Germany’s Bundesbank Had Not Sacrificed Its All for “Europe”—i.e., for Keynesian Inflationists and Centralizing Collectivists

Since 1979, the European governments have been trying to maintain a fixed exchange rate system among themselves; in the last few years, they have been trying to close the allowed bands of fluctuation—2.25 percent plus or minus the official rate—in preparation for a single European Currency Unit (ECU) that was supposed to begin at the end of 1993 and would be issued by a single European central bank.

A single European currency and central bank was sold to the world public as a giant “free trade unit,” but it actually was a giant step toward centralized government in Brussels. It was a step toward the old Keynesian dream of a world paper unit by a World Reserve Bank administered by a world government.

Fortunately, with the resistance to Maastricht, and then with the pullout of Britain from the European Currency System and the face-saving new system of very wide exchange rate bands, the ECU and the Keynesian dream lie all but dead. The world market has once against triumphed over Keynesian statism, even though the power seemed to be in the Establishment’s hands.

In the French case, there was another villain condemned by all. The German Bundesbank, worried about German inflation as a result of the mammoth subsidies to East Germany, has not been as inflationary as France would have liked. One way for France or Britain to be able to enjoy the goodies of inflation without the embarrassment of a falling currency is to try to muscle harder currencies to inflate, dragging them down to the level of the weaker currencies.

Fortunately, the Germans, even though they inflated a bit and wasted billions supporting the franc, did not inflate nearly as much as the French or British would have liked. Yet for pursuing a relatively sound monetary course, the Germans were condemned as “selfish,” for they had not sacrificed their all for “Europe”—that is, for Keynesian inflationists and centralizing collectivists.

—Murray N. Rothbard, “‘Attacking’ the Franc,” in Making Economic Sense, 2nd ed. (Auburn, AL: Ludwig von Mises Institute, 2006), 305-306.

Keynesians Harbor a Dream of a World with One Fiat Currency Issued by One World Central Bank

For a half-century, the Keynesians have harbored a Dream. They have long dreamed of a world without gold, a world rid of any restrictions upon their desire to spend and spend, inflate and inflate, elect and elect. They have achieved a world where governments and Central Banks are free to inflate without suffering the limits and restrictions of the gold standard. But they still chafe at the fact that, although national governments are free to inflate and print money, they yet find themselves limited by depreciation of their currency. If Italy, for example, issues a great many lira, the lira will depreciate in terms of other currencies, and Italians will find the prices of their imports and of foreign resources skyrocketing.

What the Keynesians have dreamed of, then, is a world with one fiat currency, the issues of that paper currency being generated and controlled by one World Central Bank. What you call the new currency unit doesn’t really matter: Keynes called his proposed unit at the Bretton Woods Conference of 1944, the “bancor”; Harry Dexter White, the U.S. Treasury negotiator at that time, called his proposed money the “unita”; and the London Economist has dubbed its suggested new world money the “phoenix.” Fiat money by any name smells as sour.

Even though the United States and its Keynesian advisers dominated the international monetary scene at the end of World War II, they could not impose the full Keynesian goal; the jealousies and conflicts of national sovereignty were too intense. So the Keynesians reluctantly had to settle for the jerry-built dollar-gold international standard at Bretton Woods, with exchange rates flexibly fixed, and with no World Central Bank at its head.

As determined men with a goal, the Keynesians did not fail from not trying. They launched the Special Drawing Right (SDR) as an attempt to replace gold as an international reserve money, but SDRs proved to be a failure. Prominent Keynesians such as Edward M. Bernstein of the International Monetary Fund and Robert Triffin of Yale, launched well-known Plans bearing their names, but these too were not adopted.

Ever since the Bretton Woods system, hailed for nearly three decades as stable and eternal, collapsed in 1971, the Keynesians have had to suffer the indignity of floating exchange rates. Ever since the accession of Keynesian James R. Baker as Secretary of Treasury in 1985, the United States has abandoned its brief commitment to a monetarist hands-off the foreign exchange market policy, and has tried to engineer a phase transformation of the international monetary system. First, fixed exchange rates would be obtained by coordinated action of the large Central Banks. This has largely been achieved, at first covertly and then openly; the leading Central Banks picked a target point or zone, for, say, the dollar, and then by buying and selling dollars, manipulated exchange rates to stay within that zone. Their main difficulty has been figuring out what target to pick, since, indeed, they have no wisdom in rate-fixing beyond that of the market. Indeed, the concept of a just exchange-rate for the dollar is just as inane as the notion of the “just price” for a particular good.

—Murray N. Rothbard, “The Keynesian Dream,” in Making Economic Sense, 2nd ed. (Auburn, AL: Ludwig von Mises Institute, 2006), 315-316.

In the 1960s, Jacques Rueff Preached the Inevitable Implosion of the Dollar-Based Bretton Woods System

De Gaulle gave a famous press conference on February 4, 1965, in which he elaborated the economic logic behind his conclusion that the dollar could never act as “an impartial and international trade medium . . . it is in fact a credit instrument reserved for one state only.” De Gaulle was no economist, so it was apparent that the acuity of his analysis owed to someone schooled in the art. Though he denied being “in any degree scriptwriter to General De Gaulle,” this was unmistakably Keynes’s old intellectual sparring partner over German World War One reparations, Jacques Rueff. Rueff became, with Triffin, the most notable prophet of doom during the 1960s preaching the inevitable implosion of the dollar-based Bretton Woods system. Though the diagnosis of the two was identical, their cures could not have been more different.

