Why Mises Thought Fractional Reserve Banking Caused the Boom-Bust Cycle

This is the Human Action Podcast where we debunk the economic, political, and even cultural myths of the days. Here's your host, Dr. Bob Murphy. Hey everybody, welcome back to Human Action Podcast. In this episode, we are returning to the issue of fractional reserve banking because in the commentary following the wake of my last episode, it became clear to me that even people that I know are trying to be above board and even handed and intellectually curious. They're misunderstanding what the objection is coming from the Mises, and I would even say, "Hi-Eck, Rothbard, Ian Camp, two fractional reserve banking per se." So that's what I'm going to cover in this episode, whether you agree with it or not, I just want to lay out why I'm going to focus on Mises himself. I also have a quote from Hi-Eck, why they thought fractional reserve banking per se really causes the boom bust cycle. I think that's particularly relevant. It's not merely that I'm saying, "Hey, Mises and Hi-Eck were pretty good economists, don't you think?" And since they thought fractional reserve banking caused the business cycle, maybe you should too. That's not my point, even though that wouldn't be a weak point. My point is there are a lot of people who call themselves Austrian school economists or fans of the Austrian school, and yet they side with guys like George Selgin and Larry White on the issue of what's called free banking, which is what I talked about last episode. So I'm saying it's interesting that I think a lot of people believe that the business cycle is caused by artificially low interest rates fueled by cheap credit. Maybe they think the federal reserve causes the business cycle because it pumps in artificially cheap credit, and they know the standard Austrian story about what are artificially low interest rates that causes businesses to expand entrepreneurs, run their calculations at the low interest rates and think that a project sustainable when really it isn't, there's not enough genuine saving, all that kind of stuff. And yet, a lot of them nonetheless think that guys like George Selgin and Larry White are correct in saying, "Hey, just let the free market decide banks can set whatever reserve ratios they want." And so in that context, then I'm talking to those sorts of people, and I used to be in that camp myself, it's relevant to know that the very theory of the business cycle you are endorsing, if you go and read the people who developed it and see what do they say causes that very same business cycle, it is not the central bank. It is the banking system per se. It is private banks who are engaging in what Mises called credit expansion, and that is fractional reserve banking per se. It's not overly excessive fractional reserve banking or fractional reserve banking subsidized or protected by government intervention that then takes things too far. No, it's having reserve ratios below 100% per se causes the boom bus cycle and the Misesian framework. Again, maybe Mises was wrong. I'm not making an appeal to authority. I'm just saying there's lots of people who, if you ask them what causes the business cycle will give you some variant of the story Mises told, and I don't think they're aware of what Mises thought actually sowed the seeds of the boom bus. Okay. So that's the main thing. Before I get going, let me just have a housekeeping note. After reviewing the last episode I did where I was quoting heavily from Murray Rothbard's book review of Larry Whites book on free banking in Scotland, we are focused on heavily. George Selgin said, "Hey, Bob, why don't you link to Larry Whites response?" All right. At the time I wasn't trying to hide it or something. I linked to what George's view on was just inside the people. Go ahead and check out George's views on this if you want to see the free banker position. But sure. I will, in the show notes to this page, go ahead and add this. I'll also see if we can add it to the other one too, just for completeness, for people who've stung on that other episode. Okay. So again, Larry Whites in a subsequent edition of his free banking in Britain, I think was the title, has a section where he specifically responds to the pretty harsh review that Rothbard gave of the first edition of that book. All right. So I will link to that in the show notes page. So returning now to our present discussion here, what I'm also going to link to because I'm going to draw upon it heavily is my article in the quarterly journal of Austrian economics called More than Quibbles, problems with the theory and history of fraction reserve free banking. And the point here isn't to tout me. The point is because I had all the quotes from Mises that I wanted in this article. And so that's why it's handy is a reference. So I'll link to this in case you want to go look this up stuff up yourself. Okay. My plan for the rest of this episode of the Human Action podcast is I'm going to read some quotes to make it unambiguously clear that little Vignan Mises, whether he was right or wrong, thought that fraction reserve banking is what caused the boom bus cycle, not government intervention. And then after I document that, I will stop back and try to give some intuition to understand why was he saying that? All right. That's my plan for the rest of this episode. Okay. So the smoking gun for Mises on this issue to me is taken from human action. It's actually in a footnote, but you know, it flows with the with the main text. And I think this is it right here. So here's Mises in human action. The notion of quote normal, so he's got the word normal in quotation marks. The notion of normal credit expansion is absurd, issuance of additional fiduciary media, no matter what its quantity may be, always sets in motion. Those changes in the price structure, the description of which is the task of the theory of the trade cycle. Of course, if the additional amount issued is not large, neither are the inevitable effects of the expansion. Okay. So again, let me just in case I'm losing some people fiduciary media, that's a weird term, right? That's not something that you usually learns the sixth grade. So what does that mean? In the Mises in framework, fiduciary media referred to claims that banks issue that are not backed up by money proper in the vault. All right. Back in the days when private banks used to issue bank notes, like if there are gold coins where they actually will hard money, the lawful money of the realm, right? That's what people would pay for goods and services with is gold coins, let's say, and then a bank for convenience is, hey, why don't you put your gold coins on deposit with us in what's called a demand deposit account, meaning anybody here, here's some notes issued by this bank. The bearer of this note, a pond demand can get one gold coin, present it to any of our branches. All right. And so then the bank's got to store the gold coins in the vaults. So in the Misesian framework, in the terminology he adopted, if such a bank were to print up more claim tickets, more such notes than it had coins in the vault, then the excess, the amount of notes issued over and above what they had in the vault are what Mises called fiduciary media, okay. And so again, look at this quote, and also, I should say, what's a credit expansion? For Mises, credit expansion is when the banks issue new amounts of fiduciary media over and above what they previously had issued, all right. So it can come in ways, right? If they just issue a bunch of new fiduciary media, that's a credit expansion. But then if that works, it's course, and the banks just keep rolling those loans over. So like maybe there's 50% reserves that there's a thousand ounces of gold coins in the vault and the banks printed up 2,000 ounces worth of notes that, you know, each note says the bear of this can turn in for one ounce of gold. And there's 2,000 such notes circulating the community. Once the bank does that, that initial printing of an excess 1,000 is credit expansion. But then once it works, it's effects in the community. If that's all the banks do for the rest of time, and they just maintain that 50% reserve and you've got 1,000 coins sitting in the vaults and 2,000 notes circulating amongst the members of the community, that's not continued credit expansion. That just means, yeah, there's fiduciary media floating around, right? But if they were then to lower the reserve ratio again and print up more notes still backed up by that same thousand ounces of gold in the vault, that would be an additional round of credit expansion, right? That's the way he's using these terms. So again, now that I've clarified what his terms mean, let's read that again. The notion of normal credit expansion is absurd. Issues of additional or fiduciary media, no matter what its quantity may be, always sets in motion. Of course, if the additional amount issued is not large, neither are the inevitable effects of the expansion, okay? So Mises has very Germanic flower language, but for him, the trade cycle is what we call the business cycle, all right? So back in the day, he referred to it as the circulation credit theory of the trade cycle because to him, circulation credit has to do with his fiduciary media, okay? All right? So that's his view. So let me just back up a second, 'cause I alluded earlier to this saying, I saw some people commenting on my last video and I realized they honestly don't get what the issue is. Again, maybe guys like Joe Salerno and Rothbard and Naomi following their footsteps are wrong, but it's important at least I wanna make sure people understand what the claim is. Like this is what I was debating George Selgin at the Soho Forum years ago. And so the issue is not, there might be a bank run, okay? And yeah, some of us are guilty of this and myself included that we focus on that 'cause that's gripping to the public and also for me it gives me a chance to do my Jimmy Stewart impression. But the issue, when Austria and when Rothbardians in particular, but I'll say Missessians, right? And this dimension say that fractional reserve banking is economically destabilizing or causes financial instability. We don't mean because hey, there could be a bank run in which case some of the depositors lose their money or people only end up getting paid $0.88 on the dollar. And so that's disruptive. No, that's not what we mean. That yes, that might happen. And maybe that's an indication of the public that something's screwy, right? The fact that the banks are doing this where if all of a sudden people lose confidence in the system and all comes crashing down, like maybe that's an indirect bit of evidence that something dubious is going on, right? 'Cause it's not like in other industries that happens where all of a sudden people show up at target and wanna buy all the stuff that target has available or exercise their gift certificates as target fails, right? That if target issue too many gift certificates then that would be a problem for target, right? So there's other lines that doesn't seem to be an issue, but yet with banks, if too many of their customers take advantage of what they're contractually, you know, have the right to do, then the whole system fails, okay? So, but the point is, from my point right now, is that's not the problem, okay? And I'm bringing this up because again, I saw some people saying things like, well, this is just like insurance, right? That, you know, the fractional reserve bankers in a genuinely free market, they just make estimates about how many people on a given day are gonna show up and wanna take their gold coins out of the vault. And, you know, they made entrepreneurs make estimates of that and maybe they're right, maybe they're wrong, but hey, that's the market, man. Then if they're too optimistic and they make too many loans and they have too many gold coins out, earning them interest and then the original depositors show up and they want their money and, oh, that's it and they go under. But just that's just like, you know, an insurance company. If they don't correctly forecast how many car access are gonna be and they don't charge enough in premiums, they go out of business. Rothbardians don't have a problem with that, right? They don't want the government doing top-down central planning of car insurance, right? So why would you do it with bank? And I'm saying that's missing the point because again, the issue here, you know, Mises did not say the problem is that people might show up and not get their money back. No, the issue is, as I'm gonna spell out as we go through this episode, that fractures reserve banking causes the boom bus cycle, even if there's no bank runs. It would still cause the boom bus cycle. As Mises says here, issuance of additional and fiduciary media, no matter what its quantity may be, always sets in motion, those changes in the price structure, the description of which is the task of the theory of the trade cycle, right? He didn't say an issue of additional fiduciary media if it outstrips the demand to hold more bank notes, right? He didn't say that or he didn't say, if it's subsidized by government either directly or like indirectly via FDIC or something. No, Mises just flat-out said that this practice always sets in motion the trade cycle. However, if this phenomenon is limited in scope, well, then the resulting trade cycle is not gonna be a big deal, right? He says that too. Okay, let's move on. Just to give a quick quote from Hayek. In 1925, he actually, so this is Larry White writing about it. White saying Hayek in 1925, suggested in one of his earliest writings, a radical solution to the problem of swings in the volume of commercial bank credit imposed 100% marginal reserve requirement on all bank liabilities. Okay, so I want to be clear. I'm not saying for his entire career, Hayek insisted on 100% reserves, but I'm saying at one point, he did throw that out there as, this is one possible remedy to this issue that he was studying. Likewise with Mises, in the early 1950s, he wrote an essay which happens to be included in an appendix to what we call the theory of money and credit in later editions of that. And the name of the essay, the title of the essay, was the return to sound money, right? And so he talks about like some fictitious country, Rootania, and how, oh, they went off the gold standard, but how do we get them back on the gold standard? And then he writes a section or devotes a section to the United States. Again, he's writing the 1950s, and this is an excerpt from that. So this is Mises. No bank must be permitted to expand the total amount of its deposits, subject to check or the balance of such deposits of any individual customer, otherwise then by receiving cash deposits in legal tender bank notes from the public, or by receiving a check payable by another domestic bank, subject to the same limitations. This means a rigid 100% reserve for all future deposits. In other words, all deposits not already in existence on the first day of reform. Okay, so what he was insisting on there in this particular proposal was he was saying, he wasn't saying right now, boom, we just switch over to having all, not just federal reserve notes, but any private bank demand deposits be backed up 100% by gold. Rather, what he was saying is what you do is you figure out what's the, the dot in the case of the US, the dollar price of gold that you're gonna lock in. Go ahead and lock that in, and then going forward not only do official lawful money of the United States that the Federal Reserve would issue have to be backed up any new printing of currency would have to be backed up 100% by new gold in the vaults, the government vaults, but that even with a bank, it would have to be new loans or whatever new checking account deposits would have to be backed up 100% by lawful money, which is now backed up by gold puttin' in the vaults. Okay, so the idea was over time, any new money, new dollars created would on the margin be backed up 100% by gold. And so over time asymptotically, all of the dollar supply would eventually be backed up by gold 100% again. All right, so that was his plan. I wanna be clear, I'm not here saying that throughout his career, Mises was in favor of the government mandating 100% reserves. I'm just saying, though, he did happen to have that as a feature of a proposal he wrote in the '50s. Okay, so this, I'm partly going over this stuff because one of the moves from some of the people from GMU and that crowd is to make it sound like it's these nutty Rothbardians who have this fixation with 100% reserves, where is the real economist? No, that's crazy. And we talking about lots of people, not just the Austrians, but the Chicago School too, Irving Fisher for example, had a famous plan for 100% reserves. In more modern times, other mainstream economists have also floated that idea. Like after the 2008 crisis, some economists that gained currency again, no pun intended, to say why don't we go back to 100% reserves? Maybe that would stop this instability in the banking sector, okay? So this is a very respectable idea. And yes, Murray Rothbard happened to champion it, but it's not 'cause it's some crankish notion. Okay, let me continue. I think I haven't seen other people make this point. So you can gain insight into what Mises thought caused the boom bus cycle and whether it was fractured reserve banking per se, or just if it goes too far, or fractured reserve banking under the wrong circumstance, right? 'Cause that's what the free bankers will say. Is it, no, no, it's not fractures or banking per se, that's the problem. It's only like if it's subsidized by the government or whatever, all right? There, you know, if it's, if there's FDIC, which kind of covers their losses and things like that. All right. So to that end, I think this is very instructive. So let me just take a moment to spell this out for you folks. Murray Rothbard in his book, his magnum opus, man economy in state, you know, his grand treatise on economics, he had to organise in different sections. And so one section just deals with isolated man, another section deals with man, you know, in the market economy where there's other people involved in private property and the use of a money commodity, but it's all voluntary. And then he has a section where people, you know, there's all those attributes, but it's not voluntary. There's coercion involved. And so that also allows for the analysis of government intervention because that's coercive. All right. So that's the, you know, some of the main portions of the book are how it's structured. And so where is Rothbard going to talk about wages? Well, he's going to talk about that in the pure market economy part. Where is he going to talk about interest rates, the pure market economy part? Where is he going to talk about how do you analyse a sales tax or how do you analyze? um, government caused hyperinflation. Clearly that's in the interventionist part, right? So where does Rothbard talk about the boom bus cycle? He talks about it in the section dealing with government intervention because in Rothbard's view, the boom bus cycle is we know it doesn't happen on a free market. And I think there's like two main reasons for that that are complimentary. So Rothbard agrees with me, is that what causes the boom bus cycle, you know, as we know it, right? Like there's this general upswing in the activity of the marketplace. Business in general seems brisk. Everybody seems to be doing well. Wages are rising. Businesses are expanding, you know, bidding workers away. Unemployment goes down. And then all of a sudden things change for some reason. pessimism sweeps the land. It seems like a bunch of businessmen realize all kind of at the same time, we were too optimistic. They start laying people off and then there's a crash. So the issue is what explains that, that phenomenon, right? Because it's not just, yeah, somebody might open a restaurant and think, oh, this area wants Thai food and he's wrong. He tries it for a while and goes out of business, right? We're not talking about any particular business going under. That's normal. The issue is there seems to be a cluster of errors. And so that's what we're trying to explain with the theory of the business cycle. And so Rothbard, following me says, thinks that its fractures are banking per se that causes that. But Rothbard doesn't think that phenomenon happens on a free market. And why not? It's because he doesn't think fractures are banking happens on a free market. Now why not? And I think there's two reasons. So I think one is that Rothbard believes there's something just dubious about the essence of fractures or banking that there's some sense in which is fraudulent. And so he thinks a court system in a, you know, anarcho-capitalist society where everything's private, including judicial opinions being rendered in the police force and whatnot, competing police agencies and so forth. He thinks in that kind of a system that the judges would rule according to common sense. And, you know, he thinks common law traditions and so forth going back to Roman times and that, yep, it's like a belliment contract, right? And he thinks that Rothbard thinks his government intervention on behalf of wealthy bankers over the centuries that put us in our current position where you make a demand deposit. And that's viewed as a loan to the bank as opposed to them storing your money for safekeeping, okay? So that's one reason. But even beyond that, sort of like as an independent check, there's a view among 100% reservists that if the government would just get out of the banking sector and stop propping up fractures or banking with, you know, a central bank being a lender of last resort. So whenever banks get caught of their pants down the center bank rushes in to rescue them, right? That's going to subsidize their recklessness and also having a cartel so that if a rival bank wants to open up that has a higher reserve ratio than its peers, over time it will tend to attract their deposits from their vaults into its own vault. That's a mechanism that like Vera Smith spelled out in her famous book, The rationale of central banking, right? And Mises endorses that argument, okay? So the idea is either whether it's done because of the legal system or just market mechanics would naturally lead surviving banks in the long run equilibrium to have a very high reserve ratio. So for those reasons, in general Rothbard thought in a free market, you wouldn't have fractures or banking, you wouldn't have the business cycle. So Rothbard can just to summarize in his treatise man economy and state when he's explaining the boom bus cycle, where does he put it in the book? He puts it in the section in the part where he's talking about government intervention. Mises doesn't do that, right? So Mises also, you know, splits the book up into those things like isolated man just talks about praxeology per se Robinson Crusoe alone on a tropical island and you have the categories of action and blah, blah, blah. Up, once you introduce multiple people, now it gets more complicated. Can have exchange things like that and Mises still. Yep. Files, you know, has that pattern where he first analyzes a voluntary market setting, catalactics is you add in private property and the use of money. Okay, that's what we think of as economics proper. And then Mises has to, you know, section on just outright socialism. And then he has a section to vote as interventionism or what we call the mixed economy, you know, like that term. Okay. But where does Mises put the study of the business cycle? Here, he doesn't do it Rothbard did. Mises puts it in the section dealing with the pure market economy and that might surprise you. But it's very instructive to hear why Mises put it there. Okay. And so this is what he says. You might say, well, what do we have to catch him on his deathbed? Talk him. No, he explains it right in human action why I did that. Okay. So this is going to be a lengthy quote. But again, this to me is crystal clear in trying to understand when you like the Mises, the necessity and theory of the boom bus cycle, what did he think actually triggered it? Listen to this long passage. I'm going to read you from human action. It is beyond doubt that credit expansion is one of the primary issues of interventionism. Nevertheless, the right place for the analysis of the problems involved is not in the theory of interventionism, but in that of the pure market economy. For the problem we have to deal with is essentially the relation between the supply of money and the rate of interest, a problem of which the consequences of credit expansion are only a particular instance. This is key folks. Everything that has been asserted with regard to credit expansion is equally valid with regard to the effects of any increase in the supply of money proper as far as this additional supply reaches the loan market in an early stage of its inflow into the market system. If the additional quantity of money increases the quantity of money offered for loans at a time when commodity prices and wage rates have not yet been completely adjusted to the change in the money relation, the effects are no different from those of a credit expansion in analyzing the problem of credit expansion. Cadillactics completes the structure of the theory of money and of interest. Let me pause there. I have some more to read, but let me just make sure you're getting it. What he's saying there is that, yes, right now in this section of human action, he's going through and talking about what happens when banks engage in credit expansion. In other words, issue more quantities of fiduciary media, engage in further fractionalized or banking. Make it making it deeper, right? He's saying that's going to cause the boom bust cycle, but he said the reason I'm putting this analysis here in this section of my book, my treatise, dealing with the pure market economy, he said, even though, yes, political interference historically has been intertwined with banks expanding credit and you might think it's only having to, you know, it's only an issue of interventionism. He said that would be incorrect because Mises thinks, in principle, forget the banks. Suppose I'm here, I'm giving more flavor to his remarks, but this is definitely what he's saying. Suppose you got an economy that just consists of gold coins, right? There's no banks at all. In the miners are out prospecting, you know, near a town or something, they're out in the stream or whatever out in the mountains and they get a mother load and they come in and they got all these new, all those new gold that they come into town with. And in a very familiar process called Cantalon effects, the idea is when this new money enters the system, it doesn't just cause all wages and prices to go up proportionally. Instead, the sequence by which the new money enters can affect things, right? So if the new miners come into town and they roll into the saloon and they start plunking down gold, buying whiskey and, you know, playing cards and doing other things that the Sunday preacher wouldn't approve of, that's going to push up prices in the town, but not all prices uniformly. No, it's going to push up the price of whiskey and, you know, other things, right? And then it's only going to step by step spread out, right? So the saloon owner now is going to have more money. And then maybe he buys his wife a new fur coat and that's going to push up the price of the luxury clothing. And then that person, whoever the merchant in that shop who imports stuff from France or whatever, he's going to have more money and then he's going to go maybe buy some horses. And then now the, you know, the guys run the cattle and the horses and whatnot, the ranch, the ranchers, they, they have more income and they go do something. They buy real estate and push up those prices, okay? So that's the idea that step by step is the money enters the system, it percolates around, raising prices. in its wake. Alright? That's a well-known thing called Cantalon effects. Name there's the guy who spelled it out. So the Austrian theory of the business cycle is just one particular application of that process when the new money enters the economy via the loan market. Alright? And Hayek in his book Prices and Production, which is based on lectures he gave at the London School of Economics where he was like teaching the Austrian theory of the business cycle to an English-speaking audience. Hayek explicitly makes that connection. When he's given the historical antecedents of the stuff he's about to teach them, when he's going to get into what we think of now as a Hayekian triangle and all that stuff, Hayek explicitly links it and says, "Oh yeah, Richard Cantalon showed how new money entering the system can affect prices in different sequences and they can have real effects." Right? It's not just a wash that, "Oh yeah, the money supply doubles, all the prices just double and that's it and everything's the same." No, that's not at all what happens. And so the Hayek was saying, "Okay, so you see that general phenomenon? Now I'm going to go through here and these lectures are about to give you folks and walk through a particular instance of that, namely, where the banks expand credit and that's how new money enters the economy via the banking system, not coming from increased output from goldmines." Okay? So again, what Mises is saying here is that just think back, "I've got to put in words as a mouth, but this is clearly what he's saying in the eras I'm giving you an illustration of his point is that it doesn't have to be credit expansion that causes the boom bus cycle. If new genuine commodity money comes into the system, but early on enters via the loan market, then that would also set in motion the trade cycle." Okay? So think back to our miners near a town and they come rolling and they got all this extra gold. So you know in the long run what's going to happen is the prices of everything in the town quoted in gold ounces is going to be higher because there's this big influx of new money coming in, even though it's hard commodity money, gold. They're still going to cause prices quoted in gold to go up. So and we talked about, well, what if they roll in the saloon first? That's going to push up the price of whiskey first. But what if instead of going into the saloon, what if they go to the banks first and they put on a clunk down the gold there and put it