Money Mischief.

IT IS HARD to believe that three decades have passed since Milton Friedman shook the world with Capitalism and Freedom. It was not his first book, but it was the first aimed at a popular audience. A work of unintimidating size, written with startling clarity and persuasiveness, it immediately captured hearts and minds as nothing else of its kind had done since Hayek's Road to Serfdom and Hazlitt's Economics in One Lesson.

Many of Friedman's 1962 policy proposals still appear as bold and brilliant as they did back then. His idea of using vouchers to promote choice and competition in schooling is finally beginning to bear fruit. And leading politicians from both parties have embraced Friedman's teachings on the benefits of a low, flat-rate tax. Yet he is perhaps best known for having restored our understanding of the importance of money in general, and of predictable monetary rules in particular. "Substantial inflation is always and everywhere a monetary phenomenon," Friedman insists, and so are most "cyclical" gyrations in real output and employment. This compelling "monetarist" theme, backed by awesome research in collaboration with Anna Schwartz, David Meiselman, and others, was the first successful challenge to what had become an increasingly imperious Keynesian orthodoxy.

In 1960, Friedman launched a tentative proposal that central banks be required to keep money growing at "a relatively constant rate." Sympathetic critics have since come to believe that such a quantity rule has become difficult to enforce, because of such complications as defining and measuring money when you can write checks against all sorts of mutual funds. But Friedman was always far less dogmatic about this particular monetary rule than were some of his followers. "I should like to emphasize," he wrote in 1962, "that I do not regard my particular proposal as ... a rule which is somehow to be written in tablets of stone  and enshrined for a future time."At various times, Friedman has instead proposed requiring banks to hold 100 per cent reserves against deposits, or making currency convertible into an assortment of metals, or allowing competitive private banks to issue currency notes. In Money Mischief, he offers additional heresies in support of bimetalism (a combined gold-silver standard), or a limit on the gap in interest rates between indexed and nonindexed bonds, or a "unified" system in which a country with a weak currency essentially adopts the more credible money of another country. The unchanging theme underlying all of these reforms, though, is the importance of preventing the value of money from being determined by the whim of politicians and central bankers.

Since the publication of Dollars and Deficits in 1968, many of Friedman's unique reflections on money have been relatively inaccessible to the general reader, scattered as they are among a variety of technical books and articles. Money Mischief fills this void by carefully leading the reader through an explanation of how and why money matters. Concise exercises in theory are enlivened with real-world illustrations from U.S. and foreign history. We discover how a scheme to placate U.S. senators from silver-producing states helped to bring Communism to China, and why pegging exchange rates to the dollar worked quite well to stop inflation in Israel but not in Chile.

The opening explanation of "The Mystery of Money" is actually more rigorous than it seems, teaching more crucial concepts than many students retain after two college courses in money and banking. Yet the reader is seduced into learning by the author's familiar mastery of entertaining historical anecdotes and revealing graphs. Starting with stone money on the island of Yak, we are quickly led to understand what affects people's willingness to hold money for short or long periods, how real and nominal quantities of money differ, and how the perception of individuals about the delights of having more money clashes with what is actually possible for the entire economy and thus leads to monetary mischief.

Friedman, like many of us, has become far less skeptical about the merits of a commodity standard than he was when the U.S. severed its last links to gold in 1968-71. Subsequent experience with managed money has been a harsh teacher. As Friedman notes, "the fiat monetary system has been characterized by wide fluctuations in price levels, interest rates, and exchange rates." Back in the Sixties, the heyday of arrogant economics, we were taught that it was foolish for money-issuing authorities to commit themselves to holding a stock of gold and converting currency into yellow metal on demand. Wooden nickels would be better, because they are cheaper to produce. Friedman vanquished such cavalier notions in a scholarly journal a few years ago, observing that under a fiat money system citizens have to hold their own gold hoards as a hedge against inflation. "For millennia," Friedman now writes, "the only effective limit [on money] was provided by the link between money and a commodity. That link provided an anchor for the price level .... The verdict is far from in on whether fiat money will involve a lower cost than commodity money."

Our national attitudes toward gold or silver money continue to be shaped by vague misunderstandings of our history, particularly the events leading up to the "Cross of Gold" campaign of William Jennings Bryan in 1896. Bryan has long been a hero of U.S. history texts, while McKinley is depicted as a tool of Wall Street, and the voters as fools. Friedman revisits this period in several chapters, which read like a mystery novel. In 1873, the U.S. stopped treating the silver dollar as a coin with full legal-tender status, through a decision made without much reflection or debate. Had this "Crime of '73" not occurred, Friedman shows, the U.S. would have gone back to a commodity standard three years sooner, but it would have been a silver standard, not gold. "A silver standard almost surely would have avoided . . . the disturbed years from 1891 to 1897," he writes. It "would have greatly reduced the subsequent deflation in the United States and would have avoided the monetary and political agitation and uncertainty that the deflation produced."

This analysis puts Bryan in a more favorable light, and Friedman's revival of the long-forgotten case for bimetalism is masterly. However, it is not clear to this reviewer that the farm problems of the 1890s were entirely monetary in origin.

When writing about 1933, Friedman notes that "the farm lobby supported silver purchases partly because it favored any measure that would produce inflation and thereby raise the prices of farm products." That comment seems quite applicable to 1896 as well. But the farmers' political efforts on behalf of inflation in 1896 were not as defensible as in 1933, because the deflation of the early 1890s was not nearly as severe, and was largely concentrated in farm products.

Friedman argues that a relatively mild drop in prices in the 1890s, under the gold standard, was the sole cause of "a sharp retardation [of production] from something like 1892 to 1896." But he tells a quite different story when speaking of a much deeper greenback deflation from 1865 to 1878, when wholesale prices were cut in half. At that time, Friedman writes, "deflation did not prevent rapid economic growth .... On the contrary, rapid growth was the active force that produced the deflation." Big increases in supplies push prices down. Yet there were episodes of recession and growth in both the 1870s and 1890s, so it is not obvious why the deep deflation of the earlier period should be a matter of no concern, while the much milder deflation of the 1890s should be considered a disaster that justified scrapping the entire monetary regime. By one index, Simon Kuznets's GNP deflator, prices fell by only 10 per cent from 1893 to 1896, and some other measures indicate an even less steep drop. Furthermore, on Kuznets's estimate, real GNP rose by nearly 7 per cent in the same period. The political problem was falling farm prices, not a prolonged industrial depression; and there were real forces at work here, such as global trade wars and bumper crops, not just a shortage of gold. Even today, corn prices frequently rise and fall relative to gold. But that is not necessarily an indictment of gold, or a justification for inflation.

Thanks to Christina Romer's new monthly index of industrial production, we know that the only serious drop in manufacturing output in the 1892-96 period was during late 1892 and early 1893. It is the drop in farm prices, not urban unemployment, that led to Bryan's promise to make money rain upon the nation's farms. Farm production did not fall in the years leading up to 2896, but instead soared. Indeed, huge increases in the supply of grain and cotton are at least part of the explanation of why farm prices fell far more rapidly than prices of nonfarm goods. The huge increase in agricultural output also explains why the primitive old indexes of U.S. wholesale prices for the 1890s, constructed from newspaper reports on raw commodities, appear to indicate a more rapid fall than in Britain, where farm goods accounted for a smaller share of the index. It is hard to believe that U.S. and British deflation rates for traded goods really differed for several years, since both countries were on the same gold standard.

Despite such quibbles, there is no question that Friedman's meticulous re-examination of this turning point in U.S. history has much to teach us. Personally, my own urban bias is still toward McKinley and gold in 1896, despite his nasty 1890 tariff law, but then I'm fond of Coolidge, too. On the other hand, Friedman's case for keeping the silver dollar back in 1873 is quite enticing. Just imagine how little inflation we would have had in recent years if a silver dollar could still be bought for a paper dollar.

This is another in a long series of trail-blazing books by Milton Friedman. How often do we get a chance to read something new from one of the half-dozen most influential economists who ever lived? Money Mischief will enthrall anyone interested in money or history, which ought to include just about everyone.