home | what's new | other sites | contact | about

Word Gems 

exploring self-realization, sacred personhood, and full humanity

Milton Friedman

Free To Choose

 Anatomy Of A Crisis

return to previous page

Friedman: Delancy Street in New York's lower east side, hardly one of the city's best known sites, yet what happened in this street nearly 50 years ago continues to effect all of us today. Wall Street. Most of us know what happened here 50 years ago. Inside the Stock Exchange on October 29, 1929, the market collapsed. It came to be known as Black Thursday. The Wall Street crash was followed by the worst depression in American history. That depression has been blamed on the failure of capitalism. It was no such thing but the myth lives on. What really happened was very different.

Although things looked healthy on the surface, business had begun to turn down in mid 1929. The crash intensified the recession. So did continuing bank failures in the south and Midwest. But the recession only became a crisis when these failures spread to New York and in particular to this building, then the headquarters of the Bank of United States. The failure of this bank had far reaching effects and need never have happened.

It was something of a historical accident that this particular bank played the role it did. Why did it fail? It was a perfectly good bank. Banks that were in far worse financial shape had come under difficulties before it did and had, through the cooperation of other banks, been saved. The reason why it wasn't saved has to do with its rather special character. First its name, Bank of United States, a name that made immigrants believe it was an official governmental bank although in fact it was an ordinary commercial bank. Second its ownership, Jewish, both its name and the character of its ownership which had so much to do with attracting the large number of depositors from the many Jewish businessmen in the city of New York. Both of them also had the effect of alienating other bankers who did not like the special advantage of the name and did not like the character of the ownership. As a result, other banks were all too ready to spread rumors, to help promote an atmosphere in which runs got started on the bank and which it came into difficulty. And they were less then usually willing to cooperate in the efforts that were made to save it.

Only a few blocks away is the Federal Reserve Bank of New York. It was here that the Bank of United States could have been saved. Indeed, the Federal Reserve System had been set up 17 years earlier precisely to prevent the worst consequences of bank failures.

The Federal Reserve Bank of New York, whose directors today meet in this room, devised a plan in cooperation with the superintendent of banking of the State of New York to save the Bank of United States. Their plan called for merging the Bank of United States with several other banks and also providing a guarantee fund to be subscribed to by still other bankers to assure the depositors that the assets of the Bank of United States were safe and sound. The Reserve Bank called meeting after meeting to try to put the plan into effect. It was on again, off again. But finally, after an all night meeting on December 10, 1930, the other bankers, including in particular John Pierpont Morgan, refused to subscribe to the guarantee fund and the plan was off. The next day the Bank of United States closed its doors, never again to open for business. For its depositors who saw their savings tied up and their businesses destroyed, the closing was tragic. Yet when the bank was finally liquidated, in the worst years of the depression, it paid back 92.5 cents on the dollar. Had the other banks cooperated to save it, no one would have lost a penny.

For the other New York banks, they thought closing the Bank of United States would have purely local effects. They were wrong. Partly because it had so many depositors, partly because so many of the depositors were small businessmen, partly because it was the largest bank that had ever been permitted to fail in the United States up to this time, the effects were far reaching. Depositors all over the country were frightened about the safety of their funds and rushed to withdraw them. There were runs. There were failures of banks by the droves. And all the time the Federal Reserve System stood idly by when it had the power and the duty and the responsibility to provide the cash that would have enabled the banks to meet the insistent demands of their depositors without closing their doors.

The way runs on banks can spread and can be stopped is a consequence of the way our bank system works. You may think that when you take some cash to a bank and deposit it, the bank takes that money and sticks it in a vault somewhere to wait until you need it again to turn it back over to you.

Bank teller: Okay, how would you like this? Two tens, one five and five ones. Okay.

Friedman: The bank does no such thing with it. It immediately takes a large part of what you put in and lends it out to somebody else. How do you suppose it earns interest, to pay its expenses, or pay you something for the use of your money? The result is that if all depositors in all the banks tried all at once to convert their deposits into cash, there wouldn't be anything like enough cash in the banks of the country to meet their demands. In order to prevent such an outcome, in order to cut short a run, it is necessary to have some way either to stop people from asking for it, or to have some additional source from which cash can be obtained. That was intended to be the purpose of the Federal Reserve System. It was to provide the additional cash to meet the demands of the depositors when a run arose.

A classic example of how this system could and did work properly can be found over 2,000 miles from New York near the great Salt Lake in Utah.

In the early 30's some banks in Salt Lake City and surrounding towns began to get into difficulties. The owners of one them were smart enough to see what had to be done to keep their banks open and courageous enough to do it. When fearful depositors began to clamor to withdraw all their money, one of George Eccles jobs was to brief his cashiers on how to handle the run.

George Eccles: Well, then we called all our employees together. And we told them to be at the bank at their place at 8:00 a.m. and just act as if nothing was happening, just have a smile on their face, if they could, and me too. And we have four savings windows and we said, never leave the window. Lunch hour, anything else, we must have every window open all day. But, the important things was we knew you would have a big line so there was no use trying to hurry, because the line was going to continue. So we said, now, when you get a withdraw slip and the passbook, go back and check the signature. Even though you know your friend John Jones, just to delay time, just to mark time and then when you pay the money out, we are not going to pay in $100 bills. We are going to pay in $5, $10 and $20. And count it twice and hand it out with a smile.

