All throughout his new book, The
Great Deformation: The Corruption of Capitalism in America, David A.
Stockman is critical of the Chicago School, especially its intellectual
leader during the last half of the twentieth century, Milton Friedman. He
captures the irony of the so-called free-market Chicago School on the very
first page of his introduction, where he writes of the “capture of the state,
especially its central bank, the Federal Reserve, by crony capitalist forces
deeply inimical to free markets and democracy.”
This is a deep irony because it was Chicago School economists such as
George Stigler who wrote of the “capture theory of regulation” when it came
to the trucking industry, the airline industry, and many others. That is,
they produced dozens of scholarly articles demonstrating how government
regulatory agencies ostensibly created to regulate industry “in the public
interest” are most often “captured” by the industry itself and then used not
to protect the public but to enforce cartel pricing arrangements.
This was all good, solid, applied free-market economics, but at the same
time the Chicago Schoolers ignored the biggest and most important regulatory
capture of all – the creation of the Fed. The Chicago School simply ignored
the obvious fact that the Fed was created as a governmental cartel
enforcement mechanism for the banking industry – during an era when many
other kinds of regulatory institutions were being created for the same
purpose (i.e., “natural monopoly” regulation).
Not only did the Chicago School ignore this glaring omission from its
“capture theory” tradition of research on regulation; it also ignored the
realistic, economic analysis of political decision making that was an
important part of the research of the two most famous Chicago School Nobel
laureates next to Friedman – George Stigler and Gary Becker. Stigler and
Becker published some important articles in the field that is better known as
public choice, or the economics of political decision making. Friedman
himself had long been an advisor to Republican politicians, so no one could
credibly argue that Chicago School economists were naïve about the realities
of politics.
However, if Friedmanite monetarism was anything, it was naïve about
political reality. The fatal flaw of Friedman’s famous “monetary rule” of
constant growth of the money supply in the 3-4 percent range was premised on
the assumption that a machine-like Fed chairman would selflessly pursue the
public interest by enforcing Friedman’s monetary rule. According to Friedman,
Stockman writes, “inflation would be rapidly extinguished if money supply was
harnessed to a fixed and unwavering rate of growth, such as 3 percent per
annum.” This was the fundamental assumption behind monetarism, and it flew in
the face of everything the Chicago Schoolers purported to know about
political reality. In other words, Friedmanite monetarism was never a
realistic possibility, for as Friedman himself frequently said of all other
governmental institutions besides the Fed, a government institution that is
not political is as likely as a cat that barks like a dog. Friedman’s
monetary rule, Stockman concludes, was “basically academic poppycock.” He
mocks the idea of a “monetary rule” as the “idea that the FOMC [Federal
Reserve Open Market Committee] would function as faithful monetary eunuchs,
keeping their eyes on the M1 gauge and deftly adjusting the dial in either
direction upon any deviation from the 3 percent target.” This was “sheer
fantasy,” says Stockman, and an extreme example of “political naivete.”
Stockman also takes Friedman and the Chicago School to task by writing
that “Friedman thoroughly misunderstood the Great Depression and concluded
erroneously that undue regard for the gold standard rules by the Fed during
1929-1933 had resulted in its failure to conduct aggressive open market
purchases of government debt.” Stockman debunks the notion that the Fed
failed to pump enough liquidity into the banking system by merely noting that
“there was no liquidity shortage” during that period and “commercial banks
were not constrained at all in their ability to make loans or generate demand
deposits (M1). “Friedman thus sided with the central planners,” writes
Stockman, in “contending that the … thousands of banks that already had
excess reserves should have been doused with more and still more reserves,
until they started lending and creating deposits in accordance with the
dictates of the monetarist gospel.” As a matter of historical fact, Stockman
points out, “excess reserves in the banking system grew dramatically during
the forty-five month period, implying just the opposite of monetary
stringency” (i.e., Friedman’s main argument). Thus, “there is simply no case
that monetary stringency caused the Great Depression.”
The current Fed chairman, Ben Bernanke, based his academic career on the
false Friedmanite theory of the Great Depression, Stockman writes. Bernanke’s
“sole contribution to this truly wrong-headed proposition was a few essays
consisting mainly of dense math equations. They showed the undeniable correlation
between the collapse of GDP and money supply, but proved no causation
whatsoever.” Thus, the old saying about “how to lie with statistics” was
matched by “how to mislead with mathematical models.”
Stockman makes the case that the Austrian business cycle theory is a far
more reliable source of understanding about the Great Depression. “[T]he
great contraction of 1929-1933 was rooted in the bubble of debt and financial
speculation that built up in the years before 1929,” he writes, and “not from
mistakes made by the Fed after the bubble collapsed.” Friedman’s monetary
theory, in other words, was not based on “positive economics” or historical
reality, but was assumed to be “an a priori truth” merely because it was the
“great” Milton Friedman who authored it. In any event, Friedman’s entire
theory of the Great Depression has been “demolished” by his intellectual
disciple, Ben Bernanke, who increased the excess reserves of the U.S. banking
system from $40 billion to $1.7 trillion as of 2012 with little or no
recognizable effect on the real economy.
Perhaps Friedman’s biggest sin, according to Stockman, was being the
“brains” behind Richard Nixon’s executive order in 1971 that removed gold
standard restraints on monetary printing. Friedman therefore assisted in the
institutionalization of “a regime which allowed politicians to chronically
spend without taxing,” he writes. Ironically, “the nation’s most famous
modern conservative economist became the father of Big Government, chronic
deficits, and national fiscal bankruptcy.” “For all practical purposes … it
was Friedman who shifted the foundation of the nation’s money supply from
gold to T-bills.”
Stockman describes Friedman’s political naivete as mind boggling.
“Friedman never even entertained the possibility that once the central bank
was freed from the stern discipline of protecting its gold reserves, it would
fall into the hands of monetary activists and central planners” and that the
Fed would “become a fount of rationalizations for incessant tinkering and
intervention in financial markets.” Printing dollars with reckless abandon,
the Fed fueled commodity booms in the 1970s, followed by busts and crashes,
and then did the same with stock and real estate markets in the succeeding
decades.
The Best
of Thomas DiLorenzo at LRC
Thomas DiLorenzo
Archives at Mises.org
