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

Central and Free Banking Theory 629neutral, an idea today’s monetarists have supported. Thereforeit was not until 1912, when Ludwig von Mises reformulatedCurrency School teachings, that monetary theory wasfinally fully integrated with capital theory, within a generaltheory of the economic cycle. The third fatal error of the CurrencySchool lay in the notion that, in keeping with Ricardo’ssuggestions, the best way to curtail the Banking School’s inflationaryexcesses was to grant an official central bank a monopolyon the issuance of banknotes. 53 Currency School theoristsfailed to realize that in the long run such an institution wasbound to be used by Banking School members themselves tospeed up credit expansion in the form of banknotes anddeposits in circulation.These three mistakes of the Currency School proved fatal:they were the reason Sir Robert Peel’s famous Bank CharterAct (passed on July 19, 1844), despite the highly honorableintentions of its drafters, failed to ban the creation of fiduciarymedia (deposits unbacked by metallic money) though it didban the issuance of unbacked bills. As a result, even thoughPeel’s Act marked the beginning of a central bank monopolyon the issuance of paper currency, and although the centralbank theoretically issued only banknotes fully backed byspecie (100 percent reserve), private banks were free to expandmoney by granting new loans and creating the correspondingdeposits ex nihilo. Hence expansionary booms and the subsequentstages of crisis and depression continued, and duringthese periods the Bank of England was obliged time and againto suspend the provisions of the Peel Act and to issue thepaper currency necessary to satisfy private banks’ demand forliquidity, thus, when possible, saving them from bankruptcy.Therefore it is ironic that the Currency School supported thecreation of a central bank which, gradually and due mainly topolitical pressures and the negative influence of predominantBanking School theorists, was eventually used to justify and53 Nevertheless Ricardo foresaw the importance of making the centralbank independent of the government. See José Antonio de Aguirre, Elpoder de emitir dinero: de J. Law a J.M. Keynes (Madrid: Unión Editorial,1985), pp. 52–62 and footnote 16.