Murray Rothbardâ€™s frequent and infamous propensity for denouncing fractional reserve banking as fraud and promoting instead a universal gold standard is anti-libertarian both in terms of economics and natural law. Or, at least, thatâ€™s what Iâ€™m going to argue here. Rebuttals are encouraged; this is as much an educational exercise for me, as I hope the resulting dialogue also might be for others.
First off, a gold standard, literally speaking, doesnâ€™t seem to be remotely libertarian in any conventional sense of that term. Surely a standard is centrally imposed and forcefully policed. If not, how can it be called a standard? Is a voluntary standard actually a standard? Isnâ€™t that better described as a tendency, convention or metaphor? In any event, if by â€œstandardâ€ one means voluntary standard, that is libertarian, but has zero control over monetary behaviour and clearly that was not acceptable to Rothbard. He was very clear, on countless occasions, that he considered fractional reserve banking to be fraud and that in his libertarian world the legal system would treat it as such. But isnâ€™t that, by definition, a violation of contract? Iâ€™ll return to this point momentarily.
On other matters, Rothbard was keen to say that the market would work it out. Well, letâ€™s apply that logic to free banking. It seems likely to me that under free market banking fractional reserved banks would out-compete full reserved ones. Furthermore, they wouldnâ€™t be criminal or problematically inflationary. For the moment, letâ€™s assume two banks, one of each kind. Weâ€™ll call them Rothbardâ€™s Bank and McConkeyâ€™s Bank. RB is, as he himself often described full reserve banking, simply a warehouse for people to store their gold (or whatever was the commodity for money). As a storage house, the only way to pay for the infrastructure and personnel necessary to run the business is for the customers to pay a fee for the storage service. So, people can put their money in the RB and pay whatever that costs. Or, they could put their money in the MB and not only avoid any fee, but would receive interest for their deposits. Iâ€™m guessing a lot of people â€“ maybe most â€“ certainly the overwhelming majority of those who feel the need to economize are going to prefer the MB arrangement.
However, unlike the pretty straightforward service at RB, depositing at MB will involve a contract that includes the following four conditions: 1) notes offered by MB will be redeemable in gold (or whatever is agreed upon); 2) deposits will receive interest relative to their size and term as established at a rate, subject to market forces, and always available for examination by depositors; 3) any withdrawal over a stipulated size requires a two week notice; 4) under exceptional conditions, the bank reserves the right to suspend payment on notes for a period no longer than 60 days. As these four conditions are spelled out in the contract prior to any deposit, the bank is never in violation of its contract as long as it meets these conditions. Any presumption to treat this arrangement as fraud, by Rothbard, or anybody else, is a violation of contract between the depositor and the bank and is itself in fact the actual criminal act according to libertarian principles. 
MB, then, follows the well established practices of fractional reserved banking: based upon established withdrawal patterns, it estimates how much gold reserve must be available to meet predictable demand. Deposits that exceed that necessary reserve are then lent as interest-bearing investments. If MB is run poorly, it will either lend more than it can afford or will invest in too many high-risk ventures. In either event, it could indeed find itself unable to fulfil its contract. It would then be driven out of business and (if there is no state, or at least a responsible one, there couldnâ€™t be any coercively enforced limited liability incorporation, so) its principals would be liable to repay all depositorsâ€™ outstanding deposits and interest â€“ as in any other case of theft or failure to fulfil contract obligations in a libertarian society.
If MB was run properly, though, it would make wise investments â€“ limiting risk â€“ with most loans recallable within 60 days or less. The interest on those loans would provide profit for the bank and the source funds to meet depositor interest obligations. While, from Rothbardâ€™s perspective, the bank would be objectively bankrupt since at any moment in time it wouldnâ€™t have the reserves to pay all its depositors, in fact, any withdrawal that would tax existing reserves would require a two week notice and hence provisions would be taken to meet the withdrawal. And, in the unlikely event of a run on the bank, the fourth clause could be invoked, suspending note redemptions for no more than 60 days. If MB has been running its business properly, it will be able to call in the loans necessary to meet the gold demands of note holders and depositors. Like any other business, it has to be run properly. If RB is not a properly run business it will be robbed and the depositors will be out of their deposits, too.
