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There’s in interesting debate between Larry White, Jorg Guido Hulsmann, Jeffrey Hummel, and George Selgin on The Theory of Money and Credit at 101 at The Online Library of Liberty with a similar format to that of Cato Unbound.

Most of the debate is focused on the application of The Regression Theorem to the case of Bitcoin and Mises’s position on free banking and fractional reserves. I treated this later issue before here. But one of the arguments being put forward is that even if Mises’s favored a fractional reserve practice, this would converge to a 100-percent reserve value.

This is a post that never went online. At the end of the post I make a short comment on whether we can assert that Mises thought that a free banking system would converge to hold 100-percent reserves. The only paper I know of that holds this position is one by Salerno in Procesos de Mercado.

The first section is about Mises’s position on free banking. The last part is about the 100-percent reserve convergence which is not covered in my paper.

Where does the confusion on Mises’s position come from?

There are, in my opinion, two sources that biases a reading of Mises’s into a 100-percent banker: (1) a Rothbardian influence on Mises interpretation and (2) to overlook the context of Mises’s remarks, and therefore confuse his Monetary Reconstruction (added to the 1958 edition of The Theory of Money and Credit) with his “pure theoretical” ideas.

The Rothbardian influence

It is clear that Rothbard favors a 100-percent reserve banking. He repeatedly objects to fractional reserve banking along with qualifications like “fraud” or a “violation of property rights.” Incidentally, the problem of fractional reserve banking is not only a moral or legal one, it is at the core of the Austrian Business Cycle Theory (ABCT.) If Mises and Rothbard hold different positions on the soundness of fractional reserve banking, and both hold that ABCT is a consistent theory, then Mises and Rothbard are inconsistent with each other. If all expansion of fiduciary media puts into motion the effects studied in the ABCT, then it’s clear that 100-percent reserve banking is the ultimate solution. But if not all expansion of fiduciary media leads to the ABCT story, then fractional reserve per se it’s not the problem and there is an economic role to be played by fractional reserves. The problem of fractional reserve banking goes straight to the core of one of the most well known Austrian theories. If a Mises-Rothbard denomination is to be a fair representation of what is distinctive in Austrian Economics, then agreement on key points is expected.

In the case of fractional reserves, the apparent ambiguity in some of Mises’s passages on fractional reserve banking contrasts with the clear and strong position in Rothbard, which seems to be used to solve Mises’s ambiguity. I want to be clear; I don’t imply that this is a “convenient” reading of Mises by 100-percent Rothbardians so as to homogenize Mises position to that of Rothbard, but I do think that there is some unintentional Rothbardian readings on Mises’s work that is not there. This is not the only topic where I see a too much Rothbard interpretation in Mises. Mises’s apriorism, another controversial topic, is not of the “extreme type” stated by Rothbard’s In Defense of “Extreme Apriorism” (more here for those of you with a taste for philosophy of science.)

The context of his Monetary Reform (1958)

When reading any author, to pay attention to the context of his writing is crucial. The researcher needs to identify what the author is taking for granted or baer the risk of imposing on the author his own assumptions. For instance, whether the author is making a pure theoretical remark or an economic policy suggestion should be taken into consideration. The second best option will probably differ from his first best in an ideal world. In my opinion, this has been one of the biggest reasons why Mises has been misread as a supporter of 100-percent banking.

Most of the citations in favor of the 100-percent requirement interpretation of Mises come from his “Monetary Reconstruction” which was added to the 1958 edition of The Theory of Money and Credit. Passages where Mises argues for a 100-percent marginal reserve requirement are presented as evidence if his position. Consider the following passage:

“Fiduciary media are scarcely different in nature from money; a supply of them affects the market in the same way as a supply of money proper; variations in their quantity influence the objective exchange value of money in just the same way as do variations in the quantity of money proper. Hence, they should logically be subjected to the same principles that have been established with regard to money proper [i.e. gold]; the same attempts should be made in their case as well to eliminate as far as possible human influence on the exchange ratio between money and other economic goods. The possibility of causing temporary fluctuations in the exchange ratios between goods of higher and of lower orders by the issue of fiduciary media, and the pernicious consequences connected with a divergence between the natural and money rates of interest, are circumstances leading to the same conclusion. Now it is obvious that the only way of eliminating human influence on the credit system is to suppress all further issue of fiduciary media. The basic conception of Peel’s Act ought to be restated and more completely implemented than it was in the England of his time by including the issue of credit in the form of bank balances within the legislative prohibition.” (Mises, 1912 [1981], pp. 446-447)

This is one of the passages that Huerta de Soto (1998 [2006]) uses to argue that Mises opposed to fractional reserve banking. That’s a plausible interpretation if we take this passage at face value. But such a conclusion is not evident anymore once we realize that Mises is talking about a very particular historical context: How to reconstruct sound monetary institutions after World War II. The “human influence” Mises refers to is not about commercial banks in free banking, but government officials in charge of the central banks of his time. Given that the option of closing central banks is off the table, their hands must be tied. Therefore, rather than creating a new rule Mises argues for instating Peel’s Act but without room for expansion of money substitutes.

The fact that Mises is talking about a particular historical case and how to do monetary policy, rather than what he considers to be the theoretical optimal monetary policy, should be clear for any careful reader. The title of his essay is “Monetary Reconstruction.” In case this is not enough indication of the context, this citation comes from chapter 20: “Problems of Credit Policy,” section III: “Problems of Credit Policy in the Period Immediately After the War,” point 13: “The Basic Questions of Future Currency Policy.” Further remarks of the market conditions of his time continue shortly after.

I’m not saying that the passage cited above shows that Mises preferred fractional reserve banking, all I’m showing so far is an example of how the “evidence” of Mises’s alleged support of 100-percent reserve requirement is sensitive to the context of the evidence. In fact, in his monetary reform, Mises argued to impose a marginal 100-percent requirement to new fiduciary media where new banknotes can only be issued if new units of gold are received by the bank of issue. But this marginal 100-percent rule was to only be applied to central banks, not to commercial banks who were to be free to manage their reserves as they see fit:

“The most important prerequisite of any cyclical policy, no matter how modest its goal may be, is to renounce every attempt to reduce the interest rate, by means of banking policy, below the rate which develops on the market. That means a return to the theory of the Currency School, which sought to suppress all future expansion of circulation credit and thus all further creation of fiduciary media. However, this does not mean a return to the old Currency School program, the application of which was limited to banknotes. Rather it means the introduction of a new program based on the old Currency School theory, but expanded in the light of the present state of knowledge to include fiduciary media issued in the form of bank deposits.

The banks would be obliged at all times to maintain metallic backing for all notes—except for the sum of those outstanding which are not now covered by metal—equal to the total sum of the notes issued and bank deposits opened. That would mean a complete reorganization of central bank legislation. The banks of issue would have to return to the principles of Peel’s Bank Act, but with the provisions expanded to cover also bank balances subject to check. The same stipulations with respect to reserves must also be applied to the large national deposit institutions, especially the postal savings. Of course, for these secondary banks of issue, the central bank reserves for their notes and deposits would be the equivalent of gold reserves. In those countries where checking accounts at private commercial banks play an important role in trade—notably the United States and England—the same obligation must be exacted from those banks also.” (Mises, 1928 [2006], p. 150)

The marginal 100-percent reserve requirement is to be observed by the banks of issue. Commercial banks, except those that were too big to have a sensitive effect on the market, do not need to observe this obligation. Mises was not talking in the context of an ideal free market without central banks, but in the context of the problems of monetary and credit policy under the presence of central banks. The banks of issue are not the free banking banks, but the central banks of his time. Mises explicitly refers to “those countries where checking accounts at private commercial banks play an important role.” This does not sound as a “crystal clear” support of a 100-percent reserve requirement for all banks. In short, Mises’s proposal consists of transforming the central banks into currency boards and letting commercial banks issue their own fiduciary media.

Mises and fractional reserves

If there’s a place where one would expect to find passages clearly favorable to the 100-percent reserve requirement, it is in The Theory of Money and Credit and his chapter on The Limits of Fiduciary Media in Human Action. These pro 100-percent references are not only absent, passages with a clear positive assessment of fractional reserves abound. I want to share a small sample from Human Action. Consider first the following passage from Chapter XVII.12 (The Limitation on the Issuance of Fiduciary Media):

“Issuing money-certificates is an expensive venture. The banknotes must be printed, the coins minted; a complicated accounting system for the deposits must be organized; the reserves must be kept in safety; then there is the risk of being cheated by counterfeit banknotes and checks. [A]gainst all these expenses stands only the slight chance that some of the banknotes issued may be destroyed and the still slighter chance that some depositors may forget their deposits. Issuing money-certificates is a ruinous business if not connected with issuing fiduciary media. In the early history of banking there were banks whose only operation consisted in issuing money-certificates. But these banks were indemnified by their clients for the costs incurred.” (Mises, 1949 [1996], p. 435).

