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

260 Money, Bank Credit, and Economic Cyclesbe one step away from losing the confidence of their depositors,who may force them to suspend payments and/ordeclare bankruptcy, and in this case even the 1,000,000 m.u.originally deposited in cash would be withdrawn, threateningthe existence of the entire banking system.Under ordinary conditions the contraction or deflation weare describing does not occur, because when a customer of onebank returns a loan, the sum is compensated for by anotherloan granted by another bank; in fact even within the samebank the attempt is always made to replace the repaid loanwith a new one. In addition under normal circumstances thebank may consider payment arrears just one more operatingcost. The crucial problem posed by credit tightening (as wewill examine in the following chapters) consists of the fact thatthe very process of credit expansion based on a fractionalreserve inevitably triggers the granting of loans unsupportedby voluntary saving, resulting in a process of intertemporaldiscoordination, which in turn stems from the distorted informationthe banking system imparts to businessmen whoreceive loans generated ex nihilo by the system. Hence businessmenrush out to launch investment projects as if society’sreal saving had increased, when in fact this has not happened. Theresult is artificial economic expansion or a “boom,” which byprocesses we will later study in detail, inevitably provokes an adjustmentin the form of a crisis and economic recession. This sums upthe negative effects exerted on the real economy by the financialpractice of expanding credit through the issuance of fiduciarymedia (deposits).The crisis and economic recession reveal that a highly significantnumber of investment projects financed under newloans created by banks are not profitable because they do notcorrespond to the true desires of consumers. Therefore manyinvestment processes fail, which ultimately has a profoundeffect on the banking system. The harmful consequences areevidenced by a widespread repayment of loans by many demoralizedbusinessmen assessing their losses and liquidatingunsound investment projects (thus provoking deflation andthe tightening of credit); they are also demonstrated by analarming and atypical rise in payment arrears on loans