Chicago Monetary Tradition in the Light of Austrian Theory


The extraordinary Austrian, Dr. Ludwig von Mises, celebrates his 90th birthday on September 29, 1971. The renowned dean of the Austrian School of economic thought, Mises has made profound contributions to the science of economics and to an understanding of the operation of the market economy. His contributions to monetary theory and business cycle theory are particularly cogent today.

Those who are familiar with contemporary economic thinking are aware that the Austrian School stands in fundamental opposition to Keynesian concepts, and that the Chicago School of economists has also spearheaded attacks on Keynesianism. Yet few realize the distinct approaches to monetary theory of the Austrian and Chicago Schools. Thus, while Chicagoite Milton Friedman has enjoyed widespread prestige as an economist and is considered to be a strong influence in favor of the market economy, from an Austrian perspective certain of his views—particularly his interpretation of business cycles and advocacy of steady expansion of the money supply—are erroneous and tend to breed demands for additional governmental control.

One of the worst consequences of Keynes' teachings is that they served to make inflation respectable as something to be generally accepted. Might the legacy of the Chicago School also be harmful? In this article by a leading Austrian economist, Professor Sennholz contrasts the Austrian business-cycle analysis with the Chicago approach to business recessions, and manifests his concern that the widespread influence of Chicago monetary thought may lead to a setback for libertarians.

Professor Sennholz' article shall be published by the Institute for Humane Studies in a two-volume Mises festschrift, entitled TOWARD LIBERTY. Sixty-seven admirers of Mises, from eighteen different countries, have contributed essays to TOWARD LIBERTY in Mises' honor on the occasion of his 90th birthday. The festschrift, which reproduces these essays in their original typed format, can be ordered, at the price of $10.00 (plus 5% tax for California residents), from the Institute for Humane Studies, Inc., Menlo Park, California.

REASON is proud to prepublish Professor Sennholz' important essay at this time.
—Manuel S. Klausner

Chicago Monetary Tradition in the Light of Austrian Theory is copyright 1971 by Institute for Humane Studies, Inc.

In the diversity of contemporary American monetary thought the new neoclassicism of the Chicago School has assumed an intellectual position that probably equals that of the new economics. Chicago monetary thought has invaded in force not only the American academy and the deliberations and actions of the Federal Reserve Board, but also the halls of Congress and the economic reports and policies of the President. This remarkable development is also reflected in the growing popularity and prestige now accorded to Milton Friedman, the most influential economist of the Chicago tradition.

We rejoice about this new trend in monetary thought and are appreciative of the effective Chicagoan challenge to the Keynesian orthodoxy. The analytical depth, scientific precision, and overwhelming empirical evidence offered by Professor Friedman and his colleagues have shattered many a cherished doctrine of the new economics and thereby given new life to neoclassicism. In an age of Keynesian supremacy when the discussion of money had given way to debates on the techniques of fine tuning through fiscal measures the Chicagoans restored money to its rightful place. They successfully reconstructed a version of the quantity theory of money and re-emphasized the importance of monetary policy. And last but not least, they levelled devastating criticism at official monetary managers for having generated feverish booms and disastrous recessions through gross mismanagement of our money.

And yet, this writer casts doubt on the cogency and durability of this new neoclassicism. In our judgment, it is built on the quicksand of macro-economic analysis; it misinterprets the business cycles and therefore is bound to fail as policy guide for economic stability; it is inherently inflationary as it makes government the guardian of our money. The intellectual forebears of this new neoclassicism were three Englishmen and one American: William S. Jevons, Alfred Marshall, Ralph G. Hawtroy, and Irving Fisher. As, a generation ago, their tenets gave way to the new economics of John Maynard Keynes, Alvin H. Hanson and Abba P. Lerner, so is the new neoclassicism itself destined to surrender to more statist doctrines. After all, it puts government in charge of economic stability and then prescribes monetary policies that will continue to generate business cycles. Inevitably, frustration and disappointment tend to breed demands for more government intervantion.

