This article was originally published by The Ludwig von Mises Institute of Canada on April 18, 2017
Every year, airlines deny thousands of passengers seats on flights due to overbooking. Airlines use sophisticated modeling to manage overbooking to maximize profits given the reality of passenger no- shows. Legally permissible under their “contract of carriage” with passengers, fewer than one-tenth of one percent of all passengers lose seats due to overbooking. 1 But when Dr. David Dao was violently removed from a United Airlines flight in Chicago, it did far more than generate a public relations nightmare; it exposed the absurdity of fractional reserve banking.
If an airline had 100 seats and overbooked by 10, then 91% of their seats are “reserved”. U.S. banks need only retain an effective 10% of demand deposits on hand for withdrawals while Canadian banks have no reserve requirement. Baring general capital requirements, the remainder can and is typically lent to borrowers. If an airline used 10% fractional reserve seating, the number of stranded passengers would approach 900 for a 100-seat airplane. The refugee-like look of an airline gate under such a situation would be no different than the typical bank run during the Great Depression.
Unfortunately, just as passengers lack legal recourse when denied seats, demand depositors cannot seek redress when their withdrawals are refused. As Murray Rothbard detailed in The Case Against the Fed and his other books on the history of banking, it was unfortunate 19th-century case law ceased recognizing a deposit as a bailment (the custody of another’s possessions). As Rothbard opined, the legal cover given fractional reserve banking cannot mask the fraudulent nature of lending against demand deposits. And no “contract” between a depositor and a bank can legitimize fractional reserve banking, just as naming something a “square circle” cannot create such a shape.
Even people versed in Austrian economics fail to understand the nature of fractional reserve banking. In an August 17, 2014 Forbes article entitled The Closing of the Austrian School’s Economic Mind, columnist John Tamny wrote:
“This alleged “multiplication” of money all sounds so frightening at first glance, but for those who think there might be some truth to the “money multiplier,” DO try it at home among friends. Hand the first friend $1,000, and let him lend $900 to the person next to him, followed by an $810 loan to the next tablemate. What those who try it will find is that far from creating $2,710 worth of access to the economy’s resources, there will still be only $1,000; the original holder of $1,000 with $100 in his possession, $90 in the second person’s hands, followed by $810 in the third.”2
And yet this illustration proves the opposite of Tamny’s conclusion, for the money supply is not just the physical dollars on the table. If the arrangements between the participants allow for withdrawals on demand, then each person would assume their cash balances equaled their cash on hand as well as their “demand deposit” with the next person. The money supply would absolutely equal $2,710 with only $1,000 in physical currency.
Although few understand fractional reserve banking, even fewer appreciate its repercussion. So while Dr. Dao could passively resist fractional reserve airline seats, none of us can escape the business cycles and price inflation caused by fractional reserve banking.
About the Author: Christopher P. Casey, CFA®, is a Managing Director with WindRock Wealth Management. Mr. Casey advises clients on their investment portfolios in today’s world of significant economic and financial intervention. He can be reached at 312-650-9602 or chris.casey@windrockwealth.com.
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Endnotes:
1Ben-Achour, Sabri. “Why in the world do airlines overbook tickets?” Marketplace. 27 April 2015. https://www.marketplace.org/2015/04/27/business/ive- always-wondered/why-world-do-airlines-overbook-tickets.
2 Tamny, Joh. “The Closing of the Austrian School’s Economic Mind” Forbes. 17 August 2014. https://www.forbes.com/sites/johntamny/2014/08/17/the- closing-of-the-austrian-schools-economic- mind/#36b63f455147
