“A failure to act, and act now, will turn a crisis into a catastrophe,” President Obama said.

If someone expresses skepticism, Obama and other political leaders suggest that economists are unanimous in believing that government spending is the only answer.

“We have a consensus that we need a big stimulus package that will jolt the economy back into shape,” Obama said.

House Majority Leader Steny Hoyer agreed: “Every economist from right to left, Republican, Democrat, advises that it has to be a very substantial package.”

What Consensus?

It’s a lie. There was no consensus. (Anyway, a consensus doesn’t mean something is true.) Finding an economist who opposed government spending as a way to fix the economy was easy. More than 350 signed a petition opposing the bill.

“How is it the government is going to be able to spend a dollar in such a way that it generates a dollar or more in value?” asked George Mason University economist Peter Leeson. “A more likely possibility is that a dollar that government takes out of the private sector is a dollar the private sector doesn’t have to spend.”

Leeson is referring to the “broken-window” fallacy, which comes from Frédéric Bastiat’s story about a boy who throws a rock through a shop window. Since the shopkeeper has to buy a new window, some believe the mischief will actually stimulate the local economy. The fallacy lies in overlooking that the shopkeeper would have spent the money some other way if he didn’t have to replace the window.

Every penny the government spends will first have to be borrowed from someone in the economy—that is, someone already struggling with the recession’s effects on their income, assets, and future planning. So where’s the stimulus?

It’s also quite a conceit to believe that a few men in power are smart enough to know precisely how to spend trillions of your dollars.

“They’re exploiting a minor correction in the economy. . . . Markets go through corrections all the time,” Lydia Ortega of San Jose State University told me.

I pointed out that people say this correction is worse—maybe like the Depression.

“But markets need to go through this correction,” she said. “What’s happening now, what’s making it worse, is that people don’t know what’s going to happen. There’s so much uncertainty generated by the government spending.”

The more the government does, the more private investors wait.

“Part of the reason that people aren’t spending is they don’t know what these characters in Washington are going to do,” says Howard Baetjer of Towson University.

“Japan tried six spending packages in the early 1990s. The result? A decade of lost growth,” points out Ben Powell of Suffolk University. “It’s the government’s own policies that contributed to the bubble. The government’s not the answer to it.”

One Finger in the Dike, Two Crossed

I wanted to ask the bailout’s big boosters about that. Two agreed to talk: Maxine Waters of the House Finance Committee and Majority Leader Hoyer.

Hoyer conceded that he “overstated the case” when he said every economist endorsed government action.

Wasn’t the bubble caused by too much debt?

“No doubt about it.”

So the answer is more debt?

“Most economists believe that’s the case.”

This stimulus spending, is it going to work?

“I hope so.”

Might it cause hyperinflation?

“We hope it doesn’t.”

Well, that’s comforting.

“Government can’t sit and just twiddle its fingers,” Rep. Waters told me. “We have got to interject money into these banks and these systems that help this economy work.”

How are you going to pay for it?

“We have borrowed money before. We continue to borrow money, but we pay it back.”

She left a few things out. Debt means interest payments and higher taxes in the future. It also means inflation when the Fed prints money to reduce the real value of the debt.

But the politicians are confident that they can wisely spend trillions of your dollars. The arrogance of the political class is stunning.

Menger’s great work, translated into English (but not until seventy-nine years later!) under the title of Principles of Economics, was published in 1871. (Carl Menger, Principles of Economics, trans. James Dingwall and Bert F. Hoselitz (New York: New York University Press, 1981).

In the same year, by coincidence, W. Stanley Jevons in England published his Theory of Political Economy. Both authors independently developed the concept now known as “marginal utility.” (Menger never used the term. Jevons called it “final degree of utility.” It was Wieser who first employed the German term Grenz-nutzen, which translates as “marginal utility.”)

But as few American or British economists read German in the original, it was years before the real extent of the revolution begun by Menger was realized outside of German-speaking countries. For it was Menger, by recognizing most fully the implications of the marginal-utility concept, who opened up new paths and, so to speak, turned the old classical economics upside-down.

Menger insists throughout his work that value is essentially subjective, and that therefore economics must be in the main a subjective science. Goods have no inherent value in themselves. They are valued because they help to satisfy some human want or need. A given quantity or unit of a certain good will satisfy a man’s most intense desire or need. He may also want a second, third, or fourth increment. But after each unit consumed or employed, his desire or need for a further unit of that good may be less intense, and may finally become completely satisfied.

It follows that each increment of that good at his disposal will have a reduced value to him. But as no unit of the total available quantity of that good can have a greater value in exchange than any other (of the same quality), it follows further that no other unit will be worth more in the market than the “final” unit of the supply. Thus in a given community the exchange value of a given increment of each good will be determined by the relation between its total available quantity and the intensity of the human need or want that it fills.

