T HE MONETARY IRREGULAR DEPOSIT,

" "

T
HE MONETARY IRREGULAR DEPOSIT,
T
RANSACTIONS WITHA REPURCHASE AGREEMENT
AND
LIFE INSURANCE CONTRACTS

In these first three chapters we have undertaken an analy

sis of the legal nature of the irregular deposit contract, and this
analysis could serve, among other uses, as a reliable guide to
identifying (from among the rich variety of legal contracts in
the fast-changing real world) true loan contracts, irregular
deposits in which the safekeeping obligation is met and con-
tracts of a contradictory or even fraudulent nature. This is an
important guide, as human ingenuity knows no bounds when
it comes to attempting to fraudulently circumvent traditional
legal principles for one’s own benefit and to the detriment of
others. 
Moreover, this danger is especially acute when legal prin-
ciples are not adequately defined nor defended by public
authorities, especially in a field, like that of finance, which is
very abstract and difficult to understand for most citizens.

156Money, Bank Credit, and Economic Cycles
TABLE 1
S
EVEN POSSIBLE LEGAL CLASSIFICATIONSOFTHE
EPOSIT CONTRACTWITHA FRACTIONAL RESERVE
BANK-D
1.There is deception or fraud: the crime of misappro-
priation is committed and the contract is null and
void (the historically corrupt origin of fractional-
reserve banking).
2.There is no deception, but there is an error in nego-
tio: contract null and void.
3.There is no error in negotio, but each party pursues
his typical cause in the contract: contract null and
void due to essentially incompatible causes.
4.Even if the incompatible causes are considered
compatible, the contract is null and void because
it is impossible to carry out (without a central
bank).
5.Subsidiary argument: even if the “law of large
numbers” were valid (which is not the case), the
contract would still be an  aleatory contract (it
would be neither a deposit nor a loan contract).
6.The implementation of the contract depends on a
government mandate (privilege) and the support
of a central bank that nationalizes money, imposes
legal-tender regulations and creates liquidity.
7.In any case, the contract is null and void because
it does serious  harm to third parties (economic
crises aggravated by the central bank), much
greater harm than that caused by a counterfeiter
of money.

Attempts to Legally Justify Fractional-Reserve Banking                                   157
TRANSACTIONSWITHA REPURCHASE AGREEMENT
Whenever we observe, as in the monetary deposit, that the
immediate availability of the good is offered to customers in
40
order to attract their funds and then invest their money or
employ it in private transactions, etc., we should be on our
guard, irrespective of the legal appearance of the transaction.
For example, in certain contracts with a repurchase agreement,
one of the parties commits to repurchase from the other,
whenever requested by the second party, a security, right or
financial asset at a prefixed price at least equal to that origi-
nally paid for the good. The intention in these cases, against
legal principles, is to conceal a true monetary irregular-deposit
contract, in which one of the contracting parties pursues the
essential objective of guaranteeing the immediate availability
of the good, and the other pursues the familiar, contradictory
purpose or cause of gathering monetary resources to invest
them in different business deals. In short, these are often even
fraudulent transactions, in which the professional deposit
“gatherer” tries to convince his “customers” to turn over their
available assets easily and without a heavy commitment, in
exchange for the fundamental promise that their money will
remain available to them and be returned to them whenever
they desire (via the “repurchase agreement”).
We observe a similar case when, as often happens more or
less explicitly in practice, an institution (for example, a bank)
attempts to systematically maintain or “conserve” the market
value of its stocks by carrying out a series of financial opera-
tions to indicate to the market that the sale of the stocks is
“guaranteed” at a set price. If this is true, and to the extent that
the general public believes it, we witness another transaction
in which a monetary irregular-deposit contract is ultimately
orchestrated via investment in securities, stocks or bonds
40
Many “irregular” transactions are accompanied by the “guarantee” of
continuous availability to persuade the customer that there is no need to
relinquish it nor make the sacrifice required by lending. This practice
makes attracting funds much easier, especially when the customer is
naïve and can be tempted (as in any sham or swindle) with the possi-
bility of obtaining high profits with no sacrifice nor risk.

