"
"
AN INADEQUATE SOLUTION:
THE REDEFINITION OF THE CONCEPT OF AVAILABILITY
The belief, held by the most qualified theorists, that it is
impossible to reconcile two contracts as incompatible as the
monetary irregular deposit and the loan contract, along with
the fact that the majority of contracts sustaining present-day
banking are demand deposits (monetary irregular-deposit con-
tracts) have led scholars to try to formulate alternative juridi-
cal constructions to harmonize the irregular deposit contract
with “traditional” banking, i.e., fractional-reserve banking.
Some have tried to solve this contradiction by “redefining”
availability. In fact, for subscribers to this line of thought, avail-
ability need not be understood in a strict sense (100-percent
reserve ratio or keeping the tantundem available to the deposi-
tor at all times), but could be interpreted in a “lax” one: for
example, the “general” solvency of the bank by which it meets
its obligations; “prudent” investing; avoidance of high-risk
speculation and the corresponding losses; maintenance of
appropriate liquidity and investment ratios; and in short, com-
pliance with an entire body of rigorous banking laws, which
together with the hypothetical operation of the “law of large
numbers” in the opening of deposit accounts and withdrawal
Attempts to Legally Justify Fractional-Reserve Banking 147
of demand deposits, could ultimately guarantee the bank’s
ability to return deposits whenever requested by a depositor.
Thus, to Garrigues the obligation to maintain deposits
available to depositors “becomes a duty to work diligently, to
make prudent and sensible use of deposits, so the bank is
always capable of returning them on demand.”33Following
Lalumia’s example, Garrigues adds that the depositary is not
“obliged to keep the tantundem, but only to invest it wisely
and keep it liquid so he is always in a position to return it if
necessary.”34The bank would only have to keep in its vaults
enough money to satisfy the “probable” demands of its
clients. Garrigues therefore concludes that
in bank deposits, the element of custody is replaced by the
technical element of calculating the probability of deposit
withdrawals. In turn, this calculation depends on the fact
that bank deposits are made on a large-scale.35
148
Money, Bank Credit, and Economic Cycles
33Garrigues, Contratos bancarios, p. 375.
34Ibid., p. 365.
35Ibid., p. 367. García-Pita y Lastres defends the same theory in his
paper “Los depósitos bancarios de dinero y su documentación,” where
he concludes that
under the circumstances, instead of regarding “availability”
as the simple right to claim immediate repayment, we should
consider it a combination of behaviors and economic and
financial activities aimed at making repayment possible. (p.
990)
He continues in the same vein in his paper “Depósitos bancarios y pro-
tección del depositante,” pp. 119–226. Also espousing this view,
Eduardo María Valpuesta Gastaminza argues that
the bank is under no obligation to hold the deposited good,
but rather custody becomes a responsibility to prudently
manage both the customers’ and the bank’s resources, and to
keep these available, which is also ensured by legitimate gov-
ernmental regulations (which set the reserve requirement,
limits to risk-taking, etc.). (pp. 122–23)
See “Depósitos bancarios de dinero: libretas de ahorro” in Contratos
bancarios, Enrique de la Torre Saavedra, Rafael García Villaverde, and
Rafael Bonardell Lenzano, eds. (Madrid: Editorial Civitas, 1992). The
same doctrine has been endorsed in Italy by Angela Principe in her
Quite significantly, Garrigues himself acknowledges that
all of this doctrine involves “the unavoidable replacement of
the traditional concept of custody by an ad hoc concept, the
plausibility of which is highly doubtful.”36Garrigues is right
in considering this reinterpretation by theorists of the concept
of availability “forced” (even though he eventually accepts it).
