View From a Height
Commentary from the Mile High City
Thursday, January 08, 2004

Free To Choose

I was a physics major in college, not an economics major or a business major. I was the black sheep of the family, as both my sister and father graduated from McIntire at Virginia. So getting my MBA has required considerable backing and filling. I've recently been reading Milton & Rose Friedmans' Free To Choose. Although it was written almost 25 years ago, a number of the issues are fairly contemporary, such as the value of school vouchers in introducing competition to education. Friedman noticed early on the Left's desire to decrease freedom in order to will equality of outcomes.

He also makes another point. We exercise great power with our purchases, because they tend to be narrow choices. We can get close to 100% of what we want from a given purchase by choosing carefully. Elections, however, are a package deal. You have to set priorities, and unless you're the candidate, you'll get lots of things you don't like along with the things you do. Friedman keenly notes that this means we should reserve political action of things actally requiring consensus, rather than politicizing large swatches of our personal lives. Usually, we won't like the results.

Worth reading on its own is his description of the Great Depression's advance through the economy. We usually think of the stock market crash as being contemporaneous with the Depression, bank failures, apple carts, and sky-diving investors. In fact, the economy had begun to slow down in summer, the stock market bubble burst in October, but the bank failures didn't really start until the fall of 1930. Similar crises had ended painfully but quickly before. Why did this one go on?

First, the Fed failed to intervene in time to save the banks from a crisis of confidence. In the past, when recession turned into panic, banks facing a liquidity crisis could first turn to each other, and later to the regional Federal Reserve bank. But, riven by internal politics, the Fed refused to act decisively to save the Bank of the US (a private bank, despite the name). The name of the bank made it popular with immigrants and foreigners, but any large bank failure would have had much the same effect. (Interestingly, Friedman attributes its failure at least in part to anti-Semitism. The bank was one of the very few Jewish-owned institutions, serving mostly the Jewish immigrant community. I confess, I haven't been able to verify this. But I've never heard Friedman's reputation impeached on this point.)

The Fed, in fact, reacted by raising interest rates. Hoover raised taxes to balance the budget, and helped push through the high-tariff Smoot-Hawley bill. This triple-whammy helped turn what would have been a sharp, painful, but relatively short panic into the Great Depression. Friedman uses this to show that while the private sector generally was effective at halting panics and recessions, the Fed managed, within 20 years of its founding, to throw the world into economic chaos.

But the similarity to 1999-2000 is all too clear. A stock market bubble burst in early 2000, the economy went into recession shortly thereafter. The Republican response was to cut taxes and keep interest rates low. The Democratic response would have been to raise taxes and tariffs. While there's no evidence that a crisis of confidence in the banks was in the offing, it's almost certain that President Bush's tax cuts helped stave off what could have been a much worse recession, while the Democratic formula almost completely fails to learn from history.

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