Authors

Economics

Macro & Market Update

[This piece can be seen at Sean’s blog here http://truesinews.com/2015/02/17/macro-market-update/]

More than half a century ago, in his role as an advisor to the men responsible for trying to set Taiwan on the road to prosperity, a redoubtable economist called Sho-Chie Tsiang argued that the monetary authorities should stop suppressing interest rates and directly rationing credit and should move instead toward a more market-oriented system where real rates were sufficiently elevated to encourage productive saving.

His reasoning was that the existing combination of what we might call Z(Real)IRP with ‘macro-prudential’ control was plagued with several significant drawbacks.

Firstly, rationed credit tended to be crony credit – with only the politically-favoured having any hope of persuading the banks to lend to them. Secondly, the erosion of purchasing power suffered by any one depositing money in the bank at the prevailing yields meant that savers looked for other outlets for their surpluses, such as property and precious metals, neither of which did much to augment the stock of productive capital. Thirdly, this lack of genuine saving meant that all extra funding had to rely on inflationary credit creation and thus necessitated even more macro-prudential monkeying with the price mechanism. Fourthly, anyone outside the charmed circle of accepted borrowers – which tended to mean anyone with a hint of genuine entrepreneurship – had to raise funds in a quasi-illicit and certainly non-transparent manner and so had to promise exorbitantly high ‘curb’ rates of interest to compensate their lenders for the extra hazards involved.

Tsiang argued – and was soon to be proved totally correct in his assertions – that by allowing the rate of interest to find a level where market for funds cleared – essentially where the impulse to thrift intersected the expectation of profit – not only would all these disadvantages be eradicated, but the funding rate applicable to the WHOLE economy, as opposed to that charged to the privileged few, would be lower on average, not higher, as the risk premia associated with the ‘shadow’ market were removed.

In the decades after the Second World War, Taiwan, not entirely coincidentally, transformed itself from a backward, low-value added, crisis-wracked basket case into the economic prodigy to which we still look for so many of our high tech gizmos today.

The reason for the history lesson should be obvious if we consider that much of the same reasoning is relevant to mainland China today, even if the scale of the problem is somewhat larger in a country of 1 1/3 billion people.

Beijing knows that it cannot afford to persist with ‘business as usual’, that the ‘three overhangs’ relating to past over-expansion and misdirected effort have to be overcome while moving to the ‘new normal’ of less force-fed growth-for-growth’s sake. The issues with this are twofold: will the authorities stick to their course, even when the waters get choppy and, if they do, can they then hope to bring the ship of state safely into harbour before the leaks springing from its every timber send it to the bottom?

On the monetary front alone, the issue is fraught. The PBoC, as everyone knows, was moved to cut the required reserve rate a week or so back and so sparked a renewed clamour for further, substantial easing even though the main reason for the reduction was technical: the traditional Lunar New Year cash squeeze was bumping up against the very substantial reserve drain occasioned by the last few months’ sizeable forex outflows.

[CLICK TO ENLARGE ALL GRAPHS]

15-02-16 China M1

Against such a backdrop, the monthly money and credit numbers were exceptionally hard to read. TSF rose, but less than it did in each of the past two years. Loan growth, however, was the second highest on record. On the other side of the balance sheet M2 slowed to a multi-year low increase of 10.2% (even though overall deposits jumped by the most on record!) and yet, within that total, M1 money remained unchanged in a month in which it often falls so its rate of climb therefore rose to a 20-month high of 10.6%. Confusion confounded, indeed!

15-02-16 China TSF

What is key here is that Lui Lei of the central bank came out to argue that any intervention should henceforth only be aimed at alleviating liquidity shortages, not at fostering hothouse growth, while Xu Lin of the NDRC hinted that the latest Five-year Plan would insist on a ‘floor’ for growth of a mere 6.5% – a significant psychological climb down from the economy-doubling 7-handles to which the regime has heretofore grimly clung. Guan Tao of the SAFE next went so far as to make explicit reference to the parallels between his country today and its Asian neighbours back in 1997 on the eve of their great crisis (and he should know: $10 billion+ leaked out again in January, his employers had just revealed).

Courtesy: Bloomberg

For all the worries, this was not enough to prevent the ChiNext from making a new high – taking its run to 233% these past two years. We suspect, however, that it will pay to sell a reversal somewhere in the next 10%. We are also intrigued by the similarity between the HK H-Shares chart and that for pre-collapse crude – or, for that matter, between the index and all manner of commodity-related indices in recent months.

Courtesy: Bloomberg

It is also fascinating to watch sentiment start to dissolve among the US punditry. As the newsflow become more nuanced, market participants have become schizophrenic with regard to oil prices – lower is ‘a tax cut for the consumer’ but is also about to blow up the junk bond market, depending on who is talking. The Dow, for its part, has rallied on cheap energy, but also rallied on a rebound in oil prices which was said to signal continued demand. So long as it rallies, one supposes…

Amid a stretch of numbers which, aside from those concerning employment, were somewhat disappointing to a consensus only lately set four-square behind the thesis of US economic triumphalism, some unusual attention has been paid of late to the lacklustre retail and wholesale sales numbers – mainly becuase they, too, looked weak.

For our part, since these are the nearest thing we get to a timely measure of economy-wide revenues (and hence not just to an NGDP number, all you market monetarists and Neo-Hayekians out there, but to an NSOP – a nominal structure-of-production flow) we tend to pay close attention to them as a matter of routine. What is at issue here, however, is the very fact that these arenominal numbers and are therefore hard to interpret when large, supply-side price changes are underway, as is arguably the case in all things related to natural resources as well as, for the US with its persistently strengthening currency, to imported goods of a more general character.

Since it is the sales margin that ultimately counts for the success of an enterprise, the first thing we need to assure ourselves is that falling revenues need not be wholly bad, as long as costs fall commensurately alongside them. There are, as ever, several caveats to this broad pronouncement.

Firstly, we have to hope that the aggregate decline in selling and buying prices does not mask too great a disparity between conditions in one business and the next. We must also beware the fact that any resulting windfall for one is not ruined by the shortfall for another when the impact is not a simple matter of addition and subtraction but acts in a non-linear fashion – e.g., through its implications for the credit structure. Finally, we have to wonder how the necessary fall in nominal costs will be achieved when it comes to those associated with the payroll. We should all recognise that real wages are what determine our standard of living, but we must also bear in mind that it is the nominal ones over which we fight and for whose maintenance jobs are often sacrificed.

Courtesy: Bloomberg
Courtesy: Bloomberg

With that in mind, let us note three broad trends which are at work. Number one, inventory/sales ratios are rising to levels not seen (barring the Snowball Earth episode of the Lehman Crash) in anything up to thirteen years across manufacturing, wholesale, and retail. To what extent this just reflects a lag in marking down inventory values but having instantlyto recognise lower sale sprices, rather than something much more sinister, only time will tell. Nevertheless, the adjustment, when it comes, will have to be reflected in both a capital write down and a temporary reduction in profits in the relevant period, so there is scope for further anguish.

Courtesy: Bloomberg
Courtesy: Bloomberg

Number two, wage bills in relation to sales receipts have also been pushed to their least favourable in more than a decade and, again, while the marginal return on labour could come out unchanged if the margins are unaltered, lowered revenues could nonetheless serve to jeopardize employment levels. Number three is that the value of outstanding C&I loans is rising in relation to the stock it is financing i.e., collateral coverage is slipping to an extent which may soon start causing jitters among the lenders.

Courtesy: Bloomberg
Courtesy: Bloomberg

While bearing this wobble in mind, also consider that P/Es are back to where they were on the eve of the last crash as is price/book. Price/sales is where it was at the height of the Tech Bubble and returns on capital – measured using both cash flow and free cash flow – are at or approaching their lowest in five years. As ever, the main source of support for the stock market is the deliberately suppressed level of bond yields.

15-02-16 REGF SPX

One way of illustrating this distortion of the bond market is to look at bond risk – such as modified duration – versus bond return, i.e., yield-to-worst. Off the scale, is the simplest way to describe it.

Courtesy: Bloomberg
Courtesy: Bloomberg

As unsustainable as all this looks – not to mention how perilous it all is – the key is to try to find a reversal clear enough to be played. A week or two back, we suggested that the T-bond might be headed to 2.20% and that, if such a level held, one should try to sell against it, scaling in above 2.45/50%. Well, 2.22% has been the low so far and we have had a smart 43bp, 8.3% price reversal since hitting it. So far, so good, so short.

Courtesy: Bloomberg
Courtesy: Bloomberg

As for the rest of the market, WTI is testing the top of a neat profile built at the bottom of the rout (and so, theoretically signalling much lower lows ahead). If it breaks the top of this band, it could swing up to a nice, round $60/bbl where the mid-point of the Thanksgiving Day massacre comes in. Brent looks a touch more positive, so signals are mixed and while not yet convinced we have seen the worst, we would hesitate just yet to position too aggressively as a result of the disparity.

Courtesy: Bloomberg
Courtesy: Bloomberg

Copper, too has seen a little cautious buying, taking it back to the bottom of the old range. On the one hand we have maximum spec shorts both outright and as a percentage of O/I: on the other, the recent, hefty cash premium has almost disappeared as LME inventories have built rapidly, rising 85% since Christmas to a 16-month high. Sell any identifiable failure here but stop out if it does build back above $6000

Courtesy: Bloomberg
Courtesy: Bloomberg

Likewise, gold – while below $1245/50  – stays negative, looking for a possible retest of $1180 and, one day, a break of the decade-old uptrend to usher in the opening up of a route back to the LEH crisis levels down around $800/oz.

If gold is to weaken further, that almost presumes that risk will not spike higher and also that dollar strength will continue at what is now an important technical level for the greenback – at the 50% retracement of the 2002-11 decline and at fairly overbought levels.

Courtesy: Bloomberg
Courtesy: Bloomberg

While below $1.450/00 the euro does not look like spoiling the party but rather giving it a boost by falling to the long-term linear mid at $1.0700 (and possibly, since the trend on this chart has already given way to the log one at $9275/00)

Courtesy: Bloomberg
Courtesy: Bloomberg

However it is espressed in the weakness of pair currencies, a continued USD advance should mean positive feedback with other US asset classes so it is worth noting that the MSCI US index is fast approaching its historic peak relative to the ROW equivalent. Bears will hope that top holds: bulls will be wishing for a full, swing pattern repeat of the 1988-2002 move and hence for much more upside to come.

Courtesy: Bloomberg
Courtesy: Bloomberg

The Nikkei, meanwhile, remains locked – once we peel back the veil of weak Yen money illusion – in the range which has contained it these last 18 months or so. the best hope is that this consolidation wil eventually move the longest line higher both on the medium term scale of the last 5 years of rebound and on the larger scale of the whole three decades of bubble-and-bust.

Courtesy: Bloomberg
Courtesy: Bloomberg

The sad fact remains that, if we adjust for changes in the yen’s international worth via the TWI, returns for the entirety of that period sweep out a quasi-normal, mean reverting distribution. Still, a push to the top of that formation’ s value area would be nothing to sniff at, were it to come about through the processes just discussed.

Courtesy: Bloomberg
Courtesy: Bloomberg

Finally to Europe, where NIRP is beginning to preclude even momentum-driven returns on bonds and is pushing people instead into the stock market. The DAX appears to have broken out against the REX as a result, meaning it has every chance to test the last cyclical highs, set back in 2007, in the weeks ahead.

Courtesy: Bloomberg
Courtesy: Bloomberg

Note, however, that though the idea of European outperformance is becoming more widely shared – not least because of effects of the rapid growth in money supply even pre-QEuro – there is actually little in the graph of Germany v the USA in common currency to suggest this presentiment will be borne out in practice. If you do wish to play for a rise on the Continent, therefore, it seems as though you would be best advised to hedge up your forex exposure when you do so.

Courtesy: Bloomberg
Courtesy: Bloomberg

Good hunting!

Economics

Richard Ebeling, “Introductions to the Selected Works of Ludwig von Mises (2000-12)” Part 1

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

PREFACE

This three-volume set of the Selected Writings of Ludwig von Mises has been published in reverse chronological order. The current volume, the last prepared in the series, in fact, is devoted to some of the earliest of Mises’s writings on a variety of economic issues. They mostly cover monetary, fiscal, and general economic policy matters in the Austro-Hungarian Empire before and during the First World War, with additional articles that Mises wrote in the postwar period that had not been included in volume 2. An appendix to the present volume includes a talk that Mises delivered at his private seminar, which would meet in his office at the Vienna Chamber of Commerce, in the spring of 1934 on the methodology of the social sciences, before he moved to Geneva, Switzerland; and the curriculum vitae that his great-grandfather prepared for the Habsburg Emperor in 1881 as part of his ennoblement that gave him and his heirs the hereditary title of “Edler von.”

It is in the second volume of the Selected Writings (2002), Between the Two World Wars: Monetary Disorder, Interventionism, Socialism, and the Great Depression, that the reader will find a large collection of Mises’s many articles and policy pieces from the 1920s and 1930s dealing with the Great Austrian Inflation, fiscal and regulatory mismanagement by the government, and the negative effects of numerous forms of government intervention and controls before and during the Great Depression. The volume also includes critiques of socialist central planning and his defense of praxeology, the science of human action.

The third volume of the Selected Writings (2000), The Political Economy of International Reform and Reconstruction, focuses on Mises’s writings mostly from the first half of the 1940s. In the midst of the Second World War, Mises lectured and wrote on the pressing issues of how Europe, small nations, and underdeveloped countries could recover [xii] from war and poverty and start on the path to economic renewal and prosperity.

Each volume begins with an introduction in which I try to explain the historical context in which Mises wrote the pieces in that particular volume. I have also tried to assist the reader with footnotes explaining some of the ideas, persons, events, or geographical locations to which Mises refers in the text.

This project developed out of the discovery of the “lost papers” of Ludwig von Mises in a formerly secret KGB archive in Moscow, Russia, in 1996. Looted by the Gestapo from Mises’s Vienna apartment in March 1938 shortly after the Nazi annexation of Austria into the German Third Reich, they ended up among a huge cache of stolen documents, papers, and archival collections that the Nazis had plundered from all over occupied Europe. At the end of the Second World War the entire cache, including Mises’s papers, was captured by the Soviet Red Army in a small town in western Czechoslovakia. After being informed about what had been captured, Stalin instructed that it all be brought to Moscow and that a secret archive be built to house it. For half a century, only the Soviet secret police and the Soviet Ministry of Foreign Affairs had access to the collections in this archive.

In the introduction to volume 2 in these Selected Writings of Ludwig von Mises, I describe in detail how my wife and I came to find out about this archive and the existence of Mises’s papers among them, amounting to about 10,000 pages of material. In October 1996, we journeyed to Moscow and spent about two weeks carefully going through the entire collection of Mises’s papers. We returned to the United States with photocopies of virtually the entire collection, which includes Mises’s correspondence, unpublished manuscripts, published articles, policy memoranda prepared during the years when he worked for the Vienna Chamber of Commerce, material relating to his teaching at the University of Vienna and his famous private seminar, and his military service during the First World War. Many of the articles, policy memoranda, essays, and speeches that were found among Mises’s “lost papers” have been included in this series, especially in volumes 1 and 2 of his Selected Writings.

Shortly after the discovery of the “lost papers” was announced, Liberty Fund contacted Hillsdale College and me about the possibility of publishing a selection of these and some of Mises’s related essays, lectures, and articles covering the period from before the First World War [xiii] to the 1940s during the Second World War. I most happily accepted Liberty Fund’s kind offer to serve as editor of the translations (mostly from German) and to prepare the volumes for publication.

It has been a labor of love that has ended up taking far longer to complete than I had expected. A good part of the delay in finishing the last of these volumes was due to a five-year “distraction” during which I served as the president of the Foundation for Economic Education (FEE) from 2003 to 2008. But my return to the “calmer” life of academia has permitted me to finally finish the task.

Ludwig von Mises is most famous for his great works on monetary theory, socialist central planning, the general theory of the market process, and the methodology of the social sciences, the leading ones, of course, being The Theory of Money and Credit; Socialism: An Economic and Sociological Analysis;Liberalism; Critique of Interventionism; Epistemological Problems of Economics; Bureaucracy;Omnipotent Government; Human Action: A Treatise on Economics; Theory and History; and The Ultimate Foundations of Economic Science.

But what the Selected Writings of Ludwig von Mises, in general, bring out is the “unknown Mises,” if you will. Not the Mises of grand economic theory and sweeping political economy, or the fundamental problems of human action. Here, instead, is Mises as applied economist, detailed policy analyst, and economic policy problem-solver in the detailed reality of the many pressing public policy issues that confronted the old Austro-Hungarian Empire and the new Austrian Republic in the aftermath of the Great War, and then the need for reconstruction and economic reform after the Second World War.

For those who have sometimes asked, “Well, but how do you apply Austrian economics to the ‘real world’ of public policy?” here is the answer by the economist who was considered the most original, thoroughgoing, and uncompromising member of the Austrian School in the twentieth century!

Indeed, it can be argued that it was having to grapple with the intricacies of these types of everyday economic policy issues during a time of great, and sometimes cataclysmic, change in the Europe and the Austria of the first half of the twentieth century that helped to guide and form Mises’s thinking on those wider and more general problems for which he is most famous.

The Selected Writings of Ludwig von Mises provide an insight into and a better understanding of the first two-thirds of Mises’s long and [xiv] productive life as a professional economist in a way that has not been available before. It also brings into English translation for the first time the vast majority of his practical economic policy writings from this, in many ways his most prolific, period before he left war-ravaged Europe in 1940 to make a new home and career for himself in the United States.

INTRODUCTION TO VOLUME 1

The articles and lectures included in this volume by the Austrian economist Ludwig von Mises were written in the years before, during, and after the Great War of 1914-18, as the First World War used to be called. They focus on the monetary, fiscal, and general economic policy problems of, first, the Austro-Hungarian Empire and, then, the new postwar Austrian Republic after the dismantling of the Habsburg Monarchy.

For those who may be familiar with Mises’s more theoretical works on various themes of monetary theory and policy,1 comparative economic systems—capitalism, socialism, and interventionism2—the general nature and workings of the market economy, or the methodology and philosophy of the social sciences,3 most of these articles and lectures (like the ones in volume 2 and 3 in this series)4 offer a different [xvi] perspective on Mises as an applied economist. Here is not the broad theorist concerned, often, with stepping back from the particular details of specific historical circumstances to investigate and evaluate the essential and universal properties of human action; or the institutional prerequisites for economic calculation and the rational allocation of resources among competing ends; or the relationships between time preference, investment time horizons, monetary expansion, and the sequential stages of the business cycle.5

Instead, these essays investigate and analyze the historical and institutional workings of the pre-World War I monetary system of the Austro-Hungarian Empire, and the issues surrounding legal specie redemption for the banknotes of the Austro-Hungarian Bank; the politics behind the establishment of the gold standard in Austria-Hungary; the growing fiscal imbalances developing in the Habsburg Empire due to the patterns of government spending and taxing policies in the first decade of the twentieth century; and the reasons behind the economic crisis that hit Austria-Hungary in the years immediately before the start of the Great War. Here, too, we see Mises analyzing during the war the motives behind German and Austro-Hungarian trade policy, the impact and significance of emigration from Austria, the effects from the monetary inflation used to fund the government’s war expenditures, and the pros and cons of financing those war expenditures through taxation versus borrowing by the issuance of war bonds.

After the war, Mises explains the distorting effects from the new Austrian government’s control and rationing of foreign exchange for imports and exports; the impact on the Austrian foreign exchange rate of monetary expansion to finance the government’s huge deficit spending; a specific policy agenda to bring the country’s financial house back into order, and the need for cooperation from both businesses and labor unions if this was to be achieved without Austria’s currency collapsing into hyperinflation; the claims that holders of banknotes of the old Austro-Hungarian Bank could make on the new Austrian National [xvii] Bank in the postwar period; Austria’s fiscal problems in the period after the end of the inflation; and the lessons for banking reform after the collapse of several banks in 1931.

Ludwig von Mises became immersed in these issues because he had to earn a living outside the Austrian academic arena. University teaching appointments were few and far between in Austria both before and after the First World War, even though Mises was clearly qualified for such a position.6 His only formal relationship with the University of Vienna, after graduating in 1906 with a doctoral degree in jurisprudence,7 was as a privatdozent (an unsalaried lecturer), which permitted him the privilege of offering seminars during the academic year. Mises offered such a seminar almost every term from 1913 to 1934 (except for most of the time during the Great War). He was promoted to professor extraordinary in May 1918, but this was a purely honorific title that was still unsalaried and with a nominal “tenure” as a professor in this status.8

However, from 1920 until the spring of 1934, Mises organized and chaired a privatseminar (private seminar) of interested scholars in the fields of economics, history, sociology, political science, and philosophy. It met twice a month between October and June on Friday evenings at 7 p.m. at his office at the Vienna Chamber of Commerce. The private seminar came to an end when Mises accepted a full-time teaching position at the Graduate Institute of International Studies in Geneva, Switzerland, as professor of international economic relations beginning in autumn 1934.9

Because an academic career was closed off to him, from 1909 to 1934 Mises made his living as an economic advisor and policy analyst for the Vienna Chamber of Commerce, Crafts, and Industry. First hired as an assistant for the drafting of documents, in 1910 he was promoted to deputy secretary. When he returned from active duty in the First World War, he was made “first secretary” at the Chamber, responsible for matters relating to a wide variety of areas including monetary and fiscal affairs, trade and financial issues, and administrative and constitutional law.

He developed and refined his skills as an economist having to deal with the everyday practical affairs and policy issues of the Austria of his time. He had to master and maintain a thorough and extremely detailed knowledge of the Austrian economy and the impact of Austrian government policy on the industrial, commercial, and monetary and fiscal affairs of the country.10 As Mises expressed it years later in his Memoirs:

My job with the Handelskammer [the Chamber of Commerce] greatly expanded my horizons. That I now have the material for a social and economic history of the downfall of the Austrian civilization readily at hand is to a great degree the result of the studying that was required of me to be able to carry on with my work in theHandelskammer. Travels that led me to all parts of old Austria-Hungary from 1912-1914 taught me much in particular. In visiting the centers of industry, my intent was to become acquainted with the industrial situation in view of the renewal of customs and trade relations with Hungary, and the adoption of new, autonomous tariffs and trade treaties.

The main thrust of my job with the Handelskammer was not dealing with commercial questions, but those pertaining to finance, currency, credit, and tax policy. In addition, I was given special assignments on [xix] an ongoing basis. From the time of the armistice until the signing of the Peace Agreement of Saint Germain [in September 1919] I was the consultant on financial questions to the Foreign Office. Later, when the terms of the peace treaty were put into effect, I was in charge of the office concerned with the prewar debt. In this capacity I had numerous dealings with the representatives of our former enemies. I was the Austrian delegate to the international Handelskammer [the International Chamber of Commerce] and a member of many international commissions and committees, whose insoluble task it was to facilitate the peaceful exchange of goods and services in a world pervaded by national hatred and the precursors of genocide.11

At a relatively early age Mises seems to have formulated in his mind a rather comprehensive classical liberal worldview of the social order. His experience in the role of applied economist clearly left its mark and influenced his understanding of the effects that government intervention could have on the effective functioning of a modern market economy. To appreciate this, and the writings included in his volume, it is necessary to take a glance at the political and economic environment of the old Austro-Hungarian Empire and the Austrian monetary system as it developed in the nineteenth century.