Friedman: The banks survived the morning. But they didn't have enough cash left so in the afternoon they called for more from the Federal Reserve Bank.

George Eccles: So the Federal Reserve sent up the armored car, two big sacks full of currency were brought in by the guard crowded through the crowd and the assistant manager, Morgan Kraft, came in also. So Mariner and my brother grabbed Mr. Kraft and he says, now, get up on this marble counter and tell these people that you brought up a lot of money and there is more where that came from! And he did. And then Mariner got up and said now you've heard that story, were not going to close. We're going to stay open as long as any of you people want your money. So don't worry about it at all. Well, of course, you had one other bank in the city and we called him and told him he couldn't close either. He said well I can't I haven't got any money to stay open. So we made him a temporary loan. Because if we had another bank close while this run was going on the psychology of the public would be such that they'd, we'd never break the run in our bank. Everybody would come until they got all of their money out. (END)

The bank survived the first day's run. It was time to change psychology. The second day was to be very different.

George Eccles: So that evening we called our employees all together because we knew that the next day that people had been working during the day and would have heard about this and the next morning we'd have them with us. So we figured now we can't let a crowd build up in the lobby. So we told our tellers, I say now, you pay out this money just as fast as you can. So when anybody comes in the front door they don't see a line. You pay out in $100 bills and don't let any line ever develop at your window. Well it never did. So along about noon time people were just coming and going in a normal fashion and the run was over.

Friedman: It was all a question of reassuring the public that they could get their money. The Federal Reserve System was there to insure that this happened by supplying cash to the banks.

Why didn't this system prevent The Great Depression after 1929? Because from 1929 to 1930 after the stock market crashed, the Federal Reserve system allowed the quantity of money to decline slowly thereby throttling the monetary structure. By December 1930, the quantity of money had fallen by 3% which may not seem much, but a growing economy needs additional money in order to prevent deflation and problems. Given this throttling of the monetary system, what happened after that was more or less inevitable. If the Bank of United States had not happened to fail, some other bank would have been the victim. It would have failed and would've set off the runs. Once the runs started, the Federal Reserve could have prevented them from having the disastrous consequences they did by stepping in and providing the banking system in general through creating new money with the cash it needed to meet the demands of the depositors. After all, once depositors start trying to take their money out of the banks, there is a strong tendency for the quantity of money to fall. Each dollar of cash which is withdrawn from a bank had been backing several dollars of deposits. If the Federal Reserve had stepped in, bought government securities on a large scale, provided the cash, the depositors would have found that they could've got their money and they would have stopped asking for it.

Ironically, the people at the New York Reserve Bank knew that this was the right policy. No one had advocated it more forcefully than Benjamin Strong, the first head of the bank. Tragically for America, he died two years before the real crisis.

With the death of Benjamin Strong, a truly remarkable man who not only ran the New York bank but was also the key figure in the entire Federal Reserve system. A struggle for power broke out between New York, the other banks and the Board in Washington. New York lost, the other banks and even more, the Board in Washington, won. That was a little noticed event but it was the first step in that massive move of power to Washington that has dominated our lives ever since. Then and now, this building housed the U.S. Treasury Department. But at that time, the Federal Reserve Board also had its modest offices somewhere in the same building. The shift of power was sealed a few years later when the Board got its own magnificent temple a few blocks away from here on Constitution Avenue. Despite excellent advice from New York, the system refused to buy government bonds, something which would have provided cash to the commercial banks with which they could have met more easily the insisted demands of their depositors. Instead, believe it or not, the system stood idly by while banks crashed on all sides. As the head of one of the banks put it, the reserve system had to keep its powder dry for a real emergency.

But if this wasn't an emergency, what was? As bank after bank closed a chain reaction was in process destroying money as it went. It's a process that even today a few bankers understand.

If you ask an individual banker whether he creates money, he'll look at you as if you are mad. Of course not, he'll say. I don't create money, all I do is I accept deposits from high customers, I put a little of that deposit in the vault as a reserve and I lend the rest out. I don't create money. From the point of view of the economist, the situation is very different. As I explained earlier, most of the deposits on the books of banks were put there by an accountant's pen. But that simple fact is concealed from the individual banker, because is doesn't happen here, inside the bank, it happens as a result of the transactions between banks.

As the men who ran the Federal Reserve knew very well, it happens when money loaned by one bank is deposited into another bank, to be loaned out yet again. In the depression the process was working in reverse. The banks were destroying money. Nonetheless, the Federal Reserve let it happen.

The end result was that by the time the whole sorry episode was over, by 1933 the quantity of money in the United States had gone down by a third. The slow throttling had turned into strangulation. For every $3 of currency in deposits the people had in 1929, only $2 were left. For every three banks that were open in 1929, in 1933 only two were left.

The terrible depression that followed was a direct result of bungling by the Federal Reserve System. Their monetary policy starts with any hope of economic recovery. Worse still, America's depression was to become worldwide because of what lies behind these doors.

