Understanding True Credit and False Credit

[Editor’s Note: This piece first appeared here]

There are two kinds of credit: that which would be offered in a market economy with sound money and banking (true credit), and that which is made possible only through a system of central banking, artificially low interest rates, and fractional reserves (false credit).

Banks cannot expand true credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (i.e., those lending to the bank) to borrowers.

Consider the case of a baker who bakes ten loaves of bread. Out of his stock of real wealth (ten loaves of bread), the baker consumes two loaves and saves eight.

He lends his eight remaining loaves to the shoemaker in return for a pair of shoes in one-week’s time.

Note that credit here is the transfer of ”real stuff,” i.e., eight saved loaves of bread from the baker to the shoemaker in exchange for a future pair of shoes.

Also, observe that the amount of real savings determines the amount of available credit. If the baker had saved only four loaves of bread, the amount of credit would have only been four loaves instead of eight.

Note that the saved loaves of bread provide support to the shoemaker. That is, the bread sustains the shoemaker while he is busy making shoes.

This means that credit, by sustaining the shoemaker, gives rise to the production of shoes and therefore to the formation of more real wealth. This is the path to real economic growth.

Money and Credit

The introduction of money does not alter the essence of what credit is. Instead of lending his eight loaves of bread to the shoemaker, the baker can now exchange his saved eight loaves of bread for eight dollars and then lend them to the shoemaker.

With eight dollars the shoemaker can secure either eight loaves of bread or other goods to support him while he is engaged in the making of shoes. The baker is supplying the shoemaker with the facility to access the pool of real savings, which among other things also has eight loaves of bread that the baker has produced. Also note that without real savings the lending of money is an exercise in futility.

Money fulfills the role of a medium of exchange. Thus, when the baker exchanges his eight loaves for eight dollars he retains his real savings, so to speak, by means of the eight dollars.

The money in his possession will enable him, when he deems it necessary, to reclaim his eight loaves of bread or to secure any other goods and services.

There is one provision here that the flow of production of goods continues. Without the existence of goods, the money in the baker’s possession will be useless.

The existence of banks does not alter the essence of credit. Instead of the baker lending his money directly to the shoemaker, the baker lends his money to the bank, which in turn lends it to the shoemaker. In the process the baker earns interest for his loan, while the bank earns a commission for facilitating the transfer of money between the baker and the shoemaker.

The benefit that the shoemaker receives is that he can now secure real resources in order to be able to engage in his making of shoes.

Despite the apparent complexity that the banking system introduces, the essence of credit remains the transfer of saved real stuff from lender to borrower.

Without an increase in the pool of real savings, banks cannot create more credit. At the heart of the expansion of good credit by the banking system is an expansion of real savings.

Now, when the baker lends his eight dollars we must remember that he has exchanged for these dollars eight saved loaves of bread. In other words, he has exchanged something for eight dollars. So when a bank lends those eight dollars to the shoemaker, the bank lends fully “backed” dollars, so to speak.

False Credit: An Agent of Economic Destruction

Trouble emerges when instead of lending fully backed money, a bank engages in issuing empty money (fractional reserve banking) that is backed by nothing.

When unbacked money is created, it masquerades as genuine money that is supposedly supported by real stuff. In reality however, nothing has been saved. So when such money is issued, it cannot help the shoemaker since the pieces of empty paper cannot support him in producing shoes — what he needs instead is bread.

Since the printed money masquerades as proper money it can be used to divert bread from some other activities and thereby weaken those activities. This is what the diversion of real wealth by means of money out of “thin air” is all about.

If the extra eight loaves of bread weren’t produced and saved, it is not possible to have more shoes without hurting some other activities, which are much higher on the priority list of consumers as far as life and well-being is concerned. This in turn also means that unbacked credit cannot be an agent of economic growth.

Rather than facilitating the transfer of savings across the economy to wealth generating activities, when banks issue unbacked credit they are in fact setting in motion a weakening of the process of wealth formation.

It has to be realized that banks cannot pursue unbacked lending on an ongoing basis without the existence of the central bank. The central bank, by means of monetary pumping, makes sure that the expansion of unbacked credit doesn’t cause banks to bankrupt each other.

We can thus conclude that as long as the increase in lending is fully backed by real savings it must be regarded as good news since it promotes the formation of real wealth. False credit, which is generated out of “thin air,” is bad news since credit which is unbacked by real savings is an agent of economic destruction.


Does Walmart Prove Minimum Wage Laws Will Help Workers?

[Editor’s Note: this piece was first published by Mises Canada here]

In a recent column Paul Krugman has one of the most curious arguments supporting the minimum wage that I’ve everwalmart seen from a professional economist:

A few days ago Walmart, America’s largest employer, announced that it will raise wages for half a million workers. For many of those workers the gains will be small, but the announcement is nonetheless a very big deal, for two reasons. First, there will be spillovers….Second, and arguably far more important, is what Walmart’s move tells us — namely, that low wages are a political choice, and we can and should choose differently.

Some background: Conservatives — with the backing, I have to admit, of many economists — normally argue that the market for labor is like the market for anything else. The law of supply and demand, they say, determines the level of wages, and the invisible hand of the market will punish anyone who tries to defy this law.

But labor economists have long questioned this view. …[B]ecause workers are people, wages are not, in fact, like the price of butter, and how much workers are paid depends as much on social forces and political power as it does on simple supply and demand.

…[Walmart’s justification for its wage hike] echoes what critics of its low-wage policy have been saying for years: Paying workers better will lead to reduced turnover, better morale and higher productivity.

What this means, in turn, is that engineering a significant pay raise for tens of millions of Americans would almost surely be much easier than conventional wisdom suggests…

The point is that extreme inequality and the falling fortunes of America’s workers are a choice, not a destiny imposed by the gods of the market. And we can change that choice if we want to.

As with all of Krugman’s jaw-dropping pieces, other economists have jumped in on this one too. For example, David R. Henderson challenges Krugman’s history of unions and his claim that supply and demand don’t work when it comes to labor, and in the comments of his post points people to my own assessment of the minimum wage empirical literature that is decidedly more nuanced than Krugman’s summary.

However, in this post I want to focus on two other points that I haven’t seen Krugman’s critics address. First, it is a very strange argument to say, as Krugman does, that since we observe Walmart raising wages voluntarily, that therefore having the government force other firms to do so involuntarily won’t cause any major problems.

Look, Target just announced that it will lay off thousands of workers as part of a package to save $2 billion over two years. So should Stephen Moore write an op ed arguing that the government should require all existing firms to lay off thousands of workers, because the possible downsides are obviously smaller than what conventional wisdom suggests?

Or, if my Target analogy is too extreme for you–even though it’s exactly what Krugman did with Walmart–try this one: Chick-fil-A doesn’t serve food on Sundays. So that means the government could pass a law forcing all fast food restaurants to stay closed on Sundays, since clearly the gains to the workers (in the form of more time with their families) is higher than any potential downsides, such as convenience to consumers and paychecks for the workers. Right?

But moving beyond the absurdity of the basic premise of Krugman’s piece–namely, looking at a particular decision by one company in the market and then enforcing it upon every firm in the market–let’s focus on his other trademark, where he accuses people of swallowing naive economic doctrines that sophisticated thinkers like Krugman know are wrong.

Specifically, Krugman is rolling at his eyes at those conservatives–who, he admits, actually can find some economists out there to back up this view–who think supply & demand works in labor markets the same way it works in the butter market.

Indeed, I have found an economics textbook that pushes exactly this kind of simplistic view–even down to the specific example of a “butter mountain”! Here is a screenshot from the textbook that I grabbed from Google Books:

Krugman Butter Mountain

Man, this textbook does EXACTLY what Krugman is complaining about, doesn’t it? In case some readers are using their smart phones and the above screenshot is hard to read, let me summarize: The text’s discussion first uses supply & demand to illustrate the problems of a price floor in the butter market, and explains how historically this caused the European Commission to find itself “the owner of a so-called butter mountain, equal in weight to the entire population of Austria.” Then, after explaining how price floors screw up agricultural markets, it goes right into the minimum wage, saying “when the minimum wage is above the equilibrium wage rate, some people who are willing to work–that is, sell labor–cannot find buyers–that is, employers–willing to give them jobs.”

Those of you familiar with my critiques of Krugman over the years, will not be surprised to learn that the above textbook discussion comes from…Paul Krugman’s micro text (co-authored with Robin Wells). So when in his op ed Krugman admitted that the conservatives who thought you could analyze the minimum wage the same way you look at price floors on butter could actually cite some economists to support this view…one of those economists would be Paul Krugman.

Let me conclude this post by saying that in economics, as in other disciplines, there are varying degrees of sophistication. Sometimes you have to teach beginners things that are not quite right, in order to get the underlying lesson across, and then only later (for example students who are econ majors or those getting advanced degrees) do you introduce more nuances. So my problem isn’t that Krugman might fairly be arguing that the simplistic things we teach in Econ 101 are not the end of the story for what government policymakers should do.

Rather, my problem is with the tone and spirit of Krugman’s discussion. The casual reader would have NO IDEA that Krugman himself in his own textbook first talked about butter mountains, and then moved right on to minimum wage causing unemployment. (Go click the Google Books link and look around; there are no caveats surrounding the discussion.) Indeed, this is so much standard operating procedure for Krugman that I went looking for it. It’s not that I had this butter mountain example in my back pocket. No, I Googled “krugman wells minimum wage” to see what they said about it in their book, and foundJeremy Hammond’s discussion.

For those readers who still might think I’m exaggerating just how outrageous Krugman’s behavior here is, go look again at the discussion from his op ed, particularly this sentence: “Setting a minimum wage, it’s claimed, will reduce employment and create a labor surplus, the same way attempts to put floors under the prices of agricultural commodities used to lead to butter mountains, wine lakes and so on.” That is not a standard talking point. In my textbook, for example, I don’t use the term “butter mountain” or “wine lake.” No, the reason that example was in Krugman’s head, is that he was remembering how he himself treated the issue in his own textbook. It is really something amazing to behold.



One of the great myths about the capitalist system is the presumption that businessmen make profits at the expense of the consumers and workers in society. Nothing could be further from the truth.

In the free market, consumers are the sovereign rulers who determine what gets produced, and with what qualities and features. The sovereign consumers also determine who will be the owners and entrepreneurs of business enterprises.

The “captains of industry” are not the businessmen, but the buying public who steer the directions into which production is taken. Businessmen, to use a metaphor, are more like the “first mate” aboard a ship who after being given his orders by captain consumer passes it on to the crew, that is, those employed within the enterprises, companies, and firms in terms of the tasks to be done to bring the economic ship to where captain consumer wants it to go.

Consumers Appoint the Entrepreneurs Who Direct Production

As the Austrian economist, Ludwig von Mises, once explained,

“In the capitalist system of society’s economic organization the entrepreneurs determine the course of production. In the performance of this function they are unconditionally and totally subject to the sovereignty of the buying public, the consumers . . .

“The consumers by their buying and abstention from buying elect the entrepreneurs in a daily repeated plebiscite, as it were. They determine who shall own [businesses and enterprises] and who shall not, and how much each owner should own . . .

“If they fail to produce in the cheapest and best possible way those commodities which the consumer are asking for most urgently, they suffer losses and are finally eliminated from their entrepreneurial position. Other men who know better how to serve consumers replace them . . .”

The British economist, William H. Hutt coined the term, “consumers’ sovereignty,” back in the 1930s, especially in his book, Economists and the Public (1936). His point was to emphasize that the essence of the market economy is to be found in the liberty of the individual to make his own choices as both a consumer and a producer.

Consumer as King Cartoon

The Consumers’ Sovereignty Means Freedom in Market Choices

An essential element of an individual’s liberty is that he may not be compelled by either the threat or the use of force by others in society to make him do that which he does not want to do or accept.

This is the hallmark of the meaning of voluntary exchange. You may be reasoned with, argued with, persuaded with. But coercion may not be applied to make you enter into a transaction or accept the terms as which an offer is made if you find it not to your benefit and liking.

In the market economy people divide their labor. Each finds a niche in which to specialize his talents and abilities to earn a living. But he can only earn that living if he successfully directs his energies and efforts to making and supplying some good or service that others are willing to purchase and at a price they are willing to pay.

In this role, each producer is servant to the masters of the market – the consumers. With the income that we have earned in our producer capacity we reenter the market as a consumer, ourselves, and those whom we have served to acquire that income now must serve us in their respective capacities as producers.

How much we have to spend, and therefore, to make monetary “claims” on the outputs and productions of others is a reflection of the extent to which we have satisfied the desires of others in society.

W. H. Hutt photo

As William Hutt explained in Economists and the Public:

“In regarding the individual as a consumer, we do not see him in his full relationship to society. He is usually also a producer. But as a producer he is the servant of the community. He must apply himself and the property and equipment he possesses to producing what the community wants [that is, all other individuals in their role as consumers] or he will obtain nothing in the form of claims on others in return [in the form of the money income earned with which he demands as a consumer the things he desires from others].

“As a consumer, he commands other producers . . . As a ‘consumer,’ each directs. As a ‘producer,’ each obeys . . . The defense of consumers’ sovereignty rests . . . upon an assumption that liberty does possess supreme importance . . . The complete sovereignty of the consumer is compatible with the fullest scope to the initiative of the individual . . . In other words, it is in harmony with the idea of liberty.”

Free to Choose as Consumers and Producers

Now, it is certainly true that the professional sportsman or movie star has earned far more money than I have as an economics professor. But this is a reflection of the degree to which our fellow citizens place a higher entertainment value on watching the services of the sportsman or film star than they do on information to be gleaned from hearing a lecture or reading an article about “consumers’ sovereignty” and the benefits from free markets.

Could I have attempted to pursue a financially more lucrative profession? Yes. Might I have succeeded? It is possible. But I, early on, made an implicit trade-off in my life: to forego other possible income-earning uses of my human skills to, instead, follow a calling that I both enjoy and find highly rewarding, namely the sharing of my understanding of economics with others and most especially with young minds in the classroom.

Thus, my capacity to “command” the services of others in the marketplace through the dollars that I have to spend is far less than the well-paid professional athlete or multi-million dollar movie “heart-throb.”

Or again to quote from William H. Hutt’s Economists and the Public:

“The sovereignty of the consumer over producers does not extend beyond creating a situation in which the latter can choose between various alternatives. There is no absolute coercion on any individual to act (i.e., to apply his property and powers) in a certain way in reply to society’s [consumers’] indication of its [their] preferences.

“He has the liberty of following his own inclinations and sacrificing advantages which would be available to him from a higher income . . . When he ignores society’s [consumers’] demands . . . he exercises his sovereignty over the disposal of his own powers and property . . . The artist, for example, who could earn [$50,000] a year producing ‘commercial art’ which pleases the public, may decide to follow his own inclinations and produce instead what gives him the greatest satisfaction, but has little commercial value.”

Incomes Earned Reflects What Consumers Think Workers are Worth

In this is another significant lesson about the nature and workings of the free market economy: the “distribution” of income in society is not arbitrary or a matter of the caprice or stone heartedness of the employer.

What businessmen and entrepreneurs offer to pay to those whose labor services and other productive abilities they employ is a reflection of what they think those people and skills are worth in terms of the value they add towards the manufacturing of some finished product they hope to successfully sell to consumers; and what they think they must offer to outbid other businessmen who are their rivals for hiring and employing those whose services of which they are also in need.

Thus, suppose that an employer judges a potential employee’s services in his firm to be worth paying a maximum of, say, $12 an hour. If he could get that worker to take the job for $9 an hour he would view himself as have gotten a profitable bargain.

But he cannot ignore that fact that if there are two competing employers who, respectively, may value that same prospective worker’s labor at $11 and $11.50 an hour, he must, then, offer enough to attract that worker to take a job with him instead of his next closest rival. He must offer a wage above that $11.50 his competitor may be offering and, thus, he tends to bring that employee’s wage closer to the highest value of what some employer thinks that worker’s labor to be worth.

This logic of the competitive process of the free market, however, is often misunderstood because the nature and workings of laissez-faire capitalism is confused with the affect of various government interventions on the outcomes of market interactions.

What are outcomes and effects resulting from interferences by government in the market process are erroneously identified with the results of the free market, or “capitalism.”

This, too, was discussed and explained by William H. Hutt back in the 1930s through a distinction that he made between “natural scarcities” and “contrived scarcities.”

“Natural Scarcities” of Means Insufficient to Fulfill All Desired Ends

Man cannot escape from the fact that he is always confronted with the need and necessity to make choices, to make trade-offs between alternatives, and decide what he values more highly and what he values less highly.

The inescapable reason for this is the scarcity of means available in their quantities and/or qualities to serve and satisfy fully all the ends, goals and purposes for which we would like to apply them.

Our time is scarce, with only twenty-four hours in a day. Our mental and physical strength is limited with which to pursue our purposes. The resources and raw materials around us that we identify as “useful things” to make the finished goods and services that we desire are limited in their amounts to produce all the things for which we think them useable.

In the free market economy the relative scarcities of both finished consumer goods and the resources, labor and capital equipment out of which those consumer goods can be made are all registered in the form of the competitive prices at which they may be bought and sold.

If we, as consumers, demand more automobiles we offer to pay higher prices for the greater number of cars we wish to purchase. But to produce more automobiles off the assembly line means that fewer of the scarce resources that go into the manufacture of cars – workers and their labor time, resources, raw materials, component parts, and the machinery needed – will not be available to produce other, alternative, goods that could have been produced with those same means of production, instead.

The prices paid to attract those greater quantities of scarce means into the auto industry (including the additional wages to draw more workers into this sector of the market) are what economists call their “opportunity costs.” That is, the prices that need to be offered and paid that are just sufficient to attract them from an alternative employment in which they also have value in producing something else consumers also want, but not as intensely.

This is the reality of a world in which we are not able to have everything we want, where we want it, in the full amounts we desire. This is why, no matter how hard we try, we can never have it “all.”

Even when through savings, investment, innovation, and industry we succeed over time in increasing our ability to produce more of the things we wish to have, we still never have it all. It is part of the human make-up that as soon as we have successfully reached some desired goals our mind and imagination runs ahead to new and different things that are, once again, not fully within our reach.

It is like walking towards the horizon; no matter how far we go and how fast we try to get there, the horizon remains in front of us, and out of our reach. This is man’s frustration but also the stimulus for all the material and cultural achievements that we call “civilization” that have raised humanity up from primitive subsistence existence.

In the competitive free market, the limits on how much of goods in general and the relative amounts of each within that total is possible of being produced is limited and constrained by what William H. Hutt defined as the “natural scarcities” existing in any society within a period of time. Said Hutt:

“We must conceive of a society in which there are no restrictions on the free movement, adjustment and full utilization of the productive resources in response to the dictates of consumers’ will [as expressed in their market demands for various goods and services].”

Under the “natural scarcity” of things in a free market some people may wish that more hospitals were built for the sick or more research undertaken for a cure for cancer, or more wildlife areas set aside for peaceful contemplation of the beauty of nature. But the critic has no one to blame but the free choices of his fellow citizens and even himself in actually demanding more of other things that prevents the necessary scarce resources and labor from being available to do more of these other desired things as well.

“Contrived Scarcities” and “Contrived Plentitudes” Caused by Government

The critic may not be satisfied with his own (perhaps failed) attempts to persuade enough of his fellow citizens to demand and spend less on these other things so more scarce resources can be freed up and used for more hospitals, medical research and nature preserves. He may then turn to the government and its political power to get what he wants without the agreement and voluntary participation of his “preference-misguided” fellows in society.

William H. Hutt argued that when various individuals and special interest groups turn to the State to get what they want its brings about what he called “contrived scarcities” and “contrived plenitudes.”

If the government increases taxes on the citizenry to fund the supplying of more hospitals, cancer research and wildlife areas, it creates a “contrived plenitude,” that is, an amount of these things in excess of what the market would have found it profitable to supply if production had been guided by what consumers would have wanted and demanded if more of their earned income had not been taxed away.

The amount of such “good things” as hospitals, medical research facilities, and nature areas are, in fact, out of balance – over supplied – with what a free market would have supplied of them if the determination of production in society had been left more fully to be guided by the wishes and desires of the “sovereign consumers.”

On behalf of those not satisfied with the free choices of their fellow citizens and who are willing to use political compulsion to get what they want, government has intruded into and violated the “sovereignty of the consumer” to peacefully, honestly, and voluntarily decide what he wants based on his values, beliefs and desires, and to make it profitable on the competitive market for others to provide him with what he wants out of the income he has peacefully, honestly and voluntarily earned in his own role as a producer.

But the other side of this coin is that there are “contrived scarcities” – a reduced availability – of the goods and services that those sovereign consumers would have been able to have if the greater taxes collected and spent by the government had not resulted in scarce resources and labor being drawn away from producing the goods and services those consumer/taxpayers would have spent their income on if it had not been reduced due to those higher taxes.

Red Tape in Every Direction

“Contrived Scarcities” from Import Tariffs and Price Subsidies

Such contrived scarcities take on other forms, as well, other than only the direct taxing away of people’s income. If the government imposes an import tariff or an import quota on foreign goods entering the domestic economy, the available supplies of those goods will be less; and the prices of these goods that consumers will now have to pay will be higher, as a result, than if free trade was practiced and consumers had had a wider free market choice of domestic and foreign suppliers.

Suppose that the government starts to guarantee dairy farmers minimum prices for their produce (as the U.S. government does under its farm price-support programs). With a higher guaranteed price than the market-established price, dairy farmers would find it profitable to expand their dairy cowherds. But this requires more grazing land for the increased number of cows.

The expanded grazing land will have to come from somewhere. Suppose that this land comes out of wheat growing. The wheat crops will tend to decrease, an essential ingredient in bread baking will be reduced in quantity, and the supply of wheat bread available in groceries may be less, with a resulting higher price per loaf that consumers now must pay.

Thus, government interventions such as these would abridge the market-based sovereignty of the consumers, bringing about too much of some goods being produced and too little of others being supplied.

Difficulty of Seeing Government’s Hand in Contrived Scarcities

But the perversity from these types of “contrived scarcity” policies is that the consumers find it difficult to know whether and to what extent the supplies available and the prices paid for goods are due to market-determined “natural scarcities” and how much is due to government manipulation of quantities produced and offered on the market.

In the case of the farm price-support programs, consumers in the market end up paying no less than the government guaranteed price for dairy products, for example, since dairy farmers have no incentive to offer it for less since they know that any unsold surpluses at the guaranteed price will be bought up by the government at taxpayers’ expense.

At the same time, the possible reduced wheat crops that negatively impacts the supply of wheat bread and raises its price, for instance, is so many steps away from the immediate vision and understanding of the consumers of bread that it is nearly impossible for ordinary citizens to appreciate the links in the chains of government intervention that has made bread more costly and less available.

Thus, the “free market” gets blamed for high or rising prices for various goods because of the businessman’s “greedy profit motive” that makes him fail to produce more of what people want and desire.

Consumers seem to be unrestricted in their choices concerning how to spend whatever after-tax income that may remain in their pockets; market interactions of supply and demand seems to determine the prices that those consumers pay; and thus the reason for any frustrating scarcities and expensiveness of desired goods gets placed at the doorstep of “selfish” acts of profit-motivated capitalists and businessmen, in general.

But behind the scenes the incentive, profitability and opportunity to produce goods guided by the actual demands of the “sovereign consumers” have been thwarted by government taxing, pricing and regulatory policy manipulations bringing about contrived or artificial scarcities of some goods on the supply-side of the market or wasteful over production or “contrived plentitudes” of other goods not reflecting what those consumers would really want produced if the market was left free of the intervening and distorting hand of the those in political power serving particular special interest groups.

Government as Golieth cartoon

Getting Government Out of the Market Can End Contrived Scarcities

While “natural scarcities” can only be reduced in the longer-run through savings, investment, innovation and industry that increases the supply and improves the qualities of desired goods, in principle, “contrived scarcities” and artificial “plentitudes” can be corrected much sooner.

Or as William H. Hutt expressed it, “Contrived scarcities, unlike natural scarcities, are not beyond the power of change by individuals and hence of a different degree of permanence: restrictions can be overcome . . . Contrived scarcities involve, then the frustration of consumers’ sovereignty; and what is usually meant when the removal of restrictions on competition is recommended is that such contrivances shall be eliminated.”

One of the tasks of friends of capitalism and free markets, therefore, is to explain to our fellow citizens that while a “natural scarcity” of useful means to achieve our various ends is inescapable in the reality of the human circumstance, there are some scarcities of resources and desired goods that are artificial, “contrived scarcities,” due precisely to government and its interventions in the market process.

Such contrived scarcities, in principle, could be gone tomorrow if the government’s economic policies fostering, creating and sustaining them were abolished and eliminated. The individual’s sovereignty over his choices and actions as both consumer and producer will have been more fully restored.

Free men in free markets would then be at liberty to improve their conditions without the disrupting and distorting hand of political power and special interest politicking that invariably makes many things less available and more expensive than if competitive capitalism were unshackled from the government policies that only succeed in making us poorer and far less free than we need to be.


Rand Paul Draws Liberal Fire As The Left Discovers Its Inner Love Of The Fed, Part Two

Sen. Rand Paul is drawing liberal fire from many left wing commentators, now including Prof. Paul Krugman.  Many of the criticisms are badly off base. As noted in yesterday’s column there is so much simply factually incorrect about The New Republic’s Danny Vinik recent Rand Paul Has the Most Dangerous Economic Views of Any 2016 Candidate — for example — that one hardly knows where to begin.  So, to quote the composer John Cage, let’s “begin anywhere.”

First, Rand Paul, unlike Ron Paul, nowhere appears on record as advocating the gold standard. Implication of such advocacy to Sen. Paul is, flatly, wrong.  This is sloppy journalism.

Second, whatever Sen. Paul’s views may be, the current overwhelming opposition to the gold standard by academic economists is reminiscent of nothing so much as the Wizard of Oz’s movie peroration: “I, your Wizard, per ardua ad alta, am about to embark upon a hazardous and technically unexplainable journey into the outer stratosphere…to confer, converse, and otherwise hobnob with my brother wizards.” The pronouncements of such eminent economic wizards as those sampled by the Booth School are as unpersuasive as they are rotund.  In the unvarnished language of contributor Nathan Lewis, a leading witness to the fact that the Emperor has no clothes, “Academic economists of every variety, along with high-fashion architects, are now generally regarded as deluded nincompoops….”

Third, it is irrelevant and downright misleading to observe that the gold bugs have been (as indeed many of them have been for 40 years) prognosticating skyrocketing inflation. This misleads by collapsing the distinction between the primary advocates of the gold standard by such public intellectuals as Steve Forbes and Lewis E. Lehrman (with whose Institute I once had a professional relationship) and academics such as Prof. Lawrence White and Prof. Brian Domitrovic, among many others … with the views of the gold bugs.  These represent two entirely separate ideological camps.

It betrays deep ignorance to conflate them. Responsible opponents of the gold standard really should come to grips with the fact that few, if any, of the leading advocates of, or sympathizers with, the gold standard have been prognosticating inflation, skyrocketing or otherwise. The (extensively) stated leading concerns of gold standard proponents have been historically anemic growth rates and median family wage stagnation — both of which are in evidence — rather than incipient hyperinflation.

An empirical review published in 2011 by the Bank of England — not exactly a “fever swamp” — of the performance of the fiduciary currency standard relative to the performance of the Bretton Woods gold-exchange standard and the classical gold standard, found, as then summarized by contributor Charles Kadlec:

  • Economic growth is a full percentage point slower, with an average annual increase in real per-capita GDP of only 1.8%
  • World inflation of 4.8% a year is 1.5 percentage point higher;
  • Downturns for the median countries have more than tripled to 13% of the total period;
  • The number of banking crises per year has soared to 2.6 per year, compared to only one every ten years under Bretton Woods;
  • The number of currency crises has increased to 3.7 per year from 1.7 per year;
  • Current account deficits have nearly tripled to 2.2% of world GDP from only 0.8% of GDP under Bretton Woods.

The concerns raised are well grounded and a far cry from the straw man ones presented by Vinik.

Vinik shows his hand — as a fabulist, not a journalist — in his final paragraph.

Of course, the Republican Party itself has an incredibly misguided position on monetary policy. In 2012, its platform included returning to the gold standard. That’s a good reason why just about any Republican nominee would be a dangerous president. But Paul is far more open about his disdain for the Fed, and given his ideological bent, he’s far less likely to listen to conservative economists who reject his monetary policy views. At least on the economy, that makes Rand Paul by far the most dangerous candidate in the 2016 field.

“[J]ust about any Republican nominee would be a dangerous president”?

Hello Democratic National Committee, send this man a box of fine Cuban cigars!

Vinik, had he taken a moment actually to read the GOP 2012 platform, would have discovered that nowhere in its platform is there a call for a return to the gold standard … or even the mention of the gold standard (except as a metaphor for the quality of care for wounded warriors). It contains, rather, a call for a “commission to investigate possible ways to set a fixed value for the dollar.”

The horror!

Vinik by no means is the only commentator to go into hyperbolic meltdown over Rand Paul.  Nobel Prize economics laureate Paul Krugman, recently, in Money Makes Crazy:

Right now, the most obvious manifestation of money madness is Senator Rand Paul’s “Audit the Fed” campaign. Mr. Paul likes to warn that the Fed’s efforts to bolster the economy may lead to hyperinflation; he loves talking about the wheelbarrows of cash that people carted around in Weimar Germany.

Prof. Krugman, a polemicist, characteristically exaggerates.  Mr. Paul “likes to warn?”  The record demonstrates two brief statements of concern, made in obscure venues, by Dr. Paul.  If there are any more they must be obiter dicta in venues even more obscure, showing these “likes” to be far less than a leitmotif of Paul’s rhetoric, much less agenda.

Krugman goes on to indict the Republicans as “monetary crazy” — based mostly on a few stray comments and some utterly irrelevant, outlying, positions such as one derived from Ayn Rand.  Few of the positions he cites are any part of the real discourse now ongoing among the center right.  Krugman studiously ignores intelligent concerns stated by the Honorable Paul Volcker, the Honorable Jeb Hensarling, the Honorable Scott Garrett, and the Honorable Kevin Brady, among others, as well as scholarly publications by Heritage Foundation, Cato Institute, Atlas Foundation, and other center-right policy institutes (such as American Principles in Action, which I professionally advise).

Prof. Krugman and Danny Vinik thus present themselves as exhibits in support of the observation of Sen. Nelson Aldrich, head of the National Monetary Commission, before the New York Economics Club in 1909, “[T]he study of monetary questions is one of the leading causes of insanity” … (which the erudite Krugman’s headline, Money Makes Crazy, echoes).

Krugman is right about one thing, though: “Monetary policy … should be” a major issue in the 2016 campaign. And Danny Vinik, despite his errors, is right about one thing. Rand Paul might well be “by far the most dangerous candidate in the 2016 field” — though for the the progressive central planning agenda, not for the economy.

Liberal fire is a badge of honor.  Liberal fire will be an asset, should he choose to run, in the presidential primaries. Rand Paul draws liberal fire.


New high! (Zzz.)

“The FTSE 100 has at last topped the record it set at the close of 1999. Should Britons celebrate ? Probably not.”

–       John Authers, The Financial Times, ‘FTSE hits record, but hold off the bubbly.”


“To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the ‘Hallelujah Chorus’ in the Buffett household. When hamburgers go up in price, we weep. For most people, it’s the same with everything in life they will be buying — except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”

–       Warren Buffett, 10th December 2001.


“I’m thinking of making a purchase of Berkshire [Hathaway], but I’m concerned about something happening to you, Mr. Buffett. I cannot afford an event risk.”

–       Attendee at a shareholders’ meeting of Berkshire Hathaway.


“Neither can I.”

–       Warren Buffett’s response.


“The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.”

–       Benjamin Graham.


“Investors’ delight as shares smash record.”

–       The Times.


On the fiftieth anniversary of Warren Buffett’s taking control of the Berkshire Hathaway company, his annual letter to shareholders has been keenly anticipated. It does not disappoint. The compounded annualised gain in book value per share for the company from 1965 to 2014 equates to 19.4%. The annualised percentage gain for the S&P 500 over the same period, with dividends reinvested, equates to 9.9%. That differential has delivered astronomical comparative performance. The overall gain for the US market comes to 11,196% over the period. The overall gain for Berkshire Hathaway stock comes to 751,113%. If the efficient market hypothesis were correct, a differential of that magnitude could not possibly exist, in this or any other universe. As Buffett himself has remarked,

“I’d be a bum on the street with a tin cup if the markets were always efficient.”

So it is something of a shame that Buffett has never been awarded a Nobel prize for economics, as opposed to Eugene Fama, the father of the efficient market hypothesis, who has. No doubt Buffett’s net worth of roughly $60 billion takes some of the sting away.

Buffett in this year’s letter takes an explicit swipe at another piece of conventional investment wisdom – the idea that risk is essentially encapsulated in price volatility (step forward, Harry Markowitz, and any number of cheerleaders and ‘consultants’ who claim to be professional investors):

“For the great majority of investors.. who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities [i.e. cash and bonds]. If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement.”

In October 2009, Buffett’s business partner and Berkshire Hathaway Vice-Chairman Charlie Munger was interviewed on the BBC and was asked about how much concern he had for the company’s latest stock price decline. His response:

“Zero. This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%. I think it’s in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by, say, 50%. In fact, you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder, and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.” [Emphasis ours.]

There will be plenty of commentary online about Buffett’s letter and we don’t intend to distract readers from the source material. There’s just one line from it we’d like to reiterate:

“Although our form is corporate, our attitude is partnership.”

Berkshire’s structure is unusual. It’s a diversified holding company but clearly for many shareholders it has acted extraordinarily well as an investment manager. Berkshire and Buffett have benefited, in turn, from access to genuinely permanent capital and to unusually patient shareholders – a fact Buffett is only too happy to acknowledge. But the bottom line is that the relationship has been symbiotic: a partnership between co-investors, as opposed to an adversarial relationship between lots of mouths needing to be fed, and customers who are second in the queue for capital returns after all those mouths have been fed. As at year-end 2014, Berkshire was a business with $526 billion in assets, with a corporate headquarters employing just 25 people. Now that is decentralised capital allocation.

50 years. A 750,000% return. But the most striking thing about Warren Buffett at Berkshire Hathaway is not even the absurdly enviable track record of demonstrable investment success. The ‘value’ methodology, originally developed by Benjamin Graham, and subsequently adapted by Buffett to take account of Berkshire’s ever-increasing size, is almost entirely transparent, and a matter of historical record, not least in the Berkshire shareholders’ letters. Buffett himself acknowledged the perversity in his 1984 Appendix to Graham’s ‘The Intelligent Investor’:

“I can only tell you that the secret has been out for 50 years, ever since Ben Graham and David Dodd wrote ‘Security Analysis’ [and since Ben Graham followed up with ‘The Intelligent Investor’], yet I have seen no trend toward value investing in the 35 years that I’ve practised it. There seems to be some perverse human characteristic that likes to make easy things difficult..

“There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham and Dodd will continue to prosper.”

No, the most striking thing about Benjamin Graham, Warren Buffett, Berkshire Hathaway, and ‘value’ investing is why on earth anybody would want to invest any other way.


No need to say much more than the quotations cited above with regard to the latest non-event from the FTSE 100 index:

  • The new ‘high’ is only a high in nominal terms. As Merryn Somerset Webb points out, UK retail prices have risen by more than 50% since the last ‘high’ 16 years ago.
  • As the FT’s John Authers points out, the UK’s annualised real return of 1.4% since the last ‘high’ severely lags behind the rest of the world (2.1%) and even Spain (3.4%). And as Authers rightly also observes, the composition of the FTSE 100 is itself pretty arbitrary – 100 large companies, with particular concentration in banking and commodities, that just happened to list in the UK.
  • Per Buffett, if you are an ongoing consumer of UK stocks as hamburgers, this is actually bad news. It just means the market is more expensive.
  • If, like us, you have no interest in index-tracking, and are instead looking for compelling value, this is nothing more than a giant, irrelevant yawn. We are far more interested in what Ben Graham called “the ever-present bargain opportunities in individual securities”. Anglophile investors should be aware that there are currently more attractive sources of value in markets outside the UK and US.
  • This ‘news’ clearly appeals to those participants in the financial media for whom relevance to the real world comes secondary to the excitement and entertainment engendered by a good sports story.

The last word should probably to America’s finest news source.

From ‘The Onion’,back in 2000:

Blue Line Jumps 11 Percent

NEW YORK–Excitement swept the financial world Monday, when a blue line jumped more than 11 percent, passing four black horizontal lines as it rose from 367.22 to 408.85.

It was the biggest single-day gain for a blue line since 1994.

“Even if you extend the blue line’s big white box back many vertical lines, you won’t find a comparably large jump,” said Milton Vogel, a senior analyst with Merrill Lynch. “That line just kept going up, up, up.”

The blue line, which had been sluggish ever since the red line started pointing down in April, began its rebound with an impressively pointy 7 percent rise Friday. By noon Monday, it had crossed the second horizontal line from the top for the first time since December.

Ecstatic investors are comparing the blue line to the left side of a very tall, steep blue mountain.

“It’s a really steep line,” said Larry Danziger, a San Jose, CA, day trader and golf enthusiast. “I stand to make a tremendous amount of money as a result of the steepness of this line.”

“It looks like the line’s about to shoot out of the box,” said Boston-area investor Michael Lupert, enjoying a glass of white zinfandel on the bow of his 30-foot yacht. “I’m definitely going to keep a close eye on this line as it continues to move to the right.”

Despite such bullishness, some financial observers are urging caution.

“Given this line’s long history of jaggedness, we really should take a wait-and-see approach,” Fortune magazine associate editor Charles Reames said. “And even if this important line continues its upward pointiness, we must remember that there are other shapes, colors, numbers, and lines to consider when judging the health of the economy.”

Reames also warned that the upward angle of the line, which most analysts agreed was approximately 80 degrees, may have been exaggerated by the way the graph was drawn.

“The stuff that’s written along the bottom of the graph is all squished together, making the line look a lot more impressive than it is,” Reames said. “Had that same stuff been spread out more, the line would have looked a lot less steep.”

Still, most U.S. investors found it hard to contain their enthusiasm as the blue line shot up sharply, outperforming the green line, the yellow line, and even the thriving dotted purple line.

“Typically, the blue line rises or falls no more than 10 in a day,” said Beverly Hills plastic surgeon Dr. Jeffrey Gruber. “But Monday, it went up an astonishing 41–and during a time when we have a big red slice showing on our pie charts, no less. We live in a truly remarkable time.”



Rand Paul Draws Liberal Fire As The Left Discovers Its Inner Love Of The Fed, Part One

The New Republic, in its February 8th issue, carries an article by Danny Vinik entitled Rand Paul Has the Most Dangerous Economic Views of Any 2016 Candidate.  It appears that TNR’s fact checkers decamped along with its top journalists. Vinik:

Speaking in front of more than 150 Iowa activists, Paul ripped into the Federal Reserve and promoted his “Audit the Fed” bill, which he introduced earlier this week. “I think there needs to be some sunshine,” he said, according to reports of the event. …

Paul’s bill …would significantly damage the Fed’s independence, which exists so that politicians cannot influence the central bank for their own political purposes. In other words, “Audit the Fed” would lead legislators to interfere with monetary policy matters and put the entire economy at risk.

Whether or not one supports Audit the Fed, the argument really cannot rest on the Fed’s independence.  Fed independence currently is a polite fiction. As I have cited before:

As journalist Steven Solomon wrote in his indispensable exploration of the Fed, The Confidence Game: How Unelected Central Bankers Are Governing the Changed World Economy (Simon & Schuster, 1995):

“Although they strained to portray themselves as nonthreatening, nonpartisan technician-managers of the status quo, central bankers, like proverbial Supreme Court justices reading election returns, used their acute political antennae to intuit how far they could lean against the popular democratic winds.  “Chairmen of the Federal Reserve,” observes ex-Citibank Chairman Walter Wriston, “have traditionally been the best politicians in Washington.” contributor Dr. Norbert Michel recently published a column here relying on the rather shabby tactic of citing empirical evidence to demonstrate how dubious is the claim of Fed independence.   Michel:

Here are just a few examples (with Fed Chair dates provided):

  • William Martin (1951 – 1970). President Eisenhower directed his Treasury Secretary to put the “utmost pressure” on Chairman Martin to “get a greater money supply throughout the country.”  When Martin refused, Eisenhower pressured him to resign or reconsider.  Martin reconsidered.
  • Arthur Burns (1970 – 1978). President Nixon repeatedly worked with Burns to secure easy monetary policy with the view that it would help win elections.  On one of Nixon’s famous tapes, Nixon and Burns openly mocked the idea of Federal Reserve independence.
  • G. William Miller (1978 – 1979). President Carter found Miller uncooperative, so he replaced him as Fed Chair (he made Miller his Treasury Secretary).
  • Paul Volcker (1979 – 1984). Ronald Reagan openly cultivated a working relationship with Volcker and repeatedly asked him for tighter monetary policy.  Alan Greenspan reports that, in one meeting, Reagan reminded Volcker that the Federal Reserve Act was subject to change.
  • Alan Greenspan (1987 – 2006).  Alan Blinder, appointed to the Fed Board by President Clinton, publicly suggested Greenspan was catering to Clinton.
  • Ben Bernanke (2006 – 2014).  A 2012 New York Fed publication notes: “The U.S. Treasury and the Federal Reserve System have long enjoyed a close relationship…. This relationship proved beneficial during the 2008-09 financial crisis, when the Treasury altered its cash management practices to facilitate the Fed’s dramatic expansion of credit to banks, primary dealers, and foreign central banks.”

Perhaps the Fed’s defenders have some other definition of independence in mind?

The issue of central bank independence from political meddling is a venerable one.  As the New York Fed’s Liberty Street Economics eruditely notes, in a recent column anticipating Valentine’s Day:

John Keyworth, curator of the Bank of England’s museum, has provided on the Bank’s website a full explanation for why the institution is called “The Old Lady of Threadneedle Street.” It stems from an elaborate 1797satirical cartoon created by James Gillray. The author’s words best explain what is going on in the cartoon:

“The cartoon shows the Prime Minister of the day, William Pitt the Younger, pretending to woo an old lady, the personification of the Bank, but what he is really after is the Bank’s reserves, represented by the gold coin in her pocket, and the money-chest on which she is firmly seated.”

Unsurprisingly, this action was seen by the Government’s detractors as outrageous and Sheridan, representing the Whig opposition, described the Bank as ‘an elderly lady in the City who had . . . unfortunately fallen into bad company’.

There is a certain irony. Sen. Paul might be counted as one of the great champions of protection of the Fed from abuse by the political authorities.  It is very probable that Sen. Paul’s motive is to rescue the Fed from having “unfortunately fallen into bad company.” Although the Fed, the Democrats, and leftish economic commentators may dispute his chosen means they may share a common ideal: high integrity monetary policy.

Fed independence from political meddling — which I support  — actually became crippled when Lyndon Johnson, in the wake of the Tet Offensive, closed the London gold pool.  It died when Richard Nixon closed “the gold window” in 1971.  It is after he genuflects to the shibboleth, though, that Vinik really goes off the rails:

But a Paul presidency would still have disastrous effects on the U.S. economy, for other reasons that were on wide display in Iowa on Friday night.

“Once upon a time, your dollar was as good as gold,” he said. “Then for many decades, they said your dollar was backed by the full faith and credit of government. Do you know what it’s backed by now? Used car loans, bad home loans, distressed assets and derivatives.” Paul’s comments make very little sense. When Paul asks what backs the U.S. dollar now, he’s effectively asking what makes it valuable. When the U.S. used a gold standard, it meant that a dollar was worth a certain amount of gold. Economists overwhelmingly agree that that was a terrible idea, but the connection seemed to explain why dollars had value. …

“What Paul and his followers are concerned about is the purchasing power of the dollar. They want to return the U.S. to the gold standard to ensure that inflation doesn’t undermine the actual purchasing power of the dollar. Over the long run, a gold standard would guarantee that price stability. But over the short run, prices would still fluctuate violently, as happened when the U.S. used the gold standard.

“In terms of current policy, goldbugs, as they are often called, think the Fed’s recent decisions—its zero interest rate policy and bond-buying program—will cause skyrocketing inflation and reduce what you can buy with dollars.”

There is so much just factually wrong about this that one hardly knows where to start.

To be continued.


Richard Ebeling, “Introductions to the Selected Works of Ludwig von Mises (2000-12)” Part 3

[Editor’s Note: this lengthy piece, by Richard Ebeling, primarily based on the “lost papers” of Ludwig von Mises that he and his wife, Anna,  discovered in a formerly secret KGB archive in Moscow, Russia, is well worth reading as it shows Mises’s brilliance for understanding the problems of his time as well as purely abstract economics.]

Introduction to Volume 3

Ludwig von Mises: The Man and His Ideas

All except one of the essays in this volume were written by Austrian economist Ludwig von Mises in the four years immediately after his arrival in the United States in the summer of 1940 as a refugee from war-torn Europe. Half of them were delivered as lectures. The others were prepared as monographs on special topics. Their general theme is the problem of international reconstruction and reform in the era succeeding the Second World War.[1]

In the Europe he had left behind, Ludwig von Mises had been one of the most celebrated—and controversial—economists of his time. Over the preceding thirty years, he had acquired an international reputation as one of the leading contributors to the Austrian School of economics and as possibly the foremost critic of the collectivist trends of the early twentieth century. In the 1920s, when the appeal of socialism in its various forms was at its zenith, Mises boldly challenged the feasibility of a fully centralized planned economy. He also questioned the long-term stability of an interventionist or mixed economy as a sustainable “middle way” between a free market system and a socialist, centrally planned economy. And he forcefully argued that only a system of laissez-faire capitalism—of genuine capitalism—could successfully assure freedom and prosperity.

At the same time, he developed his analysis of alternative systems of social and economic order in the wider context of a philosophical and methodological approach that ran counter to the Marxist, positivist, and historicist prejudices of the time. He insisted that social analysis had to have as its starting point a general theory of individual human action and choice. It could not be successfully constructed on the basis of mythical racial, class, or nationalistic aggregates.

An understanding of Mises’s arguments on these subjects, as well as his [ix] work as an influential economic policy analyst in the Austria between the two world wars, is essential if one is to appreciate his ideas on postwar reconstruction and reform. In 1920, Mises published “Economic Calculation in the Socialist Commonwealth,”[2] which he expanded into a comprehensive treatise on Socialism in 1922.[3]In 1927, he published Liberalism,[4] which was followed two years later by Critique of Interventionism.[5] In these important books, he offered a detailed and consistent defense of free-market capitalism in opposition to the regulated economy and socialism.

For Mises, one of the greatest accomplishments of mankind has been the discovery of the higher productivity arising from a division of labor. The classical economists’ analysis of comparative advantage—under which specialization in production increases the quantities, qualities, and varieties of goods available to all participants in the network of exchange—is more than merely a sophisticated demonstration of the mutual gains from trade. As Mises was to later express it, the law of comparative advantage actually is the law of human association: The mutual benefits resulting from specialization of activities constitute the origins of society and the development of civilization.[6]

The rationality of the market economy lies in its ability to allocate the scarce means of production in society for the most efficient satisfaction of consumer wants in a complex system of division of labor—that is, to see to [xi] it that the means at individuals’ disposal are applied to the most highly valued uses, as expressed in the free choices those individuals make in the marketplace. Of course, this requires some method of discovering the alternative uses for which scarce means might be employed and their relative value in their competing uses. Mises explained that competitively determined market prices, in an institutional setting of private ownership over the means of production, provide the only reliable method for solving this problem. On the market for consumer goods, buyers express their valuations for commodities in the form of the prices they are willing to pay. Similarly, on the market for producer goods, entrepreneurs express their appraisals of the relative future profitability of using factors of production in manufacturing various goods through the prices they are willing to pay.

