The False Promises Of Two Percent Price Inflation

A specter is haunting the world, the specter of two percent inflationism. Whether pronounced by the U.S. Federal Reserve or the European Central Bank, or from the Bank of Japan, many monetary central planners have declared their determination to impose a certain minimum of rising prices on their societies and economies.

One of the oldest of economic fallacies continues to dominate and guide the thinking of monetary policy makers: that printing money is the magic elixir for the creating of sustainable prosperity.

In the eyes of those with their hands on the handle of the monetary printing press the economic system is like a balloon that, if not “fully inflated” at a desired level of output and employment, should be simply “pumped up” with the hot air of monetary “stimulus.”

The Fallacy of Keynesian Macro-Aggregates

The fallacy is the continuing legacy of the British economist, John Maynard Keynes, and his conception of “aggregate demand failures.” Keynes argued that the economy should be looked at in terms of series of macroeconomic aggregates: total demand for all output as a whole, total supply of all resources and goods as a whole, and the average general levels of all prices and wages for goods and services and resources potentially bought and sold on the overall market.

If at the prevailing general level of wages, there is not enough “aggregate demand” for output as a whole to profitably employ all those interested and willing to work, then it is the task of the government and its central bank to assure that sufficient money spending is injected into the economy. The idea being that at rising prices for final goods and services relative to the general wage level, it again becomes profitable for businesses employ the unemployed until “full employment” is restored.

Over the decades since Keynes first formulated this idea in his 1936 book, The General Theory of Employment, Interest, and Money, both his supporters and apparent critics have revised and reformulated parts of his argument and assumptions. But the general macro-aggregate framework and worldview used by economists in the context of which problems of less than full employment continue to be analyzed, nonetheless, still tends to focus on and formulate government policy in terms of the levels of and changes in output and employment for the economy as a whole.

In fact, however, there are no such things as “aggregate demand,” or “aggregate supply,” or output and employment “as a whole.” These are statistical creations constructed by economists and statisticians, out of what really exists: the demands and supplies of multitudes of individual and distinct goods and services produced, and bought and sold on the various distinct markets that comprise the economic system of society.

The Market’s Many Demands and Supplies

There are specific consumer demands for different kinds and types of hats, shoes, shirts, reading glasses, apples, and books or movies. But none of us just demands “output,” any more than there is just a creation of “employment.”

When we go into the marketplace we are interested in buying the specific goods and services for which we have particular and distinct demands. And businessmen and entrepreneurs find it profitable to hire and employ particular workers with specific skills to assist in the manufacture, production, marketing and sale of the distinct goods that we as individual consumers are interested in purchasing.

In turn, each of these individual and distinct goods and services has its own particular price in the market place, established by the interaction of the individual demanders with the individual suppliers offering them for sale.

The profitable opportunities to bring desired goods to market results in the demand for different resources and raw materials, specific types of machinery and equipment, and different categories of skilled and lesser skilled individual workers to participate in the production processes that bring those desired goods into existence.

The interactions between the individual businessmen and the individual suppliers of these factors of production generate the prices for their purchase, hire or employment on, again, multitudes of individual markets in the economic system.

The “macro” economist and his statistician collaborator then proceed to add up, sum and averages all these different individual outputs, employments and specific prices and wages into a series of economy-wide measured aggregates.

But it should be fairly clear that in doing so all the real economic relationships in the market, the actual structure of relative prices and wages, and all the multitude of distinct and interconnected patterns of actual demands and supplies are submerged and lost in the macro-economic aggregates and totals.

Balanced Markets Assure Full Employment

Balanced production and sustainable employments in the economy as a whole clearly requires coordination and balance between the demands and supplies of all the particular goods and services in each of the specific markets on which they are bought and sold. And parallel to this there must be comparable coordination and balance between the businessmen’s demands for resources, capital equipment and different types of labor in each production sector of the market and those supplying them.

Such coordination, balance, and sustainable employment requires adaptation to the every-changing circumstance of market conditions through adjustment of prices and wages, and to shifts in supplies and demands in and between the various parts and sectors of the economy.

In other words, it is these rightly balanced and coordinated patterns between supplies and demands and their accompanying structures of relative prices and wages that assure “full employment” and efficient and effective use of available resources and capital, so entrepreneurs and businessmen are constantly and continuously tending to produce the goods we, the consumers, want and desire, and at prices that are covering competitive costs of production.

All this is lost from view when reduced to that handful of macro-aggregates of “total demand” and “total supply” and a statistical average price level for all goods relative to a statistical average wage level for all workers in the economy.

The Keynesian Government “Big Spender”

In this simplified and, indeed, simplistic view Keynesian-type view of things all that needs to be done from the government’s policy perspective is to run budget deficits or create money through the banking system to push up “aggregate demand” to assure a targeted rise in the general price level so profit-margins “in general” are widened relative to the general wage level so employment “in general” will be expanded.

We can think of government as a “big spender” who comes into a town and proceeds to increase “aggregate demand” in this community by buying goods. Prices for final output rise, profit margins are widened relative to the general wage level and other general cost-prices. Private businesses, in general, employ more workers, purchase or hire other inputs, and “aggregate supply” expands to a point of desired “full employment.”

The presumption on the part of the center bankers in targeting a rate of an average annual price inflation of two percent is that while selling prices are to be pushed up at this average annual rate through monetary expansion, the average level of cost prices (including money wages in general) will not rise or not by the same percentage increase as the average increase in the “price level.”

If cost prices in general (including money wages) were to rise at the same rate as the price level, there would be no margin of additional profits to stimulate greater aggregate output and employment.

Market Anticipations Undermine Keynes’ Assumptions

The fallacy in thinking that cost-prices in general will permanently lag behind the rate of increase in the price level of final goods and services was pointed out long ago, in 1898, by the famous Swedish economist, Knut Wicksell:

“If a gradual rise in prices, in accordance with an approximately known schedule, could be reckoned on with certainty, it would be taken into account in all current business contracts; with the result that its supposed beneficial influence would necessarily be reduced to a minimum.

“Those people who prefer a continually upward moving to a stationary price level forcibly remind one of those who purposely keep their watches a little fast so as to be more certain of catching their train. But to achieve their purpose they must not be conscious or remain conscious of the fact that their watches are fast; otherwise they become accustomed to take the extra few minutes into account, and so after all, in spite of their artfulness, arrive too late . . .”

Yellen and the Fed goes wrong cartoon

The Government “Big Spender” Unbalances Markets

But the more fundamental error and misconception in the macro-aggregate approach is its failure to appreciate and focus on the real impact of changes in the money supply that by necessity result in an unsustainable deviation of prices, profits, and resources and labor uses from a properly balanced coordination, the end result of which is more of the very unemployment that the monetary “stimulus” was meant to cure.

Let’s revert to our example of the “big spender” who comes into a town. The townspeople discover that our big spender introduces a greater demand into the community, but not for “goods in general.” Instead, he announces his intention of building a new factory on the outskirts of the town.

He leases a particular piece of land and pays for the first few months rent. He hires a particular construction company to build the factory, and the construction company in turn increases its demand not only for workers to do the work, but orders new equipment, that, in turn, results in the equipment manufacturers adding to their workforce to fulfill the new demand for construction machinery.

Our big spender, trumpeting the wonders for the community from his new spending, starts hiring clerical staff and sales personal in anticipation of fulfilling orders once the factory is completed and producing its new output.

The new and higher incomes earned by the construction and machinery workers, as well as the newly employed clerical and sales workers raise the demand for various and specific consumer and other goods upon which these people want to spend their new and increased wages.

The businesses in the town catering to these particular increased consumer demands now attempt to expand their supplies and, perhaps, hire more retail store employees.

Over time the prices of all of these goods and services will start to rise, but not at the same time or to the same degree. They will go up in a temporal sequence that more or less tends to match the pattern and sequence of the changed demands for those goods and services resulting from the new money injected by the “big spender” into this community.

Inflationary Spending Has to Continue and Increase

Now, whether some of the individual workers drawn into this specific pattern of new employments were previously unemployed or whether they had to be attracted away from existing jobs they already held in other parts of the market, the fact remains that their continued employments in these particular jobs is dependent on the “big spender” continuing to inject and spend his new money, period-after-period of time, in the same way and in sufficient amounts of dollar spending to assure that the workers he has drawn into his factory project are not attracted to other employments due to the rise in all of these alternative or other demands, as well.

If the interdependent patterns of demands and supplies, and the structure of interconnected relative prices and wages generated by the big spender’s spending are to be maintained, his injection of new money into the community must continue, and at an increasing rate of spending if they are not be fall apart.

An alternative imagery might be the dropping of a pebble or stone into a pond of water. From the epicenter where the stone has hit the surface of the water a sequence of ripples will be sent out which will be reversed when the ripples finally hit the surrounding shore, and will then finally come to rest when there is no longer any new disturbances affecting the surface of the pond.

But if the pattern of ripples created are to be sustained, new pebbles or stones must be continuously dropped into the pond and with increasing force if the resulting counter-waves coming back from the shore are not to disrupt and overwhelm the ripple pattern moving out from the original epicenter.

Yellen and the Good Ship Fed cartoon

The “Austrian” Analysis of Inflation

It is no doubt that this way of analyzing and understanding the dynamics of how monetary expansion affects market activities is more complex and complicated than the simplistic Keynesian-style of macro-aggregate analysis. But as the famous Austrian-born economist, Joseph A. Schumpeter emphasized:

“The Austrian way of emphasizing the behavior or decisions of individuals and of defining the exchange value of money with respect to individual commodities rather than with respect to a price level of one kind or another has its merits, particularly in the analysis of an inflationary process; it tends to replace a simple but inadequate picture by one which is less clear-cut but more realistic and richer in results.”

And, indeed, it is this “Austrian” analysis of monetary expansion and its resulting impact on prices, employment and production, especially as developed in the 20th century by Ludwig von Mises and Friedrich A. Hayek, that explains why the Keynesian-originated macro-aggregate approach is fundamentally flawed.

As Hayek once explained the logic of the monetary inflationary process:

“The influx of the additional money into the [economic] system always takes place at some particular points. There will always be some people who have more money to spend before the others. Who these people are will depend on the particular manner in which the increase in the money stream is being brought about . . .

“It may be spent in the first instance by government on public works or increased salaries, or it may be first spent by investors mobilizing cash balances for borrowing for that purpose; it may be spent in the first instance on securities, or investment goods, on wages or on consumers’ goods . . .

“The process will take very different forms according to the initial source or sources of the additional money stream . . . But one thing all these different forms of the process will have in common: that the different prices will rise, not at the same time but in succession, and that so long as the process continues some prices will always be ahead of others and the whole structure of relative prices therefore will be very different from what the pure theorist describes as an equilibrium position.”

An inflationary process, in other words, brings about distortions, mismatches, and imbalanced relationships between different supplies and demands, and the relationships between the structure of relative prices and wages that only last for as long as the inflationary process continues, and often only at an accelerating rate.

Or as Hayek expressed it on a different occasion:

“Any attempt to create full employment by drawing labor into occupations where they will remain employed only so long as the [monetary and] credit expansion continues creates the dilemma that either credit expansion must continue indefinitely (which means inflation), or that, when it stops unemployment will be greater than it would be if the temporary increase in employment had never taken place.”

The Inflationary “Cure” Creates More Market Problems

Once the inflationary monetary expansion ends or is slowed down, it is discovered that the artificially created supply and demand patterns and relative price and wage structure are inconsistent with non-inflationary market conditions.

In our example of the “big spender,” one day the townsfolk discover that he was really a con artist who had only phony counterfeit money to spend, and whose deceptive promises and temporary spending drew them into in all of those specific and particular activities and employments. They now find out that the construction projects began cannot be completed, the employments created cannot be maintained, and the investments started in response to the phony money the big spender injected into this community cannot be completed or continued.

Many of the townspeople now have to stop what they had been doing, and try to discover other demanders, other employers and other possible investment opportunities in the face of the truth of the big spenders false incentives to do things they should not have been doing from the start.

The unemployment and under utilization of resources that “activist” monetary policy by governments are supposed to reduce, in fact, set the stage for an inescapable readjustment period of more unemployment and temporary idle resources, when many of the affected supplies and demands have to be rebalanced at newly established market-based prices if employments and productions are to be sustainable and consistent with actual consumer demands and the availability of scarce resources in the post-inflationary environment.

Thus, recessions are the inevitable result from prior and unsustainable inflationary booms. And even the claimed “modest” and “controlled” rate of two percent annual price inflation that has become the new panacea for economic stability and growth in the minds of central bankers, brings in its wake a “wrong twist” to many of the micro-economic supply and demand and price-wage relationships that are the substance of the real economy beneath the superficial macro-aggregates.

Governments and their monetary central planners, therefore, are the cause and not the solution to the instabilities and hardships of inflations and recessions. To end them, political control and manipulation of the money and banking systems will have to be abolished.

[This piece first appeared here:]


The Case For Monetary Freedom And Free Banking

There has been no greater threat to life, liberty, and property throughout the ages than government. Even the most violent and brutal private individuals have been able to inflict only a mere fraction of the harm and destruction that have been caused by the use of power by political authorities.

The pursuit of legal plunder, to use Frédéric Bastiat’s well-chosen phrase, has been behind all the major economic and political disasters that have befallen mankind throughout history.

Government Spending Equals Plundering People

We often forget the fundamental
truth that governments have nothing 
to spend or redistribute that they do not first take from society’s producers. The fiscal history of mankind is nothing but a long, uninterrupted account
of the methods governments have devised for seizing the income and wealth of their citizens and subjects.

Parallel to that same sad history must be an account of all the attempts by the victims of government’s legal plunder to devise counter-methods to prevent or at least limit the looting of their income and wealth by those in political power.

Every student who takes an economics course learns that governments have basically three methods for obtaining control over a portion of the people’s wealth: taxation, borrowing, and inflation––the printing of money.

It was John Maynard Keynes who pointed out in his 1919 book, The Economic Consequences of the Peace:

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they also confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some . . .

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Limiting Government with the Gold Standard

To prevent the use of inflation by governments to attain their fiscal ends, various attempts have been made over the last 200 years to limit the power of the State to print money to cover its expenditures. In the nineteenth and early twentieth centuries the method used was the gold standard. The idea was to place the creation of money outside the control of government.

As a commodity, the amount of gold available for both monetary and non-monetary uses is determined and limited by the same market forces that determine the supply of any other freely traded good or service: the demand and price for gold for various uses relative to the cost and profitability of mining and minting it into coins or bullion, or into some other commercial form.

Any paper money in circulation under the gold standard was meant to be money substitutes––that is, notes or claims to quantities of gold that had been deposited in banks and that were used as a convenient alternative to the constant withdrawing and depositing of gold coins or bullion to facilitate everyday market exchanges.

Under the gold standard, the supply of money substitutes in circulation was meant to increase and decrease to reflect any changes in the quantity of gold in a nation’s banking system. The gold standard that existed in the late nineteenth and early twentieth centuries never worked as precisely or as rigidly as it is portrayed in some economics textbooks. But, nonetheless, the power of government to resort to the money printing press to cover its expenditures was significantly limited.

Governments, therefore, had to use one of the two other methods for acquiring their citizens’ and subjects’ income and wealth. Governments had to either tax the population or borrow money from financial institutions.

But as a number of economists have pointed out, before World
War I many of the countries of North
America and western and central Europe operated under an “unwritten
fiscal constitution.” Governments, except during times of national emergency, were expected to more or less 
balance their budgets on an annual 

If a national emergency
 (such as a war) compelled a government to borrow money to cover its
 unexpected expenditures, it was expected to run budget surpluses to
pay off any accumulated debt when the emergency had passed.

This unwritten balanced-budget rule was never rigidly practiced either, of course. But the idea that needless government debt was a waste and a drag on the economic welfare of a nation served as an important check on the growth of government spending.

When governments planned to do things, the people were more or less explicitly presented with the bill. It was more difficult for governments to promise a wide variety of benefits without also showing what the taxpayer’s burden would be.

World War I Destroyed the Gold Standard

This all changed during and after World War I. The gold standard was set aside to fund the war expenditures for all the belligerents in the conflict. And John Maynard Keynes, who in 1919 had warned about the dangers of inflation, soon was arguing that gold was a “barbarous relic” that needed to be replaced with government-managed paper money to facilitate monetary and fiscal fine-tuning.

In addition, that unwritten fiscal constitution which required annual balanced budgets was replaced with the Keynesian conception of a balanced budget over the phases of the business cycle.

In practice, of course, this set loose the fiscal demons. Restrained by neither gold nor the limits of taxation, governments around the world went into an orgy of deficit spending and money creation that led some to refer to a good part of the twentieth century as the “age of inflation.”

Politicians and bureaucrats could now far more easily offer short-run benefits to special-interest groups through growth in government power and spending, while avoiding any mention of the longer-run costs to society as a whole, in their roles as taxpayers and consumers.

Obama and Santa Cartoon

The Counter-Revolution Against Keynesianism

Beginning in the late 1960s and 1970s a counter-revolution against Keynesian economics emerged, especially in the United States, which came to be identified with Milton Friedman and monetarism.

To restrain government’s ability to create inflation, Friedman proposed a “monetary rule”: the annual increase in the money supply should be limited to the average annual increase in real output in the economy. Put the creation of paper money on “automatic pilot,” and governments would once more be prevented from using the printing press to capriciously cover their expenditures.

But in the years after receiving the Nobel Prize in economics in 1984, Friedman had second thoughts about the effectiveness of his monetary rule. He stated that Public Choice theory – the use of economic theory to analyze the logic and incentives in political decision-making – persuaded him that trying to get central banks to pursue a monetary policy that would serve the long-run interest of society was a waste of time.

Just like the rest of us, politicians, bureaucrats, and central bankers have their own self-interested goals, and they will use the political power placed at their disposal to advance their interests.

Said Friedman: “We must try to set up institutions under which individuals who intend only their own gain are led by an invisible hand to serve the public interest,” He also concluded that after looking over the monetary history of the twentieth century, “Leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.”

Separating Money from Government Control

Though Milton Friedman was unwilling to take his own argument that far, the logical conclusion of his admission that the control of money can never be trusted in the hands of the government is the need to separate money creation from the State. What is required is the denationalization of money, or in other words, the establishment of monetary freedom in society.

Under a regime of monetary freedom the government would no longer have any role in monetary and banking affairs. The people would have, to use a phrase popularized by the Austrian economist F. A. Hayek, a “choice in currency.” The law would respect and enforce all market-based, consensual contracts regardless of the currency or commodity chosen by the market participants as money. And the government would not give a special status to any particular currency through legal-tender laws as the only “lawful money.”

Monetary freedom encompasses what is known as “free banking.” That is, private banks are at liberty to accept deposits in any commodity money or currency left in their trust by depositors and to issue their own private banknotes or claims against these deposits.

To the extent these banknotes and claims are recognized and trusted by a growing number of people in the wider economic community, they may circulate as convenient money substitutes. Such private banks would settle their mutual claims against each other on behalf of their respective depositors through private clearinghouses that would have international connections as well.

Few advocates of the free market have included the privatization of the monetary system among their proposed economic policy reforms. The most notable advocate of monetary freedom and free banking in the twentieth century was the Austrian economist Ludwig von Mises, who demonstrated that as long as governments and their central banks have monopoly control over the monetary system inflations and the business cycle are virtually inevitable, with all of their distorting and devastating effects.

But the last 30 years have seen the emergence of a body of serious and detailed literature on the desirability and workability of a fully private and competitive free-banking system as an alternative to government central banking.

Self-Interest and Monetary Freedom

Its political advantage is that it completely removes all monetary matters from the hands of government. However effective the old gold standard may have been before the First World War, it nonetheless remained a government-managed monetary system that opened the door to eventual abuse.

Furthermore, a free-banking system fulfills Milton Friedman’s recommendation that the monetary order should be one that harnesses private interest for the advancement of the public interest through the “invisible hand” of the market process.

The interests of depositors in a reliable banking system would coincide with the self-interest of profit-seeking financial intermediaries. A likely unintended consequence would be a more stable and adaptable monetary system than the systems of monetary central planning the world labors under now.

Of course, a system of monetary freedom does not do away with the continuing motives for government to grow and spend. Even limits on the government’s ability to create money to finance its expenditures does not preclude fiscal irresponsibility, with damaging economic consequences for a large segment of the population through deficit spending and growing national debt.

Obama as Santa Cartoon

Monetary Freedom and a Philosophy of Liberty

In the long run, the only way to limit the growth of government spending and power over society is to change political and ideological thinking. As long as many people want government to use its power to tax and regulate to benefit them at the expense of others, it will retain its power and continue to grow.

Monetary and fiscal reform is ultimately inseparable from the rebirth and implementation of a philosophy of freedom that sees government limited to the protection of each individual’s right to his life, liberty, and honestly acquired property.

As Ludwig von Mises expressed it ninety years ago in the aftermath of the First World War and during the Great German Inflation of the early 1920s:

“What is needed first and foremost is to renounce all inflationist fallacies. This renunciation cannot last, however, if it is not firmly grounded on a full and complete divorce of ideology from all imperialist, militarist, protectionist, statist, and socialist ideas.”

If the belief in and desire for personal and economic liberty can gain hold and grow once more in people’s hearts and minds, monetary freedom and fiscal restraint will eventually come by logical necessity.

[Editor’s note: this piece first appeared here]


Sound money, monetary freedom, and the government

Testimony for the Subcommittee on Domestic Monetary Policy and Technology, on “Sound Money: Parallel Currencies and the Roadmap to Monetary Freedom, Thursday, August 2, 2012.

The gold standard alone is what the nineteenth-century freedom- loving leaders (who championed representative government, civil liberties, and prosperity for all) called “sound money.” The eminence and usefulness of the gold standard consists in the fact that it makes the supply of money depend on the profitability of mining gold, and thus checks large-scale inflationary ventures on the part of governments.

– Ludwig von Mises

To discuss a possible roadmap to monetary freedom in the United States requires us to first determine what may be viewed as a “sound” or “unsound” money. Through most of the first 150 years of U.S. history, “sound money” was considered to be one based on a commodity standard, most frequently either gold or silver. In contrast, the history of paper, or fiat, monies was seen as an account of abuse, mismanagement and financial disaster, and thus “unsound” money.

Read the full report (PDF).


Monetary Policy, the Federal Reserve, and the National Debt Problem

The following testimony was delivered before the House of Representatives Subcommittee on Domestic Monetary Policy and Technology, chaired by Congressman Ron Paul (R-Texas), on “Monetary Policy and the Debt Ceiling: Examining the Relationship between the Federal Reserve and Government Debt,” in Washington, D.C. on May 11, 2011. It was previously published on Northwood University’s blog In Defense of Capitalism & Human Progress

“I place economy among the first and most important virtues, and public debt as the greatest of dangers to be feared . . . To preserve our independence, we must not let our rulers load us with public debt . . . we must make our choice between economy and liberty or confusion and servitude . . . If we run into such debts, we must be taxed in our meat and drink, in our necessities and comforts, in our labor and in our amusements . . . If we can prevent the government from wasting the labor of the people, under the pretense of caring for them, they will be happy.”

Thomas Jefferson

Government Debt and Deficits

The current economic crisis through which the United States is passing has given a heightened awareness to the country’s national debt. After a declining trend in the 1990s, the national debt has dramatically increased from $5.7 trillion in January 2001 to $10.7 trillion at the end of 2008, to over $14.3 trillion through April of 2011. The debt has reached 98 percent of 2010 U.S. Gross Domestic Product.

