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

Central and Free Banking Theory 615later discredited by Hume and Austrian School monetary theorists,has in one form or another survived up to the present,not only through the work of nineteenth-century Banking-School theorists, but also through many modern-day monetaristsand Keynesians. In short, Law attributes Scotland’spoor level of economic activity in his time to the “reduced”money supply and thus carries the ideas of the MercantilistSchool to their logical conclusion. For this reason, Law claimsthe primary objective of any economic policy must be toincrease the amount of money in circulation, an aim heattempted to accomplish in 1705 by introducing paper moneybacked by what then was the most important real asset:land. 27 Law later changed his mind and centered all his economic-policyefforts on the establishment of a fractionalreservebanking system which, through the issuance of papermoney redeemable in specie, was expected to increase themoney supply as needed in any given situation to sustain andfoster economic activity. We will not dwell here on the detailsof the inflationary boom Law’s proposals generated in eighteenth-centuryFrance, nor on the collapse of his entire system,which brought great social and economic harm to that nation.A contemporary of John Law was fellow banker RichardCantillon (c. 1680–1734), whose life and adventures we havealready covered. Cantillon, also a speculator and banker, wasendowed with great insight for theoretical analysis. He produceda highly significant study of the influence an increasein the quantity of money in circulation exerts on prices, aninfluence which first becomes evident in the prices of certaingoods and services and gradually spreads throughout theentire economic system. Therefore Cantillon argued, as Humelater would, that variations in the quantity of money mainlyaffect the relative price structure, rather than the general priceamount, and each reduction in the money supply lowers theemployment level to the same extent. (Quoted by Hayek in“First Paper Money in Eighteenth-century France,” chapter10 of The Trend of Economic Thinking, p. 158)27 See John Law’s Essay on a Land Bank, Antoin E. Murphy, ed. (Dublin:Aeon Publishing, 1994).