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[Suresh]

Book Take on Money Mischief by Milton Friedman

Amazon.com: Money Mischief by Milton Friedman

I. Basics of Money and Money Supply

A. Dr. Friedman terms the metallist fallacy as the notion that the exchange value of paper money depends on the purchasing power of the commodity to which the paper money can be converted. He asserts that the purchasing power of the commodity need not have anything to do with its utility as a commodity. As examples, he cites the use of cigarettes and cognac in post-WWI Germany.
1. Although I agree with that statement, it ignores the value of the commodity based on its scarcity, and by extension, the government’s inability to create the commodity out of thin air. Moreover, it ignores, in the case of gold and silver, for instance, the expenditure of effort and resources to acquire same. These characteristic of a scarce commodity supports its ability to maintain its value.

B. Money is that which has no intrinsic value other than the fact that people are willing to exchange it for goods and services and the value thereof depends on supply and demand.
1. In light of the discontinuation of M3 money supply publication, that just does not ring true to me. If the value of paper money depends on awareness of supply and demand, then how will people know how to value the money if M3 money supply figures are not available for them to compare with GDP figures, for example?

C. A change in the rate of monetary growth leads to a change in the rate of nominal income in about 6-9 months. A change in the rate of monetary growth leads to a change in the rate of physical output in about 6-9 months. A change in the rate of monetary growth leads to a change in the rate of consumer price inflation in about 2 years. As time increases, the change in monetary growth primarily affects output (in a 3-10 year span) and primarily affects prices (in a decade(s) span). Over long periods of time, the money supply growth rate and the consumer price inflation rate trend toward each other.

II. Basics of Inflation

A. Fiat currency cycle flows from initial stability to moderate overissue to substantial overissue to abandonment. In the past, overissue was done to finance wars and revolutions.
1. I suggest that, prospectively, overissue is likely to finance all manner of unfunded government liabilities, including social security and healthcare entitlements, and pension bailouts.

B. Higher government spending does not lead to inflation, if the additional expenditures are financed by taxes or by borrowing from the public.

C. Higher government spending does lead to inflation, if it is financed by increasing the money supply. How does this happen?
1. The U.S. Treasury sells U.S. Treasury securities (e.g., bills, notes, and bonds) to the Federal Reserve. The Federal Reserve pays for the U.S. Treasury securities with newly printed Federal Reserve Notes (what you and I call dollars – although Constitutionally, that’s incorrect), or by electronic credit to the Treasury. The Treasury then pays for the higher spending with this new money. The recipients of the new money deposit it in their commercial banks. The deposits serve as reserves upon which more money can be loaned out by the banks in a ratio determined by the Federal Reserve-prescribed Reserve Ratio. Note that the new money becomes what is called "high powered money" when it is received by banks and a multiple of which can be loaned out subject to the Reserve Ratio. No other transaction generates this multiplier effect on the money supply.
2. To get around bond sale limits to the Federal Reserve, the Treasury sells U.S. Treasury securities to the public and the Federal Reserve buys same from the public with newly printed Federal Reserve Notes.

D. The Federal Reserve can also buy outstanding U.S. Treasury securities with newly printed Federal Reserve Notes to the same effect.

E. Initial effects of outsized money supply include permitting governments (and anyone with access to credit, I should think,) spend more without anyone having to spend less. Not surprisingly, this spending increases the number of jobs, and increases business sales.
1. I think it’s interesting that most of us don’t immediately mind inflation because although we prefer the cost of what we buy to go down or stay the same, we love to see what we sell (labor, houses, and other assets) go up in price. We attribute the latter increases in price to our own productivity or savvy, but increases in former prices to seller greed. Indeed, the Mainstream Media encourages this misimpression by offering up plenty of scapegoats: greedy companies (especially greedy oil companies), stingy oil producing nations, bad weather, and spendthrift consumers. But, as Dr. Friedman writes, "Any of these can produce high prices for individual items. . . . But they cannot produce continuing inflation, for a simple reason: not one of the alleged culprits possesses a printing press on which it can legally turn out those pieces of paper we carry in our pockets and call money." He further reminds us that inflation is "always and everywhere a monetary phenomenon," placing the blame for inflation squarely at the feet of the federal government and central bank, as they control fiscal and monetary policies.

