A Review of Paul Volcker's New Book Revives Dated Monetary Fallacies
Back in the inflationary 1970s that emerged from President Nixon’s mistaken decision to sever the dollar’s link to gold, many countries around the world suffered agony similar to what Americans did. Figure that a global dollar standard that is somewhat implicit today was explicit back then. When we devalued the dollar, our error was globalized to the extent that other countries mimicked Nixon’s error.
England was one of those nations that fell for the biggest, lying-est monetary trick in the book that says prosperity can be had through the shrinkage of the unit of account. Translated, British monetary authorities followed our devaluation error to similarly gruesome effect. The chaos that resulted from shrunken money logically led to all sorts of economic problems, including banking crises that authorities tried to fix through mandatory reserve requirements, and “corsets” meant to “increase lending rates to borrowers.”
Nigel Lawson, Margaret Thatcher’s Chancellor of the Exchequer, described all of the above in detail in his spectacular 1992 book, The View From No. 11. Lawson made plain that attempts by the Bank of England to limit lending failed rather impressively. As Lawson recalled, mandatory reserve requirements were overcome by banks “via offshore subsidiaries outside the Bank’s [of England] control.” As for “corsets” implemented to increase lending rates, Lawson observed that a “bank whose deposits were up against the corset limits could use its Paris branch to bid for sterling funds and that branch could make the loan to the UK resident.” Lawson concluded that it was unserious for central bankers to believe that bank lending could be “fine-tuned.” More specifically, market actors always and everywhere work around central bankers to reveal the real cost of credit.
Which brings us to James Grant’s recent review of Paul Volcker’s new book, Keeping At It. Grant sees Volcker as a hero, as someone who restrained inflation by somehow tightening credit. Except that per Lawson’s UK example, the Fed could do no such thing. When government entities or those tied to government strive to impose the Rule of Man over the Rule of Market, markets ultimately adjust to correct what’s artificial.
Grant no doubt understands the above well from his years in New York. Rent controls placed on the city’s apartments didn’t make them plentiful at low rental rates; rather they logically authored scarcity at the prices set by the city. Obviously. Markets once again always correct what’s artificial. What’s true for apartments is true for credit. With credit, no one’s borrowing “money,” they’re borrowing what money can be exchanged for. This includes apartments. Implicit in Grant’s easy/tight orientation when it comes to credit is that the Fed can decree easy or difficult access to trucks, tractors, computers, apartments, labor, and everything else. The Fed can do no such thing. Grant surely knows this to be true for most any market good, but seems to have ignored that the Fed can’t operate outside normal market constraints. Reality ultimately sets in.
Thinking about this through the prism of the Fed’s vain attempts to control lending rates and total credit, Lawson pithily explained long ago how lenders ably worked around what was plastic. In other words, the Fed can’t rewrite reality. To the extent that it wants some semblance of reality when it comes to interest rates, it must follow market rates as opposed to setting them. Just as British banks worked around what was artificial, so logically did U.S. lenders during the Volcker era. Credit – meaning resources - flows to its highest use, and surely never sits idle. Volcker couldn’t turn off credit access as is so readily assumed, and the central bank he oversaw couldn’t deviate from market rates without credit suppliers working around its faux rate setting. If the Fed could truly central plan the cost of access to economic resources as Grant seems to believe, the U.S. economy would be perpetually recessed.
So there perhaps lies the problem with Grant writing about Volcker and the Fed. To the extent that he contends the Fed runs roughshod over always powerful and loud market forces, he promotes fallacy. This becomes rather apparent in his reverential approach to the former central banker more broadly.
Up front, Grant jumps on a filled-to-the-brim bandwagon of thinkers who still promote the popular falsehood that Volcker beat inflation by allowing “joblessness [to] mount, bankruptcies climb and brickbats rain down.” In Grant’s defense, countless Reaganites have fallen for the same Phillips Curve fallacy which says economic growth is the driver of inflation, so the path to beating it is a crushing recession; the latter all centrally planned by the supposedly heroic Volcker during Reagan’s early years in office. But that’s not serious. Inflation is an effect of a weak dollar. Ronald Reagan ran on reviving the dollar through a gold definition, and the greenback’s value began to reflect Reagan’s monetary vision after his 1980 New Hampshire primary win. The dollar soared throughout 1980, and after Reagan actually won the White House. In short, Reagan beat inflation simply because president’s get the dollar they want, and investors began to price in a Reagan victory before voters went to the polls in November of 1980. The previous point actually bears repeating: presidents generally get the dollar they want, the Fed be damned. If readers doubt this, it’s worth noting that FDR and Nixon devalued the dollar in 1933 and 1971-73 despite persistent Fed protests. About this, Fed officials could only protest. The dollar’s exchange rate versus foreign currencies and gold has never been part of the Fed’s portfolio.
After that, economic growth is the biggest driver of falling prices precisely because investment is what powers economic growth. Important here is that investment is what enables the production of more and more with exponentially less capacity and exponentially fewer human inputs. To be explicit, you know an economy is growing when prices across the board are falling.
In Grant’s case, he stands with the mainstream view embraced by most economists that Volcker “stuck to his anti-inflationary guns” by centrally planning a recession induced by a central-bank administered credit crunch. But that can’t be. Just as central banks can’t make credit “easy,” they also can’t engineer a lack of same. See Lawson.
