Money, Bank Credit, And Economic Cycles

MONEY,
BANK CREDIT,
AND
ECONOMIC CYCLES
SECOND EDITION

MONEY,
BANK CREDIT,
AND
ECONOMIC CYCLES
SECOND EDITION
JESÚS HUERTA DE SOTO
TRANSLATED BY MELINDA A. STROUP
Ludwig
von Mises
Institute
AUBURN, ALABAMA

First Spanish edition 1998, Dinero, Crédito Bancario y Ciclos
Económicos, Unión Editorial, Madrid
Copyright © 1998 Jesús Huerta de Soto
Second Spanish edition 2002, Unión Editorial, Madrid
Third Spanish edition 2006, Unión Editorial, Madrid
Copyright © 2006, 2009 Jesús Huerta de Soto
Money, Bank Credit, and Economic Cycles
Translated from Spanish by Melinda A. Stroup
First English edition 2006
Second English edition 2009
Cover design: Photograph by Guillaume Dubé of a series of arches in a
cloister in Salamanca, Spain.
Ludwig von Mises Institute
518 West Magnolia Avenue
Auburn, Alabama 63832-4528
All rights reserved. Written permission must be secured from the
publisher to use or reproduce any part of this book, except for
brief quotations in critical reviews or articles.
ISBN: 978-1-933550-39-8

CONTENTS
PREFACE TO THE SECOND ENGLISH EDITION . . . . . . . . . . . . . . . . . .xvii
PREFACE TO THE FIRST ENGLISH-LANGUAGE EDITION . . . . . . . . .xxxi
PREFACE TO THE THIRD SPANISH EDITION . . . . . . . . . . . . . . . . . .xxxiii
PREFACE TO THE SECOND SPANISH EDITION . . . . . . . . . . . . . . . .xxxvii
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xli
CHAPTER 1: THE LEGAL NATURE OF THE MONETARY
IRREGULAR-DEPOSIT CONTRACT . . . . . . . . . . . . . . . . . . . . . . .1
1 A Preliminary Clarification of Terms:
Loan Contracts (Mutuum and Commodatum)
and Deposit Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
The Commodatum Contract . . . . . . . . . . . . . . . . . . . . .2
The Mutuum Contract . . . . . . . . . . . . . . . . . . . . . . . . . .2
The Deposit Contract . . . . . . . . . . . . . . . . . . . . . . . . . . .4
The Deposit of Fungible Goods or “Irregular”
Deposit Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4
2 The Economic and Social Function of Irregular
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6
The Fundamental Element in the Monetary
Irregular Deposit . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
Resulting Effects of the Failure to Comply
with the Essential Obligation in the
Irregular Deposit . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Court Decisions Acknowledging the
Fundamental Legal Principles which Govern
the Monetary Irregular-Deposit Contract
(100-Percent Reserve Requirement) . . . . . . . . . . . . .11
v

vi
Money, Bank Credit, and Economic Cycles
3 The Essential Differences Between the Irregular
Deposit Contract and the Monetary Loan Contract . . . .13
The Extent to Which Property Rights are
Transferred in Each Contract . . . . . . . . . . . . . . . . . .13
Fundamental Economic Differences Between
the Two Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . .14
Fundamental Legal Differences Between the
Two Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17
4 The Discovery by Roman Legal Experts of the
General Legal Principles Governing the Monetary
Irregular-Deposit Contract . . . . . . . . . . . . . . . . . . . . . . . . .20
The Emergence of Traditional Legal Principles
According to Menger, Hayek and Leoni . . . . . . . .20
Roman Jurisprudence . . . . . . . . . . . . . . . . . . . . . . . . . .24
The Irregular Deposit Contract Under Roman
Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27
CHAPTER 2: HISTORICAL VIOLATIONS OF THE LEGAL
PRINCIPLES GOVERNING THE MONETARY
IRREGULAR-DEPOSIT CONTRACT . . . . . . . . . . . . . . . . . . . . . . .37
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37
2 Banking in Greece and Rome . . . . . . . . . . . . . . . . . . . . . . . . .41
Trapezitei, or Greek Bankers . . . . . . . . . . . . . . . . . . . .41
Banking in the Hellenistic World . . . . . . . . . . . . . . . .51
Banking in Rome . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53
The Failure of the Christian Callistus’s Bank . . . . . .54
The Societates Argentariae . . . . . . . . . . . . . . . . . . . . . .56
3 Bankers in the Late Middle Ages . . . . . . . . . . . . . . . . . . . . .59
The Revival of Deposit Banking in
Mediterranean Europe . . . . . . . . . . . . . . . . . . . . . . . .61
The Canonical Ban on Usury and the
“Depositum Confessatum” . . . . . . . . . . . . . . . . . . . .64

Contents vii
Banking in Florence in the Fourteenth Century . . . .70
The Medici Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72
Banking in Catalonia in the Fourteenth and
Fifteenth Centuries: The Taula de Canvi . . . . . . . . .75
4 Banking During the Reign of Charles V and the
Doctrine of the School of Salamanca . . . . . . . . . . . . . . . . .78
The Development of Banking in Seville . . . . . . . . . .79
The School of Salamanca and the Banking
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83
5 A New Attempt at Legitimate Banking: The Bank of
Amsterdam. Banking in the Seventeenth and
Eighteenth Centuries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98
The Bank of Amsterdam . . . . . . . . . . . . . . . . . . . . . . . .98
David Hume and the Bank of Amsterdam . . . . . . .102
Sir James Steuart, Adam Smith and the
Bank of Amsterdam . . . . . . . . . . . . . . . . . . . . . . . . .103
The Banks of Sweden and England . . . . . . . . . . . . .106
John Law and Eighteenth-Century Banking in
France . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109
Richard Cantillon and the Fraudulent Violation
of the Irregular-Deposit Contract . . . . . . . . . . . . . .111
CHAPTER 3: ATTEMPTS TO LEGALLY JUSTIFY
FRACTIONAL-RESERVE BANKING . . . . . . . . . . . . . . . . . . . . . . . .115
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115
2 Why it is Impossible to Equate the Irregular Deposit
with the Loan or Mutuum Contract . . . . . . . . . . . . . . . .119
The Roots of the Confusion . . . . . . . . . . . . . . . . . . . .119
The Mistaken Doctrine of Common Law . . . . . . . .124
The Doctrine of Spanish Civil and Commercial
Codes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .127

viii
Money, Bank Credit, and Economic Cycles
Criticism of the Attempt to Equate the Monetary
Irregular-Deposit Contract with the Loan or
Mutuum Contract . . . . . . . . . . . . . . . . . . . . . . . . . . .133
The Distinct Cause or Purpose of Each Contract . .134
The Notion of the Unspoken or Implicit
Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139
3 An Inadequate Solution: The Redefinition of the
Concept of Availability . . . . . . . . . . . . . . . . . . . . . . . . . . .147
4 The Monetary Irregular Deposit, Transactions
with a Repurchase Agreement and Life Insurance
Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155
Transactions with a Repurchase Agreement . . . . . .157
The Case of Life Insurance Contracts . . . . . . . . . . . .161
CHAPTER 4: THE CREDIT EXPANSION PROCESS . . . . . . . . . . . . . . . .167
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167
2 The Bank’s Role as a True Intermediary in the Loan
Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .172
3 The Bank’s Role in the Monetary Bank-Deposit
Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178
4 The Effects Produced by Bankers’ Use of Demand
Deposits: The Case of an Individual Bank . . . . . . . . . . .182
The Continental Accounting System . . . . . . . . . . . .184
Accounting Practices in the English-speaking
World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194
An Isolated Bank’s Capacity for Credit
Expansion and Deposit Creation . . . . . . . . . . . . . .200
The Case of a Very Small Bank . . . . . . . . . . . . . . . . .208
Credit Expansion and Ex Nihilo Deposit
Creation by a Sole, Monopolistic Bank . . . . . . . . .211

Contents ix
5 Credit Expansion and New Deposit Creation by
the Entire Banking System . . . . . . . . . . . . . . . . . . . . . . . .217
Creation of Loans in a System of Small
Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .223
6 A Few Additional Difficulties . . . . . . . . . . . . . . . . . . . . . . .231
When Expansion is Initiated Simultaneously by
All Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .231
Filtering Out the Money Supply From the
Banking System . . . . . . . . . . . . . . . . . . . . . . . . . . . .239
The Maintenance of Reserves Exceeding the
Minimum Requirement . . . . . . . . . . . . . . . . . . . . . .242
Different Reserve Requirements for Different
Types of Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . .243
7 The Parallels Between the Creation of Deposits
and the Issuance of Unbacked Banknotes . . . . . . . . . . .244
8 The Credit Tightening Process . . . . . . . . . . . . . . . . . . . . . . .254
CHAPTER 5: BANK CREDIT EXPANSION AND ITS
EFFECTS ON THE ECONOMIC SYSTEM . . . . . . . . . . . . . . . . . . . . .265
1 The Foundations of Capital Theory . . . . . . . . . . . . . . . . . .266
Human Action as a Series of Subjective
Stages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .266
Capital and Capital Goods . . . . . . . . . . . . . . . . . . . . .272
The Interest Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . .284
The Structure of Production . . . . . . . . . . . . . . . . . . .291
Some Additional Considerations . . . . . . . . . . . . . . .297
Criticism of the Measures used in National
Income Accounting . . . . . . . . . . . . . . . . . . . . . . . . .305
2 The Effect on the Productive Structure of an Increase
in Credit Financed under a Prior Increase in
Voluntary Saving . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .313

x
Money, Bank Credit, and Economic Cycles
The Three Different Manifestations of the
Process of Voluntary Saving . . . . . . . . . . . . . . . . . .313
Account Records of Savings Channeled into
Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .315
The Issue of Consumer Loans . . . . . . . . . . . . . . . . . .316
The Effects of Voluntary Saving on the
Productive Structure . . . . . . . . . . . . . . . . . . . . . . . .317
First: The Effect Produced by the New Disparity
in Profits Between the Different Productive
Stages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .319
Second: The Effect of the Decrease in the Interest
Rate on the Market Price of Capital Goods . . . . .325
Third: The Ricardo Effect . . . . . . . . . . . . . . . . . . . . . .329
Conclusion: The Emergence of a New, More
Capital-Intensive Productive Structure . . . . . . . .333
The Theoretical Solution to the “Paradox of
Thrift” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .342
The Case of an Economy in Regression . . . . . . . . . .344
3 The Effects of Bank Credit Expansion Unbacked
by an Increase in Saving: The Austrian Theory or
Circulation Credit Theory of the Business Cycle . . . . .347
The Effects of Credit Expansion on the
Productive Structure . . . . . . . . . . . . . . . . . . . . . . . .348
The Market’s Spontaneous Reaction to Credit
Expansion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .361
4 Banking, Fractional-Reserve Ratios and the Law of
Large Numbers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .385
CHAPTER 6: ADDITIONAL CONSIDERATIONS ON THE THEORY
OF THE BUSINESS CYCLE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .397
1 Why no Crisis Erupts when New Investment is
Financed by Real Saving (And Not by Credit
Expansion) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .397

Contents xi
2 The Possibility of Postponing the Eruption of the
Crisis: The Theoretical Explanation of the Process
of Stagflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .399
3 Consumer Credit and the Theory of the Cycle . . . . . . . . .406
4 The Self-Destructive Nature of the Artificial Booms
Caused by Credit Expansion: The Theory of
“Forced Saving” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .409
5 The Squandering of Capital, Idle Capacity and
Malinvestment of Productive Resources . . . . . . . . . . . .413
6 Credit Expansion as the Cause of Massive
Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .417
7 National Income Accounting is Inadequate to Reflect
the Different Stages in the Business Cycle . . . . . . . . . . .418
8 Entrepreneurship and the Theory of the Cycle . . . . . . . . .421
9 The Policy of General-Price-Level Stabilization and
its Destabilizing Effects on the Economy . . . . . . . . . . . .424
10
How to Avoid Business Cycles: Prevention of and
Recovery from the Economic Crisis . . . . . . . . . . . . . . . . .432
11 The Theory of the Cycle and Idle Resources:
Their Role in the Initial Stages of the Boom . . . . . . . . . .440
12 The Necessary Tightening of Credit in the Recession
Stage: Criticism of the Theory of “Secondary
Depression” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .444
13
The “Manic-Depressive” Economy: The Dampening
of the Entrepreneurial Spirit and Other Negative
Effects Recurring Business Cycles Exert on the
Market Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .456
14
The Influence Exerted on the Stock Market by
Economic Fluctuations . . . . . . . . . . . . . . . . . . . . . . . . . . . .459
15
Effects the Business Cycle Exerts on the Banking
Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .467
16
Marx, Hayek and the View that Economic Crises
are Intrinsic to Market Economies . . . . . . . . . . . . . . . . . .468
17
Two Additional Considerations . . . . . . . . . . . . . . . . . . . . . .474

xii
Money, Bank Credit, and Economic Cycles
18 Empirical Evidence for the Theory of the Cycle . . . . . . . .476
Business Cycles Prior to the Industrial
Revolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .479
Business Cycles From the Industrial
Revolution Onward . . . . . . . . . . . . . . . . . . . . . . . . .482
The Roaring Twenties and the Great
Depression of 1929 . . . . . . . . . . . . . . . . . . . . . . . . . .487
The Economic Recessions of the Late 1970s
and Early 1990s . . . . . . . . . . . . . . . . . . . . . . . . . . . . .494
Some Empirical Testing of the Austrian
Theory of the Business Cycle . . . . . . . . . . . . . . . . .500
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .503
CHAPTER 7: A CRITIQUE OF MONETARIST AND
KEYNESIAN THEORIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .509
1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .509
2 A Critique of Monetarism . . . . . . . . . . . . . . . . . . . . . . . . . . .512
The Mythical Concept of Capital . . . . . . . . . . . . . . .512
Austrian Criticism of Clark and Knight . . . . . . . . .518
A Critique of the Mechanistic Monetarist
Version of the Quantity Theory of Money . . . . . .522
A Brief Note on the Theory of Rational
Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .535
3 Criticism of Keynesian Economics . . . . . . . . . . . . . . . . . . .542
Say’s Law of Markets . . . . . . . . . . . . . . . . . . . . . . . . .544
Keynes’s Three Arguments On Credit
Expansion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .546
Keynesian Analysis as a Particular Theory . . . . . . .553
The So-Called Marginal Efficiency of Capital . . . . .555
Keynes’s Criticism of Mises and Hayek . . . . . . . . .557
Criticism of the Keynesian Multiplier . . . . . . . . . . .558
Criticism of the “Accelerator” Principle . . . . . . . . .565

Contents xiii
4 The Marxist Tradition and the Austrian Theory of
Economic Cycles: The Neo-Ricardian Revolution
and the Reswitching Controversy . . . . . . . . . . . . . . . . . .571
5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .576
6 Appendix on Life Insurance Companies and Other
Non-Bank Financial Intermediaries . . . . . . . . . . . . . . . . .584
Life Insurance Companies as True Financial
Intermediaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .586
Surrender Values and the Money Supply . . . . . . . .591
The Corruption of Traditional Life-Insurance
Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .594
Other True Financial Intermediaries: Mutual
Funds and Holding and Investment
Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .597
Specific Comments on Credit Insurance . . . . . . . . .598
CHAPTER 8: CENTRAL AND FREE BANKING THEORY . . . . . . . . . . .601
1 A Critical Analysis of the Banking School . . . . . . . . . . . . .602
The Banking and Currency Views and the
School of Salamanca . . . . . . . . . . . . . . . . . . . . . . . .603
The Response of the English-Speaking World
to these Ideas on Bank Money . . . . . . . . . . . . . . . .613
The Controversy Between the Currency School
and the Banking School . . . . . . . . . . . . . . . . . . . . . .622
2 The Debate Between Defenders of the Central Bank
and Advocates of Free Banking . . . . . . . . . . . . . . . . . . . .631
Parnell’s Pro-Free-Banking Argument and the
Responses of McCulloch and Longfield . . . . . . . .632
A False Start for the Controversy Between
Central Banking and Free Banking . . . . . . . . . . . .633
The Case for a Central Bank . . . . . . . . . . . . . . . . . . .635

xiv
Money, Bank Credit, and Economic Cycles
The Position of the Currency-School Theorists
who Defended a Free-Banking System . . . . . . . . .639
3 The “Theorem of the Impossibility of Socialism”
and its Application to the Central Bank . . . . . . . . . . . . .647
The Theory of the Impossibility of
Coordinating Society Based on Institutional
Coercion or the Violation of Traditional
Legal Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . .650
The Application of the Theorem of the
Impossibility of Socialism to the Central
Bank and the Fractional-Reserve Banking
System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .651
(a) A System Based on a Central Bank
Which Controls and Oversees a
Network of Private Banks that
Operate with a Fractional Reserve . . . . . . . . .654
(b) A Banking System which Operates with
a 100-Percent Reserve Ratio and is
Controlled by a Central Bank . . . . . . . . . . . . .661
(c) A Fractional-Reserve Free-Banking
System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .664
Conclusion: The Failure of Banking
Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .671
4 A Critical Look at the Modern Fractional-Reserve
Free-Banking School . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .675
The Erroneous Basis of the Analysis: The
Demand for Fiduciary Media, Regarded as
an Exogenous Variable . . . . . . . . . . . . . . . . . . . . . .679
The Possibility that a Fractional-Reserve
Free-Banking System May Unilaterally
Initiate Credit Expansion . . . . . . . . . . . . . . . . . . . .685
The Theory of “Monetary Equilibrium” in
Free Banking Rests on an Exclusively
Macroeconomic Analysis . . . . . . . . . . . . . . . . . . . .688

Contents xv
The Confusion Between the Concept of Saving
and that of the Demand for Money . . . . . . . . . . . .694
The Problem with Historical Illustrations of
Free-Banking Systems . . . . . . . . . . . . . . . . . . . . . . .701
Ignorance of Legal Arguments . . . . . . . . . . . . . . . . .706
5 Conclusion: The False Debate between Supporters of
Central Banking and Defenders of Fractional-
Reserve Free Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . .713
CHAPTER 9: A PROPOSAL FOR BANKING REFORM:
THE THEORY OF A 100-PERCENT RESERVE REQUIREMENT . . . .715
1 A History of Modern Theories in Support of a
100-Percent Reserve Requirement . . . . . . . . . . . . . . . . . .716
The Proposal of Ludwig von Mises . . . . . . . . . . . . .716
F.A. Hayek and the Proposal of a 100-Percent
Reserve Requirement . . . . . . . . . . . . . . . . . . . . . . . .723
Murray N. Rothbard and the Proposal of a
Pure Gold Standard with a 100-Percent
Reserve Requirement . . . . . . . . . . . . . . . . . . . . . . . .726
Maurice Allais and the European Defense of
a 100-Percent Reserve Requirement . . . . . . . . . . .728
The Old Chicago-School Tradition of Support
for a 100-Percent Reserve Requirement . . . . . . . .731
2 Our Proposal for Banking Reform . . . . . . . . . . . . . . . . . . .736
Total Freedom of Choice in Currency . . . . . . . . . . .736
A System of Complete Banking Freedom . . . . . . . .740
The Obligation of All Agents in a Free-Banking
System to Observe Traditional Legal Rules
and Principles, Particularly a 100-Percent
Reserve Requirement on Demand Deposits . . . .742

xvi
Money, Bank Credit, and Economic Cycles
What Would the Financial and Banking System
of a Totally Free Society be Like? . . . . . . . . . . . . . .743
3 An Analysis of the Advantages of the Proposed
System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .745
4 Replies to Possible Objections to our Proposal for
Monetary Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .760
5 An Economic Analysis of the Process of Reform
and Transition toward the Proposed Monetary
and Banking System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .788
A Few Basic Strategic Principles . . . . . . . . . . . . . . . .788
Stages in the Reform of the Financial and
Banking System . . . . . . . . . . . . . . . . . . . . . . . . . . . .789
The Importance of the Third and Subsequent
Stages in the Reform: The Possibility They
Offer of Paying Off the National Debt or
Social Security Pension Liabilities . . . . . . . . . . . . .791
The Application of the Theory of Banking
and Financial Reform to the European
Monetary Union and the Building of the
Financial Sector in Economies of the
Former Eastern Bloc . . . . . . . . . . . . . . . . . . . . . . . . .803
6 Conclusion: The Banking System of a Free Society . . . . .806
BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .813
INDEX OF SUBJECTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .861
INDEX OF NAMES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .875

PREFACE TO THE
SECOND ENGLISH EDITION
Iam happy to present the second English edition of Money,
Bank Credit, and Economic Cycles. Its appearance is particu-
larly timely, given that the severe financial crisis and result-
ing worldwide economic recession I have been forecasting,
since the first edition of this book came out ten years ago, are
now unleashing their fury.
The policy of artificial credit expansion central banks have
permitted and orchestrated over the last fifteen years could not
have ended in any other way. The expansionary cycle which
has now come to a close began gathering momentum when the
American economy emerged from its last recession (fleeting
and repressed though it was) in 2001 and the Federal Reserve
reembarked on the major artificial expansion of credit and
investment initiated in 1992. This credit expansion was not
backed by a parallel increase in voluntary household saving.
For many years, the money supply in the form of bank notes
and deposits has grown at an average rate of over 10 percent
per year (which means that every seven years the total volume
of money circulating in the world has doubled). The media of
exchange originating from this severe fiduciary inflation have
been placed on the market by the banking system as newly-
created loans granted at very low (and even negative in real
terms) interest rates. The above fueled a speculative bubble in
xvii

xviii
Money, Bank Credit, and Economic Cycles
the shape of a substantial rise in the prices of capital goods,
real-estate assets and the securities which represent them, and
are exchanged on the stock market, where indexes soared.
Curiously, like in the “roaring” years prior to the Great
Depression of 1929, the shock of monetary growth has not sig-
nificantly influenced the prices of the subset of consumer
goods and services (approximately only one third of all
goods). The last decade, like the 1920s, has seen a remarkable
increase in productivity as a result of the introduction on a
massive scale of new technologies and significant entrepre-
neurial innovations which, were it not for the injection of
money and credit, would have given rise to a healthy and sus-
tained reduction in the unit price of consumer goods and serv-
ices. Moreover, the full incorporation of the economies of
China and India into the globalized market has boosted the
real productivity of consumer goods and services even fur-
ther. The absence of a healthy “deflation” in the prices of con-
sumer goods in a stage of such considerable growth in pro-
ductivity as that of recent years provides the main evidence
that the monetary shock has seriously disturbed the economic
process. I analyze this phenomenon in detail in chapter 6, sec-
tion 9.
As I explain in the book, artificial credit expansion and the
(fiduciary) inflation of media of exchange offer no short cut to
stable and sustained economic development, no way of avoid-
ing the necessary sacrifice and discipline behind all high rates
of voluntary saving. (In fact, particularly in the United States,
voluntary saving has not only failed to increase in recent
years, but at times has even fallen to a negative rate.) Indeed,
the artificial expansion of credit and money is never more
than a short-term solution, and that at best. In fact, today there
is no doubt about the recessionary quality the monetary shock
always has in the long run: newly-created loans (of money cit-
izens have not first saved) immediately provide entrepreneurs
with purchasing power they use in overly ambitious invest-
ment projects (in recent years, especially in the building sector
and real estate development). In other words, entrepreneurs
act as if citizens had increased their saving, when they have not
actually done so. Widespread discoordination in the economic

Preface to the Second English Edition xix
system results: the financial bubble (“irrational exuberance”)
exerts a harmful effect on the real economy, and sooner or
later the process reverses in the form of an economic recession,
which marks the beginning of the painful and necessary read-
justment. This readjustment invariably requires the reconver-
sion of every real productive structure inflation has distorted.
The specific triggers of the end of the euphoric monetary
“binge” and the beginning of the recessionary “hangover” are
many, and they can vary from one cycle to another. In the cur-
rent circumstances, the most obvious triggers have been the
rise in the price of raw materials, particularly oil, the subprime
mortgage crisis in the United States, and finally, the failure of
important banking institutions when it became clear in the
market that the value of their liabilities exceeded that of their
assets (mortgage loans granted).
At present, numerous self-interested voices are demand-
ing further reductions in interest rates and new injections of
money which permit those who desire it to complete their
investment projects without suffering losses. Nevertheless,
this escape forward would only temporarily postpone prob-
lems at the cost of making them far more serious later. The cri-
sis has hit because the profits of capital-goods companies
(especially in the building sector and in real-estate develop-
ment) have disappeared due to the entrepreneurial errors pro-
voked by cheap credit, and because the prices of consumer
goods have begun to perform relatively less poorly than those
of capital goods. At this point, a painful, inevitable readjust-
ment begins, and in addition to a decrease in production and
an increase in unemployment, we are now still seeing a harm-
ful rise in the prices of consumer goods (stagflation).
The most rigorous economic analysis and the coolest, most
balanced interpretation of recent economic and financial
events support the conclusion that central banks (which are
true financial central-planning agencies) cannot possibly suc-
ceed in finding the most advantageous monetary policy at
every moment. This is exactly what became clear in the case of
the failed attempts to plan the former Soviet economy from
above. To put it another way, the theorem of the economic
impossibility of socialism, which the Austrian economists

xx
Money, Bank Credit, and Economic Cycles
Ludwig von Mises and Friedrich A. Hayek discovered, is fully
applicable to central banks in general, and to the Federal
Reserve—(at one time) Alan Greenspan and (currently) Ben
Bernanke—in particular. According to this theorem, it is
impossible to organize society, in terms of economics, based
on coercive commands issued by a planning agency, since
such a body can never obtain the information it needs to
infuse its commands with a coordinating nature. Indeed,
nothing is more dangerous than to indulge in the “fatal con-
ceit”—to use Hayek’s useful expression—of believing oneself
omniscient or at least wise and powerful enough to be able to
keep the most suitable monetary policy fine tuned at all times.
Hence, rather than soften the most violent ups and downs of
the economic cycle, the Federal Reserve and, to some lesser
extent, the European Central Bank, have most likely been their
main architects and the culprits in their worsening. Therefore,
the dilemma facing Ben Bernanke and his Federal Reserve
Board, as well as the other central banks (beginning with the
European Central Bank), is not at all comfortable. For years
they have shirked their monetary responsibility, and now they
find themselves in a blind alley. They can either allow the
recessionary process to begin now, and with it the healthy and
painful readjustment, or they can escape forward toward a
“hair of the dog” cure. With the latter, the chances of even
more severe stagflation in the not-too-distant future increase
exponentially. (This was precisely the error committed follow-
ing the stock market crash of 1987, an error which led to the
inflation at the end of the 1980s and concluded with the sharp
recession of 1990–1992.) Furthermore, the reintroduction of a
cheap-credit policy at this stage could only hinder the neces-
sary liquidation of unprofitable investments and company
reconversion. It could even wind up prolonging the recession
indefinitely, as has occurred in Japan in recent years: though
all possible interventions have been tried, the Japanese econ-
omy has ceased to respond to any monietarist stimulus involv-
ing credit expansion or Keynesian methods. It is in this context
of “financial schizophrenia” that we must interpret the latest
“shots in the dark” fired by the monetary authorities (who
have two totally contradictory responsibilities: both to control

Preface to the Second English Edition
xxi
inflation and to inject all the liquidity necessary into the finan-
cial system to prevent its collapse). Thus, one day the Federal
Reserve rescues Bear Stearns, AIG, Fannie Mae, and Freddie
Mac or Citigroup, and the next it allows Lehman Brothers to
fail, under the amply justified pretext of “teaching a lesson”
and refusing to fuel moral hazard. Then, in light of the way
events were unfolding, a 700-billion-dollar plan to purchase
the euphemistically named “toxic” or “illiquid” (i.e., worth-
less) assets from the banking system was approved. If the plan
is financed by taxes (and not more inflation), it will mean a
heavy tax burden on households, precisely when they are
least able to bear it. Finally, in view of doubts about whether
such a plan could have any effect, the choice was made to
inject public money directly into banks, and even to “guaran-
tee” the total amount of their deposits, decreasing interest
rates to almost zero percent.
In comparison, the economies of the European Union are in
a somewhat less poor state (if we do not consider the expansion-
ary effect of the policy of deliberately depreciating the dollar, and
the relatively greater European rigidities, particularly in the labor
market, which tend to make recessions in Europe longer and
more painful). The expansionary policy of the European Central
Bank, though not free of grave errors, has been somewhat less
irresponsible than that of the Federal Reserve. Furthermore, ful-
fillment of the convergence criteria involved at the time a healthy
and significant rehabilitation of the chief European economies.
Only the countries on the periphery, like Ireland and particularly
Spain, were immersed in considerable credit expansion from the
time they initiated their processes of convergence. The case of
Spain is paradigmatic. The Spanish economy underwent an eco-
nomic boom which, in part, was due to real causes (liberalizing
structural reforms which originated with José María Aznar’s
administration in 1996). Nevertheless, the boom was also largely
fueled by an artificial expansion of money and credit, which
grew at a rate nearly three times that of the corresponding
rates in France and Germany. Spanish economic agents essen-
tially interpreted the decrease in interest rates which resulted
from the convergence process in the easy-money terms tradi-
tional in Spain: a greater availability of easy money and mass

xxii
Money, Bank Credit, and Economic Cycles
requests for loans from Spanish banks (mainly to finance real-
estate speculation), loans which these banks have granted by
creating the money ex nihilo while European central bankers
looked on unperturbed. When faced with the rise in prices,
the European Central Bank has remained faithful to its man-
date and has tried to maintain interest rates as long as possi-
ble, despite the difficulties of those members of the Monetary
Union which, like Spain, are now discovering that much of
their investment in real estate was in error and are heading for
a lengthy and painful reorganization of their real economy.
Under these circumstances, the most appropriate policy
would be to liberalize the economy at all levels (especially in
the labor market) to permit the rapid reallocation of produc-
tive factors (particularly labor) to profitable sectors. Likewise,
it is essential to reduce public spending and taxes, in order to
increase the available income of heavily-indebted economic
agents who need to repay their loans as soon as possible. Eco-
nomic agents in general and companies in particular can only
rehabilitate their finances by cutting costs (especially labor
costs) and paying off loans. Essential to this aim are a very
flexible labor market and a much more austere public sector.
These factors are fundamental if the market is to reveal as
quickly as possible the real value of the investment goods pro-
duced in error and thus lay the foundation for a healthy, sus-
tained economic recovery in a future which, for the good of
all, I hope is not long in coming.
We must not forget that a central feature of the recent
period of artificial expansion was a gradual corruption, on the
American continent as well as in Europe, of the traditional
principles of accounting as practiced globally for centuries. To
be specific, acceptance of the International Accounting Stan-
dards (IAS) and their incorporation into law in different
countries (in Spain via the new General Accounting Plan, in
effect as of January 1, 2008) have meant the abandonment of
the traditional principle of prudence and its replacement by

Preface to the Second English Edition xxiii
the principle of fair value in the assessment of the value of bal-
ance sheet assets, particularly financial assets. In this aban-
donment of the traditional principle of prudence, a highly
influential role has been played by brokerages, investment
banks (which are now on their way to extinction), and in gen-
eral, all parties interested in “inflating” book values in order
to bring them closer to supposedly more “objective” stock-
market values, which in the past rose continually in an eco-
nomic process of financial euphoria. In fact, during the years
of the “speculative bubble,” this process was characterized by
a feedback loop: rising stock-market values were immediately
entered into the books, and then such accounting entries were
sought as justification for further artificial increases in the
prices of financial assets listed on the stock market.
In this wild race to abandon traditional accounting prin-
ciples and replace them with others more “in line with the
times,” it became common to evaluate companies based on
unorthodox suppositions and purely subjective criteria
which in the new standards replace the only truly objective
criterion (that of historical cost). Now, the collapse of finan-
cial markets and economic agents’ widespread loss of faith in
banks and their accounting practices have revealed the seri-
ous error involved in yielding to the IAS and their abandon-
ment of traditional accounting principles based on prudence,
the error of indulging in the vices of creative, fair-value
accounting.
It is in this context that we must view the recent measures
taken in the United States and the European Union to “soften”
(i.e., to partially reverse) the impact of fair-value accounting
for financial institutions. This is a step in the right direction,
but it falls short and is taken for the wrong reasons. Indeed,
those in charge at financial institutions are attempting to “shut
the barn door when the horse is bolting”; that is, when the
dramatic fall in the value of “toxic” or “illiquid” assets has
endangered the solvency of their institutions. However, these
people were delighted with the new IAS during the preceding
years of “irrational exuberance,” in which increasing and
excessive values in the stock and financial markets graced
their balance sheets with staggering figures corresponding to

xxiv
Money, Bank Credit, and Economic Cycles
their own profits and net worth, figures which in turn encour-
aged them to run risks (or better, uncertainties) with practi-
cally no thought of danger. Hence, we see that the IAS act in a
pro-cyclic manner by heightening volatility and erroneously
biasing business management: in times of prosperity, they cre-
ate a false “wealth effect” which prompts people to take dis-
proportionate risks; when, from one day to the next, the errors
committed come to light, the loss in the value of assets imme-
diately decapitalizes companies, which are obliged to sell
assets and attempt to recapitalize at the worst moment, i.e.,
when assets are worth the least and financial markets dry up.
Clearly, accounting principles which, like those of the IAS,
have proven so disturbing must be abandoned as soon as pos-
sible, and all of the accounting reforms recently enacted,
specifically the Spanish one, which came into effect January 1,
2008, must be reversed. This is so not only because these
reforms mean a dead end in a period of financial crisis and
recession, but especially because it is vital that in periods of
prosperity we stick to the principle of prudence in valuation,
a principle which has shaped all accounting systems from the
time of Luca Pacioli at the beginning of the fifteenth century
to the adoption of the false idol of the IAS.
In short, the greatest error of the accounting reform
recently introduced worldwide is that it scraps centuries of
accounting experience and business management when it
replaces the prudence principle, as the highest ranking among
all traditional accounting principles, with the “fair value”
principle, which is simply the introduction of the volatile mar-
ket value for an entire set of assets, particularly financial
assets. This Copernican turn is extremely harmful and threat-
ens the very foundations of the market economy for several
reasons. First, to violate the traditional principle of prudence
and require that accounting entries reflect market values is to
provoke, depending upon the conditions of the economic
cycle, an inflation of book values with surpluses which have
not materialized and which, in many cases, may never mate-
rialize. The artificial “wealth effect” this can produce, espe-
cially during the boom phase of each economic cycle, leads to
the allocation of paper (or merely temporary) profits, the

Preface to the Second English Edition xxv
acceptance of disproportionate risks, and in short, the com-
mission of systematic entrepreneurial errors and the consump-
tion of the nation’s capital, to the detriment of its healthy pro-
ductive structure and its capacity for long-term growth.
Second, I must emphasize that the purpose of accounting is
not to reflect supposed “real” values (which in any case are
subjective and which are determined and vary daily in the
corresponding markets) under the pretext of attaining a
(poorly understood) “accounting transparency.” Instead, the
purpose of accounting is to permit the prudent management
of each company and to prevent capital consumption,1 by
applying strict standards of accounting conservatism (based
on the prudence principle and the recording of either histori-
cal cost or market value, whichever is less), standards which
ensure at all times that distributable profits come from a safe
surplus which can be distributed without in any way endan-
gering the future viability and capitalization of the company.
Third, we must bear in mind that in the market there are no
equilibrium prices a third party can objectively determine.
Quite the opposite is true; market values arise from subjective
assessments and fluctuate sharply, and hence their use in
accounting eliminates much of the clarity, certainty, and infor-
mation balance sheets contained in the past. Today, balance
sheets have become largely unintelligible and useless to eco-
nomic agents. Furthermore, the volatility inherent in market
values, particularly over the economic cycle, robs accounting
based on the “new principles” of much of its potential as a
guide for action for company managers and leads them to sys-
tematically commit major errors in management, errors which
have been on the verge of provoking the severest financial cri-
sis to ravage the world since 1929.
1See especially F. A. Hayek, “The Maintenance of Capital,” Economica 2
(August 1934), reprinted in Profits, Interest and Investment and Other Essays on
the Theory of Industrial Fluctuations (Clifton, N.J.: Augustus M. Kelley, 1979;
first edition London: George Routledge & Sons, 1939). See especially section
9, “Capital Accounting and Monetary Policy,” pp. 130–32.

xxvi
Money, Bank Credit, and Economic Cycles
In chapter 9 of this book (pages 789–803), I design a
process of transition toward the only world financial order
which, being fully compatible with the free-enterprise system,
can eliminate the financial crises and economic recessions
which cyclically affect the world’s economies. The proposal
the book contains for international financial reform has
acquired extreme relevance at the present time (November
2008), in which the disconcerted governments of Europe and
America have organized a world conference to reform the
international monetary system in order to avoid in the future
such severe financial and banking crises as the one that cur-
rently grips the entire western world. As is explained in detail
over the nine chapters of this book, any future reform will fail
as miserably as past reforms unless it strikes at the very root
of the present problems and rests on the following principles:
(1) the reestablishment of a 100-percent reserve requirement
on all bank demand deposits and equivalents; (2) the elimina-
tion of central banks as lenders of last resort (which will be
unnecessary if the preceding principle is applied, and harmful
if they continue to act as financial central-planning agencies);
and (3) the privatization of the current, monopolistic, and
fiduciary state-issued money and its replacement with a clas-
sic pure gold standard. This radical, definitive reform would
essentially mark the culmination of the 1989 fall of the Berlin
Wall and real socialism, since the reform would mean the
application of the same principles of liberalization and private
property to the only sphere, that of finance and banking,
which has until now remained mired in central planning (by
“central” banks), extreme interventionism (the fixing of inter-
est rates, the tangled web of government regulations), and
state monopoly (legal tender laws which require the accept-
ance of the current, state-issued fiduciary money), circum-
stances with very negative and dramatic consequences, as we
have seen.
I should point out that the transition process designed in
the last chapter of this book could also permit from the outset
the bailing out of the current banking system, thus preventing

Preface to the Second English Edition xxvii
its rapid collapse, and with it the sudden monetary squeeze
which would be inevitable if, in an environment of wide-
spread broken trust among depositors, a significant volume of
bank deposits were to disappear. This short-term goal, which
at present, western governments are desperately striving for
with the most varied plans (the massive purchases of “toxic”
bank assets, the ad hominem guarantee of all deposits, or sim-
ply the partial or total nationalization of the private banking
system), could be reached much faster and more effectively,
and in a manner much less harmful to the market economy, if
the first step in the proposed reform (pages 791–98) were
immediately taken: to back the total amount of current bank
deposits (demand deposits and equivalents) with cash, bills to
be turned over to banks, which from then on would maintain
a 100-percent reserve with respect to deposits. As illustrated in
chart IX-2 of chapter 9, which shows the consolidated balance
sheet for the banking system following this step, the issuance
of these banknotes would in no way be inflationary (since the
new money would be “sterilized,” so to speak, by its purpose
as backing to satisfy any sudden deposit withdrawals). Fur-
thermore, this step would free up all banking assets (“toxic”
or not) which currently appear as backing for demand
deposits (and equivalents) on the balance sheets of private
banks. On the assumption that the transition to the new finan-
cial system would take place under “normal” circumstances,
and not in the midst of a financial crisis as acute as the current
one, I proposed in chapter 9 that the “freed” assets be trans-
ferred to a set of mutual funds created ad hoc and managed by
the banking system, and that the shares in these funds be
exchanged for outstanding treasury bonds and for the implicit
liabilities connected with the public social-security system
(pp. 796–97). Nevertheless, in the current climate of severe
financial and economic crisis, we have another alternative:
apart from canceling “toxic” assets with these funds, we could
devote a portion of the rest, if desired, to enabling savers (not
depositors, since their deposits would already be backed 100
percent) to recover a large part of the value lost in their invest-
ments (particularly in loans to commercial banks, investment
banks, and holding companies). These measures would

xxviii
Money, Bank Credit, and Economic Cycles
immediately restore confidence and would leave a significant
remainder to be exchanged, once and for all and at no cost, for
a sizeable portion of the national debt, our initial aim. In any
case, an important warning must be given: naturally, and I
must never tire of repeating it, the solution proposed is only
valid in the context of an irrevocable decision to reestablish a
free-banking system subject to a 100-percent reserve require-
ment on demand deposits. Any of the reforms noted above, if
adopted in the absence of a prior, firm conviction and decision
to change the international financial and banking system as
indicated, would be simply disastrous: a private banking sys-
tem which continued to operate with a fractional reserve
(orchestrated by the corresponding central banks), would gen-
erate, in a cascading effect, and based on the cash created to
back deposits, an inflationary expansion like none other in
history, one which would eventually finish off our entire eco-
nomic system.
The above considerations are crucially important and
reveal how very relevant this treatise has now become in light
of the critical state of the international financial system (though
I would definitely have preferred to write the preface to this
new edition under very different economic circumstances).
Nevertheless, while it is tragic that we have arrived at the cur-
rent situation, it is even more tragic, if possible, that there exists
a widespread lack of understanding regarding the causes of
the phenomena that plague us, and especially an atmosphere
of confusion and uncertainty prevalent among experts, ana-
lysts, and most economic theorists. In this area at least, I can
hope the successive editions of this book which are being pub-
lished all over the world2 may contribute to the theoretical
2Since the appearance of the first English-language edition, the third and
fourth Spanish editions have been published in 2006 and 2009. Moreover,
Tatjana Danilova and Grigory Sapov have completed a Russian translation,

Preface to the Second English Edition xxix
training of readers, to the intellectual rearmament of new gen-
erations, and eventually, to the sorely needed institutional
redesign of the entire monetary and financial system of cur-
rent market economies. If this hope is fulfilled, I will not only
view the effort made as worthwhile, but will also deem it a
great honor to have contributed, even in a very small way, to
movement in the right direction.
Jesús Huerta de Soto
Madrid
November 13, 2008
which has been published as Dengi, Bankovskiy Kredit i Ekonomicheskie Tsikly
(Moscow: Sotsium Publishing House, 2008). Three thousand copies have
been printed initially, and I had the satisfaction of presenting the book Octo-
ber 30, 2008 at the Higher School of Economics at Moscow State University.
In addition, Professor Rosine Létinier has produced the French translation,
which is now pending publication. Grzegorz Luczkiewicz has completed
the Polish translation, and translation into the following languages is at an
advanced stage: German, Czech, Italian, Romanian, Dutch, Chinese, Japan-
ese, and Arabic. God willing, may they soon be published.

PREFACE TO THE FIRST
ENGLISH-LANGUAGE
EDITION
It is a genuine pleasure for me to see this handsomely-
printed English edition of my book, Dinero, Crédito Bancario
y Ciclos Económicos, which first appeared in Spain in 1998.
This translation incorporates the small number of corrections
included in the second Spanish edition of January 2002, and it
is the result of the great effort of Melinda A. Stroup, who
wrote the first English manuscript of the entire book.
This English version was thoroughly examined by Dr. Jörg
Guido Hülsmann, whose comments on several important
points improved the manuscript significantly. I would also
like to acknowledge the work of my research assistant, Dr.
Gabriel Calzada, who searched for various English editions of
rare books unavailable in Spain and looked up certain quota-
tions and references. Last, I personally inspected the final ver-
sion in its entirety to ensure the accuracy of its content.
I am grateful to the Ludwig von Mises Institute, and espe-
cially to its president, Lewellyn H. Rockwell, Jr., for bringing
the project to its culmination with such high standards.
Jesús Huerta de Soto
Señorío de Sarría
May 2005
Note: The author welcomes any comments on this English-language edition
and requests they be sent to huertadesoto@dimasoft.es.
xxxi

PREFACE TO
THE THIRD
SPANISH EDITION
In this, the third edition of Dinero, Crédito Bancario y Ciclos
Económicos, an attempt has been made to preserve as far as
possible the contents, structure, and page numbering of
the two previous editions. However, changes have been nec-
essary in certain cases, as I have taken this new opportunity to
raise some additional arguments and points, both in the main
text and in several footnotes. Also, the bibliography has been
updated with the new editions and Spanish translations
which have appeared in the four years since the previous edi-
tion, and with a few new books and articles which have a par-
ticular bearing on the topics covered in the book.1 Finally, the
editor of the English version, Money, Bank Credit, and Economic
Cycles,2 Judith Thommesen, very patiently and painstakingly
1One such book is Roger W. Garrison’s Time and Money: The Macroeco-
nomics of Capital Structure, published by Routledge in London and New
York in 2001, three years after the appearance of the first Spanish edition
of Money, Bank Credit, and Economic Cycles. Garrison’s text can be viewed
as complementary to this one. His book is especially noteworthy, because
in it he develops the Austrian analysis of capital and economic cycles in
the context of the different paradigms of modern macroeconomics, and
the approach and language he uses to do so are fully consistent with
those used by the mainstream in our discipline. Hence, Garrison’s book
will undoubtedly help build awareness among economists in general of
the need to consider the Austrian perspective and its comparative
advantages. I do feel that Garrison’s explanations are too mechanistic
xxxiii

xxxiv
Money, Bank Credit, and Economic Cycles
verified hundreds of quotations in English and other lan-
guages against their original sources. A significant number of
small misprints had been detected and have now been recti-
fied, and thus her efforts have helped to make this third edi-
tion even more polished. I am deeply grateful to her, as well
as to Dr. Gabriel Calzada, Associate Professor at the Universi-
dad Rey Juan Carlos, for his assistance in reviewing and cor-
recting certain bibliographic references.
In the interval since the publication of the previous edi-
tion, economic trends have been marked by the high fiduciary
inflation and the sharp increase in public deficits necessary to
finance the war in Iraq and to meet the rising costs which the
“welfare state,” plagued by severe and insoluble problems,
generates in most western countries. The money supply and
the interest rate have been subject to further manipulation. In
fact, the United States Federal Reserve lowered the rate to a
historical minimum of 1 percent, thus preventing the neces-
sary correction of the investment errors committed prior to the
2001 recession. The above circumstances have triggered a new
speculative bubble in real estate markets, along with a dra-
matic rise in the price of the energy products and raw materi-
als which are the object of almost unlimited demand on a
worldwide scale, due to new investment projects undertaken
mainly in the Asiatic basin, and particularly in China. Thus,
we seem to be approaching the typical turning-point phase of
and that he falls short of providing sufficient justification for his analysis
from the juridical-institutional standpoint. Nonetheless, I thought it
advisable to promote the book’s translation into Spanish by a team of
professors and disciples from my department at the Universidad Rey
Juan Carlos. Dr. Miguel Ángel Alonso Neira led the team, and the trans-
lation has already been published in Spain under the title Tiempo y
dinero: la macroeconomía en la estructura del capital (Madrid: Unión Edito-
rial, 2005).
2The English edition was beautifully published in 2006 as Money, Bank
Credit, and Economic Cycles under the auspices of the Ludwig von Mises
Institute in Auburn, Alabama, thanks to the support of the Institute’s
president, Llewellyn H. Rockwell.

Preface to the Third Spanish Edition
xxxv
the cycle, the phase which precedes every economic recession.
Moreover, the very recent 180-degree turn in the monetary
policy of the Federal Reserve, which has jacked up interest
rates to 4 percent in only a few months, confirms the trend
even further.
It is my hope that this new edition will help readers and
scholars to better understand the economic phenomena of the
world that surrounds them. May it also serve to convince spe-
cialists and framers of current economic policy that we must
abandon social engineering in the monetary and financial
sphere as soon as possible. The attainment of these goals will
mean the complete fulfilment of one of my primary objectives.
Jesús Huerta de Soto
Formentor
August 28, 2005

PREFACE TO
THE SECOND
SPANISH EDITION
Following the success of the first edition of Dinero,
Crédito Bancario y Ciclos Económicos, which sold out
rapidly, I am pleased to present the second edition to
Spanish-speaking readers. To avoid confusion and facilitate
the work of scholars and researchers, the contents, struc-
ture, and page numbering of the first edition have been
maintained in the second, though the book has been thor-
oughly examined and all misprints detected have been
eliminated.
In the wake of a decade marked by great credit expan-
sion and the development of a large financial bubble, the
course of economic events in the world from 1999 through
2001 was characterized by the collapse of stock-market val-
ues and the emergence of a recession which now simultane-
ously grips the United States, Europe, and Japan. These cir-
cumstances have left the analysis presented in this book
even more clearly and fully illustrated than when it was first
published, at the end of 1998. While governments and cen-
tral banks have reacted to the terrorist attack on New York’s
World Trade Center by manipulating interest rates, reducing
them to historically low levels (1 percent in the United
States, 0.15 percent in Japan and 2 percent in Europe), the
massive expansion of fiduciary media injected into the sys-
tem will not only prolong and hinder the necessary stream-
lining of the real productive structure, but may also lead to
xxxvii

xxxviii
Money, Bank Credit, and Economic Cycles
dangerous stagflation. In light of these worrisome economic
conditions, which have repeated themselves since the emer-
gence of the current banking system, I fervently hope the
analysis this book contains will help the reader to under-
stand and interpret the phenomena which surround him and
will exert a positive influence on public opinion, my univer-
sity colleagues and economic-policy authorities in govern-
ment and central banks.
Various reviews of this book’s first edition have
appeared, and I am grateful to the eminent authors of them
for their many positive comments.1 A common denomina-
tor among all has been to urge the translation of this book
into English, a task now complete. It is my hope that, God
willing, the first English edition of this book will soon be
published in the United States and will thus become avail-
able to some of the most influential academic and political
circles.
Finally, since 1998 this manual has been employed suc-
cessfully as a textbook during the semester devoted to the
theory of money, banking, and business cycles in courses on
Political Economy and in Introduction to Economics, first at
the law school of Madrid’s Universidad Complutense and
later at the school of law and social sciences of the Universi-
dad Rey Juan Carlos, also in Madrid. This educational expe-
rience has been based on an institutional and decidedly mul-
tidisciplinary approach to economic theory, and I believe this
method can be easily and successfully applied to any other
course connected with banking theory (Economic Policy,
Macroeconomics, Monetary and Financial Theory, etc.). This
experience would not have been possible without the keen
interest and enthusiasm hundreds of students have
expressed each academic year as they studied and discussed
the teachings contained in the present volume. This book, to
1I am particularly grateful to Leland Yeager (Review of Austrian Econom-
ics 14 no. 4 [2001]: 255) and Jörg Guido Hülsmann (Quarterly Journal of
Austrian Economics 3, no. 2 [2000]: 85–88) for their remarks.

