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June 10, 2021 | The Greatest Failure of American Macroeconomic Policy

Is an American author of books and articles on economic and financial subjects. He is the founder and president of Agora Publishing, and author of the daily financial column, Diary of a Rogue Economist.

Or like stout Cortez when with eagle eyes

He stared at the Pacific – and all his men

Look’d at each other with a wild surmise –

Silent, upon a peak in Darien.

– On First Looking Into Chapman’s Homer, by John Keats

YOUGHAL, IRELAND – We ended yesterday’s Diary with a question: Who will tame inflation this time?

You already know the answer, don’t you, Dear Reader? No one.

It’s too late for that. Too many businesses… households… and the government itself depend on “printing press money.”

Too many economists, investors, politicians, and policymakers have forgotten how inflation works. They think it stimulates the economy.

And today, the costs of tapering off the Federal Reserve’s crackpot policies are far too high.

At the time of its last encounter with double-digit consumer price inflation, the federal government owed roughly $1 trillion dollars. Now, it owes nearly 30 times as much. It cannot “taper” off its money-printing now.

Interest rates would rise. And with so much debt outstanding, the carrying costs would crush the economy.

Debt and Despair

Yes, Dear Reader, in the physical world, you only get to discover the New World once.

But in the world of government policies, money, and poetry… we cross the same oceans… look out at the same horizon… and are surprised to find the same hill in Darien every time.

And now… we look out on a vast Pacific of debt and delusion… and we despair.

Where are the old “conservatives,” who will “just say no” to deficits, boondoggles, and money-printing?

Where is Paul Volcker, the old-fashioned banker who understood what caused inflation and was able to stop it?

Go Fish

In 1971, the Quantity Theory of Money (QTM) – which we explained yesterday – caught up with the Nixon Administration.

Richard Nixon’s predecessor, Lyndon B. Johnson, had spent too freely. “Guns and butter” – a war against the Commies in Vietnam and a war on poverty at home – were his doing. Both cost money. Both were lost.

And by 1971, the U.S. owed money all over town, particularly to the French.

The honest thing would have been to tighten belts, pay down the debt, and bring things back to normal.

Instead, Nixon, aided and abetted by his Secretary of the Treasury, John Connally (about whose financial genius you will have a better idea in a few minutes) pulled a fast one, a switcheroo.

They changed America’s dollar from a gold-backed currency to a “fiat” currency, backed only by the full faith and credit of its governors. If the French – or anyone else – wanted to trade their pieces of green paper for gold… well, they could just go fish!

Greatest Failure

The dollar promptly fell, as investors saw what the full faith and credit of politicians was actually worth.

And over the next 10 years, U.S. prices more than doubled.

The CPI (consumer price index… expressed here as an annual rate of increase) began the decade at only 6%. It finished it, in December of 1979, above 13%.

Wharton professor Jeremy Siegel called it “the greatest failure of American macroeconomic policy in the postwar period.”

By 1980, consumer price inflation had taken on a life of its own. People expected higher prices. So they spent quickly, increasing the “velocity” of money, a key component of the inflation formula.

Interest rates rose, but struggled to stay ahead of rising prices. Real output slowed, even as prices soared.

The feds faced a tough choice. They could get ahead of inflation and pinch it off. But it would mean a recession. Maybe worse.

If they let inflation continue, on the other hand, it would plague the country for years… And who knew where it would end up.

Tall Paul to the Rescue

Then, in August 1979, into the breach stepped then Fed chairman “Tall Paul” Volcker, who announced that he would stop it. Yes, it was stout Volcker who planted his feet at the Fed and set to work.

He raised its key lending rate to 20%, effectively shutting off credit to the whole banking sector.

Immediately, the press… business lobbies… consumers… Wall Street – almost everyone – called for his head. He was “destroying jobs,” they said. He was stifling investment. He was causing a recession!

Of course, that was exactly what he was doing. He was deflating the economy. And Ronald Reagan kept him at his post until the job was done.

By 1982, the inflation rate had been cut in half. By 1983, it was below 3%.

No Volcker or Reagan

And now, four decades later… it’s time for a re-discovery.

In the first quarter of this year, consumer prices rose at a 5% annualized rate. Sooner or later, the “inflation rate” will hit 10%.

But don’t bother to look for a Paul Volcker or a Ronald Reagan; there are no candidates.

And even if there were, neither would be allowed anywhere near Washington.

Instead, the money-printing will continue (perhaps interrupted by a brief taper), until it results in a much more serious disaster.

Jeremy Seigel… you ain’t seen nuthin’ yet.

Swimming Naked

Money-printing isn’t poetry. But it has its own rhymes and rhythms… and its re-discoveries, too.

And so there was a kind of poetry in The New York Times’ headline on August 1, 1987:

Real Estate Woes Force Connally Bankruptcy

John B. Connally, a former United States Treasury Secretary and Democratic Governor of Texas who later sought the Republican Presidential nomination, filed a bankruptcy petition today, citing problems brought on by a depressed Texas real estate market.

Poor Mr. Connally had reached his hill in Darien. He looked out with eagle eyes… and realized he was broke.

“This is one of the most difficult things I have ever done, but obligations arising out of the Barnes-Connally Partnership operation have sorrowfully left me no choice,” Mr. Connally said in a statement.

And here we offer a useless prediction…

No Volckers will appear. Nor any Reagans.

But Connallys… we will see aplenty.

Regards,

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Bill

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June 10th, 2021

Posted In: Bill Bonner's Diary

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