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III: The Reappearance of Cycles - Ludwig von Mises, On the Manipulation of Money and Credit: Three Treatises on Trade-Cycle Theory 
On the Manipulation of Money and Credit: Three Treatises on Trade-Cycle Theory. Translated and with a Foreword by Bettina Bien Greaves,. Edited by Percy L. Greaves, Jr. (Indianapolis: Liberty Fund, 2011).
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The Reappearance of Cycles
Metallic Standard Fluctuations
From the instant when the banks start expanding the volume of circulation credit until the moment they stop such behavior, the course of events is substantially similar to that provoked by any increase in the quantity of money. The difference results from the fact that fiduciary media generally come into circulation through the banks, i.e., as loans, while increases in the quantity of money appear as additions to the wealth and income of specific individuals. This has already been mentioned and will not be further considered here. Considerably more significant for us is another distinction between the two.
Such increases and decreases in the quantity of money have no connection with increases or decreases in the demand for money. If the demand for money grows in the wake of a population increase or a progressive reduction of barter and self-sufficiency resulting in increased monetary transactions, there is absolutely no need to increase the quantity of money. It might even decrease. In any event, it would be most extraordinary if changes in the demand for money were balanced by reciprocal changes in its quantity so that both changes were concealed and no change took place in the monetary unit’s purchasing power.
Changes in the value of the monetary unit are always taking place in the economy. Periods of declining purchasing power alternate with those of increasing purchasing power. Under a metallic standard, these changes are usually so slow and so insignificant that their effect is not at all violent. Nevertheless, we must recognize that even under a precious metal standard periods of ups and downs would still alternate at irregular intervals. In addition to the standard metallic money, such a standard would recognize only token coins for petty transactions. There would, of course, be no paper money or any other currency (i.e., either notes or bank accounts subject to check which are not fully covered). Yet even then, one would be able to speak of economic “ups,” “downs” and “waves.” However, one would hardly be inclined to refer to such minor alternating “ups” and “downs” as regularly recurring cycles. During these periods when purchasing power moved in one direction, whether up or down, it would probably move so slightly that businessmen would scarcely notice the changes. Only economic historians would become aware of them. Moreover, the fact is that the transition from a period of rising prices to one of falling prices would be so slight that neither panic nor crisis would appear. This would also mean that businessmen and news reports of market activities would be less occupied with the “long waves” of the trade cycle.1
Infrequent Recurrences of Paper Money Inflations
The effects of inflations brought about by increases in paper money are quite different. They also produce price increases and hence “good business conditions,” which are further intensified by the apparent encouragement of exports and the hampering of imports. Once the inflation comes to an end, whether by a providential halt to further increases in the quantity of money (as for instance recently in France and Italy) or through complete debasement of the paper money due to inflationary policy carried to its final conclusions (as in Germany in 1923), then the “stabilization crisis”2 appears. The cause and appearance of this crisis correspond precisely to those of the crisis which comes at the close of a period of circulation credit expansion. One must clearly distinguish this crisis [i.e., when increases in the quantity of money are simply halted] from the consequences which must result when the cessation of inflation is followed by deflation.
There is no regularity as to the recurrence of paper money inflations. They generally originate in a certain political attitude, not from events within the economy itself. One can only say, with certainty, that after a country has pursued an inflationist policy to its end or, at least, to substantial lengths, it cannot soon use this means again successfully to serve its financial interests. The people, as a result of their experience, will have become distrustful and would resist any attempt at a renewal of inflation.
Even at the very beginning of a new inflation, people would reject the notes or accept them only at a far greater discount than the actual increased quantity would otherwise warrant. As a rule, such an unusually high discount is characteristic of the final phases of an inflation. Thus an early attempt to return to a policy of paper money inflation must either fail entirely or come very quickly to a catastrophic conclusion. One can assume—and monetary history confirms this, or at least does not contradict it—that a new generation must grow up before consideration can again be given to bolstering the government’s finances with the printing press.
Many states have never pursued a policy of paper money inflation. Many have resorted to it only once in their history. Even the states traditionally known for their printing press money have not repeated the experiment often. Austria waited almost a generation after the bank-note inflation of the Napoleonic era before embarking on an inflation policy again. Even then, the inflation was in more modest proportions than at the beginning of the nineteenth century. Almost a half century passed between the end of her second and the beginning of her third and most recent period of inflation. It is by no means possible to speak of cyclical reappearances of paper money inflations.
The Cyclical Process of Credit Expansions
Regularity can be detected only with respect to the phenomena originating out of circulation credit. Crises have reappeared every few years since banks issuing fiduciary media began to play an important role in the economic life of people. Stagnation followed crisis, and following these came the boom again. More than ninety years ago Lord Over-stone described the sequence in a remarkably graphic manner:
We find it [the “state of trade”] subject to various conditions which are periodically returning; it revolves apparently in an established cycle. First we find it in a state of quiescence,—next improvement,—growing confidence,—prosperity,—excitement,—overtrading,—convulsion,— pressure,—stagnation,—distress,—ending again in quiescence.3
This description, unrivaled for its brevity and clarity, must be kept in mind to realize how wrong it is to give later economists credit for transforming the problem of the crisis into the problem of general business conditions.
Attempts have been made, with little success, to supplement the observation that business cycles recur by attributing a definite time period to the sequence of events. Theories which sought the source of economic change in recurring cosmic events have, as might be expected, leaned in this direction. A study of economic history fails to support such assumptions. It shows recurring ups and downs in business conditions, but not ups and downs of equal length.
The problem to be solved is the recurrence of fluctuations in business activity. The Circulation Credit Theory shows us, in rough outline, the typical course of a cycle. However, so far as we have as yet analyzed the theory, it still does not explain why the cycle always recurs.
According to the Circulation Credit Theory, it is clear that the direct stimulus which provokes the fluctuations is to be sought in the conduct of the banks. Insofar as they start to reduce the “money rate of interest” below the “natural rate of interest,” they expand circulation credit, and thus divert the course of events away from the path of normal development. They bring about changes in relationships which must necessarily lead to boom and crisis. Thus, the problem consists of asking what leads the banks again and again to renew attempts to expand the volume of circulation credit.
Many authors believe that the instigation of the banks’ behavior comes from outside, that certain events induce them to pump more fiduciary media into circulation and that they would behave differently if these circumstances failed to appear. I was also inclined to this view in the first edition of my book on monetary theory.4 I could not understand why the banks didn’t learn from experience. I thought they would certainly persist in a policy of caution and restraint, if they were not led by outside circumstances to abandon it. Only later did I become convinced that it was useless to look to an outside stimulus for the change in the conduct of the banks. Only later did I also become convinced that fluctuations in general business conditions were completely dependent on the relationship of the quantity of fiduciary media in circulation to demand.
Each new issue of fiduciary media has the consequences described above. First of all, it depresses the loan rate and then it reduces the monetary unit’s purchasing power. Every subsequent issue brings the same result. The establishment of new banks of issue and their step-by-step expansion of circulation credit provides the means for a business boom and, as a result, leads to the crisis with its accompanying decline. We can readily understand that the banks issuing fiduciary media, in order to improve their chances for profit, may be ready to expand the volume of credit granted and the number of notes issued. What calls for special explanation is why attempts are made again and again to improve general economic conditions by the expansion of circulation credit in spite of the spectacular failure of such efforts in the past.
The answer must run as follows: According to the prevailing ideology of businessman and economist-politician, the reduction of the interest rate is considered an essential goal of economic policy. Moreover, the expansion of circulation credit is assumed to be the appropriate means to achieve this goal.
The Mania for Lower Interest Rates
The naive inflationist theory of the seventeenth and eighteenth centuries could not stand up in the long run against the criticism of economics. In the nineteenth century, that doctrine was held only by obscure authors who had no connection with scientific inquiry or practical economic policy. For purely political reasons, the school of empirical and historical “Realism” did not pay attention to problems of economic theory. It was due only to this neglect of theory that the naive theory of inflation was once more able to gain prestige temporarily during the World War, especially in Germany.
