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

608 Money, Bank Credit, and Economic Cyclesthat their standard of prudence is not an objective criterion adequateto direct the actions of bankers. It certainly does notcoincide with bankers’ ability to return all deposits in theirkeeping at any time, and Molina and Lugo themselves arecareful to point out that bankers commit “mortal sin” whenthey use their depositors’ funds speculatively and imprudently,even if such actions end well and they are able to return theirdepositors’ money in time. 11 Moreover the standard of prudenceis not a sufficient condition: a banker may be very prudent yetnot very perceptive, or he may even have bad luck in business,so that when the time comes to pay he lacks ample liquidityand cannot return deposits. 12 What, then, is an acceptablestandard of prudence? This question clearly has no objectiveanswer capable of serving as a guide in banking. Furthermoreas we saw in earlier chapters, the law of large numbers isinapplicable to fractional-reserve banking, since the creditexpansion involved in such banking practices leads to recurrentcycles of boom and recession which invariably cause difficultiesfor bankers. Indeed the banking business itself createsthe liquidity crises and thus, the widespread insolvencyof banks. At any rate, when the crisis hits it is highly likely thatthe bank will be unable to pay, i.e., that it will suspend payments,and even if in the end all its creditors are lucky enoughto receive their money, in the best of circumstances this onlyhappens after a long liquidation process in which the depositors’role is altered. They lose immediate availability of theirmoney and become forced lenders with no choice but to postponewithdrawal of their deposits until the liquidation is over.Tomás de Mercado was undoubtedly motivated by theabove considerations when he emphasized that Molina and11 Perhaps it is Juan de Lugo who most clearly and concisely expressesthis principle, as we saw in footnote 102 of chapter 2.12 In other words a banker may commit pure or genuine entrepreneurialerrors (ones not insurable by the law of large numbers) which result inserious entrepreneurial losses, regardless of the degree of prudence hehas shown. On the concept of “genuine error,” see Israel Kirzner, “Economicsand Error,” in Perception, Opportunity and Profit (Chicago: Universityof Chicago Press, 1979), chap. 8, pp. 120–36.