F. Early intermediate effects of outsized money supply include workers’ wages not keeping up with consumer price inflation, and businesses’ input costs rising faster than sales, crimping profit margins.

G. Late intermediate effects of outsized money supply include even higher consumer and producer prices, less demand, and stagflation. There is a temptation to increase the money supply even faster. But, an ever larger amount of money is required to jump start the economy.
1. By way of reference, consider the two tables in The Many Faces of Liquidity post, which show the effect of additional money and credit on the GDP growth.

H. Early effects of slower monetary growth (relative to GDP growth) include lower economic growth and higher unemployment without a reduction in consumer price inflation.
1. Consider the Federal Reserve’s Mission Statement, which includes conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates. Imagine the quandary of the Federal Reserve in reining in prices and interest rates, while avoiding an increase in unemployment.
2. Dr. Friedman correctly notes that slow growth and high unemployment, e.g., by price/wage controls or increased governmental regulation, are not cures for inflation, which is, of course, caused by excessive money supply.


I. Later effects of slower monetary growth (relative to GDP growth) include lower consumer price inflation rates, and a potential for rapid noninflationary growth
1. I suspect this rapid noninflationary growth owes from increased productivity and savings-based (as opposed to credit-financed) investment.

J. If these are the inevitable effects of excessive money supply growth, why does the federal government permit it?
1. It dilutes the existing money supply, effecting taxation without representation via legislative and executive approval. Such taxation is clearly preferable to legislated tax increases, which are politically unpalatable.
2. It promotes tax bracket creep, forcing people into higher income tax brackets.
3. It reduces the real value of the government’s debts and entitlement pay-outs.

III. Feasibility of a Fiat Currency, or "Irredeemable Paper Money"

A. Dr. Friedman cites Irving Fisher, who in 1911, noted, "Irredeemable paper money has almost invariably proved a curse to the country employing it," Dr. Friedman provides supporting examples of hyperinflation after WWI and WWII, multiple South American hyperinflationary periods, and worldwide hyperinflation in the 1970s.

B. Such fiat currency monetary systems have produced two schools of thought.
1. According to the scientific literature school, money is whatever money is defined to be and thus need not be commodity-backed. Clearly, Dr. Friedman puts himself in the "scientific literature school."
a. In all due respect to Dr. Friedman, I find this approach highly academic, and by that I mean, unrealistic for use in the real world. Dr. Friedman readily admits that fiat currency according to this school requires political unprofitability of monetary inflation because of sophisticated public sensitivity. But, I ask you, from whence should we expect this well-spring of sophisticated public sensitivity? The federal government intends to not publish M3 money supply data, thereby keeping the public in the dark as to the Federal Reserve’s devaluation of the Federal Reserve Note, colloquially called the U.S. dollar. The main stream media is ignorant of the basis of consumer price inflation and consequently focuses on corporate greed, for example, as the culprit. With the government and the media, at the very least not helping us, how are we in the public supposed to develop this sophisticated sensitivity?
2. According to the popular literature school, money must be commodity-backed to avoid eventual runaway inflation.
a. The characterization of this school as "popular" shows the disdain Dr. Friedman has for this schoo, as being populated by unsophisticates. I suggest to you, however, that even an unsophisticate can tell when something is not working and he is being told otherwise.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Milton Friedman: Death of a Giant
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More than anyone else, Milton Friedman was responsible for challenging the worldview of British economist John Maynard Keynes, who believed in the power of government to guide and stimulate economic growth. As an alternative to Keynesianism, he put forth a more laissez-faire philosophy known as monetarism—the doctrine that the best thing the government can do is supply the economy with the money it needs and stand aside.

