Werner Erhard’s life is best understood through his ideas and their application to people’s lives. In this video Werner describes his use of a three act play as a metaphor for life”
“We human beings don’t leave the past in the past. We have the past in the future and when you do that it looks like the past gives you who you are and gives you your life in the present – kind of like two file cabinets. One file cabinet says the past the other one says the future and you’ve got the stuff that should be in the past filing cabinet stored in the future. If you take the past stuff out of the future and put it into the past (and there’s a way to do that) what have you got in the future? Nothing! – Which is wonderful because if who I am in the present is given by the future into which I live, I can create a future for myself that gives me being in the present, that has joy, that has vitality, that has self-expression that has the things that make life worth living.” – Werner Erhard
SATELLITE SEMINAR SERIES: April 4, 1987
THIS BUSINESS OF MONEY: A Conversation of Personal and Global Import.
INTERVIEW WITH PROFESSOR MILTON FRIEDMAN
Werner Erhard: In a way it seems a bit redundant for me to introduce Professor Milton Friedman. He’s probably more closely associated with economic science and more widely recognized as a leader in his field than anyone else living today. Professor Friedman, holder of the 1976 Nobel Prize in Economics, currently serves as a Senior Fellow at the Hoover Institute at Stanford University and as Professor Emeritus of Economics at the University of Chicago. He has written and taught in the field of Economics for more than 50 years and during that time has played a key role in shaping both the way we understand the economy and the direction of public policy in that area. He has done a lifetime of research on how wealth and outcome determine our behavior and Professor Friedman is perhaps uniquely qualified to give us a sense of the causes and implications of our own economic behavior and how that relates to economic policies and outcomes on a national scale and even on a global plane.
As I promised this morning, and we will now ask Mr. Friedman to give us some sense of what we’re told is important and what might be even more important.
Milton Friedman: Thank you very much for that introduction. In response to this suggestions by Werner Erhard, I thought I would talk about what I regard as the longer term issues concerning the U.S. I’m not going to tell you what the stock market is going to do next week. I might tell you what it will do in 10 years, because then there’s no problem with checking up. (Laughter) And I’m not going to try to tell you whether the economy is going to go up next quarter at 3.6% or 3.4%. Those are worthwhile and useful pursuits, but I don’t think that is what is important for people in the United States to understand the problems facing the United States and what we as a people can do about them and what we ought to be concerned about.
I thought I would do this, first, by indicating what I believe are false issues. And then turning to what I think are the real issues. I do that, because the issues that gain most attention in the public media, the issues that you see headlined in the newspapers and you see repeatedly referred to in the evening broadcasts, are in my opinion almost all of them false issues and lead to a misunderstanding of what the real problems are. If you, as ardent readers of the newspaper, as you probably are, and watchers of the news media, if you were to be asked what are the key problems facing this country, I have no doubt that a large fraction of you would come out and say one of the biggest issues is the deficit of the federal government. And you would come out and say, “Well, another big issue is the debt issue.” And you would say the debt issue is that the government is owing too much debt and also we are owing too much abroad, that this country is becoming a debtor nation and that’s terrible. And the third issue you would undoubtedly come up to is related to this debtor abroad, you would say it’s a balance of payments issue. It’s a fact that we’re spending more on Japanese goods than Japan is spending on ours.
Now, in my opinion, all three of those are false issues. That doesn’t mean that they aren’t derived from real issues, but they misrepresent what the real issues are. And what I want to do is really to spend my time discussing the real issues underlying these false issues. And those real issues as I see them are, first of all, not the budget deficit, but the level of government spending. The real issues are not the level of the government debt, but the prospects for inflation. The real issue is not the foreign trade balance, but how we maintain a free trade world, a world in which people are free to buy goods wherever they are cheapest and to use their resources most effectively. Those are the real issues and they tend to be misrepresented and to lead to false policies, if you concentrate on the false issues.
Let me take them up one at a time. Let me start with government spending. If government spends – it’s simplest to think in terms of the federal government, although I will talk about all governments, federal, state and local – if the federal government spends a trillion dollars and takes in what it calls taxes 800 billion, where do you suppose the other 200 billion come from? Do you suppose there is an Arab sheik or somebody who is showering us with the money, is there a tooth fairy? The American people pay that extra 200 billion. The 200 billion dollars which is called a deficit is mislabeled. It is not a deficit. It’s a hidden and concealed form of taxation. If the government spends a trillion dollars, there’s a trillion dollars that is not available for private people to spend. It doesn’t make any difference whether the piece of paper you get back for your money is a receipt for taxes, or is a nicely engraved piece of paper saying government bonds, in either case, the money you paid over for those pieces of paper is not available for you to spend. Somebody else is spending it on your behalf, supposedly. That’s the government is spending it on your behalf.
So if you’re going to look at the cost to the economy, the cost to the public – I shouldn’t say “economy” because really what matters are the people. The cost to the people is what government spends, plus a good deal more. Why do I say “plus a good deal more”? Because some of the things that government does that are very costly to people, don’t involve very much government spending. For example, everybody is required – and some of these things may be good things or bad things – I’m just trying to suggest the fallacy in looking only at the budget. For example, everybody is required to put certain antipollution devices on his automobile. Let’s suppose they cost $300 to put on. It would make absolutely no difference if the government taxed everybody $300 and paid for those antipollution devices or if the government says you are required to put them on. It’s an indirect form of taxation and in principle, the $300 ought to be added to government spending and ought to be added to government taxes.
Or again, government imposes a tariff on a commodity that you can buy from abroad. Let’s suppose it’s a prohibitive tariff, so nothing is imported. The government gets no revenue, it doesn’t enter into the budget, but that doesn’t mean it doesn’t impose a cost on the people who would like to buy that product. A whole host of government regulations, from minimum wage laws, from anti-pollution requirements – and as I say, some of them are good, some of them are bad. That’s not my point. My point is what is government costing the American people.
Now as I say, the real cost is what government spends plus the burden of all these regulations. And that’s not trivial. For example, Murray Wiedenbaum** has estimated that the total cost of government regulations on businesses only, on corporations, comes to several hundred billion dollars a year. So it’s not a trivial sum. But for simplicity, the one number you can really put your finger on is what government spends, so I’m going to talk about that.
I want to turn now to one of these figures I have up here, this Figure 1, if you can see it all right, which is a record going back from 1900 to 1980 of what has been happening to the level of government spending in the United States. (Pointing to Chart) This is the total. This is Federal, and this is state and local. Now there are two fascinating things about this. The first is, if you look just at State and Local and Federal, you will see that until about the 1930s which is where this is, the amount that was being spent by the States and localities exceeded the amount spent by the Federal Government. If we go back to the 1929 or 1930, just before the Great Depression, the Federal Government was spending an amount equal to about 3 to 4 % of the national income, and I may say if you go back for 100 years before that, except for a time of great war, the Civil War, the First World War, the Spanish American War – except for time of war, the Federal Government never spent more than about 3% of the national income. It’s very hard to believe that today. I may say half of that went for the military. The state and local governments were spending twice as much. Most of that went for roads and schools and police forces, that’s what those were going for. So up here (pointing to chart) you had government primarily decentralized, as the founders of the Constitution intended. The states and localities were running their own businesses. The federal government was concerned with what was really its business, national defense. Government was performing the basic underlying functions of government.
Then beginning about 1930 you had a revolution – really beginning in 1933 as a result of the Great Depression, a change in people’s attitudes – which I will come back to in a moment – but let’s get the facts straight first. Spending absolutely exploded. Total spending went up from about 10% of national income to over 40%, close to 45% of national income, and more than two-thirds of that is federal. State and local has been staying roughly constant as a fraction of the national income throughout this period, while federal government spending has escalated.
