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

Attempts to Legally Justify Fractional-Reserve Banking 159employ their analytical judgment in the study of this economic-financialtransaction and to decide exactly what type ofoperation it is, its true nature and its consequences, in light ofthe legal principles examined in these first three chapters andthe economic implications we will now consider. 43 Furthermore,this analysis would acquire vital importance if one dayin the future the existent financial system based on themonopoly of a public central bank were ever completely privatizedand a free-banking system subject to general legalprinciples were established. In this case, the current tangledweb of administrative banking regulations would be replacedthe interest on the original amount at the agreed-upon rate up until thedate he exercises the option. For the client, this operation is identical toa loan backed by securities, combined with an American option. Anoption is an agreement conferring the right, not the obligation, to buy orsell a certain quantity of an asset on a particular date or up until a particulardate. An option to purchase is a call option, and an option to sell,a put option. If the right granted lasts until a specified date, the optionis called an “American” option; if it refers to a particular date, a “European”option. The acquirer of the right compensates the other party viathe payment of a premium at the moment the contract is finalized. Theclient will exercise his option only if the interest rates paid on new timedeposits maturing at the same time as his exceed the rate he originallynegotiated. He will not exercise the option if interest rates fall, even if heneeds the liquidity, because he will normally be able to take out a loan forthe remainder of the term at a lower rate of interest and provide the bondcertificates as collateral. Some institutions even offer these contractsaccompanied by the cashier services typical of checking accounts, so thecustomer can issue checks and pay bills by direct debiting. Banks use thiscontract as a way to speculate with securities, since the public financesthem and banks keep the profits. We are grateful to Professor RubenManso for providing us with some details of this type of operation.43 Another interesting question is how to determine in practice whentime “deposits” (loans) with a very short term become true deposits.Although the general rule is clear (the subjective intention of the partiesmust prevail, and upon maturity all loans become deposits requiring a100-percent reserve until withdrawn), for practical purposes a temporarylimit is often needed (a month? a week? a day?), under which loansgranted to the bank should be regarded as actual deposits. As for the socalledsecondary medium of exchange, which are not money but can beconverted into cash very easily, meriting an additional premium fortheir purchase on the market, see Mises, Human Action, pp. 464–67.