1. Introduction

The economic theory of money, banking, and business cycles is a relatively recent development in the history of economic thought. This body of economic knowledge has followed the relevant events (the development of fractional-reserve banking and the recurring cycles of boom and recession) and corresponding legal formulations with great delay. As we have seen, the study of legal principles, the analysis of their loopholes and contradictions, the search for and correction of their logical defects, etc. took place much earlier in history and can even be traced back to classical Roman legal doctrine. In any case, in keeping with the evolutionary theory of institutions (legal, linguistic, and economic), according to which institutions emerge through a lengthy historical process and incorporate a huge amount of information, knowledge, and experience, the conclusions we will reach through our economic analysis of the monetary bank-deposit contract in its current form are hardly surprising. They largely coincide with and support inferences the reader may have already drawn (from a purely legal standpoint) in preceding chapters.

Our analysis of banking will be limited to the study of the monetary deposit contract, which in practice applies to so-called demand checking accounts, savings accounts and time deposits, whenever the last two permit the de facto withdrawal of the balance by the customer at any time. Hence, our study excludes numerous activities private banks presently engage in which are in no way related to the monetary irregular-deposit contract. For example, modern banks offer their customers bookkeeping and cashier services. They also buy and sell foreign currencies, following a money-changing tradition that dates back to the appearance of the first monetary units. In addition, banks accept deposits of securities and on behalf of their clients collect dividends and interest from the issuers, informing customers of increases in owner's equity, stockholders' meetings, etc. Moreover, banks buy and sell securities for their clients through discount houses and offer safe deposit box services at their branches. Likewise, on many occasions banks act as true financial intermediaries, attracting loans from their customers (that is, when customers are aware they are providing a loan to the bank, as holders of bonds, certificates, or true time “deposits”) and then lending those funds to third parties. In this way, banks derive a profit from the interest rate differential between the rate they receive on loans they grant and the one they agree to pay to customers who initially give loans to them. None of these operations constitutes a monetary bank-deposit, a transaction we will examine in the following sections. As we will see, this contract undoubtedly represents the most significant operation banks carry out today and the most important from an economic and social standpoint.

As we have already pointed out, an economic analysis of the monetary bank-deposit contract provides one more illustration of Hayek's profound insight: whenever a universal legal principle is violated, either through systematic state coercion or governmental privileges or advantages conferred on certain groups or individuals, the spontaneous process of social interaction is inevitably and seriously obstructed. This idea was refined in parallel with the theory of the impossibility of socialism and has spread. Whereas at one point it was only applied to systems of so-called real socialism, it has now also come to be associated with all parts or sectors of mixed economies in which systematic state coercion or the “odious” granting of privileges prevails.

Although the economic analysis of interventionism appears to pertain more to coercive governmental measures, it is no less relevant and illuminating with respect to those areas in which traditional legal principles are infringed via the granting of favors or privileges to certain pressure groups. In modern economies there are two main areas where this occurs. Labor legislation, which thoroughly regulates employment contracts and labor relations, is the first. Not only are these laws the basis for coercive measures (preventing parties from negotiating the terms of an employment contract as they see fit), they also confer important privileges upon pressure groups, in many ways allowing them to act on the fringes of traditional legal principles (as unions do, for instance). The second area in which both privileges and institutional coercion are preponderant is the general field of money, banking, and finance, which constitutes the main focus of this book. Although both areas are very important, and thus it is urgent that both be theoretically examined in order to introduce and carry through the necessary reforms, the theoretical analysis of institutional coercion and the granting of privileges in the labor field is clearly less complex. As a result, the awareness it arouses has spread faster and penetrated deeper at all levels of society. Related theories have been significantly developed and broad social consensus has even been reached regarding the need for reforms and the direction they should take. In contrast, the sphere of money, bank credit and financial markets remains a formidable challenge to theorists and a mystery to most citizens. Social relationships in which money is directly or indirectly involved are by far the most abstract and difficult to understand, and as a result the related knowledge is the most vast, complex, and elusive. For this reason, systematic coercion in this area by governments and central banks is by far the most harmful and pernicious.¹ Furthermore, the insufficient formulation of monetary and banking theory adversely affects the development of the world economy. This is evidenced by the fact that, despite theoretical advances and government efforts, modern economies have yet to be freed of recurring booms and recessions. Only a few years ago, despite all the sacrifices made to stabilize western economies following the crisis of the 1970s, the financial, banking and monetary field was invariably again plagued by the same reckless errors. As a result, the beginning of the 1990s marked the inevitable appearance of a new worldwide economic recession of considerable severity, and the western economic world has only recently managed to recover from it.² And once again, more recently (in the summer of 1997), an acute financial crisis devastated the chief Asian markets, threatening to spread to the rest of the world. A few years later (since 2001) the three main economic areas of the world (the United States, Europe, and Japan) have simultaneously entered into a recession.

The purpose of the economic analysis of law and legal regulations is to examine the role the latter play in the spontaneous processes of social interaction. Our economic analysis of the monetary bank-deposit contract will reveal the results of applying traditional legal principles (including a 100-percent reserve requirement) to the monetary irregular-deposit contract. At the same time, it will bring to light the damaging, unforeseen consequences that follow from the fact that, in violation of these principles, bankers have been permitted to make self-interested use of demand deposits. Until now these effects have gone mainly unnoticed.

We will now see how bankers' use of demand deposits enables them to create bank deposits (that is, money) and in turn, loans (purchasing power transferred to borrowers, whether businessmen or consumers) from nothing. These deposits and loans do not result from any real increase in voluntary saving by social agents. In this chapter we will concentrate on substantiating this assertion and some of its implications and in subsequent chapters will undertake the study of the economic effects of credit expansion (the analysis of economic crises and recessions).

To continue the pattern set in the first chapters, we will first consider the effects from an economic and accounting perspective in the case of the loan or mutuum contract. In this way, by comparison, we will be better able to understand the economic effects of the essentially distinct monetary bank-deposit contract.