Thursday, January 31, 2013

#19.1 The Austrian School, agreements and divergences – Part 1

This series is going to be a gloss on a glyph of the Austrian School of Economics. The purpose is to make clear the agreements and disagreements between (the or an) VEN and ideas proposed and discussed by the Austrian economists. The glyph is the standard encyclopedia article presumed to be among the most official that appeared on the official von Mises Institute website. Words from the article will be in blue, mine in black as usual. I'm also including, at the end, all the notes that appeared in the original for those who would like to do further research.

The Austrian School of Economics is a school of economic thought that derives its name from its Austrian founders and early supporters, including Carl Menger, Eugen von Böhm-Bawerk and Ludwig von Mises. Other significant Austrian writers and economists include Murray Rothbard, Nobel Laureate Friedrich Hayek and journalist Henry Hazlitt. Current research is produced by, among many others, scholars from the Ludwig von Mises Institute, and "Austrian" economists can now come from any part of the world. They are identified with the School through their shared views on the nature of economic science and its proper methodology.

The Nobel Laureate reference is duly noted and discarded, as the entire integrity of the Nobel prize and its claims to authority or infallibility are disclaimed: the Nobel prizes have always been nothing but to showcase those whose efforts are blessed by the elites and nothing more. We aren't impressed and we don't care what rewards anyone has won, all we care about is the truth. As was the case with Ayn Rand, we aren't going to be following anyone's particular lead if it does not prove accurate or truthful. We will cherry pick as we go along.

The [Austrian] school emphasizes the spontaneous organizing power of the price mechanism and holds that the complexity of subjective human choices makes mathematical modeling of the evolving market practically impossible and therefore its scholars eschew what they consider "naïve" and pointless mathematical modeling of the economy, considering much of mainstream economics a form of economic charlatanism.[1]

We agree, so much so that several examples could well prove the point, but again we will need another post to discuss this. E. C. Riegel recognized the spontaneous organizing power of the price mechanism as “price relativity.” However, Riegel maintained that price relativity had nothing to do with the stability of the money, his “value unit” the actual yardstick we are at present forbidden by trademark to use his name for [Thanks, Laurence!], certainly would have maintained that price wobbles should not be affected by known causes of inflation.

Its [the spontaneous organizing power of the price mechanism] proponents tend to advocate the strong protection of private property rights and the strict enforcement of voluntary contractual agreements between economic agents, 

We will also. They will all be called credit contracts and their terms and types will also be described in a future post.

but otherwise advocate a laissez-faire approach to the economy and hold that the smallest imposition of coercive FORCE (especially government-imposed FORCE) on commercial transactions is the most effective way to secure [sic] [impair] long-run economic stability and well-being.

We agree with this too. This is actually the way it reads on the website. I have corrected it here. Someone at the von Mises Institute should really get around to changing this as it leaves the wrong impression.

In particular, they [the Austrian school economists] voice serious concerns about the distorting and damaging effects of government involvement in commerce, arguing that few government regulations in this area are necessary or desirable and often trigger a "ratchet effect" as problems associated with existing regulations are often blamed on the free market, thereby justifying further damaging, coercive incursions into the market.

We recognize the phenomenon and have seen the cause, which the Austrian school fails to notice; the costs of regulation are meant to set up an artificial barrier to competition from below the level of the huge multinational limited liability corporations, supported by the too big to fail banks. The (or an) VEN would never allow the so called “public” corporation as a member, because we do not recognize or accept absentee ownership of any business as legitimate. And limited liability is likewise discarded as recognized as nothing more than a desire to get away with any damages the enterprise might cause. Neither of these will be allowed in (the or an) VEN to any of its members.

They are particularly critical of long-standing governmental incursions into the area of private money production, advocating instead the immediate abolition of all coercive legal tender laws and the return to full reserve - or free - banking, where the financial system is decentralized and not dominated or controlled by coercive monopoly government or a monopoly central bank.

Breaking it down: by long-standing governmental incursions into the area of private money production this could not equate better to E. C. Riegel's understanding of watering down legitimate money with illegitimate money created as we all know by government borrowing from a central bank at interest and then becoming the largest buyer in an economy purchasing what seems necessary to itself with secondary reference to the needs of the people. This practice will not happen in (the or an) VEN. All the money will be legitimate [despite whatever certain people like Laurence Gilbert might suppose to the contrary.].

We also very clearly advocate the immediate abolition of all coercive legal tender laws. If parties to an VEN accepted credit contract involving the sale of any major capital item, a car, house, boat, farm, etc. they will all assume that all such legal tender laws are unlawful and not binding on them. In fact such language would be included in every legitimate credit contract to pass through an IE.

