The Age of Magic Money
Can Endless Spending Prevent Economic Calamity?
After taking office in the depths of the Great Depression, U.S. President Franklin Roosevelt quickly upended the relationship between the government and the economy. With the New Deal, Washington took the unprecedented step of creating new industries and millions of jobs. This spending rescued countless Americans from poverty and ultimately fueled the remarkable postwar economic boom. By the 1980s, however, a new bipartisan consensus had taken hold, one that saw small government and low taxes as the key to economic prosperity. In 1941, Roosevelt declared that every American deserved “freedom from want” and that it was the government’s responsibility to lead the way. But by 1996, President Bill Clinton was promising that “the era of big government is over.” What changed?
Nicholas Wapshott’s new book, Samuelson Friedman, tells that story—the victory of 1980s free-market libertarianism over the midcentury welfare state—as a battle between two economic titans, Paul Samuelson and Milton Friedman. Samuelson was a Keynesian, best known for his work on the so-called neoclassical synthesis, which advocated a measure of government intervention in the economy. Friedman, by contrast, was a one-time New Dealer who by the 1950s had become perhaps the most pugilistic and passionate libertarian of his day.
Amid a global pandemic, there is much to learn from the Samuelson-Friedman saga. Today, as in the 1960s and 1970s, the assumptions of a previous era are falling away. The small-government, low-tax economy that Friedman and others imagined and brought into being is finally slipping from power. Not only is the American public questioning old beliefs—that markets are best when they are free and governments are best when they are small—but experts from across the political spectrum are also increasingly admitting that these assumptions have proved false. COVID-19 has put into sharp relief something the economic data have long suggested: a laissez-faire system produces rising inequality rather than shared prosperity. With these deeply held convictions under assault, leaders have a crucial opportunity to design a more equitable economy.
Wapshott begins his book in the mid-1960s, with the story of the Newsweek editor Osborn Elliott’s quest for new columnists who could outshine the magazine’s stodgy rival, Henry Luce’s Time. Perhaps great economists commenting on the news of the day would appeal to his younger audience.
Elliott felt lucky to secure Samuelson, the greatest theoretical economist of his time. He was also the author of what has become the best-selling economics textbook of all time, first published in 1948 and titled simply Economics. Samuelson, who had been made a full professor at the Massachusetts Institute of Technology at the age of 32, needed neither the headache nor the income that writing a magazine column could bring, but he was seduced by the idea of reaching Newsweek’s 14 million weekly readers. Elliott also tried to sign up Friedman, a conservative libertarian at the University of Chicago who was an outsider to the Keynesianism that dominated midcentury economic thinking in the United States. Friedman initially refused Elliott, saying he was too busy. But Friedman’s wife, Rose, pressed the case. “The task of explaining the relationship between political freedom, for example, and a free-market economy . . . has not been performed very well,” she wrote in a 1976 article for The Oriental Economist. (Wapshott’s storytelling could have used more from Rose Friedman. A distinguished economist in her own right and a co-author of much of Milton Friedman’s work, she was responsible for turning a collection of speeches into her husband’s most influential popular text, Capitalism and Freedom.)
Samuelson and Friedman joined Newsweek in 1966 and wrote for the magazine until the early 1980s. Throughout their tenure, both thinkers covered the central economic debates of the time, including the appropriate level of taxation and the role of the Federal Reserve. As Wapshott documents, however, the two fundamentally disagreed over central elements of economic theory—specifically, whether a market system could regulate itself without external intervention. Friedman believed that his unfettered version of capitalism, free from nearly all forms of government interference, was synonymous with both economic and political freedom. Samuelson, by contrast, maintained until the end of his life that “there can be no solution without government.”
The economy that Friedman and others brought into being is finally slipping from power.
Samuelson Friedman subscribes to the great man theory (gender intentional) of intellectual history. In Wapshott’s narrative, the two economists represent almost the entirety of the debate between Keynesianism, a shorthand for active government management of the economy through fiscal policy, and libertarian-inflected monetarism, by which central banks and the money supply take center stage. The intellectual networks to which Samuelson and Friedman belonged get short shrift. This is a fundamental omission. Friedman, for instance, was a founder, along with Friedrich Hayek, Ludwig von Mises, Karl Popper, and others, of the Mont Pelerin Society—an influential group that originally developed and propagated the idea of neoliberalism. Such networks provide vital intellectual, social, and political support to their members, helping their ideas gain acceptance and legitimacy. Wapshott pays a little more attention to the power of select academic institutions—such as MIT, the University of Chicago, and the University of Virginia—that educated generations of students, both Keynesians and neoliberals. But these institutions still take a back seat to Samuelson and Friedman themselves.
