Reply to Larry Sechrest's Preface to Free Banking

In June 2008, just months prior to the death of Larry J. Sechrest (1946-2008), the Ludwig von Mises Institution published a second edition of Sechrest's 1993 book Free Banking: Theory, History and a Laissez-Faire Model. More specifically, Sechrest wrote a Preface to this new print, clearly in response to a number of critical publications in the field of fractional-reserve free banking (FRFB), which had seen light since Sechrest publishing his first edition. But instead of convincingly defending FRFB against these criticisms, Sechrest completely fails in his task to refute them. His new Preface only consists of the same fallacies that plague any work favorable to FRFB, besides a number of misreadings and misunderstandings regarding the works or even persons he aims to defend FRFB against. The result is that the detractors of FRFB, most notably the Rothbardians, get defended all the more and FRFB is once again unmasked as a non-viable "alternative" to the present flawed fiat money system, which in fact is already an implementation of the "free" banking that Sechrest promoted. Below is an alinea-by-alinea rebuttal of Sechrest's PREFACE TO NEW PRINTING to the 2008 edition of his book. Sechrest's words are quoted in italics; replies are given immediately below.

Alinea 1
After the first edition of this book appeared in 1993, I turned away from many of the banking issues explored herein. Anarchocapitalism, taxation, and public goods in maritime history occupied most of my professional attention, while at the same time there was an ongoing personal project, a 1300-page manuscript analyzing merchant sailing ship performances, on which I have been working for some 20 years. I continued to think and write about business cycles, but largely left free banking behind. This was because I thought that the case for fractional reserve free banking based on a commodity “outside” money had been persuasively presented by myself and others such as Lawrence H. White, George Selgin, and Kevin Dowd. And I still do.
How can the self-called anarchocapitalist Sechrest support historical episodes of FRB, while these were not free markets, hence not FRFB, but only existed because of government interference?
How can an economist create a "theory of FRFB", while the actual practice of FRB was never based on a solid theory, but mostly on opportunism, fallacy and fraud?
How can the self-called anarchocapitalist Sechrest support FRB based on history, while history also shows that individuals protested against FRB?

a) Mind that Sechrest’s free banking is far removed from anarcho-capitalism, as will appear below. Sechrest later refers willingly to Rothbard's work on cartels. But strange enough, in the next alinea Sechrest attacks "certain Rothbardians" because they "reject and attack laissez-faire banking". Although the term "free banking" as interpreted by Sechrest et al. looks promising for free markets supporters, it is in fact a highly misleading label. Only the bankers would have the freedom to carry out certain monetary policies, apparently without regard to their customers' needs. Nowhere in his book does Sechrest make it clear why people in a free market would deliberately choose fractional-reserve free banking (it's not even a real market), with its artificial and abstract targets and which he and his fellows like Selgin, White and Dowd have been promoting actively for decades.
b) Moreover, fractional-reserve free banking cannot be based on a commodity "outside" money. Either money is a 100 percent commodity or it is fiat, created out of thin air and hence backed by nothing. The mixture Sechrest proposes is a contradictio in terminis and cannot exist in a free market as people would never freely choose such a highly dubious system. In fact, we currently have such a system, not as a free market choice, but because of legal tender and banking privileges. Besides, terms like "inside" and "outside" money only muddy the waters even further.
c) Contrarily to what Sechrest wrote, the works of the FRFB'ers he names are packed with the same fallacies he himself shows up with, which completely undermines and destroys their case too.
D) The core feature of FRFB is that it is based on nothing. Either money is a 100 percent commodity or it is fiat, created out of thin air and backed by nothing. The mixture Sechrest proposes is a contradiction in terminis and cannot exist, most definitely not in a free market. Terms like “inside” and “outside” money only muddy the waters even further.
e) It does not bother Sechrest that outside and inside monies are itself fallacies or at best a description of an already existing FRB practice and that the criticisms are right.

Alinea 2
However, one group of economists has continued to reject and attack laissez-faire banking, at least so long as such banks are based on the holding of less than 100 percent (primary) reserves. This group is principally composed of certain Rothbardians associated with the Ludwig von Mises Institute, some of whom, by the way, I am pleased to think of as friends. It includes, among others, Walter Block, Jörg Guido Hülsmann, Hans-Hermann Hoppe, William Barnett II, and especially Jesús Huerta de Soto. In what follows I will explain why I think their various condemnations of fractional reserve free banking (FRFB), despite their energetic efforts, remain unconvincing.
a) Unconvincing for whom? The free market defenders which Sechrest names, all argue from a position of free choice and no government interference in money and banking, as well as a logical, natural view on law and property rights. Sechrest's FRFB builds on the historical, fallacious non-market money and banking, for which he and his fellows define only a quasi-justification.
b) Mind that Sechrest nowhere refutes Von Mises or Rothbard. If anything, both Mises and Rothbard rejected FRB, many decades before the FRFB'ers came on the scene, only to repeat the long-rebuked fallacies. So blaming "certain Rothbardians" for not subscribing to FRFB is putting the matter on its head: it's not the Rothbardians that keep rearing their heads, but the FRFB'ers who just keep repeating countless ancient economic fallacies.
c) Laissez-faire banking would in reality not mean the FRFB practices that Sechrest propagates. Contrarily, it would mean 100 percent reserve banking, defended by property rights, as this would provide safety to people's money and easy ways of doing business and earning interest by using for examle time deposits. This would be the choice of people in a free market. Moreover, this confirms again Sechrest places emphasis on the freedom of bankers to do as they deem necessary to achieve certain abstract goals, like all FRFB'ers do. Hence they completely overlook the needs and choices of individual people. This is not free-market thinking.