The Habsburg Monarchy and the Austro-Hungarian Empire12

The House of Habsburg, which came to rule a vast empire for nearly eight hundred years, had its origin in the thirteenth century. Through [xx] a series of royal marriages, treaties, and some conquests, the Habsburg Monarchy gained control over a large territory in Central and Eastern Europe, and for a period of time large areas in Western Europe as well, including Spain, parts of modern-day France, Italy, Germany, and Switzerland, and what later became Holland, Belgium, and Luxemburg. From the thirteenth century to the middle of the nineteenth century, the Habsburgs also nominally headed the Holy Roman Empire, or its later, loose German Confederation.

It was during this time, when the Habsburgs were beginning to dominate so much of Europe, that Emperor Frederick III (1415-93) had inscribed on official buildings the five vowels, A E I O U, which he interpreted as “Alles Erdreich Ist Österreich Untertan” (“All the earth is subject to Austria”), or in Latin, “Austriae Est Imperare Orbi Universo” (“Austria must rule the universe”).13

The Habsburgs ruled as absolute monarchs. But under the influence of the Age of Enlightenment and the early phase of the French Revolution, Empress Maria Theresa (1717-70) and then her sons, Joseph II (1740-90) and Leopold II (1747-92), attempted to introduce various forward-looking reforms while retaining the principle of absolutism. The dark turn taken in the French Revolution and the rise of Napoleon to power shifted the monarchy back in a far more conservative direction under Francis II (1768-1835). With Napoleon’s victories over the German states, the Holy Roman Empire was dissolved and Francis II declared himself emperor of Austria in 1804.

As one of the final victors over the French after Napoleon’s defeat in Russia in 1812, the Habsburg Empire in Central and Eastern Europe was consolidated following the Congress of Vienna in 1815 as one contiguous territory that by the 1880s incorporated what are today Austria, Hungary, the Czech Republic, Slovakia, Slovenia, Croatia, Bosnia, and large parts of Italy, Poland, Ukraine, and Romania.

In the years just preceding the First World War, the Austro-Hungarian Empire covered a territory of about 415,000 square miles and included within its borders a dozen or so national and linguistic groups, including Germans, Hungarians, Czechs, Slovaks, Croatians, Romanians, Italians, Poles, Bulgarians, Serbians, Slovenians, and Ruthenians. Out of a population of 50 million the Germans and Hungarians [xxi] each numbered about 10 million, with the remaining 30 million made up of these other groups.

Europe of the nineteenth century experienced a relentless battle between four powerful ideas: monarchical absolutism, political and economic liberalism, integral nationalism, and revolutionary socialism. Absolutism insisted upon the divine rights of kings to rule without restraint; liberalism demanded the recognition of individual liberty, representative and limited constitutional government, and freedom of private enterprise from state control; integral nationalism (by the middle decades of the nineteenth century) increasingly insisted upon the unification and political independence of peoples sharing a common language, culture, and history, and finally a common ethnicity or race;14 and socialism called for the overthrow of private property, nationalization of the means of production, and greater economic and social equality by either violent or democratic methods. All four of these ideological forces were at work in the Habsburg Monarchy until the end of the Austro-Hungarian Empire in the ruins of the First World War.

The French Revolution of February 1848 reverberated across much of Europe, including in the Austrian Empire. Within days and weeks of the uprising in Paris, students on the streets of Vienna demanded constitutional change, and the Italians and Hungarians were in open revolt against their Habsburg rulers. By the end of 1849, however, the Italians and Hungarians had been crushed (the latter through the intervention of the Russian Imperial Army), and Habsburg rule was once more imposed with especial ruthlessness against the Hungarians.

At first reforms were promised to the Austrian liberals, with a constitution promised in July 1848. And when eighteen-year-old Francis Joseph (1830-1916) assumed the throne upon the abdication of his uncle, Ferdinand I (1793-1875), in December 1848, the new emperor gave his support to the constitutional changes.15 Almost immediately, however, [xxii] he reversed himself and insisted upon the reassertion of absolutist authority. What Francis Joseph had inherited from his ruling ancestors was a belief in “his divine right of unlimited monarchical power,” tempered with the idea “that his rule must, before all, produce the best possible results for the peoples of his realm. . . . Yet, up to the end he did not doubt that his empire, composed of so many different races and lands, could be governed successfully only by a hereditary monarch and according to his absolute will.”16 Thus, he could not make concessions that would have undermined his absolute rule in the name of caring for the well-being of his subjects.

Neither could he completely concede to the increasing nationalist sentiments of the diverse peoples in his large realm without also abdicating his responsibility as that benevolent ruler. Many Austrian liberals who lived a good portion of their lives under the reign of Francis Joseph believed that he twice missed the opportunity to successfully transform his multinational empire into a federal domain that might have reconciled the conflicting interests and demands of the national groups under his rule. The ideal of these liberals from the middle of the nineteenth century to the First World War had been what some of them called “the Austrian idea.” If a federal structure of government could have been set up in which each of these peoples had wide political and social autonomy within their own lands while sharing a common bond of economic freedom and civil liberties, the Habsburg Monarchy could have created on a larger and far grander scale what had been formed in the Swiss confederation with its reconciliation and harmony among its French-, German-, and Italian-speaking citizens.17

Francis Joseph’s rejection of constitutional reforms and the reimposition of central authority over the Italians, Hungarians, and his Slav [xxiii] subjects in 1848-49 was the first chance lost for any such reconciliation. The second lost opportunity occurred following his defeat at the hands of the Prussians in 1866, when Bismarck pushed Austria out of the German Confederation. Fearful of the Hungarians taking advantage of the empire’s postwar weakness to claim full independence through another violent uprising, Francis Joseph agreed to the Ausgleich, the “Compromise,” of 1867 that transformed the Austrian Empire into the Austro-Hungarian Empire. While Francis Joseph remained emperor of both halves of his domain, Hungary became widely independent in many of its domestic affairs. Only a common customs and monetary system and a shared military and foreign policy completely linked Hungary to the Austrian “Crownlands” directly ruled by Francis Joseph’s government in Vienna.18

As Hans Kohn, one of the twentieth century’s leading experts on the history and philosophy of nationalism, who had grown up under the rule of Francis Joseph in Prague, explained, “In the Compromise with the Hungarian nobility in 1867, the aspirations of the Czechs, Slovaks, Serbs, Croats, and Romanians, who in large majority were then still loyal to the dynasty, were sacrificed for the purpose of winning the assent of the Magyars to a common foreign and military policy on the part of what now became the Dual Monarchy.”19 Indeed, at first, several leading Czech and Hungarian nationalist leaders believed that the flowering of their people’s cultural and linguistic identities could best flourish in the wider setting of a multinational Habsburg Empire. But as the nineteenth century progressed this sentiment shifted into a belief that only national independence could secure these goals.

A far more liberal-minded voice in the Habsburg family was Francis Joseph’s son, Crown Prince Rudolf (1858-89), the heir to the throne. Among his personal tutors had been Carl Menger (1840-1921), the founder of the Austrian School of economics. Under Menger’s guidance, Crown Prince Rudolf had become well versed in the free trade and relatively laissez-faire ideas of the Classical economists.20Menger [xxiv] also had coauthored with Rudolf a scathing criticism of the Austrian nobility, who were accused of having lost their sense of social duty and, instead, had escaped into frivolous court intrigues, pointless social entertainments, and financial irresponsibility. It was a clear call for recognition of and respect for the middle-class values of enterprise, frugality, and personal responsibility. The bourgeois virtues needed to replace the anachronistic role of the aristocracy in society, who had lost their way in the pretensions of power and lure of wasteful pleasures.21 But whatever influence the crown prince might have had on the course of events in Austria-Hungary was cut short by his suicide in 1889 at his hunting lodge at Mayerling.22

The particularly nationalist imperialism of the Hungarians against the other peoples under their control was not the only problem as the nineteenth century progressed in terms of growing antagonism among the subject peoples in the Dual Monarchy. The German-Austrians, also, increasingly became defensive and antagonistic toward the rising nationalist aspirations of the Czechs, Poles, Slovenians, and others in the Crownlands, as well as the growing demands of the Hungarians for independence.

As Hans Kohn pointed out, “The spread of democracy, literacy, and economic well-being in the western half of the monarchy after 1867 strengthened the non-German nationalities there at the expense of the Germans. The result was that many Germans in the monarchy lost their faith in an Austrian idea as much as many Slavs and other non-Germanic peoples did. . . . By the end of the nineteenth century many Austrian Germans looked to the Prussian German Reich as their real home and venerated [Otto von] Bismarck.”23

Looking back at the events that brought about the demise of the Habsburg Empire in the immediate aftermath of the First World War, Ludwig von Mises explained why many German-Austrians turned against liberalism as a foundation for the preservation of the monarchy and [xxv] the Austro-Hungarian state. Over the centuries German-Austrian settlers had made their homes in the eastern reaches of the empire. They brought with them the German language, culture, literature, commercial knowledge, and knowhow. They viewed themselves as a “civilizing force” among the lesser-advanced nationalities, especially among the Slavic peoples. Indeed, many of these subject peoples became acculturated into German-Austrian life, since the latter was the dominant group; the German language in particular became the venue for social and economic advancement. But as literacy and national consciousness awakened among these other peoples in the nineteenth century, loyalties to and identification with German-Austria and the Habsburg dynasty were replaced with a growing allegiance and sense of belonging to their own ethnic and linguistic groups.

Furthermore, these peoples had higher birth rates than the Germans living among them. Cities and towns that had been settled and predominantly populated by Germans for centuries became increasingly Czech or Hungarian or Polish or Romanian or Slovenian communities. German-Austrians found themselves shrinking minorities in lands that they had long considered to be their own politically, culturally, and commercially. This was especially true in the Czech lands with Prague at the center.

As the nineteenth century progressed, German-Austrians discovered that adherence to liberal principles of representative government and full individual and cultural equality before the law meant the demise of the German communities sprinkled across the Habsburg domains. For many German-Austrian liberals the choice was between a liberalism that would logically mean the decentralization and possible eventual breakup of the empire along nationalist lines, or advocacy of centralized political control, monarchical dictate when required, and subversion of democratic aspirations among the non-German peoples.

The first course meant the eventual loss of German political and cultural domination in the non-German lands; the second meant holding onto both political and cultural power as long as possible in the non-German areas of the empire, but only by increasingly alienating the other subject peoples. As Mises explained, part of the German-Austrian tragedy was that national and linguistic imperialism won over liberal idealism.24

What enabled the Habsburg Empire to endure for fifty years after the establishment of the Dual Monarchy in 1867 was the constitutional order that had been implemented at the same time as theAusgleich (or “Compromise”). The Constitution of 1867, which accompanied the creation of “Austria-Hungary,” was imbued with the spirit of the classical liberal ideas that were then at their zenith in Europe.25 Every subject of the Habsburg emperor was guaranteed freedom of religion, language, association, profession, and occupation, and could appeal to a special higher court of law if a violation of these rights had occurred. Any subject might live wherever he chose throughout the emperor’s domain. Private property was secure, and relatively free trade prevailed within the boundaries of the empire, though protectionist barriers to international trade not only continued but grew in various ways in the last decades of the nineteenth and first decade of the twentieth centuries.26

The economic free trade zone that made up the Austro-Hungarian Empire fostered significant economic development beginning in and especially after the 1880s, though very far from matching the economic progress in Western Europe or in Imperial Germany after 1871.27 However, various forms of government controls and regulations began to be domestically superimposed on the society, including the nationalization of the railways, starting in the 1880s. As a result, the remaining [xxvii] history of the monarchy was one of liberal freedoms introduced in 1867 being undermined by nationalist discord, periods of rule by central government decree, and the continuation or introduction of interventionist policies that merely intensified the antagonisms among the subject peoples. As A. J. P. Taylor explained:

In another way, the Austrian state suffered from its strength: it never had its range of activity cut down during a successful period of laissez-faire, and therefore the openings for national conflict were far greater. There were no private schools or hospitals, no independent universities; and the state, in its infinite paternalism, performed a variety of services from veterinary surgery to the inspecting of buildings. The appointment of every schoolteacher, of every railway porter, of every hospital doctor, of every tax collector, was a signal of national struggle. Besides, private industry looked to the state for aid from tariffs and subsidies; these, in every country, produce “log-rolling,” and nationalism offered an added lever with which to shift the logs. German industries demanded state aid to preserve their privileged position; Czech industries demanded state aid to redress the inequalities of the past. The first generation of national rivals had been the products of universities and fought for appointments at the highest professional level; their disputes concerned only a few hundred state jobs. The generation that followed them was the result of universal elementary education and fought for the trivial state employment that existed in every village; hence, the more popular national conflicts at the end of the century.28

In spite of all this, and the international tensions and foreign policy fiascos that would eventually plunge Austria-Hungary and the rest of Europe into the calamitous cauldron of conflict in 1914, the Habsburg Monarchy succeeded in generating a cosmopolitan culture, especially in Vienna, that brought all the subject peoples together and fostered an inspiring and flourishing world of the arts, music, literature, philosophy, the humanities, and the sciences.29

It gave many who lived in the postwar period of rising totalitarianism in the 1920s and 1930s a deep nostalgia for what seemed a far more [xxviii] civilized and humane epoch in turn-of-the-century Vienna. One voice that attempted to capture this “lost world” was that of Stefan Zweig (1881-1942), a renowned Austrian novelist and essayist who fled Vienna in 1934 and committed suicide in Brazil during the Second World War out of despair for all that was happening in the European world that he had known. In his posthumous work The World of Yesterday, he said:

One lived well and easily and without cares in that old Vienna. . . . “Live and let live” was the famous Viennese motto, which today still seems to me more humane than all the categorical imperatives, and it maintained itself throughout all classes. Rich and poor, Czechs and Germans, Jews and Christians, lived peaceably together in spite of occasional chafing, and even the political and social movements were free of the terrible hatred which has penetrated the arteries of our time as a poisonous residue of the First World War. In the old Austria they still strove chivalrously, they abused each other in the news and in the parliament, but at the conclusion of their ciceronian tirades the selfsame representatives sat down together in friendship with a glass of beer or a cup of coffee, and called each other Du [the “familiar” in the German language]. . . . The hatred of country for country, of nation for nation, of one table for another, did not yet jump at one daily from the newspaper, it did not divide people from people and nations from nations; not yet had every herd and mass feeling become so disgustingly powerful in public life as today. Freedom in one’s personal affairs, which is no longer considered comprehensible, was taken for granted. One did not look down upon tolerance as one does today as weakness and softness, but rather praised it as an ethical force. . . . For the genius of Vienna—a specifically musical one—was always that it harmonized all the national and lingual contrasts. Its culture was a synthesis of all Western cultures. Whoever lived there and worked there felt himself free of all confinement and prejudice.30

For Zweig, thinking back on that bygone paradise, “It was sweet to live here, in this atmosphere of spiritual conciliation, and subconsciously every citizen became supernational, cosmopolitan, a citizen of the world.”31

It was, of course, only an illusion. That twilight of the liberal era in the old Austro-Hungarian Empire about which Zweig was so nostalgic [xxix] had never been as pure and perfect as his mind recalled it. It was certainly true that liberal ideals had been established in the Constitution of 1867, and that they were implemented and enforced for the most part, especially in the Crownlands more directly under Emperor Francis Joseph’s imperial authority. But beneath the surface of tolerance, civility, and cosmopolitanism were all the undercurrents of racial and nationalist bigotry, economic collectivism, and political authoritarianism that poured forth like destructive lava from an exploding volcano during and in the aftermath of the First World War.

The Austrian Monetary System, 1867-191432

A leading theme of Mises’s articles in the first part of this volume concerns the reasons for and the resistance to the full implementation of a gold standard in Austria-Hungary. His arguments in these essays can be better understood against the backdrop of Austria’s monetary policies and experiences during the nineteenth century leading up to the currency reform act of 1892.

The story of the Austrian currency in the late eighteenth century and the first two-thirds of the nineteenth century is one of almost continual financial mismanagement. The government would debase the currency to cover its expenses, then make promises to put its budget on a sound footing, only to see another crisis arise requiring once again turning the handle on the monetary printing press.33

The Austrian government made several experiments with state-chartered [xxx] banks in the 1700s. But each of these banks soon collapsed or was closed due to lack of public confidence following large quantities of paper monies being issued to cover government expenditures. These expenditures reached huge proportions during the long years of war between the Austrian Empire and first Revolutionary and then Napoleonic France.

Between 1797 and 1811, the supply of government paper money increased from 74,200,000 florins to 1,064,000,000 florins, yielding a fourteen-fold increase over this period. Not surprisingly, whereas the price of silver coin expressed in paper money was 118 in 1800, it rose to 203 by 1807, then to 500 by 1810, and reached 1,200 by 1811.

The government announced its intention in 1811 to stop the printing presses and issue a new currency that would be converted at the ratio of five old florins for one new florin, with the total amount of paper money in circulation to be reduced to 212,800,000 florins. But the renewal of the war with Napoleon in 1812 resulted in the new currency being increased to 678,716,000 florins by 1816, a near tripling of the “reformed” currency in five years.

With the final defeat of Napoleon, the Austrian government announced that it would use a portion of the war reparations being paid by France to retire about 131,829,900 florins from circulation, leaving the paper money supply outstanding at around 546,886,000 florins. This process was assisted with the establishment of a new National Bank of Austria, with the Bank withdrawing government paper money in circulation in exchange for its own banknotes, until by early 1848, the total currency supply in circulation had been reduced to 241,240,000 florins; that is, there was an almost two-thirds reduction in the paper money supply over a thirty-year period. The National Bank, in February 1848, had silver reserves of about 65,000,000 florins, or, an approximate 25 percent specie cover for its outstanding currency in circulation.

But all of these monetary reforms began to unravel with the outbreak of the revolution of 1848, especially the Hungarian revolt against Austrian rule. Within days, panic runs on the National Bank reduced its silver reserves to 35,023,000 florins, a 53 percent loss in specie. The Austrian government suspended silver redemption and banned the exporting of silver and gold. Putting down the revolution forced the government to again borrow heavily from the National Bank. As a result, confidence in the Bank fell so low that in 1849 the government publicly promised to stop borrowing and cease increasing the currency.

But the process started again in a few years with Austria’s military mobilization during the Crimean War, and then its wars against Italian nationalists and their French ally in a vain attempt to maintain control of portions of northern Italy. In 1850 government indebtedness to the National Bank had stood at 205,300,000 florins. With the Crimean War of 1854, the government’s debt increased to 294,200,000 florins. It was reduced to 145,700,000 florins by 1859. But the start of the Italian campaigns that year pushed it up again to 285,800,000 florins, along with a renewed suspension of specie payments as the public wished to redeem the paper currency representing the value of this enlarged debt.

In 1863, an attempt was made, once again, to introduce a currency reform—the Plener Act—this time along the lines of Britain’s Peel’s Bank Act of 1844. But Austria’s disastrous war with Prussia in 1866 pushed the supply of paper money in circulation from 80,000,000 florins before the conflict to 300,000,000 florins at its end.

The Compromise of 1867 that formally created the Austro-Hungarian Empire granted Hungary its own parliament, government, and domestic budget. It established a customs union and a common military and foreign policy between the two parts of the Habsburg domain, and a monetary union with the Austrian National Bank retaining its monopoly of note issue throughout Francis Joseph’s domain. Some of the Hungarian liberals had advocated a system of competitive note-issuing private banks in place of the National Bank, but secret agreements between the emperor’s government and the Hungarian nobility eliminated this as an option.

On July 1, 1878, the Austrian National Bank was transformed into the Austro-Hungarian Bank. The emperor, under joint nomination of the Austrian and Hungarian parliaments, appointed its governor. He was assisted by two vice-governors—one Austrian and the other Hungarian—appointed by the respective governments. The Bank’s operating privileges were renewed in 1887, 1899, and 1910, with few substantial changes in their detail.

Formally, from 1816, Austria had been on a silver standard. But as we saw, the Austrian National Bank maintained unofficial specie redemption only for limited periods of time, soon interrupted usually by another war crisis requiring currency expansion to fund the government’s expenditures.

The paper currency florin, not surprisingly, traded at a significant [xxxii] discount against the silver coin florin. Between 1848 and 1870, this discount was never less than about 14 percent and was often between 20 and 23 percent. But restrictions on note issuance under the operating rules of the Bank limited the expansion of the supply of banknotes. The provisions of the 1863 Bank Act limited the circulation of “uncovered” florins to 200,000,000. Any amount above that had to be covered by gold or silver coin or bullion. Any additional “uncovered” banknote issuance was subject to a penalty tax against the Bank of 5 percent.

With many of the major governments of Europe and North America establishing or reestablishing their economies on a gold basis in place of silver in the 1870s, the world price of silver began to fall.34 After the Austro-Prussian War of 1866, the government’s pressures on the Bank to fund deficits were greatly reduced, and the Bank could more or less follow the rules against uncovered note issuance. As a result, the paper florin’s discount relative to silver disappeared by 1878. Silver began to flow into Austria-Hungary in such quantities that the Bank was instructed by the government to end the free minting of silver.

As a result, the paper florin actually rose to a premium against silver. As Friedrich von Wieser expressed it, “Silver had become of less value than paper!”35 In addition, the florin was significantly appreciating in value against gold. The price in paper florins for 100 gold florins between 1887 and 1892 was:

Average for the year Austrian florin notes
1887 125.25
1888 122.87
1889 118.58
1890 115.48
1891 115.83

The major monetary issue, therefore, during these years was to bring a halt to any further increase in the value of the Austrian paper currency. In February 1892, the Austrian and Hungarian governments invited a group of professional and academic experts to meet and address a set of questions relating to whether a gold standard should be [xxxiii] adopted; if so, should it be monometallic or partly bimetallic with silver; what should be the status of government notes in circulation; how should the conversion from the existing florin to a gold standard be undertaken; and what monetary unit should be chosen?

Some of the most illustrious people in the field were brought together to offer their views and opinions on these questions. Thirty years later Ludwig von Mises described them in the following manner:

From March 8 to March 17, 1892, the government-convened Currency Inquiry Commission met in Vienna. The chairman was Finance Minister [Emil] Steinbach; beside him stood the memorable Eugen von Böhm-Bawerk, as section head. Thirty-six experts appeared before the commission to answer five questions that were posed by the government. No Austrian was left off the list of participants at the inquiry who had anything of importance to say on currency matters. Along with Carl Menger, the founder of the Austrian School of economics, there was Wilhelm von Lucam, the highly honored longtime secretary general of the Austro-Hungarian Bank; Moriz Benedikt, the publisher of Neue Freie Presse [New Free Press]; Theodor Thaussig, the spiritual leader of the Viennese banking world; and Theodor Hertzka, the well-known writer on monetary matters and social policy. The thick quarto volume that makes up the stenographic minutes of the inquiry remains today a source for the best ideas on all matters relating to monetary policy.36

Virtually all of the participants spoke in favor of Austria’s adoption of a gold standard. Menger, for example, at one point said: “Gold is the money of advanced nations in the modern age. No other money can provide the convenience of a gold currency in our age of rapid and massive commodity exchanges. Silver has become a troublesome tool of trade. Even paper money must yield to gold when it comes to monetary convenience in everyday life. . . . Moreover, under present conditions only a gold currency constitutes hard money. Neither a bank note and treasury note nor a silver certificate can take the place of gold, especially in moments of crisis.”37

Later summarizing the work of the commission, Wieser supported the adoption of the gold standard in colorful language:

Money is like speech; it is a means of intercourse. He who would have dealings with others must speak their language, however irrational he may find it. Language is rational by the very fact that it is intelligible to others, and more rational in proportion as it is intelligible to more people or to all. There can no more be an independent money system than independent speech; indeed, the more universal character of money, as compared with language, appears in this, that while a national language has its justification and significance in the intercourse of the world, there is no place for a national monetary system in the world’s intercourse. If Europe errs in adopting gold, we must still, for good or evil, join Europe in her error, and we shall thus receive less injury than if we insist on being “rational” all by ourselves.38

The Currency Commission, in its official report to the Upper House of the Austrian Parliament, was no less adamant that gold, and only gold, was the recognized and essential international money. For that reason Austria-Hungary needed to adopt gold as the nation’s standard if it was to successfully participate in the commerce and trade of the world.39

The commission proposed and the government accepted that the monetary unit would be renamed thekrone (the crown), with the new crown being equal to one-half the replaced florin. Standard coins would be gold pieces of ten and twenty crowns, each one being of 900 parts gold to 100 parts copper. The twenty-crown coin would have a full weight of 6.775067 grams, and a fine weight of 6.09756 grams. In 1892 an exchange rate for the crown was fixed at 1.05 Swiss francs and 0.8505 German marks.

Silver was kept as a secondary medium of exchange of limited legal tender status for smaller transactions. Government paper money was temporarily kept in circulation up to a certain maximum, but with the expectation of its eventual retirement. For the transition to a full gold standard with legally mandated redemption of banknotes for specie, it was expected that the Austro-Hungarian Bank would continue to accumulate sufficient supplies of gold until at an unspecified date formal redemption would be instituted.

An obligation to redeem crowns for gold was, in fact, never made into law. Yet from 1896 and most certainly after 1900 up until the outbreak of the war in 1914, the Austro-Hungarian Bank acted as if it now had that obligation and did pay in gold for its banknotes presented for redemption. Indeed, the oversight of this “shadow” gold standard (as it was called) by the Austro-Hungarian Bank, with maintenance of the exchange rate within a margin not much off the “gold points,” was praised by authorities at the time as an exemplary case of a highly successful “managed currency.”40

Ludwig von Mises’s Writings on Monetary and Fiscal Policy Before the Great War

Ludwig von Mises’s earliest writings on monetary and fiscal policy were published between 1907 and 1914,41 and focused on these currency reform and related issues. He devoted a chapter in his Memoirsto explaining the background behind some of these articles.42 He details his frustrations when the articles resulted in his coming face-to-face for the first time with opposition by government officials to reasonable and publicly endorsed policies due to political corruption and misappropriation of “secret” slush funds that would be threatened by implementing a fully convertible gold standard.

But he does not go into very great detail about the content of these early essays. They may be grouped under two headings. The first consists of articles concerning the political pressures that finally led to putting Austria formally on the path of a gold standard in 1892, and the reasons for the resistance and delay in legally establishing gold convertibility up to the beginning of World War I. The second group deals with fiscal extravagance and the regulatory and redistributive intrusiveness of the Austro-Hungarian government, which was leading the [xxxvi] country to a potential financial and economic crisis. Even if the events of the war had not intervened to accelerate the process that culminated in an end to the nearly eight-hundred-year reign of the Habsburgs, the growth of the interventionist state was weakening the foundations of the country.

The earliest of these essays is “The Political-Economic Motives of the Austrian Currency Reform.” It is primarily an analysis of the changing factors influencing various interest groups that finally led to a sufficient coalition of these interests endorsing the move toward a gold standard. It highlights the fact that a major shift in economic policy is often dependent upon the vagaries of unique historical events, without which such a change might never have the chance to be implemented.43

From 1872 to 1887, the Austrian currency had been depreciating on the foreign exchange market. Many of the agricultural and manufacturing interests in both Austria and Hungary did not object to this trend, since it reduced foreign competition by raising the costs of imports and worked to make Austrian goods more competitive in other countries. But beginning in 1887, the currency began to appreciate, and continued to do so until 1891. The same interests that were quite happy living with a currency losing value were extremely anxious with an appreciating currency that lowered the costs of imports and raised the costs of Austrian exports.

By the time the Austrian Currency Commission was convened in 1892, all the leading manufacturing, agricultural, and financial interests had agreed behind the scenes on the necessity for currency reform to bring the appreciation of the Austrian florin to a halt. And they all concurred on the desirability for Austria-Hungary to establish a gold standard, while they initially argued over the particular rate of exchange at which the new currency—the crown—would be stabilized.

Mises’s essay reads partly as what, today, would be considered a “public choice” analysis of the special-interest politicking that often guides [xxxvii] public policy. It brings out how a concentrated benefit to a wide array of interest groups served to generate a consensus on a significant institutional change in the existing monetary system. It also demonstrates how the costs or burdens imposed on a variety of smaller interest groups—particularly creditors and a number of medium-sized businesses who gained from currency appreciation, and conservatives who opposed a gold standard on ideological grounds—could be outweighed and outmaneuvered into being unable to prevent the monetary reform.

But at first, the Austro-Hungarian Bank was not legally compelled to redeem its notes for specie (gold). Its initial task was to prevent any further appreciation of the new crown from its formal foreign exchange rate. It was not given any direct instruction to prevent any renewed depreciation, if it were to occur. This, too, was consistent with the dynamics of the coalition of interest groups that had opposed any further increase in the value of the currency, but had not objected to the earlier years of currency depreciation.

But after 1896, the Austro-Hungarian Bank had accumulated enough gold and foreign exchange that it could assure the stability of the Austrian crown’s foreign exchange rate within both the upper and lower ends of the gold points, and in fact kept it within less than one percent of the parity rate most of the time. And after 1900, the Bank was redeeming and issuing its notes for gold as well as for foreign exchange on an unofficial de facto basis, while still not legally required to follow a policy of specie redemption.

This was the context in which Mises wrote four of the essays in this volume: “The Problem of Legal Resumption of Specie Payments in Austria-Hungary,” “The Foreign Exchange Policy of the Austro-Hungarian Bank,” “On the Problem of Legal Resumption of Specie Payments in Austria-Hungary,” and “The Fourth Issuing Right of the Austro-Hungarian Bank.”

Mises’s argument was that nothing was keeping the Austro-Hungarian Bank from now being given the legal obligation to redeem gold on demand for its banknotes, and thus formally joining the international community of gold standard nations. He insisted that this would immediately raise the creditworthiness of debt issued by the Austrian and Hungarian governments on foreign markets, and therefore lower the costs of borrowing from international creditors. It would also improve global confidence in Austria-Hungary as a developing nation desirous [xxxviii] of attracting foreign investment and lower the cost of international capital for Austrian entrepreneurs.

Opponents of formal specie redemption argued that requiring the Austro-Hungarian Bank to redeem gold would risk a large hemorrhage of specie reserves at any time an international crisis induced holders of crown notes to transfer their liquid capital out of the country. If during such an international crisis other central banks were to raise interest rates to protect their gold reserves from the danger of capital flight, the Austro-Hungarian Bank would be compelled to also raise its interest rate to prevent loss of its own gold reserves. Domestic manufacturing and commerce would then find that the cost of capital was held captive to the uncontrollable market forces of international finance. Domestic interest rates could experience swings that would carry negative effects for business within the country, merely to counteract speculators who wished to move gold in and out of the country to take advantage of interest rate spreads that had nothing to do with the legitimate needs of the import and export trade to facilitate international transactions. These critics argued that it was far better to maintain the present system of de facto specie payments, which gave the Austro-Hungarian Bank the latitude and liberty to, at any time, refuse gold or foreign exchange redemption for its notes to shelter the domestic economy from unnecessary and destabilizing interest rate changes.

Mises counterargued in these articles that since the 1860s, first the old Austrian National Bank and then its successor, the Austro-Hungarian Bank, had had legal authority to hold a sizable portion of its reserves against notes outstanding (even when official redemption was not imposed) in foreign bills of exchange, foreign currency, and other foreign-denominated assets that were, themselves, redeemable abroad in specie money. In other words, the Austrian central bank operated on the basis of a gold-exchange standard rather than a full gold standard. Through this method the Austro-Hungarian Bank was able to earn a significant interest income from its reserve holdings instead of letting its gold sit idle in the Bank’s vaults. At the same time, these foreign earnings not only went to the Bank’s stockholders, but were shared by law with the Austrian and Hungarian governments, thus reducing what otherwise might have been higher taxes to cover government expenditures.

For a long time the Bank already had been utilizing its holdings of foreign exchange and other foreign-denominated assets precisely to [xxxix] substitute for having to meet every demand with an actual gold outflow. This not only was an effective tool for meeting “legitimate” needs for specie in international transactions, but served to counteract speculative demands for gold or foreign exchange to keep the crown’s foreign exchange rate within the gold points, beyond which it would become profitable to export or import gold.

Furthermore, the Austro-Hungarian Bank did, in fact, export gold at times of international crisis, as well as on a regular basis. In normal times it exported gold precisely to replenish its stock of foreign exchange, foreign bills of exchange, and other foreign-denominated assets redeemable in specie abroad to maintain a supply sufficient to cover its international dealings and obligations. And during international financial crises it consciously exported gold to markets in Germany, Great Britain, and France to help alleviate the pressure for gold abroad, and at the same time earned a handsome return when gold prices were high. By supplying gold to foreign markets at such times, it also reduced the need to raise interest rates at home since the gold exports reduced the need for other central banks to raise their interest rates to protect their own gold reserves.

Finally, even while not legally obligated to redeem its notes for specie, the Austro-Hungarian Bank used its discount rate when it deemed it necessary to dampen the demand for both gold and other foreign-denominated assets among its reserves on the part of “speculators” and any others. Thus the Bank was already doing all the things that it would be required to do or could do under formal specie redemption to both maintain the official parity rate and preserve its gold reserves from undesired withdrawals. From any of the critics’ perspectives, no case could be reasonably made against the Austro-Hungarian government’s legislatively enacting the final completion of the currency reform process that had begun in 1892.

So why did the Austrian and Hungarian governments never pass legislation establishing formal specie redemption on the part of the Austro-Hungarian Bank? Mises gave no fully satisfactory answer in these articles, which were all published in respected scholarly journals of the time. However, in his MemoirsMises explained that behind the scenes the opposition to formal convertibility was partly because a portion of the rather large funds earned from foreign exchange dealings by the Austro-Hungarian Bank were hidden away in a secret account from which senior political and ministerial officials could draw for [xl] various “off the books” purposes, including influencing public opinion through the media. He learned about this special fund from Eugen von Böhm-Bawerk (1851-1914),44 the internationally renowned Austrian economist and Mises’s mentor, who told him about it off the record. Böhm-Bawerk was disgusted by the whole business and frustrated that even when he was finance minister (1900-1904), he had not been able to abolish the fund. A good part of the opposition and anger expressed against Mises’s defense of legal convertibility was the fear by those accessing these special funds that this source of money would dry up under the more transparent accounting procedures that would come with legal redemption.45

In his 1909 article “The Problem of Legal Resumption of Specie Payments in Austria-Hungary,” Mises did point out that one reason behind the opposition to legal convertibility was the resistance of the Hungarians. They wanted to weaken the power of the joint Austro-Hungarian Bank as a way to continue their drive for independence from the Habsburg Monarchy. Since the Compromise of 1867,

Hungarian politics have ceaselessly endeavored to loosen the common bonds that connect that country to Austria. The achievement of economic autonomy from Austria has appeared as an especially important goal for Hungarian policy as a preliminary step leading to political independence. The national rebirth of the non-Magyar peoples of Hungary—Germans, Serbo-Croatians, Romanians, Ruthenians, and Slovaks—will, however, pull the rug out from under these endeavors and contribute to the strengthening of the national ideal of Greater Austria. At the moment, however, Hungarian policy is still determined by the views of the Magyar nobility, and the power of the government rests in the hands of the intransigent Independence Party.

The nationalistic “rebirth” of these peoples under the often oppressive control of the Hungarians did not strengthen the “national ideal of Greater Austria”—that “Austrian idea” of a harmonious multinational empire under the reign of the Habsburgs—that Mises assumed and clearly hoped would triumph. Instead, the appeal of nationalism over individual liberty and liberalism that had been developing throughout [xli] the empire for decades finally contributed to the death of the Habsburg dynasty in 1918.46

But if the centrifugal forces of nationalism were pulling the empire apart from within, it was also being undermined by the fiscal cost and growth of the state. This was the second theme in Mises’s policy writings before the First World War, in two essays: “Financial Reform in Austria” and “Disturbances in the Economic Life of the Austro-Hungarian Monarchy During the Years 1912-13.”

After having its financial house in order for almost twenty years, Mises pointed out, the Austrian government was now threatening the fiscal stability of the society with increasing expenditures, rising taxes, and budget deficits. Government spending was likely to significantly grow in future years partly due to the expenses of maintaining costly military forces in an environment of an international arms race. The other major factor at work on the spending side of the government’s ledger were social welfare expenditures that the Austrian authorities were taking on, and which would only grow in the years ahead. Already in the preceding ten years, government spending had increased by over 53 percent, and over the same decade the cost of funding the government’s debt had increased by nearly 20 percent. The cost of financing many of the ministries was exploding; the nationalized railway system was running large deficits that had to be covered from other government funding sources; and the Austrian Crownlands were managed with a three-layered bureaucratic system of administrators at the national, provincial, and municipal levels, each with its own rules, regulations, [xlii] and taxing authorities—and often in contradiction with each other.

To cover these expenditures, a wide variety of taxes were being increased, including inheritance taxes, sales and excise taxes, and income and corporate taxes. They frequently were manipulated to shift the incidence of the tax burden away from the agricultural and rural areas of Austria onto the shoulders of the urban populations and especially onto industry and manufacturing. In addition, the finance ministry wanted to implement legislation giving the government the authority to examine the books of businesses and industries. Mises observed that “Austrian entrepreneurs rightly see in this arrangement an intensification of the harassment that the authorities display toward them.” Although the tax rates and burdens that Mises analyzes and criticizes seem by today’s higher and more intrusive fiscal standards to be part of that bygone, idyllic world of limited government liberalism before the First World War, they all represented significant increases at the time, and all pointed in a dangerous direction for the future.

What Mises also found most disturbing in the coalition of political forces raising taxes and shifting them onto industry and the urban areas was a clear ideological bias against modern capitalist society. There were conservative and rural interests who wished for a return to the preindustrial era, Mises claimed, and were using their preponderant representation in the Austrian parliament to place roadblocks in the way of modernization, and delay if not stop the economic development of the country.

The economic crisis in Austria-Hungary in 1912 and 1913, Mises argued, showed that fiscal irresponsibility was pervasive in both the government and the private sector. Everywhere consumption spending was growing at the expense of savings, while everyone did all in their power to avoid work. Government expenditures were expanding and eating away at the hard-won wealth and capital accumulation of previous years as a result of government deficit spending. But the private sector was no more frugal than government. In every walk of Austrian life, people attempted to live beyond their means. Everyone lived on credit that depended upon the illusion that debts accumulating on the books of retailers and wholesalers eventually could be repaid. Retailers extended credit to their customers; wholesalers extended credit to retailers; and the financial institutions extended credit to the wholesalers, manufacturers, and merchants.

It was a financial game of musical chairs in which everyone throughout the entire chain of production and sales appeared to be prosperous and profitable only because of the claims on the books against others up and down the payment structure of the economy. A serious default anywhere along the line could set off repercussions that would threaten the entire financial system. And precisely because of this, whenever anyone failed to pay even a fraction of the balances owed, the lines of credit were extended further to put off the inevitable day of reckoning and keep the illusions going.

The financial crisis of 1912-13, Mises explained, had been partially that day of reckoning in which the financial system was found to be built on sand. Mises could only hope that some lessons would be learned: that consumption needed to be based on production, and debts undertaken needed to be repaid through savings, work, and investment. He feared that the lessons had not been learned. Within a matter of months after writing in early 1914 his analysis of the causes and consequences of this crisis, Austria-Hungary was plunged into a far more disastrous crisis from which it would not survive as a political entity.

In two pieces written in 1913, “The General Rise in Prices in the Light of Economic Theory” and “On Rising Prices and Purchasing Power Policies,” Mises had attempted to explain the monetary mechanism by which increases in the supply of money and credit bring about a general rise in prices. Mises develops part of the argument that he had formulated in 1912, in The Theory of Money and Credit,47 that the period of inflation through which Austria-Hungary and much of the world was passing was due to the expansion of credit by the banking system in the form of fiduciary media. The latter, in Mises’s terminology, are money substitutes in the form of banknotes and checking deposits that are claims against specie currency held as reserves by the central bank and other lending institutions. However, such fiduciary media may be of two sorts: those that Mises calls “commodity credit,” which is fully backed by bank reserves, and “circulation credit,” which is only partially backed by reserves in the banking system. It is the fractional reserve basis behind a growing amount of the fiduciary media in circulation, Mises insists, that is the real cause of price inflation and the business cycle. Creating and lending unbacked fiduciary media at [xliv] artificially lowered rates of interest produces an imbalance between savings and investment that leads to an unsustainable boom, which finally has to end in an economic downturn and a period of readjustment in the market.48

But Mises suggested that another influence was generating a general rise in prices, which he argued was caused by the nature of monetary transactions in an increasingly complex market order. In a developed market with multistaged processes of production, in which producers no longer meet face-to-face with their ultimate consumers, each seller must fix his prices on the basis of his expectations about what he thinks buyers further down the production chain may be willing to pay. This expectation about what his buyer will be willing to pay, in turn, influences the price he will be willing to pay to the producer or wholesaler from whom he purchases goods.

To the extent that such a seller expects that his buyer may be willing to pay more, he then will be willing to pay prices to those who sell to him that he otherwise might consider too high. Thus, Mises argued, a dynamic is set in motion that results in a continuing rise in prices throughout the various sectors of the economy in a certain temporal sequence. For example, trade unions may demand wages higher than employers consider the workers’ labor to be worth. But if those employers are confident that they can pass on the cost of paying higher money wages to those to whom they sell their products, they acquiesce in money wage demands that would otherwise be unjustifiable. At the same time, the higher real wages that those workers hope to obtain through an increase in their money wages will be eroded as prices of finished goods continue to rise in the economy due to this general inflationary process throughout the market. What trade unions might consider their demonstrated capacity to improve the real wages of workers was illusionary, since over time any temporary gains would be washed out by the general rise in prices. In the long run workers [xlv] could not obtain real wages in excess of the value of their marginal product.

Mises went as far as to say that nothing really could be done about this inherent price-increasing process; he even suggested that it was indicative of a dynamic and growing economy in which constant shifts in supply and demand and the conditions and methods of production required pricing decisions to be made on the basis of expectations under inescapable uncertain future market conditions. Mises concluded that the fact that the economy was not static, and therefore not more fully predictable, was a reason for optimism that these changing economic circumstances were bringing about improvements all the time.

What is missing in this part of Mises’s analysis is any clear link with either a prior or simultaneous increase in the supply of money and fiduciary media that permits this price-inflationary process to continue, or an indication that the process implies an increase in the velocity of money that would allow the same number of market transactions to be facilitated at rising prices. As he formulated it in these two articles, his argument seems to represent a version of what in the post-World War II period became known as cost-push inflation.49

War Financing, Inflation, and the Goals of International Trade Policy

When war broke out in summer 1914, Mises’s artillery reserve unit was called up for active duty. For part of the next four years he sometimes saw intense action on the eastern front against the Russian Army. However, in 1918, during the last year of the war, Mises was assigned to work in various consulting capacities for the Austrian High Command in Vienna. And for a short time he served in Austrian-occupied Ukraine involved with currency matters.50

In 1916, he published “On the Goals of Trade Policy,” in which he presents a clear analysis of the gains from division of labor and international trade. But Mises goes on to explain that what motivated nations such as Germany and Austria-Hungary was a particular dilemma. For [xlvi] these relatively overpopulated countries in Europe, the greater economic opportunities in foreign countries resulted in emigration that meant a loss of manpower both for future wars and as part of the work-force during peace as well as at times of international conflict. Also, in the cultural struggles between countries, emigration meant a loss of part of a nation’s human heritage, since over time many such emigrants were absorbed into the culture and language of the host nation.

Thus, in countries like Germany and Austria-Hungary the task was to develop policies that would raise the living standards and opportunities in the homeland to reduce the incentive to leave and be “lost” to the fatherland. The nationalist trade method rejected free trade and erected protectionist barriers to artificially raise prices and secure domestic employments for the population. Alternatively, such a country could attempt territorial expansion into surrounding areas to gain the land and resources that would overcome the too densely populated condition within the pattern of existing political boundaries in which, for example, Germany was currently confined. One other method was to acquire colonies abroad to which emigrants could move while retaining their cultural identity and political allegiance to the fatherland.

Writing at a time of war, Mises carefully emphasized that these political trade policy goals were in the long run incompatible with the economic forces of an increasingly global market society. These forces were constantly working to guide both labor and capital to where their productive capacity was most highly valued, which inevitably would result in redistributions of people around the world to reflect their most optimal employments in the international division of labor. In the long run, the logic and incentives of the market would transcend the political goals of nationalist ideology.

In “Remarks Concerning the Problem of Emigration,” a memorandum that Mises prepared in 1918 for the Austrian government commission to which he was assigned in Vienna, he suggested a variety of domestic policies that would reduce the incentive for workers to leave Austria. These included making more farmland available out of existing larger estates for the benefit of small landholders who currently could not support their families on the properties they owned. It would be useful for the government and private associations to assist seasonal migrant labor in finding more attractive wage and work condition opportunities abroad, thus increasing the likelihood they would return home to a country that cared about their well-being. It was also necessary [xlvii] to reduce the burden and inconveniences of compulsory military service that too often induced some workers employed abroad to not come home.

Also in the summer of 1918, Mises delivered a public lecture, “On Paying for the Costs of War and War Loans.” He praised the military successes of Austria’s armed forces in its fight against the Allied Powers and the industrial efficiencies of Austrian business that had provided the manufacturing wherewithal for, Austria to do so well, even in the face of Allied blockades that cut Austria off from foreign sources of supply. But production had to be paid for, and the issue arose of whether the government’s war costs should be covered by taxation or debt.

Mises reminded his listeners that borrowing did not enable the current generation to shift any part of the costs of war to a future generation. Current consumption could only come out of current production, and this applied no less to consumption of finished goods designed for and used in war. Whether the war was financed by taxes or borrowing, the citizenry paid for it today by forgoing all that could have been produced and used, if not for the war. Mises also explained to his audience what today is often referred to as the Ricardian equivalence theorem, named after British economist David Ricardo (1772-1823). In his 1820 essay, “Funding System,” Ricardo argued that all that the borrowing option entailed was a decision whether to be taxed more in the present or more in the future, since all that was borrowed now would have to be paid back at a later date through future taxes; therefore in terms of their financial burden the two funding methods can be shown to be equivalent, under specified conditions. Ricardo, however, also pointed out that due to people’s perceptions and evaluations of costs in the present versus the future, they were rarely equivalent in their minds.51

But Mises raised a different point in favor of certain benefits to debt financing for the government’s war expenditures. First, many who would not have the liquid assets to pay lump-sum wartime taxes would either have to sell off less liquid properties to pay their tax obligation, or would have to borrow the required sum to pay the tax. In the first case, a sizable number of citizens might have to liquidate properties more or less all at the same time to improve their cash positions, which would put exceptional downward pressure on the market prices of those assets. [xlviii] This would impose a financial loss on those forced to sell these properties and assets to the benefit of those who were able to buy them at prices that would not have been so abnormally low if not for the war and need for ready cash to pay the tax obligation. Second, to the extent that some citizens would need to borrow to cover their wartime tax payments, the private individual’s creditworthiness undoubtedly would be much lower than the government’s. As a consequence, these private individuals would have to pay a noticeably higher interest rate than that at which the government could finance its borrowing. Thus, the interest burden from government borrowing to be paid for out of future taxes would be less for the citizenry than the financial cost of their having to borrow money in the present to cover all the costs of war through current taxation.52 Hence it was both patriotic and cost-efficient for those listening to Mises’s presentation to buy war bonds in support of the war effort.

