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Impacts of Monetary Policies

MONEY MISCHIEF: EPISODES IN MONETARY HISTORY. By Milton Friedman, Harcourt Brace Jovanovich, 288 pp., $19.95

MILTON FRIEDMAN, a Nobel Prize laureate in economics, has classified his considerable writings as "popular" or "scholarly." When his secretary asked him under which of these categories to file "Money Mischief," he replied that it was in between the two.

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That anecdote says something of the character of this book. It is not like "Free to Choose," the easy-to-read book he wrote with his wife, Rose, that became an international bestseller.

Nor is it similar to "A Monetary History of the United States, 1867-1960," which he wrote in 1963 with Anna J. Schwartz. That book's 860 pages are laden with charts, numbers, and footnotes. It's dry as granary dust but has been explosive in its impact on economic theory and, to a considerable degree, actual monetary policy.

When the Federal Reserve lowered interest rates again earlier this month, policymakers acted because Drs. Friedman and Schwartz had proved that changes in money growth importantly affect the business cycle.

"Money Mischief" won't have that sort of impact. But it does show through various historical events the economic and political damage that can result from misunderstanding of monetary economics.

For example, Friedman explains how President Franklin D. Roosevelt's decision to please a few senators from the American West by pushing up the price of silver with federal purchases contributed to the fall of the Chinese regime of Chiang Kai-shek to communism in 1949. China had a currency based on silver, rather than gold, and the jump in the price of silver, Friedman and other scholars theorize, accelerated the onset of inflation. That became hyperinflation in 1948 and 1949, undermining popular support

for Chiang Kai-shek.

Another example of monetary mischief is a long look at "the crime of 1873," the start of the battle between supporters of bimetalism (silver and gold) as the base for the currency and backers of a gold standard. That prompted William Jennings Bryan in 1896 to say to the Democratic Party convention: "You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold."

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Today, the US dollar and every other major currency in the world has an irredeemable paper-money standard. It is fiat money, not redeemable in gold or any other commodity. This situation, notes Friedman, has no historical precedent. It opens the door to the "printing" of money by governments as a way of financing budget deficits and avoiding more taxation. That in turn produces more inflation, which picks the pocket of taxpayers.

In the US, higher inflation and thus higher interest rates led to the S&L crisis with its massive costs, Friedman says. It robbed owners of US Treasury securities and other fixed-rate investments. For years "bracket creep" raised taxes on the American public without legislative action.

Friedman offers some hope that inflation has become less attractive as a political option, however. "Given a voting public very sensitive to inflation, it may currently be politically profitable to establish monetary arrangements that will make the present irredeemable paper standard an exception to Fisher's generalization," he writes. Economist Irving Fisher wrote in 1911 that fiat money "has almost invariably proved a curse to the country employing it."

In the US, Congress passed legislation that indexes the personal-tax schedule for inflation. This has largely, though not entirely, eliminated bracket creep as a source of government revenue. Developments in the financial market, notes Friedman, have sharply eroded the government's prospects for issuing long-term debt at such low nominal interest rates that it can be easily devalued by unanticipated inflation. So it hardly pays for the US government to cheat the public by an inflationary monetary policy.

Maybe, writes Friedman, advanced countries in the coming decades "will succeed in developing monetary and fiscal institutions and arrangements that will provide an effective check on the propensity to inflate and that will again give a large part of the world a relatively stable price level over a long period of time."

If fiat money results in more inflation, an alternative could be a return to a commodity standard, such as a gold standard of one sort or another, Friedman writes. "The final answer will come only as history unfolds over the next decades."