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

Central and Free Banking Theory 655cannot prevent it. In a fractional-reserve free-banking system(with no central bank), the reversion tends to occur much earlier,due to spontaneous interbank clearing processes (thoughthe productive structure is still somewhat distorted). The creationof a central bank to act as lender of last resort and supplythe liquidity necessary in times of crisis tends to neutralize themarket’s spontaneous reversion and recovery processes, and asa result expansionary policies can become much more lastingand damaging. 81The central bank, as the “financial central-planningboard,” embodies an intrinsic contradiction. Indeed, as F.A.Hayek has revealed, all central banks face a fundamental dilemma,since they invariably wield great discretionary power in the administrationof their policies, yet they do not have all the informationthey need to reach their objectives. The central bank exercises itspower over private banks mainly by threatening to not providethem with the liquidity they need. And at the same timeit is believed that the chief duty and purpose of the centralbank consists precisely of not refusing to supply the liquiditynecessary when bank crises hit. 8281 Furthermore the central bank cannot guarantee all customers of privatebanks the recovery of their deposits in monetary units of unalteredpurchasing power. The belief that central banks “guarantee” all citizensthe return of their deposits, regardless of the actions of the private banksinvolved, is pure fiction, since the most central banks can do is to createnew liquidity ex nihilo to meet all deposit demands private banks areconfronted with. Nevertheless, by doing so they trigger an inflationaryprocess which often significantly lowers the purchasing power of themonetary units withdrawn from the corresponding deposits.82 There is one basic dilemma, which all central banks face,which makes it inevitable that their policy must involve muchdiscretion. A central bank can exercise only an indirect andtherefore limited control over all the circulating media. Itspower is based chiefly on the threat of not supplying cashwhen it is needed. Yet at the same time it is considered to beits duty never to refuse to supply this cash at a price whenneeded. It is this problem, rather than the general effects ofpolicy on prices or the value of money, that necessarily preoccupiesthe central banker in his day-to-day actions. It is atask which makes it necessary for the central bank constantly