The problem with the "real bills" doctrine

Re: Free banking vs.the real bills doctrine

I wrote the letter below to Don Boudreaux of Cafe Hayek. Under the real bills doctrine, banks would be allowed to create demand deposits backed by promissory notes and not reserves. Those who adhere to this doctrine, such as Mr. White, author of the above essay, believe that money backed by "real bills" is superior to money backed only fractionally by reserves. I make the point that both fractional reserve banking and real bills adherents are advocates of the same fraud: i.e., that bankers' demand deposits are NOT backed by reserves but by debt that may or may not be collectible. PB

Dear Don,

What free banking advocates such as Mr. White are really saying is that a free banker operating under the real-bills doctrine must be careful not to perpetrate too much fraud and catch the attention of the public, who will make a run upon his bank. The point is not what the banker wants but what the recipient of the banker's supposedly demand note believes that he has. A banker's demand note promises the holder that it may be exchanged for real reserves that constitute a final claim upon money; i.e., gold, silver, or even Federal Reserve Notes. This is my main problem with those who claim that they would not be alarmed if their banker engaged modestly in fractional reserve banking. The account holder is passing a check to someone who has no way of knowing that he is receiving a check that is backed only fractionally by reserves. In other words, he is the victim of fraud. Under Rothbard's two bank system--the Deposit Bank and the Loan Bank--only the Loan banker would purchase commercial credits, because there is the possibility that the commercial credit may fail.

Respectfully,

Patrick Barron