How the spirit of capitalism returned to America

One lesson we could have learned from the Weimar Republic and the rise of Hitler is that "political freedom cannot be preserved unless inflation is kept in bounds," said Milton Friedman in his PBS program "How to Cure Inflation." "Unfortunately," added the leader of the monetarist counter-revolution, "there's no way to avoid the difficult road the Japanese had to follow [in the 1970s]. … First they had to live through a recession until slow monetary growth had its delayed effect. … Inflation is just like alcoholism. …When you stop drinking or when you stop printing money, the bad effects come first and the good effects only come later. Every country that has had the courage to persist in a policy of slow monetary growth has been able to cure inflation and at the same time achieve a healthy economy."

It is impossible to say how much more damage the Keynesian doctrine could have inflicted upon the United States without the rise of Paul Volcker and Ronald Reagan to the two most powerful offices in government. It is highly unlikely that any other economist considered for Fed chairman in the late 1970s or a presidential hopeful in the 1980 election would have had the courage to resist the political pressures, media attacks, and public opinion and maintain the unpopular measures long enough to put the American economy back on its feet. Volcker was not saying much but his wife admitted in 1982, "He thinks he is the only man in the country who can do the job." Reagan understood that Friedman and Volcker were right, that Americans had to "suffer two, three years of hard times to pay for the [inflationary] binge."

"The ultimate accomplishment of Reagan and Volcker," wrote Robert J. Samuelson in his book The Great Inflation and Its Aftermath, "was to show that government could govern and, in so doing, they restored-at least temporarily-Americans' confidence in their leaders and political institutions." Their efforts invigorated global capitalism. Putting in practice the ideas of Friedrich Hayek and Friedman, the president and his Fed chairman impacted the country in ways as profound as FDR and the Great Depression.

Before the 1930s, America's national government consumed less than 3 percent of the Gross Domestic Product. With the New Deal, Uncle Sam expanded to colossal proportions with a budget often exceeding a fifth of the nation's income. During the 1960s the MIT-Ph.D.'s-controlling-the-economy utopia promised "universal affluence that would gradually purge poverty and social injustice." It turned into stagflationary nightmare. Reagan and Volcker challenged the idea that the country should be run as a corporation on three pillars: big government, big business, and big unions. America woke up to the reality that freedom and prosperity require the acceptance of "greater inequalities and individual insecurities."

"On the whole," noted Samuelson, "this remade economy was more stable and productive than its predecessor." Ironically, after the government abandoned its efforts to smooth out short-term market fluctuations through fiscal policies, the economy expanded for 25 years with just two mild interruptions (eight months in 1990-91 and eight months in 2001), a period known as the Great Moderation. Friedman triumphed over Keynes in both the ivory towers of academia and in the public square, restoring the power of individuals to choose, based, as former California Gov. Arnold Schwarzenegger said, on the "simple idea that we are responsible for our own lives, to live them as we see fit as long as it does not violate the liberty of others."

Read Alex Tokarev's previous columns in this series.