So, it seems that when Mises talks about theory and not monetary policy under particular institutional constraints fiduciary media is not only legal, but needed for banks to avoid bankruptcy. In fact, the only reference to a 100-percent reserve requirement that can be found in this 12-page long chapter is on Fisher’s proposal. But his reference is not to praise Fisher’s recommendation, but to explain why he thinks it is inconsistent. The above passage was not a slip of Mises’s mind; compare with the following:

“It is very easy for a bank to increase the number of people who are ready to accept loans granted by credit expansion and paid out in an amount of money-substitutes. But it is very difficult for any bank to enlarge its clientele, that is, the number of people who are ready to consider these claims as money-substitutes and to keep them as such in their cash holdings. To enlarge this clientele is a troublesome and slow process, as is the acquisition of any kind of good will. On the other hand, a bank can lose its clientele very quickly. If it wants to preserve it, it must never permit any doubt about its ability and readiness to discharge all its liabilities in due compliance with the terms of the contract. A reserve must be kept large enough to redeem all banknotes which a holder may submit for redemption. Therefore no bank can content itself with issuing fiduciary media only; it must keep a reserve against the total amount of money-substitutes issued and thus combine issuing fiduciary media and money-certificates.

Again, the reference is to the entrepreneurial management of fractional reserve banking on part of bank managers. A reserve “large enough” is not a 100-percent, as he explains at length in the The Theory of Money and Credit and in Human Action. Banking is a profitable business with a combination of money-certificates and fiduciary media. It is not a 100-percent reserve requirement that is needed to control monetary expansion, but free banking competition:

Free banking is the only method available for the prevention of the dangers inherent in credit expansion. It would, it is true, not hinder a slow credit expansion, kept within very narrow limits, on the part of cautious banks which provide the public with all information required about their financial status. But under free banking it would have been impossible for credit expansion with all its inevitable consequences to have developed into a regular—one is tempted to say normal— feature of the economic system. Only free banking would have rendered the market economy secure against crises and depressions.” (Mises, 1949 [1996], p. 443)

Peel’s Act

Mises’s position regarding Peel’s Act offers a good example of how his prescription changes when he’s talking about pure theory and when he’s talking about a policy constrained by market and political institutions. Mises’s passages where he proposes the reinstatement of a corrected Peel’s Act are well known and are part of the “textual evidence” that is used to present him as a supporter of the 100-percent reserve requirement. However, Mises has a specific section (chapter 20) in The Theory of Money and Credit dedicated to analyze Peel’s Act where he opposes limitations on the issuance of banknotes:

To start from the Banking Principle, which denies the possibility of an over-issue of bank-notes and regards ‘elasticity’ as their essential characteristic, is necessarily to arrive at the conclusion that any limitation of the circulation of notes, whether they are backed by money or not, must prove injurious, since it prevents the exercise of the chief function of the note-issue, the contrivance of an adjustment between the stock of money and the demand for money without changing the objective exchange-value of money. (Mises, 1912 [1981], pp. 406-407)

After this passage, Mises asses positively the “flaw” in Peel’s Act:

As far as Peel’s Act was concerned, however, this very shortcoming of the theory that had created it turned out to be an advantage; it caused the incorporation in it of the safety valve without which it would not have been able to cope with the subsequent increase in the requirements of business. The fundamental mistake of Peel’s system, which it shares with all other systems which proceed by restricting the note circulation, lies in its failure to foresee the extension of the quota of notes not backed by metal that went with the increase on the demand for money in the broader sense. As far as the past was concerned, the act sanctioned the creation of a certain amount of fiduciary media and the influence that this had on the determination of the objective exchange value of money; it did not do anything to counteract the effects of this issue of fiduciary media. But at the same time, in order to guard the capital market from shocks, it removed all future possibility of partly or wholly satisfying the increasing demand for money by the issuing of fiduciary media and so of mitigating or entirely preventing a rise in the objective exchange value of money. This amounts to the same thing as suppressing the creation of fiduciary media altogether and so renouncing all the attendant advantages for the stabilization of the objective exchange value of money. (Mises, 1912 [1981], p. 408)

Mises, the policy advisor, the one who faces central banks and the impossibility of a free banking world, favors a marginal 100-percent constraint on central banks. Because the Gold Standard is not working properly anymore and it won’t be restated, there’s need of an alternative. Rather than replacing Peel’s Act, he suggests fixing Peel’s Act and to impose it on issuer [central] banks but not on commercial banks. But for Mises the scholar, it is precisely free banking that is needed to coordinate money supply with money demand. The remarks on Peel Act demonstrate a clear example of two different positions that are not contradictory as the 100-percent interpretation would imply, but two positions that reflect a different context and problem.

