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

The Credit Expansion Process 253as unbacked banknotes. As a result, the Act did not outlawfractional-reserve banking and allowed the age-old practice of“issuing” unbacked (secondary) deposits to continue. In realitysecondary deposits predated the fiduciary issue of banknotes,but because the former proved much more complex,only the latter was (very belatedly) prohibited. The monetarybank-deposit contract with a fractional reserve is still legaltoday, even though it has exactly the same economic natureand produces the same damaging effects as the issuance ofunbacked banknotes prohibited in 1844 by the Peel Act. 4141 As chapter 8 will reveal in greater detail (pp. 605 ff. and 625 ff.), thefirst theorist to realize that bank deposits are money and that fractionalreservebanking increases the money supply was the Spanish scholasticLuis de Molina, Tratado sobre los cambios, edited and prefaced by FranciscoGómez Camacho (Madrid: Instituto de Estudios Fiscales, 1991;first edition was published in Cuenca in 1597). See esp. Disputation 409,pp. 145–56, esp. p. 147. Nevertheless, Luis de Molina did not observe theparallels between secondary deposits and unbacked bills, since in histime banks had still not begun to exploit the possibility of issuing banknotes.It would not be until 1797 that Henry Thornton would for the firsttime refer to the equivalence of bills and deposits (see his Response ofMarch 30, 1797 in “Evidence given before the Lords’ Committee ofSecrecy appointed to inquire into the courses which produced the Orderof Council of the 27th February 1797,” reproduced in An Inquiry into theNature and Effects of the Paper Credit of Great Britain, F. A. Hayek, ed. (Fairfield,N.J.: Augustus M. Kelley, 1978), p. 303. Several years later the sameconclusion was reached by Walter Boyd, James Pennington, and thePennsylvania senator Condy Raguet, who believed that deposits andbanknotes both constituted part of the money supply and that any bankwhich failed to immediately and on demand pay the value of banknotesissued by it should lose its license to operate, as should any bank whichfailed to immediately and in cash honor requests for withdrawals ofdeposits the bank had issued [see the “Report on Bank Charters” byCondy Raguet, included in the Journal of the Senate, 1820–1921, PennsylvaniaLegislature, pp. 252–68 and Murray N. Rothbard’s related commentsincluded in his book, The Panic of 1819: Reactions and Policies (NewYork and London: Columbia University Press, 1962), p. 148]. Quite significantly,Banking School theorists themselves were the first to rightlyinsist that it was very paradoxical to try to limit the issuance of unbackedbills while not advocating the same measure regarding deposits, giventhat bills and deposits had exactly the same economic nature. See, forexample, James Wilson’s book, Capital, Currency and Banking (London: