Currency Wars_ The Making of the Next Global Crisis - James Rickards [50]
In the eyes of many, it was a world gone mad. A new term, “stagflation,” was used to describe the unprecedented combination of high inflation and stagnant growth happening in the United States. The economic nightmare of 1973 to 1981 was the exact opposite of the export-led growth that dollar devaluation was meant to achieve. The proponents of devaluation could not have been more wrong.
With faith in the dollar near the breaking point, new leadership and new policies were desperately needed. The United States found both with the appointment of Paul Volcker as chairman of the Federal Reserve Board by President Jimmy Carter in August 1979 and the election of Ronald Reagan as president of the United States in November 1980.
Volcker had been undersecretary of the Treasury from 1969 to 1974 and had been intimately involved in the decisions to break with gold and float the dollar in 1971–1973. He was now living with the consequences of those decisions, but his experience left him extremely well prepared to use the levers of interest rates, open market operations and swap lines to reverse the dollar crisis just as he and Arthur Burns had done during the sterling crisis of 1972.
As for inflation, Volcker applied a tourniquet and twisted it hard. He raised the federal funds rate to a peak of 20 percent in June 1981, and the shock therapy worked. Partly because of Volcker, annual inflation collapsed from 12.5 percent in 1980 to 1.1 percent in 1986. Gold followed suit, falling from an average price of $612.56 in 1980 to $317.26 by 1985. Inflation had been defeated and gold had been subdued. King Dollar was back.
Although Volcker’s efforts were heroic, he was not the sole cause of declining inflation and a stronger dollar. Equal credit was due to the low-tax and deregulatory policies of Ronald Reagan. The new president entered office in January 1981 at a time when American economic confidence had been shattered by the recessions, inflation and oil shocks of the Nixon-Carter years. Although the Fed was independent of the White House, Reagan and Volcker together constructed a strong dollar, implemented a low-tax policy that proved to be a tonic for the U.S. economy and launched the United States on one of its strongest periods of growth in history. Volcker’s hard-money policies combined with Reagan’s tax cuts helped gross domestic product achieve cumulative real growth of 16.6 percent in the three-year span from 1983 to 1985. The U.S. economy has not seen such levels of growth in any three-year period since.
The strong dollar, far from hurting growth, seemed to encourage it when combined with other progrowth policies. However, unemployment remained high for years after the last of the three recessions ended in 1982. The trade deficits with Germany and Japan were growing as the stronger dollar sent Americans shopping for German cars and Japanese electronics, among other goods.
By early 1985, the combination of U.S. industries seeking protection from imports and Americans looking for jobs led to the usual cries from unions and industrial-state politicians for devaluation of the dollar to promote exports and discourage imports. The fact that this policy had failed spectacularly in 1973 did not deter the weak-dollar crowd. The allure of a quick fix for industries in decline and those with structural inadequacies is politically irresistible. So, under the guidance of another Treasury secretary from Texas, James A. Baker,