What produced those changes? There really is no doubt about what produced those changes. It was a fact that up until the Great Depression, it had been taken for granted that government had very limited functions. The government’s functions were to protect the nation from foreign enemies, local governments to protect people from their fellow people, the police, to provide roads and schools, very simple, and it was not the business of government to look after the rest. There is a famous statement by President Cleveland, back in the 19th Century. When somebody in one of the Houses of Congress or maybe both of them, passed a bill to provide federal assistance to a particular local emergency, I think it was a flood or something like that – I’ve forgotten what it was, but it’s his remark that I think is fascinating. He said it is not the duty of the government to support the people, it is the duty of the people to support the government. Can you imagine any modern politician making a statement like that? Well that was the attitude. And it was an attitude – I won’t go back to the source of it – but it was an attitude that had served the country well, because after all we are talking about a period during which the United States rose from a backward fringe on the Atlantic to the greatest nation in the world.
But the Great Depression changed that. The Great Depression, rightly or wrongly – I believe it was wrongly — persuaded the public at large that there was something wrong with the private market, that you could not depend on private enterprise, and that you had to bring government in – and that the way to solve problems was to get government to take a bigger role. And from then on, government started to take a bigger role and to do things that it had never before done. Things like, I recall — things like Social Security, things like welfare programs, things like, much later, taking over the railroad transportation. I shouldn’t say that – during World War I the U.S. government did take over railroads but then it gave it up after the war, that was strictly a wartime measure.
At any rate, you all know about that. There is no question that the tremendous growth in the size of government was a result of this change in public attitudes. Plus the fact that the idea that somehow or other you had to balance the budget. That somehow or other if the government was going to spend money, it ought to stand up and vote for taxes. That idea too became old fashioned. You had a new doctrine in economics, the so-called Keynesian revolution which led to the belief that after all we only owed it to ourselves and there was no problem about deficits and that government spending could stimulate the economy. Well I won’t go into all the ins and outs of all that. That would take us a year’s course and not an hour’s lecture.
But I want to go on to the fact that what happens to the climate of public opinion ultimately determines what happens to the course of public policy. But the word “ultimately” is very, very important. You have a change in the attitude in public opinion and it doesn’t reflect itself in public policy for 20 or 30 or 40 years, very often. If I go back to this chart. If you go back to the ‘20s, by the 1920s the intellectual community in the United States was overwhelmingly Socialist. There is no question that on the campuses and elsewhere that the dominant set of political ideas was socialist. Every single element of a socialist platform in 1929 has now been enacted into law. The most important political party in the United States was the Socialist Party. Didn’t win any elections, but it changed people’s ideas. But it took 20, 30 years before those ideas came into effect and that’s why you have this long record (pointing to chart).
Why do I say that? Because I think there has been another change in people’s ideas. I think you have a long history in which ideas change infrequently and take a long time to influence the public. You go back. In 1776, Adam Smith wrote the Wealth of Nations, the U.S. had the Declaration of Independence. At that time you had a change in public ideas, away from the prior centralized government, what economists call mercantilism, toward free trade and free markets. It took 70 years after Adam Smith’s death before Great Britain became a free trade nation. It took a long time before the same thing happened in the United States. So there is a long lag. The Fabian Socialism became the dominant economic trend in Britain between 1870s and 1890s or 1900. It wasn’t until just before World War I that it started to really affect public policy.
In the same way, since the 1950s and 1960s in this country, we have been having a changing intellectual climate. That changing intellectual climate is moved, is dominated by the fact that the promises of government have not been achieved. That we have had one great program after another that was intended to – a War on Poverty that was going to eliminate poverty and poverty goes up, etc., etc. There has been disillusionment, but also, as far as the public at large is concerned – let me stop. You have to distinguish intellectuals and the public at large. So far as the intellectual community is concerned, much the change has been brought about by a whole series of writings – The Road To Serfdom by Freda Kai **??, the books by Ayn Rand, Atlas Shrugged, and so on, etc. But in the public’s mind, what has happened has been the failure of government programs on the one hand and on the second, the heavy burden of taxation. And indeed, the heavy burden of taxation I think plays a major role in changing people’s attitudes and minds. That’s why Ronald Reagan got elected in 1980. Ronald Reagan was saying the same things in 1980 that Barry Goldwater was saying in 1964. Ronald Reagan was not elected in 1980 because he was a good movie star or because he was a good TV performer. He is, he’s a charming gentleman and all that. But so was Barry Goldwater. Barry Goldwater was overwhelmingly defeated. Ronald Reagan was overwhelmingly elected. Why? Because by 1980 the public at large had come to side with the views that Ronald Reagan had rather than with the views that John F. Kennedy and Lyndon Johnson expressed in 1964.
So changes in opinion have an effect, but there is a long lag before they do. This change in opinion I may say is worldwide. We’re not talking about a provincial thing. Look around the world and you will see wherever you look, you will see a change in public attitude. Thirty or forty years ago, you could have found people around the world who would have told you that you ought to have government owned and operation of industries, because that would be more efficient. You would find it very hard to find anybody, even in the depths of the Soviet Union or of China, who would say that to you now. There’s nobody who thinks that government enterprises are more efficient. It’s absurd when you look at the record. Great Britain, became the Fabian Socialists, the Labor Government right after World War II – nationalized a lot of industries on that ground. They’re in the process of denationalizing it, and even the Labor Government isn’t objecting to it. In fact the whole thrust of the left wing governments has changed. They’ve changed from the virtue of socialism as a way to operate an economy efficiently, to the virtues of socialism as a way to take from some and give to others, redistribution of income.
So this is worldwide. It’s manifested just as much in the solidarity movement in Poland, in the reforms that have been taking place in China, in the reforms that are taking place in Russia – it’s manifested just as much there as it was in the election of Ronald Reagan or the election of Thatcher. And that change will continue.
Now I’ve been talking only about spending. Let me go on and talk about what people talk about so much, the deficit, and ask why is the deficit so important and where does it come from? If I go from this first one (removing chart) to a second one. (Pointing to a new chart.) This is a closer birds eye view of a year to year record from 1929 to 1983. Aren’t these computers marvelous, this was all generated on my home computer. The numbers came in over the telephone and I fed them in, and out comes this graph. This number, this big bump is World War II. This is total spending, federal, state and local. And this lower line down here is receipts. And the difference is the deficit. Now I ask you, what’s important about that figure, is it the difference or is it the level of both of those? If you look at it you will see that generally speaking, until about the 1970s, you had a roughly balanced budget. You will think that’s curious. The reason is because the state and local governments have consistently run at surplus – I’ll show you that in a moment — while the federal government has run a deficit. When people complain about the deficit, they only look at the federal government. But after all if the federal government runs a deficit and the state and local governments run a surplus, you ought to add those two together and balance them. And you can see that it’s only really since about 1974 that you’ve had a more or less consistent pattern of deficit. Those deficits are really very small relative to the national income. They are 2 to 3% of the national income. They are not good – don’t misunderstand me. Well, I don’t mean that. On one level they’re not good, and on another level, one of the best things we have had are the deficits. I’ll come back and explain that in a moment. That’s federal state and local.
(Pointing to New Chart) This is state and local, and you can see that the state and local has been running a big surplus. You may be surprised at that. The reason is that they have been accumulating pension funds, and it is the pension funds that account for the surplus. The federal government on the other hand has been running a deficit, that’s the difference, and you can see that. Now, if you can see – I’m not sure this is large enough for you to see – you would see that what’s been happening since about 1975 or 1976, taxes have – this is all expressed as a fraction of income, changes in prices inside the economy – taxes as a fraction of income have remained roughly constant, they’ve been horizontal. They run about 19% or 20% of the GNP. Spending as a percentage of income as continued to grow. And the deficit has been produced by the increase in spending, not by any reduction in taxes. There has been a lot of nonsense.