into their accounts? And then the bankers now, and even if they buy like CDs and say, yeah, yeah, here I want to save this, let me buy 12 month CDs. And now the bankers had this influx of new money and they go lend it out. Okay? That just as we saw, even though, you know, there's nothing coercive involved about the miners coming in and buying whiskey, right? They didn't cheat them and they didn't defraud anybody. It was really gold. It wasn't fake, but yet that has cantalana facts, right? And so Mises is saying here, if they happen instead of spending on whiskey, if they go ahead and give it to the bankers and it enters the community through loans, then that's also going to set in motion the trade cycle. I'll read that part again and then I'll continue reading. Everything that has been asserted with regard to credit expansion is equally valid with regard to the effects of any increase in the supply of money proper. So money proper, meaning like not bank notes, but like the actual underlying lawful money. Everything asserted with regard to credit expansion is equally valid with regard to the effects of any increase in the supply of money proper. As far as this additional supply reaches the loan market at an early stage of its inflow into the market system, if the additional quantity of money increases the quantity of money offered for loans at a time when commodity prices and wage rates have not yet been completely adjusted to the change in the money relation, the effects are no different from those of a credit expansion. Okay, so now just to get as, you know, to dot his eyes and cross his teeth though, Mises is going to explain, because you might be saying, oh, so how come Mises didn't think historically the business cycle was all about, you know, new discoveries of gold happening to hit the loan market first. And he's going to explain why empirically, even though he just said theoretically, you could have a boom bus cycle, even just from gold, and during the system, you know, via the loan market first, why he's going to say empirically, that's not a big deal. And why, you know, it's important for economists to focus on bank credit expansion to understand historically what the heck goes on with the market economy when it has these boom bus cycles. Okay, so here's Mises. What differentiates credit expansion from an increase in the supply of money as it can appear in an economy employing only commodity money and no fiduciary media at all is conditioned by divergences in the quality of the increase and in the temporal sequence of its effects in the various parts of the market. Even a rapid increase in the production of the precious metals can never have the range which credit expansion can attain. The gold standard was an efficacious check upon credit expansion is it forced the banks not to exceed certain limits in their expansion and ventures. The gold standards own inflationary potentialities were kept within limits by the vicissitudes of gold mining. Moreover, only a part of the additional gold immediately increased the supply offered on the loan market. The greater part acted first upon commodity prices and wage rates and affected the loan market only at a later stage of the inflationary process. Okay, so there's to recapitulate there we said there's two main reasons even though after Mises says theoretically, yet even in a pure market economy, even without fiduciary media, whatsoever, if everyone just used hard commodity money and there was no banks or there was no fiduciary media, excuse me, you could still have the boom bus cycle. If there's an expansion in the stock of money proper, there's new gold being mined. That's money. It's interchangeable with the other types of gold. This isn't fake or artificial. It's not unbacked. This is not a gold. But if the people came and happened to give that to the bankers first before they spent that elsewhere and that's so the rest of the economy is receiving this new influx of gold only downstream from the banks, Mises is saying, yep, in theory, that would cause the boom bus cycle too, just as surely as credit expansion. And that's why again, Mises saying that's why I'm analyzing this in the portion of my treatise human action dealing with the pure market economy. However, he's saying in practice, there's two main reasons we don't really, we need to worry about gold production causing a boom bus cycle. The first reason is it's just a scale issue that, in any given year, the amount of new gold being mined relative to the existing stock of gold that's already been mined is pretty small compared to like, you know, even with gold rushes and whatever, compared to the ability of the banking system to rapidly expand the quantity of money. Okay, so he says there's no comparison there in terms of just how much can you scale up the stock of money if you're doing it with gold coins versus paper bank notes. Okay, so there's that element with anything even beyond that, even if there is a huge increase in how much gold was mined this year, you know, compared to previous years, still in practice, most of that new gold entering the market comes in various channels. It doesn't all flow through the loan sector. Whereas with credit expansion, it's not just that the increase in the stock of money can be larger because it's easier to print bank notes than to go dig up gold, but also all of it when it's there's bank credit expansion, all of that new money comes in the economy via loans being made by the bankers. Whereas again, new gold is mined, it's coming in through all sorts of channels. Only one of it would be the loan market. Okay. All right, so I will stop reading from mises there and let me just now just take a few moments here as I wind this thing down just to try to give you the big picture. Right. So I think I've stressed, some might say too much beaten a dead horse that clearly mises thought it was bank credit expansion per se that causes the boom bus cycle. Right. And that's why I spent so much time going through that. Once you see the logic, again, whether you think it's right or wrong, and this is there's all sorts of debate Austrians have on this stuff. Okay. Walter Block and Bill Barnett don't think that newly mined gold can cause a boom bus cycle. They think, well, no, if the people go to town and they give it to the banks, that genuine saving. And so yep, interest rates would go down to get that gold out into the system, but that's correct. In other words, that's not artificially low interest rates. Okay. That's a plausible argument or perspective. Not saying they're wrong. Right. So here again, don't don't misunderstand me. I'm not laying down what I think the gospel is. I'm just telling you what mises view was. Okay. But I'm saying when you understand that, you see how mises was saying, yeah, if new money, even in the form of gold coins, enters the economy via the loan market, that's going to set in motion a small boom bus cycle. All right, because how are those coins gonna get out? out there. It's going to have to temporarily lower the interest rate. And that's what it's going to cause the boom bus cycle. So once you see that, then you see how it has to be the case that Mises thinks when the banks just print up more paper tickets without there having been more genuine saving involved, that also has to set in motion the boom bus cycle. It doesn't matter whether the public wants to hold more bank notes, I'll sell it in white, right? Mises there wasn't saying, oh, well, you know, if the demand to hold gold coins went up, and that's what spurred the miners to go dig up more gold. And then they put it, you know, they gave it to the banks, then it would be an empirical question to see like a magnitude. If you know, did the amount flown to the banks exceed the public's desire to hold more gold? No, Mises didn't talk about that at all. You saw how crystal clear he was. New money enters the system. If it goes to the low market first in a relative of the other stage, cause the boom bus cycle. Okay. So again, maybe he's right. Maybe he's wrong. That's his view. So given that, you can see why he thinks fiduciary media per say causes the boom bus cycle. So where's he coming up with that? Let me just end trying to give you the intuition. And here it's good to take the advice from Hayek. He's got a line. And I first saw this Roger Garrison had this as like the tag line for his, one of his PowerPoint presentations where, where Garrison shows sustainable versus unsustainable. I'll link to that case you haven't seen it, folks. It's really good stuff. But, um, Roger Garrison, the late novel, like Roger, they had an amazing set of PowerPoints. And one of them is to show sustainable, expand a sustainable expansion of the production structure versus an unsustainable one. And he starts out with a quote from Hayek. This is a paraphrase as close though, saying something like, in order to understand what can go wrong with the market economy, it's first necessary to understand how things could ever go right. All right. So the idea is instead of just jumping right into and saying, Oh, what causes the business cycle? First, just think through how complicated the market economy is when you start realistically incorporating in your conception of it, the structure of production that spans years. Right? That, you know, there's, um, things are, are, are, are, let's do it to agricultural one, right? So first, the farmers harvest the wheat. And then that gets ground in the flower. And then the bakers take that and they mix it with water and, and they make bread. And then that goes somewhere and it gets packaged up and slight, you know, sliced in package and it goes to a warehouse. And then they put it on a truck and that goes out to a grocery store, right? And so there's all these different stages involved spanning along stretch of time. And if you talk about like mining metals and stuff like that and how long that process could be. All right. You see how complicated the market economy is. And so now one of the features of that is the rate of interest. And it's not just in the loan market, but it also pervades the entire structure of production in that you have what are called higher order goods like, you know, wheat or raw metal that's first mined. You know, that's very distant from the final consumption good. And so people get that at a high stage, they process it a little bit, then they sell it to the next stage, right? So like the eighth order good might be processed and sold to the seventh stage, seventh order stage in the Austrian terminology. And they add some labor to it. Some other raw materials from nature process it, sell it to the sixth order and did, did it sew on down the line until it's finally the finishing touches are put on it. And now it's a consumer good for sale in the grocery store or at the mall. Okay. And so the point is at each stage, the people who spend money on the factors of production and buy the goods in process from the previous stage, they spend a bunch of money. Some time passes and then they sell, you know, they're things like a baton, they're handing down, but they keep adding to it. And then they sell it to the next stage. And so there's a markup all along the way due to the passage of time, right? Because you have to earn interest on the financial capital that you invested. And so the pervasive rate of interest prevailing in the market economy has to do with the magnitude of that markup. All right. And so that's partly what happens when you say, oh, what if people now decide to save more? And so if they save more, that means in general, they're willing to tolerate a smaller percentage markup in, you know, what they spend on the factors of production and buying, you know, the goods in process from the prior stage, they work on it, sell it to the next person in line, you know, over the course of a year, let's say. And so how much of a markup do they need to earn to make that worth their while? If people become more patient, they're willing to save more, that lowers that increment. Okay. And so that's what allows for an elongation of the structure of production. You can get higher orders of goods underway, right? Instead of having just eight stages, now