We would accept only
full reserve financing. The word banking itself is misleading, since one usually imagines one's money in a bank is always there, when under fractional reserve banking, it might not always be there. The control sites of (the or an) VEN will be known as exchanges, not banks. Each member will have an account and the money they have, also called exchange notes rather than bank notes, will always be there, there will not be any need to wait to make a simple transaction, nor will there be any need whatever for deposit insurance. The money in any account will always be there and belong to the member, not the exchange.

The VEN financial system will be decentralized and not dominated or controlled by coercive monopoly government or a monopoly central bank.


While the Austrian School of Economics has connections as far back as the 15th century, it began with notable 19th century economists of Austrian origin. It is recognized to have emerged after the publication in 1871 of a trilogy of works (by Jevons, Walras, and Menger) which introduced the idea of the subjective theory of value and began what has been called “the marginal revolution” in economic thought.[2]

Other early theorists of the Austrian School were Eugen von Böhm-Bawerk, Ludwig von Mises, Friedrich Hayek, and Friedrich von Wieser. Austrian economists no longer need be from Austria, and the term describes a particular school of economic thought rather than the nationality of its practitioners.

Pre-Austrian Economists

With noted contributions of earlier thinkers, like Nicole Oresme, the Austrian school traces its roots to the followers of St. Thomas Aquinas, writing and teaching at the University of Salamanca in Spain.

These Late scholastics established the first modern economic theories and argued, in current terms, for free trade and property rights. Over the course of several generations, they discovered and explained the laws of supply and demand, the cause of inflation, the operation of foreign exchange rates, and the subjective nature of economic value. They were advocates of property rights and the freedom to contract and trade.

We too are advocates of property rights and the freedom to contract and trade. We again wish to point out here that the so called legal tender laws stand directly against the freedom to contract and trade and are thus unlawful, only applicable under cover of law.

"Austrians share the scholastic belief that there is no such thing as an economic science dealing with autonomous variables. Economic problems are aspects of larger social phenomena; and it is most expedient to deal with them as such, rather than to analyze them in some twisted separation."[3]

We too would be relatively unimpressed by such mathematical modelling as proving nothing concrete about how real economies would behave.

The first general treatise on economics, Essay on the Nature of Commerce, was written in 1730 by Richard Cantillon, a man schooled in the scholastic tradition. Born in Ireland, he emigrated to France. He saw economics as an independent area of investigation, and explained the formation of prices using the "thought experiment." He understood the market as an entrepreneurial process, and held to an Austrian theory of money creation: that it enters the economy in a step-by-step fashion, disrupting prices along the way.

This is a simple theoretical idea that starts from observed phenomena, the prices of everyday items relative to how much money one has committed to buying, and extends the ideas in both directions; back to the issuance of the first legitimate money and forward into the future of prices and their relative stability in a properly functioning market.

Cantillon was followed by Anne Robert Jacques Turgot, the pro-market French aristocrat and finance minister under the ancien regime, one of the Physiocrats. His economic writings were few but profound. His paper "Value and Money" spelled out the origins of money, and the nature of economic choice: that it reflects the subjective rankings of an individual's preferences. Turgot solved the famous diamond-water paradox that baffled later classical economists, articulated the law of diminishing returns, and criticized usury laws (a sticking point with the Late Scholastics). He favored a classical liberal approach to economic policy, recommending a repeal of all special privileges granted to government-connected industries.

The diamond-water paradox is the idea that water being plentiful costs less than diamonds, being rare, therefore costs cannot be related to value since water is infinitely more valuable than diamonds. The paradox is supposedly solved by defining marginal and total utility and ranking them. This invites more probably pointless mathematical modelling. But there is another reason why we would approach this subject from a different perspective; (the or an) VEN seeks to discourage as far as possible, opportunities to speculate on future prices. We consider this as market manipulation by those who either have more at stake than anyone else in the market due to scale or have no direct interest in the market but to make money on money without providing value. We wont be having it.

Turgot was the intellectual father of a long line of great French economists of the eighteenth and nineteenth century, most prominently Jean-Baptiste Say and Claude Frédéric Bastiat. Say was the first economist to think deeply about economic method. He realized that economics is not about the amassing of data, but rather about the verbal elucidation of universal facts (for example, wants are unlimited, means are scarce) and their logical implications.

