The Night Watchman

A Small Beacon in the Night of Unreason
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More Salsman Nonsense

In an earlier article, I took Richard Salsman to task for his vile and unjust treatment of George Reisman. To summarize: he tries to hide the fact that it was Reisman who identified the "primacy of profits" principle, i.e. the principle that wages are a deduction from profits, not the other way round; and he grossly misrepresents Reisman’s theory of profit.

A young man of my acquaintance, who is very interested in Austrian economics(1), recently sent me a couple of quotes from Richard Salsman that he had picked up on the net. While those quotes are undoubtedly taken out of a larger context, of which I know nothing, I think they do shed light on Salsman’s flawed understanding of Austrian economics.

In the Austrian theory of business cycles, it is easy to detect a lack of appreciation for the intelligence, wisdom and foresight of entrepreneurs, businessmen and investors. Austrian economists presume producers are easily fooled by government manipulations of money, credit, and the economy—especially by the alleged phenomenon of "artificially" low interest rates. They claim producers are conned into undertaking projects that later will turn out badly and require liquidation. In fact, producers are not fooled; they know, even if implicitly, which government policies are conducive to wealth creation and which are destructive. That is, they know when it’s worth producing and when it’s only worth shrugging. And when they shrug and production grinds to a halt, it does not grind to a halt because they had previously produced. [All italics mine.]

One would expect a minimal understanding of the Austrian theory of business cycles from anyone who attempts to criticize or refute it. But this is a "strawman argument" if ever I saw one. For who has said that production in a depression grinds to a halt because the producers had previously produced? It grinds to a halt because they had produced the wrong things. They had produced things for which there was an appearance of a demand, an appearance that later turned out to be illusory.

Salsman is obviously unaware of what the theory he attacks actually says, so a short recapitulation might be necessary. It starts with the observation that newly created money reaches some recipients first and other recipients only later – so that, in the beginning of an inflation, the first recipients stand to gain, while the later recipients stand to lose. This is so, because the first recipients receive their money before prices have risen, while the later recipients receive it when prices have already risen.

But this is not all. The next step is that newly created money and artificial credit expansion necessarily lead to malinvestments. To take a standard, simplified example: suppose that the new money and the artificial credit first go to the shoe industry (because the government believes that the shoe industry is in need of "stimulation"). Now, more shoes will be produced. Labor will be attracted to the shoe industry, which is now in a position to offer higher wages. There is now a greater demand for leather, so the same thing will happen to the leather industry. And more animals will be bred for the purpose of providing the leather industry with hides. In short, industries connected with shoes will experience a "boom". In this example, other branches, such as the shirt industry, will suffer a set-back: their workers will go into the shoe industry, there will be a lower demand for wool and cotton; sheep farmers and cotton growers will not fare as well.

And later, when the "boom" turns into a "bust", it will emerge that more shoes had been produced than people actually need; more leather than needed had been produced, and more animals bred only for their hides. Shoes will have to be sold at very low prices to be sold at all, workers will have to be laid off, shoe and leather manufacturers will experience hard times, even bankruptcy. But is this because the shoe and leather manufacturers had previously produced? No. It is because they had produced the wrong things – in this case, too many shoes and too few shirts.

Now, this is a simplified example, because credit is usually not artificially expanded to favor one particular branch, but rather to "set the wheels rolling" in the economy as a whole. But the example serves to show what will happen. In real life, what happens to the shoe industry in my example will simply be multiplied to many other industries and branches.

What about the claim that "the phenomenon of ‘artificially’ low interest rates" is merely alleged? Well, not to mince words, it is ridiculous.

On an unhampered market, free of government intervention, lower interest rates are a signal that big projects that were earlier marginally unprofitable now are marginally profitable. (One may think of projects such as digging a tunnel or a canal or building a big bridge or a new railway – any big and costly project like that.) This fact, by the way, plays a prominent role in Reisman’s Capitalism: it means that when profits and interest fall, if will set in motion what Reisman calls "springs to profitability" (and therefore, one never has to fear that profits would ever be "too low" or fall to zero.)

But it is very different when the government and its central bank create fiat money and extends it in the form of loans; for now it appears that those big projects have become marginally profitable, although in actual sober (market oriented) fact they are not. It simply sets in motion the "boom-bust" cycle.

Now to the question whether "producers are conned into undertaking projects that later will turn out badly and require liquidation". The simplest answer to that is that if they were not conned, the "boom-bust" cycle would not take place. But it does. Certainly, entrepreneurs, businessmen and investors may respond differently to artificially expanded credit – those who take it "with a grain of salt" will fare better in the long run than those who do not. And Mises himself has once pointed out that if his business cycle theory were more widely known, people might respond to credit expansion with more caution.(2)

But there is a further reason why the bad effects of artificial credit expansion are inescapable, and that is that banks have to compete with low interest rates. A bank obviously does not attract loan customers by offering a high interest rate: it has to offer as low an interest rate as is still profitable to the bank. Now, the first effect of credit expansion is that interest falls. (This is the reason for the credit expansion in the first place: one wants to create "easy money". Later in the business cycle, interest goes up – unless this is foolishly counteracted by a new injection of fiat money.) If some bank did not follow suit but continued to make loans to the previous higher interest, it would attract no customers and would have to face bankruptcy.

