Destaque: "How Much Money Does an Economy Need?"

Review by David Gordon

[How Much Money Does an Economy Need? Solving the Central Economic Puzzle of Money, Prices, and Jobs. By Hunter Lewis. Axios Press. Vi + 185 pages.]

"In Are the Rich Necessary? Hunter Lewis showed himself to be a master of dialectics; and he here applies the same method to monetary theory. Not content to expound his own views, Lewis carefully explains conflicting standpoints as well. Lewis does not disguise his own strong commitment to Austrian economics, but the reader of this book will understand not only this position, but its chief competitors as well.(...)"

As Lewis notes, cycles cannot be blamed on the free market. The flaw that makes the cycle possible is fractional-reserve banking, in which a bank is permitted to create credit in excess of the deposits that have been made to it. The bank is required only to maintain a certain ratio between deposits on hand and its credit expansion. A free market need not incorporate fractional-reserve banking; it can, instead, institute the alternative 100% reserve system. Indeed, Murray Rothbard argued that a free market required this latter arrangement. The fractional-reserve system is the artifact of particular legal decisions. Lewis calls attention in this connection to two decisions of British courts in the early nineteenth century.

An effort to require banks to maintain 100% reserves against all deposits failed in British courts in 1811 and 1816. The House of Lords also confirmed the right to maintain fractional reserves in 1848. (p. 55)

How does fractional-reserve banking make the business cycle possible? The problem arises if the government, in an effort to promote prosperity, increases the generation of bank credit. (Lewis discusses in detail various ways in which the Federal Reserve System can do this.) The increase in the money supply lowers the monetary rate of interest. Investment then increases: because business loans are available at lower interest rates, projects that were formerly unprofitable are now feasible. Business then expands, especially in capital goods.

Trouble — usually sooner rather than later — arises. The interest rate is not in essence a monetary phenomenon. Quite the contrary, interest reflects time preference, the rate at which people prefer present goods to future goods. This rate will not in general alter just because of the monetary expansion. The lowering of the interest rate thus proves a temporary affair, and the interest rate rises to reflect time preference. As a result, some of the new investments prove unprofitable and must be liquidated.

In the Austrian view, this liquidation ought to be allowed to proceed unhindered. Should the government attempt to alleviate matters by further monetary expansion, the result will be another artificial boom that will again require correction. The necessary liquidation cannot be indefinitely deferred. If the government continues its expansionist course, the upshot will be hyperinflation and the collapse of the monetary system altogether.

Keynes denied this analysis."