New Perspectives on
Political Economy
A bilingual interdisciplinary journal
Vol. 7, No. 2, 2011
New Perspectives on Political Economy
A bilingual interdisciplinary journal / Vol. 7, No. 2, 2011
New Perspectives on Political Economy is a peer-reviewed semi-annual bilingual interdisciplinary
journal, published since 2005 in Prague. The journal aims at contributing to scholarship
at the intersection of political science, political philosophy, political economy and
law. The main objective of the journal is to enhance our understanding of private property-,
market- and individual liberty-based perspectives in the respected sciences. We also belive
that only via exchange among social scientists from different fields and cross-disciplinary
research can we critically analyze and fully understand forces that drive policy-making and
be able to spell out policy implications and consequences. The journal welcomes submissions
of unpublished research papers, book reviews, and educational notes.
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Editor-in-Chief:
Josef Šíma, President, CEVRO Institute, Prague
Advisory Editor:
Ladislav Mrklas, CEVRO Institute, Prague
Associate Editors:
Pavel Pšeja (political science), Masaryk University, Brno
Michal Kořán (international relations), Institute of International Relations, Prague
Alena Zemplinerová (political economy), Institute of Economics, Academy of Science,
Prague
Roman Cardal (political philosophy), CEVRO Institute, Prague
Petr Koblovský (law), University of Economics, Prague
Book Review Editors:
Jan Jireš CEVRO Institute, Prague
Managing Editor:
Veronika D’Evereux, CEVRO Institute, Prague
Language Editor:
Shelly Gussis
A bilingual interdisciplinary journal 5
Editorial Board:
Terry Anderson, Hoover Institution, Stanford University
Peter Boettke, George Mason University
Hardy Bouillon, Trier University
Enrico Colombatto, University of Turin
Christie Davies, University of Reading
Frank van Dun, Ghent University, Faculty of Law
Richard Ebeling, Trinity College
Richard Epstein, New York University School of Law
Robert Higgs, The Independet Review
Jesus Huerta de Soto, Universidad Rey Juan Carlos
Jorg Guido, Hulsmann Université Anger
Zdeněk Kühn, Charles University, Faculty of Law
Miroslav Novák, CEVRO Institute
Svetozar Pejovich, Texas A&M University
Gerald Steele, Lancaster University
František Zoulík, CEVRO Institute
A bilingual interdisciplinary journal 163
On Government Investment and
Consumption
Matthew McCaffrey1
Abstract
This paper critically evaluates the argument that all government spending is, from the perspective
of economic theory, simply consumption spending. The argument is questionable
because it assumes that for investment to be meaningful, it must be directed toward consumer
satisfaction, where “consumers” are a group mutually exclusive from government
officials. Further, it assumes that government officials can be neither future- or consumeroriented
in their behavior. Related to these points, the argument also contains terminology
structured so as to rule out objections simply by definition. In addition, the consumptiontheory
of government spending also potentially incorporates hidden value judgments. Finally,
the argument actually overlooks important facts about government production which
would otherwise go unnoticed.
Keywords: Consumption Spending, Capital and Investment, Structure of
Production, Public Finance, Demonstrated Preference.
1	 Matthew McCaffrey, University of Angers, Mcm0016@gmail.com; The author wishes to thank Carmen
Dorobăț, Xavier Méra, and Joseph Salerno for their comments on earlier drafts of this paper. Any remaining
errors are entirely my own. This paper was written while the author was a research fellow at the Ludwig von
Mises Institute.
New Perspectives on Political Economy164
Certain Austrian economists have advanced the claim that from the perspective of economic
theory, all government spending, even spending that is ostensibly investment, is actually
consumption spending. The most important of these are Rothbard (2000; 2004) and
Block (1998). The purpose of this note is to clarify and criticize this argument. I identify
four difficulties with this approach. First, the authors in question conflate statements about
welfare with statements concerning production theory. Second, by carefully defining terms,
they not only produce somewhat tautological results, but also (third) potentially violate the
principle of value freedom. Finally, by oversimplifying the analysis, this argument obscures
some important insights into the theory of economic intervention. However, although I will
show that the arguments advanced are not correct as stated, portions of the underlying
analysis appear sound, and have some further implications for the analysis of intervention
in the market.
I shall focus mainly on the argument of Rothbard, who has the most systematic exposition
of the argument. As we shall see, Rothbard’s thesis depends on a few key assumptions
and definitions, the most important of which is his emphasis on consumer satisfaction as
the ultimate and only meaningful end of economic activity.2
Throughout Rothbard’s exposition
of economic theory in his Man, Economy, and State, saving, investment, and production
are always regarded as processes leading to the satisfaction of consumer wants, and
many basic definitions are constructed with reference to consumer welfare. For example,
when he considers the distinction between consumers’ and producers’ goods, he states:
We call the retail sale of the butter the sale of the consumers’ good, since it is the last sale
for money along the path of the butter’s production. Now the good is in the hands of the
ultimate consumer… Capital goods are produced goods that must be combined still further
with other factors in order to provide the consumers’ good— the good that finally yields the
ultimate satisfaction to the consumer. (Rothbard, 2004, pp. 298—299; emphasis in origi-
nal)
Rothbard’s definitions of capital goods and investment are also built on the distinction
between the production of goods for the purpose of consumer satisfaction, and production
that takes place contrary to consumer wishes:
The consumer’s standard of living, however, is the be-all and end-all of the entire production
process. Production makes no sense whatever except as a means to consumption.
Investment in capital goods means nothing except as a necessary way station to increased
consumption. (Rothbard, 2004, p. 966; emphasis in original)
These distinctions are closely related to Rothbard’s utility and welfare theory, which will
help to explain his theory of investment. Rothbard’s distinct approach to welfare analysis
allows him to draw a sharp line between economic activities in accordance with consumer
demands and activities that serve other purposes. This division is then used to support the
2	 Rothbard’s theory of public finance appears to have built on the work of Jean-Baptiste Say. Cf. Brandly
(2007).
A bilingual interdisciplinary journal 165
argument denying the possibility of government investment, so let us examine it briefly
before proceeding to the theory of production.
Rothbard (1997, 2004) develops a theory of the welfare implications of both market
(voluntary) and government (coercive) behavior. Rothbard (1997) contends that the concept
of ‘demonstrated’ or ‘revealed’ preference is the unifying principle that can be used to
discuss the welfare implications of human behavior. His approach to preference is distinct,
however, from that found in the standard revealed-preference literature.3
The essence of the
theory can be summarized in a few short principles. Put simply, if an actor chooses a certain
course of action, he demonstrates a preference for that action while simultaneously
demonstrating that he did not prefer any other course of action he considered available at
the time. The chosen behavior is thus optimal from the actor’s perspective, and maximizes
utility ex ante. Consequently, if all individuals act voluntarily, the welfare of society (a collection
of individual actors) is maximized. Likewise, if an actor is coerced into committing
a certain action, he thus demonstrates that that action was not optimal from his perspective;
otherwise he would not need to be coerced. He thus suffers a decrease in welfare by
being prevented from pursuing his most highly valued end. Coerced behavior does, however,
maximize the utility of the coercing individual, who does demonstrate a preference for
the action. These two principles together form the core of Rothbard’s utility and welfare
economics. Notice that the emphasis is largely on the ex ante situation. Ex post, we can
say almost nothing about welfare outcomes using this theory, because these outcomes are
not revealed through action. The ex ante situation is, therefore, the vital one in Rothbard’s
welfare theory (Herbener, 1997).
How does this theory apply to government investment? Recall that a state or government
is usually defined as the monopolist of coercion and taxation within certain geographical
limits.4
The implication for Rothbard is that, inasmuch as government is coercive, government
activities (specifically, government spending) are not welfare maximizing, and therefore,
never Pareto-superior. The demonstrated preferences of both the coerced and coercing
parties reveal as much. There are two forms of government action in particular that concern
us: taxation and production. The above welfare analysis is crucial, because it means that
taxation (a coercive activity) decreases the utility of the taxpayers at the expense of those
acquiring taxed resources. We also know then that production— the time-consuming allocation
of taxed resources by the state— benefits those redistributing resources, although the
effect on other members of society is unclear. Let us now turn to the production aspect of
government behavior.
3	 For a review and defense of this approach to utility and welfare economics, cf. Gordon (1993) and Herbener
(1997).
4	 Consider for instance North’s definition: “A state is an organization with a comparative advantage in violence,
extending over a geographical area whose boundaries are determined by its power to tax constituents” (North,
1981, p. 21). I use the term “coercive” throughout this paper, although in his discussions of government, it is
important to note that Rothbard is speaking of the initiation of coercion, or in other words, aggression.
New Perspectives on Political Economy166
The next step in Rothbard’s reasoning is to point out that when goods are produced using
expropriated funds, these goods are not being used in accordance with the preferences
of consumers:
In any sort of division-of-labor economy, capital goods are built, not for their own
sake by the investor, but in order to use them to produce lower-order and eventually
consumers’ goods. In short, a characteristic of an investment expenditure is that the
good in question is not being used to fulfill the needs of the investor, but of someone
else— the consumer. Yet, when government confiscates resources from the private market
economy, it is precisely defying the wishes of the consumers; when government
invests in any good, it does so to serve the whims of government officials, not the desires
of consumers. Therefore, no government expenditures can be considered genuine
‘investment,’ and no government-owned assets can be considered capital. Government
expenditures are divisible into two parts: consumption expenditures by government
officials, beneficiaries of government subsidies, and other nonproductive recipients; and
waste expenditures, where government officials really believe that they are ‘investing’
in ‘capital.’ These waste expenditures result in waste assets. (Rothbard, 2004, p. 941;
emphasis in original)5
Using the demonstrated preference approach, Rothbard can conclude that taxation, because
it is coercive, redirects the pattern of investment away from what it would have been
in an unrestricted market. If entrepreneurs wanted to invest in the same projects as government,
they would not need to be coerced. Therefore, the presence of coercion demonstrates
a shift in production away from the pattern that would have prevailed in an unrestricted
market. In addition to redirecting production, this approach also leads Rothbard to a public
choice-style argument that much government intervention, especially intervention that
erects barriers to entry, grants privileges to market participants; that is, it enables and provides
an incentive for rent-seeking (Frech, 1973).
The line of reasoning runs from consumer demands, to welfare analysis and demonstrated
preference, to the theory of public finance. Rothbard’s argument ultimately leads him to conclude
that a “system of compulsory investment lowers the standard of living of almost everyone,
certainly in the near future… government ‘investment,’ as we have noted above, turns out
to be a peculiar form of wasteful ‘consumption’ by government officials” (Rothbard, 2004,
966; emphasis in original). Rothbard’s argument reduces to the claim that all government
spending is simply consumption spending (cf. also Rothbard, 2000, p. 20). Although very
few economists would argue that all government investment is economically viable, the claim
that all government expenditure is really just consumption is a strong one indeed, and deserves
5	 Cf. also Rothbard (2004, pp. 962-96; 2000, p. 20n15).
A bilingual interdisciplinary journal 167
attention. One important implication of this argument, if correct, would be that government
spending cannot be entrepreneurial, because entrepreneurship implies investment.
Rothbard is claiming that because governments can neither invest nor own real capital,
they can never engage in any sort of productive activity at all. But the key to understanding
this reasoning lies in how he defines terms such as ‘consumption’ and ‘investment.’ It
should be emphasized that Rothbard speaks of capital and investment with reference to the
idea of production designed to increase consumer satisfaction.6
He is quite clear in stating
that investment is defined with respect to consumer demand: “Investment occurs where
producers’ goods are bought by entrepreneurs, not at all for their own use or satisfaction,
but merely to reshape and resell them to others— ultimately to the consumers” (Rothbard,
2004, p. 1259).7
Government allocations of resources then, by the demonstrated preference
argument, are by definition not investment. I shall return to this point below.
Given the above discussion of consumer wants, however, it appears that Rothbard uses
the non-consumer-driven quality of government investment as the criterion for distinguishing
it from “true” production, and for distinguishing ‘investment’ from ‘consumption’ and
‘capital’ from ‘non-capital.’ In fact the trouble is precisely this: Rothbard equates the concepts
‘capital’ and ‘non-capital’ with ‘capital valued according the wants of consumers’
and ‘capital to some degree not valued by the wants of consumers.’ If this is all he means,
then there is nothing in Rothbard’s distinction between capital and non-capital that is not
summed up in the distinction between consumer-driven and non-consumer-driven production
processes, and there is no analytical gain from his terminology. Such definitions simply
preclude the possibility of government production. Additionally, there is tension between
this definition of capital and Rothbard’s simpler, more general, definitions which do not
exclude the possibility of government capital. Take, for instance, the produced-means-ofproduction
definition of capital goods (Rothbard, 2004, p. 10), or the definition of capital
with respect to some consumer, as opposed to a consumer different from the entrepreneur
(Rothbard, 2004, pp. 298—299).
In supporting Rothbard’s position, Block (1998) argues along similar lines:8
While an orthodox economist may take one look at an airport, for example, and immediately
classify it as investment, the Austrian must not be fooled by the chemical,
physical, mechanical or engineering aspects of the facility; he must probe beneath the
surface, and ascertain the purposes of such an expenditure. In the private sector, the
6	 Rothbard’s terminology in the above should also be understood contextually, and might appear odd when
removed from its original setting. Rothbard in the passage above is addressing (ostensibly) common fallacies
relating to “binary [government] intervention,” especially those of national income accounting, and so it is
natural he would have chosen his terminology with this topic in mind.
7	 Rothbard (2000, p. 20n15) contains the same definition.
8	 Block has certainly been influenced by Rothbard’s work on the theory of public finance. On this point, and for
a more general critique of public finance from this perspective, cf. Block (1989).
New Perspectives on Political Economy168
purpose of an airport, or any other such capital good is clear: it is to make profits, by
providing consumers… with a service they value, and for which they are willing to pay.
In contrast, a politically-created airport need have no such goal. And, typically, it does
not. Rather, the purpose is usually to buy votes, or to enhance political prestige, or for
the sheer desire, on the part of the politician, to see an airport erected on a particular
cite [sic]. It may be located so far away from the consumers that it is hardly used at
all… In any case, the wishes of the consumer are all but irrelevant. But the whole point
of investment is, ultimately, consumer satisfaction. Government expenditure, safe from
the wrath of the final customer, thus cannot be considered investment. (Block, 1998)
Block argues that any theory of government investment is actually based on some type of
“chemical, physical, mechanical, or engineering” standard. This sort of theory is opposed
then to an assessment using the standard of the subjective theory of value, which examines
economic phenomena primarily inasmuch as they relate to the valuations of individuals.
This latter approach is the one taken by Rothbard and Block. The distinction is important,
because, given the subjective theory of valuation, we can only speak of physical, chemical,
mechanical, or engineering properties of things with reference to individual preferences:
these characteristics have no distinct economic meaning independent of such values. It is
therefore reasonable to suggest, as Block does, that any definition of terms must relate to
some form of valuation. However, for Block’s argument to prove decisive against alternative
theories of government investment, it must also be the case that there is no possible alternative
theory of government investment that is also consistent with the subjectivist approach.
It should be obvious though that this is not necessarily the case. To point out that particular
definitions do not properly take valuation into account does not imply that no other definition
can (see below for a proposed alternative). And Block and Rothbard certainly do not
attempt to make such a general argument. As a critique of alternative approaches then,
Block is not necessarily successful. One might still ask though whether there is a theoretical
justification for the terminology employed by Block and Rothbard, which might make
it superior to others.
Let us look further at their classification system. As with the concept of capital, ‘investment’
for Rothbard and Block only involves production activity that is undertaken in order
to satisfy consumer demand. The corollary term ‘malinvestment’ in this context refers to
production that is not undertaken for this purpose. Government production is not investment
then, but only because investment has been defined from the outset to exclude government
spending. But of course, government spending can still be production for some
future satisfaction of wants. In claiming that government investment is not investment at all,
Rothbard and Block conflate two different statements: first, that all meaningful government
production is impossible, and second, that government production, because of its coercive
quality, does not increase consumer welfare.
However, in the more limited sense that scarce resources are devoted to time-consuming
production processes, government production is no different from ordinary investment. Its
A bilingual interdisciplinary journal 169
status as investment activity does not depend on who exactly desires it but merely requires
that it may be desired by someone.9
The subjective theory of value does not distinguish
between different groups of individuals; it merely postulates the existence and importance
of individual preferences and the fundamental fact of economic valuation. If we must employ
definitions related to valuation, government investment does not pose a problem. In
addition, it is also questionable whether a simple line can be drawn at all between “consumers”
and “government” viz. production. That is to say, there is not one group, ‘consumers’,
that exists completely separate from another group, ‘the state and its beneficiaries.’ These
two are often intermixed, and it is not clear whether a given demand occurs as a result of
membership one group or the other, and thus whether production benefits one group over
another. This is not to say that market and government investment are equivalent, only that
government investment is meaningful as such, and that the consumer-based definition of
investment overlooks this possibility. I argue, then, that carefully constructed terminology
leads Rothbard and Block to make misleading inferences about government spending and
investment.
It must be emphasized that the foregoing discussion does not imply that government
investment is strictly equivalent to market investment. Certainly is it not. Political resource
allocation is fraught with difficulties, most notably the impossibility of (or severely limited
access to) economic calculation, as discussed by Mises and others (Mises, 1981, 1998).
There are, furthermore, the problems of knowledge elaborated by Hayek (1945, 1948; esp.
chaps. VIII & IX), and the issues of rent-seeking and capture found throughout the public
choice literature. All these difficulties reduce or eliminate the ability of government allocations
to achieve the level of success or the arrangement (coordination) of the structure of
production obtained by market entrepreneurs. Yet— once again emphasizing broad definitions
of terms— there is no reason why these decisions cannot in theory result in the production
of saleable resources which might be called “investment” (McCaffrey and Salerno,
2011). The above issues, along with the demonstrated preference approach to utility, are
extremely important and should not be left out of the analysis, but the point regarding the
conceivability of government “investment” still appears to stand.10
Continuing this line of thought, Rothbard’s and Block’s theory passes over the difference
between the immediate implications of government appropriations and the— temporally
later— effects of government spending. Even if resources are first appropriated in a welfaredecreasing
manner, this does not mean they cannot be redirected to producing things that
consumers find desirable in the future (although the ex ante welfare, calculation, and rent-
9	 I use the qualifying words “may be” instead of “is” to emphasize that there is uncertainty in production processes
that is borne by the entrepreneur. In particular cases, it is not strictly speaking correct to say the market
produces things people desire, but rather those things entrepreneurs believe, based upon economic calculation,
people will desire.
10	 A simple analogy may clarify the point. If a thief spends his ill-gotten gains in the stock market, might not he
aid in the production of valuable goods? The complications which arise from replacing this individual thief
with government do not appear to change the essence of the problem.
New Perspectives on Political Economy170
seeking problems still imply the superiority of the market in making these decisions). The
ex post results of redistribution are unclear, and Rothbard’s welfare-based approach only
sheds light on one part of the problem to be examined. But a government may, if it exercises
a sufficient amount of entrepreneurial insight (which, given the difficulties involved,
might boil down to an impossible amount of good luck), discover profitable avenues of
investment. The exact likelihood of this actually happening is relevant for considering how
to minimize the negative effects of the original appropriation. But what matters for this
paper is that it is conceivable, even if only as an inferior solution. Rothbard’s welfare theory
does not take account of the multi-period allocation of resources, and because of its ex
ante focus, neglects to address consumer welfare in subsequent stages of production.11
The
problems of resource allocation and uncertainty-bearing are not inapplicable in the case of
government. In fact, “political entrepreneurship” is a matter of accurate speculative decisions
on the part of government resource owners, which are not inconceivable (McCaffrey
and Salerno, 2011). Further, even if the entire welfare picture could be discovered through
the demonstrated preference approach, the welfare effects alone would not be enough to
dismiss government investment as consumption, because, as we have seen, it is not necessary
to define terms in this way. A conflation of welfare analysis and production theory
would still lurk beneath the surface of the investigation.
