Bernanke Attacks Austrian School Economics: Crazy Opinons

FT's Martin Wolf recently had lunch in Chicago with former Fed chairman Ben Bernanke, who is still on the road hustling his book, The Courage to Act: A Memoir of a Crisis and Its Aftermath.

During the lunch, Wolf asked Bernanke about critics who argue that the Fed shouldn't have intervened in the downturn, that the downturn would have been self-cleansing.The only economic school to hold this view is the Austrian School.

Wolf and Bernanke don't mention at their lunch the Austrian school by name, but that certainly is the school of thought they are discussing.

Here's the exchange:

Other critics argue, I note, that the Fed’s intervention prevented the cathartic effects of a proper depression. He teases me by responding that I have a remarkable ability to keep a straight face while recounting what he clearly considers crazy opinions.

I add that many critics still expect hyperinflation any day now. “Well, we were quite confident from the beginning there would be no inflation problem. And, of course, the greater problem has been getting inflation up to target. As for allowing the economy to go into collapse, this is the Andrew Mellon [US Treasury secretary] argument from the 1930s. And I would think that, certainly among mainstream economists, it has no credibility. A Great Depression is not going to promote innovation, growth and prosperity.”

I cannot disagree, since I also consider such arguments mad. Nevertheless, I note, we have to recognise that neither he nor the Fed expected the meltdown.

Actually, as Murray Rothbard and Robert Higgs have both pointed out, the Great Depression was not prolonged because of monetary policy but because of other government policies that did not permit the economy to self-cleanse.

Bottom line: Bernanke's distortion machine was working well in Chi-town. His "book" tour seems to be as much about dissing Austrian economics and gold, then it is about promoting his book. He fears the Austrians.

-RW

A Used Book Dealer on Paul Krugman

Yesterday, I picked up a mint condition copy of Toward Liberty: Essays in Honor of Ludwig Von Mises on the Occasion of His 90th Birthday, from a used book dealer.

I talked to the proprietor for a bit and he told me that books by Ludwig von Mises, Friedrich Hayek and Murray Rothbard, he liked to carry. While he did have familiarity with these Austrian school economists by name, it didn't seem that he had any in depth knowledge of their theories.

Then, out of the blue, he said to me, "I carry Mises. Rothbard and Hayek, but I don't carry Paul Krugman. Krugman seems to just write about current hot topics and then interest in his books fades."

Murray Rothbard: Hayek & His Lamentable Contemporaries

Clueless Santorum Tries to Copy Ron Paul

Rick Santorum is out with a new economic plan that includes a call for:

[An]  audit of the Federal Reserve and return to it’s original purpose – a single charter to only manage inflation.

Sound familiar? He is trying to grab from Ron Paul's playbook by calling for an audit of the Fed, but has no clue that the original purpose of the Fed was just as bad as what the modern day Fed has morphed into. It makes no sense to return to the original purpose of the Fed The Fed was founded to create inflation. As Murray Rothbard wrote in The Mystery of Banking:

The new Federal Reserve System was deliberately designed as  an engine of inflation, the inflation to be controlled and kept uniform by the central bank.

This management of inflation causes the boom-bust cycles that we see in the economy. Rothbard again:

[New York Fed Governor Benjamin] Strong pursued an inflationary policy throughout his reign, first during World War 1, and then in spurts of expansion of the bank reserves in the early 1920s, 1924 and 1927...With the Federal Reserve System established and in place after 1913, the remainder of the road to the present may be quickly sketched.....Fed inflation led to the boom of the 1920s and the bust of 1929...

This is what Santorum wants to return to?

Ron Paul is calling for an audit, because the Fed has been up to even more mischief since its founding, but this in no way means that he wants to bring the Fed back to simply its original purpose of inflating the money supply and causing the boom-bust cycle.

Santorum's call for a return to just the original purpose of the Fed shows just how clueless he is about the subject.

He is basically saying, "Let's return the Fed to the days when it created the boom-bust cycle that ended up creating the Great Depression."

Scary.

A Rejoinder to John Carney on MMT and Austrian Economics

CNBC's John Carney has responded to my earlier comments on his favorable view of Modern Monetary Theory.

In his response, Carney writes:

The MMTers believe that the modern monetary system—sovereign fiat money, unlinked to any commodity and unpegged to any other currency—that exists in the United States, Canada, Japan, the UK and Australia allows governments to operate without revenue constraints. They can never run out of money because they create the money they spend.

Here is problem one with Carney's view of MMT. MMTers do not hold that all fiat money is the same. Although they object to Federal Reserve notes, they see no problem with a fiat currency being issued they call "US notes".

Here is MMTer  Bill Still, who is seeking to become the Libertarian Party presidential nominee:

A sovereign nation does not have to borrow, in fact, being debt-free is the very definition of sovereignty. Pay off the existing bonds -- which is our National Debt -- as they come due, but pay them off with debt free U.S. Notes (or their electronic equivalents) instead of Federal Reserve Notes, which are all borrowed into existence.

Here is MMTer Cullen Roche on fiat money:

Money is always created by the state and must therefore be regulated by the state; however, ultimately the private sector must accept this legal tender as the currency unit. Therefore, the private and public sectors should best be thought of as being in partnership with one another and not opposing forces.

Thus, when Carney tries to give the impression that MMTers and Austrians have a lot in common, he is just wrong. Austrians reject the idea that a fiat money of any sort is necessary in a highly industrialized economy (and any other type economy). A gold coin standard could function much better in the eyes of Austrians. A government couldn't inflate a gold standard at will, further the Austrians see no need to ever inflate a currency, unlike MMTers.

Here's Roche again:

The economy is a complex dynamical system with irrational participants. It cannot be expected to regulate itself or behave rationally at all times. Therefore, some level of government intervention and involvement is not only beneficial, but necessary

An Austrian simply doesn't see the world this way, where "irrational participants" occur on such a scale that they must be counteracted by government. An Austrian would first ask, if there are so many "irrational participants" who is to say they aren't in government also? Remember, before the real estate crisis, it was Fed chairman Bernnake who said there was no problem with the real estate market.

Secondly, Austrians would argue that the "cluster of errors"s made because of fiat currency creation are what cause the boom-bust cycle and that without fiat money creation no such "cluster of errors" would occur. Thus, the Austrian position here is diametrically opposed to the MMT view that there are times when monetary inflation is called for.

Carney writes:

The MMTers think the financial system tends toward crisis. Wenzel writes that the financial system doesn’t tend toward crisis. But a moment later he admits that the actual financial system we have does tend toward crisis. All Austrians believe this, as far as I can tell.

What has happened here is that Wenzel is now the one confusing the world as it is with the world as he wishes it would be. Perhaps under some version of the Austrian-optimum financial system—no central bank, gold coin as money, free banking or no fractional reserve banking—we wouldn’t tend toward crisis. But that is not the system we have.

The MMTers aren’t engaged with arguing about the Austrian-optimum financial system. They are engaged in describing the actual financial system we have—which tends toward crisis.

They even agree that the tendency toward crisis is largely caused by the same thing, credit expansions leading to irresponsible lending.

If I say that automobiles don't tend to drive off cliffs, but if I am looking at a baby that is behind the driving wheel of a car that is about to go off a cliff and I say, "Hey, that car is about to go off a cliff." It doesn't in anyway mean that I am saying all cars will go off cliffs.

In the same way, the financial system, like a car, does not have a tendency to drive off a cliff. If the Fed prints money it may go off a cliff, just as a car may go off a cliff when driven by a baby. My solution for the cars being driven by babies is to stop the babies from driving cars, for the economy, it is to stop the Fed from driving the economy. To say that I should just deal with the reality of a baby driving a car and hop in the back seat, makes no sense. Anymore than it makes sense, when arguing monetary policy, to say hey just deal with the Fed's inflationary boom-bust ways.

Carney then writes:

The MMTers say that “capitalist economies are not self-regulating.” Again, Wenzel dissents. But if we read “capitalist economies” as “modern economies with central banking and interventionist governments” then the point of disagreement vanishes.

John, puhleeze. Of course, if you define capitalism to mean, well, the exact opposite of capitalism "the point of disagreement vanishes."

Carney writes:

Wenzel’s challenge to the idea of functional finance is untenable—and not particularly Austrian. He argues that the subjectivity of value means it is impossible for us to tell whether something is “good for the economy.” Humbug.

I should first note that I specifically state that I am referencing how "fiscal policy should be measured" Indeed, I further write:

Thus, it is extremely dangerous to go around talking about what is "good for the economy", especially when you are talking fiscal policy.

Far from this being "not particularly Austrian", it is at the heart of the Austrian view that subjective value can not be measured in the pubic sector ( as opposed to the private sector where exchange tales place voluntarily between two individuals). Indeed, the Austrian economist Murray Rothbard, even suggested that ALL government spending is a negative that should be subtracted from GDP:.

..most of the resources consumed by the maw of government have not even been seen, much less used, by the consumers, who were at least allowed to ride in their buggies. In the private sector, a firm's productivity is gauged by how much the consumers voluntarily spend on its product. But in the public sector, the government's "productivity" is measured—mirabile dictum—by how much it spends! Early in their construction of national product statistics, the statisticians were confronted with the fact that the government, unique among individuals and firms, could not have its activities gauged by the voluntary payments of the public—because there were little or none of such payments. Assuming, without any proof, that government must be as productive as anything else, they then settled upon its expenditures as a gauge of its productivity. In this way, not only are government expenditures just as useful as private, but all the government need to do in order to increase its "productivity" is to add a large chunk to its bureaucracy. Hire more bureaucrats, and see the productivity of the public sector rise! Here, indeed, is an easy and happy form of social magic for our bemused citizens.

The truth is exactly the reverse of the common assumptions. Far from adding cozily to the private sector, the public sector can only feed off the private sector; it necessarily lives parasitically upon the private economy. But this means that the productive resources of society—far from satisfying the wants of consumers—are now directed, by compulsion, away from these wants and needs. The consumers are deliberately thwarted, and the resources of the economy diverted from them to those activities desired by the parasitic bureaucracy and politicians. In many cases, the private consumers obtain nothing at all, except perhaps propaganda beamed to them at their own expense. In other cases, the consumers receive something far down on their list of priorities—like the buggies of our example. In either case, it becomes evident that the "public sector" is actually antiproductive: that it subtracts from, rather than adds to, the private sector of the economy. For the public sector lives by continuous attack on the very criterion that is used to gauge productivity: the voluntary purchases of consumers.

We may gauge the fiscal impact of government on the private sector by subtracting government expenditures from the national product. For government payments to its own bureaucracy are hardly additions to production; and government absorption of economic resources takes them out of the productive sphere. This gauge, of course, is only fiscal; it does not begin to measure the anti-productive impact of various government regulations, which cripple production and exchange in other ways than absorbing resources. It also does not dispose of numerous other fallacies of the national product statistics.

Carney may, or may not, agree with this view, but he must agree that it is distinctly Austrian and not in line with MMT thinking.

Carney concludes by stating:

At the level of theory, Austrians and MMTers have a lot in common. Tactically, an alliance makes sense.

I just don't see where the Austrians and MMTers have much in common at all. And, a tactical alliance with a group that is in favor of creating a new fiat money, to replace the current fiat money, seems to be of little value to Austrians. More than anything, there is great educational value in pointing out the important differences between MMTers and Austrians.

Murray Rothbard and Third Parties

Murray Rothbard

By Robert Wenzel

As part of the recent attacks on Ron Paul, some have raised the point that attempts were made to reach out to various right wing groups. Murray Rothbard was probably influential with these attempted alliances, although I'm not sure how seriously he took them himself. In addition to being a genius, making major contributions in economics, history, political philosophy and legal theory, he had a bug for third party politics.

At times, approaches to right wing groups were made, but Rothbard also once endorsed Norman Mailer for Mayor of New York City and at another time called for William Kunstler to be freed from jail.

A Presidential Role Model

Murray Rothbard on the least bad president and why.

More Krugman Konfusion

Paul Krugman wrote recently in a post at the NYT:

OK, strictly speaking the time hasn’t run out — we could, I guess, see an explosion of inflation next year. But with commodity prices down, wages going nowhere, and the dollar actually strengthening against other currencies, it’s kind of hard to see where that’s supposed to come from.

Look, the Austrian/Ron Paul types made some very strong predictions about inflation — and rightly, given their model of how the world works. In their version of reality, it really isn’t possible to triple the monetary base without dire effects on the price level. In my version of reality, of course, that’s not only possible but what the model predicts in a liquidity trap.

So since we did indeed triple the monetary base with nothing much happening to inflation, the right lesson to draw is that their model is all wrong.

This is simply wrong. There is no Austrian economist that has contributed to the development of Austrian business cycle theory, who discussed the monetary base as the figure to watch in determining price inflation . In the camp of contributors, I include Ludwig von Mises, Friedrich Hayek and Murray Rothbard.

Indeed, Rothbard even understood the dangers of looking just at the monetary base, before Fed chairman Bernanke started paying interest on reserves. In his book, The Mystery of Banking, Rothbard wrote:

The numerous problems of new bank instruments and how to classify them, as well as the multifarious Ms, have led some economists, including some monetarists, to argue quite sensibly that the Fed should spend its time trying to control its own liabilities rather than worrying so much about the activities of the commercial banks. But again, more difficulties arise. Which of its own actions or liabilities should the Fed try to control? The Friedmanite favorite is the monetary base...Looking at the aggregate figure of the monetary base cloaks significant changes in the banking picture.

If Rothbard was suspicious of the monetary base, as a means for measuring money supply, before the advent of interest being paid on reserves, he most assuredly would be even more suspicious now.

Now, in the post, Krugman references Peter Schiff, but I consider Schiff a popularizer of Austrian theory and not someone who has expanded thinking in the area of business cycle theory. I don't listen or read Schiff that much, perhaps Krugman does, so maybe he has heard Schiff say something about the monetary base. But those that developed Austrian business cycle theory never focused on the monetary base. Indeed, in the quote above, Rothbard disses Friedmanite focus on the monetary base.

In other words, Krugman just doesn't know what the hell he is talking about.

As for the Austrian School view on what causes price inflation, I am writing up a full commentary on that which I will most likely publish on Monday, so I won't get into that here.

Brad DeLong: I Have Been Wrong, Wrong, Wrong....

Brad DeLong lists at his blog eleven things that he has "gotten really, really wrong so far" in his career.

I think many of his new views as implied by what he says he got wrong are wrong also, but there are 3 where I agree, at least in part, that he now sees the world more clearly.He writes:

My belief that central banks had the tools, the skill, and the political will to stabilize economies at high levels of employment and low levels of inflation...

In the above wrong, he goes on to talk nonsense about the necessity for fiscal policy to fix what he thought the Fed could fix and now realizes he was wrong about. But, it is good to see that at least he doesn't see the Fed as God, anymore.

Another wrong he lists is:

Walking in the Cinders of Ayn Rand

There's a funny musical video now circulating (see below) on the internet that was originally published in December 2008. Both the Big Picture and Naked Capitalist have posted it. It's about Alan Greenspan, as Fed chairman and his relationship with Ayn Rand.

Unfortunately, the production mis-states a few facts. It charges Greenspan with being for self-regulation, against government oversight and a libertarian. This is an absurd case to make since Greenspan was head of the Federal Reserve, which is all about government mass manipulation of the economy. This is about as far as you can get from government non-interference.

Barbara Walters, who was dating Alan Greenspan when he took the position as Fed chairman got this. In her book, Audition, she writes:

How Alan Greenspan, a man who believed in the philosophy of little government interference and few rules or regulations, could end up becoming chairman of the greatest regulatory agency in the country is beyond me. It was a big issue when Alan was first appointed...

Greenspan  has never been noyhing but a tool of the interventionist establishment elitists. This becomes clear from an understanding of who Greenspan's "friends" really were.

He writes in his memoir, The Age of Turbulence:

Even so, I did build up a wonderful circle of friends, Barbara [Walters] threw me a fiftieth birthday party. The guests were people I'd come to think of as my New York friends: Henry and Nancy Kissinger, Oscar a, Henry and Louise Grunwald and David nd Annette de la Renta, Felix and LIz Rohatyn, Punh and Carol Sulzberg Henry and Louise Grunwald and David Rockefeller. I am still friendly with many of these people today,more than thirty years later.

Rockefeller, Rohatyn, Sulzberg? How much more establishment can you get?

Murray Rothbard was unlikley to have known who Greenspan had as his "NYC friends", but as usual Rothbard instincts were right on. In 1987, he wrote:

Greenspan’s real qualification is that he can be trusted never to rock the establishment’s boat. He has long positioned himself in the very middle of the economic spectrum.

As for the Greenspan relationship with Rand and what that meant for Greenspan in terms of realeconomik, Rothbard had that nailed also:

There is one thing, however, that makes Greenspan unique, and that sets him off from his Establishment buddies. And that is that he is a follower of Ayn Rand, and therefore “philosophically” believes in laissez-faire and even the gold standard. But as the New York Times and other important media hastened to assure us, Alan only believes in laissez-faire “on the high philosophical level.” In practice, in the policies he advocates, he is a centrist like everyone else because he is a “pragmatist.”

As an alleged “laissez-faire pragmatist,” at no time in his prominent twenty-year career in politics has he ever advocated anything that even remotely smacks of laissez-faire, or even any approach toward it. For Greenspan, laissez-faire is not a lodestar, a standard, and a guide by which to set one’s course; instead, it is simply a curiosity kept in the closet, totally divorced from his concrete policy conclusions.

Thus, Greenspan is only in favor of the gold standard if all conditions are right: if the budget is balanced, trade is free, inflation is licked, everyone has the right philosophy, etc. In the same way, he might say he only favors free trade if all conditions are right: if the budget is balanced, unions are weak, we have a gold standard, the right philosophy, etc. In short, never are one’s “high philosophical principles” applied to one’s actions. It becomes almost piquant for the Establishment to have this man in its camp.

Krugman Calls for More Inflation but Disses Those who Bring up Zimbabwe or Weimar

There's nothing like ending a work week with Paul Krugman calling for a good dose of inflation. At 5:18 PM, probably before heading out to a "Pass the canned tuna, you can't eat gold, meeting", he posted this call for inflation (and, btw, doubled-down on his view that we are currently under "depression conditions")

One thing I often see in comments is people attributing to me, or to others, the notion that you can inflate your way to prosperity — which is presented as self-evidently absurd.

Well, if you think that it’s self-evidently absurd, you’ve been listening to the wrong people.

Nobody thinks that an economy operating somewhere near full employment can inflate its way to higher output. But under depression conditions — which is what we have now — inflation is very much a positive thing.

This is a tired warn out model of a trade-off between inflation and unemployment. That is Krugman is still using the Phillips curve to defend his call for inflation. The damn thing was discredited decades ago. Here's Murray Rothbard, years ago, on the absurdity of the thing:

Every time someone calls for the government to abandon its inflationary policies, establishment economists and politicians warn that the result can only be severe unemployment. We are trapped, therefore, into playing off inflation against high unemployment, and become persuaded that we must therefore accept some of both.

This doctrine is the fallback position for Keynesians. Originally, the Keynesians promised us that by manipulating and fine-tuning deficits and government spending, they could and would bring us permanent prosperity and full employment without inflation. Then, when inflation became chronic and ever-greater, they changed their tune to warn of the alleged tradeoff, so as to weaken any possible pressure upon the government to stop its inflationary creation of new money.

The tradeoff doctrine is based on the alleged "Phillips curve," a curve invented many years ago by the British economist A.W. Phillips. Phillips correlated wage rate increases with unemployment, and claimed that the two move inversely: the higher the increases in wage rates, the lower the unemployment. On its face, this is a peculiar doctrine, since it flies in the face of logical, commonsense theory. Theory tells us that the higher the wage rates, the greater the unemployment, and vice versa. If everyone went to their employer tomorrow and insisted on double or triple the wage rate, many of us would be promptly out of a job. Yet this bizarre finding was accepted as gospel by the Keynesian economic establishment.

By now, it should be clear that this statistical finding violates the facts as well as logical theory. For during the 1950s, inflation was only about one to two percent per year, and unemployment hovered around three or four percent, whereas later unemployment ranged between eight and 11%, and inflation between five and 13 %. In the last two or three decades, in short, both inflation and unemployment have increased sharply and severely. If anything, we have had a reverse Phillips curve. There has been anything but an inflation- unemployment tradeoff.

In his post, Krugman has pretty much banned anyone who brings up the dangers of hyperinflation (since he only wants to inflate a "little"):

...you get an immediate failing grade if you start ranting about Zimbabwe or Weimar.

But how is Krugman going to deal with Rothbard's correct attack on the Phillips curve itself?

Parallel Lives: Liberty or Power?

Lew Rockwell has written a must read article that contrasts the life of Murray Rothbard and Alan Greenspan.

Rockwell captures the essence of these two men. At one point, Rockwell writes:

As for Rothbard's own character, the contrast with Greenspan could not be starker. If Greenspan was the dreary undertaker, Rothbard was the happy warrior. Rothbard thrilled to spend time with students and faculty and anyone interested in liberty. When you spoke to him, he was glad to talk about the field of interest that was the other person's specialization. Whether it was history, philosophy, ethics, economics, politics, religion, Renaissance painting, music, sports, Baroque church architecture, or even the soaps on TV, he always made others feel more important.

I met Greenspan once at a conference in Berlin. His hand shake was like shaking a cold dead fish. There was no life to the man. He did not appear to hold any excitement in him about anything.  The undertaker, indeed. Rand nailed him.

I also had the opportunity to meet personally with Rothbard on two occasions (and saw him at perhaps three conferences.) What a contrast. He was full of life and you quickly learned that, with every laugh and comment he made, came an observation about the world that you realized no one else had ever pointed out.

