Rothbard’s Anti-libertarian Gold Standard?

Murray Rothbard’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, that’s what I’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, doesn’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? Isn’t that better described as a tendency, convention or metaphor? In any event, if by “standard” 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 isn’t that, by definition, a violation of contract? I’ll return to this point momentarily.

On other matters, Rothbard was keen to say that the market would work it out. Well, let’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 wouldn’t be criminal or problematically inflationary. For the moment, let’s assume two banks, one of each kind. We’ll call them Rothbard’s Bank and McConkey’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.[1] 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. I’m guessing a lot of people – maybe most – 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. [2]

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 couldn’t be any coercively enforced limited liability incorporation, so) its principals would be liable to repay all depositors’ outstanding deposits and interest – 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 – limiting risk – 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 Rothbard’s perspective, the bank would be objectively bankrupt since at any moment in time it wouldn’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 others’ notes at par. This is simply smart business: any one that didn’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 other’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 MB3’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.

I’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 – or, for that matter, uncritically jump on Ron Paul’s gold standard bandwagon – are doing the libertarian cause a disservice.



[1] Strangely, Rothbard regularly overlooks the fact that 100% reserve banking is – and long has been – available for those who wanted it. It’s called a safety deposit box.

[2] 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, they’re begging the question: it is precisely the natural law status of such a contract that is under discussion: one doesn’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 don’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? Isn’t that how drug prohibition, “socialized” health care and “public” education are justified by statists? As Rothbard frequently observed, society is nothing but externalities.

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17 Responses to “Rothbard’s Anti-libertarian Gold Standard?”

  1. Paul Geddes says:

    Good stuff! Especially if this gets people reading more Selgin & White!!

  2. Though I’ve tried to address the matter both in the original article and in the comments section, the continual recurrence of the “fraud” allegation in relation to the MB style banks discussed above has me thinking that perhaps a different tack might be profitable. Admittedly, no analogy is perfect, but perhaps this comparison might be helpful.

    Happily, I now have a Kindle and get my books delivered minutes after buying them. (Hurrah Kindle!) There was a time, though, when I bought paper books from Amazon. In those days, no transaction between us was initiated until they had my credit card information and had charged me for the book. However, it generally took them about a week before they got the book into the mail. Was that fraud? The credit was gone from my account. They had my money, but they also had my book. I gave them money for the book, but I had neither and they had both. In fact, sometimes it was worse than time. On more than one occasion, due to transit or inventory problems (particularly with Canadian history books, I’ve noticed) it took over a month for them to get the book into the mail. So, was this fraud? Of course not: buying a book from Amazon entails entering a contract that recognizes the material realities that paper books cannot be delivered instantly, but that Amazon will not undertake the work of retrieving the book from their warehouse and processing it unless it is paid in advance. And, under unusual conditions, the delay may be longer than normal. We’ve agreed to a contract that simply acknowledges the material realities.

    Likewise, if I deposit my money in an MB as discussed above, yes, I’ve given them my money and yes they are obliged to return it to me when I want it back. However, not necessarily instantly; I entered a contract with this bank specifically because I want them to invest it in projects that will produce profit, in the form of interest, for me. The material reality is that my money cannot be both invested in projects generating interest for me AND simultaneously sitting in the bank vault waiting for me to pick it up. That is no more materially possible than that Amazon can instantly hand over a paper book to me on receipt of my payment. In both cases, recognizing the limitations of the material reality involved, we’ve signed a contract together that regulates how we agree to manage details of our arrangement, so that everyone gets what they want under mutually workable conditions.

    If Amazon is not engaging in fraud, I don’t see why the MBs are. And if it is, failing Star Trek style transport, I don’t know how material goods can be expected to be in two places simultaneously. Hell, if you want to really quibble over it, even in the case of my Kindle, for several minutes I have neither money nor book. In a true spot market, where buyer and seller hand over the exchanged goods on the spot, matters are straightforward. However, when time off-set is a consideration, we make contracts to manage the details to mutual benefit. If the contract is signed freely and its terms are met, where’s the fraud exactly?

  3. minarchiste says:

    The author forgot to talk about the impact of fractional reserve banking on the business cycle. That's central to this theme in my view. I would suggest he reads De Soto on that…

    • The Austrian business cycle is based upon there being so much funny money in the system that investors get wrong signals and are led to mal-investments. As I explained above, in a competitive, free market banking system, each bank's own competitors are a check upon any of them excessively inflating their currency. If they do, their competitors will drain away their reserves and drive them out of business. No?

      • John says:

        That is correct, and that is why fractional reserve banks will all be run out of business. In an honest market, "excessivly inflating" their currency is equivalent to fractional reserve banking. Your third and fourth conditions are also what would scare investors away from fractional banks.
        And the fraud argument can't simply be dismissed as by 'rote' when you don't address its central principle in your article. That is, when the bank loans out more money than it owns, that money lays more claim to real resources than are available. Therefore, your second contract condition alone will cause your bank to fail, with the third and fourth only serving to scare away potential customers.
        Also, the Austrian business cycle theory is about money that doesn't represent real resources being used to divert them from where they'd otherwise be. Your system does this. Free market checks only lessen the magnitude of a fundamental problem you haven't touched.
        It boils down to this: If fractional reserve banks could compete on the market, maybe they would have, but the many runs on banks throughout the nineteenth and into the twentieth century before the banking system was cartelized and legitimate competition (gold) outlawed only serve to show you should read Rothbard's history of money and banking in the United States before touting the possibility of fractional reserve banking.

