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

A Proposal for Banking Reform:The Theory of a 100-Percent Reserve Requirement 777Even various members of the Neo-Banking School offractional-reserve free banking have exaggerated the supposeddangers of “deflation.” For example, Stephen Horwitzquestions the gradual, continuous decline in prices in ourmodel and states that just as sudden changes affect growthin prices today, abrupt decreases in prices would beinevitable in the system we propose (!). Horwitz fails to seethat a monetary standard inflexible to contractions wouldrender such abrupt decreases practically impossible, exceptunder the extraordinary circumstances of natural disasters,wars and other similar phenomena. Under normal conditions,there would be no reason for the demand for money toever increase traumatically; in fact it would graduallydecrease as the rise in the purchasing power of the monetaryunit made it unnecessary for economic agents to hold suchhigh real cash balances. 80The model of slight, gradual, and continuous “deflation”which would appear in a system that rests on a pure gold standardand a 100-percent reserve requirement would not onlynot prevent sustained, harmonious economic development,but would actively foster it. Furthermore this has taken place80 Horwitz, “Keynes’ Special Theory,” footnote 18 on pp. 431–32. MoreoverHorwitz asserts that the Austrians who defend a 100-percentreserve requirement have been unable to explain why a drop in thedemand for money would necessarily be different, in terms of favoringthe appearance of economic crises, than a rise in the supply of money.Horwitz overlooks the fact that it is the granting of fiduciary mediaunbacked by real saving, i.e., credit expansion, rather than a generalizeddecrease in the demand for money, which distorts the productive structureand causes crises. Other things being equal, a fall in the demand formoney could only cause a decline in the purchasing power of the monetaryunit and would not necessarily influence the creation of loansunbacked by real saving and thus, society’s productive structure. Hencewe must reject Horwitz’s conclusion that “100-percent reserve bankingis insufficiently flexible to maintain monetary equilibrium,” since thisnotion is based on a misleading theoretical analysis which fails to adequatelydeal with the mechanisms of discoordination set in motion inthe economic cycle.