Mises: The Man Who Predicted the Depression

Econophile's picture

By Jeff Harding
The Daily Capitalist

I've been meaning to write a piece on Ludwig von Mises, the greatest economist who ever lived, and, if you will, a hero of mine. This is a piece from the Op-Ed page of the Wall Street Journal by Mark Spitznagel. Spitznagel is the head of Universa Investments and is a protege and partner of Nassim Taleb of Black Swan fame. Those of you who have been following my blog know of my admiration of Mr. Taleb. He and Mr. Spitznagel were also "right," and Universa made a lot of money for their investors from our economic crisis.

Mises had as big a brain as you can get, and, in the social sciences field, he is the equivalent of Albert Einstein. His masterpiece, Human Action, was the summation of his ideas and philosophy. To explain his ideas would take some time. The thing is, it's difficult stuff. But, to use an analogy, he created a "unified field theory" equivalent for the social sciences. That is, he started with the basics, epistemology (the science of who you know what you know) and worked up from there, and created a complete explanation of human action, especially as an economic being.

His scholarship is peerless, his ideas are timeless, and, as Spitznagel puts it, he was "right." And still is. I don't mean to be hagiographic here, but he's that important of a scholar. I actually met Mises and his wife just before he died. I recall bringing my copy of Human Action along, but I was too shy to actually ask him to autograph it, although he and his wife were very gracious.

For those who wish to know more about Mises, there is plenty of information at the Mises Institute. I highly recommend his biography, Mises: The Last Knight of Liberalism, a massive work but is virtually a history of economics.

The Man Who Predicted the Depression

Ludwig von Mises explained how government-induced credit expansions led to imbalances in the economy.



Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today.

Mises's ideas on business cycles were spelled out in his 1912 tome "Theorie des Geldes und der Umlaufsmittel" ("The Theory of Money and Credit"). Not surprisingly few people noticed, as it was published only in German and wasn't exactly a beach read at that.


Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention. Left alone, interest rates would adjust such that only the amount of credit would be used as is voluntarily supplied and demanded. But when credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen.


Government-imposed expansion of bank credit distorts our "time preferences," or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers leads to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption.


Ordinarily, any random spikes in credit would be quickly absorbed by the system—the pricing errors corrected, the half-baked investments liquidated, like a supple tree yielding to the wind and then returning. But when the government holds rates artificially low in order to feed ever higher capital investment in otherwise unsound, unsustainable businesses, it creates the conditions for a crash. Everyone looks smart for a while, but eventually the whole monstrosity collapses under its own weight through a credit contraction or, worse, a banking collapse.


The system is dramatically susceptible to errors, both on the policy side and on the entrepreneurial side. Government expansion of credit takes a system otherwise capable of adjustment and resilience and transforms it into one with tremendous cyclical volatility.


"Theorie des Geldes" did not become the playbook for policy makers. The 1920s were marked by the brave new era of the Federal Reserve system promoting inflationary credit expansion and with it permanent prosperity. The nerve of this Doubting-Thomas, perma-bear, crazy Kraut! Sadly, poor Ludwig was very nearly alone in warning of the collapse to come from this credit expansion. In mid-1929, he stubbornly turned down a lucrative job offer from the Viennese bank Kreditanstalt, much to the annoyance of his fiancée, proclaiming "A great crash is coming, and I don't want my name in any way connected with it."


We all know what happened next. Pretty much right out of Mises's script, overleveraged banks (including Kreditanstalt) collapsed, businesses collapsed, employment collapsed. The brittle tree snapped. Following Mises's logic, was this a failure of capitalism, or a failure of hubris?


Mises's solution follows logically from his warnings. You can't fix what's broken by breaking it yet again. Stop the credit gavage. Stop inflating. Don't encourage consumption, but rather encourage saving and the repayment of debt. Let all the lame businesses fail—no bailouts. (You see where I'm going with this.) The distortions must be removed or else the precipice from which the system will inevitably fall will simply grow higher and higher.


Mises started getting some much-deserved respect once "Theorie des Geldes" was finally published in English in 1934. It is unfortunate that it required such a disaster for people to take heed of what was the one predictive, scholarly explanation of what was happening.


But then, just Mises's bad luck, along came John Maynard Keynes's tome "The General Theory of Employment, Interest and Money" in 1936. Keynes was dapper, fresh and sophisticated. He even wrote in English! And the guy had chutzpah, fearlessly fighting the battle against unemployment by running the currency printing press and draining the government's coffers.


He was the anti-Mises. So what if Keynes had lost his shirt in the stock-market crash. His book was peppered with fancy math (even Greek letters) and that meant rigor, modernity. To add insult to injury, Mises wasn't even refuted by Keynes and his ilk. He was ignored.


Fast forward 70-some years, during which we saw Keynesianism's repeated disappointments, the end of the gold standard, persistent inflation with intermittent inflationary recessions and banking crises, culminating in Alan Greenspan's "Great Moderation" and a subsequent catastrophic collapse in housing and banking. Where do we find ourselves? At a point of profound insight gained through economic logic, trial and error, and objective empiricism? Or right back where we started?


With interest rates at zero, monetary engines humming as never before, and a self-proclaimed Keynesian government, we are back again embracing the brave new era of government-sponsored prosperity and debt. And, more than ever, the system is piling uncertainties on top of uncertainties, turning an otherwise resilient economy into a brittle one.


How curious it is that the guy who wrote the script depicting our never ending story of government-induced credit expansion, inflation and collapse has remained so persistently forgotten. Must we sit through yet another performance of this tragic tale?


Mr. Spitznagel is the founder and chief investment officer of the hedge fund Universa Investments LP, based in Santa Monica, Calif.

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Anonymous's picture

My guess is that you have never actually even read any of the intros to either of their writings.

You just have no idea what you are talking about.

Anonymous's picture

and repeal the laws of gravity, conservation of mass/energy, and thermodynamics while they are at it.

Anonymous's picture

The inflationary attempts of the goverment where thus offset by the peoples attempts to convert their bank deposits into legal tender. (1930)

Americas great depession- Murray Rothbard

Is this the endgame for Bernanke and Obama when the public loses all their trust in the monetary system beacause of the reckless policys?

Lionhead's picture

You can't fix what's broken by breaking it yet again. Stop the credit gavage. Stop inflating. Don't encourage consumption, but rather encourage saving and the repayment of debt. Let all the lame businesses fail—no bailouts.

Precisely, & exactly what extracted the US from depression after the WWII. The war was a forced savings program by way of rationing ultimately leading to increased demand & savings to supply the demand. Duh, what part of this doesn't bernanke understand, the great scholar of the depression he proclaims himself to be. Let the market work!!!

bugs_'s picture

Rather than Albert Einstein I think Von Mises
is the Nikola Tesla of Economics.

Fabulous post!

Anonymous's picture

The inflationary attempts of the goverment where thus offset by the peoples attempts to convert their bank deposits into legal tender. (1930)

Americas great depession- Murray Rothbard

Is this the endgame for Bernanke and Obama when the public loses all their trust in the monetary system because of the reckless policys?

heatbarrier's picture

Mises an Fisher are the most relevant economists to understand the current situation. Mises saw the crash coming in the late 20s, Fisher missed it and he lost all in it, but in 1933 Fisher produced one of the most insightful analysis of the Great Depression,


If Fisher is right, we are headed for deflation. If Mises is right we are headed for inflation. I think Fisher's theory is correct, this is a global balance sheet recession and inflation may be very far down the line.  This is Richard Koo-Nomura, on balance sheet recessions,


mannfm11's picture

I believe Bernanke is following Fisher and Koo's ideas are along the same lines.  What they do is propose to make the depression last 20 or 30 years ala Japan.  Koo thinks the Japanese plan kept the country from collapsing and the only thing needed was to bail out the banks.  I kind of get his theory in that it theoretically allows the government to keep the money supply up, employment up while allowing for private side deleveraging.  But, Koo is a central banker and Fisher was a prime establishment guy and they miss the point that the problem is in banking itself when the government gets involved.  High levels of debt are in essense transfers of wealth and labor.  It appears to me that Koo creates perpetual debt bondage. 

Mises, on the other hand, proposed the system be wiped out and started over again.  Rothbard, a contemporary, basically calls banking a scam.  The granting of the manufacture of money to a select group who can use it for unconscionable gain or to wreck the economy, especially with the shield of deposit insurance that can only be paid in the end by the depositor, clearly makes it appear so.  Under the ideas of Mises, credit would be used wisely and rarely ever over extended.  The spirit of John Law and Louis XIV live on. 

heatbarrier's picture

Capital injections seems to be the way to restore the balance sheet imbalance, as Koo points out. But it has to be a large capital injection, which leads to the State as one of the key players. Fiscal stimulus just adds capacity, so that is not a solution, as Japan shows.  Perhaps an equity arm inside Treasury, similar to a Sovereign Fund.

The problem with all solutions proposed by eminent economists like Fisher, Keynes, is their reliance on debt to restore stability. This is the current strategy being followed and it won't work in a balance sheet recession. Mises was right in that more debt won't solve the problem but letting the system crash in not an option either, that would lead to the political chaos and wars, as history shows.

Apocalypse Now's picture

Excellent insights. 

We are currently in a credit collapse deflationary "deepression", and our current problems can only be solved with wage inflation and job growth - it can't be solved from the top down except for the government to help through job creation policies benefiting small and medium sized businesses where jobs are grown and ensuring they receive credit - not by giving money to monopolies that helped provide campaign contributions to shutter competitors.  Consumers can't increase spending without increases in disposable income or credit lines.

The upside down pyramid of assets with gold on the bottom describes the perceived riskiness of assets and the ultimate base (gold), but the picture does not include the other two primary risks - the income statement (increasing/decreasing disposable income) and the liability side of the balance sheet (primarily interest & the cost of future promises that are linked to incomes & public taxes) which both impact the sum total value of the asset class pyramid.  The growth and decline of average income (especially positive or negative disposable income) inflates and deflates the sum total value of all the asset classes.

The fed and treasury are merely buying time and trying to maintain population stability while the only economic indicators to watch are related to employment & income, credit expansion/deflation, gold increasing/decreasing, and interest rates.  Decreasing CPI, PPI, home prices, employment and therefore disposable income, and credit show that we are in a deflationary deepression.  Manipulation of a few statistics and pumping up financial assets don't point to inflation - they are designed to get people to fear inflation so they spend cash, if people don't spend we crash quicker.

With zero interest rates, extremely low 30 year rates, and continued deterioration in economic indicators like wage and PPI deflation there is no threat of inflation on the horizon.  Since demand is decreasing, factories and/or shifts should decrease to adjust to the new demand levels. 

However, capital is flowing out of the country or into gold, USD is dropping, and I believe that is more of a concern over a currency collapse (potential for failed debt auctions, difficulty in meeting national interest payments, and a crisis of confidence).  If this went full steam, it could create a currency crisis and hyper-inflation but I don't think we're there yet.  I would prefer japan over weimar or zimbabwe.

Unscarred's picture

I agree with much of what you have said.  Given the incestuous counter-party exposure in the U.S. financial system, matched with the interconnectedness of the global marketplace, the panic sell-off last September came from the risk of counter-party default.  Arguably, going forwards, this also poses the single greatest threat to both financial markets AND to global economic growth.

The best way to alleviate that risk is to inflate income and wages to further ensure that future liabilities will be met (which you stated in your post).  The inherent problem with that, obviously, is the devaluation of assets.

Conversely, that's what we would get if we faced a larger and more-protracted crisis in the future (like what we're facing with commercial real estate).

Simply stated, we need to choose between the real devaluation of assets (inflation) or nominal devaluation of assets (reduced market prices).

As per the future price of the dollar, I think it is important to keep in mind that the dollar's value is still relative to other global currencies.  Supposing the the dollar faces another 10- to 15-percent slide, other nations (especially Asian nations) will be forced to intervene, themselves.  The long-term result will be a weaker dollar, but this will happen in a more gradual and orderly manner.

The biggest question that I see going forwards is whether the inflation of income and wages will be significant enough to stave off counter-party catastrophe.  We already know what the consequences will be for inflating ourselves out of this mess, and the cures will be some very harsh medicine; what we don't know is whether the patient will be up and walking around or still lying on it's death bed.

Dantzler's picture

"As per the future price of the dollar, I think it is important to keep in mind that the dollar's value is still relative to other global currencies"

Except gold perhaps...

Unscarred's picture

Keep in mind that gold is not a fiat currency.  Gold is a store of value, and a long position in gold is in essence a short position on all global currencies (and likewise, owning fiat currencies is a short position on gold).

The key phrase in that statement is "relative to other currencies."  As all global currencies continue taking turns depreciating against each other, commodities and other economic inputs like gold (and oil, copper, iron ore, etc.) will continue to increase in nominal terms.

The real bitch will be when wages and income fail to increase in real terms, meaning we'll see a nation facing less discretionary income due to the increased prices of economic inputs (raw materials, etc.).

Anonymous's picture

While not the most wonderful mutual fund in the world, Eaton Vance Global Macro Absolute Return's (EAGMX) manager is a member of the Mises Institute.

Comrade de Chaos's picture

thanks, Human Action is on my winter reading list.

Voluntary Exchange's picture

Don't forget those who followed in his footsteps: Murry N. Rothbard, and Hans-Hermann Hoppe to name a few.


Interesting that when a great light (Von Mises) comes along, usually a great darkness comes along as well (Keynes). The Austrian school of economics allows you to make useful predictions, the Keynesian and other bunk help organized criminals (governments) to prey upon the productive. No wonder the Keynes junk is taught in the universities.


Anonymous's picture

And don't forget Professor Antal Fekete (who is still alive!). Professor Fekete says Mises was a great thinker but he made one mistake. The mistake was not to include Real Bills as a clearing system to allow for fluctuations in trade. Professor Fekete also says that continuously falling interest rates destroys capital by increasing the liquidation value of the (fixed rate)debt. He also says that we should have triple bottom line accounting so companies have a more accurate picture of their capital situation because of changes in interest rates. www.professorfekete.com