August 5, 2002

August 5, 2002 | Lecture on Political Thought

Ludwig von Mises as Policy Analyst: Monetary Reform, Fiscal Policy, and Foreign Exchange Controls

Ludwig von Mises was one of the outstanding economists of the 20th century. Born in Lemberg, Austria-Hungary, in September 1881, he graduated from the University of Vienna with a doctoral degree in jurisprudence, with an emphasis on economics, in 1906. Shortly before the First World War he published his first important book, The Theory of Money and Credit, in which he developed a version of the cash balance approach to explain the demand for money. He also formulated a theory of the business cycle that integrated Eugen von Boehm-Bawerk's "Austrian" theory of capital with Knut Wicksell's theory of the natural rate of interest. He explained how monetary and credit expansion had the potential to distort the market's equilibrium rate of interest, causing an imbalance between savings and investment, which could generate an initial inflationary economic expansion that would then be followed by corrective economic recession or depression.

But Mises' most famous contribution to economic theory during his lifetime was his critique of socialism. In a 1920 article entitled "Economic Calculation in the Socialist Commonwealth," and in a book on Socialism that he published two years later in 1922, Ludwig von Mises argued that comprehensive socialist central planning would result in economic inefficiency and waste rather than the bountiful horn of plenty promised by the advocates of various forms of collectivism. The abolition of private property, market competition, and market-generated money-prices for the society's scarce factors of production would eliminate all capability for any rational economic calculation of the opportunity costs concerning the application and use of resources, labor, and capital. Socialism totally triumphant and implemented would merely lead to Planned Chaos, as he expressed it in the title of one of his later works.

Mises complemented his argument against socialism with a companion critique of various systems of intervention and regulation of the market economy. The market process reflected an intricate and interdependent network of supplies and demands for multitudes of goods and services, and the resources, labor, and capital out of which those goods and services were produced. The market structure of relative prices and factor costs integrated the actions and activities of each and every participant in the social system of division of labor. The plans of the entrepreneurs represented the directing hands that guided the allocation of resources, labor, and capital into channels of production most likely to satisfy the wants of the consuming public, as the entrepreneurs of the marketplace pursued possible profits and attempted to avoid potential losses.

Mises' case against interventionism and regulation was that such injections of political power in the market threatened to distort and falsify the information that market-generated prices were supposed to supply to the entrepreneurs in assisting their decisions about what to produce, how, and where. Price controls also created imbalances between supplies and demands, disrupting the ability of the market to successfully match consumption with production. Government regulations and restrictions on the forms and techniques of production hindered the entrepreneurs' abilities and incentives to be constantly improving the methods for satisfying the demands of the consuming public.

The capstone of Ludwig von Mises' writings in the first half of the 20th century was the publication of his 1949 treatise on economics, Human Action. In this work the monetary theorist, the critic of socialism and interventionism, the defender of the Classical Liberal free-market order, widened his horizon into that of a social philosopher and political economist writing on a vast canvas. Between the covers of Human Action, Mises formulated a theory of human nature and the origins and foundations of human knowledge, while at the same time criticizing the Historicist, Positivist, and Marxist trends of his time. He restated in extended detail the nature and workings of the market process and the social institutions essential for its functioning, the role of the entrepreneur, the characteristics of capital and the basis of interest, the dynamic qualities of money's influence on market activity and a refined presentation of his "Austrian" theory of the business cycle, and a revised reformulation of his critiques of socialism, interventionism, and the welfare state. Friedrich A. Hayek referred to the book's "intellectual spaciousness," in which Mises appeared more "of an eighteenth century philosopher than...a modern specialist."

Mises as Policy Analyst with the Austrian Chamber of Commerce
But for most of the years from the time he graduated from the University of Vienna in 1906 until the autumn of 1934, when he accepted a full-time academic position at the Graduate Institute of International Studies in Geneva, Switzerland, Mises' daily intellectual focus and activity was far removed from the more abstract and rarefied concerns of pure economic theory or the broader issues involved in the evaluation of alternative economic systems. Full-time academic positions were extremely limited in number in Austria, especially after the First World War when his native land was much smaller and poorer than it had been during the twilight years of the old Austro-Hungarian Empire that came to an end in 1918. In 1913, the University of Vienna faculty approved Mises as a privatdozent, an unsalaried instructor permitted to teach one course a term at the University. When he returned from active service in the Austrian Army in World War I, he was promoted to "Professor Extraordinary," but still in an unsalaried category.

Mises made his living during these years as an economic policy analyst. In 1909, the Vienna Chamber of Commerce, Crafts and Industry had hired him as an assistant for the drafting of documents, and then promoted him to a deputy secretary of the Chamber the following year. When he returned to his position at the Chamber of Commerce at the end of the war, he was appointed a "first secretary" of the organization. From 1918 until he left Vienna in 1934 for the teaching position in Geneva, Mises was in charge of the Chamber's finance department, which was responsible for banking and insurance questions, currency problems, foreign exchange regulations, and public finance and taxation. He was also frequently consulted on matters pertaining to civil, administrative, and constitutional law.

At the war's end, he was also put in charge of the section of the Austrian Reparations Commission for the League of Nations concerned with the settlement of outstanding pre-war debts. And in 1922 and 1923, when the League of Nations stepped in to restructure the country's monetary and banking system following the end of the Austrian Great Inflation, Mises had a senior responsibility for the writing of the charter and by-laws of the reorganized Austrian National Bank.

Austria Between the Two World Wars
However briefly, the situation in Austria in the years after the war has to be understood to appreciate the context in which Mises' policy analysis was done. The end of the First World War had reduced Austria to a small fraction of its size under the old Hapsburg Monarchy, with a population of only about six million; of these, two million lived in the capital of Vienna. The disintegration of the old Empire had not only resulted in the creation of new and reshaped countries on the map of Central Europe, it also rapidly generated a strong spirit of both political and economic nationalism. The new states of Czechoslovakia, Hungary, and Yugoslavia imposed high tariff and other trade barriers against the new Austrian Republic.

Within the new Austria a political battle broke out that continued for most of the 1920s and 1930s between the Social Democrats, who controlled the municipal government in Vienna, and the Christian Socialists, who dominated the national legislature due to their strong following in the rural provinces of the country. Austria's capital soon became internationally known as "Red Vienna," where the Social Democrats pursued their vision of the socialist society of the future. The Christian Socialists fostered policies at the national level of intervention, protectionism, and fiscal redistribution to benefit the various interest groups in the agricultural parts of the country. In addition, both political parties had their own private armies that were heavily armed and equipped, and occasionally fought actual battles in the countryside. These private armies were significantly larger than the official 30,000-man Austrian Army permitted under the peace treaty that ended the war between Austria and the Allied Powers in 1919.

In addition, the high inflation of the war years in Austria-Hungary was continued in the post-war period and threatened by 1922 to become as catastrophic as the hyperinflation in neighboring Germany. Thousands were starving on the streets of Vienna. In the provinces, the local governments imposed trade barriers and visa requirements between their jurisdictions within the country to hoard food and other supplies for their own local citizens. Food, housing, and health care and unemployment subsidies, especially in the cities, generated huge budget deficits that were covered by the issuance of paper money. Finally, in 1922 the League of Nations stepped in for financial guarantees and an austerity program that required an end to the food subsidies especially, a reorganization of the Austrian Central Bank to end the inflation, and the firing of over 80,000 civil servants to reduce the fiscal burden on the government.

By 1923, the inflation had been brought to an end and in 1924 Austria officially went on a gold-exchange standard, with legal gold redemption in 1925. But once the direct supervision of the League was terminated, taxing, spending, and the budget deficits all once again increased throughout the rest of the 1920s. The deficits were mostly covered by foreign loans. The Great Depression finally severely hit Austria in 1931 following a major banking crisis. To avoid the loss of gold and hard currency reserves, the Austrian government imposed foreign exchange controls that greatly restricted trade, with the government allocating scarce foreign exchange according to pressures of various interest groups.