Developing his theory, Rothbard considers the problem in a slightly different way:
All government expenditure for resources is a form of consumption expenditure, in
the sense that the money is spent on various items because the government officials so
decree. The purchases may therefore be called the consumption expenditure of government
officials. It is true that the officials do not consume the product directly, but their
wish has altered the production pattern to make these goods, and therefore they may
be called its “consumers.” [A]ll talk of government “investment” is fallacious. (Rothbard,
2004, 1153; emphasis in original)
In this version of the theory the key point is the apparently arbitrary ability of government
officials to alter production. Government “wishes” divert production from a pattern
favorable to consumers, and therefore is not investment, and anything produced in the process
must be considered consumption goods for government officials. Yet once again, it is
not necessarily the case that government decisions are made without regard for some group
of consumers, even if other groups are severely harmed in the process.12
Furthermore, Bar-
11	 It should be noted that focusing on the ex ante aspects of exchange is not a flaw in Rothbard’s approach, but
a necessity, because ex post valuations cannot be demonstrated through action.
12	 Another problem presents itself. Definitions which insist that the entrepreneur does not produce for himself
but rather for “consumers” imply two things: (1) there can be no such thing as capital or investment in a Crusoe
economy, because there are no consumers toward whose satisfaction production is oriented, and therefore
A bilingual interdisciplinary journal 171
nett and Block (2009) argue that the wishes of officials are not an appropriate test for determining
whether spending is consumption or investment, because all spending depends on
the “wishes” of some actor. Specifically, while it is true that market investment is directed
toward satisfying the desires of consumers, this is by no means an automatic process. The
structure of production must be adjusted preemptively by entrepreneurs, whose “wishes”
determine the arrangement of the factors of production. In this narrow sense, the decisions
of entrepreneurs and government officials are equivalent, because either group may allocate
resources toward future increased consumption, which is a “non-controversial” definition of
investment (Barnett and Block, 2009).13
In a study similar to Rothbard (2004) and Block (1998), Hoppe (1990) attempts to
clarify their position somewhat by referring to government investment as ‘the structure
of mal-production’, This term is perhaps more appropriate than simply ‘consumption’, because
it at least views government investment as some sort of production. Nevertheless,
it is also problematic. Specifically, this particular characterization potentially violates the
principle of value-freedom; to describe production not in accord with consumer wants as
‘mal-production’ may be to assume or, at least imply, the superiority of consumer-driven
allocations of resources and the inferiority of government allocations. At best, however,
from the perspective of economic theory, government investment merely divides the overall
investment in the economy into two groups: investment for some consumers on the one
hand, and investment for the state and its favored parties (other consumers) on the other.
Which (if either) of these is preferable is not a matter of economics, but of ethics. This
point is significant, should we choose to abide by the value-free approach.
This apparent value judgment also appears in Rothbard’s treatment:
Deprived of a free price system and profit and-loss criteria, the government can only
blunder along, blindly “investing” without being able to invest properly in the
right fields, the right products, or the right places… A beautiful subway will be
built, but no wheels will be available for the trains; a giant dam, but no copper for
transmission lines, etc. These sudden surpluses and shortages, so characteristic of government
planning, are the result of massive malinvestment by the government. (Rothbard,
2004, p. 967; emphasis added).14
(2) in this sense, Crusoe is on the same footing as government officials. As an interesting comparison, Fetter
implies that entrepreneurial (non-contractual) income is one of the only incomes in a Crusoe economy (Fetter,
1915, pp. 318—319).
13	 Barnett and Block (2009) only mention the case of an official who allocates for his own future goals, but
neglect the possibility that officials might be interested in, for instance, serving consumers.
14	 In the above quotation from Block (1998), it is evident that the preference for consumer-oriented definitions
is present in his argument as well.
New Perspectives on Political Economy172
It is not clear economically speaking why consumer-driven production should be considered
any more ‘right’ or ‘correct’ than government production. This terminology is only
meaningful if ‘correct’ is defined as ‘in accordance with the wants of consumers.’ But in this
case too, there is the possibility of a hidden value judgment, which, at the least, should be
carefully noted. It would have to be shown that there is something more correct about consumer
preferences than government investments. This is a problem of semantics though, of
classification from one point of view (the point of view of consumers) that conflicts with
another classification and viewpoint (the perspective of a state).15
It is odd that Rothbard
should fall into this error, given that he makes precisely the same criticism of national
income accounting, arguing that to treat the public and private sector as separate, economically
similar entities implies positive moral and economic assumptions about the state
(Rothbard, 2011). As a terminological issue though, it should not matter if we call government
assets ‘capital’ and certain government expenditures ‘investment’: even if we maintain
Rothbard’s theory, all that matters is the distinction between consumer-driven processes
and non-consumer driven processes of production.
Rothbard appears to realize the awkwardness of the above arguments and later provides
a more concise version in his Power and Market:
As for the transfer expenditures made by the government (including the salaries of
bureaucrats and subsidies to privileged groups), it is true that some of this will be saved
and invested. These investments, however, will not represent the voluntary desires of
consumers, but rather investments in fields of production not desired by the producing
consumers. They represent the desires, not of the producing consumers on the free
market, but of exploiting consumers fed by the unilateral coercion of the State… The
new investments called forth by the demands of the specially privileged will turn out to
be malinvestments. (Rothbard, 2004, p. 1168; emphasis in original)
Rothbard has discarded his earlier potentially confusing terminology, and his claim is no
longer that governments cannot meaningfully invest or own capital. Instead, he is merely
pointing out that government investment diverts the structure of production from the course
that it would otherwise have taken (in an unregulated market). Government investment is
only necessarily ‘malinvestment’ from the perspective of those who ultimately lose from redistribution,
not the redistributive winners. This is an improvement on the stronger version
of the claim made above. However, for the purposes of production theory, we can discuss
15	 Uncritical use of these basic definitions comes close to what Professor Yeager, following Popper and Schumpeter,
calls the problem of “essentialism”: that is, of assigning universal and unchangeable defining characteristics
to words and concepts. Cf. Yeager (2010). It is appropriate that Schumpeter originally addressed this
problem in relation the definition of concepts such as “capital” (1954, p. 989). Note that this form of essentialism
is different from the “methodological essentialism” of Menger and Böhm-Bawerk, as discussed in Kirzner
(1992) and Smith (1994).
A bilingual interdisciplinary journal 173
government ‘investment’ and ‘capital’ merely in terms of time-consuming production processes
for the benefit of some individual(s), without reference to welfare properties, or any
other characteristics that would render government spending a distinctly and universally
consumptive activity. A careful rephrasing yields the conclusion that government spending
can be investment. The difference between market and government investment depends on
who the investment is designed to benefit. For Rothbard, this difference consists in a distortion
of the ‘structure of production,’ and subsequent welfare losses, but this is not the same
as the consumption-vs.-production problem.
Similarly, Barnett and Block (2009) reject the position that all government spending is
consumption spending, pointing out that the purposes of government or criminal resource
use are not necessarily consumption-oriented, but might easily be future-oriented instead.
Additionally, the ethical status of an investor does not change the praxeological problem
of investment (discussed further below), or in other words, the ethical aspects of spending
do not necessarily effect the economic question of whether it is consumption or investment
spending.
The original government-investment-as-consumption approach does not then live up to
its ambitions. There are simply too many careful definitions, seemingly designed to rule out
the conclusion that government spending could ever be productive in a meaningful market
sense. And although the demonstrated preference approach to welfare analysis is useful,
it does not fill the gap in Rothbard’s critique of public finance. All this is not to say that
there is some inherent efficiency or welfare-increasing aspect of government investment. All
I mean to argue is that government may be an investor and producer in ways that cannot
be characterized as consumption, and that are consistent with the subjective approach to
valuation, despite being inferior to market allocations in highly significant ways.
As a way of emphasizing the arguments of this paper, one can do no better than examine
Mises’ treatment of the problem. Mises also takes the broadly subjective approach
of Rothbard and Block, pointing out that capital cannot meaningfully be defined without
reference to valuation: “The idea of capital has no counterpart in the physical universe of
tangible things. It is nowhere but in the minds of planning men” (Mises, 1998, p. 511).
Physical definitions of capital are, therefore, sterile, as Block (1998) notes. A praxeological
approach, however, views capital with respect to action, but Mises does not state which
kind of action:
Capital is a praxeological concept… It is a product of reasoning, and its place is in the
human mind. It is a mode of looking at the problems of acting, a method of appraising
them from the point of view of a definite plan. It determines the course of human action
and is, in this sense only, a real factor. It is inescapably linked with capitalism, the
market economy. It is a mere shadow in economic systems in which there is no market
exchange and no money prices of goods of all orders. (Mises, 1998, p. 512; emphasis
added)
New Perspectives on Political Economy174
In this passage Mises takes a position similar to Rothbard and Block, but avoids potentially
confusing terminology or definitions. Capital is a useful concept with reference to
human plans, but Mises does not say that those plans must involve consumer satisfaction
in the sense used by Rothbard or Block. Satisfaction of some wants is clearly necessary
in the concept of capital, and furthermore, genuine markets are necessary conditions as
well. However, Mises does not comment on the essence of capital beyond implying two
extremes— unregulated markets and socialism. The last sentence echoes Mises’ criticism
of socialism, and explicitly states that under such a system, there would be no such thing
as capital, but merely a collection of goods. The definite implication, though, is that in
a mixed economy there is some semblance of calculation— capital is not “a mere shadow,”
but something more substantial, although distorted compared to market results. Other comments
make this point more explicit, as when Mises argues that even under a system of
intervention, markets and economic calculation still exist in some form (Mises, 1998, pp.
712—715). Perhaps capital in such cases might be called “quasi-capital,” to capture the
relevant similarities and differences. In any case, when Mises discusses the praxeological
aspect of capital, he implies much the same argument made above: that praxeology by itself
provides no reason why we should privilege “action for the benefit of consumers” over “action
in general” in the definition of capital (or related concepts such as “investment”).16
One possible counter-argument remains. It might be claimed that because capital
formation requires saving, government expenditures cannot qualify as saving, because
government resource allocations do not require any political actor to refrain from consumption
(instead they impose restrictions on taxpayers). Mises provides a response to
this criticism. He continues the line of thought previously cited, arguing that capital formation
can take place without reduced consumption, if, for example, individuals spontaneously
discover methods of increasing net production (Mises, 1998, pp. 512—513). There
is, therefore, a false conflation of saving and reducing present consumption: the two need
not coincide.
As a closing point, I must emphasize the relevance of this topic for contemporary research.
It is important that Rothbard’s approach actually conceals several more fundamental
claims. The most important is that government spending creates a pattern of investment
different— not necessarily inferior in any particular case— from that which would have occurred
in an unregulated market. Ultimately then, there is nothing to preclude the possibility
of government investment as such. An immediate implication of this fact is that
definite opportunities exist for “political entrepreneurship,” government investment in timeconsuming
production, subject to uncertainty and capable of yielding a market income
(McCaffrey and Salerno, 2011). There is an added layer of complexity that appears when
we take into consideration the possibility of government as an investor, and this complexity
may have important and fruitful implications for the theories of public finance, political
16	 This does not, however, mean that any non-praxeological distinctions of this type would not be important. If
raised, presumably they could be evaluated on their own merits.
A bilingual interdisciplinary journal 175
entrepreneurship, and the theory of intervention generally. I hope that the conclusions of
this paper will help spur further exploration in these areas.
References
Block, Walter. 1998. “Taxes and the Structure of Production.” Journal of Public Finance and
Public Choice. 17 (2-3): 145—59.
—. 1989. “The Justification for Taxation in the Public Finance Literature: an Unorthodox
View.” Journal of Public Finance and Public Choice. 7 (3): 141—58.
Barnett, William, and Walter Block. 2009. “Investment and Consumption: a Critique of
Rothbard’s Claim that there can be No Such Thing as Governmental ‘Investment’.”
Journal of Public Finance and Public Choice. 27 (2—3): 183—188.
Brandly, Mark. 2007. “Jean—Baptiste Say: The Father of Austrian Public Finance: Views on
Taxation.” Quarterly Journal of Austrian Economics. 10 (1): 65—78.
Fetter, Frank A. 1915. Economic Principles. New York: The Century Co.
Frech, H.E. 1973. “The Public Choice Theory of Murray N. Rothbard, a Modern Anarchist.”
Public Choice. 14 (1): 143—54.
Gordon, David. 1993. “Toward a Deconstruction of Utility and Welfare Economics.” Review
of Austrian Economics. 6 (2): 99—112.
Hayek, Friedrich August von.1948. Individualism and Economic Order. Chicago: University
of Chicago Press.
—. 1945. “The Use of Knowledge in Society.” American Economic Review. 35 (4): 519—530.
Herbener, Jeffrey M. 1997. “The Pareto Rule and Welfare Economics.” Review of Austrian
Economics. 10 (1): 79—106.
Hoppe, Hans—Hermann. 1990. “The Economics and Sociology of Taxation.” Journal des
Economistes et des Etudes Humaines. 1 (2).
Kirzner, Israel M. 1992. “Carl Menger and the Subjectivist Tradition.” In The Meaning
of Market Process: Essays in the Development of Modern Austrian Economics. London:
Routledge.
McCaffrey, Matthew, and Joseph T. Salerno. 2011. “A Theory of Political Entrepreneurship.”
Modern Economy. 2 (4): 552—60.
Mises, Ludwig von. 1998. Human Action: The Scholar’s Edition. Auburn, Al: The Ludwig
von Mises Institute.
—. 1981. Socialism: An Economic and Sociological Analysis. Trans. J. Kahane. Indianapolis:
Liberty Fund.
North, Douglass C. 1981. Structure and Change in Economic History. New York: W.W. Norton
& Company.
Rothbard, Murray N. 2011. “The Fallacy of the “Public Sector”.” In Economic Controversies.
Auburn, Al: The Ludwig von Mises Institute.
—. 2004. Man, Economy, & State: Scholar’s Edition. Auburn, Al: The Ludwig von Mises
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Institute.
—. 2000. America’s Great Depression. 5th
ed. Auburn, Al: Ludwig von Mises Institute.
—. 1997. “Toward a Reconstruction of Utility and Welfare Economics.” In The Logic of Action
One. Cheltenham, UK: Edward Elgar.
Schumpeter, Joseph A. 1954. History of Economic Analysis. New York: Oxford University
Press.
Smith, Barry. 1994. “Aristotelianism, Apriorism, Essentialism.” In The Elgar Companion to
Austrian Economics. Ed. Peter J. Boettke. Aldershot, UK: Edward Elgar.
Yeager, Leland B. 2010. “Bank Reserves: A Dispute Over Words and Classifications.” Review
of Austrian Economics. 23 (2): 183—91.
A bilingual interdisciplinary journal 177
The rationale of originary interest
Eduard Braun1
Abstract
Judging from the tenor of some recent publications, time preference is still not generally
accepted as the cause of originary interest. Up to the present day, the theory has not been
formulated in a way to rest its case beyond doubt. In this paper it is argued that the time
preference theory is deterministic and therefore incompatible with freedom of choice. The
reason for originary interest must not be looked for in preferences, but in the logic of action
itself. Based on the critique uttered in the earlier chapters, a positive and truly praxeological
theory of originary interest is developed. The reason for originary interest has to be looked
for in the value-spread between the psychic costs and the psychic revenues of actual human
actions, not in contingent preferences.
Keywords: interest theory, praxeology, time preference
1	 Dr. Eduard Braun is a research assistant at the chair for economic theory at the University of Passau (Germany)
and a former PhD-student at the University of Angers (France). E-mail: braun28@googlemail.com. He is
grateful to the professors Jörg Guido Hülsmann and David Howden and to an anonymous referee for helpful
comments on an earlier draft of this paper.
New Perspectives on Political Economy178
1. Introduction
In a recent article,2
Professor Hülsmann proposed a radically new “Theory of Interest.”
He maintains that time preference is not, if at all, the sole cause of the phenomenon of
originary interest. Instead, originary interest must be regarded as the fundamental value differential
between means and ends in human action. The article has, up to the present day,
not been the object of debate3
although highly deserving of it. Hülsmann shows, contrary to
Frank Fetter and Ludwig von Mises, that there is still a decisive step to make until a purely
praxeological explanation of originary interest is reached. In the present essay it is argued
that Hülsmann is correct in criticising the time preference theory. But the theory that he
presents as a substitute does not totally satisfy either. He concentrates on the role of means
and ends. The relationship between these two is, however, only of a technical character. The
relevant economic relationship can only be found between the psychic costs and the psychic
revenues of human action. It is there that the reason for originary interest can be found.
In chapter two, the concept of originary interest is shortly explained. Chapter three
summarises Hülsmann’s critique of the time preference theory. As the name of the latter already
indicates, the phenomenon that the corresponding theorists have in mind is a matter
of contingent preferences. It therefore does not rest on praxeological laws. Chapter four illustrates
that Professor Hülsmann himself, although being aware of the problems, does not
entirely succeed in providing a praxeological theory of interest. In the fifth chapter, the reason
for originary interest is argued to lie in the value-spread between the psychic costs and
the psychic revenues of human action, no matter what the preferences of the respective actors
look like. The sixth chapter contains the essence of our a priori knowledge concerning
the relationship between time and action. It explains why total interest payments increase
with the passing of time. Chapter seven deals with actions that could be problematical to
the proposed theory. Chapter eight explains the existence of monetary interest as a simple
implication of the logic of action. On the basis of the theoretical results, chapter nine finally
argues that the higher productivity of roundabout production processes is a result, not the
cause, of the interest phenomenon.
2. Originary interest
It has been recognised for centuries that the passing of time is not without influence on
human behaviour. And this influence becomes especially visible in the phenomenon of interest
that has to be paid for borrowed money. The longer the period of time that money is
borrowed, the higher total interest payments become. Now, as Ludwig von Mises and other
2	 See Hülsmann (2002).
3	 An exception is Gunning (2005).
A bilingual interdisciplinary journal 179
economists of the Austrian School show, the role of interest rate on loans is “one of complete
and utter dependence on the rate of interest as determined”4
elsewhere. According to
them, the interest rate pervades the whole economy.5
All producers in a market economy
are producing because they expect to profit “from the price spread between their selling
price and their aggregate factor prices.”6
These price spreads would exist even if there were
no loan and no capital markets and, therefore, no plainly visible interest rate.7 Without
these spreads, there would be no “incentive for investment“8
in the first place. It is important
to add that, in the eyes of the named theorists, these price spreads do not disappear in
the evenly rotating economy.9
In other words, they still exist in equilibrium, that is, after all
“latent forces operating which will go on bringing about price changes” have acted out, and
“provided no new data appear, the final price and the final state of rest are established.”10
The equilibrium spread between the prices of consumption goods and the sum of the prices
of the factors of production employed in their production is called originary interest.11
It
is the task of this paper to explain this spread based on our a priori knowledge of human
action.
3. Time preference as the reason for originary interest
Depsychologising Frank Fetter’s and Franz Čuhel’s exposition,12
Mises13
explains the
phenomenon of originary interest by the existence of “time preference” — the fact that
men “discount future goods as against present goods.”14
As this statement alone would be
very general, he confines the discount to present and future goods “of the same kind and
quantity.”15
This expression goes back to Eugen von Böhm-Bawerk. “The core and central
4	 Rothbard ([1962] 2004, p. 425), see also Mises (1949, p. 524), Dorp (1937, p. 62), and Fillieule (2010,
p. 126).
5	 See Fillieule (2010, p. 124).
6	 Rothbard ([1962] 2004, p. 423, emphasis by Rothbard), similarly Hülsmann (2002, p. 77).
7	 See Rothbard ([1962] 2004, pp. 425 f.).
8	 Ibid. (p. 425)
9	 See Mises (1949, p. 521).
10	 Both quotes from ibid. (p. 247).
11	 See ibid. (p. 521), also Hülsmann (2002, p. 87), Fillieule (2005, p. 5).
12	 See Pellengahr (1996, p. 11). Fetter’s exposition can be found in Fetter (1915, chapter 20), Čuhel’s remarks in
Čuhel (1907, p. 304).