Market prices, expressed through the common denominator of money, are what make economic calculation possible. The relative costs and expected revenues from alternative productive activities are compared and contrasted with ease and efficiency. The competitive processes of the market tend to assure that none of the scarce factors of production is applied for any productive purpose for which there is a more highly valued use (as expressed in a rival entrepreneur’s bid for their hire). The value of the goods desired by consumers is imputed back to the scarce means of production through the competitive rivalry of entrepreneurs. Thus the means available in society are applied to best serve people’s ends.

Mises’s crucial argument against all forms of socialism and interventionism is that they prevent the effective operation of this market process and thus reduce the rationality of the social system. The triumph of socialism—with its nationalization of the means of production under government control and central planning—meant the irrationalization of the economic order. Without market-based prices to supply information about the actual opportunity costs of using those resources (as estimated by the competing market actors themselves) decision-making by socialist central planners is inevitably arbitrary and “irrational.” The socialist economy is, therefore, fundamentally anti-economic.

Interventionism does not abolish the market economy. Instead, it introduces various forms of onerous controls and regulations that deflect production from the paths that would have been followed if entrepreneurs, in the search for profits through the best satisfaction of consumer demand, had been left free to fully follow their own judgments concerning the use and disposal of the factors of production under their control. Price controls, [xii] in particular, distort competitively determined relationships between selling prices and cost prices, resulting in severe misallocations of resources and misdirected production activities.

One other major contribution by Mises during his years in Europe was his pioneering work on monetary theory and policy. Before the first World War he published The Theory of Money and Credit(1912).[7] In this book, he applied the Austrian theory of marginal utility to the problem of explaining the value of money on the basis of individuals’ demands for holding cash balances. He also developed a dynamic sequence analysis, enabling him to explain the process by which changes in the quantity of money bring about redistributions of wealth, relative price changes that modify the allocation of real resources among various sectors of the market, as well as how monetary changes introduced through the banking system can distort interest rates in such a way as to generate business cycles. One of the conclusions that Mises reached in his analysis of monetary processes is that business cycles are not a phenomenon inherent in the market economy. Rather, they are caused by government mismanagement of the monetary and banking system. He later restated and refined his arguments relating to monetary policy in Monetary Stabilization and Cyclical Policy.[8]

A wider theme of Mises’s writings in the period between the world wars is the philosophical and methodological foundations of economic science. In a series of essays written in the 1920s and early 1930s he argued that economics belongs to a more general science of human action, which he came to call “praxeology.” He stated that economics begins with the concept of intentionality and purposefulness, and that this makes economics—and its methods of analysis—different from the approaches followed for the study of the physical sciences. At the same time, the logic of action and choice, which economists take as their starting point for [xiii] analysis of market phenomena, has universal properties and characteristics concerning the human condition from which the general laws of economics can be derived. As a result, Mises strongly opposed the highly popular positivist and historicist ideas of his time. The essays in which he developed these ideas on the methodology of the human sciences were published as a collection in 1933.[9]

Besides his writings on capitalism, socialism, interventionism, and the monetary order, Mises also attempted to influence the course of events in Austria as a policymaker. Beginning in 1909, he was employed in the department of finance at the Vienna Chamber for Commerce, Trade, and Industry as an economic analyst. In this capacity he evaluated and made recommendations about various legislative proposals in the areas of banking, insurance, monetary and foreign-exchange policy, and public finance. In the years between the two world wars, he was a senior secretary with the Chamber, enabling him to argue with some authority on the economic policy issues confronting the Austrian government.[10]

A review of documents and memoranda he prepared for the Vienna Chamber of Commerce during the 1920s and early 1930s shows his consistent emphasis on the desirability of freeing the Austrian economy of high taxes and tariffs, foreign-exchange controls, industrial regulation and price controls, and the excessive power of special interest groups, especially trade unions to control labor markets. The general consensus of economists and others who knew Mises during this period is that he was extremely influential in moderating collectivist and inflationary policies in Austria. For [xiv] example, he was instrumental in preventing the full nationalization of the Austrian economy by a socialist government immediately after the end of the first World War. He successfully helped to redirect public and political opinion to bring the Great Austrian Inflation to an end in 1922. And in the aftermath of this monetary disaster, he played an important role in the writing of the statutes and by-laws of the National Bank of Austria, which was reconstructed under the auspices of the League of Nations in 1923.

Mises’s early activities at the Chamber were interrupted in 1914 when his reserve unit in the Austro-Hungarian army was called up for active service in the first World War. For part of the next four years, he served as an artillery officer on the Russian front. Three times he was decorated for bravery under fire. Following the signing of the Treaty of Brest-Litovsk between imperial Germany and Lenin’s new Bolshevik government that ended the war on the Eastern front in March of 1918, Mises was appointed the officer in charge of currency control in Austrian-occupied Ukraine. His headquarters were in Odessa. Later in the same year he was transferred to duty in Vienna to serve as an economic expert for the Austrian General Staff. In this role he was responsible for preparing memoranda on inflation, war industry, war finance, and related issues. With the end of the war, Mises returned to civilian life. Besides his duties with the Vienna Chamber of Commerce, he was appointed in late 1918 as director of the League of Nations Reparations Commission for the settlement of prewar debts and war claims. He held this position until 1920.

In 1913, Mises had been granted the right to teach at the University of Vienna as a Privatdozent, or unsalaried lecturer; in 1918, he was promoted to the title of Professor Extraordinary. Except during the war, he taught a course at the university almost every semester until 1934, thus influencing a new generation of young Viennese and foreign scholars. He also cofounded and served as vice president of the Austrian Economic Society. In 1920, Mises began a Privatseminar, or private seminar, that normally met twice a month from October to June at his Chamber office. This seminar brought together a group of Viennese scholars in economics, political science, philosophy, sociology, and law, many of whom went on to become world-renowned scholars in their respective fields.[11] Almost [xv] to a man, the participants recalled that the seminar was one of the most rigorous and rewarding experiences of their lives.[12]

One other singularly important activity of Mises during this period was his founding of the Austrian Institute for Business Cycle Research in 1926. With the future Nobel laureate, twenty-seven-year-old Friedrich A. Hayek, as the first director, the Institute was soon internationally recognized as a leading center for economic forecasting and policy analysis in Central Europe.[13] Shortly after it was founded the Institute began to be commissioned by the League of Nations to prepare reports and studies on the economic situation in Central and Eastern Europe. When, in 1931, Hayek accepted an appointment at the London School of Economics, another young Austrian economist, Oskar Morgenstern, assumed the position of Institute director. Morgenstern remained the director until 1938, when Nazi Germany annexed Austria. Mises served as the Institute’s vice president until 1934.

In March of 1934, William E. Rappard, cofounder and director of the Graduate Institute of International Studies in Geneva, Switzerland, wrote to Mises in Vienna inquiring if he would be willing to accept a visiting professorship in international economic relations.[14] Mises accepted the appointment and assumed his responsibilities at the Graduate Institute in October of 1934. Shortly after arriving in Geneva, he began a project he had in mind for many years, namely the writing of a comprehensive treatise on economics. Apart from his light teaching responsibilities (one course and one seminar a semester), most of his time during the next six years was devoted to this project. In May of 1940, as Europe was falling under the dark cloud of Nazi occupation, this monumental work,Nationalökonomie, was published in Switzerland.[15] It served as the basis for his later English-language treatise, Human Action, published in 1949.


In June of 1940, Mises resigned from his position at the Graduate Institute. On July 4, he left Geneva for the United States. After a harrowing journey across France and Spain to Lisbon, Portugal, he embarked on an ocean liner on July 24, and he arrived in New Jersey on August 2, 1940.

Mises’s first years in the United States—the period when the essays in this volume were written—were not easy ones. He experienced great difficulty in finding a permanent teaching position, partly because of his age (he was fifty-nine years old when he arrived) and partly because of the intellectual climate that then prevailed. His was a voice for an older classical liberalism and free-market capitalism that was out of step with the popular trends of socialism, interventionism, and Keynesian economics embraced by a large majority of American academics and policymakers.

However, Mises was supported through research grants generously supplied by the Rockefeller Foundation as well as an affiliation with the National Bureau of Economic Research. He completed two works that were both published in 1944: Omnipotent Government: The Rise of the Total State and Total War[16] and Bureaucracy.[17] A third book, written shortly after his arrival in the United States,Government and Business, remained unpublished until just recently, when it appeared under the titleInterventionism: An Economic Analysis.[18]

Not until 1945 was Mises appointed to an academic post as a visiting professor in the Graduate School of Business at New York University, a position he retained until his retirement in 1969 at the age of eighty-eight. During almost a quarter of a century of teaching in the United States, he was able to train a new American generation of “Austrian” economists.[19] He also published a number of significant books, including [xvii] Planning for Freedom,[20] The Anti-Capitalistic Mentality,[21] Theory and History: An Interpretation of Social and Economic Evolution,[22] The Ultimate Foundation of Economic Science,[23] and The Historical Setting of the Austrian School of Economics.[24]

When Ludwig von Mises died on October 10, 1973, at the age of ninety-two, there is no doubt that he left a profound and lasting legacy as an economic theorist and a champion of liberty.

Economic Nationalism in the Period Between the Two World Wars

The catastrophe of the Second World War was, in Mises’s view, the logical culmination of the political and economic policies of the 1920s and 1930s. Having after 1914 abandoned the principles and practice of economic liberalism and free trade, Europe (and the world in general) had created a political environment in which social conflict within countries and war between nations was almost inevitable.

In a social setting of free-market capitalism, in which governments basically confined themselves to the equal protection of each person to his liberty and property before the law, sectional and national conflicts were practically nonexistent. Directed by the incentives of market opportunities, every individual found his place in the social system of division of labor. Labor, capital, and commodities migrated to those places offering the most attractive returns. Production and employment were localized where market profitability suggested the greatest productive advantage.

Moreover, in such a free-market setting, rivalries between competitors [xviii] were private affairs in which their only weapons were cheaper and better products to capture more consumer business. With governments limited to the protection of life and property, national boundaries were merely administrative lines on maps with no economic significance. Men, money, and goods moved freely and unhindered by politically imposed barriers.

In the generally free-market order before 1914, most of the world’s monetary system was based on a market-based commodity: gold. Though governments through national central banks relegated to themselves control over the money supply, they managed the monetary system by the “rules” of the gold standard. The quantity of money was determined by the profitability of gold mining based on the demand for gold for monetary as well as commercial uses. The purchasing power of money was set by the market forces of supply and demand, and only to a relatively limited extent by the manipulations of governments pursuing various and sundry political goals.

It is always easy to look back at earlier times and to picture them nostalgically as “golden ages” from which the present represents a tragic fall. In fact, however, the period before the first World War possessed many of the characteristics summarized in Mises’s conception of a world of free trade and free markets.[25] It is true that even before the first World War destroyed this epoch of classical liberalism, the world had been returning to policies of governmental intervention and trade restrictions, with imperial Germany in the lead.[26] Nonetheless, the era before 1914 was a world characterized by what Gustav Stolper called the epoch of the “three freedoms”: freedom of movement for men, for goods, and for money.[27] In addition, the world enjoyed an unprecedented level of peace. Conflicts and even wars did occur, but, under the classical liberal ideal of individual freedom, private property, and limited government, wars—especially in Europe—were [xix] few in number, short in duration, and restrained in their damage to life and property.[28]

The First World War ushered in an era of economic planning, price and production controls, foreign-exchange regulations, restrictions on international trade, capital movements, and migration, and a flood of paper-money inflations to cover the costs of war. When the war ended on November 11, 1918, the world had to reconstruct the political and economic landscape. The political map of Europe was radically redrawn, with the German, Austro-Hungarian, and Russian empires carved up to make a tapestry of new and differently shaped nation-states in Central and Eastern Europe. But with the emergence of political nationalism came the rise of economic nationalism.[29] Each of the new successor states imposed tariff barriers and artificially stimulated the creation of greater agricultural or industrial sectors in their economies. These policies were enacted through subsidies, monopoly rights of production and sale, import and export regulations and quotas, tax incentives, foreign exchange controls, and restrictions on the free movement of capital and labor.[30]

Each of these nations of Europe considered that political independence required a corollary: economic independence. The ideal of “autarky” —economic self-sufficiency—increasingly became the basis upon which the governments of these countries judged the appropriateness of any economic policy.[31]Domestic and foreign economic policies by one country became the cause for suspicion and planned counter-policy by its [xx] neighbors. Nor did the countries of Western Europe fully return to the freer policies that prevailed before 1914; they, too, retained various forms of the controls that had been implemented during the war. Consequently, a climate of antagonism, fear, and economic warfare came to dominate the arena of international politics.

Furthermore, whereas the gold standard had formed the basis of the monetary system of virtually all major countries before the first World War, in the postwar era monetary nationalism joined economic nationalism as the new currency order of the world.[32] Under the prewar gold standard, a unit of each nation’s currency was fixed as a certain quantity of gold, exchangeable on demand at that ratio at any representative bank. Through this common gold connection, the national currencies of the world were bound into a unitary and international monetary order.[33]

After the monetary chaos of the immediate postwar period, during which some currencies, like Germany’s, were literally destroyed by hyperinflation, there was an attempt to return to monetary stability and a weaker form of the gold standard.[34] Most governments, however, were unwilling or unable to follow the “rules of the game” required under the gold standard. Money was no longer a market-based medium of exchange through which were facilitated the domestic and global transactions of private trade and investment. Instead, money was increasingly viewed as a tool of national economic policy. Money’s domestic purchasing power and external foreign-exchange value were things to be manipulated by governments to further “national purposes.” With the advent of the Great Depression in 1929, these tendencies merely continued and intensified.[35]

There were half-hearted attempts to restore international trade and [xxi] monetary order in the 1920s and 1930s, but they all failed.[36] The forces of political and economic nationalism, the emerging idea of economic planning, the pragmatic politics of interventionist policies to foster the special interests of domestic groups, and the formal abandonment of the gold standard in favor of purely fiat monies exacerbated the disintegration of the international economic order.[37] In the 1930s, governments increased their subsidies and protectionist supports to industry and agriculture, their interference in the management and control of private enterprise, their monetary and fiscal manipulations to influence domestic output and employment, their taxing policies to modify the distribution of wealth, and their regulation of foreign trade and foreign-exchange rates.[38] The benefits of a free international economic order were forgotten.[39]

With the growth of political and economic nationalism came political [xxii] and economic tyranny. Dictators emerged all across the face of Central and Eastern Europe. Freedom was under attack as never before in modern times.[40] Political and economic nationalism in Europe finally culminated in the barbarism and destruction of World War II.

International Reconstruction and Reform after the Second World War

Even before the worst carnage of the war had occurred, economists, political scientists, historians, sociologists, and men of practical politics had begun to ask themselves how the world had reached such a state of disorganization and chaos and how the era to come after the war could be made better. At first, when the outcome of the war was still uncertain, the analysis often focused on what the alternative international orders might look like were the postwar world to be primarily totalitarian or democratic, or if there were to be a division of the globe between the two rival political systems.[41] As the war progressed, it became clear that the Western democracies would triumph, with fascist and Nazi totalitarianism unconditionally defeated. Accordingly, the world was faced with the serious need to reconstruct the international political and economic order. A general consensus existed, especially among economists, that the world required a reversal of the economic nationalism and protectionism that had plagued the interwar period. There was plenty of evidence that such policies only [xxiii] led to economic disaster and political tension. The postwar world would desperately need the benefits of free trade and the advantages of an international division of labor.