Triffin harked directly back to Keynes’s “bancor” alternative to the White Plan: a new international reserve currency managed by the IMF. He suggested some bureaucratic safeguards against the potential inflationary bias of the scheme, but was otherwise satisfied simply to quote Keynes at length. Rueff, in stark contrast, advocated a return to the pre-1914 classical gold standard. He was adamant that he had “no religious belief in gold”; other commodities might in principle do as well, even if gold had history on its side. It was rather the mechanism of a genuine gold standard that was needed to ensure that global imbalances were automatically restrained by credit expansion in the surplus country and contraction in the deficit country—or put alternatively, “to prevent the home population from consuming a part of domestic production that must be made available for export” in order to counteract a payments deficit. Triffin’s (and Keynes’s) alternative of a new international reserve unit, in Rueff’s view, represented a “purely arbitrary creation of means of foreign payment”; or put more bluntly, “nothingness dressed up as currency.” It had a built-in inflationary dynamic that no bureaucracy would be able to control. For his part, Triffin believed that Rueff’s vision “impl[ied] the total surrender of national sovereignty . . . over all forms of trade and payment restrictions, and even over exchange rates. Such surrenders,” he said, were “utterly inconceivable today in favor of a mere nineteenth century laissez faire, unconcerned with national levels of employment and economic activity.”

—Benn Steil, epilogue to The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order (Princeton, NJ: Princeton University Press, 2013), 334-335. 

Keynesian Economists Arrogantly Declared that We Need Not Worry about Dollar Balances Piling Up Abroad under Bretton Woods

It took a great deal of American pressure, wielding the club of Lend–Lease, to persuade the reluctant British to abandon their cherished currency bloc of the 1930s. By 1942, Hull could expect confidently that “leadership toward a new system of international relationship in trade and other economic affairs will devolve very largely upon the United States because of our great economic strength. We would assume this leadership, and the responsibility that goes with it, primarily for reasons of pure national self-interest.”

For a while, the economic and financial leaders of the United States thought that the Bretton Woods system would provide a veritable bonanza. The Fed could inflate with impunity, for it was confident that, in contrast with the classical gold standard, dollars piling up abroad would stay in foreign hands, to be used as reserves for inflationary pyramiding of currencies by foreign central banks. In that way, the United States dollar could enjoy the prestige of being backed by gold while not really being redeemable. Furthermore, U.S. inflation could be lessened by being “exported” to foreign countries. Keynesian economists in the United States arrogantly declared that we need not worry about dollar balances piling up abroad, since there was no chance of foreigners cashing them in for gold; they were stuck with the resulting inflation, and the U.S. authorities could treat the international fate of the dollar with “benign neglect.”

—Murray N. Rothbard, The Mystery of Banking, 2nd ed. (Auburn, AL: Ludwig von Mises Institute, 2008), 250.

The National and Regional Economic Warfare During the 1930s Precipitated World War II

Since only the United States remained on even a partial gold standard, while other countries moved to purely fiat standards, gold began to flow heavily into the United States, an inflow accelerated by the looming war conditions in Europe. The collapse of the shaky and inflationary British-created gold exchange standard during the depression led to a dangerous world of competing and conflicting national currencies and protectionist blocs. Each nation attempted to subsidize exports and restrict imports through competing tariffs, quotas, and currency devaluations.

The pervasive national and regional economic warfare during the 1930s played a major though neglected role in precipitating World War II. After the war was over, Secretary of State Cordell Hull made the revealing comment that

war did not break out between the United States and any country with which we had been able to negotiate a trade agreement. It is also a fact that, with very few exceptions, the countries with which we signed trade agreements joined together in resisting the Axis. The political lineup follows the economic lineup.

A primary war aim for the United States in World War II was to reconstruct the international monetary system from the conflicting currency blocs of the 1930s into a new form of international gold exchange standard. This new form of gold exchange standard, established at an international conference at Bretton Woods in 1944 by means of great American pressure, closely resembled the ill-fated British system of the 1920s. The difference is that world fiat currencies now pyramided on top of dollar reserves kept in New York instead of sterling reserves kept in London; once again, only the base country, in this case the U.S., continued to redeem its currency in gold.

—Murray N. Rothbard, The Mystery of Banking, 2nd ed. (Auburn, AL: Ludwig von Mises Institute, 2008), 249-250.

September 20, 1931 Was the Last Day of the Age of Economic Liberalism in which Great Britain Had Been Leader of the World

England betrayed not only the countries that aided the pound, but also the countries it had cajoled into adopting the gold-exchange standard in the 1920s. It also specifically betrayed those banks it had persuaded to keep huge sterling balances in London: specifically, the Netherlands Bank and the Bank of France. Indeed, on Friday, September 18, Dr. G. Vissering, head of the Netherlands Bank, phoned Monty Norman and asked him about the crisis of sterling. Vissering, who was poised to withdraw massive sterling balances from London, was assured without qualification by his old friend Norman that, England would, at all costs, remain on the gold standard. Two days later, England betrayed its word. The Netherlands Bank suffered severe losses. The Netherlands Bank was strongly criticized by the Dutch government for keeping its balances in sterling until it was too late. In its own defense, the bank quoted repeated assurances from the Bank of England about the safety of foreign funds in London. The bank made it clear that it was betrayed and deceived by the Bank of England.

The Bank of France also suffered severely from the British betrayal, losing about $95 million. Despite its misgivings, it had loyally supported the English gold-standard system by allowing sterling balances to pile up. The Bank of France sold no sterling until after England went off gold; by September 1931, it had amassed a sterling portfolio of $300 million, one-fifth of France’s monetary reserves. In fact, during the period of 1928–31, the sterling portfolio of the Bank of France was at times equal to two-thirds of the entire gold reserve of the Bank of England.

Despite Montagu Norman, who began to blame the French government for his own egregious failure, it was not the French authorities who put pressure on sterling in 1931. On the contrary, it was the shrewd private French investors and commercial banks, who, correctly sensing the weakness of sterling and the British refusal to employ orthodox measures in its support, decided to make a run on the pound in exchange for gold. The run was aggravated by the glaring fact that Britain had a chronic import deficit, and also was scarcely in a position to save the gold standard through tight money when the British government, at the end of July, projected a massive fiscal 1932–33 deficit of £120 million, the largest since 1920. Attempts in September to cut the budget were overridden by union strikes, and even by a short-lived sit-down strike by British naval personnel, which convinced foreigners that Britain would not take sufficient measures to defend the pound.

