This article reviews the first English edition of Prof. Jesús Huerta de Soto´s book `Dinero, Crédito Bancario y Ciclos Económicos´ which first appeared in Spain in 1998.Business Cycle Theory; Law and Economics of Money and Banking; Austrian school; new institutional economics; financial markets; history of money; credit and banking; deregulation of financial institutions; economics of transition

van den Hauwe, Ludwig

English

Research Papers in Economics

ISSN 1801-0938
New Perspectives on Political Economy
Volume 2, Number 2, 2006, pp. 135 – 141
Book Review
Jesús Huerta de Soto. Money, Bank Credit, and Economic Cycles. Translated by
Melinda A. Stroup. Auburn: Ludwig von Mises Institute, 2006.136 New Perspectives on Political Economy
The book under review is the ﬁrst English edition of Prof. Jesús Huerta de Soto’s
book Dinero, Crédito Bancario y Ciclos Económicos which ﬁrst appeared in Spain in 1998.
A second edition of the book followed at the beginning of the year 2002 in the wake of
worldwide economic events illustrating the great timeliness of the book and the consider-
able relevance of its subject matter. In the meantime previous reviewers of the book had
urged the translation of the book into English1, a task now completed as a result of the
great effort of Melinda A. Stroup, who wrote the ﬁrst English manuscript of the entire
book, and of the determination of Lewellyn H. Rockwell, Jr., President of the Ludwig
von Mises Institute.
The contribution made by the book’s author cannot simply be categorized as be-
longing exclusively to a particular sub-discipline within economics. Most naturally it
addresses macroeconomists and monetary theorists, but it can equally be considered an
exploration into the now rapidly expanding ﬁeld of new institutional economics, or into
the Law and Economics of money and banking. Experts of the work of F. A. Hayek will
recognize it as the accomplishment of a long-awaited feat: an integration of Hayek’s early
work on money and business cycles with his later work on legal theory, institutional eco-
nomics and spontaneous order. Some commentators had started raising doubts about the
compatibility and ultimate consistency between these various strands of thought in the
old master’s multifaceted oeuvre.2 With Dr. Huerta de Soto’s accomplishment, the vari-
ous pieces of the Hayekian puzzle have been shown to consistently ﬁt together yielding a
coherently integrated picture capable of explaining a wide variety of juridical, historical
and economic phenomena.
As Hayek explained, man is as much a rule-following animal as a purpose-seeking
one.3 Where economic agents’ behaviour is governed by particular abstract rules of con-
duct, spontaneous order will emerge and social life will run its course in a well-ordered
and coordinated fashion. To the contrary, whenever those rules are violated on a more
or less signiﬁcant scale, life in society will become dis-coordinated and a process of de-
civilization will set in. With unprecedented thoroughness and clarity Prof. Huerta de
1 See in particular L. Yeager (2001, 255) and J. G. Hülsmann (2000).
2 See in particular U. Witt (1997). This author argues that Hayek’s early work on the theory of the business
cycle is difﬁcult to make sense of in terms of his later work on spontaneous economic order and believes
that Hayek pursued two different and basically incompatible research programs consecutively.
3 See Hayek (1973, 11).Book Review 137
Soto has detailed what exactly those rules of conduct are in the domain of money and
banking.
One of the main these of the book is indeed that whereas the economic analysis of
juridical institutions has thus far had almost exclusively microeconomic implications,
the approach to the economic analysis of juridical institutions developed by the Austrian
School yields critical implications and conclusions that are essentially macro-economic
in nature, elucidating macro-economic phenomena like inﬂation, recurring boom-bust
cycles and stagﬂation, besides their devastating consequences.
The juridical foundations are treated in the ﬁrst and third chapters of the book. Chap-
ter 1 (1-36) deals with the different legal logic inherent in the monetary irregular-deposit
contract on the one hand, and the loan contract or mutuum on the other, explaining
their inherent mutual incompatibility at a fundamental level. In Chapter 3 (115-165) the
author considers different theoretical attempts to come up with a new contractual frame-
work aimed at justifying banks’ lending of demand-deposit funds to third parties; it is
shown that these attempts at justiﬁcation are riddled with an insoluble logical contradic-
tion and are therefore doomed to failure.
Chapter 2 (37-114), which presents various historical examples of violations of the
legal principles governing the monetary irregular-deposit contract by bankers and au-
thorities in three different historical instances, by itself is worth the price of the book.
If it is undeniably true that historical experience amply illustrates the relevance of the
book’s main theses, historians who have made important contributions to the histori-
ography of money, credit and banking have mostly been unaware of the conclusions of
the Austrian theoretical analysis and have often had recourse to somewhat inadequate
theoretical tools. This chapter reviews and integrates the celebrated work of some of the
most important historians from the perspective of the theoretical analysis developed in
the book.4
4 The three historical instances are the Greco-Roman world; the Mediterranean trading cities of the late
Middle Ages and the beginning of the Renaissance; and, ﬁnally, the emergence of the ﬁrst important
government banks beginning in the seventeenth century. The reader is offered fascinating introductions
into the work of such important historians like Raymond de Roover, Raymond Bogaert, Michael Ros-
tovtzeff, Jean Imbert, Henri Pirenne, Abbott Payson Usher, Marjorie Grice-Hutchinson, Carlo Cipolla
and Ramón Carande, among others.138 New Perspectives on Political Economy
Chapter 4 offers a detailed description of the credit expansion process and occupies
a central place in the book because it paves the way toward a comprehension of the
processes through which banking institutions and their stockholders expropriate great
amounts of wealth from all of the rest of society. This chapter precedes the chapters de-
voted to the theoretical analysis of the business-cycle effects of credit expansion (Chapter
5, 265-395) and to a highly interesting series of additional considerations on the theory
of the business cycle (Chapter 6, 397-508).
Some critics will perhaps object that the author resorts to a mono-causal explanation
of such complex phenomena like business cycles and may want to point to the possible
advantage of taking a more eclectic approach when analyzing the causes of business cy-
cles. However, it can be pointed out that mainstream writers generally “sin” even more
excessively in this respect since these authors do not discuss or criticize the Austrian the-
ory – if they mention it at all – while the book under review offers a thorough criticism
of rival approaches to the understanding of business cycles. The author’s critical analysis
and refutation of the alternative explanations for business cycle phenomena offered by
the monetarist and Keynesian schools is contained in Chapter 7 (509-600).
Chapter 8 (601-714) offers a fascinating overview of past as well as more recent con-
troversies relating to the role of a central bank as well as a brilliant refutation of the
rationale for both central banking and fractional-reserve free banking.
On the critical side, advocates of a system of fractional-reserve free banking will likely
remain unconvinced by the way the author portrays the internal dynamics of a fractional-
reserve free banking system, contained in the section devoted to the analysis of such a
banking system (664 ff.), in particular as regards the author’s suggestion that fractional-
reserve free banking will inevitably evolve towards a system of central banking. The
main issue can be summarized as follows.
In Table VIII-2 on page 667 of the book the author conceives of the interaction pat-
tern between banks in a fractional-reserve free banking system as a classic prisoner’s
dilemma, a conceptualization which is here intended to elucidate the typical “tragedy of
the commons” effect which will appear under fractional-reserve free banking: bankers
face the almost irresistible temptation to be the ﬁrst to initiate a policy of expansion,
particularly if they expect all other banks to follow suit to one degree or another. In theBook Review 139
prisoner’s dilemma conﬁguration comprising two banks, if either bank expands credit
alone, its viability and solvency will be endangered by interbank clearing mechanisms,
which will rapidly shift its reserves to the other bank if the ﬁrst fails to suspend its credit
expansion policy in time. Furthermore, the situation in which both banks simultane-
ously initiate credit expansion – a strategy which yields the same large proﬁts to both
– represents the mutually cooperative outcome, while the situation in which neither of
the banks expands and both maintain a prudent policy of loan concession represents the
outcome of mutual defection. Prof. Huerta de Soto concludes that it follows from this
interaction conﬁguration that the two banks will face a strong temptation to arrive at an
agreement and, to avoid the adverse consequences of acting independently, initiate a joint
policy of credit expansion, and particularly, to urge authorities to create a central bank.
However, and even if the author’s conclusion remains fully relevant in view of the
historical evidence presented in the book, the aforementioned argument, as it stands,
clearly presents a theoretical gap. Without a more detailed description of how, in the
absence of extra-market devices and interventions such as those of a central bank, the
two banks will actually coordinate their courses of action upon the mutually cooperative
outcome (in-concert expansion), the argument is not entirely tight. Indeed according to
the logic of the prisoner’s dilemma game all players will end up defecting so that no over-
expansion will ensue.5 This is the conclusion Prof. L. White (1995, 16) seems to have had
