I have two grandsons for whom I conduct a quarterly seminar, and one of them is a recent recruit into the banking industry. Since I believe I can enlighten the lad about the fragility of the system and individual banks, the easiest way for me is to look to the past masters, say, Ludwig von Mises in his monumental 1949 book, Human Action:
p. 440 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 terms of the contract…Free banking is the only method available for the prevention of the dangers inherent in credit expanion…under free banking it would have been impossible for credit expansion with all its inevitable consequences to have developed into a regular—one is tempted to say normal—feature of the economic system. Only free banking would have rendered the market economy secure against crises and depressions…the blunders committed by liberalism in handling the problems of banking were a deadly blow to the market economy. There was no reason whatever to abandon the principle of free enterprise in the field of banking. The majority of liberal politicians simply surrendered to the popular hostility against money lending and interest taking. They failed to realize that the rate of
[p. 441] interest is a market phenomenon which cannot be manipulated ad libitum by the authorities or by any other agency. They adopted the superstition that lowering the rate of interest is beneficial and the credit expansion is the right means of attaining such cheap money. Nothing harmed the cause of liberalism more than the almost regular return of feverish booms and of the dramatic breakdown of bull markets followed by lingering slumps…People did not conceive that what they lamented was the necessary outcome of policies directed toward a lowering of the rate of interest by means of credit expansion. They stubbornly kept to these policies and tried in vain to fight their undesired consequences by more and more government interference.
p. 445 In fact the chief objective of present-day government interference is to intensify further credit expansion. This policy is doomed to failure. Sooner or later it must result in a catastrophe.
p. 566 The dearth of credit which marks the crisis is caused not by contraction but by the abstention from further credit expansion…As the outstanding debts are not paid back, the banks lack the means to grant credits even to the most solid firms. The crisis becomes general and forces all branches of business and all firms to restrict the scope of their activities. But there is no means of avoiding these secondary consequences of the preceding boom. They are inevitable…the depression brings about a cash-induced tendency toward an increase in the purchasing power of the monetary unit…This may be properly called deflation…The entrepreneurs enlarge their cash holding because they abstain from buying goods and hiring workers as long as the structure of prices and wages is not adjusted to the real state of the market data.