“The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race.” – Ludwig von Mises, from Human Action

Henry Ford is alleged to have said that “it is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

The spirit of his words encourages us to put forward questions about the banking and monetary system — especially in view of the international credit-market crisis. Is it a good thing that central banks have cut interest rates essentially to zero and have increased the base-money supply dramatically to support the financial sector? Will depression be prevented if governments underwrite banks’ balance sheets and run up huge deficits in an attempt to strengthen production and employment?

To answer these questions, a diagnosis of the root cause of the debacle is indispensible, and once the root cause has been identified, a proper remedy can be formulated.

The diagnosis provided by the Austrian School of economics can be distilled into one sentence: governments have caused the monetary and economic debacle by taking control of money production.

Money and Credit

To explain this one-sentence conclusion — which may of course be surprising or even irritating to many — it must be noted that the defining characteristic of today’s monetary systems is that state-controlled central banks hold the monopoly over the money supply. The US dollar, euro, Japanese yen, British pound, and the Swiss franc share the essential feature of being currencies produced by governments.

What is more, these monies are produced through circulation-credit expansion — credit that is not backed by real savings. One can even say that today’s monies are produced out of thin air. These monies are often called fiat money: they are established by government decree, not legally convertible to any other thing, and created by political expediency.

Fiat money regimes create economic disequilibria, and do so inevitably. This is because the rise in circulation credit lowers market interest rates below their natural levels — that is, the levels that would have otherwise prevailed, had the credit supply not been artificially increased.

The downward-manipulated interest rate induces additional investment and, at the same time, provokes a rise in consumption out of current income, at the expense of savings. Monetary demand outstrips the economy’s resource capacity. A rising money supply pushes up prices sooner or later, be it the prices for consumer goods or for assets.

What is more, the artificially suppressed interest rate shifts scarce resources increasingly into more time-consuming production processes for capital goods — at the expense of production processes for consumer goods, causing intertemporal distortions of the economy’s production structure.

A circulation-credit-driven boom is economically unsustainable and must be followed by bust. If the injection of additional credit and money out of thin air was a one-off affair, it presumably wouldn’t take long for the artificial boom to unwind. A recession would restore the economy back to equilibrium.

Unfortunately, however, the increase in credit and money out of thin air is not a one-off affair under today’s monetary systems. As soon as recession approaches public opinion calls for countermeasures, and central bankers increase the credit-and-money supply even further, thereby bringing interest rates to even-lower levels. In other words, monetary policy fights the correction of the debacle by taking recourse to the very action that has caused the debacle in the first place.

Such a strategy may work occasionally. But as soon as credit expansion comes to a halt — that is, when commercial banks refrain from lending altogether — the inevitable adjustment will unfold. Borrowers will default, and firms will liquidate unsound investments and cut down jobs.

The longer an artificial boom is kept going, the greater the malinvestments are that have to be corrected, and the higher will be output and employment losses.

Mises knew that pushing down interest rates to ever-lower levels would not solve the problem but would lead to an even-bigger disaster. He wrote,

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.[1]

Intervention and Reform

If one subscribes to the diagnosis provided by Austrian School of economics, two important observations must be made. First, more circulation credit and fiat money at lower interest rates will not, and cannot, prevent a disaster that has been caused by too much credit and money. Second — and this aspect may not attract peoples’ attention right away — governments’ ongoing attempts to fight the economic correction will destroy what little is left of the free market order.

In his book Interventionism, Mises explained that market interventions would not create a lasting system of economic organization. He wrote,

If governments do not give them up and return to the unhampered market economy, if they stubbornly persist in the attempt to compensate by further interventions for the shortcomings of earlier interventions, they will find eventually that they have adopted socialism.[2]

Interventionism in the field of monetary affairs — most notably by governments controlling money production — has caused damage on the grandest scale.

There are a number of economists who have identified the serious economic and ethical problems caused by fiat money. Among them are, most notably, Ludwig von Mises, F.A. Hayek, and Murray Rothbard. They basically recommend privatizing money production, which would pave the way to sound money — money that is compatible with the principles of a free-market society, money that does not cause boom-and-bust cycles.

Under privatized money production, people would freely decide on the kind of money they wanted to use. Such a money would presumably be anchored by gold, but it could possibly be anchored by other media (for example, silver or platinum). The government and its central bank would be closed down and lose control over money production. From then on, the interest rate would be determined by free-market forces rather than government action.

Conclusion

The global monetary fiasco is a reminder that it is high time to seek monetary reform along the lines of that which is recommended by the Austrian School of economics. It is the only way to protect and maintain peoples’ freedom and economic well-being.

Murray Rothbard wrote that “Mises, almost single-handedly, has offered us the correct paradigm for economic theory, for social science, and for the economy itself, and it is high time that this paradigm be embraced, in all of its parts.”[3] This holds true especially for Mises’s monetary theory.

So if one wishes to hold a positive view on the progress of civilization, it necessarily implies that the future monetary system will be a free-market-money system, as envisioned by the Austrian School of economics — and that the era of fiat money must come to an end.

[Thorsten Polleit is Honorary Professor at the Frankfurt School of Finance & Management.  This talk was first given at the SIX Swiss Exchange Bond Event, 2010.  The article's original post is here. Receive free copies of the Mises Institute's Free Market magazine to your mailbox here.]

“Tyranny ends when we cease to voluntarily support our own serfdom.”

One of my trips abroad took me to Cambodia where I saw sobering sights as seen in the picture.  Seeing an obelisk several stories tall filled with human skulls leads one to imagine how such a tragedy could have occurred – and how the seeds of tyranny can be prevented from sprouting.

I won’t bore you with the details on how the unintended consequences of the illegal bombings of neutral Cambodia during the Vietnam War led to the demise of Lon Nol’s regime and the rise of Saloth Sar’s (Pol Pot) Khmer Rouge – a demented communist agrarian-torture-chaos state.  However, the stark reality is the means to prevent such evil lie within us.

The truth is the collective rule of the Democrats and Republicans has been impoverishing America for quite some time.  Ultimately, economic suppression is no less evil than physical suppression.  We must remember that once the skulls start piling up, the situation is already totally out of control.  Sure, by no means do I infer the modern-day United States is the equivalent of Pol Pot’s Killing Fields.

However, what about the several million dead in the 20-year-long Iraq War?  Are the 10,000+ civilian deaths during the Afghanistan War any less horrific because they did not occur on American soil?  Care to tell the mothers of the  5,511 American service members who died violently in Iraq and Afghanistan that no heads are rolling?

The below excerpt is taken from an acceptance speech given at the Instituto Mises Brasil by Helio Beltrao.  It was included in this month’s Free Market newsletter, shipped to your home free of charge by the Mises Institute.  Click here to spend 1 minute ordering:

The history of ethics has been a history of exploitation. From time immemorial, individuals were set apart into two groups: those that must obey the rules, and those that need not. The people must observe ethics and morals, while rulers not.

The ethics that you and I must observe correctly advocates that one should not steal the property of others, should not murder, and should not force others to do something against their will.

But note that those ethical rules do not apply to government — the government takes your money, calls it “democratic taxes,” and presto! — it is now authorized to steal.

If one enslaves another, this is considered a heinous crime. After all, slavery is the antithesis of individuality! However, in the case of government, they will draft you to “serve your nation” for a year, call this conscription “military service,” and serfdom becomes perfectly legal.

If one kills a neighbor, this is murder. However, if he is an agent of the government — particularly that of the United States — using an olive-green uniform, and invoking a “preventive” war or similar excuse, suddenly it becomes permissible to murder — legally.

Counterfeiting is a crime, but only for you and me. For the government has the money-printing machine, or more precisely, the counterfeiting machine. If it is they doing it, fine. If it is we, we go to jail.

Three hundred years ago, a substantial part of the population in the Americas was comprised of slaves. One hundred percent of the fruits of their labor were the property of their owners. Today, we are no longer slaves. However, about 40 to 50 percent of the product of your efforts and talent are not your property, but your masters’ — that is, the government and its friends. This is what you pay, whether you like it or not, embedded in the prices of the products, or through other taxes, duties, or tariffs. We are no longer slaves, but we are serfs.

Previously, the slave owner would threaten to punish with a whip a slave who refused to work. Now, if you refuse to pay the government, you are summoned and attacked with lawsuits, until you are finally thrown into jail. In both cases, the violence is of the same nature. The gun doesn’t even need to be displayed, as in the case of the customary robber. The mere threat of violence suffices. But the gun is always present, in the robber’s pocket and in the ruler’s jacket.

Theft and slavery are crimes, even if sanctioned by the majority of the people! Theft of the government, by the government, and for the government is somehow accepted and rationalized by the population at large. Why does that majority agree with this theft?

We must analyze the most misrepresented concept nowadays: the concept of democracy.

The conventional use of the term “democracy” conveys a certain disrespect for semantics. Most of us utilize the word democracy when we actually mean other concepts, such as the “rule of law,” “liberty,” “equality before the law,” “individual rights,” “solid institutions,” “justice,” and other concepts that have specific words to designate them. Democracy is, formally, the regime of majority rule, that is, the majority of voters decides whatever it sees fit. Or, as is commonly said, it is the tyranny of the majority — which in practice means the tyranny of the minority: that of the politicians who rule over our lives and property.

The adulteration of meanings has practical consequences. When we say that Brazil is a “democracy,” we assume that we are “rulers of ourselves” — while, in fact, there are still rulers on the one hand, and citizen-subjects on the other. The concept of democracy is employed to obfuscate and confound, with the purpose of having us believe that there is equality among all.

Yet, dumbfounded or not by the smoke and mirrors, why do we suffer so much at the hands of those ruler-governors, if we are many and they are few? Why do we become enchanted with the belief that our ruler-governors are just and benevolent, when we experience evidence otherwise every day, everywhere? Why do we allow so many abuses of liberty and property, if the power the rulers possess is only that which we bestow onto them? Why do we let them treat us like beasts?

The recapture of our rights does not require that we take up arms, demonstrate, or even vote — we are, after all, a much larger legion than our ruler-governors. In a face-to-face combat of the many against the few, where the many fight for the grand prize of liberty, while the few fight for the chance to subjugate the many, it is likely that no shots need be fired before the many are declared the winners. We, therefore, reach the paradoxical conclusion that we don’t reclaim our rights because we do not want to; because we support, explicitly or tacitly, the tyranny inflicted by the ruler-governors…

To read the conclusion to the speech, please visit here.  Below is a video on the philosophy of liberty.