1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar
Source link: http://archive.mises.org/6615/lionel-robbins-the-great-depression/

Lionel Robbins: The Great Depression

May 11, 2007 by

The Great Depression is a full-scale Austrian explanation of the Depression. It came out in 1934. Here it is in pdf.

The conditions of recovery which have been stated do indeed involve the restoration of what has been called capitalism. But the slump was not due to these conditions. On the contrary, it was due to their negation. It was due to monetary mismanagement and State intervention operating in a milieu in which the essential strength of capitalism had already been sapped by war and by policy. Ever since the outbreak of war in 1914, the whole tendency of policy has been away from that system, which in spite of the persistence of feudal obstacles and the unprecedented multiplication of the people, produced that enormous increase of wealth per head which was characteristic of the period in which it was dominant. Whether that increase will be resumed, or whether, after perhaps some recovery, we shall be plunged anew into depression and the chaos of planning and restrictionism—that is the issue which depends on our willingness to reverse this tendency….

All over the world, Governments to-day are actively engaged, on a scale unprecedented in history, in restricting trade and enterprise and undermining the basis of capitalism. Such a policy is not confined to the Socialists. Indeed the political power of the socialist parties in many parts of the world may be said to be waning. But their opponents, the dictators and the reactionaries, are inspired by the same ideas. I t is a complete misapprehension to suppose that the victory of the Nazis and the Fascists is a defeat for the forces making for the destruction of capitalism. They have the same fanatical hatred of economic liberalism, the same hopes of a planned society. The differences are hierarchical. In Germany it is a crime deserving of torture or exile to be a Jew; in Russia to possess two cows. In our own more tranquil community the differences are equally non-economic. No doubt to their respective friends and colleagues it seems to make a world of difference whether agriculture is planned by Major Elliot or Dr. Addison. From the economic point of view there is continuity of policy. Such policies, as we have seen, have a cumulative tendency. They lead to an order of society which is likely to be less stable, less free, less productive, than our own.


Dennis May 11, 2007 at 12:05 pm

This is another important work that largely was relegated to the Orwellian memory hole as a result of the Keynesian revolution, or more accurately the Keynesian retrogression.

Interestingly, Robbins’s comments regarding the policies that virtually all governments were already implementing lends great support to the thesis that Keynes’s “General Theory” did not advance economic science but rather provided a pseudo-intellectual justification for these policies.

Paul Marks May 11, 2007 at 12:14 pm

Sadly Robbins sold out on most of this later. Going along with the “New Economics” of Lord Keynes.

Robbins spend the last years of his life arguing for government subsidies for higher education (for example in the infamous “Robbins Report” which tried to justify the creation of a lot of new governement universities). Of course depending on government for money has led to the present situation where British academics spend much of their time form filling for the government.

Dennis May 11, 2007 at 12:19 pm

I should also add that Keynes’s “General Theory”, while contributing nothing to the advancement of accuracy and truth in economic science, did greatly contribute to increasing the power, prestige, and employment opportunities of those in the economics profession (as distinct from those pursuing economics as a vocation).

OH May 11, 2007 at 2:56 pm

Fantastic! My sincere thanks!


miller May 12, 2007 at 5:23 pm

bring back the old books by Hayek — Prices and Production, The Pure Theory of Capital.

Antony Mueller May 12, 2007 at 6:46 pm

You can access these Hayek books at “www.continentaleconomics.com”

Björn Lundahl May 12, 2007 at 9:36 pm

Today central banks around the world have “inflation targets” or the objectives of keeping inflation (inflation defined as decreases of the purchasing power of money) around 2% yearly.

I do believe that the origin of these policies during the post-war period can be derived from the influence of Milton Friedman during the 70s and 80s. The means and objectives of the central banks are not exactly what Friedman once proposed as he wanted zero inflations and monetary rules, but they are similar as they focus on central banks as the determinants of inflation and therefore also monetary policy. The “pioneering” countries of such inflation targeting were Germany and Switzerland.

Some people declare Monetarism dead but they miss the very point, Monetarism is stronger than ever and, de facto, this theory powerfully influences central banker’s monetary policy around the globe.

The years just before the breakthrough of Milton Friedman and Monetarism, I spotted the following.

A/ A general ignorance among central bankers and economists that inflation is a monetary phenomenon.

B/ Fiscal policy and not monetary policy were considered the main instrument to promote economic stability. The main focus was not, therefore, on central banks.

C/ Central banks did not enjoy the independence from parliaments as they do today.

D/ Floating exchange rates were considered something exotic and unknown as an instrument in balancing payments between nations.

Today the story is quite different and all of mentioned points have changed because of Milton Friedman and Monetarism.

Keynesianism is played in a playing field apart from reality and the real world and fiscal policy has nothing to do with the business cycle at all. Keynesians do believe, naturally, that fiscal policies highly influence the business cycle but they are utterly wrong and live in some kind of dream world wholly apart from reality.

Monetarism is different as it focuses on monetary policies. It does it superficially, but still the Monetarists see a connection between monetary policy, inflation and the business cycle. The Austrian business cycle theory is the correct one and its implementations of a 100% gold reserve money standard would eliminate the business cycle once and for all, but despite this fact, it is not excluded that monetary policies around the world guided with the aim of about 2% inflation annually and a steady growth of money could keep business cycles relatively small and hinder the occurrence of depressions.

