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Monetary Central Planning and the State, Part 27: Milton Friedman’s Second Thoughts on the Costs of Paper Money


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In July 1985, Milton Friedman delivered the presidential address at the Western Economic Association on the topic “Economists and Economic Policy,” which was published in the January 1986 issue of Economic Inquiry. He stated that his many years in advocating a monetary “rule,” under which the central monetary authority would increase the money supply at a constant annual rate regardless of changing economic conditions, had been a waste of time. The reason, he said, is that there is no basis for thinking it would ever be in the interest of those who managed the government monetary system to follow such a rule:

“Most of my own work dealing with public policy has had the same character of proceeding as if I were addressing governmental officials selflessly dedicated to the public interestŠ. I have attempted to persuade the Federal Reserve System that it was doing the wrong thing and it ought to adopt a different policy. This time was ill-spent Š because the public-interest characterization of government is basically flawed…. We do not regard a businessman as selflessly devoted to the public interest. We think of a businessman as in business to improve his own welfare, to serve his own interest…. Why should we regard government officials differently? They too aim to serve their own interest, and in government as in business we must try to set up institutions under which individuals who intend only their own gain are led by an invisible hand to serve the public interestŠ. The Federal Reserve System puts a great deal of power in the hands of a few people and it is so constructed that it has been in their self-interest to pursue a policy which, I believe, has been very harmful for the public rather than helpful…. Clearly, it was not in the self-interest of the Federal Reserve hierarchy to follow the hypothetical policy [of a monetary rule]. It was therefore a waste of time to try to persuade them to do so.”

But if government officials, including central monetary authorities, cannot be trusted to serve some rightly understood conception of the “public interest” instead of various political agendas that further their personal and ideological interests, what kind of monetary order can ensure that this does not occur or that its likelihood is minimized?

Milton Friedman, as we have seen, had advocated a fiat or paper money standard guided by a monetary rule of an annual expansion of the money supply at a fixed rate because he believed that it was less costly than a gold standard, less open to inflationary excess, and more likely to provide the monetary framework for general economic stability. (See “Monetary Central Planning and the State, Part 26: Milton Friedman and the Monetary ‘Rule’ for Economic Stability,” in Freedom Daily, February 1999.)

But by the mid 1980s, Friedman had second thoughts about whether government could be trusted ever to follow the necessary restraint to provide this supposedly superior paper money system. He began to regularly quote a sentence from Irving Fisher’s 1911 book, The Purchasing Power of Money : “Irredeemable paper money has almost invariably proved a curse to the country employing it.”

In June 1986, Friedman published a short article in the Journal of Political Economy entitled “The Resource Cost of Irredeemable Paper Money.” He said:

“In earlier discussions, other monetary economists and I took it for granted that the real resource cost of producing irredeemable paper money was negligible, consisting only of the cost of paper and printing. Experience under a universal irredeemable paper money standard makes it crystal clear that such an assumption, while it may be correct with respect to the direct cost to the government of issuing fiat money, is false for the society as a whole.”

The costs of a paper money standard to the society as a whole, Friedman argued, arose precisely from the uncertainty of future monetary policy under government monetary discretion and the inflationary bias that always tended to persist under government control of paper money. During inflationary times, people often tied up real resources that otherwise could have been applied for productive activities in the accumulation of gold and silver hoards as a hedge against rising prices. It led individuals to absorb greater costs in searching out investment strategies that would earn interest incomes believed likely to stay ahead of paper money’s depreciation over time.

It also created incentives for the development of futures markets in commodities and currencies that would efficiently help protect individuals from the greater uncertainty concerning price and foreign exchange-rate fluctuations during periods of monetary instability but which might never have needed to come into existence if not for paper money mismanagement by governments.

Friedman concluded that “the direct resource cost of the gold and silver accumulated in private hoards [in the 1970s and 1980s] may have been as great as or greater than it would have been under an effective gold standard.” And while such commodity and currency futures markets

“serve a useful function by enabling economic agents to hedge against uncertainty and undertake long-term commitments … nevertheless … they would not have arisen if the new [paper] monetary regime had not led to greatly increased uncertainty about interest rates and inflation.”

Also in 1986, Friedman coauthored an article with Anna Schwartz in the Journal of Monetary Economics that asked the question, “Has Government Any Role in Money?” They concluded that in principle it did not need to have one and historically sometimes had none. They argued:

“The apparently great value to the economy of having a single unit of account linked with an (ultimate) medium of exchange does not mean that government must play any role, or that there need be a single producer of the medium of exchange. And indeed, historically, governments have entered the picture after the event, after the community had settled on a unit of account and private producers had produced media of exchange…. Historically, producers of money have established confidence by promising convertibility into some dominant money, generally specie [e.g., gold or silver]. Many examples can be cited of fairly long-continued and successful producers of private moneys convertible into specie. We do not know, however, of any example of the private production of purely inconvertible fiduciary moneys.”

They stated: “Our own conclusion … is that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.” However, they did not argue for a return to a gold standard. In his article on irredeemable paper money, Friedman made this point very clear:

“Let me emphasize that this note is not a plea for a return to a gold standard…. I regard a return to a gold standard as neither desirable nor feasible — with the one exception that it might become feasible if the doomsday predictions of hyperinflation under our present system should prove correct.”

Why wouldn’t a market-based gold standard be feasible or desirable under present circumstances? Friedman explained his reasoning in an April 1976 lecture entitled “Has Gold Lost Its Monetary Role?” that was delivered in Johannesburg, South Africa. Simply put, governments are no longer willing to be restrained by a gold standard. They want control over money for various macroeconomic manipulative purposes. However, Friedman said that

“if you could re-establish a world in which government’s budget accounted for 10 percent of the national income, in which laissez-faire reigned, in which governments did not interfere with economic activities and in which full employment policies had been relegated to the dustbin, in such a world you might be able to restore a real gold standardŠ. A real honest-to-God gold standard is not feasible because there is essentially no government in the world that is willing to surrender control over its domestic monetary policy.”

But if a “real honest-to-God” market-based gold standard were to be reestablished, how might it be brought about? Milton Friedman offered his own suggestion in a 1961 paper entitled “Real and Pseudo Gold Standards,” which was reprinted in his collection of essays Dollars and Deficits (1968). Individuals should, once more, be free to use money as gold, should they so choose, with the prices of goods and services expressed in units of gold, he said. Friedman explained:

“Under such a real gold standard, private persons or government might go into the business of offering storage facilities, and warehouse receipts might be found more convenient than the gold itself for transactionsŠ. If individuals find warehouse certificates for gold more useful than literal gold, private enterprise can certainly provide the service of storing the gold. Why should gold storage and the issuance of warehouse certificates be a nationalized industry? Finally, private persons or governments might issue promises to pay gold either on demand or after a specific time interval which were not warehouse receipts but nevertheless were widely acceptable because of confidence that the promises would be redeemed. Such promises to pay would still not alter the basic character of the gold standard so long as the obligors were not retroactively relieved from fulfilling their promises, and this would be true even if such promises were not fulfilled on time, just as the default of dollar bond issues does not alter the monetary standard. But, of course, promises to pay that were in default or that were expected to be defaulted would not sell at face value, just as bonds in default trade at a discount…. Such a system might, and I believe would, raise grave social problems and foster pressure for government prohibition of or control over the issue of promises to pay gold on demand. But that is beside my present point, which is that it would be a real gold standard.”

And Friedman also emphasized his political-philosophic view of such a gold-based monetary system: “A real gold standard is thoroughly consistent with [classical] liberal principles and I, for one, am entirely in favor of measures promoting its development.”

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    Dr. Richard M. Ebeling is the BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).