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

394 Money, Bank Credit, and Economic Cyclesthe ex nihilo creation of money, an ability all credit expansioninvolves, generates such large profits that bankers eventuallysuccumb to the temptation to revert to a fractional reserve. Inaddition no particular banker can be absolutely certain his bankwill be one of those that eventually suspend payments or fail,since he can always hope to be able to withdraw from theprocess before the crisis hits, demand the repayment of loans,and avoid defaulters. Thus a typical tragedy of the commons, aprocess known to be triggered whenever the property rightsof third parties are inadequately defined or defended (as inthe case which concerns us), is set in motion. We will study theprocess in greater depth in chapter 8. In light of the above it isunsurprising banks face an irresistible temptation to expandtheir credit before other banks and hence to take full advantageof the profits of the expansion while leaving the rest ofthe banks, and the entire economic system in general, tojointly bear the extremely harmful consequences which ultimatelyfollow. 98To conclude, the technical impossibility of insuring againstthe risk of deposit withdrawal via a fractional-reserve ratioalso explains, as we will see in chapter 8, that bankers themselveshave been the chief defenders of the existence of a centralbank which, as lender of last resort, could guarantee their98 We first had the opportunity to defend the thesis that the theory of the“tragedy of the commons” should be applied to fractional-reserve bankingat the Regional Meeting of the Mont-Pèlerin Society which tookplace in Rio de Janeiro, September 5–8, 1993. There we pointed out thatthe typical “tragedy of the commons” clearly applies to banking, giventhat the entire expansive process derives from a privilege against propertyrights, since each bank entirely internalizes the benefits of expandingits credit while letting the other banks and the whole economic systemshare the corresponding costs. Moreover as we will see in chapter 8, aninterbank clearing mechanism within a free banking system may thwartindividual, isolated attempts at expansion, but it is useless if all banks,moved by the desire for profit in a typical “tragedy of the commons”process, are more or less carried away by “optimism” in the granting ofloans. On this topic see our “Introducción Crítica a la Edición Española”to Vera C. Smith’s book, Fundamentos de la banca central y de la libertad bancaria[The Rationale of Central Banking and the Free Banking Alternative](Madrid: Unión Editorial/Ediciones Aosta, 1993), footnote 16 on p. 38.