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Fractional-Reserve Banking, Contracts of Deposit, and the Title-Transfer Theory of Contract

Fractional-Reserve Banking, Contracts of Deposit, and the Title-Transfer Theory of Contract

Someone asked me the proper way to view deposit contracts, in the context of a discussion about fractional-reserve banking (FRB). He noted that in my A Libertarian Theory of Contract I state that contractual obligations can either be “to do” or “to give”; and that “to do” contracts are generally not enforceable due to specific performance, but can only result in damages if non performance actually occurs. This implies that the only real enforceable obligations are “to give” something. My correspondent asked me if this means that a deposit contract is not really a contract–i.e., based on the idea that a deposit is a “to do” contract (i.e., safekeep this deposit), while a loan would be a “to give” contract (i.e., return the money at the end of the term). An edited version of my reply follows.First, I don’t view a loan as an obligation to return “the” money. It’s just a transfer of title to a certain sum of future money (IF you own it at the time). See my Contracts paper, pp. 32 et seq.

Second: in my article I wrote: “Contractual obligations may be classified as obligations to do or to give. An obligation to give may be viewed as a transfer of title to property, as it is an obligation to give ownership of the thing to another. An obligation to do is an obligation to perform a specific action, such as an obligation to sing at a wedding or paint someone’s house. ” The purpose of noting the positive law’s obligation to do/to give classification was to show that even in the current law, it’s really all about title transfer–to set the stage for Rothbard/Evers’s title-transfer theory of contract. Actually, I don’t view contracts as really being obligations at all; they are just title transfers. If I sell you my apple for $1, then the title to my apple transfers to you, even if/while I still (temporarily) possess it. Now, I am holding your apple, and I now have an obligation to let you have it, when you demand it, but not because of a contract or obligation to do, but just because of property rights, which the contract has rearranged. Contracts change, or rearrange property titles. Once this happens, people can then have different obligations–obligations to respect the property rights of the owners. If you find yourself in possession of property belonging to another person because a contract’s title-transfer provision has been triggered, even though it was your money a minute before, you now have to respect the wishes of the (new) owner.

I then explained that in the positive law, “to do” contracts are generally not enforceable due to specific performance, but can only result in damages if non performance actually occurs. My inquisitor says this implies that the only real enforceable obligations are “to give” something. And this is correct. And even in the case where they are enforced, such as a contract for a piece of real property, even here it’s not against the person but just effectuates the property title. I.e., you don’t need to call it an obligation. Again, my point was to show that the practical results of the current law can be achieved by the title-transfer conception of contract.

Now, does this imply that a deposit contract is not really a contract, on the grounds that a deposit is a “to do” contract (i.e., safekeep this deposit), while a loan would be a “to give” contract (i.e., return the money at the end of the term)? I don’t think so. I think that there are no obligations to do something–to perform; but you can arrange a contract so that there are consequences (the payment of damages, say–a title transfer to money) for failure to do something–the failure to do serves as a condition or trigger of a title transfer. Again, this is what the result is, in effect, in positive law, because obligations to do are not usually enforceable by “specific performance,” but by an award of monetary damages for failure to perform–for a “breach.” In the title-transfer theory of contract, failure to perform is not a breach of an obligation; it is just a previously-agreed upon trigger of a payment of damages. (In this way it is similar to the law and economics idea of “efficient breach of contract“–but arrives at this naturally, as a result of a principled respect for property rights–without any wealth-maximization contortions.)

In other words, the law views contracts as enforceable promises, and has various theories to justify this. Rothbard and Evers (and I) view this as confused. Rahter a contract should be seen as one or more title transfers. The ability to transfer title to property simply flows from the property rights of the owner–his right to exclude people, to permit them to use it, or to transfer all or some of the title to others, for charitable purposes, or in exchange for something else (some performance, or some other title transfer).

Now, how does all this apply to deposit “contracts”? Well, first, I assume we are talking here about a genuine deposit, as opposed to a FRB “deposit.” In a FRB it is a loan by the customer, not a deposit, since the customer loses title to his money–he has to in order for the “bank” to have the right to loan it to some borrower (who needs to have title to the money in order to use it for the purposes for which he borrowed it). On this see Huerta de Soto, Money, Bank Credit, and Economic Cycles, pp. 3 et seq., where he explains quite correctly that a standard loan is a mutuum (sometimes called a “loan for consumption”–see my A Civil Law to Common Law Dictionary).

