Discussion 2
Reagan Era
a. The Reagan Revolution: Repudiations and Deformations
In truth, these promises were long faded ideological dreams, but the passage of
the Troubled Asset Relief Program (TARP) by a Republican government was the
final, jarring end note. It amounted to a stark repudiation of the Reagan Revolution. It
proved that the great tax and spending cut campaigns of 1981 had not bent the
contours of history in the slightest. They had been a flash in the pan, which twenty-
seven years later illuminated nothing at all. In fact, there was a Reagan-era fiscal
legacy still alive in September 2008, but it was an ironic one which presented itself in
twisted, perverse aspect. Ronald Reagan had spent a political lifetime excoriating
deficits, but the takeaway from his presidency among Republican politicians was that
he had proved the contrary: that deficits don’t matter.
Moreover, during the George W. Bush era this insidious idea became
operational policy. It was embodied in two costly unfinanced wars and two giant tax
cuts which were paid for by massive issuance of treasury bonds. So when the once-in-
a-generation test of the nation’s fiscal mettle came in the midst of the Wall Street
storm, there was no conservative party left to safeguard the gates to the treasury. In
fact, Republican politicians had embraced a dangerous rationalization that weakened
any vestigial fiscal resolve; namely, that deficits were the passive result of an
underperforming economy, not the deliberate consequence of profligate fiscal policy.
Accordingly, the GOP shifted its deficit-fighting efforts to a more pleasant
chore; that is, peddling new tax cut gimmicks to spur “growth.” The implication was
that without constant ministrations from Washington, the nation’s economy would
falter. In the heat of crisis, therefore, the GOP became an easy mark for the Bernanke–
Paulson canard that Wall Street’s long overdue meltdown would pull Main Street
America into a vortex of economic collapse. Republican politicians thus concluded,
anomalously, that issuing a $700 billion blank check would result in lower, not higher,
federal deficits. It was just another variation of the pro-business Keynesianism that
morphed out of the Reaganite tax-cutting religion.
Indeed, over time, Republicans became unwavering adherents to the various
renditions of the supply-side economic doctrine, often referred to as a shibboleth,
which posits that higher economic growth inevitably leads to lower deficits. This
theory, deeply embedded in their economic philosophy, suggests that cutting taxes and
reducing regulation would spur investment, create jobs, and ultimately increase
government revenues through enhanced economic activity. This belief system became
so ingrained that it influenced a wide array of policy decisions, regardless of the
economic context or empirical evidence.
As the financial crisis of 2008 unfolded, this long-standing conviction led
Republicans to quickly rationalize that rescuing Wall Street was not merely a
necessity to stave off economic collapse but also a strategic move to foster economic
growth. They argued that by stabilizing the financial sector, they could prevent a more
severe economic downturn, maintain market confidence, and ensure the continued
flow of credit to businesses and consumers. In their view, these measures would lead
to a swift economic recovery, higher growth rates, and, consequently, increased tax
revenues that would help reduce the deficit over time.
This rationalization took hold despite the significant moral and philosophical
contradictions it entailed. Traditionally, free market proponents and fiscal
conservatives espouse limited government intervention, emphasizing the importance
of letting market forces dictate outcomes. However, faced with the imminent collapse
of major financial institutions and the potential for a widespread economic depression,
many Republicans found themselves endorsing massive government bailouts and
unprecedented fiscal interventions.
The rationale was framed within the familiar narrative of supply-side
economics: if Wall Street's giants could be kept afloat, the benefits would trickle
down to the broader economy. They believed that propping up these financial
behemoths would preserve jobs, protect savings and investments, and maintain
consumer and business confidence. This, in turn, was expected to stimulate economic
growth, leading to higher tax revenues and, ultimately, lower budget deficits.
Furthermore, Republicans pointed to the interconnected nature of the global
financial system and argued that the collapse of major U.S. financial institutions
would have catastrophic consequences not just domestically but internationally. The
fear was that such a collapse would trigger a domino effect, leading to a global credit
freeze, massive unemployment, and severe economic contraction. By intervening
decisively, they believed they were averting a far greater economic disaster.
However, this approach was met with significant skepticism and criticism.
Critics argued that the bailouts effectively socialized losses while privatizing gains,
benefiting the very institutions whose reckless behavior had precipitated the crisis.
They contended that the policy of rescuing Wall Street contradicted the principles of
market discipline and accountability, creating a moral hazard by signaling to financial
institutions that they could expect government support in future crises.
Moreover, the empirical evidence on the effectiveness of supply-side
economics in reducing deficits was mixed at best. While tax cuts and deregulation can
stimulate economic growth under certain conditions, they do not always lead to
increased revenues or reduced deficits. The economic outcomes depend on a variety
of factors, including the overall health of the economy, the structure of the tax system,
and the specific design of fiscal policies.
Despite these criticisms, the belief in supply-side economics remained a
powerful force within the Republican Party. The decision to support Wall Street
bailouts was framed as a pragmatic choice aligned with their broader economic
philosophy. By prioritizing the stabilization of the financial sector, they aimed to
create a foundation for sustained economic growth that would ultimately benefit all
Americans.
