Milton Friedman y El Costo Del No Patron Oro

7/27/2019 Milton Friedman y El Costo Del No Patron Oro

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The Resource Cost of Irredeemable Paper MoneyAuthor(s): Milton FriedmanReviewed work(s):Source: Journal of Political Economy, Vol. 94, No. 3, Part 1 (Jun., 1986), pp. 642-647Published by: The University of Chicago PressStable URL: http://www.jstor.org/stable/1833052 .

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The Resource Cost of IrredeemablePaper Money

Milton FriedmanHoover Institution

Since 1971, no majorcurrencyhas a formal link to a commodity.Forthe first time in history,every currency s wholly rredeemable,not asa temporaryexpedient but as a permanentmatter.Monetaryecono-mistshave generally treatedirredeemablepaper moneyas involvingnegligiblereal resource costscompared with a commoditycurrency.Tojudge from recentexperience, that view is clearlyfalse as a resultof the decline in long-term price predictability.A key question forthe future is, What if any substitutefor a commoditystandardwillemerge as a long-termanchor for the price level?

Monetary economists have long stressed that the resource cost of apure commodity currency is a major factor encouraging the introduc-tion of fiduciary elements. As I put it many years ago, "Private prom-ises to pay the monetary commodity are as good as the monetarycommodity itself-so long as they command confidence that they willbe fulfilled-and far cheaper to produce, since the issuers can meetpossible demands for redemption by keeping on hand an amount ofthe monetary commodity equal to only a fraction of their outstandingpromises. A pure commodity standard therefore tends to breakdown" (Friedman 1960, p. 6).Government, of course, stepped in at an early stage in the introduc-tion of fiduciary elements, both to regulate private issuers of frac-tional reserve promises to pay and to take advantage of the possibilityof obtaining real resources by introducing fiat elements into promisesto pay the monetary commodity. The process has now come full cir-

journall of Political Economy, 1986, vol. 94, no. 3]? 1986 by The University of Chicago. All rights reserved. 0022-3808/86/9403-0005$01.50

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IRREDEEMABLE PAPER MONEY 643cle: the commodity Cheshire cat has completely disappeared, andonly the fiat grin remains.The world's current monetary system is, I believe, unprecedented.No major currency has any link to a commodity. What economists calloutside money consists entirely of government fiat in the form ofpaper currency, minor coin, and bookkeeping entries such as depositsat U.S. Federal Reserve Banks. The major earlier episodes in whichgovernments departed from a specie standard and issued irredeem-able paper money were expected to be temporary, and most of themwere. The others ended in disaster, as in the hyperinflations afterWorld Wars I and II. They were followed by monetary reforms thatrestored some relation between the currency and a commodity. Onlysince President Nixon ended Bretton Woods by closing the gold win-dow on August 15, 1971, have the United States and all other majorcountries explicitly adopted monetary systems in which there is nolink to a commodity and no commitment to restoring such a link,though all of them still genuflect to the past by retaining an entry oncentral bank balance sheets for the value of gold reserves.Nixon's action simply put an official seal on a process that had beenevolving for decades, certainly since the end of World War I, a pro-cess marked by such milestones in the United States as the prohibitionof the private ownership of gold in 1933 and the elimination of goldreserve requirements for Federal Reserve deposits in 1965 and Fed-eral Reserve notes in 1968 (Hurst 1973, p. 93).In earlier discussions, other monetary economists and I took it forgranted that the real resource cost of producing irredeemable papermoney was negligible, consisting only of the cost of paper and print-ing. Experience under a universal irredeemable paper money stan-dard makes it crystal clear that such an assumption, while it may becorrect with respect to the direct cost to the government of issuing fiatoutside money, is false for society as a whole and is likely to remain sounless and until a monetary structure emerges under an irredeem-able paper standard that provides a high degree of long-run price-level predictability.The earlier commodity link provided a physical anchor to the pricelevel over the long term. The price level in Britain in 1930 wasroughly the same as in 1740; in the United States in 1932 it wasroughly the same as in 1832. This long-term predictability of the pricelevel did not hold for shorter periods, as the fluctuation in prices overboth short business cycles and much longer swings demonstrates.Nonetheless, long-term predictability had important effects on assetpreferences and interest rates. Though economic theorists such asIrving Fisher emphasized the distinction between nominal and realinterest rates, in practice the distinction was of little importance, espe-


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644 JOURNAL OF POLITICAL ECONOMYcially for long-term interest rates, which displayed remarkable stabil-ity. Long-term bonds were the investment of choice for "widows andorphans."Under the current fiat system, the situation has been very different.Uncertainty about the long-term behavior of the price level has al-most surely increased sharply in recent years (see Klein 1978).1 Therates of inflation during the 1970s and early 1980s have no peacetimeprecedent in either the United States or the United Kingdom. TheU.S. price level in 1985 is eight times its 1939 level; the U.K. pricelevel, 20 times its 1939 level. In addition, interest rates, especiallylong-term interest rates, have risen to levels unprecedented inpeacetime and have fluctuated widely, paralleling rates of inflation.No one any longer regards long-term fixed interest bonds as theinvestment of choice for "widows and orphans." And no one anylonger disregards Fisher's distinction between nominal and real inter-est rates.This experience has strongly reinforced the impression derivedfrom earlier episodes of irredeemable paper money, as summarizedby Fisher in 1911 when he wrote, "Irredeemable paper money hasalmost invariably proved a curse to the country employing it" (1920,p. 131). One result has been a growth industry of "hard money"financial advisers producing newsletters and books and holding well-attended conferences, all devoted to warning the public of the cominghyperinflation or perhaps hyperdeflation and encouraging them toprepare for the disaster by accumulating gold or silver bullion, coins,or other collectibles, as well as by preparing hideouts well stocked withfood and means of self-defense. Real resources are employed in theseactivities, as well as in the production of the gold and silver absorbedin the hoards accumulated by both their clients and the many otherswho have come to regard gold or silver as a prudent component oftheir asset portfolios. Since the end of Bretton Woods, even the directresource cost of the gold and silver accumulated in private hoardsmay have been as great as or greater than it would have been underan effective gold standard. That depends on whether gold produc-tion since 1971 has been greater or less than it would have been underan effective gold standard-a promising research topic whose conclu-sion is by no means obvious from casual empiricism.Another real cost is more indirect, reflected in developments in thefinancial markets. The inflation that started in the United States in the1960s and elsewhere even earlier was partly a cause, partly a conse-

' Klein's estimates end in 1976. I suspect that the addition of the years 1977-84would reinforce his conclusion that long-term price uncertainty has risen sharply rela-tive to short-term price uncertainty.


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IRREDEEMABLE PAPER MONEY 645quence, of the abandonment of a commodity link. The variable andunpredictable character of this inflation has had far-reaching effects.In the United States it rapidly produced market interest rates consid-erably higher than the interest rates that banks were legally permittedto pay depositors. This discrepancy led to the introduction of moneymarket mutuals to enable persons with relatively small asset holdingsto benefit from the higher rates, and the introduction of money mar-ket mutuals, in turn, ultimately forced the abolition of the controls.The money market funds performed a valuable service, given thecontrols, but they would have been unnecessary if the controls hadnot existed or, alternatively, if the inflation had not made the legallimits untenable. This development, too, imposed a real resource coston society. Subsequent innovations have continued to reduce the roleof commercial banks and have forced the further deregulation ofbanking institutions. Innovations have also led to banking crises suchas the Continental Illinois, Ohio, and Maryland crises in the UnitedStates. These may be only transitional pains of adjustment to the newsystem; they have nonetheless involved substantial real resource costs.Prior to the 1970s, public futures markets in commodities had ex-isted for many years. There were no similar futures markets in cur-rency or in financial instruments, though banks did provide futurecover for the foreign exchange transactions of their customers. It isnot an accident that public futures markets in foreign exchange andin financial instruments developed only after the emergence of anirredeemable paper money standard. The function of futures mar-kets is to enable economic agents to cope more effectively with priceuncertainty. That is why they developed for those commodities thatwere subject to the greatest price uncertainty. The different characterof price and interest rate uncertainty under an international system offixed exchange rates linked to a commodity meant that public futuresmarkets in exchange rates and financial instruments were not viable.The uncertainty was about major changes at widely separated inter-vals such as currency depreciations or departures from a commoditystandard. Such uncertainty did not generate a demand for continu-ous short-term hedging or an opportunity for similar speculation.Trading in foreign exchange futures on the Chicago InternationalMoney Market began in 1972 and grew explosively in the new envi-ronment of floating exchange rates. Subsequent fluctuations in infla-tion and interest rates led to futures markets in a wide range offinancial instruments. The latest development is the opening of afutures market in the consumer price index by the New York-basedCoffee, Sugar, and Cocoa Exchange.These futures markets serve a useful function by enabling eco-nomic agents to hedge against uncertainty and undertake long-term


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646 JOURNAL OF POLITICAL ECONOMYcommitments that they would not be willing to undertake in the ab-sence of such facilities. Nonetheless, in terms of our present focus,they do absorb real resources and, like the money market mutuals,would not have arisen if the new monetary regime had not led togreatly increased uncertainty about interest rates and inflation. Doubt-less there are other effects of the change in the monetary regime thataffect the amount of real resources either absorbed or released that Ihave not recognized.I do not know of any attempt to measure the real resource costs ofan irredeemable paper currency and to compare such costs with thereal resource costs of a commodity currency. That is clearly a muchneeded research project.Let me emphasize that this note is not a plea for a return to a goldstandard, whatever that ambiguous phrase is taken to mean. On thecontrary, I regard a return to a gold standard as neither desirable norfeasible-with the one exception that it might become feasible if thedoomsaying predictions of hyperinflation under our present systemshould prove correct. These remarks do call attention to one charac-teristic of an irredeemable paper currency that has been neglected bymonetary economists. In addition they underline a point that hasbeen frequently recognized, namely, that there is need for eithersome anchor to provide long-term price predictability, some substi-tute for convertibility into a commodity, or, alternatively, some devicethat would make predictability unnecessary. Many possible anchorsand devices have been suggested, from monetary growth rules totabular standards to the separation of the medium of exchange fromthe unit of account. As yet, no consensus has been reached amongthem.

Finally, generals are by no means the only ones who fight the lastwar. Despite a burst of both scientific and popular writing generatedby the change in the monetary regime, much scientific and pop-ular analysis fails to recognize the unprecedented character of thecurrent regime. Few questions seem to me either more fascinatingscientifically or more important practically than whether Fisher's1911 generalization will hold for our current regime and, if not, whatforces will operate to prevent that outcome.2ReferencesFisher, Irving. The Purchasing Power of Money: Its Determinationand Relation toCredit,Interest and Crises. Rev. ed. New York: Macmillan, 1920.

2 A preliminary stab at discussing this issue is contained in Friedman and Schwartz(1986).


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IRREDEEMABLE PAPER MONEY 647Friedman, Milton. A Program or MonetaryStability.New York: Fordham Univ.Press, 1960.Friedman, Milton, and Schwartz, Anna J. "Has Government Any Role inMoney?" J. MonetaryEcon. 17 (January 1986): 37-62.Hurst, James W. A Legal History of Money in the United States, 1774-1790.Lincoln: Univ. Nebraska Press, 1973.Klein, Benjamin. "The Measurement of Long- and Short-Term Price Uncer-tainty: A Moving Regression Time Series Analysis." Econ. Inquiry 16 (July1978): 438-52.

Milton Friedman y El Costo Del No Patron Oro

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