In truth, the stronger Reagan dollar was the “recession,” and it’s crucial to stress that it was only “recessionary” insofar as it reoriented investment back into the economy of the mind, and away from economy-sapping inflation hedges (oil, gold, housing, land, rare art & stamps) that reigned during the weak dollar 1970s. The recession was the Reagan-era cure, but Volcker’s role in the cure has long been overstated based on a misunderstanding of what inflation is, along with overdone mysticism with regard to the power of the Fed to control the cost of credit. It can’t be repeated enough that for one to believe the central bank can decree credit expensive is as confused as the belief that the Fed can decree it cheap, or costless via a zero rate. No. The price of access to goods and services is set in the market economy despite the efforts of central bankers to bend the will of those same markets.
And for those still convinced that Volcker’s policies, not Reagan’s, pushed the dollar upward, there’s more. It’s not just that the dollar’s exchange rate has never been part of the Fed’s portfolio. In Volcker’s case, he began his high-interest-rate monetarist experiment in October of 1979. The dollar plummeted in concert with Volcker’s experiment, with gold hitting a then all-time-high of $875 in early 1980. Gold only fell – as previously mentioned – after Reagan won New Hampshire. Reagan beat inflation, not Volcker, nominally high rates, or discredited theories of the Phillips Curve variety.
The problem is that Grant doesn’t stop there. Seemingly always a bear, Grant attacks Volcker’s successors for their actions taken to “quash interest rates, lift the stock market and rescue the overextended American financial system in the wake of the 2008 crisis.” Without defending mediocre economic thinkers like Bernanke and Yellen for even a second, and surely without defending the economy-sapping and bank-weakening bailouts, one can only wonder what’s happened to the right. It used to be that market interventions by government officials always brought on scorn from the limited government crowd for them creating worse outcomes than would have materialized if fallible men and women had done nothing. Not anymore, and this is puzzling. According to Grant and countless modern conservatives, the Fed’s anti-growth measures whereby it purchased $4 trillion in Treasuries and mortgages meant to push down Treasury rates while boosting housing consumption somehow tricked markets into rally mode. To be clear, they’re not saying what’s true, that stocks would have done better absent Fed meddling; they’re saying the Fed meddling was the source of the market’s vitality. Really? How?
Implicit in what doesn’t stand up to basic scrutiny is that the high-flying equities of recent years that drove the equity rally (think Alphabet, Amazon, Apple, Facebook, etc.) really weren’t that great. As opposed to the companies mentioned innovating their way to surging valuations, the actual truth is that the Fed’s manipulations somehow lifted them while not lifting other stocks as much. That’s the case because it’s once again true that like all bull markets, they tend to be top heavy. In this instance, to accept the QE-as-market-stimulant narrative one would have to believe that the Fed’s manipulations lifted the FAANGs, but somehow passed by Sears, Ford and other monuments to the old economy? If Grant is to be believed that’s surely what happened, but that’s not realistic. Furthermore, it loudly insults the achievements of some great American companies. And then if central banks could truly engineer bull outcomes as Grant seems to believe, how might he explain Japan? Despite years of QE and zero rates, equities are still below levels they hit in 1989. Were Bernanke and Yellen skillful when it came to manipulating markets in ways that Japanese central bankers were not, or is Grant’s contention that the Fed made these markets not his best analysis? Logic leans toward the latter.
Which brings us to arguably the biggest economic fallacy of all, and one that Grant disappointingly embraces. Though he’s got the right idea about re-linking the dollar to gold, Grant writes that as a result of Nixon’s 1971 decision to cut the dollar “loose from its golden anchor,” the “U.S. could issue as many greenbacks, and run up as much debt, as the traffic would bear.” No. Grant must know it’s not that simple.
Seemingly missed by the market watcher is that whether investors are buying equities, corporate bonds or Treasuries, they’re buying future wealth denominated in dollars. Crucial here is that investors aren’t buying dollars as much as they’re buying what dollars can be exchanged for. By Grant’s own correct admission, the severing of the dollar’s link to gold was a devaluation of the dollar unit. Nixon’s errant decision rendered the dollar exchangeable for less. All of this rates prominent discussion simply because Grant’s arguing that a floating, devalued dollar enables more debt issuance than one that is stable and backed by gold. The very supposition dies of countless contradictions. It does because buyers of Treasuries are once again not buying dollars as much as they’re buying what dollars can be exchanged for. That the dollar’s value has been uncertain and often in freefall since ’71 is a sign that debt has become less attractive since Nixon’s monumental error, and surely not more.
After that, debt is attractive to investors insofar as investors trust it being paid back. That’s why countries with currencies backed by gold have always been able to borrow so easily. Not only are the income streams trustworthy, but good money correlates with booming economic growth. This also explains why, assuming the dollar is still tied to gold, that federal debt would likely be higher today alongside lower interest rates. If debt issuance were as easy as printing money, then Haiti, Peru and Zimbabwe would have as much of it as the U.S. does, and probably more. No. Investors are wise. Grant’s presumption is that they’re stupid, that they’ll easily exchange what money buys in the present for future dollars that will buy less and less. Grant likely doesn’t mean what he wrote in his review.
Grant concludes that Volcker was “tall” for making the paper dollar “respectable.” Not really. The dollar’s exchange rate is once again not part of the Fed’s portfolio, nor does the central bank’s definition of inflation have anything to do with sound money. The Fed believes growth is the source of inflation, and in lionizing “Tall Paul,” Grant is giving life to a cruel economic fallacy tying soaring unemployment to low inflation all the while promoting others that don’t stand up to the most simplistic of analysis.