Have Fiat Money, Will Inflate

by George F. Smith

Exclusive to STR

Mark Skousen’s recent article on Strike The Root, “Vienna and Chicago: Friends or Foes?,” which is the opening chapter of his book of the same title, raises the question of which economic school of thought best supports liberty. [1] According to Skousen, both sides claim to be “freedom fighters” and talk about the value of “free markets and free minds.”  But rhetoric aside, which group would actually deliver on its promise?

If liberty is defined as freedom from force, then the answer is clear: Only the Austrians advocate a coercion-free society.  With its call for controlled inflation, the Chicago school gives government an important role and thereby invites abuse.

In discussing their opposing views on sound money, Skousen says “[m]ost Austrians prefer a gold standard, or more generally, a naturally-based commodity standard created by the marketplace.”

While that’s not incorrect, the wording leaves one wondering if they also prefer blondes and peach cobbler.

The Austrian position is to let the market work, period – and that includes money.  If the market is advanced enough to use a medium of exchange as opposed to straight barter, then market participants will determine what will serve as that medium.  Historically, they have chosen a commodity they can readily exchange, and the overall winner has been gold.   It’s not as if Austrians have some fetish for gold and are delighted the market happens to agree with them.  They “prefer” gold because the unhampered market has selected gold as money.

A gold standard works in the absence of force.  As Ludwig von Mises has written,

“The international gold standard works without any action on the part of governments. It is effective real cooperation of all members of the world-embracing market economy. There is no need for any government to interfere in order to make the gold standard work as an international standard.”  [2]

Fiat money, by contrast, requires the iron fist of government to make us accept it.  This is the kind of money people have never trusted, that makes everyone poorer except the politically connected; it depletes personal savings, leads to wars, bureaucracies, business cycles, personal and public debt, a breakdown in morals, and ultimately to complete destruction of the monetary unit.

Fiat money is the choice of the Chicago school, with one important qualification.  As Skousen explains, they reject “the gold standard in favor of an irredeemable [fiat] money system, where the money supply increases at a steady or neutral rate (the monetarist rule).”

But why would government let some economist’s “rule” keep it from getting the goods it wants or posturing as the world’s savior?  Would such a rule have kept Bush from invading Iraq or throwing out tens of billions of dollars to an incompetent and corrupt federal relief agency, even if the rule were law?  As it does with the Constitution, government can always claim it’s acting for a more “noble purpose” and do what it pleases.

The differences in the schools are reflected in their incompatible views of U.S. monetary history.

Skousen lauds monetarists Milton Friedman and Anna Schwartz for their “empirical” explanation of the Great Depression, who pin responsibility for it on the government’s monetary policies, not the free market. Skousen admits that “the Vienna school blamed government, too, for the Great Depression, but did so in a qualitative way without relying on empirical evidence; Friedman and Schwartz told the story in a way that convinced many non-believers.”

Those former non-believers would do well to read the Austrian account first-hand in Murray Rothbard’s America’s Great Depression. [3]  They might also check out the debate between Richard Timberlake and Joseph Salerno that ran in The Freeman from 1999 – 2000. [4] 

The monetarist Timberlake maintains that the Fed did not inflate during the period from 1921 – 1928, nor did it inflate during the recession that followed, which he believes was a fatal mistake. “Between 1929 and 1933, the Federal Reserve System . . . monetarily starved the country into the worst economic crisis it has ever experienced,” Timberlake asserts.

The Austrian Salerno claims the Fed did indeed inflate before and after the Crash.  Many Austrians maintain that if the Fed is creating money, it is creating inflation, and eventually a recessionary correction will follow as bad investments are liquidated.  Though increases in the money supply will put upward pressure on prices, measuring inflation by price changes can be inconclusive.  Prices are subject to factors other than the supply of money and rarely give a clear picture of printing press misdeeds.

But according to Chicago school economists, inflation doesn’t exist if it doesn’t increase prices.  Thus, monetarists found no inflation during the 1920s because wholesale prices remained fairly stable. Rothbard stresses the point that controlled bank reserves increased more than uncontrolled reserves declined during the 1920s, from which he concludes the Federal Reserve deliberately created inflation. [5]

It was the first-generation monetarist Irving Fisher who declared 14 days before the 1929 Crash: "In a few months I expect to see the stock market much higher than today.”  Fisher subsequently took a $140 million bath.  John Maynard Keynes, the exalted inflationist, lost one million English pounds in the crash.  Mises, on the other hand, rejected a high position in one of Europe’s largest banks in the summer of 1929 because he foresaw a great crash coming and didn’t want his name in any way connected with it. [6]

Skousen is thus correct in saying both the monetarists and Austrians blame government for the Depression, but they do so for fundamentally different reasons.  Skousen’s attempt to make the Chicago approach sound compelling by claiming it was “empirical,” as opposed to the Austrians’ “qualitative” methodology, is puzzling at best.  Readers hungry for relevant charts and numbers will find an abundance of them in the Austrians’ presentations [3, 4], along with the explanations needed to make sense of them.

Let’s not forget we once had a government-hindered gold standard that was still strong enough to fuel a thriving economy and preserve the value of the dollar from one generation to the next.  As long as monetary matters are under control of government, we will never have sound money; and without sound money, our liberty is at the mercy of big-government crusaders.

Notes

1 Mark Skousen, Vienna and Chicago: Friends or Foes? Tale of Two Schools of Free-Market Economics, September 16, 2005

2 Ludwig von Mises, Gold Standard, September, 1981

3 Murray Rothbard, America’s Great Depression, The Ludwig von Mises Institute, Auburn, Alabama, 2000

4 Timberlake – Salerno Series in The Freeman: Ideas on Liberty:

(a) Richard Timberlake, Money in the 1920s and 1930s, April, 1999

(b) Richard Timberlake, Gold Policy in the 1930s, May, 1999

(c) Richard Timberlake, The Reserve Requirement Debacle of 1935-1938, June, 1999 

(d) Joseph T. Salerno, Money and Gold in the 1920s and 1930s: An Austrian View, October, 1999

(e) Richard Timberlake, Austrian “Inflation,” Austrian “Money,” and Federal Reserve Policy, September, 2000 

(f) Joseph T. Salerno, Inflation and Money: A Reply to Timberlake, September, 2000

(g) Richard Timberlake, Final Comment on Salerno’s Monetary Program, September, 2000

5.  Rothbard, p. 108

6. Hernán Cortés Douglas, What Macroeconomists Don’t Know, September 12, 2003.