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

374 Money, Bank Credit, and Economic Cyclesbegun and which they begin to see threatened, turn tobanks and demand additional loans, offering a higherand higher interest rate for them. Thus they start a“fight to the death” to obtain additional financing. 84The entrepreneurs cannot procure the funds they need for thefurther conduct of their ventures. The gross market rate ofinterest rises because the increased demand for loans is notcounterpoised by a corresponding increase in the quantity ofmoney available for lending. (Mises, Human Action, p. 554)84 Entrepreneurs determined to complete their endangeredlong-term capital projects turn to the banks for more bankcredit, and a tug-of-war begins. Producers seek new bankloans, the banking system accommodates the new loandemand by creating new money, product prices rise ahead ofwage costs. In each market period the process repeats itself,with product prices always rising ahead of wages. (Moss andVaughn, “Hayek’s Ricardo Effect: A Second Look,” p. 554)In Human Action Mises explains the process in this way:This tendency toward a rise in the rate of originary interestand the emergence of a positive price premium explain somecharacteristics of the boom. The banks are faced with anincreased demand for loans and advances on the part of business.The entrepreneurs are prepared to borrow money athigher gross rates of interest. They go on borrowing in spiteof the fact that banks charge more interest. Arithmetically, thegross rates of interest are rising above their height on the eveof the expansion. Nonetheless, they lag catalactically behindthe height at which they would cover originary interest plusentrepreneurial component and price premium. The banksbelieve that they have done all that is needed to stop“unsound” speculation when they lend on more onerousterms. They think that those critics who blame them for fanningthe flames of the boom-frenzy of the market are wrong.They fail to see that in injecting more and more fiduciarymedia into the market they are in fact kindling the boom. It isthe continuous increase in the supply of the fiduciary mediathat produces, feeds, and accelerates the boom. The state ofthe gross market rates of interest is only an outgrowth of thisincrease. If one wants to know whether or not there is creditexpansion, one must look at the state of the supply of fiduciarymedia, not at the arithmetical state of the interest rates.(Mises, Human Action, pp. 558–59)