Or – Why Murray Rothbard and the Social Credit Theorists are Wrong
One of the arguments that rumbles around some of the various blogs I read is an old one about the nature of what banks do. It pops up on a regular basis when economic theorists get involved in discussions about banking. This argument is founded in what I consider to be a misunderstanding of the nature of money itself.
To me, the argument boils down to a simple question – are deposits in banks “money”, properly so called? If it is, then banks can create money simply by accepting a deposit at call and then making a loan.
What follows is a short, but I believe still correct, discussion. If you want more, please raise points in the comments.
Rothbard founds his argument against modern banking practice (see Chapter VII of the link – opens in new window) on what I believe to be a misconception: that when you deposit money in a bank what you have is still money, only in the form of a bank deposit, rather than a claim on the assets of the bank. To emphasise his point he calls bank deposits “warehouse receipts” as if the process of putting your money in the bank is the same as storing furniture in a warehouse.
The Rothbardians out there may be horrified at the thought, but he is making a very similar argument to Maj. C.H. Douglas in his Social Credit framework – that banks manufacture money. Here, in a speech to the King of Norway (opens in new window), is the clearest exposition of this I can find:
[banks] make … it in exactly the same sense that the brickmaker makes bricks, and not in the sense that Mr. Jones makes money; Mr. Jones only gets it from somebody else, but the banker makes it. The method by which the banker makes money is ingenious, and consists very largely of bookkeeping.
The social credit people then move from there is all sorts of directions, some into outright socialism and some to a position very close to (if not actually in full agreement with) the Rothbardians.
Why they Are Wrong
They are both wrong. Banks do not “manufacture” money and for a very simple reason. To use Rothbard’s analogy – when you deposit your furniture in a warehouse you pay the warehouse to store your furniture. When you “store” your money in a bank, the bank pays you. Why is this? Simple. When you loan your money to a bank you are (implicitly or explicitly) authorising them to lend that money back out to someone else and for the bank to make a return on it.
The interest I receive in lending my money to the bank is to compensate me for two main things (and several others, not important here):
- the time value of money, where I get compensated for delaying my use of the money while the bank uses it; and
- credit risk, the risk that the bank will not be able to pay me when I walk up to the bank (or now my web browser) and tell the bank I want to withdraw.
To use Rothbard’s analogy, if I was doing the equivalent thing with my furniture I would expect to get rent for it – the rent amount being to compensate me for not using the furniture for the time I do not have it and for the risk that my furniture will have been lost or stolen when I ask for it back.
To put it another way – when you deposit your money in a bank it is no longer your money. It is the bank’s money and you are compensated for this transformation through being paid interest – or at least not having to pay them a storage fee. In this I fully agree with Lord Cottenham in Foley v. Hill and Others (I am quoting here from Rothbard as the Google copy is not in text form)
Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it . . . . The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the mount, because he has contracted . . . .
Rothbard, looking at Foley which clearly stated this principle, saw it as a disastrous mistake. I would agree if I were paying the bank to store my money. I am not, though. The bank pays me while they have it. Where do they get this money? By lending it out – therefore, when I deposit my money in a bank it is no longer my money, but a claim on the assets of the bank.
If what you want is a place to store your money and be sure that the money is safe, great. They are called safety deposit boxes and are available in the vaults of most major banks. Just expect to pay for their use.
[Update – I changed the title to more closely follow what I actually said in the post]