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

232 Money, Bank Credit, and Economic Cyclesexpand credit without having to decrease their cash reserves,because although they grant loans which could lead to a withdrawalof cash (as we have supposed up until now in theaccounting entries), they simultaneously receive the depositof a portion of the money loaned by other banks. Hence inpractice, significant decreases in each bank’s reserves will not necessarilyoccur, and each bank, while maintaining its reserves practicallyintact, will be able to make loans and therefore create depositswithout serious risk.This theoretical argument has prompted various authors,among them Murray N. Rothbard, 33 to write about the processof credit expansion in the banking system from the viewpointthat an isolated bank does not lose reserves when it grantsnew loans. Instead, while maintaining the volume of itsreserves intact, it makes every attempt to make new loans fora multiple determined by the inverse of the reserve ratio. Theargument for explaining the bank multiplier in this way, evenin the case of an isolated bank, is that the bank will attempt toavoid reducing its reserves in the process of granting loans(i.e., the banker will not wish to keep 100,000 m.u. and loan900,000). Instead, it is much more advantageous for the bankto maintain its reserve ratio by loaning a much larger amountof money and keeping the initial cash reserves unaltered (thatis, by holding 1,000,000 m.u. in cash and creating ex nihilo9,000,000 m.u. in new loans). In practice, the level of cashreserves can be ensured if the credit expansion process takesplace simultaneously at all banks. This is because the decreasein cash a bank experiences upon granting loans will tend to becompensated for by the reception of new deposits originatingin loans made by other banks.When the expansion process is presented in this way, it isnot often easily understood by nonspecialists, nor even byprofessionals in the banking sector, who are accustomed toconsidering their “business” mere intermediation betweendepositors and borrowers. However, clear evidence that the33 Rothbard, The Mystery of Banking, chap. 8, pp. 111–24.