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

A Proposal for Banking Reform:The Theory of a 100-Percent Reserve Requirement 763to disproportionate investment projects which they will neverbe able to successfully complete.Therefore this second objection is unfounded: with a 100-percent reserve requirement, banks would continue to loanwhat is saved, yet entrepreneurs would tend to invest savedfunds in a much more prudent, realistic manner. If, from thestart, businessmen were to encounter greater obstacles tofinancing certain entrepreneurial projects, such difficultieswould be the logical manifestation of the healthy functioningof the only market mechanism capable of halting the initiationof unprofitable investment projects in time, and thus avoidingtheir unwise and discoordinated execution, which the currentsystem promotes during credit booms.As to the interest rate, there is no indication that in thelong term it would be higher in the proposed system than inthe current one. Indeed the interest rate ultimately depends oneconomic agents’ subjective valuations of time preference. Inour model, economic agents would not be affected by the massivesquandering of capital goods which accompanies recurrenteconomic recessions. Furthermore it is clear that, otherthings being equal, in a system like the one we recommend, theinterest rate would tend to be quite low in nominal terms, sincethe corresponding premium for the expected evolution of thepurchasing power of money would in most cases be negative.Also, the component of risk would depend on the precariousnessof each specific investment project undertaken and, followinga period without economic recessions, would tend tofall as well. Hence we conclude that there is absolutely no theoreticalbasis for the assumption that the interest rate would behigher in the proposed system than it is now. Quite the reversewould be true. There are very powerful reasons to believe thatin both real and nominal terms, the market rates of interestwould be lower than those we are presently accustomed to. 6363 For example, let us suppose the economy grows at an average rate ofaround 3 percent per year, and the money supply (the world stock ofgold) rises by 1.5 percent. Under these circumstances, we will see veryslight deflation of 1.5 percent per year. If the real market rate of interestis 4 percent (a natural rate of 3 percent and a risk component of 1