Study Guide to the Theory of Money and Credit
14. The Monetary Policy of Étatism
Summary
Étatism as a theory is the doctrine of the omnipotence of the State. As a policy, étatism is the attempt to regulate all social and economic affairs by authoritative commandment and prohibition.
The étatist views money as a creature of the State, and hence (erroneously) believes that a powerful and rich State should have a correspondingly “good” money. But history is full of cases where even the victors in a war saw the collapse of their currency, or where a wealthy country had a very weak currency.
Often the authorities will try to mitigate the consequences of inflationism by imposing price controls. If the controls are applied to a small number of items, then shortages will develop because the producers of these items will see other prices rise but will not be able to charge appropriate prices for the items in question. The authorities must then either abandon their policy or intervene further still, controlling more prices and possibly compelling people to work against their will.
A popular view holds that a country experiencing a debit balance of payments cannot stabilize the value of its money, until the underlying defects are rectified. However, if a country uses purely metallic money, then a debit balance of payments will eventually reverse itself automatically, because the outflow of metal will lead to falling domestic prices. For countries on credit or fiat money, a similar principle holds. A debit balance of payments per se cannot unilaterally cause a nation’s currency to depreciate, because the debit balance itself is caused by inflation. No matter the foreign trade situation, a country can always choose sound money.
If the government wishes to avoid having its currency “attacked” by speculators, it need only abandon inflationist policies.
Chapter Outline
1. The Monetary Theory of Étatism
Étatism as a theory is the doctrine of the omnipotence of the State. As a policy, étatism is the attempt to regulate all social and economic affairs by authoritative commandment and prohibition. Although the outward appearances of private property and entrepreneurship may be left intact, in practice étatism can only be realized as State Socialism. Because sociology and economics detail the limits on what sheer might can achieve in attempting to redesign human society, étatists seek to discredit these fields.
2. National Prestige and the Rate of Exchange
The étatist views money as a creature of the State, and hence (erroneously) believes that a powerful and rich State should have a correspondingly “good” money (i.e., money with a high exchange rate). But history is full of cases where even the victors in a war saw the collapse of their currency, or where a wealthy country had a very weak currency.
3. The Regulation of Prices by Authoritative Decree
Often the authorities will try to mitigate the consequences of inflationism by imposing price controls, in which people are punished by fines or prison sentences for asking (or even paying) prices above the legal ceiling. If the controls are applied to a small number of items, then shortages will develop because the producers of these items will see other prices rise but will not be able to charge appropriate prices for the items in question. This outcome is the opposite of what the authorities intended; they had imposed the price controls to keep the items accessible to the public, not to eradicate them from the store shelves. At this point, the authorities must either abandon their policy or intervene further still, controlling more prices and possibly compelling people to work against their will.
4. The Balance of Payments Theory as a Basis of Currency Policy
A popular view holds that a country experiencing a debit balance of payments cannot stabilize the value of its money, until the underlying defects are rectified. However, the classical economists and later the Currency School demonstrated the flaws in this view. If a country uses purely metallic money, then a debit balance of payments will eventually reverse itself automatically, because the outflow of metal (such as gold) will lead to falling domestic prices. Eventually, residents will prefer to buy from domestic producers rather than foreigners, and foreign purchasers will prefer to buy more cheaply from them as well. Thus the debit balance will turn into a credit balance of payments, and the monetary metal will tend to flow back into the country that originally experienced the drain.
For countries on credit or fiat money, a similar principle holds. A debit balance of payments per se cannot unilaterally cause a nation’s currency to depreciate, because the debit balance itself is caused by inflation. No matter the foreign trade situation, a country can always choose sound money.
5. The Suppression of Speculation
When inflationist policies lead to a depreciation of a country’s money against other currencies, government officials will often denounce foreign speculators for “attacking the currency.” Yet in general, speculators cannot alter the average price of a good (including money), they simply smooth out the ups and downs. The speculator tries to buy low and sell high (or vice versa). By buying undervalued currencies, the speculator pushes up the price toward its long-run level, and by selling overvalued currencies, the speculator pushes them down toward the “correct” level. If the government wishes to avoid having its currency “attacked” by speculators, it need only abandon inflationist policies.
Important Contributions
• On pages 246–48, Mises explains the process by which limited interventions lead to undesirable consequences, even from the point of view of the authorities. These in turn lead to further interventions, in an attempt to counteract the bad consequences. The process continues until the authorities either abandon their program or reach full-blown socialism. Although economists before Mises understood the undesirable effects of price ceilings, this broader dynamic was something that Mises stressed throughout his career. Mises contrasted the virtues of a free market versus outright socialism, precisely because he thought it was a mirage to endorse a “mixed economy” that avoided either extreme. In fact in 1950 he would deliver a speech entitled, “Middle of the Road Policy Leads to Socialism.”
• On pages 249–52, Mises showcases his numerous talents as an economist. He demonstrates a command of pure economic theory, the history of economic thought, and the day-to-day activities in the actual foreign exchange market. It is only because of his mastery of all three areas that he can so confidently explain the errors in rival doctrines, and why the businessman is fooled by correlations that do not represent actual causality when it comes to trade flows and exchange rates.
New Terminology
Étatism (as theory): The doctrine of the omnipotence of the State.
Étatism (as policy): The attempt to regulate all social and economic affairs by authoritative commandment and prohibition.
Mixed economy: An economy possessing aspects of both capitalism and socialism, in which private individuals retain nominal ownership of the means of production, but the government extensively regulates their use of this property, including wages, interest rates, and other prices set on the market.
Debit balance of payments: The situation occurring when the people of a country collectively spend more on foreign goods and assets than vice versa. It is settled by an outflow of money from the country.
Credit balance of payments: The situation occurring when the people of a country collectively spend less on foreign goods and assets than vice versa. It is settled by an inflow of money to the country.
Shortages: A shortfall in the quantity of goods offered for sale, compared to the amount consumers wish to purchase. Shortages are caused when a price ceiling holds the price below the market-clearing level.
Study Questions
1. Why does economic science pose a threat to étatism? (p. 243)
2. After a price ceiling is imposed, what happens once the stocks of goods that were already on the shelves have been sold off? (p. 247)
3. Explain: “If the regulation of prices had been successful, it would have paralyzed the whole economic organism. The only thing that made possible the continued functioning of the social apparatus of production was the incomplete enforcement of the regulations that was due to the paralysis of the efforts of those who ought to have executed them.” (p. 248)
4. Explain: “Price fluctuations are reduced by speculation, not aggravated, as the popular legend has it.” (p. 253)
5. Explain: “The fluctuations of the foreign-exchange rate are not determined solely by bears selling but just as much by bulls buying.” (p. 253)
