What PC? 1996 August/WPCAUG96.ISO/database/power/friedman.txt

Text File | 1996-06-13 | 15.1 KB | 380 lines

1.5
Although now
acknowledged as one
of the century's great
economists, in his
early years Friedman
was an outstanding
statistician. From
1946 in the University
of Chicago he became
a pillar of the 'Chicago
School', noted for
strong liberal values
and the belief that
economics is an
empirical science
based on fact rather than philosophy. The epitome of
this approach was his A Theory of the Consumption
Function (1957); it taught economists how to pursue
their trade. In the Fifties most economists thought
money didn't matter; Friedman, arch monetarist,
demonstrated that it did. In his monumental Monetary
History of the United States with Anna Schwarz he
showed that rapid monetary expansion was the cause
of inflation, and sharp monetary contraction the main
cause of deep recessions. It was persuasive. The
world's financial authorities switched from fiscal fine-
tuning and the pursuit of real output and employment
goals to targeting monetary growth. His arguments for
free exchange rates, low and uniform but indexed tax
rates, an all-volunteer army, vouchers for education
and health and reform of the welfare system are all on
the agenda of our times. His theories informed the
policies of US and British governments throughout the
Eighties, and were enthusiastically adopted by the
emerging market economies of eastern Europe after the
fall of communism. In the Nineties his ideas have gone
out of fashion, but that does not detract from the worth
of his analysis.In depth, scope and effectiveness he has
few rivals
@
2.2
The Thatcher and Reagan governments have only
slowed the growth of public spending and government
interference in the economy and have failed to reverse
it, Professor Milton Friedman says in a study published
today of the progress of free-market economics.

"The high hopes that many of us placed in the elections
of Margaret Thatcher in Britain and Ronald Reagan in
the United States have been realized to only a limited
extent."

Professor Friedman accepts the turnround in the size
and scope of government started earlier in Britain and
that Mrs Thatcher has made notable achievements in
privatizing state industries and ending exchange
control.  But he argues that the only major reversals of
policy have been in countries with collectivist
governments, notably China.

In the United States, government spending last year
was 38.5 per cent of national income plus transfer
payments, compared with 14.8 per cent in 1930

Professor Friedman criticizes the proliferation of new
protectionist devices such as "voluntary" restraints as a
cost of government.

"A particularly clear case is the so-called voluntary
quotas on imports of Japanese cars introduced by the
Reagan Administration in 1981.  These restrictions
have cost car buyers many billions of dollars, and yet
they involved negligible government spending," he
argues.
  @
2.3
Someone remarked last week, contemplating this
month's economic media event, namely the arrival in
town of Professor Milton Friedman, of Chicago and San
Francisco, that there are really two Friedmans.  There
is Professor Friedman, the social scientist, pre-eminent
monetary economist, who bases his conclusions on the
most carefully researched data.  And there is Professor
Friedman the polemicist, who wishes to sell the
message (which has little to do with his monetary
economics) that market forces and the price
mechanism, if allowed unfettered play, would improve
the lot of man in every way.

This second Friedman advances his case in debate with
charm, effect and wild unsupported assertions.

Observers have been surprised to hear that the
development and prosperity of the modern Japanese
textile industry was the result of the Japanese
government's enthusiastic devotion to the principles of
free trade.  The assertion was so breathtakingly
confident that it took a moment to realize that it was
also contrary to the facts.

Indeed, advocates of the market have to digest the
difficult fact that the Japanese, and some other major
economic miracles, took place in the context of
draconian protectionism under an interventionist
government.

Without question Professor Friedman Mark II has
made a powerful and important contribution in
reminding the modern world of the theories of Adam
Smith.  The benign workings of market forces certainly
have been underestimated in the post-war era.  But
there is a danger of overdoing a good thing, and it is a
danger to which all good propagandists must be prone.

Mark II falls into this trap by creating the impression
that market forces can solve all problems - down to
ingrowing toe-nails.

Professor Friedman would probably lose political and
industrial support for his views on market forces and
the pound's exchange rate.  In the later stages of the
last Labour government there was what passed for a
"great debate" on what should be done with the
revenues from North Sea oil.  Certainly there was
general agreement that they should not just be
frittered away.  There was even a White Paper, which
suggested options such as using the money to repay
overseas debt, or to regenerate the rest of industry.

This Government stopped the debate and took
decisions.  Exchange controls were removed and
substantial quantities of long-term savings were used
to acquire foreign assets, which will be useful sources
of income when North Sea oil runs out.  And the
exchange rate was allowed to rise to levels which the
overwhelming majority of industrialists consider to be
impossibly high.  They argue that if and when a regime
involving a high exchange rate manages to bring down
inflation, it will be too late because whole sections of
industry will have passed more or less peacefully
away.

It would be no surprise to Professor Friedman that
farmers now believe the pound is too strong, and they
have never been notable defenders of free trade.

Professor Friedman's view is that the Government
should relax and let the exchange rate be what it will.
He would disapprove of authorities which from time to
time take action to stop it going higher.

His argument goes like this: what does it matter if
marginal industries go to the wall and imports of
industrial goods rise, while exports fall?  So long as the
oil side of the balance of trade is in surplus, why do
you want the non-oil side to be in surplus as well?
Why not live off oil while you have got it and get the
standard of living benefits of the high exchange rate?
Of course, the oil will run out; but then, if you do not
interfere with the market, the exchange rate will come
down and it will be possible for the non-oil sector to
start expanding again, since it will once again be
competitive.

This is the sort of line that is easier for advisers to give
than for governments to follow.  Governments, for all
their manifest weakness, have to deal with the real
consequences of their actions.  And there are some
industries, deep coal mining for example, which cannot
be switched on and off except over a time scale
measured in decades and certainly not in response to
movements in the medium term exchange rate.

The question of what the proper exchange rate should
be is clearly contentious.

It is possible that a market-determined rate could
produce an answer in the medium-term no worse than
one chosen on any other basis.  On the face of it,
however, it seems unreasonable that the rate with
which the non-oil economy has to live should be so
influenced by what is happening on the oil side of the
account.

There is a mechanism available by which the
Government could at least neutralize that upward
pressure on the rate.  It could estimate the net
contribution of the total oil account to the balance of
payments.  It could then instruct the Bank of England
to intervene in the foreign exchange markets by selling
sterling over, say, a year in order to add that sum to
the official reserves.  This would then leave the pound
at the mercy of the non-oil economy alone.  It would,
incidentally, allow an equal repayment of the still huge
burden of foreign official debt.  In addition, for the
rest, market forces could still be allowed free rein.
@
2.4
Share prices on Wall Street have plunged by nearly a
quarter, a far steeper drop than in the crash of 1929.
Dow Jones fell 508.32 points. In London, the FTSE 100
share index fell 250 points, wiping ú50bn off share
values.  Tokyo followed the same pattern early today

The dollar dropped sharply.  Mr James Baker, US
Treasury Secretary, went into urgent talks with the
West German Finance Minister  British Petroleum
shares plunged 34p down at 316p.

President Reagan, after "watching with great concern"
Wall Street's blackest day, sought last night to reassure
apprehensive and frightened Americans that "the
underlying economy remained sound."

His words were echoed by other senior figures in
Washington and New York who insisted that the
situation is dramatically different from 1929.

President Roosevelt's famous remark in his first
inaugural address that "the only thing we have to fear
is fear itself" was widely quoted as the Dow Jones
Industrial Average plunged 508.32 points to 1,738.41,
a decline of 22.6 per cent.

This drop made October 19, 1987, Wall Street's worst
day, exceeding the 13.2 per cent fall on October 29,
1929. The pace of fall increased toward the close of
business as computer investment programmes gave out
their "sell" signals and panic spread throughout the
investment community.

In Tokyo early today, share prices opened sharply
lower as a flood of sell orders gripped the market.  The
225-share Nikkei average lost 159.9 points in the first
15 minutes, moving to 25,586.67.

Heavy clouds hang over the world's financial system,
threatening a flood of business failures and
bankruptcies unless the fall is reversed.  Mr John
Phelan, chairman of the New York Stock Exchange,
spoke of "a financial melt-down", adding: "I would not
want to be around for anything like this again."

He said that the Stock Exchange would open again
today, although earlier Mr David Ruder, chairman of
the Securities and Exchange Commission, had suggested
that the market might be temporarily closed "if the
chaos continues".

In London yesterday the stock market suffered its
worst fall when prices and confidence were stricken by
Friday's collapse on Wall Street and early indications
that the fall in New York would continue.  Key stock
markets throughout the world had also taken a beating.

Although there were no signs of panic selling in
London, the absence of buying and the nature of the
new electronic dealing system were enough to send
values plummeting.

As in New York, the news of American attacks in the
Gulf did nothin to calm frayed nerves.  At the lowest
point, ordinary shares had shed more than $63 billion.
A small and fragile rally reduced the day's aggregated
losses to $50.6 billion.

The FT-SE 100 share index, which had fallen 302.1 just
after 4pm to below 2,000, ended the day 249.6 down
at 2,052.3 - a drop of 10.6 per cent.

The FT 30 share index also recovered a little ground
before closing 183.7 down at 1,629.2 - a fall of 10.1 per
cent.  This is the sharpest fall, both in absolute and in
percentage terms, since the end of the Second World
War.

The worst day for the FT index before yesterday was
March 1, 1974, when in response to Labour's return to
office the index dropped 7.4 cent.

The gilt-edged market was also in retreat but as in the
equity market, there was more emotion than panic.

There were fears for the huge British Petroleum share
issue today.  Although it is underwritten and the
Government is assured of its money, it is unlikely to
attract popular support in a devastated market.  The
shares were 34p down at 316p: the new shares are
priced at 330p.

The market has two basic fears.  First, that Wall Street
and the New York bond market will continue to fall,
evoking fears of another 1929 crash; second, that
interest rates will be forced up and slow the rate of
economic growth.

In the last three working days last week the Dow Jones
Industrial Average dropped by 260 points (10 per
cent).  When the market opened yesterday the fall
gathered even more momentum.

The index has fallen 37 per cent from its August peak
of 2,772.42.  Because of the virtual absence of dealing
in London on Friday in the wake of the storm that
struck southern England, the adjustment in London
prices was more concentrated than it would otherwise
have been.

In the foreign exchange markets the dollar wilted
before the West German mark, while the pound
remained firm but largely on the sidelines.

At the weekend the Germans seemed determined to
raise their interest rates.  This provoked a pained
reaction from Mr James Baker, the US Secretary of the
Treasury, who declared that this was "not in keeping
with the spirit of what we agreed in Washington three
weeks ago".

The West German Finance Minister, Herr Gerhard
Stoltenberg, seemed yesterday to step back from the
brink: "I assume", he said, "that monetary co-operation
with the US will continue."  Mr Baker has decided to
visit Europe to bolster the Louvre accord, and last night
paid a surprise visit to the Germans.

YUPPIES AGHAST AT END OF BOOM

Crowds of dazed young brokers milled around Wall
Street yesterday evening trying to come to terms with
the unthinkable - the roaring Eighties, the years of
easy prosperity, could be over.

As Mr John Phelan, chairman of the Stock Exchange, sat
in the ornate boardroom putting a brave face on the
day's massacre, tireless young operators stood in the
street and agreed: "Maybe this is the big melt-down."

"I've lost my shirt today as well as the money of a lot
of other guys," said one stereotype of the Yuppies who
swarmed to the financial world to reap the benefit of
the Reagan boom.

"We knew this was coming one day," said another,
equipped with the red braces and horn-rim glasses
that are the badge of office for the generation who
came straight from college and have never seen a bear
market.

A few streets away, in Harry's Bar, crowds of young
brokers swilled their beer from the bottle, their hands
trembling from the day's havoc but still cracking
nervous jokes.  "Maybe we should call it Fall Street,"
said one, glancing at The New York Post with its banner
headline "Wall Street goes mad".

"Tomorrow's another day.  Perhaps we'll see it go up
another three hundred again when it opens tomorrow,"
one hopeful operator said.  Jokes about leaping from
windows abounded, but there was a feeling that the
country was not in such a bad shape as it was in 1929.

Older hands said they saw an end to the collapse
provided the market came to its senses within the next
few days.  They pointed to the continuing strength of
the economy, still growing after the longest post-war
expansion.

But it was obvious nothing would be the same again
after Black Monday.  A black man on a bicycle seized
the mood when he shouted at the brokers: "Freedom!
The Reagan revolution is over.  Death to Yuppies."

A tubby broker bellowed back at him: "Whoever dies
with the most toys, wins.  We start over again
tomorrow."