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

Bank Credit Expansion and Its Effects on the Economic System 389unbacked by a prior increase in saving (credit expansion) andinitially provokes artificial widening and lengthening of theproductive structure (illustrated by the shaded areas inChart V-6). Nevertheless sooner or later the microeconomicfactors explained in detail in the previous section set inmotion social processes which tend to reverse the entrepreneurialerrors committed, and consequently the productivestructure comes to resemble that illustrated in Chart V-7.There we see that the new stages by which an attempt wasmade to lengthen the productive structure (stages six andseven of Chart V-6) disappear altogether. Furthermore the“widenings” of stages two through five are liquidated,bringing about the general impoverishment of society, aresult of the unwise investment of its scarce real savedresources. Accordingly a highly significant number of therecipients of loans derived from credit expansion are ultimatelyunable to repay them and become defaulters, initiatinga process in which both suspensions of payments andbankruptcies multiply. Hence default comes to affect a verylarge percentage of bank loans. In fact once the crisis hits andit becomes evident that the investment projects launched inerror should not have been undertaken, the market value ofthese projects is reduced to a fraction of their initial value,when it does not disappear completely.The extent to which this generalized decrease in the valueof many capital goods is carried over to banks’ assets is graphicallyillustrated precisely by the loan amounts which correspondto the shaded areas in Chart V-6. This chart reflects, inmonetary terms, the erroneous lengthening and widening ofthe productive structure: changes attempted in the expansivephases of the economic cycle, due to the cheap, easy financingof bank loans (unbacked by a prior increase in voluntary realsaving). Inasmuch as the errors committed are revealed and the“lengthenings” and “widenings” of the productive structure areabandoned, liquidated, or realigned, the value of the assets of theentire banking system diminishes dramatically. Moreover thisdecline in value is gradually accompanied by the credit tighteningprocess we analyzed in accounting terms at the end ofchapter 4 and which tends to aggravate even further the negativeeffects the recession exerts on the assets of the banking