The hardest-hitting chapter of The Evil Princes of Martin Place is a critique of the legality of fractional reserve banking. Chris Leithner makes the case that fractional reserve banking is constructive fraud. This is a direct challenge to the arguments of George Selgin and Lawrence White in their Review of Austrian Economics paper defending contractually based fractional banking. Leithner argues that even if parties sign a contract that permits a bank to treat demand-deposits as loans, this cannot be a valid contract:
The inescapable problem is that agreements and contracts cannot create reality; they must presuppose it… Proponents of [fractional reserve banking] fail or refuse to recognise that [a fractional reserve banking] agreement implies no less an impossibility – and constructive fraud – than that involved in the purchase of dogs that lay eggs…[I]t’s logically impossible that a bank and a customer can agree to convert money substitutes (i.e. warehouse receipts, banknotes and demand deposits) into debts. It’s also logically impossible for two people to simultaneously own the same item of property. They may, of course, certify otherwise…But what they…certify is objectively false.
What about the argument that fractional reserve banking is only fraud when a bank cannot fulfil requests for redemption as they arise? Leither is not having it:
Quite the contrary: [the fractional reserve bank] commits fraud each time it DOES fulfil its obligation to redeem!…[FRB] clearly contradicts the title-transfer theory of contract that defenders of FRB claim that they’ve accepted. In accordance with this theory, individuals can only contract to transfer their own property. In contrast, FRB, by its very nature (and even if practiced “successfully”, that is, until the inevitable crisis and bust occur) involves contracts concerning the transfer of other people’s property. Hence the issue of fiduciary media is inherently incompatible with the title-transfer theory of contract; hence the constructive fraud.
What do readers think?