So far this may seem like little more than a refinement on the old classical doctrine that value and price are determined by supply and demand. It seems merely to state that doctrine in subjective rather than objective terms. But then Menger comes to point out some of its implications. The values of goods are mutually interdependent. Bread is valued because it meets a direct consumption need. Flour is valued because it is needed to bake bread. Wheat is valued because it is needed to produce flour. Plows, seed, land, and labor are valued because they are necessary to produce wheat, and so on.

Values are also interdependent because, for example, if one raw material necessary in combination for the production of a final product is missing, that lack reduces the usefulness and value of the other raw materials needed.

Goods wanted and ready for direct use or consumption are called by Menger “goods of the first order.” Raw materials and other factors necessary to produce these are called “goods of the second order.” Materials, machinery, labor, and other factors needed in turn to produce these goods of the second order are called goods of the third order, and so on. These goods of the second, third, and other “higher” orders are valued because of the consumption goods that they produce.

Thus while the classical Ricardian doctrine held that the “normal” value of consumption goods was determined by their “cost of production,” the Austrian doctrine holds that the “cost of production” itself is ultimately determined by the value of consumption goods.

These two doctrines can be partly reconciled in the statement that though what a good has cost to produce cannot directly determine its value, what it will cost to produce determines how much of it will continue to be made. It is the limit that cost of production puts upon the total quantity of a good produced that determines its marginal value and therefore its market price. Thus there is a constant tendency for marginal cost of production and market price to equal each other, though not because the first directly determines the second.

Opportunity Costs

Something should be said also about the sharp distinction between the Ricardian and the Austrian concept of “cost.” The Ricardian (and the modern businessman) thinks of cost as a money outlay. But the Austrian economist has a much wider concept, what economists now call “opportunity” costs, or “forgone opportunity” costs. Such costs exist, of course, not only in business but in all our decisions and actions in life. The cost of learning French in any given period is to forgo learning German, or to learn less mathematics, or to give up some tennis or bridge, and so on.

Menger emphasizes the importance of time and the role of uncertainty in the whole productive process. He also points out that no single good, no matter how abundant, can maintain life and welfare, but that these depend upon the production of combinations of goods of different kinds in the proper proportions. And he points out, finally, that the process of production cannot be expected to go on at an adequate rate unless there is adequate protection of property.

The economic value of goods, to repeat, depends upon their respective quantities in relation to the human needs they meet. It does not necessarily depend upon the amount of labor expended in their production. To quote from Menger’s Principles of Economics: “Hence, if there were a society where all goods were available in amounts exceeding the requirements for them, there would be no economic goods nor any ‘wealth.’ . . . Hence we have the queer contradiction that a continuous increase of the objects of wealth would have, as a necessary final consequence, a diminution of wealth” (pp. 109–10).

(In other words, Menger pointed out more than a century ago a basic fallacy in the now-fashionable national income statistics.)

“The value of goods arises from their relationship to our needs, and is not inherent in the goods themselves . . . . Objectification of the value of goods, which is entirely subjective in nature, has nevertheless contributed very greatly to confusion about the basic principles of our science. . . . The importance that goods have for us and which we call value is merely imputed” (pp. 120–21, 139).

“There is no necessary and direct connection between the value of a good and whether, or in what quantities, labor and other goods of higher order were applied to its production. . . . Whether a diamond was found accidentally or was obtained from a diamond pit with the employment of a thousand days of labor is completely irrelevant for its value” (p. 146).

Menger goes on to discuss further how higher goods, including capital goods, get their value: “[I]t is evident that the value of goods of higher order is always and without exception determined by the prospective value of the goods of lower order in whose production they serve” (p. 150).

He outlines a theory of interest, but he leaves it vague. On page 156 of Principles of Economics he tells us: “[W]e have reached one of the most important truths of our science, the ‘productivity of capital.’” But he emphasizes that this productivity occurs only through the passage of time, and that therefore the market value of presently existing and available goods is at a “discount” compared with the expected value of equivalent goods in the future.

A Time-Preference Theory

This suggests that Menger leaned more toward a “time preference” than a “productivity” theory of interest, though the distinction between these theories was not sharpened and made explicit until the publication of Böhm-Bawerk’s Capital and Interest in 1884 and his Positive Theory of Capital in 1888. Böhm-Bawerk laid great emphasis upon the superior productivity of “roundabout” processes of production, and therefore (after a brilliant demolition of productivity theories of interest) ended by himself offering a theory of interest that combined productivity and time preference. Nearly all “Austrians” today, however, following the lead of Frank A. Fetter and later of Ludwig von Mises, support a pure time-preference theory.

