Lessons From the Great Inflation

Paul Volcker and Ronald Reagan's forgotten miracle created a quarter century of prosperity--and a dangerous bubble of complacency.

Robert J. Samuelson from the January 2009 issue

(Page 4 of 4)

A majority of today’'Americans have never experienced double-digit inflation. In 2008 slightly more than 60 percent of today’s roughly 300 million Americans were born in 1962 or later, meaning that the oldest of them would have been only 17 or 18 when inflation peaked in 1979 and 1980. They were too young for it to have made much of an impression. Even for some of those who lived through it, the memory of inflation has faded.

In a very superficial way, that provides a serviceable explanation for the way inflation’s memory has faded. But the same arithmetic applies to Vietnam—indeed more so, since it was an earlier event—and yet Vietnam retains a powerful grip on the national consciousness. Something else must be at work.

Closer to the truth, I think, is a collective failure of communication and candor by the nation’s economists. At its base, double-digit inflation was their doing, a product of their bad ideas. There is now a widespread recognition of this, and although there are many technical studies of inflation and of the period of high inflation, there has not been much in the way of public apologies (from those who were complicit in the error) or reprimands (from those who were not, because they either dissented or were too young). There seems to be an unspoken pact of self-restraint to let bygones be bygones, perhaps out of collective embarrassment or a recognition that dwelling excessively on past failures might compromise economists’ prospects as government advisers and high-level appointees.

Over the course of 2008, inflation has risen to the uncomfortable level of about 5 percent, driven largely by higher prices for oil and food emanating from international markets. Whether it will go higher or subside to the negligible range of zero to 2 percent (a level at which most economists believe prices changes are so slight that they barely affect most consumers or businesses) is impossible to say. What is less uncertain is the similarity between our present predicament and the situation that led to higher inflation in the 1960s and ’70s. Then, a little inflation seemed unthreatening; but a little led to a little more, and a little more led to a lot.

This article is adapted from The Great Inflation and Its Aftermath: The Past and Future of American Affluence, written by Robert J. Samuelson and published by Random House. Samuelson, a columnist for Newsweek and The Washington Post, is also the author of The Good Life and Its Discontents: The American Dream in the Age of Entitlement. © 2008 by Robert J. Samuelson. Reprinted by arrangement with the Random House Publishing Group.

Comments

|12.18.08 @ 12:23PM|#

I just want to point out that Ronald Reagan's forgotten miracle is revisionist history. RR was an R, hence he stole from the poor to give to the rich.

There is a new sheriff in town and he is a D. Miracles, real ones, will soon follow.

|12.18.08 @ 12:26PM|#

Amazing, an entire "Who was to blame?" section on 70's inflation without a mention of the defining moment - Nixon unpegging gold from a fixed price of $35 an ounce.

That event took many years to settle in the currency market. Inflation was raging well before Carter took office - Whip Inflation Now was an empty slogan before the GOP became the official standard-bearer of empty slogans.

ed|12.18.08 @ 12:28PM|#

Prosperity in our time!

Erm|12.18.08 @ 12:39PM|#

The sad thing about wayne's comment is how spot-on he is with his impression of a dim-witted partisan.

|12.18.08 @ 12:54PM|#

Amazing, an entire "Who was to blame?" section on 70's inflation without a mention of the defining moment - Nixon unpegging gold from a fixed price of $35 an ounce.

That event took many years to settle in the currency market. Inflation was raging well before Carter took office - Whip Inflation Now was an empty slogan before the GOP became the official standard-bearer of empty slogans.

RTFA.

Samuelson states:

From 1960 to 1979, annual U.S. inflation increased from a negligible 1.4 percent to 13.3 percent.

Nixon is included in that isn't he?

|12.18.08 @ 12:59PM|#

The inflationary episode was a deeply disturbing and disillusioning experience that eroded Americans' confidence in their future and their leaders.

