The Causes of the Economic Crisis and Other Essays Before and After the Great Depression

“Every boom must one day come to an end.”  —Ludwig von Mises (1928)

“The crisis from which we are now suffering is also the outcome of a credit expansion.”  —Ludwig von Mises (1931)

In the 1912 edition The Theory of Money and Credit, Ludwig von Mises foresaw the revival of inflation at a time when his contemporaries believed that no great nation would ever again resort to irredeemable paper money. This book also presented his monetary theory of the trade cycle, a fundamental explanation of economic crises. Mises devoted a great part of his life to attempts to improve and elaborate on his presentation of what has since become known as the Austrian trade cycle theory. This volume includes several of those attempts which have not previously been available in English.

The first, Stabilization of the Monetary Unit—From the Viewpoint of Theory, was sent to the printers in January 1923, more than eight months before the German mark crashed. In this contribution, Mises punctured the then popular fallacy that there is not enough gold available to serve as a sound medium of exchange.

The second contribution, Monetary Stabilization and Cyclical Policy, is probably Mises’s longest and most explicit piece on misguided attempts to stabilize the purchasing power of money and eliminate the undesired consequences of the “trade cycle.” He goes into more detail and explains more of the important points on which the monetary theory of the trade cycle is based than he does anywhere else. It appeared in 1928 and must have been completed early that year. Yet, with his usual exceptional foresight, he foresaw the futile policies that the Federal Reserve System was to follow from the 1928 fall election in the United States until the stock market crashed the following fall.

Mises pointed out that if it ever became the task of governments to influence the value of money by manipulating the quantity of its monetary units, the result would be a continual struggle of politically powerful groups for favors at the expense of others. Such struggles can only produce continual disturbances with results far less “stable” than the rules of the gold standard.

In the first section of this essay, Mises demonstrates the inevitable failure of all attempts to attain a money with a “stable” purchasing power by manipulating the quantity. As he expresses it,

There is no such thing as “stable” purchasing power, and never can be. The concept of “stable value” is vague and indistinct. Strictly speaking, only an economy in the final state of rest—where all prices remain unchanged—can have a money with fixed purchasing power.

Mises shows conclusively that purchasing power cannot be measured. Consequently, there is no scientific basis for establishing a starting point for such an unattainable idea. The very concept of “stable value” denies flexibility to the myriads of market prices which actually reflect the ever-changing subjective values of all participants.

No one knows the future, but so far as market participants can foresee the future, the anticipated future purchasing power of any monetary unit will be reflected in the “price premium” factor in market interest rates. If prices are expected to rise continually, the longer the period of a loan, the higher the interest rate will be. Before the German mark crashed in 1923, interest rates of 90 percent or more were considered low.

Mises also points out that those who save and lend their savings to productive efforts play a major role in raising production and living standards. It would seem that they are entitled to the free market fruits of their contributions. As just mentioned, unmanipulated interest rates would reflect market expectations of changes in the purchasing power of the monetary unit. However, if the principal of loans could be, and always were, repaid with sums representing the purchasing power originally borrowed, the lending savers would be prevented from sharing in the general progress and resulting lower prices their savings helped make possible. Then everybody but the lending saver would benefit from his savings.

This would, of course, reduce the incentive for people to lend their savings to those who can make a more productive use of them. With less production, the living standards of all consumers would fall. So the “stable money” goal, even if it were achievable, would be a stumbling block to progress. All progress is the result of free-market incentives which lead enterprisers to attempt to improve on the “stable” patterns of the past.

Mises also refers to the fact that deflation can never repair the damage of a priori inflation. In his seminar, he often likened such a process to an auto driver who had run over a person and then tried to remedy the situation by backing over the victim in reverse. Inflation so scrambles the changes in wealth and income that it becomes impossible to undo the effects. Then too, deflationary manipulations of the quantity of money are just as destructive of market processes, guided by unhampered market prices, wage rates and interest rates, as are such inflationary manipulations of the quantity of money.

The second part of the 1928 piece is a masterpiece in which Mises shows how the artificial lowering of interest rates intensifies the demand for credit that can only be met by a credit expansion. This addition to the quantity of money that can be spent in the market place must lead to a step-by-step redirection of the economy by raising certain prices and wage rates before others are affected, as the recipients of this newly created credit bid for available supplies of what they want but could not buy without having obtained the newly created credit.

Mises was then writing at a time when such credit expansion was primarily in the form of discounting short term (not longer than 90 days) bills of exchange. Consequently, such loans were always business loans. The first consequence was always a bidding up of the prices of certain raw materials, capital goods, and wage rates, for which the borrowers spent their newly acquired credit. This has led some writers on the subject to believe that all such loans went into the lengthening of the production period. Some did, of course, but Mises recognized that the lower interest rates attracted all producers who could use borrowed funds. Consequently all the resulting malinvestment does not result in longer processes. The effects depend on just who the borrowers are and how they spend their new credit in the market.

Since 1928, banks have extended credit expansion not only to business but also to consumers, and not only for short term loans but also for long term loans, so that the specific effects of credit expansion today are somewhat different than they were in the 1920’s. However, the results are still, as Mises pointed out, a step-by-step misdirection in the use and production of available goods and services. As Mises wrote in 1928, as well as in Human Action, the result is not overinvestment, as some have thought, but malinvestment. Investment is always limited by what is available.

Although later and better statistics are now available and the Harvard “barometers” have been superseded by computer models, what Mises said then about the Harvard “barometers” also applies to the statistics gathered and rearranged by the more sophisticated computer techniques of today. Such research materials may support Mises’s theory, but they provide little help in furnishing an answer to the problem of finding the cause of recessions and depressions so that the cause may be eliminated.

The answer, as Mises attests, is a return to free market interest rates which restrain loans to available savings, i.e., the elimination of credit expansion, a system whereby banks lend more funds than they have available for lending by the artificial creation of monetary units in the form of bank accounts subject to withdrawal by checks. Mises saw the answer in free banking, with banks subject only to the commercial and bankruptcy laws that apply to all other forms of business.

In 1928, Mises also foresaw the attempts now being made to remove the brakes on credit expansion by international agreements. He recognized that if all major governments could ever be persuaded to expand credit at the same rate, it might then become more difficult for the residents of individual countries to detect the expansion or to check the expansion by sending their funds to countries where there was less credit expansion.

While Mises refined his presentation, particularly his scientific terminology, by the time he wrote Human Action, this 1928 contribution establishes him as the unquestioned originator of the monetary “Austrian” theory of the trade cycle. Others have since written on the subject. None has substantially added to, or subtracted from, his presentation.

This basic explanation is very late in appearing in English. It is to be hoped that it will correct some of the misunderstandings resulting from the writings of others that have preceded its English appearance. This great contribution to human knowledge should be read by all those interested in saving our capitalistic civilization and capable of spreading a better understanding of the inherent dangers to our society in the political manipulation of money and credit.

The third contribution, The Causes of the Economic Crisis, is a translation of a speech he gave at the depth of the Great Depression on February 28, 1931, before a group of German industrialists. After a clear but simple presentation of consumer sovereignty in an unhampered market society, Mises described how the lowered interest rates produced the then current crisis. He goes on to explain the duration of the crisis as the result of other interventionist hamperings of market processes. He shows that continued mass unemployment is due to interference with free market wage rates. He also shows how political interventions affecting prices, as well as heavy taxes on capital and its yield, had hindered recovery.

In this speech, five years before the appearance in 1936 of Keynes’s The General Theory of Employment, Interest and Money, Mises made a devastating criticism of the basic Keynesian tenet that has since become so popular. It is the idea that inflation can bring the higher than free market wage rates extorted by labor unions into a viable relationship with other costs. Accepting the idea that it was politically impossible to reduce the higher than free market union wage rates that had produced mass unemployment, Keynes proposed to lower the real wages of all workers by lowering the value of the monetary unit, i.e., inflation. Unfortunately, England’s inflation only lowered the real wages of the privileged union members temporarily, while disorganizing the nation’s whole market economy. This, in turn, created a clamor for more political interventions that sponsors hoped would correct the undesired results of the inflation.

Mises correctly foresaw that the politically feared labor unions would, sooner or later, insist on higher money wages. The eventual solution, as Mises has maintained, must be a return to free market wage rates. He was certainly many years a head of his time. There is still a popular feeling that inflation is a means of offsetting unemployment, with little recognition that such inflations must inevitably lead to the undesired recessionary consequences that every responsible person wants to prevent.

The fourth piece is a translation of a 1933 contribution he made to Arthur Spiethoff’s Festschrift devoted to the status and prospects of business cycle research. Mises used to say that all a good economist needed was some sound ideas, writing materials, an armchair, and a waste basket. He, of course, recommended wide reading but he insisted that it was the ideas that were important and that without ideas all statistics were meaningless.

In this piece Mises comments on the clamor for cheap credit. Throughout history there have been governments that have sponsored high prices and governments that have sponsored low prices, but all governments have been advocates of low interest rates. Politicians never seem to learn that the best way to attain low interest rates is to stop inflating the quantity of money and remove all obstacles to the greater accumulation of capital. Mises also explodes the naïve inflationist theory that prosperity requires ever-rising prices.

The final piece is not a translation. It was prepared in early 1946 for an American business association for which Mises served as a consultant. He discusses his cycle theory in the American milieu and points out that low interest rates actually hurt the American masses who, as savings bank depositors, life insurance policy holders and beneficiaries of pension funds, are the creditors of large corporations and governmental bodies which are today the major borrowers of savings. He also gives a clear explanation of the important difference between “commodity credit” and “circulation credit.” It is the latter which is so disastrous in disorganizing free market guidelines. Our real problem is not a shortage of money, but a shortage of the factors of production needed to produce more of the things that consumers want.

While Mises’s most valuable contributions were not always easy reading, he did not lapse into abstruse or convoluted esoterics. He wrote what he had to say simply and directly, perhaps on some occasions too simply and too concisely for many readers to grasp the full implications which he did not always spell out. He had a dislike for translations. He maintained that each language group had some ideas, customs, and traditions which were impossible to translate accurately into the languages of another language group with different ideas, customs, and traditions. He would ask, how could such thoroughly American traditions as college fraternities and football extravaganzas be translated into the German language, which had no precise terms for expressing such alien ideas.

My wife, Bettina Bien Greaves, started these translations a few years after she became a student of Mises. In the years that have intervened, she has become one of his most careful students. She prepared a bibliography of his works, catalogued his library, attended his seminar for eighteen years, and assisted him in many ways. In 1971, Mises approved the publication of these translations when he was assured that they would be edited by the undersigned, also a long-time and serious student of Mises’s ideas.

The completion of this project has taken longer than expected. However, no effort has been spared in the attempt to present Mises’s ideas in a form we hope he would have approved. We trust this volume will lead to a better understanding of Mises’s contributions to man’s knowledge of money, credit, and the trade cycle.

Percy L. Greaves, Jr., Editor
July 4, 1977