Samuel Son, Great Inflation, 1970s Inflation, Volcker, Reagan, Keynesian Policies, Monetary Policy, Entitlements

8/2/2019 Samuel Son, Great Inflation, 1970s Inflation, Volcker, Reagan, Keynesian Policies, Monetary Policy, Entitlements

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BOOK REVIEW

The Great Inflation and its Aftermathby

Robert J. Samuelson

FUTURECASTS online magazine

www.futurecasts.comVol. 11, No. 8, 8/1/09

Homepage

Chronic inflation:

&

It took inflation two decades from 1960 to rise from 1.4%to 13.3%, and about two more decades to decline to 1.6%.There were profound impacts both on the way up and the way

down, not just on the U.S. economy, but also on its politics,society and international affairs. Few people today appreciate

these impacts, and most people don't even think about it anymore.&

The business cycle

turned vicious with

interest rates, price

inflation and

unemployment all

rising to double

digit peaks before it

was over.

As price inflation

declined in the

1980s and 1990s,

interest rates

declined,

unemployment rates

declined, the

business cycle wasgreatly moderated

and stock prices

pushed persistently

higher. The nation

enjoyed two

decades of

increasing

prosperity and

international

influence

highlighted byvictory in the Cold

War.

In "The Great Inflation and its Aftermath: The Past andFuture of American Affluence," Robert J. Samuelson explains

the political and societal forces that generated the governmentpolicies that caused the Great Inflation and discusses thecontinuing economic impacts of such forces today.

"It's impossible to decipher our era, or to thinksensibly about the future, without understanding theGreat Inflation and its aftermath."

The Great Inflation was profoundly destabilizing, Samuelson

emphasizes. The business cycle turned vicious with interestrates, price inflation and unemployment all rising to double digit

peaks before it was over. Public confidence in its leaders andgovernment collapsed. It made Ronald Reagan's election

possible.&By successfully reining in inflation - by "disinflation" - all of

these miseries were reversed. As price inflation declined in the1980s and 1990s, interest rates declined, unemployment rates

declined, the business cycle was greatly moderated and stockprices pushed persistently higher. The nation enjoyed two

decades of increasing prosperity and international influencehighlighted by victory in the Cold War. Under U.S. leadership,globalization spread prosperity broadly around the world to allnations participating in globalization, NATO spread security inCentral Europe, EU expansion promoted democracy andcapitalism among European spin-offs from the Soviet bloc, andtroubles in the Balkans, the Middle East and elsewhere were

contained.

"Paradoxically, this prolonged prosperity also

helped spawn complacency and carelessness, whichultimately climaxed in a different sort of economicinstability and the financial turmoil that assaulted

muelson, Great Inflation, 1970s inflation, Volcker, Reagan, Keynesian... http://www.futurecasts.com/Book review 11-6.ht

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the economy in 2007 and 2008."

There are disturbing similarities between current conditionsand those of the early 1970s. Samuelson questions whether thenation has the self-discipline to avoid another Great Inflation. Hereminds us of how the inflationary conditions of the 1970s weregenerated.

"Our acceptance of present pain was so slight thatit led not to future gain but to ever-greater doses of

future pain. Inflation rose; recessions got worse. Intheir early phases, the social and economic costs ofinflation are not immediately apparent. Indeed, thefirst effects are often pleasurable. People and firms

believe their incomes are higher. They suffer 'moneyillusion' -- the mirage that higher wages, salaries and

profits signify real gains in purchasing power, when

in fact they reflect only the deceptive side effects of

inflation. By the time people awaken to reality,inflation has secured a strong beachhead in wageand price behavior that can be reversed only withdifficulty. Inflationary psychology and an upwardwage-price spiral have taken hold."

FUTURECASTS has been explainingthese aspects of inflation and the GreatInflation period of the 1970s for more

than a decade already.

Only government

can expand the

money supply

sufficiently to

generate chronic

price inflation.

Before the triumph

of Keynesian

concepts, the

Korean War was

fought without

substantial chronic

inflation.

"This inflation wasa self-inflicted

wound."

Inflation is always caused by government. Only governmentcan expand the money supply sufficiently to generate chronic

price inflation. The Great Inflation was caused by the greatestdomestic policy blunders since WW-II, and the federalgovernment is now at risk of repeating them.&

Samuelson acknowledges that the Vietnam War played somerole in generating the Great Inflation, but he minimizes the

economic impacts of the war and the related budget deficits.After all, before the triumph of Keynesian concepts, the Korean

War was fought without substantial chronic inflation.&Samuelson correctly discounts the "oil shocks" as primary

causes of the Great Inflation. He correctly identifies the primaryculprit. "The main villains were our own poor economic

policies."

"America's most protracted peacetime inflation was

the unintended side effect of economic policiesdesigned to reduce unemployment and eliminate the

business cycle. This inflation was a self-inflicted

wound that resulted from collective hopefulness andintellectual overconfidence."

In fact, the oil shocks could not have


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occurred in the absence of the previousdecade of monetary inflation that was

undermining the purchasing power ofthe dollar. With monetary inflation

being determinedly employed to keepreal interest rates near or below zero, oilin the ground was worth more than oil

produced.

The Keynesians

blamed the

electorate - the

people. The U.S.

was 'ungovernable,"

they lamented.

Some of the economic and social impacts of rapid inflationare summarized by Samuelson.

"[Inflation] destroys both the economy and publictrust. Private virtues -- hard work, saving, planningahead -- are neutralized, because savings can berendered worthless and hard work becomes

pointless when pay depreciates so rapidly in value.

People devote more time to spending their earnings

quickly -- as opposed to working and producing --before the paper money becomes entirely useless."

Keynesian economists denigrated inflation worries, assertingthat inflation could always be readily controlled. They didn'twant fear of inflation to obstruct the aggressive use of budget

deficits and monetary inflation to stimulate the economy.&By the end of the 1970s, however, the Keynesians were forced

to admit that inflation could only be controlled by policies ofausterity severe enough to cause a severe recession. So severe

was this prospect that they despaired of getting the public toaccept the economic pain involved. The Keynesians despairedof finding politicians willing to spend the political capital tosupport austerity. They thus implied that government and its

Keynesian economic policies were not to blame. Theexpectations of continued increases in economic prosperity

were to blame. They blamed the electorate - the people. TheU.S. was 'ungovernable," they lamented.

"But in the end, these theories were not so much

explanations of the country's mood as excuses notto do anything about inflation, and the point atwhich they became less believable was the 1980election."

High inflation

meant high

unemployment and

low productivity

growth. Most

important, interest

rates rose and fellwith inflation rates,

albeit with a time

lag.

Ronald Reagan had the courage to spend political capital.Federal Reserve chairman Paul Volcker was able to restrictmoney growth and put the nation through the 1980-1982

depression because Reagan provided the essential politicalsupport. By 1984, Reagan was easily reelected on a wave ofreturning public optimism.

&The correlation between unemployment, productivity and

inflation rates during the four decades from 1950 is emphasizedby Samuelson. Low inflation meant low unemployment rates


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We are today

repeating many of

the mistakes of the

1960s and 1970s.

and high productivity growth. High inflation meant highunemployment and low productivity growth. Most important,

interest rates rose and fell with inflation rates, albeit with a timelag.&

The many pervasive, noxious economic impacts of inflationare summarized by Samuelson. There were frequent and

increasingly vicious and lengthy economic recessions, there wasthe collapse of the savings and loan banks, boom and bust on

the farms, the third world debt crisis (presided over by RobertMcNamara as president of the World Bank in his usual

cock-sure but totally inept manner), and a 16 year period from1966 of range-bound stock prices that were actually fallingrapidly behind the pace of inflation.&As inflation declined after 1980, on the other hand, there were

many pervasive virtuous economic impacts. Interest ratesdeclined, unemployment declined, the business cycle was

greatly moderated, the stock market doubled and doubled anddoubled again in "real" inflation adjusted terms. Ultimately,

however, confidence became overconfidence and economicexpansion became economic and financial bubbles. There were,of course, a multitude of factors involved in these events, butthe rise and fall of price inflation rates were by any measure

among the most significant.&Yet most economic and political history today tends to

minimize the role of inflation during the post WW-II period.This absent-mindedness is dangerous, Samuelson points out. We

are today repeating many of the mistakes of the 1960s and1970s.&

Economists are

loath to remind the

public of the

immense damage

that they caused.

Economists have

generally declined

to write for the

public about the

economic history of

the Great Inflation

and their role in it.

Whether yourpolicies caused the

Great Inflation or

combated it by

It was the containment of inflation, not the marginalincreases and decreases in taxes, government spending and

deficits, that was primarily responsible for the increasinglyprosperous two decades of the Great Moderation after 1982.

Lower tax rates and declining deficits helped, but were notdecisive. The containment of inflation was the "major economicevent of this period." And this change was world wide.

&One reason for this determined memory lapse is professional

embarrassment. Economists are loath to remind the public ofthe immense damage that they caused. Historians write mainly

political, social and military history. They highlight Vietnam andoil embargoes, tax policy and budget policy. Economics baffles

them so they generally just note major economic events withoutexplanation or economic context. Economists have generallydeclined to write for the public about the economic history ofthe Great Inflation and their role in it.

"At its base, double-digit inflation was their doing.It resulted from bad ideas that -- promoted by manyleading economists and converted into government

policies -- produced bad results. There is now a


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causing the1980-1982

depression, there is

no incentive to

dwell on it.

widespread recognition of this, and although thereare many technical studies of inflation and of the

period of high inflation, there has not been much inthe way of public apologies -- from those who werecomplicit in the error -- or reprimands -- from thosewho were not, because they either dissented orwere 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 pastfailures might compromise economists' prospects as

government advisers and high-level appointees."

Moreover, we are still too close to these events. Political andideological biases color current history. Political memoirs givethe Great Inflation short shrift. Whether your policies causedthe Great Inflation or combated it by causing the 1980-1982depression, there is no incentive to dwell on it. "History skimps

on economics, and economics skimps on history."&

Keynesians:

&

The triumph of Keynesian economics during the Kennedyand Johnson administrations started the ball rolling downhill.

Kennedy brought Keynesian economists into his administration,and they entertained no doubts about the effectiveness of

Keynesian policies.

Samuelson explains the intellectual background ofthe Keynesian ideological triumph. His explanation

contains a few dubious assertions, but is adequatefor the purposes of this book.

The Keynesians

assured everyone

that government

could "obsolete" the

business cycle.

Periods of highunemployment

would not be

tolerated. With the

advent of the Nixon

administration,

Republican and well

as Democratic

politicians

recognized high

employment levels

as more importantthan price stability.

At first, everything went according to plan. A big tax cutboosted economic growth and reduced unemployment to 4% in1965. Moreover, there was no increase in price inflation.

The dollar was still pegged to gold during the1960s. The inflationary pressures could thus be

fended off by sales from the nation's large butrapidly declining gold reserves. These substantial

benefits of the gold standard were widely ignoredand even disparaged. Samuelson, too, ignores them.

The widespread acceptance of Keynesian concepts meant thatpoliticians would henceforth have intellectual support for takingcredit for prosperity, but would not be able to avoid blame for

economic contractions. After all, the Keynesians assuredeveryone that government could "obsolete" the business cycle.

Periods of high unemployment would not be tolerated. With theadvent of the Nixon administration, Republican and well asDemocratic politicians recognized high employment levels as

more important than price stability.

"The result of this mind-set was that the samemistakes were repeated for fifteen years. Inflation


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was underestimated; policies to 'stimulate' theeconomy -- tax cuts, budget deficits, easy money --

were overused; and wage-price controls, either'voluntary' or mandatory, were seen--despiteconstant failure--as a reasonable way to reconcile'full employment' with low inflation. Wishfulthinking triumphed. People believed what they

wanted to believe."

By 1966, inflation at 3.5% was being determinedly ignored by

the Johnson administration. A tradition of underestimatingfuture inflation levels began and continued throughout the

1970s. Economic policy failures were determinedly ignored.When price inflation reached crisis levels and could no longer

be ignored, it became a matter of crisis management.

"Most presidents' first impulse was to preventinflation from frustrating other goals -- including

'full employment' --, not to sacrifice other goals tosuppress inflation. The result was that these

presidents did not devote to inflation the time orrigor required to develop an independent judgment

as to what could or should be done. Instead, theywent along with what seemed most convenient."

