I know this is a somewhat tired and worn subject. Friedman, while very good on many free-market subjects, was terribly wrong on some of the most important: central banking, government involvement in education, and his role in payroll tax withholding. So for me to jump in on this with a post on this topic is kind of like shooting fish in a barrel.
I have wanted to address some of the specific issues I have with Friedman’s views for some time – call it my desire to place a marker in order to measure my own progress, I guess. So in this post, I will comment on his views of monetary policy and central banking. Like I said, I don’t think there is anything terribly earth shattering here, this is more for personal reasons.
Capitalism and Freedom, by Milton Friedman
Chapter 3: The Control of Money
Milton Friedman is held by many to be the champion of free market capitalism. It is a wrong view; it is a view established by the gatekeepers to ensure one boundary of acceptable dialogue when it comes to economic and monetary possibilities. Friedman is presented as the free-market goal post – any thoughts beyond those of Friedman’s are out of bounds.
The Great Depression in the United States, far from being a sign of the inherent instability of the private enterprise system, is a testament to how much harm can be done by mistakes on the part of a few men when they wield vast power over the monetary system of a country.
Mistakes…cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality.
It shouldn’t surprise any regular visitors of this site that I share precisely the same view on these matters as does Friedman – at least as far as this excerpt goes. Using these views as the basis, I will explore Friedman’s free-market credentials, as well as consistency in his logic regarding his recommendations toward resolving this problem.
Friedman outlines his view of the range of opinions regarding monetary schemes. He portrays himself as charting a course through two unacceptable extremes, a Hegelian dialectic, if you will:
The Scylla is the belief that a purely automatic gold standard is both feasible and desirable and would resolve all the problems of fostering economic cooperation among individuals and nations in a stable environment. The Charybdis is the belief that the need to adapt to unforeseen circumstances requires the assignment of wide discretionary powers to a group of technicians, gathered together in an “independent” central bank, or in some bureaucratic body.
With this, Friedman sets the stage of possibilities. He paints the picture of two extremes, presumably with the truth to be found somewhere in between these.
Yet there is a possibility that lies outside of the range Friedman has defined. I suggest it is outside of the range Friedman offers because it is the free market approach; the extremes of Friedman’s range (and presumably every point in between) would require government force over voluntary contracts.
Friedman, the free market champion, does not offer a possibility of a free market option. Friedman’s book was written in 1962. Despite being first published in 1949, perhaps Friedman had not yet had a chance to read “Human Action”, by Ludwig von Mises – specifically chapter 17, section 12. To make a long story short, Mises offered free banking as the best possible solution, at the same time accepting that free markets would not likely result in any pure standard of any type when it came to money and credit:
Free banking is the only method available for the prevention of the dangers inherent in credit expansion. It would, it is true, not hinder a slow credit expansion, kept within very narrow limits, on the part of cautious banks which provide the public with all information required about their financial status. But under free banking it would have been impossible for credit expansion with all its inevitable consequences to have developed into a regular - one is tempted to say normal - feature of the economic system. Only free banking would have rendered the market economy secure against crises and depressions.
Even Murray Rothbard, the Austrian economist perhaps most closely identified with the idea of a 100% gold standard, demonstrates some hesitation. From "The Mystery of Banking, Chapter 17, section 3:
While the outlawing of fractional reserve as fraud would be preferable if it could be enforced, the problems of enforcement, especially where banks can continually innovate in forms of credit, make free banking an attractive alternative.
The free-market champion, Friedman, apparently has not considered the free-market option – the one presented by Mises some thirteen years before Friedman wrote this book. (As an aside, I do not hold to the view of FRB as fraud, as bank deposits are not demand deposits in the traditional sense of a warehouse receipt – see here for one example.)
Returning to his false thesis, regarding the “automatic gold standard,” Friedman attributes mythical – and utopian – characteristics. Such a standard, he suggests its proponents claim, “would resolve all the problems…in a stable environment.” This, of course, is a straw man – I am aware of no serious economist of any stripe that would suggest the possibility of any economic scheme being a cure-all for the failings inherent in human life.
Friedman states that “[t]here is widespread agreement that government must have some responsibility for monetary matters.” This, of course, is a mandatory position to hold if one wants to be included within the circle of those who are polled for purpose of identifying the “widespread agreement.” They only consider as valid the opinions of people who hold this opinion.
He goes on, demonstrating he is not blind to the risks of such monopolized power:
There is also widespread recognition that control over money can be a potent tool for controlling and shaping the economy. Its potency is dramatized in Lenin’s famous dictum that the most effective way to destroy a society is to destroy its money….this has been true from early times when monarchs clipped coins and adopted similar expedients to the present with our more sophisticated modern techniques for turning the printing press or simply altering book entries.
Despite seeing the regular and virtually certain abuse by government when it comes to involvement in money, Friedman suggests the possibility of success in altering this pattern, perhaps by creating a new man:
The problem is to establish institutional arrangements that will enable government to exercise responsibility for money, yet at the same time limit the power thereby given to government and prevent this power from being used in ways that will tend to weaken rather than strengthen a free society.
