Milton Friedman. Eamonn Butler

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      Keynesians – that is, nearly all of Friedman’s professional contemporaries before the 1980s – dismissed the quantity theory as outdated and crude. At its crudest, it runs like this: governments control the amount of money in their country’s economy by printing new banknotes and minting new coins. If they print or mint a lot more currency, then – like anything that suddenly becomes more plentiful – its value falls. Producers then demand more pounds or more dollars for their goods and services, because they now value those notes and coins less. In other words, prices rise. We call this inflation, and its cause is a rise in the quantity of money. Control the production of money, and you control inflation.

      Friedman did not invent the quantity theory; it had been around for centuries. But mainstream economists attributed price rises to other causes – the rising cost of oil or food imports, for example. And even if the quantity of money did increase, they thought, people might not spend it; perhaps it would just sit in their wallets or bank accounts, where it had no effect on the economy or prices at all – Keynes’s famous ‘liquidity trap’.

      By the mid-20th century, the quantity theory seemed dead and buried; but it was not. In a 1956 article, ‘The Quantity Theory of Money: A Restatement’, Friedman brilliantly revived it. The theory’s power to predict inflation hinged not on the supply of money from governments, but on the demand for that money from consumers – the amount that people actually choose to keep readily to hand. Friedman proved that this demand is surprisingly stable. If extra money is created, it does not languish unused in people’s wallets or bank accounts: consumers actually keep a pretty constant amount of cash to hand. Any extra, they spend; and it is this extra spending that bids up prices. The quantity theory really does explain inflation.

      Friedman’s 1962 A Monetary History of the United States, co-authored with Anna Jacobson Schwartz, demonstrated the impact of money on inflation in enormous detail. It furnished a fine example of the role of money in inflation: during the American Civil War, the South suffered huge price rises – which ended abruptly after Northern troops captured the presses that printed the South’s money. It also showed that the Great Depression, a time of dramatic price falls, stemmed not from any inherent instability of capitalism, but from the US Federal Reserve’s inept constriction of the supply of money.

      “During the Civil War the North, late in the Civil War, overran the place in the South where the printing presses were sitting up, where the pieces of paper were being turned out. Prior to that point, the South had a very rapid inflation. If my memory serves me right, something like 4% a month. It took the Confederacy something over two weeks to find a new place where they could set up their printing presses and start them going again. During that two-week period, inflation came to a halt. After the two-week period, when the presses started running again, inflation started up again. It’s that clear, that straightforward.”

      – Milton Friedman, Free to Choose, Episode 9

      Taking on Keynes

      Friedman’s work on consumer behaviour at the National Resources Committee 20 years earlier gave him more facts to back up his thinking. It also enabled him to demolish another key part of Keynes’s economic structure, one that had encouraged governments to expand in size and to raise taxes.

      Keynes thought that as we grow wealthier, we tend to spend less and save more. With less being spent on goods and services, production would decline and unemployment would rise. That argued for high taxes to limit people’s incomes, and for higher government spending to fill the spending gap.

      But in The Theory of the Consumption Function, published in 1957, Friedman showed that people who have different levels of lifetime income actually have remarkably consistent spending and saving habits. Keynes was simply wrong about the facts of human behaviour, and consequently had greatly overstated the need for government spending and taxation.

      The Public Intellectual

      However, the postwar years were dominated by a general belief in the necessity and effectiveness of government controls. Those who, like Friedman, valued individual freedom and supported free-market capitalism were a beleaguered minority. In 1947 the economist and political scientist Friedrich Hayek brought a handful of them together in the Swiss resort of Mont Pelerin. He hoped they could form an intellectual kernel to keep the values of liberalism – in the classical, European sense – alive during what seemed particularly dark times.

      Two of the participants at Hayek’s meeting were Milton Friedman and his friend George Stigler. Though the ideas of the Mont Pelerin Society, as it became known, remained in the intellectual wilderness for decades, it continued to grow, becoming a leading focus for liberal ideas. It would produce many Nobel economists – including Friedman, Hayek and Stigler – and Friedman would become one of its most distinguished presidents.

      Some 15 years after that first meeting in Mont Pelerin, Friedman produced a book that changed him from a little-known professional economist (albeit one who focused on the big public issues like inflation) into a famously controversial public intellectual.

      His 1962 book Capitalism and Freedom, written with his wife Rose, pulled no punches. It began with a thoroughgoing endorsement of the principles of personal liberty on which their country was founded. It went on to show how government intervention had eroded this liberty, leaving human society less free and the economy less efficient, capable and prosperous. It closely reflected the views of the 19th-century English philosopher John Stuart Mill: a belief in the dignity of the individual, a conviction that progress occurs only through the genius of individuals, and the conclusion that we must uphold the diversity and variety that allows individualism to flourish. It also drew from the arguments in Hayek’s seminal book The Road to Serfdom, that the greatest threat to freedom and progress is concentrated power.

      From this liberal foundation, Capitalism and Freedom went on to address the great public issues of the day – economic policy, trade, education, discrimination, monopoly and poverty. Its policy prescriptions seemed unachievably radical at the time; but 40 years on, almost all of them have begun to be implemented or trialled in some part of the world or another. It called for flat taxes, with everyone paying the same rate – a system pioneered by Estonia and now adopted by a score of other countries. It demanded that state-run Ponzi-scheme pension systems should be replaced by saving through personal accounts – a transformation made by Chile and a growing number of other nations. It recommended replacing the state mail service by competition, which is happening today across the European Union. It called for an end to military conscription, a bitter argument in the United States at the time, which Friedman eventually won. It recommended that drugs should be decriminalised – a policy that is now being tested in several places.

      “Every friend of freedom. . .must be as revolted as I am by the prospect of turning the United States into an armed camp, by the vision of jails filled with casual drug users and of an army of enforcers empowered to invade the liberty of citizens on slight evidence.”

      – Milton Friedman in The Wall Street Journal, 7 September 1989

      The book was a huge success, selling hundreds of thousands of copies. Milton and Rose called their summer cottage in Vermont Capitaf after it. And it confirmed Friedman’s status as a national controversialist. His quick wit, engaging personality and easy-to-grasp arguments made him a natural participant in any public debate – particularly when some lone voice against mainstream thinking was needed. He wrote magazine articles, appeared on radio discussions, and was always happy to criticise the Federal Reserve at Congressional hearings in Washington.

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