Thursday, October 28, 2010

What Would Ludwig von Mises Do?

Earlier this week, we had the Cato Institute calling for more inflation based on the arguments of Milton Friedman. Today, WSJ asks, What Would Milton Friedman Do?  Their conclusion:
Friedman would have scoffed at the notion that the Fed is out of ammunition. He believed in the potency of "quantitative easing," or QE—printing money to buy bonds.

"The Bank of Japan can buy government bonds on the open market…" he wrote in 1998. "Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand…loans and open-market purchases. But whether they do so or not, the money supply will increase…. Higher money supply growth would have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately."...The Friedman logic...makes the case for QE2.
This is all true, the public generally doesn't understand that Friedman was an inflationist.

So have there ever been any true inflation fighters? Not many, but a few. Murray Rothbard comes to mind and his great teacher, Ludwig von Mises.

Let's take a look at how Mises might view the current situation.

First, Mises, unlike Friedman and current Fed chairman Ben Bernanke, understood that the printing of money distorts the structure of the economy, In his magnum opus Human Action (first published in 1949 by Yale University Press), he writes:

The notion of "normal" credit expansion is absurd. Issuance of additional fiduciary media, no matter what its quantity may be, always sets in motion those changes in the price structure the description of which is the task of the theory of the trade cycle...banks and the monetary authorities are guided by the idea that the height of interest rates as the free loan market determines it is an evil, that it is the objective of a good economic policy to lower it, and that credit expansion is an appropriate means of achieving this end without harm to anybody but parasitic moneylenders. It is this infatuation that causes them to embark upon ventures which must finally bring about the slump...The objective of credit expansion is to favor the interests of some groups of the population at the expense of others.

Ludwig von Mises

Mises taught us that it was the money manipulated boom that plants the seeds of the downturn, and he understood the damage it does to a society. The real estate boom and bust and the current chaos would not have surprised him:
The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration.
Yet, he wouldn't be surprised that under these conditions, which show the damage that inflation does, organizations like Cato and WSJ would call for more inflation:
Many governments, universities, and institutes of economic research lavishly subsidize publications whose main purpose is to praise the blessings of unbridled credit expansion and to slander all opponents as ill intentioned advocates of the selfish interests of usurers.
So what would Mises do, under current circumstances? This clear writer left us a full blueprint (in 1949!) of what he would do, and also warned us about the inflation advocates such as Cato, Friedman, Berrnanke, Krugman, Mankiw and WSJ:
Out of the collapse of the boom there is only one way back to a state of affairs in which progressive accumulation of capital safeguards a steady improvement of material well-being: new saving must accumulate the capital goods needed for a harmonious equipment of all branches of production with the capital required. One must provide the capital goods lacking in those branches which were unduly neglected in the boom. Wage rates must drop; people must restrict their consumption temporarily until the capital wasted by malinvestment is restored. Those who dislike these hardships of the readjustment period must abstain in time from credit expansion.

There is no use in interfering by means of a new credit expansion with the process of readjustment. This would at best only interrupt, disturb, and prolong the curative process of the depression, if not bring about a new boom with all its inevitable consequences.

...the chief objective of present-day government interference is to intensify further credit expansion. This policy is doomed to failure. Sooner or later it must result in a catastrophe... Continued inflation must finally end in the crack-up boom, the complete breakdown of the currency system.


  1. Excellent post.

    I especially like the quote:

    "Many governments, universities, and institutes of economic research lavishly subsidize publications whose main purpose is to praise the blessings of unbridled credit expansion and to slander all opponents as ill intentioned advocates of the selfish interests of usurers."

    It reminds me of Ross Clark's article in the UK magazine "The Spectator" entitled Savers are Britain's Underclass.

    Politicians always hawk low interest rates in a one sided and partisan way they would never hawk any other price, whether wages, housing prices, you name it.

  2. I believe the authors in the second link are reading Friedman incorrectly, as the CATO writers certainly are. Fortunately many commenters in a related EPJ thread seem to get it.

    Friedman's monetarist views were flawed in positing a) that a government and/or monopoly issuer can be trusted to control the money supply, b) that an issuing authority can maintain the value of money in a manner superior to the discipline enforced by gold (even with its known but non-political deficiencies) and c) that steady growth can be driven by supplying additional money at a controlled rate. Nonetheless, even Friedman would suggest there are limits to how far such course of action from point c) could be pushed. One could not expect, for example, to double the money supply overnight and expect to get reasonable, nondistortionary growth. He would recognize that there are limits.

    Indeed, as observed by Supply-Sider Jude Wanniski (one of the good ones that basically operated in a manner I describe as Austrian light, understanding that low tax/stable money is the correct policy mix but not otherwise questioning government or monopoly issue), the monetarist experiment fails because it does not consider the demand for money as well as the supply. Adding 3% more supply in a given year when demand for it, driven by miserable fiscal/regulatory policy, declines by 7% might lead to a 10% inflation rate (like we saw at times in the late 70s when the Monetarist labcoats got their day in the sun) with all of the Misesian distortions that must inevitably bring about.

    Not many people have the proper appreciation for Austrian Business Cycle Theory (ABCT), I believe including Friedman (though I believe it would be clear to him at extreme levels), but this is only one weakness exhibited by so many professional commentators--among far too many who should know better.

    It goes without saying that you should stop listening the minute anyone starts talking about aggregate demand. What intelligent observers understand is that economic activity is driven by incentives, and the current policy prescription gets the incentives entirely backwards, putting the money cart before the productivity horse. Good Austrians, Supply-Siders, libertarians, and other fellow travellers recognize that implicitly. Everyone else is--to put it politely--confused.

  3. The shame of it is that Friedman, in his free to choose series knew full well what was causing the high inflation of that era.

    He dramatically demonstrated that the cure of inflation was to stop the money printing presses. He even got the treasury (or whoever was printing the money) to allow him to push a red stop button which brought the presses to a halt.

    Friedman was a mystery to me. He wrote about freedom and the problem with government, but thought the answer was to make it more efficient. Maybe he just wanted to be popular with the powers to be. Mises and Rothbard understood what government was. Friedman was, well, a friedmanite fan.

  4. If these old comments from Friedman's former co-author Anna Schwartz are a guide, she, and perhaps Milton too, might not necessarily be the QE-2 boosters that Cato and WSJ claim.

    Schwartz, although not an Austrian, was sounding more and more like an Austrian in her later days. And Friedman's "libertarianism" seemed to become less GOP oriented and closer to "plumb line" and "antiwar" libertarianism than during his younger days.

    It is possible that as beltway insiders both Cato and WSJ may have a stake in repainting their historical legacy.