Friedman blamed inflation on tinkering by governments and central banks. Along with Edmund Phelps of Columbia University, who won the 2006 Nobel prize, Friedman showed that central banks can't buy permanently lower unemployment with slightly higher inflation.
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Economists now generally reject heavy-handed Keynesian intervention and agree with Friedman that inflation is a monetary phenomenon. Friedman backed away from the crudest version of monetarism, which said that central banks should do little but set a target for the growth rate of the money supply. For example, he had high praise for former Federal Reserve Chairman Alan Greenspan, even though Greenspan paid little attention to the size of the money supply when setting short-term interest rates.
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During the Depression, Friedman worked in Washington on a large consumer-budget study that later led to one of his best-known achievements, the so-called "theory of the consumption function," which says that people's spending is determined by their expectations of future or "permanent" income, not just their current income.
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In the theory of consumption function, Dr. Friedman explained his permanent income hypothesis. According to Wikipedia,

[Suresh]

Economist's View blog: "The Collapse of Monetarism and the Irrelevance of the New MonetaryConsensus"
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[M]onetary policy, monetarism, the natural rate of unemployment and the priority of fighting inflation over fighting unemployment ... is here that Friedman had his largest practical impact and also his greatest intellectual success. It was on this battleground that he beat out the entire Keynesian establishment of the 1960s, stuck as they were on a stable Phillips Curve.
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What was monetarism?

Friedman famously defined it as the proposition that “inflation is everywhere and always a monetary phenomenon.” This meant that money and prices were tied together. But more than that, Friedman believed that money was a policy variable – a quantity that the Central Bank could create or destroy at will. Create too much, there would be inflation. Create too little, and the economy might collapse. There followed from this that the right amount would generate the right result: stable prices at what Friedman came to call the natural rate of unemployment.
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From1979, the Federal Reserve formally went over to short-term monetary targets. The results were a cascading disaster: twenty-percent interest rates, a sixty percent revaluation of the dollar, eleven percent unemployment, recession, deindustrialization through the Midwest including here in Ohio, and in Indiana, Illinois and Wisconsin, and ultimately the debt crisis of the Third World. In August 1982, faced with the Mexican default and also a revolt in Congress – which I engineered from my perch at the Joint Economic Committee – the Federal Reserve dumped monetary targeting and never returned to it.

By the mid-1980s, the rigorous monetarism Friedman had championed also faded from academic life. Money growth became high and variable, but inflation never came back. Perhaps inflation was “always and everywhere a monetary phenomenon.” But monetary phenomena could happen without inflation. ...

What remained in the aftermath was a sequence of doctrines. All were far more vague and imprecise than monetarism but they carried a similar policy message: the Fed should place inflation control at the center of its operations, it should ignore unemployment except if that variable fell too low. Further, there was a sense that instability in the financial sector should be ignored by macroeconomic policymakers except when it could not be ignored any longer.
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And then we got Ben Bernanke and ostensible doctrine of “inflation targeting.” This idea -- Dr. Bernankenstein’s Monster – rests on something Professor Marvin Goodfriend of Carnegie- Mellon University calls the “new consensus monetary policy.” This is a collection of ideas framed by the experience of the early 1980s but adapted, at least on the surface, to changing conditions since then.
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First, is the proposition that monetary policy can reduce inflation permanently and at reasonable cost the “main monetarist message”? The idea is absurd. The main monetarist message was that the control of inflation was to be effected by the control of money growth. We have not even attempted this for a generation. Money growth has been allowed to do whatever it wanted. The Federal Reserve stopped paying attention, and even stopped publishing some of the statistics. Yet inflation has not returned. The main monetarist message is plainly false. As for the question of cost, no one ever doubted that a harsh recession could stop inflation. But in fact the monetarists’ recession of 1981-82 was by far the deepest on the postwar record. It was far worse than any inflicted under Keynesian policy regimes. In misstating this history, Goodfriend also completely overlooks the catastrophe inflicted by the global debt crisis on the developing world.
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What in monetarism, and what in the “new monetary consensus,” led to a correct or even remotely relevant anticipation of the extraordinary financial crisis that broke over the housing sector, the banking system and the world economy in August 2007 and that has continued to preoccupy central bankers ever since? The answer is, of course, absolutely nothing. You will not find a word about financial crises, lender-of-last-resort functions or the nationalization of banks like Britain’s Northern Rock in papers dealing with monetary policy in the monetarist or the “new monetary consensus” traditions. What you will find, if you find anything at all, is a resolute, dogmatic, absolutist belief that monetary policy should not – should never – concern itself with such problems. That is partly why I say that monetarism has collapsed. And that is why I say that the so-called new monetary consensus is an irrelevance.
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Chairman Ben Bernanke faces an intellectual dilemma. He can stick with Milton, in which case he must admit that the only possible cause of the present financial crisis and evolving recession is the tightening action of the Federal Reserve, against which, when it started back in 2004 only two voices were heard: that of Jude Wanniski, the original supply-sider, and my own, in a joint Op-Ed piece no one would publish except the Washington Times. Or he can stick with the so-called “new monetary consensus,” which holds that the Fed should now return to its inflation targets, pursue a much tighter policy, and that no recession will result. If Bernanke chooses the first, he must of course assume responsibility for the unfolding disaster.
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And if both sides of Bernanke’s dilemma are wrong, what is a beleaguered central banker to do? I have an answer to that. Let Ben Bernanke come over to our side. Let him acknowledge what is obvious: the instability of capitalism, the irresponsibility of speculators, the necessity of regulation, the imperative of intervention. Let him admit the intellectual victory of John Maynard Keynes, of John Kenneth Galbraith, of Hyman Minsky.
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The the effect of money supply growth doesn't immediately appear in consumer prices doesn't mean that money supply growth is unrelated to the consumer price inflation rate. If I understand Dr. Friedman correctly, he readily admitted that there was a lag between a rise in monetary growth and a rise in the consumer price inflation rate.
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Telegraph writer Ian Campbell asks, "What would Milton Friedman have done?" Mr. Campbell's impression of what Dr. Friedman would have done is strikingly similar to Ambrose Evans-Pritchard's prescription of tight fiscal policy and loose monetary policy to solve the current crisis. If this solution works too quickly, then the same sectors that experienced overinvestment and malinvestment caused by cheap and easy credit will not experience consolidation and liquidation sufficient to eliminate the excess. If this solution works too slowly, then hyperinflation will follow, absent a miraculously smooth exit strategy.

Mr. Campbell, however, does not mention that Dr. Friedman would not have engaged in active and loose monetary policy fostering the current crisis in the first place. As I recall, Dr. Friedman advocated a fixed rate of money supply growth, presumably commensurate with the expected rate of economic growth.
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Telegraph: Money from helicopters is Ben Bernanke's modern encapsulation of Milton Friedman's bold revelation
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Friedman may have been a champion of the free market and small government. But he is nevertheless the intellectual author of today's easy money and bank bailouts.

Friedman blamed the Depression on mistaken monetary policy – not too-loose money before the Crash, when stock prices bubbled, but afterwards, when they sank. For Friedman, the crash and downturn were a stock-market correction and "a normal recession" which policy mistakes by the US Federal Reserve turned into a decade-long global disaster.

What went wrong was that the US money supply was allowed to contract by a third after the shock of the market rout. The Fed, in Friedman's view, ought to have prevented that from happening by stimulating money growth to prevent the self-reinforcing spiral into depression.

Ben Bernanke, the current Federal Reserve chairman, has relied on the Friedman blueprint as he has tackled the deflationary fall in US house prices, the plummeting of international stock markets and the intense strains in the US banking system that have threatened a second depression.
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Has Bernanke's Fed done too much? In some ways, Friedman might have gone further. He criticised a Fed that "stood idly by" in 1931 as a New York bank collapsed, triggering other failures, when the central bank might have provided lenders with the cash "to meet the insistent demands of their depositors without closing their doors". Perhaps with Friedman at the Fed, Lehman Brothers would still be around and the global financial panic of 2008 might not have been so great – and perhaps therefore more cheaply addressed.

But the current expansion into double digits of the US government's budget deficit goes against Friedman's thinking. For him, activist monetary policy was the key, not fiscal policy. And if he were to support an active fiscal policy to counteract deflation, there is no doubt he would recommend tax cuts, not the massive increases in government spending since the onset of the latest crisis. His faith was always in the private sector and private spending. Friedman's view today would almost certainly be that big government is getting in the way of the free market's salutary forces.
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Reason: Bernanke's Philosopher
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Trillions of dollars have been staked on the insights of “monetarism,” the economic theory of central banking and inflation-management associated with Friedman and Anna Schwartz. Though Schwartz now distances herself from Bernanke, opposing his reappointment on the grounds that he’s gone too far, the irony remains that a series of Fed policies many libertarians find repugnant are being championed by a man claiming to take his chief inspiration from the most influential libertarian economist of the 20th century.

A Monetary History of Ben Bernanke

The story begins in 1963, when Friedman and co-author Anna Schwartz published A Monetary History of the United States, an opening salvo in what Friedman called a “counterrevolution” against Keynesian theory. Their chapter on the Great Depression was spun off into a stand-alone book, The Great Contraction: 1929–1933, an epic revisionist history that changed America’s understanding of the causes of the Depression. Friedman and Schwartz contended that the Federal Reserve—not capitalism or Wall Street—was to blame for the dismal ’30s.

“The fact of the matter is that it was the [Fed’s] decision to tighten credit policy in 1928 that produced the Great Contraction,” the 93-year-old Schwartz says by phone from her office at the National Bureau of Economic Research in New York City. The Fed hiked interest rates in 1928 to curb what it saw as rampant speculation on Wall Street—a conflagration of leverage, margin buying, and outright Ponzi scheming fueled in the first instance by cheap credit from the Federal Reserve.
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Bad loans and reckless banking practices were a “minor factor,” at most, in the Great Depression, they said. In this narrative, a Federal Reserve paranoid about speculation had needlessly constricted the money supply, imploding an otherwise sound economy.

After the Great Crash of 1929, the Federal Reserve drastically cut interest rates from a brief high of 6 percent to 1.5 percent by mid-1931. But during the first few years of the crisis, the Fed occasionally felt forced to abruptly raise rates again in complicated maneuvers to stem outflows of gold into Europe. Friedman and Schwartz blamed these sporadic interest rate hikes for smothering incipient recoveries, opening a vortex of deflation, and transforming a recession into the Great Depression.
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“The monetary authorities,” they wrote, “could have prevented the decline in the stock of money—indeed, could have produced almost any desired increase in the money stock.”
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When it comes to his academic specialty, Bernanke is a disciple of Friedman and Schwartz.
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When the economy collapsed two years into Bernanke’s watch because of a massive credit bubble, he slashed interest rates to zero and ordered the money-printing presses to full steam. He also embarked on a course of “quantitative easing,” where a central bank convolutedly buys its own government’s bonds with printed money so as to sink interest rates even further.

This approach was not new. Friedman had prescribed quantitative easing, combined with “easy money” and inflation, as a cure for Japan’s 1990s economic slump....

Stateside, in the shadow of the Fed’s multi-trillion-dollar balance sheet, it has been all too easy to categorize Bernanke simply as a Keynesian supporter of public works projects, socialistic safety nets, and profligate, government-led consumption. While it’s true that the Obama ad-ministration is pursuing Keynesian fiscal stimulus, the Federal Reserve under Bernanke has consciously acted on the Friedman/Schwartz insight that loosening central bank credit is a fundamental tool in forestalling deflation and depression. Understanding that monetarism can mean both the management of low inflation in good times, and the creation of inflation in bad times, has proven too difficult for most of the media.
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Friedman and Schwartz, those champions of low inflation, have helped inspire the greatest monetary expansion in Federal Reserve history, a program of limitless market interventions and tireless money printing whose end game is likely to be a return to the bad old days of inflation that they fought for so long. For two libertarian champions of free markets and limited government, this unintended legacy has the ring of a world-historic irony.
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Churchill Associates' estimation of how long it takes for changes in money supply to cause changes in prices of various segments of an economy
_________________
Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.