This is very strange and sad.

On November 5th, I wrote my initial post about Milton Friedman, based on a San Jose Mercury News interview I read that weekend. In it, Friedman discusses his thoughts on education, health care, and Iraq.

Milton Friedman has now passed away today, eleven days later. There is really nice coverage of his death on the Business Week website. A sample:

More than anyone else, Milton Friedman was responsible for challenging the worldview of British economist John Maynard Keynes, who believed in the power of government to guide and stimulate economic growth. As an alternative to Keynesianism, he put forth a more laissez-faire philosophy known as monetarism—the doctrine that the best thing the government can do is supply the economy with the money it needs and stand aside.

Friedman blamed inflation on tinkering by governments and central banks. Along with Edmund Phelps of Columbia University, who won the 2006 Nobel prize, Friedman showed that central banks can’t buy permanently lower unemployment with slightly higher inflation. Wrote Friedman: “Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.”

One of the things I learned from responses to my original post is that far more people disagreed with Milton Friedman than who had actually read or understood his work. I think I’m going to re-read some of the material I have on my shelf from him this weekend.

Paul Kedrosky’s comments on his blog sum up my feelings as well:

Whatever your views on Friedman’s economics and/or politics, he was a giant of an intellectual figure, a provocative, thoughtful, and maddening figure, about whom the least you can say is that his influence and reputation will outlive all of us.

I want to take this opportunity to just say thank you to Mr. Friedman for his contributions to my understanding of economics.

There is a wonderful Q&A with Milton Friedman in today’s San Jose Mercury News. Milton Friedman is 94, and won the Nobel Prize for economics in 1976.

He is most famous for being the intellectual backbone for more libertarian monetary policy, and the economic grounding for the Reagan administration.

MercuryNews.com | 11/05/2006 | Q&A with Milton Friedman

It is very hard to read the writings of Friedman, or even his live Q&A, without being immediately struck by the depth of his intellect and the strength of his convictions. You may disagree with some of his policy conclusions, but his type of clarity is rare.

Since I was only 5 years old when Reagan was elected, I obviously didn’t appreciate at the time the momentous step this country took in rejecting Jimmy Carter and embracing Reagan in the heart of hyper-inflation, recession, and international trauma. However, I’ve learned over time that many of the aspects of the Reagan administration that I did appreciate seem to be derivatives of Milton Friedman’s philosophy.

I’m going to reproduce the text of the article here, only because I don’t trust the SJ Mercury news to keep the link live forever. However, if the link above still works, use it.

Q&A with Milton Friedman
NOBEL PRIZE WINNER EXPOUNDS ON EDUCATION, HEALTH CARE, IRAQ

By Scott Duke Harris
Mercury News

When Milton Friedman talks, not everybody listens. To many, his libertarian views are predictable. But he always offers grist for debate.

Friedman recently sat down with the Mercury News for an interview. Following are edited excerpts of the conversation:

Q You’ve described yourself as “a libertarian with a small ‘I’ and a Republican with a capital ‘R,’ ” for expediency. Yet you’ve expressed disappointment with Republican control of the federal government. Why?

A If you look at the record, the structure of government that is most favorable to low spending and low taxes is a Democrat in the White House and Republicans in control of both houses of Congress, because the spending propensities of the Democrats are held down by Republicans. And when you have a Republican government in power, those spending propensities aren’t held down. In this case, we’ve got Republicans all around, and the budget has gotten out of control.

Obviously the Republicans had been out of [the White House] for a long time, and when they got it [in 2000], they had things they wanted to do, and they did it regardless of the budget consequences.

The problem is not the deficit. The problem is the amount of spending — the fraction of people’s income — which is spent for them, on their behalf by their government.

Q But many people find the deficits troubling.

A I am not concerned with deficits in the federal budget at all. I am concerned with the level of the federal budget. I’d rather have a $1 trillion budget with a deficit of $1 trillion, than have a $2 trillion budget that is completely balanced with taxes.

The deficit is a form of hidden taxation. . . . So I’m not satisfied with a high structural deficit, but it’s really because that implies a high level of government spending.

Q What troubles you about the spending?

A Everything. Most of the spending is wasted. . . . The worst is the “earmarks,” because they have no democratic control at all, being arbitrarily set in by individual members.

If you take education: The federal constitution doesn’t have the word education in it, but every state constitution does. . . . In 1994, when the Republicans took over [Congress], their “Contract With America” included abolishing the Department of Education. Instead, 12 years later now, the [department’s] budget has tripled or quadrupled — something like that.

Q Your ideas influenced the rise of economic conservatism, from Reagan to George Bush today. How would you compare the Reagan and Bush administrations?

A The thing that endears [Reagan] is that he was a person of principle. He was willing to take political chances in order to promote his principles.

At the time Reagan became president, in 1980, we had gone through a period of high inflation and high unemployment. The Federal Reserve, after Reagan got elected, changed to a very restrictive policy, which broke the back of the inflation, but also created a very substantial recession. And Reagan’s standing in public opinion polls went way down.

No other president in the post-war period would have stuck with that policy. Every one of them would have forced the Fed to reverse that policy before it really broke the hold on recession. . . .

I think the problem with the Bush administration is that the whole thing is dominated by Iraq. . . . I think going into Iraq was a mistake. But once you got into it, you’ve got to live with what you’re doing. And it would be an equally big mistake, or bigger, to pull out prematurely. You’ve got to try to come out with some honor and some measure of success. I don’t know how to do it, and the prospects do not look good. The situation looks terrible. . . .

