The Theory of Money and Credit - Ludwig von Mises [143]
That demand for money and money substitutes which determines the exchange ratio between money and other economic goods achieves expression only in the behavior of individuals when buying and selling other economic goods. Only when, say, money is being exchanged for bread is the position of the economic goods, money and commodity, in the value scales of the individual parties to the transaction worked out and used as a basis of action; and from this the precise arithmetical exchange ratio is determined. But when what is demanded is a money loan that is to be paid back in money again, then such considerations do not enter into the matter. Then only the difference in value between present goods and future goods is taken into account, and this alone has an influence on the determination of the exchange ratio, that is, on the determination of the level of the rate of interest.
For this reason the Banking principle is unable to prove that no more fiduciary media can be put into circulation than an amount determined by fixed circumstances not dependent on the will of the issuer. It has therefore directed its chief attention to the proof of the assertion that any superfluous quantity of fiduciary media will be driven out of circulation back to the issuing body. Unlike money, fiduciary media do not come on to the market as payments, but as loans, Fullarton teaches; they must therefore automatically flow back to the bank when the loan is repaid. [12] This is true. But Fullarton overlooks the possibility that the debtor may procure the necessary quantity of fiduciary media for the repayment by taking up a new loan.
Following up trains of thought that are already to be found in Fullarton and the other writers of his circle, and in support of certain institutions of the English and Continental banking system, which, it must be said, have quite a different significance in practice than that which is erroneously ascribed to them, the more recent literature of banking theory has laid stress upon the significance of the short-term commodity bill for the establishment of an elastic credit system. The system by which payments are made could, it is said, be made capable of the most perfect adjustment to the changing demands upon it, if it were brought into immediate causal connection with the demand for media of payment. According to Schumacher, that can only be done through banknotes, and has been done in Germany by basing the banknotes on the commodity bills, the quantity of which increases and decreases with the intensity of economic life. Through the channel of the discounting business, in place of interest-bearing commodity bills (which have only a limited capacity of circulation because their amounts are always different, their validity of restricted duration, and their soundness dependent on the credit of numerous private persons), banknotes are issued (which are put into circulation in large quantifies by a well-known semipublic institution and always refer to the same sums without limitation as to time, and therefore possess a much wider capacity of circulation, comparable to that of metallic money). Then on the redemption of the discounted bill an exchange in the contrary direction is said to take place: the banknotes, or instead of them metallic money, flow back to the bank, diminishing the quantity of media of payment in circulation. It is argued that if money is correctly defined as a draft on a consideration for services rendered, then a banknote based on an accepted commodity bill corresponds to this idea to the fullest extent, since it closely unites the service and the consideration for it and regularly disappears again out of circulation after it has negotiated the latter. It is claimed that through such an organic connection between the issue of banknotes and economic