Worse still, America’s depression was to become worldwide because of what lies behind these doors.

This is the vault of the Federal Reserve Bank of New York. Inside is the largest horde of gold in the world. Because the world was on a gold standard in 1929, these vaults, where the U.S. gold was stored, provide an excellent test of where the depression originated. If the depression had started in Europe or somewhere else in the world, the U.S. would have lost gold, more gold would have flown out of the country then came in. If, on the other hand, the depression started in the United States, the opposite would happen. More gold would come in from abroad as the effects of our depression spread there then went out abroad, in reality that is exactly what happened.

When the international money system was based on gold, the rules of the game were these. The gold in the United States was supposed to control the amount of money issued by the Federal Reserve. In turn, the amount the Federal Reserve issued controlled the amount of money issued by the commercial banks which in turn controlled the amount of money that individuals, businesses and industry could get from the banks. The result, a monetary structure all supposedly tied to the amount of gold in the vaults in the United States. But in 1930 the Federal Reserve didn’t play by the rules. It stood by as banks started to collapse and with each one that went the money supply fell. Businesses and industry inevitably began to fail. Americans, now poor, bought less from abroad. Britain was one of the countries effected. Like the United States, Britain had its own monetary structure tied to gold. The trouble was that Britain could now sell less abroad. It cut down the amount it bought from abroad but not by enough. Under the rules of the gold standard, it had to pay the difference in gold. With every bar of gold that was shipped out of Britain, the amount of money decreased.

A depression that was already underway in Britain got worse. British gold flowed into the United States, supposedly to form the foundation of a new slice of the monetary structure. But the Federal Reserve didn’t let it. The gold was simply locked away. The results, Britain remained in trouble until in 1931 it went off the gold standard cutting the link between the amount of gold and the amount of money. In the United States, suffering the worst depression in history, there was plenty of gold, but to no avail.

Although these events happened almost 50 years ago, many of our policies today derived directly from them. Central bankers throughout the world, government officials everywhere, are afraid of a new great depression. They, have therefore, moved the opposite direction. Instead of the problem of too little money, we are faced with the problem of too much money. The problems of inflation that plagues us today trace directly from the problem of deflation that plagued us from 1929 to 1933.

People came to believe that free market capitalism had failed. Something was needed to replace it. At Cambridge University in England, a new orthodoxy emerged in the 30’s one that has remained powerful to this day.

It owes its influence to the brilliance of one man. John Manrd Kane was unquestionably one of the greatest economists of all time. Like other economists of his generation, he found The Great Depression both a paradox and a challenge. It was a paradox because it seemed to contradict some of the fundamental principles that economists have come to take for granted. Kane rose to the challenge by constructing a complex and sophisticated hypothesis which not only explained what had been going on, but also offered a way out way to end The Great Depression and to avoid similar episodes in the future. The core of his theory was that what happened to the quantity of money didn’t matter. What really mattered was a particular category of spending. In economists jargon, autonomous spending. What kind of spending is that? It might be investment by business enterprises in building factories and adding to the number of machines and adding to inventories. It might be spending by individuals to build houses. Or, most important of all, it might be deficit spending by government. If private spending on investment, on house building, is not enough to maintain full employment, then government could always step in and spend enough to make up the difference. The theory of pump priming was born. The theory was a godsend to politicians who had been grasping at any expedient. After all, throughout the ages, politicians had been only too willing to spend money provided they didn’t have to tax their citizens to pay for it. And here along came a scientific theory offered under the most responsible of auspices that justified what they had been wanting to do all along. Is it any wonder that government spending has exploded ever since or that deficit spending, even without the excuse of war, and on a large scale, has become the order of the day?

In America, the new Roosevelt administration adopted the Keynesian approach. It authorized massive spending on government projects. It involved government increasingly in the running of the economy. It developed programs designed to provide security for every individual. In England too, the idea that only the government could bolster the economy was firmly established as this film at the time makes clear.

With the assistance of the national government, work was restarted on the great Granada, 534. And we all hope that this is a prelude to a period of increasing prosperity in the industry. Exports of cotton goods to India have increased and as a result of the quota system in the colonies, which the national government introduced in order to diminish the dangers of Japanese competition, exports of cotton good to those colonies have been more than doubled. One of the most important contributions which the national government has made toward the improvement of social conditions has been a housing campaign without parallel in our history.

Though some of these measures may have been useful and indeed needed during the depression years, the length to which they have since then carried would have horrified Kane.

