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December 4, 2015

Gold Money vs. Fiat Money

It follows from the propositions I have so far stated that inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. However, there are many different possible reasons for monetary growth, including gold discoveries, financing of government spending, and financing of private spending. [emphasis in the original]

The Counter-Revolution in Monetary Theory (1970)
Milton Friedman
The quantity theory of money goes back to Irving Fisher. Friedman's lecture is from 1970. Richard Nixon closed the gold window in 1971 making way for genuine fiat currency. I left in the part about "gold discoveries" in the quote above to highlight the importance of the fact that the whole thing is based on gold standard currency. Is it valid for fiat currency?

My own take is that Milton Friedman has been proven wrong, money does not cause inflation.

Suppose there was twice the amount of air in the atmosphere, we would not breathe twice as much. If there were not enough air as in the Black Hole of Calcutta, we would choke. In the latter condition adding some air would help us breathe better. In nature there is a phenomenon known as "state change." H2O can be solid, liquid or a gas. In each state H2O behaves differently.

Since gold is limited, choking for lack of money under the gold standard is not unusual. The gold standard was designed to do just that, keep kings and sovereigns in check. But once you go to a genuine fiat currency, unlimited in quantity (state change), inflation is no longer a question of money supply. Fiat money, as gold bugs emphasize, has no intrinsic value and that is its beauty! (Fiat) money becomes just a record keeping device. Money ceases to be a commodity and becomes information pure and simple.

It should not come as a surprise that commodity or gold money behaves differently than information or fiat money.

Denny Schlesinger

The Counter-Revolution in Monetary Theory by Milton Friedman

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