The Theory of Money and Credit - Ludwig von Mises [142]
Tooke, Fullarton, Wilson, and their earlier English and German disciples, teach that it does not lie in the power of the banks-of-issue to increase or diminish their note circulation. They say that the quantity of notes in circulation is settled by the demand within the community for media of payment. It the number and amount of the payments are increasing, then, they say, the media of payment must also increase in number and amount; if the number and amount of the payments are diminishing, then, they say, the number and amount of the media of payment must also diminish. Expansion and contraction of the quantity of notes in circulation are said to be never the cause, always only the effect, of fluctuations in business life. It therefore follows that the behavior of the banks is merely passive; they do not influence the circumstances which determine the amount of the total circulation, but are influenced by them. Every attempt to extend the issue of notes beyond the limits set by the general conditions of production and prices is immediately frustrated by the reflux of the surplus notes, because they are not needed for making payments. Conversely, it is said, the only result of any attempt at an arbitrary reduction of the note circulation of a bank is the immediate filling of the gap by a competing bank; or, if this is not possible, as for instance because the issue of notes is legally restricted, then commerce will create for itself other media or circulation, such as bills, which will take the place of the notes. [9]
It is in harmony with the views expounded by the Banking theorists on the essential similarity of deposits and notes to apply what they say on this point about notes to deposits also. It is in this sense that the doctrine of the elasticity of fiduciary media is generally understood today;[10] it is in this sense alone that it is possible to defend it even with only an appearance of justification. We may further suppose, as being generally admitted, that it is not because of lack of public confidence in the issuing bank that the fiduciary media are returned to it, whether in the form of notes presented for conversion into cash or as demands for the withdrawal of deposits. This assumption also agrees with the teachings of Tooke and his followers.
The fundamental error of the Banking School lies in its failure to understand the nature of the issue of fiduciary media. When the bank discounts a bill or grants a loan in some other way, it exchanges a present good for a future good. Since the issuer creates the present good that it surrenders in the exchange—the fiduciary media—practically out of nothing, it would only be possible to speak of a natural limitation of the quantity of fiduciary media if the quantity of future goods that are exchanged in the loan market against present goods was limited to a fixed amount. But this is by no means the case. The quantity of future goods is indeed limited by external circumstances, but not that of the future goods that are offered on the market in the form of money. The issuers of the fiduciary media are able to induce an extension of the demand for them by reducing the interest demanded to a rate below the natural rate of interest, that is below that rate of interest that would be established by supply and demand if the real capital were lent in natura without the mediation of money,[11] whereas on the other hand the demand for fiduciary media would be bound to cease entirely as soon as the rate asked by the bank was raised above the natural rate. The demand for money and money substitutes that is expressed on the loan market is in the last resort a demand for capital goods or, when consumption credit is involved, for consumption goods. He who tries to borrow "money" needs it solely for procuring other economic goods. Even if he only wishes to supplement his reserve, he has no other object in this than to secure the possibility