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

Second, there is the distinction between the banks as "cloakrooms" (and bankers as mere middlemen) among final borrowers and primary lenders, and as creators of (bank) credit ex nihilo. Mises sets off from the idea that, as long as they issue only monetary certificates (notes and deposits wholly covered by reserves), the banks put into circulation purchasing power that is already present in the system but whose origin he does not explain. We can thus understand those who want to attribute to Mises the traditional idea that the collecting of deposits is a necessary condition prior to the granting of loans. But there is room for a very different reading. For, Mises says very clearly that when the issue of banknotes or the extending of loans become a normal banks' business, they lend from a fund" that did not exist before the loans were granted' (Mises, 1971, p. 271). From here there is only one step to stating that in a modern banking system, loans always precede deposits.(18) With the passage of time, however, Mises is more insistent on the need to keep the closest possible correspondence between credit extended and reserves of money. To this end, he discusses a variety of possible means of monetary reform. Thus, the monetary economy is referred back to "commodity credit," the one ruling in a barter economy, and banks are forced to operate as simple intermediaries in transferring purchasing power from savers to entrepreneurs. But, when money substitutes serve the same functions as money in the narrower sense, and it becomes possible to issue more of them than there are money certificates, the banking system has the means for the creation of bank money.(19) The equality between loans and deposits of money proper must then be interpreted in Mises as an equilibrium condition, or better still, as a brake imposed on banks to hinder investments exceeding savings.(20)

Third, we saw at the outset that a very authoritative - and, maybe, the most widespread among non-Austrian authors - reading of Mises attributes to him the idea that the inflationary process comes to an end because the banks are compelled to raise the interest rate to deal with liquidity problems arising from an internal and/or external drain of metallic money. He does allow that a sequence of this sort can indeed come about, but he does not appeal to it in the abstract reconstruction of the business cycle. What stops him is his powerful reference to Wicksell's pure credit, even in a mixed-money economy. So powerful a reference that Mises takes Wicksell to task for the contradiction between that model (which is the Swede's underlying picture of the cumulative process) and the readjustment mechanism that Mises sees at work on the same pages of Interest and Prices. It is worth quoting Mises at length here:

But if we start with the assumption, as Wicksell does, that only fiduciary media are in circulation and that the quantity of them is not legislatively restricted, so that the banks are entirely free to extend their issues of them, then it is impossible to see why rising prices and an increasing demand for loans should induce them to raise the rate of interest they charge for loans. Even Wicksell can think of no other reason for this than that since the requirements of business for gold coins and bank-notes becomes greater as the price level rises, the banks do not receive back the whole of the sums they have lent, part of them remaining in the hands of the public; and that the banks reserves are consequently depleted while the total liabilities of the banks increase; and that this must naturally induce them to raise their rate of interest. But in this argument Wicksell contradicts the assumption that he takes as the starting-point of his investigation. Consideration of the level of its cash reserves and their relation to the liabilities arising from the issue of fiduciary media cannot concern the hypothetical bank that he describes. He seems suddenly to have forgotten his original assumption of a circulation consisting exclusively of fiduciary media, on which assumption, at first, he rightly laid great weight (Mises, 1971, p. 356; emphasis added).(21)