20th Anniversary of an Op-Ed
Jude Wanniski
July 26, 2001


Memo To: Alan Greenspan
From: Jude Wanniski
Re: The Burden of Monetarism

Twenty years ago today, The New York Times Sunday business section ran my intemperate, savage attack on Milton Friedman and his monetarist idea that the Fed could manage the economy by keeping the money-supply growing at the same, steady rate. The reason I launched the attack, Alan, was that I knew the wonderful “Reagan tax cuts” that had been enacted a few days earlier would be overwhelmed by the Federal Reserve attempts to hit Milton’s targets and would produce a deep, deflationary recession. If I had been polite, nobody would have noticed. So I decided to be so graphic in describing Milton as a huge weight on Reagan’s back, despite his diminutive size. Other supply-siders were so confident the tax cuts would propel the economy forward that they criticized me for unnecessarily making enemies of the monetarists. But we were at war with the monetarists as Milton was manically convinced control of the supply of money could bring prosperity without inflation, with no regard to countervailing signals from the price of gold that demand for his money supply was collapsing. As the field general for the supply-siders, I had to make it clear that we were not going to take the blame for the monetary recession his ideas were creating. As it was, the Democrats and the Hoover Republicans tried their best to denounce the Reagan tax cuts for the recession that followed, but Fed Chairman Paul Volcker pulled us out of the deflation in the nick of time, in August 1982, and the Reagan boom began in earnest.

I’m writing this to you, Alan, because you were never a fan of Friedman or the monetarists and I’m sure you were delighted to read the op-ed when it appeared. Yet here we are now, in exactly the same position, with you as Fed Chairman scrambling to explain to Congress why we are sliding into a recession and why it is not your fault. Friedman was wrong because he persuaded Ronald Reagan to ignore the price signals thrown off by the dollar/gold price. Now you are stuck with the results of an economic mess created when you decided to ignore the dollar/gold price in 1997, when it began its deflationary decline. The reason I am reminding you about the failed monetarist experiment, my old friend, is that I think you are trying to tell yourself that if you wish hard enough, the mess will go away, and your name will be favorably preserved in history. The way your name will be preserved in history is if you admit you should have been paying more attention to gold, call Treasury Secretary Paul O’Neill, and ask for a pow-wow with the President. It could all be cleaned up quickly, but not unless you are willing to say that your assumptions did not hold up. The more you accept responsibility for your error, the more lustrous will be your place in history.


by Jude Wanniski
July 26, 1981

Milton Friedman is not a big man, but he is very heavy. His monetarist economic ideas are a deadweight burden on the shoulders of Menachem Begin and the Israeli economy. They crush down on Margaret Thatcher as England riots. They are crippling the Nobel Laureate’s old friend, Ronald Reagan, the United States economy and indirectly, all of our trading partners. Professor Friedman is barely five feet tall, but his shadow falls across the last decade of global inflation.

How ironic that “Reaganomics” has come to be identified as the twinning of “tax cuts and tight money,” a marriage of supply-side fiscal policy and Friedman monetarism. The classical, supply-side movement was revived a decade ago in reaction to the success of Professor Friedman in selling his theories to policymakers.

The monetarists gave two cheers when President Nixon closed the gold window on August 15, 1971. But it was not enough for them. The Nixon White House had bought the Keynesian idea that the dollar had to be devalued in order to make the Japanese and West Germans less competitive and American industry more competitive.

Thus, in the spring of 1973, the monetarist gave their third cheer when Treasury Secretary George P. Shultz, a Friedman disciple and fellow Chicago economist, succeeded in “floating” the American dollar. Henceforth, the dollar would not be defined in terms of anything. It would be a managed currency, managed according to the theories of the monetarists.

These developments led Robert Mundell, A Canadian economist now at Columbia University to predict a global inflation.

The Mundell vantage point, which permitted him to view the future so clearly, was classical and simply explained. The individual baker comes into the marketplace with bread, wanting to exchange his surplus production for wine. The vintner comes with a surplus of wine, seeking an exchange for bread. The government, which maintains the marketplace, taxes the exchange, taking some bread and some wine to finance its activities. Fiscal policy generally bears on the baker’s and vintner’s willingness to produce for current consumption needs. If the government takes too much bread or wine, the baker and vintner are discouraged from coming to the marketplace and the government gets none of their output.

People produce not only for current consumption needs. They produce for the future. The baker wants to save part of his daily output for his retirement, or an illness, or to finance his children’s college tuition down the road. For this, he needs a financial asset, a way of saving a loaf of bread without having it spoil. The market place provides a bank, which give the baker a dollar asset in exchange for a loaf of bread. It is the government that provides the dollar through its monopoly over official “money”. The dollar is a “unit of account,” which theoretically permits the baker to keep track of his loaf of bread over time, as the dollar asset remains more or less a loaf of bread.

The supply-side economist is concerned when the government either changes the unit of account purposely or simply loses the ability to maintain it, try as it might. In either case, the baker is discouraged from producing for future consumption. He sees his loaf become half a loaf, then a slice, then a crumb. Why bother? He will direct production as much as possible toward current consumption, in a self-defense against the government’s failure to maintain the unit of account, the monetary standard.

National wealth and productivity are enhanced by faithful maintenance of the unit of account. President Kennedy was the last President who really believed this, having had the idea drummed into him not by economists but by his father. In a July 1963 message to Congress, John Kennedy affirmed: “This nation will maintain the dollar as good as gold at $35 an ounce the foundation stone of the free world’s trade and payments system.

The monetarists do not see the dollar simply as a unit of account, a standard of value, a medium of exchange. The see it as an article of intrinsic wealth. Consumer demand drives the economy, they believe, as do the Keynesians. When the government puts more money into the baker’s pocket by printing more, there is less unemployment of winemakers, but a tendency to higher prices. Reducing the amount of money combats “inflation,” but the price is lessened economic activity, stagnation.

To experiment with this theory requires that the dollar have no definition, that it be linked to nothing. The currency cannot be managed if it is convertible because an excess of dollars, over and above the number the baker and vintner need for their transactions, will result in a citizen coming to the central bank with the excess and demanding that it be converted into gold, or whatever.

This is what Professor Mundell saw happening. The dollar, which has been maintained as the foundation stone of the free world’s trade and payments system, would no longer serve that function. It would be jiggled and wiggled from hour to hour, day to day, month to month, to the monetarist tune, vainly trying to dance toward a money-supply target, thwarted again and again by the market’s shifting demand for money.

The bakers and vintners of the world, who had viewed the dollar as a faithful measuring rod of value, reliable tool and instrument, would view it as ever changing, elastic, and they would have to defend themselves against its vagaries.

For a while after 1973, the bureaucrats at the Federal Reserve resisted conforming to monetarist prescriptions, still insisting on using interest rates as a policy guide, not quantity targets. But in October 1979, under pressure from Paul A. Volcker, the monetarists were given almost everything they wanted. Professor Friedman had earlier won over the Israeli central bank, which by 1980 presided over inflation rates of more than 100 percent. Margaret Thatcher bought monetarism in the spring of 1979, and after 26 months of squeeze not only looks at riots and 11.5 percent unemployment, but also at a 19.5 percent rise in consumer prices for the last quarter, at an annual rate.

Now, Professor Friedman has finally come to full flower in Washington.

The President even carried him to Ottawa, selling the Summit gang on a six-month dose of global Thatcherism. Inflation is to be whipped with a worldwide going-out-of-business sale. The bond market responded by hitting an all-time low, and the Dow took it on the chin, too.

The baker, the vintner, the automaker and the homebuilder are eager to produce and exchange. Consenting adults across the land are eager to commit commerce because the Government is altering tax policy to let them keep more of their production. But the monetarist model reads this as inflationary and must choke it off. And when the Fed whips those producers to their knees, bankrupting them at alarming rates, monetary authorities will then see that it is all right to flood the nation with more dollars, and consumer prices will soar again.

For old times’ sake, Ronald Reagan will put up with it. Milton Friedman is an old friend, a certified conservative who faithfully trumpets the doctrine that government bureaucrats are ill-suited to manage anything, except the currency. The only question is how long the president will carry the professor on his back. There, the United States has an advantage over Britain.

Britain has scheduled elections every five years, which means Margaret Thatcher can carry the Nobel Laureate for another two years, unless there is a revolution. The United States has Congressional elections every two years, another coming up in 15 months. Every Republican candidate for the Senate and the House will have Milton Friedman on his or her back. Unless the “experiment” ends soon, austerity is “just around the corner for the G.O.P.”