Money, Bank Credit, and Economic Cycles - The Ludwig von Mises ...

Historical Violations of the Legal PrinciplesGoverning the Monetary Irregular-Deposit Contract 69deposits, often, in fact, to rulers. This gave rise to fractionalreservebanking and artificial credit expansion, which in thefirst stage appeared to spur strong economic growth. Thewhole process ended in a general economic crisis and the failureof banks that could not return deposits on demand oncethe recession hit and they had lost the trust of the public.Whenever loans were systematically made from demanddeposits, the historical constant in banking appears to havebeen eventual failure. 51 Furthermore, bank failures wereaccompanied by a strong contraction in the money supply(specifically, a shortage of loans and deposits) and by theresulting inevitable economic recession. As we will see in thefollowing chapters, it took economic scholars nearly five centuriesto understand the theoretical causes of all of theseprocesses. 5251 For example, Raymond Bogaert mentions that of the 163 known banksin Venice, documentary evidence exists to show that at least 93 of themfailed. Bogaert, Banques et banquiers dans les cités grecques, note 513, p.392. A detailed list of 46 failures of deposit banks in Venice can also beseen in Mueller, The Venetian Money Market, pp. 585–86. This same fateof failures affected all banks in Seville in the 15th century. Hence, thesystematic failure of fractional-reserve private banks not supported bya central bank (or equivalent) is a fact of history. Pascal Salin overlooksthis fact in his article “In Defense of Fractional Monetary Reserves,” presentedat the Austrian Scholars Conference, March 30–31, 2001.52 As is logical, bankers always carried out their violations of generallegal principles and their misappropriations of money on demanddeposit in a secretive, disgraceful way. Indeed, they were fully aware ofthe wrongful nature of their actions and furthermore, knew that if theirclients found out about their activities they would immediately loseconfidence in the bank and it would surely fail. This explains the excessivesecrecy traditionally present in banking. Together with the confusing,abstract nature of financial transactions, this lack of opennesslargely protects bankers from public accountability even today. It alsokeeps most of the public in the dark as to the actual nature of banks.While they are usually presented as true financial intermediaries, itwould be more accurate to see banks as mere creators of loans anddeposits which come out of nowhere and have an expansionary effecton the economy. The disgraceful, and therefore secretive, nature of thesebanking practices was skillfully revealed by Knut Wicksell in the followingwords: