For Austrians, Economics without the Entrepreneur is Like Hamlet without the Prince

We have attempted to outline the elements essential for understanding Austrian Capital Theory (ACT). A good grasp of ACT is absolutely necessary for understanding what Austrian economics is all about, and how it differs from the mainstream and other heterodox schools of economics, both in its reasoning and in its policy implications.

If one were to pick the one theoretical component that distinguishes Austrian from mainstream economics, it would surely have to be the presence of the entrepreneur. Neoclassical economic analysis has almost nothing to say about the entrepreneur. Its equilibrium analysis proceeds in terms of the eradication of all profit opportunities, and, if there are no profits there will be no entrepreneurs. More accurately, the entrepreneur is that shadowy figure who ensures that profits cannot last for very long in the theory. His appearance is instantaneously eradicated en route to the final equilibrium that is the center of the analysis. By contrast, the entrepreneur is the heart and soul of Austrian economics, wherein he is a vibrant, busy, creative, reckless, innovator. He is a prominent, perpetual presence. As Mises and Kirzner affirm, he is the driving force of the market process. For Austrians, economics without the entrepreneur is like the proverbial Hamlet without the prince. If the objective is to understand the how real-world markets work, the entrepreneur must take center stage.

—Peter Lewin and Nicolas Cachanosky, Austrian Capital Theory: A Modern Survey of the Essentials, Cambridge Elements in Austrian Economics (Cambridge, UK: Cambridge University Press, 2019), 65-66.

Neoclassical Economics Confuses Competitive Process with a Final, Static Equilibrium Condition

Most economists would agree that pure competition is not actually possible. Some would agree, perhaps reluctantly, that it might not even be desirable or optimal if it could exist. (If they agree to this, of course, then they must also agree that moving toward pure competition is not necessarily desirable, either). But few economists have noticed or emphasized the fundamental flaw of the purely competitive model, namely, that it is not a description of competition at all. Pure competition is a static, equilibrium condition whose very assumptions are such that competitive process is ruled out by definition. Or to put the matter more charitably, while pure competition may describe the final outcome of a particular competitive situation, the ultimate end result, it does not describe the competitive process that produced that particular outcome. The purely competitive theory is not a theory of competition as such.

The neoclassical habit of confusing competitive process with a final, static equilibrium condition makes for gross errors in economic analysis. For instance, product differentiation, advertising, price competition (including price discrimination), and innovation are rather routinely condemned as “monopolistic” and, thus, as resource misallocating and socially undesirable. this condemnation follows “logically” since not one of these activities is possible under purely competitive conditions. Hence everything that is truly competitive in the real world, truly rivalrous, gets labeled as “monopolistic” and resource misallocating in the Alice-in-Wonderland, purely competitive world. The analytical conclusions one is forced to come to, employing the purely competitive perspective, are not just wrong, not just unrealistic, but the very opposite of the truth. Far from being able to “predict,” or tell us anything meaningful concerning competitive behavior, pure competition can only describe what things would be like if the world contained zombie-like consumers with homogeneous tastes, atomistically structured firms identical in every important respect, with no locational advantages, no advertising, no entrepreneurship, and no rivalry whatever. Surely this is the major flaw and absurdity inherent in the purely competitive perspective.

—D. T. Armentano, “A Critique of Neoclassical and Austrian Monopoly Theory,” in New Directions in Austrian Economics, ed. Louis M. Spadaro, Studies in Economic Theory (Kansas City: Sheed Andrews and McMeel, 1978), 96-97.

In the Neoclassical Vision, Firms Respond to a New Set of Perfect Information Provided Like Manna from Heaven

The founders of the discipline did not reason about competition within an intellectual matrix comparable to that which dominates the mind grounded in neoclassical method. The classicists saw the market as an incessant discovery process by which consumer preferences and the least-cost methods of satisfying those preferences were revealed. The entrepreneur was indispensable to this process, for he possessed a comparative advantage in gathering and weighing dispersed and often conflicting signals. That is, the entrepreneur existed because judgments had to be made, as contrasted with the neoclassical vision, in which the only acceptable behaviour of firms is to mechanically reallocate capital in response to a new set of perfect-information emissions—provided like manna from heaven, indiscriminately and simultaneously—to the roboticked helmsmen of each firm. In classical economics, to summarize, competition was the process of action and reaction by which firms learned what to produce and how to produce; the relative absence of these adaptive forces was associated with the complacency induced by the privilege of monopoly.