There were some who forcefully called for a revival of classical liberal ideals for domestic and international economic reconstruction and reform.[42] But such voices for a return to pre–World War I classical liberalism were in a small minority. The general view among proponents of a new international economic order was that an unregulated and unplanned market economy was a thing of the past—and would be undesirable even if it were feasible. Under the influence of Keynesian economics and the apparent “advantages” of wartime planning, the majority of economists expected that, in peacetime, governments would still extensively intervene in and regulate the market economy. They asserted with confidence, in the words of Howard Ellis, that “governments have definitely accepted welfare economics as a basic policy; and it is altogether unlikely that any nation will again leave to the vagaries of unregulated international competition the crucial matter of total effective demand for its products and its manpower.”[43] As Charles E. Merriman, a supporter of this new consensus, said: “Planning is coming. Of this there can be no doubt. The only question is whether it will be democratic planning of a free society, or totalitarian in character.”[44]

The ideal was the so-called “middle way” between laissez-faire and a totally planned economy.[45] But a middle way necessarily involved a [xxiv] pre-eminent position for governments in regulating prices and production, and in managing domestic aggregate employment and output and the price level through various monetary and fiscal methods. If a world economic order were to be reconstructed, governments would have to be the overseers and coordinators, meshing their internal plans with any intergovernmental policies for international trade, investment, and exchange-rate stability.[46]

International organizations, therefore, became the vehicle for intergovernmental planning and coordination: the International Monetary Fund, the International Trade Organization, the International Bank for Reconstruction and Development, the World Bank, and numerous agencies surrounding the United Nations.[47] The creation of these organizations involved a radically different ordering of international economic relationships. Before 1914, international trade and investment were mostly private matters of business and commerce, with the leading governments securing the political and legal framework within which private enterprises went about their market-oriented affairs.[48]After the Second World War, the new [xxv] international order was to be based on planned, regulated, and intergovernmentally managed trade.[49]

It is true that, for the first two decades after the end of the Second World War, the Western world experienced a degree of economic prosperity and stability unknown in the period between the world wars.[50] Freer trade was the hallmark of postwar international commerce in comparison to the aggressive economic nationalism of the interwar era. But it was governments, through the international organizations established after the war, that determined the degree and form that trade and investment patterns assumed.[51] Additionally, the apparent stability of foreign-exchange rates and the international monetary order were punctuated with periods of crisis and disorder because of national inflationary policies.

The period following the Second World War was also deeply affected by the protracted tensions and conflicts of the Cold War. Communism and central planning became the new ideals of the emerging Third World countries. Consequently, some feared that freedom and democracy would perish in the ideological contest with Marxism around the globe.[52] Even Western economists looked at the trends of growth in Gross National Product in the United States and the Soviet Union in the 1950s and 1960s and concluded, by extrapolation, that before the end of the century the revolutionary center of communism might very well outstrip the world’s bastion of capitalism in production and standards of living.[53]

The world has turned out differently from what many had either anticipated or feared in the 1960s and 1970s. Notwithstanding the regime in China, communism officially died in 1991 with the collapse of the Soviet Union. The former Soviet-bloc countries are implementing some market-style reforms through privatization. Western and Central Europe [xxvi] are moving toward economic integration. Third World countries have begun turning away from central planning and have entered the epoch of market-oriented industrialization and computerization. But bureaucrats and politicians still manipulate the global marketplace. The welfare state still remains entrenched in the Western world. Through central banks, monetary central planners still control and manipulate the currencies of every country. Economic crises due to governmental mismanagement of monetary, fiscal, and foreign-exchange institutions still erupt. Much of the world still subscribes to the policies of the interventionist state and the mentality of the social engineer.

Mises’s Proposals for International Economic Reconstruction and Reform

In the first five essays in this collection—delivered as lectures at Yale University, New York University, and Columbia University—Ludwig von Mises explored the causes of Europe’s decline into war and destruction in the years between the two world wars, and the general ideological and policy changes that were needed for a return to peace and prosperity in the postwar period. He argued that the reconstruction of the international economic order could be fully successful only if the nations of the world abandoned the ideology of economic nationalism. There could be neither domestic nor international peace as long as governmental policy had as its objective the bestowing of privileges and favors on some at the expense of others. Mises explained that economic nationalism is the foreign policy corollary of internal interventionism for the purpose of bestowing such privileges and favors.

Generally speaking, less efficient producers who are unable to devise ways of meeting the competition of their more efficient rivals in the domestic market turn to the government for protection and financial assistance to maintain their market position and to limit or prohibit the ability of their rivals within the country to compete against them. In the arena of international trade, less efficient producers turn to their respective governments to limit or prohibit foreign rivals from competing in their domestic market. The purpose of economic nationalism is to impose “harm” on foreign producers who otherwise would have profited from better [xxvii] satisfying the wants of consumers than some domestic manufacturers and suppliers.

By politicizing the market rivalries of private producers, international trade becomes one of “affairs of state.” Foreign producers and investors came to be viewed as “enemies” to defeat or take advantage of through political means. The tools of “economic warfare” between countries guided by economic nationalism are tariffs and import quotas, export subsidies, foreign-exchange controls and manipulations, and taxes and regulations on foreign investors. The results, insisted Mises, are international tensions and hostilities that narrow or even destroy the international division of labor. finally, he warned that actual war can grow out of economic nationalism if one of the “combatants” in these trade conflicts believes he is strong enough to defeat an opponent and capture his resources, raw materials, and markets. Mises pointed out that the distinctive feature of economic nationalism in Germany under the Nazis was the German political leadership’s confidence it could use military force to conquer Lebensraum (“living-space”) for the German people—living space in terms of resources, land, markets, and military security in a world in which other nations were also attempting to close off their markets for the exclusive advantage of their own citizens.[54]

Mises was not surprised that in the 1930s collective security had failed to frustrate the territorial ambitions and conquests of Europe’s tyrants. Considering that the various nations of Europe viewed each other as rivals and even “enemies” in the arena of economic warfare, it was unlikely that they could successfully unify their political and military efforts to prevent Nazi, fascist, and Soviet aggrandizement.

Furthermore, as Mises explained, political and economic problems in Central and Eastern Europe contained a distinctive quality not present to the same extent in Western Europe. Almost all the countries in the eastern half of Europe were made up of “mixed” populations of diverse linguistic, religious, and ethnic backgrounds. Interventionist policies in these countries were frequently used as tools for discrimination against minorities. Taxing, regulatory, licensing, and trade policies were often applied as devices to impose economic disadvantages upon some of these national [xxviii] minorities for the economic benefit of more politically influential groups. Social peace within the borders of these nations was impossible as long as economic nationalism was the prevailing ideology.

Antagonisms in Central and Eastern Europe were reinforced by the politics of national self-determination, according to which countries coveted territories belonging to their neighbors on the basis of the idea that all peoples speaking the same language should be unified within the same nation-state. But precisely because linguistic and ethnic groups in this part of Europe were so intermingled within geographic areas, no redrawing of boundaries could successfully separate peoples in such a way that nationalistic tensions could be eliminated or even significantly minimized. The only answer, Mises declared, was a return to the political philosophy of classical liberalism and a consistent free-market capitalism, under which social and economic relationships would be depoliticized.

Mises warned that the end of the Second World War would find Europe economically destroyed. Capital would have been consumed and ill maintained as a result of the war. The infrastructure of the society—roads, bridges, railways, housing—would be ruined or in a state of disrepair. The quantity and quality of the work force would be weakened due to the conflict, lowering the productivity of labor. Agriculture would be less productive. Postwar Europe would be much poorer than before the conflict. In such a setting, Europe would no longer be able to afford the politics of redistribution and the economics of intervention and nationalism.

Work, savings, investment, and capital formation would be essential. A reconstitution and reintegration of Europe within the global division of labor would be imperative. For this to happen, Mises wrote, three changes needed to occur in the European mentality. The first required change concerned the attitude that economic policy was only about achieving short-run goals. Practical politics in the earlier decades of the twentieth century had been geared to providing immediate benefits to various groups that could be satisfied only by undermining the long-run prospects and prosperity of society. In the new postwar era, Mises argued, taxes could no longer be confiscatory. International debts could no longer be repudiated or diluted through currency controls or foreign-exchange rate manipulations. Foreign investors could no longer be viewed as victims to be violated or plundered through regulation or nationalization.

The countries of Europe would have to think about and design their economic policies from a long-term point of view. To avoid reliance solely [xxix] on internal savings, Europe would desperately need infusions of foreign capital. But attracting private foreign investors—which in the postwar period primarily meant private American investors—would require a secure system of property rights, strict enforcement of market contracts for both domestic and foreign businessmen, low and stable taxes, reduced and limited government expenditures and balanced budgets, and a stable, noninflationary monetary system. Only then would governments have done everything in their power to create the political and economic environment most conducive for participants in the market to begin and achieve economic recovery. Consistent with a leading theme expressed in many of his writings, Mises emphasized that the prime movers in the social system of division of labor were the entrepreneurs—the creators and coordinators of the market process—whose central role needed to be appreciated and given unrestricted freedom of action. The ideology of anti-capitalism, therefore, had to be rejected in its entirety.

The second change required of European thinking, Mises wrote, concerned the attitude that politics should be geared toward special interest groups. Earlier in the twentieth century, governments had increasingly used their regulatory and fiscal powers to prevent the market forces of supply and demand (and the market forces of profit and loss) from determining success and failure in the economy. Instead, government interventions had maintained less efficient producers by placing barriers in the way of new and innovative entrepreneurs, by fixing prices at nonmarket-determined levels, and by imposing tariff and other trade walls against foreign competitors. Economic reconstruction required the acceptance that such short-sighted “producer policies” are counter to the economic wellbeing of the society. The essential function of market competition is to continuously discover each participant’s comparative advantage and, therefore, most economically appropriate place in the system of division of labor. Market prices are the mechanism through which the opportunity costs of using resources (including labor) and the relative profitabilities of alternative lines of production are discovered for purposes of assuring the greatest satisfaction of consumer demands.

Mises warned that postwar Europe would be too poor to afford the waste and misuse of its scarce factors of production. The purpose of production is consumption. The use and value of the means has to reflect the importance and value of the ends for which they are applied. This requires a “consumer-oriented” policy in which production would be constantly [xxx] adjusted to actual and changing demand and supply conditions in the market. The only rational policy for reconstruction and rising standards of living, therefore, is unhampered free-market competition.

The third of Mises’s recommendations for a change in European thinking concerned the ethics of the redistributive state. Mises emphasized several times in these first essays that Europe’s problem at the end of the Second World War would be moral and spiritual. The “dependency state” had become the ideal and demand of large segments of the European population. Governments had been expected to be the guarantor of employment and profits, and the provider of income and security. The redistribution of wealth, rather than its creation, had become the hallmark of “progressive economic policy.” But, in truth, he wrote, governments can supply none of these in the long run. Employment and profits arise out of savings, investment, work, and intelligent direction of production to serve consumer demands by market-selected entrepreneurs. Governments can provide and secure income for some only by taxing and redistributing the income and wealth of others. Such redistributive policies weaken incentives, retard the formation of capital, and consume the private wealth accumulated in the past. The inevitable results from such policies are stifled growth and a diminished standard of living.

Europe’s moral and spiritual decay, in the early twentieth century, was due to a declining sense of individual responsibility, a loss of the understanding that the truly “social” requires relationships of peaceful and voluntary cooperation through the market, and a growing illusion that society can long endure in a setting of plunder, confiscation, group conflict, and war. Consequently, Mises wrote, the revival of prosperity and a sustainable future of material and cultural improvement could not be imported from or subsidized by foreign sources. In other words, the economics, politics, and ethics of the free and prosperous society could only come from within each nation—from a change in the minds and ideas of each nation’s citizens.

Government-to-government aid and loans or government-subsidized and government-guaranteed investments to private enterprise would merely perpetuate the interventionist myths of the past that had brought so much misery, poverty, crises, and war. International organizations for intergovernmental cooperation in matters of money, finance, and trade, Mises concluded, are unworkable in the long run if the member governments continue to function on the basis of interventionism and economic nationalism. His reasoning was that each nation would try to use [xxxi] governmentally directed organizations to further its own “interests” at the expense of other countries. If, on the other hand, each nation were to adopt and follow the precepts of classical liberalism and economic liberty in domestic and foreign trade policies, such international organizations would be unnecessary. If the major nations of the world were to practice free trade in both their domestic and foreign affairs, international order would emerge out of the peaceful and mutually beneficial relationships of private transactors in the marketplace. Intergovernmental agreements and international bureaucracies, Mises concluded, are not a substitute for sound policies of economic freedom at home.

The various proposals for intergovernmental monetary coordination during the war years, eventually instituted through the Bretton Woods Agreement and the establishment of the International Monetary Fund and related organizations, were viewed by Mises, therefore, as misplaced solutions to the fundamental problem of international monetary order. His reasons for this view and his alternative proposal are presented in “A Noninflationary Proposal for Postwar Monetary Reconstruction” and “The Main Issues of Present-Day Monetary Controversies.”

The interwar period had seen the demise of an international monetary system. The gold standard that prevailed prior to the first World War had been destroyed by governments wishing to use the printing press to finance their wartime expenditures. The half-hearted attempts to reconstruct the gold standard in the 1920s had been a failure because governments were no longer willing to allow the supply and value of money to remain outside of their direct and discretionary control. Whether to finance current expenditures to satisfy special interest groups or to inflate the general level of prices to influence employment and production in the domestic economy, monetary manipulation was a vital tool in the quest for the attainment of short-run policy goals.

If the world after the Second World War was to once again have a sound monetary system, each country would have to begin the process “at home.” The determinates behind the quantity and value of money would have to be put beyond the immediate reach of governments. Historically, the only monetary regime that had succeeded to any great extent in doing this was the gold standard. Therefore, Mises proposed a return to a gold standard.

The first step toward a sound monetary system for any country, Mises argued, would be to balance the government’s budget, so that the pressure to increase the money supply to cover current expenditures would [xxxii] be relieved. The second step would be the adoption of a 100 percent gold reserve system. The existing money supply would be frozen, and any additions to the supply of money in the form of currency or bank demand deposits would occur only through a new deposit of a sum of gold. The ratio of currency or bank deposit money to be issued on the basis of a new gold deposit would be temporarily set by the market price between dollars and gold plus a margin of 10 percent. The third step, instituted at the same time as the second, would be the abolition of all restrictions on a free market for gold and foreign-exchange dealings. The fourth and final step would occur after a period of time during which foreign-exchange markets would have established a fairly stable rate of exchange between, for example, dollars and gold. At that point, a new gold parity for the dollar would be legally fixed between gold and the total quantity of currency and bank deposit money in the U. S. economy. After that, dollars would be fully redeemable on demand in gold. Currency and deposit money would be fully backed, dollar for dollar, with a sum of gold held as a 100 percent reserve at currency-issuing and deposit-issuing institutions.

Mises was not unique or alone in proposing a 100 percent reserve banking system. In the 1930s, a number of economists proposed such an institutional change.[55] However, these proponents advocated a 100 percent fiat money system managed and controlled by the government. The government would have the task of consciously changing the total quantity of money in circulation to maintain a particular policy target—usually price-level stabilization. Mises’s proposal, in contrast, had the precise goal of removing government from the monetary process except for the initial role in establishing the monetary “rules of the game”: a 100 percent gold reserve requirement on all banking institutions, redemption of all currency and deposits by those institutions on demand at the specified gold parity, and a free foreign-exchange market on the basis of the gold [xxxiii] standard. The quantity of money and its value (or purchasing power) over goods would be determined by the market forces of supply and demand, not by government.[56] Mises’s reasoning was that government simply could not be trusted with control over a monopoly printing press. Furthermore, as these two essays demonstrate, he did not believe that it was in government’s power or ability to successfully manage the monetary system or stabilize any “targets” such as the general price level. Mises’s ultimate ideal for a monetary order most consistent with a free society was for a system of free banking based on a market-selected commodity like gold. But he considered the establishment of this ideal system to be possible only far off in the future, when there would have been a complete renunciation of socialist and interventionist ideas.[57]

Mises knew that a sound monetary system did not require international agreements or intergovernmental monetary organizations. Any country could adopt such a gold-based monetary order independent of what other nations might do. If international agreements attempted to restrain member countries from following inflationary paths in an ideological environment in which national governments had the desire to continue abusing their monetary powers, the result would be tensions, conflicts, crises, and a final collapse of the intergovernmental monetary system. The disintegration in 1971 of the Bretton Woods system of fixed exchange rates under a system of national currencies open to governmental manipulation strongly suggests that Mises was correct in his judgments.

The one essay in this collection written by Mises before his arrival in the United States is “A Draft of Guidelines for the Reconstruction of Austria.” It was prepared in May of 1940 for Otto von Habsburg, former archduke of Austria, shortly before Mises’s departure from Geneva. It diagnoses the reasons for Austria’s political and economic problems in the 1920s and 1930s and presents the reforms and policy changes that would have to be implemented for Austria’s rebirth and revival as a prosperous and [xxxiv] independent nation in the postwar period. Because Austria is a small country with various economic disadvantages in comparison with other, larger nations better endowed with resources and fertile land, Mises recommended that the country adapt to the international trade environment. Austria should find its place in the global system of division of labor and acquire through imports the food, raw materials, and capital it needed from other countries by exporting those industrial goods for which it had a comparative advantage.

