Mises Daily Articles
Ending the Monetary Fiasco — Returning to Sound Money
[This talk was given as the Ludwig von Mises Lecture at the Austrian Scholars Conference on March 14, 2009. It is also available in audio and video.]
Ludwig von Mises is, and I suppose virtually all of you would agree, the dean of the Austrian School of economics, and I do not hesitate to add, he is also the most important economist of the 20th century and one of the greatest social philosophers.
Mises's personal courage and rigorous intellectual reasoning are, and will always be, an inspiration and encouragement to all students of economics, social affairs and philosophy.
His outstanding expertise in the fields of economics, politics, history, and psychology — combined with his amazing ability to integrate these diverse elements into a coherent theoretical system — is what sets Mises apart from other economists.
Mises not only reconstructed the theory of economics along the lines of a humanistic social theory, which he called praxeology: the science of the logic of human action. He also made a scientifically founded ethical case for capitalism, showing that the free market — the organization based in private property — essentially means productive, peaceful, and sustainable association and cooperation among free individuals.
Mises knew that capitalism, for a number of reasons, has politically powerful enemies. The most powerful, most destructive, and most vicious and subversive of these would be false monetary theory and, as a result, a misguided monetary system, as it inevitably will destroy the free societal order. In The Theory of Money and Credit, published in 1912, Mises noted
It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown.
By fiduciary medium Mises meant fraudulent money: money that systematically violates the principle of private property — money that isn't backed by freely chosen money proper (such as gold and silver). Government controlled fiat money is and will always be, by construction, fraudulent money.
We already find ourselves facing the destructive consequences that the worldwide fiat-money regime has engendered: impoverishment, caused by malinvestment, and rising despair among the people — which, it must be feared, will set into motion disintegrating forces for capitalism, the productive, peaceful, and sustainable societal cooperation.
We are witnessing yet another sign of the failure of the fiat-money regime — this time perhaps its eventual collapse — on a worldwide scale. It has been predicted, logically deduced from praxeology, by Mises and his followers, as a result of state interventionism in monetary affairs.
However, this assessment is not shared by public majority opinion. On the contrary, free markets are being blamed for having caused the disaster, and even more government interventionism — controls, regulations, restrictions, special privileges, subsidies, or Keynesian-type government spending programs — is seen as the way out of the catastrophe.
"Interventionism is," as Mises wrote,
not an economic system, that is, it is not a method which enables people to achieve their aims. It is merely a system of procedures which disturb and eventually destroy the market economy. It hampers production and impairs satisfaction of needs. It does not make people richer; it makes people poorer.
From the viewpoint of the Austrian School of economics, only a return to sound money — that is free-market money — can prevent further impoverishment and destruction of individual freedom, the inevitable consequence of interventionism in monetary affairs.
There is no means of avoiding the final collapse of a boom brought about by [and here I may add: circulation] credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.
[T]he clamor to eliminate the deficiencies in the filed of money has become universal. People have become convinced that the restoration of domestic peace within nations and the revival of international economic relations are impossible without a sound monetary system.
Today, with the standard of living relatively high in the major economies and international relations between the economic and militarily powerful nations being by and large peaceful by historical standards, one would think that the chances for monetary reform are much more promising than they were back in the 1920s.
In an era of big government, however, with its corrupting effects in the society increasingly weakening the voices of freedom, the chances for returning to what Mises called sound money — before the damage spins out of control completely — have undoubtedly declined.
But change hasn't become impossible. Powerful tools remain in place: intellectual debate, education, and conversion of a large number of people to the cause. The most powerful and rigorous arguments making an uncompromising case for sound money as an indispensable prerequisite of freedom can be found in the works of Ludwig von Mises.
Having said that, please let me briefly outline the structure of the rest of my talk. In the second part, I will review the milestones of Ludwig von Mises's prolific achievements in the theory of money, economics, and its epistemological foundation.
In the third part I will turn our attention to the current state of world monetary affairs. I will take stock of the latest developments from a Misesian theoretical perspective. In the fourth part, I will outline a strategy for ending the monetary fiasco and returning to sound money.
II. A Brief Overview of Mises's Work
Mises's book The Theory of Money and Credit (1912) was a ground-breaking work. In it he succeeded in solving what had been seen so far as an insurmountable task: integrating the value of money into the marginal-utility theory. In doing so, Mises not only provided a microeconomic foundation for determining the value of money but also solved the so-called "Austrian circle."
In Principles of Economics (1871), Carl Menger (1840–1921) had developed a logical-historical theory of the origin of money. Money, he maintained, could only have originated out of barter. Such an explanation, however, led to the problem of the "Austrian circle": At any given time, the purchasing power of money is determined by the supply of and demand for money which, in turn, depend on the preexisting purchasing power of money. This leads to an infinite logical regress backward in time.
Mises showed that the hitherto-assumed infinite logical regress was not infinite: the regress ends at precisely the point in time when money is a useful nonmonetary commodity in a barter economy. Mises's regression theorem demonstrates that the value of money has a historical dimension, as was stated by Menger, and it also provides a logical explanation for Menger's theory.
What is more, the regression theorem shows that money must be established by free-market forces, that it cannot be established by government interventionism. The only possibility for the government obtaining control over the money supply is through coercive action.
In The Theory of Money and Credit, Mises also laid the foundation of what later became the Austrian monetary theory of the trade cycle, developed further in the second edition of The Theory of Money and Credit in 1924.
Mises built his business-cycle theory basically out of three preexisting theoretical elements: the boom-and-bust model of the Currency School, the differentiation between the natural interest rate and the market interest rate as developed by Knut Wicksell (1851–1926), and the capital-and-interest-rate theory as developed by Eugen von Böhm-Bawerk (1851–1914).
By integrating these previously separated theories, Mises showed that any artificial government manipulation of the interest rate by expanding — what he called — circulation credit sets into motion an economic boom that must inevitably end in bust.
Early on, Mises was of the opinion that government market interference would almost invariably prove to be counterproductive, and his works on money and the business cycle confirmed and reinforced this view.
Whenever the state intervenes, it invariably ends not in solving the problem it tries to solve but in creating additional problems, provoking even further government interference in private property. Sooner or later, society is faced with a choice: either returning to capitalism or drifting to full-scale socialism, as ongoing interventionism would sooner or later replace the free societal order.
From 1913 to 1934, Mises was an unpaid professor at the University of Vienna while working as an economist for the Vienna Chamber of Commerce, serving as the principal economic adviser to the Austrian government.
After having fled Hitler-dominated Europe in 1940, Mises continued his prolific work in the United States of America. He was a visiting professor at New York University from 1945 until he retired in 1969.
All of these works made important contributions to economic theory and the procapitalism debate, and all of them were in stark opposition to the prevailing mainstream viewpoint of the profession — which had been characterized by (logical) positivism, empiricism, and societal relativism — in fact, these tenets have remained the very guiding principles along which today's mainstream economics is still being built.
Perhaps most characteristically, in his monumental Human Action, Mises gave economic theory a solid epistemological foundation, reshaping economic theory as the implication of the formal fact of human action.
He cast economics as a subdivision of praxeology, the science of the logic of human action. Economics follows the discipline of applied logic, based on the axiom of action, an a priori true proposition, thereby following the epistemological tradition of the great philosopher Immanuel Kant (1724–1804) who outlined in his Critique of Pure Reason (1781) that truth follows from self-evident axioms.
Mises concluded on the science of economics
Its statements and propositions are not derived from experience. They are, like those of logic and mathematics, a priori. They are not subject to verification or falsification on the ground of experience and facts. They are both logically and temporally antecedent to any comprehension of historical facts.
Mises not only gave a philosophically sound defense of the economic method in line with earlier Austrians; he also refuted the claims of positivists, empiricists, and neoclassical economists, revealing their views as mistaken and unscientific, and showing that the methodology of a science of human action is different from that of natural science, hence his call for methodological dualism.
It goes without saying that praxeology — building on axiomatic-deductive arguments for providing irrefutable truths — brought Mises, in an age of socialism, interventionism, democratic egalitarianism, and ethical relativism into severe conflict with the mainstream economic profession. But he held the course, even at the price of his academic career, which was hardly a success by conventional standards.
III. The Role of Money in the Process of Civilization
I would now like to move our attention to Mises's achievements in monetary theory, which is, as will be seen shortly, inseparably linked to the scientific case for capitalism.
Capitalism rests on individuals' property rights: private ownership of the means of production. All claims capitalism makes — such as, for instance, fostering free, peaceful, productive, and sustainable association among individuals — result from this fundamental insight.
Motivated by self-interest, property encourages individuals to increasingly take advantage of the division of labor and free trade, as the latter allow for higher productivity and incomes when compared with a system of economically self-sufficient individuals.
Money emerges from individuals pursuing their self-interest. Using money no longer restricts exchange to a double coincidence of wants of the parties involved, thereby expanding the possibilities of exchange in an economy organized along the lines of property rights.
Mises realized that money is not an abstract concept that can be treated separately from the sphere of commodities, but that money is itself a commodity: in a free market, money is the kind of commodity that is considered most exchangeable.
With prices of all vendible items expressed in terms of a single commodity, transaction costs are greatly diminished, requiring fewer resources for making exchange possible, thereby contributing to higher productivity and higher standards of living.
The use of money as an accounting tool provides for an accurate expression of an individual's opportunity cost. This, in turn, supports efficient decision making on the part of consumers and producers.
Money allows for higher incomes. And higher incomes lower people's time preference, that is individuals' preference for present goods over future goods. And the lower people's time preference is, the earlier the onset of the process of capital formation starts.
A decline in people's time preference means that a greater portion of current income will be saved and invested. As the stock of capital rises, and as production becomes more roundabout, the marginal productivity of labor increases, and this leads to higher employment and higher wages.
The expansion of the division of labor and free trade, accompanied by a rise in saving and investing, brings about ever closer economic ties between individuals.
Growing economic integration makes people less present oriented and more future oriented, and this too gives another boost to a higher degree of interpersonal cooperation and association, or in other words, civilization.
We can conclude that money plays a key role in facilitating and intensifying the process of civilization. However, this holds true only for free-market money, while with government-controlled fiat money, the opposing tendency comes into operation, namely the process of decivilization.
IV. The Sound Money Principle
As noted already, Mises, following Carl Menger, showed that money — its origin and evolution — is an integral and seminal element of the free-market system. In that sense, free-market money can be characterized as "sound money."
In The Theory of Money and Credit, he wrote,
[T]he sound-money principle has two aspects. It is affirmative in approving the market's choice of a commonly used medium of exchange. It is negative in obstructing the government's propensity to meddle with the currency system.
It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of right.
Mises's sound-money principle is a protection against destructive government interference in the free market. In that sense, sound money can be interpreted as a means to an end: sound money safeguards the free-market order, leading to prosperity and the process of civilization.
It is against this backdrop that today's monetary regimes — which in the last decades have evolved in diametrical opposition to Mises's sound-money principle — must be seen as a source of destruction to the free societal order.
Today's money is supplied by government-controlled central banks, which hold the money-supply monopoly. Today's money is fiat money; it no longer has any link to a commodity such as gold. Central banks can, and do, issue new money "out of thin air."
The stock of money is increased without invoking any wealth-producing activities as required in the free market. Fiat-money creation — which is typically done via the credit markets — can therefore — from the viewpoint of the best legal tradition — be called counterfeiting money.
In a free market, wealth can only be created through homesteading, producing, and contracting. Exchanging goods and services against fiat money — be that in the market for present goods or in the time market, where present goods are exchanged against future goods — is a violation of the free-market principle, as it is no longer mutually beneficial for all parties involved.
V. The Austrian Monetary Theory of the Trade Cycle
Let us turn to Mises's business-cycle theory. From praxeology we can deduce that government fiat money is to be held responsible for the recurrence of boom-and-bust cycles, as outlined by Mises's monetary theory of the trade cycle. Let us take a look at the chain of events.
An increase in the fiat-money supply through what Mises called the expansion of circulation credit lowers — and necessarily so — the market interest rate below the natural rate, or people's time-preference rate. It is this artificial downward manipulation of the market interest rate that sets into motion the economically harmful and politically devastating boom-and-bust cycles.
The increase in the fiat-money supply via circulation credit is inflationary, and its consequence is prices for consumer or asset prices going up.
What is more, it leads to a false sense of real savings. The artificially lowered market interest rate induces investment projects that would not have been undertaken under an unchanged credit and money supply.
The artificially lowered market interest rate makes production more roundabout, that is, economic resources are increasingly diverted from the production of consumption (or lower-order) goods to investment (or higher-order) goods.
The lowered market interest rate reduces real savings and increases consumption and investment, making monetary demand overstretch the economy's real resources and diverting people's saving-consumption relation from their actually desired path.
Sooner or later, however, people return to their favored savings-consumption ratio. When this happens, it becomes obvious that the economy has lived beyond its means, that is it has embarked upon an unsustainable path, and the credit-and-money-fuelled boom turns into bust.
But now comes the hard — the political-economic — part, of which Mises was so well aware. In view of an approaching depression, people start calling for the continuation of the very policies that have caused the malaise: even lower interest rates through a further increase in the supply of credit and money; more credit and money at the lowest possible interest rate are seen as a remedy rather than cause of the malaise.
Lower central-bank interest rates may prevent depression on some occasions, but this comes at a high price. A correction of the distortions in the production structure is prevented, and the artificially lowered interest rate encourages even more distortions in the economy's production structure.
As a result, a monetary policy that tries to fend off depression — the economically painful but necessary process of correcting malinvestment — merely postpones the inevitable crisis and, because it increases the amount of malinvestment, increases the costs of the final and inevitable bust.
One may blame the public's economic illiteracy and its anticapitalist mentality for failing to come up with the right diagnosis of the causes of the crisis and to advocate an appropriate cure. This, however, would run the risk of underrating the disaster-causing role of government.
Governments and their sympathizers and beneficiaries have an existential interest in preserving and strengthening the fiat-money regime, marketing it in public — especially in state-funded schools and universities — as being in the best interest of the people, suggesting that there is no viable alternative.
VI. Taking Stock of World Monetary Affairs
But of course there is a viable alternative: free-market money. And monetary regime change is badly needed, a case unmistakably made by the disintegrating of fiat-money systems the world over.
But the majority of the people do not believe in free markets, as epitomized by the popular term international credit crisis.
To put it mildly, this is a misleading interpretation of what is really going on. What is called crisis is actually an inevitable process through which malinvestment — provoked by a relentless expansion of circulation credit and fiat money in the last decades — is corrected.
However, governments and their central banks take measures — essentially bailouts of the greatest possible dimension — for fending off the inevitable correction. It goes without saying that they won't improve things but will make them even worse.
In view of the gigantic debt pyramid, which has been heaped up over the last decades, lenders have become concerned about the ability of their borrowers to service their debt.
Creditors are no longer willing to refinance loans falling due, let alone increase their credit exposure. Borrowers, accustomed to carrying high debt loads, cannot repay their maturing debt and shoulder higher refinancing rates.
In an effort of deleveraging and derisking their balance sheets, commercial banks reign in their credit supply and call upon borrowers to repay their debt. As a result, the credit and money supply contracts.
If commercial banks default on their debt, bank liabilities — in the form of unsecured and secured debentures — and finally also demand, time, and savings deposits would be destroyed.
The economic correction process, brought about by the remaining free-market forces under a fiat-money system, would transform the inflation regime (the period of a rising fiat-money stock) into a deflation regime (a period of a contraction of the money stock).
Before we talk in some more detail about inflation and deflation and its economic consequences, please let us take a brief look at the current state of worldwide monetary affairs and the very developments that led to it.
Stock prices around the world are falling sharply, in particular bank stocks. This might reflect growing investor concern about the future profitability of banking, especially so in view of growing banking nationalization efforts on the part of governments.
In fact, Karl Marx would most likely be delighted to see what mainstream economists, including many who would think of themselves as capitalism-friendly economists, are calling for.
In effect, most mainstream economists agree now with Marx in calling for the "centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly," which is actually proposal number five in his Communist Manifesto, published in 1848.
Unemployment rates are on the rise, not only in the United States but also in Europe and Japan. Mass unemployment is a likely, and sad, perspective, the result of the malinvestment, bringing "clusters of errors" to the surface.
Despite government guarantees for bank liabilities, banks' refinancing costs have continued to edge up — basically across all rating categories — not only in the United States but also elsewhere.
The collapse of stock-market valuations has been accompanied by skyrocketing price volatility. In the US stock market, volatility has reached levels last seen in the Great Depression period.
The price volatility of gold has also been going up dramatically, having returned to levels last seen when paper money devalued sharply against gold, that is in 1933–34, the early 1970s and 1980s.
In an effort to prevent losses from destroying banks' equity capital, the Fed is monetizing banks' troubled assets. As a result, the monetary base is now growing at the highest annual rate since data became available, that is since 1918.
What is more, governments around the world have underwritten domestic banks' balance sheets with tax payers' money. This, in turn, has increased investor concern about possible government defaults, as reflected in strongly rising premiums for insuring government bond portfolios, or so-called "credit default swap spreads."
The credit quality of the corporate sector has not remained unaffected. As another indicator for investor-credit-default concerns, the yield spreads of AAA and BBA rated corporate bonds over the T-Bill rate have risen to the highest levels since the Great Depression.
Turning to the causes of the crisis, the US private savings ratio has been declining considerably from around 10% in the early 1980s. It basically hit zero in 2008; and only lately has a reversal set in, pushing the savings ratio back to above 2%.
The trend decline in the US savings ratio, which set in the early 1980s, has been accompanied by bank credit expansion exceeding the expansion of nominal GDP by quite a margin, suggesting an increase in bank credit in excess of savings — which might illustrate what Mises termed circulation credit.
Viewed from a somewhat different angle, the trend decline in the federal-funds rate, which started in the early 1980s, has been fuelled by a massive rise in the economy's total debt outstanding in percent of GDP.
In this context it should be of particular interest to take into account that the relation between government's debt level and the Fed's interest rate is negative. Declining Fed rates have been accompanied by rising government debt and vice versa. By the way, such a relation can also be detected in other countries, for instance, Japan.
After the credit-boom collapse in the early 1990s, the Bank of Japan lowered rates towards zero, with the government trying to deficit-spend the banking sector back to health and the economy out of recession. After years of running huge Keynesian-inspired public deficits, Japan's gross public debt-to-GDP ratio is now approaching 200%.
The negative relation between central-bank rates and the level of government debt deserves some further comment at this juncture, especially in view of the monetary fiasco and the response it has provoked on the part of governments the world over.
If the government holds the monopoly of the money supply, inflating is a readily available source of government revenue. However, once inflation reaches a certain level, it becomes politically extremely difficult to handle.
This is because inflation undermines the principle of mutually beneficial exchange, thereby damaging the prosperity-creating forces of the free market. It leads to hardship for many, and sooner or later it makes people dissatisfied with government, threatening its very existence through nonviolent or violent action.
When compared with inflation, issuing government debt seems to be a much more politically convenient instrument of expropriation and redistribution from the viewpoint of the ruling class and the class of the ruled.
On the one hand, government debt allows the government to secure its revenues. On the other hand, investors in government debt form an alliance with the state aimed at expropriating future generations of taxpayers.
One should have no illusions about the fact that the gigantic government debt piles, which have accumulated over the last decades, and which will grow even bigger by governments trying to fend off depression, represent pent-up inflation. Mises, in view of the German experience made in the early 1920, put it succinctly:
[I]nflation becomes one of the most important psychological aids to an economic policy which tries to camouflage its effects.
By deceiving public opinion, it permits a system of government to continue which would have no hope of receiving the approval of the people if conditions were frankly explained to them.
VII. Deflation under Fiat Money
The monetary fiasco, which has been coming to the surface in recent months, causes concerns of deflation rather inflation — despite unprecedented increases in base money supply and the drastic increases in government debt.
In mainstream economics, inflation is typically defined as an ongoing rise in the economy's overall prices, while deflation is understood as an ongoing fall in overall prices. These definitions have become popular with the price index regime as put forward by Irving Fisher (1867–1947).
Mises had a different view. He noted that inflation and deflation are not praxeological concepts, but were created by economists adhering to the fallacious notion of the stability of money.
In human action, however, there are no constants, and there is no such thing as stable money. Money is a good like any other, and as such it is subject to the law of diminishing marginal utility — that is the law of determining subjective value. In that sense, there would always deflation or inflation under free-market money.
But let us just focus on deflation. Under commodity money, deflation is a phenomenon inherent in the free market. It is either a result of voluntary exchange or a correction of a preceding violation of property rights — a consequence of banks' issuing fiduciary media. In that sense, there is nothing wrong with deflation as such.
Under a fiat-money system, especially so after a worldwide, decade-long inflation, it is important to note that deflation would yield consequences different from deflation under free-market money.
First and foremost, under fiat-money deflation — the contraction of the money supply — would be arbitrary, like any other action on the part of the government; and so it cannot be expected to yield desirable economic results.
What is more, deflation cannot return the fiat-money regime to some kind of market equilibrium in terms of the money supply, prices, the production structure, and employment. The reason is that fiat money does not have any base of money proper towards which it could deflate.
Third, deflation would in all likelihood bring about a collapse of government, whose existence rests to a large extent on debt financing. Under deflation, government tax revenues would drop, and governments would no longer be in a position to roll over their debt falling due, let alone increase their debt.
I may add a political consideration here: public opinion, massaged by government preservers, will presumably see inflation — the increase in the money stock — as the lesser evil. The total destruction of the currency would presumably be within reach.
It is in this context that we should remind ourselves of the (most prominent) German experience in the early 1920s. It was a democratically elected government which decided, in view of reparation payment obligations and depleted funds, to take recourse to the printing press, which ended in hyperinflation, unspeakable hardship for the people and paved the way towards totalitarianism.
VIII. Ways of Returning to Sound Money
There is a way of transforming the fiat-money regime into a sound money regime. Praxeology, the science of the logic of human action, allows us to state the very principle along which a sound money system must be (re-)built: namely allowing for complete freedom of the supply of and demand for the currency.
This, in turn, implies privatizing the money system, establishing free banking, based on 100% reserve banking that complies with traditional legal rules of property rights. The corollary would be ending any government inference in monetary affairs, abolishing the central bank.
But how can the current fiat-money regime be transformed into a sound-money system? The answer to this question can be found in Mises's regression theorem.
The regression theorem implies that today's fiat money was, and could only be, established by governments violating money holders' property rights — actually through a lengthy process illustrated by Rothbard in his famous What Has Government Done To Our Money?
The regression theorem implies that the exchange values of fiat money rest on a (freely chosen) commodity. But such a link no longer exists. As a result, the exchange value of fiat money can decline to basically zero: all it takes is people starting to fear that government will not stop printing new money. And once the exchange value of paper money has moved towards zero, it can never be restored.
As was outlined earlier, neither inflation nor deflation will prevent the final collapse of the fiat-money regime. So if we want to return to sound money, and if, by doing so, we want to prevent the total destruction of the exchange value of existing fiat monies, the only option available is a re-anchoring of the stock of fiat money to a commodity.
Mises, as the first 20th century economist proposing free banking with a 100% reserve requirement on demand deposits, had worked out such a reform proposal — "Monetary Reconstruction" — as an appendix to the 1953 edition of The Theory of Money and Credit.
Mises demanded that banks must no longer be permitted to expand the money stock, and that all future, that is newly created, deposits would be subject to a 100% reserve of money proper. Rothbard built on Mises's proposal, supporting it with a strong legal foundation.
Rothbard proposed in his The Mystery of Banking, published in 1983, a two way strategy. In a first step, the outstanding liabilities of the commercial banking sector plus notes and coins would be backed by gold which is still held by the central bank.
Holders of bank liabilities plus cash money would receive the legal right to convert, at any one time, their holdings into a predetermined amount of gold ounces.
By doing so, the currency names — such as, for instance, US dollar, euro, British Pound, Swiss franc — would simply become expressions of certain weights of gold ounces.
In a second step, the monetary system would be privatized, that is, a system of free banking would be established. Central banks loose their monopoly over the money supply, and they could no longer manipulate the market interest rates.
The critical question is, how much should a unit of outstanding fiat money fetch in terms of central bank gold? It is this very decision that determines whether, and if so, by how much, the outstanding stock of fiat money will be reduced in the transition to free-market money.
The equation below, the gold cover ratio, should help outline the options available. It simply shows the sum of C, that is cash circulating (notes and coins), D, T, and S, which are demand, time, and savings deposits, respectively, and L, which is defined as banks' long-term liabilities (debentures), divided by the amount of gold ounces in the cellar of the central bank:
If only C and D, that is the stock of payments, are backed by gold, the price of gold in terms of existing fiat money would be relatively low. Alternatively, if C, D, T, S, and L were backed by gold, the price of gold in currency terms would be relatively high.
What is more, we have to take into account that the economy's money stock would be the gold stock held by the national central bank plus any outside gold, that is, gold that is already circulating. So the choice of the gold-cover ratio has an important impact on the money stock. Let us consider three options available for setting the gold-cover ratio.
Option #1 would be a gold backing of commercial banks' total liabilities plus coins and notes. In this case, deflation — and I am talking about a contraction of the existing money stock resulting from bank defaults — would be mitigated to the greatest possible extent.
Option #2 would be a gold backing just for monetary aggregates such as M1, M2, or M3, which represent a portion of banks' liabilities. Bank defaults could wipe out part of people's savings in the form of non-gold-backed bank deposits and bank debentures.
Option #3 is to use the prevailing gold price for backing fiat money with gold. Such a choice would — with the gold price slightly above US$900 per ounce — lead to a result basically similar to option #2, that is, a less-than-100% gold backing of the money stock.
That said, option #1, which implies a 100% gold backing of banks' liabilities, would preserve people's total nominal amount of money holdings, while options #2 and #3 would allow for a potential reduction in the money stock caused by bank failures.
In other words, option #1 would, assuming that outside gold will qualify as a means of payments, exert the biggest loss in the purchasing power of existing fiat money. Options #2 and #3 would mitigate the extent of debasing, as the rise in the money supply through outside gold would be accompanied by a fall in the existing fiat-money stock.
What these considerations make clear is that there is actually no alternative to unmasking the loss of exchange value already incurred by fiat-money holders and investors in fiat money denominated paper. Just consider the alternatives:
If the current fiat-money system is pushed into deflation, ensuing bank defaults would wipe out the paper claims people hold against their banks. It could — as the regression theorem shows — lead to a complete breakdown of the exchange value of money.
If the path of inflation — namely the ongoing increase in fiat money — is not abandoned, sooner or later the exchange value of money will be destroyed completely by hyperinflation.
And it is also no viable strategy if governments issue more debt for keeping afloat the fiat-money regime, as this would merely postpone the inevitable day of reckoning.
So what about setting the gold-cover ratio, an admittedly arbitrary act? Mises gives us guidance for answering this question. He noted that
Economics recommends neither inflationary nor deflationary policy. It does not urge the governments to tamper with the market's choice of a medium of exchange.
And further, Mises noted that it would be a delusion "that the evils caused by inflation could be cured by a subsequent deflation." The effects of inflation, followed by the effects of deflation, do not cancel each other out.
Against this background it should be reasonable to opt for a gold-cover ratio that backs less than 100% of banks' liabilities, such as M1 or M2. This may keep the inflation effect due to outside gold within limits.
If, for instance, US M2 were backed by gold, the resulting gold price would, under current circumstances, climb to more than US$31,000 per ounce; in the case of a 100% gold backing of M1, the gold price would exceed US$6,000 per ounce.
If, for instance, the euro area also backed its fiat-money stock with gold, as defined by M3, the resulting price for a gold ounce would be more than €26,000.
But whatever the gold-cover ratio will be, the really important issue is the re-anchoring of money to gold, which would save the currency system from complete destruction and pave the way towards free-market money, that is, sound money.
IX. Conclusion and Outlook
In conclusion, I have tried to take the opportunity to pay tribute to Ludwig von Mises. He truly deserves to hold the preeminent place in the intellectual history of social theory.
In the Misesian tradition, I have tried to outline the key role of sound money for peaceful and productive cooperation in society, an insight that is actually inherent in Mises's scientifically based procapitalism case.
Mises lays bare, and unmistakably so, the decivilization process caused by government-controlled fiat money. Fiat money destroys, sooner or later, the free society, through the economic and political catastrophes it provokes.
The only way out is a return to sound money, namely free-market money under free banking. Free-market money — which would presumably be built on gold — and individual freedom are inseparable, as Mises clearly recognized.
The global financial debacle is a testimony to what Mises and his followers have stated on the basis of praxeology, namely the failure of government-controlled fiat money, and that it is high time to seek a fundamental monetary reform: the return to free-market money.
It is my impression that the number of supporters for ending the monetary fiasco and returning to sound money is growing by the day. This development is no doubt to a great extent attributable to the fantastic work of the Ludwig von Mises Institute.
I imagine that if Ludwig von Mises, the defender of freedom, could see his intellectual heritage being cared for by the Mises Institute, he would not only be highly delighted, but also take hope that, eventually, sound money will win over fiat money, and capitalism over socialism.
I would like to thank you very much for your attention.
 In this tribute, I draw heavily on, inter alia, Reisman, G. (2006), "Mises: Defender of Freedom," Mises Daily September 29, 2006, Ludwig von Mises Institute, Auburn, Alabama; Rothbard, M.N. (1999), Ludwig von Mises: The Dean of the Austrian School, 15 Great Austrian Economists, Ludwig von Mises Institute, Auburn, Alabama, pp. 143–165; Hülsmann, J. G. (2007), Mises: The Last Knight of Liberalism, Ludwig von Mises Institute, Auburn, Alabama.
 Mises, L. v. (2006), "Stabilization of the Monetary Unit — From the viewpoint of Theory," The Causes of the Economic Crisis and other Essays Before and After the Great Depression, Ludwig von Mises Institute, Auburn, Alabama, p.2
 Mises, L. v. (1996), Human Action: A Treatise on Economics, 4th ed., Fox & Wilkes, San Francisco, p. 32.
 Mises, L. v. (1981), The Theory of Money and Credit, Liberty Fund, Indianapolis, p. 454.
 Ibid, p. 455.
 Mises, L. v. (2006), "Stabilization of the Monetary Unit — From the viewpoint of Theory," The Causes of the Economic Crisis and other Essays Before and After the Great Depression, Ludwig von Mises Institute, p. 38.
 Mises, L. v. (1996), Human Action: A Treatise on Economics, 4th ed., Fox & Wilkes, San Francisco, p 470.
 Ibid, p. 784.