—Frank M. Machovec, Perfect Competition and the Transformation of Economics, Foundations of the Market Economy (London: Routledge, Taylor and Francis e-Library, 2003), 15-16.

Market Process Theory Rejects Both Mainstream Perfect Knowledge Assumptions and Radical Uncertainty

Mainstream economics, Garrison pointed out, has gravitated to one polar position on knowledge. ‘Perfect knowledge — or perfect knowledge camouflaged beneath an assortment of frequency distributions — has been the primary domain of standard theory for several decades now’ (Garrison 1982). (We may add that, in multiperiod models of general equilibrium incorporating intertemporal exchange, this perfect knowledge assumption has been extended, in principle, to knowledge of all future time.) Much of the criticism, from post-Keynesians, Shackle and others, of mainstream economics has taken its point of departure to be the radical uncertainty which shrouds the future. This uncertainty is seen as so impenetrable as to render absurdly irrelevant all those neoclassical theories built up from individual optimizing decisions, assumed to be made between well-defined alternative future possibilities. As Shackle (1972) put it, the ‘gaps of knowledge’ which arise from an uncertain future ‘stultify rationality’. Knowledge is not, of course, completely absent but, the critics would maintain, there is no way, within a theory of markets, that existing ‘open-ended’ (Shackle 1972) ignorance can be systematically eliminated. (Search is no solution because the ‘worth of new knowledge cannot begin to be assessed until we have it. By then it is too late to decide how much to spend on breaching the walls to encourage its arrival’). Thus the brute circumstance of ignorance concerning the future actions of other people makes it impossible for markets to induce consistency among individual decisions (Lachmann 1986a).

It is here that the Austrian theory of market process takes a position concerning knowledge and possible market equilibration which avoids both these extremes. On the one hand the perfect knowledge assumption makes it pointless to ask how the market process can induce co-ordination among decisions; such co-ordination is already implied in the perfect knowledge assumption. On the other hand the assumption of invincible ignorance places the possibility of a systematic market process of systematic co-ordination entirely beyond reach.

For Austrians, however, mutual knowledge is indeed full of gaps at any given time, yet the market process is understood to provide a systemic set of forces, set in motion by entrepreneurial alertness, which tend to reduce the extent of mutual ignorance. Knowledge is not perfect; but neither is ignorance necessarily invincible. Equilibrium is indeed never attained, yet the market does exhibit powerful tendencies towards it. Market co-ordination is not to be smuggled into economics by assumption; but neither is it to be peremptorily ruled out simply by referring to the uncertainty of the future.

—Israel M. Kirzner, “Market Process Theory: In Defence of the Austrian Middle Ground,” in The Meaning of Market Process: Essays in the Development of Modern Austrian Economics, Foundations of the Market Economy (London: Routledge, Taylor and Francis e-Library, 2001), 4-5.

Neoclassical Economics Developed as a Copy of Mechanical Physics Replacing Energy with Utility

Perhaps at this time it is most important to highlight the negative influence which the static conception of energy efficiency has exerted on the development of economics. Hans Mayer and Philip Mirowski have pointed out that neoclassical economics developed as a copy of nineteenth-century mechanical physics: using the same formal method, yet replacing the concept of energy with that of utility and applying the same principles of conservation, maximization of the result and minimization of waste. The leading author most representative of this trend, and the one to best illustrate this influence of physics on economic thought, is Leon Walras. In his paper ‘Economics and Mechanics’, published in 1909, he claims that in his Elements of Pure Economics he uses mathematical formulas identical to those of mathematical physics, and he stresses the parallel between the concepts of force and rareté (which he regards as vectors), and between those of energy and utility (which he regards as scalar quantities).

—Jesús Huerta de Soto, “The Theory of Dynamic Efficiency,” in The Theory of Dynamic Efficiency, Routledge Foundations of the Market Economy 28 (London: Routledge, Taylor and Francis, 2009), 4.

Hans Mayer On the Disguised Fiction at the Heart of Mathematical Equilibrium Theories

Another aspect of interest is the different position of the two schools [Neoclassical versus Austrian] regarding the utilization of mathematical formalism in economic analysis. From the origins of the Austrian School, its founder, Carl Menger, took care to point out that the advantage of verbal language is that it can express the essences (das Wesen) of economic phenomena, something that mathematical language cannot do. In fact, in a letter he wrote to Walras in 1884, Menger wondered: ‘How can we attain to a knowledge of this essence, for example, the essence of value, the essence of land rent, the essence of entrepreneurs’ profits, the division of labour, bimetalism, etc., by mathematical methods?’ Mathematical formalism is especially adequate for expressing the states of equilibrium that the neoclassical economists study, but it does not allow the inclusion of the subjective reality of time and, much less, the entrepreneurial creativity which are essential features of the analytical reasoning of the Austrians. Perhaps Hans Mayer summed up the insufficiencies of mathematical formalism in economics better than anyone when he said that:

In essence there is an immanent, more or less disguised, fiction at the heart of mathematical equilibrium theories: that is, they bind together in simultaneous equations, non-simultaneous magnitudes operative in genetic-causal sequence as if these existed together at the same time. A state of affairs is synchronized in the ‘static’ approach, whereas in reality we are dealing with a process. But one simply cannot consider a generative process ‘statically’ as a state of rest, without eliminating precisely that which makes it what it is.

—Jesús Huerta de Soto, “The Ongoing Methodenstreit of the Austrian School,” in The Theory of Dynamic Efficiency, Routledge Foundations of the Market Economy 28 (London: Routledge, Taylor and Francis, 2009), 39-40.

Economists Delude Themselves If They Substitute a Holistic Macroeconomic Approach for an Individualistic Approach

The authors who think that they have substituted, in the analysis of the market economy, a holistic or social or universalistic or institutional or macroeconomic approach for what they disdain as the spurious individualistic approach delude themselves and their public. For all reasoning concerning action must deal with valuation and with the striving after definite ends, as there is no action not oriented by final causes. It is possible to analyze conditions that would prevail within a socialist system in which only the supreme tsar determines all activities and all the other individuals efface their own personality and virtually convert themselves into mere tools in the hands of the tsar’s actions. For the theory of integral socialism it may seem sufficient to consider the valuations and actions of the supreme tsar only. But if one deals with a system in which more than one man’s striving after definite ends directs or affects actions, one cannot avoid tracing back the effects produced by action to the point beyond which no analysis of actions can proceed, i.e., to the value judgments of the individuals and the ends they are aiming at. . . .

The macroeconomist deceives himself if in his reasoning he employs money prices determined on the market by individual buyers and sellers. A consistent macroeconomic approach would have to shun any reference to prices and to money. The market economy is a social system in which individuals are acting. The valuations of individuals as manifested in the market prices determine the course of all production activities. If one wants to oppose to the reality of the market economy the image of a holistic system, one must abstain from any use of prices.

—Ludwig von Mises, The Ultimate Foundation of Economic Science: An Essay on Method, ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2006), 74-76.

All Socialist Theories and Utopias Have Always Had Only the STATIONARY CONDITION in Mind

To assume stationary economic conditions is a theoretical expedient and not an attempt to describe reality. We cannot dispense with this line of thought if we wish to understand the laws of economic change. In order to study movement we must first imagine a condition where it does not exist. The stationary condition is that point of equilibrium to which we conceive all forms of economic activity to be tending and which would actually be attained if new factors did not, in the meantime, create a new point of equilibrium. In the imaginary state of equilibrium all the units of the factors of production are employed in the most economic way, and there is no reason to contemplate any changes in their number or their disposition.

Even if it is impossible to imagine a living — that is to say a changing — socialist economic order, because economic activity without economic calculation seems inconceivable, it is quite easy to postulate a socialist economic order under stationary conditions. We need only avoid asking how this stationary condition is achieved. If we do this there is no difficulty in examining the statics of a socialist community. All socialist theories and Utopias have always had only the stationary condition in mind.

—Ludwig von Mises, Socialism: An Economic and Sociological Analysis, trans. J. Kahane (Indianapolis: Liberty Fund, 1981), 142.

Mises Identified a Source of Perennial Confusion Concerning the ROLE OF TIME in the Austrian Theory

Mises, while paying tribute to the “imperishable merits” of Böhm-Bawerk’s seminal role in the development of the time-preference theory, sharply criticized the epistemological perspective from which Böhm-Bawerk viewed time as entering the analysis. For Böhm-Bawerk time preference is an empirical regularity observed through casual psychological observation. Instead, Mises saw time preference as a “definite categorial element . . . operative in every instance of action.” In Mises’ view, Böhm-Bawerk’s theory failed to do justice to the universality and inevitability of the phenomenon of time preference. In addition, Mises took Böhm-Bawerk to task for not recognizing that time should enter analysis only in the ex ante sense [forward-looking sense]. The role that time “plays in action consists entirely in the choices acting man makes between periods of production of different length. The length of time expended in the past for the production of capital goods available today does not count at all. . . . The ‘average period of production’ is an empty concept.” It may be remarked that here Mises identified a source of perennial confusion concerning the role of time in the Austrian theory. Many of the criticisms leveled by Knight and others against the Austrian theory are irrelevant when the theory is cast explicitly in terms of the time-conscious, forward-looking decisions made by producers and consumers.

—Israel M. Kirzner, “Ludwig von Mises and the Theory of Capital and Interest,” in The Economics of Ludwig von Mises: Toward a Critical Reappraisal, ed. Laurence S. Moss (Kansas City: Sheed and Ward, 1976), 55-56.

A Completely Socialized, Planned Economy Must Be a Natural (Moneyless) Economy

Like Mises, Weber was prompted to make his argument by Otto Neurath’s writings. Weber agrees with Neurath’s contention that a completely socialized, planned economy must be a natural (moneyless) economy. Technically or formally, says Weber, money is the most perfect means of economic calculation. Without money, calculation purely in physical units can be performed where wants “are strictly given” and “so long as the situation does not require a very precise estimate of the comparative utility to be gained from the allocation of the available resources to each of a large number of very heterogeneous modes of use.” Otherwise, scope for accurate calculation is limited, and even the simple, self-sufficient household faces problems, solved partly by tradition and partly by “very rough estimates.”

The problems become more difficult with changes in wants and production conditions, with growing complexity, and with the decline of purely traditional standards. Given monetary calculation, costs can be assessed in money terms, but with moneyless calculation, all the different ways of using all means of production have to be taken into account.

—David Ramsay Steele, From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation (La Salle, IL: Open Court Publishing, 1992), e-book.

Treatment of the Capital Structure as a Given Datum Is Implied Whenever We Focus on “the Quantity of Capital”

Hayek also made a point against Pigou similar to one he would make against Knight: when an economist limits his attention to stationary states, he cannot analyze how the structure of capital responds to shifts in time preference or technology. When a structure of capital, “which is the result of the equilibrating process, is treated as if it were a datum”— that is, the set of capital goods is treated as “given”— the result is a blindness to capital adjustment issues. Treatment of the capital structure as a datum is implied whenever an economist focuses exclusively on “the quantity of capital,” and whenever said “quantity” is held constant.

—Lawrence H. White, ed., editor's introduction to The Collected Works of F. A. Hayek, vol. 11, Capital and Interest, by F. A. Hayek (Chicago: University of Chicago Press, 2015), xxix.

Mises Distinguishes “Commodity Credit” (Healthy Kind) from “Circulation Credit” (Unhealthy Kind)

In order to understand the ABCT it is necessary to grasp a distinction between two different kinds of credit first introduced by Ludwig von Mises himself. The first one, commodity credit, is, in Mises’s opinion, the healthy kind of credit. Somebody saves out of his income and transfers the savings to somebody else, mainly by means of financial intermediaries. As this kind of credit necessitates savings, it involves an exchange of present goods for future goods. In the words of Mises, credits of this kind are

characterized by the fact that they impose a sacrifice on that party who performs his part of the bargain before the other does—the foregoing of immediate power of disposal over the exchanged good.

