The Mystery of Banking

Foreword
xvii
Foreword v6.qxp 8/4/2008 11:37 AM Page xvii

---

Rothbard will have none of this shabby and disrespectful
treatment of his reader and of his science that is meted out by the
typical textbook author. In sharp contrast, he begins by 
first
clearly presenting the fundamental principles or “laws” that gov-
ern money and monetary institutions. These universal and
immutable laws form a fully integrated system of sound monetary
theory that has been painstakingly elaborated over the course of
centuries by scores of writers and economists extending back at
least to the sixteenth-century Spanish Scholastics of the School of
Salamanca. As the leading authority in this tradition in the latter
half of the twentieth century, Rothbard expounds its core princi-
ples in a logical, step-by-step manner, using plain and lucid prose
and avoiding extraneous details. He supplements his verbal-logi-
cal analysis with graphs and charts to effectively illustrate the
operation of these principles in various institutional contexts. 
It is noteworthy that, despite the fact that this book was writ-
ten twenty-five years ago, the theory Rothbard presents is up to
date. One reason is that the advancement of knowledge in non-
experimental or “aprioristic” sciences like economic theory, logic,
and mathematics proceeds steadily but slowly. In the case of
sound monetary theory, many of its fundamental principles had
been firmly established during the nineteenth century. In the Ger-
man edition of 
The Theory of Money and Credit
published in
1912, Ludwig von Mises, Rothbard’s mentor, integrated these
principles with value and price theory to formulate the modern
theory of money and prices. Rothbard elaborated upon and
advanced Mises’s theoretical system. Thus the second reason that
the monetary theory presented in the book remains fresh and rel-
evant is that Rothbard himself was the leading monetary econo-
mist in the sound money tradition in the second half of the twen-
tieth century, contributing many of the building blocks to the
theoretical structure that he lays out. These include: formulating
the proper criteria for calculating the money supply in a fractional-
reserve banking system; identifying the various components of the
demand for money; refining and consistently applying the supply-
and-demand apparatus to analyzing the value of money; drawing
xviii
The Mystery of Banking
Foreword v6.qxp 8/4/2008 11:37 AM Page xviii

---

a categorical distinction between deposit banking and loan bank-
ing; providing the first logical and coherent explanation of how
fiat money came into being and displaced commodity money as a
result of a series of political interventions. All these innovations
and more were products of Rothbard’s creative genius, and many
of his theoretical breakthroughs have not yet been adequately rec-
ognized by contemporary monetary theorists, even of the Aus-
trian School. 
Rothbard’s presentation of the basic principles of money-and-
banking theory in the first eleven chapters of the book guides the
reader in unraveling the mystery of how the central bank operates
to create money through the fractional-reserve banking system
and how this leads to inflation of the money supply and a rise in
overall prices in the economy. But he does not stop there. In the
subsequent five chapters he resolves the historical mystery of how
an inherently inflationary institution like central banking, which
is destructive of the value of money and, in the extreme case of
hyperinflation, of money itself, came into being and was accepted
as essential to the operation of the market economy. 
As in the case of his exposition of the theory, Rothbard’s
treatment of the history of the Fed is fundamentally at odds with
that found in standard textbooks. In the latter, the history is shal-
low and episodic. It is taken for granted that the Fed, like all cen-
tral banks, was originally designed as an institution whose goal
was to promote the public interest by operating as a “lender of
last resort,” providing “liquidity” to troubled banks during times
of financial turbulence to prevent a collapse of the financial sys-
tem. Later the Fed was given a second mandate, to maintain “sta-
bility of the price level,” a policy which was supposed to rid the
economy of business cycles and therefore to preclude prolonged
periods of recession and unemployment. Thus strewn throughout
a typical textbook one will find accounts of how the Fed han-
dled—usually, although not always, in an enlightened manner—
various “shocks” to the monetary and financial system. Culpabil-
ity for such shocks is almost invariably attributed to the unruly
propensities or irrational expectations of business investors,