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

Central and Free Banking Theory 653and credit matters, our situation matches that which prevailedin the socialist countries of the former Eastern bloc, whichattempted to coordinate their economic decisions andprocesses through a system of central planning. In otherwords “central planning” has become commonplace in thebanking and credit sector of market economies, so it is naturalthat in this area we should see the same discoordination andinefficiency which plagues socialism. Let us now examinethree separate instances of interventionism and/or privilegesin the organization of banking. The theorem of the impossibilityof socialism applies in each, namely: (a) the most widespreadcase of a central bank which oversees a fractionalreservebanking system; (b) the case of a central bank whichmanages a banking system that operates with a 100-percentreserve ratio; and finally, (c) the case of a free-banking system(with no regulation and no central bank) which neverthelessexercises the privilege of maintaining only a fractional reserve.though the notion that the current banking system shares the characteristicsof a socialist or controlled economy may initially surprise many, itis easy to understand when we remember that: (a) the entire systemrests on the government monopoly on currency; (b) the system is basedon the privilege which permits banks to create loans ex nihilo by holdingonly a fractional reserve on deposits; (c) the management of the wholesystem is performed by the central bank, as an independent monetaryauthority which acts as a true planning agency with respect to the financialsystem; (d) from a legal standpoint, the principle which applies tothe government, i.e., that it may act only within its jurisdiction, alsoapplies to banks, in contrast to the rule for other private entities, whomay always do anything that is not prohibited; (e) banks are commonlyexcluded from the general bankruptcy proceedings stipulated in mercantilelaw and are instead subject to administrative law proceduressuch as intervention and the replacement of management; (f) bank failuresare prevented by externalizing the effects of banks’ liquidity crises,the costs of which are met by the citizenry through loans from the centralbank at prime rates or non-recoverable contributions from a depositguarantee fund; (g) a vast, inordinately complicated set of regulationsapplies to banking and closely resembles that which controls government;and (h) there is little or no supervision of government interventionin bank crises. In many cases such intervention is determined adhoc, and principles of rationality, efficiency, and effectiveness are disregarded.