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

A Proposal for Banking Reform:The Theory of a 100-Percent Reserve Requirement 767this legitimacy in keeping with traditional legal principles. Infact if third parties suffer harm as a result of such a contract,the contract is illegitimate, null, and void, because it disruptsthe public order. 67 According to the analysis we present in thisbook, it is precisely this lack of legitimacy which pertains tofractional-reserve banking. This practice not only gives rise tothe creation of additional means of payment to the detrimentof all citizens, who watch as their monetary units decline inpurchasing power; 68 it also deceives entrepreneurs on a broadscale, leading them to invest where and when they should not,and triggering recurrent cycles of boom and recession with avery heavy cost in human, economic and social terms.Finally, we must counter the oft-heard argument 69 whichcenters around the claim that economic agents are unwilling67 By the same token, a free, voluntary “contract” by which two partiesagree that one will pay the other to murder a third party would beinvalid, since it would disturb the public order and be detrimental tothird parties. The contract would be null and void even in the absenceof deception or fraud, and even if both parties entered into it willfullyand with full knowledge of its nature.68 We are not referring to a drop in purchasing power in absolute terms,but in relative terms, with respect to the growth which could beexpected in the purchasing power of money in a banking system with a100-percent reserve ratio. In addition, the economic consequences ofcurrent banking practices are, in this respect, identical to those of counterfeiting,an activity everyone agrees should be punished as a breach ofpublic order, even if it is impossible to individually identify its victims.69 Juan José Toribio Dávila offers this critical argument, among others,in his paper, “Problemas Éticos en los Mercados Financieros,” which hepresented at the Encuentros sobre la dimensión ética de las instituciones ymercados financieros, which took place in Madrid under the auspices ofthe Fundación BBV in June 1994. Moreover Toribio Dávila argues thata stable monetary policy could be achieved with any reserve ratio, whilehe fails to consider the factors behind the theoretical impossibility ofcentral planning in general, and of its application to the financial sectorin particular. These factors account for central bankers’ lack of abilityand desire to adequately calculate the demand for money and to controlthe supply which, supposedly, should match the demand. FurthermoreToribio Dávila overlooks the profound discoordinating effects whichany growth in the money supply in the form of credit expansion (i.e.,