those in the working class who saved in an attempt to improve their position in society.
After War: Hyperinflation and Fiscal Mismanagement in the New Austria 53
In October and November 1918, the Austro-Hungarian Empire began to disintegrate as various national groups began to break away and declare their independence, most notably the Czechs and Slovaks, who joined in creating their own country, then the Hungarians, who were then followed by the Serbs, Croats, Slovenians, and Bosnians, who formed a new Yugoslavia. The Romanians soon began to incorporate Transylvania within their borders, and Italy seized south Tyrol and the port of Trieste. Galicia became a battleground between the Poles, the Ukrainians, and the Russian Bolsheviks in the next few years.
In what was declared the new state of German-Austria a coalition government was formed between the Social Democrats, the Christian Socialists, and the Nationalist Party. Almost immediately, they began a campaign of expensive food subsidies for the urban population at controlled prices, compulsory requisitioning of agricultural goods from the rural parts of the country, foreign exchange controls on all imports and exports at an artificial rate of exchange, a vast array of social welfare programs, and the use of the monetary printing press to finance it all. By the middle of 1919 and then into 1920 and 1921, serious inflation had degenerated into hyperinflation.54
Mises’s articles “Monetary Devaluation and the National Budget” and “For the Reintroduction of Normal Stock Market Practices in Foreign Exchange Dealings” explained that the foreign exchange rate was a market-created price that could not be simply fixed and manipulated by the state. The value of any one currency in terms of another was ultimately a reflection of each currency’s purchasing power. Guided by the “law of one price,” the market tendency was to establish the exchange rate at that point at which the attractiveness of buying some quantity of a good in either country was the same. Setting the exchange rate at some level other than the market-determined rate merely meant that it was artificially fixed at too dear or too cheap a price. In the face of the currency shortages that the exchange control resulted in, the government then commanded that all foreign exchange earnings be sold to the Austrian Exchange Control Authority at the fixed rate, with the government bureaucracy now determining the rationing of it to both importers and exporters.
Prohibiting normal foreign exchange dealings merely drove transactions underground into the black market, and prevented the functioning of those institutional arrangements through which individuals can hedge against uncertain fluctuations in the foreign exchange rate by utilizing a legal futures market. Instead, the inflationary environment, with limited legal avenues to “take cover” against the effects of a depreciating currency, meant that more and more people were shifting into the use of foreign monies in domestic Austrian business transactions. The foreign exchange controls needed to be abolished, and the printing presses needed to be brought to a halt if a monetary disaster was to be averted.
The fundamental cause for Austria’s problems was that it was in the stranglehold of the socialist idea, with all of its negative consequences. This was the theme in two pieces by Mises: “The Austrian Problem” and “The Social Democratic Agrarian Program.” The socialists were determined to control and spend their way into the destruction of the country. Under this administration, taxes and inflation ate away at the accumulated wealth of the past and hindered any capital formation in the present. They demagogically promised wealth while causing waste by nationalizing and regulating industries that ended up suffering losses that needed to be paid for through even more inflation. Their agricultural agenda was to do with the rural economy the same harm they were doing with industry and manufacturing in the cities.
What was to be done? In February 1921, Mises presented the outline of a plan in answer to the question, “How Can Austria Be Saved?” The first order of 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.”
