The Great Inflation and Its Aftermath: The Past and Future of American Affluence, by Robert J. Samuelson (Random House, 336 pp., $26)
In conventional telling, postwar American history resembles thermodynamics: action and reaction ad infinitum. The dull Eisenhower years gave way to the optimism of the John F. Kennedy and Lyndon Johnson administrations. Student movements (in reaction to the Vietnam War) and race riots of the 1960s exploded into chaos, out of which Richard Nixon emerged, promising order only to give us Watergate. This ushered in the malaise-ridden cardigan presidency of Jimmy Carter, which then propelled Ronald Reagan and conservatism to power. And so on.
President-elect Barack Obama promises deliverance from this combustible cycle. Before he sets out to fulfill this pledge, however, he may want to read Robert Samuelson’s new book. The Great Inflation and Its Aftermath is revisionist history like it ought to be. Samuelson, a Washington Post and Newsweek columnist, downplays some conventional elements, resurrects others long forgotten or ignored, and weaves them all into a compelling—and instructive—narrative.
The book’s title refers to the period from the mid-1960s to the early 1980s, when “inflation was rising from negligible to double-digit levels.” Samuelson’s ambitious argument is that the entire history of the U.S. since 1960 can be viewed through an inflationary lens: “Inflation and its fall shaped, either directly or indirectly, how Americans felt about themselves and their society,” he writes. Everyone fears inflation but few claim to understand it—it differs from what we think of as a “normal” economic shock, like a stock-market crash or a natural disaster. Money is the economic equivalent of blood circulating through the body: we know it’s important, but its ubiquity can obscure its vitality. When inflation stealthily saps the value of money, the consequences become apparent only too late.
This is precisely what happened in the 1970s, when double-digit increases in the consumer price index wrecked asset values, wage gains, and productivity growth. Samuelson sets out to revise the historical misreading that placed blame solely on Middle East wars and corrupt oil sheikhs. If we treat inflation as an outside force that suddenly attacks the economy, he believes, we will combat it with the wrong weapons. The real source is human: “The malaise,” he writes, “was man-made.”
The lesson of The Great Inflation can be summarized in the oft-quoted dictum of John Maynard Keynes:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.
In postwar America, that “defunct economist” turned out to be Keynes himself.
Seemingly the only economist able to provide a compelling explanation and cure for the Great Depression, Keynes saw that a largely self-organizing economy could become stuck at a less-than-optimal equilibrium. Falling demand and supply would reinforce one another. To break this cycle, Keynes recommended that government temporarily step in and stimulate demand through public spending. Such a stimulus appeared to arrive in the form of World War II, but many historians now see the money supply as the saving grace. Just as a tight monetary policy helped turn the 1929 market crash into the Depression, an expansion of credit in the late 1930s helped avoid a renewed depression after the war, which many had anticipated.
Yet the notion that World War II cured the Depression (the rudiment of Keynes’s insight) survived and morphed into Keynesian economics, which, together with new computer models, set the stage for the Great Inflation. President Kennedy brought to the White House a cadre of young economists devoted to this “new economics.” They sincerely believed that they had figured out how to tame the business cycle and use government fiscal policy to ensure permanent expansion and full employment—an obsession, Samuelson argues, that created the inflation.
Samuelson brings a broad indictment against storied economic names: Paul Samuelson (no relation), James Tobin, Robert Solow, and others. Led by Walter Heller, chairman of Kennedy’s Council of Economic Advisers, these economists saw themselves as “public-spirited engineers” who could “fine-tune” the economy. Arthur Okun, a Yale economist who advised LBJ, declared in 1970 that “recessions are now considered to be fundamentally preventable.” Inflation, even monetary policy, counted for little in this new “active economic management” because economists believed in the Phillips Curve, which purportedly demonstrated a mechanical trade-off between unemployment and inflation. Too much unemployment? Push inflation up just a bit. Prices rising too rapidly? Just nudge unemployment up a tad. Never mind that Milton Friedman and Edmund Phelps had already disproved the Phillips Curve’s premise. The mid-1960s economy was humming along, and the economists’ claim of conquest over the business cycle went unchallenged.
That is, until the economy itself intervened. The long postwar expansion crashed and burned in the 1970s. Recessions in 1969–1970, 1973–1975, and 1980 should have undermined the “new economics,” but they only drove economists and policymakers to do more of the same. Richard Nixon pushed full employment as his top economic goal and, in a political game of chicken with Democrats, imposed disastrous wage and price controls. Gerald Ford actually made some effort to address inflation, but the Carter administration, in an almost unbelievable escalation of error, continued to make the same mistakes.
Fiscal and monetary policy had become inverted in importance: most of the economists advising Kennedy and Johnson “regarded Federal Reserve policy . . . as playing a subordinate and supporting role” to fiscal policy. A gradual move away from the dollar-gold standard, culminating in Nixon’s final repudiation of the Bretton-Woods system in 1971, had the unseen effect of loosening limits on credit creation and expansion: “Inflation would no longer control itself. It had to be controlled—and so the ideas, beliefs, motives and behaviors of people charged with controlling it mattered,” Samuelson writes. Unfortunately, those people—officials at the Federal Reserve—became swept up in the all-out push to full employment.
Samuelson’s treatment of the Fed is as unsparing as his treatment of the economists and politicians. The Fed, through “lax money and credit policies,” steered itself into a “political and intellectual cul-de-sac.” Even after Friedman’s groundbreaking work on inflation as a monetary phenomenon, and even after years of rising prices throughout the economy, G. William Miller, who served a brief stint as Fed chairman under Carter, still warned about the “limitations of monetary policy as the main bulwark against inflation.”
So how did the United States escape the maelstrom of rising prices and eroding growth? Only a new set of ideas, promulgated by strong individuals, could break the inflationary spiral. That task fell to Ronald Reagan and Paul Volcker.
Samuelson places great emphasis on psychology, an aspect of Keynes’s work that many Keynesians in the 1960s ignored. Reagan and Volcker succeeded because they attacked the expectations that are the most damaging consequence of inflation. Their efforts had little to do with abstract theory or political dealmaking; Volcker and Reagan, never close, instead formed a “compact of conviction.” Enduring the harshest recession since World War II and the general opprobrium of politicians and business owners, Volcker embarked on a new course (regulating the money supply, not interest rates) and Reagan provided political cover.
Samuelson’s story, then, turns on human tendencies and considerations that Euripides and Sophocles would have readily recognized: “Political ideas often follow the familiar cycle of infatuation and disenchantment. . . . So it was with the pledge to abolish business cycles.” Hubris and overreach, followed by fear and timidity. Inflation receded not because of superhuman acts of brilliance, but through human virtues often lacking in democratic leaders: patience, perseverance, and courage.
Looking forward, Samuelson worries that we have become so acclimated to a world without inflation that disaster awaits: we enjoy “a perplexing prosperity with manifest imperfections.” Undeniably, the conquest of inflation in the early 1980s helped unleash a wave of prosperity, and Samuelson ably documents the ways in which the American economy became more entrepreneurial. Productivity returned as companies were forced to compete on price and quality; the stock market soared with the democratization of finance; regulatory strictures came down. The result was the “Great Moderation”—the recessions of 1990–91 and 2001 were short and mild, and unemployment (until recently) remained low.
Yet critics often deride these gains as Potemkin prosperity. The by-product of increased competition and a more liquid financial system has been greater individual economic insecurity. While today’s economy may offer greater overall stability, Samuelson notes, it provides little comfort for those caught in the downdraft of declining industries. But we tend to romanticize the economy of the 1960s as the zenith of American economic achievement: job stability, predictability, expanding affluence, little friction. This, alas, is a myth. The seeds of that economy’s demise were sown into it, fostered by almost nonexistent foreign competition, the exclusion of large parts of the American population, and, of course, inflationary economic policies.
Samuelson also dismantles a second line of attack on today’s prosperity—income inequality. He points to research showing that changes in household composition explain the widening wealth gap—two-earner marriage is increasingly the real income divide in this country. Other research has shown that, when broken down by the inflation rates that apply to the different goods and services consumed by the rich and poor, inequality—as measured by income statistics—almost disappears. Our economy today isn’t perfect, but neither was the economy of the 1960s. Samuelson worries that the Great Moderation may now have instilled complacency: “We simply do not know whether the economy is self-stabilizing—and, if not, whether government can always stabilize it.”
Samuelson concludes by considering the “future of affluence.” He sees a real possibility of “affluent deprivation . . . a period of slower economic growth that doesn’t satisfy what people regard as reasonable private wants and public needs.” After a brief defense of economic growth as a moral good, he lays out the three main threats to American prosperity. The first is the welfare state, which, although it helps many in need, “now threatens the very economy that supports it.” Second is the private debt burden of Americans, and third is globalization—not in the sense of other countries taking American jobs, but the possibility that it could, like the last great era of globalization a century ago, end in an abyss of violence and instability.
Samuelson seems to believe that the debt burden will work itself out as people adjust to their circumstances. He favors a consumption tax to help finance the welfare state even as we pare it back a bit (for example, by raising the eligibility age for Social Security). His ideas of how to deal with globalization’s potential dangers are mostly boilerplate (adopt common standards, avoid nationalism), and he includes a brief discussion of the challenge of global warming that seems out of place.
Perhaps inevitably, in a book about one specific episode and its prelude and aftermath, The Great Inflation sometimes strains to fit events into its frame of reference. Globalization? Technology? Deregulation? They all come back to inflation. Samuelson recognizes that inflation cannot explain everything, and he attempts to parse out causality. But he only gives a nod to a major source of growth in the 1980s and 1990s: new companies. In 1985, Peter Drucker declared America to be an entrepreneurial economy and chronicled the rise of new industries that, when old-line steel and automobile companies faltered, stood ready to pick up the slack. These were not the high-tech start-ups of Silicon Valley, however. Glance over the 1982 Inc. 500 list, for example, and you will find rather pedestrian businesses that nonetheless achieved remarkable growth (pool cleaning, parking lot management, and stationery, among others). The resurgence of high-growth firms helped the United States fend off the challenge from Japan in the 1980s and outdistance the European Union in the last decade. Falling prices helped, too, of course, but even European countries with low inflation remained mired in high unemployment and low productivity.
Samuelson concludes by pointing out that capitalism’s inherent restlessness is the source of both its prosperity and instability: “Our relentless search for some sensible balance can never reach a permanent resting place. . . . Some economic turmoil is always inevitable, and the very effort to suppress it may bring it about.” The great lesson of The Great Inflation, though, is one that Samuelson himself may not fully recognize. A highly developed market economy achieves order and avoids chaos because, for the most part, individual actions are remarkably well-coordinated. The crucial organizational tool is the price mechanism. In 1945, Friedrich Hayek observed:
The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.
The only way to coordinate such decentralized information is through prices that constantly adjust according to innumerable individuals’ states of knowledge. When prices get distorted, the entire system can break down. The great mistake of the 1960s and 1970s was to believe the conceit that government could actually control and guide economic order. The economy, it turned out, was not a clockwork, and the result was havoc-wreaking inflation. This should be a timeless lesson for all of us, especially presidents-elect. The Great Inflation deserves a spot on Barack Obama’s bookshelf.