-: Hello, Instructional Dynamics Incorporated welcomes you
to this weekly series of commentaries
on the current economic scene.
Reporting to you will be
one of the nation's leading economists,
Professor Milton Friedman of the University of Chicago.
-: I'd like to start today by first briefly
continuing the dialogue with my respected old friend
and frequent opponent, Paul Samuelson,
about eclecticism, fiscal policy, and monetary effects.
I feel like saying, as is often said in books,
for those who aren't interested in this,
skip to the next chapter, but I shall try to be brief.
I'm delighted that this dialogue has led Paul
to look up some numbers and discover
that there is no sure-fire formula
for predicting changes in GNP for monetary changes.
As I indicated several weeks ago in my tape
discussing the debate that I had with Walter Heller,
I am very far indeed from arguing
that there is such a precise relationship,
there is a lot of noise in the relationship,
but it is precisely because there is
that I am in favor of the rule
increasing the quantity of money by a steady rate
rather than trying to manipulate the quantity of money
very delicately to produce fine tuning in the economy.
Unfortunately or fortunately, there is no way
in which simply by looking at the quantity of money
you can make a precise prediction
of what's going to happen to the quantity,
to GNP or other magnitudes,
in the next quarter, or two quarters later,
or three quarters later.
You may be able to do better that way
than you can most other ways,
but that's still very far from perfect.
Apparently I did not make myself clear
and Paul misunderstood what the thrust of my comment was.
Paul had quoted the slight slowdown in the rate
of growth of GNP in the third quarter of this year
as evidence that fiscal policy was starting
to exert its effect, that the increase in the surtax
had exercised a dampening influence
on the rate of growth of the national economy.
It was this statement that I was referring to.
The point of my remark was that that slowdown
was not relevant evidence, was not valid evidence,
that fiscal policy was indeed having an effect
since the slowdown in the GNP could equally well
have been explained by monetary factors alone.
I did not mean to suggest that monetary factors alone
did explain the slowdown, I did not mean to say
that fiscal policy was from this one case alone
proved to be ineffective, that would be silly,
one swallow doesn't make a spring,
you need a good deal of evidence.
All I was saying was that this case was no evidence
in that direction, since monetary policy could have
or monetary changes could have explained the slowdown.
It may be that fiscal policy does have an effect
on the growth of GNP, though I believe as I stated earlier,
that the evidence to date is against it.
But if one is to demonstrate that fiscal policy
has an effect one needs much more persuasive evidence
than this particular slowdown.
But let me turn now from this interesting intramural debate
which I may say while it is academic
in the very best sense of the term,
is also far from academic in the bad sense of that term.
It has very great importance for governmental policy
as well as the conduct of private affairs.
Let me turn however from that topic
to the events of the recent period.
Clearly the most interesting event of this period
has been the international financial crisis
and its aftermath.
As I mentioned in my last tape,
in many ways the really important thing about this crisis
is that the U.S. was hardly involved,
or rather I should say the U.S. dollar
was hardly involved, it was an intra-European crisis
among European currencies.
If such a crisis had blown up a year ago,
there is little doubt that it would have
affected the dollar.
The fact that it did not this time
is strong evidence for the point I was making
in my last tape, namely that the uncertainties
in France in May last year, this year,
and the Russian invasion of Czechoslovakia
has changed drastically the attitude
of holders of capital throughout the world
toward the dollar.
It has rendered almost impossible
a private run on the dollar.
The dramatic development in the crisis
was de Gaulle's apparently one man decision
to hold the franc at its prior value
and not devalue.
Apparently it was believed by all and sundry
that agreement had been reached among the central bankers
and ministers of finance who had been meeting for three days
that the franc would be devalued,
and indeed according to the talk that came out
the only real question was by how much.
It was believed that a condition
of a grant of a two billion dollar credit to France
was that the franc be devalued
but that it not be devalued by so large an amount
that it would produce great difficulties
for the pound sterling.
Perhaps commentators are only repeating
the discussion of a year ago when sterling was in crisis,
the international bankers at that time
attached as a condition to their loan to sterling
a mild devaluation of sterling, as a result
sterling has been in difficulty ever since.
As a footnote, it might be worth noting
that this is a distinct change from most postwar experience.
In most of the postwar episodes
when a devaluation occurred, the devaluation was larger
than was strictly needed.
This was a case in the earlier pound devaluation to 80,
it was a case when de Gaulle devalued the franc
in 1958 shortly on coming into office.
One effect of devaluing too much
is to give some margin for error, some leeway,
and to permit thereafter a favorable balance
of payments which would allow reserves
to be accumulated.
It was the over-devaluation by de Gaulle in 1958
which enabled him to accumulate the large stockpile
of gold and dollars that gave him
so much political strength in the following years.
But this time, the international bankers
were determined to prevent Britain, a year ago,
from going too far, and so they attached
as a condition to their loan, that the devaluation
be limited, the rumor at that time
was that the maximum that was acceptable was 15%
and Britain almost went that far.
Similarly this time it was said
that the central bankers were very much
disposed to limit the French devaluation
to somewhere within the range of 10 to 15%.
But de Gaulle fooled them all by
deciding that he was gonna stick
to the existing rate for the franc.
He has been widely criticized for doing this
but I must admit that I am inclined rather
to be on his side.
If you are going to have a fixed exchange rate,
you better have it fixed.
If you make frequent adjustments in the level
at which you peg it, at which you fix the exchange rate,
the effect of this is simply to invite
widespread destabilizing speculation.
It may be that de Gaulle did this for wrong reasons,
he did it for reasons of pride and arrogance,
all that may be, I know nothing about that,
but it would not be the first time
that the right decision was reached for the wrong reasons.
If you look at the situation from an economic
point of view, and for the moment
put political considerations aside,
de Gaulle had three basic alternatives.
First, he had the alternative he followed
to hold the rate, and try by internal measures
to adjust internal policies so that the internal value
of the franc would correspond to its external value.
Second, he could have devalued by a fixed amount,
shifted the price of the franc
from its existing level to a new pegged level,
this was the measure that most people thought
he was going to take.
Third, he could have floated the franc,
that is to say, he could have said
we cannot hold the present price
of the franc, or we do not choose to.
We do not want to simply repeat our past policy
of going to a new level that we will get stuck on,
we will simply let the franc find its own level
in the free market, and whatever price
people want to buy and sell francs for
in terms of foreign currencies.
This is what Canada did in 1950
when it had exchange problems.
At the time it did it offered the excuse
that it was going to allow the Canadian dollar
to float temporarily because it did not know
what the right price for the dollar was.
It expressed the view that as it floated
the market would enable a better determination
to be made of the new price.
It was on this ground that the International Monetary Fund
approved the Canadian shift to a floating rate,
regarding it as a transitional device to a new parity.
As it happened that transition lasted some 12 years
and it was terminated, not because Canada found
the right price for the dollar,
but rather because the Canadian government
embarked on an ill-advised policy of speculation
in the Canadian dollar that started it going down,
and it found no way of getting off of the tiger
it had jumped on, except to shift, to re-peg
the Canadian dollar at a new rate.
Well similarly in this occasion,
General de Gaulle could very well have economically said
that he was floating the franc
either in order to find out by experience
what the right level was
or because he was just going to let it
find its own level indefinitely.
I may say that in my opinion this third course,
floating the franc, would have been by far and away,
the best policy for him to have followed
in terms of his own interests, and the interests of France,
and also I may say in terms of the interests
of the world financial system.
Floating the franc would have made it unnecessary
for him to take the widespread measures
of direct exchange control that he has adopted,
it would have made it unnecessary for him
to engage in the other measures
many of which are undesirable on domestic grounds
that he has been forced to take.
Of course it's not all one way.
Some of the measures he has taken on domestic grounds
are very desirable in and of themselves.
However, whatever might have been
the abstract desirability of floating the franc,
this was largely ruled out so far as France was concerned
by de Gaulle's own past rhetoric.
He has for years been preaching the doctrine
that we need a real gold standard
rather than our present gold exchange standard.
He has been preaching the doctrine
that we need a world of fixed exchange rates
but exchange rates that are held fixed
by the literal transfer of gold
to settle balance of payments deficits.
Given this rhetoric, it would have been
very, very difficult indeed for him
to have floated the franc.
In addition to his own rhetoric, floating the franc
was largely ruled out by the universal disapproval
of floating rates by central bankers,
that is to say, by the people who would have been
advising de Gaulle.
de Gaulle is obviously not a great economist on his own,
he must act in accordance with the advice he gets.
He is known to place great reliance on the advice
of Jacques Rueff, who is an extremely sophisticated
and subtle person in financial matters,
the man who was largely responsible for the measures
which de Gaulle took in 1958 on the financial side
and which were so spectacularly successful.
Rueff would almost surely have been opposed
to floating rates and so would most
of the other central bankers.
I may come back in a moment as to why
they are so opposed and to why in my opinion
they are wrong in being opposed.
But to continue with the French story,
as between the two alternatives
that he regarded as really open to him,
holding the rate fixed and devaluing to a new level,
there are two major advantages in sticking
to the present rate, rather than going to a new peg.
First, it gives de Gaulle a political basis
from which he can justify and get public support
for internal disinflationary measures.
It's very hard it seems to me to rally such support
for measures in order to protect the franc at a lower rate.
After all, if 10% devaluation is okay,
why not a 20% devaluation?
Why not a large enough devaluation
so you don't have to take these unpleasant measures?
On the other hand, the argument that the franc
must be held at a rate which it has been held at
for over 10 years now that this is a way
to get a permanent, stable value for the franc,
that in order to do this the country must
gird its loins and all the other usual rhetoric,
that seems to me a much stronger position
for a politician to stand on.
As I've already mentioned, many of these measures
he took for this purpose are undesirable,
particularly the measures involving control
of foreign exchange, but some of the others,
particularly those involving cuts in government budgets,
and lower rate of monetary expansion,
and in general a less inflationary internal policy,
seem to be highly desirable for internal
as well as external reasons.
The second reason why holding to the present rate
is preferable in my opinion to devaluing
is that it is likely to have more favorable effects
in the future.
If a country, every year, or two years, or three years
is known to resort to devaluations
and not to hesitate to do so,
this lessens greatly the assistance which that country
will get from speculators.
Now that may be putting it backward,
I ought to say it increases greatly
the extent to which speculators will make it difficult
for the country to hold any one
of those intervening steps.
Every time there is a slight uncertainty
about the balance of payment situation,
speculators remember what happened before
and they say well, this country is not afraid
to devalue, we've got our place set.
Let me not give any misimpression,
I'm not criticizing speculators,
on the contrary, I think they perform
an extremely useful function, that it is very desirable
that there be some trigger mechanism
which will signal to the public at large
difficulties in the balance of payment situation,
rather than simply leave a false sense of security
which will encourage the government to go much too far
in the policies that are producing the problems.
But, if you're going to have the speculators
contribute as much as possible to the stability,
you don't want them to set them off on all sorts
of false alarms.
Yet, once a country gets a reputation for devaluing
under the slightest of provocations,
of course that's not quite the French case,
but it's worth exaggerating to make the point,
why then every minor tremor is likely
to set off a wave of speculation.
We have already seen this happen.
One of the striking things about the success
of international currency crises of the past year or two
is how rapidly people all over the world
have learned the possibilities of speculation.
The people who speculate are not only those
you might call professional speculators
but businessmen of every variety and description
who have occasion to deal in different currencies,
have learned, and whenever rumors get around
or there are signs that currency might be devalued,
you'd better take some steps to in order to assure yourself
that you will not be caught in the currency
that is likely to be devalued.
Hence, if de Gaulle can carry through
his present policy, if he can make
the old exchange parity stick, he will give speculators
a second thought the next time difficulties arise
and you will have a less extreme
and less rapid speculative movement of funds out of France.
Question of course, the $64 question of course,
is whether de Gaulle will in fact be able
to make his decisions stick.
Here the initial indications are favorable.
The crucial time is the first couple of days
after such an announcement.
In those first couple of days the franc seems to have held
and there seems not to have been a renewal
of a major flight out of the franc.
If you can get past that initial period
then from a short run point of view
there tends to be a great reverse flow of francs
to support the franc.
That is to say you have all of the people
who sold the franc short, or who converted
francs that they own into other currencies,
in the hope that there was going to be
or fear or expectation that there was going to be
a devaluation, now there has not been a devaluation.
They are typically in the habit of holding those funds
in francs, they will therefore tend
to repatriate their funds and this will tend
to make the franc look fairly good.
The question is, for how long
will these favorable indications hold?
That's a much harder question to answer
because that depends critically
on how successful France is internally
in making the disinflationary policies take hold,
how successful it is in raising the internal value
of the franc and making it match
the external value of the franc,
so I have no firm answer, it's highly possible
that even though the present measure holds,
long about next March or April or May
you may have another franc crisis.
Spring up, we will have to see what happens
inside France before we can have
much of a judgment on that.
However in my opinion in many ways
a more difficult question, although it is one
that has hardly been spoken of,
and has received very much less attention,
is whether Germany will be able to hold
to its policy of keeping the present rate
for the mark unchanged, except for the implicit revaluation
involved in the changes in the taxes and subsidies
on imports and exports.
Those changes which I discussed in my last tape
have turned out in the event
to be even smaller than I was contemplating then,
even various experts estimate that they are equivalent
to perhaps a three or four percent revaluation of the mark.
That would seem to be a much too small
a revaluation of the mark to cut Germany's present
balance of payment surplus.
As one reads all of the discussion
about the present economic crisis, you might suppose
that Germany is benefiting from its large
foreign exchange surplus,
that revaluation of the mark would hurt Germany,
that if Germany is forced to revalue the mark
it will be a sacrifice on the part of Germany
for the benefit of other countries.
This however is the old, old, mercantilist fallacy.
It really is exactly the same argument
as was widespread in the 18th and 17th centuries,
which justified protective policies
on the grounds of what a nation had to do
was to accumulate gold and silver treasure,
that exports were wonderful and imports were terrible.
The fact is, it is in Germany's own interest
to have a mark valued at a level at which
its surplus is drastically cut down.
Holding the mark at its present level
without internal inflation, will mean
that Germany is paying a very high price.
Let's look at what that price is.
If it holds the mark at its present level
and it also succeeds in avoiding inflation internally,
then Germany will continue to have a very large surplus
in its balance of payment account.
What does that mean?
That means, put very crudely,
that it exports a great deal more than it imports,
a great deal more in value terms.
But that in effect means that Germany gets to use
for domestic purposes, a smaller fraction
of its current output.
For every hundred units of output
it gets to consume at home or add to domestic capital
a smaller fraction of that than it would
if it were not accumulating a surplus of dollars
or of other currencies.
In effect, Germany is accumulating capital
by making foreign loans to the extent of its surplus.
Now it might be that Germany
would want to make foreign loans
and insofar as it desires to make foreign loans
those are voluntary foreign investments,
they are made because people believe the rate of return
on those is higher than the rate of return
on internal investments and that's fine.
But insofar as it is accumulating let us say
dollar assets in the form of dollars
that people turn into the German central bank
for marks, because at the present price of the mark
they prefer the mark to the dollar,
insofar as it is involuntarily accumulating
these foreign assets, it is in effect
making loans to foreign countries
which are less advantageous than the investments
it could make at home.
Indeed, insofar as it holds the funds that come in
in the form of dollars proper,
in the form of non-interest bearing dollars,
either currency or demand deposits at commercial banks
or federal reserve banks in the United States,
Germany is making an interest-free loan
to the U.S., I speak of the U.S.,
but exactly the same thing is true
insofar if Germany accumulates francs, or lire, or pounds,
in each of those cases it is making
an interest-free loan to the country in question.
In respect to all of these issues,
it seems to me that the best way
to get a sensible perspective on them
is always to try to match statements in terms of dollars
with statements in terms of goods and services.
From the point of view of goods and services
there is nothing that is more advantageous to a country
than a balance of payments deficits.
The feature of a balance of payments deficit
is that you are getting more goods coming in
than you are having to send out,
you're getting goods in return for sending out
pieces of paper, for dollars,
there is hardly a more advantageous export.
The only trouble with a balance of payments deficit
is that you cannot continue it indefinitely.
In consequently, it's fine while it lasts,
but it can't last.
Put in terms of the United States,
people are always talking about as if
the problem for the United States
is the existence of a balance of payments deficit.
There, in my opinion, is not the case.
The balance of payments deficit by itself
is an advantage, it means that we are getting something
in return for pieces of paper, dollar bills,
or bonds or things like that that we are shipping out.
The real problem for the United States
is not the deficit, but is the measures that we take
to eliminate the deficit.
In particular the kind of exchange controls
that we have taken in the form of controls
over direct investment abroad,
in the form of controls over bank lending,
interest equalization tax and so on.
These are the real problem.
If we only had the courage and the guts
simply to eliminate all these things,
to say we are not going to peg the dollar,
we are not going to impose controls on our people,
we are going to say a dollar is a dollar
and people can do whatever they want with it.
Why then we might still have a deficit
but if we did it would be because
people abroad wanted to accumulate dollars
as part of their assets,
and that would actually be fine from our point of view,
we would be getting as it were an interest-free loan
or a loan at a very low rate.
Such a policy of course to be viable for a long period,
would mean that we would have to be prepared,
if necessary, to let exchange rates go.
And this brings me back to the question
of why it is that central bankers all over the world
are always so opposed to fluctuating rates?
At bottom I think the reason is a very simple one.
The adoption of a world floating exchange rate system
of free markets for exchange rates
would put central bankers out of business.
Now I don't mean this quite so crudely as it sounds,
I don't mean to say that any central banker
ever says my god I mustn't let floating rates go
or else I would be out of a job.
He wouldn't be, he would still have
his domestic responsibilities.
I mean it in a much more subtle and sophisticated sense.
The central bankers are now engaged
in what seems to them very, very important duties.
They are, at the drop of a hat, being forced to fly over
oceans in order to meet in one or another places,
to meet for days, with every headline in every paper
in the world recording their doings,
they are at the center of things.
In a world of floating rates this wouldn't happen,
there would be no need for such conferences,
just as there are no need for such conferences
in the American stock exchange,
because rates there float.
It is very hard for people involved
in these conferences to say to themselves,
what I am doing is a bunch of make-work
of no importance, I could be replaced
by simply a market in which rates floated.
And consequently it is psychologically almost impossible
for central bankers, who like the rest of us,
must regard the work that they are doing
as serious, important and worthwhile,
it is almost impossible for them to accept the idea
that a floating rate system would work fine
and would make unnecessary these repeated crises,
these repeated international conferences.
Thank you, this is Milton Friedman.
-: Thank you, sir.
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