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

5BANK CREDIT EXPANSIONAND ITS EFFECTS ON THEECONOMIC SYSTEMIn the previous chapter we explained how the monetarybank-deposit contract with a fractional reserve leads to thecreation of new money (deposits) and its infusion into theeconomic system in the form of new loans unbacked by a naturalincrease in voluntary saving (credit expansion). In thischapter we will focus on the effects of credit expansion on theeconomic system. We will analyze the distortions the expansionprocess causes: investment errors, credit squeezes, bankcrises and eventually, unemployment and economic recessions.First, however, we must examine in detail both the theoryof capital and the productive structure of a real economy,since a clear grasp of both is essential to understanding theprocesses triggered in the market by banks’ concession ofloans not derived from a previous increase in voluntary saving.Our analysis will reveal that the legal concept which concernsus (the monetary bank-deposit contract with a fractionalreserve) does great harm to many economic agents (and tosociety in general) inasmuch as it is the principal root of recurringeconomic recessions. Moreover we will show that becausecredit expansion precipitates economic and bank crises, it rendersthe “law of large numbers” inapplicable in banking andtherefore makes it technically impossible to ensure the completionof banks’ fractional-reserve operations. This factacquires great significance in light of the inevitable emergenceof the central bank as a lender of last resort, which we willexplore in depth in a later chapter. We will begin by explaining265