Seven Crashes, page 22
The most extensive intellectual case for protectionism was made in Cambridge—the home of Keynes and Keynesianism. The Department of Applied Economics, and especially its director, Wynne Godley, a talented and cultured man (he had been the principal oboist at the Royal Opera House, Covent Garden), insistently argued the need for tariffs and trade protection. In 1975, the department’s Economic Policy Review announced that “there seems now to be no way of obtaining simultaneously an improvement in the current balance and keeping unemployment below one million other than by introducing some form of import restriction.”14 As Godley later put it, the boom of the 1960s had sent the wrong signals: “People were misled by the fact that in the boom periods money and jobs were easier to find by selling foreign goods than by manufacturing them for ourselves.”15 His colleague Francis Cripps explained: “In order to get the system growing again, you’ve got to find some way of shifting the balance of advantage so that the people who need growth most can start to gain somehow in their share of trade. Then the whole trading system can take off again.”16 The idea was to grow capacity very quickly behind a protectionist curtain. This was the 1976 recommendation: “If any viable arrangement can be reached which removes the balance-of-payments obstacle to future growth of demand, the British economy should now be capable of a period of very fast growth (by the standard of past performance) at a sustained rate of 5% a year or more for many years to come. This would provide the opportunity for a transformation of industry and the economy in which the critical structural problems existing today could be resolved.”17
This extreme advice was not heeded. Indeed, by the early 1980s, after the second oil shock following the Iranian Revolution, the Cambridge view shifted to a focus on the international system as a whole, and an argument that higher oil prices, and indeed commodity prices in general, would be a way to promote a new sort of growth: “very high world oil prices would provide a stronger inducement to developed countries to reduce their energy consumption and would help a wide range of countries to develop less accessible oil reserves and other natural energy resources.”18
As the cost of imported goods increased, governments did not want to force an adjustment and compress wages and incomes. A common historical interpretation holds that the Federal Reserve was bullied by Richard Nixon, and later by Jimmy Carter, to push inflation. Edward Nelson’s recent wide-ranging study of Milton Friedman and the U.S. monetary debate refutes that interpretation. Fed Chair Arthur Burns, a man of impeccable monetary orthodoxy, and an early teacher and a friend and a father figure of Friedman, consistently insisted that the Fed was determined to prevent a new inflationary spiral. But he had a mistaken theory of how inflation arose. He was confident that he would succeed because price and wage controls—which he advocated—would control the wage-push effect that might be generated by a onetime shock. There was also a measurement issue, in that the Fed based its assessments on the room for expansion (or the output gap) on values that turned out to be substantially larger than those calculated later using revised values.19 Until 1981, the Fed did not respond to inflation by increasing interest rates sufficiently to keep real rates (and expected future rates) positive.20 The Fed thus went into the Great Inflation of the 1970s with a wrong doctrine, and Friedman built his reputation on his prediction of a bad inflationary outcome. The inflation unleashed by the Fed was destabilizing, and it also—especially in the later 1970s—undermined the role of the dollar as an international currency.
At the outset of the inflationary development, asset prices (notably stock prices) rose, but as the realization of the inflationary process sank into market psychology, the markets sputtered after 1972 in the United States and the UK. By contrast, there were dramatic surges in Japan and, later and more modestly, in Germany (see Figure 5.3).
In Europe, especially in France and Germany, inflation was understood largely as imported from the outside, through the international monetary system. In the 1960s, French policy-makers and theorists had attacked the role of the dollar in the international monetary system: President Georges Pompidou pressed Finance Minister Valéry Giscard d’Estaing to explain to the IMF Annual Meeting that “you cannot set watches to a defective clock.”21 German economists such as Egon Sohmen saw inflation as imported, and the critique was taken up vigorously by the influential German central bank, the Bundesbank.
