Free To Choose: A Personal Statement – Charter 9 : The Cure for Inflation (1)

The Tide Is Turning

CHAPTER 9 Compare two rectangles of paper of about the same size. One is mostly green on the back side and has a picture of Abraham Lincoln on the front side, which also has the number 5 on each of its corners and some printing. You can exchange this piece of paper for some quantity of food, clothing, or other goods.

People will willingly make the trade.

The other piece of paper, perhaps cut from a glossy magazine, may also have a picture, some numbers, and some printing on its face. It may also be colored green on its back. Yet it is fit only to light the fire.

Whence the difference? The printing on the $5 bill gives no answer. It simply says, “FEDERAL RESERVE NOTE / THE UNITED STATES OF AMERICA / FIVE DOLLARS ” and, in smaller print, “THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE. ” Until not very many years ago, the words “WILL PROMISE TO PAY ” were included between “THE UNITED STATES OF AMERICA ” “FIVE DOLLARS. ” That seemed to explain the difference be-be-_ tween the two pieces of paper. But it meant only that if you had gone to a Federal Reserve Bank and asked a teller to redeem the promise, he would have given you five identical pieces of paper except that the number l took the place of the number 5 and George Washington’s picture the place of Abraham Lincoln’s.

If you had then asked the teller to pay the $1 promised by one of these pieces of paper, he would have given you coins which, if you had melted them down (despite its being illegal to do so), would have sold for less than $1 as metal. The present wording is at least more candid if equally unrevealing. The legal-tender quality means that the government will accept the pieces of paper in discharge of debts and taxes due to itself, and that the courts will regard them as discharging debts stated in dollars. Why should they also be accepted by private persons in private trans- actions in exchange for goods and services? 248 The Cure for lnflation 249 The short answer is that each person accepts them because he is confident that others will. The pieces of green paper have value because everybody thinks they have value. Everybody thinks they have value because in his experience they have had value. The United States could not operate at more than a small fraction of its present level of productivity without a common and widely accepted medium of exchange (or at most a small number of such media); yet the existence of a common and widely accepted medium of exchange rests on a convention that owes its existence to the mutual acceptance of what, from one point of view, is a fiction.

The convention or the fiction is no fragile thing. On the con- trary, the value of having a common money is so great that people will stick to the fiction even under extreme provocation— whence, as we shall see, comes part of the gain that issuers of the money can derive from inflation and hence the temptation to inflate. But neither is the fiction indestructible: the phrase “not worth a Continental” is a reminder of how that fiction was de- stroyed for the Continental currency issued in excessive amount by the U.S. Continental Congress to finance the American Revo- lution.

Though the value of money rests on a fiction, money serves an extraordinarily useful economic function. Yet it is also a veil.

The “real” forces that determine the wealth of a nation are the capacities of its citizens, their industry and ingenuity, the re- sources at their command, their mode of economic and political organization, and the like. As John Stuart Mill wrote more than a century ago: “There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.” 1 Perfectly true, as a description of the role of money, provided we recognize that society possesses hardly any other contrivance that can do more damage when it gets out of order.

We have already discussed one example: the Great Depression, 250 when money got out of order through too sharp a reduction in its quantity. This chapter discusses the opposite and more com- mon way in which money has gotten out of order—through too sharp an increase in quantity.