But, Mises asked, given the inevitable state of postwar poverty under which Austrians would be living, how would the incentives be created to begin the process of economic recovery? The answer is that domestic regulations would have to be abolished, labor markets would have to be freed from trade-union domination and control, government expenditures and redistributionist policies would have to be drastically cut back, nationalized industries would have to be privatized, Austrian businessmen driven from their homeland by anti-Semitism and Nazi policies would have to be invited back and made welcome in their own country, the multiple levels of bureaucratic administration throughout the country would have to be reduced and streamlined, the monetary system would have to be based on gold, and international economic relations would have to be guided by the idea of free trade. The only permissible trade restrictions would be retaliatory tariffs against specific countries that might discriminate against or prohibit Austrian goods from being sold in their markets.

Crucial to Austrian recovery and reconstruction, Mises wrote, would be fiscal policy. The fostering of savings, investment, and capital formation would be imperative. He proposed the end of all direct income taxation. Instead, the primary sources of all government revenues would be, first, general consumption taxes, including: (a) excise taxes on alcoholic beverages and tobacco products, (b) sales taxes, but only on final goods sold to the consuming public, and (c) a playing-card stamp tax. Second, there should be wealth taxes on consumption, including: (a) a progressive tax on higher consumption levels, based on housing expenditures (excluding those in the lower-income housing categories), (b) a tax on ownership of higher-priced automobiles for private use, and (c) a tax on lottery winnings. Third, there should be business and employment taxes, including: (a) a moderate tax on net profits paid out to shareholders of corporations and partners in limited partnerships, when the annual disbursements exceed six percent of capital assets, (b) administrative fees for patent rights, registration of brand names, and other official stamps, and (c) a wage tax [xxxv] paid by employers to cover social insurance programs, but which would not be deducted from wages. Mises stressed that, except for the wage tax and the net profits tax, all earnings would be exempt from direct taxation. This would create the fewest disincentives to income and wealth creation.

Such, he concluded, is the path to economic recovery for a small country like Austria. But Mises pointed out there were problems unique to Central and Eastern Europe because of their mixed populations of numerous linguistic, ethnic, and religious groups. The essay “An Eastern European Democratic Union: A Proposal for the Establishment of a Durable Peace in Eastern Europe” is Mises’s suggestion for solving these problems in a world still in the grip of political and economic nationalism.

In two of his earlier works, Nation, State, and Economy[58] and Liberalism,[59] Mises dealt extensively with the problem of nationality and national self-determination. He emphasized that among the principles of classical liberalism is the right of self-determination and freedom of association. In classical liberal thought, this means the self-determination of the individual. Each individual has, in principle, the right to decide of which political entity he will be a member. But, because of administrative constraints, the practical meaning of this principle is that the citizens within districts and regions, and even towns and villages, should have the right of plebiscite to express their preference to remain part of the nation-state to which they presently belong, to join some other nation-state, or to form a new state of their own.

Unfortunately, during the nineteenth and twentieth centuries this idea had been distorted to mean “national self-determination,” that is, that all peoples belonging to the same linguistic or ethnic group should belong to the same nation-state, regardless of the actual wishes of the individual residents within a geographical area. This idea of national self-determination has been the cause of many of the tensions, antagonisms, and conflicts within and between nations in Europe. And it served as the rationale for Hitler’s insistence on the annexation of parts of countries adjoining Nazi Germany that contained German-speaking peoples.[60]


Mises noted that the problem of nationalist antagonisms is exacerbated in an ideological setting of interventionism. Governments become the tools for linguistic and ethnic groups seeking to use the power of the state for their own benefit through discriminatory laws and policies against others. The only way to protect against such a political environment is to create a vast political and economic union. Mises proposed such a union for all the countries of Eastern Europe from the Baltic Sea to the Aegean Sea, including Estonia, Latvia, Lithuania, Poland, Czechoslovakia, Austria, Hungary, Romania, Yugoslavia, Bulgaria, Albania, Greece, and the part of Germany east of the Oder-Neisse Rivers. Only such a union, Mises reasoned, would have the combined strength to repel military aggression against these countries by either Germany or Russia. More important, such a union would diminish the ability of the member governments to use their domestic power to discriminate against national minorities and threaten war on their neighbors in the name of political or economic nationalism.

Mises proposed that political authority and legislative power would be reserved to a single parliamentary chamber that would have the only power to tax and upon which the member states would be dependent for disbursement of funds for administrative expenditures. The member states would retain their flags, symbols, anthems, and even embossed coins and stamps, but they would no longer have the power to pass legislation or impose laws that could infringe on a regime of private property and free trade within their jurisdictions and between the member states. Discriminatory laws against linguistic, ethnic, or religious groups would be forbidden. There would be for all citizens the freedom to move, live, and work within the boundaries of the union, and the same rights would apply to foreigners who chose to live, work, and invest in any part of this Eastern European Union.

In Mises’s view, under such a regime of free markets and free trade, no individual would or could be abused by national political power. All persons would be free to pursue the trade, profession, and occupation of their choice without political restraint and to speak and educate their children in the language and customs of their own choice. Schools would be primarily private and eligible for receiving lump-sum per-pupil tax revenues [xxxvii] as long as they were in compliance with certain basic rules and standards specified by the central government of the union.

Mises was not so naive as to expect to see the immediate acceptance and establishment of a broad political and economic union along the lines he recommended. But he believed that movement toward this goal was the only way to introduce restrictions on the interventionist power of national governments. And, indeed, the only rationale for such a union was to bring about the implementation of the ideals of the free market and free trade. Unless a union were constituted for this purpose, its existence would be impossible to justify.

Under the sponsorship of the School of Economics at the National University of Mexico, Mises spent January and February of 1942 lecturing in Mexico City and other Mexican cities. In June of 1943 he prepared for an association of Mexican businessmen a detailed report, “Mexico’s Economic Problems,” in which he recommended policies that would most likely assist in fostering Mexican economic development and industrialization.[61]

In this report, Mises maintained that the war-related trading opportunities that Mexico was enjoying with the United States were likely to end with the cessation of the conflict. Mexico, therefore, must look forward to an agenda of postwar market-oriented reforms for further economic improvement. Free trade is essential to the country’s future, he wrote, and in this context he emphasized that the benefit from trade comes from the imports obtainable at prices less costly than those incurred by alternative domestic production. Exports are the means for acquiring those imports and not an end or a good in themselves.

Anticipating one of the major schemes proposed by postwar development planners, Mises strongly criticized what he labeled the “closed door method of industrialization,” which became more widely known and popular in Third World countries after 1945 as the “import-substitution method” for development. According to this method, industrialization is to be forced through trade restrictions and high tariff barriers behind which domestic industries will be stimulated at artificially high prices far above those in the general global market. He pointed out that countries implementing this method inevitably make their own people poorer and less productive.


To the extent that imports are reduced so, too, Mises wrote, are exports. Potential foreign buyers of Mexican goods would lose the means of earning the Mexican revenue that would have provided them with the financial wherewithal to purchase Mexican exports. This would bring about a misdirection of Mexican production inconsistent with a most efficient use of the country’s resources. Mexico would be locked out from maximizing the income it could earn from exporting those goods for which it had the greatest comparative advantage in the international market. And consumers would have to pay the cost of such a method of “hothouse” industrialization through a lower standard of living due to the higher prices and lower quality of the domestic substitutes they would be forced to purchase on the Mexican market. Import-substitution methods of economic development merely represent a modern version of the eighteenth-century mercantilist fallacies.

Equally disastrous for Mexican development would be any attempt to raise Mexican wages to comparable United States levels through either government legislation or trade-union pressure. Mexico in the 1940s, Mises added, was a capital-poor country with a relatively large supply of labor. This necessarily meant that labor productivity was far lower than that of American workers. The only way that Mexican labor could compete with American labor and other competitors in the global market would be to take advantage of those opportunities in which it could be a lower-cost producer in labor-intensive lines of production. The standard of living in Mexico could permanently rise only through the normal processes of market-directed capital formation over time and through migration of a part of the labor force to other countries where wages and the marginal productivity of labor were higher. Since the latter method was generally closed off, due to immigration barriers in the United States and other countries, only the former method was available to Mexico under prevailing international conditions, Mises reasoned. Raising wages above market-determined levels could only condemn a part of the Mexican labor force to permanent unemployment or more primitive lines of employment.

Since Mexico had long practiced protectionist, interventionist, and socialist policies, the country would have to make a transition to a regime of free markets and free trade. Those familiar with Mises’s apparently “intransigent” and “dogmatic” advocacy of laissez-faire economics may be surprised that he proposed a series of “gradualist” policies for Mexico. For example, because a number of industries had been long protected behind high tariff walls, Mises suggested a transition to free trade over a period of [xxxix] years during which tariff levels would be reduced by 10 percent a year. (In this, Mises merely followed in the tradition of many of the earlier classical economists who also called for a gradual shift to free trade so as to minimize the severity of the economic adjustment.)[62]

While generally critical of government-sponsored and supported cooperative movements,[63] Mises argued that full land privatization in Mexico should be supported for the poor peasantry through government assistance in forming farm-producer cooperatives and even limited but temporary state subsidies to help them get started. In the area of privatization, Mises argued that the most desirable course of action was full denationalization. But, given the ideological climate in Mexico, Mises proposed that the national railway system, for instance, be transformed into a government-owned but independent corporation; management of the rail system would operate on a for-profit basis.

Crucial and central to any economic reform project in a country such as Mexico, Mises again emphasized, would be the establishment and the strict enforcement of property rights and contract, for both Mexican and foreign investors alike. Inflationary monetary policies would have to be renounced, and a policy of free trade would have to be practiced.


Ludwig von Mises’s purpose in preparing the lectures and writing the monographs included in this volume was to restate fundamental truths at a time when many of the most important premises of sound economic thinking seemed to have been forgotten or rejected. He realized that in a world dominated by socialist and interventionist ideas this was often a thankless task. But he believed that no real change for the better was possible unless the truth was spoken.

Mises was determined to explain why, after the Second World War, economic liberty was both desirable and essential if the world was to avoid the mistakes of the past. Yet he was aware that ways had to be found to [xl] encourage a rebirth of the ideal and practice of market freedom. The first task was to explain how the world had arrived in its present state and why previous ideologies and policies had led to disaster. Next, the logic and benefits of the free-market order had to be articulated once again. finally, specific policies had to be formulated to begin the process of international reconstruction and reform.

Today the world is searching for a new international economic order, just as it was searching for one in the mid–1940s. The former communist bloc countries, including the former Soviet Union, are groping with varying degrees of success toward the establishment of a market order and democratic political regimes. The countries of Asia, Africa, and Latin America are trying to escape from socialist and neo-mercantilist experiments of previous decades. The Western industrial democracies are looking for ways to overcome the burdens of the welfare state and the regulated economy.

The world at the third millennium abounds with proposals for economic and monetary unions, international trading agreements and intergovernmental rules for investment and capital movements. But what is lacking in many, if not most, of these proposals is a clear statement of first principles and a clear conception of where any particular policies implemented should be leading in terms of a long-run vision of the free and prosperous society. Many in the public arena praise and endorse the idea of a global free-market order. But beneath the rhetoric of some alleged free-market proponents are variations on the old interventionist theme. These proponents are merely proposing islands of market activity in an ocean of regulations, controls, and political redistributions of wealth.

This is not the meaning of the free market as it was understood by Ludwig von Mises.[64] He chose to call things by their real names and explain them in terms of their real meanings. Anything less, he believed, would be a betrayal of truth and understanding. It is perhaps appropriate, therefore, to conclude by recurring to Mises’s own thoughts on this point, which ended his lecture on “The Fundamental Principle of Pan-European Union”:

It is a thankless job indeed to express such radical and “subversive” [free-market] opinions and to incur the hatred of all supporters of the old [interventionist] system that has amply proven its inexpediency. But it is not the duty of an economist to be fashionable and popular; he has to be right. Those timid souls who fear challenging spurious doctrines and superstitions because they have the support of influential circles will never improve conditions. Let them call us “orthodox”; it is better to be an intransigent orthodox than an opportunist time-server.

Endnotes to Volume 3

[1.] Two other previously unpublished papers from 1943 by Mises on the related topics of “Autarky and Its Consequences” and “Economic Nationalism and Peaceful Economic Cooperation” were included in an earlier collection; see Richard M. Ebeling, ed., Money, Method, and the Market Process: Essays by Ludwig von Mises (Norwell, Mass.: Kluwer Academic Press, 1990), pp. 137–65.

[2.] Ludwig von Mises, “Economic Calculation in the Socialist Commonwealth,” [1920] in F. A. Hayek, ed., Collectivist Economic Planning (London: Routledge & Sons, 1935), pp. 87–130.

[3.] Ludwig von Mises, Socialism (Indianapolis: Liberty Fund, [1951] 1981); on Mises’s critique of socialism and its relation to earlier criticisms of central planning, see Richard M. Ebeling, “Economic Calculation under Socialism: Ludwig von Mises and His Predecessors,” in Jeffrey M. Herbener, ed., The Meaning of Ludwig von Mises (Norwell, Mass.: Kluwer Academic Press, 1993), pp. 56–101.

[4.] Ludwig von Mises, Liberalism in the Classical Tradition (Irvington-on-Hudson, N.Y., and San Francisco, Calif.: Foundation for Economic Education and the Cobden Press, [1927] 1985).

[5.] Ludwig von Mises, Critique of Interventionism (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, [1929] 1996).

[6.] Ludwig von Mises, Socialism, pp. 258–61; Human Action, A Treatise on Economics (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 4th rev. ed., 1996), pp. 157–66.

[7.] Ludwig von Mises, The Theory of Money and Credit (Indianapolis: Liberty Fund, 3rd revised ed., [1924; 1953] 1980).

[8.] Ludwig von Mises, “Monetary Stabilization and Cyclical Policy,” [1928] in Percy L. Greaves, ed., On the Manipulation of Money and Credit (Dobbs Ferry, N.Y.: Free Market Books, 1978); see Richard M. Ebeling, “Ludwig von Mises and the Gold Standard,” in Llewellyn H. Rockwell, Jr., ed., The Gold Standard: An Austrian Perspective (Lexington, Mass.: Lexington Books, 1983), pp. 35–59; and Richard M. Ebeling, “Variations on the Demand for Money Theme: Ludwig von Mises and Some Twentieth Century Views,” in John W. Robbins and Mark Spangler, eds., A Man of Principle: Essays in Honor of Hans F. Sennholz (Grove City, Pa.: Grove City College Press, 1992), pp. 127–38.

[9.] Ludwig von Mises, Epistemological Problems of Economics (New York: New York University Press, [1933] 1976); for an exposition and analysis of Mises’s ideas on the logic of human action and his comparative study of capitalism, socialism, and interventionism, see Richard M. Ebeling, “A Rational Economist in an Irrational Age: Ludwig von Mises,” in Richard M. Ebeling, ed., The Age of Economists: From Adam Smith to Milton Friedman, Champions of Freedom Series, Vol. 26 (Hillsdale, Mich.: Hillsdale College Press, 1999), pp. 69–120; Mises’s theory of human action was influenced by the phenomenological method of Edmund Husserl and the sociological approach of Max Weber; see Richard M. Ebeling, “Austrian Subjectivism and Phenomenological Foundations,” in Peter J. Boettke and Mario J. Rizzo, eds., Advances in Austrian Economics, Vol. 2A (Greenwich, Conn.: JAI Press, 1995), pp. 39–53; and Richard M. Ebeling, “Expectations and Expectations Formation in Mises’ Theory of the Market Process,” in Peter J. Boettke and David L. Prychitko, eds., The Market Process: Essays in Contemporary Austrian Economics (Brookfield, Vt.: Edward Elgar, 1994), pp. 83–95.

[10.] Ludwig von Mises, Notes and Recollections (South Holland, Ill.: Libertarian Press, 1978), pp. 71–92.

