måndag, februari 11, 2008


Professor Bordo on fractional reserves

I quote Professor Michael D. Bordo.

”Once the goldsmiths learned that not all of the claims were redeemed at the same time, they were able to circulate claims of value greater than their specie reserves. Thus was born fiduciary money and fractional reserve banking.”

In my opinion Professor Bordo is mistaken concerning the nature of bank notes backed by a fractional coin reserve.

A bank note backed by a fractional coin reserve represents a debt and the debtor is of course not in any way obliged to keep the coin he has borrowed in a vault, since in that case he would have no reason to borrow the coin. The reason for borrowing the coin is of course that the debtor wishes to spend the coin.

In this context it is also important to remember that it is costly to store precious metals for which reason a debtor who had to keep the coin he had borrowed in safety not only would be unable to spend the coin, but also would have to carry the expenses associated with the storage.

If there ever were banks who issued currency fully backed by coin, those banks most obviously charged their customers fees. I doubt that there ever were such "banks".

A far more likely explanation for the emergence of bank notes is that since it is costly to store gold coins, it is a good business to lend coins against 0% interest. The borrower issues a promissory demand note payable to the bearer when he receives the coin and the lender thereafter spends the note as if it were a precious metal coin.

If somebody, the bearer, wishes to present the note for payment, he is authorized to do so and there is of course no absolute guarantee for the solvency of the issuer. A person who accepts a bank note instead of a precious metal coin is aware of the risk of a possible insolvency of the debtor, but when accepting a bank note the person who accepts it has estimated that risk as lesser than the costs associated with the circulation of precious metal coins.

It is also possible to print such notes without even having seen the precious metal coins these notes refer to. However, it is a risky business to put such notes in circulation since the issuer thereby authorizes those who get such notes in their hands to present them for payment in precious metal coins and thereby drive the issuer into bankruptcy.

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