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

The Credit Expansion Process 199The main advantage of the Anglo-Saxon accounting systemis that it demonstrates, as Herbert J. Davenport pointedout in 1913, that banks “do not lend their deposits, but rather,by their own extensions of credit, create the deposits.” 19 Inother words, banks do not act as financial intermediaries whenthey loan money from demand deposits, since this activitydoes not constitute mediation between lenders and borrowers.Pedraja García’s book, Contabilidad y análisis de balances de la banca, vol. 1:Principios generales y contabilización de operaciones (Madrid: Centro de Formacióndel Banco de España, 1992), esp. pp. 116–209.19 Herbert J. Davenport, The Economics of Enterprise (New York: AugustusM. Kelley, [1913] 1968), p. 263. Fourteen years later, W.F. Crickexpressed the same idea in his article, “The Genesis of Bank Deposits,”Economica (June 1927): 191–202. Most of the public and even some scholarsas distinguished as Joaquín Garrigues fail to understand that banksare mainly creators of loans and deposits, rather than mediatorsbetween lenders and borrowers. In his book Contratos bancarios (pp.31–32 and 355), Garrigues continues to insist that banks are primarilycredit mediators that “loan money which has been lent to them” (p. 355)and also that bankersloan what they are lent. They are credit mediators, businessmenwho mediate between those who need money for businessdeals and those who wish to invest their money profitably.Banks, however, may engage in two different types ofactivities: they may act as mere mediators who bring togethercontracting parties (direct credit mediation) or they may carryout a double operation consisting of borrowing money inorder to later lend it (indirect credit mediation). (p. 32)Garrigues clearly does not realize that, with respect to banks’ mostimportant enterprise (accepting deposits while maintaining a fractionalreserve), banks actually grant loans from nothing and back them withdeposits they also create from nothing. Therefore, rather than creditmediators, they are ex nihilo creators of credit. Garrigues also subscribesto the popular misconception that “from an economic standpoint,” thebank’s profit consists of “the difference between the amount of interest itpays on the deposit operation and the amount it earns on the loan operation”(p. 31). Though banks appear to derive their profit mainly from aninterest rate differential, we know that in practice the chief source of theirprofit is the ex nihilo creation of money, which provides banks withfinancing indefinitely. Banks appropriate these funds for their own benefitand charge interest on them to boot. In short, bankers create moneyfrom nothing, loan it and require that it be returned with interest.