certain industries, the Great Depression was already underway in the ’20s—a preview of what everyone would experience after 1929. In both the 1920s and the 1980s, the Federal Reserve was the central engine of control, the economic regulator that imposed these terms. Federal Reserve chairman Paul Volcker’s management of money and the economy during the late ’70s and ’80s followed the pattern set by Benjamin Strong, the New York Fed president who had dominated America’s new central bank during its early decades. Across six decades, Paul Volcker and Benjamin Strong were likeminded men of finance, who shared the same conservative values. Both men assumed the central bank’s first obligation was to protect the banking system from crisis and chaos and they worked strenuously to do so. More important, Volcker and Strong were both absorbed—if not obsessed —by a single-minded conception of economic order. For both of them, economic order was defined, above all else, by the stable value of money, i.e. little or no inflation. To achieve that ideal, the Federal Reserve proceeded in both decades to first induce a brutal recession, a suppression of economic activity that was designed to break an inflationary surge. Just as the twenties opened with the severe recession engineered by the Federal Reserve in 1920-1921, Volcker’s management produced the devastating contraction of 1981-1982. The lever for halting inflation in both cases was a traumatic and unprecedented increase in interest rates, which is essentially the price of money—forcing business activity to subside and surpluses to accumulate. The accompanying economic suffering it was argued, was the necessary prelude to long-lasting prosperity, an era of order and stability in which all could benefit. After each of these recessions, however, in order to preserve stable prices, the central bank did not give free rein to the economy in recovery. The Federal Reserve, instead, managed money and interest rates in such a way that the surpluses caused by the recession remained—surplus labor, surplus grain, surplus oil, surplus goods—and these surpluses continued to suppress prices and wages. For relatively long periods, therefore, Volcker and Strong each succeeded in maintaining an economy free of inflation. Both men were widely admired for this achievement. The maintenance of low inflation, however, required a condition of continuing failure for many. The average price level was prevented from rising because certain prices continued to fall. Through the twenties, farmers never really recovered from Benjamin Strong’s devastating recession of 1920-1921, and farmers did not recover from Paul Volcker’s in the 1980s. Nor did organized labor, nor mines and mills, nor the oil industry and certain other producers. Stable money was, ultimately, an illusion. It was nothing more than a statistical artifice that concealed The deflation destroying American farmers and other producers was not imposed by remote conspirators, but by their own government in Washington. harsh realities. In both eras, the Federal Reserve was celebrated for accomplishing what it took to be its highest purpose, the virtual elimination of inflation. Yet the ideal was mearly an economic abstraction and it was not neutral. It was simply an averaging of gains and losses that produced the comforting illusion of balance. Indeed, the restoration of stable money produced a smug sense of moral satisfaction, in which the “roaring twenties” served as a crude precedent for the “go-go eighties.” Those who succeeded indulged in elaborate fantasies of ostentatious consumption. Those who failed, amid the general prosperity, were blamed for their own mistakes. Farmers and oil producers, it was said, had borrowed excessively in the past, pursuing unrealistic expectations about the future. Their punishment, though regrettable, was justified by their own imprudence. The rationale ignored what had actually transpired: the government itself had drastically and abruptly altered the terms for the future. Its actions put all debtors at a sudden disadvantage, the wise and the unwise alike, with no real opportunity to adjust to the changed circumstances. The default of producers, it was said further, would enhance the efficiency of the nation, as the weak and marginal were weeded out. Deflationary pressures did indeed force producers to cut their costs and eliminate waste, but the central consequence was merely a consolidation of ownership. Farmland in Iowa did not disappear when its value collapsed and the farmer defaulted on his loans. Nor did oil rigs and reserves in Oklahoma or Texas. They were acquired at depressed prices by other, oftentimes larger owners, who could operate profitably in the new environment of deflation because they had more money and hence a lower ratio of debt. Ownership of family farms passed on to large-scale corporate enterprises. Oil reserves held by failing independent producers became the property of their creditors. The ultimate effect of the liquidation in the 1980s, just as in earlier episodes of deflation, was to further concentrate the ownership of wealth. With neither political party prepared to represent them on the money question, farmers and the other victims of deflation protested impotently. Their complaints were often misdirected, and even when they did challenge monetary policy itself, their arguments were deflected by the Federal Reserve’s imposing mystique. Dissent was intimidated by Paul Volcker’s awesome reputation. In February 1985, Paul Volcker— who was appointed to a 4-year term as Federal Reserve Chairman in 1979 by Jimmy Carter and reappointed by Ronald Reagan in 1983—faced a delegation of state legislators from thirteen distressed farm states— Iowa, Nebraska, the Dakotas and others who had traveled to Washington to plead for relief. In the magnificent boardroom of the Federal Reserve, the chairman listened to the farm representatives argue for easier money, for lower interest rates and an end to the price deflation. His response chilled them. “Look,” Volcker said, “your constituents are unhappy, mine aren’t.” The essence of monetary policy, despite the complexities and the aura of scientific decision-making that surrounds it, is always a choice of values. Which economic goals mattered most? What came first? Paul Volcker’s sure-handed management of money had effectively decided the priorities for the nation. Yet the Federal Reserve’s control produced disappointing results in the real economy. Various forecasters during the ’80s kept predicting a revived boom, but it never materialized. The economic expansion remained fitful and fainthearted, performing far below the economy’s potential and below the historic averages for recovery cycles. From the middle of 1984 onward, the economy settled into a jigsaw pattern of uneven advances—weakening one quarter, then resurgent the next, then weakening again. The Federal Reserve eased or restrained in carefully measured steps, averting a recession but also failing to break out of the lackluster pattern. Even the Fed’s own conservative expectations for the economy were disappointed. Over the subsequent twenty-four months, the economy grew in real terms by less than 2.5 percent. The general disappointment was crisply summarized by Fortune magazine in its report on the 1985 performance of the Fortune 500 corporations. Overall sales moved up only 2.8 percent, less than the inflation rate. Profits sank 19.1 percent, the worst performance since the recession year of 1982. Slack demand, a strong From 1982 to 1987, the value of Dow Jones stocks rose by more than 230 percent. Yet real economic growth totaled only 20 percent. dollar, and fierce international competition all hurt. Metals, transportation equipment, textiles and mining fared poorly. Even computers and office equipment fell 6.2 percent. Only 242 companies among the 500 showed profit increases and 70 lost money—a record.... Unable to wring satisfactory returns from their traditional businesses last year, many of the 500 companies put efforts into rearranging their existing resources and buying new ones. They restructured through mergers and acquisitions, stock repurchases and leveraged buy outs.... Yet Volcker stood his ground. When the economy weakened in the spring quarter of 1985 and many forecasters worried aloud about a possible recession, Volcker relented—but only slightly. The Board of Governors agreed on May 17 to reduce the Discount rate by .5 percent. Economic growth picked up somewhat subsequently as interest rates declined and recession was averted. Except for that limited concession, however, Volcker was unyielding. Despite the gathering deflation and the disappointing business activity, he kept interest rates at the same high level and declined to do more to help the struggling economy. ft ensible businessj J men do not pro- duce things they cannot sell and certainly they do not build new factories when they have usable factories standing idle.” The observation by businessman and author George P. Brockway, simple and obvious as it seemed, went to the heart of the matter— the fundamental economic disorder that confronted not just the United States, but the world. The contest of currencies, the political controversies over trade restrictions, were the visible struggles that concealed a much deeper malady, one that was shared by all. The U.S. economy and the world’s were awash in surpluses —an overabundance of available labor, of foodstuffs and raw materials, of manufactured goods. Worldwide, the existing capacity to produce goods far exceeded the aggregate demand for them—a glut of supply. Given that basic dilemma, nations n’aturally’fought over market shares and erected trading barriers to protect their own producers. Unemployment remained high in most industrial nations and prices remained depressed—all because the world could produce more goods than its markets could absorb. The United States was operating far below its capacity, but so were Japan and West Germany and other major producers. The glut was visible in most basic markets: oil and grains, cotton and sugar, steel and copper and other metals. But the excess productive capacity also afflicted many manufactured goods: automobiles and machine tools, personal computers and industrial chemicals, microchips and tape recorders, and many others. The imbalance of supply was, of course, another way of saying that there was inadequate demand. Around the world, there were simply not enough people who had the money to buy all the goods the world’s economies could now produce. The underlying causes of this disorder were deeper than money- economic changes in the world that had been developing for many years. Two decades of global development, led by multinational corporations and financed by bank lending, had greatly enlarged the world’s productive capacity, building new factories where none had existed a generation ago, creating a much larger industrial base for the world. The paradox of the 1980s was that, in a sense, Economist John Maynard Keynes got the last laugh, after all. The American President who came to power focused the debate on improving the “supply side” of the economy. Keynesian “demand side” economics was eclipsed. The Reagan tax cuts, by directing most of the money to investors, would launch a great burst of capital formation, building new factories, developing more supply capacity. Yet the fundamental disorder of the 1980s was essentially the same one that Keynes and the New Deal liberals had identified—there was already too much supply and not enough demand. The Reagan tax cuts, combined with the Fed’s tight money policy, obscured this reality with the anomalous conditions they created. The tax reductions did not produce an investment boom for the very good reason cited by Brockway—why build new factories when you can’t sell the goods produced by the old factories? Instead, the fiscal stimulus from the federal deficits drove a boom in consumption—and a burgeoning of debt, both private and public. But, given the overvalued dollar created by the Fed’s tight money, a huge share of the American consumption was captured by the cheaper-priced imports instead of by American-made goods. The U.S. market was buying the surplus production of other economies and allowing American producers to suffer the consequences of the supply glut. Americans, in effect, were carrying the world—and borrowing the money to do so. The disorder of the eighties— excess supply, inadequate demand and the maldistribution of incomes— was parallel to the underlying conditions that led to the collapse of 1929. There were important differences, including the fact that burgeoning debt in the 1920s did not include huge government deficits and that productivity in the 1980s was much weaker. A similar outcome might yet be avoided in the eighties if governments acted to confront the real economic vulnerabilities, though that seemed unlikely. It would require political leaders not only to abandon the economic orthodoxies that had guided their careers, but also to reconsider the very ideas they had disparaged. The world economy, in short, required a new version of Keynesian economics—but a strategy vastly more complex and far-ranging than the original one. The same basic questions that New Dealers faced in the 1930s were appropriate—how to stimulate demand, how to limit supply. But now answers would have to be devised in terms of global application. The world was no longer divided, as it had been in Keynes’s day, between wealthy industrial nations and colonial territories that provided the raw materials. The U.S. no longer dominated, either with its trade or currency, and the economic vulnerabilities confronting it could not be Clinton St. Quarterly—Winter, 1988-89 13
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