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

Central and Free Banking Theory 637jeopardize those banks which expand their credit base fasterthan the rest. Even if most banks expand their deposits andbills simultaneously, the spontaneous processes identified bythe theory of economic cycles soon gather momentum andtend to reverse the initial expansionary effects and bankruptmarginally less solvent banks. In contrast, the existence of acentral bank, a lender of last resort, may prolong the processof credit and monetary expansion much further in relation tothe independent process which would be set in motion in afree-banking system. It is impossible to ignore the contradictioninherent in the institution of the central bank, which was theoreticallycreated to curb monetary expansion, maintain economicstability and prevent crises, but which in practice isdevoted to providing new liquidity on a massive scale whenbanks face crises and panics. If we also consider political influencesand the inflationary desires of the public, we will understandwhy inflationary processes and their distortion of theproductive structure have been aggravated and the historicalresult has been much more severe and profound economiccrises and recessions than those which would have arisen in afree-banking system. Therefore we can conclude that this secondargument in favor of the central bank is groundless, sincethe very existence of the central bank tends to exacerbateeconomic crises and recessions. Nevertheless we must alsoacknowledge that crises would erupt even in a fractionalreservefree-banking system, though they would not cause asmany repercussions as in a monetary system directed by acentral bank. We have made this point in previous chaptersand will demonstrate it further on. In any case, we do not haveto resign ourselves to living with recurrent economic crisesand recessions, since the mere re-establishment of generallegal principles (100-percent reserve requirement) would preventa free-banking system from exerting any negative effectson economic processes, and in this way the most common pretextfor creating a central bank would disappear.The third argument in favor of a central bank is that insupplying the liquidity necessary, it provides the best way todeal with crises once they have hit. Again it is evident that thefailure to clearly identify the essential root of the economicproblems of banking leads theorists to err substantially in