29 thoughts on “Nobody can make a pencil

  1. I don’t think Leonard Reed (the original author, and founder of “foundation for economic education”) nor Milton Friedman were highlighting the specialisation angle… as important as that is.

    I think they were trying to draw attention to the ability of the market to coordinate a diverse range of resources and people towards a common end… even without anybody planning the operation.

  2. What John said. Even a communist command economy entails specialisation on a large scale.

    If the economy were a magic cook book then the price mechanism is the means by which the ingredients are accurately sorted and measured out for todays meal. Which by reason of changing taste and season is necessarily different to yesterdays meal. A system without the price mechanism may still have all the correct ingredients but it will waste large quantities and ultimately it bakes a cake nobody really wants to eat.

    Better specialisation is one reason we should cut taxes. A functional price mechanism is the reason we should avoid price fixing. Price controls are typically much more disruptive than taxes.

    It continues to amaze me how the economics profession as a whole, and the mainstream media as well, remains silent in the midst of a credit crisis about the price controls exercised in credit markets. It is blindness on a monumental scale. A crazy sequence of reasoning and a desire for not just fiat currencies but specifically for volatile fiat currencies has been allowed to justify a centrally managed credit price. It is not as if creating IOUs in the correct quantity is substantially different to creating the components of a pencil in correct quantity. And we don’t seem to have a pencil crisis.

  3. One argument we used to make was that free enterprise can take trees from Canada or wherever, turn them into paper, transport it across the world, gather information from the all over, collate it, edit it and print it, then distribute it to your door, for less than the government can deliver a letter to the next street.

  4. Yeah Friedman sure can be persuasive, like most of the chapters of his book which I’m just reading now, Free to Choose.

    Mind you, by contrast, his chapter about central banking is totally unconvincing and unclear. Friedman just talks about accommodating the banking systems need by providing money during a crisis.

    I just don’t think he explained the Great Depression correctly. He suggested that 1932 was a good year because the Fed started pumping money, but they stopped short and thats why the decline resumed in 1933.

  5. Some of what Friedman proposed in terms of monetary policy reveals that his thinking on the topic was often just plain wrong.

  6. I am not too crazy about Friedman’s point of view on central banking. For this particular issue, I think that it is better to go straight to the Austrian economists.

  7. I am not to crazy about some of the Austrians views on money. The Rothbardians are worse than Friedman. For this particular issue I think it is better to go straight to the supply side economists. Give me a Robert Mundell or a Steve Hanke any day.

  8. Friedman is responsible for perhaps the most important book on monetary policy ever when he explained (with Anna Schwartz) how contractionary monetary policy turned a financial downturn into a great depression.

    I can’t see how Friedman was fundamentally wrong. The complaint about money stock targeting of the 1970s misses his main underlying point.

  9. Isn’t any fiat monetary policy incompatible with libertarianism and thus ‘wrong’ though John? It would seem to me that the correct monetary position should be free market money with zero government involvement. Of course, this means that it’s harder for the government to collect taxes (and thus exist at all) – I assume they’d target the most popular monetary commodity or somehow choose among competing money (substitute) producers. Anything that makes it harder for the government to collect taxes is a good thing though!

  10. Ultimately, fiat money is bad. It survives because no government allows metal money to compete with it. In a truely libertarian society (perhaps we could call it Locketopia, since John Locke wrote about many ideas that are now called libertarian), individuals would use many monies, though the government might decree that it would only accept silver or gold units, to standardise things.

  11. Well we are each free to make up our own minds on central banking.

    It seems all sides are capable of interpreting history from their perspective. Friedman says the Great Depression was caused by not enough monetary expansion. The Austrians say it was caused by the monetary expansion during the 1920s.

    In all my years, I’ve never seen a coherent argument for targetting the stock of money or interest rates. I don’t understand Keynes idea that fractional reserve “turns bread into stone”, and I think I’d be completely out of my mind if I ever did accept that.

  12. Some of you may have seen “The Dangerous Return to Keynesian Economics,” by Steven Kates which raises some points I have not run into before.

    In Britain, economic policy during the Great Depression saw the application of a full-scale classical approach. A policy of balancing the budget and the containment of expenditure was adopted. By 1933, the budget had been balanced and it was from 1933 onwards that Britain emerged from the downturn of the previous four years.

    It is worth noting that it was balancing the budget that was seen to have made the all-important difference. In rejecting deficit financing during his budget speech of 1933, the British Chancellor of the Exchequer, Neville Chamberlain, made this explicit statement:

    At any rate we are free from that fear which besets so many less fortunately placed, the fear that things are going to get worse. We owe our freedom from that fear largely to the fact that we have balanced our budget.

    The same story could be told about Australia, where the Scullin Labor government made the decision in adopting the “Premiers’ Plan” which sought a cut in public spending, a return to budget surplus and cuts to wages. In the light of later Keynesian theory, nothing would have been seen as less likely to have achieved a return to prosperity, but a return to prosperity was most assuredly the result. All this is perfectly captured by Edna Carew (The Language of Money, 1996):

    A strategy was adopted in June 1931 by Australia’s Scullin government to reduce interest rates and cut expenditure by 20 per cent, partly through slashing public-sector wages. The objective was to reduce Australia’s huge budget deficit problems. Australia had to get its books in order if the country was to continue to get overseas finance. Devaluation had already been forced and increased tariffs tried. The rationale behind the Premiers’ Plan was to revive business confidence.

    The plan was welcomed as an example of creative economic planning; Douglas Copland claimed it was “a judicious mixture of inflation and deflation”. Later it was criticised as overly deflationary.

    Certainly it was “later” criticised as overly deflationary after the depression had passed and Keynesian economics had become the vogue, but at the time, while the Great Depression was an actual fact of life, rather than it having been criticised, this was the consensus view of the economics profession of Australia. And it worked.

  13. There is nothing inherently wrong with fiat currency. If it was set up voluntarily and in the private sector, then it is perfectly libertarian.

    I agree with free banking. But libertarians often get involved in “lesser-of-two-evils” debates. For example, in arguing for a low flat income tax you are accepting the existence of an income tax. I would prefer no income tax. But if we are going to have one… then I want a low flat income tax.

    The same applies with monetary policy. I would prefer free banking. But if the government is going to get involved in monetary policy then I would prefer the money supplier is corporatised and that monetary authorities learned the lessons of Friedman.

    All suppliers of money are ultimately going to have to deal with their mechanism for determining supply. There is no silver bullet to this issue. The great contribution of Friedman was to point out that (1) monetary policy can impact strongly on the real sector — eg contraction lead to great depression; and (2) the government shouldn’t try to use active monetary policy because ultimately it will always come back to bite them.

  14. John – we have had this Friedman money debate before. I’m not into a having a repeat right now so I’ll just register my lack of agreement with some of your position and leave it at that. However on the issue of income tax I did want to say that I actually prefer a low progressive income tax rather than a low flat income tax. And your past advocacy of 30/30 actually amounts to an income tax that is more progressive than the current setup. 😉

  15. Jim – I haven’t read any of Steven Kates work in a long time. I had an email exchange with him many years ago to discuss some of his work and in terms of economists I think he is one of the really good guys in Australia and a rare advocate for the significance of Says Law (he wrote a book on the topic). Having said that I do need to take issue with the passage above. It seems to omit any mention of the monetary errors Britian made in 1925 and which Australia and other commonwealth nations inherited via their fix to the Pound Sterling. I think this omission is a key weakness in the analysis. It is one of the rare periods in history where I think the inflationists were broadly correct. Cutting public sector wages does make a kind of sense if you are in the midst of a deflation (which they were) but it would have made more sense to simply reflate via a currency devaluation (which was not tried in any significant way). The circumstances today are not the same.

  16. Ultimately, fiat money is bad. It survives because no government allows metal money to compete with it.

    I don’t believe that’s the case, nic. There is nothing to stop you and another person from contracting in gold or the Japanese yen for consideration.

  17. “There is nothing inherently wrong with fiat currency. If it was set up voluntarily and in the private sector, then it is perfectly libertarian.”

    If we’re using the actual definition of fiat (ie, decree) then private fiat is a contradiction. If you mean fiat as in non-backed notes then yes it could happen privately. I can’t see how unbacked money in the private sector would ever be accepted though.

    I agree with most of the rest of your post.

  18. Promisory notes backed merely by a promise, a reputation, contract law and some good management worked just fine in the days of old. In essence they were like demand deposits that circulated. There were however denominated by an independent reference point, typically gold coin. Notes with no independent reference for value don’t seem to have prospered anywhere in history except when managed by government or where the means of producing new notes was lost (eg Swiss Dinar in Iraq).

    JCs comment at #20 is spot on in my view. Our fiat currencies don’t succeed principly due to mandate but because of two other major factors. One is the demand for these currencies created by taxation and the second is the governments significant roll as a market participant. The combined effect of these two forces is strong enough to make even a lousey currency dominant and displace otherwise superior alternatives. And of course once a currency dominates even a little other players quickly make the switch and the rising liquidity and utility of the currency make it’s rise all but inevitable. Currency choice is dictated by a powerful and almost inescapable Nash equilibrium.

  19. JC, the term ‘fiat money’ literally derives from the government commanding people to accept notes as cash. It’s a command from the government, designed to cut the link between money and objective standards, so they can inflate as they like. I repeat, fiat money is bad. It is based on governments wanting more money without raising taxes or earning it.
    Whilst we might get away with trading in gold privately, if we went public, wouldn’t the powers that bewilder insist we pay taxes on the deals? All governments try to retain monopolies on money, if they can.

  20. Greego — if the government never got involved in money then I think the dominant currency would likely be asset backed. Perhaps gold backed.

    However, I think the easiest way to get to free banking is simply to privatise the RBA and remove all legislation regarding money, and have the government accept all forms of liquid assets as tax.

    Under that situation, I think the incumbency advantage of the RBA non-backed currency would allow them to maintain a good market share, so long as they maintained low inflation.

    But these are idle speculations about business models. It doesn’t bother me which currency “wins”.

  21. Jono,

    Under free banking, private banks would need to target prices and aggregates. Inflation would tend to zero and moiney growth would vary with economic growth due to issue (competition)and loan book (asset-liability management) constraints.

    As long as we have a central bank, something needs to be done to minimise inflation and deflation. Free banking would be better for at least practical reasons, such as a lack of political favouritism and a true profit motive.

  22. Interesting aside. The first currency of significance in European Australia was rum. It took the government of the day over 25 years of active effort to displace it’s position of dominance. Even though they wanted to get rid of rums monetary role the government was still forced by market circumstance to pay wages in rum. If they had implemented a rum standard and then later uncoupled the paper currency from rum perhaps they would have ended rums monetary role much sooner.

  23. I think of it this way- I hope to be known as a great wit one day, and my friends assure me that I’m already halfway there!

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