The theory that in the irregular deposit contract the safekeep-
ing obligation merely consists of using resources “prudently”
so the bank retains the solvency necessary to pay its debts is
actually untenable. The prudent use of resources is advisable
in all human actions; for instance, in all loan (not deposit) con-
tracts which specify that certain resources are to be used and
then returned following a set term. That is, it is advisable if
there is a desire to comply with this obligation (the very mean-
ing of solvency).37 However, as we know, the purpose of the
irregular deposit contract is different from that of the loan
contract and requires something markedly different: the cus-
tody or safekeeping of the good at all times. So if the deposi-
tors try to withdraw their deposits and the bank cannot pay
them, regardless of whether it is solvent overall and can pay
once it converts its investments into cash, the essential obliga-
tion in the deposit contract is clearly violated. This is due to
the fact that some contracting parties (depositors) who have
entered into the contract believing its fundamental purpose to
be the custody and safekeeping of the good and its continuous
availability are compelled to become something radically dif-
ferent: forced lenders. As such, they lose the immediate avail-
ability of their goods and are obliged to wait for a prolonged
Attempts to Legally Justify Fractional-Reserve Banking 149
book La responsabilità della banca nei contratti di custodia (Milan: Editorial
Giuffrè, 1983).
36Garrigues, Contratos bancarios, p. 365.
37Furthermore, the standard criterion of “prudence” is not applicable in
this case: an imprudent bank may be successful in its speculations and
preserve its solvency. By the same token, a very “prudent” banker may
be seriously affected by the crises of confidence that inevitably follow
artificial booms, which are generated by the fractional-reserve banking
system itself. Hence, prudence is of little use when there is a violation of
the only condition capable of guaranteeing the fulfillment of the bank’s
commitments at all times (a 100-percent reserve ratio).
period of time until the bank has, in a more or less orderly
fashion, converted its assets into cash and can pay.
Though the concepts of solvency and the prudent use of
resources are not sufficient to modify the essential meaning of
availability in the irregular deposit contract, one might at least
think the problem could be resolved by the calculation of
probabilities and the “law of large numbers,” to which Gar-
rigues refers. Nevertheless, as we argued above, even if it
were statistically possible to calculate probabilities in this field
(which is certainly not the case, as will be shown in the fol-
lowing chapters), the contract would at any rate cease to be a
deposit and become an aleatory contract in which the possi-
bility of obtaining the immediate repayment of the deposited
good would depend on the greater or lesser probability that a
certain number of depositors would not simultaneously go to
the same bank to withdraw their deposits.
In any case, in chapter 5 we will argue that we cannot
apply the objective calculation of probabilities to human acts in
general, and in particular to those related to the irregular
deposit. This is because the very institution of irregular
deposit with no safekeeping obligation (i.e., with a fractional
reserve), a legally paradoxical contract, triggers economic
processes leading banks to make, on a large scale, unwise
loans and investments with the deposits they appropriate or
create. This is the case because these loans and investments
are ultimately financed by credit expansion which has not
been preceded by an increase in real savings. Economic crises
inevitably result, along with a decrease in banks’ solvency and
depositors’ confidence in them, which in turn sets off a mas-
sive withdrawal of deposits. Every actuary knows that if the
consequences of an event are not completely independent of
the existence of the insurance policy itself, these consequences
are not technically insurable, due to moral hazard. In the fol-
lowing chapters we will show that the fractional-reserve
banking system (i.e., a system based on the monetary irregu-
lar deposit in which 100 percent of the tantundem is not kept in
reserve and available to depositors) endogenously, inevitably
and repeatedly generates economic recessions, making it reg-
ularly necessary to liquidate investment projects, return loans
and withdraw deposits on a massive scale. Therefore, the
150
Money, Bank Credit, and Economic Cycles
banking system based on the irregular deposit with a frac-
tional reserve, the institution Clemente de Diego called an
“aberration” or “legal monster,” invariably and ultimately
(and this is one of the main contributions made by economic
analysis to this field of law) leads bankers to become insolvent
and unable to honor their commitment to return deposits on
demand, even if they maintain a sufficiently elevated reserve
ratio. This is precisely the reason the overwhelming majority
of private banks that did not fully comply with the safekeep-
ing obligation eventually failed. This state of affairs existed
until bankers demanded the creation of a central bank38and
their demands were met. The central bank was to act as a
lender of last resort, ready to grant bankers all the liquidity
they needed during the recurrent stages of crisis caused by the
instability of the fractional-reserve system itself.
