Mix together milk and water. Soften gelatin in a ½ cup of the milk and water mixture.
Soften peanut butter over hot water or in the microwave, then blend with gelatin mixture.
Combine the rest of the water/milk mixture with sugar in a saucepan. Bring to a boil and boil rapidly for 5 minutes, stirring constantly.
Remove from heat and mix in peanut butter mixture until it is smooth.
Pour into greased loaf pan and let stand overnight (not in the fridge). Remove from pan onto the sugared surface and cut into squares with sharp knife moistened with water. Roll squares in sugar.