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

262 Money, Bank Credit, and Economic Cyclescautious about granting more. Hence the natural reluctance ofthe demoralized public to request loans is reinforced bybanks’ greater prudence and rigor when it comes to givingthem. In addition, as bankers see their profitability fall alongwith the value of their assets as a result of irrecoverable loans,they will attempt to be more careful, and other things beingequal, to increase their cash on hand by raising their reserveratio, which will have an even greater tightening effect.Finally business failures and frustration arising from theinability to honor commitments to banks will contribute evenmore to the demoralization of economic agents and to theirdetermination to avoid new investment projects financed withbank loans. In fact many businessmen eventually realize theyallowed themselves to be carried away by unjustified optimismin the phases of expansion, largely due to the excessivelygenerous credit terms bankers initially offered, and the businessmencorrectly attribute their errors in judgment to these easyterms. 43 As a result they resolve not to commit the same errorsagain. (Whether or not their attempt at rectification is successfuland in the future the businessmen remember theirunpleasant experiences during the stage of recession is a differentissue we will confront later.)In conclusion, we have seen that the fractional-reservebanking system can contract and drastically reduce the moneysupply just as easily as it expands credit and increases themoney supply. In other words, the system generates an elasticand extremely fragile stock of money which is subject to great43 See also chapter 5, sec. 4. The serious harm bankers do those customersthey urge to “enjoy” new loans and get involved in businessdeals requiring bank financing should theoretically be admitted in legalcases in which banks would be sued for damages with respect to theinjury they inflict upon borrowers in this way. If until now such suitshave not been brought before the court, it is because economic theoryhad not been advanced enough to clearly identify the cause and natureof the injury. However nowadays theoretical developments make it possibleto apply theory in court. A very similar, parallel case would be theuse of breakthroughs in biology to facilitate judicial declarations ofpaternity which were impossible a few years ago.