by Gary North
Ludwig von Mises made several important contributions to the theory of money: the regression theorem, which explains why money originally developed from non-monetary commodities; the refutation of any concept of neutral money that somehow does not redistribute income when the money supply changes; the idea of every existing money supply as maximizing benefits to participants in an indirect-exchange economy; changes in the money supply as conferring no identifiable increase in social value; and the monetary theory of the business cycle. In my opinion, these were peripheral to his major contribution to monetary theory. His most important and unique contribution was a single idea, which is denied by all other schools of economic opinion:
The State's coercive interference in either money or banking, including its licensing of a monopolistic central bank, reduces all men's freedom and most men's wealth.
Mises offered a theory of money and credit that is "market endogenous," i.e., a theory of money that affirms the free market's ability, through men's voluntary transactions, to establish market-clearing prices, day after day, year after year, apart from any government agency's decree. All other schools of monetary thought deny the ability of an autonomous, self-regulating free market to maximize efficiency, freedom, and productivity. Every other school of opinion calls for State intervention into the money supply: always increasing it, never decreasing it. All other schools of thought favor the creation of a central bank, legally independent of the government, yet the offspring of the government, possessing a lawful monopoly over the control of the money supply. In short, all other schools of economics are statist in their theory of money and credit.
Mises, by establishing his theory of money on the conceptual foundation of the free market, alone offered a completely free market theory of money and credit. He called on civil governments to enforce banking contracts that establish both money certificates and credit money, just as governments should enforce all other private contracts. Mises offered a theory of money and credit in which civil governments have no monetary policies at all.
A FREEZE ON ADDITIONAL GOVERNMENT MONEY
A free market money system does not exist today. Every national government, through its licensed monopoly, the fractionally reserved central bank, and its licensed oligopolies, fractionally reserved commercial banks, is deeply involved in setting monetary policy. For national governments in general and the U.S. government in particular, Mises had a single policy recommendation: create no new money. He made this point in his 1951 essay, "The Return to Sound Money."
The first step must be a radical and unconditional abandonment of any further inflation. The total amount of dollar bills, whatever their name or legal characteristic may be, must not be increased by further issuance. No bank must be permitted to expand the total amount of its deposits subject to check or the balance of such deposits of any individual customer, be he a private citizen or the U.S. Treasury, otherwise than by receiving cash deposits in legal-tender banknotes from the public or by receiving a check payable by another domestic bank subject to the same limitations. This means a rigid 100 percent reserve for all future deposits; that is, all deposits not already in existence on the first day of the reform (p. 448).
Where statist money is concerned, Mises had only one suggestion: do not add to the money supply. Enough is enough.
Mises also opposed deflation as a policy, just as he opposed inflation. But, most important and most adamantly, he opposed any further intervention by the State or its central bank to increase the money supply. He wanted government out of the money-creation business. Every anti-inflation policy must begin with the policy-makers' refusal to add to the central bank's monetary base.
This position has a corollary, which Mises stated explicitly: the State and the central bank must not interfere with bank runs. There should be no State intervention of any kind in saving over-extended banks that are being bankrupted by their depositors. It is the State's attempt to undermine contracts that is the root cause of credit-money inflation. No bank should be too small to fail or too big to fail. The threat of bankruptcy must be on the mind of every banker at all times, in order to offset his temptation to issue fiduciary media.
This position leads to a policy conclusion: The deflation of the money supply is valid if this deflationary process is the result of depositors' withdrawal of their funds and the conversion of these funds into currency, which is not fractionally reserved. To the degree that the existing money supply is the result of fractional reserve banking, the State and its central bank should accept any deflation that results from the reduction of fractional reserves by the decisions of depositors to exchange deposits for currency and not redeposit their money in another member bank in the fractional reserve banking system. A bank run is the depositors' negative sanction that provides them with their sovereignty over their own property, i.e., their money.
As a defender of the ideal of free banking (see Part IV), Mises again and again warned the State not to intervene in banking affairs, except to enforce contracts. The depositors' decision to withdraw their funds by converting their deposits into currency is the essence of the original contract between banks and depositors. So, while Mises was not an advocate of the State's deliberate policy of deflation, he was a strong advocate of the legal right of depositors to withdraw their money out of their banks on demand. The State should not intervene in order to save over-extended commercial banks. But over-extended banks, by becoming insolvent, reduce the supply of credit money. Thus, Mises was not an opponent of deflation in general, for thus would have made him an opponent of depositor-induced deflation. He was an opponent of State-induced deflation. Nowhere in his writings did he recommend that the State or the central bank create new monetary reserves in order to offset a reduction in the money supply caused by depositors' withdrawal of their funds. On the contrary, in "The Return to Sound Money," he told us that what is required is a complete freeze on the central bank's creation of additional money, for any reason.
Sound money still means today what it meant in the nineteenth century: the gold standard. The eminence of the gold standard consists in the fact that it makes the determination of the monetary unit's purchasing power independent of the measures of governments. It wrests from the hands of the "economic tsars" their most redoubtable instrument. It makes it impossible for them to inflate. This is why the gold standard is furiously attacked by all those who expect that they will be benefited by bounties from the seemingly inexhaustible government purse. What is needed first of all is to force the rulers to spend only what, by virtue of duly promulgated laws, they have collected as taxes. Whether governments should borrow from the public at all and, if so, to what extent are questions that are irrelevant to the treatment of monetary problems. The main thing is that the government should no longer be in a position to increase the quantity of money in circulation and the amount of checkbook money not fully — that is, 100 percent — covered by deposits paid in by the public. No backdoor must be left open where inflation can slip in. No emergency can justify a return to inflation. Inflation can provide neither the weapons a nation needs to defend its independence nor the capital goods required for any project. It does not cure unsatisfactory conditions. It merely helps the rulers whose policies brought about the catastrophe to exculpate themselves. One of the goals of the reform suggested is to explode and to kill forever the superstitious belief that governments and banks have the power to make the nation or individual citizens richer, out of nothing and without making anybody poorer. The short-sighted observer sees only the things the government has accomplished by spending the newly created money. He does not see the things the non-performance of which provided the means for the government's success. He fails to realize that inflation does not create additional goods but merely shifts wealth and income from some groups of people to others. He neglects, moreover, to take notice of the secondary effects of inflation: malinvestment and decumulation of capital (pp. 438-39).http: //www.econlib.org/library/Mises/msT9.html
Mises suggested a reform: the re-establishment of a traditional, government-guaranteed gold standard. The likelihood of implementing this reform rested on an assumption: "Keynesianism is losing face even at the universities" (p. 439). His timing was way off. Keynesianism had only just begun to exercise control over every area of American economic opinion. When, in the mid-1960's, monetarism visibly raised its anti-gold standard head, the case against the gold standard and in favor of fiat money grew even more academically acceptable. Thus, his statement in 1951 seems utopian today: "The political chances for a return to sound money are slim, but they are certainly better than they have been in any period after 1914" (p. 439).
Mises opposed a State-imposed policy of deflation. To re-establish a traditional gold standard, the national civil government must guarantee to buy and sell gold at an official price. For a national government to re-establish the official price of gold at the price that had prevailed before the expansion of credit money would require a policy of deflation leading to economic contraction. This is what Great Britain had done after the Napoleonic Wars in 1815 and after World War I in 1925. Mises regarded both decisions as unwise (p. 455). So, Mises said, the official price of gold should be restored at something close to the free market price. He said that the Treasury must sell gold at the fixed price for what we call M-1: currency, token coins, and checks drawn upon a member bank (p. 450).
He did not say, but obviously believed, that the monetary reserves of the central bank must not increase as the result of a hike in gold's official price. The official price today is $42.22 per ounce. It was $35 in 1951. He thought that it might have to be raised to somewhere between $36 and $38 (p. 449) — perhaps 10 percent. If gold's official price were raised to the free market's price today, the Federal Reserve System's Open Market Committee (FOMC) would be required to sell Treasury debt to offset the gold price revision's increase in the monetary base. Alternatively, the Fed's Board of Governors would have to raise the reserve requirements for commercial banks. Either policy would raise interest rates.
The gold reserves of the United States in December, 2001, totalled a little over $11 billion at the official price of $42.22. This would have to be multiplied by about seven, or about $77 billion, an increase of $66 billion. The FOMC would then have to sell $66 billion of Treasury debt. With the adjusted monetary base at about $655 billion, this would be a 10% decrease in the monetary base. This would raise short-term interest rates. If the Federal Reserve System then refused to interfere by adding to reserves — which Mises's reform proposal mandated — a deflation of the money supply would take place when bank runs toppled insolvent banks. There would be a recession, or worse.
Mises's proposal was to restore the traditional government-guaranteed gold standard, in which every national government's central bank would still keep on deposit the bulk of the national economy's gold. If the public were to begin to redeem gold, the central bank would then sell Treasury debt, thereby deflating the money supply, thereby raising interest rates, thereby halting the gold outflow. "Keep your money in the bank at high interest rates. Don't withdraw non-interest-paying gold." Deflation with rising interest rates create recessions.
The money-stabilizing strategy of the traditional gold standard always assumed that most people would always leave most of their gold on deposit with the commercial banks (pre-1914) or with the central bank (post-1914). Put another way, the logic of the traditional State-run gold standard assumes that the public must always be kept from reclaiming most of its gold by having banks call in loans, shrink the money supply, and raise interest rates. But there is always the other option for the banks: default. The political popularity of default eventually wins out over the pain of recession. At that point, advocates of the gold standard are back to square one: blamed for the recession and rejected as obsolete voices of the past. They are dismissed by politicians and economists as barbarous relics.
Leaving gold in the possession of fractional reserve bankers is like issuing a license for them to steal the gold whenever some emergency appears that supposedly justifies the State's suspension of gold convertibility, i.e., another violation of contract. Once people's gold is in the possession of fractional reserve banks, it will not be returned to them. Initially, banks will raise interest rates by reducing credit money in order to persuade depositors not to reclaim their gold. When this fails to persuade them, the banks will steal their gold by defaulting on their contracts to redeem gold on demand, and the State will authorize this. Once a nation's gold supply goes into a fractional reserved banking system, most of it never comes out. This is the golden rule of fractional reserve banking: Do unto depositors before the depositors do it unto you. Mises did not formulate this rule; I did. He merely described its operation. I learned how it operates from him.
Mises wrote in 1951: "The Classical or orthodox gold standard alone is a truly effective check on the power of the government to inflate the currency. Without such a check all other constitutional safeguards can be rendered vain" (p. 452). Mises in this passage implicitly accepted the fact that the United States government, through its monopolistic central bank, controlled the money supply in his day. The United States government had confiscated the public's gold in 1933. Mises in 1951 affirmed the classical gold standard as the only way to keep the civil government from inflating the money supply. This does not mean that he believed that only the civil government should control the money supply. He did not believe this. On the contrary, he believed that the free market should be the sole source of money. He defended this position when no other economist was willing to. His followers still are the only economists who defend this proposition. The classical gold standard was his recommended policy for an undesirable condition: control over money by civil government.
The political theory of judicial sovereignty rests on a presupposition: there is no higher earthly court of appeal beyond a sovereign State. This is an updated version of early modern Europe's doctrine of the divine right of kings. This doctrine was popular with King James I. It was rejected by his contemporary, the English constitutional law jurist, Sir Edward Coke ["Cook"]: Petition of Right (1628). The theory of the classical gold standard assumes the legal sovereignty of the State over money. In terms of this theory, there is no judicial authority to preserve the classical gold standard from the government's desire to escape its restrictions. The classical gold standard, by definition, is self-imposed by the civil government. So, when incumbent politicians in search of new money to buy votes tire of this self-imposed limitation, they abandon it. Who can stop them? Not depositors, who are the default's immediate victims. Not voters, who do not understand monetary theory. Not Keynesian or monetarist economists, who hate the gold standard. Not supply-side economists, who are of two opinions during recessions: the need to defend the gold standard and the need for the central bank to create more money, after tax cuts have failed to revive the sagging economy.
By 1949, Mises had no illusions about the honesty of governments or their statutory creations, central banks. In Human Action, he wrote derisively of the Bretton Woods gold-exchange standard: "In dealing with the problems of the gold exchange standard all economists — including the author of this book — failed to realize the fact that it places in the hands of governments the power to manipulate their nations' currency easily. Economists blithely assumed that no government of a civilized nation would use the gold exchange standard intentionally as an instrument of inflationary policy" (p. 786).
A gold standard that the public can safely rely on must not have anything to do with a government's guarantee to redeem gold on demand. Such a guarantee is unenforceable in any government court after the government revokes it. Governments eventually cheat on their promise to redeem money-certificates for gold. They either devalue the currency (lower the quantity of gold redeemable per currency unit) or else they default: cease redeeming IOU's for any quantity of gold. There have been no exceptions in history.
The definition of a crazy person is someone who keeps doing something, over and over, even though it fails to achieve his goal. It is time for defenders of sound money to cease being crazy. It is time to stop promoting the traditional gold standard. The traditional gold standard is a game for suckers. The government or its licensed agents announce: "Bring us your gold, and we will store it for you free of charge, and you can get it back at any time at the price at which you sold it us." To which I reply: "There ain't no such thing as a free government-guaranteed gold standard."
How, then, can a nation return to a gold standard that is the product of the free market rather than the State? I offer the following suggestion in the spirit of Mises, though not the letter.
"MR. GREENSPAN, TEAR DOWN THESE WALLS!"
In the underground vault at 33 Liberty Street, New York City, the Federal Reserve Bank of New York stores most of the world's gold. This gold belongs to central banks. It used to belong to private citizens. The vault's walls protect the Federal Reserve's gold and foreign central banks' gold from the public. There are walls for the vault at Fort Knox that perform the same restrictive function.
All over the world during the twentieth century, the State, in conjunction with State-created central banks, deliberately stole the public's gold. In Europe, this was done in two steps. At the beginning of World War I, every government passed laws allowing its commercial banks to refuse to redeem gold on demand. (Step one.) Governments thereby escaped a future vote of monetary no confidence by depositors who had unwisely trusted the State to enforce laws of contract. The depositors' IOU's to gold became "IOU-nothings." The national central banks then created additional fiat money and bought the newly confiscated gold. (Step two.) The gold wound up in the vaults of the national central banks or their main fiduciary agents, the Bank of England and the newly created Federal Reserve System.
The Fed's gold, which was bought and paid for with its very own fiat money, along with foreign central banks' gold that is held for safekeeping and convenient inter-bank swapping, has always been stored at the Federal Reserve Bank of New York.
(Note: the day that this gold begins to be shipped to Basle, Switzerland, to be held for safekeeping by the Bank for International Settlements, is that day that American sovereignty gets unofficially transferred.
In the United States, the theft was more blatant: in 1933, the government made it illegal for American citizens to own non-numismatic gold coins or non-jewelry gold. The government openly stole the gold from the public, and then sold it to the Federal Reserve System in exchange for the Fed's newly issued money. Then the Treasury spent the newly created money. (See Part IV.)
Central banks have demonetized gold by stealing it. This has enabled them to monetize government debt with far less restriction: no threat of any withdrawals of gold by the previous private owners of gold. This demonetization of gold took place three generations ago in Europe, two generations ago in the United States. It is "old news." This happened so long ago that it was never on anyone's radar screen. It happened prior to the invention of radar.
How can the public re-monetize its gold? By demanding the return of the gold. Central banks must be compelled by law to return the stolen goods. The stolen gold surely will not be returned by the thieves voluntarily. (Here, let me imitate a Chicago School economist: "Let us assume that there are two people, a thief and his victim's grandson. The thief has on his side the police, the media, and every economics department on earth, including mine. If transaction costs were zero, the victim's grandson could suggest a mutually beneficial exchange." And so forth.)
I am unaware of any non-Austrian school of economic opinion that has seriously suggested the return of central banks' gold to the public. The operating assumption of all rival schools of monetary opinion is this: "Stealers, keepers; losers, weepers." Also, "Possession is ten-tenths of the law."
This return of the public's gold need not be deflationary. Each government could issue non-interest-bearing, 100-year bonds to its central bank. The bonds should be equal in value to the officially listed value of the central bank's gold supply. In the United States, this would be $42.22 per ounce times the ounces held, or $11 billion. This gold presently earns no interest; therefore, neither should the bonds. The bonds will replace the gold as the central bank's legal reserve for the nation's money supply. No muss, no fuss: call these bonds a gold tranche or whatever fancy-Dan word that economists choose. I would call them Solvency Operating Bonds, or SOB's.
The Treasury Departments of the world would then possess the gold that they sold decades ago to their central banks. But not for long. All of this gold — every ounce — would be sold to the public in the form of coins, preferably one-tenth of a troy ounce of gold, 99.9% fine, but with additional copper or some other hardening metal, so that the coins can circulate without much wear. The time limit on the sake of this gold would depend on the output of the mint on a 24x6 schedule. (Give them Sundays off.) The government will then use the income generated from the sale of the coins to reduce the government's debt. (This debt-reduction procedure is not necessary to make the transition to a full gold coin standard, but since I'm dreaming of that which is politically remote, why not dream big?)
If the sale of gold is politically unacceptable, then the government can hold a national lottery, with all of the proceeds going to the two dominant political parties, or to whatever other boondoggle is acceptable to Congress. I do not care who gets the lottery money. I care who gets ownership of the gold coins: the public. I think a national lottery would generate more public interest in the coins than a series of auctions. There is already an existing distribution system: local convenience stores. Let local banks get involved, too. "Come one, come all: get your tickets here!"
Call the lottery "Golden Opportunity," or "El Dorado," or "Streets of Gold," or "End of the Rainbow." Call it "Return of Stolen Goods." Whatever some New York ad agency thinks will work, use.
Whether bought from the government or won from the government, the coins will enjoy income-tax-free status for five years. The deal would be this: unless the recipient sells the coins for currency or bank credit money, he can keep them or trade them, income-tax-free, for five years. So can the people who receive them in exchange. Each coin will be income tax-free money for 60 months after the release date of the coin, which will be stamped accordingly.
Want to replace the fiat money standard? Want alternative markets in which gold coins are recognized and sought-after? Just grant income-tax-free status to each coin for five years. The "good" coins — tax-free time remaining — will drive the "bad" coins out of circulation after five years. This is the opposite of Gresham's Law. The "defunct" coins will then be used mainly in what I prefer to call unofficial markets, which will have several years to develop.
The reason why the coins should be tenth-ounce coins is simple: no one will want to receive change in paper money, because this change would constitute taxable income: selling for paper money part of the value of a tax-exempt coin. No one will want to receive taxable money for tax-free money. The coins must therefore be small-weight coins.
The governments of the world are not about to give up their control over bank credit money. The world is dependent on the existing structure of credit-money prices. What I am proposing is the creation of a parallel standard. Mises argued that parallel standards for gold and silver existed for millennia. This is what I am proposing: a free market gold coin standard side by side with a fiat money standard for the government's bank money, which we have anyway. All that my proposal would change is this: the return of the stolen gold.
This gold-transfer program would be opposed by "gold bugs," who are invested in gold. The price of gold would fall if all governments started selling all of the gold they have repurchased from the central banks. Gold bugs are like condominium owners in New York City who are opposed to price controls in general, but opposed to the abolition of rent controls in New York City. Such an abolition would produce windfall profits for the owners of rent-controlled buildings, and capital losses for owners of condos. The available supply of condo-competing rental property would increase. There would be fewer cheap middle-class apartments, but the market for condos would go down.
What is good for the world would not be good in the short run for gold bugs, of whom I am chief. That is the price of liberty.
Is my suggested reform politically possible because it is conceptually possible? No. I have described this reform only as an exercise to demonstrate that a top-down, non-deflationary, political reform of the banking system is conceivable. The public might respond favorably to the offer of economic liberty, if given the opportunity. But this opportunity will not be given — surely not by the present system's beneficiaries, central bankers, who long ago established the terms of debate regarding central banking. The debate is this: politically independent national central banks vs. a single politically independent international central bank. Other debaters need not apply.
Nevertheless, there will be a reform, one that undermines central banking.
The public will at some point break the banks by abandoning today's officially sanctioned money system. The central banks will inflate to keep the inflation-induced economic boom alive. The public, through the free market, will eventually abandon the official money system and substitute an alternative monetary unit on its own authority. Mises spelled this out in 1912: "It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown" (TM&C, p. 409). The defenders of central banking have persuaded the public that the great advantage of central banking is "flexible money." The public is going to get flexible money, good and hard.
The banks' self-destruction could also go the other way: mass deflation. Banks at the end of some future trading day may not be able to clear their accounts with each other because of an unforeseen breakdown in the international payments system. They may cease operating because of what Greenspan has called a cascading chain reaction of cross-defaults.
To be sure, we should recognize that if we choose to have the advantages of a leveraged system of financial intermediaries, the burden of managing risk in the financial system will not lie with the private sector alone. As I noted, with leveraging there will always exist a possibility, however remote, of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked. Only a central bank, with its unlimited power to create money, can with a high probability thwart such a process before it becomes destructive. Hence, central banks will of necessity be drawn into becoming lenders of last resort. But implicit in the existence of such a role is that there will be some form of allocation between the public and private sectors of the burden of risk, with central banks responsible for managing the most extreme, that is the most systemically sensitive, outcomes. Thus, central banks have been led to provide what essentially amounts to catastrophic financial insurance coverage. Such a public subsidy should be reserved for only the rarest of disasters. If the owners or managers of private financial institutions were to anticipate being propped up frequently by government support, it would only encourage reckless and irresponsible practices. (Speech, "Understanding today's international financial system," May 7, 1998)http://www.federalreserve.gov/boarddocs/speeches/1998/19980507.htm
Like a juggler with too many oranges in the air at one time, fractional reserve banking looks impressive for a while. Then it fails, taking the division of labor with it. This is the ultimate price of fractional reserve banking: the universally unexpected reduction in the division of labor.
NO OFFICIAL PRICE OF GOLD
Gold does not need an official price because no price needs to be official. An official price is set by government officials. That is the problem with every official price. The great advantage of a free market, gold coin standard is that no government official possesses the legal authority to set an official price for gold.
The classical, government-guaranteed gold standard was never any better than a government's promise to allow the public to redeem gold at an officially fixed price. In every case, governments eventually defaulted.
No defrauded citizen can successfully sue a national government for its having defaulted on its promise to redeem gold at a fixed price, for the courts of the national government regard the national government as legally sovereign, therefore enjoying sovereign immunity from lawsuits that either the politicians or the courts choose not to hear. When an official IOU for gold is issued by a civil government or its licensed agent, the central bank, it is worth the now-used paper that it is printed on. Any value greater than this is the free market's imputed value to the government's promise. In every case, this promise has been broken.
There are a handful of people — only rarely are they academically certified economists — who still call for a restoration of some version of the classical gold standard, or even some version of the central banks' gold-exchange standard. These people are well-intentioned but naive. They look at a system that defaulted in 100% of the cases during the twentieth century, yet they still call for its restoration. They honestly expect to gain a permanent monetary system settlement on their terms from the well-organized enemies of every gold standard, whose power and wealth would be restricted by any gold standard. Mises wrote in 1944, "The gold standard did not collapse. The governments destroyed it" (Omnipotent Government, p. 251). In the face of this historical reality, today's tiny army of true believers who defend a government-guaranteed gold standard tell us, "Next time, it will be different." These people are slow learners.
National central banks now own the people's gold. They are unlikely to surrender this stolen gold until they have to. This "have to" will be imposed, if at all, by some market crisis, not by conventional, pre-crisis politics. Politically, there will be no change that significantly restricts central banks' power over money until the voting public imposes a change. This will not happen until voters not only understand the logic of the free market gold standard but are also ready to make this reform a single issue in their voting behavior.
Today, there is no understanding of the gold standard, classical or free market, especially among economists. The public has forgotten all about a gold coin standard. People have no awareness that the world's central banks stole their grandparents' and great-grandparents' gold coins. There will be no groundswell of political opinion in favor of a free market gold coin standard until there is an economic crisis that forces a reconsideration of monetary policy on the politicians.
Political economic policy is preceded by economic theory. Today, the anti-gold bias of monetary theorists is overwhelming. Every school of economic opinion except the Austrian School believes that a national government should enforce the decisions of its central bank, which establishes and enforces national monetary policy. The only exceptions to this rule are a few internationalists who believe that a world central bank should establish monetary policy for every nation.
ADVICE TO WOULD-BE REFORMERS
Leonard E. Read, the founder in 1946 of the Foundation for Economic Education, used to say that we should postpone our attempts to implement our grand schemes until we have made major progress in our own personal programs of self-education and self-reform. Our reforms should begin at home. I agree.
I have written this little book on Mises's view of money in order to help readers begin to think about the issue of money — in both senses — and help them begin their own programs of intellectual and financial self-improvement. Mises offered a theory of money that was self-consciously based on a theory of individual decision-making. He offered no grand scheme for political reform. He offered only one policy: shrink the State.
Mises presented a comprehensive theory of money which rested on only two legal pillars, both of which have been undermined by modern law: (1) the enforcement of contracts by the civil government; (2) the right of peaceful, non-fraudulent voluntary exchange. His monetary theory was a consistent extension of his theory of the free market. He did not rely on a theory of State regulation of the monetary system, any more than he relied on a theory of State regulation of any other sphere of the economy. He denied the need for such regulation. He showed why such regulation is counter-productive for a society. He recommended only one monetary policy: the State's enforcement of voluntary contracts. That was his recommended economic policy in general. This minimalist theory of civil government makes his theory of money unique in the history of academic economic thought.
Mises's answer to the question, "What kind of money should we have?" was simple: "whatever individuals voluntarily choose to use." He wanted the State to get out of the money business. This included the State's monopolistic agent, the central bank. He offered a comprehensive theory of money that demonstrated that the State does not need to be in the money business in order for a free market social order to prosper. The money system, as is true of the other subdivisions in a free market economy, is part of a self-adjusting, self-correcting system of dual sanctions. These dual sanctions are profit and loss. Money is market-generated. It is also market-regulated. It is a product of consumer sovereignty, not State sovereignty. The State is always an interloper in monetary affairs. The State reduces market freedom and efficiency. The State makes things worse from the point of view of long-term economic stability. So does the State's now-independent step-child, central banking.
This theory of endogenous money is unique to Mises and his followers. No other school of economic opinion accepts it. Every other school appeals to the State, as an exogenous coercive power, to regulate the money supply and create enough new fiat or credit money to keep the free market operational at nearly full employment with nearly stable prices. Every other theory of money invokes the use of the State's monopolistic power to supply the optimum quantity of money. No matter how often some non-Austrian School economist says that he is in favor of the free market, when it comes to his theory of money, he always says, "I believe in the free market, but. . . ." As Leonard Read wrote in 1970, we are sinking in a sea of buts.
When they are not outright collectivists, non-Austrian School economists are defenders of the so-called mixed economy: economic direction to the free market provided by State officials, on pain of punishment. This position is clearest in their universal promotion of non-market, State-regulated, central-bank money. Mises denied that there can be a mixed economy. There are only State directives that affect market operations, in most cases negatively. (Rothbard substituted, "in all cases negatively.")
Mises's theory of money offers hope. The public is in charge, not central bankers. The public will decide what money it prefers and how it will be used. The free market is economically sovereign, not the State. Monetary reform, when it comes, will be imposed from the bottom up.
If what he wrote is true, then we need not waste our time by building reformist sand castles in the air by designing sophisticated, top-down monetary reforms that voters do not understand, politicians do not have time to consider, and central bankers will successfully thwart for not being in their personal self-interest. The free market will triumph without the implementation of our well-intentioned but politically amateurish monetary reform schemes. Mises's theory of money and credit shows us why the central bankers cannot win, just as his theory of economic calculation showed us why Marxist central planners could not win. Unfortunately, it took seven decades of economic losses and about a hundred million needless deaths to confirm his theory.
Here is my advice: do not adopt a theory of money and banking until you understand the free market. Money and banking are not independent of the free market. They are extensions of the free market. When searching for a consistent theory of money, begin with a consistent theory of the free market. Begin here: Human Action, Chapter 15: "The Market," Part 1, "The Characteristics of the Market Economy."
The market economy is the social system of the division of labor under private ownership of the means of production. Everybody acts on his own behalf; but everybody's actions aim at the satisfaction of other people's needs as well as at the satisfaction of his own. Everybody in acting serves his fellow citizens. Everybody, on the other hand, is served by his fellow citizens. Everybody is both a means and an end in himself, an ultimate end for himself and a means to other people in their endeavors to attain their own ends.
This system is steered by the market. The market directs the individual's activities into those channels in which he best serves the wants of his fellow men. There is in the operation of the market no compulsion and coercion. The state, the social apparatus of coercion and compulsion, does not interfere with the market and with the citizens' activities directed by the market. It employs its power to beat people into submission solely for the prevention of actions destructive to the preservation and the smooth operation of the market economy. It protects the individual's life, health, and property against violent or fraudulent aggression on the part of domestic gangsters and external foes. Thus the state creates and preserves the environment in which the market economy can safely operate. The Marxian slogan "anarchic production" pertinently characterizes this social structure as an economic system which is not directed by a dictator, a production tsar who assigns to each a task and compels him to obey this command. Each man is free; nobody is subject to a despot. Of his own accord the individual integrates himself into the cooperative system. The market directs him and reveals to him in what way he can best promote his own welfare as well as that of other people. The market is supreme. The market alone puts the whole social system in order and provides it with sense and meaning.
The market is not a place, a thing, or a collective entity. The market is a process, actuated by the interplay of the actions of the various individuals cooperating under the division of labor. The forces determining the — continually changing — state of the market are the value judgments of these individuals and their actions as directed by these value judgments. The state of the market at any instant is the price structure, i.e., the totality of the exchange ratios as established by the interaction of those eager to buy and those eager to sell. There is nothing inhuman or mystical with regard to the market. The market process is entirely a resultant of human actions. Every market phenomenon can be traced back to definite choices of the members of the market society.
The market process is the adjustment of the individual actions of the various members of the market society to the requirements of mutual cooperation. The market prices tell the producers what to produce, how to produce, and in what quantity. The market is the focal point to which the activities of the individuals converge. It is the center from which the activities of the individuals radiate.
The market economy must be strictly differentiated from the second thinkable — although not realizable — system of social cooperation under the division of labor; the system of social or governmental ownership of the means of production. This second system is commonly called socialism, communism, planned economy, or state capitalism. The market economy or capitalism, as it is usually called, and the socialist economy preclude one another. There is no mixture of the two systems possible or thinkable; there is no such thing as a mixed economy, a system that would be in part capitalist and in part socialist. Production is directed by the market or by the decrees of a production tsar or a committee of production tsars.
If within a society based on private ownership by the means of production some of these means are publicly owned and operated — that is, owned and operated by the government or one of its agencies — this does not make for a mixed system which would combine socialism and capitalism. The fact that the state or municipalities own and operate some plants does not alter the characteristic features of the market economy. The publicly owned and operated enterprises are subject to the sovereignty of the market. They must fit themselves, as buyers of raw materials, equipment, and labor, and as sellers of goods and services, into the scheme of the market economy. They are subject to the laws of the market and thereby depend on the consumers who may or may not patronize them. They must strive for profits or, at least, to avoid losses. The government may cover losses of its plants or shops by drawing on public funds. But this neither eliminates nor mitigates the supremacy of the market; it merely shifts it to another sector (pp. 257-58).
January 26, 2002
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