The doctrine of inflationism by way of fiduciary media was more durable. Adam Smith had battered it severely, as had others even before him, especially the American William Douglass.5 Many, notably in the Currency School, had followed. But then came a reversal. The Banking School confused the situation. Its founders failed to see the error in their doctrine. They failed to see that the expansion of circulation credit lowered the interest rate. They even argued that it was impossible to expand credit beyond the “needs of business.” So there are seeds in the Banking Theory which need only to be developed to reach the conclusion that the interest rate can be reduced by the conduct of the banks. At the very least, it must be admitted that those who dealt with those problems did not sufficiently understand the reasons for opposing credit expansion to be able to overcome the public clamor for the banks to provide “cheap money.”
In discussions of the rate of interest, the economic press adopted the questionable jargon of the business world, speaking of a “scarcity” or an “abundance” of money and calling the short-term loan market the “money market.” Banks issuing fiduciary media, warned by experience to be cautious, practiced discretion and hesitated to indulge the universal desire of the press, political parties, parliaments, governments, entrepreneurs, landowners and workers for cheaper credit. Their reluctance to expand credit was falsely attributed to reprehensible motives. Even newspapers, that knew better, and politicians, who should have known better, never tired of asserting that the banks of issue could certainly discount larger sums more cheaply if they were not trying to hold the interest rate as high as possible out of concern for their own profitability and the interests of their controlling capitalists.
Almost without exception, the great European banks of issue on the continent were established with the expectation that the loan rate could be reduced by issuing fiduciary media. Under the influence of the Currency School doctrine, at first in England and then in other countries where old laws did not restrict the issue of notes, arrangements were made to limit the expansion of circulation credit, at least of that part granted through the issue of uncovered banknotes. Still, the Currency Theory lost out as a result of criticism by Tooke (1774–1858) and his followers. Although it was considered risky to abolish the laws which restricted the issue of notes, no harm was seen in circumventing them. Actually, the letter of the banking laws provided for a concentration of the nation’s supply of precious metals in the vaults of banks of issue. This permitted an increase in the issue of fiduciary media and played an important role in the expansion of the gold exchange standard.
Before the war , there was no hesitation in Germany in openly advocating withdrawal of gold from trade so that the Reichsbank might issue sixty marks in notes for every twenty marks in gold added to its stock. Propaganda was also made for expanding the use of payments by check with the explanation that this was a means to lower the interest rate substantially.6 The situation was similar elsewhere, although perhaps more cautiously expressed.
Every single fluctuation in general business conditions—the up-swing to the peak of the wave and the decline into the trough which follows—is prompted by the attempt of the banks of issue to reduce the loan rate and thus expand the volume of circulation credit through an increase in the supply of fiduciary media (i.e., banknotes and checking accounts not fully backed by money). The fact that these efforts are resumed again and again in spite of their widely deplored consequences, causing one business cycle after another, can be attributed to the predominance of an ideology—an ideology which regards rising commodity prices and especially a low rate of interest as goals of economic policy. The theory is that even this second goal may be attained by the expansion of fiduciary media. Both crisis and depression are lamented. Yet, because the causal connection between the behavior of the banks of issue and the evils complained about is not correctly interpreted, a policy with respect to interest is advocated which, in the last analysis, must necessarily always lead to crisis and depression.
Every deviation from the prices, wage rates and interest rates which would prevail on the unhampered market must lead to disturbances of the economic “equilibrium.” This disturbance, brought about by attempts to depress the interest rate artificially, is precisely the cause of the crisis.
The ultimate cause, therefore, of the phenomenon of wave after wave of economic ups and downs is ideological in character. The cycles will not disappear so long as people believe that the rate of interest may be reduced, not through the accumulation of capital, but by banking policy.