In short, before commodity credit can be granted, somebody must have saved up goods or money that can now be lent to the debtors. The sacrifice of the savers is the necessary condition for this kind of credit.

The second kind of credit Mises calls circulation credit. In his opinion, it constitutes the unhealthy kind of credit. It does not stem from anybody’s savings, but from the power of banks to lend additional money into existence. It is not necessary to go into the details of fractional reserve banking here. That this kind of banking is able to create additional credit via lending out its own banknotes (in earlier times) or demand deposits that are at any time convertible into money is generally accepted by economists. The phenomenon is called the money multiplier. Mises’s point is that this kind of credit creation does not presuppose savings and therefore causes nearly no costs to either the issuing bank or anybody else. This

group of credit transactions is characterized by the fact that in them the gain of the party who receives before he pays is balanced by no sacrifice on the part of the other party.

According to Mises’s definition, what he calls circulation credit is not a proper credit transaction from an economic point of view. “[T]he essential element, the exchange of present goods for future goods, is absent.” No savings and no sacrifices are necessary:

If a creditor is able to confer a loan by issuing claims which are payable on demand, then the granting of the credit is bound up with no economic sacrifice for him.

—Eduard Braun, “The Subsistence Fund in Ludwig von Mises's Explanation of the Business Cycle,” in Theory of Money and Fiduciary Media: Essays in Celebration of the Centennial, ed. Jörg Guido Hülsmann (Auburn, AL: Ludwig von Mises Institute, 2012), 194-195.

Israel M. Kirzner Reduces Mises's Views on Capital and Interest to Six Major Theses

Mises’s views on capital and on interest may be conveniently summarized as follows:

1. Interest is not the specific income derived from using capital goods; nor is it “the price paid for the services of capital.” Instead, interest expresses the universal (“categorical”) phenomenon of time preference and will therefore inevitably emerge also in a pure exchange economy without production.
2. Since production takes time, the market prices of factors of production (which tend to reflect the market prices of the consumer goods they produce) are themselves subject to considerations of time preference. Thus the market in a production economy generates interest as the excess value of produced goods over the appropriately discounted values of the relevant factors of production. 
3. The concept of capital (as well as of its correlative income) is strictly a tool for economic calculation and hence has meaning only in the context of a market in which monetary calculation is meaningful. Thus, capital is properly defined as the (subjectively perceived) monetary value of the owner's equity in the assets of a particular business unit. Capital is therefore to be sharply distinguished from capital goods.
4. Capital goods are produced factors of production; they are “intermediary stations on the way leading from the very beginning of production to its final goal, the turning out of consumers’ goods.”
5. It is decidedly not useful to define capital as the totality of capital goods. Nor does the concept of a totality of capital goods provide any insight into the productive process. 
6. Capital goods are the results of earlier (i.e., higher) stages of production and therefore are not factors of production in their own right apart from the factors employed in their production. Capital goods have no productive power of their own that cannot be attributed to these earlier productive factors. 

—Israel M. Kirzner, “Ludwig von Mises and the Theory of Capital and Interest,” in The Economics of Ludwig von Mises: Toward a Critical Reappraisal, ed. Laurence S. Moss (Kansas City: Sheed and Ward, 1976), 52-53.

Mises Emphasizes the Teleological Nature of Time-Preference Expressed by Forward-Looking Decisions

Mises criticizes Böhm-Bawerk for not recognising that time should enter analysis only in the ex ante sense.

The role that time “plays in action consists entirely in the choices acting man makes between periods of production of different length. The length of time expended in the past for the production of capital goods available today does not count at all […] The ‘average period of production’ is an empty concept.” (ibid., pp. 488-489). In other words, Mises emphasizes the teleological nature of time-preference as it is expressed by forward-looking decision made by producers and consumers.

—Agnès Festré, “Knowledge and Individual Behaviour in the Austrian Tradition of Business Cycles: von Mises vs. Hayek,” History of Economic Ideas 11, no. 1 (2003): 22.

Böhm-Bawerk and the So-Called Naïve Productivity Theory of Interest (Part 1)

One of the most important contributions Böhm-Bawerk made in understanding interest was in his identification and framing of the phenomenon under scrutiny. Specifically, Böhm-Bawerk argued that the task of the economic theorist was to explain why owners of capital could regularly earn a net return on their assets, even though, unlike laborers, they apparently did nothing to earn this interest income. After this starting point, Böhm-Bawerk transformed the task by showing that it was equivalent to explaining why there was an apparent premium—what he called agio—in intertemporal exchanges, those that involve goods from different time periods.

We can illustrate Böhm-Bawerk's approach with the example of a tractor. Typically, a capitalist who invests in a tractor, either directly or by lending funds to a farmer, can earn an interest return on the investment; that is, he will have more wealth, measured in money terms, after the tractor has been used to harvest crops. What Böhm-Bawerk realized was that this phenomenon—the growth in financial wealth through investment in the tractor—relies on an apparent undervaluation of the tractor.

To see this, suppose that the tractor is expected to yield an additional $1,000 worth of revenue every year, and that it will last ten years before being junked. Böhm-Bawerk argued that the only reason a capitalist could earn money through ownership of the tractor is that its initial purchase price is less than $10,000. Only in that case could an investor use an initial amount of financial wealth and turn it into a greater subsequent amount (ten years later). In other words, if the capitalist had to spend a full $10,000 upfront to buy the tractor, and then it increased the harvest on the farm to allow for an extra $1,000 in crops to be earned each year for a decade, the capitalist would only break even, recouping his initial $10,000 investment. To earn a positive rate of return, the initial purchase price had to be less than the $10,000. If, for example, a new tractor had a purchase price of only $5,000, then the capitalist would effectively double his money over the course of 10 years for an annualized rate of return of about 7 percent.

By this procedure, Böhm-Bawerk had transformed his original question. Rather than asking, “Why do capitalists earn an effortless flow of interest income?” he could instead wonder, “Why is it that the initial purchase prices of capital goods systematically fall short of the future income their use is expected to yield?” Against this metric, Böhm-Bawerk measured all of the explanations of interest that economic theorists had offered before his own writing.

—Robert P. Murphy, Choice: Cooperation, Enterprise, and Human Action (Oakland, CA: Independent Institute, 2015), e-book.

The Goods-In-Process Conception of Capital Has a Long and Honorable History

What, then, is the case for capital-based macroeconomics? Considerations of capital structure allow the time element to enter the theory in a fundamental yet concrete way. If labor and natural resources can be thought of as original means of production and consumer goods as the ultimate end toward which production is directed, then capital occupies a position that is both logically and temporally intermediate between original means and ultimate ends. The goods-in-process conception of capital has a long and honorable history. . . .

This temporally intermediate status of capital is not in serious dispute, but its significance for macroeconomic theorizing is rarely recognized. Alfred Marshall taught us that the time element is central to almost every economic problem. The critical time element manifests itself in the Austrian theory as an intertemporal capital structure.

—Roger W. Garrison, Time and Money: The Macroeconomics of Capital Structure, Foundations of the Market Economy (London: Routledge, 2002), 7-8.

Neoclassical Economics Has NOT Changed Much Because It Conceives of TIME in Static, NOT Dynamic, Terms

In a certain respect, neoclassical economics has not changed much in the past 50 years. Many of the recent “innovations” in theory simply extend the static maximizing apparatus to allegedly dynamic issues. In  particular, time is still most frequently conceived in purely static terms. As such, it is analogized to space: Just as an individual may allocate portions of space (land) to certain purposes, he can also allocate portions of time to certain activities. In principle, time and perfect predictability are compatible. The dynamic conception of time, on the other hand, is time perceived as a flow of events. Implicit in this idea of a flow is that of novelty or true surprise. The individual’s experience of today’s events itself makes tomorrow’s perceptions of events different than it otherwise would be. As an individual adds to the stock of his experiences, his perspective changes and so both the present and the future are affected by the past flow of events. Flows, however, are continuous, and hence the individual’s perspective changes right up to the moment of any experience. This renders perfect prediction of the experience impossible. Since all individuals are similarly affected, and since, as we have seen, the consequences of an individual’s course of action depends on what others will do, this idea of time has implications for decision-making. Choices made in real time are thus never made with complete knowledge (either deterministic or stochastic) of their consequences. The recognition of this fact by individuals is the source of rule-following behavior and, on a social level, of the development of institutions.

—Gerald P. O’Driscoll Jr. and Mario J. Rizzo, The Economics of Time and Ignorance, Foundations of the Market Economy (London: Routledge, Taylor and Francis e-Library, 2002), 2-3.

Mises Distinguishes Between a Cash Transaction and a Credit Transaction

Acts of exchange, whether direct or indirect, can be performed either in such a way that both parties fulfill their parts of the contract at the same time, or in such a way that they fulfill them at different times. In the first case we speak of cash transactions; in the second, of credit transactions. A credit transaction is an exchange of present goods for future goads.

—Ludwig von Mises, The Theory of Money and Credit, trans. H. E. Batson (Indianapolis: Liberty Fund, 1981), 296.

In a Credit Transaction, the Possessor of Money (Useful Present Good) Exchanges It for an “I Owe You” (Future Good)

None of this discussion is meant to impugn the general practice of credit, which has an important and vital function on the free market. In a credit transaction, the possessor of money (a good useful in the present) exchanges it for an IOU [an I Owe You, a debt] payable at some future date (the IOU being a “future good”) and the interest charge reflects the higher valuation of present goods over future goods on the market. But bank notes or deposits are not credit; they are warehouse receipts, instantaneous claims to cash (e.g., gold) in the bank vaults. The debtor makes sure that he pays his debt when payment becomes due; the fractional reserve banker can never pay more than a small fraction of his outstanding liabilities.

—Murray N. Rothbard, What Has Government Done to Our Money? (Auburn, AL: Ludwig von Mises Institute, 2010), 46-47.

Money Facilitates Credit Transactions, Which Are the Exchange of Present Goods against Future Goods

The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. Many investigators imagine that insufficient attention is devoted to the remarkable part played by money in economic life if it is merely credited with the function of being a medium of exchange; they do not think that due regard has been paid to the significance of money until they have enumerated half a dozen further “functions”—as if, in an economic order founded on the exchange of goods, there could be a more important function than that of the common medium of exchange.

After Menger’s review of the question, further discussion of the connection between the secondary functions of money and its basic function should be unnecessary. Nevertheless, certain tendencies in recent literature on money make it appear advisable to examine briefly these secondary functions—some of them are coordinated with the basic function by many writers—and to show once more that all of them can be deduced from the function of money as a common medium of exchange.

This applies in the first place to the function fulfilled by money in facilitating credit transactions. It is simplest to regard this as part of its function as medium of exchange. Credit transactions are in fact nothing but the exchange of present goods against future goods.

—Ludwig von Mises, The Theory of Money and Credit, trans. H. E. Batson (Indianapolis: Liberty Fund, 1981), 46-47.

Mises: The Distinction Between Commodity and Circulation Credit Is the Key to Understanding Banking Theories

The recent financial crisis has undermined well-established convictions and paradigms within the “mainstream” macroeconomic profession, triggering an intense search for better “analytics”, as the models dominating so far largely turned out insufficient not only in predicting the crisis, but even in explaining it. In searching for new theories attention is sometimes turned to past ideas. One of them are the monetary and business cycle theories of Ludwig von Mises, which were subsequently refined by Friedrich von Hayek and other economists of the Austrian School of Economics (ASE). This big picture overview focuses on explaining the kernel of Austrian Business Cycle Theory (ABCT), which is the distinction between the two types of credit (commodity credit and circulation credit) and how this distinction applies to two types of banking activity: negotiation of credit and issuance of credit, and how these findings are being “rediscovered” in current monetary theory. Mises (1981) emphasized 101 years ago (in 1912 his “Theory of Money and Credit” was first published) that understanding of this distinction is the key to understanding banking theories (p. 297). This lesson has been forgotten for a long time, but now is being rediscovered.

—Marcin Mrowiec, “Rediscovering Mises-Hayek Monetary and Business Cycle Theory in Light of the Current Crisis: Credit Expansion as a Source of Economic Boom and Bust,” Financial Internet Quarterly 9, no. 2 (2013): 64.

Austrian and New Classical Schools Differ on the Homogeneity Postulate So They Produce Different Business Cycle Theories

The difference between Austrians and New Classicals as regards the appropriateness of the homogeneity postulate for agents and goods leads to a difference in their respective business cycle theories. Austrians explain such cycles in terms of coordination failures between the agents’ savings and investment decisions. These failures arise from non-neutral monetary injections in the economy, which disturb the structure of relative prices. This disturbance bring about malinvestments, culminating in distortions of the structure of production.

New Classicals, on the other hand, assume that there is ‘helicopter money’, which can be spread immediately and proportionately over the economy. From a full-information point of view, money is then neutral in a comparative-static sense. Furthermore, the homogeneity postulate for goods eliminates malinvestments. Consequently, the NCE [New Classical Economics] explains business cycles in terms of overinvestments.

—Rudy van Zijp, “Austrian and New Classical Business Cycle Theories” (PhD diss., Free University of Amsterdam, 1992), 257-258.

The Concept of “Neutral Money” Stems from 3 Fundamental Errors: Static Analysis, Assumptions, and Methodology

I showed that while mainstream economics usually posits neutrality of money in the long term, when addressing short-to-mid-term cycles, it is acknowledged that changes in money supply do have an impact on the real sphere. Different schools of economics present different views on the causes of this phenomenon. Monetarists emphasize adaptive expectations, neoclassicists point to imperfect information with rational expectations and the new Keynesians focus mostly on price rigidity.

On the other hand, the Austrian school emphasizes the case in which “the monetary injection is not distributed among individuals in exact proportion to their previous shares of money holdings” (Blaug, 1985), which is responsible for the non-neutrality of money that exists even in the long term.

The concept of neutral money in its most popular view stems from erroneously applying conclusions drawn from static analysis of two equilibrium states to dynamic market processes, accepting simplified, unrealistic assumptions and holistic methodology. It seems, therefore, that the 11th of the 13 most important issues in economics, according to Morgenstern (1972), that demand resolution —that is departure from studying aggregates like “general price level” and more attention to dynamic analysis of money in Cantillon’s spirit — still remains unresolved.

I trust that my book is a step in the direction suggested by Morgenstern.

—Arkadiusz Sieroń, Money, Inflation and Business Cycles: The Cantillon Effect and the Economy, trans. Martin Turnau, Routledge International Studies in Money and Banking (Milton Park, UK: Routledge, 2019), 11-12.

Mainstream Macroeconomics and the Keynesian Revolution Can ONLY Be Understood in Relation to Malthus’s Economics

The Keynesian Revolution, and therefore the origins of virtually all macroeconomic theory today, can only be understood in relation to Keynes’s coming across Malthus’s economic writings in 1932. In particular, it was his reading of the Malthus side of the Malthus — Ricardo correspondence, which had been unearthed in 1930 by his close associate Piero Sraffa, that turned Keynes’s mind to the possibility of demand deficiency as a cause of recession. Until that time, economists had been near unanimous in arguing that insufficient demand as a cause of recession was fallacious, and until reading the Malthus  — Ricardo correspondence, this possibility had never crossed Keynes’s mind. . . .

It was Malthus, of course, who had been the leading advocate in the nineteenth century of demand deficiency as a cause of recession, and of increased levels of unproductive spending as the cure. Reading Malthus’s letter to Ricardo, and then the text of Chapter VII of Malthus’s Principles, both of which Keynes did at the end of 1932, ought to be recognized as the single most important reason why Keynes was to write what he wrote in the way that he did.

—Steven Kates, Free Market Economics: An Introduction for the General Reader (Cheltenham, UK: Edward Elgar Publishing, 2017), Kobo e-book.