Nixon respondedwith wage and price

controls and the

abandonment of the

dollar peg to gold.

This freed the

Federal Reserve to

attack

unemployment with

aggressive

monetary expansion

in preparation for

the 1972 election.

Johnson didn't intend to let inflation - or Vietnam - get inthe way of his Great Society ambitions, so he kept trying to push

them both onto the back burner. Unfortunately, they wouldn'tstay there. For Nixon and Carter, inflation was just "an

annoying distraction" that kept getting in the way of theirdomestic and foreign affairs agendas.&Inflation hit 6.2% in 1969. It only dropped to 5.6% during the

mild 1970 recession even though unemployment surged to 6%.The high unemployment exposed Nixon to political attack by the

Democrats, so Nixon responded with wage and price controlsand the abandonment of the dollar peg to gold. This freed theFederal Reserve to attack unemployment with aggressive

monetary expansion in preparation for the 1972 election.

&Economists, Democrats and many Republicans, the business

community, and the public as well, applauded. Nixon won a

landslide victory in 1972. Keynesianism was triumphantthroughout the nation.

&

Keynesian

stimulation as

always stimulated

nothing but higher

inflation, higher

interest rates,

higher

unemployment, and

greater economic

However, controls as always quickly became unmanageableand had to be removed. With the lid off, price inflation surged todouble digit levels. Carter learned nothing from this episode anddeterminedly refused to confront his inflation problems untilthey approached 15%. Unemployment was still stubbornly highat 5.4% when he took office. Government economists assuredhim that a Keynesian stimulus program of accelerated monetary

expansion and deficit spending would push inflation no higherthat 5.8%. Keynesian economists from both political parties and


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instability.

the business community supported this view. However, 1978saw 9% inflation - and 6% unemployment. Keynesian

stimulation as always stimulated nothing but higher inflation,higher interest rates, higher unemployment, and greatereconomic instability.&Only Gerald Ford determinedly grappled with inflation during

this period - at the cost of the severe 1974 recession and 9%unemployment. He brought inflation down from 12.3% to under

5%, and the economy was beginning to recover by 1976, butpolitically it was too late. He was rewarded by the public with

electoral defeat in 1976.

"But it is misleading to blame individuals, whenthe real source of error lay in prevailing doctrines. Itwas the power of ideas that ordained failure, not theshortcomings of individuals. All these presidentsand their advisers embraced the same basic

concepts that, despite modest differences anddisagreements, inevitably led them to make baddecisions in the name of a good cause. Different

people adopting the same ideas would have endedup in virtually the same place. For the political logicof the 'new economics' virtually guaranteed inflationthat would, almost automatically, become too greatto be halted painlessly."

It was reducing unemployment that was the politicalimperative.

"The fact that unemployment tended to declinebefore inflation rose -- reflecting a 'lag' between

tight labor markets and higher wages -- only madethe policy more hazardous. The obsession withlowering unemployment meant that, even if therehad been no Vietnam War or oil price explosion,there would have been high inflation. The outcomewas built into the system."

However, the politicians were in fact

primarily to blame. The reason whyKeynesian concepts triumphed was

because the politicians loved being toldthey could deficit spend and employmonetary inflation, so they hiredKeynesian economists despite the

patent ridiculousness of Keynesiantheory. See, Keynes, "The GeneralTheory, "Part I, "Elements of the

General Theory," and Part II, "Interest

Rates, Aggregate Demand & theBusiness Cycle." Ultimately, thissupported Keynesian domination of theacademic field as well. Politics and thelure of political appointments corrupted


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the entire academic field.

Economists kept hunting for the point along the "Phillips

Curve" for the optimum tradeoff between inflation andunemployment. However, the Phillips Curve was just anotherKeynesian illusion. Rising rates of inflation, after an enticing lag,always cause higher unemployment. Samuelson provides an

explanation by Milton Friedman for how inflation causes higherunemployment (but this explanation just scratches the surface of

all the noxious economic impacts of inflation).&By the end of the 1970s, inflation was at double digit levels even

though unemployment was rising. Misguided by an intellectual

community in thrall to ridiculous Keynesian concepts, there waswidespread public and political despair that inflation could ever becontrolled.

"Government wouldn't suppress it, because doing so

would involve large, politically unacceptable socialcosts--higher unemployment, lower incomes and

profits. As long as people believed this, meaning aslong as they harbored high inflationary expectations,they would act in ways that made an acceleration of

inflation self-fulfilling. Workers would seek wageincreases compensating for past inflation, plus a littlemore, and companies would meet these expectation,

because they believed they could pass the higher laborcosts along in higher prices. Inflation would feed on

itself, and if government permitted it by creatingever-larger amounts of money, it would beunstoppable."

There is no such thing as "cost-push"

inflation. Even "demand-pull" inflation isa misleading half-truth since in omits the

monetary expansion that causes theincrease in demand. There is no suchthing as "wage-push" inflation.

&

These concepts are just some moreKeynesian myth adopted to deflect blameaway from Keynesian policies of budget

deficits accommodated by monetaryexpansion. Chronic inflation is ALWAYSa monetary phenomenon. It begins -albeit with a misleading time lag - withmonetary inflation and can continue only

so long as the deflationary impacts ofprice increases are offset -"accommodated" is the misleading term

used by economists - by monetaryinflation. It is the Keynesian policy ofmonetary inflation - not the wage

demands of labor or rising costs of


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production or rising demand fromconsumers - that causes chronic inflation.

See, "Understanding Inflation."

As Samuelson accurately points out, it is a "truism that all majorinflations involve 'too much money chasing too few goods.'America's worst peacetime inflation occurred because thegovernment, through the Fed, created too much money."&

However, this is actually only part of the story. Fed ChairmanArthur Burns and most of the Fed had become enthusiastic

Keynesians. They were willing participants in the grandexperiment of using monetary expansion to manage the economy

and reach higher employment levels.&

Samuelson explains Fed "monetary policy. (See, "Friedman &Schwartz, "Monetary History of U.S." Part III, "The Age ofChronic Inflation (1933-1960)." and Meltzer, "History of Federal

Reserve, Part III," The Engine of Inflation (1933-1951).") TheKeynesian belief was that as long as the economy had "ample

slack -- meaning unemployed workers and spare industrialcapacity," it could not generate price inflation. (We hear this same

song again today.) Supply would be able to expand to meet extrademand created by monetary expansion. Neither "wage push" nor"demand pull" inflation would occur.&

Samuelson blames two errors for the failure of this policy. Heasserts that the "full employment" rate was thought to be between

4% and 4.5% when it was really about 6%, and that productivitygrowth was thought to be 2.5% to 3% when it was only about 1%.

