Governments Engage in “Disguised Absolutism” When They Arrogate to Themselves the Right to Cover Deficits by Issuing Notes

The socialistic or semi-socialistic state needs money in order to carry on undertakings which do not pay, to support the unemployed, and to provide the people with cheap food. It also is unable to secure the necessary resources by means of taxation. It dare not tell the people the truth. The state-socialist principle of running the railways as a state institution would soon lose its popularity if it was proposed, say, to levy a special tax for covering their running losses. And the German and Austrian people would have been quicker in realizing where the resources came from that made bread cheaper if they themselves had had to supply them in the form of a bread tax. In the same way, the German government that decided for the “policy of fulfillment” in opposition to the majority of the German people, was unable to provide itself with the necessary means except by printing notes. And when passive resistance in the Ruhr district gave rise to a need for enormous sums of money, these, again for political reasons, were only to be procured with the help of the printing press.

A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, that is, of antidemocratic, policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. It explains why inflation has always been an important resource of policies of war and revolution and why we also find it in the service of socialism. When governments do not think it necessary to accommodate their expenditure to their revenue and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism. 

—Ludwig von Mises, The Theory of Money and Credit, trans. H. E. Batson (Indianapolis: Liberty Fund, 1981), 254-255.

The Keynesian Multiplier is the Bigfoot of Economics—Something That Many Assume Exists But Is Rarely, If Ever, Seen

The Keynesian multiplier theory rests on the assumption that a dollar of government deficit spending can produce more than a dollar of total economic output after all secondary effects are taken into account. The multiplier is the Bigfoot of economics—something that many assume exists but is rarely, if ever, seen. The foundation of Keynesian public policy is called aggregate demand, or the total of all spending and investment in the domestic economy, excluding inventories. For example, if a worker is fired, he not only loses his income, but he also then stops spending in ways that cause others to lose income as well. The lost income and lost spending cause a drop in aggregate demand, which can feed on itself, leading more businesses to fire more employees, who then spend less, and so on in a vicious circle. Keynesian theory says that government can step in and spend money that individuals cannot or will not spend, thereby increasing aggregate demand. The government spending can reverse the slide and contribute to renewed economic growth. 

The problem with this theory of government spending to boost aggregate demand is that governments have no money of their own in the first instance. Governments have to print the money, take the money in the form of taxes or borrow the money from their citizens or from abroad. Printing money can cause nominal growth, but it can also cause inflation, so that real growth is unchanged over time. Taxing and borrowing may enable the government to spend more, but it means there is less for the private sector to spend or invest, so it is not clear how aggregate demand increases. This is where the multiplier claims to play a role. The idea of the multiplier is that one dollar of government spending will stimulate more spending by others and result in more than one dollar of increased output, and this is the justification for taking the dollar from the private sector. 

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2012), 184-185.

Central Banks Want to Eliminate Cash So They Can Implement Negative Real Interest Rates and Defeat Deflationary Trends

The second reason for eliminating cash is to impose negative interest rates. Central banks are in a losing battle against deflationary trends. One way to defeat deflation is to promote inflation with negative real interest rates.

A negative real rate occurs when the inflation rate is higher than the nominal interest rate on borrowings. If inflation is 4 percent, and the cost of money is 3 percent, the real interest rate is negative 1 percent ( 3 - 4 = -1). Inflation erodes the dollar’s value faster than interest accrues on the loan. The borrower gets to pay back the bank in cheaper dollars. Negative real rates are better than free money because the bank pays the borrower to borrow. Negative real rates are a powerful inducement to borrow, invest, and spend, which feeds inflationary tendencies and offsets deflation. 

How do you create negative real interest rates when inflation is near zero? Even a low nominal interest rate of 2 percent produces a positive real interest rate of 1 percent when inflation is only 1 percent (2 - 1 =1). 

The solution is to institute negative interest rates. With negative nominal rates, a negative real rate is always possible, even if inflation is low or negative. For example, if inflation is zero and nominal interest rates are negative 1 percent, then the real interest rate is also negative 1 percent (-1 - 0 = -1).

Negative interest rates are easy to implement inside a digital banking system. The banks program their computers to charge money on your balances instead of paying. If you put $100,000 on deposit and the interest rate is negative 1 percent, then at the end of one year you have $99,000 on deposit. Part of your money disappears. 

Savers can fight negative real rates by going to cash. Assume one saver pulls $100,000 out of the bank and stores the cash safely in a non-bank vault. Another saver leaves her money in the bank and “earns” an interest rate of negative 1 percent. At the end of one year, the first saver still has $100,000, the second saver has $99,000. This example shows why negative interest rates work only in a world without cash. Savers must be forced into an all-digital system before negative interest rates are imposed.

—James Rickards, The Road to Ruin: The Global Elites’ Secret Plan for the Next Financial Crisis (New York: Portfolio / Penguin, 2016), 28-29.

By Overvaluing the Conversion Rate Between the Pound and Gold, The U.K. Economy Was in Depression by 1926 (NOT 1929)

Most important, nations [under the gold exchange standard] had to choose a conversion rate between their currencies and gold, then stick to that rate as the new system evolved. In view of the vast paper money supply increases that had occurred during the First World War, from 1914 to 1918, most participating nations chose a value for their currencies that was far below the prewar rates. In effect, they devalued their currencies against gold and returned to a gold standard at the new, lower exchange rate. France, Belgium, Italy, and other members of what later became known as the Gold Bloc pursued this policy. The United States had entered the war later than the European powers, and its economy was less affected by the war. The United States also received large gold inflows during the war, and as a result, it had no difficulty maintaining gold’s prewar $20.67-per-ounce exchange rate. After the Gold Bloc devaluations, and with the United States not in distress, the future success of the gold exchange standard now hinged on the determination of a conversion rate for U.K. pounds sterling.

The U.K., under the guidance of chancellor of the exchequer Winston Churchill, chose to return sterling to gold at the prewar rate equivalent to £4.86 per ounce. He did this both because he felt duty bound to honor Bank of England notes at their original value, but also for pragmatic reasons having to do with maintaining London’s position as the reliable sound money center of world finance. Given the large amount of money printed by the Bank of England to finance the war, this exchange rate greatly overvalued the pound and forced a drastic decrease in the money supply in order to return to the old parity. An exchange rate equivalent to £7.50 per ounce would have been a more realistic peg and would have put the U.K. in a competitive trading position. Instead, the overvaluation of pounds sterling hurt U.K. trade and forced deflationary wage cuts on U.K. labor in order to adjust the terms of trade; the process was similar to the structural adjustments Greece and Spain are experiencing today. As a result, the U.K. economy was in a depression by 1926, years before the conventional starting date of 1929 associated with the Great Depression and the U.S. stock market crash.

—James Rickards, The Death of Money: The Coming Collapse of the International Monetary System (New York: Portfolio / Penguin, 2017), 222-223.

“Exchange” in “Gold Exchange Standard” Means that FOREIGN EXCHANGE BALANCES Are Treated LIKE GOLD for Reserve Purposes

Yet important changes had taken place since the heyday of the classical gold standard. The United States had created a new central bank in 1913, the Federal Reserve System, with unprecedented powers to regulate interest rates and the supply of money. The interaction of gold stocks and Fed money was still an object of experimentation in the 1920s. Countries had also grown used to the convenience of issuing paper money as needed during the war years of 1914-1918, while citizens had likewise become accustomed to accepting paper money after gold coins had been withdrawn from circulation. The major powers came to the Genoa Conference with a view to reintroducing gold on a more flexible basis, more tightly controlled by the central banks themselves.

From the Genoa Conference there emerged the new gold exchange standard, which differed from the former classical gold standard in significant ways. Participating countries agreed that central bank reserves could be held not only in gold but in the currencies of other nations; the word “exchange” in “gold exchange standard” simply meant that certain foreign exchange balances would be treated like gold for reserve purposes. This outsourced the burden of the gold standard to those countries with large gold holdings such as the United States. The United States would be responsible for upholding the gold value of the dollar at the $20.67 per ounce ratio while other nations could hold dollars as a gold proxy. Under this new standard, international accounts would still be settled in gold, but a country might accumulate large balances of foreign exchange before redeeming those balances for bullion. 

In addition, gold coins and bullion no longer circulated as freely as before the war. Countries still offered to exchange paper notes for gold, but typically only in large minimum quantities, such as four-hundred-ounce bars, valued at the time at $8,268 each, equivalent today to over $110,000. This meant that gold bullion would be used only by central banks, commercial banks and the wealthy, while others would use paper notes backed by the promises of governments to maintain their gold equivalent value. Paper money would still be “as good as gold,” but the gold itself would disappear into central bank vaults. England codified these arrangements in the Gold Standard Act of 1925, intended to facilitate the new gold exchange standard.

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2012), 61-62.

Qualitative Credit Theorists Joined the Austrians in Opposing the Bank Credit Inflation of the 1920s and in Warning of Impending Depression

Various “qualitative credit” schools, however, also see the depression as inevitably generated by an inflationary boom. They agree with the Austrians, therefore, that booms should be prevented before they begin, and that the liquidation process of depression should be allowed to proceed unhampered. They differ considerably, however, on the causal analysis, and the specific ways that the boom and depression can be prevented.