        • It's funny to me that everyone assumes I haven't read Rothbard because I'm posing an alternative to his analysis. Almost as though one couldn't have read and still disagree with him. It would be strange (and, in fact, impossible) to write this article if I hadn't read him. I feel sometimes invoking his name, among some, is a kind of magic incantation.

          I actually did address the fraud issue: fraud is a matter of misrepresentation in contract. Since the MBs wouldn't be doing that, they wouldn't be engaging in fraud. I repeat, rote repetition is not an argument.

          As I said, I'm not at all convinced that a small amount of inflation won't actually have benefits for productivity. Again, there's no argument here against that possibility. One gets the impression that some people are too busy writing their critiques to finish reading the article.

          As to whether such banks would inevitably fail in a free banking market, well, only time will tell. I certainly don't know. Again, my point wasn't to argue the superiority of such banking, it was to question the libertarian ethics of treating such private contracts as criminal actions. And, I must say, the tone of some of these responses aren't making me feel any more confident in what some people consider to be libertarian.

  4. lemoutongris says:

    Anti libertarian? I object!

    For millenia, gold had been the currency of the world. It's when the government started intervening in the monetary system.

    Also, you have apparently not read The Case for a 100 Percent GOld dollar. In this book, people would be free to buy various debentures (certificats of deposit, mutual funds) that can be readily transformed in short or long term loans. It is reimbursed on time with interest.

    Finally, fractionnal banking is plain frauding. It pretends to have money that doesn't exist and is indeed a cause for inflation

    • mstob says:

      As long as the bank is able to meet the 4 conditions laid out in the imaginary contract Dr. McKonkey laid out above, what is fraudulent? The contract is being fulfilled.

      A bank operating with fractional reserves, as long as it can satisfy consumer deposit withdrawels at any time, and establishes conditions to prevent runs, would be operating on a consensual basis, no?

    • I didn't say there was anything wrong with gold. I'm only arguing that the proper libertarian position is that people should be free to choose whatever options the free market makes available.

      Rote repetition of the fraud allegation isn't actually an argument.

      Of course I've read the book and many other things Rothbard wrote on the topic. That's why I wrote the above.

      • lemoutongris says:

        so you would agree that a banker lends money he doesn't actually own?

        btw, before the state started intervening, the market had chosen gold and silver as media of exchange

        • That's not entirely true, because the state has always endeavoured to control currency and banking for its own interests. We don't know what would result from a free banking market. But, I repeat, I have no argument with gold. My argument is with the allegation that anything other than a pure gold standard is criminal. That position, to me, is not free market or libertarian.

          • lemoutongris says:

            Actually, the state has started to control the monetary system around the renaissance, when it needed more cash to finance its constly colonization.

            I admit that "anything other than pure gold standard is criminal" might be pushed a little far. However, anything other than 100% reserve IS criminal, as not everyone can get a hold of tis property.

            Just curious : would you agree witht the Chcago school and agree with 100% fiat money reserve?

          • mstob says:

            As I see it libertarians are opposed to violations of contracts.

            If I place my money in a bank and contractually agree to conditions where I may not be able to withdraw it on an immediate basis, and am made aware that it may be loaned to someone else, what contract is being violated? Dr. McKonkey made this clear in his article.

            This argument seems to be going in circles.

          • I’m not sure why you say that state control of money began in the Renaissance. I mean, the Roman Empire was pretty prickly about the minting of coins. And it’s not like they invented the idea.

            As you ask my opinion, the MBs described above are not engaging in fraud nor for that matter are they lending out money they do not have. Quite the contrary, they are specifically lending out money that they do have precisely because they do not keep 100 percent of deposits in reserve. Indeed, their contractual obligation is to lend out some specified portion of deposits to generate interest on behalf of their depositors. If they didn’t do so, then, and only then, would they be in breach of contract and engaging in fraud.

            I don't know enough about the Chicago School to express an opinion, though my understanding was that the whole premise of Friedman's position was based on there being a central bank to regulate the currency. I obviously wouldn't approve of that. However, I'm open to consenting adults engaging in any kind of voluntary financial association that they like and let the market sort out what provides value and what doesn't. Surely that's why we believe in markets, no?

  5. mstob says:

    This is a great article. I've always been more in the free banking camp and never really understood why it was taken for granted that people would not agree to place their savings in a banking institution that would in turn lend them out to other investors. I think it was in the "Anti-capitalists at the gates" lecture where Larry Sechrest says that we have always had 100% fractional reserve banking, it is called a safety deposit box. You touched on that point as well.

    I'd just like to point out that I don't see why "a standard is centrally imposed and forcefully policed." Can't standards be voluntary? Rectangular credit cards, pens with blue ink, printer paper a certain size, soccer balls measuring a certain diameter. One of the arguments libertarians make against enforced government standards is that the market forces just the right amount of standardization among its participants as desired by consumers.

  6. @seanpk8 says:

    I only read up until the "To conclude …" paragraph, but what has been laid out fits with my understanding of Free Market Banking.
    I could even see the same bank having both 100% and fractional accounts and allowing customers to dedicate some of their interest from the second to pay for the first …

    Still, I think it would be worth a little more effort to figure out who actually owns what at any given point of time. It is important for a non-fraudulent fractional reserve system to identify a clear owner for each asset at any given point of time …
    See "Fractional-Reserve Banking Violates Property Rights" here:

  7. Have you read Selgin? Because you pretty much sound like him.

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