I guess that would depend on whether fractional reserve banking is inherently fraudulent or not which seems to be a hotly contested issue among free marketers.

Given that, the financial performance of the banks should have been better, and Richard shows that it was. Capital ratios were much higher and we never had a financial panic as large as the Great Depression, nor a period of sustained inflation like we had in the 1970s. In fact, the only periods of inflation were when we went off the gold standard, for example during the Civil War.

Richard covers the whole history of banking from the early 1800s (and possibly before, I can’t remember) until the date he published the book in 1990. He backs up his work with data on all the key financial ratios that describe the financial performance of the banks in each era during this period.

Unusually large financial capital pools are indicative of ex nihilo credit expansion. If capital seems unbiquitous as it shouldn’t then somethings up.

19th century America, being a far shallower capital pool — i.e. far fewer investors, with less capital than now — means that the supply of capital is relatively small, and easily depleted or lost in bad ventures. When there’s only two banks in town and one fails, that’s a big loss. When one business venture is a huge success, the resulting boom is similarly large relative to the economy as a whole.

As an economy grows, however, the pool of capital (including the number of potential sources) outgrows these things. Hurricane Katrina, as big as it was, and as exacerbated as it was by government, wasn’t even enough to burst the bubble we now know was brewing in 2005.

In fact, what we are now seeing is that while our economy has outgrown natural disasters, there is one man-made disaster that has scaled up with it and remains fully capable of destroying it completely: government.

Anti-capitalists and anti-Austrians always cite the Panic of 1893 as a failure of Austrian theory because the Austrian Credit Cycle supposedly doesn’t account for it, something I find doubtful.

This is true, but it is important not to accept, even implicitly, the unreal standard for judging a free market propounded by those who think it is “imperfect” and needs to be fixed. The root of these ideas is that information is costless, that market participants magically gain all relevant facts and, by implication, there are no errors.

Such a state of affairs does not exist and is an unreal standard to judge any economic system.

I don’t think we can really know how large the dislocations would be in a laissez-faire world. They would be smaller than what we experience today, and we would be experiencing them in the context of a vastly wealthier society, and one whose standard of living was growing at an incredibly fast rate.

But such dislocations, to the extent they occur, are no more problematic than the fact there is crime, or that businesses fail, or that there are days when the weather is bad. To even begin to demand that they magically “go away” (as the Keynesians and maybe even some free market advocates do) is to demand the unreal.

To be sure, the market foments constant creative destruction (perfect competition is a neoclassical fantasy) but I don’t know if I would call it a business cycle since I’m guessing the contractions would be too few and far apart to legitimize such a categorization.

Also, by “business cycle” I mean a macroeconomic contraction, an economy-wide recession where the productive capacity of the entire economy shrinks for at least two whole fiscal quarters. The car contraction surely liquidated many mal-investments but I don’t know if it contribited to a macro-contraction lasting two fiscal quarters.

Also, historical examples are tainted inevitably by government intervention. I wouldn’t be surprised given everything I’ve read/seen if the government was involved somehow.

I would hope that with today’s electronic information dissemination and financial product innovation, a laissez-faire capitalist economy would be incredibly sensitive and responsive to mal-adjustments and mal-investments, so much so that contractions would be marginal.

The false information you refer to can occur through entrepreneurial actions. In particular, this is true when scientists and entrepreneurs develop a wonderful new technology. People invest in it in many ways, trying out many business methods, before the best way is sorted out by the market. That sorting out process can result in dislocations.

For example, there were (if I recall correctly) over 1,000 car companies at the turn of the last century. This sorted itself down to a handful. But, before that could happen, millions of dollars were raised in the capital markets and invested in sundry factories and processes. There was a natural boom. Then, as the winners emerged (Henry Ford, et al.), there was a consolidation period, or a bust.

From an informational perspective, it is not that different than the bad information supplied by manipulated interest rates. Most of those entrepreneurs had “bad” information. When the market revealed that it was bad, they had to close down, perhaps in many cases through bankruptcies and the liquidation of financial capital.

The important point here, though, is that this result is natural and good. There is no such thing as “perfect information” in the marketplace. However, what is perfect about a free market is that it allows success to be rewarded to the fullest extent possible, and errors and failure to result in liquidation. On a large scale, when this happens, the economy could experience small dislocations or cycles, but they would be much less severe than those caused by monetary manipulation.

Moreover, those dislocations are the result of a good and productive process whereby new technologies get rapidly incorporated into the economy.

http://mises.org/media.aspx?action=author&ID=424

Now all of this is caused simply by the advancement of false information. Its caused by credit expansion unbacked by increased savings which yield inaccurate interest rates, rates that do not reflect the real demand for and supply of credit. In a free market, interest rates will always reflect as accurate as possible the demand for and supply of credit. No entrepreneur would accept unreliable inflationary currency that offers faux interest rate signals. The business cycle is caused by false information propagated by methods which either wouldn’t exist in a free market al all or would exist only on the fringes along side things like loan sharking where its economic influence would be neligible at best. Bankers in such an environment would not be allowed to systematically violate monetary irregular deposit contracts and therefore inflate the money supply as they do today.

The cause of these natural, small disturbances or cycles is technological change and natural periods of optimism and consolidation that ensue.

Fractional reserve banking, as such, is no big deal—even today. The central bank and its monopoly on money is the problem.