Today is the centennial of Ronald Reagan, being wildly praised by Republicans, conservatives, and others, even as some point out that many things being said about him now are myths in one form or another. I shall add to this with a few points regarding things that he has been credited with, which were actually due to his much-maligned predecessor, Jimmy Carter, although it is debatable whether or not all of these were ultimately good things.
Before piling on the debunking, let me note that not all that Reagan did was bad. I applaud his willingness to negotiate with Gorbachev when he came to power. I also applaud his willingness to back off the next round of his tax cuts in August, 1982, thus allowing for an easier monetary policy, when the incoming Mexican finance minister arrived threatening a default, which allowed for a recovery from that very deep recession (and thus for his "morning in America" 1984 campaign after 8% GDP growth in 1983). He also discretely held off many more conservative initiatives that he supposedly supported and were pushed for by some of his backers.
Anyway, two things that Reagan receives praise for are the decline in inflation during his presidency and his support of the Mujaheddin rebellion against Soviet rule in Afghanistan, usually placed into the list of things that more generally led to the fall of the Soviet Union, which he widely gets credit for, even though it happened during the presidency of his successor.
Anyway, I am not a monetarist, but maybe I am enough of one to believe that if the Fed really cracks down hard with a super tight monetarist policy, it will eventually reduce inflation while also bringing about at least a nasty recession. That was indeed what Paul Volcker did after being appointed Fed Chairman by Jimmy Carter, with the Fed-induced recession having a lot to do with Carter's failure to be re-elected. Indeed, it was the 1982 deal that brought an end to this super monetarist policy that certainly played a major role in the reduction of inflation, although it was Carter, not Reagan, who initiated it by appointing Volcker.
Also, it was Carter in 1979, who made the crucial decision to aid the Mujaheddin against the Soviets after they conquered Afghanistan. That also is arguably a mixed bag in that of course this would eventually lead to the Taliban controlling Afghanistan and al Qaeda using it for a base to attack the US, etc. Indeed, it was during Carter's presidency that the crucial decision to send Osama bin Laden to Pakistan to assist the Mujaheddin was made by Saudi intel with the concurrence of the CIA, although I doubt Carter was involved with that specific decision, despite his rep for micro-managing, although that reportedly had more to do with who got access to the WH tennis court.
"Anyway, I am not a monetarist, but maybe I am enough of one to believe that if the Fed really cracks down hard with a super tight monetarist policy, it will eventually reduce inflation while also bringing about at least a nasty recession. That was indeed what Paul Volcker did after being appointed Fed Chairman by Jimmy Carter, with the Fed-induced recession having a lot to do with Carter's failure to be re-elected. Indeed, it was the 1982 deal that brought an end to this super monetarist policy that certainly played a major role in the reduction of inflation, although it was Carter, not Reagan, who initiated it by appointing Volcker....
ReplyDeleteBarkley, your interpretation of events goes completely counter to a number of economic historians.
It has been argued (quite convincingly by William Greider, Michael Moffit and others) that the 'tight monetarist policy' of Volker actually increased inflation in the US and elsewhere.
Here's an excerpt from Michael Moffit's 1983 book 'The World's Money - International banking from Bretton Woods to the Brink of Insolvency'. It explains when and how things got out of control. The process of 'disintermediation' - large global corporations could evade national controls through intra-corporate borrowings across national boundaries. They could play off the banks to force higher interest payments on their deposits etc. As you will read, national monetary policy looks like it is is only effective against small business and households, leaving the large corporation with an ongoing unregulated source of cheap finance.
“Ever since the credit crunch of 1966, US banks have resorted to the Euromarket as a source of funds whenever the Fed tightened monetary policy at home. In 1966, banks tapped the fledgling Euromarket when the Fed clamped Regulation Q ceilings on domestic interest rates. When the Federal Reserve refused to lift the ceilings on the interest rates banks could pay on the certificates of deposit, the large banks that had operations in London issued Euro-CDs as an alternative source of funds. The banks’ Euromarket branches loaned these funds to New York, which used them to sustain credit expansion at home. In 1969, when Federal Reserve policy turned restrictive in a belated attempt to combat Vietnam-related inflation the banks played the Eurocard again. By then more banks were involved and they were more experienced at it. In 1969, US banks borrowed about $15 billion from their Euromarket branches in order to maintain credit expansion at home.
Moffit continued: " Probably the greatest example of how banks use their global reach to undercut US monetary policy came in 1979. Prior to the announcement of the October 6 measures, US banks had been borrowing heavily in the Euromarket (particularly from their own subsidiaries) to expand credit in the United States. Domestic loan demand was strong (in part because low real interest rates encouraged borrowing) and with the proceeds of new OPEC price increases pouring into the Euromarket, it made sense for banks to borrow in the Euromarket to relend at home. The Federal Reserve Board calculated that “US banks borrowed $30 billion from their foreign branch offices during the first three quarters of 1979.” The Fed had been tightening monetary policy and interest rates were rising, but the huge flow of Eurodollars in the US economy was fueling credit expansion. In the summer and early fall of 1979, according to the Fed, imported Eurodollars and other exotic bank liabilities financed about “half the increase in bank credit over that period.” Volker correctly perceived that to control inflation, it was necessary to get a handle on bank credit expansion. Thus on October 6, he did take some steps to reduce the flow of Eurodollars to the US economy, placing reserve requirements on US banks’ Eurodollar borrowings.
ReplyDeleteWhile bankers universally supported Volker’s October 6 inititiatives, in the ensuing months they flaunted their extra-terrritoriality and directly undermined the effectiveness of the October 6 measures. Less than a month after the October 6 package, Rimmer de Vries of Morgan Guaranty told the Joint Economic Committee how US banks could get around the new reserve requirements by lending directly to the foreign subsidiaries of the US-based companies. The multinationals, over which the Fed has no control, could then brink back the funds to the United States with no questions asked. Chase Manhattan’s London branch, for example, could lend to an Exxon subsidiary in Europe which could transfer the funds to New York for use in the United States. Other forms of financial innovation were also used. According to de Vries, blue chip borrowers could tap nonblank channels of credit, such as the commercial paper markets in New York and London. Finally, foreign banks could lend directly to US companies and Volker could only protest. ..."
Early 1981. US Government intervention in the foreign exchange markets of the world ended (for a time). [BjR: this came on the back of the Monetary Control Act of 1980 that removed the usury ceilings on interest rates]. Beryl Sprinkel ,undersecretary for monetary affairs in the Office of the US Treasury, reasoned that ‘free markets’ give the most efficient result in the allocation of resources. A rise in the US dollar occurred “such as has not been seen for over a decade.” Britain, France, West Germany and Belgium objected saying that “By allowing the dollar to rise without any countervailing intervention …[the US was] forcing up interest rates in other countries and hurting their economies.” Beryl Sprinkel countered this by saying that “more often there has been no correlation between exchange rate movements and changes in interest rate differentials” and Sprinkel asserted that there was “an inherent efficiency in free and open exchange market operations, and “concocted” government buying and selling of currencies inhibits that built-in efficiency.” + Maxwell Newton’s notes on how a monopolist like the US Fed cannot control both the price (of money) and the quantity (of money) at the same time….[As of 1983] we have had the worst of both worlds. We have had violent fluctuations in the rate of interest AND violent fluctuations in the growth of money. The consequence has been the destruction of the raison d’etre of the Fed – namely, stability in the value of the dollar, in interest rates, and in money growth.
ReplyDeleteSee: ‘The Fed – Inside the Federal Reserve the Secret Power Center that Controls the American Economy’ by Maxwell Newton. Times Books 1983.
Brenda,
ReplyDeleteWhat triggered the final burst of inflation after 1979 was the fall of the Shah of Iran, the subsequent collapse of oil production there to 10% of its previous level, and the subsequent quadrupling of the price of oil, despite the efforts of the Saudis to moderate it by increasing their oil production. The price of oil peaked in March, 1981 two months after Reagan became president, then moderated.
If it was not the two recessions driven by the tight monetarist policy (admittedly not as tight as some claim) of the Fed, then what finally brought down the rate of inflation, which did come down substantially?
Re: "If it was not the two recessions driven by the tight monetarist policy (admittedly not as tight as some claim) of the Fed, then what finally brought down the rate of inflation, which did come down substantially? "
ReplyDeleteWilliam Greider, in his 1989 book 'Secrets of the Temple, How the Federal Reserve Runs the Country' says (referring to the year 1983 on page 562 of his book):
"... Price inflation, after all had fallen drastically since 1981, by about two-thirds. Nominal interest rates had also declined since mid-1982 - but only about one thrid. [Real interest rates were kept at historic highs.] The difference meant that the real return for lenders was increasing dramatically. ...Dollars were "hardening" and worth more - ... finance was also collecting more dollars on every transaction...Traditional expectations about the reasonable return on capital were shattered... "
At the same time William Greider points to the shift from the failed monetarists policies of Milton Friedman (where the supply of money could not be controlled within the US domestic economy) to the Fed's new policy of 'inflation targetting'.
Page 587:
"...The tacit acceptance of 7 percent unemployment as the norm represented another fundamental shift in the American political agenda. Twenty years before, government economists had considered 4 percent unemployment the national goal, the practical equivalent of full employment, and it was actually achieved in the 1960s. In the 1970s, 6 percent was ... accepted as the best that might be achieved without provoking inflation. In the 1980s, the government's economic policy makers retreated further. There was not much protest from the public and even the >Democratic Party dropped its old rhetoric of full employment... "
[The promise offered to labor was that if it accepted "still more wage concessions, its members could go back to work...Yet the jobs did not return"
Page 588:
[governor Partee:] What you do is just accept any unemployment number that you get and say that that's what's necessary to avoid any upward pressure on wages and prices."
Greider"...that was what the Federal Reserve did...Paul Volcker's views on the matter did not change. The heart of his concern was stable money. Driving down price inflation came before other considerations..."
More on 'inflation targeting --->
Deflation (in the US) took hold in the 1980s. In farm and oil prices. In the price of automobiles etc.
ReplyDeleteUS inflation was 'exported' to the rest of the world.
Page 592 'Secrets of the Temple':
"...bizarre things happened ...when products crossed international boundaries. The bushel of wheat that sold for $3.85 in Kansas City now effectively cost $5 or $6 when sold in Europe. In Brazil, a barrel of imported crude oil cost Brazilians the equivalent of $50 or $60 in their own currency. The price of French steel sold in the United States had fallen $125 a ton in less than a year. A Toyota, once delivered in San Francisco for $10,000, could now be marketed in America at a real cost to the Japanese of only $7,500.[25]
The hardy American dollar, created by Paul Volcker's successful campaign against inflation, was the explanation for every one of these anomalies. the dollar continued to rise in value against the world's other major currencies - appreciating by more than 50 percent since 1979 - and that altered the terms of trade for every international transaction... The effects were devastating for some - another element in the rolling liquidation that persisted long after the national recession hardened. American grain farmers lost more than a thrid of their share of the global market from 1981 to 1983 as the export price of their wheat and corn practically doubled (and the debt-burdened Latin-American countries cut back their food imports in order to pay their bank loans). Meanwhile, foreign producers of autos, steel, machine tools, computer chips and a long list of other manufactured products grabbed a larger and larger share of the American domestic market - riding the artificial price advantage provided them by the dollar's rising exchange rate. US imports of manufactured goods rose by 66 percent over four years time and US exports declined by 16 percent... "
Also see:
'Prices of wheat and oil' New York Times, August 21, 1983.
Deregulation, of all kinds, appears to have been a very successful way to 'target inflation'.
ReplyDeleteThat is, until the chickens finally came home to roost in the new world of ubiquitous financial crises, climate change, acidic oceans and pollutin catastrophes like the gigantic oil spill in the Gulf of Mexico.
Brenda,
ReplyDeleteGreider is right about many of the details of how he US Fed operates, and its focus on protecting US banks. Its policy was not all that lay behind breaking the end of the great inflation, with both the deg movement and Reagan's breaking of the air traffic controllers strike, which led to a major shift in income distribution in the US. It is also true that high interest rates have a short term inflationary effect.
However, I think it is the case that the Fed tight monetary policy during 1979-82 was the most important force in breaking the inflation, which ran through a pair of massively deep recessions. There is an old line that "One can lead a horse to water, but one cannot make it drink," which is a story about how expansionary monetary policy may not be able to stimulate a depressed economy, something we have been reminded of during the last few years. However, the rarely stated followup to this is that indeed one can keep a horse from drinking by pulling on its reins and keeping it from getting near the water. It remains true that a central bank can crash an economy by squasing credit availability (coinciding with high interest rates), which is what the Fed did during that period.
Re: "I think it is the case that the Fed tight monetary policy during 1979-82 was the most important force in breaking the inflation..."
ReplyDeleteThis is what happened with the US Fed's 'tight monetary policy' (one that didn't apply to a certain number of multinational banks and corporations and the Hunt family; the latter heavily engaged in unrestrained commodity speculation ):
The US rate of increase in nominal GNP dropped dramatically in 1982. By 8%. “Real gross national product (GNP) fell by 2.5 percent in 1982, as the unemployment rate rose above 10 percent and almost one-third of America's industrial plants lay idle, according to the US State Department.
Jude Wanniski said of this time: "What the press and policymakers are calling "disinflation" is simply deflation, the deterioration of the monetary standard characterized by falling prices...."
