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Sound Monetary Policy Is Necessary But More Is Needed
Raymond Richman, 10/28/2010

David Wessel of the Wall Street Journal, in its edition of 10-28-2010, asks what the late Prof. Milton Friedman, the leading monetarist and proponent of free enterprise of the Chicago school, would think of Federal Reserve Chairman Bernanke’s “imminent move to print hundreds of billions of dollars to buy more Treasury bonds to put more money into the economy.” He put the question to one of Friedman’s eminent students, Prof. Robert Lucas.  As a former student of Prof. Friedman, I found myself in agreement with their description of Friedman’s views on monetary policy.  But to suggest that Friedman would have approved Bernanke’s policy for Quantitative Easing (QE2) is wrong. Much more needs to be done before monetary policy can make a real contribution to economic recovery.

Moreover, the notion expressed at the beginning of the article that “We can be sure (that Keynes) … would advise “more government spending to spur U.S. economic growth” assumes that he would have learned nothing from the recession of 1936-37 which demonstrated that government spending has no multiplier effect at all and which is confirmed by our experience with Pres. Obama’s 2009 Recovery Act. Spending $800 billion dollars has given a small temporary boost to income and employment as the data for 2009-10 confirm.

As the article points out, Friedman did not trust central bankers and blamed the Fed for the severity of the Great Depression and its cause.  Friedman also warned against “erratic swings” in the money supply, which has indeed been swinging erratically lately, as shown by the black line in the graph below. The red line shows the change in M1, which is controlled by the Federal Reserve through open market purchases of short-term US Treasury Notes. The Federal Reserve uses its control over M1 to affect M2, a broader measure of the Money Supply. Right now, the Federal Reserve is growing M1 quite rapidly in order to bring up M2 growth, possibly to the 8% range, which will likely cause inflation to rise. This is erratic alright.


Friedman advocated steady growth in the quantity of money making allowance for inflation and changes in the velocity of money as noted in the article.

I believe that Friedman, who was indeed a free trader as I can testify, would not have stood by idly while witnessing the loss of millions of jobs as foreign companies and the outsourcing of production closed hundreds if not thousands of factories here. He was not one to maintain a policy that reality shows is based on an erroneous theory. Free trade only works when all resources , i.e. labor, goods, and capital are free to move over boundaries at will. The only example of which we are aware where free trade works is the USA where it is guaranteed and enforced by the U.S. Constitution.

I believe that Friedman would not have tolerated our principal trading partners  pursuing mercantilist practices. Like us he would have come to realize that the damage to the U.S. economy was likely to become permanent. Like us, he would surely have availed himself of the provisions of world trade rules which permitted aggrieved nations to impose tariffs and other barriers to foreign imports even those produced by American-owned companies.  What incentives do American producers have to produce their products here when they can produce them more cheaply abroad and suffer no barriers to exporting them to the U.S.?

We already know that Keynes would not have tolerated the loss of U.K. jobs to the “beggar one’s neighbor” policies of her trading partners. How do we know that? He said so in no uncertain terms. Are we to believe that Friedman would do less. We believe he would approve our recommendation for “scaled tariffs”, tariffs that vary with the size of the trade deficit and apply only to countries with which we have been experiencing chronic large trade deficits. The trade rules of the World Trade Organization(WTO) authorize countries to deal with Balance of Payment deficits by imposing tariffs and other barriers to imports. The scaled tariffs would work like a currency revaluation but would have a number of advantages. It would yield substantial revenues while trade is being balanced. It would make outsourcing less profitable and encourage domestic manufactures.

Ben Bernanke, in a speech he gave while he was Chairman of the President’s Council of Economic Advisors attributed the trade deficits to a global savings glut in which foreign governments used their trade surpluses to expand their dollar reserves. We cite it in our book, Trading Away Our Future (Pittsburgh, PA., Ideal Taxes Assn, 2008) p.54.

Increasing the money supply is long overdue but it will have little effect on the economy. Our big need is manufacturing investment. Pres. Obama’s stimulus program, as we wrote the other day, has been a failure. And the lack of stimulus has been exaggerated by new government regulations and high taxes.

As we noted in recent articles on this site, the policy Geithner recommended to the G-20 finance ministers is worse than useless because it simply delays really constructive measures that can be taken. We have written about them and will continue to do so. The administration seems to be opposed to securing energy independence based on fossil fuels. The recent moratorium on drilling in the gulf and forbidding drilling on public lands are what we don’t need. Under current conditions, monetary policy will be unable to stimulate the economy. We must create the conditions under which U.S. manufacturing makes us once more competitive with other manufacturing nations.

Perhaps the forthcoming mid-term elections will provide a new realistic and competent crop of leaders. Is it too much to hope for real leaders to come out of the forthcoming mid-term elections to do what we must do to achieve recovery? Let us pray.

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]