In his memoirs, the economist Moritz J. Bonn neatly summed up the significance of England’s action in September 1931:

September 20, 1931, was the end of an age. It was the last day of the age of economic liberalism in which Great Britain had been the leader of the world. . . . Now the whole edifice had crashed. The slogan “safe as the Bank of England” no longer had any meaning. The Bank of England had gone into default. For the first time in history a great creditor country had devalued its currency, and by so doing had inflicted heavy losses on all those who had trusted it.

As soon as England went off the gold standard, the pound fell by 30 percent. It is ironic that, after all the travail Britain had put the world through, the pound fell to a level, $3.40, that might have been viable if she had originally returned to gold at that rate. Twenty-five countries followed Britain off gold and onto floating, and devaluating, exchange rates. The era of the gold-exchange standard was over.

—Murray N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II, ed. Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 2002), 429-431.

What the Bank of England Did VERSUS the Correct Way of Solving a Gold Standard Crisis

With the successful runs on Austria and Germany, it was clear that England would be the next to suffer a worldwide lack of confidence in its currency, including runs on gold. Sure enough, in mid-July, sterling redemption in gold became severe, and the Bank of England lost $125 million in gold in nine days in late July.

The remedy to such a situation under the classical gold standard was very clear: a sharp rise in bank rate to tighten English money and to attract gold and foreign capital to stay or flow back into England. In classical gold standard crises, the bank had raised its bank rate to 9 or 10 percent until the crises passed. And yet, so wedded was England to cheap money, that it entered the crisis in mid-July at the absurdly low bank rate of 2.5 percent, and grudgingly raised the rate only to 4.5 percent by the end of July, keeping the rate at this low level until it finally threw in the towel and, on the black Sunday of September 20, went off the very gold-exchange standard that it recently had foisted upon the rest of the world. Indeed, instead of tightening money, the Bank of England made the pound shakier still by inflating credit further. Thus, in the last two weeks of July, the Bank of England purchased nearly $115 million in government securities.

England disgracefully threw in the towel even as foreign central banks tried to prop the Bank of England up and save the gold-exchange standard. Answering Norman’s pleas, the Bank of France and the New York Fed each loaned the Bank of England $125 million on August 1, and then, later in August, another $400 million provided by a consortium of French and American bankers. All this aid was allowed to go down the drain on the altar of inflationism and a 4.5-percent bank rate.

—Murray N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II, ed. Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 2002), 428-429.

In 1930 BoE Governor Montagu Norman Got His “Central Bankers’ Bank,” the Bank for International Settlements

In 1930, Montagu Norman got part of his wish to achieve a formal intercentral bank collaboration. Norman was able to push through a new “central bankers’ bank,” the Bank for International Settlements (BIS), to meet regularly at Basle, to provide clearing facilities for German reparations payments, and to provide regular facilities for meeting and cooperation. While Congress forbade the Fed from formally joining the BIS, the New York Fed and the Morgan interests worked closely with the new bank. The BIS, indeed, treated the New York Fed as if it were the central bank of the United States. Gates W. McGarrah resigned his post as chairman of the board of the New York Fed in February 1930 to assume the position of president of the BIS, and Jackson E. Reynolds, a director of the New York Fed, was chairman of the BIS’s first organizing committee. J.P. Morgan and Company unsurprisingly supplied much of the capital for the BIS. And even though there was no legislative sanction for U.S. participation in the bank, New York Fed Governor George Harrison made a “regular business trip” abroad in the fall to confer with the other central bankers, and the New York Fed extended loans to the BIS during 1931.

During 1931, many of the European banks, swollen by unsound credit expansion, met their comeuppance. In October 1929, the important Austrian bank, the Boden-Kredit-Anstalt, was headed for liquidation. Instead of allowing the bank to fold and liquidate, international finance, headed by the Rothschilds and the Morgans, bailed the bank out. The Boden bank was merged into the older and stronger Österreichische-Kredit- Anstalt, now by far the largest commercial bank in Austria, capital being provided by an international financial syndicate including J.P. Morgan and Rothschild of Vienna. Moreover, the Austrian government guaranteed some of the Boden bank’s assets.

But the now-huge Kredit-Anstalt was weakened by the merger, and, in May 1931, a run developed on the bank, led by French bankers angered by the announced customs union between Germany and Austria. Despite aid to the Kredit-Anstalt by the Bank of England, Rothschild of Vienna, and the BIS (aided by the New York Fed and other central banks), to a total of over $31 million, and the Austrian government’s guarantee of Kredit-Anstalt liabilities up to $150 million, bank runs, once launched, are irresistible, and so Austria went off the gold standard, in effect, declaring national bankruptcy in June 1931. At that point, a fierce run began on the German banks, the Bank for International Settlements again trying to shore up Germany by arranging a $100 million loan to the Reichsbank, a credit joined in by the Bank of England, the Bank of France, the New York Fed, and several other central banks. But the run on the German banks, both from the German people as well as from foreign creditors, proved devastating. By mid-July, the German banking system collapsed from internal runs, and Germany went off the gold standard.

—Murray N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II, ed. Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 2002), 426-428.

The Indian “Gold-Exchange Standard” Received Great Praise from Keynes for Its Inflationary Potential

The gold-exchange standard was not created de novo by Great Britain in the interwar period. It is true that a number of European central banks before 1914 had held foreign exchange reserves in addition to gold, but these were strictly limited, and they were held as earning assets—these after all were privately owned central banks in need of earnings—not as instruments of monetary manipulation. But in a few cases, particularly where the pyramiding countries were from the Third World, they did function as a gold-exchange standard: that is, the Third World currency pyramided its currency on top of a key country’s reserves (pounds or dollars) instead of on gold. This system began in India, after the late 1870s, as a historical accident. The plan of the British imperial center was to shift India which, like many Third World countries, had been on a silver standard, onto a seemingly sounder gold, following the imperial nations. India’s reserves in pound sterling balances in London were supposed to be only a temporary transition to gold. But, as in so many cases of seeming transition, the Indian gold-exchange standard lingered on, and received great praise for its modern inflationary potential from John Maynard Keynes, then in his first economic post at the India Office. It was Keynes, after leaving the India Office and going to Cambridge, who trumpeted the new form of monetary system as a “limping” or imperfect gold standard but as a “more scientific and economic system,” which he dubbed the gold-exchange standard. As Keynes wrote in February 1910, “it is cheaper to maintain a credit at one of the great financial centres of the world, which can be converted with great readiness to gold when it is required.“ In a paper delivered the following year to the Royal Economic Society, Keynes proclaimed that out of this new system would evolve “the ideal currency of the future.”

Elaborating his views into his first book, Indian Currency and Finance (London, 1913), Keynes emphasized that the gold-exchange standard was a notable advance because it “economized” on gold internally and internationally, thus allowing greater “elasticity” of money (a longtime code word for ability to inflate credit) in response to business needs. Looking beyond India, Keynes prophetically foresaw the traditional gold standard as giving way to a more “scientific” system based on one or two key reserve centers. “A preference for a tangible reserve currency,” Keynes declared blithely, “is . . . a relic of a time when governments were less trustworthy in these matters than they are now.” He also believed that Britain was the natural center of the new reformed monetary order. While his book was still in proofs, Keynes was appointed a member of the Royal Commission on Indian Finance and Currency, to study and make recommendations for the basic institutions of the Indian monetary system. Keynes dominated the commission proceedings, and while he got his way on maintaining the gold-exchange standard, he was not able to convince the commission to adopt a central bank. However, he managed to bully it into including his annex favoring the state bank in its report, completed in early 1914. In addition, in his work on the commission, Keynes managed to enchant his doting mentor, Alfred Marshall, the unquestioned ruler of academic economists in Britain.

—Murray N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II, ed. Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 2002), 387-389.

Under the 1920s Gold-Exchange Standard, Britain “Exported” Her Inflation to Other Nations Without Paying a Price

The major twist, the major deformation of a genuine gold standard perpetrated by the British in the 1920s, was not the gold bullion standard, unfortunate though that was. The major inflationary camouflage was to return, not to a gold standard at all, but to a “gold-exchange” standard. In a gold-exchange standard, only one country, in this case Great Britain, is on a gold standard in the sense that its currency is actually redeemable in gold, albeit only gold bullion for foreigners. All other European countries, even though nominally on a gold standard, were actually on a pound-sterling standard. In short, a typical European country, say, “Ruritania,” would hold as reserves for its currency, not gold but British pounds sterling, in practice, bills or deposits payable in sterling at London. Anyone who demanded redemption for Ruritanian “rurs,” then, would receive British pounds rather than gold.

The gold-exchange standard, then, cunningly broke the classical gold standard’s stringent limits on monetary and credit expansion, not only for the other European countries, but also for the base or key currency country, Great Britain itself. Under the genuine gold standard, inflating the number of pounds in circulation would cause pounds to flow into the hands of other countries, which would demand gold in redemption. Thereby gold would move out of British bank and currency reserves, and pressure would be put on Britain to end its inflation and to contract credit. But, under the gold-exchange standard, the process was very different. If Britain inflated the number of pounds in circulation, the result, again, was a deficit in the balance of trade and sterling balances piling up in the accounts of other nations. But now that these nations have been induced to use pounds as their reserves rather than gold, these nations, instead of redeeming the pounds in gold, would inflate, and pyramid a multiple of their currency on top of their increased stock of pounds. Thus, instead of checking inflation, a gold-exchange standard encourages all countries to inflate on top of their increased supply of pounds. Britain, too, is now able to “export” her inflation to other nations without paying a price. Thus, in the name of sound money and a check against inflation, a pseudo gold standard was instituted, designed to induce a double-inverted pyramid of inflation, all on top of British pounds, the whole process supported by a gold stock that does not dwindle.

Since all other countries were sucked into the inflationary gold-exchange trap, it seemed that the only nation Britain had to worry about was the United States, the only country to continue on a genuine gold standard. That was the reason it became so vitally important for Britain to get the United States, through the Morgan connection, to go along with this system and to inflate, so that Britain would not lose gold to the United States.

—Murray N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II, ed. Joseph T. Salerno (Auburn, AL: Ludwig von Mises Institute, 2002), 384-386.

Michael Heilperin’s Error Was His Proposal for a Managed Gold Bullion Standard with Government as Money Manager

Like the more famous advocate of the gold standard, Jacques Rueff, Heilperin was long an opponent of the gold exchange standard and presented insightful and prophetic critiques of the system, especially as it operated during the Bretton Woods era (1946-1971). His prophecies of its eventual and inevitable collapse, though derided when they were initially advanced, were right on the money in light of later developments. This serves as an invaluable illustration of the usefulness of sound deductive economic theory in the forecasting of the evolution and devolution of broad patterns of economic activities. Moreover, Heilperin’s objections to the gold exchange standard have contemporary relevance in view of the support for a return to a system of the Bretton Woods type that has been voiced by a number of prominent supply siders and other advocates of a monetary “price rule.”

Contemporary proponents of a genuine gold standard can hopefully learn from the damaging mistakes committed by Heilperin in his characterization and defense of the international gold standard. His errors in this respect stem from a fundamental misconception, shared with most modern economic theorists and policymakers, of the nature and evolution of money and monetary institutions. It was this underlying “constructivist” approach to money that led Heilperin to propose a “semiautomatic” or “managed” gold bullion standard in which the government is accorded the role of money manager. The unfortunate fact is that proposals like Heilperin’s have lent credibility to the distorted portrayal of the gold standard as nothing more than a government price-fixing scheme carried out on a grand scale.

—Joseph T. Salerno, “Gold and the International Monetary System: The Contribution of Michael A. Heilperin,” in The Gold Standard: Perspectives in the Austrian School, ed. Llewellyn H. Rockwell Jr. (Auburn, AL: Ludwig von Mises Institute, 1992), 82.

The International Gold Standard Provided an Automatic Mechanism for Keeping the Balance of Payments in Equilibrium

The international gold standard provided an automatic market mechanism for checking the inflationary potential of government. It also provided an automatic mechanism for keeping the balance of payments of each country in equilibrium. As the philosopher and economist David Hume pointed out in the mid-eighteenth century, if one nation, say France, inflates its supply of paper francs, its prices rise; the increasing incomes in paper francs stimulate imports from abroad, which are also spurred by the fact that prices of imports are now relatively cheaper than prices at home. At the same time, the higher prices at home discourage exports abroad; the result is a deficit in the balance of payments, which must be paid for by foreign countries cashing in francs for gold. The gold outflow means that France must eventually contract its inflated paper francs in order to prevent a loss of all of its gold. If the inflation has taken the form of bank deposits, then the French banks have to contract their loans and deposits in order to avoid bankruptcy as foreigners call upon the French banks to redeem their deposits in gold. The contraction lowers prices at home, and generates an export surplus, thereby reversing the gold outflow, until the price levels are equalized in France and in other countries as well.

--Murray N. Rothbard, What Has Government Done to Our Money? (Auburn, AL: Ludwig von Mises Institute, 2010), 90-91.

The Interwar Revolution in Monetary Thinking: Internal Stability, Full Employment, and NO Regard to the Balance of Payments

Stripped of technicalities and of short-run considerations the controversy over exchange rates: fixed or flexible, is essentially an aspect of the broader controversy over international economic integration (on the basis of the price mechanism and a common standard of value) as opposed to economic nationalism. The latter takes the form, in the area of monetary relations, of concern over a country’s ‘monetary independence’. Flexible or floating exchange rates have, in the opinion of their advocates, the great virtue of allowing a country (i.e. a government) to adopt an internal monetary, financial and, indeed, economic policy without concern for balance-of-payments equilibrium. As Professor Friedrich A. Lutz wrote in the December 1954 issue of the Banca Nazionale del Lavoro Quarterly Review: ‘The main advantage that can be claimed for a policy of flexible exchange rates is that it allows a country both to avoid quantitative import controls and to follow . . . an “independent” monetary policy, i.e. a policy that is unaffected by deficits or surpluses in its balance of payments.’

Several years ago, writing in the same vein, Professor Alvin H. Hansen of Harvard University spoke of a revolution in monetary thinking: ‘In the interwar decades a new standard of monetary policy increasingly won its way—emancipation from the adjustment process dictated by the gold standard; freedom to pursue a programme of internal stability and full employment without regard to the balance of payments.’ I have italicized the last words of the quotation; they express, as does the earlier quotation from Professor Lutz, one of the widespread and yet very fallacious aspirations of certain governments (their number has happily shown a substantial decline of late) and of altogether too many learned economists, aspiration to ‘do as one pleases’ without suffering any adverse consequences. A very human aspiration indeed—but also one that has been proved time and again to be unattainable—and one in which it is rather unwise to persevere.

—Michael A. Heilperin, “Fixed Parities and International Order (1955),” in Aspects of the Pathology of Money: Monetary Essays from Four Decades (Auburn, AL: Ludwig von Mises Institute, 2007), Ludwig von Mises Institute e-book.

What Does “Keeping the General Price Level Stable in Some Sense” Mean for Policy Makers Today?

What does “keeping the general price level stable in some sense” mean for policy makers today? It certainly does not mean complete price-level stability. The shift from inelastic commodity money to elastic paper money was consummated precisely in order to allow the constant expansion of the money supply, and, as we have seen and as is not contested by the mainstream, this will lead to an ongoing decline in money’s purchasing power. Today’s macroeconomic consensus maintains that this is helpful for growth. In the preceding chapters we saw that this is not the case. Be that as it may, a too-rapid decline in money’s purchasing power is deemed undesirable, and good money is thus defined as money whose purchasing power diminishes constantly but at a moderate pace. Most major central banks now define price level stability as constant inflation of around 2 percent per annum.

In some way, the fixation with the price level is understandable if we consider that accelerating inflation and ultimately hyperinflation is an inherent risk in any paper currency but logically impossible in commodity money systems such as proper gold standards. As we will see in the next part of our investigation, every paper money system in history has, after some time, experienced rising inflation, and no paper money system in history has survived. Either a voluntary return to commodity money was accomplished before a complete currency meltdown occurred, or the system collapsed in hyperinflation and economic and social chaos. We are frequently told that this time is different. Policy makers assure us that they have learned the lessons of history and will now pay close attention to the inflation rate. Thus, we may appreciate why the price level has achieved such extraordinary importance in policy debates. This focus, however, has been the source of new and dangerous fallacies.

—Detlev S. Schlichter, Paper Money Collapse: The Folly of Elastic Money, 2nd ed. (Hoboken, NJ: John Wiley and Sons, 2014), 160-161.

Under the Gold standard, the Formation of the Value of the Monetary Unit Is Not Directly Subject to the Action of the Government

Under the gold standard, the formation of the value of the monetary unit is not directly subject to the action of the government. The production of gold is free and responds only to the opportunity for profit. All gold not introduced into trade for consumption or for some other purpose flows into the economy as money, either as coins in circulation or as bars or coins in bank reserves. Should the increase in the quantity of money exceed the increase in the demand for money, then the purchasing power of the monetary unit must fall. Likewise, if the increase in the quantity of money lags behind the increase in the demand for money, the purchasing power of the monetary unit will rise.

There is no doubt about the fact that, in the last generation, the purchasing power of gold has declined. Yet earlier, during the two decades following the German monetary reform and the great economic crisis of 1873, there was widespread complaint over the decline of commodity prices. Governments consulted experts for advice on how to eliminate this generally prevailing “evil.” Powerful political parties recommended measures for pushing prices up by increasing the quantity of money. In place of the gold standard, they advocated the silver standard, the double standard [bimetallism] or even a paper standard, for they considered the annual production of gold too small to meet the growing demand for money without increasing the purchasing power of the monetary unit. However, these complaints died out in the last five years of the nineteenth century, and soon men everywhere began to grumble about the opposite situation, i.e., the increasing cost of living. Just as they had proposed monetary reforms in the 1880s and 1890s to counteract the drop in prices, they now suggested measures to stop prices from rising.

—Ludwig von Mises, “Monetary Stabilization and Cyclical Policy (1928),” in The Causes of the Economic Crisis: And Other Essays Before and After the Great Depression, ed. Percy L. Greaves Jr., trans. Bettina Bien Greaves and Percy L. Greaves Jr. (Auburn, AL: Ludwig von Mises Institute, 2006), 60-61.

