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3. Triangular Intervention

1. Price Control

The intervener may set either a minimum price below which a product cannot be sold, or a maximum price above which it cannot be sold. He can also compel a sale at a certain fixed price. In any event, the price control will either be ineffective or effective. It will be ineffective if the regulation has no current influence on the market price. Thus, suppose that automobiles are all selling at about 100 gold ounces on the market. The government issues a decree prohibiting all sales of autos below 20 gold ounces, on pain of violence inflicted on all violators. This decree is, in the present state of the market, completely ineffective and academic, since no cars would have sold below 20 ounces. The price control yields only irrelevant jobs for government bureaucrats.

On the other hand, the price control may be effective, i.e., it may change the price from what it would have been on the free market. Let the diagram in Figure 1 depict the supply and demand curves, respectively SS and DD, for the good.




FP is the equilibrium price set by the market. Now, let us assume that the intervener imposes a maximum control price 0C, above which any sale becomes illegal. At the control price, the market is no longer cleared, and the quantity demanded exceeds the quantity supplied by the amount AB. In the ensuing shortage, consumers rush to buy goods that are not available at the price. Some must do without; others must patronize the market, revived as “black” or illegal, while paying a premium for the risk of punishment that sellers now undergo. The chief characteristic of a price maximum is the queue, the endless “lining up” for goods that are not sufficient to supply the people at the rear of the line. All sorts of subterfuges are invented by people desperately seeking to arrive at the clearance provided by the market. “Under-the-table” deals, bribes, favoritism for older customers, etc., are inevitable features of a market shackled by the price maximum.1

It must be noted that, even if the stock of a good is frozen for the foreseeable future, and the supply line is vertical, this artificial shortage will still develop, and all these consequences ensue. The more “elastic” the supply, i.e., the more resources will shift out of production, the more aggravated, ceteris paribus, the shortage will be. If the price control is “selective,” i.e., is imposed on one or a few products, the economy will not be as universally dislocated as under general maxima, but the artificial shortage created in the particular line will be even more pronounced, since entrepreneurs and factors can shift to the production and sale of other products (preferably substitutes). The prices of the substitutes will go up as the “excess” demand is channeled off in their direction. In the light of this fact, the typical government reason for selective price control—”we must impose controls on this product as long as it is in short supply”—is revealed to be an almost ludicrous error. For the truth is precisely the reverse: price control creates an artificial shortage of the product, which continues as long as the control is in existence—in fact, becomes ever worse as resources continue to shift to other products.

Before investigating further the effects of general price maxima, let us analyze the consequences of a minimum price control, i.e., the imposition of a price above the free-market price. This may be depicted as in Figure 2.

DD and SS are the demand and supply curves respectively. 0C is the control price and FP the market equilibrium price. At 0C, the quantity demanded is less than the quantity supplied, by the amount AB. Thus, while the effect of a maximum price is to create an artificial shortage, a minimum price creates an artificial unsold surplus. AB is the unsold surplus. The unsold surplus exists even if the SS line is vertical, but a more elastic supply will, ceteris paribus, aggravate the surplus. Once again, the market is not cleared. The artificially high price attracts resources into the field, while, at the same time, it discourages buyer demand. Under selective price control, resources will leave other fields where they serve their owners and the consumers better, and transfer to this field, where they overproduce and suffer losses as a result.


This illustrates how intervention, by tampering with the market, causes entrepreneurial losses. Entrepreneurs operate on the basis of certain criteria: prices, interest rates, etc., established by the free market. Interventionary tampering with these criteria destroys the adjustment and brings about losses, as well as misallocation of resources in satisfying consumer wants.

General, overall price maxima dislocate the entire economy and deny the consumers the enjoyment of substitutes. General price maxima are usually imposed for the announced purpose of “preventing inflation”—invariably while the government is inflating the money supply by a large amount. Overall price maxima are equivalent to imposing a minimum on the purchasing power of the money unit, the PPM (see Figure 3).