Almost 100 years ago WILLIAM STANLEY JEVONS had attempted "to substitute exact inquiries, exact numerical calculations, for guesswork and groundless argument" in his analysis of quantitative data on prices and business movements.[1] In a paper on "The Variation of Prices, and the Value of the Currency since 1782" Jevons studied the changing purchasing power of money between 1782 and 1865. He concluded his analysis with the following comment on gold: "in itself gold-digging has ever seemed to me almost a dead loss of labor as regards the world in general—a wrong against the human race, just such as is that of a government against its people, in overissuing and depreciating its own currency."[2] Instead, Jevons favored a "tabular standard of value" which his own work on index numbers was supposed to promote. He was convinced that some day this system would come into use and that gold coins would cease to be the principal media of exchange.[3]

ALFRED MARSHALL lent his support to the Jevons plan. Mindful of the great changes in the purchasing power of money and their detrimental effects on contractual relationships, he searched for a stable monetary unit. In a proposal to the Royal Commision on the Depression of Trade and Industry, in 1886, he urged the government to publish tables showing changes in the purchasing power of money so that contracts would be made in terms of units of constant purchasing power.[4] Professor Marshall introduced the great dichotomy that continues to guide most contemporary economists, that is, the separation of the micro sphere in which individual prices are determined by supply and demand, from the macro sphere in which the total supply of money and its velocity determine the value of money and the price level.[5] Although Marshall did not draw the political conclusion from this doctrine, his followers in Great Britain and America later went the final step: they called on government for price level stabilization through manipulation of the quantity of money stock.

RALPH G. HAWTREY, an economist connected with the British Treasury from 1919 to 1937, developed a purely monetary theory of business cycle on a macroeconomic concept of equilibrium. Changes in the flow of currency, in particular bank credit, cause instability in production and employment. At first, total bank credit expands as interest rates are reduced. Total demand for finished goods rises, which causes prices to rise.

Businessmen use easy money to expand their inventories. The expansion of credit thus causes incomes to rise, which eventually leads to more currency passing into circulation. And under the gold standard this currency has to be either gold coin or paper money backed by gold. But such a demand encroaches on the available supplies of gold in all gold standard countries and especially in central banks. According to Hawtrey, "the flow of currency into circulation in such circumstances is very gradual, and lags far behind the expansion of credit which causes it. The result is that, if the authorities controlling credit are guided in their action by the adequacy of their stock of gold, their intervention is bound to be very tardy. And the expansion and contraction of credit are both likely to be very slow processes in a group of countries which are all made to keep pace with one another by the rather cumbersome expedient of gold movements."[6]

In short, the trade cycle which is a credit phenomenon is causes by the defects of the gold standard as a regulator of credit. Guided by their gold reserves the monetary authorities intervene too slowly first in the restriction of bank credit and then in the expansion during periods of recession. The Great Depression, according to Hawtrey, was the result of such defects. Throughout those baneful years he called for more credit expansion by the central banks as the only remedy for unemployment.[7] In 1962 Hawtrey restated his conclusion: "When we look back on the monetary experience we have had since 1932, surely the moral to be drawn from it is above all the importance of maintaining stability of the money unit. The depression of the nineteen thirties was due to the doubling of the wealth-value of gold."[8]

Similar conclusions were drawn by IRVING FISHER, the American economist who spearheaded the new neoclassicism. "The key to the business failure, and therefore the key to the depression," he wrote in 1933, "is the deflated price level; the key to the deflated price level is monetary deflation; the principal kind of money which deflates is our checking accounts at the banks."[9] This is why Fisher called for reinflation throughout the Great Depression. In particular, he urged President Roosevelt to devalue the dollar and later hailed him for having done so. In fact, Fisher went further. "We might even abandon gold altogether, and resort to a managed currency with no base but paper. Several other nations have done this to their distinct advantage."[10]

Professor Fisher had a simple explanation for business cycles. Credit currency perpetuates its own motion in a sort of vicious circle, or rather a vicious spiral-upward or downward as the case may be. But what determines the direction of the spiral? Fisher gave at least three different answers: (1) the motion springs from completely random, uncoordinated, inexplicable "frenzies of enterprise;"[11] (2) "if something big enough hits humanity" the spiral may be set into motion. A war may trigger it. According to this explanation, "the depression grew out of a boom which started in a credit currency boom, which started from a debt boom, which grew out of the World War."[12] And (3), faulty monetary management by the central bank may redirect the motion. In 1928, for instance, the Federal Reserve Board brought the speculative movement to a stop through credit stringency, which then began to be felt in legitimate business.[13]

Fisher's crusading spirit led him to be active in many fields of reform, such as health, conservation, prohibition, the League of Nations, and many others. But throughout his active life he crusaded above all for economic stabilization and monetary reform. In numerous writings he presented his plan for the "compensated dollar," a dollar of constant purchasing power, sometimes called the "commodity dollar." The conventional gold standard was to be replaced by a standard that defined the dollar in terms of constant value, which was to be determined by an index number of commodity prices of a given basket of goods. This commodity standard was to be strengthened further by "100% money," that is, a cash reserve of 100% against all demand deposits. A "Currency Commission" would issue new money and turn into cash the assets of every commercial bank so that the cash reserve of each bank would be increased to 100% of its checking deposits. The new money thus would provide an all-cash backing for the checking accounts without either increasing or decreasing the total stock of money in the country. Thereafter the banks would be required to maintain permanently a 100% cash reserve against their demand deposits. According to Professor Fisher, his plan would keep banks 100% liquid, prevent inflation and deflation, cure or prevent depressions, and wipe out much of the national debt.[14]


The principal successors to this train of monetary thought from Alfred Marshall to Irving Fisher were economists at the University of Chicago. Frank H. Knight, Jacob Viner, Lloyd Mints, Henry Simons and Milton Friedman have made Chicago an important center of contemporary economic thought. While Professor Knight greatly strengthened the neoclassical structure with his analysis of the role of profit in economic life, Henry Simons led a fierce attack on Keynes and his American disciples.

Simons' theory of money deserves our attention because it is clearly reflected in contemporary Chicago thought and it points up the differences between the new economics and the new neoclassicism, between the "fiscalists" and the "monetarists." In his attacks on Alven Hansen, the leading academic Keynesian, Professor Simons not only restated the framework of the quantity theory but also sharply criticized the various Keynesian schemes for recovery from the Great Depression. A virulent critic of Keynes[15] Simons nevertheless revealed a striking similarity in premise and analysis, which, in our judgment, affords a common bond not only for Professors Keynes and Simons but also all fiscalists and monetarists.[16] Surely Lord Keynes basically agreed with Professor Simons' analysis of the gold standard. In Simons' own words, "the worst financial structure is realized when many nations, with similar financial practices and institutions and similar credit pyramids (and narrowly nationalist commercial policies), adopt the same commodity as the monetary standard. When one thinks of the total potential creditor demands for gold for hoarding; in and after 1929, it seems almost beyond diabolical ingenuity to conceive a financial system better designed for our economic destruction. The anomaly of such a system is perhaps abundantly evident in the strong moral restraints and inhibitions which dissuade many people from exercising their legal rights under it. Given the vagaries of commercial, fiscal, banking, and currency policies in the various countries, and given the character of national financial structures and price rigidites, it is to the writer a source of continued amazement that so many people of insight should hold unwaveringly to the gold standard as the best foundation of national policies. The worship of gold, among obviously sophisticated people, seems explicable only in terms of our lack of success in formulating specifications for a satisfactory, independent national currency.…"[17]

Professors Keynes and Simons also were in basic agreement on the causes that generated the Great Depression. While Keynes lamented about the increase in liquidity and lack of investments, Simons deplored the sharp fall in velocity, which of course, are similar macro-economic phenomena. To Simons "aggregate turnover" needed stimulation, to Keynes it was "aggregate demand." But when it came to the appropriate policies to overcome the depression, Messrs. Simons and Keynes differed noisily. Keynes favored stimulation of investment by immediate government spending, while Simons advocated "definite rules of the game." He called upon government to provide a stable framework of rules for monetary authorities to follow. "In the past," Simons wrote, "governments have grossly neglected their positive responsibility of controlling the currency; private initiative has been allowed too much freedom in determining the character of our financial structure and in directing changes in the quantity of money and money substitutes." [18] To Professor Simons the rule of price-level stabilization appeared "extremely attractive" either as a definite reform or as a transition expedient toward ultimate stabilization of the quantity of money. But no matter what rule of the game was to be adopted ultimately "the power to issue money and near-money should increasingly be concentrated in the hands of the central government."[19] It is true, Professor Simons summarily rejected the numerous Keynesian schemes that require discretionary authority rather than "rules of the game." But in spite of his virulent opposition to the new economics he took great pains in keeping even greater distance from the economic principles "to which reactionaries would have us return." For these principles "are perhaps worse than none at all."[20]

The Simons student who has captured the imagination of scores of economists and legislators is MILTON FRIEDMAN. To do justice to such a colorful man who, through his tireless work and great force of persuasion set the agenda for most economic debates of the post-World War II era, is an impossible task. We must therefore limit ourselves, in the pages allotted to this article, to a few observations on his monetary thought. After a brief presentation of his views we would like to aim our observations at the essential differences between the monetary theories of the Chicago tradition, which Professor Friedman so brilliantly represents, and the subjective theories of the Austrian School of which Ludwig von Mises is its revered elder. For these differences are greater than the similarities, which we gladly acknowledge in so many other fields of economic analysis. Henry Simons clearly perceived the gap when he rejected the economic principles to which "reactionaries would have us return." It is true, Professor Friedman has rarely directed his critical pen at the literary efforts of subjective economists. His primary target has been the Keynesian orthodoxy that continues to rule the day. With massive empirical evidence he launched a many-pronged counterattack on the new economics and demonstrated the futility of its policies. Above all, he restored money to a position of importance, which Lord Keynes and his followers had denied it in theory and policy. He emphasized the power of monetary policy and questioned the Keynesian faith in fiscal policy. He reconstructed a version of the quantity theory of money, and then reinterpreted the Great Depression in the light of his theory.

