Chapter Eight.qxp
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The Mystery of Banking
Thus, total liabilities, or demand deposits, remain what they were after the immediate loan to Smith. Fifty thousand dollars is owed to the original depositors of gold (and/or to people who sold goods or services to the original depositors for gold); Smith has written a check for his $80,000 for the purchase of equipment from Jones, and Jones is now the claimant for the $80,000 of demand deposits. Total demand deposits for the Rothbard Bank have remained the same. Moreover, all that has happened, from the Rothbard Bank’s point of view, is that deposits have been shuffled around from one of its clients to another. So long, then, as confidence is retained by its depositors in the Rothbard Bank, it can continue to expand its operations and its part of the money supply with impunity. But—and here is the rub—suppose that Jones is not a client of the Rothbard Bank. After all, when Smith borrows money from that bank he has no interest in patronizing only fellow clients of his bank. He wants to invest or spend the money in ways most desirable or profitable to himself. In a freely competitive banking system, there is no guarantee—indeed not even a likelihood—that Jones, or the person whom Jones will spend the money on, will himself be a client of the Rothbard Bank. Suppose, then, that Jones is not a client of the Rothbard Bank. What then? Smith gives a check (or a note) to Jones for the equipment for $80,000. Jones, not being a client of the Rothbard Bank, will therefore call upon the Rothbard Bank for redemption. But the Rothbard Bank doesn’t have the money; it has only $50,000; it is $30,000 short, and therefore the Rothbard Bank is now bankrupt, out of business. The beauty and power of this restraint on the banks is that it does not depend on loss of confidence in the banks. Smith, Jones, and everyone else can go on being blithely ignorant and trusting of the fractional reserve banking system. And yet the redemption weapon does its important work. For Jones calls on the Rothbard Bank for redemption, not because he doesn’t trust the bank or thinks it is going to fail, but simply because he patronizes another bank and wants to shift his account to his preferred bank. The