gold standard (as it was called) by the Austro-Hungarian Bank, with maintenance of the exchange rate within a margin not much off the “gold points,” was praised by authorities at the time as an exemplary case of a highly successful “managed currency.”40
Ludwig von Mises’s Writings on Monetary and Fiscal Policy Before the Great War
Ludwig von Mises’s earliest writings on monetary and fiscal policy were published between 1907 and 1914,41 and focused on these currency reform and related issues. He devoted a chapter in his Memoirs to explaining the background behind some of these articles.42 He details his frustrations when the articles resulted in his coming face-to-face for the first time with opposition by government officials to reasonable and publicly endorsed policies due to political corruption and misappropriation of “secret” slush funds that would be threatened by implementing a fully convertible gold standard.
But he does not go into very great detail about the content of these early essays. They may be grouped under two headings. The first consists of articles concerning the political pressures that finally led to putting Austria formally on the path of a gold standard in 1892, and the reasons for the resistance and delay in legally establishing gold convertibility up to the beginning of World War I. The second group deals with fiscal extravagance and the regulatory and redistributive intrusiveness of the Austro-Hungarian government, which was leading the country to a potential financial and economic crisis. Even if the events of the war had not intervened to accelerate the process that culminated in an end to the nearly eight-hundred-year reign of the Habsburgs, the growth of the interventionist state was weakening the foundations of the country.
The earliest of these essays is “The Political-Economic Motives of the Austrian Currency Reform.” It is primarily an analysis of the changing factors influencing various interest groups that finally led to a sufficient coalition of these interests endorsing the move toward a gold standard. It highlights the fact that a major shift in economic policy is often dependent upon the vagaries of unique historical events, without which such a change might never have the chance to be implemented.43
From 1872 to 1887, the Austrian currency had been depreciating on the foreign exchange market. Many of the agricultural and manufacturing interests in both Austria and Hungary did not object to this trend, since it reduced foreign competition by raising the costs of imports and worked to make Austrian goods more competitive in other countries. But beginning in 1887, the currency began to appreciate, and continued to do so until 1891. The same interests that were quite happy living with a currency losing value were extremely anxious with an appreciating currency that lowered the costs of imports and raised the costs of Austrian exports.
By the time the Austrian Currency Commission was convened in 1892, all the leading manufacturing, agricultural, and financial interests had agreed behind the scenes on the necessity for currency reform to bring the appreciation of the Austrian florin to a halt. And they all concurred on the desirability for Austria-Hungary to establish a gold standard, while they initially argued over the particular rate of exchange at which the new currency—the crown—would be stabilized.
Mises’s essay reads partly as what, today, would be considered a “public choice” analysis of the special-interest politicking that often guides public policy. It brings out how a concentrated benefit to a wide array of interest groups served to generate a consensus on a significant institutional change in the existing monetary system. It also demonstrates how the costs or burdens imposed on a variety of smaller interest groups—particularly creditors and a number of medium-sized businesses who gained from currency appreciation, and conservatives who opposed a gold standard on ideological grounds—could be outweighed and outmaneuvered into being unable to prevent the monetary reform.
But at first, the Austro-Hungarian Bank was not legally compelled to redeem its notes for specie (gold). Its initial task was to prevent any further appreciation of the new crown from its formal foreign exchange rate. It was not given any direct instruction to prevent any renewed depreciation, if it were to occur. This, too, was consistent with the dynamics of the coalition of interest groups that had opposed any further increase in the value of the currency, but had not objected to the earlier years of currency depreciation.
But after 1896, the Austro-Hungarian Bank had accumulated enough gold and foreign exchange that it could assure the stability of the Austrian crown’s foreign exchange rate within both the upper and lower ends of the gold points, and in fact kept it within less than one percent of the parity rate most of the time. And after 1900, the Bank was redeeming and issuing its notes for gold as well as for foreign exchange on an unofficial de facto basis, while still not legally required to follow a policy of specie redemption.
This was the context in which Mises wrote four of the essays in this volume: “The Problem of Legal Resumption of Specie Payments in Austria-Hungary,” “The Foreign Exchange Policy of the Austro-Hungarian Bank,” “On the Problem of Legal Resumption of Specie Payments in Austria-Hungary,” and “The Fourth Issuing Right of the Austro-Hungarian Bank.”
Mises’s argument was that nothing was keeping the Austro-Hungarian Bank from now being given the legal obligation to redeem gold on demand for its banknotes, and thus formally joining the international community of gold standard nations. He insisted that this would immediately raise the creditworthiness of debt issued by the Austrian and Hungarian governments on foreign markets, and therefore lower the costs of borrowing from international creditors. It would also improve global confidence in Austria-Hungary as a developing nation desirous of attracting foreign investment and lower the cost of international capital for Austrian entrepreneurs.
Opponents of formal specie redemption argued that requiring the Austro-Hungarian Bank to redeem gold would risk a large hemorrhage of specie reserves at any time an international crisis induced holders of crown notes to transfer their liquid capital out of the country. If during such an international crisis other central banks were to raise interest rates to protect their gold reserves from the danger of capital flight, the Austro-Hungarian Bank would be compelled to also raise its interest rate to prevent loss of its own gold reserves. Domestic manufacturing and commerce would then find that the cost of capital was held captive to the uncontrollable market forces of international finance. Domestic interest rates could experience swings that would carry negative effects for business within the country, merely to counteract speculators who wished to move gold in and out of the country to take advantage of interest rate spreads that had nothing to do with the legitimate needs of the import and export trade to facilitate international transactions. These critics argued that it was far better to maintain the present system of de facto specie payments, which gave the Austro-Hungarian Bank the latitude and liberty to, at any time, refuse gold or foreign exchange redemption for its notes to shelter the domestic economy from unnecessary and destabilizing interest rate changes.
Mises counterargued in these articles that since the 1860s, first the old Austrian National Bank and then its successor, the Austro-Hungarian Bank, had had legal authority to hold a sizable portion of its reserves against notes outstanding (even when official redemption was not imposed) in foreign bills of exchange, foreign currency, and other foreign-denominated assets that were, themselves, redeemable abroad in specie money. In other words, the Austrian central bank operated on the basis of a gold-exchange standard rather than a full gold standard. Through this method the Austro-Hungarian Bank was able to earn a significant interest income from its reserve holdings instead of letting its gold sit idle in the Bank’s vaults. At the same time, these foreign earnings not only went to the Bank’s stockholders, but were shared by law with the Austrian and Hungarian governments, thus reducing what otherwise might have been higher taxes to cover government expenditures.
For a long time the Bank already had been utilizing its holdings of foreign exchange and other foreign-denominated assets precisely to substitute for having to meet every demand with an actual gold outflow. This not only was an effective tool for meeting “legitimate” needs for specie in international transactions, but served to counteract speculative demands for gold or foreign exchange to keep the crown’s foreign exchange rate within the gold points, beyond which it would become profitable to export or import gold.