Friedman's position is at apparent odds with that of his Keynesian adversaries. Despairing about unpredictable changes in money velocity they doubt the reliability of monetary policy. In contrast, Friedman postulates a satisfactory stability of velocity, that is, a stable demand for money as a stable function of a limited number of variables that can be specified reliably. Therefore, he concludes, monetary policy can be an important factor of economic stabilization.[21] To Professor Friedman the quantity theory is as valid now as it was in the past. "There is perhaps no other empirical relation in economics" he writes, "that has been observed to recur so uniformly under so wide a variety of circumstances as the relation between substantial changes over short periods in the stock of money and in prices; the one is invariably linked with the other and is in the same direction; this uniformity is, I suspect, of the same order as many of the uniformities that form the basis of the physical sciences."[22]

The problem of maintaining economic stability is far too complex to be left to fiscal finetuners. Therefore, Professor Friedman advocates a simple rule for steady monetary expansion, which could either be adopted by the Federal Reserve System itself, or be prescribed by Congress. For maximum price level stability he recommends a rate of increase of 3 to 5 percent per year for currency plus all commercial bank deposits. The particular rate of increase is less important than the adoption of a fixed rate that lies within this range. [23] It is the role of the monetary authorities to provide a stable monetary background that facilitates reasonable economic stability. Countercyclical actions as recommended by the Keynesians usually have destabilizing effects as "there is likely to be a lag between the need for action and government recognition of this need; a further lag between recognition of the need for action and the taking of action; and a still further lag between the action and its effects."[24] But there are also considerable time lags between monetary changes and their economic effects. According to Professor Friedman, "there is a connection which is, on the average, close but which may be quite variable in an individual episode. I have emphasized that the inability to pin down the lag means that there are lots of factors about which I am ignorant. That doesn't mean that money doesn't have a systematic influence. But it does mean that there is a good deal of variability in the influence."[25]

In fact, changes in the stock of money are mainly responsible for changes in money income, which characterize the business cycles. All major depressions from the 1870's to the 1930's are explained in terms of shrinking money stock. But while Professor Friedman presents massive statistical evidence he is reluctant to develop a precise business cycle theory that would explain the causal relationships. "It is one thing," according to Friedman, "to assert that monetary changes are the key to major movements in money income; it is quite a different thing to know in any detail what is the mechanism that links monetary change to economic change; how the influence of the one is transmitted to the other; what sectors of the economy will be affected first; what the time pattern of the impacts will be, and so on. We have great confidence in the first assertion. We have little confidence in our knowledge of the transmission mechanism, except in such broad and vague terms as to constitute little more than an impressionistic representation rather than an engineering blueprint."[26] But Professor Friedman is fully convinced that the Great Depression was the inevitable result of a sharp and unprecedented decline in the quantity of money, for which the Federal Reserve System bears the main responsibility. It failed to create the necessary bank reserves that would have maintained price level stability and economic prosperity. The Reserve System did nothing, or even raised its discount rate while hundreds of banks succumbed to bank runs and losses.[27]

One of the reasons for this deplorable failure of monetary authorities to create the needed reserves, according to Friedman, was their domination by "external forces," that is, by gold movements that dictated inaction or even contraction while the internal situation called for expansion. Therefore, national independence in monetary policy is desirable and should be achieved through immediate suspension of gold payments and freely floating exchange rates. Let the price of gold be determined in the free markets of the world, and not by costly "price support" measures on the part of the U.S. Government. If the free world were to adopt such a system, Professor Friedman assures us, the countries could enjoy independence of internal monetary policy and maximum international cooperation. [28]


