The Classical Concepts of a “Wage Fund” and of a “Subsistence Fund” (the Sum Total of All Funds Saved from Consumption and Available for Investment) Fell into Oblivion

Hahn (1920) and Keynes (1936) pushed Macleod’s approach to its logical conclusion. It was not savings that led to (credit-financed) investment but (credit-financed) investment that led to savings. Thus they had finally arrived at the exact antithesis of classical economics. If investments could easily be made without saving, then it would be superfluous to explore profound theories on the real economic importance of foregoing consumption. The classical concepts of a “wage fund” and of a “subsistence fund” (the sum total of all funds saved from consumption and available for investment) thus fell into oblivion. After the World War II, they were mentioned in textbooks only as a curious idea of the nineteenth century (see Braun 2012, 2014). Previously, cutting consumption was considered an indispensable prerequisite for the production of goods. Now it appeared to be superfluous, at best. More realistically, it appeared as a potential disruptive factor. After all, at least some part of income that was not spent on consumers’ goods would not be spent at all, but hoarded, with corresponding losses for “aggregate demand” and thus for production.

--Jörg Guido Hülsmann, “Mises' Monetary Theory,” in Banking and Monetary Policy from the Perspective of Austrian Economics, ed. Annette Godart-van der Kroon and Patrik Vonlanthen (Cham, CH: Springer International Publishing, 2018), 34-35.

The Neo-Mercantilist Movement Brushed Aside the Theory of the Wage Fund and Say's Law; Hence, the Foundations of the Theory of Finance Have Remained in an Unsatisfactory State for Decades

The youthful and boastful neo-mercantilist movement of the 1930s and the early postwar period did not bother to refute the classical conceptions in any detail. The theory of the wage fund was brushed aside, rather than carefully analyzed and criticized, just as Keynes had brushed aside Say’s Law without even making the attempt to dissect it. As a consequence, the foundations of the theory of finance have remained in an unsatisfactory state for many decades. A newer vision of finance had supplanted the older one. But was the latter without merit? The new theory appeared to be new. But was it true?

The present book is one of the very first modern discussions that attempts to come to grips with these basic questions. Steeped in the tradition of the Austrian school, Dr. Eduard Braun delivers a sweeping and original essay on the foundations of finance. Relying on sources in three languages, and delving deeply into the history of capital theory — most notably the neglected German-language literature of the 1920s and 1930s — his work sheds new light on a great variety of topics, in particular, on the history of the subsistence fund theory, on the relation between monetary theory and capital theory, on economics and business accounting, on price theory and interest theory, on financial markets, on business cycle theory, and on economic history.

--Jörg Guido Hülsmann, foreword to Finance Behind the Veil of Money: The Economics of Capital, Interest, and the Financial Market, by Eduard Braun (West Palm Beach: Liberty.me, 2014), e-book.

Lachmann Suggests Dispensing with the Notion “Period of Production”and Replacing It with the Notion “Degree of Complexity”

An important aspect of the information revolution is that it allows for the formation and management of ever more complex capital structures. In his work on capital Lachmann proposed a reinterpretation of a controversial aspect of Böhm-Bawerk’s theory, his famous proposition concerning the superior productivity of roundabout production (i.e. of production processes that are more indirect, that take more “production time”) (Lachmann 1978: ch. V). Lachmann regarded Böhm-Bawerk's use of time as a unit of measurement for the capital stock as untenable and seriously misleading. He felt strongly, however, that Böhm-Bawerk’s intuition about the sources of economic progress was correct. “[T]he intuitive genius of Böhm-Bawerk gave an answer [that], to be sure we cannot fully accept and which, moreover, is marred by an excessive degree of simplification, yet an answer we cannot afford to disregard” (Lachmann 1978:73). Therefore he suggests dispensing with the notion “period of production” and replacing it with the notion “degree of complexity.” Whereas Böhm-Bawerk argued that the period of production increased with capital accumulation, Lachmann argues that capital accumulation results in the increasing complexity of the production process. In this way he hoped to have given a new and more appropriate meaning to the notion of increased roundaboutness.

--Peter Lewin, Capital in Disequilibrium: The Role of Capital in a Changing World, Routledge Foundations of the Market Economy (London: Taylor and Francis e-Library, 2003), 130.