13	 See Mises (1949, pp. 521 ff.).
14	 Ibid. (p. 523)
15	 Ibid. (p. 521)
New Perspectives on Political Economy180
point of interest theory,” the latter expounds, is that, “as a general rule, present goods are
worth more than future goods of the same kind and quantity.”16
Mises erases the expression
“as a rule” and maintains that this statement holds generally.17
The expression “preference” as used by time preference theorists indicates that they
consider time preference to be subject to human discretion. This would imply that one
could have a preference for time or not, just as one can have a preference for apples or not.
But this is not how Mises wants this term to be understood. “Time preference is a categorial
requisite of human action.”18
It appears in all actions, and can therefore not be subject to
human discretion.
If Mises now went on to show that time preference indeed is a “categorial requisite” of
human action, our sole point would be that the expression “preference” is misleading. Yet,
he does not succeed in formulating a praxeological theory of time preference.19
This point
has been brought home by Professor Hülsmann. Following the latter, Mises’s explanation
of time-preference can be called “the consumption theory of time preference.”20
It is based
on the observation that people consume, which is an empirical or historical fact, but not
a praxeological law. People do not necessarily consume, i.e., they do not necessarily prefer
present goods to future goods. Even the consumption that is essential for survival is not
forced on us by praxeological laws. There exist and always have existed men who value specific
things more than their own survival. Hülsmann mentions warriors and martyrs.21
The
will to consume even the minimum, consequently, is not fixed in man by some praxeological
law. Think only of the case of breathing. Man has to breathe to survive. Nobody would deny
that. But it is not the logic of action that forces us to breathe. In the formulation Mises gave to
it, time preference is a matter of contingent preferences, not a law of action.
At this point it seems to be indicated to go into an argument that many Austrian econo-
mists22
discuss in order to support their theory of time preference. They try to demonstrate
that their opponents violate the ceteris paribus condition. Therefore, they discuss the following
objection: “In wintertime, why should anyone prefer ice delivered then [present good]
16	 Böhm-Bawerk (1921b, p. 318, see also p. 327). Similarly Fisher (1930, p. 36).
17	 See Hülsmann (2002, p. 79 f.).
18	 Mises (1949, p. 481, emphasis added)
19	 His arguments also do not seem to be accepted, or even recognised, by most other economists: “To our knowledge
no one has ever provided convincing evidence that there is in fact normally positive time preference, or
even specified an empirical test capable of‘ determining whether there is or not.” (Olson/Bailey 1981, p. 1)
20	 Hülsmann (2002, p. 79) Professor Gunning (2005, p. 83) is searching “in vain” for corresponding textual evidence.
However, the passage by Mises he himself quotes seems to contain support enough for this interpreta-
tion.
21	 See Hülsmann (2002, p. 80).
22	 See e.g. Rothbard ([1962] 2004, p. 15 f., n. 15), Huerta de Soto (2009, p. 272, n. 9), Mises (1949, p. 486 f.),
and Fetter (1915, p. 238).
A bilingual interdisciplinary journal 181
to ice delivered in the following summer when the weather is very hot [future good].”23
This
argument is thought to provide an example of a situation where most people actually prefer
a future good to a present good. According to the Austrian authors, however, this example
violates the ceteris paribus condition. Consumption of ice-cream in winter, they say, is not
the same good as consumption of ice-cream in summer.24
Yet, if we construct the same example in a way that doesn’t violate the ceteris paribus
condition, it cannot be inferred from the then prevailing situation that, now, it is perfectly
clear that the present good is always preferred over the future one. It is not at all definitive
that people having the choice between ice-cream this summer and ice-cream in the next one
will always opt for the former. There is no praxeological law hindering people from preferring
the latter option. Human preferences are not subject to restrictions of this kind.
The essence of this point is that time preference cannot be found in the relationship
between different ends in mere human choices, like between consumption today and consumption
tomorrow. There is no order of ends fixed in the value scales of individuals that
forces them to consume at all in order to survive, i.e., that forces them to prefer present
ends to future ones. This area is open to human discretion. Time preference, therefore, cannot
be the cause of originary interest because it does not necessarily exist, at least in the way
it is presented by Ludwig von Mises. Seeing this shortcoming, Professor Hülsmann25
looks
for originary interest directly in the relationship between ends and means, i.e. in the logic of
action itself, not in the concrete content of human preferences.
4. Originary interest as fundamental value-spread between
means and ends
In his paper, Professor Hülsmann tries to develop a purely praxeological theory of interest
without accounting for time preference as a fundamental cause of originary interest. For
him, originary interest is to be found in the value-spread between the means and the ends
of human actions. “Originary interest is the fundamental spread between the value of an end
and the value of the means that serve to attain this end.”26
As reason for the fundamental value
spread he mentions the fact
that the purpose of employing a means can only be to attain the end. The end is what
really counts for the acting person, whereas the means is merely the thing or the action
23	 Shapiro (1974, p. 238)
24	 See Pellengahr (1996, p. 63).
25	 See Hülsmann (2002).
26	 Ibid. (p. 87, emphasis by Hülsmann)
New Perspectives on Political Economy182
that is in between his present state of affairs and the state of affairs in which his end
is realized. […]
[I]t follows from this fact that, by their very nature, ends have, in the eyes of the acting
person, a higher value than the corresponding means.27
In the following five pages Hülsmann explains why this fundamental value spread has been
ignored so far.28
His main point is that “it did not square with mainstream views on value
and value imputation.”29
According to him, even most Austrian economists, following the
lead of Carl Menger30
, have explicitly or implicitly assumed that the value of the ends “is
fully imputed on the means,”31
thereby not leaving any value spread that could explain the
existence of originary interest.
By claiming this, Professor Hülsmann does not totally do justice to these authors. It
is true, even Mises declares that “the value attached to a product is equal to the value of
the total complex of complementary factors of production.”32
But it is too much to say, in
reference to this statement, “that Mises, at least occasionally, did champion value imputation
and that he therefore believed there was no value spread between means and ends.”33
For Hülsmann neglects a very important part of the sentence he himself quotes. Mises
only holds this equality between means and ends with “due allowance being made for time
preference.”34
We see that Mises actually pays attention to the value spread between means
and ends. This can be seen even better in the following passage:
The prices of consumers’ goods are by the interplay of the forces operating on the market
apportioned to the various complementary factors cooperating in their production.
As the consumers’ goods are present goods, while the factors of production are means
for the production of future goods, and as present goods are valued higher than future
goods of the same kind and quantity, the sum thus apportioned, even in the imaginary
construction of the evenly rotating economy, falls behind the present price of the consumers’
goods concerned. This difference is the originary interest.35
27	 Ibid. (p. 86 f.)
28	 See ibid. (pp. 88-92).
29	 Ibid. (p. 88)
30	 See Menger (1871).
31	 Hülsmann (2002, p. 89).
32	 Mises (1949, p. 332, emphasis added)
33	 Hülsmann (2002, p. 89)
34	 Mises (1949, p. 332)
35	 Ibid. (p. 521)
A bilingual interdisciplinary journal 183
The difference between Mises and Hülsmann is the cause to which they assign the
spread between means and ends. Mises thinks that the cause is time preference, the fact
that “present goods are valued higher than future goods of the same kind and quantity.” For
him, this relationship is fundamental. Hülsmann thinks that the spread between means and
ends is fundamental and independent of the time factor.
If originary interest is defined, after Professor Hülsmann, as the value-spread between
means and ends, two things are essentially needed as given (or at least determinable). These
are the value of the means and the value of the ends. This is the weak spot of Hülsmann’s
theory of interest. The problem with his argument is the lack of an explanation of how the
value of the means is derived. Without the latter one cannot say anything about the nature
of the value-spread between means and ends. In addition, when originary interest is to be
the fundamental value spread between means and ends, it is necessary that the value of the
means is determined in a way independent of originary interest. It would be a logical circle
to explain the value of the means as depending on originary interest, and then declare that
originary interest depends, next to the value of the ends, on the value of the means. Now,
Hülsmann himself provides the following explanation as to the value of the means:
If a means is ever chosen, then the only purpose of this choice is to attain the end it
serves. The very nature of a means implies that it is not sought for its own sake.36
Thus the value of the means depends on the value of the end it serves. It is not valued for
its own sake. In consequence, before the fundamental value spread between means and
ends can be explained, first of all the value of the means has to be clearly derived. And this
can only be done by the help of (1) the value of the end, and (2) something in addition.
Behind this ‘something in addition’, however, “lurks implicitly the rate of interest itself.”37
Hülsmann is trapped in a logical circle. He does not provide for an explanation of the value
of the means that does not presuppose originary interest.
Yet, Professor Hülsmann’s attempt to explain originary interest praxeologically does not
consequently have to be dismissed. His critique of Mises’s statements of time preference
as the source of originary interest remains valid. Time preference as the reason of a valuespread
between different ends (present and future ones) is a historical, not a theoretical
explanation. The explanation of originary interest has rather to be looked for in the logic of
action itself, and this is what Hülsmann has done. But, as was shown above, in his theory
the means derive their value from the ends they serve in combination with an already existing
originary interest. Contrary to his opinion, the value-spread between them is not selfexplanatory.
The value-difference between means and ends must not be seen as explanans,
but as an explanandum.
36	 Hülsmann (2002, p. 87)
37	 Fisher (1930, p. 55)
New Perspectives on Political Economy184
5. The value-spread between psychic costs and psychic revenues
5.1 The technical vs. the economic point of view
Both theories mentioned so far each contain a fundamental truth. The time preference
theory looks for originary interest in the relationship between two goods that are both valued
independently of each other: a present good on the one hand, and a future good on the
other. However, it is deterministic. It does not try to find originary interest in the logic of action,
but in contingent preferences. Professor Hülsmann’s theory has it the other way round.
It correctly looks for originary interest in action, but does not consider that the value spread
between means and ends is not fundamental but presupposes originary interest.
If there should happen to exist a fundamental value spread in human action over time,
it must be found between two goods that are valued independently of each other. The value
of the means employed cannot therefore be taken as part of the explanation. Man does not
compare the means with the ends and then only acts insofar as the ends seem more valuable
to him than the means he has to give up. That one needs the means A, B, and C in
order to produce the consumer good D is a technical, not an economic problem.38
In order
to become an economic one, there would have to be a trade-off between the means and
the end.39
To employ the means, e.g. exchanging them, destroying them in production etc.,
however, does not mean to sacrifice them. There is no trade-off. It is the way they fulfil their
destiny.40
They have to be employed this way; they have to be used up — it is part of their
technical function in production. Otherwise, their existence is good for nothing. To be true
alternatives, the options the acting person faces must both be directly valuable to him. The
problem that constitutes the subject matter of this chapter is to find these true alternatives
that are both valuable to the acting person, and also to find the reason for the supposed
value spread over time between these two. It is there that the reason for originary interest,
if it should happen to exist, has to be looked for: between something foregone in the present
and something obtained in return in the future, i.e. between what is given up in the present
and what is obtained for it in the future.
38	 See Plenge (1964, pp. 123 f.) and Liefmann (1923, p. 539).
39	 See Liefmann (1923, p. 334).
40	 Similarly ibid. (p. 557).
A bilingual interdisciplinary journal 185
5.2 Costs as sacrifice of potential well-being
If the means one employs in action do not represent a sacrifice, is there a cost at all? Are
action and production — we use both terms synonymously41
 — costless? Of course not.
However, when man wants to obtain an end in the future he has to employ not only means
of production like labour and instruments, but also something in addition. Between the setting
in of any action and the attainment of the end sought there always elapses a fraction of
time.42
This time could well have been used to enjoy leisure.43
If one uses this time to attain
another end instead, one sacrifices the present enjoyment of leisure.44
Time is available for
every free man and not enjoying it as present leisure time definitely can be called a sacri-
fice — if we assume leisure to be a consumer good.45
If leisure was not a consumer good, its
employment in attaining future ends would not be a sacrifice. The relationship between its
employment and the aspired ends would become a mere technical one. Costs only arise whenever
one has to abstain from consumption in order to attain one’s end. This does not only hold
for leisure time, but for all sorts of consumption goods that cannot be consumed because
of other ends pursued in action.
The forgoing of consumption is the sacrifice that we are looking for. In contrast to means
or producer goods, consumer goods are valued by the actor even if they are not employed
to attain different ends. That is why the actor considers them as consumer goods, i.e., as
ends themselves. And not consuming them because of his actions is a sacrifice. Without
this action they could have been consumed.
Notice that we are not employing the concept of opportunity costs here. Instead, we
follow George Reisman who shows that this concept only refers to the fact that one has to
choose between several alternatives. We refer the interested reader to his exposition. He argues
that “[t]he doctrine of opportunity cost is not required for ascertaining how one might
do better. Its sole contribution is obfuscation, not perception.”46
Furthermore, we do not try
to make costs “objectively determinable.”47
This point has been raised against other theories
that oppose the opportunity cost doctrine.48
The adherents of the latter maintain that
these theories lack the understanding of the fact that costs can only be felt by the person
deciding and, therefore, are a subjective phenomenon.49
This critique does not affect our
41	 See e.g. Fillieule (2010, pp. 89 f.).
42	 See Mises (1949, p. 476).
43	 See Kirzner (1963, p. 145).☺
44	 See Salin (1990, p. 16).
45	 According to Rothbard ([1962] 2004, p. 43), leisure can generally be considered as a consumers’ good.
46	 Reisman (1998, p. 460). Also Huerta de Soto (2009) most of the time does without the opportunity cost con-
cept.
47	 Buchanan ([1969], 1999, p. 24)
48	 Ibid. He especially thinks of the classics (pp. 37 ff.) and welfare economics (p. 49).
49	 Baxter/Oxfeldt (1968, p. 307), see also Thirlby (1946, p. 33) and Mises (1949, p. 393).
New Perspectives on Political Economy186
notion of costs. The sacrifice of a consumer good is also subjectively felt. We do not claim
to be able to measure the size of the sacrifice. It is a psychic magnitude that is connected to
the consumer good that is given away. At this, what is and what isn’t a consumption good
is determined by the acting person.
5.3 Psychic profit
We come to the conclusion that, in evaluating human action, two things are essential: on
the one hand, the consumer goods that one wants to attain in the future. The utility derived
from these goods will be called psychic revenues.50
On the other hand, there is the potential
consumption that one has to sacrifice in order to obtain the psychic revenues. This sacrifice
causes psychic costs.
Now, in order to interrelate these two with each other, we have to draw on an aspect
of human action which is commonly accepted by economists. It says that people only act
insofar as they think to improve their situation. “[A]ll acting is invariably induced by one
motive only, viz., to substitute a state that suits the actor better for the state that would
prevail in the absence of this action.”51
Or more succinctly: “The objective of all human
action is to produce value.”52
It is not difficult to apply this insight to the problem at hand.
By acting a person demonstrates that he values the aspired consumer goods more than the
consumer goods he sacrifices. In the words of Huerta de Soto: “The actor is only willing to
sacrifice his immediate consumption […] if he thinks that by doing so he will achieve goals
he values more.”53
The difference between the psychic revenue and the psychic costs we will
call psychic profit.54
It seems necessary to mention that the consumer goods in question are not, as in the time
preference theory, “of the same kind and quantity.” We do not maintain a necessary relationship
between present and future goods that somehow prevails in human preferences. Preferences
are not predetermined. What can be said, however, is that in actual action the acting
person reveals that his preferences, at this moment and in this place, are constituted such that
the good he is striving for is worth more to him than the costs he has to incur. So our analysis
holds true also for someone who sacrifices ten apples of high quality today in order to get
one apple of low quality next month. As long as this person acts this way we know that, to
him, the bad apple tomorrow is worth more than the ten apples today.
50	 See Rothbard ([1962], 2004, pp. 71 f.).
51	 Mises (1962, p. 77), also Rothbard ([1962] 2004, p. 19).
52	 Salin (1991, p. 10)
53	 Huerta de Soto (2009, p. 276), similarly Kellenberger (1916, p. 92).
54	 See Rothbard ([1962] 2004, p. 20).
A bilingual interdisciplinary journal 187
5.4 The prices of the factors of production
We are now able to explain how the psychic profit that we have found to be a necessary part
of human action is reflected in the prices of the factors of production. For the time being,
we abstract from the existence of money. The monetary rate of interest that manifests itself
in the money price differential between the means of production and the consumer goods
will be explained in chapter eight.
To recall, originary interest is the price spread between the factors of production and the
consumer goods they produce that remains even in equilibrium. On first sight, the factors
of production are only of technical importance. In order to build a house, one needs wood,
bricks, three hundred hours of labour, etc. Economically, these producer goods concern the
acting person only insofar as he has to sacrifice potential consumption, i.e., incur psychic
costs, in order to employ them. For example, if he has to work himself, he has to abstain
from enjoying leisure. If he also employs other production factors, be it labour services of
other people, capital goods, or land, he probably has to pay a price for them, that is, some
sort of good. This price is what he has to trade off against the good he wants to obtain, not the
paid services or goods themselves. If the price he has to pay should happen to have no value
to him as a consumer good, we are back to a technical relationship between means and
ends. In this case he has to pay the price, yes, but so what? It does not cost him anything.
An economic relationship would only be at hand if he eventually has to sacrifice a consumer
good in order to obtain the good constituting the price in the first place. The important
relationship is the one between costs and revenues, and not between means and ends. And
costs mean consumption sacrifice.
The price of a means of production reflects the consumption sacrifice that was necessary
to obtain it. Thus, the value-spread that we have discovered in human action between
sacrificed and obtained consumer goods, i.e., psychic profit, is transferred to the relationship
between the price of the means and the attained end. By giving away a consumer good
in order to get a means of production, an actor demonstrates that the end that this means
serves to attain is worth more to him than the consumer good he has given away. In other
words, in human action, the future consumption good is valued higher than the price of
the means.
5.5 Psychic profit in equilibrium
From the logic of action results our knowledge of the value-spread between the consumer
good sacrificed today and the consumer good attained in return in the future. We know that
this spread exists at least in the mind of the acting person, as the latter would not act if it
didn’t exist. This value spread is, however, not yet the originary interest that we are looking
for. It is merely psychic profit.
The difference between the value of the price paid (the costs incurred) and that of the
goal attained is called gain or profit or net yield. Profit in this primary sense is purely
New Perspectives on Political Economy188
subjective, it is an increase in the acting man’s happiness, it is a psychical phenomenon
that can be neither measured nor weighed.55
Now, in some areas it will be much more advantageous to act than in others. The psychic
profit will differ from person to person and from action to action. In a market economy,
however, where goods are traded on markets and competition prevails, entrepreneurs are
“intent upon profiting by taking advantage of differences in prices,”56
in our case between
the costs and the resulting revenues. “They buy where and when they deem prices too low,
and they sell where and when they deem prices too high.”57
In this way, the price spread
between the costs and the revenues aimed at will diminish until, in the final state of rest,
it nearly disappears.58
However, even in equilibrium nobody would act without expecting
to profit from his action. Notwithstanding the competition, a spread will remain between
the price of the means and the end. It is closely related to what we have called originary
interest.
We have therewith traced back a price spread in equilibrium to an underlying valuespread
between two goods that are both valued for their own sake. Of course, as we have
not yet introduced money, it is impossible to express the difference between costs and
revenues in any meaningful numbers.59
When costs consist in leisure time and the revenue
in apples, we cannot tell anything about the size of the “profit,” even in the final state of
rest. To express this spread in numbers and to call it “originary interest” it is necessary for
costs and revenues to have a common denominator, for example money prices. However,
even without such a denominator, we know that a spread must be there as long as people
act and produce.
