Paul Volcker As 'Inflation Slayer' Is Hagiography, Not Biography

During a recent work trip, my wife asked me to participate in an interview she wanted to conduct with a potential new babysitter for our daughter. I was in San Francisco, the would-be babysitter was in Salt Lake City, and my wife at our apartment in Washington, D.C.

We conducted the interview via Skype, during which the babysitter was able to get to know us, we her, plus she got to meet our daughter, see her, etc.  The good news is that we all got along very well. She was hired. The new hire will be moving to Washington, D.C. in the new year in order to look after our 3-year old.

Amazing to me as the interview took place was that it was essentially costless. No doubt we all had access to high-speed internet that made the call possible, but that was it. No bill from Skype even though we talked for over ½ hour. Imagine that. Twenty years ago such a call wouldn’t have been possible since Skype didn’t even exist until 2003. For the longest time Skype was a gift (do you remember being asked "Do you have Skype?"), as opposed to something one can download for free. Communication by phone would have been the only option when the 21st century began, and it would have been extraordinarily expensive. In this case we were able to talk over camera for next to nothing.

It’s a useful reminder of something that is too readily forgotten: economic growth is a certain sign that the prices of most consumer goods are in the midst of stupendous decline. That is so simply because investment, not consumption, is the driver of economic growth. And investment is all about producers devising new ways to produce abundant goods and services at prices that continue to fall.

Conversely, it’s when the economy isn’t growing that we know prices are stickiest. A lack of growth is a consequence of reduced investment that reveals itself through less in the way of abundance since there’s less investment making the production of plenty possible.

All of this came to mind while reading the numerous obituaries penned about Paul Volcker last week. By most accounts he was a kind, colorful man. The late, great Robert Bartley in particular thought a great deal of him, as he made plain in his classic 1992 book, The Seven Fat Years. So while it was always botheresome that then Fed Chairman Volcker was a routine leaker against Ronald Reagan’s tax cuts, and while it bothered me in subsequent years that Volcker was a scold about seemingly everything else (think so-called "trade deficits," think his mindless dismissal of financial advances created by great minds in the financial space, think his wholly misguided and self-righteous "Volcker Rule"), Bartley’s praise spoke volumes about a person who was clearly well-liked.

At the same time the obituaries were disappointing for them almost uniformly promoting the fiction of Volcker as inflation slayer. Such a view doesn’t square with simple economic history. Indeed, explicit in the accepted wisdom that Volcker was “inflation’s worst enemy” (Hoover Institution’s John Taylor) is that economic growth causes inflation. As Phillips Curve devotee Neil Irwin put it in the New York Times, Volcker allegedly beat inflation “at the cost of what would become the worst recession in the seven decades between the Great Depression and the global financial crisis.” In the analysis of seemingly everyone, job loss and greatly reduced prosperity were necessary for Volcker to slay the dragon of rising prices. Which is all the evidence we need that Volcker’s policies weren’t the cause of price declines. To suggest otherwise speaks to a very fundamental misunderstanding of prices, and how economies work.

Stating what should be obvious, the answer to rising prices is always and everywhere economic growth. Growth is yet again an effect of investment, and investment is all about the creation of more goods and services at prices that continue to fall. Volcker as inflation fighter is quite a bit more hagiography than serious biography.

But wait, some will say, the dollar strengthened while Volcker was Fed Chair, which means he beat inflation. Ok, no doubt a revived dollar signaled a very happy retreat from the dollar devaluation that was inflation, but were Volcker’s machinations the cause? Market signals from the time in question say no. If we ignore that the dollar’s exchange rate has never been part of the Fed’s policy portfolio as is, Volcker’s monetarist experiment whereby per Taylor he “emphasized the money supply” began on October 6, 1979. The date is important simply because the dollar subsequently collapsed; gold soaring all the way to an all-time high of $875 in January of 1980.

Notable about the dollar reaching all-time lows in early ’80 is that its descent soon reversed, and did so substantially that year. One clue for why is that in February of 1980 Reagan won the New Hampshire primary, after which his momentum toward the Republican presidential nomination grew. Reagan ran on reviving the dollar with some kind of commodity definition. The dollar soared throughout the year, and lurched upward quite a bit the day after Reagan’s landslide victory over Jimmy Carter confirmed a change in policy.

This rates serious thought in consideration of the popular view that a so-called tightening of the “money supply” somehow arrested inflation. The dollar once again collapsed in concert with this policy. Whether it was coincidental or not is up for debate, though it says here it was coincidental. That’s the case because the dollar is a political concept more than anything. The value of it rose once it became apparent that dollar policy from the White House would change. Fast forward to 1985, the dollar weakened when Reagan and his Treasury reversed course on the Administration’s policy of a revived dollar with the Plaza Accord. The dollar’s exchange value is once again not a Fed thing.

And what of “money supply”? The latter is a consequence of economic activity, not Fed ease. Readers witnessed this up close in recent years amid the Fed’s feckless QE. Copious amounts of dollars were “created,” but with growth slight stateside, those dollars rapidly migrated out of the U.S. Looking back to the early ‘80s, once the economy took off so did “money supply.” Where there’s growth there’s always money. If readers doubt this, imagine what the result would be if the Fed aggressively drained money from banks in Las Vegas with aggressive bond sales there. Rest assured there would be no loss of “money supply” as a result given the global nature of credit. Since money liquefies highly lucrative economic activitiy in Vegas, what the Fed would naively take away would be made up for by domestic and global dollar flows within minutes. 

Bringing this back to Volcker, just as we do now, back then all-too-many overstated the power of the Federal Reserve to control the economy. The recession then wasn’t a consequence of “tight money” as much as a soaring dollar that reflected Reagan’s reversal of the Nixon/Carter devaluations brought on a migration away from the physical economy (oil, housing, and other hard assets boomed in the devaluationist ‘70s), and back toward the metaphysical economy; as in the economy of the mind. Translated, when money is healthy there’s a rush of investment into the creation of new wealth, and a rush away from physical, commoditized wealth that already exists. The adjustment was "recessionary," but signaled vibrant economic health going forward. 

Basically Paul Volcker’s role in what took place in the early ‘80s is well overstated. This isn’t a knock on him as much as it’s a knock on oversold notions so many have about the Fed. By the accounts of many Volcker was a good man. He should be given his due because he was. At the same time, it does nothing for his memory and good name to revive what isn’t true, and which runs counter to logic. The Phillips Curve has long been dead. Let’s not use Volcker’s sad passing to revive it.