Chapter 14, titled Booms, is a detailed and excellent narrative of a relatively short period of Mises’s life when he exercised strong intellectual influence and contributed significantly to the reemergence of free market ideas in Europe, particularly in Austria and Germany. At the London School of Economics, in persons of Professors Lionel Robbins and Friedrich von Hayek, Mises’s ideas had been given additional boost in the English speaking world.
During that time, Mises’s undeniable intellectual influence finally got him on the board of Verein für Socialpolitik, an association of German speaking economists. In addition, he was also extensively involved in the establishment and work of the Austrian Institute for Business Cycle Research that produced important studies advancing and spreading the word about Austrian theory of business cycles.
On the theoretical front, Mises formulated new directions in the theory of value and in monetary economics. It is on these two aspects of Mises’s work that I would like to comment in the following.
First, a short comment concerning an important detail in connection with Mises’s Irving Fisher’s proposal on monetary reform, which in its political dimension essentially pointed to a governmentally managed monetary system, with similar proposals offered by Keynes in his A Tract on Monetary Reform and other economists.
Mises devastated Fisher’s proposal on several junctures and showed that it was theoretically flawed as well as impracticable.
The principal argument for the reform was that for economies to function without both business fluctuations and major disturbances in the distribution of income between debtors and creditors, an elastic currency must be present to ensure stability of purchasing power of money. Incidentally, the essence of this argument has not lost any of its weight and continues to represent the final line of defense of those who see in central banking and the fractional reserve banking system indispensable institutions for promoting macroeconomic performance and maintaining price stability. To ensure stability of purchasing power a price index was to be worked out which would link the price of dollar currency not just to changes in the price of one commodity (gold under a gold standard) but to a set of different goods.
In the first place, Mises pointed to insurmountable difficulties in arriving on an objective standard for an index due to the existence of no objective standard for the importance of various goods that would be accounted for in such an index. Second, Mises tried to show that one of alleged major “evils” of unstable currency – the problem of unexpected shifts in the distribution of income between debtors and creditors, which would occur whenever the purchasing power of money changes, is entirely illusory.
While I agree with Mises’s overall conclusion that “unstable” currency based on the gold standard is not a problem, I tend disagree with one aspect of his analysis. Mises argued that so-called “price premiums” in the “gross interest rate” would usually take care of the alleged redistributive effect that failing (or rising) prices cause in the relation between debtor and creditor. I object to the analysis and argue that the doctrine of “purchasing-power-price premiums” leads directly to the erroneous conclusion that under conditions of rapid increases in productivity and falling prices, the “negative” premium would decrease or rather eliminate the rate of interest on the market for loanable funds. A zero rate interest on the loanable funds market in turn implies a stronger incentive to hold money rather than to invest it which, in turn, would reduce spending and incomes in the process. But this is a completely erroneous, and thus politically potentially dangerous, point of view.
In reality, decreasing or increasing commodity prices do not have any influence on the rate of profit, and thus on the interest on the market for loanable funds.
The reason Mises advocated the doctrine of “purchasing-power-price premiums” is that he, along with virtually all other Austrian economists up to the present with the sole exception of George Reisman, worked within the conceptual framework of Böhm-Bawerkian theory of interest (Prof. Reisman offers a thorough refutation of this theory in his book, Capitalism: A Treatise on Economics, pp. 792-797. See also his lecture on the same subject he delivered at the Mises Summer University in 2005.).
In a nutshell, the theory attempts to explain the category of interest, or, more precisely, the originary interest, on the basis of the relation between subjective values of present and future goods. The fundamental flaw in this theory is that it provides an explanation in terms of value while its actual purpose is to explain how the rate of interest is determined in terms of money. Böhm-Bawerk’s theory, as well as very similar nonmonetary theories of Irving Fisher and Frank Knight, is utterly incapable of explaining precisely because there is only calculation in terms of money. Unfortunately, nowhere in his writings did Mises develop a theory of interest in accordance with his own great discovery in the realm of economic calculation.
From what we have just seen, the theory of interest has an obvious connection to the theory of value, or, more accurately, the theory of economic calculation. The subject of my second comment is the relation between Mises’s calculation argument and Austrian subjective theory of value in general.
Prof. Hülsmann’s discussion of the development of Mises’s views on the theory of value confirms my own reading and understanding of Mises on that subject: his insight that there is no calculation in terms of value but only calculation in terms of money is indeed revolutionary. The problem is that Mises’s great insight is incompatible with almost everything the subjective theory of value of Menger and Böhm-Bawerk stands for. One economist at least, Friedrich von Hayek, did recognize the incompatibility when he wrote, without mentioning Mises by name, that:
Of course, in so far as one believes that a completely satisfactory solution to the problem [of imputation] has not yet been found, we cannot exclude the possibility from the very outset that the determinants of the prices of the factors of production are to be found in the exchange economy alone, and therefore that an imputation of value is not applicable, a view held by several younger authors. Nevertheless, if this view were regarded as valid, the result would be that we would have no satisfactory explanation of economic processes based on the subjective theory of value, and it would also follow that these authors too would lack any basis for many of their investigations. (cf. pp. 472-473 of Last Knight)
Hayek’s point is confirmed by Prof. Hülsmann in his summary of Mises’s views on the subject:
In contrast, other economists [than Mises] believed economic calculation was possible outside the framework of a market economy. They assumed that calculation in terms of market prices was only one form of economic calculation. More to the point, they believed that it was possible in principle for the members of society to perform calculation in terms of utility, which they assumed to be quantifiable. It followed that all elements of economic science–the science of calculated action–had the same general applicability as marginal value theory. Categories such as saving, consumption, capital, profit, loss, and efficiency were not just categories of the market, but of human action in general. (cf. ibid p. 596)
I think Hayek is exactly right: this view is diametrically at variance with almost everything the subjective theory of value, posed as the alleged true foundation of all of economic science, stands for. This is because one of central tenets of the subjective theory of value is that categories of saving, consumption, capital, profit, loss etc. will exist under any form of economic organization because they are eternal categories of human action. Mises, as late as in Human Action, taught, in perfect accordance with everything Menger and Böhm-Bawerk wrote on the subject before him, that, for example, the phenomenon of interest would be present even under socialism and as such is explainable by the alleged universal preference of present goods to future goods which, in turn, is implied by the very nature of human action itself. The same goes for all economic phenomena, that is, they all can and must be explained by the subjective theory of value as developed by Menger, Böhm-Bawerk and other champions of subjectivism in economics.
Mises could not free himself from the shackles of the subjective theory of value but he showed the way to construct a new and much more coherent theory of the market process. And this is one of the most significant pieces of information I have gained from reading The Last Kinght Of Liberalism. I hope that contemporary Austrian economists take this extremely important aspect of Mises’ work and its implications for economic theory in general more seriously.