Alinea 3-1
Allow me to begin with the last, Huerta de Soto. His massive 876-page treatise, Money, Bank Credit, and Economic Cycles (2006), is intended to be the final and decisive proof that fractional reserves are incompatible with a) a proper defense of private property rights, b) morality, and c) a stable economy. With painstaking effort he investigates legal theory, banking history, business cycles, and even variations in medieval theological doctrine. There is much to interest the curious reader, but a great deal is actually irrelevant to the author’s professed intent.
a) De Soto did what Sechrest himself should have done: carrying out extensive research and argumentation, in order to build or reject his case. Sechrest and his fellows only argue from a mechanical point of view: the supposed "workings" of FRFB, as if any human consideration simply does not exist. But mind that factors a, b and c play a pivotal role in human life, in particular in a free market. So these topics are not "actually irrelevant" as Sechrest all too easily dismisses them. Neither does Sechrest prove that De Soto's mission failed.
b) Sechrest himself completely omits any reference to property rights related to bank deposits and money lending in his book. This is unrealistic. Not only are rights a pivotal aspect in a free market, as people naturally seek safety for their money and goods generally (instead of endangering them), but once they are violated for the sake of FRFB, both inflation of the money supply and prices as well as bankruns and the impossibility to return the depositor’s money will do the job of proving its importance. c) Incorrect: all aspects are of interest in economic sense and to humans in general. People in a free market would have the same considerations as de Soto, would they have free choice. Sechrest only calls it irrelevant, but does not tell the reader why. Moreover, he sums up property rights and morality separately, but on the next page he heaps them together.

So what does Sechrest actually do with his book? In fact, ls book is mostly irrelevant, as he does not deal with the reality of a free market with all its considerations that human action would be based on. He does not even describe an hypothetical market, but a fictitious one. So Sechrest is irrelevant here.

His focus is on the practice of banking, not on their customers' needs. This is not fm thinking. Mind that frfb demands from bankers the same fallacious attitude and flawed tools that central banking deploys. This runs into unsurmountable problems and would not even take off. See q7 of the faq.

Alinea 3-2
Further, one will repeatedly encounter, along with some careful scholar- ship, “straw man” arguments, non sequiturs, and question-begging. Pervading the early portions of the work is the assertion that ancient Roman law, and medieval European law based upon it, correctly identified the true nature of demand deposits (“monetary irregular deposits”) as warehouse contracts involving fungible goods (though he seems strangely unaware that commodity coins have often not been fungible due to debasement, or normal wear and tear).
a) Sechrest does not draw the logical conclusion that there can be no two opposed identifications of contract that are both right. As HHB 1998 argue, there is not third option. If coins were not really fungible, then customers would not have placed them in a deposit account, where they would be heaped up with other coins. Moreover, it is the gold weight that counts, not the uniqueness of the coins.
b) Sechrest does not refute the Roman stance on demand deposits. He does not argue why Roman law would be incorrect in this. Even the practical impossibility of multiple claims on the same money, apart from what the Romans wrote, is not given. In the essay Against Fiduciary Media
c) Sechrest fails to judge both debasement and wear and tear correctly. On debasement: this would in a free market be a non-issue, as banks would have any incentive to prevent clipping of coins, debasement or other means of influencing the quality of money. On wear and tear: the less a coin is worn out, the more fungible it is in the absence of difference between sort like coins. The more a coin is worn out, the more fungible it is as well: only the pure gold grams of a coin will have any value. And in between, if an individual connects any value to a particular coin, he will not deposit it in any bank. The fact that people deposit coins and accept them to be mixed with other people’s money, already means they consider them to be fungible. Hence Sechrest is wrong on this point as well.

d) Sechrest does not refute the Roman stance on demand deposits. He does not argue why Roman law would be incorrect in this. Even the practical impossibility of multiple claims on the same money, apart from what the Romans wrote, is not given.

e) Moreover, Sechrest fails to judge both debasement and wear and tear correctly. On debasement: this would in a free market be a non-issue, as banks would have any incentive to prevent clipping of coins, debasement or other means of influencing the quality of money. On wear and tear: the less a coin is worn out, the more fungible it is in the absence of difference between sort like coins. The more a coin is worn out, the more fungible it is as well: only the pure gold grams of a coin will have any value. And in between, if an individual connects any value to a particular coin, he will not deposit it in any bank. The fact that people deposit coins and accept them to be mixed with other people’s money, already means they consider them to be fungible. Hence Sechrest is wrong on this point as well.

On wear and tear: if customers do not consider coins to be fungible, due to specific wear and tear, they will not deposit them in a fungible bank account in the first place. At best, they will store them in a private or bank vault. What remains and falls under consideration here concerning deposits and credit out of existing savings, are the coins that customers see and treat as fungible.

Alinea 3-3
Any deviation from such contractual relations (e.g., fractional reserves) he thus castigates as an act of fraud or theft on the part of the banker. If that sounds as if the book adopts a severely moralizing tone, it does. In fact, there is use of the term “sin” when reviewing various episodes in banking history (pp. 88, 92, 97). And fractional reserve depositaries are even described as “legal aberrations” possessing no legal standing, much like human “monsters” with physical deformities (p. 143). Moreover, Huerta de Soto insists that banks indulging in fractional reserves inevitably open the Pandora’s Box of monetary inflation, excessive credit creation, malinvestment, and business cycles (pp. xxvi, 56 n32, 265–395).
1) Sechrest in his book makes not a single refer to property rights, while they would be pivotal in a free market. Neither does he refute the Roman Law. Here he omits this by quickly referring to the supposed moralism of De Soto.
2) Fraud is not (just) a moral issue, but above all a legal notion. This is where De Soto focuses on. So it's Sechrest who creates a straw man here, but pretending moral does not play any role in economics. In fact, it is one of the drivers of human action, of which money and banking are prime examples.

3) Pandora’s Box opening by FRB is of course correct and which is not refuted by Sechrest. There is plenty of evidence both in De Soto's book as in many other works of the Austrian School, to which Sechrest curiously appeared to subscribe. In fact, FRFB is a fallacious answer to business cycles as it above all causes and intensifies these cycles.

De Soto does not proclaim FRFB is a sin, but quotes it as part of legal, economical and moral writings in the 16th century. Besides, Sechrest does not refute why FRFB would be morally right and both De Soto and his quoted scholars are wrong on this point. Sechrest lifts De Soto's words out of their context. People in a free market would definitely make moral based decisions, hence quoting moral scholars is definitely a right thing to do. It is a legal aberration "since at a fundamental level it conflicts with universal legal principles" (p. 143). It is exactly these legal principles that De Soto treats exhaustively and which Sechrest dismisses lightly, without offering any alternative.