Although our space does not permit us detailed discussions of epistemological differences, we cannot ignore the chasm that separates the Chicago School from the Austrian School in all matters of epistemology. For these differences leave their mark on many economic theories, in particular, monetary theory. The Chicagoans, and especially Professor Friedman, represent variants of logical positivism, while the Austrians view monetary knowledge in the light of a general theory of human knowledge, called praxeology. The Chicagoans like to don the white robe of scientists whenever they deal with economic phenomena. They are seeking knowledge of which experience is the content. Professor Friedman's "positive" economics comprises descriptions of economic reality, which hopefully provides the tools for predictions. Disagreements usually are not over ends-in-view, but over predictions regarding the effects of policies aiming at certain ends. They can be resolved by empirical evidence. [29] Austrian economists view economics in an entirely different light. To them it is a branch of praxeology which is purely theoretical and systematic. Its doctrines are not derived from experience, but are a priori like those of logic and mathematics, and antecedent to any comprehension of economic facts and events. Economics is not "quantitative" and does not measure human action because there are no constants in individual choice and preference. Austrian economists do not search for better technical methods of measurement because they realize its futility on ontological grounds. Statistical research into economic events offers interesting historical information on nonrepeatable data, but provides no knowledge that is valid universally. It does not afford the material of which economic theories are made, nor does it permit predictions of future events.[30]

To the Chicagoans the ultimate function of money is the measure of values. From Marshall to Friedman money has been criticized for its lack of stability, which frustrates accurate measurement and thereby precipitated grievous economic and social evils. Above all, monetary instability is held responsible for the business cycles that again and again have inflicted havoc on market economies. If only the price level could be stabilized and thus money be permitted to serve its true function! To the Austrians money is the most marketable good a person can acquire. It is never "idle," nor is it just "in circulation"; it is always in the possession or under the control of someone. The demand for money is subject to the same consideration as that for all other goods and services. People expend labor or forego the enjoyment of goods and services in order to acquire money. Thus individual demand and supply ultimately determine the purchasing power of money in the same way as they determine the mutual exchange ratios of all other goods. The quantity theory of money as understood by Austrian economists is merely another case of the general theory of demand and supply. They reject the quantity theory of the "monetarists" as a manifestation of holistic thought and a tool for government intervention.

It is true, the Chicagoans are familiar with the principles that determine individual prices. But their conclusions are drawn in the sphere of macro-economics in which the total money supply and a given velocity determine the price level. Here they call on government to take measures to stabilize the level and thus cure the business cycle. In this respect they are akin to the Keynesians who, too, seek stabilization through government manipulation. But while the Keynesians recommend compensatory fiscal policies the Chicagoans realize the futility of continuous finetuning and therefore seek long-term stabilization through a steady 3 to 5 percent expansion of the money supply. In the light of Austrian theory such an expansion of the stock of money would suffice to generate some malinvestments and maladjustments that later necessitate readjustments, that is, recessions. Professor Mises' trade cycle theory envisions economic booms and busts in every case of credit expansion, from one percent to hundreds of percent.

The magnitude of expansion does not negate its effects, it merely determines the severity of the maladjustment and necessary readjustment. Even if most prices should decline while monetary authorities expand credit at a modest rate the injection of fiduciary funds falsifies interest rates and thereby causes erroneous investment decisions. If by discretionary decision of the monetary authorities the expansion should be directed at certain industries, instead of being distributed widely over the loan market, the maladjustments would grow even more serious in the industries thus favored. In short, if the monetary authorities expand fiduciary credit and thereby lower interest rates, economic production is distorted. At first, it generates overinvestment in capital goods and causes their prices to rise while production of consumers' goods is necessarily neglected. But because of lack of real savings the investment boom is bound to run aground. The boom causes factor prices to rise, which are business costs. When profit margins finally falter, a recession develops in the capital goods industry. The recession is a period of readjustment, that is, the malinvestments are liquidated, and the long neglected consumer goods industries once again attract their proper share of resources in accordance with the true consumption-investment ratio.[31]

The monetarists actually have no business cycle theory, merely a prescription for government to "hold it steady." From Fisher to Friedman the antidote for depressions has always been the same: reinflation. The central banker who permits credit contraction is the culprit of it all. If there is a recession he must issue more money, and if there is inflation, that is, rising price levels, he must take some out. Professor Friedman himself seems to be aware of his lack of business cycle theory when he admits "little confidence in our knowledge of the transmission mechanism." He has no "engineering blueprint," merely an "impressionistic representation" that monetary changes are "the key to major movements in money income." His "gap hypothesis," therefore, is designed to fill the gap of theory and allow for the time it takes for maladjustments to be corrected. It endeavors to time the recession without explaining it.

And yet, the Chicagoans proclaim in loud voices that business recessions in general, and the Great Depression in particular, are the result of monetary contractions. Mistaking symptoms for causes they prescribe policies that would treat the symptoms. But the treatment, which is reinflation, tends to aggravate the maladjustments and delay the necessary readjustment. Thus, Chicagoan monetary policy, wherever practised, would not only prolong the recession but also cause many goods prices to rise throughout the recession. Austrian economists see the Great Depression in an entirely different light. They reject the simplicity of fiscalist and monetarist explanations and, instead, endeavor to analyze specific policies in the light of Austrian theory. In their view, the Great Depression was the inevitable outcome of a series of disastrous policies that first initiated the boom and later prolonged the depression. The first phase had its beginning in 1924 when the Federal Reserve System under the Coolidge Administration embarked upon massive credit expansion. During a short business decline the System decided to create some $500 million in new credit, which led to a bank credit expansion of some $4 billion in less than one year. The Federal Reserve System launched yet another burst in 1927 that lasted through 1928. Some $400 million in new Federal Reserve credit were created, discount rates reduced, and bank credit expansion invited. Consequently total currency outside banks, demand and time deposits in the United States increased from $44.71 billion at the end of June, 1924, to $53.4 billion in 1927, and $57.158 billion in October, 1929.[32] The United States Government thus was sowing the wind and the people were facing the economic whirlwind, which blows with the inevitability of inexorable economic law. The money and credit expansion by the Coolidge Administration made 1929 inevitable.

By 1930 the American economy had fallen in what today would be called a "recession." Under absence of new causes for depression the following year should have brought recovery through readjustment as it did in all other cycles before. What then precipitated the abysmal collapse that was to follow?

Following a long tradition of GOP hostility toward international trade the Hoover Administration began to curtail foreign imports. The Hawley-Smoot Tariff Act of June, 1930, raised American tariffs to unprecedented levels, which practically closed our borders to foreign goods. According to many economic historians, this was the crowning folly of the whole period from 1920 to 1933 and the beginning of the real depression. "Once we raised our tariffs," wrote Benjamin Anderson in his great treatise, "an irresistible movement all over the world to raise tariffs and to erect other trade barriers, including quotas, began. Protectionism ran wild over the world. Markets were cut off. Trade lines were narrowed. Unemployment in the export industries all over the world grew with great rapidity."[33] But this was not all. The Revenue Act of 1932 Doubled the income tax. It ordered the sharpest increase in federal tax burden in American history. Exemptions were lowered, "earned income credit" was eliminated. Normal tax rates were raised from a range of 1½%—5% to 4%—8%, surtax rates from 20% to a maximum of 55%. Corporation tax rates were boosted from 12% to 13¾% and 14½%. Estate taxes were raised and gift taxes imposed with rates from ¾% to 33½%. When state and local governments faced shrinking tax collections they, too, joined the federal government in imposing new levies. Murray Rothbard, in his authoritative work on AMERICA'S GREAT DEPRESSION estimates the enormous increase in the fiscal burden of government during the depression as follows: The federal costs rose from approximately 5% to 8% of Gross Private Product, and from 6% to 10% of Net Private Product. The state and local government burden rose from 9% to 16% of Gross Product, and from 10% to 19% of Net Product. Total government burden rose from 14.3% to 24.8% of Gross Product, and from 15.7% to 28.9% of Net Product.[34] In short, the burden of government nearly doubled during the depression, which alone would bring any economy to its knees.

During the Roosevelt New Deal internal regimentation triumphed over freedom. Like Hoover before him, Roosevelt wanted the federal government in the driver's seat. He was not content with clearing away the economic barriers which his predecessor had erected. Instead, he untiringly built his own, such as, a sweeping industrial reorganization by the National Industrial Recovery Act, higher income taxes, estate taxes, business taxes, the Wagner Act that revolutionized American labor relations, the Wages and Hours Act that greatly reduced labor productivity and raised labor costs, plus countless regulations and restrictions. The American economy thus would not recover from the abyss of depression into which it was first cast by the radical intervention of Republican administrations and then kept lingering by the Democratic New Deal. Individual enterprise, this mainspring of economic improvement, just did not have a chance.

In historical understanding as well as scientific method, theory, and policy the Chicago and Austrian Schools are worlds apart. To the Chicagoans money is a product of government, created and managed according to some rule of the game arrived at by political process. To Austrian economists money is a marketable commodity, such as gold or silver, that has become a widely accepted medium of exchange. It is a product of trade voluntarily entered upon by individuals. Banknotes and demand deposits are merely substitutes that receive their value from the money proper. These economists deplore the seizure of commodity money by government and its replacement by fiat money which is characterized by rapid inflation and depreciation. They advocate the orthodox gold standard because it makes the value of money independent of government as the quantity of gold in existence is independent of the wishes and manipulations of government officials and politicians, parties and pressure groups.

The monetarists are unanimous in their condemnation of the gold standard. But while they argue for government fiat "on purely scientific grounds," they pay lip service to monetary freedom. Professor Friedman would not deny us the freedom to buy, hold, and use gold in all economic exchanges, but paradoxically he would also impose a fiat standard. He seems to be unaware that monetary freedom would soon give birth to a "parallel standard" that permits individuals to make "gold contracts" and "gold clauses" calling for payment of measures of gold. Thus individual freedom alone, needing no reform law, no conversion or parity, no rule of the game, would lead us back to the gold standard as free individuals would prefer gold over government paper.[35]

Under the steadily growing influence of Chicagoan monetary thought the U.S. Government may some day soon remove the last vestiges of the gold-exchange standard. Both the fiscalists and monetarists would rejoice about this triumph of fiat money over gold. But to Austrian economists such a step would merely divide the free world into currency blocs and invite more inflation and depreciation. It would merely be another chapter in the age-old struggle between monetary freedom and governmental control.


[2] Ibid., p. 104
[3] Cf. also "An Ideally Perfect System of Currency" in INVESTIGATIONS IN CURRENCY AND FINANCE, pp. 297-302; "The Variation of Prices and the Value of the Currency Since 1782," ibid., pp. 120 ff.
[4] OFFICIAL PAPERS (London: Macmillan & Co., 1926) for the Royal Economic Socity, pp. 10-12; Also MONEY, CREDIT AND COMMERCE (N.Y.: Augustus M. Kelley reprint, 1923) p. 36. According to Marshall, "An official index number, representing average movements of the prices of important commodities, might well afford the basis for a Unit of general purchasing power, in terms of which long-period obligations might be expressed: and in this matter the State might advantageously lead. The Unit would be derived from an official price list by adding together the prices of certain quantities of wheat, barley, oats, hops, beef, mutton, tea, coffee; together with staple timbers, minerals, textile materials and fabrics and so on. A new contract for interest on loans and other longstanding obligations might then be arranged by free consent of both parties to it in terms of the standard unit, instead of money."
[5] MONEY, CREDIT, AND COMMERCE, p. 43 et seq. his theory was later put into the form of a quantitative equation by Professor Pigou in QUARTERLY JOURNAL OF ECO ECONOMICS, Vol. XXXII, Nov., 1917 1917.

[6] THE GOLD STANDARD IN THEORY & PRACTICE (London: Longmans, Green & Co., Ltd., 1939, 4th ed.) pp. 101, 102, 121, 122; cf. also CURRENCY AND CREDIT (London: Longmans, Green & Co., Ltd., 1927, 3rd ed.) pp. 156 et seq.; MONETARY RECONSTRUCTION (London: Longmans, Green & Co., Ltd., 1926, 2nd ed.) p. 156; TRADE AND CREDIT, (London: Longmans, Green & Co., Ltd., 1928) p. 82 et seq.
[7] THE ART OF CENTRAL BANKING (London: Longmans, Green & Co., Ltd., 1932) pp. 446 et seq.
[8] A CENTURY OF BANK RATE (New York: Augustus M. Kelley, 1962, 2nd ed.) p. xxi.
[9] MASTERING THE CRISIS (London: George Allen & Unwin, Ltd., 1934) p. 21.
[10] INFLATION (London: George Allen & Unwin, Ltd., 1934) p. 91.

[11] MASTERING THE CRISIS, p. 37. Professor Fisher apparently applied this version of trade cycle theory to his own financial transactions. He was caught unaware of the 1929 stock market crash and remained bullish throughout the decline. Although he enjoyed great reputation as an economic forecaster he failed to foresee the depression and therefore lost his sizeable fortune. Cf. Irving N. Fisher, MY FATHER, IRVING FISHER (N.Y.: Comet Press, 1956). According to his son, "the 1929 stock market crash caught him unawares. Placing his faith unreservedly in the 'new economic era' he did not foresee that it was destined to collapse like a house of cards." p. 242. Between 1929 and 1933 Fisher lost an eight to ten million dollar fortune which he had pyramided on his wife's blue-chip inheritance and was left with an ultimate debt of three-quarters of a million dollars to his aunt. A committee of a lawyer and two nephews finally handled his intricate debt relationship. pp. 264-267.
[12] INFLATION, p. 80.
[13] STABILIZED MONEY, ibid., pp. 259-262.
[14] 100% MONEY (N.Y.: Adelphi, 1935) pp. 8-9.
[15] according to Simons, "attempting mischievous and salutory irritation of his peers…he (Keynes) may only succeed in becoming an academic idol of our worst cranks and charlatans—not to mention the possibilities of the book as the economic bible of a fascist movement." Cf. "Keynes' Comments on Money," CHRISTIAN CENTURY, July 22, 1936, pp. 1016, 1017.

[16] See Milton Friedman, "The Monetary Theory and Policy of Henry Simons," JOURNAL OF LAW & ECONOMICS, Vol. X, Oct. 1967, pp. 1-13.
[17] ECONOMIC POLICY FOR A FREE SOCIETY (Chicago: The Univ. of Chicago Press, 1948) p. 168.
[18] ECONOMIC POLICY, pp. 161, 162.
[19] Ibid,. p. 180.
[20] Ibid,. p. 176.

[21] Milton Friedman & David Meiselman, "The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897-1958," STABILIZATION POLICIES (The Commission on Money and Credit, Prentice-Hall, Inc., 1963). Also Milton Friedman, "A Monetary and Fiscal Framework for Monetary Stability," AMERICAN ECONOMIC REVIEW, June 1948, reprinted in ESSAYS IN POSITIVE ECONOMICS (Chicago: Univ. of Chicago Press, 1953) pp. 133-156 and "Has Fiscal Policy Been Oversold?" MONETARY VS. FISCAL POLICY, A Dialogue between Milton Friedman and Walter W. Heller (New York: W. W. Norton & Co., 1969) pp. 43-62, 71-80.
[22] STUDIES IN THE QUANTITY THEORY OF MONEY (Chicago: Univ. of Chicago Press, 1956) pp. 20-21.
[23] A PROGRAM FOR MONETARY STABILITY (Chicago: Univ. of Chicago Press, 1953) p. 91.
[24] ESSAYS IN POSITIVE ECONOMICS (Chicago: Univ. of Chicago Press, 1953) p. 315.
[25] MONETARY VS. FISCAL POLICY, ibid., p. 76. For further details on his lags hypothesis cr. ESSAYS IN POSITIVE ECONOMICS, ibid., pp. 133-156.

[26] THE OPTIMUM QUANTITY OF MONEY AND OTHER ESSAYS (Chicago: Aldine Publishing Co., 1969) p. 222.
[27] Milton Friedman & Anna J. Schwartz. A MONETARY HISTORY OF THE UNITED STATES, 1867-1960 (National Bureau of Economic Research, Princeton University Press, 1963) p. 300.
[28] "The Case for Flexible Exchange Rates," in ESSAYS IN POSITIVE ECONOMICS, ibid., p. 157-203; also si, A PROGRAM FOR MONETARY STABILITY, ibid., pp. 81-101.
[29] Milton Friedman, "The Methodology of Positive Economics," in POSITIVE ECONOMICS, ibid., pp. 3-43.
[30] Ludwig von Mises, HUMAN ACTION (New Haven: Yale University Press, 1949) p. 30 et seq.; also his THEORY AND HISTORY (New Haven: Yale University Press, 1957) p. 240 et seq.; EPISTEMOLOGICAL PROBLEMS OF ECONOMICS (Princeton, N.J.: D. Van Nostrand Co. 1960); THE ULTIMATE FOUNDATION OF ECONOMIC SCIENCE (Princeton, N.J.: D. Van Nostrand Co., 1962); Friedrich A. Hayek, THE COUNTER-REVOLUTION OF SCIENCE (Glencoe, III.: Free Press, 1952).

[31] Cf. Ludwig von Mises, THE THEORY OF MONEY AND CREDIT (first German edition in 1912; English ed. New Haven: Yale University Press, 1953) p. 365 et seq.; also HUMAN ACTION, ibid., p. 535 et seq.; also F.A. Hayek, MONETARY THEORY AND THE TRADE CYCLE (first German edition in 1929; English ed. A.M. Kelley, 1966); PROFITS, INTEREST AND INVESTMENT (London: G. Routledge and Sons, 1939).
[32] Milton Friedman & Anne J. Schwartz, A MONETARY HISTORY OF THE UNITED STATES, 1867-1960, ibid., pp. 711, 712.
[33] ECONOMICS AND THE PUBLIC WELFARE (Princeton, N.J.: D. Van Nostrand, 1949) p. 225.
[34] AMERICA'S GREAT DEPRESSION (Princeton, N.J.: D. Van Nostrand, 1963) p. 303.
[35] Cf. Hans F. Sennholz, INFLATION OR GOLD STANDARD (Lansing, Mich.: Constitutional Alliance, 1970).