158Money, Bank Credit, and Economic Cycles
whose liquidity on the market is implicitly “guaranteed” at all
41
times by a trustworthy institution. Therefore, it is not sur-
prising that many bank crises have arisen more from the mas-
sive sale of bank stocks than from a widespread withdrawal of
deposits. These stocks were supposed to constitute a safe
refuge for money while nearly guaranteeing its immediate
availability. When the bank’s solvency comes into question, its
securities are the first to be sold on a massive scale, rendering
the bank unable to continue honoring its implicit commitment
to maintain the market value of the stocks. At least in the past,
these massive sales have resulted from the fact that the indis-
criminate assistance supplied by central banks to private
banks in times of need has not reached the point of continual
preservation of shares’ current market price. The most recent
bank crises in Spain and other countries have demonstrated
that ultimately, the only “depositors” to lose out have been the
stockholders themselves.
There are many other “borderline” cases. For example,
some finance and holding companies, to encourage the sub-
scription of their stocks, “commit” to repurchase them at the
original price whenever requested by the shareholder. In gen-
eral, we should be suspicious of any transaction with a repur-
chase agreement in which the price of the repurchase is fixed
and is not the current price of the item on the corresponding second-
42
Hence, it falls to the jurist and the economist to
ary market.
41
If we carry this line of reasoning to extremes, the entire stock market
could be viewed as an orchestrator of true deposits if the state were to
at all times guarantee the creation of the liquidity necessary to maintain
stock market indexes. For reasons of public image, governments and
central banks have insisted on pursuing this objective and policy at least
occasionally, during many stock market crises.
42
Another example of a simulated deposit is a temporary assignment
with an agreement of repurchase on demand. This transaction is con-
ducted as a loan from customer to bank: Collateral is offered in the form
of securities, normally national bond certificates, in case of noncompli-
ance by the depositary. The loan bears interest at an agreed-upon rate up
until a specified date and is repayable at the simple request of the
“lender” prior to that date. If he exercises this option of early cancella-
tion, the resulting amount to be paid him is calculated by compounding

Attempts to Legally Justify Fractional-Reserve Banking                                   159
employ their analytical judgment in the study of this eco-
nomic-financial transaction and to decide exactly what type of
operation it is, its true nature and its consequences, in light of
the legal principles examined in these first three chapters and
43
Further-
the economic implications we will now consider.
more, this analysis would acquire vital importance if one day
in the future the existent financial system based on the
monopoly of a public central bank were ever completely pri-
vatized and a free-banking system subject to general legal
principles were established. In this case, the current tangled
web of administrative banking regulations would be replaced
the interest on the original amount at the agreed-upon rate up until the
date he exercises the option. For the client, this operation is identical to
a loan backed by securities, combined with an American option. An
option is an agreement conferring the right, not the obligation, to buy or
sell a certain quantity of an asset on a particular date or up until a par-
ticular date. An option to purchase is a call option, and an option to sell,
a put option. If the right granted lasts until a specified date, the option
is called an “American” option; if it refers to a particular date, a “Euro-
pean” option. The acquirer of the right compensates the other party via
the payment of a premium at the moment the contract is finalized. The
client will exercise his option only if the interest rates paid on new time
deposits maturing at the same time as his exceed the rate he originally
negotiated. He will not exercise the option if interest rates fall, even if he
needs the liquidity, because he will normally be able to take out a loan for
the remainder of the term at a lower rate of interest and provide the bond
certificates as collateral. Some institutions even offer these contracts
accompanied by the cashier services typical of checking accounts, so the
customer can issue checks and pay bills by direct debiting. Banks use this
contract as a way to speculate with securities, since the public finances
them and banks keep the profits. We are grateful to Professor Ruben
Manso for providing us with some details of this type of operation.
43
Another interesting question is how to determine in practice when
time “deposits” (loans) with a very short term become true deposits.
Although the general rule is clear (the subjective intention of the parties
must prevail, and upon maturity all loans become deposits requiring a
100-percent reserve until withdrawn), for practical purposes a tempo-
rary limit is often needed (a month? a week? a day?), under which loans
granted to the bank should be regarded as actual deposits. As for the so-
called secondary medium of exchange, which are not money but can be
converted into cash very easily, meriting an additional premium for
their purchase on the market, see Mises, Human Action, pp. 464–67.

