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

74 Money, Bank Credit, and Economic Cyclesunbacked by growth in real savings, the reversal of theprocess was inevitable, as chapters 4 and following willexplain in detail. This is exactly what happened in Italy’s largebusiness centers in the second half of the fifteenth century. Interms of economic analysis, Raymond de Roover’s grasp ofthe historical process is unfortunately even shallower thanCipolla’s, and he even goes so far as to state, “what causedthese general crises remains a mystery.” 61 However, it is notsurprising that the Medici Bank eventually failed, as did theother banks that depended on fractional-reserve banking for alarge part of their business. Though Raymond de Rooverclaims he does not understand what caused the general crisisat the end of the fifteenth century, his blow-by-blow historicalaccount of the final stage of the Medici Bank reflects all of thetypical indications of an inescapable recession and creditsqueeze following a process of great artificial credit expansion.De Roover explains that the Medicis were forced toadopt a policy of credit restriction. They demanded the repaymentof loans and attempted to increase the bank’s liquidity.Moreover, it has been demonstrated that in its final stage theMedici Bank was operating with a very low reserve ratio,which even dropped below 10 percent of total assets and wastherefore inadequate to meet the bank’s obligations during therecession period. 62 The Medici Bank eventually failed and all61 Ibid., p. 239.62 Hence, over the bank’s lifespan, its owners gradually increased theirviolations of the traditional legal principle requiring them to maintainpossession of 100 percent of demand deposits, and their reserve ratiocontinuously decreased:A perusal of the extant balance sheets reveals another significantfact: the Medici Bank operated with tenuous cashreserves which were usually well below 10 percent of totalassets. It is true that this is a common feature in the financialstatements of medieval merchant-bankers, such as FrancescoDatini and the Borromei of Milan. The extent to which theymade use of money substitutes is always a surprise to modernhistorians. Nevertheless, one may raise the questionwhether cash reserves were adequate and whether the MediciBank was not suffering from lack of liquidity. (Ibid., p. 371)