In May 1973, the Bundesbank saw an opportunity to end the fixed exchange link with the dollar and embark on a course of monetary control. Its move was not welcomed by all Germans. The banking sector feared that there would be bank failures; exporting businesses worried about exchange-rate appreciation. But the central bank persisted. From 1974, the Bundesbank operated with a target range for central bank money, a narrow measure of the money supply, which it saw as a way of communicating an appropriate inflation goal to markets, and to the parties in coordinated wage bargaining processes. Later, with much lower rates of inflation than the United States, and lower interest rates in consequence, Germans argued that the initial success allowed them to treat the oil price increase that followed later in 1973 as a genuinely one-off event, accommodate it, and in consequence experience a milder version of the general world downturn in 1975.22
Figure 5.3. Stock market indices, 1969–1980 (1969 = 100) (Source: Calculated from Global Financial Data)
The different responses figured prominently in a debate about the competence and effectiveness of governments. The unsuccessful attempts to deal with the energy question and the price inflation question through controls discredited the leaders who presided over those strategies. In the United States, President Gerald Ford became unfairly a figure of fun: someone who could be presented in late-night comedy programs as a man who had played too much football at high school, or who couldn’t walk down the street and at the same time chew gum (there were also much cruder varieties of the jibe). His successor, Jimmy Carter, looked even more hapless. In a dramatic moment of introspection, he canceled a scheduled Independence Day speech in 1979 and went instead to Camp David for ten days, where he invited Americans from all over the country to present the president with their honest views. Then he presented the outcome in a televised address on July 15: it became known as the “crisis of confidence” speech, or also as the “malaise” speech (though Carter did not use that word). He started with the brutal criticism: “This from a southern governor: ‘Mr. President, you are not leading this nation—you’re just managing the government.’” His lower lip then trembled. He cited others: “This was a good one: ‘Be bold, Mr. President. We may make mistakes, but we are ready to experiment.’” The “crisis of confidence” was striking “at the very heart and soul and spirit of our national will. We can see this crisis in the growing doubt about the meaning of our own lives and in the loss of a unity of purpose for our nation. The erosion of our confidence in the future is threatening to destroy the social and the political fabric of America.”23
The initial reaction to this speech was enthusiastic, and opinion polls showed a widespread appreciation of the frank reckoning. Once the dust settled, however, the frank avowal defined Carter as a leader who had lost control. And that was the theme that dominated the 1980 presidential campaign, with many holding up “ABC” signs: Anyone But Carter. The eventual Republican challenger, Ronald Reagan, made very effective use of the “malaise” theme. Inflation provided the key to the indictment—it had reached 18 percent at the beginning of 1980, as Reagan pointed out in a decisive televised debate with Carter: “he has blamed the people for inflation, OPEC, he has blamed the Federal Reserve system, he has blamed the lack of productivity of the American people, he has then accused the people of living too well and that we must share in scarcity, we must sacrifice and get used to doing with less. We don’t have inflation because the people are living too well. We have inflation because the Government is living too well.”24 Politicians generally attacked inflation, and at the same time did not know what to do about it, as disinflationary courses looked hard and unattractive: and the combination of handwringing and an absence of ameliorative policies made them look ineffective.
The British government looked even more incompetent, because of the heavy reliance of both Conservative and Labour administrations on price and wage controls. In 1974, Conservative Prime Minister Edward Heath, after bitter struggles with unions (in particular the coal miners) that shut down the country, called a premature general election to resolve the question “Who governs Britain?” The electorate rejected him. The Labour government that replaced Heath’s also worked with wage and price controls. In both the Conservative and Labour guises, wage guidance and controls involved impossible choices. Were nurses more valuable than teachers, policemen than coal miners? The process of making awards set off distributional conflicts, and also ratcheted wages up as one group pointed to another settlement and claimed that they needed more. The temporal spacing of settlements created the possibility of leapfrogging, and that increased discontent and heightened politicization.
By 1976, a currency crisis developed as UK costs exploded. Chancellor of the Exchequer Denis Healey turned back from Heathrow Airport, where he was supposed to be flying to the annual IMF meeting, in order to manage the urgent domestic crisis. Later, in the winter of 1978 –1979, a “winter of discontent” with strikes and shortages, garbage piling up uncollected in the streets, and bodies waiting for burial, Prime Minister James Callaghan returned, with a sun tan, on January 10, 1979, from an international meeting in the Caribbean (Guadeloupe) and was misquoted when he landed in a phrase that became the obituary for his government, and indeed for the old Labour Party: the popular tabloid the Sun ran as its banner headline “Crisis? What Crisis?” Callaghan’s words were in fact: “I don’t think other people in the world will share the view that there is mounting chaos.” He stated that the mounting chaos interpretation was a “rather parochial view.”25 Callaghan in the end was deeply depressed: he felt he had been bitterly let down by his own side, by the trade union movement to which he had devoted his political life.26 The devastating pun, devised by the advertising agency Saatchi & Saatchi, that drove the Conservative election campaign was “Labour isn’t working.”
It wasn’t just parties and governments that weren’t working. Capitalism also looked as if it had failed. Heath branded Tiny Rowland of Lonrho, a buccaneering maverick who had pushed his company into wild expansion in Africa, as the “unacceptable face of capitalism.” Rowland, born to German parents in a First World War internment camp in India, as a white Rhodesian farmer moved on to bridge “the commercial gap between the end of the British empire and the rise of the international company.”27 Lonrho had pushed a dramatically expensive expansion project in South Africa, the opening of a new mine, Western Platinum, and had betted on volatile commodity markets. In 1973 the board tried but failed to expel him. He then went on to buy a major British newspaper, the Observer, in the hope of generating better publicity.
Italy and Germany had their own version of malaise, “lead years” (anni di piombo, bleierne Zeit), driven by a constant threat of terrorism. In Germany the threat mostly came from the leftist Red Army faction, but it was more complex in Italy, where there was both neofascist terrorism and the activities of the Brigate Rossi, with rumors of the involvement of the intelligence services in both. The Italian prime minister from 1974 to 1976, Aldo Moro, the Christian Democrat who tried to build a coalition of stability with the Communist Party, was kidnapped by the Brigate Rossi and killed after fifty-five days as a hostage. Both Italy and the UK required an IMF package negotiated in 1977–1978 to impose some external discipline.
By contrast with the British and Italian leaders, Chancellor Helmut Schmidt in Germany looked more firmly in control. But he was consistently depressed about the viability of democracy and the threat that the Bonn Republic (West Germany) would be like Weimar, irritated by the opposition in his own party, and on several occasions seriously contemplated resigning as chancellor. People called him “The Doer” (Der Macher). He had a reputation for competent and unideological management from his time as a minister in the city-state of Hamburg during a great flood in February 1962. He derided promises and big visions: “whoever has visions should go to the eye doctor.” In April 1974, shortly before he became chancellor, Schmidt composed a memorandum titled “Ökonomisches Papier” (Economic Paper) warning of the consequences of the oil shock and inflationary international currency developments. He feared that “democratic structures within the industrial societies would break up,” especially in countries that needed to export in order to earn the currency necessary to pay for imports: Japan and Europe. This projection was “not an apocalyptic vision but a real possibility for the world economy.” As chancellor, Schmidt constantly pushed the need to “stabilize national economies and stabilize the world economy by international action.” He began to talk of a need for “global economic governance” (Weltwirtschaftsregierung).28 In a long interview with Spiegel he explained that in economic matters, Germany was a Weltmacht, a world power. He also emphasized, talking about himself in the third person, that “the current chancellor has occupied himself very intensively over the last three years with world economic and monetary problems and in that sense has brought fortunate preconditions for a special judgment in this area.”29 He saw himself as a “world economist” (Weltökonom), advising American presidents in a rather paternal way.30 The investments of the oil producers in other countries, including in Germany, where oil countries started to invest in the German automobile industry, was a good way of bringing the Arab leaders to “realize what they were doing.” “People think that the world is ending if foreigners buy stakes in German industry: that isn’t the case.”31
Japan experienced its own version of the generalized spread of doubt about politics. The early 1970s was the era of crazy prices (kyoran bukka); in 1974, consumer prices rose by 23.2 percent. The government of Kakuei Tanaka, which had promised an ambitious infrastructure investment and development plan (the Japanese Archipelago Rebuilding Plan), collapsed in 1974 amid corruption scandals. His successor, Takeo Miki, was uncorrupt and popular with the public, but lost the support of his own party. The hesitations of politics, however, were compensated by coordinated action by the big business associations, Keidanren and Nikkeiren, to modernize and transform Japan’s economy.
The 1970s was thus a decade of diverging views about inflation in the major industrial countries: Germany looked like an outlier, with only 7.0 percent in 1974 (Italy was at 19.2, the UK at 15.9 percent, the United States at 11.0). Even in stability-oriented Switzerland, the inflation rate was higher than in Germany. The divergence only started to change with a dramatic reorientation of U.S. policy, which followed from an intellectual reassessment of monetary policy, but also from the sense that the weakness of the dollar undermined the U.S. position in the world. The United States–United Kingdom axis turned from being at the top of the international range of inflation outcomes to a center of stability, but the disinflation was a long and painful process.
On October 6, 1979, the new chairman of the Federal Reserve Board, Paul Volcker, announced a reorientation of policy “emphasizing the supply of reserves and constraining the growth of the money supply through the reserve mechanism” in order to obtain “firmer control over the growth in money supply in a shorter period of time.” The nominal federal funds rate target was raised sharply from around 11 percent in September 1979 to around 17 percent in April 1980. The result was a sharp recession, to which the Fed responded with a cut in rates. In 1981, there was a new tightening, and another recession, after which the Fed brought the nominal federal funds rate down, from 19 percent in the summer to the 14 percent range by the end of the year. In the summer of 1982, there was a further reduction, to around 10 percent.
The UK, under the new government of Margaret Thatcher, turned in March 1980 to a Medium Term Financial Strategy in order to squeeze out inflation, with the specification of a series of declining target ranges for the major monetary target (£M3) over a four-year period on the principle that “control of the money supply will over a period of years reduce the rate of inflation.” Both the American and British approaches initially prompted widespread criticism, not least because of surges of monetary growth that occurred in the process of disinflation. For Britain, for instance, from January 1980 to July 1981, the main money supply measure, £M3, grew by 34 percent. Later Volcker gave a retrospective view of the successes of central banks and monetary policy in promoting stabilization, explaining that “the record is quite clear that, despite varied efforts here and abroad, central banks did not discover any monetarist holy grail. In the end, no country in which inflation had become embedded seemed able to moderate that inflation without a painful transitional period of high unemployment, recession, and profit squeeze.”32
Volcker became disenchanted with the monetary targeting exercise, especially as the Carter administration ground to a debilitating close and Ronald Reagan won the November 1980 election. In November, the central banker lamented:
