Now here’s
a five-star book. I know that I say good things about almost every book I read,
but this one really stood out as an excellent book, written in a way that gives
you not only a really detailed look at the Federal Reserve during Paul Volcker’s
term (1979-1987) but the whole history of the institution and a deep analysis
of its effects on average Americans.
When President
Jimmy Carter appointed Paul Volcker to be the new Fed Chairman in 1979, the
country was dealing with high inflation that had not really abated since World
War Two. Volcker was determined to end inflation. The inflation had a few
different effects on the American economy. Inflation caused prices to continue
to increase, which generally has a negative psychological effect on consumers.
It also resulted in higher interest rates, because if a creditor charged 5%
interest on a loan in an economy with 7% inflation, they would lose money on their
loan. It had positive effects, however, because with more inflation, people’s
salaries went up and their house values also went up. It also means that debtors/borrowers
are favored over creditors since the real value of loans decreases.
It happened
that by the end of the 1970’s, the Democrats were abandoning the liberalism
that they had embraced since FDR’s time, largely in reaction to the high
inflation that government spending had helped create. They repealed usury laws,
allowed interest to be gathered on checking accounts, and abolished interest
rate ceilings, all things that helped the financial sector. It was likely because
of the shame they felt over the high inflation, and they were trying to “apologize”
to creditors. Greider compares the repeal of usury prohibition to the end of sexual
and moral taboos that had begun to become more permissive in the 1960’s and 70’s.
Usury, however, unlike sexual and moral taboos such as drugs, homosexuality, and
the role of women, was allowed with no controversy at all. Creditors would now
charge exorbitant rates to their lenders.
Volcker
was concerned in 1979 that the economy was running on borrowed money and wanted
to put an end to inflation for fear that it could “heat up” enough to cause a
crisis in which the dollar lost its value. There was a big controversy about
ending inflation. It had been tried before but had failed, often because the
cost was so high. To end inflation would likely mean a recession, as people who
had taken out loans will find they can’t pay them back at interest rates that
have effectively increased, being that they expected to pay their interest
based on a higher inflation rate. The Fed, however, represented large banks,
who were major creditors, and wanted higher returns on their loans. In Mach 1980,
the Fed announced credit controls meant to reduce borrowing and lower the amount
of money moving around the economy. It had a sharp impact. Unlike measures that
had been announced the past October, the Fed announcement in March was made in
blunt, easy-to-understand language. The nation needed to borrow less and stop
using their credit cards so much. Unlike October, the mostly aesthetic changes
in March caused Gross National Product to drop 10% in just three months. For
the first time in history, a Democrat (Jimmy Carter) put the nation’s economy
into recession.
However,
the recession didn’t last. Scared by the effects of what they did, the Fed backed
off and allowed inflation to return to 11%, letting the economy grow once
again. As I learned in this book, inflation tells you the maximum amount that
an economy can grow by. So in 1980, there was a sharp dip and a return to
normal growth. However, that same year they would return to the hard-money
politics that caused the recession as they tried to beat inflation again. Part of
the motivation was political, being that it was an election year. Volcker didn’t
want to be seen as helping the president who nominated him. Instead of heling Carter,
he would end up crushing him in the second recession of the year.
In Part
2 of the book, we go back in time and study the history of the Federal Reserve.
I really enjoyed learning about the Populist movement and all the lawmaking in
the 1910’s that developed the Fed. I also want to know more about the “great
contraction” that happened in 1937, that Greider attributes to a reduction in
government spending, as well as post WWII Fed actions that kept inflation high.
I understand now that JFK and LBJ overheated the economy in the 1960’s and that
the Fed needs to “lean against the wind,” meaning higher taxes and lower
spending in good times, lower taxes and higher spending in bad times. It’s just
like how the Egyptians prepared for a famine by storing grain in the good times
to be ready for the bad times. One problem, however, comes up again and again. No
one wanted to turn off the proverbial faucet of high spending and low taxes. It
was just too tempting and caused huge inflation from the 1940s through 70s.
When Reagan came into office in 1981, tried to hit a perfect (and impossible)
trifecta: increasing growth, decreasing inflation, and having no deficit. This
cannot happen (especially when they also proposed increased military spending)
because with less money circulating, growth could only be maintained by people
spending that money faster. The numbers didn’t add up, and with the help of tax
cuts, the deficit grew. They raised taxes later, but the plan was fundamentally
political, not economic.
Early in
Reagan’s administration, the Fed, against Reagan’s wishes, caused another recession
to reduce inflation. In retrospect, however, this was probably better for
Reagan since it meant that it would not come when he was up for reelection. Reagan
would manage to pass tax cuts through congress by putting out fake projections,
although Reagan himself was not notified, reflecting the distance he had from
his own administration. The tax cut would largely benefit the rich, as would
the increase in interest rates from 1979 onward. By 1982, those interest rate
hikes would generate 148 billion dollars in additional income for the owners of
financial assets. That huge increase brought American income from interest
payments to $366 billion, almost as much as the $374 billion spent on veterans
pensions, Social Security, and welfare combined. It was a redistribution of
wealth! However, while people are always talking about whether welfare is worth
the cost, you probably haven’t heard as much about interest payments to the
wealthy.
This is
all very politically bad. You would think that people would be up in arms about
this sort of thing, but they were not. This was largely because they could not
understand it. Even the men and women in Congress couldn’t understand it. The Fed
had always been mysterious to most, but Volcker purposely obfuscated what he
was doing. Following the advice of “monetarists” like Milton Friedman, he
decided to stop using interest rates and rather use the money supply to affect
interest rates. This further muddled the situation as Volcker claimed that the
abnormally high interest rates that plunged the country into a recession were
not really his doing, even though they were. The problem with the money supply,
however, is that it does not create the stable, non-inflationary currency that
monetarists thought it would. It fails to take into account the velocity of
money, which is to say how fast it changes hands. This meant that the Fed had
to intervene just as much anyway. When Volcker finally let up and allowed
reasonable inflation again, the markets responded the opposite of how he
thought they would. Inflation did not skyrocket back up. The policy had its
effect and interest rates went down even with inflation.
A good metaphor Greider uses is
that Congress cannot control the economic brakes—money and interest rates, and
the Federal Reserve can’t control the accelerator—federal spending and taxes.
This creates what Greider calls a car with two drivers, a problem that
continues to exist today as the nation struggles to achieve a coherent national
economic plan. Something else fundamental at the Fed that seems wrong is the
ideology that banks must be saved. The Fed consolidates banks by bailing out
the largest ones who are “too big to fail.” This is because any rational
investor would rather put their money in a giant bank that the government will
not allow to fail rather than a small bank that can fail.
Something really critical that
helped shape the 80’s was the fact that while both interest rates and inflation
fell, inflation fell more than interest rates, leaving people with higher real
interest rates. This meant huge earnings for the financial sector while normal
people suffered, especially all across what would become known soon after as
the “rust belt” of the United States as major manufacturing companies failed
due to pricey capital. It was also hit with a second punch- the appreciation of
the dollar by 50% in just four years (!), meaning a big reduction in the
ability to export goods. In the 1980’s, interest rates exceeded growth rates,
meaning that loaning money was more profitable that actually making something,
a huge reversal of the way things need to be for an economy to work.The “misery
index,” conceived of by economist Arthur Okun, who added the unemployment rate to
the inflation rate, hit 19 percent in 1980, but managed to decline to just 11
percent by 1984. However, the “hardship index,” invented by David Eastburn,
former President of the Philadelphia Fed, may have been a better descriptor.
The hardship index combined the real interest rate on home mortgages to the
inflation and unemployment rates. That revealed two years, 1980 and 84, that
were essentially identical at 21 percent. So even if people had jobs and
inflation was low, it was still very hard to settle down and buy a home (or a
car). During the Reagan Presidency, for the first time in history, home
ownership went down. Climbing steadily from 40% in 1940 to 66% in 1981,
homeownership fell to 63.9% by 1986. Car ownership also declined, and young
people couldn’t settle down as easily as the generation before them.
Anyway, those are my thoughts on
the book. The book was long and I want to move on to other ones, so this blog
post is not particularly “organized” and is really just whatever I thought of
as I went through my notes. The main takeaways for me are that the Fed is
dangerously undemocratic and views its constituency as big banks. The 1980’s
were not good times for America. We need to get the Fed under control and get
it to stop triggering recessions.
No comments:
Post a Comment