The Golden Rule | Mises Institute

[Money, Sound and Unsound by Joseph T. Salerno (Ludwig von Mises Institute, 2010; xxvi+ 616 pp.)]

In the acknowledgements to his last great work of scholarship, An Austrian Perspective on the History of Economic Thought, Murray Rothbard says that, “Here again I must single out Joseph T. Salerno of Pace University, who has done remarkably creative work in the history of economic thought; and in Classical Economics, the second volume of his History of Economic Thought, he says about the bullionist debates of the nineteenth century, “Professor Joseph T. Salerno has recently made a notable advance by providing a far superior framework of analysis of the various thinkers.”

The controversies to which Rothbard refers featured a battle between the currency school, which wanted sound money (i.e., money not subject to state manipulation), and the banking school, which supported expansion of the money supply in times of depression. Readers will of course recognize that this dispute underlies the struggle between the Austrian theory of the business cycle, on the one hand, and various varieties of Keynesianism and monetarism in the twentieth century down to our own time.

In his introduction, a full-length essay, Salerno explains the currency school’s key doctrine and locates some flaws in it:

The sound money doctrine reached the peak of its influence in the mid-nineteenth century after another great debate in Great Britain between the “currency” school and the “banking” school. Supporters of the “currency principle” favored a monetary system in which the money supply of a nation varied rigidly with the quantity of metallic money (gold or silver) in the possession of its residents and on deposit at its banks. Their banking school opponents upheld the “banking principle,” according to which the national money supply would be adjusted by the banking system to accommodate the ever fluctuating “needs of trade.”. . . But although the currency principle was basically sound, its policy application was considerably weakened by two serious errors committed by its proponents. First, they failed to include demand deposits in the money supply, along with metallic coins and bank notes. . . . The result was that the money supply was still free to vary beyond the limits imposed by international gold flows thus subjecting the economy to continued recurrence of the inflation-depression cycle. This error in the currency school program was compounded by a second one that further undermined its ultimate goal of sound money and rendered the economy even more susceptible to cyclical fluctuations. . . The currency school proposed that the Bank of England, a governmentally privileged bank with a quasi-monopoly of the note issue, oversee the application and enforcement of the currency principle.

Displaying his ability to use the history of monetary theory, Salerno finds the root of efforts to use money as a policy tool in the inflationist John Law (1671–1729), notorious for his harebrained bubble that nearly wrecked the French economy. He says that,

The neo-Keynesians, monetarists, and supply-siders, differ among themselves in important areas of theory and policy, but all share most of Law’s fundamental ideas about money. All three schools predicate their monetary theories and policy prescriptions on Law’s fundamental assumption that money is a means or “tool” to be used by government planners in pursuing certain objectives, usually referred to as “policy goals.” In modern welfare states, these goals are typically formulated in terms of statistical aggregates and averages which are presumed to gauge the performance of the overall national, or “macro,” economy, e.g., the CPI, the unemployment rate, the rate of growth of real GNP, and so forth.

The modern followers of Law of course deny that they are inflationists but instead pose as defenders of stable money. This idea, Salerno shows, finds its most important theoretical defender in Irving Fisher, whose formulation of the quantity theory of money remains influential today. Salerno rejects the quantity theory of money, instead showing himself to be a creative exponent of the greatest of all monetary economists, Ludwig von Mises, whose epochal money regression theorem integrated monetary theory into the subjective theory of value. As Salerno puts it,

Thus, as Mises stated, “Precisely because the price increases have not affected all commodities at one time, shifts in the relationships of wealth and income are effected which affect the supply and demand of individual goods and services differently. Thus, these shifts must lead to a new orientation of the market and of market prices.” Moreover, as Mises contended in criticizing Irving Fisher’s formulation of the quantity theory, Fisher was led to contrive his artificial dichotomy between monetary theory and value theory as a makeshift defense against just such a charge of elementary logical error. . . .

In fact the efforts by neoclassical monetary theorists following [Don] Patinkin to “integrate monetary and value theory” missed the point, because they were aimed at repairing the Fisherian dichotomy without coming to terms with the value-theoretic error embodied in the neutral-money doctrine.

I have space for only one other example of Salerno’s work, and this is his reply to Gordon Tullock’s criticism of the Austrian theory of the business cycle. Salerno points out that a correct theory of the cycle cannot be content with the clever asides that were Tullock’s trademark but requires instead a proper methodological foundation:

The final nit Tullock picked out stems from his apparent misunderstanding of the methodological context of the Austrian business-cycle theory. Thus, the author faults Rothbard for ignoring the results of statistical tests that suggest that depressions and booms do not follow a cycle but, instead, follow a so-called “random walk.” This is beside the point, however, since Austrians do not construe the term business cycle as a mechanistic or statistical regularity that openly manifests itself in history, but as a recurring qualitative sequence of abstract economic phenomena that can only be detected in the historical data by the application of theory. In an early contribution, Mises wrote: “Neither the connection between boom and bust nor the cyclical change of business conditions is a fact that can be established independent of theory. Only theory, business cycle theory, permits us to detect the wavy outline of a cycle in the tangled confusion of events.”

I urge you to read this outstanding book. If you do, you will find that Salerno is sound on sound money.