One area of disagreement within Austrian Economics is on the subject of the proper role of banks. Specifically, many Austrians disagree on whether or not banks should be required to maintain full reserves on savings. This divergence goes back to Mises (a defender of free banking) and Rothbard (a proponent of full reserve banking). It is important to recognize that both positions are very different from, and preferable to, the status quo. However, I believe free banking is both the most economically beneficial position, and the position that stands on free market principles.
I will attempt to simplify the issue:
Assume there exists an island on which only two people, Fred and George, make up the population. Fred spends his time picking apples, while George spends his time on bananas. Both depend entirely upon the consumption of apples or bananas for survival. Trade exists between apples and bananas, so it is possible for both Fred and George to consume a combination of apples and bananas, instead of relying completely on one or the other.
One day, Fred decides to leave some of his apples with George, in exchange for protection of his apple supplies while Fred goes out picking for more apples. George decides to consume the apples in order to maintain the energy levels for one day's banana picking.
Clearly, George expects to receive a higher value in banana picking for the day than the value he consumed in apples. If this were not the case, George would have not touched Fred's stock of apples. (This is assuming that George receives utility from Fred's "banking" with him. George wants Fred to continue to leave his apples with him in the future, so that he may use the apple resources to generate more bananas.) So, George wants Fred's initially banked value to be returned to him when he demands it. George is able to meet Fred's demands because his apple resources were used to generate an equal or higher value in bananas (if things go as expected).
This is precisely what is going on in a free market, fractional reserve banking system, except rather than using banked funds themselves, banks loan out the funds for others to use on investments. There is no false credit expansion as we have currency debasement. The credit expansion is real because the loanable funds are true sources of wealth that are being used to generate returns on investments. Thus, I reject the Rothbardian case for full-reserve banking as a means to prevent a Misesian boom-bust cycle.
There is an objection that may be raised. What if things do not go as expected in the world of Fred and George? What if George uses Fred's apples but fails to gain the necessary return on investment? Fred would not be able to collect his full demand.
This is certainly a concern, but hardly one that is not inherent to a market economy. Suppose instead Fred had invested his apples in George's firm, Bananas Inc. There is clearly a possibility that Bananas Inc. will fail and Fred's initial investment will not be returned. Fred implicitly accepted that risk when he invested the money.
The same is true for Fred, or any person, who puts their money in a bank. There is a natural risk (albeit small) that the banked money will not be returned in full. Fred was compensated for this risk by the security George provided in watching over his stock of apples. In our world, bank savers are compensated in a similar manner.
I seriously doubt any Austrian economist would demand an S&P 500 company maintain full reserves on money invested by a stockholder. When a company uses the unused resources of savers to invest in current and future production, we see it as the eloquent functioning of the market. But when this same activity is organized through a banking system, it is called credit manipulation or fraud.