Preface to the Second Spanish Edition
xxxix
which they have dedicated their efforts, is chiefly aimed at
them, and I thank all of them. May they continue to cultivate
their critical spirit and intellectual curiosity as they progress
to higher and increasingly enriching stages in their forma-
tive journey.2
Jesús Huerta de Soto
Madrid
December 6, 2001
2Comments on this second edition are welcome and may be sent to
huertadesoto@dimasoft.es.

INTRODUCTION
The economic analysis of juridical institutions has come
to the fore in recent years and promises to become one
of the most fruitful spheres of economics. Much of the
work completed thus far has been strongly influenced by tra-
ditional neoclassical assumptions, namely by the concept of
strict maximization in contexts of equilibrium. Still, economic
analyses of law reveal the shortcomings of the traditional
approach and do so perhaps better than any other branch of
economics. In fact, juridical institutions are so intimately
involved in daily life that it is notoriously difficult to apply the
traditional assumptions of economic analysis to them. I have
already attempted elsewhere to expose the dangers the neo-
classical perspective brings to the analysis of juridical institu-
tions.1 Economic analyses of law are certainly necessary, but
they call for a less restrictive methodology than has generally
been used to date, one more suited to this particular field of
research. The subjectivist view is a more fitting approach.
Developed by the Austrian School, it is based on their concept
of creative human action or entrepreneurial activity and
implies a dynamic analysis of the general processes of social
interaction. This perspective promises to make great contribu-
tions to the future development of the economic analysis of
juridical institutions.
In addition, most studies of juridical institutions carried
out so far have had exclusively microeconomic implications
because, among other reasons, theorists have simply borrowed
the traditional analytical tools of neoclassical microeconomics
1See Jesús Huerta de Soto, “The Ongoing Methodenstreit of the Aus-
trian School,” Journal des Économistes et des Études Humaines 8, no. 1
(March 1998): 75–113.
xli

xlii
Money, Bank Credit, and Economic Cycles
and applied them to the analysis of law. This has been the
case, for example, with respect to the economic analysis of con-
tracts and civil liability, bankruptcy law, the family, and even
criminal law and justice. Very few economic analyses of law
have had mainly macroeconomic implications, and this reflects
the harmful decades-long separation between these two sides
of economics. However, this need not be the case. It is neces-
sary to recognize economics as a unified whole, where macro-
economic elements are firmly rooted in their microeconomic
foundations. In addition, I will attempt to demonstrate that
the economic analysis of some juridical institutions yields crit-
ical implications and conclusions that are essentially macro-
economic. Or, in other words, even when the basic analysis is
microeconomic, the conclusions drawn and primary out-
comes resulting from it are macroeconomic. By closing the
profound artificial gap between micro and macroeconomics,
we arrive at a unified theoretical treatment of legal issues in
the economic analysis of law.
This is my primary goal as I undertake an economic analy-
sis of the monetary irregular-deposit contract, in its different
facets. Furthermore, I intend my examination to cast light on
one of the most obscure and complex spheres of economics:
the theory of money, bank credit, and economic cycles. Now
that the issue of socialism has been resolved,2 at least from a
theoretical standpoint, and it has been empirically illustrated
to be impracticable, the main theoretical challenge facing
economists at the dawn of the twenty-first century lies most
likely in the field of money, credit, and financial institutions.
The highly abstract nature of social relationships involving
money in its various forms makes these relationships remark-
ably difficult to understand and the corresponding theoretical
treatment of them particularly complex. In addition, in the
financial and monetary spheres of western countries, a series of
institutions has been developed and imposed; namely central
banks, bank legislation, a monopoly on the issue of currency,
2Jesús Huerta de Soto, Socialismo, cálculo económico y función empresarial
(Madrid: Unión Editorial, 1992; 2nd ed., 2001).

Introduction xliii
and foreign exchange controls. These institutions thoroughly
regulate every country’s financial sector, rendering it much
more similar to the socialist system of central planning than is
appropriate to a true market economy. Hence, as I will attempt
to demonstrate, the arguments which establish the impracti-
cability of socialist economic calculation are fully applicable to
the financial sphere. Supporters of the Austrian School of eco-
nomics originally developed these arguments when they
showed it was impossible to organize society in a coordinated
fashion via dictatorial commands. If my thesis is correct, the
impracticability of socialism will also be established in the
financial sector. Furthermore, the inevitable discoordination
to which all state intervention gives rise will be vividly
revealed in the cyclical phases of boom and recession which
traditionally affect the mixed economies of the developed
world.
Any theoretical study today which attempts to identify the
causes, stages, remedies for, and chances of preventing eco-
nomic cycles is guaranteed to be front-page material. As a
matter of fact, as I write these lines (November 1997), a serious
financial and banking crisis grips Asian markets and threatens
to spread to Latin America and the rest of the western world.
This crisis comes in the wake of the period of apparent eco-
nomic prosperity which in turn followed the severe financial
crises and economic recessions that shook the world at the
beginning of the nineties and particularly the end of the sev-
enties. Furthermore, in the eyes of ordinary people, politi-
cians, and the majority of economic theorists themselves, an
understanding has not yet been reached as to the true causes
of these phenomena, the successive and recurrent appear-
ances of which are constantly used by politicians, philoso-
phers, and interventionist theorists alike as a pretext for reject-
ing a market economy and justifying an increasing level of
dictatorial state intervention in the economy and society.
For this reason, from the point of view of classical liberal
doctrine, it is of great theoretical interest to scientifically ana-
lyze the origin of economic cycles, and in particular, to deter-
mine the ideal model for the financial system of a truly free
society. Libertarian theorists themselves still disagree in this

xliv
Money, Bank Credit, and Economic Cycles
area, and there are great differences of opinion as to whether
it is necessary to maintain the central bank or whether it
would be better to exchange it for a system of free banking,
and in the latter case, as to what concrete rules economic
agents participating in a completely free financial system
should have to follow. The central bank originally appeared as
the result of a series of dictatorial government interventions,
though these were mainly urged by various agents of the
financial sector (specifically by private banks themselves),
who on many occasions have considered it necessary to
demand state support to guarantee the stability of their busi-
ness activities during stages of economic crisis. Does this
mean the central bank is an inevitable evolutionary outcome
of a free-market economy? Or rather, that the way private
bankers have characteristically done business, which at a cer-
tain point became corrupt from a legal point of view, has
brought about financial practices unsustainable without back-
ing from a lender of last resort? These and other issues are of
utmost theoretical interest and should be the object of the
most careful analysis. In short, my main objective is to
develop a research plan to determine which financial and
banking system is appropriate for a free society.
I intend this research to be multidisciplinary. It will have to
rest not only on the study of juridical science and the history of
law, but also on economic theory and specifically on the theory
of money, capital, and economic cycles. Furthermore, my analy-
sis will shed new light on some historical economic events
related to the financial realm, and will better illustrate the evo-
lution of certain trends in the history of economic thought itself,
as well as the development of various accounting and banking
techniques. A proper understanding of finance requires the
integration of various disciplines and branches of knowledge,
and we will consider these from the three perspectives I deem
necessary to correctly comprehend any social phenomenon:
historical-evolutionary, theoretical, and ethical.3
3I have presented the theory of the three-tiered approach to studying
social issues in Jesús Huerta de Soto, “Conjectural History and Beyond,”
Humane Studies Review 6, no. 2 (Winter, 1988–1989): 10.

Introduction xlv
This book comprises nine chapters. In the first I describe
the legal essence of the monetary irregular-deposit contract,
paying special attention to the main characteristics distin-
guishing it from a loan contract, or mutuum. In addition,
Chapter 1 deals with the different legal logic inherent in these
two institutions, their mutual incompatibility at a fundamen-
tal level, and how the unique ways each is regulated embody
traditional, universal legal principles identified and devel-
oped from the time of Roman classical law.
Chapter 2 is a historical study of economic events. There I
examine ways in which the traditional legal principle govern-
ing the irregular-deposit contract has been corrupted over
time, mainly due to the temptation felt by the first bankers to
use their depositors’ money to their own benefit. The interven-
tion of the political establishment has also played an important
role in this process. Always eager to secure new financial
resources, political authorities have turned to bankers
entrusted with others’ deposits and have attempted to exploit
these funds, granting the bankers all sorts of privileges, chiefly
authorization to use their depositors’ money for their own ben-
efit (of course on condition that a significant part of such funds
be loaned to the politicians themselves). This chapter offers
three different examples (classical Greece and Rome, the resur-
gence of banking in medieval Italian cities, and the revival of
banking in modern times) to illustrate the process by which the
traditional legal principles governing the monetary irregular-
deposit bank contract have become corrupted and to outline
the resulting economic effects.
In chapter 3 I adopt a legal viewpoint to consider different
theoretical attempts to come up with a new contractual frame-
work in which to classify the monetary bank-deposit contract.
Such attempts are aimed at justifying banks’ lending of
demand-deposit funds to third parties. I intend to show that
these attempts at justification are riddled with an insoluble
logical contradiction and therefore doomed to failure. I will
also explain how the effects of privileged banking practices (see
chapter 2) expose profound contradictions and weaknesses in
the formulation of a new legal, theoretical basis for the mone-
tary irregular-deposit contract. The attempt to establish such a

xlvi
Money, Bank Credit, and Economic Cycles
foundation dates back to the Middle Ages and has continued
until practically the present day. We will take a detailed look
at different efforts to formulate an unorthodox legal principle
capable of governing present-day monetary bank deposits in
a logical, coherent manner. I conclude that such attempts
could not possibly have been successful, because current
banking practices are based precisely on the violation of tra-
ditional principles inherent in property rights, which cannot
be violated without serious harmful effects on the processes of
social interaction.
Chapters 4, 5, 6, and 7 comprise the heart of my economic
analysis of the bank-deposit contract as it has developed over
time; that is, using a fractional-reserve ratio in violation of tra-
ditional legal principles. I will explain why Hayek’s insightful
rule rings true in the banking field as well. This rule states that
whenever a traditional legal principle is violated, sooner or
later there are serious harmful effects on society. From a theo-
retical viewpoint, I will analyze the effects the current banking
practice of disregarding traditional legal principles in the
monetary-deposit contract has on the creation of money, intra-
and intertemporal market coordination, entrepreneurship,
and economic cycles. My conclusion is that the successive
stages of boom, crisis, and economic recession recurring in the
market result from the violation of the traditional legal princi-
ple on which the monetary bank-deposit contract should be
based. They stem from the privilege bankers have come to
enjoy and have been granted in the past by governments for
reasons of mutual interest. We will study the theory of eco-
nomic cycles in depth and critically analyze the alternative
explanations offered by the monetarist and Keynesian schools
for this type of phenomena.
Chapter 8 focuses on the central bank as a lender of last
resort. The creation of this institution resulted inevitably from
certain events. When the principles which should govern the
irregular-deposit contract are violated, such acute and
inescapable effects appear that private bankers soon realized
they needed to turn to the government for an institution to act
on their behalf as lender of last resort and provide support
during stages of crisis, which experience demonstrated to be a

Introduction xlvii
recurrent phenomenon. I will endeavor to show that the cen-
tral bank did not emerge spontaneously as the result of mar-
ket institutions, but was forcibly imposed by the government
and responds to the demands of powerful pressure groups. I
will also examine the current financial system, which is based
on a central bank, and apply to it the analytical economic the-
ory of the impracticability of socialism. Indeed, the current
financial system rests on a monopoly one government agency
holds on the chief decisions regarding the type and quantity
of money and credit to be created and injected into the eco-
nomic system. Thus it constitutes a financial market system of
“central planning” and therefore involves a high level of inter-
vention and is to a great extent “socialist.” Sooner or later the
system will inevitably run up against the impossibility of
socialist economic calculation, the theorem of which main-
tains it is impossible to coordinate any sphere of society, espe-
cially the financial sphere, via dictatorial mandates, given that
the governing body (in this case the central bank) is incapable
of obtaining the necessary and relevant information required
to do so. The chapter concludes with a review of the recent
central-banking/free-banking controversy. We will see that
most current free-banking theorists have failed to realize that
their plan loses much of its potential and theoretical weight if
not accompanied by a call to return to traditional legal princi-
ples; that is, to banking with a 100-percent reserve require-
ment. Freedom must go hand-in-hand with responsibility and
strict observance of traditional legal principles.
The ninth and last chapter presents an ideal, coherent
model for a financial system which respects traditional legal
principles and is thus based on the adoption of a 100-percent
reserve requirement in banking. Also considered are the dif-
ferent arguments made against my proposal. I criticize them
and explain how the transition from the current system to the
proposed ideal system could be carried out with a minimum
of tension. A summary of main conclusions wraps up the
book, along with some additional considerations on the
advantages of the proposed financial system. The principles
studied here are also applied to certain urgent practical issues,
such as the construction of a new European monetary system

xlviii
Money, Bank Credit, and Economic Cycles
and of a modern financial system in the former socialist
economies.
A summarized version of this book’s essential thesis was
first presented in a paper before the Mont Pèlerin Society in
Rio de Janeiro in September 1993 and received the support of
James M. Buchanan, to whom I am very grateful. A written,
Spanish version has been partially published in the “Intro-
ducción Crítica” of the first Spanish edition of Vera C. Smith’s
book, The Rationale of Central Banking and the Free Banking
Alternative.4 It was later published in French as an article enti-
tled “Banque centrale ou banque libre: le débat théorique sur
les réserves fractionnaires.”5
I express my gratitude to my colleague at the law school of
Madrid’s Universidad Complutense, Professor Mercedes
López Amor, for her help in the search for sources and a bibli-
ography regarding the treatment under Roman law of the
irregular deposit of money. Also, my former professor, Pablo
Martín Aceña, from the University of Alcalá de Henares
(Madrid), offered direction in my study of the evolution of
banking throughout the Middle Ages. Luis Reig, Rafael Man-
zanares, José Antonio de Aguirre, José Luis Feito, Richard
Adamiak of Chicago, the late Professor Murray N. Rothbard,
4Vera C. Smith, Fundamentos de la banca central y de la libertad bancaria
(Madrid: Unión Editorial/Ediciones Aosta, 1993), pp. 27–42. (The Ratio-
nale of Central Banking and the Free Banking Alternative [Indianapolis: Lib-
erty Press, 1990].)
5Jesús Huerta de Soto, “Banque centrale ou banque libre: le débat
théorique sur les réserves fractionnaires,” in the Journal des Économistes
et des Études Humaines 5, no. 2/3 (June-September 1994): 379–91. This
paper later appeared in Spanish with the title “La teoría del banco cen-
tral y de la banca libre” in my book, Estudios de economía política, chap.
11, pp. 129–43. Two other versions of this article were also later pub-
lished: one in English, entitled “A Critical Analysis of Central Banks and
Fractional Reserve Free Banking from the Austrian School Perspective,”
in The Review of Austrian Economics 8, no. 2 (1995): 117–30; the other in
Romanian, thanks to Octavian Vasilescu, “Banci centrale si sistemul de
free-banking cu rezerve fractionare: o analizá criticá din perspectiva
Scolii Austriece,” Polis: Revista de stiinte politice 4, no. 1 (Bucharest, 1997):
145–57.

Introduction xlix
and Professors Hans-Hermann Hoppe from Las Vegas Uni-
versity in Nevada, Manuel Gurdiel from the Universidad
Complutense in Madrid, Pablo Vázquez from the University
of Cantabria (Spain), Enrique Menéndez Ureña from the Uni-
versidad Comillas (Madrid), James Sadowsky from Fordham
University, Pedro Tenorio from the U.N.E.D. (Spain), Rafael
Termes from the I.E.S.E. (Madrid), Raimondo Cubeddu from
the University of Pisa, Rafael Rubio de Urquía from the Uni-
versidad Autónoma in Madrid, José Antonio García Durán
from the Universidad Central de Barcelona (Spain), and the
learned José Antonio Linage Conde from the University of San
Pablo-C.E.U. in Madrid have been a great help with their sug-
gestions and provision of books, articles, and rare biblio-
graphic references on banking and monetary issues. My stu-
dents in doctorate courses at the law school of Madrid’s
Universidad Complutense, especially Elena Sousmatzian,
Xavier Sampedro, Luis Alfonso López García, Rubén Manso,
Ángel Luis Rodríguez, César Martínez Meseguer, Juan Igna-
cio Funes, Alberto Recarte and Esteban Gándara, along with
Assistant Professors Óscar Vara, Javier Aranzadi, and Ángel
Rodríguez, have provided innumerable suggestions and
worked hard to correct typing errors in several previous ver-
sions of the manuscript. I express my gratitude to all of them
and free them, as is logical, of all responsibility for the book’s
final contents.
Finally, I would like to thank Sandra Moyano, Ann Lewis,
and Yolanda Moyano for their great help and patience in typ-
ing and correcting the different versions of the manuscript.
Above all, I am grateful, as always, to my wife, Sonsoles, for
her help, understanding, and continual encouragement and
support throughout this entire project. This book is dedicated
to her.
Jesús Huerta de Soto
Formentor
August 15, 1997

1
THE LEGAL NATURE
OF THE MONETARY
IRREGULAR-DEPOSIT
CONTRACT
1
A PRELIMINARY CLARIFICATION OF TERMS:
LOAN CONTRACTS (MUTUUM AND COMMODATUM)
AND DEPOSIT CONTRACTS
According to the Shorter Oxford English Dictionary, a loanis
“a thing lent; esp. a sum of money lent for a time, to be
returned in money or money’s worth, and usually at
interest.”1 Traditionally there have been two types of loans:
the loan for use, in which case only the use of the lent item is
transferred and the borrower is obliged to return it once it has
been used; and the loan for consumption, where the property of
the lent item is transferred. In the latter case, the article is
handed over to be consumed, and the borrower is obliged to
return something of the same quantity and quality as the
thing initially received and consumed.2
1The Shorter Oxford English Dictionary, 3rd ed. (Oxford: Oxford Univer-
sity Press, 1973), vol. 1, p. 1227.
2Manuel Albaladejo, Derecho civil II, Derecho de obligaciones, vol. 2: Los
contratos en particular y las obligaciones no contractuales (Barcelona: Librería
Bosch, 1975), p. 304.
1

2
Money, Bank Credit, and Economic Cycles
THE COMMODATUM CONTRACT
Commodatum (from Latin) refers to a real contract made in
good faith, by which one person—the lender—entrusts to
another—the borrower or commodatary—a specific item to be
used for free for a certain period of time, at the end of which
the item must be restored to its owner; that is, the very thing
that was loaned must be returned.3 The contract is called
“real” because the article must be given over. An example
would be the loan of a car to a friend so he can take a trip. It
is clear that in this case the lender continues to own the lent
item, and the person receiving it is obliged to use it appropri-
ately and return it (the car) at the end of the arranged period
(when the trip is over). The obligations of the friend, the bor-
rower, are to remain in possession of the article (the car or
vehicle), to use it properly (following traffic rules and taking
care of it as if it were his own), and to return it when the com-
modatum is finished (the trip is over).
THE MUTUUM CONTRACT
Though the commodatum contract is of some practical
importance, of greater economic significance is the lending of
fungible4 and consumable goods, such as oil, wheat, and espe-
cially, money. Mutuum (also from Latin) refers to the contract
by which one person—the lender—entrusts to another—the
borrower or mutuary—a certain quantity of fungible goods,
and the borrower is obliged, at the end of a specified term, to
return an equal quantity of goods of the same type and quality
(tantundem in Latin). A typical example of a mutuum contract
is the monetary loan contract, money being the quintessential
3Juan Iglesias, Derecho romano: Instituciones de derecho privado, 6th rev.
updated ed. (Barcelona: Ediciones Ariel, 1972), pp. 408–09.
4Fungible goods are those for which others of the same sort may be sub-
stituted. In other words, they are goods which are not treated separately,
but rather in terms of quantity, weight, or measure. The Romans said
that things quae in genere suo functionem in solutione recipiunt were fungi-
ble; that is, things quae pondere numero mensurave constant. Consumables
are often fungible.

The Legal Nature of the Monetary Irregular-Deposit Contract 3
fungible good. By this contract, a certain quantity of monetary
units are handed over today from one person to another and
the ownership and availability of the money are transferred
from the one granting the loan to the one receiving it. The per-
son who receives the loan is authorized to use the money as his
own, while promising to return, at the end of a set term, the
same number of monetary units lent. The mutuum contract,
since it constitutes a loan of fungible goods, entails an exchange
of “present” goods for “future” goods. Hence, unlike the commo-
datum contract, in the case of the mutuum contract the estab-
lishment of an interest agreement is normal, since, by virtue of
the time preference (according to which, under equal circum-
stances, present goods are always preferable to future goods),
human beings are only willing to relinquish a set quantity of
units of a fungible good in exchange for a greater number of
units of a fungible good in the future (at the end of the term).
Thus, the difference between the number of units initially deliv-
ered and the number received from the borrower at the end of
the term is, precisely, the interest. To sum up, in the case of the
mutuum contract, the lender assumes the obligation to hand
over the predetermined units to the borrower or mutuary. The
borrower or mutuary who receives the loan assumes the obli-
gation to return the same number of units of the same sort and
quality as those received (tantundem) at the end of the term set
for the contract. Plus, he is obliged to pay interest, as long as an
agreement has been made to that effect, as is usually the case.
The essential obligation involved in a mutuum contract, or loan
of a fungible good, is to return at the end of the specified term
the same number of units of the same type and quality as those
received, even if the good undergoes a change in price. This
means that since the borrower only has to return the tantundem
once the predetermined time period has ended, he receives the
benefit of temporary ownership of the thing and therefore enjoys
its complete availability. In addition, a fixed term is an essential
element in the loan or mutuum contract, since it establishes the
time period during which the availability and ownership of the
good corresponds to the borrower, as well as the moment at
which he is obliged to return the tantundem. Without the explicit

4
Money, Bank Credit, and Economic Cycles
or implicit establishment of a fixed term, the mutuum contract or
loan cannot exist.
THE DEPOSIT CONTRACT
Whereas loan contracts (commodatum and mutuum)
entail the transfer of the availability of the good, which shifts
from the lender to the borrower for the duration of the term,
another type of contract, the deposit contract, requires that the
availability of the good not be transferred. Indeed, the contract of
deposit (depositum in Latin) is a contract made in good faith by
which one person—the depositor—entrusts to another—the
depositary—a movable good for that person to guard, protect,
and return at any moment the depositor should ask for it.
Consequently, the deposit is always carried out in the interest
of the depositor. Its fundamental purpose is the custody or safe-
keeping of the good and it implies, for the duration of the con-
tract, that the complete availability of the good remain in
favor of the depositor, who may request its return at any
moment. The obligation of the depositor, apart from delivering
the good, is to compensate the depositary for the costs of the
deposit (if such compensation has been agreed upon; if not,
the deposit is free of charge). The obligation of the depositary
is to guard and protect the good with the extreme diligence
typical of a good parent, and to return it immediately to the
depositor as soon as he asks for it. It is clear that, while each
loan has a term of duration during which the availability of
the good is transferred, in the case of a deposit this is not so.
Rather a deposit is always held and available to the depositor,
and it terminates as soon as he demands the return of the good
from the depositary.
THE DEPOSIT OF FUNGIBLE GOODS
OR “IRREGULAR” DEPOSIT CONTRACT
Many times in life we wish to deposit not specific things
(such as a painting, a piece of jewelry, or a sealed chest full of
coins), but fungible goods (like barrels of oil, cubic meters of
gas, bushels of wheat, or thousands of dollars). The deposit of
fungible goods is definitely also a deposit, inasmuch as its

The Legal Nature of the Monetary Irregular-Deposit Contract 5
main element is the complete availability of the deposited
goods in favor of the depositor, as well as the obligation on the
part of the depositary to conscientiously guard and protect the
goods. The only difference between the deposit of fungible
goods and the regular deposit, or deposit of specific goods, is
that when the former takes place, the goods deposited become
indiscernibly mixed with others of the same type and quality
(as is the case, for example, in a warehouse holding grain or
wheat, in an oil tank or oil refinery, or in the banker’s safe).
Due to this indistinguishable mixture of different deposited
units of the same type and quality, one might consider that the
“ownership” of the deposited good is transferred in the case
of the deposit of fungible goods. Indeed, when the depositor
goes to withdraw his deposit, he will have to settle, as is logi-
cal, for receiving the exact equivalent in terms of quantity and
quality of what he originally deposited. In no case will he
receive the same specific units he handed over, since the
goods’ fungible nature makes them impossible to treat indi-
vidually, because they have become indistinguishably mixed
with the rest of the goods held by the depositary. The deposit
of fungible goods, which possesses the fundamental ingredi-
ents of the deposit contract, is called an “irregular deposit,”5
as one of its characteristic elements is different. (In the case of
the contract of regular deposit, or deposit of a specific good,
5Our student César Martínez Meseguer argues convincingly that
another adequate solution to our problem is to consider that in the irreg-
ular deposit there is no true transference of ownership, but rather that
the concept of ownership refers abstractly to the tantundem or quantity
of goods deposited and as such always remains in favor of the deposi-
tor and is not transferred. This solution is the one offered, for example,
in the case of commixture covered in article 381 of the Spanish Civil
Code, which admits that “each owner will acquire rights in proportion
to the part corresponding to him.” Though the irregular deposit has tra-
ditionally been viewed differently (as involving the actual transfer of
ownership of physical units), it appears more correct to define owner-
ship in the more abstract terms of article 381 of the Spanish Civil Code,
in which case we may consider there to be no transference of ownership
in an irregular deposit. Moreover, this seems to be the view of Luis Díez-
Picazo and Antonio Gullón, Sistema de derecho civil, 6th ed. (Madrid: Edi-
torial Tecnos, 1989), vol. 2, pp. 469–70.

6
Money, Bank Credit, and Economic Cycles
ownership is not transferred, but rather the depositor contin-
ues to own the good, while in the case of the deposit of fungi-
ble goods, one might suppose that ownership is transferred to
the depositary). Nevertheless, we must emphasize that the
essence of the deposit remains unchanged and that the irregu-
lar deposit fully shares the same fundamental nature of all
deposits: the custody and safekeeping obligation. Indeed, in the
irregular deposit there is always an immediate availability in
favor of the depositor, who at any moment can go to the grain
warehouse, oil tank, or bank safe and withdraw the equiva-
lent of the units he originally turned over. The goods with-
drawn will be the exact equivalent, in terms of quantity and
quality, of the ones handed over; or, as the Romans said, the
tantundem iusdem generis, qualitatis et bonetatis.
2
THE ECONOMIC AND SOCIAL
FUNCTION OF IRREGULAR DEPOSITS
Deposits of fungible goods (like money), also called irreg-
ular deposits, perform an important social function which
cannot be fulfilled by regular deposits, understood as deposits
of specific goods. It would be senseless and very costly to
deposit oil in separate, numbered containers (that is, as sealed
deposits in which ownership is not transferred), or to place
bills in an individually-numbered, sealed envelope. Though
these extreme cases would constitute regular deposits in
which ownership is not transferred, they would mean a loss of
the extraordinary efficiency and cost reduction which result
from treating individual deposits jointly and indistinctly from
one another6 at no cost nor loss of availability to the depositor,
who is just as happy if, when he requests it, he receives a tan-
tundem equal in quantity and quality, but not identical in
terms of specific content, to that which he originally handed
over. The irregular deposit has other advantages as well. In
6In the specific case of the monetary irregular deposit, the occasional use
of cashier services offered by banks is an additional advantage.

The Legal Nature of the Monetary Irregular-Deposit Contract 7
the regular deposit, or deposit of specific goods, the depositary
is not responsible for the loss of a good due to an inevitable
accident or act of God, while in the irregular deposit, the
depositary is responsible even in the case of an act of God.
Therefore, in addition to the traditional advantages of imme-
diate availability and safekeeping of the entire deposit, the
irregular deposit acts as a type of insurance against the possi-
bility of loss due to inevitable accidents.7
THE FUNDAMENTAL ELEMENT IN THE
MONETARY IRREGULAR DEPOSIT
In the irregular deposit, the obligation to guard and pro-
tect the goods deposited, which is the fundamental element in
all deposits, takes the form of an obligation to always main-
tain complete availability of the tantundem in favor of the
depositor. In other words, whereas in the regular deposit the
specific good deposited must be continually guarded consci-
entiously and in individuo, in the deposit of fungible goods,
what must be continually guarded, protected and kept avail-
able to the depositor is the tantundem; that is, the equivalent
in quantity and quality to the goods originally handed over.
This means that in the irregular deposit, custody consists of the
obligation to always keep available to the depositor goods of the
same quantity and quality as those received. This availability,
though the goods be continually replaced by others, is the equiv-
alent in the case of fungible goods of keeping the in individuo
good in the case of non-fungibles. In other words, the owner
of the grain warehouse or oil tank can use the specific oil or
grain he receives, either for his own use or to return to
7As Pasquale Coppa-Zuccari wisely points out,
a differenza del deposito regolare, l’irregolare gli garantisce la
restituzione del tantundem nella stessa specie e qualità, sem-
pre ed in ogni caso. . . . Il deponente irregolare è garantito
contro il caso fortuito, contro il quale il depositario regolare
non lo garantisce; trovasi anzi in una condizione economica-
mente ben più fortunata che se fosse assicurato. (See Pasquale
Coppa-Zuccari, Il deposito irregolare [Modena: Biblioteca dell’
Archivio Giuridico Filippo Serafini, 1901], vol. 6, pp. 109–10)

8
Money, Bank Credit, and Economic Cycles
another depositor, as long as he maintains available to the origi-
nal depositor oil or grain of the same quantity and quality as those
deposited. In the deposit of money the same rule applies. If a
friend gives you a twenty-dollar bill in deposit, we may con-
sider that he transfers to you the ownership of the specific bill,
and that you may use it for your own expenses or for any
other use, as long as you keep the equivalent amount (in the
form of another bill or two ten-dollar bills), so that the
moment he requests you repay him, you can do so immedi-
ately with no problem and no need for excuses.8
8Coppa-Zuccari may have expressed this essential principle of the irreg-
ular deposit better than anyone when he said that the depositary
risponde della diligenza di un buon padre di famiglia
indipendentemente da quella che esplica nel giro ordinario
della sua vita economica e giuridica. Il depositario invece,
nella custodia delle cose ricevute in deposito, deve spiegare la
diligenza, quam suis rebus adhibere solet. E questa diligenza
diretta alla conservazione delle cose propie, il depositario
esplica: in rapporto alle cose infungibili, con l’impedire che
esse si perdano o si deteriorino; il rapporto alle fungibili, col
curare di averne sempre a disposizione la medesima quantità
e qualità. Questo tenere a disposizione una eguale quantità è
qualità di cose determinate, si rinnovellino pur di continuo e
si sostituiscano, equivale per le fungibili a ciò che per le
infungibili è l’esistenza della cosa in individuo. (Coppa-Zuc-
cari, Il deposito irregolare, p. 95)
Joaquín Garrigues states the same opinion in Contratos bancarios
(Madrid, 1975), p. 365, and Juan Roca Juan also expresses it in his article
on the deposit of money (Comentarios al Código Civil y Compilaciones
Forales, under the direction of Manuel Albaladejo, tome 22, vol. 1, Edito-
rial Revista del Derecho Privado EDERSA [Madrid, 1982], pp. 246–55), in
which he arrives at the conclusion that in the irregular deposit the safe-
keeping obligation means precisely that the depositary
must keep the quantity deposited available to the depositor at
all times, and therefore must keep the number of units of the
sort deposited necessary to return the amount when it is
requested of him. (p. 251)
In other words, in the case of the monetary irregular deposit, the safe-
keeping obligation means the demand for a continuous 100-percent
cash reserve.

The Legal Nature of the Monetary Irregular-Deposit Contract 9
To sum up, the logic behind the institution of irregular
deposit is based on universal legal principles and suggests that
the essential element of custody or safekeeping necessitates the
continuous availability to the depositor of a tantundem equal to
the original deposit. In the specific case of money, the quintes-
sential fungible good, this means the safekeeping obligation
requires the continuous availability to the depositor of a 100-
percent cash reserve.
RESULTING EFFECTS OF THE FAILURE TO COMPLY
WITH THE ESSENTIAL OBLIGATION IN THE IRREGULAR DEPOSIT
When there is a failure to comply with the obligation of
safekeeping in a deposit, as is logical, it becomes necessary to
indemnify the depositor, and if the depositary has acted
fraudulently and has employed the deposited good for his
own personal use, he has committed the offense of misappro-
priation. Therefore, in the regular deposit, if someone receives
the deposit of a painting, for example, and sells it to earn
money, he is committing the offense of misappropriation. The
same offense is committed in the irregular deposit of fungible
goods by the depositary who uses deposited goods for his
own profit without maintaining the equivalent tantundem
available to the depositor at all times. This would be the case
of the oil depositary who does not keep in his tanks a quantity
equal to the total deposited with him, or a depositary who
receives money on deposit and uses it in any way for his own
benefit (spending it himself or loaning it), but does not main-
tain a 100-percent cash reserve at all times.9 The criminal law
9Other related offenses are committed when a depositary falsifies the
number of deposit slips or vouchers. This would be the case of the oil
depositary who issues false deposit vouchers to be traded by third par-
ties, and in general, of any depositary of a fungible good (including
money) who issues slips or vouchers for a larger amount than that actu-
ally deposited. It is clear that in this case we are dealing with the
offenses of document forgery (the issue of the false voucher) and fraud (if
in issuing the voucher there is an intention to deceive third parties and
obtain a specific profit). Later on we will confirm that the historical
development of banking was based on the perpetration of such criminal
acts in relation to the “business” of issuing banknotes.

10
Money, Bank Credit, and Economic Cycles
expert Antonio Ferrer Sama has explained that if the deposit
consists of an amount of money and the obligation to return
the same amount (irregular deposit), and the depositary takes
the money and uses it for his own profit, we will have to
determine which of the following situations is the correct
one in order to determine his criminal liability: at the time
he takes the money the depositary has sufficient financial
stability to return at any moment the amount received in
deposit; or, on the contrary, at the time he takes the money
he does not have enough cash of his own with which to meet his
obligation to return the depositor’s money at any moment he
requests it. In the first case the offense of misappropriation
has not been committed. However, if at the time the deposi-
tary takes the deposited amount he does not have enough
cash in his power to fulfill his obligations to the depositor,
he is guilty of misappropriation
from the very moment he takes the goods deposited for his
own use and ceases to possess a tantundem equivalent to the
original deposit.10
10Antonio Ferrer Sama, El delito de apropiación indebida (Murcia: Publica-
ciones del Seminario de Derecho Penal de la Universidad de Murcia,
Editorial Sucesores de Nogués, 1945), pp. 26–27. As we indicated in the
text and Eugenio Cuello Calón also explains (Derecho penal, Barcelona:
Editorial Bosch, 1972, tome 2, special section, 13th ed, vol. 2, pp. 952–53),
the crime is committed the moment it is established that appropriation
or embezzlement has occurred, and the offense actually derives from
the intention of committing the appropriation. Due to their private
nature, these intentions must be perceived by the result of external acts
(like the alienation, consumption or lending of the good). These deeds
generally take place long before the discovery is made by the depositor
who, when he tries to withdraw his deposit, is surprised to find that the
depositary is not able to immediately hand over to him the correspon-
ding tantundem. Miguel Bajo Fernández, Mercedes Pérez Manzano, and
Carlos Suárez González (Manual de derecho penal, special section, “Deli-
tos patrimoniales y económicos” [Madrid: Editorial Centro de Estudios
Ramón Areces, 1993]) also conclude that the offense is committed the
very moment the act of disposal takes place, no matter what the subse-
quent effects are, and continues to be a crime even when the object is
recovered or the perpetrator fails to profit from the appropriation,
regardless of whether the depositary is able to return the tantundem the

The Legal Nature of the Monetary Irregular-Deposit Contract 11
COURT DECISIONS ACKNOWLEDGING THE FUNDAMENTAL LEGAL
PRINCIPLES WHICH GOVERN THE MONETARY IRREGULAR-DEPOSIT
CONTRACT (100-PERCENT RESERVE REQUIREMENT)
As late as the twentieth century, court decisions in Europe
have upheld the demand for a 100-percent reserve require-
ment, the embodiment of the essential element of custody and
safekeeping in the monetary irregular deposit. On June 12,
1927, the Court of Paris convicted a banker for the crime of
misappropriation for having used, as was the common practice
in banking, funds deposited with him by a client. On January
4, 1934, another ruling of the same court maintained the same
position.11 In addition, when the Bank of Barcelona failed in
moment it is required (p. 421). The same authors contend that there exists
an unacceptable legal loophole in Spanish criminal law, compared to
other legal systems containing
specific provisions for corporate crimes and breach of trust,
under which it would be possible to include the unlawful
behaviors of banks with respect to the irregular deposit of
checking accounts. (p. 429)
In Spanish criminal law, the article governing misappropriation is arti-
cle 252 (mentioned by Antonio Ferrer Sama) of the new 1996 Penal Code
(article 528 of the former), which states:
The penalties specified in article 249 or 250 will be applied to
anyone who, to the detriment of another, appropriates or
embezzles money, goods, securities or any other movable
property or patrimonial asset which he has received on
deposit, on consignment or in trust, or by way of another
claim carrying the obligation to deliver or return the property,
or who denies having received it, when the amount appro-
priated exceeds 300 euros. These penalties will be increased
by 50 percent in the case of a necessary deposit.
Finally, the most thorough work on the criminal aspects of the misap-
propriation of money, which covers in extenso the position of Professors
Ferrer Sama, Bajo Fernández, and others, is by Norberto J. de la Mata
Barranco, Tutela penal de la propiedad y delitos de apropiación: el dinero como
objeto material de los delitos de hurto y apropiación indebida (Barcelona: Pro-
mociones y Publicaciones Universitarias [PPU, Inc.], 1994), esp. pp.
407–08 and 512.
11These judicial rulings appear in Jean Escarra’s Principes de droit com-
mercial, p. 256; Garrigues also refers to them in Contratos bancarios, pp.
367–68.

12
Money, Bank Credit, and Economic Cycles
Spain, Barcelona’s northern court of original jurisdiction, in
response to protests of checking-account holders demanding
recognition as depositors, pronounced a judgment acknowledg-
ing them as such and identifying their consequent preferential
status as creditors of a bankruptcy claiming title to some of the
assets. The decision was based on the fact that the right of
banks to use cash from checking accounts is necessarily
restricted by the obligation to maintain the uninterrupted
availability of these account funds to the checking-account
holder. As a result, this legal restriction on availability ruled
out the possibility that the bank could consider itself exclusive
owner of funds deposited in a checking account.12 Though the
Spanish Supreme Court did not have the opportunity to rule
on the failure of the Bank of Barcelona, a decision pronounced
by it on June 21, 1928 led to a very similar conclusion:
According to the commercial practices and customs recog-
nized by jurisprudence, the monetary deposit contract con-
sists of the deposit of money with a person who, though he
does not contract the obligation to retain for the depositor
the same cash or assets handed over, must maintain posses-
sion of the amount deposited, with the purpose of returning it, par-
tially or in its entirety, the moment the depositor should claim it;
the depositary does not acquire the right to use the deposit for his
own purposes, since, as he is obliged to return the deposit the
moment it is requested of him, he must maintain constant posses-
sion of sufficient cash to do so.13
12“Dictamen de Antonio Goicoechea,” in La Cuenta corriente de efectos o
valores de un sector de la banca catalana y el mercado libre de valores de
Barcelona (Madrid: Imprenta Delgado Sáez, 1936), pp. 233–89, esp. pp.
263–64. Garrigues also refers to this ruling in Contratos bancarios, p.
368.
13José Luis García-Pita y Lastres cites this decision in his paper, “Los
depósitos bancarios de dinero y su documentación,” which appeared in
La revista de derecho bancario y bursátil (Centro de Documentación Ban-
caria y Bursátil, October–December 1993), pp. 919–1008, esp. p. 991.
Garrigues also makes reference to this ruling in Contratos bancarios, p.
387.

The Legal Nature of the Monetary Irregular-Deposit Contract 13
3
THE ESSENTIAL DIFFERENCES BETWEEN THE
IRREGULAR DEPOSIT CONTRACT AND THE
MONETARY LOAN CONTRACT
It is now important to review and stress the fundamental
differences between the irregular deposit contract and the
loan contract, both with respect to money. As we will see later
in different contexts, much of the confusion and many of the
legal and economic errors surrounding our topic derive from
a lack of understanding of the essential differences between
these two contracts.
THE EXTENT TO WHICH PROPERTY RIGHTS ARE
TRANSFERRED IN EACH CONTRACT
To begin with, it is necessary to point out that the inability
to clearly distinguish between the irregular deposit and the
loan arises from the excessive and undue importance given to
the fact that, as we already know, in the irregular deposit of
money or of any other fungible good we may consider that the
ownership of the deposited good is transferred to the deposi-
tary, “just as” in the loan or mutuum contract. This is the only
similarity between the two types of contract and it has led
many scholars to confuse them without reason.
We have already seen that in the irregular deposit the
transfer of “ownership” is a secondary requirement arising
from the fact that the object of the deposit is a fungible good
which cannot be handled individually. We also know there are
many advantages to putting a deposit together with other sets
of the same fungible good and treating the individual units
indistinctly. Indeed, as one may not, in strictly legal terms,
demand the return of the specific items deposited, since this is
a physical impossibility, it may appear necessary to consider
that a “transfer” of ownership occurs with regard to the individ-
ual, specific units deposited, as these are indistinguishable from
one another. So the depositary becomes the “owner,” but only
in the sense that, for as long as he continues to hold the tan-
tundem, he is free to allocate the particular, indistinguishable
units as he chooses. This is the full extent to which property

14
Money, Bank Credit, and Economic Cycles
rights are transferred in the irregular deposit, unlike the loan
contract, where complete availability of the loaned good is
transferred for the duration of the contract’s term. Therefore,
even given the one feasible “similarity” between the irregular
deposit and the monetary loan (the supposed “transfer” of
ownership), it is important to understand that this transfer of
ownership has a very different economic and legal meaning in
each contract. Perhaps, as we explained in footnote number
five, it would even be wisest to hold that in the irregular
deposit there is no transfer of ownership, but rather that the
depositor at all times maintains ownership over the tantundem
in an abstract sense.
FUNDAMENTAL ECONOMIC DIFFERENCES
BETWEEN THE TWO CONTRACTS
This variation in legal content stems from the essential dif-
ference between the two contracts, which in turn derives from
the distinct economic foundation on which each is based. Thus,
Ludwig von Mises, with his habitual clarity, points out that if
the loan
in the economic sense means the exchange of a present good
or a present service against a future good or a future service,
then it is hardly possible to include the transactions in ques-
tion [irregular deposits] under the conception of credit. A
depositor of a sum of money who acquires in exchange for it
a claim convertible into money at any time which will per-
form exactly the same service for him as the sum it refers to,
has exchanged no present good for a future good. The claim
that he has acquired by his deposit is also a present good for
him. The depositing of the money in no way means that he
has renounced immediate disposal over the utility that it
commands.
He concludes that the deposit “is not a credit transaction,
because the essential element, the exchange of present goods
for future goods, is absent.”14
14Ludwig von Mises, The Theory of Money and Credit (Indianapolis, Ind.:
Liberty Classics, 1980), pp. 300–01. This is the best English edition of H.E.
Batson’s translation of the second German edition (published in 1924) of

The Legal Nature of the Monetary Irregular-Deposit Contract 15
Therefore, in the monetary irregular deposit there is no
relinquishment of present goods in favor of a larger quantity
of future goods at the end of a time period, but rather simply
a change in the manner of possessing present goods. This
change occurs because under many circumstances the depos-
itor finds it more advantageous from a subjective standpoint
(that is, more conducive to his goals) to make a monetary
irregular deposit in which the actual good deposited is mixed
with others of the same sort and treated indistinguishably
from them. Among other advantages, we have already men-
tioned an insurance against the risk of loss due to inevitable
accident and the opportunity to use the cashier services pro-
vided by banks to customers with a checking account. In con-
trast, the essence of the loan contract is radically dissimilar.
The aim of the loan contract is precisely to cede today the avail-
ability of present goods to the borrower for his use, in order to
obtain in the future a generally larger quantity of goods in
exchange at the end of the term set in the contract. We say
“generally larger” because, given the logical time preference
inherent in all human actions, which indicates that, other
things being equal, present goods are always preferable to
future goods, it is necessary to add to the future goods a dif-
ferential amount in the form of interest. Otherwise, it would
be difficult to find anyone willing to give up the availability of
present goods, which is a requirement of every loan.
Hence, from an economic viewpoint the difference
between the two contracts is quite clear: the irregular deposit
contract does not entail the exchange of present goods for
future goods, while the loan contract does. As a result, in the
irregular deposit the availability of the good is not transferred,
but rather the good remains continuously available to the
depositor (despite the fact that in a sense “ownership” has
been shifted from a legal standpoint), while in the loan con-
tract there is always a transfer of availability from the lender
to the borrower. Furthermore, the loan contract usually
includes an interest agreement, whereas in the monetary
Theorie des Geldes und der Umlaufsmittel, published by Duncker and Hum-
blot in Munich and Leipzig. The first edition was published in 1912.

16
Money, Bank Credit, and Economic Cycles
irregular-deposit contract, interest agreements are contra natu-
ram and absurd. Coppa-Zuccari, with his customary insight,
explains that the absolute impossibility of including an inter-
est agreement in the irregular deposit contract is, from a legal
viewpoint, a direct result of the right granted the depositor to
withdraw the deposit at any time, and the depositary’s corre-
sponding obligation to maintain the associated tantundem con-
stantly available to the depositor.15 Ludwig von Mises also
indicates that it is possible for the depositor to make deposits
without demanding any type of interest precisely because
the claim obtained in exchange for the sum of money is
equally valuable to him whether he converts it sooner or
later, or even not at all; and because of this it is possible for
him, without damaging his economic interests, to acquire
such claims in return for the surrender of money without
demanding compensation for any difference in value arising
from the difference in time between payment and repay-
ment, such, of course, as does not in fact exist.16
Given the economic foundation of the monetary irregular-
deposit contract, which does not imply the exchange of pres-
ent goods for future goods, the uninterrupted availability in
favor of the depositor and the incompatibility with an interest
agreement arise logically and directly from the legal essence
15
Conseguenza immediata del diritto concesso al deponente di
ritirare in ogni tempo il deposito e del correlativo obbligo del
depositario di renderlo alla prima richiesta e di tenere sempre
a disposizione del deponente il suo tantundem nel deposito
irregolare, è l’impossibilità assoluta per il depositario di cor-
rispondere interessi al deponente. (Coppa-Zuccari, Il deposito
irregolare, p. 292)
Coppa-Zuccari also points out that this incompatibility between the
irregular deposit and the payment of interest does not apply, as is logi-
cal, to the completely separate case where interest is awarded because
the depositary fails to return the money upon request, thus becoming a
defaulter. As a result, the concept of depositum confessatum was, as we
shall see, systematically used throughout the Middle Ages as a legal ploy
to bypass the canonical prohibition on the charging of interest on loans.
16Mises, The Theory of Money and Credit, p. 301.