you can have 12 rolling over. And so it takes, you know, 12 years now for the goods to reach the final consumer and that allows for higher physical productivity, right? Because longer, more around about processes, you can tend to find ones that are more physically productive. Okay. So this is all, you know, here I'm covering a lot of material, but I'm just trying to show you that's what the standard Austrian story is for genuine sustainable saving, leading to a sustainable expansion of production in a higher standard of living. It explains how can it be that if a society is willing to save more, it's standard of living is going to be higher in 20 years than a society that doesn't save as much. Okay. So now in that framework, Roger Harrison then shows, okay, so what if the interest rate falls, not because people save more, but because the banking system just creates more claim tickets on money and lends it out. And that's why the interest rate drops. And now it's unsustainable, right? Because now you're still trying to get expansion into those earlier stages, workers and other materials are now redeployed away from consumer goods into the earlier stages, but you don't have the genuine saving, right? So the original process that was sustainable because people were saving more consumption actually drops in the short term. That's how that's what it means to save more. You live below your means out of your income, you consume less. So the idea is in the aggregate, the macro lines up with the micro, if you want to talk like that in a sustainable expansion, because when households save more, consumption drops. So the businesses that previously were making TVs and sushi dinners and sports cars, shrink, they release some of their workers and the other equipment and raw materials and stuff that went into those lines. And those can be redeployed earlier. And now you can have goods rolling over for a longer process or longer time, longer pipeline. But when they finally do come out down the road, there's going to be more because again, a longer pipeline, having factors of production just state for longer, other things equal, tends to produce more physical output. So that's the story when it's sustainable. But now the point is, what if businesses are getting the same signals, the interest rate drops just like it would if there were genuine saving by the households, but it's just because the banks are printing up more claim tickets that actually hasn't been more genuine saving. Well, now you got a problem. Now the businesses try to expand like they did before to open up, you know, 9th, 10th, 11th, 12th order stages and hire workers away from the others to do that. But households are still spending, actually the households are spending more because their preferences didn't change. They didn't become more far-sighted. Their time preferences didn't drop. They're just as impatient now as they were before and now interest rates are lower. They can borrow more cheaply on credit and go buy stuff on credit. And so it's unsustainable. You get two forces tugging on the structure of production. Entrepreneurs want to expand it at the lower interest rates, but consumers want to spend more because rates are lower and their preferences haven't changed. All right. So that's the disconnect. And so I'm saying to relate it now to what we're talking about, you know, with Mises and fiduciary media and so on, that's what he thought happened. That when the banking system wants to just print up more tickets as claims to money that aren't backed up by more genuine saving from the community, how are the bankers going to get those loans out there? They're going to have to lower the rate of interest, right? If before you were an equilibrium and now the banks want to advance a greater quantity of volume of loans, they got to lower the rate of interest. But the point is that's going to still give that signal to the entrepreneurs. All right. And so it's going to set up that process, right? So that's where Mises is coming from. That's I think a faithful summary of his perspective. I hope you can at least see why it's internally consistent and plausible. So again, you can disagree with them as you want, but that's where he was coming from. And so notice, last thing I'll say, again, the issue with that, if guys like Joe Salerno and Murray Rothbite are saying, "Fracture reserve banking per se is economically destabilizing that's separate from saying it's fraudulent or not, or legally dubious." This is an economic claim, and that it's also separate from saying depositors might lose their money if there's a bank run. And notice, if Mises is right in the way he's explaining it, whether the fractional reserve bankers correctly anticipate withdrawal requests or not is a secondary, you know, it's just a separate matter. Even if they do correctly forecast it, it doesn't matter. They're still going to have to lower the interest rate relative to what it would have been under 100% reserves and Mises thinks in a sense that's telling the entrepreneurs there's more saving that just happened, even though it didn't happen. And something's got to give, and in his framework, what happens is that leads to an unsustainable boom where there's capital consumption is what's going on, so people can feel like there's prosperity because they're eating the seed corn metaphorically. So that's where that comes from. During the boom, it really is. People really do have above average standards of living, but they're unwittingly consuming their capital, and that's why there has to be a crash later. It's not just a matter of, oh, why don't we just keep the boom going? No, it's physically unsustainable. At some point, there's going to be a crash, and the sooner you just let reality reassert itself, the better it's going to be. OK, so I'll stop there. Like I said, I'll put some links to all these things you want to engage in further research. Thanks for your attention, everybody. See you next time. Check back next week for a new episode of the Human Action Podcast. In the meantime, you can find more content like this on leases.org.