Finally, the economic crisis turned into a political crisis in 1934, when a four-day civil war broke out in Vienna, with the Social Democrats taking up arms against the Christian Democratic government. The socialists were routed and the Social Democratic Party banned. A corporativist-style fascist dictatorship was declared by the Christian Democrats, which remained in effect until March 1938 when Hitler ordered the occupation and Nazi annexation of his native Austria.

This was the political and ideological setting in which Ludwig von Mises went about the task, in his capacity as a senior economic policy analyst for the Vienna Chamber of Commerce, of attempting hold back the tide of socialism, nationalism, and interventionism in his native Austria in the years between the two World Wars. His efforts during this time can broadly be summarized under three general headings: First, monetary policy and institutional reforms under conditions of political change and inflation. Second, fiscal policy for non-inflationary economic growth. And, third, foreign exchange policy under conditions of an international debt crisis.

Hyperinflation and Monetary Reform
The political disintegration of the Austro-Hungarian Empire into new "successor states," as they were called, meant that the Empire's single monetary regime was ending as well. Czechoslovakia, Hungary, and Yugoslavia announced their intentions to establish their own national currencies. Mises prepared a detailed memorandum in April 1919 in which he proposed that all those holding bank notes issued by the Austro-Hungarian Bank, both those living in various parts of former Empire and foreigners, would be permitted to convert their notes into the currency of the successor state of their own choosing. In fact, Czechoslovakia and Yugoslavia arbitrarily declared dates in the early spring of 1919 when all Austro-Hungarian Bank notes on their territory would be stamped as legal tender within their respective jurisdictions. The stamped notes would be convertible into the new currencies they were to issue, with all unstamped Austro-Hungarian Bank notes after that period to be considered worthless on their territories. And the new Austrian government followed the same procedure in their footsteps

As for the apportionment of the Empire's debt among the successor states, Mises worked out a plan that was accepted by the League of Nations Reparations Commission and implemented by the successor states. All pre-war Austro-Hungarian government debt was divided into two categories, secured and unsecured. Secured debts, such as debts against which the property had been secured for the loan, were charged to the country in whose territory the property was now located. If the property was located across more than one of the successor states, each country was responsible for the portion of the debt corresponding to the amount of the secured property under its jurisdiction. Unsecured debt was distributed among the successor states on the basis of the fraction of the tax revenue its territory had supplied to the Austro-Hungarian monarchy.

But of even greater concern in 1919 was the worsening inflation in the new Austria. To finance food subsidies for the population in Vienna and to cover the rising costs of the welfare programs both the Social Democrats and the Christian Democrats agreed on implementing, the Austrian government had speeded up the printing presses. In the first half of 1919, the Austrian money supply increased from 831.6 million crowns in March to 8.3 billion crowns in July. The note issue reached 12 billion crowns by December. When the inflation was finally ended in 1923 the money supply had increased to 7.1 trillion crowns. In January 1919, one dollar could purchase 16.1 crowns on the Vienna foreign exchange market. By 1923, one dollar could buy 70,800 crowns.

In a paper marked "confidential" that Mises prepared in May 1919 for Viennese bankers and businessmen associated with the Chamber of Commerce, he suggested that they needed to have a contingency plan in case the worst were to happen and the currency were to rapidly depreciate to a value of zero. He emphasized that the monetary situation might very well never reach such a disastrous state, but if it did, such a complete collapse of the currency would threaten social chaos, especially in Vienna, as food became unobtainable and desperate people rioted and looted property in an attempt to survive. The private sector--the bankers and businessmen--would have to step in to save society. Said Mises, "It is up to the citizens to try to do ourselves what the government is failing to do for us. All we can hope from the government is that it not stymie the endeavors of its private citizens."