To return to Menger: His Principles of Economics next presents a “theory of exchange.” In this he points out that men do not buy from or sell to or exchange with each other merely because of a “propensity of men to truck and barter,” as implied by Adam Smith, but because each man seeks to maximize his satisfactions by exchanging what he values less for what he values more. In this way the satisfaction of all is increased. Exchange is thus an integral part of the whole process of production. What is being produced is value. Menger’s whole theory of price, to repeat, is developed on the basis of “the subjective character of value.”

The final chapter of Menger’s Principles is on “The Theory of Money.” This does not explicitly discuss such subjects as interest rates or inflation, but deals solely with fundamentals, especially the origin and evolution of money. “Money is not the product of an agreement on the part of economizing men nor the product of legislative acts. No one invented it” (p. 262). It developed out of barter. Because it so seldom happened that A and B each had and was willing to offer exactly what the other wanted, triangular and indirect barter began to take place. Men first offered their specialized goods for more “marketable” goods more widely wanted, in the hope that they could exchange these, in turn, for the particular goods that they themselves wanted. As a result these more “saleable” goods became still more saleable because of this extra demand. The most saleable of all finally became “money.” Historically, all kinds of goods have served as money, though it later came down to coins of precise weights of copper, silver, or gold.

Money is not a “measure of value,” though it is legitimate to call it a measure of price. It is the only commodity in which all others can be evaluated without roundabout procedures. It is the most appropriate form in which people can save and store part of their wealth. The right of coinage has generally been left to governments, even though “they have so often and so greatly misused their power” (p. 283).

I may have seemed to devote a disproportionate amount of space to Menger, but the special contributions of Austrian economics can be most clearly realized, it seems to me, if we begin by dwelling in some detail on those of its originator.

Menger’s first important successor as an “Austrian” economist was Friedrich von Wieser, who, beginning in 1884, published several books elaborating, rounding out, and refining Menger’s theory of value, clarifying especially problems of cost, “imputation,” and distribution.

The next great successor was Eugen von Böhm-Bawerk, whose trailblazing contributions in Capital and Interest, in 1884, and the Positive Theory of Capital, in 1888, have already been referred to. In addition, Böhm-Bawerk wrote a brilliant demolition of Marx’s Das Kapital in 1896, in a comparatively short work first translated into English under the title Karl Marx and the Close of His System. In this essay Böhm-Bawerk exposed particularly the fallacies in Marx’s labor theory of value and his “exploitation” theories, which the latter had derived as a supposed corollary from errors of Ricardo. It should be emphasized that it was the analysis of Austrian economics that made Böhm’s refutation of Marx so conclusive. No refutation based on the assumptions of the old classical economics could have been as devastating.

But just as “good” buildings require different floor plans depending on their purpose, the structure of a “good” society also depends on the objectives of the society’s occupants. Barnett attempts to describe the structure of a society that will allow “each person to pursue [his subjectively determined perception of] happiness, peace, and prosperity while acting in close proximity to others.” Such a society requires justice and the rule of law, as the subtitle of the book suggests, so Barnett focuses on the necessary components of the structure of liberty in the face of the problems of knowledge, interest, and power. The result is an insightful, often brilliant presentation that deserves serious attention from those of us who share this vision of the good society.

Barnett is not attempting here to convince modern liberals or modern conservatives to become classical liberals or libertarians. Instead, he is writing to classical liberals and libertarians who already share his vision in an effort to show them what the structure of liberty requires. Convincing people that particular laws or policies are undesirable will have little long-term benefit if we do not have institutions of governance that sustain better rules and policies. Barnett argues that those institutions must be structured to handle the problems of knowledge, interest, and power.

Other political philosophers, of course, have wrestled with the problem of structuring liberty, but most who have preceded Barnett have not focused adequately on power. By bringing all three problems into the analysis Barnett is able to offer new insights regarding the kinds of institutions that are likely to produce justice and the rule of law in support of liberty. He questions some widely accepted principles of governance long cherished by classical liberals and proposes replacements.

Perhaps the best examples of this are in chapters 12 and 13, where Barnett turns to the problem of enforcement abuse and the nature of effective constitutional restraints on power. He challenges the argument by John Locke and other classical liberals who contend that a coercive monopoly of power is necessary to handle the problem of enforcement abuse. The “single power principle” has led classical liberals to focus on designing constitutional rules to shackle the monopoly in various ways. Barnett explains that the single power principle is itself a primary source of abuse and that the rule of law is not likely to be maintained even with such constraints as periodic elections and checks and balances.

Furthermore, the single power principle is inconsistent with other liberal tenets. For instance, as Barnett explains, “Some think that law enforcement and adjudication are so important that we must make an exception to the background right of freedom of contract and permit a coercive monopoly to provide such services. . . . [But] the more vital a good or service is, the more dangerous it is to let it be produced by a coercive monopoly.”