To put it another way; mentioned policies could actually keep a firewall around the fires and destructiveness that central banker’s and fractional reserve banker’s cause and in doing so might be quite effective.

It is not impossible that we will enjoy relatively stability and also have done so already without eliminating the very cause of business cycles.

The Federal Reserve:

“Remarks by Governor Ben S. Bernanke
At the Annual Washington Policy Conference of the National Association of Business Economists, Washington, D.C.
March 25, 2003

A Perspective on Inflation Targeting

One of the more interesting developments in central banking in the past dozen years or so has been the increasingly widespread adoption of the monetary policy framework known as inflation targeting. The approach evolved gradually from earlier monetary policy strategies that followed the demise of the Bretton Woods fixed-exchange-rate system–most directly, I believe, from the practices of Germany’s Bundesbank and the Swiss National Bank during the latter part of the 1970s and the 1980s.”


“The Library of Economics and Liberty

An Interview with Milton Friedman

Russ Roberts: I was an undergraduate and a graduate in the 1970s and my textbooks at the undergraduate level—not the graduate level, because I attended a small university in the Midwest I think you used to have an affiliation with, the University of Chicago—but as an undergraduate, my textbooks talked about all the different theories of inflation—cost push, cost pull, the role of unions, the role of industrial concentration and, of course, the possibility that Milton Friedman, this maverick thinker was right, that money had something to do with it.

It’s my impression that’s not true anymore; that the intellectual environment understands today that inflation is caused by a rapid growth in the money supply.

Milton Friedman: I think it does. I think that’s clear and the last 30 years, last 20 years I should say, has done a great deal to rub that in because every central bank has come to accept the view that it’s responsible for inflation.

Russ Roberts: And you’re suggesting that the Monetary History was the beginning of a revision toward a different perspective.

Milton Friedman: Well, I don’t know. On the ideological side, there were other things at work. Hayek’s Road to Serfdom, which was published in 1945 made the ideological case. I don’t know what role the Monetary History played in the public at large but in terms of the monetary authorities, in terms of money, there’s no doubt that it played a considerable role.

Russ Roberts: And that chapter on the Great Depression must have alarmed them greatly about their potential for doing harm.

Milton Friedman: Exactly, exactly.

Russ Roberts: Focusing on the central bank role, going back again to the ’70s when I was in school and shortly after your book came out, the focus was on the money supply—the quantity of money, counting it, controlling it through open market operations.

Something changed in the last 25 or 30 years. That’s not what Alan Greenspan or Ben Bernanke talk about. They talk about other things and they play with that short-term interest rate, not the so-called stock of money that you focused on so intensely in the book.

Milton Friedman: That’s what the talk about but that’s not what they do.

Russ Roberts: What do they do?

Milton Friedman: They use the short-term interest rate as a way of controlling the quantity of money. If you look at the statistics, the rate of change of the quantity of money from month to month, quarter to quarter, year to year, it has never been so low as it has been over the last 20 years.

I don’t believe there’s another 20-year period in the history of the country in which you can find so steady a rate of growth in the quantity of money and that can’t all be an accident. That’s because they use the short-term interest rate. Look at it in the simplest possible way.
The Fed says the short-term interest rate should be 4.5 percent. How do they keep it there? By buying and selling securities on the open market. Now you’re Mr. Bernanke; you’re Mr. Greenspan. You’re watching that. And with the current short-term interest rate, you find that the quantity of money is starting to creep up more rapidly than you really want. Well, then you will tend to be favorable to raising to a higher rate of interest.

At that higher rate of interest, the demand for money is less and so the supply of money under that phenomenon, instead of having to sell government bonds to keep it there, they have to buy government bonds to keep it there or vice versa. Maybe I’m getting it mixed up. But in any event, the short-term interest rate is a tool with which you can control the quantity of money.

Russ Roberts: But they don’t talk about it that way.

Milton Friedman: No, they don’t talk about it that way.

Russ Roberts: Why do you think that is? Do you have any idea?

Milton Friedman: I don’t know. I’ve always been puzzled by why they insist on using the interest rate rather than the quantity of money.
If you really carried out the logic concerning the quantity of money, you deprive the Federal Reserve of anything to do. Suppose the Federal Reserve said it was going to increase the quantity of money by 4 percent a year, year after year, week after week, month after month. That would be a purely mechanical project. You could program a computer to do that.

Russ Roberts: Like an indexed mutual fund takes away the fun of being a fund manager.

Milton Friedman: Right. That’s part of the reason. But the main reason, I think, is different. It’s that the central bank associates with banks. It regards itself as sort of a mentor of the banking system and, to the individual bank, it doesn’t believe it creates a quantity of money. That doesn’t make any sense to them.

What they deal with are interest rates and therefore, it’s natural and so many of the central bankers are themselves from the banking industry. They’re bankers. And so it’s natural for them to think in terms of interest rates and, moreover, when they think in terms of interest rates, they’ve got all kinds of interest rates—short-term interest rates, long-term interest rates—all kinds of excuses for exercising power or thinking they’re exercising power.

Russ Roberts: Taking credit for exercising power.

Milton Friedman: I’ve always been in favor of abolishing the Federal Reserve and substituting a machine program that would keep the quantity of money going up at a steady rate.

Russ Roberts: And over the last 20 years or so, they’ve approximated that.

Milton Friedman: Come closer to approximating it. Absolutely.

Russ Roberts: And I would argue, and I assume you would as well, that the relative stability of the U.S. economy over the last 20 years is a reflection of that steady growth in the money supply.

Milton Friedman: I think there’s no doubt at all.

Russ Roberts: The non-erratic path.

Milton Friedman: It’s a golden period. It’s a period in which you had declining inflation but a fairly steady rate, a steady level. You had only three recessions, all of them brief, all of them mild. I don’t believe you can find another 20-year period in American history. But it’s interesting to note that so far as the international acceptance of monetary control is concerned, it was started by the Bank of New Zealand, not by the Federal Reserve Bank.

It was some time in the 1980s when New Zealand essentially came close to privatizing its central bank. It set up a situation in which the governor of the Central Bank of New Zealand had a contract with the government in which he agreed to keep the price level—inflation—within a certain bound; 0 to 3 percent or 0 to 2 percent. And if he did not do so, he could be fired.

Russ Roberts: Not decapitated, merely fired.

Milton Friedman: Merely fired.

Russ Roberts: But it still concentrated his mind sufficiently.

Milton Friedman: Oh, yes. And Don Brash was appointed as the first governor of the Central Bank of New Zealand. He’s now the leader of the opposition in the New Zealand Parliament. But at the time, he came from business. He was a businessman and he is an extraordinarily able and effective fellow and he took this job on at the time when New Zealand had a very high inflation rate and he succeeded in living up to his contract.

And that really set the pattern. It was the New Zealand experience, I’m sure, that had more to do with other central banks around the world adopting inflation targeting than the United States experience.

Russ Roberts: Because it was so dramatically effective in New Zealand?

Milton Friedman: It was the first time that anybody had explicitly adopted an inflation target. So that was something that everybody observed. And, secondly, it was so dramatically effective.

Russ Roberts: So are you optimistic about the role the central bank will continue to play in that inflation and price level story? You said we’ve had a golden era of 20, 25 years of stable prices, steady growth with only minor—by historical standards—minor recessions. Are you optimistic about the next 25 years?

Milton Friedman: I have great difficulty not being optimistic about it. All the evidence would seem to be optimistic. On the other hand, I can’t hold back a doubt. Governments want to spend money and sooner or later, governments are going to want to spend money without taxing it and the only way to do that is to print money—to create inflation.
Inflation is a form of taxation. How long will governments be able to resist the temptation? And particularly as people become adjusted to being in a world of stable inflation. They will be bigger suckers as it were. It will be easier to get a lot out of it. If everybody anticipated inflation, you couldn’t get anywhere by inflating.

Russ Roberts: But once you get people lulled into the expectation of a lack of it, there’s the potential to exploit it. Let me ask the question in a different way. A lot of people credit Alan Greenspan with the expansion and success. They give Paul Volcker some credit as well at the early part of this period that we’re talking about.
But they make it sound like the key to success in monetary policy is you just got to get the right person in the job. When Ben Bernanke or whoever is following him comes in, there’s this absurd microscopic examination of the aura and vapors around such a person. And you’re suggesting it really has nothing to do with it.

Milton Friedman: Well, how is it that New Zealand can do it. How is it that Australia can do it. How is it that Great Britain can do it. These are all countries which followed New Zealand. New Zealand started it. But then Australia and Great Britain also adopted inflation targeting.”


The Central Bank of Iceland:

Inflation target

The Central Bank of Iceland’s main objective is price stability, defined as a 12-month rise in the CPI (Consumer Price Index) of 2½%.


Sveriges Riksbank (The Swedish Central Bank):

“The objective of monetary policy

According to the Sveriges Riksbank Act, the objective of monetary policy is to “maintain price stability”. The Riksbank has interpreted this objective to mean a low, stable rate of inflation.
More precisely, the Riksbank’s objective is to keep inflation around 2 per cent per year, as measured by the annual change in the consumer price index (CPI). There is a tolerance range of plus/minus 1 percentage point around this target. At the same time, the range is an expression of the Riksbank’s ambition to limit such deviations. In order to keep inflation around 2 per cent the Riksbank adjusts its key interest rate, the repo rate.”


ECB (European Central Bank)


The primary objective of the ECB, and the wider ESCB, is “to maintain price stability” within the euro area, i.e., to keep inflation low. The present target is to keep inflation below, but close to, 2%.”


Bank of England:

“A principal objective of any central bank is to safeguard the value of the currency in terms of what it will purchase. Rising prices – inflation – reduces the value of money. Monetary policy is directed to achieving this objective and providing a framework for non-inflationary economic growth. As in most other developed countries, monetary policy operates in the UK mainly through influencing the price of money – the interest rate. In May 1997 the Government gave the Bank independence to set monetary policy by deciding the level of interest rates to meet the Government’s inflation target – currently 2%.
Low inflation is not an end in itself. It is however an important factor in helping to encourage long-term stability in the economy. Price stability is a precondition for achieving a wider economic goal of sustainable growth and employment. High inflation can be damaging to the functioning of the economy. Low inflation can help to foster sustainable long-term economic growth.”