A medium of exchange would have to be available that the people knew and trusted and which they would accept as payment for salaries and in exchange for goods and services. He proposed that private businessmen and bankers would use a part of their revenues from exports and sales of assets to accumulate small denomination units of Swiss money for use as a temporary, emergency medium of exchange. Mises estimated that approximately 30 million Swiss francs would be needed. He calculated that there were about 1.5 million employees in Austria who were not self-employed or not working in the agricultural or timber sectors of the economy. Assuming that the average monthly income was 1,500 crowns, the total monthly income to be covered would be 2,250 million crowns. At the going exchange rate, that came to 22.5 million Swiss francs. Assuming an additional 150 million crowns for government subsistence, unemployment, and pension payments, that added another 1.5 million Swiss francs to the total. And to meet any unexpected events, Mises suggested adding an extra 25 percent to that amount for a total of 30 million Swiss francs.

He emphasized that if such an extreme emergency were to arise this fund of Swiss currency would only be needed until normal export sales and capital transfers supplied the required amounts of gold and foreign currencies for the population to use as the more permanent substitute monies in a post-inflationary Austria. If the government did not interfere, he said, "free market forces will automatically come into play that will supply the economy with the exact amount of money it needs." In essence, Mises was suggesting in 1919 what Friedrich Hayek proposed over fifty years later in the 1970s, that in place of and as an escape from their own government's monetary system and inflationary policies, people should be free to have a "choice in currency" of either gold or the use of any variety of alternative national currencies.

But Mises was also realistic enough to know that the likelihood of a denationalized monetary system was almost zero. When the inflation finally ended, the question would be what kind of monetary regime Austria would adopt. Many in Austria, in the years immediately after the First World War, did not believe that their country could survive politically and economically on its own. It was presumed by a majority of Austrians that Austria inevitably would be unified with Germany into one nation state. If and when that day came, the issue would arise as to how the monetary systems of Germany and Austria would be joined into a single currency area.

Mises dealt in detail with this issue as well in a lengthy study written in the summer of 1919. And the topic obviously has a modern ring to it in the context of the recent introduction of the euro in place of the separate national currencies of a number of European countries. If the German mark and the Austrian crown were on a gold standard, the conversion to a single monetary unit would be relatively simple, Mises suggested. But in fact both nations were on irredeemable paper money standards experiencing serious inflation. The first task toward monetary union was an end to inflation in both Germany and Austria. This required ending the use of the printing press to finance government expenditures. In addition it required a coordination of the two countries' fiscal policies, and since Austria was the smaller of the two countries in terms of population and output, this meant the subordination of Austrian fiscal policy to that of Germany. Full political unification would necessitate Germany's absorption of Austria's national debt. Austria's fiscal status, therefore, had to be reduced to one similar to any one of the states of the German Republic. Full fiscal autonomy by Austria leading up to economic and political integration with Germany could only result in further accumulations of national debt that would forestall the unification process.

And a central reason for the need to end inflationary policies in Germany and Austria before unification was due to the fact that monetary expansions were non-neutral in their effects on the structure of relative prices that also brought about a change in the general purchasing power, or value, of the monetary unit. For purposes of currency conversion, the market needed time to settle upon a rate of exchange that would more or less reflect the equilibrium purchasing power parities of the two currencies. And this could not be successfully established until a sufficient period of time had passed during which the inflationary influences would have fully worked their effects on the respective price systems of Austria and Germany. A rate of exchange between crowns and marks might be officially established a year after the two countries had ended their inflationary policies.

Finally, for the transition to a common currency, Mises suggested that the German mark should first be introduced as a "core" or reserve currency in Austria, with a specific ratio of exchange at which the Austrian National Bank would be legally obligated to redeem Austrian notes for German marks, and vice versa. Any increases or decreases in the number of units of Austrian currency in circulation would be dependent upon deposits or withdrawals of marks from the Austrian banking system. Thus, leading up to monetary unification, the Austrian National Bank would no longer be an independent authority determining the quantity of money in the country. In other words, Mises was proposing the establishment in Austria of what nowadays is referred to as a "currency board," and that this currency board mechanism would serve as the stepping-stone to a single currency. Final unification would come through the German central bank's redeeming all Austrian bank notes for marks at the specified rate of conversion, after which there would be only one monetary system and one currency in what would be becoming one country.

