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 Liberty In The News
Von Mises: the man who predicted the Depression
Mint, India Sunday, November 8, 2009

Right out of Mises’ script, overleveraged banks collapsed, businesses and employment collapsedOnly with the creative action of a critical mass of people, can we think of vibrant urban centres in India, writes Mark Spitznagel in Mint

Ludwig von Mises was snubbed by economists worldwide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today.

Mises’ ideas on business cycles were spelt out in his 1912 tome Theorie des Geldes und der Umlaufsmittel (The Theory of Money and Credit).


Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention. Left alone, interest rates would adjust such that only the amount of credit would be used as is voluntarily supplied and demanded. But when credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen.

Government-imposed expansion of bank credit distorts our “time preferences”, or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers lead to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption.


The system is dramatically susceptible to errors, both on the policy side and on the entrepreneurial side. Government expansion of credit takes a system otherwise capable of adjustment and resilience and transforms it into one with tremendous cyclical volatility.

Theorie des Geldes did not become the playbook for policymakers. The 1920s were marked by the brave new era of the Federal Reserve system promoting inflationary credit expansion and, with it, permanent prosperity.


We all know what happened next. Pretty much right out of Mises’ script, overleveraged banks (including Kreditanstalt) collapsed, businesses collapsed, employment collapsed. The brittle tree snapped. Following Mises’ logic, was this a failure of capitalism, or a failure of hubris?

Mises’ solution follows logically from his warnings. You can’t fix what’s broken by breaking it again. Stop the credit gavage. Stop inflating. Don’t encourage consumption, but encourage saving and the repayment of debt. Let all the lame businesses fail—no bailouts.


Mises started getting some much-deserved respect once Theorie des Geldes was finally published in English in 1934.


But then, just Mises’ bad luck, along came John Maynard Keynes’s tome The General Theory of Employment, Interest and Money in 1936. Keynes was dapper, fresh and sophisticated. He even wrote in English! The guy had chutzpah, fearlessly fighting unemployment by running the currency printing press and draining the government’s coffers.

He was the anti-Mises. So what if Keynes had lost his shirt in the stock market crash. His book was peppered with fancy math and that meant rigour, modernity. Mises wasn’t even refuted by Keynes and his ilk. He was ignored.


How curious it is that the guy who wrote the script depicting our never ending story of government-induced credit expansion, inflation and collapse has remained so persistently forgotten. Must we sit through yet another performance of this tragic tale?



This article was published in the Mint on Sunday, November 8, 2009. Please read the original article here.
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Tags- Find more articles on - interest rates | Keynes | savings | Theorie des Geldes | Theory of money and credit | Von Mises

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