What happened was that before this date – and this is where we are going to come to our second topic, you had inflation. Inflation was absolutely God’s gift to the politician. Because inflation meant that without anybody voting for higher taxes, you could get higher taxes. Everything was being pushed up. You had what was called bracket creek (**??) What more can a politician ask for? He can stand up and vote for spending, which was good. We just had this highway built that was a disaster. Did you hear anybody in discussing that say a word about the fate of the taxpayers who were going to pay for it? All you heard about was the fact that Altuna** was going to get an 11 mile stretch of highway, but you never heard that you were going to pay for it. At any rate, from a politician’s point of view, inflation enables taxes to rise more rapidly than spending and enables you, therefore, to spend more. That’s why, up until this point, you had taxes rising along with spending. Then the combination of the 1981 cut in tax rates, the index for inflation of the tax system, and the decline in the rate of inflation, meant the tax receipts didn’t go down, but they didn’t go up, they stayed stable as a fraction of income. But spending continued on its upward course. Why? Because about one-third of the increase in spending was due to the increase in the military. More than two-thirds was due to spending on entitlement programs, spending on social security, welfare, poverty, etc., etc.
At any rate, the main point is that the deficit is not the problem, spending is a problem. And on the contrary, the deficit has been serving as a very useful function in recent years, because it’s the only thing that has kept spending from going up more rapidly. Suppose by some miracle, tax receipts had been 100 billion dollars more last year. Do you think the deficit would have been 100 billion dollars less? Don’t kid yourself. Government spending – the first year it wouldn’t have been 100 billion higher – the first year the deficit would have gone down by 20 billion, spending up by 80 billion. But then the next year the other 20 billion would have been gobbled up.
The simplest rule of politics is that government will spend whatever the taxes will raise plus as much more as they can get away with. So the deficit has been serving the very useful purpose of holding down government spending. Now that doesn’t mean deficits are good things. They are bad things. They are bad things because of their political effect. Economically, they really don’t matter very much in my opinion. But politically the possibility of having a deficit encourages the government to spend too much, and that’s why deficits are a bad thing. The way to solve that problem is through a balanced budget amendment, but that’s a very different subject.
I may say that I believe myself that the course of policy is ultimately determined by the course of public opinion, and the public opinion has made up its mind that it wants to hold government spending in total down and that it doesn’t want any higher taxes. That doesn’t mean – there is nothing inconsistent between that and the fact that everybody wants his pet project to be funded. That’s all right. Each one of us knows that what’s good for us is good for the country. But in my opinion, the basic fundamental force is change is public opinion, and therefore whether good or bad on other grounds – I don’t think that whether the Senate become Democratic or the next President is Democratic or not, is going to affect the situation. Walter Mondale taught the Democrats a lesson, that they cannot get elected on a platform of higher taxes and higher spending. And it is notable that this highway bill is the first major spending program that has really been passed in the past six years. The increase in spending has not come from new legislation, it has come from the carrying out of earlier legislation, the Social Security and welfare legislation.
Now I want to turn to the second of those two topics, inflation. Again, I’ve spent too much time on this, I’ll try to get through this subject and this area is even harder, because it’s the area where I’ve spent most of my professional life. I don’t mean in creating inflation, I mean in studying it. There’s a wide range of views in people about inflation. There are people who are worried about the fact that we are going off on an inflationary binge, and there are people who are saying inflation is dead, you don’t have to worry about it. I think that the way to get more perspective on this, as it is on so many things, is to get a longer view. If you read what is written in the papers, you will many times conclude that all of American History is divided into two parts: 1776 to 1985 and 1985 to 1987. Because people tend to look at the last two years and forget everything else. So I want to give you a very long view on the subject of inflation. (Pointing to chart.) This chart gives you a very long view on the subject of inflation, and I think it’s very instructive because I think it’s concerned with what it is that is fundamentally the source of inflation. Inflation, as I have said over and over again, is primarily a monetary phenomenon. What I have in this graph is a record for 100 years, a century, 1886 to 1986. And it has two lines, which go so closely together that for most of the period you can’t tell the difference between them. Which is the whole point of the graph. One of those lines is the amount of money per unit of output. That is to say, the amount of money has to be compared to the amount of goods and services that that money is going to buy or sell. So it’s the amount of money per unit of output. The total number of dollars in the country divided by a measure – well, let me go back. Obviously the unit of output is arbitrary. But don’t worry about that, because the way I’ve drawn this graph is I’ve constructed some figures, wherever figures were available, and then I said, “I want to be able express everything as a percentage of the average over the period of the whole.” So what these numbers are are percentages. What this says is that in 1985 the amount of money per unit of output was four times as high as it was on the average of the whole 100 years. And back in 1886 it was about 25 percent of the average for the whole year. So I’ve done that for money per unit of output. And I’ve done it for a price index. It’s called the deflator on there – don’t let that deflate you. The deflator is just simply a particular price index, a measure of how much on the average goods and services are. And that said, for example, that the averages prices in 1986 were four times as high for the 100 years as a whole. Now the crucial thing about the graph, and that stands out clearly, is that they are mirror reflections of one another. They fit on top of one another. You can draw that graph for Brazil or for Argentina, or for any country you want, and you get the same result. Money is the dominant factor over long periods – let me emphasize long periods – it’s the dominant factor over long periods and determines what the inflation rate is going to be. What the level of prices is going to be. (Pointing to chart) You’ve got some discrepancies. This is World War I, this is World War II, and you can understand why these things should go somewhat astray. The interesting thing is that when one of these lines moves away from another, they tend to come back together again. That’s the story of the past 100 years.
Now, the second point I want to bring about is the difference between this part (pointing to chart) and this part. Here you have a very long period in which prices, if not perfectly stable, are nonetheless relatively stable. And in fact prices in the United States in 1930 were roughly the same as they were in 1830.
So over that period you don’t have to have any inflation. What happened was two wars, the Civil War and the First World War, doubled the prices and, after the war, they came back down again. All of a sudden beginning after World War II and at an accelerated rate at the beginning of 1971, the thing gets out of control. The money per unit of output zooms up, and prices zoom up. Why? Well, that’s the story of gold versus paper. That’s the story of the fact that the monetary situation of the world since 1971 is without precedent in history. Historically money has always been linked to commodities. Not necessarily to gold, sometimes to silver, sometimes to stones, sometimes to feathers, literally, sometimes to cowry shells, Indian wampum. But money has been linked to commodities. There have been breaks in that, like our greenback period, like Britain after the Napoleonic war, when countries have departed from the gold standard, they have come back to it – or from the silver standard or different commodities. But since 1971, is the first time in the history of the world, that every major country in the world is on a pure paper standard. And the virtue of a gold standard is that it does give an anchor to the long-term price level. Because gold is physical, it’s limited, you can’t increase it. The vice of a paper standard is that there is no such limits. And historically, paper standards have led to runaway inflation. But let me hasten to say, in this description I am not making a case for gold. On the contrary, I am not in favor of a gold standard, because while it has a virtue of giving this long-term stability, it does not give you short-term stability.
What you have here (pointing to new chart) is taken from the same data, but it shows the year to year fluctuations. The fluctuations in the price index and in money supply. And you will see that in the very period when prices on the average were stable, they fluctuated the most from year to year. You had the most instability, the widest cyclical fluctuation, ups and downs in the economy. The period from here on, the first period in which this line is always above zero, the rate of growth is always above zero, is also a period when you had short-term greater stability. So while the gold standard gives you long-term price stability, it gives you – it is not inconsistent. After all, we had the Great Depression under the gold standard, we had the Depression in 1920 and 1921 under the gold standard. The gold standard did not stop prices from doubling during World War I, they did not prevent prices from coming down by 40% or 50% from 1929 to 1933. So the gold standard is no panacea, regardless of what the gold bugs may say.
