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

Bank Credit Expansion and Its Effects on the Economic System 391minor and merely a matter of degree, making a significantfinancial and credit squeeze inevitable. Events of this sort (suchas the economic crisis Florentine banks provoked in the fourteenthcentury) have repeatedly occurred since the dawn offractional-reserve banking. At any rate it has been demonstratedthat the fractional-reserve system endogenously triggersprocesses which make it impossible to insure banking via theapplication of the law of large numbers. These processes causesystematic crises in the banking system, which sooner or laterplague it with insuperable difficulties. This invalidates one ofthe stalest arguments to technically justify the existence of acontract which, like that of the monetary bank deposit with afractional reserve, is of an inadmissible legal nature (as we sawin chapter 3), given that it originates solely from a privilegegranted by public authorities to private banks.One might mistakenly believe that the high incidence ofdefault and the generalized loss of value on the asset side ofbank balance sheets, both products of the economic crisis,could from an accounting standpoint be offset with no problemby eliminating the corresponding deposits which balancethese loans on the liability side. Not in vain did chapter 4show that the credit expansion process entails banks’ creationof such deposits. Nonetheless economically speaking thisargument is invalid. While banks’ creation of money in theform of deposits initially coincides with their creation of loans,and both are granted to the same actors, loan recipients immediatelypart with the m.u. received as deposits, using them topay their suppliers and owners of the original means of production.Hence the direct recipients continue to owe the loanamounts to the bank, yet the deposits change hands at once.This precisely is the root of banks’ inherent insolvency whichendangers their survival in the stages of severe economicrecession. In fact the businessmen who receive loans commiten masse entrepreneurial errors which the crisis reveals. Theymistakenly instigate processes of investment in capital goods,in which the loans materialize, loans whose value falls dramaticallyor is completely lost. Substantial default results, andthe value of a large portion of banks’ assets plummets. Howeverat the same time, the deposit holders, now third parties,maintain their claims intact against the banks that brought