Where’s The Magic Formula?

In Full Archive by Nathan Lewis

Eugene Bohm von Bawerk was a leading light of the “Austrian School,” serving as the Finance Minister of Austria three times between 1895 and 1904. In 1891, he became the head of the tax department of Austria’s Ministry of Finance, and undertook a major reform of both direct and indirect taxation. In 1892, he became the head of a national commission to restore the gold standard in Austria, after a long period of a gently floating currency. This was achieved in 1896. He also wrote a three-volume book, Capital and Interest (1890), as a refutation of Marxism. But, he didn’t seem to have much to say in it about either Low Taxes or Stable Money. In 1913, he admitted: “I have not yet included the theory of money in the subject matter of my thinking …”

In The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor (1998), David Landes concluded that the answer was basically: culture. While this has some truth to it — all of the Anglophone countries have been rich from the start — it doesn’t say much about specific policy. Between 1700 and 1900, Britain consistently had the lowest taxes and most stable money in Europe, and ended up with the largest empire in the great age of European Empire.

In Why Nations Fail: the Origins of Power, Prosperity, and Poverty (2012), Daron Acemoglu and James Robinson claimed that successful countries could attribute their wealth to: democracy. This too has some truth to it. The British parliamentary system, with the Parliament responsible for taxation and the king responsible for spending, kept taxes low for generations. If democracy has any lasting advantage, it is that it leads to better policy, or at least, avoidance and correction of major policy mistakes. But, many countries have been successful without democracy. Hong Kong has never had it, but it became wealthy anyway, with Low Taxes and Stable Money. China has never had democracy in all of its five-thousand-year history, but as early as the fifth century B.C., Confucius insisted that taxes should not exceed 10% of income or production. For 2,500 years afterward, Chinese government officials were required to study his works in detail.

The Ancient Greeks considered any type of direct taxation to be a form of slavery. Except for some short periods during wartime, their silver drachma was unchanged for six centuries. This basic principle too was written into the U.S. Constitution, which effectively disallowed direct taxation until the Sixteenth Amendment was added in 1913. The Constitution also explicitly states that “No State shall … make any thing except gold and silver coin a tender in payment of debts,” and though the letter of this law was never followed (banknotes were common from the start), the United States nevertheless maintained the principle of gold-based money until 1971. The Magic Formula was written in black letters into the supreme law of the land — the summary wisdom of perhaps the greatest group of political thinkers that has ever been assembled anywhere on Earth —  but we can’t quite remember it today.

The IMF informs us that roughly two-thirds of all governments have a policy of linking their currency to an external standard of value, usually either the dollar or euro. There has been too much experience with unstable money, especially since the end of the Bretton Woods gold standard in 1971. The gold standard — the usual practice of responsible governments for centuries before 1971 — was a variant of this basic principle. And yet, hardly any economist today has anything to say about “Stable Money” — what it is, and what it might be good for. They are all money manipulators, whether of the seat-of-the-pants variety or the “rules-based” sort.

Thus, the Magic Formula seems to be something that everyone knows, and that everyone has forgotten. I think we should keep it in mind today.