1. Introductory: Cycles in Monetary Theory and Policy

If the luck of a monetary theorist is to be measured by the variety of things he has experienced during his lifetime, then, indeed, I must be considered fortunate, for I lived through times of the widest changes in the monetary field: from the relative stability of the era before 1914, through the inflationism of World War I and the more violent excesses of inflation that followed; through the deep and stubborn deflationism from 1929 onwards, then through the ups and downs of the thirties; and finally the mounting inflation of the recent decade, that has gripped the whole world and has again in parts of Europe and in the Orient passed beyond the limits of control. Throughout most of these periods monetary theorists, by and large, were engaged in rationalizing, justifying and defending the excesses of those responsible for monetary policy. My situation, on the other hand, was often that of a Cassandra who saw the ominous implications of what the majority of theorists considered harmless or even beneficial.

I have attempted to counter to the best of my ability the noxious extremes to which monetary policy and theory seem to swing, pendulum-like, as if subject to a historical law. My first publication, the Volkswirtschaftliche Theorie des Bankkredits,¹ it is true, was an inflationary book in an inflationary time; it was understandable, however, as a reaction against the hyper-classicism of prevailing theory in which the effects on the economy of manipulation of money and credit were entirely ignored. It is, to my present way of thinking, a typical soft money book and I attribute its success mainly to the fact that any soft money book—any book that promises prosperity by the relatively easy means of monetary manipulations—is eagerly taken up by readers who have recently witnessed the beneficial effects of inflation in its first phases.

Monetary policy, abandoning conservatism with the beginning of World War I, became extremely inflationary in Europe from about 1920 on; and monetary theorists—laying the blame for the depreciation of the currency to deficits in the balance of payments rather than to inflation—lent support to the prevailing policy. The aim of the articles I wrote during this period was chiefly to combat the inflationary policy of the German Reichsbank and its underlying philosophy. These articles were published in 1924 under the title Geld und Kredit.

In articles covering the stabilization and post-stabilization periods I pointed out what I considered the shortcomings of the policy of the Reichsbank under Schacht’s first presidency. They were assembled in 1929 under the title Geld und Kredit, Neue Folge. The reader who is interested in these two books will find their contents listed in Appendices IV and V.

When in 1929 practice and theory again became deflationary in most countries, and especially in Germany, my fight was directed against deflationism, particularly of the Bruening-Luther brand which, I was convinced, would undermine the economy to the breaking point. The Nazi revolution was, in my opinion, largely the inevitable result of the deflationary policy of the last pre-Hitler government. By lectures and articles in daily papers, notably the Frankfurter Zeitung, and in journals, I tried in vain to combat this policy. Of longer articles that were published separately, 1st Arbeitslosigkeit unvermeidlich? (Is Unemployment Unavoidable?) and Kredit und Krise (Credit and Crisis) may be mentioned.² Like that of all similar endeavors, their effect was frustrated by the strongly anti-inflationary editorial attitude of the influential Frankfurter Zeitung and the Deutsche Volkswirt which, even after the pound sterling had been devaluated, saw in every monetary adjustment an attack on the value of the mark and persistently warned against what they called unzulässige Währungsexperimente (inadmissible currency experiments). As occurs all too frequently, the people, politicians, and economists had forgotten the past and were solely under the impression of the immediately preceding experience—the hyper-inflation of 1921-23.

In the entire world the great depression led to theoretical views that are again clearly on the soft money side.

I felt compelled to change sides once more. My fight during the last decade has been against what I consider a dangerous swing to the other extreme, towards inflationism.

As theory and policy during the last decade have been strongly influenced by the late Lord Keynes and his followers, my recent work is squarely addressed to the refutation of Keynesian theory. The articles I have published in the last few years represent, therefore, my criticism of Keynesianism and a further elaboration of what I wrote in the Neue Zürcher Zeitung (November 1920, 1936) immediately after the appearance of The General Theory of Employment, Interest, and Money.

These articles are reprinted in this volume with only slight alterations—some omissions to prevent repetitions, and a few supplementary footnotes.³ I am conscious that today I would express many things differently and, above all, that somebody else, more familiar with the English language and the technique of expressing theoretical statements usual in this country could do better. However, in view of the almost entire lack of anti-Keynesian literature, I have felt obliged to surmount my inhibitions in order to relieve this situation to the best of my ability.

As will be evident from this volume, one of my chief objections to Keynes’ theory is that it, like all previous inflationary theories of employment, presupposes that the members of the community are blissfully ignorant of the changes. In other words, that it presupposes one can take away from some and give to others without arousing “compensating reactions” on the part of the former. That is why I have not called this book “Money and Credit, third collection”—which it actually is—but The Economics of Illusion, after Chapter 14, in which I emphasize this angle of approach.

It will be further evident from the following that to my mind Keynesianism is, with relation to its position within the history of economic thought, nothing but another one-sided swing of the pendulum monetary theory has often experienced—this time toward the distinct overestimation of the possibilities and effects of monetary manipulations and changes.

Generally speaking, I cannot help thinking that what is today praised as the “Keynesian Revolution” should, more accurately, be called the “Keynesian General Confusion.” Not every paradox is correct just because it is a paradox. And what may be an interesting and intriguing mental exercise for specialists who are certain never to lose the firm ground of common sense and fundamental economic insight, becomes irritating and misleading heresy when swallowed whole by minor minds and fanatics. In fact, I sometimes think Keynes wrote his book with his tongue in his cheek. He was doubtless often surprised at the seriousness with which his colleagues took his theses. And if to all this one should remark that I am incapable of grasping the Keynesian intricacies, I would have to console myself with what an old Berlin banker said to an apprentice who was desperate because he was unable to comprehend what a client had written: “Young man, if you are not able to understand his letter, it is probably because it is not understandable.”

In rejecting Keynesianism, I am in a peculiar position. Keynesianism is a sin of my youth, for as early as 1920 in my Volkswirtschaftliche Theorie des Bankkredits I presented what to me are the basic Keynesian statements.⁴ As I confessed later,⁵ “all that is wrong and exaggerated in Keynes I said much earlier and more clearly.” Unfortunately I cannot refer to an English translation of my book to prove my claim to priority to English readers. However, Howard S. Ellis gives a very good résumé of my theories in his German Monetary Theory (Harvard University Press, 1934). In order that the reader may judge for himself, and because I refer several times to my work in the following articles, the chapter of Ellis’s book summarizing my theory is reprinted in Appendix I. For the same reason, part of Gottfried Haberler’s extensive résumé and criticism of my book, which appeared in the Archiv für Sozialwissenschaft und Sozialpolitik,⁶ has been translated (Appendix II). Another reason for adding these two excerpts is that what the authors say, with full justification, against my theses can be said with the same justification against Keynes, but has not been.

Chapter 16 is a study of the relation between Keynes’ General Theory and my Volkswirtschaftliche Theorie des Bankkredits, and includes some remarks on the fate of what may be called German pre-Keynesianism. If one compares the passages quoted from the two books, I think that one cannot but be amazed at the similarity not only of the essence of the ideas but also in some instances of the wording.

In publishing this volume I am prompted by a sense of duty rather than by hope that they may prove a timely warning signal. Life has taught me that men, including economists, are influenced chiefly by their latest experience. Until very recently they were still under the spell of deflation and had forgotten the preceding inflation. Monetary opinion spreads like an infectious disease. Economists make the same mistake as businessmen and stock exchange traders who during a boom see only the bullish argument and during a depression only the bearish argument. Perhaps it is asking too much of a generation engaged in the undoubtedly attractive occupation of working out ever more refinements of the Keynesian theory—see, for example, the multiplier literature—to examine the fundamental question whether the basis of Keynes’ work is valid and whether all their zeal is not expended on an undeserving cause. They seem to have lost the ability to think along classical lines and may no longer be able to go in for such an examination. Blinded by the allegedly overwhelming importance of demand, they fail to see the implications of costs.

The situation will, I fear, prove dangerous when this country again faces real economic difficulties. It would be an economic policy of illusion to rely, on the one hand, on forecasts of economic developments by economists and government agencies and, on the other hand, on governmental interference to prevent depression and unemployment. As long as the world is not entirely totalitarian, neither the objective data of the future nor the subjective reactions of millions of individuals can be predicted. That is why all models, estimates, and forecasts are either right purely by chance or, if they hedge against future developments, worthless. Unforgotten are the forecasts of a postwar depression (see Chapter 5). The mistake common to all forecasts is that they try to predict the unpredictable. Specific amounts of goods are supposed to come to the market manufactured at a rate of productivity calculated in advance to meet a demand fixed by inveterate investment or consumption habits. The forecasters do not take into account the fact that the slightest change in certain objective factors, such as wage rates, or the slightest modification of the psychological atmosphere can cause fluctuations in the markets that set at nought the calculations based upon estimates of productivity, of pent-up demand, saving habits, and so on. As far as governmental interference itself is concerned, one should never forget that serious economic disturbances are the consequences of basic maladjustments. The effect of correcting or not correcting such maladjustments is infinitely greater than any artificial creation of demand by government in an economy that, in most sectors, is still free. Therefore an economic policy that concentrates on artificially filling up an investment or spending gap rather than on fostering adjustments—and thus creating demand in a natural way—is doomed to fail in any severe crisis.

¹ Tübingen, 1st ed., 1920; 2d ed., 1924; 3d ed., 1930.

² Berlin, 1930; Tübingen, 1931. These articles, as well as those mentioned above, are available in the New York Public Library.

³ A summary of this volume will appear in German in “Ordo,” Zeitschrift für Ordnung von Gesellschaft und Wirtschaft, 1949, and in French in Economie appliquée, Archives de l’Institut de Science Economique Appliquée.

⁴ Remarks on my priority are to be found in Gottfried Haberler, Prosperity and Depression (1939), Wilhelm Lautenbach, “Zur Zinstheorie von John Maynard Keynes,” in Weltwirtschaftliches Archiv (Vol. 45, 1937), Heimann, History of Economic Doctrines (1945), and others.

⁵ In my first criticism of The General Theory in 1936, mentioned above.

⁶ Vol. 57, pp. 803 ff. (Tübingen, 1927).