Barnett also points out that the reality of Western legal tradition is one of polycentric law, not monopolized law, and the competition between legal jurisdictions is actually the source of much of what is good about our modern legal system (many aspects of which are being undermined by increasing centralization of law). The rule of law, he argues, actually requires a polycentric constitutional order.

A brief review cannot possibly do justice to Barnett’s analysis. The two chapters devoted to the importance of the rule of law are truly outstanding, but I would not hesitate to say the same about many other of his arguments. This book makes an important contribution toward a more complete understanding of the structure that must underlie a society in which individuals can live in peace and prosperity. I strongly recommend The Structure of Liberty to anyone who seeks such a society.

Bruce Benson is DeVoe Moore Distinguished Research Professor at Florida State University.

This is a book on a vital—and much misunderstood—topic. It is sometimes excellent, but largely disappointing.

The book consists of 13 chapters divided into three sections: The History of the Modern International Monetary System, Modern Money and Central Banking, and Foundations for Monetary and Banking Reform. The editors’ introduction provides a good summary of each chapter. As Merton Miller notes in the foreword, the authors felt free to “disagree among themselves in their interpretations of key events, empirical evidence on devaluations, and a variety of other monetary issues.”

The book’s first section is its strongest. The late Murray Rothbard’s contribution, “The Gold-Exchange Standard in the Interwar Years,” alone is worth the price. Rothbard is especially effective in differentiating the “gold-exchange” standard, which Britain adopted in 1925, from pre-World War I monetary arrangements when gold coins circulated freely. Another noteworthy chapter is Frank van Dun’s “National Sovereignty and International Monetary Regimes,” in which the author draws on the work of political philosophers to explain why governments seek to dominate monetary systems at the expense of market efficiency.

The latter two sections generally reflect a weakness characterized by the first word in the book’s title—an excessive emphasis on money that disregards how electronic technology has altered the financial marketplace in recent years. By failing to describe how this marketplace actually works today, particularly in the industrialized nations, the authors misinterpret recent monetary events, which leads to policy prescriptions based on outdated understandings of that marketplace.

Today, all forms of money are merely credit instruments that also readily serve as media of exchange. That is, coins, currency, and checkable bank deposits represent credit extended to the issuers of media of exchange.

The authors seem not to understand that inflation is caused by excessively rapid credit expansion, because it is credit, not media of exchange per se, that gives individuals, businesses, and governments the ability to own assets or mortgage future income and tax collections. Media of exchange merely represent one way to facilitate a purchase; using a credit card or a check drawn against a pre-established line of credit represents an increasingly common way of buying something without any “money” changing hands.

Such transactions create credit; credit growth in turn is controlled by interest rates. If rates are too low, in real or inflation-adjusted terms, credit will grow too rapidly, causing inflation, regardless of what happens to the money supply. If rates are too high, credit demand will contract, eventually causing a recession, again regardless of changes in the money supply.

Interest, of course, is a price. Therefore, price stability depends on how accurately the credit markets price interest. Inflation’s decline in recent years reflects the improved functioning of the increasingly globalized financial marketplace in which debtors and creditors, acting out of self-interest, negotiate interest rates whose cumulative effect is to foster non-inflationary credit growth.

Unfortunately, the essays provide no sense of how the credit markets work and the overriding importance of properly priced interest even as they acknowledge the importance of the pricing mechanism generally. Consequently, they present worn-out, statist solutions, usually involving central banks, for ensuring price stability. For example, Steve Hanke and Kurt Schuler advocate currency boards (backing the local currency with the currency of another country). However, currency boards are unnecessary: merely guaranteeing the convertibility of government-issued currency into debt carrying a market rate of interest will protect any economy from a currency-driven inflation.

Lawrence White, Richard Timberlake, and others write fondly of a gold-based monetary standard. Gold and other specie standards, however, have never provided price stability, except over the very long term, nor have they been sustainable.

Several authors advocate fixed exchange rates, but they are unsustainable and wreak economic havoc when the inevitable devaluation occurs—witness today’s Asian crisis. Robert Keleher, for example, argues in “Global Economic Integration: Trends and Alternative Policy Responses” that fixed exchange rates “minimize the variability and dispersion of many other prices, and so further improve the workings of the price system.” Such price smoothing, though, distorts important price signals coming from the rest of the world. What advocates of fixed exchange rates ignore is that an exchange rate is a price, and therefore should no more be manipulated than the price of crude oil or toothpaste. Instead of distorting the pricing mechanism, public policy should ensure price stability by relying on market-determined prices, especially the price of credit and prices expressed in other currencies.

The subject of this book—ideal modern monetary and credit policies and institutions—desperately needs a penetrating analysis. Sadly, this book fails to deliver it. I hope that the next book to address this subject will.