6. The time span between costs and revenues
On the one hand, costs precede revenues, and on the other hand, the acting persons
expect the revenues to be worth more to them than the costs. With these results, we will be
able to explain the existence of originary interest once we introduce money prices. However,
another aspect of originary interest has been neglected so far. Any theory of originary
interest has to account for the fact “that interest can never be calculated otherwise than
55	 Mises (1949, p. 97). We fully agree with this statement, as far as it goes. The reader should keep in mind, however,
that Mises generally has a different notion of cost in mind, i.e., opportunity cost.
56	 Ibid (p. 325)
57	 Ibid.
58	 See ibid (p. 331).
59	 See Liefmann (1925, p. 147).
A bilingual interdisciplinary journal 189
with the formula capital multiplied by time multiplied by interest rate. Therefore, also the
emergence of interest as costs of the capital-using production must somehow have something
to do with time.”60
In other words, why is it that the price spread between costs and
revenues becomes larger the longer the time span between the two becomes?
If one is to look for the reason of the rate of originary interest, the fact that every actor
aims at the improvement of his situation by getting a surplus of his revenue over his costs
does not suffice. It is impossible to explain with the help of this proposition why interest
payments increase with time. The interest rate is calculated as percent per annum. If originary
interest is somehow to be explained by the logic of human action, an analogous interrelation
must be shown to exist in the latter as well, i.e., an increase of psychic profit with
the passing of time. In terms of Professor Hülsmann’s terminology, this theory would have
to explain why the value-spread between means and ends grows larger the longer the period
between the two gets. In our terminology, it would have to explain why the subjectively felt
value-spread between costs and revenue grows larger the longer the action endures. If such
an interrelation between the passing of time and action could be deduced, the basis for the
explanation would have been found as to why interest rates are calculated per annum, i.e.,
per period of time.
Traces of such a theory can be found in the works of some Austrian economists. It is important
to realise that the time preference theory of interest is not always expounded entirely
homogeneously. Rothbard and Huerta de Soto do not consistently define time preference
as a value-spread between ends at different points of time. Instead, according to Rothbard,
“with any given end to be attained, the shorter the period of action, i.e., production, the
more preferable for the actor. This is the universal fact of time preference. […] The less waiting
time, the more preferable it is for him.”61
Now, in the end, this slightly different formulation
does not change the general argument of these authors at all. Its implication, both authors
seem to think, is just the same as Mises’s notion of time preference criticised above. Says
Professor Huerta de Soto: “[T]o put it even more briefly, other things being equal, ‘present
goods’ are always preferable to ‘future goods.’”62
Also Rothbard and Huerta de Soto both
see time preference as a preference of one good or end over another one. Unfortunately, they
equate the notion that man prefers a shorter period of action, or wants to attain his end as
fast as possible, with the alleged higher valuation of present goods as compared to future
goods.63
As has been shown by Hülsmann, the value difference between present and future
goods does not exist by necessity. It is not a praxeological law. Consequently, it cannot be used
to substantiate the claim that man always wants to act as fast as possible, i.e., to attain his
end in the shortest possible period of time.
60	 Strigl (1935, p. 210)
61	 Rothbard ([1962] 2004, p. 15, emphasis by Rothbard). The same thought can be found in Huerta de Soto
(2009, pp. 269 f.).
62	 Huerta de Soto (2009, p. 270). See Rothbard ([1962] 2004, p. 15, n. 15) for a similar statement.
63	 See also Hoppe (1983, p. 67).
New Perspectives on Political Economy190
The first part of their argument, however, seems to lie closer to our own opinion. They
seem to try to explain time preference independently of the concrete content of ends, out
of the pure logic of action itself. This becomes clear in the above quoted statement by
Rothbard that “the shorter the period of action […] the more preferable for the actor.”
However, if a praxeological explanation of originary interest should happen to exist, the
claim that man always prefers a shorter period of action must be capable of being deduced
from a priori valid axioms. In this case, the claim would be neither verifiable nor falsifiable,
just like the proposition that action is the application of means to attain ends. Rothbard
and Huerta de Soto have not provided us with the said deduction. And, as the still ongoing
debate demonstrates, neither has anybody else, or, at least, the argument has not yet been
formulated in a way to be self-evident. What is to be tried here is to find a formulation of the
nature of the relationship between action and the passing of time that accords to Mises’s
dictum: “[T]he characteristic feature of a priori knowledge is that we cannot think of the
truth of its negation or of something that would be at variance with it.”64
“As far as man acts he acts in the shortest way possible” is neither self-evident, stated like
this, nor does it follow obviously from a self-evident axiom. That is why the meaning of this
sentence shall be clarified in the following discussion.
That man acts to achieve his ends in the shortest time possible is knowledge that is
placed in our mind as we are, as Mises would say, acting and thinking beings65
ourselves.
We are acting beings ourselves, and therefore we cannot accept the fact that somebody else
is acting in a categorically different way than we do. As Mises says,
[F]or the comprehension of action there is but one scheme of interpretation and analysis
available, namely, that provided by the cognition and analysis of our own purposeful
behavior.66
Thus, if my assertion is correct and one indeed cannot help acting in the shortest time possible,
it follows that one expects others to do the same. If, for example, we observe another
person who does not seem to act as fast as possible, we automatically look for a logical explanation
for this observation. We do not accept the fact per se because we are humans and
cannot imagine a human not trying to attain his ends as fast as possible. And we can only
explain the fact that somebody does not try to attain his end as fast as possible by automatically
assuming that he prefers to strive for another end at the same time.
The point can be illustrated by an example from physics. Gravitation is recognised by
man. If a ball one lets go of falls to the floor, one does not look for a special explanation
for this observation. One counts on the law of gravitation to work, no matter whether one
64	 Mises (1962, p. 18). See also Mises (1949, p. 34) and Hoppe (1995, pp. 22 ff.).
65	 See Mises (1949, pp. 23 ff.).
66	 Ibid. (p. 26)
A bilingual interdisciplinary journal 191
has heard of the law before or not. Now, if the ball didn’t fall downward but to the left, one
would not assume that the law of gravitation has somehow stopped. Instead, one would look
for a reasonable explanation for this observation. It is the same with the proposition that man
acts in the shortest period possible to him. If someone appears to behave differently, we
automatically look for a logical explanation for this fact. We do not accept it per se.
Propositions like this cannot be proved — they are synthetic and a priori. “Synthetic a priori
propositions are those whose truth-value can be definitely established, even though in
order to do so the means of formal logic are not sufficient (while, of course, necessary) and
observations are unnecessary.”67
The best that we can do is to consider the arguments that
will probably be put forward against it. It is to be hoped that the point will become clearer
throughout this discussion.
First of all, some might argue that the opposite proposition could be defended by the
same token. Man, one might say, always acts as slow as he can, and if he should happen to
act faster, then it is only because he has other ends in his mind that induce him to accomplish
the first one a little earlier. Against this argument one can consult one’s inner experience.
If we watch somebody doing something very slowly, we are, in order to explain this
fact, automatically looking for reasons that are lying outside the realm of what we see him
doing. He might be lazy or tired, he might try to look cool, be lost in thought, or whatnot.
Yet, we would never say that he is acting slowly for no reason. It must be because the acting
person is not only striving for one end, but for several ones. On the other hand, when we see
someone acting very fast, we are not looking for an explanation that lies outside the realm
of what he is doing at the moment. What we would say is: Yes, this person is very eager
to attain his end! He even disregards other ends, like preserving a good image, not getting
exhausted, or whatever, that others might not disregard in his situation. In any way, acting
extremely and unusually fast can be explained by the fact that the actor has no or only few other
ends in mind, but obsesses about the one he is striving for right now. No further explanation is
needed than that he really wants to do what he is doing now, and that nothing else is important
to him. Only when someone is acting more slowly than he could we know that there must
be something else, another end that hinders him from eagerly striving for the first one.
A second argument that will probably be produced against our proposition is that there
are countless cases where people are acting slowly or are letting time lapse before they even
start to act. Someone who has to bake a cake by the end of the week, one might argue, will
not produce it on Monday, but will possibly wait until the day when he has to deliver it.
Doesn’t this prove that, very often, people do not act in the shortest possible time? Yet,
what these deliberations prove is simply that, very often, people have several ends in mind.
The baker in the example does not only want to bake a cake, but to bake a cake that is ready
at the end of the week. Probably he also wants this cake to be fresh and tasty, and therefore
he will bake it just in time. What we do know is that man will not wait or act slowly for no
reason. We know, a priori, that man cannot arbitrarily choose to not act as fast as possible.
67	 Hoppe (1995, p. 18). See there for further methodological details
New Perspectives on Political Economy192
7. Problematical actions
7.1 Coinciding means and ends
Some further possible counter-arguments have to be considered before we get to explain
monetary interest in chapter eight. First of all, what about actions that are pursued because
they are valued themselves, i.e., what about those cases when means and ends coincide with
each other? An example would be a piano player who enjoys playing the piano. A slightly
different one would be the case where he plays not for himself but for a friend. Here means
and ends still coincide, yet can easily be distinguished. By the way, the coincidence of
means and ends cannot at all be regarded as a special case as one might think. In every act
of consumption, like eating, drinking, playing games, means are employed to attain a coinciding
end.68
As long as the action in question takes a period of time it does not pose any problems to
our theory. Other things equal, the piano player will play his piece of music as fast as possible.
If he does not play it quickly, it is not because of an inborn low time preference rate.
We know, instead, that there must be a specific reason for it, that the piano player must have
another end in mind in addition to simply “playing this piece of music.” Probably the music
sounds more enjoyable when performed more slowly, or it can be learned more easily this
way. We couldn’t explain the observation without being aware of a logical reason. So for
these cases as well, our statement holds that the subjectively felt reduction of dissatisfaction
is larger the longer the action endures. Otherwise, the actor would choose shorter paths of
action.
The point is more difficult in cases of action that appear to have no time dimension.
Hülsmann mentions spot market exchanges as an important example for actions that provide
an agio for the parties involved yet have no time dimension.69
He writes about coincidences
when means and ends “coexist at the same point of time.”70
If he was correct, we
would have to admit that the passage of time in action is not “the only determining factor,
but merely one out of two causes operating to the same effect”,71
i.e., the reduction of dissatisfaction
by action. There would be a value-spread between means and ends at a point in
time. This could not be explained by our rate of originary interest that links the increase of
value to the passage of time.
To illustrate his point that there can be a value-spread between means and ends, even if
both coincide and do not extend in time, Professor Hülsmann uses the example of a barter
exchange between two parties:
68	 See Barnett/Block (2007, p. 130)
69	 See Hülsmann (2002, p. 92 ff.).
70	 Ibid. (p. 94, emphasis added)
71	 Ibid. (p. 92)
A bilingual interdisciplinary journal 193
Any contractual agreement is made at a point of time, namely, at the point of time
when both partners have agreed on the terms of the exchange. By its very nature,
choice, in the sense this term is used in economic theory, is made at points of time
rather than throughout a process. And because a market exchange involves the decisions
of at least two people, the exchange becomes effective only when the last partner
has made the decision to cede the title to his property in order to acquire title for another
piece of property.72
This way of stating the argument takes the effect for the cause. It is surely correct to regard
a person’s choice as evidence for this person valuing the option he chooses higher than
the one he does not choose. So if A hands over an apple to B in order to receive a tomato
in exchange this obviously tells us that A and B both think to reduce their subjectively felt
dissatisfaction this way. However, they do not achieve this by merely deciding to do so, or
by contracting accordingly. These events indeed happen at points of time, not in periods of
time. Yet, the parties improve their situation only if the exchange actually proceeds. And an
exchange definitely requires at least one of them to act. And, different from decisions, an
action cannot take place at one point of time. It extends in time.73
The choice to act in a specific way is only the consequence of an actor appreciating this
way of action as being of advantage to him. The advantage, however, must be brought about
by action, i.e., by a process that has a time dimension. At the instance of the decision one
only chooses between different possibilities of action that could — if actually executed — decrease
dissatisfaction.
7.2 Durable means
Another problem arises because some means do not wear off by the attainment of a single
end. They can be used to achieve several of them. Accordingly, it happens very often that
someone employs a means that costs much more than the end it serves at the moment. This
observation seems to contradict our theory of originary interest because, in these cases,
the actor does not value the end more than the price of the means. The following lines will
show, however, that this point does not pose any serious problems to our approach.
To give an example: it is impossible to deduce from the observation of someone eating
dinner with golden dishes that this person values the meal (his end) more than the golden
dishes (means). The dishes do not disappear because of the meal. Our gourmet only parts
with the money he spends for the food, and, possibly, some milligrams of the gold in so far
as the dishes wear off a little bit. After all, the dishes are available to be put to further uses
after dinner in pretty much the same condition as before dinner. There can only be a valuespread
between the end on the one hand and that part of the means perished during the
72	 Ibid. (p. 95)
73	 See Rothbard ([1962] 2004, p. 4).
New Perspectives on Political Economy194
attainment of this end on the other. If the dishes were indestructible, the notion of a valuespread
between the dishes and the meal would become meaningless.
Important for our analysis is not the price of the means employed, but the price of that
part of the means that has been used up in action — accountants call this the write-off. To
stay in our example, the meal does not have to be worth more than the cost of the dishes,
but only than the cost of that part of the dishes that wore off during the meal. At least the
person employing the golden dishes thinks so; otherwise he would not employ them.
8. The monetary rate of interest
Finally, we are able to explain the emergence of a monetary rate of originary interest as
the result of the logic of action. That businessmen orientate their actions by money prices
and try to obtain an excess of monetary revenues over monetary costs is nothing more
than a corollary of what has been said about action in general, namely that it implies an
expected excess of psychic revenues over psychic costs.74
This latter characteristic of human
action, we have seen, lies behind what has been called psychic profit in equilibrium. Now,
as far as this psychic phenomenon is concerned, it does not manifest itself in an observable
way. As laid down by Hülsmann, it “is not a manifestation of human action in the world of
physical things, but a structural feature of human action itself.“75
We know that there must
be a value-spread between costs and revenues, but it cannot be demonstrated empirically,
as psychic magnitudes defy measurement. In a monetised market economy matters stand
differently. There, costs and revenues are
physically homogeneous to the point that one can calculate a quantitative difference between
the two, that is, between monetary proceeds from selling a product and monetary
expenditure for the corresponding factors of production.76
As money could be held in cash balances without physical deterioration if it were not invested,
we know for sure that the expected price-spread between the costs and the revenues
of investments must be expected to be positive. It would be “absurd”77
to invest it without
the intention to make monetary profit or, in Marxian terminology, a “surplus value.”78
74	 The same idea is expressed by Hülsmann (2002, p. 93) in terms of means and ends.
75	 Hülsmann (2002, p. 97)
76	 Ibid. (p. 93, similarly on p. 96). Hülsmann, however, refers to means and ends, not to costs and revenues.
77	 Marx (1967, Vol. 1, p. 162)
78	 Ibid. (p. 165)
A bilingual interdisciplinary journal 195
Furthermore, following our discussion on human action in general, the monetary profit
that is expected from any investment must increase with the time spread between the incurrence
of costs and the attainment of revenues. If there are two investment options with
no difference in risk which both promise to return 110 monetary units to an investment of
100, other things being equal, of course that option which takes a shorter time is preferred.
A longer time-spread between costs and revenues is only accepted if the expected monetary
reward is augmented enough.
Now, the existence of money prices not only makes visible the spread between monetary
costs and revenues. It also makes the plans of businessmen homogeneous in that they are all
striving for monetary profits. So if some entrepreneurs make high money profits in a special
kind of business, other market participants will lower them “by entering the same business,
thus bidding up the prices of the required factors of production, and bidding down the
prices of the product.”79
Entrepreneurial competition will tend to erase the differences that
exist in the monetary profit rate in different lines of business.80
Competition will thereby
tend to adjust the profit rate to the length of the investment. A doubling of this length will
bring about a doubling of the rate such that the rate per period of time tends to become
equal. In the words of Rothbard, if this rate should happen to be five percent per year, “[a]
production process or investment covering a period of two years will, in equilibrium, then
earn 10 percent, the equivalent of 5 percent per year.”81
The rate of profit per period of time that remains despite the tendency of competition to
eliminate profits can be called originary interest or, if one wishes, the market rate of interest.
We know from our analysis that the price spreads that correspond to this rate “do not
come into being by accident.” Rather, they are the “premeditated result of entrepreneurial
action.”82
Businessmen only act insofar as they expect the monetary revenues to be higher
than the costs.83
This difference “cannot be arbitraged away.”84
Thus, there will always be
a positive market rate of interest in terms of money.85
The height of this rate of originary interest is determined by the actions of those who
invest money. The more they invest, the higher will be the prices of those goods they invest
in, i.e., the originary factors of production and production goods, and the lower will be the
prices of the goods that constitute the final output, as their supply will increase. Thus, the
more people invest, the lower will be the spread between costs and revenues. Entrepreneurs
have, it is true, different minimal spreads between costs and revenues that they are willing
79	 Hülsmann (2002, p. 98)
80	 See Mises (1949, p. 533), Fillieule (2005, p. 5).
81	 Rothbard ([1962] 2004, p. 372. emphasis by Rothbard)
82	 Both quotes from Hülsmann (2002, p. 93).
83	 See ibid. (p. 98).
84	 Ibid. (p. 93)
85	 Ibid. (p. 99)
New Perspectives on Political Economy196
to accept. But these differences can be smoothed out.86
Those who would accept a smaller
rate of profit than the one prevailing on the market will gladly accept the latter. Those who
demand a higher one will cease investing.
9. The productivity of roundabout production processes
In the foregoing analysis we have obtained two results:
1. man acts to render conditions less unsatisfactory
2. man acts in the shortest possible period of time
These two propositions allow us to understand the phenomenon of originary interest. In the
following pages, it will be shown that they can also explain a phenomenon that has gained
a lot of prominence within the Austrian School. Although Böhm-Bawerk criticises all kinds
of productivity theories at length in his Geschichte und Kritik der Kapitalzins-Theorien,87
he
himself mentions as the famous third reason of interest the higher physical productivity of
time-consuming roundabout production processes.88 Unsurprisingly, his theory has been
attacked several times by eminent scholars. It is held that it falls prey to the very same criticism
Böhm-Bawerk expounds against former productivity theories.89
It cannot explain why
the value of the consumer goods is not fully imputed to the production factors.90
Nonetheless, Böhm-Bawerk’s productivity theory is based on a  correct observation.
More roundabout processes of production indeed are, as a rule, physically more productive
than shorter ones. Let it be understood, we do not maintain that all theoretically possible
roundabout ways of production are more productive than their shorter counterparts. Of
course, there are roundabout ways that are totally unproductive, and short production processes
that are highly productive. This point is hinted at by John Maynard Keynes:
It is true that some lengthy or roundabout processes are physically efficient. But so are
some short processes. Lengthy processes are not physically efficient because they are
86	 Ibid.
87	 See Böhm-Bawerk (1921a, pp. 103—170).
88	 See Böhm-Bawerk (1921b, p. 339).
89	 See e.g. Wicksell (1893, p. 87), Mises (1949, p. 486). Also Kirzner (1996, p. 127), Pellengahr (1996, pp. 11
and 21), and Fillieule (2010, p. 123).
90	 See Pellengahr (1996, p. 17), Dorp (1931, p. 293).
A bilingual interdisciplinary journal 197
long. Some, probably most, lengthy processes would be physically very inefficient, for
there are such things as spoiling or wasting with time.91
Anyway, it is not from the observation of the higher physical productivity of the more
roundabout ways of production that interest can be deduced. It is the other way round.
Because we know that all human actions fulfil the two propositions stated above, we know
that longer production processes actually chosen are, as a rule, physically more productive
than shorter ones. First of all, we know that every production process has to be regarded
as being productive in a subjective sense, that is, from the point of view of the producer
himself. Otherwise, he wouldn’t think this production to render conditions less unsatisfactory
than they would have been without it, i.e., to lead to revenues that surpass costs, and
consequently he would not undertake it. In the words of Eduard Kellenberger, the “much
disputed productivity” in question “in the end rests upon the insight of the people.”92
Furthermore,
it is clear from the second proposition that the person wants his production
process to be accomplished in the shortest possible time. If he nonetheless chooses a longer
production process, we can be sure that there must be a reason for it. It might be that it is
more productive physically. Then it brings forth more of the same good than a shorter process
does. But it might also be that it brings forth different goods that are more valuable than
the goods that can be produced in shorter processes; or that the longer production processes
make it possible for the producer to strive for further ends, like leisure, in addition to
the goods he produces in his production process.93 The only one who knows the reason is
the actor himself. What should be clear is that he only chooses longer or more roundabout
processes of production if they appear to him to be more productive.94
As Kellenberger
notes, it is not correct
to understand by physical productivity the production of more or better — more use-
ful — goods as if the adjectives ‘better’ and ‘more useful’ had an absolute meaning,
a meaning which was independent of man; as if it wasn’t the appreciation of man that
the judgment concerning what is better or more useful depends. All that ‘better’ and
‘more useful’ can signify is ‘suited better,’ that is, ‘more valuable’ for special purposes.
[…] Therefore, the deliberate and purposeful production of better and more useful
goods is, from the start, value production and not physical production.95
91	 Keynes (1936, p. 214)
92	 Both quotes from Kellenberger (1916, p. 86, emphasis added).
93	 See Fillieule (2010, p. 95).
94	 See Huerta de Soto (2009, pp. 269 f.) for a similar point.
95	 Kellenberger (1916, p. 91, some emphasis added)
New Perspectives on Political Economy198
So the higher physical productivity of more roundabout ways of production is not the (or
leastwise one) reason for the existence of interest. Instead, “every purposeful production
of goods is ex ante psychic or value production.”96
The higher physical productivity of most
of the actually employed roundabout ways only follows from the fact that they are necessarily
expected to be of higher value productivity, and the latter results from the two propositions
developed above, i.e., from originary interest.
Böhm-Bawerk himself somehow is conscious of the problem described here. He acknowledges
that there is nothing in longer ways of production per se that could account
for the higher physical productivity. That is why he sometimes — not always — confines the
higher productivity only to those longer processes that are wisely chosen [“klug” or “geschickt
gewählt”].97
In other words, it seems that he tries to deduce the higher productivity
of more roundabout processes from human action from the fact that people purposefully
pursue those projects that produce value.98
Yet, he does not think that it is necessarily the
case that humans choose “wisely”. If he had realised that his doubt is only reasonable ex
post and that, ex ante, everybody acts in a way he thinks proper to produce value,99
or, as
Walter Eucken terms it, in a “rational” way,100
his point would correspond to our notion of
originary interest.
The analysis of originary interest as presented above also helps to understand some
popular examples given to illustrate the productivity of time or waiting. Wine101
or wood102
are very often103
mentioned as goods that increase in value by the mere passage of time.104
But one has to realise that there is an indefinite number of instances where time just works
in the opposite direction and has a destructive influence on things. Milk, fruits, vegetables,
meat, and even wine and wood can — if one waits too long — lose their value to man completely
by the passage of time. It is not true without qualification that “wine […] becomes
the longer it is stored.”105
Again, it is not the productivity of time or waiting from which
stems the interest phenomenon. Instead, we know from the propositions derived above that
time apparently is productive in the actual production of wine and wood.
96	 Ibid., emphasis added.
97	 See for example Böhm-Bawerk (1921b, pp. 16, 111, 115, and elsewhere), and Böhm-Bawerk (1921c, p. 2). Strigl
(1934, p. 81) uses the same terminology. Böhm omits the idea of “wisely chosen” processes in 1921b (pp. 121,
146, and elsewhere). See also Fillieule (2005, p. 6; 2010, p. 96).
98	 See Lutz (1967, p. 13).
99	 See Rothbard ([1962] 2004, p. 277).
100	Eucken (1954, p. 69)
101	See Rothbard ([1962] 2004, p. 14), already James Mill (1844, p. 102).
102	See e.g. Eucken (1954, pp. 72 f.).
103	See Lutz (1967, p. 11).
104	Kirzner (1996, p. 139) provides further examples from the literature.
105	Stackelberg (1944, p. 31)
A bilingual interdisciplinary journal 199
10. Conclusion
The purpose of this paper was to show that the reason for the interest phenomenon has
nothing to do with preferences. Instead, originary interest can be explained as the result
of two propositions concerning the logic of action. According to the first one, men act to
render circumstances less unsatisfactory. According to the second, men always want to attain
their ends as fast as possible. The combination of both has brought us to a praxeological
explanation of originary interest. It has also been shown that the earlier attempt in this
direction by Professor Hülsmann has not been entirely successful.
A value-spread over time can be found in every human action, no matter whether we
look at goods of the same kind and quantity or not. It is true, it totally depends on the
preferences of the actors which goods they consider to produce psychic revenues or psychic
costs, and how they balance them against each other. Yet, nothing can be said about these
preferences in advance, and they are surely not predetermined in the way maintained by the
time preference theory. The results of our investigation indicate that the term “time preference”
should be abolished as a praxeological category. It should be substituted by the two
propositions presented in this paper. “Time preference” might well continue to serve as an
expression describing human characteristics, just like the expressions industry, quickness,
or laziness do. However, it is not suited for the praxeological deduction of interest.
References:
Barnett/Block 2007: William Barnett II and Walter Block: Saving and Investment: A Praxeological
Approach, in: New Perspectives on Political Economy 3 (2), pp. 129—138
Baxter/Oxenfeldt 1968: W. T. Baxter and A. R. Oxenfeldt: Costing and Pricing: The Cost
Accountant versus the Economist, in: Studies in Cost Analysis, 2nd
edition, edited by
David Solomons, London: Sweet & Maxwell, pp. 293—312
Böhm—Bawerk 1921a: Eugen von Böhm-Bawerk: Geschichte und Kritik der Kapitalzins-Theorien,
4th ed., Jena: Gustav Fischer
Böhm-Bawerk 1921b: Eugen von Böhm-Bawerk: Positive Theorie des Kapitals Band I, 4th ed.,
Jena: Gustav Fischer
Böhm-Bawerk 1921c: Eugen von Böhm-Bawerk: Positive Theorie des Kapitals Band II
(Exkurse), Jena: Gustav Fischer
Buchanan [1969] 1999: James M. Buchanan: The Collected Works of James M. Buchanan.
Volume 6: Cost and Choice. An Inquiry in Economic Theory, Indianapolis (IN): Liberty
Fund
Čuhel 1907: Franz Čuhel: Zur Lehre von den Bedürfnissen. Theoretische Untersuchungen
über das Grenzgebiet der Ökonomik und der Psychologie, Innsbruck: Wagner
Dorp 1931: E. C. van Dorp: Agio oder Lohnfonds?, in: Archiv für Sozialwissenschaft und
Sozialpolitik 66, pp. 284—319
New Perspectives on Political Economy200
Dorp 1937: E[lisabeth] C. van Dorp: A Simple Theory of Capital, Wages and Profit or Loss.
A New and Social Approach to the Problem of Economic Distribution, London: King
Eucken 1954: Walter Eucken: Kapitaltheoretische Untersuchungen, 2. ed., with 3 additional
essays, Tübingen and Zürich: Mohr (Siebeck)
Fetter 1915: Frank A. Fetter: Economic Principles, New York: Century
Fillieule 2005: Renaud Fillieule: The “Value-Riches” Model: An Alternative to Garrison’s
Model in Austrian Macroeconomics of Growth and Cycle, in: The Quarterly Journal of
Austrian Economics 8 (2), (Summer 2005), pp. 3—19
Fillieule 2010: Renaud Fillieule: L’école autrichienne d’économie. Une autre hétérodoxie, Villeneuve
d’Ascq: Presses universitaires du septentrion
Fisher 1930: Irving Fisher: The Theory of Interest as Determined by Impatience to Spend
Income and Opportunity to Invest It, New York: Macmillan
Gunning 2005: J. Patrick Gunning: Interest: In Defense of Mises, in: The Quarterly Journal
of Austrian Economics 8 (3), (Fall 2005), pp.81—91
Hoppe 1983: Hans-Hermann Hoppe: Kritik der kausalwissenschaftlichen Sozialforschung —
Untersuchungen zur Grundlegung von Soziologie und Ökonomie, Opladen: Westdeutscher
Verlag
Hoppe 1995: Hans-Hermann Hoppe: Economic Science and the Austrian Method, Auburn:
Ludwig von Mises Institute
Huerta de Soto 2009: Jesús Huerta de Soto: Money, Bank Credit, and Economic Cycles,
translated by Melinda A. Stroup, Auburn: Ludwig von Mises Institute
Hülsmann 2002: Jörg Guido Hülsmann: A Theory of Interest, in: The Quarterly Journal of
Austrian Economics 5 (4), (Winter 2002), pp. 77—110
Kellenberger 1916: Eduard Kellenberger: Thesaurieren, Sparen, Kapital und Zins im Zusammenhang
mit den Erfahrungen des Krieges, in: Zeitschrift für die gesamte Staatswissenschaft
72 (1), pp. 72—102
Keynes 1936: John Maynard Keynes: The General Theory of Employment, Interest, and Money,
London: Macmillan
Kirzner 1963: Israel M. Kirzner: Market Theory and the Price System, Toronto et al.: van
Nostrand
Kirzner 1996: Israel M. Kirzner: Essays on Capital and Interest. An Austrian Perspective,
Cheltenham (UK) and Brookfield (US): Elgar
Liefmann 1923: Robert Liefmann: Grundsätze der Volkswirtschaftslehre, I. Band: Grundlagen
der Wirtschaft, 3rd ed., Stuttgart and Berlin: Deutsche Verlagsanstalt
Liefmann 1925: Robert Liefmann: Wirtschaftlichkeit und Gewinn, in: Zeitschrift für Betriebswirtschaft
2, pp. 140—148
Lutz 1967: Friedrich A. Lutz: Zinstheorie, 2nd ed., Zürich and Tübingen: Mohr (Siebeck)
Marx 1967: Karl Marx: Das Kapital. Kritik der politischen Ökonomie, 3 volumes, Frankfurt
am Main
Menger 1871: Carl Menger: Grundsätze der Volkswirthschaftslehre, Wien: W. Braumüller
Mill 1844: James Mill: Elements of Political Economy, 3rd
edition, revised and corrected,
London: Henry G. Bohn
A bilingual interdisciplinary journal 201
Mises 1949: Ludwig von Mises: Human Action — A Treatise on Economics, New Haven: Yale
University Press
Mises 1962: Ludwig von Mises: The Ultimate Foundation of Economic Science — An Essay on
Method, Toronto et al.: Van Nostrand
Olson/Bailey 1981: Mancur Olson and Martin J. Bailey: Positive Time Preference, in: The
Journal of Political Economy 89 (1), (Feb., 1981), pp. 1—25
Pellengahr 1996: Ingo Pellengahr: The Austrian Subjectivist Theory of Interest. An Investigation
into the History of Thought, Frankfurt am Main et al.: Lang
Plenge 1964: Johann Plenge: Cogito ergo sumus. Eine Auswahl aus den Schriften von Johann
Plenge 1874—1963, edited by H. Linhardt, Berlin: Duncker & Humblot
Reisman 1996: George Reisman: Capitalism — A Treatise on Economics, Ottawa (Illinois):
Jameson Books
Rothbard [1962] 2004: Murray N. Rothbard: Man, Economy, and State — A Treatise on ����Economic
Priciples, Auburn: Ludwig von Mises Institute
Salin 1990: Pascal Salin: La Vérité sur la Monnaie, Paris: Jacob
Salin 1991: Pascal Salin: Macroéconomie, Paris: Presses Universitaires de France
Selgin 1990: George A. Selgin: Praxeology and Understanding — An Analysis of the Controversy
in Austrian Economics, Auburn: Ludwig von Mises Institute
Shapiro 1974: Milton M. Shapiro: Foundations of the Market—Price System, Pomona (CA):
California State Polytechnic University
Stackelberg 1944: Heinrich von Stackelberg: Kapital und Zins in der stationären Wirtschaft,
in: Zeitschrift für Nationalökonomie 10 (1), pp. 25—61
Strigl 1934: Richard von Strigl: Kapital und Produktion, Wien: Springer
Strigl 1935: Richard von Strigl: Zeit und Produktion, in: Zeitschrift für Nationalökonomie 6
(2), pp. 209—229
Thirlby 1946: G. F. Thirlby: The Subjective Theory of Value and Accounting “Cost”, in:
Economica (New Series) 13 (49), (Feb. 1946), pp. 32—49
Wicksell 1893: Knut Wicksell: Über Wert, Kapital und Rente — Nach den Neueren Nationalökonomischen
Theorien, Jena: Gustav Fischer
New Perspectives on Political Economy202
A bilingual interdisciplinary journal 203
MISES ON FRACTIONAL RESERVES
A REVIEW ON HUERTA DE SOTO’S ARGUMENT
Nicolás Cachanosky1
Abstract
The interpretation that Mises preferred banking with a 100% reserve requirement finds
strong support in Huerta de Soto’s Money, Bank Credit, and Economic Cycles. This article
seeks to review his arguments concluding that it is in fact more feasible to interpret that
Mises preferred free banking with fractional reserves to the 100% reserve requirement.
Keywords: free banking, fractional reserves, Ludwig von Mises
1	 Nicolás Cachanosky, Suffolk University, Department of Economics, 73 Tremont St. (10th floor) Boston MA
02108, email: ncachanosky@suffolk.edu, http://www.ncachanosky.com. I thank Adrián Ravier, Ivo A. Sarjanovic,
Matías Spelta and Gabriel J. Zanotti, for providing comments that were very helpful in the writing of
this article. I’m the only one responsible for any error or omission.
New Perspectives on Political Economy204
1. Introduction
In the debate between free banking with fractional reserves versus banking with a 100% reserve
among Austrian economists, special attention is given to Mises’ opinion on this topic.
This is, of course, a different debate from the one asking which one of these two systems is
preferable. The first one concerns author interpretation; the second one is theoretical.
Since we cannot settle this debate by asking Mises for his thoughts, this question of how
to interpret his writings can become a never-ending discussion. Many economists sustain
that Mises’ opinion was primarily in favor of free banking with fractional reserves, but many
others sustain the contrary position, that he preferred banking with a 100% reserve.
Standing out among the works arguing that Mises defended a 100% reserve requirement
is Jesús Huerta de Soto’s book Money, Bank Credit, and Economic Cycles (1998), especially
Chapter 9.1. Huerta de Soto’s exposition has become a strong reference supporting the
interpretation that Mises favored banking with a 100% reserve. The recent translation of
Huerta de Soto’s book to English in 2006 is one of the latest expositions on this topic.
Any academic debate is about ideas, not people; this article reviews Huerta de Soto’s case
because of the importance of his tidy and relevant work. Nevertheless, many of the reviews
and comments could probably be extended to other authors holding a similar interpretation
of Huerta de Soto’s views.
This article seeks to contribute to the debate by reviewing Huerta de Soto’s argument,
concluding that it is more likely to affirm that Mises’ free market ideal was not a 100%
reserve requirement but was instead free banking with fractional reserves. This article does
not deal with the free banking with fractional reserve versus banking with 100% reserve requirement
discussion or with other related issues like the “fraud” or “money created out of
thin air” arguments; it only deals with a revision on Huerta de Soto’s exposition in chapter
9.1 of his Money, Bank Credit, and Economic Cycles. That is, it only deals with the Mises
interpretation aspect of the debate and not with the theoretical discussion. For this review,
the article will only refer to the specific chapter and pages in Huerta de Soto’s book where
he affirms that Mises’ inclination was a 100% reserve requirement. Regarding Mises’ writings,
the article will mainly refer to the same chapters and sections Huerta de Soto does,
with a few auxiliary exceptions for purposes of clarification. This is intended to emphasize
the conclusion that even from the same chapters from where Huerta de Soto quotes Mises,
it is also plausible to conclude that he preferred free banking with a fractional reserve.
The article has the following structure. In the first section, we will review the six references
offered by Huerta de Soto to assert that Mises preferred banking with a 100% reserve.
Second, we offer two short comments, one on the final footnote, 9, of Huerta de Soto’s
chapter and the second one on Mises’ opinion of Peel’s Act. Finally, we summarize our
arguments in a conclusion. In all the following quotes, the boldface is added.
A bilingual interdisciplinary journal 205
2. Review on Huerta de Soto’s Argument
First Reference
The Theory of Money and Credit (1924 edition)
The first reference Huerta de Soto offers of Mises’ defense of banking with a 100% reserve
is from the 1924 edition of The Theory of Money and Credit. The two quotes offered from
Mises are the following:
Fiduciary media are scarcely different in nature from money; a supply of them affects
the market in the same way as a supply of money proper; variations in their quantity
influence the objective exchange value of money in just the same way as do variations
in the quantity of money proper. Hence, they should logically be subjected to the same
principles that have been established with regard to money proper; the same attempts
should be made in their case as well to eliminate as far as possible human influence on
the exchange ratio between money and other economic goods. The possibility of causing
temporary fluctuations in the exchange ratios between goods of higher and of lower
orders by the issue of fiduciary media, and the pernicious consequences connected
with a divergence between the natural and money rates of interest, are circumstances
leading to the same conclusion. Now it is obvious that the only way of eliminating
human influence on the credit system is to suppress all further issue of fiduciary
media. The basic conception of Peel’s Act ought to be restated and more
completely implemented than it was in the England of his time by including the
issue of credit in the form of bank balances within the legislative prohibition.2
Just after this quote, Huerta de Soto continues, “Mises adds:” and quotes the following:
It would be a mistake to assume that the modern organization of exchange is bound
to continue to exist. It carries within itself the germ of its own destruction; the
development of the fiduciary medium must necessarily lead to its breakdown.3
These two quotes, especially the second one, seem to be very conclusive and clear. However,
the problem is their context. The section where they come from seems to be more
concerned with historical monetary difficulties than with pure theory. It is well known that
the fourth part of Theory of Money and Credit added in 1958 is more focused on political
2	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. pp. 446-447. Italics are from Huerta de Soto.
3	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 448. Italics are from Huerta de Soto.
New Perspectives on Political Economy206
and historical problems than with theory, and this is where many citations are taken to
support the opinion that Mises’ ideal was banking with a 100% reserve, but this last part
of the 1924 second edition is also concerned with very important political and historical
considerations, as the section heading suggests. Both quotes come from chapter 20 titled
(italics added), “Problems of Credit Policy,” section III “Problems of Credit Policy in the Period
Immediately after the War,” point 13 “The Basic Questions of Future Currency Policy”.
What can be seen here is that the section titles are clear indications that Mises is writing
in reference to specific historical problems involving credit policy and not to those involving
credit theory. This last chapter of the 1924 edition is Mises’ consideration on political
problems after World War I.4
If we consider these circumstances, then it might be correct to
presume that he is making a second-best policy recommendation rather than describing his
first-best (free banking) ideal. These references would be of much more value if they came
from any of the 19 previous chapters, where he deals with theory, but passages like these
are not easily found in those chapters.
However, the chapter headings are not the only clues showing that Mises is not talking
about “pure theory” but about monetary policy issues. As we see how Mises continues immediately
after the first quote, we find the following:
At first it might appear as if the execution of such radical measures would be bound
to lead to a rise in the objective exchange-value of money. But this is not necessarily
the case. It is not improbable that the production of gold and the increase in
the issue of bank-credit are at present increasing considerably faster than the
demand for money and are consequently leading to a steady diminution of the
objective exchange-value of money. And there can be no doubt that a similar result
follows from the apparently one-sided fixing of prices by sellers, the effect of which in
diminishing the value of money has already been examined in detail. The complaints
about the general increase in the cost of living, which will continue for a long
time yet, may serve as a confirmation of the correctness of this assumption, which
can be neither confirmed nor refuted statistically. Thus, a restriction of the growth of
the stock of money in the broader sense need not unconditionally lead to a rise in the
purchasing power of the monetary unit; it is possible that it might have the effect of
completely or partly counteracting the fall in the value of money which might otherwise
have occurred.5
4	 Although the first edition is from 1912, the second edition in German is from 1924, and Mises performed
some modificatins in this chapter 20. This English translation is from this second German edition. Huerta de
Soto advises the reader that he is quoting this 1924 edition.
