No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eleven: Money, Money, Money! 259 In terms of a “first best world,” there would be no fractional reserve banking; as practiced, it only leads to inflation and financial system instability (at least when combined with central banks—see “Fraud!” example). Further, God warns against fraud, and money tampering is repeatedly condemned. Recall that one of the primary functions of money is that of a unit of account: the measuring of how pricing should take place. Imagine a world where the physical measurements of weights and lengths were variable. What havoc would it wreak if the engineer could not reference a common standard to build to? I wouldn’t want to drive across the bridge he or she built. It is the same way with money; for financial calculation we need a common standard. There is always a benefit to those committing the initial fraud, and God gives his condemnation in Deuteronomy 25:15 and Proverbs 20:10 . The Lord detests differing weights and measures. In Old Testament times, the merchant would have scales to weigh both the commodity being sold and the metal used in payment. The merchant might try to be dishonest and have differing weights and measures to obtain more profit from the consumer. The merchant might have more familiarity with weights and measures (since he used them daily) and thus more of an opportunity to exploit the consumer. North s uggests God’s repeated strong condemnation of false weights and measures is due to the merchant in effect saying God is an unjust ruler; God won’t punish me for this sin. A just king would prohibit this type of fraud, and since God doesn’t, he is an unjust King. Of course that is not true, and may be the reason for God’s repeated condemnation of this crime. In any case, God is against one person exploiting another through fraud, as false weights and measures are. FRAUD! FRACTIONAL RESERVE VS. FREE BANKING There are a whole host of economists who argue that fractional reserve banking is immoral, since it makes promises that cannot be kept. Murray Rothbard’s arguments are at the forefront; see his text Man, Economy & State (Chapter 11, p. 800) for one example. Gary North is a Christian economist who says essentially the same thing . In the 2nd best world we live in, a free banking system that could include fractional reserves would be a drastic improvement over current monetary arrangements. Economists George Selgin and Larry White have shown theoretically and historically how free banking mitigates inflationary and business cycle risk. For Selgin and White, the problem is not fractional reserve banking per se, but fractional reserve banking that is unconstrained by having a central bank to enable excessive lending. Regarding fraud, if depositors were fully informed that they were indeed surrendering their money with no certainty of payment on demand, the problem of fraud is avoided. Basically, we would officially eliminate the concept of demand deposit—unless people wanted to purchase a safety deposit box. Under free banking, maybe we just need a big sign in every bank: WARNING: WE PRACTICE FRACTIONAL RESERVE BANKING—DEPOSIT AT YOUR OWN RISK!