Hence, the redefinition of the concept of availability is a
leap into the void. First, banks continue to accept deposits as
if they were loans and accordingly invest them in private busi-
ness deals, and depositors still make deposits with the main
intention of transferring the custody and safekeeping of their
money while retaining its full availability. In other words, the
forced attempt to redefine the concept of availability has not
lessened the contradiction in legal logic. Second, from the
strict viewpoint of private law and in keeping with the teach-
ings of economic theory, the general guideline of a “prudent”
use of resources and the application of the “calculation of
probabilities” not only is not sufficient to guarantee that when
Attempts to Legally Justify Fractional-Reserve Banking 151
38Rothbard, The Case Against the Fed, pp. 90–106. This is how Rothbard
explains the leading role private bankers, especially J.P. Morgan, played
in the creation of the American Federal Reserve:
J.P. Morgan’s fondness for a central bank was heightened by
the memory of the fact that the bank of which his father
Junius was junior partner—the London firm of George
Peabody and Company—was saved from bankruptcy in the
Panic of 1857 by an emergency credit from the Bank of Eng-
land. The elder Morgan took over the firm upon Peabody’s
retirement, and its name changed to J.S. Morgan and Com-
pany. (p. 93 footnote 22)
a fractional reserve is used the bank will always be able to
honor all repayment requests, but it also infallibly starts a
process which, at least every certain number of years, results
in the inevitable loss of confidence in banks and the massive
unforeseen withdrawal of deposits. Conclusive proof of all of the
above is offered by the fact that fractional-reserve banking (i.e., bank-
ing without a strict safekeeping obligation) has not been able to sur-
vive without a government-created central bank, which by imposing
legal-tender regulations and compelling the acceptance of paper
money, could produce out of nowhere the liquidity necessary in
emergencies. Only an institution in conformity with general
legal principles can survive in the marketplace without the
need of privileges and government support, but solely by
virtue of citizens’ voluntary use of its services within the
framework of general and abstract civil-law rules.
Availability has also been defined as private banks’ com-
pliance with the whole structure of government banking leg-
islation in exchange for the backing of the central bank as
lender of last resort. However, this requirement is also artifi-
cial and shifts the issue of the impossibility of legally defining
the fractional-reserve bank deposit contract from the field of
private law (where the two cannot be reconciled) to the field
of public law; that is, administrative law and pure volun-
tarism by which the authorities can legalize any institution, no mat-
ter how legally monstrous it may seem. It is an odd paradox that
the entire financial system is made to depend on the supervi-
sion of the state (which historically has been the first to bene-
fit from profits obtained through the non-fulfillment of the
safekeeping obligation in the monetary-deposit contract), and,
as F.A. Hayek wisely indicates,
The history of government management of money has . . .
been one of incessant fraud and deception. In this respect,
governments have proved far more immoral than any pri-
vate agency supplying distinct kinds of money in competi-
tion possibly could have been.39
152
Money, Bank Credit, and Economic Cycles
39Hayek, The Fatal Conceit, pp. 103–04.
Hayek means that today’s banking structure may appear
sustainable despite its juridical inconsistency, due to the sup-
port it currently receives from the state and to an official cen-
tral-banking institution which generates the liquidity neces-
sary to bail out banks in trouble (in exchange for their
compliance with a tangled web of administrative legislation
comprising endless, cryptic and ad hoc directives and memo-
randa). Nevertheless, the violation of the traditional legal
principles governing property rights inescapably results in
negative social consequences. For instance, the return of
deposits may be thus “guaranteed” at least theoretically
(even using a fractional-reserve ratio, assuming the central
bank lends its support). However, what cannot be guaranteed is
that the purchasing power of the monetary units will not vary
greatly with respect to the original deposit. In fact, ever since
the creation of modern monetary systems, each year with
slight differences in degree, we have been plagued by serious
chronic inflation which has significantly decreased the pur-
chasing power of the monetary units returned to depositors.