Convergence to 100-percent reserves?

There is another variation of the interpretation that Mises preferred a 100-percent reserve requirement (not discussed in my paper). This position argues that even if Mises did not oppose to fractional reserve banking, he thought that market competition will eventually result in a de facto 100-percent reserve practice on part of free banking issuer banks. Salerno, for instance, argues that contrary to free bankers, “Mises emphatically did not foresee the free-banking system evolving toward a minuscule reserve ratio,” and for “Mises, evolution was rather all in the opposite direction” with the “cyclical fluctuations leading slowly back to a system of marginal 100-percent reserves.”

I don’t know any passage where Mises articulates this position. Salerno refers to The Causes of Economic Crises (1978), which is a collection of early essays by Mises written between 1919 and 1946, but he does not offer a passage where Mises unequivocally says that such convergence will take place. Salerno also cites Mises’s memoirs to argue that his monetary theory matured by the time he published Nationalökonomie (1940). If that’s the case, then the claim that Mises changed his position between The Theory of Money and Credit (1912) and Nationalökonomie (1940) is untenable. In The Theory of Money and Credit (1912) Mises implicitly favored free banking, in Human Action (1949) he is clearly in favor of free banking and in the 1954 edition of The Theory of Money and Credit he still prefers free banking. Still, The Causes of Economic Crises, that Salerno cites addresses business cycles produced by central banks, not business cycles under free banking. As he proposed in his Monetary Reconstruction, the point is to limit central banks, not commercial banks.

The convergence position is based on the fact that Mises did defend free banking as a system that results in an “extreme restraint in the issue of fiduciary media.” After a brief discussion of the check and balances under a free banking system, Mises concludes with the following passage:

In the course of the development of a banking system with fiduciary media, crises could not have been avoided. However, as soon as bankers recognized the dangers of expanding circulation credit [fiduciary media], they would have done their utmost, in their own interests, to avoid the crisis. They would then have taken the only course leading to this goal: extreme restraint in the issue of fiduciary media. (Mises, 1928, [2006], p. 125)

Maybe those who argue that Mises thought that free banking would converge to a 100-percent rule “extreme restraint” is defined as 100-percent rule, but extreme precaution can also mean to be careful to not let reserves go below the precautionary level (whatever that level is) for too long. Nothing in “extreme” implies 100-percent. This is an example of where a Rothbardian reading of Mises may be unintentionally sneaking in.

Nonetheless, if it were the case that Mises holds this position, it would only imply an incorrect prediction on his part. There is no historical evidence of free banking converging to 100-percent reserves. The failure of the Ayr Bank during the Scottish Free Banking can be interpreted as a crisis that “could not been avoided” in Mises’s passage. And the later stability of the Scottish free banking, is not a case of free bank taking “extreme restraint” to avoid failures once “the bankers recognized the dangers of expanding” fiduciary media excessively?


The reading that Mises favored a 100-percent reserve requirement is far from “crystal clear.” On the contrary, Mises is straightforward about the benefits of fiduciary media and the costs that would produce arise if a 100-percent reserve requirement were to be imposed. For Mises the problem is not fiduciary media per se, but the presence of central banks that enjoys the luxury of avoiding bankruptcy when they fail to redeem their convertible banknotes (under gold standard.) It is a mistake to find in Mises a position that any expansion of fiduciary media puts into motion the effects described by the ABCT, and that therefore he was opposed to fractional reserves. Only an expansion of credit supply that lowers the market interest rate below the natural [equilibrium] level is problematic.

The problem with the 100-percent interpretation of Mises is that is inconsistent with his passages in favor of fractional reserves on the one hand and his passages against legal limitations to the issuance of fiduciary media on the other. That’s not the case if Mises is interpreted as being in favor of free banking with fractional reserves and carefully distinguishing his pure theoretical thoughts from his historical policy prescriptions. The only way to maintain a resemblance of a 100-percent reserve requirement in Mises is via the convergence argument. Such a reading, however, has even weaker evidence (if it can be considered as such) than the 100-percent interpretation.