Austrian Politics at the Onset of the Gold-Exchange Standard

The establishment of the Institut and the beginning of Mises's liaison with the Rockefeller Foundation coincided with a fundamental change of the business environment in Austria. The Geneva Protocols of October 1922 and the simultaneous currency reform had eliminated the government's financial disasters, but came at the price of Austria's sovereignty. Inflation continued but at a much lower pace, while unemployment soared from 49,000 in 1922 to 150,000 in 1925. Red Vienna and other socialist municipalities grew larger with the help of foreign loans. Business expanded too, especially because the financial and industrial community in Vienna had successfully renewed its prewar ties with other regions of the former Austro-Hungarian Empire. The wounds the war had left in the social fabric of Central Europe seemed to be healing. The quiet growth began to leave its mark on Austrian psychology. Many now believed that the country was destined to act as intermediary between East and West. Optimism and wishful thinking combined in extrapolating the debt-financed expansion into an indefinite future.

These fantasies were crushed by the establishment of the gold exchange standard in 1925. The new monetary system stimulated the international division of labor and brought greater growth to all participating countries. But it also exposed mercilessly the limits of their interventionist governments.²⁸ International competition drove down prices, and while the consumers rejoiced, firms found it nearly impossible to cut costs accordingly because of labor-union power and entrenched economic regulations.

The inflation of the early 1920s reduced the harm done by labor unions and regulations because rising costs were paired with rising prices. But with the return to an international gold standard in 1925 sales prices stabilized and even decreased, while there was still no downward flexibility on the cost of labor. Doing business in Austria became ever more difficult and discouraging. Industrial firms found it harder to raise new funds through equity capital or bonds. Labor unions, local politicians, and newspapers began pressuring the banks to fill the gap. They “had to fulfill an economic duty” of bailing out “the threatened firms during bad times.”²⁹

This was the context in which Mises wrote and spoke during the second half of the 1920s on monetary problems and public finance. Shortly after the creation of the Institut, he gave a widely publicized public address on the consequences of Austria's interventionist policies.³⁰ Mises argued that, after a year of doing business under the gold standard, the time had come for a sober analysis of the impact of Austrian economic policies. The effects of inflation on business accounting had been exhausted and the new gold-denominated balance sheets provided a more realistic picture of the state of the economy. The past policies had not merely taxed the income streams of business, but had actually eaten up their capital.³¹

Mises demanded an immediate reduction of taxes and of the companies' contributions to the government's social insurance schemes. He also called for the privatization of public firms such as postal savings offices, railroads, postal and telegram services, forestry, and coal and steel firms, arguing that their deficits amounted to more than 170 million schillings, which was more than the federal government's 1927 budget deficit of 135 million schillings.³² This calamity, Mises argued, was the inevitable result of two entirely incorrect principles of public finance: that (1) public expenditure comes first, and public income follows public expenditure; and (2) taxation of capital and private enterprise does not affect the broad masses of the people.

The proposal to privatize the deficit-prone public firms was a slap in the face of the statists in all parties. The main bastion of statism was Otto Bauer's socialist party, and one of their preferred means of political “persuasion” was the open threat of violent insurrection. A few months after Mises's talk, however, the credibility of those threats received a serious setback in a showdown between the socialists and the Vienna police. The event occurred in the wake of a questionable court decision that had, in the socialists' view, been slanted in favor of a political right-winger. The socialists now called for a general strike and demonstrations on Friday July 15, 1927. To the government, this was a thinly disguised attempt at its overthrow.³³ When the crowd gathered in front of the palace that hosted the department of justice, someone set the building on fire and the police stepped in immediately. In the resulting carnage, ninety demonstrators were killed even before the army arrived. Mises commented in a private letter to a former student in Paris:

Friday's putsch has cleansed the atmosphere like a thunderstorm. The social-democratic party has used all means of power and yet lost the game. The street fight ended in complete victory of the police.... All troops are loyal to the government.

The general strike has collapsed and the leaders of the social democrats then had to cancel it.

The threats by which the social-democratic party has up to now permanently tried to bully the government and the public have proved to be far less dangerous than one had believed.³⁴

The failure of the general strike and the accompanying massacre also had an unexpected personal impact on Mises's life, as we will see at the end of the present chapter.