[11.] Mises, Notes and Recollections, pp. 93–100.

[12.] For recollections of Mises’s Privatseminar by former members, see the appendix in Margit von Mises, My Years with Ludwig von Mises (Cedar Falls, Iowa: Center for Futures Education, 2nd ed., 1984), pp. 199–211; see also Earlene Craver, “The Emigration of the Austrian Economists,” History of Political Economy, Vol. 18, No. 1 (1986), pp. 1–32.

[13.] See Richard M. Ebeling, “Friedrich A. Hayek: A Centenary Appreciation,” The Freeman (May 1999), pp. 28–33.

[14.] See Richard M. Ebeling, “William E. Rappard: An International Man in an Age of Nationalism,”The Freeman (January 2000), pp. 39–46.

[15.] Ludwig von Mises, Nationalökonomie: Theorie des Handelns und Wirtschaftens (Munich: Philosophia Verlag, [1940] 1980).

[16.] Ludwig von Mises, Omnipotent Government: The Rise of the Total State and Total War (Spring Mills, Pa.: Libertarian Press, [1944] 1985).

[17.] Ludwig von Mises, Bureaucracy (Spring Mills, Pa.: Libertarian Press, [1944] 1983).

[18.] Ludwig von Mises, Interventionism: An Economic Analysis (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1998).

[19.] On the history and ideas of the Austrian School of economics, see Ludwig M. Lachmann, “The Significance of the Austrian School of Economics in the History of Ideas,” [1966] in Richard M. Ebeling, ed., Austrian Economics: A Reader, Champions of Freedom Series, Vol. 18 (Hillsdale, Mich.: Hillsdale College Press, 1991), pp. 17–39; and Richard M. Ebeling, “The Significance of Austrian Economics in Twentieth-Century Economic Thought,” in Richard M. Ebeling, ed., Austrian Economics: Perspectives on the Past and Prospects for the Future, Champions of Freedom Series, Vol. 17 (Hillsdale, Mich.: Hillsdale College Press, 1991), pp. 1–40.

[20.] Ludwig von Mises, Planning for Freedom (South Holland, Ill.: Libertarian Press, 4th ed., 1980).

[21.] Ludwig von Mises, The Anti-Capitalistic Mentality (Spring Mills, Pa.: Libertarian Press, [1956] 1990).

[22.] Ludwig von Mises, Theory and History: An Interpretation of Social and Economic Evolution(Auburn, Ala.: Ludwig von Mises Institute, [1957] 1985).

[23.] Ludwig von Mises, The Ultimate Foundation of Economic Science: An Essay on Method (Kansas City, Kans.: Sheed Andrews and McMeel, [1962] 1978).

[24.] Ludwig von Mises, “The Historical Setting of the Austrian School of Economics,” [1969] in Bettina Bien Greaves, ed., Austrian Economics: An Anthology (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1996), pp. 53–76.

[25.] See Mises, Omnipotent Government, pp. 95–96; also John Maynard Keynes, The Economic Consequences of the Peace, in D. E. Moggridge, ed., The Collected Works of John Maynard Keynes(New York: Macmillan Co., [1919] 1971), pp. 5–7

[26.] See Hermann Levy, Economic Liberalism (London: Macmillan Ltd., 1913), p. 1; Wilhelm Röpke,German Commercial Policy (London: Longman, Green and Co., 1934); and Gustav Stolper, German Economy, 1870–1940 (New York: Reynal and Hitchcock, 1940), pp. 60–92.

[27.] Gustav Stolper, This Age of Fable: The Political and Economic World We Live In (New York: Reynal & Hitchcock, 1942), pp. 7–8.

[28.] See Richard M. Ebeling, “World Peace, International Order and Classical Liberalism,”International Journal of World Peace (December 1995), pp. 47–68.

[29.] See T. E. Gregory, “Economic Nationalism,” International Affairs (May 1931), pp. 289–306; Lionel Robbins, “The Economic Consequences of Economic Nationalism,” Lloyds Bank Limited Monthly Review (May 1936), pp. 226–39; William E. Rappard, “Economic Nationalism,” in Authority and the Individual, Harvard Tercentenary Conference of Arts and Sciences (Cambridge, Mass.: Harvard University Press, 1937), pp. 74–112; Michael A. Heilperin, Studies in Economic Nationalism(Geneva: Libraire E. Droz, 1962).

[30.] See Leo Pasvolsky, Economic Nationalism of the Danubian States (New York: Macmillan Co., 1928); Antonin Basch, The Danubian Basin and the German Economic Sphere (New York: Columbia University Press, 1943); Frederick Hertz, The Economic Problems of the Danubian States: A Study in Economic Nationalism (London: Victor Gollancz, 1947).

[31.] See A. G. B. Fisher, Economic Self-Sufficiency (Oxford: Clarendon Press, 1939); and Leo Grebler, “Self-Sufficiency and Imperialism,” Annals of the American Academy of Political and Social Science(July 1938), pp. 1–8.

[32.] See F. A. Hayek, “Monetary Nationalism and International Stability” [1937] in Stephen Kresge, ed., The Collected Works of F. A. Hayek, Vol. VI: Good Money, Part II (Chicago: University of Chicago Press, 1999), pp. 27–100; and Lionel Robbins, Economic Planning and International Order (London: Macmillan Ltd., 1937), pp. 280–301.

[33.] See Wilhelm Röpke, International Order and Economic Integration (Dordrecht, Holland: D. Reidel Publishing Co., 1959), pp. 75–77; also T. E. Gregory, The Gold Standard and Its Future (New York: E. P. Dutton, 1935), pp. 1–21; and Moritz J. Bonn, “The Gold Standard in International Relations,” in William E. Rappard, ed., Problems of Peace, 8th Series (Freeport, N.Y.: Books for Libraries, [1934] 1968), pp. 163–79.

[34.] See Leland B. Yeager, Experiences with Stopping Inflation (Washington, D.C.: American Enterprise Institute, 1981), pp. 45–98.

[35.] See Frederic Benham, “The Muddle of the Thirties,” Economica (February 1945), pp. 1–9.

[36.] See William E. Rappard, Post-War Efforts for Freer Trade (Geneva: Geneva Research Centre, 1938) and “The Common Menace of Economic and Military Armaments,” [1936] in Varia Politica,Republication of Essays by William Rappard on the Occasion of His Seventieth Birthday (Zurich: Editions Polygraphics, 1953), pp. 76–100; Jacob Viner, “International Economic Relations and the World Order,” in Walter H. C. Laves, ed., The Foundations of a More Stable World Order (Chicago: University of Chicago Press, 1940), pp. 42–45; Commercial Policy in the Interwar Period: International Proposals and National Policies (Geneva: League of Nations, 1942); and Ragnar Nurkse,International Currency Experience: Lessons of the Inter-war Period (Princeton, N.J.: Princeton University Press, 1944).

[37.] See Ludwig von Mises, “The Disintegration of the International Division of Labor,” [1938] in Richard M. Ebeling, ed., Money, Method, and the Market Process, pp. 113–36; and Wilhelm Röpke,International Economic Disintegration (Philadelphia, Pa.: Porcupine Press, [1942] 1978).

[38.] See Moritz J. Bonn, “Introductory Address,” in The State and Economic Life, A Record of a First International Study Conference (Paris: International Institute of Intellectual Cooperation, 1932), pp. 7–15; J. B. Condliffe, “Vanishing World Trade,” Foreign Affairs (July 1933), pp. 645–56; Lionel Robbins, The Great Depression (London: Macmillan Ltd., 1934); Gustav Stolper, “Politics versus Economics,” Foreign Affairs (April 1934), pp. 357–76; P. W. Martin, “The Present Status of Economic Planning: I. An International Survey of Governmental Economic Intervention,” International Labour Review (May 1936), pp. 619– 45; Henry J. Tosca, World Trade Systems (Paris: International Institute of Intellectual Cooperation, 1939); Margaret S. Gordon, Barriers to World Trade: A Study of Recent Commercial Policy (New York: Macmillan Co., 1941); and Richard M. Ebeling, “Liberalism and Collectivism in the 20th Century,” in Alexsandras Shtromas, ed., The End of “Isms”? Reflections on the Fate of Ideological Politics After Communism’s Collapse (Cambridge, Mass.: Blackwell Publishers, 1994), pp. 69–84.

[39.] See J. B. Condliffe, “The Value of International Trade,” Economica (May 1938), pp. 123–37.

[40.] William E. Rappard, “Nationalism and the League of Nations Today,” in Problems of Peace, 8th Series (New York: Books for Libraries Press, [1934] 1968), pp. 17–19; also by Rappard, The Crisis of Democracy (Chicago: University of Chicago Press, 1938); and William Henry Chamberlin,Collectivism: A False Utopia (New York: Macmillan Co., 1938).

[41.] See J. B. Condliffe, The Reconstruction of World Trade: A Survey of International Economic Relations (New York: W. W. Norton & Co., 1940); Michael A. Heilperin, “Totalitarian Trade,” World Affairs Interpreter (January 1941), pp. 1–8; Lewis L. Lorwin, Economic Consequences of the Second World War (New York: Random House, 1941); Douglas Miller, You Can’t Do Business with Hitler(Boston: Little, Brown and Co., 1941); Thomas Reveille, The Spoil of Europe: The Nazi Technique in Political and Economic Conquest (New York: W. W. Norton, 1941); Howard Ellis, “The Problems of Exchange Systems in the Postwar World,” American Economic Review (May 1942), pp. 195–205; Frank Munk, The Legacy of Nazism: The Economic and Social Consequences of Totalitarianism (New York: Macmillan Co., 1943); and Jacob Viner, Trade Relations Between Free Market and Controlled Economies (Geneva: League of Nations, 1943).

[42.] See Henry Simons, “Trade and the Peace,” in Seymour E. Harris, ed., Postwar Economic Problems (New York: McGraw-Hill Book Co., 1943), pp. 141–55; also Benjamin M. Anderson, “The Road Back to Full Employment,” in Paul T. Homan and Fritz Machlup, eds., Financing American Prosperity: A Symposium of Economists (New York: Twentieth Century Fund, 1945), pp. 9–70.

[43.] Howard Ellis, “Removal of Restrictions on Trade and Capital,” in Seymour Harris, ed., Postwar Economic Problems, p. 345; see also Richard M. Ebeling, “The Global Economy and Classical Liberalism: Past, Present, and Future,” in Richard M. Ebeling, ed., The Future of American Business, Champions of Freedom Series, Vol. 24 (Hillsdale, Mich.: Hills-dale College Press, 1996), pp. 9–60, especially pp. 18–23, on the relationship between domestic intervention and “demand management,” and regulation of international trade.

[44.] Charles E. Merriam, “The Place of Planning,” in Seymour E. Harris, ed., Saving American Capitalism: A Liberal Economic Program (New York: Alfred A. Knopf, 1948), p. 161

[45.] See Eugene Staley, World Economy in Transition: Technology vs. Politics, Laissez Faire vs. Planning, Power vs. Welfare (Port Washington, N.Y.: Kennikat Press, [1939] 1971), pp. 127–200 and 225–326, and “The Economic Side of Stable Peace,” Annals of the American Academy of Political and Social Science (July 1945), pp. 27–36; and J. B. Condliffe, Agenda for a Postwar World (New York: W. W. Norton, 1942).

[46.] See Jacob Viner, “The International Economic Organization of the Future,” in Ernest H. Wilkins, ed., Toward International Organization (New York: Harper & Brothers, 1942) and “International Economic Cooperation,” in William B. Willcox and Robert B. Hall, eds., The United States in the Postwar World (Ann Arbor, Mich.: University of Michigan Press, 1947), pp. 15–36; also J. B. Condliffe and A. Stevenson, The Common Interest in International Economic Organization (Montreal: International Labor Organization, 1944).

[47.] See H. W. Arndt, The Economic Lessons of the Nineteen-Thirties (London: Oxford University Press, 1944), pp. 295–302; Murray Shields, ed., International Financial Stabilization: A Symposium(New York: Irving Trust Co., 1944); Michael A. Heilperin, International Monetary Organization: The Bretton Woods Agreements (Washington, D.C.: American Enterprise Association, 1945); Nathaniel Weyl and Max J. Wasserman, “The International Bank, An Instrument of World Economic Reconstruction,” American Economic Review (March 1947), pp. 93–107; Raymond F. Mikesell, “Quantitative and Exchange Restrictions under the ITO Charter,” American Economic Review (June 1947), pp. 351–68; Philip Cortney, The Economic Munich: The I.T.O. Charter, Inflation or Liberty, The 1929 Lesson (New York: Philosophical Library, 1949); Henry Hazlitt, From Bretton Woods to World Inflation: A Study of Causes and Consequences (Chicago: Regnery Gateway, 1984)

[48.] However, on the extent to which governments did attempt to influence for political or economic reasons the private patterns of foreign loans and investments in the nineteenth and early twentieth centuries, see Jacob Viner, “Political Aspects of International finance,” Journal of Business (April and July 1928), pp. 141–73 and 324–63.

[49.] Henry Hazlitt, “The Coming Economic World Pattern,” [1944–45] in From Bretton Woods to World Inflation: A Study of Causes and Consequences, pp. 127–42.

[50.] See Gottfried Haberler, “The Liberal International Economic Order in Historical Perspective,” [1979] in Anthony Y. C. Koo, ed., The Liberal Economic Order, Vol. I (Brookfield, Vt.: Edward Elgar, 1993), pp. 354–55; and Jagdish Bhagwati, Protectionism (Cambridge, Mass.: MIT Press, 1988), pp. 1–15.

[51.] See Jan Tumlir, Protectionism: Trade Policy in Democratic Societies (Washington, D.C.: American Enterprise Institute, 1985)

[52.] Jean-François Revel, Why Democracies Perish (Garden City, N.Y.: Doubleday, 1984)

[53.] Paul Samuelson, Economics (New York: McGraw-Hill, 7th ed., 1967), pp. 790–92; and Campbell R. McConnell, Economics: Principles, Problems, and Policies (New York: McGraw-Hill, 10th ed., 1987), p. 904.

[54.] The term and concept of Lebensraum apparently was first coined and argued for by the German author Moeller van den Bruck (1876–1925), after the first World War; see Frank Munk, The Economics of Force (New York: George W. Stewart, 1940), pp. 23–24.

[55.] See Henry Simons, Economic Policy for a Free Society (Chicago: University of Chicago Press, 1948), pp. 62–65 and 160–83; Irving fisher, 100% Money (New Haven: City Printing Co., 1945); James W. Angell, “The 100 Per Cent Reserve Plan,” Quarterly Journal of Economics (November 1935), pp. 1–35; and Frank D. Graham, “Partial Reserve Money and the 100 Per Cent Proposal,” American Economic Review (September 1936), pp. 428– 40; also Milton Friedman, “A Monetary and Fiscal Framework for Economic Stability,” [1948] in Essays in Positive Economics (Chicago: University of Chicago Press, 1953), pp. 135–36, and A Program for Monetary Stability (Bronx, N.Y.: Fordham University Press, 1960), pp. 65–76; and Lloyd W. Mints, Monetary Policy for a Competitive Society(New York: McGraw-Hill, 1950).

[56.] For a defense of a 100 percent gold reserve system by a student of Mises’s, see Murray N. Rothbard, “The Case for a 100 Percent Gold Dollar,” in Leland B. Yeager, ed., In Search of a Monetary Constitution (Cambridge, Mass.: Harvard University Press, 1962), pp. 94–136.

[57.] Mises, The Theory of Money and Credit, pp. 434–38; “Monetary Stabilization and Cyclical Policy,” pp. 138–40, 145–46, 156; and Human Action, pp. 443–48; also Lawrence
H. White, “Mises on Free Banking and Fractional Reserves,” in John W. Robbins and Mark Spangler, eds., A Man of Principle, 517–33.

[58.] Ludwig von Mises, Nation, State, and Economy: Contributions to the Politics and History of Our Time (New York: New York University Press, [1919] 1983), pp. 9–56.

[59.] Mises, Liberalism, pp. 105–24.