Now in 1911, the greatest American economist, Irving Fischer, said in one of his books and I quote, “Irredeemable paper money has almost invariably proved a curse to the country employing it.” And he was right as of his time and he’s been right since, up to 1971 at least, and he’s been right currently for countries like Argentina, Brazil, Israel, which have employed irredeemable paper money. It’s almost always runaway. But I am not a pessimist myself with respect to the irredeemable paper money situation in the world today. I think that we have to recall that we’ve been in a transitional phase, an experimental phase of moving from one basic system to another basic system, and we’re just finding out how to run it, and from 1971 to now is only 16 years which is not very long in the history of the world.
I may note that the departure from gold was a very gradual process. We departed partly in WWI, partly again in the 30’s, partly again in the 40’s. 1971 just happens to be a convenient marking point because it was on August 15, 1971 that President Nixon closed the gold window and put a formal final terminal to the Brettenwood (**) system.
But the point I want to make is different. You have to ask, if you’re going to talk about the future prospects, you have to ask why inflation occurs. I’ve answered that in one sense but not in another. It occurred because we printed too much money. But you have to ask why did we print too much money? And the answer has always been very simple. The fundamental reason why too much money has been created is because it’s a very nice way to impose taxes on the people to pay the expense of the government. Everybody here would love to have a printing press in his basement on which he could turn out green pieces of paper and the U.S. Government is no exception, it loves it.
So historically, most major inflations have occurred as a way in which government can impose taxes.
Now let me note that deficits per se are not inflations. During the great depression, 1929 to 1933, when prices were falling drastically, we had deficits every year. Whether deficits are inflationary or not depends on how they are financed. If deficits are financed by borrowing from the public, the government has more to spend and the public has less to spend. But deficits that are financed by printing money are inflationary. Now governments have found that printing money is a very good way to get finances for spending and that’s been the major reason.
How do you get revenue from inflation? There are three ways. The pieces of paper you print enable you to buy things and that’s the direct way. That used to be very important. But as our banking system has become more and more complex, the amount of paper or the equivalent – what economists call high-powered money – the stuff that the government prints and gets the benefits from, has become smaller and smaller relative to the national income. It’s now about 6% of the national income. So even if you inflated it every year at 10% a year, that would only yield you six-tenths of one percent of a year’s national income as revenue. That’s a lot of dollars, but for a government that is spending 30% of the national income, it doesn’t go a great deal to finance activity. That has not been the most important way.
A second way you get money is by repudiating the debt. When you inflate, the bonds that you issue become worth less in terms of what they can buy. The biggest bucket shop operation in the history of the United States was the sale of U.S. Savings bonds during the 1940s and ‘50s and ‘60s and ‘70s. Anybody who bought those bonds, 10 years later got back an amount of money which was less than he had paid in the first place in terms of purchasing value. Everybody is complaining about the federal debt now. In 1946 at the end of WWII, the federal debt was over 100% of the national income. We paid it off. We didn’t pay it off because we ran surpluses in the formal books. We paid it off by inflation. We paid it off by repudiating it. By the fact that the interest rates were less than the rate of inflation, and by the 1970s the debt was down to about 25 or 30% of the national income. Everybody is now complaining, but it’s only up to about 35 or 40% of the national income. Much less than it was in the 50s and 60s when nobody was talking about it. But that’s the second way you get revenue is by paying off the debt.
The third way, and the most important way is what I mentioned before, bracket creep, by pushing up taxes in the higher brackets. The reason I am confident about the future –
Werner Erhard: Could you say a little bit more about bracket creep. It’s not clear –
Milton Friedman: Okay. Bracket creep means – you adopt an income tax schedule which involves paying, let’s say, 20% at an income of $10,000. When $10,000 means something, when $10,000 is a middle class income. Now, prices double. $10,000 is now the equivalent of $5,000, but the tax rate is still 20%. So in effect you have imposed the tax on a lower real income than you intended. And everybody gets pushed up into higher tax brackets and pays more.
I remember a breakfast meeting I once had with the Senate Finance Committee about 15 or 20 years ago when Senator Long was the chairman. The breakfast meeting was indeed in connection with the fact that I was trying to propagandize them to index the taxes. Jim Buckley, the Senator from New York, was very much in favor of it, and as a result he didn’t get re-elected. Good ideas are not necessarily politically profitable. At any rate, Sen. Long said at that time, “You know, we never could have enacted through the legislature the tax rates that we now impose on people of low and middle income.” He said, “When we passed those rates, they only affected high income people, and now they are affecting low and middle income people. We couldn’t have done that.” But inflation did it for him. And that’s why inflation was such a godsend to the politicians. But, and here’s the key point, the profit has gone out of inflation for the government. Indexing the tax system reduces any possibility of benefiting by bracket creep.
The public has gotten wise to the fact that it’s not sensible to buy a government bond at 4% when inflation is 5% or 6%. And so the government has had to make its debt much shorter term, shifting from long-term to short-term debt. You can’t make much out of short-term debt, you have to inflate real fast and real hard to get anything out of that.
In the third place, the development of this market has been such that any sign of inflation is immediately reflected in long-term bond yields. So again, the government can’t really issue any long-term bonds. Nobody is willing to buy them. The result is that most of the profit has gone out of that source of revenue. And as I said before high-powered money has become a much smaller fraction of the total.
So all told, it’s no longer anything like it’s politically profitable to inflate. Moreover, the public at large because of the experience it had in the 1970s is much more directly concerned about inflation. Why has Germany had so much better outcomes in terms of inflation? Believe it or not it’s because of what happened in 1919, 1920, after WWI when Germany had a hyper inflation and that sensitized people for a very long time, and that’s still there, still present. The same thing is true in Japan. So my own belief is that we are going to have, over a long period that this money system will be consistent. We will have to develop some mechanisms to make it so. I have proposals and suggestions and so on. They won’t be adopted, but something will be.
Let me only say one more thing. From 1960 to 1980 we were on what I have described as a roller coaster of inflation around an upward trend. We had generally climbing inflation, going up and down. Beginning in 1981 or so, we turned around, we are now on a roller coaster of inflation around a downward trend. The trend is downward, but the roller coaster is still there. And therefore I believe that we are at the bottom of one of these roller coasters loops, and that in the next year or two we are going to have significantly higher inflation. But I don’t believe that that’s a sign that over the next 20 years we will. I think that what it will be is a roller coaster around a continued declining trend.
I have been taking too much time on this. I’ve overstayed my leave and I haven’t gotten to the third point I want to talk about.
Werner Erhard: Would you take a few minutes and just speak about the third point, at least to touch on it?
Milton Friedman: I would be glad to and that has to do with protectionism and balance of payments deficit and I will have to be very brief and dogmatic. Not that I haven’t been, dogmatic, I mean. You’ve heard a lot that all these Japanese imports are losing jobs. About the balance of payments deficit and the fact that we’re spending more for foreign goods than they are spending on us, and that that’s losing jobs. Now I ask you only one question: If balance of payments deficits lose jobs, what should be the effect of balance of payments surpluses? They should create jobs. Well, let’s look at the experience. The United States has had big balances of payment deficits. In the last six years we have created something like 10 million jobs. Germany has had big balance of payments surpluses. In the last 10 years the number of jobs in Germany has gone down. Well, if deficits lose jobs and surpluses create jobs, how can you reconcile that? What’s true of Germany, I must say, is true of the whole common market. It’s true of Japan. Jobs in the United States have gone up much more rapidly than in Japan who just had a big balance of payment surplus. Why is that? It’s because what balance of payments deficits do is to lose some jobs and gain other jobs, and the jobs that are gained are more numerous than the jobs that are lost. You lose jobs in the industries which become non-competitive in exports, namely automobiles, for example, steel. On the other hand, the counterpart of the balance of payments deficit is a capital accounts surplus. What’s happening to those dollars of foreign surplus? They are buying bonds of the U.S. Government, they’re buying stock on the stock exchange, they’re building factories in Tennessee. Those create jobs, but they don’t count on the balance of payments surplus as exports. If one of those factories that was built in Tennessee by a Japanese auto company – if you could put it on a boat and ship it outside the country, it would count as exports. But because it stays in this country it doesn’t count as an export, but is there any difference economically?
