Between Wicksell and Hayek: Mises' theory of money and credit revisited - Special Invited Issue: Money, Trust, Speculation and Social Justice - Part 2: Trust and Money

American Journal of Economics and Sociology, The, Oct, 1998 by Riccardo Bellofiore

On the basis of this analysis of the money supply, Mises observes that Wicksell's account of an "organised credit economy" concentrated on the case of "pure credit" is far from illogical. Indeed, it is quite proper and applies also to less strict conditions than the Swede had presupposed. As long as nonconvertible paper money is the only sort in circulation and the banks increase their liabilities at the same pace, the supply of money substitutes is infinitely elastic. By definition, within a world economic system there cannot be any "external drain."(16) Nor is there any need for an adjustment mechanism to deal with "internal drain." For this would presuppose that inflation, the inflow of fresh fiduciary media, would give rise to an outflow of commodity money from circulation on account of an increase in demand for it as cash and for industrial purposes - something that is explicitly ruled out under these hypotheses. Furthermore, we know

That all credit-issuing banks endeavor to extend their circulation of fiduciary media as much as possible, and that the only obstacles in their way nowadays are legal prescriptions and business customs concerning the covering of notes and deposits, not any resistance on the part of the public. If there were no artificial restriction of the credit system at all, and if the individual credit-issuing banks could agree to parallel procedure, then the complete cessation of the use of money [in the narrower sense] would only be a question of time. It is, therefore, entirely justifiable to base our discussion on the above assumption [of a situation akin to the "pure credit" system]. (Mises, 1971, p. 358)

The tendency toward the pure credit system, the only one on which banking theory should start dealing with interest rate policy and relative prices in pure theory, is already written into the actual trend. If it has not been yet fully realized, that is because of legal and political obstacles, which hold on to the use of metallic money at the national and international level. Sticking to the assumption of pure credit and supposing that no commodity money circulates, Mises concludes that" there is no longer any limit, practically speaking, to the issue of fiduciary media" (Mises, 1971, pp. 358-359; emphasis added).

It is worth pointing out three features of Mises' monetary analysis. First, in the passages we have been discussing, we find a particularly lucid and consistent analysis of the creation of the money supply. In modern terms, the Theory highlights how, in a fiat money system, an individual bank's credit potential is constrained by the market share in deposits, whereas there is no such limit for the banking system taken as a whole or for banks growing in concert.(17) Moreover, whereas in a closed economy where the central bank is liquid by definition, it is not so in an open economy where payments are not regulated by the bank's liabilities and it is necessary for the bank to get hold of reserves of means of payment that are accepted abroad.