The Theory of Money and Credit - Ludwig von Mises [146]
Of course, all of this is true only under the assumption that all banks issue fiduciary media according to uniform principles, or that there is only one bank that issues fiduciary media. A single bank carrying on its business in competition with numerous others is not in a position to enter upon an independent discount policy. If regard to the behavior of its competitors prevents it from further reducing the rate of interest in bank-credit transactions, then—apart from an extension of its clientele—it will be able to circulate more fiduciary media only if there is a demand for them even when the rate of interest charged is not lower than that charged by the banks competing with it. Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow an independent interest policy. But in doing so, they help to stabilize the objective exchange value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause. And just because it has employed a false principle for explaining the phenomenon that it has observed, it has also completely closed the way to understanding of a second tendency of the market, that emanates from the circulation of fiduciary media. It was possible for it to overlook the tact that so far as the banks proceed uniformly, there must be a continual augmentation of the circulation of fiduciary media, and consequently a fall of the objective exchange value of money.
5 The Significance of the Exclusive Employment of Bills as Cover for Fiduciary Media
The German Bank Act of March 14, 1875, required that the notes issued in excess of the gold cover should be covered by bills of exchange; but in practice this provision has been understood to refer only to commodity bills. The significance of this prescription differs from that popularly attributed to it. It does not make the note issue elastic; it does not even bring it, as is erroneously believed, into an organic connection with the conditions of demand for money; these are all illusions, which should long ago have been destroyed. Nei ther has it the significance for maintaining the possibility of conversion of the notes that is ascribed to it; this will have to be referred to in greater detail later.
The limitation of the note issue not covered by metal, that is of fiduciary media in the form of banknotes, is the fundamental principle of the German act, which is based upon Peel's Act. And among the numerous and multiform obstacles that have been set up with this aim, the strict provision concerning the investment of the assets backing the note issue takes a not altogether unimportant place. That these must consist not merely in claims, but in claims in the form of bills; that the bills must have at the most three months to run; that they should bear the names, preferably of three, but at least of two, parties known to be solvent—all these conditions limit the note issue. At the very beginning, a considerable part of the national credit is kept away from the banks. A similar effect results from the further limitation of the note cover merely to commodity bills, as was undoubtedly intended by the legislature even though express provision for it was omitted from the Bank Act, probably because of the impossibility of giving a legal definition of the concept of a commodity bill. That this limitation did in fact amount to a restriction of the