The Legal Nature of the Monetary Irregular-Deposit Contract 17
of the irregular deposit contract, which contrasts sharply with
the legal essence of the loan contract.17
FUNDAMENTAL LEGAL DIFFERENCES BETWEEN
THE TWO CONTRACTS
The essential legal element in the irregular deposit con-
tract is the custody or safekeeping of the money deposited. To
the parties deciding to make or receive an irregular deposit,
this is the most important aim or purpose of the contract,18 and
it varies greatly from the essential purpose of the loan con-
tract, which is the transfer of the availability of the loaned good
to the borrower so he can use it for a period of time. Two other
important legal differences arise from this essential dissimilar-
ity in purpose between the two types of contract. First, the
irregular deposit contract lacks a term, the essential element
identifying a loan contract. Indeed, while it is impossible to
17The fact that interest agreements are incompatible with the monetary
irregular-deposit contract does not mean the latter should be free of
charge. Indeed, in keeping with its very nature, the irregular deposit
usually includes the stipulation of payment by the depositor to the
depositary of a certain amount for the costs of guarding the deposit or
maintaining the account. The payment of interest is a reasonable indi-
cation that the essential obligation of safekeeping in the irregular
deposit contract is almost certainly being violated and that the deposi-
tary is using the money of his depositors for his own benefit, misappro-
priating part of the tantundem which he should keep available at all
times to the depositors.
18J. Dabin, La teoría de la causa: estudio histórico y jurisprudencial, trans-
lated by Francisco de Pelsmaeker and adapted by Francisco Bonet
Ramón, 2nd ed. (Madrid: Editorial Revista de Derecho Privado, 1955),
pp. 24 and on. That the purpose of the irregular deposit contract is cus-
tody or safekeeping and is different from the object of the loan contract
is recognized even by authors who, like García-Pita or Ozcáriz-Marco,
still do not accept that the unavoidable, logical consequence of its pur-
pose of safekeeping is a 100-percent reserve requirement for bank
demand deposits. See José Luis García-Pita y Lastres, “Depósitos ban-
carios y protección del depositante,” Contratos bancarios (Madrid: Cole-
gios Notariales de España, 1996), pp. 119–266, and esp. 167–91; and Flo-
rencio Ozcáriz Marco, El contrato de depósito: estudio de la obligación de
guarda (Barcelona: J.M. Bosch Editor, 1997), pp. 37 and 47.

18
Money, Bank Credit, and Economic Cycles
imagine a monetary loan contract without a fixed term (during
which not only is ownership transferred, but availability is lost
to the lender as well), at the end of which it is necessary to
return the tantundem of money originally loaned plus interest,
in the irregular deposit contract there is no term whatsoever, but
rather there is continuous availability in favor of the depositor,
who may withdraw his tantundem at any time.19 The second
essential legal difference refers to the obligations of the two par-
ties: in the irregular deposit contract the legal obligation
implied by the nature of the contract consists, as we know, of
the conscientious custody or safekeeping (as would be expected of
a good parent) of the tantundem, which is kept continually avail-
able to the depositor.20 In the loan contract this obligation does
not exist, and the borrower may use the loaned amount with
total freedom. Indeed, when we speak of the legal “transfer of
ownership” in the two contracts, we allude to two very dis-
similar concepts. Whereas the “transfer” of ownership in the
19Civil law experts unanimously agree that a term is essential to a loan
contract, unlike an irregular deposit contract, which has no term. Manuel
Albaladejo emphasizes that the mutuum contract concludes and the
loan must be given back at the end of the term (for example, see article
1125 of the Spanish Civil Code). He even indicates that if a term has not
been explicitly designated, then the intention to set one for the debtor
must always be assumed, since a term is required by the essential nature of
the loan contract. In this case a third party (the courts) must be allowed
to stipulate the corresponding term (this is the solution adopted in arti-
cle 1128 of the Spanish Civil Code). See Albaladejo, Derecho civil II, Dere-
cho de obligaciones, vol. 2, p. 317.
20Clearly, it is the tantundem which is kept continually available to the
depositor, and not the same specific units deposited. In other words,
even though ownership of the concrete physical units deposited is
transferred and they may be used, the depositary does not gain any real
availability, since what he gains with respect to the specific units
received is exactly compensated by the necessary loss of the equivalent
availability regarding other specific units already in his power, and this
necessity stems from the obligation to keep the tantundem constantly
available to the depositor. In the monetary deposit contract, this con-
stant availability to the depositor is usually referred to by the expression
“on demand,” which illustrates the essential, unmistakable purpose of
the checking account or “demand” deposit contract: to keep the tantun-
dem continually available to the depositor.

The Legal Nature of the Monetary Irregular-Deposit Contract 19
TABLE 1-1
ESSENTIAL DIFFERENCES BETWEEN TWO
RADICALLY DISTINCT CONTRACTS
Monetary Irregular Deposit
Monetary Loan
Economic Differences
1. Present goods are not
1.
Present goods are
exchanged for future
exchanged for future
goods.
goods.
2. There is complete, contin-
2. Full availability is
uous availability in favor
transferred from lender
of the depositor.
to borrower.
3. There is no interest, since
3. There is interest, since
present goods are not
present goods are
exchanged for future
exchanged for future
goods.
goods.
Legal Differences
1.
The essential element
1.
The essential element is
(and the depositor’s main
the transfer of avail-
motivation) is the custody
ability of the present
or safekeeping of the tan-
goods to the borrower.
tundem.
2.
The contract requires
2.
There is no term for
the establishment of a
returning the money, but
term for the return of
rather the contract is “on
the loan and calcula-
demand.”
tion and payment of
3.
The depositary’s obliga-
interest.
tion is to keep the tantun-
3.
The borrower’s obliga-
dem available to the
tion is to return the
depositor at all times
tantundem at the end of
(100-percent cash
the term and to pay the
reserve).
agreed-upon interest.

20
Money, Bank Credit, and Economic Cycles
irregular deposit contract (which could be considered a
requirement of the fungible nature of the deposited goods)
does not imply a simultaneous transfer of availability of the
tantundem, in the loan contract there is a complete transfer of
ownership and availability of the tantundem from lender to
borrower.21 The differences covered in this section are out-
lined in Table 1-1.
4
THE DISCOVERY BY ROMAN LEGAL EXPERTS OF THE
GENERAL LEGAL PRINCIPLES GOVERNING THE
MONETARY IRREGULAR-DEPOSIT CONTRACT
THE EMERGENCE OF TRADITIONAL LEGAL PRINCIPLES
ACCORDING TO MENGER, HAYEK, AND LEONI
The traditional, universal legal principles we dealt with in
the last section in relation to the irregular deposit contract
have not emerged in a vacuum, nor are they the result of a pri-
ori knowledge. The concept of law as a series of rules and
institutions to which people constantly, perpetually and cus-
tomarily adapt their behavior has been developed and refined
21At this point it is important to draw attention to the “time deposit”
contract, which possesses the economic and legal characteristics of a
true loan, not those of a deposit. We must emphasize that this use of ter-
minology is misleading and conceals a true loan contract, in which pres-
ent goods are exchanged for future goods, the availability of money is
transferred for the duration of a fixed term and the client has the right to
receive the corresponding interest. This confusing terminology makes it
even more complicated and difficult for citizens to distinguish between
a true (demand) deposit and a loan contract (involving a term). Certain
economic agents have repeatedly and selfishly employed these terms to
take advantage of the existent confusion. The situation degenerates fur-
ther when, as quite often occurs, banks offer time “deposits” (which
should be true loans) that become de facto “demand” deposits, as the
banks provide the possibility of withdrawing the funds at any time
without penalty.

The Legal Nature of the Monetary Irregular-Deposit Contract 21
through a repetitive, evolutionary process. Perhaps one of Carl
Menger’s most important contributions was the development
of a complete economic theory of social institutions. According
to his theory, social institutions arise as the result of an evolu-
tionary process in which innumerable human beings interact,
each one equipped with his own small personal heritage of sub-
jective knowledge, practical experiences, desires, concerns,
goals, doubts, feelings, etc. By means of this spontaneous evo-
lutionary process, a series of behavior patterns or institutions
emerges in the realms of economics and language, as well as
law, and these behaviors make life in society possible. Menger
discovered that institutions appear through a social process
composed of a multiplicity of human actions, which is always
led by a relatively small group of individuals who, in their par-
ticular historical and geographical circumstances, are the first
ones to discover that certain patterns of behavior help them
attain their goals more efficiently. This discovery initiates a
decentralized trial and error process encompassing many gen-
erations, in which the most effective behavior patterns gradu-
ally become more widespread as they successfully counter
social maladjustments. Thus there is an unconscious social
process of learning by imitation which explains how the pio-
neering behavior of these most successful and creative individ-
uals catches on and eventually extends to the rest of society.
Also, due to this evolutionary process, those societies which
first adopt successful principles and institutions tend to spread
and prevail over other social groups. Although Menger devel-
oped his theory in relation to the origin and evolution of money,
he also mentions that the same essential theoretical framework
can be easily applied to the study of the origins and develop-
ment of language, as well as to our present topic, juridical insti-
tutions. Hence the paradoxical fact that the moral, juridical, eco-
nomic and linguistic institutions which are most important and
essential to man’s life in society are not of his own creation,
because he lacks the necessary intellectual might to assimilate
the vast body of random information that these institutions
generate. On the contrary, these institutions inevitably and
spontaneously emanate from the social processes of human

22
Money, Bank Credit, and Economic Cycles
interaction which Menger believes should be the main subject
of research in economics.22
Menger’s ideas were later developed by F.A. Hayek in
various works on the fundamentals of law and juridical insti-
tutions,23 and especially by the Italian professor of political
science, Bruno Leoni, who was the first to incorporate the fol-
lowing in a synoptic theory on the philosophy of law: the eco-
nomic theory of social processes developed by Menger and
the Austrian School, the most time-honored Roman legal tra-
dition, and the Anglo-Saxon tradition of rule of law. Indeed,
Bruno Leoni’s great contribution is having shown that the
Austrian theory on the emergence and evolution of social
institutions is perfectly illustrated by the phenomenon of com-
mon law and that it was already known and had been formu-
lated by the Roman classical school of law.24 Leoni, citing
22Carl Menger, Untersuchungen über die Methode der Socialwissenschaften
und der Politischen Ökonomie insbesondere (Leipzig: Duncker and Hum-
blot, 1883), esp. p. 182. (Investigations into the Method of the Social Sciences
with Special Reference to Economics [New York: New York University
Press, 1985]). Menger himself eloquently formulates this new question
which his proposed scientific research program for economics is
designed to answer:
How is it possible that the institutions which are most signif-
icant to and best serve the common good have emerged with-
out the intervention of a deliberate common will to create
them? (pp. 163–65)
The best and perhaps the most brilliant synopsis of Menger’s theory on
the evolutionary origin of money appears in his article, “On the Origin
of Money,” Economic Journal (June 1892): 239–55. This article has been
reprinted by Israel M. Kirzner in his Classics in Austrian Economics: A
Sampling in the History of a Tradition (London: William Pickering, 1994),
vol. 1, pp. 91–106.
23F.A. Hayek, The Constitution of Liberty (London: Routledge, 1st edition
[1960] 1990); Law, Legislation and Liberty (Chicago: University of Chicago
Press, 1978); and The Fatal Conceit: The Errors of Socialism (Chicago: Uni-
versity of Chicago Press, 1989).
24See Jesús Huerta de Soto, Estudios de economía política (Madrid: Unión
Editorial, 1994), chap. 10, pp. 121–28, and Bruno Leoni, Freedom and the
Law (Princeton, N.J.: D. Van Nostrand Company, 1961), essential reading
for all jurists and economists.

The Legal Nature of the Monetary Irregular-Deposit Contract 23
Cicero’s rendering of Cato’s words, specifically points out that
Roman jurists knew Roman law was not the personal inven-
tion of one man, but rather the creation of many over genera-
tions and centuries, given that
there never was in the world a man so clever as to foresee
everything and that even if we could concentrate all brains
into the head of one man, it would be impossible for him to
provide for everything at one time without having the experi-
ence that comes from practice through a long period of his-
tory.25
In short, it was Leoni’s opinion that law emerges as the
result of a continuous trial-and-error process, in which each
25
Nostra autem res publica non unius esset ingenio, sed multo-
rum, nec una hominis vita, sed aliquod constitutum saeculis
et aetatibus, nam neque ullum ingenium tantum extitisse
dicebat, ut, quem res nulla fugeret, quisquam aliquando fuis-
set, neque cuncta ingenia conlata in unum tantum posse uno
tempore providere, ut omnia complecterentur sine rerum usu
ac vetustate. (Marcus Tullius Cicero, De re publica, 2, 1–2
[Cambridge, Mass.: The Loeb Classical Library, 1961], pp.
111–12. See Leoni, Freedom and the Law, p. 89)
Leoni’s book is by all accounts exceptional. Not only does he reveal the
parallelism between the market and common law on the one hand, and
socialism and legislation on the other, but he is also the first jurist to rec-
ognize Ludwig von Mises’s argument on the impossibility of socialist
economic calculation as an illustration of
a more general realization that no legislator would be able to
establish by himself, without some kind of continuous collab-
oration on the part of all the people concerned, the rules gov-
erning the actual behavior of everybody in the endless rela-
tionships that each has with everybody else. (pp. 18–19)
For information on the work of Bruno Leoni, founder of the prestigious
journal Il Politico in 1950, see Omaggio a Bruno Leoni, Pasquale
Scaramozzino, ed. (Milan: Ed. A. Guiffrè, 1969), and the article “Bruno
Leoni in Retrospect” by Peter H. Aranson, Harvard Journal of Law and
Public Policy (Summer, 1988). Leoni was multifaceted and extremely
active in the fields of university teaching, law, business, architecture,
music, and linguistics. He was tragically murdered by one of his tenants
while trying to collect the rent on the night of November 21, 1967. He
was fifty-four years old.

24
Money, Bank Credit, and Economic Cycles
individual takes into account his own circumstances and the
behavior of others and the law is perfected through a selective
evolutionary process.26
ROMAN JURISPRUDENCE
The greatness of classical Roman jurisprudence stems pre-
cisely from the realization of this important truth on the part
of legal experts and the continual efforts they dedicated to
study, interpretation of legal customs, exegesis, logical analy-
sis, the tightening of loopholes and the correction of flaws; all
of which they carried out with the necessary standards of
prudence and equanimity.27 The occupation of classical jurist
was a true art, of which the constant aim was to identify and
define the essence of the juridical institutions that have devel-
oped throughout society’s evolutionary process. Furthermore,
classical jurists never entertained pretensions of being “origi-
nal” or “clever,” but rather were “the servants of certain fun-
damental principles, and as Savigny pointed out, herein lies
their greatness.”28 Their fundamental objective was to dis-
cover the universal principles of law, which are unchanging
and inherent in the logic of human relationships. It is true,
however, that social evolution itself often necessitates the
26In the words of Bruno Leoni, law is shaped by
una continua serie de tentativi, che gli individui compiono
quando pretendono un comportamento altrui, e si affidano al
propio potere di determinare quel comportamento, qualora
esso non si determini in modo spontaneo. (Bruno Leoni,
“Diritto e politica,” in his book Scritti di scienza politica e teoria
del diritto [Milan: A. Giuffrè, 1980], p. 240)
27In fact, the interpreter of the ius was the prudens, that is, the legal
expert or iuris prudens. It was his job to reveal the law. Jurists provided
advice and assistance to individuals and instructed them in business
practices and types of contracts, offered answers to their questions and
informed judges and magistrates. See Juan Iglesias, Derecho romano:
Instituciones de derecho privado, 6th rev. ed. (Barcelona: Ediciones Ariel,
1972), pp. 54–55.
28Iglesias, Derecho romano: Instituciones de derecho privado, p. 56. And esp.
Rudolf von Ihering, El espíritu del derecho romano, Clásicos del Pensamiento
Jurídico (Madrid: Marcial Pons, 1997), esp. pp. 196–202 and 251–53.

The Legal Nature of the Monetary Irregular-Deposit Contract 25
application of these unchanging universal principles to new
situations and problems arising continually from this evolu-
tionary process.29 In addition, Roman jurists worked inde-
pendently and were not civil servants. Despite multiple
attempts by official legal experts in Roman times, they were
never able to do away with the free practice of jurisprudence,
nor did the latter lose its enormous prestige and independence.
Jurisprudence, or the science of law, became an independ-
ent profession in the third century B.C. The most important
jurists prior to our era were Marcus Porcius Cato and his son
Cato Licianus, the consul Mucius Scaevola, and the jurists
Quintus Mucius Scaevola, Servius Surpicius Rufus, and
Alfenus Varus. Later, in the second century A.D., the classical
era began and the most important jurists during that time
were Gaius, Pomponius, Africanus, and Marcellus. In the
third century their example was followed by Papinian, Paul,
Ulpian, and Modestinus, among other jurists. From this time
onward, the solutions offered by these independent jurists
received such great prestige that the force of law was attached
to them; and to prevent the possibility of difficulties arising
from differences of opinion in the jurists’ legal writings, the
force of law was given to the works of Papinian, Paul, Ulpian,
Gaius, and Modestinus, and to the doctrines of jurists cited by
them, as long as these references could be confirmed upon
comparison with original writings. If these authors were in
disagreement, the judge was compelled to follow the doctrine
defended by the majority; and in the case of a tie, the opinion
of Papinian was to prevail. If he had not communicated his
opinion on an issue, the judge was free to decide.30
29
The occupation of interpretatio was intimately related to the
role of advisor to individuals, magistrates, and judges, and
consisted of applying time-honored principles to new needs;
this meant an expansion of the ius civile, even when no new
institutions were formally created. (Francisco Hernández-
Tejero Jorge, Lecciones de derecho romano [Madrid: Ediciones
Darro, 1972], p. 30)
30This force of law was first acquired in a constitution from the year 426,
known as the Citation Law of Theodosius and Valentinianus III. See
Hernández-Tejero Jorge, Lecciones de derecho romano, p. 3.

26
Money, Bank Credit, and Economic Cycles
Roman classical jurists deserve the credit for first discov-
ering, interpreting, and perfecting the most important juridi-
cal institutions that make life in society possible, and as we
will see, they had already recognized the irregular deposit
contract, understood the essential principles governing it, and
outlined its content and essence as explained earlier in this
chapter. The irregular deposit contract is not an intellectual,
abstract creation. It is a logical outcome of human nature as
expressed in multiple acts of social interaction and coopera-
tion, and it manifests itself in a set of principles which cannot
be violated without grave consequences to the network of
human relationships. The great importance of law in this evo-
lutionary sense, distilled and rid of its logical flaws through
the science of legal experts, lies in the guidance it provides
people in their daily lives; though in most cases, due to its
abstract nature, people may not be able to identify or under-
stand the complete specific function of each juridical institu-
tion. Only recently in the historical evolution of human
thought has it been possible to understand the laws of social
processes and gain a meager grasp on the role of the differ-
ent juridical institutions in society, and the contributions of
economics have been mostly responsible for these realiza-
tions. One of our most important objectives is to carry out an
economic analysis of social consequences resulting from the
violation of the universal legal principles regulating the mon-
etary irregular-deposit contract. In chapter 4 we will begin this
theoretical economic analysis of a juridical institution (the
monetary bank-deposit contract).
The knowledge we have today of universal legal princi-
ples as they were discovered by Roman jurists comes to us
through the work of the emperor Justinian, who in the years
528–533 A.D. made an enormous effort to compile the main
contributions of classical Roman jurists and recorded them in
three books (the Institutiones, the Digest, and the Codex Consti-
tutionum, later completed by a fourth book, the Novellae),
which, since the edition of Dionysius Gottfried,31 are known
as the Corpus Juris Civilis. The Institutiones is an essential work
31Corpus Juris Civilis (Geneva: Dionysius Gottfried, 1583).

The Legal Nature of the Monetary Irregular-Deposit Contract 27
directed at students and based on Gaius’s Institutiones. The
Digest or Pandecta is a compilation of classical legal texts which
includes over nine thousand excerpts from the works of differ-
ent prestigious jurists. Passages taken from the works of
Ulpian, which comprise a third of the Digest, together with
excerpts from Paul, Papinian, and Julianus, fill more of the book
than the writings of all of the rest of the jurists as a group. In all,
contributions appear from thirty-nine specialists in Roman clas-
sical law. The Codex Constitutionum consists of a chronologi-
cally-ordered collection of imperial laws and constitutions (the
equivalent of the present-day concept of legislation), and Novel-
lae, the last work in the Corpus, contains the last imperial con-
stitutions subsequent to the Codex Constitutionum.32
Now let us follow up this brief introduction by turning to
the Roman classical jurists and their treatment of the institu-
tion of monetary irregular deposit. It is clear they understood
it, considered it a special type of deposit possessing the essen-
tial deposit characteristics and differentiated it from other
contracts of a radically different nature and essence, such as
the mutuum contract or loan.
THE IRREGULAR DEPOSIT CONTRACT UNDER ROMAN LAW
The deposit contract in general is covered in section 3 of
book 16 of the Digest, entitled “On Depositing and Withdraw-
ing” (Depositi vel contra). Ulpian begins with the following def-
inition:
A deposit is something given another for safekeeping. It is so
called because a good is posited [or placed]. The preposition de
32Justinian stipulated that the necessary changes be made in the com-
piled materials so that the law would be appropriate to the historical
circumstances and as close to perfect as possible. These modifications,
corrections and omissions are called interpolations and also emblemata
Triboniani, after Tribonian, who was in charge of the compilation. There
is an entire discipline dedicated to the study of these interpolations, to
determining their content through comparison, logical analysis, the
study of anachronisms in language, etc., since it has been discovered
that a substantial number of them were made after the Justinian era. See
Hernández-Tejero Jorge, Lecciones de derecho romano, pp. 50–51.

28
Money, Bank Credit, and Economic Cycles
intensifies the meaning, which reflects that all obligations cor-
responding to the custody of the good belong to that person.33
A deposit can be either regular, in the case of a specific
good; or irregular, in the case of a fungible good.34 In fact, in
number 31, title 2, book 19 of the Digest, Paul explains the dif-
ference between the loan contract or mutuum and the deposit
contract of a fungible good, arriving at the conclusion that
if a person deposits a certain amount of loose money, which
he counts and does not hand over sealed or enclosed in
something, then the only duty of the person receiving it is to
return the same amount.35
33Ulpian, a native of Tyre (Phoenicia), was advisor to another great
jurist, Papinian, and together with Paul, he was an advising member of
the concilium principis and praefectus praetorio under Alexander Severus.
He was murdered in the year 228 by the Praetorians. He was a very pro-
lific writer who was better known for his knowledge of juridical litera-
ture than for his creative work. He wrote clearly and was a good com-
piler and his writings are regarded with special favor in Justinian’s
Digest, where they comprise the main part. On this topic see Iglesias,
Derecho romano: Instituciones de derecho privado, p. 58. The passage cited
in the text is as follows in Latin:
Depositum est, quod custodiendum alicui datum est, dictum
ex eo, quod ponitur, praepositio enim de auget depositum, ut
ostendat totum fidei eius commissum, quod ad custodiam rei
pertinet. (See Ildefonso L. García del Corral, ed., Cuerpo de
derecho civil romano, 6 vols. [Valladolid: Editorial Lex Nova,
1988], vol. 1, p. 831)
34However, as Pasquale Coppa-Zuccari astutely points out, the expres-
sion depositum irregolare did not appear until it was first used by Jason
de Maino, a fifteenth century annotator of earlier works, whose writ-
ings were published in Venice in the year 1513. See Coppa-Zuccari, Il
deposito irregolare, p. 41. Also, the entire first chapter of this important
work deals with the treatment under Roman law of the irregular
deposit, pp. 2–32. For an excellent, current treatment in Spanish of bib-
liographic sources on the irregular deposit in Rome, see Mercedes
López-Amor y García’s article, “Observaciones sobre el depósito irreg-
ular romano,” in the Revista de la Facultad de Derecho de la Universidad
Complutense 74 (1988–1989): 341–59; and also Alicia Valmaña Ochaita, El
depósito irregular en la jurisprudencia romana (Madrid: Edisofer, 1996).
35This is actually a summary by Paul of Alfenus Varus’s Digest. Alfenus
Varus was consul in the year 39 A.D. and the author of forty books of the
Digest. Paul, in turn, was a disciple of Scaevola and an advisor to Papinian

The Legal Nature of the Monetary Irregular-Deposit Contract 29
In other words, Paul clearly indicates that in the monetary
irregular deposit the depositary’s only obligation is to return
the tantundem: the equivalent in quantity and quality of the
original deposit. Moreover, whenever anyone made an irreg-
ular deposit of money, he received a written certificate or
deposit slip. We know this because Papinian, in paragraph 24,
title 3, book 16 of the Digest, says in reference to a monetary
irregular deposit,
I write this letter by hand to inform you, so that you will know,
that the one hundred coins you have entrusted to me today
through Sticho, the slave and administrator, are in my pos-
session and I will return them to you immediately, when-
ever and wherever you wish.
This passage reveals the immediate availability of the
money to the depositor and the custom of giving him a
deposit slip or receipt certifying a monetary irregular deposit,
which not only established ownership, but also had to be pre-
sented upon withdrawal.36
during the time Papinian was a member of the imperial council under
Severus and Caracalla. He was a very ingenious, learned figure and the
author of numerous writings. The passage cited in the text is as follows
in Latin:
Idem iuris esse in deposito; nam si quis pecuniam numeratam
ita deposuisset ut neque clausam, neque obsignatam traderet,
sed adnumeraret, nihil aliud eum debere, apud quem
deposita esset, nisi tantundem pecuniae solvere. (See Ildefonso
L. García del Corral, ed., Cuerpo de derecho civil romano, 6 vols.
[Valladolid: Editorial Lex Nova, 1988], vol. 1, p. 963)
36Papinian, a native of Syria, was Praefectus Praetorio beginning in the
year 203 A.D. and was sentenced to death by the emperor Caracalla in
the year 212 for refusing to justify the murder of his brother, Geta. He
shared with Julianus the reputation for being the most notable of Roman
jurists, and according to Juan Iglesias, “His writings are remarkable for
their astuteness and pragmatism, as well as for their sober style” (Dere-
cho romano: Instituciones de derecho privado, p. 58). The passage cited in the
text is as follows in Latin:
centum numos, quos hac die commendasti mihi annumerante
servo Sticho actore, esse apud me, ut notum haberes, hac epi-
tistola manu mea scripta tibi notum facio; quae quando volis,
et ubi voles, confestim tibi numerabo. (García del Corral, ed.,
Cuerpo de derecho civil romano, vol. 1, p. 840)

30
Money, Bank Credit, and Economic Cycles
The essential obligation of depositaries is to maintain the
tantundem constantly available to depositors. If for some reason
the depositary goes bankrupt, the depositors have absolute
privilege over any other claimants, as Ulpian skillfully explains
(paragraph 2, number 7, title 3, book 16 of the Digest):
Whenever bankers are declared bankrupt, usually
addressed first are the concerns of the depositors; that is,
those with money on deposit, not those earning interest on
money left with the bankers. So, once the goods have been
sold, the depositors have priority over those with privileges,
and those who received interest are not taken into account—
it is as if they had relinquished the deposit.37
Here Ulpian indicates as well that interest was considered
incompatible with the monetary irregular deposit and that
when bankers paid interest, it was in connection with a totally
different contract (in this case, a mutuum contract or loan to a
banker, which is better known today as a time “deposit” con-
tract).
As for the depositary’s obligations, it is expressly stated in
the Digest (book 47, title 2, number 78) that he who receives a
good on deposit and uses it for a purpose other than that for
which it was received is guilty of theft. Celsus also tells us in
the same title (book 47, title 2, number 67) that taking a
deposit with an intent to deceive constitutes theft. Paul
defines theft as “the fraudulent appropriation of a good to
gain a profit, either from the good itself or from its use or
possession; this is forbidden by natural law.”38 As we see, what
37
Quoties foro cedunt numularii, solet primo loco ratio haberi
depositariorum, hoc est eorum, qui depositas pecunias
habuerunt, non quas foenore apud numularios, vel cum
numulariis, vel per ipsos exercebant; et ante privilegia igitur,
si bona venierint, depositariorum ratio habetur, dummodo
eorum, qui vel postea usuras acceperunt, ratio non habeatur,
quasi renuntiaverint deposito. (García del Corral, ed., Cuerpo
de derecho civil romano, vol. 1, p. 837)
38
Furtum est contrectatio rei fraudulosa, lucri faciendi gratia,
vel ipsius rei, vel etiam usus eius possessionisve; quod lege
naturali prohibitum est admittere. (Ibid., vol. 3, p. 645)

The Legal Nature of the Monetary Irregular-Deposit Contract 31
is today called the crime of misappropriation was included
under the definition of theft in Roman law. Ulpian, in reference
to Julianus, also concluded:
if someone receives money from me to pay a creditor of
mine, and, himself owing the same amount to the creditor,
pays him in his own name, he commits theft. (Digest, book
47, title 2, number 52, paragraph 16)39
In number 3, title 34 (on “the act of deposit”), book 4 of the
Codex Constitutionum of the Corpus Juris Civilis, which includes
the constitution established under the consulship of Gor-
dianus and Aviola in the year 239, the obligation to maintain
the total availability of the tantundem is even clearer, as is the
commission of theft when the tantundem is not kept avail-
able. In this constitution, the emperor Gordianus indicates to
Austerus,
if you make a deposit, you will with reason ask to be paid
interest, since the depositary should thank you for not holding
him responsible for theft, because he who knowingly and will-
ingly uses a deposited good for his own benefit, against the will
of the owner, also commits the crime of theft.40
Section 8 of the same source deals expressly with deposi-
taries who loan money received on deposit, thus using it for
their own benefit. It is emphasized that such an action violates
the principle of safekeeping, obligates depositaries to pay
interest, and makes them guilty of theft, as we have just seen
in the constitution of Gordianus. In this section we read:
If a person who has received money from you on deposit
loans it in his own name, or in the name of any other person,
39Ibid., p. 663.
40
Si depositi experiaris, non immerito etiam usuras tibi restitui
flagitabis, quum tibi debeat gratulari, quod furti eum actione
non facias obnoxium, siquidem qui rem depositam invito
domino sciens prudensque in usus suus converterit, etiam furti
delicto succedit. (Ibid., vol. 4, p. 490)

32
Money, Bank Credit, and Economic Cycles
he and his successors are most certainly obliged to carry out
the task accepted and to fulfill the trust placed in them.41
It is recognized, in short, that those who receive money on
deposit are often tempted to use it for themselves. This is
explicitly acknowledged elsewhere in the Corpus Juris Civilis
(Novellae, Constitution LXXXVIII, at the end of chapter 1),
along with the importance of properly penalizing these
actions, not only by charging the depositary with theft, but
also by holding him responsible for payment of interest on
arrears “so that, in fear of these penalties, men will cease to
make evil, foolish and perverse use of deposits.”42
Roman jurists established that when a depositary failed to
comply with the obligation to immediately return the tantun-
dem upon request, not only was he clearly guilty of the prior
crime of theft, but he was also liable for payment of interest on
arrears. Accordingly, Papinian states:
He who receives the deposit of an unsealed package of
money and agrees to return the same amount, yet uses this
money for his own profit, must pay interest for the delay in
returning the deposit.43
This perfectly just principle is behind the so-called deposi-
tum confessatum, which we will consider in greater detail in the
next chapter and refers to the evasion of the canonical prohibi-
tion on interest by disguising actual loan or mutuum contracts
41
Si is, qui depositam a te pecuniam accepit, eam suo nomine
vel cuiuslibet alterius mutuo dedit, tam ipsum de implenda
suscepta fide, quan eius successores teneri tibi, certissimum.
est. (Ibid., p. 491)
42“Ut hoc timore stultorum simul et perversorum maligne versandi cur-
sum in depositionibus homines cessent.” As is clear and we will later
expand upon, it had already been demonstrated that depositaries made
perverse use of money entrusted to them by their depositors. See ibid.,
vol. 6, pp. 310–11.
43
Qui pecuniam apud se non obsignatam, ut tantundem red-
deret, depositam ad usus propios convertit, post moram in
usuras quoque iudicio depositi condemnandus est. (Ibid., vol.
1, p. 841)

The Legal Nature of the Monetary Irregular-Deposit Contract 33
as irregular deposits and then deliberately delaying repay-
ment, thus authorizing the charging of interest. If these con-
tracts had from the beginning been openly regarded as loan or
mutuum contracts they would not have been permitted by
canon law.
Finally, we find evidence in the following extracts (among
others) that Roman jurists understood the essential difference
between the loan or mutuum contract and the monetary irreg-
ular-deposit contract: number 26, title 3, book 16 (passage by
Paul); number 9, point 9, title 1, book 12 of the Digest (excerpts
by Ulpian); and number 10 of the same title and book. How-
ever, the clearest and most specific statements to this effect
were made by Ulpian in section 2, number 24, title 5, book 42
of the Digest, in which he expressly concludes that “To loan is
one thing and to deposit is another,” and establishes
that once a banker’s goods have been sold and the concerns
of the privileged attended to, preference should be given
people who, according to attested documents, deposited
money in the bank. Nevertheless, those who have received
interest from the bankers on money deposited will not be
dealt with separately from the rest of the creditors; and with
good reason, since to loan is one thing and to deposit is
another.44
44
In bonis mensularii vendundis post privilegia potiorem
eorum causam esse placuit, qui pecunias apud mensam
fidem publicam secuti deposuerunt. Set enim qui depositis
numis usuras a mensulariis accepurunt, a ceteris creditoribus
non seperantur; et merito, aliud est enim credere, aliud
deponere. (Ibid., vol. 3, p. 386)
Papinian, for his part, states that if a depositary fails to comply with his
responsibilities, money to return deposits can be taken not only from
deposited funds found among the banker’s assets, but from all the
defrauder’s assets. The depositors’
privilege extends not only to deposited funds still among the
banker’s assets, but to all of the defrauder’s assets; and this is
for the public good, given that banking services are necessary.
However, necessary expenses always come first, since the cal-
culation of assets usually takes place after discounting them.
(The principle reflected here of bankers’ unlimited liability
appears in point 8, title 3, book 16 of the Digest.)

34
Money, Bank Credit, and Economic Cycles
It is therefore clear from Ulpian’s writings in this section
that bankers carried out two different types of operations. On
one hand, they accepted deposits, which involved no right to
interest and obliged the depositary to maintain the full, con-
tinuous availability of the tantundem in favor of the deposi-
tors, who had absolute privilege in the case of bankruptcy.
And, on the other hand, they received loans (mutuum con-
tracts), which did obligate the banker to pay interest to the
lenders, who lacked all privileges in the case of bankrupcy.
Ulpian could show no greater clarity in his distinction
between the two contracts nor greater fairness in his solutions.
Roman classical jurists discovered and analyzed the uni-
versal legal principles governing the monetary irregular-
deposit contract, and this analysis coincided naturally with
the development of a significant business and trade economy,
in which bankers had come to play a very important role. In
addition, these principles later appeared in the medieval legal
codes of various European countries, including Spain, despite
the serious economic and business recession resulting from
the fall of the Roman Empire and the advent of the Middle
Ages. In Las Partidas (law 2, title 3, item 5) it is established that
a person who agrees to hold the commodities of another takes
part in an irregular deposit in which control over the goods is
transferred to him. Nevertheless, he is obliged, depending
upon agreements in the corresponding document, to return
the goods or the value indicated in the contract for each good
removed from the deposit, either because it is sold with the
authorization of the original owner, or is removed for other,
unexpected reasons.45 Moreover, in 1255 the Fuero Real (law 5,
45In Las Partidas (c. 1312) deposits are called condesijos [hidden deposits],
and in law 2 of this work we read that
Control over the possession of goods given another for safe-
keeping is not transferred to the receiver of the goods, except
when the deposit can be counted, weighed or measured when
handed over; and if it is given the receiver in terms of quan-
tity, weight or measure, then control is transferred to him.
However, he must return the good or the same amount of
another equal to that given him for safekeeping.

The Legal Nature of the Monetary Irregular-Deposit Contract 35
title 15, book 3) the distinction is made between the deposit
“of some counted money or raw silver or gold,” received from
“another, by weight,” in which case “the goods may be used
and goods of the same quantity and quality as those received
may be returned;” and the deposit “which is sealed and not
counted or measured by weight,” in which case “it is not to be
used, but if it is used, it must be paid back double.”46 These
medieval codes contain a clear distinction between the regular
deposit of a specific good and the irregular deposit of money,
and they indicate that in the latter case ownership is trans-
ferred. However, the codes do not include the important clar-
ifications made in the Corpus Juris Civilis to the effect that,
though ownership is “transferred,” the safekeeping obliga-
tion remains, along with the responsibility to keep continu-
ally available to the depositor the equivalent in quantity and
quality (tantundem) of the original deposit. Perhaps the reason
for this omission lies in the increasing prevalence of the deposi-
tum confessatum.
In conclusion, Roman legal tradition correctly defined the
institution of monetary irregular deposit and the principles
governing it, along with the essential differences between this
contract and other legal institutions or contracts, such as the
loan or mutuum. In chapter 2 we will consider ways in which
the essential principles regulating human interactions in the
monetary irregular deposit (and more specifically, the rights
of availability and ownership implied by the contract) were
gradually corrupted over the centuries as a result of the com-
bined actions of bankers and politicians. We will analyze the
circumstances which made these events possible, as well as the
reasons behind them. In chapter 3 we will study the different
attempts made by the legal profession to justify contracts
This topic is covered with the utmost eloquence and clarity in Las Par-
tidas. See Las Siete Partidas, annotated by the university graduate Grego-
rio López; facsimile edition published by the Boletín Oficial del Estado
[official gazette] (Madrid, 1985), vol. 3, 5th Partida, title 3, law 2, pp. 7–8.
46See the reference made by Juan Roca Juan to the Fuero Real in his arti-
cle on “El depósito de dinero,” in Comentarios al Código Civil y Compila-
ciones Forales, vol. 1, tome 22, p. 249.

36
Money, Bank Credit, and Economic Cycles
which, against traditional legal principles, gradually gained
acceptance. Then in chapter 4 we will begin to consider the
economic consequences of these events.

2
HISTORICAL VIOLATIONS
OF THE LEGAL PRINCIPLES
GOVERNING THE MONETARY
IRREGULAR-DEPOSIT
CONTRACT
In this chapter we will present various examples to show
how bankers have throughout history violated traditional
legal principles in the irregular deposit, and we will con-
sider the reasons behind the failure of society’s regulatory
mechanisms to put a stop to these abuses. We will also con-
template the role of governments in this process. Far from
endeavoring to scrupulously defend property rights, they
supported bankers’ improper activity almost from the begin-
ning and granted exemptions and privileges in order to take
advantage of this activity for their own uses. Thus the intimate
complicity and solidarity traditionally present (and still exis-
tent) in relations between state and bank institutions. To
understand why the different attempts to legally justify abuses
have failed, we must first properly understand the legally cor-
rupt origin of fractional reserves in monetary bank deposits.
We will examine attempts at justification in chapter 3.
1
INTRODUCTION
In the last chapter we presented the clear, coherent legal
nature of the monetary irregular-deposit contract. Undoubtedly,
37

38
Money, Bank Credit, and Economic Cycles
those who from the beginning received money from their fel-
low citizens for safekeeping knew the obligations they were
taking on, specifically, to guard the tantundem like a good par-
ent, to keep it constantly available to the depositor. This is pre-
cisely the meaning of safekeeping in a deposit contract of a
fungible good. However, while the legal nature of the irregu-
lar deposit contract is clear and easy to understand, human
nature is imperfect and weak. Therefore it is comprehensible
that those receiving monetary deposits were tempted to vio-
late the safekeeping obligation and use for themselves money
that should have been kept available to others. The temptation
was very strong: without depositors realizing it, bankers
could handle large amounts of money; and if they used it well,
it could generate substantial profit or interest, which bankers
could keep without openly harming anyone.1 Given the weak-
ness of human nature and the almost irresistible temptation
felt by bankers, it is comprehensible that the traditional prin-
ciples of safekeeping on which the monetary irregular-deposit
contract is based were violated from the very beginning in a
concealed manner. In addition, given the abstract, confusing
nature of monetary relations, most citizens and the majority of
authorities in charge of enforcing moral and legal principles
failed to notice this phenomenon, except in rare instances.
And once abuses and cases of fraud began to surface and
became better understood, the institution of banking had
1We are referring to the most obvious source of profit, which initially
motivated bankers to misappropriate depositors’ money. In chapter 4
we will examine a source of much greater earnings: the power of
bankers to issue money or create loans and deposits out of nowhere. The
resulting profit is immensely larger; however, as it arises from an
abstract process, it is certain not even bankers were fully aware of it
until very late in the evolution of finance. Nevertheless, the fact that
they did not understand, but only intuited, this second type of profit
does not mean they failed to take advantage of it completely. In chapter
4 we will explain how bankers’ violation of traditional legal principles
through fractional-reserve banking makes it possible to create loans out
of nowhere, the return of which is then demanded in hard cash (with
interest to boot!). In short, we are dealing with a constant, privileged
source of funding in the shape of deposits bankers create out of nothing
and constantly employ for their own uses.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 39
already been in operation so long and had acquired such
power that it was practically impossible to effectively curb
corruption. Moreover, the gradual discovery authorities made
of banks’ immense power to create money explains why, in
most instances, governments ended up becoming accomplices
to banking fraud, granting privileges to bankers and legaliz-
ing their improper activity, in exchange for the opportunity to
participate, directly or indirectly, in their enormous profits. In
this way they established an important alternative source of
state funding. Furthermore, this corruption of the state’s tra-
ditional duty to define and defend property rights was
encouraged by governments’ enormous, recurrent need for
resources, due to their historical irresponsibility and lack of
financial control. Thus, a more and more perfect symbiosis or
community of interests was formed between governments
and bankers, a relationship which to a great extent still exists
today.
However, despite the complexity of the above situation,
certain shrewd thinkers long ago began to understand it. Doc-
tor Saravia de la Calle, in his book, Instrucción de mercaderes,
attributes the destructive effects of banking to the fact that
man’s insatiable greed has so thoroughly banished his fear
of God and sense of shame, and I even believe it is due to the
neglect of the republic’s spiritual and temporal leaders.2
If Saravia de la Calle shows any weakness, it is an excess
of charity toward the leaders. He correctly attributes fraud in
the irregular deposit to men’s frailty or greed, but he only
holds the leaders responsible for their “neglect” in not being
able to end abuses. Historical events reveal that, apart from
demonstrating undeniable neglect, on many occasions gov-
ernments have clearly and explicitly taken advantage of the
large profits of the banking “business.” In addition, we will
see that, in other instances, authorities have not only granted
2Luis Saravia de la Calle, Instrucción de mercaderes (Medina del Campo:
Pedro de Castro, 1544; Madrid: Colección de Joyas Bibliográficas, 1949),
chap. 8, p. 179.

40
Money, Bank Credit, and Economic Cycles
the bankers privileges so they could carry out their activities
with impunity in exchange for specific favors, but they have
even created government banks in order to directly take
advantage of the corresponding profits.
Although banking activities developed long ago and prac-
tically coincided with the appearance of money, the dawn of
trade, and the first steps in the division of labor3, we will pres-
ent and illustrate the violation of traditional legal principles in
3The archeologist Lenor Mant discovered among the ruins of Babylon a
clay tablet with an inscription attesting to intercity trading and the use
of commercial and financial means of payment. The tablet mentions an
Ardu-Nama (the drawer, of the city of Ur) ordering a Marduk-Bal-at-
Irib (the drawee) of the city of Orkoe to pay in Ardu-Nama’s name the
sum of four minas and fifteen shekels of silver to Bel-Abal-Iddin within
a set time period. This document is dated the 14th of Arakhsamna, year
2 of the reign of Nabonaid. For his part, the researcher Hilprecht dis-
covered in the ruins of the city of Nippur a total of 730 baked clay tablets
with inscriptions, thought to have belonged to the archives of a bank
existing in the city in 400 B.C., called Nurashu and Sons (see “Origen y
desenvolvimiento histórico de los bancos,” in the Enciclopedia universal
ilustrada europeo-americana [Madrid: Editorial Espasa-Calpe, 1979], vol.
7, p. 477). In turn, Joaquín Trigo, apart from offering us the above infor-
mation, reports that around the year 3300 B.C. the temple of Uruk owned
the land it exploited, received offerings and deposits and granted loans
to farmers and merchants of livestock and grain, becoming the first bank
in history. In the British Museum we also find tablets recording the finan-
cial operations of the bank Sons of Egibi. The sequence of the tablets
demonstrates that from the time of the Assyrians, and for more than 180
years, the institution was controlled by a true financial dynasty. The
Code of Hammurabi facilitated the transfer of property and strictly reg-
ulated the rights associated with it, as well as commercial activity, limit-
ing interest rates and even establishing public loans at 12.5 percent. Part-
nership agreements were also regulated, as was the keeping of accounts
of operations. The Manu Smriti of India also makes reference to banking
and financial operations. In short, remaining records indicate that finan-
cial operations occurred between 2300 and 2100 B.C., though the spread
of the “banking” business began between 730 and 540 B.C., when Assyr-
ian and New Babylonian dynasties ensured safe trade, which gave rise
to specialized banks. This activity also spread to Egypt, and later from
there to the Ancient Greek world (Joaquín Trigo Portela, “Historia de la
banca,” chapter 3 of the Enciclopedia práctica de la banca (Barcelona: Edito-
rial Planeta, 1989), vol. 6, esp. pp. 234–37).

