The Austrians vs. the Keynesians: The end of the Federal Reserve

Austrian School economics is a philosophy almost exactly opposite to Keynesian economics. Where the Keynesians believe in a fiat (paper) money system in which a dollar is worth whatever they say it is and they can print as many of them as they want to manipulate price levels in the economy, the Austrians believe in a sound money system where the value of the dollar is directly tied to a fixed asset value. Gold is the preferred asset because it has a long history of acceptance as a global monetary exchange medium, and our own Constitution requires that gold and silver be the only forms of money used as legal tender for the re-payment of debts (Article 1, sections 8 and 10). In an Austrian monetary system, the central bank would not be allowed to simply print fiat money to suit its whims, every dollar would be accountable to an equivalent amount of reserve gold. And actually, in a true Austrian monetary system there would be no central bank. A central bank wouldn’t be necessary since interest rates and the money supply would not be manipulated, the primary means used by the Federal Reserve in its mandate for price stability.

In a true free-market economy, there is a fixed number of dollars, meaning that inflation is impossible unless you can inflate the asset to which the dollar is tied. The only way to inflate the value of a dollar tied to gold, for instance, is to dig up more gold. It is safe to say any inflation as a result would be slow and certainly able to be controlled. But in a Keynesian-managed monetary system, inflation is always a danger because to control price levels, the Federal Reserve is constantly printing and destroying money in a complex and difficult balancing act that has, as we are all too aware, gotten far out of control. Once out of control, then deflation becomes a threat when the credit bubbles created by unrestrained monetary inflation start to burst. The ‘tech’ bubble and the recent housing bubble were both a result of monetary credit inflation caused by the Federal Reserve’s inability to competently control interest rates. The Fed ineptly kept rates so low for so long, consumers and businesses were extended credit in amounts they will never be able to repay. Asset or credit bubbles can not occur in an Austrian School economy. It is simply impossible because the money supply can not be inflated and therefore a grossly exaggerated credit expansion simply cannot occur. The dollars, quite literally, just would not have been there to loan to un-creditworthy borrowers.

The Austrians are firm believers in laissez-faire when it comes to banking and financial interest rates. As with any other business service or product, the Austrians believe consumers will determine the interest rate they are willing to pay by virtue of their patronage of the various institutions. They contend that regulation of interest rates is only necessary in a managed economy where the central monetary authority (i.e., the Fed) artificially sets the rates; consumers cannot vote with their patronage, since neither they nor the banks have control over the prevailing rates which are artificially set by the central bank. Therefore, only under a managed financial system is it necessary to monitor compliance of the institutions to the mandates of the central authority. In a free market financial system, consumers would vote with their feet, choosing the banks with the best services and interest rates over the ones with less deficient services or exorbitant rates, just as they choose between Wal-mart and Target, etc.

[image-1]Fiat money systems always fail. There is no historical record of a country with a fiat money system which survived the ages. However, history is littered with fiat systems that failed, including our own Continental dollar during the American Revolution and greenbacks during the Civil War. This picture of a Weimar Republic woman burning German fiat money after WWI is not a joke. It was literally more efficient to burn the currency than the wood it would buy after the fiat currency hyper-inflated.

The Austrians insist you cannot spend your way out of a crisis caused by credit expansion (easy money debt). Decades ago the famous Austrian School economist Ludwig von Mises wrote:

"There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.”

If the Austrian School economists are right, the methods being employed by the President, the Congress, the Federal Reserve and the Treasury Department are exactly the wrong things to do for a swift end to the economic crisis. We can’t spend our way out of the mess we are in. Attempting to do so puts a huge strain on our dollar and will inevitably help it to collapse.

In this October 2008 Fox News interview of Ron Paul, he explains very well why the stimulus appropriations are a bad idea and points out the dangers of the Keynesian approach to monetary manipulation:

So, we have the Austrians led by Ron Paul, Peter Schiff and a growing coalition of concerned, enlightened congressmen pitted against the representatives of the money elite of the world, the Federal Reserve System led by Ben Bernanke, Timothy Geitner, Larry Summers and a truly global consortium of others… a veritable re-enactment of David and Goliath. The battle lines are drawn. Whoever wins will have a real and substantive impact on all of our lives for better or for worse for decades to come.

Next installment: The final installment of this series will explain how the Austrians are attempting to get the message out to you that there is an alternative to a Keynesian manipulated economy where booms and busts are artificially created and controlled by a central monetary authority. We will look at what they are doing to spread the word and assess the prospect of their ultimate success or failure. Stay tuned.

By Al Coryell

PoHo correspondent

In Part 1 and Part 2 of this series we learned the origin of the Federal Reserve System and looked at the Keynesian economic philosophy, the preferred philosophy of economists who have run the Fed since the Great Depression. We learned that Keynesian economic philosophy is an anti-free market philosophy, one that supports a centrally managed economy utilizing money and interest rate manipulation and taxation to control prices in the economy. Now we will look at the Austrian School economic philosophy and make some comparisons. There is a battle shaping up in Congress between the proponents of each philosophy. The winner of the battle will ultimately decide our collective economic fates well into the future...

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