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

624 Money, Bank Credit, and Economic Cyclesissuance of paper bills unbacked by commodity-money, permitsincreases in the money supply to meet the “needs oftrade” without producing inflationary effects or distortions inthe productive structure.John Fullarton (c. 1780–1849) was undoubtedly the mostprominent of Banking School representatives. He was amongthe school’s most persuasive authors and in 1844 published awidely-read book entitled On the Regulation of Currencies. 45Here Fullarton puts forward what would become a famousdoctrine, Fullarton’s law of reflux of banknotes and credit.According to Fullarton, credit expansion in the form of billsissued by a fractional-reserve banking system poses no dangerof inflation because the bills banks issue are injected into theeconomic system as loans, rather than direct payment forgoods and services. Thus, Fullarton reasons, when the economy“needs” more means of payment it demands more loans,and when it needs less, loans are repaid and flow back tobanks, and therefore credit expansion has no negative effectswhatsoever on the economy. This doctrine became quite popular,yet it was a clear step backward with respect to advancesHume and other authors had already made in monetary theory.Nevertheless it surprisingly gained the unexpected supportof even John Stuart Mill, who eventually, by and large,endorsed Fullarton’s theories on the issue.We have already explained at length why the essentialprinciples of the Banking School are fundamentally unsound.Only ignorance of the simplest basics of monetary and capital45 John Fullarton, On the Regulation of Currencies, being an examination ofthe principles on which it is proposed to restrict, within certain fixed limits, thefuture issues on credit of the Bank of England and of the other banking establishmentsthroughout the country (London: John Murray, 1844; 2nd rev.ed., 1845). Fullarton’s law of reflux appears on p. 64 of the book. In continentalEurope, Adolph Wagner (1835–1917) popularized Fullarton’sversion of the Banking School inflationist creed. John Fullarton was asurgeon, publisher, tireless traveler, and also a banker. On the influenceFullarton exerted on such diverse authors as Marx, Keynes, andRudolph Hilferding, see Roy Green’s essay published in The New Palgrave:A Dictionary of Economics, vol. 2, pp. 433–34.