Notes

Introduction by Joseph T. Salerno

Monetary Theory and the Trade Cycle (1933)

Translated from the German by N. Kaldor and H.M. Croome (London: Jonathan Cape, 1933). Originally written in German as Geldtheorie und Konjunkturtheorie (Vienna: Holder-Pichler-Tempsky, 1929).

Dr. O. Morgenstern’s recent categorical denial (Wirtschaftsprognose: Eine Untersuchung ikrer Voraussetzungen und Möglichkeiten ) of the possibility of forecasting seems to be due only to the fact that he demands more from forecasting than is justifiable. Even the ability to forecast a hailstorm would not be useless—but, on the contrary, very valuable—if the latter could thereupon be averted by firing rockets at the clouds!

This account of the business cycle, based upon our statistical analysis, revolves about the fluctuation of short-time interest rates, speculation, and business. We may think of interest rates as varying inversely with the amount of the bank reserves in the credit reservoir. The flow in the supply pipe to this reservoir depends upon the volume of gold imports, gold production, and the volume of paper currency. There are two outlets from this reservoir of credit: one pipe furnishes credit for speculation in securities; the other pipe is for the flow of credit into business. When the level of credit in the reservoir is high, and perhaps the outlet to business is partially clogged, the flow of funds into speculation begins. After this flow goes on for some time, however, and the flow into business increases, the level of credit in the reservoir falls. Obstruction is offered to the flow into speculative markets by the devices of higher interest rates and direct discrimination against speculation and in favor of business. The outlet into speculation therefore becomes clogged but the flow into business goes on. The level in the reservoir becomes still lower until the time is reached when bankers consider it dangerous to allow the outflow to continue. We then have a halt in further credit expansion, or to use our illustration, both outlets are clogged for a time and bank reserves are brought back to normal by allowing the supply to again fill the tank. (“A non-technical explanation of the index of general business conditions,” The Review of Economic Statistics 2 [1920]: 47)

Modern developments follow the exposition of H.J. Davenport, The Economics of Enterprise (New York: Macmillan, 1915), pp. 250 et seq.; and mention should, in particular, be made of C.A. Phillips’s, Bank Credit (New York: Macmillan, 1920), esp. chap. 3, “The Philosophy of Bank Credit”; W.F. Crick, “The Genesis of Bank Deposits,” Economica 7, no. 20 (June 1927); and R.G. Rodkey, The Banking Process (New York: Macmillan, 1928). Apart from these, we must include in our list the well-known works of Hartley Withers, Irving Fisher, and R.G. Hawtrey and, in German literature, K. Wicksell, Geldzins und Güterpreise, p. 101; A. Weber, Depositenbanken und Spekulationsbanken, 2nd ed. (Munich: Duncker & Humblot, 1922); the works which we have already mentioned by Mises and Hahn, G. Haberler’s essay on the latter “Hahns Volkswirtschaftliche Theorie des Bankkredits,” Archiv für Sozialwissenschaften 57 (1927); and, finally, H. Neisser, Der Tauschwert des Geldes (Jena: Gustav Fischer, 1928).

The theory has been severely criticized especially by Professor Cannan, W. Leaf, and more recently by R. Reisch, “Die ‘Deposit’-Legende in der Banktheorie,” Zeitschrift für Nationalökonomie 1 (1930).

This is the usual sequence—an increase of deposits being followed by an increase of the currency. Ordinarily the first effect of an increase in business activity upon the banking position is a growth in loans and deposits. ... There comes a time when the increase of business activity and the fuller employment of labor and increased pay rolls call for an increase of actual pocket money to support the increased wage disbursements and the increased volume of purchases at retail.

The foregoing presents the extreme case of the expansion and contraction of bank loans in relation to prices, but in principle quite small changes in the loan policies of banks affecting the volume of commercial loans, discount rates, and percentages of reserves, are of the same nature. They cause and constitute inflation and deflation of the exchange medium and of commercial purchasing power, not originating in the amount of standard money but in the elasticity of banking loan funds. This word “elasticity” has long been used in discussions of banking policy to designate a quality assumed to be wholly desirable in bank note issues and customers’ credits, but with only vague suggestions as to what is the need, standard, or means, with reference to which bank loans should expand and contract.

Rather, it may be more exact to say, the tacit assumption has been that the bank loan funds should be elastic in response to the “needs of business.” But “the needs of business” appears to be nothing but another name for changes in customers’ eagerness for loans; and this eagerness increases when prices are beginning, or are expected, to rise and often continues to gather momentum while prices rise and until, because of vanishing reserve percentages (and other factors), the limit of this elasticity and also the limit of price increase are in sight. In this situation the most conservative business operations become intermixed with elements of investment speculation, motivated by the rise of prices and the hope of profit that will be made possible by a further rise. Throughout this process the much-esteemed elasticity of bank funds is the very condition causing, or making possible, the rising prices which stimulate the so-called “needs of business.” Truly a vicious circle, to be broken only by crisis and collapse when bank loans reach a limit and prices fall. (My italics)

Further, we should point out the connection between our theory and a famous thesis of Mr. R.G. Hawtrey. The phrase “so long as credit is regulated with reference to reserve proportions, the trade cycle is bound to recur” (Monetary Reconstruction, 2nd ed. , p. 135) is undoubtedly correct, though perhaps in a sense somewhat different from that intended by the author; for a regulation of this volume of loans exclusively from the point of view of liquidity can never effect a prompt adjustment of the rates charged on loans to the changes in the equilibrium rate, and thus cannot help providing opportunities for the temporary creation of additional credits as soon as (at a given rate of interest) the demand for credit surpasses the accumulation of savings; that is, when the natural rate of interest has risen. See, finally, the remarks of Professor W. Röpke, Kredit und Konjunktur, p. 274.

Professor Schumpeter’s, Dr. Neisser’s, and Professor Fetter’s works already mentioned; A. Hahn, “Zur Theorie des Geldmarktes,” Archiv für Sozialwissenschaften und Sozialpolitik 51 (1924). Karin Kock, “A Study of Interest Rates,” Stockholm Economic Studies no. 1 (London: P.S. King, 1929).

W.W. Riefler, Money Rates and Markets in the United States (New York and London: Harper and Brothers, 1930).

The problems arising out of empirical research are well summarized by O. Donner and A. Hanau, “Untersuchung zur Frage der Marktzusammenhänge,” Vierteljahrshefte zur Konjunkturforschung, 3rd year, no. 3 A (Institut für Konjunkturforschung, Berlin 1928), an investigation which is a model of its kind.

The “Paradox” of Saving (1929, 1931)

This essay originally appeared in the Zeitschrift für Nationalökonomie 1, no. 3 (1929), under the title “Gibt es einen Widersinn des Sparens?” The translation is the work of Mr. Nicholas Kaldor and Dr. Georg Tugendhat and was published in Economica (May 1931).

This brings us back to the “Dilemma,” and also brings us back to the obvious and only escape from the Dilemma; namely, the progressive increase, in relation to the price-level of goods, of the scale of money compensation to individuals for their productive effort if that productive effort is progressively increasing in efficiency. (Italics mine)

Prices and Production (1931, 1935)

First published in London by Routledge and Sons in 1931. The second edition was published by Routledge and Kegan Paul in 1935.

Considerable elements of Professor Mises’s theory and particularly the doctrine of “Forced Saving” seem to have been introduced into America through Professor Schumpeter’s Theorie der Wirtschaftlichen Entwicklung (Munich: Duncker & Humblot, 1911) and Dr. B.M. Anderson’s Value of Money (New York: Macmillan, 1917) and gained considerable vogue since. In any case, since the publication of this book in 1917, “Forced Saving” has been discussed by Professors F.W. Taussig, Principles of Economics, 3rd ed. (New York: Harper & Row, 1915), pp. 351, 359; F. Knight, Risk, Uncertainty and Profit (New York: Houghton Mifflin, 1921), p. 166, note and Index; D. Friday, Profit, Wages and Prices (New York: Harcourt, Brace, 1921), pp. 216–17; and A.H. Hansen Cycles of Prosperity and Depression (Madison: University of Wisconsin Press, 1921), pp. 104–06. Whether the American author whose views on these problems comes nearest to those expressed in the present book, Mr. M.W. Watkins, whose exceedingly interesting article on “Commercial Banking and the Formation of Capital,” Journal of Political Economy, 27 (1919), I have only recently become acquainted with, is indebted to the same source I do not know.

In England similar ideas seem to have been developed independently, first by Professor Pigou, Is Unemployment Inevitable? (London: Macmillan, 1925), pp. 100–11 and then in much greater detail by Mr. D.H. Robertson, Banking Policy and the Price Level (London: P.S. King, 1926), passim.

a good many belong to several orders at the same time. For instance, a railway train may be carrying people on a pleasure excursion, and so far it is a good of the first order; if it happens to be carrying at the same time some tins of biscuits, some milling machinery and some machinery that is used for making milling machinery, it is at the same time a good of the second, third and fourth order.

In cases like this a transfer of its services from a later to an earlier stage (or, to use Menger’s terminology, from a lower to a higher order) is, of course, particularly easy. A plant manufacturing equipment for the production of consumers’ goods as well as for the production of further machinery will sometimes be used mainly for the former and sometimes mainly for the latter purpose.

Messrs. Hansen and Tout think that such a permanent change in the time preference of the income receivers “is not unlikely, since an increase or decrease in money supply is likely to increase the real income of the community.” This seems to show conclusively that what they have in mind is not the effect on the quantity and distribution of resources, but on individual time preferences.

Monetary Nationalism and International Stability (1937)

Originally published by Longmans, Green in London, 1937; The Graduate Institute of International Studies, Publication no. 18, Geneva, 1937; reprinted by Augustus M. Kelley in New York, 1964 and 1971.

For this purpose it may arrange with central banks to have gold earmarked for their account and transferable on their order, to open accounts through which central banks can transfer their assets from one currency to another and to take such other measures as the Board may think advisable within the limits of the powers granted by these Statutes.

Reflections on the Pure Theory of Money of Mr. J.M. Keynes (1931, 1932)

This article was originally published in two parts. Part one first appeared in Economica 33 (August 1931): 270–95; part two in Economica 35 (February 1932): 22–44.

The Mythology of Capital (1936)

This article first appeared in the Quarterly Journal of Economics 50 (February 1936): 199–228.

[1] “Capitalist Production, Time and the Rate of Return,” Economic Essays in Honour of Gustav Cassel (London: George Allen and Unwin, 1933): 327–42.

[2] “Capital Time, and the Interest Rate,” Economica n.s. 1, no. 3 (August 1934): 257–86.

[3] “Professor Hayek and the Theory of Investment,” Economic Journal 45, no. 177 (March 1935): 77–94.

In addition, certain other articles by Professor Knight which bear closely on the subject and to some of which I may occasionally refer may also be mentioned.

[4] “Professor Fisher’s Interest Theory: A Case in Point,” Journal of Political Economy 39, no. 2 (April 1931): 176–212.

[5] Article on “Interest,” Encyclopaedia of Social Sciences 8 (1932), pp. 131–44.

[6] “The Ricardian Theory of Production and Distribution,” The Canadian Journal of Economics and Political Science 1, no. 1 (February 1935): 3–25.

The classical “Austrian” position has recently been ably and lucidly restated and defended against Professor Knight’s criticism by Professor Fritz Machlup in an article, “Professor Knight and the ‘Period of Production’,” which appeared, together with a comment by Professor Knight, in the Journal of Political Economy for October 1935. But this as well as Professor Knight’s answer to Mr. Boulding (“The Theory of Investment Once More: Mr. Boulding and the Austrians,” in the last issue of this Journal) reached me too late to refer to them in the body of the article. But one or two references to these latest publications have been added in footnotes where I refer to the comment and the reply to Mr. Boulding with the numbers [7] and [8], respectively.

the simple “technological” fact that it is possible to increase the volume (time rate) of production after any interval by the use during that interval of a part of existing productive resources—in large part the same resources previously and subsequently used for producing “current consumption income”—to produce, instead of current consumption income, instruments of agencies of various sorts, tangible or intangible, which when produced become “productive” of additional current income. This activity or process we call investment.

In giving permission to quote the above sentence from his letter Professor Knight adds:

It would induce to clearness to add that it is my view that the interval in question approaches determinateness as we impose stationary or given conditions in a sense so rigid that such an expression as “might have been obtained” loses all meaning.” I am afraid this explanation leaves me more perplexed than ever. As I have tried to show in the last section of this paper, all Professor Knight’s former argument against the concept of a determinate investment period depends exactly on the most rigid static assumptions of this kind.

In the traditional exposition of the theory of roundabout production, this case, where only total capital, but not necessarily capital per head of those employed, has been increased, has been taken account of by saying that the average period of production (i.e., the average period for which the labor actually employed is invested) will only increase when capital per head increases, but will remain constant when capital is increased by an extension of its “labor dimension” instead of its “time dimension.” Although this mode of expression is sometimes useful, I think it has to be abandoned together with the concept of the average period of production.

In reality most investments not only begin at a fairly early date to yield their income in consumable services... but in addition they begin fairly soon to yield more than interest on cost in this form, and entirely liquidate themselves in a moderate period of time. This additional flow of consumable services is ordinarily treated as a replacement fund, but is available for consumption or for reinvestment in any form and field of use at the will of the owner.

But in [3], p. 83, in order to support his thesis about the perpetuity of capital, this periodic liquidation is denied:

It cannot now escape observation that “capital” is an integrated, organic conception, and the notion that the investment in a particular instrument comes back periodically in the form of product, giving the owner freedom to choose whether he will re-invest or not, is largely a fiction and a delusion.

The basic issue is the old and familiar one of choice between two conceptions of capital. In one view, it consists of “things” of limited life which are periodically worn out or used up and reproduced; in the other, it is a “fund” which is maintained intact tho the things in which it is invested may come and go to any extent. In the second view, which of course is the one advocated here, the capital “fund” may be thought of as either a value or a “capacity” to produce a perpetual flow of value.

Investment That Raises the Demand for Capital (1937)

This article first appeared in The Review of Economic Statistics 19, no. 4 (November 1937): 174–77.