Even if governments had never concerned themselves with the issue of fiduciary media, there would still be banks of issue and fiduciary media in the form of notes as well as checking accounts. There would then be no legal limitation on the issue of fiduciary media. Free banking would prevail. However, banks would have to be especially cautious because of the sensitivity to loss of reputation of their fiduciary media, which no one would be forced to accept. In the course of time, the inhabitants of capitalistic countries would learn to differentiate between good and bad banks. Those living in “undeveloped” countries would distrust all banks. No government would exert pressure on the banks to discount on easier terms than the banks themselves could justify. However, the managers of solvent and highly respected banks, the only banks whose fiduciary media would enjoy the general confidence essential for money-substitute quality, would have learned from past experiences. Even if they scarcely detected the deeper correlations, they would nevertheless know how far they might go without precipitating the danger of a breakdown.
The cautious policy of restraint on the part of respected and well-established banks would compel the more irresponsible managers of other banks to follow suit, however much they might want to discount more generously. For the expansion of circulation credit can never be the act of one individual bank alone, nor even of a group of individual banks. It always requires that the fiduciary media be generally accepted as a money substitute. If several banks of issue, each enjoying equal rights, existed side by side, and if some of them sought to expand the volume of circulation credit while the others did not alter their conduct, then at every bank clearing, demand balances would regularly appear in favor of the conservative enterprises. As a result of the presentation of notes for redemption and withdrawal of their cash balances, the expanding banks would very quickly be compelled once more to limit the scale of their emissions.
In the course of the development of a banking system with fiduciary media, crises could not have been avoided. However, as soon as bankers recognized the dangers of expanding circulation credit, they would have done their utmost, in their own interests, to avoid the crisis. They would then have taken the only course leading to this goal: extreme restraint in the issue of fiduciary media.
Government Intervention in Banking
The fact that the development of fiduciary media banking took a different turn may be attributed entirely to the circumstance that the issue of banknotes (which for a long time were the only form of fiduciary media and are today  still the more important, even in the United States and England) became a public concern. The private bankers and joint-stock banks were supplanted by the politically privileged banks of issue because the governments favored the expansion of circulation credit for reasons of fiscal and credit policy. The privileged institutions could proceed unhesitatingly in the granting of credit, not only because they usually held a monopoly in the issue of notes, but also because they could rely on the government’s help in an emergency. The private banker would go bankrupt if he ventured too far in the issue of credit. The privileged bank received permission to suspend payments and its notes were made legal tender at face value.
If the knowledge derived from the Currency Theory had led to the conclusion that fiduciary media should be deprived of all special privileges and placed, like other claims, under general law in every respect and without exception, this would probably have contributed more toward eliminating the threat of crises than was actually accomplished by establishing rigid proportions for the issue of fiduciary media in the form of notes and restricting the freedom of banks to issue fiduciary media in the form of checking accounts. The principle of free banking was limited to the field of checking accounts. In fact, it could not function here to bring about restraint on the part of banks and bankers. Public opinion decreed that government should be guided by a different policy—a policy of coming to the assistance of the central banks of issue in times of crises. To permit the Bank of England to lend a helping hand to banks which had gotten into trouble by expanding circulation credit, the Peel Act was suspended in 1847, 1857 and 1866. Such assistance, in one form or another, has been offered time and again everywhere.
In the United States, national banking legislation made it technically difficult, if not entirely impossible, to grant such aid. The system was considered especially unsatisfactory, precisely because of the legal obstacles it placed in the path of helping grantors of credit who became insolvent and of supporting the value of circulation credit they had granted. Among the reasons leading to the significant revision of the American banking system [i.e., the Federal Reserve Act of 1913], the most important was the belief that provisions must be made for times of crises. In other words, just as the emergency institution of Clearing House Certificates was able to save expanding banks, so should technical expedients be used to prevent the breakdown of the banks and bankers whose conduct had led to the crisis. It was usually considered especially important to shield the banks which expanded circulation credit from the consequences of their conduct. One of the chief tasks of the central banks of issue was to jump into this breach. It was also considered the duty of those other banks who, thanks to foresight, had succeeded in preserving their solvency, even in the general crisis, to help fellow banks in difficulty.
