What We Need to Know about Money
[From The Daily Bell, July 3, 2011]
Daily Bell: You've just published a new book. Can you tell us about it?
Dr. Joseph Salerno: I would be happy to. The book is entitled Money: Sound and Unsound and was published in 2010 by the Ludwig von Mises Institute. It is a collection of essays on monetary topics that I have written over the past 25 years. It features a new introduction in which I relate these essays to recent monetary and financial developments and assess what I believe to be their specific contributions to Austrian monetary economics. The essays were originally published in a wide variety of academic journals, scholarly and popular books, periodicals, and web publications. Some are more technical than others, but all of the essays are written in straightforward English and are accessible to the literate and interested nonspecialist.
The range of topics covered by these essays is broad. I will mention a few that may be of special interest to your readers as well as a few that have had some influence on other scholars. There is one that formulates a specifically Austrian definition of the "true" money supply based on insights by Murray Rothbard, and applies it to calculating the US money supply. There is another essay that describes and classifies the different kinds of deflation, and argues that most kinds are economically and socially benign. A related essay argues that there is no empirical link between deflation and depression. How inflation generated by central-bank money creation conceals the true cost of war is the subject of another essay.
There are four essays dealing with the gold standard. These essays explain the operation of a pure, 100 percent gold standard, refute common objections to a gold money, distinguish between "true" and "false" gold standards, and analyze various proposals for reestablishing a modern gold standard. There is an essay that defends Murray Rothbard's characterization of the 1920s as an inflationary decade against the criticisms of Richard Timberlake, a prominent monetarist and monetary historian. A follow-up essay challenges Timberlake's claims that the Fed pursued a deflationary monetary policy throughout the 1930s and that this policy was responsible for prolonging the Great Depression. Finally, I might also mention two essays originally published in the first half of the last decade in which I criticize Alan Greenspan, then at the peak of his fame as the monetary "Maestro," as a clueless and dangerous inflationist whose policies were driving the US economy toward an economic disaster.
DB: Where can your book be found?
DB: What do you think laypeople would find most compelling about it?
JS: The fact that it is written in plain English and that it deals with topics and events that do or will affect their daily lives.
DB: What are some other books you have written or edited?
JS: I have edited, and written introductions or epilogues for, several important works by the Austrian masters, most notably: F.A. Hayek, Prices and Production and Other Works on Money, the Business Cycle, and the Gold Standard; Murray N. Rothbard, A History of Money and Banking in the United States; Rothbard, The Mystery of Banking; Rothbard, Man, Economy, and State with Power and Market (Scholar's Edition); and Ludwig von Mises, Economic Calculation in the Socialist Commonwealth.
DB: Are you happy with the growth of free-market thinking in the 21st century?
JS: I am thrilled with the rapid expansion of free-market thinking and scholarship in the new millennium. What especially impresses me is that much, if not most, of it has been inspired by the writings of Mises, Hayek, and Rothbard via the multimedia efforts of the Mises Institute — through its books, journals, instructional and professional conferences, daily articles, podcasts, and so forth.
I am especially gratified that students, business and finance professionals, a few maverick journalists and media commentators, and just plain ordinary people who have real careers and jobs in the private sector have been the ones in the vanguard of this resurgence of interest in free-market ideas in general and in Austrian economics in particular. It has been this sea change in "public opinion" that has compelled establishment pundits and intellectuals, and even mainstream economists, to confront Austrian arguments against the Fed and fiat money and to try to engage the Austrian theory of the business cycle.
This development must be credited in no small part to the influence of Ron Paul and his unique ability to bypass and short-circuit the media elites and communicate directly with the public. This is especially true in the case of the spontaneous growth of anti-Fed sentiment and the questioning of the Fed's policies and profoundly undemocratic "independence" that has spread so rapidly throughout society, even making inroads into the mainstream business media. So great has been the damage done to the Fed's reputation, that Chairman Bernanke felt compelled to descend from the Olympian heights to sit — quite uncomfortably it appears — for an interview on 60 Minutes, a popular TV news magazine. Credit is also due to the Mises Institute, whose efforts to broadly disseminate sound economic ideas to all sectors of society have been instrumental in raising public awareness of the true nature of the Fed and its culpability for the economic events of the past decade.
It is also important to realize that this remarkable resurgence of interest in sound money and free markets has vindicated the view of political and social change expressed by Mises and Rothbard. Both men emphasized that the only means to radical social change was for free-market economists and other libertarian scholars to directly convey knowledge of the benefits of a free society to the productive classes, who are being systematically misled and bamboozled by the intellectual and media elites. A number of contemporary Austrian economists and libertarians have been surprised by the spontaneous libertarian movement that has grown up around a popular figure like Ron Paul. Some are even skeptical of its beneficial effects precisely because it is a populist movement whose ideas have not been properly vetted by intellectuals ensconced in universities, think tanks, and media firms.
