Monday, September 04, 2006

The Principle of Sound Money

The Principle of Sound Money
By Ludwig von Mises

The Classical Idea of Sound Money

The principle of sound money that guided nineteenth-century monetary doctrines and policies was a product of classical political economy. It was an essential part of the liberal program as developed by eighteenth-century social philosophy and propagated in the following century by the most influential political parties of Europe and America.

The liberal doctrine sees in the market economy the best, even the only possible, system of economic organization of society. Private ownership of the means of production tends to shift control of production to the hands of those best fitted for this job and thus to secure for all members of society the fullest possible satisfaction of their needs. It assigns to the consumers the power to choose those purveyors who supply them in the cheapest way with the articles they are most urgently asking for and thus subjects the entrepreneurs and the owners of the means of production, namely, the capitalists and the landowners, to the sovereignty of the buying public. It makes nations and their citizens free and provides ample sustenance for a steadily increasing population.

As a system of peaceful cooperation under the division of labor, the market economy could not work without an institution warranting to its members protection against domestic gangsters and external foes. Violent aggression can be thwarted only by armed resistance and repression. Society needs an apparatus of defense, a state, a government, a police power. Its undisturbed functioning must be safeguarded by continuous preparedness to repel aggressors. But then a new danger springs up. How keep under control the men entrusted with the handling of the government apparatus lest they turn their weapons against those whom they were expected to serve? The main political problem is how to prevent the rulers from becoming despots and enslaving the citizenry. Defense of the individual's liberty against the encroachment of tyrannical governments is the essential theme of the history of Western civilization. The characteristic feature of the Occident is its peoples' pursuit of liberty, a concern unknown to Orientals. All the marvelous achievements of Western civilization are fruits grown on the tree of liberty.




Sound money meant a metallic standard. Standard coins should be in fact a definite quantity of the standard metal as precisely determined by the law of the country. Only standard coins should have unlimited legal-tender quality. Token coins and all kinds of moneylike paper should be, on presentation and without delay, redeemed in lawful standard money.

So far there was unanimity among the supporters of sound money. But then the battle of the standards arose. The defeat of those favoring silver and the unfeasibility of bimetallism eventually made the sound-money principle mean the gold standard. At the end of the nineteenth century there was all over the world unanimity among businessmen and statesmen with regard to the indispensability of the gold standard. Countries which were under a fiat-money system or under the silver standard considered adoption of the gold standard the foremost goal of their economic policy. Those who disputed the eminence of the gold standard were dismissed as cranks by the representatives of the official doctrine — professors, bankers, statesmen, editors of the great newspapers and magazines.

It was a serious blunder of the supporters of sound money to adopt such tactics. There is no use in dealing in a summary way with any ideology however foolish and contradictory it may appear. Even a manifestly erroneous doctrine should be refuted by careful analysis and the unmasking of the fallacies implied. A sound doctrine can win only by exploding the delusions of its adversaries.

The essential principles of the sound-money doctrine were and are impregnable. But their scientific support in the last decades of the nineteenth century was rather shaky. The attempts to demonstrate their reasonableness from the point of view of the Classical value theory were not very convincing and made no sense at all when this value concept had to be discarded. But the champions of the new value theory for almost half a century restricted their studies to the problems of direct exchange and left the treatment of money and banking to routinists unfamiliar with economics. There were treatises on catallactics which dealt only incidentally and cursorily with monetary matters, and there were books on currency and banking which did not even attempt to integrate their subject into the structure of a catallactic system.[1] Finally the idea evolved that the modern doctrine of value, the subjectivist or marginal utility doctrine, is unable to explain the problems of money's purchasing power.[2]

It is easy to comprehend how under such circumstances even the least tenable objections raised by the advocates of inflationism remained unanswered. The gold standard lost popularity because for a very long time no serious attempts were made to demonstrate its merits and to explode the tenets of its adversaries.

The Virtues and Alleged Shortcomings of the Gold Standard






For the naive mind there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared with that of the government's Treasury Department! The government, professors tell us, "can raise all the money it needs by printing it."[4] Taxes for revenue, announced a chairman of the Federal Reserve Bank of New York, are "obsolete."[5] How wonderful! And how malicious and misanthropic are those stubborn supporters of outdated economic orthodoxy who ask governments to balance their budgets by covering all expenditures out of tax revenue!










What all the enemies of the gold standard spurn as its main vice is precisely the same thing that in the eyes of the advocates of the gold standard is its main virtue, namely, its incompatibility with a policy of credit expansion. The nucleus of all the effusions of the anti-gold authors and politicians is the expansionist fallacy.






The Full-Employment Doctrine

The inflationist or expansionist doctrine is presented in several varieties. But its essential content remains always the same. The oldest and most naive version is that of the allegedly insufficient supply of money. Business is bad, says the grocer, because my customers or prospective customers do not have enough money to expand their purchases. So far he is right. But when he adds that what is needed to render his business more prosperous is to increase the quantity of money in circulation, he is mistaken. What he really has in mind is an increase of the amount of money in the pockets of his customers and prospective customers while the amount of money in the hands of other people remains unchanged. He asks for a specific kind of inflation; namely, an inflation in which the additional new money first flows into the cash holdings of a definite group of people, his customers, and thus permits him to reap inflation gains. Of course, everybody who advocates inflation does it because he infers that he will belong to those who are favored by the fact that the prices of the commodities and services they sell will rise at an earlier date and to a higher point than the prices of those commodities and services they buy. Nobody advocates an inflation in which he would be on the losing side.

This spurious grocer philosophy was once and for all exploded by Adam Smith and Jean-Baptiste Say. In our day it has been revived by Lord Keynes, and under the name of full-employment policy is one of the basic policies of all governments which are not entirely subject to the Soviets. Yet Keynes was at a loss to advance a tenable argument against Say's law. Nor have his disciples or the hosts of economists, pseudo and other, in the offices of the various governments, the United Nations, and diverse other national or international bureaus done any better. The fallacies implied in the Keynesian full-employment doctrine are, in a new attire, essentially the same errors which Smith and Say long since demolished.

Wage rates are a market phenomenon, are the prices paid for a definite quantity of labor of a definite quality. If a man cannot sell his labor at the price he would like to get for it, he must lower the price he is asking for it or else he remains unemployed. If the government or labor unions fix wage rates at a higher point than the potential rate of the unhampered labor market and if they enforce their minimum-price decree by compulsion and coercion, a part of those who want to find jobs remain unemployed. Such institutional unemployment is the inevitable result of the methods applied by present-day self-styled progressive governments. It is the real outcome of measures falsely labeled pro-labor. There is only one efficacious way toward a rise in real wage rates and an improvement of the standard of living of the wage earners: to increase the per-head quota of capital invested. This is what laissez-faire capitalism brings about to the extent that its operation is not sabotaged by government and labor unions.

We do not need to investigate whether the politicians of our age are aware of these facts. In most universities it is not good form to mention them to the students. Books that are skeptical with regard to the official doctrines are not widely bought by the libraries or used in courses, and consequently publishers are afraid to publish them. Newspapers seldom criticize the popular creed because they fear a boycott on the part of the unions. Thus politicians may be utterly sincere in believing that they have won "social gains" for the "people" and that the spread of unemployment is one of the evils inherent in capitalism and is in no way caused by the policies of which they are boasting. However this may be, it is obvious that the reputation and the prestige of the men who are now ruling the countries outside the Soviet bloc and of their professorial and journalistic allies are so inseparably tied up with the "progressive" doctrine that they must cling to it. If they do not want to forsake their political ambitions, they must stubbornly deny that their own policy tends to make mass unemployment a permanent phenomenon and must try to put on capitalism the blame for the undesired effects of their procedures.

The most characteristic feature of the full-employment doctrine is that it does not provide information about the way in which wage rates are determined on the market. To discuss the height of wage rates is taboo for the "progressives." When they deal with unemployment, they do not refer to wage rates. As they see it, the height of wage rates has nothing to do with unemployment and must never be mentioned in connection with it.

If there are unemployed, says the progressive doctrine, the government must increase the amount of money in circulation until full employment is reached. It is, they say, a serious mistake to call inflation an increase in the quantity of money in circulation effected under these conditions. It is just "full-employment policy."

We may refrain from frowning upon this terminological oddity of the doctrine. The main point is that every increase in the quantity of money in circulation brings about a tendency of prices and wages to rise. If, in spite of the rise of commodity prices, wage rates do not rise at all or if their rise lags sufficiently behind the rise in commodity prices, the number of people unemployed on account of the height of wage rates will drop. But it will drop merely because such a configuration of commodity prices and wage rates means a drop in real wage rates. In order to attain this result it would not have been necessary to embark upon increasing the amount of money in circulation. A reduction in the height of the minimum-wage rates enforced by the government or union pressure would have achieved the same effect without at the same time starting all the other consequences of an inflation.

It is a fact that in some countries in the 1930s, recourse to inflation was not immediately followed by a rise in the height of money wage rates as fixed by the governments or unions, that this was tantamount to a drop in real wage rates, and that consequently the number of unemployed decreased. But this was merely a passing phenomenon. When in 1936 Lord Keynes declared that a movement of employers to revise money-wage bargains downward would be much more strongly resisted than a gradual and "automatic" lowering of real wage rates as a result of rising prices,[8] he had already been outdated and refuted by the march of events. The masses had already begun to see through the artifices of inflation. Problems of purchasing power and index numbers became an important issue in the unions' dealings with wage rates. The full-employment argument in favor of inflation was already behind the times at the very moment when Keynes and his followers proclaimed it as the fundamental principle of progressive economic policies.

The Emergency Argument in Favor of Inflation

All the economic arguments in favor of inflation are untenable. The fallacies have long since been exploded in an irrefutable way.

There is, however, a political argument in favor of inflation that requires special analysis. This political argument is only rarely resorted to in books, articles, and political speeches. It does not lend itself to such public treatment. But the underlying idea plays an important role in the thinking of statesmen and historians.

Its supporters fully accept all the teachings of the sound-money doctrine. They do not share the errors of the inflationist quacks. They realize that inflationism is a self-defeating policy which must inevitably lead to an economic cataclysm and that all its allegedly beneficial effects are, even from the point of view of the authors of the inflationary policy, more undesirable than the evils which were to be cured by inflation. In full awareness of all this, however, they still believe that there are emergencies which peremptorily require or at least justify recourse to inflation. A nation, they say, can be menaced by evils which are incomparably more disastrous than the effects of inflation. If it is possible to avoid the total annihilation of a nation's freedom and culture by a temporary abandonment of sound money, no reasonable objection can be raised against such a procedure. It would simply mean preferring a smaller evil to a greater one.

In order to appraise correctly the weight of this emergency argument in favor of inflation, there is need to realize that inflation does not add anything to a nation's power of resistance, either to its material resources or to its spiritual and moral strength. Whether there is inflation or not, the material equipment required by the armed forces must be provided out of the available means by restricting consumption for non-vital purposes, by intensifying production in order to increase output, and by consuming a part of the capital previously accumulated. All these things can be done if the majority of citizens are firmly resolved to offer resistance to the best of their abilities and are prepared to make such sacrifices for the sake of preserving their independence and culture. Then the legislature will adopt fiscal methods which warrant the achievement of these goals. They will attain what is called economic mobilization or a defense economy without tampering with the monetary system. The great emergency can be dealt with without recourse to inflation.



Western liberty cannot hold its ground against the onslaughts of Oriental slavery if the peoples do not realize what is at stake and are not ready to make the greatest sacrifices for the ideals of their civilization. Recourse to inflation may provide the government with the funds which it could neither collect by taxation nor borrow from the savings of the public because the people and its parliamentary representatives objected. Spending the newly created fiat money, the government can buy the equipment the armed forces need. But a nation reluctant to make the material sacrifices necessary for victory will never display the requisite mental energy. What warrants success in a fight for freedom and civilization is not merely material equipment but first of all the spirit that animates those handling the weapons. This heroic spirit cannot be bought by inflation.

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