5 First Writings on the Theory of Money

Karl Helfferich, in his 1903 book, Das Geld, asserted that the theory of marginal utility had failed to solve the problem of money value. I wanted to investigate the validity of this objection. In 1906 I began addressing the problems of money and banking, zealously studying the great theoretical works as well as the history of currencies in European countries, the United States, and British India. I sought to negotiate my way through an abundance of literature.

My first effort appeared in volume XVI of the Zeitschrift für Volkswirtschaft, Sozialpolitik und Verwaltung, under the title “Die Wirtschaftspolitischen Motive der Österreichischen Valutaregulierung.”¹

In the fall of 1908, Edgeworth² asked Philippovich³ if he wanted to write a short essay for the Economic Journal. It was to be no more than ten pages in length, and was to be a comprehensive look at the foreign-exchange policy of the Österreichisch-Ungarischen Bank.⁴ Philippovich turned down the offer, but recommended me. I accepted, but decided to complete a full treatment of the subject in the German language as well. The resulting essay, “Das Problem gesetzlicher Aufnahme der Barzahlung in Österreich-Ungarn,”⁵ appeared in Schmoller’s Jahrbuch of 1909 and provoked strident protest from the most powerful members of the Austrian inflation party.

Ideas I pondered during the period in which I was writing these essays had already led me to a realization of the greatest failings of the prevailing monetary theory. I was convinced of the lack of validity of the balance-of-payments theory and the doctrine of “elasticity” of bank credit, but brief essays dealing with problems found in economic history and policy offer little opportunity for analysis of such large questions. I would have to save these efforts for the theoretical work I had planned for later, and, for the time being, maneuver within the framework of more widely accepted views.

I’ve chosen at this writing to bypass my critique of Knapp’s treatment of the foreign exchange policies of central banks. Although admired by everyone in Germany and Eastern Europe during their day, his teachings have long been forgotten. But anyone who studies the general decline of German thought, and in particular, that of German economic thought will find the most remarkable and psychologically interesting problems in those parts of Knapp’s teachings that I criticize in the sixth part of my essay on cash payments. Knapp spoke of losses, for example, that the central bank suffered through foreign-exchange policy, and urged the state to reimburse the bank for these losses. One look at the bank’s balance sheets and income statements could have shown him that foreign exchange transactions yielded the bank considerable profits, and that the state was in part responsible for these gains.

My essay dealt with the question of the legal requirement demanding the redemption of the Austro-Hungarian central bank’s gold notes. For many years and without hesitation or discrimination, the bank had met all demands for foreign exchange at a rate that in no case exceeded the lawful gold parity of the crown by more than a margin. In gold-standard countries this is referred to as the upper gold point. In essence, gold payments in Austria-Hungary had resumed de facto. Under discussion now was whether this de facto situation should be made a legal requirement. One argument for the change was the more favorable conditions under which foreign markets would grant loans in Austrian currency, if gold payments for notes were independent of the bank’s discretion. This position was championed in Hungary, especially, where the dismissive attitude of bank officials in some Austrian circles was seen as an effort to make Hungary dependent on Viennese money markets, and to make it impossible for it to tap cheaper money sources in other western countries. There were no cogent arguments against the legalization of the de facto situation.

Those opposed to the legally required resumption of gold payments had crafted an untenable theory to support their point of view. They argued that a bank that is legally obligated to make gold payments must adjust its rates to conform to the prevailing rate in the world market. They claimed that the Austro-Hungarian Bank found itself in a more favorable position due to the circumstances of not being obliged to make gold payments. The bank was in a position to differentiate between legitimate and illegitimate demand. Demand was said to be illegitimate if it aimed at shifting funds abroad in order to take advantage of higher interest rates abroad. The bank ought not consider this illegitimate interest-rate arbitrage, and only satisfy legitimate demand. In this way it could avoid, or at least postpone, the raising of rates made inevitable by mandatory redemption.

This doctrine was completely erroneous. The bank had never distinguished between legitimate and illegitimate demand; it had met all demands for payment since 1900. Had it gone ahead in the manner prescribed by those opposed to mandatory payments, all arbitrage speculators denied payment would have sought to buy foreign exchange in the open market. This would have raised the exchange rate and depreciated Austrian currency.

