The Mystery of Banking

Rentenmark
.” The mark was
2
In Fritz K. Ringer, ed., 
The German Inflation of 1923
(New York:
Oxford University Press, 1969), p. 96.
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scrapped, or rather, a new currency, the 
Rentenmark
, was issued,
valued at 1 trillion old marks, which were convertible into the
new currency. The government pledged that the quantity of
Rentenmarks
issued would be strictly limited to a fixed amount (a
pledge that was kept for some time), and the Reichsbank was pro-
hibited from printing any further notes to finance the formerly
enormous government deficit. Once these stern measures had
been put into effect, the hyperinflation was brought to an end.
The German economy rapidly recovered. Yet, it must be pointed
out that the German economy did not escape a posthyperinflation
recession, called a “stabilization crisis,” in which the swollen and
unsound investments of the inflationary period were rapidly liq-
uidated. No one complained bitterly; the lessons of the monstrous
inflation were burned into everyone’s heart.
3
Only a clear and dramatic cessation of the spiraling expansion
of the money supply can turn off the money tap and thereby
reverse the accelerating inflationary expectations of the public.
Only such a dramatic end to monetary inflation can induce the
public to start holding cash balances once again. 
Thus we see that price levels are determined by the supply
and the demand for money, and that expansion of the money sup-
ply—a function solely of government—is the prime active force
in inflation.
74
The Mystery of Banking
3
For a good overview of the German economy, see Gustav Stolper, 
The
German Economy, 1870 to the Present
(New York: Harcourt, Brace &
World, 1967); for an excellent history and analysis of the German hyperin-
flation, see Costantino Bresciani-Turroni, 
The Economics of Inflation
(Lon-
don: George Allen & Unwin, 1937).
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VI.
L
OAN
B
ANKING
W
e have so far seen how price levels are determined,
showing how they are set by the interaction of the sup-
ply of and demand for money. We have seen that the
money supply is generally the dominant force in changing prices,
while the demand for money is reactive either to long-term con-
ditions or to changes in supply. We have seen, too, that the cause
of our chronic inflation is continuing increases in the supply of
money, which eventually generate inflationary expectations that
aggravate and accelerate the inflation. Eventually, if unchecked,
the inflation runs away into a crack-up boom and destruction of
the currency. In recent decades, absolute control over the supply
of money has been in the hands, not of private enterprise or the
free market, but of government. 
How does 
banking
fit into all this? In what way does banking
generate part of the supply of money? Is banking inflationary, and
if so, in what sense? How does banking work? 
When one speaks of 
banks
, there is a semantic problem, since
the word bank covers several very different functions and activi-
ties. In particular, modern banking mixes and confuses two differ-
ent operations with very different effects: loans and deposits. Let
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us first see how what we might call