160Money, Bank Credit, and Economic Cycles
by a few clear, simple rules included in the Civil, Commercial
and Penal Codes. The main purpose of these rules would be to
guarantee adherence to the strict safekeeping principle (100-
percent reserve requirement) regarding not only monetary
demand-deposit contracts, but also any other economic-finan-
cial transaction in which the chief goal of the participants is to
obtain custody and safekeeping for their deposits. In this (for
now) hypothetical situation, the analysis we are proposing
would greatly assist judges and jurists in making sense of the
rich, extremely complex variety of contracts and transactions
constantly emerging in the economic-financial world and
would allow them to determine when to classify these trans-
actions as null and void and/or criminal according to general
44
civil and penal provisions.
At any rate, we should avoid a selfishly defeatist attitude
common in the financial sector. It is based on the belief that
human ingenuity will be capable of finding ever more sophisti-
cated means of fraudulently evading universal legal principles
and that therefore in practice they will never be obeyed and
defended. We should avoid this defeatist posture, because the
proliferation of ingenious ways to violate these principles stems
precisely from the fact that public authorities have always
defined and defended them in an extremely confusing, ambigu-
ous and contradictory manner, and as a result there is no gen-
eral awareness of the importance of respecting them. Quite the
opposite is true. The prevailing values and ideas have over time
become so corrupted that now people consider the irregular
deposit contract with a fractional reserve to be legitimate. If
general legal principles were again understood and respected,
the number of irregular behaviors would decrease significantly
(especially if public authorities really took care to preserve and
defend the corresponding propertyrights). At the same time,
the proven fact that human ingenuity continually searches for
44
In the model we propose (and which we will consider in greater detail
in the last chapter), the control exerted in the financial sphere by the cen-
tral bank and its officials would be replaced by that of judges, who
would recover their full authority and central role in the application of
general legal principles in the financial area as well.

Attempts to Legally Justify Fractional-Reserve Banking                                   161
new ways to break the law and defraud others does not in the
least detract from the fundamental importance of a set of clear
principles to guide citizens and direct authorities in their duty
to define and defend property rights.
T
ASEOF LIFE INSURANCE CONTRACTS
HE C
Life insurance is a typical time-honored legal institution,
one that has been very well-formulated with respect to its
essence and legal content and well-supported by actuarial,
economic and financial practices. Nevertheless, lately some
have tried to use it to conduct transactions which are very
similar to the monetary irregular deposit with a fractional
reserve. These attempts have been very detrimental to the
development and traditional solvency of life insurance as an
institution and have involved deceiving supposed “policy-
holders-depositors.”
Indeed, above all it is important to understand that the
contract of life insurance bears no relation to the monetary
irregular-deposit contract. Life insurance is an aleatorycontract
by which one of the parties, the contracting party or policy-
holder, commits to the payment of the premium or price of the
operation, and in return the other party, the insurance com-
pany, agrees to pay certain benefits in the event that the poli-
cyholder dies or survives at the end of a term specified in the
contract. Therefore, the premiums paid by the policyholder com-
pletely cease to be available to him, and availability is fully trans-
45
ferred to the insurer.
Hence, all life insurance contracts
involve an exchange of present, certain goods for future, uncer-
tain goods (since their payment depends on an uncertain
45
As life insurance entails disciplined saving over a period of many
years, it is much more difficult to sell than other financial products sold
with the guarantee that the customer’s money will remain continuously
available to him (deposits). For this reason life insurance is sold through
a costly network of salespeople, while the public goes willingly and
without prompting to make bank deposits. Life insurance companies
foster and encourage voluntary, long-term saving, whereas banks pro-
duce loans and deposits from nothing and require no one to make the
prior sacrifice of saving.