Mises' own monetary policy prescription was for a gold standard. He argued then as in later years that the leading benefit from a full gold standard was that it eliminated any direct control over the printing press by the government. The money supply either directly or indirectly under the control or influence of the government would always mean that the society would be susceptible to inflationary abuse and the ups and downs of the business cycle. Special interest groups would always be at work for various material and ideological purposes to "print money" if government had it readily in its power to do so. And Mises' final monetary policy proposal was for the end of monetary policy by the privatization of money through a commodity-based free banking system. But he readily admitted that this was a policy prescription the possibility of which would only be far into the future given the political and ideological trends of his time.

Fisfal Policy, Capital Consumption, and the Need for Budgetary Restraint
Central to the monetary mismanagement of that period between the two World Wars, Mises argued, was the fiscal philosophy of the time. Governments had taken on vast, new responsibilities for social and welfare redistribution programs. Industries were nationalized in the euphoria of a making a socialist society and these state enterprises invariably ended up running huge losses that the government had to cover through taxation. Mises said that "The old fable of Midas has been turned on its head: whatever gold governments touch turns to dust." Protectionism and domestic subsidy schemes spent fortunes on artificially maintaining or creating various industrial or agricultural sectors of the economy. In Austria, Mises explained, the government subsidized agriculture at the expense of industry and manufacturing, which were mostly centered in Vienna. In Hungary it was the reverse, with industrialization subsidized at the expense of farming and the rural areas.

In the more Classical Liberal era of the 19th century, Mises said, the presumption was that taxes were an evil to be minimized to provide those essential but limited functions of providing protection of life, liberty, property and a few other narrow responsibilities. But now the presumption was that there was no limit to government spending, regardless of how much and for what. Indeed, the fundamental principle of economic reasoning was turned upside down by government. In the private sector the presumption is that the ends that may be pursued are constrained by the means available to attain them, and that in general expenditures must be kept within the bounds of income. The reverse was the philosophy practiced by governments, including most especially the Austrian government. In the public sector the assumption was that taxes were to be raised to enable the pursuit of any level of expenditure, no matter how extravagant. Between 1925 and 1929, all levels of government spending in Austria had increased by 31.4 percent, or almost 8 percent per year, Mises pointed out. Direct federal taxes alone had increased by 35 percent during this period.

This philosophy of government spending was based on two erroneous ideas, Mises argued. First, was the notion that programs couldn't be cut because they were mandated by previous laws and were now "entitlements" that made them "inevitable" and unavoidable. Mises replied by asking, "What exactly does `inevitable' mean in this context? That these expenditures are based on various laws that have been passed in the past is not an objection if the argument for eliminating these laws is based on their damaging effects on the economy. The metaphorical use of the term `inevitable' is nothing but a haven in which to hide in the face of the inability to comprehend the seriousness of the situation. People do not want to accept the fact that the public budget has to be radically reduced."

The second mistaken idea was that higher and higher tax burdens on income and capital need had no negative effect on capital formation and entrepreneurial innovation. Not only had capital formation been retarded, the effect of fiscal and related interventionist policies, Mises explained, was a destructive process of actual capital consumption in the Austria of the 1920s and early 1930s. In a report that he co-authored for the Austrian government in 1931, he drew upon a vast array of statistical data to show how this had come about. He demonstrated that between 1925 and 1929, taxes had risen by 32 percent, social insurance payments by employers had gone up by 50 percent, industrial wages under union pressure supported by the government had increased by 24 percent, agricultural wages had increased by 13 percent and transportation costs by 15 percent. During this time, on the other hand, an index of the prices of manufactured goods bearing these costs had only increased by 4.74 percent between 1925 and 1930.