88: De Soto treats sin in the context of the School of Salamanca. Mind that the referred to scholar "Saravia de la Calle makes a neat distinction between the two radically different operations bankers carry out: demand deposits and time “deposits.”" So it was not just the Romans who had (correct and logical) ideas of deposits, but people in later generations as well. Mind that De la Calle points out why it is a sin to deposit money against interest, as well as the bankers who commit FRB: besides the dubious practice itself, the bankers make "disproportionate profits" with this practive, just as they do in today's world of FRB privilege. De la Calle notes the boom-bust cycles, the expansions and recessions that inevitably are part of this practice. Sechrest himself considers deflation a problem, to be prevented by FRFB, which is a moral judgment as well. Moreover, De Soto himself states that "However, in his [Saravia de la Calle] criticism of bankers, he perhaps places too much emphasis on the fact that they charged and paid interest in violation of the canonical prohibition of usury, instead of emphasizing that they misappropriated demand deposits." (p. 89).

On the "Pandora’s Box", De Soto is of course correct, as such factors as monetary inflation, excessive credit creation, malinvestment, and business cycles have been recognized over the centuries. On the quoted pages: xxvi: "My conclusion is that the successive stages of boom, crisis, and economic recession recurring in the market result from the violation of the traditional legal principle on which the monetary bank-deposit contract should be based. They stem from the privilege bankers have come to enjoy and have been granted in the past by governments for reasons of mutual interest."

56 n32: "However, this requirement [unlimited liability] is not necessary to achieve a solvent banking system, nor would it be a a sufficient measure. It is not necessary, since a 100-percent reserve requirement would eliminate banking crises and economic recessions more effectively. It is not sufficient, because even if banks’ stockholders had unlimited liability, bank crises and economic recessions would still inevitably recur when a fractional reserve is used."

265–395: a whole chapter devoted to the effect of FRB on the economic system. De Soto uses a number of sources to build his argument. Again, Sechrest does not refute the writing of De Soto, nor that of the quoted authors.

Alinea 4
He does recognize that loans (mutuum contracts) are also legitimate, but at the same time insists that all loans must be for a stated time period. Amazingly, Huerta de Soto declares that loans devoid of such a time stipulation “cannot exist” (pp. 3–4). And yet they do exist. Prepayment options are common today in both mortgage contracts and tuition loans to college students. At a number of points elsewhere in the book, he claims that throughout history the principal, if not the only, reason for bank failures and bank runs has been fractional reserves. Here he ignores two crucial facts: a) bank failures have often been the result of constraining regulations and/or errors in granting loans and b) during bank runs, consumers have often shifted their checkable deposits from an insolvent fraction- al reserve bank to some other, solvent fractional reserve bank—instead of simply holding greater amounts of cash, either at home or in a safety deposit box. It is precisely this sort of faulty reasoning, born of a plausible premise but impervious to the facts, which will justifiably fail to persuade many economists.
It’s unclear what the relevance of prepayment options is in this context. Perpetual loans are gifts, so a stated time period is a logical must to be a loan.

This looks more like a snear because De Soto rejects FRFB, than a true argument. What that nature is supposed to be and how De Soto would have it wrong, remains unclear. De Soto and fellow Rothbardians understand FR(F)B and its consequences like no one else, as they look into the economic/legal/moral nature and its consequences.. Hence their criticisms and their proposal of a 100 percent reserve banking.

Sechrest overlooks the massive bankruns and –collapses in the 1930s, culminating in a national bank holiday in 1933. And he is wrong again: FRB makes banks insolvent by definition. The shift of deposits to those other banks does not justify FRFB. It merely perpetuates a legally, economically and morally problematic situation.

Sechrest overlooks that in a FRB system, customers have no other choice than to go to another FRB bank.

Alinea 5
In effect, Huerta de Soto defines demand deposits as a warehousing contract and then proceeds to provide many details on how that sort of contract has often been violated by banks. He never really comes to grips with the nature of FRFB, nor with its defenders’ arguments (though he attempts to do this in his Chapter 8). This book chronicles many episodes in banking history, but the conclusions that are drawn are highly dependent upon the assumptions from which they commence. For example, a speech given by Demosthenes in 362 B.C. is discussed at some length in order to glean an understanding of ancient Greek banking. However, when Demosthenes declares that the main reason for bank failures was the extension of credit to unworthy borrowers, Huerta de Soto suddenly parts company with him, insisting that he is “mistaken” since the real reason for such failures was bankers’ failure to hold 100 percent reserves (pp. 48–49). Similarly, after favorably citing works by scholars Ramon Carande , Abbott P. Usher, and Raymond De Roover, he asserts that they all have misinterpreted the historical evidence insofar as they fail to dwell on what he would, no doubt, describe as the egregious fraud of fractional reserves (pp. 71 n56, 74, 81).
Again, there's no real difficulty here. De Soto rightfully remarks that these authors describe the crises in the eras under consideration, but they did not know or understand the cause and nature of them. Nonetheless, they found there were crises and insofar they were right. Equally right is De Soto by giving the right explanation, frb, even if this means to break with the original authors. Sechrest does not like this explanation, hence he thinks he needs to point to supposed inconsistency in De Soto's citing. But Sechrest fails again.

Moreover, Sechrest strays away by quoting fraud as the source of De Soto's disagreement, thus ridiculing it, while in this case the economic argument is in place.

So what did Sechrest mean with "come to grips"? How does he explain and justify FRFB? Referring to the demand for money, but this has never been because of stability but of egoism. So Sechrest does not come to grips with De Soto and mixes historical abuse with his seemingly justified frfb, while both have never had any connection. The historical episodes have nothing to do with the frfb of sechrest et al, which is a late 20 c invention. Quasi justified but no hist basis whovh was always egoism.

Sechrest overlooks that in all historical cases if frb, government gave an explicit right to commit it. This fact proves that in a free market, frb would not exist, as the privilege requires explicit political permission. Mind that historically, there was never any frfb with its aim of stability, but only individual interest. Sechrest also ignores that individuals started complaints against FRB banks, which in some cases they even won.