Kane died in 1946. I have always regarded it as a tragedy that they did not live another decade. He was the one man who had the standing, the personality, the force of character to persuade his disciples not to carry too far some ideas which were good for the 1930’s but which did not apply in the post war situation. That he might have done so is suggested by an article he wrote just before his death. The last article he ever wrote published after his death. In that article he expressed strong reservations about the lengths to which some of his disciples had been carrying his ideas. If he had been able, if he had lived another decade, the postwar inflationary explosion might have been avoided.

For the past 7 years Maureen Ramsey has had to buy food and clothes for her family out of a government handout. For the whole of that time, her husband, Steve, hasn’t had a job. Each week he collects what’s known in Britain as Social Security. The government looks after him, his wife and their children. But accepting welfare payments means accepting the rules of those who hand them out.

Mrs. Ramsey: My opinion, anyway you feel as they own you. You know, there is no other way of putting it. Say I got a job tomorrow, because I needed something, well I know that means I’ve got to go down there and report it. Because I couldn’t go into the job because you’d be looking over your shoulder thinking well the Social Security is coming in. And I’m going to be done for it. It’s just hopeless, you can’t fight against that.

Mr. Ramsey: The jobs are out there you only come up with about 45 pounds a week. And you need a doctors stamp over there. You see, you finish up with about 29 pound. So what good is it working? You still get the same thing, you know what I mean? I can’t make any sense of it.

Friedman: Of course, he’s quite right. It may not pay to get a job now. That’s not his fault and I don’t blame him. He’s acting sensibly and intelligently for his own interest and the interest of his family. It’s the fault of the system which takes away the incentive from him to get a job.

But suppose you were cruel and simply took away the welfare overnight. Cut it off. What would happen? He would find a job. What kind of a job? I don’t know. It might not be a very nice job. It might not be a very attractive job. But at some wage, at some level of pay, there will always be a job which he could get for himself. It might be also that he would be driven to rely on some private charity. He might have to get soup kitchen help or the equivalent. Again, I’m not saying that’s desirable or nice or a good thing it isn’t, but as a matter of actual fact as to what would happen, there is little doubt that he would find some way to earn a living.

The American government is trying to break the welfare trend. These people were unemployed. They are now being trained at the taxpayers expense. It may or may not lead to a real job.

Lawrence Davenport: Here we have a vast national welfare system which is diametrically opposed to everything that America believes in. Because America was founded on a work ethic, has practiced a work ethic, and it’s said this is what we want everybody to do. An opportunity to hold a job in America.

Friedman: Everyone here has to clock in and do a full days work. It’s an attempt to make it seem like a real job.

Lawrence Davenport: We’re saying a job is a part of the American way of life and we’re going to help you find a job. So that you can get a piece of the pie. You can pay taxes, you can become a part of that American dream.

Friedman: But the dream isn’t working. Schemes like this run under the government’s Comprehensive Education and Training Act (CETA) have a high drop out rate and many trainees end up back where they began, on welfare.

The men and women who administer CETA and similar programs, the officials of the Department of Health, Education and Welfare are dedicated people. Their motives are good. Their achievements are not.

The results of these programs have been disappointing. Why? I believe that the basic reason is because it is very hard to achieve good objectives through bad means. And the means we have been using are bad in two very different respects.

In the first place, all of these programs involve some people spending other people’s money for objectives that are determined by still a third group of people. Nobody spends somebody else’s money as carefully as he spends his own. Nobody has the same dedication to achieving somebody else’s objectives that he displays when he pursues his own.

Beyond this, the programs have a insidious effect on the moral fiber of both the people who administer the programs and the people who are supposedly benefiting from it. For the people who administer it, it instills in them a feeling of almost Godlike power. For the people who are supposedly benefiting it instills a feeling of childlike dependence. Their capacity for personal decision making atrophies. The result is that the programs involved are misuse of money, they do not achieve the objectives which it was their intention to achieve. But far more important than this, they tend to rot away the very fabric that holds a decent society together.

If you think that’s overstating the case, look what ATW found when it made a special investigation into the spending of the vast funds it administers.

Public Health Service worker: We just got the plan from the Public Health Service on reducing unnecessary beds.

Friedman: In these reels of tape that record every payment made, every recipient, they found evidence that a staggering $7.5 billion had been lost by fraud, waste and abuse in one year.

Doctors, building contractors, hospitals, schools, welfare recipients, everyone had been fraudulently dipping into the pot. And the investigation isn’t over yet.

The inevitable consequence of having a huge pot of taxpayers money is that all of us want to get our hands in it. You can be sure that we’ll all be able to find very good reasons why we should be the ones to spend somebody else’s money.

Somebody or other put up a good case for spending taxpayers money to subsidize rents in New York City, including the rents of these apartments. The people who occupy these apartments pay something like $200 a month less than the market rent. And that subsidy comes out of the taxes of people, most of whom are much poorer than the people who live here. It’s not unusual for this sort of thing to happen when government tries to do good with our money.

Look at what happened in Chicago. For most visitors, the immediate impression is of a rich, prosperous, bustling city. But like every large city in America, it has its problem areas. Over crowded slums breeding poverty and crime.

After WWII, one such area developed in Hyde Park. In the 50’s, plans were drawn up to pull down large areas of slum buildings and to rebuild using government funds under an urban renewal program. It was to be a show project replacing a blighted area with an integrated community. Who controlled the spending of that government money? It was in fact, my own University of Chicago which felt it’s very existence threatened by the spread of urban blight and crime. Government money was used to tear down an area that contained many small shops as well as families of low income. Once the area was cleared, private money rebuilt it with middle class apartments, townhouses and shopping complexes. The blight had been cleared here, but only to be shifted elsewhere.

Joe Gardner: In may instances, when government administers large grants, a lot of those funds don’t wind up directly serving the people and achieving the objectives that were the intent of the programs. Because the grant has too feed that large government bureaucracy.

December 2006 • Volume: 56 • Issue: 10 •

Milton Friedman, who died last month at age 94, was one of the twentieth century’s most influential champions of individual liberty and free markets. The 1976 winner of the Nobel Prize in economics and an early associate of FEE, Friedman did more than any single person in our time to teach the public the merits of deregulation, privatization, low taxes, and free trade. His work inspired the economic agendas of President Ronald Reagan and British Prime Minister Margaret Thatcher, as well as the liberalization of economies in eastern Europe and the former Soviet Union.

Born in New York City in 1912 to Jewish immigrants, Friedman went on to become a major force in theoretical economics in the second half of the century and the leading figure of the Chicago, or monetarist, school. As a professor of economics at the prestigious University of Chicago, he is widely credited with overturning the dominant Keynesian paradigm regarding the tradeoff between unemployment and inflation. He made monumental (if controversial) contributions to monetary theory, policy, and history in such books as Studies in the Quantity Theory of Money (1956) and A Monetary History of the United States , 1867–1960 (co-written with Anna Schwartz, 1963).

Slayer of Keynesianism

In the post-World War II era, when Keynesianism dominated the economics profession, Friedman undertook a series of studies to undermine some of Keynes’s leading assumptions. In the late 1940s he challenged the Keynesian position that discretionary government policy was essential to assure full employment. Friedman was able to show that the macroeconomic policymakers would never have sufficient knowledge about changing market conditions to successfully manipulate the fiscal and monetary policy tools in a timely manner. Instead, he argued, the wisest long-run policy was for government to follow a small number of predictable policy rules.

Beginning in the 1950s Friedman presented a restatement of the quantity theory of money, arguing that all prolonged and sustained general rises in prices were caused by an increase in the supply of money. “Inflation,” he said, “is always and everywhere a monetary phenomenon.” His Monetary History of the United Statesdemonstrated that government manipulation of the money supply was the primary factor behind the boom-and- bust cycles experienced in the twentieth century. In addition he argued that it was misguided Federal Reserve policy in the early 1930s that generated the severity of the Great Depression—and not any inherent failures in the market economy.

This led Friedman to make the case for a “monetary rule,” under which the monetary authority would be denied any discretionary powers over the money supply. Instead, the Federal Reserve would be limited to increasing the supply of money at a fixed annual rate of around 3 percent. This would create a high degree of predictability about monetary policy and generate a relatively stable price level in a growing economy.

In making the case for a monetary rule, Friedman advocated a paper-money standard rather than the gold standard, arguing that this would save on the resource costs of digging the metal out of the ground just to store it away in bank vaults. But in the years after he received the Nobel Prize he had second thoughts about his monetary rule and the gold standard. In a series of articles in the 1980s Friedman stated that Public Choice theory had convinced him it will never be in the long-run interest of governments or their monetary authorities to follow the type of rule he proposed, since the temptation to abuse the printing press for political reasons would always be too strong. He therefore concluded that, given the actual history of Federal Reserve policy in the twentieth century, remaining on the gold standard would have been far less costly for America than the Fed-created inflations and recessions.

One final and lasting contribution of Friedman’s was his formulation of the “natural rate” of unemployment. The Keynesians of the 1950s and 1960s believed that it was possible to permanently lower the rate of unemployment through manipulation of the rate of inflation. In his presidential address before the American Economic Association in 1967, Friedman argued that, at most, monetary policy could temporarily lower the level of unemployment. But in the long run it would return to its “natural rate.”

He said that the amount of unemployment at any time was determined by changing supply-and-demand conditions in the market and people’s expectations about the future rate of inflation, which influenced their resource-price and wage demands. The monetary authority could fool people by increasing the inflation rate above people’s expectations, resulting in prices rising faster than wages, and the resulting larger profit margins would create an incentive for employers to increase output and hire more workers. But over time, as people discovered the truth about the rate of inflation, they would demand higher wages and resource prices to compensate for lost purchasing power. That would reduce profit margins and return unemployment to its “natural” level.

Unless the monetary authority was willing to continuously increase the rate of price inflation above people’s adjusted expectations, the lesson had to be accepted that in the long run, monetary policy cannot influence levels of employment and output. These are ultimately determined by market conditions and not by government manipulation.

Through these contributions, Friedman permanently transformed the debate in macroeconomics and in the process undermined many of the most cherished assumptions of Keynesian economics.

Public Intellectual

As influential as Friedman’s academic work was among professional economists, he had as profound an impact on non-economists’ thinking about the virtues of free markets and limited government. At a time when popular writing that went against the collectivist grain had few mass outlets, Friedman managed to reach a wide audience with his clear and good-natured style. He accomplished this through many books, a long-runningNewsweek column, and his 1980 television series, “Free to Choose,” based on his bestselling book of the same title.

His 1962 book Capitalism and Freedom was an accessible volume that presented bold free-market thinking on such issues as medical licensing, the volunteer army, and antitrust laws. It was also the book in which Friedman unveiled controversial proposals for school vouchers and the negative income tax as transitions from the welfare state. The book undoubtedly inspired many youthful readers to pursue careers in economics.

Friedman started addressing a large popular audience in 1966, when he inaugurated a regular column inNewsweek, succeeding Henry Hazlitt. Friedman’s column, which rotated with those of the Keynesian Paul Samuelson and Henry Wallich, presented the case for free-market policies across a wide range of issues—such as wage and price controls (imposed by President Nixon in 1971) and the minimum wage—and did much to inject the libertarian perspective into the public debate. The column ran until 1983. (A compilation of columns was published as Bright Promises, Dismal Performance.)

Meanwhile, on December 19, 1969, Friedman’s picture made the cover of Time under the title “Will There Be a Recession?” It was a rare distinction for an academic economist, but by then, Friedman was more than that: he was a public intellectual.

Friedman achieved bona fide star status in 1980 with release of his book Free to Choose, written with his wife Rose Friedman, also an economist. In Free to Choose Friedman explained the unparalleled contributions to human well-being of the division of labor and free exchange, the tyranny of government regulation, the dangers of inflation and the welfare state, and the problems intrinsic to the government school monopoly. His chapters on how the competitive marketplace protects consumers and workers were eye-openers for an audience that until then had been led to believe that only coercive government could do those things.

Free to Choose, according to the Fortune Encyclopedia of Economics, became the best-selling nonfiction book of 1980. Sales were boosted by the ten-part companion television series on PBS. Each week viewers saw the congenial Friedman clearly explain why free markets serve individuals and society best, and why government creates chaos and poverty—all well illustrated with beautiful location footage, including scenes of Hong Kong ‘s success.

Four years later Friedman again combined a book with a television series in The Tyranny of the Status Quo, also co-written with Rose Friedman.

Friedman was fearless in the face of controversy, vigorously opposing the military draft during the Vietnam War and drug prohibition. But he was no idle author. In 1969-70 he participated in the President’s Commission on an All-Volunteer Armed Force. His pro-freedom credentials made his a powerful voice in the effort to end the involuntary servitude of conscription.

Friedman won many honors for his work. Besides the Nobel Prize he also won the Presidential Medal of Freedom and the National Medal of Science, both in 1988. He served as president of the American Economic Association.

In 1947 Friedman was one of a select group of some 40 economists and writers invited by F. A. Hayek to attend the founding meeting of the Mont Pelerin Society in Switzerland. Leonard Read, FEE’s founding president, Henry Hazlitt, and Ludwig von Mises also participated in that meeting to establish a worldwide network of classical-liberal scholars.

Friedman co-wrote (with George Stigler, who also later won the Nobel Prize) one of the first publications FEE released, the 1946 pamphlet “Roofs or Ceilings? The Current Housing Problem,” a critique of rent control.

Sadly, Milton Friedman is gone from us now. But his legacy and devotion to liberty will inspire freedom lovers for many generations.