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

Central and Free Banking Theory 639supposed “need” for a “rational” monetary policy imposedfrom above through the central bank. The second argument isrelated to the first and centers around the need to establish anadequate policy of monetary cooperation among differentcountries. Supposedly this goal also requires the existence ofdifferent, coordinated central banks. We will examine the theoreticalimpossibility of implementing a monetary and bankingpolicy in a centralized, coercive manner through a centralbank in a forthcoming section, where we will apply the theoryof the impossibility of socialism to the banking and financialsector. Therefore we will refrain from analyzing these last twoarguments in depth here.THE POSITION OF THE CURRENCY SCHOOL THEORISTSWHO DEFENDED A FREE-BANKING SYSTEMUnfortunately, due to their inability to equate the economiceffects of deposits with those of banknotes, and to theirnaiveté in proposing the creation of a central bank to check theabuses of fractional-reserve banking, Currency School theoristswere unable to foresee that the remedy they prescribedwould necessarily prove much worse than the sickness theyhad correctly diagnosed. Only a handful of Currency Schooltheorists understood that their goals of monetary stabilityand solvency would be at much greater risk if a central bankwere created, and as a lesser evil and in order to preventabuses as far as possible, these theorists recommended themaintenance or establishment of a free-banking system withno central bank. Nonetheless most Currency School writerswho defended free banking were not deceived as to theexpansionary possibilities of such a system, and they alwaysmaintained that the final solution to the problems posed wouldonly be achieved with the prohibition of the issuance of newfiduciary media (i.e., with the prohibition of credit expansionunbacked by an increase in real voluntary saving). In proposinga system in which banks could freely issue bills and deposits,they basically hoped that interbank clearing mechanisms, customersupervision and control through the market, and theimmediate failure of banks which lost public confidencewould serve to more effectively limit the issuance of unbacked