De Soto's interpretation is not proven wrong, as he refers to the pure legal context of Demosthenes' speech. The facts of that particular era in Greek history might (or even do) confirm his reading. Moreover, there's a connection between FRFB and the creditworthiness of borrowers. Von Mises remarks on the seeming profitability of projects under FRFB and the artificially lowered interest make this clear. Again, Sechrest does not refute what De Soto in note 56 writes. De Soto notes the credit expansion and inevitable crisis, the `credit shortage` which in fact was a reaction the an artifical credit boom. These are proven facts. De Soto correctly notes that he (Cipolla) `ignores the prior economic boom, unconsciously lapsing into a “monetarist” interpretation of history and thus failing to recognize the artificial boom caused by credit expansion as the true source of the ensuing, inevitable recessions `. Moreover, the failure of A.P. Usher and Raymond de Roover (De Soto, pp. 71 note 56) to even come to grips with medieval recessions which were “mysterious and inexplicable” to them, only underscores this point. De Soto rightfully asserts they misinterpreted history. Wrong, De Soto criticizes A.P. Usher and Raymond de Roover (De Soto, pp. 71 note 56) not for misunderstanding the fraudulous nature of FRB, bur for failing to see the resulting boom that causes the bust in the first place.

Wrong. De Soto refers to Roman Law (Sechrest himself notices this) to provide a reasonable picture of demand deposits. Sechrest does not define or otherwise state how demand deposits should be seen. Neither does he refute De Soto (nor the Romans) on this point and why people in a free market would `define` demand deposits otherwise. Moreover, customers of a bank naturaly assume their money is safe and not used by the banker by multiplying it.

Alinea 6
While discussing theorists of the famed School of Salamanca, he concedes that some actually favored fractional reserves, but these he dismisses as being Jesuit “deviationists” (p. 95, n97). He does of course praise those Dominicans of Salamanca who, he believes, were advocates of 100 percent reserves. However, it is not entirely clear from the citations provided whether these Dominicans’ criticisms were actually aimed at fractional reserves per se or at “usurious” loan contracts between bankers and their customers (pp. 85–88). In fact, he comes rather close, though unintentionally, to conceding the latter (p. 89).
The complete quote in this is ` It seems clear that the core members of the School of Salamanca were Dominican, and at least on banking matters it is necessary to separate them from Jesuit theologians, a deviationist and much less rigorous group.` (De Soto, pp. 94-95, n97)

Alinea 7
There are also some rather far fetched connections that Huerta de Soto is willing to use as “evidence” in his favor. One particularly notable example has to do with his judgment of the operations of Spanish banks during the sixteenth century. Here he depends largely on the work of Carlo M. Cipolla regarding Italian banks of that same time period. Amazingly, Huerta de Soto reassures the reader that the details on Italian banks are “directly applicable” to Spanish banks because of the close economic ties between the two nations (p. 81). I would grant that banking practices in one nation might mirror those in another nation, but I would need more of an explanation than the mere assertion that the two economies were, in certain ways, interdependent. Great Britain and the United States have been linked economically for a long time, but does that justify the conclusion that any analysis of American banking practices would be equally applicable to Britain?
Alinea 8
The foregoing indirectly brings to mind a further possible problem for the reader, though not necessarily a flaw in the presentation. Huerta de Soto is obvi- ously multilingual, which is entirely to his credit of course. His sources include ones which are in English, Latin, Spanish, Italian, and French. However, any reader fluent in only one of those languages—and who might have reservations about Huerta de Soto’s evidence—must be left with the nagging question of whether certain of the cited sources actually do support the book’s arguments.
a) Anyone can learn languages and check if De Soto’s quotes are correct; b) Sechrests accusation is a slap in the face of every scientist who quotes from other languages, whichever that may be; c) Sechrest does not and cannot state which language would or should be the correct one to use and hence which one(s) would not constitute the supposed problem he sketches; d) Sechrest contradicts himself by giving De Soto credits for being multilingual, but on the other hand questioning the validity of its use;

Alinea 9-1
Above all, Huerta de Soto refuses to even consider the possibility that banks’ customers may have been quite willing to face some risk exposure in exchange for the benefits of a) the receipt of interest on their deposits and b) having circulating inside money in the form of “payable to the bearer” banknotes (something 100 percent reserve banks are unable to provide, since they must charge security fees on all demand deposits).
Interest could, should and would be paid by investing time deposits without FRFB. Sechrest clearly overlooks this natural option.

Wrong. Banknotes would be in use under 100 percent banking. Sechrest does not explain the negation of this option.

>Alinea 9-2
Instead, he is driven to a heavily conspiratorial interpretation of banking history. In his hands any departure from 100 percent reserve banking is automatically taken to be evidence of malfeasance by bankers, even when there is no clear data on the details of the contractual relations negotiated by depositors. “[T]he traditional principles of safekeeping on which the monetary irregular-deposit contract is based were violated from the very beginning [of banking] in a concealed manner. . . . [Governments] supported bankers’ improper activity almost from the beginning” (pp. 37–38). This may accord with Murray Rothbard’s view of the political class as some sort of unrepentant cabal, but it sheds rather little light on the essence of banking.
The essence of banking is or should be to deliver services that their customers want. Sechrest takes history for granted, not seeing that frb and government interference are one and the same kind. Mind that the Romans had a great understanding of this, which ls completely overlooks. Sechrest misunderstands Hulsmann's case. This makes FRFB in a free market beforehand impossible, so Sechrest’s booklength argument fails. So Sechrest may refer to Rothbard, but he still misses the point.

Alinea 10
A clever variation on this same theme of fractional reserve banking as fraud can be found in Jörg Guido Hülsmann’s article “Has Fractional-Reserve Banking Really Passed the Market Test?” (The Independent Review, Winter 2003). The novelty here is the argument that the “IOUs” of fractional reserve banks (their issues of banknotes and deposit credits) are naturally differentiable due to the varying risk characteristics of each bank, and thus such fiduciary instruments will vary in price, with all being traded at a discount relative to real money (specie) and money titles (notes issued by 100 percent reserve banks).
The history of money and banking is loaded with bankruns, discounted money, boom-bust cycles and malinvestments.