This is the vault of the Federal Reserve Bank of New York. Inside is the largest horde of gold in the world. Because the world was on a gold standard in 1929, these vaults, where the U.S. gold was stored, provide an excellent test of where the depression originated. If the depression had started in Europe or somewhere else in the world, the U.S. would have lost gold, more gold would have flown out of the country then came in. If, on the other hand, the depression started in the United States, the opposite would happen. More gold would come in from abroad as the effects of our depression spread there then went out abroad, in reality that is exactly what happened.

When the international money system was based on gold, the rules of the game were these. The gold in the United States was supposed to control the amount of money issued by the Federal Reserve. In turn, the amount the Federal Reserve issued controlled the amount of money issued by the commercial banks which in turn controlled the amount of money that individuals, businesses and industry could get from the banks. The result, a monetary structure all supposedly tied to the amount of gold in the vaults in the United States. But in 1930 the Federal Reserve didn't play by the rules. It stood by as banks started to collapse and with each one that went the money supply fell. Businesses and industry inevitably began to fail. Americans, now poor, bought less from abroad. Britain was one of the countries effected. Like the United States, Britain had its own monetary structure tied to gold. The trouble was that Britain could now sell less abroad. It cut down the amount it bought from abroad but not by enough. Under the rules of the gold standard, it had to pay the difference in gold. With every bar of gold that was shipped out of Britain, the amount of money decreased.

A depression that was already underway in Britain got worse. British gold flowed into the United States, supposedly to form the foundation of a new slice of the monetary structure. But the Federal Reserve didn't let it. The gold was simply locked away. The results, Britain remained in trouble until in 1931 it went off the gold standard cutting the link between the amount of gold and the amount of money. In the United States, suffering the worst depression in history, there was plenty of gold, but to no avail.

Although these events happened almost 50 years ago, many of our policies today derived directly from them. Central bankers throughout the world, government officials everywhere, are afraid of a new great depression. They, have therefore, moved the opposite direction. Instead of the problem of too little money, we are faced with the problem of too much money. The problems of inflation that plagues us today trace directly from the problem of deflation that plagued us from 1929 to 1933.

People came to believe that free market capitalism had failed. Something was needed to replace it. At Cambridge University in England, a new orthodoxy emerged in the 30's one that has remained powerful to this day.

It owes its influence to the brilliance of one man. John Manrd Kane was unquestionably one of the greatest economists of all time. Like other economists of his generation, he found The Great Depression both a paradox and a challenge. It was a paradox because it seemed to contradict some of the fundamental principles that economists have come to take for granted. Kane rose to the challenge by constructing a complex and sophisticated hypothesis which not only explained what had been going on, but also offered a way out way to end The Great Depression and to avoid similar episodes in the future. The core of his theory was that what happened to the quantity of money didn't matter. What really mattered was a particular category of spending. In economists jargon, autonomous spending. What kind of spending is that? It might be investment by business enterprises in building factories and adding to the number of machines and adding to inventories. It might be spending by individuals to build houses. Or, most important of all, it might be deficit spending by government. If private spending on investment, on house building, is not enough to maintain full employment, then government could always step in and spend enough to make up the difference. The theory of pump priming was born. The theory was a godsend to politicians who had been grasping at any expedient. After all, throughout the ages, politicians had been only too willing to spend money provided they didn't have to tax their citizens to pay for it. And here along came a scientific theory offered under the most responsible of auspices that justified what they had been wanting to do all along. Is it any wonder that government spending has exploded ever since or that deficit spending, even without the excuse of war, and on a large scale, has become the order of the day?

In America, the new Roosevelt administration adopted the Keynesian approach. It authorized massive spending on government projects. It involved government increasingly in the running of the economy. It developed programs designed to provide security for every individual. In England too, the idea that only the government could bolster the economy was firmly established as this film at the time makes clear.

With the assistance of the national government, work was restarted on the great Granada, 534. And we all hope that this is a prelude to a period of increasing prosperity in the industry. Exports of cotton goods to India have increased and as a result of the quota system in the colonies, which the national government introduced in order to diminish the dangers of Japanese competition, exports of cotton good to those colonies have been more than doubled. One of the most important contributions which the national government has made toward the improvement of social conditions has been a housing campaign without parallel in our history.

Though some of these measures may have been useful and indeed needed during the depression years, the length to which they have since then carried would have horrified Kane.

Kane died in 1946. I have always regarded it as a tragedy that they did not live another decade. He was the one man who had the standing, the personality, the force of character to persuade his disciples not to carry too far some ideas which were good for the 1930's but which did not apply in the post war situation. That he might have done so is suggested by an article he wrote just before his death. The last article he ever wrote published after his death. In that article he expressed strong reservations about the lengths to which some of his disciples had been carrying his ideas. If he had been able, if he had lived another decade, the postwar inflationary explosion might have been avoided.

The massive growth of central government that started after the depression has continued ever since. If anything, it has even speeded up in recent years. Each year there are more buildings in Washington occupied by more bureaucrats administering more laws. The Great Depression persuaded the public that private enterprise was a fundamentally unstable system. That the depression represented a failure of free market capitalism, that the government had to step in to perform the essential function of stabilizing the economy, of providing security for its citizens. The widespread acceptance of these views, sparked the enormous growth in the power of government that has occurred in the decade since and that is still going on. We now know as many economists knew then that the truth about the depression was very different. The depression was produced or at the very least, made far worse by perverse monetary policies followed by the U.S. authorities.