The approximately $3.6 trillion that has been added to the national debt since the end of 2008 is more than double the market value of all private sector manufacturing in 2009 ($1.56 trillion), more than three times the market value of spending on professional, scientific, and technical services in 2009 ($1.07 trillion), and nearly five times the amount spent on non-durable goods in 2009 ($722 billion). Just the interest paid on the government’s debt over the first six months of the current fiscal (October 2010-April 2011), nearly $245 billion, is equal to more than 40 percent of the total market value of all private sector construction spending in 2009 ($578 billion)[1]

This highlights the social cost of deficit spending, and the resulting addition to the national debt. Every dollar borrowed by the United States government, and the real resources that dollar represents in the market place, is a dollar of real resources not available for use in private sector investment, capital formation, consumer spending, and therefore increases and improvements in the quality and standard of living of the American people.

In this sense, the government’s deficit spending that cumulatively has been increasing the national debt has made the United States that much poorer than it otherwise could have and would have been, if the dollar value of these real resources had not been siphoned off and out of use in the productive private sectors of the American economy.

What has made this less visible and less obvious to the American citizenry is precisely because it has been financed through government borrowing rather than government taxation. Deficit spending easily creates the illusion that something can be had for nothing. The government borrows “today” and can provide “benefits” to various groups in the society in the present with the appearance of no immediate “cost” or “burden” upon the citizenry.

Yet, whether acquired by taxing or borrowing, the resulting total government expenditures represent the real resources and the private sector consumption or investment spending those resources could have financed that must be foregone. There are no “free lunches,” as it has often been pointed out, and that applies to both what government borrows as much as what it more directly taxes to cover its outlays.

What makes deficit spending an attractive “path of least resistance” in the political process is precisely the fact that it enables deferring the decision of telling voter constituents by how much taxes would otherwise have to be increased, and upon whom they would fall, in the “here and now” to generate the additional revenue to pay for the spending that is financed through borrowing.[2]

But as the recent fiscal problems in a number of member nations of the European Union have highlighted, eventually there are limits to how far a government can try to hide or defer the real costs of all that it is providing or promising through its total expenditures to various voter constituent groups. Standard & Poor’s recent decision to downgrade the U.S. government’s prospective credit rating to “negative” shows clearly that what is happening in parts of Europe can happen here.

And given current projections by the Congressional Budget Office, the deficits are projected to continue indefinitely into future years and decade, with the cumulative national debt nearly doubling from its present level.[3] In addition, whether covered by taxes or deficit financing, these debt estimates do not include the federal government’s unfunded liabilities for Social Security and Medicare through most of the 21st century. In 2009, the Social Security and Medicare trust funds were estimated to have legal commitments under existing law for expenditures equal to at least $43 trillion over the next seventy-five years.[4] Others have projected this unfunded liability of the United States government to be much higher – possibly over $100 trillion.[5]

The Federal Reserve and the Economic Crisis

The responsibility for a good part of the current economic crisis must be put at the doorstep of America’s central bank, the Federal Reserve. By some measures of the money supply, the monetary aggregates (MZM or M-2) grew by fifty percent or more between 2003 and 2007. This massive flooding of the financial markets with huge amounts of liquidity provided the funds that fed the mortgage, investment, and consumer debt bubbles in the first decade of this century. Interest rates were pushed far below any historical levels.

For a good part of those five years, according to the St. Louis Federal Reserve Bank, the federal funds rate (the rate of interest at which banks lend to each other), when adjusted for inflation – the “real rate” – was either negative or well below two percent. In other words, the Federal Reserve supplied so much money to the banking sector that banks were lending money to each other for free for a good part of this time. It is no wonder that related market interest rates were also pushed way down during this period.[6]

Market interest rates are supposed to tell the truth. Like any other price on the market, interest rates are suppose to balance the decision of income earners to save a portion of their income with the desire of others to borrow that savings for various investment and other purposes. In addition, the rates of interest, through the present value factor, are meant to limit investment time horizons undertaken within the available savings to successfully bring the investments to completion and sustainability in the longer-term.

Due to the Fed’s policy, interest rates were not allowed to do their “job” in the market place. Indeed, Fed policy made interest rates tell “lies.” The Federal Reserve’s “easy money” policy made it appear, in terms of the cost of borrowing, that there was more than enough real resources in the economy for spending and borrowing to meet everyone’s consumer, investment and government deficit needs far in excess of the economy’s actual productive capacity.[7]

The housing bubble was indicative of this. To attract people to take out loans, banks not only lowered interest rates (and therefore the cost of borrowing), they also lowered their standards for credit worthiness. To get the money, somehow, out the door, financial institutions found “creative” ways to bundle together mortgage loans into tradable packages that they could then pass on to other investors. It seemed to minimize the risk from issuing all those sub-prime home loans, which we now see were really the housing market’s version of high-risk junk bonds. The fears were soothed by the fact that housing prices kept climbing as home buyers pushed them higher and higher with all of that newly created Federal Reserve money.

At the same time, government-created home-insurance agencies like Fannie Mae and Freddie Mac were guaranteeing a growing number of these wobbly mortgages, with the assurance that the “full faith and credit” of Uncle Same stood behind them. By the time the Federal government formally had to take over complete control of Fannie and Freddie in 2008, they were holding the guarantees for half of the $10 trillion American housing market.[8]

Low interest rates and reduced credit standards were also feeding a huge consumer-spending boom that resulted in a 25 percent increase in consumer debt between 2003 and 2008, from $2 trillion to over $2.5 trillion. With interest rates so low, there was little incentive to save for tomorrow and big incentives to borrow and consume today. But, according to the U.S. Census Bureau, during this five-year period average real income only increased by at the most 2 percent. Peoples’ debt burdens, therefore, rose dramatically.[9]

The easy money and government-guaranteed house of cards all started to come tumbling down in the second half of 2008. The Federal Reserve’s response was to open wide the monetary spigots even more than before the bubbles burst.

The Federal Reserve has dramatically increased its balance sheet by expanding its holding of U.S. government securities and private-sector mortgage-back securities to the tune of around $2.3 trillion. Traditional Open Market Operations plus its aggressive “quantitative easing” policy have increased bank reserves from $94.1 billion in 2007 to $1.3 trillion by April 2011, for a near fourteen-fold increase, and the monetary basis in general has expanded from $850.5 billion in 2007 to $2,242.9 billion in April of 2011, a 260 percent increase. The monetary aggregates, MZM and M-2, respectively, have grown by 28 percent and 21.6 percent over this same period.[10]

In the name of supposedly preventing a possible price deflation in the aftermath of the economic boom, Fed policy has delayed and retarded the economy from effectively readjusting and re-coordinating the sectoral imbalances and distortions that had been generated during the bubble years.[11] Once again interest rates have been kept artificially low. In real terms, the federal funds rate and the 1-year Treasury yield have been in the negative range since the last quarter of 2009, and at the current time is estimated to be below minus two percent.

This has prevented interest rates from informing market transactors what the real savings conditions are in the economy. So, once again, the availability of savings and the real cost of borrowing is difficult to discern so as to make reasonable and rational investment decisions, and not to foster a new wave of misdirected and unsustainable private sector investment and financial decisions.

The housing market has not been allowed to fully adjust, either. With so much of the mortgage-backed securities being held off the market in the portfolio of the Federal Reserve, there is little way to determine any real market-based pricing to determine their worth or their total availability so the housing market can finally bottom out with clearer information of supply and demand conditions for a sustainable recovery.

This misguided Fed policy has been, in my view, a primary factor behind the slow and sluggish recovery of the United States economy out of the current recession.

Federal Reserve Policy and Monetizing the Debt

Many times in history, governments have used their power over the monetary printing press to create the funds needed to cover their expenses in excess of taxes collected. Sometimes this has lead to social and economic catastrophes.[12]

Monetizing the debt refers to the creation of new money to finance all or a portion of the government’s borrowing. Since the early 2008 to the present, Federal Reserve holdings of U.S. Treasuries have increased by about 240 percent, from $591 billion in March 2008 to $1.4 trillion in early May 2011, or a nearly $1 trillion increase. In the face of an additional $3.6 trillion in accumulated debt during the last three fiscal years, it might seem that Fed policy has “monetized” less than one-third of government borrowing during this period.

However, the Fed’s purchase of mortgage-backed securities, no less than its purchase of U.S. Treasuries, potentially increases the amount of reserves in the banking system available for lending. And since 2008, the Federal Reserve had bought an amount of mortgaged-backed securities that it prices on its balance sheet as being equal about $928 billion.

The $1.4 trillion increase in the monetary base since the end of 2007, from $850.5 billion to $2.2 trillion, has increased MZM measurement of the money supply by $2,161.1, or an additional $769 billion dollars in the economy above the increase in the monetary base. This is an amount that is 83 percent of the dollar value of the $927 billions in mortgage-backed securities.

Due to the “money multiplier” effect – that under fractional reserves, total new bank loans are potentially a multiple of the additional reserves injected into the banking system – it is not necessary for the Fed to purchase, dollar-for-dollar, every additional dollar of government borrowing to generate a total increase in the money supply that may be equal to the government’s deficit.

Thus, it can be argued that Fed monetary policy has succeeded, in fact, in generating an increase in the amount of money in the banking system that is equal to two-thirds of the government’s $3.6 trillion of new accumulated debt.

That the money multiplier effect has not been as great as it might have been, so far, is because the Federal Reserve has been paying interest to member banks to not lend their excess reserves. This sluggishness in potential lending has also been affected by the general “regime uncertainty” that continues to pervade the economy. This uncertainty concerns the future direction of government monetary and fiscal policy. In an economic climate in which it difficult to anticipate the future tax structure, the likely magnitude of future government borrowing, and the impact of new government programs, hesitancy exists on the part of both borrowers and lenders to take on new commitments.

But the monetary expansion has most certainly been the factor behind the worsening problem of rising prices in the U.S. economy and the significant fall in the value of the dollar on the foreign exchange markets.

The National Debt and Monetary Policy

It is hard for Americans to think of their own country experiencing the same type of fiscal crisis that has periodically occurred in “third world” countries. That type of government financial mismanagement is supposed to only happen in what used to be called “banana republics.”

But the fact is, the U.S. is following a course of fiscal irresponsibility that may lead to highly undesirable consequences. The bottom line truth is that over the decades the government – under both Republican and Democratic leadership – has promised the American people, through a wide range of redistributive and transfer programs and other on-going budgetary commitments, more than the U.S. economy can successfully deliver without seriously damaging the country’s capacity to produce and grow through the rest of this century.

To try to continue to borrow our way out of this dilemma would be just more of the same on the road to ruin. The real resources to pay for all the governmental largess that has been promised would have to come out of either significantly higher taxes or crowding out more and more private sector access to investment funds to cover continuing budget deficits. Whether from domestic or foreign lenders, the cost of borrowing will eventually and inescapably rise. There is only so much savings in the world to fund private investment and government borrowing, particularly in a world in which developing countries are intensely trying to catch up with the industrialized nations.

Interest rates on government borrowing will rise, both because of the scarcity of the savings to go around and lenders’ concerns about America’s ability to tax enough in the future to pay back what has been borrowed. Default risk premiums need not only apply to countries like Greece.

Reliance on the Federal Reserve to “print our way” out of the dilemma through more monetary expansion is not and cannot be an answer, either. Printing paper money or creating it on computer screens at the Federal Reserve does not produce real resources. It does not increase the supply of labor or capital – the machines, tools, and equipment – out of which desired goods and services can be manufactured and provided. That only comes from work, savings and investment. Not from more green pieces of paper with presidents’ faces on them.

