Theory of Money and Fiduciary Media

9

Eduard Braun

The Subsistence Fund in Ludwig von Mises’s Explanation of the Business Cycle

In 1974 Friedrich von Hayek was awarded the Nobel Prize in Economics for his contributions to the circulation credit theory of the trade cycle. The first exposition of this theory goes back to the year 1912. Ludwig von Mises expounded on it briefly in his habilitation treatise entitled Theorie des Geldes und der Umlaufsmittel [Theory of Money and Fiduciary Media].1 Today this theory is one of the central themes in Austrian economics. For this reason, it is very often called the “Austrian” theory of the business cycle (ABCT). It is mainly concerned with the effect that the financial sector—especially the monetary policy of the central bank or the banking system—has on the “real” sector. Its principle examination object is the artificial expansion of circulation credit and the influence the latter has on the economic system. Although circulation credit originates in the financial market, ABCT maintains that it has devastating effects on the real economy. In short, an expansion of circulation credit is supposed to cause an artificial lowering of the interest rate which provokes entrepreneurial malinvestments that, sooner or later, will lead to an economic crisis as the malinvestments will have to be liquidated.

In this paper it is argued that Ludwig von Mises, the originator of this theory, did not expound his theory homogenously. During his career, he changed the way he explained the feedback between the financial and the real sector rather substantially. Whereas he stressed the role of the subsistence fund in the original version, he substituted it by other concepts in later publications. It will be shown that, at least in this respect, the original version in Theorie des Geldes und der Umlaufsmittel is more consistent than the later ones, even the elaborated exposition that can be found in Mises’s most important work, Human Action.

Commodity Credit and Circulation Credit

In order to understand the ABCT it is necessary to grasp a distinction between two different kinds of credit first introduced by Ludwig von Mises himself.2 The first one, commodity credit, is, in Mises’s opinion, the healthy kind of credit. Somebody saves out of his income and transfers the savings to somebody else, mainly by means of financial intermediaries. As this kind of credit necessitates savings, it involves an exchange of present goods for future goods.3 In the words of Mises, credits of this kind are

characterized by the fact that they impose a sacrifice on that party who performs his part of the bargain before the other does—the foregoing of immediate power of disposal over the exchanged good.4

In short, before commodity credit can be granted, somebody must have saved up goods or money that can now be lent to the debtors. The sacrifice of the savers is the necessary condition for this kind of credit.

The second kind of credit Mises calls circulation credit. In his opinion, it constitutes the unhealthy kind of credit. It does not stem from anybody’s savings, but from the power of banks to lend additional money into existence. It is not necessary to go into the details of fractional reserve banking here. That this kind of banking is able to create additional credit via lending out its own banknotes (in earlier times) or demand deposits that are at any time convertible into money is generally accepted by economists.5 The phenomenon is called the money multiplier. Mises’s point is that this kind of credit creation does not presuppose savings and therefore causes nearly no costs to either the issuing bank or anybody else. This

group of credit transactions is characterized by the fact that in them the gain of the party who receives before he pays is balanced by no sacrifice on the part of the other party.6

According to Mises’s definition, what he calls circulation credit is not a proper credit transaction from an economic point of view. “[T]he essential element, the exchange of present goods for future goods, is absent.”7 No savings and no sacrifices are necessary:

If a creditor is able to confer a loan by issuing claims which are payable on demand, then the granting of the credit is bound up with no economic sacrifice for him.8

Now, in all of his versions of the ABCT, Mises maintains that an expansion of circulation credit, as distinguished from an increase of commodity credit, causes a boom that must ultimately result in a bust. So far, the earlier and the later versions are homogeneous. However, they differ in the way that Mises explains the effect that an expansion of circulation credit has on the economy. It will be shown that it is on this point that Mises’s first theoretical book, The Theory of Money and Credit, has to be preferred to all of his later writings.

