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

Central and Free Banking Theory 691Chart VIII-1 the increase in the demand for fiduciary mediashifts the hypotenuse of the triangle toward the left. Thismovement reflects a drop in the monetary demand for consumerand investment goods, since the proportion of one tothe other (or time preference) has not varied. In this chart, surface“A” represents economic agents’ new demand for (or“hoarding” of) fiduciary media (see Chart VIII-1).The fundamental conclusion of the theory of monetaryequilibrium in a fractional-reserve free-banking system is thatbanks would respond to this rise in the demand for fiduciarymedia by expanding their issuance by a volume equal to thatof the new demand (represented by surface “A”), and the productivestructure, as shown in Chart VIII-2, would remainintact (see Chart VIII-2).Nonetheless we must remember that banks do not directlytransfer the new fiduciary media they create to their final users(the economic agents whose demand for fiduciary media hasincreased by the volume represented by surface “A” in ChartVIII-1). Instead, the deposits are lent to entrepreneurs, whospend it on investment goods and thereby initially create a morecapital-intensive structure, which we represent in Chart VIII-3.Nevertheless this more capital-intensive productive structurecannot be maintained in the long term. For once the newfiduciary media reach their final recipients (who in the verybeginning accumulated the bank money they needed, as surface“A” in Chart VIII-1 indicates), they will spend them,according to our postulate of unchanging time preference, onconsumer and investment goods in a proportion equal to thatshown in Charts VIII-1 and VIII-2. If we superimpose ChartVIII-3 on Chart VIII-2 (see Chart VIII-4), the distortion of theproductive structure becomes clear. Shaded area “B” representsthe investment projects entrepreneurs have launched in error,since all of the fiduciary media banks have issued to adjust tothe increase in the demand for them have been channeled intoinvestment loans. 135 Shaded area “C” (with a surface identical135 Selgin and White implicitly acknowledge this point when they assert:Benefits accrue . . . to bank borrowers who enjoy a more amplesupply of intermediated credit, and to everyone who works