business was to stop the monetary printing presses. But this could be done only if the costly food subsidies were eliminated and the nationalized industries were reprivatized to end the huge expenses to cover their deficits, so the national budget once again could be brought into balance. Foreign exchange controls had to be abolished with a free market in all currency dealings. At the same time, the value of the Austrian crown had to be stabilized once the central bank had stopped issuing paper money and the depreciation of the currency was brought to a halt. All domestic regulations and controls inhibiting free commerce among the various provinces of Austria had to be lifted, and free trade had to be reintroduced in all forms of foreign trade. This was the path to a revitalized and prosperous Austria.
A sound monetary system was unlikely if the governments of those new states that had formerly been part of the Austro-Hungarian Empire looted the assets of a reconstructed Austrian central bank. Thus, in “The Claims of Note Holders upon Liquidation of the Bank,” published in February 1921, Mises argued against those who asserted that those other governments had a right to a portion of the old Austro-Hungarian Bank’s gold reserves. Under the Treaty of Saint-Germain, which had ended the war between Austria and the Allied Powers, the successor states were obligated to redeem the old crown notes on their territories for their own respective currencies. The old Austro-Hungarian Bank notes were then to be turned over to the new Austrian central bank, which would take them out of circulation. Mises argued that everyone knew that the huge expansion of banknotes to fund the government’s war expenses were backed by nothing, and certainly not by whatever gold may have remained in the central bank’s vaults. To demand anything else would be to plunder the gold and other assets upon which a reconstituted Austrian monetary system would be built.
Mises observed in an article early in 1922, “The Austrian Currency Problem Thirty Years Ago and Today,” that the key to ending Austria’s problems was stopping inflation. Thirty years earlier, in 1892, the task had been to stabilize a currency that was appreciating in value. The task in 1922 was to bring a halt to its depreciation. But the method was the same: link the currency to gold and do not manipulate its quantity in circulation.
As the situation worsened, Mises put together a proposal on behalf of the Vienna Chamber of Commerce for “The Restoration of Austria’s Economic Situation,” which was submitted to other trade and labor union associations in the country to devise a way to bring an end to the government budget deficits as a prelude to stopping the inflation. In a nutshell, Mises recommended the establishment of price indexation throughout the economy. Already government expenditure levels were automatically adjusted in line with a cost-of-living index. Now the same arrangement had to be set up for government revenues. Otherwise nominal expenditures would keep growing while nominal tax revenues would always lag behind, never leading to an end to the deficits. Incomes, profits, and wages and prices all had to be indexed to the market value of gold. This would continually adjust government tax revenues to government expenditures. It would mean that government nationalized sectors, such as the railway system, would have their prices rise in tandem with the average rate of depreciation of the currency reflected in its link to the price of gold, which would help to reduce their losses and maybe even earn a profit from transit fees for cargos passing through Austria. At the same time, gold indexation would assist in keeping the wages and salaries of many workers rising to maintain a certain real value of their income.
Mises emphasized that such an indexation policy was desirable not only due to questions of equity in a period of rapid depreciation and the need to bring the government’s budget better into balance. It was also needed because inflation distorted the very essence of a money-using economy: the ability for economic calculation to reasonably estimate profit and loss, and relative profitability of alternative lines of production. Price and wage indexation linked to the price of gold would help to reduce the miscalculations that inflation caused, and which often resulted in capital consumption. This measure, Mises stated, was meant to be a transition method to bring stability to the Austrian economy, or, as he concluded, “We must make up our minds to return from the extravagant intoxication of spending ‘billions’ to the sober, more modest financial figures of a smaller state. The object of the proposed plan is to avoid a sudden and disastrous collapse.”
The inflation was brought to a halt in late 1922 and early 1923 with the financial assistance and supervisorial oversight of the League of Nations. In 1925, in “The Gold-Exchange Standard,” Mises pointed out that while Austria and a number of other countries were moving back to a gold-backed currency, it was not a full gold standard system. Most countries did not have large amounts of actual gold reserves, and gold coins were nowhere in circulation. Instead, their monetary systems (like that under the old Austro-Hungarian Bank) were gold-exchange standards, under which most reserves were held in other countries in the forms of financial assets that were, in principle, redeemable in gold in those other countries. The entire system depended upon at least a few countries, like the United States at that time, being willing to serve as ultimate gold reserve redeemers. Mises thought that this was only a shadow of the type of real gold-backed system that could assure noninflationary stability to the various countries of the world.
In 1926, Mises had spent three months traveling in the United States. When he returned he delivered the talk “America and the Reconstruction of the European Economy.” Any further European recovery from the effects of the Great War could not count upon American political or economic leadership. Both manufacturing and agricultural interests in the United States were heavily protectionist and therefore resistant to imports. This, in turn, made it difficult for Europeans to find markets for their goods or to earn the dollars to pay back their wartime loans to America. While the United States was a creditor nation with the means to invest in Europe, money would not be given away but would depend on the profitability of such investments. Thus Europe would have to rely upon itself if it was to continue to overcome the legacy of the war.
Mises pointed out the difficulty for such stable recovery and growth in a summary he presented in 1928, “The Currency and Finances of the Federal State of Austria.” Five years after the end to Austria’s inflation, the currency was on a relatively sound basis. A new schilling had replaced the old crown and was fixed at a specific value in terms of gold. The rules under which the new Austrian National Bank operated made it difficult for it to serve as a means to finance the expenses of the government.
However, the fiscal affairs of the nation were far from sound. The government was still running budget deficits, but all of it was due to cost overruns in the nationalized sectors of the economy, especially the railway system and the lumber industry in the nationalized forest system. Financial pressures were placed on the federal authority because of the tax and related transfers to the provincial governments, which were all overlaid with bureaucratic regulatory structures and mismanagement. And in Vienna, where the Social Democrats controlled the municipal government, the financial extravagance on public projects was exceptionally large. For domestic growth and international competitiveness, Austria had to make its economy more productive. Cutting wasteful government and radically reducing taxes was the only avenue to a prosperous future for Austria.
When the Great Depression began in the early 1930s, the banking system was badly shaken. The collapse in May 1931 of the Austrian bank, Credit-Anstalt, in particular, sent shock waves throughout the financial markets. Shortly afterward, Mises wrote “The Economic Crisis and Lessons for Banking Policy.” In his eyes, the banking systems in Germany and Austria had two weaknesses. First, too many banks had become financially entangled with the industrial corporations to whom they lent. In fact, they often had become major shareholders in the very companies whose financial status they were supposed to oversee with a critical eye in terms of continuing creditworthiness. Instead, they unsoundly extended more credit to companies they should have pulled back from because their own balance sheets were too closely linked to the illusion of their continuing profitability. Finally the situation imploded, taking the banks down with those companies.
Second, those same banks had poorly managed the term structure of their investment portfolios. They lent long, while being liable for depositor withdrawals on demand. In other words, they had become caught in the system of fractional reserve banking, in which the amount of claims payable on demand far exceeded their available cash reserves to meet depositor liabilities.
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