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- Deliberate Dollar Debasement -
- The Congenital Disease of All Paper Currencies -
- Omnipotent Government -
- Demonetizing Gold –
The Portuguese
Bank Note Case
At the end of the previous Lecture I ran out of time
and couldn't include the story of the Portuguese bank notes as I had
intended. It is such an amusing and instructive story that I would not let
you miss it, so I start with it this time.
Misesthere, however, it raises more questions than it answers. Should
the practice of producing present goods out of nothing be outlawed along with
quackery and witchcraft - regardless whether this dangerous prestidigitation
is practiced by honorable gentlemen, the bankers,
or by disreputable crooks, the counterfeiters? Both the banker and
counterfeiter are illusionists, mesmerizing the public into believing that
their product, the bank note, is a present good and not merely a promise to
deliver present good on demand. Both the banker and the counterfeiter are
determined to escape any and all responsibility concerning the bank note
after they have succeeded in putting it into circulation. The activities of
the two are hardly different from an economic point of view. The difference
is exclusively in our legal arrangements, aiding and abetting the former,
while criminalizing the latter. It should criminalize both.
The following example, known as the Portuguese bank
note case, is quite instructive and you will be pleased to hear it. In the
late 1920's an astonishing and ingenious crime led to a fascinating civil
suit that was not without its ironic side. A gang of international swindlers
succeeded in convincing the well-respected London firm Waterlow
& Sons, engravers of postage stamps and bank notes, that they were the
representatives of the Bank of Portugal placing an order for the printing of
a large quantity of fresh Portuguese bank notes. The order was duly filled
and the bank notes were delivered to the swindlers. When the fraud was
finally discovered, the Bank of Portugal was forced to call in all its extant
notes, replacing them with a new issue. The criminals were never apprehended,
but the Bank of Portugal sued Waterlow & Sons
in British courts, demanding compensation for losses resulting from the issue
of fraudulent notes. In listening to expert testimony the Court discovered
that the case involved issues of unusual subtlety and complexity. The Court
admitted evidence of negligence, but the question of damages was another matter.
If it had been postage stamps instead of irredeemable bank notes in which the
swindlers had trafficked, it would have been clear that the loss incurred by Portugal was
equal to the face value of the fraudulent issue. With respect to bank notes,
however, no such simple assertion could be made. Among the questions that
troubled the experts the following stood out as particularly relevant to our
study: would the Bank of Portugal have issued the same amount of bank notes
even if the swindlers had not done so? If not, was the increase in the supply
of paper currency resulting from the fraudulent notes beneficial or
detrimental to the Portuguese economy? Some experts even testified that the
swindlers may have done an unintentional favor to Portugal in
helping fend off an imminent deflation. At any rate, why should the face
value, rather than replacement value of a counterfeit bank note, govern
considerations for damages, if the bank note is irredeemable anyway? These
and other considerations led the high court to award only a small fraction of
the damages claimed. See: C.H. Kisch, The
Portuguese Bank Note Case, London, 1932,
and Wilhelm Röpke, The Economics of Free
Society, Chicago,
1963.
The Yellowback Saga
My next example will, more than any other, demonstrate
the difference between a present good and a promise to deliver a present good
to bearer on demand. A U.S. $20 gold certificate (nicknamed the "yellowback" in order to distinguish it from the
"greenback") and a U.S. $20 gold coin were both present goods, in
the sense of Mises, on Saturday, March 4, 1933, the
day of the inauguration of F.D. Roosevelt as the 31st president of
the United States.
The new president was elected to office in 1932 on a platform which contained
the following preamble:
Believing that a party platform is a Covenant
with the people to be faithfully kept by the party when entrusted with power,
and that the people are entitled to know in plain words the terms of contract
to which they are asked to subscribe, we hereby declare this to be the
platform of the Democratic Party . . .
and this declaration:
A sound currency
is to be preserved at all hazards.
During the election campaign of 1932 Mr.
