, in the amount of 100 gold ounces. But as part of the contract, A is granted the right to ask for money back from B at anytime. For clarification, he only gets to request money and B is under no legal obligation to fulfill this request. This is because the IOU is not an ownership title. B may have the money available, or it may have lent it out. So the bank can choose whether or not to fulfill the request depending on the situation.

At the same time, Bank B may discover another Client C to whom it wants to loan. In order to do this, it will extend to that client, say, 75 ounces worth of the IOUs. This client will, like A, have the “right to ask” B for money in the amount of up to 75 ounces. In exchange for these IOUs, C transfers to B his own IOU to pay back, plus interest, the full amount of the loan.

In this way, according to Rozeff, the banking system can run on fractional reserves, depositors can accept that their deposits are being lent out, and at the same time they can ask for this money if they want it.

Let’s compare the above view with how fractional reserve banking was structured historically, which is what RothbardMisesHoppeBlock (chapter 3), and so on are arguing against in their works.

  • In the above, A transfers ownership to B. In Rothbard’s FRB, A retains ownership (his actual meaning of a deposit)
  • In the above, A and B have a creditor/debtor relationship. In Rothbard’s FRB, A and B would have a bailor/bailee relationship (B warehouses what is owned by A).
  • In the above, A can ask for money, but B has no legal obligation to fulfill. In Rothbard’s FRB, A can legally demand his own money, and B does have a legal obligation to fulfill.
  • In the above, C receives IOUs just as A receives them. In Rothbard’s FRB, both A and C receive money substitutes, which are ownership claims for money.
  • Based solely on the above and assuming no other clients exist, in the above there is 100 ounces of money in existence and 175 IOU units. In Rothbard’s FRB, there would be 100 ounces of money in existence and 175 ownership claims on that money.

So then, as you can see very clearly, Rozeff’s conception of fractional reserve banking is not fractional reserve banking as it was historically practiced and which Rothbard heavily criticized. What would bring legions of helpfulness to the debate is if the fractional reserve advocates could come out and say “I agree with Rothbard that FRB as he defined it is legally incoherent,” rather than changing the meaning of FRB in order to defend it.

What I am arguing here is that the Austro-libertarian scholars who discard the legal possibility of Fractional Reserve Banking have always done so according to a certain set of definitions which have yet to be overcome by the advocates of fractional reserve banking. What Rozeff offers in his essay is the conception of something totally different on the basis that it is actually neither a depository contract nor a loan contract at all. It is something else, it is not fractional reserve banking at all, at least in the historical/Rothbardian sense.

This, however, doesn’t mean it hasn’t been addressed before. In fact, what may be surprising to those in Rozeff’s camp is that the above scenario as actually considered legally legitimate by those in the Rothbardian camp. That’s right, the Rothbardians have accepted the legality of the Rozeff’s above arrangement (see de SotoHulsmannHoppeBlock (Chapter 3)Bagus/Howden/Block).  But categorically and definitionally consider it as not fractional reserve banking because the there are no money substitutes/ownership claims. It is instead a curious case for an aleatory contract system.

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. Rather than being a sure and certain medium of exchange, which is what role money plays in an economy of indirect exchange, the “right to ask” tickets are uncertain and, importantly, incalculable.

Acting man uses money to the extent that he prefers indirect exchange to direct exchange and chooses this money based on how well it can demand a great number of producer and consumer goods on the market. Money, as an economy’s medium of exchange, can either itself be used for trade, or it can sit in a vault while titles to that money is used in its stead. The reason that titles to money instead of money itself (money proper) can be used is because the ownership of the money is being transferred from one person to another.

But IOU tickets confer no transfer of money ownership; they merely transfer the chance to get money. But if a “chance to get money” unit is itself not ownership of money, then by definition, these chance tickets are not mediums of exchange. Moreover, the IOU tickets are economically distinct from money in that money can be used to calculate profit and loss whereas the value of an IOU “right to ask” ticket is dependent on the probability of the capability of redemption, which is structurally unknowable and always in flux.

As Hans Hoppe writes:

While such a practice would indeed dispose of the charge of fraud, it is subject to another fundamental criticism, for such notes would no longer be money but a peculiar form of lottery ticket. It is the function of money to serve as the most easily resalable and most widely acceptable good, so as to prepare its owner for instant purchases of directly or indirectly serviceable consumer or producer goods a t not yet known future dates; hence, whatever may serve as money, so a s to be instantly resalable a t any future point in time, it must be something that bestows an absolute and unconditional property right on its owner. In sharp contrast, the owner of a note to which an option clause is attached does not possess an unconditional property title. Rather, similar to the holder of a “fractional reserve parking ticket” (where more tickets are sold than there are parking places on hand, and lots are allocated according to a “first-come-first-served” rule), he is merely entitled to participate in the drawing of certain prizes…. But as drawing rights—instead of unconditional ownership titles— they only possess temporally conditional value, i.e., until the drawings, and become worthless as soon as the prizes have been allocated to the ticket holders; thus, they would be uniquely unsuited to serve as a medium of exchange.

It is for these reasons that the Rothbardians, while considering these lottery tickets as legally permissible, refuse to focus on them in the context of an investigation into the theory of money and banking. Aleatory contracts are a different topic than money and banking. Rozeff might be surprised that the Rothbardians consider his suggested system as legally permissible because he does not understand how their framework of money and banking is formulated. But indeed, Bagus, Howden, and Block write:

“While aleatory contracts are legitimate, they represent separate cases than both deposit and loan contracts and generally fall outside the scope that either encompasses.

In his own comments on the possibility of an aleatory system (he doesn’t use this phrase), Guido Hulsmann makes an important observation that should be taken to heart by those in Rozeff’s camp: “Fractional reserve banks [under Rozeff’s formulation of the idea] would have to use a different language than they commonly use, because words such as “deposit” are deceptive.” I think this gets to the core of the matter. The pro-fractional reserve folks use terms such as “deposit” in a much different sense than the Rothbardians do and therefore express confusion when the Rothbardians “presupposes” that the deposit must be readily available.

By understanding the differences between the two formulations of fractional reserve banking, I think that those laymen leaning toward Rothbard can more easily admit that Rozeff’s system, even if it has little to do with money and banking in the Austrian tradition, is legally permissible. Similarly, by understanding how Rothbard defined his terms and structured his arguments, the pro-fractional reserve bankers should be able to admit that Rothbard was right as far as he goes and that he was not, as Rozeff false assumes, “imputing his own ethics onto the banking system.”

In the end, my agreement lies with Hulsmann who points out that, based on the nature of the aleatory contract and the IOU tickets, the aleatory system “would lead a fringe existence in a truly free economy.” This is not because it “is a bad idea” anymore than lotteries are fringe because they may be “a bad idea.” Rather, the aleatory arrangement would lead a fringe existence because it does not fulfill the purpose of money and banking according to the Misesian system of economic theory. The reason the Rothbardians dismiss it so easily is because it falls “outside the scope” of any analysis of money and banking.

In conclusion, the Rozeffians, in my estimation, misunderstand the Rothbardian case for full reserve banking because they misunderstand the Misesian taxonomy of money. They also misunderstand the Rothbardian legal insights because they fall into the “libertarianism means I can do whatever I want” trap. Lastly, they do not properly understand the distinction between money substitutes and IOUs and therefore confuse the two as referring to the same function.

Thus, my position on all this is that the aleatory contract and the fractional reserve banking issue are two different subjects.

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