 This is Jeff Deist and you're listening to the Human Action Podcast. This is the Human Action Podcast and today we're discussing the theory of money and credit, which may be the most important book about money ever written. In fact, Professor Guido Halsman thinks in some ways it represents a bigger achievement for Mises than human action. Yet Mises produced it as his first major work in his late 20s as what we would today call his PhD dissertation. Because of this book, for the first time, we understand how and why money has value as a commodity with non-monetary uses that holds its worth over time. And it was precisely this temporal element that had eluded economists up until then, including Carl Menger whom we discussed a week ago with Dr. Joe Salerno. Mises not only applies Menger's idea of marginal utility to money and creates an entirely new theory of value for money, but he also presents us with an early version of business cycle theory and the importance of interest rates in guiding or in many cases misleading entrepreneurial action. This is a staggering work. It's one that deserves more attention. It's far shorter than human action and easier read. And so Professor Jeffrey Herbner of Grove City College joins us to give this a really full length treatment and do a deep dive into some of the economic theory that Mises presents. If you like the show, if you're interested in reading the book and understanding some of the monetary theory it presents, we have an offer at Mises.org slash TMC. Again, Mises.org slash TMC for the theory of money and credit put in the code HA POD, Human Action POD, and you'll get $5 off the hardcover version of this book, bringing it from $15 down to $10, which is an absolute great bargain for the hardcover. You can also just go to Mises.org and search theory of money and credit, and you'll find our free HTML and PDF links if you'd rather just consume it at no cost online. We hope you enjoy this discussion with Dr. Jeffrey Herbner, and we hope you're enjoying the new format podcast with deeper dives into presenting actual Austrian theory rather than just generalize libertarians' topics. So stay tuned for the theory of money and credit. Dr. Jeffrey Herbner, thank you for joining us on the Human Action Podcast. Well, thanks for having me, Jeff. It's a great pleasure. Well, I know you just finished up your student conference at Grove City College in Pennsylvania. Talk a little bit about that and how did it go and what is it entail? How can people find out more about that? Well, we are in our 15th year annually for doing the Austrian Student Scholars Conference, and I think the Institute posted a pair of Bailons keynote talk on Mises.org just this morning. So from there, I think you can get to the web site that we have for the conference, and you can not only see all of the keynotes, but you can get electronic copies of the papers that the students presented. We had 22 students present papers from about half from Grove City College and about half from the colleges and universities around the country and some from foreign countries. So it's a great program, and we hope to keep it going in the future. It's a wonderful networking opportunity for our students and the like-minded students at other places. It's a good way to contact some faculty that they've maybe read their work or like Pear Bailond and Chris Coyne and so on. So yeah, it's a great event. Well, ladies and gentlemen, we're all worried about the state of higher education, especially undergraduate higher education, some of the craziness that's going on, the lack of learning and really the brainwashing of young people. So we have to find whether we, I don't know if it's applicable to call young people the remnant, but we have to find the good young people out there. We have to reach them. We have to get them motivated and interested in Austrian economics and libertarian theory, because if we don't, they are going to be supplanted or outshouted or outvoted or outnumbered by the socialist young people. So I can't stress enough, if you have young people in your lives, high school, young college age people to get them to mises.org, to get them thinking about places like Grove City for their own studies, and you have not only Dr. Herbner there, but also his colleague, Sean Rittenauer. So for see Jeff, I've got a couple of years before college with my own kids. But so as I mentioned in the introduction, we are talking about mises is great. The theory of money and credit is his first full length book. Not only is it that it's basically his PhD dissertation. It is his thesis for his habilitation degree at the University of Vienna. He's writing this book, Jeff, between about 1906 and 1911. So all this is pre-war. Just talk about how this young guy is about 31 when it's published in 1912. I mean, this is basically the first big work he's done. It's not coincidentally a work on money. And if you believe Joe Salerno, if you believe Guido Halsman, this is one of the four great Austrian economic treatises. And it's a book on theory. And it's his first book. I mean, as your professor, just set for us what an achievement this was. Yeah, it's absolutely incredible. It's not only a very densely insightful book in terms of the particulars that he goes through in developing the theory, but he addressed the most pressing issue that was left untouched by the Marge's revolution, which was how do we integrate the value of money into the system of marginal utility and give a demand and supply explanation of the value of money? I mean, this was an amazing achievement that one could expect perhaps from a genius who had been in the middle of his career and had the time to master all of the literature. Imagine what he had to read in order to write a book on money and credit. And yet, as you say, he was writing this in his late 20s and then published it in 1931. I should say also that when I taught money in banking about 10 years ago at Grove City College, I taught it for four or five years, I used the theory of money and credit as the textbook. And it's accessible to students. It's an amazing work, deeply insightful and yet lucid and clear and organized in a way that's very accessible to the students. Well, it's strange to me, Jeff, I find it a far easier read than human action. I mean, even though obviously it's translated from the original German, then there's two different translations out there, two major translations. It's not a tough sled. Right, no, that's absolutely right. And the students appreciated that. You'd see them walk in the halls with their copies of theory of money and credit or you go to the library and then they are reading theory of money and credit. And coming in my office and asking me questions, insightful questions, they're obviously grasping what he's doing and they appreciate the organized structure of it. Well, I bet they also appreciate a $12 paperback as opposed to a $120 Samuel's or whatever. But what's interesting to me is there's this great anecdote in Huerta Serto's write up of the Austrian school where he says, Mises read Manger's principles in 1903. And up until then, like Manger had mostly trained in law and law was a little bit different. Legal education was a little different back then. It had some economics involved with it. But so in 1903, he makes this decision internally to become an economist. And less than a decade later in 1912, he's got theory of money and credit. Pretty remarkable. Yeah, just absolutely incredible, especially given his testimony, of course, that when he read Manger's work in 1903, it made an economist of him because before that, he was sort of a pragmatic, soft interventionist. Right. And Manger's principles does not give us a Mangerian monetary policy or a Mangerian monetary policy per se. It talks about the origins of money. But we can't really say at that point that Manger had delivered any kind of real monetary theory for Mises to build upon. Yeah, that's right. About the only other thing was the cash balance approach to the demand for money. So I think Mises saw that in Manger's work. Now, for folks who are wondering what I say the four great treatises of Austrian economics, there's some debate over this. Doctors Halsman and Salerno, for example, are not entirely in agreement. But generally speaking, people consider Mises' theory of money and credit, Manger's principles, Mises' human action and Rothbard's man economy and state as those four. So if you just read those, you're way ahead of the game. Jeff, I want to talk to you a little bit about the context, not just the Mangerian context, but the classical context in which Mises wrote this book. He talks at some length about the banking school versus the currency school, a debate that's still somewhat with us today. So can you give us sort of a rough draft of the banking school versus the currency school and why this milieu mattered when Mises wrote this book? Right. So the currency school of which Mises considered himself a member held this view that Mises develops in the theory of money and credit that any issue of fiduciary media, as he called it, would set in motion a boom bus cycle and that the origin then of the boom bus cycle was really embedded in the monetary regime and the way in which credit could be expanded through monetary inflation. And the banking school held the view that this Mises calls the inflationist view in theory of money and credit, that it was necessary for there to be monetary inflation to sort of fund additional economic activity. And so Mises was really writing within that debate when he talked about these issues of money and banking. Right. And the banking school, this idea is still with us today that we need a flexible amount of money in the economy to allow for growth. And I think if I recall, Rothbard touches on this in his short, what has government done to our money? In other words, we don't care per say about what the money supply is in society. In other words, prices adjust. Yes, that's absolutely right. So that's the one wing of the argument, right? Is that we don't need monetary inflation to have economic progress because the structure of prices adjusts through entrepreneurial anticipations and movements in demand across all the production processes and input prices in the economy. And then Mises furthers this, right, with his theory of the business cycle to show that not only don't we need monetary inflation, the monetary inflation is actually harmful to the process of economic progress. Okay, but I want to drive home this point. So the banking school is basically telling us that any kind of system of full convertibility to metal of paper money is actually harmful to the economy. It's going to hamstring the economy. And the currency school is sort of telling us, look, any kind of banking school approach is going to allow for paper to eventually overwhelm metal. And it's going to it's there's always going to be an incentive by kings or monarchs or states or whoever to create inflation. Yeah, that's exactly right. And courses is pointed out by others. The the only drawback or blindside of the currency school is that they didn't consider bank deposits as fiduciary issue. They thought of only bank note issue as creating this credit expansion process. And so in the restrictions that they put on bank note issue like the appeal act were inadequate. And then of course, they were discredited because monetary inflation credit expansion proceeded to pace even though the banking system had or at least the English state had adopted their policy. So but why do we use the term banking school? In other words, they're they're an inflationary school, a notion that we need to be able to expand the money supply. But it also implies that we need banks, whether that's central banks or commercial banks, a lot of people in libertarian circles at least today would say money could exist privately. So I mean, is this banking mean pro bank in this sense? Yeah, that's a good question. I'm not sure of the exact historical reason for the choice of the terminology why it's banking school and currency school. But Mises addresses the underlying theoretical issues in theory of money and credit where he talks conceptually about banking and the functions of banks that are performed legitimate important functions like financial intermediation and production of money substitutes and you know a currency exchange and so on and so forth. So these functions are important to be performed in in an economy, whether they're performed by banks or not is I guess an incidental feature. But in a world of Jeffrey Herbner's monetary regime, what would banks likely exist? Would they perform a useful or I should say value adding intermediary function in the economy? I think the answer would probably be yes. Yes, indeed. Right. So the banks or some institution would be valuable for the function of financial intermediation of borrowing from small savers and then pooling the money and investigating the credit worthy investors and then making loans and so on. So they perform that function and they would undoubtedly still provide us with a checking account balances but they would just be back to 100% by money itself. Well, can I just as an aside, Jeff, when I was young, I have some memory of my great grandfather who whose wife had died and he lived with us for a period. He had been in World War One and had learned his profession of electrician through a correspondent school literally from a match book company. And I remember him telling or remember my father conveying to me that he had gotten a bank loan for his house as a youngish man coming back from World War One based, you know, think about this at the time. There's no social security number. There's no credit system of Experian or any of these rating agencies. He had gotten a loan from a bank basically based on his local reputation as a guy who had was good at his job or showed up dutifully for work or was honorable or something. I mean, just imagine how and this is not too long after Mises writes this book. So just imagine what a different world we're living in. I mean, he literally got bank credit based on his localized reputation. Yeah, that's a very interesting case. It just goes to show you the way in which the function of financial intermediation, you know, borrowing, banks borrowing from some and then intermediating the credit to others can be performed efficiently by these market institutions in different settings, you know, one that's more it's more relevant to have a local base of information and a local base of operation and then others where maybe the bank is international and has other ways of ascertaining credit worthiness and happy, you know, the appropriate interest rate spread and so on and so forth. Well, I suspect he wasn't the only guy getting alone. No, I suspect the bank wasn't losing money. Right. So, but I want to get I want to move to part one of this book, which is really about the the origins of money. And I guess I want to ask you first, does it build much on mangers earlier insights that that money arises as the most saleable or marketable commodity in the economy? Does it does it build profoundly on that? Well, it develops from from manger. So, yeah, I would say it does. Mises, of course, solved the great logical problem that had been pointed out by Helferich against applying the marginal utility theory of value to money, which was, of course, what we call today the regression theorem of Mises. So, that is all really an outgrowth of mangers, a story about the origin of money. So, how it proceeds from a barter setting then step by step into into the generally saleable good and then into money. What about this idea that money is neither a production or consumption good? Is that novel at the time? I wouldn't say it's entirely novel. In my understanding, I think there were perhaps other economists who would have held this view. But I think it's certainly a minority position. And of course, what Mises is trying to show with this is that all of the important functions of money stem from its use as a general medium of exchange. So, the fact that it's a unit of count stems from its use as a general medium of exchange. And the use of money as a store of value is only undertaken by people because money is the general medium of exchange. So, that I think that position was, I think, unique with Mises. Well, what's interesting is it foreshadows a bit this debate between Mises and Hayek over what imperfect information in the economy really means to a capitalist or to an entrepreneur. Is it about a lack of knowledge? Or is it about a lack of property rights and the ability to calculate? Those are kind of two different things. And I think unit of account really goes to that calculation. In other words, capitalists need money prices. Yeah, no, you're at, you put your finger on it exactly. So, this is, Mises is the root of Mises' argument about calculation is that only with money prices can we reduce all of the different exchange ratios in the economy that entrepreneurs need to know to a common unit. And this common unit is the monetary unit. And then with that, comparisons could be made and we get economic calculation. And without that common unit, then we could have all the information of the sort of raw exchange ratios in barter or whatever, and it would do us no good. So, when we move into the part two of the book, which is all about the value of money, how money gets value, there really is no theory of value of money at the time. I mean, there are some ideas, but Mises is being novel here. He's creating a theory of value. Yeah, see, that's exactly right. Prior to Mises' work, of course, the value of money in the objective sense, the purchasing power of money, was conceived only through the quantity theory as a kind of aggregate relationship. And what Mises accomplished, of course, was to show that that's not correct to think of it this way, any more than it would be correct to think of the price of bread this way, or that there's aggregate demand for bread and the stock of bread and so on. But you have to build the theory from individual demands, individual marginal utilities. And so this was the big achievement on the value of money question. What is the quantity theory of money? Explain that for us. Well, the quantity theory of money is just based on the quantity equation, which is an accounting identity that says the money that's spent to buy goods is equal to the monetary value of the goods. And then this equation is disaggregated into components. So the money spent is disaggregated into the money stock and the so-called velocity of money. The number of times each monetary unit is spent on average over some period. And then the monetary value of the goods is split into the prices of the goods and then the quantities of the goods bought and sold. And so then from that point, depending on what you assume about the relationship between these four aggregate variables, you can get a definite relationship between prices in general and the money stock. So the classic case would be say in the short run, if you assume the velocity and the quantity of goods is fixed, then any increase in the money stock on the left side of the equation would be balanced by an equivalent increase in the price array on the right side of the equation. But of course, Mises brings up Kentillon. We see that new money is never evenly distributed. We all don't get an extra zero on our bank accounts. It flows through the economy unevenly and some people get rich. And this is exactly why he or it was the implication of his stress on the cash balance approach to money. This was the bridge that he used between the individual valuation of money and the demand for it that we can then aggregate the individual demand for it in cash balances. And this then allowed him to see how Kentillon effects are integrated into a value theory. Well, okay, help me with this. I bet like a lot of our listeners, I don't really get. I'm suspicious of this idea of velocity of money. It sounds like this Keynesian stimulus project, where if we're all out there moving money that somehow that motion equals action and we're getting wealthier. I mean, I'm reading this wrong. No, no, you're reading it exactly right. The whole terminology is disorienting and inappropriate. We don't talk this way about any other good. We don't talk about the velocity of automobiles or the velocity of men's dress shoes and so on as a way to explain the price of automobiles or the price of dress shoes. So Mises is saying, why do we do this? Why take this ad hoc-ish approach to money? Why can't we just think about money and its purchasing power in the same way that we think about the price of any other good? It's just determined by demand and supply. And the demand is determined by the value, the marginal utility that we place on the unit of the good, whether it's a new pair of shoes or a new sum of money. But all this goes back to what is money. It seems like the other schools have this mystical view of it. It's almost a historical and philosophical question as much as it is economics. What exactly is money? If you don't accept Mises's and Manger's notion of money as a commodity, all kinds of divisions are bound to happen, it seems to me. You're absolutely right. And Mises takes a lot of time and very money and credit to talk about these alternative views of money, like money as a claim and so on. And of course what Mises is insisting upon and Manger before Mises is that money is a good. And if it's an economic good, it's a scarce good, then it will conform to all the laws of human action that all other goods will in the