Bank of Canada:

“The Bank of Canada aims to keep inflation at the 2 per cent target, the midpoint of the 1 to 3 per cent inflation-control target range. This target is expressed in terms of total CPI inflation, but the Bank uses a measure of core inflation as an operational guide. Core inflation provides a better measure of the underlying trend of inflation and tends to be a better predictor of future changes in the total CPI.”


Reserve Bank of New Zealand:

“The Reserve Bank’s primary function, as defined by the Reserve Bank of New Zealand Act 1989 is to provide “stability in the general level of prices.””

“The Reserve Bank Act requires that price stability be defined in a specific and public contract, negotiated between the Government and the Reserve Bank. This is called the Policy Targets Agreement (PTA). The current PTA signed in September 2002, defines price stability as annual increases in the Consumers Price Index (CPI) of between 1 and 3 per cent on average over the medium term. Previously, price stability was deemed to be 0 to 3 per cent inflation over 12 months.”


Reserve Bank of Australia:

“Since 1993, these objectives have found practical expression in a target for consumer price inflation, of 2-3 per cent per annum. Monetary policy aims to achieve this over the medium term and, subject to that, to encourage the strong and sustainable growth in the economy. Controlling inflation preserves the value of money. In the long run, this is the principal way in which monetary policy can help to form a sound basis for long-term growth in the economy.”


The Swiss National Bank (SNB):

“The National Bank equates price stability with a rise in the national consumer price index (CPI) of less than 2% per annum.”



Inflation Targeting and the IMF

Prepared by Monetary and Financial Systems Department, Policy and Development Review

Department, and Research Department1

Approved by Mark Allen, Ulrich Baumgartner, and Raghuram Rajan

March 16, 2006


Björn Lundahl

TLWP Sam May 12, 2007 at 11:28 pm

Is that 2% (or so) monetary expansion gross or net? It’s interesting to hear that 2% to 3% more gold is injected into the world’s supply every year. Yet this would be a gross figure as people also consume gold as well. Then again if I were to take a wild stab at the overall net inflation of gold thanks to mining I’d personally only take into account usages in which the gold used is ultimately no longer seriously recoverable. Dentistry? Electronics? High-end Microscopy? You know, just wondering?

Björn Lundahl May 13, 2007 at 4:04 am


Mentioned 2% increases of the supply of money that central bankers targets are net increases and world gold production is irrelevant regarding the supply of money as the world money supplies are not backed and redeemable into gold. By the way, cutting the link between gold and money was also something which Milton Friedman recommended and which governments and central bankers later followed.

Apart from this I wouldn’t have the slightest idea if world gold production is gross or net figures.

I would like to add this to my comment as the link I delivered to The Swiss National Bank (SNB) is no longer in use:

The Swiss National Bank (SNB):

“Price stability

Price stability is an important condition for growth and prosperity. Inflation and deflation are inhibiting factors for the decisions of consumers and producers; they disrupt economic activity and put the economically weak at a disadvantage. The SNB equates price stability with a rise in the national consumer price index of less than 2% per annum. Monetary policy decisions are made on the basis of an inflation forecast and implemented by steering the three-month Libor.”




Björn Lundahl

Björn Lundahl May 13, 2007 at 4:40 am

A little more regarding ECB which also might increase the insight concerning the tremendous influence Monetarism and the ideas of Milton Friedman have on central bankers in the world of today.

ECB (European Central Bank)

“Quantitative definition of price stability

The ECB’s Governing Council has defined price stability as “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Price stability is to be maintained over the medium term”.

The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.”


“Inflation – a monetary phenomenon

In the long run a central bank can only contribute to raising the growth potential of the economy by maintaining an environment of stable prices. It cannot enhance economic growth by expanding the money supply or keeping short-term interest rates at a level inconsistent with price stability. It can only influence the general level of prices.

Ultimately, inflation is a monetary phenomenon.
Prolonged periods of high inflation are typically associated with high monetary growth. While other factors (such as variations in aggregate demand, technological changes or commodity price shocks) can influence price developments over shorter horizons, over time their effects can be offset by a change in monetary policy.”


Björn Lundahl

TLWP Sam May 13, 2007 at 7:15 am

Oh OK. Thanks. ;D

TLWP Sam May 13, 2007 at 7:33 am

Well, of course, I was hinting that in a gold-coin currency more gold-mining would be inflating the currency. Anyone with their gold stashed in a shoebox under the mattress would really be cringing if new and better mining technology came along or if a new gold site was found because they’d know that ultimately there was going to be gold monetary inflation. ‘Cause I read about one place that new whiz-bang nanotechnology which could recover metals (including gold) from very low grade source dirt potentially ending the law of diminishing returns from the current mining methods. But then again you can’t go believe everything you read on the Net either. You know, just saying and stuff.

Björn Lundahl May 13, 2007 at 10:55 am


“Well, of course, I was hinting that in a gold-coin currency more gold-mining would be inflating the currency.”

I suspected also that you were, but you never know.

Historically, prices of goods and services fell (deflation defined as increases of the purchasing power of money) during the gold standard period. This could of course be altered (if we would adopt a gold standard again) as this is not a praxeological fact.

In addition to this I would also like to mention that increases of gold supplies under a gold standard would not either cause business cycles as only small parts of the new supplies would reach the banking sector before reaching other parts of society.

Increases of money supplies managed by the fractional reserve banks or by the central banks starts in the fractional reserve banking sector and afterwards spreads to other parts of society. This process lowers initially the rate of interest and misleads businessmen to invest as if savings have increased and starts also, therefore, the boom phase.