However, what inflation can do is:

  • Accelerate the devaluation of the dollar on the foreign exchange markets, and thereby disrupting trading patterns and investment flows between the U.S. and the rest of the world;
  • Reduce the value, or purchasing power, of every dollar in people’s pockets throughout the economy as prices start to rise higher and higher;
  • Undermine the effectiveness of the price system to assist people as consumers and producers in making rational market decisions, due to the uneven manner in which inflation impacts of some prices first and affects others only later;
  • Potentially slow down capital formation or even generate capital consumption, as inflation’s uneven effects on prices makes it difficult to calculate profit from loss;
  • Distort interest rates in financial markets, creating an imbalance between savings and investment that sets in motion the boom and bust of the business cycle;
  • Create incentives for people to waste their time and resources trying to find ways to hedge against inflation, rather than devote their efforts in more productive ways that improve standards of living over time;
  • Bring about social tensions as people look for scapegoats to blame for the disruptive and damaging effects of inflation, rather than see its source in Federal Reserve monetary policy;
  • Run the risk of political pressures to introduce distorting price and wage controls or foreign exchange regulations to fight the symptom of rising prices, rather than the source of the problem – monetary expansion.

What is To Be Done?

The bottom line is, government is too big. It spends too much, taxes too heavily, and borrows too much. For a long time, the country has been trending more and more in the direction of increasing political paternalism. Some people argue, when it is proposed to reduce the size and scope of government in our society, that this is breaking some supposed “social contract” between government and “the people.”

The only workable “social contract” for a free society is the one outlined by the American Founding Fathers in the Declaration of Independence and formalized in the Constitution of the United States. This is a social contract that recognizes that all men are created equal, with governmental privileges and favors for none, and which expects government to respect and secure each individual’s right to his life, liberty, and honestly acquired property.

The reform agenda for deficit and debt reduction, therefore, must start from that premise and have as its target a radical “downsizing” of government. That policy should plan to reduce government spending across the board in every line item of the federal budget by 10 to 15 percent each year until government has been reduced in size and scope to a level and a degree that resembles, once again, the Founding Father’s conception of a free and limited government.[13]

A first step in this fiscal reform is to not increase the national debt limit. The government should begin, now, living within its means – that is, the taxes currently collected by the Treasury. In spite of some of the rhetoric in the media, the U.S. need not run the risk of defaulting or losing its international financial credit rating. Any and all interest payments or maturing debt can be paid for out of tax receipts. What will have to be reduced are other expenditures of the government.

But the required reductions and cuts in various existing programs should be considered as the necessary “wake-up call” for everyone in America that we have been living far beyond our means. And as we begin living within those means, priorities will have to be made and trade-offs will have to be accepted as part of the transition to a smaller and more constitutionally limited government.

In addition, the power of monetary discretion must be taken out of the hands of the Federal Reserve. The fact is, central banking is a form of monetary central planning under which it is left in the hands of the members of the Board of Governors of the Federal Reserve to “plan” the quantity of money in the economy, influence the value or purchasing power of the monetary unit, and manipulate interest rates in the loan markets.

The monetary central planners who run the Federal Reserve have no more or greater knowledge, wisdom or ability that those central planners in the old Soviet Union. The periodic recurrence of the boom and bust of the business cycle demonstrates that there is no way for them to get it right – in spite of them saying, again and again, that “next time” they will get it right.

It is what the Nobel Prize-winning, Austrian economist, Friedrich A. Hayek, once called a highly misplaced “pretense of knowledge.” That is why in a wide agenda for reform, the goal should be to move towards a market-based monetary system, the first step in such an institutional change being a commodity-backed monetary order such as a gold standard.[14]

And in the longer-run serious consideration must be given the possibilities of a monetary system completely privatized and competitive, without government control, management, or supervision.[15]

The budgetary and fiscal crisis right now has made many political issues far clearer in people’s minds. The debt dilemma is a challenge and an opportunity to set America on a freer and potentially more prosperous track, if the reality of the situation is looked at foursquare in the eye.

Otherwise, dangerous, destabilizing, and damaging monetary and fiscal times may be ahead.

[1] The 2011 Statistical Abstract: The National Data Book (Washington, D.C., U.S. Census Bureau, 2011), Table 669.

[2] Richard M. Ebeling, Why Government Grow: The Modern Democratic Dilemma,” AIER Research Reports, Vol. LXXV, No. 14 (Great Barrington, MA: American Institute for Economic Research, August 4-18, 2008); James M. Buchanan and Richard E. Wagner, Democracy in Deficit: The Political Legacy of Lord Keynes (New York: Academic Press, 1977); and earlier, Henry Fawcett and Millicent Garrett Fawcett, Essays and Lectures on Social and Political Subjects (Honolulu, Hawaii: University Press of the Pacific, [1872] 2004), Ch. 6: “National Debts and National Prosperity,” pp. 125-153.

[3] The Budget and Economic Outlook: Fiscal Years 2011 to 2021 (Washington, D.C.: Congressional Budget Office, January 27, 2011)

[4] Richard M. Ebeling, “Brother, Can You Spare $43 Trillion? America’s Unfunded Liabilities,” AIER Research Reports, Vol. LXXVI, No. 3 (Great Barrington, MA: American Institute for Economic Research, March 2, 2009), pp. 1-3.

[5] Michael D. Tanner, “The Coming Entitlement Tsunami.” April 6, 2010. (accessed May 5, 2011).

[6] For more details, see, Richard M. Ebeling, “The Financial Bubble was Created by Central Bank Policy,” American Institute for Economic Research, November 5, 2008, (accessed on May 5, 2011).

[7] See, Richard M. Ebeling, “Market Interest Rates Need to Tell the Truth, or Why Federal Reserve Policy Tells Lies,” in Richard M. Ebeling, Timothy G. Nash, and Keith A. Pretty, eds., In Defense of Capitalism (Midland, MI: Northwood University Press, 2010) pp. 57-60;

[8] Thomas Sowell, The Housing Boom and Bust (New York: Basic Books, 2010); Johan Norberg, Financial Fiasco (Washington, D.C.: Cato Institute, 2009).

[9] Richard M. Ebeling, “Is Consumer Credit the Next Bomb in the Economic Crisis?” American Institute for Economic Research, October 22, 2008, (accessed May 5, 2011).

[10] Monetary Trends (St. Louis, MO: St. Louis Federal Reserve, May 2011)

[11] See, Richard M. Ebeling, “The Hubris of Central Bankers and the Ghosts of Deflation Past” July 5, 2010, (accessed May 5, 2011)

[12] See, Richard M. Ebeling, “The Lasting Legacies of World War I: Big Government, Paper Money, and Inflation,” Economic Education Bulletin, Vol. XLVIII, No. 11 (Great Barrington, MA: American Institute for Economic Research, November 2008), for a detailed example of the German and Austrian instances of monetary-financed inflationary destruction following the First World War.

[13] See, Richard M. Ebeling, “The Cost of the Federal Government in a Freer America,” The Freeman: Ideas on Liberty (March 2007), pp. 2-3; (accessed May 5, 2011).

[14] See, Richard M. Ebeling, “The Gold Standard and Monetary Freedom,” March 30, 2011,

[15] See, Richard M. Ebeling, “Real Banking Reform? End the Federal Reserve,” January 22, 2010,


The Gold Standard and Monetary Freedom

(This talk was delivered at a debate on whether “America Should Adopt the Gold Standard,” sponsored by the Atlas Economic Research Foundation and the Forum for Citizenship and Enterprise, held at Northwood University on March 29, 2011)

The severity of the current economic crisis has been serving as a catalyst for reconsideration of some fundamental questions about economic policy. This has included the size and role of government in society, the national debt burden and the unsustainability of various entitlement programs, and the relevance of fiscal “stimulus” for economic recovery.

It has also thrown up into sharp relief some crucial flaws in the nature and workings of the prevailing monetary system. The central question, I would argue, is whether or not we should continue to leave monetary and banking policy in the discretionary hands of central banks and the monetary central planners who manage them.

Central Banking as Monetary Central Planning

And make no mistake about it. Central banking is monetary central planning. The United States and, indeed, virtually the entire world operate under a regime of monetary socialism. Historically, socialism has meant an economic system in which the government owned, managed, and planned the use of the factors of production.

Modern central banking is a system in which the government, either directly or through some appointed agency such as the Federal Reserve in the United States, has monopoly ownership and control of the medium of exchange. Through this control, the government and its agency has predominant influence over the value, or purchasing power, of the monetary unit, and can significantly influence a variety of market relationships. These include the rates of interest at which borrowing and lending goes on in the banking and financial sectors of the economy, and therefore the patterns of savings and investment in the market.

If there is one lesson to be learned from the history of the last one hundred years – during which the world and the United States moved off the gold standard and onto a government-managed fiat, or paper, money system – is the fundamental disaster of placing control of the money supply in the hands of governments.

Government Abuse of Money and the Benefits of the Gold Standard

If is worth recalling that money did not originate in the laws or decrees of kings and princes. Money, as the most widely used and generally accepted medium of exchange emerged out of the market transactions of a growing number of buyers and sellers in an expanding arena of trade. Commodities such as gold and silver were selected over generations of market participants as the monies of free choice, due to their useful characteristics to better facilitate the exchange of goods in the market place.

And for almost all of recorded history, governments have attempted to gain control of the production and manipulation of money to serve their seemingly insatiable appetite to extract more and more of the wealth produced by the ordinary members of society. Ancient rulers would clip and debase the gold and silver coins of their subjects. More modern rulers – whether despotically self-appointed through force, or democratically elected by voting majorities – have taken advantage of the monetary printing press to churn out paper money to fund their expenditures and redistributive largess in excess of the taxes they impose on the citizenry. Today the process has become even easier through the mere click of a “mouse” on a computer screen, which in the blink of an eye can create tens of billions of dollars out of thin air.

Thus, monetary debasement and the price inflation that normally accompanies it have served as a method for imposing a “hidden taxation” on the wealth of the citizenry. As John Maynard Keynes insightfully observed in 1919:

By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some. The process engages all of the hidden forces of economic law on the side of destruction, and does it in a manner that not one man in a million can diagnose.

It is the corrosive, distortive, and destructive effects from monetary manipulation by governments that led virtually all of the leading economists of the nineteenth century to endorse the “anchoring” of the monetary system in a commodity such as gold, to prevent governments from using their powers over the creation of paper monies to cover their budgetary extravagance. John Stuart Mill’s words from the middle of the nineteenth century are worth recalling:

No doctrine in political economy rests on more obvious grounds than the mischief of a paper currency not maintained at the same value with a metallic, either by convertibility, or by some principle of limitation equivalent to it . . . All variations in the value of the circulating medium are mischievous; they disturb existing contracts and expectations, and the liability to such changes renders every pecuniary engagement of long date entirely precarious . . .

Great as this evil would be if it [the supply of money] depended on [the] accident [of gold production], it is still greater when placed at the arbitrary disposal of an individual or a body of individuals; who may have any kind or degree of interest to be served by an artificial fluctuation in fortunes; and who have at any rate a strong interest in issuing as much [inconvertible paper money] as possible, each issue being itself a source of profit. Not to add, that the issuers have, and in the case of government paper, always have, a direct interest in lowering the value of the currency because it is the medium in which their own debts are computed . . . Such power, in whomsoever vested, is an intolerable evil.

Under a gold standard, it is gold that is the actual money. Paper currency and various forms of checking and other deposit accounts that may be used in market transactions in exchange for goods and services are money substitutes, representing a fixed quantity of the gold-money on deposit with a banking or other financial institution that are redeemable on demand.

Any net increases in the quantity of currency and checking and related deposits are dependent upon increases in the quantity of gold that depositors with banking and financial institutions add to their individual accounts. And any withdrawal of gold from their accounts through redemption requires that the quantity of currency notes and checking and related accounts in circulation be reduced by the same amount. Under a gold standard, a central bank is relieved of all authority and power to arbitrarily “manage” the monetary order.

Many critics of the gold standard consider this a rigid and inflexible “rule” about how the monetary system and the quantity of money in the society is to be determined and constrained. Yet, the advocates of the gold standard have long argued that this relative inflexibility is essential to discipline governments within the confines of a “hard budget.”

