When Ben Bernanke took charge of the Federal Reserve in 2006, the media made a few passing references that suggested he secretly subscribed to libertarianism. “I worked with him for years before I even knew he was a libertarian-leaning Republican,” the former Fed vice chairman Alan Blinder told CNN. The Wall Street Journal reported that Bernanke, “though a libertarian Republican …displays few partisan leanings.”
Last summer President Barack Obama re-nominated Bernanke to another four-year term atop the central bank, a reward for allegedly saving the world from a second Great Depression. Bernanke will arrive at his Senate confirmation hearings this January with an unbeatable recommendation. “As an expert on the causes of the Great Depression,” Obama raved in August, “I’m sure Ben never imagined that he would be part of a team responsible for preventing another. But because of his background, his temperament, his courage and his creativity, that’s exactly what he has helped to achieve.”
“Mission Accomplished,” the banner might have read.
Missing from Obama’s speech was any mention of Bernanke’s economic philosophy. These days, the media have taken to calling him a Keynesian—a believer in fiscal stimulus and the mixed economy. “We are all Keynesians again,” the liberal Washington Monthly headlined a January 2009 feature on the Fed chief.
In reality, Bernanke is following a monetarist depression-prevention model laid out by Nobel laureate and libertarian patron saint Milton Friedman. The Fed chairman has invoked the late economist in support of lowering interest rates to zero and bailing out banks. Trillions of dollars have been staked on the insights of “monetarism,” the economic theory of central banking and inflation-management associated with Friedman and Anna Schwartz. Though Schwartz now distances herself from Bernanke, opposing his reappointment on the grounds that he’s gone too far, the irony remains that a series of Fed policies many libertarians find repugnant are being championed by a man claiming to take his chief inspiration from the most influential libertarian economist of the 20th century.
A Monetary History of Ben Bernanke
The story begins in 1963, when Friedman and co-author Anna Schwartz published A Monetary History of the United States, an opening salvo in what Friedman called a “counterrevolution” against Keynesian theory. Their chapter on the Great Depression was spun off into a stand-alone book, The Great Contraction: 1929–1933, an epic revisionist history that changed America’s understanding of the causes of the Depression. Friedman and Schwartz contended that the Federal Reserve—not capitalism or Wall Street—was to blame for the dismal ’30s.
“The fact of the matter is that it was the [Fed’s] decision to tighten credit policy in 1928 that produced the Great Contraction,” the 93-year-old Schwartz says by phone from her office at the National Bureau of Economic Research in New York City. The Fed hiked interest rates in 1928 to curb what it saw as rampant speculation on Wall Street—a conflagration of leverage, margin buying, and outright Ponzi scheming fueled in the first instance by cheap credit from the Federal Reserve. (Goldman Sachs’ various pyramid schemes from that era, after they collapsed in 1929, generated losses of $475 billion in today’s dollars.)
Friedman and Schwartz rejected the widely held theory that speculation had been a major problem, or that there had even been a credit bubble in the 1920s. Bad loans and reckless banking practices were a “minor factor,” at most, in the Great Depression, they said. In this narrative, a Federal Reserve paranoid about speculation had needlessly constricted the money supply, imploding an otherwise sound economy.
After the Great Crash of 1929, the Federal Reserve drastically cut interest rates from a brief high of 6 percent to 1.5 percent by mid-1931. But during the first few years of the crisis, the Fed occasionally felt forced to abruptly raise rates again in complicated maneuvers to stem outflows of gold into Europe. Friedman and Schwartz blamed these sporadic interest rate hikes for smothering incipient recoveries, opening a vortex of deflation, and transforming a recession into the Great Depression.
“What the Fed had to do was increase the money supply,” Schwartz tells me. “By taking that action, it would have revived the economy. That’s the lesson of the Great Depression.” In The Great Contraction, she and Friedman argued that the Fed squandered its ample latitude to combat deflation. “The monetary authorities,” they wrote, “could have prevented the decline in the stock of money—indeed, could have produced almost any desired increase in the money stock.”
When it comes to his academic specialty, Bernanke is a disciple of Friedman and Schwartz. In 2002, at Friedman’s 90th birthday party at the University of Chicago, Bernanke was effusive. “Among economic scholars,” he began, “Friedman has no peers.” He developed the “leading and most persuasive” explanation of the Depression, whose impact on economics and the popular mind “cannot be overstated.”
At the end of his encomium, Bernanke made a soon-to-be-famous apology on behalf of the Federal Reserve, where he was then president of the powerful New York branch: “I would like to say to Milton and Anna…regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” (The speech was published as the afterword to the latest edition of The Great Contraction.)
