4 - A glimpse into the Austrian School of Economics

4 - A glimpse into the Austrian School of Economics

By CryptoGameTheory | Crypto4Friends | 11 May 2020


Money is the essence of economic activity. Then, the roots of money should be found in economic thought. At some point in economic history there is a break in the approach of how the genesis of money, and money itself, is conceived. In particular, in the XX century, after countries have experienced a financial crisis and after being exhausted by wars, in the general public arose different points of view about the economic activity, therefore, economists have shifted mainly in two different currents of thoughts.

At one side, the orthodox view regards money as an abstract unit endogenous to the economic activity, which needs to be controlled by authorities to ensure value and to maintain it; this current of thought is supported by Institutionalist, Keynesian, Marxist and Monetarist.

On the other side, the heterodox view regards money as a commodity, that is exogenous to the economics process and which value depends on the willingness of people and it's expressed by the market; this current of thought is often sustained by the Austrian school of Economics, with some major exponents such as Menger, Hayek, Mises and Rothbard.

Through the 1930s Hayek was best known for his development of business cycle theory, "which was one of the most prominent alternatives to Keynes's ideas on macroeconomics as the world languished in the Great Depression of the 1930s [1]. With the rapid ascension of Keynesian macroeconomics and the increasing belief that centralization of the economic activity was more efficient in maximizing the social welfare, the Austrian business cycle theory ceased to be considered seriously by the mainstream, and the consensus on the socialist calculation debate was thought to be concluded.

However, a prolonged period of stagnation of the economy fitted closely to the Austrian School analysis, that resurged again after the collapse of the gold standard in 1971. After a long period of debate, "the reputation of the Austrian school received a major boost in the 1990s, due to the fall of the Berlin Wall in 1989, due to the break-up of the Soviet Union in 1991 and the financial crisis of the 1990s and 2000s [1]".

The demise of those centrally planned economies, as they turned away from central planning and toward markets, led economists to reevaluate the ideas of the Austrian school, in a period when there was a fear, during the Cold War, that even a slight strategic political miscalculation might set off a hot war, ending in a destructive massive nuclear exchange driven by most powerful economies.

So, in the early twenty-first century, the most prominent alternatives that challenged Keynesian macroeconomics were the Austrian School and the monetarist framework. Meanwhile, the economic analysis has continued through time, with continuous improvements in the construction of mathematical and statistical models incorporated into economic plans, that resulted in the most recent foundation of macroeconomic equilibrium analysis. The equilibrium approach to economic welfare takes a static view of the efficiency of resource allocation. Welfare is maximized when resources are allocated in such a way that nobody can be made better off without making someone else worse off. This condition, is called Pareto optimality.


The Austrian school of Economics

Usually, a school of thought is defined by the ideas of its members, and there is not a clear line that identifies its borders, but we can distinguish some features of the Austrian school that differ remarkably to the other school of thought. One of the distinguishing features is that the Austrian school focuses on the ongoing market process that tends to lead an economy toward equilibrium more than on the equilibrium outcome itself.

They recognize that there are market forces in an economy that create a tendency for it to move towards equilibrium, but also that an economy will never reach an equilibrium, because the market environment is always changing, partly because preferences are subjective, and partly because as knowledge advance, new products, and new technologies are always developed.

Another reason an economy will never reach equilibrium is that the information necessary to arrive at equilibrium is spread among all the participants of the economy, and the nature of this decentralized information means that it can never be aggregated in such a way as to produce the desired equilibrium [1]. The economy is always moving "dinamically" and when the existing state is disrupted by the introduction of important innovations, the result will be a structural change, in which the economy moves from one level of equilibrium to another, but never returns to where it was previously.

In this framework, the market emerges as a spontaneous order that enables individuals to make use of the information they possess to plan their activities in such a way that they are consistent with everyone else's plan [1]. The market is intended as the sum of all the products, commodities and services available for people to engage in every economic activity, as long as there are a seller and a buyer willing to make a deal. However, their interaction cannot be predicted, because the market is a complex self-organizing system, which means that it can never be comprehended in its entirety, so changes in one part of the system will have unanticipated consequences in other parts.