We must also consider the effects of the intra- and inter-tem-
poral social discoordination inflicted on modern economies
by the current financial system, based on a fractional reserve
for private banks and the conducting of monetary policy by
the central bank. These effects consist of recurrent, successive
phases of artificial boom and economic recession involving
high unemployment rates, which do great harm to the har-
monious, stable development of our societies.
As a result, in the banking and monetary fields we again
observe the validity of Hayek’s seminal idea that whenever a
traditional rule of conduct is broken, either through direct
governmental coercion or the granting of special governmen-
tal privileges to certain people or organizations, or a combina-
tion of both (as occurs in the monetary irregular deposit with
a fractional reserve), sooner or later damaging, undesired con-
sequences follow, to the great detriment of the spontaneous
social processes of cooperation. The traditional rule of conduct
broken in banking, as we have studied in detail in these first
three chapters, is the general legal principle that in the mone-
tary irregular-deposit contract, custody and safekeeping (the
essential element or purpose of all deposits) should always
Attempts to Legally Justify Fractional-Reserve Banking 153
take the form of a continuous 100-percent reserve require-
ment. Consequently, any use of this money, particularly to
make loans, entails a violation of this principle and an act of
misappropriation. Throughout history, bankers have been
quick to violate this traditional rule of conduct, making self-
interested use of their depositors’ money, as demonstrated by
various examples in chapter 2. At first the bankers did this
guiltily and in secret, since they were still aware of the wrong-
ful nature of their actions. Only later, when they obtained the
government privilege of making personal use of their deposi-
tors’ money (generally in the form of loans, which at first were
often granted to the government itself), did they gain permis-
sion to openly and legally violate the principle. The legal
orchestration of the privilege is clumsy and usually takes the
form of a simple administrative provision authorizing only
bankers to maintain a reduced reserve ratio.
This marks the beginning of a now traditional relationship
of complicity and symbiosis between governments and banks.
This relationship explains the intimate “comprehension” and
close “cooperation” which is still present today between the
two types of institutions and has almost always existed, with
slight variations, in all western countries. Bankers and author-
ities soon realized that by sacrificing traditional legal princi-
ples in the deposit they could take part in an extremely lucra-
tive financial activity, though a lender of last resort, or central
bank, was required to provide the necessary liquidity in times
of difficulty, and experience showed that sooner or later these
times always returned. However, the damaging social conse-
quences of this privilege granted only to bankers were not fully
understood until the theory of money and capital theory
made sufficient progress in economics and were able to
explain the recurrent emergence of economic cycles. The Aus-
trian School in particular has taught us that the contradictory
(from a legal-contractual as well as a technical-economic
standpoint) objective of offering a contract comprising essen-
tially incompatible elements and aimed at combining the
advantages of loans (especially the possibility of earning inter-
est on “deposits”) with those of the traditional monetary
irregular deposit (which by definition must allow the deposi-
tor to withdraw his funds at any time) is sooner or later bound
154
Money, Bank Credit, and Economic Cycles
to cause inevitable spontaneous adjustments. At first these
adjustments manifest themselves as expansions in the money
supply (via the creation of loans which do not correspond to
an actual increase in voluntary saving), inflation, a general-
ized poor allocation of society’s scarce productive resources at
a microeconomic level, and ultimately, recession, the rectifica-
tion of errors caused in the productive structure by credit
expansion, and widespread unemployment. The next chap-
ters will be devoted to examining all these issues from the
standpoint of economic theory. Nevertheless, first we should
wrap up our legal study with the analysis of some other
juridical institutions related to bank deposits.
