– December 10, 2019

The recent death of Paul Volcker, Federal Reserve Chairman from 1979 to 1987, has generated the usual but undeserved encomiums from media outlets. Sebastian Mallaby at The Washington Post declares that Mr. Volcker was “the savior our economy needed.” Brian Cheung at Yahoo Finance contends that Volcker “tackled the Great Inflation by inspiring a rethink of monetary policy” that “during his eight years at the helm of the central bank, he endured a number of economic crises: rampant inflation, an unstable dollar, the Latin American sovereign debt crisis, the collapse of Continental Illinois National Bank” and “through it all, made quick use of the Fed’s toolbox, elevating the Fed to its modern-day reputation as the first responder to economic crises.”

Set aside for a now the undocumented, underlying premise that money, banking and markets left alone somehow generate inflation, exchange-rate instability, financial crises, and bank failures, while central bankers allegedly cause none of these things but instead fix or mitigate them as heroic rescuers and “first responders.” The naïve imagery of Volcker or the Fed as fixers with a “toolbox” has been common among Fed apologists for decades.  Yet the facts show that the Fed particularly and central bankers generally have instigated many of these troubles.

It is now long forgotten by most monetary economists and biographers that for five years (1969-1974) Volcker was undersecretary for monetary affairs at the U.S. Treasury and in 1971, after just two years on the job, joined Milton Friedman and others in pushing President Nixon to jettison the gold-exchange standard.  Perhaps that’s what Cheung means by Volcker’s “inspiring rethink of monetary policy.” The subsequent decade saw wildly fluctuating exchange rates, double-digit inflation, a dollar crisis, and economic stagnation. Not coincidentally, post-war U.S. productivity gains began diminishing in the 1970s and have never fully revived. Few economists today will attribute it to our inferior monetary regime.

Mr. Volcker has long been portrayed as slayer of some inflation dragon, when in fact he unleashed it; thereafter, in his first few years as Fed chairman (1979-1982), he put the Fed funds rate above 20%, forcing the U.S. economy to suffer two brutal recessions. Duly trained as a Keynesian, Volcker thought prosperity caused inflation, so he tried to kill the former. Was this too an “inspiring rethink of monetary policy,” or was it akin to bloodletting?

By helping to cut the dollar’s tether to gold, Volcker helped Washington’s politicians engage in perpetual fiscal profligacy, which he complained about without ever citing the source of the problem.  Since 1971 in the U.S., compounded, annual rates of change in federal debt, money supply (M-1), and the Consumer Price Index have been 8.6%, 6.1%, and 3.9%, respectively, while real GDP and the Industrial Production Index have grown by merely 2.8% and 2.2% p.a.  In contrast, under the Bretton Woods gold-exchange standard (1948-1971), when the dollar was defined and fixed at 1/35th an ounce of gold, real GDP and the Industrial Production Index grew robustly (by 3.9% and 4.2% p.a.) while federal debt, money supply, and Consumer Price Index increased by only 2.1%, 3.1%, and 2.2% p.a.

Under the Bretton Woods system the U.S. federal budget was in surplus 33% of the time and the ratio of U.S. federal debt to GDP declined steadily from 92% (1948) to 35% (1971); since then, under an irredeemable dollar, the U.S. federal budget has been in surplus only 10% of the time and the federal debt ratio has tripled to 105% of GDP  Prior to 1971, America produced real wealth at a faster rate than it produced money or public debt; since then, we’ve had more money and more public debt than we’ve had more real output. Why should anyone prefer the production of money (and higher prices) to the production of wealth

Did China, Mexico or cross-border trade do this to America, or did her political-economic-financial “leaders” do it?  The latter did it – and one of America’s main leaders was Mr. Volcker. The extent to which America enjoyed a financial-economic revival beginning in the 1980s reflected the advice given to President Reagan by a handful of pro-gold, supply-side economists, but Volcker, Friedman, and others dismissed them as practitioners of “voodoo.” 

The facts are plain that the subjective Volcker-Greenspan-Bernanke-Yellen-Powell “standard” (1971-present) has underperformed the objective gold standard (1948-1971), yet the latter is still dismissed, despised, or distorted by most monetary economists, while central banking (i.e., central planning applied to money and banking) is still widely promoted and praised.

What might explain this?  In 1990, speaking at a Kansas City Fed conference on “The Role of Central Banks,” Volcker observed that “central banks were not exactly the harbingers of free market economies and were not at the cutting edge of capitalist finance,” “they were almost entirely a phenomenon of the twentieth century” and “created mainly as a means of financing the government.” In this he was correct, although few economists admit it (and he sure didn’t admit it while in office). Volcker should have known it well, given his role in ridding America of the gold standard in 1971 and his knowledge of the resulting inferior financial-economic performance. Yes, central banks are “a means of financing the government,” and unrestrained governments that spend more than what they’re willing (or able) to collect in taxes are in the greatest need of financing.  Perhaps we have so many fans of central banking today because we have so many fans of fiscally profligate government. That so many political economists today reject the gold standard may mean that they are more politicians than economists.

Richard M. Salsman

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AIER Senior Fellow Richard M. Salsman is president of InterMarket Forecasting, Inc. and a visiting assistant professor of political economy at Duke University. Previously he was an economist at Wainwright Economics, Inc. and a banker at the Bank of New York and Citibank. Dr. Salsman has authored the books Gold and Liberty (1995), The Collapse of Deposit Insurance and the Case for Abolition (1993) and Breaking the Banks: Central Banking Problems and Free Banking Solutions (1990), all published by AIER, and, most recently, The Political Economy of Public Debt: Three Centuries of Theory and Evidence (2017). Dr. Salsman earned a B.A. in economics from Bowdoin College (1981), an M.A. in economics from New York University (1988), and a PhD in political economy from Duke University (2012).

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