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

644 Money, Bank Credit, and Economic Cyclesfree-banking system as a means to curb abuses and movetoward the ideal of a 100-percent reserve requirement. 69The tradition of Modeste, Cernuschi, Hübner, andMichaelis was continued by Ludwig von Mises, who in 1912conclusively upheld the tenets of the Currency School. He notonly asserted that both banknotes and deposits were fiduciarymedia, but he also grounded monetary theory on that of marginalutility and Böhm-Bawerk’s theory of capital. The resultwas, for the first time, a complete, coherent and integratedtheory of economic cycles. Thus Mises realized that EnglishCurrency School theorists were mistaken in recommending acentral bank and that the best, in fact the only, way to achievethe school’s goals of monetary solvency was through theestablishment of a free-banking system subject, without privileges,to private law (i.e., to a 100-percent reserve requirement).Furthermore Mises recognized that in the end mostadvocates of Banking School principles cheerfully acceptedthe establishment of a central bank which, as lender of lastresort, would guarantee and perpetuate the expansionaryprivileges of private bankers. These individuals made anincreasing effort to shirk their commitments and devote themselvesto the lucrative “business” of creating fiduciary moneyvia credit expansion, and central-bank support allowed themto do so without having to worry too much about liquidityproblems. Not surprisingly, Mises is especially critical of thefact that Peel’s Bank Charter Act of 1844, despite the excellentestablish a 100-percent reserve requirement. Smith claims such an actionwould involve a deflationary process, but she fails to take into accountthat, as we will see in the next chapter when we consider the process oftransition toward a 100 percent-based system, it is not necessary to reestablishthe relationship which existed between banknotes and specieprior to the issuance of fiduciary media. On the contrary, any healthytransition process demands the avoidance of deflation and the redefinitionof the relationship between fiduciary media and specie in light ofthe total quantity of banknotes and deposits already issued by the bankingsystem. Therefore the point is not to trigger a monetary contraction,but to prevent any subsequent credit expansion.69 Otto Michaelis, Volkswirthschaftliche Schriften (Berlin: Herbig, 1873),vols. 1 and 2.