Friedman Economics

Is Fed chairman Ben Bernanke a follower of John Maynard Keynes or Milton Friedman?

Ben Bernanke just had a fine month. For allegedly saving the world from a second Great Depression, President Barack Obama awarded the Federal Reserve chairman a second four-year term. "As an expert on the causes of the Great Depression, I'm sure Ben never imagined that he would be part of a team responsible for preventing another," the president said. "But because of his background, his temperament, his courage and his creativity—that's exactly what he has helped to achieve."

"Mission Accomplished," the banner might have read.

Missing from Obama's speech was any mention of Bernanke's economic ideology. The New York Times and Bloomberg News have called him a strict Keynesian—a liberal fan of fiscal stimulus—and that label has stuck.

In reality, Bernanke is following the monetarist depression-prevention model hatched by Nobel laureate and libertarian patron saint Milton Friedman. Bernanke has repeatedly invoked the late libertarian economist in support of lowering interest rates to zero, bailing out banks, and pumping untold trillions of dollars into the financial system. The implicit goal of these policies is to ignite artificial inflation.

The story begins in 1963, when Friedman and co-author Anna Schwartz published The Monetary History of the United States. Their chapter on the Great Depression was spun off into a standalone book, The Great Contraction: 1929-1933, an epic revisionist history that changed America's understanding of the causes of the Depression. Friedman and Schwartz contended that the Federal Reserve—not capitalism or Wall Street—was to blame for the dismal '30s. "The fact of the matter is that it was the decision to tighten credit policy in 1928 that produced the Great Contraction," the 93-year-old Schwartz said by phone from her office at the National Bureau of Economic Research in New York City. Interest rate hikes had been undertaken in 1928 to curb what the Fed saw as rampant speculation on Wall Street—a conflagration of leveraging, margin buying, and outright Ponzi scheming fueled by cheap credit that was supplied in the first instance by the Federal Reserve. (Goldman Sachs' pyramid schemes of the era, when they collapsed, would generate losses of $475 billion in today's dollars.)

Friedman and Schwartz, however, denied that speculation had ever posed a problem, or that there had even been a credit bubble in the 1920s. In their narrative, a paranoiac Federal Reserve had needlessly constricted the money supply and thereby crashed an otherwise prosperous economy.

After the Great Crash of 1929, the Federal Reserve drastically cut interest rates; but, on occasion, the Fed was forced to abruptly raise them again in complicated maneuvers to stem outflows of gold into Europe. Friedman and Schwartz blamed these sporadic interest rate hikes for smothering several incipient recoveries, opening a vortex of deflation, and turning a recession into the Great Depression.

Friedman and Schwartz's overarching thesis was that the Depression would have never happened if the Federal Reserve had inflated the American economy. As Schwartz told me, "What the Fed had to do was increase the money supply. By taking that action, it would've revived the economy. That's the lesson of the Great Depression." In The Great Contraction, she and Friedman argued that the Fed had an infinite capacity to inflate. "The monetary authorities," they wrote, "could have prevented the decline in the stock of money—indeed, could have produced almost any desired increase in the money stock."

Which brings us back to the question of Ben Bernanke's economic ideology. When it comes to the Great Depression, Bernanke is a disciple of Friedman and Schwartz. In 2002, at Friedman's 90th birthday party at the University of Chicago, Bernanke was effusive. "Among economic scholars," he began, "Friedman has no peers." He developed the "leading and most persuasive" explanation of the Depression, whose impact on economics and the popular mind "cannot be overstated."

At the conclusion of his encomium, Bernanke made a stunning and ominous apology on behalf of the Federal Reserve. "I would like to say to Milton and Anna…regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

Schwartz was also present at the birthday party. "I'm sure he was sincere when he said that," she recalled. And Bernanke stayed true to his word. In 2006, he replaced Alan Greenspan as chairman of the Federal Reserve. Greenspan had engineered an era of non-inflationary loose credit that won Friedman's endorsement: "There is no other period of comparable length in which the Federal Reserve System has performed so well," Friedman declared in The Wall Street Journal.

When the economy collapsed two years into Bernanke's watch because of a massive credit bubble, Bernanke slashed interest rates to zero and ordered the money-printing presses to full steam. He also embarked on a course of "quantitative easing," whereby a central bank convolutedly buys its own government's bonds with printed money so as to sink interest rates even further.

This approach was nothing new. Friedman had recommended quantitative easing, combined with ultra-loose credit and inflation, as a panacea for Japan's slump in the 1990s, which he described as an "eerie, if less dramatic, replay of the Great Contraction." As he did with the Depression-era Fed, Friedman emphasized that, "There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so." In 1998, a year after Friedman penned his advice in The Wall Street Journal, Japan introduced monetary stimulus: a cocktail of zero interest rates and quantitative easing. But deflation continued. Today, Japan's exports are down an unthinkable 36 percent from last year and prices are plummeting at an all-time record pace.

Stateside, in light of the Fed's multi-trillion dollar balance sheet, it has been all too easy to mistake Bernanke for a Keynesian supporter of public works projects, socialistic safety nets, and government-led consumption. And while it's true that the Obama administration is pursuing Keynesian fiscal stimulus, the Federal Reserve, as an independent, semi-private institution owned by America's banks and largely walled off from the executive and legislative branches, has developed its own agenda. That agenda is monetarist. Yet the media consistently gets this crucial fact wrong.

The New York Times, for instance, has identified Bernanke as "a student if not necessarily a devotee of the British economist John Maynard Keynes." But Bernanke actually spent most of his academic career elaborating on Friedman's interpretation of the Great Depression. Though his research sometimes strayed into non-monetary subjects, it was always "an embellishment of the Friedman-Schwartz story… and no way contradict[ed] the basic logic of their analysis," as Bernanke assured Friedman at his birthday party.

Bernanke's infamous moniker, "Helicopter Ben," came about when he quoted Friedman on the importance of conjoining fiscal and monetary policies. In a 2002 speech, "Deflation: Making Sure 'It' Doesn't Happen Here," Bernanke described the ideal fiscal stimulus as a shower of tax cuts "equivalent to Milton Friedman's famous 'helicopter drop' of money." Friedman had originally used that phrase to counter Keynes' idea of the "liquidity trap," where zero-interest rates lead to bank hoarding and leave the Federal Reserve no maneuvering room. Friedman suggested that countries could escape the liquidity trap by handing out money to consumers, and he laid out his argument in a tale about a helicopter unloading cash on a town. To that effect, Bernanke's Federal Reserve has created special "vehicles" to disburse consumer credit.

In February of this year, Bloomberg News added to the confusion by reporting, "Federal Reserve Chairman Ben S. Bernanke is siding with John Maynard Keynes against Milton Friedman by flooding the financial system with money." Of course, Bernanke has said precisely the opposite. He's flooding the financial system with money as Friedman would have him do.

On February 10, Bernanke further revealed his allegiance to Friedman in an overlooked Capitol Hill Q&A session with Rep. Ron Paul (R-Texas). Their exchange is worth dusting off and quoting at length.

"Chairman," Paul began, "you have written a lot about the Depression. There was a famous quote you made once to Milton Friedman, apologizing for the Federal Reserve bringing on the Depression. But you assured him it wouldn't happen again….But the key to this discussion has to be: was it too much credit in the '20s that created the conditions that demanded a recession/depression; or was it lack of credit in the Depression that caused the prolongation?…Here we're working frantically to keep prices up. What's wrong with allowing the market to dictate this…and prices to go down quickly so we can all go back to work again?"

In response, Bernanke repeated the lesson of The Great Contraction and asserted that he was acting on it: "Milton Friedman's view was that the cause of the Great Depression was the failure of the Federal Reserve to avoid excessively tight monetary policy in the early '30s. That was Friedman and Schwartz's famous book. With that lesson in mind," Bernanke continued, "the Federal Reserve has reacted very aggressively to cut interest rates in this current crisis. Moreover, we've tried to avoid the collapse of the banking system."

For her part, Schwartz is now conflicted about Bernanke's application of her and Friedman's theories. "You don't have to lower the interest rates to the extent that he has in order to increase the money supply," she informed me. "The essential action should be increasing the money supply. That's the lesson of the Great Depression."

She upholds the analogy between today's crisis and what she and Friedman prescribed in The Great Contraction. "There's nothing contradictory in The Great Contraction with reference to what the Fed should be doing currently…. And I don't believe there's any contradiction between what The Great Contraction was reporting and the current condition of the banking system in this country."

Schwartz sounded alarmed, though, at the zealousness with which Bernanke has put "monetary expansion" into practice. She berated the Fed for going too far and predicted that it will have to raise interest rates "in the near future" to arrest inflation. Asked if she sees hyperinflation on the horizon, she exclaimed, "Oh, yes!"

But Schwartz also seems to have undergone a late-life conversion to Keynesian theory. Asked to offer a solution to the crisis, she repeated the ultimate Keynesian maxim: the government should pick up slackening demand in the private sector.

