capitalism

24 Banking, Austrian Theory of
would document the fact that money had been deposited
with him and could be redeemed at any time.
Conceivably, bankers also would propose investment
schemes that bear a certain resemblance to the business of
storing money and issuing money titles. For example, they
could offer to issue IOUs for money invested in their bank
and try to make these IOUs more attractive by promising to
liquidate them on demand at face value. They might even
issue them in forms that are virtually identical with the
forms in which money titles appear: “bank notes,” “smart
cards,” “credit cards,” and so on. This, in turn, might induce
some market participants to accept these IOUs as payment
in market exchanges, just as they occasionally accept mortgages
or stock-market paper as payment.
Some economists think that such investment schemes
have been realized in the past and call them fractionalreserve
banking. They also use the term bank notes to
describe these IOUs. Still it is important to be aware of the
essential differences that exist between these IOUs and
money titles. Despite these resemblances in appearance and
use, money titles entail claims to money, while the promise
to redeem an IOU entails claims to the efforts of a banker.
Although all money titles can be redeemed at any time,
only a part of these IOUs can be liquidated as promised by
the banker, only a limited number of receipt owners can
obtain such liquidation at the same time, and so on.
Identical names and the identical outer appearance of
both money titles and liquid IOUs are not a mere coincidence.
Historically, in most cases, bankers issuing liquid
IOUs took pains to hide the real differences distinguishing
their product from genuine money titles. Insofar as such
efforts are meant to deceive other market participants,
fractional-reserve banking is a fraudulent scheme that violates
the principles of the free market and merely serves to
enrich some individuals (the bankers and their customers)
at the expense of all others.
The great issue in monetary and banking policy is
whether free-market banking and the free-market production
of money can be improved by schemes relying on coercion.
The history of monetary analysis and policy has been
the history of debates on the insufficiencies of the unhampered
market and on how to remedy them with statist monetary
schemes. Virtually all these discussions have revolved
around problems of alleged money shortages, and the
essence of all institutions designed to overcome these problems
is to produce more money than could possibly be produced
on the unhampered market.
Mercantilist writers traditionally argued that more
money meant higher prices and lower interest rates, and
that these in turn invigorated commerce and industry.
Moreover, it was much simpler to levy taxes in a monetary
system than in a barter economy. Thus, the mercantilists
urged that imports of gold and silver be stimulated through
tariffs on foreign goods and export subsidies for domestic
products, endorsed fractional-reserve banking to the benefit
of the Crown, and supported special monopoly privileges
for national or central banks.
They had a point: The kings profited from increased
monetary circulation, which made looting their subjects far
easier. However, the French physiocrats and the British classical
economists were able to entirely destroy the intellectual
underpinning of the mercantilist scheme. Tariffs and
export subsidies, they pointed out, cannot permanently increase
the domestic money supply, and the amount of money circulating
in the economy has no positive impact on trade and
industry considered as a whole. The great contribution of
classical economics to the theory of monetary policy was to
show that increasing the quantity of money could never
increase the amount of services that money can render to the
nation as a whole. A higher money supply merely leads to
higher money prices, but it does not affect aggregate industry
and aggregate real output. This principle is what classical
economists had in mind when referring to money as a
veil that is superimposed on the physical economy.
Later economists further refined this analysis by giving a
more sophisticated account of the impact of money on the
real economy. They showed that increases in the money supply
brought about two forms of redistribution of income. On
the one hand, increasing the money supply entailed that the
purchasing power of each money unit is diluted. If this loss
of purchasing power was not anticipated, the effect would
be that borrowers would benefit at the expense of lenders.
On the other hand, and independently of the market participants’
anticipations, new money first reaches some market
participants before others, and these people can now buy
more out of an unchanged supply of real goods. All others
will buy less at higher prices as the less valued money circulates
throughout the economy because spending the additional
money units raises market prices. Hence, although
variations in the quantity of money bring no overall
improvement for the national economy, they benefit some
persons, industries, and regions at the expense of the other
market participants.
For more than 100 years, the idea that a community
could promote its well-being by increasing the money supply
beyond what would exist on the unhampered market
was discredited among professional economists, although
the influential J. S. Mill undermined this monetary orthodoxy
by various concessions.
Then John Maynard Keynes almost single-handedly
gave new life to the old mercantilist policies. The charismatic
Keynes was the most famous economist of the bestknown
economics department of his time. In his writings,
public speeches, and private conversations, he used his personal
and institutional prestige to promote the idea that
multiplying money could achieve more than simply redistributing
income in favor of the government and the groups
that control it.