To the extent that new capital had been created in Austria, a large portion of it had been financed by investment loans from abroad because the domestic sources for investment funds were strangled by the weight of taxation. The socialist ideology of envy generated the idea that impoverishing entrepreneurs and the owners of capital through taxation assured social justice for the society as a whole. All the while, in reality, the consumption of capital impoverished the poor and the working class by lowering the marginal productivity of labor and raising the cost of living.

In 1930, Mises detailed a series of institutional and administrative reforms for Austria to reduce or eliminate unnecessary or duplicative activities at the various local, provincial, and federal levels of the bureaucracy that would lower the fiscal and regulatory burdens on business and the taxpayer. He proposed that such reforms first be introduced in the smaller, rural Austrian provinces to see how effective they would be, and then when they had proven their effectiveness, they could be extended to the rest of the country.

Government expenditures had to be cut down to size, including the size of the bureaucracy. How could the resistance of the bureaucratic establishment be overcome? Mises proposed, without saying so quite so directly, an approach of divide and conquer. Those civil servants in the more essential departments and agencies of the government that would be cut the least or not at all should be reminded that out of the expenditure savings could come not only reductions in the tax burden for the taxpayers but salary increases for those whose continuing employment by the government was needed.

Corporate taxes and income taxes had to be cut because they were destroying the productive capability and economic well-being of the country. But if not corporate and income taxes, how then shall even those limited though essential functions of the Classical Liberal state be funded? And one who turns to Mises' Human Action to find out his views of the appropriate fiscal regime for the Classical Liberal society will be disappointed. He discusses the dangers of excessive and confiscatory taxation on capital formation, entrepreneurial creativity and competition, and on the incentives to work, save, and invest. But there is virtually nothing about what a rational fiscal policy should be that is more likely to foster entrepreneurship, capital formation, and economic growth.

In the 1920s, Mises reminded his fellow Austrians that "In the eyes of the older liberals, taxation of income and the interest on capital had the negative effect of slowing down the process of capital formation and hence retard economic progress." The policy prescription for many of these 19th century liberals was a system of low, indirect taxes on various consumption items that did not impose an excessive burden on the general citizenry. "The ability to economize, not the invention of new taxes, is the hallmark of a good finance minister," Mises stated.

In May 1940, while Mises was still in Europe before coming to the United States, he outlined the particulars of what he considered a liberal fiscal regime in the context of a series of "guidelines" he prepared at the request of Otto von Hapsburg, the heir to the Austrian throne, for the reconstruction of Austria when the Second World War was over and Austria was once again an independent nation.

Austria, Mises said, would be a poor country. The destruction of war, the consumption and misuse of capital, the destruction of a large portion of the Austrian entrepreneurial class due to the expelling or murder of so many Jewish businessmen and financiers, and the debilitation of the labor force from death and permanent injury in battle would require Austria to turn its back on its socialist, interventionist, and welfare-statist past. Only economic freedom and hard work could restore Austria from a condition that we might nowadays loosely refer to as "third world" status.

Fiscal policy, therefore, would have to be designed to do everything possible to unleash private sector incentives and opportunities for investment, capital formation, and entrepreneurship. Virtually all taxes, Mises suggested, should be skewed toward consumption and away from production. What type of broadly based consumption taxes? He proposed: (1) excise taxes on alcoholic beverages, tobacco, and related tobacco products; (2) a sales tax exclusively on the sale of goods and services to the final consumer; there should be no explicit or hidden value added taxes; (3) a progressive consumption tax based on housing expenditures, but with an exemption for housing expenditures for those in the lower income brackets; (4) a tax on luxury automobiles for private or personal use; (5) a tax on lottery winnings; (6) a stamp tax on playing cards; (7) administrative fees for certain government services, such as issuing patent rights, brand name registrations, determination of weights and measures, and "official stamps" to cover the cost of providing various types of documentation; (8) a wage tax paid by employers that was not deducted from the employee's salary to fund existing social insurance programs; and (9) a moderate net profits tax on shareholders and limited liability partnerships when annual disbursements exceeded 6 percent of the enterprise's capital assets; retained earnings by the enterprise would be exempt from taxes so as not to discourage capital formation.

