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

Attempts to Legally Justify Fractional-Reserve Banking 151banking system based on the irregular deposit with a fractionalreserve, the institution Clemente de Diego called an“aberration” or “legal monster,” invariably and ultimately(and this is one of the main contributions made by economicanalysis to this field of law) leads bankers to become insolventand unable to honor their commitment to return deposits ondemand, even if they maintain a sufficiently elevated reserveratio. This is precisely the reason the overwhelming majorityof private banks that did not fully comply with the safekeepingobligation eventually failed. This state of affairs existeduntil bankers demanded the creation of a central bank 38 andtheir demands were met. The central bank was to act as alender of last resort, ready to grant bankers all the liquiditythey needed during the recurrent stages of crisis caused by theinstability of the fractional-reserve system itself.Hence, the redefinition of the concept of availability is aleap into the void. First, banks continue to accept deposits asif they were loans and accordingly invest them in private businessdeals, and depositors still make deposits with the mainintention of transferring the custody and safekeeping of theirmoney while retaining its full availability. In other words, theforced attempt to redefine the concept of availability has notlessened the contradiction in legal logic. Second, from thestrict viewpoint of private law and in keeping with the teachingsof economic theory, the general guideline of a “prudent”use of resources and the application of the “calculation ofprobabilities” not only is not sufficient to guarantee that when38 Rothbard, The Case Against the Fed, pp. 90–106. This is how Rothbardexplains the leading role private bankers, especially J.P. Morgan, playedin the creation of the American Federal Reserve:J.P. Morgan’s fondness for a central bank was heightened bythe memory of the fact that the bank of which his fatherJunius was junior partner—the London firm of GeorgePeabody and Company—was saved from bankruptcy in thePanic of 1857 by an emergency credit from the Bank of England.The elder Morgan took over the firm upon Peabody’sretirement, and its name changed to J.S. Morgan and Company.(p. 93 footnote 22)