A Last Mission

After their overthrow of the Kerensky government in November 1917, the Bolsheviks called for an immediate end of the war on the Eastern Front on a status quo ante basis and without reparations for either side. Moreover, they began to make public highly secret prewar Entente plans for punishing Germany in case of victory. These revelations increased the political pressure on the Allies to seek an early peace as their reasons for going to war now appeared in a decidedly less saintly light. The stark contrast between the evil Germanic autocrats and the humane democracies of the West faded away and was slowly replaced by a more realistic picture of the situation. But most of all, the Bolshevik push for peace changed the military situation since it brought the prospect of relieving Austria and Germany from their awkward two-front struggle.

These prospects materialized very slowly, though, because the German side insisted on war reparations that the Bolsheviks would not accept. The peace negotiations started in Brest-Litovsk shortly before Christmas 1917 and were brought to an end only after an Austro-German ultimatum forced the Russian side to sign a treaty by which it ceded military control of the entire Ukraine to its enemies. Thus, what initially promised to be a great military and political success for the Austro-German side had turned into a disaster. Precious time had been lost to move troops to the Western Front. And the imposed “agreement” failed to pacify the Russians, so precious Mittelmächte forces were diverted to defend against a possible Russian backlash. In short, all political advantages had vanished. Lloyd George, Wilson, and the Western press immediately presented the treaty of Brest-Litovsk as evidence of the imperial expansionism of their enemies.

The official rationale for a military occupation of the Ukraine was the exploitation of its rich natural resources. Few people in Germany and Austria knew that this idea was flawed. Mises knew it. In his Archiv article “On the Goal of Trade Policy” he had pointed out that economic control over resources can be enjoyed even in the absence of political control. Access to Ukrainian resources would have been possible through regular trade channels and did not require military occupation of the entire country. Mises relentlessly insisted on this point with an intransigence that had almost cost him his life.

The real “economic” rationale for the occupation of the Ukraine was the usual one: it brought unearned riches to a select few. In the present case, the economic exploitation of the occupied zone was to be confided to an “Ostsyndikat”—a cartel of big industrialists and big bankers with good government connections. Each of them would have monopoly rights to certain Ukrainian products. A May 1918 meeting in Berlin brought all interested men together and determined the broad division of the loot, in particular, each party's “trade contingent”—its exclusive trade domain.¹⁰⁶

One of the unsettled questions after the Berlin meeting was the future monetary constitution of the Ukraine. The Austrian side had a special interest in the question because Austrian war inflation had swept large quantities of kronen into the occupied zone. Decisions about Ukrainian money and currency would most certainly affect the demand for krone notes and thus could possibly break up the krone's fiat exchange rate.

The fundamental problem was that Austria-Hungary, like all other warring states, had vastly inflated its currency, which consistently lowered its exchange rate with other, less-inflated currencies. The only thorough way to stop both the inflation and its symptoms (higher prices and depreciating exchange rates) was, of course, to stop producing additional krone notes, but many statists and money cranks sought schemes to get around this appalling measure. One of these tricks was to make payments in money titles issued on behalf of banks other than the Austro-Hungarian Central Bank in Vienna. The Austrians applied this measure in their occupied territories in Italy. They made payments to their Italian suppliers in Darlehenskassenscheinen (Loan Bureau Notes) denoted in lire to bolster the krone exchange rate against the lira.

Similar measures were taken on the Eastern Front. In August 1918, when the Germans had for some time already made ruble payments in the territories they controlled, the Bankstelle (bank office) of the East Army Command submitted a memorandum¹⁰⁷ proposing similar measures for the territories occupied by Austrian forces. According to the economists of the Bankstelle, the krone surplus on the market resulted from large military payments that were not sufficiently compensated by kronen flowing out as payments for imports from Germany. The German authorities, selfishly concerned with the strength of the mark, were unwilling to cooperate to achieve stable exchange rates. Therefore, the Austrian army should also change its policies by (a) suppressing contraband imports from Austria and exports to Russia and (b) making payments in rubles. These policies would give the Bankstelle time to absorb krone surpluses in the Ukraine by offering interest-paying (2 percent) demand deposits with the local exchequer of the East Army, which would assume the function of a branch office of the Austro-Hungarian Central Bank. This would supposedly bring the millions of kronen now being hoarded in private wallets and strongboxes back into circulation where they could be used in the interest of the national economy and of the currency itself. The Bankstelle clearly had no idea that these measures were entirely unfit to attain the end that it sought. Few in Austria-Hungary could even comprehend, let alone solve such problems.

In June 1918, Otto Katz, director of the Union Bank in Vienna, approached Mises on behalf of a financial policy mission to solve the currency problems in the Ukraine. Mises would be charged with monetary policy in this important occupied territory. The head of the group would be Exzellenz Kraus, under whose leadership Mises had already fought the last battles of the Bukovina and the 12th Isonzo battle.¹⁰⁸ The mission represented a great opportunity for Mises. A thirty-six-year-old captain, he still had one of the lower officer ranks, and his position in civilian life was not especially elevated either. His main capital was the solid reputation he had gained as an expert on money and banking. Katz's offer was therefore a unique career opportunity. At the very least it promised exceptional exposure to high-profile policy-making. There was nothing to do but to thank God, fate, and Katz for the offer, and to accept it immediately and wholeheartedly.

Characteristically, however, Mises spelled out his conditions. He would offer his services for this venture only if he had full decision-making power, being the officer with exclusive responsibility for the financial and monetary policy of the Ukraine. This required in turn that he be transferred into the civil service and obtain a position corresponding to that of Bosnian secretary of state.¹⁰⁹ Most importantly, he demanded that his bureaucratic authority be completely clarified to avoid later frictions that could turn out to be harmful to the cause. He combined this demand with a hard-hitting attack on the bad habits of Austrian bureaucracy. Unlike their German cousins, he argued, the Austrians lacked the ability for detached commitment to a cause:

The usual words of appeasement offered in response to claims made about us—“they will get ahead based on character alone” or “things will sort themselves out in time”—are completely false. I am convinced that I could assert myself and secure a “comfortable” position. But what matters is objectivity; for such personal advantages are gained through a yielding of resolve when it comes to things in which one should have remained firm, and through needless caballing, which leaves no time for solid work. One must be capable of pure objectivity. That the Germans are objective is the basis of their success.¹¹⁰

Mises had no illusions about the acceptability of his proposals. Setting clear terms of cooperation in the interest of the cause was simply not the style of the Austrian administration, and he therefore thought the negotiations at an end. But some days later, Lieutenant Colonel Maximilian Edler von Becher, a high officer from the Imperial General Staff in Vienna, asked him to name the concrete conditions under which he would be willing to join 2nd Army Command as a financial and monetary consultant. He answered in a letter dated June 26, 1918.

Mises suggested dividing the civil service of the 2nd Army Command into three departments: one for political affairs, one for financial and monetary affairs, and one for public finance. He would become director of the department for financial and monetary affairs. He had to be made a civil servant to have authority in dealing with the other representatives of the state, and he had to be an Imperial (k.u.k.) employee to reduce conflicts with Austrian, Hungarian, and local state agents. For the same reason, it would not be advisable for him to remain an officer of the Kammer. For in his capacity as monetary officer he would have to revise agreements between the Ukraine and the Austrian Trade Bureau, an appendix organization of the Kammer, which had a monopoly privilege in Ukrainian imports and exports. His negotiations with the Bureau would lack credibility because of the Bureau's executives within the Kammer; and they risked inciting nationalist resentments since they could be depicted as an inner-Austrian deal to the detriment of the other nations.

Becher seemed to endorse Mises's arguments and restated them almost word-for-word in an official recommendation to his superiors. In this public paper, of which Mises received a copy, Becher suggested that Mises be invited to go to Odessa for an oral presentation and also to study conditions in Kiev and other large Ukrainian towns.

Behind the curtains of the General Staff, however, plans were made to induce the cooperation of the recalcitrant captain without giving in to his demands. In mid-July, the head of Department 10, Colonel Linoch, received an order to further reduce his staff. The order came from very high up, and it was specific about the staff members to be dismissed. Mises was among them. When he received the news from Linoch, he knew the only choice left to him was between the front and a Ukrainian mission without conditions.¹¹¹ Linoch managed to extend Mises's leave in Bad Gastein.¹¹² Then the commander of the East Army, General Alfred Kraus, sent Mises on a two-week mission to Odessa and Kiev and ordered him to report about Ukrainian currency and finance.¹¹³

Mises arrived in Odessa on September 7 and quickly learned that the Germans were pushing to establish a Ukrainian fractional-reserve central bank, whereas the Austrians—in particular Herr Pollak from the k.u.k. Ministry of Finance and the Vienna Association of Bankers—resisted this plan.¹¹⁴ As things stood, it was politically inevitable that any monetary constitution for the Ukraine would have to involve a central bank with a monopoly on the issuance of banknotes. The question was whether the new establishment could be limited to providing currency, or if it would also be drawn into attempts to solve the pressing financial problems of the country.

Such attempts would jeopardize the stability of the new currency, but how else could the financial burdens be shouldered? At a meeting with the local Austrian commander, Mises convinced the Austrian bankers to promote sales of Vienna stocks and bonds to the Ukrainian public.¹¹⁵

To avoid the monetary inflation the Germans advocated, the Misesian strategy was to seek a private-business solution through an increase of foreign holdings of Austrian stock and debt. In a later report to General Kraus he made comments and suggestions to improve this proposed institution as much as possible. In particular, he recommended that the future central bank be built on the model of the Bank of the Russian Empire.¹¹⁶ The Ukrainian central bank should be a pure government institution (as distinct, for example, from the formal set-up of the Bank of England or the German Reichsbank), and half of its endowment should be held as cash reserves. In its investment policies, the new bank should follow private banking principles: no risky investments and no long-term engagements. Mises also stressed that reserve ratios were “of crucial importance” to create trust and credit for the banknotes. The reserves had to be in cash. Anything else would

not offer any tangible security for the note owner [or] in any way prevent an unlimited note-issue that eventually results in the note's complete devaluation. The history of the French assignats, which had been “covered” through liabilities on all of the State's territories, serves here as a warning example.¹¹⁷

Mises thus proposed a form of fractional-reserve central banking system better known as the gold exchange standard. He recommended keeping reserves for one third of all circulating banknotes, and these reserves should be either in cash (gold and silver), in foreign currency, or in bills of exchange on foreign currency. Moreover, the management of the bank should “of course” be subordinate to the government, preferably to the trade minister, since the finance minister would be tempted to abuse it for fiscal purposes.

Mises's proposals were never put into practice. A week after his return to Vienna, the Bulgarian front crumbled and after another month, both Austria-Hungary and Germany were in a state of political and military dissolution. The war ended in sudden chaos, and the empire—a centuries-old order—vanished almost overnight.