This doctrine was neither new nor uniquely Austrian. It was the old fallacy expounded by proponents of the French gold-premium policy fifteen or twenty years earlier. But these proponents never argued that such a policy would cause exchange rates to rise. They recommended this policy for France, one of the great exporters of capital at the time, and not for import countries such as Austria-Hungary. For a debtor country to loosen its relationship with foreign money markets would lead to an increase in the cost of its credits, not a reduction.

I had just completed my essay when I was surprised by an invitation from the vice president of the bank. I called on Mr. Waldmayer in his office. He said that he had heard from Professor Landesberger that I was in need of material for a study of bank policy, and that he would make it available to me. Of course I would be required to show my work to bank officials before it could go to press. I declined, politely, but decidedly. At the time I was not acquainted with Professor Landesberger, but knew that he was a good friend of Philippovich; I could only guess that Philippovich had granted him a look at my essay, or had told him of its contents.

From the conversation I had with Mr. Waldmayer, I was given the impression that bank management was especially interested in upholding existing conditions. This I could not understand. I knew that a mandatory gold payment would curtail the bank’s right to invest some reserves in foreign accounts and obligations yielding interest, and that this would reduce the bank’s gross returns. This would cause difficulty for stockholders above all, and for the two countries sharing in the bank’s returns. Through appropriate changes to tax law, the secretaries of both treasuries would have seen to it that the greatest loss would have fallen on the stockholders. The interest of stockholders was represented by no one, least of all by the bank management, who had been appointed by the two governments. When I left Mr. Waldmayer’s office I sensed that I would have been offered a considerable sum of money had I only been less dismissive. The bank maintained a press fund for such purposes.

It was many years later that an explanation was granted to me. In 1912, when I published an article on the fourth renewal of the bank’s privileges, and was again attacked by the opponents of gold payments, Böhm-Bawerk instructed me in the causes of the bank’s resistance. A portion of the proceeds from the obligations invested abroad, he reported, was credited to a special, secret account, which was at the disposal of the bank’s governor alone. Already highly compensated bank officials, government officials who supervised the bank, journalists, politicians, and others received attractive payments from this secret fund on occasion. Böhm-Bawerk had learned about the fund by chance when the Hungarian finance minister complained that the share going to Austrians was too large compared to that going to Hungarians. The whole affair pained him to the highest degree, and caused him to loathe his position as well any other within the administration. But his wish to put and end to the antics was resisted by the Hungarian finance minister. “I feel obligated to make these facts known to you, in order that you may understand the background of the current struggle,” Böhm remarked to me. I had to promise him that I would remain silent about the matter unless I should hear about it from other sources. I’ve remained silent until today, although the former press secretary of the bank told me most openly about the use of the fund a few years after the war. The actual amounts were more modest than those of Bismarck’s famed Reptilienfonds.⁶ They were nevertheless ample enough to explain strong opposition on the part of the bank’s management and others to a reform that would have caused the source of the fund to run dry.

The strongest attacks against my argument came from Walther Federn, the publisher of a weekly economic journal, the Österreichischen Volkswirt.⁷ Federn had held many lesser positions in banks, and had become the stock exchange reporter for various papers. He had been publishing the Volkswirt for some years, as it was financed by a bank director friend of his who went by the name of Rosenbaum. Federn was ignorant of economics, and with the exception of Knapp’s Staatliche Theorie des Geldes, had never read a book on the subject. He possessed limited knowledge of economic conditions and statistics, and was wholly uncritical and incapable of independent thought. Though he himself was considered intellectually inept, his flowing style received praise. The principal source of revenue for his paper, which at the time had few subscribers, were the cash contributions which banks and large corporations paid newspapers and weekly and monthly journals for running advertisements, income statements, balance sheets, and announcements of stockholder meetings. No special conditions were attached to the granting of these sums. Publishers naturally feared an interruption of further contributions on the part of concerns against which they had launched particularly nasty attacks, but moderate criticism of such enterprise was permissible.

It was not these contributions that robbed Viennese economic journalism of its independence. It was ignorance that fettered journalists. The great age of Viennese economic journalism had long since passed. That group of outstanding economists who had collaborated from 1860 to 1900—Menger among them—found no worthy heirs. The editorial staffs of the Der Neue Freie Presse and the Neues Wiener Tagblatt were the only ones composed of economists exhibiting knowledge and intellectual power. Other editors were ignorant and could not think; they depended on information coming from interested parties. Stock exchange reporters received their information from stock exchange men from the big banks. When a government regulation was passed or important business was transacted, journalists would rush to the responsible government officials or concerned business parties. The information the journalists received from them was then passed on to the public. The government did not need to bribe journalists; it was enough to merely inform them. Journalists feared nothing more than being made privy to information one day later than another member of the press. To avoid this plight, they were always prepared to represent the government’s point of view. Their ignorance of economics afforded them the advantage of being able to proceed in a manner void of sacrificium intellectus.⁸

Federn had received a brushing up on the problems of foreign exchange by bank officials about two years before the publication of my essay; he published what he had learned in several articles in Viennese newspapers and in the Frankfurter Zeitung. He was very proud of his work, and considered it a great journalistic achievement. My critique bruised his vanity. The fanatical intensity of his attacks had to do with this fact above all. Naturally, his desire to please bank officials and the treasury also played a role. Federn did not propagate the bank’s position because of the sums it was paying to him, however. I am convinced as well that he did not know that such subsidies were coming from a secret fund that would have been placed into jeopardy by the legalization of gold payments. Individual beneficiaries could receive bank moneys in good faith: the bank also used funds derived from open revenues. Those who did not know the total amount spent on the press and other protected parties could assume that the endowment of the press fund was legal.

When Böhm-Bawerk revealed to me the secret of the bank’s special fund, I was faced with a new problem. At this point I had been established, so to speak, for many years. I had worked in the treasury and in the office of the public prosecutor for many months; I had worked in the court for two years, and had been with the Handelskammer since 1909. I recognized the corruption that is an inevitable concomitant of interventionism; I knew very well that it extended to the highest positions of the state. But it was the first time that I faced opponents whose motives were not objective within the context of a scientific exchange. After long and in-depth consideration of what position I best take, I at last arrived at a clear response.

The economist must deal with doctrines, and not with men. It is for him to critique errant doctrine; it is not his charge to uncover the personal motives behind heterodoxy. The economist must face his opponents under the fictitious assumption that they are guided by objective considerations alone. It is irrelevant whether the advocate of a false notion acts in good or bad faith; what matters is if the stated notion is true or false. It is the charge of others to reveal corruption and enlighten the public concerning the same.

I have held fast to these principles throughout my life. Though I have known much, if not all, about the corruption of the interventionists and socialists with whom I have had to deal, I have never made use of this information. My point of view has not always been understood. Being the subject of the less than tasteful attacks of the Viennese Social Democrats, people have supplied me with ample material on the corrupt practices of these socialist leaders. Yet even without the help of informers I was well schooled in the moral decadence of the party; the materials passed on to me would not have been necessary had I wanted to occupy myself with the business of disclosure. The fact of my having graciously declined offers to prove fraud and embezzlement on the part of my opponents, admissible in courts of law, has often stirred resentment.

In the winter of 1912–1913, in the midst of the crisis created by the Balkan War, the Austro-Hungarian bank did indeed make an attempt to allow a portion of the demand for foreign exchange to remain unmet. The natural outcome of this was an increased demand on the open market and a climb in foreign exchange rates. The bank had to return at once to its former policy of unlimited and unconditional sale of foreign exchange. The bank imagined its operation of increasing just slightly the rate at which it was willing to sell to be an especially clever one. But all this action reaped was a decline in confidence in Austrian currency and the withdrawal of sizeable sums of foreign short-term money invested in Austria.

The intended goal of inflationists was the reduction of the purchasing power of the Austrian crown relative to gold, foreign exchange, and international economic goods. This was readily acknowledged by intelligent opponents of gold payment, such as Professor Landesberger and Richard Riedl, chairman of the Commerce Department’s tariff division. Only a mental midget like Federn could believe that a refusal of note redemption would not affect the stability of exchange rates. Inflationists welcomed a small devaluation of the crown as a first step on a path that they considered to be a good one. Their one regret was that the bank returned to a policy of unconditional redemption in gold. They were not incorrect in considering the bank’s retreat a result of my influence.

Naturally I was fully aware that public opinion in Austria was in favor of inflationism, and that aside from me there were few who supported a policy of stable exchange rates. The minister of finance at the time, Count Zaleski, was a Pole who had received his appointment on purely political grounds. He freely admitted to never before having dealt with financial problems. “Members of the Polish Club told me that a rise in foreign exchange rates must be seen as a favorable rather than unfavorable phenomenon,” Zaleski explained to me in a conversation that took place in the home of a mutual friend. “For agriculture,” he went on, “a ten-percent rise would be a direct blessing.”

This blessing would soon come in good measure.