Schwartz was present at the birthday party. “I’m sure he was sincere when he said that,” she says. And Bernanke stayed true to his word. In 2006 he replaced Alan Greenspan as chairman of the Federal Reserve. Greenspan, a self-described “libertarian Republican” who had once been part of Ayn Rand’s inner circle, had engineered an era of low-inflation growth that won Friedman’s endorsement. “There is no other period of comparable length in which the Federal Reserve System has performed so well,” Friedman declared in The Wall Street Journal on January 31, 2006.
Monetarism and Freedom
When the economy collapsed two years into Bernanke’s watch because of a massive credit bubble, he slashed interest rates to zero and ordered the money-printing presses to full steam. He also embarked on a course of “quantitative easing,” where a central bank convolutedly buys its own government’s bonds with printed money so as to sink interest rates even further.
This approach was not new. Friedman had prescribed quantitative easing, combined with “easy money” and inflation, as a cure for Japan’s 1990s economic slump, which he described as an “eerie, if less dramatic, replay of the Great Contraction.” As he did with the Depression-era Fed, Friedman emphasized that “there is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so.” In 1998, a year after Friedman penned his advice in The Wall Street Journal, Japan introduced monetary stimulus: a cocktail of zero interest rates and quantitative easing. But deflation continued. Today Japan’s exports are down an unthinkable 36 percent from just last year, and prices are plummeting at an all-time record pace.
Stateside, in the shadow of the Fed’s multi-trillion-dollar balance sheet, it has been all too easy to categorize Bernanke simply as a Keynesian supporter of public works projects, socialistic safety nets, and profligate, government-led consumption. While it’s true that the Obama ad-ministration is pursuing Keynesian fiscal stimulus, the Federal Reserve under Bernanke has consciously acted on the Friedman/Schwartz insight that loosening central bank credit is a fundamental tool in forestalling deflation and depression. Understanding that monetarism can mean both the management of low inflation in good times, and the creation of inflation in bad times, has proven too difficult for most of the media.
The New York Times, for instance, has identified Bernanke as “a student if not necessarily a devotee of the British economist John Maynard Keynes.” Actually, Bernanke spent most of his academic career elaborating on Friedman’s Keynes-refuting interpretation of the Great Depression. Athough his research sometimes strayed into nonmonetary subjects, it was always, as he said at Friedman’s birthday party, “an embellishment of the Friedman-Schwartz story…and in no way contradict[ed] the basic logic of their analysis.” In 2003, at a conference honoring Friedman’s Free to Choose, Bernanke said, “Friedman’s monetary framework has been so influential that, in its broad outlines at least, it has nearly become identical with modern monetary theory and practice.” So great was Friedman’s influence that Bernanke compared it with Shakespeare’s contributions to English literature.
Even Bernanke’s nickname “Helicopter Ben” derives directly from Milton Friedman. It came about during a 2002 speech entitled “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” in which he quoted Friedman on the importance of conjoining fiscal and monetary policies. The ideal fiscal stimulus, Bernanke said, was a shower of tax cuts “equivalent to Milton Friedman’s famous ‘helicopter drop’ of money.” Friedman had originally used the phrase to counter Keynes’ idea of the “liquidity trap,” in which setting interest rates at zero leads to bank hoarding and leaves the Federal Reserve no room to maneuver. Friedman suggested that countries could escape the liquidity trap by handing out money to consumers, and he explained his argument in a tale about a helicopter unloading cash on a town. Likewise, Bernanke’s Federal Reserve has created special “vehicles” to disburse consumer credit from on high.
In February, Bloomberg News added to the philosophical confusion by reporting that “Federal Reserve Chairman Ben S. Bernanke is siding with John Maynard Keynes against Milton Friedman by flooding the financial system with money.” Of course, Bernanke has said precisely the opposite. He’s flooding the financial system with money during a deflationary crisis, he says, because that’s what Friedman would have him do.
On February 10, Bernanke further underscored his allegiance to Friedman in an overlooked Capitol Hill question-and-answer session with Rep. Ron Paul (R-Texas). Their exchange is worth quoting at length.
“Chairman,” Paul began, “you have written a lot about the Depression. There was a famous quote you made once to Milton Friedman, apologizing for the Federal Reserve bringing on the Depression. But you assured him it wouldn’t happen again.…But the key to this discussion has to be: Was it too much credit in the ’20s that created the conditions that demanded a recession/depression, or was it lack of credit in the Depression that caused the prolongation?…Here we’re working frantically to keep prices up. What’s wrong with allowing the market to dictate this…and prices to go down quickly so we can all go back to work again?”
In response, Bernanke repeated the lesson of The Great Contraction: “Milton Friedman’s view was that the cause of the Great Depression was the failure of the Federal Reserve to avoid excessively tight monetary policy in the early ’30s. That was Friedman and Schwartz’s famous book. With that lesson in mind, the Federal Reserve has reacted very aggressively to cut interest rates in this current crisis. Moreover, we’ve tried to avoid the collapse of the banking system.”
For her part, Schwartz is critical of Bernanke’s application of her and Friedman’s theories. “You don’t have to lower the interest rates to the extent that he has in order to increase the money supply,” she says. “The essential action should be increasing the money supply. That’s the lesson of the Great Depression.” She adds, “There’s nothing contradictory in The Great Contraction with reference to what the Fed should be doing currently.”
Schwartz is alarmed by the enthusiasm with which Bernanke has put “monetary expansion” into practice. She berates the Fed for going too far and predicts that it will have to raise interest rates “in the near future” to arrest inflation. Asked if she sees hyperinflation on the horizon, she exclaims, “Oh, yes!”
In a New York Times op-ed last July, Schwartz criticized Bernanke as a “man without a plan,” warning that his “easy monetary policy is a sin.” She concluded, “He does not deserve reappointment.”
Schwartz also seems to have undergone a late-life conversion to at least some part of Keynesian theory. Asked for her current solution to the crisis, she repeats the ultimate Keynesian maxim: The government should pick up slackening demand in the private sector.
“People are saving, not spending. In order to revive this economy,” she says, hesitating before continuing, “the government will have to resume spending. By spending, the government will require that the current inventory will be depleted and have to be replenished. And that will bring on additional production and jobs.”
Bernanke’s Money Mischief
Ron Paul, like Schwartz and Friedman, is a libertarian, but he embraces the “Austrian” school of economic theory that rejects the very concept of the Federal Reserve. He is critical of what he sees as the Fed’s ongoing monetarism. “In essence,” Paul says in a phone interview, “Bernanke is following Friedman’s advice. He’s a Friedmanite when it comes to massively inflating. Bernanke was able to justify [his policies] by using Friedman.”
Does Friedman’s enthusiasm for inflating the monetary supply in crises flout libertarianism? “Absolutely,” Paul answers. “The monetarists said that you could overcome a natural market correction of a collapsing system by inflation—print money faster! Which contradicts Friedman’s whole thesis. He wanted a steady, managed increase in the supply of money of about 3 percent.” Here Paul is alluding to Money Mischief, Friedman’s 1991 book in which he called on the Fed to grow the money supply at 3 percent annually, presumably forever. “Yet at the same time, Friedman said the Depression could have been prevented by massively inflating.” Paul has kind words for Friedman, whom he praises as a staunch defender of economic liberty, but his final summation is damning: “Friedman’s very, very libertarian—except on monetary issues.”
With Bernanke at the helm, the Federal Reserve has unleashed monetary expansion, the very definition of inflation—and Friedman’s blueprint for averting economic depression. According to Bernanke, Obama, and scores of economists, it’s working. “Prospects for a return to growth in the near term appear good,” Bernanke predicted in August.
But with lenders foreclosing on 358,000 homes that month, the commercial real estate market only beginning to collapse, a 20 percent annual fall in railroad freight, and unemployment projected to crack double digits any minute now, the much-vaunted recovery is no given. And if it isn’t working, we might still relapse into recession, or worse.
The total cost of the Fed’s monetarist-inspired program is mysterious. Paul, whose bill to audit the Fed is now co-sponsored by more than half of the House of Representatives, declares: “We don’t know for sure how much the Fed has spent—I’ve heard it could be $6 trillion. But we have no knowledge of what the Fed’s doing. All these dealings are very secret.” A Reuters estimate in late September pegged the Fed’s balance sheet around $2.1 trillion, with $111 billion doled out to banks every day through the Fed’s overnight discount window. Bloomberg News has sued the Federal Reserve for full disclosure, and we may soon find out the exact number. Manhattan Chief U.S. District Judge Loretta Preska has ordered the Federal Reserve to open its books, though the bank has filed an appeal.
Friedman and Schwartz, those champions of low inflation, have helped inspire the greatest monetary expansion in Federal Reserve history, a program of limitless market interventions and tireless money printing whose end game is likely to be a return to the bad old days of inflation that they fought for so long. For two libertarian champions of free markets and limited government, this unintended legacy has the ring of a world-historic irony.