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

Additional Considerations on the Theory of the Business Cycle 46715EFFECTS THE BUSINESS CYCLE EXERTSON THE BANKING SECTORAt this point in our analysis it should be easy to identifythe effects and relationships which link the business cycle andthe banking sector. To begin with, we must recognize that thebusiness cycle stems from credit expansion the banking sectorbrings about as a result of its legal privilege of implementingmonetary demand-deposit contracts with a fractional reserveratio. Moreover in chapter 4 we saw that this privilegeexplains the trend toward mergers in the banking industry,since the larger a bank’s relative size is in the market, thegreater are its possibilities for credit expansion unlimited bythe corresponding bank clearing house. Furthermore bankconsolidation makes it possible to better “manage” fractionalcash reserves, allowing banks to satisfy normal withdrawalswith lower central cash balances.Nevertheless in chapter 5 we saw how the credit expansionprocess inevitably provokes a crisis and readjustmentperiod, during which much of the book value of banks’ assetsevaporates, and in addition a widespread increase occurs inthe demand for money and in the withdrawal of deposits (atleast in the marginally less solvent banks). Therefore thisaccounts for the fact that bankers have forced the creation of apublic institution, called the “central bank,” designed to actbasically as lender of last resort in the stages of economicrecession which are so dangerous for banks. Also the difficultiesand overwhelming worries which beset bankers as a consequenceof default and the withdrawal of deposits during thestage of readjustment and economic recession reinforce evenfurther the trend toward bank mergers. In fact in this waybanks are able to treat defaulters more uniformly, achieve significanteconomies of scale in the management of paymentarrears and avoid the marginally more insolvent situation inwhich they would find themselves if a higher percentage oftheir loans were non-performing or if the public had less confidencein them.