In His 1903 Work Titled “Money” (“Das Geld”), Karl Helfferich Laid Down the “Austrian Circle” Challenge to the Austrian School of Economics

In 1903, the influential monetary economist Karl Helfferich, in his work on Money, laid down a challenge to the Austrian School. He pointed out correctly that the great Austrians, Menger, Böhm-Bawerk, and their followers, despite their prowess in analyzing the market and the value of goods and services (what we would now call “micro-economics”), had not managed to solve the problem of money. Marginal utility theory had not been extended to the value of money, which had continued, as under the English classical economists, to be kept in a “macro” box strictly separate from utility, value, and relative prices. Even the best monetary analysis, as in Ricardo, the Currency School, and Irving Fisher in the United States, had been developed in terms of “price levels,” “velocities,” and other aggregates completely ungrounded in any micro analysis of the actions of individuals.

In particular, the extension of Austrian analysis to money faced a seemingly insuperable obstacle, the “problem of the Austrian circle.”

—Murray N. Rothbard, The Essential von Mises (Auburn, AL: Ludwig von Mises Institute, 2009), 55.

The Austro-Hungarian Bank Saw Mises’s Gold Standard Proposal as a Threat to Its Secret and Illegal Slush Fund

In 1906, his doctorate out of the way, Mises determined to take up the Helfferich challenge, apply marginal utility theory to money, and solve the problem of the Austrian circle. He devoted a great deal of effort to both empirical and theoretical studies of monetary problems. The first fruits of this study were three scholarly articles, two in German journals and one in the English Economic Journal in 1908–09, on foreign exchange controls and the gold standard in Austria-Hungary. In the course of writing these articles, Mises became convinced that, contrary to prevailing opinion, monetary inflation was the cause of balance of payments deficits instead of the other way round, and that bank credit should not be “elastic” to fulfill the alleged needs of trade.

Mises’s article on the gold standard proved highly controversial. He called for a de jure return in Austria-Hungary to gold redemption as a logical conclusion of the existing de facto policy of redeemability. In addition to running up against advocates of inflation, lower interest rates, and lower exchange rates, Mises was surprised to face ferocious opposition by the central bank, the Austro-Hungarian Bank. In fact, the Bank’s vice-president hinted at a bribe to soften Mises’s position. A few years later, Mises was informed by Böhm-Bawerk, then Minister of Finance, of the reason for the vehemence of the Bank’s opposition to his proposal for a legal gold standard. Legal redemption in gold would probably deprive the Bank of the right to invest funds in foreign currencies. But the Bank had long used proceeds from these investments to amass a secret and illegal slush fund, from which to pay subventions to its own officials, as well as to influential journalists and politicians. The Bank was keen on retaining the slush fund, and so it was fitting that Mises’s most militant opponent was the publisher of an economic periodical who was himself a recipient of Bank subsidies.

—Murray N. Rothbard, The Essential von Mises (Auburn, AL: Ludwig von Mises Institute, 2009), 56-57.

It Is the Fact of Time Preference that Results in Interest and Profit

Again working from analysis of the individual, Böhm-Bawerk saw that it was a basic law of human action that each person wishes to achieve his desires, his goals, as quickly as possible. Hence, each person will prefer goods and services in the present to waiting for these goods for a length of time in the future. A bird already in the hand will always be worth more to him than one bird in the bush. It is because of this basic primordial fact of “time preference” that people do not invest all their income in capital equipment so as to increase the amount of goods that will be produced in the future. For they must first attend to consuming goods now. But each person, in different conditions and cultures, has a different rate of time preference, of preferring goods now to goods later. The higher their rate of time preference, the greater the proportion of their income they will consume now; the lower the rate, the more they will save and invest in future production. It is the fact of time preference that results in interest and profit; and it is the degree and intensity of time preferences that will determine how high the rate of interest and profit will be.

—Murray N. Rothbard, The Essential von Mises (Auburn, AL: Ludwig von Mises Institute, 2009), 9.