These difficulties enter into the authors’ discussion of the issue of “freedom of contract.” Their argument is straightforward.
If a bank does not represent or expressly oblige itself to hold 100 percent reserves, then fractional reserves do not violate the contractual agreement between the bank and its customer…. Outlawing voluntary contractual arrangements that permit fractional reserve-holding is thus an intervention into the market, a restriction on the freedom of contract which is an essential aspect of private property rights.
This passage reveals again Selgin and White’s already noted ultra-subjectivism. According to this view, it is voluntary agreements that make for—constitute and define—a valid contract. However, valid contracts are agreements regarding the transfer of real property; hence, the range of valid contracts is in fact first and foremost constrained by the nature of things and property (and only then by agreement). It was thus that Hoppe (p. 70) explained that
Freedom of contract does not imply that every mutually advantageous contract should be permitted…. Freedom of contract means instead that A and B should be allowed to make any contract whatsoever regarding their own properties, yet fractional reserve banking involves the making of contracts regarding the property of third parties.
Selgin and White refer to this charge somewhat misleadingly as “third-party effects” and counter it by charging Hoppe in turn with elementary confusion as regards the nature of property and property rights. They state first, that
spill-overs from others’ actions to the value of C’s property … are an inescapable free-market phenomenon and not a violation of C’s private-property rights, [whereas] physical invasions of C’s property … are of course inconsistent with the protection of C’s property rights. It should be obvious that if A and B are to be barred from any transaction that merely affects the market value of C’s possessions, without any physical aggression or threat against C or C’s rightful property, then the principles of private property, freedom of contract, and free-market competition are completely obliterated. Is B to be barred from offering to sell compact disc recordings to A, merely because doing so reduces the market value of C’s inventory of vinyl records?
Second, they state that the reduction of the purchasing power of money, which they admit must result from every issue of fiduciary media, is as such a harmless value-effect and thus “provides no justification for legally barring the bank’s action.” Hence they conclude that Hoppe’s argument is “invalid” (and incompatible with Rothbard’s theory of property).
Selgin and White’s counterargument contains two errors. First, while the major premise is correct, it is false that Hoppe is mistaken about it. Hoppe has written extensively on the theory of property rights, and is not only aware of the distinction mentioned by Selgin and White but even provides a praxeological defense of it; hence, in this regard no difference of judgment whatsoever between Rothbard and Hoppe exists.
Second, the minor premise is demonstrably false (and hence, so is the conclusion). Selgin and White claim that the fall in the purchasing power of money resulting from the issue of fiduciary media is the same sort of harmless event as a fall in the price of anything else (caused by changes in supply and/or demand). That money owners lose purchasing power as a result of fractional reserve banking, they claim, is not different from the situation in which the owners of potatoes or cars suffer a value-loss due to a larger supply of or a reduced demand for potatoes and cars.
Here again, Selgin and White conflate money (gold)—that is, property—and money substitutes (banknotes)—that is, property titles. To be sure, the issue of fiduciary media does not lead to physical damage to real property. After all, a banknote is just a piece of paper, and paper does not exert any relevant physical effect on the external world. But the same can be said also about the issue of fiduciary titles to potatoes or cars (titles backed by assets other than potatoes or cars). They, too, are merely pieces of paper, and as such have no impact on the real world. Yet there exists an important difference
between changes in a potato or car owner’s wealth position due to changes in the supply or demand for potatoes or cars on the one hand, and changes brought about by changes in the supply or demand for titles to nonexisting (unchanged) quantities of potatoes or cars on the other hand. Surely, the owners of potatoes or cars are affected differently in both cases. In the first case, if the price of potatoes or cars falls due to a larger potato or car supply, all current potato or car owners remain (unchangingly) in possession of the same quantity of property (potatoes or cars). No one’s physical property is diminished. Likewise, if the price falls because potato or car buyers are willing to offer only lesser quantities of other goods in exchange for potatoes or cars, this by itself has no effect on any current potato or car owner’s physical quantity of potatoes or cars. In distinct contrast in the second case, the issue and sale of an additional title to an unchanged quantity of potatoes or cars does lead to a quantitative diminution of some current potato or car owner’s physical property. It does not merely have a value-effect: the purchasing power of potato or car titles will fall. It does have a physical effect: the issuer and seller of fiduciary potato or car titles misappropriates other people’s potatoes or cars. He appropriates other people’s property without relinquishing any property of his own (in exchange for an empty property title).