Baseline: differentiability is an issue and only for economical reasons it is put aside. So there's no novelty in this observation. Nonetheless selgins remarks are not at all free from fallacious thinking. Though a cartel is officially

Alinea 10-2
To overcome this problem, Hülsmann claims that FRFB will unavoidably gravitate toward forming a cartel in which all individual banks agree to “homogenize” inside money by accepting one another’s IOUs at par. Their goal is to accomplish the “semantic trickery” (p. 411) of deceiving the public into thinking that the banknotes or deposit credits issued by fractional reserve banks are no different from money or money titles.
Sechrest should answer another question: could FRB be viable in a free market, without cartel, with no central bank? If not then FRFB is futile. Comment: Sechrest overlooks that a merge of FRB into a central bank, would be the inevitable outcome, the more so under legal tender. In a free market with free choice in money, this risk would be absent.

a) Legal tender laws are a prerequisite for FRB
b) These laws not only facilitate but stimulate FRB
c) A cartel will only be erected when there are LTL, or else it will fail
d) In a free market, both LTL and its inevitable consequence of FRB are excluded
e) FRFB is a contradiction in terms: in a free market, FRB would stand no chance as both LTL and cartelization of the monopoly of money would not exist

Alinea 11
There are two flaws in this argument. First, if the cartel is voluntary, it will have little chance of surviving. As Murray Rothbard pointed out in Man, Economy, and State (pp. 579–86), such cartels are inherently unstable. They either revert to a multiplicity of competitors or merge into one large firm. If we are to take Hülsmann’s hypothesis seriously, then it is incumbent upon him to explain why cartels are generically unstable, but somehow stable in the context of fractional reserve banking. On the other hand, if compulsion is involved, what one has is the imposition of a central bank on the economy. The former case is ineffective, and the latter has no relevance to the case for FRFB.
Here a few institutions run across one another. The acceptance of notes, the institution of a cartel and if it could survive in a free market an d the semantic trickery that Hulsmann notes and Sechrest quotes.

Alinea 12
Second, Hülsmann apparently wants the reader to believe that consumers are somehow steadfastly incapable of differentiating a) money warehouses which issue money titles and charge their customers fees for the provision of security (and perhaps transaction services such as accounting entries which transfer funds from one customer to another) from b) financial intermediaries which issue their own distinctive inside money (“IOUs”), offer transaction services, and pay inter- est on their customers’ account balances. In fact, he even claims that Gresham’s Law becomes operative in this environment (p. 408). That is, he insists that the “overpriced” IOUs tend to drive the “underpriced” money titles out of circulation.
Alinea 13-1
One immediate problem with this is that, as Murray Rothbard stated emphat- ically (Man, Economy, and State, p. 783), Gresham’s Law only applies to the case where one form of money is officially overpriced and the other officially under- priced, that is, by an act of government. It does not apply to free market relation- ships.
So apparently Sechrest indeed assumes a free market on which his FRFB supposedly takes place. Ironically, Sechrest overlooks that in practice, if free banking would indeed work out as its proponents like to see, Gresham would automatically work. That is at least what follows from their theory. Sechrest draws heavily from Selgin (1988), from which in chapter 2 the reader might conclude that Gresham works: “In a mature free-banking system, such as Ruritania’s, commodity money seldom if ever appears in circulation, most of it (outside numismatic collections) having been offered to the banks in exchange for inside money. ”, quoted by Sechrest (p. 13). So "bad money drives out good" will take place, according tot he free bankers; this is essentially what FRFB is about: the driving out of gold and replacing it with inside money (in fact credit). If Gresham indeed only works under government force, then Sechrest and fellows should explain how and why without such force, without legal tender, in their free market, the same phenomenon of driving out good money, would occur. Why free people would choose this type of money and banking practice. And why we have government intervention in the free market, if the outcome on a free market would be the same.

Alinea 13-2
A further, obvious inconsistency is revealed as soon as the reader recalls that these selfsame bank customers are allegedly able to differentiate among the IOUs issued by various fractional reserve banks (based on the variation in risk) and simultaneously unable to tell the difference between a fractional reserve IOU and a real money title issued by a 100 percent reserve bank warehouse. This is nonsensical. It seems comparable to claiming that a person can differentiate among the numerous breeds of dogs, but cannot tell that a cat is not a dog.
Again, let's quote Hulsmann, this time on Gresham's Law (p. 400 & 408) as a consequence of a cartel: "Notice first that the confusion between money titles and fractional-reserve IOUs brings into operation what is commonly known as Gresham’s Law. Imagine a potential bank customer who is offered two types of deposits with a bank. He believes that both deposits deliver exactly the same services. The only difference is that he has to pay for the first type of deposit, whereas does not have to pay—or even receives payment—for the second type of deposit. Clearly, he will choose not to be charitable to his banker and will subscribe to a deposit of the second type. When genuine money titles and fractional-reserve IOUs are confused, therefore, the latter will drive the former out of the market." A result (even an aim) of a cartel would indeed be to obfuscate the differences between the money titles and fractional IOUs.

Sechrest overlooks the real importance of Hulsmann's writing. A number of bullets will capture it best.
* Product differentiation is a free market feature, contrary to government-protected monopolies, with their purposely limited supply that ignores different buyer's needs. FRB "might be a legitimate free-market activity" (p. 400, mind Hulsmann's careful words), that might exist besides 100 percent money be it in narrow circles. This differs from the FRFB who assume FRB would be the only money in a free market and fractional policy the only and hence dominant way of economic acting.
* These fractional IOUs (contra genuine money titles) would play a limited role:
* The fact that bankers "The history of banking is replete with such cases, wherein semantic trickery from the side of fractional-reserve bankers prompted upset customers to file lawsuits against their banks." (p. 412), is proof of the stated fact that bankers "relied on obscurity of language" (p. 400), which in its turn proves the difficulty of FRB in a free market or even in a government-sanctioned regime. This means that a genuine, non-obscure, non-fraudulent way of FRB de facto does not exist, or else why would bankers in past and present have to rely on obscure language? Examples of these obscurities are given by Hulsmann:

