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

598 Money, Bank Credit, and Economic Cycleshave spread, the contracts and institutions in question havebegun to produce the same harmful effects as fractionalreservebanking. Therefore as we will see in the followingchapters, any proposal to reform the banking system mustinclude a plan to quickly identify different abusive legal procedureswhich could be conceived to mask true fractional-reserve,demand-deposit contracts. Such procedures must be curtailed,as they go against general legal principles and seriously disruptthe harmonious process of economic coordination.SPECIFIC COMMENTS ON CREDIT INSURANCEFinally we should briefly mention credit insurance operations,which have spontaneously emerged in developedeconomies. In exchange for a premium, these policies guaranteethat in the event that the customers of insured businessand industrial enterprises cannot pay their debts, which areusually paid within a certain period (thirty, sixty, ninety days,etc.) using a given financial instrument (for example, a bill ofexchange), the insurance company will pay a percentage ofthe total corresponding debt (between 75 and 95 percent), thustaking it over and later collecting the amount from the delinquentcustomer. Therefore credit insurance addresses a realneed which arises in markets. It responds to a set of circumstanceswhich derives from the credit that different industrialand business enterprises habitually extend to their customers.Such credit corresponds, economically speaking, to a traditionaloperation in which savers, generally capitalists whoown a business, advance financial resources for a time toits nominal value (not at the unpredictable, oscillating price of the secondarymarket) constitutes a demand deposit which requires a 100-percentreserve ratio. Indeed the only way for a company to guarantee atall times its ability to honor all its repurchase agreements is to keepavailable a monetary reserve equal in value to the total that would haveto be paid if all agreements were exercised at once (100-percent reserveratio). As long as companies fail to maintain such a reserve, they willalways run the risk of being unable to immediately comply with theexercise of the repurchase option, a possibility which, during stages ofrecession in the economic cycle, will almost become a certainty withoutthe unconditional support of a central bank to act as lender of last resort.