Friday, March 1, 2013

Theory of Employment, Money, Interest, and the Capitalist Process: The Misesian Case Against Keynes

It is my goal to reconstruct some basic truths regarding the process of economic development and the role played in it by employment, money, and interest. These truths neither originated with the Austrian School of economics, nor are they an integral part of this tradition of economic thinking alone. In fact, most of them were part and parcel of what is now called classical economics, and it was the recognition of their validity that uniquely distinguished the economist from the crackpot. Yet the Austrian School, in particular Ludwig von Mises and, later, Murray N. Rothbard, has given the clearest and most complete presentation of these truths. 1 Moreover, they have also presented their most rigorous defense by showing them to be ultimately deducible from basic, incontestable propositions (such as that man acts and knows what it means to act) so as to establish them as truths whose denial would not only be factually incorrect but, much more decisively, would amount to logical-praxeological contradictions and absurdities.
First, I will systematically reconstruct this Austrian theory of economic development. Then I will turn to the “new” theory of Keynes, which belongs, as he himself cannot help but acknowledge, to the tradition of “underworld” economics (like Mercantilism) and of economic cranks (like Silvio Gesell). 3 I will show that Keynes’s new economics, too, is cranky: a tissue of logical-praxeological falsehoods reached by means of obscure jargon, shifting definitions, and logical inconsistencies, intent to create an anticapitalist, anti-private-property, and antibourgeois mentality.
“Unemployment in the unhampered market is always voluntary.” 4 Man works, because he prefers its anticipated result to the disutility of labor and the psychic income to be derived from leisure. He “stops working at that point, at which he begins to value leisure, the absence of labor’s disutility, more highly than the increment in satisfaction expected from working more.” 5 Obviously, then, Robinson Crusoe, the self-sufficient producer, can only be unemployed voluntarily (because he prefers to remain idle and consume present values instead of expending additional labor in the production of future ones).
The result is not different when Friday enters and a private property economy is established based on a initial recognition of each person’s rights of exclusive ownership over those resources which he had recognized as scarce and appropriated (homesteaded) by mixing his labor with them before anyone else had done so, and of all goods produced with their help. In this situation not only exchange ratios—prices—for the purchase or rental of material goods become possible, but also prices (wages) for the rental of labor services. Employment will ensue whenever the offered wage is valued more highly by the laborer than the satisfaction to be derived from self sufficiently working with and/or consuming his own resources (or of appropriating previously submarginal resources). Employment will increase, and wages rise, so long as entrepreneurs perceive existing wages as lower than the marginal value product (discounted by time preference) 6 which a corresponding increment in the employment of labor can be expected to bring about. On the other hand, unemployment will result, and increase, so long as a person values the marginal value product attained through self-employment more highly than a wage that reflects his labor services’ marginal productivity.
In this construction there is no logical room for such a thing as involuntary unemployment. As employment is always voluntary, so is unemployment (self-employment).

Involuntary unemployment is only logically possible once the situation is fundamentally changed and a person or institution is introduced which can successfully exercise control over resources which he has not homesteaded, or acquired through voluntary exchange from homesteaders. Such an extra-market institution, by imposing, for instance, a minimum wage higher than the marginal productivity of labor, can effectively prohibit an exchange between a supplier of labor service and a capitalist which would be preferred by both, if both had unrestricted control over their homesteaded property. The would-be laborer then becomes involuntarily unemployed, and the would-be employer is forced to dislocate complementary factors of production from more into less value productive usages. As a matter of fact, an extra-market institution can in principle create any desired amount of involuntary unemployment. A minimum wage of say, $1 million per hour would, if enforced, involuntarily disemploy practically everyone and would, along this way toward forced self-employment, condemn most of today’s population to death by starvation.
In the absence of an institution exempt from the rules of the market involuntary unemployment is logically impossible, and prosperity instead of impoverishment will result.
Man participates in an exchange economy (instead of remaining in self-sufficient isolation) insofar as he is capable of recognizing the higher productivity of a system of the division of labor and he prefers more goods over less. Out of his market participation arises in turn his desire for a medium of exchange (money). Indeed, only if one were to assume the humanly impossible (that man had perfect foresight regarding the future), would there be no purpose for him to have money. For with all uncertainties removed, in the never-never land of equilibrium one would know precisely the terms, times, and locations of all future exchanges, and everything could be prearranged accordingly and would take on the form of direct rather than indirect exchanges. 8 Under the inescapable human condition of uncertainty, however, when all this is not known and action must by nature be speculative, man will begin to demand goods no longer exclusively because of their use-value, but also because of their value as media of exchange.
Faced with a situation where his reservation demand for some supplied goods or services is low or nonexistent, and where a directly satisfying exchange, due to the absence of double coincidences of wants, is out of the question, he will also consider trading whenever the goods to be acquired are more marketable than those to be surrendered, such that their possession would then facilitate the acquisition of directly serviceable goods and services at not yet known future dates.
Moreover, since it is the very function of a medium of exchange to facilitate future purchases of directly serviceable goods, man will naturally prefer the acquisition of a more marketable and, at the limit, universally marketable medium of exchange to that of a less or nonuniversally marketable one so that

there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money. 9

On the way toward this ultimate goal, by selecting monies that are increasingly more widely used, the division of labor is extended and productivity increased.
However, once a commodity has been established as a universal medium of exchange, and the prices of all directly serviceable exchange goods are expressed in terms of units of this money (while the price of the money unit is its power to purchase an array of nonmoney goods), money no longer exercises any systematic influence on the division of labor, employment, and produced income. Once established, any amount of money is compatible with any amount of employment and income. 10 Indeed, as explained above, in the nevernever land of equilibrium there would be no money, but there would still be employment and income. This demonstrates that money on the one hand and employment and income on the other must be regarded as logically-praxeologically independent and unrelated concepts. For instance, should the supply of money increase, other things being equal, this would surely have redistributive effects, depending on where and how the additional money entered the economy; but it would just as surely have no systematic effect on the amount of employment and the size of the social product. Prices and wages generally would go up, and the purchasing power of the money unit would go down. However, nothing would follow with regard to employment and social product. They may be different, or they may be the same. The same is true of changes in the demand for money. An increase in the demand for money (i.e., a higher relative value attached to additional cash as compared to additional nonmoney), would certainly change relative prices; yet it would not imply anything as far as employment and social product is concerned. In equilibrating an increased demand for money with a given stock of money, the general level of prices and wages must fall, and the purchasing power of the money unit must rise, mutatis mutandis. But there is no reason to suppose that this should have any impact on employment or income. Money wages fall, but simultaneously the purchasing power of money increases, leaving real wages and real social product entirely unaffected.
The result is no different if changes on the nonmoney side are considered. Other things being equal, an increase in the supply of goods and services, for instance, brings about an increase in the purchasing power of money; money prices fall. This reduces the quantity of money demanded (the demand schedule for money being given), because the cost of holding onto money instead of spending it on non-money has risen; and this lowered demand for cash implies in turn a reverse tendency toward rising prices and a reduced purchasing power of money. Nothing concerning employment and social product follows. Nor does the picture change when expectations are explicitly taken into account. Inflationary (deflationary) expectations reduce (increase) the demand for money immediately and thus speed up the adjustment toward whatever has been anticipated; and if something wrong has been anticipated (i.e., something out of line with the underlying reality), then the process of self-corrective adjustments is sped up through the workings of expectations. But none of these monetary phenomena has any systematic praxeological connection with employment and social product, which may well remain the same throughout all monetary changes.
Invariably, money is “neutral” to employment and social product.
Money is “neutral” also to interest. However, interest, unlike money, is praxeologically related to employment and social product.
As money is the result of uncertainty, so interest results from time preference, which is as essential to action as uncertainty (and in a sense to be explained shortly even more so). In acting, an actor not only invariably aims to substitute a more for a less satisfactory state of affairs and so demonstrates a preference for more rather than less goods; he must invariably also consider when in the future his goals will be reached (i.e., the time necessary to accomplish them) as well as a good’s duration of serviceability, and every action thus also demonstrates a universal preference for earlier over later goods and of more over less durable ones. Every action requires some time to attain its goal; since man must consume something sometimes and cannot stop consuming entirely, time is always scarce. Thus, ceteris paribus, present or earlier goods are, and must invariably be, valued more highly than future or later ones. 11 In fact, if man were not constrained by time preference and the only constraint operating were that of preferring more over less, he would invariably choose those production processes that would yield the largest output per input, regardless of the length of time needed for these methods to bear fruit. For instance, instead of building a fishing net first, Crusoe would immediately begin constructing a fishing trawler, as the economically most efficient method for catching fish. That no one, including Crusoe, acts in this way makes it evident that man cannot but “value fractions of time of the same length in a different way according as they are nearer or remoter from the instant of the actor’s decision.” 12
Thus, constrained by time preference, man will only exchange a present good against a future one if he anticipates thereby increasing his amount of future goods. The rate of time preference, which can be different from person to person and from one point in time to the next, but which can never be anything but positive for everyone, simultaneously determines the height of the premium which present goods command over future ones as well as the amount of savings and investment. The market rate of interest is the aggregate sum of all individual time preference rates, reflecting, so to say, the social rate of time preference, and equilibrating social savings (i.e., the supply of present goods offered for exchange against future goods) and social investment (i.e., the demand for present goods capable of yielding future returns).

No supply of loanable funds could exist without previous savings, i.e., without the abstention from some possible consumption of present goods. Furthermore, no demand for loanable funds would exist if no one were to perceive any opportunity to employ present goods productively (i.e., to invest them so as to produce a future output that would exceed current input). Indeed, if all present goods were consumed and none invested in time-consuming production processes, there would be no interest or time preference rate, or rather, the interest rate would be infinitely high, which outside of the Garden of Eden, would be tantamount to eking out a primitive subsistence living by encountering reality with nothing but one’s bare hands and with nothing but a desire for instantaneous gratification.
A supply of and a demand for loanable funds only arises—and this is the human condition—once it is recognized that indirect, more roundabout, lengthier production processes can yield a larger or better output per input than direct and short ones; 13 and it is possible, by means of savings, to accumulate the amount of present goods needed to provide for all those wants whose satisfaction during the prolonged waiting time is deemed more urgent than the increment in future well-being expected from the adoption of a more time-consuming production process. 14
So long as this is the case, capital formation and accumulation will set in and continue. Instead of being supported by and engaged in instantaneously gratifying production processes, the originary factors of production, land and labor, are supported by an excess of production over consumption and employed in the production of capital goods. These have no value except as intermediate products in the process of turning out final (consumer) goods. In other words, their value lies in the fact that whoever possesses them can use them to produce other capital goods more efficiently. The excess in value (price) of a capital good over the sum expended on the complementary originary factors required for its production is due to this time difference and the universal fact of time preference. It is the price paid for buying time; for moving closer to the completion of one’s ultimate goal rather than having to start at the very beginning. Because of time preference, the value of the final output must exceed the sum spent on its factors of production (the price paid for the capital good and all complementary labor services).
The lower the time preference rate, then, the earlier the process of capital formation will set in, and the faster it will lengthen the roundabout structure of production. Any increase in the accumulation of capital goods and in the roundaboutness of the production structure in turn raises the marginal productivity of labor. This leads to either increased employment and/or wage rates, and, in any case (even if the labor supply curve should become backward sloping with increased wages), to a higher wage total. 15 Supplied with an increased amount of capital goods then, a better paid population of wage earners will produce an overall increased—future—social product, raising at last, after that of the employees, also the real incomes of the owners of capital and land. While interest (time preference) thus has a direct praxeological relation to employment and social income, it has nothing whatsoever to do with money. To be sure, in a money economy there also exists a monetary expression for the social rate of time preference. Yet this does not change the fact that interest and money are systematically independent and unrelated, and interest is a “real,” not a monetary phenomenon. In fact, in the never-never land of equilibrium there would be no place for money because the future by definition would be certain and with all uncertainty removed no one would have any need for cash holdings (whose sole purpose it is, cash being neither productive nor consumable, to have one prepared for not yet known purchases at not yet known dates). Time preference and interest, however, cannot be conceived of as disappearing even then. For even in equilibrium the existing capital structure needs to be constantly maintained over time (so as to prevent it from gradually becoming consumed in the even course of an endlessly repeated pattern of productive operations). There can be no such maintenance, however, without ongoing savings and reinvestments: and there can be no such things as these without the expectation of a positive rate of interest. (Indeed, if the rate of interest paid were zero, capital consumption would result, and one would move out of equilibrium.) 16
Matters become somewhat more complex under conditions of uncertainty, with money actually in use, but the praxeological independence of money and interest remains fully intact. Under these conditions, man invariably has three instead of two alternatives as to how to allocate his current income. He must not only decide how much to allocate to the purchase of present goods and how much to future goods (i.e., how much to consume and how much to invest), but also how much to keep in cash. There are no other alternatives. Yet while man must at all times make adjustments concerning three margins at once, invariably the outcome is determined by two distinct and praxeologically unrelated factors. The consumption/investment proportion is determined by time preference. The source of the demand for cash, on the other hand, is the utility attached to money (i.e., its usefulness in allowing immediate purchases of directly serviceable goods at uncertain future dates). Both factors can vary, independent of one another.
If the supply of money changes, or if the demand for money changes with a given social stock of money, the purchasing power of money will also change. However, aside from causing changes in relative incomes, no such changes in a money unit’s purchasing power would have any effect on overall real income. Incomes in terms of money increase or decrease, yet the purchasing power of money correspondingly falls or rises, leaving real income unchanged. Or, with money incomes unchanged, more or less of it will be held in cash (hoarded), but then the purchasing power of money correspondingly rises or falls, once again leaving the real income purchased with a smaller or larger sum of money unaltered. It is this real income, however, not money as such, to which a man’s time preference schedule is related, and in light of which his effective rate of time preference is determined. Since real income does not change through all these monetary changes, there is no reason to suppose that the rate of time preference will. If, for instance, the Keynesian nightmare of increased hoarding becomes reality and prices generally fall while the purchasing power of money correspondingly rises, this will leave the real investment/consumption proportion entirely unaffected. Unless the time preference schedule is assumed to have changed at the same time, the additional hoards will be drawn from funds that formerly were spent on consumption and from funds that formerly went into investment in the same pre-established proportion, so as to leave real consumption and real investment at precisely their old levels. However, if time-preference is assumed to change concomitantly, then everything is possible. Indeed, if the additional hoards come exclusively from previous consumption spending, an increased demand for money can go hand in hand even with a fall in the rate of interest and increased investment. Yet this is due not to changes in the demand for money but exclusively to a change (a fall) in the time preference schedule. 17
With the division of labor established and extended to its ultimate limit via the development of a universal medium of exchange, the process of economic development is essentially determined by time preference.
To be sure, there are other factors that are important: the quality and quantity of the population, the endowment with nature-given resources, and the state of technology. Yet of these, the quality of a people is largely beyond anyone’s control and must be taken as a given: the quantity of a population may or may not advance economic development, depending on whether the population is below or above its optimum size for a given-sized territory: and nature-given resources or technological know-how can only have an economic impact if discovered and utilized. To do this, though, there must be prior savings and investment. It is not the availability of resources and technical or scientific knowledge that imposes limits on economic advancement: rather, it is time preference that imposes limits on the exploitation of actually available resources as well as on the utilization of existing knowledge (and also on scientific progress for that matter, insofar as research activities, too, must be supported by saved-up funds).
Thus, the only viable path toward economic growth is through savings and investment, governed as they are by time preference. Ultimately there is no way toward prosperity except through an increase in the per capita quota of invested capital. This is the only way to increase the marginal productivity of labor and only if this is done can future income rise in turn. With real incomes rising, the effective rate of time preference falls (without, however, ever reaching zero or even becoming negative), adding still further increased doses of investment, and setting in motion an upward spiraling process of economic development.
There is no reason to suppose that this process should come to a halt short of reaching the Garden of Eden where all scarcity has disappeared—unless people deliberately choose otherwise and begin to value additional leisure more highly than any further increase in real incomes. Nor is there any reason to suppose that the process of capitalist development would be anything but smooth and that the economy would flexibly adjust not only to all monetary changes but to all changes in the social rate of time preference as well. Of course, so long as the future is uncertain, there will be entrepreneurial errors, losses, and bankruptcies. But no systematic reason exists why this should cause more than temporary disruptions, or why these disruptions should exceed, or drastically fluctuate around, a “natural rate” of business failures. 18
Matters become different only if an extra-market institution such as government is introduced. It not only makes involuntary unemployment possible, as explained above: the very existence of an agency that can effectively claim ownership over resources which it has neither homesteaded, produced, nor contractually acquired, also raises the social rate of time preference for homesteaders, producers, and contractors, and hence creates involuntary impoverishment, stagnation, or even regression. It is only through government that mankind can be stopped on its natural course toward a gradual emancipation from scarcity long before ever reaching the point of a voluntarily chosen zero-growth. 19 And it is in the presence alone of a government, that the capitalist process can possibly take on a cyclical (rather than a smooth) pattern, with busts following booms. Exempt from the rules of private property acquisition and transfer, government naturally desires a monopoly over money and banking and wants nothing better than to engage in fractional reserve (deposit) banking—in nontechnical terms: monopolistic counterfeiting—so as to enrich itself at the expense of others through the much less conspicuous means of fraud rather than through outright confiscation. 20 Boom and bust cycles are the outcome of fraudulent fractional reserve banking. If and insofar as the newly created counterfeit money enters the economy as additional supplies on the credit market, the rate of interest will have to fall below what it otherwise would have been. Credit must become cheaper. Yet at a lower price more credit is taken, and more resources then are invested in the production of future goods (instead of being used for present consumption) than otherwise would have been. The roundaboutness of the entire production structure is lengthened. In order to complete all investment projects that now are underway, more time is needed than that required to complete those begun before the credit expansion. All the goods which would have been created without credit expansion must be produced; plus those that are newly added. For this to be possible, however, more capital is required. The larger amount of future goods can only be produced successfully if additional savings provide for a fund of means of sustenance sufficiently large to bridge, and carry workers through, the longer waiting time. But, by assumption, no such increase in savings has taken place. The lower interest rate is not the result of a larger supply of capital goods. The social rate of time preference has not changed at all. It is solely the result of counterfeit money entering the economy through the credit market. It follows logically that it must be considered impossible to successfully complete all investment projects underway after a credit expansion due to a systematic lack of real capital. Projects will have to be liquidated so as to shorten the overall production structure and to readjust it to an unchanged rate of social time preference and the corresponding real investment-consumption proportion. 21
These cyclical movements can neither be avoided by expecting them (according to the motto “a cycle anticipated is a cycle avoided”): They are the praxeologically necessary consequence of additional counterfeit credit being successfully placed. Once this is the case, a boom-bust cycle is inevitable, regardless of what actors correctly or incorrectly believe or expect. The cycle is induced by a monetary change, but it takes effect in the realm of “real” phenomena and will be a “real” cycle no matter what beliefs people happen to hold. 22
Nor can it be realistically expected that the inevitable cyclical movements resulting from an expansion of credit will ever come to a halt: So long as an extra-market institution like government is in control of money, a permanent series of cyclical movements will mark the process of economic development. For through the creation of fraudulent credit, a government can engender a smooth and highly inconspicuous income and wealth redistribution in its own favor. There is no reason (short of angelic assumptions) to suppose that it would ever deliberately stop using this magic wand merely because credit expansion has the “unfortunate” side-effect of business cycles.
Economics and Ethics of Private Property: Studies in Political Economy and Philosophy, The

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