Samuelson here mistakes cause and effect - a

common failing in economic analysis given theendless chains of cause and effect. The 6% "fullemployment" rate and 1% productivity growth ratewere not natural limits that caused inflation. It was

inflation that reduced productivity growth to 1% andrendered unsustainable unemployment rates below6%. Indeed, even 6% unemployment and 1%

productivity growth became unsustainable because ofinflation.

Thus, Samuelson becomes an apologist for Keynesian policyfailures. The policies weren't wrong, they were just applied tooaggressively as the Fed tried to fulfill popular wishes and politicalagendas.

&

Monetary history:

&

A brief history of U.S. monetary history is provided bySamuelson. (See, the three articles beginning with Friedman &Schwartz, "Monetary History of U.S." Part I, "Greenbacks andGold," and the three articles beginning with Meltzer, "History ofFederal Reserve," vol. 1, Part I, "The Search for Monetary

Stability (1913-1923).")


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Samuelson believes the monetarist myth that alack of aggressive Fed monetary expansion

"permitted" the Great Depression. It is true that theFed played a significant role in that vast tragedy, butthose errors were only part of the story - and at no

point were even the most significant part. The Fedcould definitely have mitigated some of the impactsof the Great Depression in several ways, but couldnever alone have prevented it or even materially

shortened it.&

The limits of aggressive monetary policy can beseen again during the Credit Crunch. Aggressivemonetary policy - indeed more than a doubling ofthe basic money supply along with two trilliondollars in budget deficits - failed to avoid the CreditCrunch economic contraction and is failing to

materially shorten it. It will continue until thefundamental cause - the housing inventory bubble -is sufficiently liquidated by market forces.

Throwing vast sums of money at the problem doesno more than mitigate some of its impacts and mustleave a residue of problems that will constrain therecovery. See, Great Depression: "Summaries ofControversies and Facts: The Great Deception."

The abandonment of the gold standard set the stage for theGreat Inflation.

"The gold standard was hardly ideal. Had it

remained, the U.S. economy and those of othercountries would probably have fared worse after

World War II than they did. Growing economiesneed more money and credit. The gold standardlimited money and credit, reflecting the metal's rigidand unpredictable supply. But this vice was also, to

some extent, a virtue. It imposed limits on moneyand credit creation that prevented runaway inflation.

The removal of these limits created an entirely newsituation, requiring new understandings andobligations. Inflation would no longer control itself.

It had to be controlled--and so the ideas, beliefs,motives and behavior of people charged withcontrolling it mattered. They had to understand why

preventing it was important and that it was their job

to do so. These responsibilities got lost."

Determined ignorance of economic realities led to repeatedefforts to control price inflation by means of price and wage

controls. The myth that controls worked during WW-II waswidely believed (and is still believed by some even today). Price

and wage controls - administered alternatives to market prices -are actually impossible.


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This is something the Securities and ExchangeCommission proved back in the 1960s, but which is

generally determinedly ignored by the rest of thegovernment. See, Administered Prices & HealthCare." at segment on "The SEC studies."

Like the mad scientists in Gulliver's Travels, political leadersand their Keynesian economists followed failure after failurewith one repetitive attempt after another. Samuelson's account ofthe varying rationalizations used to support these doomed efforts

is both comic and a sad reflection on the economic ignorance ofthe nation's leaders and of the electorate that accepts their

excuses. These efforts did give the appearance that governmentwas doing something about price inflation, and so were repeatedto sooth public ire during election years.

"Indeed, all the programs of wage and price

restraints actually made matters worse by obscuringthe essential nature of inflation. The deploredbehavior of wage and price increases of firms,

unions and workers were not themselves the causeof inflation. They were not spontaneous and

independent events--as they were often portrayed--reflecting economic power, selfishness orself-interest. They were, rather, the consequences oflax money and credit policies, centered at theFederal Reserve. Companies and workers weremerely defending themselves against and, in some

cases, exploiting an inflation that was not of theirown making."

Wage and price controls designed to

restrain price increases are inherentlyinflationary. They do nothing to restraindemand and do nothing to encourage

production.

Austerity - with

restraints on both

spending and

monetary growth -

and the severe

economic

contraction that

austerity brings -

has always been

and remains the

only remedy forestablished price

inflation.

Everyone was looking for an easy escape from inflation.(Unfortunately, none has ever been found in the 2,500 years ofmonetary history.) Austerity - with restraints on both spendingand monetary growth - and the severe economic contraction that

austerity brings - has always been and remains the only remedyfor established price inflation.

"By the late 1970s, the Fed had maneuvered itselfinto a political and intellectual cul-de-sac. Theadvent of fiat currency had transformed its chiefresponsibility into guarding the stability of thenation's currency. Yet both the public at large and

the nation's political leaders saw the Fed as anessential instrument in achieving rapid economic

growth and maintaining 'full employment.' The Fedhad adhered to economic doctrines that promised to

accomplish both these goals, but in practice, it was


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achieving neither. There seemed to be no way out,and there wouldn't be until both economic ideas and

political objectives changed."

Volcker andReagan:

Paul Volcker and Ronald Reagan provided the necessaryleadership. They grabbed hold of the nation's economic history

and changed its course. Their alliance was implicit rather than

explicit, but it held fast.&

Volcker bludgeoned the economy with monetary austerity,and Reagan expended the political capital needed to give him

political cover. Samuelson provides many of the specifics.&

Prime interest rates soared to 21.5%. Industrial productionplunged 12% in little more than a year from the middle of 1981.Unemployment hit 10.8% by late 1982. It was the worst

economic contraction since the Great Depression. It was truly a

small "d" depression. Along with extensive deregulation, the1980-1982 depression knocked the stuffing out of inflation. Priceinflation declined from 11.8% to 3.7%. In 1983, it declined to

0.6%.&

Samuelson asserts convincingly that no other potentialpresident, Democratic or Republican, would have stood thepolitical heat. Reagan was truly the man for the moment.Politicians from both parties, along with the liberal press and awide variety of interest groups howled in pain and called forVolcker's head, but Reagan's support for Volcker remained

unflinching. Even as unemployment surged into double digits,inflation remained his "number one enemy," and he continued toexpress confidence in Volcker.

