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

The Credit Expansion Process 177intermediary—Bank A—; seven, in the course of its activities,Business Z brought in a profit enabling it to make the interestpayment of 150,000 m.u. (these 150,000 m.u. do not representany money creation, but are simply obtained by Business Z asthe result of its sales and purchases); eight, at the end of oneyear, Business Z returned 1,000,000 m.u. to Bank A, and BankA paid the same amount back to the original lender, alongwith 100,000 m.u. in interest; nine, as a result, Bank A obtainedan entrepreneurial profit of 50,000 m.u. (the differencebetween the interest it paid the original lender and the interestit received from Business Z), a sheer entrepreneurial profitresulting from its legitimate business activity as intermediary.As is logical, Bank A could have been mistaken in itschoice of Business Z. It could have miscalculated the riskinvolved, or the ability of Business Z to return the loan andpay the interest. Therefore, the success of the bank’s activity inthis case depends not only upon its bringing the operationwith Business Z to a successful conclusion, but also on its ownobligation (to return to the original lender 1,000,000 m.u. plus10-percent interest) falling due after Business Z repays the loanto the bank, along with 15-percent interest. In this way thebank can maintain its solvency and avoid any unfortunateincidents. Nevertheless, like any other business, banks aresubject to possible entrepreneurial error. For example, BusinessZ could be unable to return on time the amount it owesthe bank, or it could even suspend payments or go bankrupt,which would render Bank A insolvent as well, since it wouldbe unable to in turn pay back the loan it received from theoriginal lender. However, this risk is no different from thatinherent in any other business activity and can be easilyreduced through the use of prudence and deliberation by thebank in its business activities. Moreover, for the length of theoperation (throughout the year), the bank remains fully solventand faces no liquidity problems, since it has no obligationto make any cash payments for as long as its loan contract with theoriginal lender remains in force. 55 Murray N. Rothbard, in reference to banks’ role as true intermediariesbetween original lenders and final borrowers, states: