There are no ivory towers to house economists. Whether he likes it or not, the economist is always dragged into the turmoil of the arena in which nations, parties, and pressure groups are battling. Nothing absorbs the minds of our contemporaries more intensely than the pros and cons of economic doctrines. Economic issues engross the attention of modern writers and artists more than any other problem. Philosophers and theologians today deal more often with economic themes than with those topics which were once considered as the proper field of philosophical and theological studies. What divides mankind into two hostile camps, whose violent clash may destroy civilization, is antagonistic ideas with regard to the economic interpretation of human life and action.

Politicians proclaim their utter contempt for what they label as “mere theory.” They pretend that their own approach to economic problems is purely practical and free from any dogmatic prepossessions. They fail to realize that their policies are determined by definite assumptions about causal relations, i.e., that they are based on definite theories. Acting man, in choosing certain means for the attainment of ends aimed at, is necessarily always guided by “mere theory”; there is no practice without an underlying doctrine. In denying this truth, the politician tries in vain to withdraw the faulty, self-contradictory, and a hundred-times refuted misapprehensions directing his conduct of affairs from the criticism of the economists.

The social function of economic science consists precisely in developing sound economic theories and in exploding the fallacies of vicious reasoning. In the pursuit of this task the economist incurs the deadly enmity of all mountebanks and charlatans whose shortcuts to an earthly paradise he debunks. The less these quacks are able to advance plausible objections to an economist’s argument, the more furiously do they insult them.

Sound Money versus Inflationism and Expansionism

At the beginning of our century the governments of the civilized nations were committed either to the so-called classical gold standard or to the gold exchange standard. Their conduct of monetary and credit policies was, to be sure, not free from mistakes, and they indulged in a certain amount of credit expansion. But when compared with conditions after 1914, they were moderate in their expansionist ventures and spurned the fantastic projects of the so-called “monetary cranks” who advocated boundless inflation and credit expansion as the patent medicine for all economic ills.

Yet this rejection of the plans which aimed at making people prosperous through increasing the quantity of money and fiduciary media was not founded upon a satisfactory cognition of the inevitable and undesired consequences of such a policy. The governments were disinclined to deviate from traditional standards of monetary management because the troubles engendered by earlier inflations had not yet been obliterated from the memory of the older statesmen and some vestiges of the prestige of the classical economists still prevailed. Professors and bankers loathed the writings of Ernest Solvay (1838-1922), Silvio Gesell (1862-1930), and a host of other expansionists. But hardly anybody knew why these authors were wrong or how to refute them. In fact the doctrines generally accepted by the treasuries, the central banks, the financial press, and the universities did not differ essentially from the ideas advanced by the “monetary cranks.” These champions of a sweeping social reform to be accomplished by monetary measures only carried the official doctrine to its ultimate logical consequences. It was to be expected that in a coming emergency, such as a great war or revolution, those in office would turn away from their cautious reserve and that orgies of inflation and credit expansion would be rife.

Such was the state of monetary and credit theory when my Theory of Money and Credit was published.1  I tried to construct a theory based entirely upon the modern subjectivist methods of dealing with economic issues, the marginal utility concept. What was called “inflation” at that time and is passionately praised today under the labels of deficit spending and pump-priming can never make a nation more prosperous. It may bring about a shift of income and wealth from some groups of the population to other groups, but it invariably tends to impair the prosperity of the whole nation. In my book, I pointed out that the phenomenon of interest, i.e., the higher valuation of present goods as against future goods, is an ineluctable category of human conduct which does not depend on the particular structure of society’s economic organization; it cannot be abolished by any statutes or reforms. Endeavors to keep the rate of interest below the height it would attain on a market not sabotaged by credit expansion are doomed to failure in the long run. In the short run they result in an artificial boom which inevitably ends in a crash and slump. The recurrence of periods of economic depression is not a phenomenon inherent in the very course of affairs under laissez-faire capitalism. It is, on the contrary, the outcome of the reiterated attempts to “improve” the operation of capitalism by “cheap money” and credit expansion. If one wants to avert depressions, one must abstain from any tampering with the rate of interest. Thus was elaborated the theory which supporters and critics of my ideas very soon began to call the “Austrian theory of the trade cycle.”

As expected, my theses were furiously vilified by the apologists of the official doctrine. Especially abusive was the response on the part of the German professors, the self-styled “intellectual bodyguard of the House of Hohenzollern.” In exemplifying one point, a hypothetical assumption was made that the purchasing power of the German mark might drop to a one-millionth of its previous equivalent. “What a muddle-headed man who dares to introduce?if only hypothetically?such a fantastic assumption!” shouted one of the reviewers. But a few years later the purchasing power of the mark was down not to one-millionth, but to one-billionth of its prewar amount!

It is a sad fact that people are reluctant to learn from either theory or experience. Neither the disasters manifestly brought about by deficit spending and low interest rate policies, nor the confirmation of the theories in my Theory of Money and Credit by such eminent thinkers as Friedrich von Hayek, Henry Hazlitt and the late Benjamin M. Anderson have up to now been able to put an end to the popularity of the fiat money frenzy.*  The monetary and credit policies of all nations are headed for a new catastrophe, probably more disastrous than any of the older slumps.

The Economic Theory of Socialism

Sixty years ago Sidney Webb boasted that the economic history of the century is an almost continuous record of the progress of socialism. A few years later an eminent British statesman, Sir William Harcourt, asserted: “We are all Socialists now.” There cannot be any doubt that all nations were pursuing policies which were bound to result finally in the establishment of all-round planning exclusively by the government, i.e., socialism or communism.

Yet nobody ventured to analyze the economic problems of a socialist system. Karl Marx had outlawed such studies as merely “utopian” and “unscientific.” As he saw it, the mythical productive forces which inevitably determine the course of history and direct the conduct of men “independently of their wills” would in due time arrange everything in the best possible way; it would be a vain presumption of mortal men to arrogate to themselves a judgment in these matters. This Marxian taboo was strictly observed. Hosts of pseudo-economists and pseudo-experts dealt with alleged shortcomings of capitalism and praised the blessings of government control of all human activities; but hardly anybody had the intellectual honesty to investigate the economic problems of socialism.

To put an end to this intolerable state of affairs I wrote several essays and finally a book on socialism.2  The main result of my studies was to prove that a socialist commonwealth would not be in a position to apply economic calculation. When socialism is limited to one or to a few countries only, the socialists can still resort to economic calculation on the basis of prices determined on the markets of non-socialist countries. But once all countries adopted socialism, there would no longer be any market for the factors of production, the factors of production would no longer be sold and bought and no prices would be determined for them.

This means that it would become impossible for a socialist management to reduce the various factors of production to a common denominator and thereby resort to calculation in planning future action and in appraising the result of past action. Such a socialist management would simply not know whether what it planned and executed was the most appropriate procedure to attain the ends sought. It would operate in the dark. It would squander scarce factors of production, both material and human (labor). The paradox of planning is precisely that it abolishes the conditions required for rational action based on weighing cost (input) and result (output)..What is advocated as conscious planning is in fact the elimination of conscious purposive action.

The socialist and Communist authors could not help admitting that my demonstration was irrefutable. To save face they radically reversed their argument. Until 1920, the year in which my thesis on economic calculation was first published, all socialists had declared that the essence of socialism was the elimination of the market and market prices. All the blessings which they expected from the realization of socialism were described as the result of this abolition of the price system. But now they are anxious to show that markets and market prices can be preserved even under socialism. They are drafting spurious and self-contradictory schemes for a socialism in which people “play” market in the way children play war or railroad. They do not comprehend in what respect such childish play differs from the real thing it tries to imitate.

The Middle Way

Many politicians and authors believe that they could avoid the necessity of choosing between capitalism (laissez faire) and socialism (communism, planning). They recommend a third solution which?as they say?is as far from capitalism as it is from socialism. In imperial Germany this third system was called Sozialpolitik; in the United States it is known as the New Deal. Economists prefer the term used by the French, interventionism. The idea is that private ownership of the means of production should not be entirely abolished; but the government should “improve” and correct the operation of the market by interfering with the operations of the capitalists and entrepreneurs?by means of orders and prohibitions, taxes, and subsidies.

But interventionism cannot work as a permanent system of society’s economic organization. The various measures recommended must necessarily bring about results which?from the point of view of their own advocates and the governments resorting to them?are more unsatisfactory than the previous state of affairs which they were designed to alter. If the government neither acquiesces in this outcome nor derives from it the conclusion that it is advisable to abstain from all such measures, it is forced to supplement its first steps by more and more interference until it has abolished private control of the means of production entirely and thus established socialism. The conduct of economic affairs, i.e., the determination of the purposes for which the factors of production should be employed, can ultimately be directed either by buying and abstention from buying on the part of consumers, or by government decrees. There is no middle way. Control is indivisible.

It is interventionism that produces all those evils for which a misguided public opinion indicts laissez-faire capitalism. As has been pointed out above, the endeavors to lower the rate of interest by means of credit expansion generate the recurrence of depression. Attempts to raise wage rates above the height they would attain in an unhampered market result in prolonged mass unemployment. “Soak-the-rich” taxation results in capital consumption. The joint outcome of all interventionist measures is general impoverishment. It is a misnomer to call the interventionist state the welfare state. What it ultimately achieves is not improving but lowering the common man’s welfare, his standard of living. The unprecedented economic development of the United States and the high standard of living of its population were achievements of the free enterprise system.

The Interconnectedness of All Economic Phenomena

Economics does not allow any breaking up into special branches. It invariably deals with the interconnectedness of all phenomena of acting and economizing. All economic facts mutually condition one another. Each of the various economic problems must be dealt with in the frame of a comprehensive system assigning its due place and weight to every aspect of human wants and desires. All monographs remain fragmentary if not integrated into a systematic treatment of the whole body of social and economic relations.

To provide such a comprehensive analysis is the task of my book Human Action, a Treatise on Economics (New Haven: Yale University Press, 1949). It is the consummation of lifelong studies and investigations, the precipitate of half a century of experience. I saw the forces operating which could not but annihilate the high civilization and prosperity of Europe. In writing my book, I was hoping to contribute to the endeavors of our most eminent contemporaries to prevent this country from following the path which leads to the abyss.

Reprinted from Plain Talk, September 1949.

• 1<em>Die Theorie des Geldes und der Umlaufsmittel</em>, first German-language edition, 1912; English translation, <em>The Theory of Money and Credit</em> (J. Cape, 1934; Yale, 1953; FEE, 1971; and Liberty Fund, 1980).
• *F. A. Hayek (1899- ), author of The Road to Serfdom (1944) was appointed Nobel Laureate economist in 1974. Henry Hazlitt (1894- ), economic journalist, was the author of the popular Economics in One Lesson. B. M. Anderson (1886-1949) was well known as the economist for the Chase Bank.
• 2<em>Die Gemeinwirtschaft</em>, first German-language edition, 1922; English language translation, <em>Socialism</em> (J. Cape, 1936; Yale, 1951; J. Cape 1969; Liberty Fund, 1981).

The intellectual and moral faculties of man can thrive only where people associate with one another peacefully. Peace is the origin of all human things, not—as the ancient Greek philosopher Heraclitus said—war. But as human nature is, peace can be established and preserved only by a power fit and ready to crush all peacebreakers.

Government or state is the social apparatus of coercion and compulsion. Its purpose is to make the world safe for peaceful human cooperation by protecting society against attacks on the part of foreign aggressors or domestic gangsters. The characteristic mark of a government is that it has, within a definite part of the earth’s surface, the exclusive power and right to resort to violence.

Within the orbit of Western civilization the power and the functions of government are limited. Many hundreds, even thousands of years of bitter conflicts resulted in a state of affairs that granted to the individual citizens effective rights and freedom, not mere freedoms. In the market economy the individuals are free from government intervention as long as they do not offend against the duly promulgated laws of the land. The government interferes only to protect decent law-abiding people against violent or fraudulent attacks.

There are people who call government an evil, although a necessary evil. However, what is needed in order to attain a definite end must not be called an evil in the moral connotation of the term. It is a means, but not an evil. Government may even be called the most beneficial of all earthly institutions as without it no peaceful human cooperation, no civilization and no moral life would be possible. In this sense the apostle declared that “the powers that be are ordained of God.”

But the very existence of a government apparatus of coercion and compulsion makes a new problem arise. The men handling this apparatus yield too easily to the temptation of misusing their power. They turn their weapons against those whom they were expected to serve and to protect. The main political problem of all ages was and is: how to prevent the rulers from turning into despots and making the state totalitarian. Defense of the individual’s liberty against the encroachments of tyrannical governments, against the dangers of a totalitarian regime, was and is the essential issue of the history of Western civilization.

Now in our age the cause of totalitarianism has won new vigor through the adoption of a ruse. The radical suppression of every individual’s freedom to choose his own way for the benefit of the supreme political authority is praised, under the labels of socialism, communism or planning, as the attainment of true liberty. Those aiming at a state of affairs in which every individual will be reduced to the status of a mere cog in the plans of the “social engineers” are parading as the successors of the great champions of freedom. The subjugation of a free nation by the forces of the most tyrannical regime history has ever known is called “liberation.”

Middle-of-the-Road Policy

Faced with the tremendous challenge of totalitarianism, the ruling parties of the West do not venture to preserve the system of free enterprise that gave to their nations the highest standard of living ever attained in history. They ignore the fact that conditions for all citizens of the United States and those other countries which have not put too many obstacles in the way of free enterprise are much more favorable than conditions for the inhabitants of the totalitarian countries. They think that it is necessary to abandon the market economy and to adopt a middle-of-the-road policy that is supposed to avoid the alleged deficiencies of the capitalistic economy. They aim at a system which, as they see it, is as far from socialism as it is from capitalism and which is better than either of those two. By direct intervention of the government, they want to remove what they consider unsatisfactory in the market economy.

Such a policy of government interference with the market phenomena was already recommended by Marx and Engels in the Communist Manifesto. But the authors of the Communist Manifesto considered the ten groups of interventionist measures they suggested as measures to bring about step-by-step full socialism. However, in our time the government spokesmen and the politicians of the left recommend the same measures as a method, even as the only method, to salvage capitalism.

The advocates of interventionism or government interference with the market protest that they do not want socialism, but rather to retain private ownership of the material factors of production, free enterprise, and market exchange. But they assert that these institutions of the market economy could be easily misused, and are often misused, by the propertied classes for an unfair exploitation of the poorer strata of the population. To prevent such an outcome they want to restrain the discretion of the individuals by governmental orders and prohibitions. The government should interfere with all those actions of the businessmen which it considers as detrimental to the public interest; in other respects, however, it should leave the market alone.

According to this interventionist doctrine the government alone is called upon to decide in every single case whether or not the “public interest” requires government intervention. The real meaning of the interventionist principle, therefore, amounts to the declaration: Business is free to act as long as what it does complies exactly with the plans and intentions of the government. Thus nothing is left to the market other than the right to execute meekly what the government wants it to do. Nothing remains of the market economy but some labels, although their meaning is radically altered.

The interventionist doctrine fails to comprehend that the two systems?the market economy of consumers’ supremacy and the government directed economy?cannot be combined into a practicable composite. In the market economy the entrepreneurs are unconditionally subject to the supremacy of the consumers. They are forced to proceed in such a way that their operations are approved by the purchases of the consumers and thus become profitable. If they fail in these endeavors, they suffer losses and must, if they do not succeed in amending their methods, go out of business.

However, even if the government prevents the entrepreneurs from choosing those projects that the consumers wish them to execute, it does not attain the ends it wanted to attain by its order or prohibition. Both producers and consumers are forced to adjust their behavior to the new state of affairs brought about by the government’s intervention. But it may happen that the way in which they, the producers and consumers, react appears as still less desirable, in the eyes of the government and the advocates of its interference, than the previous state of the unhampered market that the government wanted to alter. Then if the government does not want to abstain from any intervention and to repeal its first measure, it is forced to add to its first intervention a new one. The same story then repeats itself at another level. Again the outcome of the government’s intervention appears to the government as even more unsatisfactory than the preceding state that it was designed to remedy.

In this way, the government is forced to add to its first intervention more and more decrees of interference until it has actually eliminated any influence of the market factors?entrepreneurs, capitalists, and employees as well as consumers?upon the determination of the ways of production and consumption.

Reprinted from Christian Economics, February 4, 1964.

For about a hundred years the Communists and interventionists of all shades have been indefatigable in predicting the impending final collapse of capitalism. While their prophecies have not come true, the world today has to face the agony of the much glorified policies of the Welfare State.

The Welfare State

The guiding principles of the Welfare State were best laid down by Ferdinand Lassalle (1825-1864), both the friend and rival of Marx. Lassalle ridiculed the liberal doctrines. They assigned to the state, he remarked sneeringly, only the functions of a night watchman. In his eyes the state (with a capital S) was God and Santa Claus at the same time. The state had inexhaustible funds at its disposal, which could freely be used to make all citizens prosperous and happy. The state should nationalize big business, underwrite projects for the realization of which private capital was not available, redistribute national income, and provide for everyone security from the cradle to the grave.

For Bismarck and his professorial henchmen, deadly foes of “Anglo-Saxon” freedom as they were, this welfare state program was the consummation of the historical mission of Germany’s ruling Hohenzollern dynasty as well as of the social gospel of a new Christianity. This Sozialpolitik provided a common ground for the cooperation of churchmen and atheists, of royalists and republicans, of nationalists and internationalists. Capitalism had multiplied population figures and raised the average standard of living to an unprecedented height. Yet all these groups were united in the fight against capitalism’s alleged inhumanities.

The new German policy was soon enthusiastically praised by British Fabianism, and later adopted by all European nations and by the United States.

The Welfare State school communicated to mankind the tidings that the philosophers’ stone had finally been found. Self-styled “new economics” dismissed as palpable nonsense what “orthodox” economics had said about the alleged nature-given limitation of useful goods and resources and the consequent necessity of saving and progressive capital accumulation. There is, they shouted, abundance; poverty is merely the outcome of bad policies favoring the selfish interests of the few at the expense of the many.

Let the Rich Pay

If the interventionist says the state should do this or that (and pay for it) he is fully aware of the fact that the state does not own any funds but those which it collects as taxes from citizens. His idea is to let the government tax away the greater part of the income and capital of the wealthy citizens and spend this revenue for the benefit of the majority of the people. The riches of the nabobs are considered inexhaustible, and so, consequently, are the funds of the government. There is no need to be stingy in matters of public expenditure. What may appear as waste in the affairs of individual citizens, when we consider the nation’s budget, is a means of creating jobs and promoting welfare.

Under the impact of such doctrines the system of progressive tax rates was carried to extremes. But then finally the myth of the inexhaustibleness of the wealth of the rich had to evaporate. The politicians were perplexed when they discovered that they had reached the limit. Several years ago, Mr. Hugh Gaitskell [1906-1963], head of the British Treasury in the socialist cabinet of Mr. Clement Attlee [1883-1967], had to admit “that there is not enough money to take away from England’s rich to raise the standard of living any further.” The same is true for all other nations. In this country even if all taxable income of those earning more than $25,000 were confiscated, the additional income to the government would amount to much less than $1,000,000,000, a trifle when compared with a [1953] budget of roughly $78,000,000,000 and a threatened deficit of $10,000,000,000. The house of cards built by the “new economics” is crashing.

Politics seemed to be a very simple thing in these last decades. The main task of a politician was to induce the government to spend more and more. Subsidies, public works, new offices with hosts of employees, and many other costly things secured popularity and votes. Let “them,” that is, the rich, pay. But now their funds are spent. Henceforth the funds of the beneficiaries themselves will have to be tapped if more handouts are to be made to them.

The statist philosophy considers the entrepreneur a useless idler who skims the cream from industry without performing any corresponding economic service. The nationalization of business it is said merely abolishes the unjustified privileges of parasitic drones. A salaried public servant does the jobs previously assigned to the businessman much more efficiently and much more cheaply. The expropriation of private ownership is especially urgent in the field of public utilities.

Guided by these principles, the governments of the various European countries long ago nationalized the railroads, the telephone and the telegraph, and many other branches of business. The result was catastrophic: scandalously poor service, high rates, yearly increasing deficits that have to be covered out of budgetary allowances.

Derailment of State Railroads

The financial embarrassment of the main European countries is predominantly caused by the bankruptcy of the nationalized public utilities. The deficit of these enterprises is incurable. A further rise in their rates would bring about a drop in total net proceeds. The traffic could not bear it. Daily experience proves clearly to everybody but the most bigoted fanatics of socialism that governmental management is inefficient and wasteful. But it is impossible to sell these enterprises back to private capital because the threat of a new expropriation by a later government would deter potential buyers.

In a capitalist country the railroads and the telegraph and telephone companies pay considerable taxes. In the countries of the mixed economy, the yearly losses of these public enterprises are a heavy drain upon the nation’s purse. They are not taxpayers, but tax-eaters.

Under the conditions of today, the nationalized public utilities of Europe are not merely feasting on taxes paid by the citizens of their own country; they are also living at the expense of the American taxpayer. A considerable part of the foreign-aid billions is swallowed by the deficits of Europe’s nationalization experiments. If the United States had nationalized the American railroads, and had not only to forgo the taxes that the companies pay, but, in addition, to cover every year a deficit of several billions, it would not have been in a position to indemnify the European countries for the foolishness of their own socialization policies. So what is postponing the obvious collapse of the Welfare State in Europe is merely the fact that the United States has been slow and “backward” in adopting the principles of the Welfare State’s “new economics”: it has not nationalized railroads, telephone, and telegraph.

Yet Americans who want to study the effects of public ownership of transit systems are not forced to visit Europe. Some of the nation’s largest cities?among them Detroit, Baltimore, Boston, San Francisco?provide them with ample material. The most instructive case, however, is that of the New York City subways.

New York City subways are only a local transit system. In many technological and financial respects, however, they surpass by far the national railroad systems of many countries. As everybody knows, their operation results every year in a tremendous deficit. The financial management accumulates operating deficits, planning to fund them by the issuance of serial bonds. Only a municipality of the bigness, wealth, and prestige of New York could venture on such a policy. With a private corporation financial analysts would apply a rather ugly word to its procedures: bankruptcy. No sane investor would buy bonds of a private corporation run on such a basis.

Incorrigible socialists are, of course, not at all alarmed. “Why should a subway pay?” they are asking. “The schools, the hospitals, the police do not pay; there is no reason why it should be different with a transit system.” This “why” is really remarkable. As if the problem were to find an answer to a why, and not to a wherefrom.

There is always this socialist prepossession with the idea that the “rich” can be endlessly soaked. The sad fact, however, is that there is not enough left to fill the bottomless barrels of the public treasury. Precisely because the schools, the hospitals, and the police are very expensive, the city cannot bear the subway deficit. If it wants to levy a special tax to subsidize the subway, it will have to tax the same people who are supposed to profit from the preservation of the low fare.

The other alternative is to raise the fare from the present [1953] level of ten cents to fifteen cents.1  It will certainly be done. And it will certainly prove insufficient. After a while a rise to twenty cents will follow?with the same unfavorable result. There is no remedy for the inefficiency of public management. Moreover there is a limit to the height at which raised rates will increase revenue. Beyond this point further rises are self-defeating. This is the dilemma facing every public enterprise.

Subways at a Dead End

How little the management of the New York City subways is touched by the spirit of business was proved a short time ago when it triumphantly announced economies made by cutting down services. While all private enterprises in the country compete with one another in improving and expanding services, the municipality of New York is proud of cutting them down!

When economists clearly demonstrated the reasons why socialism cannot work, the statists and interventionists arrogantly proclaimed their contempt for mere theory. “Let the facts speak for themselves; not economics books, only experience counts.” Now the facts have spoken.

It is just an historical accident that transportation systems were nationalized while bakeries and automobile factories remained in the hands of private capital. If it had been the other way round, the socialists would perorate: “It is obvious that bakeries and automobile plants cannot pay like railroads. They are public utilities supplying the masses with vital necessities. They must show deficits, and the taxes paid by the extremely profitable railroads must provide the government with the funds required for making good these deficits.”

It is paradoxical indeed that Washington is eager to spend the taxpayers’ money for the benefit of European deficit railroads and does not bother about the transit deficits of large American cities. Marshall Plan aid2  seems to differ from charity, at least in this respect?it does not begin at home.

History has been rather kind to the American voter. It has provided him with object lessons in socialism. If he looks behind the Iron Curtain, he can learn useful things about the one-party system of the classless and profitless “peoples’ democracies.” If he studies European budgets, he will be informed about the “blessings” of nationalization. Even if he stays at home, he can extend his views by carefully reading what the newspapers report about the financial breakdown of New York City, the world’s largest and richest urban agglomeration, the intellectual capital of Western civilization, the home of the United Nations. There is plenty of experience that can induce a man to analyze scrupulously what the progressive propaganda has taught him, and to think twice before again casting his vote for the apostles of socialization and advocates of public spending.

Reprinted from The Freeman, May 4, 1953.

• 1On January 1, 1990, the fare on the New York City subway was raised to $1.15.
• 2The foreign aid plan sparked June 5, 1947, by General George C. Marshall, then Secretary of State, which became the European Recovery Program.

When in the 19th century the question was asked: What can be done in order to raise wage rates and thereby to improve the average standard of living of the most numerous class of the population, the economists answered: One has to accelerate the increase of capital as compared with population. This answer infuriated the reformers and socialists. Historian Thomas Carlyle called economics the dismal science, and Karl Marx smeared the economists as bourgeois idiots and sycophants of the exploiters. But such abusive language cannot change the facts. Today the statesmen of all underdeveloped countries realize very well that what is needed to improve the lot of the masses of their peoples is investment of additional capital. In spending dozens of billions of dollars for foreign aid the American Government implicitly admits the correctness of this thesis. And even the most fanatical foes of capitalism no longer venture to deny that the comparatively high standard of living of the manual workers in this country and in some parts of Europe is due to the increase in the amount of capital invested per head of the employees.

Thus at least in dealing with the economic problems of underdeveloped nations the President, Congress, and public opinion virtually acknowledge the doctrine of the much abused classical economists. But in dealing with domestic problems they are guided by very different ideas. They proceed as if the height of wage rates could be fixed ad libitum [at will] by government decree or by labor union pressure and compulsion. Our tax system?especially the way in which personal incomes, corporations and estates and inheritances are taxed?not only reduces considerably the amount of savings, but in many regards directly results in capital decumulation. But the authorities and their advisers are not concerned about these effects. They are intent upon raising wage rates either through decreeing minimum wage rates or through pro-union policies.

Labor Union Privileges

The laws have in the last decades granted to the unions many privileges. But these legal privileges also would not have given to unions and to the methods of collective bargaining the tremendous power that they enjoy today in this country and in almost all other non-communist countries. What makes the unions formidable is the fact that the authorities?the federal government as well as the state and municipal governments?have designedly and wittingly abandoned for the benefit of the unions the essential power of political sovereignty, viz., the exclusive right to suppress disobedience by recourse to violent action. When striking workers resort to acts of violence against strikebreakers or against the persons or the property of those who employ strikebreakers, the authorities preserve a lofty neutrality. The police do not protect those attacked; the district attorneys do not prosecute the assailants and consequently no opportunity is given to the penal courts to try to punish them.

What is today euphemistically called the right to strike is in fact the right of striking workers, by recourse to violence, to prevent people who want to work from working. This means that the authorities have surrendered to the unions an essential attribute of their governmental functions. In matters of wage determination the voice of the unions has the power that in other matters the Constitution and the laws assign exclusively to orders of the authorities issued in conformity with the laws. You must obey such orders and prohibitions or else your obedience will be obtained by beating you into submission.

The statesmen and politicians who step by step?not only in this country but also in all other countries of Western industrialism?granted this quite exceptional, tremendous privilege to the unions were guided by the belief that raising wage rates above the height the unhampered market would have fixed them is beneficial to all those who want to make a living by earning wages. As they saw it, a rise in wage rates will reduce profits and interest rates and thus improve the lot of those toiling in factories and offices at the sole expense of a socially quite useless “leisure class.”

These self-styled friends of the common man failed to see the fact that capitalism is essentially mass production for supplying the masses. In the precapitalistic ages the processing industries, the artisans organized in guilds and crafts, produced only for the wants of small groups of well-to-do. Under capitalism, however, the masses of the working people are the main consumers of the products. Big business always serves the many; the shops serving the fancies of the rich never attain bigness. If we refer to the consumers, we refer, by and large, to the same people we are talking about in referring to the wage earners.

Above Market Wage Rates

The labor market fixes wage rates at the height at which all those intent upon hiring workers can hire as many as they want and all those anxious to find a job can find one. If wage rates, either by government decree or by union pressure and compulsion, are raised above this height, there are two alternatives. Either prices are raised concomitantly, so both demand and sales drop, production must be curtailed and a part of the previously employed workers must be discharged. Or prices remain unchanged, although the cost of production is increased, so that firms that are producing under the least favorable conditions and, therefore, with the highest costs will suffer losses and be forced to go out of business or at least to restrict the quantity of their production. Again workers will have to be discharged. Thus, whatever is done to impose wage rates higher than those the free unhampered market would have determined results in unemployment of a part of the potential labor force.

If a union succeeds in forcing the employers to pay higher wage rates than those they were prepared to pay under the prevailing state of market conditions, this is not a victory for “labor,” i.e., for all those who are anxious to earn wages. It is a boon only for those workers who will be employed at the new rates. It is a calamity for all those whom it condemns to lasting unemployment.

The effect of raising wage rates above the potential market rates, i.e., unemployment for some, is not denied by any economist. Even Lord Keynes did not question it. He realized very well that there is no other means to fight unemployment than to adjust wage rates to the height consonant with the state of the unhampered market. The characteristic mark of the Keynesian approach to the problem of unemployment is that, for practical and tactical reasons, he suggested bringing about this adjustment by inflation and its inevitable consequence, a rise in commodity prices. He thought that “a movement by employers to revise money-wage bargains downward will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices.”1  As everybody knows today it is impossible to delude the unions and their members in this way. People are nowadays index conscious.

The outstanding fact is that it is impossible to raise wage rates by coercive measures, be it a direct government minimum wage decree, or labor union violence or threat of such violence, without bringing about lasting unemployment of a part of those looking for jobs. The exceptional powers the governments granted to the unions do not benefit all those anxious to earn wages, but only a part of them. The others are victimized. Experience with labor union policies and governmental minimum wage rates has confirmed what economic theory teaches: There is no other method of improving the well-being of the whole class of wage earners than by accelerating saving and the accumulation of new capital.

• 1The General Theory of Employment, Interest and Money, London, 1936, p. 264.

Public opinion, misguided by the fanatical propaganda on the part of the deadly foes of freedom and prosperity, looks upon the disputes concerning the height of wage rates as if they were only conflicts between wage earners and employers. It ascribes to the employers the power to determine wage rates ad libitum. It fails to realize the fact that the entrepreneur is not sovereign in the conduct of his enterprise but entirely subject to the most rigid orders given by his customers, the public. It does not depend on the businessman’s arbitrariness to determine what he produces and how. He is, by the instrumentality of the profit and loss system, forced to supply the buying public in the best possible and cheapest way with those commodities and services which they are asking for most urgently. All his measures are directed toward meeting the wishes of the public. The consumers are sovereign and the businessmen are their servants.

Consumer Sovereignty

It is the consumers that ultimately determine the prices of the products and thereby indirectly the prices their purveyors are able to pay for the material means of production and for the labor required for turning out the products. It is the consumers that determine that a movie star should get a much higher pay than a welder, a charwoman much less than a boxing champion.

Economics describes this state of affairs in formulating its marginal utility doctrine. It points out that the price paid for every factor of production, whether material or human, depends on the value that the consumers ascribe to its contribution to the turning out of the product. If the businessman spends more for the purchase of a factor than the consumers are prepared to refund to him in buying the product, he suffers losses and, if he does not change his practice in time, he is forced to go out of business. In this way the market, i.e., all of the people, determine the prices of the material factors of production and the height of salaries and wage rates paid to all people working in the offices, shops, and farms.

This is what is meant by those who call the market economy a democracy in which every penny gives a right to vote. The whole of the nation is, as it were, a tribunal that assigns to everybody the prices which he can reap in selling his products or his labor. Everybody participates in this process in a double capacity. On the one hand he is, as a buyer and a consumer, a member of the tribunal that assigns to everybody his income and on the other hand he is, as a breadwinner, one of those to whom an income is assigned. In buying admission to a show, the man who makes a hundred dollars a week in his job in a factory assigns a salary of $10,000 a week to an actor. It is the same man’s valuation that assigns a much lower pay to the work of a bus driver or a housepainter.

What Makes Wages Rise

In their capacity as earners of wages and salaries the immense majority of the nation are vitally interested in the establishment of conditions that cause wages and salaries to rise. There is but one way to attain this end, viz., to raise the marginal productivity of the individual job holder’s contribution by increasing the amount of capital invested per capita. The height of wages depends on the height of the per head quota of capital invested. When the accumulation of capital outruns the increase in population, the marginal utility of the worker’s contribution rises and makes wages go up concomitantly. Saving and capital accumulation are the very implements of improving the material conditions of the wage earners.

Wages and salaries are in present-day America much higher than they were in the past because the quantity of capital invested increased more rapidly than the number of people anxious to get jobs. The plight of the underdeveloped nations is due to their shortage of capital. It is not denied by anybody that what these countries need in order to improve the standard of living of their masses is more capital. A man working in India with the primitive tools that in the capitalistic countries have been discarded long since produces much less per unit of time than the American or British worker. Consequently the compensation he receives is much lower.

It is the most stupid of all Communist lies that the considerable capital investments America and Western Europe made in Latin America, Asia, and Africa mean “exploitation” of the natives for the benefit of the foreign capitalists. What was wrong with these economically backward countries was that they did not develop spontaneously those legal and institutional conditions that make saving and capital accumulation safe against the arbitrariness and the greed of those in political office. Where the laws do not sufficiently protect private ownership of the means of production, there cannot be any indigenous development of modern industrial plants. Nature has endowed much better with natural resources most of those countries that are today looked upon as backward than it has the soil of the countries occupied by the capitalistic nations. The poverty of these underdeveloped nations is not due to natural conditions. It is a result of their bad policies. If the foreign capitalists had not provided them with capital, most of them would still even have to do without railroads and hydroelectric power plants. Every investment that foreigners made in their lands was immediately followed by an upward movement of wages, not only in the plants erected by the foreigners themselves, but also in other fields of business.

What Generates Unemployment

Public opinion believes that the improvement in the conditions of the wage earners is an achievement of the unions and of various legislative measures. Public opinion gives to unionism and to legislation credit for the rise in wage rates, the shortening of hours of work, the disappearance of child labor and many other changes. The prevalence of this belief made unionism popular and is responsible for the trend in labor legislation of the last decades. As people think that they owe their high standard of living to unionism, they condone violence, coercion, and intimidation on the part of unionized labor and are indifferent to the curtailment of personal freedom inherent in the union-shop and closed-shop clauses.

But this popular doctrine misconstrues every aspect of economic reality. As has been pointed out, the height of wage rates at which all those eager to get jobs can be and are employed depends on the marginal productivity of their performance. If the employers are prevented, either by union pressure and compulsion or by government decree, from hiring help at this market rate, and are forced to pay more, the costs incurred by the employment of workers in the production of a number of articles rise above the prices the consumers are prepared to expend for the value added to the product by these workingmen’s efforts. In order to avoid losses and bankruptcy, the businessmen are under the necessity to restrict their production activities and therefore to reduce the number of men employed.

At the wage rates established in a free labor market, i.e., in a market not manipulated?we may better say not sabotaged?by labor union or government compulsion, all those who are anxious to get jobs can find employment. But if wage rates are fixed above the potential market rates, unemployment of a part of the potential labor force develops. Mass unemployment becomes a lasting phenomenon.

It is not the operation of the market economy that generates unemployment with all its moral and material evils, but precisely the ill-contrived, although well-intentioned, actions of unions and governments. There is no other means to do away with unemployment than to abstain from any government and union meddling with the height of wage rates.

Inflation Not Fit to Fight Unemployment

The self-styled American “liberals” propose to do away with unemployment by inflation. They suggest an increase in the quantity of money in circulation through credit expansion.

Lord Keynes did not invent, but merely popularized this makeshift. He was well aware of the fact that inflation inevitably results in a rise in all commodity prices or, what is merely another way of describing the same effect, in a drop in the monetary unit’s, the dollar’s, purchasing power. But he argued that the wage earners will acquiesce in “a gradual and automatic lowering of real wages as a result of rising prices.”1  It is obvious that Keynes thus fully admitted that nothing but a lowering of real wage rates can do away with unemployment. The inflation which he recommended was designed as a clever trick to cheat the workers. He expected that they would not be shrewd enough to realize that real wages had dropped and that, therefore, they would not ask for higher pay to compensate for the reduction in the monetary unit’s purchasing power.

Keynes failed entirely to see that the decades of reckless inflation have made everybody?the newspapers, the average man, the housewives, and the workers and union leaders?index conscious. His assumption underrates in an almost unbelievable way the intellectual powers of the masses. One cannot avoid the nefarious implications of the spurious union doctrine by deceiving the public. Moreover it must be remembered that inflation is not a policy that can last. If inflation and credit expansion are not stopped in time, they result in a more and more accelerated drop in the monetary unit’s purchasing power, and in skyrocketing commodity prices until the inflated money becomes entirely worthless and the whole government-manipulated currency system collapses. In our age, this has happened to the monetary regime of various countries.

How Honest Workers Plan to Do Away with Unemployment

An analysis of the Keynesian prescription for doing away with unemployment clearly shows that Lord Keynes also never doubted that what causes unemployment is a policy that fixes wage rates above the level at which the free market would have fixed them. What he suggested to attain full employment was a peculiar, and as he believed, very cunning, method to reduce real wage rates. In fact all people who gave serious thought to the matter agree in pointing out that at the wage rates determined on the unhampered labor market all those eager to find jobs are getting them. (Incidentally it may be mentioned also that Karl Marx and the doctrines of the Marxian parties admitted that unions as well as governments cannot, without creating unemployment, raise wage rates above the rates corresponding to the conditions of the market.)

The terrorism of the union bosses and the political parties fed by ample union subsidies have for many years succeeded in popularizing the myth that expects a betterment of the wage earners’ material conditions, not from an increase in the per head quota of capital invested and the resulting technological advancement, but from government action and from union violence. But fortunately it is impossible for lies to remain unchallenged forever. There are signs that the truth about industrial relations is beginning to spread in spite of all endeavors of the union bosses to conceal it.

While the Administration and Congress are embarrassed by the rising tide of unemployment and do not consider any other method to reduce it than by resorting to inflation, better schemes are recommended from the midst of the unemployed. In Wheeling, West Virginia, a community on the Ohio River, an unemployed steelworker named Thomas E. Elliott, who has worked only a month and a half in the past four years, advances an anti-unemployment plan that does not require any aid from Washington. His plan as outlined in U.S. News and World Report,2  is to offer to prospective employers better and cheaper labor. He and 1,400 other unemployed will promise any company coming in that they will do an honest day’s work at a fair wage, but if the plant makes a profit they will expect to get additional pay. “Steel wages are too high today,” Mr. Elliott said. “Some men who have been getting $3 an hour in the steel mills will have to be satisfied with $1.85 or $2 an hour.” Better to have a job at lower wages, he decided, than to remain unemployed while asking for $3 an hour.

If this plan materializes, a plain citizen will have contributed to the welfare of the nation and its manual workers more than all the learned advisers of the Administration and all the members of the innumerable government agencies. Good luck to you, Mr. Elliott!

Reprinted from Christian Economics, April 18, 1961.

• 1Keynes, General Theory (1936) p. 264.
• 2January 9, 1961, pp. 101-103. Mr. Elliott’s “Save-a-Plant Plan” could have helped his economically depressed area insofar as above-market wage rates were the cause of its problems. However, since 1961, traditional smokestack industries in the United States have been beset by other exorbitant and mandatory costs, notably for federally imposed pollution control and safety standards.

To answer that question we must first look at a little history. In the pre-capitalistic ages a nation’s social order and economic system were based upon the military superiority of an elite. The victorious conqueror appropriated to himself all the country’s utilizable land, retained a part for himself and distributed the rest among his retinue. Some got more, others less, and the great majority nothing. In the England of the early Plantagenets [the line of British kings, descended from French Normans, who reigned from 1154 to 1399], a Saxon was right when he thought: “I am poor because there are Normans to whom more was given than is needed for the support of their families.” In those days the affluence of the rich was the cause of the poverty of the poor.

Conditions in the capitalist society are different. In the market economy the only way left to the more gifted individuals to take advantage of their superior abilities is to serve the masses of their fellowman. Profits go to those who succeed in filling the most urgent of the not-yet-satisfied wants of the consumers in the best possible and cheapest way. The profits saved, accumulated, and plowed back into the plant, benefit the common man twice. First, in his capacity as a wage earner, by raising the marginal productivity of labor and thereby real wage rates for all those eager to find jobs. Then later again, in his capacity as a consumer when the products manufactured with the aid of the additional capital flow into the market and become available at the lowest possible prices.

The characteristic principle of capitalism is that it is mass production to supply the masses. Big business serves the many. Those outfits that are producing for the special tastes of the rich never outgrow medium or even small size. Under such conditions those anxious to get jobs and to earn wages and salaries have a vital interest in the prosperity of the business enterprises. For only the prosperous firm or corporation has the opportunity to invest, that is, to expand and to improve its activities by the employment of ever better and more efficient tools and machines.

The better equipped the plant is the more can the individual worker produce within a unit of time, the higher is what the economists call the marginal productivity of his labor and, thereby, the real wages he gets. The fundamental difference between the conditions of an economically underdeveloped country like India and those of the United States is that in India the per head quota of capital invested and thereby the marginal productivity of labor and consequently wage rates are much lower than in this country. The capital of the capitalists benefits not only those who own it but also those who work in the plants and those who buy and consume the goods produced.

And then there is one very important fact to keep in mind. When one distinguishes, as we did in the preceding observations, between the concerns of the capitalists and those of the people employed in the plants owned by the capitalists, one must not forget that this is a simplification that does not correctly describe the real state of present-day American affairs. For the typical American wage earner is not penniless. He is a saver and investor. He owns savings accounts, United States Savings Bonds and other bonds and first of all insurance policies. But he is also a stockholder. At the end of the last year [1961] the accumulated personal savings reached $338 billion. A considerable part of this sum is lent to business by the banks, savings banks and insurance companies. Thus the average American household owns well over $6000 that are invested in American business.

The typical family’s stake in the flourishing of the nation’s business enterprises consists not only in the fact that these firms and corporations are employing the head of the family. There is a second fact that counts for them, to wit that the principal and interest of their savings are safe only as far as the American free enterprise is in good shape and prospering. It is a myth that there prevails a conflict between the interests of the corporations and firms and those of the people employed by them. In fact, good profits and high real wages go hand in hand.

Transcript of radio broadcast made during intermission of the U.S. Steel Concert Hour, May 17, 1962; first published in The Freeman, May 1988. Mises had been asked to respond to the question: “Are the interests of the American wage earners in conflict with those of their employers, or are the two in agreement?”

At the price determined in an unhampered market all those who consider it satisfactory can sell and all those who are prepared to pay it can buy. if commodities remain unsold, this is not due to their “unsalability” but to speculation on the part of their owners; they hold out because they expect that they will be able to sell later at a higher price.

It is different when the authorities try to influence the market by compulsion. If the government decrees and enforces minimum prices higher than the potential market prices, a part of the supply offered for sale at the official minimum price remains unsold. This fact is well known. Therefore, if a government wants to push the price of a commodity above the potential market price, it does not simply resort to the fixing of minimum prices. Rather it tries to reduce the quantity offered for sale on the market, for instance by purchasing and withholding a part of the supply available.

All this applies also to labor. At the wage rates determined in the labor market everybody who looks for a job can get it and everybody who wants to employ workers can hire them. In the unhampered labor market, wage rates always tend toward full employment.

Market wage rates rise when the marginal productivity of labor outruns the marginal productivity of capital goods; or, more simply, when the per-head quota of capital invested increases. This is effected either by accumulation of new capital or by a drop in the number of workers. An increase in the amount of capital is the result of saving and consequent investment. A reduction in the supply of labor on the market can be brought about by restricting immigration. In the age of liberalism, in the traditional classical meaning of the term, there were practically no migration barriers. In this age of welfarism and unionism, well-nigh all governments have either completely prohibited immigration or, as for instance the United States and other American republics, stipulated definite quotas. Beyond that, some American unions have tried to reduce still more the number of jobseekers in their segments of the labor market by excluding racial minorities from some kinds of employment and by rendering entrance into certain branches extremely difficult.

There is need to emphasize that only such “artificial” or “institutional” reduction of the labor supply makes it possible for the unions to raise their members’ wage rates. Their success in raising the wages of their members is won at the expense of those whom they have excluded. These outsiders are forced to look for jobs in industries in which remuneration is lower than what they would have earned in the field that is closed to them.

Effects of Labor Unions

Labor unionism as we know it today is the outcome of a long evolution. In the beginning only a few branches were organized, mostly those with the best-paid skilled workers. At that time, those who could not find a job in a unionized industry because wages had been pushed above the potential market height and thereby the demand for labor had been reduced, were forced to go into the non-unionized branches of business. Their influx into these branches increased in them the number of jobseekers and thus tended to depress there the height of wage rates. Thus, the higher wages of unionized workers brought about pressures on the jobs and wages of non-unionized workers. The more unionization spread, the more difficult it became for those who had lost their jobs on account of union policy to find other jobs; they remained unemployed. Wherever and whenever the unions succeeded in raising wage rates above the potential market rate, i.e., above the amount the workers would have earned without union interference, “institutional” unemployment developed as a lasting phenomenon.

As the union leaders see it, the determination of wage rates is the outcome of a struggle for power between the employers and the employees. Their interpretation does not acknowledge that wages depend on the state of the market and that the workers who receive the wages form the immense majority of the consumers out of whose pockets the wages are ultimately paid. The average wage earner considers it unfair that the movie star and the boxing champion are paid a hundred times more than the welder and the charwoman. He fails to see that his own behavior, his own purchases on the market, and those of other wage earners like him contribute to this result. An entrepreneur cannot pay more to a worker than he expects to collect from the customers for this man’s performance. Even the most infatuated supporters of the exploitation doctrine are finally forced to admit that, at a certain height of wage rates, lasting unemployment of a considerable part of the potential labor force becomes unavoidable.

The market economy is ultimately controlled by the conduct of the consumers, that is by the conduct of all the people. In buying or in desisting from buying, the consumers determine what ought to be produced, of what quality and in what quantity. They determine who should make profits and who should suffer losses. They make rich men poor and poor men rich. The consumers are continuously shifting control of the material factors of production into the hands of those entrepreneurs, capitalists, and landowners who are most successful in supplying them, the consumers, in the cheapest and best possible way. Thus, in the capitalistic economy control of the factors of production is, as it were, a revocable mandate granted by the public. The operation of the market, in a daily repeated plebiscite, assigns to everybody the place in which he is to contribute to the united effort of all. This daily plebiscite determines the height of everybody’s income.

The Alternative?Socialism

The individual resents the fact that he is forced to adjust himself to the conditions of the market and must forgo many of his own wishes and inclinations. However, it is obvious that the immeasurable benefits that cooperation under the system of the social division of labor affords to everybody must be paid for by some sacrifices. Whatever society’s economic organization may be, it must always prevent man from behaving without due concern for the existence of others. The alternative to the hegemony of the market under capitalism is not absolute freedom, but the unconditional surrender of all to the supremacy of the socialist planning authority.

Society cannot do without an institution that channels the available workers into those branches in which they are most urgently needed and withdraws them from those in which there is less need for them. The labor market serves this purpose in raising wage rates in expanding industries and reducing them in shrinking industries. The alternative is to assign to each man a job by government order.

The tyranny of the labor market is milder than that of socialist regimentation. It grants to the individual a margin within which he is free to ignore the market’s directives. If he is prepared to put up with a lower income, he can choose vocations in which he can either dedicate himself to his ideals or indulge his inclination for laziness. But the command of the socialist dictator does not brook contradiction.

There is only one method to abolish lasting mass unemployment, the return to the freedom of the labor market. Lasting mass unemployment is always institutional. It is the inevitable effect of the enforcement of wage rates that are higher than the potential market rates at which all jobseekers could find employment. It does not matter whether these minimum wage rates were decreed directly by the government or induced indirectly by the fact that the government is not willing to protect the enterprises and the strikebreakers against the violence of the unions.

The political power of the unions has succeeded in suppressing the dispassionate discussion of these problems. But it could not prevent the undesirable consequences of the unions’ policies from wreaking havoc. In the twenties, in many European countries mass unemployment became the main political embarrassment. It was clear that these conditions could not continue indefinitely. Something had to be done. Smart politicians thought that they had found a solution. As it was deemed impermissible to antagonize the unions, and to tamper with the money wage rates dictated by them, they resorted to currency devaluation, reducing purchasing power and, thus, real wage rates. England took the lead in 1931. Very soon other countries followed.

For a while the nostrum worked. Some time passed before the unions began to pay full attention to the drop in the monetary unit’s purchasing power. But when the index of the cost of living became the main issue in wage negotiations, the monetary method of eliminating mass unemployment had exhausted its serviceableness.

A New Messiah

It was precisely at this juncture that Lord Keynes entered the scene with his good tidings, the allegedly new economic doctrine designed to supersede all previous economic teachings, including those of the earlier writings of Keynes himself. Following in the wake of the politicians who in 1931 had demolished the British gold standard, and of their imitators, he pointed out that “a gradual and automatic lowering of real wages,” that results from a lowering of the monetary unit’s purchasing power, will be less strongly resisted than attempts to revise money wages downward. But in 1936, when Keynes’ book was published, this no longer agreed with the facts.

Keynes’ General Theory of 1936 and his later writings are hardly different from the bulk of inflationist literature which for more than a century has flooded the world. Like the authors of all these pamphlets, Keynes tries to dispose of all those who do not share his opinions by calling them “orthodox.” He never tries to disprove their teachings rationally. He enriched the prosaic language of diplomatic correspondence by terms borrowed from the messianic jargon of the “monetary cranks.” For instance, in the British document that inaugurated the events which finally led to the establishment of the International Monetary Fund, he declared that credit expansion performs the “miracle ... of turning a stone into bread.” But he did not add any new idea to the old, long since entirely refuted and discredited arguments of the inflationists. All Keynes accomplished was to coin a new slogan?”full employment”?which became the motto of present-day policies of inflation and credit expansion.

The full-employment doctrine underlying these inflation and credit expansion policies, in complete accord with the teachings of the Communist Manifesto, declares that the very operation of the capitalistic mode of production inevitably generates the emergence of mass unemployment. Unlike the creed of the more consistent Marxians it does not, however, contend that the return of periods of economic depression and large-scale unemployment is absolutely inevitable in the market economy. It attributes to the State (with a capital S) the power to create jobs for everybody. All that the State has to do is to put more money into the hands of the people and thereby to increase demand. It is wrong, this official full-employment doctrine goes on to assert, to call an increase in the quantity of money created for this purpose, inflation. It is just “full-employment” policy. Those “reactionaries” who ramble on about monetary stability and the return to gold are depicted as the worst enemies of civilization, public welfare and the common man.

The climate of opinion of the United States is fully dominated by these ideas. The unions are in a position to succeed in what are euphemistically called wage negotiations because the laws are loaded in favor of the unions and because the Government is always prepared to use its power to their advantage. (In this regard it does not make much difference whether the Administration is Republican or Democratic.) From time to time the unions ask for raises; the employers are forced to yield; as soon as business begins to slacken and workers are discharged, public opinion vehemently asks for more “easy money.” After a short period of hesitation the Administration gives in and puts pressure upon the Federal Reserve Board to reduce interest rates, so as to increase the quantity of money and make it “easier.”

A Few Dissenters

Fortunately the inflationary policy is still seriously resisted by a group of critics who are not numerous but who are conspicuous by their competence and familiarity with the problems involved. Among these dissenters are several eminent writers, a few influential businessmen and, what is worthy of notice, also some members of the Federal Reserve Board. This handful of men do not have the power to put an end to this nefarious monetary and credit policy. Yet their weighty reasoning has in the last years, especially under President Eisenhower’s regime, succeeded in keeping the inflationary ventures within narrow limits. It is the merit of their warning voices that the world’s richest country has up to now not embarked upon the pernicious policy of runaway inflation.

The full significance of this success can only be appreciated if one takes into account the vehemence of the pro-inflationist propaganda of university teachers and of “progressive” politicians and journalists. Some of the utterances of these people are really amazing. Thus several years ago the then Chairman of the Federal Reserve Bank of New York declared: “Final freedom from the domestic money market exists for every sovereign national state where there exists an institution which functions in the manner of a modern central bank, and whose currency is not convertible into gold or into some other commodity.” The lecture that contained this statement had the characteristic title: “Taxes For Revenue Are Obsolete.” In the same vein, a professor of economics pointed out, in a voluminous work, that the government, “can raise all the money it needs by printing it”; the purpose of taxation is “never to raise money” but “to leave less in the hands of the taxpayer.”

The weakness of the small group advocating sound monetary policy and fighting all inflationary measures is their disinclination to attack the “full employment” doctrine openly and directly. It is practically impossible to bring this issue up before the public. Certainly there are men with the courage to risk their careers or even their personal safety by criticizing the “full employment” doctrine. But there are neither newspapers nor publishers who would dare to spread doctrines that criticize and reject the institution of unionism in principle. Even those writers who occasionally expose blackmail and embezzlement on the part of individual union officers emphasize again and again that they consider the institution of unionism as such, and the policies of the unions, as beneficial to the welfare of the wage earners and the whole nation; they merely intend to free the unions from dishonest leaders. As long as such ideas about the effects of unionism prevail, even modest attempts at repealing the privileges granted to the unions by the New Deal are doomed to fail, and there cannot be any question of Protecting enterprises and those willing to work against violence on the part of the unions.

At the most recent meeting of the International Monetary Fund there was much talk about the danger of inflation. In order to fight this danger, it is no longer enough to work for a better understanding of monetary problems. It is no less important to enlighten public opinion about the absurdity of the “full-employment” doctrine that guides the conduct of all governments and all political parties today.

Reprinted from National Review, June 22, 1957.

Most people take it for granted that the world will never return to the gold standard. The gold standard, they say, is as obsolete as the horse and buggy. The system of government-issued fiat money provides the treasury with the funds required for an open-handed spending policy that benefits everybody; it forces prices and wages up and the rate of interest down and thereby creates prosperity. It is a system that is here to stay.

Now whatever virtues one may ascribe—undeservedly—to the modern variety of the greenback standard, there is one thing that it certainly cannot achieve. It can never become a permanent, lasting system of monetary management. It can work only as long as people are not aware of the fact that the government plans to keep it.

The Alleged Blessings of Inflation

The alleged advantages that the champions of fiat money expect from the operation of the system they advocate are temporary only. An injection of a definite quantity of new money into the nation’s economy starts a boom as it enhances prices. But once this new money has exhausted all its price-raising potentialities and all prices and wages are adjusted to the increased quantity of money in circulation, the stimulation it provided to business ceases. Thus even if we neglect dealing with the undesired and undesirable consequences and social costs of such inflationary measures and, for the sake of argument, even if we accept all that the harbingers of “expansionism” advance in favor of inflation, we must realize that the alleged blessings of these policies are short-lived. If one wants to perpetuate them, it is necessary to go on and on increasing the quantity of money in circulation and expanding credit at an ever-accelerated pace. But even then the ideal of the expansionists and inflationists, viz., an everlasting boom not upset by any reverse, could not materialize.

A fiat-money inflation can be carried on only as long as the masses do not become aware of the fact that the government is committed to such a policy. Once the common man finds out that the quantity of circulating money will be increased more and more, and that consequently its purchasing power will continually drop and prices will rise to ever higher peaks, he begins to realize that the money in his pocket is melting away. Then he adopts the conduct previously practiced only by those smeared as profiteers; he “flees into real values.” He buys commodities, not for the sake of enjoying them, but in order to avoid the losses involved in holding cash. The knell of the inflated monetary system sounds. We have only to recall the many historical precedents beginning with the Continental Currency of the War of Independence.

Why Perpetual Inflation Is Impossible

The fiat-money system, as it operates today in this country and in some others, could avoid disaster only because a keen critique on the part of a few economists alerted public opinion and forced upon the government cautious restraint in their inflationary ventures. If it had not been for the opposition of these authors, usually labeled orthodox and reactionary, the dollar would long since have gone the way of the German mark of 1923. The catastrophe of the Reich’s currency was brought about precisely because no such opposition was vocal in Weimar Germany.

Champions of the continuation of the easy money scheme are mistaken when they think that the policies they advocate could prevent altogether the adversities they complain about. It is certainly possible to go on for a while in the expansionist routine of deficit spending by borrowing from the commercial banks and supporting the government bond market. But after some time it will be imperative to stop. Otherwise the public will become alarmed about the future of the dollar’s purchasing power and a panic will follow. As soon as one stops, however, all the unwelcome consequences of the aftermath of inflation will be experienced. The longer the preceding period of expansion has lasted, the more unpleasant those consequences will be.

The attitude of a great many people with regard to inflation is ambivalent. They are aware, on the one hand, of the dangers inherent in a continuation of the policy of pumping more and more money into the economic system. But as soon as anything substantial is done to stop increasing the amount of money, they begin to cry out about high interest rates and bearish conditions on the stock and commodity exchanges. They are loath to relinquish the cherished illusion which ascribes to government and central banks the magic power to make people happy by endless spending and inflation.

Full Employment and the Gold Standard

The main argument advanced today against the return to the gold standard is crystallized in the slogan “ full-employment policy.” It is said that the gold standard paralyzes efforts to make unemployment disappear.

On a free labor market the tendency prevails to fix wage rates for every kind of work at such a height that all employers ready to pay these wages find all the employees they want to hire, and all job-seekers ready to work for these wages find employment. But if compulsion or coercion on the part of the government or the labor unions is used to keep wage rates above the height of these market rates, unemployment of a part of the potential labor force inevitably results.

Neither governments nor labor unions have the power to raise wage rates for all those eager to find jobs. All they can achieve is to raise wage rates for the workers employed, while an increasing number of people who would like to work cannot get employment. A rise in the market wage rate—i.e., the rate at which all job-seekers finally find employment—can be brought about only by raising the marginal productivity of labor. Practically, this means by raising the per-capita quota of capital invested. Wage rates and standards of living are much higher today than they were in the past because under capitalism the increase in capital invested by far exceeds the increase in population. Wage rates in the United States are many times higher than in India because the American percapita quota of capital invested is many times higher than the Indian per-capita quota of capital invested.

There is only one method for a successful “full-employment policy”: let the market determine the height of wage rates. The method that Lord Keynes has baptized “full-employment policy” also aimed at re-establishment of the rate which the free labor market tends to fix. The peculiarity of Keynes’ proposal consisted in the fact that it proposed to eradicate the discrepancy between the decreed and enforced official wage rate and the potential rate of the free labor market by lowering the purchasing power of the monetary unit. It aimed at holding nominal wage rates, i.e., wage rates expressed in terms of the national fiat money, at the height fixed by the government’s decree or by labor union pressure. But as the quantity of money in circulation was increased and consequently a trend toward a drop in the monetary unit’s purchasing power developed, real wage rates, i.e., wage rates expressed in terms of commodities, would fall. Full employment would be reached when the difference between the official rate and the market rate of real wages disappeared.

There is no need to examine anew the question whether the Keynesian scheme could really work. Even if, for the sake of argument, we were to admit this, there would be no reason to adopt it. Its final effect upon the conditions of the labor market would not differ from that achieved by the operation of the market factors when left alone. But it attains this end only at the cost of a very serious disturbance in the whole price structure and thereby the entire economic system. The Keynesians refuse to call “inflation” any increase in the quantity of money in circulation that is designed to fight unemployment. But this is merely playing with words. For they themselves emphasize that the success of their plan depends on the emergence of a general rise in commodity prices.

It is, therefore, a fable that the Keynesian full-employment recipe could achieve anything for the benefit of the wage earners that could not be achieved under the gold standard. The full-employment argument is as illusory as all the other arguments advanced in favor of increasing the quantity of money in circulation.

The Specter of an Unfavorable International Balance

A popular doctrine maintains that the gold standard cannot be preserved by a country with what is called an “unfavorable balance of payments.” It is obvious that this argument is of no use to the American opponents of the gold standard. The United States [1953] has a very considerable surplus of exports over imports. This is neither an act of God nor an effect of wicked isolationism. It is the consequence of the fact that this country, under various titles and pretexts, gives financial aid to many foreign nations. These grants alone enable the foreign recipients to buy more in this country than they are selling in its markets. In the absence of such subsidies it would be impossible for any country to buy anything abroad that it could not pay for, either by exporting commodities or by rendering some other service such as carrying foreign goods in its ships or entertaining foreign tourists. No artifices of monetary policy, however sophisticated and however ruthlessly enforced by the police, can in any way alter this fact.

It is not true that the so-called have-not countries have derived any advantage from their abandonment of the gold standard. The virtual repudiation of their foreign debts, and the virtual expropriation of foreign investments that it involved, brought them no more than a momentary respite. The main and lasting effect of abandoning the gold standard, the disintegration of the international capital market, hit these debtor countries much harder than it hit the creditor countries. The falling off of foreign investments is one of the main causes of the calamities they are suffering today.

The gold standard did not collapse. Governments, anxious to spend, even if this meant spending their countries into bankruptcy, intentionally aimed at destroying it. They are committed to an anti-gold policy, but they have lamentably failed in their endeavors to discredit gold. Although officially banned, gold in the eyes of the people is still money, even the only genuine money. The more prestige the legal-tender notes produced by the various government printing offices enjoy, the more stable their exchange ratio is against gold. But people do not hoard paper; they hoard gold. The citizens of this country, of course, are not free to hold, to buy, or to sell gold.1  If they were allowed to do so, they certainly would.

No international agreements, no diplomats, and no supernational bureaucracies are needed in order to restore sound monetary conditions. If a country adopts a non-inflationary policy and clings to it, then the condition required for the return to gold is already present. The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity.

The excellence of the gold standard is to be seen in the fact that it makes the monetary unit’s purchasing power independent of the arbitrary and vacillating policies of governments, political parties, and pressure groups. Historical experience, especially in the last decades, has clearly shown the evils inherent in a national currency system that lacks this independence.

Reprinted from The Freeman, July 13, 1953.

• 1This right to own gold was restored to U.S. citizens as of January 1, 1975.

There has been so much learned talk about the threats and dire consequences of inflation that plain folks begin to be suspicious. Did not the economists of the 1920s, except for a few outsiders whom the others scorned as orthodox doctrinarians, forecast everlasting prosperity? What if their present fears are no better founded than their optimism fifteen years ago? The layman, therefore, has the right to ask the specialist to explain the matter and to do so in simple terms. We economists should not be exempt indefinitely from the obligation, which is accepted by doctors, engineers, and other scientists, of making ourselves understood by the layman. The obligation is clear-cut in the matter of inflation, an economic problem which is as close to every American as his own skin.

Everybody knows that inflation consists of a large increase in the available quantity of money and money substitutes such as bank credits. In a country like the United States, which transacts so much of its business by checks and through bank credits, the main vehicle of inflation is not so much the printing of additional paper money as the increase of deposit currency. Everybody also knows that a general rise of prices and wages is the unavoidable and inescapable result of inflation. And finally, most people realize that when inflation is going on price control is a quite ineffective method of controlling prices and wages; at best, it is a temporary expedient to break or postpone the force of inflationary effects.

There is widespread ignorance, however, concerning the social implications of inflation. How will it affect you personally, if you are a professional man, a worker, a farmer? What will it do to your possessions, your debts, your insurance policies?

Social and Economic Effects of Inflation

The first fact that needs to be noted in answering such questions is that inflation is detrimental to all creditors. The higher prices rise, the lower will fall the purchasing power of the principal and interest payments due. The dollar which was loaned out had a higher purchasing ability, could provide more goods, than the dollar which is paid back.

And who is a creditor? Does inflation touch only businessmen and financiers? Nothing of the sort. You who read these lines are certainly a creditor. Every person who has a legal claim to deferred payments of any kind is a creditor. If you have a savings account with a bank, if you own bonds, if you are entitled to a pension, if you have paid for an insurance policy, you are a creditor, and are, hence, directly hit by inflation.

Professional men, civil servants, commissioned officers of the armed forces, teachers, most white-collar workers, salaried employees, skilled specialists, mechanics, and engineers normally provide for their own old age and for their dependents in ways that make them creditors, that is through savings, insurance, pensions, and annuities. Moreover, Social Security has brought the great masses of ordinary workers into the ranks of creditors. For all these millions of people, every further step towards inflation means a further decline in the real value of the claims or credits they have saved up by years of toil and sacrifice. They will collect the number of dollars to which they are entitled?but each of those dollars will be thinner than it used to be, capable of providing less food, clothing, and shelter.

The loss of the creditor, of course, is the profit of the debtor. The man who borrowed a thousand or a million full-sized dollars repays his lender with a thousand or a million depreciated dollars. The mortgages on farms and on real estate, the debts owed by industrial enterprises, all shrink as inflation proceeds. Thus, a comparatively small group of debtors is favored at the expense of the teeming groups of creditors.

The most fateful results of inflation derive from the fact that the rise of prices and wages which it causes occurs at different times and in a different measure for various kinds of commodities and labor. Some classes of prices and wages rise more quickly and rise higher than others. Not merely inflation itself, but its unevenness, works havoc.

While inflation is under way, some people enjoy the benefit of higher prices for the goods or services they sell, while the prices for goods and services they buy have not yet risen or have not risen to the same extent. These people profit from their fortunate position. Inflation seems to them “good business,” a “boom.” But their gains are always derived from the losses of other sections of the population. The losers are those in the unhappy situation of selling services or commodities whose prices have not yet risen to the same degree as have prices of the things they buy for daily consumption.

These victims, by and large, are the same kind of people?roughly, the middle classes?who are injured as creditors through the depreciation of their bank savings, insurance policies, pensions, etc. The salaries of teachers and ministers, the fees of doctors, go up only slowly as compared to the tempo with which prices of food, rent, clothing, and so on, go up. There is always a considerable time lag between the increase in the money income of the white-collar workers and professional people and the increase in costs of food, clothing, and other necessities.

Hedging Against Inflation

Has the average man any means of evading the detrimental effects of inflation?

Those insured, or entitled to pensions or social security benefits, cannot avoid being victimized. And the picture is not much brighter for other groups of creditors. Of course, the bondholder may sell his bonds and the bank depositor may withdraw his balance. But if they keep the money, they are no less subject to the harmful effects of the fall in the money’s purchasing power. In other words, the dollar continues to evaporate whether it is resting in a bank, a bond, or a strongbox at home.

For the Europeans, struck by the great inflations of World War I and its aftermath, there was a simple means of escape. They needed only to change their local currencies for the money of a country with a sound currency. They bought dollars or they bought gold. It might have been illegal, but it worked. For Americans, no such remedy is available. If the dollar goes bad, no foreign currency can conceivably prove better. At the same time, the U.S. government has closed the avenue of escape by forbidding its citizens to own gold coins or ingots.1

You may buy a farm. But that is a remedy only if you become a farmer and till the soil with your own hands. Otherwise, it is a remedy not for yourself but for the tenant who works the farm. It may reasonably be expected that, in the course of inflation, new laws will safeguard tenants?whether on farms or in residences?against rises in rent.2  In European inflations, rents were always restricted by legislation.

You may buy a home for yourself and your family. But in a period of inflation, economic conditions change swiftly and in unexpected ways. You cannot foresee whether it will be necessary suddenly to change your place of residence and employment. Then you will have to sell the house?renting it is almost useless?and experience proves that such forced sales rarely bring the amounts laid out for acquiring the property.

You may buy common stock. But the experts are convinced that taxation will confiscate not only the profits but a good deal of the capital invested, too. While the prices of all commodities are rising, stock market quotations may still cling more or less to pre-inflation levels. This means that in owning common stock you are not much better protected than in owning bonds.

You may buy jewelry and other valuables. But you cannot always expect to sell these at a later date for what you paid for them. Nobody knows in advance how the market conditions for any given valuable will develop. Diamonds and rubies, for instance, may hold much of their value. But what if the owners of the largest hoards of precious stones should unload them because of changing political or social conditions?

Neither is it possible to escape the detrimental effects of the time lag between the rise of different prices and wages. Trade union policies are futile in this connection. As long as the war (World War II) is going on, labor may succeed in obtaining, at least for some groups, wages which correspond to the rise of commodity prices. But sooner or later if industry does not keep pace, they will face the choice between a sharp decline in wages and the maintenance of high wage levels with long-lasting unemployment for millions. In the long run, inflation hurts the interests of all groups of labor, as well as those of the middle classes.

There is only one class which, as a whole, derives profit from inflation: the indebted farmers. Their mortgages are wiped out and the products of their own toil bring higher returns corresponding to the higher prices they must pay for things they purchase.

The owners of really large fortunes, too, may succeed in preserving a greater or smaller portion of their wealth, but inflation results in the consumption of a good deal of a nation’s capital stock.

Even if some special groups profit, the whole country is poorer.

Moral and Political Effects of Inflation

Worse than the immediate economic consequences of inflation are its attendant moral and political dangers.

It has been asserted that Nazism is the fruit of the vast German inflation of 1923. That is not quite correct. It would be more correct to say that the great inflation and the Nazi scourge both derived from the mentalities and the doctrines that long dominated German public opinion. The State, which the German socialist Ferdinand Lassalle had already proclaimed as god, was supposed to be able to achieve anything. The omnipotent State was credited with the magic power of unlimited spending without any burden on the citizenry. Money, said the German “monetary cranks,” is a creature of the State; there is no harm in issuing infinite quantities of paper currency.

Fortunately, such superstitions are strange to the healthy common sense of America. Inflation, therefore, will never go as far in this country as it did in Germany. Even a much more moderate inflation, however, shakes the foundations of a country’s social structure. The millions who see themselves deprived of security and well-being become desperate. The realization that they have lost all or most all of what they had set aside for a rainy day radicalizes their entire outlook. They tend to fall easy prey to adventurers aiming at dictatorship, and to charlatans offering patent-medicine solutions. The sight of some people profiteering while the rest suffer infuriates them. The effect of such an experience is especially strong among the youth. They learn to live in the present and scorn those who try to teach them “old-fashioned” morality and thrift.

Inflation and Government Borrowing

The writer, having witnessed the course of inflations in one European nation after another, believes that it is not too late to stop further inflation in the United States by bold and painful measures. Inflation is not an act of God. It is a result of the methods used to provide a part of the means for the conduct of the war. One set of methods can still be replaced by another, less harmful set. It is still possible to keep down the amount of money and money substitutes by financing the total amount necessary through taxation and loans.

People sometimes call inflation a special way of “taxing” a country’s citizens. This is a dangerous opinion. And it is wholly untrue. Inflation is not a method of taxation, but an alternative for taxation. When a government imposes taxes, it has full control. It can tax and distribute the burden any way it considers fair and desirable, allotting a larger share of the tax burden to those who are better able to carry it, reducing the burden on the less fortunate. But in the case of inflation, it sets in motion a mechanism that is beyond its control. It is not the government, but the operation of the price system, that decides how much this or that group will suffer.

And there is another important difference. All taxes collected flow into the vaults of the public treasury. But with inflation, the public treasury’s gain is less than what it costs the individual citizen, since a considerable part of that cost is drained off by the profiteers, the minority that benefits from the inflation.

It is no less fallacious to consider inflation as a method of raising loans for public use. Technically, inflation does increase the total of the government’s indebtedness to the banks. But the banks’ intervention is only instrumental. If the government borrows from the banks, the banks do not grant loans out of their own funds, or out of money deposited with them by the public; the banks are not real lenders; they grant the loans out of their “excess reserves.” They merely expand credit for the benefit of the government. In other words, they increase the quantity of money substitutes.

When you as an individual buy a government bond, you make a loan to the government; you put part of your cash holdings into the hands of the treasury. There is then no increase in the total quantity of currency or credits available and hence no inflation.

However, it is different when government borrows from the banks’ “excess reserves.” Their so-called “excess reserves” are not a tangible thing. The term is merely a phrase indicating the limits within which the law is prepared to tolerate credit expansion, that is to say further inflation. The effects of loans from available “excess reserves” are just as inflationary as the effects of issuing more paper money. It is a mistake, therefore, to confuse this government “borrowing” from the “excess reserves” of the banks with genuine loans.

Popular education is absolutely essential. It is clear that the efforts of the U.S. government to collect the means necessary for the conduct of the war by taxation and by sale of government bonds represent sound measures for heading off inflation. Everybody should be made to understand that the burden of high taxes and of making personal loans to the government are minor evils compared to the disastrous and inexorable consequences of inflation. Not only for the sake of the national welfare, but for the sake of your own interests?whether you are rich or poor, employer or wage earner?you should do your best to arrest the further progress of inflation.

Reprinted from Mercury, July 1942.

• 1From 1933 to 1975, U.S. citizens were prohibited by law from owning monetary gold.
• 2In October of 1942, Congress “authorized and directed” President Roosevelt to control prices, wages, salaries, and rents. Nationwide price, wage, and rent controls continued throughout the war, but were ended shortly thereafter. However, some cities chose to continue rent controls thus distorting the market and prices, and producing persistent shortages of rental housing in those localities.

The government provides a part of the funds required for rearmament by inflation, that is, by increasing the quantity of money in circulation and the amount of bank balances subject to check.

The unavoidable consequence of inflation is the emergence of a general tendency of all prices to rise. If the government had procured all the money it needed for rearmament by taxing the citizens, the increased demand on its part would have been counteracted by a drop in the purchases of the taxpayers. The expanded military consumption would have been neutralized on the market by a restriction in civilian consumption. But with inflation the additional demand of the armed forces comes on top of the non-decreased demand of the public and makes prices soar.

What the bureaucrats have in mind when talking about “fighting” inflation is not avoiding inflation, but suppressing its inevitable consequences by price control. This is a hopeless venture. The attempt to fix prices at a lower rate than that which the unhampered market would determine renders unremunerative the business of some producers; that is, those operating at the highest costs. This forces them to discontinue production.

Wartime Experience

Inflation, in conjunction with price control, brings about scarcity. Housewives remember very well what happened in World War II with meat, butter, eggs, and many other articles under the regime of the Office of Price Administration. Yet price control has been re-established.1  If Congress does not let the present price control law expire on June 30, as scheduled, the country will very soon experience anew not only all the hardships of inflation, but also all the evils created by the vain attempts to conceal these hardships by price control.

Economists know very well that there is only one means available to prevent a further rise in all commodity prices, namely, to end inflation entirely. If the government obtains all its funds from the public and stops increasing the quantity of money in circulation and borrowing from the commercial banks, prices will remain unchanged, by and large, and there will not be any need for the activities of a price dictator.

But the administration does not want to stop inflation. It does not want to endanger its popularity with the voters by collecting, through taxation, all it wants to spend. It prefers to mislead the people by resorting to the seemingly non-onerous method of increasing the supply of money and credit. Yet, whatever system of financing may be adopted, whether taxation, borrowing, or inflation, the full incidence of the government’s expenditures must fall upon the public.

With inflation as well as with taxation, it is the citizens who must foot the total bill. The distinguishing mark of inflation, when considered as a method of filling the vaults of the Treasury, is that it distributes the burden in a most unfair way, overcharging those who are least able to bear it.

A Semantic Trick

To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call “inflation” the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase.

They put the responsibility for the rising cost of living on business, This is a classical case of the thief crying “catch the thief.” The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices. While the Office of Stabilization and Price Control is busy annoying sellers as well as consumers by a flood of decrees and regulations, the only effect of which is scarcity, the Treasury goes on with inflation.

Reprinted from the New York World Telegram & Sun, May 7, 1951.

• 1After the outbreak of the Korean conflict in June 1950, President Truman was authorized under the Defense Production Act (signed September 8, 1950) to “stabilize prices and wages.” This price control law was revised several times and extended until April 30, 1953. Eisenhower, who had become President in January 1953, did not request a further extension and it was allowed to expire.

In dealing with problems concerned with the economics of mobilization, it is first of all necessary to realize that fiscal policies have reached a turning point.

In recent decades all nations have looked upon the income and the wealth of the more prosperous citizens as an inexhaustible reserve which could be freely tapped. Whenever there was need for additional funds, one tried to collect them by raising the taxes to be paid by the upper-income brackets. There seemed to be enough money for any suggested expenditure because there seemed to be no harm in “soaking the rich” a bit more. As the votes of these rich do not count much in elections, the members of the legislative bodies were always ready to increase public spending at their expense. There is a French dictum: Les affaires, c’est l’argent des autres. “Business is other people’s money.” In these last 60 years political and fiscal affairs were virtually “other people’s money.” Let the rich pay, was the slogan.

End of an Era

Now this period of fiscal history has come to an end. With the exception of the United States and some of the British Dominions, what has been called the ability-to-pay of the wealthy citizens has been completely absorbed by taxes. No further funds of any significance can be collected from them. Henceforth all government spending will have to be financed by taxing the masses.

The European nations concerned are not yet fully aware of this fact because they have found a substitute. They are getting Marshall Plan aid; the U. S. taxpayer fills the gap.

In this country things have not yet gone as far as they have in other countries. It is still possible to raise an additional $2 or $3 billion, or perhaps even $4 billion, by increasing corporation taxes, and “excess profits” taxes, and by rendering the personal income tax more progressive. But under present conditions, even $4 billion would be only a fraction of what the Treasury needs. Thus, in this country we are also at the end of a period of fiscal policies. The whole philosophy of public finance must undergo a revision. In considering the pros and cons of a suggested expenditure the members of Congress will no longer be able to think: The rich have enough; let them pay. In the future, the voters on whose ballots the Congressmen depend will have to pay.

Inflation, an increase in money and credit, is certainly not a means to avoid or to postpone for more than a short time the need to resort to taxes levied on people other than those belonging to the rich minority. If, for the sake of argument, we leave aside all the objections which may be raised against any inflationary policy, we must take into account the fact that inflation can never be more than a temporary makeshift. Inflation cannot be continued over a long period of time without defeating its fiscal purpose and ending in a complete debacle as was the case in this country with the Continental currency, in France with the mandats territoriaux and in Germany with the mark in 1923.

What makes it possible for a government to increase its funds by inflation is the ignorance of the public. The people must ignore the fact that the government has chosen inflation as a fiscal system and plans to go on with inflation endlessly. It must ascribe the general rise in prices to other causes than to the policy of the government and must assume that prices will drop again in a not-too-distant future. If this opinion fades away, inflation comes to a catastrophic breakdown.

The Housewife’s Behavior

If the housewife who needs a new frying pan reasons: “Now prices are too high; I will postpone the purchase until they drop again,” inflation can still fulfill its fiscal purpose. As long as people share this view, they increase their cash holdings and bank balances, and a part of the newly created money is absorbed by these additional cash holdings and bank balances; prices on the market do not rise in proportion to the inflation.

But then?sooner or later?comes a turning point. The housewife discovers that the government expects to go on inflating and that consequently prices will continue to rise more and more. Then she reasons: “I do not need a new frying pan today; I shall only need one next year. But I had better buy it now because next year the price will be much higher.” If this insight spreads, inflation is done for, Then all people rush to buy. Everybody is anxious to reduce his holding of cash because he does not want to be hurt by the drop in the monetary unit’s purchasing power. The phenomenon then appears which, in Europe was called the “flight into real values.” People rush to exchange their depreciating paper money for something tangible, something real. The knell sounds of the currency system involved.

In this country we have not yet reached this second and final stage of every protracted inflation. But if the authorities do not very soon abandon any further attempt to increase the amount of money in circulation and to expand credit, we shall one day come to the same unpleasant result. It is not a matter of choosing between financing the increased government expenditure by collecting taxes and borrowing from the public on the one hand and financing it by inflation on the other hand. Inflation can never be an instrument of fiscal policy over a long period of time. Continued inflation inevitably leads to catastrophe.

Therefore, we should not waste our time in discussing methods of price control. Price control cannot prevent the rise in prices if inflation is going on. Even capital punishment could not make price control work in the days of Emperor Diocletian or during the French Revolution. Let us concentrate our efforts on the problem of how to avoid inflation, not upon useless schemes of how to conceal its inexorable consequences.

Taxation the Key

What is needed in wartime is to divert production and consumption from peacetime channels toward military goals. In order to achieve this, it is necessary for the government to tax the citizens, to take away from them the money, which they would otherwise spend for things they must no longer buy and consume, so the government can spend it for the conduct of the war.

At the breakfast table of every citizen in wartime sits an invisible guest, as it were, a GI who shares his meal. Parked in the citizen’s garage is not only the family car, but also?invisibly?a tank or a plane. The important fact is that a GI needs more in food, clothing, and other things than he used to consume as a civilian. And military equipment wears out much more quickly than civilian equipment. The costs of a modern war are enormous.

The adequate method of providing the funds the government needs for war is, of course, taxation. Part of the funds may also be provided by borrowing from the public, the citizens. But if the Treasury increases the amount of money in circulation or borrows from the commercial banks, it inflates. Inflation can do the job for a limited time. But it is the most expensive method of financing a war; it is socially disruptive and should be avoided.

Inflation: A Convenient Makeshift

There is no need to dwell upon the disastrous consequences of inflation. All people agree in this regard. But inflation is a very convenient makeshift for those in power. It is a handy means to divert the resentment of the people from the government. In the eyes of the masses, big business, the “profiteers,” the merchants,?not the Administration?appear responsible for the rise in prices and the ensuing need to restrict consumption.

Perhaps somebody will consider what I am saying here as anti-democratic, reactionary, and economic royalism. But the truth is that inflation is a typically anti-democratic measure. It is a policy of governments that do not have the courage to tell the people honestly what the real costs of their conduct of affairs are.

A truly democratic government would have to tell the voters openly that they must pay higher taxes because expenses have risen considerably. But it is much more agreeable for a government to present only a part of the bill to the people and to resort to inflation for the rest of its expenditures. What a triumph if they can say: Everybody’s income is rising, everybody has now more money in his pocket, business is booming.

Deficit spending is not a new invention. During the greater part of the 19th century it was the preferred fiscal method of precisely those governments that were not then considered democratic and progressive?Austria, Italy, and Russia. Austria’s budget showed a deficit yearly from 1781 on, until the late ‘80s of the 19th century, when an orthodox professor of economics, Dunajewski, as Minister of Finance, restored the budgetary equilibrium. There is no reason to be proud of deficit spending, nor to call it progress.

Going After Lower Brackets

If one wants to collect more taxes, it will be necessary to lay a burden greater than hitherto on the lower income brackets, the strata of society whose members consume the much greater part of the total amount consumed in this country. Up to now it has been customary to tax predominantly corporations and individuals with higher incomes. But even the outright confiscation of these revenues would only cover a fraction of the additional funds the country needs today.

Some experts have declared that it is necessary to tax the people until it hurts. I disagree with these sadists. The purpose of taxation is not to hurt, but to raise the money the country needs to rearm and to fight in Korea. It is a sad fact that world affairs now make it necessary for the government to force people who used to buy nylon stockings and shirts to shift to other du Pont products, namely munitions.

In his book on Eternal Peace, the German philosopher Immanuel Kant (1724-1804) suggested that government should be forbidden to finance wars by borrowing. He expected that the warlike spirit would dwindle if all countries had to pay cash for their wars. However, no serious objection can be raised against borrowing from the public, from people who have saved and are prepared to invest in government bonds. But borrowing from the commercial banks is tantamount to printing additional bank notes and expanding the amount of deposits subject to check. That is inflation.

Semantic Confusion

There is nowadays a very reprehensible, even dangerous, semantic confusion that makes it extremely difficult for the non-expert to grasp the true state of affairs. Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term “inflation” to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. It follows that nobody cares about inflation in the traditional sense of the term. As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this technological confusion is not entirely wiped out, there cannot be any question of stopping inflation.

Look at the silly term, “inflationary pressures.” There is no such thing as an “inflationary pressure.” There is inflation or there is the absence of inflation. If there is no increase in the quantity of money and if there is no credit expansion, the average height of prices and wages will by and large remain unchanged. But if the quantity of money and credit is increased, prices and wages must rise, whatever the government may decree. If there is no inflation, price control is superfluous. If there is inflation, price control is a sham, a hopeless venture.

It is the government that makes our inflation. The policy of the Treasury, and nothing else.

We have been told a lot about the need for, and the virtues of, direct controls.

We have learned that they preserve the individual’s liberty to choose the grocer he prefers. I do not want to examine what value may be attached to direct controls from a metaphysical point of view. I only want to stress one fact: As a means for preventing and fighting inflation or its consequences, direct controls are absolutely useless.

Transcript of remarks before the Conference on the Economics of Mobilization, held at White Sulphur Springs, West Virginia, April 6-8, 1951, under the sponsorship of the University of Chicago Law School. Reprinted from The Commercial and Financial Chronicle, April 26, 1951.

The most serious dangers for American freedom and the American way of life do not come from without. They are not of a military character. Neither will socialism conquer this country?and, for that matter, the civilized nations of Western Europe?in the shape of an open surrender to the program of the Communist International. Whatever chances socialism may have in the United States are due to the economic policies of our own political parties that gradually undermine the economic and social foundations of American freedom and prosperity.

Both traditional parties, the Republicans as well as the Democrats, are sincere in protesting their abhorrence of totalitarianism. The voters in casting their ballots for either of these parties are fully convinced that they are voting for officeholders who are firmly committed to the preservation intact of the Constitution and all the freedoms it grants to the individual citizens. These politicians and their supporters would be seriously alarmed if they realized that they are virtually paving the way for a system that does not differ essentially from the totalitarian system they decidedly reject.

Socialism and Planning Not Different from Communism

The fundamental fallacy that leads contemporary political thinking astray is to be seen in the fictitious distinction between communism on the one side and socialism and planning on the other side.

The two terms socialism and communism are synonyms. Communism is a very old term, while the term socialism was first coined in France at the end of the 1830s. Up to the year 1917 both were used indiscriminately. Thus Marx and Engels called the program they published in 1848 the Communist Manifesto, while the parties they organized for the realization of this program called themselves socialist parties.

Before 1917 no distinction was made between the two words. When Lenin called his party “communist,” he meant that it was a party sincerely aiming at the realization of socialism as distinct from the parties that, according to Lenin, merely called themselves socialist parties while in fact they were “social traitors” and “servants” of the bourgeoisie. Lenin never pretended that his Communist party had any other goal than the realization of socialism. The official name he gave to his government was?and is?the Union of the Soviet Socialist Republics. If somebody says he is opposed to communism, but cherishes socialism, he is no more consistent or logical than a man who declares that he is opposed to murder but cherishes assassination.

The essential feature of the socialist, or communist conduct of affairs is the substitution of the government’s unique plan for the plans of individual citizens. “Planning” is therefore nothing but one term more to signify what the terms socialism and communism are designed to signify.

Yet many leaders of our political parties are deluded by the idea that socialism and planning are something different from communism and that in fostering these schemes they are opposing communism, while in fact they are fully adopting the Communist program. Of course, these confused politicians pretend that what they are aiming at is a socialist system that preserves democracy and representative government. They say they want to abolish “only” economic freedom and to retain political freedom. They are at a loss to realize that economic control is not merely control of one sector of human life which can he separated from other sectors. If the government controls all material factors of production, it controls all aspects of the individuals’ activities. If it controls all publishing facilities, all printing presses, radio, television, and all assembly halls, every political activity depends on the discretion of the authorities. If everybody is bound to work according to the orders of the government, only those whom the rulers trust are free to devote their time and their efforts to public affairs. It is not an accident that representative government and civil liberties developed step by step with the substitution of capitalism for feudalism and disappeared everywhere as soon as socialism?whether the “right” model (German Nazism and Italian Fascism) or the “left” model (Russian Bolshevism)?supplanted the market economy. Despotism is the necessary political corollary of socialism just as representative government is the necessary constitutional corollary of capitalism.

Unwitting Support of Socialism by Inflationary Policies

Certainly there are many among the “left” wing leaders of both political parties who are consciously intent upon abolishing any trace of freedom and converting America into a full replica of the Soviet system. But most of our politicians and the rank and file of the voters are not guilty of such a betrayal. On the contrary, they are anxious to preserve the traditional system of government, the free institutions, established by the founding fathers, the institutions that were the foundations of this country’s greatness, glory and prosperity, as they were the essential features of the civilization of Western Europe. But even these sincere advocates of liberty are, unbeknown to themselves, undermining the “American way of life.” They are lending a helping hand to allegedly beneficial economic policies that, on the one side, sabotage the operation of the market economy and, on the other side, restrict the individuals’ self-determination by expanding the field of government control, euphemistically called “social” control.

The most detrimental of all varieties of economic policies is inflation, i.e., the policy of increasing the supply of money and money substitutes. If additional legal-tender banknotes are issued or if additional bank balances subject to check (checkbook money) are created, nothing is added to the material wealth of a country. But those persons into whose pockets these newly created means of payment are flowing are thereby in a position to expand their purchases. Thus an additional demand for commodities and services comes into being while the supply of such commodities and services has not been increased. The inevitable outcome is a tendency for prices to soar.

There is no need to depict in detail the unwelcome, nay the catastrophic effects of such a state of affairs. Everybody is familiar with them; everybody knows how he was hurt by them. Among reasonable men there is hardly anybody who would dare to advocate openly a policy of inflation. Nonetheless this country, and most other countries of the world, have for many decades been committed to inflationist measures.

The fault rests with a lack of responsibility and a fickleness of character on the part of statesmen and politicians as well as with the greed of powerful pressure groups who want to get handouts from the government, the notorious “something for nothing.” A government cannot spend but at the expense of the people. As taxes have already long since overstepped the optimum of returns and there is hardly any sizeable increase to be expected from further raising the already levied taxes or devising new ones, the main way to finance additional government spending is with inflation.

It is a serious error to assume that a nation can win and can become richer by increasing the supply of money and money substitutes. What one group of people may gain, is lost by other groups.

Inflation and the Creditors

Let us look upon one important aspect of the problem, the nexus of creditor and debtor. One of inflation’s main effects is the progressive dilution of debts. The more inflation progresses, the more is the debtor favored at the expense of the creditor. While the nominal value of a loan remains unchanged, its purchasing power shrinks more and more. Of course, some people believe that this is after all not too bad, or that it may even be desirable. The creditors, they think, are rich and will get over such losses. But the debtors are poor and will be benefited by a reduction in the burden of their debt.

Yet, this way of reasoning is entirely fallacious. It is based upon a fateful misconstruction of essential features of the capitalistic system, under which a continually increasing multitude of people with moderate means are becoming creditors.

One of the main achievements of the capitalistic system is to be seen in the opportunity it offers to the masses of citizens to save and thereby to improve their material well-being.

In the “good old days,” effectual saving was possible only for the well-to-do. The farmer, the artisan and the owner of urban real estate could fructify their thrift into improvement of their own farms, shops and buildings. But the landless worker had only one method of saving, to hoard by burying a few coins or hiding them in some other way. This was a very unsatisfactory method of saving. Its main deficiency was that it did not bear any interest and did not give the saver an opportunity to acquire a share of the material factors of production. While new capital stock was added to the already previously available equipment, while new houses and workshops were built and were better equipped, the manual worker saw no way to contribute to this effort, nor to participate directly in its fruits. In this sense, he could feel that he was a “proletarian,” a man who did not own any property and who was forever destined to live from hand to mouth.

The financial techniques of capitalism radically altered this state of affairs. Capitalism not only increased the marginal productivity of labor spectacularly and thereby raised wage rates and the employees’ standard of living. It also made it possible for thrifty laborers to join in the endeavors of accumulating capital. It inaugurated institutions to fructify everybody’s parsimony, first of all savings banks and insurance organizations. Even the smallest savings deposit bears interest. The success of these schemes was overwhelming. Billions were added to the capital working in the plants, farms, mines and transportation facilities. A continually growing part of the nation’s wealth is the counterpart of these holdings of the common man.

The Common Man a Creditor

These conditions manifest themselves in the fact that the average man is today a creditor rather than a debtor. The much talked-about rise in consumers’ credit lending, originating from installment selling and buying must not deceive us. In the balance the common man is by far a creditor, not a debtor. The billions of dollars that big business and real estate owe to mortgage banks, commercial banks, savings banks, and insurance companies belong?virtually, although not formally?to the common man. He owns corporate bonds as well as bonds issued by the U.S. Treasury and by various subdivisions of the government. And finally familiarity with these types of investment provides him with a better understanding of the ways and practices of business and thus enables him also to venture on the acquisition of common stock. One of the most characteristic developments of present-day finance, the mutual funds and kindred schemes, shows the extent to which what is called risk capital also turns into a popular way of saving and investing.

Yet, however momentous these attempts to make the common man an owner of common stock may be, the main method of making employees, in their capacity as capitalists, participate in the well-being created by the free economy is by the acquisition of titles and claims payable in definite amounts of the nation’s monetary unit. From this point too the masses acquire a lively interest in the stability of the nation’s legal tender, for the value of all kinds of deposits, bonds and insurance policies is inseparably linked to the purchasing power of the dollar. A policy of “creeping inflation” such as this country has now pursued for a long series of years?apart from all the other detrimental effects it produces?is in the strict meaning of the words antisocial and antidemocratic. It is a policy against the vital material interests of the common man. It hurts seriously those judicious and conscientious earners of wages and salaries who are intent upon improving their own and their families’ lot by thrift.

Under a sound money policy these people would become more and more deproletarianized. They would acquire a continually rising share in the nation’s wealth and become interested in the nation’s economic effort, not only as employees, but also as owners of interest-bearing investments. But under inflationary policies they see how the purchasing power of their savings, their insurance policies and their pensions is persistently dwindling. Their hopes for steady material improvement are dispelled. Their attempts to join those strata of the population who, by saving and capital accumulation are cooperating in the improvement of economic conditions, are thwarted. They become desperate and lose their confidence in the fairness and efficiency of the market economy.

The Communists Favor Inflation

The Communist chiefs know very well how their cause is furthered by undermining the purchasing power of the dollar. They know they cannot succeed in a country in which the masses of the wage earners rely upon their savings and upon other income such as pensions and social security benefits determined in fixed amounts of the nation’s legal tender. The main obstacle which their propaganda encounters in this country is the fact that the “common man” is more and more deproletarianized and sees his personal economic condition improved, not only by rising wages and salaries, but also by his claims to pensions and interest from savings. The 65 percent of the American population who hold life insurance policies are proof against the venom of the Communist slogans and so are the 47 percent of the entire population who are time depositors in mutual savings and commercial banks. But when these people see the value of their thrift continually diminished by inflation, they lose their faith in the system and become an easy prey to the mendacious incitation of the subversive parties.

It is a really diabolic makeshift to egg various pressure groups on to ask for more and more government spending to be financed by credit expansion. The bill for such government extravagance is always footed by the most industrious and provident people. It is their claims that are shrinking with the dollar’s purchasing power.

A sound monetary policy is one of the foremost means to thwart the insidious schemes of communism.

Reprinted from Christian Economics, October 18, 1960.

This country, and with it most of the Western world, is presently going through a period of inflation and credit expansion. As the quantity of money in circulation and deposits subject to check increases, there prevails a general tendency for the prices of commodities and services to rise. Business is booming.

Yet such a boom, artificially engineered by monetary and credit expansion, cannot last forever. It must come to an end sooner or later. For paper money and bank deposits are not a proper substitute for non-existing capital goods.

Economic theory has demonstrated in an irrefutable way that a prosperity created by an expansionist monetary and credit policy is illusory and must end in a slump, an economic crisis. It has happened again and again in the past, and it will happen in the future, too.

If one wants to avoid the recurrence of periods of economic depression, one must start by preventing the emergence of artificial booms. One must prevent the governments from embarking upon a policy of cheap interest rates, deficit spending, and borrowing from the commercial banks.

This is, of course, a very difficult task. Governments are in this regard very obstinate. They long for the popularity that booming business conditions seldom fail to win for the party in power. The Unavoidable crash, they think, will appear only later; then the other party will be in power and will have to account to the voters for the evils which their predecessors have sown.

Thus there is no doubt that we shall one day have to face again an economic recession, although it is impossible to determine the date of its outbreak and the degree of its severity. It will be bad indeed. But worse than the crisis itself could prove the psychological and ideological consequences of an erroneous interpretation of its causes.

For the spokesmen of the artificial expansionist policy are busy denying that economic crises are the inevitable effect of the preceding expansionist policy. They are anxious to exonerate the governments. As they see it, inherent shortcomings of the capitalist mode of production cause the periodical recurrence of bad business. There is no other means, they conclude, to avoid a crisis than to put the economic system under the full tutelage of a central planning board.

This is essentially the doctrine of Karl Marx. Those supporting it, those passionately attacking the insight that it is the policy of inflation and credit expansion which produces economic depressions are?sometimes unwittingly?serving the cause of the Communists. When the slump comes, people indoctrinated by their teachings will argue precisely as Stalin expects them to. They will think: The efforts to preserve capitalism have proved vain; capitalism necessarily results in the recurrence of economic catastrophes; if we want stability, we must turn toward Communism.

In the antagonism between the doctrine of the economists who ascribe the emergence of economic crises to the policy of credit expansion and the official doctrine that ascribes them to alleged inherent defects of capitalism there is much more at stake than a merely doctrinal quarrel. The way in which people will react to the?unfortunately hardly avoidable?letdown of business that will follow the end of the present armament boom may decide the fate of our civilization.

People must learn in time what the inevitable consequences are of the monetary and credit policies adopted by the present administration. They must realize that what the collapse of the artificial boom will establish will not be any insufficiency of capitalism, private enterprise, and the market economy, but the failure of the methods of financing public expenditure as practiced by the New Deal and the Fair Deal.

A comprehension of the nature of the boom will also make people more cautious in their business dealings. They will not fall victim to the deception that the boom will go on forever.

Reprinted from the New York World Telegram & Sun, August 28, 1951.

People by and large know today that a boom brought forth by a policy of credit expansion and “easy money” cannot last forever and must sooner or later lead to a slump. They do not want to be taken by surprise and ruined. They are anxious to learn in time when the turning point will come because they plan to arrange their affairs early enough so as not to be hurt by, or even to profit from, the crash. As they believe that economics is the art of predicting tomorrow’s business conditions, they consult the economists.

“How will business be in the coming months?” asks the newspaperman when interviewing the economist. No convention of businessmen is held without the solicited presence of a professor of economics, or the head of a bank’s research department, who in guarded language produces a cautiously qualified prediction about the nation’s, or the world’s business. Whenever and wherever a businessman catches sight of an economist, he tries to sound him out about the future state of the market.

What Brings About the Slump

Economics explains the phenomenon of the trade cycle (i.e., the repeated emergence of periods of unusually good business that are invariably followed after some time by a reversal into unusually bad business) as the necessary effect of the attempts to manipulate the rate of interest. Governments and political parties are committed to the idea that it is good policy to lower the rate of interest below the height it would attain on a free market. And they believe that the expansion of bank credit is the right means to produce this desired effect. They do not realize that the boom which they artificially create by such credit expansion must finally result in the catastrophe of the depression.

Spokesmen of governments tried to disparage the economists’ explanation of the recurrence of economic depressions. They tried in vain. This economic doctrine, the so-called monetary or circulation-credit theory of the business cycle, is irrefutable. The fanatical supporters of inflationism, unbalanced budgets, and reckless government spending have, it is true, succeeded in banning sound theory from universities and textbooks. And they have founded special research institutions whose main purpose it is to put the monetary theory into oblivion. But their triumph is always short-lived. Today people are fully aware of the fact that credit expansion is the ultimate cause of the slump. All public declarations on the state of business, even those uttered by bureaucrats, are based upon a full acknowledgment of the monetary doctrine of the trade cycle. It is precisely the cognition of this theory’s correctness that in the present boom period alarms businessmen and prompts them to inquire nervously about the date of the turning point.

Economics: Not Quantitative

Economics predicts the outcome of definite modes of conduct, in our case, of a policy of credit expansion. But this prediction is qualitative only. Economic prediction can never disclose anything about the quantitative relations concerned. There is not, and there cannot be such a thing as quantitative economics.

In the field of the natural sciences there prevail constant relations between definite magnitudes. By means of laboratory experiments the scientists are in a position to determine these constants and to make practical use of them in predictions and in technological design. But in human action there are no such constant relations between magnitudes. There, all quantities are variables or, as a more appropriate term describes them, historical data. It is, therefore, not due to alleged backwardness, or to the much-talked-about “youth” of economic science, that it is not quantitative but, as people say, “merely” qualitative. No constant, fixed quantitative economic relationships exist, on which quantitative economic predictions would have to be based. And what does not exist cannot become a matter of scientific inquiry.

Economics can only tell us that a boom engendered by credit expansion will not last. It cannot tell us after what amount of credit expansion the slump will start or when this event will occur. All that economists and other people say about these quantitative and calendar problems partakes of neither economics nor any other science. What they say in the attempt to anticipate future events makes use of specific “understanding,” the same method which is practiced by everybody in all dealings with his fellow man. Specific “understanding” has the same logical character as that which characterizes all anticipation’s of future events in human affairs?anticipation’s concerning the course of Russia’s foreign policy, religious and racial conditions in India or Algeria, ladies’ fashions in 1960, the political divisions in the U.S. Senate in 1970; and even such anticipation’s as the future marital relations between Mr. X and his wife, or the success in life of a boy who has just celebrated his tenth birthday. There are people who assert that psychology may provide some help in such prognostications. However that may be, it is not our task to examine this problem. We have merely to establish the fact that forecasts about the course of economic affairs cannot be considered scientific.

Statistics: Necessarily Retrospective

The usual method employed in business forecasts is statistical and, thereby, retrospective.

The statistician recites a mass of statistical information, which necessarily refers to the past only, and he works it into charts and curves. He is so preoccupied with arranging and rearranging the data available that he entirely fails to realize that they do not have any relevance to the problems in question. They refer to the past, not to the future. They depict trends that prevailed in the past and are, by and large, familiar to everybody. They in no way answer the questions that all people, and especially businessmen, are asking. People know that trends can change; they are afraid that they will change; and they would like to know when the change will occur. But the statistician knows only what everybody knows, namely, that they have not yet changed.

In the sphere of human action statistics are a special method of historical research. They record historical facts in quantitative terms. But history deals always with the past, never with the future. If the future were merely a continuation of the trends that prevailed in the past, it would not be uncertain and we would not then be in need of any forecasting. But as this is not the case, what is called economic forecasting is merely guesswork.

Professional forecasters blame their much talked about failures on the fact that the figures available are insufficient and reach them too late. This apology misses the point. However complete and recent statistical information may be, it always remains information about the past and does not assert anything about the future.

The Self-Contradiction of Forecasting

People’s ideas about the possibility of business forecasting, and its practical value for the conduct of one’s own affairs, are self-contradictory and unrealizable.

The businessman thinks: If I know the date of the boom’s collapse some time in advance, I will be in a position to sell my stocks and reduce my inventories of both raw materials and products at boom prices. Then, at the critical moment, I will have cash and no debts. The man who entertains such ideas overlooks the fact that this knowledge could be helpful to him only if he alone has it, while all other people are still bullish. But how could this occur if, as popular opinion assumes, economic doctrine enables the economists to predict the day of the crisis? If economists really could predict when the crisis would occur, then all people would learn simultaneously the date of the impending crash. Consequently, they would all immediately try to adjust their transactions to this expectation. They would all stop buying forthwith and start selling. But then, as a consequence of this attitude, the catastrophic drop in prices, the slump, would appear at once; it would not wait for the distant day the economists had predicted. Nobody would derive any advantage from the economists’ forecast; at the very instant this forecast was uttered and accepted as correct, the crisis would already be consummated.

From time immemorial people have known that the very act of predicting may change the actions of men and thus eliminate the forces that are required to bring about the predicted outcome. Obstinate fatalists have acquiesced in the illusion that all attempts to avoid a prognosticated evil are futile; and that frequently, in some mysterious way, against the intention of the actor, they even bring the prophecy about. No such subterfuge is permissible in our case. The very fact that people are putting faith in the forecast of a crash results in the annulment of the prediction: it instantly produces the crash. Thus, what the businessman wants to attain by asking the economist for information about the future of the market could not be realized, even if the economist were in a position to answer.

Reprinted from National Review, April 4, 1956.