Both Fisher and Keynes Wanted a Government “Manipulated” Standard to Hold the Purchasing Power of the Monetary Unit Stable

One of the proposals, for a multiple commodity standard, was intended simply to supplement the precious metals standard. Putting it into practice would have left metallic money as a universally acceptable medium of exchange for all transactions not involving deferred monetary payments. (For the sake of simplicity in the discussion that follows, when referring to metallic money we shall speak only of gold.) Side by side with gold as the universally acceptable medium of exchange, the index or multiple commodity standard would appear as a standard of deferred payments.

Proposals have been made in recent years, however, which go still farther. These would introduce a “tabular,” or “multiple commodity,” standard for all exchanges when one commodity is not exchanged directly for another. This is essentially Keynes’ proposal. Keynes wants to oust gold from its position as money. He wants gold to be replaced by a paper standard, at least for trade within a country’s borders. The government, or the authority entrusted by the government with the management of monetary policy, should regulate the quantity in circulation so that the purchasing power of the monetary unit would remain unchanged.

The American, Irving Fisher, wants to create a standard under which the paper dollar in circulation would be redeemable, not in a previously specified weight of gold, but in a weight of gold which has the same purchasing power the dollar had at the moment of the transition to the new currency system. The dollar would then cease to represent a fixed amount of gold with changing purchasing power and would become a changing amount of gold supposedly with unchanging purchasing power. It was Fisher’s idea that the amount of gold which would correspond to a dollar should be determined anew from month to month, according to variations detected by the index number. Thus, in the view of both these reformers, in place of monetary gold, the value of which is independent of the influence of government, a standard should be adopted which the government “manipulates” in an attempt to hold the purchasing power of the monetary unit stable.

—Ludwig von Mises, “Monetary Stabilization and Cyclical Policy (1928),” in On the Manipulation of Money and Credit: Three Treatises on Trade-Cycle Theory, trans. Bettina Bien Greaves, ed. Percy L. Greaves Jr. (Indianapolis: Liberty Fund, 2011), 60-61.

Irving Fisher Made One of the First Attempts to Dismiss the Business Cycle as an Independent Economic Concept

In 1891, Fisher wrote the first dissertation in economics at Yale University, Mathematical Investigations in the Theory of Value and Prices (1892). It was directed in part by members of the Yale mathematics faculty and became a true landmark in the development of mathematical economics. The use of mathematics in economics spread in the first half of the twentieth century and came to dominate the economics profession in the second half of the century. It now enjoys near complete supremacy in graduate programs and in the leading academic journals devoted to economics. Likewise, the general equilibrium theorizing from his dissertation has also become the stock in trade of mainstream economics.

Fisher (1913) also changed how the economics profession viewed the quantity theory of money. He converted the classical view of the quantity theory from a theory into a mechanism that could (and should) be manipulated in order to stabilize the value of money. He presented his views in The Purchasing Power of Money, where he introduced the concept of a “compensated dollar.” He wanted to change our notion of the dollar from one of a coin with a constant weight of gold to one of a currency that had constant purchasing power. Fisher is therefore credited with forming the foundations of monetarism and the monetary policy rules used today by central bankers.

Fisher’s development of index numbers as a method of measuring the purchasing power of the dollar is also a landmark in the history of modem economic orthodoxy. His policy of price-level stabilization requires the central bank’s monetary policy to target and stabilize a price index. Fisher (1927) was one of the first to define and calculate index numbers and he even began to publish a weekly wholesale price index in the early 1920s. His foundational work The Making of Index Numbers showed the basis of how central bankers could conduct and review monetary policy. Modern mainstream economists today would view any other approach to monetary policy as unscientific and they are in agreement with Fisher that price-level inflation and deflation are inherently bad things, and that the value of the dollar (as measured by price indexes) should be stabilized like physical measurements such as the meter or kilogram. Fisher (1925) can also be credited with one of the first attempts to dismiss the business cycle as an independent economic concept.⁷ He even discovered what was to become the famous Phillips curve (which depicts an inverse relationship between inflation and unemployment) decades prior to A. W. Phillips. In this light, modem macroeconomics can be seen as nothing but a thick layer of dust on the foundations laid by Fisher.

⁷ See Fisher (1925) where he attempts to empirically show that it is the instability of the purchasing power of the dollar that is the problem, not the business cycle per se. Mainstream economists also dismiss the idea of the business cycle and that it is really just “shocks” and “real factors” that cause changes in the economy. See for example Milton Friedman's (1993) plucking model.

—Mark Thornton, “The Great Depression: Mises vs. Fisher,” Quarterly Journal of Austrian Economics 11, no. 3 (Fall 2008): 233, 233n7.

In 1928, Mises Published a Book Predicting that Fisher’s Approach Would Lead to an Economic Crisis and Collapse

Ludwig von Mises established the foundations of modern Austrian economics while Irving Fisher established the foundations of modern mainstream macroeconomics and central bank policy. Fisher helped create and was a proponent of mathematical economics, statistics and index numbers, and a monetary policy that “stabilized” the value of the dollar. Fisher claimed that his scientific approach established a new era of prosperity during the 1920s. Mises published a book in 1928 that critiqued Fisher’s approach and predicted that it would lead to an economic crisis and collapse. Before the stock market crash in 1929 Fisher proclaimed a perpetual prosperity for the economy and continued to recommend investing in stocks long after the market had collapsed. In this important case study, Mises passed the “market test” while Fisher lost his personal fortune during an economic crisis that his economics help create.

—Mark Thornton, “The Great Depression: Mises vs. Fisher,” abstract, Quarterly Journal of Austrian Economics 11, no. 3 (Fall 2008): 230.

During the 1930s, Fisher and the Chicago School Were “pre-Keynes Keynesians” Wanting to “Reflate” the Price Level

And now, in his highly touted Monetary History of the United States, Friedman has demonstrated his Fisherine bias in interpreting American economic history. Benjamin Strong, undoubtedly the single most disastrous influence upon the economy of the 1920s, is lionized by Friedman for his inflation and price-level stabilization during that decade. In fact, Friedman attributes the 1929 depression not to the preceding inflation boom but to the failure of the post-Strong Federal Reserve to inflate the money supply enough before and during the depression.

In short, while Milton Friedman has performed a service in bringing back to the notice of the economics profession the overriding influence of money and the money supply on business cycles, we must recognize that this “purely monetarist” approach is almost the exact reverse of the sound—as well as truly free-market—Austrian view. For while the Austrians hold that Strong’s monetary expansion made a later 1929 crash inevitable, Fisher-Friedman believe that all the Fed needed to do was to pump more money in to offset any recession. Believing that there is no causal influence running from boom to bust, believing in the simplistic “Dance of the Dollar” theory, the Chicagoites simply want government to manipulate that dance, specifically to increase the money supply to offset recession.

During the 1930s, therefore, the Fisher-Chicago position was that, in order to cure the depression, the price level needed to be “reflated” back to the levels of the 1920s, and that reflation should be accomplished by:

1. the Fed expanding the money supply, and
2. the Federal government engaging in deficit spending and large-scale public works programs.

In short, during the 1930s, Fisher and the Chicago School were “pre-Keynes Keynesians,” and were, for that reason, considered quite radical and socialistic—and with good reason. Like the later Keynesians, the Chicagoans favored a “compensatory” monetary and fiscal policy, though always with greater stress on the monetary arm.

—Murray N. Rothbard, “Milton Friedman Unraveled,” in Economic Controversies (Auburn, AL: Ludwig von Mises Institute, 2011), 906-907.

The Chicagoite “Pure Monetary” Theory of the Business Cycle and the “Dance” of the “Price Level”

But the key problem with Friedman’s Fisherine approach is the same orthodox separation of the micro and macro spheres that played havoc with his views on taxation. For Fisher believed, again, that on the one hand there is a world of individual prices determined by supply and demand, but on the other hand there is an aggregate “price level” determined by the supply of money and its velocity of turnover, and never the twain do meet. The aggregate, macro, sphere is supposed to be the fit subject of government planning and manipulation, again supposedly without affecting or interfering with the micro area of individual prices.

In keeping with this outlook, Irving Fisher wrote a famous article in 1923, “The Business Cycle Largely a ‘Dance of the Dollar’”—recently cited favorably by Friedman—which set the model for the Chicagoite “purely monetary” theory of the business cycle. In this simplistic view, the business cycle is supposed to be merely a “dance,” in other words, an essentially random and causally unconnected series of ups and downs in the “price level.” The business cycle, in short, is random and needless variations in the aggregate level of prices. Therefore, since the free market gives rise to this random “dance,” the cure for the business cycle is for the government to take measures to stabilize the price level, to keep that level constant. This became the aim of the Chicago School of the 1930s, and remains Milton Friedman’s goal as well.

—Murray N. Rothbard, “Milton Friedman Unraveled,” in Economic Controversies (Auburn, AL: Ludwig von Mises Institute, 2011), 904.

The Keynesian and Fisherian/Chicagoan Bodies of Monetary Thought Theorize in an “Acatallactic” Fashion

There is, and always has been, wide disagreement among economists on the basic principles that determine the purchasing power of all this money. But in spite of all the disagreements among economists, there are only two basic schools of thought. One endeavors to explain the purchasing power of money on the basis of individual choice and action and to develop the theory of the value of money from a general theory of value. Its monetary doctrines remain an integrated part of general economics, and as such may be called the integrated or catallactic monetary doctrines. The other school embodies all doctrines and theories that are alien to any theory of exchange or system of the market society, and thus deny the principles of individual choice and exchange. Such monetary doctrines may be called segregated or acatallactic, for they do not view money as a market phenomenon.

Most contemporary theories of the value of money must be classified as acatallactic. Presented in mathematical, holistic equations, they either ignore individual choice and valuation, or merely pay lip service to individual action while theorizing about collective wholes. Some writers, especially in government, resemble the medieval schoolmen who ascribed the power to fix the values of coins to their princes. They hold that the value of money is a valor impositus, a value authenticated by the President and enforced through price and wage controls. To them, monetary phenomena, like all the phenomena of social life, are merely manifestations of the exercise of political power and government force. Their monetary explanations are not fallacious theories — they are not theories at all.

Some even deny the very existence of the science of economics. The radical inflationists, for instance, question the natural scarcity of economic goods and services, which is the very object of economic analysis. They blame selfish restraints on credit expansion imposed by bankers and other money lenders as the causes of scarcity and poverty, and therefore recommend unlimited public spending as the panacea. Their monetary pronouncements are built on a denial of economics.

But the two most popular bodies of monetary thought which shape contemporary monetary policies actually pay lip service to subjective economic theory while theorizing in acatallactic fashion. Both the income-expenditure theory of John Maynard Keynes and his numerous followers, and the quantity theory of Irving Fisher and his disciples, especially at the University of Chicago, completely ignore their catallactic premises when they arrive at the value of money. They deal with “price levels,” “national economies as a whole,” “levels of national output, employment, and income,” and other holistic concepts that have no place in subjective economic thought. Such theories are as sterile and futile as their primitive acatallactic predecessors, but they are very popular with governments eager to indulge in deficit spending.

An integrated or catallactic explanation of the value of money starts with the subjective valuations and actions of individuals. It never loses sight of the fact that a complete theory of money must rest on the subjective theory of value. In order to explain the determinants of the purchasing power of money and not only the causes of its changes, it endeavors to analyze the subjective significance or utility money has for individuals. For just as the price of an economic good is ultimately determined by the subjective valuation of buyers and sellers, so is the purchasing power of money.


—Hans F. Sennholz, “The Value of Money,” in Age of Inflation (Belmont, MA: Western Islands, 1979), 11-13.

The Alleged “Inevitable” Tendency Toward Monopoly Has Been Largely Confined to the Two “New Eras”

Every era of speculation brings forth a crop of theories designed to justify the speculation, and speculative slogans are easily seized upon. The term “new era” was the slogan for the 1927-1929 period. We were in a new era in which old economic laws were suspended. . . .