"People are saving, not spending. In order to revive this economy…" she paused, hesitating on the thought, "the government will have to resume spending. By spending, the government will require that the current inventory will be depleted and have to be replenished. And that will bring on additional production and jobs."

Paul, a libertarian like Schwartz and Friedman, worries that the Federal Reserve is bringing the pair's monetarist model into reality. In a phone interview, he noted, "In essence, Bernanke is following Friedman's advice. He's a Friedmanite when it comes to massively inflating. Bernanke was able to justify [his policies] by using Friedman."

Asked if Friedman's enthusiasm for inflation flouts libertarianism, Paul answered: "Absolutely. The monetarists said that you could overcome a natural market correction of a collapsing system by inflation—print money faster! Which contradicts Friedman's whole thesis. He wanted a steady, managed increase in the supply of money of about 3 percent." Here Paul is alluding to Money Mischief, Friedman's 1991 book in which he called on the Federal Reserve to grow the money supply at 3 percent annually, presumably forever. "Yet, at the same time, Friedman said the Depression could've been prevented by massively inflating."

Paul has kind words for Friedman, whom he praises as a staunch defender of economic liberty, but his final summation is damning: "Friedman's very, very libertarian—except on monetary issues."

With Bernanke at the helm, the Federal Reserve has unleashed monetary expansion, the polite term for inflation—and Friedman's catchall remedy for economic depression. And if Bernanke, Obama, and scores of economists are correct, it may be working. But with 300,000 more people having foreclosed on their homes in July, widespread hunger in Detroit, dust bowl conditions in the California valleys, a stock market crash in China, and unemployment projected to crack double digits later this year, the much-vaunted recovery is no certainty. And if it isn't working, we might still be in for a depression, or worse.

On top of that, the total price of the Fed's monetarist program is a mystery beyond human reckoning. Paul, whose bill to audit the Fed has stalled despite co-sponsorship from more than half of the House, declared, "We don't know for sure how much the Fed has spent—I've heard it could be six trillion dollars. But we have no knowledge of what the Fed's doing. All these dealings are very secret." Earlier this year a Bloomberg estimate pegged the number at around $13 trillion—an amount roughly 1,300 times the age of the universe. (We may soon find out the exact number. On August 25, a Manhattan court ordered the Federal Reserve to open its books.)

Friedman and Schwartz, in other words, have helped to spawn the grandest expansion in the Federal Reserve's history, a program of limitless market interventions and tireless money printing whose unstated aim is all-out inflation. For two libertarian champions of free markets and limited government, this legacy has the ring of a world-historic irony.

Penn Bullock is a freelance writer for Village Voice Media. He lives in Florida.

Correction: This article originally misidentified the concepts of qualitative and quantitative easing.

Comments

[kilroy]

Bernanke may say he believes Friedman's ideas, he does not.

[Joe M]

Bwahahahaha! If I'd been eating or drinking when I read that, I'd be dead right now.

[Your Good Buddy Johnny Clarke]

I sort of lost interest in him when he said, and I quote:

"Economic forecasting makes weather forecasting look like physics."

And then he kept right on making predictions. If I'd just admitted my predictive powers were utter crap, I'd have the decency to shut up.

[mark]

He also embarked on a course of "qualitative easing,"
Yes! Qualitatively, he made it much easier to be a corrupt asshole banker.

In Friedman's Free to Choose series, he describes the untimely deaths of Benjamin Strong, Jr. in 1928 and JMK in 1946 as consequentially devastating to capitalism and laissez-faire principles. To that list I would have to add Friedman himself; I doubt he would have approved of any "stimulus" or a bailout of AIG, for instance.

[silvermine]

Maybe Bernake thought Friedman really meant he should go out and drop money out of a helicopter.

If Bernake thinks he's doing anything Friedman would like, he's more insane than I thought. I don't remember Old Milt saying, "Yes, I think we should just keep shoveling power at the Fed and let them do whatever they want". I must have missed that article.

[Draco]

Ron Paul is wrong. Milton Friedman (as always) is right.

The problem is that instead of dropping the money from helicopters (i.e. withholding tax holiday for x months) as a libertarian or Republican might have done, the Democrats are in charge politically, and are doing it through the favored Democrat means: massive, targeted government spending, funneled toward and through their favorite interest groups. That turns it into theft (via redistribution) on a massive scale. Instead of distributing the created money in a fair and equitable way (even dropping it from helicopters over cities would be fairer), they hog it to themselves and their cronies. So, with respect to the money that needed to be created and injected in the economy, the Democrats today are like the rampaging Visigoths of old, pillaging and looting. The only difference is the Dems are carrying it out using only the threat of force, instead of actively wielding the swords and axes -- which they would be too cowardly (to a man) to do.

Pussy thieves. Lowest of the low.

[David]

I've never heard of qualitative easing. That must be some term that Austrian economists invented...sort of like their definition of inflation. Quantitative easing is a different story, though. I don't believe Friedman would have supported the way that Bernanke handled the current crisis. Friedman did worry about deflation, but not about bank failure. Bernanke worries about both, and that difference is, in practice, quite large.

[David]

It was also Friedman who suggested we replace all of the Fed's discretionary power with an equation based on the quantity theory of money. He was hardly a Fed power monger.

[Sean W. Malone]

My interest in economics was largely sparked by Friedman (as I'm sure it did for many others), but the great depression analysis never set well with me. I accepted it at first, thinking "ok, so the Federal reserve contracted the money supply just at the wrong time and suddenly everyone was hurting.", and this is true - but the question of what the Fed was doing in the mid 20s seemed more important.

As I point out here, the Fed added $10 Billion to the money supply between 1923 and 1929. Considering M2 in 1920 was around $34 Billion total, adding 1/3rd again as much money to the economy seems more relevant than the slight contraction during the first few years of the depression. New Deal window-breaking policy also seems more relevant.

Ultimately, it was Friedman's explanation of the depression that pushed me over into the Austrian camp.

[Sean W. Malone]

The Austrian definition of inflation wasn't made up by them, David - it is the definition pre-Keynesian economists used to use all the time.

[IceTrey]

Of course the Fed caused the Depression that was their intent. That's why we need to get rid of it.

[Astronomer]

"Earlier this year a Bloomberg estimate pegged the number at around $13 trillion-an amount roughly 1,300 times the age of the universe."

Universe is 13.7 billions years old. ~950 times. Not that comparing quantities of money to years makes sense like that. Unless you say "That's $950 dollars spent per year of the Universe's existence". Which makes it sound like chump change.

[Sean W. Malone]

Ha... reminds me of what Richard Feynman once said:

"There are 10^11 stars in the galaxy. That used to be a huge number. But it's only a hundred billion. It's less than the national deficit! We used to call them astronomical numbers. Now we should call them economical numbers."

[Bulbie]

Ron Paul wants to get rid of the Federal Reserve and return to the gold standard. Doing that is no cure for economic slumps. Think of the nasty depressions in 1873 and 1893 and the financial panic of 1907. Those events led to high unemployment and violent conflict between labor and management.

Capitalism is the only economic system that has even created prosperity on a mass scale. But getting all the bugs out of it is a work in progress.

[Space Fiend]

Bulbie - Around those bitter contractions in the 19th century, the American economy grew faster than any other in recorded history. China would be jealous.

Since 1913, with a few exceptions due to tax cuts, the economy has grown excruciatingly slowly, compared to in the past.

[Sean W. Malone]

"Think of the nasty depressions in 1873 and 1893 and the financial panic of 1907."

Nasty in that they lasted all of what, a year? We've had 10 recessions in the last 50 years after the Great Depression... I think sometimes people miss the forest for the trees talking about recessions in the 1800s - and they inevitably forget that the gold standard/lack of a central bank wasn't perfect in preventing government from using inflation to pay their bills. Did a damn fine better job than the Fed though.

[Graphite]

The inaccurate portrayal of the 1800s as a period of constant recurring depressions and panics is a key plank in the case for a debt-based, paper money. The Fed depends on bad historiography for its existence as much as it does upon craven politicians with a desire to inflate.

[qwerty]

Bulbie is right. China's growth in the past 30 years was far greater than that of the US in the 19th century. Rates of US growth after the depression are also less volatile now than they were then.

Guys, we are not going back to the gold standard. Ever. Nor should we.

[Tim]

""Mission Accomplished," the banner might have read." Nothing warms my heart more than President Obama to Bush comparisons; as I feel that the President's entire economic policy could also be called the "economic patriot act."

Also, I am not the first to say this but Libertarians should be careful what they wish for when they want a more accountable Fed. It won't be in the hands of Ron Paul for sure, and it might just end up in the hands of Nanci Pelosi. The last thing we want is the money supply even more in the hands of short sighted and economically illiterate politicians who have to get popularly elected every 2-6 years; for the simple reason that inflation gives goodies now at a cost later, and it benefits debtors the largest of whom is the U.S. Government.

[Graphite]

Bulbie is right. China's growth in the past 30 years was far greater than that of the US in the 19th century.

Even assuming we can trust the Chinese government's statistics (and we can't), their economy had the advantage of starting from a base which had been thoroughly pillaged and destroyed by decades of Maoist communism.

Would you point me to some statistics comparing the highest-growth 3 decade stretch in 19th century America with China of the past 30 years?

Rates of US growth after the depression are also less volatile now than they were then.

Who cares about volatility if the overall growth rates were higher? And let's not forget that the absolute worst depression in the country's history (so far) happened under the Fed's thoughtful stewardship, despite a little thing called the Civil War which happened before it was created.

If you want to see what suppressing volatility gets you, Japan of the past couple of decades is a great place to look. Entire generations have lost their chances to build and participate in their economy.

[Graphite]

The last thing we want is the money supply even more in the hands of short sighted and economically illiterate politicians who have to get popularly elected every 2-6 years

What I want is a money supply controlled and managed by a variety of competing private issuers, like GoldMoney.

[Tim]

Who cares about rates of growth? China was devastated by communist policies, of course they are going to grow fast while starting from practically nothing with even the smallest economically liberal reforms.

[faithkills]

Ron Paul is wrong. Milton Friedman (as always) is right.

If that's true, and this ends well, it will be a first.

Austrians have been right the whole time and the economy has done exactly what Austrians predict.

If you honestly think this will be an upset for the Austrian shut out, I enthusiastically suggest you short commodities;)

[Tim]

Also you can get a high growth rate by increasing inflation for a short time; everyone will say it is a wonderful policy, then when it comes crashing down they blame the crash on something completely unrelated.

So I would say that volatility is a concern, but not in the sense that only looks at volatility on the downside; and that sees recessions as a problem and not a cure for mal investment, however policy makers should rightly be concerned with policies that lead to the mal investment that creates the volatility in the first place. Such as a poorly managed money supply.

[Graphite]

If you honestly think this will be an upset for the Austrian shut out, I enthusiastically suggest you short commodities;)

The Austrians who have most accurately called the crisis are ones like Mish and Frank Shostak who foresee deflation in the short term as debts are written off.

The ones calling for imminent hyperinflation unfortunately share Milton Friedman's mistaken belief that the Fed can and will restart inflation (to the detriment of its member banks) by ceaselessly printing money in the face of a disorderly debt contraction.

[faithkills]

Think of the nasty depressions in 1873 and 1893 and the financial panic of 1907.

Your understanding is very poor. The 'Long Depression' after 1873 was hardly nasty. Productivity increased and prices dropped. This process is a mystery to Monetarists apparently;) It turns out decreasing prices are just dandy for workers.. whose production wage adjustments must lag price adjustments. In general this period saw a vast increase in American productivity. Granted the monied interests in Europe didn't so much like it. The result of this period was an industrial economy that (for better or worse) put us in a position to influence to influence in WW1.

Fiat inflation is good for bankers (first to lend new money before it's devalued), governments (last to repay old money after it's devalued), and employers (wage lag).

Hence we have permanent inflation.

[tlauf]

$13 trillion is 1,300 times the age of the universe! OMG! How far would it reach if you put the bills end to end? Isn't that what's really important? ;(

[faithkills]

The Austrians who have most accurately called the crisis are ones like Mish and Frank Shostak who foresee deflation in the short term as debts are written off.

Mish is right in the short term.

The ones calling for imminent hyperinflation unfortunately share Milton Friedman's mistaken belief that the Fed can and will restart inflation (to the detriment of its member banks) by ceaselessly printing money in the face of a disorderly debt contraction.

They are right in the long term.

The fed will have to. They won't have a choice. This is why Ben is sending fiscal hawk warnings.. he knows he will be pressured, and maybe forced, to monetize the debt. RP has noble motives, but nothing will come of his audit bill.. until the dems are ready to force Ben's hand. Then they will threaten the Fed with an 'audit' or worse.

But you're wrong about printing money being a detriment to banks, at least not the Fed banks who get to lend, the newly printed money, and who will play the game accordingly. It's the non Fed banks who will take the hit.

[Draco]

If you want to understand why we need the Fed and a fiat currency, and why a gold standard would be a bad idea, you could do worse than read the simple six-part series on Steve Conover's blog, starting here:

http://www.optimist123.com/optimist/2006/06/money_the_econo.html

This is a quick read, and has great diagrams which will help the beginner better understand something about monetary theory.

The Austrians are right about many things (as Conover concedes in a more recent post), but not about everything, and not about commodity currencies.

[Sean W. Malone]

Draco - I haven't managed to read the whole thing yet - but at the very beginning, Steve is making a case for a Federal Reserve/Fiat currency that has never existed... that is to say, the mythical 1:1 growth of money and productive output. Are we talking about the real world where the Fed is entirely inflationary all the time, or the fake one of Mr. Connor's theoretical imaginings?

[Draco]

Sean - you need to understand that a fiat currency system and a free economy (together) are not possible without running deficits. Deficit spending is the way we create money in a fiat currency system. This is the one thing that good conservatives/libertarians need to get over, to help them think clearly about these issues. A balanced budget or a surplus, over any but the very short term, would be a disaster for economic growth.

Furthermore, there is a difference between increasing the money supply, and inflation. I'm thinking you may have the two confused. Read the whole series, should only take you a few minutes.

[Bill Cohens]

Draco,

I didn't read whole series, but read last chapter which explains that 7 brief periods of debt paying resulted in recessions. I see same arguments from a few Ph.D. professors and would like to address it.

USA had more than 23 recession (if I correctly recall) after it's inception. If 7 where immediately just after (or in-line with) brief debt paying periods than rest 16 has to be after immediate deficit spending years. That means deficit spending has more chances of bringing economic contractions.

Look to the most recent contraction, deficit spending was historically high when recession hit us in 2007. According to theories proposed by deficit spending squads, shouldn't now be a period of high growth?

Besides that, I never heard of any deficit spending advocate explaining how hyperinflation happened in other countries. Austrian school have clear explanation of it. In my own words...

1. First they borrowed and started spending recklessly the money people saved, on the things we don't need, you know, to promote growth.
2. Then they looted people by rising tax, when people ran out of saving, in order to continue spending.
3. Then, after they ran out of all resource, they started creating money recklessly in order to continue spending on name of growth.
4. Kaboom, hyperinflation is there!!! No problem, blame it on free market.

[Graphite]

Sean - you need to understand that a fiat currency system and a free economy (together) are not possible without running deficits. Deficit spending is the way we create money in a fiat currency system. This is the one thing that good conservatives/libertarians need to get over, to help them think clearly about these issues. A balanced budget or a surplus, over any but the very short term, would be a disaster for economic growth.

Gotta keep running up those Margaritaville blenders on the plastic, guys, come on!

It's for the economy ..... aaaaaaaaand IT'S GONE!

[Sean W. Malone]

Let me restate that actually:

In a commodity money system, the money is deflationary - that is to say, if the money supply doesn't change and production increases, over time less currency buys you more stuff. The price of goods change virtually every day, but wages change only once or twice a year - so wages naturally lag behind any change in money value.

In a deflationary setting, you may see decreases in your salary over time (though from a psychological standpoint, I find that very hard to believe), but those downshifts will always be outstripped by lowering prices. Thus your money keeps getting valued higher & higher and you keep making the same wage. Your income chases lower and lower prices down and your standard of living goes up consistently.

In an inflationary system (as the entire history of the 20th Century should indicate), the opposite is true. Wage rates still lag behind the change in monetary value - but they're chasing higher and higher prices. This is bad for obvious reasons.

What Connor seems to be suggesting is that a fiat currency could be used to keep an equilibrium and have the value of money never change.

That's just an insult to Hayek.

Fundamentally, our real-world choices are clearly 1. stable currency and gradual deflation, or 2. manipulated currency, bubbles and inflation.

[Sean W. Malone]

Fiat currency and a free economy, I think, are mutually exclusive.

[Graphite]

One thing the horrible gold standard economy of the nineteenth century managed never to do was leverage itself into a 375% total-debt-to-GDP ratio. I would love for Draco or some of the other Fed apologists here to explain why such a high debt load is a sign of economic health and dynamism.

[A T]

Sean, not that I don't agree with you and Austrians that natural deflation is good, but if wages lag behind prices, companies that hire labor will suffer because their revenue is shrinking faster then the payroll. Adapting wages would have to be done more flexible then 2 times a year, but it can be made to work.
Draco, I've started reading your link, and my first question is: what does Conover mean by insufficient liquidity? Any amount of money is sufficient if it can be physically subdivided.

[Sean W. Malone]

AT - this is a gradual process, and as the negative effects on price of inflation are tempered by increases in efficiency and production, so too are the effects of deflation tempered by increases in efficiency. If the history of the 1800s is any guide, then deflation would occur at about 2-3% a year. Increases in production would mean that your revenue should probably not be going down at all, much less at a rate any faster than 2-3% per year, and naturally, as a business owner all your other costs are going down too.

[A T]

Also, Draco, about Friedman as opposite to what the Democrats seem to be doing: at the end of the day what Friedman is calling for is a monetary artifice, i.e. inflating the money supply. The Democrats do it in a politically oriented way, but it's still inflating, so it should still work, according to Friedman.

Austrians on the other hand are saying that no artifice can correct the problem, that actual market forces have to find their equilibrium, by liquidating the insolvent. The problem with what the gov. is doing then, is not that it is inserting money in the economy through corrupt channels, but by so doing, it does not allow for liquidation, deflation, and thus a reestablishment of equilibrium.
At least that's what I make of it.

[A T]

Sean, I see your point. Bottom line, I think deflation could work without adverse effects, if everybody is aware of it and they know for sure nobody is printing more money.

[Sean W. Malone]

I wish I could access gmail... I wrote out whole thing for a guy the other day on this topic, after my monetary value chart appeared at mises.org (linked above somewhere).

In hypothetical terms, the main point right now is that with the inflationary system that we have today, prices grow at a much faster rate than both wages & production, so while increases in production mitigate some of the really horrendous effects, over the long term, we're fighting a losing battle and are watching our ultimate standards of living decline - or more accurately, we're currently watching the rate of increase in our standard of living decline.

Frankly, I think we're coming to a point very soon where the rate in growth of our standard of living will hit 0, and then go negative... if that isn't already the case. The collapse right now certainly hurts, since now prices are still up and will start heading up even further while wages are declining. Big big problem.

[Sean W. Malone]

*in non-hypothetical terms...

[Draco]

A T,

Briefly, yes, from a monetary perspective it still "works" when the Democrats do it their way -- or it would work if they were competent enough to avoid botching even a giveaway! The basic mechanism is for the government to spend money, to replace what the private sector can no longer provide due to severe contraction in money and credit available, so that we all don't wind up living in shacks, eating beans and rice.

What I was saying was that it would have been far, far better to have just declared a Social Security or Income Tax Withholding holiday to "give" the equivalent amount of money away. But that's anathema to Democrats and "Progressives" because it would give the people a taste of freedom from government.

[Draco]

Graphite,

This is not like personal spending and credit. It's a completely different ballgame when you are talking about sovereign nations and fiat currencies. It's apples and oranges. Reasoning by analogy in such cases just doesn't work.

I want to be both free, and wealthy. Attacking the Fed and the fiat money system isn't the way to achieve freedom and wealth. The main problem isn't the Fed, it's the politicians who have commandeered larger and larger slices of the GDP, and our freedoms. Fighting against the Fed is a useless distraction IMHO.

[Sean W. Malone]

"What I was saying was that it would have been far, far better to have just declared a Social Security or Income Tax Withholding holiday to "give" the equivalent amount of money away."

Assuming I agreed with the need for stimulus, then yes - that would actually make sense. If you want the average person to be less effected by the collapse, and to keep up "aggregate demand" (shudder...) then giving them a lot more of their own money, rather than taking all of their money and handing it to major investment banks would be the right choice.

However, that would mean that Obama wouldn't be giving massive kickbacks to top campaign contributors like Goldman Sachs, or his union buddies.

[Sean W. Malone]

"The main problem isn't the Fed, it's the politicians who have commandeered larger and larger slices of the GDP, and our freedoms."

Draco, do you really not understand that it's precisely because of fiat currency and a central bank that politicians can do what they've done!?

Just take the Iraq war. The war has been paid for (as have all other wars in the US in the 20th Century) by borrowing and inflation. If they had to tax people to pay for things like the Department of Homeland Security, the politicians would be out on their asses instantly. If they had to tax to fund wars, Iraq would already be over. Inflationary monetary policy is the way politicians can tax people without them knowing it... It's just the modern equivalent of coin-debauching.

[faithkills]

@ Draco

A balanced budget or a surplus, over any but the very short term, would be a disaster for economic growth.

The evidence is just the contrary.

What was the result of Clinton/Ginrich's (mostly) balanced budget? A prolonged period or prosperity which Bush was able to loot.

Currency isn't production. If it were we could simply add a zero to all currency and the economy would take off. Prosperity isn't a bunch of digits on a piece of paper. Prosperity is the actual things you can use the paper to acquire.

Fiat money is simply wealth redistribution to the rich.

However Draco, you are about to have a very up close experience of the policy you promote. unfortunately I have to experience it with you.

@ AC

but if wages lag behind prices, companies that hire labor will suffer because their revenue is shrinking faster then the payroll. Adapting wages would have to be done more flexible then 2 times a year, but it can be made to work.

It certainly is an issue for employers but as you say, it can, and always has been, made to work. The relationship between employer and employed is one which seems quite adaptable;)

Natural inflation and deflation will always require one party to go back to the table. But there will rarely be the excesses either way that are allowed by fiat money that make this process so painful to some parties.

Fiat money puts the burden perpetually on the worker.. which benefits big business, banks and government.

Monetarists would have you believe that you can have perpetual booms. They take credit for the roaring 20's but hide from blame for the great depression.

We're seeing exactly the same thing now.

You can borrow from the future to have 'more' now but history is pretty clear the bill always comes due.

It's a nice fantasy, but it doesn't work. Hell if it was a century ago and we didn't have abundant counter evidence I might be tempted to buy it too.

Simply.. printed money will be used to buy something. Whoever sells the something is at a disadvantage because they are accepting currency with an impending devaluation, so they in turn must spend it as fast as possible, etc etc. All this just means more money chasing the same commodities.. more inflation. But the ones punished most are the ones who actually produce things because they are always the last ones to get the most devalued money in exchange for real goods.

It's a game of hot potato and manufacturing always gets the potato (the devalued dollar) in the end in exchange for real goods. This is a systemic disadvantage for manufacturing. As well inventory is devalued over time.. which encourages people to defer buying excess inventory because the currency they hold will always be worth less. So inventory is a really bad thing and this makes manufacturing more fragile than need be. When things go bad they really go bad because the entire market is against you. They are always behooved to wait you out.

These are just some reasons the US manufacturing base has withered. That's a problem. We don't produce. We borrow and consume.

[faithkills]

This is not like personal spending and credit. It's a completely different ballgame when you are talking about sovereign nations and fiat currencies. It's apples and oranges. Reasoning by analogy in such cases just doesn't work.

It's not analogy it's reality. The debt must be serviced somehow and this is a drain on the economy. It comes from somewhere.

Monetarist and Keynesian policy has the track record you would expect from economic quackery. You can see every detail but you ignore it, instead you pull the camera back, put gauze over the lens, and superimpose a CGI fantasy. It's why the public has no faith in 'economists', because they hear every day about how economists were 'surprised' by 'unexpected' events.

Your theory only works if you accept that we will eventually count on the existence of our nukes to safeguard us when we renounce our debt.

[LeeJoe Cruz]

It's nice to read so many great comments on both sides of this issue. I was first into friedman and that led me to the Austrian Views. My understanding is that you can't print wealth, you can't create wealth from fiduciary media. Fiat currency is a claim to wealth. When you apply the economic law of marginal utility to any currency, it's less valuable. So creating more claims to wealth that exists makes everyone poorer. How that can be good?

[Sean W. Malone]

LeeJoe - did you see the chart?

[LeeJoe Cruz]

Hey Sean,

No I'm sorry I haven't checked my e-mail in the last couple of days, I'll check it tonight! Thanks buddy, that's awesome if you were in Colo Springs I'd buy a beer.

[qwerty]

Would you point me to some statistics comparing the highest-growth 3 decade stretch in 19th century America with China of the past 30 years?

Here you go:

http://www.economicadventure.org/teachers/primer.pdf

The US growth in 19th century was not even as great as the US 20th century growth, and not even close to Chinese growth.

their economy had the advantage of starting from a base which had been thoroughly pillaged and destroyed by decades of Maoist communism.

No arguments here, but Space Fiend was simply wrong in his post.

[Sean W. Malone]

PS: LeeJoe; if I sent you the graph as an attachment, it might be the "wrong" one. I changed it slightly to remove one confusing element - and the right one is now at Mises.org, found here.

Sadly, the wrong one was put up on Digg - and although it made it to the front page and last I checked had over 1600 "diggs", it's annoying that it has something more confusing than necessary on it. Makes me look bad.

[Graphite]

This is not like personal spending and credit. It's a completely different ballgame when you are talking about sovereign nations and fiat currencies. It's apples and oranges. Reasoning by analogy in such cases just doesn't work.

That 375% debt-to-GDP ratio includes both the public and private debt. And the idea that the public sector can achieve miracles which the private sector can't, just because it has a printing press to inflate away its debts, is an immensely destructive Keynesian lie.

[Sean W. Malone]

"The US growth in 19th century was not even as great as the US 20th century growth, and not even close to Chinese growth."

2 things:

1. China lies... A lot. So, let's not be too sure about Chinese growth, and I say that as a proud supporter of China's move towards market liberalism.
2. Comparing pre-industrial revolution growth to post industrial revolution growth seems a little silly. Once the assembly-line became standard practice and we could start getting raw materials from anywhere in the world, and with communications technology improving - NO KIDDING there was more growth in the 20th C. We also didn't experience a civil war destroying all of our local stuff and setting us back...