See: The 1982 Deflation
Jude Wanniski. August 28, 1998
http://polyconomics.com/ssu/ssu-980828.htm
Barkley: "It remains true that a central bank can crash an economy by squashing credit availability (coinciding with high interest rates), which is what the Fed did during that period."
The US Fed raised global interest rates because third world and other debt was denominated in US dollars.
I question whether the Fed, in the years you refer to (1979-1982) actually did quash credit availability. After all, huge loans were already made and nations and householders can't eliminate their debt just because interest rates go up. Actually, it becomes much harder to decrease the level of debt when the real level of interest you pay goes up without a corresponding increase in income. Real incomes for nations and ordinary people did not go up during this severe recession.
Jude Wanniski again:
"[in 1982]...Milton Friedman's followers were insisting that if he injected liquidity, "increasing the money supply," the bond market would collapse. I told Volcker the bond market would boom, because debtors would then be able to pay and their creditors would rejoice. By July, Volcker had no choice. Mexico said it could not pay its dollar debt to U.S. banks because the price of oil had collapsed. Its government oil company had borrowed when oil was $35 a barrel and now it was below $20. Volcker had to buy $3 billion in Mexico peso bonds, which Mexico used to pay the banks. With all this liquidity flooding the banking system, the bond market boomed, so did stocks, and the monetarists went off scratching their heads, wondering what happened. "
It seems that the actual real level of debt around the world increased in response to high interest rates. "Total credit market debt as a percentage of US GDP began to rise very noticably under Reagan and continued to rise sharply under Clinton and Bush II."
See:
American Businesses and Consumers are NOT Deleveraging ... They Are Going On One Last Binge
Saturday, September 18, 2010
http://www.washingtonsblog.com/2010/09/american-consumers-are-not-deleveraging.html
An alarming percentage of the substantial growth in US GNP in the 1980s was based on deficit spending. (US State Dept).
Central banks around the globe began to print money like never before. American productivity went down. American consumption of goods produced by other countries rose sharply. After 1983 inflation began its long term rise.
See: The True Meaning Of Inflation
John Tamny, 01.25.10. Forbes magazine.
http://www.forbes.com/2010/01/24/inflation-prices-gold-standard-opinions-columnists-john-tamny.html
Brenda,
ReplyDeleteJude Wanniski is not someone that I take remotely seriously, intellectual leader of the supply-siders, whose pernicious influence on current politicians who want to cut taxes endlessly and do nothing else (because they claim revenues will rise) is all too strong.
Regarding the Hunt brothers, they lost several billion, along with the currenet King of Saudi Arabia, when the silver bubble crashed very hard in 1982 as a result of the recession induced by the Fed's tight monetary policy. It went from $52/oz to about $6/oz within a couple of months.
So, it remains the case: central banks can keep the horse from drinking by pulling sharply enough on the horse's reins (with a strong enough tight monetary policy).
Barkley, a higher price on borrowed money may prevent individuals and businesses from borrowing money, as you say. …assuming 'rationality' in economic behaviour and thinking and also that (i) entities have an opportunity to not borrow funds and (ii) potential borrowers do not have the means to avoid higher interest rates by, for instance, borrowing in another currency or from some other cheaper source etc.
ReplyDeleteWhich raises the question: Do central banks still have control over interest rates in the first instance?
A cover story for Businessweek on 11th July 2005, entitled ‘Too Much Money’ explores a rethinking of the rules governing the world economy that was then beginning. Something major has changed. “The theory that low interest rates are the result of a US Fed (and other central banks’) easy money policy becomes less tenable after two years of central bank rate increases and a global economy growing at 5.1% in 2004”. The forecasts predicting a rise in long rates failed to materialise. This author noted that a “global glut of savings” could explain low interest rates. In March 2005 US Fed governor Ben Bernanke gave a speech on the “global savings glut”. The IMF estimates global savings in 2005 to be $11 trillion, almost the size of the US economy. Most of the savings is going to one country... the U.S. alone is soaking up as much as three-quarters of the excess global supply of savings (because China keeps its currency low by investing in US Treasuries, Fannie Mae and Freddie Mac).
I’ve written a couple of articles on the contradictions inherent in Bernanke’s ‘global savings glut’ speech of 2005, by the way:
Bernanke's Saving's Glut Hypothesis. Contradiction Number One.
http://econospeak.blogspot.com/2009/12/bernankes-savings-glut-hypothesis.html
Bernanke’s Saving’s Glut Hypothesis - Contradiction Number Two.
http://econospeak.blogspot.com/2009/12/bernankes-savings-glut-hypothesis_21.html