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IV: The Crisis Policy of the Currency School - 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 Crisis Policy of the Currency School
The Inadequacy of the Currency School
Every advance toward explaining the problem of business fluctuations to date is due to the Currency School. We are also indebted to this School alone for the ideas responsible for policies aimed at eliminating business fluctuations. The fatal error of the Currency School consisted in the fact that it failed to recognize the similarity between banknotes and bank demand deposits as money substitutes and, thus, as money certificates and fiduciary media. In their eyes, only the banknote was a money substitute. In their view, therefore, the circulation of pure metallic money could only be adulterated by the introduction of a banknote not covered by money.
Consequently, they thought that the only thing that needed to be done to prevent the periodic return of crises was to set a rigid limit for the issue of banknotes not backed by metal. The issue of fiduciary media in the form of demand deposits not covered by metal was left free.1 Since nothing stood in the way of granting circulation credit through bank deposits, the policy of expanding circulation credit could be continued even in England. When technical difficulties limited further bank loans and precipitated a crisis, it became customary to come to the assistance of the banks and their customers with special issues of notes. The practice of restricting the notes in circulation not covered by metal, by limiting the ratio of such notes to metal, systematized this procedure. Banks could expand the volume of credit with ease if they could count on the support of the bank of issue in an emergency.
If all further expansion of fiduciary media had been forbidden in any form, that is, if the banks had been obliged to hold full reserves for both the additional notes issued and increases in customers’ demand deposits subject to check or similar claim—or at least had not been permitted to increase the quantity of fiduciary media beyond a strictly limited ratio—prices would have declined sharply, especially at times when the increased demand for money surpassed the increase in its quantity. The economy would then not only have lacked the drive contributed by any “forced savings,” it would also have temporarily suffered from the consequences of a rise in the monetary unit’s purchasing power [i.e., falling prices]. Capital accumulation would then have been slowed down, although certainly not stopped. In any case, the economy surely would not then have experienced periods of stormy upswings followed by dramatic reversals of the upswings into crises and declines.
There is little sense in discussing whether it would have been better to restrict, in this way, the issue of fiduciary media by the banks than it was to pursue the policy actually followed. The alternatives are not merely restriction or freedom in the issue of fiduciary media. The alternatives are, or at least were, privilege in the granting of fiduciary media or true free banking.
The possibility of free banking has scarcely even been suggested. Intervention cast its first shadow over the capitalistic system when banking policy came to the forefront of economic and political discussion. To be sure, some authors, who defended free banking, appeared on the scene. However, their voices were overpowered. The desired goal was to protect the noteholders against the banks. It was forgotten that those hurt by the dangerous suspension of payments by the banks of issue are always the very ones the law was intended to help. No matter how severe the consequences one may anticipate from a breakdown of the banks under a system of absolutely free banking, one would have to admit that they could never even remotely approach the severity of those brought about by the war and postwar banking policies of the three European empires.2
In the last two generations, hardly anyone who has given this matter some thought can fail to know that a crisis follows a boom. Nevertheless, it would have been impossible for even the sharpest and cleverest banker to suppress in time the expansion of circulation credit. Public opinion stood in the way. The fact that business conditions fluctuated violently was generally assumed to be inherent in the capitalistic system. Under the influence of the Banking Theory, it was thought that the banks merely went along with the upswing and that their conduct had nothing to do with bringing it about or advancing it. If, after a long period of stagnation, the banks again began to respond to the general demand for easier credit, public opinion was always delighted by the signs of the start of a boom.
In view of the prevailing ideology, it would have been completely unthinkable for the banks to apply the brakes at the start of such a boom. If business conditions continued to improve, then, in conformity with the principles of Lord Overstone, prophecies of a reaction certainly increased in number. However, even those who gave this warning usually did not call for a rigorous halt to all further expansion of circulation credit. They asked only for moderation and for restricting newly granted credits to “nonspeculative” businesses.
Then finally, if the banks changed their policy and the crisis came, it was always easy to find culprits. But there was no desire to locate the real offender—the false theoretical doctrine. So no changes were made in traditional procedures. Economic waves continued to follow one another.
The managers of the banks of issue have carried out their policy without reflecting very much on its basis. If the expansion of circulation credit began to alarm them, they proceeded, not always very skillfully, to raise the discount rate. Thus, they exposed themselves to public censure for having initiated the crisis by their behavior. It is clear that the crisis must come sooner or later. It is also clear that the crisis must always be caused, primarily and directly, by the change in the conduct of the banks. If we speak of error on the part of the banks, however, we must point to the wrong they do in encouraging the upswing. The fault lies not with the policy of raising the interest rate, but only with the fact that it was raised too late.
[1. ]Even the countries that have followed different procedures in this respect have, for all practical purposes, placed no obstacle in the way of the development of fiduciary media in the form of bank deposits.
[2. ][An informal alliance of AustriaHungary, Germany, and Russia, known as the “Three Emperors’ League” (1872). Its influence was declining by 1890, and World War I dealt it a final blow.—Ed.]