Finally, in “Inflation,” another lecture delivered in the late summer of 1918, Mises explained the impact of the government’s financing a large amount of its war expenditures through monetary expansion. First, all creditors who had failed to anticipate the resulting depreciation in the value of the Austrian crown are paid back in money possessing less purchasing power than when the loan was issued. This might seem to be a desirable side effect, since clearly the debtor gains by paying back his loan in depreciated crowns, especially if it is “the poor” who are the predominant debtor group. But it was worth recalling, Mises said, that in modern society the debtors were most often businesses that had borrowed to cover investment costs, while the creditors were middle-class citizens, widows and orphans, civil servants, and members of the lower-income working class who had put their savings into the financial institutions that did the lending. Hence, Mises pointed out, in this debtor-creditor relationship, under inflation the “rich” benefited at the expense of the middle class and the “poor.”

Some saw the benefit from inflation in that it also reduced the real value of the government’s accumulating debt, thus reducing the “real” cost of the war. At the same time, rising money incomes and profits in the private sector due to inflation meant that the government gained higher tax revenues in money terms. On the other hand, to the extent [xlix] to which the government had covered part of its debt with foreign borrowing denominated in another currency, the falling value of the crown on the foreign exchange market due to inflation increased the amount of crowns the government had to pay to meet its foreign financial obligations. Also, some taxes were fixed at a specified level, so in this instance the taxpayer gained in real terms during inflation while the government lost. Furthermore, the worse and more continuing the inflation, the more reluctant citizens would be to buy war bonds and other government debt instruments, thus increasing the difficulties of financing the war other than through inflation. Thus, from a variety of perspectives, inflation was a dangerous and undesirable method of covering the costs of war, since it undermined the real wealth of the middle class and those in the working class who saved in an attempt to improve their position in society.

After War: Hyperinflation and Fiscal Mismanagement in the New Austria53

In October and November 1918, the Austro-Hungarian Empire began to disintegrate as various national groups began to break away and declare their independence, most notably the Czechs and Slovaks, who joined in creating their own country, then the Hungarians, who were then followed by the Serbs, Croats, Slovenians, and Bosnians, who formed a new Yugoslavia. The Romanians soon began to incorporate Transylvania within their borders, and Italy seized south Tyrol and the port of Trieste. Galicia became a battleground between the Poles, the Ukrainians, and the Russian Bolsheviks in the next few years.

In what was declared the new state of German-Austria a coalition government was formed between the Social Democrats, the Christian Socialists, and the Nationalist Party. Almost immediately, they began a campaign of expensive food subsidies for the urban population at controlled prices, compulsory requisitioning of agricultural goods from the rural parts of the country, foreign exchange controls on all imports and exports at an artificial rate of exchange, a vast array of social welfare [l] programs, and the use of the monetary printing press to finance it all. By the middle of 1919 and then into 1920 and 1921, serious inflation had degenerated into hyperinflation.54

Mises’s articles “Monetary Devaluation and the National Budget” and “For the Reintroduction of Normal Stock Market Practices in Foreign Exchange Dealings” explained that the foreign exchange rate was a market-created price that could not be simply fixed and manipulated by the state. The value of any one currency in terms of another was ultimately a reflection of each currency’s purchasing power. Guided by the “law of one price,” the market tendency was to establish the exchange rate at that point at which the attractiveness of buying some quantity of a good in either country was the same. Setting the exchange rate at some level other than the market-determined rate merely meant that it was artificially fixed at too dear or too cheap a price. In the face of the currency shortages that the exchange control resulted in, the government then commanded that all foreign exchange earnings be sold to the Austrian Exchange Control Authority at the fixed rate, with the government bureaucracy now determining the rationing of it to both importers and exporters.

Prohibiting normal foreign exchange dealings merely drove transactions underground into the black market, and prevented the functioning of those institutional arrangements through which individuals can hedge against uncertain fluctuations in the foreign exchange rate by utilizing a legal futures market. Instead, the inflationary environment, with limited legal avenues to “take cover” against the effects of a depreciating currency, meant that more and more people were shifting into the use of foreign monies in domestic Austrian business transactions. The foreign exchange controls needed to be abolished, and the printing presses needed to be brought to a halt if a monetary disaster was to be averted.

The fundamental cause for Austria’s problems was that it was in the stranglehold of the socialist idea, with all of its negative consequences. This was the theme in two pieces by Mises: “The Austrian Problem” and “The Social Democratic Agrarian Program.” The socialists were [li] determined to control and spend their way into the destruction of the country. Under this administration, taxes and inflation ate away at the accumulated wealth of the past and hindered any capital formation in the present. They demagogically promised wealth while causing waste by nationalizing and regulating industries that ended up suffering losses that needed to be paid for through even more inflation. Their agricultural agenda was to do with the rural economy the same harm they were doing with industry and manufacturing in the cities.

What was to be done? In February 1921, Mises presented the outline of a plan in answer to the question, “How Can Austria Be Saved?” The first order of business was to stop the monetary printing presses. But this could be done only if the costly food subsidies were eliminated and the nationalized industries were reprivatized to end the huge expenses to cover their deficits, so the national budget once again could be brought into balance. Foreign exchange controls had to be abolished with a free market in all currency dealings. At the same time, the value of the Austrian crown had to be stabilized once the central bank had stopped issuing paper money and the depreciation of the currency was brought to a halt. All domestic regulations and controls inhibiting free commerce among the various provinces of Austria had to be lifted, and free trade had to be reintroduced in all forms of foreign trade. This was the path to a revitalized and prosperous Austria.

A sound monetary system was unlikely if the governments of those new states that had formerly been part of the Austro-Hungarian Empire looted the assets of a reconstructed Austrian central bank. Thus, in “The Claims of Note Holders upon Liquidation of the Bank,” published in February 1921, Mises argued against those who asserted that those other governments had a right to a portion of the old Austro-Hungarian Bank’s gold reserves. Under the Treaty of Saint-Germain, which had ended the war between Austria and the Allied Powers, the successor states were obligated to redeem the old crown notes on their territories for their own respective currencies. The old Austro-Hungarian Bank notes were then to be turned over to the new Austrian central bank, which would take them out of circulation. Mises argued that everyone knew that the huge expansion of banknotes to fund the government’s war expenses were backed by nothing, and certainly not by whatever gold may have remained in the central bank’s vaults. To demand anything else would be to plunder the gold and other assets upon which a reconstituted Austrian monetary system would be built.

Mises observed in an article early in 1922, “The Austrian Currency Problem Thirty Years Ago and Today,” that the key to ending Austria’s problems was stopping inflation. Thirty years earlier, in 1892, the task had been to stabilize a currency that was appreciating in value. The task in 1922 was to bring a halt to its depreciation. But the method was the same: link the currency to gold and do not manipulate its quantity in circulation.

As the situation worsened, Mises put together a proposal on behalf of the Vienna Chamber of Commerce for “The Restoration of Austria’s Economic Situation,” which was submitted to other trade and labor union associations in the country to devise a way to bring an end to the government budget deficits as a prelude to stopping the inflation. In a nutshell, Mises recommended the establishment of price indexation throughout the economy. Already government expenditure levels were automatically adjusted in line with a cost-of-living index. Now the same arrangement had to be set up for government revenues. Otherwise nominal expenditures would keep growing while nominal tax revenues would always lag behind, never leading to an end to the deficits. Incomes, profits, and wages and prices all had to be indexed to the market value of gold. This would continually adjust government tax revenues to government expenditures. It would mean that government nationalized sectors, such as the railway system, would have their prices rise in tandem with the average rate of depreciation of the currency reflected in its link to the price of gold, which would help to reduce their losses and maybe even earn a profit from transit fees for cargos passing through Austria. At the same time, gold indexation would assist in keeping the wages and salaries of many workers rising to maintain a certain real value of their income.

Mises emphasized that such an indexation policy was desirable not only due to questions of equity in a period of rapid depreciation and the need to bring the government’s budget better into balance. It was also needed because inflation distorted the very essence of a money-using economy: the ability for economic calculation to reasonably estimate profit and loss, and relative profitability of alternative lines of production. Price and wage indexation linked to the price of gold would help to reduce the miscalculations that inflation caused, and which often resulted in capital consumption. This measure, Mises stated, was meant to be a transition method to bring stability to the Austrian economy, or, as he concluded, “We must make up our minds to return from [liii] the extravagant intoxication of spending ‘billions’ to the sober, more modest financial figures of a smaller state. The object of the proposed plan is to avoid a sudden and disastrous collapse.”

The inflation was brought to a halt in late 1922 and early 1923 with the financial assistance and supervisorial oversight of the League of Nations. In 1925, in “The Gold-Exchange Standard,” Mises pointed out that while Austria and a number of other countries were moving back to a gold-backed currency, it was not a full gold standard system. Most countries did not have large amounts of actual gold reserves, and gold coins were nowhere in circulation. Instead, their monetary systems (like that under the old Austro-Hungarian Bank) were gold-exchange standards, under which most reserves were held in other countries in the forms of financial assets that were, in principle, redeemable in gold in those other countries. The entire system depended upon at least a few countries, like the United States at that time, being willing to serve as ultimate gold reserve redeemers. Mises thought that this was only a shadow of the type of real gold-backed system that could assure noninflationary stability to the various countries of the world.

In 1926, Mises had spent three months traveling in the United States. When he returned he delivered the talk “America and the Reconstruction of the European Economy.” Any further European recovery from the effects of the Great War could not count upon American political or economic leadership. Both manufacturing and agricultural interests in the United States were heavily protectionist and therefore resistant to imports. This, in turn, made it difficult for Europeans to find markets for their goods or to earn the dollars to pay back their wartime loans to America. While the United States was a creditor nation with the means to invest in Europe, money would not be given away but would depend on the profitability of such investments. Thus Europe would have to rely upon itself if it was to continue to overcome the legacy of the war.

Mises pointed out the difficulty for such stable recovery and growth in a summary he presented in 1928, “The Currency and Finances of the Federal State of Austria.” Five years after the end to Austria’s inflation, the currency was on a relatively sound basis. A new schilling had replaced the old crown and was fixed at a specific value in terms of gold. The rules under which the new Austrian National Bank operated made it difficult for it to serve as a means to finance the expenses of the government.

However, the fiscal affairs of the nation were far from sound. The government was still running budget deficits, but all of it was due to cost overruns in the nationalized sectors of the economy, especially the railway system and the lumber industry in the nationalized forest system. Financial pressures were placed on the federal authority because of the tax and related transfers to the provincial governments, which were all overlaid with bureaucratic regulatory structures and mismanagement. And in Vienna, where the Social Democrats controlled the municipal government, the financial extravagance on public projects was exceptionally large. For domestic growth and international competitiveness, Austria had to make its economy more productive. Cutting wasteful government and radically reducing taxes was the only avenue to a prosperous future for Austria.

When the Great Depression began in the early 1930s, the banking system was badly shaken. The collapse in May 1931 of the Austrian bank, Credit-Anstalt, in particular, sent shock waves throughout the financial markets. Shortly afterward, Mises wrote “The Economic Crisis and Lessons for Banking Policy.” In his eyes, the banking systems in Germany and Austria had two weaknesses. First, too many banks had become financially entangled with the industrial corporations to whom they lent. In fact, they often had become major shareholders in the very companies whose financial status they were supposed to oversee with a critical eye in terms of continuing creditworthiness. Instead, they unsoundly extended more credit to companies they should have pulled back from because their own balance sheets were too closely linked to the illusion of their continuing profitability. Finally the situation imploded, taking the banks down with those companies.

Second, those same banks had poorly managed the term structure of their investment portfolios. They lent long, while being liable for depositor withdrawals on demand. In other words, they had become caught in the system of fractional reserve banking, in which the amount of claims payable on demand far exceeded their available cash reserves to meet depositor liabilities.

The banking crisis, as far as Mises was concerned, was not the end of capitalism, but showed the need to reorganize the way banks managed their liabilities and investments after the crisis had passed. Sounder banking principles in a market economy were the avenue to avoid similar crises in the future.

Interventionism, Collectivism, and Their Ideological Roots

In the 1920s, one of the contributions for which Mises was most famous was his theory of government intervention. In 1930, he published “The Economic System of Interventionism,” a brief summary of his critique of this practice, with particular emphasis on the deleterious effects from all forms of control over prices. While various forms of production regulations had the tendency to reduce productivity, price controls were a far more directly harmful type of intervention. They inevitably distorted the relationship between supply and demand, artificially generated either shortages or surpluses, and deflected production from those avenues most likely to satisfy consumer demand. They also had a tendency to spread out to more and more sectors of the economy, as the government imposed similar controls on other markets and industries in a vain attempt to compensate for the imbalances the earlier price controls had created. If followed to their logical conclusion, such price controls led to a fully planned economy through piecemeal interventions imposed one after another.

Where did all this lead? In “Economic Order and the Political System” (1936), Mises pointed out that in the eighteenth and early nineteenth centuries, political democracy, civil liberty, and economic freedom had grown hand in hand. But in the second half of the nineteenth century the idea had taken hold that political democracy and personal freedom could be preserved even if the government increasingly intervened in and controlled the economic affairs of the citizenry in the name of social justice and socialist planning.

What the twentieth century was showing, however, was that political democracy and individual freedom could not last long when government planning increasingly replaces the market economy. Economic planning means planning people’s lives, and people must then conform in all their affairs to what the plan dictates. In countries like Soviet Russia, fascist Italy, or National Socialist (Nazi) Germany even the appearance of preserving democratic and personal liberties had been discarded and the reality of where planning leads could be most clearly seen. This was the crossroads that now confronted the remaining relatively free and democratic societies in the West: freedom or planning.

More than twenty years later, in 1959, Mises offered “Remarks Concerning the Ideological Roots of the Monetary Catastrophe of 1923,” when hyperinflation had brought Germany to the edge of total economic [lvi] collapse. He reflected back to when he was a young man before the First World War, during the years when he wrote those early pieces on the gold standard and had only just published The Theory of Money and Credit. He had attended the meetings of the Verein für Sozialpolitik (Society for Social Policy), the leading and most influential social science association in the German-speaking world, which was dominated by members of the German Historical School. Here he came face-to-face with the enemies of economic liberalism, who rejected most of economic theory in the name of a historically based approach to social analysis, on the basis of which they rationalized aggressive nationalistic conclusions, all leading to an eventual war. They had contempt for the Austrian economists and ridiculed the idea that there were “laws of economics” that should stand in the way of markets and money being controlled by the state. These were the thinkers who were the harbingers of many of the disasters of the twentieth century. Their aggressive nationalism had led to two world wars; their belief in the interventionist state had cultivated the coming of the planned and regulated society; and their confidence that money and its value were creatures of the state had fostered the inflations of the twentieth century.

And though Mises did not point it out, many of these German thinkers laid the ideological groundwork for the mass murder of millions at the hands of the National Socialists, including the destruction of six million Jews. Indeed, it was because of such ideas and their consequences that Mises himself was forced to flee a Nazi-dominated Europe and find sanctuary in America in the midst of the Second World War.

Leaving Europe for America had not been an easy decision for Mises. Indeed, he said in a letter to Friedrich A. Hayek in May 1940, as he was approaching his departure from Switzerland for the United States, “The decision to leave is truly difficult. For me, it represents saying good-bye to a life which I have always lived, it is for me an ‘adieu’ to a Europe which is about to disappear forever.”55

It is only appropriate, therefore, that before concluding this introduction we should take a look at Mises’s Jewish family roots in the old Habsburg Empire and how the fate of the Austrian Jews led to a man [lvii] like Mises having to say good-bye to the life and world in which he made his career and won his reputation as one of the leading economists of his time, and his having to make a new start at the age of fifty-eight in the New World.

Liberating Liberalism and the Austrian Jews56

Ludwig von Mises was born on September 29, 1881, into a prominent Jewish family in Lemberg (Lvov in present-day Ukraine), the capital of the Austrian Crownland of Galicia, far to the east of Vienna and near the border with the Russian Empire. In the last decades of the nineteenth century, more than 50 percent of the population of some parts of Galicia was Jewish, with the center of Jewish life and culture being in Lemberg.57

The documents that Ludwig von Mises’s great-grandfather, Mayer Rachmiel Mises (1801-91), prepared as background for his ennoblement by the Austrian emperor, Francis Joseph, in mid-1881 (just a few months before Ludwig was born), record the history of the Mises family in Lemberg going back to the 1700s. Mayer’s father, Fischel Mises, had been a wholesaler and real estate owner who had received permission to live and conduct business in the “restricted district” reserved for non-Jews. At the age of eighteen, Mayer married a daughter of Hirsch Halberstamm, the leading Russian-German export trader in the Galician city of Brody.

Mayer took over the family business following his father’s death and also served for twenty-five years as a commissioner in the commercial court of Lemberg. For a time he also was on the city council and was a full member of the Lemberg Chamber of Commerce. He also was a cofounder of the Lemberg Savings Bank, and later was a member of the board of the Lemberg branch of the Austrian National Bank. He also was one of the founders of the Cracow-Lemberg railway line. In addition, he was a founder of a Jewish orphanage, a reform school, a secondary education school, a charitable institution for infant orphans, and a library in the Jewish community. Some of these charities were [lviii] begun with funds provided by Mayer for their endowment. Indeed, it was for his service to the emperor as a leader of the Jewish community in Lemberg that Mayer Mises, great-grandfather of Ludwig von Mises, was ennobled.

Mayer’s oldest son, Abraham Oscar Mises, ran the Vienna office of the family business until he was appointed in 1860 the director of the Lemberg branch of the Credit-Anstalt bank. Abraham also was the director of the Galician Carl-Ludwig Railroad. His other son, Hirsch Mises, was a partner in and a director of the Halberstamm and Nirenstein banking company.58

It is perhaps because of the family’s connection with the railroad business that Hirsch Mises’s son, Arthur Edler von Mises, took up civil engineering with a degree from the Zurich Polytechnic in Switzerland, and then worked for the Lemberg-Czernowitz Railroad Company. Arthur married Adele Landau, the granddaughter of Moses Kallir and the grandniece of Mayer Kallir, a prominent Jewish merchant family in the city of Brody. Arthur and Adele had three sons, of whom Ludwig was the oldest. His brother, Richard, became an internationally renowned mathematician who later taught at Harvard University. The third child died at an early age.

Members of the Mises family also were devout practitioners of their Jewish faith. The vast majority of the Galician Jews were Hasidic, with all the religious customs and rituals that entailed. But the Mises family was part of that movement in the Jewish community devoted to theological and cultural reform, and participated in the liberal-oriented political activities that were attempted in nineteenth-century Galicia. As a small boy, Ludwig would have heard and spoken Yiddish, Polish, and German, and studied Hebrew in preparation for his bar mitzvah.

Ludwig’s father, Arthur, like many of his generation, chose to leave Galicia and make his life and career in the secular and German cultural world of Vienna, where he accepted a civil servant’s position with the Austrian Ministry of Railways. But from the documents among [lix] Ludwig von Mises’s “lost papers” found in the Moscow archives,59 it is clear that his mother maintained ties to her birthplace, contributing money to several charities in Brody, including a Jewish orphanage. In Vienna in the 1890s, Arthur was an active member of the Israelite Community’s Board, a focal point for Jewish cultural and political life in the Austrian capital.60

Until the early and middle decades of the nineteenth century, Jews throughout many parts of Europe were denied civil liberties, often being severely restricted in their economic freedom, and, especially in Eastern Europe, confined to certain geographical areas. In the 1820s it was still not permitted for Jews to unrestrictedly live and work in Vienna; this required the special permission of the emperor.61Commercial and civil liberation of the Austrian Jews occurred only in the aftermath of the Revolution of 1848, and most especially with the new constitution of 1867, which created the Austro-Hungarian Dual Monarchy following Austria’s defeat in its 1866 war with Prussia. The spirit and content of the 1867 constitution, which remained the fundamental law of the empire until the collapse of Austria-Hungary in 1918, reflected the classical liberal ideas of the time. Every subject of the emperor was secure in his life and private property; freedom of speech and the press was guaranteed; freedom of occupation and enterprise was permitted; all religious faiths were respected and allowed to be practiced; freedom of movement and residence within the empire was a guaranteed right; and all national groups were declared to have equal status before the law.

