We Should All Be Misesians Now


After several centuries of experimentation with boom-and-bust monetary and fiscal policies, we need to give the Austrian school a chance.


Free market capitalism is under assault. Framed as the culprit for the global financial crisis by the popular media, politicians and ideological opportunists alike, who expediently blame the United States for igniting the crisis. The irony is that we haven’t had true free market capitalism in the U.S. for a very long time. Plagued with recurring financial panics, recessions and downright depressions, the real culprit is the federal government management of money and credit that is quite antithetical to free markets.

Article I, Section 8 of the U.S. Constitution clearly gives Congress the enumerated right “To coin money, regulate the value thereof…” But in 1913, Congress decided to outsource monetary management to the Federal Reserve Banking System. And it did so for purely political reasons [1-4]: to charter an ‘independent’ body with the power to print paper money when the needs of government or special interests arose. More to the point: to finance government debt and perpetuate government spending habits; to rescue banks that become illiquid and insolvent due to risk mismanagement and/or instabilities in a fractional reserve banking system; and most insidiously, to inject inflation into the economy when prices fall below a certain point (price controls). None of these actions belong to free market measures in a capitalist society.

The stark reality is that the U.S. abandoned free market principles when it adopted fiat currency manipulation strategies and promoted a fractional reserve banking system that lends out many more dollars than exist in real deposits. A fiat currency (e.g., U.S. Dollar, Euro, Sterling, Yen) by itself is not the problem; it is the abusive government regulation of the value of the fiat currency that is anti-free market. Purposefully driving interest rates to zero instead of allowing for market determination of rates is anti-free market manipulation. Likewise, lending money created from thin air instead of from a rational measure of deposits undermines the supply and demand of resources that are natural to a free market and distorts healthy business cycles, not to mention the high risk of high leverage if loans default. The U.S. did not invent this brand of money and credit misregulation – it was adopted from millennia of central banking history in Britain and Europe [1,5,6]. The U.S. has become perhaps uniquely addicted to the easy money and credit binges promoted by our central bank, the Fed – especially since demand for Treasurys by foreign creditors (i.e., China and Japan) is limited. Runaway government spending, off-balance sheet entitlement liabilities and easy credit promises made to voters have throttled this modus operandi. And the crony capitalism of government welfare (bailouts, “subsides”) to large corporations and financial institutions has only made the addiction worse.

Consider the following basic examples to further illustrate. In a free market, interest rates are set by the supply and demand of the market, not artificially by a central bank. “When the Fed lowers rates artificially, they no longer reflect the true state of consumer demand and economic conditions in general. People have not actually increased their savings or indicated a desire to lower their present consumption. These artificially low interest rates mislead investors. They make investment decisions suddenly appear profitable that under normal conditions would be correctly assessed as unprofitable. From the point of view of the economy as a whole, irrational investment decisions are made and investment activity is distorted” [3]. Artificially low rates are used to “stimulate” the consumer driven economy and interest rate sensitive investments, but the damage is borne in a misallocation of resources and a distortion of healthy free market driven business cycles. Consumers save less and consume more resources, and businesses that choose to invest will not only find resources limited and even more expensive as time progresses, but lending supply limited unless banks relax their reserve requirements. Modern fractional reserve banking answers this problem: banks lend from checkable demand deposits as well as timed deposits (such as CDs). Money that is lent can be multiplied by lending out on a basis of fractional reserves – for every dollar in checkable deposits, a dollar lent is deposited in checking and loaned again, up to the legal reserve limit. In a loose monetary environment, credit expansion means greater risk, as we have seen just recently in the credit boom of the last decade. In the worst case, artificially low rates and the artificial growth in lending supply (credit expansion though the creation of money in fractional banking) end in a business recession or depression: businesses cannot complete all of the invested projects due to the scarcity and/or inflationary expense of specific resources, and consumers cannot continue to spend what they don’t have. Natural supply and demand of the business cycle is disrupted.

As [3] succinctly points out, “The interest rate coordinates production across time.” And as far as the growth in the money supply caused by the artificial credit expansion, the effect on the fiat currency is profound: it further drives up prices of specific resources. When the system becomes unstable, banks run into liquidity and/or insolvency problems. And the central bank (the Fed) exists to reliquify banks that hit the instability curve. “Although interbank clearing mechanisms and continuous public supervision would tend to limit credit expansion in a fractional-reserve free-banking system, they would be unable to prevent it completely, and bank crises and economic recessions would inevitably arise. There is no doubt that crises and recessions provide politicians and technocrats with an ideal opportunity to orchestrate central bank intervention…Until traditional legal principles are reestablished, along with a 100-percent reserve requirement in banking, it will be practically inconceivable for the central bank to disappear” [6]. In short, the free market and healthy business cycles are held hostage by the Fed.

The interplay between the savings rate, interest rates and lending, as they affect business cycles and consumer spending habits, are central to Austrian business cycle theory, founded by Ludwig von Mises. The Austrian economics school [7], led by Mises, his student Friedrich Hayek, and a range of economics scholars including Murray Rothbard and Henry Hazlitt, propose a different route to promote a free market economy – one based on a commodity-backed currency or standard that cannot be easily manipulated, banking and credit institutions that do not rely on an unstable fractional reserve practice for lending, and the lack of a need for a central bank that intervenes in markets with planning and control to undermine them.

As Mises noted in his seminal “Theory of Money and Credit:” “There is need to realize the fact that the present state of the world and especially the present state of monetary affairs are the necessary consequences of the application of the doctrines that have got hold of the minds of our contemporaries. The great inflations of our age are not acts of God. They are man-made or, to say it bluntly, government-made. They are off-shoots of doctrines that ascribe to governments the magic power of creating wealth out of nothing and of making people happy by raising the ‘national income’” [8].

Hayek in his Nobel lecture on unemployment, aggregate demand and inflation: “The very measures which the dominant ‘macroeconomic’ theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable. The continuous injection of additional amounts of money at points of the economic system where it creates temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate” [9].

Rothbard in his “Case Against the Fed:” “The Federal Reserve System is accountable to no one; it has no budget; it is subject to no audit; and no Congressional committee knows of, or can truly supervise, its operations. The Federal Reserve, virtually in total control of the nation’s vital monetary system, is accountable to nobody—and this strange situation, if acknowledged at all, is invariably trumpeted as a virtue” [2].

Hazlitt on inflation, government spending and monetary management: “It is next to impossible to avoid inflation with a heavy [government] deficit. That deficit is almost certain to be financed by inflationary means – i.e., by directly or indirectly printing more money. Huge government expenditures are not in themselves inflationary – provided they are made wholly out of tax receipts, or out of borrowing paid for wholly out of real savings. But the difficulties in either of these methods of payment, once expenditures have passed a certain point, are so great there is almost inevitably a resort to the printing press.”…“’Monetary management’ in practice is merely a high-sounding euphemism for continuous currency debasement. It consists of constant lying in order to support constant swindling. Instead of automatic currencies based on gold, people are forced to take managed currencies based on guile. Instead of precious metals they hold paper promises whose value falls with every bureaucratic whim. And they are suavely assured that only hopelessly antiquated minds dream of returning to truth and honestly and solvency and gold” [10].

Robbins on conditions of recovery from “The Great Depression:” “The policies which have been pursued by the Central Banks in the attempt to counter deflation have resulted in the creation of a basis for credit expansion much more considerable than that existing at the commence of the slump. If business prospects were to brighten and confidence were to be restored, it would probably be incumbent on the authorities actually to contract this basis if things were not to get out of hand. To carry through such a policy of business stabilization and at the same time to attempt to get back to the price-level of 1926 are not compatible undertakings” [11].

