Copyright: 1992
Publisher: Harcourt Brace Jovanovich
ISBN: 0-15-162042-3
From Stone Money to the "Cross of Gold", Friedman does his best to keep the reader interested in exchange rates, inflation and monetary policy in this excellent book. While injecting plenty of his own theory, philosophy and conjecture into the text, Friedman does a marvelous job of documenting the history of money as it relates to the supply of money. Beginning with a brief and yet solid background into what money really is he moves quickly into a primer of the supply and demand dynamics of money. From there he launches into several comprehensive historical accounts in which he explores what happens when the supply and demand of money get out of sync with the monetary policies of the various government.
Stone Money
Like me, you may have already heard the story of the island with stone money. The Caroline Islands in Micronesia have an island call Uap or Yap. In 1903 the American anthropologist, William Henry Furness III spent some time on this island and discovered their peculiar monetary system. The stone money called fei consisted of round stones, anywhere from one foot to twelve feet in diameter, with holes in the center to accommodate carrying poles for transportation. The size of these stones often meant that it was inconvenient to actually possess the stones so owners often would simply accept the knowledge of the transfer of "funds" rather than take the steps to actually take the stone into his possession. In one interesting episode, the German Government, on purchasing the islands, attempted to get the chiefs of the districts to repair the roads. The locals, quite comfortable with the state of the roads were loathe to attempt the repairs. The Germans finally levied a fine which was extracted by marking a number of the most valuable fei with a black cross. This act impoverished a number of the locals who then dutifully fixed up the roads. The fine was "paid" when the officials washed the black mark from the stones and the people were restored in full of their wealth.
Lest we be too absorbed in our ethnocentric view of this episode, Mr. Friedman reminds us that Western cultures (and others of course) expend considerable time and energy extracting gold and silver ore from the ground, only to process it, mint it, ship it across the country and re-bury it in underground vaults. Sounds silly when you think about it doesn't it?
The Money Helicopters
One of the fascinating stories that Milton Friedman shares in this book is actually pure fiction. By way of illustrating the cause of inflation, he tells the story of an isolated community that has a fixed share of money. This community is disrupted one day by a helicopter dropping large piles of money randomly throughout. After examining the effect of this influx of money, we discover that without any change in output, the effect of an increase in money supply is simply higher prices.
Several variations of this story are used to illustrate the effect of continuous increases in the money supply (in excess of production) and how they come to be calculated into the cost of transactions. These stories, while simple fiction, are illustrative of the real world effects of the California and Australian Gold Rushes. In more complex terms, this is also what has historically happened when, as America did during the Civil War, a nation adopts a fiat money standard in order to finance a war. Prices go up all around and the only ones enriched in any sense of the word are the ones who are closest to the source of the new money.
"The Crime of 1873"
A considerable portion of the book is given to the discussion of the bi-metallic standard vs. a gold or silver mono-metallic standard of money. In 1796 Alexander Hamilton urged Congress to adopt a bi-metallic (gold AND silver) standard with the ratio of silver to gold being pegged at 15:1. Shortly thereafter, the market rates for gold increased to 15.5 to 1 (15.5 units of silver to purchase 1 unit of gold) meaning that gold was more expensive on the market than it was at the mint. Put another way, gold was worth more as bullion than as coin, so the United States effectively went on a silver standard. This state existed until 1834 when the official ratio of silver to gold was put at 16:1. With the market rate still effectively 15.5:1, the U.S. now was on an effective gold standard, even though the free coinage of silver was still available.
As mentioned above, during the Civil War the U.S. went off the metal standard and began printing money that was not backed by any metal. This of course resulted in a great deal of inflation but enabled the funding of the war effort. After the war, prices were very high and the men of Congress recognized the need to resume a specie standard. In 1873 the ground work had been laid and Congress passed the "Coinage Act of 1873" which resumed the free coinage of gold but failed to include silver. This meant that the U.S. was no longer just on an "effective" gold standard but had now joined with Britain in being on a "true" gold standard.
The consequences were far reaching for this simple omission. Ultimately the political fallout gave rise to William Jennings Bryan's rise to political fame. His famous "Cross of Gold" speech delivered on July 8, 1896 at 63rd and Cottage Grove in Chicago was a battle cry for the "silver" movement. This speech, given at his nomination for Presidency at the Democratic National Convention is considered by many to be one of the most influential and powerful political speeches of all time. Of course Bryan went on to lose the election to McKinley and even though he ran again in 1904 and 1908 he never managed to win the White House. The fact that natural forces were in play to "do something for silver" and create the inflation that so many people desperately wanted was most certainly his downfall.
Inflation is Good?
If you are like most people in my generation, inflation is a bad word. So why would anyone ever run a political campaign on the platform of creating inflation? To understand this, you have to understand what inflation means to the consumer. Inflation is a broad rising of prices without a corresponding rise in output. From the perspective of a producer this means he or she can charge more for his or her goods. Put another way, this means you and I can charge more per hour for our labor.. we get a raise without having to do more work.
The other side of this coin however tells the real story. Since we spend our money on a broad basket of goods and services, we aren't as conscious of the movements of overall prices as we are of the movement of our wages. We know immediately if our wages are cut or raised, but overall prices can move quite a bit before we are aware simply because they are disparate in nature. Most of us in 2005 knew that gas prices were soaring, but how many of us could give an accurate account of the price of milk for the last 12 months? Or of bread? Or of toothpaste? Today we rely on CNN and MSNBC to tell us about inflation via the Consumer Price Index but in our day to day life we are rarely cognizant of inflation, much less it's effects.
If inflation is "always and everywhere a monetary phenomenon" as Milton Friedman exclaims, then why would the government allow the money supply to grow faster than output if the end result is simply turmoil in the markets? Inflation is good for government in three basic ways:
- Increased implicit inflation tax on base money holding
- Unvoted increase in explicit taxes as a result of "tax bracket" creep
- Reduction in real value of outstanding government debt
To understand these more you should read Friedman's book, especially his chapter on
Monetary Policy in a Fiat World.
Conclusion
This book for me was a fascinating read. I would urge anyone who has ever wondered about inflation or the money supply to pick this book up and read it with interest.