Human Action: A Treatise on Economics

by Ludwig VonMises

  Capital flight into a foreign country presupposes the propensity of foreigners to exchange their investments abroad against those in the country from which capital flees. A British capitalist cannot flee from his British investments if no foreigner buys them. It follows that capital flight can never result in the much talked about deterioration of the balance of payments. Neither can it make foreign exchange rates rise. If many capitalists—whether British or foreign—want to get rid of British securities, a drop in their prices will ensue. But it will not affect the exchange ratio between the sterling and foreign currencies.

  The same is valid with regard to capital invested in ready cash. The owner of French francs who anticipates the consequences of the French Government’s inflationary policy can either flee into “real goods” by the purchase of goods or into foreign exchange. But he must find people who are ready to take francs in exchange. He can flee only as long as there are still people left who appraise the future of the franc more optimistically than he himself does. What makes commodity prices and foreign exchange rates rise is not the conduct of those ready to give away francs, but the conduct of those refusing to take them except at a low rate of exchange.

  Governments pretend that in resorting to foreign exchange restrictions to prevent capital flight they are motivated by consideration of the nation’s vital interests. What they really bring about is contrary to the material interests of many citizens without any benefit to any citizen or to the phantom of the Volkswirtschaft. If there is inflation going on in France, it is certainly not to the advantage either of the nation as a whole or of any citizen that all the disastrous consequences should affect Frenchmen only. If some Frenchmen were to unload the burden of these losses on foreigners by selling them French banknotes or bonds redeemable in such banknotes, a part of these losses would fall upon foreigners. The manifest outcome of the prevention of such transactions is to make some Frenchmen poorer without making any Frenchmen richer. From the nationalist point of view this hardly seems desirable.

  Popular opinion finds something objectionable in every possible aspect of stock market transactions. If prices are rising, the speculators are denounced as profiteers who appropriate to themselves what by rights belongs to other people. If prices drop, the speculators are denounced for squandering the nation’s wealth. The profits of the speculators are vilified as robbery and theft at the expense of the rest of the nation. It is insinuated that they are the cause of the public’s poverty. It is customary to draw a distinction between this dishonest bounty of the jobbers and the profits of the manufacturer who does not merely gamble but supplies the consumers. Even financial writers fail to realize that stock exchange transactions produce neither profits nor losses, but are only the consummation of profits and losses arising in trading and manufacturing. These profits and losses, the outgrowth of the buying public’s approval or disapproval of the investments effected in the past, are made visible by the stock market. The turnover on the stock market does not affect the public. It is, on the contrary, the public’s reaction to the mode in which investors arranged production activities that determines the price structure of the securities market. It is ultimately the consumers’ attitude that makes some stocks rise, others drop. Those not saving and investing neither profit nor lose on account of fluctuations in stock exchange quotations. The trade on the securities market merely decides which investors shall earn profits and which shall suffer losses.17

  9. Money and Capital; Saving and Investment

  Capital is computed in terms of money and represents in such accounting a definite sum of money. But capital can also consist of amounts of money. As capital goods also are exchanged and as such exchanges are effected under the same conditions as the exchange of all other goods, here too indirect exchange and the use of money become peremptory. In the market economy no participant can forego the advantages which cash-holding conveys. Not only in their capacity as consumers, but also in their capacity as capitalists and entrepreneurs, individuals are under the necessity of keeping cash holdings.

  Those who have seen in this fact something puzzling and contradictory have been misled by a misconstruction of monetary calculation and capital accounting. They attempt to assign to capital accounting tasks which it can never achieve. Capital accounting is a mental tool of calculating and computing suitable for individuals and groups of individuals acting in the market economy. Only in the frame of monetary calculation can capital become computable. The sole task that capital accounting can perform is to show to the various individuals acting within a market economy whether the money equivalent of their funds devoted to acquisitive action has changed and to what extent. For all other purposes capital accounting is quite useless.

  If one tries to ascertain a magnitude called the volkswirtschaftliche capital or the social capital as distinct both from the acquisitive capital of various individuals and from the meaningless concept of the sum of the various individual’s acquisitive capital funds, then, of course, one is troubled by a spurious problem. What is the role of money, one asks, in such a concept of social capital? One discovers a momentous difference between capital as seen from the individual’s point of view and as seen from the standpoint of society. However, this whole reasoning is utterly fallacious. It is obviously contradictory to eliminate reference to money from the computation of a magnitude which cannot be computed otherwise than in terms of money. It is nonsensical to resort to monetary calculation in an attempt to ascertain a magnitude which is meaningless in an economic system in which there cannot be any money and no money prices for factors of production. As soon as our reasoning passes beyond the frame of a market society, it must renounce every reference to money and money prices. The concept of social capital can only be thought of as a collection of various goods. It is impossible to compare two collections of this type otherwise than by declaring that one of them is more serviceable in removing the uneasiness felt by the whole of society than the other. (Whether or not such a comprehensive judgment can be pronounced by any mortal man is another question.) No monetary expression can be applied to such collections. Monetary terms are void of any meaning in dealing with the capital problems of a social system in which there is no market for factors of production.

  In recent years economists have paid special attention to the role cash holding plays in the process of saving and capital accumulation. Many fallacious conclusions have been advanced about this role.

  If an individual employs a sum of money not for consumption but for the purchase of factors of production, saving is directly turned into capital accumulation. If the individual saver employs his additional savings for increasing his cash holding because this is in his eyes the most advantageous mode of using them, he brings about a tendency toward a fall in commodity prices and a rise in the monetary unit’s purchasing power. If we assume that the supply of money in the market system does not change, this conduct on the part of the saver will not directly influence the accumulation of capital and its employment for an expansion of production.18 The effect of our saver’s saving, i.e., the surplus of goods produced over goods consumed, does not disappear on account of his hoarding. The prices of capital goods do not rise to the height they would have attained in the absence of such hoarding. But the fact that more capital goods are available is not affected by the striving of a number of people to increase their cash holdings. If nobody employs the goods—the nonconsumption of which brought about the additional saving—for an expansion of his consumptive spending, they remain as an increment in the amount of capital goods available, whatever their prices may be. The two processes—increased cash holding and increased capital accumulation—take place side by side.

  A drop in commodity prices, other things being equal, causes a drop in the money equivalent of the various individuals’ capital. But this is not tantamount to a reduction in the supply of capital goods and does not require an adjustment of production activities to an alleged impoverishment. It merely alters the money i
tems to be applied in monetary calculation.

  Now let us assume that an increase in the quantity of credit money or of fiat money or credit expansion produces the additional money required for an expansion of the individuals’ cash holdings. Then three processes take their course independently: a tendency toward a fall in commodity prices brought about by the increase in the amount of capital goods available and the resulting expansion of production activities, a tendency toward a fall in prices brought about by an increased demand of money for cash holding, and finally a tendency toward a rise in prices brought about by the increase in the supply of money (in the broader sense). The three processes are to some extent synchronous. Each of them brings about its particular effects which, according to the circumstances, may be intensified or weakened by the opposite effects originating from one of the other two. But the main thing is that the capital goods resulting from the additional saving are not destroyed by the coincident monetary changes—changes in the demand for and the supply of money (in the broader sense). Whenever an individual devotes a sum of money to saving instead of spending it for consumption, the process of saving agrees perfectly with the process of capital accumulation and investment. It does not matter whether the individual saver does or does not increase his cash holding. The act of saving always has its counterpart in a supply of goods produced and not consumed, of goods available for further production activities. A man’s savings are always embodied in concrete capital goods.

  The idea that hoarded money is a barren part of the total amount of wealth the increase of which causes shrinkage in that part of wealth that is devoted to production is correct only to the extent that the rise in the monetary unit’s purchasing power results in the employment of additional factors of production for the mining of gold and in the transfer of gold from industrial to monetary employment. But this is brought about by the striving after increased cash holdings and not by saving. Saving, in the market economy, is possible only through abstention from the consumption of a part of income. The individual saver’s employment of his savings for hoarding influences the determination of money’s purchasing power, and may thus reduce the nominal amount of capital, i.e., its money equivalent; it does not render any part of the accumulated capital sterile.

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  1. Why man proceeds in this way, will be shown on the following pages.

  2. If the lengthening of durability were not at least proportionate to the increment in. expenditure needed, it would be more advantageous to increase the quantity of units of a shorter durability.

  3. Cf. Böhm-Bawerk, Kleinere Abhandlungen über Kapital und Zins, vol. II in Gesammelte Schriften, ed. F, X. Weiss (Vienna, 1926), p. 169.

  4. Time preference is not specifically human. It is an inherent feature of the behavior of all living beings. The distinction of man consists in the very fact that with him time preference is not inexorable and the lengthening of the period of provision not merely instinctive as with certain animals that store food, but the result of a process of valuation.

  5. For a detailed critical analysis of this part of Böhm-Bawerk’s reasoning the reader is referred to Mises, Nationalökonomie, pp. 439–443.

  6 Cf. F. A. Fetter, Economic Principles (New York, 1923), I, 239.

  7. These considerations explode the objections raised against the time-preference theory by Frank H. Knight in his article, “Capital, Time and the Interest Rate,” Economica, n.s., I, 257–286.

  8. Cf. F. A. Hayek, The Pure Theory of Capital (London, 1941), p. 48. It is awkward indeed to attach to certain lines of thought national labels. As Hayek remarks pertinently (p. 47, n. 1), the classical English economists since Ricardo, and particularly J. S. Mill (the latter probably partly under the influence of J. Rae) were in some regards more “Austrian” than their recent Anglo-Saxon successors.