Intervention No Remedy
It may well be asked whether the damage inflicted by misguiding entrepreneurial activity by artificially lowering the loan rate would be greater if the crisis were permitted to run its course. Certainly many saved by the intervention would be sacrificed in the panic, but if such enterprises were permitted to fail, others would prosper. Still the total loss brought about by the “boom” (which the crisis did not produce, but only made evident) is largely due to the fact that factors of production were expended for fixed investments which, in the light of economic conditions, were not the most urgent. As a result, these factors of production are now lacking for more urgent uses. If intervention prevents the transfer of goods from the hands of imprudent entrepreneurs to those who would now take over because they have evidenced better foresight, this imbalance becomes neither less significant nor less perceptible.
In any event, the practice of intervening for the benefit of banks rendered insolvent by the crisis, and of the customers of these banks, has resulted in suspending the market forces which could serve to prevent a return of the expansion, in the form of a new boom, and the crisis which inevitably follows. If the banks emerge from the crisis unscathed, or only slightly weakened, what remains to restrain them from embarking once more on an attempt to reduce artificially the interest rate on loans and expand circulation credit? If the crisis were ruthlessly permitted to run its course, bringing about the destruction of enterprises which were unable to meet their obligations, then all entrepreneurs— not only banks but also other businessmen—would exhibit more caution in granting and using credit in the future. Instead, public opinion approves of giving assistance in the crisis. Then, no sooner is the worst over than the banks are spurred on to a new expansion of circulation credit.
To the businessman, it appears most natural and understandable that the banks should satisfy his demand for credit by the creation of fiduciary media. The banks, he believes, should have the task and the duty to “stand by” business and trade. There is no dispute that the expansion of circulation credit furthers the accumulation of capital within the narrow limits of the “forced savings” it brings about and to that extent permits an increase in productivity. Still it can be argued that, given the situation, each step in this direction steers business activity, in the manner described above, on a “wrong” course. The discrepancy between what the entrepreneurs do and what the unhampered market would have prescribed becomes evident in the crisis. The fact that each crisis, with its unpleasant consequences, is followed once more by a new “boom,” which must eventually expend itself as another crisis, is due only to the circumstances that the ideology which dominates all influential groups—political economists, politicians, statesmen, the press and the business world—not only sanctions, but also demands, the expansion of circulation credit.
[1. ]To avoid misunderstanding, it should be pointed out that the expression “long waves” of the trade cycle is not to be understood here as it was used by either Wilhelm Röpke or N. D. Kondratieff. Röpke (Die Konjunktur, Jena, 1922, p. 21) considered “long-wave cycles” to be those which lasted five to ten years generally. Kondratieff (“Die langen Wellen der Konjunktur” in Archiv für Sozialwissenschaft, Vol. 56, pp. 573ff.) tried to prove, unsuccessfully in my judgment, that, in addition to the seven to eleven year cycles of business conditions which he called medium cycles, there were also regular cyclical waves averaging fifty years in length.
[2. ][The German term, “Sanierungskrise,” means literally “restoration crisis,” i.e., the crisis which comes at the shift to more “healthy” monetary relationships.—Ed.]
[3. ]Overstone, Samuel Jones Loyd (Lord). “Reflections Suggested by a Perusal of Mr. J. Horsley Palmer’s Pamphlet on the Causes and Consequences of the Pressure on the Money Market,” 1837. (Reprinted in Tracts and Other Publications on Metallic and Paper Currency, London, 1857), p. 31.
[4. ]See Theorie des Geldes und der Umlaufsmittel (1912), pp. 433ff. I had been deeply impressed by the fact that Lord Overstone was also apparently inclined to this interpretation. See his Reflections, pp. 32ff. [These paragraphs were not included in the second German edition (1924) from which the English translation, The Theory of Money and Credit, was made.—Ed.]
[5. ][William Douglass (1691–1752), a physician, came to America in 1716. His “A Discourse Concerning the Currencies of the British Plantations in America” (1739) first appeared anonymously.—Ed.]
[6. ]See the examples cited in The Theory of Money and Credit [(Yalé, 1953), pp. 387–390; (Liberty Fund, 1981), 426–429.—Ed.].