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So, What's New?

The "New Economy" looks like the same Old Economy to the Nobel Laureate, Milton Friedman.

Milton Friedman's gait has slowed down, and so has his schedule. But not his mind. At age 88, the Nobel Laureate in economics understandably grants interviews and writes commentaries only rarely. But that doesn't mean he isn't paying attention to what's going on around the world or that he is any less opinionated about the latest economic trends--from the New Economy to the euro to the electricity crisis in California, where he now resides.

Friedman and John Maynard Keynes are arguably the most influential economists of the Twentieth Century. But as we begin a new millennium, it is Friedman who seems to be winning the debate between the free-market school that he epitomizes and the government-interventionist advocates who see Keynes as their champion. Friedman's fans include the most powerful economist in the world today, Alan Greenspan. The Federal Reserve Chairman has joked that the diminutive Friedman, barely five feet tall and slight of frame, has the world's biggest brain per square inch of body.

I had an opportunity to chat with Friedman in February at the Hoover Institution at Stanford University. Friedman spends most of his time at home in San Francisco. But he still keeps an office at Hoover, where he has been a senior research fellow since 1977, a year after winning the Nobel Prize.

Accompanied by his wife and constant companion, Rose, Friedman revealed no retreat from the views that have made him famous--and helped shaped the views of two generations of economic policymakers around the globe: Free markets rule. Flexible exchange rates are better than fixed rates. Economies are shaped by monetary policy, not Keynesian fiscal stimulus. The inflation-versus-unemployment tradeoff is a false choice.

Of course, the world has changed dramatically in the nearly four decades since Friedman and co-author Anna Jacobson Schwartz published his seminal work, A Monetary History of the United States, 1867-1960 (Princeton University Press [for the National Bureau of Economic Research], 1963). But Friedman dismisses the New Economy as a fad, not lasting change in economic relationships. "I don't think anything is fundamentally new," he said, and then added with a chuckle, "I suppose it's easy to be a stick in the mud."

The Internet craze of the 1990's is reminiscent of the 1920's in the United States and the 1980's in Japan, he told me. "Those are three decades in which you've had technological revolutions and enormous gains in the stock market set off by those technological developments." In the 1920's, hundreds of new automobile companies came into being, a phenomenon similar to the explosion of Internet startups over the past decade. Today, those dot-com companies are disappearing as fast as they popped up--just like an auto industry shakeout that began in the 1930's. "How many auto companies are there today?" Friedman asked rhetorically.

Japan's exploding stock and real estate markets seemed to have no limits either, thanks to a revolution in manufacturing techniques that promised to produce the highest-quality goods in the world and wipe out every other industrialized nation's manufacturing base. "We know how those first two decades ended" Friedman observed with a grin.

As for the much-vaunted productivity revolution that has spawned a New Economy with a higher growth potential than previously thought, it's just another passing cycle to Friedman. "We've been here before." More than 100 years ago. From 1876 to 1886, a productivity boom was sparked by the invention of electricity, the telephone, and telegraph, which made communications far more efficient and reduced manual labor. But that surge in productivity didn't last.

So is the United States headed for another depression or will it stagnate for a decade like Japan? Friedman doesn't think the Fed will let that happen. "Alan Greenspan is looking back at the 1930's in the U.S. and the 1990's in Japan. He's saying, `If I make a mistake, I'd rather err on the side of being too expansive than too contractionary.'"

As of early March, that Friedman observation ran counter to the conventional wisdom on Wall Street. If anything, traders were upset that Greenspan seemed to have lost his golden touch for managing the economy and wasn't easing monetary policy fast enough to suit them. Their fear: a stock market crash--the NASDAQ at the end of February was already down 60 percent from its all-time high--and a deep recession.

But Friedman shrugs off the doom-and-gloom talk. Yes, the economy has faltered and could wind up in a recession. But if there is a downturn, he expects it to be short and shallow because the Fed has been pumping up the money supply very aggressively.

Indeed, while everyone else is worried about the "R" word, the guru of the Chicago School of monetary economics is--no surprise--worded about the "I" word. He noted that in the prior two months, M2 grew at an 11 percent annual rate. That was not meant as a criticism of the Fed. "I have a great deal of sympathy for them," he told me. But it was a source of concern to him that in trying to thwart a recession, Greenspan was planting the seeds for higher inflation next year. Friedman pointed out that inflation already has risen from 2 percent in 1999 to 3 percent last year, and it could reach 5 percent next year. That would be the largest jump in prices in more than a decade.

Inside the Fed, several officials reject that monetarist argument. They say energy is the main culprit behind the rise in inflation since 1999. But they expect a leveling off of energy prices combined with slack demand to keep inflation low for several years.

Some Fed officials believe the main weakness in Friedman's analysis is that the definition of money keeps changing, so it is becoming ever more difficult to find an accurate measure of the money supply. That is why Greenspan no longer uses any of the Ms as a definitive guide for setting policy.

Friedman, refusing to yield an inch of ground, accuses these Fed officials of evading the facts. "All the Ms are behaving the same way: M2, M3, MZ, the monetary base. They're all going up a lot. I agree there's a lot of noise that distorts M2, but that's not the only measure."

Interestingly, not everyone at the Fed dismisses Friedman's inflation jitters. A few officials believe he may prove prescient. Bush administration economists also are concerned. They believe inflation next year could top 4 percent.

When I asked Friedman what he thought about Japan's economy, he called it a textbook case for why Keynes was wrong: "Fiscal stimulus has had no impact on the economy. Japan ought to print more money." (In the United States, he added, "the Keynesians are turned on their heads. They say a budget surplus is good.")

When our conversation turned to currency exchange rates, Friedman pointed out that the thirty years since August 15, 1971, when fixed exchange rates were dropped, represent the first time in world history that no currency has been linked to a commodity. He said the move to floating exchange rates was inevitable and has resulted in the steady expansion of trade.

There has been increasing hand wringing around the world that the record--and growing--U.S. current account deficit will reach a breaking point and send the dollar into a tailspin. But Friedman doesn't share that concern because he expects the markets to solve the problem in an orderly way. "There's no reason to be anxious. The dollar is overvalued and the euro is undervalued. As that corrects itself, the current account deficit will shrink. The dollar is already becoming weaker and the euro is starting to turn because the economy in Euroland is looking better."

Friedman is no fan of European Monetary Union, which he sees as a prime example of big government getting bigger, and believes the jury is still out on whether a United States of Europe will succeed as a single economic entity. Without flexible exchange rates, some countries pay a price when their economies are stronger than most of Europe. Ireland, for example, has to pay a high relative price for investment capital, he says.

Still, Friedman admits that he is not as negative about the experiment as he had been. "I no longer think the euro will be as much of a flop," he said, because trade in Euroland is growing more than he expected.

That's not to suggest that Friedman has had a change of heart when it comes to his fervent opposition to any movement toward a one-world currency, whether it be EMU or dollarization. "It's the worst thing you could do" he insisted. "One world currency is equal to one world government."

In his view, dollarization is a bad idea except for small countries that trade extensively with the United States, such as Panama. The dollar may be a sound currency today, but Friedman believes it has been poorly managed at least as often as its value has been kept stable. "If I were Argentina, I wouldn't want to be tied to the dollar. Look what happened to Chile. It went through a major depression. If you're looking for stabilization, a currency board makes more sense."

As I concluded our interview, I asked Friedman to identify the biggest economic challenge facing the world as it begins the new millennium. Without so much as a pause, he launched an assault on big government.

"The great danger is the excessive growth of government," he declared. "You've had some shift so that governments are doing less detailed regulation" he added, referring to the deregulation of numerous industries over the past few decades. But retrenchment in economic micromanagement has been offset by an increase in "social intervention." He cited as examples, growing regulation of the health-care system and protections for the disabled. "The result is you've had no reduction in the size of government."

Friedman was particularly critical of California's partial deregulation of electricity, which has resulted in shortages, rolling power blackouts, the near bankruptcy of the state's two largest utilities, and higher prices. "They deregulated wholesale prices but not retail prices. Halfway deregulation has made the situation worse."

He thinks the state government's solution, namely, using taxpayer money to guarantee an adequate supply of power at a fixed price is crazy. "Taxpayers would be better off paying higher energy bills than higher taxes. You wouldn't have leakage to bureaucracies for administration and you'd have incentives to conserve. It's far more effective to let people manage their energy needs than the government."

Friedman embraced President George W. Bush's tax cut as a way to keep the federal government from growing, but he rejected Bush's argument that tax cuts will rescue the economy. "I'm strongly in favor of tax cuts of any means to reduce government spending. But they're not useful for stimulating the economy."

He thinks Bush is off to a good start but doesn't see the new president as a champion of smaller government. "The American public is committed to creeping socialism. The only question in the election was whether to creep slowly with Bush or fast with Gore."

Friedman's most realistic wish is that political gridlock will keep Washington from getting any larger. He's given up hope that government, in the United States or anywhere, might get smaller. He'd love, for example, to see the International Monetary Fund abolished. "But it won't happen," he assured me. "Once established, government institutions have an infinite life. The League of Nations still has an office in Geneva. Look it up."

Owen Ullmann is Editor of The International Economy.
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Title Annotation:economist Milton Friedman
Publication:The International Economy
Article Type:Interview
Geographic Code:1USA
Date:Mar 1, 2001
Previous Article:Small Is Big.
Next Article:Now What, Alan?

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