Monetarism Is Suffocated By Its Endless Contradiction

For those who fear the capture of higher education by the left, the late Milton Friedman rejects the very notion. To this day, left, right and center from the most elite of elite colleges the world over embrace the Friedmanite view that the trick to booming, non-inflationary growth is wise oversight of “money supply” from the proverbial Commanding Heights. Friedman was a man of the right, but his views on money sadly have mass appeal. Adam Smith would be disappointed.

The sole use of money is to circulate consumable goods. Adam Smith wrote the latter in the 18th century. It was a throwaway line so obvious was it. Absent wealth, there’s no need for money. And there’s no money circulating. Money is an effect of wealth as opposed to instigator of it. Basic stuff. You can’t eat dollars, or name your currency.

All of the above is a reminder that as opposed to money being “supplied” by governments, central banks, or treasuries, money is a natural market phenomenon. Where there’s production, there’s always money. The latter explains why the U.S. dollar liquefies so much exchange in countries not the U.S. Neither the Fed nor the U.S. Treasury “supplies” dollars around the world as much as production around the world renders circulation of reasonably trusted dollars in foreign countries as natural as gravity.

It’s basic stuff, but be careful whom you discuss the basics with. Members of the Monetarist School believe that as opposed to money being a natural consequence of production, it’s instead a function of wise planners whereby monetary authorities in government “supply” it to producers. Who knew producers were so reliant on central planners? Monetarists explain the relationship as a necessary one to keep inflation in check.

Which means on its face, one can make a case that monetarist theology is well intentioned. Monetarists believe that increases in what they imagine is “money supply” lead to inflation, which is a decline in the value of the exchange medium. Except that the latter is not true. Money once again exists to circulate the exchange of real wealth, which means central planning meant to limit the circulation of money imagines a static wealth pie whereby money in circulation never goes up.

Think of the above in terms of the United States. From 1790 to the early part of the 20th century, dollars circulating in the U.S. increased something like 163x. Were the U.S.’s first 125 years defined by endless hyperinflation per the monetarist school? Obviously not. Soaring dollars in circulation merely signal soaring economic activity. Where there’s growth there’s always more money facilitating the movement of the fruits of growth, as if by an invisible hand.

Again, money in circulation is a market phenomenon. Just don’t tell monetarists that. They believe money in circulation must be controlled by a central authority to avoid increases in the circulation of money. Their fear is overdone. That’s the case because in locales and countries where there’s very little production, there’s logically very little money. In locales and countries booming with economic activity, money in circulation is enormous. To understand this better, stop and speculate where dollars circulate in greater amount: Baltimore vs. Palo Alto. It’s a waste of words to say which. Did the Fed plan more dollars in one city versus the other? Not at all.

Money in circulation is once again a market phenomenon. Applied to Palo Alto, the Fed could theoretically drain every dollar from every bank and financial institution at 9 am tomorrow, but by 9:15 Palo Alto would yet again be awash in dollars, or some other medium of exchange. Money is where the production is, and it’s not where the production isn’t.

The monetarist definition of inflation as a rise in so-called “money supply” is just a variation of the Phillips Curve that says economic growth is inflationary. It’s not.

To which some proponents of the quantity theory of money will seek clarification. They don’t really mean that inflation is an increase in so-called “money supply,” rather they mean it’s an increase in so-called “money supply” at a rate faster than the economy’s ability to produce goods and services. Which is, if possible, even more detached from reality than the previous definition of inflation. For one, the markets for money are already exacting about money in circulation not exceeding production. See Baltimore vs. Palo Alto if you’re confused.

From there, didn’t central planning fail? This is important because in their evolving definition of inflation, monetarists claim the latter springs from a monetary authority increasing so-called “money supply” faster than the economy’s ability to produce goods and services. Such a definition implies that non-inflationary policy from the state involves the state matching the supply of money to production in exacting fashion. Stop and think about this. No reasonable person would ascribe to politicians (or economists employed by politicians) the power to tell milk carton producers how many milk cartons to produce annually, but monetarists claim the state has an ability (one it frequently doesn’t bother to live up to, apparently) to plan somewhat precisely the amount of dollars required not just by U.S. milk-carton producers, but the money required by producers of everything in the U.S. in concert with the world’s producers given the fact that most dollars in circulation circulate outside the United States. This one fascinates. Central planning has never worked, government as supplier of anything is hopelessly inept, but monetarists slave over the Ms in order to divine the “right” amount of dollars the Fed or some entity should supply in non-inflationary fashion. Apparently central planning works if the right people are doing the planning? Maybe, maybe not. With monetarists, they reserve the right to change their inflation definitions as reality changes.

Applied to money, it’s understandably difficult for quantity theorists to explain the miraculous mechanics of centrally-planned “money supply,” at which point some pivot to “money printing.” They claim that “money printing” causes money in circulation to rise, and that’s inflationary. Such a response changes the subject, but it’s a useful change. It is simply because “money printing” logically does not increase money in circulation. To suggest it does is to believe markets aren’t just stupid, but monumentally so. The view implies that governments can decree as “money” what producers will accept in return for goods and services. No, they can’t. To wantonly “print” money is to ensure that it’s not circulated, and that’s broadly the case in countries like Argentina, Iran, and Venezuela that tried to “make fetch happen” with the peso, rial, and bolivar. No doubt all three exist, but good luck buying real goods and services with them. This explains why the dollar circulates broadly in the countries mentioned, but not the local currencies.

Which hopefully reveals the circularity of the monetarist viewpoint. Supposedly increases in “money supply” are indicative of inflation, except that all growing countries experience commensurate increases in circulating exchange mediums. At which point it’s money in circulation beyond production, except that money goes where it’s treated well, meaning it already doesn’t circulate where production is slight. Ok, but “money printing” allegedly increases money in circulation, except that it doesn’t since markets are rather efficient and reject money that’s not trusted. A conversation with a monetarist is circular to reflect the myriad contradictions of this well-intentioned religion, one that fails like all well-intentioned forms of central planning do.

Republished from RealClear Markets


  • John Tamny

    John Tamny is a popular speaker and author in the U.S. and around the world. His speech topics include "Government Barriers to Economic Growth," "Why Washington and Wall Street are Better Off Living Apart," and more.

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