This link which I have already posted, leads to a video film which illustrates a practical example of how central banks increase the supply of money through the fractional reserve banks. In this case it is The Swiss National Bank (SNB):


Still, in the short run the U.S. Congress should legislate a monetary framework, that also should be a section of the U.S. Constitution, and which would force the Federal Reserve to pursue a monetary policy that leads to a 2% inflation rate per year.

It should be politically feasible as so many nations have already done this. Implicitly the Federal Reserve follows this policy but the governing board could change their minds at any time in the future.

“Better to have something than nothing.”

Björn Lundahl

lester May 13, 2007 at 11:13 am

bjorn- you must be more precise in your responses. this forum is for economics, not stand up comedy

Björn Lundahl May 13, 2007 at 11:43 am

Business cycles and the free market, America’s Great Depression, by Murray Rothbard:

“The potential range of such cyclical effects in practice, of course, is severely limited: the gold supply is limited by the fortunes of gold mining, and only a fraction of new gold enters the loan market before influencing prices and wage rates. Still, an important theoretical problem remains: can a boom–depression cycle of any degree be generated in a 100 percent gold economy? Can a purely free market suffer from business cycles, however limited in extent? One crucial distinction between a credit expansion and entry of new gold onto the loan market is that bank credit expansion distorts the market’s reflection of the pattern of voluntary time preferences; the gold inflow embodies changes in the structure of voluntary time preferences. Setting aside any permanent shifts in income distribution caused by gold changes, time preferences may temporarily fall during the transition period before the effect of increased gold on the price system is completed. (On the other hand, time preferences may temporarily rise.) The fall will cause a temporary increase in saved funds, an increase that will disappear once the effects of the new money on prices are completed. This is the case noted by Mises.

Here is an instance in which savings may be expected to increase first and then decline. There may certainly be other cases in which time preferences will change suddenly on the free market, first falling, then increasing. The latter change will undoubtedly cause a “crisis” and temporary readjustment to malinvestments, but these would be better termed irregular fluctuations than regular processes of the business cycle. Furthermore, entrepreneurs are trained to estimate changes and avoid error. They can handle irregular fluctuations, and certainly they should be able to cope with the results of an inflow of gold, results which are roughly predictable. They could not forecast the results of a credit expansion, because the credit expansion tampered with all their moorings, distorted interest rates and calculations of capital. No such tampering takes place when gold flows into the economy, and the normal forecasting ability of entrepreneurs is allowed full sway. We must, therefore, conclude that we cannot apply the “business cycle” label to any processes of the free market. Irregular fluctuations, in response to changing consumer tastes, resources, etc. will certainly occur, and sometimes there will be aggregate losses as a result. But the regular, systematic distortion that invariably ends in a cluster of business errors and depression—characteristic phenomena of the “business cycle”—can only flow from intervention of the banking system in the market.”


Björn Lundahl

Björn Lundahl May 13, 2007 at 11:51 am

The purchasing power of money, the gold standard and fiat money

If the gold supply will, on the average, increase as much as total output in a 100% gold reserve money standard or not, is not a praxeological fact but a speculation. It might be a relatively good speculation, but it still is a speculation. Technological advancements that favour increased gold supplies have, of course, been going on since the beginning of the industrial revolution.

Historically, prices have on the average fallen when economies were on a gold standard and those economies were not even based on a 100% gold reserve money standard.

Deflation defined as increases of the purchasing power of money is not, at all, harmful for the society and the economy.

Rothbard saw falling prices as a natural condition of a market economy, For a New Liberty:

“Thus, falling prices are apparently the normal functioning of a growing market economy.”
“And, indeed, if we look at the world past and present, we find that the money supply has been going up at a rapid pace. It rose in the nineteenth century, too, but at a much slower pace, far slower than the increase of goods and services; but, since World War II, the increase in the money supply—both here and abroad—has been much faster than in the supply of goods. Hence, inflation.”


Now when another masterpiece has been added to the great family of books in Austrian economics with the title “Money, Bank Credit, and Economic Cycles” written by Jesús Huerta De Soto, I am pleased to quote the author’s comment about the purchasing power of money under 100% gold reserve money standard page 776:

“Consequently one aspect we can foresee is that in the proposed model, nominal interest rates would reach historically low level. Indeed, if on average we can predict an increase in productivity of around 3 percent and growth in the world’s gold reserve of 1 percent each year, there would be slight annual “deflation” of approximately 2 percent.”

And on page 777:

“The model of slight, gradual, and continues “deflation” which would appear in a system that rests on a pure gold standard and a 100-percent reserve requirement would not only not prevent sustained, harmonious economic development, but would actively foster it.”

