More Financial Crisis

1.
“Money is much too serious a matter to be left to central bankers”

- Milton Friedman

In an attempt to understand better what has been happening on Wall Street and in Washington the last few days, I reread Milton Friedman’s 1992 book Money Mischief. It seemed a good place to start. Professor Friedman was both a great economic thinker and good writer, and there certainly seems to be some mischief going on with our money. A couple of his observations can perhaps make some of the recent events make a little more sense. First and most important, he makes the point that money is whatever the people in a society agree that money is, and that money stays valuable as money only so long as people continue in their belief that it is money. While this is true even of commodity-based money such a gold and silver coins, the element of belief is especially important with regard to the fiat money of our era. Second, he notes that there “is strong evidence that a monetary crisis involving a substantial decline in the quantity of money is a necessary and sufficient condition for a major depression.”

During the last few weeks we may have seen a both a danger of a drastic drop in the amount of (broadly defined) money and a risk that people would start to wonder if their deposits and money market funds and other money instruments really were money after all. If so, then perhaps governments around the world may have been right to guarantee everything in sight and to manufacture lots of new money out of debt and thin air to replace what had vanished. However, even if they were right in principle, we still have to worry about a botched execution. They could do too little too late and fail to prevent a deflation, or they could do too much and cause crippling inflation down the road. We can hope they get it more or less right. However such hope would not be based on any experience, but on the notion that, like a guy in a one for 28 hitting slump, they might be due.

We also have to worry about moral hazard, the precedents that have been set, and the glaring obviousness of it all. The micro effect of much that has been done is to punish the prudent and rescue the reckless. Bitter and sensible taxpayers are saying “gee, maybe I should have bought a bigger house too”. No one in Washington wants to be around on the day that productive and responsible people figure out fully and en masse that our government has declared clearly and over decades that productivity and responsibility are for suckers. It is surely in the interest of the government to forestall this realization in some fashion and keep the goose laying.

2.

As to the two candidates for president, neither one is making much sense. In fact their public comments on the question pretty much reduce to the following:

Obama: Bush did it. Don’t blame me.

McCain: Frank and Dodd did it. Don’t blame me.

Obama: I can save our bacon, just me by myself.

McCain: I can save our bacon, just me being bipartisan.

Obama : I will give every American forty acres.

McCain: I will give every American forty acres and a mule.

Obama: I will give every American forty acres and a mule and a hat for the mule.

McCain: How about two hats?

However, we must remember that they are in a tough race in which most of the knowledgeable and principled voters have already made up their minds. They are left in a serious struggle for the undecided votes of the less ideological and generally more ignorant and gullible of our citizens. So the dissembling is understandable. We should hope that whoever wins knows that he is blowing smoke and will be more sensible after he takes over.