In conclusion, the Republicans' steadfast adherence to supply-side economics
led them to rationalize the rescue of Wall Street as a necessary step to ensure higher
economic growth and, consequently, lower deficits. This rationale, deeply rooted in
their economic ideology, underscored their belief in the trickle-down benefits of
supporting the financial sector, despite the significant philosophical and empirical
challenges it posed. The events of 2008 highlighted the complexities and
contradictions inherent in applying supply-side principles to the real-world challenges
of managing a financial crisis.
b. The Reaganite Legends of Fiscal Restraint and Economic Revival
The Reaganite legend begins with the false proposition that the Reagan
Administration stopped the march of “Big Government” and brought a new fiscal
restraint to Washington. Yet after the economy had rebounded and recession-bloated
spending had subsided during Reagan’s second term, federal outlays averaged 21.7
percent of gross domestic product (GDP). That was obviously no improvement at all
on the 21.1 percent of GDP average during the alleged “big spending” Carter years,
and compared quite miserably to the 19.3 percent of GDP recorded during Lyndon
Johnson’s final four years of “guns and butter” extravagance.
Nor had the Reagan Revolution planted any seeds of future fiscal restraint.
During the administration of George H. W. Bush, federal spending averaged nearly 22
percent of GDP—still another presidential record and one that came after the end of
the Cold War and the resulting 15 percent decline in real defense spending. But it was
the second Bush who took Reaganomics to its logical extreme, demolishing
Republican fiscal rectitude once and for all in a fury of “guns and butter,” and tax
giveaways, too. Federal outlays in the final budget of George W. Bush soared to 25
percent of GDP. That was a post–World War II record by a long shot, but even that
figure did not assay the full extent of the Bush fiscal debacle.
Measured in inflation-adjusted dollars (2005$), federal spending increased by
50 percent, rising from $2.1 trillion to $3.2 trillion in only eight years. Accordingly,
just the gain on George Bush’s watch—$1.1 trillion— dwarfed all prior episodes of
profligacy. It was more than the entire $1 trillion federal budget, in the same inflation-
adjusted dollars, posted under what Republican orators had long ago pilloried as
Lyndon B. Johnson’s calamitous “guns and butter” budget of 1968. Republican
apologists have long managed to deny the Reagan fiscal debauch and its (two) Bush
progeny, however, by claiming that the Reagan Revolution worked where it counted:
in reviving the national economy and then causing it to grow smartly for several
decades. The trouble is, that didn’t happen either.
Rather than a permanent era of robust free market growth, the Reagan
Revolution ushered in two spells of massive statist policy stimulation before it finally
ran out of steam at the turn of the century. The first spell of Washington-induced
prosperity flowed from the giant Reagan deficits, the second from the money-printing
and Wall Street–coddling policies of the Greenspan Fed in the 1990s. But the proof
that these were unsustainable bubbles fostered by the state rather than real growth and
prosperity arising from the free market became acutely evident after the turn of the
century. Then another round of Greenspan bubble finance and the George W. Bush
fiscal profligacy converged in a temporary spree of phony prosperity: the domestic
consumption boom and the real estate bubble.
Yet now that these ambitious policies and economic doctrines have gone
resoundingly bust, the stark data reveal a grim reality: the nation's economic
fundamentals have been relentlessly deteriorating for more than a decade. This
prolonged decline is evident across a wide array of economic indicators, painting a
bleak picture of the overall health and sustainability of the economy.
In the aftermath of the 2008 financial crisis, it became increasingly clear that
the supply-side economic policies championed by their proponents had failed to
deliver the promised results. Instead of ushering in an era of robust growth and fiscal
stability, these policies contributed to widening income inequality, stagnant wages,
and a ballooning national debt. The anticipated trickle-down effects never
materialized for the majority of Americans, leaving many struggling to make ends
meet in an economy that seemed to be recovering only for the wealthy and well-
connected.
Unemployment rates, which had spiked dramatically during the crisis,
remained stubbornly high for years, particularly in regions and industries hardest hit
by the recession. While the official unemployment figures eventually improved, they
masked a more troubling reality: a significant portion of the workforce had either
given up looking for work or had been forced into part-time or precarious
employment. Labor force participation rates declined, reflecting a broader
disengagement from the economy and a loss of hope among many workers.
Wage growth, which had been sluggish even before the crisis, continued to lag
behind inflation, eroding the purchasing power of average Americans. Despite
significant gains in productivity, the benefits of economic growth were increasingly
concentrated at the top, with corporate profits and executive compensation soaring
while workers' wages stagnated. This growing income inequality exacerbated social
and economic tensions, contributing to a sense of disillusionment and frustration
among the middle and working classes.
The housing market, which had been at the epicenter of the financial crisis,
experienced a painfully slow recovery. Many homeowners found themselves
underwater on their mortgages, owing more than their homes were worth.
Foreclosures and evictions surged, displacing families and destabilizing communities.
The lack of affordable housing became a persistent problem, with rising rents and
home prices outpacing income growth and making it increasingly difficult for people
to secure stable housing.
In addition to these challenges, the national debt soared to unprecedented
levels as successive administrations grappled with the costs of economic stimulus
programs, bailouts, and ongoing military engagements. The fiscal imbalance raised
concerns about the long-term sustainability of government finances, with mounting
interest payments consuming an ever-larger share of the federal budget. Efforts to
address the deficit through austerity measures often exacerbated economic hardships,
cutting essential services and social safety nets just when they were most needed.
The deteriorating economic fundamentals were also evident in the nation’s
infrastructure, which continued to crumble from years of underinvestment. Roads,
bridges, public transit systems, and water infrastructure fell into disrepair, hindering
economic efficiency and posing safety risks. The lack of investment in critical
infrastructure not only hampered economic growth but also underscored the
government's failure to address the basic needs of its citizens.
Educational outcomes also revealed troubling trends, with significant
disparities in access to quality education based on socioeconomic status and
geographic location. These disparities contributed to a widening skills gap, leaving
many workers ill-prepared for the demands of a rapidly changing economy. The rising
cost of higher education and the burden of student debt further constrained economic
mobility, trapping young people in a cycle of debt and limited opportunities.
Healthcare costs continued to rise, straining household budgets and adding to
the financial pressures on families. Despite significant advancements in medical
technology and treatment, the healthcare system remained inefficient and inequitable,
with many Americans lacking access to affordable care. The economic burden of
healthcare costs exacerbated financial insecurity and limited disposable income,
further dampening consumer spending and economic growth.
Environmental degradation and climate change posed additional economic
risks, with extreme weather events and natural disasters becoming more frequent and
severe. The economic costs of these events, including damage to infrastructure, loss of
productivity, and increased insurance premiums, added to the overall economic
challenges facing the nation.
In summary, the stark data now reveal that the economic fundamentals of the
nation have been relentlessly deteriorating for more than a decade. The lofty promises
of supply-side economics and other ambitious policies have not been realized.
Instead, the reality has been one of stagnation, inequality, and increasing economic
insecurity for the majority of Americans. The need for a comprehensive and
sustainable approach to economic policy has never been more apparent, as the nation
grapples with the long-term consequences of these failed strategies.
Long-term investment has grown by less than 1 percent annually since 2000
and the nonfarm payroll count has hardly increased at all for 12 years. Likewise, the
real incomes of the middle class have fallen back to 1996 levels—even as the
American economy has tumbled into a frightful debt to the rest of the world. In short,
the American economy did not falter due to a mysterious “contagion” in September
2008. It had been heading for a crash landing for the better part of three decades.
c. Triumph of the Warfare State: How the Budget Battle Was Lost
A riotous expansion of the warfare state was foremost among the policy errors
of the Reagan Revolution, and its repercussions have echoed through the subsequent
decades, shaping the political and economic landscape of the United States in
profound and often troubling ways. Under President Ronald Reagan's administration,
there was an unprecedented increase in military spending, driven by a staunch
commitment to combating the perceived threat of the Soviet Union during the final
years of the Cold War. This commitment to a massive military buildup was justified
under the banner of restoring American strength and global preeminence, yet it led to
a host of unintended consequences that continue to challenge the nation.
The Reagan administration's defense budget grew exponentially, with
spending on weapons systems, troop deployments, and military infrastructure
skyrocketing. This surge in military expenditure was partly fueled by ambitious
projects like the Strategic Defense Initiative (SDI), colloquially known as "Star
Wars," which aimed to develop a sophisticated missile defense system. While these
initiatives were intended to bolster national security, they also significantly increased
the federal budget deficit. The rationale was that such spending would deter Soviet
aggression and ensure the United States maintained a superior military edge.
However, this aggressive defense posture came at a steep cost.
The massive allocation of resources to the military-industrial complex diverted
funds away from essential domestic programs. Public investment in education,
healthcare, and infrastructure suffered as more of the federal budget was consumed by
defense-related expenditures. The opportunity costs were substantial, with long-term
implications for American society. The neglect of these critical areas contributed to
the erosion of public services and the widening of socio-economic disparities. Schools
became underfunded, healthcare systems struggled to keep up with demand, and
infrastructure projects were delayed or abandoned, leading to a decline in the quality
of life for many Americans.
Furthermore, the economic strategy of coupling increased military spending
with significant tax cuts for the wealthy, a hallmark of Reaganomics, exacerbated the
fiscal imbalance. The theory was that these tax cuts would spur economic growth by
encouraging investment and consumption, thereby increasing overall tax revenues.
However, the anticipated growth did not materialize to the extent necessary to offset
the lost revenue, leading to burgeoning deficits and a rapidly growing national debt.
The federal government was forced to borrow extensively, which had long-term
implications for fiscal policy and economic stability.
The prioritization of military expansion also had profound implications for
American foreign policy. The United States engaged in numerous proxy conflicts and
military interventions, from Central America to the Middle East, often with
controversial and destabilizing effects. These interventions, justified by the doctrine
of containing communism and promoting American interests abroad, frequently led to
prolonged conflicts and unintended consequences. The invasion of Grenada, support
for the Contras in Nicaragua, and involvement in Lebanon are just a few examples of
the far-reaching impact of this aggressive foreign policy stance.
Domestically, the focus on military buildup contributed to the entrenchment of
the military-industrial complex, a network of defense contractors, lobbyists, and
government officials with vested interests in sustaining high levels of defense
spending. This complex became a powerful force in American politics, influencing
policy decisions and perpetuating a cycle of ever-increasing defense budgets. The
intertwining of economic and military interests ensured that defense spending
remained a priority long after the end of the Cold War, shaping the economic and
political priorities of successive administrations.
Moreover, the emphasis on military prowess and the framing of national
strength in terms of defense capabilities contributed to a culture of militarism. This
cultural shift had wide-ranging effects, from the glorification of military service to the
proliferation of military-style policing tactics within domestic law enforcement
agencies. The societal impacts of this shift are evident in the way American identity
and patriotism have become closely linked with military power.