"Both men believed, mostly as a matter of faith,that high inflation was shredding the fabric of theeconomy and of American society. The countrycould not thrive if it persisted. Buttressed by these

beliefs, they broke with the past. Each had a role toplay, and each played it somewhat independently ofthe other."

This belief was more than just a"matter of faith." It was knowledge

based on 2,500 years of monetary andeconomic history.&Rather than being unstoppable, history

demonstrates that inflation is alwaysultimately stopped. The obvious reasonis that, despite the very real pain of

austerity, the pain of inflation becomesworse - indeed, unbearable. Moreover,

austerity at least promises better daysahead, while inflation is unending and

persistently worse over time until


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austerity is finally accepted. It is anothereconomic myth that society can "live

with inflation." If inflation continuesunchecked, it destroys nations andsocieties.

"Reagan counted, because the Fed needed politicalprotection. One threat to Volcker's policies wascongressional action forcing the Fed to relent. Likeany bureaucracy, the Fed tries to placate its

adversaries, sometimes by giving ground to them.The paradox: To safeguard its independence, the Fed

may sacrifice its independence."

Reagan understood

that inflation had to

be contained at any

cost, that it was a

monetary

phenomenon, thatregulatory control

was impossible, and

that Volcker was

competently doing

what had to be

done.

The political backlash became vicious. All manner of hamhanded bills were introduced in Congress to impose explicit

political controls on the Fed and dictate monetary inflation.

Reagan stood fast, even as his popularity polls declined to 35%.

He matched Volcker's monetary actions with tax cuts andsubstantial cuts in discretionary spending. He understood thatinflation had to be contained at any cost, that it was a monetary

phenomenon, that regulatory control was impossible, and thatVolcker was competently doing what had to be done.

&Volcker had been chosen as Fed chairman in 1979 because

Pres. Carter couldn't get any of the other qualified alternatives

to preside over his inflationary mess. Volcker quickly decided todecelerate the growth of the money supply. The low - and

frequently negative - "real" inflation adjusted interest rates ofthe 1970s would no longer be tolerated. Interest ratesimmediately surged higher into double digit levels.&

Samuelson relates the technical complications anduncertainties that bedeviled this effort. The modern definition of

"money," after all, is not that definitive. The politics of the 1980election year intruded. The credit controls that Carter initiatedwere a disaster. Controls and other administered alternatives to

market mechanisms always seem so easy in contemplation, andalways fall apart under an avalanche of unintended

consequences. Congress, with its usual brilliance, attempted toblock the incoming tide. It issued warnings that the effort to

curb inflation must not cause recession. By the second quarterof 1980, the economy was in a depression. "To succeed against

entrenched inflation, policies had to be harsh."&

The resulting

economic

contraction was theworst since the

Great Depression.

Even Volcker had to bend to political realities - especiallyduring an election year. He responded to the economiccontraction of the second quarter with a rapid spurt in themoney supply. The economy rebounded through the election

period - and so did inflation. This economic rebound wascompletely artificial and unsustainable. (Many economists

stupidly consider these two quarters as a period of realeconomic revival, and it is so presented by the Business Cycle

Dating Committee of the National Bureau of Economic


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Research. ) In November, 1980, having lost a year in the effort,Volcker again tightened the monetary screws. The resulting

economic contraction was the worst since the Great Depression.&Public and political pressures against Volcker and the Fed were

fierce. Samuelson describes the economic pain, ruined plans andlives. (He does not do nearly so good a job in describing the

economic disruptions and pain of double digit inflation.) Theeconomic contraction was considerably deeper and longer than

expected.&

By mid 1982, there was fear of a full fledged financialcollapse. There were increasing doubts at the Fed. However,monetary progress became apparent in July, and the Fed tookthe opportunity to ease somewhat. Discount rate cuts came insteady succession, inflation was down to 3.8% by the end of1982, and economic growth began in early 1983. The stockmarket responded vigorously, beginning an historic 18 year bull

market run.&

How can the

political system

"take actions

though immediately

painful and

unpopular, seem

essential to thesociety's long term

well-being."

This was just in time in several ways. 1984 was a presidential

election year, and the Fed had to have progress to show for thepain of its austerity program. The Democrats were strengthened

by the 1982 congressional elections, and a liberal DemocraticCongress could turn ugly.

"[The] taming of inflation reinvigorated the

economy as nothing else; the expansion lasted from

early 1983 until the late summer of 1990. At thetime, it was the second longest peacetime expansionin U.S. history. The Volcker-Reagan campaign

discredited many of the ideas that had misgovernednational economic policy for nearly two decades.

The notion that the Federal Reserve couldn'tcontrol inflation was discredited. The notion that alittle less unemployment could be exchanged for alittle more inflation was discredited. In their place, aconsensus slowly developed that 'price stability'--avague term that both Volcker and his successor,

Alan Greenspan, defined as inflation so low that itbarely affected people's decisions--was desirableand would promote a more stable and productive

economy."

Reagan and Volcker launched a frontal attack on apredominant problem of democratic governance. How can thepolitical system "take actions that, though immediately painfuland unpopular, seem essential to the society's long termwell-being."&

It takes real leadership. For two decades, no otheradministration and Fed leadership had been able to square this

circle. By their courage and determination, they permitted theeconomy to stabilize and resume sustainable growth, and


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restored American confidence in its leaders and government.&

Capitalist markets

brought a f lood of

opportunities and

material benefits,

but also imposedthe risks of the

market.

Competition

imposed its

discipline and

direction on an

unruly economic

world. It was hardly

perfect, but it was

always far moreeffective than any

administered

alternative.

The economy was not just freed from inflation. Deregulation

- begun towards the end of the Carter administration -introduced competition into major industries such as therailroads, trucking, phone and airlines with rapid improvementsin productivity and massive benefits for consumers.

