Originally published: 1912
526 pages
Chapter 34

THE THEORY OF MONEY AND CREDIT


Ludwig von Mises
 
Ludwig von Mises was born in Lemberg, Austria, in 1881. From that year until his death almost a century later in New York City the world and its economic underpinnings was turned upside down. Mises, who never won recognition outside the intellectual and academic circles that were both his audience and the frequent targets of his criticism, fought difficult battles on the road to his (then) under-appreciated and under-recognized achievements. His fidelity to his work was remarkable in light of the derision, ignorance, and just plain stubbornness of less accomplished but more popular thinkers. Although a Nobel Prize was never in the wings, he changed the way that the world thought about money and commercial relationships. His understanding of the full impact of inflation and the boom-and-bust cycle of business, among other economic phenomena, were seen as unfashionable at the time he wrote. His enduring contribution regarding the nature of money-that it is a commodity like any other-initially caused consternation. It later elicited mere circumspection and eventually won acceptance.
     Being out of step caused Mises to remain a peripheral figure among professional economists, thus limiting his personal prospects. He labored in the backwaters for many years, trying to establish a comprehensive understanding of all sides of economics, an understanding roughly analogous to physicist Albert Einstein's goal of a unified theory of the physical world. The approach of Mises demanded working on a broad range of issues in a complex agglomeration of disciplines: economics, history, sociology, and even scholarly methodology. His 

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achievements, the scope of which is apparent from his major works, led to inescapable economic conclusions, which in turn caused a revolution in how governments are organized and how they approach economic planning and execution.
     Mises had a great antipathy toward any attempt to control human behavior through governmental activity. The individual and his actions constituted the fundamental building blocks of the economic paradigm Mises describes. In his preface to the English edition of this work he notes that a deep knowledge of economics is not necessary to gauge the immediate effects of monetary or economic policy. The trick, and the substance of The Theory of Money and Credit, is to determine long-term effects

               so that we may avoid such acts as attempt to remedy a present ill by sowing
               the seeds for a much greater ill in the future.

     Mises maintains that the answer to resolving any present ill lies in individual human action, not government direction or control. In his text he offers examples of long-term ills on both the micro- and macroeconomic stages caused by implementation of short-term (often politically expedient) solutions; for Mises the law of unintended consequences was ever in effect.
     Relevant to the current debate on the globalization of most economic sectors, Mises long ago recognized commonplace misunderstandings of the international division of labor, that it is no
different from the division of labor in any venue-whether that be in a factory or within a national economy. He also saw and described the negative effects of nationalism and protectionism. Economic specialization and the expansion of trade in the early twentieth century were a fulfillment of Adam Smith's comprehension of human economic activity as seen in the eighteenth century. Mises understood that governmental shoveling against this natural tide, in the guise of protective tariffs, was a formula for economic disaster of the sort that did occur with the Great Depression. Regrettably, the persons who could have made a difference were unable or unwilling to see the logic of Smith and Mises.
     The policies of John Maynard Keynes that expanded public enterprise at the expense of the already overburdened private sector (through untenable increased taxation) were sold wholesale during the first third of the twentieth century. The world was much the worse off as a result. The autarky (nationalistic economic self-sufficiency) of the seventeenth

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century and before was seen by Keynesians as a goal rather than an anachronism. This goal was to be achieved through high tariffs and jingoistic monetary policy. The effect of these efforts was to extend and make deeper the economic depression those economists who followed Keynes had created in the first place. Mises makes several points about economics as a method of assessing or guiding human activity and how its functional attributes weren't always used to good effect in the years just prior to the Great Depression.
     When Mises steps back to look at economics as a discipline (certainly more art than science) he finds that once economic activity passed beyond production for individual consumption, then economics-the dismal science-was invented. In reality, economics is not gloomy; it is the method that we use for predicting and then ameliorating the bad effects, or expanding the good effects, of human economic actions.
     Economics as a methodology is scientific in its observations, but that which it observes is not scientifically organized. Human economic behavior is random and overall not wholly predictable, thus the dismal, or frustrating part-the non-science. Mises observes that economics is not prescriptive (that is, future economic results do not fit into rules that are immutable), it is projective (economists can guess at what will happen in the future based on what has happened in the past, but these are and always will be guesses); we see economic "rules" only after the fact, and the rules change as fast as the facts change. Governments and politicians get in trouble when they view the past as a formula for the future. Economic "laws" don't determine human action; human action determines economic laws. The chicken did in fact come before the egg in this instance.