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 41
the irregular deposit by bankers and authorities in three dif-
ferent historical instances: the Greco-Roman world; the Mediter-
ranean trading cities of the late Middle Ages and the begin-
ning of the Renaissance; and finally, the emergence of the first
important government banks beginning in the seventeenth
century. Moreover, the evolution of banking in these three sep-
arate historical instances produced to a large extent the same
characteristic results. Indeed, in each case we observe that as
people began to violate traditional legal principles, harmful
effects followed, not only in the shape of bank failures, but
also profound financial and economic crises. In the following
historical examples the same frauds are committed, followed
by the same typical stages and results, and the same failed
attempts to enforce traditional principles of safekeeping. The
same damaging effects then inexorably follow, and this process
is repeated again and again, up to the present day. Let us now
examine the violation of legal principles and authorities’ com-
plicity in banking frauds and abuses throughout history.
2
BANKING IN GREECE AND ROME
In ancient Greece temples acted as banks, loaning money
to individuals and monarchs. For religious reasons temples
were considered inviolable and became a relatively safe
refuge for money. In addition, they had their own militias to
defend them and their wealth inspired confidence in deposi-
tors. From a financial standpoint the following were among
the most important Greek temples: Apollo in Delphi, Artemis
in Ephesus, and Hera in Samos.
TRAPEZITEI OR GREEK BANKERS
Fortunately certain documentary sources on banking in
Greece are available to us. The first and perhaps most impor-
tant is Trapezitica,4 written by Isocrates around the year 393
4Raymond de Roover points out that the current term banker originated
in Florence, where bankers were called either banchieri or tavolieri,
because they worked sitting behind a bench (banco) or table (tavola). The

42
Money, Bank Credit, and Economic Cycles
B.C.5 It is a forensic speech in which Isocrates defends the
interests of the son of a favorite of Satyrus, king of Bosphorus.
The son accuses Passio, an Athenian banker, of misappropri-
ating a deposit of money entrusted to him. Passio was an ex-
slave of other bankers (Antisthenes and Archetratos), whose
trust he had obtained and whose success he even surpassed,
for which he was awarded Athenian citizenship. Isocrates’s
forensic speech describes an attempt by Passio to appropriate
same logic was behind terminology used in ancient Greece as well,
where bankers were called trapezitei because they worked at a trapeza, or
table. This is why Isocrates’s speech “On a Matter of Banking” is tradi-
tionally known as Trapezitica. See Raymond de Roover, The Rise and
Decline of the Medici Bank, 1397–1494 (Cambridge, Mass.: Harvard Uni-
versity Press, 1963), p. 15. The great Diego de Covarrubias y Leyva, for
his part, indicates that
the remuneration paid to money changers for the exchange of
money was called collybus by the Greeks, and therefore
money changers were called collybists. They were also called
nummularii and argentarii, as well as trapezitei, mensularii
or bankers, because apart from changing money, they carried
out a much more profitable business activity: they received
money for safekeeping and loaned at interest their own
money and that of others.
See chapter 7 of Veterum collatio numismatum, published in Omnium ope-
rum in Salamanca in 1577.
5Isocrates was one of the ancient macróbioi, and he lived to be almost 100
years old (436–338 B.C.). His life began during the last years of peaceful
Athenian dominance over Persia and lasted through the Peloponnesian
War, Spartan and Theban supremacy and the Macedonian expansion,
which ended in the battle of Chaeronea (Chaironeia), in which Philip II
defeated the Delian League the same year Isocrates died. Isocrates’s
father, Theodorus, was a middle-class citizen whose flute factory had
earned him considerable wealth, permitting him to give his children an
excellent education. Isocrates’s direct teachers appear to have included
Theramines, Gorgias, and especally Socrates (there is a passage in Phae-
drus where Plato, using Socrates as a mouthpiece, praises the young
Isocrates, apparently ironically, predicting his great future). Isocrates
was a logographer; that is, he wrote legal speeches for others (people
suing or defending their rights) and later he opened a school of rhetoric
in Athens. For information on Isocrates, see Juan Manuel Guzmán Her-
mida’s “Introducción General” to Discursos (Madrid: Biblioteca Clásica
Gredos, 1979), vol. 1, pp. 7–43.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 43
deposits entrusted to his bank by taking advantage of his
depositor’s difficulties, for which he did not hesitate to
deceive, forge, and steal contracts, bribe, etc. In any case, this
speech is so important to our topic that it is worth our effort to
consider some of its passages in detail.
Isocrates begins his arguments by pointing out how haz-
ardous it is to sue a banker, because
deals with bankers are made without witnesses and the
injured parties must put themselves in jeopardy before such
people, who have many friends, handle large amounts of money
and appear trustworthy due to their profession.6
It is interesting to consider the use bankers have always
made of all of their social influence and power (which is enor-
mous, given the number and status of figures receiving loans
from them or owing them favors) to defend their privileges
and continue their fraudulent activity.7
6Isocrates, “Sobre un asunto bancario,” in Discursos I, p. 112.
7More than 2200 years after Isocrates, the Pennsylvanian senator Condy
Raguet also recognized the great power of bankers and their use of it to
intimidate their enemies and to in any way possible discourage deposi-
tors from withdrawing their deposits and hinder these withdrawals,
with the vain hope, among others, of avoiding crises. Condy Raguet
concluded that the pressure was almost unbearable and that
an independent man, who was neither a stockholder or a
debtor who would have ventured to compel the banks to do
justice, would have been persecuted as an enemy of society.
See the letter from Raguet to Ricardo dated April 18, 1821, published in
David Ricardo, Minor Papers on the Currency Question 1805–1823, Jacob
Hollander, ed. (Baltimore: The Johns Hopkins University Press, 1932),
pp. 199–201. This same idea had already been expressed almost three
centuries earlier by Saravia de la Calle, who, indicating obstacles cre-
ated by bankers to keep depositors from withdrawing their money,
obstacles few dared to protest, mentioned the
other thousands of humiliations you inflict upon those who
go to withdraw their money from you; you detain them and
make them waste money waiting and threaten to pay them in
weak currency. In this way you coerce them to give you all
you want. You have found this way to steal, because when

44
Money, Bank Credit, and Economic Cycles
Isocrates explains that his client, who was planning a trip,
deposited a very large amount of money in Passio’s bank.
After a series of adventures, when Isocrates’s client went to
withdraw his money, the banker claimed he “was without
funds at the moment and could not return it.” However, the
banker, instead of admitting his situation, publicly denied the
existence of any deposit or debt in favor of Isocrates’s client.
When the client, greatly surprised by the banker’s behavior,
again claimed payment from Passio, he said the banker,
after covering his head, cried and said he had been forced by
economic difficulties to deny my deposit but would soon try
to return the money to me; he asked me to take pity on him
and to keep his poor situation a secret so it would not be dis-
covered he had committed fraud.8
It is therefore clear that in Greek banking, as Isocrates indi-
cates in his speech, bankers who received money for safe-
keeping and custody were obliged to safeguard it by keeping
it available to their clients. For this reason, it was considered
fraud to employ that money for their own uses. Furthermore,
the attempt to keep this type of fraud a secret so people would
conserve their trust in bankers and the latter could continue
they go to withdraw their money they do not dare ask for cash,
but leave the money with you in order to collect much larger
and more infernal profits. (Instrucción de mercaderes, p. 183)
Richard Cantillon mentions a list of tricks used by bankers to delay
the payment of deposits in his Essai sur la nature du commerce en général
(London: Fletcher Gyles, 1775), pp. 425–26. Finally, Marx also mentions
the fear and reverence bankers inspire in everyone. He cites the follow-
ing ironic words of G.M. Bell:
The knit brow of the banker has more influence over him than
the moral preaching of his friends; does he not tremble to be
suspected of being guilty of fraud or of the least false statement,
for fear of causing suspicion, in consequence of which his bank-
ing accommodation might be restricted or cancelled? The
advice of the banker is more important to him than that of the
clergyman. (Karl Marx, Capital, vol. 3: The Process of Capitalist
Production as a Whole, Friedrich Engels, ed., Ernest Untermann,
trans. [Chicago: Charles H. Kerr and Company, 1909], p. 641)
8Isocrates, “Sobre un asunto bancario,” pp. 114 and 117.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 45
their fraudulent activity is very significant. Also, we may
deduce from Isocrates’s speech that for Passio this was not an
isolated case of fraud, an attempt to appropriate the money of
a client under favorable circumstances, but that he had diffi-
culty returning the money because he had not maintained a
100-percent reserve ratio and had used the deposited money in
private business deals, and he was left with no other “escape”
than to publicly deny the initial existence of the deposit.
Isocrates continues his speech with more words from his
client, who states:
Since I thought he regretted the incident, I compromised
and told him to find a way to return my money while sav-
ing face himself. Three days later we met and both promised
to keep what had happened a secret; (he broke his promise,
as you will find later in my speech). He agreed to sail with
me to Pontus and to return the gold to me there, in order to
cancel the contract as far from this city as possible; that way,
no one from here would find out the details of the cancella-
tion, and upon sailing back, he could say whatever he chose.
Nevertheless, Passio denies this agreement, causes the dis-
appearance of the slaves who had been witnesses to it and
forges and steals the documents necessary to try to demon-
strate that the client had a debt with him instead of a deposit.
Given the secrecy in which bankers performed most of their
activities, and the secret nature of most deposits,9 witnesses
were not used, and Isocrates was forced to present indirect
witnesses who knew the depositor had taken a large amount
of money and had used Passio’s bank. In addition, the wit-
nesses knew that at the time the deposit was made the depos-
itor had changed more than one thousand staters into gold.
9The Greeks distinguished between monetary demand deposits (phan-
erà ousía) and invisible deposits (aphanés ousía). The distinction, rather
than denote whether or not the money was continually available to the
depositor (in both cases it should have been), appears to have referred to
whether or not the deposit and its amount were publicly known. If they
were, the money could be seized or confiscated, mostly for tax reasons.

46
Money, Bank Credit, and Economic Cycles
Furthermore, Isocrates claims that the point most likely to
convince the judges of the deposit’s existence and of the fact
that Passio tried to appropriate it was that Passio always
refused to
turn over the slave who knew of the deposit, for interroga-
tion under torture. What stronger evidence exists in con-
tracts with bankers? We do not use witnesses with them.10
Though we have no documentary evidence of the trial’s
verdict, it is certain that Passio was either convicted or arrived
at a compromise with his accuser. In any case, it appears that
afterward he behaved properly and again earned the trust of
the city. His house was inherited by an old slave of his,
Phormio, who successfully took over his business.
More interesting information on the activity of bankers in
Greece comes from a forensic speech written by Demosthenes
in favor of Phormio. Demosthenes indicates that, at the time of
Passio’s death, Passio had given fifty talents in loans still out-
standing, and of that amount, “eleven talents came from bank
deposits.” Though it is unclear whether these were time or
demand deposits, Demosthenes adds that the banker’s profits
were “insecure and came from the money of others.” Demos-
thenes concludes that “among men who work with money, it
is admirable for a person known as a hard worker to also be
honest,” because “credit belongs to everyone and is the most
important business capital.” In short, banking was based on
depositors’ trust, bankers’ honesty, on the fact that bankers
should always keep available to depositors money placed in
demand deposits, and on the fact that money loaned to
bankers for profit should be used as prudently and sensibly as
possible. In any case, there are many indications that Greek
bankers did not always follow these guidelines, and that they
used for themselves money on demand deposit, as described
by Isocrates in Trapezitica and as Demosthenes reports of
other bankers (who went bankrupt as the result of this type of
activity) in his speech in favor of Phormio. This is true of
10Isocrates, “Sobre un asunto bancario,” p. 116.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 47
Aristolochus, who owned a field “he bought while owing
money to many people,” as well as of Sosynomus, Timode-
mus, and others who went bankrupt, and “when it was nec-
essary to pay those to whom they owed money, they all sus-
pended payments and surrendered their assets to creditors.”11
Demosthenes wrote other speeches providing important
information on banking in Greece. For example, in “Against
Olympiodorus, for Damages,”12 he expressly states that a cer-
tain Como
placed some money on demand deposit in the bank of Her-
aclides, and the money was spent on the burial and other rit-
ual ceremonies and on the building of the funerary monu-
ment.
In this case, the deceased made a demand deposit which
was withdrawn by his heirs as soon as he died, to cover the
costs of burial. Still more information on banking practices is
offered in the speech “Against Timothy, for a Debt,” in which
Demosthenes affirms that
bankers have the custom of making entries for the amounts
they hand over, for the purpose of these funds, and for
deposits people make, so that the amounts given out and
those deposited are recorded for use when balancing the
books.13
11Demosthenes, Discursos privados I, Biblioteca Clásica Gredos (Madrid:
Editorial Gredos, 1983), pp. 157–80. The passages from the text are
found on pp. 162, 164 and 176, respectively, of the above edition. For
information on the failure of Greek banks, see Edward E. Cohen, Athen-
ian Economy and Society: A Banking Perspective (Princeton, N.J.: Princeton
University Press, 1992), pp. 215–24. Nevertheless, Cohen does not seem
to understand the way in which bank credit expansions caused the eco-
nomic crises affecting the solvency of banks.
12Demosthenes, Discursos privados II, Biblioteca Clásica Gredos (Madrid:
Editorial Gredos, 1983), pp. 79–98. The passage mentioned in the main
text is found on p. 86.
13Ibid., pp. 99–120. The passage cited is found on p. 102.

48
Money, Bank Credit, and Economic Cycles
This speech, delivered in 362 B.C., is the first to document
that bankers made book entries of their clients’ deposits and
withdrawals of money.14 Demosthenes also explains how
checking accounts worked. In this type of account, banks
made payments to third parties, following depositors’ instruc-
tions.15 As legal evidence in this specific case, Demosthenes
adduced the bank books, demanded copies be made, and
after showing them to Phrasierides, I allowed him to inspect
the books and make note of the amount owed by this indi-
vidual.16
Finally, Demosthenes finishes his speech by expressing his
concern at how common bank failures were and the people’s
great indignation against bankers who went bankrupt.
Demosthenes mistakenly attributes bank failures to men who
in difficult situations request loans and believe that credit
should be granted them based on their reputation; however,
once they recover economically, they do not repay the
money, but instead try to defraud.17
We must interpret Demosthenes’s comment within the
context of the legal speech in which he presents his argu-
ments. The purpose of the speech was precisely to sue Timo-
thy for not returning a bank loan. It would be asking too much
to expect Demosthenes to have mentioned that most bank fail-
ures occurred because bankers violated their obligation to
safeguard demand deposits, and they used the money for
themselves and put it into private business deals up to the
point when, for some reason, the public lost trust in them and
tried to withdraw their deposits, finding with great indigna-
tion that the money was not available.
14G.J. Costouros, “Development of Banking and Related Book-Keeping
Techniques in Ancient Greece,” International Journal of Accounting 7, no.
2 (1973): 75–81.
15Demosthenes, Discursos privados II, p. 119.
16Ibid., p. 112.
17Ibid., p. 120.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 49
On various occasions research has suggested Greek
bankers usually knew they should maintain a 100-percent
reserve ratio on demand deposits. This would explain the lack
of evidence of interest payments on these deposits, as well as
the proven fact that in Athens banks were usually not consid-
ered sources of credit.18 Clients made deposits for reasons of
safety and expected bankers to provide custody and safekeep-
ing, along with the additional benefits of easily-documented
cashier services and payments to third parties. Nevertheless,
the fact that these were the basic principles of legitimate bank-
ing did not prevent a large group of bankers from yielding to
the temptation to (quite profitably) appropriate deposits, a
fraudulent activity which was relatively safe as long as people
retained their trust in bankers, but in the long run it was des-
tined to end in bankruptcy. Moreover, as we will illustrate
with various historical examples, networks of fraudulent
18Stephen C. Todd, in reference to Athenian banking, affirms that
banks were not seen as obvious sources of credit . . . it is strik-
ing that out of hundreds of attested loans in the sources only
eleven are borrowed from bankers; and there is indeed no evi-
dence that a depositor could normally expect to receive inter-
est from his bank. (S.C. Todd, The Shape of Athenian Law
(Oxford: Clarendon Press, 1993), p. 251)
Bogaert, for his part, confirms that bankers paid no interest on demand
deposits and even charged a commission for their custody and safe-
keeping:
Les dépôts de paiement pouvaient donc avoir différentes
formes. Ce qu’ils ont en commun est l’absence d’intérêts.
Dans aucun des cas précités nous n’en avons trouvé des
traces. Il est même possible que certains banquiers aient
demandé une commission pour la tenue de comptes de dépôt
ou pour “l’exécution des mandats.” (Raymond Bogaert, Ban-
ques et banquiers dans les cités grecques [Leyden, Holland: A.W.
Sijthoff, 1968], p. 336)
Bogaert also mentions the absence of any indication that bankers in
Athens maintained a certain fractional-reserve ratio (“Nous ne possé-
dons malheureusement aucune indication concernant l’encaisse d’une
banque antique,” p. 364), though we know that various bankers, includ-
ing Pison, acted fraudulently and did not maintain a 100-percent reserve
ratio. As a result, on many occasions they could not pay and went bank-
rupt.

50
Money, Bank Credit, and Economic Cycles
bankers operating, against general legal principles, with a frac-
tional-reserve ratio bring about credit expansion19 unbacked
by real savings, leading to artificial, inflationary economic
booms, which finally revert in the shape of crises and economic
recessions, in which banks inexorably tend to fail.
Raymond Bogaert has mentioned the periodic crises
affecting banking in ancient Greece, specifically the economic
and financial recessions of 377–376 B.C. and 371 B.C., during
which the banks of Timodemus, Sosynomus and Aristolochus
(among others) failed. Though these recessions were triggered
by the attack of Sparta and the victory of Thebes, they
emerged following a clear process of inflationary expansion in
which fraudulent banks played a central part.20 Records also
reflect the serious banking crisis which took place in Ephesus
following the revolt against Mithridates. This crisis motivated
authorities to grant the banking industry its first express, his-
torically-documented privilege, which established a ten-year
deferment on the return of deposits.21
In any case, the bankers’ fraudulent activity was extremely
“profitable” as long as it was not discovered and banks did
not fail. We know, for example, that the income of Passio
reached 100 minas, or a talent and two-thirds. Professor Trigo
Portela has estimated that this figure in kilograms of gold
would be equivalent today to almost two million dollars a
year. This does not seem an extremely large amount, though it
was really quite spectacular, considering most people lived at
mere subsistence level, ate only once a day and had a diet of
cereals and vegetables. Upon his death, Passio’s fortune
19
The money supply at Athens can thus be seen to consist of
bank liabilities (“deposits”) and cash in circulation. The
amount of increase in the bank portion of this money supply
will depend on the volume and velocity of bank loans, the
percentage of these loan funds immediately or ultimately
redeposited in the trapezai, and the time period and volatility
of deposits. (Cohen, Athenian Economy and Society, p. 13)
20Bogaert, Banques et banquiers dans les cités grecques, pp. 391–93.
21Ibid., p. 391.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 51
amounted to sixty talents; given a constant value for gold, this
would add up to nearly forty-four million dollars.22
BANKING IN THE HELLENISTIC WORLD
The Hellenistic period, especially Ptolemaic Egypt, was a
turning point in the history of banking because it marked the
creation of the first government bank. The Ptolemies soon
realized how profitable private banks were, and instead of
monitoring and cracking down on bankers’ fraudulent activi-
ties, decided to cash in on the overall situation by starting a
government-run bank which would conduct business with
the “prestige” of the state.
Although there was never a true government monopoly on
banking, and private banks (mostly run by Greeks) continued
to operate, Egypt’s prosperity secured a predominant role for
the state bank. Rostovtzeff observes that the Ptolemaic bank
also developed a sophisticated accounting system:
Refined accounting, based on a well-defined professional
terminology, replaced the rather primitive accounting of
fourth-century Athens.23
Several archaeological studies show how widespread
banking was during the Hellenistic period in Egypt. An
incomplete document found in Tebtunis containing daily
account records of a rural bank in the province of Hera-
cleopolis shows the unexpectedly high number of villagers
22Trigo Portela, “Historia de la banca,” p. 238. Raymond Bogaert, in con-
trast, estimates Passio’s annual income before his death at nine talents,
several times larger:
Cela donne en tout pour environ 9 talents de revenus annuels.
On comprend que le banquier ait pu constituer en peu d’an-
nées un important patrimonie, faire des dons généreux à la
cité et faire les frais de cinq triérchies. (Bogaert, Banques et ban-
quiers dans les cités grecques, p. 367 and also Cohen, Athenian
Economy and Society, p. 67)
23Michael Rostovtzeff, The Social and Economic History of the Hellenistic
World (Oxford: Oxford University Press, 1953), vol. 1, p. 405.

52
Money, Bank Credit, and Economic Cycles
who, whether farmers or not, did business through banks and
made payments out of their deposits and bank accounts. Rel-
atively wealthy people were few, and most of the bank’s cus-
tomers were retailers and indigenous craftspeople, linen mer-
chants, textile workers, tailors, silversmiths and a tinker. Also,
debts were often paid in gold and raw silver, following the
ancient Egyptian tradition. Grain, oil and cattle dealers, as
well as a butcher and many innkeepers were documented as
clients of the bank. The Ptolemaic government bank, private
banks, and temples alike kept custody of different kinds of
deposits. According to Rostovtzeff, bankers accepted both
demand deposits and interest-paying time deposits. The latter
were, in theory, invested in
credit operations of various sorts—loans on collateral secu-
rity, pledges, and mortgages, and a special very popular
type—bottomry loans.24
Private banks kept custody of their clients’ deposits while
at the same time placing their own money in the government
bank.
The main innovation of Egyptian banking was centraliza-
tion: the creation of a government central bank in Alexandria,
with branches in the most important towns and cities, so that
private banks, when available, played a secondary role in the
country’s economy. According to Rostovtzeff, this bank held
custody of tax revenues and also took in private funds and
deposits from ordinary clients, investing remaining funds in
benefit of the state. Thus, it is almost certain that a fractional-
reserve system was used and that the bank’s huge profits were
appropriated by the Ptolemies. Zeno’s letters provide ample
information on how banks received money from their clients
and kept it on deposit. They also tell us that Apollonius, the
director of the central bank in Alexandria, made personal
deposits in different branches of the royal bank. All of these
sources show how frequently individuals used the bank for
24Michael Rostovtzeff, The Social and Economic History of the Hellenistic
World (Oxford: Oxford University Press, 1957), vol. 2, p. 1279.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 53
making deposits as well as payments. In addition, due to their
highly-developed accounting system, paying debts through
banks became extremely convenient, as there was an official
record of transactions—an important piece of evidence in case
of litigation.
The Hellenistic banking system outlived the Ptolemaic
dynasty and was preserved during Roman rule with minor
changes. In fact, Ptolemaic centralized banking had some
influence on the Roman Empire: a curious fact is that Dio Cas-
sius, in his well-known Maecenas speech, advocates the cre-
ation of a Roman government bank which would offer loans
to everyone (especially landowners) at reasonable interest
rates. The bank would draw its capital from earnings on all
state-owned property.25 Dio Cassius’s proposal was never put
into practice.
BANKING IN ROME
Since there are no Latin equivalents of the speeches by
Isocrates and Demosthenes, Roman banks are not docu-
mented in as much detail as their Greek counterparts. How-
ever, we know from Roman law that banking and the mone-
tary irregular deposit were highly developed, and we have
already considered (in chapter 1) the regulations classical
Roman jurists provided in this area. Indeed, Roman argentarii
were not considered free to use the tantundem of deposits as
they pleased, but were obliged to safeguard it with the utmost
diligence. This is precisely why money deposits did not pay
interest and in theory were not to be lent, although the depos-
itor could authorize the bank to use the money for making
payments in his name. Likewise, bankers took in time
“deposits,” which were actually loans to the bank or mutuum
contracts. These paid interest and conferred upon bankers the
right to use the funds as they thought fit for the duration of
the agreed-upon term. References to these practices appear as
early as 350 B.C. in comedies such as Plautus’s Captivi, Asi-
naria and Mostellaria, and Terence’s Phormio, where we find
25Ibid., p. 623.

54
Money, Bank Credit, and Economic Cycles
delightful dialogues describing financial operations, clearings,
account balances, the use of checks and so on.26 In any case, it
appears the work done by professional jurists better regulated
Roman banking and provided at least a clearer idea of what
was and was not legitimate. However, this is no guarantee that
bankers behaved honestly and refrained from using money
from demand deposits to their own benefit. In fact, there is a
rescript by Hadrianus to the merchants in Pergamum who
complained about the illegal exactions and general dishonesty
of their bankers. Also, a written document from the city of
Mylasa to the emperor Septimius Severus contains a decree by
the city council and the people aimed at regulating the activi-
ties of local bankers.27 All this suggests that, while perhaps less
frequently than was common in the Hellenic world, there were
in fact unscrupulous bankers who misappropriated their
depositors’ funds and eventually went bankrupt.
THE FAILURE OF THE CHRISTIAN CALLISTUS’S BANK
A curious example of fraudulent banking is that of Callis-
tus I, pope and saint (217–222 A.D.), who, while the slave of
the Christian Carpophorus, acted as a banker in his name and
took in deposits from other Christians. However, he went
bankrupt and was caught by his master while trying to
escape. He was finally pardoned at the request of the same
Christians he had defrauded.28
26In Plautus’s Captivi, for example, we read: “Subducam ratunculam
quantillum argenti mihi apud trapezitam sied” (i.e., “I go inside because
I need to calculate how much money I have in my bank”) cited by Knut
Wicksell in his Lectures on Political Economy (London: Routledge and-
Kegan Paul, 1935), vol. 2, p. 73.
27Trigo Portela, “Historia de la banca,” p. 239.
28The extraordinary fact that someone in the banking profession actu-
ally became Pope and later a saint would seem to make Callistus I a
good choice for a patron saint. Unfortunately, he set a bad example as a
failed banker who abused the good faith of his fellow Christians.
Instead, the patron saint of bankers is St. Charles Borromeo (1538–1584),
Archbishop of Milan. He was the nephew and administrator of Gio-
vanni Angelo Medici (Pope Pius IV) and his feast day is November 4.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 55
Refutatio omnium haeresium, a work attributed to Hippoly-
tus and found in a convent on Mount Athos in 1844, reports
Callistus’s bankruptcy in detail.29 Like the recurring crises
which plagued Greece, the bankruptcy of Callistus occurred
after a pronounced inflationary boom followed by a serious
confidence crisis, a drop in the value of money and the failure
of multiple financial and commercial firms. These events took
place between 185 and 190 A.D. under the rule of the Emperor
Commodus.
Hippolytus relates how Callistus, at the time a slave to his
fellow Christian Carpophorus, started a banking business in
his name and took in deposits mainly from widows and
Christians (a group that was already increasing in influence
and membership). Nevertheless, Callistus deceitfully appro-
priated the money, and, as he was unable to return it upon
demand, tried to escape by sea and even attempted suicide.
After a series of adventures, he was flogged and sentenced to
hard labor in the mines of Sardinia. Finally, he was miracu-
lously released when Marcia, concubine of the Emperor Com-
modus and a Christian herself, used her influence. Thirty years
later, a freedman, he was chosen the seventeenth Pope in the
year 217 and eventually died a martyr when thrown into a well
by pagans during a public riot on October 14, 222 A.D.30
We can now understand why even the Holy Fathers in
their Apostolic Constitutions have admonished bankers to be
honest and to resist their many temptations.31 These moral
exhortations warning bankers against temptation and remind-
ing them of their duties were used constantly among early
Christians, and some have even tried to trace them back to the
Holy Scriptures.
29Hippolytus, Hippolytus Wercke, vol. 2: Refutatio omnium haeresium
(Leipzig: P. Wendland), 1916.
30Juan de Churruca, “La quiebra de la banca del cristiano Calisto (c.a.
185–190),” Seminarios complutenses de derecho romano, February–May 1991
(Madrid, 1992), pp. 61–86.
31“Ginesthe trapezitai dókimoi” (“bankers, you must be honest!”). See
“Orígenes y movimiento histórico de los bancos,” in Enciclopedia universal
ilustrada europeo-americana (Madrid: Espasa Calpe, 1973), vol. 7, p. 478.

56
Money, Bank Credit, and Economic Cycles
THE SOCIETATES ARGENTARIAE
Banker associations or societates argentariae were a peculi-
arity of banking in the Roman world. Financial contributions
from members supplied the capital to form them, and this
capital was relied upon to pay debts. However, as banks were
of particular public interest, Roman law established that
members of the societates argentariae must guarantee deposits
with all of their assets.32 Hence, members’ joint, unlimited
liability was a general principle of Roman law, intended to
minimize the effects of fraud and abuse by bankers and to
protect depositors’ right to recover their money at any time.33
32See Manuel J. García-Garrido, “La sociedad de los banqueros (societas
argentaria),” in Studi in honore di Arnaldo Biscardi (Milan 1988), vol. 3,
esp. pp. 380–83. The unlimited liability of banker association members
under Roman law was established, among other places, in the afore-
mentioned text by Ulpian (Digest, 16, 3, 7, 2–3) and also in a passage by
Papinian (Digest, 16, 3, 8), where he dictates that money to repay the
debts of fraudulent bankers be drawn not only from “deposited funds
found among the banker’s assets, but from all the defrauder’s assets”
(Cuerpo de derecho civil romano, vol. 1, p. 837). Some present-day authors
have also proposed a return to the principle of unlimited liability for
bankers, as an incentive for them to manage money prudently. How-
ever, this requirement is not necessary to achieve a solvent banking sys-
tem, nor would it be a sufficient measure. It is not necessary, since a 100-
percent reserve requirement would eliminate banking crises and
economic recessions more effectively. It is not sufficient, because even if
banks’ stockholders had unlimited liability, bank crises and economic
recessions would still inevitably recur when a fractional reserve is used.
33Under the Roman Empire, some large, influential temples continued
to double as banks. Among these were the temples at Delos, Delphi,
Sardis (Artemis), and most importantly, Jerusalem, where Hebrews, rich
and poor, traditionally deposited their money. This is the context in
which we must interpret Jesus’s expulsion of the money changers from
the temple in Jerusalem, as described in the New Testament. In Matthew
21:12–16 we read that Jesus, entering the temple,
overturned the tables of the money changers and the benches
of those selling doves. “It is written,” he said to them, “My
house will be called a house of prayer,” but you are making it
a “den of robbers.”
Mark 11:15–17 offers an almost identical text. John 2:14–16 is a bit more
explicit and tells us how, after entering the temple courts,

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 57
The argentarii conducted their business in a special place
called a taverna. Their books reflected the debits and credits
made to their clients’ checking accounts. Roman bankers’
books qualified as evidence in court and had to be kept as set
down in the editio rationum, which stipulated the way
accounts were to be dated and managed.34 Bankers were also
he found men selling cattle, sheep and doves, and others sit-
ting at tables exchanging money. So he made a whip out of
cords, and drove all from the temple area, both sheep and cat-
tle; he scattered the coins of the money changers and overturned
their tables.
(New International Version). The translation of these biblical passages is
not very accurate, and the same mistake is found in García del Corral’s
translation of the Digest. Instead of “money changers,” it should read
“bankers,” which is more in accordance with the literal sense of the Vul-
gate edition of the Bible in Latin, in which Matthew’s account reads as
follows:
Et intravit Iesus in templum et eiiciebat omnes vendentes et
ementes in templo, et mensas numulariorum, et cathedras
vendentium columbas evertit: et dicit eis: Scriptum est:
Domus mea domus orationis vocabitur: vos autem fecistis
illam speluncam latronum. (Biblia Sacra iuxta Vulgatam
Clementinam, Alberto Colunga and Laurencio Turrado, eds.
(Madrid: Biblioteca de Autores Cristianos, 1994), Mateo
21:12–13, p. 982)
These evangelical texts confirm that the temple at Jerusalem acted as a
true bank where the general public, rich or poor, made deposits. Jesus’s
clearing of the temple can be interpreted as a protest against abuses
stemming from an illicit activity (as we know, these abuses consisted of
the use of money on deposit). In addition, these biblical references illus-
trate the symbiosis already present between bankers and public offi-
cials, since both the chief priests and the teachers of the law were out-
raged by Jesus’s behavior (all italics have, of course, been added). On
the importance of the Jerusalem temple as a deposit bank for Hebrews,
see Rostovtzeff, The Social and Economic History of the Roman Empire, vol.
2, p. 622.
34Jean Imbert, in his book, Historia económica (de los orígenes a 1789),
Spanish translation by Armando Sáez (Barcelona: Editorial Vicens-
Vives, 1971), p. 58, points out that
the praescriptio was an equivalent of today’s checks. When a
capitalist instructed a banker to make a loan payment in his
name, the banker would do so upon presentation of a bank
draft called a praescriptio.

58
Money, Bank Credit, and Economic Cycles
called mensarii, after the mensa or counter where they origi-
nally carried out their money-changing activities. Much like
today’s banking licenses, the mensa could be transferred. In
Rome, however, as the state owned the premises where bank-
ing took place, it was the right to operate (granted by the state)
that was transmitted. A transfer could include all furniture
and implements of the taverna, as well as financial assets and
liabilities. In addition, bankers formed a guild to defend their
common interests and obtained significant privileges from
emperors, especially Justinian. Some of these privileges
appear in the Corpus Juris Civilis.35
The economic and social disintegration of the Roman
Empire resulted from inflationary government policies which
devalued the currency, and from the establishment of maxi-
mum prices for essential goods, which in turn caused a gen-
eral shortage of these goods, the financial ruin of merchants
and the disappearance of trade between different areas of the
Empire. This was also the end for banking. Most banks failed
during the successive economic crises of the third and fourth
centuries A.D. In an attempt to contain the social and eco-
nomic decay of the Empire, additional coercive, intervention-
ist measures were taken, further accelerating the process of
disintegration and enabling the barbarians (whom Roman
legions had defeated repeatedly and kept at bay for years) to
devastate and conquer the remains of the ancient, thriving
Roman Empire. The fall of the classical Roman world began
the long medieval period, and it was nearly eight hundred
years later that banking was rediscovered in the Italian cities
of the late Middle Ages.36
35See, for instance, New Constitution 126 on “Bank Contracts,” edict 7
(“Decree and Regulation Governing Bank Contracts”) and edict 9, “On
Bank Contracts,” all by Justinian and included in the Novellae (see Cuerpo
de derecho civil romano, vol. 6, pp. 479–83, 539–44 and 547–51).
36A superb overview of the causes of the fall of the Roman Empire
appears in Ludwig von Mises’s work, Human Action: A Treatise on Eco-
nomics, Scholar’s Edition (Auburn, Ala.: Ludwig von Mises Institute,
1998), pp. 161–63. We will also quote Mises’s Human Action by the more
widespread third edition (Chicago: Henry Regnery, 1966), pp. 767–69.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 59
3
BANKERS IN THE LATE MIDDLE AGES
The fall of the Roman Empire meant the disappearance of
most of its trade and the feudalization of economic and social
relationships. The enormous reduction in trade and in the
division of labor dealt a definitive blow to financial activities,
especially banking. The effects of this reduction lasted several
centuries. Only monasteries, secure centers of economic and
social development, could serve as guardians of economic
resources. It is important to mention the activity in this field of
the Templars, whose order was founded in 1119 in Jerusalem
to protect pilgrims. The Templars possessed significant finan-
cial resources obtained as plunder from their military cam-
paigns and as bequests from feudal princes and lords. As they
were active internationally (they had more than nine thousand
centers and two headquarters) and were a military and reli-
gious order, the Templars were safe custodians for deposits
and had great moral authority, earning them the trust of the
people. Understandably, they began to receive both regular
and irregular deposits from individuals, to whom they
charged a fee for safekeeping. The Templars also carried out
transfers of funds, charging a set amount for transportation
and protection. Moreover, they made loans of their own
resources and did not violate the safekeeping principle on
demand deposits. The order acquired a growing prosperity
which aroused the fear and envy of many people, until Philip
the Fair, the King of France, decided to dissolve it. He con-
demned those in charge to be burned at the stake (including
Jacques de Molay, the Grand Maître), with the prime objective
of appropriating all of the order’s riches.37
37See, for example, Jules Piquet’s book, Des banquiers au Moyen Age: Les
Templiers, Étude de leurs opérations financièrs (Paris, 1939), cited by
Henri Pirenne in his work, Histoire Économique et Sociale Du Moyen Age
(Paris: Presses Universitaires de France, 1969), pp. 116 and 219. Piquet
believes he sees the beginnings of double-entry bookkeeping and even
a primitive form of check in the records kept by the Templars. How-
ever, it appears the Templars’ accounting practices were, at most, mere
direct predecessors of double-entry bookkeeping, later formalized in

60
Money, Bank Credit, and Economic Cycles
The end of the eleventh century and beginning of the
twelfth brought a moderate resurgence of business and trade,
mainly among the Italian cities on the Adriatic (especially
Venice), Pisa, and later, Florence. These cities specialized in
trade with Constantinople and the Orient. Significant financial
growth in these cities led to the revival of banking, and the pat-
tern we observed in the classical world was reproduced.
Indeed, bankers at first respected the juridical principles passed
down from Rome and conducted their business lawfully, avoid-
ing illicit use of demand deposits (i.e., irregular deposits of
money). Only money received as loans (i.e., time “deposits”)
was used or lent by bankers, and only during the agreed-upon
term.38 Nevertheless, bankers again became tempted to take
advantage of money from demand deposits. This was a gradual
process which led to abuses and the resumption of fractional-
reserve banking. The authorities were generally unable to
enforce legal principles and on many occasions even granted
privileges and licenses to encourage bankers’ improper activity
and derive benefits from it, in the shape of loans and tax rev-
enues. They even created government banks (such as
1494 by Luca Pacioli, the great Venetian monk and friend of Leonardo
da Vinci. A bank in Pisa used double-entry bookkeeping as early as
1336, as did the Masari family (tax collectors in Genoa) in 1340. The
oldest European account book we have evidence of came from a Flo-
rentine bank and dates back to 1211. See G.A. Lee, “The Oldest Euro-
pean Account Book: A Florentine Bank Ledger of 1211,” in Accounting
History: Some British Contributions, R.H. Parker and B.S. Yamey, eds.
(Oxford: Clarendon Press, 1994), pp. 160–96.
38
In theory at least, early banks of deposit were not discount
or lending banks. They did not create money but served a
system of 100 percent reserves, such as some monetarists
today would like to see established. Overdrafts were forbid-
den. In practice, the standards proved difficult to maintain,
especially in face of public emergency. The Taula de Valen-
cia was on the verge of using its deposited treasure to buy
wheat for the city in 1567. Illegal advances were made to city
officials in 1590 and illegal loans to the city itself on a num-
ber of occasions. (Charles P. Kindleberger, A Financial His-
tory of Western Europe, 2nd ed. [Oxford: Oxford University
Press, 1993], p. 49)

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 61
Barcelona’s Bank of Deposit, or Taula de Canvi, and others we
will consider later).39
THE REVIVAL OF DEPOSIT BANKING IN MEDITERRANEAN EUROPE
Abbott Payson Usher, in his monumental work, The Early
History of Deposit Banking in Mediterranean Europe,40 studies the
gradual emergence of fractional-reserve banking during the
late Middle ages, a process founded on the violation of this
general legal principle: full availability of the tantundem must
be preserved in favor of the depositor. According to Usher, it
is not until the thirteenth century that some private bankers
begin to use the money of their depositors to their own advan-
tage, giving rise to fractional-reserve banking and the oppor-
tunities for credit expansion it entails. Moreover, and contrary
to a widely-held opinion, Usher believes this to be the most
significant event in the history of banking, rather than the
appearance of banks of issue (which in any case did not occur
until much later, in the late seventeenth century). As we will
see in chapter 4, although exactly the same economic effects
result from the issuance of bank notes without financial back-
ing and the loaning of funds from demand deposits, banking
was historically shaped more by the latter of these practices
39Islamic law also banned bankers’ personal use of irregular deposits
throughout the medieval period, especially on the Iberian Peninsula.
See, for instance, the Compendio de derecho islámico (Risála, Fí-l-Fiqh), by
the tenth-century Hispano-Arabic jurist Ibn Abí Zayd, called Al-
Qayrawání, published with the support of Jesús Riosalido (Madrid: Edi-
torial Trotta, 1993). On p. 130 we find the following statement of a juridi-
cal principle: “he who uses a money deposit to do business commits a
reprehensible act, but if he uses his own money, he may keep the profit.”
(See also pp. 214–15, where it is stipulated that, in the case of a true loan
or mutuum, the lender may not withdraw the money at will, but only at
the end of the agreed-upon term; the Islamic legal concept of money
deposit closely parallels that of the Roman irregular deposit.)
40Abbott Payson Usher taught economics at Harvard University and
authored the celebrated work, The Early History of Deposit Banking in
Mediterranean Europe (Cambridge, Mass.: Harvard University Press,
1943).

62
Money, Bank Credit, and Economic Cycles
than by the former. Usher states that: “the history of banks of
issue has, until lately, obscured the importance of due deposit
banking in all its forms, whether primitive or modern.” In an
ironic reference to the undue importance given by economists
to the problems of banks of issue versus the older but equally
harmful activities of deposit banks, he concludes that:
the demand for currency, and the theoretical interests cre-
ated by the problem, did much to foster misconceptions on
the relative importance of notes and deposits. Just as French
diplomats “discovered” the Pyrenees in the diplomatic cri-
sis of the eighteenth century, so banking theorists “discov-
ered” deposits in the mid-nineteenth century.41
Again and again, Usher shows that the modern banking
system arose from fractional-reserve banking (itself the result of
fraud and government complicity, as Usher illustrates in detail
via the example of the late medieval Catalonian banking sys-
tem), and not from banks of issue, which appeared much later.
Usher points out that the first banks in twelfth-century
Genoa made a clear distinction in their books between demand
deposits and “time” deposits, and recorded the latter as loans
or mutuum contracts.42 However, bankers later began gradu-
ally to make self-interested use of demand deposits, giving rise
to expansionary capabilities present in the banking system;
more specifically, the power to create deposits and grant cred-
its out of nowhere. Barcelona’s Bank of Deposit is a case in
point. Usher estimates that the bank’s cash reserves amounted
to 29 percent of total deposits. This meant their capacity for
credit expansion was 3.3 times their cash reserves.43
41Ibid., pp. 9 and 192.
42“In all these Genoese registers there is also a series of instruments in
which the money received is explicitly described as a loan (mutuum).”
Ibid., p. 63.
43
Against these liabilities, the Bank of Deposit held reserves in
specie amounting to 29 percent of the total. Using the phrase-
ology of the present time, the bank was capable of extending
credit in the ratio of 3.3 times the reserves on hand. (Ibid., p.
181)

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 63
Usher also highlights the failure of public officials at dif-
ferent levels to enforce sound banking practices, particularly a
100-percent reserve requirement on demand deposits. More-
over, the authorities ended up granting banks a government
license (a privilege—ius privilegium) to operate with a frac-
tional reserve. Banks were nevertheless required to guarantee
deposits.44 At any rate, rulers were usually the first to take
advantage of fraudulent banking, finding loans an easy source
of public financing. It is as if bankers were granted the privi-
lege of making gainful use of their depositors’ money in
return for their unspoken agreement that most of such use be
in the shape of loans to public officials and funding for the
government. On various occasions, rulers went so far as to
create government banks, in order to directly reap the consid-
erable profits available in banking. As we will see, Barcelona’s
Bank of Deposit, the Taula de Canvi, was created with this main
objective.
However, we cannot agree with the statement Usher makes immedi-
ately afterward; he contends that private banks also operating in
Barcelona at the time must have had a much lower reserve ratio. Quite
the opposite must have been true. As private banks were smaller, they
would not have inspired as much confidence in the public as the munic-
ipal bank did, and as they operated in a strictly competitive environ-
ment, their cash reserves must have been higher (see pp. 181–82 of
Usher’s book). In any case, Usher concludes that
there was considerable centralization of clearance in the early
period and extensive credit creation. In the absence of com-
prehensive statistical records, we have scarcely any basis for
an estimate of the quantitative importance of credit in the
medieval and early modern periods, though the implications
of our material suggest an extensive use of credit purchasing
power. (Ibid., pp. 8–9)
We will later cite works by C. Cipolla, which fully confirm Usher’s main
thesis. In chapter 4 we will examine bank multipliers in depth.
44In fifteenth-century Catalonia, guarantees were not required, though
only bankers who offered them were allowed to spread tablecloths over
their counters. By this system, the public could easily identify the more
solvent businesses. Ibid., p. 17.

64
Money, Bank Credit, and Economic Cycles
THE CANONICAL BAN ON USURY AND THE
“DEPOSITUM CONFESSATUM”
The ban on usury by the three major monotheistic reli-
gions (Judaism, Islam and Christianity) did much to compli-
cate and obscure medieval financial practices. Marjorie Grice-
Hutchinson has carefully studied the medieval prohibition of
interest and its implications.45 She points out that Jews were
not forbidden to loan money at interest to Gentiles, which
explains why, at least during the first half of the medieval
period, most bankers and financiers in the Christian world
were Jewish.46
This canonical ban on interest added greatly to the intrica-
cies of medieval banking, though not (as many theorists have
insisted) because bankers, in their attempt to offer a useful,
necessary service, were forced to constantly search for new
ways to disguise the necessary payment of interest on loans.
When bankers loaned money received from clients as a loan
(or “time” deposit), they were acting as true financial inter-
mediaries and were certainly doing a legitimate business and
significantly contributing to the productive economy of their
time. Still, the belated recognition by the Church of the legiti-
macy of interest should not be regarded as overall approval of
the banking business, but only as authorization for banks to
loan money lent to them by third parties. In other words, to
45Marjorie Grice-Hutchinson, Early Economic Thought in Spain 1177–
1740 (London: George Allen and Unwin, 1978). See “In Concealment of
Usury,” chap. 1, pp. 13–60.
46
Until the thirteenth century, the greater part of financial activ-
ity was in the hands of Jews and other non-Christians, usually
from the Near East. For such unbelievers from the Christian
point of view there could be no salvation in any event, and
the economic prohibitions of the Church did not apply to
them. . . . Hatred for the Jews arose on the part of the people
who resented such interest rates, while monarchs and
princes, if less resentful, scented profits from expropriation of
this more or less helpless group. (Harry Elmer Barnes, An Eco-
nomic History of the Western World [New York: Harcourt, Brace
and Company, 1940], pp. 192–93)

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 65
act as mere financial intermediaries. The evolution of Church
doctrine on interest in no way implies a sanction of fractional-
reserve banking, i.e., bankers’ self-interested use (which usu-
ally means granting loans) of demand deposits.47
To a great extent, the conceptual confusion we are dealing
with arose in the Middle Ages as a result of the canonical ban
on interest. One of the main artifices48 devised by economic
agents to conceal actual interest-paying loans was to disguise
them as demand deposits. Let us see how they did it. First, we
must think back to our discussion of the monetary irregular-
deposit contract in chapter 1. One of the most notable guide-
lines found for this contract in the Corpus Juris Civilis stipu-
lated that, if the depositary were unable to return the deposit
on demand, not only was he guilty of theft for misappropria-
tion, but he was also obliged to pay interest to the depositor
for his delay in repayment (Digest, 16, 3, 25, 1). Hence, it
should come as no surprise that throughout the Middle Ages,
47This is precisely the opinion held by Father Bernard W. Dempsey S.J.,
who concludes in his remarkable book Interest and Usury (Washington,
D.C.: American Council of Public Affairs, 1943) that even if we accept
interest as legitimate, fractional-reserve banking amounts to “institu-
tional usury” and is especially harmful to society, since it repeatedly
generates artificial booms, bank crises and economic recessions (p.
228).
48A clear, concise list of the tricks used to systematically disguise loans
and interest can be found in Imbert’s book, Historia económica (de los orí-
genes a 1789), pp. 157–58. Imbert mentions the following methods of
concealing interest-bearing loans: (a) bogus contracts (such as repur-
chase agreements or real estate guarantees); (b) penalty clauses (dis-
guising interest as economic sanctions); (c) lying about the amount of
the loan (the borrower agreed to repay a sum higher than the actual
loan); (d) foreign exchange transactions (which included the interest as
an additional charge); and (e) income or annuities (life annuities includ-
ing a portion of both the interest and the repayment of the principal).
Jean Imbert makes no express mention of the depositum confessatum, one
of the most popular ways of justifying interest. It fits well into the
“penalty clauses” category. See also the reference Henri Pirenne makes
to the “utmost ingenuity” used to conceal “dangerous interest.” Eco-
nomic and Social History of Medieval Europe (London: Kegan Paul, Trench,
Trubner and Company, 1947), p. 140.

66
Money, Bank Credit, and Economic Cycles
in order to circumvent the canonical ban on interest, many
bankers and “depositors” expressly declared that they had taken
part in a monetary irregular-deposit contract, when they had
actually formalized a true loan or mutuum contract. The
method of concealment to which this declaration belonged was
aptly named depositum confessatum. It was a simulated deposit
which, despite the declarations of the two parties, was not a
true deposit at all, but rather a mere loan or mutuum contract.
At the end of the agreed-upon term, the supposed depositor
claimed his money. When the professed depositary failed to
return it, he was forced to pay a “penalty” in the shape of inter-
est on his presumed “delay,” which had nothing to do with the
actual reason for the “penalty” (the fact that the operation was
a loan). Disguising loans as deposits became an effective way
to get around the canonical ban on interest and escape severe
sanctions, both secular and spiritual.
The depositum confessatum eventually perverted juridical
doctrine on the monetary irregular deposit, robbing these
tenets of the clarity and purity they received in classical Rome
and adding confusion that has persisted almost to the present
day. In fact, regardless of experts’ doctrinal stand (either
strictly against, or “in favor” within reasonable limits) on
interest-bearing loans, the different approaches to the deposi-
tum confessatum led theorists to stop distinguishing clearly
between the monetary irregular deposit and the mutuum con-
tract. On one hand, over-zealous canonists, determined to
expose all hidden loans and condemn the corresponding
interest, tended to automatically equate deposit contracts with
mutuum contracts. They believed that by exposing the loan
they assumed was behind every deposit they would put an
end to the pretense of the depositum confessatum. This is pre-
cisely where their error lay: they regarded all deposits, even
actual ones (made with the essential purpose of safeguarding
the tantundem and keeping it always available to the deposi-
tor) as deposita confessata. On the other hand, those experts
who were relatively more supportive of loans and interest and
searched for ways to make them acceptable to the Church,
defended the depositum confessatum as a kind of precarious
loan which, according to the principles embodied in the
Digest, justified the payment of interest.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 67
As a result of both doctrinal stances, scholars came to
believe that the “irregularity” in the monetary irregular
deposit referred not to the deposit of a certain quantity of a
fungible good (the units of which were indistinguishable from
others of the same type and the tantundem of which was to be
kept continually available to the depositor), but rather to the
irregularity of always disguising loans as deposits.49 Further-
more, bankers, who had used the depositum confessatum to dis-
guise loans as deposits and to justify the illegal payment of
interest, eventually realized that the doctrine which held that
deposits always concealed loans could also be extremely prof-
itable to them, because they could employ it to defend even
the misappropriation of money which had actually been
placed into demand deposits and had not been loaned. Thus,
49Canonists’ equation of the monetary irregular deposit with the
mutuum or loan contract led experts to search for a common juridical
feature between the two contracts. They soon realized that in the deposit
of a fungible good, “ownership” of the individual units deposited is
“transferred,” since the depositary is only obliged to safeguard, main-
tain, and return upon demand the tantundem. This transfer of ownership
appears to coincide with that of the loan or mutuum contract, so it was
natural for scholars to automatically assume that all monetary irregular
deposits were loans, since both include a “transfer” of “ownership” from
the depositor to the depositary. Hence, theorists overlooked the essential
difference (see chapter 1) between the monetary irregular deposit and
the mutuum or loan: the main purpose of the irregular deposit is the cus-
tody and safekeeping of the good, and while “ownership” is in a sense
“transferred,” availability is not, and the tantundem must be kept contin-
ually available to the depositor. In contrast, a loan entails the transfer of
full availability, apart from ownership (in fact, present goods are
exchanged for future goods) and involves this fundamental element: a
term during which the goods cease to be available to the lender. Irregu-
lar deposits do not include such a term. In short, since the canonical pro-
hibition of interest gave rise to the fraudulent and spurious institution of
the depositum confessatum, it was indirectly responsible for the loss of clar-
ity in the distinction between the monetary irregular deposit and the
mutuum. This confusion is clearly behind the wrong 1342 final court
decision on the Isabetta Querini vs. The Bank of Marino Vendelino case, men-
tioned by Reinhold C. Mueller in The Venetian Money Market: Banks, Pan-
ics, and the Public Debt, 1200–1500 (Baltimore: Johns Hopkins University
Press, 1997), pp. 12–13.