The most venerable wing of qualitative credit theory is the old Banking School doctrine, prominent in the nineteenth century and indeed until the 1930s. This is the old-fashioned “sound banking” tradition, prominent in older money-and-banking textbooks, and spearheaded during the 1920s by two eminent economists: Dr. Benjamin M. Anderson of the Chase National Bank, and Dr. H. Parker Willis of the Columbia University Department of Banking, and editor of the Journal of Commerce. This school of thought, now very much in decline, holds that bank credit expansion only generates inflation when directed into the wrong lines, i.e., in assets other than self-liquidating short-term credit matched by “real goods,” loaned to borrowers of impeccable credit standing. Bank credit expansion in such assets is held not to be inflationary, since it is then allegedly responsive solely to the legitimate “needs of business,” the money supply rising with increased production, and falling again as goods are sold. All other types of loans—whether in long-term credit, real estate, stock market, or to shaky borrowers—are considered inflationary, and create a boom-bust situation, the depression being necessary to liquidate the wasteful inflation of the boom. Since the bank loans of the 1920s were extended largely in assets considered unsound by the Banking School, these theorists joined the “Austrians” in opposing the bank credit inflation of the 1920s, and in warning of impending depression.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2008), 76.

Early in 1930 the Government Instituted a Massive EASY MONEY Program Lead by the New York Federal Reserve

Dr. Anderson records that, at the end of December, 1929, the leading Federal Reserve officials wanted to pursue a laissez-faire policy: “the disposition was to let the money market ‘sweat it out’ and reach monetary ease by the wholesome process of liquidation.” The Federal Reserve was prepared to let the money market find its own level, without providing artificial stimuli that could only prolong the crisis. But early in 1930, the government instituted a massive easy money program. . . . 

A leader in the easy money policy of late 1929 and 1930 was once more the New York Federal Reserve, headed by Governor George Harrison. The Federal Reserve, in fact, began the inflationist policy on its own. Inflation would have been greater in 1930 had not the stock market boom collapsed in the spring, and if not for the wave of bank failures in late 1930. The inflationists were not satisfied with events, and by late October, Business Week thundered denunciation of the alleged “deflationists in the saddle,” supposedly inspired by the largest commercial and investment banks.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2008), 239-241.

Socialism Will Inevitably Lead to Dictatorship and Will Inevitably Fall under the Control of the Worst Individuals

The Road to Serfdom, by F. A. Hayek, is a masterly performance of the job it undertakes. That job is to show by general and historical reasoning, the latter primarily with reference to the course of events in Germany, two things: first, that any such policy as socialism, or planned economy, will inevitably lead to totalitarianism and dictatorship; and second that such a social order will inevitably fall under the control of “the worst” individuals. The argument is naturally political rather than economic, except in the indirect sense that the problems solved, the functions performed, by the open-market system of organization are economic and they cannot be solved, or performed by government under a free political order, nor the open-market system itself maintained under a democratic political regime. There is little or no economic theory in the book. The fifteen short chapters ably describe the old liberalism and contrast it with current tendencies which are virtually antithetical and discuss such problems as individualism, democracy, the rule of law, security and freedom, the place of truth in political and social life, the relation between material conditions and ideal ends, and the problem of international order.

—Frank Knight, appendix to The Collected Works of F. A. Hayek, vol. 2, The Road to Serfdom: Text and Documents, definitive ed., by F. A. Hayek, ed. Bruce Caldwell (Chicago: University of Chicago Press, 2007), 249.

The Various Kinds of Collectivism, Communism, Fascism Differ in the Nature of THE GOAL Toward Which They Want to Direct the Efforts of Society

The common features of all collectivist systems may be described, in a phrase ever dear to socialists of all schools, as the deliberate organization of the labors of society for a definite social goal. That our present society lacks such “conscious” direction toward a single aim, that its activities are guided by the whims and fancies of irresponsible individuals, has always been one of the main complaints of its socialist critics.

In many ways this puts the basic issue very clearly. And it directs us at once to the point where the conflict arises between individual freedom and collectivism. The various kinds of collectivism, communism, fascism, etc., differ among themselves in the nature of the goal toward which they want to direct the efforts of society. But they all differ from liberalism and individualism in wanting to organize the whole of society and all its resources for this unitary end and in refusing to recognize autonomous spheres in which the ends of the individuals are supreme. In short, they are totalitarian in the true sense of this new word which we have adopted to describe the unexpected but nevertheless inseparable manifestations of what in theory we call collectivism. 

The “social goal,” or “common purpose,” for which society is to be organized is usually vaguely described as the “common good,” the “general welfare,” or the “general interest.”

—F. A. Hayek, The Collected Works of F. A. Hayek, vol. 2, The Road to Serfdom: Text and Documents, definitive ed., ed. Bruce Caldwell (Chicago: University of Chicago Press, 2007), 100.