I quote from the book “Democracy The God That Failed”, by Hans-Hermann Hoppe, page 58:

“During the monarchical age with commodity money largely outside of government control, the “level” of prices had generally fallen and the purchasing power of money increased, except during times of war or new gold discoveries. Various prices indices for Britain, for instance, indicate that prices were substantially lower in 1760 than they had been hundred years earlier, and in 1860 they were lower than they had been in 1760. Connected by an international gold standard, the development in other countries was similar. In sharp contrast, during the democratic-republican age, with the world financial center shifted from Britain to the U.S. and the latter in the role of international monetary trend setter, a very different pattern emerged. Before World War I, the U.S. index of wholesale commodity prices had fallen from 125 shortly after the end of the War between the States, in 1868, to below 80 in 1914. It was then lower than it had been in 1800. In contrast, shortly after World War I, in 1921, the U.S. wholesale commodity price index stood at 113. After World War II, in 1948, it had risen to 185. In 1971 it was 255, by 1981 it reached 658 and in 1991 it was near 1,000. During only two decades of irredeemable fiat money, the consumer price index in the U.S. rose from 40 in 1971 to 136 in 1991, in the United Kingdom it climbed from 24 to 157, in France from 30 to 137, and in Germany from 56 to 116.

Similarly, during more than seventy years, from 1845 until the end of World War I in 1918, the British money supply had increased about six-fold. In distinct contrast, during the seventy-three years from 1918 until 1991, the U.S. money supply increased more than sixty-four-fold.”

Björn Lundahl

lester May 13, 2007 at 11:57 am

hilarious really. You’re a regular jay Leno with the jokes

Björn Lundahl May 13, 2007 at 12:03 pm

“bjorn- you must be more precise in your responses. this forum is for economics, not stand up comedy.”

This is an example of an imprecise and funny way to respond. Was that all that this person could deliver?

Björn Lundahl

lester May 13, 2007 at 2:06 pm

Bjorn- I was kidding. Your responses are in fact, unusually well thought out and supported. so it was sarcasm on my part

Björn Lundahl May 13, 2007 at 2:32 pm


Thank you. Well, I thought that you might be a rude left winger who did not like my writings. Anyone can post here and that is also a very good thing.



Björn Lundahl May 13, 2007 at 3:52 pm

The main reason why central bankers and governments have chosen to pursue 2% inflation rates yearly instead of a zero inflation rate as Milton Friedman suggested is that they are afraid of deflations. They want to be sure that deflations will be avoided and wants to have a margin.

The main reason why they have not chosen a strict monetary rule as Milton Friedman recommended, is that they are not convinced that the demand of money is stable (in their terms; velocity of circulation) and if the central banks mechanically injects a certain amount of money, prices could still fall or rise (more than 2% yearly). By pursuing a 2% inflation rate yearly, the central banks, for example during deflations, could inject more money into the system and make up the difference. The other reason might be that they do not know which monetary definition they should be guided by. To master a certain inflation rate “solves” the problems handsomely.

I think that they logically and cleverly are reacting in a rational manner as they believe that the condition is true and that is that business cycles are caused be changes in aggregate demand.

For an Austrian economist the business cycle is caused by increases of the money supply (bank credit) through the process of fractional reserve banking and the solution of the problem is therefore quite different or in other words; stops injecting money into the system at once. You cannot either trust central banks and governments that they will ever do that so we should adopt a 100% reserve gold money standard. This would also be extremely more fixed and difficult to later alter than a change in the constitution would be.

Björn Lundahl

Björn Lundahl May 14, 2007 at 2:33 am

Over the longer term, though, when the economy is adjusted to a very slow growth of the money supply as under a gold standard or adjusted to a faster growth of the money supply as under a fiat monetary system with a yearly inflation rate of 2% (again inflation here is defined as decreases of the purchasing power of money), I do believe that the demand for money would also be quite stable. That is also why De Soto wrote that “there would be slight annual “deflation” of approximately 2 percent” under a gold standard. He too expects, therefore, the demand for money to be quite stable. This is only an observation and not a praxeological fact and the demand for money can always, therefore, change.

As so many nations today pursue a policy of a yearly inflation rate of 2%, it will be quite interesting to observe what the effects this will have on the world economy.

During the 80s, for example, when Switzerland pursued that policy it had, if I remember it correctly, some severe recessions. Today when all “important” economies follow a similar policy, external negative impacts on each other will be much smaller. So what we have in front of us is really a great laboratory test of Monetarism and floating exchange rates.

We could expect the most stable outcome of employments and economic outputs during the post-war period but still, stock market crashes, won’t probably be avoided.

Björn Lundahl

Paul Marks May 14, 2007 at 10:10 am

The following should not need to be said here – but it seems it does.

A credit-money expansion that aims at “price stability” is still a credit bubble. Remember New York Federal Reserve Bank Governor Ben Strong – his policy is the late 1920′s?

Inceasing the credit-money supply in order to prop up the overvalued exchange rate of the British Pound (at the request of the Governor of Bank of England M. Norman).

This policy was supposed to be O.K. because prices in the shops (what some people seem to think “inflation” means) were not rising. In reality it was anything but O.K. – it led to the crash of 1929 (although I fully accept that it was the government response to the crash, via such things as efforts to prevent wages falling and increases in trade taxes, that turned the crash into the Great Depression – rather than a rerun of the crash of 1921).

As for the practical side of an “inflation rate target” (even one of zero).

Milton Friedman himself (the high priest of the Chicago School) despaired of trusting governments to do that. That is why he held that the monetary base should be frozen (even if this meant some gentle decline of prices in the shops over time).

The key point that this misses (of course) is that fractional reserve banks (and other financial institutions) can create expansions in the credit money supply (and hence boom-busts) even if the monetary base is frozen.

