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

810 Money, Bank Credit, and Economic Cyclescredit expansion and for imposing on all citizens the legal tenderregulations of its own monopolistic currency.Nevertheless the unfortunate social consequences of thisprivilege granted to bankers (yet to no other institution or individual)were not entirely understood until Mises and Hayekdeveloped the Austrian theory of economic cycles, which theybased on the theory of money and capital and we analyzed inchapters 5 through 7. In short, Austrian theorists have demonstratedthat the pursuit of the theoretically impossible (from alegal-contractual and technical-economic standpoint) goal ofoffering a contract comprised of fundamentally incompatibleelements, a contract which combines ingredients typical ofmutual funds (particularly the possibility of earning intereston “deposits”) with those typical of a traditional deposit contract(which by definition must permit the withdrawal of thenominal value at any time) will always, sooner or later, triggercertain spontaneous readjustments. Initially these readjustmentstake the form of the uncontrolled expansion of themoney supply, inflation, and generalized poor allocation ofproductive resources on a microeconomic level. Eventuallythey manifest themselves in financial crisis, an economic recession,the elimination of the errors exerted on the productivestructure by credit expansion, and massive unemployment.It is important to understand that the privilege whichallows banks to operate with a fractional reserve represents anobvious attack by government authorities on the correct definitionand defense of depositors’ private-property rights,when respect for these rights is essential to the proper functioningof any market economy. As a result, a typical “tragedyof the commons” effect invariably appears, as it does wheneverproperty rights are not adequately defined and defended.This effect consists of an increased inclination on the part ofbankers to try to get ahead of their competitors by expandingtheir own credit base sooner and more than their rivals. Consequentlythe fractional-reserve banking system always tendstoward more or less rampant expansion, even when it is“monitored” by central bankers who, contrary to what hasnormally occurred in the past, seriously (and not just rhetorically)concern themselves with setting limits.