A Free-Market Monetary System and The Pretense of Knowledge

A FREE-MARKET

MONETARY SYSTEM

A FREE-MARKET

MONETARY SYSTEM

Ludwigvon MisesInstituteAUBURN, ALABAMA

FRIEDRICH A. HAYEK

Copyright © 2008 Ludwig von Mises Institute

Permission was granted by the Nobel Foundationto reproduce the “The Pretence of Knowledge.”Copyright © 1974 The Nobel Foundation

Ludwig von Mises Institute518 West Magnolia AvenueAuburn, Alabama 36832 U.S.A.www.mises.org

ISBN: 978-1-933550-37-4

A claim for equality ofmaterial position can be

met only be a governmentwith totalitarian powers.

F.A. Hayek

CONTENTS

A Free-Market Monetary System

The Pretense of Knowledge

. . . . . . . . 7

. . . . . . . . . . 29

5

7

A FREE-MARKET

MONETARY SYSTEM

hen a little over twoyears ago, at the secondLausanne Conference ofthis group, I threw out,almost as a sort of bitterjoke, that there was nohope of ever again hav-

ing decent money, unless we took fromgovernment the monopoly of issuing moneyand handed it over to private industry, Itook it only half seriously. But the sugges-tion proved extraordinarily fertile. Following

A lecture delivered at the Gold and Monetary Conference,New Orleans, November 10, 1977. It made its first appear-ance in print in the Journal of Libertarian Studies 3, no 1(Fall 1979).

W

it up I discovered that I had opened a pos-sibility which in two thousand years no sin-gle economist had ever studied. There werequite a number of people who have sincetaken it up and we have devoted a greatdeal of study and analysis to this possibility.

As a result I am more convinced thanever that if we ever again are going to havea decent money, it will not come from gov-ernment: it will be issued by private enter-prise, because providing the public withgood money which it can trust and use cannot only be an extremely profitable busi-ness; it imposes on the issuer a discipline towhich the government has never been andcannot be subject. It is a business whichcompeting enterprise can maintain only if itgives the public as good a money as any-body else.

Now, fully to understand this, we mustfree ourselves from what is a widespreadbut basically wrong belief. Under the GoldStandard, or any other metallic standard, thevalue of money is not really derived fromgold. The fact is, that the necessity ofredeeming the money they issue in gold,places upon the issuers a discipline whichforces them to control the quantity of money

10 A FREE-MARKET MONETARY SYSTEM

in an appropriate manner; I think it is quiteas legitimate to say that under a gold stan-dard it is the demand of gold for monetarypurposes which determines that value ofgold, as the common belief that the valuewhich gold has in other uses determines thevalue of money. The gold standard is theonly method we have yet found to place adiscipline on government, and governmentwill behave reasonably only if it is forced todo so.

I am afraid I am convinced that the hopeof ever again placing on government thisdiscipline is gone. The public at large havelearned to understand, and I am afraid awhole generation of economists have beenteaching, that government has the power inthe short run by increasing the quantity ofmoney rapidly to relieve all kinds of eco-nomic evils, especially to reduce unemploy-ment. Unfortunately this is true so far as theshort run is concerned. The fact is, that suchexpansions of the quantity of money whichseems to have a short run beneficial effect,become in the long run the cause of a muchgreater unemployment. But what politiciancan possibly care about long run effects if inthe short run he buys support?

FRIEDRICH A. HAYEK 11

My conviction is that the hope of return-ing to the kind of gold standard systemwhich has worked fairly well over a longperiod is absolutely vain. Even if, by someinternational treaty, the gold standard werereintroduced, there is not the slightest hopethat governments will play the game accord-ing to the rules. And the gold standard is nota thing which you can restore by an act oflegislation. The gold standard requires aconstant observation by government of cer-tain rules which include an occasionalrestriction of the total circulation which willcause local or national recession, and nogovernment can nowadays do it when boththe public and, I am afraid, all those Keyne-sian economists who have been trained inthe last thirty years, will argue that it is moreimportant to increase the quantity of moneythan to maintain the gold standard.

I have said that it is an erroneous beliefthat the value of gold or any metallic basisdetermines directly the value of the money.The gold standard is a mechanism whichwas intended and for a long time did suc-cessfully force governments to control thequantity of the money in an appropriatemanner so as to keep its value equal with


that of gold. But there are many historicalinstances which prove that it is certainly pos-sible, if it is in the self-interest of the issuer,to control the quantity even of a tokenmoney in such a manner as to keep its valueconstant.

There are three such interesting histori-cal instances which illustrate this and whichin fact were very largely responsible forteaching the economists that the essentialpoint was ultimately the appropriate controlof the quantity of money and not itsredeemability into something else, whichwas necessary only to force governments tocontrol the quantity of money appropriately.This I think will be done more effectivelynot if some legal rule forces government, butif it is the self-interest of the issuer whichmakes him do it, because he can keep hisbusiness only if he gives the people a stablemoney.

Let me tell you in a very few words ofthese important historical instances. The firsttwo I shall mention do not refer directly tothe gold standard as we know it. Theyoccurred when large parts of the world werestill on a silver standard and when in the sec-ond half of the last century silver suddenly


began to lose its value. The fall in the valueof silver brought about a fall in variousnational currencies and on two occasions aninteresting step was taken. The first, whichproduced the experience which I believeinspired the Austrian monetary theory, hap-pened in my native country in 1879. Thegovernment happened to have a really goodadviser on monetary policy, Carl Menger,and he told them,

Well, if you want to escape theeffect of the depreciation of silveron your currency, stop the freecoinage of silver, stop increasingthe quantity of silver coin, and youwill find that the silver coin willbegin to rise above the value oftheir content in silver.

And this the Austrian government did andthe result was exactly what Menger had pre-dicted. One began to speak about the Aus-trian “Gulden,” which was then the unit incirculation, as banknotes printed on silver,because the actual coins in circulation hadbecome a token money containing muchless value than corresponded to its value. Assilver declined, the value of the silver


Gulden was controlled entirely by the limi-tation of the quantity of the coin.

Exactly the same was done fourteenyears later by British India. It also had had asilver standard and the depreciation of silverbrought the rupee down lower and lower tillthe Indian government decided to stop thefree coinage; and again the silver coinsbegan to float higher and higher above theirsilver value. Now, there was at that time nei-ther in Austria nor in India any expectationthat ultimately these coins would beredeemed at a particular rate in either silveror gold. The decision about this was mademuch later, but the development was theperfect demonstration that even a circulatingmetallic money may derive its value from aneffective control of its quantity and notdirectly from its metallic content.

My third illustration is even more inter-esting, although the event was more shortlived, because it refers directly to gold. Dur-ing World War I the great paper money infla-tion in all the belligerent countries broughtdown not only the value of paper moneybut also the value of gold, because papermoney was in the large measure substitutedfor gold, and the demand for gold fell. In


consequence, the value of gold fell andprices in gold rose all over the world. Thataffected even the neutral countries. Particu-larly Sweden was greatly worried: because ithad stuck to the gold standard, it wasflooded by gold from all the rest of theworld that moved to Sweden which hadretained its gold standard; and Swedishprices rose quite as much as prices in therest of the world. Now, Sweden also hap-pened to have one or two very good econ-omists at the time, and they repeated theadvice which the Austrian economists hadgiven concerning the silver in the 1870s,“Stop the free coinage of gold and the valueof your existing gold coins will rise abovethe value of the gold which it contains.” TheSwedish government did so in 1916 andwhat happened was again exactly what theeconomists had predicted: the value of thegold coins began to float above the value ofits gold content and Sweden, for the rest ofthe war, escaped the effects of the gold infla-tion.

I quote this only as illustration of whatamong the economists who understand theirsubject is now an undoubted fact, namelythat the gold standard is a partly effective


mechanism to make governments do whatthey ought to do in their control of money,and the only mechanism which has been tol-erably effective in the case of a monopolistwho can do with the money whatever helikes. Otherwise gold is not really necessaryto secure a good currency. I think it isentirely possible for private enterprise toissue a token money which the public willlearn to expect to preserve its value, pro-vided both the issuer and the public under-stand that the demand for this money willdepend on the issuer being forced to keepits value constant; because if he did not doso, the people would at once cease to usehis money and shift to some other kind.

I have as a result of throwing out thissuggestion at the Lausanne Conferenceworked out the idea in fairly great detail ina little book which came out a year ago,called Denationalization of Money. Mythought has developed a great deal since. Irather hoped to be able to have at this con-ference a much enlarged second editionavailable which may already have beenbrought out in London by the Institute ofEconomic Affairs, but which unfortunately


has not yet reached this country. All I haveis the proofs of the additions.

In this second edition I have arrived atone or two rather interesting new conclu-sions which I did not see at first. In the firstexposition in the speech two years ago, Iwas merely thinking of the effect of theselection of the issuer: that only those finan-cial institutions which so controlled the dis-tinctly named money which they issued, andwhich provided the public with a money,which was a stable standard of value, aneffective unit for calculation in keepingbooks, would be preserved. I have nowcome to see that there is a much more com-plex situation, that there will in fact be twokinds of competition, one leading to thechoice of standard which may come to begenerally accepted, and one to the selectionof the particular institutions which can betrusted in issuing money of that standard.

I do believe that if today all the legalobstacles were removed which prevent suchan issue of private money under distinctnames, in the first instance indeed, as all ofyou would expect, people would from theirown experience be led to rush for the onlything they know and understand, and start


using gold. But this very fact would after awhile make it very doubtful whether goldwas for the purpose of money really a goodstandard. It would turn out to be a verygood investment, for the reason that becauseof the increased demand for gold the valueof gold would go up; but that very factwould make it very unsuitable as money.You do not want to incur debts in terms ofa unit which constantly goes up in value asit would in this case, so people would beginto look for another kind of money: if theywere free to choose the money, in terms ofwhich they kept their books, made their cal-culations, incurred debts or lent money, theywould prefer a standard which remains sta-ble in purchasing power.

I have not got time here to describe indetail what I mean by being stable in pur-chasing power, but briefly, I mean a kind ofmoney in terms which it is equally likely thatthe price of any commodity picked out atrandom will rise as that it will fall. Such astable standard reduces the risk of unfore-seen changes in the prices of particular com-modities to a minimum, because with such astandard it is just as likely that any one com-modity will rise in price or will fall in price


and the mistakes which people at large willmake in their anticipations of future priceswill just cancel each other because there willbe as many mistakes in overestimating as inunderestimating. If such a money wereissued by some reputable institution, thepublic would probably first choose differentdefinitions of the standard to be adopted,different kinds of index numbers of price interms of which it is measured; but theprocess of competition would graduallyteach both the issuing banks and the publicwhich kind of money would be the mostadvantageous.

The interesting fact is that what I havecalled the monopoly of government of issu-ing money has not only deprived us of goodmoney but has also deprived us of the onlyprocess by which we can find out whatwould be good money. We do not evenquite know what exact qualities we wantbecause in the two thousand years in whichwe have used coins and other money, wehave never been allowed to experiment withit, we have never been given a chance tofind out what the best kind of money wouldbe.


Let me here just insert briefly one obser-vation: in my publications and in my lecturesincluding today’s I am speaking constantlyabout the government monopoly of issuingmoney. Now, this is legally true in mostcountries only to a very limited extent. Wehave indeed given the government, and forfairly good reasons, the exclusive right toissue gold coins. And after we had given thegovernment that right, I think it was equallyunderstandable that we also gave the gov-ernment the control over any money or anyclaims, paper claims, for coins or money ofthat definition. That people other than thegovernment are not allowed to issue dollarsif the government issues dollars is a per-fectly reasonable arrangement, even if it hasnot turned out to be completely beneficial.And I am not suggesting that other peopleshould be entitled to issue dollars. All thediscussion in the past about free bankingwas really about this idea that not only thegovernment or government institutions butothers should also be able to issue dollarnotes. That, of course, would not work.

But if private institutions began to issuenotes under some other names without anyfixed rate of exchange with the official


money or each other, so far as I know thisis in no major country actually prohibited bylaw. I think the reason why it has not actu-ally been tried is that of course we knowthat if anybody attempted it, the governmentwould find so many ways to put obstacles inthe way of the use of such money that itcould make it impracticable. So long, forinstance, as debts in terms of anything butthe official dollar cannot be enforced in legalprocess, it is clearly impracticable. Of courseit would have been ridiculous to try to issueany other money if people could not makecontracts in terms of it. But this particularobstacle has fortunately been removed nowin most countries, so the way ought to befree for the issuing of private money.

If I were responsible for the policy ofany one of the great banks in this country, Iwould begin to offer to the public both loansand current accounts in a unit which Iundertook to keep stable in value in terms ofa defined index number. I have no doubt,and I believe that most economists agreewith me on that particular point, that it istechnically possible so to control the valueof any token money which is used in com-petition with other token monies as to fulfill


the promise to keep its value stable. Theessential point which I can not emphasizestrongly enough is that we would get for thefirst time a money where the whole businessof issuing money could be effected only bythe issuer issuing good money. He wouldknow that he would at once lose hisextremely profitable business if it becameknown that his money was threatening todepreciate. He would lose it to a competitorwho offered better money.

As I said before, I believe this is our onlyhope at the present time. I do not see theslightest prospect that with the present typeof, I emphasize, the present type of demo-cratic government under which every littlegroup can force the government to serve itsparticular needs, government, even if itwere restricted by strict law, can ever againgive us good money. At present theprospects are really only a choice betweentwo alternatives: either continuing an accel-erating open inflation, which is, as you allknow, absolutely destructive of an eco-nomic system or a market order; but I thinkmuch more likely is an even worse alterna-tive: government will not cease inflating, butwill, as it has been doing, try to suppress the


open effects of this inflation; it will bedriven by continual inflation into price con-trols, into increasing direction of the wholeeconomic system. It is therefore now notmerely a question of giving us better money,under which the market system will functioninfinitely better than it has ever done before,but of warding off the gradual decline into atotalitarian, planned system, which will, atleast in this country, not come because any-body wants to introduce it, but will comestep by step in an effort to suppress theeffects of the inflation which is going on.

I wish I could say that what I propose isa plan for the distant future, that we canwait. There was one very intelligentreviewer of my first booklet who said,

Well, three hundred years agonobody would have believed thatgovernment would ever give up itscontrol over religion, so perhaps inthree hundred years we can seethat government will be preparedto give up its control over money.

We have not got that much time. We arenow facing the likelihood of the mostunpleasant political development, largely as


a result of an economic policy with whichwe have already gone very far.

My proposal is not, as I would wish,merely a sort of standby arrangement ofwhich I could say we must work it outintellectually to have it ready when the pres-ent system completely collapses. It is notmerely an emergency plan. I think it is veryurgent that it become rapidly understoodthat there is no justification in history for theexisting position of a government monopolyof issuing money. It has never been pro-posed on the ground that government willgive us better money than anybody elsecould. It has always, since the privilege ofissuing money was first explicitly repre-sented as a Royal prerogative, been advo-cated because the power to issue moneywas essential for the finance of the govern-ment—not in order to give us good money,but in order to give to government access tothe tap where it can draw the money itneeds by manufacturing it. That, ladies andgentlemen, is not a method by which wecan hope ever to get good money. To put itinto the hands of an institution which is pro-tected against competition, which can forceus to accept the money, which is subject to


incessant political pressure, such an author-ity will not ever again give us good money.

I think we ought to start fairly soon, andI think we must hope that some of the moreenterprising and intelligent financiers willsoon begin to experiment with such a thing.The great obstacle is that it involves suchgreat changes in the whole financial struc-ture that, and I am saying this from the expe-rience of many discussions, no seniorbanker, who understands only the presentbanking system, can really conceive howsuch a new system would work, and hewould not dare to risk and experiment withit. I think we will have to count on a fewyounger and more flexible brains to beginand show that such a thing can he done.

In fact, it is already being tried in a lim-ited form. As a result of my publication Ihave received from all kinds of surprisingquarters letters from small banking houses,telling me that they are trying to issue goldaccounts or silver accounts, and that thereis a considerable interest for these. I amafraid they will have to go further, for thereasons I have sketched in the beginning.In the course of such a revolution of ourmonetary system, the values of the precious


metals, including the value of gold, aregoing to fluctuate a great deal, mostlyupwards, and therefore those of you whoare interested in it from an investor’s pointof view need not fear. But those of youwho are mainly interested in a good mone-tary system must hope that in the not toodistant future we shall find generally appliedanother system of control over the monetarycirculation, other than the redeemability ingold. The public will have to learn to selectamong a variety of monies, and to choosethose which are good.

If we start on this soon we may indeedachieve a position in which at last capitalismis in a position to provide itself with themoney it needs in order to function properly,a thing which it has always been denied. Eversince the development of capitalism it hasnever been allowed to produce for itself themoney it needs; and if I had more time Icould show you how the whole crazy struc-ture we have as a result, this monopoly orig-inally only of issuing gold money, is verylargely the cause of the great fluctuations incredit, of the great fluctuations in economicactivity, and ultimately of the recurringdepressions. I think if the capitalists had been


allowed to provide themselves with themoney which they need, the competitivesystem would have long overcome themajor fluctuations in economic activity andthe prolonged periods of depression. At thepresent moment we have of course beenled by official monetary policy into a situa-tion where it has produced so much misdi-rection of resources that you must not hopefor a quick escape from our present diffi-culties, even if we adopted a new monetarysystem.


The Pretense ofKnowledge

he particular occasion of thislecture, combined with the chiefpractical problem which econo-mists have to face today, havemade the choice of its topicalmost inevitable. On the one

hand the still recent establishment of theNobel Memorial Prize in Economic Sciencemarks a significant step in the process bywhich, in the opinion of the general public,

29

“The Pretense of Knowledge” is Friedrich A. Hayek’s NobelPrize Lecture delivered at the ceremony awarding him theNobel Prize in economics in 1974 in Stockholm, Sweden.It is included here with permission of the NobelFoundation.

T

economics has been conceded some of thedignity and prestige of the physical sci-ences. On the other hand, the economistsare at this moment called upon to say howto extricate the free world from the seriousthreat of accelerating inflation which, itmust be admitted, has been brought aboutby policies which the majority of econo-mists recommended and even urged gov-ernments to pursue. We have indeed at themoment little cause for pride: as a profes-sion we have made a mess of things.

It seems to me that this failure of theeconomists to guide policy more success-fully is closely connected with their propen-sity to imitate as closely as possible the pro-cedures of the brilliantly successful physicalsciences—an attempt which in our field maylead to outright error. It is an approachwhich has come to be described as the “sci-entistic” attitude—an attitude which, as Idefined it some thirty years ago,

is decidedly unscientific in the truesense of the word, since it involvesa mechanical and uncritical appli-cation of habits of thought to fields


different from those in which theyhave been formed.1

I want today to begin by explaining howsome of the gravest errors of recent eco-nomic policy are a direct consequence ofthis scientistic error.

The theory which has been guidingmonetary and financial policy during thelast thirty years, and which I contend islargely the product of such a mistaken con-ception of the proper scientific procedure,consists in the assertion that there exists asimple positive correlation between totalemployment and the size of the aggregatedemand for goods and services; it leads tothe belief that we can permanently assurefull employment by maintaining totalmoney expenditure at an appropriate level.Among the various theories advanced toaccount for extensive unemployment, this isprobably the only one in support of which


1“Scientism and the Study of Society,” Economica,IX, no. 35 (August 1942), reprinted in The Counter-Revolution of Science (Glencoe, Ill.: The Free Press,1952), p. 15.

strong quantitative evidence can beadduced. I nevertheless regard it as funda-mentally false, and to act upon it, as we nowexperience, as very harmful.

This brings me to the crucial issue.Unlike the position that exists in the phys-ical sciences, in economics and other disci-plines that deal with essentially complexphenomena, the aspects of the events to beaccounted for about which we can getquantitative data are necessarily limitedand may not include the important ones.While in the physical sciences it is gener-ally assumed, probably with good reason,that any important factor which determinesthe observed events will itself be directlyobservable and measurable, in the study ofsuch complex phenomena as the market,which depend on the actions of many indi-viduals, all the circumstances which willdetermine the outcome of a process, forreasons which I shall explain later, willhardly ever be fully known or measurable.And while in the physical sciences theinvestigator will be able to measure what,on the basis of a prima facie theory, hethinks important, in the social sciencesoften that is treated as important which


happens to be accessible to measurement.This is sometimes carried to the pointwhere it is demanded that our theoriesmust be formulated in such terms that theyrefer only to measurable magnitudes.

It can hardly be denied that such ademand quite arbitrarily limits the factswhich are to be admitted as possiblecauses of the events which occur in thereal world. This view, which is often quitenaively accepted as required by scientificprocedure, has some rather paradoxicalconsequences. We know: of course, withregard to the market and similar socialstructures, a great many facts which wecannot measure and on which indeed wehave only some very imprecise and generalinformation. And because the effects ofthese facts in any particular instance can-not be confirmed by quantitative evidence,they are simply disregarded by thosesworn to admit only what they regard asscientific evidence: they thereupon happilyproceed on the fiction that the factorswhich they can measure are the only onesthat are relevant.

The correlation between aggregatedemand and total employment, for instance,


may only be approximate, but as it is theonly one on which we have quantitativedata, it is accepted as the only causal con-nection that counts. On this standard theremay thus well exist better “scientific” evi-dence for a false theory, which will beaccepted because it is more “scientific,” thanfor a valid explanation, which is rejectedbecause there is no sufficient quantitativeevidence for it.

Let me illustrate this by a brief sketch ofwhat I regard as the chief actual cause ofextensive unemployment—an accountwhich will also explain why such unem-ployment cannot be lastingly cured by theinflationary policies recommended by thenow fashionable theory. This correct expla-nation appears to me to be the existence ofdiscrepancies between the distribution ofdemand among the different goods andservices and the allocation of labor andother resources among the production ofthose outputs. We possess a fairly good“qualitative” knowledge of the forces bywhich a correspondence between demandand supply in the different sectors of theeconomic system is brought about, of theconditions under which it will be achieved,


and of the factors likely to prevent such anadjustment. The separate steps in theaccount of this process rely on facts ofeveryday experience, and few who take thetrouble to follow the argument will questionthe validity of the factual assumptions, or thelogical correctness of the conclusions drawnfrom them. We have indeed good reason tobelieve that unemployment indicates thatthe structure of relative prices and wageshas been distorted (usually by monopolisticor governmental price fixing), and that torestore equality between the demand andthe supply of labor in all sectors changes ofrelative prices and some transfers of laborwill be necessary.

But when we are asked for quantitativeevidence for the particular structure ofprices and wages that would be required inorder to assure a smooth continuous sale ofthe products and services offered, we mustadmit that we have no such information. Weknow, in other words, the general condi-tions in which what we call, somewhat mis-leadingly, an equilibrium will establishitself: but we never know what the particu-lar prices or wages are which would exist ifthe market were to bring about such an


equilibrium. We can merely say what theconditions are in which we can expect themarket to establish prices and wages atwhich demand will equal supply. But wecan never produce statistical informationwhich would show how much the prevailingprices and wages deviate from those whichwould secure a continuous sale of the cur-rent supply of labor. Though this account ofthe causes of unemployment is an empiricaltheory, in the sense that it might be provedfalse, e.g., if with a constant money supply,a general increase of wages did not lead tounemployment, it is certainly not the kind oftheory which we could use to obtain specificnumerical predictions concerning the ratesof wages, or the distribution of labor, to beexpected.

Why should we, however, in economics,have to plead ignorance of the sort of factson which, in the case of a physical theory, ascientist would certainly be expected to giveprecise information? It is probably not sur-prising that those impressed by the exampleof the physical sciences should find thisposition very unsatisfactory and should insiston the standards of proof which they findthere. The reason for this state of affairs is


the fact, to which I have already brieflyreferred, that the social sciences, like muchof biology but unlike most fields of thephysical sciences, have to deal with struc-tures of essential complexity, i.e., with struc-tures whose characteristic properties can beexhibited only by models made up of rela-tively large numbers of variables. Competi-tion, for instance, is a process which willproduce certain results only if it proceedsamong a fairly large number of acting per-sons.

In some fields, particularly where prob-lems of a similar kind arise in the physicalsciences, the difficulties can be overcomeby using, instead of specific informationabout the individual elements, data aboutthe relative frequency, or the probability,of the occurrence of the various distinctiveproperties of the elements. But this is trueonly where we have to deal with what hasbeen called by Dr. Warren Weaver (for-merly of the Rockefeller Foundation), witha distinction which ought to be much morewidely understood, “phenomena of unor-ganized complexity,” in contrast to those“phenomena of organized complexity”with which we have to deal in the social


sciences.2 Organized complexity heremeans that the character of the structuresshowing it depends not only on the proper-ties of the individual elements of which theyare composed, and the relative frequencywith which they occur, but also on the man-ner in which the individual elements areconnected with each other. In the explana-tion of the working of such structures wecan for this reason not replace the informa-tion about the individual elements by statis-tical information, but require full informa-tion about each element if from our theorywe are to derive specific predictions aboutindividual events. Without such specificinformation about the individual elementswe shall be confined to what on anotheroccasion I have called mere pattern predic-tions—predictions of some of the generalattributes of the structures that will formthemselves, but not containing specific


2Warren Weaver, “A Quarter Century in the NaturalSciences,” The Rockefeller Foundation AnnualReport 1958, chapter I, “Science and Complexity.”

statements about the individual elements ofwhich the structures will be made up.3

This is particularly true of our theoriesaccounting for the determination of the sys-tems of relative prices and wages that willform themselves on a wellfunctioning mar-ket. Into the determination of these pricesand wages there will enter the effects of par-ticular information possessed by every oneof the participants in the market process—asum of facts which in their totality cannot beknown to the scientific observer, or to anyother single brain. It is indeed the source ofthe superiority of the market order, and thereason why, when it is not suppressed bythe powers of government, it regularly dis-places other types of order, that in the result-ing allocation of resources more of theknowledge of particular facts will be utilizedwhich exists only dispersed among


3See my essay “The Theory of ComplexPhenomena” in The Critical Approach to Scienceand Philosophy. Essays in Honor of K.R. Popper, ed.M. Bunge (New York, 1964), and reprinted (withadditions) in my Studies in Philosophy, Politics andEconomics (London and Chicago, 1967).

uncounted persons, than any one personcan possess. But because we, the observingscientists, can thus never know all the deter-minants of such an order, and in conse-quence also cannot know at which particularstructure of prices and wages demand wouldeverywhere equal supply, we also cannotmeasure the deviations from that order; norcan we statistically test our theory that it isthe deviations from that “equilibrium” systemof prices and wages which make it impossi-ble to sell some of the products and servicesat the prices at which they are offered.

Before I continue with my immediateconcern, the effects of all this on theemployment policies currently pursued,allow me to define more specifically theinherent limitations of our numerical knowl-edge which are so often overlooked. I wantto do this to avoid giving the impression thatI generally reject the mathematical methodin economics. I regard it in fact as the greatadvantage of the mathematical techniquethat it allows us to describe, by means ofalgebraic equations, the general character ofa pattern even where we are ignorant of thenumerical values which will determine itsparticular manifestation. We could scarcely


have achieved that comprehensive pictureof the mutual interdependencies of the dif-ferent events in a market without this alge-braic technique. It has led to the illusion,however, that we can use this technique forthe determination and prediction of thenumerical values of those magnitudes; andthis has led to a vain search for quantitativeor numerical constants. This happened inspite of the fact that the modern founders ofmathematical economics had no such illu-sions. It is true that their systems of equa-tions describing the pattern of a marketequilibrium are so framed that if we wereable to fill in all the blanks of the abstractformulae, i.e., if we knew all the parametersof these equations, we could calculate theprices and quantities of all commodities andservices sold. But, as Vilfredo Pareto, one ofthe founders of this theory, clearly stated, itspurpose cannot be “to arrive at a numericalcalculation of prices,” because, as he said, itwould be “absurd” to assume that we couldascertain all the data.4 Indeed, the chief


4V. Pareto, Manuel d'économie politique, 2nd. ed.(Paris, 1927), pp. 223–24.

point was already seen by those remarkableanticipators of modern economics, the Span-ish schoolmen of the sixteenth century, whoemphasized that what they called pretiummathematicum, the mathematical price,depended on so many particular circum-stances that it could never be known to manbut was known only to God.5 I sometimeswish that our mathematical economistswould take this to heart. I must confess thatI still doubt whether their search for meas-urable magnitudes has made significant con-tributions to our theoretical understandingof economic phenomena—as distinct fromtheir value as a description of particular sit-uations. Nor am I prepared to accept theexcuse that this branch of research is stillvery young: Sir William Petty, the founder ofeconometrics, was after all a somewhat sen-ior colleague of Sir Isaac Newton in theRoyal Society!


5See, e.g., Luis Molina, De iustitia et iure, Cologne1596–1600, tom. II, disp. 347, no. 3, and particularlyJohannes de Lugo, Disputationum de iustitia et iuretomus secundus (Lyon, 1642), disp. 26, sect. 4, no. 40.

There may be few instances in whichthe superstition that only measurable magni-tudes can be important has done positiveharm in the economic field: but the presentinflation and employment problems are avery serious one. Its effect has been thatwhat is probably the true cause of extensiveunemployment has been disregarded by thescientistically minded majority of econo-mists, because its operation could not beconfirmed by directly observable relationsbetween measurable magnitudes, and thatan almost exclusive concentration on quan-titatively measurable surface phenomena hasproduced a policy which has made mattersworse.

It has, of course, to be readily admittedthat the kind of theory which I regard as thetrue explanation of unemployment is a the-ory of somewhat limited content because itallows us to make only very general predic-tions of the kind of events which we mustexpect in a given situation. But the effectson policy of the more ambitious construc-tions have not been very fortunate and Iconfess that I prefer true but imperfectknowledge, even if it leaves much indeter-mined and unpredictable, to a pretense of


exact knowledge that is likely to be false.The credit which the apparent conformitywith recognized scientific standards can gainfor seemingly simple but false theories may,as the present instance shows, have graveconsequences.

In fact, in the case discussed, the verymeasures which the dominant “macro-eco-nomic” theory has recommended as a rem-edy for unemployment, namely the increaseof aggregate demand, have become a causeof a very extensive misallocation ofresources which is likely to make laterlarge-scale unemployment inevitable. Thecontinuous injection of additional amountsof money at points of the economic systemwhere it creates a temporary demandwhich must cease when the increase of thequantity of money stops or slows down,together with the expectation of a continu-ing rise of prices, draws labor and otherresources into employments which can lastonly so long as the increase of the quantityof money continues at the same rate—orperhaps even only so long as it continuesto accelerate at a given rate. What this pol-icy has produced is not so much a level ofemployment that could not have been


brought about in other ways, as a distribu-tion of employment which cannot be indef-initely maintained and which after sometime can be maintained only by a rate ofinflation which would rapidly lead to a dis-organization of all economic activity. Thefact is that by a mistaken theoretical viewwe have been led into a precarious positionin which we cannot prevent substantialunemployment from re-appearing; notbecause, as this view is sometimes misrep-resented, this unemployment is deliberatelybrought about as a means to combat infla-tion, but because it is now bound to occuras a deeply regrettable but inescapableconsequence of the mistaken policies of thepast as soon as inflation ceases to acceler-ate.

I must, however, now leave these prob-lems of immediate practical importancewhich I have introduced chiefly as an illus-tration of the momentous consequences thatmay follow from errors concerning abstractproblems of the philosophy of science. Thereis as much reason to be apprehensive aboutthe long run dangers created in a much widerfield by the uncritical acceptance of assertionswhich have the appearance of being scientific


as there is with regard to the problems I havejust discussed. What I mainly wanted to bringout by the topical illustration is that certainlyin my field, but I believe also generally in thesciences of man, what looks superficially likethe most scientific procedure is often themost unscientific, and, beyond this, that inthese fields there are definite limits to whatwe can expect science to achieve. This meansthat to entrust to science—or to deliberatecontrol according to scientific principles—more than scientific method can achievemay have deplorable effects. The progressof the natural sciences in modern times hasof course so much exceeded all expecta-tions that any suggestion that there may besome limits to it is bound to arouse suspi-cion. Especially all those will resist such aninsight who have hoped that our increasingpower of prediction and control, generallyregarded as the characteristic result of sci-entific advance, applied to the processes ofsociety, would soon enable us to mouldsociety entirely to our liking. It is indeedtrue that, in contrast to the exhilarationwhich the discoveries of the physical sci-ences tend to produce, the insights whichwe gain from the study of society more


often have a dampening effect on our aspi-rations; and it is perhaps not surprising thatthe more impetuous younger members ofour profession are not always prepared toaccept this. Yet the confidence in the unlim-ited power of science is only too oftenbased on a false belief that the scientificmethod consists in the application of aready-made technique, or in imitating theform rather than the substance of scientificprocedure, as if one needed only to followsome cooking recipes to solve all socialproblems. It sometimes almost seems as ifthe techniques of science were more easilylearnt than the thinking that shows us whatthe problems are and how to approachthem.

The conflict between what in its presentmood the public expects science to achievein satisfaction of popular hopes and what isreally in its power is a serious matterbecause, even if the true scientists should allrecognize the limitations of what they cando in the field of human affairs, so long asthe public expects more there will alwaysbe some who will pretend, and perhapshonestly believe, that they can do more tomeet popular demands than is really in their


power. It is often difficult enough for theexpert, and certainly in many instancesimpossible for the layman, to distinguishbetween legitimate and illegitimate claimsadvanced in the name of science. The enor-mous publicity recently given by the mediato a report pronouncing in the name of sci-ence on The Limits to Growth, and thesilence of the same media about the devas-tating criticism this report has received fromthe competent experts,6 must make one feelsomewhat apprehensive about the use towhich the prestige of science can be put.But it is by no means only in the field ofeconomics that far-reaching claims are madeon behalf of a more scientific direction of allhuman activities and the desirability of


6See The Limits to Growth: A Report of the Club ofRome's Project on the Predicament of Mankind(New York, 1972); for a systematic examination ofthis by a competent economist cf. WilfredBeckerman, In Defence of Economic Growth(London, 1974), and, for a list of earlier criticisms byexperts, Gottfried Haberler, Economic Growth andStability (Los Angeles, 1974), who rightly calls theireffect “devastating.”

replacing spontaneous processes by “con-scious human control.” If I am not mistaken,psychology, psychiatry, and some branchesof sociology, not to speak about the so-called philosophy of history, are even moreaffected by what I have called the scientis-tic prejudice, and by specious claims ofwhat science can achieve.7

If we are to safeguard the reputation ofscience, and to prevent the arrogation ofknowledge based on a superficial similarityof procedure with that of the physical sci-ences, much effort will have to be directedtoward debunking such arrogations, some ofwhich have by now become the vestedinterests of established university depart-ments. We cannot be grateful enough tosuch modern philosophers of science as SirKarl Popper for giving us a test by which we


7I have given some illustrations of these tendenciesin other fields in my inaugural lecture as VisitingProfessor at the University of Salzburg, Die Irrtümerdes Konstruktivismus und die Grundlagen legitimerKritik gesellschaftlicher Gebilde (Munich, 1970), nowreissued for the Walter Eucken Institute, at Freiburgi.Brg. by J.C.B. Mohr (Tübingen, 1975).

can distinguish between what we mayaccept as scientific and what not—a testwhich I am sure some doctrines now widelyaccepted as scientific would not pass. Thereare some special problems, however, in con-nection with those essentially complex phe-nomena of which social structures are soimportant an instance, which make me wishto restate in conclusion in more generalterms the reasons why in these fields notonly are there only absolute obstacles to theprediction of specific events, but why to actas if we possessed scientific knowledgeenabling us to transcend them may itselfbecome a serious obstacle to the advance ofthe human intellect.

The chief point we must remember isthat the great and rapid advance of thephysical sciences took place in fields whereit proved that explanation and predictioncould be based on laws which accountedfor the observed phenomena as functionsof comparatively few variables—either par-ticular facts or relative frequencies ofevents. This may even be the ultimate rea-son why we single out these realms as“physical” in contrast to those more highlyorganized structures which I have here


called essentially complex phenomena.There is no reason why the position must bethe same in the latter as in the former fields.The difficulties which we encounter in thelatter are not, as one might at first suspect,difficulties about formulating theories for theexplanation of the observed events—although they cause also special difficultiesabout testing proposed explanations andtherefore about eliminating bad theories.They are due to the chief problem whicharises when we apply our theories to anyparticular situation in the real world. A the-ory of essentially complex phenomena mustrefer to a large number of particular facts;and to derive a prediction from it, or to testit, we have to ascertain all these particularfacts. Once we succeeded in this thereshould be no particular difficulty aboutderiving testable predictions—with the helpof modern computers it should be easyenough to insert these data into the appro-priate blanks of the theoretical formulae andto derive a prediction. The real difficulty, tothe solution of which science has little tocontribute, and which is sometimes indeedinsoluble, consists in the ascertainment ofthe particular facts.


A simple example will show the natureof this difficulty. Consider some ball gameplayed by a few people of approximatelyequal skill. If we knew a few particular factsin addition to our general knowledge of theability of the individual players, such as theirstate of attention, their perceptions and thestate of their hearts, lungs, muscles etc., ateach moment of the game, we could proba-bly predict the outcome. Indeed, if we werefamiliar both with the game and the teamswe should probably have a fairly shrewdidea on what the outcome will depend. Butwe shall of course not be able to ascertainthose facts and in consequence the result ofthe game will be outside the range of thescientifically predictable, however well wemay know what effects particular eventswould have on the result of the game. Thisdoes not mean that we can make no pre-dictions at all about the course of such agame. If we know the rules of the differentgames we shall, in watching one, very soonknow which game is being played and whatkinds of actions we can expect and whatkind not. But our capacity to predict will beconfined to such general characteristics ofthe events to be expected and not include



the capacity of predicting particular individ-ual events.

This corresponds to what I have calledearlier the mere pattern predictions to whichwe are increasingly confined as we penetratefrom the realm in which relatively simplelaws prevail into the range of phenomenawhere organized complexity rules. As weadvance we find more and more frequentlythat we can in fact ascertain only some butnot all the particular circumstances whichdetermine the outcome of a given process;and in consequence we are able to predictonly some but not all the properties of theresult we have to expect. Often all that weshall be able to predict will be some abstractcharacteristic of the pattern that will appear—relations between kinds of elements aboutwhich individually we know very little. Yet,as I am anxious to repeat, we will stillachieve predictions which can be falsifiedand which therefore are of empirical signifi-cance.

Of course, compared with the precisepredictions we have learnt to expect in thephysical sciences, this sort of mere patternpredictions is a second best with which onedoes not like to have to be content. Yet the

danger of which I want to warn is preciselythe belief that in order to have a claim to beaccepted as scientific it is necessary toachieve more. This way lies charlatanismand worse. To act on the belief that we pos-sess the knowledge and the power whichenable us to shape the processes of societyentirely to our liking, knowledge which infact we do not possess, is likely to make usdo much harm. In the physical sciencesthere may be little objection to trying to dothe impossible; one might even feel that oneought not to discourage the over-confidentbecause their experiments may after all pro-duce some new insights. But in the socialfield the erroneous belief that the exercise ofsome power would have beneficial conse-quences is likely to lead to a new power tocoerce other men being conferred on someauthority. Even if such power is not in itselfbad, its exercise is likely to impede the func-tioning of those spontaneous ordering forcesby which, without understanding them, manis in fact so largely assisted in the pursuit ofhis aims. We are only beginning to under-stand on how subtle a communication sys-tem the functioning of an advanced indus-trial society is based—a communications



system which we call the market and whichturns out to be a more efficient mechanismfor digesting dispersed information than anythat man has deliberately designed.

If man is not to do more harm than goodin his efforts to improve the social order, hewill have to learn that in this, as in all otherfields where essential complexity of anorganized kind prevails, he cannot acquirethe full knowledge which would make mas-tery of the events possible. He will thereforehave to use what knowledge he can achieve,not to shape the results as the craftsmanshapes his handiwork, but rather to cultivatea growth by providing the appropriate envi-ronment, in the manner in which the gar-dener does this for his plants. There is dan-ger in the exuberant feeling of ever growingpower which the advance of the physical sci-ences has engendered and which temptsman to try, “dizzy with success,” to use acharacteristic phrase of early communism, tosubject not only our natural but also ourhuman environment to the control of ahuman will. The recognition of the insupera-ble limits to his knowledge ought indeed toteach the student of society a lesson ofhumility which should guard him against

becoming an accomplice in men’s fatal striv-ing to control society—a striving whichmakes him not only a tyrant over his fellows,but which may well make him the destroyerof a civilization which no brain has designedbut which has grown from the free efforts ofmillions of individuals.


A Free-Market Monetary System and The Pretense of Knowledge

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