Friedman is suggesting the impossible – create a government-enforced monopoly that will not be co-opted by those who would abuse a government-enforced monopoly. With this, Friedman will present his third possibility – his higher level of Hegelian-derived truth. Before he gets to this, he spends time further bashing the 100% gold standard. He recognizes that historically it has been a commodity standard – often gold or silver – that has been used. If such a standard were maintained in the market, he suggests there would be no need for government involvement – in other words, because the gold standard was never pure (never remaining 100% gold-backed), there must be a role for government.
But why not market-derived money and credit, wherever that leads? Friedman, the free-market champion, doesn’t even pretend this is a possibility.
He sees the deviation from a pure gold standard as proof that a) it cannot work, and b) government must be involved in money:
Actual commodity standards have deviated very far from this simple pattern [of a pure commodity standard] which requires no governmental intervention.
He suggests that such systems have rarely remained pure; it was almost always accompanied by some form of fiduciary media. For this reason, he concludes such an “automatic commodity standard” is not feasible. But what if the deviation is market derived? Why would this necessitate “government intervention”?
My conclusion is that an automatic commodity standard is neither a feasible nor a desirable solution to the problem of establishing monetary arrangements for a free society.
Of course, such an “automatic commodity standard” is not the only possibility for a free market to develop – frankly a pure standard as Friedman suggests (gold coins only, no fiduciary media of any type) likely would not arise from a free market at all. But it is an easy straw man to attack, as Friedman does with relish.
It is not desirable because it would involve a large cost in the form of resources used to produce the monetary commodity.
Friedman is suggesting that economic goods should not cost anything to produce. Let’s try this another way:
[Food] is not desirable because it would involve a large cost in the form of resources used to produce the [dietary] commodity.
[Clothing] is not desirable because it would involve a large cost in the form of resources used to produce the [fashionable] commodity.
[Shelter] is not desirable because it would involve a large cost in the form of resources used to produce the [protective] commodity.
There is no economic good absent scarcity. There is no scarcity in a good if there is no cost to produce it. Friedman speaks the language of the economic dreamer – economic goods can be created in unlimited supply at no cost, if only we wish it so.
It is not feasible because the mythology and beliefs required to make it effective do not exist.
The only myth is the one Friedman has created – the better to skewer gold with, apparently.
Next, Friedman turns to the Federal Reserve System:
No sooner was the [Federal Reserve] Act passed than World War I broke out. There was a large-scale abandonment of the gold standard.
Other than having the words in close proximity to each other, Friedman apparently finds no reason to connect these events? Abandon gold + central banking = the bloodiest century in recorded history (this might help for those economists who can only think in equations)…. He doesn’t seem to even blink.
Having debunked the straw man of 100% commodity as the only possible option on the one hand, and a group of wise men left free to do as they please on the other, Friedman turns to his solution – his centrally-planned solution:
The only way that has yet been suggested that offers promise is to try to achieve a government of law instead of men by legislating rules for the conduct of monetary policy that will have the effect of enabling the public to exercise control over monetary policy through its political authorities, while at the same time it will prevent monetary policy from being subject to the day-by-day whim of political authorities.
Utopia. After recognizing the damage that can be done by “a system which disperses responsibility yet gives a few men great power,” Friedman goes on to suggest a “rule” to be determined by a few other men with great power. Instead of central bankers doing as they please, Friedman suggests congress (or some regulatory body) creates rules as they please.
Could a more complete statement of government intervention and central planning have been written by Marx (oh, I forgot; he did: see number 5)? Change the word “public” in the above quoted paragraph to “party” and try it again (as if “public” has any meaning even tangentially approaching the meaning Friedman tries to give it).
Friedman’s rule is one of regular growth in money at a rate of somewhere between 3% and 5%. He believes such a rule would tie the hands of the legislators and the central bankers.
It is too bad Friedman wasn’t alive to see the results of the monetary quacks in practice. I am not aware of anything Friedman has written that suggested that a) 2008 could happen (even the best and brightest at the Fed had no clue as late as 2007), and b) the so-called solution would be found by increasing the monetary base by trillions of dollars (and counting). Friedman’s rules, if enacted before the crisis, would have lasted no longer than the time it took Paulson to get on bended knee in front of Pelosi – “please change the rules, Nancy, or else the world will end!”
There are a few tests, call these litmus tests, that I suggest should be applied to assess the free-market bona fides of any economist or economic commentator. One of these is the position taken regarding money and banking.
Friedman was allowed to hold the unofficial chair as the champion of the acceptable (so-called) free-market position in economics because he did not question central banking. He had to hold to this view to keep the chair. I believe he earned the chair when he helped to develop the system of payroll tax withholding – a gift to the state far greater than even the staunchest socialist could have given.
But the fallacies of this view on central banking are so transparent. It is central planning, and central planning of the single most important commodity in a division-of-labor society. The ramifications of this should be obvious.
Any advocate of central planning cannot be an advocate of free markets. This is infinitely more true for advocates of central planning for money and credit.
Friedman, as the ultimate advocate of central planning, was no champion of free markets.