Banking Crisis

Author Interview - What Would Milton Friedman Have Said Of The Credit Crunch?

Tom Burroughes Group Editor London 21 June 2011

Author Interview - What Would Milton Friedman Have Said Of The Credit Crunch?

Milton Friedman, who died in 2006, is regarded by admirer and foe alike as one of the most important economists of modern times. What would this champion of markets have to say about the credit crunch and its aftermath? This publication interviewed the author of a study about the man's ideas.

It is fashionable these days to argue that the world needs new regulations to rein in private banks and prevent excesses of unfettered markets. Almost within days of the 2008 credit crunch disaster, such calls could be heard around the world.

A man who would have had little time for this outlook was Milton Friedman (1912-2006) the University of Chicago professor who, along with the likes of Friedrich Hayek in the post-war period, led what might be called a counter-revolution against the dominant Keynesian and central planning notions fashionable in the 1950s and 60s. When the world experienced “stagflation” in the 1970s – which was not supposed to happen in the Keynes playbook – Friedman’s ideas won a growing audience. He became something of a TV star and his name became famous, or infamous, to admirers and detractors. And although renowned as a top-class technical economist as well as proselytizer for free markets, his concerns were not narrowly about the business of “getting and spending”. He championed such causes as ending military conscription, decriminalising drugs and supporting parental school choice. And to a limited degree, Friedman’s ideas resonate even more loudly today than perhaps they did 30 years ago. For instance, the UK government’s reforms of education to promote parental choice are an echo of his voucher idea. The US – at Friedman’s urging – scrapped the military draft in the 1970s, and it is no longer political suicide for even senior police officers or politicians to wonder out loud about the costs of the War on Drugs on civil society.

But at the core of any assessment about Friedman’s legacy is economics. And few people are better placed to give a portrayal – and sympathetic one – than Dr Eamonn Butler of the Adam Smith Institute, who has recently published a book on the man. Unsurprisingly for someone who helped found a think tank named after a champion of markets, Dr Butler is a Friedman fan. He points out, however, that it is important to be clear about what the 94-year-old academic stood for to avoid misunderstandings.

What would Friedman say about the recent credit crunch and the response of policymakers?

“First of all, he would say the problem was caused entirely by government: printing too much money, which caused a fake boom that could not be sustained. He would point to US legislation to lend to people with bad credit risks – that no-doubt well meaning policy created the sub-prime mortgage crisis,” Dr Butler told this publication recently. 

Friedman would have argued that the recent wave of new regulation would not deal with these underlying problems – such as central bank cheap money – and cause new problems instead, Dr Butler continued.

In other words, Friedman would have pointed to the vast array of bank regulations being enacted and proposed and warned either that they would cause fresh problems, or fail to tackle the underlying issue of cheap government money. Dr Butler stressed, however, that Friedman would certainly not have given bankers a total free pass; rather, he would have argued that the price signals to which bankers respond had been so distorted by cheap money that the excesses of recent years were inevitable, as highlighted by similar problems in the past when governments injected too much cheap credit in to the system, as in the 1920s in the US or the 1970s in the UK.

An interesting point, for example, is that Friedman was concerned about the dangers of fractional reserve banking and lack of competition, said Dr Butler.

“Friedman was a believer in free banking and said it should be as competitive as other businesses. He was also a believer in 100 per cent reserve banking, saying that banks should keep all customer deposits in their vaults,” Dr Butler said. (Simply put, fractional reserve banking is the process by which banks can lend out more in credit instruments than is in fact covered by deposited cash - some economists argue that this is at the core of what causes boom-bust cycles). 

One insight that Friedman arrived at – perhaps also inherited from the great Adam Smith himself – was the danger of what happens when banks and other businessmen get too close to politicians. Today, for example, some Wall Street and City banks that received bailout cash from taxpayers were accused of having too cozy a link to the people supposedly regulating them. Friedman, Dr Butler says, was concerned about how regulators could end up being “captured” by the very industries they were supervising. Even those who did not share his free market views might regard that insight as a valuable one.

Dr Butler’s book, Milton Friedman: A Concise Guide to the Ideas and Influence of the Free Market Economist, is available now in paperback, running to a succinct 162 pages. For admirers and critics alike, this book appears to be an admirable introduction to one of the most important economists of our time. It is published by Harriman House, ISBN: 9780857190369.


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