A key disagreement between the Austrian economists and Keynesian economists is over the consequences of expanding the money supply. Keynesians claim that increasing the money supply will cause a beneficial increase in economic activity, whereas Austrians claim that increases in the money supply cause all manner of bad consequences, one of which is the lowering of the purchasing power of all money currently in circulation. The most visible sign of such loss of purchasing power is a general rise in the price level. Therefore, it is important that the Austrians answer the Keynesians who say that the Austrian monetary theory is wrong, because the government’s pump priming, trillion dollar stimulus spending and the Fed’s massive asset purchases have not caused runaway price inflation. In this essay I will answer this criticism by explaining the fundamental forces at work to explain the relationship between the money supply and the price level and the forces of government intervention that make short term price level predictions impossible.

One of the conundrums of current economic life is why the increase in the money supply had not caused runaway price inflation. Furthermore, the federal government has run a one-trillion-dollar deficit this year, with promises of more for several more years, while at the same time interest rates have fallen to unprecedented low levels. Both of these phenomena seem to violate economic law. Shouldn’t more money drive up prices? And shouldn’t government’s massive borrowings cause interest rates to rise? Yet prices for most goods have remained stable and the interest rate is at historic lows. Has all economic law been shown to be fallacious?

So Congress has finally passed its much-anticipated reform of the financial system. Like all modern pieces of legislation, it supposedly fixes a problem created by the free market but it actually is a problem that government itself caused. Its main tenets are pure demagoguery and would have the public believe that bankers are brainless. For instance, it proclaims that lenders must do sufficient due diligence to satisfy regulators that the borrower can pay back the loan. Wow! Now, who in the banking industry would ever have thought of that?

My students at the University of Iowa must understand how the Fed operates. We study books and articles by great Austrian economists, such as The Mystery of Banking by Murray N. Rothbard. Even though Professor Rothbard presents his subject in about as clear and concise terms as one can imagine, it takes some serious application of one’s time and energy to comprehend all that the Fed does and how it does it. It then takes even more time and energy to comprehend the Fed’s impact on the economy to arrive at a conclusion that is greatly at odds with mainstream economists. Mainstream economists revere the Fed as the “All-wise, All-knowing Great Oz” that stabilizes the economy, prevents depressions, ensures full employment, etc. And, they have formulas and econometric models to prove it! By contrast we Rothbardian Austrians conclude that the Fed causes the boom/bust business cycle by expanding the money supply and encouraging malinvestment that must later be liquidated. This is known as the Austrian theory of the business cycle. After studying the Fed’s operation, students dive into the study of this equally serious and time-consuming subject.

The world’s largest economies are being prevented from recovering from massive malinvestment by wrongheaded governmental interventions. Japan, currently the world’s second largest economy, has had zero growth for twenty years. A good case can be made that the U.S. has had zero growth for ten years, because the so-called growth of the first decade of the new millennium now appears to be phony. All those houses were built at a loss, which we are only now recognizing. We have yet to plumb the total extent of the rot.

The reports from Europe that the Greek debt crisis may bring down the Euro and/or the European Union (EU) must seem bizarre to most people. How did this one little country at the edge of Europe, storied ancient history notwithstanding, become so important? The short story line is that Greece can’t pay its debts, or at least that Greece has to pay higher rates to finance its growing sovereign debt, but this leaves open the question of how this threatens the European Union and the Euro. In fact, it does not…or at least it need not. But ancient and historical forces are at work to transform a Greek tragedy (sorry, I just couldn’t resist!) into a European crisis that either will propel Europe into a federalist direction or break it apart.

The mainstream media would have us believe two myths about the Greek financial crisis: one, that the inability of the Greek government to meet its debt payments is a threat to the Euro and perhaps to the European Union itself; and, two, that Greek “austerity” would be a disaster for the Greek people.

All economists, whether they are of an Austrian, a Keynesian or a Monetarist bent, as well as nearly every investor, would agree that money plays a vitally important role in the economy. And a correct measure of its supply is an indispensable input into every economic and financial forecast. How could it not, for money is one half of every economic transaction.

Yet, despite its importance, the money supply metrics used by the majority of today’s economists and investors are seriously flawed, for they are founded on a faulty definition of money.

A friend wrote to me recently expressing his concern that the US electorate is choosing socialism. That certainly seems to be the case. Republican President George W. Bush socialized prescription drugs for seniors, and now Democratic President Barack Obama has socialized the entire healthcare system. There are other examples, such as the government taking an equity position in General Motors, once the world’s largest private enterprise, and major banks. Since there is little real doubt that Barack Obama and his Democratic Party won the last election fairly and squarely, there is some justification to the claim that we are getting what we wanted—socialism. At least that is the conclusion that one must draw when our fairly elected representatives vote to enact these social programs.

The citizenry of the world are being misled by the faulty economic doctrine of Keynesianism, which places consumption as the most important factor in producing prosperity. Business is slow? Then boost spending! Already in debt up to your eyeballs? Then borrow even more! Can’t borrow more? Then lobby the federal government to spend! It is not limited in its spending; it can print all the money that it needs. This is what passes for economic reasoning at the pinnacles of government power throughout the world.