No group within the Austro-Hungarian Empire took as much advantage of the new liberal environment as the Jews. In the early decades of the nineteenth century a transformation had begun among the Jewish community in Galicia. Reformers arose arguing for a revision in [lx] the practices and customs of Orthodox Jewry. Jews needed to enter the modern world and to secularize in terms of dress, manner, attitudes, and culture. The faith had to be stripped of its medieval characteristics and ritualism. Jews should immerse themselves in the German language and German culture. All things “German” were distinguished as representing freedom and progress.62

With the freedoms of the 1867 constitution, Austrian and especially Galician Jews began a cultural as well as a geographical migration. In 1869, Jews made up about 6 percent of the population of Vienna. By the 1890s, when the young Ludwig von Mises moved to Vienna from Lemberg with his family, Jews made up 12 percent of the Vienna population. In District I, the center of the city where the Mises family lived, Jews made up over 20 percent of the population. In the neighboring District II, the Jews made up over 30 percent.63

But in the late nineteenth and early twentieth centuries, there was a stark contrast between these two districts of the city. In the central District I, the vast majority of the Jewish population had attempted to assimilate with their non-Jewish neighbors in dress, manners, and cultural outlook. In District II, bordering on the Danube, on the other hand, the Jewish residents were more likely to have retained their Hasidic practices and orthodox manners, including their traditional dress. It was the visible difference of these Jews, who often had more recently arrived from Galicia, which so revolted the young Adolf Hitler—who was shocked, and wondered how people acting and appearing as they did could ever be considered “real Germans.” They seemed such an obviously alien element in Hitler’s eyes.64

The characteristic mark of most of the Jews who migrated to Vienna (and other large cities of the empire such as Budapest or Prague) was their desire and drive for assimilation; in many ways they tried to be more German than the German-Austrians.65 The Czechs, the Hungarians, and the Slavs, on the other hand, often were still focused on their traditional ways; the Hungarians in particular were suspicious of the Enlightenment, civil liberties, and equality—these threatened their dominance over the subject peoples in their portions of the empire (the Slovaks, Romanians, and Croats). To constrain the Hungarians, the emperor increasingly put the Czechs, Poles, and Slavs under direct imperial administration on an equal legal footing with the German-Austrians. For the Jews, Austrian imperial policy meant the end of official prejudice and legal restrictions, and a securing of civil rights and educational opportunities.66 Their continuing and generally steadfast loyalty to the Habsburgs, however, led many of the other nationalities to be suspicious and anti-Semitic as the years went by. The Jews were viewed as apologists and blind supporters of the Habsburg emperor, without whose indulgence and protection the Jews might have been kept within the ghetto walls.67

Civil liberties and practically unrestrained commercial and professional [lxii] opportunity soon saw the Jews rise to prominence in a wide array of areas of Viennese life.68 By the beginning of the twentieth century more than 50 percent of the lawyers and medical doctors in Vienna were Jewish. The leading liberal and socialist newspapers in the capital were either owned or edited by those of Jewish descent, including the New Free Press, the Viennese newspaper for which Mises often wrote in the 1920s and 1930s. The membership of the journalists’ association in Vienna was more than 50 percent Jewish. At the University of Vienna, in 1910, professors of Jewish descent constituted 37 percent of the law faculty, 51 percent of the medical faculty, and 21 percent of the philosophy faculty. At the time Mises attended the university in the first decade of the twentieth century almost 21 percent of the student body was Jewish. The proportion of Jews in literature, theater, music, and the arts was equally pronounced.69

The main avenue for social and professional advancement was education in the gymnasium system—the high school system in the German-speaking world. But the gymnasium education not only offered a path to higher education and a university degree for many Jews, it also was an avenue for acculturation and assimilation into European and especially German culture. For example, Mises and his fellow student Hans Kelsen (who later became an internationally renowned philosopher of law and the author of the 1920 constitution of the Republic of Austria) attended the Akademisches Gymnasium in the center of Vienna. It was meant for students preparing for the university and professional careers. Here a wide liberal arts education was acquired, with mandatory courses in Latin, Greek, German language and literature, history, geography, mathematics, physics, and religion, with electives in either French or English—Mises selected French. At the core of the curriculum was the study of the ancient Greek and Roman classics. Mises and other Jewish students at the Akademisches Gymnasium, as a part of their religion training, had courses in Hebrew.70 According to memoirs written by people who attended theAkademisches Gymnasium in the 1880s and 1890s, most of the students ridiculed [lxiii] the religion classes as “superstition.” The Greek and Roman classics were considered literary avenues for entering the mainstream of modern European and Western culture. And while it was not assigned, the students absorbed on their own contemporary writings in history, social criticism, literature, and the sciences as their way to integrate themselves into modern and “progressive” society.71

In the 1890s, during Mises’s time at the Akademisches Gymnasium, 44 percent of the student body was Jewish. But there were some gymnasiums at which Jewish admission was informally restricted. For example, the Maria Theresa Academy of Knights in Vienna was reserved for the children of the nobility and senior officials. Joseph Schumpeter attended it in the 1890s, but only because his stepfather was a lieutenant field marshal. No matter what his academic qualification, Mises would have had virtually no chance to be accepted there. Thus clusters of these gymnasiums were clearly closed to Jews, even if they were converts to Christianity, while other clusters represented the high schools where middle-class Jewish businessmen, professionals, and civil servants sent their children.72

But for all their assimilationist strivings—their conscious attempts to be German-Austrians in thought, philosophy, outlook, and manner—the Jews remained distinct and separate. Not only was this because they belonged to schools, professions, and occupations in which they as Jews were concentrated, but because non-Jewish German-Austrians viewed them as separate and distinct. However eloquent and perfect their German in literature and the spoken word, no matter how contributing they were to the improvement of Viennese society and culture, most non-Jewish Viennese considered these to be Jewish contributions to and influences on German-Austrian corners of cultural life.73

Name, family history, gossip, and mannerisms made it clear to most [lxiv] people who were Jewish and who were not. The wide and pronounced success of so many Viennese Jews made non-Jews conscious of their preponderance and presence in many visible walks of life. This success also served as the breeding ground for anti-Semitism.74

In the Habsburg domain, part of this anti-Semitism was fed by conservative and reactionary forces in society who often resented the emperor’s diminishment or abolition of the privileges, favors, and status of the Catholic Church and the traditional landed aristocracy. The high proportion of Austrian Jews involved in liberal or socialist politics made them targets of the conservatives who said they were carriers of modernity, with its presumption of civil equality, unrestrained market competition, and a secularization that was said to be anti-Christian and therefore immoral and decadent. Preservation and restoration of traditional and Christian society, it was claimed, required opposition to and elimination of the Jewish influence on society. Jews were the rootless “peddlers” who undermined traditional occupations and ways of earning a living, as well as the established social order of things. They pursued profit. Honor, custom, and faith were willingly traded away by them for a few pieces of gold, it was said. Craft associations became leading voices of anti-Semitism, especially when economic hard times required small craftsmen and businessmen to go hat in hand to Jewish bankers for borrowed sums to tide them over.75

German nationalism also was a vehicle for growing anti-Jewish sentiment. The paradox here is that in the 1860s and 1870s a sizable number of Jewish intellectuals were founders and leaders in the Austrian and German nationalist movements. German culture and society were viewed as representing the universal values of reason, science, justice, and openness in both thought and deed. German culture and political predominance within the Austro-Hungarian Empire restrained the backward-looking forces of darkness—the Hungarian, Czech, and Slavic threats. At the same time, German culture in Central Europe offered rays of enlightenment in the regions of Eastern Europe.

Mises estimated that before the Second World War, Jews made up 50 percent of the business community in Central Europe and 90 percent of the business community in Eastern Europe.76 Indeed, in Omnipotent Government he asserted that in Eastern Europe “modern civilization was predominantly an achievement of Jews.”77 What the Jews in these parts of Europe introduced and represented, at least in their own minds, was the enlightened German mind, with its culture and institutions. But to those other nationalities being introduced to and “threatened” by this German cultural influence, it was perceived as being Jewish as much as German—a dominating, imperial, and “foreign” culture.

At the same time, in both Germany and German-Austria, the Jews in the forefront of the Pan-German nationalist movements were viewed as interlopers by many of the Christian German nationalists. As a consequence, there emerged in the second half of the nineteenth century [lxvi] rationalizations to justify the rejection of Jewish participation in the cause of German nationalism and culture. First, it was said that only Christians and the Christian faith were consistent with true German life and culture. But when a significant number of German and Austrian Jews converted to Christianity, it still was found not to be enough. Now it was claimed that to be a true German it was not sufficient to be a convert to Christianity. “Germanness” was a culture, an attitude toward life, and a certain sense of belonging to the Volk community.

As a growing number of Jews immersed themselves in all things German—language, philosophy, literature, dress, and manner—it was found, again, not to be enough. Really to be a German was to share a common ancestry, a heritage of a common blood lineage.78 This was one barrier the German and Austrian Jews could not overcome. In the emergence of racial anti-Semitism in the 1880s and 1890s, there were laid the seeds of the “final solution.”

In Vienna, Karl Lueger, who was mayor of the capital city in the first decade of the twentieth century and a leader of the Christian Social Party, represented the spirit of anti-Semitism. He insisted that only “fat Jews” could weather the storm of capitalist competition. Anti-Semitism, Lueger said, “is not an explosion of brutality, but the cry of oppressed Christian people for help from church and state.”79 He blended anti-Semitism with social-left reforms, which included civil service and municipal government restrictions on Jewish access to city jobs or contracts. On the other hand, when Lueger was challenged as to why he had Jewish friends and political associates, he replied, “I decide who is a Jew.”80

But in spite of the presence and growth of anti-Semitic attitudes in [lxvii] the late nineteenth and early twentieth centuries in Austria in general and Vienna in particular, Mises’s seeming lack of attention to his own Jewish family background or any hint of the impact of anti-Semitism around him—there were anti-Jewish student riots at the University of Vienna during the years when he was a student there around the turn of the century—was in fact not uncommon.81 One can read Stefan Zweig’s fascinating account of everyday life in the Vienna of this time and have the distinct impression that anti-Semitic attitudes or municipal government policy were virtually nonexistent.

Yet many invisible walls characterized the circles in which people moved in Viennese society both before and after the First World War. Traditional or Orthodox Jews lived and worked within a world of their own in the city.82 Secular and assimilated Jews, like Ludwig von Mises and Hans Kelsen, moved in circles of both Jews and non-Jews, but even the nonreligious and German-acculturated Jews clustered together. A review of the list of participants in Mises’s famous private seminar in Vienna, for example, shows a high proportion of Jews.83 And even after Mises had moved to Geneva, Switzerland, in 1934, his agenda books for this time show that many of his social engagements were with other Jews residing in or visiting that country.

The end of the nineteenth and the beginning of the twentieth century saw the eclipse of liberalism in Austria and the rise of socialism in its place, centered in the political ascendancy of the Social Democratic Party. A sizable number of Jews were prominent in the Austrian socialist movement; they were anticapitalist and viewed the entrepreneurial segment of the society as exploiters and economic oppressors. The capitalist class would be swept away in the transformation to socialism, including the Jewish capitalists in the “ruling class.” Most of the Jews in the socialist movement not only were secular and considered themselves harbingers of the worker’s world to come; they were contemptuously opposed to cultural and religious Judaism as well.84

These three political movements in Austria and Vienna when Mises was a young man—conservatism, German nationalism, and radical socialism—were, each for its own reasons, enemies of liberal society, opponents of free-market capitalism, and therefore threats to the ideas and occupations of those middle class, or “bourgeois,” walks of life heavily populated by the Jews of Austria and Vienna.

The history of Austrian Jewry during this time is a story of triumph and tragedy. The winds of nineteenth-century liberalism freed the Austrian Jewish community, both internally and externally. Internally, the liberal idea pried open Orthodox Jewish society in places such as Austrian Galicia. It heralded reason over ritual; greater individualism over religious collectivism; open-minded modernity over the strictures of traditionalism. Externally, it freed the Jewish community from legal and political restraints and restrictions. The right of freedom of trade, occupation, and profession opened wide many opportunities for social improvement, economic betterment, and political acceptance.85

Within two generations this transformed Austrian Jewish society. And that same span of time saw the rise of many Jews to social and economic prominence, with greater political tolerance than ever known before. If these two liberating forces had not been at work, there would not have been Ludwig von Mises—the economist, the political and social philosopher, and the notable public figure and policy analyst in Austria both before and between the two world wars.

At the same time, these two liberating forces set the stage for the tragedy of the German and Austrian Jews. Their very successes in the arts and the sciences, in academia, and in commerce fostered the animosity and resentment of those less successful in the arenas of intellectual, cultural, and commercial competition. It set loose the emotion of envy, the terror of failure, and the psychological search for scapegoats and excuses. It ended at the gates to the Nazi death camps.

In Mises’s case and for many others it meant leaving the country of their birth and seeking refuge in other lands. Among those who left before or immediately after Germany’s annexation of Austria were many members of the Austrian School of economics or Mises’s private seminar circle (both Jews and non-Jews): Martha Steffy Browne, Gottfried Haberler, Friedrich A. Hayek, Felix Kaufmann, Fritz Machlup, Ilse Mintz, Oscar Morgenstern, Paul N. Rosenstein-Rodan, Alfred Schutz, and Erich Voegelin, to name just a few.

Mises had departed in autumn 1934 for a teaching position at the Graduate Institute of International Studies in Geneva, when it was clear that the collectivist darkness was starting to fall over the center of Europe. He made a new life for himself after 1940 in the United States, like many of his Austrian colleagues and friends, where the spirit of freedom was not yet in the same shadow of tyranny as in their native Austria. America, for them, was still a land where Austrian Jews such as Mises could breathe the air of liberty.

He continued to explain and defend the principles and ideals of classical liberalism and the free market in his new home in America until his death on October 10, 1973, at the age of 92.

Endnotes to Volume 1

1.

Ludwig von Mises, The Theory of Money and Credit (Indianapolis: Liberty Fund, 3rd rev. ed., [1924; 1953] 1981) and “Monetary Stabilization and Cyclical Policy,” (1928) in The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression (Auburn, Ala.: Ludwig von Mises Institute, 2006), pp. 53-153.

2.

Ludwig von Mises, Socialism: An Economic and Sociological Analysis (Indianapolis: Liberty Fund, [1951] 1981), Liberalism: The Classical Tradition (Indianapolis: Liberty Fund, [1927] 2005), Critique of Interventionism (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, [1929] 1996),Interventionism: An Economic Analysis (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, [1940] 1996), Bureaucracy (Indianapolis: Liberty Fund, [1944] 2007), and Planning for Freedom, and Other Essays (Indianapolis: Liberty Fund, [1951] 2008).

3.

Ludwig von Mises, Epistemological Problems of Economics (New York: New York University Press, [1933] 1981), Human Action: A Treatise on Economics (Indianapolis: Liberty Fund, [1949; 4th rev. ed. 1966] 2007), Theory and History: An Interpretation of Social and Economic Evolution (Indianapolis: Liberty Fund, [1957] 2005), and The Ultimate Foundation of Economic Science (Indianapolis: Liberty Fund, [1962] 2006).

4.

Richard M. Ebeling, ed., Selected Writings of Ludwig von Mises, vol. 2, Between the Two World Wars: Monetary Disorder, Interventionism, Socialism, and the Great Depression (Indianapolis: Liberty Fund, 2002); Selected Writings of Ludwig von Mises, vol. 3, The Political Economy of International Reform and Reconstruction (Indianapolis: Liberty Fund, 2000).

5.

On Mises’s life and contributions to economics in general and the philosophy of freedom, see Richard M. Ebeling, “A Rational Economist in an Irrational Age: Ludwig von Mises,” in Austrian Economics and the Political Economy of Freedom (Northampton, Mass.: Edward Elgar, 2003), pp. 61-100, and Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition (London: Routledge, 2010); also, Murray N. Rothbard, Ludwig von Mises: Scholar, Creator, Hero (Auburn, Ala.: Ludwig von Mises Institute, 1988); Israel M. Kirzner, Ludwig von Mises(Wilmington, Del.: ISI Books, 2001); and Jörg Guido Hülsmann, Mises: The Last Knight of Liberalism(Auburn, Ala.: Ludwig von Mises Institute, 2007).

6.

For Friedrich A. Hayek’s explanation for Mises’s failure to obtain a formal academic position, see Peter G. Klein, ed., The Collected Works of F. A. Hayek, vol. 4, The Fortunes of Liberalism: Essays on Austrian Economics and the Ideal of Freedom (Chicago: University of Chicago Press, 1992), pp. 127-28. While anti-Semitism may have played a part in Mises’s not being offered a position at the University of Vienna, Hayek believed that it was mostly due to Mises’s uncompromising and outspoken criticism of socialism when the intellectual community of Vienna was heavily dominated by the Left.

7.

Training as an economist was received through the faculty of law at the University of Vienna.

8.

He was also permitted to serve as a chair on dissertation committees and was regularly called upon as a faculty participant at graduate student oral defenses of theses. For example, the book by Fritz Machlup on the gold-exchange standard that Mises discusses in Chapter 22 of this volume was Machlup’s dissertation under Mises’s supervision at the University of Vienna. He was also on the faculty committee that questioned Alfred Schutz, later internationally known as a sociologist and phenomenological philosopher, when he defended his thesis at the University of Vienna.

9.

See Appendix A in this volume for Mises’s last paper presented at his private seminar, “Maxims for the Discussion of the Methodological Problems of the Social Sciences,” in March 1934. Many of those who participated in the seminar recalled in later years that they considered it to be one of the most rewarding and challenging intellectual experiences of their lives because of the consistent quality of the papers delivered and the discussions that followed. For accounts of the seminar by some of the participants, see Ludwig von Mises, Memoirs (Auburn, Ala.: Ludwig von Mises Institute, [1940] 2009), pp. 81-83, and the recollections of other members of the seminar in the appendix to Margit von Mises,My Years with Ludwig von Mises, 2nd ed. (Cedar Falls, Iowa: Center for Futures Education, 1984), pp. 201-10.

10.

For a detailed discussion of Mises’s policy writings and work at the Vienna Chamber of Commerce in the interwar period, see Richard M. Ebeling, “The Economist as the Historian of Decline: Ludwig von Mises and Austria Between the Two World Wars,” in Political Economy, Public Policy, and Monetary Economics, pp. 88-140. For many of Mises’s articles and Chamber of Commerce policy pieces during the 1920s and 1930s, see Richard M. Ebeling, ed., Selected Writings of Ludwig von Mises, vol. 2,Between the Two World Wars: Monetary Disorder, Interventionism, Socialism, and the Great Depression.

11.

Ludwig von Mises, Memoirs, pp. 63-64; also see, on Mises’s work at the Chamber, Alexander Hörtlehner, “Ludwig von Mises und die österreichissche Handelskammerorganisation” [“Ludwig von Mises and the Chamber of Commerce”], Wirtschaftspolitische Blatter, no. 28 (1981), pp. 140-50.

12.

The following summary of the history of the Habsburg Empire is drawn from Henry Wickham Steed, The Hapsburg Monarchy (New York: Howard Fertig, [1914] 1969); Oscar Jaszi, The Dissolution of the Habsburg Monarchy (Chicago: University of Chicago Press, 1929); A. J. P. Taylor, The Habsburg Monarchy, 1809-1918: A History of the Austrian Empire and Austria-Hungary (Chicago: University of Chicago Press, [1948] 1976); Arthur J. May, The Hapsburg Monarchy, 1867-1918 (Cambridge: Harvard University Press, 1951); Arthur J. May, The Passing of the Hapsburg Monarchy, 1914-1918(Philadelphia: University of Pennsylvania Press, 1966); Robert A. Kann, The Multinational Empire: Nationalism and National Reform in the Habsburg Monarchy, 1848-1918, 2 vols. (New York: Columbia University Press, 1950); Robert A. Kann, A History of the Habsburg Empire, 1526-191 8 (Berkeley: University of California Press, 1974); Hans Kohn, The Habsburg Empire, 1804-1918 (New York: D. Van Nostrand, 1961); Edward Crankshaw, The Fall of the House of Habsburg (New York: The Viking Press, 1963); C. A. Macartney, The Habsburg Empire, 1790-1918 (New York: Macmillan, 1969); Gordon Brook-Shepherd, The Austrians: A Thousand-Year Odyssey (New York: Carroll & Graf, 1996); and Robin Okey, The Habsburg Monarchy: From Enlightenment to Eclipse (New York: St. Martin’s Press, 2001).

13.

See Hans Kohn, “The Problem of Central Europe: The Legacy of the Habsburgs,” in Not by Arms Alone: Essays on Our Time (Cambridge: Harvard University Press, 1940), pp. 43-64.

14.

On the development and evolution of the nationalist idea in the nineteenth century, see G. P. Gooch, Nationalism (New York: Harcourt Brace & Howe, 1920); Carlton J. H. Hayes, The Historical Evolution of Modern Nationalism (New York: Richard R. Smith, 1931); Walter Sulzbach, National Consciousness (Washington, D.C.: American Council on Public Affairs, 1934); Frederick Hertz,Nationality in History and Politics (New York: Oxford University Press, 1944); Hans Kohn,Nationalism: Its Meaning and History (Princeton, N.J.: D. Van Nostrand, 1955) and Nationalism and Realism: 1852-1879 (Princeton, N.J.: D. Van Nostrand, 1968).

15.

On the life and reign of Francis Joseph, who ruled over the empire for sixty-eight years, see Joseph Redlich, Emperor Francis Joseph of Austria (New York: Macmillan, 1929); and Alan Palmer, Twilight of the Habsburgs: The Life and Times of Emperor Francis Joseph (New York: Grove Press, 1994).

16.

Joseph Redlich, “The End of the House of Austria,” Foreign Affairs (July 1, 1930), p. 605; see also Kohn, The Habsburg Empire, 1804-1918, p. 49: “Like a good eighteenth century monarch, [Francis Joseph] regarded himself as the first servant of the nation, but he identified the nation with himself and his dynasty. He worked indefatigably for the good of his people, but they were his people and he interpreted what was good for them.”

17.

On the mutual benefits to be derived from a state that incorporates a variety of different national groups, see the classic essay by Lord Acton, “Nationality,” (1862) in J. Rufus Fears, ed., Selected Writings of Lord Acton, vol. 1, Essays in the History of Liberty (Indianapolis: Liberty Fund, 1985), pp. 409-33; for a contrary view as to why such a Swiss-type solution to the nationalist tensions of the Austro-Hungarian Empire was not feasible, see Benedetto Croce, History of Europe in the Nineteenth Century (New York: Harcourt, Brace, 1933), pp. 181-86.

18.

The Habsburg “Crownlands” directly under the emperor’s authority were made up of the territory of present-day Austria, Bohemia, and Moravia (the present-day Czech Republic), Galicia and Bukovina (now part of western Ukraine), Slovenia, Dalmatia (along part of the Adriatic seacoast), and southern Tyrol (now part of northern Italy); Bosnia was ruled as a separate administrative entity.

19.

Hans Kohn, “The Viability of the Habsburg Monarchy,” Slavic Review (March 1963), p. 38.

20.

See Erich W. Streissler and Monika Streissler, eds., Carl Menger’s Lectures to Crown Prince Rudolf of Austria (Northampton, Mass.: Edward Elgar, 1994).

21.

Crown Prince Rudolf and Carl Menger, “The Austrian Nobility and Its Constitutional Vocation: A Warning to Aristocratic Youth,” (1878) in Eugene N. Anderson, Stanley J. Pinceti, and Donald J. Siegler, eds., Europe in the Nineteenth Century, a Documentary Analysis of Change and Conflict, vol. 2, 1870-1914 (Indianapolis: Bobbs-Merrill, 1961), pp. 78-101.

22.

See Richard Barkeley, The Road to Mayerling: The Life and Death of Crown Prince Rudolph of Austria (New York: Macmillan, 1958); and Judith Listowel, A Habsburg Tragedy: Crown Prince Rudolph (New York: Dorset Press, 1978). Rudolph’s domestic liberalism, however, was combined with support for Austrian foreign policy imperialism; see Robert A. Kann, The Multinational Empire, vol. 2, pp. 181-87.

23.

“Viability of the Habsburg Monarchy,” p. 39.

24.

Ludwig von Mises, Nation, State, and Economy: Contributions to the Politics and History of Our Time (Indianapolis: Liberty Fund, [1919] 2006), pp. 88-109.

25.

See Kohn, The Habsburg Empire, 1804-1918, p. 72: “Amidst all the controversies and upheavals caused by the growing conflict of nationalities and by the vain search for an Austrian idea, the Austrian Constitution of December 31, 1867, which was a document of mid-century liberalism, remained in force for over half a century.” The Fundamental Law Concerning the General Rights of Citizens from the Austrian Constitution of 1867 may be found at http://www.h-net.org/∼habsweb/sourcetexts.auscon.htm. However, see Robert S. Wistrich, The Jews of Vienna in the Age of Franz Joseph (New York: Oxford University Press, 1989), p. 151: “[Adolf] Fischof put his finger on the central contradiction of the 1867 Constitution—that Austria-Hungary was a multinational state masquerading under liberal German hegemony as a nation-state on the Western European model. It had a dual personality, liberal with regards to the rights of the individual but oppressive in its relation to the Slav nationalities who were treated as ‘servant peoples.’” Adolf Fischof (1816-93) was a prominent figure in the Austrian Revolution of 1848, and an outspoken liberal in support of autonomy for the various subject nationalities in the Austro-Hungarian Empire.

26.

In 1867, for example, the Lower Austrian Chamber of Commerce located in Vienna declared, “The state has fulfilled its task if it removes all obstacles to the free, orderly activity of its citizens. Everything else is achieved by the considerateness and benevolence of the factory owners and above all by the personal efforts and thriftiness of the workers.” See Okey, Habsburg Monarchy, p. 206.

27.

See David Good, The Economic Rise of the Habsburg Empire, 1750-1914 (Berkeley: University of California Press, 1984).

28.

The Habsburg Monarchy, 1809-1918, p. 173.

29.