We need not forever succumb to the mentality “We are all Keynesians now.” Keynesian monetary and fiscal policies – from artificially low interest rates and central bank bias toward inflation to high government deficits – have been utilized in one form or another over the last hundred years or so, with few exceptions. Mises may have had the last great word on Keynes though: “None of the arguments that economics advances against the inflationist or expansionist doctrine is likely to impress demagogues. For the demagogue does not bother about the remoter consequences of his policies. He chooses inflation and credit expansion although he knows that the boom they create is short-lived and must inevitably end in a slump. He may even boast of his neglect of the long-run effects. In the long run, he repeats, we are all dead; it is only the short run that counts” [8].

The bottom line is that it would be a tragedy if we forever abandon free markets, trust in money and banking, and ultimately, genuine economic liberty and prosperity. Let us all become Misesians.

References and Endnotes:

[1] “The Fed,” Martin Mayer (The Free Press, 2001).

[2] “The Case Against the Fed,” Murray N. Rothbard, (Ludwig von Mises Institute, 1994, 2007). This is available in epub format for download from the LvM Institute at mises.org.

[3] “Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse,” Thomas E. Woods Jr. (Eagle/Regnery Publishing, 2009). An excellent book with straightforward explanations of concepts that ought to be second nature in a free market. A must read for the high school and college students that will shape our future economies.

[4] “End the Fed,” Ron Paul (Grand Central Publishing, 2009).

[5] “The Evolution of Central Banks,” Charles Goodhart (MIT Press, 1988). As Goodhart contends, a central bank is a necessary development out of a conversion from commodity-backed money to fiat money and fractional banking.

[6] “Money, Bank Credit, and Economic Cycles,” Jesús Huerta de Soto (Ludwig von Mises Institute, 2006). Noted italicized quote is from p.638. This is a highly recommended work on the legal and ethical aspects of fractional reserve banking, including history of legal challenges to this system, which extend back over millennia.

[7] The Mises Institute, started in 1982 by Austrian School scholars, exists today as an education and research organization focused on promoting Austrian economics theory, as well as classical liberalism (which shares many concepts with modern conservatism). Classic works by von Mises, Hayek, Rothbard and others are freely available to read online at http://www.mises.org.

[8] “Theory of Money and Credit,” Ludwig von Mises (Yale University Press, 1953). Quotes are from the preface to the new edition, 1952. In this seminal work, Mises discusses the value of money, the business of banking under fiat money, interest rate policy and production, credit and economic crises, and finally, a treatise on the return to sound money (monetary reconstruction). Contrary to popular opinion among economists, the re-adoption of a commodity standard can be straightforward and with high-merit. Mises further outlines a re-adoption prescription in [8]. Woods concisely reviews the myths and merits of a commodity standard on p.130-134 in [6].

[9] “The Pretence of Knowledge,” Friedrich August von Hayek (Economics Nobel Lecture, 1974).

[10] “The Inflation Crisis, and How to Resolve It,” Henry Hazlitt (Arlington House Publishers, 1978). Noted italicized quotes are from p.39 and p.32. A classic book on the myths and fallacies surrounding inflation, and straight talk on how to confront the inflation compulsion. Hazlitt appears to have been a staunch supporter of an international gold standard, which he passionately, if not controversially, comments upon (p.37): “It is precisely the merits of the international gold standard which the world’s money managers and bureaucrats decry. They do not want to be prevented from inflating whatever they see fit to inflate. They do not want their domestic economy and prices to be tied into the world economy and world prices. They want to be free to manipulate their own domestic price level. They want to pursue purely nationalistic policies (at the expense or imagined expense of other countries), and their pretenses to “internationalism” are a pious fraud.” Hazlitt echoes similar arguments made by Hayek in his book “Denationalization of Money” (Institute of Economic Affairs, 1990).

[11] “The Great Depression,” Lionel Robbins (Books for Libraries Press, 1934). Noted italicized quote is from p.164. This is an amazing book, written during the Great Depression by a keen observer from the London School of Economics. Robbins clearly began to understand and elucidate (particularly in Chapter III) the boom-bust cycles created by money and credit expansion, and the devastating effect it can have on capital formation, business planning and expectations. It is both a mystery and a tragedy that such an early text on the subject matter was not taken more seriously by other contemporary economists and economic policy makers.


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