0F is the money stock in the society; DmDm the social demand for money; FP is the equilibrium PPM (purchasing power of the monetary unit) set by the market. An imposed minimum PPM above the market (0C) impairs the clearing “mechanism” of the market. At 0C the money stock exceeds the money demanded. As a result, the people possess a quantity of money GH in “unsold surplus.” They try to sell their money by buying goods, but they cannot. Their money is anesthetized. To the extent that a government's overall price maximum is upheld, a part of the people's money becomes useless, for it cannot be exchanged. But a mad scramble inevitably takes place, with each one hoping that his money can be used.2 Favoritism, lining up, bribes, etc., inevitably abound, as well as great pressure for the “black” market (i.e., the market) to provide a channel for the surplus money.

A general price minimum is equivalent to a maximum control on the PPM. This sets up an unsatisfied, excess demand for money over the stock of money available—specifically, in the form of unsold stocks of goods in every field.

The principles of maximum and minimum price control apply to all prices, whatever they may be: consumer goods, capital goods, land or labor services, or the “price” of money in terms of other goods. They apply, for example, to minimum wage laws. When a minimum wage law is effective, i.e., where it imposes a wage above the market value of a type of labor (above the laborer's discounted marginal value product), the supply of labor services exceeds the demand, and this “unsold surplus” of labor services means involuntary mass unemployment. Selective, as opposed to general, minimum wage rates create unemployment in particular industries and tend to perpetuate these pockets by attracting labor to the higher rates. Labor is eventually forced to enter less remunerative, less value-productive lines. The result is the same whether the effective minimum wage is imposed by the State or by a labor union.

Our analysis of the effects of price control applies also, as Mises has brilliantly shown, to control over the price (“exchange rate”) of one money in terms of another.3 This was partially seen in Gresham's Law, but few have realized that this Law is merely a specific case of the general law of the effect of price controls. Perhaps this failure is due to the misleading formulation of Gresham's Law, which is usually phrased: “Bad money drives good money out of circulation.” Taken at its face value, this is a paradox that violates the general rule of the market that the best methods of satisfying consumers tend to win out over the poorer. Even those who generally favor the free market have used this phrasing to justify a State monopoly over the coinage of gold and silver. Actually, Gresham's Law should read: “Money overvalued by the State will drive money undervalued by the State out of circulation.” Whenever the State sets an arbitrary value or price on one money in terms of another, it thereby establishes an effective minimum price control on one money and a maximum price control on the other, the “prices” being in terms of each other. This, for example, was the essence of bimetallism. Under bimetallism, a nation recognized gold and silver as moneys, but set an arbitrary price, or exchange ratio, between them. When this arbitrary price differed, as it was bound to do, from the free-market price (and such a discrepancy became ever more likely as time passed and the free-market price changed, while the government's arbitrary price remained the same), one money became overvalued and the other undervalued by the government. Thus, suppose that a country used gold and silver as money, and the government set the ratio between them at 16 ounces of silver to one ounce of gold. The market price, perhaps 16:1 at the time of the price control, then changes to 15:1. What is the result? Silver is now being arbitrarily undervalued by the government, and gold arbitrarily overvalued. In other words, silver is forced to be cheaper than it really is in terms of gold on the market, and gold is forced to be more expensive than it really is in terms of silver. The government has imposed a maximum price on silver and a minimum price on gold, in terms of each other.

The same consequences now follow as from any effective price control. With a maximum price on silver (and a minimum price on gold), the gold demand for silver in exchange exceeds the silver demand for gold. Gold goes begging for silver in unsold surplus, while silver becomes scarce and disappears from circulation. Silver disappears to another country or area where it can be exchanged at the free-market price, and gold, in turn, flows into the country. If the bimetallism is worldwide, then silver disappears into the “black” market, and official or open exchanges are made only with gold. No country, therefore, can maintain a bimetallic system in practice, because one money will always be under- or overvalued in terms of the other. The overvalued will always displace the undervalued from circulation.

It is possible to move, by government decree, from a specie money to a fiat paper currency. In effect, almost every government of the world has done so. As a result, each country has been saddled with its own money. In a free market, each fiat money will tend to exchange for another according to the fluctuations in their respective purchasing-power parities. Suppose, however, that Currency X has an arbitrary valuation placed by its government on its exchange rate with Currency Y. Thus, suppose five units of X exchange for one unit of Y on the free market. Now suppose that Country X artificially overvalues its currency and sets a fixed exchange rate of three X's to one Y. What is the result? A minimum price has been set on X's in terms of Y, and a maximum price on Y's in terms of X. Consequently, everyone scrambles to exchange X's for Y's at this cheap price for Y and thus profit on the market. There is an excess demand for Y in terms of X, and a surplus of X in relation to Y. Here is the explanation of that supposedly mysterious “dollar shortage” that plagued Europe after World War II. The European governments all overvalued their national currencies in terms of American dollars. As a consequence of the price control, dollars became short in terms of European currency, and the latter became a glut looking for dollars without finding them.

Another example of money-ratio price control is seen in the ancient problem of new versus worn coins. There grew up the custom of stamping coins with some name designating their weight in specie in terms of some unit of weight. Eventually, to “simplify” matters, governments began to decree worn coins to be equal in value to newly minted coins of the same denomination.4 Thus, suppose that a 20-ounce silver coin was declared equal in value to a worn-out coin now weighing 18 ounces. What ensued was the inevitable effect of price control. The government had arbitrarily undervalued new coins and overvalued old ones. New coins were far too cheap, and old ones too expensive. As a result, the new coins promptly disappeared from circulation, to flow abroad or to remain under cover at home; and the old worn coins flooded in. This proved discouraging for the State mints, which could not keep coins in circulation, no matter how many they minted.5

The striking effects of Gresham's Law are partly due to a type of intervention adopted by almost every government—legal-tender laws. At any time in society there is a mass of unpaid debt contracts outstanding, representing credit transactions begun in the past and scheduled to be completed in the future. It is the responsibility of judicial agencies to enforce these contracts. Through laxity, the practice developed of stipulating in the contract that payment will be made in “money” without specifying which money. Governments then passed legal-tender laws, arbitrarily designating what is meant by “money” even when the creditors and debtors themselves would be willing to settle on something else. When the State decrees as money something other than what the parties to a transaction have in mind, an intervention has taken place, and the effects of Gresham's Law will begin to appear. Specifically, assume the existence of the bimetallic system mentioned above. When contracts were originally made, gold was worth 16 ounces of silver; now it is worth only 15. Yet the legal-tender laws specify “money” as being an equivalent of 16:1. As a result of these laws, everyone pays all his debts in the overvalued gold. Legal-tender laws reinforce the consequences of exchange-rate control, and the debtors have gained a privilege at the expense of their creditors.6

Usury laws are another form of price control tinkering with the market. These laws place legal maxima on interest rates, outlawing any lending transactions at a higher rate. The amount and proportion of saving and the market rate of interest are basically determined by the time-preference rates of individuals. An effective usury law acts like other maxima—to induce a shortage of the service. For time preferences—and therefore the “natural” interest rate—remain the same. The fact that this interest rate is now illegal means that the marginal savers—those whose time preferences were highest—now stop saving, and the quantity of saving and investing in the economy declines. This results in lower productivity and lower standards of living in the future. Some people stop saving; others even dis-save and consume their capital. The extent to which this happens depends on how effective the usury laws are, i.e., how far they hamper and distort voluntary market relations.

Usury laws are designed, at least ostensibly, to help the borrower, particularly the most risky borrower, who is “forced” to pay high interest rates to compensate for the added risk. Yet it is precisely these borrowers who are most hurt by usury laws. If the legal maximum is not too low, there will not be a serious decline in aggregate savings. But the maximum is below the market rate for the most risky borrowers (where the entrepreneurial component of interest is highest), and hence they are deprived of all credit facilities. When interest is voluntary, the lender will be able to charge very high interest rates for his loans, and thus anyone will be able to borrow if he pays the price. Where interest is controlled, many would-be borrowers are deprived of credit altogether.7

Usury laws not only diminish savings available for lending and investment, but create an artificial “shortage” of credit, a perpetual condition where there is an excessive demand for credit at the legal rate. Instead of going to those most able and efficient, the credit will therefore have to be “rationed” by the lenders in some artificial and uneconomic way.

Although there have rarely been minimum interest rates imposed by government, their effect is similar to that of maximum rate control. For whenever time preferences and the natural interest rate fall, this condition is reflected in increased savings and investment. But when the government imposes a legal minimum, the interest rate cannot fall, and the people will not be able to carry through their increased investment, which would bid up factor prices. Minimum interest rates, therefore, also stunt economic development and impede a rise in living standards. Marginal borrowers would likewise be forced out of the market and deprived of credit.

To the extent that the market illegally reasserts itself, the interest rate on the loan will be higher to compensate for the extra risk of arrest under usury laws.

To sum up our analysis of the effects of price control: Directly, the utility of at least one set of exchangers will be impaired by the control. Further analysis reveals that the hidden, but just as certain, effects are to injure a substantial number of people who had thought they would gain in utility from the imposed controls. The announced aim of a maximum price control is to benefit the consumer by insuring his supply at a lower price; yet the objective result is to prevent many consumers from acquiring the good at all. The announced aim of a minimum price control is to insure higher prices for the sellers; yet the effect will be to prevent many sellers from selling any of their surplus. Furthermore, price controls distort production and the allocation of resources and factors in the economy, thereby injuring again the bulk of consumers. And we must not overlook the army of bureaucrats who must be financed by the binary intervention of taxation, and who must administer and enforce the myriad of regulations. This army, in itself, withdraws a mass of workers from productive labor and saddles them onto the backs of the remaining producers—thereby benefiting the bureaucrats, but injuring the rest of the people. This, of course, is the consequence of establishing an army of bureaucrats for any interventionary purpose whatever.

  • 1. Bribing is made necessary by government outlawing of the exchange; a bribe is the sale, by the government official, of permission for the exchanges to proceed.
  • 2. Ironically, the government's destruction of part of the people's money almost always takes place after the government has pumped in new money and used it for its own purposes. The injury that the government imposes on the public is thus twofold: (1) it takes resources away from the public by inflating the currency; and (2) after the money has percolated down to the public, it destroys part of the money's usefulness.
  • 3. Ludwig von Mises, Human Action (New Haven: Yale University Press, 1949), pp. 432 n., 447, 469, 776.
  • 4. Perhaps one of the reasons was that State mint monopolies, instead of serving customers with desired coins, arbitrarily designated a few denominations that they would mint and circulate. A coin of slightly lighter weight was then treated as an intruder.
  • 5. A modern example of the impossibility of keeping undervalued coins in circulation is the disappearance of silver dollars, half-dollars, and other coins that circulated in the United States during the 1960's. William F. Rickenbacker, Wooden Nickels (New Rochelle, N.Y.: Arlington House, 1966).
  • 6. On legal-tender laws, see Lord Farrer, Studies in Currency 1898 (London: Macmillan & Co., 1898), p. 43, and Mises, Human Action, pp. 432 n., 444, 447.
  • 7. In recent years, the myth has developed that usury laws in the Middle Ages were justifiable because they dealt with the consumer who had to borrow rather than with productive business.
         On the contrary, it is precisely the risky consumer-borrower (who most “needs” the loan) who is most injured by the usury laws because he is the one deprived of credit.