To look beyond Iraq, Bush had been on the right side. He cut taxes, and he was in favor of trying to privatize Social Security. . . . He’s been in favor of getting rid of the inheritance tax, which is the right thing.

Q Is there no tax you like?

A Yes, there are taxes I like. For example, the gasoline tax, which pays for highways. You have a user tax. The property tax is one of the least bad taxes, because it’s levied on something that cannot be produced — that part that is levied on the land. So some taxes are worse than others, but all taxes are bad.

As things are now, taxes amount to something like 35 to 40 percent of national income, if you include federal, state and local taxes. Out of every dollar the average citizen earns, he gets to spend 60 cents of it — and not according to his own views, because the government also steps in and says what you can and cannot spend on. For example, according to the government, you cannot spend it on cocaine. I’m in favor of legalization of all drugs.

Q And prostitution?

A Well, sure.

Q What are the economic issues you’re thinking about now?

A On the one hand, health care. And on the other hand, education . . .

We have a very poor education system. I’m talking about elementary and secondary. Something like a quarter to a third of all youngsters never graduate high school and those who graduate high school are in many cases barely literate in terms of reading, writing and arithmetic. In international comparisons, our kids do quite well at grade 1 to 4, but as you go up the grade levels, the performance gets worse and worse in comparison other countries. So it looks like we have a system that teaches kids not to learn rather than one that teaches them to learn.

And in health care today, most transactions are third party transactions. Traditionally, you would go to the doctor and there would be a deal between you and him. Direct payment. [Today] that almost never happens because of insurance — so-called insurance.

It’s a misnomer really. It isn’t insurance at all. Insurance makes sense when you have a small probability for a large cost and you want to share that probability with others. But it doesn’t make sense for ordinary day-to-day care. What we call medical insurance is not really insurance at all. It’s pre-paid medical care.

Q How would you respond?

A By getting rid of third-party payment — by returning it to a deal between the patient and the provider. You don’t need that institutional framework. That huge framework largely is the result of third-party payment.

Q Has anything in recent history made you question your convictions?

A No, on the contrary. . . . The basic conviction is that the biggest danger to human freedom comes from government. . . .

The collapse of the Soviet Union has persuaded almost everybody around the world that collective organization is not a good way to run a country.

Is there anybody now who believes that’s a good way to run a country? I don’t think so.

There is a very nice write-up today on Vanguard’s RSS Feed from John Brennan, Chairman of Vanguard Group.

Vanguard − Chairman’s Corner: A look at the year’s sleeper hit

This is a good overview of some fairly significant changes Congress made this year to the retirement and college savings vehicles available to most Americans.

I want to take a moment to note what is likely the biggest enhancement to the entire “defined contribution” style of retirement plans: the autopilot 401(k).

Let me preface this by saying that, by nature, I am a very strong advocate for self-directed savings vehicles. However, in recent years it has become apparent to me how much “defined benefit” plans, like traditional pension plans, provided for individuals.

In my opinion, more than anything, they provided an automatic way for people to “save” for their retirement, without really knowing they were saving. To participate in a pension, people do not need to understand compounded interest, inflation, “their number”, or diversification between different types of assets.

As we move to a society with more individual responsibility and accountability, we’re learning a lot about the realities of how human beings relate to concepts like long term investment. In fact, there is almost a cottage industry now just advising people on common mistakes people make with their 401ks.

One of the things we have learned is that psychological inertia is a powerful force. The National Bureau of Economic Research does a good job explaining that employees typically follow the path of least resistence.

In a normal 401k plan, a new employee starts at the company, and by default is not enrolled in the plan. They get a lot of material, and they put it aside, planning on “seriously looking at it” sometime in the future.

Years go by, and they are still not enrolled. From a long term saving perspective, with compounding, this is a disaster for their long-term financial well-being.

Now, some of this has to do with the Paradox of Choice. Companies, well intentioned, give employees too many options, too much to analyze. It leads to a state of paralysis.

But, what the National Bureau outlines is that for 401k plans, the biggest issue is psychological inertia. People never enroll, the never increase their contributions with raises, and they end up woefully behind in their saving. Amazingly, this inertia is so powerful, it even overwhelms free money! That’s right, employee matching funds. A free lunch. Enrollment still lags, even with free money, sometimes measured in thousands of dollars, left on the table.

Enter the automatic 401(k).

In this case, the employer automatically enrolls new employees in the 401(k) program when they start. They even automatically increase the contribution percentage every year.

The effect is breathtaking in terms of the financial well-being of the employees. In this case, inertia works for the employee, not against.

Now, in our litigious society, companies had to previously be afraid of automatic 401(k)s – what if the NASDAQ crashes, and employees sue for “automatically” being enrolled.

The Pension Protection Act of 2006 resolves this dilemma, by defining clearly what the US Government considers an acceptable automatic 401(k) program.

The reason I get excited about legislation like this is that it represents not only a growing understanding of how people are irrational with money, but also it represents our progress at designing legislation around the ways that human beings are predictably irrational with money.

People are still in control of their own savings, their own future. But with this minor modification, by default, people are put on the right track.

The US Congress may not have done everything right in 2006, but this is an improvement that is worth noting.