By George P. Brockway, originally published November 27, 1989
James Mac Gregor Burns, Pulitzer Prize-winning biographer, historian, and political scientist, recently published The Crosswinds of Freedom, the third and final volume of his history of The American Experiment. The book confirms Burns’s standing as one of the foremost observers of the modern American scene. It also carries forward the foreboding analysis he initiated in The Deadlock of Democracy: that American law, by creating a stalemate in politics, makes an almost impossible demand on-and for-leadership.
Jimmy Carter of course figures in Crosswinds, and reading about him makes you want to cry. He was (and is) a decent man who apparently thought decency was enough, who had a talent for offbeat public relations, and who also had a propensity for shooting himself in the foot. The prime example was the Iran hostage affair. As Burns points out, it was Carter who kept that in the news, and it helped defeat him. On the other hand, if not for Iran, Ted Kennedy might have been able to grab the Democratic nomination. The economic situation was probably enough to finish Carter, no matter what. In that connection I offer a footnote to Burns’s magisterial book.
During the last two years of Carter’s presidency we had double-digit jumps in the Consumer Price Index. It is not clear why this happened. The usual explanation blames OPEC. What is generally forgotten is that OPEC blamed the strong dollar for its price increases. For almost three decades – long before the advent of Paul Volcker – the Federal Reserve Board and other First World central banks had been steadily pushing interest rates higher, thus overhauling their currencies and raising the cost of the goods the OPEC members (which generally had few resources aside from their oil) bought from us. Before raising their prices, OPEC tried for several years to persuade us to change our policies; but the Reserve plowed ahead, increasing the federal-funds rate from 4.69 percent in March 1977 to 6.79 percent in March 1978 and 10.09 percent in March 1979.
Finally, on March 27, 1979, OPEC oil went up 9 percent, to $14.54 a barrel, and three months later there was another jump of 24 percent. In December OPEC was unable to agree on a uniform price, but individual hikes were made across the board. By July 1, 1980, the barrel price ranged from $26.00 in Venezuela to $34.72 in Libya. Thus, in a little over a year, the cost of oil had more than doubled.
Yet petroleum accounted for less than 3 percentage points of the inflation. Moreover, in every OPEC year (and, indeed, in every year on record), the nation’s interest bill has been substantially greater than the national oil bill (including domestic oil and North Seas oil as well as OPEC oil). If OPEC is to blame for the inflation of 1979-81, the Federal Reserve Board is even more to blame.
A major cause of the rest of it was hoarding, which resembles speculation yet differs from it in that real things are involved. During this period the stock market was quiescent: The price/earnings ratio was lower than it had been at any time since 1950, and less than half what it would be in 1987 or is today . But hoarding, probably prompted by memories of the gas lines following the 1974 OPEC embargo, was heavy.
And not merely in petroleum; it extended to all sorts of commodities. Manufacturers, wholesalers, retailers, and private citizens tried frenziedly to protect themselves against expected shortages. As often happens in such situations, the expectations were immediately self-fulfilled. Confident that shortages would allow them to raise prices, manufacturers eagerly offered high prices themselves for raw materials they needed. Maintenance of market share became an almost obsessive objective of business management.
In the book business, for example, “defensive buying” became common. Bookstores and book wholesalers increased their prepublication orders for promising titles so that they would have stock if a runaway best-seller developed. Publishers consequently increased their print orders to cover the burgeoning advance sales. It soon became difficult to get press time in printing plants, and publishers increased press runs for this reason, too. Naturally, everyone also stockpiled paper, overwhelming the capacity of the mills. For all I know, the demand for pulpwood boosted prices of chain saws and of the Band-Aides needed by inexperienced sawyers.
Unlike speculation, hoarding has physical limits. After a while, there’s no place to put the stuff. And after a while, the realization dawns that a possible shortage of oil and gasoline doesn’t necessarily translate into an actual shortage of historical romances. Moreover, the shortage of oil and gasoline, once the tanks were topped off, disappeared. There was plenty of oil and gasoline; you just needed more money to buy it. Hoarding-or most of it-slowed down and stopped. Business inventories declined $8.3 billion in 1980. But prices didn’t come down.
All this time Jimmy Carter was not idle, for he prided himself on being what we’ve come to call a hands-on manager. As early as July 17, 1979, he got resignations from his Cabinet members and accepted several, including that of Treasury Secretary W. Michael Blumenthal. To fill the Treasury slot, he chose G. William Miller, chairman of the Federal Reserve, and that opened the spot for Paul A. Volcker, who was nominated on the 25th amid cheers on Wall Street. At his confirmation hearings on September 7, Volcker revealed the conventional wisdom to the House Budget Committee. “The Federal Reserve,” he testified, “intends to continue its efforts to restrain the growth of money and credit, growth that in recent monhts has been excessive.”
True to Volcker’s promise, on September 18 the Reserve raised the discount rate from 10.5 to 11 percent; and then, less than three weeks later, from 11 to 12 percent. An additional reserve requirement of 8 percent was imposed on the banks. More important, a fateful shift to monetarism was announced. The Reserve, Volcker said, would be “placing greater emphasis on day-to-day operations of the supply of bank reserves, and less emphasis on confining short-term fluctuations in the Federal funds rate.” On February 15, 1980, the discount rate was set at 13 percent.
Despite this conventionally approved strategy, prices kept going up. In January and February, the inflation rate was 1.4 percent a month, or about 17 percent a year.
Again President Carter took action. On March 14, 1980, using his authority under the Credit Control Act of 1969, he empowered the Federal Reserve Board to impose restraints on consumer credit. It immediately ordered lenders to hold their total credits to the amount outstanding on that day. If they exceeded that amount, 15 percent of the increase would have to be deposited in a non-interest bearing account in a Federal Reserve Bank. The banks and credit-card companies, adopting various procedures, hastened to comply.
All that was good standard economics. If inflation is caused by too much money, the obvious cure is to reduce the amount of money. President Carter and Chairman Volcker were in complete agreement.
The new policy had an immediate effect that, surprisingly, surprised the president and the Chairman. Not only did sales slow down, as expected, but profits did, too-as should have been expected. The automotive industry cried hurt almost at once. General Motors reported an 87 percent drop in profits, and Ford and Chrysler reported losses. The housing industry saw trouble coming as well. It even appeared that consumers were taking seriously their leaders’ pleas to cut down consumption: Some credit-card companies found their cardholders responding to restrictions by borrowing less than now permitted.
Alarmed by these and other complaints, the Reserve relaxed the new regulations after two and a half weeks, cut the reserve requirements on May 22, lowered the discount rate on May 28, and abolished the credit controls on July 3, whereupon the president rescinded the Board’s authority to act. It was all over in three and a half months, in plenty of time for the nominating conventions. Everyone pretended to be pleased with the result, and in fact the inflation rate did fall, but not below the double-digit range. Still, Carter had shown that he could “kick ass” (his phrase), so he won renomination. His hope of reelection, though, was dashed.
As Jimmy Carter moved back to Plains, Georgia, he must have wondered why inflation remained high. The OPEC turbulence had subsided. Hoarding had largely stopped. Cutting consumer purchasing power had brought on instant recession.
Conventional theory has taught us to look at the money supply, or the budget deficit, or the trade deficit in seeking an explanation for inflation, since it is supposed to follow when these are high and going up. Well, M1, the measure of the money supply the Federal Reserve claimed to control, went from 16.8 percent of GNP at the start of Carter’s term down to 15.3 percent at the end. Carter’s reputation as a spendthrift notwithstanding, the budget deficit, again as a percentage of GNP, was lower in every one of his years than in any one of Ronald Reagan’s. As for international trade, the deficit on current account was four and a half times greater in Reagan’s first term than it was under Carter, and of course in the second term it pierced the stratosphere- where on a clear day it can still be seen.
Carter’s mistake- and the mistake of the American people-was the common one of simply accepting what someone says he or she is doing. Everybody, including the Federal Reserve Board itself, believed its contention that it was fighting inflation by encouraging the interest rate to soar. Meanwhile, in the last two years of Carter’s term the nation’s interest bill went up 51 percent, although the outstanding indebtedness increased only 23 percent. In addition to the fall in M1 that we’ve noted, the board increased the federal-funds rate 68 percent and the New York discount rate 59 percent. In 1951 (when the Reserve started its well-publicized wrestle with inflation) it took only 4.59 percent of GNP to pay all domestic nonfinancial interest charges. The Reserve pushed the rate up, in good years and bad, until it stood at 15.04 percent at the end of Carter’s term. (It’s much higher now [in 1989].)
It is generally recognized that Volcker slowed inflation (he obviously didn’t stop it) by inducing a serious recession, (if not depression) in 1981-83. Putting aside the question of whether causing so much grief was a noble idea, we may ask how pushing the interest rate up caused the recession. The answer, of course, is that it made goods too expensive for most consumers. Standard economics, though it pretends the consumer is supreme in the marketplace, perversely believes that consumption is a bad thing.
Goods became unaffordable for two reasons. On the supply side, interest is a cost of doing business; so the prices businesses charged had to cover all the usual costs, plus the cost of usurious interest. On the demand side, interest is a cost of living; so the prices consumers could afford were reduced by the interest they had to pay. Usurious interest pushes prices up and the ability to pay down.
Had the interest rate not risen, wages would probably have risen. Unemployment would certainly have fallen. More people could have bought more things. More producers could have sold more things. Prices might have gone up until could no longer afford to buy; but if so, that stage would not have been reached so quickly or so inexorably as with usurious interest. And those who had money to lend would have been worse off, unless they were wise enough to invest their money in productive enterprise or spend it on consumption.
Would instant Utopia have been achieved? Of course not. The point is that the conventional policies of Jimmy Carter and Paul Volcker were good for lenders but bad for everyone else
The tests of a “sound” economy that people still chatter about-a stable money supply. A balanced budget, and a favorable trade balance-all were worse under Reagan than under Carter. Inflation was worse under Carter-and defeated him-because the interest rate was higher. Professor Burns rightly fears that we will not find leaders able to organize power to handle the usual social and international problems. I fear that we are even less likely to find leaders capable of understanding and leading us out of the slough of conventional economics.
The New Leader