For this reason, differently from equilibrium economics, it is thought that people have incomplete information, and that information is not obtained costlessly. Nobody knows everything everyone else knows, so the knowledge one person has will be different from, and perhaps contradictory to, the knowledge of other people. Much of the knowledge people have is tacit knowledge, which means knowledge that they are able to use but which they are not able to effectively communicate to others, because learned through experience, needed for individuals to provide a basis for action and decision making. Hence, the market is a coordination mechanism adopted to make effective use of the decentralized knowledge of individuals, and is the responsible to the forces that clear the quantity supplied and demanded, rather than the equilibrium itself; nobody tells buyers and sellers what equilibrium prices are.

When knowledge is decentralized and tacit, there is no way even in theory that a central planner could gather up all the relevant information and allocate resources efficiently because the sum of small changes may lead to unexpected structural changes.

Further, it is important to remember that the market activity is spontaneous, in that everybody is free to make an exchange or not. This is true even in very competitive markets, like stock markets, where traders can interact entering a market order to buy at the "market" price, that is the lowest price at which someone has entered an offer to sell; similarly, putting in a market order to sell means the price is set by the person who has entered the lowest offer to buy. Prices are set by buyers' and sellers' offers to buy and sell at a particular price, not by "the market" [1]. This means that, contrary to equilibrium economics, price is not a fixed variable, rather it depends on the general conditions of the economy.

Then, because of economic forces, prices of goods for which the quantity supplied exceeded the quantity demanded would fall, and prices of goods for which the quantity demanded exceeded the quantity supplied would rise, until the economy came to rest with a temporary equilibrium configuration of prices. So prices follow a path that tends to clear the market, and that price is revealed as a result of all of the transactions that are made in the market. Therefore, the market generates information that allows individuals to adapt, so that as the future unfolds, people are able to realize their updated plans with new information they acquire.

This is especially significant with regard to capital goods, because they are durable goods whose value depends upon the value of the final goods they will produce. Expectations about future market conditions, clouded by the uncertainty of the future, determine the value of capital goods, and capital markets are required to coordinate these expectations of investors.

To understand why this is important, we should consider the basic principle of future uncertainty. If it is true that the future is unpredictable, that means that outcomes cannot be programmed in advance, and one can only assign probabilities to certain outcomes in terms of expectations. While all this may sound obvious, note that general equilibrium growth models that are often employed by economists are deterministic, so that initial conditions in the present determine the future trajectory of the economy. 

In the face of this type of uncertainty, and with decentralized and tacit knowledge, the market is a discovery process, where preferences are revealed only after the market transaction is concluded. One cannot know whether an investment will be more profitable than another, because the answer depends on people's subjective preferences and the circumstances. "The market is a discovery process that reveals these values, but information about the values of these goods would not exist if the market process did not produce it. The result is that a substantial amount of information is contained in market prices, needed to allow economic calculation [1]".

Indeed, taking a market process approach to the analysis of individual action, people engage in economic activity because they believe they will be better off because of their actions and exchanges, or at least, they expect not to lose, depending on risk aversion. The essential relationship between utility and individual interaction is that people act because they think to buy the goods they want or selling the good they don't need, will increase their well-being. In these terms, if there are unnoticed profit opportunities, people with an entrepreneurial spirit would try to take advantage of them until they are fully exploited, meanwhile the market equilibrate forces again.

In other words, the market could be thought as a mechanism that rewards the effective use of knowledge with profits and penalizes the ineffective use of knowledge with loss, so directing resources towards those goods and services consumers value most, as long as people's actions reveal the improvement in utility by their voluntary willingness to pay for it.

In this framework, we could identify five prominent figures which interact with the market: consumers, workers, managers, capitalists, and entrepreneurs. Along with the economy, consumers drive the demand, while the others are the suppliers of the offer; obviously one can be both a consumer and a producer. Capitalists own the means to engage in economic activities and collaborate with workers, managers, and entrepreneurs to move fruitfully capital resources such as lands, material, plants or financial capital. The role of the firm's management is to select the right combination of inputs to produce the output at the lowest cost, which is determined by the production function, and to try to minimize any waste in the production process. Entrepreneurs instead, take advantage of profit opportunities previously unnoticed, where firms are the institutional structure within which they work to realize their profit, or their return to entrepreneurship.

"This could mean looking for a different production function, or recipe for production, using different inputs, producing a different output or selling to a different market. Entrepreneurship can be also thought of as arbitrage: buying at one price and selling at a higher one. For example, someone might notice that apples sell for 0.75 in one city and 1 in a nearby one. A profit opportunity exists because apples can be purchased for 0.75 and sold for 1. To actually engage in the entrepreneurial act, however, will take production and time, and this is true whether one is selling apples, building automobiles or engaging in arbitrage trading in international exchange markets" [1, pag.24]

The Austrian school of economics regards entrepreneurship as the true element which triggers economic cycles, and even if good management is important to the firm, entrepreneurs are absolutely essential, because entrepreneurs are always looking for innovative profit opportunities. Indeed, Schumpeter [2] made a distinction between invention and innovation. Invention is the technical advance, or in other words, the science and engineering that adds to knowledge and enables new products to be made. Innovation instead, is the employing of these inventions into marketable products. Hence, while managers and other economic actors try to make profits fully exploiting inventions - searching for equilibrium and stability, entrepreneurs are the disruptive force that shift the economy towards an higher equilibrium, increasing the standard of living. 

Henry Ford's adoption of the assembly line to produce automobiles is the prototypical example of innovation in the production process. Assembly lines had been used before Ford used them, but not for producing automobiles. Ford spotted the profit opportunity in using this new production method to produce automobiles.

However, there is always a substantial amount of judgment that goes into determining whether any given entrepreneurial action will, in fact, be profitable and because profits are never certain, entrepreneurs will engage in innovative activity only if they anticipate that the reward in terms of profit outweighs the potential for loss.

Those running the firm can look at prices of inputs and prices they command for their output and get a substantial amount of information. But information by itself is often not useful; it needs to be combined with other information to provide knowledge upon which decisions can be made. People who have more information, and who have a better idea of how the various pieces of information related to each other, have a better knowledge base upon which to make decisions.

Profit and loss serve the important role of providing an incentive for firms to add value to the economy and are an indicator of whether entrepreneurs are successful in creating value. If the value of the output the firm produces is greater than the cost of purchasing the inputs, then the firm adds value to the economy by taking less valuable inputs and combining them into more valuable output.

The difference between the cost of the inputs and the revenue from selling the output is profit, so firms receive a profit when they add value to the economy. Conversely, if a firm sells its output for less than the cost of the inputs it uses to produce that output, the firm destroys some value in the economy, and the firm suffers losses [1].

Though, in the real world of competitive markets characterized by continual economic progress, firms have to continually modify everything that they do so that they can keep up with their competitors. The improved products and production methods that lower costs and raise people's material well-being present a continual challenge to the people who run firms.

Each firm specializes in developing a particular type of knowledge that other firms do not have, and do not need to have. This division of knowledge makes firms more productive because they can specialize and focus their attention on a more narrow set of activities, while lowering output's costs and increasing quality. This provides one explanation for why firms purchase inputs from a supply chain rather than producing their own inputs; suppliers can demonstrate that they have the tacit knowledge to produce a superior input without revealing the knowledge necessary to produce it.

A famous example, took from the famous essay, "I, pencil" written by Leonard Read, about the process of production says that nobody in the world, alone, has sufficient knowledge to build a pencil. "The cedar wood for the pencil undergoes a separate complex process before being mated with the graphite. The brass ferrule that holds the eraser has to be mined and refined, and the eraser is made from rape-seed oil that originated in the Dutch East Indies and pumice from Italy, combined with other ingredients [1]."

This story is powerful because shows how something as simple as a pencil requires the coordination of the economic activities of people from all over the world. These people cooperate even though they will never meet, and speak different languages, "yet their economic activities are coordinated so that they all cooperate to produce a pencil that is inexpensively available to consumers throughout the world [1]". Much of the information people need to know about the economic activities of others is summarized in market exchanges, where entrepreneurs discover the prices of graphite, cedar, brass and the other ingredients that go into making a pencil, so firms that produce them can decide on how much of what combination of materials to use in the manufacturing process.

Whether entrepreneurs are looking out for the good of the economy as a whole, or selfishly seeking profit for their own benefit, their entrepreneurial actions benefit everyone, because they increase the economic value which then is reflected in money. As Adam Smith noted, in a market economy individuals pursuing their own interests are led by an invisible hand to promote the general welfare.

However, firms can tell whether their current activities are profitable, but they cannot tell whether some alternative would have been more profitable, so they cannot know whether they are, in fact, maximizing their profits. In this way, we can think to profit as an indicator of progress, but not a measure of progress, in that some of the benefits of economic progress go to consumers. When a profitable product is introduced, some of the benefits go to the entrepreneurial firm in the form of profit, but some go to consumers, who benefit from consuming that new product rather than what was available before [1].

Hence, profit has not to be confounded with the final goal of a capitalistic society, but rather as an evolutionary process; it should not measure the level of "happiness" or "self-fulfillment" of the community, it indicates the level of "vitality" of the economy in a particular point in time.

Differently, taking an equilibrium approach to economic analysis, profit is an indicator of an inefficient allocation of resources and indicates either that the economy is not in equilibrium, which is inefficient, or that the profitable firms have some monopoly power, which is also inefficient. For these reasons, a model of market socialism would result in economic stagnation because it offers no mechanism for an economy to make use of newly developed knowledge, nor to incorporate entrepreneurial innovations into an economy.

Economists often measure growth as income growth, but aggregating growth this way while leaving out economic progress leaves out the fundamental cause of growth. 

When one considers how much better off the conditions of people are today than they were a century ago, a large part of that increase in well-being is the result of the new goods and services that come with economic progress. "For instance, in the United States, per capita income increased by about seven times in the XX century, but people were not consuming seven times the amount of the same goods and services at the end of the century that they consumed at the beginning [1]".

That economic progress is the result of entrepreneurship, and that entrepreneurship can only take place within the economic calculation of the market economy.

Furthermore, because the economy is a complex system, government interventions into the economy are likely to create additional unanticipated problems, and these new problems will then result in a demand for additional interventions to solve the new problems. In this way, one intervention leads to another, with the result that if a society chooses the mixed economy as its model of economic organization, the economy will move further and further away from a market economy over time, and more toward central economic planning. Even if one assumes that everyone in government is public-spirited and tries to do the best they can to further the public interest, they still cannot do it, because without market prices rational economic planning is not possible.

In a socialist economy, money would not need to change hands; prices would be used for accounting purposes only. Therefore, most of the assumptions carried out by the Austrian school of Economics will not work without a sound monetary system.



The effects of inflation


The arguments developed by the Austrian school during the economic debate helped to solidify the Austrian school's ideas about the role of market prices in economic calculation, but also provided a clear picture of business cycles. Beyond a doubt, the Austrian business cycle theory is a monetary theory, that found the root of the causes of economic cycles related to money and banking, but leaves open the possibility that these fluctuations could have other causes as well.

To understand the difference between fluctuation caused by the real economy and monetary fluctuations, we should be sure to have fully understood the meaning of capital goods. The most common capital goods are property, plant, and equipment, or fixed assets such as buildings, machinery and equipment, tools, and vehicles.

Capital goods can be employed in different ways, so the return to capital depends on how it is used. It is important to understand that capital produces no return by itself; rather, when the owners of capital employ their capital in specific uses, the capital earns a return based on its productivity. So what about money? Following what we found, the answer depends on how money is conceived.

If money is considered as a special commodity exogenous to the economic process, it can be added to the capital goods, with the particularity that it functions as a mean of exchange and it can be converted at any time in other capital goods. Then, the total stock of value is the sum of all the capital goods plus the commodity money; it follows that money, like all other capital goods, does not produce interests. Otherwise, when money is considered as a unit of account endogenous to the economic activity, it cannot be separated from the process of evaluation because business cycles are intrinsic to the value of the monetary unit and there is no outside shock that leads to the cycle; in this way fictitious interests are possible. To differ from commodity money, in this case, we refer to financial capital, often associated to the activity of credit creation.

Of course, the way money is conceived changes the gears at the base of the economy, causing different effects on business cycles. And because the economy is constantly changing, prices will follow the economic activity; when there is high demand we are witnessing a generalized increase in prices in what is habitually called inflation.

However, there is another way in which the economy could experience inflation, and it is the consequence of an increase in the quantity of money. This reasoning makes us understand that, even if the result is similar, the causes are completely different.

When using commodity money, an increase in demand on capital goods means an increase in price and a decrease in the demand for money, but it can be seen as a good sign of the economy as long as people are willing to pay for goods and services to satisfy their needs. Conversely, a decrease in demand in capital goods means a lower price, or specularly, it means that money is appreciating, because future consumption is valued more. There is no loss on well-being and changes in demand and supply are the real causes of economic cycles.

In the second case instead, inflation does not add value to the economy, it only dilutes prices, lowering the purchasing power of money, without accounting the real needs of people; with inflation, these needs can only be fictitiously induced. This is meant as the monetary cycle. For this reason, Austrian thinkers believe that successful money needs a fixed definition rooted in the commodity most suited to a monetary use, and a legal system that enforces contracts and punishes theft and fraud.

In such a free-market system, money would be convertible domestically and internationally. Demand deposits would have 100% reserves, while "the reserve ratios for time deposits would be subject to the economic prudence of bankers and the watchful eye of the consuming public [3]. As we have seen, in a free market, the result has been a gold standard, however, in the course of history, the concept of sound money is gone gradually lost to leave space to the fractional reserve system.

Under a gold standard with fractional reserve banking, even if the amount of gold backing the money supply does not change, the quantity of money in circulation in the form of financial credit, will change depending upon the fraction of their deposits banks hold on reserve. In this way, reserves are only needed to guarantee the liquidity to face bank runs started by the owners of gold, thus, constraining the amount of the monetary base.

However, as monetary institutions developed over the twentieth century, the world's economies went off the gold standard, allowing for central banks to control completely the size of the monetary base. In the current system, the monetary base is replaced by government's bonds and other financial assets, which play the same role that gold played under the gold standard. So, the expansions that under the theory as originally developed were solely the result of an elastic currency under fractional reserve banking, now can be caused by central banks expanding and contracting the monetary base indefinitely.

The key difference is that governments have direct control of the monetary base when it is able to establish fiat money as the medium of exchange, in contrast to a gold standard in which the monetary base is determined by the demands people have to hold gold relative to money.

This makes monetary fluctuations even more difficult to predict than under a gold standard, where the amount of gold in the monetary base placed a limit on the amount of credit expansion. A typical monetary cycle due to fractional reserves works in this way.

In a stable economy, when the economic outlook appears positive, banks will find it advantageous to increase the amount of money they lend, because banks' profit comes from the interest they earn on their loans. However, because the amount depends on reserves of liquidity, they can leverage their lendings proportionally. As a consequence, managing bank businesses becomes unpractical for fully backed banks, in that they cannot compete with interests on deposits of high-leveraging banks.