Without the “escape hatch” of the monetary printing press, governments either must tax the citizenry or borrow a part of the savings of the private sector to cover its expenditures. Those proposing government spending must either justify it by explaining where the tax dollars will come from and upon whom the taxes will fall; or make the case for borrowing a part of the savings of the society to cover those expenditures – but at market rates of interest that tell the truth about what it will cost to attract lenders to lend that sum to the government rather than to private sector borrowers, and therefore, at the social cost of private sector investment and future growth that will have to be foregone.

In other words, it prevents the government from “monetizing the debt” to cover all or part of its budget deficits. The borrowed sums cannot be created out of thin air through central bank monetary expansion. The government, under a gold standard, can no longer create the illusion that something can be had for nothing.

As Austrian economist, Ludwig von Mises, expressed it:

Why have a monetary system based on gold? Because, as conditions are today and for the time that can be foreseen today, the gold standard alone makes the determination of money’s purchasing power independent of the ambitions and machinations of governments, of dictators, and political parties, and pressure groups. The gold standard alone is what the nineteenth-century freedom-loving leaders (who championed representative government, civil liberties, and prosperity for all) called “sound money.”

Milton Friedman’s “Second Thoughts” About the Benefits of Paper Money

It must be admitted that even some advocates of economic freedom and limited government have been advocates of paper money. The most notable one in the second half of the twentieth century was Milton Friedman. Over most of his professional career he argued that maintaining a gold standard was a waste of society’s resources. Why squander the men, material and machinery digging gold out of the ground to then simply store it away in the vaults of banks? It is better to use those scarce resources to produce more of the ordinary goods and services that can enhance the standard and quality of people’s lives. Control the potential arbitrary recklessness of central banks, Friedman proposed, by setting up a monetary “rule” that says: Increase the paper money supply by some small annual percent, with no discretion left in the hands of the monetary managers.

But it less well known is that in the years after Friedman won the Nobel Prize in Economics in 1976, he had second thoughts about this monetary prescription. In a 1986 article on, “The Resource Costs of Irredeemable Paper Money,” he argued that when looking over the monetary mismanagement and mischief caused by governments and central banks during the twentieth century, it was “crystal clear” that the costs of mining, minting and storing gold as the basis of a monetary system would have been far less than the disruptive and destabilizing costs imposed on society due to paper money inflations and the booms and busts of the business cycle brought about by central bank manipulations of money and interest rates.

In his 1985 presidential address before the Western Economic Association on “Economists and Public Policy,” he said that Public Choice theory had persuaded him that it would never be in the long-run self-interest of governments or central bankers to manage the monetary system according to some hypothetical “public interest.” Those in government or holding the levers of the monetary printing press will always be susceptible to the temptations and pressures of short-run political gains that monetary expansion can fund. He admitted that it had been a “waste of time” on his part to try to get governments and central banks to follow his idea for a monetary rule.

And in another article in 1986 (co-authored with Anna Schwartz) on, “Has Any Government Any Role in Money?” Friedman said that while he was not ready at that time to advocate a return to the gold standard, he did conclude that “that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.”

Monetary Mismanagement versus Markets and Gold

But it is not only the political dangers arising from government mismanagement of paper money that justifies the establishment of a gold standard. It is also and equally the fact that monetary central planning is unworkable as a means to maintain economy-wide stability, full employment, and growth.

Especially since the 1930s, many economists and policy makers influenced by Keynes and the Keynesian Revolution have believed markets are potentially unstable and susceptible to wide and prolonged fluctuations in employment and output that only can be prevented or reduced in severity through “activist” monetary and fiscal policy.

But in reality, the causation runs the in the opposite direction. It is central bank manipulations of money, credit and interest rates that have generated the instability and periodic swings in economy-wide production and employment.

The fact is financial institutions and interest rates have important work to do in the market economy. Banks and other financial intermediaries are supposed to serve as the “middlemen” who bring together those who wish to save portions of their earned income with others who desire to borrow and invest that savings in profit-oriented productive ways that generate capital formation, technological improvements, and cost-efficient production of new, better and more goods and services to satisfy consumer demands in the future.

Market-determined interest rates are meant to bring those savings and investment plans into coordination with each other, so the amount of invested capital and the time-shape of the investment horizons undertaken are consistent with the available real savings to support them to maintainable completion.

Monetary expansion by central banks creates the illusion that there is more actual investable savings in the economy than really exists. And the false interest rate signals generated in the banking system by the monetary expansion not only misinforms potential investment borrowers about the amount of real savings available for capital projects, but creates an incorrect basis for determining the present value calculations that influence the time horizons for the investments undertaken.

It is these false monetary and interest rate signals that induces the misdirection of resources, the mal-investment of capital, and the incorrect allocation of labor among employments in the economy that sets the stage for an inevitable and inescapable “correction” and readjustment that represents the recession stage of the business cycle that follows the collapse of the artificial boom.

The monetary central planners can never be more successful in determining a “optimal” quantity of money or the “right” interest rates to assure savings-investment coordination than all other socialist planners were when they tried to centrally plan agricultural production or investment output for an entire society. All such attempts at monetary planning and management by central bankers are instances of what Friedrich A. Hayek called in his Nobel Lecture a, “pretense of knowledge,” that they can know better and do better than the outcomes generated by competitive interactions of the market participants, themselves. And as Adam Smith warned, nowhere is such regulatory power “so dangerous as in the hands of a man who had the folly and presumption enough to fancy himself fit to exercise it.”

There is no way of knowing the optimal amount of money in the economy other than allowing market participants in the competitive exchange process to decide what they want to use as money – which has historically been a commodity such as gold or silver. And there is no way of knowing what interest rates should be other than allowing the market forces of supply and demand for lending and borrowing to determine those interest rates through the process of private sector financial intermediation, without government or central bank interference or manipulation.

The Return to the Gold Standard as a Monetary Constitution

Finally, how do we return to a functioning and workable gold standard? Under the current government and central bank-controlled monetary system the simplest method might be for the monetary authority to stop creating and printing money and credit. Over a short period of time a fairly reasonable estimate could be made about the actual quantity of a nation’s currency and checking and related deposits that are in existence and in circulation. A new legal redemption ratio could be established by dividing the estimated total quantity of all forms of these money-substitutes into the quantity of gold possessed by the government and the central bank.

A country following this procedure would then, once again, be on the gold standard. Its long-run maintainability, of course, would require the government and the central bank to follow those “rules of the game” that no increase in the quantity of money-substitutes may be created and brought into circulation unless there have been net deposits of gold in people’s accounts with banking and other financial institutions.

Can we trust governments and central banks to abide by these rules of the game? The temptations to violate them will still remain strong in a political environment dominated by ideologies of wealth redistribution, special interest favoritism, and numerous “entitlement” demands.

It is why the real long-run goal of monetary reform should be the denationalization of money. That is, the separation of money from the state by ending of central banking, altogether. In its place would emerge private, competitive free banking – a truly market-based money and banking system.

But nevertheless, in the meantime, a gold standard can serve as a form of a “monetary constitution” setting formal limits and imposing restraints on those in government who would want to abuse the monetary printing press, similar to the way political constitutions, however imperfectly, are meant to limit the abuses of power-lusting monarchs and the plundering majorities in functioning democracies.

If it fails, it should not be for want of trying. And a gold standard can be one of the positive institutional reforms in the attempt and on the way to a fully free market monetary system.


Practising the Principle of Freedom — At Home and Abroad

One of the great aspects of Richard Cobden’s defence of freedom of trade was his emphasis on its relationship to peace.

Minimal intercourse between governments, as he said, and the greatest possible intercourse among nations (i.e., people themselves through trade and commerce).

In my history of economic thought class recently I was explaining to my students how the ideas of Adam Smith had inspired the free trade movement in Great Britain in the years after the wars with France. And how the motto of the Anti-Corn Law League became “Free Trade, Peace, and Good-Will Among Nations“.

Reading through that older literature from the late 19th and early 20th centuries, virtually all of the British liberals, inspired by and loyal to the spirit of Cobden and the free trade movement, were strongly and vocally anti-imperialism, anti-arms race, and anti-war.

Today, following a UN resolution, British and French forces are preparing to enforce a “ban on all flights in Libyan airspace”.

This essay, first published in 1995, sets out the case for non-intervention.

Personal Freedom and the Principle of Non-Intervention at Home

As an advocate of individual liberty, I consider all forms of government interference in people’s lives, other than those minimally essential for the protection of life, liberty, and property, to be morally wrong, politically harmful, and economically counterproductive. As part of that political philosophy, I believe that the government of the United States should no more intervene into the internal affairs of other countries than in the personal, peaceful, and voluntary affairs of its own citizens at home.

Many of my fellow countrymen follow courses of action in their own lives that I consider stupid, immoral, and harmful. But I also feel strongly that it would be morally wrong and pragmatically counterproductive to force my fellow countrymen to follow the courses of action I consider to be wiser and better for them.

Either every man must be respected and protected as a free agent in his own affairs, or we run the risk of degenerating into a society of coercing meddlers, each with his own banner of “right living,” each trying to use the political power of the state to make our fellow citizens bend to our vision of the good, proper, and virtuous life. Society becomes a war of all-against-all, as individuals sharing similar conceptions of that “right living” form coalitions for strength in the struggle for votes, influence, and control of the state’s authority to use force.

Personal Choice, Not Political Coercion, Makes for Moral People and a Good Society

But men being what they are, even when they begin as pure-at-heart “true believers,” only wishing to use the state for the good of others (as they conceive that good), soon are taken over by the “dark side of the force.” The welding of power over others becomes an aphrodisiac, a “high” stronger than any narcotic; and, besides, having political power also has its use for material gain, both for oneself and for those with whom one is in coalitions for power. Few have been able to resist these temptations over the ages. Even when the first generation of coercing meddlers coming to power remained fairly uncorrupted by the opportunities for personal gain, their heirs in acquiring the reins of political authority have tended to have fewer inhibitions for resisting these temptations.

Furthermore, coercion can never, ultimately, be a means for making men good or virtuous. Force can control men’s behaviour — it can prohibit them from doing certain things and command them to do others — under the threat and use of various physical or psychological punishments. But this does not make those actions moral or virtuous. An act is moral or virtuous only by virtue of it being the free choice of a human being who, in principle, could have done the opposite. Morality and virtue are in the minds and hearts of men, not in the control of their external conduct.

Imposed conformity does not result in moral conduct; it is the denial of morality. By narrowing or abrogating the field in which a man in his actions must make up his own mind as to what is “the right thing to do,” the state removes the necessity to more conscientiously think and decide about what he should do as a self-responsible human being.

By denying him the freedom to choose in various corners of his life, the state frees the individual from being more fully responsible for his actions. When men are freed from responsibility for their actions, the conditions are created for the growth of a climate of amorality: “It’s not my responsibility, I paid my taxes” or “I’m not accountable, I just obeyed orders.”

In the free society, the only appropriate means for trying to change other people’s conduct is through reason, persuasion, and example. The coerced man often harbours resentment and anger in his heart, both against the coercer and at himself because he had not the courage to resist being made to do what he did not want. The free man, when he changes the things he does due to the persuasion or example of others, feels gratitude and joy for having been shown a better purpose in life or how to more successfully pursue his ends.

When other men freely choose to change their behaviour due to our arguments or example, it is more likely, therefore, to represent an actual change of heart or of mind. And that is how the world is, ultimately, really changed — one person at a time, for good or evil.

The Dangers and Unintended Consequences from Foreign Intervention

Men and governments in other countries have done and are doing many evil things. They have killed, brutalized, tortured, and destroyed; and especially in the century that has recently ended, it was done on a scale that goes beyond our mind’s ability to fully comprehend. They have shocked our conscience and made us doubt the existence of any humanity in the human being. In a world of such conduct by others in other lands, it has been natural that many in America have wanted to “do something” — to come to the aid of those victimized by evil and to stop evil from doing it anymore.

But similar to the pattern too often at home, people disturbed by the immoral acts of others abroad have turned to the state to right the wrongs occurring in foreign lands. They have wanted their government to intervene in the affairs of people in other countries, to oppose bad governments and evil men and, in their place, foster good government and support better men.

