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December 1, 2008
by Gary North, Ph.D.
I would put it somewhat differently. I would say that the nine-decade blackout on Mises' theory of money has fared better than the seven-decade blackout on his theory of why socialist economic calculation is impossible (no capital markets), and therefore socialism as a system will fail. What rescued Mises' theory of socialism was the bankruptcy of the Soviet Union in 1988, the fall of the Berlin Wall in 1989, and the suicide of the Soviet Union in 1991. Reality had undeniably triumphed. So, grudgingly, there was a new willingness by a few mainstream economists to give Mises' 1920 essay, "Economic Calculation in the Socialist Commonwealth," at least a footnote. One old-line socialist even admitted in print that Mises had been right. Robert Heilbroner, who became a multimillionaire from royalties on his undergraduate textbook on the history of modern economic thought, The Worldly Philosophers, which did not mention Mises, said so in print. He made his admission in a non-economics setting: The New Yorker (Sept. 10, 1990). So far, there has not been a breakdown of the monetary system comparable to the breakdown of the Soviet Union. The Soviet Union always was, in Richard Grenier's magnificent phrase, Bangladesh with missiles. Because it had power, Western intellectuals gave its system credence. But it had always been blood and mirrors from 1917. When it went belly-up, Western economists at last abandoned ship. They had not even made it in time to the lifeboats. They had only their lifesavers to let them float away. What we need -- and what we are going to get -- is a monetary crisis comparable in scope to the crisis of the Soviet Union. Mises called this event the crack-up boom: mass inflation. It will undermine the capital markets. Thus, Western state capitalism, funded by fiat money through fractional reserve banks, will at long last achieve what socialist economies achieved first: economic blindness. Meanwhile, Austrian School economists suffer from Aretha Syndrome. Anderson writes:
The real market test is not what a guild of self-accredited academic economists write in the tenured safety of their tax-funded ivory towers. It is not what a committee of equally subsidized peers determines is fit for publication in the guild's unread and unreadable academic journals. It is the market outside the insulated halls of ivy that determines what survives and what does not. MISES VS. FISHER We have seen a similar test before. The real world imposed a vote of "no confidence" on an earlier critic of Mises: Irving Fisher. Fisher was the dean of American economists in 1929. For two decades, his theory of money was dominant. He did not accept Mises' theory of the effects of central bank fiat money: to destroy capital investment by lowering the interest rate below what it would otherwise had been. Fisher believed in monetary aggregates, not monetary distortion. The entire academic profession agreed with Fisher. It still does. The debate has not changed fundamentally in over nine decades. Each side refines its arguments, but the basics do not change. Mises used his monetary theory to predict the Great Depression of the 1930's. In 1929, he turned down a lucrative job offer from Austria's Credit Anstalt Bank. He was convinced that the bank was vulnerable to the panic that was coming. He did not want his name associated with the bank. In 1931, its collapse triggered a wave of bank defaults in Europe. Mises wrote a critique of Fisher in 1928, which is available free on-line here. It is found in the section on "Monetary Stabilization and Cyclical Policy." Fisher's conceptual error, Mises argued in 1928, was that he did not recognize the distorting effects of monetary inflation, caused by expansionary central bank policies. The price level -- always a statistical tool of special interests -- may remain stable, but this does not overcome the boom-bust effects of monetary inflation on the structure of production (pp. 85-88). Fisher's theory of money defined inflation as a rise in prices, not an increase in money. His theory produced blindness to the effects of central bank inflation on relative prices, especially of capital goods. Fisher did not see the depression coming. Mises did. On September 15, 1929, on the basis of his theory of money, Fisher issued this now legendary prediction: "Stock prices have reached what looks like a permanently high plateau." He repeated this for months thereafter. Fisher had invented the Rolodex card file. He was a rich man in 1929. He lost his entire fortune, valued in the millions, plus the fortune of his wife's sister, in the ensuing depression. It is amusing to learn that two staff economists at the Federal Reserve Bank of Minneapolis have used modern (non-Austrian) economic theory to conclude: "Fisher Was Right!" They published this in the Bank's in-house academic journal.
It was a great theory, they say. It was the theory that counted, not his forecast. He was right in theory. He was wrong in his prediction. He was wrong in both. The modern economics profession is so hostile to Mises, who argued that central bank inflation in the 1920's caused the Great Depression, that they are still ready to swallow Fisher -- hook, line, and sinker. SCHIFF VS. LAFFER The debate goes on. This time, however, it is between two real-world economists. One has a Ph.D. from the University of Chicago. The other has no Ph.D. Neither is in academia. They both sell their services as forecasters. Schiff saw this bust coming and said so on national television in 2006. Laffer responded on-screen, dismissing this prediction as nonsense. The video is here. Schiff said that America would enter a major recession in 2007 or 2008, and that it would be long and deep. Laffer was contemptuous of Schiff's forecast. "I don't know where he is getting this," he said. He was getting it from Mises. He was getting it from Murray Rothbard. In short, he was getting it from Austrian School economics. Dr. Laffer has little use for Austrian economics. He shares this opinion with 99% of academic economists and stockbrokers. He insisted that American tax policy was great, monetary policy was great, and there was no crisis facing the American economy. Everything was just fine, Dr. Laffer insisted. That was then. This is now. Now he says we are facing the end of prosperity. He has now written an article in the Wall Street Journal, titled provocatively, "The Age of Prosperity Is Over." He had written this:
Quite correct. This is exactly what financial panics do. Peter Schiff had predicted this financial panic. Dr. Laffer had denied it was coming.
He can say that again! That is why I am pointing attention to a very good decision: Peter Schiff's decision in 2006 to go on national television and warn viewers about the financial panic that has now hit with devastating force. Dr. Laffer made a bad decision: to tell viewers everything was A-OK. Now, he says this: Twenty-five years down the line, what this administration and Congress have done will be viewed in much the same light as what Herbert Hoover did in the years 1929 through 1932. Whenever people make decisions when they are panicked, the consequences are rarely pretty. We are now witnessing the end of prosperity. This is exactly what Peter Schiff was saying in 2006. He has not changed his views. Dr. Laffer has changed his. Dr. Laffer is not a fast learner, but he is not a suicidally slow learner, either. He changed horses mid-stream -- not in terms of economic theory but in terms of the terrible reality of the effects of the economic policies of Mr. Bush, Mr. Greenspan, and now Dr. Bernanke. Dr. Laffer remains a non-learner with respect to Austrian School economic theory, but at least he can see what is in front of his nose: a major recession, a collapsing stock market, and a catastrophic economic policy. He is therefore a lot faster learner than the non-learners on Tout TV who keep telling viewers that "the bottom is near: so here's a stock to buy today to make money." So, we find Dr. Laffer blaming the Federal Reserve System for the present crisis -- not the FED under Greenspan, which he publicly praised in his debate with Schiff, but Bernanke's tight money policy, which ended in August 2008. As reported in the financial press,
Chicago School economists hate stable money -- the kind of money provided by (1) the gold standard and (2) 100% reserve banking. They like "mild" money manipulation by the Federal Reserve System. That was Friedman's argument in A Monetary History of the United States (1963). The FED did not inflate enough in the early 1930's. It was opposed by Murray Rothbard in America's Great Depression (1963). The FED inflated too much in the late 1920's. Both books were published in Princeton, New Jersey: one by Princeton University Press and the other by Van Nostrand. Which book won Nobel Prize for its author? Which book did academia accept? Which one was ignored for 20 years until Paul Johnson discovered it and used it as the basis for his chapter on the Great Depression in Modern Times (1983)? Need I ask? SCIENTIFIC IS AS SCIENTIFIC DOES Friedman, a disciple of Fisher's monetary economics, wrote in a famous essay in 1953 that the sole test for an economic theory is its ability to produce accurate forecasts. Mises opposed this interpretation. He argued for the sole test as internal consistency and the self-evident accuracy of a few axioms. The great irony here is that Mises and those who use his theories have predicted recessions better than Fisher and his disciples. Rothbard, who was in agreement with Mises on methodology, provided a summary of Fisher's forecasting abilities.
But what of Fisher's disciples? The head of the Federal Reserve Bank of Dallas, also named Fisher, remains in awe of him. He writes:
The debate goes on because the strict free market views of Mises are anathema to academic economists, who are hired by the Federal Reserve System to continue the cheerleading. The graduate schools without exception favor the FED. Without exception, the textbooks do not treat the FED as a cartel, which it is, according to the definitions in the textbooks' chapters on cartels and oligopolies. The one book that blows the whistle is Murray Rothbard's The Mystery of Banking, which was not aimed at a collegiate market and has never been assigned there. You can get it free here. CONCLUSION The debate between Mises and Fisher, Mises and the Chicago School, and Schiff vs. mainstream economists in 2006 boil down to this: Can we trust the Federal Reserve System? The Austrian School's answer: no. Why not? Because the Federal Reserve System substitutes the judgment of monopolistic central planners for consumers and investors. It substitutes the decisions of people with job tenure and little accountability for the decisions of people who put their own wealth at risk. It substitutes the judgments of non-owners for owners. We find that academic economists, either tenured or seeking tenure, side with Fisher. The textbooks side with the academic economists. You would be wise to side with Mises. Dr. Gary North earned a Ph.D. in history and is one of America's keenest economic analysts and commentators. He supports the Austrian school of economics and is a previous assistant to libertarian congressman Dr. Ron Paul. Visit his website at http://garynorth.com. To subscribe to Gary North's Reality Check go to http://www.dailyreckoning.com/sub/GetReality.cfm If you enjoyed this essay and would like to read more of Gary's writing please visit his website at http://www.garynorth.com or http://www.freebooks.com
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