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

704 Money, Bank Credit, and Economic CyclesCourcelle-Seneuil’s influence in Chile during the ten years hetaught there was so great that in 1860 a law permitting theestablishment of fractional-reserve free banking (with no centralbank) was enacted. At this point the traditional financialstability of the Chilean system gave way to stages of artificialexpansion (based on the concession of new loans), followedby bank failures and economic crises. The convertibility of thepaper currency was suspended on several occasions (1865,1867, and 1879), and a period of inflation and serious economic,financial and social maladjustment began. This periodresides in the collective memory of Chileans and explainswhy they continue to mistakenly associate financial disturbanceswith the doctrinal economic liberalism of Courcelle-Seneuil. 151151 Albert O. Hirschman, in his article, “Courcelle-Seneuil, Jean-Gustav,”The New Palgrave: A Dictionary of Economics, John Eatwell, Murray Milgate,and Peter Newman (London: Macmillan, 1992), vol. 1, pp. 706–07,states that Chileans have even come to demonize Courcelle-Seneuil andto blame him for all the economic and financial evils which befell Chilein the nineteenth century. Murray N. Rothbard believes this demonizationis unjust and stems from the fact that the poor functioning of thefree-banking system Courcelle-Seneuil introduced in Chile also discreditedthe deregulating initiatives he launched in other areas (such as mining),when these efforts had a positive effect. See Murray N. Rothbard,“The Other Side of the Coin: Free Banking in Chile,” Austrian EconomicsNewsletter (Winter, 1989): 1–4. George Selgin responds to Rothbard’sarticle on free banking in Chile in his paper, “Short-Changed in Chile:The Truth about the Free-Banking Episode,” Austrian Economics Newsletter(Spring–Winter, 1990): 5ff. Selgin himself acknowledges that theperiod of free banking in Chile from 1866 to 1874 was an “era of remarkablegrowth and progress,” during which “Chile’s railroad and telegraphsystems were developed, the port of Valparaiso was enlarged andimproved, and fiscal reserves increased by one-quarter.” According tothe Austrian theory, all of these phenomena are actually symptoms ofthe substantial credit expansion which took place during those yearsand was ultimately bound to reverse in the form of a recession (as, infact, occurred). However Selgin attributes the subsequent bank crises(but not the recessions) to the Chilean government’s maintenance of anartificial parity between gold and silver. When gold rose in value, thisparity resulted in the massive outflow of gold reserves from the country(see Selgin, “Short-Changed in Chile,” pp. 5, 6 and footnote 3 on p. 7).