Globalization broadened both competition and opportunities,undermining pricing power and rent seeking by largecorporations and their unions in such industries as steel,

automobiles, machine tools, televisions, clothing, with additionalmajor improvements in productivity and benefits for consumers.

&The capitalist economic system was rejuvenated. The dollar

strengthened, the United States regained world leadership, andEvil Empire and socialist autocracies collapsed throughout the

second and third worlds. Samuelson explains how a strong U.S.economy with a strong dollar facilitated globalization andwidespread prosperity.

&With the collapse of utopian illusions ranging from socialism to

a benevolent "mixed economy" and the entitlement welfarestate, capitalist markets brought a flood of opportunities andmaterial benefits, but also imposed the risks of the market.Competition imposed its discipline and direction on an unruly

economic world. It was hardly perfect, but it was always farmore effective than any administered alternative.

"Contrary to much commentary, government's sizedid not shrink in the new economic order.Government regulation remains pervasive. But

there was a shift in its role and in perceptions andemphasis. Government became less ambitious,

because people lost faith that new programs couldsolve all social and economic problems. That was a

major political legacy of inflation and the failure toend the business cycle. Ideas changed. This was

particularly true of economic policy. At the Fed,Friedman's view that money creation is at the core

of inflation became conventional wisdom."

Price stability - control of price inflation - was recognized as anecessary part of any economic policy.&

The GreatModeration:

The characteristics of the "Great Moderation," whichextended over two decades from the end of 1982, are discussed

by Samuelson.&

The old order was

based on utopianillusions that were

disastrous in

execution. The

Competition ruled this world, introducing numerous

economic threats and offering glittering opportunities.

"[The new economic order] has delivered aperplexing prosperity with manifest imperfections.


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current economic

system was not a

conscious choice of

conservative

ideologues and

profiteering

businessmen. It was

a series of essential

reactions "to the

crippling

shortcomings of the

old order."

Jobs are more plentiful--but less secure. Livingstandards are higher-- but incomes are more

unequal and less predictable. Business cycles aremilder--but financial markets seem more erratic andunstable. Competition has inspired newtechnologies and products--but has also threatenedcompanies and industries wedded to old

technologies and products. The economicadaptability that we admire--the ability to make the

most of change--seems to inflict the very insecuritythat we deplore. 'Hardly any company is too

successful nowadays to consider a large-scalecutback in jobs,' social critic James Lardner haswritten."

Critics assert that the previous economy was more humane,morally superior and more concerned with "fairness." However,their views of both the previous economy and the current

economy are just caricatures of reality. The old order was basedon utopian illusions that were disastrous in execution. Thecurrent economic system was not a conscious choice of

conservative ideologues and profiteering businessmen. It was aseries of essential reactions "to the crippling shortcomings of theold order."

"The central contradiction was that an economicsystem premised on change could simultaneously

banish change. We would enjoy the gains and avoidthe pain. The fact that the ideal seemed to have

been realized briefly in the late 1960s, whenAmerican companies dominated the world and the

U.S. economy was in the midst of a fabulous boom,created the myth--still cherished by some--that theold order was a practical possibility. In fact, thistemporary triumph was mostly the result of the firstintoxicating phase of inflationary economic policies-- which created the initial boom -- and the lingeringaftereffects of World War II -- which eliminated

most international competition --. In the 1970s, bothprops collapsed." (Not just coincidentally, the gold

peg prop under the value of the dollar also gave outat this time.)

No matter how good the current reality, it can never match

the "imagined and romanticizedversion of the old order," muchless the impossible utopian alternatives. The two decades of theGreat Moderation constituted an extraordinary rebirth of

economic prosperity and power for the U.S. Competition madecompanies and workers far less secure, but the business cycle hadnever been so mild for so long. Job changes - forced and

voluntary - were twice as frequent, but the instabilities ofrunaway inflation were gone and unemployment levels wereseveral percentage points below previous levels.

&


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Economic inequality increased dramatically, but the assertionthat "typical living standards have stagnated" is preposterous.

"Since 1980, most households have experiencedsubstantial income gains. Vast numbers of Americansenjoy gadgets and conveniences that didn't exist thenor barely existed -- computers, cell phones,flat-screen TVs --. Homes got larger. Poverty ratesfell. In the 1970s and 1980s, a third or more of blacksroutinely had incomes beneath the government's

official poverty line. By 2001, that had dropped to22.7 percent." (It has since risen somewhat, but the

poverty line itself has risen considerably.)

The availability of credit became widespread, but the abuse ofcredit bred instability among individuals, businesses, nations, andthroughout the global economy. Credit fueled the tech boom andsupported a wide variety of new businesses, but abuses brought

the 1987 stock market crash, the 1997-1998 Asian Contagioncrisis, the 2000 tech bust and the 2007-2008 mortgage-backed-

securities bubble Credit Crunch.&

In fact, the uncertainties of flexible labor markets and

competitive globalized markets are responsible for rapidproductivity growth and the more competitive economy thatsustains both prosperity and overall stability. That this vast andcomplex economy still harbors many weaknesses and abuses is

nevertheless inevitable. There are always some in managementwho abuse credit in constructing houses of cards or are involvedin abuse of their position and even outright fraud. Samuelson

mentions the spectacular increase in CEO pay, but this is just thetip of the iceberg. (See, Tavakoli, "Dear Mr. Buffett.")

Corporate allegiance "no longer counts for so much," but asof 2006, more than a quarter of workers 55 to 64 had put in20 years or more with their current employer and almost70% had put in 5 years or more. Workers still value the

benefits of an existing job and corporations still valueworker experience and capabilities as they reach their most

productive period. However, corporations have been drivenby competition to adjust to changing conditions often at theexpense of some of their workers, and workers feel more

free to seek better opportunities elsewhere. About 30% ofjob changes are voluntary.

Corporations no longer shield workers from risks. "The webof formal and informal guarantees that protected many

workers from joblessness, steep health care costs andpoverty in old age has shredded." However, suchprotections have never been even remotely universal, and

substantial protections still in fact exist for many.Corporations still contribute towards health insurance and

pensions. Fear of loss of productive employees providesstrong incentives to improve wages, benefits and working


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conditions. (So do unions or the fear of unionization.)

