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

Bank Credit Expansion and Its Effects on the Economic System 395survival during panic stages. 99 From this point of view, the historicalemergence of the central bank as an institution was aninevitable result of the very privilege which allows banks to loanmost of the money they receive on deposit, through the maintenanceof a fractional-reserve ratio. Furthermore it is evident thatuntil traditional legal principles, and thus a 100-percent reserverequirement, are reestablished, it will be impossible to managewithout the central bank and to introduce a true free-banking systemwhich is subject to the law and does not adversely affect thecourse of the economy by regularly provoking destabilizingphases of artificial expansion and economic recession. 10099 The standard analysis of the “public-choice school” could also be mentionedhere to explain how banks, as a powerful pressure group, havemobilized to protect their privilege, establish a legal foundation for it andobtain government support whenever necessary. Thus it is not surprisingauthors such as Rothbard conclude that “bankers are inherently inclinedtoward statism.” Murray N. Rothbard, Wall Street, Banks, and American ForeignPolicy (Burlingame, Calif.: Center for Libertarian Studies, 1995), p. 1.See also the literature on the economic effects of demand deposits in currentmonetary systems based on central banks (among others Douglas W.Diamond and Phillip H. Dybvig, “Bank Runs, Deposit Insurance, and Liquidity,”Journal of Political Economy 91 [1983]: 401–19; and Itay Goldstein andAdy Pauzner, “Demand-Deposit Contracts and the Probability of BankRuns,” Journal of Finance 60, no. 3 [June 2005]: 1293–1327).100 Therefore the central bank constitutes the most concrete historicalproof of the practical and theoretical failure of the attempt to insureagainst deposit withdrawal via a fractional reserve. The fact that a lenderof last resort, to create and provide the liquidity required in times ofpanic, is considered necessary shows that such insurance is impossibleand that the only way to avoid the inevitable, damaging consequencesthat the institution of fractional-reserve banking produces for banks is bycreating and preserving an institution with absolute control over themonetary system and the ability to create the necessary liquidity at anytime. In other words, the fractional-reserve privilege is also ultimatelyresponsible for the central bank’s strong, frequent intervention in thefinancial system, which is thus excluded from the processes of the freemarket subject to traditional legal principles. This book began with theassertion that the main practical and theoretical challenge facing theeconomy at the start of this new century is precisely to put an end to theintervention and systematic coercion of the state and to privileges withinthe financial system, by subjecting it to the same traditional legal principleswhich are invariably demanded of all other economic agents operatingin a free market. This assertion is now perfectly understandable.