Vienna musings

by Kurt Schuler March 30th, 2014 11:03 pm

Before I greatly reduce the frequency of my posts sometime in April, I have a backlog of items to unburden myself of. Here's one.

A month ago I visited Vienna briefly to attend a conference. I had a couple of hours free before the conference began, so I walked around the center of the city. I was particularly curious to see two places where Ludwig von Mises had lived, identified in Jörg Guido Hülsmann's sweeping biography. Alas, Mises's boyhood home, Friedrichstrasse 4, is undergoing renovation and has a big protective mesh over it to keep the plaster from falling on pedestrians. His later home, Wollzeile 24, is an undistinguished building that looks more modern than many others around it. I assume that was where Mises wrote The Theory of Money and Credit and Socialism, at least when he wasn't writing at the office. No plaque or other marker denotes the spot.

Ludwig von Mises and his brother Richard (later a renowned mathematician who became a professor at Harvard) attended the Akademische Gymnasium, Vienna's oldest and most famous high school. It is on the Beethovenplatz in a magnificent building. The alumni list includes Franz Schubert, Erwin Schödinger, and Lise Meitner (co-discoverer of nuclear fission, should have received the Nobel Prize in Physics), all of whom are listed on plaques on the front of the building. I didn't see any for the Mises brothers...apparently they were not famous enough to make the cut.

Thinking about Ludwig von Mises and his work, it occurred to me that he rarely covered the same ground twice. Many of his works had partly overlapping subjects, but if he touched on a subject again it was as part of a different enterprise. After The Theory of Money and Credit he wrote and later discussed monetary issues in monographs, essays, and other works (notably Human Action), but did not publish another full-length book on money.  I don' t know if Mises intended from the start to be a system-builder, but looking back on the books he published during his life makes it apparent that he covered a wide ground at the intersection of economics, political philosophy, and epistemology. It was not just a collection of problems that interested him; it was a group of topics that he considered vital for the future of civilization. Considered in that light, it is not so surprising that he did not publish a second full-length book on money; his time was too precious. As I have commented in a previous post, I do not think that Mises integrated his ideas on socialist calculation and his ideas on monetary theory as well as he could have. That was left to a later generation, starting with Larry White.

While I am on the subject of Vienna, I will mention this passage I recently found in Herbert Simon's book Models of My Life on Karl Menger, the mathematician son of Carl Menger the founder of the Austrian School of economics. Karl had the good sense to leave Europe for the United States in the 1930s. Eventually he ended up as a highly honored professor at the Illinois Institute of Technology (IIT) in Chicago, where Simon taught as a young man.

Toward the end of my career at IIT, I had a luncheon conversation with Karl Menger that I cannot forget. He had started his career, he said, with a deep interest in logic and the foundations of mathematics. The publication of Goedel’s famous Impossibility Theorem (1931) struck him a blow from which he never recovered. If it was impossible, as Goedel had shown, to provide wholly rigorous foundations for mathematics, what was the meaning of mathematical certainty? Menger never again worked on the foundations of mathematics. Even thinking about the subject depressed him, and as he recounted the story, he gradually subsided into a gloomy silence that continued through the lunch. (p. 101)

Aside from the interest the passage has as a record of the encounter of two brilliant minds, it struck me that this passage implies that there may be a couple of as yet unexploited sources of material on Carl Menger. Karl Menger the son had children who are American citizens and may still be alive.  Hülsmann's biography of Mises (pp. 103, 136) cites an unpublished paper by Karl about Carl in the Carl Menger papers at Duke University. Perhaps somebody interested in the history of the Austrian School can get on the telephone and try to find Carl's grandchildren, or great-grandchildren, to ask whether there is any oral history that would add to the written record?


Have we got your back?

by Kurt Schuler March 25th, 2014 10:36 pm

Here is my long promised, though not likely long anticipated, post on the “backing” theory of money.

The modern controversy over "backing" originates from this article by Neil Wallace and Thomas Sargent. In the article they offer “ a simple model that is compatible with the principle of finance theory that assets are valued according to the streams of returns that back them” and appear to endorse that principle as a basis for explaining the value of money.

“Backing” clearly applies to certain cases but to my mind it just as clearly cannot serve as a general explanation of the value of the monetary base without stretching the idea so far as to make it a metaphor so vague as to have little use.

Currency boards are cases where the idea of backing is useful. Currency boards are established to provide credibility for the local currency by backing their notes, coins, and deposit liabilities (if any) 100 percent or slightly more in high-quality foreign assets. In principle, 100 percent foreign reserve backing means that a currency board can liquidate almost immediately and exchange all of its notes, coins and deposits for foreign currency at the fixed exchange rate it maintains.

For central banks, the idea of backing is less useful as an explanation of why the currencies they issue have value. Central banks can become technically insolvent with little effect on the currency, as some in fact have. (For a discussion of central bank insolvency, see this paper by Willem Buiter. Maxwell Fry’s good book Money, Interest and Banking in Economic Development also treats the subject.) As an economist I met years ago said of such cases, “The assets of the central bank are garbage; the liabilities, everyone believes in.”

There are also cases where fiat monies continue to circulate and retain value even in the absence of any politically powerful issue. Such cases happen most often during or just after wartime, when, for instance, an occupying army that has lost the war withdraws and leaves its currency behind. For example, after World War I war ended, German occupation currency continued to circulate in what are now Poland and the Baltic states during a kind of interregnum. In such cases, if the new government does nothing to hinder the currency’s use, the currency can continue to circulate even though the original issuer will not redeem it for anything.

One can reply that in the cases of insolvent central banks, occupation currencies whose occupiers have left the scene, or other examples that may be given, the currency retains value because it is either backed by the assets of the whole of the government, not just the central bank, or that in the case of an occupation currency that people expect it to receive such backing from the new ruling government. To me, that is stretching the metaphor of backing to the point of useless vagueness. A fiat currency accepted by the government in payment of taxes is not “backed” by tax revenues or even by the general assets of the government in the sense that a currency board is backed by its reserves. Holders of the fiat currency cannot necessarily redeem it for any external asset at a set rate upon liquidation.

What is the alternative, then? It is that value is based on acceptability. An unbacked currency can retain its value if people continue, for whatever reason, to accept it in payment and to hold onto it as a store of value. Conversely, a fully backed currency may not be acceptable and may not serve as a true money. As I have mentioned in previous posts, it is legal for U.S. banks to issue notes, but I cannot imagine that a bank note issue denominated in Argentine pesos, fully backed with Argentine government bonds or even with Swiss bonds segregated from the bank’s other assets, would circulate in the United States.

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Mike Sproul has the right of a guest post in reply if he wishes to use it. After that, I may or may not offer a final comment. I am now busy with a book (on currency boards, not free banking) and other projects and will be for many months, so instead of posting approximately weekly, I will be far less frequent. Without intending it I became the most frequent contributor to the blog. The editors have received my ideas for continuing a flow of content, but it is up to them whether to keep up the flow or let the blog peter out.


Wrong Way Corrigan Strikes Again

by George Selgin March 19th, 2014 5:20 pm

Over at Zero Hedge, "Tyler Durden" reposts a piece by Sean Corrigan, the link to which appears to be non-working, in which Corrigan imagines that he is having a "Gotcha!" moment, at the expense of yours truly, because he has discovered some reputable authorities who claim that (commercial) banks are in fact capable capable of making loans above and beyond any sum of deposits they acquire.  Here are the first few paragraphs:

Of late there has been much breathless wonder expressed at the Bank of England’s supposedly ground-breaking release. ‘Money in the Modern Economy’, in which it argues – shock! horror! - that banks do not lend out previously received deposits, but that they create the latter ex nihilo by first making loans. Alas, as Gunnar Myrdal waspishly observed of Keynes himself, this has been a reaction plagued with the ‘unnecessary originality’ of those who don’t know their literature.

As an example, some few months ago, I had an exchange with the disputatious George Selgin (he of the perfervid fractional free banking bent) in which I cited – after a good twenty minutes’ research – the following authorities to that very same effect:-

Roepke from a footnote (p113) to his 1936 work, ‘Crises & Cycles’:

The process [of credit creation] is now clearly explained in any text-book on economics, banking or money (especially recommendable is Hartley Withers’ Meaning of Money). A fuller treatment may be found in the following books: R. G. Hawtrey, op. cit.; J. M. Keynes, A Treatise on Money, pp. 23-49 : C. A. Philips, Bank Credit, New York, 1920; W. F. Crick, “The Genesis of Bank Deposits,” Economica, June 1927, and F. A. von Hayek, Monetary Theory and the Trade Cycle, London,1933.


Without an understanding of this process and of its limitations, no real insight into the working of our banking system and, consequently, of our entire economic system seems possible, to say nothing of the mechanism of business cycles. There may still be many people who can no more believe the story of the genesis of bank money than they can believe the genesis of the Bible, but on the whole it now seems to be generally accepted. A last but hopeless attempt at disproving it has recently been made by M. Bouniatian, Credit et conjoncture, Paris, 1933. [Emphasis mine and apparently NOT the last!]

Or as Hayek indeed noted in ‘Prices and Production’ above his own lengthy footnote (pp 81-2):

The main reason for the existing confusion with regard to the creation of deposits is to be found in the lack of any distinction between the possibilities open to a single bank and those open to the banking system as a whole.

Actually, Sean, I can assure you that I've read them all, and carefully; what's more, I've probably taught several thousand students about the process of multiple deposit expansion, being careful in doing so to make precisely the distinction Hayek insists upon between what individual banks on one hand and the system as a whole on the other are capable of making doing with any fresh deposits.* In fact, no individual bank involved can lend more than a part--usually the greater part--(the "excess reserves") of whatever fresh funds it is able to secure. It is precisely your misunderstanding of Hayek's point that was, I am inclined to think, the nub of our original disagreement!

*Here FYI is a screenshot of the relevant page of the class notes I give to my students:



White and Selgin at Heritage on the Fed tomorrow

by Bradley Jansen March 18th, 2014 2:36 pm

Larry White and George Selgin and Jerry Dwyer will be speaking at the Heritage Foundation tomorrow.

The Federal Reserve at 100: How Well Has It Done?

Has the Federal Reserve functioned as it was intended? How well has the Fed managed the economy and calmed business cycles? Do its successes outnumber and outweigh its failures? Join us as leading experts address these and other important questions.

RSVP to attend in person or just watch online.