Indeed the intellectuals have been among the very last to recognize the popular groundswell of antigovernment, anti-Fed sentiment. But the skepticism of these Austrians and libertarians is not well-grounded and stems from a misinterpretation of Friedrich Hayek's views on the strategy of transition to a free society. According to their flawed reading of Hayek, social change occurs very slowly and is a trickle-down phenomenon. That is, free-market experts and scholars who somehow have gradually ascended to positions in establishment ivory towers first formulate abstract ideas and theories that are then developed in a form that appeals to the ordinary citizen. This is necessarily a long drawn-out process because it next requires that a class of lesser libertarian intellectuals be reared up to take positions of influence in our opinion-molding institutions, i.e., media outlets, publishing firms, schools, churches, think tanks, and so on. These intellectuals are then tasked with developing these ideas and theories into concrete positions on social and economic issues that are palatable to the clueless masses.
This pseudo-Hayekian view was further distorted and rendered even sillier by ripping out of proper context Hayek's useful metaphor of "the structure of production" to represent the production of ideas. Briefly, the story here is that the scholars and experts are the original factors of production that formulate the basic ideas and theories of social and economic interaction that are passed along to the "lower-order" intellectuals and transformed step-by-step through time into an ideology ready-made for popular consumption. But this is not Hayek's story at all. In his brilliant article "The Intellectuals and Socialism," Hayek portrays the intellectual class as almost invariably statist and prone to adopting and propagating only socialistic ideas and schemes for social reform, while suppressing free-market ideas. Hayek refers to intellectuals as exercising "their censorship function." So opposed was Hayek to these intermediaries in ideas that he raised the issue of economically liquidating this class by eliminating copyright law. But he wondered whether a critical view of the social benefits of the law of copyright and "the expression of doubts about the public interest in the existence of a class which makes its living from the writing of books" could ever be openly stated in a society in which intellectuals control the media.
DB: Let's ask some slightly more technical questions. What is money in your view?
JS: I hold a fairly conventional theoretical definition of money as the general medium of exchange, meaning the good in the economy that is routinely and universally accepted in exchange for all other goods and services. Less orthodox is my view of what things constitute the money supply in our current system of central-bank-monopolized fiat money. I follow Rothbard's rule that any item that is either itself money or is redeemable at par on demand for money should be included as a component of the money supply. Thus, for the United States, I would count Federal Reserve notes held by the nonbank public, which is the basic "cash" of the system, plus all checkable deposits plus all deposits classified as savings deposits as the main elements of the US money supply. This monetary aggregate is what I call TMS for "True Money Supply."
Let me briefly explain. Savings deposits are identified as part of TMS even though they cannot be directly used in payment, because they represent instantaneous and FDIC-insured claims to immediately spendable dollars — for example, through ATM machines, cashier's checks, and personal withdrawal. The fact that they are not checkable and are less convenient to physically access than demand deposits is a mere technical detail and does not affect their status as money. Analogously, no one would deny that Fed notes left at home in a safe or buried in the backyard are any less money just because Fed notes carried in one's wallet are more conveniently spendable.
In contrast to savings accounts, shares in money-market mutual funds (MMMFs) are excluded from TMS because they are not redeemable at par. They are not federally insured and are not claims to a fixed quantity of currency. Rather they are titles to shares of a managed portfolio of highly liquid, short-term securities. The value of these shares, typically maintained at $1.00 per share, could decline below $1.00 (called "breaking the buck") depending on the performance of the fund's portfolio. Thus the equity share owner (not depositor) in the fund bears the burden of interest rate and default risk. By the way, in fall 2008, during the financial crisis, the US Treasury established a temporary program to guarantee MMMF shares giving them the character of bank demand deposits, but this program expired in 2009, so we can continue to comfortably omit them from the money supply.
For those who may be interested in a full explanation of TMS, they should read my article on the "The 'True' Money Supply" reprinted in my book Money: Sound and Unsound. I should note that, based on the same Rothbardian theoretical considerations that I used to construct TMS, Frank Shostak developed a narrower monetary aggregate, which he named the "Austrian Money Supply" or AMS.1 Michael Pollaro has labeled these aggregates TMS1 (Shostak's) and TMS2 (Salerno's) and has written an insightful article, "Money Supply Metrics, the Austrian Take," comparing and contrasting them, which is available on line.
DB: Do you believe in private fractional banking or should it be illegal?
JS: I am neither a philosopher nor a legal theorist, but I believe in the absolute right of individuals to enter into any voluntary contract that they choose. But a contract must be meaningful to be enforceable. If I pay you for a promise to paint my house red and green all over, this is not a contract but an absurdity. Likewise if I pay you (or even if you pay me) to store my motorcycle in your garage so that it is always available for me to use it and I grant you the freedom to rent it out at will. My point is that the deposit contract as modern free bankers conceive it, is a meaningless fiction. It implies that a sum of money can be both maintained on deposit for instantaneous withdrawal by the depositor and lent out to a borrower.
Now I am not saying that a free-banking deposit contract can never be formulated in a meaningful way. But then it would not be a "deposit" contract at all, but a short-term credit transaction. In fact, some free bankers have admitted that bank deposits are actually "call loans" that are extended to brokers by banks and that mature daily. This being the case, it would be explicitly stated in the contract that the "depositor's" funds were being lent or invested by the "banker" and that immediate withdrawal is contingent upon the liquidity position of the bank. There would also have to be explicitly stipulated in the contract the recourse available to the depositor and the banker's obligations in the case of temporary suspension of withdrawal privileges. It is highly unlikely that, under these circumstances, the short-term financial instruments issued by free bankers — no longer masquerading as immediate claims to fixed sums of money — would gain much circulation as currency.
There now appears to be some empirical evidence on this last point. One of the summer fellows under my direction here at the Mises Institute, Malavika Nair, is working on a very interesting study of a genuine free-banking regime, which operated in India and Burma in the late 19th and early 20th century. Unlike the alleged free-banking systems in Scotland and the United States, this regime was not propped up by central bank or government loans and bailouts and by legalized suspensions of gold and silver payments to their depositors and note-holders. In the Indian case the silver and British pounds were lent to the free bankers by "depositors" who wanted to earn a return while holding a portion of their wealth in highly liquid financial instruments, i.e. the banker's promises to pay that matured daily. The bankers then lent the silver and pounds directly to farmers, merchants, and businessmen and did not issue any currency. The depositors, for their part, were able to access their invested (not deposited) funds at any time with the explicit option reserved to the bankers to delay payment for a day or two. The depositors also had the right to have their funds transferred to third parties by a draft on their banker. From this preliminary research on the Indian case it appears that in the actual free market, as opposed to the speculative construction of academic free bankers, the financial institutions that arise to supplement commodity money would operate very much as money-market mutual funds do today.
Thus to answer the question you posed: I do not believe that "private fractional-reserve banking," as it is commonly understood in debates among libertarians and Austrians today, should be illegal. It is a self-contradictory concept that could never be formulated into a meaningful contract on a free market. Meaningful contracts would result in true financial intermediaries that did not issue currency and create money but simply invested and managed people's short-term savings in a portfolio of highly liquid assets while offering a payments mechanism to transfer funds to third parties. In fact, I am all in favor of modern money-market mutual funds as well as historical "free-banking" arrangements as exemplified in the Indian case.
DB: Do you believe that Real Bills ought to be allowed in a private money system, or should Real Bills be illegal?
JS: I see nothing wrong with people creating and transferring bills of exchange, which are simply a short-term negotiable credit instrument that facilitates payments mainly in international trade. These instruments are completely consistent with a society based on free contract. What I vigorously reject is the age-old fallacy — known as the "real-bills" doctrine — that when a bank issues currency or bank deposits to discount a trade bill it is not causing inflation. If sound monetary theory, both classical and Austrian, has taught us anything, it is that a bank creates money whenever it makes a loan or investment of any kind whatsoever. Whether a fractional-reserve bank buys a government security, provides mortgage financing, makes a credit-card loan, or discounts a "real" bill of exchange, it must increase its demand-deposit liabilities to finance this expansion of its assets. In doing so, it increases the money supply and puts upward pressure on prices. Moreover, if banks persisted in maintaining the rate at which they discounted real bills below the "natural" rate of interest (that is, the rate of return on investment), they would confront an unending supply of trade bills to discount causing an inflationary spiral of money creation and price increases.
DB: Let's get some background. Where did you grow up?
JS: I grew up in New Jersey within an hour's commuting distance of New York City, where I still reside today.
DB: How did you decide to become a hard-money economist?
JS: As an economics major in college and already a libertarian, I came across a reference to Murray Rothbard and the Austrian School in a New York Times article on the new political philosophy of libertarianism. An acquaintance subsequently gave me a copy of Murray Rothbard's small booklet on Economic Depressions: Their Cause and Cure. I learned more about inflation and depression in the 45 minutes I spent perusing that booklet than from the two semesters that I endured in Principles of Macroeconomics and Intermediate Macroeconomics courses. I subsequently sought out and devoured all the works I could find by Rothbard, Ludwig von Mises, and Friedrich Hayek. These works stimulated my interest in monetary topics and inspired me to pursue an academic career focused on a sound-money research program.
DB: Have you experienced scholastic prejudice?
JS: Yes, only once. When I came up for tenure and promotion at my second teaching position, I was denied tenure by the provost despite the fact that the economics faculty, including the department's hardcore Marxist, had voted unanimously in my favor (11-0) and that my teaching evaluations and the reports of external reviewers of my research were extremely positive. It seems that the provost and the dean of arts and sciences did not like what they perceived as the rightward slant of the economics department, most of whose members were center to slightly right-of-center mainstream economists. They contrived to reallocate economics department "lines" (faculty positions) to the left-leaning "soft" social science (sociology, political science) and humanities departments. Because I was hired specifically for my specialty in Austrian economics, I was number one on their hit list. I filed a grievance on the basis that the tenure process deviated from the formally specified procedure and I won my case. It was no coincidence that the grievance committee who ruled in my favor was made up mainly of members of the hard-science departments. I was awarded the right to reenter the tenure and promotion process but was denied a second time. Once again proper procedure had been violated and my colleagues urged me to file a second grievance, but by then I had found a better paying job at a higher rank in a much nicer (and safer) location.
DB: Should the United States pass an antidiscriminatory law against those who exhibit prejudice against free-market scholars?
JS: Absolutely not! Sound economic ideas will only triumph in a process of free and open discussion. Invoking government's oppressive and fascistic antidiscrimination laws on either side will only stunt and divert this process.
DB: (Sarcasm off.) Why is it so hard to be a free-market scholar?
JS: I do not find it very difficult at all to follow this vocation. It may be hard to find a position at a top research university here in the United States, but small liberal-arts colleges and mid- and lower-tier universities are increasingly open to Austrian scholars, and some are even seeking them out. Another heartening development is that more and more aspiring Austrian economists are attending mainstream PhD programs and acquiring the technical knowledge and skills required to land jobs at these colleges and universities. Current and former Mises summer fellows and other young scholars who have attended Mises programs are enrolled in or have recently graduated from PhD programs at the following universities: Ohio State, Indiana, Boston College, Missouri, California–Berkeley, North Carolina State, Suffolk, SUNY-Albany, and the London School of Economics.
DB: How did you find a berth at Pace University?
JS: Pace University is a large private university with campuses located both in New York City and suburban Westchester County. I teach at the Manhattan campus, which is hard by the Brooklyn Bridge and a few blocks away from both Wall Street and the New York Federal Reserve Bank. It is primarily known for its business school and has a large MBA program. It places its graduates quite well in the New York metropolitan area. It emphasizes a combination of teaching and research.
At the time I was in the market for a job, the graduate economics department in Pace's Lubin School of Business was looking for someone whose research specialty was macroeconomics and monetary economics and who was also a good teacher. The chair of the department, William Freund, who interviewed me first, was vice president and chief economist at the New York Stock Exchange. Although I did not flaunt my Austrianism at that or the subsequent interview with the search committee, I certainly did not hide it. It was decided that I was the most qualified candidate and I was hired. I won the Lubin School's research prize my first year for a paper I published on the operation of the classical gold standard and have been happily ensconced at Pace ever since.
DB: Is the Internet making free-market scholarship more available and mainstream?
JS: Yes, without a doubt. The Mises Institute in particular has had spectacular success in broadly disseminating free-market ideas through its website, Mises.org. It has made an astounding amount of resources available online to scholars, students, investors, business professionals, and to anyone else who might be interested in broadening and deepening their knowledge of the economics of the free society. Perhaps most importantly, it has an enormous number of heretofore unobtainable books on economics and other disciplines available online.
DB: Is the Internet like a modern-day Gutenberg Press, changing the way society interacts with secret knowledge?
JS: I am not sure I fully understand your question here. But the Internet is certainly comparable to the printing press in disseminating knowledge to ordinary people and increasing their awareness of the schemes and misdeeds of the ruling elites.
DB: Has the dollar-reserve system collapsed?
JS: I would say that the dollar-reserve system is going through a slow-motion collapse, much as the Bretton Woods monetary system did in the 1960s culminating with President Nixon's ignominious closing of the gold window in 1971. With the continuation of trillion-dollar Federal deficits into the foreseeable future and the relentless and accelerating accumulation of the US national debt in foreign hands, it is difficult to see how the American state can avoid defaulting on its debt or attempting to inflate it away by continuing its reckless monetary expansion. But long before this occurs it is likely that foreign holders of US dollar assets like China will begin to reduce their holdings and replace their dollar reserves with other currencies or even precious metals. At this point the dollar-reserve system and with it the US government's privileged access to international credit markets will disappear. This day cannot come too soon for the long-suffering American citizen who is on the hook for the interest and principal payments on this endless foreign borrowing used to finance reckless military adventures abroad and wasteful and oppressive programs at home like the war on terror.
DB: Are central banks going out of business?
JS: Just as no politician ever resigns, no central bank ever goes out of business, except in the most extreme circumstances. In the case of central banks operating under a fiat-money standard, their core business is literally creating money from nothing, so there is no chance of them ever becoming insolvent. Indeed the very notion of a central bank's balance sheet listing its assets and liabilities is a hollow accounting fiction designed to conceal its true nature. That said, central banks might go out of existence when they destroy the currency through hyperinflation, which is hardly a desirable prospect. It is better to look at the Fed, despite its much-touted independence from politics, as simply a particularly destructive branch of government, which should be targeted for abolition as one of the first steps in the transition to sound money.
DB: Dr. Peter Boettke, whom we have interviewed, uses some of your material. Where do you stand on the split between GMU and the Mises Institute? Is there a split? Does it matter?
JS: All very good questions that I am happy to answer because there is a great deal of rumor, speculation, and misinformation — even outright falsehoods — in circulation about a supposed split between the two institutions. Let me preface my answer with an anecdote. I once saw a television interview with Mick Jagger, lead vocalist of the Rolling Stones, in the early days of the so-called British invasion in rock music. It went something like this:
Reporter: How do you compare the Stones to the Beatles?
Jagger: I don't. We do different things.
Reporter: But who is better?
Jagger: We are good at what we do and the Beatles are good at what they do.
Reporter: But do the Stones do what they do better than the Beatles do what they do?
Jagger: [Exasperated laughter]
What Jagger was getting at was that the Rolling Stones were a band with its roots in the black American blues tradition, while the Beatles were inspired primarily by 1950s American rock and roll. In any case, the point of the story is that there are deep differences between the organizational structure, financing, and mission of George Mason University and the Mises Institute. Like the Beatles and the Rolling Stones, the two cannot really be compared.
The GMU Austrian program is located in the economics department of a public university and its various programs and graduate fellowships are funded by private money from a few, large institutional donors. Its mission is twofold. First, it seeks to train graduate students in eclectic and heterodox political economy traditions with a general market-oriented thrust. As it says on the GMU website,
graduate programs in economics are noted for their emphasis on comparative institutional analysis and their concentration on the relationships among economic, political, and legal institutions. This distinction is illuminated by the fields of study associated with the department: experimental economics, Austrian economics, public choice, constitutional political economy, law and economics, and new institutional economics.
The second goal of GMU is to place their new PhDs on the faculty of colleges and universities, particularly ones that also receive grants from the same institutional donors to run free-market programs and that usually already have one or more GMU PhDs on its faculty. There are several of these so-called "cluster" schools in the United States, both private and public. These programs in turn serve to identify and cultivate free-market undergraduates who may be inclined to pursue a PhD in economics and steer them to GMU. Thus the cluster schools are both feeder programs and employment outlets for GMU. The GMU program and its associated faculty do what they do very well.
Given the diversity of traditions taught in the GMU program, its faculty can hardly be expected to be monolithic and most would probably not classify themselves as Austrian. Indeed the faculty includes several very good economists, some of whom are Austrians and some not. A few of my favorites, whom I also count as friends, are Richard Wagner, Larry White, and Dan Klein. Bryan Caplan is also an interesting thinker and a committed libertarian, although I do not always agree with what he writes.
In contrast to GMU, the Mises Institute is a private educational and research institute funded primarily by individual, as opposed to institutional, donors. Its mission is to disseminate and teach the economic theory and political economy of the Austrian tradition to the public as well as to promote academic research in this tradition. This it does through numerous conferences, publications of books and journals, and one of the world's leading economics websites, Mises.org.
The economists associated with the Mises Institute are employed in a wide variety of public and private colleges and universities in the United States and Europe and have received their graduate training in mainstream universities from Rutgers and Columbia to VPI (now Virginia Tech) and California-Berkeley. Given their diverse training, the Institute's economists are hardly monolithic in their interests or their views on specific theoretical or policy issues. They disagree on such things as the time-preference theory of interest, the usefulness of the "structure of production" concept, the consequences of open immigration, and whether private, unregulated fractional-reserve banking is consistent with a purely voluntary society, to name only a few.
However, they are united in their view that economics is a truth-seeking vocation. They also share the view that sound economic theory can only be advanced by using the causal-realist approach, which characterizes economics as the search for the true causal laws that explain real market prices and interest rates as well as the more complicated, but no less real, phenomena of business cycles and financial crises. This approach was developed in the works of the Austrian economists such as Menger, Böhm-Bawerk, Mises, and Hayek and in the works of eminent British economists such as Philip Wicksteed and the LSE economists of the 1930s and of the American psychological school of J.B. Clark, Frank Fetter, and Herbert Davenport. Rothbard synthesized and considerably advanced this paradigm in his great treatise Man, Economy, and State. Institute scholars seek to educate the public while pursuing research within the causal-realist paradigm.
As someone closely associated with the Mises Institute, I like to think that the Institute and its affiliated economists and scholars do what they do very well.
As far as whether any split exists between MI and GMU, it is a meaningless question because they have very different missions. Comparing the two institutions would be like comparing apples and oranges, or the Stones and Beatles. However, I do concede that there is a certain unavoidable tension between the two because they both lay claim to the name Austrian as a descriptor of their very different goals, strategies, and, especially, approaches to economic theory. But engaging in semantic controversy over who or what is an Austrian has proven to be vain and futile, especially since the problem now seems to be spontaneously resolving itself.
Most of the Institute economists have begun referring to their approach to economic theory as "causal-realist." This term summarizes Menger's original description of the proper method and goal of economic theory, which were adopted and pursued not only by his Austrian followers but, as Rothbard has shown, by many Anglo-American economists. I also like the term "mundane economics," coined by Peter Klein, to characterize the project of the Institute economists to avoid esoteric meta-economic sermonizing and instead to apply economic theory to analyze real-world issues such as the causes of the financial meltdown, the nexus of entrepreneurship in modern corporations, the effects of the Fed's quantitative easing programs, etc. GMU economists have used terms such as "coordination-problem" or "spontaneous-order" economics to identify the collection of heterodox methods and traditions that they embrace. All in all, not a bad solution, and one that avoids silly and wasteful conflicts.
DB: Why do you think so highly of Hans Sennholz? Why was he underappreciated?
JS: I greatly admire the work of the late Hans Sennholz because he embodied so well the virtues and skills of a vocational economist. Sennholz did his PhD under Mises and attended Mises's NYU seminar in the company of prominent Austrians such as Rothbard, Kirzner, and Hazlitt, among others. He was therefore intimately acquainted with causal-realist economic theory. During his long and illustrious teaching career and in his voluminous writings he aptly employed this theory to elucidate and analyze the causes and solutions of the economic problems of the day as well as the dire consequences of all manner of interventionist economic policies, which have been the outgrowth of the modern American welfare-warfare state.
Not only did he educate and enlighten generations of students and lay readers, Sennholz was also an accomplished scholar and innovative thinker who made important contributions to economic science and the sound-money program. He published articles contrasting the Austrian with the Chicago (monetarist) theory of money and explaining the operation of the classical gold standard and why its restoration was the only alternative to inflation. These and other contributions on the theory and history of money and business cycles are integrated in his book Age of Inflation. He also wrote valuable scholarly essays on Menger's monetary theory and Böhm-Bawerk's capital and interest theory. Perhaps his most important publication, however, is his book Money and Freedom, which has been neglected even by hard-money Austrians. In this slim volume of less than 100 pages, he presented an innovative and eminently practicable transition plan to end the Fed's monopoly of the money supply and to introduce an inflation-proof regime of monetary freedom.
In answer to the second part of your question, Hans Sennholz has been ignored by the mainstream, and even by some who call themselves Austrian for two reasons. First, he wrote in plain English and did not mince words. As in the case of the great 19th-century French liberal economist Frédéric Bastiat, clarity of writing style was mistaken for superficiality of thought. Second, Sennholz invariably focused on real-world problems and policies and never wasted a word analyzing contrived paradoxes and puzzles or arcane historical minutiae. Furthermore, he consistently applied the tried-and-true causal-realist method in his analysis and avoided the technique-driven fashions of game theory, experimental economics, behavioral economics, computable general equilibrium models, etc.
DB: What do you think of the work of such "neo-Austrians" as Dr. Antal E. Fekete?
JS: I have very limited familiarity with Dr. Fekete's writings, so I am not in a position to comment on his work as a whole.
DB: Dr. Fekete recently wrote an open letter to Ron Paul, which you can find online. In it he used some confusing terminology, referring to the Federal Reserve when he may really have been speaking of dealer operations. He wrote that,
Most people believe, and the media confirm them in that belief, that the Fed can legally create dollars "out of the thin air"buy and sell US government, in any quantity, and can do with them as it pleases. This may well be the pipe dream of Dr. Bernanke who is quoted as saying that the US government has given the Fed a tool, the printing press, to stop deflation — but it hardly corresponds to the truth. The Fed can create new dollars only if some stringent legal conditions are satisfied, and then, it can only dispose of them in certain ways prescribed by law.
Can you comment on the "stringent legal conditions?"
Dr. Fekete then writes, "The law does not allow the F.R. banks to purchase Treasury paper directly from the Treasury because that would make money creation through the F.R. banks a charade, reserve requirements a farce, and the dollar a sham." He also writes, "The fact is that the Federal Reserve banks can purchase Treasury paper only if they pay with F.R. credit that has been legally created." Can you explain this? Is the Fed truly subject to such stringent rules? Doesn't the Fed print money from nothing or is this just a modern myth?
JS: Assuming that Fekete has actually said these things, then he is confused, to say the least. I cannot explain exactly what he means, but I will respond to some of his statements.
The Fed is certainly not now constrained in its money-creating activities by "stringent legal conditions," if it ever was. Since World War II, and especially since 1980, the Fed is able to create money at will by purchasing assets on the open market. It exercises this power every day, three blocks from my office in New York City, where the New York Federal Reserve Bank, with its "trading desk," is located. The Fed is legally authorized to buy and sell U.S. government, as well as many other types of, securities for its own account on the open market. It trades exclusively with 20 or so "primary dealers," consisting mainly of Wall Street investment banks and other large securities dealers. When the Fed wishes to increase the money supply, it simply holds a computer auction where it offers to buy Treasury securities from these firms. It will purchase from the firms offering the best-selling prices and will pay with checks written on itself. Actually, payment is not in the form of literal paper checks, but in the form of electronic transfers of funds to the sellers' bank deposits.
But from where does the Fed obtain the funds that it transfers to the sellers? It literally and instantaneously creates them out of thin air — or in cyberspace — by the stroke of a computer key. Say the Fed purchases $100 million in bonds on a given day (usually in the morning, during so-called Fed time, from 9:00 am to 11:00 am). The newly created dollars that are paid out to the sellers now swell the reserves of the banks in which they are deposited. The Fed now has $100 million dollars worth of additional assets in the form of US Treasury securities offset by $100 million dollars of new liabilities represented by the increase in reserve deposits that it holds for the banks.
While some of a bank's reserves are held as currency in its vaults and ATM machines, most are held as insubstantial cyber-credit entries in their deposit accounts on the books of the Fed. The $100 million of reserves, a component of "base money" or "the monetary base," thus created by the Fed, can fuel a multiple expansion of the money supply as the banks create new checking deposits for businesses and households by lending and relending these added reserves subject to a legal reserve requirement of 10 percent. Thus from 2001 through 2005, the Fed orchestrated a $2 trillion increase in the US money supply on the basis of open-market purchases that swelled base money by $200 billion. In effect, during the period when the financial and real-estate bubble was forming, the Fed was wildly creating new money at the rate of $1 billion per day! Again in 2008-2009 the Fed doubled the monetary base and bank reserves in a matter of four or five months by creating money to buy up not only government securities but also almost every kind of private security it could lay its hands on.
So Fekete is dead wrong in claiming that the Fed is somehow subject to rigid legal constraints in conducting monetary policy. As to his claim that the Fed is not legally permitted to purchase new issues of Treasury securities from the Treasury, it is true but beside the point. The law is a sham and does not restrain the Fed from creating money at will by simply buying previously issued Treasury securities on the open market.
Lastly, Dr. Fekete's argument that the Fed can purchase government securities "only if they pay with F. R. credit that has been legally created" proves nothing. "Federal Reserve Bank credit" merely refers to the asset side (minus gold) of the Fed's balance sheet, which can be expanded without external control or limit by the Fed itself using the dollars it creates via open market purchases.
DB: It seems to us that central banks affect the quantity and value of money even by setting interest rates.
JS: Yes, that is true. But the Fed does not directly set interest rates. This is the great modern myth, which was designed to conceal the Fed's true modus operandi. The Fed influences interest rates by creating and injecting dollar reserves into the banking system. The additional reserves increase the supply of loanable funds relative to the economy's demand and thus induce banks to offer loans at lower interest rates in order to attract borrowers for the additional funds. So causation runs from the increase in Fed–created base money to reduced interest rates. Lower interest rates are just one of the distortions caused by the Fed's unrestrained power to create money ex nihilo.
DB: Is every law and regulation a price fix? Do price fixes always distort the economy?
JS: Every attempt to fix prices from apartment rents to the prices of kidneys and other cadaveric organs for transplant distorts the economy and causes long-run consequences that most of the supporters of the regulation do not foresee and do not desire. In the case of the futile attempt to fix interest rates, these consequences are particularly devastating: inflation, bubbles, and recession or depression.
DB: What would be the best kind of money?
JS: The best kind of money is sound money. By this I mean money whose supply is completely divorced from control by the government or its central bank and whose value is therefore determined exclusively by market forces and not by the whims and conivings of politicians. In practice this means money based on a useful commodity produced on the market, historically gold or silver or both.
DB: Is the best money system simply one that allows for money-competition?
JS: Absolutely. The production of the money commodity, its transformation into convenient shapes like coins and bars, its storage in banks that issue notes and checking deposits — all of these functions should be undertaken by unregulated, competitive firms. Likewise, the entire panoply of protectionist and monopolistic regulations on financial institutions like investment banks, business and mortgage lenders, mutual funds, hedge funds, insurance companies, and so on would also be removed and the gales of rivalrous competition allowed to sweep away the rotten and inefficient firms and restructure the entire industry to serve consumers.
DB: Where is gold headed?
JS: In my estimation ever skyward, along with US deficits, national debt, money supply, and asset and consumer prices. Every fiat-money regime in history has been inflated away or collapsed and has given way to a gold standard sooner or later. I see no reason why the US dollar, the euro, and the other postwar fiat currencies will not suffer the same fate.
DB: Where is silver headed? Is silver a better buy than gold right now?
JS: I think silver will track gold but with more volatility, but I am not an investment adviser and hesitate to make a more specific prediction. But I do believe that silver will have an important role in the sound monetary system of the future.
DB: What are you working on currently?
JS: I am finishing up a few articles. One is on the sociological and political effect of the German hyperinflation on human personality and political developments in Germany; another deals with a restatement of the Austrian theory of the business cycle that fortifies it against some recent criticisms from mainstream economists.
I am also working on a book tentatively entitled, The Spending Illusion: Inflationism from John Law to Ben Bernanke. The book will argue that macroeconomics is a very old inflationist doctrine that predates scientific economics and developed independently and in opposition to it, at least until the late 19th century when the two became tragically intertwined by the emergence of the quantity theory. The main tenet of macroeconomics is that the spending of money determines the "level" of prices and drives real economic activity, a doctrine that is today accepted by almost all mainstream economists and even some economists who consider themselves Austrian. But this is an illusion that gets things precisely backwards. In fact, the amount of money that changes hands ("spending") is a trivial outcome of the dynamic pricing process.
The causal factors that determine the structure of money prices are the existing stocks of money and of the various kinds of goods and their relative rankings on people's value scales. These factors together simultaneously determine the sum of money that exchanges for each unit of a given good (the "price") and the number of units of each kind of good that is exchanged (the "quantity"). Thus the so-called "level" of prices (better terms are the "height" or "scale" of prices) is determined as part of the same process of individual exchange that determines "relative" prices, and the two cannot be conceived separately.
The amount of money spent is simply an arithmetic sum, computed after the fact, of the products of the quantity of each good sold and its price and is therefore causally irrelevant. This was recognized implicitly by the classical economists and then later explicitly by the Austrian economists, and you would be hard pressed to find the use of the term "spending" in their works. The concept of spending, however, very definitely played a central role in the works of the 18th- and 19th-century monetary cranks (i.e., macroeconomists) whose doctrines were refuted time and again by the classical economists. Unfortunately, monetary crankism became the dominant orthodoxy with the advent of the quantity theory during the bimetallic controversy of the late 19th century and eventually gave rise to the popularity of the Keynesian Revolution and the doctrine of modern macroeconomics.
DB: Do you have any books or articles you would like to recommend?
JS: Yes, I do. I highly recommend Deep Freeze: Iceland's Economic Collapse by Philip Bagus and David Howden and The Tragedy of the Euro by Philip Bagus. Both of these volumes do a wonderful job of applying causal-realist theory to analyzing and explaining momentous real-world events that have an impact on the economic welfare of many nations and people. And both books are clearly written and accessible to noneconomists as well as indispensable sources for serious scholars in the field. These are examples of the kind of work that the Mises Institute encourages its young scholars to pursue.
I am currently reading Ralph Raico's book Great Wars and Great Leaders: A Libertarian Rebuttal. Raico is a superb stylist and is unflinching in revealing the truth about the misdeeds and crimes of the "great men" of modern history like Leon Trotsky, Winston Churchill, Franklin Delano Roosevelt, and Harry Truman. Raico's book is revisionist scholarship at its finest and most compelling.
DB: Any other comments you want to make? Any points we've missed in terms of your interests or goals?
JS: No, I think we have pretty well covered the field.
DB: Thank you for your time. It's been an honor.
JS: It has been my pleasure.
DB: Thank you for your time and a very interesting interview.
[Republished with permission from the article published by the Daily Bell July 3, 2011.]
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.