market economy. And of course claims are not goods, two different things. Before we really get into this regression theorem and the circularity question, let's touch real quick on this use value versus exchange value. Manger got into it quite a bit. So the difference in a regular good, let's say a regular commodity and a money commodity, is that almost by Misesian definition anyway, there is no use value to money. Although they're both subjective that the second doesn't apply to money. It's not like a bushel of wheat you might eat. Right. Well, I would say it this way. There is no use value of money separate from its exchange value. Okay. Yeah, that I think is the way that Mises would state. So no subjective use value. There's no root subjective use value of money. In order to establish in our minds a use value for money, how we're going to subjectively rank it against goods, we have to already know it's purchasing power. Okay. So we take this Mangerian earthquake idea of marginal utility of good as a value theory for goods. But he doesn't take the next step and apply it to money. Mises does. So he creates, I guess, what we now call an Austrian theory of the value of money. Sort of give us his process or his mindset. Well, and before going through that step by step, let me just say this too. When Mises did this, he didn't just apply the marginal utility theory of value to money. He gave the final and necessary piece to explain how the marginal utility theory of value can be applied to any good in a market economy. Because if you can't have a marginal utility theory of money, then you can't conceive of how it's going to be ranked in an ordinal rank against goods. And therefore, you don't have a marginal utility theory of goods prices either. So this is what's meant by the integration that Mises achieved in applying the marginal utility theory to money. Now to go back to the regression theorem point. So the way in which it was left, this issue was left before Mises took it up, was that the marginal, if you want to think about the marginal utility of money, then you have this circularity problem. You can't even envision what the marginal utility of money could be until you already know the objective exchange value of money. And I think Visa actually made some, took some stabs at this problem by, and he was the one who first introduced the notion that there's really a time element to or a chronology to how a person would think about the subjective value of money and the purchasing power of money. We only need to know the purchasing power of money in the recent past in order to establish a subjective value for it now. And so the problem really isn't circularity along this line. The problem is we seem to be involved in an infinite regress. If we just keep regressing back in time, this sequence of marginal utility today relies on purchasing power yesterday which relied upon the marginal utility the day before and so on and so forth. We don't seem to have any stopping point. And this is where Mises built on Menger's theory of the origin of money where Mises said, yes, we do have a stopping point. The stopping point of this regress is the last day in which the commodity that became money was used just in barter. Because on that day, its subjective value, it can be determined independent from its purchasing power. Okay, so the circularity question, if we don't have a time element to this, we say, I've always struggled with the definition of this because I guess here's my thinking is, well, why do people value money because you can use it to buy stuff that you really want? Why do people accept it in exchange for stuff? Well, because it has value. So is that what it is? In other words, it has value because people assign it value and that seems circular. Is that what we mean? No, I don't think that's quite it, or at least that's not the way I would put it. I think it's just in, you can see it in comparison to another good. So if we say, how does a person establish in his mind the subjective value of an apple? We can see right away that that subjective value can be established in a person's mind independent from knowing the price of the apple. I don't need to know it at all. I can establish this just by the use value of the apple. Okay, but if money is, has use value only as the medium of exchange, then I can only establish a subjective value for it by knowing what it trades for in the market, that that's a necessary piece of information that I have to have in order to establish a subjective use value for money. And so if we go back in time, a day, a week, 10 years, and we can see that what we're using as a money commodity has value. The idea, part of the idea is that gives us greater comfort that if we accept it for stuff, that it'll have some value in the future. Right. Although Mises points out that, that money is the only good for which it's necessary for people to have some historical knowledge of, of its past exchange value. We don't need to, for this, this doesn't need to be true for other goods. But as you suggested, it needs to be true for money. Right. And some goods are brand new. Exactly. There is no past, they're a brand new product or something. But you know, here's, I think here's what critics would say, Jeff, they would say, well, okay, but a hundred years, for example, is an awful long time. And the US Fed has been producing, along with the Treasury has been producing US dollars since then. And, okay, there was Bretton Woods. And then there was Nixon's closing of the gold window convertibility in 71, yada, yada. And, you know, that's plenty far enough. And, and it, you know, being backed by the military might of the US government's enough, and you guys are looking for some pre-existing use as a commodity for money, all that is, is silly and outdated. I mean, this is, this is what I imagine as the counter. Right. Well, I guess there is some point to that, because what Mises is really pointing out in this argument is simply a question of pure logic. He's just trying to show that the argument that's been advanced about the purchasing power of money and the marginal utility of money is not subject to a logical fallacy. And he's not really interested in the historical question of how one could, could in fact trace back money. You know, if you wanted to, you could actually go back historically step by step. He's interested just in the abstract question of whether or not this argument that he's advanced about the marginal utility of money is subject to a logical fallacy. Is it subject to the logical fallacy of begging the question? Is it circular reasoning? And if not, is it then subject to the logical fallacy of infinite regress? And that's where the regression theorem comes in. So Mises is not trying to do some sort of historical analysis here. It's a purely logical question, a question of logic itself. Yeah. And of course, he's writing this against a background. Well, later he's going to work in various government functions in finance, public finance functions for the Viennese government. He's going to be a professor. He's going to be a lot of things, but he's also someone you can tell from this book is really grounded in monetary history. I mean, he talks about