Milton Friedman

Milton Friedman: His Lifetime Work and #1 Lesson for Investors

by Dr. Mark Skousen, Chairman, Investment U
November 20, 2006: Issue #609

My two favorite free-market economists are Milton Friedman and Friedrich Hayek, and I was privileged to know both of them…

In 1985, I interviewed Friedrich Hayek at his summer home in the Austrian Alps, where he talked about the importance of the Austrian theory of the business cycle, and how inflation can wreak havoc in the economy and the financial markets. Fritz, as he was known, died in 1992 at the age of 93.

Milton Friedman, with whom I had a unique friendship, died of a heart attack at the age of 94. His contributions have helped shape today’s economic landscape and have taught me an important lesson about investing…

Milton had an “open door” policy toward people of all walks of life. Always intelligent and demanding of evidence, he kept his secretary busy with a huge correspondence with friends and strangers.

When I first met him in the early 1980s, he didn’t know me from Adam, but he was willing to meet with me and answer my questions seriously. Ever since then I have kept up our friendship by letter, e-mails, telephone calls and dinner or lunch over the past dozen years. He invited me to my first Mont Pelerin Society meeting (a gathering of international scholars that Friedrich Hayek established in 1947), and through his influence, I became a member in 2002. He generously wrote blurbs for my recent books, and was a big fan of “FreedomFest,” my annual gathering of freedom lovers.

When I had the opportunity to teach at Columbia Business School, he wrote a favorable letter to the dean, which helped me get the position.

Milton loved a good argument, and we had plenty over the years, especially about the gold standard and the Austrian theory of the business cycle. When I told him the title of my new book, Vienna and Chicago, Friends or Foes?, he responded: “The answer is both. We’re friends and foes!”

In the early 1990s, when I wrote a marketing piece for another book with the headline, “Japan and Germany Will Surpass the U.S. economy by 2000,” he corrected me. “It won’t happen in my lifetime.” He was right. Occasionally, I was able to change his mind, but it was never easy.

Just last month, I had lunch with Milton at his favorite restaurant in San Francisco, where I showed him a picture of him standing next to John Kenneth Galbraith, the premier Keynesian and welfare statist of the 20th century.

It was a picture in contrast: Galbraith towered over the diminutive Friedman. Beneath the picture was a funny line by George Stigler: “All great economists are tall. There are two exceptions: John Kenneth Galbraith and Milton Friedman.” Milton was so pleased with the photo and caption that he sent it to all his friends only two weeks before his passing.

Milton Friedman’s Free-Market Reforms

No doubt you have already read an obituary or two about Friedman. He was the intellectual architect of the free-market reforms of the post-World War II era: lower inflation, lower taxes, deregulation, privatization, and the collapse of the Keynesian and Marxist paradigm. All can be laid at the feet of Milton Friedman and Friedrich Hayek. As Dan Yergin wrote in The Commanding Heights: “Half a century later, it is Keynes who has been toppled and Hayek and Friedman, the fierce advocates of free markets, who are preeminent.”

His most important work is his 1963 magnum opus, A Monetary History of the United States, 1867-1960, co-authored with Anna J. Schwartz.

His book carefully demonstrated a close correlation between monetary policy and economic activity, and confirmed beyond a doubt that government ineptitude by the Federal Reserve, and not free-enterprise capitalism, caused the Great Depression, when the Fed allowed the money supply to collapse by over a third. The book marked the beginning of a counterrevolution – away from the Keynesian view that the welfare state and big government were beneficial. Now government was seen as the “cause” of our problems, not the cure, as Reagan used to say.

Textbooks replaced “market failure” with “government failure.” And Friedman made it happen.

Milton told me that he always regarded Capitalism and Freedom as his best book for the intelligent layman. I highly recommend it as an ideal libertarian document.

Friedman’s #1 Advice to Investors

“Money matters. Watch the Fed!”

During the 1950s and 1960s, few economists and financial advisors paid much attention to the Fed. Keynesian economist Paul Samuelson expressed the conventional wisdom at the time when he wrote in his popular textbook, “Today few economists regard federal reserve monetary policy as a panacea for controlling the business cycle.”

But that all changed after Friedman demonstrated in A Monetary History that changes in monetary policy directly affected the economy and the markets. His empirical work has relevance today. In a Wall Street Journal article published Friday, November 17, Friedman said that the aggressive expansion in the money supply from 2002-04 kept the economy and the stock market from collapsing – and helped it recover faster.

Right now, it’s important to note that the Fed has raised interest rates and slowed down the money supply to a crawl. Fed chairman Ben Bernanke, an admirer of Friedman, is serious about “inflation targeting.” If inflation is subdued, that’s bullish for stocks and bonds and bearish for commodities. But the jury is still out whether Bernanke and the Fed can accomplish this.

Friedman told me on several occasions that he thinks the “economy and the stock market are different.” He was not known as a stock market prognosticator, but in the late 1990s, he thought the market was a “speculative bubble” and was vastly overvalued compared to the economic fundamentals. He was right.

Friedman was no amateur when it came to the financial markets. When he was a professor at Chicago and an advocate of flexible exchange rates, he helped create the futures market in currencies.

If he had any weaknesses, it was his failure to recognize the importance of gold as the world’s best inflation indicator, and the Austrian theory of the business cycle, which explains how inflation causes structural imbalances, asset bubbles and a boom-bust cycle. (For that, we must rely on Friedrich Hayek and the Austrian economists.)

Milton’s mind was bright and alert to the end, although he suffered pain in his legs and had a hard time walking. He had also gone through two open-heart surgeries in the 1980s, and was losing his eyesight. When he turned 94, I asked him, “Do you think you will live to be 100?” His reply: “I hope not!” But he was almost always upbeat about life, even to the end.

He was not a particularly religious man, but he expressed interest in religious topics near the end of his life. His favorite poem was Keats’s “Ode on a Grecian Urn,” which ends, “Beauty is truth, truth beauty – that is all/ Ye know on earth, and all ye need to know.”

He discovered both in a full and complete life. I consider it a privilege and honor that I knew him.

Good investing,

Mark

Today’s Investment U Crib Sheet:

For a full account of these two greatest economists, Hayek and Friedman, see my new book, Vienna and Chicago, Friends or Foes? Of this book, Milton Friedman wrote: “This tale is thorough, thoughtful, even-handed, and highly readable. It’s both instructive and entertaining.”
Coming up on InvestmentU.com, I’ll be interviewing two top financial gurus who appeared at the New Orleans Investment Conference recently: Rick Rule, president of Global Resource Investments, and Ross Beatty, president of Pan American Silver and one of the wealthiest Canadians. The topic: Commodity investments at a crossroads.