What is the basic business cycle theory developed by the Currency School?

0:00For various reasons, the banking analysis was the most popular in early classical economics in 19th century Britain where the so-called currency school works out a pretty accurate business cycle theory, at least in an embryo, emphasizing the fact that the central bank and the fractional reserve banking is the key to the flume and bust situation. Almost every macro text or international trade text has this famous known as the classical price duty flow mechanism, which is considered sort of a classical theory of international money. It's really also a theory of business cycles, and interestingly enough, Ludwig von Mises is the first modern economist to point that out.

0:45This is also a theory of business cycles, sort of a basic theory of business cycles, Namely, when the, let's say you have several countries. Country A, let's say France, it places the money supply by pouring in paper money, either convertible or inconvertible, let's say convertible theory, fractional reserve, several banks, pours them into credit, increases the money supply. Money supply goes up. This leads to an increase in prices. And as prices go up and money supply goes up, several things happen. People have more money in their pocket, more francs in their pocket. They pay for francs, but they're francs they can spend.

1:30Therefore, in addition to domestic spending going up, raising prices, foreign spending goes up. People spend more on imports, smaller domestic goods. So imports go up. Prices go up, as prices go up, another thing happens, another effect is that the fresh prices become great sentences compared to everything else, and so exports go down, and also imports go up further, so like a double effect here, much in that foreign prices are cheaper than domestic prices, and so this gives another impulse to imports. So imports go up quite a bit, exports go down, and how do the Frenchmen pay for this? There's a dozen balance of payments, gold's closed down, and as Frenchmen confront this, and the inflation proceeds get worse and worse.

2:20And you have a fractional reserve banking system with gold, several banknotes and commercial banks currently on top of the world. It's kind of a pyramid generated on top of the bank. At the top of the pyramid, paper francs keep increasing, commercial banknotes and bonds will go up. Gold is starting to flow out. Gold is flowing out of France. This makes the whole thing very top-top. The banks are getting more and more shaky positions. As far as it's going up on the French banks and pay up, the French are going to go into the French banks and pay up. They're getting scared of the ratio of getting worse week after week. And finally, the banks, in order to save themselves, the banks of France and so contracts.

3:05And you have then, this is the boom phase of the cycle, because the expansion in money and credit, Expansion prices go to close out, as the booms say, then somebody has a contraction, they have to save themselves, they have the next contract and they supply. The supply falls and prices fall and the whole thing sort of collapses. This is the recession phase of the business cycle. And then exports increase as French prices go down again and gold goes back in.