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

390 Money, Bank Credit, and Economic Cyclessystem. In fact those entrepreneurs who fortunately manageto save their companies from a suspension of payments andbankruptcy restructure the investment processes they initiated.They paralyze them, liquidate them and accumulate theliquidity necessary to return the loans they obtained from thebank. Furthermore the pessimism and demoralization of economicagents 96 means that new loan requests and theirapproval cannot compensate for the speed at which loans arerepaid. A serious credit squeeze results.Therefore one must draw the conclusion that the economicrecession caused by credit expansion results in a generalizeddecline in the value of the accounting assets of the banking system,just when depositors’ optimism and confidence are lowest.In other words, recession and default drive down the value ofbanks’ loans and other assets, while banks’ correspondingliabilities, the deposits now in the hands of third parties,remain unchanged. With respect to accounting, the financialsituation of many banks becomes particularly problematicand difficult, and they begin to announce suspensions of paymentsand failures. As is logical, from a theoretical standpointit is impossible to determine in advance which specific bankswill be relatively more affected. However we can safely predictthat those banks which are marginally less solvent will face aserious liquidity squeeze, a suspension of payments and evenbankruptcy. Such a situation can very easily precipitate a generalizedcrisis of confidence in the entire banking system,prompting individuals to withdraw their deposits en masse,not only from the banks which, relatively speaking, experiencethe greatest difficulties, but by contagion, from all the rest aswell. Indeed all banks which operate with a fractional reserveare inherently insolvent, and their differences are relatively96 The boom produces impoverishment. But still more disastrousare its moral ravages. It makes people despondent anddispirited. The more optimistic they were under the illusoryprosperity of the boom, the greater is their despair and theirfeeling of frustration. (Mises, Human Action, p. 576)Remember also what we said in chapter 4, sec. 8, pp. 254–63.