Far from being a failure of free market capitalism, the depression was a failure of government. Unfortunately, that failure did not end with The Great Depression. Ever since, government has been attempting to fine tune the economy. In practice, just as during the depression, far from promoting stability, the government has itself, been the major single source of instability.

DISCUSSION

Participants: Robert McKenzie, Moderator; Milton Friedman; Robert Lekachman, Professor of Economics, City University, New York; Nicholas Von Hoffman, Syndicated Columnist; Peter Temin, Professor of Economics, MIT; Peter Jay, British Ambassador to the United States, 1977_1979

MCKENZIE: And now we join the invited guests here at the University of Chicago, as they discuss Friedman's interpretation of those events and their implications for today.

LEKACHMAN: The 1929 crash, the succeeding calamities, were not the first of their kind. Capitalism has been subject to severe depressions since the beginning of the industrial revolution. This was the first time, however, government tried to intervene seriously. It did it very badly. The lesson I would draw is a very simple one: Government is unavoidable; the expectations of the public are proper; government ought to do better oddly enough the government did do better until very, very recently. Until, I would say, October 1973, even, government did reasonably well in fulfilling the expectations of the public. I'm an unrepentant proponent of government intervention, intelligent government intervention. But I would describe much of the intervention which has followed the great 1929 crash as quite intelligent.

MCKENZIE: Let's take a further look, though, at this argument that just as during the depression, far from promoting stability, the government has itself been the major single source of instability.

VON HOFFMAN: I_I don't think there is any stability this side of the graveyard. I mean, I think __ I don't think it matters what system you're working under, you are not going to __ you are not going to have a level and hold it under any system with living human beings.

TEMIN: Governments are larger now and therefore more of a source of an influence for good and for bad. And I think like Mr. Von Hoffman that you can't get perfect stability, given that you're going to have governments, given that there are legitimate functions of governments, there are also risks in having the government be as active as it is.

MCKENZIE: Peter Jay.

JAY: I think that government is a god that has failed. I think that we have too much of it and need less of it. I think it has failed to prevent both the modern forms of economic instability and the prewar ones. I do not, however, think that government is the original or primary source of that instability, and I do not think that simply getting rid of the government, or greatly reducing it, which I'm in favor of, will, by itself, remove the instability.

LEKACHMAN: I would put it this way: There was __ there was a great economist, with a suitably esoteric doctrine, which could nevertheless be translated as Dr. Friedman did in the film, into simple English, at the same time as there was the widespread hardship of The Great Depression and the natural yearning of human beings not to repeat anything like it. So you have a coincidence of an appropriate theory, with an appropriate public sentiment, and I suppose the symbol in the United States was the passage of 1946 of the Employment Act of that year. Which, it was a weak measure, but it was nevertheless a public declaration of an obligation of government to do something about employment, and economic prosperity, and a good thing, too.

MCKENZIE: Now that's the __ really the crux of the matter. Do you agree it was a good thing too, that obligation was accepted by government at that stage?

JAY: I think it's very important here to distinguish two completely different issues. There is the rather narrow issue as to whether Keynes was right or wrong in believing that you could stabilize the economy with regard to really one essential variable _ unemployment _ by a certain technique which he talked about. We may now think that he was wrong, but that's a quite separate issue from the broad political philosophical issue associated with socialism, associated with social democrats, and many other so-called left wing political thinkers, that the duty of government, so far as it can, is to concern itself not only with defense and law and order and the traditional things, but also with the social welfare and the economic welfare of a society. Now that's a broad philosophical __

MCKENZIE: Is that a disaster, as Milton seemed to be implying, or was it a good and helpful, useful thing to happen?

JAY: Well, that is one of the great __ perhaps the greatest of all debates in political philosophy, as to whether or not it is right or is not right to believe that a society, collectively, should concern itself with these things and has the right, having concerned itself, through law and through government and in other ways, to move to try to correct these things.

VON HOFFMAN: Well I just __ it seems to me that Americans have believed that for the last century. I mean William McKinley ran on the slogan of a full dinner pail, so that the notion that this is a government responsibility for prosperity dates from the 1930's I think is erroneous. What I wonder about after having seen that film is this: We have in 1929 __ we have the man who could have saved it dead two years and in 1946 we've got the man who might have saved it dying. So what I have to ask is: Are we doomed to find out the right answer only too late? Is it possible that our __

TEMIN: Or should we just look for somebody who's recently died.

VON HOFFMAN: Exactly. Rummage the morgues. (Laughter)

MCKENZIE: Well, you asked the question __

FRIEDMAN: No, and I think the question is a very different one. And it goes to much of the discussion to this point. Everybody looks for the right man. You say, "Government __

VON HOFFMAN: You brought'em up.