*       *       *

     A useful and significant portion of The Theory of Money and Credit is an investigation of money itself. As a medium of exchange, some tangible (or today electronic) monetary unit is necessary for any economic functioning above the direct barter system. Mises explains that money is that medium. But money's value lies in the eye of the beholder, and the same amount of money does not mean the same thing to two different people who are always in different circumstances. A million dollars on a deserted island is useless, while a hundred dollars to a single parent may hold a saving grace. Further, Mises comments on two economic verities: he demonstrates the failure of authoritative

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interference in the markets by governments, and he elaborates on the anarchic nature (because of human whims) of both production and consumption. He also levels a direct attack on
inflationary governmental policies, which if left unchecked inevitably lead to totalitarianism because when inflation is not controlled, one failed policy after another leads to an insistence of even more rather than less government. He observes that as economic activity disintegrates in the face of inflation each section of the governmentally controlled house of cards is built. Government causes inflation with deficit spending or an unrestrained increase in the supply of money, then claims only it can control inflation by directing the economy, while simultaneously refusing to recognize that its actions were the basis of the inflation in the first place. A house of cards built on inflationary actions and government hubris that it can fix things often falls with great noise in spite of its slim construction.
     Mises's investigation of inflation marks his transition from economist to political realist. He is adept at pointing out inflation's economic and political implications, one of which is the boom/bust roller coaster ride that overly regulated economies often endure. His ability to call things what they are and to discredit policies implemented solely to salve the body politic but which do not carry the seeds of successful course alterations make his economic discussion both readable and correlative to already-experienced political reality. As importantly, his observations on economics offer an accurate method of assessing political promises.
     Mises lived through an era of dictators and collectivist governments. He observes that when the state moves to intervene in or govern the market, it takes the first step on the precipitous and slippery slope to economic conflagration. Mises contends that the state has only a secondary, political interest, in the economic activity of its citizens; it is the people who have the primary interest. Private property, in all its forms, belongs to them. This includes ownership of the means of production-which is the prime moving force of economic activity. Mises holds that so long as private property exists and the means of production are allowed their anarchic relationships, state intervention usually can only negatively influence an economy (capitalist anarchy is the “creative destruction” described by Joseph Schumpeter [Chapter 38] where improvement and invention are the rule.  Products and businesses fall by the wayside if they do not match and exceed their previous efforts and those of the most creative and resourceful of

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their competitors). The real-world examples of what Mises predicts (recall, this book was written in 1912) can be seen in the encyclopedic overview of socialism versus capitalism presented in The Commanding Heights (Chapter 29), Daniel Yergin and Joseph Stanislaw's review of this battle. Whichever volume one reads first, the two together form bookends to the economic history of the twentieth century.
     The most severe indictment Mises issues is reserved for the folly of wage and price controls-government's solution to the inflation it caused in the first place. When a government begins to set wages and prices (including minimum wage levels), even in the smallest measure, its action constitutes an attack on private property and threatens its very existence. This is because fixing prices is nothing more than the taking of property without compensation. This is one of the long-term consequences of an imprudent intervention in the economy for short-term goals. It is a consequence that politicians do not care to face and thus ignore when implementing the very wage and price controls that will cause economic stability to disintegrate. These controls only ensure soaring inflation when they are lifted, or a free-fall to totalitarian solutions if they are not. In either case, their certain adjunct is a black market that further distorts an economy and undermines any government's success at economic oversight or tax collection. (It should be noted that these observations are global and do not often directly apply to the U.S. economy. The fruits of the actions described by Mises can grow anytime, any place-thus the value of understanding these economic realities irrespective of what conditions or practices may exist in any given nation at any particular time.)
     On the subject of economic regulation, Mises observes that every restriction of trade-whether by an excise duty, quotas, price controls, tariffs, government subsidies, or other mechanisms-creates vested interests in the beneficiaries thereof. From then on, the beneficiaries will be opposed to the removal of the initial restraint. No matter how allegedly laudable the immediate goal, economic interference inevitably results in cascading negative consequences. When these activities destroy lives, setting the market aright again often takes all the king's horses and all the king's men-sometimes literally.
     An example of how the human spirit circumvents or abridges the edicts of economically illiterate governors can be seen in the later years of the reign of Tsar Alexander I of Russia, grandson of Catherine the Great (c. 1822). The tsar wanted to reduce Russian dependence on foreign goods so he set steep tariffs on much that was imported

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and banned the balance of these items in an attempt to encourage his subjects to engage in their own manufacturing. Soon the shops were flooded with goods bearing Russian labels-but there wasn't much else Russian about them. As Jason Roberts notes in A Sense of the World (2006), making foreign goods expensive to buy was not the same as making production of native products affordable. It was more efficient to smuggle foreign goods in and change the labels than to manufacture such items at home.
     The demands of the tsar did not change economic reality, they only fostered an illegal charade that covered the economic futility of his plan. What must be understood in order to place the tsar's incentives and the merchant's counter-actions in perspective were the penalties for disobeying the government's rules-these were not simply white collar crimes, punishable by a suspended sentence, a small fine, and momentary public censure. The price to be paid ended on the gallows; still the violations were rampant. We see in this example the folly of attempting to force man to accede to economic policy, and the need to design economic policy to man's inherent nature. Even the incentive to obey Alexander's laws (death for violation) was not enough to overcome everyman's need to act rationally in an economic milieu.
     Mises devotes much of this treatise to refuting various existing economic theories prior to asserting his own. As the foundations for appreciating this work are self-contained, the reader needs to devote little effort toward preparation prior to reading it. Mises's logic flows so smoothly and simply that his account of historical facts virtually demands his theoretical and prescriptive conclusions. To properly appreciate the book it is best read as a whole for it does not lend itself well to being read in stages. That being said, the general reader need cover only the first sixteen chapters and the last three (21-23). A more detailed presentation of national and international monetary factors appears in chapters 17 through 20; this material requires close attention yet adds little to a general understanding of his theories.
     This book represents Mises at his best. He is so logical, so unrelenting in observing the details (wherein the devil always lies) that despite its length and intricacies his effort is simply a masterpiece of analysis and cogent, conclusive prescription. Most valuably, the reader should recall-as current-day problems are investigated and weighed against their sometimes inane political solutions-that Mises wrote this book almost a century ago, yet the answers posited then are still valid today.

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Definitions

Although Mises does not directly define any of the terms he uses, either in this book or the two others he wrote that are reviewed in this compendium (Socialism [Chapter 32] and Human Action
[Chapter 40]), context usually makes their meaning reasonably clear. Nonetheless, a distinct understanding of certain words will prove valuable because some of the terms Mises employs, though in vogue in the early part of the twentieth century and therefore part of his vocabulary, have long since gone out of popular usage. The following definitions can be useful in comprehending all three of the Mises's texts.

aleatory factor: of or depending on chance or luck.
a priori: deductive reasoning, based on logic, without recourse to experience; prior to and
     furnishing a base for understanding experience.
autarky: economic self-sufficiency as a national policy.
bourgeoisie: the social class between the aristocracy and working class, or proletariat, made up of
     shop owners, manufacturers, service providers, etc. In Marxist theory, the capitalists (i.e.,
     bourgeoisie) as a class are antithetical to the proletariat. In capitalism the bourgeois and
     proletariat complement one another.
catallactics: the science of commercial transactions.
chrematism: the science of wealth; the study of the manipulation of property and wealth.
chreotechnics: the useful arts, especially agriculture, manufacturing, commerce.
classical liberalism (now generally termed conservatism in America, liberalism in Europe): limited
     state power, free-market economy, freedom for the individual, personal responsibility, a society
     governed by the rule of law.
commodity money: that money which not only serves as money, but is also a commodity, i.e.,
     gold and silver.
credit money: money, or a claim for money, issued by a government, entity, or person, but which
     cannot be converted into gold or some other valuable commodity on demand. Credit money
     refers to a government's ability to stand behind its obligations. The value to the citizenry is in
     using this money for exchange purposes. Today, money that is legal tender in almost all countries
     is actually credit money by classical definition.

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division of labor: the incrementally smaller sphere of work each person does as specialization and
     cooperation make one more efficient.
epistemology: the branch of philosophy that investigates the origin, nature, methods, and limits of
     human knowledge.
etatism: the concept that the state is not only the center of political thought and action, but the only
     voice that should control. In monetary theory, the concept that money, and in particular an
     abundance of it and its value in relation to the money of another state, is the measure of the
     economic merit of any state. The more powerful and rich the state, the more valuable its money.
eudaemonism: the doctrine of happiness, or the system of ethics that considers the moral value of
     actions in terms of their ability to produce happiness.
fiat money: money simply created by the state that has certain legal characteristics. Fiat money has
     no correlation to any underlying value; the market establishes its value through supply and
     demand. Fiat money, when used as an economic tool, is created with the view that more money
     means more wealth. This, unfortunately, is a fallacious presumption because money's value is not
     static; its value is always in the eye of the beholder.
fiduciary media: notes and credits issued by banking or lending institutions that are not covered by
     cash on hand. The value of the notes and credits are founded in the reputation and subjective
     value and solidity ascribed to the institution itself. Fiduciary media enable monetary transactions
     to occur without the need for money. Fiduciary media multiply the economic resources of a
     nation.
Gresham's Law: bad money (cheap money, of less than par value) will chase good money out of
     the marketplace. In colonial times paper money drove gold and silver coins out of circulation
     (the coins were hoarded by individuals, not withdrawn by the government).
inflation: rising prices caused by an increase in the amount of money and credit circulating in an
     economy. Prices rise as the supply of money increases because more dollars are chasing the
     same amount of goods. Since people have more money they are willing to pay more for any
     given object, causing its price to be bid up. The increase in the amount of money is the result,
     primarily, of a government printing more currency. When the supply of money increases, the
     value of each unit of money decreases. In general, governments print more money in order to
     balance their budgets or to purchase foreign goods not available within the country because of
     the negative consequences of

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     government policy. An unbalanced budget arises when governments spend more money than      
     taxation brings in. Allowed to continue unchecked, inflation causes the monetary system to 
     collapse and the currency to become worthless, as happened in Germany in 1923 and in 
     America in 1781.
inflationism: any program that seeks to increase the quantity of money in an attempt to increase  
     the economic well-being of a given society. An inflationary policy does not create more wealth;
     such a policy devalues the goods and services extant.
latifundia (plural of latifundium): large landed estates, as in ancient Rome.
liberalism or collectivist liberalism: in the U.S. and in socialist dogma, the opposite of classical
     liberalism or European liberalism; state economic control, interventionist state actions that limit
     individual freedom, a highly progressive tax structure.
marginal utility: the value of a commodity (or service) based on subjective considerations of the
     person holding or acquiring it. If one does not have an automobile, the marginal utility (and thus
     the value) to a potential possessor is greater than an automobile to a person who already has
     ten.
meliorism: the belief that the world naturally tends to get better, and especially that it can be made
     better by human effort.
mercantilism: the doctrine or theory that the economic interests of a nation as a whole are more
     important than the interests of the individuals who make up the nation, and that exports are
     desirable because the payments that come in over the cost of imports supposedly make the
     nation wealthier. In fact, such an imbalance changes nothing. The excess of exports over imports
     (though brought into equilibrium by an inflow of money) creates no new wealth; that is, the
     exports equal the imports plus the cash difference. Also known as commercialism.
metaphysics: the branch of philosophy that deals with first principles; the systematic investigation
     of the nature of first principles, and problems of ultimate reality.
Midas theory: in international trade, the fallacious notion that exports that exceed imports make a
     country wealthier.
nominal value: that value of money decreed by the state, e.g., a U.S. dollar is worth one hundred
     cents. Nominalism's opposite, commercial value, is the value established by the market when
     money is used for exchange.

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nominalism: a doctrine that all universal or abstract terms are ephemeral, existing in name only.
     Nominalism is the opposite of realism.
normative: of or establishing a norm or standard, what should be as opposed to what is; the
     opposite of that which is positive, which already exists.
praxeology: the general theory of human action, rooted in economics. The foundation of
     economics is acts of choice (causes), and their results (effects). Economics is not about things
     but about people's actions and reactions to their world. Economics itself does not have an
     ethical or moral base; economics is only about choices and actions. Praxeology is the study of
     those actions. Praxeology is indifferent to the goals of actions; it is a science of means, not ends.
proletariat: the working class in socialistic jargon; in socialism, the antithesis of the bourgeoisie.
ratiocination: the act or process of reasoning; rational thinking; deducting consequences from
     premises.
romanticism: man's dismissal of or revolt against reason, as well as the conditions under which
     nature has compelled him to live. He uses his imagination to disregard the laws of logic and
     nature.
syndicalism: a theory and movement of trade unionism whereby the means of production and
     distribution are controlled by the workers. Workers achieve their goals by direct action, by
     striking. The general strike, akin to a revolutionary attack, is the workers' ultimate (economic)
     weapon.
tautology: needless repetition of an idea in a different word, phrase or sentence; redundancy that
     adds nothing to the sense of the matter under discussion.
teleology: the study of final causes, a belief that natural phenomena are determined not only by
     mechanical causes, but by an overall design or purpose in nature.
velocity of money: the speed with which money changes hands by traversing through the market.
     The greater the speed, the faster profits are created, the faster money is made available for
     continued economic activity, including taxation.

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About the Author
Ludwig von Mises was a product of antipathy to nineteenth-century European economic dogma; he became a prime creator of twentieth-century economic science. Born in 1881 in Austria, educated in Vienna, and chased to Geneva, Switzerland by the Nazis in the 1930s, he finally settled in the U.S. in 1940. His battles were never ending. Even in the United States, his views were so widely disputed by the ultimately discredited Keynesians that he could not secure regular employment. He eventually landed a job at New York University, but his salary was paid by outside interests not the school, and he never became a regular member of the faculty. During his career he wrote twenty-five books and hundreds of scholarly articles; his students changed economic thinking and policy in the twentieth century, literally around the world. Mises died in New York City in 1973.

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