68
Money, Bank Credit, and Economic Cycles
the canonical ban on interest had the unexpected effect of
obscuring Roman jurists’ clear, legal definition of the mone-
tary irregular-deposit contract. Many capitalized on the ensu-
ing confusion in an attempt to legally justify fraudulent bank-
ing and the misappropriation of demand deposits. Experts
failed to clear up the resulting legal chaos until the end of the
nineteenth century.50
Let us now examine three particular cases which together
illustrate the development of medieval banking: Florentine
banks in the fourteenth century; Barcelona’s Bank of Deposit,
the Taula de Canvi, in the fifteenth century and later; and the
Medici Bank. These banks, like all of the most important
banks in the late Middle Ages, consistently displayed the pat-
tern we saw in Greece and Rome: banks initially respected the
traditional legal principles found in the Corpus Juris Civilis,
i.e., they operated with a 100-percent reserve ratio which
guaranteed the safekeeping of the tantundem and its constant
availability to the depositor. Then, gradually, due to bankers’
greed and rulers’ complicity, these principles began to be vio-
lated, and bankers started to loan money from demand
50In fact, Pasquale Coppa-Zuccari, whose work we have already cited, was
the first to begin to reconstruct the complete legal theory of the monetary
irregular deposit, starting from the same premise as the classical Roman
scholars and again revealing the illegitimacy of banks’ misappropriation of
demand deposits. Regarding the effects of the depositum confessatum on
the theoretical treatment of the juridical institution of irregular deposit,
Coppa-Zuccari concludes that
le condizioni legislative dei tempi rendevano fertile il terreno
in cui il seme della discordia dottrinale cadeva. Il divieto
degli interessi nel mutuo non valeva pel deposito irregolare.
Qual meraviglia dunque se chi aveva denaro da impiegare
fruttuosamente lo desse a deposito irregolare, confessatum se
occorreva, e non a mutuo? Quel divieto degli interessi, che
tanto addestrò il commercio a frodare la legge e la cui effica-
cia era nulla di fronte ad un mutuo dissimulato, conservò in
vita questo ibrido instituto, e fece sì che il nome di deposito
venissi imposto al mutuo, che non poteva chiamarsi col pro-
prio nome, perchè esso avrebbe importato la nullità del patto
relativo agli interessi. (Coppa-Zuccari, Il deposito irregolare,
pp. 59–60)

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 69
deposits, often, in fact, to rulers. This gave rise to fractional-
reserve banking and artificial credit expansion, which in the
first stage appeared to spur strong economic growth. The
whole process ended in a general economic crisis and the fail-
ure of banks that could not return deposits on demand once
the recession hit and they had lost the trust of the public.
Whenever loans were systematically made from demand
deposits, the historical constant in banking appears to have
been eventual failure.51 Furthermore, bank failures were
accompanied by a strong contraction in the money supply
(specifically, a shortage of loans and deposits) and by the
resulting inevitable economic recession. As we will see in the
following chapters, it took economic scholars nearly five cen-
turies to understand the theoretical causes of all of these
processes.52
51For example, Raymond Bogaert mentions that of the 163 known banks
in Venice, documentary evidence exists to show that at least 93 of them
failed. Bogaert, Banques et banquiers dans les cités grecques, note 513, p.
392. A detailed list of 46 failures of deposit banks in Venice can also be
seen in Mueller, The Venetian Money Market, pp. 585–86. This same fate
of failures affected all banks in Seville in the 15th century. Hence, the
systematic failure of fractional-reserve private banks not supported by
a central bank (or equivalent) is a fact of history. Pascal Salin overlooks
this fact in his article “In Defense of Fractional Monetary Reserves,” pre-
sented at the Austrian Scholars Conference, March 30–31, 2001.
52As is logical, bankers always carried out their violations of general
legal principles and their misappropriations of money on demand
deposit in a secretive, disgraceful way. Indeed, they were fully aware of
the wrongful nature of their actions and furthermore, knew that if their
clients found out about their activities they would immediately lose
confidence in the bank and it would surely fail. This explains the exces-
sive secrecy traditionally present in banking. Together with the confus-
ing, abstract nature of financial transactions, this lack of openness
largely protects bankers from public accountability even today. It also
keeps most of the public in the dark as to the actual nature of banks.
While they are usually presented as true financial intermediaries, it
would be more accurate to see banks as mere creators of loans and
deposits which come out of nowhere and have an expansionary effect
on the economy. The disgraceful, and therefore secretive, nature of these
banking practices was skillfully revealed by Knut Wicksell in the fol-
lowing words:

70
Money, Bank Credit, and Economic Cycles
BANKING IN FLORENCE IN THE FOURTEENTH CENTURY
Around the end of the twelfth and beginning of the thir-
teenth centuries, Florence was the site of an incipient banking
industry which gained great importance in the fourteenth cen-
tury. The following families owned many of the most impor-
tant banks: The Acciaiuolis, the Bonaccorsis, the Cocchis, the
Antellesis, the Corsinis, the Uzzanos, the Perendolis, the
Peruzzis, and the Bardis. Evidence shows that from the begin-
ning of the fourteenth century bankers gradually began to
make fraudulent use of a portion of the money on demand
deposit, creating out of nowhere a significant amount of
expansionary credit.53 Therefore, it is not surprising that an
increase in the money supply (in the form of credit expansion)
caused an artificial economic boom followed by a profound,
inevitable recession. This recession was triggered not only by
Neapolitan princes’ massive withdrawal of funds, but also by
England’s inability to repay its loans and the drastic fall in the
in effect, and contrary to the original plan, the banks became
credit institutions, instruments for increasing the supplies of
a medium of exchange, or for imparting to the total stock of
money, an increased velocity of circulation, physical or vir-
tual. Giro banking continued as before, though no actual
stock of money existed to correspond with the total of deposit
certificates. So long, however, as people continued to believe
that the existence of money in the banks was a necessary con-
dition of the convertibility of the deposit certificates, these
loans had to remain a profound secret. If they were discov-
ered the bank lost the confidence of the public and was
ruined, especially if the discovery was made at a time when
the Government was not in a position to repay the advances.
(Wicksell, Lectures on Political Economy, vol. 2, pp. 74–75)
53Various articles have been written on this topic. See the interesting one
by Reinhold C. Mueller, “The Role of Bank Money in Venice,
1300–1500,” in Studi Veneziani n.s. 3 (1979): 47–96, and chapter 5 of his
book, The Venetian Money Market. Carlo M. Cipolla, in his notable publi-
cation, The Monetary Policy of Fourteenth-Century Florence (Berkeley: Uni-
versity of California Press, 1982), p. 13, also affirms: “The banks of that
time had already developed to the point of creating money besides
increasing its velocity of circulation.”

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 71
price of Florentine government bonds. In Florence, public
debt had been financed by speculative new loans created out
of nowhere by Florentine banks. A general crisis of confidence
occurred, causing all of the above banks to fail between 1341
and 1346. As could be expected, these bank failures were
detrimental to all deposit-holders, who, after a prolonged
period, received half, a third, or even a fifth of their deposits
at most.54 Fortunately, Villani recorded the economic and
financial events of this period in a chronicle that Carlo M.
Cipolla has resurrected. According to Villani, the recession
was accompanied by a tremendous tightening of credit
(referred to descriptively as a mancamento della credenza, or
“credit shortage”), which further worsened economic condi-
tions and brought about a deluge of industry, workshop, and
business failures. Cipolla has studied this economic recession
in depth and graphically describes the transition from eco-
nomic boom to crisis and recession in this way: “The age of
‘The Canticle of the Sun’ gave way to the age of the Danse
macabre.”55 In fact, according to Cipolla, the recession lasted
until, “thanks” to the devastating effects of the plague, which
radically diminished the population, the supply of cash and
credit money per capita approached its pre-crisis level and
laid the foundation for a subsequent recovery.56
54Cipolla, The Monetary Policy of Fourteenth-Century Florence, p. 9.
55Ibid., p. 1. See also Boccaccio’s commentary on the economic effects of
the plague, cited by John Hicks in Capital and Time: A Neo-Austrian The-
ory (Oxford: Clarendon Press, 1973), pp. 12–13; see footnote 60, chap. 5.
56Carlo M. Cipolla’s interpretive analysis of historical events reveals a
greater knowledge and application of economic theory than other
authors have displayed (such as A.P. Usher and Raymond de Roover,
who both express surprise at medieval economic recessions, the origins
of which are often “mysterious and inexplicable” to them). Still, his
analysis, monetarist in nature, focuses on the stages of recession, which
he attributes to a shortage of the money supply, resulting in turn from
an overall tightening of credit. Remarkably, he ignores the prior eco-
nomic boom, unconsciously lapsing into a “monetarist” interpretation
of history and thus failing to recognize the artificial boom caused by
credit expansion as the true source of the ensuing, inevitable recessions.
Cipolla’s thesis that it was the Black Death that eventually resolved the

72
Money, Bank Credit, and Economic Cycles
THE MEDICI BANK
The history of the Medici Bank has come to light through
the research and determination of Raymond de Roover, whose
work was in turn advanced by the 1950 discovery of the
Medici Bank’s confidential ledgers (libri segreti) in Florence’s
Archivio di Stato.57 The secrecy of these ledgers again betrays
the hidden, shameful nature of bankers’ activities (see footnote
52), as well as the desire of many customers of Italian banks
(nobles, princes, and even the Pope) to deposit their money in
secret accounts. The discovery of these bank books was indeed
fortunate, as they provide us with an in-depth understanding
of how the Medici Bank operated in the fifteenth century.
We must stress that the Medici Bank did not initially
accept demand deposits. At first it only took time deposits,
which were actually true loans from the customer to the bank.
These mutuum contracts were called depositi a discrezione. The
words a discrezione indicated that, as these supposed
“deposits” were really loans, the bank could make full use
of them and invest them freely, at least for the length of the
stipulated term.58 Discrezione also referred to the interest the
“shortage” of money is highly debatable, since money shortages tend to
correct themselves spontaneously through a general drop in prices (via
a corresponding increase in the value of money) which makes it unnec-
essary for individuals to maintain such high cash balances. There is no
need for a war or plague to decimate the population. Even if there had
been no plague, once the investment errors made during the boom had
been corrected, the process of economic decline would have ended
sooner or later, due to an increase in the value of money and a subse-
quent reduction in cash balances. This process undoubtedly coincided
with, yet occurred independently of the Black Death’s effects. Hence,
even the most educated and insightful historians, like Cipolla, clearly
make partial judgement errors in their interpretations when they do not
use the appropriate theoretical tools. At any rate, it is still very signifi-
cant that these defenders of an inflationary interpretation of history con-
tinue to point out the “positive effects” of wars and plagues and con-
sider them the key to recovery from economic crises.
57De Roover, The Rise and Decline of the Medici Bank, 1397–1494.
58
The Medici Bank and its subsidiaries also accepted deposits
from outsiders, especially great nobles, church dignitaries,

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 73
bank paid clients who loaned it money in the form of time
“deposits.”
In his book, Raymond de Roover performs a thorough,
detailed study of the development and vicissitudes of the
Medici Bank through the century of its existence. For our
purposes, it is only necessary to emphasize that at some point
the bank began to accept demand deposits and to use a por-
tion of them inappropriately as loans. The libri segreti docu-
ment this fact. The accounts for March 1442 accompany each
demand deposit entry with a note in the margin indicating the
likelihood that each depositor would claim his money.59
A balance sheet from the London branch of the Medici
Bank, dated November 12, 1477, shows that a significant
number of the bank’s debts corresponded to demand
deposits. Raymond de Roover himself estimates that at one
point, the bank’s primary reserves were down to 50 percent
of total demand liabilities.60 If we apply the standard crite-
rion used by A.P. Usher, this implies a credit expansion ratio
of twice the demand deposits received by the bank. There is
evidence, however, that this ratio gradually worsened over
the bank’s life-span, especially after 1464, a year that marked
the beginning of growing difficulties for the bank. The roots
of the general economic and bank crisis that ruined the
Medici Bank resemble those Carlo M. Cipolla identifies in his
study of fourteenth-century Florence. As a matter of fact,
credit expansion resulting from bankers’ misappropriation of
demand deposits gave rise to an artificial boom fed by the
increase in the money supply and its seemingly “beneficial”
short-term effects. Nevertheless, since this process sprang
from an increase in the money supply, namely credit
condottieri, and political figures, such as Philippe de Com-
mines and Ymbert de Batarnay. Such deposits were not usu-
ally payable on demand but were either explicitly or implic-
itly time deposits on which interest, or rather discrezione,
was paid. (De Roover, The Rise and Decline of the Medici Bank
1397–1494, p. 101)
59Ibid., p. 213.
60Ibid., p. 245.

74
Money, Bank Credit, and Economic Cycles
unbacked by growth in real savings, the reversal of the
process was inevitable, as chapters 4 and following will
explain in detail. This is exactly what happened in Italy’s large
business centers in the second half of the fifteenth century. In
terms of economic analysis, Raymond de Roover’s grasp of
the historical process is unfortunately even shallower than
Cipolla’s, and he even goes so far as to state, “what caused
these general crises remains a mystery.”61 However, it is not
surprising that the Medici Bank eventually failed, as did the
other banks that depended on fractional-reserve banking for a
large part of their business. Though Raymond de Roover
claims he does not understand what caused the general crisis
at the end of the fifteenth century, his blow-by-blow historical
account of the final stage of the Medici Bank reflects all of the
typical indications of an inescapable recession and credit
squeeze following a process of great artificial credit expan-
sion. De Roover explains that the Medicis were forced to
adopt a policy of credit restriction. They demanded the repay-
ment of loans and attempted to increase the bank’s liquidity.
Moreover, it has been demonstrated that in its final stage the
Medici Bank was operating with a very low reserve ratio,
which even dropped below 10 percent of total assets and was
therefore inadequate to meet the bank’s obligations during the
recession period.62 The Medici Bank eventually failed and all
61Ibid., p. 239.
62Hence, over the bank’s lifespan, its owners gradually increased their
violations of the traditional legal principle requiring them to maintain
possession of 100 percent of demand deposits, and their reserve ratio
continuously decreased:
A perusal of the extant balance sheets reveals another signifi-
cant fact: the Medici Bank operated with tenuous cash
reserves which were usually well below 10 percent of total
assets. It is true that this is a common feature in the financial
statements of medieval merchant-bankers, such as Francesco
Datini and the Borromei of Milan. The extent to which they
made use of money substitutes is always a surprise to mod-
ern historians. Nevertheless, one may raise the question
whether cash reserves were adequate and whether the Medici
Bank was not suffering from lack of liquidity. (Ibid., p. 371)

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 75
of its assets fell into the hands of its creditors. The bank’s com-
petitors failed for the same reasons: the unavoidable effects of
the artificial expansion and subsequent economic recession
invariably generated by the violation of the traditional legal
principles governing the monetary irregular deposit.
BANKING IN CATALONIA IN THE FOURTEENTH AND FIFTEENTH
CENTURIES: THE TAULA DE CANVI
The emergence of private banks in Barcelona coincided
with the development of private banking in large Italian busi-
ness centers. During the reign of Jaime I, the Conqueror,
(1213–1276), the Gothic and Roman laws governing business
were repealed and replaced by the Usos de Barcelona. In addi-
tion, a thorough, detailed set of regulations to control banking
was established by the Cortes of 1300–1301. It set down the
powers, rights, and responsibilities of bankers, and stipulated
requirements with respect to guarantors. Some of the rules
adopted are quite relevant to our topic.
For example, on February 13, 1300 it was established that
any banker who went bankrupt would be vilified throughout
Barcelona by a public spokesman and forced to live on a strict
diet of bread and water until he returned to his creditors the
full amount of their deposits.63 Furthermore, on May 16, 1301,
one year later, it was decided that bankers would be obliged
to obtain collateral or guarantees from third parties in order to
operate, and those who did not would not be allowed to
spread a tablecloth over their work counter. The purpose was
to make clear to everyone that these bankers were not as sol-
vent as those using tablecloths, who were backed by collateral.
Any banker who broke this rule (i.e., operated with a table-
cloth but without collateral) would be found guilty of fraud.64
In view of these regulations, Barcelona’s banking system must
initially have been quite solvent and banks must have largely
respected the essential legal principles governing the mone-
tary bank deposit.
63Usher, The Early History of Deposit Banking in Mediterranean Europe, p.
239.
64Ibid., p. 239.

76
Money, Bank Credit, and Economic Cycles
Nevertheless, there are indications to show that, in spite of
everything, private bankers soon began to deceive their
clients, and on August 14, 1321 the regulations pertaining to
bank failures were modified. It was established that those
bankers who did not immediately fulfill their commitments
would be declared bankrupt, and if they did not pay their
debts within one year, they would fall into public disgrace,
which would be proclaimed throughout Catalonia by a town
crier. Immediately afterward, the banker would be beheaded
directly in front of his counter, and his property sold locally to
pay his creditors. In fact, this is one of the few historical
instances in which public authorities have bothered to effec-
tively defend the general principles of property rights with
respect to the monetary bank-deposit contract. While it is
likely that most Catalonian bankers who went bankrupt tried
to escape or pay their debts within a year, documentary evi-
dence shows that at least one banker, a certain Francesch
Castello, was beheaded directly in front of his counter in 1360,
in strict accordance with the law.65
Despite these sanctions, banks’ liquid funds did not match
the amount received on demand deposit. As a result, they
eventually failed en masse in the fourteenth century, during
the same economic and credit recession that ravaged the Ital-
ian financial world and was studied by Carlo M. Cipolla.
Though there are signs that Catalonian banks held out a bit
longer than Italian ones (the terrible penalties for fraud
undoubtedly raised reserve ratios), documents show that in
the end, Catalonian banks also generally failed to meet their
obligations. In March 1397, further regulations were intro-
duced when the public began to complain that bankers were
reluctant to return money deposited, offered their clients all
65Ibid., pp. 240 and 242. In light of recent scandals and bank crises in
Spain, one could jokingly wonder if it might not be a good idea to again
punish fraudulent bankers as severely as in fourteenth-century Catalo-
nia. A student of ours, Elena Sousmatzian, says that in the recent bank
crisis that devastated Venezuela, a senator from the Social-Christian
Party Copei even “seriously” suggested such measures in a statement to
the press. Incidentally, her remarks were quite well-received among
depositors affected by the crisis.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 77
sorts of excuses, told them to “come back later” and would
pay them (in the end, if the clients were lucky) only in small
coins of little value and never in the gold which had originally
been deposited.66
The bank crisis of the fourteenth century did not lead to
increased monitoring and protection of the property rights of
depositors. Instead, it resulted in the creation of a municipal
government bank, the Taula de Canvi, Barcelona’s Bank of
Deposit. This bank was formed with the purpose of taking in
deposits and using them to finance city expenditures and the
issuance of government bond certificates for the city of
Barcelona. Hence, the Taula de Canvi fits the traditional model
of a bank created by public authorities to take direct advan-
tage of the dishonest profits of banking. A.P. Usher studied the
life of this bank in detail. Predictably, it ended up suspending
payments (in February 1468), because a large portion of its
reserves had been channeled into loans to the city of Barcelona
and the bank was unable to satisfy depositors’ demands for
cash withdrawals.67 From that point on, the bank was reor-
ganized and gradually given more and more privileges, such
as a monopoly on all deposits deriving from judicial attach-
ments and seizures. This was an almost guaranteed source of
continuous income and acted as collateral for loans to finance
the city’s projects. The Taula was also granted a monopoly on
resources from all administrative deposits, guardianships and
testate proceedings. These funds were deposited and fixed in
the bank.68
66Ibid., p. 244.
67
In February 1468, after a long period of strain, the Bank of
Deposit was obliged to suspend specie payments completely.
For all balances on the books at that date, annuities bearing
interest at 5 percent were issued to depositors willing to
accept them. Those unwilling to accept annuities remained
creditors of the bank, but they were not allowed to withdraw
funds in cash. (Ibid., p. 278)
68Documents show that in 1433, at least 28 percent of deposits in
Barcelona’s Taula de Canvi came from compulsory judicial seizures and
were very stable. See Usher, The Early History of Deposit Banking in
Mediterranean Europe, p. 339, and Kindleberger, A Financial History of

78
Money, Bank Credit, and Economic Cycles
4
BANKING DURING THE REIGN OF CHARLES V AND THE
DOCTRINE OF THE SCHOOL OF SALAMANCA69
Banking during the reign of Charles V is a good example
of the scenario we have been describing. First, the massive
influx of precious metals from the Americas shifted the eco-
nomic focus, at least temporarily, from the Northern Italian
trading cities to Spain; specifically, Seville and the other Span-
ish business centers. Second, due to his imperial policy,
Charles V was in constant need of funds, and he turned to the
banking system for a continual source of financing. In this
way, he unscrupulously took advantage of the liquidity it pro-
vided him and powerfully reinforced the traditional complic-
ity between authorities and bankers. A more disguised collab-
oration between the two was already the norm at that time.
Furthermore, Charles V was unable to keep the royal treasury
from going bankrupt, which, as could be expected, had very
negative effects on the Spanish economy and on the bankers
who had financed his projects. All of these events motivated
the most brilliant minds of the time, the scholars of the School
of Salamanca, to reflect on the financial and banking activities
they witnessed. These theorists left us with some very valu-
able analyses worthy of being studied in detail. We will now
examine each of the historical events in order.
Western Europe, p. 49. At any rate, the reserve ratio progressively wors-
ened until the suspension of payments in 1468. Following its reorgani-
zation at that time, Barcelona’s Bank of Deposit managed a fragile finan-
cial existence for the next 300 years, due to the privileges it enjoyed with
respect to judicial deposits and the limits established on loans to the city.
Shortly after Barcelona was captured by the Bourbons on September 14,
1714, the bank was taken over by a new institution with statutes drafted
by the Count of Montemar on January 14, 1723. These statutes were the
bank’s backbone until its final liquidation in the year 1853.
69Another English version of this section appeared in Jesús Huerta de
Soto, “New Light on the Prehistory of the Theory of Banking and the
School of Salamanca,” Review of Austrian Economics 9, no. 2 (1996):
59–81.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 79
THE DEVELOPMENT OF BANKING IN SEVILLE
Ramon Carande deserves credit for uncovering in some
detail the development of private banking in Seville during
the reign of Charles V.70 According to Carande, his research
was aided by the discovery of a list of bankers compiled prior
to the confiscation of precious metals by Seville’s Casa de Con-
tratación (Trading House) in 1545. An impoverished treasury
prompted Charles V to disregard the most basic legal princi-
ples and seize funds where he could find them: i.e., deposited
in the vaults of Seville’s bankers. Granted, these bankers also
violated the basic legal principles governing the monetary
irregular deposit and employed in their own private dealings
a large share of the money deposited. However, the emperor’s
policy of directly confiscating whatever funds remained in
their vaults incited bankers to routinely loan to third parties
most money on deposit. If there was ultimately no guarantee
that public authorities would respect bank reserves (and
bankers’ own experience taught them that, when short of
money, the emperor had no qualms about forcibly appropriat-
ing those funds in the form of compulsory loans to the
Crown), it seemed wiser to invest most deposited money in
loans to private industry and commerce, thus evading expro-
priation and earning higher profits.
The practice of confiscating deposits is perhaps the most
extreme example of public authorities’ traditional tendency to
capitalize on banking profits by expropriating the assets of
those who have a legal duty to better guard the deposits of
others. It is therefore understandable that rulers, being the
main beneficiaries of bankers’ dubious activities, ended up
justifying them and granting bankers all kinds of privileges to
allow them to continue operating with a fractional reserve, on
the fringes of legality.
In his chief work, Carlos V y sus banqueros, Ramón Carande
lists the most important bankers in the Seville of Charles V,
namely the Espinosas, Domingo de Lizarrazas, and Pedro de
70Ramón Carande, Carlos V y sus banqueros, 3 vols. (Barcelona and
Madrid: Editorial Crítica, 1987).

80
Money, Bank Credit, and Economic Cycles
Morga, along with the less prominent Cristóbal Francisquín,
Diego Martínez, Juan Íñiguez, and Octavio de Negrón. All of
them inexorably went bankrupt, for the most part due to a
lack of liquidity with which to satisfy depositors’ withdrawals
of demand deposits. This demonstrates they were operating
with a fractional reserve, aided by a license or privilege
obtained from the city of Seville and from Charles V himself.71
We do not have information on their exact reserve ratio, but
we do know that on many occasions they made personal
investments in the fleet used for trading with the Americas, in
the collection of taxes, etc. Such risky ventures were always
tremendously tempting, because when they went reasonably
well they yielded enormous profits. Moreover, as mentioned
above, the repeated confiscation of bank deposits of precious
metals only further encouraged bankers to carry on their ille-
gitimate activities. Consequently, the Espinosas’ bank failed in
1579 and the senior partners were imprisoned. The bank of
Domingo de Lizarrazas failed on March 11, 1553, when he was
unable to make a payment of more than six and a half million
maravedis, while the bank of Pedro de Morga, who began his
operations in 1553, failed in 1575, during the second bank-
ruptcy of Philip II. The less prominent banks suffered the
same fate. Thomas Gresham made an interesting comment on
this issue. He had traveled to Seville with instructions to with-
draw three hundred twenty thousand ducats in cash, for
which he had obtained the necessary license from the emperor
and Queen Mary. Gresham marveled that in the very city that
received the treasures of the Indies money could be so
extremely scarce. The same was true for the markets, and Gre-
sham feared that all the city’s banks would suspend payments
71Spanish banks of the seventeenth century had no better luck:
At the beginning of the seventeenth century there were
banks in the court, Seville, Toledo and Granada. Shortly after
1622, Alejandro Lindo complained that not one still existed,
the last one (owned by Jacome Matedo) having failed in
Seville. (M. Colmeiro, Historia de la economía política española
[1863; Madrid: Fundación Banco Exterior, 1988], vol. 2, p.
342)

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 81
as soon as his withdrawal was completed.72 It is unfortunate
that Ramón Carande uses such inadequate analytical tools
and that his interpretation of these bank failures derives
mainly from anecdotal information, such as the greed for met-
als, which constantly threatened banks’ solvency; bankers’
daring personal business ventures (their involvement in the
chartering of vessels, overseas merchant shipping, insurance,
various types of speculation, etc.), which continually placed
them in serious predicaments; and the royal treasury’s repeated
confiscation of valuables and its want of liquidity. He never
once mentions the following chain of events: Fractional-reserve
banking led to an artificial credit expansion unsupported by
sufficient real savings; this, along with the inflation of precious
metals from the Americas, generated an artificial boom; the
boom, in turn, produced an economic crisis and inevitable
recession; and this was the true cause of the bank failures.
Fortunately, Ramón Carande’s omission of theory has been
at least partially compensated for by Carlo M. Cipolla’s inter-
pretative study of the economic and bank crisis of the second
half of the sixteenth century. Though this analysis refers strictly
to Italian banks, it is also directly applicable to the Spanish
financial system, due to the intimate relationship existent at the
time between the financial and trade routes of the two coun-
tries.73 Cipolla explains that in the second half of the sixteenth
century, the money supply (what we refer to today as M1 or
M2) included a large amount of “bank money,” or deposits cre-
ated out of nowhere by bankers who did not maintain posses-
sion of 100 percent of the cash on demand deposit. This gave
rise to a period of artificial economic growth, which began to
72Eventually, after much effort, he was able to obtain around 200,000
ducats, writing at the time, “I am afraid I will cause the failure of all the
banks in Seville.” See Carande, Carlos V y sus banqueros, vol. 1, pp.
299–323, esp. pp. 315–16, which refer to Gresham’s visit to Seville.
73See Cipolla’s Money in Sixteenth-Century Florence (Berkeley: University
of California Press, 1989), esp. pp. 101ff. The intimate financial and trade
relationship between Spain and Italy in the sixteenth century is very
well documented in Felipe Ruiz Martín’s book, Pequeño capitalismo, gran
capitalismo: Simón Ruiz y sus negocios en Florencia (Barcelona: Editorial
Crítica, 1990).

82
Money, Bank Credit, and Economic Cycles
reverse in the second half of the sixteenth century, when
depositors nervously started to experience economic difficul-
ties and the most important Florentine banks began to fail.
According to Cipolla, this phase of expansion was set in
motion in Italy by the directors of the Ricci Bank, who used a
very large share of their deposits to buy government securities
and grant loans. The other private banks were obliged to
adopt the same policy of credit expansion if their managers
wanted to be competitive and conserve their profits and mar-
ket share. This process gave rise to a credit boom which led to
a phase of great artificial expansion that soon began to
reverse. In 1574, a proclamation accused bankers of refusing to
return deposits in cash and denounced the fact that they only
“paid with ink.” It became increasingly more difficult for
them to return deposits in ready cash, and Venetian cities
began to experience a significant money scarcity. Craftsmen
could not withdraw their deposits nor pay their debts and a
severe credit squeeze (i.e., deflation) followed, along with a
serious economic crisis analyzed in detail by Cipolla in his
interesting work. From a theoretical standpoint, Cipolla’s
analysis is stronger than Ramón Carande’s, although it is not
completely adequate either, as it places more emphasis on the
crisis and credit squeeze than on the prior stage of artificial
credit expansion, wherein lies the true root of the evil. The
credit expansion phase, in turn, is rooted in the failure of
bankers to comply with the obligation to safeguard and main-
tain intact 100 percent of the tantundem.74
74Cipolla indicates that in the 1570s, the Ricci Bank could no longer
meet demands for cash withdrawals and actually suspended payments,
only paying “in ink” or with bank policies. Florentine authorities
focused on just the symptoms of this worrisome situation and made the
typical attempt to resolve it with mere ordinances. They imposed upon
bankers the obligation to pay their creditors immediately in cash, but
they did not diagnose nor attack the fundamental source of the problem
(the misappropriation of deposits and channeling of them into loans
and the failure to maintain a 100-percent cash reserve). Consequently,
the decrees which followed failed to have the desired effect and the cri-
sis gradually worsened until it exploded violently in the mid-1570s. See
Cipolla, Money in Sixteenth-Century Florence, p. 107.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 83
Of international relevance were the long-standing rela-
tions between Charles V and members of the prominent Fug-
ger banking family (known in Spain as the Fúcares). The Fug-
gers of Augsburg started out as wool and silver merchants and
also traded spices between their city and Venice. Later they
concentrated on banking, and in their heyday they operated
eighteen branches in different parts of Europe. They granted
loans to help finance the election of Charles V as emperor and
later funded his exploits on many occasions, receiving as col-
lateral both the silver shipments from the Americas and the
authorization to collect taxes. Their business came to a stand-
still and barely escaped bankruptcy in 1557 when Philip II de
facto suspended payments, and in fact they continued to lease
the lands belonging to military orders until 1634.75
THE SCHOOL OF SALAMANCA AND THE BANKING BUSINESS
These financial and banking phenomena did not go unno-
ticed by the illustrious minds of members of the School of
Salamanca who, according to the most reliable research,
paved the way for the modern subjectivist theory of value,
developed by the Austrian School of economics.76
75The best source on the relations between the Fugger Bank and Charles
V is arguably Ramón Carande’s Carlos V y sus banqueros. Also deserving
mention is a study by Rafael Termes Carreró, entitled Carlos V y uno de
sus banqueros: Jacobo Fugger (Madrid: Asociación de Caballeros del
Monasterio de Yuste, 1993). Rafael Termes makes an interesting obser-
vation about the Fuggers’ dominance in Spain, pointing out that
there is a street in Madrid named after the Fuggers. Calle de
Fúcar, between Atocha and Moratín streets, bears the his-
panized version of their last name. In addition, the word
fúcar is listed even today as meaning “rich and wealthy per-
son” in the Diccionario of the Spanish Royal Academy. (p. 25)
76The following authors, among others, have recently examined the
contributions of Spanish scholastics to economic theory: Murray N.
Rothbard, “New Light on the Prehistory of the Austrian School,” in The
Foundations of Modern Austrian Economics, Edwin G. Dolan, ed. (Kansas
City, Mo.: Sheed and Ward, 1976), pp. 52–74, and Economic Thought
Before Adam Smith, chap. 4, pp. 97–133; Lucas Beltrán, “Sobre los orí-
genes hispanos de la economía de mercado,” in Ensayos de economía

84
Money, Bank Credit, and Economic Cycles
Chronologically speaking, the first work to consider,
and perhaps the most relevant to our thesis, is Instrucción de
mercaderes (Instruction to merchants), written by Doctor Luis
política (Madrid: Unión Editorial, 1996), pp. 234–54; Marjorie Grice-
Hutchinson, The School of Salamanca: Readings in Spanish Monetary Theory
1544–1605 (Oxford: Clarendon Press, 1952), Early Economic Thought in
Spain 1177–1740 (London: George Allen and Unwin, 1978), and Economic
Thought in Spain: Selected Essays of Marjorie Grice-Hutchinson, Laurence S.
Moss and Christopher K. Ryan, eds. (Aldershot, England: Edward Elgar,
1993); Alejandro A. Chafuen, Christians for Freedom: Late-Scholastic Eco-
nomics (San Francisco: Ignatius Press, 1986); and Huerta de Soto, “New
Light on the Prehistory of the Theory of Banking and the School of Sala-
manca,” pp. 59–81. The intellectual influence of the School of Salamanca
on the Austrian School is not a mere coincidence or quirk of history, but
a consequence of the close historical, political and cultural connections
established between Spain and Austria during the time of Charles V and
his brother Ferdinand I. These ties lasted for several centuries, and Italy
played a crucial role in them, acting as a true cultural, economic and
financial link between the two furthermost tips of the Empire (Spain and
Vienna). (On this subject, we recommend Jean Bérenger’s interesting
book, A History of the Habsburg Empire, 1273–1700, C.A. Simpson, trans.
[London: Longman, 1994, pp. 133–35]). Nevertheless, the scholastics’
doctrine on banking has been largely overlooked in the above writings.
Marjorie Grice-Hutchinson does touch upon the topic with a near verba-
tim reproduction of Ramón Carande’s brief contribution to the matter
(see The School of Salamanca, pp. 7–8). Ramón Carande, in turn, simply
cites (on pp. 297–98 of volume 1 of his book, Carlos V y sus banqueros)
Tomás de Mercado’s reflections on banking. A more profound examina-
tion is made by Alejandro A. Chafuen, who at least reports Luis de
Molina’s views on banking and considers the extent to which the School
of Salamanca approved or disapproved of fractional-reserve banking.
Another relevant source is Restituto Sierra Bravo’s work, El pensamiento
social y económico de la Escolástica desde sus orígenes al comienzo del catoli-
cismo social (Madrid: Consejo Superior de Investigaciones Científicas,
Instituto de Sociología “Balmes,” 1975). Volume 1, pp. 214–37 includes a
rather biased interpretation of the views of members of the School of
Salamanca on the banking business. According to Sierra Bravo, some
among the School’s theorists (including Domingo de Soto, Luis de
Molina, and even Tomás de Mercado) tended to accept fractional-
reserve banking. However, he ignores the writings of other members of
the School who, on firmer theoretical grounds, held a radically oppos-
ing view. The same criticism can be applied to references Francisco G.
Camacho makes in his prefaces to the Spanish translations of Molina’s
works, particularly his “Introduction” to La teoría del justo precio

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 85
Saravia de la Calle and published in Medina del Campo in
1544. Saravia de la Calle criticizes bankers harshly, calling
them “voracious gluttons who swallow everything, destroy
everything, confuse everything, steal and soil everything, like
the harpies of Phineus.”77 He says bankers “go out into the
street and square with their table and chair and cash-box and
book, like harlots to the brothel with their chair,” and having
obtained the necessary license and guarantee required by the
laws of the kingdom, they set about acquiring deposits from
clients, to whom they offer bookkeeping and cashier services,
making payments from clients’ accounts as ordered and even
paying interest on such deposits.
With sound legal reasoning, Saravia de la Calle indicates
that interest is incompatible with the nature of the monetary
deposit, and that in any case, the banker should receive a fee
for the custody and safekeeping of the money. He even
severely rebukes customers who enter into such deals with
bankers, and states:
And if you say, merchant, that you do not lend the money,
but that you deposit it, that is a greater mockery; for who
ever saw the depositary pay? He is usually paid for the trou-
ble of safeguarding the deposit. Furthermore, if you now
entrust your money to the profiteer as a loan or deposit, just
as you receive a part of the profit , you also earn a portion of
guilt, even a greater portion.78
In chapter 12 of his book, Saravia de la Calle makes a neat
distinction between the two radically different operations
(Madrid: Editora Nacional, 1981), esp. pp. 33–34. This version of the
doctrine, according to which some members of the School of Salamanca
accepted fractional-reserve banking, has been greatly influenced by an
article by Francisco Belda, S.J., entitled “Ética de la creación de créditos
según la doctrina de Molina, Lessio y Lugo,” published in Pensamiento
19 (1963): 53–89. For the reasons indicated in the text, we disagree with
the interpretation these authors make of the doctrine of the School of
Salamanca with respect to banking. We will consider these objections in
greater detail in section 1 of chapter 8.
77Saravia de la Calle, Instrucción de mercaderes, p. 180.
78Ibid., p. 181.

86
Money, Bank Credit, and Economic Cycles
bankers carry out: demand deposits and time “deposits.” In
the first case, customers entrust their money interest-free to
bankers
so the money will be safer, and more accessible for making
payments, and to avoid the hassle and trouble of counting
and guarding it, and also because, in gratitude for this good
deed they do the moneylender in giving him their money, if
it so happens they have no money left under his charge, he
will also accept some overdrafts without interest.79
The second operation, the time “deposit,” is very different
from the first and is in fact a true loan or mutuum which is
granted the banker for a fixed term and yields interest. Saravia
de la Calle, in compliance with the traditional canonical doc-
trine on usury, condemns these transactions. Furthermore, he
clearly states that in the case of the demand-deposit contract,
customers should pay the banker
for if they deposit money, they should pay for the safekeep-
ing and should not derive as much profit as the laws permit
when depositing money or property that requires safe-
guarding.80
Saravia de la Calle goes on to censure those clients who self-
ishly try to capitalize on the illicit activity of bankers, making
deposits and expecting bankers to pay interest. As he vividly
puts it,
He who deposits his money with someone he knows will
not guard it, but will spend it, is not free from sin, at least
venial sin. He acts as one who turns over a virgin to a lecher
or a delicacy to a glutton.81
Moreover, the depositor cannot ease his conscience by
thinking the banker will loan or use other people’s money but
not his own.
79Ibid., p. 195.
80Ibid., p. 196.
81Ibid., p. 197.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 87
He believes the banker will probably guard the money he
deposits and not do business with it, when this cannot be
expected of any of these profiteers. On the contrary, the
banker will soon invest the deposit for profit and try to earn
money with it. How could bankers who pay 7 and 10 per-
cent interest to those who provide them with money to do
business with possibly refrain from using deposits? Even if
it had been clearly demonstrated that you do not sin (which
is not the case, quite the opposite), the moneylender very
certainly sins when he does business with your money and
he definitely uses your money to steal the property of your
neighbors.82
Saravia de la Calle’s doctrine is very coherent, inasmuch
as the self-interested use (via the granting of loans) of money
placed on demand deposit with bankers is illegitimate and
implies a grave sin. This doctrine coincides with the one orig-
inally established by the classical authors of Roman law, a
doctrine which derives naturally from the very essence, pur-
pose, and legal nature of the monetary irregular-deposit con-
tract, which we studied in chapter 1.
Saravia de la Calle also vividly describes the dispropor-
tionate profits bankers obtain through their illegitimate prac-
tice of appropriating deposits instead of being satisfied with
the more modest earnings they would receive for the simple
custody or safekeeping of deposits. His explanation is quite
descriptive:
If you receive a wage, it should be moderate and adequate
for your support, not the excessive loot with which you
build superb houses, buy lavish estates, pay servants and
provide extravagant luxuries for your families, and you give
great feasts and dress so splendidly, especially when you
were poor before you began your dealings, and you left
humble trades.83
In addition, Saravia de la Calle explains that bankers are
quite prone to bankruptcy, and he even carries out a cursory
82Ibid.
83Ibid., p. 186.

88
Money, Bank Credit, and Economic Cycles
theoretical analysis which demonstrates that the expansionary
phase brought on by the artificial expansion of credit granted
by these “profiteers” is inevitably followed by a period of
recession, during which the non-payment of debts produces a
chain of bank failures. He adds that
the merchant does not pay the profiteer, he causes him to go
bankrupt, and he suspends payments and all is lost. As is
common knowledge, these moneylenders are the beginning,
occasion and even the cause of all this, because if they did not
exist, each person would use his money to the extent he could and
no more, and things would cost what they are worth and more
than a fair cash price would not be charged. Therefore it would
be very worthwhile for princes to stop tolerating these prof-
iteers in Spain, since no other nation in the world tolerates
them, and to banish this pestilence from their court and
kingdom.84
As we know, it is not true that the authorities of other
nations had controlled the activity of bankers more success-
fully than Spanish authorities. Instead, the same thing hap-
pened more or less everywhere, and rulers eventually granted
bankers privileges to allow them to make self-interested use of
their depositors’ money, in exchange for the ability to capital-
ize on a banking system which provided much faster and eas-
ier financing than taxes.
To conclude his analysis, Saravia de la Calle affirms that
a Christian should under no circumstances give his money
to these profiteers, because if he sins in doing so, as is
always the case, he should refrain from it to avoid sinning;
and if he does not sin, he should refrain to avoid causing the
moneylender to sin.
Furthermore, he adds that if bankers’ services are not used,
the following additional advantage will result: the depositors
will not be shocked if the moneylender suspends payments;
if he goes bankrupt, as we see so often and Our Lord God per-
mits, let him and his masters be lost like dishonest gains.85
84Ibid., p. 190; italics added.
85Ibid., p. 198.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 89
As we see, Saravia de la Calle’s analysis, along with his
cleverness and humor, is impeccable and free from contradic-
tions. However, in his criticism of bankers, he perhaps places
too much emphasis on the fact that they charged and paid
interest in violation of the canonical prohibition of usury,
instead of emphasizing that they misappropriated demand
deposits.
Another writer who examines the monetary irregular-
deposit contract is Martín de Azpilcueta, better known as
“Doctor Navarro.” In his book, Comentario resolutorio de cam-
bios (Resolutory commentary on exchanges), first published in
Salamanca at the end of 1556, Martín de Azpilcueta expressly
refers to “banking for safekeeping,” which consists of the
bank contract of monetary demand-deposit. For Martín de
Azpilcueta, banking for safekeeping, or the irregular deposit
contract, is fully just and means that the banker is
guardian, depositary and guarantor of the money given
him or exchanged for whatever purpose by those who give
or send him money, and that he is obliged to make pay-
ments to merchants or persons to whom depositors want
payments made in such and such a way, [for which] he
may legitimately charge a fair fee to the republic or the
depositors, as this trade and responsibility are useful to the
republic and free from iniquity; for it is fair for a worker to
earn his wages. And it is the moneychanger’s job to
receive, safeguard and keep the money of so many mer-
chants ready, and to write and keep their accounts, with
great difficulty and at times risk of error in their records
and in other things. This arrangement could be formalized
in a contract by which a person commits himself to hold
other people’s money in deposit, make payments and keep
records as arranged by them, etc., since this is an agree-
ment to hire a person for a job, which is a well-known, just
and blessed contract.86
86Martín de Azpilcueta, Comentario resolutorio de cambios (Madrid: Con-
sejo Superior de Investigaciones Científicas, 1965), pp. 57–58. In our
study of Dr. Navarro’s doctrines we have used the first Spanish edition,

90
Money, Bank Credit, and Economic Cycles
As we see, Martín de Azpilcueta regards the monetary
irregular-deposit contract as a completely legitimate contract
by which people entrust the custody of their money to a pro-
fessional (the banker), who must safeguard it like a good par-
ent and keep it constantly available to the depositors, provid-
ing whatever cashier services they ask of him; and he has a
right to charge the depositors a fee for his services. As a mat-
ter of fact, Martín de Azpilcueta feels it is the depositors who
must pay the depositary or banker and never the reverse, so
depositors “pay in compensation for the trouble and worries
the moneychanger has in receiving and safeguarding their
money,” and bankers must conduct
their business honestly and be satisfied with a fair wage,
receiving it from those who owe it to them and whose
money they safeguard and whose accounts they keep, and
not from those who are not indebted to them.87
Moreover, in an effort to clarify matters and avoid confu-
sion, Martín de Azpilcueta (using the same reasoning as Doc-
tor Saravia de la Calle) expressly condemns clients who wish
to pay nothing for the custody of their deposits and try to even
earn interest on them. Doctor Navarro concludes that
in this sort of exchange, not only the moneychangers sin, but
also . . . those who entrust their money to them for safe-
keeping as above. They later refuse to pay a fee, claiming the
profits earned with their money and received from those
they pay in cash is enough of a wage. And if the money-
changers request a fee, the customers leave them and take
their business elsewhere. So, to keep these clients, the
bankers renounce their fee and instead take money from
those who owe them nothing.88
published by Andrés de Portanarijs in Salamanca in 1556, as well as the
Portuguese edition, published by Ioam de Barreyra in Coimbra in 1560
and entitled Comentario resolutorio de onzenas. In this edition, the text cor-
responding to the above quotes appears on pp. 77–80.
87Azpilcueta, Comentario resolutorio de cambios, pp. 60–61.
88Ibid., p. 61.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 91
In his book, Suma de tratos y contratos (Compilation of deals
and contracts) (Seville 1571), Tomás de Mercado performs an
analysis of the banking business very much in the same line as
the studies by the preceding authors. He begins by correctly
stating that depositors should pay bankers for the work of
safeguarding their monetary deposits, concluding that
it is a common, general rule among all bankers to be able to
take wages from those who deposit money in their bank, a
certain amount each year or for each thousand, because
bankers serve depositors and safeguard their assets.89
Nevertheless, Tomás de Mercado ironically points out that
bankers in Seville are so “generous” they charge nothing for
guarding deposits: “those of this city, it is true, are so regal and
noble they ask for and take no wage.”90 Tomás de Mercado
observes that these bankers have no need to charge anything,
since the large amount of currency they obtain from deposits
earns them substantial profits in personal business deals. We
must emphasize that, in our opinion, Tomás de Mercado sim-
ply verifies a fact here and does not imply that he considers
these actions in any way legitimate, as various modern
authors (among others, Restituto Sierra Bravo and Francisco
G. Camacho) appear to suggest.91 Quite the opposite is true.
From the standpoint of the purest Roman doctrine and the
essential legal nature of the monetary irregular-deposit con-
tract analyzed in chapter 1, Tomás de Mercado is the scholas-
tic writer who most clearly demonstrates that the transfer of
property in the irregular deposit does not imply a concomitant
89We quote the Instituto de Estudios Fiscales edition published in
Madrid in 1977, edited and prefaced by Nicolás Sánchez Albornoz, vol.
2, p. 479. Restituto Sierra Bravo has another edition, published by the
Editora Nacional in 1975. The above excerpt appears on page 401 of this
edition. The original edition was published in Seville in 1571 “en casa de
Hernando Díaz Impresor de Libros, en la calle de la Sierpe.”
90Mercado, Suma de tratos y contratos, vol. 2, p. 480 of the Instituto de
Estudios Fiscales edition and p. 401 of the Restituto Sierra Bravo edition.
91See the writings by Restituto Sierra Bravo, Francisco Belda, and Fran-
cisco García Camacho cited in footnote 76.

92
Money, Bank Credit, and Economic Cycles
transfer of availability of the tantundem and therefore, for all
practical purposes, there is no full transfer of property. He
expresses himself quite well: “they [bankers] must under-
stand that the money is not theirs, but belongs to others; and
it is not fair that by using it, they cease to serve its owner.”
Tomás de Mercado adds that bankers should obey two funda-
mental principles. First: they should
not strip the bank so bare they cannot then cover the drafts
they receive, because if they become unable to pay them
because they have spent and invested the money in shady
business and other deals, they certainly sin. . . . Second: they
should not become involved in risky business deals, for they
sin even if the deals turn out successfully, because the
bankers chance not being able to fulfill their responsibilities
and doing serious harm to those who have trusted them.92
Though one could take these recommendations as an indi-
cation that Tomás de Mercado resigns to accept a certain frac-
tional reserve, it is important to keep in mind that he is very
emphatic in expressing his legal opinion that deposited
money does not ultimately belong to bankers but to deposi-
tors, and in stating, furthermore, that none of the bankers
complies with his two recommendations:
however, since when business goes well, in affluent circum-
stances, it is very difficult to bridle greed, none of them
takes heed of these warnings nor meets these conditions.93
For this reason, he considers the regulations enacted by the
Emperor Charles V in this respect to be very beneficial. They
prohibited bankers from carrying out personal business deals
and were aimed at eliminating the temptation to finance such
dealings indefinitely with money obtained from depositors.94
92Mercado, Suma de tratos y contratos, vol. 2, p. 480 of the Instituto de
Estudios Fiscales edition and p. 401 of the Restituto Sierra Bravo edition.
93Ibid.
94Nueva Recopilación, law 12, title 18, book 5, enacted in Zamora on June
6, 1554 by Charles V, Queen Juana, and Prince Philip; it reads:

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 93
Also, at the end of chapter 4 of Suma de tratos y contratos,
Tomás de Mercado states that the bankers of Seville hold
deposits of money and precious metals belonging to merchants
who traded with the New World, and that with such consid-
erable deposits they “make great investments,” obtaining
hefty profits. Here he does not openly condemn these prac-
tices, but we must remember that the passage in question is,
again, more a description of a state of affairs than a judgment
on its legitimacy. However, he does consider the issue of legit-
imacy in greater depth in chapter 14, which we have already
covered. Tomás de Mercado concludes as well that bankers
are also involved in exchanging and charging; bankers in
this republic engage in an extremely wide range of activi-
ties, wider than the ocean, but sometimes they spread them-
selves too thin and all is lost.95
The scholastics most misguided in their doctrinal treat-
ment of the monetary irregular-deposit contract are Domingo
de Soto and (especially) Luis de Molina and Juan de Lugo.
Indeed, these theorists allowed themselves to be influenced
Because the public banks in the markets of Medina del
Campo, Rioseco and Villalón, and in the cities, towns and vil-
lages of these kingdoms . . . [have engaged in business other
than their specific task concerning money], they have as a
result suspended payments and failed; [in order to] avoid the
above-mentioned events, we decree that, from now on, they
confine themselves to their specific duty, and that not just one
person but at least two be required to establish these public
banks . . . and that before they . . . [can practice their profes-
sion], they must provide sufficient guarantees. (italics added)
Note that “public banks” refers here not to government banks but to pri-
vate banks which may receive deposits from the public under certain
conditions (at least two owners, sufficient guarantees, etc.). See José
Antonio Rubio Sacristán, “La fundación del Banco de Amsterdam (1609)
y la banca de Sevilla,” Moneda y crédito (March 1948).
95This is the quotation of Mercado which Ramón Carande includes in
vol. 1 of Carlos V y sus banqueros, in the introduction to his treatment of
bankers in Seville and the crisis that led them all to fail. See Mercado,
Suma de tratos y contratos, vol. 2, pp. 381–82 of the 1977 edition of the
Instituto de Estudios Fiscales and p. 321 of the Sierra Bravo edition.

