Boom-Bust Cycles And Easy Money

A fall in the growth rate of money out of “thin air” is thereby going to undermine various non-productive activities that arose from and were supported by the fractional reserve bank lending. This sets in motion an economic downturn.

The expansion in money supply supports the emergence of non-productive activities. So if the fixed money rule were to be enforced, over time it would lead to the expansion of non-productive activities. (A fixed money supply rule is still about the expansion of money out of “thin air” though at a fixed rate). This is going to weaken the wealth generators and thus undermine the real economy.

We can conclude that Friedman’s monetary rule is simply another way of tampering with the economy and, hence, it cannot lead to economic stability.

The Gold Standard and Boom-Bust Cycles

Would the introduction of a gold standard eliminate boom-bust cycles? According to Friedman, what causes boom-bust cycles is fluctuations in the growth rate of money supply. On the gold standard there are going to be fluctuations in the growth rate of money supply. Hence, according to Friedman, the introduction of a gold standard is not going to eliminate business cycles.

It is true that the variability in the growth rate in the production of gold will create fluctuations in the growth rate of money supply. As opposed to the expansion in the money supply on a paper standard, however, the increase in the money supply on a gold standard will not result in an exchange of nothing for something. It will not result in the diversion of wealth from wealth producers towards non-wealth generating activities.

Being a commodity, apart from providing the services of the medium of exchange gold is also demanded for various industrial uses including jewelry. From this perspective, it is part of the pool of real wealth. So when gold exchanged for goods and services — something is exchanged for something else.

Note that the increase in the supply of gold is not an act of embezzlement or fraud. The increase in the supply of gold does not produce an exchange of nothing for something. Contrast this with the printing of gold receipts i.e. receipts that are not backed 100% by gold. This is an act of fraud, which is what inflation is all about. It sets a platform for consumption without contributing to the pool of real wealth. Empty certificates set in motion an exchange of nothing for something, which in turn leads to recurrent cycles.

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