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    How the Fed Rules and Inflates

    enApril 22, 2023

    About this Episode

    [From chapter 23 of The Case Against the Fed.]

    Having examined the nature of fractional reserve and of central banking, and having seen how the questionable blessings of Central Banking were fastened upon America, it is time to see precisely how the Fed, as presently constituted, carries out its systemic inflation and its control of the American monetary system.

    Pursuant to its essence as a post-Peel Act Central Bank, the Federal Reserve enjoys a monopoly of the issue of all bank notes. The US Treasury, which issued paper money as Greenbacks during the Civil War, continued to issue one-dollar "Silver Certificates" redeemable in silver bullion or coin at the Treasury until August 16, 1968. The Treasury has now abandoned any note issue, leaving all the country's paper notes, or "cash," to be emitted by the Federal Reserve. Not only that; since the US abandonment of the gold standard in 1933, Federal Reserve Notes have been legal tender for all monetary debts, public or private.

    Federal Reserve Notes, the legal monopoly of cash or "standard," money, now serve as the base of two inverted pyramids determining the supply of money in the country. More precisely, the assets of the Federal Reserve Banks consist largely of two central items. One is the gold originally confiscated from the public and later amassed by the Fed. Interestingly enough, while Fed liabilities are no longer redeemable in gold, the Fed safeguards its gold by depositing it in the Treasury, which issues "gold certificates" guaranteed to be backed by no less than 100 percent in gold bullion buried in Fort Knox and other Treasury depositories. It is surely fitting that the only honest warehousing left in the monetary system is between two different agencies of the federal government: the Fed makes sure that its receipts at the Treasury are backed 100 percent in the Treasury vaults, whereas the Fed does not accord any of its creditors that high privilege.

    The other major asset possessed by the Fed is the total of US government securities it has purchased and amassed over the decades. On the liability side, there are also two major figures: demand deposits held by the commercial banks, which constitute the reserves of those banks; and Federal Reserve Notes, cash emitted by the Fed. The Fed is in the rare and enviable position of having its liabilities in the form of Federal Reserve Notes constitute the legal tender of the country. In short, its liabilities—Federal Reserve Notes—are standard money. Moreover, its other form of liability—demand deposits—are redeemable by deposit-holders (i.e., banks, who constitute the depositors, or "customers," of the Fed) in these Notes, which, of course, the Fed can print at will. Unlike the days of the gold standard, it is impossible for the Federal Reserve to go bankrupt; it holds the legal monopoly of counterfeiting (of creating money out of thin air) in the entire country.

    The American banking system now comprises two sets of inverted pyramids, the commercial banks pyramiding loans and deposits on top of the base of reserves, which are mainly their demand deposits at the Federal Reserve. The Federal Reserve itself determines its own liabilities very simply: by buying or selling assets, which in turn increases or decreases bank reserves by the same amount.

    At the base of the Fed pyramid, and therefore of the bank system's creation of "money" in the sense of deposits, is the Fed's power to print legal tender money. But the Fed tries its best not to print cash but rather to "print" or create demand deposits, checking deposits, out of thin air, since its demand deposits constitute the reserves on top of which the commercial banks can pyramid a multiple creation of bank deposits, or "checkbook money."

    Let us see how this process typically works. Suppose that the "money multiplier"—the multiple that commercial banks can pyramid on top of reserves, is 10:1. That multiple is the inverse of the Fed's legally imposed minimum reserve requirement on different types of banks, a minimum which now approximates 10 percent. Almost always, if banks can expand 10:1 on top of their reserves, they will do so, since that is how they make their money. The counterfeiter, after all, will strongly tend to counterfeit as much as he can legally get away with. Suppose that the Fed decides it wishes to expand the nation's total money supply by $10 billion. If the money multiplier is 10, then the Fed will choose to purchase $1 billion of assets, generally US government securities, on the open market.

    Figures 10 and 11 below demonstrate this process, which occurs in two steps. In the first step, the Fed directs its Open Market Agent in New York City to purchase $1 billion of US government bonds. To purchase those securities, the Fed writes out a check for $1 billion on itself, the Federal Reserve Bank of New York. It then transfers that check to a government bond dealer, say Goldman Sachs, in exchange for $1 billion of US government bonds. Goldman Sachs goes to its commercial bank—say Chase Manhattan—deposits the check on the Fed, and in exchange increases its demand deposits at the Chase by $1 billion.

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    Where did the Fed get the money to pay for the bonds? It created the money out of thin air, by simply writing out a check on itself. Neat trick if you can get away with it!

    Chase Manhattan, delighted to get a check on the Fed, rushes down to the Fed's New York branch and deposits it in its account, increasing its reserves by $1 billion. Figure 10 shows what has happened at the end of this Step One.

    The nation's total money supply at any one time is the total standard money (Federal Reserve Notes) plus deposits in the hands of the public. Note that the immediate result of the Fed's purchase of a $1 billion government bond in the open market is to increase the nation's total money supply by $1 billion.

    But this is only the first, immediate step. Because we live under a system of fractional-reserve banking, other consequences quickly ensue. There are now $1 billion more in reserves in the banking system, and as a result, the banking system expands its money and credit, the expansion beginning with Chase and quickly spreading out to other banks in the financial system. In a brief period of time, about a couple of weeks, the entire banking system will have expanded credit and the money supply another $9 billion, up to an increased money stock of $10 billion. Hence, the leveraged, or "multiple," effect of changes in bank reserves, and of the Fed's purchases or sales of assets which determine those reserves. Figure 11, then, shows the consequences of the Fed purchase of $1 billion of government bonds after a few weeks.

    Note that the Federal Reserve balance sheet after a few weeks is unchanged in the aggregate (even though the specific banks owning the bank deposits will change as individual banks expand credit, and reserves shift to other banks who then join in the common expansion.) The change in totals has taken place among the commercial banks, who have pyramided credits and deposits on top of their initial burst of reserves, to increase the nation's total money supply by $10 billion.

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    It should be easy to see why the Fed pays for its assets with a check on itself rather than by printing Federal Reserve Notes. Only by using checks can it expand the money supply by ten-fold; it is the Fed's demand deposits that serve as the base of the pyramiding by the commercial banks. The power to print money, on the other hand, is the essential base in which the Fed pledges to redeem its deposits. The Fed only issues paper money (Federal Reserve Notes) if the public demands cash for its bank accounts and the commercial banks then have to go to the Fed to draw down their deposits. The Fed wants people to use checks rather than cash as far as possible, so that it can generate bank credit inflation at a pace that it can control.

    If the Fed purchases any asset, therefore, it will increase the nation's money supply immediately by that amount; and, in a few weeks, by whatever multiple of that amount the banks are allowed to pyramid on top of their new reserves. If it sells any asset (again, generally US government bonds), the sale will have the symmetrically reverse effect. At first, the nation's money supply will decrease by the precise amount of the sale of bonds; and in a few weeks, it will decline by a multiple, say ten times, of that amount.

    Thus, the major control instrument that the Fed exercises over the banks is "open market operations," purchases or sale of assets, generally US government bonds. Another powerful control instrument is the changing of legal reserve minima. If the banks have to keep no less than 10 percent of their deposits in the form of reserves, and then the Fed suddenly lowers that ratio to 5 percent, the nation's money supply, that is of bank deposits, will suddenly and very rapidly double. And vice versa if the minimum ratio were suddenly raised to 20 percent; the nation's money supply will be quickly cut in half. Ever since the Fed, after having expanded bank reserves in the 1930s, panicked at the inflationary potential and doubled the minimum reserve requirements to 20 percent in 1938, sending the economy into a tailspin of credit liquidation, the Fed has been very cautious about the degree of its changes in bank reserve requirements. The Fed, ever since that period, has changed bank reserve requirements fairly often, but in very small steps, by fractions of one percent. It should come as no surprise that the trend of the Fed's change has been downward: ever lowering bank reserve requirements, and thereby increasing the multiples of bank credit inflation. Thus, before 1980, the average minimum reserve requirement was about 14 percent, then it was lowered to 10 percent and less, and the Fed now has the power to lower it to zero if it so wishes.

    Thus, the Fed has the well-nigh absolute power to determine the money supply if it so wishes.Traditionally, money and banking textbooks list three forms of Fed control over the reserves, and hence the credit, of the commercial banks: in addition to reserve requirements and open market operations, there is the Fed's "discount" rate, the interest rate charged on its loans to the banks. Always of far more symbolic than substantive importance, this control instrument has become trivial, now that banks almost never borrow from the Fed. Instead, they borrow reserves from each other in the overnight "federal funds" market. Over the years, the thrust of its operations has been consistently inflationary. For not only has the trend of its reserve requirements on the banks been getting ever lower, but the amount of its amassed US government bonds has consistently increased over the years, thereby imparting a continuing inflationary impetus to the economic system. Thus, the Federal Reserve, beginning with zero government bonds, had acquired about $400 million's worth by 1921, and $2.4 billion by 1934. By the end of 1981 the Federal Reserve had amassed no less than $140 billion of US government securities; by the middle of 1992, the total had reached $280 billion. There is no clearer portrayal of the inflationary impetus that the Federal Reserve has consistently given, and continues to give, to our economy.

    Recent Episodes from Interventionism

    The Importance of Hülsmann's Groundbreaking book <em>Abundance, Generosity, and the State</em>

    The Importance of Hülsmann's Groundbreaking book <em>Abundance, Generosity, and the State</em>

    Guido Hülsmann’s Abundance, Generosity, and the State provides readers with an explanation of the nature and causes of gratuitous goods. Hülsmann demonstrates how free markets are infused with both intentional and unintentional gratuity, and how the repressive and permissive interventions of the modern state lead to their destruction.

    This work is desperately needed and represents a remarkable achievement by one of the Austrian School’s leading lights of our time. It is the first successful and systematic treatment of this underappreciated category of human action. Therefore, it is no exaggeration to say that it belongs alongside the great advancements in economic science, and I can say, without hesitation, that it will stand alongside works such as Ludwig von Mises’s Socialism and Murray N. Rothbard’s Power and Market. The knowledge and understanding it provideseconomists and noneconomists alike is indeed a gift.

    Hülsmann breaks new ground in the political economy of gratuitous goods, which fits squarely within the field of praxeology—the theory of all human action. This subcategory of praxeology has been largely ignored, even by those in the Austrian tradition. Meanwhile, the true nature, causes, and consequences of gifts and gratuity have been badly misconstrued by social scientists outside the field of economics. Furthermore, the best and latest attempts to address the topic have all failed to properly evaluate the impact of interventionism upon the economy of gifts. Hülsmann holds up the work of Kenneth Boulding, Catherine Gbedolo, and John Mueller as providing recent and helpful contributions. But despite the best efforts of these scholars, Hülsmann acknowledges that “generosity, gifts, and unearned abundance still stand at the margins of economics.” Thankfully, Abundance, Generosity, and the State sheds new and penetrating light on the subject, and convincingly delivers a Misesian-Rothbardian vision of the nature of generosity and the predations of the state upon it in a robust work of political economy.

    As a master teacher is prone to do, Hülsmann supplies the reader with clear and concise definitions of his terms. Most importantly, he illuminates the essential nature of genuine gifts and donations, which are defined by four key conditions; namely, “the donor intends to benefit some cause or person other than himself, he does not seek any compensation, he freely consents to the transfer, and his donation consists of personal savings.” Violations of each of these conditions produce a different kind of nongift. Donors make grants rather than gifts if they seek their own private benefit, and their transfers have hidden prices if they expect reciprocity. Donors are “fleeced” if they do not actually consent to the donation, and they are merely dispensing “loot” if they do not legitimately own what they are transferring.

    These definitions are systematically carried throughout the book, providing the reader with great clarity. With these distinctions being made, the readers of this periodical may already “smell a rat”—interventionism—that is responsible for driving a great number of individuals to shift their actions from genuine generosity toward these dubious “pseudo-gifts.” This is the explicit purpose of a work in political economy—to provide a demonstration of what human action looks like under conditions of private property protection versus the conditions of life when that principle is violated by the state. The latter situation is rightly described by Hülsmann as a grim picture of a world bereft of genuine gifts and proliferating in genuine miserliness and societal atomization.

    What follows is a summary of Hülsmann’s key findings along with various attempts to illuminate their importance in furthering economic science as well as some of their implications.

    The author identifies his motive early on as an attempt to respond to Pope Benedict XVI’s encyclical Caritas in veritate (2009), which exhorted people of good will to “demonstrate, in thinking and behaviour, . . . that in commercial relationships the principle of gratuitousness and the logic of gift as an expression of fraternity can and must find their place within normal economic activity.” What Hülsmann demonstrates is that in a truly free economy, every market exchange is unintentionally infused with gratuitous goods.

    Moreover, the relationship between growing economies and generosity isn’t just a run-of-the-mill positive correlation between wealth and charity. Rather, he explains, “gratuitous goods and markets are not merely complementary but symbiotic. They feed into each other. In order to understand markets, it is necessary to grasp why and how certain economic goods are transferred without payment.”

