Mises on Money



Fractional reserve banking under a gold standard, as Mises defined it, is a system of lending wherein a bank issues receipts for money metals supposedly held in reserve, which it does not have in reserve. It therefore issues promises to pay, which are legal liabilities for the bank, yet the bank cannot redeem all of these liabilities on demand. Mises called this form of money credit money or fiduciary media.


The familiar story of how fractional reserve banking began may be mythical historically, but it does accurately describe the process.

A goldsmith accepts gold bullion as a deposit from a gold owner who wants to have the goldsmith fashion the gold into something lovely. The goldsmith issues a receipt for this specific quantity and fineness of gold. The recipient then finds that he can buy things with the receipt, as if it were gold. The receipt is “as good as gold.”

Next, the goldsmith discovers something wonderful for him. He can issue receipts for gold for which there is no gold in reserve. These receipts circulate as if they were 100% reserve receipts. They are “as good as what is as good as gold.” He can spend them into circulation. Better yet, he can loan them into circulation and receive interest. The new money is cheaper to produce than mining the gold that each receipt promises to pay. The restriction of the money supply that is imposed by the cost of mining is now removed. This is supposedly the origin of fractional reserve banking.

After 1500, yes. Not in the medieval era, I think. I cannot imagine anyone with gold in the late middle ages who would trust a goldsmith with his gold for more than a few days. I also cannot imagine why he would want to spend the receipt. After all, the gold is being hammered into something of beauty. It is becoming more valuable.

There is no doubt that goldsmiths in early modern times did begin to take on the function of banks. At some point, goldsmith-bankers did begin to lend receipts to gold that were not 100% backed by gold. They did begin to collect interest payments from borrowers who believed that there was enough gold in reserve to pay off receipts under normal circumstances. Banking in Spain during the sixteenth century adopted fractional reserves, and a series of banking house bankruptcies in second half of the century proved it. The Emperor, Charles V, had legalized the system. As usual, the State authorized the practice of fractional reserve banking as a means of financing itself. It wanted a ready market for its debt.

In a world where all of the receipts for gold that are backed 100% by gold (money-certificates) look identical to receipts for gold that are not backed by gold (fiduciary media), the issuing bank faces an opportunity and a threat. The opportunity is to receive something (interest payments) for practically nothing (unbacked receipts for gold). The threat is that word may get out that the bank has issued more receipts for gold than there is gold in reserve, which everyone pretty well knows, especially rival bankers. Then there could be a run on the bank. Bankers who get greedy and issue too many receipts can get caught short. Those people who hold receipts may come down and demand payment of their gold. The gold is not the bank’s gold. It is a liability to the bank. The bank has assets to offset the liabilities: credit issued to borrowers. But the receipt-holders are lining up now, and the borrowers do not have to pay until the debts come due, one by one. The bank is “borrowed short” and “lent long.” The squeeze is on. The banker then has to go into his Jimmy Stewart routine from “It’s a Wonderful Life,” or else face bankruptcy. Not every banker can get Donna Reed to come in and help with the performance.

Everything in bank legislation is tied to one of two goals: preventing bank runs or bailing out bankrupt banks before the panic spreads to other banks. That is, everything in banking legislation is geared to the systematic violation of contracts, either before the bank run or after it begins.

The gold standard for centuries kept fractional reserve banking in golden chains. For over a century — indeed, ever since the creation of the privately owned (until 1946) Bank of England in 1694 — central bank policy and government policy have combined to extract physical gold from the owners and transfer it to members of a cartel: bankers. The policy has worked, decade after decade. First, the gold is exchanged for receipts, which are convenient. More receipts are issued than there is gold in reserve. Then, when the bank run begins — always at the outbreak of a major war — the government passes legislation allowing banks to refuse payment of gold during the national emergency.

Every currency devaluation should be understood as the breaking of contract, Mises argued: a violation of contract. He wrote in Theory of Money and Credit:

Credit money has always originated in a suspension of the convertibility into cash of Treasury notes or banknotes (sometimes the suspension was even extended to token coins or to bank deposits) that were previously convertible at any time on the demand of the bearer and were already in circulation. Now whether the original obligation of immediate conversion was expressly laid down by the law or merely founded on custom, the suspension of conversion has always taken on the appearance of a breach of the law that could perhaps be excused, but not justified; for the coins or notes that became credit money through the suspension of cash payment could never have been put into circulation otherwise than as money substitutes, as secure claims to a sum of commodity money payable on demand. Consequently, the suspension of immediate convertibility has always been decreed as a merely temporary measure, and a prospect held out of its future rescission. But if credit money is thought of only as a promise to pay, “devaluation” cannot be regarded as anything but a breach of the law, or as meaning anything less than national bankruptcy (p. 233).

http: //

Because devaluation is theft by the government, or by its chartered central bank, no one ever gets prosecuted. After World War I, European central bankers persuaded their governments to allow them to keep the stolen gold. Commercial banks were not declared bankrupt by the State for having refused to redeem the receipts, with the owners’ gold being returned to them on a pro-rata basis, as would take place in any normal bankruptcy procedure. Instead, the nationally organized gold thieves who had broken their contracts were allowed to keep the stolen goods at cartel headquarters: the national central bank.

The major national exception to this post-World War I central bank strategy of gold collection was the United States. Here, the public had not been persuaded to exchange all of their gold coins for bank receipts. So, in 1933, Franklin Roosevelt unconstitutionally confiscated Americans’ gold that was still outside the banks. By unilateral executive order, he made it illegal for American citizens to own any gold coins that had no numismatic value. The government paid the owners $20.67 per ounce. Once the gold was in the possession of the Treasury, Roosevelt officially hiked the price to $35 on January 31, 1934. The Fed then bought the gold from the Treasury by creating new money. This newly issued money was then spent into circulation by the Treasury. The Fed now holds the gold — demonetized — as part of the monetary base.

So, worldwide, governments and central banks steadily removed gold coins from the economy, thereby demonetizing gold. It was the most successful systematic theft operation in human history. It was all done officially. It was all done with paper IOU’s to gold that were revoked by sovereign governments, which in turn chose not to be sued by their victims. The public now is unfamiliar with gold coins as a medium of exchange. That was the whole point. The central banks now answer only to bond traders and investors — a narrow market compared to gold coin holders in 1790 or 1890.

This is what every government-operated gold standard has come to. When holders of receipts for gold could sue private local banks that refused to honor those receipts, the gold standard restrained the fractionally reserved commercial banks’ proclivity to inflate. When, after World War I, commercial banks and central banks colluded with national governments to allow the banking system to default, and then pass the loot on to the central banks, the gold standard ended. The gold standard was nationalized by governments, then abolished. The central banks thereby demonetized gold, so that they could more efficiently monetize government debt. That was fine with all national governments, whose leaders always want ready markets for the State’s debt. This has been the evolution of central banking from 1694 until today.


Commercial banks are still fractionally reserved, but gold is not related to bank accounts any longer. How does the system work today?

A potential depositor goes down to his bank and sees what savings plans are available. He is told that he can make a deposit and get paid interest on it, but withdraw his money at any time. He can have his cake and eat it, too.

The warning bells should go off in the depositor’s head, but bankers have done everything possible to keep warning bells from going off. The depositor should ask: “How can the borrower of my money be able to return the money — my money — on the day that I want it back?” He doesn’t ask, but he should. The new-accounts lady’s misleading but correct answer is: “We keep money in reserve.”

More bells. “But how can you make a profit if all of the money we depositors deposit is kept in reserve?” Here, the nicely dressed, low-paid woman sends you to the Assistant Manager. You repeat the question. Her answer is straightforward: “We don’t keep all of the money on reserve. We keep 3% of it on reserve. We send it to the regional Federal Reserve Bank. We lend out the rest.”

More warning bells. “But what if we depositors want to withdraw a total of 4% of our money?” Answer: “We would borrow the extra 1% from another bank. This is called the federal funds rate.” “Why is it called that?” “Because it sounds like the federal government is in on the deal to make it safer.” “You mean like the Federal Deposit Insurance Corporation?” “Oh, no; that outfit really is a government organization. It guarantees everyone’s accounts up to $100,000.” “Really? How much does that organization keep in reserve? “About $1.30 cents per $100 in deposits.” “And what does it invest the reserve money in? “U.S. Government debt.” “So, if there were a run on all of the banks, where would the government get the money to redeem these debts?” “By selling new debts to the Federal Reserve System.” “Where would that organization get the money?” “From its computer. That’s where all of the American banking system’s money originates. ‘The bucks start there,’ as we say.”

Bells, bells bells: “But if you keep only 3% on reserve, and you lend 97%, where does the money go when the borrower spends it?” “Into the bank of the person who sells something to the borrower.” “What happens to the money that he deposits?” “His bank sets 3% aside and lends out 97%.” “Then what?” “It just keeps rolling along, multiplying as it goes.” “How much money does the system create on the basis of the initial issue of money from the Federal Reserve System’s computer?” “It’s 100 divided by 3, or about 33 to one. Of course, the reserve ratio is higher on large deposits.” “But isn’t this inflationary, with all that money coming out of the system?” “Only if you define inflation as an increase in the money supply, and only weirdo economists do that any more.”

The initial injection of money comes when a central bank buys an interest-bearing asset that is legal for it to use in its reserves. Legally, the Federal Reserve System can buy an IOU from any entity, but it usually buys U.S. government debt. By creating the money to buy the IOU, the Fed injects original money into the economy, and the fractional reserve process begins the money multiplication process.

Mises was hostile to fractional reserve banking because of its low cost for increasing the money supply — lower than the cost of mining precious metals. This was the same objection that he brought against State-issued money, which I covered in Part II.


If the borrower wants to borrow money in a non-fractional reserve banking system, a depositor must sacrifice the use of his money — and therefore the goods that his money would otherwise buy — until the repayment date. In a fractional reserve system, he does not sacrifice. He can withdraw his money at any time.

The bank account depositor in a non-fiduciary, 100% reserves bank transaction surrenders the use of his money for the duration of the loan: a specified period. He sacrifices his future decision-making ability regarding this money. The borrower gains access to this money, but promises to pay back the loan, plus additional money at the due date. Both the depositor and the borrower suffer a sacrifice in the transaction. The depositor sacrifices the use of the funds; the borrower sacrifices the extra money that must be repaid.

The bank account depositor in a fiduciary transaction is told by the bank that, at any time, he may withdraw the money that he just deposited, either by demanding currency or by writing a check. He has sacrificed no loss of his decision-making ability regarding the future use of this money. The borrower, in contrast, has taken on a legal obligation to repay more money than he received when the note falls due. He has sacrificed his decision-making ability in a way that the depositor has not. This is the heart of the problem, Mises said: the presence or absence of sacrifice. The modern economist would say that the fractional reserve risk-allocating arrangement is asymmetric.

Credit transactions fall into two groups, the separation of which must form the starting point for every theory of credit and especially for every investigation into the connection between money and credit and into the influence of credit on the money prices of goods. On the one hand are those credit transactions which are characterized by the fact that they impose a sacrifice on that party who performs his part of the bargain before the other does — the forgoing of immediate power of disposal over the exchanged good, or, if this version is preferred, the forgoing of power of disposal over the surrendered good until the receipt of that for which it is exchanged. This sacrifice is balanced by a corresponding gain on the part of the other party to the contract — the advantage of obtaining earlier disposal over the good acquired in exchange, or, what is the same thing, of not having to fulfill his part of the bargain immediately. In their respective valuations both parties take account of the advantages and disadvantages that arise from the difference between the times at which they have to fulfill the bargain. The exchange ratio embodied in the contract contains an expression of the value of time in the opinions of the individuals concerned. The second group of credit transactions is characterized by the fact that in them the gain of the party who receives before he pays is balanced by no sacrifice on the part of the other party. Thus the difference in time between fulfillment and counter-fulfillment, which is just as much the essence of this kind of transaction as of the other, has an influence merely on the valuations of the one party, while the other is able to treat it as insignificant. This fact at first seems puzzling, even inexplicable; it constitutes a rock on which many economic theories have come to grief. Nevertheless, the explanation is not very difficult if we take into account the peculiarity of the goods involved in the transaction. In the first kind of credit transactions, what is surrendered consists of money or goods, disposal over which is a source of satisfaction and renunciation of which a source of dissatisfaction. In the credit transactions of the second group, the granter of the credit renounces for the time being the ownership of a sum of money, but this renunciation (given certain assumptions that in this case are justifiable) results for him in no reduction of satisfaction. If a creditor is able to confer a loan by issuing claims which are payable on demand, then the granting of the credit is bound up with no economic sacrifice for him. He could confer credit in this form free of charge, if we disregard the technical costs that may be involved in the issue of notes and the like. Whether he is paid immediately in money or only receives claims at first, which do not fall due until later, remains a matter of indifference to him (pp. 264-65).

http: //

Isn’t this wonderful? The depositor sacrifices nothing. He gets paid interest, yet he can get back his money at any time. The borrower gets the use of his money, but he can keep it until the contract comes due. The bank is “borrowed short” (from the depositor) and “lent long” (to the borrower). And not just this bank, but a whole chain of banks. Transaction by transaction, debt by debt, credit by credit, each borrower passes his newly borrowed money to a brand-new depositor-creditor. I recall a bank’s ad from my youth: “Watch your money grow!” “Watch the economy’s money grow!” is even more informative, but banks do not publicize this sort of educational endeavor. It is too much like Deep Throat’s advice to Bob Woodward regarding the Watergate affair: “Follow the money.”


Mises grew increasingly hostile to fractional reserve banking as he grew older. His 1951 appendix in Theory of Money and Credit, “Monetary Reconstruction,” represents his post-World War II, post-Keynesian hostility to monetary inflation. But even in 1924, his hostility was apparent.

His two objections to fiduciary media or credit money issued by a fractionally reserved banking system were the same as his objection to any increase in the money supply: its wealth-redistribution effects over time and its creation of a boom-bust business cycle. With respect to the first negative effect, he wrote: “The cost of creating capital for borrowers of loans granted in fiduciary media is borne by those who are injured by the consequent variation in the objective exchange value of money. . .” (p. 314). Borrowers want capital, but they get money — newly created credit money. More credit money has been issued by the banking system than savers have deposited. Those participants in the economy who suffer losses due to price changes were not parties to the original credit transactions. They are participants in the economy who receive the new money late in the process, after prices have been bid up by the credit money. In a chapter titled, “The Evolution of Fiduciary Media,” Mises summarized the process of wealth redistribution.

The requests made to the banks are requests, not for the transfer of money, but for the transfer of other economic goods. Would-be borrowers are in search of capital, not money. They are in search of capital in the form of money, because nothing other than power of disposal over money can offer them the possibility of being able to acquire in the market the real capital which is what they really want. Now the peculiar thing, which has been the source of one of the most difficult puzzles in economics for more than a hundred years, is that the would-be borrower’s demand for capital is satisfied by the banks through the issue of money substitutes. It is clear that this can only provide a provisional satisfaction of the demands for capital. The banks cannot evoke capital out of nothing. If the fiduciary media satisfy the desire for capital, that is if they really procure disposition over capital goods for the borrowers, then we must first seek the source from which this supply of capital comes. It will not be particularly difficult to discover it. If the fiduciary media are perfect substitutes for money and do all that money could do, if they add to the social stock of money in the broader sense, then their issue must be accompanied by appropriate effects on the exchange ratio between money and other economic goods. The cost of creating capital for borrowers of loans granted in fiduciary media is borne by those who are injured by the consequent variation in the objective exchange value of money; but the profit of the whole transaction goes not only to the borrowers, but also to those who issue the fiduciary media, although these admittedly have sometimes to share their gains with other economic agents, as when they hold interest-bearing deposits, or the state shares in their profits (p. 314).

http: //

He favored a privately operated gold standard as a way to hamper the State in its expansion of fiat money (p. 416). In a chapter in the 1951 appendix’s essay, “The Principle of Sound Money,” he applied this logic to credit money created by fractional reserve banking.

What all the enemies of the gold standard spurn as its main vice is precisely the same thing that in the eyes of the advocates of the gold standard is its main virtue, namely, its incompatibility with a policy of credit expansion. The nucleus of all the effusions of the anti-gold authors and politicians is the expansionist fallacy (p. 421).

http: //


Mises began a detailed discussion of fractional reserve banking in Part III, Chapter I of The Theory of Money and Credit. He pointed to banking’s two analytically separate functions: (1) serving as the intermediary between lenders and borrowers; (2) granting credit through the issuing of unbacked credit money, what he called fiduciary media. He insisted that these two aspects of banking must be discussed separately.

The business of banking falls into two distinct branches: the negotiation of credit through the loan of other people’s money and the granting of credit through the issue of fiduciary media, that is, notes and bank balances that are not covered by money. Both branches of business have always been closely connected. They have grown up on a common historical soil, and nowadays are still often carried on together by the same firm. This connection cannot be ascribed to merely external and accidental factors; it is founded on the peculiar nature of fiduciary media, and on the historical development of the business of banking. Nevertheless, the two kinds of activity must be kept strictly apart in economic theory; for only by considering each of them separately is it possible to understand their nature and functions. The unsatisfactory results of previous investigations into the theory of banking are primarily attributable to inadequate consideration of the fundamental difference between them (p. 261).

http: //

Mises’s warning should be taken seriously by his disciples. He warned that previous investigations were unsatisfactory because they confused these two analytically and economically separate economic functions. Therefore, anyone who defends fractional reserve banking because it serves a legitimate function by bringing together borrowers and lenders has confused the two separate functions of fractional reserve banking. Non-fractional reserve banking offers the service of bringing together lenders and borrowers. Mises’s objection to fractional reserve banking had nothing to do with banking’s function as an intermediary.

Banks serve as intermediaries between lenders who are willing to forego the use of money, meaning everything that this money can buy, for a period of time. They do this in exchange for a promise of a future payment of even greater quantity of money. Put differently, lenders exchange their control over present goods for the promise of future goods. Borrowers gain access to present money (goods) in exchange for future money (goods).

In an exchange apart from fiduciary media, no money is created by this exchange. Money is transferred from lender to borrower; it is not created. This is not true in the case of fiduciary media, meaning bank-created credit money. Because of the fractional reserve process, new money does come into existence.


This leads to Mises’s distinction between consumer goods and money. Money is not a consumer good. It is not desired for its own sake (except, I suppose, by misers). This is why fiduciary media — receipts for money that are not backed by money — can persist in exchange without many demands by receipt-holders to exchange the receipts for goods, whereas claims to consumer goods would be redeemed. Mises used the example of bread. “You can’t eat gold,” we are told. Quite true, Mises understood. Therein lies the difference in the way that receipts are treated by receipt-holders. He used the examples of receipts for bread and receipts for gold.

Anyone who wishes to acquire bread can achieve his aim by obtaining in the first place a mature and secure claim to bread. If he only wishes to acquire the bread in order to give it up again in exchange for something else, he can give this claim up instead and is not obliged to liquidate it. But if he wishes to consume the bread, then he has no alternative but to procure it by liquidation of the claim. With the exception of money, all the economic goods that enter into the process of exchange necessarily reach an individual who wishes to consume them; all claims which embody a right to the receipt of such goods will therefore sooner or later have to be realized. A person who takes upon himself the obligation to deliver on demand a particular individual good, or a particular quantity of fungible goods (with the exception of money), must reckon with the fact that he will be held to its fulfillment, and probably in a very short time. Therefore he dare not promise more than he can be constantly ready to perform. A person who has a thousand loaves of bread at his immediate disposal will not dare to issue more than a thousand tickets each of which gives its holder the right to demand at any time the delivery of a loaf of bread. It is otherwise with money. Since nobody wants money except in order to get rid of it again, since it never finds a consumer except on ceasing to be a common medium of exchange, it is quite possible for claims to be employed in its stead, embodying a right to the receipt on demand of a certain sum of money and unimpugnable both as to their convertibility in general and as to whether they really would be converted on the demand of the holder; and it is quite possible for these claims to pass from hand to hand without any attempt being made to enforce the right that they embody. The obligee can expect that these claims will remain in circulation for so long as their holders do not lose confidence in their prompt convertibility or transfer them to persons who have not this confidence. He is therefore in a position to undertake greater obligations than he would ever be able to fulfill; it is enough if he takes sufficient precautions to ensure his ability to satisfy promptly that proportion of the claims that is actually enforced against him (pp. 266-67).

http: //

So, the total money supply increases as credit money spreads through the fractional reserve banking system, multiplying inversely in terms of the percentage of the reserve. The introduction of new money transfers wealth to early receivers of the new money, at the expense of late users. It also creates an economic boom that will turn into an economic crisis — recession — when the economy adjusts to the new supply of money. (This is Mises’s monetary theory of the business cycle, which I cover in Part V.)

In the section, “The Case Against the Issue of Fiduciary Media,” Mises said that all banking functions that today are paid for by the profits generated from interest earned on the issue of bank credit money would have to be paid for in a banking system without fractional reserves. In short, there are no free lunches. Making individuals pay for services rendered to them would not destroy banking, he said. “It is clear that prohibition of fiduciary media would by no means imply a death sentence for the banking system, as is sometimes asserted. The banks would still retain the business of negotiating credit, of borrowing for the purpose of lending” (p. 325).

The implication is clear: fractional reserve banking subsidizes users of traditional banking services by transferring wealth to them — wealth that is extracted involuntarily from the victims of credit expansion and the resulting price inflation. It is also paid for by victims of the resulting boom-bust cycle.


What should be done to reduce the inflation caused by fractional reserves? Mises took a strictly free-market approach: remove all government protection against bank runs. It should defend the right of contract. The government should favor no bank, charter no bank, license no bank, and regulate no bank. The government should get out of the credit-money subsidy business.

Mises presented a theory of privileged banks and less privileged banks. The State grants protection, and therefore reputation, to certain banks, usually one bank: the central bank.

Furthermore, within individual countries it is usually possible to distinguish two categories of credit banks. On the one hand there is a privileged bank, which possesses a monopoly or almost a monopoly of the note issue, and whose antiquity and financial resources, and still more its extraordinary reputation throughout the whole country, give it a unique position. And on the other hand there is a series of rival banks, which have not the right of issue and which, however great their reputation and the confidence in their solvency, are unable to compete in the capacity for circulation of their money substitutes with the privileged bank, behind which stands the state with all its authority (p. 326). . . .

It has already been mentioned that in most states two categories of banks exist, as far as the public confidence they enjoy is concerned. The central bank-of-issue, which is usually the only bank with the right to issue notes, occupies an exceptional position, owing to its partial or entire administration by the state and the strict control to which all its activities are subjected. It enjoys a greater reputation than the other credit-issuing banks, which have not such a simple type of business to carry on, which often risk more for the sake of profit than they can be responsible for, and which, at least in some states, carry on a series of additional enterprises, the business of company formation for example, besides their banking activities proper, the negotiation of credit and the granting of credit through the issue of fiduciary media. These banks of the second order may under certain circumstances lose the confidence of the public without the position of the central bank being shaken. In this case they are able to maintain themselves in a state of liquidity by securing credit from the central bank on their own behalf (as indeed they also do in other cases when their resources are exhausted) and so being enabled to meet their obligations punctually and in full (p. 333).

Mises did not pursue in his early book the implications of this grant of monopoly privilege on the issuing of fiduciary media. This was a weakness of his earlier writings. In Human Action, he rectified the earlier omission.

First, he dealt with traditional suggestions of the need for legislated restrictions on the amount of bank notes. This suggestion as a result of State grants of privilege to banks, which reduced the threat of bank runs.

It must be emphasized that the problem of legal restrictions upon the issuance of fiduciary media could emerge only because governments had granted special privileges to one or several banks and had thus prevented the free evolution of banking. If the governments had never interfered for the benefit of special banks, if they had never released some banks from the obligation, incumbent upon all individuals and firms in the market economy, to settle their liabilities in full compliance with the terms of the contract, no bank problem would have come into being. The limits which are drawn to credit expansion would have worked effectively. Considerations of its own solvency would have forced every bank to cautious restraint in issuing fiduciary media (pp. 440-41).

This policy of special privilege was deliberate, Mises said. “The attitudes of European governments with regard to banking were from the beginning insincere and mendacious. . . . The governments wanted inflation and credit expansion, they wanted booms and easy money” (p. 441).

It is a fable that governments interfered with banking in order to restrict the issue of fiduciary media and to prevent credit expansion. The idea that guided governments was, on the contrary, the lust for inflation and credit expansion. They privileged banks because they wanted to widen the limits that the unhampered market draws to credit expansion or because they were eager to open the treasury a source of revenue. For the most part both of these considerations motivated the authorities. . . . The establishment of free banking was never seriously considered because it would have been too efficient in restricting credit expansion (p. 441).

Second, he did not call for State regulation over banking. “What is needed to prevent any further credit expansion is to place the banking business under the general rules of commercial and civil laws compelling every individual and firm to fulfill all obligations in full compliance with the terms of the contract” (p. 443). A government can pass a law to restrict the issue of fiduciary media, but this is no better than a statement of good intentions by the government. Then will come some emergency, and “they will always be ready to call their impasse an emergency” (p. 443).

Third, what about a banking cartel? Couldn’t banks collude to enable members to issue unlimited quantities of unbacked money? The suggestion is “preposterous,” Mises said. “As long as the public is not, by government interference, deprived of the right of withdrawing its deposits, no bank can risk its own good will by collusion with banks whose good will is not so high as its own. One must not forget that every bank issuing fiduciary media is in a rather precarious position. Its most valuable asset is its reputation. It must go bankrupt as soon as doubts arise concerning its perfect trustworthiness and solvency. It would be suicidal for a bank of good standing to link its name with that of other banks with a poorer reputation” (p. 447).

Fourth, what the banking system needs to keep it from expanding fiduciary media is the threat of bank runs by depositors. This will keep banks in line: the threat of bankruptcy. “If the government interferes by freeing the bank from the obligation of redeeming its banknotes and of paying back the deposits in compliance with the terms of the contract, the fiduciary media become either credit money or fiat money. The suspension of specie [gold coin] payments entirely changes the state of affairs” (p. 436).


Commercial banking’s potential for expanding fiduciary media is minimal compared to central banking, which is protected by government. By 1951, Mises understood that, despite the private ownership of the central banks, governments had created them and had always protected them from bank runs. There has been a joint effort by governments and their monopolistic central banks to destroy free market money. Mises minced no words in his chapter, “The Return to Sound Money,” in The Theory of Money and Credit.

The destruction of the monetary order was the result of deliberate actions on the part of various governments. The government-controlled central banks and, in the United States, the government-controlled Federal Reserve System were the instruments applied in this process of disorganization and demolition. Yet without exception all drafts for an improvement of currency systems assign to the governments unrestricted supremacy in matters of currency and design fantastic images of super-privileged super-banks. Even the manifest futility of the International Monetary Fund does not deter authors from indulging in dreams about a world bank fertilizing mankind with floods of cheap credit. The inanity of all these plans is not accidental. It is the logical outcome of the social philosophy of their authors (p. 435).

http: //

At least he did not refer to the insanity of these plans. Those plans were not insane. They were calculated to expand the supply of unbacked credit money. The result, he predicted in 1912, will be the eventual destruction of money. In a profound prediction made in the first edition of Theory of Money and Credit, and reprinted verbatim in the 1924 edition, Mises identified the final goal of all central banking: the creation of a single world bank. The goal of the central bankers is the unrestricted issue of unbacked credit money (whose borrowers must pay interest to the issuers). This prediction appears in the final paragraphs of the book.

It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown. Once common principles for their circulation-credit policy are agreed to by the different credit-issuing banks, or once the multiplicity of credit-issuing banks is replaced by a single World Bank, there will no longer be any limit to the issue of fiduciary media. At first, it will be possible to increase the issue of fiduciary media only until the objective exchange value of money is depressed to the level determined by the other possible uses of the monetary metal. But in the case of fiat money and credit money there is no such limit, and even in the case of commodity money it cannot prove impassable. For once the employment of money substitutes has superseded the employment of money for actual employment in exchange transactions mediated by money, and we are by no means very far from this state of affairs, the moment the limit was passed the obligation to redeem the money substitutes would be removed and so the transition to bank-credit money would easily be completed. Then the only limit to the issue would be constituted by the technical costs of the banking business. In any case, long before these limits are reached, the consequences of the increase in the issue of fiduciary media will make themselves felt acutely.

http: //

A central bank is a threat to economic liberty. It is also superfluous to the operation of the international gold standard. “The international gold standard works without any action on the part of governments. It is effective real cooperation of all members of the world-embracing market community. . . . What governments call international monetary cooperation is concerted action for the sake of credit expansion” (Human Action, p. 476).

I am aware of only one instance in his entire career that he admitted to having made an intellectual error. This was in regard to the creation by the major central banks of a counterfeit gold standard system known as the gold-exchange standard. This system was ratified by international agreement by the Genoa Accords of 1922. It was re-ratified in 1944 by what is known as the Bretton Woods agreement, which created the International Monetary Fund.

The gold exchange standard substituted government debt for gold. Instead of holding gold coins or gold bullion in reserve against the issue of central bank-issued money, central banks held interest-bearing debt certificates issued by a government whose central bank promised to pay other central banks — but not private citizens — a specified amount of gold per unit of the nation’s national currency unit. Central banks could then convert a non-interest-paying asset — gold — into an interest-paying asset: a foreign government’s bond. In 1922, the favored nations were Great Britain and the United States. In 1944, the only nation was the United States. This system “economized” on the use of gold as a currency reserve. It was an important step in the de-monetization of gold.

Mises faintly praised this arrangement in 1924 in his chapter, “Problems of Credit Policy.” This was the final chapter in the 1924 edition of the book. The 1951 appendixes came later. This section was in part prophetic and in part naive.

Yet the gold-standard system was already undermined before the war. The first step was the abolition of the physical use of gold in individual payments and the accumulation of the stocks of gold in the vaults of the great banks-of-issue. The next step was the adoption of the practice by a series of states of holding the gold reserves of the central banks-of-issue (or the redemption funds that took their place), not in actual gold, but in various sorts of foreign claims to gold. Thus it came about that the greater part of the stock of gold that was used for monetary purposes was gradually accumulated in a few large banks-of-issue; and so these banks became the central reserve banks of the world, as previously the central banks-of-issue had become central reserve banks for individual countries. The war did not create this development; it merely hastened it a little. Neither has the development yet reached the stage when all the newly produced gold that is not absorbed into industrial use flows to a single center. The Bank of England and the central banks-of-issue of some other states still control large stocks of gold; there are still several of them that take up part of the annual output of gold. Yet fluctuations in the price of gold are nowadays essentially dependent on the policy followed by the Federal Reserve Board. If the United States did not absorb gold to the extent to which it does, the price of gold would fall and the gold prices of commodities would rise. Since, so long as the dollar represents a fixed quantity of gold, the United States admits the surplus gold and surrenders commodities for gold to an unlimited extent, a rapid fall in the value of gold has hitherto been avoided. But this policy of the United States, which involves considerable sacrifices, might one day be changed. Variations in the price of gold would then occur and this would be bound to give rise in other gold countries to the question whether it would not be better in order to avoid further rises in prices to dissociate the currency standard from gold. Just as Sweden attempted for a time to raise the krone above its old gold parity by closing the mint time gold, so other countries that are now still on the gold standard or intend to return to it might act similarly. This would mean a further drop in the price of gold and a further reduction of the usefulness of gold for monetary purposes. If we disregard the Asiatic demand for money, we might even now without undue exaggeration say that gold has ceased to be a commodity the fluctuations in the price of which are independent of government influence. Fluctuations in the price of gold are nowadays substantially dependent on the behavior of one government, namely, that of the United States (pp. 391-92). . . . All that could not have been foreseen in this result of a long process of development is the circumstance that the fluctuations in the price of gold should have become dependent upon the policy of one government only. That the United States should have achieved such an economic predominance over other countries as it now has, and that it alone of all the countries of great economic importance should have retained the gold standard while the others (England, France, Germany, Russia, and the rest) have at least temporarily abandoned it that is a consequence of what took place during the war. Yet the matter would not be essentially different if the price of gold was dependent not on the policy of the United States alone, but on those of four or five other governments as well. Those protagonists of the gold-exchange standard who have recommended it as a general monetary system and not merely as an expedient for poor countries, have overlooked this fact. They have not observed that the gold-exchange standard must at last mean depriving gold of that characteristic which is the most important from the point of view of monetary policy — its independence of government influence upon fluctuations in its value. The gold-exchange standard has not been recommended or adopted with the object of dethroning gold. . . . But whatever the motives may have been by which the protagonists of the gold-exchange standard have been led, there can be no doubt concerning the results of its increasing popularity (p. 393).

If the gold-exchange standard is retained, the question must sooner or later arise as to whether it would not be better to substitute for it a credit-money standard whose fluctuations were more susceptible to control than those of gold. For if fluctuations in the price of gold are substantially dependent on political intervention, it is inconceivable why government policy should still be restricted at all and not given a free hand altogether, since the amount of this restriction is not enough to confine arbitrariness in price policy within narrow limits. The cost of additional gold for monetary purposes that is borne by the whole world might well be saved, for it no longer secures the result of making the monetary system independent of government intervention. If this complete government control is not desired, there remains one alternative only: an attempt must be made to get back from the gold-exchange standard to the actual use of gold again (p. 393).

Mises saw what could come, but he was not that concerned. “Since, so long as the dollar represents a fixed quantity of gold, the United States admits the surplus gold and surrenders commodities for gold to an unlimited extent, a rapid fall in the value of gold has hitherto been avoided. But this policy of the United States, which involves considerable sacrifices, might one day be changed. Variations in the price of gold would then occur and this would be bound to give rise in other gold countries to the question whether it would not be better in order to avoid further rises in prices to dissociate the currency standard from gold.” Also, “the gold-exchange standard must at last mean depriving gold of that characteristic which is the most important from the point of view of monetary policy — its independence of government influence upon fluctuations in its value.” But then he added, in his naiveté, “The gold-exchange standard has not been recommended or adopted with the object of dethroning gold.”

In Human Action, he came as close as he ever did to repenting of an intellectual error. “In dealing with the problems of the gold exchange standard all economists — including the author of this book — failed to realize the fact that it places in the hands of governments the power to manipulate their nations’ currency easily. Economists blithely assumed that no government of a civilized nation would use the gold exchange standard intentionally as an instrument of inflationary policy” (p. 786). Civil government has acted in a most uncivilized manner through its licensed, privately owned cartels, central banks.

Mises never again made the mistake of trusting any aspect of central banking. By 1949, he had become the most implacable foe of central banking in the economics profession. Only Murray Rothbard has matched him, beginning in 1962 in a chapter appropriately titled, “The Economics of Violent Intervention in the Market” (Man, Economy, and State, pp. 872-74).


Mises’s words constitute the best conclusion that I can imagine. First, this passage, taken from the final chapter of the 1924 edition of The Theory of Money and Credit. Mises quoted directly from the 1912 edition.

It has gradually become recognized as a fundamental principle of monetary policy that intervention must be avoided as far as possible. Fiduciary media are scarcely different in nature from money; a supply of them affects the market in the same way as a supply of money proper; variations in their quantity influence the objective exchange value of money in just the same way as do variations in the quantity of money proper. Hence, they should logically be subjected to the same principles that have been established with regard to money proper; the same attempts should be made in their case as well to eliminate as far as possible human influence on the exchange ratio between money and other economic goods. The possibility of causing temporary fluctuations in the exchange ratios between goods of higher and of lower orders by the issue of fiduciary media, and the pernicious consequences connected with a divergence between the natural and money rates of interest, are circumstances leading to the same conclusion. Now it is obvious that the only way of eliminating human influence on the credit system is to suppress all further issue of fiduciary media (pp. 407-8).

http: //

Second, his recommendation in the 1951 essay, “The Return to Sound Money”:

The first step must be a radical and unconditional abandonment of any further inflation. The total amount of dollar bills, whatever their name or legal characteristic may be, must not be increased by further issuance. 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, be he a private citizen or the U.S. Treasury, otherwise than by receiving cash deposits in legal-tender banknotes from the public or by receiving a check payable by another domestic bank subject to the same limitations. This means a rigid 100 percent reserve for all future deposits; that is, all deposits not already in existence on the first day of the reform (p. 448).

http: //

In Human Action, he called for free banking: the abolition of all government protection of banking. There must be no more grants of privilege or monopoly. There must be the enforcement of contracts.

If Mises was correct, then the unhampered free market will reduce to a minimum the expansion of bank credit money. The State is also removed from the money-production business. This leaves mining as the main source of new money, a source in which costs rise to match revenues, thereby also hampering the expansion of the money supply.

With State-licensed fractional reserve banking, there will be greater instability of money’s purchasing power. The system favors inflation. The State literally issues a license to print money, and even worse, create interest-bearing credit that functions as money.

Is the threat merely inflation and its wealth-redistribution effects? Mises said there is another threat: the boom-bust business cycle. I cover this in Part V.

Mises on Money: Part 3Mises on Money: Part 5Mises on Money: Conclusion

January 24, 2002

To subscribe to Gary North’s free investment letter (e-mail), click here.

© 2002

LRC needs your support. Please donate.