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

The Credit Expansion Process 20520 percent; and that the sum of the original deposits, d, madein the bank is equal to 1,000,000 m.u.; then, by substitutingthese values into formula [3] we obtain:[4] x = 1,000,000 (1 – 0.1) = 1,097,560 m.u.1 + 0.2 (0.1 – 1)Therefore we see that a bank which accepts 1,000,000 m.u.in demand deposits, and which maintains a reserve ratio of 10percent and a k of 20 percent will be able to grant loans notonly for the sum of 900,000 m.u., as we assumed for the purposeof illustration in entries (18) and following, but for a considerablylarger amount, 1,097,560 m.u. Hence, even in thecase of an isolated bank, the capacity for credit expansion andex nihilo deposit creation is 22 percent greater than we initiallysupposed in entries (18) and following. 23 As a result, weshould modify our earlier accounting entries to reflect that, inkeeping with the Anglo-Saxon accounting system, when c=0.1and k=0.2, the bank will be able to expand its credit by1,097,560 m.u., instead of the 900,000 we assumed before (thatis, the bank’s capacity for credit expansion is 22 percentgreater). The modified journal entries and corresponding balancesheet would appear as follows (compare with initialentries 18 and 19):23 Even though, from the standpoint of an isolated bank, it appears as ifthe bank were loaning a portion of its deposits, the reality is that evenan isolated bank creates loans ex nihilo for a sum larger than that originallydeposited. This demonstrates that the principal source of depositsis not depositors, but rather loans banks create from nothing. (Depositsare a secondary result of these loans.) This will be even clearer when westudy the overall banking system. C.A. Phillips expresses this fact bystating, “It follows that for the banking system, deposits are chiefly theoffspring of loans.” See Phillips, Bank Credit, p. 64, and the quotationfrom Taussig in note 63, chapter 5.