Mises's Proposals for a 100-Percent Reserve Requirement
Ludwig von Mises was the first twentieth-century economist to propose the establishment of a banking system with a 100-percent reserve requirement on demand deposits. Mises made his recommendation in the first edition of his book, The Theory of Money and Credit, published in 1912. At the end of this first edition, in a section literally reproduced in the second, which was printed in 1924, Mises draws the following conclusion:
Fiduciary media are scarcely different in nature from money; a supply of them affects the market in the same wayas a supply of money proper; variations in their quantity influence the objective exchange value of money in just thesame 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 naturaland 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. The basic conception of Peel’s Act ought to be restated and more completely implemented than it was in the England of his time by including the issue of credit in the form of bank balances within the legislative prohibition.
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.
Mises again considers the model for an ideal banking system in his 1928 book, Geldwertstabilisierung und Konjunkturpolitik (Monetary stabilization and cyclical policy). There we read:
The most important prerequisite of any cyclical policy, no matter how modest its goal may be, is to renounce every attempt to reduce the interest rate, by means of banking policy, below the rate which develops on the market. That means a return to the theory of the Currency School, which sought to suppress all future expansion of circulation credit and thus all further creation of fiduciary media. However, this does not mean a return to the old Currency School program, the application of which was limited to banknotes. Rather it means the introduction of a new program based on the old Currency School theory, but expanded in the light of the present state of knowledge to include fiduciary media issued in the form of bank deposits. The banks would be obliged at all times to maintain metallic backing for all notes— except for the sum of those outstanding which are not now covered by metal—equal to the total sum of the notes issued and bank deposits opened. That would mean a complete reorganization of central bank legislation. . . . By this act alone, cyclical policy would be directed in earnest toward the elimination of crises.
Two years later, on October 10, 1930, before the Financial Committee of the League of Nations in Geneva, Mises delivered a memorandum on “The Suitability of Methods of Ascertaining Changes in the Purchasing Power for the Guidance of International Currency and Banking Policy.” There, before the monetary and banking experts of his day, Mises expressed his ideas as follows:
It is characteristic of the gold standard that the banks are not allowed to increase the amount of notes and bank balances without a gold backing, beyond the total which was in circulation at the time the system was introduced. Peel’s Bank Act of 1844, and the various banking laws which are more or less based on it, represent attempts to create a pure gold standard of this kind. The attempt was incomplete because its restrictions on circulation included only banknotes, leaving out of account bank balances on which cheques could be drawn. The founders of the Currency School failed to recognize the essential similarity between payments by cheque and payments by banknote. As a result of this oversight, those responsible for this legislation never accomplished their aim.
Mises would later explain that a banking system based on the gold standard and a 100-percent reserve requirement would tend to push prices down slightly, which would benefit most citizens, since it would raise their real income, not through a nominal increase in earnings but through a continual reduction in the prices of consumer goods and services and relative constancy in nominal income. Mises deems such a monetary and banking system far superior to the current system, which is beset with chronic inflation and recurrent cycles of expansion and recession. In reference to the economic depression then afflicting the world, Mises concludes:
The root cause of the evil is not in the restrictions, but in the expansion which preceded them. The policy of the banks does not deserve criticism for having at last called a halt to the expansion of credit, but, rather, for ever having allowed it to begin.
Ten years after delivering this memo before the League of Nations, Mises once more defended a 100-percent reserve requirement, this time in the first German edition of his all embracing economic treatise, published as Nationalökonomie: Theorie des Handelns und Wirtschaftens (Economics: Theory of Action and Exchange). Here Mises again presents his thesis that the ideas essential to the Currency School require the application of a 100-percent reserve requirement to all fiduciary media; that is, not only to banknotes, but also to bank deposits. Moreover, in this book Mises advocates the abolition of the central bank and indicates that while this institution continues to exist, even if the issuance of new fiduciary media (bills and deposits) is strictly prohibited, there will always be a danger that “emergency” budget difficulties will be cited as political justification for issuing new fiduciary media to help finance the needs of the state. Mises implicitly responds thus to theorists of the Chicago School who in the 1930s proposed that a 100-percent reserve requirement be set for banking, but that the monetary base remain fiduciary, and that the responsibility for issuing and controlling the stock of money continue to fall to the central bank. Mises does not consider this the best solution. In this case, even with a 100-percent reserve requirement, money would still ultimately depend on a central bank and would therefore be subject to all sorts of pressures and influences, particularly the danger that in a financial emergency the state would exercise its power to issue currency in order to finance itself. According to Mises, the ideal solution would thus be to establish a system of free banking (i.e., without a central bank) subject to traditional legal principles (and hence, a 100-percent reserve requirement). In this book Mises accompanies his defense of a 100-percent reserve requirement with his objection not only to the central bank, but also to a fractional-reserve free-banking system: although such a system would greatly limit the issuance of fiduciary media, it would be inadequate to completely eliminate credit expansion nor the recurrent booms and economic recessions which inevitably come with it.
In 1949 Yale University Press published the first English edition of Ludwig von Mises’s economic treatise, entitled Human Action: A Treatise on Economics. In this English edition Mises repeats the arguments from the German edition, but he expressly refers to Irving Fisher’s plan for establishing a 100-percent reserve requirement for banking. Mises disapproves of Fisher’s plan, not because it includes a proposal for a 100-percent reserve requirement, which Mises fully supports, but because Fisher seeks to combine this measure with the conservation of the central bank and the adoption of an indexed monetary unit. In fact, according to Mises, the suggestion to reestablish a 100-percent reserve requirement, yet preserve the central bank, is insufficient:
[I]t would not entirely remove the drawbacks inherent in every kind of government interference with 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.
Mises again expresses his ideas on a 100-percent reserve requirement in an appendix (on “Monetary reconstruction”) to the 1953 English reissue of The Theory of Money and Credit, where he explicitly states:
The main thing is that the government should no longer be in a position to increase the quantity of money in circulation and the amount of checkbook money not fully—that is, 100 percent—covered by deposits paid in by the public.
Furthermore, in this appendix Mises also proposes a process of transition to the ideal system, with the following goal:
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.
[For full citations and footnotes, see Money, Bank Credit, and Economic Cycles, pp 716-722.]