162Money, Bank Credit, and Economic Cycles
event, such as the death or survival of the policyholder). The
life insurance contract is therefore equivalent to a savings
transaction (in which the ownership and availability of pres-
ent goods are relinquished in exchange for the ownership
and availability of future goods), but it is a form of perfected
savings, because it makes it possible to receive a considerable
sum from the very moment the contract takes effect, given the
anticipated, uncertain event takes place (for example, the pol-
icyholder dies). Any other traditional savings method (tradi-
tional mutuum or loan operation) would require a prolonged
period of many years of saving to accumulate the capital paid
by an insurance company in case of death. In other words, life
insurance contracts, the calculation of probabilities based on
mortality and survival tables, and the principle of mutualism
or dividing loss among all policyholders sustaining an insti-
tution make it possible from the first moment to receive, should the
anticipated event occur, a significant sum of money which, using
other methods, could only be accumulated after a period of many
years.
Moreover life insurance is a long-term contract which
incorporates complex financial and actuarial components and
requires the prudent investment of significant resources. The
availability of these resources is transferred to the mutual or
life insurance company, which must collect and invest the
mathematically-calculated reserves necessary to make the
future payments it will be obliged to make. These amounts are
called “mathematical,” because they result from the calcula-
tion of probabilities of death and survival according to mor-
tality tables, which are extremely reliable and highly constant
for most western populations. It is possible to calculate, with
as small a probability of ruin as is desired, the amount of
money necessary to pay all guaranteed benefits. Later we will
examine the radical differences which from an economic-
financial standpoint exist between life insurance and the irreg-
ular deposit contract with a fractional reserve. As opposed to
life insurance, the irregular deposit contract does not permit
the calculation of probabilities, since the institution (frac-
tional-reserve banking) does not exist completely independ-
ently of the recurrent massive withdrawal of deposits.

Attempts to Legally Justify Fractional-Reserve Banking                                   163
An added complexity emerges because some types of life
insurance include the right of surrender. This means policy-
holders can cancel their contract and obtain in cash the math-
ematical liquidation value of their policy. Some theorists have
defended the position that insurance policies which include
this “surrender value” are very similar to monetary irregular-
46
Against this view,
deposit contracts with fractional reserves.
it is important to point out that whether or not a covert irreg-
ular deposit exists depends ultimately on the true motive,
purpose or subjective cause with which the contract is carried
out. If, as is usual with traditional life insurance policies, the
client intends to keep the policy until the end of its term and
is not aware that he can redeem the funds at any time, then the
transaction is clearly not an irregular deposit but a traditional
life insurance contract. This type of insurance is sold with the
idea that surrender is a “last resort,” a solution to be applied
only in situations of pressing need when a family is com-
pletely unable to continue making payments on a policy
which is so necessary for the peace of mind of all of its mem-
47
bers.
However, we must acknowledge that (for the most part)
recently banks and other financial institutions have exerted
constant pressure to erase the fundamental, traditional dis-
tinctions and blur the boundaries between life insurance and
48
bank-deposit contracts.
46
Murray N. Rothbard, “Austrian Definitions of the Supply of Money,”
in New Directions in Austrian Economics, Louis M. Spadaro, ed. (Kansas
City: Sheed Andrews and McMeel, 1978), pp. 143–56, esp. pp. 150–51.
Rothbard’s position is fully justified, however, with respect to all the
new “life insurance” operations conceived to simulate deposit contracts.
47
Furthermore the surrender of the insurance policy traditionally entails
a significant financial penalty for the policyholder. This penalty results
from the company’s need to amortize the high acquisition costs it incurs
during the first year of the contract. The tendency to reduce these penal-
ties is a clear indication that the operation has ceased to be a traditional
life insurance policy and has become a simulated bank deposit.
48
As we will see at the end of chapter 7, from 1921 to 1938, while chair-
man of the National Mutual Life Assurance Society, a leading British life