Rarely has this been successful in achieving the end desired; and even when the result in the short-run has seemed better than what had been before, the intervention has often had longer-run, usually unintended, consequences that have made new outcomes often similar to, and sometimes worse than, the ones the intervention was meant to cure.

Even when people oppressed by a tyrant have been liberated from their torment, the people freed frequently turn against their liberators. It begins to play on their pride that they were not able to free themselves. Also, the liberating government is often not satisfied with merely eliminating the evil government; to justify the sacrifice made by its own people, in lives and money, to free those who had been living under foreign oppression, the liberating government tries to establish a “new order” of good government and honest politics in that foreign land.

But, alas, good government and honest politics often have different meanings for the people in that foreign country. Customs, traditions, and other societal practices call for political structures and methods of authority frequently quite different from what the liberating government’s “advisors” view as the good or the better. Irritated and angry at the appearance of being told by the liberators how to live their lives and run their affairs in their own country, the people in that foreign land soon start wishing that the meddling Yankee (or the Limey Brit, or the French Frog, or the Russian Bear) would go home.

And too often, the emotional reaction of being dictated to by the foreign power (who only yesterday was hailed as the great liberator), plays into the hands of the demagogue and would-be new tyrant hoping to ride to power on the wave of anti-foreign sentiment. The military forces and civilian advisers of the liberating government soon find themselves the new targeted enemy of the very people whom they wanted to free from the evils and injustices of the past.

At home, the interventionist government often finds itself — sooner or later — governing a “house divided” over the justification for the intervention and its continuance. Sometimes there is no consensus from the start that the foreign intervention is justified. People in the society, to the extent they take any interest in international events, take different sides concerning who is in the right and who has been wronged in that foreign country — who is the oppressor and who needs to be freed. If the foreign intervention is undertaken, then from the start, there will be many in the country who oppose and resent their wealth being taxed and the lives of their loved ones in the military being put in harm’s way to fight for “the wrong side.” If the foreign intervention has broad support among many in the society, then dissent is muted at first.

But if the intervention is not short and clearly successful, then second thoughts begin to emerge among a growing number of people: Was the intervention the right thing to do from the start? Are we becoming the enemy of the very people we wished to befriend? Are we making the situation in that country worse than it was before? Is it worth the sacrifice in men and money — ours and theirs — to continue the intervention?

Even if the foreign intervention seems to have been successful — with the goals appearing to have been achieved quickly, with minimal sacrifice in lives and money, and with “our boys” already having come home — the intervening government often leaves behind a situation in that foreign country that soon becomes not much different from what existed before.

Why? Because merely overthrowing the existing political order and imposing a new political order does not change the ideas, beliefs, customs, and traditions of the people. Such impositions may temporarily affect the external behaviour of those people, but it does not transform what guides their sense of right and wrong, good and bad, just or unjust; these are matters of their hearts and minds, and these cannot be coerced into change. The only alternative is for the intervening government to stay on in that foreign country as a permanent, coercing meddler, and that usually only leads to more problems, not solutions.

Practising the Principle of Freedom Abroad: Private Solutions to Foreign Problems

What, then, is to be done in the face of evil in other lands? For the advocate of freedom, the answer is the de-politicization, the privatization of foreign intervention. In our private life, we have many friends, neighbours, and family members whom we care about and desire to help; we desire to help them in getting through times of trouble and hardship, and we want to help them in trying to find better principles to guide their lives, so many of the problems that have been caused by their past choices do not happen again.

Sometimes these tasks are more than we, ourselves, can try to solve, so we form voluntary associations, organizations, and clubs to pool our efforts with those who share the same desire to help and see value in the same peaceful methods for attaining the end. Others “go it alone” in their endeavours to assist their fellow men, and still others form different associations because, though they believe in the same end, they think there are better means to achieve it than the ones we decide to try. And others in the society choose not to participate at all in these types of tasks, because they place a higher value on other things, in terms of an expenditure of their time, money, and efforts.

No one is compelled to care or to help, nor is any one forced to accept one way of doing things as the only correct method. Such voluntary associations and institutions are among the essential foundation stones of civil society. They are also the free society’s private solutions to what are called “social problems.”

The de-politicization or privatization of foreign intervention means an approach analogous to the private institutions of voluntary association for the handling of domestic “social problems.” Those who see distress and hardship among peoples in other lands, and who desire to assist them, should not be restricted in forming associations and charities to pool their resources to supply such help. But neither should others who do not share that same concern, or who consider there to be other answers to solve those foreign problems, be compelled to provide assistance if they choose not to.

If oppression reigns in a foreign land or if a peaceful people in another country are threatened or aggressed against by another state, any citizen in a free society should have the liberty to volunteer his help. This help can include financial contributions or personal service. He can offer to fight alongside the “freedom fighters” resisting their own government’s tyranny, or he can offer his services in the military of that foreign country to help repel the aggressor nation. He can choose to do so for free or for pay. He can form associations and societies to pool his own resources with those of others to buy military equipment, medical supplies, or emergency food and clothing. He can try to persuade others in his own country to see the rightness in the cause and join him in fighting the good fight to win freedom for others in those other lands.

The Importance of Principle, and Not Expediency – Even for Seemingly “Good Causes”

But what would be inconsistent with any person’s crusade in the cause of freedom in other lands would be to abrogate the freedom of his own fellow citizens in the pursuit of that cause. It is easy to say that all that is asked for is a small violation of the liberty of his fellow citizens in the good cause of the freedom of so many others. But is this any different from the appeal often heard, that it is only small violations of people’s liberty that is being asked for to feed the hungry, to house the homeless, to assist the poor, to support the handicapped, to. . .?

Once the principle of liberty is breached, no matter how deserving the cause may sound, all other such abridgements soon become matters of pragmatic judgement. Well, if it seemed reasonable or meritorious to abridge some people’s liberties for this cause, then surely to extend that abridgement just a little longer, or a little more, for this other good cause cannot be objected to, can it? If we sacrificed some people’s liberty to intervene in country X for a good cause, then surely to do it again or more forcefully for the noble endeavour of helping these other unfortunate people in country Y cannot be objected to, can it? Where does it stop? And whose judgement shall prevail in making this decision?

The fundamental duty of the state is the protection of the life, liberty and property of the citizenry within its own territorial jurisdiction. If the state goes beyond this, it can only do so by taking the wealth, income, and resources of some to improve the circumstances of others, i.e., by means of coercive meddling. Either we have the protection of equal individual rights for all before the law or we have unequal privileges for some at the expense of others. This is the choice concerning the role of the state, whether in domestic or foreign affairs. There is no third alternative.


Adventures in Economics: An Interview with Richard M. Ebeling

This interview appeared in the February 2011 issue of the “Lara-Murphy Report,” published by the United Services & Trust Corp., Nashville, Tennessee,, and was republished on Northwood University’s blog, In Defense of Capitalism & Human Progress

Austrian Economics – “Then” and “Now”

Lara-Murphy Report: You have spent your whole career promoting and teaching Austrian economics—in fact, one of us is a former Ebeling student! From your perspective, what has happened with the Austrian movement as a whole? What would you say to today’s young libertarians and Austrians, who take it for granted that the average person on Wall Street has probably at least heard of Austrian business cycle theory?

Richard Ebeling: When I first became interested in Austrian Economics as a teenager back in the 1960s, there was virtually no Austrian School – most certainly it was not mentioned in the classroom. Keynesian Economics was riding high, with its argument that only Big Government could keep the economy on an even keel through manipulative monetary and fiscal policy. And socialist central planning was considered the ideal for “third world” countries to rise out of poverty; it was also said to be a good thing if more government control, regulation, and income redistribution could be introduced here at home in America, as well.

This was the message that I was getting from all my undergraduate professors while I was studying economics. To speak up in my classes and suggest the relevancy and importance of the ideas of the Austrian Economists was to invite ridicule, sarcasm, and verbal attack from both professors and fellow students. The attitude was that the Austrian argument for a free and competitive market process was out-of-date and as dead as the Dodo bird.

I had to learn all my real economics understanding by reading on my own. That is how I found out about and came to appreciate the ideas of those earlier, leading members of the Austrian School – Carl Menger, Eugen von Böhm-Bawerk, Ludwig von Mises, and Friedrich A. Hayek.

I had the luck to be invited to a unique Austrian Economics conference sponsored by the Institute for Humane Studies in June 1974, where I had the wonderful opportunity to meet Murray Rothbard, Israel Kirzner, Ludwig Lachmann, and Henry Hazlitt, and a handful of other young people who, like myself, had discovered the Austrian tradition on their own (many of whom are prominent members of the Austrian School today).

More than thirty-five years later the world is a very different place. There are colleges and universities where a student can take courses in Austrian Economics, and even study Austrian Economics as a specialized field in an economics graduate program, such as at George Mason University in Virginia.

Every year I teach a course on Austrian Economic Theory at Northwood University in Midland, Michigan, as well as incorporating Austrian ideas into all my other classes, as part of an economics department that is free market and Austrian “friendly.”

There are Austrian-oriented institutions and think tanks, such as the Ludwig von Mises Institute in Auburn, Alabama, for instance, that offers a vast print and online library of all the great works of the Austrian Economists, and where an interested student can attend conferences on Austrian ideas. Excellent online courses are regularly offered (including by Bob Murphy) and online articles are published virtually everyday applying Austrian ideas to contemporary economic policy issues for an increasingly worldwide audience.

And there are vibrant and challenging Austrian blogs such as “Coordination Problem” and “ThinkMarkets.”

Most certainly, the current economic crisis has served as a powerful catalyst for economists and business analysts to find in the Austrian theory of money and the business cycle a clear, coherent, and empirically relevant explanation of how government manipulation of interest rates and monetary expansion create the distortions and imbalances throughout the economy that set the stage for an inescapable recession following a false boom. It has provided a far better explanation for understanding how we got in to the present mess, and why only allowing the economy to self-correct can put America back on the path of a well-coordinated and sustainable market system of freedom and prosperity.

These are wonderful times to be an Austrian Economist. The insights and contributions of great Austrian thinkers, like Mises and Hayek, are helping to clear away the intellectual rubble and misguided policies created by Keynesian and collectivist ideas.

Trends Can Change – They Have in the Past and They Will in the Future

LMR: Ironically, just when it seems everything is finally clicking for those who are interested in spreading the ideas of liberty, the U.S. government at least seems to be accelerating its slide into a form of corporatism, if not outright socialism. You have studied the history of liberty quite extensively. Is our pessimism accurate, or does every generation of liberty-lovers think they face the worst threat ever?

RE: Ludwig von Mises always emphasized that “trends can change.” He pointed out that they have changed in the past and will most likely do so again in the future. One of the most frustrating, yet promising things in life is that the future always has an element of unpredictability.

I lived a good part of my life, like many of us, in the shadow of the Cold War. As an economist I understood why socialism could not and did not work as an economic system, and why a socialist economic system always resulted in political tyranny and loss of personal freedom.

But who among us, who lived through that time, really expected to see the end of the Soviet Union in our lifetime – unless it came about either through a terrible and bloody civil war within Soviet Russia or through a catastrophic global nuclear war? And, yet, in the late 1980s and early 1990s, the contradictions and corruptions of the Soviet system began to unravel. And within a few, short years the Soviet system imploded, and only with the loss of a relatively small number lives of brave souls during those last years.

I was in the Soviet Union working as a consultant on market reform and privatization 1990-1991, and I saw with my own eyes heroic Lithuanians in Vilnius and Russians in Moscow who died fighting for freedom against Soviet tyranny. But on the whole, Soviet socialism went out with a whimper, and not a huge bloody bang. Who, honestly, predicted that this great change would happen this way, at that time?

In Human Action, Ludwig von Mises refers to the “reserve fund” of wealth and capital in a prosperous society that a plundering government can draw upon for a long time, to feed its gluttonous drive for power and to provide the favors and privileges for special interest groups that keep the political elite in control.

