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

Historical Violations of the Legal PrinciplesGoverning the Monetary Irregular-Deposit Contract 109by the bank, and an attempt was made to limit advances andloans to the government. 118 This was the dawn of the modernbanking system, based on a fractional-reserve ratio and a centralbank as lender of last resort. In chapter 8 we will analyzein detail the reasons central banks were created, their role andtheoretical incapability of fulfilling it, as well as the centralbanking vs. free banking controversy and its influence on thedifferent theories of money, banking and economic cycles. Thecurrent chapter would not be complete, however, without abrief reference to the development of banking and papermoney in eighteenth-century France.JOHN LAW AND EIGHTEENTH-CENTURY BANKING IN FRANCEThe history of money and banking in eighteenth-centuryFrance is closely linked to the Scottish financier John Law andthe “system” he concocted and put into practice there. Lawpersuaded the French regent, Philippe d’Orleans, that theideal bank was one that made use of the deposits it received,since this increased the amount of money in circulation and“stimulated” economic growth. Law’s system, like economic118 From this point on many theorists, especially in the United States,proclaimed the great threat posed to individual liberty by an implicit orexplicit alliance between bankers and governments. This type of pactwas expressed through the continual, systematic granting of privilegesto allow banks to violate their legal commitments by suspending thecash repayment of deposits. For example, John Taylor, an American senatorfrom the second half of the eighteenth century, classified this practiceas true fraud, stating that “under our mild policy the banks’ crimes maypossibly be numbered, but no figures can record their punishments,because they are never punished.” See John Taylor, Construction Construedand Constitutions Vindicated (Richmond, Va.: Shepherd and Polland, 1820;New York: Da Capa Press, 1970), pp. 182–83. Another very interestingpiece on this topic is James P. Philbin’s article entitled “An Austrian Perspectiveon Some Leading Jacksonian Monetary Theorists,” published inJournal of Libertarian Studies 10, no. 1 (Fall, 1991): 83–95, esp. 89. Murray N.Rothbard wrote a good summary of the emergence of fractional-reservebanking in the early United States: “Inflation and the Creation of PaperMoney,” chapter 26 of Conceived in Liberty, vol. 2: “Salutary Neglect”: TheAmerican Colonies in the First Half of the 18th Century (New York: ArlingtonHouse, 1975), pp. 123–40; 2nd ed. (Auburn, Ala.: Ludwig von Mises Institute,1999).