Monday, March 5, 2012

Was Mises Clueless about Currency Devaluation?

The Market Monetarist thinks so. Responding to an excerpt from Mises' Human Action discussing currency devaluation, he claims that Ludwig von Mises was "clueless about the effects of currency devaluation."

His basic claim is that Mises
forgets the real reason why it might make perfectly good sense to allow the currency to weaken. If monetary policy has caused nominal GDP to collapse as was the case during the Great Depression (or during the the Great Recession!) then a policy of devaluation is of course the policy to pursue. Hence, von Mises totally fails to understand the monetary implications of devaluation.
The author says that the reason for this lack of understanding is that Mises and Rothbard both had a hard time understanding there is good and bad deflation.

What are we to make of this criticism? In the first place, the author overstates his claim about the cluelessness of Mises. The word clueless means just what it says: clue-less, as in without a clue. It is clear from the Market Monetarist's post that not even he thinks that Mises was literally without a single clue about currency devaluation and deflation. One could just as accurately claim that the Market Monetarist is clueless about Mises and Rothbard. Neither claim would be true. To be mistaken about something is not to be necessarily clueless.

To move past rhetoric and into economics, it should be noted that Joseph Salerno has done excellent work in helping us understand the difference between "good and bad deflation." In his article, "An Austrian Taxonomy of Deflation--with Applications to the U.S" Salerno documents that both Mises and Rothbard did distinguish between benign and undesirable inflation, noting that both explicitly criticized intentional deflationary central bank policies.

Both, for example, thought Great Britain made a mistake when it sought to return to the gold standard at the pre-WWI parity. This required a serious price deflation which contributed to economic disruption. "The sensible thing to do," wrote Rothbard in What Has Government Done to Our Money?, "would have been to recognize the facts of reality, the fact of the depreciated pound, franc, mark, etc., and to return to the gold standard at a redefined rate: a rate that would recognize the existing supply of money and price levels."

The Market Monetarist then cites George Selgin's "great discussion" of Mises's views about deflation, noting Selgin conlcudes that Mises, given his perspective on deflation, should have embraced a monetary policy aimed at stabilizing nominal spending. Jeffrey Herbener has criticized Selgin's (and Larry White's) interpretation of Mises' views on gold and money in "Ludwig von Mises on the Gold Standard and Free Banking." Herbener's analysis indicates that Selgin's and White's interpretation of Mises may not be wholly accurate after all, but are, in fact, "dubious."

Specifically on the point of nominal income stabilization, he documents that Mises' proper understanding of the non-neutrality of money precludes nominal spending stability as the target to pursue for a healthy economy. Citing Mises' Theory of Money and Credit, Herbener explains,
Only if one assumes that goods-side influences are unchanged can he identify, from any change in price, the money-side influence. But goods-side influences are in continual flux and indissolubly intermixed with money-side influences. And this is true whether nominal income is rising, staying the same, or declining. A constant nominal income does not ensure constancy of the underlying demands for and supplies of goods and money and thus is no guide to bifurcating goods-side and money-side influences and, by implication, no guide to monetary policy that targets money’s value. Moreover, if nominal income could be kept constant only by a government policy of changing the money stock to offset any changes in money demand (thereby neutralizing any money-side influence) as Mises thought would be necessary to conduct such monetary policy, far from neutralizing the effect of the change in money demand, this would inject a second money-side influence into the economy on top of the (presumed) change in money demand. Even if monetary policy could put the additional money directly and immediately into the hands of those particular people whose money demands had changed and in an amount proportional to the changes in money demand for each person, a change in money supply would still fail to neutralize a change in money demand since the effects on prices of the two changes are determined by subjective valuations, which can be different in different circumstances (Mises 1980, pp. 218–19). What makes the managed monetary system less stable than the gold standard, according to Mises, is that it lacks this policy-induced money-side influence on money’s purchasing power" (pp. 72-73).

The Market Monetarist concludes by saying, "I never understood people who support free markets could also be in favour of fixing the price of the currency – to me that makes absolutely no sense." One reason Mises opposed currency devaluation is that in his context, it does not merely allow for flexibility of prices, but actually redefines the monetary unit. What I have a hard time understanding is why people who support free markets can also be in favor of fixing the supply of money through government intervention.


  1. You might read my article on Mises and the gold standard rather than rely on secondary accounts of it. Then you will see that I actually criticize Mises for not having made as strong a case for gold as he might have. "The Market Monetarists" claim that I say that Mises ought to have recommended NGDP stabilization is not one I ever made, in the article in question or anywhere else--and I commented on that blog to this effect. As you take that blog's misrepresentation at face value, I wish to correct the error here also.

    Here is the conclusion to my article: "Although I find Mises’ own arguments in defense of gold unsatisfactory, I have tried to suggest how an extension of those arguments could make for a more convincing defense of gold. This defense cannot, however, be sustained on purely theoretical grounds. Ultimately the merits of gold must be assessed in light of empirical (and statistical) evidence comparing the gold standard’s performance with that of historical fiat standards."

    The entire article is available online. If you can find any place in it in which I say that Mises should have favored stable MV over a gold standard, by all means include the proof on your post. Otherwise I hope you will correct the misstatement of my views.

  2. Dr. Selgin,

    You are right that I failed to include in my post that you conclude Mises could have made a stronger case for gold than he did. I apologize for my failure to do so.

    However, on page 262 of your article, you do write:

    "Mises’ ideal of a money with a constant inner objective exchange value (but with an outer exchange value that varied
    directly with changes in real output) was thus, in essence, equivalent to the modern idea of a nominal income (GDP) target. Mises himself, however (perhaps because of his refusal to employ the equation of exchange as a tool of reasoning), never recognized the equivalence of a stable inner objective exchange value of money and stable nominal
    income. This failure caused Mises to exaggerate the difficulties involved in efforts to deliberately achieve an ‘‘ideal’’ money and to overstate the relative advantages of a gold standard."

    Given your above paragraph, can you see how readers might surmise you think Mises' monetary ideal more compatible with stabilizing MV?

    1. Dear Shawn,

      I can see it, but only dimly: although I say that Mises exaggerated the technical difficulties of a implementing "ideal" monetary policy, I still recognize throughout the article the merit of Mises' assumption that the gold standard was the best available institutional arrangement by which to approximate his monetary ideal. Mises still had on his side the very strong argument that politics would prevent money from being responsibly managed.

  3. Lars Christensen's argument rests upon the premise that we should care about nominal GDP. I am not convinced that we should. What does it matter if nominal GDP is falling is real GDP is rising appropriately? Is the opposite what he desires? I would think not. Then what is the value of looking at nominal GDP? In that case, if the real concern is real GDP, then how can we conceivably support a loose monetary policy given the distortions in capital markets it will necessarily engender?

    1. I think you are right. To the extent that we are willing to accept GDP as a concept, real GDP is what matters as a variable that relates to actual prosperity.

      Now, the market monetarists would most likely argue that targeting a stable growth rate in NGDP is the best way of creating an environment for businesses to do their thing so as to grow real GDP. As you point out, however, they must ignore the distortionary effects of monetary inflation.