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

708 Money, Bank Credit, and Economic Cyclespublic order and harms third parties. In fact, because fractional-reservebanking expands loans without the support ofreal saving, it distorts the productive structure and thereforeleads loan recipients, entrepreneurs deceived by the increasedflexibility of credit terms, to make ultimately unprofitableinvestments. With the eruption of the inevitable economic crisis,businessmen are forced to halt and liquidate these investmentprojects. As a result, a high economic, social, and personalcost must be borne by not only the entrepreneurs“guilty” of the errors, but also all other economic agentsinvolved in the production process (workers, suppliers, etc.).Hence we may not argue, as White, Selgin, and others do,that in a free society bankers and their customers should befree to make whatever contractual agreements they deemmost appropriate. 157 For even an agreement found satisfactoryby both parties is invalid if it represents a misuse of law orharms third parties and therefore disrupts the public order.This applies to monetary bank deposits which are held with afractional reserve and in which, contrary to the norm, bothparties are fully aware of the true legal nature and implicationsof the agreement.Hans-Hermann Hoppe 158 explains that this type of contractis detrimental to third parties in at least three differentways. First, credit expansion increases the money supply andthereby diminishes the purchasing power of the monetaryunits held by all others with cash balances, individuals whosemonetary units thus drop in buying power in relation to thevalue they would have had in the absence of credit expansion.Second, depositors in general are harmed, since the creditexpansion process reduces the probability that, in the absenceof a central bank, they will be able to recover all of the monetaryunits originally deposited; if a central bank exists, depositorsare wronged in that, even if they are “guaranteed” the157 See, for example, White, Competition and Currency (New York: NewYork University Press, 1989), pp. 55–56, and Selgin, “Short-Changed inChile,” p. 5.158 Hoppe, “How is Fiat Money Possible?—or, The Devolution of Moneyand Credit,” pp. 70–71.