Full Reserve Fallacy

There is a theory that fractional reserve banking is a fraud, allowing banks to create money "out of thin air". The theory implies that legitimate banking must be full reserve.

This theory hinges on the definition of the word "bank". In "Man, Economy, and State" Rothbard makes the above argument, but explicitly limits his definition of a bank to that of a "warehouse" for money:

When a man deposits goods at a warehouse, he is given a receipt and pays the owner of the warehouse a certain sum for the service of storage. He still retains ownership of the property; the owner of the warehouse is simply guarding it for him. When the warehouse receipt is presented, the owner is obligated to restore the good deposited. A warehouse specializing in money is known as a "bank."

Banks do offer this warehousing service, in the name of safe deposit. But banks are not so narrowly defined. They also generally offer interest-bearing accounts such as savings deposit and certificates of deposit respectively. Rothbard uses the expectation of interest to differentiate warehousing money from lending it:

Someone else's property is taken by the warehouse and used for its own money-making purposes. It is not borrowed, since no interest is paid for the use of the money.

In other words, his call for full reserve does not apply to interest-bearing accounts. However he neglects to point out that interest earned on the money represented by deposits can legitimately offset otherwise necessary account fees. Banks often offer demand deposit (checking) accounts without interest. The fact of positive yield on the account is not the demarcation between warehousing and lending. The distinction is the contractual agreement between the depositor and the bank.

Since it is convenient to transfer paper in exchange rather than carry gold, money warehouses (or banks) that build up public confidence will find that few people redeem their certificates. The banks will be particularly subject to the temptation to commit fraud and issue pseudo money certificates to circulate side by side with genuine money certificates as acceptable money-substitutes. The fact that money is a homogeneous good means that people do not care whether the money they redeem is the original money they deposited. This makes bank frauds easier to accomplish.