FRIEDMAN: Those men at that time. Quite right. But a system which depends on the right man is a bad system. The Federal Reserve was a bad system because it depended on the right man working it. The idea of demand management, of the kind of thing we're talking about where Keynes' death mattered, was a bad system because it depended on a particular man working it. The notion that the problem that Bob Lekachman brought up, that the problem is not the government interferes, but it does it unintelligently, is again a demand for the right man, the man on the white horse who will know what to do. My whole view is very different. It is that it's the system that's wrong, and that we've got to have a system that the right way to accomplish these objectives is to have a system which doesn't depend on whether you happen to have the right man pushing the buttons at the right time.

TEMIN: The problem is somebody has to __

FRIEDMAN: Which relies on the __ on establishing a framework within which an invisible hand, within which the activities of people all over are jointly to produce the kind of result. It won't produce perfect stability; but it'll produce a far higher degree of stability, a far greater level of freedom, and a far greater level of prosperity than the kind of thing we've had with these governmental interventions.

TEMIN: Somebody still has to design the system. You can't take the people out of it entirely.

FRIEDMAN: Of course.

TEMIN: Unless you're in the grave as it says.

FRIEDMAN: Of course, but the __ that doesn't __

TEMIN: But the question is __ I mean it's said that generals always fight the last war. How do we know that the system won't fight the last war? We probably won't have another depression exactly like 1929 to '33.

MCKENZIE: But, but __

TEMIN: But that doesn't say we won't have another depression or another stagflation or another crisis of some other source.

MCKENZIE: But is this process reversible? Because you argued that the public, having been appalled by The Great Depression, in effect demanded of government that they accept responsibility for wellbeing of the economy, for management of the society and so on. Now, that expectation having been raised, can it be reversed?

VON HOFFMAN: Let me answer a question you didn't ask and say that it seems to me that what we're getting here is the question of sort of social astrophysics. And that is, do we have an unseen hand, or are we on the war star where we are trying to design a computer that is going to take care of the navigation of this thing. In other words, it seems to me that's our central question. Is there a mechanism that you can put right in the center of the spaceship that will operate regardless of who is the captain on the quarterdeck at any one moment in time? I don't think that's an economic question. I think that's a question that goes to religion.

MCKENZIE: Ah, well, that's not on our agenda actually. (Laughter)

VOICE OFF SCREEN: Why not?

MCKENZIE: I boldly repeat the question, though, the expectation having been __ having been raised in the public mind, can you reverse this process where government is expected to produce the happy result?

LEKACHMAN: Oh, no way. And it would be very foolish of the public which is on the whole more sensible than academic, to come to this conclusion. They look around them, what do they see? They see a whole collection of visible hands attached to EXXON, other large corporations. These are not small, independent competitors jostling with each other for the patronage of the public. These are large organizations, with substantial influence on their markets. Government's interference, clumsy as it often is, is an almost unavoidable response to the very visible manipulations of large organizations.

FRIEDMAN: If there again, you're an academic, we're talking about fact in history. Now the history is that the growth of government has not been as a result of the things you're pointing out. It isn't the large corporations. It isn't the large unions. It isn't the technological development that has produced the major growth of government. The major growth of government in our time has come in the redistributive area. It's come in the area of designing programs which take from some people and give to others. We're not going to go into those here, because we discuss those in our next two programs which deal with exactly the question of whether the government intervention that was stimulated by The Great Depression has been a success or a failure. But to your point, the grounds that you give for greater government intervention have almost nothing whatsoever to do with the actual factual growth of government. Now at the end of the war, immediately after World War II, it was thought that government was going to get involved, especially in Britain, in France, in central economic planning on a large scale.

JAY: Partly because of the war experience, too, when government was very much involved.

FRIEDMAN: Partly.

MCKENZIE: In Germany and Japan as well.

FRIEDMAN: Germany and Japan as well, it was a war. It created a myth just as the, as The Great Depression created myth.

MCKENZIE: Or rather reinforced the myth of government responsibility.

FRIEDMAN: Yes, but it created a different myth. This is a subject we don't discuss much in the film. We've discussed it in a book that we're bringing out with the same title to go along with it but __ but the great, but the great myth that was created by the war, was the myth that government was inefficient. And it was.

MCKENZIE: We won the war.

FRIEDMAN: For wartime purposes in, at least in Britain and the United States. It wasn't so inefficient in Germany and the losing countries. But why is that a myth? It was a myth because it is one thing for government to plan and to control an economy for a single overriding objective. One solitary objective __ win the war. It's a very different thing for government to control the economy for the many numerous tastes of all us, of a very large number of people in a complex world. And I __ you ask the question of whether people's opinions can be changed.

MCKENZIE: Yes.

FRIEDMAN: I can't change their opinions. You can't change their opinions, but experience is changing their opinions. Is there anybody, anywhere now who believes that government is an efficient way to run an industrial enterprise?

JAY: I think your question, can you get the genie back into the bottle, is a very important one. It is undoubtedly true that in democratic countries there will be a public urge expressed through the political process, for something to be done about anything that seems to be wrong. The one thing that inhibits that is the belief that it can't be done. There is not politically expressed desire for the government to do something about the weather because it is widely believed that the government does not control the weather. It was widely believed under the gold standard and pre-Keynes that there was nothing the government could do about the kind of economic traits I call in depressions that we had before that time. Since then it is very widely believed, Milton may believe, I may believe wrongly, but nonetheless, it's very widely believed that is now a manageable thing, and therefore the demand is expressed that unemployment should not rise too high, inflation should not rise too high, and so forth.

MCKENZIE: That we keep a war on want or a war on poverty.

JAY: If you believe, as Milton does, and on this issue I agree with him, that in fact government cannot handle this issue, and you want to get that genie back into the bottle, you can't simply do it by authorities, or pundits, or academics, or others saying, "Here is a new rule. The government will do nothing. It will not intervene; it will not perform, but will just be a simple monetary rule." You've got politically to persuade people that this is part of a system which they can understand, which will, in fact, deliver for them the minimal economic objectives that they have, which are basically high employment __ high employment and stability of prices, and one of two other things. Now in order to do that you've got to describe a political economic system which will in fact deliver that result. And they will not believe, and in my opinion they will rightfully not believe, that simply going back to where we were, or where we imagined that we were in 1930 or 1870, by withdrawing the government form the game and doing nothing else, will produce that result. And they're right not to believe it.

TEMIN: The kind of pristine view that you appear to be putting up of no government isn't really a consistent view because if you __

FRIEDMAN: I'm not putting up a view of no government. I'm putting up a view of a limited government. Limited __

TEMIN: Just how do you, how do you impose the limit?

FRIEDMAN: Note __ note that today the budget of HEW is one-and-a-half times the whole defense budget. That is not where the major growth of government has come. Whether we spend too little of too much on the military is very a arguable issue which I'm not competent to discuss.

TEMIN: Okay.

FRIEDMAN: But it is not the cutting edge of the dispute that we're engaged in. That cutting edge is on all these other functions which government has increasingly taken on its shoulders.

TEMIN: Yes, but the question __

VON HOFFMAN: How do you get from here to there?

FRIEDMAN: By persuading people to do it, and by doing it gradually. You do not get it overnight. CAB was a very, very persuasive element on __ on getting rid of one branch of regulation. The failure of government to produce the full employment and the stable prices that was promised is another. You know what is __ who are we kidding? Is there anybody around any more who really believes that government knows how to prevent by its present methods inflation or unemployment? We've had increasing inflation. We've had increasing unemployment. Not only in the United States __

VON HOFFMAN: Well we __ we know that this government doesn't __

VOICE OFF SCREEN: Wait, wait.

LEKACHMAN: It seems to me that we're talking about at least four kinds of government intervention of different popularity among the public. One is redistributive __ via the Social Security System and so on __ and lots of that is popular. Welfare is unpopular, but Social Security is quite popular. Medicare has a mixed reputation, Medicaid a bad reputation. The redistributive system is a mixed bag from the public's standpoint. Another kind of intervention deals with unemployment; a third kind deals with prices; and a fourth kind deals with regulation. Now, again, there is a cry about regulation which itself breaks down, it seems to me, into two parts: Partly a safety kind of thing, partly an economic kind of thing. I doubt that the public is prepared, for example, to eliminate the Food and Drug Administration.

FRIEDMAN: Take the way of trying to smooth out the business cycle.

LEKACHMAN: All right, now wait on that. I think that the record of doing this, in its clumsy way, Republicans, Democrats, assorted administrations in England and elsewhere, between 1945 and 1973 was quite good. Average unemployment during this considerable span of years was lower than had been probably in any previous spell of modern economic history. Inflation was not a persistent problem in this. Now I would say, putting the claim at a very modest one, that Keynesian intervention, if we use that as a label, worked pretty well for a whole generation. Now anything that works well for a whole generation isn't entirely bad. From the fact __ from that fact, and the undeniable fact that things are working poorly now, are we to conclude that the Keynesian sort of mixed regulation was wrong __

FRIEDMAN: Yes.

LEKACHMAN: __ or alternatively that we need still more regulation. That's my conclusion, I might say.

FRIEDMAN: You want the right people manipulating the leaders. But go back. Memory smooths things out. If you really look at that 25_year period you're talking about, it was not a period of stability; it was a period that was punctuated by the very sharp inflation of the Korean War. It was a period that was punctuated by three recessions in the course of about eight years in the fifties and early sixties. It was a period in which you had a __ inflation really starting to go from creeping to running, in the latter sixties. It was a period which laid the ground work for the kind of situation in which we are now, where you have both higher unemployment and higher inflation. It was __

TEMIN: I don't think that followed. I mean there were these movements, as we say, but they weren't the movements like the 1930s. There was a recession in '58, yes.

FRIEDMAN: I agree.

TEMIN: We all called it a recession. We all worried about it and so on, but it was a small thing, little potatoes.

FRIEDMAN: The same thing was true in earlier periods between The Great Depression. If you take the area between the great depression in the United States of the 1870s and the 1890s, again you had a period like that. If you take it between The Great Depression of the 1890s and World War I, with a minor __ with one minor exception, it was similar to that. So that what you have, and this is a historical fact, is that except for the great depressions, all of which are linked to monetary collapses and to governmental involvement, in the interim period, the society has been reasonably stable.

MCKENZIE: Haven't we reached the stage, incidentally, where we need not again see anything like the great depression. You say recessions, yes; but it bears no relationship to what we knew __

FRIEDMAN: No.

MCKENZIE: __ in the thirties. Have we solved that problem now? People are deeply __

JAY: No, we haven't. Because I think the seeds of it remain there. I don't agree with Professor Lekachman that everything was __ I don't want to misparaphrase him __ but did pretty well until 1973 and then it suddenly all went wrong. It seems to me that the seeds of the subsequent instability, stagflation, were there before. That each time round the economic cycle inflation went a little faster. Each time around the economic cycle unemployment tended to be a bit higher. But this brings me to what is my disagreement with Professor Friedman. I agree with him that government has failed to correct, and is bound to fail to correct that instability. I do not agree with him that it is the root cause of that instability or simply removing or containing the government will remove that instability. Because his constitution, and I agree with all the things he wants to put into it, but I want to put more into it, leaves big capital entirely free to operate. Now he doesn't mind that. In response to big capital, you are bound to get __ as a simple, natural reaction __ big labor. He doesn't mind that. He's quite happy with that. But my contention is that once you have big labor, you have a way of setting rewards in society, not only by trade unions, but through all sorts of other processes whereby groups get together in order to exploit the political process and legal rights, and to protect themselves from competition, in which, inevitably, people set rewards above what economists call the "market clearing price" for labor. They set levels of rewards which make it impossible that everybody should be employed and you therefore have a built-in tendency to high unemployment. If governments react to that on the Keynesian pattern by trying to inject spending which will enable these people to be employed, then I agree with Professor Friedman that all you get is faster and faster inflation, and that if you like, is caused by the government. But the government is a proximate cause of an original instability that is already there. And there's nothing in Professor Friedman's constitution which would correct that inherent, if you like, contradiction or flaw in classical western political economy.

FRIEDMAN: Do you deny, Peter __

MCKENZIE: Let me get the reaction to that __

FRIEDMAN: __no, I want to ask just one question of Peter. Do you deny that big government plays a large part in the rise of big capital and big labor?

JAY: I think they're interactive. I once said big capital causes big labor, causes big government, causes big failure. That is the tragic story, in my opinion, of the 20th century.

FRIEDMAN: And what about if you start that __

JAY: We have to unravel that.

FRIEDMAN: __ if you start that route with big government. Will it be wrong? Big government causes big capital, causes big labor, causes big failure?

JAY: I don't think historically that's what happened. But you and I are agreed, we don't want big government.

FRIEDMAN: That's right.

JAY: What we're disagreed about is what else we need.

LEKACHMAN: I think something is seriously wrong with a beautiful system which develops this big, clumsy, aggressive government, huge corporations, with more influence over their markets than is desirable from the standpoint of free competitive theory, trade unions, which at least according to some opinions, have a similarly malignant influence on their markets. There must be something radically flawed with the capitalist system which allows these institutional developments. This doesn't alarm me because I'm a socialist, but I would __ I would readily __

FRIEDMAN: There must be something radically wrong with socialist philosophy which allows the __ extraordinary __ the much worse developments that have occurred, wherever there has been any real significant attempt to put a thoroughgoing socialism into practice.

LEKACHMAN: Socialism is a word of many meanings.

MCKENZIE: Now I think we might easily get into a quite serious debate on that point.

VOICE OFF SCREEN: Right.

JAY: I think it's possible to note in passing that they may both be right.

MCKENZIE: Yes.

JAY: That conventional capitalism, conventional socialism, as conceived in the 20th century, are both wrong and that the polarization of the debate between those simple two alternatives greatly impoverishes the real range of political-economic choices which modern societies have.

FRIEDMAN: But what has happened? Over and over again one claim after another for the kind of socialism __ this kind of socialism or that kind of socialism __ has turned to ashes. And each time the answer has come, "Oh well, it was a wrong brand of socialism that was adopted, or the wrong people were running it."

VOICE OFF SCREEN: But you're saying __

JAY: You're arguing with yourself when you're saying __

FRIEDMAN: No I'm not.

JAY: The Federal Reserve in 1929 failed to do the right thing. It was the wrong brand of government.

FRIEDMAN: It was the wrong brand, absolutely, but what I'm saying is something different. I can at least point to examples in history of systems of capitalist systems in which the government had a fairly limited role, not my ideal government. Many things, doing many things I would not want it to do. But I'm going to point to such examples over long stretches of history in __ which have been relatively successful. Where the major achievements of humankind, not merely in economics, but in all other areas, have largely arisen. It is very difficult to point to any similar examples __

TEMIN: But then you are pointing back __

FRIEDMAN: __ of where big government has achieved such success.

TEMIN: But you said before you didn't like to go back. You're now talking about going back.

FRIEDMAN: No, no. I didn't say I didn't like to go back.

TEMIN: They took place in different times.

FRIEDMAN: What I said is going back or forward is irrelevant. What we want to do is __

TEMIN: But it's not irrelevant to this discussion __

FRIEDMAN: __ the right thing wherever it comes from.

TEMIN: __ because as Bob Lekachman said earlier, things have increased in scale, and the scale of business and increased, and you were saying just before, big government, big labor, big industry, big firms go together, and you didn't accept it before, when Bob said you'll accept it now from here.

FRIEDMAN: No, no. I don't accept it. What I accept is that big government is a major factor promoting big labor and big capital. I did not accept that in the absence of big government you would have the big capital and big labor that worries him.

TEMIN: We don't think the big capital arose before the government did?

VON HOFFMAN: Listen, what are we doing here? I mean __ defending big government is like defending death and taxes. When was the last time you met anybody that was in favor of big government?

FRIEDMAN: Today, today I met Bob Lekachman, I met __

LEKACHMAN: But that's not to say __ with discrimination __not per se.

VON HOFFMAN: You're in favor of certain functions __

FRIEDMAN: I make a living by making distinctions, after all. Certainly not without qualification.

MCKENZIE: Von Hoffman, you have the floor.

VON HOFFMAN: What I was going to say is, I think most of us are not in favor of big government as a theory. The question that keeps haunting me here is, how do you, going back to your question of just the monetary regulation, how do you make __ and let's assume that you can really, we'll go a step further and we'll say __ we'll go all the way with you. We will install that mechanism. What makes you think that when the storms arise that, that the people running that mechanism are not going to misread, just as they did in the past?

FRIEDMAN: Because I'm gonna have __ if I had my way I would have a mechanism which didn't require them to read anything.

VON HOFFMAN: In other words, simply a money formula.

FRIEDMAN: Absolutely.

VON HOFFMAN: Is cranked out in relation to the GNP regardless.

FRIEDMAN: Right.

TEMIN: The question is: How are you going to keep from tampering with this black box? Would you have a thing __

FRIEDMAN: I'm not gonna have a black box; I'm gonna have a very visible system. I have written out, as you know __

TEMIN: No, I know. Yeah, but the question is, no, you have the rule __

FRIEDMAN: __ at relative great length and precise details on what I would do.

TEMIN: __ it will calculate this, but then there's going to be someone who'll come in, the people that you dislike, they'll say, "But we could do it a little bit better by doing it this way or that way."

FRIEDMAN: Of course. Of course.

TEMIN: How will you keep them from doing it?

FRIEDMAN: Well, in the only way in which you can do it in a democratic society, by establishing both a written and an unwritten __ and the unwritten is just as important as the written __ an unwritten constitution on the part of the public at large, an acceptance of the view, that this is not what people in government ought to be doing. That it's their problem

VON HOFFMAN: A highly sacred measure of __

FRIEDMAN: Well, if you want, but not necessarily sacred in the theological sense.

JAY: It's unfair of people to say, Professor Friedman, he's a bad doctor because people won't actually take his medicine. I mean that is, that is not fair. But it does seem to me, and I say it again, that to reduce the whole debate to one, are you in favor of big government or small government, as though that is the only interesting or important political-economic choice we had to make, is very foolish.

FRIEDMAN: That is very foolish. I agree.

JAY: But __ and if you put it in that form, in practice in democratic societies, people will go on backing, supporting, and paying for big government. Because unless you __ in addition to pointing out the errors, defects, weaknesses, fallibilities, failures or government, you also describe in some detail, and to some attraction, the other changes that you're going to make in the nongovernmental sector of the economy, which are going to give people the kind of protection, the kind of opportunities, the kind of fulfillment, the kind of stability, the kind of prosperity that they want. They are not going to buy it because you're offering them a pig in the poke, and they will see it, whether or not you approve of the phrase, or whether or not I approve of the phrase, there's going back to something which they're glad to have got away from.

TEMIN: The question of how you draw the lines, and where you draw the lines is a difficult one, and I can't see any possible way of somehow making a decision on that will stand like __ like the Rock of Gibraltar against all comers.

LEKACHMAN: I don't think that the public is going to, nor should it, choose ideologically. I think it's going to favor and disfavor certain activities of government out of its experience, by its perception of what's good in its own interests and so on. And my __ I don't preclude the possibility that there will be a different mixture of perceptions by the public which will lead to a shift in the functions of government. But I think it's at least as possible that after the shift occurs, government will be perceived to have more functions as that it will have fewer functions.

VON HOFFMAN: It seems to me also that you could have the monetary policy that you are talking about, and have the very big HEW etcetera.

OFF SCREEN: Absolutely. Oh, yes.

VON HOFFMAN: And more easily.

FRIEDMAN: Unfortunately, you're right.

VON HOFFMAN: Now could you dilate on that?

FRIEDMAN: No, no I __

VON HOFFMAN: No, I mean it, seriously.

FRIEDMAN: I agree with you. I agree with Nick. These are separable issues. And Peter Jay will agree with that, too. In fact he and I are in almost complete agreement on the desirable monetary policy. Where we differ is on these other policies, and there is certainly no doubt that you could have an essentially automatic stabilizing monetary policy of the kind which I've suggested, of a fixed rate of monetary growth, no discretionary intervention for cyclical purposes, and at the same time have a very big government on HEW, have all sorts of regulation, have tariffs and all other things. With respect to Peter Jay's more general statement, it's impossible not to agree with his statement, because it's __ it concentrates on objectives and not on means. And the real issue has to do with means. What are the most appropriate and effective means which will give people the greatest assurance __ you can't give them certainty __ but the greatest assurance that they will have a reasonably stable society with opportunity for themselves and their children, for their needs, for their wants. Of course.

MCKENZIE: We must end the discussion for this week and hope you'll join us again for the next edition of Free to Choose.