David Gordon's Forbes Critique Fails Basic Economics
It is difficult to decipher why David Gordon of the Ludwig von Mises Institute is being so critical of Steve Forbes and Elizabeth Ames' book Money: How the Destruction of the Dollar Threatens the Global Economy - and What We Can Do About It. His clearest objection is Forbes and Ames' belief that money is a unit of measure that that needs a fixed gold price to remain a reliable and useful unit of value over time. In Gordon's view this belief and this book are "odd". Unfortunately, by the end of his review, the only "odd" thing is Gordon's lack of understanding of some basic economic concepts and the fundamental issues that Forbes and Ames are addressing.
Gordon's argument veers off early by confusing "money" and "purchasing power" in his attempt to refute that money is only a unit of a value or account. He asserts:
What is wrong with this? When you pay $25,000 for a car, you are not measuring the value of the car. Rather, you are showing that you prefer the car to the money: the person who sells you the car has the reverse valuation. Without this difference in preferences, no exchange would take place. If, as Forbes and Ames imagine, money measures value, both you and the car seller would arrive at the same "measure" of the car's value. We would have no account at all of why an exchange takes place.
What Gordon apparently fails to appreciate is that the exchange takes place precisely because both sides value the transaction equally. Instead, the swapping of the car for money simply allows both parties to accomplish a different goal - they have changed the composition of their wealth portfolios to something they prefer. The new car owner has a car worth $25,000 and the seller now has $25,000 of new purchasing power. The $25,000 in money? Neither party wanted the cash per se, only the value it represented. As a medium of exchange with a unit of value, it merely facilitated the trade and is no longer part of the equation when the transaction is complete.
He compounds this error by claiming that money is a commodity:
With money, it is much easier to achieve the "double coincidence of wants" required for an exchange than without it. But they [Forbes and Ames] miss why this is so. The reason is that practically everyone is willing to accept money in an exchange; it is a commodity [my italics] that everyone wants. Instead, Forbes and Ames identify the need as "for a stable unit of value to facilitate trade."
Gordon is wrong. Paper money is not a commodity. What intrinsic value does the piece of paper have? You can't eat it, sit on it, or drive it like other commodities. It is simply a medium of exchange, a representation of value. No more, no less. That is basic economics.
Gordon goes on to show a further misunderstanding of the fundamental economic issues when he begins to assert that pegging the dollar price of gold is price-fixing and anti-free market. The problems with this assertion are two-fold. First, he confuses what is meant by "price". "Price-fixing" refers to pegging the value of one commodity in terms of another. In economic jargon it is fixing the "terms of trade" or barter price between goods. That's not what Forbes and Ames are talking about. They are targeting the price level.
Second, by failing to make that distinction, Gordon completely misses the underlying economic problem that is being addressed - determinacy of the price level. In a barter model there is no price level problem. There is no money, so there is no money price level. There are just the relative prices of goods, or terms of trade, and equilibrium can be determined independently of money. However, bring in money and the problems begin. There is now one more variable, but not an additional equation. There is no unique solution to the price level. It could be anything.
Traditionally economists get around this problem by assuming some rigidity in the system. Some variable in the money world is fixed, providing the extra equation that allows price determinacy. The Monetarists, for example, assume that the quantity of money is fixed. Forbes and Ames' proposal accomplishes that end by targeting or fixing the dollar price of the commodity gold. Without these, the equilibrium price level could be most anything. This fundamental problem exists whether we assume government issued money or money arising from free banking.
I remember back in 1981 Beryl Sprinkle (Under Treasury Secretary for Monetary Affairs and later Chairman of the Council of Economic Advisors in the Reagan Administration, and a Milton Friedman protégé) coming up to me at a dinner in DC and asserting that pegging the dollar's value was anti-free market. I turned around, looked him in the eye and said, "not any more than you Monetarists' prescription to control the quantity of money is anti-free market." He was speechless, and I noticed a few smiles from other economists in the room.
So to determine the price level, something has to not give. Forbes and Ames put this point another way:
Having fixed weights and measures is essential for fair and free markets. We don't let markets each day determine how many ounces there are in a pound or how many inches there are in a foot. ... Money, similarly, is a measure of value.
Imagine in Gordon's world of "free market" weights and measures. The true weight of a pound would vary from minute to minute in some futures market. Boy, would our lives be miserable. Instead we set up a Bureau of Weights and Measures that fixes a stable standard for a pound or inch. Forbes and Ames are just proposing the equivalent for money.
From Gordon's perspective that may be some odd kind of price fixing. To me it is like the rule of law - a basic standard that allows common understanding of the rules of the game and makes the economy more efficient.