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

Central and Free Banking Theory 635THE CASE FOR A CENTRAL BANKThus began a prolonged controversy between free-bankingchampions and central-bank promoters. The latter offeredthe following arguments to support their case against theposition of the Banking and Free-Banking School:First, a free-banking system, by its very nature, even underoptimal conditions, would be prone to occasional, isolatedbank crises which would harm customers and holders of banknotesand deposits. Therefore, under such circumstances,there is a need for an official central bank with the power tostep in to protect noteholders and depositors in the event of acrisis. This argument is clearly paternalistic and aimed at justifyingthe existence of a central bank. It ignores the fact thatwhen support is provided to those hit by a crisis, in the longrun such support merely tends to further hamper the smoothrunning of the banking system, which requires constant andactive supervision and confidence on the part of the public.Supervision is relaxed and confidence bolstered when thegeneral public takes for granted the intervention of the centralbank to avoid any damage in the case of a bank failure. Moreoverbankers actually tend to exercise less responsibility whenthey too are sure of the central bank’s support should theyneed it. Hence it is quite credible that the existence of a centralbank tends to aggravate bank crises, as has been revealed evenrecently in several cases. The “deposit insurance” system inmany countries has played a major role in fostering perversebehavior among bankers and in facilitating and aggravatingbank crises. Nevertheless, from a political standpoint theabove paternalistic argument can become extremely influential,even nearly irresistible, in a democratic environment. Atany rate, this first argument marks the beginning of the falseCoquelin, Chevalier, and others) and Currency School theorists in favorof a central bank (such as Lavergne, D’Eichtal, and Wolowsky). In Germanythe quarreling factions were led by Adolph Wagner and Lasker,on the side of free banking, and Tellkampf, Geyer, Knies, and Neisser, onthe side of the pro-central-bank Currency School. On this matter, seechapters 8 and 9 of Smith, The Rationale of Central Banking, pp. 92–132.