Roosevelt chastised president Hoover
for endangering the integrity of the dollar by uttering irresponsible remarks
about the possibility of "going off the gold standard". There
appears to be no evidence that Mr. Roosevelt favored
the debasement of the dollar prior to his election. But debasement began very
soon after inauguration. By the Emergency Banking Act, passed by Congress and
signed into law on March 9, 1933, the president was empowered to prevent the
hoarding and exportation of gold. Next day the Administration took the first
step by refusing license to exporters of gold. With that refusal the dollar -
and the yellowbacks with it - declined sharply in
terms of gold and foreign exchange abroad. For all intents and purposes
the yellowback ceased to be a present good. Lest
there remain any doubt about the matter, on April 5, 1933, an Executive Order
was issued requiring the owners of gold coins, gold bullion, and gold
certificates (yellowbacks) to deliver these items
to a Federal Reserve bank against replacement in the form of Federal Reserve
notes (greenbacks) on or before May 1, 1933. The Executive Order specified
heavy penalties for non-compliance.
Deliberate
Dollar-Debasement
Actual debasement of the dollar was authorized under
Section 43 of the Agricultural Adjustment Act of May 12, 1933, the
"Thomas Amendment", empowering the president to reduce the gold
content of the dollar. On June 5, 1933, Congress passed a "Joint
Resolution to assure uniform value to the coins and currencies of the United States".
This recited that holding and dealing in gold affected public interest and
were therefore the object of regulation; that the provisions of obligations
which purport to give the obligee the right to
require payment in gold coin obstructed the power of Congress to regulate the
value of money and are inconsistent with the policy to maintain equal value
of every dollar coined or issued. It then declared that every provision in
any obligation purporting to give the obligee a
right to require payment in gold is against public policy, and directed that
"every obligation, heretofore and hereafter incurred", whether or
not any such provision is contained therein or made with respect thereto,
shall be discharged upon payment, dollar for dollar, in any coin or currency
which at the time of payment is legal tender for public and private
debts."
The final status of the yellowbacks
remained unclear until 1935, when the U.S. Supreme Court decided against the
creditors of the U.S.
government (Nortz v. the United States). In this landmark
decision the high court ruled that the government of the U.S. did not
act unconstitutionally in breaking its promise, stated on the face of the
gold certificate:
This certifies that there have been deposited
in the Treasury of the United States of America twenty dollars in gold coin
of present weight and fineness, payable to bearer on demand."
In the opinion of the Court:
These gold certificates were currency . . . Being
currency and constituting legal tender, it is
entirely inadmissible to regard the gold certificates as warehouse receipts. They
were not contracts for a certain amount of gold as a commodity. They called
for dollars, not bullion.
However, in the words of Justice McReynolds who
formulated the minority opinion of the four dissenting justices,
These were contracts to return gold left on
deposit; otherwise to pay its value in currency.
The majority of the Court argued that the
Constitution granted monetary powers to the government, including the power
"to coin money and regulate the value thereof". Therefore, the
breaking of this promise fell within the power to regulate the value of coin.
The Court side-stepped the issue whether another provision of the
Constitution, denying the power to the government to deprive citizens of
property without due process of the law, was violated or not. Incredibly, the
high court even argued that no loss accrued to the citizens in consequence of
the arbitrary action of the government, because the domestic purchasing power
of the Federal Reserve notes remained identical to that of the yellowback which it replaced. In saying this, the high
court ignored the immediate and sizeable losses of individuals under the
jurisdiction of the United
States who had obligations payable in
foreign currency, as well as losses of citizens living in or visiting foreign
countries.
Appalling Legal
and Moral Chaos
Justices McReynolds, Van Devanter,
Sutherland, and Butler
disagreed with the majority of the court. The dissenting opinion was
delivered by Justice McReynolds. It should be taught in American schools
along with the Emancipation Proclamation.
We conclude that, if given effect, the
enactments here challenged will bring about confiscation of property rights
and repudiation of national obligations. Acquiescence in the decisions just
announced is impossible; the circumstances demand a statement of our views. To
let oneself slide down the easy slope offered by the course of events and to
dull one's mind against the extent of danger . . . that is precisely to fail
in one's obligations of responsibility.