94
Money, Bank Credit, and Economic Cycles
by the medieval tradition of the glossators, which we covered
in section 2 of this chapter, and especially by the doctrinal con-
fusion resulting from the depositum confessatum. De Soto and
especially Molina view the irregular deposit as a loan in which
both the ownership and full availability of the tantundem are
transferred to the banker. Therefore, they believe the practice
of loaning deposited funds to third parties is legitimate, as
long as bankers act in a “prudent” manner. Domingo de Soto
could be considered the first to maintain this thesis, though he
did so very indirectly. In fact, in book 6, topic 11 of his work,
La justicia y el derecho (On justice and law) (1556), we read that
bankers have the
custom, it is said, of being liable for a greater amount of
money than that deposited if a merchant makes his deposit
in cash. I gave the moneychanger ten thousand; so he will be
liable to me for twelve, perhaps fifteen; because having cash
is very profitable for the moneychanger. Neither is any evil
seen in it.96
Another typical example of credit creation which
Domingo de Soto appears to accept is a loan in the form of the
discount of bills, financed using clients’ deposits.
Nevertheless, the Jesuit Luis de Molina is the scholar who
has most clearly maintained an erroneous doctrine on the
bank contract of monetary irregular deposit.97 Indeed, in
96
Habet autem praeterea istorum usus, ut fertur si mercatorum
quispiam in cambio numeratam pecuniam deponat, campsor
pro maio ri illius gratia respondeat. Numeravi campsori dece
milia: fide habebo apud ipsum & creditu pro duodecim, & for-
fam pro quim decim: qui capsori habere numerata pecuniam
bonum est lucrum. Neq, vero quicq vitij in hoc foedere
apparet. (Domingo de Soto, De iustitia et iure [Salamanca:
Andreas Portonarijs, 1556], book 6, topic 11, the only article,
p. 591. Instituto de Estudios Políticos edition [Madrid, 1968],
vol. 3, p. 591)
Sierra Bravo (El pensamiento social y económico de la Escolástica, p. 215) is
of the opinion that these words by Domingo de Soto imply his accept-
ance of fractional-reserve banking.
97It is very significant that various authors, including Marjorie Grice-
Hutchinson, hesitate to place Luis de Molina among the theorists of the

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 95
Tratado sobre los cambios (Treatise on exchanges) (1597), he
upholds the medieval doctrine that the irregular deposit is a
loan or mutuum contract in favor of the banker, a contract in
which not only ownership is transferred, but full availability of
the tantundem as well, which means the banker can legitimately
use the money in his own interest, in the form of loans or in any
other manner. Let us see how he presents his argument:
Because these bankers, like all the others, are true owners of
the money deposited in their banks, and they differ greatly in
this way from other depositaries . . . so they receive the money
as a precarious loan and hence, at their own risk.
Further on he indicates even more clearly that
such a deposit is really a loan, as has been said, and ownership
of the money deposited is transferred to the banker, so if it is
lost it is lost to the banker.98
This position conflicts with the doctrine Luis de Molina
himself upholds in Tratado sobre los préstamos y la usura (Treatise
on loans and usury), where he indicates that a term is an essen-
tial element of all loan contracts, and that if the duration of a
loan has not been expressly stipulated and a date for its return
set, “it will be necessary to accept the decision of the judge as
to the loan’s duration.”99 Moreover, Luis de Molina ignores all
of the arguments presented in chapter 1 to demonstrate that
the irregular deposit contract has nothing in common, in
School of Salamanca: “The inclusion of Molina in the School seems to
me now to be more dubious.” Marjorie Grice-Hutchinson, “The Concept
of the School of Salamanca: Its Origins and Development,” chapter 2 of
Economic Thought in Spain: Selected Essays of Marjorie Grice-Hutchinson, p.
25. It seems clear that the core members of the School of Salamanca were
Dominican, and at least on banking matters it is necessary to separate
them from Jesuit theologians, a deviationist and much less rigorous
group.
98Luis de Molina, Tratado sobre los cambios, edited and introduced by
Francisco Gómez Camacho (Madrid: Instituto de Estudios Fiscales,
1991), pp. 137–40. The original edition was published in Cuenca in 1597.
99Luis de Molina, Tratado sobre los préstamos y la usura, edited and intro-
duced by Francisco Gómez Camacho (Madrid: Instituto de Estudios Fis-
cales, 1989), p. 13. The original edition was published in Cuenca in 1597.

96
Money, Bank Credit, and Economic Cycles
terms of legal nature and essence, with the loan or mutuum
contract. Therefore, his doctrinal attempt to identify the two
contracts with each other is a clear step backward, not only in
relation to the much more coherent views of Saravia de la
Calle and Martin de Azpilcueta, but also with respect to the
true legal nature of the contract as it had already been devel-
oped by Roman juridical science. Therefore, it is strange that
a mind as bright and penetrating as Luis de Molina did not
realize the extreme danger of accepting the violation of the
general legal principles governing the irregular deposit, and
that he claimed,
it never occurs that all the depositors need their money in
such a way that they do not leave many thousands of ducats
deposited, with which the bankers can do business and
either earn a profit or suffer a loss.100
Molina does not recognize that in this way not only is the
objective or essential purpose of the contract (custody and
safekeeping) violated, but also that an incentive is provided
for all sorts of illicit dealings and abuses which inexorably
generate an economic recession and bank failures. When the
traditional legal principle requiring the continual safekeeping
of the tantundem in favor of the depositor is not respected, there
is no clear guide to avoiding bank failures. Furthermore, it is
obvious that such vague, superficial suggestions as “try to act
prudently” and “do not become involved in risky business
deals” are not sufficient help in preventing the very harmful
economic and social effects of fractional-reserve banking. At
any rate, Luis de Molina does at least bother to state,
It is important to warn that [bankers] commit mortal sin if
they use in their own business dealings so much of the
money they hold on deposit that they are later unable, at the
right time, to hand over the quantities the depositors request
or order to be paid against their deposited funds. . . . In
addition, they commit mortal sin if they become involved in
business dealings entailing a risk of not being able to return
deposits. For example, if they send so much merchandise
100Molina, Tratado sobre los cambios, p. 137.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 97
overseas that, should the ship sink or be captured by pirates,
they would not be able to repay deposits even after selling all
of their assets. And they are not guilty of mortal sin only when
the deal turns out poorly, but also when it turns out well. This is
due to the chance they take of hurting depositors and the guaran-
tors they themselves supply for the deposits.101
We find this warning of Luis de Molina admirable, but at
the same time we are astonished at his failure to recognize the
profound contradiction that ultimately exists between his
warning and his explicit acceptance of “prudent” fractional-
reserve banking. The fact is, regardless of how prudent
bankers are, the only surefire way to avoid risks and ensure
that deposits are permanently available to depositors is to
maintain a 100-percent reserve ratio at all times.102
101Ibid., pp. 138–39; italics added.
102After Molina, the leading scholar with a similar viewpoint on bank-
ing issues is Juan de Lugo, also a Jesuit. This suggests that, with regard
to banking, the School of Salamanca comprised two currents of thought:
one which was sound, doctrinally well-supported, close to the future
Currency School, and represented by Saravia de la Calle, Martín de
Azpilcueta, and Tomás de Mercado; and another, one more prone to the
follies of inflationism and to fractional-reserve banking, and close to the
future Banking School. Luis de Molina, Juan de Lugo, and to a much
lesser extent, Domingo de Soto exemplified this current. In chapter 8
we will set out this thesis in greater detail. For now we would just like
to point out that Juan de Lugo followed in Molina’s footsteps and gave
an especially clear warning to bankers:
Qui bene advertit, eivsmodi bancarios depositarios peccare
graviter, & damno subsequuto, cum obligatione restituendi
pro damno, quoties ex pecuniis apud se depositis tantam
summam ad suas negotiationes exponunt, ut inhabiles
maneant ad solvendum deposentibus, quando suo tempore
exigent. Et idem est, si negotiationes tales aggrediantur, ex
quibus periculum sit, ne postea ad paupertatem redacti pecu-
nias acceptas reddere non possint, v.g. si euenrus ex naviga-
tione periculosa dependeat, in qua navis hostium, vel
naufragij periculo exposita sit, qua iactura sequunta, ne ex
propio quidem patrimonio solvere possint, sed in creditorum,
vel fideiussorum damnum cedere debet. (R.P. Joannis de
Lugo Hispalensis, S.I., Disputationum de iustitia et iure tomus
secundus, Disp. 28, section 5 [Lyon: Sumptibus Petri Prost,
1642], pp. 406–07)

98
Money, Bank Credit, and Economic Cycles
5
A NEW ATTEMPT AT LEGITIMATE BANKING:
THE BANK OF AMSTERDAM. BANKING IN THE
SEVENTEENTH AND EIGHTEENTH CENTURIES
THE BANK OF AMSTERDAM
The last serious attempt to establish a bank based on the
general legal principles governing the monetary irregular
deposit and to set up an efficient system of government con-
trol to adequately define and defend depositors’ property
rights took place with the creation of the Municipal Bank of
Amsterdam in 1609. It was founded after a period of great
monetary chaos and fraudulent (fractional-reserve) private
banking. Intended to put an end to this state of affairs and
restore order to financial relations, the Bank of Amsterdam
began operating on January 31, 1609 and was called the Bank
of Exchange.103 The hallmark of the Bank of Amsterdam was
its commitment, from the time of its creation, to the universal
legal principles governing the monetary irregular deposit.
More specifically, it was founded upon the principle that the
obligation of the depository bank in the monetary irregular-
deposit contract consists of maintaining the constant avail-
ability of the tantundem in favor of the depositor; that is,
maintaining at all times a 100-percent reserve ratio with
respect to “demand” deposits. This measure was intended to
ensure legitimate banking and prevent the abuses and bank
failures which had historically occurred in all countries
where the state had not only not bothered to prohibit and
declare illegal the misappropriation of money on demand
deposit in banks, but on the contrary, had usually ended up
granting bankers all sorts of privileges and licenses to allow
their fraudulent operations, in exchange for the opportunity
to take fiscal advantage of them.
103As for the curious reference to the public banks of Seville (and
Venice) as models (!) for the Bank of Amsterdam, included in a petition
from leading Dutch merchants to the Council of Amsterdam, see José
Antonio Rubio Sacristán, “La fundación del Banco de Amsterdam (1609)
y la banca de Sevilla.”

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 99
For a very long time, over one hundred fifty years, the
Bank of Amsterdam scrupulously fulfilled the commitment
upon which it was founded. Evidence reflects that during the
first years of its existence, between 1610 and 1616, both the
bank’s deposits and its cash reserves came very close to one
million florins. From 1619 to 1635, deposits amounted to
nearly four million florins and cash reserves exceeded three
million, five hundred thousand. After this slight imbalance,
equilibrium was restored in 1645, when deposits equaled
eleven million, two hundred eighty-eight thousand florins and
cash reserves added up to eleven million, eight hundred thou-
sand florins. Equilibrium and growth were more or less stable,
and in the eighteenth century, between 1721 and 1722, the
bank’s deposits totaled twenty-eight million florins and its
stock of cash reached nearly that amount, twenty-seven mil-
lion. This great increase in the deposits of the Bank of Amster-
dam stemmed, among other causes, from its role as a refuge for
capital fleeing the crazy inflationist speculation that the system
of John Law produced in France in the 1720s. We will deal with
this more in depth later. This continued until 1772, in which
both deposits and cash reserves totaled twenty-eight to twenty-
nine million florins. As is evident, during this entire period, to
all intents and purposes the Bank of Amsterdam maintained a 100-
percent cash reserve. This allowed it, in all crises, to satisfy each
and every request for cash withdrawal of deposited florins.
Such was true in 1672, when panic caused by the French threat
gave rise to a massive withdrawal of money from Dutch
banks, most of which were forced to suspend payments (as
occurred with the Rotterdam and Middelburg banks). The
Bank of Amsterdam was the exception, and it logically had no
trouble returning deposits. Increasing and lasting confidence
in its soundness resulted, and the Bank of Amsterdam became
an object of admiration for the civilized economic world of the
time. Pierre Vilar indicates that in 1699 the French ambassador
wrote in a report to his king:
Of all the towns of the United Provinces, Amsterdam is
without any doubt the foremost in greatness, wealth and the
extent of her trade. There are few cities even in Europe to
equal her in the two latter respects; her commerce stretches

100
Money, Bank Credit, and Economic Cycles
over both halves of the globe, and her wealth is so great that
during the war she supplied as much as fifty millions a year
if not more.104
In 1802, when, as we will now see, the Bank of Amsterdam
started to become corrupt and violate the principles on which
it was founded, the bank still enjoyed enormous prestige, to
the point that the French consul in Amsterdam noted:
At the end of a maritime war which has kept the treasures
of the mines pent up in the Spanish and Portuguese
colonies, Europe is suddenly inundated with gold and silver
in quantities far above what is needed, so that they would
decline in value if they were put into circulation all at once.
In such an eventuality, the people of Amsterdam deposited
the metal in ingots in the Bank, where it was kept for them
at a very low cost, and they took it out a little at a time to
send to different countries as the increase in the rate war-
rants it. This money, then, which if allowed to flood in too
rapidly would have driven up the prices of everything
exceedingly, to the great loss of all who live on fixed and
limited incomes, was gradually distributed through many
channels, giving life to industry and encouraging trade. The
Bank of Amsterdam, then, did not act only according to the
special interests of the traders of this city; but the whole of
Europe is in its debt for the greater stability of prices, equi-
librium of exchange and a more constant ratio between the
two metals of which coin is made; and if the bank is not re-
established, it could be said that the great system of the
trade and political economy of the civilised world will be
without an essential part of its machinery.105
104Pierre Vilar, A History of Gold and Money, 1450–1920, Judith White,
trans. (London: NLB, 1976), p. 207. The deposit and reserve figures we
have cited in the text are also found here on pp. 208–09. Two other Euro-
pean banks modeled after the Bank of Amsterdam were the Bank of
Venice and the Bank of Hamburg. They were both founded in 1619.
Although the first eventually violated the strict safekeeping obligation
and disappeared in 1797, the Bank of Hamburg operated in a more con-
sistent manner and survived until merging with the Reichsbank in 1873.
J.K. Ingram, “Banks, Early European,” in Palgrave’s Dictionary of Political
Economy, Henry Higgs, ed. (London: Macmillan, 1926), vol. 1, pp. 103–06.
105Vilar, A History of Gold and Money, 1450–1920, p. 209.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 101
Therefore, we see that the Bank of Amsterdam did not try
to attain disproportionate profits through the fraudulent use
of deposits. Instead, in keeping with the dictates of Saravia de
la Calle and others we have mentioned, it contented itself with
the modest benefits derived from fees for safeguarding
deposits and with the small income obtained though the
exchange of money and the sale of bars of stamped metal.
Nevertheless, this income was more than sufficient to satisfy
the bank’s operating and administration costs, to generate
some profit and to maintain an honest institution that fulfilled
all of its commitments.
The great prestige of the Bank of Amsterdam is also evi-
denced by a reference to it found in the incorporation charter
of the Spanish Banco de San Carlos in 1782. Although this
bank, from its very inception, lacked the guarantees of the
Bank of Amsterdam, and it was created with the intention of
using its deposits, authority, and clout to help finance the
Treasury, it could not escape the immense influence of the
Dutch bank. Thus, its article XLIV establishes that private
individuals may hold deposits or
equivalent funds in cash in the bank itself, and whoever
wishes to make deposits shall be allowed to do so, either in
order to draw bills on the money or to withdraw it gradu-
ally, and in this way they will be exempt from having to
make payments themselves, their bills being accepted as
payable at the bank. In their first meeting, the stockholders
will determine the amount per thousand which merchants
must pay the bank in relation to their deposits, as they do in
Holland, and will establish all other provisions concerning
the best dispatch of discounts and reductions.106
106We quote directly from a copy of the Real Cédula de S. M. y Señores del
Consejo, por la qual se crea, erige y autoriza un Banco nacional y general para
facilitar las operaciones del Comercio y el beneficio público de estos Reynos y
los de Indias, con la denominación de Banco de San Carlos baxo las reglas que
se expresan (Royal Charter of H.M. and Members of the Council, by
which a universal, national bank is created, erected and authorized, to
promote trade and the common good of these kingdoms and the New
World), printed by Pedro Marín (Madrid, 1782), pp. 31–32; italics added.
There is an excellent profile on the history of the Banco de San Carlos by

102
Money, Bank Credit, and Economic Cycles
DAVID HUME AND THE BANK OF AMSTERDAM
A sign of the enormous prestige of the Bank of Amsterdam
among scholars and intellectuals, as well as merchants, is the
express mention David Hume makes of it in his essay Of
Money. This essay first appeared, with others, in a book called
Political Discourses, published in Edinburgh in 1752. In it
David Hume voices his opposition to paper currency and
argues that the only solvent financial policy is that which
forces banks to maintain a 100-percent reserve ratio, in accor-
dance with traditional legal principles governing the irregular
deposit of money. David Hume concludes that
to endeavour artificially to encrease such a credit, can never
be the interest of any trading nation; but must lay them
under disadvantages, by encreasing money beyond its nat-
ural proportion to labour and commodities, and thereby
heightening their price to the merchant manufacturer. And
in this view, it must be allowed, that no bank could be more
advantageous, than such a one as locked up all the money it
received, and never augmented the circulating coin, as is usual, by
returning part of its treasure into commerce. A public bank, by
this expedient, might cut off much of the dealings of private
bankers and money-jobbers; and though the state bore the charge
of salaries to the directors and tellers of this bank (for, according
to the preceding supposition, it would have no profit from its deal-
ings), the national advantage, resulting from the low price of
labour and the destruction of paper credit, would be a sufficient
compensation.107
Hume is not completely correct when he claims the bank
would not earn a profit, since its safekeeping fees would be
sufficient to cover operating costs, and it might even generate
modest profits, as in fact the Bank of Amsterdam did. How-
ever his analysis is categorical and reveals that, in defending
Pedro Tedde de Lorca, entitled El banco de San Carlos, 1782–1829
(Madrid: Banco de España and Alianza Editorial, 1988).
107We quote from pp. 284–85 of the excellent reissue of David Hume’s
work, Essays: Moral, Political and Literary, edited by Eugene F. Miller and
published by Liberty Fund, Indianapolis 1985; italics added.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 103
the creation of a public bank with these characteristics, he had
in mind the success of the Bank of Amsterdam and the exam-
ple it had already set for over one hundred years. Furthermore
the third edition of his Essays and Treatises on Several Subjects,
published in four volumes in London and Edinburgh,
1753–1754, includes a note by Hume in reference to the
phrase, “no bank could be more advantageous, than such a
one as locked up all the money it received.” Footnote number
four contains the following words: “This is the case with the
Bank of Amsterdam.” It appears that Hume wrote this foot-
note with the intention of more clearly emphasizing his view
that the Bank of Amsterdam was the ideal model for a bank.
Hume was not the very first to propose a 100-percent reserve
requirement in banking. He was preceded by Jacob Vanderlint
(1734) and especially by the director of the Royal mint, Joseph
Harris, for whom banks were useful as long as they “issued no
bills without an equivalent in real treasure.”108
SIR JAMES STEUART, ADAM SMITH,
AND THE BANK OF AMSTERDAM
Sir James Steuart offers us an important contemporary
study of the Bank of Amsterdam’s operation in his treatise
published in 1767 entitled, An Enquiry into the Principles of
Political Oeconomy: Being an Essay on the Science of Domestic
Policy in Free Nations. In chapter 39 of volume 2, Steuart pres-
ents an analysis of the “circulation of coin through the Bank of
Amsterdam.” He maintains that “every shilling written in the
books of the bank is actually locked up, in coin, in the bank
repositories.” Still, he states,
Although, by the regulations of the bank, no coin can be
issued to any person who demands it in consequence of his
credit in bank; yet I have not the least doubt, but that both the
credit written in the books of the bank, and the cash in the reposi-
tories which balances it, may suffer alternate augmentations and
108Quoted by Rothbard, Economic Thought Before Adam Smith, pp. 332–35
and 462.

104
Money, Bank Credit, and Economic Cycles
diminutions, according to the greater or less demand for bank
money.109
At any rate, Steuart indicates that the bank’s activities “are
conducted with the greatest secrecy,” in keeping with the tra-
ditional lack of openness in banking and especially significant
in the case of the Bank of Amsterdam, whose statutes and
operation demanded the maintenance of a continuous 100-
percent reserve ratio. If Steuart is correct and this ratio was at
times violated, it is logical that at the time the Bank of Ams-
terdam tried to hide the fact at all costs.
Although there are signs that at the end of the 1770s the
Bank of Amsterdam began to violate the principles upon
which it had been founded, in 1776 Adam Smith still affirmed
in his book, An Inquiry into the Nature and Causes of the Wealth
of Nations, that
The Bank of Amsterdam professes to lend out no part of
what is deposited with it, but, for every guilder for which
it gives credit in its books, to keep in its repositories the
value of a guilder either in money or bullion. That it keeps
in its repositories all the money or bullion for which there
are receipts in force, for which it is at all times liable to be
called upon, and which, in reality, is continually going from
it and returning to it again, cannot well be doubted. . . . At
Amsterdam no point of faith is better established than that
for every guilder, circulated as bank money, there is a corre-
spondant guilder in gold or silver to be found in the treas-
ure of the bank.110
Adam Smith goes on to say that the city itself guaranteed
the operation of the Bank of Amsterdam as described above
109We quote from the original edition, published by A. Miller and T.
Cadell in the Strand (London, 1767), vol. 2, p. 301; italics added. Prior to
Steuart’s analysis, we find a more superficial study of the Bank of Ams-
terdam’s operation in the Abbot Ferdinando Galiani’s famous book,
Della moneta. The original edition was published by Giuseppe Raimondi
(Naples, 1750), pp. 326–28.
110We quote directly from the original edition of Adam Smith, An
Inquiry into the Nature and Causes of the Wealth of Nations (London: W.
Strahan and T. Cadell in the Strand, 1776), vol. 2, pp. 72–73.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 105
and that it was under the direction of four burgomasters
who changed each year. Each burgomaster visited the
vaults, compared their content in cash with deposit entries
in the books and with great solemnity declared under oath
that the two coincided. Adam Smith remarks, tongue-in-
cheek, that “in that sober and religious country oaths are not
yet disregarded.”111 He ends his commentary by adding that
all of these practices were sufficient to guarantee the absolute
safety of deposits in the bank, a fact which was demonstrated
in various Dutch political revolutions. No political party was
ever able to accuse the prior of disloyalty in the management
of the bank. By way of example, Adam Smith mentions that
even in 1672, when the king of France marched into Utrecht
and Holland was in danger of being conquered by a foreign
power, the Bank of Amsterdam satisfied every last request for
repayment of demand deposits. As we stated before, this
acted as an even more impressive reinforcement of the pub-
lic’s confidence in the absolute solvency of the bank.
As additional evidence that the Bank of Amsterdam main-
tained a 100-percent reserve ratio, Adam Smith offers the
anecdote that some coins removed from the bank appeared to
have been damaged in the building fire that struck the bank
soon after its creation in 1609, which shows those coins had
been kept in the bank for over one hundred fifty years. Finally,
Adam Smith, in strict keeping with the true legal nature of the
irregular-deposit contract, which requires that it be the depos-
itors who pay the bank, indicates that the bank’s income
stemmed from safekeeping fees:
The City of Amsterdam derives a considerable revenue from
the bank, besides what may be called the warehouse-rent
above mentioned, each person, upon first opening an
account with the bank, pays a fee of ten guilders, and for
every new account three guilders three stivers; for every
transfer two stivers; and if the transfer is for less than three
hundred guilders, six stivers, in order to discourage the
multiplicity of small transactions.112
111Ibid., p. 73.
112Ibid., p. 74.

106
Money, Bank Credit, and Economic Cycles
In addition, Adam Smith refers to other sources of income
we have already mentioned, such as the exchange of money
and the sale of gold and silver bars.
Unfortunately, in the 1780s the Bank of Amsterdam began
to systematically violate the legal principles on which it had
been founded, and evidence shows that from the time of the
fourth Anglo-Dutch war, the reserve ratio decreased drasti-
cally, because the city of Amsterdam demanded the bank loan
it a large portion of its deposits to cover growing public expen-
ditures. Hence, deposits at that time amounted to twenty mil-
lion florins, while there were only four million florins’ worth of
precious metals in the vaults; which indicates that, not only did
the bank violate the essential principle of safekeeping on
which it had been founded and its existence based for over one
hundred seventy years, but the reserve ratio had been cut from
100 percent to less than 25 percent. This meant the final loss of
the Bank of Amsterdam’s long-standing reputation: deposits
began to gradually decrease at that point, and in 1820 they had
dwindled to less than one hundred forty thousand florins.113
The Bank of Amsterdam was the last bank in history to main-
tain a 100-percent reserve ratio, and its disappearance marked
the end of the last attempts to found banks upon general legal
principles. The financial predominance of Amsterdam was
replaced by the financial system of the United Kingdom, a
much less stable and less solvent system based on the expan-
sion of credit, deposits and paper currency.
THE BANKS OF SWEDEN AND ENGLAND
The Bank of Amsterdam was a forerunner of the Bank of
Stockholm (Riksbank), which began operating in 1656 and
was divided into two departments: one responsible for the
safekeeping of deposits (using a 100-percent reserve ratio) and
modeled after the Bank of Amsterdam; and another devoted
to loans. Although the departments supposedly functioned
113Vilar, A History of Gold and Money, 1450–1920, p. 208. On the operation
of the Bank of Amsterdam see also Wicksell, Lectures on Political Economy
vol. 2, pp. 75–76.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 107
separately from one another, in practice they were separate
only on paper, and the Bank of Stockholm soon abandoned the
standards set by the Dutch bank.114 The Swedish authorities
nationalized it in 1668, making it the first government bank of
the modern world.115 Not only did it violate the traditional
principles which guided the Bank of Amsterdam, but it also
initiated a new fraudulent and systematic practice: the
issuance of banknotes or deposit receipts for a sum higher than
actual deposits received in cash. This is how banknotes were
born, along with the lucrative practice of issuing them for a
higher amount than the total of deposits. Over time, this activ-
ity would become the banking practice par excellence, especially
in the centuries that followed, during which it deceived schol-
ars, who failed to realize that the issuance of banknotes had the
same repercussions as artificial credit expansion and deposit
creation, two practices which, as A.P. Usher has noted, had
been at the core of the banking business from its origins.
The Bank of England was created in 1694 and was also pat-
terned after the Bank of Amsterdam, due to the considerable
influence Holland exerted on England following the accession
of the House of Orange to the English throne. However, the
bank was not constituted with the same legal guarantees of
safekeeping as the Bank of Amsterdam. Instead, one of its main
aims from the outset was to help finance public expenditures.
For this reason, although the Bank of England was intended to
stop the commonplace, systematic abuses committed by pri-
vate bankers and the government,116 in practice this goal was
114In this sense, as Kindleberger perceptively points out in A Financial
History of Western Europe, pp. 52–53, the Riksbank’s system of organiza-
tion was a precursor to the structure which two centuries later the Peel
Act (Bank Charter Act) of 1844 assigned the Bank of England.
115In celebration of the tercentenary of the Bank of Stockholm in 1968,
an endowment was made to fund a yearly Nobel Prize in economics.
116For instance, in 1640, Charles I, echoing the policies pursued in Spain
a hundred years earlier by his namesake the emperor Charles V, seized
the gold and valuables deposited for safekeeping in the Tower of London
and in the process completely ruined the reputation of the mint as a safe
place for valuables. Thirty-two years later, Charles II also failed in his
duty, causing the royal treasury to suspend payments and precipitating

108
Money, Bank Credit, and Economic Cycles
never achieved. In short, the Bank of England eventually
failed, despite its privileged role as the government’s banker,
its monopoly on limited liability in England and its exclusive
authorization to issue banknotes. As a result of its systematic
neglect of the safekeeping obligation and its practice of grant-
ing loans and advances to the Treasury against the bank’s
deposits, the Bank of England eventually suspended pay-
ments in 1797 after various colorful vicissitudes, including the
South Sea Bubble.117 Also in 1797, the same year the Bank of
England was forbidden to return deposits in cash, it was
declared that taxes and debts were to be paid in bills issued by
the bankruptcy of many private banks that had extended loans to the
crown or had directly bought treasury bonds with funds from demand
deposits. See Kindleberger, A Financial History of Western Europe, pp.
53–54.
117In 1720 the South Sea Company devised an ambitious plan to take
over Britain’s national debt for a sum of money. This company emerged
from the Tory party, just like the Bank of England, and was intended to
help finance the war. In return, the government granted privileges to
certain corporations. The actual aim of South Sea Company promoters
was to speculate with company stock, to the extent that government
debt obligations were accepted in payment for new stocks. During that
year the Bank of England extended loans on its own securities to facili-
tate their acquisition, just as the South Sea Company had done. This set
off an inflationary process in which the price of company and bank
stock was driven to great heights, generating huge profits. Specula-
tors, including many company officials, took advantage of these bene-
fits. A portion of profits was invested in land, the price of which also
rose significantly. All of this speculative and inflationist mania came to
an abrupt halt during the summer of 1720, at the same time John Law’s
network of speculation began to deteriorate in Paris. Once prices began
to fall it became virtually impossible to stop their plunge. South Sea
Company stock prices plummeted from 775 points in September to 170
in mid-October and Bank of England stocks dropped from 225 points to
135 in just one month. Parliament responded by passing the Bubble Act,
which from that time on severely limited the establishment of corpora-
tions. However, it was not until 1722, and after much difficult negotia-
tion, that the financial problem was alleviated. That year Parliament
approved an agreement between the Bank of England and the South Sea
Company, stipulating that the former was to receive four million
pounds of the latter’s capital through yearly payments of 5 percent,
guaranteed by the Treasury. See also the end of footnote 43 of chapter 7.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 109
the bank, and an attempt was made to limit advances and
loans to the government.118 This was the dawn of the modern
banking system, based on a fractional-reserve ratio and a cen-
tral bank as lender of last resort. In chapter 8 we will analyze
in detail the reasons central banks were created, their role and
theoretical incapability of fulfilling it, as well as the central
banking vs. free banking controversy and its influence on the
different theories of money, banking and economic cycles. The
current chapter would not be complete, however, without a
brief reference to the development of banking and paper
money in eighteenth-century France.
JOHN LAW AND EIGHTEENTH-CENTURY BANKING IN FRANCE
The history of money and banking in eighteenth-century
France is closely linked to the Scottish financier John Law and
the “system” he concocted and put into practice there. Law
persuaded the French regent, Philippe d’Orleans, that the
ideal bank was one that made use of the deposits it received,
since this increased the amount of money in circulation and
“stimulated” economic growth. Law’s system, like economic
118From this point on many theorists, especially in the United States,
proclaimed the great threat posed to individual liberty by an implicit or
explicit alliance between bankers and governments. This type of pact
was expressed through the continual, systematic granting of privileges
to allow banks to violate their legal commitments by suspending the
cash repayment of deposits. For example, John Taylor, an American sena-
tor from the second half of the eighteenth century, classified this practice
as true fraud, stating that “under our mild policy the banks’ crimes may
possibly be numbered, but no figures can record their punishments,
because they are never punished.” See John Taylor, Construction Construed
and Constitutions Vindicated (Richmond, Va.: Shepherd and Polland, 1820;
New York: Da Capa Press, 1970), pp. 182–83. Another very interesting
piece on this topic is James P. Philbin’s article entitled “An Austrian Per-
spective on Some Leading Jacksonian Monetary Theorists,” published in
Journal of Libertarian Studies 10, no. 1 (Fall, 1991): 83–95, esp. 89. Murray N.
Rothbard wrote a magnificent summary of the emergence of fractional-
reserve banking in the early United States: “Inflation and the Creation of
Paper Money,” chapter 26 of Conceived in Liberty, vol. 2: “Salutary
Neglect”: The American Colonies in the First Half of the 18th Century (New
York: Arlington House, 1975), pp. 123–40; 2nd ed. (Auburn, Ala.: Ludwig
von Mises Institute, 1999).

110
Money, Bank Credit, and Economic Cycles
interventionism in general, arose from three different, though
interconnected factors. First, disregard for traditional legal
and moral principles, particularly the requirement for contin-
ual safekeeping of 100 percent of deposited money. Second, a
reasoning error that appears to justify violating legal princi-
ples to attain seemingly beneficial goals quickly. Third, the
fact that there will always be certain agents who view in pro-
posed reforms an opportunity to make huge profits. The com-
bination of these three factors allowed a political dreamer like
Law to launch his “banking system” in France at the begin-
ning of the eighteenth century. In fact, once the bank had
earned people’s trust, it began to issue banknotes far exceed-
ing deposits on hand and to extend loans against deposits.
The quantity of bills in circulation increased very rapidly, and
as is logical, a significant artificial economic boom resulted. In
1718 the bank was nationalized (becoming the royal bank) and
began churning out even more bills and granting more loans.
This encouraged stock market speculation in general, and in
particular speculative buying and selling of shares of Law’s
Compagnie de la Lousiane ou d’Occident or Mississippi Trading
Company, aimed at fostering trade and advancing coloniza-
tion of this French territory in America. By 1720 the absurd
proportions of the financial bubble had become clear. Law
tried desperately to stabilize the price of the company’s stock
and the value of his bank’s paper money: the bank and trad-
ing company were merged, company stock was declared legal
tender, coins lost part of their weight in an attempt to restore
their relationship to bills, etc. However, all was in vain and the
inflationary bubble burst, bringing financial ruin not only to
the bank but also to many French investors who had placed
their trust in it and in the trading company. The losses were so
heavy and the suffering so immense that for over a hundred
years it was even considered a faux pas in France to utter the
word “bank,” a term which for a time was synonymous with
“fraud.”119 The ravages of inflation plagued France again a
119A detailed account of Law’s notorious bank failure in France by a
scholar with first-hand knowledge of the events can be found in the
book Della moneta by Ferdinando Galiani, pp. 329–34; and in chapter
23 through 35 of volume 2 of An Enquiry into the Principles of Political

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 111
few decades later, as evidenced by the serious monetary chaos
during the revolutionary period and the uncontrolled
issuance of assignats at that time. All these phenomena made a
permanent impression on the collective psyche of the French,
who are still aware today of the grave dangers of paper
money inflation and preserve the custom of storing consider-
able amounts of gold coins and ingots. In fact, France,
together with India, is one of the countries whose people hold
the largest stock of gold on a private basis.
All of the above notwithstanding, and in spite of his ill-
fated banking experiment, John Law made some contribu-
tions to monetary theory. Although we cannot accept his infla-
tionist and proto-Keynesian views, we must acknowledge, as
Carl Menger did, that Law was the first to formulate a sound
theory on the spontaneous, evolutionary origins of money.
RICHARD CANTILLON AND THE FRAUDULENT VIOLATION
OF THE IRREGULAR-DEPOSIT CONTRACT
It is a remarkable fact that three of the most noted mone-
tary theorists of the eighteenth and early nineteenth centuries
were bankers: John Law, Richard Cantillon,120 and Henry
Oeconomy, by Sir James Steuart (pp. 235–91). An enlightening and theo-
retically solid analysis of the financial, monetary, and banking systems
in eighteenth-century France is found in F.A. Hayek’s article “First
Paper Money in Eighteenth Century France,” first published as chapter
10 in the book, The Trend of Economic Thinking: Essays on Political Econo-
mists and Economic History, vol. 3 of The Collected Works of F.A. Hayek,
W.W. Bartley III and Stephen Kresge, eds. (London and New York: Rout-
ledge, 1991), pp. 155–76. The best biography of John Law is by Antoin E.
Murphy, John Law: Economic Theorist and Policy Maker (Oxford: Claren-
don Press, 1997).
120Richard Cantillon was the first to maintain that “safe” banking could
be conducted with only a 10 percent reserve ratio: “Dans ce premier
exemple la caisse d’un Banquier ne fait que la dixième partie de son
commerce.” See p. 400 of the original edition of Essai sur la nature du
commerce en général, published anonymously (and falsely) in London,
Fletcher Gyles in Holborn, 1755. Incredibly, Murray Rothbard does not
mention this in his brilliant study on Cantillon. See Rothbard, Economic
Thought Before Adam Smith, pp. 345–62.

112
Money, Bank Credit, and Economic Cycles
Thornton. Their banks all failed.121 Cantillon alone escaped
relatively unscathed, not only because he stopped his risky
speculation in time, but also (and most importantly) because
of the large profits he fraudulently obtained by violating the
obligation to safeguard his customers’ assets.
Indeed, Cantillon clearly violated the contract of irregular
deposit, however in this case the deposit was not of money,
but shares of stock in the Mississippi Trading Company,
founded by John Law. Cantillon’s fraudulent scheme was as
follows: he loaned large amounts of money to his customers to
allow them to buy shares in the company, on the condition
that the stocks act as collateral and remain at Cantillon’s bank
as an irregular deposit, in this case of fungible and indistin-
guishable shares. Later Cantillon, unbeknownst to his clients,
misappropriated the deposited securities, selling them when
he thought their market price was high and keeping the
money from the sale. Once the shares had lost practically all of
their value, Cantillon bought them back for a fraction of their
old price and restored deposits, securing a hefty profit.
Finally, he demanded repayment of the loans he had initially
made to his clients, who were unable to return the money,
since the collateral they had at the bank was worth close to
nothing. These fraudulent operations led to multiple criminal
charges and civil suits against Cantillon, who, upon being
arrested and briefly incarcerated, was forced to leave France
in a hurry and flee to England.
Cantillon, in defense, put forward the same argument so
often used throughout the Middle Ages by writers deter-
mined to confuse the irregular deposit with the loan. In fact,
121Admittedly, Thornton’s bank did not fail until after his death, in
December 1825. See pp. 34–36 of F. A. Hayek’s “Introduction” to Henry
Thornton’s book An Inquiry into the Nature and Effects of the Paper Credit of
Great Britain, originally published in 1802 and reissued by Augustus M.
Kelley, 1978. A.E. Murphy also notes that Law and Cantillon share the
unhappy “distinction” of being the only economists, apart from Antoine
de Montchrétien, who were accused of murder and other crimes. See A.E.
Murphy, Richard Cantillon: Entrepreneur and Economist (Oxford: Clarendon
Press, 1986), p. 237. Thornton’s religious and puritanical reputation at
least protected him from being charged with such atrocities.

Historical Violations of the Legal Principles
Governing the Monetary Irregular-Deposit Contract 113
Cantillon tried to defend himself by claiming that the stocks
deposited with him as unnumbered fungible goods had not
actually constituted a true deposit, but a loan implying the
full transference of ownership and availability to the banker.
Thus, Cantillon considered his operations perfectly “legiti-
mate.” Nevertheless, we know his legal argument was
unsound and even though the deposit of securities was con-
sidered an irregular deposit of fungible goods, the obligation
to safeguard the shares and maintain continual possession of
all of them remained. Therefore, when Cantillon sold the
shares to the detriment of his customers he clearly committed
the criminal act of misappropriation. F.A. Hayek explains
Cantillon’s attempt to justify his fraudulent actions:
His point of view was, as he later explained, that the shares
given to him, since their numbers had not been registered,
were not a genuine deposit, but rather—as one would say
today—a block deposit so that none of his customers had
claim to specific securities. The firm actually made an
extraordinary profit in this way, since it could buy back at
reduced prices the shares sold at high prices, and mean-
while the capital, for which they were charging high inter-
est, lost nothing at all but rather was saved and invested in
pounds. When Cantillon, who had partially made these
advances in his own name, asked for repayments of the
loans from the speculators, who had suffered great losses,
and finally took them to court, the latter demanded that the
profits obtained by Cantillon and the firm from their shares
be credited against these advances. They in turn took Can-
tillon to court in London and Paris, charging fraud and usury.
By presenting to the courts correspondence between Cantil-
lon and the firm, they averred that the entire transaction was
carried out under Cantillon’s immediate direction and that
he therefore bore personal responsibility.122
In the next chapter we will explain that the violation of the
irregular deposit of securities is just as corrupt from a legal
standpoint as the violation of the irregular deposit of money
and gives rise to very similar economic and social evils. A per-
fect example in the twentieth century was the failure of the
122See Hayek, “Richard Cantillon (1680–1734),” chapter 13 of The Trend
of Economic Thinking, pp. 245–93, esp. p. 284. And also the report by

114
Money, Bank Credit, and Economic Cycles
Bank of Barcelona and of other Catalonian banks that system-
atically accepted the irregular deposit of securities without
keeping full custody of them.123 Instead, to attain a profit, they
used them in all sorts of speculative operations to the detri-
ment of their true owners, just as Cantillon had done two hun-
dred years earlier. Richard Cantillon was brutally murdered at
his London home in 1734, after twelve years of litigation, two
arrests, and the constant threat of imprisonment. Although the
official version was that he was murdered and his body
burned beyond recognition by an ex-cook who killed him to
rob him, it is also plausible that one of his many creditors
instigated the murder, or even, as suggested by A.E. Murphy,
his most recent biographer, that Cantillon staged his own
death to escape and to avoid more years of lawsuits and legal
action against him.124
Cantillon’s lawyer Henry Cochin, Memoire pour Richard Cantillon, intimé
& apellant (Paris: Andre Knapen, 1730).
123On the irregular deposit of securities and the type of misappropria-
tion committed by Cantillon and later Catalonian bankers until the start
of the twentieth century, see La cuenta corriente de efectos o valores de un
sector de la banca catalana: su repercusión en el crédito y en la economía, su cal-
ificación jurídica en el ámbito del derecho penal, civil y mercantil positivos
españoles según los dictámenes emitidos por los letrados señores Rodríguez
Sastre, Garrigues, Sánchez Román, Goicoechea, Miñana y Clemente de Diego,
seguidos de un estudio sobre la cuenta de efectos y el mercado libre de valores
de Barcelona por D. Agustín Peláez, Síndico Presidente de la Bolsa de Madrid
(Madrid: Delgado Sáez, 1936).
124Antoin E. Murphy, Richard Cantillon: Entrepreneur and Economist
(Oxford: Clarendon Press, 1986), pp. 209 and 291–97. Murphy mentions
the following facts in support of this last thesis: (1) Cantillon liquidated
a substantial part of his assets the day prior to his murder; (2) The body
was burned beyond recognition; (3) His family displayed a mysterious
indifference following the murder; and (4) The accused behaved
strangely, never acting like the typical murderer.

3
ATTEMPTS TO
LEGALLY JUSTIFY
FRACTIONAL-RESERVE
BANKING
This chapter contains a critical examination of the differ-
ent theoretical attempts to legally justify fractional-
reserve banking. We will consider the proposed argu-
ments intended to legally support a monetary irregular deposit
contract in which the depositary can make self-interested use of
money on demand deposit. In light of the legal doctrine pre-
sented in chapter 1 and the economic analysis to be performed
in the following chapters, we will critique two main lines of
defense.
1
INTRODUCTION
The legal doctrines aimed at justifying fractional-reserve
banking have been formulated ex post facto. They have not
been based on preexisting legal principles that have given rise
to certain legal acts. On the contrary, as we explained in the
previous chapter, banking practices have long infringed upon
basic, universal legal principles and have done so in response
to specific circumstances which have conspired to make these
violations possible (human avarice; inadequate regulation; gov-
ernments’ financial needs; systematic intervention of the
115

116
Money, Bank Credit, and Economic Cycles
authorities and confusion arising from the depositum confessa-
tum, a product of the canonical ban on interest). As is logical,
the lack of a legal basis for such a widespread practice soon
prompted bankers and theorists alike to search for a fitting
legal justification. Moreover, this urge was reinforced by the
fact that, on almost all occasions, the government or public
authorities ended up being the main beneficiary of fraudulent
banking practices. Therefore it is not surprising, given the tra-
ditional symbiosis between political authorities and the intel-
ligentsia, that the latter was driven by the former to search for
legal grounds to support the practices it permitted and
encouraged.1
Finding adequate legal grounds was essential to the sur-
vival of the whole network of vested interests which frac-
tional-reserve banking generates. It was clear to any educated
person that these practices should be based on something
sounder than a mere de facto situation. It is not enough to real-
ize and affirm, as Shepard B. Clough does, that
In fact, [goldsmiths] even lent money given them for safe-
keeping on the theory and experience that they needed to
have on hand only enough to meet the expected, current
demand of depositors. This practice led them, at least by the
seventeenth century, to the issuing of “promises to pay,”
that is, “goldsmiths’ notes,” which, like modern banknotes,
circulated from person to person. These “promises to pay,”
which could be paid by using the deposits of customers,
came actually to exceed the amount of money on deposit.
When this happened credit had been actually created by
issuing paper—a very major discovery.2
Nevertheless, no matter how “major” one considers the
“discovery” that it is possible to make fraudulent use of
depositors’ money or issue deposit receipts for a greater
1See Bertrand de Jouvenel, “The European Intellectuals and Capital-
ism,” in Friedrich A. Hayek, ed., Capitalism and the Historians (Chicago:
University of Chicago Press, 1954).
2Shepard B. Clough, The Economic Development of Western Civilization
(New York: McGraw-Hill, 1959), p. 109; italics added.

Attempts to Legally Justify Fractional-Reserve Banking 117
amount than is actually deposited, it is clear that these acts
share the same characteristic present in all other criminal acts
of misappropriation which have always been the object of doc-
trinal analysis by criminal law experts. The similarity between
the two sets of actions is therefore so obvious that theorists
could not remain impassive in the face of a legal irregularity
such as this in the economy.
Hence it is not surprising that great efforts have been
made to justify what appears completely unjustifiable: that it
is legitimate, from the standpoint of general legal principles,
to misappropriate funds deposited for safekeeping and to
issue deposit receipts for more money than is actually
deposited. However, the interested parties (bankers and gov-
ernments, mostly) have found it so important to find an ade-
quate theoretical justification beyond the easy solution of sim-
ply declaring legal a corrupt, criminal practice (which is what
has ultimately happened, despite all the doctrinal façades and
constructions), that many jurists are still at work trying to con-
fer legal respectability on a procedure that is commonplace
even now.
Doctrinal attempts to justify the use of a fractional reserve
in the irregular deposit can be classified into two large groups.
The first group of doctrines was intended to settle the issue by
equating the irregular deposit contract with the loan contract.
We will analyze this group of theories in detail and show that,
from a legal point of view, it is impossible to equate these two
contracts. Writers of the second and more recent set of doc-
trines start by acknowledging that there are fundamental dif-
ferences between the loan and irregular deposit contract.
These theorists have focused their efforts on the construction
of a new legal concept of “availability” and hold that this
notion should be taken “loosely,” meaning bankers should
only be required to carry out their investments “prudently”
and to comply with regulations and bank legislation at all
times. A detailed study of this second set of theories will
demonstrate that they ultimately entail a return to the failed
attempt of the first group, i.e., to justify the use of a fractional
reserve in the irregular deposit by equating the deposit con-
tract with the loan contract. Thus, the doctrines of the second

118
Money, Bank Credit, and Economic Cycles
set fall into the same errors and legal contradictions we will
see in those of the first. In addition, in the next chapter we will
explain why the doctrinal essence of the new interpretation of
availability (based on the “law of large numbers”) is inadmis-
sible from the standpoint of economic theory.
We therefore conclude that past attempts to legally justify
fractional-reserve banking with respect to demand deposits
have failed. This explains the ambiguity constantly present in
doctrines on this type of bank practice, the desperate efforts to
avoid clarity and openness in its treatment, the generalized
lack of accountability and ultimately (since fractional-reserve
banking cannot possibly survive economically on its own), the
fact that it has been provided with the support of a central
bank which institutes the regulations and supplies the liquid-
ity necessary at all times to prevent the whole set-up from col-
lapsing. In chapter 8 we will discuss central banking and
show, through a theoretical analysis, that the nationalization
of money and the central bank’s regulation of the banking sys-
tem and its laws governing it have been incapable of main-
taining a stable financial system that avoids economic cycles
and averts bank crises. Thus, we may conclude that the frac-
tional-reserve banking system has failed as well, even though
it is backed and protected by a central bank.
At the end of this chapter we will examine several new
types of financial contracts, some of which closely resemble
those bankers employ in connection with bank deposits. In
particular, we will consider the different financial operations
involving a “repurchase agreement.” We will show that these
entail an evasion of the law; whenever payment of a previ-
ously-established price is guaranteed regardless of the sec-
ondary-market price at the time the agreement is imple-
mented, such operations conceal a true deposit contract.
Finally, we will take a look at the profound, essential differ-
ences between the financial operations related to banking and
those connected with life insurance. The latter represents a
perfected form of true saving, where present goods are
exchanged for future goods. It is an exchange with especially
appealing features, but they in no way involve appropriation
of demand deposits, credit creation, nor issuance of receipts

Attempts to Legally Justify Fractional-Reserve Banking 119
without backing. We will also discuss the corrupting influence
exerted on the insurance business by the recent trend (most
apparent in government legislation) toward clouding and
obscuring the traditional legal and technical boundaries between
the two types of institutions (life insurance and banking).
2
WHY IT IS IMPOSSIBLE TO EQUATE THE IRREGULAR DEPOSIT
WITH THE LOAN OR MUTUUM CONTRACT
THE ROOTS OF THE CONFUSION
The attempts to legally equate the monetary irregular-
deposit contract with the loan or mutuum contract are partic-
ularly attractive to those who most benefit from banking prac-
tices (bankers and authorities). Indeed, in chapter 1, which
contained an explanation of the legal nature of both institu-
tions, we indicated that a loan implies the transfer not only of
ownership of the lent item, but of its full availability as well,
and therefore the borrower can make full use of it, by invest-
ing it, spending it, etc. Considering that this is ultimately what
a banker does when appropriating demand deposit funds, the
ideal legal solution for him is clearly to equate the irregular
deposit contract with the loan contract. Moreover, a worn-out
legal pretext has persistently been used to reinforce the argu-
ment for equating the two. Lax and superficial, it is as follows:
Since the irregular deposit contract consists of the deposit of
fungible goods, the very essence of which implies the
inevitable transfer of ownership of individual items deposited
(because they are indistinguishable from one another), the
deposit and the loan are naturally one and the same, as both
institutions entail the transfer of ownership.
In chapter 1 we saw that this line of reasoning is fallacious,
superficial, and abstruse. In fact, even if ownership is trans-
ferred in both cases, the two contracts still differ radically con-
cerning the availability of the item (an essential feature of the
contracts). Indeed, whereas in the loan contract full availabil-
ity of the item is transferred along with ownership, the very
essence of the irregular deposit contract demands that the

120
Money, Bank Credit, and Economic Cycles
purpose of safekeeping or custody predominate. Accordingly,
although we might in theory consider that ownership is
transferred, in practice such a transference is negligible, since
the safekeeping or custody of the fungible good requires the
constant availability of the tantundem to the depositor. There-
fore, even if ownership were transferred in the same sense in
both institutions, an essential legal difference would still exist
between them: the contrast in availability.
It may come as a surprise that the jurists who have chosen
to equate the deposit contract with the mutuum or loan con-
tract have overlooked such an obvious difference. The associ-
ation between the contracts is so forced and the arguments so
weak that it is amazing that a certain group of theorists have
tried to defend them. However, their attempt has a historical,
theoretical explanation: the depositum confessatum, a legal arti-
fice which arose in the Middle Ages from attempts to avoid
the canonical ban on interest. Although we have already
shown that the canonical prohibition on interest and the
development of fractional-reserve banking shared very little
direct connection, the depositum confessatum acted as a strong,
indirect link between them. We already know that from the
time of Roman law, if a depositary violated the essence of the
deposit contract, based on safekeeping, and appropriated
deposits and was not able to immediately return the funds
when the depositor demanded them, then the depositary was
obliged to pay interest. Then, irrespective of any other foresee-
able civil or criminal actions (the actio depositi and the actio furti),
as is logical, an additional suit was filed to obtain interest for
late payment and the loss of availability to the depositor up to
the point when the depositary returned his funds.3 Thus, it is
easy to understand how convenient it was in the Middle Ages
3As we know, the fact that the monetary irregular deposit is a deposit
contract means the actio depositi directa applies to it. Roman jurists devel-
oped this concept, which leaves it to the depositor to decide at any
moment when his deposit is to be returned to him. This availability is so
pronounced that the depositor’s claim is considered equivalent to the
ownership of the money deposited (since the tantundem of the deposit is
fully and immediately available to him).

Attempts to Legally Justify Fractional-Reserve Banking 121
to disguise a loan as a deposit in order to make the payment
of interest legal, legitimate and socially acceptable. For this
reason, bankers started to systematically engage in operations
in which the parties openly declared they were entering into a
deposit contract and not a loan contract. However, as the Latin
saying goes, excusatio non petita, accusatio manifesta (an unso-
licited excuse is tantamount to a self-accusation). Indeed, with
a true deposit it was not necessary to make any express decla-
ration, and such a declaration, when made, only revealed an
attempt to conceal a loan or mutuum contract. The purpose of
disguising a loan as a deposit was to evade the strict canoni-
cal prohibitions on interest-bearing loans and to permit many
true credit transactions highly necessary, both economically
and socially.
The depositum confessatum clouded the decidedly clear
legal boundaries between the irregular deposit contract and
the loan or mutuum contract. Whatever a scholar’s stance on
the canonical prohibition of usury, the depositum confessatum
almost inevitably led to the “natural” identification of deposit
contracts with mutuum contracts. To a theorist who wished to
discover and expose all violations of the canonical prohibition
and each case of concealment of interest, anything that
sounded like a “deposit” was sure to appear suspicious from
the start, and the most obvious and efficient solution from this
point of view was to automatically equate deposits with loans
and condemn the payment of interest in all cases, regardless of
the operation’s outer legal appearance. Paradoxically, the
more “liberal” moralists did not stop at defending the legal
existence of deposits and the consequent legitimacy of interest
for late payment; they went on to indicate that such deposits
were ultimately loans, and hence the banker could use or
invest the money. These authors sought not only to justify the
payment of interest, but also to legitimize an institution that
permitted the same acts of investment, or exchange of present
goods for future goods, that the loan contract had tradition-
ally made possible. Furthermore, this type of exchange was
quite necessary to industry and trade. Throughout the Middle
Ages, most jurists who commented on law texts held this posi-
tion. As we saw in the last chapter, it was also the opinion of

122
Money, Bank Credit, and Economic Cycles
several members of the School of Salamanca, such as Luis de
Molina, who believed the monetary irregular-deposit contract
to be a “precarious loan” in which ownership of the money is
transferred to the banker (which we have seen is admissible in
the case of a deposit of fungible money), as well as full avail-
ability (which we know is impossible and contrary to the very
essence of the deposit).4
Moreover, as we have already seen, the Irish banker and
economist Richard Cantillon, in the civil and criminal suits
brought against him for misappropriating securities deposited
with him as fungible goods through an irregular deposit con-
tract during the wave of speculation generated in France by
John Law’s system, tried to defend himself using the only doc-
trinal justification that had at that point been developed in
favor of his position: that because the contract was for an
“irregular” deposit (i.e., the securities were considered fungi-
ble goods), a complete transfer of both ownership and avail-
ability took place. Thus, he could legitimately appropriate the
shares, sell them, and use them to speculate on the market
without committing any crime nor harming his depositors.5
The same legal line of argument used by Richard Cantil-
lon’s defense had been developed by scholars with respect to
the monetary irregular deposit (and not the irregular deposit
of securities). Consequently, if it is considered legally appro-
priate and justified to equate the monetary deposit contract with
the mutuum contract, the same would certainly be applicable,
4See Luis de Molina, Tratado sobre los cambios, edited and prefaced by Fran-
cisco Gómez Camacho, Disputation 408, 1022 d., p. 138. As we have seen,
Juan de Lugo shares Molina’s viewpoint, and Domingo de Soto does also,
though to a much lesser degree. All other members of the School of Sala-
manca, particularly Dr. Saravia de la Calle, being wise jurists true to
Roman tradition, were against fractional-reserve banking despite the
pressures they were subjected to and the practices they witnessed.
5See F.A. Hayek, “Richard Cantillon (1680–1734),” in The Collected Works
of F.A. Hayek, vol. 3: The Trend of Economic Thinking: Essays on Political Econ-
omists and Economic History, p. 159. See also the classic article by Henry
Higgs, “Richard Cantillon,” in The Economic Journal 1 (June 1891): 276–84.
Finally, A.E. Murphy, Richard Cantillon: Entrepreneur and Economist; and
the report by Cantillon’s lawyer Henri Cochin, Memoire pour Richard Can-
tillan.

Attempts to Legally Justify Fractional-Reserve Banking 123
mutatis mutandis, to all other deposits of fungible goods; and
in particular, to deposits of securities as goods indistinguish-
able from one another. Hence we must emphasize that any
possible doctrinal analysis against the legality of a complete
transfer of ownership and availability in an irregular deposit of
securities also ultimately constitutes a powerful case against
the use of a fractional reserve in the monetary irregular
deposit. The great Spanish mercantilist Joaquín Garrigues has
recognized this fact. He states:
The reasoning thus far leads us to the affirmation that when
a customer entrusts his shares to the bank he intends to con-
tract a bank deposit; however, immediately after making
this assertion, we become aware of another contract with a
similar financial purpose. This contract also involves the
entrusting to the bank of a fungible good (money) and
cashier services are provided by the bank. This—defenders
of the checking account will say—is another unique con-
tract which is not called a loan nor a deposit in bank docu-
ments and which has the same legal effects as the securities
current account; namely, the transference of ownership to
the bank and the bank’s return of the tantundem.6
Despite Garrigues’s forced and unconvincing attempt to
persuade us that these two deposits are different, it is obvi-
ous that both contracts of irregular deposits of fungible
goods (of money and of securities) are essentially identical,
and therefore if we accept the transfer of full availability of
the good in one case (the deposit of money), we must also
accept it in the other. Consequently, there is no denying the
legality of one (the deposit of securities) without denying the
6On this topic see pp. 194ff. in the “Dictamen de Joaquín Garrigues,”
included in the book, La cuenta corriente de efectos o valores de un sector de
la banca catalana y el mercado libre de valores de Barcelona, pp. 159–209. In
this remarkable book, many of the arguments against the thesis that full
availability is transferred in the irregular deposit of securities as fungi-
ble goods are therefore also directly applicable to criticism of the same
theory with respect to the irregular deposit of money as a fungible good.
We will incorporate these arguments into our study whenever appro-
priate.

124
Money, Bank Credit, and Economic Cycles
legality of the other (the deposit of money).7 In conclusion,
the legal arguments used by Cantillon in his defense were
derived from theories regarding the monetary irregular-
deposit contract, and if we consider them valid, then they also
justify Cantillon’s obvious swindling of his customers and the
host of irregular and fraudulent activities later performed in
connection with irregular deposits of securities in the other
countries, especially Spain. Catalonian bankers carried out
such fraud well into the twentieth century, and Spanish schol-
ars have correctly and unanimously recognized the dishonest,
criminal nature of their behavior.8
THE MISTAKEN DOCTRINE OF COMMON LAW
The doctrine equating the monetary irregular-deposit con-
tract with the loan or mutuum contract has also prevailed in
Anglo-Saxon common law, via the creation of law in the bind-
ing case system. At the end of the eighteenth century and
throughout the first half of the nineteenth, various lawsuits
were filed by which depositors, upon finding they could not
secure the repayment of their deposits, sued their bankers for
misappropriation and fraud in the exercise of their safekeep-
ing obligations. Unfortunately, however, British case-law
judgments fell prey to pressures exerted by bankers, banking
7The opposite would be an inadmissible logical contradiction; Florencio
Oscáriz Marco, however, makes such an error. He maintains that
deposits of bulk goods are not irregular deposits “because there is no
power to use them and even less to take them at will, only power to mix
them,” while in the case of deposits of another fungible good (money),
he mysteriously does consider there to be a transfer of power over use
and availability, a transfer converting deposits into “loans.” In addition
to this conceptual error, Oscáriz makes an error in terminology: he cites
the decision of the Spanish Supreme Court regarding a deposit of oil
made by some olive dealers (Spanish Supreme Court decision of July 2,
1948) in an analysis of the “unique case” of deposits of bulk goods. In
actuality the bulk goods deposit is the best model example imaginable
of a deposit of fungible goods or irregular deposit. See Oscáriz Marco,
El contrato de depósito: estudio de la obligación de guarda, pp. 110–12.
8See La cuenta corriente de efectos o valores de un sector de la banca catalana
y el mercado libre de valores de Barcelona.

Attempts to Legally Justify Fractional-Reserve Banking 125
customs, and even the government, and it was ruled that the
monetary irregular-deposit contract was no different from the
loan contract, and therefore that bankers making self-inter-
ested use of their depositors’ money did not commit misap-
propriation.9 Of all of these court rulings, it is worthwhile to
consider Judge Lord Cottenham’s decision in Foley v. Hill and
others in 1848. Here the judge arrives at the erroneous conclu-
sion that
the money placed in the custody of a banker is, to all intents
and purposes, the money of the banker, to do with it as he
pleases. He is guilty of no breach of trust in employing it. He
is not answerable to the principal if he puts it into jeopardy,
if he engages in a haphazardous speculation; he is not
bound to keep it or deal with it as the property of his prin-
cipal, but he is, of course, answerable for the amount,
because he has contracted, having received that money, to
repay to the principal, when demanded, a sum equivalent to
that paid into his hands.10
9This type of ruling contrasts with the trend of sound judgments estab-
lished by the declaration that American grain depositaries acted fraud-
ulently in the 1860s when they appropriated a portion of the grain
deposits they were to safeguard and speculated with it on the Chicago
market. In response to this disconcerting event, Rothbard wonders:
[W]hy did grain warehouse law, where the conditions—of
depositing fungible goods—are exactly the same . . . develop
in precisely the opposite direction? . . . Could it be that the
bankers conducted a more effective lobbying operation than
did the grain men?
See Murray N. Rothbard, The Case Against the Fed (Auburn, Ala.: Lud-
wig von Mises Institute, 1994), p. 43. The same valid legal doctrine has
been evident in Spanish court decisions regarding bulk deposits of oil in
olive oil mills. (See the Spanish Supreme Court decision of July 2, 1948.)
10See the note on p. 73 of the book by E.T. Powell, Evolution of Money
Markets (London: Cass, 1966), and Mark Skousen’s comments on this
decision in his book, The Economics of a Pure Gold Standard (Auburn, Ala.:
Ludwig von Mises Institute, 1977), pp. 22–24. Two precedents of Lord
Cottenham’s decision were Sir William Grant’s ruling of 1811 in Carr v.
Carr and the judgment delivered five years later in Devaynes v. Noble. See
J. Milnes Holden, The Law and Practice of Banking, vol. 1: Banker and Cus-
tomer (London: Pitman Publishing, 1970), pp. 31–32 and 52–55.

126
Money, Bank Credit, and Economic Cycles
Considering this type of ruling, it is not surprising that
Richard Cantillon fled from France to England, where financial
practices were much more lax, and as we have seen, court rul-
ings ended up defending the same line of argument he used in
his defense. In continental Europe, in contrast, the Roman legal
tradition still exerted great influence. Roman jurists had impec-
cably formulated the nature of the monetary irregular deposit,
basing it on the safekeeping obligation and the unlawfulness of
banks’ appropriation of deposited funds. Hence Richard Can-
tillon’s fear is understandable. He fled continental Europe at a
time when the Bank of Amsterdam was still operating with its
full prestige and a 100-percent reserve ratio.11 Also, the concept
of irregular deposit began to return to its classical legal roots
(which outlawed fractional-reserve banking). It had already
become clear that all banking systems which had been based on
a fractional reserve had failed (i.e., the systematic failure of
European banks of the late Middle Ages, of banks in Seville and
Italy in the sixteenth and seventeenth centuries and the system
of Law in eighteenth-century France), and judges had regularly
pronounced rulings against bankers’ appropriation of funds on
deposit (and as we know, such decisions have even been made
well into the twentieth century in France and Spain).
We must emphasize that, at least with respect to the institu-
tion that concerns us (the irregular deposit), clearly the Anglo-
Saxon common law system has less effectively guaranteed the
defense of property rights and the correct regulation of social
interaction than the legal system of continental Europe. We do
not mean that the continental system in its latest version,
Kelsenian and positivist, is superior to the common law system,
only that the latter has often been inferior to Roman law. By
“Roman law” we refer to the evolutionary, customary system
based on the logical, exegetic, and doctrinal analysis of jurists of
the Roman classical school. To put it another way, in the Anglo-
Saxon common law system, past decisions are too binding,
11Incrediby, Cantillon does not mention in his Essai this then well-
known fact under the pretext that “he could not get the exact informa-
tion about . . . cash kept in the vaults to pay all deposits” (p. 407). It must
be assumed that the Essai was mainly written to facilitate Cantillon’s
defense in his lawsuits against his claimants.

Attempts to Legally Justify Fractional-Reserve Banking 127
judges being often more influenced by the specific details of
each case and by ostensible business activity than by the dis-
passionate, logical, and exegetic analysis which should be car-
ried out based on essential legal principles. In short the Anglo-
Saxon legal system depends excessively on precedents, while
the continental system, based on Roman law, rests on prece-
dents, sound doctrine, and juridical theory.
THE DOCTRINE OF SPANISH CIVIL AND COMMERCIAL CODES
A group of Spanish theorists has also tried to equate the
monetary irregular-deposit contract and the loan contract. Cit-
ing several articles in the Spanish Civil and Commercial Codes,
they claim the irregular deposit is not recognized as a separate
concept in Spanish legislation and therefore is no more than a
simple loan or mutuum contract. Nevertheless, not even Span-
ish positive law guarantees the association between the irregu-
lar deposit contract and the loan contract. On the contrary, such
a connection is very doubtful and uncertain, and in fact, the
majority of modern Spanish theorists have concluded, in keep-
ing with the classical construction, that even from the stand-
point of current Spanish positive law, the loan contract is one
thing and the irregular deposit contract quite another.
To justify equating the two types of contracts, theorists
have frequently referred to Article 1768 of the Spanish Civil
Code. This article states that
when the depositary has permission to use the good
deposited, the contract ceases to be a deposit and becomes a
loan or commodatum. Permission is not assumed, but must
be proven.
According to this article, if we were to understand use in its
most general and lax sense, then as all irregular deposit con-
tracts imply a transfer of ownership of the individual items
deposited and hence of the indistinct “use” of the fungible
good, the irregular deposit contract would always ipso facto
become a loan or mutuum. Although later we will examine the
different instances in which it could be considered that a “trans-
fer of use” takes place, for now it is enough to remember that,
as we saw in chapter 1, a general transfer of ownership and use

128
Money, Bank Credit, and Economic Cycles
is one thing, but in light of whether or not the tantundem is con-
stantly kept fully available to the depositor, it is quite another.
To the extent that Article 1768 is only intended to distinguish
whether or not the tantundem is kept continuously available to
the depositor, it would be perfectly possible under Spanish pos-
itive law to recognize the existence of an irregular deposit con-
tract that is radically distinct from the loan contract. In fact Arti-
cle 1770 of the very Civil Code seems to suggest this second
interpretation. Indeed, this article stipulates that
the deposited good shall be returned along with all of its
proceeds and accessions. Should the deposit consist of
money, the same provisions established in Article 1724
regarding the representative apply to the depositary.
In other words, it seems the Civil Code itself allows for a
type of monetary deposit which is not a loan. As José Luis
Albácar and Jaime Santos Briz correctly point out,
When faced with such a discrepancy—we may even call it
an antinomy—between conflicting statutory provisions [the
“classical” and the “modern”], we should note that nowa-
days the more common idea seems to be that the mutuum
and the irregular deposit are different, to the extent that
some people believe that in these cases we are dealing with
a type of deposit, an atypical and complex concept: the
irregular deposit.12
The treatment the monetary irregular deposit receives in
the Spanish Commercial Code could also appear contradic-
tory and lend itself to both interpretations. In fact Article 309
stipulates that
12José Luis Albácar López and Jaime Santos Briz, Código Civil: doctrina y
jurisprudencia (Madrid: Editorial Trivium, 1991), vol. 6, p. 1770.
Navarra’s civil code, in law 554 at the end of title 12, also makes refer-
ence to the irregular deposit:
When in the deposit of a fungible good the depositary is
either expressly or tacitly granted the power to use the good,
the provisions established for the monetary loan in laws 532,
534 and 535 shall be applied.
As we see, the content of Article 1768 of the Spanish Civil Code is
repeated here almost literally.

Attempts to Legally Justify Fractional-Reserve Banking 129
whenever the depositary, with the consent of the depositor,
uses the goods deposited, either for himself or his business
activities, or in operations ordered by the depositor, the
rights and obligations of depositor and depositary shall
cease, in favor of the rules and provisions applicable to the
commercial loan, the commission or the contract carried out
instead of the deposit.
It seems, therefore, that some parallels exist between Arti-
cle 309 of the Spanish Commercial Code and Article 1768 of
the Civil Code. However, Article 307 of the Commercial Code,
which regulates cash deposits, states that
when cash deposits are made in unmarked currency or in an
open, unsealed package, the depositary shall be responsible
for their preservation and safety according to the terms
established in paragraph 2 of Article 306.
And Article 306, paragraph 2 reads as follows:
in the safekeeping of deposits, the depositary shall be
accountable for any damage to the deposited goods resulting
from malice or negligence, as well as from the nature of the
goods or defects in them, if in such cases he fails to take nec-
essary measures to avoid or repair the damage, notifying the
depositor as soon as the damage becomes obvious. (Italics added)
Thus, if we consider the last paragraph of Article 307
together with the second paragraph of Article 306, the Spanish
Commercial Code itself fully allows for the concept of the
monetary irregular deposit contract and imposes a very clear
safekeeping obligation on the depositary in the depositor’s
favor, and even requires that, should any damage occur to the
fungible money deposited, the depositary immediately notify
the depositor. Nevertheless, Article 310 of the Commercial
Code grants bankers a statutory privilege which legalizes the
appropriation of funds deposited with them. This article spec-
ifies that
regardless of the provisions laid down in the preceding arti-
cles, deposits made in banks, public warehouses, credit asso-
ciations or any other company shall be governed first by that

130
Money, Bank Credit, and Economic Cycles
company’s statutes, then by the prescriptions of this code
and last by common law rules applicable to all deposits.
The nature of the “odious” privilege enjoyed by banks and
other similar associations is obvious. Even from the stand-
point of Spanish positive law, it could be argued that, accord-
ing to Article 306 (cited above) of the Commercial Code, any
person who is not a banker or similar professional and uses
the money entrusted to him through an irregular deposit
would violate the safekeeping obligation and therefore com-
mit the crime of misappropriation. Bankers, however, are
exempt from this possibility if their company’s statutes deter-
mine that they may use and appropriate depositors’ funds for
their own business activities. Nevertheless bank statutes and
contracts are not at all easy to understand. On the contrary,
documents of this type are usually ambiguous and confus-
ing,13 which explains court decisions stating that Spanish
13Curiously Spanish banks, when specifying the general conditions for
their different checking account contracts, avoid using the word
“deposit” for fear of the legal repercussions of such a contract (espe-
cially charges of misappropriation). They also avoid the words “loan”
and “credit” because, although they would be legally covered if they
called monetary irregular deposits “loans,” it is obvious that business-
wise, it would be much harder to attract deposits from customers if
they were generally aware that in opening a checking account they
are actually loaning money to the bank rather than making a deposit.
Consequently, bankers prefer to maintain the current ambiguity and
confusion, since the existing contractual obscurity benefits them as long
as they enjoy the privilege of using a fractional-reserve ratio and are
backed by the central bank in the event of a liquidity crisis. However,
bankers’ own legal classifications of their operations sometimes give
them away. For example, the sixth general condition established by the
Banco Bilbao-Vizcaya for draft discounting reads as follows:
Regardless of the different accounts and operations of the
assignor, whether in cash, securities, collateral, guarantees or
another type of document representing them, and notwith-
standing the manner in which they are itemized . . . the bank is
authorized to offset them by the loans it chooses to contract for
any entitlement, including any type of deposit . . . this condi-
tion shall apply even to operations and loans which the
assignor holds against the bank prior to the current transaction.

Attempts to Legally Justify Fractional-Reserve Banking 131
positive law requires bankers to maintain continuously avail-
able to depositors the entire amount of their deposits (tantun-
dem); that is, to maintain a 100-percent reserve ratio. These
judgments (such as the Spanish Supreme Court decision of
June 21, 1928 and others cited in chapter 1) have been based
on case-law interpretations of Spanish positive law and have
been pronounced well into the twentieth century.
Finally we must mention Articles 7 and 8 of the Bank of
Spain’s bylaws, which concern deposits. The first two para-
graphs of Article 7 establish that “authorized offices may
receive deposits of local currency or of notes from the bank
itself.” Article 8 states that “the responsibility of the bank as a
depositary is to return the same amount in local currency as is
deposited in cash.” Article 10, which relates to checking
accounts, has more or less the same content:
Moreover, whereas the Banco Bilbao-Vizcaya, in reference to the
demand deposit represented by the so-called “savings passbook,” clas-
sified the latter as “the justificatory claim representing the right of the
holder to request and obtain full or partial repayment of the balance in
his favor,” the Banco Hispano-Americano went even further, establish-
ing that the passbook “constitutes the nominative and non-negotiable
document which is evidence of the holder’s ownership.” As we see, in
the latter case, the bank, without realizing it, attributes ownership sta-
tus to the deposit contract; incidentally, this classification is much closer
to the true legal nature of the institution (given the continuous avail-
ability in favor of the depositor) than that of a mere loan claim on the
deposited sum. On this subject, see Garrigues, Contratos bancarios, pp.
368–79, footnotes 31 and 36. Garrigues notes that private bankers do not
refer directly to monetary deposit contracts by name, but instead usu-
ally call demand deposits checking accounts, as revealed by an exami-
nation of deposit slips and general terms of accounts, as well as by bank
statements, balance notices, etc. Moreover, this reluctance to speak of
“monetary deposits” is evident even on bank balance sheets where there
is never any mention of such a heading and where monetary irregular
deposits are instead entered under “Checking Accounts” in the corre-
sponding liabilities column under “Creditors.” Thus from a legal and
contractual standpoint, with the consent of financial authorities,
bankers purposefully contrive to conceal the true legal nature of their
activities, especially from third parties and clients. The effects of the
confusion created by banks are studied by Jörg Guido Hülsmann in his
article, “Has Fractional-Reserve Banking Really Passed the Market
Test?” The Independent Review 7, no. 3 (Winter, 2003): 399–422.

132
Money, Bank Credit, and Economic Cycles
the bank may open and manage checking accounts of cash
or securities for individuals or legal entities and duly repre-
sented corporations or organizations whose application is
confidentially reviewed by the institution and accepted. The
following may be deposited in ordinary cash accounts: legal
banknotes and coins, checks and other documents related to
other checking accounts . . . for each type of checking
account the bank will provide the checkbooks needed by the
account holder; and via the duly authorized checks, it will
pay the sums and return the securities to the debit of the cor-
responding balances. Against cash checking accounts the
following are also admissible: bearer, order, personal and
crossed checks.
As we see, these articles of the Bank of Spain’s bylaws, and
in general the statutes of all other banks, only regulate the
operation of monetary irregular-deposit accounts and check-
ing accounts from the standpoint of depositors, and they
always maintain the confusion and ambiguity regarding
whether such money is continuously safeguarded and kept
available by the bank or whether the bank is expressly
authorized by the depositor to appropriate funds and invest
them in personal business deals. We must turn to Article 180
of the Commercial Code to see the true original meaning of
Spanish commercial legislation on this point. Indeed, Article
180 specifies that “banks will keep cash in their vaults equiv-
alent to at least one fourth the sum of deposits and checking
accounts in cash and bills in circulation.” This ratio, which has
traditionally been used by the Spanish central bank as an
instrument of monetary policy and has been reduced to a cur-
rent 2 percent, is the culmination of the statutory privilege
enjoyed by the banking industry. Banking is the only institu-
tion expressly authorized by Spanish positive law to violate
the safekeeping obligations of the monetary irregular-deposit
contract, thus receiving permission to appropriate depositors’
money for bankers’ own use in investments and personal
business activities. Although the reserve requirement alone
keeps bankers from being criminals under the positive law in force in
Spain, it does not in the least compensate for the lack of legal
justification for the bank-deposit contract in its current form,
nor, as is logical, for the damaging economic effects on society

Attempts to Legally Justify Fractional-Reserve Banking 133
of the violation of traditional principles of property rights
with respect to the monetary irregular deposit. In the follow-
ing chapters we will examine these effects (the distortion of
the productive structure; the generation of successive, recur-
rent stages of economic boom and recession; the promotion of
widespread malinvestment; the creation of massive unem-
ployment and the perpetuation of a privileged financial sys-
tem incapable of guaranteeing smooth economic develop-
ment).
CRITICISM OF THE ATTEMPT TO EQUATE THE MONETARY
IRREGULAR-DEPOSIT CONTRACT WITH THE LOAN OR
MUTUUM CONTRACT
Even though the doctrinal association between irregular
deposits and monetary loan or mutuum contracts is the per-
fect tool for justifying fractional-reserve banking, this associa-
tion is so awkward that the most prestigious experts in com-
mercial law have failed to accept it. Joaquín Garrigues,
though he seems to want to unreservedly defend the doctrine
of association, ultimately realizes that it is not justifiable, and
he concludes that, despite the possible positive-law arguments
(Article 1768 of the Spanish Civil Code and Article 309 of the
Spanish Commercial Code, both cited earlier) that could be
used to justify the association between the loan or mutuum
contract and the irregular deposit contract,
there are still some factors which lead one to continue consid-
ering the contract a deposit and not a loan (for example, the
free availability to the depositor, the fact that the depositor
initiates the contract, the limited interest, etc.).14
Curiously, Joaquín Garrigues does not expound on these
factors, mentioning them only in passing. Instead he immedi-
ately tries to construct the theory based on the reinterpretation
of the concept of availability, which we will study in the next
section. Nevertheless, considering what we covered in chapter
14Garrigues, Contratos bancarios, p. 363; italics added.

134
Money, Bank Credit, and Economic Cycles
1, it would have been very interesting to know what Garrigues
could and should have said about the arguments against
equating the two contracts, a matter we will now consider in
greater depth.15
THE DISTINCT CAUSE OR PURPOSE OF EACH CONTRACT
The most significant and definitive argument in favor of a
distinction between the irregular deposit contract and the loan
or mutuum contract lies in the essential difference between the
cause or purpose of each. These terms refer to a fundamental,
15Strangely, our top commercial law scholar rushes into an attempted
justification of fractional-reserve banking while preserving the concept
of the irregular deposit through the artifice of a redefinition of avail-
ability, without pausing first to examine the factors that make it impos-
sible to equate the irregular deposit contract and the loan contract. It is
as if Garrigues were ultimately aware that his redefinition implicitly
entails equating deposits and loan contracts—at least from the banker’s
(the recipient’s) perspective. For this reason it does not behoove him to
advance a detailed argument against equating deposits and loans,
because such an argument would backfire on the doctrine he later
defends. This attitude is quite understandable in a famed scholar whose
chief customers were the country’s banks and bankers and who would
therefore think twice before jeopardizing his prestige and academic
standing by questioning the legitimacy of such an influential institution
as fractional-reserve banking, which was rooted in practice and govern-
ment-endorsed. In addition, during the years when Garrigues was
developing his theories, he could only depend for support on an eco-
nomic theory which, paralyzed by Keynesian doctrines (see footnote 20
in ibid.), justified any system of credit expansion, no matter how expe-
dient, on the mistaken assumption that this would benefit “economic
activity.” During those years of doctrinal poverty in economics, the only
possible defense for the processes of social interaction against banking
practices would have been strict observance of the basic principles gov-
erning the irregular deposit, which unfortunately received very weak
support from mainstream theorists and were quickly abandoned.
Despite all of these adverse circumstances, the writings of Garrigues
and others who concentrate on the same topic, an unmistakable impres-
sion persists: that in order to justify the unjustifiable, theorists carry out
the most forced legal reasoning and maneuverings to disguise as legal
an activity that results from an unseemly, unlawful privilege granted by
the government.

Attempts to Legally Justify Fractional-Reserve Banking 135
legal motive (related to the so-called cause16 of contracts)
which is closely connected with the parties’ distinct subjective
reason17 for deciding to enter into one contract or another.
Therefore a perfect symbiosis exists between the subjectivist concep-
tion on which modern economic theory is based18 and the legal point
of view that mainly takes into account the different subjective goals
of the parties in entering into one type of contract or another.
In chapter 1 we studied the essential, irreconcilable differ-
ences between the monetary irregular-deposit contract and
the monetary loan or mutuum contract. All of those differ-
ences could ultimately be traced to the distinct cause or pur-
pose of each contract. On one hand, the loan contract always
implies an exchange of present goods, the availability of
which is lost to the lender, for future goods, which the bor-
rower must return along with an added amount in the form of
interest, in payment for the inexorable loss of availability of
the present goods when they are transferred from lender to
borrower. On the other hand, in the monetary irregular
16See, for example, the legal treatment Jean Dabin gives the cause of
contracts in La teoría de la causa.
17For Antonio Gullón,
the equating of the irregular deposit with the mutuum is still an
artifice that conflicts with the true will of the parties. The deposi-
tor of money, for example, does not intend to grant a loan to
the depositary. Just as in the regular deposit, he desires the
safekeeping of the good and to always have it available. He
happens to achieve these objectives more easily with the
irregular deposit than with the regular deposit, since with the
latter he risks the loss of his deposit in the event of an
unavoidable accident, and he would bear the loss instead of
the depositary. Meanwhile, in the irregular deposit, the
depositary is the debtor of a type of good, which as such is
never lost. (Italics added)
Cited by José Luis Lacruz Berdejo, Elementos de derecho civil, 3rd ed.
(Barcelona: José María Bosch, 1995), vol. 2, p. 270.
18This subjectivist conception is the basis of the logic of action on which
all economic theory is constructed, according to the Austrian School of
economics, founded by Carl Menger. On this topic, see our article,
“Génesis, esencia y evolución de la Escuela Austriaca de Economía,”
published in Huerta de Soto, Estudios de economía política, pp. 17–55.

136
Money, Bank Credit, and Economic Cycles
deposit, the objective or cause of the contract is radically dif-
ferent. In this case there is no exchange of present goods for
future goods, nor does the depositor have the faintest desire to
lose the immediate availability of the good deposited. Hence
the essential element in the irregular deposit contract is not, as
in the loan contract, the transfer of availability, but rather the
custody and safekeeping of the tantundem, which constitutes
the legal cause or fundamental purpose motivating the depos-
itor to enter into the contract. For this reason, there is no term,
and the funds are deposited “on demand;” that is, they can be
withdrawn at any time. If the depositor were informed that
the contract he plans to sign is a loan contract by which he
will grant a loan to the bank, and that therefore the money
will no longer be available to him, he would certainly not go
through with the contract as if it were a deposit, and he very
well might decide to keep his money. Thus, there is
absolutely no doubt that the cause or legal purpose of each
contract is radically different from that of the other, and that
attempting to mix them is like trying to mix oil and water,
given the essential difference between them.
Theorists who attempt to equate the irregular deposit con-
tract with the loan contract fail to realize that their doctrinal
stance ignores the true cause or purpose motivating the con-
tracting parties to enter into a contract. And no matter how
many relatively empty statements they make about the equiv-
alence of the two contracts, they inevitably come up against
the same legal wall: the radical, essential difference between
the legal cause behind each contract. Therefore, they can go no
further than to state that each of the parties to the monetary
bank-deposit contract thinks it is entering into a “different”
contract. In other words, depositors hand over money as if mak-
ing a deposit, and bankers receive it as if it were a loan. Yet, what
kind of contract has two essentially distinct legal causes? Or
to put it another way: How is it possible that both parties to
the same contract simultaneously intend to retain the avail-
ability of the same sum?19 Indeed, depositors clearly turn
19Francisco Belda, following the example of Luis de Molina and Juan de
Lugo, believes he resolves this contradiction with the facile, superficial

Attempts to Legally Justify Fractional-Reserve Banking 137
over their money with the desire to retain full availability of
the good turned over (monetary deposit “on demand”),20
while banks accept deposits not with the aim of keeping 100
percent of the tantundem in their possession at all times, but
rather with the intention of using most of what they receive on
deposit to make personal loans and investments. This “dual
availability” could not possibly be ignored by Garrigues, who
logically finds it very disquieting and confusing with respect
to legality.21 As a matter of fact, for Garrigues the most out-
standing feature of monetary bank deposits in their current
version (which does not require a 100-percent reserve) is dual
availability: the deposited goods are simultaneously available
to both the bank and the customer. He adds that
assertion that “each of the two has the perfect right to view the opera-
tion from the angle which most behooves him.” However, Belda fails to
realize that, as there is an essential difference and a contradiction
between the causes motivating the parties to enter into the contract, the
problem is quite another: it is not that each party views the contract as
most behooves him, but rather that the fulfillment of the aim or cause of
one party (the investment of funds by the banker) prevents the success-
ful fulfillment of the aim or cause of the other (the custody, safekeeping
and continual availability of the money). See Belda, S.J., “Ética de la
creación de créditos según la doctrina de Molina, Lesio y Lugo,” pp.
64–87. See also Oscáriz Marco, El contrato de depósito: estudio de la
obligación de guarda, footnote 83, p. 48.
20The fact that depositors sometimes receive interest in no way detracts
from the essential purpose of the deposit (the safekeeping of money).
Since interest is attractive, the unsuspecting depositor will jump at the
offer of it if he still trusts the banker. But in the case of a true deposit, the
depositor would enter the contract even if he were not to receive any
interest and had to pay a safekeeping fee. The essential nature of the
contract is not altered by the unnatural payment of interest to deposi-
tors, and only indicates that bankers are making undue use of the
money placed with them.
21Significantly, the only theoretical reference cited by Garrigues in his
book, Contratos bancarios, is Keynes’s Treatise on Money, which he expressly
mentions at least twice in the main text (pp. 357 and 358) and twice in the
footnotes (pp. 352 and 357, footnotes 1 and 11, respectively). With such a
theoretical basis, the confusion evident in Garrigues’s entire discussion of
the irregular deposit is hardly surprising. It seems as if his remarkable
legal instinct were pointing him in the right direction, while the economic
treatises he was reading on banking were leading him astray.

138
Money, Bank Credit, and Economic Cycles
this dual availability is precisely the reason it is difficult to
formulate a legal description of the contract, because avail-
ability in favor of the depositor, a key feature of deposits,
harmonizes poorly with availability in favor of the bank.22
Rather than to say it is difficult to formulate a legal
description of the contract, it would be more accurate to say
such a description is legally impossible, given the radical differ-
ence between the cause or purpose of the two types of legal
transactions. Therefore, it is not that one instance of availabil-
ity “harmonizes poorly” with the other, but that the two
instances are mutually exclusive on a fundamental level.23
Joaquín Garrigues’s uncertainty is even more obvious when in
a footnote24 he cites the rulings of the Court of Paris which we
covered in chapter 1. These court decisions support a strict
safekeeping obligation and a 100-percent reserve ratio for
banks, which Garrigues calls “surprising assertions.” What is
surprising is that Garrigues does not realize that his own analy-
sis leads inevitably to the conclusion that the two contracts are
different and that it is therefore impossible to equate in any
22Garrigues, Contratos bancarios, p. 367; italics added. It is surprising that
Garrigues has not realized that in economic terms, dual availability
means “it becomes possible to create a fictitious supply of a commodity,
that is, to make people believe that a supply exists which does not
exist.” See William Stanley Jevons, Money and the Mechanism of Exchange
(New York: D. Appleton, 1875 and London: Kegan Paul, 1905), p. 210.
Convincing the public of the existence of a fictitious stock of fungible
goods is definitive proof of the illegitimacy of all irregular deposits (of
fungible goods) in which a fractional-reserve ratio (any ratio under 100
percent) is allowed.
23Garrigues, demonstrating his characteristic gift of expression, con-
cludes that in this contract “the banker counts on the money as if it were
his, and the customer counts on the money even though it is not his.”
The solution to this apparent paradox is very simple, because although
the customer has ceased to own the money, he retains the right to
demand the custody and safekeeping of the tantundem by the banker at
all times; that is, a 100-percent reserve ratio, in keeping with the essen-
tial, ontological legal nature of the monetary irregular-deposit contract,
which we covered in chapter 1. See Garrigues, Contratos bancarios, p.
368.
24Ibid., footnote 31 on pp. 367–68.

Attempts to Legally Justify Fractional-Reserve Banking 139
way the irregular deposit contract with the loan contract.
Upon reading Garrigues’s treatment of monetary bank-
deposit contracts, one inevitably gets the impression that Gar-
rigues himself suffers from a rather “guilty conscience” for
carrying out such a forced legal analysis to try to justify the
unjustifiable: the supposed existence of a monetary irregular-
deposit contract which legally, and in accordance with legal
principles and logic, permits the banker to freely use the
goods deposited; in other words, fractional-reserve banking.
THE NOTION OF THE UNSPOKEN OR IMPLICIT AGREEMENT
Also inadmissible is the argument that Article 1768 of the
Spanish Civil Code suggests that in irregular deposit contracts
a type of “implicit or unspoken agreement” exists by which
depositors authorize bankers to use money on deposit. This
course of reasoning is unacceptable mainly because Article
1768 speaks of permission “to use the good deposited,” and
we know that it is not the power to use the good that makes
the monetary-deposit contract an irregular deposit contract.
This authorization is inherent in all deposits of fungible
goods, the very nature of which prevents them from being
handled individually. In a sense, a transfer of ownership
results, which in turn implies authorization for the depositary
to use the goods. Nevertheless, we have already seen that this
transfer of ownership and of power to use the deposited
goods should be understood in a general sense. If it is not pos-
sible to track the individual units deposited, then we may cer-
tainly consider there to be a transfer of ownership and of
power to use the specific items deposited. However, as is log-
ical, this is perfectly compatible with a continuous 100-percent
reserve requirement; that is, the custody and safekeeping of
the tantundem and its availability to the depositor. This consti-
tutes the banker’s essential obligation and is the foundation of
the deposit contract’s essential purpose. To put it another way,
the characteristic, essential nature of the irregular deposit con-
tract is not determined by the transfer of authority to use the
goods, but by the fungible nature of the items deposited and
by the contract’s purpose. A transfer of authority to use
deposited goods may occur independently of an irregular
deposit, and this is indeed what happens, for example, in the

140
Money, Bank Credit, and Economic Cycles
mutuum or loan contract. As we know, the legal cause or pur-
pose of this contract is radically different (it entails not only
the transfer of ownership and power to use the goods, but also
the transfer of the availability of the goods, which is simulta-
neously lost to the lender). Therefore, and according to Coppa-
Zuccari, the claim that supposed authorization (express or
tacit) from the depositor converts the irregular deposit contract
into a loan or mutuum is both unnecessary and inaccurate. It is
unnecessary in the sense that all irregular deposit contracts,
due to their very nature, involve the transfer of ownership
and of the power to use the good (which is compatible, as is
logical, with the fundamental obligation to maintain 100 per-
cent of the tantundem in reserve). And it is inaccurate, since even
though the power to use the deposited good is transferred, in
no way does this alter the original purpose of the contract,
which is none other than the custody and safekeeping of the
tantundem.25 In fact, three logical possibilities exist with respect
to the supposed authorization (express or tacit) to use the
deposited good. Let us consider each one separately.
First, we may suppose that the vast majority of depositors
are not aware that by depositing their money in a bank, they at
the same time authorize the banker to use the money for his
own profit in private business deals. It is certain that when the
overwhelming majority of depositors make a demand
deposit, they are under the honest impression that they are in
fact doing just that: entering into an irregular deposit contract,
the essential purpose of which is to transfer the custody or
safekeeping of their money to the banker. In all cases, the
banker simultaneously receives the money as if it were a loan
or mutuum; that is, he considers that the full availability of the
good is transferred to him and that he is therefore authorized
to use it in his own business deals. It is obvious that the cause
or purpose of each party’s participation in the contract does
not coincide with the objective of the other party: one enters
into the contract believing it to be a deposit and hands over
the money based on that assumption, and the other receives
the money as if it were a loan or mutuum and based on that
25Coppa-Zuccari, Il deposito irregolare, p. 132.

Attempts to Legally Justify Fractional-Reserve Banking 141
idea invests it. Hence, this is a clear case of error in negotio,
which is an error concerning the nature of the transaction and
renders it completely void.26 To many this conclusion may
appear extreme or disproportionate, but it is difficult to arrive
at any other if we base our analysis on the legal arguments
and principles inherent in the contracts we are studying.27
Second, let us now assume that a certain group of bank cus-
tomers (or for the sake of argument, all of them) enter into a
deposit contract aware and fully accepting that banks will
invest (or loan, etc.) a large portion of the money they deposit.
Even so, this knowledge and hypothetical authorization does
not in any way detract from the essential cause or purpose of
the contract for these customers, whose intention is still to
entrust their money to the banker for safekeeping; that is, to
carry out a monetary irregular-deposit contract. In this case,
the contract the depositors believe they have finalized is
impossible from a technical and legal standpoint. If they allow
the banker to use the money, then it can no longer be available
to them, which is precisely the essential cause or purpose of
the contract. Moreover, in chapter 5 we will see from the per-
spective of economic theory that in a fractional-reserve bank-
ing system the massive signing of contracts and the “law of
large numbers” cannot possibly ensure the fulfillment of all
depositor requests for full repayment of deposits. At this time,
we will delay going into detail on our thesis, except to say that
it rests on the acknowledgment that the current banking sys-
tem generates loans without the backing of real savings. These
loans in turn foster the foolish investment of resources and
give rise to unwisely-invested business assets which are either
26See Hernández-Tejero Jorge, Lecciones de derecho romano, pp. 107–08.
Hernández-Tejero himself provides the following example, which is
perfectly applicable to the case we are dealing with: “If one person
entrusts to another a good on deposit, and the person receiving the good
believes the transaction to be a mutuum or loan, then neither a deposit
nor a mutuum exists.”
27Furthermore, it is obvious that permission or authorization to use the
good cannot be assumed but must be proven in each case. It seems
unlikely that in most demand deposit contracts entered into by individ-
uals such proof would be possible.

142
Money, Bank Credit, and Economic Cycles
worthless or of limited value and therefore incapable of bal-
ancing the corresponding deposit accounts on bank balance
sheets. Consequently, bank insolvency tends to recur, banks
being repeatedly unable to meet their obligations (without the
external support of the central bank).
In addition, if for the sake of argument we assume that the
law of large numbers is applicable to banking, then in the
presence of a fractional reserve the deposit contract clearly
becomes an aleatory contract.28 In such a contract, delivery of
services by the bank is in any case an uncertain event which
depends upon circumstances particular to each case. The con-
tract’s uncertainty stems precisely from the possibility that
depositors of a percentage of deposits exceeding the reserve
ratio will attempt to withdraw their deposits and hence be
unable to do so. The first to arrive would be able to retrieve
their money, but those arriving after a certain point would not.
Surely not even the depositors of this second hypothesis
intend to enter into an aleatory contract subject to the risk we
have just described. Therefore, the most logical conclusion in
this second case is either that the contract does not exist, since
its purpose is impossible (without a 100-percent reserve ratio,
it is impossible to insure that the banker will always be able to
meet his obligations), or that the supposed authorization from
the depositors lacks legal validity, because the essential objec-
tive is still the safekeeping of the good, and this inevitably and
obligatorily requires the custody of 100 percent of the tantun-
dem.29
28On aleatory contracts see Albaladejo, Derecho civil II, Derecho de obliga-
ciones, vol. 1: La obligación y el contrato en general, pp. 350–52. It is impor-
tant to emphasize that the fact that there is an aleatory nature to the
monetary irregular-deposit contract with a fractional reserve in which
the law of large numbers is fulfilled (in fact impossible) is only second-
ary to the other points we raise against such a contract.
29The popular reaction of Argentinian citizens against the banking cri-
sis of 2001 and the subsequent blockade of all their demand deposits
(known as corralito) is a perfect empirical illustration of the true safe-
keeping purpose of bank deposit contracts and of the impossibility of
fractional-reserve banking (without a lender of last resort).

Attempts to Legally Justify Fractional-Reserve Banking 143
A natural incompatibility exists between the legitimate
irregular deposit contract, the purpose of which is the custody
or safekeeping of the deposited goods, and the authorization
for depositaries to use for their own profit the money they
receive. These depositaries (bankers) take in funds they agree
to return as soon as requested by checking-account holders,
but once the bankers have received the money, they make
investments, grant loans and enter into business deals that tie
it up and under various circumstances actually prevent its
immediate return. The supposed authorization, either express
or tacit, for bankers to use money on deposit is of little impor-
tance if the essential purpose of the contract, the deposit of
money for safekeeping, continues intact. In this case the sup-
posed authorization would be irrelevant, due to its incompati-
bility with the contract’s purpose, and it would thus be as legally
null and void as any contract in which one of the parties authorizes
the other to deceive him or accepts in writing self-deception to his
own detriment. As the great Spanish expert in civil law, Felipe
Clemente de Diego, so appropriately states, an irregular
deposit contract in which the depositary is allowed to main-
tain a fractional-reserve ratio and hence can make self-inter-
ested use of a portion of deposited funds is a legal aberration,
since at a fundamental level it conflicts with universal legal
principles. For Felipe Clemente de Diego, there is no doubt
that this contract
has the disadvantage of leading us to the discovery of a
monster which, by its very nature, lacks legal viability, like
humans with devastating malformations (monstrua prodi-
gia), whom Roman law did not grant legal status. Article 30
of the Spanish Civil Code expresses a more moderate ver-
sion of the same concept: “For civil purposes, only fetuses
with a human figure will be reported as born. . . . “ For every
being has its own nature, and when this is not found in the
being itself, but is drawn from others more or less similar to
it, the being’s true nature appears to flee and vanish and
ceases to envelop it, reducing it to a monstrous hybrid bor-
dering on a non-being.30
30“Dictamen del señor de Diego (Felipe Clemente)” in La cuenta corri-
ente de efectos o valores de un sector de la banca catalana y el mercado libre de

144
Money, Bank Credit, and Economic Cycles
It would be difficult to express more accurately and suc-
cinctly the fundamental incompatibility and the insoluble
logical contradiction between the monetary irregular-deposit
contract and the loan contract. Clemente de Diego concludes
by criticizing
attempts to convert that radical opposition (between the
irregular-deposit contract and the loan contract) into a sin-
gle unit that would make up a new contract, which would
neither be one nor the other, but instead would be both at
the same time; this is impossible, as its terms are mutually
exclusive.
Such a contract is simply ontologically impossible.
To conclude our comments on this second possibility, we
must add that the contradiction is so obvious that bankers, in
their contracts, general conditions, and forms, are always
reluctant to specify the precise nature of the agreement and of
the safekeeping obligation they acquire, and whether or not
they have been authorized by the depositor to invest
deposited funds for their own profit. Everything is expressed
in a vague and confusing manner, and therefore it would not
be rash to claim that depositors’ complete and perfect consent
is missing, because the ambiguity, complexity and obscurity
of the contract undoubtedly deceive customers, who in good
faith believe they are entering into a true deposit contract. If
valores de Barcelona, pp. 370–71. It is true that Felipe Clemente de Diego
makes this comment in response to the argument of bankers who
wished to defend the validity of the contract of irregular deposit of secu-
rities, with a fractional-reserve ratio, in which the depositary would be
permitted to freely use the deposited goods, like in the monetary irreg-
ular-deposit contract. Yet as we have already mentioned, the arguments
for and against either institution are identical, as both are contracts of
the irregular deposit of fungible goods, whose legal nature, cause, pur-
pose and circumstances are the same. Pasquale Coppa-Zuccari also
highlights the contradictory nature of the monetary bank-deposit con-
tract which, in the form in which it has been “legalized” by govern-
ments, is neither a deposit nor a loan, “La natura giuridica del deposito
bancario,” Archivio giuridico “Filippo Serafini,” Modena n.s. 9 (1902):
441–72.

Attempts to Legally Justify Fractional-Reserve Banking 145
the value and efficacy of surrendering a good depend on the
procedure or document accompanying the action, then it is
clearly important that the procedure or contract be well-
defined and appropriately named, that its conditions be
well-regulated and that both parties be aware of the legal
consequences of these conditions. To fail to clarify or fully
specify these details indicates a remarkable ambiguity on the
part of bankers, and in the event that adverse legal conse-
quences result, their weight should fall on the bankers’ shoul-
ders and not on those of the contracting party, who with good
faith enters into the contract believing its essential purpose or
cause to be the simple custody or safekeeping of the money
deposited.
Third and last, we may suppose that, if this is the deposi-
tors’ real desire, they could change their original plan to make
an irregular deposit of money and instead enter into a
mutuum or loan contract in which they agree to the loss of
availability of the good and to its transfer to the banker for a set
term in exchange for interest. This would constitute a true nova-
tion of the contract, which would change from an irregular
deposit to a loan. The novation would be subject to general
legal regulations regarding this type of contractual modifica-
tion. This is a fully legitimate legal possibility which is little
used in practice. Moreover, paradoxically, when novations
take place in banking their purpose is usually the opposite. In
other words, what undoubtedly begins as a mutuum or loan
contract, although it is called a “time” deposit because it
involves the real transfer of availability of the good to the
banker for a set term or time period, on many occasions
becomes an irregular deposit contract via the corresponding
novation. This is what happens when bankers, in order to
maintain their resources or attract more, either publicly or pri-
vately, and either verbally or in writing, offer the holder of a
“time” deposit account the possibility of withdrawing his
money at any time with very little or no financial penalty. To
the extent that account holders make these “time” deposits
(which are clearly loans) with the subjective and primary goal
of depositing the money for safekeeping, then a monetary
irregular deposit clearly takes place, regardless of its external
appearance. Furthermore, insofar as the contract’s fundamental

146
Money, Bank Credit, and Economic Cycles
cause or purpose is the exchange of present goods for future
goods plus interest, a true time “deposit” takes place. From a
legal standpoint, this is unquestionably a mutuum or loan
which can later be changed to or substituted for by a monetary
irregular deposit through an express agreement between the
parties.31
In short, whichever way you look at it, the monetary irreg-
ular-deposit contract cannot be equated with the mutuum or
loan contract. The two are essentially incompatible, and the
existence of the demand deposit in fractional-reserve banking,
despite its being a “monster” or “legal aberration,” can only
be accounted for insofar as it was initially tolerated and later
deliberately legalized by those exercising political power.32
Nevertheless, the fact that such a “monstrous” (according to
Clemente de Diego) legal institution plays a role in the course
of human interaction inevitably produces damaging economic
and social consequences. In the following chapters we will
explain why fractional-reserve banking is responsible for the
crises and recessions that repetitively grip the economy, and
this will constitute an additional argument against the legiti-
macy of the bank-deposit contract, even when both parties are
in perfect agreement. Furthermore, this explains the impossi-
bility of at all times guaranteeing the repayment of these
deposits without the creation of a whole government super-
structure called the central bank. Once this organization has
31We do not support the doctrine that time “deposits” are not loan or
mutuum contracts from the legal perspective, since both their economic
and legal natures reflect all the fundamental requirements we studied in
chapter 1 for a loan or mutuum. Among the scholars who attempt to jus-
tify the theory that time “deposits” are not loans, José Luis García-Pita
y Lastres stands out with his paper, “Los depósitos bancarios de dinero
y su documentación,” esp. pp. 991ff. The arguments García-Pita y Las-
tres offers here on this topic fail to convince us.
32That is, fractional-reserve banking conflicts with traditional legal prin-
ciples and only survives as a result of an act of coercive intervention
found in a mandate or governmental statutory privilege, something that
other economic agents cannot take advantage of and which expressly
states that it is legal for bankers to maintain a fractional-reserve ratio
(Article 180 of the Spanish Commercial Code).

Attempts to Legally Justify Fractional-Reserve Banking 147
established a monopoly on the issue of paper money and
declared it legal tender, it has the function of ensuring the cre-
ation of all the liquid assets necessary to satisfy any immediate
need private banks may have for funds. In chapter 8 we will
study the resulting emergence of a centralized monetary pol-
icy, which like all attempts to coordinate society through coer-
cive measures (socialism and interventionism), and for the
same reasons, is ultimately doomed to failure. Indeed, central
banks and governmental monetary policy are the main cul-
prits in the chronic inflation which in varying degrees affects
western economies, as well as in the successive and recurrent
stages of artificial boom and economic recession which cause
so many social upheavals. But first, let us continue with our
legal analysis.
3
AN INADEQUATE SOLUTION:
THE REDEFINITION OF THE CONCEPT OF AVAILABILITY
The belief, held by the most qualified theorists, that it is
impossible to reconcile two contracts as incompatible as the
monetary irregular deposit and the loan contract, along with
the fact that the majority of contracts sustaining present-day
banking are demand deposits (monetary irregular-deposit con-
tracts) have led scholars to try to formulate alternative juridi-
cal constructions to harmonize the irregular deposit contract
with “traditional” banking, i.e., fractional-reserve banking.
Some have tried to solve this contradiction by “redefining”
availability. In fact, for subscribers to this line of thought, avail-
ability need not be understood in a strict sense (100-percent
reserve ratio or keeping the tantundem available to the deposi-
tor at all times), but could be interpreted in a “lax” one: for
example, the “general” solvency of the bank by which it meets
its obligations; “prudent” investing; avoidance of high-risk
speculation and the corresponding losses; maintenance of
appropriate liquidity and investment ratios; and in short, com-
pliance with an entire body of rigorous banking laws, which
together with the hypothetical operation of the “law of large
numbers” in the opening of deposit accounts and withdrawal

148
Money, Bank Credit, and Economic Cycles
of demand deposits, could ultimately guarantee the bank’s
ability to return deposits whenever requested by a depositor.
Thus, to Garrigues the obligation to maintain deposits
available to depositors “becomes a duty to work diligently, to
make prudent and sensible use of deposits, so the bank is
always capable of returning them on demand.”33 Following
Lalumia’s example, Garrigues adds that the depositary is not
“obliged to keep the tantundem, but only to invest it wisely
and keep it liquid so he is always in a position to return it if
necessary.”34 The bank would only have to keep in its vaults
enough money to satisfy the “probable” demands of its
clients. Garrigues therefore concludes that
in bank deposits, the element of custody is replaced by the
technical element of calculating the probability of deposit
withdrawals. In turn, this calculation depends on the fact
that bank deposits are made on a large-scale.35
33Garrigues, Contratos bancarios, p. 375.
34Ibid., p. 365.
35Ibid., p. 367. García-Pita y Lastres defends the same theory in his
paper “Los depósitos bancarios de dinero y su documentación,” where
he concludes that
under the circumstances, instead of regarding “availability”
as the simple right to claim immediate repayment, we should
consider it a combination of behaviors and economic and
financial activities aimed at making repayment possible. (p.
990)
He continues in the same vein in his paper “Depósitos bancarios y pro-
tección del depositante,” pp. 119–226. Also espousing this view,
Eduardo María Valpuesta Gastaminza argues that
the bank is under no obligation to hold the deposited good,
but rather custody becomes a responsibility to prudently
manage both the customers’ and the bank’s resources, and to
keep these available, which is also ensured by legitimate gov-
ernmental regulations (which set the reserve requirement,
limits to risk-taking, etc.). (pp. 122–23)
See “Depósitos bancarios de dinero: libretas de ahorro” in Contratos
bancarios, Enrique de la Torre Saavedra, Rafael García Villaverde, and
Rafael Bonardell Lenzano, eds. (Madrid: Editorial Civitas, 1992). The
same doctrine has been endorsed in Italy by Angela Principe in her

Attempts to Legally Justify Fractional-Reserve Banking 149
Quite significantly, Garrigues himself acknowledges that
all of this doctrine involves “the unavoidable replacement of
the traditional concept of custody by an ad hoc concept, the
plausibility of which is highly doubtful.”36 Garrigues is right
in considering this reinterpretation by theorists of the concept
of availability “forced” (even though he eventually accepts it).
The theory that in the irregular deposit contract the safekeep-
ing obligation merely consists of using resources “prudently”
so the bank retains the solvency necessary to pay its debts is
actually untenable. The prudent use of resources is advisable
in all human actions; for instance, in all loan (not deposit) con-
tracts which specify that certain resources are to be used and
then returned following a set term. That is, it is advisable if
there is a desire to comply with this obligation (the very mean-
ing of solvency).37 However, as we know, the purpose of the
irregular deposit contract is different from that of the loan
contract and requires something markedly different: the cus-
tody or safekeeping of the good at all times. So if the deposi-
tors try to withdraw their deposits and the bank cannot pay
them, regardless of whether it is solvent overall and can pay
once it converts its investments into cash, the essential obliga-
tion in the deposit contract is clearly violated. This is due to
the fact that some contracting parties (depositors) who have
entered into the contract believing its fundamental purpose to
be the custody and safekeeping of the good and its continuous
availability are compelled to become something radically dif-
ferent: forced lenders. As such, they lose the immediate avail-
ability of their goods and are obliged to wait for a prolonged
book La responsabilità della banca nei contratti di custodia (Milan: Editorial
Giuffrè, 1983).
36Garrigues, Contratos bancarios, p. 365.
37Furthermore, the standard criterion of “prudence” is not applicable in
this case: an imprudent bank may be successful in its speculations and
preserve its solvency. By the same token, a very “prudent” banker may
be seriously affected by the crises of confidence that inevitably follow
artificial booms, which are generated by the fractional-reserve banking
system itself. Hence, prudence is of little use when there is a violation of
the only condition capable of guaranteeing the fulfillment of the bank’s
commitments at all times (a 100-percent reserve ratio).

150
Money, Bank Credit, and Economic Cycles
period of time until the bank has, in a more or less orderly
fashion, converted its assets into cash and can pay.
Though the concepts of solvency and the prudent use of
resources are not sufficient to modify the essential meaning of
availability in the irregular deposit contract, one might at least
think the problem could be resolved by the calculation of
probabilities and the “law of large numbers,” to which Gar-
rigues refers. Nevertheless, as we argued above, even if it
were statistically possible to calculate probabilities in this field
(which is certainly not the case, as will be shown in the fol-
lowing chapters), the contract would at any rate cease to be a
deposit and become an aleatory contract in which the possi-
bility of obtaining the immediate repayment of the deposited
good would depend on the greater or lesser probability that a
certain number of depositors would not simultaneously go to
the same bank to withdraw their deposits.
In any case, in chapter 5 we will argue that we cannot
apply the objective calculation of probabilities to human acts in
general, and in particular to those related to the irregular
deposit. This is because the very institution of irregular
deposit with no safekeeping obligation (i.e., with a fractional
reserve), a legally paradoxical contract, triggers economic
processes leading banks to make, on a large scale, unwise
loans and investments with the deposits they appropriate or
create. This is the case because these loans and investments
are ultimately financed by credit expansion which has not
been preceded by an increase in real savings. Economic crises
inevitably result, along with a decrease in banks’ solvency and
depositors’ confidence in them, which in turn sets off a mas-
sive withdrawal of deposits. Every actuary knows that if the
consequences of an event are not completely independent of
the existence of the insurance policy itself, these consequences
are not technically insurable, due to moral hazard. In the fol-
lowing chapters we will show that the fractional-reserve
banking system (i.e., a system based on the monetary irregu-
lar deposit in which 100 percent of the tantundem is not kept in
reserve and available to depositors) endogenously, inevitably
and repeatedly generates economic recessions, making it reg-
ularly necessary to liquidate investment projects, return loans
and withdraw deposits on a massive scale. Therefore, the

Attempts to Legally Justify Fractional-Reserve Banking 151
banking system based on the irregular deposit with a frac-
tional reserve, the institution Clemente de Diego called an
“aberration” or “legal monster,” invariably and ultimately
(and this is one of the main contributions made by economic
analysis to this field of law) leads bankers to become insolvent
and unable to honor their commitment to return deposits on
demand, even if they maintain a sufficiently elevated reserve
ratio. This is precisely the reason the overwhelming majority
of private banks that did not fully comply with the safekeep-
ing obligation eventually failed. This state of affairs existed
until bankers demanded the creation of a central bank38 and
their demands were met. The central bank was to act as a
lender of last resort, ready to grant bankers all the liquidity
they needed during the recurrent stages of crisis caused by the
instability of the fractional-reserve system itself.
Hence, the redefinition of the concept of availability is a
leap into the void. First, banks continue to accept deposits as
if they were loans and accordingly invest them in private busi-
ness deals, and depositors still make deposits with the main
intention of transferring the custody and safekeeping of their
money while retaining its full availability. In other words, the
forced attempt to redefine the concept of availability has not
lessened the contradiction in legal logic. Second, from the
strict viewpoint of private law and in keeping with the teach-
ings of economic theory, the general guideline of a “prudent”
use of resources and the application of the “calculation of
probabilities” not only is not sufficient to guarantee that when
38Rothbard, The Case Against the Fed, pp. 90–106. This is how Rothbard
explains the leading role private bankers, especially J.P. Morgan, played
in the creation of the American Federal Reserve:
J.P. Morgan’s fondness for a central bank was heightened by
the memory of the fact that the bank of which his father
Junius was junior partner—the London firm of George
Peabody and Company—was saved from bankruptcy in the
Panic of 1857 by an emergency credit from the Bank of Eng-
land. The elder Morgan took over the firm upon Peabody’s
retirement, and its name changed to J.S. Morgan and Com-
pany. (p. 93 footnote 22)

152
Money, Bank Credit, and Economic Cycles
a fractional reserve is used the bank will always be able to
honor all repayment requests, but it also infallibly starts a
process which, at least every certain number of years, results
in the inevitable loss of confidence in banks and the massive
unforeseen withdrawal of deposits. Conclusive proof of all of the
above is offered by the fact that fractional-reserve banking (i.e., bank-
ing without a strict safekeeping obligation) has not been able to sur-
vive without a government-created central bank, which by imposing
legal-tender regulations and compelling the acceptance of paper
money, could produce out of nowhere the liquidity necessary in
emergencies. Only an institution in conformity with general
legal principles can survive in the marketplace without the
need of privileges and government support, but solely by
virtue of citizens’ voluntary use of its services within the
framework of general and abstract civil-law rules.
Availability has also been defined as private banks’ com-
pliance with the whole structure of government banking leg-
islation in exchange for the backing of the central bank as
lender of last resort. However, this requirement is also artifi-
cial and shifts the issue of the impossibility of legally defining
the fractional-reserve bank deposit contract from the field of
private law (where the two cannot be reconciled) to the field
of public law; that is, administrative law and pure volun-
tarism by which the authorities can legalize any institution, no mat-
ter how legally monstrous it may seem. It is an odd paradox that
the entire financial system is made to depend on the supervi-
sion of the state (which historically has been the first to bene-
fit from profits obtained through the non-fulfillment of the
safekeeping obligation in the monetary-deposit contract), and,
as F.A. Hayek wisely indicates,
The history of government management of money has . . .
been one of incessant fraud and deception. In this respect,
governments have proved far more immoral than any pri-
vate agency supplying distinct kinds of money in competi-
tion possibly could have been.39
39Hayek, The Fatal Conceit, pp. 103–04.

Attempts to Legally Justify Fractional-Reserve Banking 153
Hayek means that today’s banking structure may appear
sustainable despite its juridical inconsistency, due to the sup-
port it currently receives from the state and to an official cen-
tral-banking institution which generates the liquidity neces-
sary to bail out banks in trouble (in exchange for their
compliance with a tangled web of administrative legislation
comprising endless, cryptic and ad hoc directives and memo-
randa). Nevertheless, the violation of the traditional legal
principles governing property rights inescapably results in
negative social consequences. For instance, the return of
deposits may be thus “guaranteed” at least theoretically
(even using a fractional-reserve ratio, assuming the central
bank lends its support). However, what cannot be guaranteed is
that the purchasing power of the monetary units will not vary
greatly with respect to the original deposit. In fact, ever since
the creation of modern monetary systems, each year with
slight differences in degree, we have been plagued by serious
chronic inflation which has significantly decreased the pur-
chasing power of the monetary units returned to depositors.
We must also consider the effects of the intra- and inter-tem-
poral social discoordination inflicted on modern economies
by the current financial system, based on a fractional reserve
for private banks and the conducting of monetary policy by
the central bank. These effects consist of recurrent, successive
phases of artificial boom and economic recession involving
high unemployment rates, which do great harm to the har-
monious, stable development of our societies.
As a result, in the banking and monetary fields we again
observe the validity of Hayek’s seminal idea that whenever a
traditional rule of conduct is broken, either through direct
governmental coercion or the granting of special governmen-
tal privileges to certain people or organizations, or a combina-
tion of both (as occurs in the monetary irregular deposit with
a fractional reserve), sooner or later damaging, undesired con-
sequences follow, to the great detriment of the spontaneous
social processes of cooperation. The traditional rule of conduct
broken in banking, as we have studied in detail in these first
three chapters, is the general legal principle that in the mone-
tary irregular-deposit contract, custody and safekeeping (the
essential element or purpose of all deposits) should always

154
Money, Bank Credit, and Economic Cycles
take the form of a continuous 100-percent reserve require-
ment. Consequently, any use of this money, particularly to
make loans, entails a violation of this principle and an act of
misappropriation. Throughout history, bankers have been
quick to violate this traditional rule of conduct, making self-
interested use of their depositors’ money, as demonstrated by
various examples in chapter 2. At first the bankers did this
guiltily and in secret, since they were still aware of the wrong-
ful nature of their actions. Only later, when they obtained the
government privilege of making personal use of their deposi-
tors’ money (generally in the form of loans, which at first were
often granted to the government itself), did they gain permis-
sion to openly and legally violate the principle. The legal
orchestration of the privilege is clumsy and usually takes the
form of a simple administrative provision authorizing only
bankers to maintain a reduced reserve ratio.
This marks the beginning of a now traditional relationship
of complicity and symbiosis between governments and banks.
This relationship explains the intimate “comprehension” and
close “cooperation” which is still present today between the
two types of institutions and has almost always existed, with
slight variations, in all western countries. Bankers and author-
ities soon realized that by sacrificing traditional legal princi-
ples in the deposit they could take part in an extremely lucra-
tive financial activity, though a lender of last resort, or central
bank, was required to provide the necessary liquidity in times
of difficulty, and experience showed that sooner or later these
times always returned. However, the damaging social conse-
quences of this privilege granted only to bankers were not fully
understood until the theory of money and capital theory
made sufficient progress in economics and were able to
explain the recurrent emergence of economic cycles. The Aus-
trian School in particular has taught us that the contradictory
(from a legal-contractual as well as a technical-economic
standpoint) objective of offering a contract comprising essen-
tially incompatible elements and aimed at combining the
advantages of loans (especially the possibility of earning inter-
est on “deposits”) with those of the traditional monetary
irregular deposit (which by definition must allow the deposi-
tor to withdraw his funds at any time) is sooner or later bound

Attempts to Legally Justify Fractional-Reserve Banking 155
to cause inevitable spontaneous adjustments. At first these
adjustments manifest themselves as expansions in the money
supply (via the creation of loans which do not correspond to
an actual increase in voluntary saving), inflation, a general-
ized poor allocation of society’s scarce productive resources at
a microeconomic level, and ultimately, recession, the rectifica-
tion of errors caused in the productive structure by credit
expansion, and widespread unemployment. The next chap-
ters will be devoted to examining all these issues from the
standpoint of economic theory. Nevertheless, first we should
wrap up our legal study with the analysis of some other
juridical institutions related to bank deposits.
To conclude this section, the following table displays
seven possible ways to legally classify the bank-deposit con-
tract from the perspective of the logic inherent in the institution
(and naturally, not from the viewpoint of positive law, which
as we know, can give legal force to anything).
4
THE MONETARY IRREGULAR DEPOSIT,
TRANSACTIONS WITH A REPURCHASE AGREEMENT
AND LIFE INSURANCE CONTRACTS
In these first three chapters we have undertaken an analy-
sis of the legal nature of the irregular deposit contract, and this
analysis could serve, among other uses, as a reliable guide to
identifying (from among the rich variety of legal contracts in
the fast-changing real world) true loan contracts, irregular
deposits in which the safekeeping obligation is met and con-
tracts of a contradictory or even fraudulent nature. This is an
important guide, as human ingenuity knows no bounds when
it comes to attempting to fraudulently circumvent traditional
legal principles for one’s own benefit and to the detriment of
others.
Moreover, this danger is especially acute when legal prin-
ciples are not adequately defined nor defended by public
authorities, especially in a field, like that of finance, which is
very abstract and difficult to understand for most citizens.

156
Money, Bank Credit, and Economic Cycles
TABLE 1
SEVEN POSSIBLE LEGAL CLASSIFICATIONS OF THE
BANK-DEPOSIT CONTRACT WITH A FRACTIONAL RESERVE
1. There is deception or fraud: the crime of misappro-
priation is committed and the contract is null and
void (the historically corrupt origin of fractional-
reserve banking).
2. There is no deception, but there is an error in nego-
tio: contract null and void.
3. There is no error in negotio, but each party pursues
his typical cause in the contract: contract null and
void due to essentially incompatible causes.
4. Even if the incompatible causes are considered
compatible, the contract is null and void because
it is impossible to carry out (without a central
bank).
5. Subsidiary argument: even if the “law of large
numbers” were valid (which is not the case), the
contract would still be an aleatory contract (it
would be neither a deposit nor a loan contract).
6. The implementation of the contract depends on a
government mandate (privilege) and the support
of a central bank that nationalizes money, imposes
legal-tender regulations and creates liquidity.
7. In any case, the contract is null and void because
it does serious harm to third parties (economic
crises aggravated by the central bank), much
greater harm than that caused by a counterfeiter
of money.

Attempts to Legally Justify Fractional-Reserve Banking 157
TRANSACTIONS WITH A REPURCHASE AGREEMENT
Whenever we observe, as in the monetary deposit, that the
immediate availability of the good is offered to customers in
order to attract their funds40 and then invest their money or
employ it in private transactions, etc., we should be on our
guard, irrespective of the legal appearance of the transaction.
For example, in certain contracts with a repurchase agreement,
one of the parties commits to repurchase from the other,
whenever requested by the second party, a security, right or
financial asset at a prefixed price at least equal to that origi-
nally paid for the good. The intention in these cases, against
legal principles, is to conceal a true monetary irregular-deposit
contract, in which one of the contracting parties pursues the
essential objective of guaranteeing the immediate availability
of the good, and the other pursues the familiar, contradictory
purpose or cause of gathering monetary resources to invest
them in different business deals. In short, these are often even
fraudulent transactions, in which the professional deposit
“gatherer” tries to convince his “customers” to turn over their
available assets easily and without a heavy commitment, in
exchange for the fundamental promise that their money will
remain available to them and be returned to them whenever
they desire (via the “repurchase agreement”).
We observe a similar case when, as often happens more or
less explicitly in practice, an institution (for example, a bank)
attempts to systematically maintain or “conserve” the market
value of its stocks by carrying out a series of financial opera-
tions to indicate to the market that the sale of the stocks is
“guaranteed” at a set price. If this is true, and to the extent that
the general public believes it, we witness another transaction
in which a monetary irregular-deposit contract is ultimately
orchestrated via investment in securities, stocks or bonds
40Many “irregular” transactions are accompanied by the “guarantee” of
continuous availability to persuade the customer that there is no need to
relinquish it nor make the sacrifice required by lending. This practice
makes attracting funds much easier, especially when the customer is
naïve and can be tempted (as in any sham or swindle) with the possi-
bility of obtaining high profits with no sacrifice nor risk.

158
Money, Bank Credit, and Economic Cycles
whose liquidity on the market is implicitly “guaranteed” at all
times by a trustworthy institution.41 Therefore, it is not sur-
prising that many bank crises have arisen more from the mas-
sive sale of bank stocks than from a widespread withdrawal of
deposits. These stocks were supposed to constitute a safe
refuge for money while nearly guaranteeing its immediate
availability. When the bank’s solvency comes into question, its
securities are the first to be sold on a massive scale, rendering
the bank unable to continue honoring its implicit commitment
to maintain the market value of the stocks. At least in the past,
these massive sales have resulted from the fact that the indis-
criminate assistance supplied by central banks to private
banks in times of need has not reached the point of continual
preservation of shares’ current market price. The most recent
bank crises in Spain and other countries have demonstrated
that ultimately, the only “depositors” to lose out have been the
stockholders themselves.
There are many other “borderline” cases. For example,
some finance and holding companies, to encourage the sub-
scription of their stocks, “commit” to repurchase them at the
original price whenever requested by the shareholder. In gen-
eral, we should be suspicious of any transaction with a repur-
chase agreement in which the price of the repurchase is fixed
and is not the current price of the item on the corresponding second-
ary market.42 Hence, it falls to the jurist and the economist to
41If we carry this line of reasoning to extremes, the entire stock market
could be viewed as an orchestrator of true deposits if the state were to
at all times guarantee the creation of the liquidity necessary to maintain
stock market indexes. For reasons of public image, governments and
central banks have insisted on pursuing this objective and policy at least
occasionally, during many stock market crises.
42Another example of a simulated deposit is a temporary assignment
with an agreement of repurchase on demand. This transaction is con-
ducted as a loan from customer to bank: Collateral is offered in the form
of securities, normally national bond certificates, in case of noncompli-
ance by the depositary. The loan bears interest at an agreed-upon rate up
until a specified date and is repayable at the simple request of the
“lender” prior to that date. If he exercises this option of early cancella-
tion, the resulting amount to be paid him is calculated by compounding

Attempts to Legally Justify Fractional-Reserve Banking 159
employ their analytical judgment in the study of this eco-
nomic-financial transaction and to decide exactly what type of
operation it is, its true nature and its consequences, in light of
the legal principles examined in these first three chapters and
the economic implications we will now consider.43 Further-
more, this analysis would acquire vital importance if one day
in the future the existent financial system based on the
monopoly of a public central bank were ever completely pri-
vatized and a free-banking system subject to general legal
principles were established. In this case, the current tangled
web of administrative banking regulations would be replaced
the interest on the original amount at the agreed-upon rate up until the
date he exercises the option. For the client, this operation is identical to
a loan backed by securities, combined with an American option. An
option is an agreement conferring the right, not the obligation, to buy or
sell a certain quantity of an asset on a particular date or up until a par-
ticular date. An option to purchase is a call option, and an option to sell,
a put option. If the right granted lasts until a specified date, the option
is called an “American” option; if it refers to a particular date, a “Euro-
pean” option. The acquirer of the right compensates the other party via
the payment of a premium at the moment the contract is finalized. The
client will exercise his option only if the interest rates paid on new time
deposits maturing at the same time as his exceed the rate he originally
negotiated. He will not exercise the option if interest rates fall, even if he
needs the liquidity, because he will normally be able to take out a loan for
the remainder of the term at a lower rate of interest and provide the bond
certificates as collateral. Some institutions even offer these contracts
accompanied by the cashier services typical of checking accounts, so the
customer can issue checks and pay bills by direct debiting. Banks use this
contract as a way to speculate with securities, since the public finances
them and banks keep the profits. We are grateful to Professor Ruben
Manso for providing us with some details of this type of operation.
43Another interesting question is how to determine in practice when
time “deposits” (loans) with a very short term become true deposits.
Although the general rule is clear (the subjective intention of the parties
must prevail, and upon maturity all loans become deposits requiring a
100-percent reserve until withdrawn), for practical purposes a tempo-
rary limit is often needed (a month? a week? a day?), under which loans
granted to the bank should be regarded as actual deposits. As for the so-
called secondary medium of exchange, which are not money but can be
converted into cash very easily, meriting an additional premium for
their purchase on the market, see Mises, Human Action, pp. 464–67.

160
Money, Bank Credit, and Economic Cycles
by a few clear, simple rules included in the Civil, Commercial
and Penal Codes. The main purpose of these rules would be to
guarantee adherence to the strict safekeeping principle (100-
percent reserve requirement) regarding not only monetary
demand-deposit contracts, but also any other economic-finan-
cial transaction in which the chief goal of the participants is to
obtain custody and safekeeping for their deposits. In this (for
now) hypothetical situation, the analysis we are proposing
would greatly assist judges and jurists in making sense of the
rich, extremely complex variety of contracts and transactions
constantly emerging in the economic-financial world and
would allow them to determine when to classify these trans-
actions as null and void and/or criminal according to general
civil and penal provisions.44
At any rate, we should avoid a selfishly defeatist attitude
common in the financial sector. It is based on the belief that
human ingenuity will be capable of finding ever more sophisti-
cated means of fraudulently evading universal legal principles
and that therefore in practice they will never be obeyed and
defended. We should avoid this defeatist posture, because the
proliferation of ingenious ways to violate these principles stems
precisely from the fact that public authorities have always
defined and defended them in an extremely confusing, ambigu-
ous and contradictory manner, and as a result there is no gen-
eral awareness of the importance of respecting them. Quite the
opposite is true. The prevailing values and ideas have over time
become so corrupted that now people consider the irregular
deposit contract with a fractional reserve to be legitimate. If
general legal principles were again understood and respected,
the number of irregular behaviors would decrease significantly
(especially if public authorities really took care to preserve and
defend the corresponding property rights). At the same time,
the proven fact that human ingenuity continually searches for
44In the model we propose (and which we will consider in greater detail
in the last chapter), the control exerted in the financial sphere by the cen-
tral bank and its officials would be replaced by that of judges, who
would recover their full authority and central role in the application of
general legal principles in the financial area as well.

Attempts to Legally Justify Fractional-Reserve Banking 161
new ways to break the law and defraud others does not in the
least detract from the fundamental importance of a set of clear
principles to guide citizens and direct authorities in their duty
to define and defend property rights.
THE CASE OF LIFE INSURANCE CONTRACTS
Life insurance is a typical time-honored legal institution,
one that has been very well-formulated with respect to its
essence and legal content and well-supported by actuarial,
economic and financial practices. Nevertheless, lately some
have tried to use it to conduct transactions which are very
similar to the monetary irregular deposit with a fractional
reserve. These attempts have been very detrimental to the
development and traditional solvency of life insurance as an
institution and have involved deceiving supposed “policy-
holders-depositors.”
Indeed, above all it is important to understand that the
contract of life insurance bears no relation to the monetary
irregular-deposit contract. Life insurance is an aleatory contract
by which one of the parties, the contracting party or policy-
holder, commits to the payment of the premium or price of the
operation, and in return the other party, the insurance com-
pany, agrees to pay certain benefits in the event that the poli-
cyholder dies or survives at the end of a term specified in the
contract. Therefore, the premiums paid by the policyholder com-
pletely cease to be available to him, and availability is fully trans-
ferred to the insurer.45 Hence, all life insurance contracts
involve an exchange of present, certain goods for future, uncer-
tain goods (since their payment depends on an uncertain
45As life insurance entails disciplined saving over a period of many
years, it is much more difficult to sell than other financial products sold
with the guarantee that the customer’s money will remain continuously
available to him (deposits). For this reason life insurance is sold through
a costly network of salespeople, while the public goes willingly and
without prompting to make bank deposits. Life insurance companies
foster and encourage voluntary, long-term saving, whereas banks pro-
duce loans and deposits from nothing and require no one to make the
prior sacrifice of saving.

162
Money, Bank Credit, and Economic Cycles
event, such as the death or survival of the policyholder). The
life insurance contract is therefore equivalent to a savings
transaction (in which the ownership and availability of pres-
ent goods are relinquished in exchange for the ownership
and availability of future goods), but it is a form of perfected
savings, because it makes it possible to receive a considerable
sum from the very moment the contract takes effect, given the
anticipated, uncertain event takes place (for example, the pol-
icyholder dies). Any other traditional savings method (tradi-
tional mutuum or loan operation) would require a prolonged
period of many years of saving to accumulate the capital paid
by an insurance company in case of death. In other words, life
insurance contracts, the calculation of probabilities based on
mortality and survival tables, and the principle of mutualism
or dividing loss among all policyholders sustaining an insti-
tution make it possible from the first moment to receive, should the
anticipated event occur, a significant sum of money which, using
other methods, could only be accumulated after a period of many
years.
Moreover life insurance is a long-term contract which
incorporates complex financial and actuarial components and
requires the prudent investment of significant resources. The
availability of these resources is transferred to the mutual or
life insurance company, which must collect and invest the
mathematically-calculated reserves necessary to make the
future payments it will be obliged to make. These amounts are
called “mathematical,” because they result from the calcula-
tion of probabilities of death and survival according to mor-
tality tables, which are extremely reliable and highly constant
for most western populations. It is possible to calculate, with
as small a probability of ruin as is desired, the amount of
money necessary to pay all guaranteed benefits. Later we will
examine the radical differences which from an economic-
financial standpoint exist between life insurance and the irreg-
ular deposit contract with a fractional reserve. As opposed to
life insurance, the irregular deposit contract does not permit
the calculation of probabilities, since the institution (frac-
tional-reserve banking) does not exist completely independ-
ently of the recurrent massive withdrawal of deposits.

Attempts to Legally Justify Fractional-Reserve Banking 163
An added complexity emerges because some types of life
insurance include the right of surrender. This means policy-
holders can cancel their contract and obtain in cash the math-
ematical liquidation value of their policy. Some theorists have
defended the position that insurance policies which include
this “surrender value” are very similar to monetary irregular-
deposit contracts with fractional reserves.46 Against this view,
it is important to point out that whether or not a covert irreg-
ular deposit exists depends ultimately on the true motive,
purpose or subjective cause with which the contract is carried
out. If, as is usual with traditional life insurance policies, the
client intends to keep the policy until the end of its term and
is not aware that he can redeem the funds at any time, then the
transaction is clearly not an irregular deposit but a traditional
life insurance contract. This type of insurance is sold with the
idea that surrender is a “last resort,” a solution to be applied
only in situations of pressing need when a family is com-
pletely unable to continue making payments on a policy
which is so necessary for the peace of mind of all of its mem-
bers.47
However, we must acknowledge that (for the most part)
recently banks and other financial institutions have exerted
constant pressure to erase the fundamental, traditional dis-
tinctions and blur the boundaries between life insurance and
bank-deposit contracts.48
46Murray N. Rothbard, “Austrian Definitions of the Supply of Money,”
in New Directions in Austrian Economics, Louis M. Spadaro, ed. (Kansas
City: Sheed Andrews and McMeel, 1978), pp. 143–56, esp. pp. 150–51.
Rothbard’s position is fully justified, however, with respect to all the
new “life insurance” operations conceived to simulate deposit contracts.
47Furthermore the surrender of the insurance policy traditionally entails
a significant financial penalty for the policyholder. This penalty results
from the company’s need to amortize the high acquisition costs it incurs
during the first year of the contract. The tendency to reduce these penal-
ties is a clear indication that the operation has ceased to be a traditional
life insurance policy and has become a simulated bank deposit.
48As we will see at the end of chapter 7, from 1921 to 1938, while chair-
man of the National Mutual Life Assurance Society, a leading British life

164
Money, Bank Credit, and Economic Cycles
True monetary-deposit operations have begun to appear
on the market disguised as life insurance policies. The main
selling point presented to customers is that with these trans-
actions they need not commit to a long-term savings opera-
tion involving regular payments, since the funds handed over
to the insurance company may be recovered at any time with
no penalty and no expense whatsoever (and may even include
interest). One reason companies disguise these operations as
life insurance policies is to take advantage of the customary
tax incentives almost every government in the developed
world grants insurance companies in recognition of their ben-
eficial influence on society at all levels as promoters of volun-
tary saving and foresight, and hence on the sustained, non-
inflationary economic growth and development of the nation.
Thus, bogus “life insurance” operations have been negotiated
en masse and have really been nothing but camouflaged
deposits made effortlessly by the public, who have held the
idea that at any time their money could be recovered penalty-
free if they needed it or simply wished to place it in another
financial institution. This has generated a good deal of confu-
sion. For instance, figures corresponding to bank deposits
insurance firm, John Maynard Keynes played a key role in the corrup-
tion of traditional principles governing life insurance. During his chair-
manship, he not only promoted an “active” investment policy strongly
oriented toward variable-yield securities (abandoning the tradition of
investing in bonds), but he also defended unorthodox criteria for the
valuation of assets (at market value) and even the distribution of profits
to policyholders through bonuses financed by unrealized stock market
“earnings.” All these typical Keynesian assaults on traditional insurance
principles put his company in desperate straits when the stock market
crashed in 1929 and the Great Depression hit. As a result, Keynes’s col-
leagues on the Board of Directors began to question his strategy and
decisions. Disagreements arose between them and led to Keynes’s res-
ignation in 1938, since, as he put it, he did not think “it lies in my power
to cure the faults of the management and I am reluctant to continue to
take responsibility for them.” See John Maynard Keynes, The Collected
Writings (London: Macmillan, 1983), vol. 12, pp. 47 and 114–54. See also
Nicholas Davenport, “Keynes in the City,” in Essays on John Maynard
Keynes, Milo Keynes, ed. (Cambridge: Cambridge University Press,
1975), pp. 224–25. See also footnote 108 of chapter 7.

Attempts to Legally Justify Fractional-Reserve Banking 165
(operations completely unrelated to life insurance) have been
included in the official statistics of life insurance premiums,
and in the midst of the great confusion in the market, tradi-
tional life insurance policies have become discredited and
their definition blurred.49
Fortunately, normality is being restored, and both tradi-
tional private insurers and public authorities are beginning to
realize that nothing hurts life insurance more than blurring
the distinctions between it and bank deposits. This confusion
has been detrimental to everyone: traditional life insurance,
which has lost many of its tax incentives and faced increasing
intervention and control by the central bank and monetary
authorities; clients, who have taken out life insurance thinking
they were making bank deposits and vice versa; banks, which
on many occasions have attracted funds from true deposits
(disguised as life insurance) and tried to make long-term
investments with them, endangering their solvency; and
finally, supervising public authorities, who have gradually
lost control over the institution of life insurance, which has
become blurred in its definition and to a great extent taken
over by another institution (the central bank). Banks are a
completely separate type of institution, whose financial and
legal foundations leave much to be desired, as we are seeing.
49In short, the apparent boom in life insurance sales was an illusion,
since the figures actually corresponded to radically different operations,
i.e., fractional-reserve bank deposits. These figures completely lose their
splendor if, instead of contrasting them with traditional life insurance
sales (much more modest, since abnegation and a long-term commit-
ment to saving and foresight are required), we compare them to the total
of a country’s bank deposits, of which they make up only a small per-
centage. When only genuine life insurance sales are included in sector
statistics, the situation is put back in perspective, and the mirage every-
one (especially the government) strained to see vanishes.

4
THE CREDIT
EXPANSION PROCESS
This chapter and the following five comprise an analysis
of the economic consequences of violating the general
legal principles inherent in the irregular deposit con-
tract. We examined the legal and historical consequences of
such violations in chapters 1, 2, and 3 and will now focus on
the process by which banks create loans and deposits from
nothing and on the different implications this process has for
society. The most serious consequence of banks’ creation of
loans is the following: to the extent loans are granted without
the corresponding backing of voluntary saving, the real pro-
ductive structure is inevitably distorted and recurrent eco-
nomic crises and recessions result. We will explain the circula-
tion credit theory of the business cycle and then critically
analyze the macroeconomic theories of monetarism and Key-
nesian economics. In addition we will carry out a brief review
of the recurring economic crises which have thus far assailed
the world. The first of the two final chapters contains a theo-
retical study of central banking and free banking, and the sec-
ond consists of an examination of the proposal of a 100-per-
cent reserve requirement for banking.
1
INTRODUCTION
The economic theory of money, banking, and business cycles
is a relatively recent development in the history of economic
167

168
Money, Bank Credit, and Economic Cycles
thought. This body of economic knowledge has followed the
relevant events (the development of fractional-reserve bank-
ing and the recurring cycles of boom and recession) and cor-
responding legal formulations with great delay. As we have
seen, the study of legal principles, the analysis of their loop-
holes and contradictions, the search for and correction of their
logical defects, etc. took place much earlier in history and can
even be traced back to classical Roman legal doctrine. In any
case, in keeping with the evolutionary theory of institutions
(legal, linguistic, and economic), according to which institu-
tions emerge through a lengthy historical process and incor-
porate a huge amount of information, knowledge, and experi-
ence, the conclusions we will reach through our economic
analysis of the monetary bank-deposit contract in its current
form are hardly surprising. They largely coincide with and
support inferences the reader may have already drawn (from
a purely legal standpoint) in preceding chapters.
Our analysis of banking will be limited to the study of the
monetary deposit contract, which in practice applies to so-
called demand checking accounts, savings accounts and time
deposits, whenever the last two permit the de facto withdrawal
of the balance by the customer at any time. Hence, our study
excludes numerous activities private banks presently engage
in which are in no way related to the monetary irregular-
deposit contract. For example, modern banks offer their cus-
tomers bookkeeping and cashier services. They also buy and sell
foreign currencies, following a money-changing tradition that
dates back to the appearance of the first monetary units. In
addition, banks accept deposits of securities and on behalf of
their clients collect dividends and interest from the issuers,
informing customers of increases in owner’s equity, stock-
holders’ meetings, etc. Moreover, banks buy and sell securities
for their clients through discount houses and offer safe deposit
box services at their branches. Likewise, on many occasions
banks act as true financial intermediaries, attracting loans from
their customers (that is, when customers are aware they are
providing a loan to the bank, as holders of bonds, certificates,
or true time “deposits”) and then lending those funds to third
parties. In this way, banks derive a profit from the interest rate

The Credit Expansion Process 169
differential between the rate they receive on loans they grant
and the one they agree to pay to customers who initially give
loans to them. None of these operations constitutes a mone-
tary bank-deposit, a transaction we will examine in the fol-
lowing sections. As we will see, this contract undoubtedly
represents the most significant operation banks carry out
today and the most important from an economic and social
standpoint.
As we have already pointed out, an economic analysis of
the monetary bank-deposit contract provides one more illus-
tration of Hayek’s profound insight: whenever a universal
legal principle is violated, either through systematic state
coercion or governmental privileges or advantages conferred
on certain groups or individuals, the spontaneous process of
social interaction is inevitably and seriously obstructed. This
idea was refined in parallel with the theory of the impossibil-
ity of socialism and has spread. Whereas at one point it was
only applied to systems of so-called real socialism, it has now
also come to be associated with all parts or sectors of mixed
economies in which systematic state coercion or the “odious”
granting of privileges prevails.
Although the economic analysis of interventionism
appears to pertain more to coercive governmental measures, it
is no less relevant and illuminating with respect to those areas
in which traditional legal principles are infringed via the
granting of favors or privileges to certain pressure groups. In
modern economies there are two main areas where this
occurs. Labor legislation, which thoroughly regulates employ-
ment contracts and labor relations, is the first. Not only are
these laws the basis for coercive measures (preventing parties
from negotiating the terms of an employment contract as they
see fit), they also confer important privileges upon pressure
groups, in many ways allowing them to act on the fringes of
traditional legal principles (as unions do, for instance). The
second area in which both privileges and institutional coer-
cion are preponderant is the general field of money, banking,
and finance, which constitutes the main focus of this book.
Although both areas are very important, and thus it is urgent
that both be theoretically examined in order to introduce and

170
Money, Bank Credit, and Economic Cycles
carry through the necessary reforms, the theoretical analysis
of institutional coercion and the granting of privileges in the
labor field is clearly less complex. As a result, the awareness it
arouses has spread faster and penetrated deeper at all levels of
society. Related theories have been significantly developed
and broad social consensus has even been reached regarding
the need for reforms and the direction they should take. In
contrast, the sphere of money, bank credit and financial markets
remains a formidable challenge to theorists and a mystery to most
citizens. Social relationships in which money is directly or
indirectly involved are by far the most abstract and difficult to
understand, and as a result the related knowledge is the most
vast, complex, and elusive. For this reason, systematic coer-
cion in this area by governments and central banks is by far
the most harmful and pernicious.1 Furthermore, the insuffi-
cient formulation of monetary and banking theory adversely
affects the development of the world economy. This is evi-
denced by the fact that, despite theoretical advances and gov-
ernment efforts, modern economies have yet to be freed of
recurring booms and recessions. Only a few years ago, despite
all the sacrifices made to stabilize western economies follow-
ing the crisis of the 1970s, the financial, banking and monetary
field was invariably again plagued by the same reckless errors.
As a result, the beginning of the 1990s marked the inevitable
appearance of a new worldwide economic recession of consid-
erable severity, and the western economic world has only
1
The operation of the money and credit structure has, . . . with
language and morals, been one of the spontaneous orders
most resistant to efforts at adequate theoretical explanation,
and it remains the object of serious disagreement among spe-
cialists. . . . [S]elective processes are interfered with here more
than anywhere else: selection by evolution is prevented by
government monopolies that make competitive experimenta-
tion impossible. . . . The history of government management
of money has . . . been one of incessant fraud and deception.
In this respect, governments have proved far more immoral
than any private agency supplying distinct kinds of money in
competition possibly could have been. (Hayek, The Fatal Con-
ceit, pp. 102–04)

The Credit Expansion Process 171
recently managed to recover from it.2 And once again, more
recently (in the summer of 1997), an acute financial crisis dev-
astated the chief Asian markets, threatening to spread to the
rest of the world. A few years later (since 2001) the three main
economic areas of the world (the United States, Europe, and
Japan) have simultaneously entered into a recession.
The purpose of the economic analysis of law and legal reg-
ulations is to examine the role the latter play in the sponta-
neous processes of social interaction. Our economic analysis
of the monetary bank-deposit contract will reveal the results
of applying traditional legal principles (including a 100-per-
cent reserve requirement) to the monetary irregular-deposit
contract. At the same time, it will bring to light the damaging,
unforeseen consequences that follow from the fact that, in vio-
lation of these principles, bankers have been permitted to
make self-interested use of demand deposits. Until now these
effects have gone mainly unnoticed.
We will now see how bankers’ use of demand deposits
enables them to