See William M. Johnson, The Austrian Mind: An Intellectual and Social History, 1848-1938(Berkeley: University of California Press, 1972); Allan Janik and Stephen Toulmin, Wittgenstein’s Vienna (Chicago: Ivan R. Dee, 1973); Carl E. Schorske, Fin-de-Siècle Vienna: Politics and Culture (New York: Alfred A. Knopf, 1980); Hilde Spiel, Vienna’s Golden Autumn, 1866-1938 (New York: Weidenfeld & Nicolson, 1987); Paul Hofmann, The Viennese: Splendor, Twilight, and Exile (New York: Doubleday, 1988).

30.

Stefan Zweig, The World of Yesterday (New York: Viking Press, 1943), pp. 24-25.

31.

Ibid., p. 13; see also Richard M. Ebeling, “1914 and the World We Lost,” The Freeman: Ideas on Liberty (June 2004), pp. 2-3.

32.

Part of the discussion in this section draws upon Richard M. Ebeling, “Austria-Hungary’s Economic Policies in the Twilight of the ‘Liberal’ Era: Ludwig von Mises’ Writings on Monetary and Fiscal Policy,” in Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition, pp. 57-87.

33.

The following brief account of the history of the Austrian currency is primarily taken from Charles A. Conant, A History of Modern Banks of Issue, 5th ed. (New York: G. P. Putnam’s Sons, 1915), pp. 219-50; J. Laurence Laughlin, History of Bimetallism in the United States (New York: Appleton, 1898), pp. 189-97, 331-37; Robert Zuckerkandl, “The Austro-Hungarian Bank,” in Banking in Russia, Austro-Hungary, the Netherlands, and Japan (Washington, D.C.: Government Printing Office, 1911), pp. 55-118. Also, specifically on the currency reform of 1892 and its implementation, “The Gold Standard in Austria” [Translation of the Report of the Special Currency Commission to the Upper House of the Austrian Parliament], Quarterly Journal of Economics (January 1893), pp. 225-54; “Reform of the Currency in Austria-Hungary,” Journal of the Royal Statistical Society (June 1892), pp. 333-39; Friedrich von Wieser, “Resumption of Specie Payments in Austria-Hungary,” Journal of Political Economy (June 1893), pp. 380-405; and Wesley C. Mitchell, “Resumption of Specie Payments in Austria-Hungary,” Journal of Political Economy (December 1898), pp. 106-13.

34.

For example, following the Franco-Prussian War of 1870-71, the German Empire was proclaimed, unifying under Prussian leadership the various German states and principalities. In 1871 and 1873, legislation was passed formally putting Imperial Germany on the gold standard. See The Reichbank, 1876-1900 (Washington, D.C.: Government Printing Office, 1910).

35.

“Resumption of Specie Payments,” p. 386.

36.

“The Austrian Currency Problem Thirty Years Ago and Today,” Chapter 19, in the present volume.

37.

Quoted in Hans Sennholz, “The Monetary Writings of Carl Menger,” in Llewellyn H. Rockwell, ed.,The Gold Standard: Perspectives in the Austrian School (Auburn, Ala.: The Ludwig von Mises Institute, [1985] 1992), p. 26; see also Günther Chaloupek, “Carl Menger’s Contributions to the Austrian Currency Debate (1892) and His Theory of Money” (paper presented to the 7th ESHET Conference, Paris, France, January 30-February 1, 2003).

38.

Wieser, “Resumption of Specie Payments,” pp. 387-88.

39.

“Gold Standard in Austria,” p. 230.

40.

More recently, the Austro-Hungarian Bank’s exchange rate policy has been praised as an example of successful “target zone” management of an exchange rate band; see Marc Flandreau and John Komlos, “Target Zone in History and Theory: Lessons from an Austro-Hungarian Experiment (1896-1914),” Discussion Paper no. 18 (July 2003), Department of Economics, University of Munich, Germany.

The “gold points” represented the upper and lower limits of fluctuations of a country’s foreign exchange value under the gold standard, beyond which it would be profitable to either export gold out of or import gold into that country.

41.

Mises was between twenty-six and thirty-two years of age when he wrote these articles.

42.

Mises, Memoirs, pp. 33-42.

43.

For example, the Classical economist Henry Fawcett argued in Free Trade and Protection(London: Macmillan, 1878), pp. 17-47, that if not for the great famine due to the failure of many of the crops and therefore such a large portion of the population in England and Ireland simultaneously threatened with starvation in the winter of 1845-46, the pressure for the unilateral repeal of agricultural protectionism (the Corn Laws) might never have occurred. It was unlikely that the same passion for a radical change to free trade would have been stimulated by the existing industrial and manufacturing protectionism that affected only different diverse and limited subgroups of the consuming public.

44.

For a short biography of Böhm-Bawerk and his contributions to Austrian economics and service as Austro-Hungarian minister of finance, see Richard M. Ebeling, “Eugen von Böhm-Bawerk: A Sesquicentennial Appreciation,” Ideas on Liberty (February 2001), pp. 36-41.

45.

Mises, Memoirs, pp. 37-39.

46.

Almost fifteen years after the First World War, Mises still regretted the failure of the “Austrian idea,” referring to “the attempts which were made to find some means of ensuring the amity of the various peoples that constituted the Empire. These efforts, which met with the approval of some of the most intelligent and noble spirits of the time, aimed not only at the maintenance of the Habsburg dynasty; they were informed by the idea that an entirely satisfactory solution of the struggles of the different nationalities could not be found simply in a dismemberment of the Empire. The fact is that a large area of the old Empire was inhabited by people of different languages, living together without geographical separation. For these territories, which are the cradle of all struggles between the nationalities, a system of peaceful cooperation could be more easily found within the framework of a big empire than by giving to every nationality a separate sovereignty. Events since the armistice, both political and economic, prove ex post the soundness of the attempts to transform the Habsburg Monarchy into a kind of Eastern European League of Nations.” See Ludwig von Mises, review of “Die letzten Jahrzehnte einer Grossmacht. Menschen, Völker und Probleme des Habsburg-Reichs,” by Rudolph Sieghart in Economica (November 1932) p. 477.

47.

Pp. 261-366.

48.

For a detailed exposition of Mises’s “Austrian” theory of the business cycle, see Richard M. Ebeling, “The Austrian Economists and the Keynesian Revolution: The Great Depression and the Economics of the Short-Run,” in Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition, pp. 203-72; “Two Variations of the Austrian Monetary Theme: Ludwig von Mises and Joseph A. Schumpeter on the Business Cycle,” in ibid., pp. 273-301; and “Money, Economic Fluctuations, Expectations and Period Analysis: The Austrian and Swedish Economists in the Interwar Period,” in ibid., pp. 302-31. Also, Richard M. Ebeling, “Ludwig von Mises and the Gold Standard,” inAustrian Economics and the Political Economy of Freedom, pp. 136-58.

49.

See Fritz Machlup, “Another View of Cost-Push and Demand-Pull Inflation,” (1960) in Essays on Economic Semantics (New Brunswick, N.J.: Transaction Books, [1963] 1991), pp. 241-68; also, Gottfried Haberler, Inflation: Its Causes and Cures (Washington, D.C.: American Enterprise Institute, 1966), pp. 65-78, and Economic Growth and Stability (Los Angeles: Nash Publishing, 1974), pp. 99-116.

50.

For a thorough discussion of Mises’s wartime activities, see Hülsmann, Mises: The Last Knight, pp. 257-98.

51.

Ricardo, “Funding System,” (1820) in Piero Sraffa, ed., The Works and Correspondence of David Ricardo, vol. 4, Pamphlets and Papers, 1815-1823 (Cambridge: Cambridge University Press, 1951), pp. 149-200, especially pp. 186-87.

52.

See also Ludwig von Mises, Nation, State, and Economy: Contributions to the Politics and History of Our Time (Indianapolis: Liberty Fund, [1919] 2006), pp. 136-42.

53.

See Richard M. Ebeling, “The Economist as the Historian of Decline: Ludwig von Mises and Austria Between the Two World Wars,” in Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition, especially pp. 92-100, for a detailed account of the political and economic situation in Austria in the years following the end of the First World War.

54.

For a brief history of the inflation in Austria during and after the First World War and its disastrous consequences, see Richard M. Ebeling, “The Great Austrian Inflation,” The Freeman: Ideas on Liberty(April 2006), pp. 2-3; also, Richard M. Ebeling, “The Lasting Legacies of World War I: Big Government, Paper Money and Inflation,” Economic Education Bulletin, vol. 48, no. 11 (Great Barrington, Mass.: American Institute for Economic Research, November 2008), for accounts of the hyperinflations in both Germany and Austria.

55.

Letter from Mises to Hayek, May 22, 1940, Geneva, Switzerland, Hayek Papers, Hoover Institution archives; the original letter is in German.

56.

Part of this section draws upon Richard M. Ebeling, “Ludwig von Mises and the Vienna of His Time,” in Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition, pp. 36-56.

57.

See William O. McCagg Jr., A History of Habsburg Jews, 1670-1918 (Bloomington: Indiana University Press, 1989), pp. 105-22, 181-200.

58.

See Appendix B in the present volume for a translation of Mayer Rachmiel Mises’s short curriculum vitae that he submitted in June 1881 to the office of the Austrian emperor, Francis Joseph, as part of the legal process for ennoblement and the bestowing of the honorific and hereditary title of “Edler von.” He was ennobled on April 30, 1881, with the ennoblement document issued on July 13, 1881. Ludwig von Mises is not mentioned at the end of the document among Mayer Rachmiel Mises’s great-grandchildren because Ludwig’s birth would not occur until September.

59.

See Richard M. Ebeling, “Mission to Moscow: The Mystery of the ‘Lost Papers’ of Ludwig von Mises,” Notes from FEE (July 2004), pp. 1-3, http://www.fee.org/pdf/notes/NFF_0704.pdf; also, for a more detailed account, see Richard M. Ebeling, introduction to Selected Writings of Ludwig von Mises,vol. 2, pp. xv-xx.

60.

Robert S. Wistrich, The Jews of Vienna in the Age of Franz Joseph, p. 165.

61.

On the history of the Jews in the Austro-Hungarian Empire, see Wistrich, Jews of Vienna; McCagg,A History of Habsburg Jews, 1670-1918; Steven Beller, Vienna and the Jews, 1867-1938: A Cultural History (Cambridge, Mass.: Cambridge University Press, 1989); George E. Berkley, Vienna and Its Jews: The Tragedy of Success, 1880s-1980s (Lanham, Md.: Madison Books, 1988); and Max Grunwald, History of the Jews in Vienna (Philadelphia: Jewish Publication Society of America, 1936).

62.

This transformation of the Jewish communities in Central and Eastern Europe, especially in the German-speaking lands, is usually associated with the influence of Moses Mendelssohn, beginning in the middle of the eighteenth century. See Marvin Lowenthal, The Jews of Germany: A Story of 16 Centuries (Philadelphia: The Jewish Publication Society of America, 1938), pp. 197-216; Ruth Gay, The Jews of Germany: A Historical Portrait (New Haven, Conn.: Yale University Press, 1992), pp. 98-117; Nachum T. Gidal, Jews in Germany: From Roman Times to the Weimar Republic (Köln, Germany: Könemann Verlagsgesellschaft mbH, 1998), pp. 118-23; Amos Elon, The Pity of It All: A History of the Jews in Germany, 1743-1933 (New York: Metropolitan Books, 2002), pp. 1-64.

63.

On the demographics of the Jewish community in Vienna, see Marsha L. Rozenblit, The Jews of Vienna, 1867-1914: Assimilation and Identity (Albany, N.Y.: State University of New York Press, 1983).

64.

Adolf Hitler, Mein Kampf (Boston: Houghton Mifflin, [1925] 1943), p. 56: “Once as I was walking through the Inner City [of Vienna before the First World War] I suddenly encountered an apparition in a black caftan and black hair locks. Is this a Jew? was my first thought. For, to be sure, they had not looked like that in Linz. I observed the man furtively and cautiously, but the longer I stared at this foreign face, scrutinizing feature after feature, the more the first question assumed a new form: Is this a German?”

65.

On the parallel process of Jewish assimilation and resistance from non-Jews in Prague and Bohemia, see the autobiographical recollections of this period in Hans Kohn, Living in a World Revolution: My Encounters with History (New York: Trident Press, 1964), pp. 1-46.

66.

Habsburg enlightenment was more advanced in many ways than that of the German government. For example, before the First World War it was virtually impossible for a Jew to be commissioned as an officer in the German Army, no matter what his qualifications and merit. On the other hand, Jews were accepted as officers in the Austrian Army with no similar prejudice, and that is what enabled Ludwig von Mises to be commissioned as a reserve officer in the Austrian Army as a young man, and serve with distinction in the First World War on the Russian front. See Wistrich, Jews of Vienna, pp. 174-75:

In striking contrast to the Prussian regiments, there was no deliberate exclusion of Jewish officers and anti-Semitism was not officially tolerated. Indeed, anti-Semitism appears to have been notably weaker in the army than in many other sectors of Austrian society in spite of persistent nationalist agitation and the fact that most officers were Roman Catholic Germans. . . . In this supranational institution par excellence which was loyal to the Emperor and the dynasty alone, Jews were by and large treated on equal terms with other ethnic and religious groups. The army could simply not tolerate open racial or religious discrimination which would only undermine morale and patriotic motivation.

67.

On the perception of the Jews before the First World War by the various nationalities of the Austro-Hungarian Empire, including the Austrian-Germans, see Henry W. Steed, The Hapsburg Monarchy,pp. 145-94.

68.

See Jerry Z. Muller, The Mind and the Market: Capitalism in Modern European Thought (New York: Alfred A. Knopf, 2002), pp. 350-52.

69.

On the occupational demographics, see Rozenblit, Jews of Vienna, pp. 47-70; Beller, Vienna and the Jews, pp. 165-87.

70.

On the Vienna gymnasiums, and Jewish assimilation and social and economic advancement, see Rozenblit, Jews of Vienna, pp. 99-126; Beller, Vienna and the Jews, pp. 49-70.

71.

See Arthur Schnitzler, My Youth in Vienna (New York: Holt, Rinehart and Winston, 1970), for a rich memoir on the Akademisches Gymnasium in Vienna a few years before Mises attended as a student. Also see the fascinating account of Viennese gymnasium life during this time in Zweig, The World of Yesterday, pp. 28-66.

72.

On the Maria Theresa Academy of Knights in Vienna during the time when Schumpeter attended, see Robert Loring Allen, Opening Doors: The Life and Work of Joseph Schumpeter, vol. 1 (Brunswick, N.J.: Transaction Books, 1991), pp. 18-22; and Richard Swedberg, Schumpeter: A Biography(Princeton: Princeton University Press, 1991), pp. 10-12.

73.

In 1897, a prominent Jewish liberal political figure pointed out in a Vienna newspaper the German-Austrian attitude to the attempt by many Jews to fully integrate themselves into Austrian life: “When you consider the way the poor Jews strive to gain your favor in the ranks of the Germans, how they try to accumulate the treasures of German culture, how they work in the sciences, some perhaps dying young as a result—and still all the thanks they get is that they are not even accepted as human beings.” Quoted in Beller, Vienna and the Jews, p. 163.

74.

On the nature and evolution of anti-Semitism in Germany and Austria, see Peter G. J. Pulzer, The Rise of Political Anti-Semitism in Germany and Austria (New York: John Wiley, 1964); and Bruce F. Pauley, From Prejudice to Persecution: A History of Austrian Anti-Semitism (Chapel Hill: University of North Carolina Press, 1992).

75.

That the real target behind much of the anti-Semitism in Germany and Austria was economic liberalism has been suggested by Frederick Hertz, Nationality in History and Politics, p. 403: “It was rightly felt by many that the real object of [anti-Semitic attacks such as those by the German historian Heinrich von Treitschke] was not the Jews, but liberalism, and that the Jews were only used as a means for working up public opinion against its fundamental principles.” Similarly, Hans Kohn, Prophets and Peoples: Studies in Nineteenth Century Nationalism (New York: Macmillan, 1946), pp. 124-25: “Treitschke’s words, ‘The Jews are our misfortune,’ served as a rallying banner for the German anti-Semitic movements for the next sixty years. Though the Jews were the immediate goal of the agitation, it ultimately aimed at the liberalism that had brought about Jewish emancipation. Treitschke hated the liberal middle-class society of the West and despised its concern for trade, prosperity and peace. . . . In view of the apparent decay of the Western world through liberalism and individualism, only the German mind with its deeper insight and its higher morality could regenerate the world.” See also F. A. Hayek, The Road to Serfdom (Chicago: University of Chicago Press, [1944] 2005), p. 161:

In Germany and Austria the Jew had come to be regarded as the representative of capitalism because a traditional dislike of large classes of the population for commercial pursuits had left these more readily accessible to a group that was practically excluded from the more highly esteemed occupations. It is the old story of the alien race being admitted only to the less respected trades, and then being hated still more for practicing them. The fact that German anti-Semitism and anti-capitalism spring from the same root is of great importance for the understanding of what has happened there, but this is rarely grasped by foreign observers.

And Fritz Stern, The Politics of Cultural Despair: A Study in the Rise of Germanic Ideology (Berkeley: University of California Press, 1961), pp. 142-43: “Of course, the Jews favored liberalism, secularism, and capitalism. Where else but in the cities, in the free professions, in an open society, could they escape from the restrictions and prejudices that lingered on from the closed, feudal society of an earlier era? They were, and in a sense had to be, the promoters and profiteers of modernity, and for this . . . [many Germans] could not forgive the Jews.”

76.

Ludwig von Mises, “Postwar Economic Reconstruction of Europe,” (1940) in Richard M. Ebeling, ed., Selected Writings of Ludwig von Mises, vol. 3, The Political Economy of International Reform and Reconstruction, p. 27.

77.

Ludwig von Mises, Omnipotent Government: The Rise of the Total State and Total War (New Haven: Yale University Press, 1944), p. 185.

78.

This attitude was expressed, as one example, during the 1930s by the ardent National Socialist Adolf Bertels, who said of Heinrich Heine (possibly, after Goethe, the greatest German writer of the nineteenth century) that “however well he handles the German language and German poetical forms, however much he knows the German way of life, it is impossible for a Jew to be a German.” Quoted in Alistair Hamilton, The Appeal of Fascism: A Study of Intellectuals and Fascism, 1919-1945 (London: Anthony Blond, 1971), p. 109.

79.

Quoted in J. Sydney Jones, Hitler in Vienna, 1907-1913: Clues to the Future (New York: Cooper Square Press, 2002), p. 155.

80.

Ibid., p. 157; also, Berkley, Vienna and Its Jews, pp. 103-11; on the history of the Christian Social movement with its blending of anti-Semitism, anticapitalism, and socialism, and Lueger’s role and participation in it, see John W. Boyer, Political Radicalism in Late Imperial Vienna: Origins of the Christian Social Movement, 1848-1897 (Chicago: University of Chicago Press, 1981) and Culture and Political Crisis in Vienna: Christian Socialism in Power, 1897-1918 (Chicago: University of Chicago Press, 1995).

81.

Mises barely mentions anti-Semitic sentiments in Austria in his Memoirs, and devotes time to a detailed discussion of it only in Omnipotent Government, pp. 169-92, written during the Second World War. For a discussion of Mises’s critique of anti-Semitism, see Richard M. Ebeling, “Ludwig von Mises and the Vienna of His Time,” especially pp. 43-49.

82.

Harriet Pass Freidenreich, Jewish Politics in Vienna, 1918-1938 (Bloomington: Indiana University Press, 1991), p. 138.

83.

Mises, Memoirs, p. 83.

84.

See Robert S. Wistrich, Socialism and the Jews (East Brunswick, N.J.: Associated University Presses, 1982).

Economics

Unemployment and groupthink

On Friday 6th February the American Bureau of Labor Statistics (BLS) released its employment estimates for January, which being better than the market expected, caused Treasury bond yields to rise and precious metals to be marked sharply lower.

Earlier that week Jim Clifton, Chairman of Gallop wrote “The official unemployment rate as reported by the US Department of Labor is extremely misleading.”

His comments attracted notice, not least because Gallop is an independent company whose business is statistics. Furthermore, it is unusual for a senior business figure to criticise a government department so openly. His basic point is that if you are unemployed and have stopped looking for work in the last four weeks you are no longer classified as unemployed.
Furthermore if you perform a minimum of one hour of work in a week and are paid at least $20, you are deemed to be employed. And so on.

This is hardly news to those of us who have been sceptical about official statistics. The fact is there are even on BLS numbers 102 million adults deemed not in the labour force or officially unemployed. Then there are those who are only partially employed, but counted by the BLS as employed. As Jim Clifton points out if we add these 34.7 million people to the BLS’s 102 million figure, only 44.2% of US adults are actually employed for 30 hours or more per week; in other words fully employed by any common-sense definition.

This is the true indication of the state of employment in the US. The BLS could be more up-front in presenting its numbers, but being a government department we have to accept that it presents these figures in the best possible light. However, they are completely open about their methodology, and any member of the public can make his own assessment. So assuming caveat emptor should apply, the fault for accepting the BLS headline without question lies with the investing public, careless enough to be egged on by sell-side analysts and the media.

The result is markets move on what amounts to state-sponsored disinformation. Unemployment statistics are only one example of the fodder for the groupthink that has become the bedrock of macroeconomics and financial analysis. Groupthink is “a psychological phenomenon that occurs within a group of people in which the desire for harmony or conformity in the group results in an irrational or dysfunctional decision-making outcome”. This definition from Wikipedia describes the relationship between US government statistics and financial markets to a tee.

It is a shame: employment statistics have the potential to be the one number in macroeconomics that tells us the true state of the economy. The two other major variables, GDP and price inflation, are badly flawed. Nominal GDP tells us the quantity of transactions, not quality, ranking wasteful government spending equally with consumer-driven economic progress. Furthermore, government statisticians use every trick in the book to under-record rising prices, otherwise no growth in real GDP would have been recorded since the Lehman crisis.

We cannot claim that the true state of the US labour market is concealed from us. We need to think for ourselves and not dismiss from our minds comments by the likes of Jim Clifton of Gallop. That we do is evidence that “irrational or dysfunctional decision-making outcomes” drive our statistical interpretation and therefore all financial markets, and is not to be confused with rational analysis.

Book Reviews

Bitcoin: The Future of Money? Interview with Dominic Frisby

With Cobden Centre contributor Dominic Frisby’s book on Bitcoin now a number 1 bestseller on Amazon in Online Trading and Investing, and certainly the best book on the market for those looking for an outline on how Bitcoin works and how it may just radically change the financial system, we asked him a few questions on how he thinks the technology will develop.

What first attracted you to crypto-currencies?

I first heard about Bitcoin in 2010. If only I’d listened.

The major theme of my first book, Life After The State, is that governments couldn’t do the things they’ve done over the past 100 years without control of money. So the solution to too much government is to use money over which they have no control – independent money in other words. Bitcoin was the logical next book to write. And I knew I’d be able to write a better book on it than anyone else.

Had you read about the theoretical foundations for private money previously, for instance Hayek’s work in this area from the ’70s?

Yes. Cryptos are a modern manifestation of all that stuff.

