Most treatments involved rest, fresh air, and a rich diet. The “mind cure” blamed the disease on the stresses of modern life and coincided with a craze for all things Japanese or Chinese. Its practitioners urged individuals to take responsibility for their own health and advocated “calming one’s fractious thoughts so that one might connect with the powerful and invisible spirit of God, humanity or some other force.”70 This was the era of positive thinking. In a speech at a local boys’ school, Fisher explained his personal philosophy:
All greatness in this world consists largely of mental self control. Napoleon compared his mind to a chest of drawers. He pulled one out, examined its contents, shut it up, and pulled out another. Mr. Pierpont Morgan is said to have a similar control. . . . What we call the life of a man consists simply of the stream of consciousness, of the succession of images which he allows to come before his mind. . . . It is in our power to so direct and choose our stream of consciousness as to form our character into whatever we desire.71
For the next six years, Fisher struggled to recover his health, natural energy, and normal high spirits. He spent nearly half a year at the Adirondack Cottage Sanitarium in Saranac, New York. The hospital was operated by Dr. Edward L. Trudeau and modeled on the Alpine sanitaria described by the German novelist Thomas Mann in The Magic Mountain. The children were dispatched to their grandparents, and Margie accompanied Fisher to Saranac. They bought a raccoon coat and a copy of John Greenleaf Whittier’s long poem Snow-Bound to read aloud. “The doctors fully expect me to get well but it takes time,” Fisher wrote to Will Eliot in December 1898. “I am sitting out on the porch, the thermometer is twenty and the snow is two feet deep. I find ink freezes and so use pencil.”72 By January 1901, Fisher’s doctors told him that he was fully recovered, but it took him three more years to regain his former energy.
Surviving tuberculosis awakened the latent preacher in Fisher. He became a crusader for public health and an advocate for healthy living and mind control, to which he believed he owed his recovery. His triumph over tuberculosis convinced Fisher that the extraordinary—such as the doubling of average life spans by the year 2000—was possible. When he met Dr. John Harvey Kellogg, the crusader for “biologic living,” Fisher told him that he was “on a quest not like Ponce de León for the fountain of youth but for ideas which may help us to lengthen and to enjoy youth.”73 Influenced by Kellogg, Fisher conducted experiments on vegetarian diets with Yale athletes as subjects, applied for the job of secretary of the Smithsonian, and lobbied for the creation of a cabinet-level health department. In 1908, after the assassination of President McKinley, Fisher was appointed by his successor, Theodore Roosevelt, the youngest president of the United States, to the National Conservation Commission. The idea of conservation “has its center of gravity in our sense of obligation to posterity.” It is hard for us in America, he noted, enjoying the present plenty, to realize that “we are scattering the substance that belongs to future generations.”74
• • •
In 1906, the year of the San Francisco earthquake, Fisher declared Homo economicus, economic man, defunct and laissez-faire a dead ideology. At a plenary address at the American Association for the Advancement of Science, he called the acceptance of government regulation and welfare measures “the most remarkable change which economic opinion has undergone during the last fifty years.”75 Experience, he said, proved that the basic tenets of liberal theory—that individuals were the best judges of self-interest and that the pursuit of self-interest would produce the maximum good for society—were wrong. Government regulation and voluntary reform movements—the nineteenth-century equivalent of today’s NGOs—were not merely not harmful, but necessary. Indeed, he said, they had already done much to preserve the natural environment and to improve public health. He said that if he had to choose between Sumner’s extreme libertarianism or Socialism, he would choose the latter, and he enumerated many instances in which what is good for the individual is not good for society and, therefore, laissez-faire is not the right policy.
The Nature of Capital and Income, published in 1906, reflected Fisher’s growing understanding of capital as a stream of future services and interest in conservation. Fisher was convinced that economic interdependence—epitomized by urbanization, economic specialization, and globalization—implied a greater need for data, education, coordination, and intervention on the part of the government. He argued that concern for the future required prevention and conservation. His near-death experience gave his concern for economic efficiency and prevention of waste even greater urgency. Perry Mehrling, a historian of economic thought, says that Fisher was influenced by a contemporary of Adam Smith, John Rae, to define “interest”—including profits, rents, and wages—as the value of the stream of services from the machines, land, and human capital accumulated in the past. All of Fisher’s reforms, observes Mehrling, from increasing life spans to preventing depressions and wars, were directed at increasing current national wealth.76
Today, economists talk of bounded rationality, externalities, and market failures. Fisher spoke of ignorance and lack of self-control. More radically, he argued that even when individuals behaved totally rationally, the combined effect of their actions might reduce collective well-being. “Not only is it false that men, when let alone, will always follow their best interests, but it is false that when they do, they will always thereby best serve society.”77 One special kind of ignorance, he explained, involved treating the present as if it was the norm. Life spans were only half as long as they could be, he thought. Productivity was just half as great. His most intriguing insight was that the mind plays tricks. He called it the money illusion. For Fisher, inflation and deflation—all changes in the overall level of prices—were evils because they misled people into making bad decisions. At the level of the economy, the money illusion meant that it took a long time for businesses and consumers to adjust to changes in prices and interest rates.
He drew two conclusions from the recognition that Homo sapiens were not Homo economicus, hyperrational calculating machines. First, there was a strong case for compulsory education. Second, there was an even stronger case for regulating individual behavior, whether via fire regulations in tenements or the prohibition of gambling or alcohol and other drugs: “It is not true that ignorant parents are justified in imposing their ideas of education upon their children; hence the problem of child-labor, instead of concerning only the individual, as was at one time thought, has important and far-reaching relations to society as a whole.”78
Fisher went much further than Marshall in pointing out the limits of the competitive model. In this he anticipated the entire arc of economic theory after World War II. “Even when government intervention is impracticable or inadvisable, there will still be good reason for attempting betterment of conditions through the influence of one class upon another, hence come social agitations.”79
Even if everyone were perfectly rational, the pursuit of self-interest wouldn’t necessarily add up to socially desirable results. “Individual action would never give rise to a system of city parks, or even to any useful system of streets,” he said. Hence, he rejected privatizing either the money supply, as Spencer advocated, or the “still more astonishing suggestion [is] that even the police function of government should be left to private hand, that police corps should be simply voluntary vigilance committees, somewhat like the old-fashioned fire companies, and that rivalry between these companies would secure better service than now obtained through government police!”80
Fisher’s illness was followed by an extraordinary burst of creativity. In the space of five or six years, he poured out ideas that had germinated during his enforced exile, in which he had embraced Indian philosophy and meditation practices.
Last night at sunset I sat out there like an Indian, thinking of nothing, but feeling the serenity and power of the Universe . . . Those sub-conscious impressions of three years or more of depression, fear and worry are sti
ll in my mental storehouse, but buried, I hope permanently. It has been only by hard work and the application of auto-suggestion that the blue devils have been crowded down at all. I have to confess that the chief thing the matter with me after the first year was fear . . . Optimism is not a question of what evil exists nor of what we may expect of the future. A man may believe the world unhappy and that the earth will grow cold and dead, that he himself is to have pain, loss of friends, honor, wealth—and yet be an optimist.81
• • •
The year 1907 was an unsettled one in the financial markets. Fisher was hurrying to finish a new book, The Rate of Interest, that he subtitled “Its Nature, Determination and Relation to Economic Phenomena.”
For the first time, he explicitly couched his theory in terms of a lack of foresight: periods of speculation and depression are the result of inequality of foresight. “A panic is always the result of unforeseen conditions and among those unforeseen conditions and partly as a result of other unforeseen conditions is scarcity of money on loan.”82
If inflation or deflation were correctly anticipated, explains Perry Mehrling, interest rates in money markets would adjust instantly and perfectly. If lenders expected the overall price level to rise, they would require borrowers to pay a commensurately higher interest rate. If they expected the overall price level to fall, they would be willing to accept a commensurately lower interest rate. By the same reasoning, if borrowers expected higher inflation, they would realize that paying nominally higher interest rates would not affect their real rate of return. If borrowers expected deflation, they would realize that they could afford to pay only a commensurately lower nominal interest rate. In short, if anticipations were correct, changes in the price level would have no effect on real output or employment. The trouble, of course, is that such perfect foresight is impossible: “Their failure to [correctly anticipate deflation] results in an unexpected loss to the debtor and an unexpected gain to the creditor.”83
Now Fisher reversed his earlier position that changes in the value of money have a negligible effect in real economic activity and decided that interest rates didn’t adjust that smoothly or completely after all to compensate for the effects of changes in the dollar purchasing power, so stable prices are necessary for a fair and transparent monetary system:
The bimetallists were partially right in their claim that the creditor class were gainers during the period of falling prices in the two decades 1875–1895. The situation has been the exact opposite during the decade 1896–1906. We must not make the mistake, however, of assuming that the enrichment of the debtor-class during the last decade atones for the impoverishment of that class during the previous two decades; for the personnel of social classes changes rapidly. Nor must we make the mistake of assuming that the debtor-class consists of the poor. The typical debtor of to-day is the stockholder, and the typical creditor, the bondholder.84 Under the prevailing monetary standard, the U.S. dollar was fixed in terms of gold weight but not in terms of gold value or purchasing power. That guaranteed that the dollar’s domestic purchasing power would rise and fall with the supply and demand for money. Most people, even the most sophisticated investors and businessmen, viewed the dollar as a measure of value, and found it difficult or impossible to track or anticipate changes in value. Inflation and deflation were harmful because investors, consumers, and businessmen couldn’t predict them perfectly—or even accurately gauge their magnitude in the present and recent past. Decisions made on the basis of faulty expectations necessarily resulted in faulty investment decisions and, from the vantage point of the economy as a whole, too much investment in some areas and too little in others: “reckless wastefulness, for which there must be a day of reckoning in the form of a commercial crisis.”85
• • •
Consider what had happened in a period of sixty years. First, Charles Dickens, Henry Mayhew, and Karl Marx described a world in which the material conditions that had condemned mankind to poverty since time immemorial were becoming less fixed and more malleable. In 1848, Karl Marx showed how competition drove businesses to produce more with the same resources, but argued that no means existed for converting production increases into higher wages and living standards.
Then, in the 1880s, Alfred Marshall discovered that an ingenious mechanism of competition encouraged business owners to make constant, incremental improvements in productivity that accumulated over time and, simultaneously, compelled them to spread the gains in the form of higher wages or lower prices, again, over time. As long as productivity determined wages and living standards, people could alter material conditions individually and collectively by becoming more productive.
Beatrice Webb invented the welfare state as well as her own vocation as social investigator. Mill argued that a welfare state would eventually absorb the entire tax revenue, and Marx insisted that such a state was a non sequitur. Webb, on the other hand, showed that destitution was preventable and that providing education, sanitation, food, medical, and other forms of in-kind assistance would increase private sector productivity and wages more than taxing would decrease it. In other words, helping the poor become literate, better fed, and less disease-ridden was more likely to raise rather than be a drag on economic growth.
Irving Fisher was the first to realize how powerfully money affected the real economy and to make the case that government could increase economic stability by managing money better. By pinpointing a single common cause for the seemingly opposite ills of inflation and deflation, he identified a potential instrument—control of the money supply—that government could use to moderate or even avoid inflationary booms or deflationary depressions.
Chapter V
Creative Destruction: Schumpeter and Economic Evolution
Historical development which would normally take centuries [was] compressed into two or three decades.
—Rosa Luxemburg, The Accumulation of Capital, 19131
On November 4, 1907, news of a run on the Knickerbocker Trust Company in New York set off a stampede on the London Stock Exchange. Frightened investors seeking safety overwhelmed the Bank of England with demands for gold bullion. Threatened with a massive outflow of reserves, the bank responded by raising the interest rate it charged other banks for overnight loans. In the midst of the panic, Joseph Alois Schumpeter, gentleman, and Gladys Ricarde-Seaver, spinster, quietly tied the knot in a registry office near Paddington Station. By the time the discount rate reached 7 percent for the first time in forty years,2 the newlyweds had left for Cairo, Egypt.
• • •
At twenty-four, Schumpeter was already a man of the world. He was born in a small factory town in what is now the Czech Republic, the only son of a third-generation textile manufacturer. After his father’s untimely death in a hunting accident at the age of thirty-one, his mother, Johanna, who was and would remain the most important person in Schumpeter’s life, resolved to go to any lengths to ensure a brilliant future for her four-year-old son. Largely for his sake, she contrived to move to Graz, a pleasant university town. When her darling turned eleven, she married a retired general thirty years her senior, and convinced her husband to relocate the family to Vienna to a luxurious apartment off the Ringstrasse. Thanks to his stepfather’s aristocratic connections, Schumpeter attended an ancient academy for the sons of nobles. At the Theresianum he acquired, in addition to skill in fencing and riding, fluency in no fewer than five classical and modern foreign languages, and invaluable social connections—as well as the flowery manners, promiscuous habits, and extravagant tastes of the titled set. His elite education came at an emotional price. The alter ego of the young social climber was the solitary and driven scholar who read philosophy and sociology texts. In a school where “to be a bit stupid” implied an aristocratic lineage, his brains and obsessive middle-class work habits only underscored his parvenu status.3 Short, slight, and swarthy, with an unusually high forehead and penetrating, slightly protuberant eyes, his exotic appearance provoked sly
taunts about “eastern” (read Jewish) origins. He compensated by excelling in riding, fencing, and verbal wit, and learned to bury his private anxieties under a blasé, ironic, world-weary, manner.
By 1901, the eighteen-year-old Schumpeter had succeeded in graduating from the Theresianum with top honors and gaining admission to the University of Vienna—the first step in what he and his mother hoped would be a rapid climb to the most rarefied reaches of Viennese society. True, Vienna’s “first society” was essentially limited to the emperor and his court. But the occupant of a university chair or a cabinet post could breach the “second society,” where the clever and capable mingled with aristocrats and plutocrats. By the time Schumpeter was a first-year law student, he already pictured himself as the empire’s youngest university professor and the emperor’s most trusted economic advisor.
• • •
Belle époque Vienna is often depicted by historians as a decadent, complacent, ossified society, and the Austro-Hungarian Empire as hopelessly backward compared with England, France, or Germany. Oszkàr Jàszi called Austria-Hungary “a defeated empire from the economic point of view.”4 Carl Schorske described the bourgeoisie as politically passive.5 Erich Streissler bemoaned the dearth of entrepreneurship and the tendency of the sons of businessmen—Ludwig Wittgenstein and Franz Kafka, among others—to choose the arts over industry.6 In Joseph Roth’s 1932 decline-and-fall novel about the Hapsburg monarchy, The Radetzky March, a Viennese aristocrat, Count Chojnicki, attributes the empire’s seemingly moribund state to the fact that “this is the age of electricity, not of alchemy.” Pointing to a brilliantly lit electrical chandelier, he exclaims, “In Franz Joseph’s castle they still burn candles!”7