The Exposition in Mises’s Theory of Money and Credit

The Role of the Subsistence Fund in the Exposition of the ABCT

In Theorie des Geldes und der Umlaufsmittel, Mises explains the influence of circulation credit on the economy in terms of the so-called subsistence fund. This fund—which consists of saved-up consumers’ goods—looms large in his then exposition of the production process. To explain the subsistence fund theory in a few words: Consumers’ goods are a necessary pre-condition of every production process. Without something to eat, something to drink, clothes, and so forth, nobody will participate in production. The owners of the originary factors of production, most notably workers, need to be furnished with consumers’ goods during the production process. The subsistence fund is especially important when it comes to determining the possible length of the production processes. It is this point which Mises stresses in his 1912 book:

The period of production . . . must be of such a length that exactly the whole available subsistence fund is necessary on the one hand and sufficient on the other for paying the wages of the laborers throughout the duration of the productive process. For if it were [longer],9 all the workers could no longer be provided for throughout its whole course, and the consequence would be an urgent offer of the unemployed economic factors which could not fail to bring about a transformation of the existing arrangement.10

He further states that the “national subsistence fund is necessarily altered by the increase of savings.”11 Thus savings, in influencing the size of the subsistence fund, determine the way production is organised in the economy:

A lengthening of the period of production is only practicable . . . when either the means of subsistence have increased sufficiently to support the laborers and entrepreneurs during the longer period or when the wants of producers have decreased sufficiently to enable them to make the same means of subsistence do for the longer period.12

So in the Theory of Money and Credit, it is the subsistence fund, the fund of saved-up consumers’ goods that determines the length of the period of production.

Entrepreneurs, when they evaluate the profitability of the different investments and decide about the production processes they want to implement, do not, of course, orientate themselves by the size of the national subsistence fund. They have probably never heard of such a thing, and even if they had, they surely could not determine its size. Instead, they are guided by the interest rate. Yet, in the Theory of Money and Credit, the interest rate bears a close relationship to the subsistence fund. It provides the entrepreneurs with the information as to how lengthy the production processes can reasonably become, that is, it informs them about the size of the subsistence fund. This can be seen especially in Mises’s exposition of the ABCT.

As was already indicated, in 1912 Mises expounds the ABCT in terms of the subsistence fund. In expanding the amount of circulation credit, the banking system decreases interest below the rate that is indicated by the amount of savings.13 So despite the fact that the subsistence fund has not increased, i.e., that “there is no possibility of lengthening the average period of production,” nonetheless “a rate of interest is established in the loan market which corresponds to a longer period of production.”14 As a consequence, in creating the illusion of the profitability of new investment possibilities—the longer production processes—“[c]redit expansion initially can produce a boom.”15 However, as the subsistence fund has not increased at all, “there cannot be the slightest doubt as to where this will lead.”16

A time must necessarily come when the means of subsistence available for consumption are all used up although the capital goods employed in production have not yet been transformed into consumption goods. . . . The means of subsistence will prove insufficient to maintain the laborers during the whole period of the process of production that has been entered upon. Since production and consumption are continuous, so that every day new processes of production are started upon and others completed, this situation does not imperil human existence by suddenly manifesting itself as a complete lack of consumption goods; it is merely expressed in a reduction of the quantity of goods available for consumption and a consequent restriction of consumption. The market prices of consumption goods rise and those of production goods fall.17

As can be seen in the preceding quotes, in the Theory of Money and Credit the subsistence fund plays a prominent role. Its size has a crucial effect on the production process as it limits the length of the production period. The entrepreneurs are informed about the size of the subsistence fund by means of the interest rate. In expanding circulation credit, the banking system artificially lowers the interest rate and thusly creates the illusion of an increased subsistence fund. Subsequently, entrepreneurs behave as if the subsistence fund has increased, i.e., they embark upon long-term investment projects. Ultimately, these projects turn out to be malinvestments as they require an amount of the subsistence fund that is not available. So after the rate of interest has fallen because of the additional circulation credit and has caused a boom, at last a counter-movement sets in. With higher consumers’ goods prices and lower producers’ goods prices, the interest rate rises again.18 It turns out that the increase of the subsistence fund has been an illusion. The consequence will be an economic crisis. Some of the longer processes of production have to be abandoned; with the higher rate of interest they cease to be profitable. A part of the new production goods “cannot be withdrawn and must therefore either be left entirely unused or at least be used less economically.”19 So, to quote Mises once more,

there has been a loss of value. Economic goods which could have satisfied more important wants have been employed for the satisfaction of less important; only in so far as the mistake that has been made can be rectified by diversion into another channel can loss be prevented.20

To sum up, according to the theory as contained in The Theory of Money and Credit, additional circulation credit creates the illusion of an increase of the subsistence fund. This way, entrepreneurs are trapped into malinvestments.

Some Smaller Inconsistencies in the Exposition

It must be pointed out that even the 1912 version is not formulated unambiguously. As long as Mises employs the term “means of subsistence,” it is clear what he is talking about. These means are definitely “available for consumption” and he contrasts them with capital goods.21 But Mises is not totally clear when it comes to defining and employing the term “subsistence fund.” On the one hand, he employs it synonymously to the “means of subsistence.” As was shown above, what he says about the subsistence fund and its role in the business cycle is consistent with this interpretation. On the other hand, he takes the term from Böhm-Bawerk, who wants it to include all kinds of goods, not only consumers’ goods.22 A point which indicates that Mises, at least sometimes, endorses this interpretation is that, in his opinion, the “quantity of metal available for industrial purposes,”23 which definitely is no consumers’ good, is part of the subsistence fund. Furthermore, at one point he even formulates his theory not in relation to either the subsistence fund or the means of subsistence, but to intermediate products:

[D]espite the fact that there has been no increase of intermediate products and there is no possibility of lengthening the average period of production, a rate of interest is established in the loan market which corresponds to a longer period of production;24

To be sure, shortly after he had written this sentence he again spoke of the means of subsistence that were missing. Yet, it can be seen from the quotes given that, even in the Theory of Money and Credit, his theory is not always and consistently formulated in terms of the subsistence fund as a fund of consumers’ goods. At some places, a different interpretation seems permissible.

Further Development of the ABCT by Mises

The Evolution of the Theory Up to 1936

It has been shown that even the 1912 version is not formulated unambiguously. Over the following decades, Mises changed the exposition of the ABCT. In 1928, Mises further developed it in his Geldwertstabilisierung und Konjunkturpolitik. At this point, he still uses the terms “subsistence fund” and “means of subsistence” as part of his explanation. He describes their role in the same way as in 1912:

Roundabout methods of production can be adopted only so far as the means for subsistence exist to maintain the workers during the entire period of the expanded process. All those projects, for the completion of which means are not available, must be left uncompleted, even though they may appear technically feasible—that is, if one disregards the supply of capital.25

From this quote, one could imagine that he uses “means of subsistence” and “capital” synonymously. And indeed, he even writes that

[i]n a given economic situation, the opportunities for production, which may actually be carried out, are limited by the supply of capital goods available.26

Shortly afterward, he employs the terms “existing resources,”27 “subsistence fund,”28 and “funds”29 to express the same idea. It is not clear what exactly, in his opinion, limits the length of the production period. In some places, it is still the subsistence fund, but as the quotes show, sometimes he refers to other entities like capital goods and resources. Unfortunately, he does not clarify the relationship between these entities.

Although there are some terminological inaccuracies, Mises’s 1928 explanation of the business cycle still runs in terms of a “subsistence fund,” however defined, that does not suffice in case of projects that only seem profitable because of credit-expansion. In the following years, Mises changes his formulation of the theory and abandons the term “subsistence fund” altogether in connection with capital or business cycle theory. In 1931, in an admittedly very short formulation of the theory, he only mentions “resources” as the decisive factor without any detailed explanation of the term.30 In 1936, it is neither the subsistence fund, nor the means of subsistence, that limit the length of the production period. Instead,

[t]he material means of production and the labor available have not increased; all that has increased is the quantity of the fiduciary media which can play the same role as money in the circulation of goods. The means of production and labor which have been diverted to the new enterprises have had to be taken away from other enterprises. Society is not sufficiently rich to permit the creation of new enterprises without taking anything away from other enterprises. As long as the expansion of credit is continued this will not be noticed, but this extension cannot be pushed indefinitely.31

Here, it is the means of production and labor that are not available in sufficient quantities. He also states that society is not “rich” enough, not specifying if this expression is supposed to correspond to the “material means of production and the labor available,” or to something else. It has to be said that this quotation is also taken from a minor publication, but still it shows that something has changed. The subsistence fund is not mentioned here at all.

The Exposition of the Business Cycle Theory in Human Action

The important question is how Mises formulates his theory in his magnum opus Human Action of 1949. There he further develops his capital theory, and so it suggests itself that an analysis of this book will help to clarify the interrelation between the terms in question. In earlier publications Mises treated the issues of capital theory only randomly.

Although, as will be shown below, Mises significantly alters the exposition of the circulation credit theory and although he does not use the term “subsistence fund” in his explanation of the ABCT, he does not forget about the “means of subsistence” altogether.

People eager to embark upon processes with a longer period of production must first accumulate, by means of saving, that quantity of consumers’ goods which is needed to satisfy, during the waiting time, all those wants the satisfaction of which they consider more urgent than the increment in well-being expected from the more time-consuming process.32

On the same page he explicitly calls these consumers’ goods “means of subsistence,” so-far-as they are used to pay labor. So, in a nutshell, he still says that the means of subsistence are the prerequisite for a lengthening of the period of production. In his Nationalökonomie, the German-language predecessor of Human Action, he specifies this thought in saying that these means serve to free [freimachen] original and produced means of production from being employed in shorter ways of production.33

It might be inferred from this quote that Mises still argues in the same vein as 1912. Yet, he does not use this concept continuously when he comes to explain the business cycle. In his earlier works, as we have seen, it was the “subsistence fund” that limited the length of the production processes. An artificial lowering of the interest rate induced the entrepreneurs to embark upon unsustainable (“too long”) production processes. In Human Action,

the drop in interest rates falsifies the businessman’s calculation. Although the amount of capital goods available did not increase, the calculation employs figures which would be utilizable only if such an increase had taken place.34

So the entrepreneurs do not act as if the subsistence fund had increased, but as if the amount of capital goods had increased. He restates this point a few pages later:

A further expansion of production is possible only if the amount of capital goods is increased by additional saving, i.e., by surpluses produced and not consumed. The characteristic mark of the credit-expansion boom is that such additional capital goods have not been made available. The capital goods required for the expansion of business activities must be withdrawn from other lines of production.35

Obviously, the limiting factor here is the capital goods. In this point, Mises differs from his earlier expositions. However, he tries to integrate both phenomena, scarce means of subsistence and scarce capital goods, in his explanation. He also echoes his earlier formulations by saying:

Production has been altered in such a way that the length of waiting time has been extended. But the demand for consumers’ goods has not dropped so as to make the available supply last for a longer period.36

With this integration of capital goods and consumers’ goods Mises simply employs Böhm-Bawerk’s concept of the subsistence fund that consists of both capital goods and consumers’ goods. Anyway, the decisive factor that marks the turning point of the business cycle is the scarcity of capital goods, not of consumers’ goods:

[The entrepreneurs] embark upon an expansion of investment on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. They must fail sooner or later.37

To sum up our findings so far: In his earlier works Mises stresses the importance of the subsistence fund, though not clearly defining it. Later on, roughly since the 1930s, he starts to stress different ideas more strongly. Though he still recognizes the importance of the means of subsistence, he doesn’t think these to be the central limiting factor for an expansion of production. Rather that capital goods gain prominence.

Now, to derive an exact notion of how he thinks the business cycle will elapse in his later writings, it is necessary to understand what he means exactly by capital goods. On one occasion in the third edition of Human Action, Mises defines capital goods as

either intermediary stages in the technological process, i.e. tools and half-finished products, or goods ready for consumption that make it possible for man to substitute, without suffering want during the waiting period, a more time-absorbing process for another absorbing a shorter time.38

But, as shown by the following quote taken from the same edition, capital goods as just defined are not scarce at all at the onset of the crisis:

However, raw materials, primary commodities, half-finished manufactures and foodstuffs are not lacking at the turning point at which the upswing turns into the depression. On the contrary, the crisis is precisely characterized by the fact that these goods are offered in such quantities as to make their prices drop sharply.39

This is exactly the opposite of what he says in the passages quoted before where he maintains that capital goods are the bottleneck at the turning point of the business cycle. However, we will not evaluate Mises’s business cycle theory on the basis of the definition just quoted. It does not appear in the first and apparently most stringent40 edition of Human Action. And there he has a different concept in mind when he states that the supply of capital goods is insufficient in the crisis, namely the following: “We may acquiesce in the terminological usage of calling the produced factors of production capital goods.”41

Capital Goods or the Subsistence Fund as the Limiting Factor?

Unfortunately, Mises does not explain why he thinks that the business cycle is caused by the fact that entrepreneurs, as a reaction on credit expansion, calculate as if the amount of capital goods had increased. It is the purpose of this chapter to demonstrate that this point could not be upheld, anyway. It is not the supply of capital goods that limits the length of the production period, and also, an expansion of circulation credit does not create the illusion of an increased supply of capital goods. The scarcity of capital goods cannot produce a bust.

Let us assume that the entrepreneurs have indeed been counting on a large supply of capital goods because of an artificially lowered interest rate. At some point, they realize that their expectations have been flawed. The price of capital goods rises. Now, it is true, this development would increase the costs to those entrepreneurs who need these goods as input. Those entrepreneurs might indeed have to stop or closes their businesses.

However, it must be remembered that capital goods, in the definition given by Mises himself, are produced means of production. If they become scarce, their supply can be increased simply by producing them. The rise of capital goods prices will establish new profit opportunities. Entrepreneurs will be eager to produce capital goods. Their supply should, therefore, increase and their prices decrease again. So the bottleneck that Mises thinks will trigger an economic crisis can easily be overcome. There is no problem with this solution unless something might hinder the production of capital goods, that is, unless another bottleneck should hinder this adjustment of the production process. If this occurred, the described solution would become unprofitable for the entrepreneurs. But then the fact that it is unprofitable to produce capital goods cannot signify their “insufficient supply.” Rather the opposite is true. Apparently, there are enough capital goods available when their production is unprofitable. To sum up, the scarcity of capital goods can be healed by producing them. When it is unprofitable to produce them they are not scarce and do not constitute a bottleneck that triggers an economic crisis.

It is different with the version that can be found in the Theory of Money and Credit. There, it was the scarcity of the subsistence fund that triggered the bust. Concerning the subsistence fund it cannot be said what was just said about capital goods. When the means of subsistence become scarce, it cannot be argued that this does not constitute problems because they can easily be produced—like capital goods. The subsistence fund comes into being by people who save parts of their income. It is necessary that some people abstain from consumption, i.e., incur a sacrifice of potential consumption. This way, consumers’ goods are made free that can now be bought by workers who do not themselves produce consumers’ goods, but work in roundabout production processes. Without savings, these workers cannot be provided with means of subsistence; no subsistence fund can be built up, and roundabout ways of production become unfeasible.

So one cannot argue that the scarcity of consumers’ goods can be overcome by producing them. The fund of consumers’ goods can only be increased by saving. And if the savings are not enough to finance the actual production processes, the interest rate will rise and many projects will become unprofitable. Businessmen themselves can do nothing to prevent this consequence as long as people do not save more. This is the problem that causes the crisis. This indeed is a bottleneck. Given the unjustifiably long production period—the result of the artificially lowered interest rate—people do not save enough, the subsistence fund shrinks, and many investment projects cannot be finished and turn out to be malinvestments. This problem cannot be healed by production, but only by saving. If people do not save more, the crisis cannot be avoided.

Conclusion

We find that the limiting factor at the turning point of the business cycle must be the available subsistence fund. This point was stressed by Ludwig von Mises in his Theory of Money and Credit. Later on, he more and more abandoned this line of reasoning and substituted the concept of capital goods. It has been shown that this change was for the worse. Capital goods—produced means of production—can never be a bottleneck in the production process as their supply can easily be increased by merely producing them. The same argument cannot be employed to refute the original version that runs in terms of the subsistence fund. The latter can only be increased by saving, not merely by production. Thus, in case savings should not increase at the turning point of the business cycle, the crisis sets in as described by Mises in his 1912 Theorie des Geldes und der Umlaufsmittel. Consumers’ goods prices rise and producers’ goods prices fall, making necessary a painful adaptation of production. As a final point, it might be interesting to note that it was Richard von Strigl who, in his book, Kapital und Produktion, elaborated on Mises’s original formulation and expounded his version of the ABCT solely in terms of the subsistence fund.42

References

Belke, Ansgar, and Thorsten Polleit 2009. Monetary Economics in Globalised Financial Markets. Berlin and Heidelberg, Springer.

Böhm-Bawerk, Eugen von. 1921. Positive Theorie des Kapitals, Band I, 4. Auflage. Jena, Fischer.

Dornbusch, Rudiger, Stanley Fischer, and Richard Startz. (2008): Macroeconomics. 10th edition, Boston: McGraw-Hill/Irwin.

Gentier, Antoine. (2003). Economie Bancaire. Essai sur les effets de la concurrence et la réglementation sur le financement du crédit. Paris: Publibook.

Herbener, Jeffrey M., Hans-Hermann Hoppe, and Joseph T. Salerno. 1998. Introduction to the Scholar’s Edition. In: Ludwig von Mises, Human Action: A Treatise on Economics. The Scholar’s Edition, Auburn, Ala.: Ludwig von Mises Institute. Pp. v–xxiv.

Huerta de Soto, Jesús. 2009. Money, Bank Credit, and Economic Cycles. 2nd ed. M.A. Stroup, trans. Auburn, Ala.: Ludwig von Mises Institute.

Mises, Ludwig von. 1912. Theorie des Geldes und der Umlaufsmittel. Munich and Leipzig: Duncker & Humblot.

——. 1940: Nationalökonomie: Theorie des Handelns und Wirtschaftens. Genf, ed. Union.

——. 1949. Human Action: A Treatise on Economics. New Haven, Conn.: Yale University Press.

——. [1912] 1953. The Theory of Money and Credit. New Haven, Conn.: Yale University Press.

——. 1966. Human Action: A Treatise on Economics. 3rd rev. ed. Chicago, Regnery.

——. [1936] 1996. “The ‘Austrian’ Theory of the Trade Cycle.” In The Austrian Theory of the Trade Cycle and other Essays. Compiled by Richard M. Ebeling. Auburn, Ala.: Ludwig von Mises Institute. Pp. 25–35.

——. [1928] 2006. “Monetary Stabilization and Cyclical Policy.” In The Causes of the Economic Crisis and other Essays Before and After the Great Depression. Percy L. Greaves, Jr. Auburn, Ala.: Ludwig von Mises Institute. Pp. 53–153.

——. [1931] 2006. “The Causes of the Economic Crisis: An Address.” In The Causes of the Economic Crisis and other Essays Before and After the Great Depression. Percy L. Greaves, Jr. Auburn, Ala.: Ludwig von Mises Institute. Pp. 155–81.

Strigl, Richard von. 2000. Capital and Production. Margaret R. Hoppe and Hans-Hermann Hoppe, trans. Edited with an Introduction by J. G. Hülsmann. Auburn, Ala.: Ludwig von Mises Institute.

Eduard Braun holds a Ph.D and is a research assistant at Clausthal University of Technology in Clausthal-Zellerfeld, Germany. An earlier version of this paper appeared in the December 2012 issue of Procesos de Mercado: Revista Europea de Economía Política.

• 1The other three treatises are Socialism (Indianapolis: Liberty Fund, 1981), Human Action (Auburn, Ala.: Mises Institute, 1998), and Theory and History (Auburn, Ala.: Mises Institute, 1985). See the complete Mises bibliography at http://mises.org/misesbib.asp. For general biographical information on Mises see Murray Rothbard, Ludwig von Mises: Scholar, Creator, Hero (Auburn, Ala.: Mises Institute, 1988), Israel Kirzner, Ludwig von Mises: The Man and His Economics (Wilmington, Del.: ISI Books, 2001), and J.G. Hülsmann, Mises: The Last Knight of Liberalism (Auburn, Ala.: Mises Institute, 2007).
• 2Keynes had written a book review of Mises’s treatise, stating it “is the work of an acute and cultivated mind. But it is critical rather than constructive, dialectical and not original. The author avoids all the usual pitfalls, but he avoids them by pointing them out and turning back rather than by surmounting them.” (Economic Journal, September 1914, p. 417). Sixteen years later he stated that “in German, I can only clearly understand what I know already!—so that new ideas are apt to be veiled from me by the difficulties of language.” Keynes, A Treatise on Money (London: Macmillan, 1930), vol. I, p. 199, note 2.
• 3The 1953 edition (New Haven, Conn.: Yale University Press) included an additional fourth part on “monetary reconstruction” that Mises had written for this new edition. In that form the book was published again three more times: 1971 (Irvington-on-Hudson, N.Y.: Foundation for Economic Education; second print in 1978), 1981 (Indianapolis: Liberty Fund), and 2009 (Auburn, Ala.: Mises Institute).
• 4Several Spanish translations (La Teoría del Dinero y Del Crédito) have been made: one by Antonio Riaño, published in 1936 (Madrid: M. Aguilar), one by José Ma. Claramunda Bes (Barcelona: Ediciones Zeus, 1961), and one by Juan Marcos (Madrid: Union Editorial, 1997).
• 5The Japanese translation was made from the second German edition by Yoneo Azuma: Kahei oyobi Ryütüjshudan no Riron (Tokyo: Jitsugyo no Nipponsha, 1949) and re-published in 1980 (Tokyo: Nihon Hyöron-Sha).
• 6Translated by H.P. Yang (Taiwan: Taiwan Bank, Economic Research Department, 1969).
• 7The Russian translation, along with annotations, was made by G. Sapov who used both the American edition and the second German edition: Теория денег и кредита (Chelyabinsk: Sotsium, 2012).
• 8The French edition (La Théorie de la monnaie et du crédit) is incomplete and only available on the Internet (http://herve.dequengo.free.fr/Mises/Tmc/TMC_1_1.htm). A print edition is forthcoming along with a preface from Antoine Gentier (Paris: Editions de l’Institut Charles Coquelin).
• 9Brad Delong, “Paul Krugman Asks a Question: On the ‘Austrian’ Hatred of Fractional Reserve Banking, Paper Money, etc. Weblogging” (http://delong.typepad.com/sdj/2012/09/paul-krugman-asks-a-question-on-the-austrian-hatred-of-fractional-reserve-banking-paper-money-etc-weblogging.html#more; accessed on 3 October 2012, at 9h32 CET)
• 10On the shortcomings of the Batson translation, see chap. 1, below.
• 11He calls money also “money in the narrow sense.” Most economists today call it “base money.” Notice that Mises argued that the essential function of money is to serve as a generally accepted medium of exchange. All other functions are consecutive functions. They are derived from this primary one (A10–12). Mises endorsed Knies classification of money as a good sui generis, that is, as distinct from consumers’ goods and from capital goods. The reason is, again, that these three types of goods are subject to different laws of valuation and pricing (A79).
• 12Mises argued most notably that the fatal error of the Currency School, which otherwise had sound conceptions that he endorsed in his book, was to regard banknotes as some form of money, whereas it considered demand deposits as pure credit instruments and not as a form of money. This was in Mises’s eyes a distinction without a difference and it led to the practical failure of Peel’s Act. We will deal with this issue in more detail below.
• 13During WWI, Mises refuted the assignment theory in a 1916 journal article “on the classification of monetary theories.” This paper would then be incorporated into the 1924 edition of his Theorie des Geldes und der Umlaufsmittel (chapter 9 of the second part; see B242–63) and remained as an appendix in the 1953 edition (see C503–24).
• 14See North (1993, p. 159).
• 15They are not different in all respects. For example, increasing the supply of fiduciary tends to entail an increase of the price level, just as it would be in the case of an increased supply of money proper or of money certificates.
• 16Unfortunately, the English rendering as Theory of Money and Credit obscured this central theme. We will address the problems of this translation below.
• 17See Menger (1968 [1909], pp. 73–75, 80–91. In the English edition the distinction between inner and outer exchange value was completely dropped. In a footnote (on p. C146) Batson explains: “Since this distinction has not been usual in English terminology, it has been omitted from the present version; and, in what follows, wherever ‘the objective exchange value of money’ is referred to, it is the innere exchange value that is meant unless the contrary is explicitly stated.”
• 18He repeatedly referred to Mathus’s Principles of Political Economy. See especially Menger (1968 [1909], p. 82).
• 19See Menger (1968 [1909], p. 75.
• 20In a passage where he explained that distinction (not translated into English), he stated (A132f., B104): “Both expressions are somewhat odd. But they have become accepted in science ever since Menger used them. Therefore they shall be used where appropriate in the following investigations.” (Beide Ausdrücke sind nicht gerade glücklich gewählt. Aber sie haben einmal in der Wissenschaft das Bürgerrecht erlangt, seit Menger sie verwendet hat; darum sollen sie auch in den folgenden Untersuchungen dort gebraucht werden, wo dies mit Nutzen geschehen kann.)