The new era of 1924-1929, like the earlier new era of 1896-1903, was characterized by a great consolidation movement. The alleged “inevitable tendency toward monopoly” in American business has been largely confined to these two “new eras.” It has not been due to technological or industrial reasons, but rather has been due to the ease with which new securities can be issued when money is excessive and stocks are rising — which makes it easy and profitable to organize holding companies and buy out competing concerns. There have been, in fact, only two great periods of consolidation in our history, the three-year period 1899-1902, and the five-year period 1924-1929. Both were periods of cheap money and excited stock markets. There were, in fact, a great many consolidations in the years 1924-1929. . . .

Bank consolidations, carefully considered, are often wholesome and beneficial, but the activities of promoters in throwing together a great many banks, as an incident to an excited stock market, were clearly unwholesome and dangerous. . . .

Another development of the period was the rapid multiplication and rapid growth of investment trusts. The investment trust idea is good in itself, and investment trusts in England and Scotland had had a long and honorable history. Investment trust management in the United States following 1932 has been, on the whole, highly creditable. But the mushroom growth of institutions of this kind in a financial atmosphere such as obtained in 1928-1929 was bound to bring a great deal of grief and humiliation.

—Benjamin M. Anderson, Economics and the Public Welfare: Financial and Economic History of the United States, 1914-1946 (1949; repr., Princeton, NJ: D. Van Nostrand Company, 1965), 202-204.

Credit Expansion Creates an Artificial Economic Inequality by Showing Up in the Stock Market and Driving Up Stock Prices

Capital in the form of credit is normally and, certainly, properly, extended out of previously accumulated savings. In sharpest contrast, credit expansion is the creation of new and additional money out of thin air, which money is then lent to business firms and individuals as though it were a supply of new and additional saved up capital funds. Its existence serves to reduce interest rates and to enable loans to be made and debts to be incurred which otherwise would not have been made or incurred. Always and everywhere, to the extent that private banks participate in the process of credit expansion, they do so with the sanction and generally with the active encouragement of the government.

Economists, above all Ludwig von Mises, have shown how credit expansion is responsible for the boom-bust business cycle and how its existence depends on deliberate government policy. Nevertheless, public opinion believes that the business cycle is an inherent feature of capitalism and that the role of government is not that of causing the phenomenon but of combating it. Indeed, as Mises observed, “Nothing harmed the cause of liberalism [capitalism] more than the almost regular return of feverish booms and of the dramatic breakdown of bull markets followed by lingering slumps. Public opinion has become convinced that such happenings are inevitable in the unhampered market economy.”

The truth is that credit expansion is responsible not only for the boom-bust cycle but also for another major negative phenomenon for which public opinion mistakenly blames capitalism. Namely, sharply increased economic inequality, in which the wealthier strata of the population appear to increase their wealth dramatically relative to the rest of the population and for no good reason.

It is not accidental that the two leading periods of credit expansion in history—the 1920s and the period since the mid 1990s—have been characterized by a major increase in economic inequality. Both in the 1920s and in the more recent period, a major cause of the increased economic inequality is that the new and additional funds created in credit expansion show up very soon in the financial markets, where they drive up the prices of securities, above all, common stocks. The owners of common stock are preponderantly wealthy individuals, who now find themselves the beneficiaries of substantial capital gains. These gains are the greater the larger and more prolonged the credit expansion is and the higher it drives the prices of shares. In the process of new and additional money pouring into the financial markets, investment bankers and stock speculators are in a position to reap especially great gains.

Since it’s so important, the main point just made needs to be repeated: credit expansion creates an artificial economic inequality by showing up in the stock market and driving up stock prices. Since  the stocks are owned mainly by wealthy people, they are the main beneficiaries of the process. The more substantial and the more prolonged the credit expansion is, the larger are the gains enjoyed by wealthy people more than anyone else.

—George Reisman, “Credit Expansion, Economic Inequality, and Stagnant Wages,” George Reisman's Blog on Economics, Politics, Society, and Culture, entry posted January 12, 2008, http://www.georgereismansblog.blogspot.com/2008/01 (accessed February 15, 2020).

Keynes, the Brilliant Generalizer of Half-Truths, Is Confused about Short-Term Speculation on the Stock Market

Once again Keynes, the brilliant generalizer of half-truths, has succumbed to the temptation of expressing a paradox at the cost of stating untrue facts and of giving dangerous advice.

Keynes’ reasoning confuses two different things: short-term investment or speculation in investments planned for the long run, and short-term investment or speculation in investments planned for the short run. It is simply not true that an investor, or even a speculator, is not interested in the long-term prospects of, say, a new plant to be installed. On the contrary, any calculation of earnings submitted to investors is based on very long-term estimates indeed. The fact that the more distant future cannot be assessed so clearly never leads to its being neglected. It only results in the attempt to reduce risks by providing for rapid amortization. However much anyone may invest for capital appreciation, he still invests with a view to the long-term earnings. Capital appreciation can ultimately be realized only by sale to an investor who, in his turn, buys the security for the sake of its long-term return.

—L. Albert Hahn, Common Sense Economics (New York: Abelard-Schumann, 1956), 208.

Keynes Thinks Investment Has Become a By-Product of a Gambling Casino So He Wants to Prevent Short-Term Speculation

In a widely known passage of his General Theory, Keynes has drawn from the undoubted dependence of stock market prices upon subjective factors, moods and errors the conclusion that the flow of savings into investments is no longer dictated by long-run expectations of yield, but rather by short-run expectations of stock market gains, particularly in the United States. Thus, he thinks, investment has become the by-product of a gambling casino! Foolish investments were made or reasonable ones omitted depending on whether speculators were pushing up or depressing prices. Keynes recommends as a remedy that the bonds between investor and investment be made as indissoluble as those of marriage, which can be separated only by death or for very important reasons. In other words, Keynes opposes negotiability of investments in securities so as to prevent short-term speculation.

—L. Albert Hahn, Common Sense Economics (New York: Abelard-Schumann, 1956), 207-208.