in mind when he wrote:
“Concerted expansion by a multiplicity of independent banks is implausible for the
same well-known reasons that the attempt to build a stable cartel arrangement among
manyﬁrmsisunlikelytobesuccessfulinanyindustryintheabsenceofalegalmechanism
enforcing cartelisation. Any ﬁrm not abiding by the cartel agreement could capture
whatever beneﬁts the agreement is supposed to bring the industry to a greater extent
than a ﬁrm adhering to the agreement.”
This does not mean that the argument is wrong or useless. In fact the conclusion is
well supported by historical evidence. It does seem to mean, however, that the conclusion
refers only to one theoretically possible scenario – the one which historical events have
5 In the prisoner’s dilemma setting players cannot reach the mutually cooperative outcome because they
cannot get together to make a binding agreement to expand together. That is why the prisoner’s dilemma
is characterized as a non-cooperative game.140 New Perspectives on Political Economy
actually taken – and not to the only possible scenario. Indeed, there are reasons to believe
that economic forces would tend to limit the practice of fractional-reserve free banking
even in the hypothesis that fractional-reserve banking were considered fully legitimate
from the ethico-juridical perspective.6
A relatively underexplored topic in the literature concerning proposals for banking
reform in general and concerning the theory of a 100-percent reserve requirement in
particular relates to the unavoidably complex issues surrounding the transition towards
a genuine gold standard. Such questions relate to the “economics of transition” in the
ﬁeld of money and banking and constitute a legitimate topic of research in themselves.
Partly taking inspiration from earlier proposals, and partly going beyond these, the book
contains an original proposal in this respect which can be expected to fuel future debate
in the relevant literature.
In the ﬁnal chapter of the book (715-812) the author thus details ﬁve basic stages of
the process of reform and transition toward the preferred monetary and banking system
(788 ff.). In this process which would culminate in complete banking freedom subject
to legal principles and in a single, worldwide monetary standard, today’s private bankers
would be converted into mere managers of mutual funds, to which banks would transfer
all of their assets and claims (except for the portion corresponding to their net worth).
The shareholders of these mutual funds would consist of two groups, on the one hand
the holders of current demand deposits who have opted for replacing these deposits with
mutual-fund shares, on the other hand – and here resides the originality of the book’s
proposal – the holders of treasury bonds who would receive, in exchange for them, the
remaining shares in the mutual funds to be established with the assets of the banking
system.
In conclusion, it should be stressed that the book under review has put the multidisci-
plinary method and approach into practice with great effectiveness. It is no exaggeration
to assert that the strongest argument in support of the author’s case ultimately derives
from the fact that the results of the historical-evolutionary, the theoretical (or economic)
and the juridico-ethical analyses converge on a similar overall conclusion.
6 See my (Winter 2006).Book Review 141
Obviously if the analytical results reached from the perspective of such various angles
all converge and point in the direction of the same overall conclusion, one is likely to have
hit upon some important truth.
Even if it may be difﬁcult at this time to gauge in any precise manner the effect the
book will have on the economics profession at large, there can be no doubt the book is
destined to become a classic, both by virtue of the subject matters that are treated and in
virtue of the manner in which they are treated: thoroughly and authoritatively.
Ludwig van den Hauwe∗
Bibliography
[1] Hayek, F.A.(1973) RulesandOrder, Vol.IofLaw,LegislationandLiberty, London:
Routledge.
[2] Hülsmann, J. G. (2000) ‘Review of: Dinero, Crédito Bancario y Ciclos Económicos,
Jesús Huerta de Soto, 1998, Madrid: Unión Editorial’, The Quarterly Journal of
Austrian Economics, Vol. 3, No. 2 (Summer 2000), 85-88.
[3] Van den Hauwe, L. (Winter 2006) ‘The Uneasy Case for Fractional-Reserve Free
Banking’, Procesos de Mercado – Revista Europea de Economía Política.
[4] White, L. H. (1995) Free Banking in Britain – Theory, Experience, and Debate, 1800-
1845 (Second Edition), London: The Institute of Economic Affairs.
[5] Witt, U. (1997) ‘The Hayekian puzzle: spontaneous order and the business cycle’,
Scottish Journal of Political Economy, 44, 44-58.
[6] Yeager, L. B. (2001) ‘The Perils of Base Money’, The Review of Austrian Economics,
14:4, 251-266.
∗ Ludwig M. P. van den Hauwe lives in Brussels; he received his Ph.D. from the Université Paris-Dauphine.

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Review of Huerta de Soto´s `Money, Bank Credit, and Economic Cycles´

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