* Mind that with Sechrest and fellows, confidence in the fiduciary media (FR money) does not play a role. This is unrealistic, as Mises (1966, p. 433) shows: "It must not increase the amount of fiduciary media at such a rate and with such speed that the clients get the conviction that the rise in prices will continue endlessly at an accelerated pace. For if the public believes that this is the case, they will reduce their cash holdings, flee into "real" values, and bring about the crack-up boom." It is excatly the history of money and banking that shows this vaporizing confidence, with all its consequences.
White VOLUME VII, NUMBER 3, WINTER 2003 -- Reply on Hulsmann
Some own remarks:
"Thus, Ludwig von Mises’s dictum that “Issuing money-certificates is a ruinous business if not connected with issuing of fiduciary media” (1966, 435) applies most forcefully to circulating notes."
-> Context LvM: "A bank can never issue more money-substitutes than its clients can keep in their cash holdings" (H.A. p. 435). Hence, credit expansion can only take place by concerted acting hence an (informal) cartel.
-> Wrong, as it does not matter who owns the gold
-> This proves all the more that using gold and silver as coins should never be let loose. Issuing money-certificates can only exist in government-protected areas, not in a genuine free market, where only coins would be used.

Alinea 14
Allow me now to leave aside further specific criticisms of particular works and instead to emphasize certain commonalities. Found in both of these above- mentioned essays, and most if not all, other defenses of 100 percent reserve bank- ing are three problematic assertions. The first is the assumption that any departure from 100 percent reserves cannot be agreeable to the bank’s customers and thus constitutes an act of fraud on the part of the banker. As a result, all the historical episodes in which banks began as money warehouses but later acted as interme- diaries holding fractional reserves are immediately interpreted as being rooted in criminality.
Indeed and it is up to Sechrest and fellows to prove otherwise. Market logic dictates FRFB is not viable. History even proves (see De Soto) that FRB mostly or even only arose in situations where kings or princes confiscated deposits or bank profits. That is not a free market If FRB were to be agreeable, then why has it never explicitly happened? Why are there no individual contracts between bankers and depositors, in which such arrangement were put on paper? Why has there always been government intervention in order to facilitate, whcih always turned out to be a privilege, a monopoly for the bankers? Mind that the origins of FRB were more to be found in goldmiths who were FRB'ing just because they were the only safe haven in times of confisquation of gold by king of England (see Selgin's source).

The obvious alternative possibility, that fractional reserve holding might have naturally evolved as an improvement on warehousing is rejected out of hand. This mode of thinking extends to court cases. Any judge who ruled that interest-bearing demand deposits were a form of loan to the banker becomes an accomplice to fraud. The idea that such a ruling might have accurately reflected a common practice, one generated by the fully-informed and voluntary actions of both banker and depositor, is never investigated seriously.

Improvement for whom? And then why were such lawsuits being held, based on discontent on the part of the depositors? Apparently, they did not see FRB as an improvement but as an impairment to their property. So Sechrest completely ignores the reality and muses again in his theoretical ideals. Sechrest states "The idea that such a ruling might have accurately reflected a common practice" does not make this any better. Again he ignores that at least some depositors did not accept this "common practice". Moreover, he begs the question if this practice itself is problematic. The fact that a certain practice is "common" does not make it right in itself. There are pretty much examples to give of this. Neither does he prove that depositors were fully informed. Mind that informal knowledge of a practice (maybe banks' customers indeed informally knew) is not the same as a formal contract in which banker and depositor agree to FRB, including a legal arrangement of any sorts (if possible at all) and the bearing of risks.

Alinea 15
The second troubling premise is the notion that, once there exists an accepted medium of exchange used by all in a given society, no changes in the money stock are ever welfare-enhancing. In other words, at that moment the existing supply is already optimal. Neither subsequent increases nor subsequent decreas- es serve any valid economic purpose (other than those deflationary decreases which are the corrective for prior inflationary increases). That having been said, they do not quite mean literally all changes in the money supply. Increases in banknotes or deposit credits which stem from an increase in the monetary gold held in the vaults of the 100 percent reserve banks are seen as natural and harmless. And they often note that such increases in the specie base have occurred historically at modest annual rates of 1 percent–5 percent.
Indeed is an increasing amount of gold and silver available harmless, if it is the result of individual investment choice, who for himself makes a non-violent justified choice, without privileges or other types of force. Any amount of money is the result of individual choices and actions. If the amount is a one-time shot, it apparently fulfills the estimation of one person in control, of a group of persons. But it is still arbitrary and could have been different according to other people’s desires. without causing problems. If the amount is the result of a continuous process of increasing and decreasing the money supply, then there is a function for changing the supply, which reflects individual preferences.

First off, if prices are purposely made imperfect, so if there is any intervention in prices (like tariffs, taxes, regulations, minimum or maximum prices and wages), then they should be eliminated, as they are the result of force and derail the free flow of production and consumption. They distort human life. Further, if inflexibility of prices is due to imperfect information or certain behavior by businessmen, there is simply no problem. Imperfection is part of human action, part of legitimate human choices. In fact, there is no perfection as there is no comparison with other choices as they have simply not been made by the same person. Neither does Sechrest prove that FRB solves the "problem" of inflexibility, or that such inflexibility would not be problematic at all under FRB. Sechrest selectively demands perfection in prices in order to let the gold flow freely in and out of the money supply. But why not demand the same perfection in the production of cars, tomatoes, apples or bricks? There are always better choices to make (in the subjective eyes of others), always more information to be found and applied to choices in production and trade. Moreover, perfect price flexibility is hard to prove. Maybe a businessman anticipates any future development and hence does not adjust his prices. So price formation is never a transparant process as people could always hide or not inform their arguments. That is their free choice and that is what freedom is all about.

Alinea 16
This proposition faces a serious difficulty. It can only be correct if it is true that the purchasing power of a given money stock adjusts immediately to reflect changing conditions, i.e., all prices must be perfectly flexible in the short run. And I have long found that latter condition to be highly questionable. Indeed, it flies in the face of certain crucial aspects of Austrian thought. For instance, all Austrians describe the market as comprising interactions between forward-looking (i.e., speculative) buyers and sellers whose state of knowledge is always incomplete, even as they strive for completeness. Moreover, this state of knowl- edge is ever-evolving precisely because the market is a discovery process. But to discover economic facts requires time. It cannot be anything close to instantaneous. And it cannot be devoid of error. Therefore, to conceive of the market as a discovery process is to cast doubt upon the idea that all prices are fully and rapidly flexible. Those who maintain that any supply of money is "optimal" seem, in effect, to live in the long run world of full equilibrium, not the real world of constant adjustments and corrections.
Mises (Human Action, p. 408) wrote: "The relation between the demand for money and the supply of money, which may be called the money reiation, determines the height of purchasing power."

