Fractional Reserve Banking is Obsolete
February 22, 2013
In the definitive treatise on Austrian Business Cycle Theory, Money, Bank Credit, and Economic Cycles, Jesús Huerta de Soto establishes the inevitability of economic crises wherever there is fractional reserve banking. All that is left for monetary scholars to do is analyze past crises and lobby the government to have the right reforms. Fortunately, for the first time in history, we are in the enviable position of not having to wait for reforms that may or may not lead to sound money. I explain why here.
My favorite part about the Bitcoin network is not that it makes society freer, more prosperous, or more just. My favorite part is that it will finally settle one of the longest debates in the history of economics: whether or not money printing and cheap credit are ever needed to stimulate growth.
Austrians know that artificial credit expansion inevitably causes a mispricing and misallocation of capital, whether it’s due to fractional reserve banking alone or in conjunction with a central bank. What is debated is the ethical legitimacy of fractional reserve banking, one side sees lending out deposits as inherently fraudulent while the other sees deposits as an especially liquid loan.
With a deposit, you are improving the custody and safe-keeping of your money and receiving other peripheral services (cashier and bookkeeping services), while at all times retaining the full availability of your money. You are relying on this service to lower the transaction costs of using your gold, silver, or government scrip. A superior service is built into Bitcoin.
- Mathematically, there is no better custodian or safe-keeper for your money than an encrypted digital wallet. If you use strong passwords, back up your data, and secure your computer, then your bitcoins are safer than your person.
- Bitcoin is the ideal cashier: it is available anywhere in the world with an Internet connection, it can make infinite amounts of change, and it can transfer money to any account almost instantly.
- The distributed, unalterable blockchain puts banks’ bookkeeping and check clearing systems to shame.
With this level of perfect security and complete convenience there is no reason to deposit your money with a 3rd party. In other words, bitcoins make fractional reserve banking an obsolete technology, and bitcoin wallets are the best 100% reserve banks conceivable.
As Bitcoin adoption increases we will finally be able to “empirically validate" what Austrians have been arguing for decades: 100% reserve banking with a scarce medium of exchange prevents speculative manias, financial crises, and economic depressions.
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What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The credit boom is built on the sands of banknotes and deposits. It must collapse.