My Letter to National Review Magazine: Tyler Cowen Does Not Understand Money

From: patrickbarron@msn.com
To: letters@nationalreview.com
Subject: Tyler Cowen Does Not Understand Money
Date: Tue, 3 Jan 2012 09:27:35 -0500




Re: The Eternal Struggle, by Tyler Cowen

Dear Sirs:
In his review of Nicholas Wapshott's new book Keynes Hayek, Tyler Cowen serves as a very poor arbiter of the monetary debate. Consider just his statement that "Whether we like it or not, the Fed has to do something (Cowen's emphasis), and letting the money supply continue to fall, in down times, is one of the worst options." This statement is followed a few paragraphs later by this one: "In essence, the American government spent almost a trillion dollars to postpone our economic pain by the grand span of two years." Is this the something that Mr. Cowen has in mind? Mr. Cowen is enamored with the discredited theory, advocated by Irving Fisher and revived by Milton Friedman, that money should be manipulated by the central bank to maintain a "stable purchasing power". This is a complete misunderstanding of what money actually is, and once one understands money's nature, one understands that pursuing a stable purchasing power is not only undesirable but also impossible. So, what is money? Money is a medium of exchange only. It is part of the market economy and is the most marketable good in an economy. Its purchasing power must be free to reflect the ever-changing ratios between itself and the thousands of an economy's vendible goods and services. As an economy gets more productive, the purchasing power of money will rise. If an economy becomes less productive--due to war, natural disaster, or anti-business government interventions--the purchasing power of money will fall. These are the signals that market participants need. The reason the money supply falls during the bust is that it was allowed to rise during the central bank initiated boom. The banks create money out of thin air during the boom. Debt created money comes into existence when they lend via the fractional reserve rules established by the Fed. But their lending is not based upon a prior act of saving, so their loans will fail. When the loan is written off, the money supply shrinks. All the Fed has accomplished by its expansion of reserves that then become money via the banking system is to create a boom/bust business cycle that destroys capital.

National Review needs to call upon some modern monetary theorists other than the likes of Mr. Cowen. Professor Joseph Salerno of Pace University, NYC, would be a good choice.