Björn Lundahl May 14, 2007 at 12:56 pm

Paul Marks

Central banks pursuing a 2% yearly inflation rate is not and far from a perfect substitute for a 100% gold reserve money standard. Such a system will probably still cause stock market crashes and will also and this surely, promote some malinvestments in the economy that never will be fully liquidated. In other words, new doses of credit will prevent their liquidation. I believe that despite this inbuilt destructiveness of such a system it will “only” cause minor recessions and probably also stock market crashes but deep recessions and depressions will be avoided. Such a system combined with flexible prices and wages, is therefore preferable to what we experienced during the 70s and will be stable compared to what we then experienced. Such a system will not cause riots in the streets and could keep the public from demanding any further actions and also something which they can live with and accept.

My points are not that that the Austrian business cycle theory is correct or not as I believe it is, but that the world is to a great extent ruled by Monetarist ideas and despite of the errors in such systems, they can still be quite successful.

As a libertarian I cannot accept Monetarist ideas and we can always be proud of supporting true economic and ethical principles which will deliver a system without any business cycles and stock market crashes combined with true justice. But knowing all this does not mean that we need to propagate that a Monetarist system will inevitably fail and cause a world depression as this is not true. As mentioned, the truth is on our side, but is that not also enough? Do we need to say anything more than what we can rationally justify?

Björn Lundahl

Björn Lundahl May 14, 2007 at 2:08 pm

I think the following will illustrate Rothbard’s views about “constant increases of the money supply” (that is the effects of Monetarism), from the book America’s Great Depression:

The Explanation: Boom and Depression

“Since it clearly takes very little time for the new money to filter down from business to factors of production, why don’t all booms come quickly to an end? The reason is that the banks come to the rescue. Seeing factors bid away from them by consumer goods industries, finding their costs rising and themselves short of funds, the borrowing firms turn once again to the banks. If the banks expand credit further, they can again keep the borrowers afloat. The new money again pours into business, and they can again bid factors away from the consumer goods industries. In short, continually expanded bank credit can keep the borrowers one step ahead of consumer retribution.”


Björn Lundahl

Paul Marks May 15, 2007 at 1:03 pm

The fear of “deflation” (which they define as falling prices – by using some “price index”) mistakes a possible result of a bust with the cause of it.

You know the above – as you that the present Fed Chaiman is one of these people who fears “deflations” and thinks that such a “deflation” caused (or, perhaps, was) the Great Depression. He is, of course, not only wrong but is wildly wrong – the cause of the crash of 1929 was the credit money bubble expansion of the late 1920′s and what turned this crash into the Great Depression was the reaction of the government to it (for example the desperate efforts to stop prices and wages falling).

Had the government done nothing the economy would have started to recover within a few months (as with the crash of 1921).

On the more general point.

Borrowing must be entirely from savings. Real savings – i.e. someone choosing not to spend their income.

“How is the above relevant to my point about gold mining?”

If gold is treated as money and someone mines gold he still has a choice – keep the gold, spend the gold (this includes giving it away) or lend the gold to someone else.

If he chooses to lend out the gold he has just mined, this may “increase prices” (if more gold is comming on the market that new supplies of other things are), but it will NOT create a boom-bust cycle.

It is only when investment is greater than real savings (i.e. by credit money exapansion being treated as “savings”) that such a boom-bust cycle can occur.

There are many complex ways in which a credit expansion can occur, but it is the credit expansion (borrowing not being totally from real savings, not just “there being more money”) that is the core of the boom-bust cycle.

So, no, just finding new gold mines (or new silver mines, if people choose to use sliver as money, or new whatever mines) will NOT cause banking collapses, a great boom and then a bust (and so on). It will only do this if the new gold is used as a base for credit exapansion – i.e. if the doctrine is that gold (or whatever) is the “base” of borrowing, rather than the 100% source of borrowing.

Murry Rothbard always regarded the pyramid credit expansions of financial institutions (whether the base of the pyramid was gold, or paper Dollars) as fraud.

One might argue with this, but it is true that the pyramid credit exapansions (the endless search for the “philosopher’s stone of finace” – a way to “reduce interest rates”, to expand lending so that it is greater than real saving) is the heart of the boom-bust cycle.

As you know all the present major economies are credit bubbles, the capital structure is distorted (to a very great degree). It is unfortunate.

Björn Lundahl May 15, 2007 at 1:45 pm

Recessions and The Great Depression were caused by Government Interventions!

In a purely free market (without Government intervention), the rate of interest is determined by people’s “willingness to save and invest” (which is called people’s time preferences) for future use, as compared to how much they are “willingly to consume now”. If people change their “willingness to save” (time preferences) and want to save more, the additional savings will cause the rate of interest to fall (increased supply of savings), and businesses will borrow and invest these additional savings. When the Central Bank (for example The Federal Reserve) increases the money supply and expands bank credit (which Central Banks does everywhere and all the time and always “out of thin air”), it initially lowers the rate of interest and thereby misleads businessmen to act in a manner as if true savings have increased, which in turn leads businessmen to invests those supposed savings in capital goods. New projects that were not profitable before, will now suddenly with this lower interest rate, be profitable. While this process is working, the economy is in an inflationary boom phase (expansion). Capital goods such as stocks, real estate etc, will be more demanded and invested in, and prices of those will rise faster and more intensely in relation to consumption goods. As these supposed savings have worked their way through the economy, prices of goods, services and wages have generally increased to a height which prices for them would have not reached without these supposed savings.