5	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 446. Bolds is added.
A bilingual interdisciplinary journal 207
These lines show more clearly that Mises is talking about a specific historical moment. We
can find another clear reference two paragraphs previous to the first quote in Huerta de
Soto’s book:
There can be no doubt that the present state of the market for gold makes a decision
between two possibilities imperative: a return to the actual use of gold after the
fashion of the English gold standard of the nineteenth century, or a transition to a fiatmoney
standard with purchasing power regulated according to index numbers. The
gold-exchange standard might be considered as a possible basis for future currency
systems only if an international agreement could impose upon each State the obligation
to maintain a stock of gold of a size corresponding to its capacity. A gold-exchange
standard with a redemption fund chiefly invested in foreign bills in gold currencies is in
the long run not a practicable general solution of the problem.6
Both these quotes, coming from the same chapter from which Huerta de Soto quotes Mises,
seem to make it clear that Mises is not dealing with pure theory but is concerned with credit
policy challenges of the time—that is, after World War I. When in the second quote Mises
says that it is a “mistake to assume that the modern organization of exchange is bound to
continue to exist,” he is not talking about free banking but what in 1924 was the “modern”
monetary system with its corresponding regulations.
Some pages later, when mentioning the Currency School, Mises says that he has nothing
to add to what he has already said in previous chapters, that the risk is not to be found in
fractional reserves per se, but in the possibility of banks to abuse such a measure. According
to Mises, this can happen in two scenarios; (1) an agreement between all banks or (2) if
there is only one issuer, a central bank. In Mises words:
The argument, however, that was then supposed to be the decisive one was provided by
the Currency Principle. From the point of view of this doctrine, any note issue that is
not covered by gold is dangerous, and so, in order to obviate the recurrence of economic
crises, such issues must be restricted. On the question of the theoretical importance
of the Currency Principle, and on the question of whether the means proposed by the
Currency School were effective, or could have been effective, or might still be effective,
there is nothing that need be added to what has been said already. We have
already shown that the dangers envisaged by the Currency Principle exist only when
there is uniform procedure on the part of all the credit-issuing banks, not merely
within a given country, but throughout the world. Now the monopolization of
6	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 446. Bolds is added.
New Perspectives on Political Economy208
the banks of issue in each separate country does not merely fail to oppose any
hindrance to this uniformity of procedure; it materially facilitates it.7
Just a few pages later, Mises repeats his conclusion that under free banking fiduciary media
can only be expanded beyond market demand with an agreement between all banks:
It has already been shown that it is impossible for a single bank by itself, and even for
all banks in a given country or for all the banks in several countries, to increase the issue
of fiduciary media, if the other banks do not do the same. The fact that tacit agreement
to this effect among all the credit-issuing banks of the world has been achieved
only with difficulty, and, even at that, has only effected what is after all but a small
increase of credit, has constituted the most effective protection in recent times against
excesses of credit policy. In this respect, we cannot yet know how circumstances will
shape. If it should prove easier now for the credit-issuing banks to extend their circulation,
then failure to adopt measures for limiting the issue of fiduciary media will involve
the greatest danger to the stability of economic life.8
Regarding the last sentence of this quote, we have to remember that Mises is referring to
monetary policy issues in a context where there is no pure free banking, but where administrators
are facing the challenges left by World War I.
It seems reasonable to conclude that for Mises the problem is not to be found in free
banking with fractional reserves per se but instead in the presence of monetary regulations,
even in chapter 20. On the free market limits of free banking, he wrote chapters 16 (The
Evolution of Fiduciary Media), 17 (Fiduciary Media and the Demand for Money) and 18
(The Redemption of Fiduciary Media), where he does not refer to a 100% reserve because
free banking regulates itself spontaneously; those are the chapters dealing with free banking
theory, not chapter 20 concerned with “Problems of Credit Policy.”
7	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 437. Bolds is added.
8	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 439. Bolds is added.
A bilingual interdisciplinary journal 209
3. Second Argument
Monetary Stabilization and Cyclical Policy (1928)
The second reference Huerta de Soto offers is Mises’ 1928 Monetary Stabilization and
Cyclical Policy. The original German text was translated to English and titled “On the Manipulation
of Money and Credit.” The quote provided from Mises is the following:
The most important prerequisite of any cyclical policy, no matter how modest its
goal may be, is to renounce every attempt to reduce the interest rate, by means of
banking policy, below the rate which develops on the market. That means a return
to the theory of the Currency School, which sought to suppress all future expansion of
circulation credit and thus all further creation of fiduciary media. However, this does
not mean a return to the old Currency School program, the application of which was
limited to banknotes. Rather it means the introduction of a new program based on the
old Currency School theory, but expanded in the light of the present state of knowledge
to include fiduciary media issued in the form of bank deposits. The banks would be
obliged at all times to maintain metallic backing for all notes—except for the sum of
those outstanding which are not now covered by metal—equal to the total sum of the
notes issued and bank deposits opened. That would mean a complete reorganization
of central bank legislation … By this act alone, cyclical policy would be directed in
earnest toward the elimination of crises.9
This quote of Mises shows several references to policy issues rather than to the free
market. More specific to cyclical policy, we can presume that Mises is again talking about
what he suggests a central bank should or should not do. The fact that Mises ends this
quote specifically mentioning the central bank legislation is a clear indication that he is not
commenting on a free banking scenario that needs to be limited. This is why in this text he
even suggests only limiting commercial banks playing an important role in the market; that
is, not all of them, which means an open door to smaller banks having fractional reserves.
Again, the problem is not to be found in fractional reserves but in monetary legislation and
monopoly of issuance. The section missing in Huerta de Soto’s quote just after “central
bank legislation” says the following:
The banks of issue would have to return to the principles of Peel’s Bank Act, but
with the provisions expanded to cover also bank balances subject to check. The same
stipulations with respect to reserves must also be applied to the large national deposit
9	 von Mises, L. (1978). The Causes of Economic Crisis. And Other Essays Before and After the Great Depression
(2006 ed.). (P. L. Greaves Jr., Ed., B. B. Greaves, & P. L. Greaves Jr., Trads.) Auburn: Ludwig von Mises
Institute. p. 150. Italics are from Huerta de Soto and bolds is added.
New Perspectives on Political Economy210
institutions, especially the postal savings. Of course, for these secondary banks of issue,
the central bank reserves for their notes and deposits would be the equivalent of
gold reserves. In those countries where checking accounts at private commercial banks
play an important role in trade—notably the United States and England—the same
obligation must be exacted from those banks also.10
As we have previously seen, given that for Mises the risk of fiduciary media is when all
banks collude or when there is only one monopolist issuer, it is realistic to conclude that
he is criticizing not free banking but instead the monetary policies carried out by central
banks. The “banks of issue” Mises is talking about are the privileged central banks, not the
banks of a nonexistent free banking scenario.
Again, the titles of the section from where Mises’ words are taken also show that he
is referring to policy issues rather than to pure theory. The quote comes from Chapter 2,
“Monetary Stabilization and Cyclical Policy” (italics added), section B, “Cyclical Policy to
Eliminate Economic Fluctuations” (italics added), part VIII, “The Aims and Method of
Cyclical Policy” (italics added), and point 1, “Revised Currency School Theory”. That is,
Mises seems to be commenting on the Currency School in the context of a cyclical currency
policy with the presence of central banks, not with a free banking scenario, where, of
course, there is no place for cyclical policy.
This second reference does not seem to strongly support that Mises was against free
banking either, but that in the presence of central banks, his second best solution is to limit
their power to issue fiduciary media.
4. Third Reference
Memorandum before the Financial Committee
of the League of Nations (1930)
The third reference of Huerta de Soto is to a memorandum on “The Suitability of Methods
of Ascertaining Changes in the Purchasing Power for the Guidance of International Currency
and Banking” delivered to the League of Nations on October 10, 1930. We should
note that this is a memorandum presented to the Financial Committee of the League of
Nations very shortly after the crisis of 1929. It is likely that this financial committee would
be more interested in Mises’ advice on monetary policy. Huerta de Soto’s first quote is the
following:
10	 von Mises, L. (1978). The Causes of Economic Crisis. And Other Essays Before and After the Great Depression
(2006 ed.). (P. L. Greaves Jr., Ed., B. B. Greaves, & P. L. Greaves Jr., Trads.) Auburn: Ludwig von Mises Institute.
p. 150. Bolds is added.
A bilingual interdisciplinary journal 211
It is characteristic of the gold standard that the banks are not allowed to increase the
amount of notes and bank balances without a gold backing, beyond the total which
was in circulation at the time the system was introduced. Peel’s Bank Act of 1844, and
the various banking laws which are more or less based on it, represent attempts to create
a pure gold standard of this kind. The attempt was incomplete because its restrictions
on circulation included only banknotes, leaving out of account bank
balances on which cheques could be drawn. The founders of the Currency School
failed to recognize the essential similarity between payments by cheque and payments
by banknote. As a result of this oversight, those responsible for this legislation never
accomplished their aim.11
Huerta de Soto continues saying that then Mises explains how “a banking system based
on the gold standard and a 100-percent reserve requirement would tend to push prices
down slightly, which would benefit most citizens, since it would raise their real income,
not through a nominal increase in earnings but through a continual reduction in the prices
of consumer goods and services and relative constancy in nominal income. Mises deems
such a monetary and banking system far superior to the current system, which is beset
with chronic inflation and recurrent cycles of expansion and recession. In reference to the
economic depression then afflicting the world, Mises concludes:”12
The root cause of the evil is not in the restrictions, but in the expansion which preceded
them. The policy of the banks does not deserve criticism for having at last called a halt
to the expansion of credit, but, rather, for ever having allowed it to begin.13
In this case, Huerta de Soto himself recognizes that Mises was talking in “reference to the
economic depression then afflicting the world.” Once more, Mises’ suggestion for monetary
policy was, given a period of strong credit expansion by central banks, to limit their expansive
power and not to promote free banking. In the political arena, to discuss free banking
without central banks was—and still is—out of the question; it not unlikely to think that this
is the constraint from which Mises was working his arguments. Other references suggesting
that Mises was referring to historical and not to theoretical problems can also be found in
11	 von Mises, L. (1990). Money, Method, and the Market Process. (R. M. Ebeling, Ed.) Norwell: Kluwer Academic
Publishers. p. 90. Italics are from Huerta de Soto.
12	 Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles (2006 ed.). (M. A. Stroup, Trad.) Auburn:
Ludwig von Mises Institute. p. 719. Bold is added.
13	 von Mises, L. (1990). Money, Method, and the Market Process. (R. M. Ebeling, Ed.) Norwell: Kluwer Academic
Publishers. p. 91. Italics are from Huerta de Soto.
New Perspectives on Political Economy212
the same text from which Huerta de Soto extracts his quotes. For example, between the first
and second quote, we can find the following:
At any rate, a solution to the difficult problem of reforming our monetary and credit system
must not be rejected offhand merely for the reason that it involves a continuous fall in the
price level.14
If we move a little further in the text to the end of this section, we find a more specific
expression that Mises was referring to monetary policy challenges:
One ultimate reason for the present drop in prices is the circumstance that the
banks—with the assent of public opinion, and indeed at the direct instigation of the
press, the business world, and the Governments—have made use of their power to issue
additional circulation, i.e., to increase credit artificially. If the banks were to make no
use of this power—which could only be the case either if the Central Banks were
explicitly prohibited in their reserve-issuing privileges or if public opinion rigorously
condemned the practice—we should have no economic fluctuations.15
We should mention two considerations on this passage by Mises. First, in this memorandum
Mises is arguing against the myth that rising prices are needed to attain growth and is
not expressing a defense of deflation. He is trying to emphasize the idea that growth without
inflation16
is possible. Note the following passage (also to be found between both quotes
provided by Huerta de Soto):
The majority of our contemporaries will find that a sufficient ground for regarding
such a monetary system as bad in itself, since they are wedded to the belief that good
business and high prices are one and the same thing. But that is a prejudice. If we had
had slowly falling prices for eighty years or more, we would have become accustomed
to look for improvements in the standard of living and increases in real income through
falling prices with stable or falling money income, rather than through increases in
money income. At any rate, a solution to the difficult problem of reforming our mon-
14	 von Mises, L. (1990). Money, Method, and the Market Process. (R. M. Ebeling, Ed.) Norwell: Kluwer Academic
Publishers. p. 91.
15	 von Mises, L. (1990). Money, Method, and the Market Process. (R. M. Ebeling, Ed.) Norwell: Kluwer Academic
Publishers. p. 92. Bolds is added.
16	 By “inflation” we mean in this paragraph what the politican and layman usually understands: “a  steady
increase in the level of prices” (the other way around for “deflation”). This is in concordance with the audience
of Mises’ text. For Mises’ consideration on inflation see von Mises, L. (1912). The Theory of Money and
Credit (1981 ed.). (H. E. Batson, Trans.) Chapter VII.7. Indianapolis: Liberty Fund; and von Mises, L. (1949).
Human Action. A Treatise on Economics (1996 ed.). Chapter XVII.6. New York: The Foundation for Economic
Education. For an interpretation of these passages see Cachanosky, N. (2009). The Definition of Inflation
According to Mises: Implications for the Debate on Free Banking. Libertarian Papers 1:43.
A bilingual interdisciplinary journal 213
etary and credit system must not be rejected offhand merely for the reason that it
involves a continuous fall in the price level.17
Second, an example of a Mises theoretical consideration —where he is not trying to convince
the Financial Committee of the League of Nations or argue against the prejudice of
rising prices— can be found at the beginning of chapter 17 (Fiduciary Media and the Demand
for Money), where he exposes the undesirable consequences of not going pari passu
with the demand of money if we stick to gold as currency without fractional reserves:
If metallic money is employed, then the advantages of a diminution of the demand
for money due to the extension of such other means of payment are obvious. In
fact the development of the clearing system and of fiduciary media has at least kept
pace with the potential increase of the demand for money brought about by the extension
of the money economy, so that the tremendous increase in the exchange-value of
money, which otherwise would have occurred as a consequence of the extension of the
use of money, has been completely avoided, together with its undesirable consequences.
If it had not been for this the increase in the exchange-value of money, and
so also of the monetary metal, would have given an increased impetus to the production
of the metal. Capital and labor would have been diverted from other branches of
production to the production of the monetary metal. This would undoubtedly have
meant increased returns to certain individual undertakings; but the welfare of
the community would have suffered. […] This all becomes particularly clear if we
think of an economic community which does not itself produce the precious metals, but
imports them. Here the amount of their cost is expressed by the quantity of commodities
that must be surrendered to foreign countries in order to obtain the supplementary
quantity of monetary metal in exchange.18
This third reference of Huerta de Soto also does not seem to provide a strong case for
Mises’ definitively preferring banking with a 100% reserve to free banking.
17	 von Mises, L. (1990). Money, Method, and the Market Process. (R. M. Ebeling, Ed.) Norwell: Kluwer Academic
Publishers. p. 91. Bolds is added.
18	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 333. Bolds is added.
New Perspectives on Political Economy214
5. Fourth Reference
Nationalökonomie (1940)
Huerta de Soto’s fourth reference is Mises’ predecessor of Human Action, Nationalökonomie,
which has not been translated to English. Given that Human Action was built on
Nationalökonomie, his thoughts on this later book should have precedence. As we will see
in the fifth reference, in Human Action Mises also does not seem to support banking with
a 100% reserve over free banking.
In this section, given that Mises’ work has not been translated to Spanish or English,
Huerta de Soto quotes Mises’ original German work in footnotes and provides an interpretation.
Huerta de Soto tells us that Mises questions the Chicago School’s proposal that
“100-percent reserves requirement be set for banking, but that the monetary base remain fiduciary,
and that the responsibility for issuing and controlling the stock of money continue
to fall to the central bank.”19
Huerta de Soto continues by claiming that for Mises a central
bank, even with a 100% reserve, will be under pressure from and influenced by the state to
issue fiduciary media in a financial emergency. Huerta de Soto then tells us that according
“to Mises, the ideal solution would thus be to establish a system of free banking (i.e., without
a central bank) subject to traditional legal principles (and hence, a 100-percent reserve
requirement).”20
Huerta de Soto continues saying that in “this book Mises accompanies
his defense of a 100-percent reserve requirement with his objection not only to the central
bank, but also to a fractional reserve free-banking system: although such a system would
greatly limit the issuance of fiduciary media, it would be inadequate to completely eliminate
credit expansion nor the recurrent booms and economic recessions which inevitably come
with it.”21
Finally, Huerta de Soto concludes this section with footnote 6, where he provides
the following English translation, a footnote originally from Nationalökonomie found in
Human Action:
The notion of ‘normal’ credit expansion is absurd. Issuance of additional fiduciary
media, no matter what its quantity may be, always sets in motion those changes in the
price structure the description of which is the task of the theory of the trade cycle. Of
course, if the additional amount issued is not large, neither are the inevitable effects
of the expansion.22
19	 Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles (2006 ed.). (M. A. Stroup, Trad.) Auburn:
Ludwig von Mises Institute. p. 720.
20	 Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles (2006 ed.). (M. A. Stroup, Trad.) Auburn:
Ludwig von Mises Institute. p. 720. Bolds is added.
21	 Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles (2006 ed.). (M. A. Stroup, Trad.) Auburn:
Ludwig von Mises Institute. pp. 720-721.
22	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 442.
A bilingual interdisciplinary journal 215
There are two elements that deserve a comment on this section by Huerta de Soto. The first
one deals with the relation between tradition legal principles and a 100% reserve requirement;
the second one deals with Huerta de Soto’s quote of Mises’ footnote.
First, the traditional legal principle Huerta de Soto mentions does not necessarily imply
a 100% reserve requirement. Bank notes represent a claim on demand, not on carry; the
contract implies that reserves have to be returned to those making claims. Assume person
A goes to Bank B and says, “I want to deposit X amount of gold in your bank for an unknown
length of time and be able to withdraw whenever it suits me”. Bank B responds: “No
problem. But be aware that this is not a safety box and that as a saving intermediary I will
lend part of your gold. I will give you notes saying that anyone who presents them at my
bank will receive the amount expressed in the note, so you can use this note for exchanges”.
Person A responds: “No problem. But if the day I come to withdraw part of my gold using
your bank notes you do not have it, I will sue your bank”. And Bank B responds: “No
problem. Deal.” Where is the breach of contract in this scenario? Whose liberty has been
coerced? This kind of contract is usually called “irregular” in the 100-percent literature, but
this terminology can be confusing. The problem with the word “irregular” is that it implies
undesirable connotations when attached to the word “contract”. The difficulty with deposit
contracts is their complexity—not their irregularity. The use of the word “irregular” to refer
to a contract is an unfortunate one because it adds confusion to the debate. It is certainly
different to talk about “complex contracts” than “irregular contracts” when dealing with
free banking.
A 100% reserve requirement is not necessarily part of the deposit contract, but to fulfill
claims on demand. We may discuss whether bank deposit contracts should be more clear
and explicit, but that is a very different conclusion than to argue for a 100% reserve requirement
because of “traditional legal principles.” The 100% reserve requirement is a non
sequitur of a “traditional legal principle,” as this principle means the bank should be able to
deliver the claim on demand or be sued because of this failure and not because it operates
with fractional reserves. This seems to stem from Huerta de Soto’s own understanding of
“traditional legal principles” in his Money, Bank Credit, and Economic Cycles rather from
than Mises’ own thoughts.
The traditional legal principle means, for Mises, that no bank should have any privilege
and that they should not be allowed to devalue their notes in order to avoid bankruptcy. If
not, the moral hazard implied would free the banks from concern over the consequences
of issuing fiduciary media beyond market demand with all of its economic consequences.
The next words of Mises from Theory of Money and Credit from chapter 16, The Evolution
of Fiduciary Media, says that fiduciary media are claims on demand and that their legal
characteristics allow them to be suitable for exchange as money:
Thus fiduciary media are claims to the payment of a given sum on demand, which
are not covered by a fund of money, and whose legal and technical characteristics
New Perspectives on Political Economy216
make them suitable for tender and acceptance instead of money in fulfillment of
obligations that are in terms of money.23
Second, the footnote of Mises provided by Huerta de Soto does not imply that Mises preferred
banking with a 100% reserve to free banking; it mainly claims that small changes in
the offer of credit also affect the market. Mises is describing the effect of a small expansion
of credit, not arguing in favor of or against them. We have already seen some quotes where
Mises saw the role of fiduciary media in a positive light by easing the change in money
pari passu with its demand. It should also be considered that this reference is a footnote in
Mises’ work, not part of the main body, found at the end of the following paragraph:
It is a fable that governments interfered with banking in order to restrict the issue of
fiduciary media and to prevent credit expansion. The idea that guided governments
was, on the contrary, the lust for inflation and credit expansion. They privileged banks
because they wanted to widen the limits that the unhampered market draws to credit
expansion or because they were eager to open to the treasury a source of revenue. For
the most part both of these considerations motivated the authorities. They were convinced
that the fiduciary media are an efficient means of lowering the rate of interest,
and asked the banks to expand credit for the benefit of both business and the treasury.
Only when the undesired effects of credit expansion became visible, were laws enacted
to restrict the issue of banknotes—and sometimes also of deposits—not covered by specie.
The establishment of free banking was never seriously considered precisely
because it would have been too efficient in restricting credit expansion. For rulers,
writers, and the public were unanimous in the belief that business has a fair claim
to a ‘normal’ and ‘necessary’ amount of circulation credit and that this amount could
not be attained under free banking.24
As we can see, Mises is explicitly saying that free banking was never seriously considered
precisely because it would have been too efficient in restricting credit expansion. What then
is the meaning of footnote 17 cited by Huerta de Soto? To comment on the last sentence of
the paragraph and to argue against the popular idea that business has a fair claim to a normal
and necessary amount of circulation credit and that this amount could not be attained
under free banking, as if a “normal” and “necessary” credit expansion did not affect the
market or were neutral. However, as we have seen in the main body of the paragraph from
23	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 311. Bolds is added.
24	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. pp. 441—442. Bolds is added.
A bilingual interdisciplinary journal 217
which footnote 17 is taken, Mises explicitly says that the “establishment of free banking was
never seriously considered precisely because it would have been too efficient in restricting
credit expansion.” This sounds like more a defense of free banking than a 100% reserve
requirement.
6. Fifth Reference
Human Action (1949)
Although in Human Action Mises dedicates a chapter to “The Limitation on the Issuance of
Fiduciary Media” (chapter XVII.12), which consists of almost 14 pages, Huerta de Soto’s
exposition of this section is quite short.25
Huerta de Soto says that, “Mises repeats the arguments from the German edition, but
he expressly refers to Irving Fisher’s plan for establishing a 100-percent reserve requirement
for banking. Mises disapproves of Fisher’s plan, not because it includes a proposal
for a 100-percent reserve requirement, which Mises fully supports, but because Fisher seeks
to combine this measure with the conservation of the central bank and the adoption of an
indexed monetary unit.”26
Huerta de Soto continues by saying that according to Mises, the
suggestion to reestablish a 100-percent reserve requirement yet preserve the central bank is
insufficient, citing:
[I]t would not entirely remove the drawbacks inherent in every kind of government
interference with banking. What is needed to prevent any further credit expansion is
to place the banking business under the general rules of commercial and civil laws
compelling every individual and firm to fulfill all obligations in full compliance with
the terms of the contract.27
A first peculiarity is that Huerta de Soto says that Mises repeats but he expressly refers to
Irving Fisher’s plan. It is true that Mises repeats his arguments, but the explicit reference
is in Theory of Money and Credit more than in Human Action. In the first book, Mises dedicates
a chapter section to Irving Fisher’s proposal in the same chapter 20 Huerta de Soto
25	 This is probably due to the fact that Huerta de Soto also refers to several other authors as well as his own
banking reform proposal, and he may not have wanted to extend this chapter by too much. Of course, this is
certainly understandable, but as this is a specific chapter of Mises’ dealing with the theoretical problems of
fiduciary media, we expected to find a stronger case in this section of Huerta de Soto’s chapter.
26	 Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles (2006 ed.). (M. A. Stroup, Trad.) Auburn:
Ludwig von Mises Institute. pp. 721-722.
27	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 443.
New Perspectives on Political Economy218
uses as a first reference. Chapter 20.III.12’s heading is “Fisher’s Proposal for a Commodity
Standard”. In Human Action there is not such a title; Mises dedicates a few paragraphs in
chapter XVII.12 (The Limitation on the Issuance of Fiduciary Media) without a titled section
referring to Fisher. This is the same chapter from which Huerta de Soto takes his quote and
the footnote 17 already mentioned in the previous reference.
If we look at Huerta de Soto’s quote we see it is an incomplete expression from Mises.
The whole quote should be as follows:
But even if the 100 percent reserve plan were to be adopted on the basis of the unadulterated
gold standard, it would not entirely remove the drawbacks inherent in every
kind of government interference with banking. What is needed to prevent any further
credit expansion is to place the banking business under the general rules of commercial
and civil laws compelling every individual and firm to fulfill all obligations in
full compliance with the terms of the contract. If banks are preserved as privileged
establishments subject to special legislative provisions, the tool remains that
governments can use for fiscal purposes. Then every restriction imposed upon
the issuance of fiduciary media depends upon the government’s and the parliament’s
good intentions.28
What Mises is doing is criticizing Fisher’s plan and not free-banking. What Mises questions
is that Fisher’s plan would not work even with a 100% reserve; the problem is a misconstruction
in the plan, not in the absence of a 100% reserve. The first part, missing in Huerta
de Soto’s quote, is as important as the final one; also missing is the part that refers to the
monetary legislation that will be present in Fisher’s plan because there will still be a central
bank.
This and the mentioned footnote 17 in Nationalökonomie are the only references offered
by Huerta de Soto from Human Action. These quotes come from a specific chapter dealing
with the limits on the issuance of fiduciary media, but no clear statement against free banking
appears here. On the contrary, if we look closely into the chapter we can find several
expressions suggesting that Mises’ thoughts are more likely to be toward free banking rather
than to banking with a 100% reserve. At the beginning of the chapter we can find the fol-
lowing:
Issuing money-certificates is an expensive venture. The banknotes must be printed, the
coins minted; a complicated accounting system for the deposits must be organized; the
reserves must be kept in safety; then there is the risk of being cheated by counterfeit
banknotes and checks. [A]gainst all these expenses stands only the slight chance that
28	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 443. Bolds is added.
A bilingual interdisciplinary journal 219
some of the banknotes issued may be destroyed and the still slighter chance that some
depositors may forget their deposits. Issuing money-certificates is a ruinous business
if not connected with issuing fiduciary media. In the early history of banking
there were banks whose only operation consisted in issuing money-certificates. But
these banks were indemnified by their clients for the costs incurred. [A]t any rate, catallactics
is not interested in the purely technical problems of banks not issuing fiduciary
media. The only interest that catallactics takes in money-certificates is the connection
between issuing them and the issuing of fiduciary media.29
Then Mises asks if there are any limits on the issuance of fiduciary media. He mentions
two limitations:
First: It must avoid any action which could make the clients—i.e., the public—suspicious.
As soon as the clients begin to lose confidence, they will ask for the redemption of the
banknotes and withdraw their deposits. How far the bank can go on increasing its issues
of fiduciary media without arousing distrust, depends on psychological factors.
Second: It must not increase the amount of fiduciary media at such a rate and with
such speed that the clients get the conviction that the rise in prices will continue endlessly
at an accelerated pace. For if the public believes that this is the case, they will reduce
their cash holdings, flee into “real” values, and bring about the crack-up boom. It
is impossible to imagine the approach of this catastrophe without assuming that its first
manifestation consists in the evanescence of confidence. The public will certainly prefer
exchanging the fiduciary media against money to fleeing into real values, i.e. to the
indiscriminate buying of various commodities. Then the bank must go bankrupt.30
Mises continues by analyzing the case where several banks coexist, saying that the limits to
the issuance of fiduciary media are narrower than when there is only one:
As there are even limits to the issuance of fiduciary media on the part of a unique bank
the clientele of which comprises all people, it is obvious that there are such limits for
a multiplicity of independently coexisting banks too. What we want to show is that
29	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 435. Bolds is added.
30	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 436.
New Perspectives on Political Economy220
for such a multiplicity of independently coexisting banks the limits are narrower
than those drawn for a single bank with an unlimited clientele.31
Here Mises is actually talking about the free banking system without central banks or monetary
regulation, but no mention of a 100% reserve requirement or the need to restate Peel’s
Act can be found. Mises continues explaining how the clearing system does not allow the
banks to expand their fiduciary media beyond the market demand for their currency:
It is very easy for a bank to increase the number of people who are ready to accept
loans granted by credit expansion and paid out in an amount of money-substitutes.
But it is very difficult for any bank to enlarge its clientele, that is, the number of
people who are ready to consider these claims as money-substitutes and to keep
them as such in their cash holdings. To enlarge this clientele is a troublesome and
slow process, as is the acquisition of any kind of good will. On the other hand, a bank
can lose its clientele very quickly. If it wants to preserve it, it must never permit any
doubt about its ability and readiness to discharge all its liabilities in due compliance
with the terms of the contract. A reserve must be kept large enough to redeem all banknotes
which a holder may submit for redemption. Therefore no bank can content
itself with issuing fiduciary media only; it must keep a reserve against the total
amount of money-substitutes issued and thus combine issuing fiduciary media
and money-certificates.32
Here, Mises expressly refers to the need to have reserves and combine them with fiduciary
media, not the need to eliminate the latter and keep only the former because the latter are illegal
or fraudulent. Mises then discusses once more the importance of the banks’ not losing
their client’s confidence, as such may result in bankruptcy, and he mentions that no law can
be a safeguard against a loss of confidence, even if it’s successful in limiting the issuance of
fiduciary media. This success Mises is talking about when referring to the limitation on the
issuance of fiduciary media is the success of these initiatives in their objective of limiting
fiduciary media, not in their convenience or inconvenience.
Mises continues referring to the Banking School and Currency School as we see in the
following paragraph:
31	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 437. Bolds is added.
32	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 439. Bolds is added.
A bilingual interdisciplinary journal 221
It must be emphasized that the problem of legal restrictions upon the issuance of fiduciary
media could emerge only because governments had granted special privileges
to one or several banks and had thus prevented the free evolution of banking. If the
governments had never interfered for the benefit of special banks, if they had never
released some banks from the obligation, incumbent upon all individuals and firms in
the market economy, to settle their liabilities in full compliance with the terms of the
contract, no bank problem would have come into being. The limits which are drawn
to credit expansion would have worked effectively. Considerations of its own solvency
would have forced every bank to cautious restraint in issuing fiduciary media. Those
banks which would not have observed these indispensable rules would have gone bankrupt,
and the public, warned through damage, would have become doubly suspicious
and reserved.33
As we can see, there would have been no problem in limiting the issuance of fiduciary media
were it not for the fact that, “governments had granted special privileges to one or several
banks and had thus prevented the free evolution of banking.” In a free banking scenario
there are no privileges by definition, no problem of limiting the issuance of fiduciary media
would arise and no need for a 100% reserve requirement; on the contrary, the, “welfare of
the community would have suffered”34
had that requirement been in place.
Note that this quote, where no banks are released from their obligation to settle their liabilities
in full compliance with the terms of their contracts, does not imply a 100% reserve
requirement. Mises explicitly says that in such a situation considerations, “of its own solvency
would have forced every bank to cautious restraint in issuing fiduciary media,” but not
to eliminating or forbidding it because it is unlawful or implies fraud. This is in agreement
with what Mises says in this same chapter of Human Action and in The Theory of Money and
Credit, that banks cannot expand their fiduciary media by fractional reserves beyond the
market demand for its currency. Fractional reserves are part of the free market system, and
it has a limit imposed by the same market as with any other commodity.
Then Mises turns to Fisher’s proposal where Huerta de Soto offers his only quote, but
if we look at the paragraph immediately after the one provided by Huerta de Soto, we find
the following statement, which requires no further clarification:
Free banking is the only method available for the prevention of the dangers
inherent in credit expansion. It would, it is true, not hinder a slow credit expansion,
kept within very narrow limits, on the part of cautious banks which provide the public
33	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 441. Bolds is added.
34	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 333.
New Perspectives on Political Economy222
with all information required about their financial status. But under free banking
it would have been impossible for credit expansion with all its inevitable consequences
to have developed into a regular—one is tempted to say normal—
feature of the economic system. Only free banking would have rendered the
market economy secure against crises and depressions.35
As we can see, this paragraph not only does not mention the 100% reserve requirement but
also puts in context the footnote 17 that Huerta de Soto refers to when talking about Nationalökonomie,
where he asserts that it has, “generated substantial confusion among those
members of the Austrian School who defend a fractional-reserve free-banking system.”36
Mises continues with some observations on the discussion concerning free banking.
Some pages later, he repeats that the risk is not in fiduciary media per se but is instead that
all banks collude and no one breaks their agreement:
But, some people may ask, what about a cartel of the commercial banks? Could not
the banks collude for the sake of a boundless expansion of their issuance of fiduciary
media? The objection is preposterous. As long as the public is not, by government interference,
deprived of the right of withdrawing its deposits, no bank can risk its own
good will by collusion with banks whose good will is not so high as its own. One
must not forget that every bank issuing fiduciary media is in a rather precarious
position. Its most valuable asset is its reputation. It must go bankrupt as soon as
doubts arise concerning its perfect trustworthiness and solvency. It would be suicidal
for a bank of good standing to link its name with that of other banks with a poorer good
will. Under free banking a cartel of the banks would destroy the country’s whole
banking system. It would not serve the interests of any bank.37
In this work, Mises dedicates a whole chapter to the specific problem of fiduciary media.
No word can be found on the necessity of eliminating fiduciary media or that of a 100% reserve
requirement in the free market as Huerta de Soto seems to claim. Huerta de Soto only
quotes a footnote and an incomplete expression of Mises when talking about Fisher’s plan,
not free banking. It seems clear from this chapter that when dealing with pure theory Mises
preferred free banking with fractional reserves limited by the market rather than a 100% re-
35	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 443. Bolds is added.
36	 Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles (2006 ed.). (M. A. Stroup, Trad.) Auburn:
Ludwig von Mises Institute. p. 721.
37	 von Mises, L. (1949). Human Action. A Treatise on Economics (1996 ed.). New York: The Foundation for Economic
Education. p. 447. Bolds is added.
A bilingual interdisciplinary journal 223
serve requirement. To comply with the contract means for Mises that the commercial banks
must fulfill the demand of their clients when a bank note is presented at the front desk and
that no privileges to devaluation should be granted; it does not mean that a reserve has to
be kept for every note in circulation. As we have previously mentioned, that is a conclusion
made by Huerta de Soto, not by Mises.
This specific chapter on limits to fiduciary media of Human Action does not seem to support
Huerta de Soto’s conclusion that Mises preferred banking with a 100% reserve.
7. Sixth Reference
Monetary Reconstruction (1953)
The sixth and final reference is to the Monetary Reconstruction appendix to The Theory of
Money and Credit. Here Huerta de Soto offers two quotes:
The main thing is that the government should no longer be in a position to increase
the quantity of money in circulation and the amount of checkbook money not fully—
that is, 100 percent—covered by deposits paid in by the public.38
Huerta de Soto continues, mentioning that Mises proposes a process of transition to the
ideal system:
No bank must be permitted to expand the total amount of its deposits subject to check
or the balance of such deposits of any individual customer, be he a private citizen or
the U.S. Treasury, otherwise than by receiving cash deposits in legal-tender banknotes
from the public or by receiving a check payable by another domestic bank subject to the
same limitations. This means a rigid 100 percent reserve for all future deposits;
that is, all deposits not already in existence on the first day of the reform.39
As these quotes come from Mises’ appendix on Monetary Reconstruction after World War II,
it is clear that this is a monetary policy suggestion on the challenges of the time. The first
line of the first quote provided by Huerta de Soto explicitly refers to limiting the government’s
ability to increase the quantity of money, not to banks in free banking. This reference
38	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 481. Bolds is added.
39	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 491. Italics are from Huerta de Soto.
New Perspectives on Political Economy224
comes from chapter 23 titled, “The Integral Gold Standard,” where he explains the main
points of returning to this regime, namely to avoid the use of central banks by governments
to finance their deficits. If we cite Mises’ paragraph at length, this becomes clear:
The eminence of the gold standard consists in the fact that it makes the determination
of monetary unit’s purchasing power independent of the measures of
governments. It wrests from the hands of the ‘economic tsars’ their most redoubtable
instrument. It makes it impossible for them to inflate. This is why the gold standard
is furiously attacked by those who expect that they will be benefited by bounties from
the seemingly inexhaustible government purpose.
What is needed first of all is to force the rulers to spend only what, by virtue of dulypromulgated
laws, they have collected as taxes. Whether governments should borrow
from the public at all and, if so, to what extent are questions that are irrelevant to the
treatment of monetary problems. The main thing is that the government should no
longer be in a position to increase the quantity of money in circulation and the amount
of cheque-book money not fully — i.e. 100 per cent — covered by deposits paid in by the
public. No backdoor must be left open where inflation can slip in. No emergency can
justify a return to inflation. Inflation can provide neither the weapons a nation needs to
defend its independence nor the capital goods required for any project. It does not cure
unsatisfactory conditions. It merely helps the rulers whose policies brought about the
catastrophe to exculpate themselves.40
As we can see, Mises is saying that a return to the gold standard is recommended because it
helps to constrain government spending, not the banks in free banking. In the same chapter
from which Huerta de Soto offers his first quote we can find the following expression of
Mises where he says that a better solution would have been free banking:
Suspension of the banknotes’ convertibility and legal-tender provisions had transformed
‘hard’ currencies of many countries into questionable paper money. The logical conclusion
to be drawn from these facts would have been to do away with privileged banks altogether
and to subject all banks to the rule of common law and the commercial codes
that oblige everybody to perform contracts in full faithfulness to the pledged word. Free
banking would have spared the world many crises and catastrophes.41
40	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 481. Bolds is added.
41	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 482. Bolds is added.
A bilingual interdisciplinary journal 225
The second quote offered by Huerta de Soto comes from a specific section discussing The
United State’s Return to a Sound Currency. Mises is offering the suggestion of monetary reconstruction
in United States after World War II. How do we know that he would offer the
same solution to all countries at any time and at any context? This is not a chapter where
Mises develops banking pure theory. Once more, Mises is dealing with a specific problem
where there is no free banking but intervention and central banks. As the elimination of
central banks is not politically feasible, his suggestion is to limit the central banks by imposing
a rigid, not flexible, gold standard with a 100% reserve in gold.
This sixth reference does not seem to be a strong case in support of the interpretation
that Mises preferred banking with a 100% reserve either; here, Mises’ arguments are very
contextual and historically specific. We should note once more that even in this appendix
Mises expressly said that “free banking would have spared the world many crises and catastrophes,”
that is, because we did not have free banking, a second best solution is to limit
central banks by imposing a 100% reserve requirement to them.
7.1 A note on Footnote 942
Although the six previous references are Huerta de Soto’s main arguments in support of the
conclusion that Mises preferred banking with a 100% reserve, his comments on footnote 9
also deserve a few remarks.
Huerta de Soto says that despite “Mises’s crystal clear statements in favor of a 100-percent
reserve requirement, his defense of free banking as an indirect step toward the ideal
of a 100 percent reserve (and thus toward a banking system subject to traditional legal
principles) has prompted some Austrian theorists of the modern Neo-Banking School to
make a self-interested interpretation of Mises’s position. Thus these theorists view Mises as
a defender of fractional-reserve free banking first, and of banking with a 100 percent reserve
second.”43
He then mentions Lawrence H. White’s Mises on Free Banking and Fractional Reserves44
as an example and quotes Joseph Salerno’s claim that White’s conclusion is untenable, “because
he overlooks important passages in the very works of Mises that he cites, and because
he ignores significant developments in Mises’s theory of money that occurred between the
42	 In the original spanish version of the text this is footnote number 8.
43	 Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles (2006 ed.). (M. A. Stroup, Trad.) Auburn:
Ludwig von Mises Institute. p. 723. Bolds is added.
44	 White, L. H. (1992). Mises on Free Banking and Fractional Reserves. In J. W. Robbins, & M. Spangler (Eds.),
A Man of Principle. Essays in Honor of Hans F. Sennholz (pp. 517-533). Grove City: Grove City College Press.
New Perspectives on Political Economy226
publication of the first German edition of The Theory of Money and Credit in 1912 and the
publication of Nationalökonomie in 1940.”45
Huerta de Soto’s mention of “Mises’ crystal clear statements in favor of a 100-percent
reserve requirement,” and “his defense of free banking as an indirect step toward the ideal
of a 100 percent reserve,” show that he views Mises’ passages as theoretical considerations
rather than as specific monetary policy. The problem with this footnote is that it leaves no
room for the interpretation that he was really talking only about Mises’ political suggestion.
Huerta de Soto is claiming that Mises was against not only central banks but also free banking
with fractional reserves.
The footnote’s assertion that Mises was crystal clear in favor of a 100% reserve requirement,
as if those who think otherwise are unable to understand Mises or are making selfinterested
interpretations of Mises’ position, as well as Salerno’s opinion that Austrians
who think Mises preferred free banking overlook important passages or ignore significant
development in Mises’ theory of money, do not seem too fair to the other half of Austrian
scholars who interpret this matter in a different way. In the quoted article, Salerno claims
that Mises and Hayek should be dehomogenized, but it is possible that it is not Hayek from
whom Mises should be dehomogenized, but it is instead ourselves; to overlook or ignore this
possibility could also affect the interpretation of Mises’ writings.
A closer inspection of Huerta de Soto’s own quote sheds doubt on the claim that Mises
was crystal clear on a 100% reserve requirement as well as the claim that Austrians ignore
or conveniently overlook some of Mises’ passages. It does not even seem to be an overstatement
to assert that a stronger case of the interpretation that Mises preferred “free banking
with fractional reserves first and a 100% reserve requirement second” is possible even from
the same chapters Huerta de Soto uses to support his claim that Mises’ preference for
a 100% reserve requirement is crystal clear. Except for a few auxiliary exceptions, all references
from Mises came from the same chapters where Huerta de Soto takes his quotes to
support his interpretations.
7. 2 A note on Mises and Peel’s Act
A good example of the disagreement and confusion around Mises’ thoughts is his opinion
on Peel’s Act. It seems natural that authors who think Mises preferred a 100% reserve
requirement would also assert that Mises was in favor of Peel’s Act. However, in a specific
section dedicated to Peel’s Act, also in chapter 20 of The Theory of Money and Credit, where
he initially talks about the banking principle and currency principle, Mises draws the following
critique on the limitation of banknotes:
45	 Salerno, J. T. (1993). Mises and Hayek Dehomogenized. The Review of Austrian Economics, 6 (2), 113—146.
p. 139. Italics are original and bold is added.
A bilingual interdisciplinary journal 227
To start from the Banking Principle, which denies the possibility of an over-issue
of bank-notes and regards ‘elasticity’ as their essential characteristic, is necessarily to
arrive at the conclusion that any limitation of the circulation of notes, whether they are
backed by money or not, must prove injurious, since it prevents the exercise of the chief
function of the note-issue, the contrivance of an adjustment between the stock of money
and the demand for money without changing the objective exchange-value of money.46
After reviewing the currency principle Mises moves on to Peel’s Act, where his opinion was
against, instead of in favor of, its spirit of limiting fiduciary media:
As far as Peel’s Act was concerned, however, this very shortcoming of the theory that
had created it turned out to be an advantage; it caused the incorporation in it of the
safety valve without which it would not have been able to cope with the subsequent
increase in the requirements of business. The fundamental mistake of Peel’s system,
which it shares with all other systems which proceed by restricting the note circulation,
lies in its failure to foresee the extension of the quota of notes not backed by metal that
went with the increase on the demand for money in the broader sense. As far as the past
was concerned, the act sanctioned the creation of a certain amount of fiduciary media
and the influence that this had on the determination of the objective exchange value of
money; it did not do anything to counteract the effects of this issue of fiduciary media.
But at the same time, in order to guard the capital market from shocks, it removed all
future possibility of partly or wholly satisfying the increasing demand for money by
the issuing of fiduciary media and so of mitigating or entirely preventing a rise in the
objective exchange value of money. This amounts to the same thing as suppressing the
creation of fiduciary media altogether and so renouncing all the attendant advantages
for the stabilization of the objective exchange value of money. It is an heroic remedy
with a vengeance, in essence hardly differing at all from the proposals of the downright
opponents of all fiduciary media.47
In the last paragraph of this chapter, Mises concludes that the real obstacle to an unlimited
issuance of fiduciary media is to be found not in legislation but in the absence of a world
bank or collusive behavior. The absence of central banks is much more effective in limiting
the issuance of fiduciary media than legislation. In this case, banks will not be able
to issue unlimited fiduciary media. Note that in his conclusions, Mises does not call for
46	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 406-407. Bolds is added.
47	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 408. Bolds is added.
New Perspectives on Political Economy228
a 100% reserve requirement, which he would regard as unnecessary and prejudicial for the
economy:
The real obstacle in the way of an unlimited extension of the issue of fiduciary media
is not constituted by legislative restriction of the note-issue, which, after all, only affects
a certain kind of fiduciary medium, but the lack of a centralized world bank or of
uniform procedure on the part of all credit-issuing banks. So long as the banks do not
come to an agreement among themselves concerning the extension of credit, the circulation
of fiduciary media can indeed be increased slowly, but it cannot be increased
in a sweeping fashion. Each individual bank can only make a small step forward and
must then wait until the others have followed its example. Every bank is obliged to
regulate its interest policy in accordance with that of the others.48
It should be noted that this quotes from The Theory of Money and Credit are from the appendix
of 1954—that is, after Human Action. This leaves practically no room to argue that
Mises has shifted his thoughts from free banking to banking with a 100% reserve. On the
contrary, in the 1924 edition of The Theory of Money and Credit, Mises is implicitly in favor
of free banking, in Human Action, written in 1949, Mises is clearly in favor of free banking,
and in the 1954 appendix to The Theory of Money and Credit, he still prefers free banking as
his theoretical opinion of Peel’s Act shows.
How do we interpret, then, the several passages of Mises where he clearly says that Peel’s
Act should be reinstated but corrected from its flaws? Unless Mises has changed his mind
or contradicted himself in a central aspect in the same chapter without noticing it (possible,
but certainly extremely unlikely) some explanation should be given. Why is Mises offering
opposing arguments on the same topic in the same chapter?
This becomes understandable when we notice that he is talking about different situations
or he is facing different problems in each case. When Mises is talking about reinstating an
improved Peel’s Act, he is talking about limiting the power of central banks and thus is
dealing with monetary policy, not with monetary pure theory. This situation is like some
of the quotes provided by Huerta de Soto. As central banks will still be around enacting
monetary policy and trying to expand credit in the market, they should at least be limited
by some norm. As something like Peel’s Act already exists, there is no need to develop
another rule anew. However, the government can reinstate and fix Peel’s Act so as not to
leave an open door for governments to enact inflationary policies again—instead leaving
fractional reserves to commercial banks but not central banks. In the above cited passage,
where Mises expressly says that Peel’s Act “amounts to the same thing as suppressing the
creation of fiduciary media altogether and so renouncing all the attendant advantages for the
48	 von Mises, L. (1912). The Theory of Money and Credit (1981 ed.). (H. E. Batson, Trad.) Indianapolis: Liberty
Fund. p. 411. Bolds is added.
A bilingual interdisciplinary journal 229
stabilization of the objective exchange value of money,” he is talking about pure theory. In the
several passages where he says that Peel’s Act should be reinstated, he is talking in reference
to central banks or monetary policy. In Human Action, Mises mentioned that under free
banking the limits on the issuance of fiduciary media are much narrower than when there
is one issuer. In order to narrow the limits on central banks’ issuance of fiduciary media, it
could be advisable to impose on them a 100% reserve requirement.
This divergence in Mises’ opinion is analogous to his thoughts on free banking with fractional
reserves and banking with a 100% reserve requirement. In the former, he is talking
about pure theory. In the second, he is talking about monetary policy with the presence of
monetary legislation and with central banks following an expansive monetary policy. As free
banking is out of the question, since governments would not renounce the central banks,
the second best choice is to impose a 100% reserve requirement to central banks. Note that
this second best is generally limited to central banks because they are the ones with the monopoly
of issuance, not to the commercial banks and rest of the banking system. Except in
certain specific passages, when Mises proposes to impose a 100% reserve requirement, he
is referring to central banks, not to the entire banking system including commercial banks.
This is important, because it means that even when proposing a 100% reserve requirement,
he is not ruling out fractional reserves on the part of commercial banks. That is, even with
the second best choice, there is room for fractional reserves.
8. Conclusions
The interpretation that Mises preferred free banking to a 100% reserve requirement seems
to be very plausible and likely. There is not much need for a proof or demonstration of
when Mises stops talking about theory and starts talking about monetary policy with the
presence of central banks or regulations. If the references in the text are not clear enough,
it should be sufficient to see Mises’ own headings of each section.
Most citations from Mises that talk about the 100% reserve requirement and the idea
of reinstating Peel’s Act come from the chapters that deal with monetary and credit policy
rather than those where pure theory is the main topic. This supports the interpretation that
Mises’ ideal was free banking. If it were crystal clear that Mises favored the 100% reserve
requirement it would be enough to quote some passages from the theoretical chapters of
Theory of Money and Credit instead of chapter 20 or some passages from the chapter dealing
with “The Limitation on the Issuance of Fiduciary Media” in Human Action; instead, only
a footnote and a partial quote referring to Fisher’s plan are provided.
It should also be mentioned that in most cases where Mises talks about limiting the
issuance of fiduciary media, this limit is to be applied to those banks with the privilege of
issuance, which are central banks, not commercial banks. Limiting fractional reserves of
commercial banks is a non sequitur from the need of limiting the central banks’ power of
fiduciary issuance. In some cases, he may have extended these limits to large commercial
New Perspectives on Political Economy230
banks due to their significant role in the market, but other commercial banks should be free
from this limitation.
The bottom line of Mises’ suggestion is that central banks should cease to be banks to
become currency boards, and commercial banks should be able to continue being banks
with fractional reserves with no legislation privileges allowing them to avoid bankruptcy by
devaluation.
The fact that this article is focused only on the same chapters from Mises where Huerta
de Soto took his quotes was intended to emphasize the conclusion that a strong case for the
interpretation that Mises preferred free banking could be made, and although Mises might
not be too clear in some passages, only implicitly embedding free banking in The Theory of
Money and Credit, clear references and passages supporting this interpretation can easily be
found along most of his work.
References
Cachanosky, N. (2009). The Definition of Inflation According to Mises: Implications for
the Debate on Free Banking. Libertarian Papers, 1:43.
Huerta de Soto, J. (1998). Money, Bank Credit, and Economic Cycles. (M. A. Stroup) (2006
ed.). Auburn: The Ludwig von Mises Institute.
Mises, L. von (1949). Human Action. A Treatise on Economics (1996 ed.). Irvington-onHudson:
The Foundation for Economic Education.
Mises, L. von (n.d.). Money, Method, and the Market Process (1990 ed.). Auburn: The Ludwig
von Mises Institute.
Mises, L. von (1978). The Causes of the Economic Crisis. (P. L. Greaves Jr.) (2006 ed.).
Auburn: The Ludwig von Mises Institute.
Mises, L. von (1912). The Theory of Money and Credit. (H. E. Batson) (1981 ed.). Indianapolis:
Liberty Fund.
Salerno, J. T. (1993). Mises and Hayek Dehomogenized. The Review of Austrian Economics,
6(2), 113-146.
White, L. H. (1992). Mises on Free-Banking and Fractional Reserves. In J. W. Robbins
& M. Spangler, A Man of Principle. Essays in Honor of Hans F. Sennholz (pp. 517-533).
Grove City: Grove City College Press.
A bilingual interdisciplinary journal 231
Book Review
TANSTAAFL: A Libertarian Perspective on
Environmental Policy,
By Edwin G. Dolan, 2011.
London UK: Searching Finance, 240 p.
The book TANSTAAFL: A Libertarian Perspective on Environmental Policy from the American
professor of economics, Edwin G. Dolan, represents an uncommon outlook on issues
of environmental policy and economics. In the mysterious abbreviation TANSTAAFL,
there is contained the principal motto which is pervading the whole book: “There ain`t
no such thing as a free lunch”. According to Dolan, the TANSTAAFL principle describes
a simple fact that “Everything of value has a cost. Calling something “free” doesn`t make
it free, it just make it harder to trace how great the cost is and who bears it.“ (p. 1). The
uncommonness of Dolan`s book consists not only in the libertarian view on the topics of
environmental policy and in applying the TANSTAAFL approach to many environmental
problems, but also in the conception of this book. The first edition of professor Dolan`s
book was published in 1971 (under the title TANSTAAFL: The Economic Strategy for Environmental
Crisis) and now, forty years later, we can read not only an ordinary reprint of
the original book, but a very actual text solving the environmental problems from today`s
point of view. The actual edition of TANSTAAFL is supplemented with the author`s commentaries,
which are as long as the original text. The commentary to each chapter is simply
organized into two subchapters: What has changed, and what has not changed.
The 232 pages of this book are divided into eight chapters and one appendix, where the
first two chapters are designed as an introduction into principles of ecological economics
and into economics in general.
The third chapter (titled Pollution and Price System) deals (mostly) with externalities
and their internalization (for example via tradable certificates for emission of pollutants).
Back in 1971 Dolan wrote that putting a price on exhaust emissions would be the best
way to solve the problem with pollution because “compared to the current system of direct
control, the price system would offer distinct advantages with respect to efficiency,
equity, and incentives” (p. 62). Compared to the situation in 1971, the main thing which
has changed is the central environmental issue. Nowadays, the principal problem of environmental
protection seems to be climate change. Why is climate change the number one
environmental problem, which we can read about every day in newspapers and journals?
Edwin Dolan offers his hypothesis to this change of focus on environmental issues: many
New Perspectives on Political Economy232
formerly “serious” environmental problems were solved during the last forty years. And the
second reason is that to be a climate-change skeptic is a good strategy for being politically
visible and perhaps also politically successful. And what has not changed regarding the issue
of pollution and price system during the last forty years? It is the political opposition
to putting a price on pollution (and it doesn`t matter if it is the political opposition from
the left or from the right.)
The use of natural resources and environmental quality in terms of efficiency as a major
theme overlapping the entire book is discussed in charter 4 (The Political Economy of
Ecological Action). The efficiency paradox marked in the text, which is seen as a “flesh and
blood world of economy” where the decision is not only influenced by material relations
among things but at the same time by social relations among men, discusses the question of
negotiations. Could externalities not be purely resolved through negotiation? Dolan mentioned
a simple question. Why is a simple solution of negotiation so unrealistic? Dolan.
discusses the problem of organizing negotiations on reducing the negative effects of production
(externalities). On the one hand Dolan mentioned problems of individual negotiation.
Individual willingness to pay the full amount of costs is low because the benefits are less
than its costs. On the other hand, collective negotiation is associated with an issue of “public
good“ and the free-rider problem. Dolan stands on the threshold of institutional ecological
economics. It defines the basic conditions for eliminating the free-rider problem — the
group size and presence of visible causal relationships. As Dolan expanded: “Things can
sometimes be arranged so that it will be worthwhile for the individual to act in the group
interest even if others do not follow his example” and, “it is sometimes possible to rig the
situation in such a way that it will not be reasonable for the individual to assume that the
behaviour of others will continue uninfluenced by his own decision.“ (p. 88). According
to Dolan, the key is the size of the group. This idea can be found in the whole range of
institutional ecological economists:  Arild Vatn’s concept of Fit, Scale and Interplay (Vatn,
2005) or his three-dimensional model; furthermore, Elinor Ostrom’s thoughts are fully
compatible with its basic conception of the problem expanded on by Dolan.
Dolan in his original book also  discussed problems in  achieving  collective  benefits.
As he connects those problems with ”public choice economics” in the Appendix chapter
“What  Has  changed”,  the main obstacle  in  achieving  collective  benefits are individual
goals  and normative  and organizational  problems. The democratic  system in it-
self hides a number of pitfalls in the form of elected officials pursuing their own interests,
then in the form of majority voting, where one group is outvoted and therefore disadvan-
taged - the optimum of each group is not taken into account. Another argument is the
existence of lobbying and the fact that in reality, there are often adopted solutions that are
highly beneficial for a minority.
Dolan mentioned at the end of the chapter  the solution of environmental degrada-
tion seen in institutional settings. Externalities will be solved by free market mechanisms
when individuals will be able to negotiate among themselves on the basis of clearly de-
fined rules set up by the government. If the offender is forced to pay the entire cost of his
A bilingual interdisciplinary journal 233
actions, there will be an efficient allocation of resources.  But this is, unfortunately, according
to Dolan, impossible, given the past and current democratic system.
The problem of the population explosion is an issue in the fifth chapter (Coping with the
population explosion). Also on this topic (in the first edition of the book) Dolan applied
TANSTAAFL principle. In general, his suggestion in the 1971 edition (for the situation in
the USA) was that the best population policy, which should be adopted by government, was
no policy at all. Contrary to many authors at that time, Dolan believed that the population
growth did not have a direct effect on the pollution and he assumed that the problem of
population and pollution are separate and distinct. But Dolan doesn`t say that these two
problems don’t relate by no means — “population growth poses real challenges for environmental
policy” (p. 127). Compared to 1971, today`s problems concerning population are
different. Forty years ago the speed of population growth was higher than today, and Dolan
even believed, that after the year 2100, the population would decline. Today, the main two
problems of population are: “dramatic rise in the old-age dependency ratio” (p. 126) and
immigration.
The three environmental problems that are independent of population growth have not
changed: 1/ global and local pollution, 2/ non-renewable resources and 3/management of
local and global commons. Dolan notes that these three problems, as well as other environmental
problems, could be solved by using the TANSTAAFL principle — by applying the
price system on these problems. With the issue of population and its explosion discussed in
chapter 5, it is closely related to chapter 6 (Environmental Problems and Economic Develop-
ment).
Dolan added to the original edition of the book, an appendix touching on the delicate
issue of our time — global warming. The classical liberal conception which is suggested by
him in the book clearly stands against an “environmental” approach associated by IPCC.
Dolan’��������������������������������������������������������������������������������s great ������������������������������������������������������������������������book should be read not only by any economist but also by environmentalists
defending current policy and its way of dealing with environmental issues including global
warming. Dolan persuasively shows us that shrinking market freedoms and increasing
bureaucracy will not give us environmental quality. Markets and freedom will.
Vítězslav Malý,
The Institute for Economic and Environmental Policy, University of Economics, Prague.
email: maly@ireas.cz
Referrences:
VATN, A. 2005. Institutions and the Environment. 1. vyd. Northampton: Edward Elgar Publishing,
2005. ISBN: 1-84376-100-9
List of Articles
Matthew McCaffrey: On Government Investment and Consumption
Eduard Braun: The Rationale Of Originary Interest
Nicolás Cachanosky: Mises On Fractional Reserves A Review On Huerta
De Soto’s Argument
Book Review
TANSTAAFL: A Libertarian Perspective on Environmental Policy, By
Edwin G. Dolan, 2011.London UK: Searching Finance, 240 p.