Here, one could certainly say that banks and their loan customers are conned by the central bank. But it is true that while a bank has to follow suit as regards interest rates, it could still remain cautious about issuing loans. If a banker knew the Austrian business cycle theory, he would. And actually, he could be cautious out of plain common sense: experience has told us over and over again that those "booms" always come to an end, and that there will be "hell to pay" later on.(3)


While this quote from Salsman might be explained by lack of knowledge, I do not know what explains the next quote, except a sheer flight into fantasy:

When the Austrian view of the business cycle is coupled with a malevolent-universe premise—with the view that in the economy or stock market "what goes up must come down," that "all good things must come to an end," that no long ride of unbroken prosperity can ever persist without taking on irrationally exuberant hitchhikers—the combination can be catastrophic. For it can bring even purported champions of capitalism to openly endorse destructive policies such as Federal Reserve interest-rate hikes, curbs on the stock exchange, and more burdensome government regulations." [Italics mine.]

Just one question: Whenever did you see or hear an Austrian economist "openly endorse destructive policies such as Federal Reserve interest-rate hikes(4), curbs on the stock exchange, and more burdensome government regulations"? Now, Austrian economist are certainly not infallible: they do make mistakes – but never this kind of mistake.(5)

So what is Salsman saying here? Merely that they would make this kind of mistake – if their view of the business cycle "is coupled with a malevolent-universe premise".(6) But please follow logic here: since they do not make those mistakes, it can only mean that no "Austrian" actually has a malevolent-universe premise! Then, why attack them as if they had? This is a strawman argument directly taken out of Salsman’s own dream world! And what do Salsman’s dreams have to do with actual, real-life reality?

This is clearly a case of Objectivism being misused as a rationalization for some devious purpose. And it is certainly a case of psychologizing (see Miss Rand’s essay "The Psychology of Psychologizing" in The Voice of Reason): argument is replaced with speculations about possible – even completely unproved – psychological motivations.


This, I think, will suffice. But there is one further point I would like to touch on: Salsman is opposed to the idea of a 100% gold standard and an advocate of a "fractional" gold standard – and because of his (undeserved) prominence in the Objectivist movement, many Objectivists swallow this view.(7) But "fractional" money is simply counterfeiting. The argument I have heard from followers of Salsman it that "fractional banking" is a phenomenon that appears on a free market, so there could be nothing wrong with it. But counterfeiting is counterfeiting, whether perpetrated by the central bank or by private banks! (Pick-pockets, too, appear on a free market; this does not make pick-pocketing right.) I have written extensively on this matter, but only in Swedish.(8)


Post scriptum: I originally excluded the following quote, because I did not know quite what to say about it. But now I think there is something to say about it, so here it is:

Another common claim about stock-price gains in the 1920s is that they were made possible by Federal Reserve "inflation." This view is held by many supposed free-market economists—monetarists and Austrians—and is certainly a tempting thesis for those who oppose central banking. But was Alan Greenspan correct when he wrote, in the mid-1960s, that the late-1920s represented a "fantastic speculative boom" that was triggered by "excess credit" pumped out by the Fed—credit which then allegedly "spilled over into the stock market"? This view of the late-1920s stock-price rise could not be more wrong.

Greenspan writes about this in his essay "Gold and Economic Freedom", which was included in Capitalism: The Unknown Ideal. And in the preceding chapter of the book, "Common Fallacies About Capitalism", one may read the following words from Nathaniel Branden:

Throughout most of the 1920’s, the government compelled banks to keep interest rates artificially and uneconomically low. As a consequence, money was poured into every sort of speculative venture. […] The boom and the wild speculation – which had preceded every major depression – were allowed to rise unchecked, involving, in a widening network of malinvestments and miscalculations, the entire economic structure of the nation. People were investing in virtually everything and making fortunes overnight – on paper. Profits were calculated on hysterically exaggerated appraisals of the future earnings of companies. Credit was extended with promiscuous abandon, on the premise that that somehow the goods would be there to back it up. […] Such, in essence, was the nature and cause of the 1929 depression. [P. 80f in my copy of CUI. Read the whole section, which is under the heading "Depressions".]

Those statements by Greenspan and Branden were first made in The Objectivist Newsletter and later included in Capitalism: The Unknown Ideal.(9) They must have had Ayn Rand’s approval! And we do know that Miss Rand had a high regard for "Austrian" economics; she disapproved of its philosophical underpinnings, but she did think it was the best school of economics.

And now, Salsman is running in – like a fool where angels fear to tread – to tell us that this is all wrong. "Easy money" and excessive credit were not operative causes at all in the Great Depression! I think this is ludicrous on the face of it, but let him prove it if he can. But then he should also have the guts to tell every "hard-core" Objectivist in sight that be believes Ayn Rand betrayed Objectivist principles by endorsing "Austrianism" in economics – and that she was a complete fool in doing so. (Yes: Salsman’s prominence in the Objectivist movement is truly undeserved.)

Salsman is also known for having stated that modern "Austrians" – including George Reisman – are "German-Kantian-Rationalists". But I will not comment on this: it is simply too low for words.


1) If you read Swedish, you can visit his blog.

2) In a letter to Ludwig Lachmann, quoted by Frank Shostak, in an article called Expectations and Austrian Cycle Theory. To this article, I also owe the point I make in the next paragraph.

3) People with more detailed knowledge than I have can probably come up with many examples. An example that comes to my mind is this: In the early 90’s, there was a banking crisis in Sweden. It followed the usual pattern: there was credit expansion and lowered interest rates, and the most visible sign was that real-estate prices high-rocketed. And a couple of years later, many loans could not be repaid, and the banks experienced considerable difficulties (one of them even went bankrupt). But there was one bank that survived this crisis relatively unscathed, and this was precisely because it did not "jump on the band wagon" and did not expand their lending the way the other banks did.

4) On this point, I received the following objection from George Reisman:

[Concerning] Austrian economists advocating Federal Reserve increases in interest rates. They actually do advocate this and it’s perfectly correct for them to do so. This is because we would all be better off if the Federal Reserve refused to lend except at an interest rate that was too high for anyone being willing to borrow at. In that case the Federal Reserve would be unable to affect the market in any way and might as well not exist. [Italics added.]

The Federal Reserve exists in order to make interest rates lower than they would otherwise be. It tries to achieve this by creating new and additional money and lending it out. The new and additional money appears on the market as an increase in the supply of loanable funds and in this way brings interest rates down. However, once the new and additional money gets out into circulation and is spent and respent, sales revenues and profits tend to rise throughout the economic system, which serves to increase the demand for loanable funds. If the Fed does not raise interest rates but simply provides more new and additional money to meet the additional demand for funds, the problem grows worse and worse. A rise in interest rates is essential to choke off the flow of new and additional money—to prevent a continuous acceleration in the creation of new and additional money. In objecting to this rise in interest rates, Salsman is in the position of advocating hyperinflation. Hyperinflation is profoundly destructive of wealth and rests on the total obliteration of any kind of objective standards in the economic system.

Yes, I agree with all of this. The Fed has to make "interest hikes" (and maybe trigger a recession) in order to avoid hyperinflation (which would be even worse). But I cannot imagine that the Fed would ever charge an interest so high that nobody will borrow from it at all - that would actually be the equivalent of the Fed committing suicide. "It might as well not exist" - and we should advocate its abolition!

(And parenthetically, I do not think Richard Salsman would consciously advocate hyperinflation. Still, this is the logic of his stand.)

5) The mistakes "Austrians" do make are seldom, if ever, in the field of economic theory, but in the field of politics. Many of them (as you probably know) are anarchists or lean heavily toward anarchism. And is seems ubiquitous that they have a view of foreign policy and of the "war on terrorism" that I would diplomatically characterize as extremely naive.

(Although it is not the subject of this article, I would like to say that the opposite holds true about Objectivists – at least ARI-affiliated Objectivists. They have a principled, realistic view of the "war on terrorism": that this war has to be won, and that it has to be strictly a war of American self-defense, not some kind of suicide mission. On economic theory, on the other hand, they are simply lousy.)

6) For those of you unfamiliar with Objectivism: the "malevolent-universe premise" is the view that the universe is inherently inimical to man and his happiness on earth – so that our pursuit of happiness is ultimately doomed to failure. (The opposite, of course, is called "the benevolent-universe premise".) For a short but good exposition, see Leonard Peikoff, Objectivism: The Philosophy of Ayn Rand, p. 342f.

But to confuse this with economics is simply ridiculous. That "booms" lead to "busts" (what Salsman obviously means with the phrases "what goes up must come down" and "all good things must come to an end") is a fact of economic reality and has nothing whatsoever to do with whether the universe as such is inimical to us or whether someone holds this flawed premise.

7) For an example of this, see Diana Hsieh’s blog post Fraud or Not? (If I ever find the time, I intend to answer this post.)

On a more positive note, I would like to mention that the person who nowadays most frequently lectures on economics at Objectivist conferences is Brian Simpson. Simpson is a "reismanite", not a "salsmanite". This might mean a turn for the better.

8) For those of you who read Swedish, here is the link:

Why "fractional banking" should be forbidden
And see also:
Why business cycles?

9) It is of course true that both Branden and Greenspan have since turned into "bad guys". But when they wrote this, they were still "good guys".

Also, I do not mean to imply that something is true, merely because it is in CUI. There are some lines in Greenspan's essay that I can only read as an endorsement of at least some extent of "fractional banking" – and I do not agree with that. But this is a very small point in the "grand scheme of things". The bigger point is that the standard "Austrian" interpretation of the cause of the Great Depression was endorsed by Ayn Rand, and should not be dismissed out of hand by self-appointed "experts" on her philosophy.

© 2007 Per-Olof Samuelsson
May be quoted freely as long as the URL to this article is included.


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