So, if we assume for the sake of argument that both RB and MB are properly run businesses, one costs the depositor to store their gold, while the other, for a small risk, offers instead to pay interest on the deposit. I expect only the very risk-averse will choose RB over MB, but, again, that would be for the market to decide, not a sage libertarian referee.
To conclude, will fractional reserve banks be a great threat of inflation, as Rothbard claims? To answer this, let us assume that there are three MB style banks in operation: MB1, MB2 and (you got it) MB3. All three of these banks accept each othersâ€™ notes at par. This is simply smart business: any one that didnâ€™t do so, while the other two did, would have their reserves constantly drained away by the other two banks as they redeemed the notes of the holdout bank. These banks, though, compete for deposits: the more deposits, the greater the reserve, the larger the total sum of the fraction that can be loaned and the larger the profits in interest on loans. Therefore, while the banks may have some areas of cooperation, they are businesses in competition with each other, as in any other market. Thus, they and their mutual competition serve as brakes upon each otherâ€™s temptation to overextend the issuance of circulation money to reserves.
If MB1 and MB2, based upon their observation of the market, conclude that MB3 is trying to squeeze out more profits, not from smart investment, but reduced reserve fractions, they may collect and hold all or some portion of MB3â€™s notes that they are redeeming at par and suddenly drop a large accumulated redemption obligation upon MB3. MB3 does have the benefit of clauses 3) and 4) from the contract, but if the principals have not been managing their bank business properly, at the end of 60 days, if they cannot meet their obligations, they are out of business. Thus, the natural competition between MB-style banks serve as a brake upon the inflationary practices of flooding the economy with money not properly backed by responsible reserves. This does not deny there can be some inflationary impact with fractional reserve banking. What there cannot be, though, is runaway inflation such as one finds with central banks that are not subject to such competitive sanctions.
However, is all inflation inherently bad? Certainly, all inflation will tend to increase prices of goods bought with the relevant money. On the other hand, constant improvement in organization and technology should lead to productivity increases that offset these inflationary effects. The mild inflation of private fractional reserve free banking, though, through moderating the price of money, serves to direct productive resources away from the actual creation of money, into other economic activity. Consequently, this redirection of resources into non-monetary goods production should actually contribute to such increases in productivity. However large or small these redirected resources may be, they would be a greater contribution to productivity than having resources directed to the production of gold or silver coins in response to high money prices.
Iâ€™m very much a novice in these matters, trying to learn my way around. However, from my research so far, it seems to me that libertarians who are too keen to grant Rothbard a wide berth on these matters â€“ or, for that matter, uncritically jump on Ron Paulâ€™s gold standard bandwagon â€“ are doing the libertarian cause a disservice.
 Strangely, Rothbard regularly overlooks the fact that 100% reserve banking is â€“ and long has been â€“ available for those who wanted it. Itâ€™s called a safety deposit box.
 Those who would argue that contracts for criminal behaviour cannot be enforceable, and since fractional reserve banking is fraud, etc. and so on…, are getting themselves into a whole heap of conceptual difficulty. First, theyâ€™re begging the question: it is precisely the natural law status of such a contract that is under discussion: one doesnâ€™t get to claim the desired conclusion as the premise. Second, those who would argue that there is third-party externalities that need to be considered ought to think more deeply before wandering down that path. Its first problem is that of course no one is required to use the currency of MB banks. If you donâ€™t use the currency, its inflation cannot affect the prices you pay for goods. If the currency actually is inflated, your gold, stored at RB, will be worth more. But, even if there were externalities; is that really the argument a libertarian wants to make? Isnâ€™t that how drug prohibition, â€œsocializedâ€ health care and â€œpublicâ€ education are justified by statists? As Rothbard frequently observed, society is nothing but externalities.