I'd like to introduce our next speaker. He is an honorary professor of economics at the
Frankfurt School of Finance and Management in Frankfurt, Germany. So he came a long ways
to participate in this conference and I'm thrilled to have him. He specializes in Austrian
monetary theory, capital market theory. He is an adjunct scholar with the Mises Institute.
speaking today on Fiat Money and Collective Corruption. Please help me welcome Thornton
Polite.
Ladies and gentlemen, thank you very much for the invitation. I really feel honored
to be here and to be part of today's Mises Circle event in New York City. In fact, I
If you fear that paper currency could be debased and perhaps not only be debased but destroyed, I could imagine that my talk will be of interest for you.
In fact, I will, in my talk, make a journey to the very heart of the problem.
I will present a theoretical explanation based on praxeology, showing why fiat money, as Ludwig von Mises told us, is an experiment that is said to fail, and necessarily so.
So, there is no means of avoiding the final collapse of a boom brought about by, and here
I may add, circulation credit expansion. The alternative is only whether the crisis should
come sooner as a result of a voluntary abandonment of further circulation credit expansion or
later as a final and total catastrophe of the currency system involved. These sentences
These were written by Ludwig von Mises in his magnum opus Human Action. What makes them
really special is the fact that they are logically inferred from the irrefutably true axiom of
human action, an a priori synthetic proposition as the great philosopher Immanuel Kant would
term it. Mises' words must be understood in the following way. If bank credit expansion
is increased further and further and the money stock is increased further and further, then
it is inevitable that the economic and monetary system will eventually collapse. This we can
say is apodictically true. It is logically inferred from the axiom of human action, which
in turn is at the heart of praxeology, the science of the logic of human action. Mises'
This insight is, and especially in view of the so-called credit market crisis, a rather
uncomfortable truth to many.
Austrian economics rests on Mises' praxeology, and it irrefutably shows that the root cause,
the root cause of the worldwide monetary and economic debacle, can be found in fiat money,
A fiduciary medium which is produced through bank circulation credit, credit that is not
backed by real savings. More precisely, the root cause can be found in the fact that governments
have monopolized money production, a system in which government officials, rather than
free markets, produce the money supply. Governments increase through bank circulation credit the
Money supply virtually out of thin air. Bank circulation credit lowers the market interest rate to below the rate level that would prevail if the credit supply was not artificially increased.
This in turn sets into motion an unhealthy economic boom. The economy starts living beyond its means and the saving consumption investment relation moves out of equilibrium.
Sooner or later, however, market agents try to move back their desired consumption-investment-saving relations back towards equilibrium.
The market interest rate is driven back from its artificially reduced level towards society's true time preference rate, thereby revealing that the boom has caused malinvestment on a grand scale.
The boom has turned into bust. Investment projects and jobs, which were created as a result of injecting additional credit and money, become unprofitable.
Malinvestment is liquidated, a process in which some firms and even banks default. Output falls and employment goes up.
The ensuing recession brings the economy back towards equilibrium.
However, governments don't allow this to happen, and in an effort to fight the recession,
central banks lower the interest rate further via bank circulation credit expansion, and
the boom and the bust is turned into another boom, causing an even greater distortion of
the economy's production structure.
This is a destructive policy, as the inevitable correction of the economic and monetary disequilibria
will be postponed and not only that. The final recession will be the more severe the longer
the correction had been prevented by further and further increases in circulation, bank
credit and money expansion. In fact, data can be used to illustrate the Austrian business
cycle quite nicely. This chart shows from the period 1960 to the end of 2009 total debt
in the United States of America, which rose from around 140% at the beginning of this chart towards more than 370% of GDP.
The rising trend of the total debt to GDP ratio started around the early 1980s, as you can see over here.
A development which was accompanied by a trend decline in the Federal Reserve fund rate.
In fact, this is a textbook illustration of the Austrian business cycle theory.
The central bank lowers interest rates further and further and the overall debt burden rises to higher and higher levels relative to income.
In fact, such a policy does not only prevent the liquidation of malinvestment,
It also induces additional credit finance investments which are provoked by artificially lowered interest rates.
And that might explain why over time the overall debt burden of the economies goes up under such a policy.
And I may add this is just a representation of the textbook example as outlined by the Austrian business cycle theory.