In conclusion, the riotous expansion of the warfare state stands as one of the
most significant policy errors of the Reagan Revolution. While it may have achieved
its short-term objectives of demonstrating American military strength and contributing
to the eventual collapse of the Soviet Union, the long-term consequences have been
far more complex and problematic. The economic, social, and political costs of this
expansion have been profound, leading to a legacy of fiscal imbalance, underfunded
public services, entangling foreign interventions, and a deeply ingrained military-
industrial complex. This era underscores the importance of balancing national security
needs with sustainable domestic policies and prudent fiscal management.
Within days of Reagan’s taking office, the White House made a historically
devastating mistake by signing over to the Pentagon a blank check known as the “7
percent real growth top line.” This massive injection of fiscal firepower nearly tripled
the annual defense budget from $140 billion to $370 billion within just six years.
More importantly, it fueled powerful expansionist impulses throughout the military-
industrial complex at exactly the wrong time in history.
d. The Great Disconnect: The $1.5 Trillion Pentagon Windfall
The Reagan defense buildup was fraught with budgetary confusion and
disconnects from the very beginning. The quantum jump in five-year defense
spending from the 7 percent top-line plan was not based on one scintilla of bottoms-
up program detail or even a single hour of professional analysis. It stemmed from a
comedy of errors within days of Reagan’s inauguration. It started with candidate
Reagan’s September 1980 “Chicago speech” which outlined a comprehensive
economic and budget program, including a promise of 5 percent annual real growth in
defense.
However, that figure had not been blessed by the campaign’s coterie of neocon
advisors led by super-hawk Senator John Tower, who wanted 8–9 percent increases.
Instead, the 5 percent growth figure had simply been shoehorned into the plan by
Reagan’s chief economic advisors—Alan Greenspan and Marty Anderson. It had been
designed to show that the numbers weren’t impossible—that is, the nation could have
a sweeping across-the-board tax cut, a major military build-up, and a balanced budget,
too, and all by 1983.
A new administration would normally resolve deep military spending
differences through several months of analysis by expert task forces focused on threat
assessments and budget resource trade-offs. On the eve of the inauguration, however,
two developments conspired to eliminate this rational course of action entirely. First,
the Carter administration had been harshly attacked during the campaign for “gutting”
national security, but now its outgoing budget plan proposed to increase real defense
spending by 5 percent annually. That eliminated on the spot any willingness by the
Reagan White House to adhere to its own Chicago speech growth rate.
Even more importantly, the new administration promised to deliver a
comprehensive economic recovery program and five-year fiscal plan by February 18.
That meant that it had less than four weeks to essentially redo the entire federal
budget. With no time to develop any bottoms-up defense plan, we resorted to a
primitive expedient; namely, a single “placeholder” number for total defense spending
for each year of our five-year fiscal plan. The numbers were agreed on during a half-
hour meeting at the Pentagon ten days after the inauguration.
From a national security perspective, these five magic numbers were virtually
content free. Indeed, the two principals at this four-person meeting, the new secretary
of defense and the budget director, knew almost nothing about defense. By the same
token, their two neocon deputies, who had already agreed upon the outcome,
maintained a discreet conspiracy of silence. In truth, the very purpose of the meeting,
to get a defense top line, was an insult to expertise. There were “no charts, no
computer printouts, no color slides, and no colonels with six-foot wooden pointers.”
The only implements on the table were “a Hewlett Packard pocket calculator and a
blank piece of paper.”
Defense Secretary Caspar Weinberger, who had not even studied his defense
brief, observed that Carter’s 5 percent growth plan wouldn’t do and that the 8–9
percent demanded by the Tower group was probably too much. Accordingly, he
proposed 7 percent. I made a few taps on the Hewlett Packard keypad. The largest
five-year defense plan in recorded history was thus agreed upon. But that wasn’t all.
The defense budget was in a state of turmoil and rising rapidly owing to continuous
add-ons and supplementals. After the hostage rescue fiasco in Iran, sentiment on
Capitol Hill intensified in favor of strengthening the military, and the Republicans’
hawkish campaign rhetoric about the Soviet threat added further impetus.
In this context, the fiscal 1980 budget of $142 billion had been the piñata
attacked by Republicans during the election campaign as evidence of the Carter
administration’s failed national security policies. Crucially, it had also been used as
the starting point for the 5 percent defense growth commitment in the Chicago speech.
In the interim, however, the defense committees first increased Carter’s fiscal 1981
budget to $170 billion, and then raised it further to more than $180 billion via mid-
year supplemental appropriations. The lame duck Defense Department further
ratcheted up the numbers, raising its request for fiscal 1982 to $205 billion.
Even this bloated figure was found to be woefully inadequate by the neocons.
So Senator Tower secured a pledge from the White House, even before Reagan took
office, for a military pay raise and other operationstype add-ons in what was called a
“get well” supplemental. Another $17 billion was thereby added. When the dust
finally settled, the fiscal 1982 defense budget stood at $222 billion—a figure nearly
60 percent larger than the $142 billion piñata that had been so roundly attacked during
the campaign. Yet it was from this vastly elevated prospective budget for 1982, not
the allegedly deficient actual 1980 spending level, that the annual growth rate
calculation was applied.
In the blink of an eye, the seemingly innocuous laws of compound arithmetic
converged with the formidable force of the military-industrial complex, catalyzing a
tumultuous and profoundly consequential juncture in governance. This convergence, a
collision of financial mathematics and political power, gave rise to a scenario that can
only be described as a lunatic miscarriage of governance, where rationality and
prudence were eclipsed by the imperatives of militarization and unchecked
expenditure.
At the heart of this confluence was the exponential growth inherent in
compound arithmetic, where small increments accumulate over time to yield
disproportionately large outcomes. In the context of government spending,
particularly military expenditures, this phenomenon took on alarming significance.
The compounding effect of allocating ever-increasing sums to defense budgets
resulted in a spiral of escalating costs, with each successive year witnessing greater
demands on public coffers and fewer resources available for other pressing priorities.
Coupled with this financial dynamic was the pervasive influence of the
military-industrial complex, a sprawling network of defense contractors, lobbyists,
and government officials with vested interests in perpetuating high levels of defense
spending. This complex wielded considerable power and influence, shaping policy
decisions, driving procurement processes, and perpetuating a culture of militarism that
permeated every facet of society. Its tentacles reached deep into the corridors of
power, ensuring that the imperatives of national security were synonymous with the
imperatives of profit and influence.
The result of this unholy alliance was a governance paradigm marked by
excess, waste, and distortion. Resources that could have been invested in education,
healthcare, infrastructure, and social welfare were diverted to fund ever more
elaborate weapons systems, overseas interventions, and military expansion. The
opportunity costs were staggering, as the nation's human capital languished,
infrastructure crumbled, and social cohesion frayed under the weight of neglect and
indifference.
Moreover, the lunatic miscarriage of governance extended beyond the realm of
fiscal mismanagement to encompass a broader erosion of democratic principles and
ethical norms. The unchecked growth of the military-industrial complex gave rise to a
state of perpetual war, where conflict became not just a means to an end but an end in
itself. The politics of fear and aggression supplanted reasoned discourse and
diplomacy, as elected officials vied to demonstrate their commitment to national
security through ever more bellicose rhetoric and hawkish policies.
In this climate of perpetual conflict and unchecked militarism, dissent and
opposition were marginalized, dissenting voices silenced, and dissenting views
dismissed as unpatriotic or naïve. The machinery of state surveillance and repression
grew ever more sophisticated, monitoring and suppressing any perceived threats to the
status quo. Civil liberties were sacrificed on the altar of national security, as the
boundaries between democracy and authoritarianism blurred and the rule of law gave
way to the rule of the military-industrial complex.
The lunatic miscarriage of governance, born of compound arithmetic and
nurtured by the military-industrial complex, represented a profound betrayal of the
principles upon which the nation was founded. It was a betrayal of the vision of a
government of the people, by the people, and for the people, replaced instead by a
government of the few, by the few, and for the few. It was a betrayal of the promise of
democracy, replaced instead by the specter of militarism and imperialism. And it was
a betrayal of the hope for a better future, replaced instead by the inevitability of
perpetual war and perpetual insecurity.
In conclusion, the convergence of compound arithmetic and the military-
industrial complex gave rise to a lunatic miscarriage of governance, where rationality
and prudence were sacrificed on the altar of militarism and unchecked expenditure.
The consequences of this miscarriage continue to reverberate through the corridors of
power and the fabric of society, shaping the world in ways that are at once tragic,
terrifying, and profoundly unjust. Only by reckoning with the lessons of the past can
we hope to forge a path towards a more just, peaceful, and sustainable future.
Given the inflation assumptions used at the time, the Chicago speech plan of 5
percent real growth would have resulted in a fiscal 1986 defense budget of about $250
billion. But based on 7 percent real growth and the much higher starting point, there
was a stunning new number: projected defense spending of nearly $370 billion for
fiscal 1986. In short, before even one dime of domestic spending had been cut, to say
nothing of the promised massive tax reductions, the out-year defense budget was 50
percent bigger than had been previously assumed. The fiscal math of the Chicago
speech, the only attempt that the Reagan campaign had ever made to reconcile the
candidate’s warring fiscal objectives, was now on the scrap heap.
I was dumbfounded when I learned about this calamitous result a few days
later. The Pentagon’s runaway top line amounted to nearly $1.46 trillion over 1982–
1986. It was greater than Jimmy Carter’s entire federal budget for the previous three
years combined, including defense, interest, Social Security, the medical entitlements,
the safety net, the national park service, and the tea tasters’ board, too. It all seemed so
outlandish. In fact, I was certain the numbers would be scaled back at a later date
when a conventional bottoms-up defense plan had been developed. Under the heading
of wishful thinking, however, that turned out to be an entry for the ages.
e. Triumph of the Warfare State: How the GOP Anti-Tax Religion Was Born
The Reagan Revolution's tax policy, heralded as a cornerstone of conservative
economic ideology, indeed bore the hallmarks of error and confusion, with far-
reaching implications for the nation's fiscal health and economic equity. Rooted in the
principles of supply-side economics, Reaganomics promised to stimulate economic
growth, curb inflation, and reduce unemployment through a combination of tax cuts,
deregulation, and tight monetary policy. However, the implementation of these
policies revealed significant flaws and unintended consequences that continue to
shape the economic landscape to this day.
At the heart of Reaganomics was the belief that reducing marginal tax rates,
particularly for the wealthiest individuals and corporations, would unleash
entrepreneurial dynamism, spur investment, and ultimately lead to higher overall tax
revenues. This theory, commonly known as the Laffer curve, posited that lower tax
rates would incentivize economic activity to such an extent that government revenue
would actually increase despite the lower rates. However, the empirical evidence for
this theory was scant, and the Reagan administration's reliance on it as the basis for
tax policy proved to be misguided.