164Money, Bank Credit, and Economic Cycles
True monetary-deposit operations have begun to appear
on the market disguised as life insurance policies. The main
selling point presented to customers is that with these trans-
actions they need not commit to a long-term savings opera-
tion involving regular payments, since the funds handed over
to the insurance company may be recovered at any time with
no penalty and no expense whatsoever (and may even include
interest). One reason companies disguise these operations as
life insurance policies is to take advantage of the customary
tax incentives almost every government in the developed
world grants insurance companies in recognition of their ben-
eficial influence on society at all levels as promoters of volun-
tary saving and foresight, and hence on the sustained, non-
inflationary economic growth and development of the nation.
Thus, bogus “life insurance” operations have been negotiated
en masse and have really been nothing but camouflaged
deposits made effortlessly by the public, who have held the
idea that at any time their money could be recovered penalty-
free if they needed it or simply wished to place it in another
financial institution. This has generated a good deal of confu-
sion. For instance, figures corresponding to bank deposits
insurance firm, John Maynard Keynes played a key role in the corrup-
tion of traditional principles governing life insurance. During his chair-
manship, he not only promoted an “active” investment policy strongly
oriented toward variable-yield securities (abandoning the tradition of
investing in bonds), but he also defended unorthodox criteria for the
valuation of assets (at market value) and even the distribution of profits
to policyholders through bonuses financed by unrealized stock market
“earnings.” All these typical Keynesian assaults on traditional insurance
principles put his company in desperate straits when the stock market
crashed in 1929 and the Great Depression hit. As a result, Keynes’s col-
leagues on the Board of Directors began to question his strategy and
decisions. Disagreements arose between them and led to Keynes’s res-
ignation in 1938, since, as he put it, he did not think “it lies in my power
to cure the faults of the management and I am reluctant to continue to
take responsibility for them.” See John Maynard Keynes, TheCollected
Writings (London: Macmillan, 1983), vol. 12, pp. 47 and 114–54. See also
Nicholas Davenport, “Keynes in the City,” in Essays on John Maynard
Keynes, Milo Keynes, ed. (Cambridge: Cambridge University Press,
1975), pp. 224–25. See also footnote 108 of chapter 7.

Attempts to Legally Justify Fractional-Reserve Banking                                   165
(operations completely unrelated to life insurance) have been
included in the official statistics of life insurance premiums,
and in the midst of the great confusion in the market, tradi-
tional life insurance policies have become discredited and
49
their definition blurred.
Fortunately, normality is being restored, and both tradi-
tional private insurers and public authorities are beginning to
realize that nothing hurts life insurance more than blurring
the distinctions between it and bank deposits. This confusion
has been detrimental to everyone: traditional life insurance,
which has lost many of its tax incentives and faced increasing
intervention and control by the central bank and monetary
authorities; clients, who have taken out life insurance thinking
they were making bank deposits and vice versa; banks, which
on many occasions have attracted funds from true deposits
(disguised as life insurance) and tried to make long-term
investments with them, endangering their solvency; and
finally, supervising public authorities, who have gradually
lost control over the institution of life insurance, which has
become blurred in its definition and to a great extent taken
over by another institution (the central bank). Banks are a
completely separate type of institution, whose financial and
legal foundations leave much to be desired, as we are seeing.
49
In short, the apparent boom in life insurance sales was an illusion,
since the figures actually corresponded to radically different operations,
i.e., fractional-reserve bank deposits. These figures completely lose their
splendor if, instead of contrasting them with traditional life insurance
sales (much more modest, since abnegation and a long-term commit-
ment to saving and foresight are required), we compare them to the total
of a country’s bank deposits, of which they make up only a small per-
centage. When only genuine life insurance sales are included in sector
statistics, the situation is put back in perspective, and the mirage every-
one (especially the government) strained to see vanishes.