But the reserve fund of private sector wealth for the government to eat from finally and inevitably must reach its end, Mises argued. That is, very possibly, what we are witnessing here in the United States and some other parts of the world today. America and countries in Europe are facing major fiscal crises caused by blood sucking taxes, crushing government debt burdens and huge unfunded liabilities adding up to tens of trillions of dollars (such as social security and government healthcare programs), strangling regulations that hinder competition and innovation, and inflationary misdirection capital and labor that throw market supplies and demands out of balance.

If we are at such a turning point – such a change in trends – what will be crucial in determining the direction it all takes will be the power and influence of the ideas that explain to our fellow citizens how the crisis has come about, why government is no longer – and never was — the answer; and why a reborn system of individual liberty and free market capitalism is essential in the decades to come.

The responsibility of making that case falls upon all of us who care about liberty.

Austrian Economics Helps Explain How the Real World Works

LMR: In the previous question, we said it was “ironic” that the growing popularity of the Austrian and libertarian movements is occurring precisely as the federal government and Federal Reserve amass more powers. But is this actually to be expected? In other words, does the public not bother to worry about “abstract” things such as economic freedom and civil liberties, when the nation is at peace and the unemployment rate is 3%? Are Americans only now looking to the Austrians because they might be able to avert the brewing disaster?

RE: Perhaps it is a part of human nature to often take the psychological attitude that, “if it ain’t broken, it don’t need fixing.” And for decades, in spite of the occasional inflationary boom and bust cycle, it seemed to many that the American interventionist-welfare state was both desirable and sustainable. The current fiscal crisis that is hitting both the Federal government and the majority of state governments across America is forcing people, as voters and taxpayers, to rethink not only what government can afford to do, but also what it is government should do.

An essential part of this rethinking about the role of government in society is understanding why politicians and bureaucrats have neither the wisdom nor the ability to manage a complex and ever-changing market order in which multitudes of millions of people interact and coordinate their diverse wants as consumers with their abilities and talents as producers.

The Austrians, more than most other economists, have demonstrated beyond any doubt that only a functioning and free market economy can provide the means for achieving this coordination through a price system that tells the truth about the changing conditions of supply and demand, and leaves people at liberty to competitively discover and take advantage of mutual gains from trade that results in rising standards and qualities of living for all in the long run.

Whether the growing number of Austrian Economists can succeed in helping to stop this massive monetary and fiscal madness before it becomes the disaster to which it must otherwise lead, only the future will tell. But either way, there is only one path back to freedom and prosperity: radically reducing the size and intrusion of government into our personal lives and market activities; drastically cutting state and federal taxing and spending and eliminating the interventionist-welfare state; and ending our system of monetary central planning by abolishing the Federal Reserve, and returning to a commodity-backed monetary system such as the gold standard, along with the total privatization of banking and the financial system.

The Austrians offer the clearest and most persuasive arguments, in my view, as to why and how this needs to be done.

The “Lost Papers” of Ludwig von Mises, and Their Significance

LMR: For our final question, could you give the highlights of your famous acquisition of Ludwig von Mises’ “lost papers”? Many of our readers might not realize that you are a real-life Indiana Jones.

RE: Actually, I’m a big fan of those Indiana Jones movies, so thank you for that comparison and complement!

Ludwig von Mises, as many of your readers may know, was one of the most influential Austrian Economists of the twentieth century. He explained why socialist central planning could not work; why government intervention leads to insoluble distortions that prevent markets from effectively functioning; and why government monetary manipulation is the source of the booms and busts of the business cycle.

He lived and worked in Austria through much of the 1920s and 1930s, and was viewed as a forceful enemy of both Soviet socialism and German Nazism. By the time Hitler invaded Austria in March 1938, Mises was teaching in Geneva, Switzerland, but he had kept part of what had been his old apartment in Vienna. The Nazis came looking for him at that apartment. He was safe in Geneva, but they boxed up and took away all his papers, correspondence, manuscripts, and family and professional documents. For the remainder of his life, he believed the Nazis had destroyed all of these materials.

In fact, they ended up in a small town in Bohemia, where the Nazis stored all the vast collections of papers, documents and archival materials that they plundered from all the countries they occupied during the war. This huge cache of material was captured by the Soviet Army at the close of the war, and ended up being housed in a special KGB archive in Moscow that Stalin ordered to be built in the late 1940s. And there they remained, closed to every one except the Soviet secret police and the Soviet foreign ministry until the 1990s.

My wife, Anna, and I found out in 1996, that Mises’ papers had survived the war and were in this archive. Anna is originally from Moscow and, using her friends and contacts in the post-Soviet government, arranged for us to gain access to Mises’ papers in this archive. We spent nearly two weeks in October of 1996 going through Mises’ papers, which turned out to be around 10,000 pages of materials, and returned to the U.S. with photocopies of virtually the entire collection.

Liberty Fund of Indianapolis contacted me shortly after our return, and offered to publish a selection of these papers. I have served as the editor of this project, overseeing the translation process and editing the papers for publication in a three-volume set under the title of the Selected Writings of Ludwig von Mises. Two of the three volumes have already been published, and the third volume should be out by late 2011 or early 2012.

It gives a unique insight into Mises, not as the grand theorist of the free market and critic of socialism, interventionism, and inflationism. But, instead, we see Mises as the detailed economic policy analyst during the years before and after the First World War when he made his living as a senior staff member as the Vienna Chamber of Commerce. For those who sometimes wonder, “Well, how do you apply Austrian Economics to the real world of economic policy and practice?” Here is it, by the leading voice of Austrian Economics during the last one hundred years.

Preparing these papers for publication has been one of the most thrilling and rewarding experiences of my long years as an economist.


Lyndon Johnson’s “Great Society”: A Free Market Critique

The following talk was delivered at John Jay College of Criminal Justice in New York City on March 7, 2011, as a lecture in a series on “The 1960s: the Struggle for Justice Intensifies.”

Fifty years separate us, now, from the 1960s. For many who are college-age students today, it all must seem like ancient history. And even for those of us who are old enough to have lived a part of our young lives in that decade, it seems a long time ago – and yet, at the same time, it seems like only yesterday.

Our memories fill up most frequently, I suppose, with two recollections of that time: the Civil Rights Movement and the Vietnam War. The first involved the abolition of the last remnants of that “peculiar” institution that had, at first, kept enslaved a portion of the population of the United States; and then, even when slavery had ended, still used legal barriers, restrictions, and sometimes-brutal force to prevent a distinguishable minority of that population from having impartially secured equal rights before the law.

The second stands out as a searing memory of a military conflict ten thousand miles away from the United States, which went on for more than a decade, and at the cost of 55,000 American lives and at least one million causalities among the Vietnamese people. It was a war that tore the United States apart unlike any other armed conflict in American history since the Civil War of the 1860s, a century earlier. Tens of thousands of young men, not fortunate enough to have a college deferment, were conscripted into the U.S. armed forces, and sent off to fight a war that at least half of the American people either did not support or did not understand. And which finally ended with one of the most humiliating defeats in American military history.

Vietnam: The Hubris of War Planning and Conflict Fine-Tuning

A part of the Vietnam War tragedy was due to the fact that it was managed by “the best and the brightest,” as David Halberstam called them in his well-known book with that title. These were the people within the Kennedy and Johnson Administrations who orchestrated and escalated the war as the conflict progressed through the 1960s.

Halberstam referred to these war managers as the “whiz kids.” They believed that they had the theoretical and quantitative knowledge and ability to fine-tune a military conflict. By incremental “escalation,” they could bring to bear just enough pressure at vital points considered crucial to the enemy in North Vietnam. This would compel the appropriate response from the communist regime in Hanoi, to assure that the conflict ended with an “acceptable” outcome.

The disaster and the destruction that befell both the American and the Vietnamese people resulted from their arrogant pretence of possessing all the necessary and relevant knowledge for them to design and direct a war on the other side of the world, and, seemingly, all according to a central plan constructed in Washington, D.C.

What they learned (or should have learned) were the inescapable limits to man’s ability to try to consciously direct the future course of human events, and the ever-present occurrence of “unintended consequences.” It was a costly lesson in the need for humility and caution in believing that it is in our power to socially engineer global affairs to our own liking.

Lyndon Johnson – Master of Events and Manipulator of Men

The same, I would like to suggest, was also the case in the domestic policies of the Lyndon Johnson Administration, which became known as the Great Society agenda. Johnson was the consummate politician. Born in west Texas, he won a seat in the House of Representatives in 1937, and was a loyal supporter of Franklin Roosevelt and his New Deal programs. He won a seat in the U.S. Senate in the 1948 election, and later became the Democratic Party leader in the Senate, until his run for the vice-presidency of the United States as John F. Kennedy’s running mate in 1960. He became president in November 1963, following the assassination of JFK.

Johnson considered himself to have an uncanny power to read situations, manipulate and intimidate men, and control the flow of political events. In his leadership role as majority leader, Johnson supposedly knew every detail of the public and private lives of all the other members of the U.S. Senate. He, seemingly, knew just the right “buttons” to push to make the votes and often the policies go the way he wanted.

In one of the ironies of history, in 1954 he was used his Senatorial influence to stop then-President Eisenhower from militarily intervening into what was at that time France’s colonial war in Vietnam against Ho Chi Minh’s communist guerrilla forces. The French defeat left a divided Vietnam that became the catalyst for next phase of this conflict, and which pulled America into the vortex of war and finally brought about the downfall of LBJ.

While the Vietnam War became inseparably intertwined with Johnson’s name and was a defining mark of his presidency, he really viewed his Great Society agenda as the legacy for which he wanted to be remembered. In his mind, he was attempting to fulfil and complete the New Deal programs initiated by his mentor, FDR.

The Great Society: Designing a “War” on America’s Ills

What guided the Great Society agenda was not just Johnson’s political savvy. It was also the equally arrogant pretence of knowledge on the part of many in the economics profession of that time. As a student in my first undergraduate economics classes in the late 1960s, I soon learned that there was only one economics: Keynesian Economics, named after the famous British economist, John Maynard Keynes, who had published a book called The General Theory of Employment, Interest, and Money, in 1936.

Most economists, especially in macroeconomics, were convinced that the market economy was inherently flawed and susceptible to periodic and wide fluctuations in employment and production. They believed they had discovered the necessary monetary and fiscal policy tools to “steer” the economy and simultaneously maintain “full employment,” stable prices, and stimulate long-run growth in the economy as a whole.

At the same time, there was a general attitude among many economists and a large number of self-proclaimed social critics that most of the “evils” of the world – poverty, illiteracy, lack of decent housing or medical care, and environmental degradation – were all due to a lack of will-power and well intentioned and implemented policy. The guiding premise was that the private sector had failed in meeting these problems, and indeed may have contributed to them due to a disregard for “national needs,” while pursuing private purposes.

In a speech in May of 1964, President Johnson proposed a series of “activist” government policies that would create a “Great Society” for America. He told his audience that he was determined “to assemble the best thought and broadest knowledge from all over the world to find [the] answers” to these social ills. In 1965, following Johnson’s reelection to the presidency, he initiated a wide variety of pieces of legislation to fight his declared “wars” on these social ills. Government programs and spending were either introduced or expanded in almost every domestic direction.

Among the leading Great Society programs were:

  • · Medicare and Medicaid (as amendments to the Social Security Act)
  • · Economic Opportunity Act
  • · Office of Economic Opportunity
  • · Community Action Agencies
  • · Elementary and Secondary Education Act
  • · Higher Education Act
  • · Model Cities Program
  • · Housing and Urban Development Act
  • · Urban Mass Transit Act
  • · Supplemental Nutrition Assistance Program (Food Stamps)
  • · National Endowments for the Arts
  • · National Endowments for the Humanities
  • · Wilderness, Endangered Species, and Federal Water Pollution Control Acts

In the time available, it would, obviously, be impossible to offer a detailed, critical examination of each of these programs and pieces of legislation, and their impacts on various parts of society over the decades. Instead, I would like to approach it from a sceptical view of the underlying political, economic and social premises upon which the Great Society agenda was proposed and implemented. And, then, draw some conclusions about their longer-term effect on American society today, including the fiscal crisis in which the country finds itself.

