Gary North’s Reality Check
Milton Friedman was very smart and a great debater. I knew him. I liked him. But he was no different from other very clever fellows. When he got something conceptually wrong, he was dangerous.
My professor of apologetics at seminary was Cornelius Van Til. Apologetics is the philosophical defense of the Christian faith. Van Til was every bit as smart as Friedman. He had a bunch of great metaphors in his arsenal of rhetoric. My favorite was the buzz saw metaphor. He said this: “You can sharpen a buzz saw all you want, but if it is set at the wrong angle, it will never cut straight.”
Milton Friedman’s “buzz saw” on monetary theory was always set at a crooked angle. It never cut straight.
He described the distribution of fiat money in terms of a metaphor: a helicopter full of paper money. It drops this money on the population below. He used this metaphor in a chapter titled “The Mystery of Money.” It is chapter 2 in his 1994 book, Money Mischief. His goal for the chapter was to show that this free money from the sky, if it continues, will raise prices. He introduced the metaphor on page 29. (For the moment, you can read the chapter here. But Web pages come and go.)
What the metaphor does not show is what Austrian School monetary theory emphasizes: the new money is introduced at specific points in the economy. It is spent into circulation by the national government, which sells its IOUs to the official counterfeiter: the central bank. The national government gets first access to this money. It then spends it. The recipients of this government spending get access to the newly created money earlier than other citizens do. So, prices in general do not rise uniformly. They may not rise at all if overall economic production increases. What always rises is government spending. This fact, not the general price effects of counterfeit money, is the heart of any accurate analysis of central bank money. It is discussed in detail only by Austrian School economists.
Friedman never admitted that this process of sequential spending is relevant. He, like his intellectual mentor Irving Fisher, self-consciously rejected the Austrians’ analytical approach. What is this approach? The approach of the script of All the Presidents’ Men: “Follow the money.”
Ludwig von Mises refuted Fisher’s 1911 book on monetary theory in Mises’ 1912 book, The Theory of Money and Credit. Fisher never responded explicitly to Mises. Their respective disciples did battle. Murray Rothbard repeatedly critiqued Friedman on this same point. Friedman never responded explicitly to Rothbard.
His helicopter metaphor became a powerful rhetorical tool to persuade others of his arguments against free-market pricing. He always said he preferred free-market pricing. But there was always this glaring exception: the pricing of money. He spent his career trying to undermine the legitimacy of the idea of free market money (gold coins) and a price system based on it. He became a public figure with his 1961 book, Capitalism and Freedom. Chapter 3 is on money. It begins with a rejection of the gold coin standard.
KEYNESIANS FLY THE HELICOPTER
From the beginning, Keynesians loved his metaphor of the helicopter full of paper money. Why? Because that metaphor portrayed the central bank as a supplier of free goods. They understood what the Austrian School economists understand: The national government gets to sell its IOUs at a lower rate of interest to the central bank than the private investors who cannot legally create money out of nothing. This lets the government spend more money than it collects from taxes and loans from the private sector. Here is the law of economics: When the price of something is reduced, more of it is demanded. Fiat money issued by a central bank therefore allows the government to buy more power and influence in the overall economy. Central bank fiat money subsidizes the national government.
Keynesians believe that government can and should increase its purchase of goods and services. Friedman always said that the government shouldn’t be allowed to do this very often, and only on an efficient basis (e.g., school vouchers). But he ignored the obvious: fiat money lowers the government’s cost of issuing IOUs. This means that the central bank provides lower-cost power and influence for the government. The government demands more of this money at artificially low interest rates, because it expands the range of government operations.
This was the heart of his analytical error all his life. This error has played well among Keynesians. They see the greatest benefit of the central bank as providing “free extra money” for government spending.
(To read the rest of my article, click the link.)