CAUSES OF CRISES AND CYCLES 201

the theory. By the operation of banks that issue notes or give
deposit credit in excess of their actual capital! he explained in
1820, the borrowers of the banks are brought into the market
with added purchasing power. Prices rise, adding fuel to the
spirit of speculation, ‘which never fails to be engendered by the
facility of procuring the means to speculate with.” Purchases are
made ‘for no other reason than that the buyers suppose they
can sell the next day at a profit.” Beguiled by the apparent
prosperity that attends rising prices and speculative activity,
people spend more lavishly. Merchants enlarge the scale of their
enterprises; manufacturers add to their plants; farmers improve
their lands and buildings. All these operations give additional
employment to labor. The demand of consumers for commodities
 becomes greater. ‘Every new sale of commodities and
property on credit creates new promissory notes, and these
create a new demand for discounts.” Thus the cycle goes on,
cumulatively generating its own momentum, until finally “the
depreciation of the currency [s. e., rise of prices] has become so
great from these extraordinary issues, that timid people become
alarmed, and make a run upon the banks, whilst coin is also demanded
 for exportation.” 2 The banks are forced to call their
loans and money becomes scarce. But the merchant has long
since parted with the money he borrowed, in purchasing goods;
the manufacturer, in building new plants; the farmer, in bettering
his land; and now they find that they can realize but a fraction of
their investment by selling what they have bought. Their goods
are no longer salable; their credits are frozen by the similar predicament
 of their debtors. Widespread disaster ensues.
L The correct criterion of whether or not banking operations result in an increase
of media of payment is, of course, issue in excess not of capital, but of cash reserve.
The fallacy of thinking in terms of capital in this connection was a frequent one,
and evidence of it may be found in our early laws.
* Raguet, Currency and Banking (1839), p. 136. All of this paragraph except the
present quotation may also be found in ‘The Principles of Banking,” Free Trade
Advocate (July 4, 1829), ii, 7. The same explanation of the business cycle is virtually
reproduced in Currency and Banking (1839), pp. 134-137. Raguet’s knowledge of
the nature of the business cycle makes it difficult to accept the statement that
“little of value can be found in discussions [of commercial crises] published prior to
1837.” E. D. Jones, Economic Crises (1900), p. 15.