Even if flexibility is imperfect, there's still no problem with that, as no one is harmed or disadvantaged by such imperfections. FRFB does not heal this supposed problem, nor is FRFB itself errorless, as it is as well prone to information imperfections and thus imperfect flexibility. It changes prices and production in an arbitrary manner, not based on investment in mining and melting when gold and silver money are simply market goods. Fractional credit is no market good, as it does not require investment, nor are they decisions of individual risk takers, but does it seem to come from a mechanical type of thinking and acting. This is not reality.

Sechrest overlooks the obvious answer to a rising demand for money: more savings, more selling, less spending. There is no necessity to increase the money supply on a FRFB basis. Should an investment into gold or silver mining, using existing savings, be profitable by mining more than the gold/silver investment, people in a free market would assumably make that choice. That would not be FRFB, but increasing the money supply on the basis of being a scarce good that demands capital investment and returns. FRFB is essentially costless for banks, but presents the bill to others than the firrst receivers of the newly created money without investment.

Sechrest once more produces a tangle of fallacies, which needs to be unraveled for a clear view of the monetary matters under consideration.
a) Sechrest's "the purchasing power of a given money stock" and its immediate adjustment, is an holistic approach, which has no place in the individual state of mind, concerning investing in mining or melting, hence altering the money supply. An entrepreneur, which individuals would be under gold and silver money, estimates or calculates what investment he needs to make into mining or melting gold and silver (by himself or through an investment fund) and what he could ultimately buy with them. So his individual spending pattern and the development of prices there within, is what makes him move into the expanding business. The "given money stock" is irrelevant in this.
b) The crucial point is not perfect flexibility of prices, but the fact that they are (idealistically) free, that is: not infringed by law. This makes price formation not perfect, but at least harmless, though the freedom itself might be considered perfect.
c) Even with free prices, they will never (100 percent) reflect all information on demand and supply, as nobody in the world has this available and/or could or wants to deploy it into his prices. But this does not pose any problem, as anyone in a free market is hit equally by this phenomenon and nobody would have any privileged advantage or disadvantage from it. Prices can be prone to fallacy, error, even misinformation or fraud, hence to imperfection, at least from somebody else's point of view. But (a) FRFB does not solve this and would only add to imperfections by giving some the privilege to exchange newly created money against goods and services at old prices (the Cantillon Effect) and (b) not perfectly flexible prices are hence an arbitrary basis for FRFB.
d) Sechrest misunderstands the phenomenon of money relations. e) Sechrest ignores that FRFB, whether increasing or decreasing the money supply, is itself prone to imperfect information, flexibility and hence action. If anything, FRFB only distorts prices even further.

Again, incompleteness, time consumption and errors are part of human action. But they are not wrong or problematic as they are not purposeful and not forced. Hence they require no forced (privileged) intervention to "correct" them or to overcome their consequences. But intervention is exactly what Sechrest proposes. A peaceful proces of trial and error, of price discovery, is distorted. It is just the intervention with FRB that creates problems, as it distorts price discovery and creates uncertainty and chaos. The alternative would be that because of inflexibility, In fact, in a free market, nobody would ask for banks to "correct" any prices with FRB.

Alinea 17
Further doubt is raised as soon as one tries to integrate full and rapid price flexibility with the Austrian theory of business cycles (ABCT). This probably cannot be done in any plausible way. ABCT is a theory of unsustainable booms— —followed at some point by inescapable contractions—which are fueled by excessive credit expansion undertaken by the central bank. Relative prices and the market rate of interest are modified in a way that is inconsistent with consumers’ time preferences. These monetary effects are far from trivial because they elicit changes in real factors, in particular, changes in the capital structure. In striking contrast to mainstream macroeconomists, who usually ignore all issues of the capital structure (and thus focus on either short run disequilibria or on full, long run equilibrium), Austrians wisely emphasize the medium run. This is a time period long enough for a restructuring of capital to take place, but too short for the resulting malinvestment to be both recognized and corrected.
Medium run is an arbitrary difference, as the effects of FRB are immediate, betterknown as the Cantillon Effect.

Sechrest creates an fallacious separation between "restructuring of capital" and the "resulting malinvestment". Both are the same. Strange as well that he praises the wise Austrians with their emphasize of the medium run, but then denies the effectiveness of their efforts with his remark on the non-recognition of malinvestments. Chaging the capital structure itself is a malinvestment, these are connected to frb. ABCT applies as well to private banks that commit FRB. Actually, most of the credit that causes the boom bust cycles, is being produced by private banks, not central banks. There is no reason why these cycles would be absent under FRFB, as Moreover, it is price imperfection that drives businessmen. FRFB would only cluster errors and other imperfections (Rothbard).

Either there would not arise any forced alternative like a central bank, such as a cartel,

Sechrest also begs the question as to why the present bankers do not protest against having a central bank and instead would support FRFB, in which they themselves fully control interest, money supply and policy. Apparently because they see that without a CB, there would be no profitable FRB at all.

On the medium run: FRB would modify the market rate of interest as well; either because banks would intervene without consent of the customers (in a cartel or other privelege), or they would

Alinea 18
Money and credit precipitate the problem; while time-consuming alterations in capital are its manifestation. Furthermore, if the array of relative prices were to be disrupted only briefly, then the capital budgeting errors that are later identified as malinvestment would be much less likely to occur in the first place. If longer-term projects were planned, but then relative prices quickly changed back so as to reveal them to be errors, many projects would never be undertaken at all, and others soon thereafter would be liquidated. The unsustainable boom would never really get underway at all. Once again, some passage of time is needed. There must be time to plan capital projects, time to put those plans in action, time during which the deceptive market signals continue to reassure entrepreneurs that their projects are justified, time for the temporal malinvestment eventually to reveal itself. ABCT deals not with the artificial world of perfect competition, per- fect knowledge, and an infallible auctioneer, but with the real world of strategic action, imperfect knowledge, and fallible entrepreneurs. ABCT would appear to require that money has powerful, but sometimes sluggish, effects on prices.
ABCT is not about CB per se, but about FRB. For free banks, the same goes: FRFB disturbs economic calculation and hence creates boom/bust cycles. The FRFB'ers mistakenly assume that it is only CB, but it is FRB no matter what the exact source is.