As mentioned, people’s “willingness to save and invest” have not changed (people’s time preferences have not changed) for it was only the Central Bank that increased, out of thin air, additional “savings”. When supposed savings have worked their way through the economy and are received, finally, in increased wages, people still spend their real wages in the same manner as before. They save/ consume in real terms and in same proportion to each other, as before mentioned increase in supposed savings. Because of this, a lack of savings will occur and the rate of interest will rise. Projects that businessmen have invested in and that seemed to be profitable when the rate of interest was lowered are now revealed to be unprofitable. All those investments are revealed to be malinvestments. Businessmen will stop investing in those projects and lay off workers. Prices of capital goods, real estate, stocks etc, will fall sharply and relatively to the fall in prices of consumer goods. The economy is in a depression phase. When those investments are liquidated, the economy is adjusted to people’s “willingness to save and invest” and to consume. The economic structure corresponds to the ratio which people want to save and consume. The economy is now healthy again.

Now then, in the 1920s the Federal Reserve, in the US, increased the money supply and bank credit, which in the 30s resulted in The Great Depression. The same story goes with Japan during the 1980s, which during the 90s, resulted in a depression, go to;


In Sweden we had banks lending out heavily during the late 80s, which also, led to a depression in the 90s. All business cycles are caused by the same phenomenon. Economic crisis can occur because of other factors such as wars, boycotts, oil prices etc, but pure business cycles have in common the same cause.

I have tried, in a very few words and in a easy manner, to explain Ludwig von Mises business cycle theory, which is also called the Austrian theory of the business cycle. All faults are mine. Friedrich August von Hayek elaborated this theory and received in 1974 the Nobel Prize* for this. Go to;


If you want to know more about this theory, go to;


And to;


Björn Lundahl

* Information about the Nobel Prize in Economics, go to;


Björn Lundahl May 15, 2007 at 1:55 pm

My view is that fractional reserve banking should be considered fraudulent because of the reason that bankers cannot fulfil their obligations against all their depositors. This is a logical proof by itself.

It does not matter if bank depositors are well educated in fraudulent banking procedures or not. Reality and logic sets the limit and real laws should be in accordance with reality. Otherwise they are destructive and wrong. No contracts can invalidate reality and logics.

It is not, logically, possible to contact terms that are contradictory. For what is contracted if the terms are contradictory? This is essentially my point. If we have a “libertarian view” is beside the point: contradictions cannot be contracted as contacts are voluntarily agreements between the parties involved and all terms should harmonize with each other.

If, for example, someone rents a commercial facility and the lease stipulates that the landlord should maintain the ceiling, it is not, logically, possible in the same lease to contract that the landlord has no responsibility if he has been careless in his maintenance and the ceiling leaks. That is also a logical contradiction. Maintenance and some minimum responsibility go hand in hand.

Fractional reserve contracts are a contradiction in terms as they are demand deposits that are redeemable on demand and are at the same time also “regarded” as monetary “loans” to the banks and on top of this absurdity, these “loans” are lacking any maturity dates.

A true monetary loan is an exchange of present goods for future goods, whereby “the future” is defined as an agreed upon time between the parties when the loan expires.

If a “depositor” really wants to lend out his money, he should also comply with what a true loan is and “not try to eat his cake and still try to keep it.”

An Austrian economist has all the reason in the world to be against fractional reserve banking as he wants the economy to correspond to a true voluntarily saving ratio and not to a vague (and therefore fraudulent) one. Because of the fact that fractional reserve banking is relied upon this vagueness and therefore swindle, he also knows that this very vagueness and swindle are the really causes of horrible and anti social depressions and business cycles, which he therefore wants to end once and for all.

Apart from mentioned logical proof of why fractional reserve banking is fraudulent, another logical proof should also be mentioned and that is that the Austrian business cycle theory by itself proves that “savings” through fractional reserve banking does not harmonize with true voluntarily saving ratios of individuals as business cycles are still existent in a fractional reserve economy and are, also, the very cause of them. The Austrian business cycle theory teaches “that recessions and depressions are caused by initially lowering of the rate of interest which do not correspond to true saving ratios, but by increases of the money supply. When the economy adjusts to true saving ratios, malinvestments are liquidated.”

Well, if demand deposits are not true savings they cannot be true loans.

In other words the depositors have been deluded that is being exposed of fraudulent actions by the banks.

We could, also, say that slave contracts should not, in a libertarian society, be allowed for the same reason i.e. they are contradictory and not in accordance with reality and logics as;

“A man cannot renounce his right to self-ownership, since a man in his very nature controls his own mind and body (natural disposition), that is, he is a natural self-owner of his own will and person (having a free will) and he will still be so even if he has “tried” to renounce his natural self-ownership to another person. He cannot renounce something which is a biological and physical fact of his very own life and which will never, as long as he lives, leave him.”

Björn Lundahl

Paul Marks May 16, 2007 at 12:00 pm

It is quite true that borrowing (whether for investment or consumption) should be entirely from real savings – i.e. rates of interest should be determined by time preference and time preference only.

However, people have for centuries tried to find ways round this. For example, by trying to twist the word “savings” to cover credit expansion games.

Comments on this entry are closed.

{ 1 trackback }

Previous post:

Next post: