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

Central and Free Banking Theory 621deposits “prudently,” for if they abandon caution, they losethe confidence of their customers and fail. As was the casewith those Salamancan scholastics (Molina and Lugo) whoseviews were closest to those of the Banking School, nowheredoes Smith define his criterion of “prudence,” nor does heever comprehend the devastating effects temporary creditexpansion (beyond the level of voluntary saving) exerts on theproductive structure. 39After Adam Smith, the most important thinkers on bankingactivities are Henry Thornton and David Ricardo. In 1802Thornton, a banker, published a noteworthy book on monetarytheory entitled An Inquiry into the Nature and Effects of thePaper Credit of Great Britain. 40 Thornton produced a highly preciseanalysis of the effects credit expansion exerts on prices inthe different stages of the productive structure. He evenguesses that whenever banks’ interest rate is lower than the“average rate” of profit companies derive, an undue increasein the issuance of bills results, triggering inflation and, in thelong run, recession. Thornton’s intuitions foreshadowed not39 Edwin G. West has noted that Perlman believes Smith was aware ofthe problems of expanding credit beyond voluntary saving, eventhough Smith was unable to resolve the contradiction between hisfavorable treatment of fractional-reserve banking and his sound thesisthat only investment financed by voluntary saving is beneficial for theeconomy. See Edwin G. West, Adam Smith and Modern Economics: FromMarket Behaviour to Public Choice (Aldershot, U.K.: Edward Elgar, 1990),pp. 67–69. Pedro Schwartz mentions that “Adam Smith did not expresshis thoughts on credit and monetary matters as clearly as Hume did”and that, in fact, “he misled several of his followers . . . by not alwaysidentifying his institutional assumptions.” Pedro Schwartz also indicatesthat Adam Smith knew much less about banking and papermoney than James Steuart and even states: “Some of the criteria inSmith’s presentation may have come from reading Steuart’s book, PoliticalEconomy.” See the article by Pedro Schwartz, “El monopolio delbanco central en la historia del pensamiento económico: un siglo demiopía en Inglaterra,” printed in Homenaje a Lucas Beltrán (Madrid: EditorialMoneda y Crédito, 1982), p. 696.40 See F.A. Hayek’s edition of this book and the introduction (New York:Augustus M. Kelley, 1978).