By constantly and forcibly adding the money supply, FRFB impairs the changing back of prices to reveal the errors. So Sechrest admits the disruption as well as the short term consequences and the fact prices can change back. But why then still insisting on FRFB? This only exercabates the disruption as it is supposed to continue permenently. By constantly and forcibly adding the money supply, FRFB impairs the changing back of prices to reveal the errors. Moreover, prices change back because of adaptions by the market participants. In particular, under gold money the adjustment of the supply by mining and melting. So this is a self-correcting process. Sechrest does again not explain why FRFB should have a place in this, what this would add to this natural process.

Alinea 19
The third problem area is a derivative of the issue of price flexibility discussed above. It is the implicit assumption that the demand for money is, in effect, irrelevant to a proper analysis of banking. Led by Murray Rothbard, various Austrians have addressed a question which will inevitably be asked of any advocate of 100 percent reserves: What happens if the demand for money rises or falls? According to these Austrians, a change in the demand for money does not justify a commensurate change in the supply of money. With a given nominal supply of money, if the demand rises (falls) all that will occur is that the purchasing power of money (the inverse of the array of goods’ prices) will rise (fall). No adjustment to the nominal stock of money is needed, so 100 percent reserve holding by banks creates no difficulty. Perfect price flexibility allegedly ensures that the real money stock adjusts in the appropriate direction. If that line of reasoning is correct, then why does this not work equally easily on the other side of the market? That is, with a given nominal demand for money, if the nominal supply of money rises (falls) why is the corrective not "simply" a fall (rise) in the purchasing power of money?
a) Sechrest does not answer the question he ends his alinea with. Of course a change in the purchasing power of money, or better: the price of gold and silver money expressed in other goods and services, is the answer. This accounts for both an unchanging money supply as an increase or decrease of it, which would only be driven by this price mechanism. After all, money (any medium of exchange) itself is an economic, scarce good, the changing demand of which alters its relationship with other goods.
b) Sechrest begs the question as to why would the demand for money (rise or fall? It is FRFB that artificially creates demand.

1) Perfect price flexibility is utopian, as information is never spread across all people in the same manner, for many reasons. But this does not pose a problem.
2) frfb does not solve this issue, in fact it only makes it worse, by meddling with the money supply and hence creating more falsified prices. In fact, imperfections are the worst basis to start disrupting money and prices.
3) Demand for money itself might be result of imperfections, hence they do not provide reason all the more.
4) the only justified interference is individual considerations to mine or melt gold and silver.
5) the cause of rising or falling demand for money remains unexplained.

Sechrest does not use terminology that belongs to the free market (demand for money = demand for cash balances), but builds on the present, central bank induced notion that demand for money = the demand for short-term loans (Mises, Human Action, p. 400)

Wrong. The right question is why there would be a change in demand and which means are there to provide this. FRFB falsely identifies this rising demand without explaining it. Moerover, it provides the wrong solution by simply creating more money. A change in the demand for money, in particular a rise, would make interest rates go up and make loans more profitable. This would induce gold miners and people holding non-monetary gold to bring their supply into the market and hence fulfill the higher demand for money. The opposite would be true for a falling demand.

Alinea 20
As questionable as the foregoing perspective is, no short-run alternative solution would seem to exist for the proponent of 100 percent reserves. Thus, in the absence of perfect price flexibility for all goods and services, both inputs and out- puts, only fractional reserve free banks are capable of responding properly to changes in the demand for money. Chapters 2 and 3, plus portions of Chapters 4 and 8, of the present work will examine that adjustment process in considerable detail.
What exactly does Sechrest say in his chapters 2,3, 4 and 8?

Sechrest begs the question of why demand for money would rise or fall. Hence he creates a straw man against 100 percent banking. Moreover, FRFB would not solve this "problem", as the only difference it would make, purely from a monetary perspective, would be to drive up prices, but not change the rising or falling demand for money. So this supposed problem would still exist, only with higher prices. More demand for money should only mean: higher interest and more supply of natural money like gold and silver, which have no (government) force behind them to be put into exchange. Further could people who demand more money work do things like working more hours, improve their skills, sell some of their property and consume less. Sechrest and fellows overlook these options but never explain why.

Alinea 21
I would like earnestly to thank Jeffrey Tucker and the Ludwig von Mises Institute for their willingness to publish this new edition. Whether or not one agrees with the conclusions found herein, I believe that it offers a valuable survey of many of the historical and theoretical issues surrounding laissez-faire banking. Therefore, I hope that one of its uses may be as a supplemental text in banking or monetary theory courses. I greatly appreciate the helpful Replys I have received from John P. Cochran, Steven Horwitz, Lawrence H. White, George Selgin, and Kevin Dowd, as well as the gracious responses from Jesús Huerta de Soto to certain questions of mine. Finally, I wish to thank my wife Mary Ann and my son Kyle for their invaluable love and support.

Larry J. Sechrest
June 2008

Actually, apart from this Preface, the "new edition" does not contain any new text at all. It's only news is this new Preface, which is as fallacious as the original book itself. Mind further that the booktext itself has been completely left intact and that the new Preface even has its own page numbering, separate from the rest of the book. Moreover, the new Preface hasn't even been included in the Contents. So Sechrest added it purposely, not because he had anything new to say, but as a certain agitation towards a number of publications on 100 percent banking and FRB. Mind that Sechrest only came up with this in 2008, 15 years after his original book. In the meantime many more critical articles on FRFB have been published, but apparently only a few then-recent ones triggered Sechrest's response. Further, not Sechrest's, but De Soto’s book should be mandatory in any course on money, banking and economics generally.


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