Daniel (Attack of the Books!) Burton's Reviews > A Free-Market Monetary System and The Pretense of Knowledge

A Free-Market Monetary System and The Pretense of Knowledge by Friedrich Hayek
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Feb 08, 12

bookshelves: need-to-know, political, classic, economics
Read in January, 2012

I recently read the short brochure “A Free-Market Monetary System,” a compilation of Friedrich A. Hayak’s 1974 Nobel Prize speech “A Pretense of Knowledge” and a short essay on proposing a free-market monetary system (hence, the name, see?). Both are short, and neither waste any time proposing radical changes to what was then, and indeed what is still, the status quo in monetary and economic policy.
Both the essay and the speech are worth reading.

In “A Free Market Monetary System,” Hayek warns that as long as central banks are in control of the money supply, we can expect to see the economic highs and lows that we have come to expect, better known as “bubbles” and “recessions.” Both are part of the market corrections that result when markets try to correct for artificial highs created by monetary policy in the control of a central bank.
Hayek’s recommendation? Let private enterprises issue their own money for circulation.

I am more convinced than ever that if we ever again are going to have decent money, it will not come from government: it will be issued by private enterprise, because providing the public with good money which ic can trust and use can not only be an extremely profitable business; it imposes on the issuer a discipline to which the government has never been and cannot be subject.

Get it? Rather than “Dollars,” we would buy, and spend, money that might be called something else. Nike “Swooshes,” perhaps, or American Express “credits.” The point is that business does not have a monopoly on money the way that government–i.e. central banks–does and therefore has a greater incentive to protect the integrity of that money from inflation and against other currencies by good policies. If it doesn’t, people won’t use it and it’s value will drop. (Can you hear the invisible hand clapping?)

“It is a business which competing enterprise can maintain only if it gives the public as good a money as anybody else,” said Hayek. Meanwhile, central banks have no such limits or restraints. Just ask Ben Bernanke.

Could it work? Would the government ever give up its control of the money supply?

Ha! Good one. Have you ever known the government to willingly give up any power?

For an interesting look at how an economy where private enterprise issues its own money, check out the speculative novel “The Unincorporated Man” by Dani Kollin and Eytan Kollin.
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The second part of the brochure is the text of ”A Pretense of Knowledge.” Hayek’s speech upon receiving the Nobel Prize for economics in 1974 (he shared the prize with Gunnar Myrdal for their work in “the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena”) was a thunderhead of a critique of policies recommended by economists and implemented by governments that had, in his words, “made a mess of things.” He attributed the failure of economists to guide public policy more successfully to a “propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences[...]” That attempt, he said, “in our field may lead to outright error.” Economics is not an exact science, and the application of “habits of thought to fields different from those in which they have been formed” lead to a “‘scientistic’ attitude” that the unknowable is knowable.

Economies involve an “organized complexity” that is too deep for economic researchers to obtain. Speaking of wages and prices as an example, Hayek argues that “the determination of [prices and wages] will enter the effects of particular information possessed by every one of the participants in the market process–a sum of facts which in their totality cannot be known to the scientific observer, or to any other single brain.” What he is saying is that while my wife at the grocery store may know enough to decide whether one can of salsa is better priced than another–based on a list of criteria only she knows, including flavor, cost relative to other salsas, cost relative to other stores and whether it is worth driving to those other stores to get the salsa, as well as how much my daughters are fussing in the shopping cart to hurry, whether we need salsa at all, and so on–the observer, the economist or market researcher or whoever is watching, can never know all that goes into her mind.

Says Hayek:

"It is indeed the source of the superiority of the market order, and the reason why, when it is not suppressed by the powers of government, it regularly displaces other types of order, that in the resulting allocation of resources more of the knowledge of particular facts will be utilized which exists only dispersed among uncounted persons, than any one person can possess."

Only the market–the composite of my wife, and the hundreds of thousands (or millions) of shoppers out there can determine what the market value–the price–of the salsa should be.

This is why governments mess things up when they try to intervene. Whether it is propping up failing auto companies (go google “GM volt january 2012 sales” to find out that the company bailed out by Washington, D.C. sold a measly 603 Volts last month) or promoting and subsidizing “green” energy companies (for this only, google “Solyndra scandal” where even the New York Times admits that the government took risks that the market would not take. I wonder why the market wouldn’t risk it?), when government tries to pick winners better than the market, it inevitably fails or produces less success than the a free market.

This isn’t to say that economics is entirely unable to offer predictive power. Quite the contrary. It just can’t do so with the same ability as the “hard sciences,” such as physics, or chemistry.

Often all that we shall be able to predict will be some abstract characteristic of the pattern that will appear–relations between kinds of elements about which individually we know very little.[...] The danger of which i want to warn is precisely the belief that in order to have a claim to be accepted as scientific it is necessary to achieve more. This way lies charlatanism and worse. To act on the belief that that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which we do not possess, is likely to make us do much harm.

Neither the Members of Congress making laws, the President and his Executive Branch (proposing, executing, and, also, making laws), nor judges in their black robes know enough to out think the decisions of millions or billions of people that make up a market.

"But in the social field the erroneous belief that the exercise of some power would have beneficial consequences is likely to lead to a new power to coerce other men being conferred on some authority. Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims."

We may not always understand why the market chooses what it does, but in large part the market chooses, through spontaneity, that which helps man get what he wants.

In other words, Hayeks’ message to economists and policy makers is simple: get out of the way and let the market choose. It’s much smarter than you are.
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