Most of the insecurity arises from health care cost inflation, not

some reduction in corporate contributions. Nevertheless, anincrease in insecurity and the risks of some substantial financialsetback are undeniable for both corporations and their workers.Competitive markets are stern taskmasters.

There has been a widening of income differences since1980. However, the figures generally cited are pretax andomit fringe benefits such as health insurance and

government non-cash benefits such as food stamps. Theyare also generally based on "household" income and ignore

the substantial changes in the characteristics of"households."

By 2006, almost 20% of U.S. households had reached the

previously exclusive level of $100,000 or more in pretax income.

Moreover, there are now far more elderly, divorced individuals,single parents and singles capable of affording their own homes orapartments and thus constituting a "household." Between 50%

and 75% of the increase in the household inequality figure hasbeen attributed to such broad social changes.

"When households are examined by size--that is, bythe way people actually live--income gains are larger.From 1990 to 2005, the median household incomerose 6.8 percent. But median income rose 10.6

percent for households with three people, 15.8

percent for those with four people and 16.9 percentfor those with five people."

Indeed, less than half the heads of households in the lowest 20%were married. A third were not even meaningfully participating in

the economy, so they really shouldn't be counted at all. A largeproportion of this lowest 20% is made up of unskilled immigrants.Since 1980, the Hispanic share of all households has increasedfrom 4.7% to 11.2% in 2006. One reason why workercompensation growth looks meager is that 35% of it has beeneaten up by the increased costs of health benefits.

&Measured in terms of access to ordinary material goods and

services, all those who engage meaningfully in economic activity

have enjoyed substantial gains since 1980. It is envy, not poverty,that modern inequality creates.&

Of course, this book ends amidst the Credit Crunch inOctober 2008. Samuelson provides a casual explanation of theCredit Crunch that depends on theory and lacks examination of

particulars, and is thus of dubious value. However, he does

correctly note that the decline of U.S. economic and financialdominance - manifested in a weakening dollar - can leave theworld without a financial leader capable and willing to act in

emergencies. The last time this happened was after WW-I when


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Great Britain was in decline and the U.S. was determinedlyunwilling to engage. That period climaxed in the Great Depression

and then WW-II.&

Acceptance of

creativedestruction:

Entitlement psychology is a primary danger in this economicworld.

&

Entitlement psychology arose from the post-WW-IIprosperity when all the other major economic powers were indisarray. It arose from the absurd notion of Keynesian

economists that the business cycle can be controlled. Creativedestruction, and the declining industries, bankrupt companies

and lost jobs involved in business cycle contractions, areessential.

The business cycle is not just an inevitable part of

a prosperous capitalist market economy, it is an

absolutely essential factor in that prosperity. Butonly government policy mismanagement andconstraint of essential market mechanisms can

change it from a series of modest infrequentcontractions of less than three years duration to

decade long periods of depression or inflation.

Economic contractions shift this process into overdrive andsweep the system clean of the houses of cards and fraudulentactivities that can otherwise grow to such enormous size andabsorb immense resources.

"Some of our economic desires are at crosspurposes, at least partially. We want higher incomes

and the 'new and improved' -- the faster computer,the cheaper airfare, the breakthrough medical

device. But the very process of 'creativedestruction' that brings forth these gains mayundermine or demolish the stability and securitythat we also crave."

The populist

threat:

We enjoy an excellent economic system. It offers anabundance of opportunities and a fair - but not assured - degree

of security. Political efforts to improve on this constitutes thegreatest threat to its continuation. Samuelson calls this "the curseof good intentions."&

Despite elaborate

computer models,

economists have a

poor record in

predicting

recessions, interestrates, inflation and

productivity trends.

If economists can't

Political programs based on good intentions and determinedignorance of economic realities bring the law of unintendedconsequences into play. The Great Inflation (like the Great

Depression) was one result. It can happen again, Samuelsonwarns.

"With hindsight, we know that the idea that the

economy's adequate, if imperfect, performancecould be substantially improved was a pipe dream.


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forecast them, it'sdoubtful they can

accurately foretell

the full effects of

many proposed

changes in

government

policies.

The resulting policies not only didn't do what theypromised, they actually did the opposite -- led to

more, not fewer, recessions; to higher, not lower,unemployment; to slower, not faster economicgrowth; to more, not less. economic anxiety. What isrelevant for our era is that these policies were notundertaken on ignorant whim. Rather, they

embodied the thinking of most of the nation's topeconomists, reflecting a broad consensus among

their peers."

The Keynesian concepts involved

were certainly no mere "whim," butthey were certainly "ignorant" ofeconomic reality.

Today, after a quarter century of prosperity, there are stillcomplaints that it is not good enough. Government must protect

the middle class, provide universal health care, exorcisecorporate greed, control globalization, and even curb global

warming. However, government capabilities are more than just alittle suspect.

"Americans' reformist enthusiasms face practicalobstacles. When thinking about the economy'sfuture, we ought to acknowledge how little--not howmuch--we know. Despite elaborate computermodels, economists have a poor record in predictingrecessions, interest rates, inflation and productivity

trends. If economists can't forecast them, it'sdoubtful they can accurately foretell the full effectsof many proposed changes in government policies.

Economic models that purport to predict the futureoften offer no more than the pretense ofknowledge."

In fact, they don't even offer thepretense of knowledge. They justprovide illusionary "projections" toimpress the press and other credulous

sectors of society. These "projections"never survive the next substantial turn

in the business cycle.

Academic pedigree

alone is not a

guarantor of useful

knowledge and

wisdom. Skepticism

ought to qualifyand restrain our

reformist

impulses."

Today, an accumulation of new taxes, programs andregulations - each of which on its own may be justified andharmless - accumulate to burdensome levels. Like in the 1960s

and 1970s, intellectuals of impeccable credentials guideeconomic policy and reform.

"They were credentialed by some of the nation'soutstanding universities: Yale, MIT, Harvard,Princeton. But their high intellectual standing didnot make their ideas any less impractical or


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destructive. Scholars can have tunnel vision,constricted by their own political or personal

agendas. Like politicians, they can also yearn for thepower and celebrity of the public arena. Even iftheir intentions are pure, their ideas may bemistaken. Academic pedigree alone is not aguarantor of useful knowledge and wisdom.

Skepticism ought to qualify and restrain ourreformist impulses."

The same kind of intellectuals - the"best and the brightest" - led the nation

into the Vietnam war during that periodand the Iraq war in the current period.See, Posner, "Public intellectuals," andKuklick, "Blind Oracles."

As the dollar

weakens, there is

increasingly a

vacuum of

financial power.

The optimistic

projections

concerning green

jobs come from

computer-driven

econometric

models, but

searching

econometric

models for

projections is the

modern day

equivalent of

searching for

omens in the

entrails of a pig.

Corn ethanol is

just one example of

the disasters that

can be expected.

Current threats to the economy include the welfare state -

especially the entitlements that are now out of control;disruptions in the financial or physical flows of globalization; andthe massive accumulation of household debt - which has risen

from 23% of household income in 1946 to 134% in 2006. (This isa very misleading use of statistics. 1946 is a very

unrepresentative point for comparison, coming as it did at theend of WW-II.)&Samuelson provides a catalogue of the various threats that a still

dangerous world poses to the global economic system. As long asglobal flows are uninterrupted, globalization is a great engine of

prosperity for all participating nations. However, trade and

payments imbalances pose immediate financial threats. Shortterm foreign capital flows provide a risky basis for long term

investments and loans. Military threats at present are actuallyminor, but both China and Russia are rapidly building formidableregional military strength with uncertain intentions.&

Meanwhile, as its dollar weakens, the ability of the U.S. tofulfill a stabilizing role diminishes. Other nations just pursue theirown narrow interests. As the dollar weakens, there is

increasingly a vacuum of financial power.

Controlling inflation is the absolute prerequisite for

prosperity. This need constrains the degree to which theFed can use monetary inflation to mitigate the businesscycle. During the 1930s, it erred on the sided of too littlemonetary expansion, in the 1970s it erred on the side of

too much. Politicians and some economists don't like toadmit it, but the public will have to understand that to

some significant extent, the business cycle must betolerated and permitted to perform its essential functions.

It is encouraging that, even as the Fed

more than doubles the money supply,Fed chairman Bernanke and cognizant


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officials in the Obama administrationare warning that the recovery and

progress in reducing unemployment willhave to be slow. High levels of priceinflation will surely accompany anyeffort to accelerate the recovery. TheCredit Crunch has reduced the

purchasing power of credit in thefinancial system by many trillions of

dollars, something only the most rabidKeynesians suggest the Fed should

attempt to fully offset.&Nevertheless, it will take extraordinary

leadership from Bernanke - if he isreappointed Fed Chairman - and theObama administration to support thetough monetary measures that will be

needed to avoid a major surge in priceinflation. Bernanke's prior record does

not provide reason for confidence.Bernanke has expressly warned that heintends to keep interest rates low for anextended period of time. He has always

exhibited a cavalier attitude towards hisprimary responsibility - preserving thepurchasing power of the dollar. After

all, The Treasury will be busy financinghuge budget deficits at the same time

and will not be happy having to payhigh real interest rates.

Government industrial policies that pick the winners andlosers and constrain domestic and foreign competition

always increase costs and make it harder to controlinflation.

The entitlement welfare state must be limited to what the

nation can afford. Samuelson reviews the bleakalternatives available. However, the most daunting

problem is the refusal of government to even confront theentitlement problems it has created.Globalization must no longer be used as a scapegoat forthe economic and financial problems we create for

ourselves. It is domestic productivity that has reducedmanufacturing jobs, and this is a good thing.

Manufacturing in the U.S. has doubled in the last quartercentury even as manufacturing employment has declined.The increase in inequality has been far more due to the

growth of domestic services, especially financial services,than globalization.

The limited capacity to deal with global warming withpresent day technology must be faced. Any diminution of

greenhouse gases in advanced nations will be swamped bypopulation and economic growth in developing nations.


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Proponents are delusional in their expectations concerningthe ease of shifting to renewable energy sources and the

ability of "green" jobs to make up for job losses elsewhereas green policies raise costs. The optimistic projectionscome from computer-driven econometric models, butsearching econometric models for projections is themodern day equivalent of searching for omens in the

entrails of a pig. Corn ethanol is just one example of thedisasters that can be expected.

Reagan and

Volcker austerity

"constituted the

single most

beneficial act of

economic policy in

the past half

century."

Intentional denial of reality characterizes global warmingpolicy as well as entitlement policy and much more of ourpolitical approach to economic policy.

"Our politics seem predisposed toward denial. Wewon't admit the inconsistence, conflicts andsimplicities of many appealing goals. We strive for

the impossible and ignore the obvious."

There is an eternal political conflict between long run economic

benefits and short term economic pain that all to often isresolved in favor of avoiding the short term pain. There is aneternal political conflict between short term benefits that

produce long term pain that again is often resolved in favor of

grabbing the short term benefits.

"Here, we encounter a powerful parallel withdouble-digit inflation. It took hold because the

policies that produced it were initially so

appealing--the first effect was a boom--and thepolicies to reverse it were unappealing. What wasremarkable about the Volcker-Reagan policies isthat they defied the standard political logic. All theadverse consequences -- high unemployment, lost

profits -- were up front. All the benefits wereindeterminate and lay in the hazy future. Theiractions constituted the single most beneficial act of

economic policy in the past half century. But at thetime, what they were doing was highly unpopular,

even if most Americans deplored inflation andwanted government to get rid of it." (Will Obamaand Bernanke or his successor be able to perform aswell?)

The business cycle

is both inevitable

and essential to the

nation's market

economic systemand continuing

prosperity.

An evaluation of future economic prospects is provided by

the author at the end of this book. He dutifully provides both apessimistic and an optimistic scenario. In other words, he doesn't

have a clue.&However, one thing he sees clearly and gets clearly right.

Perfect stability is unattainable, and policies designed to achieveit will increase instability by interfering noxiously with marketfunctions. The business cycle is both inevitable and essential tothe nation's market economic system and continuing prosperity.


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Documents

Samuel Son, Great Inflation, 1970s Inflation, Volcker, Reagan, Keynesian Policies, Monetary Policy, Entitlements