And now we have Israel Kirzner’s Essays on Capital and Interest (Edward Elgar, 1996, 166 pages, $59.95). There is no intent on the part of the author or the reviewer to station this volume between the voter and the voting booth. However, the position that this book occupies on the Austro-neoclassical landscape is an eminently strategic one—so strategic as to warrant our issuing a Mises-style taboo, not to voters, but to all economists who adopt the Austrian perspective. But first we must put into perspective this new offering by Professor Kirzner.

The significance of this volume is not diminished by the fact that all its separate parts, except for the 12-page introductory essay, have been published before. With greater accessibility and appearing now together, these Essays provide a virtual history—and prehistory—of the modern Austrian resurgence. Three decades ago, well before the resurgence began, Professor Kirzner wrote An Essay on Capital. The four parts of this book (on Unfinished Plans, Stocks and Flows, Capital and Waiting, and Measuring Capital) read like the work of a lone scholar trying—and succeeding in most instances—to satisfy himself. The 1966 Essay, possibly the most underrated of all his contributions, appears anew as the longest of the 1996 Essays.

In late 1974, Professor Kirzner presented a paper titled Ludwig von Mises and the Theory of Capital and Interest in a special symposium at the Southern Economic Association meetings in Atlanta. At that time, a year after Mises’s death, and the year that the resurgence began (with a conference in Vermont at which Professor Kirzner was a key participant), there was a small but eager audience for his Austrian perspective. Professor Kirzner shows how Mises’s theory differs from Böhm-Bawerk’s and how it compares favorably to the theories of J. B. Clark and F. H. Knight. In part a stocktaking, in part a research agenda for himself and for others, this paper was first published in 1976 along with other papers at the SEA symposium and published again in 1979 along with other writings by Professor Kirzner. Its appearance in the present volume provides a perfect segue between his early work on the theory of capital and his later work on the theory of interest.

The final essay, The Pure Time-Preference Theory of Interest, first published in 1993, is clearly the work of a well-seasoned scholar. Professor Kirzner’s good scholarship shines through in all his writings, but here we see him as a veteran of many symposia and conferences complete with their unyielding question-and-answer sessions. His work now has a growing and challenging audience. He responds to criticisms as if he has heard those criticisms many times in many different forms—because he has. The exchanges with allies and critics over the years have allowed him to clarify his own ideas and to offer them in the most rhetorically effective ways.

Ralph W. Pfouts, who offered a generally favorable assessment of the 1966 Essay in the American Economic Review, suggested that the Austrian perspective is not the magic wand that makes all mysteries disappear.^[2] Professor Kirzner, with his newly published Essays, and especially with his essay on the theory of interest, shows that it is very nearly that. Interest is always and everywhere a matter of time preferences. The primordial preference for the sooner over the later is the basis for a unified treatment of intertemporal exchange—whether the exchange is with nature or with other economic actors and whether or not it involves the use of capital. Tracing out the consequences of the systemic discounting of the future provides us with a Copernican account of an economic phenomenon that otherwise would have to be explained by what we might justifiably call Ptolemaic interest-rate theory. Capital-productivity theories and waiting-as-a-factor theories appear strained, partial, and oblique in comparison to the pure time-preference theory—that magic wand so skillfully wielded by Professor Kirzner.

If interest is to be understood in terms of time preferences, capital is to be understood in terms of multiperiod plans. An Austrian subjectivist perspective on capital features the plans of individual entrepreneurs—plans that are subject to revision as the attempts to carry them out reveal conflicts with reality and with the unfolding plans of other entrepreneurs. As Professor Kirzner demonstrates time and again, the forward-looking, plan-oriented account of a capital-using economy wins out over the alternative accounts that focus on some isolated slice of time or on the physical productivity of the produced means of production.

Professor Kirzner’s perspective on capital and interest constitutes the essential difference between Austrian economics and neoclassical (particularly Chicago) economics and the essential bridge between Austrian microeconomics and Austrian macroeconomics. The book itself contains much about the essential difference but contains little about the essential bridge. The reason for this lacking is not difficult to explain. While contributing importantly, along with F. A. Hayek and Ludwig M. Lachmann, as a bridge-builder, Professor Kirzner has never actually crossed the bridge himself. The short introductory essay includes a brief explanation of his reluctance to cross over into macroeconomics. According to Professor Kirzner (p. 2), recent Austrian work on Hayekian cycle theory [and presumably on Austrian macroeconomics generally] seems, on the whole, to fail to draw on the subjectivist, Misesian, tradition which the contemporary Austrian resurgence has done so much to revive.

We can guess what he has in mind here. Austrian macroeconomics features the intertemporal structure of production, the structure being defined as a temporal sequence of stages of production. For concreteness, the sequential stages are commonly identified with broadly defined industries, such as mining, refining, manufacturing, wholesaling, and retailing. Too quickly, all the multiperiod planning that goes on within and between these stages are allowed to gel into a simple Hayekian triangle—with its summary representation of the relationship between the time element in the production process (the roundaboutness of production) and the market value of final output.

