Liberty Matters

Further Remarks on Hülsmann and Hummel


As evidence that Mises “qualified his endorsement of free banking,” Professor Hülsmann quotes the following statement by Mises (1980, p. 439): “If it should prove easier now for the credit-issuing banks to extend their circulation, then failure to adopt measures for limiting the issue of fiduciary media will involve the greatest danger to the stability of economic life.” It is clear in the context of the surrounding sentences, however, that Mises was not here warning about any free-banking system, but was instead warning about the central-bank-dominated banking systems that actually prevailed at the time he wrote in 1924. A few sentences earlier in the same paragraph Mises wrote that the likelihood of enacting measures for restricting fiduciary media “depends upon the kind of credit policy that is followed in the immediate future by the banks in general and by the big central banks-of-issue in particular.” I doubt that Mises would have disagreed with the proposition – although he does not here state it as clearly as one might like – that any effective measures for limiting fiduciary media in a nation must first and foremost limit the issues of the national central bank. (I also doubt that Hülsmann would disagree.) In the conditions of 1924, just as today, the central bank’s liabilities were held as reserves by credit-issuing commercial banks, and the central bank’s expansion thereby drove the banking system’s expansion as a whole.
A slightly earlier paragraph in The Theory of Money and Credit is also of interest in this discussion. Mises observed that “the considerations … that are supposed to militate against the freedom of the banks” were discussed “two or three generations ago,” meaning roughly 1850-1875. The supposedly decisive argument was “the currency principle,” which held, in Mises’s words, that “any note issue that is not covered by gold is dangerous, and so, in order to obviate the recurrence of economic crises, such issues must be restricted.” Mises then rebutted this view by referring to his own findings earlier in the book: “We have already shown that the dangers envisaged by the currency principle exist only when there is uniform procedure on the part of all the credit-issuing banks, not merely within a given country but throughout the world.” That is, absent a world cartel of central banks, the Currency School view that “any note issue that is not covered by gold is dangerous,” or in other words that every issue of fiduciary media is dangerous, is invalid.
This last passage is also relevant to Professor Hummel’s argument that Austrian business cycle theory “hinges on specifying two firm dividing lines: (a) between those financial instruments that constitute inside money and those comprising what Mises considered genuine manifestations of people’s savings, and (b) between those increases in the money stock, however defined, that generate a self-reversing boom and those that do not.” I certainly agree with Hummel on the need for the second distinction. As I have previously indicated, I (along with other modern free bankers) disagree with the proposition that every increase in the money stock is disequilibrating, because an increase that counteracts an incipient excess demand for money is on the contrary equilibrating. It does not lower the market interest rate below the natural rate, but prevents the opposite discrepancy. Which side was Mises on? Although Mises elsewhere unfortunately declared that every increase in the money stock sets the business cycle in motion (seemingly regardless of whether it creates an excess supply of money or not), the modern view follows from the passage of The Theory of Money and Credit that I have twice now quoted (“Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow an independent interest policy”). Mises here pointed out that under free banking “periodical” (which I take to mean seasonal) variations in the volume of bank-issued money will match variations in the volume of demand to hold bank-issued money. Such variations can only be seen as equilibrating. And in the passage I quote in the paragraph just above, to repeat, Mises rejected the Currency School view that every increase in uncovered note-issue is dangerous (except in the limiting case of a world central banking cartel).
I am less sure about Hummel’s first distinction. I don’t see why an Austrian business cycle theory must insist that an instrument – in particular an interest-bearing checking account – cannot, under normal conditions, be both inside money and a genuine manifestation of people’s savings. That is, a particular increase in the volume of checking-account balances can be a genuine manifestation of an increase in very short-term savings (whether at the expense of current consumption or at the expense of holding wealth in some other form, for example cash, consumer durables, or longer-term savings) and not a manifestation of an excess supply of money.
I want to conclude by quoting what I think is an admirably clear statement of Mises’s favorable judgment on free banking, which appears soon after the two paragraphs I just quoted:
If the arguments for and against state regulation of the bank-of-issue system and of the whole system of fiduciary media are examined without the etatistic prejudice in favor of rules and prohibitions, they can lead to no other conclusion than that of one of the last of the defenders of banking freedom: “There is only one danger that is peculiar to the issue of notes; that of its being released from the common-law obligation under which everybody who enters into a commitment is strictly required to fulfill it at all times and in all places. This danger is infinitely greater and more threatening under a system of monopoly.”
As the source of the quoted sentences Mises cites the German free-banking proponent I. E. Horn: “Horn, Bankfreiheit (Stuttgart, 1867), pp. 376 f.” The text of Horn’s book is available here: [Editor: It was first pubished in French the year before: J.-E. Horn, La liberté des banques (Paris: Guillaumin, 1866).]