metals and bimetalism and all kinds of historical elements here that make us, you know, I think it helps sort of alter the perception of maybe some Austrian critics that this is some theoretical brainiac guy who's totally divorced from the real world where, in fact, he's anything but he works for the Viennese government. He's a soldier in the Austro-Hungarian army. He's all kinds of things. Yeah. Again, it's truly amazing when you read and absorb the work, how much he's read and retains and integrates. You know, another example of this is he points out the very first author who advanced the quantity theory, Davenzade or something like this back in the Middle Ages. They're probably not one in a thousand economists who even know that. Yeah, but this is true today, isn't it? The young PhDs in their 20s, early 30s don't really know. It's like they were dropped on an island. Yeah, that's right. Very unfortunate, but it's true. I mean, how do we deal with that? Do PhD programs not require history of economic thought? Yeah, they do not. That was driven out of professional economic training decades ago. Wow, that's interesting to me. People are interested. Bob Eklund, who is now retired from Auburn, and he's co-author of An Unbelievable. I almost call it a desktop reference on the history of economic thought because I keep it in my office. Now, it's an expensive textbook. You know the textbook racket, but it's really quite a shame. I don't know if you know this, Jeff. I'm actually happy that the newest person, the newest tenured full hire at the Auburn econ department is actually a young man. He's either from Iowa or Iowa State, who this is his area of specialization, the history of economic thought. I don't know what he thinks about the Austrians, but at least he has heard of them. He knows who they are. That's exactly right. Yeah, Eklund and Abraer's text is just wonderful, and you're absolutely right. If a newly minted PhD economist knows anything about history of economic thought, he's just a specialist in the history of economic thought. It's not like this is widely disseminated knowledge that you have to have in order to be a professional economist. But what kind of world are we in? If somebody listening to this podcast learns more about this than someone with a PhD in economics, it's upside down. Yeah, we're in the world that Joe Salerno likes to criticize. We're out of the world of vocational economics, and we're in this world of professional specialization where economists are mainly just advisors to government policy. Yeah. Well, so we struggle with this concept of value, and we come up with this, or he comes up, I should say, comes up with this breakthrough in helping us understand the value of money. And as you point out, that goes to the marginal ranking of everything, of all goods. Part three of the book is basically about money and banking. So he starts to integrate things like interest. He starts talking, giving us hints of a necessity and monetary policy. He gives us hints of a framework for business cycle theory. First and foremost, we were talking about this offline. I'm struck by his repeated use of the term fiduciary media. So first, tell us what that is. And as I said, I don't think that term was necessarily in widespread use in 1912. Right. So what Mises does here is provide a topology of what he calls money in the broad sense, the general medium of exchange. And he then categorizes, subcategorizes that into money proper, which then can take different forms, and then money substitutes, which are claims to money. And then the money substitutes, he subdivides into money certificates, which are claims that have been issued for which the issuing bank has 100% reserve of money for redemption. And then fiduciary media, which are claims, money substitutes for which the bank or issuing institution has only a fraction of reserve in money for redemption. And as he points out that this distinction is important because only the issue of fiduciary media permits the banks as a system to increase the money supply and expand credit. And as he points out, governments can issue fiduciary media too. Yes. Yes, that's exactly right. And in his day and age, that was happening as well, since Treasury Department, for example, would issue redeemable notes for gold and silver, gold and silver certificates. Well, so the rise of fiduciary media is he doesn't talk too much about full, what we would call full reserve banking or warehouse banking. I mean, so I guess the question in commercial banking, not government, what fiduciary media versus what? What's the alternative? Well, he was aware of this from the currency school debate. So the alternative was in fact a complete restriction of fiduciary issue. And we mentioned this before that the currency school, their big mistake according to Mises was they didn't grasp that bank deposits were money substitutes in the same way that written out banknotes were. And so while the currency school did say, look, we want a policy that limits the issue of additional banknotes, which would be consistent with Mises' policy, they didn't extend this to bank deposits. And so what Mises is saying, he's sort of filling in this gap and saying, no, no, it's any sort of form of the fiduciary issue that will generate monetary inflation and credit expansion. And so the best policy is to stop that additional issue. So theoretically, and this is a big debate, again, it foreshadows a debate amongst Austrians between full reserve and free banking schools. I mean, is this really a model for banks where they keep 100% of your money and you basically pay them for the security of it? And they issue kind of a warehouse receipt that's like a claim check at the opera for your code or something, and you go get your money and it's sitting there? I mean, is this a business model that's viable? Well, yes indeed. So this is what Mises writes about, of course. He says that, and I think Joe Salerno takes his position, this is my position as well, that you don't need to have a 100% reserve regulation or law. You simply have to have actual competition among banks that is not a system where they share reserves or policy in a cartilized arrangement, but each bank is independent and possesses its own money reserve into which its demand deposits are redeemable. And then just the competitive pressure among banks will limit their fiduciary issue and will achieve basically something close to 100% reserves. The fiduciary issue that would be forthcoming in a system like that would have minor effects. Now, when you say cartilized, what would be unacceptable or unacceptable? Like the Federal Reserve system, okay, unacceptable presumably in a Misesian monetary view. But what if a bunch of banks simply got together and privately sort of created their own insurance against a bank run and shared the premiums and spread the risk, and it's almost created a private FDIC. I mean, can we envision things like that? Yeah, well, we can not only envision it, we can look in history and see the clearinghouse systems that did this kind of thing, the suffix system back earlier in the 19th century. And of course, what happened is they all broke down from the moral hazard that's involved in