Money Mischief

IT IS HARD to believe that three decades have passed since Milton Friedman shook the world with Capitalism and Freedom. It was not his first book, but it was the first aimed at a popular audience. A work of unintimidating size, written with startling clarity and persuasiveness, it immediately captured hearts and minds as nothing else of its kind had done since Hayek's Road to Serfdom and Hazlitt's Economics in One Lesson.

Many of Friedman's 1962 policy proposals still appear as bold and brilliant as they did back then. His idea of using vouchers to promote choice and competition in schooling is finally beginning to bear fruit. And leading politicians from both parties have embraced Friedman's teachings on the benefits of a low, flat-rate tax. Yet he is perhaps best known for having restored our understanding of the importance of money in general, and of predictable monetary rules in particular. "Substantial inflation is always and everywhere a monetary phenomenon," Friedman insists, and so are most "cyclical" gyrations in real output and employment. This compelling "monetarist" theme, backed by awesome research in collaboration with Anna Schwartz, David Meiselman, and others, was the first successful challenge to what had become an increasingly imperious Keynesian orthodoxy.

In 1960, Friedman launched a tentative proposal that central banks be required to keep money growing at "a relatively constant rate." Sympathetic critics have since come to believe that such a quantity rule has become difficult to enforce, because of such complications as defining and measuring money when you can write checks against all sorts of mutual funds. But Friedman was always far less dogmatic about this particular monetary rule than were some of his followers. "I should like to emphasize," he wrote in 1962, "that I do not regard my particular proposal as ... a rule which is somehow to be written in tablets of stone and enshrined for a future time."At various times, Friedman has instead proposed requiring banks to hold 100 per cent reserves against deposits, or making currency convertible into an assortment of metals, or allowing competitive private banks to issue currency notes. In Money Mischief, he offers additional heresies in support of bimetalism (a combined gold-silver standard), or a limit on the gap in interest rates between indexed and nonindexed bonds, or a "unified" system in which a country with a weak currency essentially adopts the more credible money of another country. The unchanging theme underlying all of these reforms, though, is the importance of preventing the value of money from being determined by the whim of politicians and central bankers.

Since the publication of Dollars and Deficits in 1968, many of Friedman's unique reflections on money have been relatively inaccessible to the general reader, scattered as they are among a variety of technical books and articles. Money Mischief fills this void by carefully leading the reader through an explanation of how and why money matters. Concise exercises in theory are enlivened with real-world illustrations from U.S. and foreign history. We discover how a scheme to placate U.S. senators from silver-producing states helped to bring Communism to China, and why pegging exchange rates to the dollar worked quite well to stop inflation in Israel but not in Chile.

The opening explanation of "The Mystery of Money" is actually more rigorous than it seems, teaching more crucial concepts than many students retain after two college courses in money and banking. Yet the reader is seduced into learning by the author's familiar mastery of entertaining historical anecdotes and revealing graphs. Starting with stone money on the island of Yak, we are quickly led to understand what affects people's willingness to hold money for short or long periods, how real and nominal quantities of money differ, and how the perception of individuals about the delights of having more money clashes with what is actually possible for the entire economy and thus leads to monetary mischief.

Friedman, like many of us, has become far less skeptical about the merits of a commodity standard than he was when the U.S. severed its last links to gold in 1968-71. Subsequent experience with managed money has been a harsh teacher. As Friedman notes, "the fiat monetary system has been characterized by wide fluctuations in price levels, interest rates, and exchange rates." Back in the Sixties, the heyday of arrogant economics, we were taught that it was foolish for money-issuing authorities to commit themselves to holding a stock of gold and converting currency into yellow metal on demand. Wooden nickels would be better, because they are cheaper to produce. Friedman vanquished such cavalier notions in a scholarly journal a few years ago, observing that under a fiat money system citizens have to hold their own gold hoards as a hedge against inflation. "For millennia," Friedman now writes, "the only effective limit [on money] was provided by the link between money and a commodity. That link provided an anchor for the price level .... The verdict is far from in on whether fiat money will involve a lower cost than commodity money."