Inflation is now running at the unreasonable rate of 7 percent per year. In the bad old days of the 1970s and early 1980s, consumer price increases were regularly in the double digits. Inflation was 14% in 1980. Standard explanations of what caused and ended the Great Inflation were misplaced from the start. An essential step in understanding our inflation problem today is to clarify the causes of the major problem, the inflation of the “stagflation” era.
Pretty much for most of history, the money of the world has been on some kind of precious metal standard. Gold and silver coins or monetary or credit instruments redeemable in gold or silver represent the lion’s share of world monetary history, say 5,000 years. There were exceptions and flouters in many cases, etc., but the rule prevailed. This whole civilizational era ended in 1971. That’s when the United States stopped for good buybacks of the dollar in gold, causing all other major currencies to float, not to fix the rates exchange against gold or something else. The last 51 years have been unique in world monetary history.
We are done with what caused the Great Inflation of the 1970s. The abandonment of gold and fixed exchange rates are the cause. When there has been a grand global monetary order characteristic of civilization for thousands of years, and this era comes to an abrupt end, a period of price discovery will ensue during which markets will try to determine the value of the cash. This period of dollar price discovery was the inflation era of the 1970s and early 1980s. It’s a wonder most of it lasted only ten years.
The discovery of prices after the United States withdrew the dollar from gold is the complete story of the Great Inflation of the 1970s. To say otherwise is to engage in shocking revisionism. Can a currency leave the monetary standard of the ages and not see itself depreciate? This is nonsense. Therefore, 1971 brought about the 1970s.
As for alternative explanations, in the newspapers it has become a cliché that money supply statistics from the 1970s are commonplace. If the Fed were too accommodative, the monetary measure M1 failed to show anything unusual. As for interest rates, they hovered near Irving Fisher’s inflation premium, again unremarkable. Price-cost and price-wage spirals? An impossibility in a global economy integrated under the law of one price. And OPEC raised oil prices because of the devaluation and depreciation of the dollar, not the other way around, as is both obvious and well documented.
The United States abandoned gold in 1971 and then experienced 150% inflation. This assertion is sequential and causal according to the ages of history while the other explanations play post hoc fallacy, proper. The dollar depreciated after its issuer cashed in on a historical monetary standard. That is all currencies do in such circumstances.
Price discovery subsided with the Reagan-era series of tax rate cuts that began in 1978. The tax rate cuts bolstered demand for dollars for real economic purposes and slowed inflation. While inflation under gold was traditionally zero, after 1982 it was a quarter of the level of the long-term Great Inflation.
But Paul Volcker. If there had been no reduction in tax rates after 1978, it is unclear how monetary policy by the Federal Reserve might have mattered. Huge tax rate cuts are what happened, and the dollar’s decline stopped for good as they came in. Volcker himself understood that the massive explosion in real economic demand for money once tax rate cuts moved out of their legislative repeal danger zone in 1982 was the foundation of his monetary policy. (I wrote about this with Arthur Laffer here.)
In 2022, we had the fear of 7% inflation and we are preparing for more. The search for the causes of the new inflation must above all raise a question: what about the global monetary order? The answer is as clear as it is disturbing. Potential creative destruction is coming. Creative destruction via the technological revolution, over the past generation, has completely redefined and made its way with major industries such as publishing, communication, retail and entertainment and is poised to make even in transport, energy and education. The prospect of creative destruction via technology is a daunting and very real thing for all industries.
Since Bitcoin’s inception in 2009, a creative destruction challenger to the given monetary order has emerged from the womb of an ingenious creator. This first “cryptocurrency” was ridiculous and humble at first, but now crypto, with all its gyrations and quirks, is a trillion dollar phenomenon. The markets understand that in the blink of an eye, or ten years from now, it could be a $500 trillion phenomenon. In this scenario, the dollar and other sovereign currencies will be irrelevant.
Bitcoin and crypto aside, creative destruction is the thing to focus on. The administration likes the monetary system we have. The Federal Reserve, the International Monetary Fund, and academic economists assume that it is normal and rational, even enlightened, and work to serve it. Fed vice-presidential nominee Lael Brainard will make her fight against inflation the top priority, we heard last week in Congress.
The people as a whole, those of the vox populi, and more than the deplorables of Trump, have always hated fiat money and felt the fall of gold from it in 1971. When the unanalyzed will of the people aligns with the strength of business and technology creativity, the established way of doing things must be set aside or fly away. The odds that sovereign fiat money will face creative destruction in the mid-decades of the 21st century are not good. Therefore, the market began its process of discovering dollar prices. The sign is inflation at 7%.
NB: On the Laffer Center website we are increasing our content on the great monetary debates of the 1960s, 1970s and 1980s. They are discussed in my recent delivered The emergence of Arthur Laffer: the foundations of supply-side economics in Chicago and Washington, 1966-1976.