  9. Cf. W. S. Jevons, The Theory of Political Economy (4th ed. London, 1924), pp. 224–229.

  10. This implies also equality in the quantity of nature-given factors available.

  11. Cf. John Bates Clark, Essentials of Economic Theory (New York, 1907), PP-133 ff

  12. About the Marxian attack against genetics, cf. T. D. Lysenko, Heredity and Variability (New York, 1945). A critical appraisal of this controversy is provided by J. R. Baker, Science and the Planned State (New York, 1945), pp. 71–76.

  13. Cf. Mises, Omnipotent Government (New Haven, 1944), p. 99 and the books quoted there.

  14. Cf. above, pp. 382–383, and below, pp. 676–677.

  15. Cf. Hayek, “The Mythology of Capital,” The Quarterly Journal of Economics, L (1936), 223 ff.

  16. The state and the municipalities, in the market economy, are also merely actors representing concerted action on the part of definite groups of individuals.

  17. The popular doctrine that the stock exchange “absorbs” capital and money is critically analyzed and entirely refuted by F. Machlup, The Stock Market, Credit and Capital Formation, trans. by V. Smith (London, 1940), PP. 6–153.

  18. Indirectly capital accumulation is affected by the changes in wealth and incomes which every instance of cashinduced change in the purchasing power of money brings about.

  XIX. THE RATE OF INTEREST

  1. The Phenomenon of Interest

  IT has been shown that time preference is a category inherent in every human action. Time preference manifests itself in the phenomenon of originary interest, i.e., the discount of future goods as against present goods.

  Interest is not merely interest on capital. Interest is not the specific income derived from the utilization of capital goods. The correspondence between three factors of production—labor, capital, and land—and three classes of income—wages, profit, and rent—as taught by the classical economists is untenable. Rent is not the specific revenue from land. Rent is a general catallactic phenomenon; it plays in the yield of labor and capital goods the same role it plays in the yield of land. Furthermore there is no homogeneous source of income that could be called profit in the sense in which the classical economists applied this term. Profit (in the sense of entrepreneurial profit) and interest are no more characteristic of capital than they are of land.

  The prices of consumers’ goods are by the interplay of the forces operating on the market apportioned to the various complementary factors cooperating in their production. As the consumers’ goods are present goods, while the factors of production are means for the production of future goods, and as present goods are valued higher than future goods of the same kind and quantity, the sum thus apportioned, even in the imaginary construction of the evenly rotating economy, falls behind the present price of the consumers’ goods concerned. This difference is the originary interest. It is not specifically connected with any of the three classes of factors of production which the classical economists distinguished. Entrepreneurial profit and loss are produced by changes in the data and the resulting price changes which occur in the passing of the period of production.

  Naïve reasoning does not see any problem in the current revenue derived from hunting, fishing, cattle breeding, forestry, and agriculture. Nature generates deer, fish, and cattle and makes them grow, causes the cows to give milk and the chickens to lay eggs, the trees to put on wood and to bear fruit, and the seeds to shoot into ears. He who has a title to appropriate for himself this recurring wealth enjoys a steady income. Like a stream which continually carries new water, the “stream of income” flows continually and conveys again and again new wealth. The whole process is plainly a natural phenomenon. But for the economist a problem is presented in the determination of prices for land, cattle, and all the rest. If future goods were not bought and sold at a discount as against present goods, the buyer of land would have to pay a price which equals the sum of all future net revenues and which would leave nothing for a current reiterated income.

  The yearly recurring proceeds of the owners of land and cattle are not marked by any characteristic which would catallactically distinguish the
m from the proceeds stemming from produced factors of production which are used up sooner or later in the processes of production. The power of disposal over a piece of land is the control of this field’s cooperation in the production of all the fruit which can ever be grown on it, and the power of disposal over a mine is the control of its cooperation in the extraction of all the minerals which can ever be brought to the surface from it. In the same way the ownership of a machine or a bale of cotton is the control of its cooperation in the manufacture of all goods which are produced with its cooperation. The fundamental fallacy implied in all the productivity and use approaches to the problem of interest was that they traced back the phenomenon of interest to these productive services rendered by the factors of production. However, the serviceableness of the factors of production determines the prices paid for them, not interest. These prices exhaust the whole difference between the productivity of a process aided by a definite factor’s cooperation and that of a process lacking this cooperation. The difference between the sum of the prices of the complementary factors of production and the products which emerges even in the absence of changes in the market data concerned, is an outcome of the higher valuation of present goods as compared with future goods. As production goes on, the factors of production are transformed or ripen into present goods of a higher value. This increment is the source of specific proceeds flowing into the hands of the owners of the factors of production, of originary interest.