We will all be more concerned with the verbal elucidation of universal facts as participation in a truly free economy develops. But by the way, wants are unlimited, means are scarce tends to support the perception that everything is scarce and scarcity gives something its value. This only can apply at any given moment in time, not over the long run, someone's lifetime, etc. Certainly at any given moment in time, this statement tends to be true, but of what relevance is it to anyone in a local area at a particular time choosing between a dozen eggs or a hunk of cheese with the limited money allocated for spending? The world of everything that can or would be bought or sold is a world of information that simply cannot be gathered together for any useful purpose. The internet comes about as close to this as it is possible to get and yet maybe the best deals for similar items are in local free newspapers. Saying something obvious like wants are unlimited, means are scarce does not necessarily mean that it has any relevance to normal day to day economic activity.

Say discovered the productivity theory of resource pricing, the role of capital in the division of labour, and "Say's Law": there can never be sustained "overproduction" or "underconsumption" on the free market if prices are allowed to adjust.

Yes, we agree.

He [Jean-Baptiste Say] was a defender of laissez-faire and the industrial revolution, as was Bastiat. As a free-market journalist, Bastiat also argued that non-material services are subject to the same economic laws as material goods.

We also agree with all of this.

In one of his many economic allegories, Bastiat spelled out the "broken-window fallacy" later popularized by Henry Hazlitt. 

Here's a link for this. 

Despite the theoretical sophistication of this developing pre-Austrian tradition, the British school of the late eighteenth and early nineteenth centuries won the day, mostly for political reasons. This British tradition (based on the objective-cost and labour-productivity theory of value) ultimately led to the rise of the Marxist doctrine of capitalist exploitation. 

We agree with this analysis too. The political reasons all involve power, empire, hegemony, etc. and have nothing to do with the needs of the indigent or the aspirations of the middle classes. I remind you all that the level of civilization in any country, in any region of the world, is directly proportional with the success of the middle classes and nobody else. Where the middle classes are weak or few, the level of civilization falls accordingly. As the numbers of the middle class grow, civilization improves. The rich, those above the level of the John Galts, are usually destructive of civilization and the poor are ... poor. We have identified (in the #18 John Galt series) a difference between the “pillar of the community,” the John Galt, who may be wealthy and the plutocrats of the gloabalist elites and their minions. We offer a solution for the poor. We have a solution for the pillars of their communities too. We have a solution for the middle classes. The plutocrats both in and out of government, are on their own.  

The First Austrians

The dominant British tradition received its first serious challenge in many years when Carl Menger's Principles of Economics was published in 1871. Menger, the founder of the Austrian School proper, resurrected the Scholastic-French approach to economics, and put it on firmer ground.

Together with the contemporaneous writings of Leon Walras and Stanley Jevons, Menger spelled out the subjective basis of economic value, and fully explained, for the first time, the theory of marginal utility (the greater the number of units of a good that an individual possesses, the less he will value any given unit).

... solving the diamond-water paradox.

In addition, Menger showed how money originates in a free market when the most marketable commodity is desired, not for consumption, but for use in trading for other goods.

Here is where we diverge from the Austrians. Do you see where this is going? What would become the most MARKETABLE commodity desired emphasis mine, not for consumption, but for use in trading for other goods? It could only be precious metals; gold and silver. We therefore say of these people directly, all the Austrian economists, that they have not understood the basic demonstrable and obvious nature and purpose of money AT ALL. Money exists to split barter and it is backed ONLY by what it buys. It does not require ANY intrinsic value to fulfil this function, period! Money must be a yardstick of value for everything else and be independent of any value in and of itself, otherwise it ceases to function as a reliable yardstick of value because it's value is determined ... by bullion brokers in London or New York.

You cannot get around this. By accepting ANY commodity as a vehicle for trade (money to close split barter trades), one accepts that there will be fluctuations created by those who have enough of the commodity to rig the market. The prices for precious metals are set in the major national currencies in London or New York (they used to be set in Babylon and Jerusalem).

We said in an earlier post that there was no reason why a farmer selling a dozen eggs need concern himself with the price of an oz. of gold or silver and we meant it. There is only one suitable purpose for the precious metals at this late date in the history of economic systems; as a means of exchange between the emerging Value Unit world and the crumbling worlds of the major currencies.

If you were buying an oz. of gold with Value Units, its price would be affected by two things, 1) the price of gold at the inception of the Value Unit, which we said was 1,000 Value Units to the oz. and 2) whatever the manipulators of gold or silver prices had been doing since then and might be doing in the future (we said they needed to try and force the metals prices down, because if not, their paper system would look less attractive to investors; it will anyway).

At the date this is written (30 January, 2013), an oz. of gold is cheaper in Value Units than at inception. How much cheaper? Around 3% cheaper; 971.82 Value Units instead of 1,000. You'd be interested to know that since the proposed inception of the Value Unit (on 2 November, 2011), this value has changed less than 5% and has usually remained within 3%, and usually in favour of the Value Unit; from a dollar perspective it takes more dollars to buy Value Units than at inception. If the Value Unit holds its value this well when assessing gold and silver, it can certainly be counted upon as sturdy enough to measure the value of a dozen eggs or anything else for that matter.

Menger's book was a pillar of the "marginalist revolution" in the history of economic science. When Mises said it "made an economist" out of him, he was not only referring to Menger's theory of money and prices, but also his approach to the discipline itself. Like his predecessors in the tradition, Menger was a classical liberal and methodological individualist, viewing economics as the science of individual choice. His Investigations, which came out twelve years later, battled the German Historical School, which rejected theory and saw economics as the accumulation of data in service of the state.  

We believe that the German Historical School, which rejected theory and saw economics as the accumulation of data in service of the state is for the most part what academic economics has become and still is. 

They took great exception to his defence of "theory" and gave the work of Menger and his followers the derogatory name "Austrian school" because of their faculty positions at the University of Vienna. The term stuck.[4]

As professor of economics at the University of Vienna, and then tutor to the young but ill-fated Crown Prince Rudolf of the House of Habsburg, Menger restored economics as the science of human action based on deductive logic, and prepared the way for later theorists to counter the influence of socialist thought. Indeed, his student Friederich von Wieser strongly influenced Friedrich von Hayek's later writings. Menger's work remains an excellent introduction to the economic way of thinking.

Menger's admirer and follower at the University of Innsbruck, Eugen von Böhm-Bawerk, took Menger's exposition, reformulated it, and applied it to a host of new problems involving value, price, capital, and interest.

Yes, interest. Anyone who views prices as having anything to do with interest, obviously accepts and believes in the present monetary system including usury. Identity is A = A. If one takes out a loan for A and must pay back A+X%(A), clearly A is no longer A. The extra was not created, therefore it must be taken from someone else. (Some refer to this as the eleventh marble.) No matter how much of this debt based money is issued, the end results are just the same, eventually the debt service starves the legitimate economy in a monetary environment where actual units of money are kept artificially scarce because there are fewer units loaned out then are demanded back. We do not quibble about any laws restricting interest rates, we view ANY interest on loans as usury.

Yes, there are different prices for the same thing on the same day at a particular place and there are reasons for this that will be discussed, but E. C. Riegel contended that this simple mathematical fact (the eleventh marble that was not created that must be repaid) was the reason that any system built on usury would ultimately fail, every time, and history has shown that it has many times before this and will likely fail once again. In fact, there is no reason why continuing any monetary system allowing usury wouldn't assuredly cause the collapses to become more frequent.

There IS a workable solution that will be covered in a future post too. So, unlike the Austrians, who you will see view usury laws as mistaken because they interfere with a right to set terms of contracts based on risk, the E. C. Riegel camp would see that differences in price reflect the buyer's ability to pay with available money. The Austrians have a fancy name for this. They call it “time preference.”

His History and Critique of Interest Theories, appearing in 1884, is a sweeping account of fallacies in the history of thought and a firm defense of the idea that the interest rate is not an artificial construct but an inherent part of the market. It reflects the universal fact of "time preference," the tendency of people to prefer satisfaction of wants sooner rather than later (a theory later expanded and defended by Frank Fetter[5]).

Böhm-Bawerk's Positive Theory of Capital demonstrated that the normal rate of business profit is the interest rate. Capitalists save money, pay laborers, and wait until the final product is sold to receive profit.

This concept, that the normal rate of business profit is the interest rate can be expressed differently in terms that remain true to A = A while dismissing the concept of interest entirely. Price differentials are related to time of course, but they are principally related to money available to the buyer at the time of sale. Elements of risk as well as savings rates are influenced by choices involving buying on credit vs. saving for later purchases. 

In addition, he [Böhm-Bawerk] demonstrated that capital is not homogeneous but an intricate and diverse structure that has a time dimension. A growing economy is not just a consequence of increased capital investment, but also of longer and longer processes of production.

Böhm-Bawerk engaged in a prolonged battle with the Marxists over the exploitation theory of capital, and refuted the socialist doctrine of capital and wages long before the communists came to power in Russia. Böhm-Bawerk also conducted a seminar that would later become the model for Mises's own Vienna seminar.

We may look into this.

Böhm-Bawerk favored policies that deferred to the ever-present reality of economic law. He regarded interventionism as an attack on market economic forces that cannot succeed in the long run. 

If the goals are price stability, or full employment, interventionism by FORCE does not work, produces unforeseen consequences, etc. But the entire cavalcade of problems including governments being principle buyers in most societies, the debt basis of money everywhere, fractional reserve banking, central banking, all of it, make prospects for anything better quite dismal.

In the last years of the Habsburg monarchy, he [Böhm-Bawerk] three times served as finance minister, fighting for balanced budgets, sound money and the gold standard, free trade, and the repeal of export subsidies and other monopoly privileges.

Balanced budgets are possible only when governments are not allowed to go into debt to pay for their excesses and must face the electorate for taxes directly.  

Sound money is a loaded concept refuted by E. C. Riegel and others. The only backing money has is what it buys, period, end of story. Any other proposition is a LIE. The gold standard as we have also indicated only benefits those who control the gold and the same goes for silver. We do not plan on making use of precious metals for anything beyond getting people with capital out of the crumbling debt based currencies and into Value Units.

We are probably the only people on earth who have a genuine idea about how to foster genuine free trade, and we'd certainly support repeal of export subsidies and other monopoly privileges. 

Mises and Hayek

It was Böhm-Bawerk's research and writing that solidified the status of the Austrian School as a unified way of looking at economic problems, and set the stage for the School to make huge inroads in the English-speaking world. But one area where Böhm-Bawerk had not elaborated on the analysis of Menger was money, the institutional intersection of the "micro" and "macro" approach. The young Ludwig von Mises[6], economic adviser to the Austrian Chamber of Commerce, took on the challenge.

The result of Mises's research was The Theory of Money and Credit, published in 1912. He spelled out how the theory of marginal utility applies to money, and laid out his "regression theorem," showing that money not only originates in the market, but must always do so.

Let's read that again; money not only originates in the market, but must always do so. This is almost exactly what E. C. Riegel would say. He expresses it as being issued by those who need to trade with others with the understanding that they will accept the same money in payment for their goods or services.

Drawing on the British Currency School, Knut Wicksell's theory of interest rates, and Böhm-Bawerk's theory of the structure of production, Mises presented the broad outline of the Austrian theory of the business cycle. A year later, Mises was appointed to the faculty of the University of Vienna, and Böhm-Bawerk's seminar spent a full two semesters debating Mises's book.

Mises's career was interrupted for four years by World War I. He spent three of those years as an artillery officer, and one as a staff officer in economic intelligence. 1919, at war's end, he published Nation, State, and Economy, arguing on behalf of the economic and cultural freedoms of minorities in the now-shattered [Austria-Hungarian] empire, and spelling out a theory of the economics of war. Meanwhile, Mises's monetary theory received attention in the U.S. through the work of Benjamin M. Anderson, Jr.[7], an economist at Chase National Bank. (Mises's book was panned by John Maynard Keynes, who later admitted he could not read German.[citation needed]) 

Which probably means Keynes didn't even read it.

In the political chaos after the war, the main theoretician of the now-socialist Austrian government was Marxist Otto Bauer. Knowing Bauer from the Böhm-Bawerk seminar, Mises explained economics to him night after night, eventually convincing him to back away from Bolshevik-style policies.[citation needed] The Austrian socialists never forgave Mises for this, waging war against him in academic politics and successfully preventing him from getting a paid professorship at the university.

Socialism was the brain child of certain people who had in mind exactly what Rand claimed for them; a successor to the failed spiritual mysticism of the past, which demanded of its adherents the same kind and degree of fanatical belief. This is also a fundamental trait of ideologists. They begin with a mystical idealized view of the world -an idealism- and then there are just two camps of people; those who support it and those that oppose the belief. Socialism was also being propagated and paid for by the banking elites from behind the scenes and many of the journalists involved in selling socialism to the masses were their agents. This is all by this time very well documented.

Undeterred, Mises turned to the problem of socialism itself, writing a blockbuster essay in 1921, which he turned into the book Socialism over the next two years. Socialism permits no private property or exchange in capital goods, and thus no way for resources to find their most highly valued use. Socialism, Mises predicted, would result in utter chaos and the end of civilization.

It did in certain places end civilization, killed a lot of people too, but the key words here concerning socialism are that it permits no private property or exchange in capital goods thus making these economies inherently stagnant or non functioning. As we will see in a future post, the key to it all concerns finance, as without finance, much that falls under private property and capital goods could not trade.

There are doubtless some out there who right now are going to jump to the conclusion that interest rates are necessary. We can show how differences in price for the same thing on the same day are really reflected differently based solely on how much money one has to make the purchase. To the Austrians, “time preference” is the buyers and determines how much he is willing to pay over what period of time to secure private property or capital goods. To be continued .

David Burton

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