Just men regard repudiation and spoilation of citizens by their sovereign with
abhorrence; but we are asked to affirm that the Constitution has granted
power to accomplish both. No definite delegation of such power exists; and we
cannot believe the far-seeing framers, who labored
with hope of establishing justice and securing the blessings of liberty,
intended that the expected government should have authority to annihilate its
own obligations and destroy the very rights which they were endeavoring to protect. Not only is there no permission
for such actions; they are inhibited. And no plentitude
of words can conform them to our charter.
The federal government is one of delegated and
limited powers which derive from the Constitution. It can exercise only the
powers granted to it. Powers claimed must be denied unless granted . . . The
fundamental problem now presented is whether recent statutes passed by
Congress in respect of money and credits, were
designed to attain a legitimate end. Or whether, under the guise of pursuing
monetary policy, Congress really has inaugurated a plan primarily designed to
destroy private obligations, repudiate national debts, and drive into the
Treasury all the gold within the country, in exchange for inconvertible
promises to pay of much less value.
Considering all circumstances, we must
conclude they show that the plan disclosed is of the latter description and
its enforcement would deprive the parties before us of their rights under the
Constitution. Consequently the Court should do what it can to afford relief .
. .
The end or objective of the Joint Resolution
[of June 5, 1933] was not 'legitimate'. The real purpose was not 'to assure
uniform value to the coins and currencies of the United States', but to destroy
certain valuable contractual rights . . .
These words of Alexander Hamilton ought not to
be forgotten: "When a government enters into contract with an
individual, it deposes, as to the matter of its Constitutional authority, and
exchanges the character of legislator for that of a moral agent, with the
same rights and obligations as an individual. Its promises may be justly
considered as excepted out of its power to
legislate, unless in aid of them. It is in theory impossible to reconcile the
idea of a promise which obliges, with a power to make a law which can vary
the effect of it . . ."
It was not intended to give Congress the power
under the law to repudiate the obligations in question . . . No such power
was ever granted by the framers of the Constitution. It was not there then.
It was not there yesterday. It is not there today. We are confronted with a
condition in which the dollar may be reduced to 50 cents today, to 30 cents
tomorrow, to 10 cents the next day, and to 1 cent the day after . . .
Under the challenged statutes it is said that
the United States
has realized profits amounting to $2,800,000,000. But this assumes that gain
may be generated by legislative fiat. To such counterfeit profits there would
be no limit; with each new debasement of the dollar they would expand. Two
billions might be ballooned indefinitely - to twenty, thirty, or what you
will.
Losses of reputation for honorable dealing will bring us unending humiliation. The
impending legal and moral chaos is appalling.
Congenital
Disease of All Paper Currencies
Thus did the yellowback
cease to be a 'present good' at the stroke of a pen in 1935.
At any rate, the market had long recognized the true state of affairs: it
treated the yellowback as a dishonored
paper. By contrast, the $20 gold piece was still a present good after the
Supreme Court decision - as it still is today. So is the gold Napoleon. They
continue to be a present good on the same terms indefinitely, whatever fate
awaited the issuer. Paper money issued under the authority of Napoleon III, of
course, no longer enjoys present-good status. They and the yellowback have suffered from the same congenital disease
of all paper currencies: their status is tied up with the fortunes and
integrity of the issuing authority. The gold coin is free from this
congenital disease precisely because, unlike the paper currency, it is a
present good, not a promise.
I treated the saga of the yellowback
at length because it shows, I think, that Mises' concept of a present good is untenable. The yellowback lost its status as a present good, as the term is understood by Mises,
for no cause more substantial than a stroke of the pen. This not only
violates one's intuitive idea of a present good, but also obscures the real
state of affairs. It appears to condone the mischief involved in the
prestidigitation. There is no need to stretch the meaning of the term
'present good'. A perfectly satisfactory term to cover bank notes and other
varieties of paper currency redeemable in gold already exists: they are
promises to pay bearer a definite quantity of gold on demand. The value of a
present good can be protected against physical deterioration by its owner in
taking precautions to prevent it. The value of a promise cannot be so
protected: it depends on the integrity of the other party and that of the
prevailing legal system. A promise can be broken, no matter how carefully one
protects the paper on which it is written. Nor does it matter who the promissor is and what what
resources are at his disposal. As our example shows, even if the promise has
been issued by the government of the richest and 'most democratic' country on
the face of the earth, with vast economic and military resources at its
command, and even if the promise is backed up by Constitutional guarantees, a
promise is still just a promise, and not a present good. Greater economic and
military power won't make a country less likely to stoop so low as to have
recourse to fraudulent bankruptcy, in order to destroy the contractual rights
of weaker countries or individuals.
Gold needs no endorsement. It can be tested with
scales and acids. The recipient of gold does not have to trust the government
stamp on it if he doesn't trust the government that had stamped it. No act of
faith is called for when gold is used in payments, and no compulsion is
required. Gold is gold, and paper is paper. A present good is a present good,
and a promise is a promise. Finally, whether the highest of high courts
admits it or denies it, a broken promise is just that: a broken promise.
Omnipotent
Government
Apparently, Mises
maintains that even an irredeemable bank note is a present good. However, to
call an irredeemable bank note a present good is to admit that the banks and
the government can indeed create wealth out of little scraps of paper by
sprinkling some ink on them. It is an admission that governments are
omnipotent. But if we are to admit this, then we are forced to acknowledge
that the regime of irredeemable currency, based on broken promises and on the
prerogative of the government to declare bankruptcy fraudulently or, in most
general terms, on contemptuous disregard for the rules of civilized dealings
between individuals and the government, can endure indefinitely.
Apologists for the regime of irredeemable currency
have no patience with this analysis of the historical origins of their
regime. They refuse to face the fact that the viability of their regime is
based on a deliberate confusion between present and future goods, that is,
ultimately, on human gullibility. They try to assume a pragmatic stance.
"Let by-gones be by-gones",
they plead. "What alone matters is that the system works and will
endure, because all that remains to clear up is this trifling matter of
finding the 'optimal' rate at which the money supply is to be increased in
order to stabilize the value of the monetary unit." I can dispose of the
pragmatic argument that, indeed, there is a unique formula defining the
optimal rate of increase in the quantity of irredeemable currency, in one
sentence. The declining value of irredeemable currency is not a result of
having the 'wrong' rate of increase in its quantity, but it is a result of
surreptitiously smuggling an item from the liability column to the asset
column of the balance sheet of the government.
The proposition that the regime of irredeemable
currency can endure indefinitely flies in the face of historical evidence. No
irredeemable currency has ever survived the test of times. If it was not made
redeemable in specie in good time, then it ignominiously lost all its value
in due course. Nor was the destruction of value caused by 'overissuing': it was caused by the original default. When
the norms of honorable dealings between the people
and the government are turned upside down, and the dishonored
paper is being promoted as money (that is, elevated from the bottom of the
garbage heap to the position of the highest-powered monetary asset of the
credit pyramid), then the progressive depreciation of the value of the
currency is the natural course of events. First, the dishonored
paper goes to a discount in gold. Then, for a time, the discount may move up
and down, according to the expectation that reason might prevail and
redemption might be resumed. When all hope fades, the inevitable happens. The
dishonored paper loses all its remaining value.
The Revolt of
Quality
The idea that the monetary regime based on
irredeemable currency can endure indefinitely is the stuff of which the
dreams of dictators are made. The list of attempts to translate that dream
into reality is very long. Yet every one of those attempts in history failed,
and did so miserably. There is no shred of scientific evidence that the
substance of the present attempt is any different from that of the previous
ones. It is true that this experiment has so far survived longer than
previous ones. This proves nothing, nor is it necessarily an improvement, for
it only prolongs the agony, and makes the end-game even more painful. The
paramount fact is that the depreciation of currencies is continuing year in
and year out, in good times and in bad, albeit at a varying rate. The
linguistic innovation of introducing the euphemism 'price inflation' and the
official pretense that monetary depreciation is a
'natural' phenomenon rather than the direct result of dishonorable
dealings, will not make the outlook for the present experiment any brighter. Nor
is there any reasonable hope that some significant scientific discovery, or a
break-through in data processing and information technology, will change the
pessimistic long-term outlook for the regime. It cannot be emphasized too
strongly that longevity of a monetary regime is a matter decided not on the
basis of the quantity of money or the rate at which it is increased,
but by the quality of assets in the balance sheet of the monetary
authority. It is futile to pretend, as the Friedmanites
do, that restricting quantity makes for quality. Restricting the
quantity of a dishonored promise cannot make it
more valuable. If the regime of irredeemable currency could be perpetuated,
it would be tantamount to the overthrow of the fundamental principle of
double-entry book-keeping. This principle demands that an item must appear
either in the liability column, or in the asset column of the balance sheet,
and it cannot be shifted from one to the other at pleasure. It is not
possible to create a liability in the balance sheet of the government and
pretend that, by increasing this liability at the
'optimal rate' one can, somehow, increase the assets in the same balance
sheet, as the Friedmanites do.
If the revenues of the government consist
exclusively of its own liabilities, as is the case today, then the
implication is that the citizens are mere slaves of government authority with
no power over their own affairs. It means that the citizens, their children,
their chattels, their produce, all belong to the government. In order for
them to buy food, shelter, medicine, etc., they have to get permission, in
the form of a piece of government debt (itself subject to unilateral
cancellation) to do so. Elections are meaningless. They are about deciding
which party will collect the tithes, not about the question whether tithes
should be abolished altogether. The pretense is
maintained that the government is in debt to its citizens, and it is the
destiny of the debt to be retired. This has no basis in fact. The government
debt will never be retired: it is to keep growing indefinitely. It is the
citizens who are in fact in debt to the government. It is no longer true that
the government belongs to the people: rather, the people belong to the
government. In the words of the currency expert, the late Dr. Franz Pick,
government bonds are "certificates of guaranteed confiscation". Tax
revenues can, in theory, reduce the rate of increase in government debt. However,
to the extent that the government wants to translate tax revenues into
tangible goods and services, the debt reduction is immediately canceled. In order to have command over real goods and
services the government has to borrow, and borrow it must at an accelerating
pace. The burden of debt can only be lightened through ongoing currency
depreciation. This depreciation must occur in fits and starts. Otherwise
people would see clearly what is going on, and would refuse to hold the
currency, causing it to lose its value, as it were, overnight.
The unstated premise
underlying the regime of irredeemable currency is the proposition that it is
possible to keep borrowing with the right hand while destroying the value of
the resulting obligations with the left. Governments trying to perpetuate the
regime of irredeemable currency will ultimately find that they are destroying
their own credit and their ability to borrow in the process. They will, sooner
or later, reach the point where they can no longer borrow because they are no
longer trusted. This is the revolt of quality. Even with the most
drastic quantity controls of money-creation, the destruction of the regime of
irredeemable currency is inevitable.
Gold
Demonetization
In the late 1960's quantity theorists widely
predicted that the demonetization of gold would seriously undermine the
exchange value of gold. Ludwig von Mises was among
them: "The important thing to be remembered is that with every sort of
money, demonetization - i.e., the abandonment of its use as a medium of
exchange - must result in a serious fall of its exchange value." (Human
Action, p. 428, third edition, Chicago, 1963.) To a quantity theorist,
the disappearance of the lion's share of the demand, the monetary demand,
couldn't help but make gold cheaper. It is a source of endless amazement for
me that a quantity theorist could be so blinded to the other side of the
demonetization coin, namely the effect it has on the irredeemable bank note
in which gold is quoted.
It is not known whether these views of the quantity
theorists had any influence on the thinking of the decision-makers who
demonetized gold on August 15, 1971. Be that as it may, the idea that
dishonouring promises to pay gold on demand would, somehow, cause the dishonored paper to go to a premium in terms of gold is
preposterous. It is true that insolvent bankers have in the past tried to
promote their discredited paper (sometimes using extreme measures such as the
death penalty to punish the owners of contraband gold, as proposed by John
Law of Lariston and, later, by the issuers of the assignats and mandats), to no
avail. Logic and history prove that dishonored
promises to pay gold always and everywhere go to a discount, never to a
premium. Indeed, this is exactly what happened after gold was demonetized
world-wide in 1971. In
less than a decade the U.S. dollar went to a 90 percent discount in terms of
gold. Moreover, the discount was commensurate with the 90 percent loss in
purchasing power that the dollar suffered during the same period. There is no
use to blame that loss on the conspiracy of Arab sheiks and the gnomes of Zurich. The huge loss
in the value of the dollar during the decade of the 1970's was due to one cause
only: the demonetization of gold. The hope that the discount on the dollar
would ever disappear is a forlorn one. Domestically and internationally, a
deflation of that magnitude is unthinkable. Furthermore, the disarray in America's
budgetary and trade accounts suggests that the
currency depreciation is likely to continue, if not accelerate. The only way
to stop the rot would be the adoption of a reasonable plan to resume gold redeemability of the dollar. Neither party has so far
come up with a platform embracing the idea.
The use of the word 'demonetization' in connection
with gold is inappropriate. It is but a euphemism for debt-abatement (partial
debt-repudiation) inflicted upon the foreign creditors of the United States of America.
These foreign creditors were deprived of a valuable property right: the right
to a fixed amount of gold per dollar. This unilateral and capricious act has
done nothing to benefit the citizens or the government of the U.S. On the
contrary, the debt abatement had one predictable consequence: harsher terms
on future borrowing, as measured by the higher and unpredictable rates of
interest which the government and the people of the United States
had to pay on new borrowings abroad. It is true that the burden of debtors
who had contracted debt prior to the abatement was lightened but, insofar as
they were the same borrowers on whom the harsher terms on further borrowing
fell for the indefinite future, there were no beneficiaries, only losers. In
particular, the big losers were the taxpayers. The international credit of
the U.S.
government was grievously damaged as manifested by the unprecedented interest
rates (e.g., 16 percent per annum on the 30-year bonds) the Treasury was
forced to pay on its obligations.
From Greatest
Creditor to Greatest Debtor
The stubborn denial that the credit standing of the U.S. has been
damaged in any way by the demonetization of gold of 1971 is the centerpiece of mainstream economics. We must realize,
however, that gold demonetization is just a euphemism for the crime of
pauperizing the laboring classes here and abroad,
who are the main holders of the irredeemable dollar. Ironically, the 'moneyed
classes' have the habit of holding irredeemable currency for as short a
period of time as necessary. Then they get rid of it by investing their funds
in something more reasonable.
This is a world of crime and punishment. No one, not
even the government of the mightiest nation on earth can exempt itself from
the consequences, which are numerous. One of them is the fact that, in an
incredibly short period of time, America turned itself from the
world's greatest creditor into its greatest debtor country. Another is that
that part of the American industry which is not in the process of dismantling
itself, is losing international competitiveness, just at the time the country
would need a strong export industry to help pay for its burgeoning foreign
debt. Due to volatile interest rates in the 1980's, a large part of America's
park of capital goods has become submarginal. Producers
were either unwilling or unable to maintain capital by replacing worn and
obsolete equipment with new one. As capital was becoming submarginal
under a rising interest-rate structure, so were the producers. They were
forced to sell their business at a loss, and invest the proceeds in
high-yield Treasury bonds. This was a textbook-case how the government can
despoil its own taxpayers. In printing high coupon-rates on Treasury bonds,
instead of collecting taxes from the productive members of society, the
government is now obliged to pay them for holding its debt. A large segment
of the producers found themselves unable to compete
with the high coupon rates the government so cavalierly printed on its bonds
and, from producers of new wealth they became coupon-clippers. The
consequences of wholesale destruction of capital are camouflaged by the
burgeoning import of consumer goods. Foreigners accept the dollar for the
time being, as in their judgment the dollar was depreciating more slowly than
their domestic currency. Such a situation cannot continue indefinitely. The
most visible sign of the progressive deterioration is the ever-growing trade
deficit, the flip-side of the accumulation of U.S. Treasury paper in foreign
hands. At one point, the world market will get saturated with the U.S.
dollar. When that happens, another convulsion in the world's commodity and
financial markets will follow.
It is not widely understood that the dollar was
given a stay of execution by the fortuitous demise of the Soviet
Union and its Evil Empire in 1990. This unforeseen historic
event turned the dollar-glut into a fresh dollar shortage. All of a sudden a
new market, counting some 400 million souls, was thrown wide open to
dollar-penetration - a market that had earlier been hermetically sealed off
by the threat of the firing-squad. Huge though this market for dollars may
appear, it is not unlimited. At one point it would also become saturated - as
had markets in Western Europe done in the
late 1960's. It is no use predicting that the present dollar-shortage would
never turn into a dollar glut. Similar predictions were also made during the
dollar-shortage of the 1950's at a time when America's trade advantage over
the rest of the world appeared unassailable. When the dollar-glut of the late
1960's hit the unsuspecting world, those predictions were totally
discredited. Today America's
trade position is incomparably weaker, and getting
weaker still. And, remember, America
is no longer the world's greatest creditor. Now, it is the world's greatest
debtor. Accordingly, the effects of the dollar glut, when it comes, will be
that much worse.
The Swing of the
Wrecker's Ball
Another great danger has unexpectedly appeared on
the horizon, the blackhole of zero interest. It
turned out that the volatility of interest rates, that was unleashed through
the demonetization of gold, also has a long cycle measured in decades. At
first, the pendulum was swinging towards infinite interest, threatening the
dollar with hyperinflation. Right now the pendulum is swinging to the other
extreme, to zero interest, spelling hyperdeflation.
This is just as damaging to the producers as the swing towards infinite
interest was in the early 1980's. It is impossible to predict whether one or
the other extreme in the swinging of the wrecker's ball will make the world
economy to collapse. Hyperinflation and hyperdeflation
are just two different forms of the same phenomenon: credit collapse. Arguing
which of the two forms will dominate is futile: it blurs the focus of inquiry
and frustrates efforts to avoid disaster. In the meantime, the wrecker's ball
keeps swinging, with ever wider amplitude, and ever greater force.
The credit of the U.S. government suffered its
greatest setback in history, as a result of the 1971 devaluation of the
dollar, even though it was only by a relatively insignificant amount (the
official price of gold was increased from $35 only to $38). The deterioration
of the credit of the U.S.
still continues, with unforeseeable consequences. This is not generally
acknowledged by financial writers at home and abroad. The gross mismanagement
of credit in the U.S.
and in the rest of the world has created intractable problems for which there
are no painless solutions.
Such are the consequences of the confusion between
present and future goods, between capital and credit, between assets and
liabilities - deliberately fostered in the minds of the people by the
proponents of mainstream economics.
* * *
The Transition
from Direct to Indirect Exchange
Don Lloyd of Peabody,
Massachusetts, writes that I
got the meaning of Mises wrong when I referred to
the individual rearranging his scale of values in response to direct exchange
being abandoned and replaced by indirect exchange (Lecture 8, Mises by North). Suppose that he preferred apples to
oranges under direct exchange but, with the advent of indirect exchange, he
finds that he reverses his preferences. The price of an apple being $6 and
that of an orange $4 apiece, Don says that the difference in price, $2,
affords him enough extra market power to make the change worth his while. In
contrast to my suggestion, that the individual would rearrange his scale of
values to conform to the prevailing constellation of prices, he has
rearranged his to oppose it.
Don, I appreciate your comment. Here is my answer.
Apart from the fact that the changeover from direct to indirect exchange took
hundreds if not thousands of years (so that no individual could observe the
entire process), under indirect exchange you are no longer comparing apples
and oranges. You compare one apple to one orange plus something you
can buy for $2, say a plum. In other words, you haven't changed your
preference for apples at all. One apple still ranks higher in your scale of
values than one orange. The new element is that you can now measure
the difference in values; you can actually subtract one value from
another.
Your example does not weaken my position, it
confirms it. Not only does the advent of money and prices give you everything
you have had before (namely the possibility of ranking), it gives you more
(the possibility of measuring). You can now answer the question by how
much you prefer one apple to one orange. You always rank the more
expensive item higher in your scale. You don't always buy what you value
higher, but if buy the cheaper instead, then it is because of your preference
for saving the difference. It is a very common human experience to have to
make do with the cheaper item, in spite of our preferences.
It is not enough to say that you oppose the
valuation of the market. To give substance to your valuation, you have to do
something about it. This is what the entrepreneur does, in going into
production to bring down the price that, in his opinion, the market values
too highly. Indeed, I am not saying that all individuals always
conform their scale of values to the constellation
of prices. On the contrary: the exceptions are enormously important, or
should be, to an Austrian economist. These exceptions explain the origin and
nature of entrepreneurship to us. The entrepreneur dares oppose
conventional wisdom as he posits his own valuation against that of the
market. If he values A less than B but finds that in the
markets a > b (A is more expensive than B) then he
will resort to arbitrage. This may take different forms, but the one that is
important for our purposes is the entrepreneur's. He goes into the production
of A using new materials, new production technologies, or even opening
up new markets for A, so that he can bring a down and earn entrepreneurial
profits. Please note that it is not only his entrepreneurial insight that
serves as the source of those profits, but also the monetary economy which
has helped him to spot an anomaly. Entrepreneurship has become easier under
indirect exchange precisely because the entrepreneur can measure, add,
subtract, multiply and divide values, none of which were impossible under
indirect exchange.
Subjective economists, of course, have realized the
great significance of the revolution represented by the transition from
direct to indirect exchange. Nevertheless, they have failed to deal
adequately with the aspect how this transition affected the subjective
valuation of individuals. Ludwig von Mises devotes
three sentences to this in The Theory of Money and Credit:
"Nowadays exchange is usually carried on
by means of money, and since every commodity has therefore a price
expressible in money, the exchange value of every commodity can be expressed
in terms of money. This possibility enabled money to become a medium for
expressing values when the growing elaboration of the scale of values which
resulted from the development of exchange necessitated a revision of the
technique of valuation. That is to say, opportunities for exchanging induce
the individual to rearrange his scale of values." (Op.cit.,
p 61.)
I submit that this "rearranging of values"
was, in fact, a revolution in the subjective valuation of goods by
individuals. The market harmonized subjective individual values, by codifying
them in the price structure. As a result, values were lent the appearance of
being 'objective'. It may appear that subjective individual values were made
to conform to 'objective' values as manifested by prices. Of course, we know
that subjective values had been first, and they were synthesized into prices,
so we still talk about 'subjective theory of value'. The harmonization of
scattered individual values into the constellation of prices was a revolution
of the utmost significance. Among others, it was responsible for the change
that entrepreneurs started using market calculation. They could not
have done it without being able to measure the value of goods and services.
Thank you, Don, for your stimulating observations. I
hope you will eventually agree with me that this is a point where Austrian
economists could carry science further.
September 9, 2002
Antal E. Fekete
Professor Emeritus
Memorial University
of Newfoundland
St.John's, CANADA A1C5S7
e-mail: aefekete@hotmail.com
GOLD UNIVERSITY
SUMMER SEMESTER, 2002
Monetary
Economics 101: The Real Bills Doctrine of Adam Smith
Lecture
1: Ayn Rand's Hymn to Money
Lecture 2: Don't Fix the Dollar Price of Gold
Lecture 3: Credit Unions
Lecture 4: The Two Sources of Credit
Lecture 5: The Second Greatest Story Ever
Told (Chapters 1 - 3)
Lecture 6: The Invention of
Discounting (Chapters 4 - 6)
Lecture 7: The Mystery of the Discount
Rate (Chapters 7 - 8)
Lecture 8: Bills Drawn on the
Goldsmith (Chapter 9)
Lecture 9: Legal Tender. Bank Notes of Small Denomination
Lecture 10: Revolution of Quality (Chapter
10)
Lecture 11: Acceptance House (Chapter
11)
Lecture 12: Borrowing Short to Lend
Long (Chapter 12)
Lecture 13: Illicit Interest Arbitrage
FALL SEMESTER, 2002
Monetary
Economics 201: Gold and Interest
Lecture
1: The Nature and Sources of Interest
Lecture 2: The Dichotomy of Income versus Wealth
Lecture 3: The Janus-Face of
Marketability
Lecture 4: The Principle of Capitalizing Incomes
Lecture 5: The Pentagonal Structure of the Capital Market
Lecture 6: The Definition of the Rate of Interest
Lecture 7: The Gold Bond
Lecture 8: The Bond Equation
Lecture 9: The Hexagonal Structure of the Capital Market
Lecture 10: Lessons of Bimetallism
Lecture 11: Aristotle and Check-Kiting
Lecture 12: Bond Speculation
Lecture 13: The Blackhole of Zero
Interest
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