Monetarism, since my brain is still working.

Last night I intended to write about some thoughts I've had about money, but I got sidetracked which was probably better for everyone. Except it's still on my brain and I would prefer to spare Alison the forced opportunity to listen to me explain this so I'll hurl it at the vacuum of the internet and pretend I have an audience. I should also point out that there is a significant chance this has nothing to do with actual monetarism as espoused by the great Milton Friedman, it's just my pseudo-random thoughts about money as inspired by his last piece in the Wall Street Journal.

Money is convenient. By I that I don't mean when you have lots life is leisurely, what I mean is that money is more convenient than exchanging goods and services. Without currency we have a dual problem 1. do something that some group of people consider valuable 2. They do something that another group considers valuable 3. You hope those two groups intersect. With currency you still have the same problem, but it becomes much easier to work through multiple steps, A does for B, B for C, C for D and D for A without having to negotiate a trade for goods that no one along the chain wants.

So money is handy because it represents goods and services and abstracts away from all the trading (that and its easier to carry), but this is also a disadvantage. Because it abstracts there is the chance that the money ceases to represent the same amount of goods and services. So suppose a barber and a baker would happily trade a loaf of bread for a haircut, but money is such that if the barber doesn't spend it, he could get two loaves of bread tomorrow and the baker two haircuts (whatever that means). If everyone dropped prices by half everyday, very few people would buy anything because by saving you could get double later. So even though the relative price of a haircut and a loaf of bread are always the same, the constantly shifting price would prevent transactions from happening and cause economic trouble. The opposite is true for the more common situation of inflation. If the price doubles everyday, I'll happily buy 128 loaves of bread on credit and pay it off with one haircut in a week.

It's tempting the think that the panacea for all these problems is to stick with hard currency, no paper; understanding why that isn't a sure-fire fix is something that I realized this week. Hard currencies (think Gold Doubloons) are safe from over-excitable printing presses; there is a fixed supply of gold in the world, so the quantity of gold coins is fixed no matter what governments do (sure you could go dig up some more gold, but the price of gold takes into account the gold in the ground - mining costs; it should even include the probable size of yet undiscovered gold reserves). And there is the problem; take for example China. China's GDP grew by 11% last year, so if the number of gold coins is fixed it must be the case that each individual coin must buy 11% more stuff because there is 11% more stuff available to buy. If Chinese citizens can buy 11% more with their money next year by doing nothing other than putting their coins in a mattress, they're not going to spend very much and will save more. So little gets purchased and the economy collapses.

As I understand it the solution, as proposed by Friedman (at least my crude understanding of it), is that an increase in gold coins of 11%, an increase in the supply of money or the money supply, would keep the prices stable and the economy chugging along. So after periods of rapid economic growth its important to increase money supply; if you don't expect a recession. That's what happened up until the internet boom when the recession was quite mild comparatively, a fact Friedman cited as proof the loose monetary policy was a good idea. So, you can't increase the quantity of gold coins but you can increase the quantity of paper money and as long as government can keep the printing presses under control. Of course that's a big if.