Easing the Limits on Bank Credit Expansion

0:00Easing the Limits on Bank Credit Expansion The institution of central banking eased the free market restrictions on fractional reserve banking in several ways. In the first place, by the mid-19th century, a tradition was craftily created that the central bank must always act as a lender of last resort to bail out the banks should the bulk of them get into trouble. The Central Bank had the might, the law, and the prestige of the state behind it. It was the depository of the state's accounts, and it had the implicit promise that the state regards the Central Bank as too big to fail. Even under the gold standard, the Central Bank note tended to be used, at least implicitly, as legal tender, and actual redemption in Banking gold, at least by domestic citizens, was increasingly discouraged, though not actually prohibited.

1:03Backed by the central bank and beyond it by the state itself then, public confidence in the banking system was artificially bolstered and runs on the banking system became far less likely. Even under the gold standard then, domestic demands for gold became increasingly rare and there was generally little for the banks to worry about. The major problem for the bankers was international demands for gold. For while the citizens of, say, France could be conned into not demanding gold for notes or deposits, it was difficult to dissuade British or German citizens holding bank deposits in francs from cashing them in for gold.

1:48The Peel Act system ensured that the central bank could act as a cartilaging device and in particular to make sure that the severe free market limits on the expansion of any one bank could be circumvented. In a free market, as we remember, if a Rothbard bank expanded notes or deposits by itself, these warehouse receipts would quickly fall into the hands of clients of other banks and These people or their banks would demand redemption of Rothbard warehouse receipts in gold. And since the whole point of fractional reserve banking is not to have sufficient money to redeem the receipts, the Rothbard bank would quickly go under.

2:33But if a central bank enjoys the monopoly of banknotes and the commercial bank's all-paramid expansion of their demand deposits on top of their reserves or checking accounts at at the Central Bank, then all the bank need do to assure successful cartelization is to expand proportionately throughout the country so that all competing banks increase their reserves and can expand together at the same rate. Then, if the Rothbard Bank, for example, prints warehouse receipts far beyond, say, triple It's reserves and deposits at the central bank. It will not on net lose reserves if all the competing banks are expanding their credit at the same rate.

3:21In this way, the central bank acts as an effective cartelizing agent. But while the central bank can mobilize all the banks within a country and make sure they all expand the money substitutes they create at the same rate, They once again have a problem with the banks of other countries. While the Central Bank of Ruritania can see to it that all the Ruritania banks are mobilized and expand their credit and the money supplied together, it has no power over the banks or the currencies of other countries. Its cartelizing potential extends only to the borders of its own country.