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CHAPTER 4: On the Problem of Legal Resumption of Specie Payments in Austria-Hungary - Ludwig von Mises, Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War 
Selected Writings of Ludwig von Mises, vol. 1: Monetary and Economic Problems Before, During, and After the Great War, edited and with an Introduction by Richard M. Ebeling (Indianapolis: Liberty Fund, 2012).
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On the Problem of Legal Resumption of Specie Payments in Austria-Hungary
The remarks that I published in this journal last year about the problem of legal resumption of specie payments in Austro-Hungary2 have received a response by Walther Federn3 in this journal’s first issue for this year. The author says that my claim that the Austro-Hungarian Bank made foreign exchange available at all times at a rate that was lower than the upper gold point does not correspond to the facts, and, therefore, my conclusions are incorrect. In his article Mr. Federn develops his own theory (with which I disagree) more substantially and in far greater detail than in his previous, shorter newspaper articles. He is, without a doubt, one of the few representatives speaking in favor of the advantages from the current currency arrangement in Austria-Hungary who should be taken seriously. Thus, it seems appropriate that his remarks should not be left without a response.4
There is a great theoretical importance to the problems discussed here. On the one hand, there is a close relationship between this problem and the questions that Knapp’s State Theory of Money has placed at the center of modern theoretical economics. No less important, however, is the practical importance of this issue for the Austro-Hungarian Monarchy, where the question about the legal resumption of specie payments has not disappeared from the agenda. It is also of importance in Imperial Germany, where the Reichsbank is attempting to establish a position of power on the foreign exchange market similar to that already held by its Viennese sister institution.
The Development of Erroneous Views about Foreign Exchange Policy
I believe I have already said everything essential in connection with the question about the legal resumption of specie payments in my earlier essay, and Mr. Federn’s new remarks do not induce me to recant a single word of it. It should be emphasized, again, that the claim that the Austro-Hungarian Bank sometimes denied the release of foreign exchange to interest rate arbitrageurs is absolutely inconsistent with the facts.
If one asks how such an incorrect claim could be made at all, one comes upon the following:
Several banks and private bankers have complained that the Bank sometimes capitalizes on its preeminent position on the foreign exchange market to demand high prices for the foreign exchange that they request; however, it should be pointed out that the prices are always still below the upper gold point. Similarly, here and there laments are made that the Bank occasionally does not release any foreign exchange. Concerning this latter grievance, it turns out that whenever the foreign exchange rate is a considerable distance from the upper gold point the Bank sometimes shows no interest in supplying some of its foreign exchange, that is, it instructs its representatives on the foreign exchange market to reply negatively to every request for surrendering foreign exchange. Whenever the demand for foreign exchange is not insignificant, the Bank’s restrictive policy results in a rise in the foreign exchange rates. Then, when the foreign exchange rates have reached a certain level, the Bank again releases foreign exchange onto the market and brings any further increase in the exchange rates to a halt.
However, the importance of the Bank’s intervention is that it constantly occurs before the foreign exchange rate has reached the upper gold point. It is this last point that is of importance for monetary policy. How high may be the price that the Bank demands for its foreign exchange is a matter of complete indifference, so long as it demands less than would justify the costs of actually exporting gold. That the Bank, ex facto, pays specie for foreign exchange is unaffected by this. Whether it is to settle debts coming due abroad or merely to invest money abroad, anyone wanting to purchase foreign exchange or checks should certainly be pleased that it is supplied to them as inexpensively as possible. It is, of course, understandable that as long as it does not interfere with its monetary policy goal of keeping the foreign exchange rate below the upper gold point, the Bank manages its foreign exchange portfolio to earn the highest proceeds possible by charging the best price it can get for its foreign exchange.
When absolutely no gold was obtainable on the unofficial foreign exchange market of the Austro-Hungarian Empire,5 the Bank lacked any precise way of determining whether or not the upper gold point had been reached or even surpassed. In those early years of its new policy (1896-1900), the Bank sometimes released German foreign exchange at a rate of 0.75 percent, or sometimes even at one percent, above parity; indeed, once it did so at an even higher rate on March 23, 1900. However, even this represented significant progress in comparison with the older situation; indeed, in 1893, an agio emerged of up to 6.5 percent. The desired stability of the foreign exchange rate had not yet been completely achieved.
Beginning in the second half of 1901, when the Bank began to supply gold on the unofficial market, it had a reliable indicator of whether or not the upper gold point had already been reached. Whenever this point was reached, gold in circulation began to be exported and the Bank received inquiries whether it would be willing to release gold as well as surrendering foreign exchange.
To counteract such inroads into the monarchy’s gold reserves, the Bank needs no other method than to increase its discount rate. As far as banks in Vienna are concerned, the most important foreign exchange market outside Austria-Hungary is the banking centers in Germany. In comparison, the foreign exchange markets in London and Paris are only of secondary importance. The great importance of the German foreign exchange market dates from the time of close political ties between Austria and the countries of the German Confederation, and it is the many economic connections between Austria and Germany that explain the persistence of this preferential treatment.6
In 1908, trade with Imperial Germany amounted to 42 percent of Austria-Hungary’s total foreign trade. According to estimates by the Austrian Ministry of Finance, foreign investment in Austria and Hungary at the end of 1901 came to 9,353 million crowns, of which 4,568 million crowns were held by citizens of Germany, or almost 49 percent of the total. Besides this, it should also be pointed out that a large portion of the monarchy’s trade with other foreign countries takes place through German intermediation.
Therefore, the Austro-Hungarian Bank turns its attention first and foremost to the foreign exchange market in German banking centers. Since the end of 1900, the Bank has intentionally maintained the purchase price for its foreign exchange and, as a rule, it has never risen more than one-quarter of a percent above the specie parity rate of 117.563. Only on a few days in the second half of March 1907, and then in November and December of 1909, did it rise above this to a maximum of 117.925 (0.31 percent above parity); and only once, on March 26, 1907, did it reach a rate of 118.05 (0.41 percent above parity).
The Bank’s Policy in Light of the Statements by the Bank’s Governor and the Viennese Stock Exchange
Federn’s claim, that the Bank occasionally denies the release of foreign exchange, however, can only be demonstrated through counter-evidence. It should be noted that Federn stands out in making this case, because other supporters of the same viewpoint have little knowledge of the detailed facts and simply assert their claims about the supposed benefits for interest rate policy from a suspension of specie payments. Their claims about the advantage from an “isolated” currency not embroiled in the international fight for gold have been repeatedly refuted.7
If, as Federn claims, the Bank actually did occasionally deny the release of foreign exchange to interest rate arbitrageurs, then financial circles in Vienna would have some knowledge of its actions. This is, however, not the case. Whenever increases in the prime rate were being considered in Vienna due to increases in foreign exchange rates and rising interest rates on foreign markets, a refusal by the Bank to release foreign exchange has never appeared in the statements made by experts and is never mentioned in the newspapers. Rather, everyone completely understands that the Bank releases foreign exchange at a higher price and must unconditionally supply it, if it does not want to trigger a panic increase in the foreign exchange rate.
Completely opposite to what Federn alleges are the remarks made by the Austrian finance minister, Leon Ritter von Bilinski, who was governor of the Austro-Hungarian Bank at that time.8 Bilinski explained that opponents of mandatory specie payments incorrectly assumed that variability in the interest rate would arise only in the case of legal resumption of specie payments, since the Bank was already required at that time to coordinate its interest rate policy with other foreign central banks. The Austro-Hungarian Bank, he said, did not consider every export of gold to be a catastrophe. The gold did not absolutely remain in the vaults of the Bank simply to cover its banknotes; rather, it was used to cover international payments as well, insofar as they resulted from the legitimate requirements of trade and commerce.
This last statement appears to give support to Federn’s theory that the Bank satisfies only the “legitimate” requests for foreign exchanges, and sometimes refuses to release foreign exchange to the interest rate arbitrageurs. However, Bilinski’s next statements show that the Bank knew of no deterrent other than an increase in the discount rate to counter illegitimate requests for international means of payment. Namely, Bilinski then continued, “Thus, we vigorously resist every unjustified export of gold; for example, in October 1905, we already increased the interest rate as soon as gold exports exceeded two million crowns; conversely, we also often send gold to foreign markets whenever we have the expectation that this method will prevent a further increase in the foreign discount rate. By this means we stem any future export of gold from the monarchy that would require us to increase the Bank’s discount rate.”9
That is exactly the opposite of what Federn has alleged to be the policy of the Bank.
Concerning the events in 1907, about which Federn has claimed that the Bank denied the release of foreign exchange, it is stated in a report to the Viennese stock market that at the end of June, “multiple requests were sent to the Austro-Hungarian Bank, as well as other domestic institutions, whether gold bullion or gold coins could be released for export (namely to Germany and the Netherlands). Since the Bank wished to maintain its voluntary adoption and up to then impeccable record of acting as an institution that paid in specie, it was compelled to increase the discount rate from 4.5 percent to 5 percent on the 27th of June because of the small amount of gold available on the unofficial markets of the monarchy.” This increase in the rate of interest achieved the desired goal of stemming the outflow of gold.10 That it was not necessary for the Bank to increase its interest rate beyond 6 percent in the autumn of that same year can be traced back primarily to its policy earlier in the year, as can be inferred from the same report to the stock exchange: money was readily available in Vienna in November due to the precautionary action exercised by the Bank.11
Incidentally, there is nothing peculiar in the large difference in the private discount rates and the central bank rates during times of crisis. Precisely in such times, financiers become more anxious over risks that are always connected with foreign investments during a crisis; they prefer lending their money at lower interest rates closer to home to bearing the increased risk of a better rate of return abroad. In turbulent times, noticeable differences appear even between currency markets within the same country, such as between Berlin and Frankfurt.
However, even if it can be ascertained that the Bank does not proceed as Federn has depicted, a moment should still be spent to consider whether such a policy would even be possible, and in what manner an increase in the foreign exchange rate could be prevented in spite of the Bank’s refusal to release foreign exchange. There are two instances that Federn cites here. Initially, he refers to the fact that an increase in the foreign exchange rate decreases the gains from interest rate arbitrage. That this is true has never been denied. The entire objection appears invalid, however, if it is taken into consideration that since 1900 this increase in the foreign exchange rate has extended only to the upper gold point for foreign exchange at German banking centers. Thus, a limit to foreign exchange speculation receives little support on this count.
Transactions During the Bosnian Crisis
Additionally, Federn states that during the Bosnian Crisis12 the Bank took particular advantage of the fact that it was not obligated to release actual gold upon demand in support of its interest rate policy. If it had been obligated, in fact, to unrestrictedly release gold, the banking sector would have prudently withdrawn gold from the Bank and sent it abroad, Federn says. However, because the Bank did not have to actually release gold, the demand would have been concentrated on foreign exchange.
But the Bank only reluctantly satisfied this speculative demand for foreign exchange, Federn argues. It allowed the rate of foreign exchange to rise above the redemption rate, indeed somewhat above the upper gold point, and successfully countered the speculation. Whoever wanted to buy foreign exchange had to purchase it above the price for gold: consequently, he would have to bear an exchange risk and therefore decided to delay making the purchase thinking that there would always be time to acquire foreign exchange the next day in case the situation deteriorated. There would have been no need for such patience if the Bank had been obligated to release gold at its going rate, because then this risk would have disappeared. The Bank’s precious metal holdings would have been prematurely weakened, with all of the disadvantages that go hand in hand with this, Federn concludes.
In response to this argument it may be pointed out that during the entire period of the Bosnian Crisis (from October 1908 to the end of March 1909), the rates for foreign exchange at the German banking centers, without exception, ranged below the mint parity; the rate of foreign exchange in London ranged below mint parity during most of this period, with the maximum never exceeding 0.08 percent above mint parity during those six months.13
If Federn’s allegation about foreign exchange is thus completely unsubstantiated, the same goes for the claim that the Austro-Hungarian Bank did not release gold during the Bosnian Crisis. It was precisely during the Bosnian Crisis in March 1909 that an admittedly unimportant, domestic demand for actual gold occurred for the first time in Austria; when the reservists rallied to the banners and the active-duty officers and reserve troops departed for the borders, they required certain sums of money. This increased demand resulted from runs on a few provincial savings banks, and was satisfied without exception by the Bank. To have done anything else would have shaken the solid trust among the people that the Bank’s wise policies had built up over a long period of time.
Federn claims that banks carry a risk connected with the purchase of foreign exchange, while the acquisition of actual gold bears no such risk for them. It should be pointed out that the purchase of actual gold at the current parity rate for gold appears more expensive than the purchase of foreign exchange, since the latter is purchased at a rate that is already close to the gold point.
Federn makes a similar error when he claims at another point in his argument that the Bank hampers interest rate arbitrage when it releases foreign exchange under fixed-term contracts while denying foreign exchange for cash. A capitalist who desires to take advantage of a higher interest rate abroad can most easily achieve his goals by purchasing long-dated foreign exchange at foreign banking centers. If the Bank were to actually pursue the policy alleged by Federn, this could in no way counter interest rate arbitrage. Only those individuals would seemingly be damaged who had to make foreign payments coming due in the short run, since in order to settle such payments, short-term foreign exchange is needed.
The Bank has no other means to limit a rise in the foreign exchange rate above a certain level than by satisfying the demand for foreign exchange at a lower rate, regardless of the reason behind that demand. This is the policy that the Austro-Hungarian Bank has followed for more than a decade.
[1. ][This article originally appeared in German in the Jahrbuch für Gesetzgebung, Verwaltung und Volkswirtschaft (Schmollers Jahrbuch), vol. 34, no. 3-4 (1910).—Ed.]
[2. ][“The Problem of Legal Resumption of Specie Payments in Austria-Hungary,” Chapter 2 in the present volume.—Ed.]
[3. ][Walther Federn (1869-1949) was a prominent economic and financial commentator in Vienna before and after the First World War. In 1908 he founded The Austrian Economist magazine (modeled after The Economist in Great Britain), which he edited until 1934. He first immigrated to Sweden and finally came to the United States, where he lived until his death.—Ed.]
[4. ]I will not say anything further here about Mr. Federn’s remarks directed against my essay in the newspaper he publishes, Der österreichische Volkswirt (July 31, 1909), because he does not raise them again in the essay in this journal.
[5. ][The “unofficial market” was the private market on which gold was bought and sold; it was also the name for the Austro-Hungarian Bank policy after 1896 of de facto redemption of its banknotes for foreign exchange and then after 1901 for gold, though the Bank was still not legally required to do so.—Ed.]
[6. ][This refers to the period before the Austro-Prussian War of 1866, when Austria was expelled from the German Confederation as a result of Prussia’s victory in the conflict.—Ed.]
[7. ]Thus Kuranda, a Member of Parliament, explained just recently in a speech given for the Lower Austrian Trade Union, “For myself—and I know myself to be one of many—I firmly hold the conviction that the ‘splendid isolation’ of Austria’s interest rate policy must and will come to an end with the resumption of specie payments. At that moment when the Austro-Hungarian Bank will be obligated to unconditionally hand over for every note presented at its doors the equivalent in legal, metal money, the Bank’s treasury will become a capillary vessel into the system of international flow of money and gold. At a minimum, it will have to set its interest rate at the same level of that country which is momentarily most in need of the precious metals. The waves of the international economic situation will then pull our monetary and credit services into their maelstrom, regardless from whichever and however far away the center of the agitation may be from which it arises.” (See Fremdenblatt, November 6, 1909.) This argument was already refuted years ago in the writings from which I quoted in my original essay.
[8. ][Leon Ritter von Bilinski (1846-1923) was a leading Polish political figure and economist in the Austro-Hungarian Empire, who served at various times as general director of the Imperial Railway and Austrian finance minister, as well as governor of the Austro-Hungarian Bank. He also was a governor of Bosnia-Herzegovina. After the First World War, he briefly served as minister of finance in 1919 in the newly independent Poland.—Ed.]
[9. ]See von Bilinski, “Über Internationale Zahlungen” [On International Payments], lecture in the special session of the Fourth Polish Judicial and Political Economy Conference in Krakow on October 2, 1906.
[10. ]See Jahresbericht der Wiener Börsenkammer. Der Verkehr an der Wiener Börse und der Geldmarkt in Jahre 1907 [Annual Report of the Viennese Stock Market: Transactions on the Viennese Bourse and the Currency Market in 1907] (Vienna, 1908), p. 193.
[11. ]See ibid., pp. 200f.
[12. ][In 1878, Austria-Hungary occupied and obtained international recognition to administer the province of Bosnia-Herzegovina, which up until that time was under the control of the Ottoman (Turkish) Empire. On October 6, 1908, the Austro-Hungarian government announced the formal annexation of Bosnia-Herzegovina and precipitated an international crisis that threatened war between several of the leading European powers. In April 1909, an agreement was signed among the Great Powers recognizing Austria-Hungary’s annexation of the province.—Ed.]
[13. ]See “Der Compaß” Finanzielles Jahrbuch für Österreich-Ungarn [“The Compass” Financial Annual Journal for Austro-Hungary], vol. 43, no. 1 (Vienna, 1909), p. 92. For foreign exchange on the Paris market, the maximum rate amounted to 0.288 percent above parity during that six-month period: in the most critical month, March 1909, it was 0.078 percent above parity. On average, for the month of March 1909, foreign exchange in the German banking centers was posted at 0.436 percent above parity, foreign exchange in London at 0.119 percent above parity, and foreign exchange in Paris at .0137 percent below parity.