A reformulation of ABCT

Via the Cobden Centre the announcement of an interesting meeting of the London Mises Circle:

The seminars hosted by Ludwig von Mises, first in Vienna and later in New York, have a key place in the history and development of Austrian economics. Such figures as Hayek, Rothbard, and Hazlitt all attended.

Inspired by this the London Mises Circle is holding a seminar at the Institute of Economic Affairs at 6:30pm on November 1st.

The focus for November 1st will be the content of a paper [PDF 42 pages] by Joseph Salerno of Pace University which sought to defend and update the Austrian Business Cycle Theory in light of the financial crisis. Of course, November 1st is also the day of this blogs’ Rose and Crown drinks event where Brian Micklethwait will be speaking but in this case you may be forgiven!

John Phelan’s announcement says of the the paper that it:

responds to some of these criticisms and makes some additions and refinements to ABCT

This is a key theory, so I hope many readers will go along or at least read the whole paper.

Money matters

Recent developments in the Republican Presidential platform debates in the US have been most encouraging to proponents of sound, commodity-based money. Regardless of whether anything substantial materialises from them in the short-term, the mere fact that gold standards and central bank audits are being discussed openly and seriously at the heart of a major political party is a positive sign that the debate is heading in the right direction for those of a libertarian or conservative persuasion.

With this American narrative in mind, it is perhaps a good time to re-consider the arguments in favour of a return to a commodity standard of money (be it backed by governments or produced privately on the free market) and why a commodity standard is essential for a sound economy, more stable prices and for keeping the growth of government firmly in check.

To those visiting the site for the first time and who are perhaps new to free market economics, I hope this article will form a useful introduction to the question of money from an Austrian school perspective.  For others, it is merely intended as a starting point for further discussion on an issue which is sometimes thought of as an interesting aside (albeit never on Libertarian Home, whose focus on Hayek and currency competition is laudable ).

Commodity v Paper

© Tax Credits

Whilst there are various reasons why printing more money can be politically expedient in the short-term, its longer term consequences usually result in some economic or currency disaster or just the plain old expansion of government.

Thus the three major problems with the paper standard and a “flexible” paper money supply in general are:

1) Distortions in economic calculation, causing the boom and bust cycle;

2) Price inflation (and in extreme cases, hyperinflation), causing hardship;

3) The inevitable growth of government.

Taking each of these points in turn.

Booms and Busts

The logic of the Austrian Theory of the Business Cycle (ATBC), as this theory is also known, is beautiful in its simplicity. In short,  ATBC teaches that any artificial expansion of the money supply (whether by governments or by its central bank proxy) causes the market price of interest to be lower than it would be otherwise on the free market, in turn sending misleading  economic signals to producers who consequently invest and cause a boom in all sorts of interest-rate sensitive industries such as housing and construction. As the real savings and resources in the economy needed to sustain such projects do not really exist, the projects must inevitably be unwound, at which point can it be said the “bust” part of the cycle has kicked in.

Thus can it be said that the responsibility for the devastating booms and busts witnessed in the Wall Street crash stock of 1929, the doc.com “tech wreck” of the early 2000s, and the housing market collapse of 2007/2008 rests squarely at the feet of the central bank and the paper standard.

Needless to say, a return to a commodity standard would take the printing presses firmly away and thus remove the ability of central planners to foster such malinvestment and havoc.

Price Inflation

An inevitable consequence of continuously increasing the money supply, a paper money standard reduces the purchasing power of people’s savings over time and erodes their standard of living. Indeed, since the establishment of a universal paper standard in the twentieth century the value of national currencies relative to the goods and services they can buy has suffered an inexorable decline.  In the bygone days where gold or silver were in official use as currencies, people saved for retirement knowing that the purchasing power of their currency medium would be preserved. Not so today, where people who would stuff their hard-earned paper notes under the mattress would right be viewed with genuine human concern.

Whilst a return to a commodity standard would not abolish year to year fluctuations in the price of goods and services, there is little doubt the purchasing power of the circulating medium would be much better retained over the long-term.  James Turk, founder of the precious metals bank GoldMoney, often uses the example of how 2 silver dimes are able to buy the same amount of petrol at the station today as when a child his parents would fill up the family car.

Growth of Government

Perhaps most insidious of all, paper standards facilitate the sort of government expansion that would simply not be possible under a commodity standard. For with a licence to print, resting with the government itself or its central bank proxy, the political class is no longer forced to make the difficult case for raising taxes or increasing borrowing but can instead turn to this imaginative and more invisible third way of funding itself.

Under such an arrangement all sense of financial reality is abolished, that critical impediment to the inexorable growth of government. The secret darling of socialist ideologues and power-hungry political elites, a paper standard means there is no longer any real requirement to deliberate on the affordability of going to war, increasing state benefits or creating a new government agency to run some bold new initiative.  Money, it appears, does grow on trees after all.

Under such an arrangement there is no limit to the growth of the state and its concomitant influence over the lives of its people.  The opposite is true for a commodity standard, which at the very least forces a degree of transparency from the central planners who, forced to rely on more traditional methods of self-funding, have to appeal to the people directly anytime they wish for more government largesse.


Assuming then the superiority of a commodity standard over a paper one, the tricky question comes over the process of implementation. Leaving aside the question of the political obstacles that would have to first of all be surmounted, what would the new system look like? Should governments introduce a new gold standard to back their national currency? Should they permit gold and silver to trade freely in the market place in competition with their national currency? Should they remove themselves from the business of money production altogether, turning it over to a free market system of currency competition, as advanced by Hayek?

Whilst many of us would like to see the Hayekian solution, a return to a government-backed gold standard would be a step in the right direction. Yes, governments cannot be relied upon to keep their promises (i.e. to stay on the gold standard once on it) but if such a change were to ever take place it would have to be a reflection of a radical change of thinking amongst the populace at large (either through education or as a result of a financial crisis) who might just help to keep the government in check.

Whilst a new gold standard might be far from perfect, any system that might restrict the government’s ability to cause harm through excessive money printing should be given due consideration.  Such a new gold standard could serve as the first step towards re-integrating the notion of commodity money into society at large and paving the way for the complete privatisation of money production. Most importantly, it would serve to debunk and deposit that failed notion of a paper standard into the ash heap of history, where so many actual paper currencies have wound up in the past, again and again.