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2. Deposit Banking and Embezzlement

Gold coin and bullion—money—provides an even greater temptation for embezzlement to the deposit

banker than grain to the warehouseman. Gold coin and bullion are fully as fungible as wheat; the gold

depositor, too, unless he is a collector or numismatist, doesn’t care about receiving the identical gold coins he

once deposited, so long as they are of the same mark and weight. But the temptation is even greater in the

case of [p. 92] money, for while people do use up wheat from time to time, and transform it into flour and

bread, gold as money does not have to be used at all. It is only employed in exchange and, so long as the

bank continues its reputation for integrity, its warehouse receipts can function very well as a surrogate for gold

itself. So that if there are few banks in the society and banks maintain a high reputation for integrity, there need

be little redemption at all. The confident banker can then estimate that a smaller part of his receipts will be

redeemed next year, say 15%, while fake warehouse receipts for the other 85% can be printed and loaned out

without much fear of discovery or retribution.

The English goldsmiths discovered and fell prey to this temptation in a very short time, in fact by the

end of the Civil War. So eager were they to make profits in this basically fraudulent enterprise, that they even

offered to pay interest to depositors so that they could then “lend out” the money. The “lending out,” however,

was duplicitous, since the depositors, possessing their warehouse receipts, were under the impression that their

money was safe in the goldsmiths’ vaults, and so exchanged them as equivalent to gold. Thus, gold in the

goldsmiths’ vaults was covered by two or more receipts. A genuine receipt originated in an actual deposit of gold stored in the vaults, while counterfeit ones, masquerading as genuine receipts, had been printed and

loaned out by goldsmiths and were now floating around the country as surrogates for the same ounces of


The same process of defrauding took place in one of the earliest instances of deposit banking: ancient

China. Deposit banking began in the eighth century, when shops accepted valuables and received a fee for

safekeeping. After a while, the deposit receipts of these shops began to circulate as money. Finally, after two

centuries, the shops began to issue and hand out more printed receipts than they had on deposit; they had

caught onto the deposit banking scam.5 Venice, from the fourteenth to the [p. 93] sixteenth centuries, struggled

with the same kind of bank fraud.

Why, then, were the banks and goldsmiths not cracked down on as defrauders and embezzlers?

Because deposit banking law was in even worse shape than overall warehouse law and moved in the opposite

direction to declare money deposits not a bailment but a debt.

Thus, in England, the goldsmiths, and the deposit banks which developed subsequently, boldly printed

counterfeit warehouse receipts, confident that the law would not deal harshly with them. Oddly enough, no one

tested the matter in the courts during the late seventeenth or eighteenth centuries. The first fateful case was

decided in 1811, in Carr v. Carr. The court had to decide whether the term “debts” mentioned in a will

included a cash balance in a bank deposit account. Unfortunately, Master of the Rolls Sir William Grant ruled

that it did. Grant maintained that since the money had been paid generally into the bank, and was not

earmarked in a sealed bag, it had become a loan rather than a bailment.6 Five years later, in the key follow-up

case of Devaynes v. Noble, one of the counsel argued, correctly, that “a banker is rather a bailee of his

customer’s funds than his debtor, . . . because the money in . . . [his] hands is rather a deposit than a debt, and

may therefore be instantly demanded and taken up.” But the same Judge Grant again insisted—in contrast to

what would be happening later in grain warehouse law—that “money paid into a banker’s becomes

immediately a part of his general assets; and he is merely a debtor for the amount.”7

The classic case occurred in 1848 in the House of Lords, in Foley v. Hill and Others. Asserting that

the bank customer is only its creditor, “with a superadded obligation arising out of the custom (sic?) of the

bankers to honour the customer’s cheques,” Lord Cottenham made his decision, lucidly if incorrectly and even

disastrously: [p. 94]

Money, when paid into a bank, ceases altogether to be the money of the principal; it is

then the money of the banker, who is bound to an equivalent by paying a similar sum

to that deposited with him when he is asked for it . . . . The money placed in the

custody of a banker is, to all intents and purposes, the money of the banker, to do with

it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable

to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he

is not bound to keep it or deal with it as the property of his principal; but he is, of

course, answerable for the mount, because he has contracted . . . .8

Thus, the banks, in this astonishing decision, were given carte blanche. Despite the fact that the

money, as Lord Cottenham conceded, was “placed in the custody of the banker,” he can do virtually anything

with it, and if he cannot meet his contractual obligations he is only a legitimate insolvent instead of an embezzler and a thief who has been caught red-handed. To Foley and the previous decisions must be ascribed the major

share of the blame for our fraudulent system of fractional reserve banking and for the disastrous inflations of

the past two centuries.

Even though American banking law has been built squarely on the Foley concept, there are intriguing

anomalies and inconsistencies. While the courts have insisted that the bank deposit is only a debt contract, they

still try to meld in something more. And the courts remain in a state of confusion about whether or not a

deposit—the “placing of money in a bank for safekeeping”—constitutes an investment (the “placing of money

in some form of property for income or profit”). For if it is purely safekeeping and not investment, then the

courts might one day be forced to concede, after all, that a bank deposit is a bailment; but if an investment,

then how do safekeeping and redemption on demand fit into the picture?9

Furthermore, if only special bank deposits where the identical object must be returned (e.g. in one’s

safe-deposit box) are to be considered bailments, and general bank deposits are debt, [p. 95] then why

doesn’t the same reasoning apply to other fungible, general deposits such as wheat? Why aren’t wheat

warehouse receipts only a debt? Why is this inconsistent law, as the law concedes, “peculiar to the banking

business”?10, 11