[60.] See Richard M. Ebeling, “World Peace, International Order, and Classical Liberalism,” pp. 59–62, and “Nationalism and Classical Liberalism,” “Nationalism: Its Nature and Consequences,” “National Conflicts, Market Liberalism, and Social Peace,” and “Social Conflict, Self-Determination, and the Boundaries of the State,” in Richard M. Ebeling and Jacob G. Hornberger, eds., The Failure of America’s Foreign Wars (Fairfax, Va.: Future of Freedom Foundation, 1996), pp. 327–48.

[61.] This report has been translated into Spanish and published in Mexico for the first time as a monograph fifty-five years after it was originally written under the title Problemas Economicos de Mexico: Ayer y Hoy (Mexico City: Instituto Cultural Ludwig von Mises, 1998).

[62.] For example, see Adam Smith, The Wealth of Nations (New York: Modern Library, [1776] 1937), Book IV, Ch. II, p. 438; Jean-Baptiste Say, A Treatise on Political Economy (New York: Augustus M. Kelley, [1821] 1971), p. 170.

[63.] See Ludwig von Mises, “Observations on the Cooperative Movement,” [1947] in Richard M. Ebeling, ed., Money, Method, and the Market Process, pp. 238–79.

[64.] See Richard M. Ebeling, “The Free Market and the Interventionist State,” in Richard M. Ebeling, ed., Between Power and Liberty: Economics and the Law, Champions of Freedom Series, Vol. 25(Hillsdale, Mich.: Hillsdale College Press, 1998), pp. 9–46.



Chart(s) of the Day

[This piece can be seen at Sean’s blog here]

Taken over a forty year history, US gasoline is trading in its 3rd percentile – 1.8 sigmas from the mean – when expressed as a ratio of the price of heating oil. In seasonal terms, this makes sense as the winter draw for space heating coincides with the consumption lull in (discretionary) road transport and the anticipatory change of emphasis by the refiners. Given the severe weather being endured Stateside these past several weeks, it should surprise no-one to learn that stocks of heat are more than 8% below the mean for thetime of year, while those for mogas are 4.3% above that norm. Hence the wider price differential.

15-02-24 XBvHO lt
Courtesy: Bloomberg

On a much shorter timeframe, however, we can see heat coming under pressure in the current trading session as the recent crude-led rally fades. Gasoline, conversely, is so far holding up rather better. Time to spread ‘em in anticipation of the arrival of spring?

15-02-24 HO-XB
Courtesy: Bloomberg

With the yuan-dollar rate edging ever higher (led by pressures which seem to emanate from activity in the offshore version in HK), the Chinese press is starting to resound to the sound of calls for a more active policy of devaluation interspersed with a counterpoint of official denials that this is in any way being contemplated.

Apart from the slump in the euro – the ‘Zone being at least as important as the US as a Chinese export destination – the real killer has been the post-Abenomics move versus the yen, especially when gauged in terms of real (i.e., domestic price-adjusted) effective (trade-weighted) rates. Since the latter part of 2012, China’s currency has undergone a 73% overall, 19% annualized, rise versus that of Japan, prompting some of the latter’s companies to start thinking about relocating production back to their homeland. Not so much yendaka, as yuandaka, this time.

15-02-24 CNY TWI
Courtesy: Bloomberg

As WantChina Times put it  in a recent piece, the effects may already be beginning to make themselves felt:-

‘Citizen China, which produces Japanese Citizen watches, to fold its production base in Guangzhou, on the heels of Microsoft which announced on Dec. 17 its decision to close the mobile-phone factories of Nokia, under its auspices, in Beijing and Dongguan by the Spring Festival moving facilities to Nokia’s factory in Hanoi.

A number of other foreign enterprises are scheduled to join the exodus this year, including Panasonic, Sharp, Daikin, and TDK, all Japanese firms, which plan to transfer some capacity from China back to Japan or to other countries. Others, such as Uniqlo, Nike, Foxconn, Funai, Clarion, and Samsung, are setting up new factories in Southeast Asia and India, while scaling down their Chinese operations.’

So, you can see why some think China will be tempted to – err – address the balance, shall we say?

One thing is for sure, whether we look at Asian currencies’ relationship to the Greenback with (ADXY+J) or without (ADXY) the yen, the charts are pointing lower and that, in turn, suggests there is only one way for commodites to trade, too.

15-02-24 ADXY CMDT
Courtesy: Bloomberg


15-02-24 ADXYJ CMDT
Courtesy: Bloomberg

Finally, as Mme. Yellen gives us the usual rigmarole of soft-cop-hard cop-soft cop in her Congressional testimony, the market’s first reaction has been to believe that the Ghost of ’37 is still far from being laid: bonds have rallied nicely, especially in the belly where mid-curve euro$ have jumped 12bps or so in the immediate aftermath of her comments.

If, however, we compare the actual real Fed funds rate to the state of the job market – either using continuing jobless claims as a percentage of the population (here inverted) or the real wage fund (hours x pay rates / CPI) – you can see that Ms. Yellen is taking rather more of a gamble than she is willing to admit. From the Volcker Era to the Anti-Vocker Era, indeed.

Courtesy: Bloomberg
Courtesy: Bloomberg


A Salvo in the Battle for the Gold Standard

I wrote what I thought was a fairly simple article for Forbes on Tuesday. I noticed that some people really got it, and they were very excited. However, others were skeptical or asking questions that went into the weeds. The former tells me that I said something important, but the latter says that I said it in a way that not everyone could relate to.

I started with the observation that many people argue (vehemently) that money should be defined as the medium of exchange. In the US, the dollar is used to purchase everything. Therefore the dollar circulates as the medium of exchange. Therefore the dollar is money. Q.E.D.

The catch is that the dollar only circulates because the government forces it to circulate, and forces gold not to. This means that the very concept of money is under the control of the government.

Ayn Rand noted that force is not essentially about a physical push, or a bullet hitting flesh. She said, “Force and mind are opposites…” She added, “To force a man to drop his own mind and to accept your will as a substitute, with a gun in place of a syllogism, with terror in place of proof, and death as the final argument—is to attempt to exist in defiance of reality.”

She showed that force is an attack on the mind. Literally, the gun takes away your ability to see reality clearly and use logic to arrive at the best possible outcome. Instead, you must think and do as you are told. The insidious process she described is at work with the concept of money. The very concept of money has been perverted.

In most cases, people can see that government has no power to change reality, or alter the laws of physics. But in this case—by the leverage of a broken concept—many people assume that government has indeed the power to make concepts into what it wishes.

George Orwell once wrote about this.

Debt paper is not money, no matter who issues it. The government has no power to transform water into wine, or debt paper into money. I don’t think anyone is explicitly arguing that it has this power. I think their error is to gloss over why the dollar circulates, and just insist that, “well, it circulates therefore it is money.”

Thus, the government is granted the power to turn paper into gold, though the mind skitters away from openly admitting this conclusion.

The consequence to accepting the dollar as money is to think that gold goes up. As I often say, in reality, gold is going nowhere. It’s the dollar that is going down. But if the dollar is money, then the prices of all things are measured in dollars. And so, we think gold goes up. Because that’s the only way to frame it if the dollar is money.

If gold goes up, then one has made a profit. That’s right, one makes money for doing nothing, just holding a lump of metal. Where does such a free lunch come from? No time to explore that contradiction today. Let’s stay focused.

It may not be fair, but we have a capital gains tax that applies when an investment, commodity, or asset goes up. If you buy something for $1,000 and sell it for $1,500, then you have a $500 profit. You must pay tax on that income. There are no exceptions that I am aware of: antique Ferraris, stocks, bonds, bitcoin, copper, houses, etc.

And this is where the concept of money gets real.

The government has several ways of forcing gold not to circulate, of making us use their debt paper as if it were money. One of them is the capital gains tax on gold. You see, if you barter—remember, gold is not money, just a commodity—gold for a car then the government considers that to be a sale of gold at the current market price. If that is higher than what you paid when you bought, then you owe capital gains tax.

This tax makes it far too expensive to use gold in transactions, not to mention the ledger you would have to keep. So gold is forced out of circulation (and into private hoards). Gold is for holding, not for using as money.

I have been arguing that this bad tax provision ought to be repealed. And that’s the crux of the problem.

Am I just a crony, like every other crony, asking the government for a special favor and preferential treatment? Is the whole point of repealing the tax on gold so that gold speculators can make more money on their gold trades?

This was essentially the allegation of one Arizona legislator, who asked why gold should be treated differently than other investments.

If the dollar is money, then there is no good answer to this question.

To advocate for special privileges that benefit one’s own purse is to fight for cronyism (also known by its older name, fascism). This is not a principled position. Nor is it a sympathetic one. Everyone has a mental picture of a fat cats, seeking to engorge himself as public expense. Once we’re into that box, once we’re perceived that way, we’re doomed. No matter what “blah blah blah” comes out of our mouths, it will be seen as self-serving and hypocritical. And rightfully so.

Huh? Rightfully so?!? Yes. If we concede that the dollar is money, gold is a commodity, and if we concede that gold is going up, which means we make a profit, and if we demand not to be taxed on that profit, then we are no different than any other special interest group seeking favoritism. We are no different than any other rent seekers.

What is a principled free marketer to do? Well, if you cling to the notion that the dollar is money, then you are disarmed. You have to concede that gold should be taxed just like other assets. You can lobby to eliminate all capital gains tax, but that’s about it. Good luck with that. I will cheer you, but don’t expect victory any time soon.

I remind you of two things. One, tax keeps gold from circulating. In other words, the gold tax is the key to socialized money. We can never have a free market in money if gold is penalized with a tax every time the dollar loses value. Two, as Ayn Rand showed, the moral is the practical. Your belief in this bad definition of money is what keeps you from effectively fighting for a free market in money.

There is much more to say about the topic of money and credit, to support the case that gold is money. In this article, I just wanted to focus on this one issue, because I think the error is an important one. I expect gold’s enemies, as they begin to mobilize and organize, will be cunning enough to see the vulnerability and go for the jugular.

If we want to win, we will need to be armed properly for the fight. This is a battle for ideas, and the most important weapons we can wield are concepts. Preferably razor sharp concepts. Let’s get it right, starting with a clear understanding of the dollar and of gold.



“We are all at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air. We know, by the rules, that at some moment the Black Horsemen will come shattering through the great terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no-one wants to leave while there is still time, so that everyone keeps asking, “What time is it ? What time is it ?” But none of the clocks have any hands.”

–       From ‘Supermoney’ by Adam Smith.


It was not supposed to be like this. As we highlighted last week, after the Great Debt Bubble, there has been no Great Deleveraging. In fact, as the McKinsey Global Institute showed in their February 2015 report,

“After the 2008 financial crisis and the longest and deepest global recession since World War II, it was widely expected that the world’s economies would deleverage. It has not happened. Instead..

“Debt continues to grow. Since 2007, global debt has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points.”

Herbert Stein’s Law mandates that if something cannot go on forever, it will stop. The great Austrian economist Ludwig von Mises expressed the same sentiment and came to a somewhat gloomier conclusion:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

As the McKinsey data show, the voluntary abandonment of further credit expansion has clearly not occurred. If Mises is correct, and we are minded to consider that he is, then draw your own conclusions.

We have now become used to so many years of utterly extraordinary monetary experimentation and policy-making on the hoof that there is a danger that Alice-in-Wonderland central banking activity simply gets taken for granted as the natural state of affairs. This is the same type of absurd but incremental behaviour that gets frogs in pans boiled alive with their tacit approval.

Blithe sceptics to this line of thought will no doubt argue that if seven years of making-it-up-as-we-go-along monetary policy hasn’t derailed the system, then perhaps the system won’t get derailed. Perhaps it’s even un-derailable. But this sounds suspiciously like Ben Bernanke’s own flawed thinking when he suggested in July 2005 that

“We’ve never had a decline in house prices on a nationwide basis.”

In other words, because something has never happened before, it never will.

(This from the same person who observed in March 2007 that

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”)

No, the insoluble problem facing every investor today is not just that the system is unsustainable. It clearly is. The problem is that we lack a means of forecasting accurately when the system is likely to break apart. The financial market is a complex, adaptive system, reliant on confidence, the ongoing robustness of which is completely unforecastable. That confidence has been robust is not in question. The creation of trillions of dollars, pounds, euros, yen and renminbi worth of ex nihilo money has yet to dent confidence entirely in an unbacked paper money system (notwithstanding the 345% gain in the dollar price of gold since the start of the millennium).

Just before the turn of the millennium, inside the late Peter L. Bernstein’s excellent history of risk, ‘Against the Gods’, we came across the following quotation by the Swiss mathematician and physicist Daniel Bernoulli: when managing money for wealthy people,

“The practical utility of any gain in portfolio value inversely relates to the size of the portfolio.”

Bernoulli (1700-1782) has a good claim to being one of the world’s first behavioural economists, in that he observed that investment performance for the wealthy is not exactly the same as investment performance for the non-wealthy. For the objectively wealthy, or super-wealthy, any further gain in portfolio value has to be seen in the context of maintaining the original value of the portfolio. Since human beings are typically loss averse, maintaining the original purchasing power of the pot is much more important than generating further incremental gains, especially in an environment where the pursuit of those further gains risks existentially jeopardising that original pot.

US stock markets reached record highs last week. Question: does that make them riskier, or less risky ? We think the former. But for us the question is somewhat academic since we’re not remotely interested in index-tracking. Other investors, however, evidently are. Among the top 10 ETF purchases by customers of Barclays Stockbrokers last week were funds tracking:

  • The S&P 500 (iShares and Vanguard)
  • The FTSE 100 (iShares and Vanguard)
  • The FTSE 250
  • The Euro Stoxx 50
  • Japan.

We foresee all kinds of risks in taking indexed exposure to stock markets close to or at their all-time highs. Index-tracking funds offer many things. Relatively low cost market exposure, for one. But as and when stock markets go into reverse, purchasers of low cost trackers will find that they have been penny-wise and pound foolish, because low cost trackers offer precisely zero discernment or discretion when it comes to market direction. If the market goes down, they go down with it.

So rather than tag along for the ride, we much prefer to follow the ‘value’ route (to capital preservation and growth, in that order). Index benchmarking is utterly inappropriate, we would suggest, for the private investor, for whom the ultimate reference rate should be cash, since cash remains the only asset that cannot decline in nominal terms. Or at least that used to be the case, before acronyms like QE, ZIRP and now NIRP (Negative Interest Rate Policy) steamrollered over all assets in their path, like financial terminators.

If we define ‘value’ as inherent quality plus attractive valuation, it has relevance to both debt and equity market investing today. Bond markets as a whole are clearly grotesquely overvalued but may remain so or become even more overvalued because there is an 800lb gorilla in the market determinedly gobbling them up. As of March 2015, the ECB will be buying €60 billion worth every month. We doubt whether there’s that much quality debt on offer in the euro zone. But there may be elsewhere, not least because most of the world’s creditor countries lie outside the euro zone.

In equity markets, we see almost no compelling value in US stocks, which if nothing else are intensely well covered (we mean by number of analysts, not necessarily by quality of coverage) by Wall Street. We see compelling pockets of genuine value, however, in markets like Japan, which simply aren’t well covered by the analyst community, which has been scared off by 20 years of bear market conditions.

We then supplement our debt and equity exposure with uncorrelated investments (namely systematic trend-followers), which we have always regarded as bellwether holdings, and with real assets, notably the monetary metals, gold and silver.

The result: four discrete asset classes that will behave in different ways under different market conditions. High quality debt offers income and a degree of capital preservation (especially in an environment of outright deflation). High quality ‘value’ equity offers income and the potential for attractive capital growth (especially in an environment of modest inflation). Systematic trend-followers are broadly market neutral, but with the potential to deliver outsized gains in an environment of systemic financial distress (most trend-followers generated double or triple digit percentage returns in 2008, for example). And real assets, again, offer the potential to deliver outsized gains in an environment of systemic financial distress or high inflation, or both.

Unlike most of our fund management peers, we accept that we can’t predict the future. Unlike many of them, we are at least preparing for it.

But that brings us back to our initial dilemma. We think the system is desperately unsound, so we take out what insurance we can, whilst still retaining a stake in a variety of markets (on our terms admittedly, rather than according to somebody else’s irrelevant benchmark).

But insurance only works if you have it when the crisis erupts. You don’t buy house insurance after the roof catches fire.