From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm.

“A Crisis? Three Views”

By Milton Friedman, Paul A. Samuelson, Henry Wallich
Newsweek, 17 April 1967, p. 92-93
©The Newsweek/Daily Beast Company LLC

What’s ahead for the dollar, and what could the current ferment mean to the business trend of the
next few years? For three distinguished views, Newsweek assembled its economic columnists—
Milton Friedman, leader of the University of Chicago school of neo-conservative thought; Paul
A. Samuelson of Massachusetts Institute of Technology, one of the nation’s foremost liberal
economists and unofficial adviser to Presidents Johnson and Kennedy, and Henry Wallich of
Yale, a member of President Eisenhower’s Council of Economic Advisers. In a two-hour
conversation, the three economists frequently disagreed over what’s wrong with the world
monetary picture, how serious the problem is and what ought to be done about it. But they
reached surprising consensus on what may well actually happen, and what actions might be
taken if the situation worsens.

Highlights of the talk:

WALLICH: In the United States, it is very hard to understand why so small an item as our
balance-of-payments deficit should be so important. But the cost of a deficit, to us, is not so
much economic as political. The world gets in disorder; we get at odds with our allies. Now, we
have used up a large part of what can be done about the deficit, and what is the result? If you
remove the window dressing, we still have a deficit on the order of $3 billion. And because
fewer easy measures are left to be taken, the situation is basically worse than it has been.

SAMUELSON: I don’t think the window dressing is important; even the gnomes of Zurich have
learned to see through the windows. But I do think we are seeing a long-term improvement in the
balance of payments. There has been continuous inflation in Europe since 1959, much more than
we have had here. Our exports are competitively priced, and American businessmen are learning
that they can no longer make a lot of easy money and high profits by investing in the Common
Market. They aren’t fools. And that will cut down the most important single dramatic drain on
our balance of payments in recent years.

FRIEDMAN: I think Paul may well be right. In terms of prices our position is improving. But it
takes time for that to show; these balance-of-payments movements are very slow-moving things.

WALLICH: But our price level has risen for a couple of years, and will rise again this year 2.5
or 3 per cent. Our trade surplus is cut in half, almost. Our gold supply is lower, and our
liabilities, at least some of them, are higher. In all these respects we are worse off. The situation
that had been going in our favor is turning against us now.

SAMUELSON: Last year we lost some ground, but only a very small amount of ground, and the
current slowdown suggests that we are probably moving toward equilibrium. I know many
economists have been laying their reputations on the line—which is risking very little, in their

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From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm.

case—that there would be a crisis within the next six months. But if you talk to the bankers and
the large corporations, I do not think that at the moment they are particularly jittery.

FRIEDMAN: We are sitting on a keg of dynamite, but if nobody lights the fuse it won’t go off,
and we’ll never know we’ve been sitting on it. And we can keep on sitting on it for a very long
time. You have a crisis of this kind, at the most, once in 20 or 30 or 40 years, so in any particular
six-month period it is very unlikely to occur.

But it isn’t clear to me that it would be a disaster if it did occur. It might be a good thing.
Because the real problem in our balance of payments is the foolish measures it is leading us to
take, at home and abroad. It is the cures we are adopting, not the disease, that bother me. A crisis
might clear the air, bring down the present house of cards and establish a more satisfactory
arrangement.

SAMUELSON: I do not think a crisis is likely, and I would not welcome one. But let’s keep a
sense of perspective. If the worst should happen and we should wake up some morning and find
that the present parities around the globe are not the same, the Republic will not fall, the bridges
will not cease to bear the traffic, and the economy will not cease to grow. I am sure of that.

WALLICH: I am not so sure. The consequences of a crisis are fairly predictable, because we
have been through it before. We do not get a removal of trade controls, we get an increase. We
get disorderly monetary movements, as we had after ‘29. As Milton says, we do sit on a powder
keg. It does not look as hot as it did a year or two ago. But if we do not get the balance of
payments under control, then I think in a couple of years we will face a very difficult situation.
And we have very little room left for maneuver.

FRIEDMAN: I think we have plenty of maneuvering space. What I shudder at is the kind of
maneuvers we shall be led to take.

SAMUELSON: We have a great deal of room. Congress should double the interest equalization
tax, to discourage foreigners from selling securities here. If there is a serious deterioration, direct
taxation on direct investments abroad should be introduced. I do not exclude taxes to favor
exports. I see no reason why we shouldn’t use such devices if an emergency develops.