So the whole idea that balance of payments deficits lose jobs is a bunch of nonsense. In my opinion our balance of payment deficits over the past five years has been a sign of American strength and not a sign of American weakness. Why has it been a sign of American strength? Because it could only exist because foreigners wanted to invest in the United States. Now why is it a sign of our weakness if the Japanese believe that their money can earn more in the United States than they can earn at home? And ought we to complain about that? If the Japanese want to invest – now, we have a lot of complaints about subsidies to foreign exports. Tell me, do you complain when someone gives you a gift at Christmas time? Should the countries to whom we are giving foreign aid complain that we’re giving them gifts? If the Japanese want to give us foreign aid, why should we refuse? If they want to sell us goods and take pieces of paper, we can print them all the pieces of paper they want. Now they don’t. The Japanese are not foolish. They are intelligent people who want to get the most for their money, they are not going to give things away. What they have been doing is to say, “Gee, the American industrial climate is more satisfactory than our own. We can do better by investing in the United States than we can in Japan.” So they are investing in the United States and that’s very good for us, because we’ve been having less sales.
I must confess, I can’t go into all these – I’ll only say that most of what you’ve heard is a bunch of nonsense. We are just as restrictive and departing just as much from free trade as the Japanese are. The Japanese do depart from free trade, we depart from free trade. Their customers pay four times as much for meat as the world price. Our consumers pay four times as much for sugar as the world price. And I can go down the line. We are just as bad as they are. But of course it’s easier to see the mote in another’s eye than it is to see the beam in our own, as I think is a quote from some eminent source.
The long and short of this is that we have been engaging in protectionism, primarily because the people who benefit from protectionism are few and concentrated and their voices are loud. The people who benefit from free trade are all of us, the consumers as a whole, and our voices are soft. And that’s why we have been engaging in protectionism. And I think – I am a strong supporter in general of President Reagan. I support him in most of his domestic policies, but the one area in which I think he has done the least well, in which I think he deserves a great deal of criticism, is for his support of a large number of protectionist measures beginning with the so-called voluntary restraint on the import of Japanese cars, going on to the similar restriction on steel imports, textile imports, sugar quotas, and most recently this absurd and stupid policy with respect to microchips. Let me close there.
Werner Erhard: Professor Friedman, I want to go over some of what you said and ask questions that will help you to summarize for us, so that we have something we can take away, like a place to focus, now that you’ve given us a certain background in it.
Your first point, I believe, was that while the deficit may not be a great thing, in many ways, what we should really be concerned about, what we should be focused on, and what we should expand our understanding in is government spending. And understand what government spending is and the kind of forms that it takes. Have I followed what you were saying there and that that’s where you’re coaching us or recommending that we focus?
Milton Friedman: That’s right. Let me say one more thing about government spending. As I say, total government spending is now of the order of over 40% of the national income. To put it in a dramatic way, everybody works from January 1st to early June to pay the expense of the government. Now, there would be nothing wrong with that if we were getting our money’s worth. That’s a crucial point. Are we getting our money’s worth? And there is really nobody – very few people in this country, who think we are getting our money’s worth. And it doesn’t matter what you look at. Are we getting our money’s worth for the welfare expenditures? The objective is splendid. Everybody wants to help the poor and wants to reduce poverty. But since the Great Society programs have been introduced, they have been counterproductive. The number of poor has been going up, not down; we’ve constructed a system in which we encourage people to get on welfare. I don’t blame those people, don’t misunderstand me. It’s not their fault. They are just responding to the incentives we’re giving them. It’s our fault for constructing such a very bad system.
So go down the line and ask yourself: which government spending – are we getting any benefit from spending $18,000 per year per person employed in agriculture? Government spending on agriculture is greater than the total net income from agriculture. It’s mostly being wasted. The only parts of agricultural that are healthy are those that don’t have government assistance. In general, and this is a very important point, so-called government assistance is a kiss of death. Agriculture, since 1934, has been a kiss of death. Automobiles, it’s been a kiss of death. Steel, it’s been a kiss of death. You go down the line. You try to find a single example in which a government program has done what its well-meaning sponsors wanted it to do. I’m not questioning the objectives of the programs, but it’s not an accident that one after another has counterproductive events.
I once wrote a Newsweek column on this subject, on the question of the fact of why good laws do harm – laws that do harm. And at the end of it I asked people to suggest some kind of a catchy phrase to describe this, like “so-and-so’s law” or something like that, that people would catch onto. And the best suggestion I got was that it was the invisible foot of government.
Werner Erhard: We have two questions from our audience that are in this realm of a concern for government spending and our getting maybe more savvy about it, a little more educated about it, a little clear insight. But there seems to be two areas in which there is already a concern, that I would like you to speak about. The first question is: Is there a role for government, and taking care of such basic human needs as food and shelter for those unable to help themselves? And if not, should it be done at all, and if it should, how should it be done, if not by the government?
Milton Friedman: That’s a very complicated question, because it depends on where you start. I personally do not believe that in my ideal world, in my utopia, this is anything that government ought to be concerned with. I think it does it badly, and I think private charity, private human person to person connection is much more effective. But we are not in my ideal world. We are not starting with a clean slate. We are starting with a situation where we have constructed a great many programs under which we have made a great many people dependent on government. And under those circumstances, I have never been in favor of simply abolishing them altogether. I have been in favor of trying to move in the direction we want to go to, for many many years, by saying, “Instead of this whole host of special programs – what is it, I think there are something like 160 separate programs, individual programs which are directed at one or another of these aspects. I have always been in favor of abolishing them all and replacing them by a single program which I have called a negative income tax, other people have called a reverse income tax, you can have whatever name you want to. But the idea of it is we can’t simply throw these people out in the street. That would be intolerable and inhuman. What we do would be tied into our tax system. Everybody who has an income above a certain level pays a tax. Everybody who has an income below that level receives part of the difference, not all of the difference, but at least part of the difference back as a subsidy, and that would mean that you would in effect set a minimum amount that everybody would receive. We needn’t go into the details of it, but you can see the idea of it. Since I first suggested this 25 years ago, it’s become fairly widely known and I think most of you have become familiar with it.
It’s a very difficult thing to do and to get passed. The reason it’s so difficult to get passed is because there is no way you can pass it without some people getting less than they are now. Now some people ought to get less than they are now. A great many people ought to get less than they are now. We now have a program in which some poor fall through completely all the holes and some are able to do very well by combining a half a dozen or a dozen of these different programs. And the range of incomes, it’s incredible. I don’t know if any of you have ever seen figures on the average income of the people who are receiving welfare benefits. It’s extraordinary. It’s very close to the average for the country as a whole. Put it differently. If you were to say, “We’re just going to give everybody who is below the official poverty line” — which is a lousy measure, but it’s the only one we have – “everyone who is below the official poverty line we’re going to give them enough to bring them up to the poverty line.” That would cost something like 20% or 30% as much as what we’re now spending on programs for the poor. Most of it doesn’t go to the poor. And the great support for it doesn’t come from the poor, the great support comes from the bureaucracy that administers it, and that’s why it’s so hard to get rid of.
But at any rate, that answers your question about what my views are. Of which way we ought to be moving.
Werner Erhard: So I hear you saying that it’s a problem that we can’t ignore because to some degree we’ve created it ourselves with our past policy. By the same token, it’s a problem to which we don’t have a current answer – that is to say what we’re doing hasn’t been effective, and it’s something that needs serious thought, and you’re proposing what you term “negative tax” as one of those serious thoughts, like a real answer to the problem.
Milton Friedman: That’s right. There is at the moment a great deal of activity in this area, and the White House task force has produced a welfare reform program. The Governors in their convention have come very close to agreeing on that, Democrats and Republicans. And there is some chance that you will have legislation this year, which will not go all the way, but which may improve matters by consolidating some of these programs and most important of all, by assigning more responsibility to the local governments and less to the national government. It’s absolutely absurd that Washington should be figuring out how things have to be handled in Arkansas.
Werner Erhard: Okay, I’m going to give you a big hole. I’m going to give you a hole big enough to drive a truck through, so I’m going to ask this question in order to accomplish that. The people in my community who I see suffering, that concerns me. What does it cost me to be concerned?
Milton Friedman: I believe that the worst thing about the government assuming responsibility for all this, is that it puts you in the position where you can say, “Well, I don’t have to do anything because I’m paying my taxes and the government is doing it.” I think that the government assumption of responsibility for this has destroyed private charity. It’s very interesting to look at the composition – there’s a lot of talk about how much money private people contribute to charity. It’s very interesting to go beyond those totals and look at what the money is being given for. Fifty years ago, 75 years ago, a very large fraction of that money would have been going to help the poor. It would have been going to support hospitals or it would have been going to direct relief to poor people. Today a very small fraction of total private charitable donations are going that way. They are going to support museums, art institutes, ballets, symphonies and things like that. Why? Understandably. “The government is taking care of that. I’m paying for it through my taxes.” It would be a much healthier world in which we individually felt an individual responsibility to do something about it, and we would be doing a lot better if we did that, because we individually and in person-to-person relationships with people are a lot more effective than a harried government bureaucratic worker, a perfectly good worker, a good person, but she’s got more cases, or he’s got more cases on his list than he can handle, and he has to fill out mountains of paperwork. That’s a lousy way to solve this kind of a problem.
Werner Erhard: Okay, we’re still in the realm of spending, and what I as a citizen should begin to get savvy about. We’ve talked about one side of government spending, the side, let’s call it for shorthand, welfare. What about the defense budget side? For example a lot of the people listening and watching here today are concerned about ending hunger. And we’ve heard things like if we took – I don’t remember, I think it’s 3 weeks of the international budget for defense and devoted it to programs for development that we could probably end hunger in 20 years.
Milton Friedman: Well, I’m not going to comment on that final statement, which I believe is very optimistic, because I don’t believe the problem with achieving development is the problem of making money available. On the contrary, I am backward enough to believe that most of our foreign aid assistance to other countries has promoted the opposite of development, that it’s done more harm than good. But that’s a wholly different question that we won’t get into.
But let me go to your military spending. There is a general rule and a rule of thumb and a great deal of evidence that anything that government does costs on the average twice as much as if it’s done privately. If you compare the cost of running buses, which has been done worldwide, comparisons have been done in India and so on, and you have a very interesting study in which they compared the cost of running buses when the buses were privatized and when they were government owned, and one is half the other, the government is twice as much. And study after study has given about a two to one ratio.
So I have no doubt that we could get the same degree of military defense for half the money we are now spending. If – and that’s the problem, that’s the catch – If it could be done privately. But it can’t be done privately. I’ve worked for many years to try to find some way to privatize the military system and I haven’t been able to come up with anything. Maybe other people can. But as long as the government is going to do it – and we have to have a defense – we’re going to have to reconcile ourselves that we have to spend twice as much as is necessary. We’re going to have to reconcile ourselves that we have about three times as many military bases as make any political sense. Not because the military-industrial complex wants them, but because every congressman wants a military base in his area. We’ve got one right here in San Francisco that it’s very hard to justify.
Werner Erhard: That’s San Francisco harbor, you mean.
Milton Friedman: No, I don’t mean San Francisco harbor. But you won’t find very many people in San Francisco who will be in favor of abolishing the Presidio. How many people will you find in favor of abolishing the Presidio? I don’t know if that’s one of them, but the military has made a list of hundreds of military bases that from a purely military point of view that they would like to cancel. It’s not uninteresting. You know that the Graham-Redman (**) bill which provided that there would be – in case the Congress didn’t cut the deficit enough – that there would be automatic cuts. Fifty percent to the military and fifty percent to other things. But they exempted from the military cuts all military bases.
So when people talk about waste in the military, for goodness sake, don’t talk of it as if it’s the military people, or the industrial – I don’t doubt that the military people are responsible for some of the waste. I don’t doubt that the industrial people are. But the main source is to be found on Capitol Hill in Washington.
So go back. I believe that it is true that we could get it more cheaply, but we’ve got to get it through government. And there is no way that we can get it without incurring these wasteful expenditures. And I believe that defending the nation is the first and primary responsibility of the Federal Government. And then when you look at the facts, it becomes even clearer.
The fact is that 30 years ago, 40 years ago, defense expenditures were 50 percent of the Federal budget. They are now less than 25 percent of the Federal Budget. Defense expenditures are now about 6% or 7% of the national income, and 30 or 40 years ago, they were higher than that.
Werner Erhard: In times of peace?
Milton Friedman: In times of peace. Yes, even after Korea. Before Korea, before Vietnam, defense spending was then about 7 or 8 or 9% of the national income. Now, before World War II they were lower. They were on the order of 1-1/2 to 2% of the national income, but that was a different world. I don’t mean by any means to be defending our present foreign policy. As it happened, I personally am in favor of pulling out many of our troops from Europe. I think we ought to maintain our defense agreements with Europe, but we put troops in there right after WWII when they were perilous and we were not. The European continent now has a larger GNP than Russia does. It’s perfectly capable of paying its own way. It spends 3 or 4% of its national income on defense, we spend 7% on ours. I do not see any justification for our financing their defense, although I see a great deal of merit in our cooperating together for our common defense, which is a different question. That is, I’m trying to show I’m not an isolationist, at all – and I believe that would mean a considerable savings. But I think the only way in which it is responsible to speak about reducing military spending is in terms of changing our military policy or strategy around the world by reducing our commitments abroad. And it is absurd and it is really irresponsible to talk, as so many people do, like, “Well, you might as well waste money on this, because we’re wasting so much money on the military.” It’s not part of government’s function to waste money by building unnecessary bridges. It is part of the government’s function to waste money by having an effective military. I’d prefer they didn’t waste money, but I don’t know how to avoid it if the government is going to do it. We waste more money on the Post Office – as much money on the Post Office. That’s not a government function either and we could get rid of that easily. There is no reason why we shouldn’t get rid of the post office and make it into a private enterprise. UPS has done half of it already. And Federal Express and the rest of them are on the way.
Werner Erhard: Professor Friedman, I’m going to shift from the arena of spending, although there is obviously a lot more to be said there, to the issue of taxes, and ask you to speak about what drives the tax system. I think you have something – a bit different view than a lot of people.
Milton Friedman: The tax system as we have it in the United States serves two functions. One function, the one you are all familiar with, is to raise money to pay for government spending. But it also has a very very different and very important function, and that is to raise money for congressional campaigns. Let me prove that to you very quickly. For the Nation’s health, there is not doubt that it’s insane to have a new tax measure every year.
Werner Erhard: Can you say a little bit about why.
Milton Friedman: Sure. We ought to know what the rules are. We ought to know how to conduct our business, what taxes we are going to face. It’s absurd that every year everyone in the country should have to figure out, “Now, gee, how do those new changes in the tax law affect me?’ Every business, no business can plan more than a year ahead on the basis of knowing what the tax structure is. Have a good tax structure, have a bad tax structure, whatever you do, it ought to be the same for some period – five years, ten years, and then change it if you have to.
In practice we have a new tax measure every year. Why? There is no doubt what the answer is. One of the major sources of funds for many Congressmen, campaign funds, are from people who want loopholes put into the tax law or want them taken out, or want some change in the tax law, or want to prevent them from being taken out. And so members of the HouseWays and Means committee, members of the Senate Finance committee, associated members, get a large fraction of their campaign funds from people who are interested in changing the tax law. Why did we get a tax reform act last year? You will realize I’m a cynic in these matters. I would rather say a realist, but – Why did we get a tax reform measure last year that was so drastic? It wasn’t because for 25 years I have been urging a flat rate tax. I assure you that wasn’t the reason. It wasn’t because President Reagan has been in favor of a lower tax rate all along.
I think the reason is very different. Year after year we have had this process whereby the tax system has been made more and more complicated, by introducing one special privilege after another. And when the Congress started working on the tax reform bill this year the same thing happened along that line. The Senate started along that line, but they discovered much to their concern that the blackboard was filled. There wasn’t any more room for special measures. There was no way in which they could put in all these special measures for their special constituents without completely destroying the tax base and having no revenue. What do you do under those circumstances? You wipe the slate clean and start over again. And so it was in the self-interest of the Congressional tax writers and of the lobbyists, because if there was no more room there, the lobbyists were going to get squeezed out of their jobs. There’s nothing for them to do if they can’t produce changes. So I interpret this as some sort of an unholy coalition between the tax writers and the lobbyists that they would wipe the slate clean and then beginning next year they will start back again to stick in these things. They didn’t even wait until next year, because they had this collection of so-called transitional provisions which enabled them to stick in a bunch of special privilege exemptions and buy off this congressman and that congressman right away.
Now the new tax law is a vast improvement over the older one. It’s not as good as what I would like. I would like a very simple flat rate tax system which had a flat rate on all income with no deductions, only a personal exemption. But you’re not going to get that and this is much better than what you had before. But I am very dubious it will last, because the first thing that is going to happen is you’re going to have loopholes stuck back in it as these pressures come up and then a year or so from now, you will start having rates raised again. There is nothing that has been done that prevents the process that produced our monstrous tax system that was in effect last year from being restored again over the next 10 years.
I think the only real way to get effective tax reform would be by constitutional amendment that would amend the 16th Amendment, the income tax amendment, to say that Congress may levy taxes on income from any source provided that there is a single flat rate on all income, and provided that there are no deductions except for strict occupational expenses and personal exemptions. That would be a very simple amendment to write. I believe if it were put to a vote of the American public it would be overwhelmingly adopted. There is no public support for our present income tax. It’s very interesting.
People used to be concerned with what would happen to democracy. They’d say the have-nots would vote to take it away from the haves. That’s nonsense if you look at the record. In the last 10 years you’ve had about half a dozen states which have tried to impose more graduated state taxes. In every state that’s been defeated by the vote. States that haven’t had an income tax have tried to introduce it – was Connecticut one? I think so. I’ve forgotten – but one of the New England states tried to introduce an income tax and it was voted down. In Massachusetts they tried to steepen the rate schedule, it was voted down. Same thing has happened, I think, in the State of Washington.
So the public has spoken very clearly that it doesn’t like the present system. I personally believe that the system we have here in California of public referenda, is a very good system. I’d like to see that system on a national scale, because frankly I have much more confidence in the public at large than I do in the collection of people whom they send to the Congress and the Legislatures to represent them.
Werner Erhard: I like the term that you use: political profit, because it gives a bit of a different perspective on the actions of the Legislature. I mean it’s kind of easy to think about people pursuing profits, and it gives you a different perspective on the actions of the Legislature, when you think that that Legislature may be in business for political profits.
Milton Friedman: It sure does. And you should look at it that way. They’re not – they’re human people just like we are. We’d do the same thing. It’s not that they’re any worse than we are. The notion that somehow or another simply by electing a man to the Legislature, you’ve converted him into somebody who is going to have regard only to the public interest and not to his self-interest. That wouldn’t happen to any of us. As I said before, it’s not that people are dishonest. But you talk to a Legislator, and he’ll say, “Well, there are lots of good things I want to do, but I won’t be able to do them unless I get re-elected.” So the first necessity is to get re-elected. How do you get re-elected?
Werner Erhard: Okay, I want to go into the second area that you spoke about with regard to inflation and an important part of what you talked about there was some sort of a standard, e.g. the gold standard. And I just want to check with you that what a standard accomplishes essentially is a lid on the printing of money or what you call – I think you called it high powered money. And that’s really its value?
Milton Friedman: That’s right. It sets a physical limit on the amount of money that can be created.
Werner Erhard: So what I don’t understand is why is that necessary or why is that good, given what I think I remember from your charts, we’ve had a greater degree of year to year stability without a standard, so why are we worried about having any kind of standard?
Milton Friedman: because while we had a great degree of year to year stability, we had a greater instability over longer periods. We had the roller-coaster of inflation from 1960 up to 1980. I don’t think anybody here liked that, nobody here thought it was really healthy for them or anybody else to have inflation rates …
Werner Erhard: Can you blame that on the lack of a standard, given that you had those kind of things, at least as I thought –
Milton Friedman: No, you’ve had the instability, but you haven’t had this upward acceleration. You’ve never had before a period in which over 20 years the rate of inflation went from essentially zero to about 20 odd percent. You’ve never had that situation, and that is –
Werner Erhard: And that you say is a product of the lack of a standard.
Milton Friedman: No question. Well go back to earlier episodes with paper money. What happened in those cases is that this thing simply ran away. You couldn’t stop it. You take the hyperinflations after WWI in Germany, for example, when at the height of the hyperinflation, prices were doubling every day. When people were getting their pay 3 times a day, breakfast, noon and supper so they could go out and spend it before it lost its value. When John Maynard Keynes on a visit to Russia, which after the revolution was having a similar hyperinflation, saw a man pushing a wheelbarrow full of paper money – literally a wheelbarrow full of paper money, as fast as he could go to trade it in for buying some goods before it depreciated in value. And he said now I really have seen velocity of circulation of money. And you don’t have to take such extreme episodes. Take more recent experiences – take the experience of countries like Argentina and Brazil and Chile and Israel. And in each of those countries you have seen the bad effects of just paper money and having nothing to tie it to – no standard.
You see, the problem – let me put the problem to you this way, because I think it’s the simplest image. Inflation is really the same phenomenon as alcoholism. It’s not only that both reflect excess liquidity of different kinds. That’s true. But I mean something more than that. The good effects when you start drinking outweigh the bad. The good effects come first. You feel fine. We all know what we feel like. The bad effects come only later. Moreover, if you become an alcoholic it takes more and more of the alcohol to stimulate you, to get those good effects, and the bad effects get worse and worse. And ultimately you get to the point where everything is bad. Now inflation is really precisely the same thing. If you start with inflation, the good effects come first. You start printing money. People don’t recognize what is going on, the economy is stimulated in the short run.. You have the economy moving up. John F. Kennedy said in 1960, let’s get the economy moving. He did, by printing money. So printing money had good initial effects. But there was a hangover. As people caught on to what was going on, prices started to rise and as prices started to rise, you wanted to stop that, so you slowed down the monetary growth temporarily, just as a drunkard slows down the amount of alcohol he drinks, and that causes the bad effects of a recession that people didn’t like – higher interest rates that people didn’t like. And to make the image exact, each episode you have to put in more and more, just as the alcoholic has to drink more and more. To get the same good effects you have to print more and more. To begin with if you print 10% more money, maybe 8% of it will come out in output and 2% in price. The next time for 10% you’ll get 6% output and 4% price. And ultimately, you’ll get minus 5% output and 15% price.
So inflation has a problem that its initial effects are good and its ultimate effects are very bad. And in order to avoid getting into that, because the short-run temptation is always to push it out – you have to have some kind of a standard, some kind of a rule, some kind of a control that will set a limit to the amount of money that can be produced.
Werner Erhard: Since the – this is probably not quite accurate, but since this is the way the public sees it, since the guy who determines how much money gets produced is not a guy that we vote for, I’m just wondering what your assessment of Mr. Volker’s performance has been.
Milton Friedman: Well, Mr. Volker is a very smart, able man, and I don’t think one can talk about Mr. Volker’s performance. I have been a student of the Federal Reserve for many years, I have studied its history, and you cannot know – knowing the name of the Chairman is of very little help in knowing what the Federal Reserve does. The Federal Reserve is a large institution that is subject to political forces. You’re better off knowing the name of the President than knowing the name of the Chairman.
Werner Erhard: The President of the United States.
Milton Friedman: Yes. Now I would say that the monetary policies of the Federal Reserve during the past 7 years, since Mr. Volker has been Chairman, have been a mixture of good and bad. The bringing down of inflation, which was accomplished by the initial restraint was good. The fact that he has followed a very erratic, up and down policy has been very bad. And he’s responsible for the reason why interest rates fluctuated around so much, why the economy was so much more unstable in 1981, 1982 and 1983 than it needed to be, and in that respect I think his policy has been very bad. I don’t mean his policy, I mean the Federal Reserve’s policy. And one of the reasons why I said I believe that we’re heading toward a short-term uptick in inflation is because the amount of money that has been created has been too great over the last two years. And it takes about two years before it flows through into prices, and that’s why I think there is going to be a short-term uptick in prices. So I would give a mixed bag, but I don’t really want to blame any individual. I think it’s the system that is at fault and not the individual, and I personally would like to adopt a system which would make it unnecessary to have a Federal Reserve. I don’t think there ought to be a Federal Reserve system. Now there isn’t time enough for us to develop that, but I assure you that this is not a casual comment, not an off-the-cuff comment, but it is one that is based on a great deal of research and thinking. That doesn’t mean it isn’t wrong.
Werner Erhard: That kind of takes me into the last area that I want to ask you to speak in, and it’s the dilemma of the rest of us – so I’m going to split the world up into the economists and the rest of us. And it’s the dilemma of the rest of us. And I want to make a broad question, so I will give you lots of room to roam around in, and you find where you think is the most useful place to roam. First off, I’m curious about whether there is the possibility in the science of economics for breakthroughs like we’ve seen in some of the other, usually physical sciences, life sciences recently. But I’d like you to answer that question also with an eye towards and actually deal with what are the rest of us supposed to do when unlike physicists, for the most part, or chemists at least as we see it, you all don’t agree with each other. And not only that, but you all get filtered through another medium which has its own concerns and pressures on it – the media – before you get it to us.
Milton Friedman: Well, I think the contrast you’re drawing between economics, physics and so on is not valid. Physicists don’t agree with one another. You have physicists who are in favor of SDI and physicists who are opposed to SDI. The physicists agree with one another about the physical principles, but they don’t begin to agree with one another about how to apply those principles when it comes to policy. Similarly with economists. Economists agree with one another about economic principles. There is much less disagreement in that respect than most people think. They do disagree with one another when it comes to public policy.
People have different objectives about public policy, and they may agree completely about what the consequences of doing something might be, but one person likes those consequences and one person doesn’t. So I don’t believe that economics in this respect is any different whatsoever from physicists. Who should we listen to in physics? Now I think that filtering through the media has a very distorting effect in both physics and in economics. Let me illustrate. I understand that something like 90% of practicing physicists are in favor of SDI. Something like 10% are opposed to SDI. The news media is going to put on a program about SDI, on television. They want to present both sides. One person against, one person for. Public believes 50-50. In economics there is no doubt that 95% of economists are opposed to protectionism. There is one economist, a fellow in Wisconsin, who is in favor of it. It’s very hard to find anybody else. It is very hard to find anybody who is a professional economist who will come out and say a good word for protectionism. But if the media is going to put on a program, they are going to find that one fellow in Wisconsin and put him on against another economist. And that gives a wholly misimpression of the state of knowledge. And I believe that’s the real problem with the media. It’s not that the media are deliberately biased – they are, but that’s not the problem.
Werner Erhard: They are, like all of us are.
Milton Friedman: Like all of us are, sure. And the problem is that their medium makes it very difficult for them to present a fair image of what are the relevant positions on both sides. Now so far as economists are concerned, I don’t have any simple answers for anybody. I think people have to make up their own minds. They have to decide whom they trust, whom they believe in. And on most issues – you see, the real problem is that we should not be living in a world in which it is necessary for people to make such decisions. That is to say, in my ideal world, in the world in which government spends 3% of the national income – federal government, I mean – as it did up to 1929, 1930, the public at large doesn’t have to concern itself with any of these big issues. It can go about its business of using its own resources most effectively to promote its own good. That’s the way we grew, that’s the way we could have a tremendous growth now. The biggest thing that is standing in the way of tremendous growth in the United States are the obstacles and barriers that government has put in front of growth.
You asked what’s the harm done by this fiat standard. One of the harms done is that the ablest people in our society find it personally most profitable to spend their time doing things which is utterly of no value to society. You have the people involved in the financial markets – given the world as it is, it’s a perfect thing to do. Let me point one thing out to you which may surprise you in this respect. Before 1971, when the gold standard was terminated, there was not a single financial futures market. There were future markets in corn, in sugar, in pork bellies and so on. There were no financial markets. We now have the international money market in Chicago and foreign exchange, pounds, Yen, and so on. We have the futures market in government bonds. We have the futures market in stock markets. And why? The answer is very simple. Because the fiat money period, the period in which you have had no rules, has generated enormous uncertainty. The uncertainty may not have concerned year to year, but it concerned five year to five year and ten year to ten year. And it has concerned particularly because of the acceleration of inflation. It has raised enormous uncertainty and concerns about financial value. And that’s why you have this enormous proliferation of futures markets, which from a social point of view are mostly a waste. I don’t mean to say it would be desirable to abolish them – that’s like breaking the thermometer because it’s showing a high temperature. What we want to do is get rid of the causes of that uncertainty which led to their growth. And that’s why it makes so much difference whether you have real rules and you know what’s going on. Just consider the number of people who spend their lives computing taxes.
He says that’s the end so I’m supposed to exit to my left.
Werner Erhard: Professor Friedman, before you go, we want to thank you for your time and the contribution. I’d like to take a second to respond to your efforts with a promise that we’ll spend the rest of this series seeing if we can build on what you have shared with us to be able to be more useful to ourselves and thinking for ourselves in matters of economics. And I just want you to know what you can expect as a payoff for the time you spent with us. And thank you very much again for being with us. We appreciate it.
Milton Friedman: Thank you.
(Milton Friedman Exits)
END OF INTERVIEW
Stephen Jay Gould – Werner Erhard Interviews Author and Scientist in Intriguing Conversation on the Philosophy and Creativity of Science
Stephen Jay Gould (September 10, 1941 – May 20, 2002) was an American paleontologist, evolutionary biologist, and historian of science. He was also one of the most influential and widely read writers of popular science of his generation. Gould spent most of his career teaching at Harvard University and working at the American Museum of Natural History in New York. In the later years of his life, Gould also taught biology and evolution at New York University.
Gould was known by the general public mainly from his 300 popular essays in the magazine Natural History, and his books written for a non-specialist audience. In April 2000, the US Library of Congress named him a “Living Legend”.
This interview took place on December 12, 1987.