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

200 Money, Bank Credit, and Economic CyclesInstead banks simply grant loans against deposits they createfrom nothing (fiduciary media) and which therefore have notfirst been entrusted to them by any third party as deposits ofphysical monetary units. Not even under the continentalaccounting system are banks financial intermediaries, sincetrue original depositors turn their money over for custodyand safekeeping, not as a loan to the bank. Furthermore wehave already shown that by reducing to a fraction the numberof monetary units they keep on hand (reserve ratio),banks create fiduciary media by an amount equal to the totalsum of their unbacked deposits. Thus, by a somewhat moreabstract analysis, the continental accounting system leads usto the same conclusion as the Anglo-Saxon system: ratherthan credit intermediaries, banks are creators of loans anddeposits, or fiduciary media. Nevertheless, the process ismuch more obvious and easier to understand when evaluatedaccording to Anglo-Saxon accounting criteria, becausefrom the beginning this method reflects the fact that the bankcreates deposits ex nihilo and grants loans against them.Therefore, no abstract intellectual exercise is required tounderstand the process.From the perspective of economic theory, the chief disadvantageof both accounting systems is that they reflect a muchlower volume of deposit creation and loan concession thantruly exists. That is, they reveal only a fraction of the total volumeof deposits and loans which the banking system as awhole is capable of creating. Only when we consider the effectsof fractional-reserve banking from the standpoint of the overallbanking system will this important fact be confirmed. However,first it is necessary to identify the limits to deposit creationand loan concession by an isolated bank.AN ISOLATED BANK’S CAPACITY FOR CREDIT EXPANSION ANDDEPOSIT CREATIONWe will now consider the limits to an isolated bank’scapacity to create loans and expand deposits from nothing.The following variables are involved:d: the money originally deposited in the bank’s vault;