Schultz says Gov.-elect could follow in Reagan's steps.

FORMER U.S. Treasury Secretary George Shultz, sitting in serene retirement in his office on the campus of Stanford University, likes to tell this story about Arnold Schwarzenegger.

"Buffett and I"--that would be billionaire investor Warren Buffett, who with Shultz heads the soon-to-be-governor's team of informal economic advisers--"were doing a conference call with Arnold back in September. A number of businessmen had joined us. And one of them, a Latino restaurant owner, starts to push this driver's license thing."

That would be the new California law, signed by a desperate Gov. Gray Davis shortly before the recall election, allowing illegal immigrants to obtain drivers licenses.

"This fellow says, 'Arnold, all my employees are for it. All my customers are for it. You support this thing and I can guarantee you a lot of votes.'

"There was a long silence. Finally Arnold says, 'But I don't support it.'

"And this businessman says, 'But it would be very good for you,' and so on and so on.

"Another long silence. Finally, Arnold says, 'I'm sorry, I can't. What kind of governor would I be if I started supporting things I don't believe in?'

"Remember, this was not a public event for public consumption. This wasn't some kind of grandstanding, I just thought, Wow. Bam. What an answer. This guy's got it. This guy's the real thing."

A lot of people are puzzling over Arnold Schwarzenegger these days. Everyone knows--because the news reports keep telling us so--that he's a "social liberal" and "Fiscal conservative." But in trying to anticipate what kind of governor he'll be in one of the country's most liberal states, the more interesting question is, How conservative?

Shultz and Schwarzenegger were first drawn together by a shared admiration for Milton Friedman, the Nobel laureate and libertarian purist. Organizing an anniversary tribute to Friedman's TV series "Free to Choose" in 1990, Shultz asked Schwarzenegger to film a new introduction to the show. Schwarzenegger "enthusiastically" obliged.

"It was clear even then," says Shultz, "that he had a real understanding of Milton's ideas--that he understood the value of free markets and how they work."

When Schwarzenegger asked Shultz to join his campaign this summer, Shultz says be told him, "I can't help you unless we agree: The problem here in California is not taxes, it's spending. You start monkeying around with taxes, you're only going to make things worse. He agreed very emphatically."

Buffett's presence

Some fiscal conservatives fret about the hovering presence of Buffett, a traditional political liberal on matters of taxing and spending. Shultz answers those worries indirectly.

"Arnold understands you've got to divide the problem of the deficit," he says. "On the one hand, you've got the deficit in the state's operating budget. I can help him with that, on the spending side. On the other hand, you've got the problem of retiring all this debt that's been piled up. Warren knows something about restructuring debt, you know. That's where Warren can help."

Shultz dismisses the widespread criticism that Schwarzenegger's campaign was unduly vague about policy. "The press has him totally wrong," Shultz says. "There was more content to Arnold's campaign, in terms of policy, than any other I've seen in California."

Schwarzenegger's energy plan, Shultz says, was a model of specificity--and indeed it seems like a libertarian's dream.

"One of Gov. Davis's great errors was his delay in permitting retail prices of electricity to move with wholesale costs," Schwarzenegger's published platform said. "No market can function without proper prices." It called for abolishing the California Power Authority as a way of affirming the new administration's commitment to private power generation.

More clues to who the governor-elect is can be found in the transition committee. It mixes the unexpected (Ivan Reitman, director of several Schwarzenegger movies as well as the unjustly forgotten "Cannibal Girls") with the wonkish (Sally Pipes, head of the libertarian Pacific Research Institute), and the bizarre (Tammy Bruce, the nation's foremost rightwing lesbian political commentator) with the politically astute (Kevin McCarthy, a state assemblyman and former aide to U.S. House Ways and Means Committee Chairman Bill Thomas, who will help determine how much federal aid California gets).

The list reflects what Bill Whalen, a former political adviser to Schwarzenegger and now a research fellow at Stanford's Hoover Institution, considers one of the new governor's most notable characteristics--a lack of intellectual vanity.

"He knows his weaknesses and he's not embarrassed by them," Whalen says. "He knows what he doesn't know, which is why he's eager to seek advice."

And in that, Shultz says, the new governor reminds him a lot of another California governor.

"You people in the press got Ronald Reagan wrong, too," says Shultz, who served as Reagan's secretary of state after heading Treasury in the Nixon and Ford administrations.

"Everybody said, 'Oh, he's just an actor, he's vague, intellectually he's not up to snuff.' Reagan didn't mind. I don't think Arnold does either. Reagan even cultivated that image--he wanted to be underestimated. And while everybody was sort of laughing at him, he just blew right by them. I think Arnold might do the same."

Andrew Ferguson is a columnist with Bloomberg News.