Hold On There Volcker Fans, Don’t Forget The Past
Nov 17th, 2008 | By Andy Carpenter | Category: Financial NewsRumours continue to circulate that former Fed Chairman Paul Volcker will be Obama’s Treasury or Fed chief. Volcker’s hardline anti-inflation stance makes him an exciting prospect for Greenspan/Bernanke critics. But Andrew Carpenter says we should also remember the painful recessions that Volckers’ interest rate hikes induced…
This from Investor’s Daily Edge
Some people – even fellow IDE contributors – think Paul Volcker should be the next Secretary of the Treasury… even Chairman of the Federal Reserve.
A non-scientific survey leads me to believe the majority of these Volcker fans were not adults between 1979 and 1987… heck, I suspect most were in diapers or not even here yet… you know, that gleam in daddy’s eye stuff.
Because, as you’ll remember, those were the years when, as Chairman of the Federal Reserve, Volcker twice purposely sent the country into deep recessions.
The other thing I suspect is that many of today’s Volcker-ists are young goldbugs… people who really don’t care what happens to anyone or anything as long as their precious metal goes up.
Volcker is a legend to these people.
You see, back in the 1970’s when he chaired the Fed, Volcker’s attempts to use interest-rate increases to slay inflation backfired. It was met with a great deal more inflation. But, in February 1980, with the Fed funds rate at 14%, gold hit a then all-time high of $875 an ounce.
Goldbugs dined out for 25 years on that.
But, while he made a few people happy, it was Volcker’s three-year experiment with Milton Freidman’s theories on monetarism that left a real mark (scar) on the US.
Instead of targeting the Fed funds rate, Volcker tried to fight inflation by strangling the dollar’s availability. The results were disastrous.
The problem was that even though inflation is a monetary phenomenon, as Friedman noted, in the late 1970s the majority of physical dollars resided outside the 50 states (they still do), so attempts to control the quantity of dollars within the US were bound to fail.
Worse, given the Fed’s efforts to control money rather than rates, the Fed funds rate bounced wildly on a daily basis. That meant businesses and farmers faced an impossible task of trying to raise capital without knowing how much they would actually owe.
Credit became impossible… either to compute or afford.
In the end, however, Volcker’s policy ultimately did slay inflation. You see, double-digit interest rates led so many businesses to fail that millions of people lost their jobs…thousands of family farms went under.
People without money don’t spend – inflation solved.
Had you lived through this, Paul Volcker would be the very last man you’d want President-elect Obama to name to a cabinet position.
Oh, and by the way, gold was back down to about $300 an ounce by mid-1982… talk about whipping inflation!
Source: Hold On There Volcker Fans, Don’t Forget The Past
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Hey, there are so many contradictions in IDE’s analysis. First, RAISING interest rates doesn’t CAUSE inflation. Second, IDE is suggesting that “goldbugs” are Volcker fans because they want the price of gold to go up, yet Volcker is faulted for having SAVED the dollar by RAISING interest rates. That doesn’t even make sense.
Look, us “goldbugs” tend to be so beause we recognize the DANGERS of inflation. That the price of gold goes up is NOT something we cheer over. Certainly, we don’t like anti-market moves that artificially hold the price of gold down in order to obfuscate the dollar’s demise. But we remember that it isn’t that the PRICE of gold is going up. It isn’t becoming more valuable, just like houses weren’t becoming more valuable. When it takes more dollars to get gold that is because the value of the dollar is going DOWN.
We are “goldbugs” in order to PROTECT ourselves from what Greenspan and Bernanke have done. Nobody would be more happy than myself if gold were to drop back down to $20 an ounce (i.e., around what it was when the Federal Reserve was first established.)
If low interest rates are so awesome, why not fix their price at 0%, giving free credit for all borrowers? The answer is very simple. No one would supply credit at a 0% rate. It's all risk and no reward.
The reason our rates can even approach 0% without a vanishing supply of credit is because the government, via the FED, creates loanable money out of thin air. In other words, even if no one saved a penny and spent 100% of every paycheck on consumer goods, there could still be credit available at 0% interest.
But let's explore the implications of this. First off, credit would no longer be real credit. Real credit would mean someone produced something and did not consume it. IE – they saved. If no one is actually saving, credit is not access to saved goods; it is nothing more than new funds that must compete against existing funds to secure goods. This will reflect itself in price inflation, which will result in the market demanding higher nominal interest rates. Otherwise the real rates would be negative. To maintain low interest rates, the government must create ever-greater amounts of new loanable funds.
As price inflation gets ridiculously high and real interest rates remain negative, individuals are forced to find new ways of saving, an essential means of economy. Without saving, everything you produce must be immediately traded or consumed. They can't save in money, because inflation taxes the purchasing power of money too quickly.
Thus, they look to various assets. Real estate and corporate stocks are frequent choices, and not coincidently known for their frequent speculative bubbles.
But we can even go further than the asset bubbles. Eventually, too much money-creation leads to hyperinflation, where individuals seek to exchange money for any real goods as quickly as possible. This basically leads to a barter economy, barely above primacy.
Of course, liberals don't think these things through.