Except for the net profits tax and the wage tax for social insurance costs, all income and business earnings would be completely tax-exempt. And a perusal of Mises' proposed list of taxes clearly shows that he thought that, besides the general sales tax, the fiscal burden should primarily be in the form of what nowadays would be classified as "sin taxes" and a narrow selection of "luxury" expenditures. Mises' long recognized advocacy of "laissez-faire" did not mean a hands-off indifference to the path taken by the market economy. What would be produced, where and how goods would be produced, and for which segments of the consuming public would be determined by the pattern of market demand and the profit-driven entrepreneurs. As Mises expressed it in the early 1940s, "If there is any hope for an new [economic] upswing [at the end of the war] it rests with the initiative of individuals. The entrepreneurs will have to rebuild what the governments and politicians have destroyed."

But in Mises' view the government's own taxing policies should be devised in such a way that they impose the smallest fiscal burden possible with the least disincentive to those forms of market conduct most crucial and essential to generate the greatest amount of private sector financial ability and opportunity for what today is referred to as the supply-side forces of work, savings, and investment.

It should be mentioned that Mises' apparent concession to the welfare state in his listing among his fiscal suggestions of an employer's tax for social insurance expenditures did not mean his belief in their desirability or necessity. This was clearly an admission that, given the political currents, not everything could be reformed at once. For example, in 1942 Mises was invited to lecture in Mexico for six weeks during which he had the opportunity to studying the economic conditions in the country. The following year, in 1943, he prepared a lengthy monograph for an association of Mexican businessmen on "Mexico's Economic Problems." His recommendation was to not establish social insurance programs in the first place. If part of the cost of such social insurance schemes falls on the shoulders of the employers, it would only succeed in raising the cost of employing workers, with the negative effect of pricing some members of the work force out of the job market. At the same time, such government-mandated insurance policies restricted the freedom of the employee to weigh the opportunity costs of allocating his income in various ways more reflective of his own preferences and that of his family.

To reduce the fiscal burden on the society Mises also considered it essential to sell off and privatize nationalized industries and state enterprises, including the railroads, mining, and forests. In the mid-1920s, at the time when all intellectual and ideological trends were in the direction of more socialism, Mises declared there was only one remedy for the fiscal drag caused by loss-making government enterprises: "Governments and local agencies must sell off all these enterprises and turn them over to private entrepreneurs who will know how to run them at a profit." If they could not be sold to the private sector because of their inherent unprofitability, then, Mises declared, they could be shut down.

International Debt Crisis and Foreign Exchange Control
With the start of the Great Depression and the banking crisis that developed in Vienna in 1931, Mises' focus became the financial and economic crisis into which Austria had now fallen. To try to save the banking system, the Austrian National Bank extended credits for which there was not a gold backing as required by the Bank's reserve requirements, and to stop the run on its reserves the Bank had ended redemption on demand. The value of the Austrian schilling fell on the foreign exchange markets. The government's response was to institute foreign exchange control pegged at the former gold-parity rate.

Mises explained in a series of papers prepared for the Vienna Chamber of Commerce in 1932 that this would not bring about recovery in the market or restore balance in the international trade accounts. Instead, it would artificially induce even more imports and stymie the sale of exports--the exact opposite of what the government said it wished to do in terms of the country's balance of trade. The inconsistencies and contradictions in the foreign exchange control system manifested itself in the fact that as the year went on the government was forced to loosen the restrictions on the sale and purchase of foreign currencies and allow more market-based allocation and pricing of foreign exchange. The only lasting cure, Mises insisted, was to immediately abolish the entire network of controls and return to a free market in foreign exchange dealings.