It can be illustrated in many other countries in the same way.
And because I'm from Europe, you may be interested to hear that the debt situation in Europe is not better than in the United States. In fact, it is worse.
If I would put together total debt outstanding, we would reach a level in Europe or the euro area which would exceed the 370% of GDP I showed you on this chart.
It needs to be emphasized here that under a government controlled fiat money regime, interest rates will be artificially suppressed and logically so.
They will necessarily be lower than the rate that would prevail in an unhampered market.
The expansion of bank circulation credit means pushing market interest rates to below the societal time preference rate.
And this in turn induces the boom period which I just referred to.
But now let us come to basically the core message of my talk.
As you know, fiat money regimes have been established the world over,
be it the US, Europe, Japan, even China, it is all fiat money.
And this finding provokes the question, why did this happen, especially in Western Europe?
Well, from an so-called a priori theory viewpoint an exact answer can be given. And the answer
is the adoption of fiat money is the logical outcome of public ownership of government.
So you may ask what is government? And I would like to share a definition given by Hans-Hermann
Hoppe notes, quote, a government is a territorial monopolist of compulsion, an agency which
may engage in continual institutionalized property rights violations and exploitation
in the form of expropriation, taxation and regulation of private property owners.
The defining characteristic of public ownership of government is therefore that the monopoly
privilege of expropriation is collectively owned and in practice the coercive capacity
is in the hands of the caretakers of public ownership of government, namely elected politicians.
The most prominent form of public ownership of government is democracy, republicanism,
In sharp contrast I may add that at this juncture to private ownership of government which is
represented by for instance feudalism or monarchy. The caretakers of public ownership of government
do not personally own the expropriation power of government but they can take advantage
of the income it yields. Now public ownership of government encourages, and this is important
Narrow Group Interest
The voters have every economic incentive to do so. The caretakers of public ownership of government in an attempt to secure the majority of the voters have a strong economic incentive in expanding policies of expropriating the typically few high productive income earners to the benefit of the typically large group of the less productive income earners.
In other words, public ownership of government will undermine people's encompassing interest in the market economy.
Public ownership of government reduces the economic incentive for the caretakers of coercive capacity to limit their aggression against individuals' private property.
A regime of public ownership of government raises people's interest in transfer incomes and increases society's time preference, compared with, for instance, private ownership of government or a libertarian societal order, which is characterized by the principle of non-aggression against private property.
Public ownership of government necessarily reduces savings and investment and thus weakens the economic progress.
And it is also a necessary development that under public ownership of government, commodity money, so gold or silver or copper money,
was, and we know from Murray Rothbard, in a very prolonged effort replaced by fiat money.
In fact, this development can be explained, as I noted earlier, by logical reasoning.
To start with, it should be noted that government acquires its revenues in a way that is diametrically opposed to the free market.
In a free market, people acquire goods and services through mutually beneficial transactions.
Government, however, means expropriating resources from the ruled.
Such a seizure is called taxation.
Taxing people tends to be politically unfavorable.
Well, governments do it, but it's still politically relatively unfavorable.
For the caretakers of government it is, economically speaking, much more convenient
if they can increase the money stock out of thin air.
By doing so they can acquire resources slightly and almost unnoticed provided the effects
of the issuance of the new money do not become too obvious.
So for instance if we just look at consumer price inflation because people tell us this
is inflation and we disregard the economic insight that inflation is a rise in the money
Money supply and necessarily so, then of course the government or its central bank can increase
the money stock and finance basically its outlays. The control over the money supply
actually increases the scope of government and gradisement and the financial benefits
for government collaborators well beyond the boundaries set under the free market. And
And free market money, I may add here, is necessarily commodity money. That is money,
of course, which cannot be expanded according to political expediency. Fiat money makes
it easy for the government to issue debt, through which resources can be transferred
from the private sector to the caretakers of government and its prodigies. If the rise
If this in the money supply is accompanied by the increase in government debt, the market
interest rate can be held low, at a lower level compared to a situation in which government
debt increases and the money stock remains unchanged.
As you know, the last remnants of commodity-based money were abolished when in August 1971,
US President Richard Nixon suspended the gold convertibility of the US dollar as a decision
which de facto brought the world an unfettered fiat money regime. Now, it would be premature,
however, to draw the conclusion that fiat money, once established, would be upheld solely
because of the economic interest of the ruling class or government and at the expense of
of the Class of the Ruled. In fact fiat money once established increasingly finds its supporters
among the electorate. Mises held public opinion responsible for repeated increases in the bank
circulation credit supply, especially so in times when the harmful effects of fiat money
come to the surface. He wrote, I quote, in the opinion of the public, more inflation
and more credit expansion are the only remedy against the evils which inflation and credit
expansion have brought about. However, why is public opinion in favor of inflation in
the first place? Mises' answer was, quote, that public opinion could favor spurious ideologies
whose realization would harm welfare and well-being and disintegrate social cooperation.
So, to Mises, false economic theories are at the heart of the recurrence of boom and bust
and the ultimate collapse of the fiat money system.
Here, however, I would like to add that individuals' economic incentives can also be identified
to be at the heart of the malaise. In fact, one could argue that fiat money leads to collective corruption.
Well, corruption can be understood as an invasion of an individual's property rights by deliberate action of others,
thereby impairing people's virtues and moral principles.
It is easy to see, in fact, that fiat money, once established, leads to collective corruption.
Just to give you an example, let me start by saying that people embark upon careers in industries which are artificially boosted or even created through fiat money expansion.
And so income earners develop a vital economic interest in a policy that keeps the artificial boom going, otherwise they would lose their jobs or even experience a devaluation of their human capital.
People invest their savings in bank and corporate bonds, bonds that were issued for financing investment projects provoked by an increase in fiat money.
And so investors will develop a vital interest in keeping the artificial fiat money-fueled boom going.
Otherwise they would run the risk of their investment decision taking a bad turn.
Government revenues and handouts to government prodigies become dependent on ever greater amounts of fiat money, through which incomes and as a result tax revenues are stimulated.
And the greater the number of people benefiting from government and the fiat money system, the stronger will be the public support of upholding such a system.
It therefore becomes clear that once people have developed economic stakes in an economy which has become increasingly deformed by fiat money, collective corruption will be the inevitable result.
People will develop a growing vital interest in upholding the fiat money system, virtually at all costs.
From an individual's viewpoint, the hope for economic benefits of adhering to the fiat money boom can easily exceed the perceived costs of such a preference in the form of inflation, distortion of market price, malinvestment and undermining people's integrity and moral values.
In other words, fiat money fuels collective corruption and it creates resistance against correcting the economically and socially highly destructive effects resulting from fiat money.
Collective corruption may explain why a reform of the fiat monetary order, once put into place, faces such high, perhaps insurmountable hurdles.
Collective corruption results from interventionism.
Interventionism means that the government interferes with the workings of the free market.
Under interventionism, government, I quote Mises,
forces the entrepreneur and the owner of the means of production
to use the means in a way different from what they would do under the pressure of the market.
In his book Interventionism, Mises explained that market interventionism is not a lasting system of economic organization.
He wrote, quote, If governments do not give them up and return to the unhampered market economy,
if they stubbornly persist in the attempt to compensate by further and further interventions for the shortcomings of earlier interventions,
Interventions, they will find eventually that they have adopted socialism. The curse of interventionism is that once the undesirable effect of interventionism come to the fore, such as recession, unemployment, stock market crashes, etc., more of the same follows, quoting Mises, popular opinion ascribes all these evils to the capitalistic system as a remedy for the undesirable effects of
In the effects of interventionism, they ask for still more interventionism. They blame capitalism for the effects of actions of government which pursue an anti-capitalistic policy.
And so Mises concluded, quote, mankind has a choice only between the unhampered market economy, democracy and freedom on the one side and socialism and dictatorship on the other side.
A third alternative, an interventionist compromise, is not feasible.
Ladies and gentlemen, now we have come full circle.
It should be clear by now that collective corruption is a result of interventionism
and that today's fiat money regimes are manifestations of interventionism in monetary affairs
caused by public ownership of government with far-reaching destructive effects on the free market society.
The current so-called credit market crisis is an illustration of Mises' conclusion based on praxeology,
so strong epistemological foundation, that a government fiat money regime must fail.
And it is fair to say that it is the collective corruption factor that has so far prevented the system from collapsing.
Governments in a desperate effort to prop up the financial industry have guaranteed bank liabilities to restore and strengthen investor confidence.
Central banks have lowered interest rates to record lows and have started to provide banks with ever greater amounts of central bank money, of course in an effort to restore financial institutions back to health.
More recently, however, and especially in Europe, it is government credit itself, the very last pillar on which investor confidence rests, that has become subject to investor scrutiny, and it is here that things could take a new turn.
As soon as governments, which chronically rely on issuing ever-great amounts of debt, can no longer get funds in the free capital markets or borrowing rates are too high, central banks are most likely to step in.
Central banks will either loan directly to governments or start purchasing government bonds in the free market, that is, in the primary market or in secondary market.
Whatever it takes, central banks will presumably provide governments with the amount of credit and money needed.
And this in turn includes keeping the commercial banking system afloat by purchasing troubled assets or extending new central bank money loans to them.
But sooner or later, such a monetary policy will lead to a fixing of government bond and bank debaucher prices in the free market.
A policy of price fixing, implying that central banks will buy any amount of bonds necessary to keep interest rates at periodically politically desired levels, and that is artificially low levels.
And by the way, such a period could already be observed. In the period 1942 until 1951, the Federal Reserve pursued a kind of policy called fixing the long-term interest rate.
The Federal Reserve basically kept the 10-year treasury yield between 2.5% and 3% by purchasing any amount necessary to achieve that goal.
And the consequence was that market interest rates remained at fairly suppressed levels,
but the money supply increased strongly because the Fed bought the bonds by issuing new money,
and consumer prices sooner or later went up and that caused investors to accept substantially high levels of negative interest rates.
Of course, all such measures won't solve the underlying problem. In fact, such policies lead to impoverishment and they are capital consumption.
They make things worse and as was said earlier, it is not possible to create something by increasing the credit and money supply or redistributing wealth among the people.
Such policies will ultimately lead to high inflation and I brought a graph with me which some of you may like.
It shows the price of one ounce of gold in national paper currencies starting in the early 1970s.
And as you can see, for instance over here, I put all the series to 100, so the series were indexed to January 1971.
So in 1971 we had to give 100 units of the US dollar for 1 ounce of gold and that price went up to close to 1800 in the early 1980s and nowadays you pay an equivalent of more than 3000 units of the US dollar.
What this graph shows you is the underlying trend you can observe in global financial markets is all fiat currencies are in the process of getting devaluated against the ultimate means of payment.
And by the way, this process hasn't started with the subprime crisis, around about 2007, 2008. It has started with the bursting of the new economy boom.
You remember at the beginning of 2001, round about, the Federal Reserve and other central banks started cutting interest rates basically to unprecedented low levels and that policy was basically adopted all over the globe.
In view of the gigantic debt burdens in many countries, various currency will presumably not only be debased but perhaps completely destroyed, severely eroding of what little is left of the free market societal order.
The global financial debacle is a testimony to what Mises and his followers have stated on the basis of praxeology, namely the failure of government controlled fiat money and it is high time to seek a fundamental monetary reform, the return to free market money, the privatization of the production of money.
For this to happen, however, false economic theories have to be exploded, as Mises knew.
And that is quoted from a piece he basically finalized in January 1923, basically a couple
of months before the German hyperinflation took off.
The German hyperinflation basically took off around about June, July 1923 and it ended
in November the same year, so it was basically a very short period.
And Mises came forward with this piece in January of that same year, quite remarkable.
He wrote, the belief that a sound monetary system can once again be attained without
making the adequate changes in the mindset of the people is implausible.
So Mises knew that a change in the monetary order would require the abandonment of inflationary
policies, inflationary teachings, otherwise the chance of getting back to a solid and
sound monetary system would be rather low. Of course, from a praxeological viewpoint,
there's hardly any chance that today's fiat monies will escape a severe debasement of
their purchasing power and one cannot exclude that some of them will basically get destroyed
destroyed in the process. The hope is, however, that the teachings of sound economics, and
that is Austrian economics, that people will understand why today's fiat moneys have failed
so that governments won't succeed in erecting new fiat moneys on the ruins of failed fiat
moneys. Thank you very much for your attention.
Thank you very much.