Inflation is now running at the unconscionable rate of 7 percent per year. In the bad old days of the 1970s and the early 1980s, consumer price increases were regularly in the double digits. Inflation was 14 percent in 1980. Standard explanations of what caused, and ended, the Great Inflation have been misplaced from the outset. An essential step in understanding our inflation problem today is getting clear about the causes of the big one, the inflation of the “stagflation” era.
Roughly for most of history, the world’s money has been on some sort of precious-metal standard. Gold and silver coins or currency or credit instruments redeemable in gold or silver—this accounts for the lion’s share of world monetary history, call it 5,000 years. There were exceptions and flouters in many instances, etc., but the rule prevailed. This whole civilizational epoch came to an end in 1971. That is when the United States stopped for good redemptions of the dollar in gold, compelling all other major currencies to float, to be un-fixed in rates of exchange against gold or anything else. The last 51 years have been unique in world monetary history.
We have finished with what caused the Great Inflation of the 1970s. Going off gold and fixed exchange rates caused it. When there is a grand overarching monetary order characteristic of civilization for thousands of years, and that epoch sharply ends, a period of price discovery will ensue in which markets try to determine what currency is worth. That period of price discovery for the dollar was the inflation era of the 1970s and early 1980s. It is a wonder that the major part of it was only ten years.
Price discovery after the United States took the dollar off gold is the full story of the Great Inflation of the 1970s. To say otherwise is to indulge in shocking revisionism. A currency can go off the monetary standard of the ages and not see itself depreciate? This is an absurdity. Therefore, 1971 caused the 1970s.
As for the alternative explanations, in the journals it has become a cliché that money supply statistics from the 1970s are unremarkable. If the Fed was too loose, the M1 money measure fails to show anything unusual. As for interest rates, they kept close to the Irving Fisher inflation premium, again unremarkable. Cost-push, wage-price spirals? An impossibility in an integrated world economy under the law of one price. And OPEC raised petroleum prices because of dollar devaluation and depreciation, not vice versa, as is at once obvious and fully documented.
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The United States went off gold in 1971 and then had a 150 percent inflation. This statement is sequential and causative according to ages of history while the other explanations play the post hoc, proper hoc fallacy. The dollar depreciated after its issuer cashiered a historic monetary standard. That is all currencies do in such circumstances.
The price discovery abated with the series of Reagan-era tax-rate cuts that began in 1978. Tax-rate cuts enhanced the demand for the dollar for real economic purposes and slowed the inflation to a crawl. Whereas under gold inflation was traditionally nil, after 1982 it was a quarter of the Great Inflation level for the long term.
But Paul Volcker. Had there been no tax rate cuts after 1978, it is unclear how any monetary policy from the Federal Reserve could have mattered. Enormous tax rate cuts are what did happen, and the dollar’s decline arrested itself for good as they came in. Volcker himself understood that the massive burst in real economic demand for money once the tax-rate cuts emerged out of their legislative-repeal danger zone in 1982 was the grounds for his monetary policy. (I wrote about this matter with Arthur Laffer here.)
In 2022 we have had the fright of 7 percent inflation and are bracing for more. Searching for causes of the new inflation should prompt one question above all: what is going on with the overarching monetary order? The answer is as clear as it is ominous. Prospective creative destruction is coming to it. Creative destruction via the tech revolution, over the last generation, has completely redefined and had its way with such major industries as publishing, communication, retail, and entertainment and is rapidly about to do the same in transportation, energy, and education. The prospect of creative destruction via tech is a fearsome and utterly real thing for all industries.
As of Bitcoin’s creation in 2009, a creative-destruction challenger to the given monetary order peeped out of an ingenious creator’s womb. This first “cryptocurrency” was ludicrous and humble at first, but now crypto for all its gyrations and oddity is a trillion-dollar phenomenon. Markets understand that in the blink of an eye, or in ten years, it could be a $500-trillion phenomenon. In that scenario, the dollar and other sovereign currencies will be irrelevant.
Setting aside Bitcoin and crypto, creative destruction is the thing to focus on. Officialdom loves the monetary system we have. The Federal Reserve, the International Monetary Fund, and the academic economists assume it is normal and rational, enlightened even, and address themselves to servicing it. Fed vice chair nominee Lael Brainard is going to make her top priority wrestling down inflation, we heard last week in Congress.
The people at large, those of the vox populi, and more than just the Trump deplorables, have always utterly detested fiat money and resented the dropping of gold in 1971. When the unanalyzed will of the people lines up with the force of business and tech creativity, the established way of doing things must stand aside or get blown away. The chance that fiat sovereign money will face down creative destruction in the middle decades of the twenty-first century is not good. Therefore, the market has begun its process of price discovery of the dollar. The sign is inflation at 7 percent.
N.B.: On the Laffer Center’s website we are increasing our content on the great monetary debates of the 1960s, 1970s, and 1980s. They are discussed in my recent book The Emergence of Arthur Laffer: The Foundations of Supply-Side Economics in Chicago and Washington, 1966-1976.