The centerpiece of Reagan's tax policy was the Economic Recovery Tax Act of
1981, which implemented sweeping tax cuts across the board, with the largest benefits
accruing to the wealthiest Americans. The top marginal income tax rate was slashed
from 70% to 50%, and eventually to 28%, while capital gains taxes were similarly
reduced. Corporate taxes were also lowered, and numerous loopholes and deductions
were introduced, further reducing the effective tax burden on high-income earners and
corporations.
The immediate impact of these tax cuts was a surge in budget deficits and a
ballooning national debt. Despite promises that the tax cuts would pay for themselves
through increased economic growth, government revenues plummeted, leading to
record deficits throughout the 1980s. The combination of lower tax rates and
increased military spending, coupled with a lack of corresponding spending cuts or
revenue-raising measures, exacerbated the fiscal imbalance and laid the groundwork
for future fiscal crises.
Moreover, the benefits of Reagan's tax cuts were disproportionately skewed
towards the wealthy, exacerbating income inequality and widening the wealth gap.
While the wealthiest Americans enjoyed significant tax relief, working-class families
saw little tangible benefit, and many actually saw their tax burdens increase as a result
of cuts to social programs and regressive tax policies. The promise of trickle-down
economics, that the benefits of tax cuts for the rich would "trickle down" to the rest of
society, proved to be a hollow one, as wealth became increasingly concentrated at the
top.
The Reagan tax cuts also had significant implications for social welfare
programs and government services. As revenues dwindled and deficits soared,
pressure mounted to slash funding for social safety nets, healthcare, education, and
infrastructure. Programs aimed at addressing poverty, homelessness, and
unemployment were particularly hard hit, exacerbating social disparities and leaving
vulnerable populations even more marginalized. The erosion of public services
weakened the social fabric and undermined the government's ability to address
pressing social and economic challenges.
Furthermore, the Reagan tax cuts set a precedent for subsequent
administrations to prioritize tax breaks for the wealthy and powerful at the expense of
broader social and economic goals. Subsequent tax cuts under Presidents George W.
Bush and Donald Trump followed a similar pattern, further entrenching the
concentration of wealth and power in the hands of a few. The legacy of Reaganomics
continues to shape debates over tax policy, with proponents citing its supposed
benefits for economic growth and opponents highlighting its role in exacerbating
inequality and fiscal instability.
In conclusion, the Reagan Revolution's tax policy, while framed as a bold and
visionary approach to stimulating economic growth and prosperity, was ultimately
characterized by error and confusion. The reliance on supply-side economics and the
belief in the efficacy of trickle-down economics proved to be misguided, leading to
record deficits, widening inequality, and a hollowing out of social welfare programs.
The consequences of these policies continue to reverberate through the economy and
society, underscoring the need for a more equitable and sustainable approach to tax
policy and economic governance.
These misfires eventually morphed into a GOP anti-tax doctrine that was
stunning in its denial of reality. It literally stood on its head the fiscal orthodoxy that
Republicans had uniformly embraced prior to 1980. Until then, conservatives had
generally treated taxes as an element of balancing the expenditure and revenue
accounts, not as an explicit tool of economic stimulus. All three postwar Republican
presidents—Eisenhower, Nixon, and Ford—had even resorted to tax increases to
eliminate red ink, albeit as a matter of last resort after spending-cut options had been
exhausted.
These Republican administrations also espoused an economic philosophy of
lower taxes to encourage capital formation and private enterprise. But at the end of
the day, the tax code stood first and foremost as an instrument of revenue collection,
not an all-purpose elixir to promote economic growth. The story of how this tradition
of sound fiscal policy was lost after 1980 is crucial to understanding the economic
deformations plaguing the present era. This is especially so because the GOP’s
extended sojourn in the realm of fiscal know-nothingism has not been so much
purposeful and explicit as it has been convoluted and accidental in its origin and
institutionalization.
f. Origin of the Reagan Tax Cuts: Keynesian Inflation
Although the facts have been obscured by partisan revisionism from both
sides, the Reagan tax cuts were initially grounded in this earlier conservative tradition.
It was only much later that glib revisionist theories like “starve the beast” emerged.
Similarly, the bastardized supply-side notion that tax-rate reductions would not result
in revenue loss owing to the Laffer curve had few adherents beyond Laffer himself. In
fact, while the Reagan White House and practical Republican politicians alike
believed lower tax rates would stimulate economic growth and some revenue
feedback, none believed these cuts would be 100 percent self-financing. The latter
became incorporated into GOP catechism only much later—egged on by the rank
sophistry of Laffer, Jude Wanniski, and one or two other charlatans who constituted
the entirety of the supply-side coterie.
The fact is, when the Reagan administration took office it was confronted by
an immense tax roadblock to economic expansion. The pernicious interaction of the
1970’s double-digit inflation and the progressive rate structure of the individual
income tax code were causing tax rates to rise rapidly due to bracket creep. Based on
the early 1981 outlook for continued high inflation, the existing tax law, owing to
bracket creep, would have drastically and automatically raised the federal tax burden
on the economy. From a level of about 19 percent of GDP in 1980 the revenue claim
on national income would have risen to an unprecedented 24 percent by 1986.
A tax increase equal to 5 percentage points of GDP is no small matter, and
would amount to $750 billion annually in today’s economy. So what the Reagan
administration had inherited was a huge prospective enlargement of the tax burden.
What it also inherited was the legacy of Keynesian fiscal policy activism and the
resulting chronic deficits which became institutionalized in the late 1960s and had led
to inflationary money printing by the Fed. Paul Volcker was aggressively attacking the
latter, but it would take time to subdue. In these circumstances, it did not require any
belief in the finer points of supply-side doctrine to see the need for income tax
reductions. If left on automatic pilot, the “bracket creep” then raging would quash the
economy’s capacity for recovery and growth.
