Few American economists have wielded as much influence on economic thought and policy as the late Milton Friedman. He was an articulate and ardent advocate of free markets and personal liberty. In 1962, his Capitalism and Freedom, which continues to be in print with nearly one million copies sold, pointed the way not only to economic but also political freedom. A year later his Monetary History of the United States, 1867—1960, co-authored with Anna Schwartz, cast a new light on the Great Depression and the policies that caused it. He was a passionate critic of all versions of socialism and a fervent censor of Keynesian economics which stands as the most influential economic formulation of the 20th century. One of the most prolific writers of his time, Professor Friedman wrote many pertinent economic columns in Newsweek. His outstanding achievements earned him the Nobel Prize in 1976.
It may be folly to criticize and censure a famous author whom all the world admires. Yet this economist has been at odds with Professor Friedman ever since he advanced his monetarist thought. It is strange that Professor Friedman and his fellow monetarists, who are such defenders of the market order, should call on politicians and bureaucrats to provide the most important economic good — money. Granted, monetarists do not trust them with discretionary powers, which led Friedman to write a detailed prescription, a Constitutional Amendment; however, the Constitution is supreme force, backed by courts and police. The amendment is a political formula to be adopted by political authorities and, when enacted, a constitutional prohibition of monetary freedom.
The Amendment calls for issue of government money in the form of non-interest bearing obligations which would not alter the nature of currency expansion, it merely would change its technique. The stock of these obligations is supposed to grow, year after year, without any obligation to repay, which changes their nature from being obligations to being mere government paper. The Friedman proposal would merely simplify the technique of money issue; instead of the Federal Reserve creating and lending its funds to the U.S. Treasury, earning an interest thereon and then returning the interest to the Treasury as miscellaneous receipts, Friedman would have the Treasury issue non-interest bearing U.S. notes. This would save the U.S. Treasury the interest it is now paying, and eliminate the miscellaneous receipts the Treasury is now receiving.
In its search for stability, the Friedman amendment, unfortunately, proceeds on the old road to nowhere. There is no absolute monetary stability, never has been, and never can be. Economic life is a process of perpetual change. People continually choose among alternatives, attaching ever-changing values to economic goods; therefore, the exchange ratios of their goods are forever adjusting. Economists searching for absolute stability and measurement are searching in vain, and they become disruptive and potentially harmful to the economic well-being of society when they call upon government to apply its force to achieve the unattainable.
Money is no yardstick of prices. It is subject to man’s valuations and actions in the same way that all other economic goods are. Its subjective, as well as objective, exchange values continually fluctuate and, in turn, affect the exchange ratios of other goods at different times and to different extents. There is no true stability of money, whether it is fiat or commodity money. There is no fixed point or relationship in economic exchange. Yet, despite this inherent instability of economic value and purchasing power, man is forever searching for a dependable medium of exchange.
The precious metals have served him well throughout the ages. Because of their natural qualities and their relative scarcity, both gold and silver were dependable media of exchange. They were marketable goods that gradually gained universal acceptance and employment in exchanges. They even could be used to serve as tools of economic calculation because their quantities changed very slowly over time. This kept changes in their purchasing power at rates that could be disregarded in business accounting and bookkeeping. In this sense, we may speak of an accounting stability that permits acting man to compare the countless objects of his economic concern.
Contrary to monetarist doctrine, an expansion of the money stock of three to five percent suffices to generate the business cycle. Economic booms and busts occur in every case of fiat expansion, whether the expansion is one percent or hundreds of percents. The magnitude of expansion does not negate its effects; it merely determines the severity of the maladjustment and necessary readjustment.
Monetarists are quick to proclaim that business recessions in general, and the Great Depression in particular, are the result of monetary contraction. Mistaking symptoms for causes, they prescribe policies that treat the symptoms; however, the prescription, which is reinflation, tends to aggravate the maladjustments and delay the necessary readjustment.
The Friedman amendment, unfortunately, would cause the same economic and social conflicts as the present fiat system. It would create income and wealth with the stroke of a pen, and then distribute the booty to a long line of eager beneficiaries. The amendment would fix the quantity of issue, but the mode of its distribution, which confers favors and assigns losses, would be left to the discretion of the monetary authorities. It would enmesh them in ugly political battles about credit redistribution, which soon would spill over to the halls of Congress, just as it does today.
The monetarists actually have no business cycle theory, merely a prescription for government to hold it steady. From Irving Fisher to Milton Friedman the antidote for depressions has always been the same: reinflation. The central banker who permits credit contraction is the culprit of it all. If there is a recession, he must issue more money, and if there is inflation, that is, rising price levels, he must slow the increase in the supply of money, but increase it nevertheless.
Professor Friedman himself seems to have been aware of his lack of business cycle theory when he admitted little confidence in our knowledge of the transmission mechanism. He had no engineering blueprint, but merely an impressionistic representation that monetary changes are the key to major movements in money income. His gap hypothesis, therefore, is designed to fill the gap of theory and allow for the time it takes for all adjustments to be corrected. He seeks to time the recession without explaining it.
The increasing importance of government obligations as bank assets gives great confidence to monetarists; however, it creates anxiety because government obligations merely are receipts for money spent and savings consumed. Every budgetary deficit that creates more government obligations consumes productive capital and thereby hampers economic production. The growing importance of government obligations in bank portfolios actually signals government consumption of economic substance and wealth. To commercial banks, it means the loss of real property securing the loans, and the addition of yet more government promises to tax, print and pay. A banking system built primarily on government IOUs is in a precarious condition.
What Professor Friedman called the dethroning of gold was, in truth, the default of central banks to make good on their legal and contractual obligations. Following the example set by the United States on August 15, 1971, central banks all defaulted in their duty to redeem their currencies in gold. The default, unfortunately, did not bring stability and prosperity; it opened the gates for world-wide inflation. It made the U.S. dollar the world currency, elevated the Federal Reserve System to the world central bank, and inundated the world with U.S. dollars. (Cf. My Money and Freedom, Libertarian Press, 1985.)