    To further this finding, Hülsmann extends F.A. Hayek’s observations regarding the nature of market competition. Hülsmann reminds us that competition is best understood as “a process of piecemeal improvements . . . that improves the terms on which customers are served.” What emerges from this process is an unintentional, or spontaneous, gratuity. Indeed, the process of competition in an unhampered market is the mechanism through which society is freely provided with higher-quality goods at lower prices. The author further observes that “competitive behavior in Hayek’s sense entails additional benefits for other market participants. These benefits are gratuitous because in the cases Hayek envisioned, there is no obligation for individuals or firms to improve anything whatsoever and their customers do not have any right to claim such benefits. Moreover, these benefits are provided spontaneously.”

    These initial observations offer the modern reader intellectual ammunition against the age-old equivalence postulate. This Aristotelian idea still occupies the minds of many who view economic exchange as a zero-sum game. Furthermore, the reader is reminded of the fact that “as soon as they engage in an exchange, they cannot prevent the double gratuitousness that it inexorably generates.” Put another way, voluntary exchange only happens because of the improved state of affairs it yields for both participants. The implication is that in the unhampered market, there is a mutually reinforcing relationship where gratuitousness leads to more exchange and more exchange leads to greater gratuity.

    Another important takeaway from Hülsmann’s treatise is his systematic and clear distinction between genuine gifts and “pseudo-gifts.” He rightly notes that even in a free society there will be those whose hearts are duplicitous and who will extend what appear to be genuine gifts or donations while they are—as the biblical proverbs state—inwardly calculating. Such individuals are secretly counting on reciprocity while appearing to give genuine gifts that require not even the slightest form of repayment. Hülsmann refrains from making harsh judgment on the practice of reciprocity—even recognizing its importance in various cases. Indeed, he aptly observes that “reciprocation does not contradict the sacrificial nature of donations. Quite to the contrary, the particular sort of reciprocity that is found in friendship and in the loving relationships between family members can only be understood before the background of genuine sacrifice.”

    Elsewhere, Hülsmann illustrates the dangers of creating overgeneralizations about the motive of reciprocity by drawing our attention to the excesses of the works of French anthropologist Marcel Mauss and his followers, who largely contended that genuine gifts are, in fact, impossible. Mauss’s works from the early 1920s on primitive societies presented the view that “strictly speaking, there is no such thing as a pure gift at all. . . . In the real world, [Mauss] argued, all social relations are based on reciprocity, but the respective obligations cannot be final and conclusive.” It comes as no great shock, then, that Mauss and his disciples were seeking to “develop a theory of human action in deliberate opposition to economics,” motivated by their unwillingness to accept the “political (pro–free market) implications of economics.” Furthermore, the Maussians “blithely disregarded the benefits springing from property law and contracts.” In his retort, Hülsmann makes the salient observation that “it is only when each person’s obligations are clearly defined, as they tend to be in an economy based on the principle of private property, that it becomes possible to do something beyond and in excess of one’s obligations. Only then do genuine gifts become conceivable. Only then does true gratuitousness become a reality.”

    Of course, while humans always have been and will ever remain less than divine in their motives in all things, this problem of the aforementioned “pseudo-gifts” will also always exist. This is not in question. However, the task of the political economist is to demonstrate the contrast between the economics of donations under private property and under interventionism.

    Hülsmann does just that by building on some of his earlier works to explain the impacts of repressive and permissive interventionism on generosity. The former include taxation, prohibition, and regulation, which all “curb the citizens’ exercise of their ordinary property rights” and have the effect of ruining individual initiative. The latter create special classes of people who are protected and indeed encouraged to engage in “irresponsibility and outright frivolous behavior.”

    As is Hülsmann’s wonderful habit, he points to monetary interventionism as a devastating form of permissive interventionism. By manipulating money and credit, the state creates the conditions for an inflation culture. In it, rationality traps and intervention spirals are to be expected, although they may emerge slowly. Hülsmann rightly observes that as this culture begins to take hold, “the willingness to make donations of time and material goods is compromised. Less time is spent on disinterested activities, whether reading, music, sports, education of one’s children, worship, or spending time with others.”

    Monetary interventionism’s antisocial effects cannot be ignored, especially when people are increasingly stingy in sharing time with their children, faith community, or civic organizations— all things enjoyed for their own sake. These aren’t the only things that Hülsmann reminds us that we’ve lost under this statist invention. Indeed, trust, social cohesion, and friendship itself, the normal gifts of life, have eroded.

    In stark contrast to the pernicious effects of monetary interventionism upon the gift economy is the reality of the unhampered market for money. Professor Hülsmann reminds his readers that in the unhampered market money hoarding has gratuitous effects. Indeed, when this occurs, the price level falls and bystanders who expected to pay more for goods find themselves in an environment of falling prices. It is easy to see that this state of affairs benefits those who do not hoard their money, and the benefits do not stop there! With this newly increased purchasing power, people are more likely to give genuine gifts. We have more beautiful displays of shared wealth because of the gratuitous effects of money hoarding. Hülsmann also reminds us that in a free market, free of monetary interventionism, there will tend to be a higher tendency to save and invest, leading to lower returns on capital investment, and the wealthiest members of society will be more likely to make genuine sacrifices. This form of sacrifice is “a chosen abundance of economic goods that could very well be used for self-gratification. The donor deliberately limits the personal use of his resources.” For all the talk of how capitalism and free markets lead to consumerism, frivolity, waste, avarice, and insatiable greed, Hülsmann provides us with a clear-headed and coherent argument for why just the opposite is true. Indeed, it’s the unhampered market—bolstered by virtuous people who shun the promise of power that comes with interventionism—that enables people to live free and to live generously.

    Unfortunately, the permissive forms of interventionism aren’t the only ones lurking in the shadows of statism. The repressive forms of interventionism are no less destructive to generosity and the economy of gifts. Hülsmann powerfully illustrates how the repression of taxation—just one form of repressive intervention—creates conflicts of interest between “tax payers and tax receivers; the government and the citizens; employers and employees; men and women; blacks and whites; old retirees and young professionals.” This observation highlights the importance of recognizing that it is the tax authority itself that must be abolished in order to end what has truly become a war of all against all. This war is not the result of the natural free state of men, but rather is an imposition that destroys friendship, fellowship, and kinship. When the full effects of taxation have taken hold, the author observes, atomized and disintegrated individuals must “organize themselves in order to obtain power sufficient to loot others or to fend off other looters . . . the characteristic friendship of repressive interventionism is the robber gang.” The inexorable descent of many Western cities into politically generated tribal chaos provides a disquieting glimpse of repressive intervention in action.

    The author makes yet another contribution to the economics of generosity by referring to the works of Hans-Hermann Hoppe and Gordon Tullock. At various points, Hülsmann also reminds us that interventionism—especially under democratic systems—contributes to the creation of an entire political class that is sustained by the “hidden prices” that are imposed on the public. Some of the clearest examples of this reality can be clearly seen in the welfare-warfare state apparatus that provides the pseudo-gift of subsidies in exchange for political loyalty. Of course, the modern state continues to use its propaganda machine to “fleece” the public by encouraging them to give up their private wealth as a way to pay their “fair share” or exhibit true patriotism. All the while, the political class enriches itself and distributes the “loot” among the favored few. Indeed, these activities are clearly harmful to the public and as such are properly regarded as a gratuitous evil. Hülsmann in his notably moderate tone of writing never claims that excessive, unreasonable harm is impossible in the free market. However, he reminds the reader that “gratuitous evil is as a rule intentional and can be a regular and permanent side effect of human action only in exceptional circumstances (under a corrupted legal and political order).” Gratuitous evil comes about more frequently under permissive intervention, and Hülsmann reminds us that this is “not an accident, but the natural tendency of modern democratic systems. By the very logic of modern electoral politics, the welfare state is not likely to help the poor. It is likely to impoverish them further.”

    The findings of Abundance, Generosity, and the State have completely unseated the notion of positive externalities as a market failure and completely dispensed with externality theory as a whole. What have been regarded by mainstream economists as “spillovers,” “positive externalities,” and “network effects,” as so-called market failures, are no failures at all. Indeed, the author clearly demonstrates—as noted earlier—that gratuitous goods have a symbiotic relationship with all market exchanges. Furthermore, gratuitous bads are minimized and gratuitous evils dismissed when permissive and repressive interventions are abolished. It should be abundantly clear to keen observers of the interventionist state that externality theory is one of the most important plausible fallacies that the state uses to entrance the public into acquiescing to its power. By toppling this falsehood and upholding the goodness that emerges from genuinely free exchange, Hülsmann has perhaps made a more generous and benevolent future more possible.

    I would be remiss if I failed to mention that the excellence of this treatise is exceeded by the excellence of the man himself. Guido Hülsmann has embodied intentional generosity to his students, and to all those who serve, study, and speak with the goal that liberty, beauty, virtue, and truth may prevail in our time. It is true that the science of economics has been advanced through this work. Indeed, some of the most noxious and long-lasting economic doctrines that uphold the interventionist state—the equivalence postulate, the zero-sum game fallacy, and externality theory—have been cut down to size by Hülsmann’s mighty pen. Furthermore, the importance of this treatise is readily recognizable: it lies primarily in its clear demonstration that the interventionist state is at the root of Western society’s increasingly loathsome, self-destructive, and stingy culture. The author has given a gift of new economic knowledge, and those fortunate enough to know him have the even greater gift of knowing and experiencing his gratuitous kindness and friendship. Bravo, Professor!

    The Myth of the Failure of Capitalism

    The Myth of the Failure of Capitalism

    [This essay was originally published as "Die Legende von Versagen des Kapitalismus" in Der Internationale Kapitalismus und die Krise, Festschrift für Julius Wolf (1932)This essay was translated from the German by Jane E. Sanders, who wishes to gratefully acknowledge the comments and suggestions of Professor John T. Sanders, Rochester Institute of Technology, and Professor David R. Henderson, University of Rochester, in the preparation of the translation.

     

    The nearly universal opinion expressed these days is that the economic crisis of recent years marks the end of capitalism. Capitalism allegedly has failed, has proven itself incapable of solving economic problems, and so mankind has no alternative, if it is to survive, then to make the transition to a planned economy, to socialism.

    This is hardly a new idea. The socialists have always maintained that economic crises are the inevitable result of the capitalistic method of production and that there is no other means of eliminating economic crises than the transition to socialism. If these assertions are expressed more forcefully these days and evoke greater public response, it is not because the present crisis is greater or longer than its predecessors, but rather primarily because today public opinion is much more strongly influenced by socialist views than it was in previous decades.

    1.

    When there was no economic theory, the belief was that whoever had power and was determined to use it could accomplish anything. In the interest of their spiritual welfare and with a view toward their reward in heaven, rulers were admonished by their priests to exercise moderation in their use of power. Also, it was not a question of what limits the inherent conditions of human life and production set for this power, but rather that they were considered boundless and omnipotent in the sphere of social affairs.

    The foundation of social sciences, the work of a large number of great intellects, of whom David Hume and Adam Smith are most outstanding, has destroyed this conception. One discovered that social power was a spiritual one and not (as was supposed) a material and, in the rough sense of the word, a real one. And there was the recognition of a necessary coherence within market phenomena which power is unable to destroy. There was also a realization that something was operative in social affairs that the powerful could not influence and to which they had to accommodate themselves, just as they had to adjust to the laws of nature. In the history of human thought and science there is no greater discovery.

    If one proceeds from this recognition of the laws of the market, economic theory shows just what kind of situation arises from the interference of force and power in market processes. The isolated intervention cannot reach the end the authorities strive for in enacting it and must result in consequences which are undesirable from the standpoint of the authorities. Even from the point of view of the authorities themselves the intervention is pointless and harmful. Proceeding from this perception, if one wants to arrange market activity according to the conclusions of scientific thought — and we give thought to these matters not only because we are seeking knowledge for its own sake, but also because we want to arrange our actions such that we can reach the goals we aspire to — one then comes unavoidably to a rejection of such interventions as superfluous, unnecessary, and harmful, a notion which characterizes the liberal teaching. It is not that liberalism wants to carry standards of value over into science; it wants to take from science a compass for market actions. Liberalism uses the results of scientific research in order to construct society in such a way that it will be able to realize as effectively as possible the purposes it is intended to realize. The politico-economic parties do not differ on the end result for which they strive but on the means they should employ to achieve their common goal. The liberals are of the opinion that private property in the means of production is the only way to create wealth for everyone, because they consider socialism impractical and because they believe that the system of interventionism (which according to the view of its advocates is between capitalism and socialism) cannot achieve its proponents' goals.

    The liberal view has found bitter opposition. But the opponents of liberalism have not been successful in undermining its basic theory nor the practical application of this theory. They have not sought to defend themselves against the crushing criticism which the liberals have leveled against their plans by logical refutation; instead they have used evasions. The socialists considered themselves removed from this criticism, because Marxism has declared inquiry about the establishment and the efficacy of a socialist commonwealth heretical; they continued to cherish the socialist state of the future as heaven on earth, but refused to engage in a discussion of the details of their plan. The interventionists chose another path. They argued, on insufficient grounds, against the universal validity of economic theory. Not in a position to dispute economic theory logically, they could refer to nothing other than some "moral pathos," of which they spoke in the invitation to the founding meeting of the Vereins für Sozialpolitik [Association for Social Policy] in Eisenach. Against logic they set moralism, against theory emotional prejudice, against argument the reference to the will of the state.

    Economic theory predicted the effects of interventionism and state and municipal socialism exactly as they happened. All the warnings were ignored. For 50 or 60 years the politics of European countries has been anticapitalist and antiliberal. More than 40 years ago Sidney Webb (Lord Passfield) wrote,

    it can now fairly be claimed that the socialist philosophy of to-day is but the conscious and explicit assertion of principles of social organization which have been already in great part unconsciously adopted. The economic history of the century is an almost continuous record of the progress of Socialism.Cf. Webb, Fabian Essays in Socialism.… Ed. by G. Bernard Shaw. (American ed., edited by H.G. Wilshire. New York: The Humboldt Publishing Co., 1891) p. 4.

    That was at the beginning of this development and it was in England where liberalism was able for the longest time to hold off the anticapitalistic economic policies. Since then interventionist policies have made great strides. In general the view today is that we live in an age in which the "hampered economy" reigns — as the forerunner of the blessed socialist collective consciousness to come.

    Now, because indeed that which economic theory predicted has happened, because the fruits of the anticapitalistic economic policies have come to light, a cry is heard from all sides: this is the decline of capitalism, the capitalistic system has failed!

    Liberalism cannot be deemed responsible for any of the institutions which give today's economic policies their character. It was against the nationalization and the bringing under municipal control of projects which now show themselves to be catastrophes for the public sector and a source of filthy corruption; it was against the denial of protection for those willing to work and against placing state power at the disposal of the trade unions, against unemployment compensation, which has made unemployment a permanent and universal phenomenon, against social insurance, which has made those insured into grumblers, malingers, and neurasthenics, against tariffs (and thereby implicitly against cartels), against the limitation of freedom to live, to travel, or study where one likes, against excessive taxation and against inflation, against armaments, against colonial acquisitions, against the oppression of minorities, against imperialism and against war. It put up stubborn resistance against the politics of capital consumption. And liberalism did not create the armed party troops who are just waiting for the convenient opportunity to start a civil war.

    2.

    The line of argument that leads to blaming capitalism for at least some of these things is based on the notion that entrepreneurs and capitalists are no longer liberal but interventionist and statist. The fact is correct, but the conclusions people want to draw from it are wrong-headed. These deductions stem from the entirely untenable Marxist view that entrepreneurs and capitalists protected their special class interests through liberalism during the time when capitalism flourished but now, in the late and declining period of capitalism, protect them through interventionism. This is supposed to be proof that the "hampered economy" of interventionism is the historically necessary economics of the phase of capitalism in which we find ourselves today. But the concept of classical political economy and of liberalism as the ideology (in the Marxist sense of the word) of the bourgeoisie is one of the many distorted techniques of Marxism. If entrepreneurs and capitalists were liberal thinkers around 1800 in England and interventionist, statist, and socialist thinkers around 1930 in Germany, the reason is that entrepreneurs and capitalists were also captivated by the prevailing ideas of the times. In 1800 no less than in 1930 entrepreneurs had special interests which were protected by interventionism and hurt by liberalism.

    Today the great entrepreneurs are often cited as "economic leaders." Capitalistic society knows no "economic leaders." Therein lies the characteristic difference between socialist economies on the one hand and capitalist economies on the other hand: in the latter, the entrepreneurs and the owners of the means of production follow no leadership save that of the market. The custom of citing initiators of great enterprises as economic leaders already gives some indication that these days it is not usually the case that one reaches these positions by economic successes but rather by other means.

    In the interventionist state it is no longer of crucial importance for the success of an enterprise that operations be run in such a way that the needs of the consumer are satisfied in the best and least expensive way; it is much more important that one has "good relations" with the controlling political factions, that the interventions redound to the advantage and not the disadvantage of the enterprise. A few more marks' worth of tariff protection for the output of the enterprise, a few marks less tariff protection for the inputs in the manufacturing process can help the enterprise more than the greatest prudence in the conduct of operations. An enterprise may be well run, but it will go under if it does not know how to protect its interests in the arrangement of tariff rates, in the wage negotiations before arbitration boards, and in governing bodies of cartels. It is much more important to have "connections" than to produce well and cheaply. Consequently the men who reach the top of such enterprises are not those who know how to organize operations and give production a direction which the market situation demands, but rather men who are in good standing both "above" and "below," men who know how to get along with the press and with all political parties, especially with the radicals, such that their dealings cause no offense. This is that class of general directors who deal more with federal dignitaries and party leaders than with those from whom they buy or to whom they sell.

    Because many ventures depend on political favors, those who undertake such ventures must repay the politicians with favors. There has been no big venture in recent years which has not had to expend considerable sums for transactions which from the outset were clearly unprofitable but which, despite expected losses, had to be concluded for political reasons. This is not to mention contributions to non-business concerns — election funds, public welfare institutions, and the like.

    Powers working toward the independence of the directors of the large banks, industrial concerns, and joint-stock companies from the stockholders are asserting themselves more strongly. This politically expedited "tendency for big businesses to socialize themselves," that is, for letting interests other than the regard "for the highest possible yield for the stockholders" determine the management of the ventures, has been greeted by statist writers as a sign that we have already vanquished capitalism.Cf. Keynes, "The End of Laisser-Faire," 1926, see, Essays in Persuasion (New York: W.W. Norton & Co., Inc., 1932) pp. 314–315. In the course of the reform of German stock rights, even legal efforts have already been made to put the interest and well-being of the entrepreneur, namely "his economic, legal, and social self-worth and lasting value and his independence from the changing majority of changing stockholders,"Cf. Passow, Der Strukturwandel der Aktiengesellcschaft im Lichte der Wirtschaftsenquente, (Jena 1939), S.4. above those of the shareholder.

    With the influence of the state behind them and supported by a thoroughly interventionist public opinion, the leaders of big enterprises today feel so strong in relation to the stockholders that they believe they need not take their interests into account. In their conduct of the businesses of society in those countries in which statism has most strongly come to rule — for example in the successor states of the old Austro-Hungarian Empire — they are as unconcerned about profitability as the directors of public utilities. The result is ruin. The theory which has been advanced says that these ventures are too large to be run simply with a view toward profit. This concept is extraordinarily opportune whenever the result of conducting business while fundamentally renouncing profitability is the bankruptcy of the enterprise. It is opportune, because at this moment the same theory demands the intervention of the state for support of enterprises which are too big to be allowed to fail.

    3.

    It is true that socialism and interventionism have not yet succeeded in completely eliminating capitalism. If they had, we Europeans, after centuries of prosperity, would rediscover the meaning of hunger on a massive scale. Capitalism is still prominent enough that new industries are coming into existence, and those already established are improving and expanding their equipment and operations. All the economic advances which have been and will be made stem from the persistent remnant of capitalism in our society. But capitalism is always harassed by the intervention of the government and must pay as taxes a considerable part of its profits in order to defray the inferior productivity of public enterprise.

    The crisis under which the world is presently suffering is the crisis of interventionism and of state and municipal socialism, in short the crisis of anticapitalist policies. Capitalist society is guided by the play of the market mechanism. On that issue there is no difference of opinion. The market prices bring supply and demand into congruence and determine the direction and extent of production. It is from the market that the capitalist economy receives its sense. If the function of the market as regulator of production is always thwarted by economic policies in so far as the latter try to determine prices, wages, and interest rates instead of letting the market determine them, then a crisis will surely develop.

    Bastiat has not failed, but rather Marx and Schmoller.

    Energy Economics

    Energy Economics

    Some principles for understanding environmental issues. Can government steer energy use decisions to improve outcomes?

    Download the slides from this lecture at Mises.org/MU23_PPT_37.

    Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2023.

    Economic Inequality

    Economic Inequality

    Inequality is a good thing in the free market. Economic equality is a disastrous government policy that leads to economic ruin for all—including the poor and workers.

    Download the slides from this lecture at Mises.org/MU23_PPT_36.

    Recorded at the Mises Institute in Auburn, Alabama, on 28 July 2023.