In Order to Understand the Austrian Business Cycle Theory, We Must Distinguish Commodity Credit (Good Kind of Credit) from Circulation Credit (Bad Kind of Credit)

In order to understand the ABCT [Austrian Business Cycle Theory] it is necessary to grasp a distinction between two different kinds of credit first introduced by Ludwig von Mises himself. The first one, commodity credit, is, in Mises’s opinion, the healthy kind of credit. Somebody saves out of his income and transfers the savings to somebody else, mainly by means of financial intermediaries. As this kind of credit necessitates savings, it involves an exchange of present goods for future goods. In the words of Mises, credits of this kind are

characterized by the fact that they impose a sacrifice on that party who performs his part of the bargain before the other does—the foregoing of immediate power of disposal over the exchanged good.

In short, before commodity credit can be granted, somebody must have saved up goods or money that can now be lent to the debtors. The sacrifice of the savers is the necessary condition for this kind of credit.

The second kind of credit Mises calls circulation credit. In his opinion, it constitutes the unhealthy kind of credit. It does not stem from anybody’s savings, but from the power of banks to lend additional money into existence. It is not necessary to go into the details of fractional reserve banking here. That this kind of banking is able to create additional credit via lending out its own banknotes (in earlier times) or demand deposits that are at any time convertible into money is generally accepted by economists. The phenomenon is called the money multiplier. Mises’s point is that this kind of credit creation does not presuppose savings and therefore causes nearly no costs to either the issuing bank or anybody else. This

group of credit transactions is characterized by the fact that in them the gain of the party who receives before he pays is balanced by no sacrifice on the part of the other party.

According to Mises’s definition, what he calls circulation credit is not a proper credit transaction from an economic point of view. “[T]he essential element, the exchange of present goods for future goods, is absent.” No savings and no sacrifices are necessary:

If a creditor is able to confer a loan by issuing claims which are payable on demand, then the granting of the credit is bound up with no economic sacrifice for him.

Now, in all of his versions of the ABCT, Mises maintains that an expansion of circulation credit, as distinguished from an increase of commodity credit, causes a boom that must ultimately result in a bust. So far, the earlier and the later versions are homogeneous. However, they differ in the way that Mises explains the effect that an expansion of circulation credit has on the economy. It will be shown that it is on this point that Mises’s first theoretical book, The Theory of Money and Credit, has to be preferred to all of his later writings.

--Eduard Braun, “The Subsistence Fund in Ludwig von Mises's Explanation of the Business Cycle,” in Theory of Money and Fiduciary Media: Essays in Celebration of the Centennial, ed. Jörg Guido Hülsmann (Auburn, AL: Mises Institute, 2012), 194-195.

Marginal Utility Theorists Were Accused of Having to Assume the Existence of the Very Thing (Prices) the Theory Was Meant to Explain; Similar Criticisms Were Leveled When It Was Used to Explain the Value of Money

An early criticism of marginal utility theory was that it claimed to explain the emergence of prices on the basis of the marginal evaluation of goods, but, the critics said, for a marginal evaluation of goods to occur, it was first necessary for there to exist ratios of exchange at which commodities could be traded and toward which evaluations could be directed; hence, the marginal utility theorists were accused of having to assume the existence of the very thing (prices) the theory was meant to explain, thus moving in a logical circle. On how the Austrians proposed to escape from the circle through the introduction of expectations and the distinction between expected prices and realized prices, see, Böhm-Bawerk, Capital and Interest vol. 2, pp. 240-43; Leo Schönfeld-Illy, Das Gesetz des Grenznutzen (Vienna: 1948), pp. 183-238; and Israel M. Kirzner, Market Theory and the Price System (Princeton, N.J.: D. Van Nostrand, 1963), pp. 105-41.

Similar criticisms were leveled against the application of marginal utility theory to explain the value of money. Mises argued that it was true that the evaluation of the marginal utility of money was dependent upon the preexistence of the monetary unit having a specific purchasing power. Since money was directly serviceable neither for consumption nor for production but, rather, acquired its utility as a good on the basis that it could be held in the form of cash balances to facilitate future acts of exchange, any present demand for the money good presupposed it having an existing purchasing power. But logically no circular reasoning was involved, Mises argued. Money's present purchasing power could be “regressed” back to that point at which the money good was used for the first time as a medium of exchange, before which the commodity's exchange value would have been based purely upon its utility as a consumption and/or production good; Mises, The Theory of Money and Credit, pp. 129-46; also, Mises, Human Action, A Treatise on Economics 3rd ed. (Chicago: Henry Regnery, 1966), pp. 408-16.

--Richard M. Ebeling, “Ludwig von Mises and the Gold Standard,” in The Gold Standard: Perspectives in the Austrian School, ed. Llewellyn H. Rockwell Jr. (Auburn, AL: Ludwig von Mises Institute, 1992), 53n13.

It Is Seldom Recognized that by 1888 Menger Had Changed His View on Capital Theory; He Turned Against All Capital Theories, Including His Own, If They Disregarded the Everyday Language Use of “Capital”

Carl Menger changed his point of view on capital theory considerably between 1871 and 1888 (Schumpeter 1997, p. 187; Braun 2014). He did not discuss capital very deeply in his Principles (Stigler 1937, p. 248), but to the extent he did, he advocated a capital theory that is concerned with production. His capital theory was connected to his vision of the production process as divided into several successive stages, where consumer goods result from the successive processing of combinations of higher-order goods to lower-order goods. Menger (1871, p. 155) says that one possesses capital if one “already has command of quantities of economic goods of higher order … in the present for future periods of time.” By adding this aspect to production theory and associating it with capital theory, he laid the groundwork for Austrian capital theory as developed by Böhm-Bawerk (1930), Friedrich von Hayek (1941), and Ludwig Lachmann (1978).

It is seldom recognized that by 1888 Menger had changed his view. In a long article on the subject — Zur Theorie des Kapitals (A Contribution to the theory of capital) — Menger proposed a radically different vision of the scope of capital theory. Streissler (2008, p. 371) is of the opinion that, by writing his article, Menger only made a prepublication attempt to refute the theory of Böhm-Bawerk. However, it seems more probable that Menger turned against all capital theories — including his own one — which have been developed by economists in disregard of everyday language use and established business practices. At the very outset, he declares that it is

a mistake that cannot be disapproved of enough when a science … denotes completely new concepts by words that, in common parlance, already describe a fundamentally different category of phenomena — a category that is also important for the respective discipline — correctly and properly (Menger 1888, 2).

It could be suggested that he was referring mainly to Böhm-Bawerk’s theory in this quote. However, there is every indication that Menger also implicitly revoked his earlier point of view. For the common parlance concept of capital is not identical with his own one from the Principles at all. In Menger’s (1888, p. 37; emphasis added) words, the common parlance view has nothing to do with the production process or the different orders of goods:

When businessmen and lawyers speak about capital, they do mean neither raw materials, nor auxiliary materials, nor articles of commerce, machines, buildings and other goods like this. Wherever the terminology of the Smithian school has not already penetrated common parlance, only sums of money are denoted by the above word.

He hastens to add that capital only embraces sums of money that are dedicated to the acquisition of income, and that “sums of money” not only refers to plain money, but to the monetary value of all kinds of business assets in economic calculation.

Menger thus switched sides in a debate that seems to be as old as economics itself. Does the term “capital” refer to a production factor or does it refer to the organization of the market economy by calculating entrepreneurs who maximize the monetary yield on their financial capital? At a first glance, the distinction between these two viewpoints does not seem to create a great problem. . . . the two sides of the term capital do not fit together harmoniously; rather they roughly correspond to the two sides of the Methodenstreit between the Austrian and the Historical school of economics. Menger’s earlier concept was elaborated to Austrian capital theory, whereas his concept of 1888 turns out to be the one endorsed by the Historical school.

--Eduard Braun, “Unsuspected Origins of Modern Austrian Economics: The Historical School of Economics on Capital and Economic Calculation,” in The Next Generation of Austrian Economics: Essays in Honor of Joseph T. Salerno, ed. Per Bylund and David Howden (Auburn, AL: Mises Institute, 2015), 76-78.

There Is No Perfectly Rigorous Way to Define the Length of a Production Process in Purely Physical Terms; This Fact Is at the Heart of the 3 Capital Controversies (Böhm-Bawerk v. Clark, Hayek v. Knight, and the Cambridges)

The Austrian economists emphasize that production takes time, and, other things constant, the longer the (linear) supply chain, the more “time” it takes. Thus, modern production is much more “roundabout” (Böhm-Bawerk’s term) than older, more rudimentary production processes. Rather than picking the fruit in our backyard and eating it, most of us today get our fruit from farms using complex picking, sorting, and packing machinery and specialists to process carefully engineered fruit products. Consider the amount of “time” (for example, in people-hours) involved in setting up and assembling all the pieces of this complex production process from scratch—from before the manufacture of the machines and so on—to appreciate what is meant by production methods that are “roundabout.” Doing things in a more complicated, specialized way is more difficult—loosely speaking, it takes more “time” because it is more roundabout, more indirect—it involves the construction of more intermediate products (or services) before moving to the next step in the process.

The scare quotes for “time” in the previous paragraph are used because, even for simple linear processes, there is no perfectly rigorous way to define the length of a production process in purely physical terms. This essential fact is at the heart of the three capital controversies that have occurred over the last one hundred years: the first in the late nineteenth and early twentieth century involving Böhm-Bawerk and his critics (notably J. B. Clark), the second in the 1930s and 1940s involving Hayek and his critics (notably Frank Knight), and the last from the 1970s onward, lingering until today, known as the Cambridge-Cambridge debate, involving, respectively, protagonists from Cambridge, England, and Cambridge, Massachusetts. ACT [Austrian Capital Theory] was explicit in the first two controversies and implicit in the third. All concerned the essential nature of production in a capital-using economy. Böhm-Bawerk was tackled because of his use of a simplifying, inconsistent theoretical construct: the “average period of production.” It can be easily shown that any attempt to calculate such a magnitude is fraught with insurmountable difficulties except in the simplest of cases—and even there, the calculation is impossible if we consider, as we should, the interest rate implicit in the formula to be compound interest. Böhm-Bawerk’s lengthy, intuitive discussion of the nature of capitalist production as an increasing reliance on produced means of production in specialized production processes became associated with this rather specific and limited formula. Though actually a small part of his work as a whole and arguably an aberration in his breadth of vision, it became the focus for the prolonged and energetic debate in capital theory.

--Peter Lewin and Howard Baetjer Jr., “The Capital-Using Economy,” in The Oxford Handbook of Austrian Economics, ed. Peter J. Boettke and Christopher J. Coyne (New York: Oxford University Press, 2015), 146.

In a Market with Many Buyers and Sellers, the Price Reflects the Valuations of the Buyer Least Willing to Buy and the Seller Least Willing to Sell (the “Marginal Pairs”)

Menger sought to explain prices as the outcome of the purposeful, voluntary interactions of buyers and sellers, each guided by their own subjective evaluations of the usefulness of various goods and services (what we now call marginal utility, a term later coined by Friedrich von Wieser). Trade is thus the result of people’s deliberate attempts to improve their well-being, not an innate “propensity to truck, barter, and exchange,” as suggested by Adam Smith. The exact quantities of goods exchanged—their prices, in other words—are determined by the values individuals attach to marginal units of these goods. With a single buyer and seller, goods are exchanged as long as participants can agree on an exchange ratio that leaves each better off than he was before. In a market with many buyers and sellers, the price reflects the valuations of the buyer least willing to buy and the seller least willing to sell, what Böhm-Bawerk would call the “marginal pairs.” Regardless of the exact structure of the market, then, voluntary exchange takes place until the gains from trade are momentarily exhausted. Menger’s highly general explanation of price formation continues to form the core of Austrian microeconomics.

--Peter G. Klein, foreword to Principles of Economics, by Carl Menger (1976; repr., Auburn, AL: Ludwig von Mises Institute, 2007), 7-8.

Menger Transformed Economics from a Discipline Focused on the Study of Objective Wealth to One Based on Exchange or Catallactics

This theory of capital in Menger’s founding work is completely consistent with his seminal contribution to the subjective theory of value that was a paradigm shift in economics, completely transforming the discipline from one focused on the study of wealth, perceived to be objective (plutology), to one based on exchange (catallactics).

Classical economics was, at least originally, a pragmatic discipline. Its aim was to study means to increase the “wealth of nations”. Its orientation is thus to a macroeconomic magnitude. It needed a measure of wealth, and the classical notion of value was primarily designed to serve this need. Production and distribution of wealth was what really mattered. The consumer was an outsider, not an economic agent . . . . Markets, in classical doctrine, contained producers and merchants only. All this changed when subjective utility replaced objective (and measurable) cost of production as the source of value.

Economics now had to find a place for the consumer. It was he, after all,  who now bestowed value on objects. All non-consumer goods were now shown to have at best purely derivative value. . . . each consumer as an individual would now assign value to objects which become economic goods as a result of his action. (Lachmann, 1986: 145)

--Peter Lewin and Nicolas Cachanosky, Austrian Capital Theory: A Modern Survey of the Essentials, Cambridge Elements in Austrian Economics (Cambridge, UK: Cambridge University Press, 2019), 7-8.

Future Goods Trade at a Discount or Present Goods Trade at a Premium; the Payment of Interest Is a Direct Reflection of This Intertemporal Value Differential; This Is Called Böhm-Bawerk's “Agio Theory”

Early in his career, Böhm-Bawerk took up a central question that was much discussed by his contemporaries and predecessors. “Is there any justification for the payment of interest to the owners of capital?” The justification, in his view, rests on a simple fact of reality: people value present goods more highly than future goods of the same quantity and quality. Future goods trade at a discount, or alternatively, present goods trade at a premium. The payment of interest is a direct reflection of this intertemporal value differential. This interest, or agio, paid to capitalists allows workers to receive income on a more timely basis than would otherwise be possible. Böhm-Bawerk's “agio theory” and its implications for the alternative “exploitation theory” were undoubtedly enough to win him recognition by historians of economic thought. But with it he broke new ground and was able to parlay his refutation of socialist doctrine into a new understanding of the capitalist system. His Positive Theory culminates in a macroeconomic model of general equilibrium that serves to illuminate the classical issues of capital accumulation and technical progress, to resolve the neoclassical problem of the existence and the determination of the rate of interest, and to do still more.

--Roger W. Garrison, “Eugen von Böhm-Bawerk: Capital, Interest, and Time,” in The Great Austrian Economists, ed. Randall G. Holcombe (Auburn, AL: Ludwig von Mises Institute, 1999), 116.

Albert Schäffle Characterized the Function of Capital and the Capitalist-Entrepreneur in Proto-Böhm-Bawerkian Terms; Capital Is Necessary for Exploiting the Benefits of the Division of Labor

In commenting on the debate over the fate of the working class under capitalism that raged in the 1860s between German social democrats led by Ferdinand Lassalle and German laissez-faire liberals led by Hermann Schulz-Delitzsch, Schäffle sought to illuminate the Wertfrei economic principles involved. In criticizing Lassalle’s position, he resorted to the concept of a “temporal structure of the economic process” developed by one of the eminent pioneers of the German subjective-value tradition, F. W. B. Hermann (1795-1868). Elaborating on this concept, Schäffle (quoted in Hennings 1997, p. 37) characterized the function of capital and the capitalist-entrepreneur in proto-Böhm-Bawerkian terms:

It is the particular way in which labour’s services are temporally structured, in which production is separated in time and space … which conditions the peculiar position of workers in the economy, and which points to the basic reason for the position of the entrepreneur … who advances out of his capital, in the form of wages, the value of labour’s services which are not yet consumable.

He went on to argue that if the capitalist did not perform this function, then the laborer would have to acquiesce in a lengthy wait for his labor product or else the division of labor would be impossible. Thus capital was necessary for exploiting the benefits of the division of labor. Furthermore, it is by virtue of his capital-advancing role that the entrepreneur becomes the director of production and pivotal agent of income distribution. Schäffle concluded that Lassalle’s call to abolish entrepreneurship was wrong because the entrepreneur was indispensable to the proper operation of the economic process.

--Joseph T. Salerno, “Böhm-Bawerk's Vision of the Capitalist Economic Process: Intellectual Influences and Conceptual Foundations,” New Perspectives on Political Economy 4, no. 2 (2008): 93-94.

The Step Leading from Classical to Modern Economics Is the Realization that Classes of Goods in the Abstract Are Never Exchanged and Valued, But Always Only Concrete Units of a Class of Goods

Only the disintegration of the universalistic mentality brought about by the methodological individualism of the seventeenth and eighteenth centuries cleared the way for the development of a scientific catallactics. It was seen that on the market it is not mankind, the state, or the corporative unit that acts, but individual men and groups of men, and that their valuations and their action are decisive, not those of abstract collectivities. To recognize the relationship between valuation and use value and thus cope with the paradox of value, one had to realize that not classes of goods are involved in exchange, but concrete units of goods. This discovery signalized nothing less than a Copernican revolution in social science. Yet it required more than another hundred years for the step to be taken. This is a short span of time if we view the matter from the standpoint of world history and if we adequately appreciate the difficulties involved. But in the history of our science precisely this period acquired a special importance, inasmuch as it was during this time that the marvelous structure of Ricardo’s system was first elaborated. In spite of the serious misunderstanding on which it was constructed, it became so fruitful that it rightly bears the designation “classical.”

The step that leads from classical to modern economics is the realization that classes of goods in the abstract are never exchanged and valued, but always only concrete units of a class of goods. If I want to buy or sell one loaf of bread, I do not take into consideration what “bread” is worth to mankind, or what all the bread currently available is worth, or what 10,000 loaves of bread are worth, but only the worth of the one loaf in question. This realization is not a deduction from Gossen’s first law. It is attained through reflection on the essence of our action; or, expressed differently, the experience of our action makes any other supposition impossible for our thought.

--Ludwig von Mises, Epistemological Problems of Economics, trans. George Reisman, ed. Bettina Bien Greaves (Indianapolis: Liberty Fund, 2013), 139-140.