The larger problem is that Wapshott fails to give readers a sense of the times. The 1960s and 1970s were turbulent: the Vietnam War, the sexual revolution, and the civil rights movement upended the United States’ old social, racial, and economic orders. Although these changes were often liberating, the accompanying chaos led many middle-class white Americans, including suburban housewives in the Sunbelt and business leaders in the South, to reject Samuelson’s vision of federal government intervention in favor of Friedman’s simple and well-ordered system of free enterprise.
Much of the anxiety stemming from the changes crystallized in 1964, when the Republican presidential candidate Barry Goldwater ran on an anticommunist, economically conservative platform, opposing both the welfare state and the 1964 Civil Rights Act. Goldwater cast federal civil rights laws as yet another instance of unjust state interference in private affairs and, in so doing, directly linked Friedman’s small-government ideas to white southern opposition to desegregation. By the end of the 1960s, the civil rights movement itself had also begun to explicitly link race and economics, but in the opposite direction. Martin Luther King, Jr., proclaimed in 1967 that “the problems of racial injustice and economic injustice cannot be solved without a radical redistribution of political and economic power.” The economic fight had become an explicitly racial one.
The 1960s and 1970s thus pitted Samuelson’s New Deal–era vision of government against Friedman’s business-, profit-, and shareholder-focused worldview during an era of intense social upheaval. For many white Americans, Friedman’s supposedly politics-free version of economics proved to be the most compelling. According to that version, the right political, moral, and economic answer was wherever supply met demand. The theory’s monetarism—the policy of using the money supply to influence the whole economy instead of relying on complicated legislative decisions around taxing and spending—was similarly elegant and apolitical. Friedman’s economic and political arguments were one and the same. Freedom meant limited government. This was the triumph of neoliberalism.
The duel between Samuelson and Friedman was perhaps most pointed and pivotal when it came to questions about inflation: what caused it and how governments could tame it. The inflation of the 1970s remains a cautionary tale that still animates American politics. The conventional wisdom holds that the inability of Keynesianism to explain so-called stagflation, a period of paradoxically low growth and high inflation, was the major reason for Samuelson’s fall and Friedman’s rise. Stagflation presented a puzzle to which Keynesians had no answer. Inflation, which averaged about seven percent annually throughout the decade, was not supposed to be possible if unemployment was high and growth sluggish. Friedman’s characteristically simple answer to the problem was for the Federal Reserve to arrange “a 3 to 5 percent increase in the stock of money.” Otherwise, too much money would chase after too few goods, causing prices to rise even more.
Wapshott’s narrative is strongest here, revealing just how complicated and long running the inflation debates of the 1970s were. Over many years, Samuelson and Friedman argued about whether stagflation was caused by persistently high wages propped up by union contracts, the costs of the ongoing Vietnam War, or shocks to the global supply of oil. Even today, the causes of the inflation of the 1970s remain the subject of fierce debate.
The solution that Samuelson eventually proposed was to raise taxes and maintain high levels of public spending—remarkable for contemporary economists accustomed to thinking of increased interest rates as the only inflation cure. Friedman, for his part, continued to advocate a combination of lower public spending and careful control over the money supply. By the early 1980s, Samuelson’s argument for greater spending had lost. Sharply higher interest rates and a focus on inflation rather than employment became the order of the day. Ronald Reagan won the presidency, having built his political career on a Friedman-inspired promise to cut taxes and a false, racially coded campaign against so-called welfare queens—a stereotype of Black single mothers raking in government checks. Once in office, he cut taxes on the wealthy (while raising them for working people) and fought against trade unions—famously firing striking air traffic controllers. The postwar Keynesian welfare state was dead, at least in the United States. Although the economy was in deep recession, the paradigm had shifted.
