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

The Credit Expansion Process 217With only 1,000,000 m.u. in original deposits safeguardedin its vault, Bank A, a monopolist, has expanded credit bygranting loans for the sum of 9,000,000 m.u. and creating fromnothing 9,000,000 m.u. in new deposits or fiduciary media toback these loans. 29 5CREDIT EXPANSION AND NEW DEPOSIT CREATIONBY THE ENTIRE BANKING SYSTEMWe have already observed the great capacity isolatedbanks have for creating fiduciary loans and deposits. In fact,they are normally able to double their money supply on theirown. We will now see how the fractional-reserve banking systemas a whole generates ex nihilo a much larger volume of29 Also relevant is the formula for the maximum credit expansion an isolatedbank can bring about based not on the money it receives in originaldeposits, but on the reserves it holds, r, in excess of the requiredamount, cd. In this case, the decrease in reserves which results from thenew expansion x(1 – k) must be equal to the excess reserves, r, minus thereserve ratio corresponding to the portion of loans unused, k . c . x. Inother words:[18] (1 – k)x = r – k . c . xk . c . x + (1 – k)x = rx(kc + 1 – k) = r[19] x =rkc + 1 – kIf, as in our example, we suppose that an original deposit of 1,000,000m.u. is made, c=0.1 and k=0.2, the excess of reserves is preciselyr=900,000, and therefore:[20] x =900,000=900,000= 900,000 = 1,097,560 m.u.0.2 . 0.1 + 1 – 0.2 1.02 – 0.2 0.82This, of course, is exactly the same result we obtained with formula [4].