Nevertheless, as long as banks feel comfortable expanding their lending, and as long as the central bank allow interest rates - the cost of money - to remain low, the economic expansion continues. The money spreads and it bids the price up. But this dilution takes time and is therefore uneven: the first receivers of the new money gain most, and at the expense of the latest receivers. In the beginning, the counterfeiters and their local retailers have found their incomes increased before any rise in the prices of the things they buy. But, on the other hand, people in remote areas of the economy, who have not yet received the new money, find their buying prices rising before their incomes. Retailers at the other end of the country, for example, will suffer losses.

Other latecomers, which often belong to the "fixed income groups", will be stucked with loss. Ministers, teachers, people on salaries, lag notoriously behind other groups in acquiring the new money. Particular sufferers will be those depending on fixed money contracts or contracts made in the days before the inflationary rise in prices. Life insurance beneficiaries and annuitants, retired persons living off pensions, landlords with long term leases, bondholders and other creditors, those holding cash, all will bear the brunt of the inflation. They will be the ones who are indirectly "taxed" \citep{Rothbard}. In short, some people gain and many others lose.

Inflation, then, confers no general social benefit even in an expansive phase; instead, it redistributes the wealth in favor of the first-comers and at the expense of the laggards in the race. This is accentuated by the fact that, in general, the economy becomes optimistic and less cautious during the boom, and become pessimistic and more cautious during the bust, causing the money supply to expand and then contract, even with a constant monetary base.

Indeed, at some point banks will believe that it is not safe for them to draw down their reserves any further, so the monetary expansion will stop. With the supply of loanable funds no longer increasing, the interest rate, which was pushed down by the monetary expansion, will begin to rise, increasing the cost of money. Entrepreneurial ventures, which are always risky, under these conditions will not be able to pay off their debts.

Businesses will no longer find money so readily available, and at interest rates as attractive as they saw during the boom, so projects that appeared profitable during the boom will no longer look as attractive. It becomes more and more apparent that many projects initiated during the expansion are no longer economically feasible and that the change in business conditions due to the end of monetary expansion will mean that a larger number of projects will end in failure. In addition, in a phase of recession, only firms with high ratings will receive money, often big corporations or big financial institutions, while small retailers with low scores will be cut off the system, increasing the effects of redistribution in favor of centers of power.

The structural change in the economy leads to slow and painful adjustments, but when the economy recovers, the cycle repeats itself as expansions and contractions in the economy are caused by expansions and contractions in the money supply, which are a product of fractional reserve banking.

One of the big problems of this system is that banks lend out leveraged money which they don't really have in their accounts. This means that when a bank makes loans, it creates money out from thin air. This money is then added to the monetary base and create inflation. Most of its liabilities are instantaneous, but its assets are not. The bank does not, like everyone else, have to acquire money by producing and selling its services. On the contrary, when a businessman borrows or lends money, he does not add to the money supply. The loaned funds are saved funds, part of the existing money supply being transferred from saver to borrower.

Hence, when a venture is aimed at financial institutions to borrow money, the result is that the credit is created from leverage, but the debts have to be paid with real resources or sound money - the time spent on producing goods and services.

With Rothbard's word, the great difference between the fractional reserve business and all other business is this:

"[...] entrepreneurs use their own or borrowed capital in ventures, and if they borrow credit, they promise to pay at a future date, taking care to have enough money at hand on that date to meet their obligation. If Alice borrows 100 gold ounces for a year, he will arrange to have 100 gold ounces available on that future date. But the bank isn't borrowing from its depositors; it doesn't pledge to pay back gold at a certain date in the future. Instead, it pledges to pay the receipt in gold at any time, on demand. In short, the banknote or deposit is not an IOU, or debt; it is a warehouse receipt for other people's property [3, pag.22]."

This was certainly true in a gold standard, while it is less clear what could be redeemed in the current system. During the gold monetary system the bank promised to redeem on demand, but when it issued any fake receipts, it was already committing fraud, since it immediately became impossible for the bank to keep its pledge and redeem all of its notes and deposits.

The bank was already and at all times bankrupt, but its bankruptcy was only revealed when customers get suspicious and precipitate "bank runs". [...] No other business could be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged [3]".

Nowadays, as we have seen, the financial system works in a similar way, where financial assets contribute to the determination of value. However, also the causes of cycles are the same, since they are generated by the fractional reserve system of credits. This creates a problem of moral hazard, because banks can make loans essentially without risk. When bad loans become unsustainable, the biggest banks are said to be "too big to fail", they are bailed out by central bankers which act as lenders of last resort. Successively, these bailouts impact citizens in the form of increasing taxation.

Nevertheless, inflation has other disastrous effects. The monetary expansions and contractions that underlie the business cycle present a problem to those entrepreneurs, borrowers, and lenders because fluctuations distort the price signals that market participants rely on to gather information about economic activity. Inflation distorts the keystone of our economy - business calculation, in all the production chain.

Since "prices do not all change uniformly and at the same speed, it becomes very difficult for a business to separate the lasting from the transitional, and gauge truly the demands of consumers or the cost of their operations [3]".

For example, if an entrepreneur is considering an investment, during the boom when interest rates are lower and the economy is expanding, economic conditions will look more favorable than otherwise. Almost all firms will seemingly prosper. As inflation intervenes, new money is invested by businessmen in various projects, and paid out to workers and other factors as higher wages and prices. Accounting practice enters the "cost" of an asset at the amount the business has paid for it.

But when the new money filters down to the whole economy, people tend to reestablish their old voluntary consumption/saving proportions, and the cost of replacing the asset when it wears out becomes far greater than that recorded on the books. As a result, "business accounting will seriously overstate their profits during inflation and may even consume capital while presumably increasing their investments [3]".

Similarly, stockholders and real estate holders will acquire capital gains during inflation that are not really "gains" at all. But they may spend part of these gains without realizing that they are thereby consuming their original capital. By creating illusory profits and distorting economic calculation, inflation will suspend the free market's process of penalizing of inefficient firms and rewarding of efficient firms.

The false notion of endless growth which leads to unbridled consumerism, penalizing thrift and encouraging debt. As any sum of money loaned will be repaid in a currency of purchasing power lower than when originally received, the incentive is to borrow and repay later rather than save and lend. The quality of work will decline, because arise a multitude of "get-rich-quick" schemes. The general atmosphere of a "sellers' market" will lead to a further decline in the quality of goods and of service, since consumers often resist price increases less when they occur in the form of downgrading of quality.

Inflation, therefore, lowers the general standard of living in the very course of creating a tinsel atmosphere of "prosperity", where entrepreneurs are deprived of the essential function of learning by doing. "Here we conclude that, morally, such a banking system would have no more right to exist in a truly free market than any other form of implicit theft. [3]"

"Only the establishment of money-prices on the market allows the development of a civilized economy, for only they permit businessmen to calculate economically. Since all these prices are expressed in terms of money, the businessmen can determine whether they are making profits or losses. The improved standards of living come to the public from the fruits of capital investment. Increased productivity tends to lower prices (and costs) and thereby distribute the fruits of free enterprise to all the public, raising the standard of living of all consumers. Forcible propping up of the price level prevents this spread of higher living standards [3, pag.10].

Which, in conclusion, means that commodity money acts itself as a "measure of last resort", in that it could not fail as long it can always be used to acquire goods. A beautiful consequence of this kind of money, when fixed in supply and divisible, is that the more it become saleable, the more it acquires value, or specularly, the more the price of goods is lower compared to money. This is why commodity money act as social security that benefits everyone; in its essence, money acquires the value of the possible infinite array of exchange-ratios of people who use it for its scope.






[1] - R. G. Holocombe. Advanced introduction to the Austrian school of economics.

[2] - E. S. Andersen.  A theory of social and economic evolution.

[3] - M. Rothbard. What has government done to our money? 


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