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July 1, 2011, 12:01 a.m. EDT
By Howard Gold
NEW YORK (MarketWatch) "” Some of the biggest names in economics gathered at the University of Chicago in November 2002 for a 90th birthday celebration of the brightest star of them all. Milton Friedman, a Nobel laureate and seminal thinker, was returning to the university where he had made his name.
One of the speakers was a Federal Reserve governor, Ben S. Bernanke. In a scholarly address, he endorsed Friedman's view that the Fed was instrumental in causing the Great Depression with a tight monetary policy that turned a contraction into something much, much worse.
Matt Phillips explains how the end of QE2, which ends today, will affect the treasury market in the coming weeks.
In concluding, he addressed Friedman and Anna Schwartz, co-authors of the magisterial "A Monetary History of the United States," in which that thesis originally appeared. "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," Bernanke said.
He kept his word. When the financial crisis and recession descended six years later, Bernanke, now the Fed chairman, followed Friedman's monetarist playbook to a "T": He flooded the system with liquidity and stuffed banks full of reserves in a series of desperate efforts to stanch the new Great Contraction.
"Bernanke is following a monetarist depression-prevention model laid out by Nobel laureate and libertarian patron saint Milton Friedman," the libertarian magazine Reason wrote in 2009. "Trillions of dollars have been staked on the insights of "?monetarism'"¦ 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. "
Meanwhile, Presidents Bush and Obama took the route of another legendary economic theorist, John Maynard Keynes. In two, maybe 2 1/2, economic stimulus packages, they used all the Keynesian tools "” direct tax rebates, temporary tax cuts, boosting unemployment insurance, bailing out state and local governments and building infrastructure "” to boost consumption and thus make up for the sharp plunge in private demand.
The government spent nearly $1 trillion on stimulus programs. The Fed boosted its reserves by $2 trillion. Now, almost three years after the fall of Lehman Brothers, gross domestic product is growing at less than 3% annually, while the official unemployment rate is 9.1%. Add those who are working part time and the total is over 15%.
Many economists agree that the drastic measures taken probably prevented a repeat of the Great Depression. But the "recovery" has been so weak that much of the public thinks, with good reason, that we never emerged from recession.
Truth is, the giants Friedman and Keynes have met their Waterloo in a housing depression that shows few signs of recovery, a financial crisis that has suppressed growth and a looming debt crisis in Europe and the U.S.
We're witnessing the collision of theory and reality. And when that happens, no matter how elegant or persuasive the theory, reality always wins.
Read Howard's "Where Liberals Failed" and "Where Conservatives Failed" on the Independent Agenda.
"This stuff doesn't work the way it used to work," said Mark Skousen, who edits the Forecasts and Strategies investment newsletter and has written many books about economics, including "The Making of Modern Economics."
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