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

A Proposal for Banking Reform:The Theory of a 100-Percent Reserve Requirement 7695. “Financial ‘innovations’ will inevitably trigger the resurgenceof fractional-reserve banking.” According to this argument,any legal precautions taken to prohibit fractional-reservebanking and, thus, to establish a 100-percent reserve requirementon demand deposits will be insufficient; such measureswill always, ultimately be circumvented via new forms ofbusiness and financial “innovations” which, in evasion of thelaw or not, in one way or another, will tend to achieve thesame end as fractional-reserve banking. Hence as early as 1937even Hayek affirmed:It has been well remarked by the most critical among the originatorsof the scheme that banking is a pervasive phenomenonand the question is whether, when we prevent it fromappearing in its traditional form, we will not just drive itinto other and less easily controllable forms. 71Hayek cited Peel’s Act of 1844 as the most notable precedent.Because those who introduced this act neglected toimpose a 100-percent reserve requirement on deposits, fromthat point on, monetary expansion mainly took the form ofdeposits, rather than banknotes. 72as Gresham’s Law. Imagine a potential bank customer who isoffered two types of deposits with a bank. He believes thatboth deposits deliver exactly the same services. The only differenceis that he has to pay for the first type of deposit,whereas he does not have to pay—or even receives payment—forthe second type of deposit. Clearly he will choosenot to be charitable to his banker and will subscribe to adeposit of the second type. When genuine money titles andfractional-reserve IOUs are confused, therefore, the latter willdrive the former out of the market. (Hülsmann, “Has Fractional-ReserveBanking Really Passed the Market Test?” pp.399–422; quotation is from pp. 408–09)71 Hayek, Monetary Nationalism and International Stability, p. 82. On thesame topic, see Simons, “Rules versus Authority in Monetary Policy,” p.17.72 However, we can imagine how different the economic history of thelast 150 years would have been had Peel’s Act not neglected to imposea 100-percent reserve requirement on deposits as well! Incidentally,Hayek has argued that it is impossible to radically separate the different