Man, Economy, and State with Power and Market

Chapter 2 described the difference between “claims to present goods” and “claims to future goods.” The same analysis applies to money as to barter. A claim to future money is a bill of exchange—an evidence of a credit transaction. The holder of the bill—the creditor—redeems it at the date of redemption in exchange for money paid by the debtor. A claim to present money, however, is a completely different good. It is not the evidence of an uncompleted transaction, an exchange of a present for a future good, as is the bill; it is a simple evidence of ownership of a present good. It is not uncompleted, or an exchange on the time market. Therefore, to present this evidence for redemption is not the completion of a transaction or equivalent to a creditor’s calling his loan; it is a simple repossessing of a man’s own good. In chapter 2 we gave as examples of a claim to present goods warehouse receipts and shares of stock. Shares of stock, however, cannot be redeemed in parts of a company’s fixed assets because of the rules of ownership that the companies themselves set up in their co-operative venture. Furthermore, there is no guarantee that such assets will have a fixed money value. We shall therefore confine ourselves to warehouse receipts, which are also more relevant to the supply of money.

When a man deposits goods at a warehouse, he is given a receipt and pays the owner of the warehouse a certain sum for the service of storage. He still retains ownership of the property; the owner of the warehouse is simply guarding it for him. When the warehouse receipt is presented, the owner is obligated to restore the good deposited. A warehouse specializing in money is known as a “bank.”

Claims to goods are often treated on the market as equivalent to the goods themselves. If no fraud or theft is suspected, then evidence of ownership of a good in a warehouse is considered as equivalent to the good itself. In many cases, individuals will find it advantageous to exchange the claims or evidences—the goods-substitutes—rather than the goods themselves. Paper is more convenient to transfer from person to person, and the expense of moving the goods is eliminated. When Jones sells Smith his wheat, therefore, instead of moving the wheat from one place to another, they may well agree simply to transfer the warehouse receipt itself from Jones to Smith. The goods remain in the same warehouse until Smith needs them or until the receipt is transferred to someone else. Of course, Smith may prefer, for one reason or another, to keep the goods in his own warehouse, in which case they are moved from one to the other.

Let us take the case of a warehouse owned by the Trustee Warehouse Company. It holds various goods in its vaults for safekeeping. Suppose that this company has developed a reputation for being very reliable and theft-free. Consequently, people tend to leave their goods in the Trustee Warehouse for a considerable length of time and, in the case of goods that they do not use frequently, will even tend to transfer the goods-certificates (the warehouse receipts, or evidences of ownership of the goods) and not redeem the goods themselves. Thus, the goods-certificates act as goods-substitutes in exchange. Suppose that the Trustee Company sees this happening. It realizes that a good opportunity for fraud presents itself. It can take the depositors’ goods, the goods that it holds for safekeeping, and lend them out to people on the market. It can earn interest on these loans, and as long as only a small percentage of depositors ask to redeem their certificates at any one time, no one is the wiser. Or, alternatively, it can issue pseudo warehouse receipts for goods that are not there and lend these on the market. This is the more subtle practice. The pseudo receipts will be exchanged on the market on the same basis as the true receipts, since there is no indication on their face whether they are legitimate or not.

It should be clear that this practice is outright fraud. Someone else’s property is taken by the warehouse and used for its own money-making purposes. It is not borrowed, since no interest is paid for the use of the money. Or, if spurious warehouse receipts are printed, evidences of goods are issued and sold or loaned without any such goods being in existence.

Money is the good most susceptible to these practices. For money, as we have seen, is generally not used directly at all, but only for exchanges. It is, furthermore, a widely homogeneous good, and therefore one ounce of gold is interchangeable with any other. Since it is convenient to transfer paper in exchange rather than carry gold, money warehouses (or banks) that build up public confidence will find that few people redeem their certificates. The banks will be particularly subject to the temptation to commit fraud and issue pseudo money certificates to circulate side by side with genuine money certificates as acceptable money-substitutes. The fact that money is a homogeneous good means that people do not care whether the money they redeem is the original money they deposited. This makes bank frauds easier to accomplish.

“Fraud” is a harsh term, but an accurate one to describe this practice, even if not recognized as such in the law, or by those committing it. It is, in fact, difficult to see the economic or moral difference between the issuance of pseudo receipts and the appropriation of someone else’s property or outright embezzlement or, more directly, counterfeiting. Most present legal systems do not outlaw this practice; in fact, it is considered basic banking procedure. Yet the libertarian law of the free market would have to prohibit it. The purely free market is, by definition, one where theft and fraud (implicit theft) are illegal and do not exist.

To part with goods or money held in trust or to issue spurious warehouse receipts is, of course, a dangerous business, even when the law permits it. If the warehouse once failed to meet its contractual obligations, its fraud would be discovered, and a general panic “run” on the warehouse or bank would ensue. It would then be quickly plunged into bankruptcy. Such a bankruptcy, however, would not be similar to the failure of an ordinary speculative business enterprise. It is rather similar to the absconder who gets caught before he has returned the funds he has “borrowed.”

Even if the receipt does not say on its face that the warehouse guarantees to keep it in its vaults, such an agreement is implicit in the very issuance of the receipt. For it is obvious that if any pseudo receipts are issued, it immediately becomes impossible for the bank to redeem all of them, and therefore fraud is immediately being committed. If a bank has 20 pounds of gold in its vaults, owned by depositors, and gold certificates redeemable on demand for 30 pounds, then notes to the value of 10 pounds are fraudulent. Which particular receipts are fraudulent can be determined only after a run on the bank has occurred and the later claimants are left unsatisfied.

In a purely free market where fraud cannot, by definition, occur, all bank receipts will be genuine, i.e., will represent only actual gold or silver in the vaults. In that case, all the bank’s money-substitutes (warehouse receipts) will also be money certificates, i.e., each receipt genuinely certifies the actual existence of the money in its vaults. The amount of gold kept in bank vaults for redemption purposes is called its “reserves,” and the policy of issuing only genuine receipts is therefore a policy of “100-percent reserves” of cash to demand liabilities (liabilities that must be paid on demand).30 However, the term “reserve” is a misleading one, because it assumes that the bank owns the gold and independently decides how much of it to keep on hand. Actually, it is not the bank that owns the gold, but its depositors.31

An enormous literature has developed dealing with the physical form of the money receipts, and yet the physical form is of no economic importance. It may be in the form of a paper note, a token coin (essentially a note stamped on coin instead of paper), or a book credit (demand deposit) in the bank. The demand deposit is not tangibly held by the owner, but can be transferred to anyone he desires by written order to the bank. This order is called a check. The depositor has a choice of which form of receipt to take, according to his convenience. Which form he chooses makes no economic difference.

• 30Time deposits are, legally, future claims, since banks have a legal right to delay payment 30 days. Moreover, they do not pass as final media of exchange. The latter fact is not determining, however, since a secure claim to a money-substitute is itself part of the money supply. “Idle” cash balances are kept as “time deposits,” just as gold bullion is a more “idle” form of money than coins. The deciding factor, perhaps, is that the 30-day limit is virtually a dead letter, for if a “savings” bank should impose it, a bankrupting “run” on the bank would ensue. Furthermore, actual payments are sometimes made by “cashiers’ checks” on time deposits. Thus, “time” deposits now function as demand deposits and should be treated as part of the money supply. If banks wished to act as genuine savings banks, borrowing and lending credit, they could issue I.O.U’s for specified lengths of time, due at definite future dates. Then no confusion or possible “counterfeiting” could arise.
• 31Such items as bills of lading, pawn tickets, and dock warrants have been warehouse receipts rooted in the specific objects deposited, in contrast to the loose “general deposits” where a homogeneous good can be returned. See W. Stanley Jevons, Money and the Mechanism of Exchange (16th ed.; London: Kegan Paul, Trench, Trübner & Co., 1907), pp. 201–11.