Moreover, this looming, unlegislated escalation of the tax burden was
something entirely new under the fiscal sun. To be sure, if the old right had long
fulminated against the “abomination of 1913” which saw enactment of both the
income tax and the Federal Reserve. But during peacetime, anyway, this potential
witches’ brew of inflationary money and confiscatory taxation had never really
materialized. During the Roaring Twenties era, for example, consumer prices had
averaged a zero rate of change. Thus, there was no bracket creep during the income
tax’s first peacetime decade, just deep legislated cuts in the high wartime tax rates
engineered by the incomparable Andrew Mellon.
Likewise, after plunging by 20 percent during the initial four years of the
Great Depression, consumer prices had drifted up only tepidly until the onset of the
Second World War. So there had been no bracket creep in the 1930s, just Franklin D.
Roosevelt’s deliberate legislative enactments aimed at soaking the rich. When
economic normalcy again returned after the Korean War, the consumer inflation rate
settled into a peacetime crawl, rising by an average of 1.6 percent annually during
1953–1967. So again, significant bracket creep had still not emerged, while
discretionary legislative action had functioned to modestly reduce income tax rates.
As it happened, President Lyndon Johnson’s misbegotten “guns and butter”
crusade eventually did uncork the evil genie of 1913. During the years subsequent to
1967, a pusillanimous Fed, shorn after 1971 of its last link to the fixed financial
anchor of gold, unleashed a runaway inflation for the first time in peacetime history.
This unique outbreak of peacetime inflation is now forgotten, but its importance
cannot by overemphasized. Consumer prices rose at an average rate of nearly 7.5
percent annually over the next decade and a half, including four years of double-digit
gains.
The resulting relentless push of inflation-swollen incomes into higher tax
brackets indeed had a profound impact on economic dynamics, stifling
entrepreneurial energies and eroding business investment incentives in a manner that
significantly contributed to the abrupt slowdown of real GDP growth. This
phenomenon, often referred to as "bracket creep," occurs when rising incomes, driven
by inflation, push taxpayers into higher tax brackets, effectively increasing their tax
liabilities without any corresponding increase in purchasing power or real income.
The adverse effects of bracket creep were particularly pronounced during the
period following the implementation of Reagan's tax cuts, which coincided with a
period of high inflation. As incomes rose due to inflationary pressures, many
individuals and businesses found themselves catapulted into higher tax brackets,
despite experiencing little to no real increase in purchasing power. This resulted in a
significant erosion of disposable income and profitability, as a larger share of earnings
was siphoned off to meet tax obligations.
The impact of bracket creep on entrepreneurial energies and business
investment incentives was multifaceted and far-reaching. For entrepreneurs and small
business owners, the prospect of facing higher tax rates as their incomes rose served
as a disincentive to innovation, risk-taking, and investment. The marginal tax rates
imposed by the progressive tax system discouraged individuals from pursuing
entrepreneurial ventures or expanding existing businesses, as the potential rewards
were diminished by the prospect of higher taxation.
Similarly, larger corporations and investors faced reduced incentives to
allocate capital towards productive investments or expansion initiatives. The higher
tax rates imposed on corporate profits and capital gains diminished the after-tax
returns on investment, making it less attractive to undertake long-term projects or
strategic initiatives. This dampened business confidence and investment sentiment,
leading to a contraction in capital expenditure and a slowdown in economic growth.
Moreover, the uncertainty and volatility introduced by bracket creep
exacerbated the challenges faced by businesses and investors, as they struggled to
navigate an increasingly complex and unpredictable tax environment. The lack of
stability and predictability in tax policy hindered long-term planning and investment
decision-making, as businesses grappled with the prospect of facing higher tax
liabilities in the future.
The ripple effects of bracket creep extended beyond the realm of
entrepreneurship and business investment to encompass broader macroeconomic
dynamics. The erosion of purchasing power resulting from higher tax burdens reduced
consumer spending and aggregate demand, further dampening economic activity and
exacerbating the slowdown in GDP growth. This negative feedback loop, wherein
higher taxes led to reduced investment, diminished consumer spending, and slower
economic growth, underscored the detrimental impact of bracket creep on overall
economic performance.
In response to these challenges, policymakers sought to address bracket creep
through various means, including indexing tax brackets to inflation, implementing tax
relief measures, and undertaking broader tax reform initiatives. However, the political
and ideological constraints inherent in the tax policy debate often hindered efforts to
implement comprehensive solutions, leaving many individuals and businesses
vulnerable to the adverse effects of bracket creep.
In conclusion, the relentless push of inflation-swollen incomes into higher tax
brackets had significant implications for entrepreneurial energies, business investment
incentives, and overall economic growth. The erosion of purchasing power and
profitability resulting from bracket creep stifled innovation, dampened investment
sentiment, and contributed to a slowdown in real GDP growth. Addressing the
challenges posed by bracket creep requires a nuanced and comprehensive approach to
tax policy that balances the need for revenue generation with the imperative of
fostering economic dynamism and prosperity.
