53 pages • 1 hour read
Milton FriedmanCapitalism And Freedom
Nonfiction | Book | Adult | Published in 1962A modern alternative to SparkNotes and CliffsNotes, SuperSummary offers high-quality Study Guides with detailed chapter summaries and analysis of major themes, characters, and more.
Chapters 3-4Chapter Summaries & Analyses
Chapter 3 Summary: “The Control of Money”
Friedman attacks the notion that a private, free-enterprise economy is unstable by nature and characterized by recurrent boom and bust cycles that require government intervention. He says this viewpoint was common during and following Great Depression and helped spur New Deal policies. Friedman thinks the severity of the Great Depression resulted from missteps by the government, not market instabilities. He asserts that the Federal Reserve made terrible decisions concerning the money supply in 1930 and 1931, which turned a market contraction into a “major catastrophe” (38).
In Friedman’s view, Americans’ dissatisfaction with the commodity standard of the late 1800s contributed to a string of financial crises, which in turn led to the establishment of the Fed. A commodity standard is a system in which money is backed by a commodity, such as gold or tin. Since a commodity standard requires real resources, which are costly, it is usually accompanied by fiduciary money, such as an agreement stating that a person must receive the commodity in question according to a set of fixed terms. When the people in charge of the money stock circulate agreements such as these, less of the commodity needs to be kept on hand. Friedman says that once fiduciary elements enter the picture, there’s a tendency for “extensive intervention by the state” (41).
When the Fed was created, most of the world operated on a gold standard. Friedman says people assumed this trend would continue, effectively curbing the Fed’s power. But when World War I began, many countries abandoned this standard and the Fed became “a powerful discretionary authority able to determine the quantity of money in the United States and to affect international financial conditions throughout the world” (43). Power was handed to just a handful of Fed officials, so we should not be surprised that a disaster resulted, Friedman concludes. With this in mind, he proposes that the Fed operate with a set of Constitution-like rules. He also says the Fed should to try to grow the country’s money stock at an annual rate of 3 to 5 percent.
Chapter 4 Summary: “International Financial and Trade Agreements”
Friedman believes that international monetary and trade agreements present immediate risks to economic liberty in the United States. When problems involving international monetary arrangements arise, it’s tempting for the government to exert control over the economy to solve them. In the process, economic freedom disappears. Friedman says this has happened in other countries, when the government began imposing direct controls on foreign exchange; in these situations, societies with market economies turned into authoritarian systems. He explains that these direct controls lead “to the rationing of imports, to control over domestic production that uses imported products or that produces substitutes for imports, and so on in a never-ending spiral” (57).
In some countries, the government decides that its currency can’t be converted into the currency of another country or government. When Friedman wrote Capitalism and Freedom, the U.S. dollar was inconvertible and had been for nearly thirty years. Plus, Americans were not allowed to buy, sell, or hold gold. Friedman points out that the government controls the price of gold in an attempt to keep it lower than the market price. He feels that control of any price, including that of gold, is not acceptable in a free-market economy. Friedman also complains that Americans had to surrender their gold to the government in 1933 and 1934. He views this requirement as a violation of property rights.
Two common problems involving international trade are balance-of-payments problems and runs. Friedman says a balance-of-payments problem, such as too little money in a lending institution income account, usually comes about slowly, whereas a run can happen out of the blue. There is some time to solve a balance problem, but a run must be addressed immediately. Depositors can lose confidence in a lending institution such as the U.S. Treasury even if its income account is doing just fine; if this occurs, many of them are likely to want their deposits back. If lots of foreign parties try to convert their U.S. dollars into gold at the same time, a run on the U.S. Treasury can occur. If this happens, the federal government can remedy the problem by drawing down its reserve of foreign currencies, forcing domestic prices down relative to foreign ones, altering exchange rates, or using direct controls, such as import quotas.
Friedman complains that the U.S. has not adopted a consistent international trade policy, which confuses foreign-trading partners and encourages them to “make the same ostrich-like pronouncements as we do” (65). This hampers trade for all involved. He thinks that the wisest approach is adoption of floating exchange rates that would allow any currency to be exchanged for any other type of currency. These would allow trade to be truly free. The market would determine the rates with no intervention from the government. Friedman says these rates should be relatively stable; if they are not, it’s a sign that the economic structure has stability issues that need attention.
In addition to advocating floating exchange rates, Friedman advocates several other policy changes to enable a free market in gold and foreign exchange. These include ending the U.S. practice of buying and selling gold at a fixed price and allowing Americans to buy, sell, or hold gold again. He also advocates that the U.S. end economic-aid grants to foreign governments, drop restrictions on imports, and offer full cooperation with any foreign country interested in trading.
Chapters 3-4 Analysis
Financial crises, including market contractions and runs on banks, make an appearance in both of these chapters. Friedman suspects that the stress of these situations creates pressure for the government to intervene in economic matters in ways that it shouldn’t, for instance by adding direct controls to foreign exchange. He says that these measures, like other forms of inappropriate government intervention, erode freedom and keep the market from functioning how it should.
Poor decision-making during times of economic stress is one reason to adopt the set of Constitution-like rules Friedman proposes for the Fed. He feels that such rules would minimize arbitrary decisions by Fed leaders and help them think about monetary issues as a whole, rather than focusing on their parts, a problem that can lead to poor choices like those Friedman thinks worsened the Great Depression.
