Gray areas with fractional reserve banking

Alex M posted on Wed, Nov 4 2009 9:39 PM

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Whether you're a free banker or one who would consider fractional reserve banking to be a punishable offense, where do you draw the line between legitimate banking practices and cycle-generating credit expansion? For instance, if instead of there being warehouse receipts that said "redeemable for 10 ounces of gold", the phrasing "redeemable for 10 ounces of gold upon availability" were used, would it be permissible for a bank to loan out the money of those depositors who were provided with receipts with the latter phrasing? The "upon availability" signifies that, while the bank still owes the depositor money, if not all the money is there, the depositor will have to wait until loans are called and money is freed up before he/she can withdrawal. It would not mean the bank would have to close up shop due to insolvency and failure to meet its obligations, since the obligations weren't strictly demand deposits, but rather demand deposits upon availability of funds. A bank run needn't ruin the bank the day it happens, though the bank would quickly lose its reputation after the fact and would likely have trouble attracting future business.

So it seems to me in this case that the contract between the bank and the clients is clear -- the money is there, eventually you'll be able to take it out, though in most cases you can take it out right away. The receipts don't claim to be backed by immediately-withdrawalable money, but likely, people will treat the receipts as a money substitute, and that's really all it takes to generate a business cycle, since the money supply (including the substitutes) has increased and will likely be loaned out to businesses. All you anti-free-bankers out there, would you consider such a system to be fraudulent? How can you tell which banking practices are considered fraudulent, since whatever people consider to be money-substitutes is purely subjective? Certainly there are cases where we can all agree that a banking practice is not fraudulent and does not generate a business cycle, but some cases are less obvious. What if I have a CD that offers a higher IR than a savings account, but I have the option (at some penalty) of taking out the money before the maturity date -- is that to be considered credit expansion? If I consider the money I can extract from the CD whenever I'd like to be money "on hand", is this yet again an example of credit expansion? Where do you draw the line? It's seems like there are so many insurmountable gray areas to this, and I don't simply want to make a rule that any practice that generates a business cycle is fraudulent, simply because the mere existence of business cycles is troublesome to me.