While studying updated Keynesian economics, I keep hearing about the other side, exemplified by Ludwig von Mises, Friedrich Hayek, and Milton Freidman- prominent leaders in successive phases of conservative economics in the 20th century. Additionally, the Atlantic magazine recently ran a puff profile of Ron Paul, with glowing references to Mises, whetting my curiosity about this virtually forgotten economist.
Reading samples of their work, it quickly becomes apparent that we are not dealing with equal intellects. Hayek (The road to serfdom) is far and away the deepest and most interesting of the bunch. Friedman was solid in some respects, but was overly ideological, cherry-picking his stories and evidence, failing to quite understand banking, and wedded to both his hypotheses and to always being right. Which is very annoying. And Mises.. just an out and out crank, whose ongoing theme is that gold is the only reliable form of money. For all his cult-like following, Mises never gained a permanent academic position, either in Austria, or later in the US, indicating that others saw him similarly. Here is a relatively coherent sampling of Mises's thought.
(I am indebted to Bill Mitchell's blog for ongoing insight into these issues, and to a 2002 review of later parts of this history, by David Colander.)
Mises
The immediate predecessor to Mises was the Austrian economist Eugen von Böhm-Bawerk, who, in opposition to Marx, developed the idea that capitalists, far from exploiting labor, offer labor the opportunity to work and gain income in advance of sales, taking upon themselves the risk of enterprise and economic uncertainty. He wrote extensively on the roles of capital and interest in a modern economy. He, Mises, and Hayek all cut their teeth in the Austrian finance ministry, which was in the thick of world-wide problems with gold, silver, and bimetallic monetary standards, followed by the German and Austrian hyperinflations of the 1920's.
At the beginning of this story (late 1800's), most people were only comfortable with some precious metal backing (or actual content) to their currency. For example, the US went off the gold standard during the Civil War, and issued greenbacks for the first time. This allowed inflation, which essentially amounted to confiscation of private wealth in the North for the sake of war finance. The Confederacy did the same, with far more disastrous hyperinflation. (As had the Continental Congress before them.) Popular sentiment as well as contemporary economic theory forced the country back onto the gold standard within a decade, leading to the chronic deflations of the late 1800's. While now all countries are permanently on fiat paper money, in those days none were, and the lessons of history all said that paper money led inexorably to inflation.
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| Original greenback |
Given the metallic standards, money was originally a mostly private affair. The original way a mint worked was as a service to private people, not as an issuer of the government's money. You brought your gold or silver to the mint, and it would mint you your coins as per the official coinage weight and design of the day. The mint might charge a small fee, and that would be that- money supply established! Mises makes a great deal of this origin of money- that people come up with money as a spontaneous convention, which in many cultures has converged on the most precious, portable (in small amounts!), durable, and divisible substance- gold.
"I would like to attack the problem from another point of view and say: “There is nothing in the world less fit to serve as money than paper, printed paper.” Nothing is cheaper."
The issue, of course, is that a gold standard, while it does virtuously constrain everyone in a monetary system, including the government, has many disadvantages as well. Firstly, it is not elastic. When economic production doubles, does the gold supply double? Maybe yes, probably no. They are not fundamentally coupled, so one's money will be worth different amounts of real goods as new gold discoveries are made, or as economic growth makes static gold more valuable. This is a particularly painful problem in the case of deflation, where those with gold (banks, rich people) find their real wealth increasing effortlessly, while those producing goods, and especially those in debt, find what they sell buying less, and their debts rising in value over time.
As Mises acolyte Murray Rothbard puts it: "In a developing free-market economy unhampered by government-induced increases in the money supply, prices will generally fall as the supply of goods and services expands. And falling prices and costs were indeed the welcome hallmark of industrial expansion during most of the nineteenth century." Planning for Freedom, p.247
A shocking and typically blind statement, really. While the Austrian school is inflation-phobic in the extreme, and supposedly supports "sound" monetary value, it turns out that deflation is just fine. This obviously shows which side of the perennial class conflict they occupy. I would also note that deflation exhibits an exponential process of sorts when it is rapid (as does inflation conversely). As the currency becomes more valuable, it gets horded, and less is used for economic activity or lent out. What is the point if just holding it gets you regular returns? Less exchange leads to more deflation, and the system seizes up with nothing happening, unemployment prevalent, and no easy way out. So proper monetary management aims for a Goldilocks mean of stable monetary value- the ideal is 1-2% inflation which encourages money circulation and investment, without eroding its value unduly.
Also, government temptations hardly disappear on a gold standard. A customary way to run such a standard is to issue paper notes redeemable for gold at a set amount. But does the government have to hold a full amount of gold to "back" each note and outstanding ledger entry with gold? Not really. As long as it has enough to meet the expected traffic of redemptions, it only needs enough, say, to back 1/10 of the outstanding currency. How about 1/20? Or 1/100? These kinds of games are every bit as tempting as running an outright fiat currency, and at some point, public confidence breaks down, a run occurs, and the government summarily "closes the gold window", as Nixon finally did in 1971.
So, as Keynes said, gold as monetary backing is a barbarous relic. But Ron Paul and countless gold bugs and libertarians around the world pine for its return, as part of a more general program of breaking the stranglehold that contemporary governments have over us all. It is our collective faith in our collective government that is the monetary standard now, and while there have been many bumps on the road, we seem to have the sophistication these days to make a go of it.
The formative experience for the Austrians was the German (and Austrian) hyperinflation of the 1920's. This horrible and traumatic loss of a key foundation of civilization seared into them a distrust of government and a love of gold that still animates so many today and gives gold coins a semi-mystical aura to the older generation. The German experience is well-told here, (but see here for a contrasting account), and I will only mention a couple of aspects. First is that the process began easily enough. A weak government didn't want to tax to cover its needs, but kept spending without a macroeconomic rationale. It also allowed its all-too-independent central bank to lend excessively, especially to foreign currency speculators. This set the stage for continuous inflation.
Second, many investors and businesses did fine in the inflation- those who were a step ahead could take out loans soon to be worthless, and/or buy real estate or gold to preserve their savings, etc. Life certainly became more complex, but some people came out ahead- it isn't only the government that wins. Lastly, such inflation leads to an interesting exponential process, where as it heats up, everyone gradually realizes that their money is becoming worthless, and all money gets sucked out of its hiding places- mattresses, savings accounts, etc. The beginning of this process creates the illusion of prosperity, but the end of course creates the spiralling worthlessness where people are paying for bread with wheelbarrows of notes.
Friedman
So Mises kept preaching the gospel of "sound money" and the dangers of government control, topics that were continued in various forms by Hayek and Friedman. Friedman wrote an interesting book on bimetallism- the once-common practice of backing money with both silver and gold, (Christmas theme, anyone?), which he deems more stable than either silver or gold alone, for what that is worth in hindsight. The reason is that the more inflationary metal will always drive out the lesser. If gold is getting scarce and more valuable, then people will hoard it and instead bring their silver to the mint for coinage. Thus, in a world of economic growth, where a metal standard is almost always deflationary, it is better to have two horses to choose from, rather than only one, as geologic and technologic vagaries alter the supplies of these metals (for instance, cyanide processing of gold ores). Friedman doesn't come out explicitly for a return to such a standard, but sighs and moans about the bad historical behavior of governments with fiat currencies.
Friedman's mantra is that inflation is always a monetary phenomenon. In a way, this is a truism, since the problem certainly is money getting less valuable. But the underlying idea just isn't correct, since Zimbabwe's catastrophe shows that plummeting real economic production can also cause a disconnect between money value and the economic production base it rests on, again leading to inflation. And it can be a banking problem as well, if banks are not closely regulated. It isn't always the government "printing" excess money. He is right, however, that inflation is never merely a psychological issue of "wage expectations" and the like. There have to be real factors at work.
Incidentally, do we hear about the "money supply" on the evening news any more? No we don't- this was Milton Friedman's hobby horse, now thankfully retired. It turns out that all the measures of "money supply" are hopelessly uninformative- it is terribly hard to measure, and impossible to control in any direct way. These days, the Federal reserve just sets the interest rate to adjust the rate of money/credit growth coming from the banks, and leaves it pretty much at that, barring the kind of special crisis/financial meltdown we are currently in.
Hayek
Now let me turn to Hayek, author most famously of "The road to serfdom". The title sounds a bit alarmist, even McCarthyite, and the book does veer a bit back and forth between froth and sober political theory. But the core consists of very sound analysis, both political and economic, that today we regard on both the left and right as conventional wisdom. His ideal is traditional English liberalism, (strongly laissez-faire), advocated with the true fervor of a former student of Mises and an immigrant who spent the height of his career teaching at the London school of economics.
Planning
His first theme is relatively straight economics, inherited from the Austrian school and developed by Hayek into Nobel-prize work: the superiority of markets over socialist or communist economic planning. Hayek wrote at a time (1940's) when socialism had been intellectually respectable for decades, and many thought that the economic miracles of the Soviet Union showed that it was a truly viable economic, if not social, system. The bloom was not quite off the communist rose (sickle?), and socialist parties would continue to have strong influence in Europe for decades, though increasingly defanged in favor of liberalism (just look what has become of the Labor party in England!). The economic successes of the Nazi system also provided strong arguments in favor of direct state economic control. Fascism was thought, in economic terms, to be the practical middle way between communism and laissez-faire.
There was, in short, a real debate whether the burgeoning complexity of modern economic systems would be best met by explicit state planning, or whether the old system of higgledy-piggledy markets would continue to be up to the task. Hayek was a complete believer in the latter, making the trenchant argument that complexity is exactly what markets do best, organizing millions of personal preferences and a thousands of supply constraints into an efficient system perfectly suited to continue serving human needs for private goods into the modern age. As we might put it now, markets are parallel processing information systems, far superior to the kind of serial processing, however well-meaning, that bureaucrats can devote to economic affairs. In this, of course, he was doing little more than restating Adam Smith, however important it was at the time to do so.
He was fully aware of the need for public goods and the many forms of public support (legal, educational, macro-economic, regulatory, etc.) needed for markets to work, so wasn't as doctrinaire as many other Austrian acolytes. But he didn't compromise in his conviction that in the long run, the Soviet system in particular could never outproduce the free systems of the West ... if the systems of the West remained free!
"The refusal to yield to forces which we neither understand nor can recognize as the conscious decisions of an intelligent being is the product of an incomplete and therefore erroneous rationalism. It is incomplete because it fails to comprehend that the coordination of the multifarious individual efforts in a complex society must take account of facts no individual can completely survey. And it fails to see that, unless this complex society is to be destroyed, the only alternative to submission to the impersonal and seemingly irrational forces of the market is submission to an equally uncontrollable and therefore arbitrary power of other men." p.224
Freedom
Freedom was the mainstay of Hayek's, and the Austrian philosophy generally. Mises had a whole mythology of markets being the natural state of man, who voluntarily exchange goods with no compulsion or state apparatus. To which I have one answer- the family, the even more elemental state of nature comprising complete state control of the means of production, as well as everything else. Hayek stuck with easier territory, explaining how markets are one important mechanism of freedom, allowing each consumer the sovereign choice of products, (barring monopolies and other problems), and bending each producer to virtual slavery at the customer's beck and call (had never heard of advertising, apparently).
Freedom to employ capital, freedom to choose products, and freedom to work and be paid by one's ability- each was central to Hayek's view, and each was in danger when the private economy was put under what went by the name of "planning" at the time- socialism or communism. Once one official is given the task of specifying what widgets should be made here, for the common good, some other price has to be "stabilized" there, some worker has to be shifted around over there, and pretty soon, the whole system has to be run out of 10 Downing Street. That was the road to serfdom that Hayek was talking about, and, among many other examples, our military-industrial complex is eloquent testimony to the inherent morbidities of such a system, however well-intentioned.
The issue was quite live at the time, as Britain was destined to keep some of its war-time economic planning apparatus in place into peacetime, to minimize disruptions on returning to free markets, to help repay its enormous wartime debts, and as part of the Labor party platform. Britain's excellent state-run health care system was born at this time, as a continuation of war-time institutions. The socialists argued that wartime planning worked so well that it was the only solution to long-term economic competitiveness against such planning behemoths as Soviet Russia.
The Nazi economic system was another influential template, with its stunning success in putting everyone in Germany to work and building, out of the economic ruins of the Weimar Republic, an economic juggernaut that almost defeated the entire Western world. After the war, Eisenhower took a page from that playbook by building the American Autobahn, er, interstate highway, system.
"It cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history. But though its policy has brought salvation for the moment, it is not of the kind which could promise continued success. Fascism was an emergency makeshift. To view it as something more would be a fatal error."
- Mises
Nazism
Hayek devotes some attention to exploring the origins of Nazism, making an interesting case that it was the unholy spawn of left and right low-brow anti-liberal sentiment in Germany, combining socialists and nationalists. Thus the name: national socialism, which is so curious to the naive observer. It is sort of as though Sarah Palin decided to ally herself with American labor unions and the Chamber of Commerce in a new system combining jingoistic nationalism, militant trade protectionism, and encouragement of "rational" monopolies among the largest businesses. All for the low, low price of dictatorship!
"It will be those whose vague and imperfectly formed ideas are easily swayed and whose passions and emotions are readily aroused who will thus swell the ranks of the totalitarian party." p. 153
"The way in which, in the end, with few exceptions, her scholars and scientists put themselves readily at the service of the new rulers is one of the most depressing and shameful spectacles of the whole history of National Socialism." p. 209
"It should never be forgotten that the one decisive factor in the rise of totalitarianism on the Continent, which is yet absent in England and America, is the existence of a large recentgly dispossessedmiddle class." p.229
The point, of course, is that what seems like rational planning at the outset turns inexorably into a nightmare of state control over everything and everyone. Such systems also select for exactly those people who are willing to make the brutal tradeoffs that liberal-minded idealists would blanch at, and which democracies would endlessly dither over: "... socialism can only be put into practice only by methods which most socialists disapprove ..." (p.151).
Hayek makes lengthy points about the rule of law, and how it is antithetical to a regulatory, "planning" state. If the law sets out explicit rules confining the state's behavior, then it can not really meet economic contingencies as they arise. At the same time, such a rule of law constitutes a guarantee of personal freedom, since the state is boxed up with its explicit rules, while the individual is free to live around them.
To put it in aphoristic terms, if the law knows you and you don't know the law, you live in despotism. If the law doesn't know you, but you know the law, you are (relatively) free. Proper laws (public, non-retroactive, limited in scope, etc.) can be changed through democratic institutions. But if the law authorizes open-ended/arbitrary forms of meddling, regulation, "planning", excessive secrecy, and so forth, then we are, as it were, on the road to serfdom.
What to think of all this? Hayek's concerns were understandably overheated due to the dramatic times. His fallacy was of the classic slippery-slope variety, and though we have to ask how free we really are in our highly regulated, patted-down, terror-alerted nations of today, the basic ethic of English liberalism seems to remain alive, even ascendent. China over the last three decades has essentially taken the road back from serfdom. There was a middle way, and it wasn't fascism. It was Keynesianism- the insightful use of state power to manage economies on the macro level against the all-too inevitable failures of free markets, without displacing them, indeed making them more fair, robust, and effective.
Unfortunately, over the last couple of decades, Keynesianism went into occultation in academia, as Friedman, Lucas, and other Chicago school neo-Austrians pursued their ivory tower models of perfect markets, rational actors, and evil governments. The resulting public debate is now weirdly unmoored from its proper foundatations, as mainstream economists hold their noses as they recommend Keynesian stimulus, and simultaneously engage in self-defeating deficit hysteria. The ideological content of mainstream economic thought is so prevalent that it goes virtually unnoticed, making explicit and persistent corrective public commentary so critical.
The Austrians and their progeny make the basic error of thinking markets are the point, where they really are a tool, of human betterment. And conversely, of thinking that government is somehow optional instead of integral in the economic system (that we can "go Galt", as it were). As we have learned in countless areas like health care, environmental management, and the financial system, markets can be disastrously defective, completely unable to cope with problems of their own making or with others we desperately need to solve. Indeed, functioning markets require rather close state supervision. There is no shame in that, and we should continue to search for ways to use markets creatively and as widely as possible (e.g. a carbon tax, cap-and-trade). But ultimately, the buck stops with the state, so it is better to tend to the long-term health of our political systems than to denigrate them as incapable of doing what they so patently need to do.
- Martin Wolf, on the inevitability of Irish default, and generally on liberalism in a strong state: "The Irish banking system is worse than too big to fail; it is too big to save."
- Pottersville- Austrian ideal, or "planned", progressive mess?
- Obama's message is ... the GOP is right!
- Another reason to disregard mainstream economics textbooks.
- The free market and shopping: our real religion?
- Gender and deep reporting.
- Is the Afghan government for or against the Taliban?
- Love in grade school.
- Corruption in the US, political and intellectual.
- But there are occasional glimmers of sanity in the media.
