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

The Credit Expansion Process 187Nevertheless the form of the money varies: Borrower Z possessesit in a different form from Mr. X, who made the deposit.Indeed, Z has available to him 900,000 physical monetary units(which we could call commodity money or, nowadays, papermoney or fiat money), while Depositor X has a checking accountcontaining a deposit of 1,000,000 m.u. Considering the bank haskept 100,000 m.u. in its vault as a security reserve or reserveratio, the difference between 1,900,000 m.u. and the 1,000,000m.u. existing in physical form is equal to the amount of moneythe bank created from nothing. (A total money supply of1,900,000 m.u. minus 900,000 physical m.u. in Z’s possessionand 100,000 physical m.u. in the bank’s vault equals 900,000m.u. which do not physically exist anywhere.) As this moneylacks the corresponding backing and exists due to the confidenceDepositor X has in Bank A, it is called fiduciary money (or,better, fiduciary media). It is important to emphasize that to allintents and purposes demand deposits are like physical units;that is, they are perfect money substitutes. The depositor can usethem to make payments at any time by issuing a check onwhich he writes the sum he wishes to pay and giving instructionsto the bank to make the payment. The portion of theseperfect money substitutes, or demand deposits, which is notfully backed by physical monetary units in the bank’s vault(the 900,000 m.u. not backed by reserves in the present example)is called fiduciary media. 10Demand deposits backed by cash reserves at the bank(100,000 m.u. in our example) are also called primary deposits,while the portion of demand deposits not backed by the10 “If the money reserve kept by the debtor against the money-substitutesissued is less than the total amount of such substitutes, we call thatamount of substitutes which exceeds the reserve fiduciary media.” Mises,Human Action, p. 430. Mises clarifies that it is not generally possible todeclare whether a particular money substitute is or is not a fiduciarymedium. When we write a check, we do not know (because the bankdoes not directly inform us) what portion of the check’s sum is backedby physical monetary units. As a result, from an economic standpoint,we do not know what portion of the money we are paying is a fiduciarymedium and what portion corresponds to physical monetary units.