This article was published in the Spring 2000 issue of Formulations
formerly a publication of the Free Nation Foundation,
now published by the Libertarian Nation Foundation

A Note on Credit Institutions in a Free Nation

by Roderick T. Long





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In his article "Money, Banking, and the Gambling-Stakes Paradigm for Loan Collateral and Labor Contracts" (this issue), Roy Halliday argues that in a free nation, neither fractional-reserve banking nor the enforcement of unsecured loans would be legally permissible. I am in broad agreement with Roy’s arguments, but just want to register a couple of caveats.

First, Roy grants that fractional-reserve institutions could legitimately exist (since they represent a voluntary agreement between a service provider and its customers), but denies that such institutions should be called banks, since the term "bank" suggests a 100% reserve. I do not see that the term "bank" suggests any such thing. Institutions called "banks" have been around for centuries, engaging in both fractional-reserve and 100% reserve services. To insist that the term be restricted to the latter strikes me as unjustifiable linguistic legislation in defiance of standard usage.

It is indeed fraudulent to represent a fractional-reserve system as a 100% reserve system, but as long as an institution makes clear which of its services are which, I cannot see anything inaccurate in fractional-reserve institutions describing themselves as banks.

It follows that there is also nothing wrong with fractional-reserve currencies, so long as they are not fraudulently represented to their recipients as 100% reserve currencies. One can even pay one’s bills with lottery tickets, so long as people are willing to accept them. (After all, even 100% reserve currencies are not devoid of risk; the bank might be hit by a tornado, or what have you.)

On the issue of unsecured loans: I agree that one cannot surrender one’s right to control one’s future labor. Thus, if I borrow $1000 from Roy, but when the repayment date comes I am broke, he cannot force me to labor to repay it. But what if I do eventually become able to pay? May he then permissibly insist on repayment?

Roy’s answer is unclear. He says, "you may have an enforceable claim to the money in their possession, but you cannot force them to work to pay you back." But is Roy referring to "the money in their possession" only at the time the loan comes due, or later on as well? If he means the latter, then unsecured loans are enforceable through garnishment of wages and the like. However, he also insists that "a loan contract should specify the collateral that is at risk," which suggests that unsecured loans are not enforceable after all.

I’m not sure what position Roy means to take on this issue, but here is mine: If Roy transfers $1000 to me on condition that I pay him back in a year’s time, then if I do not do so, the condition on which the transfer depended is not met, and so the transfer is nullified; ownership of the $1000 reverts to Roy and he has the right to collect it. If I have no money then he cannot permissibly force me to work to pay off the debt, but once I do become able to pay then forcible collection becomes permissible.

There are limits to this, however. As I have argued elsewhere:

"Coercion, to be legitimate, must pass three tests: first, it must be a response to aggression on the part of someone else; second, it must be necessary in order to end or prevent that aggression; and third, it must be proportionate to the seriousness of the aggression."1

"I think a libertarian justice system would probably recognize some limitations on the right to garnish wages. Even when A has a right to recover some property in B's possession, there are limits to the harm A can inflict in exercising this right. If you swallow my diamond ring, I do not have the right to cut you open to get it out, possibly killing you or causing serious injury. If you are trespassing on my property, I do not have the right to shove you off my front lawn and onto the street at the precise moment that a truck is coming that would flatten you. I think similar considerations would limit the percentage of a poor person's wages that a wealthy creditor could legitimately claim."2

"[One’s] response to a rights-violation should not be disproportionate to the seriousness of that violation. (For example, although one has a right not to have one’s foot stepped on, one does not have the right to use deadly force in order to prevent someone from stepping on one’s foot—even if in the circumstances only deadly force would prevent the act.) The burdens imposed on the perpetrator by the restitution requirement, then, cannot be so onerous as to be out of proportion to the seriousness of the offense. For example, if a billionaire’s million-dollar vase is broken by a fellow billionaire, the second billionaire may be required to pay full restitution to the first; but if the vase is broken by an indigent laborer, a million-dollar debt constitutes a greater burden (a lifetime of debt)—a burden which, in this case, is arguably out of proportion to the seriousness of the offense—and thus the amount of damages that can be demanded of the offender is far less."3

 Hence not only has Roy no right to force me to work in order to repay him, he also has no right to seize $1000 from me once I get it, if his doing so would cause me harm disproportionate to his loss. But if such seizure would not cause disproportionate harm, it seems to me that Roy would be within his rights in seizing the debt. So unsecured loans are enforceable, at least to some extent.

However, if the enforcement of unsecured loans is to be justified by the principle of conditional transfer, this seems to set a limit on the amount of interest whose payment may be enforced, contrary to Roy’s statement that in a libertarian society "there would be no usury laws that limit the rate of interest that can be charged." Suppose Roy lends me $1000 but charges 500% interest. That is, he transfers $1000 to me now, on condition that I transfer $6000 to him a year from now. If I refuse to pay him the $6000, then the condition is nullified, and I now owe him his $1000 back, plus damages—but I do not owe him $6000.

One final point: even if unsecured loans were not enforceable, it would not follow that it could never be rational to make any such loans except to close friends one trusted. For there are other ways to secure compliance besides the use of force. Consider the Law Merchant, an early system of commercial law which, as I have pointed out elsewhere, "relied not on state-imposed penalties but on credit reports; those who refused to abide by the system's rules and decisions would have a hard time finding other merchants willing to deal with them."4  Many contracts not enforceable by law—including "usurious" ones—would still exist and thrive in a free nation. D

Notes

1 "Punishment vs. Restitution: A Formulation," Formulations, Vol I, No. 2 (Winter 1993-94)

2 "Beyond the Boss: Protection from Business in a Free Nation," Formulations, Vol. 4, No.1 (Autumn 1996)

3 "The Irrelevance of Responsibility," p.128, in Social Philosophy & Policy, Vol. 16, No.2 (Summer 1999), pp. 118-145.

4 "The Nature of Law, Part I: Law and Order without Government," Formulations, Vol. 1, No. 3 (Spring (1994); cf. William C. Wooldridge, Uncle Sam, the Monopoly Man (New Rochelle: Arlington House, 1970).
 

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