• 21B200, my emphasis JGH. The word “inner” lacks in the English edition, see C272. Similarly, see the definition of the term “inflationism” on A265 (deleted from the second edition). Mises was reluctant to use the term inflation at all, referring to the reservations expressed by Pigou. He thought scientific analysis could do without them. For a penetrating history of the common definitions of the terms inflation and deflation see Bryan (1997).
• 22A246, B200. Again, the English edition lacks the words “inner” (see C248). The translator, Batson, also tried to make a distinction between Geldwertpolitik, Geldpolitik, and Währungspolitik (see C247, footnote), whereas Mises used all three terms synonymously, as is common in the German-language literature. Similarly, Mises stated that monetary policy in that sense is the “complement” or “corollary” (Gegenstück) of policies designed to influence the prices of single commodities or groups of commodities. Batson translates Gegenstück out of context as “antithesis.”
• 23Amadeus Gabriel highlights the interesting fact that the core idea of the regression theorem can be traced back to the contemporary German literature. See Gabriel (2012) in the present volume, chapter 2.
• 24See A154f., B122f., C164.
• 25In a passage deleted as from the second edition (see A244f.), Mises discusses Irving Fisher’s attempt to empirically validate his contention about the relationship between real and nominal interest rates. Mises points out that Fisher succeeded only in those cases in which the inter-temporal exchange (the credit) involved several currencies; but not in those cases in which the credit was given and returned in terms of a commodity money.
• 26A78, C101f. See also A263, A402f.
• 27At one point he almost justified his repetitiveness, stating: “This was not recognized for a long time and to a large extent it is not recognized even nowadays” (A403, C379).
• 28The monetary interventionism recommended by mercantilist authors such as John Law was therefore not modern monetary policy in Mises’s sense. The mercantilists wished to increase the money stock, but they did not wish to diminish the PPM (even though they might have accepted this consequence as a collateral effect of their policies). See A263f.
• 29C250, A250, B203.
• 30He points out that the monetary history of Austria-Hungary in the nineteenth century was one of the most important cases of deflationist policies (A257).
• 31C264, A261, B217. At this point he quotes Bentham’s In Defence of Usury (1790).
• 32In the second edition, too, he characterizes a stable inner objective exchange value of money as a—yet unattainable—ideal of monetary policy (see B401).
• 33C269f., B222, A288. Notice that the English text falsely translates Sachgeld (commodity money) as metallic money.
• 34C270, B222, A290.
• 35AIV. The original text: “Manche ihrer Fehler sind von Tooke und Fullarton mit Recht getadelt worden. Aber das, was diese beiden an die Stelle der Currency-Theorie gesetzt haben, ist mit nichten eine brauchbare Theorie. Die Banking-Theorie enthält nicht nur Irrtümer, sie fehlt schon in ihrer Problemstellung.”
• 36A417, C390. Mises mentions the circumstance that explains this neglect: Currency School and Banking School agreed amongst themselves that there could be no such thing as costless credit. See A406f., C381.
• 37See A410, A412, A415–17, A428–30.
• 38This distinction is one of the central concepts to which Mises refers constantly through the entire book. See pp. A80, A145, A353, A358, A358, A419, A422, A429, A430f., A432, A435f., A445, A452.
• 39The only exception concerns commodity money. Here an increase in the demand for money tends to entail increases of the interest rate; but Mises contends that this fact is without practical significance. For a more recent re-interpretation of the significance of this fact see J.G. Hülsmann, “The Demand for Money and the Time Structure of Production,” Hülsmann and Kinsella, eds., Property, Freedom, and Society: Festschrift for Hans-Hermann Hoppe (Auburn, Ala.: Mises Institute, 2009); Dan Mahoney, “Free Banking and the Structure of Production: A Contrast of Competing Banking Systems,” Libertarian Papers 3, no. 14 (2011).
• 40A428f., B369f., C399.
• 41A430f. In the second edition, he modified the argument concerning the nature of the impossibility of artificially lengthening the period of production. He stated “and so, although it is in the last resort inadmissible and impracticable, a lengthening of the period of production promises for the time to be profitable” (C399; emphasis JGH). The original text of the second edition: “damit wird die Verlängerung der Produktionsperiode, obwohl in letzter Linie unzulässig und undurchführbar, zunächst scheinbar rentabel” (B371). The original text of the first edition reads: “damit wird die Verlängerung der Produktionsperiode, obwohl volkswirtschaftlich unzulässig und undurchführbar, privatwirtschaftlich zunächst rentabel” (A430). Thus whereas Mises argued at first that the artificial expansion of the money supply entailed a contradiction between overall possibilities and the individual assessment of those possibilities, he later argued that it temporarily entailed illusory profits. Clearly this new argument is problematic, because not all profits in the boom phase are illusory. The main motivation behind the change of argument seems to be Mises’s general quest, in the second edition, to get rid of all references to an overall or macroeconomic (volkswirtschaftlich) point of view, to emphasize methodological individualism, and to deny the existence of possible contradictions between individual interests and the common good. Thus we find in the new chapter on “the monetary policy of étatism” the following statement: “In this case, as in all others in which similar assertions are made, it is not true that there exists an opposition between the interests of the individual and the interests of the community” (B240, C290).
• 42The chapter title has subsequently been changed into “Pre-war policy problems relating to fiduciary media” (Probleme der Umlaufsmittelpolitik in der Zeit vor dem Kriege; English translation: “Problems of credit policy before the war”). The concluding fourth part of the first edition (A467–76) has subsequently been deleted respectively integrated into the final pages of the last chapter of part three.