Thin Air Fallacy

There is a theory that fractional reserve banking inherently gives banks the ability to create money at no material cost. The theory does not depend on the state privilege of seigniorage. It is considered a consequence of the accounting practices of free banking. This is sometimes referred to as creating money ex nihilo or "out of thin air".

Adherents describe two competing views on money creation:

Naive View

Money is created by miners at a material cost, potentially sold to people, and eventually lent to people. This theory holds that the lender is lending only money he owns. As such the lender is operating at full reserve and cannot engage in the practice of fractional reserve, which is considered fraudulent. As an honest lender he is only able to issue promissory notes (claims) against money in his possession, preventing credit expansion and therefore general price inflation.

Practical View

Money is created by banks, at no material cost, as a consequence of fractional reserve lending. The supply of this money expands with every loan, contracting only as loans are settled. Given the implied lack of constraint on credit expansion, overall debt grows without bound, creating general price inflation.

In a free market people can perform the same operations as banks, without necessarily calling themselves banks. Therefore the distinction between these two possibilities must be based on obscuration of the supposed fraud. The theory holds that this obscuration is accomplished using an accounting trick that is not widely understood. So let us investigate the difference. Any money will suffice in this investigation of the money substitutes created in either case, including Gold or Bitcoin.