By contrast, in a deposit (see Huerta de Soto, pp. 4-5) the depositary or custodian does not acquire title to the property. In a regular or specific deposit, such as a warehousing arrangement or safe deposit box, the depositor retains title to his property. For example, in a deposit arrangement, you give your money to the bank to warehouse it for you. In this case you don’t actually transfer title to your gold–you put it in the bank’s safety deposit box, say. Now is this really a deposit “contract”? Well, this description is a bit misleading. Contracts transfer title; but the title to the gold has not been transferred. What of the depositary’s “obligation” to warehouse the gold? Well, note that property owners have the right to set rules for use of their property; they have the right to give others varying levels and types of permissions or consent as to what they can do with their property. I can invite you to a party to my house, and some of the rules, stated or implied, include: you may not fornicate on my kitchen floor; you may not slap my dog; etc. I can lend you my car (a commodatum, Huerta de Soto, p. 3–or “loan for use,” Civil Law Dictionary) to drive to the movie for an afternoon, but not to abscond to Canada for a month.

So in a typical deposit arrangement, the best way to describe the relationship and situation consonant with libertarian property principles and the title-transfer theory of contact is that the bank agrees (consents) to let you use their property (box) in certain ways; while you let them control your gold in limited ways (they can prevent even you from accessing it, if you don’t: show proper ID, come during business hours, pay any owed fees, etc.). You agree to pay them a fee every month–title transfer of money to them, in exchange for their letting you use their box. So there is no real title transfer of the gold. (Consider a guard you hire to guard your home while you are on vacation; you “deposit” your home into his care, and agree to pay him for watching it; you do not give him permission to hold parties at the house or to own it or sell it. The depositary is like the guard. Would you call the arrangement with the guard a “house deposit contract”? If he trashes your house has he breached his contractual obligations, or has he simply committed trespass?)

In any event, the regular deposit is expensive and inefficient for deposits of fungible goods, such as grain or money, so such items are usually intermixed with deposits of other depositors; this is an irregular deposit (Huerta de Soto, p. 4). The irregular deposit can be viewed in this way: say there are 100 depositors. These people all agree to transfer title to their gold, and in exchange they receive a fractional ownership of the fungible mass of gold in the bank, with the right to withdraw their share at any time. The bank again has no title to the gold. They are like the warehouser in the case of the regular deposit. The depositors jointly own all the gold, have specified among themselves how each can withdraw his portion and exit the relationship.

Now if the bank loans your gold to someone else, they are actually stealing it–converting it. Trespassing. It has little to do with contract, unless by “contract” you mean the rules you, as owner, lay down for the banks’ use of your property (gold)–but by this loose usage, if you fornicate in my house during a party, you are in breach of contract. Okay, fine, but this is a bit of a stretch. I’d say it was a type of trespass–a use of my property that i have not consented to. But you can view the permissions granted by the owner as a type of contract, since it’s like a temporary and limited grant of a certain specified right to use the property to another person, whereas a normal contractual title transfer is usually permanent and complete.

Incidentally, I think we can assume there are a bunch of subsidiary, implied (or written) accessory contractual title transfers: e.g., IF the banker doesn’t safeguard your gold, THEN he pays damages to you (which is a title transfer of his money), etc. So there is a contract there.

So I would say a “contract of deposit” refers to the various permissions with respect to property (the bank’s permission to limit access to your money, but not permission to loan it out; your permission to use the bank’s facilities to store your gold); and subsidiary and related title transfers (your payment of fees; the bank’s payment of damages if it breaches certain prohibitions).

Note, however, that if we are talking about a FRB “deposit,” which is not really a deposit, but rather a loan to the bank, the entire analysis changes. In this case, the FRB does acquire title to the customer’s property; in exchange the customer acquires a future, conditional title-transfer from the FRB: title to a certain sum of money in the future at a certain time (say, when the customer makes a “demand”), but of course, only if the bank owns at that time assets to which title can transfer to the customer. If the FRB is bankrupt, due to a run (as some of believe is inevitably the case), then when the customer demands money, the bank simply has no money. This situation is then analogous to that of the deadbeat debtor discussed on pp. 32-33 of A Libertarian Theory of Contract.

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