I can recall a conference in California, where a bunch of economists and economics students were sitting around a bit bored when one of the economists blurted out, "Where's Murray?" Everyone knew that meant that with Murray around the excitement and energy would return to the room.

Rothbard seemed to carry around an incredible energy and knowledge that spewed from him like a volcano in full eruption.  

The Rockwell piece is here.

Ludwig von Mises on the Meaning and Significance of Deflation

After Richard Ebeling sent the letters from the Cambridge vs LSE debates, we had the following email exchange:

Wenzel: I note that Hayek comes out against deflation. I think it is pretty clear that Murray Rothbard would not be against such deflation. I'm curious if in your readings you have come across Mises anywhere explicitly stating his view on deflation? Do you think he would be in the Hayek or Rothbard camp?

Ebeling: We need to distinguish between "price deflation" and "monetary deflation."

Ludwig von Mises argued that falling prices due to growth in the economy (technological innovations, productivity improvements, increases in the supplies of the factors of production, etc.) that lowered costs of production and expanded the general supply of goods and services in the market was not in anyway harmful. Indeed, this could be considered one indicator of economic progress. It enables consumers to buy more with their given money incomes as a result of the increased purchasing power of the monetary unit.

And this particular analysis of a "supply-side" generated decline in the general "scale of prices" (price deflation) has been a hallmark of "Austrian" monetary theory and policy analysis since the 1920s. It is one that was shared in the 20th century by other Austrian Economists, including F. A. Hayek, Gottfried Haberler, Fritz Machlup, and Murray N. Rothbard, to name a few of the "older" Austrians. Among the more recent Austrians or Austrian-oriented economists, this view of price deflation has been defended by Lawrence H. White and George Selgin with great cogency, and many other "younger" Austrians.

Mises, however, was not in favor of an active government policy of contracting the money supply (a monetary deflation). His writings from the 1920s throughout the rest of his life make it very clear that he was not a "monetary deflationist." He pointed out that if a man is run over by a car and seriously hurt, you do not make his condition better by putting the car in reverse and running over him again. (See, Ludwig von Mises, 'The Non-Neutrality of Money' [1938] in Richard M. Ebeling, ed., "Money, Method, and the Market Process: Essays by Ludwig von Mises" (Mises Institute, 1990) p. 76.)

An monetary inflation generates a series of distortions and imbalances in the market. These distortions and imbalances are not set right by then intentionally contracting the money supply. In Mises' view, this merely, and inescapably, superimposes a new series of distortions and imbalances as a result of the monetary deflation.

Thus, when he wrote on or was questioned at lectures about the best means to, say, return to a gold standard, Mises never proposed contracting the money supply to return to the former pre-inflation purchasing power (a lower "price level") to restore the original parity or exchange rate between the currency unit and gold.

He argued that it was best for the monetary authority to stop any further increase in the supply of money and credit, allow the market a period of time to stabilize and determine, on an unregulated and free gold market, the post-inflation parity or exchange rate between the depreciated monetary unit and gold. Then, when the market had decided what that ratio of exchange should be based on overall supply and demand conditions, the monetary authority should declare that as the new official rate of redemption at which a unit of gold will be exchanged for a given quantity of the currency in circulation. This becomes the basis of a new legal gold standard.

To try to return to the pre-inflation gold-currency redemption rate for a reestablished, legal gold standard would necessitate dragging the domestic market and its structure of relative prices and wages down to a much lower scale (or general level) of prices to bring the internal market into balance with such a restored external value of the monetary unit.

On this point, Mises followed Carl Menger, the founder of the Austrian School. Menger was a participant in the deliberations that lead to the establishment of a gold standard in Austria-Hungary in 1892. In some of his writings, Mises quoted from and agreed with Menger's recommendation at that time that the new legal redemption rate between gold and the new Austrian "crown" should be established at the rate set by the market, and not artificially imposed at an exchange rate either higher or lower than this. To do so would only impose unnecessary adjustments and hardships on various sectors of the Austrian economy.

(See, for example, Ludwig von Mises, 'The Political-Economic Motives of the Austrian Currency Reform' [1907] in Richard M. Ebeling, "Selected Writing of Ludwig von Mises," Vol. 1: "Monetary, Fiscal, and Economic Policy Problems Before, During, and After the Great War" (Indianapolis: Liberty Fund, forthcoming, 2011).

However, Mises did believe that due to fractional reserve banking, during a period of an expansion of money and credit, the structure of relative prices and wages (and the allocation of labor and capital among alternative productive uses) will have been both distorted and pushed up to a general scale or level that will need correction. Once an monetary inflation had been brought to an end, the "discovery" of misdirected resources and malinvested capital that are unsustainable in the post-inflation market environment will necessitate a "rebalancing" of both the structure of relative prices and wages and the reallocation of labor, capital and other resources to reflect the post-boom reality of actual supply and demand conditions.

At the same time, part of the credit expansion induced by the increase in the monetary reserves within the banking system (and which has had a "multiplier" effect on bank credit due to fractional reserve banking) will likely contract as investment borrowers face some losses and bank depositors withdraw money from their accounts.

Thus, a degree of price deflation may be inevitable as an integral part of the readjustment of outstanding bank credit in the post-boom period. Mises occasionally, in his writings, makes the historical observation that this has been a pattern in the past once the business cycle is in its "downturn" phase.

What Mises did think can and had generated an unnecessary "cumulative" general decline in prices and wages, were rigidities in the structure of relative prices and wages. Thus, when selling prices are having to be adjusted (downwards) to a new "market clearing" level in the post-boom period, money wages were often "rigid" or inflexible in adapting to the new market environment due to government intervention or trade union resistance to accepting reductions in money wages to bring the cost of labor more into line with the lower prices at which goods that labor assists in producing could be sold for.

Falling employment due to money wage inflexibility reduces the unemployed's ability to buy goods, and the same cycle begins again. But the problem, Mises was adamant in emphasizing, is not a short-fall in anything called "aggregate demand" (as the Keynesians argued) but a failure for appropriate adjustments in the structure of money wages to the new relevant post-boom structure (and level) of goods prices to restore a sustainable and profitable pattern of wage costs relative to selling prices.

(See, for example, Ludwig von Mises, 'The Economic Crisis and Capitalism,' [1931] in 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) pp. 169-173.)

Thus, Ludwig von Mises, to a certain extent, would be somewhere in between either Hayek or Rothbard on the meaning and policy relevance of price deflation or monetary deflation.

Wenzel: Thanks for a great exposition. I want to push you a bit further on the point, though.

It appears that Hayek in the letter is referring specifically to price deflation, not caused by growth, but by hoarding. This I would argue is part of what is occurring in today's economy.

Since I am travelling, I don't have reference to my library, but, if I recall correctly, Rothbard explicitly stated that he has no problem with price deflation caused by hoarding--which appears to be in opposition to what Hayek signed as part of the LSE group.

I don't recall Mises ever discussing the hoarding that tends to go on during the down phase of a business cycle and am wondering if you recall doing os and if so, on this particular type of price deflation (from hoarding especially during the down phase of the business cycle), does he take the Hayek view or the Rothbard view.

Also, do you agree that Hayek's view may suggest money printing as a remedy--since he does see hoarding price deflation as a problem?

Ebeling: Mises is ambiguous on the issue of "hoarding" in the downturn. And never, to the best of my knowledge, addresses directly in the way you are asking about.

But from "reading between the lines" (if I may), I would suggest that he considers such an "abnormal" rise in the demand to hold cash balances ("hoarding") inevitable once the "crisis" emerges. General uncertainty, wanting to hold on to cash in the face of falling sales to have the means to meet financial obligations, etc., one of the side effects of the discovery of investment and pricing errors, and transition to a rebalancing as part of the adjustment process. That this may result in further downward pressure on prices in general is part of the process, as individuals attempt to grope their individual ways toward re-coordination of in the market.

He would NOT consider any attempt to "reflate" the supply of money and credit to "prop" prices up as a stabilizing step in the face of falling prices either resulting from the rebalancing to re-coordination or as a "solution" to the rigidity of various wages and prices that are retarding the adjustment process. Rather, it would run the risk of setting in motion a new wave of malinvestments and and unsustainable employments in various sectors of the economy. Furthermore, it would generate even more wasted capital in wrongly invested capital projects that will, then, mean even lower wages for workers due to a resulting lower marginal productivity of labor as a byproduct of squandering scarce capital.

Somebody Please Send to the Brokers Testifying Today...

The Mystery of Banking by Murray Rothbard.

These guys have no understanding of the business cycle and the primary role of the Federal Reserve in causing the business cycle. If they did, they would be able to turn the questions around by the Senators  about whether Goldman played a role in the financial crisis.

