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

678 Money, Bank Credit, and Economic CyclesIn a nutshell, this argument centers around the hypotheticalresults of an increase in economic agents’ demand for fiduciarymedia, assuming reserves of specie in the banking systemremain constant. In that event, theorists reason, the paceat which fiduciary media are exchanged for bank reserveswould slacken. Reserves would increase and bankers, awareof this rise and eager to obtain larger profits, would expandcredit and issue more banknotes and deposits, and the growthin fiduciary media would tend to match the prior increase indemand. The opposite would occur should the demand forfiduciary media decrease: Economic agents would withdrawgreater quantities of reserves in order to rid themselves offiduciary media. Banks would then see their solvency endangeredand be obliged to tighten credit and issue fewer banknotesand deposits. In this way a decrease in the supply offiduciary media would follow the prior decrease in thedemand for them. 113The theory of “monetary equilibrium” obviously echoesFullarton’s law of reflux and, especially, the Old BankingSchool arguments concerning the “needs of trade.” Accordingto these arguments, private banks’ creation of fiduciary mediais not detrimental if it corresponds to an increase in the“needs” of businessmen. These arguments are repeated andcrystallized in the “new” theory of “monetary equilibrium,”which states that private banks’ creation of fiduciary media inthe form of notes and deposits does not generate economiccycles if it follows a rise in public demand for such instruments.Although Lawrence H. White does develop an embryonic versionof this reformed “needs of trade” doctrine in his book onfree banking in Scotland, 114 credit for theoretically formulating113 The detailed analysis appears, among other places, in Selgin’s book,The Theory of Free Banking, chaps. 4, 5 and 6, esp. p. 34 and pp. 64–69.114 Stephen Horwitz maintains that Lawrence Whiteexplicitly rejects the real-bills doctrine and endorses a differentversion of the “needs of trade” idea. For him the “needsof trade” means the demand to hold bank notes. On this interpretation,the doctrine states that the supply of bank notesshould vary in accordance with the demand to hold notes. As