All very true. Ultimately the Fed, however, has no more of a role in real economic growth and prosperity than the Wizard had in getting Dorothy home. They are masters of a monetary illusion. We offer far too much deference to the institution's ability to do much more than make things worse in the long run by trying to manage the business cycle in the short run.

|12.18.08 @ 1:06PM|#

How did Dorothy get home?

squarooticus|12.18.08 @ 1:08PM|#

TANSTAAFL. That's the lesson to learn from this recession, the imminent collapse of the dollar, and the very high probability of a hyperinflationary depression.

We thought we could finance our standard of living by replacing gold with the dollar as the universal store of value, and then debasing the dollar to our advantage. As with all schemes that depend on the blindness of others to succeed, it worked for a while... but the day of reckoning, put off several times already, was always inevitable.

From the future, we borrowed a nearly 40-year advantage over historically-sustainable rates of economic growth; now, it's payback time, which will result in several decades of regression to the mean. The Great Inflation is now underway, and I see no way that this ends well for the majority of people.

Cue Warren.

|12.18.08 @ 1:09PM|#

It is a good rule to remember that anytime an economist tells you that he has found a way to avoid the business cycle, he is selling you fools gold. What the great inflation and the last 10 years have in common is the idea that monetary and fiscal policy could prevent recessions from ever happening. There should have been a serious recession after the tech bubble burst. But, Greenspan used monetary policy to blow up the real estate bubble and forstall a resession. We are now having to take our medicine in double doses because of that decision.

|12.18.08 @ 1:12PM|#

"The Great Inflation is now underway, and I see no way that this ends well for the majority of people."

I disagree. I think the danger now is deflation. The fed is pumping dollars into a system that is losing value. Asset values and commodity values are falling. That means that the danger is deflation not inflation. In fact, delfation is even worse than inflation. Despite their glee, the goldbugs are still wrong.

ed|12.18.08 @ 1:15PM|#

Indeed, business cycles are inevitable in a truly free economy, but they tend to be brief and self-correcting. It's government intrusion into the marketplace that causes catastrophic swings, often with deadly, irreversible consequences.

|12.18.08 @ 1:15PM|#

How did Dorothy get home?

Exactly! It was all a dream. How I wish the same was true of our current nightmare.

|12.18.08 @ 1:22PM|#

From 1960 to 1979, annual U.S. inflation increased from a negligible 1.4 percent to 13.3 percent.

That is miserly information for such a lofty section header. You may be satisfied but I like more depth.

I suppose that JFK is as culpable as Nixon?

Yeah, right.

squarooticus|12.18.08 @ 1:27PM|#

I disagree. I think the danger now is deflation. The fed is pumping dollars into a system that is losing value.

I agree that's exactly what they're doing, and that is precisely what will result in the Great(er) Inflation. I fail to see how pointing out that we are currently in deflation---from illusory capital disappearing back into the ether---somehow negates the argument that hyperinflation will follow.

Hyperinflation historically results from central bank reactions to deflation. Increased prices across-the-board are caused by an increase in overall demand, but the cause of this increase in demand isn't magic: what other than an increase in the money supply beyond the rate of actual wealth creation would raise aggregate demand in such a way as to force producers to raise prices without rationing?

You can argue that the central bankers are doing a good job and won't inflate too much, a point with which I'd heartily disagree based simply on historical precedent; but that's completely different from dismissing the danger of hyperinflation by saying that currently there is deflation. I mean... duh. Deflation is always the precursor to hyperinflation, the latter of which is purely a central banking phenomenon.

Despite their glee, the goldbugs are still wrong.

I would hardly call Mises a "goldbug", but he has still been spot-on in predicting this crisis. I suspect we are seeing the start of the crack-up boom. But I've given up trying to convince the deflationistas and monetarists. Time will tell who's right. My money is where my mouth is.

Sam Grove|12.18.08 @ 1:35PM|#

The fed is pumping dollars into a system that is losing value. Asset values and commodity values are falling.

Pumping dollars into the system sounds a lot like monetary inflation.

Whether deflation is a negative or a positive depends on its cause.

When prices go down because of a market correction, that is a necessary, if unpleasant for some, function signaling mal-investment due to previous stimulation.

However, if the value of the dollar goes down even more, some things will increase in price, provided those prices were not previously inflated.