That said, all this has done is mitigate a lot of the pain we would have otherwise experienced with the dollar losing 96% of its value over the last 100 years.

[Sean W. Malone]

"In the long run we're all dead... muaaaah hahahahahahah!!"

-Evil Zombie Keynes

[Graphite]

Welcome to the long run.

http://www.angryflower.com/buyeve.html

[TheZeitgeist]

Even if Friedman was right about the Federal Reserve's austerity driving the depression, in the current context two glaring things stick out:

One: The very theory of what "money" consists of has utterly changed. Whether you are a Goldilocks (I'm not) or a Xerox man (I'm not that either), money in the 30's was based on a limited "thing" (gold) and today's money is not. I don't know what that entails relative to the current mess - I'm no economist - but that's a rather glaring difference that no one seems to notice or acknowledge.

Two: The strength of the USA's balance sheet vis-a-vis the rest of the world then vs. now is stark. In the 30's, darkest depths of the recession-Steinbeck-type shit, the United States was the world's biggest creditor, biggest manufacturer, trade-surplus gorilla. Now? Even before the current disaster, we were leveraged up to our ass with foreigner's money. Unlike in the 30's, the United States does not control its own destiny in the same way because it's bartered that away for a loan over the past thirty years.

Those two vivid differences between the USA of yore vs. the USA of now make the whole Great Depression analogy with today's disaster writ all somewhat suspect me thinks. I wager we are in uncharted waters and looking astern at history while the iceberg we've never encountered before looms before us in the dark.

Blub-blub-blub.

[Draco]

The US dollar being convertible to gold would have been far worse for our economic prospects than a fiat currency not backed by any commodity has been. People who know what they are doing have been in charge of this, fortunately, not random blog posters, as much as I like all of you guys (we are on the same team fellows, I am a libertarian too), nor the Congress (which would have been a disaster).

@TheZeitgeist

The value of the US dollar is backed only by its acceptability by the US Govt to discharge federal income tax obligations. That's it. Amazing, isn't it, that the US economy -- no, the world economy -- hinges on that reality, which is little understood by the layman? If you've got dollars (this goes for the Chinese as well as Americans), you've got something you can pay income taxes with. And yet that's enough to be the world's reserve currency. Go to anyone in the world and offer them a stack of $100 bills and see if they turn their noses up.

Don't get me wrong: the dollar can be destroyed, as any other fiat currency can be, by hyperinflation. But we are nowhere near that -- yet. Bernanke did what he had to do to prevent aggregate demand collapse. He'll clean up after himself in due course. Because he knows what he is doing. Be very, very glad that Obama didn't replace him with an idiot leftist ideologue.

[David Small]

Wow, glad to see a real monetary discussion at Reason. Draco, you make a good point that we are all on the same (libertarian) team, which is why I think the discussion has been so civil.

Personally, I fall in the hard money camp (Austrian economics). One thing to note, hard money does not mean perpetual deflation. In the first 100+ years of this country, the dollar only deflated a grand total of 11%. Why is that? Because commodities like gold become more scarce as productivity increases. As it becomes more scarce, it sends the proper market signal to mine more gold.

The Fed was suppose to provide us greater monetary stability, but since its inception has devalued our currency by 95%. As for myself, I'll take the 11% deflation in the first 100 years as a better marker of monetary stability. All this incessant inflation has brought us, is forcing average workers to take more risk with their savings to keep up. Of course, the sharks like this.

[Sean W. Malone]

"People who know what they are doing have been in charge of this"

Are you trying to piss people off??

Seriously Draco, I think you're insane. The people who are "in charge" are idiot Keynesians who got nothing right leading up to the crisis, they have no understanding of how they created it, they have no idea what they're doing now and the Federal Reserve has the worst track-record imaginable keeping the value of money stable, and they've done exactly what Andrew Jackson warned about back in the 1830s:

1. It concentrates the country's finances in only one institution
2. It enables foreign banking interests to control the US government
3. The central bank itself weilds too much control over members of Congress
4. It favored northeastern states over the southern & western states (of which Jackson was a citizen) - more to the point, the central bank favored investment to industrial interests at the expense of agriculture
5. It served mainly to make the rich richer

Draco, your history is simply wrong, as is your faith in fiat money.

[David Small]

Sean, good points. I find it odd that someone would favor free markets to set the price of goods for everything else except for money. Money is a desired good like any other commodity. If it's scarce (low savings), then its price (interest rate) should be high. Conversely, if there is a glut of savings, interest rates should be low.

The price of money should not be dependent on some high priest dictates every quarter. It should move as frequently and as much as the market indicates.

[LeeJoe Cruz]

"Paper money always returns to it's intrinsic value, which is zero." Voltaire

[faithkills]

we are on the same team fellows, I am a libertarian too

Glad to hear it. You may then be able to be redeemed from blind faith in quack economics.

Economics isn't really that complex. What is complex is when you try to justify a myth that flies in the face of evidence and logic and when you try to explain away the failures of policies justified by the myth.

I'm not suggesting you do this intentionally, I'm suggesting you're a victim of a deception.

Hayek, Rothbard, Mises, Hazlitt are good starts on clearing away the BS.

[TheZeitgeist]

I can't say I am a hard-money (in the sense of gold, or silver) person. When I first started learning about money I was drawn to the idea. But over time my views have moderated considerably. Obsessing over a lump of yellow metal is about as inane as rubbing your greedy hands watching the Xerox. Besides, "cheating" with clipped coins and the like is the original monetary manipulation via the state anyways, it doesn't fix it.

My problem with the current money system is that its a rigged game. Think what you may about the Federal Reserve, my problem with it is its the only game in town. I can't go start a bank based on "hard" currency or giant stone wheels or whatever, without going to jail.

Its not the current theory of money that I have a problem with, its the state-sanctioned monopoly of control over money thats the problem. This would be true in a hard currency situation as well; its about control, not theoretical underpinnings.

[Draco]

@Sean

I'm trying to keep my tone moderate (well, okay, except for my first post where I took at shot at Congress, calling them pussies and thieves -- which they are). I think you may be getting a little riled up, however. There's no need for that.

I don't think it would be accurate to describe Alan Greenspan and Ben Bernanke as "idiot Keynesians."

The monetary system doesn't lend itself as well to armchair bloviation as other topics near and dear to libertarian hearts do. It's relatively hard to understand, even for intelligent and educated people. Keep that in mind.

For example, most people don't realize that deficits (of a controlled size) are necessary under a fiat currency system with a central bank, as we have in the USA. That every dollar increase in deficit is a dollar sent from the public sector to the private sector, whereas every dollar in surplus is a dollar sent from the private sector to the public sector. Federal government (not state govt, they don't print their own currencies!) surpluses are a disaster if ongoing, because they must lead to socialism (government ownership of more and more assets). You need to run a deficit to expand the money supply and provide needed liquidity in a growing economy. Ben Bernanke understands this, and acts accordingly. The average man at a Tea Party doesn't begin to grasp this.

And it's easy for a mob of such men to accidentally (and with good intentions) tear down something that is serving them rather well, but which they don't understand.

In any case, we're not about to go over to a commodity money system any time soon. Probably never (unless some very, very disruptive stuff happens).

Again, read http://www.optimist123.com (for example) to learn more about this perspective.

Disclaimer: I studied monetary theory (and finance) at Wharton under Jeremy Siegel. (Does that make me the enemy?)

[LeeJoe Cruz]

That's the joke right? That every dollar is created in debt and that debt has to be serviced somewhere. Essentially you give the power to the people who issue that debt and you have to continually increase the debt because you don't create the interest for that debt when you create the debt in question???

[mark]

Draco, I think paying down the national debt has got to be the most efficient use of tax money, if you're going to use it at all. All that debt crowds out investment.

[TheZeitgeist]

"Federal government (not state govt, they don't print their own currencies!) surpluses are a disaster if ongoing, because they must lead to socialism (government ownership of more and more assets). You need to run a deficit to expand the money supply and provide needed liquidity in a growing economy. Ben Bernanke understands this, and acts accordingly."

So, a financially sound government instead of one permanently digging a hole for the entire nation via a rigged bank cartel is necessary for freedom's sake? An easy fix for an outstanding surplus to avoid the Government Buys Your Grandma problem you allude to above is:

Pay its goddamned bills that it keeps "off-budget" (like its own pension fund) and the other trick is to hand it back out to the taxpayer ("stimulus," without the Xerox).

[David Small]

@Draco

I'm curious has a sovereign nation ever gone bankrupt running an indefinite deficit? And when we have to raise interest rates and our debt service dramatically jumps, that will be a good thing?

[Tim]

Did I read somewhere yesterday that the only way to create money is through deficit spending? What about fractional reserve banking, which can create money with either fiatt or commodity backed money?

We don't need the fed to monetize the debt so Barney Frank can go around giving out subprime loans in order to keep the market liquid.

Competing private banks could vary the money supply by varying the reserve ratio while still maintaining convertibility to gold. However if by Gold standard we mean 100% reserve requirements with convertibility to gold that indeed is retarded.

[TheZeitgeist]

"I'm curious has a sovereign nation ever gone bankrupt running an indefinite deficit? And when we have to raise interest rates and our debt service dramatically jumps, that will be a good thing?"

I can't recollect a nation ever "declaring" bankruptcy. However permanent deficit spending eventually broke the back of the British Empire, starting in the 30's...that's a good example. The fix for them? Punch out of the gold standard to enable the printing of the monies. Britain didn't go broke (conquered by Nazis in this case) save for the grace of Lend/Lease in WWII, but they ceased being the world's reserve currency and didn't get a semblance of credibility back until we joined them in their fiat techniques in 1972.

Another thing about deficit spending, it only becomes a permanent fixture in a nation's history when the money can be created/inflated in-step (or out of step) with the deficit spending. In that context, they all go bankrupt because I can't find a single purely fiat currency in world history that held out for at least a century before an epic financial collapse relegated said currency to having no social credibility (the ultimate value of any money). This pattern begins in the Song Dynasty, who invented non-convertible paper money.

[faithkills]

Federal government (not state govt, they don't print their own currencies!) surpluses are a disaster if ongoing, because they must lead to socialism (government ownership of more and more assets).

There should be a 12 step program for Disney economics.

You can wish it all you want but you will never, in all of history, find a socialist state that got there because of surpluses.

In fact it's just the opposite.

FFS connect a few dots.

For example, most people don't realize that deficits (of a controlled size) are necessary under a fiat currency system with a central bank, as we have in the USA. That every dollar increase in deficit is a dollar sent from the public sector to the private sector, whereas every dollar in surplus is a dollar sent from the private sector to the public sector.

Holy crap, they did quite a number on you.

That's a beautiful fantasy until you wake up and understand inflation is a tax, and a most un 'progressive' one and the debt must be serviced.

Sure spending may go to the private sector but it didn't come from nowhere. That's the glaring flaw. The resources come from the private sector to support the spending.

Even Friedman understood that. It might help you to watch that.

You need to run a deficit to expand the money supply and provide needed liquidity in a growing economy

That liquidity has a cost that is always paid. That's the problem. We're paying it now while we continue to do the same thing that caused the problem.

The average man at a Tea Party doesn't begin to grasp this.

Friedman and the average man at a tea party have a better grasp than you currently do.

In sum, for all the reasons that a free market is patently superior to a managed market, the same applies to the currency market, except much much more so.

The history of managed currency markets is pretty clear on this point, and it has often lead to failed states and failed empires.

[David Small]

From Tim:

However if by Gold standard we mean 100% reserve requirements with convertibility to gold that indeed is retarded.

A gold standard does not necessarily negate fractional reserve banking. And even without fractional reserve banking, a bank could still negotiate to lend out time deposits (not demand deposits). That said, how is the fictitious creation of money (not wealth) out of thin air the sensible thing to do?

[EllisWyatt]

" Federal government (not state govt, they don't print their own currencies!) surpluses are a disaster if ongoing, because they must lead to socialism (government ownership of more and more assets)."

I'd really like an explanation of this one. It makes no sense to me.

[Tony]

Hayek, Rothbard, Mises, Hazlitt are good starts on clearing away the BS.

You have everything but reality and evidence on your side, faithkills. When has there ever been a laissez-faire system that has been sustainable? When, EVER? When has one ever really existed for that matter? Reality suggests that the more laissez-faire an economy gets the more prone to income inequality and crashes it gets... but then of course you'll retort that it was never laissez-faire enough. Apparently there's a magical moment at where things stop getting worse and get better, but there's just the tiny problem of no one ever having witnessed such a thing.

[Graphite]

Disclaimer: I studied monetary theory (and finance) at Wharton under Jeremy Siegel. (Does that make me the enemy?)

Yikes. Still holding onto your "stocks for the long run" then?

Draco, what would you say to ending the Federal Reserve's legal monopoly on the issue of money? Surely, if it is such a useful and well-designed tool of the modern economy, it should be able to compete on its own merits. Can our wondrous, elastic fiat currency -- carefully administered by modern-day Nicholas Biddles -- survive without this prop?

[Graphite]

Apparently there's a magical moment at where things stop getting worse and get better ...

Yes, in many ways the Industrial Revolution and the rapid development of the nineteenth century were miraculous, almost magical.

[David Small]

Tony, what we do have evidence of is more government intervention destroys more aggregate wealth. What's the average monthly salary of a worker in Cuba? Nine dollars a month. Well at least they are all equally dirt poor. At least you socialist have something to strive for.

[JR]

"He also embarked on a course of "qualitative easing," whereby a central bank convolutedly buys its own government's bonds with printed money so as to sink interest rates even further (not to be confused with quantitative easing, in which a central bank tries to stimulate the economy by maintaining interest rates at or near zero). "

Isn't anybody bothered by the fact the author doesn't know what he is talking about?

Quantitative easing is what he thinks qualititative easing is (expansion of balance sheet, i.e. buying assets ), while qualitative easing is a change in the composition of the assets on the balance sheet (more illiquid and risky).

[John Papola]

First off,

George Selgin has done an excellent job refuting the mainstream view about the 19th century panics that lead to the creation of the Fed. Selgin argues, I believe effectively, that a combination of state restrictions on national branch banking combined with civil war era regulations requiring national bank notes to be backed by US treasuries.

http://www.csmonitor.com/2009/0803/p09s01-coop.html

So it was not capitalism or free banking that caused the banking panics. It was government.

As for this idea of "money as debt"? I'm unconvinced of that description or the notion that paying off the national debt can somehow be a disaster for our economy. I'd like to hear money about that, because it's not intuitive.

[Graphite]

You have everything but reality and evidence on your side, faithkills. When has there ever been a laissez-faire system that has been sustainable? When, EVER?

Laissez-faire systems are unsustainable only because they eventually succeed in creating so much wealth and comfort that it leads to demands for expanded entitlements, as a result of burgeoning confidence in the given society's ability to afford more and more of such measures. But this is a problem with the human failure to learn from history, not with laissez-faire itself.

"The debate over 'universal health care' is the perfect place for the optimistic psychology of a Grand Supercycle degree peak to have its last stand, as stocks reach back toward Dow 10,000 one last time ... such reforms [are] obvious manifestations of an extreme attitude about entitlements to comfort and support that may not have existed in history except perhaps in the late Roman Empire." -Robert Prechter

[faithkills]

Reality suggests that the more laissez-faire an economy gets the more prone to income inequality and crashes it gets

Really Tony? Reality suggests that? Then that reality should be reflected by some history or evidence.

To what example pray tell can you point that will support this assertion?

but then of course you'll retort that it was never laissez-faire enough

No, that's your game, I wouldn't dare intrude.

I'll hold my breath waiting for your examples of 'laissez-faire' economies that have been 'more prone to income inequality and crashes' than managed economies.

This will be rich.

[Draco]

Ok, very quickly: a surplus to the Govt means exactly that: a surplus. It means they collected more in tax revenue than they needed to cover their expenditures. That means they removed net wealth from the private sector. And similarly for a deficit, but the opposite: every dollar added to the deficit is a dollar of wealth left in the private sector.

As I said, very simple, and apodictically true, but the average guy just doesn't get it. Because he "knows" that surpluses are good (because he loves to have surpluses, personally). But he's wrong.

This doesn't mean I'm in favor of massive, ever increasing deficits. I never said that. And I've said I'm not in favor of the Feds having control over any more of the GDP than they need to (and I want it to be a hell of a lot smaller than it is right now).

Sorry, all I have time for right now. Google Warren Mosler and Soft Currency Economics, or Interview with the Chairman if you want a quick education.

Later!

[Tony]

Laissez-faire systems are unsustainable only because they eventually succeed in creating so much wealth and comfort that it leads to demands for expanded entitlements

Er... do what now? I'm pretty sure social welfare programs were not the result of bored politicians wanting to experiment, but rather massive social inequality that could not be justified by magic market theories about individual ingenuity leading to wealth. The U.S. economy grew to become the most powerful on earth only after it was radically transformed into one that provide a social safety net to ensure a robust middle class (people who had money to spend). I would argue that the economy was trucking along pretty well, give or take, until the full force of Reaganomics finally was felt in the last months of the Bush administration when deregulatory zeal led to fairly predictable recklessness in the market and a massive recession--which of course has been partially mitigated, once again, by massive government spending.

[EllisWyatt]

"Ok, very quickly: a surplus to the Govt means exactly that: a surplus. It means they collected more in tax revenue than they needed to cover their expenditures. That means they removed net wealth from the private sector. And similarly for a deficit, but the opposite: every dollar added to the deficit is a dollar of wealth left in the private sector."

There's an easy way to handle this. Simply amend the Constitution to require that a surplus be used to pay down the national debt (if any), otherwise, the surplus is to be returned to the taxpayer.

[faithkills]

Laissez-faire systems are unsustainable only because they eventually succeed in creating so much wealth and comfort that it leads to demands for expanded entitlements, as a result of burgeoning confidence in the given society's ability to afford more and more of such measures.

That's a factor but only part of the equation. Generally government is first expanded by monied interests to facilitate their ends. Certainly this was true in the US. The 'people' are generally propagandized to believe it is in their interests, but of course it's not true, and never will be. Certainly this is been clear last and current administrations. I honestly didn't think anyone could be worse than Bush. Lol, boy did I underestimate.

Look at the Fed as the perfect example. A plan for a government enforced private monopoly sold to the public as a plan to 'save' them from economic tumult. Of course it immediately created an unprecedented disaster.

But you are right. It is the lack of vigilance of the people that is the problem. The Constitution was supposed to be a safeguard but it's been turned into a tool for the statists.

The result is always crony capitalism. The parties are just arguing over whose cronies.

Sadly the economically illiterate rubes, like Tony, think they will be cut in on the deal, so they clamor for more government power, which is of course promptly bought by the monied interests.

[EllisWyatt]

"I would argue that the economy was trucking along pretty well, give or take, until the full force of Reaganomics finally was felt in the last months of the Bush administration when deregulatory zeal led to fairly predictable recklessness in the market and a massive recession--which of course has been partially mitigated, once again, by massive government spending."

Ah yes, the continuing myth that Bush was deregulating. Bush is the President who signed Sarbanes-Oxley into law, the most onerous piece of legislation ever forced on the stock market. Why do you think so many of us libertarians didn't like Bush? Because he was a "Big Government Conservative"!

I feel like I'm talking to a wall when I deal with people like you. Government intervention is what caused the bubble that caused all this damage to the economy. The massive government spending you love so much has already led to a 9.4% unemployment yet, and it hasn't even fully hit us yet! I really fear for the future of this country.

[Tony]

Ellis,

Without the stimulus spending, most economists think, the economy would still be in freefall and 9.4% unemployment would sound pretty good. I don't see how you can blame the unemployment rate on the stimulus; in fact the idea is completely bonkers.

[Graphite]

a massive recession--which of course has been partially mitigated, once again, by massive government spending

Yeah, borrowing 13% of GDP to stand still is just a brilliant strategy.

In 2007 "most economists" thought global economic growth was permanent and unstoppable. They're idiots.

[faithkills]

And similarly for a deficit, but the opposite: every dollar added to the deficit is a dollar of wealth left in the private sector.

Dead wrong. Because that wealth is taken from the private sector. If it's via taxes the chilling effect is immediate and obvious. But even when there's a delay in the paying of that cost (as in debt servicing or debt monetization) the private sector knows they will bear the burden so it, reasonably, husbands resources.

This is exactly what we are seeing now.

Read Mountford and Uhlig's analysis of the data of various fiscal strategies that have been tried.

[faithkills]

Without the stimulus spending, most economists think, the economy would still be in freefall and 9.4% unemployment would sound pretty good.

The same ones who said that unemployment would not go over 8% with the spending? The same ones who recommended ratcheting down interests rates in response to the subprime bubble? (cough PK)

Disney economists have been wrong at every juncture. PK most of all, he's just a joke.

This is why people think economists have no clue. Because they think Disney economics is real economics.

The only predictions that have been on target have been from Austrians.. who predicted this recession years before Roubini said a word.. who predicted that unemployment would continue to rise as a result of the 'stimulus'.

And it's going to go higher.

[faithkills]

which of course has been partially mitigated, once again, by massive government spending.

It also bears pointing out that the dotcom bubble wasn't responded to with 'stimulus' and it was quite brief. Another example was the crash of 1920, which was responded to with prudence and was also quite brief.

Then on the 'stimulus' side you have the great depression, Japan's lost decade, et al.

Keynes is batting zero.

Find a chart correlating spending to unemployment... just so you can bust a neuron trying to explain away the correlation.

[ar]

never mind that roubini uses austrian methodology and krugman would be an austrian if the mises institute could outbid the new york times

[Tim]

@David Small,

FEE makes a good case for fractional reserve banking with "Fractional Reserve Banking is more libertarian than the gold standard". http://fee.org/audio/160/

[David Small]

Tim, I would concur that the freedom to choose to engage in fractional reserve banking is in align with free markets, as long as there are no implicit or explicit government guarantees, which we've had since our country's inception.

Second, fractional reserve banking and hard money are not mutually exclusive.

[faithkills]

There's nothing wring with fractional reserve banking or paper currency. The problem is a government enforced monopoly on them. Similarly there's nothing magical about gold, nor should it be mandated as a currency by government. It's merely a pretty durable and portable store of value.

It's not a problem if banks print specie, the burden is on the bank customer to judge the stability of the bank and the likelihood the bank will be able to redeem the specie. That's one of the reasons why interest existed in the first place.. the cost of risk.

Now it's a largely a result of fiat inflation.

In the US there have been various periods prior to the fed and between the national banks where there was a nearly free banking market. Unfortunately when banks had difficulty (sometimes self inflicted sometimes otherwise) they always bought favor from government to protect their interests.

Just like today:(

Not that most collectivists ever have the sense to make it, but a legitimate critique of libertarian economics would be this:

Even accepting that the greatest good for the greatest number is accomplished by free markets.. is it actually possible to accomplish free markets in the face of the wealth they create and the resultant increased opportunity to corrupt government?

I don't know if it's possible. But my answer is: even if it's not, it's clear that more free markets result in greater prosperity and happiness for all than less free markets. Thus even if it is an asymptote, and the goal is never to be completely reached, the further we can get to the goal of liberty the better we all are.

Certainly the more free we are.

[DownSouth]

Absolutely superb!

For those who enjoyed this essay, the following about Friedman by Paul Krugman might also be of interest:

http://www.nybooks.com/articles/19857

Bullock's concluding sentence--"For two libertarian champions of free markets and limited government, this legacy has the ring of a world-historic irony."--says volumes about the entire discipline of economics. Such ironies become inevitable when a discipline becomes so theoretical that it completely divorces itself from any this-world reality.

Fortunately for the people of the United States, the theorists have always been kept in check by men of action or of experience. As Reinhold Niebuhr put it: "Any modern community which establishes a tolerable justice is the beneficiary of the ironic triumph of the wisdom of common sense over the foolishness of its wise men."

Hannah Arendt provides a more elaborate explanation of America's extraordinary stroke of good luck deriving from its colonial experience. The American revolutionaries

"knew of the enormous power potential that arises when men 'mutually pledge to each other their lives, their Fortunes and the sacred Honour.' "

"This was the experience that guided the men of the Revolution; it had taught not only them but the people who had delegated and 'so betrusted' them, how to establish and found public bodies, and as such it was without parallel in any other part of the world. The same, however, is by no means true of their reason, or rather reasoning, of which Dickinson rightly feared that it might mislead them. Their reason, indeed, both in style and content was formed by the Age of Enlightenment as it had spread to both sides of the Atlantic; they argued in the same terms as their French or English colleagues, and even their disagreements were by and large still discussed within the framework of commonly shared references and concepts... This lack of conceptual clarity and precision with respect to existing realities and experiences has been the curse of Western history ever since, in the aftermath of the Periclean Age, the men of action and the men of thought parted company and thinking began to emancipate itself altogether from reality, and especially from political factuality and experience."

Theory-based dogmas like libertarianism thus ALWAYS deteriorate into these situations where there is layer upon layer of irony and hypocrisy. Niebuhr provides another example of libertarian hypocrisy:

"Thus, for instance, a laissez faire economic theory is maintained in an industrial era through the ignorant belief that the general welfare is best served by placing the least possible political restraints upon economic activity..."

"When economic power desires to be left alone it uses the philosophy of laissez faire to discourage political restraint upon economic freedom. When it wants to make use of the police power of the state to subdue rebellions and discontent in the ranks of its helots, it justifies the use of political coercion and the resulting suppression of liberties by insisting that peace is more precious than freedom and that its only desire is social peace."

[DownSouth]

And Greg Grandin provides yet another example of libertarian hypocrisy, where its mandarins (Friedman and Friedrich von Hayek, perhaps the best known of the Friedmanettes) throw their support behind a murderous military dictatorship and demand a country be brought to its knees on the altar of fiscal austerity, while back at home preach freedom and democracy and argue money should be showered down from helicopters:

http://www.counterpunch.org/grandin11172006.html

[DownSouth]

So to conclude, all these Keynesians, Friedmanites, libertarians, Austrians, classicists, neo-Keynesians and neoclassicists ought to get together for one big onanistic blowout.

For when we talk about Keynes and Friedman we're talking Tweedle Dee and Tweedle Dum. Both were consummate polemicists that had one objective, and that was to exculpate the princes of Wall Street for their sins.

Compare these two statements, this one from the Bullock piece:

"Friedman and Schwartz, however, denied that speculation had ever posed a problem, or that there had even been a credit bubble in the 1920s. In their narrative, a paranoiac Federal Reserve had needlessly constricted the money supply and thereby crashed an otherwise prosperous economy."

(To give some idea of just how off base Friedman and Schwartz were, these two chapters from Frederick Lewis Allen's "Only Yesterday" give a superb account of the go-go years leading up to the Great Depression: http://xroads.virginia.edu/~HYPER/ALLEN/ch7.html http://xroads.virginia.edu/~HYPER/ALLEN/ch12.html )

And this one from a synopsis of Keynes' 1936 book "The General Theory of Employment, Interest and Money" where Keynes discusses the causes of the Great Depression:

"A peculiar state of affairs, indeed: a tragedy without a villain. No one can blame society for saving, when saving is so apparently a private virtue. It is equally impossible to chastise businessmen for not investing when no one would be so happy to comply as they--if they saw a reasonable chance for success. The difficulty is no longer a moral one--a question of justice, exploitation, or even human foolishness. It is a technical difficulty, almost a mechanical fault"
--Robert Heilbroner, "The Worldly Philosophers"

(Ha! Ha! I'll bet Marx and Veblen were rolling over in their graves!)

Then place the two above statements within this framework provided by Reinhold Niebuhr in "Moral Man and Immoral Society":

"The physical sciences gained their freedom when they overcame the traditionalism based on ignorance, but the traditionalism which the social sciences face is based upon the economic interest of the dominant social classes who are trying to maintain their special privileges in society. Nor can the difference between the very character of social and physical sciences be overlooked. Complete rational objectivity in a social situation is impossible. The very social scientists who are so anxious to offer our generation counsels of salvation and are disappointed that an ignorant and slothful people are so slow to accept their wisdom, betray middle-class prejudices in almost everything they write. Since reason is always, to some degree, the servant of interest in a social situation, social injustice cannot be resolved by moral and rational suasion alone, as the educator and social scientist believes. Conflict is inevitable, and in this conflict power must be challenged by power. That fact is not recognized by most of the educators, and only very grudgingly admitted by most of the social scientists."

According to Hannah Arendt, the concept that power must be met with power comes down to us, vis-?-vis the Founding Fathers, from Montesquieu:

"For Montesquieu's discovery actually concerned the nature of power, and this discovery stands in so flagrant a contradiction to all conventional notions on this matter that it has almost been forgotten, despite the fact that the foundation of the republic in America was largely inspired by it. The discovery, contained in one sentence, spells out the forgotten principle underlying the whole structure of separated powers: that only 'power arrests power'? Power, contrary to what we are inclined to think, cannot be checked, at least not reliably, by laws?and in a conflict between law and power it is seldom the law which will emerge as victor."

[Gorillaz]

"He also embarked on a course of "qualitative easing," whereby a central bank convolutedly buys its own government's bonds with printed money so as to sink interest rates even further (not to be confused with quantitative easing, in which a central bank tries to stimulate the economy by maintaining interest rates at or near zero)."

This article fails hard at defining qualitative easing correctly. A good example of what real qualitative easing is would be the fed undertaking toxic mortgage securities in its balance sheet. It doesn't have to do it with printed money either.

[faithkills]

For when we talk about Keynes and Friedman we're talking Tweedle Dee and Tweedle Dum. Both were consummate polemicists that had one objective, and that was to exculpate the princes of Wall Street for their sins.

That's true. However when you throw Austrians in there it's not true at all.

Friedman and Friedrich von Hayek, perhaps the best known of the Friedmanettes

Again it's entirely specious to lump these two together. I will assume this is from ignorance. But Hayek and Friedman disagreed strongly on the very point you are imputing marks them as similar.. monetary policy.

Thus, for instance, a laissez faire economic theory is maintained in an industrial era through the ignorant belief that the general welfare is best served by placing the least possible political restraints upon economic activity

Whereas managed market theory is maintained on the, more than ignorant, entirely absurd belief, rebutted by the entire history of managed markets, that the restrictions placed on markets are ever used to the betterment of anyone but the rich who have access to government.

Conflating Hayek and Friedman is basically missing the entire point of Hayek.

Hayek isn't describing a utopia, nor is he saying a free market perfectly allocates resources.

That's what Disney economists of all stripes do.

What Hayek said was that a free market was the optimum and most fair and efficient method achievable. He didn't say that humans were perfectly rational, quite the contrary, but the the most rational possible result was that which incorporated all possible actors through the price mechanism.

Managed markets maximize irrationality and cause self reinforcing irrationality feedbacks, like artificially low interest rates, subsidies, tax breaks, etc.

Free markets minimize irrationality because all feedbacks are the most representative of individual choice. Thus 'unintended' managed market policy consequences are not possible, because there are no policies to cause them.

People buy houses because interest rates are lower than they should be and they get a tax break, therefore real estate does not artificially rise, causing rent to go up, causing the proliferation of derivatives based on all the cheap real estate money, which is just a market response to try to move the cheap money into other markets.. and so it did move.. but money flooded into one sector.. giving that sector undue influence over government policy.. which was of course used to perpetuate the bubble.

All of these crises are trivial to understand and predict.. if you're mind is not pervaded with Disney economics.

Could similar things happen in a free market? Sure, but the more free the market the less frequent it does, since they are naturally baffled.

[Tim]

I don't think this guy clearly understands Milton Friedman. The fed follows no path that recommended by MF, or we probably wouldn't have had the downturn. Since we did irresponsibly lead our system to near collapse, if the money was released in the form of tax cuts, we would have much better recovery now. The money is being held to spend in the most democrat-favorable methods.

Fortunately, when writing about MF, 1/2 the people say so what, please change the channel, and the other 1/2, you cannot fool.

[faithkills]

True Tim, MF wasn't in favor of the sort of activist monetary control we've seen from the Fed, however was in favor of some control.

But if it's wrong to conflate MF and Keynsians on a quantitative distinction it's absurdly wrong to conflate Austrians like Hayek with either, who generally believed in natural money.

As an aside there have been several attempts to have commodity based 'credit' cards, which Hayek discussed. Well debit cards, rather. Just gold so far but we can hope for others. The first one got shut down, but I think there's another. Clearly this is a huge threat to central banks and they will stop it if they can, but it may be hard to stop them. The possibilities are very very hopeful.

[economist]

Ben Bernanke is a firm devotee of the "Give it in the ass and make them thank you for it" school of economics.

[you can call me Roy]

How they are both wrong.
I know that Time magazine is full of progressive's but I had no idea that it's editors were so stupid when it comes to economics? The Federal Reserve is a private corporation that
lends money to our government with an interest rate! Thank God (that's OK, I know the people at Time don't believe in God) that Ron Paul's HR-1207 (a bill to audit the FED) has passed the house. Because the FED (Federal Reserve Bank) is neither federal, nor do they harbor any reserves. It is a private corporation that "lends" money to our government at an interest rate. Which is where all your income tax money goes...to service the INTEREST on the national debt. Nowhere else. Not for roads or bridges or anything that would benefit We The People. GET IT? Oh. you don't? Read some more. The value of the dollar has declined by over 90 percent since the creation of the Federal Reserve in 1913. Did the Fed really cause this loss of savings, insurance policies, retirement funds, and purchasing power? The answer, emphatically, is that with the cooperation of government, the Fed has indeed destroyed the dollar's value. In January 1993, National Geographic
magazine published an article entitled "The Power of Money." Written by Associated Editor Peter T. White, it presented a very clear explanation of how the Fed operates. White asked a
Fed official where the organization had obtained $100 million it had just used to purchase some securities. "We created it," said the Fed employee.
"It's money that didn't exist before." He matter-of-factly admitted that no limit existed on the Fed's ability to create money out of nothing.

In 2006, China and Hong Kong accounted for more than 50 percent of the increase in the amount of Treasury debt sold to the public.
In 2008, their share had fallen to 22 percent as the U.S. government increased its public debt by a record $1.2 trillion.
In the first half of THIS year, China and Hong Kong acquired only 9 percent of the more than $800 billion worth of Treasury bonds that were sold.
And in June, China became a net SELLER of U.S. Treasury notes and bonds!

Hope everybody's got their beef jerky and ammo stored up!
Oh, great job Ben.

[battery]

thanks good,very good post,thanks,it is very useful for me

[abercrombie milano]

My only point is that if you take the Bible straight, as I'm sure many of Reasons readers do, you will see a lot of the Old Testament stuff as absolutely insane

[abercrombie milano]

My only point is that if you take the Bible straight, as I'm sure many of Reasons readers do, you will see a lot of the Old Testament stuff as absolutely insane

[Cameron]

Friedman would never advocate bailing out a failing business.

[nike shox]

is good

[???? ??????]

thank u

[New Balacefashionworld]

In reality, Bernanke is following the monetarist depression-prevention model hatched by Nobel laureate and libertarian patron saint Milton Friedman.

[ahmed kamel]

Eh bien, je suis un bon poste watcher vous pouvez dire et je ne donne pas une seule raison de critiquer ou de donner une bonne critique ? un poste. Je lis des blogs de 5 derni?res ann?es et ce blog est vraiment bon cet ?crivain a les capacit?s pour faire avancer les choses i aimerais voir nouveau poste par vous Merci

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