Political Paternalism and the Reduction of Freedom

The fundamental premise upon which the Great Society vision for America was conceived is the idea of political paternalism. Good men, with enough political power, authority, and financial resources can successfully solve the problems of society. The dilemma, however, is that for government to do anything for us, it must at the same time have the police power do things to us.

If government is to plan our retirement, provide our education, oversee and guarantee our health care, supply our housing, and give us various amounts of cash and other in-kind benefits, then that same government must, invariably, determine and dictate the form, quality, quantity, and conditions under which we can be and will remain eligible for such welfare redistributive benefits.

Thus, many of the welfare programs specified, for example, the make-up and membership of a household to receive government housing, child allowances, and cash payments. Federal money to education invariably ended up coming with standards, requirements, and restrictions on the content of what was taught and the benchmarks for measuring student success for continued funding. Government financing of health care necessarily incorporated regulations, controls, and rules about the pricing of health care services, the types of treatments and coverage permitted or restricted, and access to what care in terms of age and gender.

Increasingly, the individual’s options and choices were narrowed by, and confined to, what the government directly supplied, or mandated through its rules and regulations. This, obviously, hit those in the lower income categories the most. Once such individuals and groups were completely or heavily dependent upon these government programs, escape from them was difficult due to the significant loss of benefits if such a recipient wished to find private-sector employment at a wage that would greatly reduce or terminate their eligibility for these programs. Thus, an underclass of more or less permanent wards of the state was created with inter-generational dependency on government transfers growing in frequency.

This political paternalism, obviously, also implied that those in the government establishing these standards and rules for welfare eligibility presumed to know what all those receiving such benefits and services “really” needed. That is, what kind of housing, what type of medical care, what content of education, what kind of nutritional requirements the recipients of these programs should receive.

Political Hubris and Unintended Consequences

This, too, was no less an arrogance or hubris on the part of the government welfare providers that the poor and unfortunate recipients of the government largess clearly did not have the knowledge, experience, or forethought to make such decisions for themselves. Since the State was providing these benefits, the State clearly knew best what “these” people really needed for them to have some minimum form of a “decent life.” The “poor” were classified and homogenized into one or a small handful of sizes that were to “fit all,” with little regard or sensitivity to the diversity between individuals and their personal and family needs and values.

This implicitly condescending attitude toward those receiving Great Society transfers resulted in some free market critics, such as Milton Friedman, to argue that if government was going to redistribute wealth it would show much more respect and confidence in such recipients if, instead of in-kind benefits in the form of such things as government housing, food stamps, health care services, etc., the government merely gave them cash equivalents. This way, each individual, in his own circumstances, and in terms of his own judgment about what was more or less important to her and her family could make the market-based trade-offs that would most fit with what they needed or valued.

But here, in essence, was the same fundamental flaw in the Great Society agenda as was to be found in the executing of the Vietnam War: the confidence and belief on the part of the implementers of these programs that they could redesign the social order at home just like the foreign policy makers believed they could remake entire societies abroad.

And here, too, were a series of unintended consequences. These included the weakening and break-up of groups and families due to inter-generational dependency on government programs; the emergence of an “entitlement mentality” that taxpayer-funded transfers from the government were as legitimate as a source of income as earning a living from a private-sector job; the entrapment of those on welfare in isolated, poorly-managed, and increasingly crime-infested public housing projects; and the deterioration of educational standards in public schools, especially in inner city areas of the country.

For the free market critic, the entire direction of the Great Society agenda was wrong-headed. Precisely because it was desirable to see an improvement in the condition of those least and less well off in society, government’s role had to be less rather than more. As a later president was to say, “Government was the problem, not the solution.”

The Free Market Agenda for a Truly Great Society

The free market agenda for a truly great society was for people to have the liberty to make their own decisions, find and take advantage of their opportunities, and have the latitude and incentive to design their own lives, according to their own conception of the good, desirable, and worthwhile. Government controls, regulations, redistribution, and handouts were the opposite of the direction needed for America.

  • · Government regulations and licensing requirements had to be reduced and abolished to make it easier for the less well off to start their own businesses, or expand their existing businesses to improve their own lives and create employment opportunities for others.
  • · Taxes had to be lowered in all personal income and corporate brackets to leave income, wealth, and savings in the hands of the people, themselves, to generate over time the investment and capital formation that would create jobs, raise the productivity and value of those in the work force, and increase standards of living for all over time, through more and better goods and services of all kinds offered on the market.
  • · Union power had to be reduced since, historically, it had been used to limit entry into the labour market in many “closed-shop” sectors of the economy, to artificially keep up the wages and benefits of those fortunate enough to belong to a particular labour union monopoly, at the expense of others locked out of employment opportunities.

Individual freedom, personal choice and responsibility, and open, competitive markets in a setting of limited government taxation, limited government spending, and limited or no government regulation, was the social and institutional circumstance most conducive to really fighting a war on poverty and illiteracy, and the lack of economic opportunity, with equal justice for all before the law.

Eliminating the disincentives for private sector construction of less expensive housing would better provide more housing for lower income groups. This would include ending or reducing zoning and various building codes that limited the locations for low-income housing and raised the costs of construction; it also required reducing property and other related taxes on the residential housing market.

Shifting to market-based education in place of the government monopoly school system would introduce needed competition in the educational market to improve the quality, variety and availability of education for all, including and especially for those in the lower income categories.

And moving to a truly market-based health and medical care system would provide the market-generated competition to keep costs down, while providing the incentives to improve hospital services and treatments.

Benefiting All Through the Freedom of Each

Free market economists, like Friedrich A. Hayek, explained that there is more knowledge and wisdom dispersed and decentralized in all the minds of all the members of society than can ever be known, integrated, or mastered by even the “best and brightest” who assert their ability to manage, direct, and redesign the complex society in which we live.

That is the advantage and the benefit of the competitive market order: it brings to bear all that there is to know and can be used to improve the condition of society through the informational mechanism of the price system, and the unhindered interactions of supply and demand. Shall we rely upon, and be limited to, what the government regulators, planners, and redistributors are able to know and understand; or shall we be free to utilize and benefit from what all of us can contribute through the institutions and workings of the free market economy?

Deficits, Inflation and Keynesian Mismanagement

Another legacy of the Great Society was the false confidence of the Keynesian macroeconomic planners that they could push the fiscal buttons and turn the monetary dials in just the right calibrated amounts to maintain full employment, stable prices, and economic growth all at the same time. They were sure that they could juggle the costs of an ever-more expensive war in Vietnam and supply all the needed money for the increased spending of the domestic Great Society programs without having to significantly raise taxes to foot the expanding financial bill, so the Johnson Administration could do all it wanted to do, both at home and abroad.

The government funded much of its spending through deficit financing. The amounts seem small by today’s trillion-dollar deficit standards, but for the 1960s the spending and the deficits were large compared to what government had spent in earlier years. The Federal Reserve – America’s central bank – attempted to keep interest rates low and private sector investment high by basically printing the money that was needed to feed the costs of growing government. In other words, they “monetized” the debt, to use the jargon of the economist.

Thus, added to everything else, by the end of the 1960s and into the 1970s, the United States was starting to experience and suffer from serious price inflation. Manipulated interest rates distorted and imbalanced the relationship between savings and investment; those who saved saw the real value of their “nest-eggs” eaten away due to rising prices; inflation distorted cost-accounting by making it difficult to know what one’s wealth, capital, and investments were really worth due to the uncertainty of what prices and costs of doing business would be tomorrow compared to today.

The inflationary spiral was not “broken” until the early 1980s, by which time America was suffering from “stagflation” – rising prices and increasing unemployment – a dilemma for which standard Keynesian theory had no answer.

Thus, the Great Society dream heralded by Lyndon Johnson in 1964 and 1965 began to degenerate into a disillusioning reality in the 1970s and 1980s. The Great Society provided neither the prosperity, nor the justice, nor the freedom that Lyndon Johnson had held out as its promise.

Liberalism: True and False

And that gets us to our conclusion: What is a just, good and great society? The Great Society advocates of the 1960s argued that theirs was a liberal vision for a better America. But was it?

I would like to suggest that theirs was a false conception of liberalism, and therefore a misguided idea of a free and great society. The real, or true, liberalism, as it took form in the nineteenth century as a political and economic ideal, and an agenda for social reform, emphasized the freedom and rights of the individual to his life, liberty, and honestly-acquired property. The individual human being was an end in himself, not a tool or means to the coercing will of others possessing political power.

These earlier (or, classical) liberals opposed and helped to do away with absolute monarchy and replace it with representative government. They led the cause for, and finally triumphed in bringing about, the end to human slavery. They insisted upon civil liberties and equal justice before the law for those whom the older political order had discriminated against, including Jews, religious dissenters, various ethnic and national groups, and women.

They also considered economic liberty – the freedom to own and use private property for consumption and production purposes; to peacefully compete in any trade, profession, or occupation the individual found attractive and advantageous; and to freely enter into any voluntary association and market exchange found to be mutually agreeable, including the terms of trade found acceptable by the traders – to be inseparable from any understanding of and practical existence to human freedom.

The classical liberals considered this also to be a morally better society. Why? Because it is based on the idea of respecting the dignity of the individual not to be viewed and treated as a “pawn” (a coerced means) to be manipulated, controlled or restricted by police power, to serve someone else’s preferred ends — even if that “someone else” is a large majority of his fellows in society.

The Self-Governing Individual and the Free Society

For these liberals, “self-government” did not only mean the right of the citizenry to participate in the political process to select those who will hold political office and enforce the laws of the land. It also crucially meant the “self-governing” individual. The individual was “sovereign” to freely live his life in peace, deciding what values and goals will give meaning and purpose to his own sojourn on earth. The individual had the unmolested right to the private property he had honestly produced or acquired in trade, as the means for pursuing and possibly fulfilling his dreams and conceptions of a good and happy life for himself and those others he may care about.

They considered such a truly liberal society also to be the one that provided the free market incentives and opportunity structures that would have the good affect of directing men (without force, and through the motive of self-interested improvement) to apply their knowledge, ability, and experience in ways — as if by an “invisible hand” — to reciprocally help improve the conditions of others as they advanced their own desired ends in the interplay of market competition.

They also argued that such a free society is more conducive to not only raising people out of poverty and making it possible for more people to be self-supporting, but also to foster a proper sense of benevolence and compassion towards others who may have fallen upon misfortune or “hard times” not of their own making. The history of voluntary charity and benevolence in the era of nineteenth century classical liberalism – before the advent of the modern welfare state and its undermining of some of this philanthropic spirit – attests to the magnitude of this private generosity and its success.

The Politically Governed Individual

What I have suggested to be considered the false liberalism of the Great Society turned its back on this earlier liberal tradition. Indeed, it turned liberalism on its head. Liberalism now meant bigger government, more intrusive government, more regulating and controlling government, with government’s very visible hand increasingly in every corner and aspect of American life.

Rather than self-governing, the individual in this new Great Society was to be governed. By whom? By those who arrogated to themselves the idea that they were “the best and brightest,” the social engineering “whiz kids,” who claimed to know how various segments and groups in the society should and would be made to live.

This paternalistic legacy of the Great Society era remains with us today. Indeed, it is at the centre of the political and social controversies enveloping American debate and conflict about the future direction of the country. Many, if not most, of the supposedly “untouchable” entitlement programs that are at the heart of the current budgetary and debt crisis facing both the Federal government and state governments are the outgrowths of the redistributive programs either introduced by or greatly expanded during the Great Society presidency of Lyndon Johnson.

LBJ wanted to be remembered for his Great Society legacy. And he has had his wish. His paternalistic and welfare state agenda is the Albatross that has a stranglehold around the fiscal neck of the American people.