Lesson 9 of 9
The narrow agreement
After two lessons of argument, the part nobody disputes. The definitions and the mechanism are shared, and one question is left between the sides.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- Both sides use Mises's categories, both hold that competing banks restrain each other through redemption, and both hold that a central bank removes the restraint.
- Both hold that credit nothing real supports drives the money rate below the natural rate, and that this is what starts the cycle. That mechanism is the next course.
- One question is left: whether claims issued to meet a greater demand to hold them count as credit of that kind.
Two lessons of argument. This one states what is not in dispute, which is more than either of them would suggest.
Where the line actually falls
Not in dispute
- Mises's categories: money proper, substitutes, certificates, fiduciary media.
- That a redeemable fractionally backed claim is not a fiat money.
- That competing banks restrain each other through redemption and clearing.
- That a central bank removes the restraint.
- That credit nothing real supports drives the money rate below the natural rate.
In dispute
- Whether an issue matched by a greater demand to hold it is credit of that kind.
- Whether holding money is a form of saving.
- Whether a demand deposit is a bailment or a debt.
- Whether competitive note issue was stable where it was tried.
The agreement is about the mechanism. The disagreement is about what trips it.
The restraint, and what removes it
Rothbard gives a chapter of The Mystery of Banking to the limits on bank credit inflation under free banking, and concludes there that redemption demanded by one bank of another keeps any single bank's expansion severely limited. That is the restraint Selgin's chapter 3 names the principle of adverse clearings.
Mises states it too, in the section on the freedom of the banks: banks in one country, or in several, cannot increase their issue unless the others do the same. Both sides then hold that a central bank removes it, and Rothbard's next chapter is titled for exactly that.
The mechanism
Both sides accept the step the rest of this track is built on. Mises sets it out in the part of The Theory of Money and Credit on money, credit and interest: a money rate held below the rate that would match saving to investment changes which projects look worth starting, and the crisis is the correction.
Selgin and White say plainly that they share the view that monetary instability contributes to cycles and crises. They differ on its cause, not on what it does.
The one question left
Whether claims issued because people want to hold more of them are credit of that kind.
The striking thing is that Mises wrote both answers into one section of Human Action. A footnote there says the idea of a normal credit expansion is absurd, because any issue of additional fiduciary media sets in motion the price changes the cycle theory describes. In the same section he writes that free banking is the only method available for preventing the dangers of credit expansion, and that it would not stop a slow expansion by cautious banks that disclose their position.
The full-reserve side takes the footnote. Selgin and White take the passage. Each is reading him accurately, which is why the dispute has lasted.
Why it matters, and what it is not
Not a forecast, and it does not become one. It decides what a credit figure means before anybody interprets it.
Told that bank credit grew, a reader has one of the two numbers the argument turns on. The other is whether the demand to hold those claims grew too. On one account the first settles it. On the other it settles nothing. Neither says what happens next, and the next course says why a mechanism of this shape cannot be turned into a date.
Check yourself
Which restraint do both sides accept?
- A statutory reserve requirement
- That competing banks force each other to contract by presenting claims for redemption
- That depositors monitor their bank's reserve ratio
Show the answer
Answer: B.
Rothbard's chapter on the limits under free banking and Selgin's principle of adverse clearings describe the same thing, and Mises states it too.What is the question actually left open?
- Whether banks should be regulated
- Whether an issue matched by a greater demand to hold the claims counts as credit expansion
- Whether the money rate can differ from the natural rate
Show the answer
Answer: B.
Both sides accept the categories and the mechanism. They divide on whether that particular issue trips it.What does the disagreement change for a reader?
- Which direction rates will move
- What a figure for credit growth means before anyone interprets it
- Whether the cycle theory is correct
Show the answer
Answer: B.
One account reads credit growth as sufficient on its own. The other asks whether the demand to hold those claims grew too.Sources
- Mises, The Theory of Money and Credit, German original 1912, English translation by Batson 1934, part three, chapter 18 on the redemption of fiduciary media, where the case for prohibiting their issue is set out and declined; chapter 19 on money, credit and interest, on the equilibrium rate against the money rate of interest and on credit and economic crises; and chapter 20, section 11, on the problem of the freedom of the banks, where he states that banks in one country or in several cannot increase their issue unless the others do the same.
- Mises, Human Action, 1949, chapter XVII, section 12, on the limitation of the issuance of fiduciary media and its observations on the discussions concerning free banking, which is where both halves of the later dispute appear: the footnote holding that any issue of additional fiduciary media sets the cycle's price changes in motion, and the passage holding that free banking is the only available method of prevention and would not stop a slow expansion by cautious banks.
- Rothbard, The Mystery of Banking, 1983, chapter VIII on free banking and the limits on bank credit inflation, where the day-to-day restraint is redemption demanded by the customers of other banks, and chapter IX on central banking removing those limits.
- Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue, 1988, chapter 3, for the same restraint under the name principle of adverse clearings.
- Selgin and White, 'In Defense of Fiduciary Media, or, We are Not Devo(lutionists), We are Misesians!', Review of Austrian Economics, volume 9 number 2, 1996, for their statement that they share the view that monetary instability contributes to cycles and crises while attributing it to central banking and other intervention rather than to fractional reserves as such.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The 8 percent is invented to show where the two readings diverge. It describes no banking system and no period.
- The agreement described here is about analysis, not about policy. The two sides disagree sharply about what should be permitted, and this track takes no position on that.
- Calling the remaining disagreement narrow is this lesson's own summary of the works cited. Economists on both sides have argued at length that it is not narrow at all, and neither side has signed this description of it.