The Causes of the Economic Crisis and Other Essays Before and After the Great Depression

1. Victory and Inflation

No one can any longer maintain seriously that the rate of exchange for the German paper mark could be reestablished [in 1923] at its old gold value—as specified by the legislation of December 4, 1871, and by the coinage law of July 9, 1873. Yet many still resist the proposal to stabilize the gold value of the mark at the currently low rate. Rather vague considerations of national pride are often marshaled against it. Deluded by false ideas as to the causes of monetary depreciation, people have been in the habit of looking on a country’s currency as if it were the capital stock of the fatherland and of the government. People believe that a low exchange rate for the mark is a reflection of an unfavorable judgment as to the political and economic situation in Germany. They do not understand that monetary value is affected only by changes in the relation between the demand for, and quantity of, money and the prevailing opinion with respect to expected changes in that relationship, including those produced by governmental monetary policies.

During the course of the war, it was said that “the currency of the victor” would turn out to be the best. But war and defeat on the field of battle can only influence the formation of monetary value indirectly. It is generally expected that a victorious government will be able to stop the use of the printing press sooner. The victorious government will find it easier both to restrict its expenditures and to obtain credit. This same interpretation would also argue that the rate of exchange of the defeated country would become more favorable as the prospects for peace improved. The values of both the German mark and the Austrian crown rose in October 1918. It was thought that a halt to the inflation could be expected even in Germany and Austria, but obviously this expectation was not fulfilled.

History shows that the foreign exchange value of the “victor’s money” may also be very low. Seldom has there been a more brilliant victory than that finally won by the American rebels under Washington’s leadership over the British forces. Yet the American money did not benefit as a result. The more proudly the Star Spangled Banner was raised, the lower the exchange rate fell for the “Continentals,” as the paper notes issued by the rebellious states were called. Then, just as the rebels’ victory was finally won, these “Continentals” became completely worthless. A short time later, a similar situation arose in France. In spite of the victory achieved by the Revolutionists, the agio [premium] for the metal rose higher and higher until finally, in 1796, the value of the paper monetary unit went to zero. In each case, the victorious government pursued inflation to the end.

2. Establishing Gold “Ratio”

It is completely wrong to look on “devaluation” as governmental bankruptcy. Stabilization of the present depressed monetary value, even if considered only with respect to its effect on the existing debts, is something very different from governmental bankruptcy. It is both more and, at the same time, less than governmental bankruptcy. It is more than governmental bankruptcy to the extent that it affects not only public debts, but also all private debts. It is less than governmental bankruptcy to the extent that it affects only the government’s outstanding debts payable in paper money, while leaving undisturbed its obligations payable in hard money or foreign currency. Then too, monetary stabilization brings with it no change in the relationships among contracting parties, with respect to paper money debts already contracted without any assurance of an increase in the value of the money.

To compensate the owners of claims to marks for the losses suffered, between 1914 and 1923, calls for something other than raising the mark’s exchange rate. Debts originating during this period would have to be converted by law into obligations payable in old gold marks according to the mark’s value at the time each obligation was contracted. It is extremely doubtful if the desired goal could be attained even by this means. The present title-holders to claims are not always the same ones who have borne the loss. The bulk of claims outstanding are represented by securities payable to the bearer and a considerable portion of all other claims have changed hands in the course of the years. When it comes to determining the currency profits and losses over the years, accounting methods are presented with tremendous obstacles by the technology of trade and the legal structure of business.

The effects of changes in general economic conditions on commerce, especially those of every cash-induced change in monetary value, and every increase in its purchasing power, militate against trying to raise the value of the monetary unit before [redefining and] stabilizing it in terms of gold. The value of the monetary unit should be [legally defined and] stabilized in terms of gold at the rate (ratio) which prevails at the moment.

As long as monetary depreciation is still going on, it is obviously impossible to speak of a specific “rate” for the value of money. For changes in the value of the monetary unit do not affect all goods and services throughout the whole economy at the same time and to the same extent. These changes in monetary value necessarily work themselves out irregularly and step-by-step. It is generally recognized that in the short, or even the longer run, a discrepancy may exist between the value of the monetary unit, as expressed in the quotation for various foreign currencies, and its purchasing power in goods and services on the domestic market.

The quotations on the Bourse for foreign exchange always reflect speculative rates in the light of the currently evolving, but not yet consummated, change in the purchasing power of the monetary unit. However, the monetary depreciation, at an early stage of its gradual evolution, has already had its full impact on foreign exchange rates before it is fully expressed in the prices of all domestic goods and services. This lag in commodity prices, behind the rise of the foreign exchange rates, is of limited duration. In the last analysis, the foreign exchange rates are determined by nothing more than the anticipated future purchasing power attributed to a unit of each currency. The foreign exchange rates must be established at such heights that the purchasing power of the monetary unit remains the same, whether it is used to buy commodities directly, or whether it is first used to acquire another currency with which to buy the commodities. In the long run the rate cannot deviate from the ratio determined by its purchasing power. This ratio is known as the “natural” or “static” rate.16

In order to stabilize the value of a monetary unit at its present value, the decline in monetary value must first be brought to a stop. The value of the monetary unit in terms of gold must first attain some stability. Only then can the relationship of the monetary unit to gold be given any lasting status. First of all, as pointed out above, the progress of inflation must be blocked by halting any further increase in the issue of notes. Then one must wait a while until after foreign exchange quotations and commodity prices, which will fluctuate for a time, have become adjusted. As has already been explained, this adjustment would come about not only through an increase in commodity prices but also, to some extent, with a drop in the foreign exchange rate.17

• 16[Mises later came to prefer the term “final rate” or the rate that would prevail if a “final state of rest,” reflecting the final effects of all changes already initiated, were actually reached. See Human Action, chapter XIV, section 5.—Ed.]
• 17[For a later elaboration of this position, see Mises’s “Monetary Reconstruction,” epilogue to the 1953 (and later) editions of The Theory of Money and Credit.—Ed.]