If the government does not care how far foreign exchange rates may rise, it can for some time continue to cling to credit expansion. But one day the crack-up boom will annihilate its monetary system."
Ludwig von Mises
The acid test of intelligence is whether the things you believe in turn out to be true. Thus it’s always good to periodically examine one’s premises. I regularly immerse myself in the books of the Austrian School economists, Ludwig von Mises (Meesez), Murray Rothbard and Nobel prize winner Friedrich Hayek. It’s made me more certain than ever that we, as a nation, have drifted so far from rational economic moorings that a monumental financial disorder cannot be avoided.
Today, Austrian economics remains a little known economic school. Contemporary economists totally ignore the Austrian school and question the sanity of anyone who would use this obscure philosophy as the springboard for views that predict financial catastrophe. Nevertheless, Austrian school thinking, however unfashionable, has an impressive intellectual history. For example, economists from Adam Smith to Karl Marx believed that the value of a thing was determined by the amount of labor that went into making it. Thus Marx could claim that, since laborers created the value of things, they were due all the profits and capitalists were cheating them. "Workers of the world unite." From this premise spread the disruptive Marxist philosophy which, at times, seemed to own the world, (especially intellectuals within the United States).
However, in Austria a professor of economics (Bohm-Bawerk) developed a different explanation of how a thing got value. He knew that ten thousand men could labor to build a pyramid and no one would pay anything for it. But pick up a diamond off an Arkansas hillside and you could sell it for $10,000. Why was gold worth more than silver, which was more useful to industry? This was the paradox of value which no economist could resolve.
Bohm-Bawerk knew that you and other consumers are the true arbiters of value. You choose whether an item has value to you. Value is subjective. If you have three wagon loads of grain to last you the winter and you plan to eat one load, use another for seed and feed the birds with the other, you would naturally price them differently. You would trade the third load for much less than the second. The last (or most recent) sale you make of a bag of grain from your wagon is the present value. It’s called marginal-utility. The bag with the least marginal-utility (value to you) sets the value.
The Austrians solved the value paradox by stating that you don’t value the entire world supply of an item, but only a given supply which you can use at that moment. This brilliant analysis became the accepted economic alternative to the value theory of Marxist economists, and the core of Austrian economic theory. Economics professor Hans Sennholz states that the Austrians "thereby managed to place the individual in the center of their analysis and the consumer at the core of the economic order."
Socialists want the state to determine price and value, the Austrians know that only the individual can accomplish this. The buying choices of the individual make the world go round, and this free choice is basic to our liberty. The buying choice of the consumer determines profit and loss and the success and failure of businesses and products.
In the 1930s, the economic thought of John Maynard Keynes made an influential mark and relegated the Austrian school to the back of the bus. Among other things, Keynes pushed consumption over savings and government intervention over market solutions. He proposed that the state manipulate taxes, money supply, government spending and subsidies to foster demand. The politicians loved it and today, "we are all Keynesians." Nevertheless, were he alive today, John Maynard Keynes would cringe at our low savings, speculation and excessive monetary meddling. He would refuse to take the blame for such extremes.
Austrian economics bases its views on the actions of individuals. These actions can’t be codified because of the unpredictable responses people will give to each circumstance. One person prefers chewing gum while another likes breath mints. Some will buy a pack at a time, others go to Sam’s and load up. Each person and his or her actions are different and unique. Modern economics tends to treat us like so many units, with algebraic certainty. Economic outcomes cannot be determined by laws similar to physics. Austrian economics does not lend itself to mathematics. Professor Mises dismissed mathematical analysis as unworkable poppycock. Economics is a branch of philosophy and not an exercise of math. Yet, the most influential mathematical economists in the United States don’t recognize Austrian economics because it does not lend itself to mathematics.
Austrian economists decry big government, subsidies, social engineering and easy money. Their views go unheeded. Today we inflate at will. This fiat money created out of thin air, runaway government borrowing, huge government financial guarantees, staggering levels of leverage in securities markets, consumer credit excesses, low savings rates and monstrous trade and budget deficits have created a financial house of cards. Mises warned that the employment of these policies leads to economic disaster and makes a collapse inevitable. History bears him out. Mises is the economist whose views you should listen to. Not the Marxists and Socialists of academia, not the Wall Street and Washington Keynesians, who manipulate interest rates and the money supply and claim to foster everlasting prosperity.
Contrast the go-go world of today’s easy money with the way things once were when gold was money. In my book, The Start-up Entrepreneur, I quote F. W. Woolworth, who claimed that Dutch businessmen taught him how to flourish in business without borrowing money. "They ran their stores on the same policy for more than half a century; they did not progress, except as a tree progresses in size. They grew wealthy slowly, but surely. They never went into debt; they always paid for what they bought, and paid with cash. They bought at the lowest price, and they bought not a cent’s worth more than they actually needed. When they put money in the bank – salted it away – it was put away to stay. There were no liens on anything they owned. These Dutch merchants taught me to manage my own business and never to let my business manage me."
That’s an America we no longer recognize. And, what of the future? I believe it’s spelled out clearly and concisely by Professor von Mises in the following paragraphs.
"The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly…. If the credit expansion is not stopped in time, the boom turns into the crackup boom; the flight into real values begins, and the whole monetary system founders. Continuous inflation and credit expansion must finally end in the crack-up boom and the complete breakdown of the currency system.
"Credit expansion is not a nostrum to make people happy. The boom it engenders must inevitably lead to a debacle and unhappiness…. Accidental, institutional, and psychological circumstances generally turn the outbreak of the crisis into a panic. The description of these awful events can be left to the historians. It is not…(our task)…to depict in detail the calamities of panicky days and weeks and to dwell upon their sometimes grotesque aspects.
"The final outcome of the credit expansion is general impoverishment. Some people may have increased their wealth; they did not let their reasoning be obfuscated by the mass hysteria, and took advantage in time of the opportunities offered by the mobility of the individual investor….but the immense majority must foot the bill for the malinvestments and the overconsumption of the boom episode."