To conclude this section, the following table displays
seven possible ways to legally classify the bank-deposit con-
tract from the perspective of the logic inherent in the institution
(and naturally, not from the viewpoint of positive law, which
as we know, can give legal force to anything).
impossible to reconcile two contracts as incompatible as the
monetary irregular deposit and the loan contract, along with
the fact that the majority of contracts sustaining present-day
banking are demand deposits (monetary irregular-deposit con-
tracts) have led scholars to try to formulate alternative juridi-
cal constructions to harmonize the irregular deposit contract
with “traditional” banking, i.e., fractional-reserve banking.
Some have tried to solve this contradiction by “redefining”
availability. In fact, for subscribers to this line of thought, avail-
ability need not be understood in a strict sense (100-percent
reserve ratio or keeping the tantundem available to the deposi-
tor at all times), but could be interpreted in a “lax” one: for
example, the “general” solvency of the bank by which it meets
its obligations; “prudent” investing; avoidance of high-risk
speculation and the corresponding losses; maintenance of
appropriate liquidity and investment ratios; and in short, com-
pliance with an entire body of rigorous banking laws, which
together with the hypothetical operation of the “law of large
numbers” in the opening of deposit accounts and withdrawal
Attempts to Legally Justify Fractional-Reserve Banking 147
of demand deposits, could ultimately guarantee the bank’s
ability to return deposits whenever requested by a depositor.
Thus, to Garrigues the obligation to maintain deposits
available to depositors “becomes a duty to work diligently, to
make prudent and sensible use of deposits, so the bank is
always capable of returning them on demand.”33Following
Lalumia’s example, Garrigues adds that the depositary is not
“obliged to keep the tantundem, but only to invest it wisely
and keep it liquid so he is always in a position to return it if
necessary.”34The bank would only have to keep in its vaults
enough money to satisfy the “probable” demands of its
clients. Garrigues therefore concludes that
in bank deposits, the element of custody is replaced by the
technical element of calculating the probability of deposit
withdrawals. In turn, this calculation depends on the fact
that bank deposits are made on a large-scale.35
148
Money, Bank Credit, and Economic Cycles
33Garrigues, Contratos bancarios, p. 375.
34Ibid., p. 365.
35Ibid., p. 367. García-Pita y Lastres defends the same theory in his
paper “Los depósitos bancarios de dinero y su documentación,” where
he concludes that
under the circumstances, instead of regarding “availability”
as the simple right to claim immediate repayment, we should
consider it a combination of behaviors and economic and
financial activities aimed at making repayment possible. (p.
990)
He continues in the same vein in his paper “Depósitos bancarios y pro-
tección del depositante,” pp. 119–226. Also espousing this view,
Eduardo María Valpuesta Gastaminza argues that
the bank is under no obligation to hold the deposited good,
but rather custody becomes a responsibility to prudently
manage both the customers’ and the bank’s resources, and to
keep these available, which is also ensured by legitimate gov-
ernmental regulations (which set the reserve requirement,
limits to risk-taking, etc.). (pp. 122–23)
See “Depósitos bancarios de dinero: libretas de ahorro” in Contratos
bancarios, Enrique de la Torre Saavedra, Rafael García Villaverde, and
Rafael Bonardell Lenzano, eds. (Madrid: Editorial Civitas, 1992). The
same doctrine has been endorsed in Italy by Angela Principe in her
Quite significantly, Garrigues himself acknowledges that
all of this doctrine involves “the unavoidable replacement of
the traditional concept of custody by an ad hoc concept, the
plausibility of which is highly doubtful.”36Garrigues is right
in considering this reinterpretation by theorists of the concept
of availability “forced” (even though he eventually accepts it).
The theory that in the irregular deposit contract the safekeep-
ing obligation merely consists of using resources “prudently”
so the bank retains the solvency necessary to pay its debts is
actually untenable. The prudent use of resources is advisable
in all human actions; for instance, in all loan (not deposit) con-
tracts which specify that certain resources are to be used and
then returned following a set term. That is, it is advisable if
there is a desire to comply with this obligation (the very mean-
ing of solvency).37 However, as we know, the purpose of the
irregular deposit contract is different from that of the loan
contract and requires something markedly different: the cus-
tody or safekeeping of the good at all times. So if the deposi-
tors try to withdraw their deposits and the bank cannot pay
them, regardless of whether it is solvent overall and can pay
once it converts its investments into cash, the essential obliga-
tion in the deposit contract is clearly violated. This is due to
the fact that some contracting parties (depositors) who have
entered into the contract believing its fundamental purpose to
be the custody and safekeeping of the good and its continuous
availability are compelled to become something radically dif-
ferent: forced lenders. As such, they lose the immediate avail-
ability of their goods and are obliged to wait for a prolonged
Attempts to Legally Justify Fractional-Reserve Banking 149
book La responsabilità della banca nei contratti di custodia (Milan: Editorial
Giuffrè, 1983).
36Garrigues, Contratos bancarios, p. 365.
37Furthermore, the standard criterion of “prudence” is not applicable in
this case: an imprudent bank may be successful in its speculations and
preserve its solvency. By the same token, a very “prudent” banker may
be seriously affected by the crises of confidence that inevitably follow
artificial booms, which are generated by the fractional-reserve banking
system itself. Hence, prudence is of little use when there is a violation of
the only condition capable of guaranteeing the fulfillment of the bank’s
commitments at all times (a 100-percent reserve ratio).
period of time until the bank has, in a more or less orderly
fashion, converted its assets into cash and can pay.
Though the concepts of solvency and the prudent use of
resources are not sufficient to modify the essential meaning of
availability in the irregular deposit contract, one might at least
think the problem could be resolved by the calculation of
probabilities and the “law of large numbers,” to which Gar-
rigues refers. Nevertheless, as we argued above, even if it
were statistically possible to calculate probabilities in this field
(which is certainly not the case, as will be shown in the fol-
lowing chapters), the contract would at any rate cease to be a
deposit and become an aleatory contract in which the possi-
bility of obtaining the immediate repayment of the deposited
good would depend on the greater or lesser probability that a
certain number of depositors would not simultaneously go to
the same bank to withdraw their deposits.
In any case, in chapter 5 we will argue that we cannot
apply the objective calculation of probabilities to human acts in
general, and in particular to those related to the irregular
deposit. This is because the very institution of irregular
deposit with no safekeeping obligation (i.e., with a fractional
reserve), a legally paradoxical contract, triggers economic
processes leading banks to make, on a large scale, unwise
loans and investments with the deposits they appropriate or
create. This is the case because these loans and investments
are ultimately financed by credit expansion which has not
been preceded by an increase in real savings. Economic crises
inevitably result, along with a decrease in banks’ solvency and
depositors’ confidence in them, which in turn sets off a mas-
sive withdrawal of deposits. Every actuary knows that if the
consequences of an event are not completely independent of
the existence of the insurance policy itself, these consequences
are not technically insurable, due to moral hazard. In the fol-
lowing chapters we will show that the fractional-reserve
banking system (i.e., a system based on the monetary irregu-
lar deposit in which 100 percent of the tantundem is not kept in
reserve and available to depositors) endogenously, inevitably
and repeatedly generates economic recessions, making it reg-
ularly necessary to liquidate investment projects, return loans
and withdraw deposits on a massive scale. Therefore, the
150
Money, Bank Credit, and Economic Cycles
banking system based on the irregular deposit with a frac-
tional reserve, the institution Clemente de Diego called an
“aberration” or “legal monster,” invariably and ultimately
(and this is one of the main contributions made by economic
analysis to this field of law) leads bankers to become insolvent
and unable to honor their commitment to return deposits on
demand, even if they maintain a sufficiently elevated reserve
ratio. This is precisely the reason the overwhelming majority
of private banks that did not fully comply with the safekeep-
ing obligation eventually failed. This state of affairs existed
until bankers demanded the creation of a central bank38and
their demands were met. The central bank was to act as a
lender of last resort, ready to grant bankers all the liquidity
they needed during the recurrent stages of crisis caused by the
instability of the fractional-reserve system itself.
Hence, the redefinition of the concept of availability is a
leap into the void. First, banks continue to accept deposits as
if they were loans and accordingly invest them in private busi-
ness deals, and depositors still make deposits with the main
intention of transferring the custody and safekeeping of their
money while retaining its full availability. In other words, the
forced attempt to redefine the concept of availability has not
lessened the contradiction in legal logic. Second, from the
strict viewpoint of private law and in keeping with the teach-
ings of economic theory, the general guideline of a “prudent”
use of resources and the application of the “calculation of
probabilities” not only is not sufficient to guarantee that when
Attempts to Legally Justify Fractional-Reserve Banking 151
38Rothbard, The Case Against the Fed, pp. 90–106. This is how Rothbard
explains the leading role private bankers, especially J.P. Morgan, played
in the creation of the American Federal Reserve:
J.P. Morgan’s fondness for a central bank was heightened by
the memory of the fact that the bank of which his father
Junius was junior partner—the London firm of George
Peabody and Company—was saved from bankruptcy in the
Panic of 1857 by an emergency credit from the Bank of Eng-
land. The elder Morgan took over the firm upon Peabody’s
retirement, and its name changed to J.S. Morgan and Com-
pany. (p. 93 footnote 22)
a fractional reserve is used the bank will always be able to
honor all repayment requests, but it also infallibly starts a
process which, at least every certain number of years, results
in the inevitable loss of confidence in banks and the massive
unforeseen withdrawal of deposits. Conclusive proof of all of the
above is offered by the fact that fractional-reserve banking (i.e., bank-
ing without a strict safekeeping obligation) has not been able to sur-
vive without a government-created central bank, which by imposing
legal-tender regulations and compelling the acceptance of paper
money, could produce out of nowhere the liquidity necessary in
emergencies. Only an institution in conformity with general
legal principles can survive in the marketplace without the
need of privileges and government support, but solely by
virtue of citizens’ voluntary use of its services within the
framework of general and abstract civil-law rules.
Availability has also been defined as private banks’ com-
pliance with the whole structure of government banking leg-
islation in exchange for the backing of the central bank as
lender of last resort. However, this requirement is also artifi-
cial and shifts the issue of the impossibility of legally defining
the fractional-reserve bank deposit contract from the field of
private law (where the two cannot be reconciled) to the field
of public law; that is, administrative law and pure volun-
tarism by which the authorities can legalize any institution, no mat-
ter how legally monstrous it may seem. It is an odd paradox that
the entire financial system is made to depend on the supervi-
sion of the state (which historically has been the first to bene-
fit from profits obtained through the non-fulfillment of the
safekeeping obligation in the monetary-deposit contract), and,
as F.A. Hayek wisely indicates,
The history of government management of money has . . .
been one of incessant fraud and deception. In this respect,
governments have proved far more immoral than any pri-
vate agency supplying distinct kinds of money in competi-
tion possibly could have been.39
152
Money, Bank Credit, and Economic Cycles
39Hayek, The Fatal Conceit, pp. 103–04.
Hayek means that today’s banking structure may appear
sustainable despite its juridical inconsistency, due to the sup-
port it currently receives from the state and to an official cen-
tral-banking institution which generates the liquidity neces-
sary to bail out banks in trouble (in exchange for their
compliance with a tangled web of administrative legislation
comprising endless, cryptic and ad hoc directives and memo-
randa). Nevertheless, the violation of the traditional legal
principles governing property rights inescapably results in
negative social consequences. For instance, the return of
deposits may be thus “guaranteed” at least theoretically
(even using a fractional-reserve ratio, assuming the central
bank lends its support). However, what cannot be guaranteed is
that the purchasing power of the monetary units will not vary
greatly with respect to the original deposit. In fact, ever since
the creation of modern monetary systems, each year with
slight differences in degree, we have been plagued by serious
chronic inflation which has significantly decreased the pur-
chasing power of the monetary units returned to depositors.
