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

Central and Free Banking Theory 633analysis has considerable merit and lies at the heart of thearguments invoked to date in favor of free banking. His analysiswas used and developed even by certain authors of theCurrency School (like Ludwig von Mises) who were nonethelesshighly skeptical of the central-bank system. 57A FALSE START FOR THE CONTROVERSY BETWEENCENTRAL BANKING AND FREE BANKINGTwo distinguished theorists of the Currency School, J.R.McCulloch and S.M. Longfield, challenged Parnell’s claim.McCulloch argued that the mechanism Parnell describedwould not curb inflation if all banks in a free-banking systemshould collectively yield to a wave of expansion in theissuance of banknotes. 58 Samuel Mountifort Longfield carriedMcCulloch’s objection even further and contended that even ifa single bank expanded its paper-money base, in a free-bankingsystem the rest would inevitably be forced to follow suitlest their financial-market share or their profits drop. 59 Longfield’sargument contains an important kernel of truth, sincethe liquidation of excess banknotes through a clearing house57 See, for example, Mises, “The Limitation of the Issuance of FiduciaryMedia,” section 12 of chapter 17 of Human Action, pp. 434–48; see esp.“Observations on the Discussions Concerning Free Banking,” p. 444.58 J.R. McCulloch, Historical Sketch of the Bank of England with an Examinationof the Question as to the Prolongation of the Exclusive Privileges of thatEstablishment (London: Longman, Rees, Orme, Brown and Green, 1831).See also his A Treatise on Metallic and Paper Money and Banks (Edinburgh:A. and C. Black, 1858).59 Longfield’s contributions appeared in a series of four articles on“Banking and Currency” published by the Dublin University Magazine in1840. Vera C. Smith concludes:The point raised by the Longfield argument is by far the mostimportant controversial point in the theory of free banking.No attempt was made in subsequent literature to reply to it.(Smith, The Rationale of Central Banking and the Free BankingAlternative, p. 88)See also our analysis supporting the initial Longfield insight on pp.664–71.