Last week we wrote about the reasons for and against “creating” money, with the view of Keynesians, monetarists, and market monetarists and lastly sound money advocates (us!). Following on from this we explain the view of Milton Friedman, American economist, libertarian and… monetarist.
Friedman laid out his ideas in his 1960 paper, A Program for Monetary Stability, but thankfully for us he laid out his conclusions in the much more concise, Capitalism and Freedom.
But a very quick quote to preface, from the very same chapter of Capitalism and Freedom: “If money consisted of a physical commodity, there would be, in principle, no need for control by the government at all”.
Back to Friedman, there are a few conclusions he makes before his proposed twist on monetarism:
- A full gold standard is not workable as society inevitably drifts towards “fiduciary” money. By this he means, fractional reserve banking. It is also not desirable due to the amount of resources needed to create commodity backed money.
- That power concentrated in the hands of a few men is a bad thing as they inevitably, whether good or bad, will make mistakes.
- Central bank policy of targeting price level (in a similar vein to the Bank of England’s inflation target), is flawed: although there is an unquestionable link between money supply and price level, the connection is not so direct that it is appropriate.
Friedman’s argument is:
I would specify that the Reserve System(as in the Federal Reserve) shall see to it that the total stock of money … rises month by month, and indeed, so far as possible, day by day, at an annual rate of X percent, where X is some number between 3 and 5.
This is usually called the k-percent rule nowadays.
A few comments on Friedman’s views in order:
- Fiduciary money may have been inevitable but that shouldn’t stop us from undoing it! Secondly, if the cost of pulling resources out the ground is too high, then prices will deflate until it becomes profitable to do so again.
- How true. This means something like the Monetary Policy Committee at the Bank of England is too much power for too few people.
- This is the key part, and why it differs from other monetarists. Friedman helps us understand that centralization is unworkable. The theory that a central bank can control prices and the economy is flawed as the economy is just a name given to all of us making individual decisions, with individual motives and individual needs, means and process.
Friedman’s main motivation for the k-percent rule was to stop government meddling with the money supply for their own agenda, and to prevent endless bailouts-a noble motive. However, as we have seen on countless occasions, governments from all around the world, particularly Western ones, are really good at breaking promises. So the idea that they would stick to this rule is wishful thinking in the first place. But if it were to be successfully implemented, would it work? There is a chance it would improve responsibilities of the major banks to hold more reserves in the anticipation that rates would not be lowered in the inevitable bust, but ultimately it is just another variation of the pyramid scheme we call monetarism.