But the fundamental cures for Austria's problems in the world economic crisis required, among other things, the restoration of redemption of the Austrian currency at the legal gold parity. To do so, the Austrian National Bank had to reverse the monetary and credit expansion it had been following. Mises clearly stated that this monetary deflation had to be instituted as quickly as possible before the entire structure of prices and wages in the country had fully adjusted to the depreciated value of the schilling. At that point, returning to the legal gold parity would necessitate a wrenching adjustment of prices and wages downwards that might not be possible.

And equally crucial to a return to economic balance and the path to prosperity were reductions in government spending to alleviate the strain on the private sector from a state budget that was pushing the country to living beyond its means. It was government spending that was creating the pressure for increases in taxes, which Mises considered a serious danger to Austrian business. But if certain taxes were raised, at least they should be imposed in a way that did not unduly discriminate against some sectors of the economy for the benefit of others.

When the Austrian government applied for and received an international loan from the League of Nations to facilitate a solution to its financial difficulties, Mises endorsed it, but only if it was understood and used as a "breathing space" for actual and real institutional reform in the government's taxing and spending practices. Otherwise, it would be merely digging Austria's financial grave even deeper.

At the end of 1934, as Mises was departing for Geneva, Switzerland, to take up his teaching appointment at the Graduate Institute of Economic Studies, he wrote a short piece, "The Direction of Austrian Financial Policy: A Retrospective and Prospective View." Democratic government had ended in Austria, a brief civil war had been fought and had crushed the Social Democrats, and now Mises hoped that a new calm in the country could serve as the backdrop for returning to the path of economic reform and recovery. He reviewed the course of Austrian economic policy during the preceding fifteen years since the end of the First World War. And he emphasized that what the country still needed was less government spending and taxing, more flexibility in the country's price and wage structure, a stable currency, and acceptance that as a small nation in a large global economy Austria had to adjust to the international conditions of supply and demand. Alas, in less than four years, Austria's fate would be sealed for the duration of the Second World War.

Old Lessons for a New Age
Shortly after Mises came to the United States in the summer of 1940 he penned a short memoir that contains his reflections on his life in Austria and the Europe he had left behind. It's written in a tone of despair and dismay about the direction in which European civilization seemed to be moving at the end of the first four decades of the 20th century. In clear anguish and frustration, he summarized how he viewed his own efforts as an economist in Europe in general, and Austria in particular, during those years between the two World Wars:

Occasionally I entertained the hope that my writings would bear fruit and show the way for policy. Constantly I have been looking for evidence of a change in ideology. But I have never allowed myself to be deceived. I have come to realize that my theories explain the degeneration of a great civilization; they do not prevent it. I set out to be a reformer, but only became the historian of decline.

His mood in this passage is reminiscent of Adam Smith's remark in the Wealth of Nations at the end of his criticisms and refutation of the Mercantilist system. "To expect, indeed," Smith said, "that the freedom of trade should ever be entirely restored in Great Britain, is as absurd as to expect that an Oceana or Utopia should ever be established in it. Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it."

Yet, within one lifetime the ideas of Adam Smith and like-minded thinkers transformed Great Britain into a nation operating on the basis of free markets at home and free trade in international affairs. And Great Britain's example helped reform much of the rest of the "civilized" world in the same direction.

I would like to suggest that Ludwig von Mises' articles, essays, and monographs, originally written more than 60 and 70 years ago in the context of the economic and political policy controversies of those times, can serve as warning signs and guideposts for us as we have now entered the 21st century. They remind us of the consequences that can befall a country when it goes down the road of interventionism and welfare statism. But they also offer ideas and prescriptions for free-market alternatives in the arena of monetary and fiscal policy, besides many other areas of public policy.

With luck, the despair expressed by Ludwig von Mises in 1940 will turn out to be as misplaced as Adam Smith's resignation to the permanence of Mercantilism in 1776. And with the theoretical and policy ideas of Mises and like-minded economic liberals, the 21st century can become even more of a shining example of freedom's potential than was the 19th century.

Richard M. Ebeling is the Ludwig von Mises Professor of Economics and Chairman of the Economics and Business Administration Department at Hillsdale College, Hillsdale, Michigan.

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