Toward Sound Money

The stamping of the krone banknotes had prevented a catastrophe, but the great remaining question was of course how Austrian monetary policy and public finance could be restored to sanity. This had to happen quickly, but the average intellectual saw no way of of this mess. Stopping the printing press seemed to imply the destruction of firms and laborers:

From a theoretical point of view it is correct to put the principle of economic freedom into practice, but this principle cannot be realized (because of the destruction of great masses of entrepreneurs and laborers that would result from it) without revolutionary changes; thus the political consequences of putting this principle into practice would prevent it from having its effect.⁴⁰

In reality, this “destruction” would not have been harmful for the workers. Stopping the inflation would have left intact the physical production facilities—and thus the source of the laborers' income; the production sites, factories, and other producers' goods would merely have changed owners. What the inflation did was to prevent such a sweeping redistribution of capital goods from the economic establishment to private entrepreneurs. In a profound sense, the socialist status quo was not pro-working class, but pro-establishment. From this point of view, the argument that Mises's anti-inflationist endeavors were “politically unfeasible” was clearly about what was and was not palatable to the powers that be.

He began an anti-inflation campaign in the winter and spring of 1919. His greatest asset was the readership of the liberal Vienna press—a well-positioned audience. His status as a recognized authority on financial matters put the stamp of officialdom on his pronouncements and he was therefore a carefully read commentator on current events—so carefully read that he preferred to publish some of his pieces anonymously. Mises gladly accepted an offer from his friend Victor Graetz who ran a major printing company and published the daily newspaper Neues Wiener Tagblatt. Graetz had no competent journalists to cover economic policy, and monetary policy in particular, and thus wanted Mises to write for his paper. The prolific Mises already wrote on monetary policy for the Neue Freie Presse,⁴¹ but Graetz offered attractive terms: Mises would dictate his articles to a stenographer who would come every morning between 8 and 9 o'clock to his apartment. Moreover, Mises would not have to sign the articles and there would be no indication that they were written by a non-staff author.⁴²

He also gave public lectures on these problems, almost exclusively to educated audiences (lawyers and businessmen—not politicians) who were taken with his personality and lecture style.⁴³ One of the obstacles he had to overcome was that the inflation's effects were not yet visible. In Germany and Austria, price controls suppressed domestic price increases thus limiting the most noticeable and painful consequence of inflation to the decreasing number of unregulated markets—and to black markets. The public is thus deceived and fallacious doctrines take hold. These fallacies in turn lead to bad policies, in particular to foreign exchange controls.

The only “official” evidence that something was wrong with the krone was the constant decline of exchange rates, in particular with the currencies of neutral countries. Yet the champions of inflation successfully prevented this fact from alarming the public. They argued that the declining exchange rates resulted from the mechanics of the balance of payments and that there was no necessary relationship between increases of the money supply and the exchange rate.

In two papers, Mises gave a concise refutation of this balance-of-payments theory and made the case for the quantity theory of money. He pointed out that all shortcomings of the quantity theory could not affect its main tenet: that there is a positive relationship between variations of the quantity of money and variations of the price level.

These articles—“The Quantity Theory of Money” and “Balance of Payments and Exchange Rates”⁴⁴—appeared in a low-circulation professional journal, and Mises had had to be very cautious in wording his critique to protect these papers from the government censor. Nevertheless, his frontal attack on the monetary status quo encountered fierce resistance from several “practitioners” of economic policy, including Siegfried Rosenbaum, the director of the Anglo-Austrian Bank and main sponsor of Walther Federn's journal. But the spell was broken. Mises's papers were widely read and discussed in the following years. Their circulation could have been even larger if Mises had not prevented new printings of “Balance of Trade and Exchange Rates,” which he intended to integrate into the second edition of The Theory of Money and Credit.

In a parallel effort to his sound money campaign, Mises worked out two plans for monetary reform—an official one proposing action for “normal” times, and a secret contingency plan in case of a sudden emergency. The monetary problem that virtually monopolized the attention of the Austrian government and public in the first few months of the republic was a proposed currency union with Germany. Prevailing wisdom—and the angst Austrians felt from a lack of political or national identity after the collapse of the empire—had it that Austria was incapable of solving problems without assistance from her big brother to the north. Mises was charged with defining the Austrian position for the upcoming negotiations with the Germans, and was invited to contribute an expert report on the question to a special Verein für Sozialpolitik volume that analyzed the Austrian economy. The volume was meant to give a summary of the situation in Austria and thus serve to inform a larger German public about the specific conditions of their neighbors to the south.

The technical details of Mises's report are still relevant to the modern world of paper money. He pointed out that all problems of Austria's proposed monetary unions with the German Reich arose from the fact that both countries presently used paper monies.

A currency community of two states on the basis of a paper currency is hardly feasible if there is not from the very outset the intention to abstain from any further inflation, and if this intention is not strictly put into practice. As soon as inflationary measures are resorted to, to add to the state treasury, there must arise differences of opinion about the distribution of the new quantities of money that are to enter circulation.⁴⁵

The only example of such a currency community based on paper money was the Austro-Hungarian dual monarchy, which had been established in 1867 and featured two states using the same currency, namely the currency of their common predecessor, the Kaisertum Österreich. Yet this currency community could be successful because it was based on the principle that the total quantity of banknotes in circulation could not be increased. Thus distributive conflicts were avoided from the outset. But if the proposed currency union involved any inflationary measures, the only way to avoid such distributive conflicts was to establish a common financial administration, he thought.

It is therefore clear from the outset that German-Austria's adoption of the German Reich's currency can begin only once the political unification has been [if not achieved, then] at least unchangeably decided.⁴⁶

It was Mises's position that Austria should be granted a special subsidy during the first years of the unification because Austrians had made greater contributions to the war effort, and had suffered more from defeat. Also, the financial agreement between the two states had to allow Austrian entrepreneurs to redeem discounted war bonds at the central bank. This was absolutely essential because they had invested much more of their capital in war bonds than had the German entrepreneurs. Mises insisted on these two points, mentioning each of them twice in his 25-page report.

As for the ratio for the conversion of kronen into marks, Mises argued that it should be based on the prevailing market exchange rate between the two currencies. The ratio would also have to account for the future redemption rate of marks into gold. He recommended that this rate be based on the prevailing mark-price of gold. Attempts to reestablish the prewar rate would hurt exports, which would be devastating under the present circumstances, especially for the Austrians.

The transition from the present state of two independent paper monies to the desired currency union could most suitably be achieved through the intermediate creation of a mark-exchange standard. In this scheme, the Austrian central bank would start redeeming its notes for marks, thus making kronen de facto money substitutes for marks. “By this very fact, German-Austria's adoption of the German currency is put into practice. The krone is nothing but a name for a part of the mark.”⁴⁷ The final step would be the replacement of krone notes by mark notes.

This was a simple and elegant solution, but it was already moot by the time Mises finished the revision of his paper. In early May 1919, the Entente powers issued a decree containing the peace conditions for Germany, and one of them was that Germany could not unite with Austria. The western allies would not budge from this position, and on June 28 the German delegation signed the diktat of Versailles.

Political union had become impossible, and so had Austria's monetary and financial annexation to the German Reich. But Mises pointed out in his report that his plan for currency unification could still work, even under the conditions of the Versailles treaty. In fact, the proposed mark-exchange standard had great legal advantages:

German-Austria's adoption of the mark-exchange standard does not require any action of the German Reich's government. It therefore does not affect the obligation that the German Reich incurred in the peace treaty on behalf of Austria's independence.⁴⁸

His government colleagues preferred other options. They did not see sound money as a priority. They still sought ways to get around the repayment of wartime debts and to expropriate private savings. Misesian reform—stopping inflation, abolishing price controls, and moving toward laissez faire—was out of the question. Apart from all other considerations, these policies would have exposed the enormous redistributive effects of the wartime policies. Renner and Bauer looked for an alternative.

One way to deal with the effects of “surplus money” was to seize cash holdings. Expropriation from German-Austria's former creditors was planned and propagated under the insidious term of Vermögensabgabe, which can be translated as “sharing the wealth.” This rhetorically philanthropic measure was an all-out attack on the country's capitalists who had heavily invested in war bonds and then redeemed them at a loss from the Austro-Hungarian Bank after the dissolution of the old krone currency area. The proposal encountered the fierce opposition of the Kammer, of course, and the socialists were forced to consider other alternatives.

After the peace agreement had been signed on September 10, Austria received loans from the West, giving the government new financial flexibility. Characteristically, the foreign credits were used to buy food for Vienna's now inactive proletarian masses, and many Austrians were already counting on more western help in the future. Mises spoke out against the childish notion that foreign capitalists and governments could have any long-term interest in financing a ruinous socialist experiment in Vienna.

A conference on Austria's currency problems organized by the Vienna Association of Commerce and Industry gives a good sense of his alternative program.⁴⁹ Mises and his friend Wilhelm Rosenberg were the main speakers.⁵⁰ Rosenberg explained that foreign-exchange controls and banking regulations had stopped the inflow of badly needed foreign credit, and encouraged costly barter and black-market exchanges. The present relief was only temporary. He proposed attracting foreign credit by granting special privileges to foreign companies in such fields as mining, road construction, and tourism. Then Mises observed that strikes and work stoppages were pandemic in Austria. The only exception was the printing press of Austria's central bank, which worked day and night. If this state of affairs continued, the krone notes would soon become worthless, their circulation would break down, and chaos would ensue. Mises then explained the origins of the present mess: the government itself had created the inflation; it then took the ensuing price rises as a pretext for imposing price controls and many more interventions. As in ancient Rome, the Austrian government was now at the point of providing the means of sustenance for a majority of the metropolitan population. Hoping for more Allied financial support was futile. The only way out was for the government to spend no more than it took in.

But Mises was completely disillusioned concerning the government's capacity to solve the problems that threatened to bring chaos and violence throughout the country. It had taken him time to learn this lesson, and he learned it the hard way. He had had his own ideas about how an enlightened government could enact a thorough monetary reform but he now knew that it would never happen. He developed instead a revolutionary private-enterprise strategy for the establishment of sound money and was resolved to pursue it without delay.

The fundamental paradigm shift at the heart of the Mises Plan was simply to ignore the government, and to make the reform of the monetary system an affair of the country's principal bankers, merchants, and industrialists. In the fall of 1919, Mises distributed a confidential memorandum. He argued that there was an imminent danger that the inflation and the plummeting krone exchange rate would incite people to give up on using krone banknotes altogether, and that it was necessary to prepare for this day.

One can hardly expect the government to make such preparations. It cannot be assumed that the financial administration that for five years has not only followed, but also repeatedly sought to defend the disastrous inflation policy, and which in complete ignorance of the sole source of the decreasing value of money has accelerated the decline of the krone, would suddenly change its mind. Leaders responsible for its policies who correctly saw the economic connections have up to now been unable to overcome prevailing in-house traditions. Citizens must seek to achieve through their own powers that which the government fails to bring about. All one can hope for on the part of the government is that it not hamper the initiative of the private sector. It is the duty of the banks—and with the banks, that of big corporations in industry and trade—to make ready the measures that appear necessary to overcome the catastrophic consequences of the collapse of currency. This is in their own interest and also a service to society as a whole.⁵¹

Mises then gave the details of his plan. He proposed to take measures to replace the krone with a foreign currency. If the inflationary process was sufficiently slow, he argued, no further measures would be necessary. The krone would then be replaced in a continuous process without threatening a disruption of business operations. The danger lay exclusively in the scenario of a sudden collapse that would leave the citizens without money. In this case, disruption could ensue and lead to misery and violence. It was in anticipation of this possibility that he urged the Austrian entrepreneurs to seek a credit of 30 million Swiss francs that could be used for the payment of one month's worth of wages and for retail payments. Moreover, it was of utmost importance that this sum be available in very small denominations lest it be useless for the man on the street.

Austrian law did not allow this, but in the emergency scenario underlying the Mises Plan such legal considerations would be secondary. And he urged his readers not to despair about the possibility of such an emergency, but to see it instead as an opportunity for political improvement:

Political ideas that have dominated the public mind for decades cannot be refuted through rational arguments. They must run their course in life and cannot collapse otherwise than in great catastrophes....

One has to accept the catastrophic devaluation of our currency as foregone. Imperialist and militarist policy necessarily goes in hand with inflationism. A consequent policy of socializations necessarily leads to a complete collapse of the monetary order. The proof is delivered not only through the history of the French revolution, but also through the present events in Bolshevist Russia and a couple of other states that more or less imitate the Russian example, even though they do not display the atrocious brutality of the Jacobins and Bolshevists, but prefer less bloody methods instead. As unbecoming as the collapse of the currency is in its consequences, it has the liberating effect of destroying the system that brings it about. The collapse of the assignats was the kiss of death for the Jacobin policy and marked the beginning of a new policy. In our country too a decisive change of economic policy will take its impetus from the collapse of the currency⁵²