Goods (and Services) Price Inflation and Asset Price Inflation Are the Two Forms of MONETARY DISEASE that PLAGUE the Modern Economy

The writers of the Maastricht Treaty had no knowledge about the disease of asset price inflation let alone any prophetic vision of its potential threat to the survival of their cherished monetary union. The monetary constitution in the Treaty was put together by a committee of central bankers who made low inflation (euphemistically described as ‘price stability’), as measured exclusively in the goods and services markets, the key objective. The famed monetarist Bundesbankers of the 1970s (subsequently described in this volume as ‘the Old Bundesbankers’) had departed the scene to be replaced by politicos and econometricians. 

The Old Bundesbankers, in fairness to their successors, also had no clear understanding of asset price inflation. But they did instinctively realize that strict monetary base control (MBC) in which interest rates were free of manipulation was essential to overall monetary stability in a wide sense (which transcended the near-term path of goods and services prices). Instinctively they applied a doctrine of pre-emption. According to this the pursuance of strict monetary control would mean less danger of various forms of hard-to-diagnose economic disease (possibly as yet unclassified), including those characterized by excessive financial speculation, with their origin in monetary disequilibrium. 

The intuition of the monetarist Bundesbankers took them one stage further than Milton Friedman’s famous pronouncement that ‘inflation [goods and services] is always and everywhere a monetary phenomenon’. Indeed, we should say the same about asset price inflation. Goods (and services) price inflation and asset price inflation are the two forms of monetary disease that plague the modern economy. They have their joint source in money ‘getting out of control’.

—Brendan Brown, Euro Crash: How Asset Price Inflation Destroys the Wealth of Nations, 3rd ed. (Houndmills, UK: Palgrave Macmillan, 2014), Kobo e-book. 

The Gold Standard Is the Enemy of Big Government Because It Prohibits Inflation for the Purpose of Monetizing Debt

 During the time we were on a gold standard federal deficits were very small or nonexistent. Money that the government did not have, it could not spend nor could it create. Taxing the people the full amount for extravagant expenditures would prove too unpopular and a liability in the next election. 

Justifiably, the people would rebel against such an outrage. Under the gold standard, inflation for the purpose of monetizing debt is prohibited, thus holding government size and power in check and preventing significant deficits from occurring. The gold standard is the enemy of big government. In time of war, in particular those wars unpopular with the people, governments suspend the beneficial restraints placed on the politicians in order to inflate the currency to finance the deficit. Strict adherence to the gold standard would prompt a balanced budget, yet it would still allow for “legitimate” borrowing when the people were willing to loan to the government for popular struggles. This would be a good test of the wisdom of the government’s policy. 

Finally, the inflationary climate has encouraged huge deficits to be run up by governments at all levels, as well as by consumers and corporations. The unbelievably large federal contingent liabilities of over $11 trillion are a result of inflationary policies, pervasive government planning, and unwise tax policies.

—Ron Paul and Lewis Lehrman, The Case for Gold: A Minority Report of the U.S. Gold Commission (Auburn, AL: Ludwig von Mises Institute, 2007), 155.

For Rothbard, Reaganomics Is a Blend of Monetarism and Fiscal Keynesianism Swathed in Classical Liberal and Supply-Side Rhetoric

 It is, furthermore, too late for gradualism. The only solution was set forth by F. A. Hayek, the dean of the Austrian School, in his critique of the similarly disastrous gradualism of the Thatcher regime in Great Britain. The only way out of the current mess is to “slam on the brakes,” to stop the monetary inflation in its tracks. Then, the inevitable recession will be sharp but short and swift, and the free market, allowed its head, will return to a sound recovery in a remarkably brief time. Only a drastic and credible slamming of the brakes can truly reverse the inflationary expectations of the American public. But wisely the public no longer trusts the Fed or the federal government. For a slamming on of the brakes to be truly credible, there must be a radical surgery on American monetary institutions, a surgery similar in scope to the German creation of the rentenmark which finally ended the runaway inflation of 1923. One important move would be to denationalize the fiat dollar by returning it to be worth a unit of weight of gold. A corollary policy would prohibit the Federal Reserve from lowering reserve requirements or from purchasing any assets ever again; better yet, the Federal Reserve System should be abolished, and government at last totally separated from the supply of money. 

In any event, there is no sign of any such policy on the horizon. After a brief flirtation with gold, the Presidentially appointed U.S. Gold Commission, packed with pro-fiat money Friedmanites abetted by Keynesians, predictably rejected gold by an overwhelming margin. Reaganomics—a blend of monetarism and fiscal Keynesianism swathed in classical liberal and supply-side rhetoric—is in no way going to solve the problem of inflationary depression or of the business cycle. 

—Murray N. Rothbard, preface to the 4th edition of America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2008), xxi-xxii.

The Razzle-Dazzle of Reaganomics Was Supposed to Reverse Inflationary Expectations; the Gradualism Was to Eliminate Inflation without Recession

The Reagan administration knew, of course, that inflationary expectations had to be reversed, but where they miscalculated was relying on propaganda without substance. Indeed, the entire program of Reaganomics may be considered a razzle-dazzle of showmanship about taxes and spending, behind which the monetarists, in control of the Fed and the Treasury Department, were supposed to gradually reduce the rate of money growth. The razzle-dazzle was supposed to reverse inflationary expectations; the gradualism was to eliminate inflation without forcing the economy to suffer the pain of recession or depression. Friedmanites have never understood the Austrian insight of the necessity of a recession to liquidate the unsound investments of the inflationary boom. As a result, the attempt of Friedmanite gradualism to fine-tune the economy into disinflation-without-recession went the way of the similar Keynesian fine-tuning which the monetarists had criticized for decades. Friedmanite fine-tuning brought us temporary “disinflation” accompanied by another severe depression.

In this way, monetarism fell between two stools. The Fed’s cutback in the rate of money growth was sharp enough to precipitate the inevitable recession, but much too weak and gradual to bring inflation to an end once and for all. Instead of a sharp but short recession to liquidate the malinvestments of the preceding boom, we now have a lingering chronic recession coupled with a grinding, continuing stagnation of productivity and economic growth. A pusillanimous gradualism has brought us the worst of both worlds: continuing inflation plus severe recession, high unemployment, and chronic stagnation. 

—Murray N. Rothbard, preface to the 4th edition of America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2008), xx-xxi.

Social-Democratic Socialism, Russian-Type Socialism, and Pure Capitalism All Differ on the Question of the Politicalization of Society

The difference between both types of socialism lies (only) in the following: under Russian-type socialism society’s control over the means of production, and hence over the income produced with them, is complete, and so far there seems to be no more room to engage in political debate about the proper degree of politicalization of society. The issue is settled—just as it is settled at the other end of the spectrum, under pure capitalism, where there is no room for politics at all and all relations are exclusively contractual. Under social-democratic socialism, on the other hand, social control over income produced privately is actually only partial, and increased or full control exists only as society’s not yet actualized right, making only for a potential threat hanging over the heads of private producers. But living with the threat of being fully taxed rather than actually being so taxed explains an interesting feature of social-democratic socialism as regards the general development toward increasingly politicalized characters. It explains why under a system of social-democratic socialism the sort of politicalization is different from that under Russian-type socialism. Under the latter, time and effort is spent nonproductively, discussing how to distribute the socially owned income; under the former, to be sure, this is also done, but time and effort are also used for political quarrels over the issue of how large or small the socially administered income-shares should actually be. Under a system of socialized means of production where this issue is settled once and for all, there is then relatively more withdrawal from public life, resignation, and cynicism to be observed. Social-democratic socialism, on the other hand, where the question is still open, and where producers and nonproducers alike can still entertain some hope of improving their position by decreasing or increasing taxation, has less of such privatization and, instead, more often has people actively engaged in political agitation either in favor of increasing society’s control of privately produced incomes, or against it.

—Hans-Hermann Hoppe, A Theory of Socialism and Capitalism, 2nd ed. (Auburn, AL: Mises Institute, 2016), 68-69.

Money by Its Very Nature Constitutes a Kind of Loose Joint in the Self-Equilibrating Apparatus of the Price Mechanism

But even without further continuing the discussion of the rôle money plays in this connection, we are certainly entitled to conclude from what we have already shown that the extent to which we can hope to shape events at will by controlling money are much more limited, that the scope of monetary policy is much more restricted, than is today widely believed. We cannot, as some writers seem to think, do more or less what we please with the economic system by playing on the monetary instrument. In every situation there will in fact always be only one monetary policy which will not have a disequilibrating effect and therefore eventually reverse its short-term influence. That it will always be exceedingly difficult, if not impossible, to know exactly what this policy is does not alter the fact that we cannot hope even to approach this ideal policy unless we understand not only the monetary but also, what are even more important, the real factors that are at work. There is little ground for believing that a system with the modern complex credit structure will ever work smoothly without some deliberate control of the monetary mechanism, since money by its very nature constitutes a kind of loose joint in the self-equilibrating apparatus of the price mechanism which is bound to impede its working—the more so the greater is the play in the loose joint. But the existence of such a loose joint is no justification for concentrating attention on that loose joint and disregarding the rest of the mechanism, and still less for making the greatest possible use of the short-lived freedom from economic necessity which the existence of this loose joint permits. On the contrary, the aim of any successful monetary policy must be to reduce as far as possible this slack in the self-correcting forces of the price mechanism, and to make adaptation more prompt so as to reduce the necessity for a later, more violent, reaction.

—F. A. Hayek, The Collected Works of F. A. Hayek, vol. 12, The Pure Theory of Capital, ed. Lawrence H. White (Indianapolis: Liberty Fund, 2007), 367.

The Type of Economy Determines the “Propagation Mechanism,” How the Economy Reacts to Monetary or Real “Impulses”

The crucial property of a money economy is that, absent neutral money, a divergence of investment from voluntary saving becomes possible. In particular, Hayek considers an excess of investment over saving, financed by credit creation (inflation), as the root cause of maladjustments in the structure of production and thus ultimately of the crisis. These maladjustments will arise irrespective of whether the exogenous change that generates excessive investment originates from the monetary or the real side. Or put in terms of the interest rate criterion: It does not matter if a discrepancy comes about by a fall in the money rate or a rise in the natural rate—the former resulting from a policy of monetary expansion, the latter from an increase in the (expected) rate of profit, possibly due to technical progress. Indeed, Hayek in Monetary Theory and the Trade Cycle stressed fluctuations in the natural rate (relative to an unchanged money rate) as the typical impulse, while later on in Prices and Production he started the analysis of maladjustments from assuming a fall in the money rate. Framing the problem—anachronistically—in terms of Ragnar Frisch’s famous distinction, the type of economy—money or barter—determines the propagation mechanism, that is, how the economy reacts to impulses, be they monetary or real. According to Hayek it is the distinguishing property of a (non-neutral) money economy that it will not react to such impulses by an immediate tendency towards equilibrium.

—Hansjoerg Klausinger, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 7, Business Cycles, Part I, by F. A. Hayek (Carmel, IN: Liberty Fund, 2017), 19-20.

This Is the ONLY Sense in Which It is Proper to Speak of a MONETARY Explanation of the Business Cycle

Introducing Prices and Production in 1935, Hayek contrasted the two main pillars of his theory of the cycle,  “the monetary factors which cause the trade cycle” and “the real phenomena which constitute it.” In the following we will keep to this distinction and first concentrate on money as the prime cause of the cycle before turning to the changes in the structure of production as the crucial cyclical mechanism. 

As already noted, Hayek maintains that cycles and crises are possible only in a money economy. The analytical force of this argument draws on the distinction between neutral and non-neutral money, epitomised in the interest rate criterion, and in the identification of violations of this criterion as the ultimate cause of the business cycle. This is the only sense in which it is proper to speak, in Hayek’s view, of a monetary explanation of the business cycle. With the introduction of money the tendency towards equilibrium prevalent in the static economy is replaced by the more complicated adjustment patterns of dynamic theory. Yet, among the various peculiarities that make the money economy differ from its static counterpart, the most systematic, and that most pertinent to the existence of the business cycle, is the effect of credit creation (or destruction) in causing an incongruity between investment and voluntary saving.

—Hansjoerg Klausinger, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 7, Business Cycles, Part I, by F. A. Hayek (Carmel, IN: Liberty Fund, 2017), 19.

Alvin Hansen’s “Stagnation Thesis” Has Characteristics Similar to Joseph Schumpeter’s Business Cycle Theory

Schumpeter’s second explanation is that innovations cluster in only one or a few industries and that these innovation opportunities are therefore limited. After a while they become exhausted, and the cluster of innovations ceases. This is obviously related to the Hansen stagnation thesis, in the sense that there are alleged to be a certain limited number of “investment opportunities” — here innovation opportunities — at any time, and that once these are exhausted there is temporarily no further room for investments or innovations. The whole concept of “opportunity” in this connection, however, is meaningless. There is no limit on “opportunity” as long as wants remain unfulfilled. The only other limit on investment or innovation is saved capital available to embark on the projects. But this has nothing to do with vaguely available opportunities which become “exhausted”; the existence of saved capital is a continuing factor. As for innovations, there is no reason why innovations cannot be continuous or take place in many industries, or why the innovatory pace has to slacken. 

—Murray N. Rothbard, Man, Economy, and State with Power and Market, 2nd ed. of the Scholar’s ed. (Auburn, AL: Ludwig von Mises Institute, 2009), 856.

Keynesian Theory ‘Demoted’ the Interest Rate from the Rôle of Guiding Intertemporal Allocation to that of Rewarding the Sacrifice of Liquidity

Keynesian theory depicted current income as proximately determined by current expenditure (Y = C + I + G) rather than by prior production. The ‘circular flow’ supplanted capital theory in macroeconomics. Current-period analysis displaced intertemporal analysis. The interest rate no longer played an equilibrating rôle. Left to its own devices, the economy could readily get stuck at a level of expenditure too small to achieve full employment. Smithies found it remarkable (note his apparently sneering use of quotation marks) that “Professor Hayek’s point of view is that a ‘real’ economy, if left to itself, will automatically achieve ‘equilibrium’ and that the disturbances that occur in real life are due to the subversive influence of money.” Keynesian theory, as Uhr put it, ‘demoted’ the interest rate from the rôle of guiding intertemporal allocation to that of rewarding the sacrifice of liquidity. Though it never became mainstream doctrine, some Keynesians nearly overthrew the idea that capital is scarce, and needs to be carefully allocated, in favour of the ‘secular stagnation’ thesis that remunerative uses of capital are or soon will be hard to come by.

—Lawrence H. White, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 12, The Pure Theory of Capital, by F. A. Hayek (Indianapolis: Liberty Fund, 2007), xxxi.

On the Necessity of Organizing Production Around the Needs of Consumers, Not Around the Needs of Producers

 One of the great ideas of liberalism is that it lets the consumer interest alone count and disregards the producer interest. No production is worth maintaining if it is not suited to bring about the cheapest and best supply. No producer is recognized as having a right to oppose any change in the conditions of production because it runs counter to his interest as a producer. The highest goal of all economic activity is the achievement of the best and most abundant satisfaction of wants at the smallest cost. 

This position follows with compelling logic from the consideration that all production is carried on only for the sake of consumption, that it is never a goal but always only a means. The reproach made against liberalism that it thereby takes account only of the consumer viewpoint and disdains labor is so stupid that it scarcely needs refutation. Preferring the producer interest over the consumer interest, which is characteristic of antiliberalism, means nothing other than striving artificially to maintain conditions of production that have been rendered inefficient by continuing progress. Such a system may seem discussible when the special interests of small groups are protected against the great mass of others, since the privileged party then gains more from his privilege as a producer than he loses on the other hand as a consumer; it becomes absurd when it is raised to a general principle, since then every individual loses infinitely more as a consumer than he may be able to gain as a producer. The victory of the producer interest over the consumer interest means turning away from rational economic organization and impeding all economic progress. 

—Ludwig von Mises, Nation, State, and Economy: Contributions to the Politics and History of Our Time, trans. Leland B. Yeager, ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2006), 164-165.

The “Correct” Length of the Roundabout Method of Production Is Determined by the Size of the Subsistence Fund or the Period of Time for which this Fund Suffices

Let us assume that in some country production must be completely rebuilt. The only factors of production available to the population besides laborers are those factors of production provided by nature. Now, if production is to be carried out by a roundabout method, let us assume of one year’s duration, then it is self-evident that production can only begin if, in addition to these originary factors of production, a subsistence fund is available to the population which will secure their nourishment and any other needs for a period of one year. The population would in any case have an interest in stretching the roundabout method of production as long as possible, as every “cleverly chosen” lengthening of the roundabout method of production results in increased output. The extent to which the roundabout method of production can be lengthened is restricted, however, by the limited nature of the subsistence fund. The greater this fund, the longer is the roundabout factor of production that can be undertaken, and the greater the output will be. 

It is clear that under these conditions the “correct” length of the roundabout method of production is determined by the size of the subsistence fund or the period of time for which this fund suffices. If a shorter roundabout method of production were begun with a subsistence fund that suffices for one year, then the output would be smaller than it could have been. However, if the roundabout method of production is too long, then it could not be completed without interruption. 

—Richard von Strigl, Capital and Production, trans. Margaret Rudelich Hoppe and Hans-Hermann Hoppe, ed. Jörg Guido Hülsmann (Auburn, AL: Ludwig von Mises Institute, 2000), 6-7.

In the “Mengerian” Approach to Capital and Interest the ENTIRE Explanatory Burden Is Assigned to Consumer Valuations

In that controversy [Cambridge Capital Controversy] mainstream neoclassical theory was under relentless attack by economists seeking to reverse the marginalist revolution and to return to the classical perspective. The critics, especially insofar as they were following Sraffa (1960), argued for an economics in which the objective conditions of production determine economic events, with virtually no role assigned to consumer demand. We wish to emphasize that what was overlooked in that debate was the existence of a third theoretical approach (a “Mengerian” approach) to capital and interest issues, in which the entire explanatory burden is assigned to consumer valuations.

—Israel M. Kirzner, author's introduction to Essays on Capital and Interest: An Austrian Perspective, ed. Peter J. Boettke and Frédéric Sautet, The Collected Works of Israel M. Kirzner (Indianapolis: Liberty Fund, 2010), 5.

The Worst Outgrowth of the Use of the Mythical Notion of Real Capital Was the Spurious Problem of the Productivity of Real Capital

 Mises’s adoption of Menger’s concept of capital made it possible for him to avoid the pitfalls in interest theory that stem from the capital-income dichotomy. In everyday lay experience the ownership of capital provides assurance of a steady income. As soon as capital is identified as some aggregate of factors of production, it becomes tempting to ascribe the steady income that capital ownership makes possible as somehow expressing the productivity of these factors. This has always been the starting point for productivity theories of interest. Knight’s permanent-fund-of-capital view of physical capital is simply a variant of those theories that view interest as net income generated perpetually by the productivity of the abstract capital temporarily embodied in particular lumps of physical capital. The capital stock, in this view, is a permanent tree that spontaneously and continuously produces fruit (interest). Mises was explicit in concluding that this erroneous view of interest results from defining capital as an aggregate of produced factors of production. “The worst outgrowth of the use of the mythical notion of real capital was that economists began to speculate about a spurious problem called the productivity of (real) capital.” It was such speculation, Mises made clear, that is responsible for the “blunder” of explaining “interest as an income derived from the productivity of capital.”

—Israel M. Kirzner, “Ludwig von Mises and the Theory of Capital and Interest,” in Essays on Capital and Interest: An Austrian Perspective, ed. Peter J. Boettke and Frédéric Sautet, The Collected Works of Israel M. Kirzner (Indianapolis: Liberty Fund, 2010), 143-144.

In Theorizing on Capital, Hayek Uses the Wieserian Device of a COMMUNIST SOCIETY (!) Subject to an Omniscient Dictator

But the Mengerian tradition was developed in very different directions by his brilliant followers, Eugen von Böhm-Bawerk and Friedrich von Wieser, and by their own students and followers. Without tracing out this doctrinal development in any detail, suffice it to say that today the term “Austrian economics” is used to designate two very different paradigms. One derives from Wieser and may be termed the “Hayekian” paradigm, because it represents an elaboration and systematization of the views held by F. A. Hayek, a student of Wieser’s at the University of Vienna. Although it is yet to be generally recognized by Austrians, Wieser’s influence on Hayek was considerable and is especially revealed in the latter’s early work on imputation theory, which sought to vindicate the Wieserian (as against the Böhm-Bawerkian-Misesian) position that the imputation problem must be solved within the context of an exchangeless economy subject to the control of a single will yet somehow able to calculate using (subjective) value as the “arithmetic form of utility.”³

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³That there is no possibility of economic calculation and rational or purposeful allocation of resources within an economy based on division of labor where one will alone acts is, of course, the essence of Mises’s critique of socialism. Perceiving the unbridgeable gulf between his own and Wieser’s position on the possibility of directly imputing values to higher-order goods in the absence of monetary exchange, Mises, in his Notes and Recollections wrote that “[Wieser’s] imputation theory is untenable. His ideas on value calculation justify the conclusion that he could not be called a member of the Austrian School, but rather was a member of the Lausanne School.”

Also, Hayek, explicitly following Wieser, conceives the main problem of capital theory to be to explain how it is that the nonpermanent resources constituting the capital stock can yield a permanent net (physical) return. This Wieser-Hayek method of describing the quaesitum [something sought for, end or objective] of capital theory loads the dice in favor of explaining the interest return on capital in terms of productivity (rather than time-preference) considerations and, at the same time, diverts attention from what Böhm-Bawerk brilliantly perceived to be the fundamental question that must be satisfactorily answered by a correct theory of interest and was so answered by Mises’s pure time-preference theory: What is the cause of the difference in value between goods which differ only in their temporal availability? 

In theorizing on capital, moreover, Hayek makes significant use of the Wieserian device of a communist society subject to the control of an omniscient dictator, a device which reflects a paradigmatic lack of concern with problems of monetary appraisement and calculation. 

—Joseph T. Salerno, “Mises and Hayek Dehomogenized,” Review of Austrian Economics 6, no. 2 (1993): 114, 114n. 

De-Homogenizing Mises and Hayek: Hayek Favors the Productivity Explanation of Interest Instead of the Fetter-Mises Subjectivist Theory

A major reason for the neglect of this model is that in the United States, where the Austrian School experienced a renaissance in the second half of the twentieth century, the scholars adopted the Fetter-Mises subjectivist theory of interest instead of a productivity theory. The time preference theory of interest was endorsed by Rothbard ([1962] 2009), Garrison (1979), Kirzner (1993), and other authors (see Pellengahr 1996). Hayek (1941), on the other hand, very explicitly chose the productivity explanation of interest, even though he thought that time preference could also play a (minor) role in the determination of interest.³¹ As a result, his model—interpreted by Hayek as a validation of the productivity theory of interest—was largely overlooked.

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³¹ “Of the two branches of the Böhm-Bawerkian school, that which stressed the productivity element almost to the exclusion of time preference, the branch whose chief representative is K. Wicksell, was essentially right, as against the branch represented by Professors F. A. Fetter and I. Fisher, who stressed time preference as the exclusive factor and an at least equally important factor respectively.” (Hayek 1941, 420)

—Renaud Fillieule, “The Macroeconomic Models of the Austrian School: A History and Comparative Analysis,” Quarterly Journal of Austrian Economics 22, no. 4 (Winter 2019): 558-559.