trying to privately arrange cartil agreements. They're all subject to the same kind of problem that cheaters can benefit at the expense of those who continue to follow the cartel restrictions. And it was no different with private arrangements to cartilize and then share a pooled reserve. Now, what about there are free banking advocates around, like Larry White and George Seljanicato, who are certainly familiar with Austrian literature. Just in Jeff Herbner's banking system, are they allowed to have, let's say, low reserve riskier banks that actually pay interest against the really safe 100% reserve bank that maybe the little old lady goes to for security? I mean, are we allowed to have this kind of cowboy wheeling and dealing? And I don't want to get into the whole question of fraud and full reserve, but I mean, is that something that you would envision? Banks would be, yeah, my take on this is that, yes, banks would be legally free to try this out. They'd be legally free to try out any sort of voluntary financial innovation that they wanted to try out with their customers. And then we'd just let competition take its course. And so sure, they could try this out. But that's not really what's happened, though, is it in the 20th century? Oh, no. A fiduciary media has exploded and for unholy reasons starting with the Fed. Yeah, absolutely. And of course, here, we would agree with those on the free banking, the so-called free banking side. But here's the thing, it's fiduciary media today versus in Mises' time, I think we have to expand this. I mean, if we look at broader ideas or concepts of the broadest money supply, how much money is really out there sloshing around? You know, we've got base money, but now we've got M3 and even M4. I mean, there are things today we might almost hybrid instruments we might look at and say, gosh, that's basically a money substitute. Some people are even saying that about like Goldman Sachs bonds. In other words, it seems like we're on a slippery slope to creating so many money substitutes that we have a world awash in everything except all kinds of money and credit, but not enough of the real kind. Yeah, and here again, in thinking about that issue, Mises is our guide, right? And he very definitively defines what a money substitute is. It's a redemption claim for money that's perfectly secure and executable on demand for money. And so that focuses our attention on exactly what constitutes a money substitute. And then we can identify who's issuing actual claims like this. And we could discover then adding up what all of these money substitutes actually are in the economy. All of these other liquid assets then are in a sense pyramidable on top of this base money. And so the problem of the extension of these other liquid assets is partially at least a problem of the expansion of fiduciary media at the bottom of the base of this expansion. And so removing that and removing all implicit bailout guarantees and so on and so forth that generate the kind of moral hazard that's shot through our system. Then all of these highly liquid forms would also have to be radically reduced. But look at the stuff that's out there. I mean, we saw derivatives were a lot of derivative instruments were indeed bailed out in the 2008 crash because the Fed bought them from in bundles from commercial banks. I mean, we have money market funds. We have mutual funds. We have all kinds of bonds. It seems to me that there's an awful lot of stuff out there that investors minds or savers minds is almost money. Well, I think you're right. I think the increasing liquidity, the kind of artificial liquidity that can be created by fractional holdings can be extended way beyond money substitutes. And this is what has been done in our day and age. Well, let's talk about interest, about this, what it is and its function. And Joe Salerno and I talked about in Manger's principles, Frank Knight had a not too friendly snipe at Mises in the introduction to that. And he said, well, you know, Manger doesn't go quite so far as to have introduced this complete time theory of money, excuse me, time theory of interest. And so help us understand how does Mises see interest? What's its function? And how do we understand it in the economy? Right. Well, we only get the beginning of his interest rate theory really in this book, Theory Money and Credit. But his mature work, he adopts mainly from Frank Federer, who was a pure time preference theory theorist on interest, who argued that it's just embedded in the human condition that a present satisfaction is always preferred to the same satisfaction in the future. So sooner satisfaction always preferred to later satisfaction. So then the argument is that when money is exchanged intertemporally, present money will always command a premium based on this time preference element over future money. So there will always be a positive payment of interest made by the borrower paying back to the lender. So we always, for instance, we'd rather have our dream house at 40 than 90. Right. Because time has uncertainties, we could die, all kinds of things could happen. So we always prefer consumption or at least the satisfaction from having the money to potentially consume. We always prefer it sooner. Right. Okay. So I think Bombarever called it value spread. That's right. Yeah, there's been a long development of this theory and sort of the purging of fallacies. And Boombabrik, of course, was instrumental in the purging of all sorts of fallacies based on productivity as the source of interest. But he himself didn't go all the way to a pure time preference theory like Federer did, which is what Mises adopts. And so there's been this kind of gradual progress toward the Mises' final position. And Boombabrik was an important step in that. But what's, I think what's important here, one thing that's important is that Mises says interest is not part of production. It's something that lies outside of that because the marks and angles, the communists say, well, all value is created by labor. So if anyone's getting paid interest, that's just stolen from labor. And then I think even Sey, Jean-Baptiste Sey says, well, it's kind of income from capital. But I think what Mises is talking about is something very different here that this is separate from the productive process. Yes, that's absolutely right. People integrate time preference into their decisions to invest in production. But interest is not emanate out of production. It's just like all prices, it's a manifestation of our preferences for things. So is interest outside of the structure of production? The formation of interest is outside of the structure of production. But the structure of production then comes into existence in conformity with that rate of interest that or at least the fundamental rate of time preference that people have concerning trading off a present for future satisfaction. But here's what strikes me as if time plays such an important element in understanding the regression theorem and the value of money. It plays such an important element in understanding interest and banking. It seems like even today people just gloss over it, that they still don't see an intertemporal element to any of this. If