For Friedman, however, even this outcome was no victory. Wapshott’s description of Friedman’s anguish as Paul Volcker, then chair of the Federal Reserve, implemented sharp interest rate hikes in the fall of 1979 contains some of the book’s most powerful insights. Friedman, who called Volcker’s 20 percent rate increase “monetarism lite,” had long advocated steady and algorithmically determined changes in the money supply, with no discretion left to the Federal Reserve chair or other political actors. But simple theories, where simplicity itself is the virtue and the appeal, are rarely easy to implement. Even the highest of economic priests bitterly disagree, constrained by their own prior assumptions.
Americans can learn much from the 1970s. Although it is easy to reduce to a simple clash of economic titans the rupture that broke Keynesianism and brought Reaganomics to power, that change took more than a decade. The transformation was rooted not in individual personalities but in how economic theories filter through complex political realities.
Today’s economic paradigm shift has also taken place over time, having begun long before the emergence of COVID-19, as Wapshott documents. Understanding the current upheaval means examining the policy failures that led to the 2008 financial crisis and the subsequent recession. Americans’ veneration of private capital faltered with the collapse of the financial giants Bear Stearns and Lehman Brothers. Everyday people quickly came to believe that these institutions no longer had their best interests at heart. According to Gallup polling, public confidence in the banking system dropped from 53 percent in 2004 to 22 percent in 2009 and has never recovered.
Now, more than a decade after the crisis, something very new is emerging at the highest levels of government: Brian Deese, the director of the Biden administration’s National Economic Council, has made it clear that the current government’s COVID-19 economic recovery plan is “quite different” from previous ones. The American Rescue Plan, the stimulus package passed by Congress in March, prioritizes providing funds directly to unemployed Americans and struggling states and cities. Austerity, that watchword of decades past, is finished. President Joe Biden himself has argued for a new economic paradigm. “We can’t go back to the old, failed thinking,” he proclaimed in July.
Today’s economic paradigm shift began long before the emergence of COVID-19.
This new paradigm is notably more complicated than Friedman’s monetarism. Most mainstream economists, in fact, now reject the latter for its relentless focus on the amount of money in circulation. Instead, the emerging framework is about encouraging the federal government to play various roles meant to promote the health of the U.S. economy and society. Public institutions, its advocates argue, should make and enforce strict rules to prevent corporate monopolies, invest in green energy, and spend much more on such public goods as health care, childcare, and education. Government should also deliberately seek to close racial gaps in wages, wealth, housing, education, health, and other areas.
Parts of this new vision are already coming to life. The $4 trillion allocated for the CARES Act and the American Rescue Plan—both immediate responses to the pandemic—includes an unprecedented amount of government support for low-income and working-class Americans, parents with young children, and small and medium-sized businesses. Although the relief is temporary, it kept the worst effects of the recent economic downturn at bay in ways that were unthinkable only a few years ago. Federal rescue funds have also driven wage increases, and—absent new COVID-19-related shutdowns—the current recovery is on pace to be five times as fast as the recovery from the Great Recession: two years, not ten.
But although the pandemic may be the final nail in Friedmanomics’s coffin, a durable world of higher taxes and government management of the economy—one that Samuelson might have recognized and even embraced—has yet to fully emerge. Whether this new paradigm takes root the way Keynesianism did in the 1940s and Friedmanesque market fundamentalism did in the 1980s will depend on many factors. “The culture wars”—a go-to euphemism for the backlash against racial and gender equality—could pull the United States away from acting on truly inclusive policies. A small but powerful group of climate-denying politicians might continue to bury their heads in the sand about the immediate need to cut carbon emissions. The government’s talent pipeline and institutional resilience might not be sufficient to implement the ambitious programs currently under consideration. The government itself might be unable to regain the trust of Americans who, for a host of reasons, may be suspicious and distrustful of federal action.
But if U.S. leaders persevere, this model will open up vast new social and political possibilities. International economic cooperation might aspire to solve genuine public problems, such as international tax evasion or the lack of pandemic preparedness, rather than merely lower trade barriers for multinational corporations. More working-class Americans might finally have access to economic security rather than living paycheck to paycheck. Washington could incentivize a transition to a low-carbon economy in time to stave off the worst effects of climate change. And perhaps most important, the United States might become a country whose idea of freedom is not primarily based on market transactions but instead built on the promise of a more egalitarian and democratic future.