In 1913 Ludwig von Mises Warned That There Is a Serious Danger for the Future of the Individualistic Organization of the Economy in the Development of Fiduciary Media

As I have explained elsewhere, there is a serious danger for the future of the individualistic organization of the economy in the development of fiduciary media; if the legislature does not put some obstacle in the way of its expansion, an unrestrained inflation could easily come about, the destructive effects of which cannot really be imagined. Even if we ignore this, as yet, not immediate threat, there is sufficient risk from the very nature of the system of fiduciary media. We have already mentioned that it would be desirable to put an end to the artificial expansion of fiduciary media. It would not only slow down the rate of devaluation, but it would also be the best way of preventing economic crises.

Mises defined “money substitutes” as claims to a commodity money such as gold in the form of banknotes or checks that are readily and generally accepted in transactions and that are believed to be fully redeemable on demand at the banking institution that has issued them. Mises distinguished between money substitutes that are backed 100 percent by commodity money reserves at the issuing institution (“money certificates”) and those money substitutes issued by a bank that are less than fully backed (“fiduciary media”). Loans extended on the basis of 100 percent reserve backing were referred to as “commodity credit” and those loans extended on the basis of less than 100 percent reserve backing were called “circulation credit.” Mises argued that it was the extension of fiduciary media not covered by 100 percent reserves that was the source of business cycles, in that it created the illusion of more savings available in society (in the form of money loans extended through the banking system) to support and sustain investment and capital formation than really existed.

—Ludwig von Mises, “The General Rise in Prices in the Light of Economic Theory,” in Selected Writings of Ludwig von Mises, vol. 1, Monetary and Economic Policy Problems Before, During, and After the Great War, ed. Richard M. Ebeling (Indianapolis: Liberty Fund, 2012), 155, 135n5.