you read, I don't know, Krugman or something, that all of this stuff is just sort of a, interest is just a policy tool. And none of this has anything to do with time or any things on the margin. I never hear anyone talk about time. No, you're absolutely right. Economists generally in the neoclassical mainstream think of just equilibrium. And so they think of the economy or even parts of the economy in a timeless way. And they certainly don't have an intertemporal capital structure like the Austrians do. So this is a big gap in the sort of conventional economists thinking about the economy. And you're also right that to the extent that they think about this issue of interest at all, it's just the, they would say maybe the price of money or the price of loanable funds in this market over here and that it can be manipulated by policy lowered by the Fed targeting or whatever. And this would stimulate aggregate demand and so on and so forth. So they think of interest only as a channel by which aggregate demand can be affected by policy, as you say. And so Mises sees the issuance of fiduciary media as something that suppresses or affects interest rates. Walk us through his nascent, I guess, version of Austrian business cycle theory that we get from this book. Right. So Mises says that if banks were not issuing fiduciary media, then they would just be intermediating credit. So they would have to borrow these funds from savers and pay them an interest rate and then perform their middleman function and lend the money to investors at the, so to speak, retail interest rate, paying the savers, the wholesale interest rate. So they get the interest rate spread for financial intermediation. And then the whole resource allocation that goes into producing capital goods along the production structure is constrained by this pool of saving that has been, well, the banks are intermediating part of it. And then some of it would be self-financed by entrepreneurs and so on. But it's limited to what savers wish to provide voluntarily given the payment of interest. So what fiduciary media issue allows is for banks to, by just creating fiduciary media claims out of thin air, just writing loans into people's bank accounts that can extend credit. And of course, if you increase the supply of any good, the market will only clear at a lower price. So you increase supply of credit, then interest rates must go down on these extended credit loans. And then through arbitration, the interest rate will lower on other, these funds can be channeled into other loan areas and then into the general production processes in the economy. So at low interest rates, the funds will be borrowed by entrepreneurs and they'll use these funds to buy new facilities or to use it as working capital to buy resources. And so production starts to be expanded in a way that's inconsistent with people's time preferences. Okay. And give us an example of that. In other words, all of a sudden, you've heard the saying lots of things look good on paper when interest rates are low. And I think this is true of all kinds of bubbles. Right. It's true of all the bubbles. So just take the housing bubble. So here, mortgage interest rates are suppressed and consumers then take out bigger mortgages by bigger houses. This stimulates profitability for construction of the houses. Then the entrepreneurs who are in the construction business see both more income from their production and low interest rates for expansion. And so they buy more equipment. And then the same phenomena occurs for the equipment producers. And so on and so forth, all the way back to the extraction of raw materials. So the iron mining companies find the same improvement in their financial condition and the same cheap credit that permits them to also finance an expansion in their own capital capacity and then, of course, investing more in working capital and so on. And so this whole process then proceeds along these lines. And the basic unsustainability of it all is realized through the artificial lengthening out of all of these production processes. That becomes inconsistent with the real resources that people actually desire to have allocated across the production of consumer goods and then they're saving and investing across all of the production of capital goods. So let's take your example of a construction company. Let's say they ramp up higher a bunch of guys buy a bunch of equipment. The notion of malinvestment comes in when all of a sudden demand for their housing in a region drops. We have a housing bust and all these guys and equipment because of their particular attributes or skills are not quickly and easily converted into, let's say that now the demand is for electric cars or something. In other words, there's a lot of waste. That's exactly right. And the waste is felt most with, as we say in economics, the specific assets that have been built up in these production processes. So the workers can probably find jobs at similar wages elsewhere in the economy. But the excavation equipment to be much more difficult to transfer at its boom level prices to sell into other uses. It's the capital capacity that has a high degree of specificity that loses most of its value. And then this explains, of course, why claims to those assets like stock markets and bond markets collapse. Well, I don't recall going through the book over the weekend, theory of money credit, which I've read a couple of times and I haven't read thoroughly recently. I don't recall, but I don't think Mises uses the term malinvestment in this book. No, I haven't noticed that either. I don't think he does. So this is something that comes, this is a term that comes long later to describe what happens in this length in the structure of production. Yes, that's right. Okay. Let's finish by talking about the closing part of the book, which is what he calls sound money. He's already discussed politics. He's already discussed a lot of the history of money. And I got to tell you, ladies and gentlemen, as we discussed earlier, this is not a tough read. Rothbard called it the most important book on money ever written. So we're happy to get a copy out to you. It's available for free online at Mises.org. We've got a great study guide that Bob Murphy wrote as well. So don't shy away from this book if you're not somebody who necessarily tackled or enjoyed human action, because this is a different animal. This is a younger Mises. And even with the translation from a German, I would say a punchier Mises, no offense to the great man. So when I look at this, to me, when he says sound money, he's not giving us some necessity in monetary policy. He's basically just saying metallic standard of some kind. Right. He defines sound money in this way, I think this is what he's driving at anyway. He says sound money is money that doesn't have its purchasing power influenced by politics. And this in his day and age, this meant commodity money, because the commodity has to be produced at cost and therefore it can't be just arbitrarily inflated at infant item. So this money supply business that we hear about all the time, why do we care? In other words, if the total supply of money doesn't increase or it increases slowly, why do we care? Prices adjust. Purchasing power is what we care about. Yes, that's right. The purchasing power and the relationship between prices. And as you say, the entrepreneurs in the market, this is their function to adjust input prices to output prices. So even if we had a time period for which there was mild price deflation, we would see entrepreneurs adjusting their demands as their output prices felled. Entrepreneurs would adjust their demands downward for input they use and input prices would fall and this would keep in balance the profitability of production. So when we're talking about commodities, historically the dominant commodity form of money has been gold. Mises talks about a gold standard. Give us the definition of a classical gold standard, but also give us a modern take what Jeffrey Herbner's present day gold standard might look like, gold in a modern economy. Okay, well the classical gold standard was a system in which each country who participated in the classical gold standard defined its currency in terms of weights of gold. So each currency was just by definition then redeemable for a certain amount of gold. This meant of course that each currency, say the dollar and the pound, had a fixed relationship in terms of gold claims to each other. So this was not a system of fixed exchange rates. It was a system of fixed definitions of currency in terms of gold. So the exchange rates so-called were given just by definition. And then of course in the actual trade of currencies in the market they could vary somewhat from this gold claim definition, but not very much because if they varied significantly, then there was an arbitrage profit that investors could get by selling one of the currencies and buying the other through exchanging gold. So the classical gold standard system kept a cap on the extent to which fiduciary media could be issued because it meant that as one fiduciary issue was issued more readily in one country, the reserve of gold as a ratio of the fiduciary issue would be reduced and then holders of this currency would begin to redeem and this redemption would place too much pressure on the remaining gold reserve and the countries would be forced to cut back. And so this is what you saw play out during the heyday of the gold standard, this kind of attempt on the part of governments to inflate and then a drawing back as international trade forced their hand as gold flowed out of their country. Now I think my ideal system is not this system at all but of course just a market system of production. So we'd have companies that would market their currencies, their production of money, gold coins or whatever it happened to be and then we would just let the competition sort things out. So whether we wound up on a gold standard or some mixed system would just be an entrepreneurial question that would be determined by everyone as users of the medium of exchange. Do you have any thoughts on cryptos and whether they could satisfy the market? Yeah, I think again I don't have any opinion as to whether they would win out in the competitive activity of the market but I think sure they should be tried, entrepreneurs should be able to try them out. Well I will say one thing about Bitcoin. I don't think Bitcoin would win out and it's precisely for the reason that most people advocate Bitcoin and this is that Bitcoin has an upper limit on its production. But if then that upper limit were ever reached then in a progressing economy you would have significant price deflation way more than we've ever seen historically and in fact it could get so extensive that price deflation rates could be larger than time preference interest rates in which case no lending could be done in Bitcoin and there'd have to at least be an auxiliary money used for all credit transactions. Well it's interesting talking about gold and whether it would win out in Professor Herbner's ideal system it's you know we tend to think of gold as this heavy shiny bulky thing and of and of course in part that's why paper currencies arose because they were more portable and divisible and you could have smaller denominations and they just represented gold in a bank hopefully. But you know there are people in the modern context writing about this. Steve Forbes has a book about gold James Rickards at Agora Publishing has a book called The New Gold Standard. Lewis Lehrman has written a book sort of the new case for gold I think and he wrote the in the 1980s the gold report for the Reagan commission with Dr. Ron Paul. So you know I think a lot of our listeners might say even our good libertarian and Austrian listeners might say well Professor Herbner that's great but we're not going to use gold anytime soon and this is all in the past and I'm as much as the Fed and the Treasury Department have tried to beat us over the head with fiat for a hundred years I'm not sure that that's necessarily true in your conception. Right I don't know if it's true or not it seems to be just to be an empirical question. Mises of course was in a different situation it was it was true for him that gold was the obvious alternative that the people would accept if if governments went back to sound money. It's also interesting that in his monetary proposal he advocates for the in this conversion agency that's going to print currency redeemable and gold he advocates for them to only produce really small bills and fairly large ones because Mises thought that just as an historical question if the gold standard was to be enduring people had to actually use gold coins physically because then when they were taken away they would object. Isn't that interesting people people could actually feel the difference in their hands in their pockets. On that note I'm just going to leave our audience with a couple sentences from the preface that Mises wrote to the English edition this book this was in 1934 so a couple decades after he finished it and he says I'm quoting him attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by the expansion of the circulation and this as must constantly be emphasized must necessarily lead to crisis and depression. I mean I read that sentence to talk about oppression guy I mean you you could have read that in 2008 in front of Bernanke you could read that today in front of Jerome Powell and and it would read every bit is true. Ladies gentlemen again check out the book it's well worth your time and as I mentioned in the introduction we do have a discount you know you can get a copy of this book in hardcover actually from the Mises Institute for only $10 we also have a discount on Bob Murphy's study guide to the theory of money and credit they're both well worth your time. Drs. F. R. Herbner I haven't seen you for a while hope to see you soon but it's great to connect with you via this medium and thank you so much for your time. Well thank you Jeff and we will see each other soon at the AERC. Yeah that's right that's right in March both Dr. Herbner and our audience I hope you enjoyed the Human Action Podcast. The Human Action Podcast is available on iTunes, SoundCloud, Stitcher, Spotify, Google Play and on Mises.org. Subscribe to get new episodes every week and find more content like this on Mises.org.