Bitcoin has attracted a huge range of aficionados from computer coders and techies, to drug dealers, to economists, to anarchists, to libertarians. I suppose I came at it from a kind of libertarian economist viewpoint. In the course of writing the book, my eyes were opened in a way that I didn’t expect. Because what is so amazing about this, in a technological sense– What is so amazing about this technology is that in solving the problem of digital cash. Let me just explain quickly what that problem was. If I’m standing next to you in a room, I can give you– I can hand you cash, and there’s no middle man. Whereas if I want to spend any kind of digital money, whether it’s supermarket reward points or dollars or air miles. Whatever kind of digital money it is, you’re always going through a middle man. For years, people have been trying to technologically replicate or digitally replicate that process of handing cash directly from one person to another. Nobody has been able to do it. That was the genius of Bitcoin. All sorts of digital cash have been before, but they all involve the middle-man. And suddenly thanks to this tech at the centre of Bitcoin known as Blockchain, this problem of digital cash was solved, and suddenly the process of handing one thing direct to somebody else with no middle-man was able to be done online. Obviously the implications of a new form of money for Government and banks and all the rest of it is incredibly exciting, but this technology– the Bitcoin developers are looking at this technology and thinking, “Right, we’ve successfully cut out governments and banks from the creation and transfer of money, what other middle-man can we cut out?” And this whole movement is known as disintermediation. So we’ve disintermediated Governments and banks from money, what else can we disintermediate? And the implications of disintermediation are simply immense.

How do you see the technology developing in the future?

The technology behind bitcoin effectively removes middle men. It’s known as disintermediation. In the coming years, you’re not only going to see governments and banks cut out of the money creation and transfer process, but you’re going to see the likes of gmail and yahoo disintermediated from emails, Twitter cut out of tweeting, Facebook cut out of social networking, brokers cut out of the transfer of financial assets, stock markets disintermediated, even health and education services just completely bypassed. The tech is so mind-boggling disruptive. And hardly anybody can see what’s coming.

When the Blockchain is downloaded, (it can be downloaded by all the users)… I just downloaded it some time ago and I think it was about 50 gigabytes. Obviously if something like YouTube was a Blockchain it would be exabytes or whatever you get to after that. So how would that work in terms of just the sheer number of– the sheer amount of memory required for that kind of thing?

I’m not entirely sure, and it’s still very very theoretical at this stage, but the whole way the internet works– I mean the internet is just basically one huge middle-man. Just a melange of middlemen. Amazon is a middleman, YouTube is a middleman, Facebook is a middleman, they’re all different kinds of middlemen, and this– through this kind of watershed tech – which is the Blockchain – which basically disintermediates everything. And I’m not like one of these people who’s out to destroy the middleman, because middlemen play an incredibly useful role, and I have an agent who represents me for work and I’m sure everyone who wants to hire me would rather not have to go through the agent, the agent does a very god job for me and I’m happy to give him 15% of everything I earn, because of the job that he does do for me. But the– It’s incredibly subversive and disruptive basically, and all those– The wonderfully exciting thing, if you like subversion, about the internet is that all the old monopolies, whether it the newspapers or television or music industries, they were all subverted and disrupted and they either had to adapt or die, and then all these new, groovy businesses came along. But suddenly 10 years on, 15 years on, they’ve all got these vast monopolies, so I think it’s– They probably don’t even realise it yet, but the monopoly that is Google or Facebook or YouTube, or whatever it is, could well be disrupted and subverted within ten years or something.

What threat do governments and regulatory bodies pose to crypto-currencies?

About as much as they did to the internet in 1991, to steam-power in the 18th century or fossil-fueled locomotion in the 19th – or the wheel whenever that was invented. They’ll be like a snail reacting to a speeding car whizzing past.
I guess another interesting question on this, on the down side perhaps, is the ability for enabling crime. If you’re a libertarian then presumably you should be more or less in favour of drug legalisation or whatever. That side of things isn’t so bad if it’s not hurting other people, but with some of the assassinations and so on…

You’re opening up so many cans of worms, but there are so many laws that in my view are just– shouldn’t be the law. The law is doing more damage than those who break the law are, with people’s lives. Then if some kind of new technology comes along and subverts that then that is a good thing in my opinion. But yes, that’s a moral argument. And like you say, Bitcoin enables crime. It enables money laundering, money transfer. All sorts of horrible things get sold on the Darknet. They’re horrible, quite frankly. Bitcoin facilitates takes that, but so did the internet when it came along. It’s exactly the same dynamics. Black markets are much faster. They’re much more flexible than other types of markets. They’re very quick to embrace new technologies and make them work on a practical day-to-day basis, because black markets can’t gobble up loads of venture capital and survive on that kind of backing. They need to turn a profit pretty quickly. They’ve embraced Bitcoin. If you want to take the kind of, “Bitcoin should be illegal because it facilitates illegal activity,” I get that argument. I think it’s a puritanical small-minded argument.

What about Satoshi himself…?

Again, when I started writing this book – and everyone who’s new to Bitcoin I think goes through this as part of the journey – they decide they want to know who Satoshi Nakamoto is, the guy who invented it. It became slightly obsessive for me. The more I found out, the more I realized I didn’t know. I put a lot of sleeping hours in trying to work out who he was, probably more than anyone else. There might be one guy in America, a blogger who’s done more hours than me trying to figure out who he is, but I think I’ve got the answer right, and now that I’ve got the answer right I say it– I write about it. But I’m not sure not we actually need to know anymore. There is a certain amount of importance in knowing, but in the– he controls about probably 10% of all the Bitcoins there is, and therefore what he does can have great– in the same way you’d want to know what Steve Jobs is doing with his Apple shares or something. So there is some importance from that point of view, but the guy is a genius, and I don’t use that word lightly. And to come along– the sheer depth and specificity of knowledge required. Bitcoin isn’t something you just come along a just suddenly code on a whim like this if you’re 22-years old and you’re a genius with code. You need huge experience of– huge knowledge of money, you need knowledge of data bases, computer coding, economic history, how to maintain your anonymity on the Internet. There was just so many different skills that this guy brought into play at an extremely high level and his achievement is nothing short of monumental.

Like I say, I think I’ve worked out who it is and I do write about it at great length in the book, but there’s a certain amount of apology and regret in saying what I’ve said once I’ve said it. But once I did it, I could not say it. Because I’ve actually been in extensive contact with the guy who I think is Satoshi and we seem to have quite a good relationship. He denies it’s him, but then he wouldn’t say anything else and I sent him a copy of the book and I hope he likes it.

Do you see crypto-currencies as part of a wider shift online towards “digital anarchy”?

Yup. Already you have things like Bitmessage which is an ability to send an email from A to B without having to go through Gmail or Yahoo or whoever it is. There are all sorts of implications for privacy as well. You have Twister, which is like Twitter but with no central body organizing all the tweets. It’s a much more effective way to, say, organise an Arab Spring or indulge in a bit too much free speech. The stock markets can be put on the Blockchain. Financial assets can be traded directly with no middle man. That has huge implications for stock markets, share registrars, brokers, the whole financial industry. We could register car ownership. You can even put the land registry on the Blockchain. The land registry badly needs a boot up its backside. Something like 50% of land in the UK is still unregistered according to a book about 10 years ago by a guy called Kevin Cahill. And even things like YouTube put on a Blockchain, and that has huge implications for the movie industry, copyright, television.

What are your thoughts on the boarder philosophical themes surrounding cryptocurrencies, ranging from libertarianism to cypherpunk philosophy?

Bring it on, baby.

 

 

Dominic Frisby is the author of Bitcoin: the Future of Money? The audiobook is available here.

Economics

Greece, Germany and the ECB: and what it means for Bonds, Stocks and the Euro

Greece is back in the spotlight amid renewed fears of a break-up of the Euro as the Syriza party show a 3.1% lead over the incumbent New Democracy in the latest Rass opinion poll – 4thJanuary. The average of the last 20 polls – dating back to 15th December shows Syriza with a lead of 4.74% capturing 31.9% of the vote.

These election concerns have become elevated since the publication of an article in Der Spiegel Grexit Grumblings: Germany Open to Possible Greek Euro Zone Exit -suggesting that German Chancellor Merkel is now of the opinion that the Eurozone (EZ) can survive without Greece. Whilst Steffen Seibert – Merkle’s press spokesman – has since stated that the “political leadership” isn’t working on blueprints for a Greek exit, the idea that Greece might be “let go” has captured the imagination of the markets.

A very different view, of the potential damage a Greek exit might cause to the EZ, is expressed by Market Watch – Greek euro exit would be ‘Lehman Brothers squared’: economistquoting Barry Eichengreen, speaking at the American Economic Association conference, who described a Greek exit from the Euro:-

In the short run, it would be Lehman Brothers squared.

Writing at the end of last month the Economist – The euro’s next crisis described the expectation of a Syriza win in the forthcoming elections:-

In its policies Syriza represents, at best, uncertainty and contradiction and at worst reckless populism. On the one hand Mr Tsipras has recanted from his one-time hostility to Greece’s euro membership and toned down his more extravagant promises. Yet, on the other, he still thinks he can tear up the conditions imposed by Greece’s creditors in exchange for two successive bail-outs. His reasoning is partly that the economy is at last recovering and Greece is now running a primary budget surplus (ie, before interest payments); and partly that the rest of the euro zone will simply give in as they have before. On both counts he is being reckless.

In theory a growing economy and a primary surplus may help a country repudiate its debts because it is no longer dependent on capital inflows.

The complexity of the political situation in Greece is such that the outcome of the election, scheduled for 25th January, will, almost certainly, be a coalition. Syriza might form an alliance with the ultra-right wing Golden Dawn who have polled an average of 6.49% in the last 20 opinion polls, who are also anti-Austerity, but they would be uncomfortable bedfellows in most other respects. Another option might be the Communist Party of Greece who have polled 5.8% during the same period. I believe the more important development for the financial markets during the last week has been the change of tone in Germany.

The European bond markets have taken heed, marking down Greek bonds whilst other peripheral countries have seen record low 10 year yields. 10 year Bunds have also marched inexorably upwards. European stock markets, by contrast, have been somewhat rattled by the Euro Break-up spectre’s return to the feast. It may be argued that they are also reacting to concerns about collapsing oil prices, the geo-political stand-off with Russia, the continued slow-down in China and other emerging markets and general expectations of lower global growth. In the last few sessions many stock markets have rallied strongly, mainly on hopes of aggressive ECB intervention.

Unlike the Economist, who are concerned about EZ contagion, Brookings – A Greek Crisis but not a Euro Crisis sees a Euro break-up as a low probability:-

A couple of years ago the prospect of a Syriza-led government caused serious tremors in European markets because of the fear that an extremely bad outcome in Greece was possible, such as its exit from the Euro system, and that this would create contagion effects in Portugal and other weaker nations. Fortunately, Europe is in a much better situation now to withstand problems in Greece and to avoid serious ramifications for other struggling member states. The worst of the crisis is over in the weak nations and the system as a whole is better geared to support those countries if another wave of market fears arise.

It is quite unlikely that Greece will end up falling out of the Euro system and no other outcome would have much of a contagion effect within Europe. Even if Greece did exit the Euro, there is now a strong possibility that the damage could be confined largely to Greece, since no other nation now appears likely to exit, even in a crisis.

Neither Syriza nor the Greek public (according to every poll) wants to pull out of the Euro system and they have massive economic incentives to avoid such an outcome, since the transition would almost certainly plunge Greece back into severe recession, if not outright depression. So, a withdrawal would have to be the result of a series of major miscalculations by Syriza and its European partners. This is not out of the question, but the probability is very low, since there would be multiple decision points at which the two sides could walk back from an impending exit.

I think The Guardian – Angela Merkel issues New Year’s warning over rightwing Pegida group – provides an insight into the subtle change in Germany’s stance:-

German chancellor Angela Merkel in a New Year’s address deplored the rise of a rightwing populist movement, saying its leaders have “prejudice, coldness, even hatred in their hearts”.

In her strongest comments yet on the so-called Patriotic Europeans Against the Islamisation of the West (Pegida), she spoke of demonstrators shouting “we are the people”, co-opting a slogan from the rallies that led up to the fall of the Berlin Wall 25 years ago.

“But what they really mean is: you are not one of us, because of your skin colour or your religion,” Merkel said, according to a pre-released copy of a televised speech she was to due to deliver to the nation on Wednesday evening.

“So I say to all those who go to such demonstrations: do not follow those who have called the rallies. Because all too often they have prejudice, coldness, even hatred in their hearts.”

Concern about domestic politics in Germany and rising support for the ultra right-wing Pegida party makes the prospect of allowing Greece to leave the Euro look like the lesser of two evils. Yet a Greek exit and default on its Euro denominated obligations would destabilise the European banking system leading to a spate of deleveraging across the continent. In order to avert this outcome, German law makers have already begun to soften their “hard-line” approach, extending the olive branch of a potential renegotiation of the terms and maturity of outstanding Greek debt with whoever wins the forthcoming election. I envisage a combination of debt forgiveness, maturity extension and restructuring of interest payments – perish the thought that there be a sovereign default.

Carry Concern

Last month the BIS – Financial stability risks: old and new caused alarm when it estimated non-domestic US$ denominated debt of non-banks to be in the region of $9trln:-

Total outstanding US dollar-denominated debt of non-banks located outside the United States now stands at more than $9 trillion, having grown from $6 trillion at the beginning of 2010. The largest increase has been in corporate bonds issued by emerging market firms responding to the surge in demand by yield-hungry fixed income investors.

Within the EZ the quest for yield has been no less rabid, added to which, risk models assume zero currency risk for EZ financial institutions that hold obligations issued in Euro’s. The preferred trade for many European banks has been to purchase their domestic sovereign bonds because of the low capital requirements under Basel II. Allowing banks to borrow short and lend long has been tacit government policy for alleviating bank balance sheet shortfalls, globally, in every crisis since the great moderation, if not before. The recent rise in Greek bond yields is therefore a concern.

An additional concern is that the Greek government bond yield curve has inverted dramatically in the past month. The three year yields have risen most precipitously. This is a problem for banks which borrowed in the medium maturity range in order to lend longer. Fortunately most banks borrow at very much shorter maturity, nonetheless the curve inversion represents a red flag : –

Date 3yr 10yr Yield curve
14-Oct 4.31 7.05 2.74
29-Dec 10.14 8.48 -1.66
06-Jan 13.81 9.7 -4.11

 

Source: Investing.com

Over the same period Portuguese government bonds have, so far, experienced little contagion:-

Date 3yr 10yr Yield curve
14-Oct 1.03 2.56 1.53
29-Dec 1.06 2.75 1.69
06-Jan 0.92 2.56 1.64

 

Source: Investing.com

EZ Contagion

Greece received Euro 245bln in bail-outs from the Troika; if they should default, the remaining EZ 17 governments will have to pick up the cost. Here is the breakdown of state guarantees under the European Financial Stability Facility:-

 

Country Guarantee Commitments Eur Mlns Percentage
Austria 21,639.19 2.78%
Belgium 27,031.99 3.47%
Cyprus 1,525.68 0.20%
Estonia 1,994.86 0.26%
Finland 13,974.03 1.79%
France 158,487.53 20.32%
Germany 211,045.90 27.06%
Greece 21,897.74 2.81%
Ireland 12,378.15 1.59%
Italy 139,267.81 17.86%
Luxembourg 1,946.94 0.25%
Malta 704.33 0.09%
Netherlands 44,446.32 5.70%
Portugal 19,507.26 2.50%
Slovakia 7,727.57 0.99%
Slovenia 3,664.30 0.47%
Spain 92,543.56 11.87%
EZ 17 779,783.14 100%

Assuming the worst case scenario of a complete default – which seems unlikely even given the par less state of Greek finances – this would put Italy on the hook for Eur 43bln, Spain for Eur 28.5bln, Portugal for Eur 6bln and Ireland for Eur 3.8bln.

The major European Financial Institutions may have learned their lesson, about over-investing in the highest yielding sovereign bonds, during the 2010/2011 crisis – according to an FTinterview with JP Morgan Cazenove, exposure is “limited” – but domestic Greek banks are exposed. The interconnectedness of European bank exposures are still difficult to gauge due to the lack of a full “Banking Union”. Added to which, where will these cash-strapped governments find the money needed to meet this magnitude of shortfall?

The ECBs response

ECB Balance Sheet - Bloomberg

Source: Bloomberg

In an interview with Handelsblatt last week, ECB president Mario Draghi reiterated the bank’s commitment to expand their balance sheet from Eur2 trln to Eur3 trln if conditions require it. Given that Eurostat published a flash estimate of Euro area inflation for December this week at -0.2% vs +0.3% in November, I expect the ECB to find conditions requiring a balance sheet expansion sooner rather than later. Reuters – ECB considering three approaches to QE – quotes the Dutch newspaper Het Financieele Dagbad expecting one of three actions:-

…one option officials are considering is to pump liquidity into the financial system by having the ECB itself buy government bonds in a quantity proportionate to the given member state’s shareholding in the central bank.

A second option is for the ECB to buy only triple-A rated government bonds, driving their yields down to zero or into negative territory. The hope is that this would push investors into buying riskier sovereign and corporate debt.

The third option is similar to the first, but national central banks would do the buying, meaning that the risk would “in principle” remain with the country in question, the paper said.

The issue of “monetary financing” – forbidden under Article 123 of the Lisbon Treaty – has still to be resolved, so Outright Monetary Transactions (OMT) in respect of EZ government bonds are still not a viable policy option. That leaves Covered bonds – a market of Eur 2.6trln of which only around Eur 600bln are eligible for the ECB to purchase – and Asset Backed Securities (ABS) with around Eur 400bln of eligible securities. These markets are simply not sufficiently liquid for the ECB to expand its balance sheet by Eur 1trln. In 2009 they managed to purchase Eur 60bln of Covered bonds but only succeeded in purchasing Eur 16.9bln of the second tranche – the bank had committed to purchase up to Eur 40bln.

Since its inception in July 2009 the ECB have purchased just shy of Eur 108bln of Covered bonds and ABS: –

Security Primary Secondary Total Eur Mlns Inception Date
ABS N/A N/A 1,744 21/11/2014
Covered Bonds 1 N/A N/A 28,817 02/07/2009 *
Covered Bonds 2 6015 10375 16,390 03/11/2011
Covered Bonds 3 5245 24387 29,632 20/10/2014
Total 76,583
* Original purchase Eur 60bln

Source: ECB

These amounts are a drop in the ocean. If the ECB is not permitted to purchase government bonds what other options does it have? I believe the alternative is to follow the lead set by the Bank of Japan (BoJ) in purchasing corporate bonds and common stocks. To date the BoJ has only indulged in relatively minor “qualitative” easing; the ECB has an opportunity to by-pass the fragmented European banking system and provide finance and permanent capital directly to the European corporate sector.

Over the past year German stocks has been relatively stable whilst Greek equities, since the end of Q2, have declined. Assuming Greece does not vote to leave the Euro, Greek and other peripheral European stocks will benefit if the ECB should embark on its own brand of Qualitative and Quantitative Easing (QQE):-

Athens_vs_DAX_one_year bloomberg

Source: Bloomberg               Note:      Blue = Athens SE Composite               Purple = DAX

It is important to make a caveat at this juncture. The qualitative component of the BoJ QQE programme has been derisory in comparison to their buying of JGBs; added to which, whilst the socialisation of the European corporate sector is hardly political anathema to many European politicians it is a long way from “lending at a penal rate in exchange for good collateral” – the traditional function of a central bank in times of crisis.

Conclusion and investment opportunities

European Government Bonds

Whilst the most likely political outcome is a relaxation of Article 123 of the Lisbon Treaty, allowing the ECB, or the national Central Bank’s to purchase EZ sovereign bonds, much of the favourable impact on government bond yields is already reflected in the price. 10 year JGBs – after decades of BoJ buying – yield 30bp, German Bunds – without the support of the ECB – yield 46bp. Aside from Greek bonds, peripheral members of the EZ have seen their bond yields decline over the past month. If the ECB announce OMT I believe the bond rally will be short-lived.

European Stocks

Given the high correlation between stocks markets in general and developed country stock markets in particular, it is dangerous to view Europe in isolation. The US market is struggling with a rising US$ and collapsing oil price. These factors have undermined confidence in the short-term. The US market is also looking to the Europe, since a further slowdown in Europe, combined with weakness in emerging markets act as a drag on US growth prospects. On a relative value basis European stocks are moderately expensive. The driver of performance, as it has been since 2008, will be central bank policy. A 50% increase in the size of the ECB balance sheet will be supportive for European stocks, as I have mentioned in previous posts, Ireland is my preferred investment, with a bias towards the real-estate sector.

The Euro

Whilst the EUR/USD rate continues to decline the Nominal Effective Exchange Rate as calculated by the ECB, currently at 98, is around the middle of its range (81 – 114) since the inception of the currency and still some way above the recent lows seen in July 2012 when it reached 94. The October 2000 low of 81 is far away.

If a currency war is about to break-out between the major trading nations, the Euro doesn’t look like the principal culprit. I expect the Euro to continue to decline, except, perhaps against the JPY. Against the GBP a short EUR exposure will be less volatile but it will exhibit a more political dimension since the UK is a natural safe haven when an EZ crisis is brewing.

Politics

Yes, Virginia, There Is No Political Santa Claus

At a time of the year when gift giving and charitable good spirit fills the air, please allow me to be the one who rains on the parade: “Yes, Virginia, there is no Santa Claus!”

I don’t mean the Santa who comes down the chimney with toys for every girl and boy. This is the Santa who really is Mom or Dad, Grandparent or other family members or close friends who out of their own earned income choose to purchase, wrap and give gifts to those little ones on Christmas morning.

The small child may have been told the fairy story about an jolly, fat man in a red suit who lives in the far north, working with his elves all year long so the toys and other presents are ready to be miraculously delivered to every “good boy and girl” around the world in one night.

But we “adults” all know that is all just a story for the children at an early and gullible age when the fantasy of it all seems possibly real. And many of us cherish those early years of wonder and make-believe, before the reality breaks through that it just does not and cannot happen that way.

The Redistributing and Regulating Political Santa

I mean the Uncle Sam “Santa” that, not just at Christmas time, but year-round, is believed by many people to have the ability to bring them many of the good things they want from a mythical North Pole called Washington, D.C., or any governmental capital around the world.

This is the political Santa who delivers subsidies of various sorts to farmers or “alternative energy” manufacturers. The Santa who redistributes vast sums of money for educational expenditures, or public housing, welfare and food stamps, or government defense contracts, and even “bridges to nowhere.”

This is also the political Santa who can magically fill the global skies with unmanned drones for surveillance and death, or fund decade-long trillion-dollar wars in far-off lands, or bankroll “friendly” governments in other places around the world while punishing “bad” countries for what Uncle Sam defines as “misbehavior.”

This is the Santa who claims the power and ability remake human nature, control human thought, and redesign some or even all of human society into various preferred shapes and forms.

This political Santa works hard to create the illusion that prosperity and improvement in the human condition cannot happen if not for the guiding, regulating, and manipulating hand of “benevolent” government.

The Political Myth of Something for Nothing

But while almost all children grow out of their belief in a Santa Claus with his home at the North Pole who “somehow” succeeds in manufacturing all those “goodies” that he carries on his sleigh on Christmas Eve, many people go through their entire life convinced of the Santa-like abilities of a paternalistic government that can “somehow” assure many, if not all, of the desired good things of life.

However, just as “Santa” is really Mom and Dad who buy the presents, and wrap them to put under the Christmas tree, governmental “Santa” are those in political office who have no ability to bestow desired benefits on “all” without, in fact, first taking from some to give to others.

Mom and Dad work. They assist in producing goods or in performing services for others in the marketplace, which earns them a salary or nets them a profit. They have had to first produce to, then, through the income they earned, have the ability to consume, including on the goods that their children find on Christmas morning.

The governmental Santa must, first, tax away the income and wealth of some to, then, redistribute it in one form or another to others in the country over which those in political power assert fiscal and regulatory authority.

For the mythical Santa at the North Pole there are no costs for anything he does. The resources, raw materials and tools with which his Christmas goodies are made just appear. The elves work, apparently, for nothing and their food and clothes do not need to be produced, either.

For our political Santa Claus to rain redistributive “gifts” on those he considers deserving and “nice,” he must take from those found to be “naughty” and not nice.

Santa vs. Government Giveaway cartoon

Political Santa’s “Gifts” Carry High Costs

Our political Santa Claus imposes real and meaningful costs on many in society to do his magical “social work.” First, he must appropriate part of the material wealth produced by those productive members of society. People who, in a free market, only earn what they have by peacefully offering to others things those others desire and value enough to pay an agreed-upon price to acquire.

A portion of the intellectual and material effort of real men and women are seized from them through compulsory taxation. The government classifies these net taxpayers in society as having more than they “really” need, and usually don’t ethically “deserve.”

They get “sack of coal” for being “bad” in the form of being left with less than the full value of their creative and hardworking effort. They are denied the opportunity and the right to enjoy the complete fruits of their mental and physical labors. Their choices to spend what they have honestly earned are narrowed to what the political Santa decides they should have available to spend.

The “good” little political citizens who are given the redistributive benefits, therefore, are the net recipients of what others have produced, and which they have received due the ideological and pressure group power they can bring to bear in collaboration with the political Santa in the municipal, state, and national halls of governmental control.

But the costs of political Santa’s generosity do not come just in the form of direct redistributions. They also come in the form of regulations, restrictions, and licensing requirements that determine who may allowed to compete, work, and earn a living in a particular line of enterprise, production, and trade.

This “sack of coal” for the “bad” citizens also comes in the form in the inability to start a business or expand and successfully run an enterprise as the result of the regulatory hand of political Santa. The costs also take the form of closed opportunities for those with little or no skills to find work or be hired at a starting wage that would give them a chance at improving their own lives through honest employment in the free marketplace.

It also costs the consumers who find their choices and options are more limited or nonexistent than the free market would have provided, if only the government had not imposed these barriers, walls, and hurtles in the way of those who merely wish to be left alone to go about their private and personal affairs of life by offering new, better, and less expense goods and services to their fellow men through honest, peaceful, and mutually agreed terms of trade.

The “good little citizens” in this case are those on the supply-side of the market who are sheltered from the competition of real or potentially more efficient and productive rivals. Their larger market shares, greater profit margins, and costly inefficiencies are protected by the political Santa’s regulatory power; he, in turn, receives the campaign contributions and implicitly bought votes on election days that keep him in office.

The Myth of Needing a Political Santa for Life

For political Santa to pursue his mythical game in governmental plunderland, he must do all in his power to persuade and convince his citizen “children” that they do not have a right to their own life and to live it in their own chosen way. They must be indoctrinated to either passively accept the role of life-long dependent upon the political Santa, or to serve as the self-sacrificing elves who must do the work to produce all the goods and services in the world that will be redistributed out of the political Santa’s sack of taxed and regulated benefits.

Santa will educate you; he will see that you have a job and that you receive a “fair” wage. He will make sure that you are safe and satisfied by controlling what is produced, how it produced, and the terms under which the “bad” business children under his regulatory supervision market and sell many of those “goodies” to you.

When sick or disabled, political Santa will give you medical care; and he will guarantee you a retirement free from the need for planning for these things yourself.

All you need to do is accept your status as a lifetime adolescent needing supervision, care, and oversight in everything and in all things that you do. The spirit and psychology of being political Santa’s dependent was captured in that government website cartoon during the first Obama Administration called “The Life of Julia.”

“Julia” needed government to supply the hospital in which she was born; to provide the pre-school education with which her political indoctrination began; too see that Julia was given not only a government high school diploma, but got taxpayer subsidies and special quotas to make it into a preferred college or university; to see that gender affirmative action laws guaranteed a “fair chance” to a good paying job and career that she otherwise could never get on her own; and to see that in later years Julia has the safety-net of government Social Security, without having to bear the responsibility of carrying for this herself.

President Santa Claus cartoon

Self-Sacrificing “Elves” to Serve Political Santa

The other side of political Santa’s plunderland is the indoctrination of the productive and producer “elves” who are needed to do the work that supplies all that government can give away. This requires convincing everyone that “society” comes before the individual; that anything that the individual has is not due to his own effort and his peaceful and voluntary associations with others, or as President Obama asserted, “You did not built it.”

Instead, what you have is due to the collective efforts of all, so that you cannot claim a right to anything or any more than what the collective deems you to deserve. And it is political Santa who represents and acts for the social collective in determining what shall be expected from you and in what form, and what you shall be allowed to have from “society” (or that you are allowed to keep) as bestowed by the government’s redistributive and regulatory activities.

But just as there is no Santa at the North Pole, there is no political Santa in society. Political Santa is really those who run for political office to gain and retain governmental control and power over other people’s lives. Political Santa is really all the special interest groups who wish to use the halls of governmental power to obtain through regulation and taxation what they cannot honestly earn in the open competition of the free marketplace.

Ethical Benevolence vs. Political Immorality

Benevolence and voluntary charity, and a properly understood spirit of “giving” to those you value and love at Christmas time are right and virtuous sentiments of free people in the open society.

But belief in and actions based upon the idea of a “political Santa” only succeeds in weakening and finally destroying the spirit and ethical health of a free and prosperous society.

So, yes, Virginia, there is no Santa Claus. Neither a North Pole Santa who comes down the chimney in a red suit, nor a political Santa who can give people “something for nothing” in a world in which all that people want and desire must be creatively produced by someone before it may used to satisfy those wants and desires.

What makes the mythical belief in a political Santa far worse than the short-lived childhood belief in the North Pole Santa, is that the idea of a political Santa challenges and destroys the spirit of individualism upon which the good, free and prosperous society ultimately rests.

Economics

The Real Fed Tug Of War: the Yellen Doctrine vs. the Volcker Doctrine

The financial markets are on a hair trigger as to when, and how quickly, the Fed will tighten and raise interest rates.  Billions of dollars will be won or lost by investors on this wager.

For the rest of us, getting it right — as did Chairman Volcker and (during his first two terms), Greenspan is crucial to the creation of a climate of equitable prosperity in which jobs are created in abundance.  39 million jobs were created during the “Great Moderation.” We haven’t seen anything remotely like that since.

Getting it right is crucial to economic mobility — raises, bonuses, and promotions — to let us workers climb the ladder to decent affluence. Thus, just when to raise rates is much less important than the bedrock issue.

For over a decade now job creation has been poor. Poor, too, has been economic mobility.  The left is very much on record as calling for extended ease — keeping interest rates down.  The right has been critical over the Fed’s “zero interest rate policy.” Yet the real tug of war is over whether the Fed should follow a monetary rule or exercise discretion; and, if a rule is preferable, what rule?

Yellen has been on a campaign to demonstrate her empathy with workers.  Less well known: this empathy is shared by many conservatives and libertarians. I, among others, find Yellen’s new openness to rank and file workers and activists a refreshing change of tone from that of the formerly hermetically sealed “Temple.” There are few matters on which I agree on with Sen. Sherrod Brown. This is one of them. As Sen. Brown told Politico:

“I love that Chair Yellen and three Fed governors actually had public meetings,” said Sen. Sherrod Brown of Ohio, an outspoken member of the Senate Democrats’ liberal wing, commending Yellen and her colleagues for recently meeting with progressive activists. “She wants to set a different tone there where they’re listening to the public and listening to people who have lost jobs, listening to people who have seen their life savings evaporate….

Yellen’s descent from Temple Mount to we plain people of the plane is a notable shift. It well accords, at least in style and possibly in substance, with the new populist spirit abroad in the land.  It is imperative, however, that it prove substantive and not merely cosmetic.  And substantive means an intellectual openness to a diversity of views.

The right is not the party of Ebenezer Scrooge.  The right is all for job creation and a rising tide lifting all boats. Yet Yellen has been connecting, so far exclusively, with the left. In her first year, Yellen visited a trade school and donned a welding mask (a terrific photo op, truly); toured a low income neighborhood before speaking, to wide note, at a Boston Fed conference where she advocated for the social safety net and social services (notably, mysteriously, not speaking about monetary policy); met with President Obama on the eve of the 2014 election; and recently took an unprecedented meeting with what Bloomberg.com called “labor and community organizers.”

It is my guess that Janet Yellen reaches out to the social-democratic left because it represents her native intellectual milieu. They speak her language.  Many progressives simply find the right foreign, our language alien. (Memo to Yellen: If all I knew about my team was what I read from Paul Krugman I, too, would disdain me. The mainstream media portrayal of the right is a grotesque caricature.  We’re not the way we are portrayed.  We are, however, skeptical of the efficacy of central planning.  For good reason. And, Dr. Yellen? America is a center right nation.)

Soon we shall stop guessing and find out if Janet Yellen truly is open to hearing a diversity of views … or whether this really is merely a “charm campaign.” One of the leading monetary integrity advocacy groups (and the lead gold standard advocacy group) on the center right, American Principles in Action, which I professionally advise, recently hand-delivered to the Fed a request to Madam Yellen that she meet with representatives of the right.

The letter, signed by 20 high profile figures on the right, stated:

This is to endorse the pending request by American Principles in Action’s Steve Lonegan for a meeting with you, Vice Chair Fischer, and others of your selection, to gather and exchange views with a delegation of monetary policy thought leaders from the center-right.

The left by no means has a monopoly on concern for unemployment and wage stagnation.  To balance a meeting with a group composed of, as described by Bloomberg News, “labor and community organizers” with one of the leading representatives of the center right experts would honor that principle of “a diversity of views”. An evenhanded insight on achieving our shared goal of job creation and economic mobility would facilitate steps toward realization of this mutual objective.

The letter is noteworthy and may portend a significant shift in the discourse. The “money quote:”The left by no means has a monopoly on concern for unemployment and wage stagnation.” This is a thematic development that Yellen would do well to encourage. The difference between members of the humanitarian left and humanitarian right is one of means, not ends.

All agree that money matters, and that the Fed is the fulcrum of the world’s monetary system.  The left believes that discretion is the recipe for more equitable prosperity. The right believes that a monetary rule will yield greater equitable prosperity. Both cannot be right.  Yet this is, and should be treated as, an empirical, not doctrinal, matter. It is not, at heart, a “left vs. right” issue.

In a way, it’s “Yellen vs. Volcker.”  Contrast a statement by Madam Yellen with one made by former (and iconic author of the Great Moderation) Fed Chairman Paul Volcker, reprised in an earlier column:

Madame Yellen [at hearing of the House Financial Services Committee chaired by Chairman Jeb Hensarling earlier this year] stated that “It would be a grave mistake for the Fed to commit to conduct monetary policy according to a mathematical rule.”  Contrast Madame Yellen’s protest with a recent speech by Paul Volcker in which he forthrightly stated: “By now I think we can agree that the absence of an official, rules-based cooperatively managed, monetary system has not been a great success.  In fact, international financial crises seem at least as frequent and more destructive in impeding economic stability and growth. … Not a pretty picture.”

Not all rules are mathematical.  There may be room for agreement implicit in Yellen’s statement.

There is no generic rule. And a bad rule, or a rule badly implemented, could be worse than no rule at all. If a rule is to be preferred, which rule?

There are contending schools of thought. These prominently include the Taylor Rule, NGDP targeting, inflation targeting, commodity price targeting, and the gold standard. Of the latter, Paul Volcker, not himself a proponent of the gold standard, once had this to say in his Foreword to Marjorie Deane and Robert Pringle’s The Central Banks (Hamish Hamilton, 1994):

It is a sobering fact that the prominence of central banks in this century has coincided with a general tendency towards more inflation, not less. By and large, if the overriding objective is price stability, we did better with the nineteenth-century gold standard and passive central banks, with currency boards, or even with ‘free banking.’

Which rule would most likely be optimal for fomenting equitable prosperity as well as price stability? Each regime has eloquent advocates.

It is, in fact, an open question.

Thus the safest path forward out of the uncharted territory in which we find ourselves appears to be the proposed Brady-Cornyn monetary commission introduced in the 113th Congress. It reportedly is certain to be re-introduced in the 114th.

The proposed commission, widely praised in the financial media, is designed to be strictly bipartisan and meticulously empirical.  It is chartered to make an objective assessment of the real outcomes of the various rules now being propounded. While many commissions are designed to derail an issue, a monetary commission would be very much in order. Monetary policy is intricate and potent, not amenable to political towel-snapping-as-usual.

This proposed commission is not in at all inimical to the Fed. The Fed Chair gets an appointment of an ex-officio Commissioner to ensure that the monetary authorities have a dignified voice in the review process.  The Treasury Secretary gets to appoint an ex-officio commissioner as well.

Politico has termed Yellen’s the “Toughest job in Washington.” This surely is apt.   In taking a step away from her crystal ball and connecting with the rank and file Janet Yellen may have unleashed a healthy dynamic that could prove beneficial to making progress.  But only if she listens to all sides.  Moreover, the Commission would provide a civil buffer from the sobering reality that, as Politico reported, “Republican leaders and staff said in interviews that they plan to use their new dominance on both sides of Capitol Hill next year to target the Fed for much greater scrutiny, including aggressive hearings ….”

On the surface it’s a tug of war between raising and lowering interest rates.  At root, it’s an argument about whether the Fed should be following a rule or making one up as it goes along.  If Yellen proves open to a diversity of viewpoints, and if the Fed puts its benediction on the Brady-Cornyn monetary commission legislation, 2015 well could see the beginning of a move in the direction of credit both affordable and abundant that could rival for job creation the Great Moderation.

Originating at http://www.forbes.com/sites/ralphbenko/2014/12/15/the-yellen-tug-of-war/

Economics

Total Output grew by 2.17% in 2012

October 31st saw the belated release of the 2014 Input-Output Supply and Use Data. This is important because it incorporates a larger amount of economic activity than GDP data, but comes at the cost of only appearing as an annual series, and with an 18 month (or longer) lag. The diagram below shows the breakdown of the measure for 1997:

I’ve previously mentioned that Gross Output data is now an official BEA statistic, and I am interested in seeing equivelent figures for the UK. Here they are.

Firstly, in terms of absolute numbers, we can see that Total Output dwarfs Nominal GDP.

In fact Total Output is around twice as large as Nominal GDP:

The reduction in the ratio that occured in 2002-2005 is a result of Nominal GDP growth running ahead of Total Output growth. But notice the dramatic increase in the ratio in 2006. This was because Nominal GDP was growing at 5.81%, whilst Total Output grew at 8.73%. This reveals that economic activity was running at a significantly higher pace than a focus on GDP data was telling us:

One of the main reasons why the September revisions to GDP had such an impact was because of a reclassification of R&D spending. This rests on a conceptual problem with distinguishing between investment and intermediate consumption. As more and more economic activity becomes service based we might expect this problem to grow over time. One of the chief benefits of using a broader measure of national income is that it captures all intermediate consumption, and therefore the boundary between intermediate and final consumption/investment becomes less relevent.

These figures reveal that in 2010 and 2011 the wider economy was growing at a higher rate than that being measured by GDP, and in 2012 they were effectively the same. It is very difficult to read much into these annual growth rates, given that there is likely to be a lot of quarterly volatility. But in the same way that the US have started releasing this as a quarterly series, there would be much to gain from the ONS doing likewise.

Economics

Are major economies suffering from the deficiency of demand?

In his article “The curse of weak global demand”, Financial Times November 18, 2014, the economics columnist Martin Wolf wrote that today’s most important economic illness is chronic demand deficiency syndrome. Martin Wolf argues that despite massive monetary pumping by the central banks of US and EMU and the lowering policy interest rates to around zero both the US and the EMU economies have continued to struggle.

After reaching 1.0526 in Q1 2006 the US real GDP to its trend ratio fell to 0.966 by Q3 2011. By Q3 2014 the ratio stood at 0.98. The ratio of EMU real GDP to its trend after closing at 1.061 in Q1 2008 fell to 0.954 by Q3 2014.

Real GDP Ratios

Martin Wolf is of the view that what is needed is to raise the overall demand for goods and services in order to revive economies. He also holds that there is a need to revive consumer confidence that was weakened by the severe weakening of the financial system.

He is also of the view that there is a need for the banks to lift their lending in order to revive demand, which in turn, he suggests, will revive the economies in question. He also blames massive debt for the economic difficulties that the US and the EMU economies are currently experiencing.

Martin Wolf views the current economic illness as some mysterious and complex phenomena, which requires complex and non-conventional remedies.

We suggest that the essence of Wolf’s argument is erroneous. Here is why.

There is no such thing as deficiency of demand that causes economic difficulties. The heart of economic growth is the process of real wealth generation.

The stronger this process is the more real wealth can be generated and the stronger so-called economic growth becomes. What drives this process is infrastructure, or tools and machinery. With better infrastructure more and a better quality of goods and services i.e. real wealth, can be generated.

Take for instance a baker who has produced ten loaves of bread. Out of this he consumes one loaf and the other nine he saves.

He can exchange the saved bread for the services of a technician who will enhance the oven. With an improved oven the baker can now produce twenty loaves of bread. Now he can save more and use the larger savings pool to further invest in his infrastructure such as buying other tools that will lift the production and the quality of the bread.

Observe that the key for wealth generation is the ability to generate real wealth. This in turn is dependent on the allocation of the part of wealth towards the buildup and the enhancement of the infrastructure.

Also, note that if the baker were to decide to consume his entire production i.e. keeping his demand strong, then he would not be able to expand the production of bread (real wealth).

As time goes by his infrastructure would have likely deteriorated and his production would have actually declined.

The belief that an increase in the demand for bread without a corresponding increase in the infrastructure will do the trick is wishful thinking.

We suggest that there is no such thing as a scarce demand. Most individuals have unlimited desires for goods and services.

For instance, most individuals would prefer to live in nice houses rather than in small apartments.

Most people would like to have luxuries cars and be able to dine in good quality restaurants. What prevents them in achieving these various desires is the scarcity of means.

In fact as things stand most individuals have plenty of desires i.e. goals, but not enough means.

Unfortunately means cannot be generated by boosting demand. This will only increase goals but not means.

Contrary to the popular way of thinking we can conclude that demand doesn’t create supply but the other way around.

As we have seen by producing something useful i.e. bread, the baker can exchange it for the services of a technician and boost his infrastructure.

By means of the enhanced infrastructure the baker can generate more bread i.e. more means that will enable him to attain various other goals that previously were not reachable by him.

The current economic difficulties are the outcome of past and present reckless monetary and fiscal policies of central banks and governments.

It must be realized that neither central banks nor governments are wealth generating entities. All that they can set in motion is a process of real wealth redistribution by diverting real wealth from wealth generators towards non-wealth generating activities.

As long as the pool of real wealth is expanding the central bank and the government can get away with the myth that their policies can grow the economy.

Once however, the pool of wealth becomes stagnant or starts shrinking the illusion of the central bank and government policies are shattered.

It is not possible to expand real wealth whilst the pool of real wealth is shrinking. Again a shrinking pool of wealth over time can only support a shrinking infrastructure and hence a reduced production of goods and services that people require to maintain their life and well being – real wealth.

The way out of the current economic mess is to close all the loopholes of wealth destruction. This means to severely cut government involvement with the economy. It also, requires closing all the loopholes for the creation of money out of “thin air”.

By curtailing the central bank’s ability to boost money out of “thin air” the exchange of nothing for something will be arrested. This will leave more real wealth in the hands of wealth generators and will enable them to enhance and to expand the wealth generating infrastructure.

Contrary to Martin Wolf the expanding of bank loans as such is not going to revive the economy. As we have seen the key for the economic revival is the buildup of infrastructure that could support an expanding pool of real wealth.

Banks are just the facilitators in the channeling of real wealth. However, they do not generate real wealth as such.

The lending expansion that Martin Wolf suggests is associated with fractional reserve lending i.e. lending out of “thin air” and in this respect it is bad news for the economy – it sets in motion the diversion of real wealth from wealth generators to non wealth generating activities.

We can conclude that the sooner governments and central banks will start doing nothing the sooner economic revival will emerge. We agree with Martin Wolf that the economic situation currently seems to be difficult; however, it cannot be improved by artificially boosting the demand for goods and services.

Summary and conclusion

Some experts are of the view that today’s most important economic illness is chronic demand deficiency syndrome. It is because of this deficiency that world economies are still struggling despite massive monetary pumping by central banks, or so it is held. We suggest that this way of thinking is erroneous. The key problem today is a severe weakening in the wealth generation process. The main reason for this is reckless monetary and government policies. We hold that the sooner central banks and governments start doing nothing the sooner economic revival will occur.

Money

Understanding the Money Creation and Society Debate

Together with colleagues spanning four parties – Michael Meacher (Lab), Caroline Lucas (Green), Douglas Carswell (UKIP) and David Davis (Con) – I have secured a debate on Money Creation and Society for Thursday 20 November. Here’s a quick guide to understanding the debate.

First, we have a system of paper or “fiat” money: it exists due to legal mandate as opposed to being a physical commodity like gold. Reserves, notes and coins are created by the state but claims on money are created by the banks when they lend. Most of the money we have was created by banks lending.

This excellent video from Dominic Frisby is a great place to begin:

There was once a time when the literature about money creation was sufficiently off the mainstream to be dismissed. The Bank of England now explains:

I published a short paper on what is wrong with the current system and what to do about it, first inBanking 2020 and then Jesús Huerta de Soto kindly republished it in his journal Procesos De Mercado Vol.X nº2 2013. A further monetary economist privately reviewed the paper but errors and omissions remain my own. You can download it here:

Recent emergency monetary policy has been dominated by Quantitative Easing: the Bank of England has provided a report on The distributional effects of asset purchases (PDF). However, the financial system has been chronically inflationary throughout my lifetime, ever since the Bretton Woods currency system ended.

If QE has distributional effects, why not all money creation?

Here is a historic price index from the Office for National Statistics and House of Commons Library: Consumer Price Inflation since 1750 (PDF).

Price Index 1750-2003

And here is the growth of broad money from 1982 to date via the Bank of England (series LPMAUYM). Note that the money supply stopped accelerating in the course of the crisis, during the period of QE:

M4: 1982-2014

No one can argue prosperity has not increased over the period but if distributional effects matter at all, one must ask “Who benefits?” Via Positive Money, here’s where the new money went:

Sectoral lending

As I said in debate on 6 Dec 2011:

Why are we in this debt crisis? I have just checked the M4 money supply figures—I am sorry to return to aggregates, but needs must. When Labour came to power the money supply was about £700 billion and it is now about £2.1 trillion, so it has tripled over the past 14 years. Unfortunately, most economists talk about money flowing into the economy as if it were water poured into a tank that found its own level immediately, but what if it is like treacle or honey? What if it builds up in piles when poured into the economy and takes a while to spread out? What if that money was loaned into existence in response to individual choices led by the excessively low interest rates pushed by the central bank? What if it was loaned into existence in particular sectors, such as the housing sector, where prices have more than doubled over the same period, and what if it was the financial sector that received the benefit of that new money first? Would that not explain why financiers and bankers are so much wealthier than everyone else, and why economic activity and wealth has been reorientated towards the south-east?

This debate will explore the effects on society of long-term money creation by private banks’ lending in the context of the present financial system.

Further reading: