He is known, of course, for his work on money and inflation. But he did not propose, as Hayek did, competition in currency production. He thought the reality of our times is that governments are in control of the money supply, so the question is simply how to sustain them. He thought a gold standard impractical – inevitably, rather than using the metal itself as money, people would use paper (or electronic) receipts for it, so you have the same problem of potential over-printing of that paper as you do today. So he thought the best thing was to have a monetary rule, preventing politicians from over-producing the paper money we have today.

While having a consistent ideology is important, it is always tempered by pragmatism. This is due to the very simple fact that humans are finite beings and cannot possibly fight every possible ideological battle that could possibly be fought. There are limits to what one person can do. Therefore, every person usually compromises his ideals at some point in life. Sometimes this leads to regret, sometimes this leads to relief.

Milton Friedman is no exception to this. Though he was very much a libertarian, he thought monetary policy to be a point of pragmatism. I’m not sure it’s wise to fault him for this, given the setting in which he made his decision. Government interference in all aspects of the economy was pretty rampant, and the general trend towards statism was ramping up when he hit it big. He had respect and was listened to by many people. But even Friedman had to pick his battles. It’s easy to criticize his decisions ex post, but it’s helpful to remember that he could not foresee most of the consequences.

Now, one can credibly argue that it’s foolish to trust the government to arbitrary rules about money policy. This assertion is true. One could also argue that “sound” money forces the government to be honest. This is also true, assuming you can keep the money sound. See, the United States used to be on a gold standard, then it left it. Going back to a gold standard, though desirable, was no guarantee against this happening again. As such, from a practical standpoint, it didn’t really matter what rules the government constrained the government; the government was going to look for ways to get around them and inflate the currency, one way or another.

It is certainly legitimate to criticize Friedman for his failure to harp on sound money, given the scope of his influence. Perhaps then much of the mess the United States face today would have been headed off earlier. Perhaps not; we can’t be sure. However, it is unfair to paint Friedman as a statist when his record is clearly libertarian. He may have been unnecessarily pragmatic on monetary policy, which is a matter with plenty of room for reasonable disagreement, but he certainly worked to advance the cause of freedom, and for that he should be thanked.

As such, it makes no sense that governments should create money through “quasi-private” central banks.  If there is consumer demand for facilitating the exchange of goods and services, then there will arise through the spontaneous order of the free market a system of competing providers of currencies.  Presumably, those who produce money that will retain its value will drive out of the market those incompetent or unscrupulous competitors producing depreciating money.  This is because money that retains its value over time will make the exchange of products easier because businesses will be able to make better calculations in exchange, and because as with any product, a premium will be placed on maintenance of value over depreciation.

One could speak to a host of problems with government currency: that inflation of the money supply unfairly benefits debtors at the expense of creditors and serves as an outright tax on all; that a constantly debased currency allows the government to fund unjustifiable wars in addition to all sorts of social programs and other means of unjust and unconstitutional wealth redistribution; that government naturally will mismanage the money supply just as they do all programs from a purely economic standpoint; that it is absurd that the government should have the power to outlaw monopolies yet grant itself a monopoly on a commodity like money that serves a specific special interest of the banking sector; and finally that government’s record in management of the money supply has been horrendous, with central banks creating a perpetual boom-bust cycle and constantly devaluing the people’s money.  Concentrating the monopoly power over the money supply in the hands of a select group of bureaucrats is an asinine, irrational and furthermore dangerous policy.

But without going into these sometimes arcane economic phenomena, the most important thing to understand is that at its core, money supply is just like the supply of any other good or service except to the extent that its value is derived from its use as a commodity in exchange, rather than from the utility we gain in consuming a traditional good or service.  If the market can provide other goods and services in the proper quantities and qualities to meet the demands of society, then surely it too can provide the proper quantity and quality of money.  To believe that somehow, government provision of money is any more sacred or preferable to government provision of any other good or service is pure folly.

2. The Federal Reserve has the monopoly power to print or inflate the money supply, thus artificially lowering the cost of money (the aforementioned interest rate).  This means that they can (and always do) devalue the money in your pocket as every dollar printed decreases the value of all dollars to come before them.  Inflating the money supply may not lead to an increase in prices if an equal or greater amount of goods is produced, but the purchasing power of the dollar will still be reduced because without printing money, your dollars would have been able to buy more goods.  Alternatively, if more dollars are printed than goods are produced, prices will increase though not necessarily uniformly across all goods.  Inflation may not manifest itself in explicitly higher prices but merely impede prices from falling for certain goods as they would were the money supply to remain constant.

3. When you deposit money in a regular checking account, the bank doesn’t hold onto this money.  Banks only keep a small percentage of the money you deposit on hand in their reserves, lending the majority of the money you (or the Fed for that matter) deposit to others who lend it to still others and so on, in the process substantially increasing the money supply.  This is known as fractional reserve banking.  If everyone in America or even a decent percentage of Americans tried to take their money out of the bank on a given day, millions would be unable to access their cash.  Effectively, even with FDIC Insurance, all of the banks are insolvent as they do not hold anywhere near 100% of the money you deposit in their vaults.  The hypothetical that the Fed could potentially print up money for the FDIC to distribute is beyond the scope of this post.

4. The government’s debt is merely an insidious tax like inflation.  Government debt can only be paid down by taxing the people.  This tax can occur through direct confiscation by government, or indirectly when holders of our government’s debt demand a higher rate of interest, which in turn signals to markets that our economy is not generating sufficient revenues to pay down the debt, which leads to a perception of economic weakness and thus an increased cost of borrowing for everyone in the economy.  If the government prints money to pay down debt (which in and of itself should cause our creditors to flood the markets with our debt and thus raise interest rates on everyone), this will represent a tax on the people as well.

5. Deflation, or a decrease in the money supply is the only antidote to inflation.  If the money supply is decreased, each dollar in your pocket becomes worth more.  The concomitant fall in prices will correct the artificial initial rise in prices from government printing of money.  In the process, since decreasing the money supply increases the cost of money, unsustainable enterprises with heavy debt loads will be put out of business, cleansing the economy by freeing up unproductive resources.  Where debtors benefit from an increase in the money supply because they can pay down their borrowings with cheaper dollars, creditors will benefit from a decrease in the money supply because they are paid back with more valuable dollars, which is one of the reasons why government prefers to inflate as it can lessen its own debt load and that of its constituents.  Deflation in prices while a symptom of deflation of the money supply is also the natural result of increases in productivity, as goods produced more cheaply in greater quantities (in the absence of money printing) will lead to falling prices which benefits consumers.  The so-called “paradox of thrift” that the MSM uses to vilify deflation in prices is wrongheaded, as people will spend on all sorts of products knowing that over time they will fall in price, as we have witnessed with numerous electronics over the years.  Even during a depression, when asset prices fall to certain levels there will necessarily be buyers, presumably those who saved prior to the downturn.  And if people are paying off their debt and/or saving in a time of falling prices in lieu of spending, this will be good for the economy because deleveraging corrects the excesses of the boom and increasing the pool of real savings lowers the interest rate and allows businesses and individuals to borrow funds for investment at a lower cost, legitimately stimulating the economy.

6. The last point mentioned above is imperative.  Growth in an economy occurs when real savings increase.  This is true whether in a booming market or a depression.  In fact, saving is the only way out of a depression.  Saving creates a pool of funds for banks to lend to businesses so they can expand their capital, increase expenditures on R&amp and generally take the entrepreneurial risks necessary for innovation and growth.  Americans have long consumed far more than we have produced, leaving us as massive net debtors to the rest of the world.  The only way to get out of debt and expand our economy is to save.  One cannot solve a problem of too much money and credit with more money and credit.  This however is what our government is trying to do by continuing to run the printing presses, trying to inflate our way out of debt.

7. Government cannot create wealth.  All it can do is take money from some people and redistribute it to others.  Every dollar the government uses must be taken from the private economy. Printing money to pay for things as we noted merely devalues your dollars, effectively taxing you.  Government financing through debt represents a claim on your wealth, a tax which as noted may be paid directly or indirectly.  Thus, while federal, state and local taxes may appear on a historical basis relatively low, the tax rate is deceptively masked by excluding government bilking through inflation and debt.  In addition, all government enterprises ultimately fail because government is not subject to the profit and loss mechanism of the market and thus does not respond to the demands of consumers, amongst other reasons.  In the process of failing, government wastes resources that could be better put to use by private individuals.  Government is a wealth killer, not a wealth creator.

8. The purchasing of all sorts of less than creditworthy assets from the big banks by the Federal Reserve allows the government to pump money into the financial system, and allows the banks to foist assets it doesn’t want onto the back of the taxpayer.  When we combine these asset purchases with the rest of the wasteful deficit spending on government jobs and reckless bailouts of the financial institutions and auto companies, our appraisal of the situation is as follows: while the little guy delevers, the government counteracts this necessary private balance sheet cleansing by levering up its own balance sheet at the expense of the taxpayer,  for the benefit of the financiers and the unions.

9. The real estate problem in our economy centers on the fact that people owe more money on their mortgages than they are able to pay down.  The only fix to this problem is for people to either generate more income to service their mortgages, or default.  Any intervention to keep people in homes they can’t afford will merely perpetuate market imbalances, propping up the value of real estate and preventing qualified buyers from purchasing homes at fair prices.  There will be no true recovery in the mortgage-backed securities  market until the forces of supply and demand sort out this mess (a mess which will be made worse as there are continued resets in mortgage rates over the coming years).  The same goes for any of the other assets whose values were bid up to unjustified levels because of easy money and credit.

10. Our economic crisis at the most basic level occurred because too much money and credit were pumped into the economy, given that again the interest rate was set artificially low not by supply and demand in the market but by government fiat.  The recession signals that we must fix the distortions and malinvestments resulting from the centrally planned interest rate. The healthy path to recovery is to allow prices to fall (aided by debt repayment), liquidate failed enterprises (reallocating of land, labor and capital to more productive and profitable lines of business) and encourage saving to increase the pool of loanable funds for economic expansion. Any actions to the contrary (i.e. more or less all government policies being implemented or bandied about) will merely prolong the pain.

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