The right triangle, which Hayek introduced in his Prices and Production,^[3] gave him a leg up on Keynes, who paid no attention to production time. Consumer spending was represented by one leg of the triangle. This macroeconomic magnitude had the attention of both Keynes and Hayek. The other leg tracks the goods-in-process as the individual plans of producers transform labor and other resources into the goods that consumers buy. The Hayekian triangle allows us to show that (1) increased saving can make for more output but only in the more-distant future and (2) monetary expansion can deceive the market and derail the process that would otherwise keep production plans on track with intertemporal consumption preference. All this is well and good. But once the theory has been recast as a Hayekian triangle that can be reshaped by preference changes and distorted by policy activism, it is all too easy for the Austrian subjectivist to become a not-so-Austrian geometrician. This is Professor Kirzner’s lament.

And so now it is time for our Mises-style taboo: No Austrian economist who takes his subjectivism seriously should draw a Hayekian triangle until he has read Professor Kirzner’s Essays! There is no inherent clash between the macroeconomic theorizing that the Hayekian triangles facilitate (including the Austrian theory of the business cycle) and the Kirznerian perspective that keeps the triangle adequately subjectivized. Quite to the contrary, it is precisely our understanding of the process that Professor Kirzner elucidates, the ongoing attempts on the part of many entrepreneurs to carry out their individual multiperiod plans (as guided by market rates of interest or as misguided by the central bank’s rate of interest), that breathes subjectivist life into those otherwise meaningless triangles.

Professor Kirzner may well believe that if our Mises-style taboo keeps would-be macroeconomists from crossing the bridge without first reading the Essays, then the book itself will dissuade the readers—as it has dissuaded its writer—from crossing the bridge at all. Others, however, may believe that even the fullest compliance with the taboo will allow—even facilitate—some subjectively respectable bridge crossings. Austrian macroeconomics is not the oxymoron that some have long suspected it of being. While those practitioners among us will quickly forgive Professor Kirzner for never crossing over into macroeconomics, they can offer nothing but praise for the job of bridge-building that he has done so well.

Notes

1. Ludwig von Mises, Capital and Interest: Eugen von Böhm-Bawerk and the Discriminating Reader, Freeman, vol. 9, no. 8 (August) 1959, p. 52.
2. Ralph W. Pfouts, Review of An Essay on Capital, American Economic Review, vol. 58, no. 1 (March) 1968, p. 98.
3. Friedrich A. Hayek, Prices and Production, 2nd ed. (Clifton, N.J.: Augustus M. Kelley, Publishers, 1967 [originally published, 1935]).

Government lending is not limited to the lending of money. The government’s guarantee, when it is held by private people, is no less a pledge of the public credit than is the government’s direct loan paid out in cash; each is the undertaking to risk the government’s funds in a venture managed by private parties.

In the sense that each borrower undertakes to repay out of the revenues produced by his Work, all government lending is lending to finance enterprise. Where there is no enterprise, there is no prospect of repayment. In this broad sense, where enterprises and enterprisers are discussed in these general comments, the terms are used to apply to farmers and working people as well as to businessmen, partnerships, and corporations.

The theory of government lending is that it produces economic activity which otherwise would not occur. This means that if the government offers to pay the bills, now or later, homes will be built, factories will be constructed and outfitted, minerals will be mined, crops will be grown, electric power and telephone lines will be erected, goods will be exported for sale abroad, employment opportunities will be created, and many other business transactions will be undertaken, even if in each case it would have been unattractive or financially impossible for the people concerned to undertake the transaction unassisted.

Thus, by having the use of the government’s financial resources, through a loan or a guarantee, a man can become the owner of a home without first having earned and saved enough money to make a substantial down-payment. A manufacturer, producer, or distributor can expand his facilities and his output without first having accumulated enough property to collateralize a bank loan. A rural cooperative group can sponsor the extension of power and telephone lines into sparsely populated areas without first having acquired enough wealth to make the initial investment and to pay the premium costs of a marginal operation. An exporter can ship his goods for sale abroad in the face of substantial uncertainty concerning profits and collections. An employer can meet payrolls even though his resources may be temporarily frozen in overstocked supply bins and warehouses or in over-expanded customer charge accounts. And many businesses are afforded the opportunity to recover from disaster or from the mistakes of faulty management which, but for the government’s assistance, would have brought the threat of business failure and bankruptcy . . . .

These are the aims and the direct results of government lending, and they are represented to be its benefits. What are the indirect results and what, if any, are the drawbacks?

By legal restrictions and other requirements of trusteeship, private lenders are sometimes restrained from making a loan simply because the borrower’s need is too great or because it extends over too long a term.

When the government lends to fill this so-called credit gap, or when through its guarantee it induces private lenders to do so, it takes a considerable share in responsibility for initiating the borrower’s project, or for sponsoring its continued operation, more or less in the form in which the borrower conceived it. By doing so, the government relieves both the borrower and the private lender of responsibility for finding additional private investors, for reorganizing the project in other ways, or for working it out by other private means. Among other things, in a particular case, this may tend to stifle initiative.

The need for funds in large amounts or for long periods of time more often than not is the need for owner’s capital, and it is unsound economically to try to meet this need by supplying lender’s capital instead. Owners are free to tie up their funds for long periods. They also may take risks which lenders may not take. Where the government undertakes to lend what should be owner-cap-ital, or where a. banker does so in response to the government’s urging, they shift the business risk from owner to lender and the effect is to lower the standards of lending.

The hazard which goes along with lowering the standards of lending is the hazard that an owner will lose his property by inability to repay the loan with interest, and the lender will become the owner in his place.

The risks of ownership are inseparably woven into the concept of private property. When an owner is relieved of his normal risks other than by his own effort and industry, he is beholden to those who assume the risks in his place. This increases the likelihood that he also will be relieved of the other attributes of property ownership—the right, for example, to decide how, when, where, and by whom the property shall be used. In the end he is likely to be relieved of the property as well. When these things occur where the government provides the financing, the private property becomes public property instead and the government has the right to decide how, where, when, and by whom the property shall be used.

Responsibility follows risk. When an owner’s risk in an enterprise has been minimized or eliminated because the government has supplied the funds which he otherwise would have to supply, then, speaking comparatively, the owner tends to feel no great pain from the failure of the enterprise. He would stand to gain by its success, of course, and so he would tend to work for its success; but his position is an unbalanced one because he will not try desperately to prevent its failure . . . .

Private lenders are sometimes restrained from making a loan because the borrower’s collateral is not sufficiently marketable or because there is not enough of it and accordingly the risk of loss is too great.

When the government lends to fill this credit gap, or when through its guarantee it induces a private lender to do so, it takes the risk of tying up its funds beyond the time agreed upon; or it takes more than the normal risk of losing them in whole or in part. It may take both. Also, it takes the responsibility which goes along with the decision to initiate or prolong what certainly is a marginal enterprise and what may well be an uneconomic enterprise.

Here the government not only shifts the business risk from owner to lender, but also it weakens the nation’s economic structure by preventing the failure or other elimination of weak links in the chain.

We may not like to acknowledge it, but it is an essential truth that many in our society, though they may honestly wish to try, are not capable of being successful businessmen, successful farmers, or even successful homeowners. The failures of such people may be personal misfortunes, but there seems little justification for assessing the taxpayers to cover their losses.

The effect of government lending in these circumstances is not only to lower the standards of lending but to encourage mistaken enterprise with its accompanying dissatisfactions and frustrations.

Private lenders are sometimes restrained from supplying funds to a particular borrower because, though the risks are not too great, equally good investments are more conveniently available, or more profitable investments can be made at a lesser risk.

Where the government lends to fill such a credit gap as this, it is assisting unsuccessful competitors. The risks are the normal risks of conventional lending. But in addition, the government assumes responsibility for launching the projects which the borrowers could not launch through their own contacts in the private economy; and it does so without curing the defects which stood in the way.

When loans are made to business enterprises under these circumstances, the borrowers and their business associates are assisted in their competition with others who do not have the backing of the government. This raises in each case the question of whether the general public gains more benefit from helping the otherwise unfortunate loan applicant than it loses by hindering his otherwise more fortunate competitor. It is not possible for the government to assist one competitor without placing handicaps in the path of another.

When a private lender advances funds to a private borrower, both have a stake in the borrower’s enterprise. The lender will see to it that the borrower has a sufficient investment to assure his wholehearted effort for success of the undertaking; and once the lender has invested, he may generally be counted on to support the enterprise in every way that he can. Both stand to gain by its success. Lenders looking out for their own best interests can be, have been, and should continue to be a constructive force in the sound development of homes, communities, and businesses in the United States.

Something less than this occurs when the government makes direct loans. The government will not fail and go out of existence because its loans go bad. It will not even be seriously inconvenienced, and its officials are less likely to be criticized for having made a bad loan than they are for having rejected a borrower’s application. The government’s interest in success of the borrower’s enterprise is a remote, impersonal, statistical sort of an interest, almost totally dissociated from its interest as a lender.

A private lender’s interest in a borrower’s enterprise tends to be equally remote and impersonal when the lender holds the government’s guarantee. This has been amply demonstrated of late by the Senate’s inquiry into the “Federal Housing Administration scandal.” The private lender’s investment here is not a stake in an enterprise. It may appear to be one, but it actually is an investment in governmental debt and its financial soundness as an investment is unaffected by the fortunes of the borrower’s enterprise.

