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

636 Money, Bank Credit, and Economic Cyclesstart in the free-banking/central-banking debate, in the sensethat the argument would be meaningless if traditional legalprinciples were respected and a 100-percent reserve requirementwere reestablished for banking. Under these conditions,no harm would be done to holders of banknotes and deposits,who would always be able to withdraw their money, regardlessof the fate of their bank. Therefore the paternalistic argumentthat a central bank is necessary to protect the interests ofinjured parties makes no sense. If we follow the logic of a fractional-reservebanking system, this first argument in favor ofa central bank is at least very doubtful, while in the context ofa free-banking system based on traditional legal principlesand a 100-percent reserve requirement, it is completely irrelevant.The second argument expressed in favor of central banksrests on the notion that a banking system controlled by a centralbank provokes fewer economic crises than a free-bankingsystem. This argument, like the first one, represents an inappropriateapproach to the debate. We already know that thefractional-reserve free-banking system may stimulate growthin the money supply in the form of loans, and that this growthinvariably distorts the productive structure of capital goodsand endogenously and repetitively triggers a reversionprocess that manifests itself as an economic recession that hitsbanks particularly hard. In fact it was the very desire to protectbanks from the effects of the repetitive crises created byfractional-reserve banking which prompted bankers themselvesto demand the establishment of a central bank to loan themmoney as a last resort. Experience has shown that far fromdefusing economic crises, the advent of the central bank hasexacerbated them. In a fractional-reserve free-banking system(with no central bank), even though the expansionaryprocesses which provoke crises cannot be avoided, the reversionmechanisms which lead to the necessary readjustmentand correction of economic errors operate much sooner andmore quickly than in the central-bank-based system. Indeed theloss of public confidence is not the only factor to endanger themost expansionist banks, the reserves of which rapidly diminishas the holders of their bills withdraw their countervalue inspecie. Interbank clearing mechanisms related to deposits also