Walter Block, Fractional Reserve Banking, and Fraud

Last weekend, I attended several talks by Austrian economist Walter Block during my trip to New York City. I spoke to Block personally after one of these talks, to ask him for clarification regarding the idea that banks should have to hold 100% reserves.

For those unfamiliar with this debate, banks today engage in a practice known as “fractional reserve banking,” or “FRB” in the literature. In a fractional reserve system, banks are not required to hold 100% of their customers’ cash at all times. So, if I deposit $100 in the bank, the bank will then loan that money to another individual at whatever ratio does satisfy the reserve requirement. Assuming a 10% reserve requirement (which means that the bank has to hold on to 10% of the cash that I and every other customer deposit), they can loan $90 to the second individual. The problem with fractional reserve banking is that it creates two claims to the same property. I may go out and spend my $100 on a boombox, while the other individual may go out and spend his $90 on new clothes. Thus, a total of $190 are spent, but only $100 were initially deposited. This system is not found out until the vendors of the clothes and boomboxes both go to the bank to retrieve the cash, at which point it becomes clear that it is not there and the bank fails. This, of course, is an oversimplification, as today’s modern economy is grand and largely electronic.

Austrians have different views on FRB. Some, such as Dr. Block, think that banks should be required to maintain 100% reserves, while others, such as myself, believe that “free banking” is the best model. In free banking, banks can choose whatever FRB and reserve policies they like, but are not to be bailed out if they fail. The belief behind a system of free banking is that the market will root out winners and losers, and will thus promote the best possible policy.

Dr. Block told me to e-mail him about this, so I did. Impressively, he responded with an alphabetized reading list on the subject just a week later. The list is very long and, combined with my current work on Human Action , will take up most of my free time for the next few weeks.

I plan to post extensively here on what I read, and welcome any debate or questions as usual.

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