Deflation is a positive provided that it is caused by increasing productivity and not by monetary contraction.

|12.18.08 @ 1:38PM|#

Since when is Robert J. Samuelson an economist?

|12.18.08 @ 2:09PM|#

Despite their glee, the goldbugs are still wrong.

John,
Speaking as a certified "goldbug"; First of all I'm not in the least bit gleeful. Believing that the dollar should be on the gold standard hasn't motivated me to hoard gold (though I now have a small pile of silver). But even if I did, gold is still way off it's highs from earlier in the year. The prospect of runaway inflation frightens me greatly. If I'm right and next year inflation hits and gold prices soar, having gold only means you're not loosing as much value as everyone else. But I'd rather be middle class in a vibrant economy than an aristocrat in a feeble one. Inflation is going to hurt everyone, even those who guess right about where to put their savings.

Second of all, I see nothing in what you've said that contradicts the thesis that we should back our currency with gold.

Naga Sadow as Henry Paulson|12.18.08 @ 2:19PM|#

FOOLS!!! All fools!!! This is the time for a bold new experiment! The market is not functioning correctly and old methods don't work anymore! Give me 10 trillion dollars and I will save the economy! (immitates Dr. Evil by lifting pinky to lips)

§|12.18.08 @ 2:20PM|#

TANSTAAFL
There are no such thing as a free lunch? Am?

squarooticus|12.18.08 @ 2:22PM|#

http://en.wikipedia.org/wiki/Tanstaafl

The intarwebs are a wonderful thing, them tubes are.

|12.18.08 @ 2:24PM|#

blockquote>In fact, delfation is even worse than inflation.

Monetary deflation is no worse than inflation, int he long term. Changes in the money supply, whether natural or artificial, affect different sectors of the economy differently. They affect earlier stages of production first, and consumers last. We see the bad effects of deflation before we see the good effects, which is opposite of inflation. With deflation we see unemployment right off the bat, while under monetary inflation we don't see the price increases until later.

But in the long run one is no better or worse than the other. How is the scaling back of production under deflation worse than the inevitable bust in production under inflation?

Setting a small but positive inflation target is good, but only because a small deflation is natural.

p.s. Just to mollify the goldbugs, I think the gub'ment should get out of the money business altogether, but if it's going to meddle around, I would prefer a firm inflation target than the arbitrary whims we have today.

Bingo|12.18.08 @ 2:27PM|#

How about a compromise:

Uranium instead of gold! Benefits are that you will want to spend it as soon as you get it or you will want put it in a bank... so much for hoarding coins in your house. It increases both consumption and saving! Additionally, economic superpowers become nuclear superpowers - but only if they keep actual reserves on hand. Plus there's the small chance that we all become superheroes every time we grab change from a vending machine.

Win-Win-Win

Naga Sadow|12.18.08 @ 2:29PM|#

But Bingo . . . what are about the children?

Bingo|12.18.08 @ 2:32PM|#

Our extra-limbed children will be so much more productive with their additional extremities that we will be able to pay for social security and universal healthcare and as many financial institutions as our heart desires.

Naga Sadow|12.18.08 @ 2:49PM|#

I'm with ya Bingo. Though a reorganization of the Justice Department will be necessary. Toddlers running around spreading doom where ever they decide to play. Plus . . . who will handle their radioactive diapers?

|12.18.08 @ 3:09PM|#

"Jack Kemp (D-N.Y.), a Republican supply-sider..."

I'm confused...

Neu Mejican|12.18.08 @ 3:18PM|#

Somehow this made me think of this article at Edge.org*

http://www.edge.org/3rd_culture/brown08/brown08_index.html

Be sure to read the comments.

I liked Douglas Rushkoff's response in particular.

*I believe this has been posted on H&R previously.

Kolohe|12.18.08 @ 3:52PM|#

Bingo-
The problem with a uranium standard is that it's naturally deflating. Unless you do some sort of uranium-lead bimetalism.

|12.18.08 @ 3:59PM|#

...I think the gub'ment should get out of the money business altogether...

The US constitution specifies how the government should be in the money business, and precisely what constitutes money: gold and silver.