FRIEDMAN: We may have serious consideration of controls over tourist expenditures. We can
attract foreign money by offering high interest rates. We can bring pressure to bear on our allies
to keep them from turning in their dollars for gold. And undoubtedly the ingenuity of the
Treasury and Federal Reserve officials will find some things I have left out. I’m not saying any
of these things are desirable. Quite the contrary. But if you ask what we could do . . .

WALLICH: I don’t disagree with either of you. We could also, as a rather minor action, remove
the legal requirement that keeps most of our remaining gold tied up as backing for our currency;
we all agree on that. We can bring troops home, but we would regard that as an unhappy action.
In fact, the easy things have been done. Most of the others are either very time-consuming to
introduce, or very major. The hard things are still available, but they are hard.

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From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm.

SAMUELSON: The pessimists say we are running out of time, we are running out of gold, we
are running out of makeshifts and it is unthinkable not to maintain the parity of the dollar. And
they say the only lasting cure is to engineer a slowdown of considerable magnitude, with
unemployment rising to 5 per cent, to 5.5 per cent. That is tough bananas, they say, but that is
what you have to do in order to have the discipline of a fixed parity rate. Speaking for myself, I
would rather not have balance in the balance of payments than to have it brought about through
that kind of rigor mortis.

FRIEDMAN: It seems to me utterly inconceivable that a deliberate choice will be made in the
next year or two to incur unemployment for balance-of-payments reasons.

SAMUELSON: What is utterly inconceivable to Milton is often conceivable to me, and

sometimes is favored by the betting odds.

FRIEDMAN: But this time it isn’t.

SAMUELSON: No, I don’t think a tolerated recession is likely and I wouldn’t favor it. But I do
not rule it out. If unemployment does go that high, it will happen because we do not take the
militant action that we could take to prevent it; and as far as I can see, only the balance of
payments could stop us from taking that action.

WALLICH: In other words, it might happen but we will never admit it.

FRIEDMAN: But short of that, most of the measures we have talked about have been selective
devaluations. The interest equalization tax, for example, means that in effect the exchange rate is
different for a capital movement than it is for other transactions. Why is it that it is all right to
have devaluations in this concealed and selective form, but somehow it isn’t feasible simply to
have an out-and-out change in exchange rates?

The ideal solution would be to have free market exchange rates, to stop pegging the price of
gold. Shifting to a floating rate is a radically different thing from making an abrupt change in a
pegged rate from time to time. And until we do this, I don’t see any way of avoiding the
recurring danger of a crisis.

SAMUELSON: Well, the answer to your question is that it just is not feasible. There is no
argument in principle against it. But I predict that in the kind of world we live in, you will not get
floating exchange rates short of a very great crisis.

WALLICH: If we put the dollar on a floating basis now it would float downward, because we
have a deficit. I don’t think the other countries would take this lying down. They would be
undersold by us, and they would defend themselves by putting in trade controls.

FRIEDMAN: There is a real split on this between the business and banking community on the
one hand, and the academic community on the other. I think at the moment you would find a
majority of the academic community favoring greater exchange flexibility.

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From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm.

WALLICH: I would put it at 75 per cent or more, and most of those who don’t share that point
of view have some other unorthodox point of view. Very few hold to the orthodox theory that
international exchange rates should be stable, and that the ultimate means of adjusting to this,
unfortunately, is to go through a temporary period of low production and high unemployment.

But when you are in the real crunch, that is always the solution that every country picks, with
rare and explosive exceptions. I do not see us going to a flexible rate. I believe in none of this
because I do not believe economists would have the power to put it over; the politicians will be
in charge.

So if the balance of payments gets very serious—and I do not think it will this year, but possibly
next—I would expect tighter controls over foreign investment, trade, and perhaps travel and I
would not preclude something like Britain’s current austerity program. But I do not want to
predict this.

FRIEDMAN: This is an interesting thing. Here is a subject, the balance of payments, on which I
think you could not get a hundred votes in an election. It is of no internal political importance,
and yet somehow we get ourselves into a position where the political authorities impose
enormous costs and constraints on the economy because it is regarded as unfeasible to float
exchange rates.

SAMUELSON: It isn’t a political force only because it is kept under the carpet. But it certainly
would be, if it came to devaluation.

FRIEDMAN: In any case, before you could have a British-type action in the United States, you
would have to have a British-type crisis. And we have not come anywhere close to that.

SAMUELSON: No. If some foreign gold holder were to ask me what the chances are of making
a killing—well, I’d have to say that’s still a sucker’s game.

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Compiled by Robert Leeson and Charles Palm as part of their “Collected Works of Milton
Friedman” project.

Reformatted for the Web.

10/25/12