We must also consider the effects of the intra- and inter-tem-
poral social discoordination inflicted on modern economies
by the current financial system, based on a fractional reserve
for private banks and the conducting of monetary policy by
the central bank. These effects consist of recurrent, successive
phases of artificial boom and economic recession involving
high unemployment rates, which do great harm to the har-
monious, stable development of our societies.
As a result, in the banking and monetary fields we again
observe the validity of Hayek’s seminal idea that whenever a
traditional rule of conduct is broken, either through direct
governmental coercion or the granting of special governmen-
tal privileges to certain people or organizations, or a combina-
tion of both (as occurs in the monetary irregular deposit with
a fractional reserve), sooner or later damaging, undesired con-
sequences follow, to the great detriment of the spontaneous
social processes of cooperation. The traditional rule of conduct
broken in banking, as we have studied in detail in these first
three chapters, is the general legal principle that in the mone-
tary irregular-deposit contract, custody and safekeeping (the
essential element or purpose of all deposits) should always
Attempts to Legally Justify Fractional-Reserve Banking 153
take the form of a continuous 100-percent reserve require-
ment. Consequently, any use of this money, particularly to
make loans, entails a violation of this principle and an act of
misappropriation. Throughout history, bankers have been
quick to violate this traditional rule of conduct, making self-
interested use of their depositors’ money, as demonstrated by
various examples in chapter 2. At first the bankers did this
guiltily and in secret, since they were still aware of the wrong-
ful nature of their actions. Only later, when they obtained the
government privilege of making personal use of their deposi-
tors’ money (generally in the form of loans, which at first were
often granted to the government itself), did they gain permis-
sion to openly and legally violate the principle. The legal
orchestration of the privilege is clumsy and usually takes the
form of a simple administrative provision authorizing only
bankers to maintain a reduced reserve ratio.
This marks the beginning of a now traditional relationship
of complicity and symbiosis between governments and banks.
This relationship explains the intimate “comprehension” and
close “cooperation” which is still present today between the
two types of institutions and has almost always existed, with
slight variations, in all western countries. Bankers and author-
ities soon realized that by sacrificing traditional legal princi-
ples in the deposit they could take part in an extremely lucra-
tive financial activity, though a lender of last resort, or central
bank, was required to provide the necessary liquidity in times
of difficulty, and experience showed that sooner or later these
times always returned. However, the damaging social conse-
quences of this privilege granted only to bankers were not fully
understood until the theory of money and capital theory
made sufficient progress in economics and were able to
explain the recurrent emergence of economic cycles. The Aus-
trian School in particular has taught us that the contradictory
(from a legal-contractual as well as a technical-economic
standpoint) objective of offering a contract comprising essen-
tially incompatible elements and aimed at combining the
advantages of loans (especially the possibility of earning inter-
est on “deposits”) with those of the traditional monetary
irregular deposit (which by definition must allow the deposi-
tor to withdraw his funds at any time) is sooner or later bound
154
Money, Bank Credit, and Economic Cycles
to cause inevitable spontaneous adjustments. At first these
adjustments manifest themselves as expansions in the money
supply (via the creation of loans which do not correspond to
an actual increase in voluntary saving), inflation, a general-
ized poor allocation of society’s scarce productive resources at
a microeconomic level, and ultimately, recession, the rectifica-
tion of errors caused in the productive structure by credit
expansion, and widespread unemployment. The next chap-
ters will be devoted to examining all these issues from the
standpoint of economic theory. Nevertheless, first we should
wrap up our legal study with the analysis of some other
juridical institutions related to bank deposits.
To conclude this section, the following table displays
seven possible ways to legally classify the bank-deposit con-
tract from the perspective of the logic inherent in the institution
(and naturally, not from the viewpoint of positive law, which
as we know, can give legal force to anything).
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