Jay1|12.18.08 @ 4:58PM|#

Reading the article you forget that Carter was President for the first 2 years of Volker's interest rate hikes.

Samuelson says that most Presidents wouldn't have accepted Volker's 'plan'....ignores that Carter did just that.

Revisionist deification of Reagan is a full time job. Keep it up Bob!

|12.18.08 @ 5:19PM|#

Nixon unpegging gold from a fixed price of $35 an ounce.

How is "price fixing" libertarian?

|12.18.08 @ 5:31PM|#

You can argue that the central bankers are doing a good job and won't inflate too much, a point with which I'd heartily disagree based simply on historical precedent; but that's completely different from dismissing the danger of hyperinflation by saying that currently there is deflation. I mean... duh. Deflation is always the precursor to hyperinflation, the latter of which is purely a central banking phenomenon.

Squarooticus, my old monetary adversary...

At least now you are acknowledging deflation as being real and worrisome. Now, the question of whether this inevitably leads to massive government spurred hyperinflation can be properly addressed from a realistic reference frame.

The only fiat currency inflationary episode under the current system was the 70's. It was effectively quelled by tightening rates. At the time, this was a controversial notion, but no longer. Even when people were still using artificially low (but politically popular) unemployment and the fallacy of the Phillips curve to justify inflation - it didn't get over 20 odd percent. Don't get me wrong, that's BAD. But it's not Zimbabwe bad, or even Turkey bad. And that was when we lacked the political will to fix it, and few people in power understood the cause and the solution. Why do you assume this time will be much much worse?

|12.18.08 @ 6:02PM|#

Brandybuck,

But in the long run one is no better or worse than the other. How is the scaling back of production under deflation worse than the inevitable bust in production under inflation?

Deflation as a natural state under a fixed sized currency is not conducive to any type of credit. Say you want to buy a 100,000 house. You borrow your 80k and pay 0% interest. Over the thirty year loan life, you have 3% deflation. Now your house has decreased in value (to around 40k - which will buy the same stuff as 100k did 30 years ago) and you have payed back 80k in dollars that were 3% sucessively harder to earn every year you have paid a 3% real interest rate. This is exactly the same as if you paid 6% interest, with 3% inflation.

People go around talking about nominal interest rates (0% and 6% in the above example) like they know what they are talking about. Rubbish - the two cases are economically identical. The supply and demand for credit sets the real interest rate given a rational expectation of in/deflation. In a world where 3% deflation was the steady norm and rates were 0%, it's not hard to imagine that people would bake in an assumption that this trend would continue.

Now here is the problem: Lets say, for whatever reason, that demand for credit went down. Maybe some banks screwed up, maybe there was uncertainty politically, maybe there is a dry spell where few technological innovations occurred. Whatever. Even though the demand for credit should reduce the interest rate banks can charge - it's already at 0%. They cannot reduce it any further, because no lender would consent to lending unencumbered cash for less than a 0% nominal rate of interest - they could always do better in their mattress. Therefore there is a market failure whereby lenders refuse to lend because the market clearing rate is too low (

Ken Braun|12.20.08 @ 1:23AM|#

"The US constitution specifies how the government should be in the money business, and precisely what constitutes money: gold and silver."

This is a popular misconception stoked by some politicians who profess to adhere to the constitution, but don't necessarily read it.

In fact, the words "gold" and "silver" make just one appearance in the document: Art 1, Sec 10:

"No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts..."

And on it goes, laying out several other restrictions on the power of STATES. Not rules for the FEDERAL government, mind you, but rules for the STATES.

Some powers of the federal government, namely Congress, are detailed just two sections earlier in Art 1, Sec 8. Among those, interestingly, are...

"To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures..."

So, Congress has the power not only to create money, but also to regulate what it is worth. Imagine Congress exercising this to the letter and voting on what the dollar should be worth. Wouldn't THAT be neat?

Instead, by some miracle, the looters decided to create the Fed and delegate a lot of this "money" authority to it. Constitutionally, they could seize the authority back, but they have not done so.

The results, while they could certainly be improved upon, have hardly been the nightmare that is often portrayed.