Why Did Milton Friedman Think a Modern Economy Needed Heavy-Handed Government Regulation in the Liquidity Services Industry and Nowhere Else?
In my rare coffees and phone calls with Milton Friedman, I found I could distract him whenever I was losing an argument by saying: "Why is it that the government needs to intervene and keep the flow of liquidity services provided to the economy growing along a smooth path? Why must there be a quantitative target achieved by government for the path of the liquidity services industry--commercial banking--when there must not be a quantitative target for kilowatt hours or freight-car loadings?"
He would chuckle and say it was a hard problem, but that he was confident that someday he or somebody else--maybe even me--would find a good, concise, convincing way of proving the point that a modern economy needed very heavy-handed government intervention in regulating the commercial banking industry but nowhere else. It was, he thought, something about the social waste of unnecessary bankruptcy, the catastrophic consequences of bank failures, debt deflation, and the fact that the price of liquidity services was intimately tied up with the units of account that we used to denominate our web of debt.
Milton Friedman, Unperson: [Milton] Friedman, it turns out, was too nuanced and realist a figure for the modern right, which doesn’t do nuance and rejects reality, which has a well-known liberal bias. One way to think about Friedman is that he was the man who tried to save free-market ideology from itself, by offering an answer to the obvious question: “If free markets are so great, how come we have depressions?” Until he came along, the answer of most conservative economists was basically that depressions served a necessary function and should simply be endured…. Such dismal answers drove many economists into the arms of John Maynard Keynes.
Friedman, however… was willing to… admit that government action was indeed necessary to prevent depressions. But the required government action, he insisted, was of a very narrow kind: all you needed was an appropriately active Federal Reserve… [that] pumped enough reserves into the banking system to prevent a sharp decline in the money supply.
This was, as I said, a move toward realism (although it looks wrong in the light of recent experience). But realism has no place in today’s Republican Party: both Mr. Paul and Mr. Ryan have furiously attacked Ben Bernanke for responding to the 2008 financial crisis by doing exactly what Friedman said the Fed should have done in the 1930s--advice he repeated to the Bank of Japan in 2000. “There is nothing more insidious that a country can do to its citizens,” Mr. Ryan lectured Mr. Bernanke, “than debase its currency.”
Oh, and while we’re on the subject of debasing currencies: one of Friedman’s most enduring pieces of straight economic analysis was his 1953 argument in favor of flexible exchange rates… countries finding themselves with excessively high wages and prices relative to their trading partners--like the nations of southern Europe today--would be better served by devaluing their currencies than by enduring years of high unemployment “until the deflation has run its sorry course.” Again, there’s no room for that kind of pragmatism in a party in which many members hanker for a return to the gold standard.
Now, I don’t want to put Friedman on a pedestal…. The past 15 years… shows that Keynes was right and Friedman was wrong about the ability of unaided monetary policy to fight depressions… we need a more activist government than Friedman was willing to countenance. The point, however, is that modern conservatism has moved so far to the right that it no longer has room for even small concessions to reality. Friedman tried to save free-market conservatism from itself--but the ideologues who now dominate the G.O.P. are beyond saving.