The business cycle is always a first and foremost a monetary phenomena, once you understand this, it doesn't matter what Goldman Sachs is doing, it's pretty easy to spot the crisis coming.

 

Understanding Just How Dangerous a Value-Added Tax Is

By Murray N. Rothbard

This originally appeared in Human Events, March 11, 1972.

One of the great and striking facts of recent months is the growing resistance to further taxes on the part of the long-suffering American public. Every individual, business, or organization in American society acquires its revenue by the peaceful and voluntary sale of productive goods and services to the consumer, or by voluntary donations from people who wish to further whatever the group or organization is doing. Only government acquires its income by the coercive imposition of taxes. The welcome new element is the growing resistance to further tax exactions by the American people.

In its endless quest for more and better booty, the government has contrived to tax everything it can find, and in countless ways. Its motto can almost be said to be, "If it moves, tax it!"

Every income, every activity, every piece of property, every person in the land is subject to a battery of tax extortions, direct and indirect, visible and invisible. There is of course nothing new about this; what is new is that the accelerating drive of the government to tax has begun to run into determined resistance on the part of the American citizenry.

It is no secret that the income tax, the favorite of government for its ability to reach in and openly extract funds from everyone's income, has reached its political limit in this country. The poor and the middle class are now taxed so heavily that the federal government, in particular, dares not try to extort even more ruinous levies.

The outraged taxpayer, after all, can easily become the outraged voter. How outraged the voters can be was brought home to the politicians last November, when locality after locality throughout the country rose in wrath to vote down proposed bond issues, even for the long-sacrosanct purpose of expanding public schools.

Defeat in New York

The most heartening example – and one that can only give us all hope for a free America – was in New York City, where every leading politician of both parties, aided and abetted by a heavily financed and demagogic TV campaign, urged the voters to support a transportation bond issue. Yet the bond issue was overwhelmingly defeated – and this lesson for all of our politicians was a sharp and salutary one.

Finally, the property tax, the mainstay of local government as the income tax is at the federal level, is now generally acknowledged to have a devastating effect on the nation's housing. The property tax discourages improvements and investments in housing, has driven countless Americans out of their homes, and has led to spiraling tax abandonments in, for example, New York City, with a resulting deterioration of blighted slum housing.

Government, in short, has reached its tax limit; the people were finally saying an emphatic "No!" to any further rise in their tax burden. What was ever-encroaching government going to do? The nation's economists, most of whom are ever eager to serve as technicians for the expansion of state power, were at hand with an answer, a new rabbit out of the hat to save the day for Big Government.

They pointed out that the income tax and property tax were too evident, too visible, and that so are the generally hated sales tax and excise taxes on specific commodities. But how about a tax that remains totally hidden, that the consumer or average American cannot identify and pinpoint as the object of his wrath? It was this deliciously hidden quality that brought forth the rapt attention of the Nixon administration, the "Value Added Tax" (VAT).

The great individualist Frank Chodorov, once an editor of Human Events, explained clearly the hankering of government for hidden taxation:

It is not the size of the yield, nor the certainty of collection, which gives indirect taxation [read: VAT] preeminence in the state's scheme of appropriation. Its most commendable quality is that of being surreptitious. It is taking, so to speak, while the victim is not looking.

The VAT is essentially a national sales tax, levied in proportion to the goods and services produced and sold. But its delightful concealment comes from the fact that the VAT is levied at each step of the way in the production process: on farmer, manufacturer, jobber and wholesaler, and only slightly on the retailer.

The difference is that when a consumer pays a 7 percent sales tax on every purchase, his indignation rises and he points the finger of resentment at the politicians in charge of government; but if the 7 percent tax is hidden and paid by every firm rather than just at retail, the inevitably higher prices will be charged, not to the government where it belongs, but to grasping businessmen and avaricious trade unions.

While consumers, businessmen, and unions all blame each other for inflation like Kilkenny cats, Papa government is able to preserve its lofty moral purity, and to join in denouncing all of these groups for "causing inflation."

It is now easy to see the enthusiasm of the federal government and its economic advisers for the new scheme for a VAT. It allows the government to extract many more funds from the public – to bring about higher prices, lower production, and lower incomes – and yet totally escape the blame, which can easily be loaded on business, unions, or the consumer as the particular administration sees fit.

The VAT is, in short, a looming gigantic swindle upon the American public, and it is therefore vitally important that it not pass. For if it does, the encroaching menace of Big Government will get another, and prolonged, lease on life.

Read the rest here.