Irresponsible undertakings occur in these circumstances, and they are directly the result of the circumstances. Government lending tends to increase the incidence of irresponsibility in the undertaking of business transactions, including the undertaking to own a home.

Whether we like the idea or are repelled by it, promoters have always been important figures on our national scene. These are enthusiastic people with attractive ideas and persuasive ways. They know how to make friends and influence people.

The function of the promoter has been to originate new ventures and then to find operators and financiers and bring them together. The promotion may be as small a thing as the making of home repairs, and it may be as large a thing as the building of a bridge over the Bosporous . . . .

The economic problem concerning promoters is to keep them responsible, to restrain them. A part of the restraint comes from the prospective operator who, knowing his business, decides that the promoter’s dream makes sense or it doesn’t; in part, it comes from the prospective financier who, knowing his business, finds the financial risks acceptable or not. The financier and the operator working together explode the promoter’s dream or bring it to fruition, or they may give it a try and fail. Between them also they help to control the promoter’s fee, commission, or other compensation, this being a matter directly related to the success of their mutual undertaking.

When the government is the financier much of the restraint on promoters is gone; government lending officials have nothing at stake in the borrowers’ ventures. When the government is both the operator and the financier, the lack of restraint is even more severe. And anything can happen when the government is the promoter as well as the operator and the financier.

The establishment of a government lending program is an invitation to promoters . . . . It is particularly an invitation to the irresponsible element among the promoters because the government is not a canny lender. When the lender is not canny, promotion meets with less resistance and it is more than likely to yield the promoter more lucrative returns.

An important feature of the study of Reconstruction Finance Corporation lending made by the Senate’s Fulbright subcommittee in 1950 and 1951 was the disclosure of the weakness of the government’s officials and their inability to stand off the promoters. Now in 1954 we read of roving bands of promoters who sell overpriced substandard repair jobs to unwary homeowners to be paid for with the proceeds of loans guaranteed by the government . . . .

A good loan is one which is certain to be repaid with interest at maturity. The certainty of repayment is at risk on a poor one. The better the collateral pledged to secure repayment, the better the loan. Possession of the collateral, however, and freedom to use it, are at least as valuable to the borrower as they are to the lender and so it is generally to the borrower’s narrow interest to pledge as little as he can get by with. If only the borrowers’ inclinations were to govern, the nation’s loans would grow more and more speculative.

When private lenders are the custodians of the standards of lending, there is a strong resistance to a lowering of the standards. The lenders’ own selfish interests are involved. This is one of the strengths of our American competitive economic system . . . .

Government lending programs and government guarantee programs have a fatal attraction politically. They can be used handily to bestow favor on particular groups and persons. Through them the use of the nation’s wealth can be channeled to those people who are adjudged to have the need but not the means, and this can be done in large part without the appearance of taxing those who have the means. For lending purposes, the savings and other wealth of the people are assembled in the national treasury by issue of the government’s obligations in one form or another and through the lending programs, they are applied where their owners would not otherwise willingly apply them. Indirectly, this is compulsory lending. It is politically acceptable—even desirable—because the compulsion is concealed by the indirection. Who could object to the exchange of his savings for government bonds? And who really feels injury when a bad loan comes to light, as in recent years they have been doing with disturbing frequency?

Because it is attractive politically, government lending grows and grows. Each successive national administration offers more than the last, lest there appear to be retrogression where progress is desired; and there are plenty of pressure groups ready, willing, and able to point to any appearance of retrogression. On the face of it, the only way for a new national administration to offer more than its predecessor did is to expand the volume of the programs and the fields in which they are available, and to ease up on the standards so that more and more people can have the advantages with less and less risk on their own part.

When FHA began in 1934, a very substantial equity investment, as high as 50 per cent in some areas, was necessary before a man could borrow enough to build himself a home. Now, 20 years later, the proposal has been made in all seriousness, that FHA be authorized in some circumstances to pledge the government’s credit where a prospective homeowner has no resources at all and where 40 years is fixed as the term in which he will work out the mortgage. Forty years for many of us is the entire span of our working life and for some it is even more . . . .

Important economic degradation inevitably results when the government’s credit is placed at the disposal of private persons and private business concerns to help them gain competitive advantages, and it is the opinion of the task force that the long-term debilitating effects of this latter class of lending outweigh the benefits which the activities yield. These lending programs stifle the private initiative of individual people and though the government can rather easily engage in activities which stifle initiative, there is no positive way in which it can repair the damage. Initiative is encouraged and character is strengthened mainly through the opportunity and experience of overcoming adversity. []

Extracted from the February 1955 report by the Task Force on Lending Agencies, prepared for the Hoover Commission on Organization of the Executive Branch of the Government.

Henry Hazlitt, Newsweek, February 13, 1956