Are "normal" businesses 100% reserved?

When discussing the "fraudulent" nature of fractional-reserve banking, the crux of the issues seems to be how the law distinguishes between banks and other businesses. I think all sides accept that accounting requirements are different for banks than for other businesses, however accounting principles are different for different types of business. I simply don't have enough knowledge of auditing law to pass judgment on whether banks are treated differently because of legal privilege, or simply because they have unique attributes that auditors attempt to interpret accounting law in light of. (Note: and neither do the auditors I have asked about this!)

The argument against fractional reserves relies on the assertion that "normal" businesses are unable to operate in the same way as banks, and are forced to maintain "100% reserves" at all times. Here is an example that I'd be interested in feedback on. Consider the following bet:

"The FTSE 100 will rise by 5% or more within the next week"

I am willing to bet £1,000 that it *will*, and you are willing to bet £1,000 that it will *not*

1. From a legal point of view, based on current UK law - have I committed fraud?
2. From a free market perspective - have I done anything wrong?

Is it possible to answer those questions from the information given? If so, how do your answers to those questions change based on the following information:

Scenario A: When we make the bet I do not have £1,000 in cash available and have no hope of having £1,000 in cash at any point in the near future. I win the bet though, so this isn't revealed

Scenario B: When we make the bet I do not have £1,000 in cash available and have no hope of having £1,000 in cash at any point in the near future. I lose the bet. I can't pay you

Scenario C: When we make the bet I do not have £1,000 in cash available, however my salary is due to enter my account before the end of the week, which would mean that I do have the cash available. I also have lots of highly liquid assets that I could liquidate should I need to. I am able to convince a reasonable person that should I lose the bet, I would be able to pay out.

Scenario D: When we make the bet I have £100,000 in cash available, and have £1,000 set aside in an enveloped with your name on it, just in case I lose

Which of the above scenarios would make you answer "yes" to either question 1 or 2? It strikes me that A and B do, and D does not. So the real issue is scenario C. If you told me that scenario C is illegal I'd be very surprised - how often do you make an agreement to make a future payment and have the finances available throughout? If C is illegal this suggests that if I bet £1m at odds of 150-1 that Everton will win the Premier League, the bookies is required by law to increase their cash reserves by £151,000,000 today and to maintain this for the duration of the season. Do they?

Here's how I think the analogy ties into the fractional reserve debate:

1. You and I have a £1 bet on whether the FTSE 100 will rise by more than 1% by 1pm
2. I lose the bet, and don't have £1 on me. So I write you an IOU that says "I promise to pay the bearer of this note £1" and you are willing to accept it
3. You go to a cafeteria, and ask to use the IOU to pay for your cup of coffee. The barista agrees to accept it as payment
4. The following day the barista comes to me and wants to redeem the IOU. I now have £1 and give it to him
5. Seeing how the barista is happy to accept this, I issue 100 similar notes. People voluntarily accept them
6. Since I don't want to have to keep £100 cash on me, I put a small caveat on the note saying that I reserve the right to not pay out, but will pay an interest rate for any day that I don't

Which of those events (1-5) are illegal? Which should be illegal?

Cross posted at The Cobden Centre

Comments

[Boonton]

Actually I'm not sure any of them are illegal. Let's air out a few points:

1. I know the UK loves gambling but the game you describe is not a 'normal business'.

2. No business is required to operate on '100% reserves'. In the transactions you describe, there are varying amounts of credit risk. In case A the other person in the bet is bearing all the credit risk. In case D the other guy is bearing no credit risk. You're going to find 'normal businesses' operating in cases A and D and everything inbetween. Consider a vendor that sells a shipment of goods to a retail store on credit. That is like case A where the supplier is trusting the store to make good. In contrast consider the vending machine. You have to put your money in before anything will come out. That's like case D.

But, of course, there's two sides. Consider if the shipment of goods is defective. The retail store bears little risk in case A since they can refuse to pay. In case D, though, what if the vending maching gives you spoiled candy or no candy at all? You're bearing all the risk!

[Boonton]

AS for which of your examples should be illegal, I don't see anything wrong with any of them. If the barista is willing to accept your IOU's or your non-convertable 'money' what law is there against it?

[Current]

I wrote another post about this on the Cobden centre blog. I mostly agree with what Boonton has said above (for once). The critical part is what is being claimed when a transaction takes place.

Let's take scenario A.
"Scenario A: When we make the bet I do not have £1,000 in cash available and have no hope of having £1,000 in cash at any point in the near future. I win the bet though, so this isn't revealed"

As I understand it this is only fraud if you haven't made it clear to the other party that you don't have the money available. If you mislead the other party into thinking that you do then it's fraud.

The main point of contention in the last example is the language of the banknote contract, the words "promise to pay the bearer on demand". According to Rothbardians that can only be considered a bailment contract. So, to a Rothbardian the fraud comes about when you give that document to someone (the barista) without having specie to back it up. Normal legal theory though considers these words to signify a debt contract. I think lawyers have been more reasonable than Rothbardians here. However, it would do no harm to tidy up the law by requiring note issuers to explain in extremely specific wording that a note or current account is credit.

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