So it was the stagflationary breakdown of the national economy resulting from
Nixon’s abandonment of sound money in August 1971 which ultimately triggered the
Reagan Revolution. Real growth faltered badly for the better part of a decade,
averaging just 2.5 percent per annum in the eight inflation-racked years ending in
1981, compared to 3.8 percent during the two decades prior to 1969. It was these
threats to the middle-class living standard which set the stage for the 1980 campaign
referendum on the “are you better off” question. Believing that it was worse off and
fearing even further decline in the future, the public sent Ronald Reagan to the White
House to fix the underlying problem Nixon had bequeathed.
g. Why The Chickens Didn’t Come Home to Roost: The Nixon Abomination of
August 1971
By the late 1980s, the United States found itself grappling with a perplexing
conundrum: despite a seemingly robust economy, the nation was saddled with sizable
budget deficits that defied conventional fiscal wisdom. This paradox, born out of the
complex interplay between economic factors and policy decisions, presented a
formidable challenge for policymakers and economists alike, as the old-time fiscal
religion appeared ill-equipped to provide satisfactory explanations or solutions.
At the heart of this conundrum was the juxtaposition of strong economic
growth and burgeoning deficits, two phenomena that seemed fundamentally at odds
with one another. On one hand, the economy was experiencing a prolonged period of
expansion, characterized by low unemployment, healthy consumer spending, and
robust business investment. Gross domestic product (GDP) was growing at a steady
pace, and many sectors of the economy were thriving, fueling optimism about the
nation's economic prospects.
However, this economic prosperity was overshadowed by the persistent
presence of large budget deficits, which had ballooned in the wake of Reagan's tax
cuts and increased military spending. Despite efforts to rein in spending and
implement deficit reduction measures, the deficits persisted, reaching unprecedented
levels and casting a shadow of uncertainty over the nation's fiscal health. The
mismatch between economic performance and fiscal indicators confounded observers
and policymakers alike, raising questions about the sustainability of the nation's
economic policies and the efficacy of traditional fiscal approaches.
The conundrum was further compounded by the lack of consensus among
economists and policymakers about the underlying causes of the deficits and the
appropriate course of action to address them. Some argued that the deficits were
primarily driven by structural factors, such as entitlement spending and demographic
trends, which necessitated fundamental reforms to entitlement programs like Social
Security and Medicare. Others pointed to cyclical factors, such as the business cycle
and fluctuations in interest rates, as key drivers of the deficits, suggesting that fiscal
stimulus measures and monetary policy adjustments were needed to stimulate growth
and reduce unemployment.
Moreover, the conundrum highlighted the limitations of the old-time fiscal
religion, which had traditionally emphasized the virtues of balanced budgets and
fiscal austerity as the cornerstone of sound economic policy. In an era marked by
globalization, technological change, and shifting demographics, the simplistic
prescriptions of the past seemed increasingly inadequate to address the complex
challenges facing the modern economy. The dogma of fiscal conservatism clashed
with the realities of a rapidly evolving economic landscape, leaving policymakers
struggling to reconcile competing priorities and ideologies.
In response to the conundrum, policymakers and economists began to explore
alternative approaches to fiscal policy that transcended traditional ideological
boundaries. Calls for a more pragmatic and flexible approach to deficit reduction
emerged, advocating for a combination of targeted spending cuts, revenue increases,
and structural reforms to address long-term fiscal imbalances. The concept of "grand
bargains" and bipartisan cooperation gained traction, as policymakers sought to forge
consensus on comprehensive deficit reduction packages that balanced competing
interests and priorities.
Furthermore, the conundrum spurred renewed interest in the role of monetary
policy in shaping fiscal outcomes, as policymakers looked to the Federal Reserve to
help stabilize the economy and mitigate the impact of deficits on interest rates and
inflation. The concept of "fiscal-monetary coordination" gained prominence, as
policymakers sought to align fiscal and monetary policy objectives to achieve optimal
macroeconomic outcomes.
In conclusion, the conundrum of strong economic growth and big deficits
presented a formidable challenge for policymakers and economists in the late 1980s,
as the old-time fiscal religion struggled to provide satisfactory explanations or
solutions. The mismatch between economic performance and fiscal indicators
highlighted the need for a more nuanced and flexible approach to fiscal policy that
could adapt to the complexities of the modern economy. This period of uncertainty
and introspection ultimately paved the way for a new era of fiscal policymaking,
marked by greater pragmatism, flexibility, and cooperation across ideological lines.
In violation of all the classical canons of sound fiscal policy, the deluge of
Reagan-era red ink was being readily financed, with no apparent boost to inflation or
interest rates and no visible harm to economic growth and investment. This
macroeconomic hall pass was a pivotal development in the fiscal unraveling which
has now engulfed the nation. It gave birth to the fatuous Cheney theorem—that
Ronald Reagan proved deficits don’t matter—and gave it credence, too. Republican
politicians came to embrace it because the empirical evidence did not refute it. In the
epigrammatic phrase of the great French monetary economist Jacques Rueff, the door
had been opened to “deficits without tears.”
The GOP was thus relieved of the conservative party’s true calling in a modern
welfare state democracy; that is, hard labor on the oars of fiscal rectitude. Indeed,
with the fear of deficits gone, the GOP drifted into what amounted to Keynesianism
for the prosperous classes. Tax cutting became its preferred tool for macroeconomic
stimulus and for nursing private enterprise to a more vigorous performance path than
it might achieve on its own. There was an irony in this because it made the state and
its politicians, rather than the free market economy, the arbitrator of how much
growth and prosperity was possible. Any shortfall from the potential growth rate
stipulated by the GOP’s supply-side oracles became an excuse for further deficit
financed tax cuts. Worse still, K Street became the breeding ground for the manifold
instruments of this Keynesian-style tax stimulus, thereby placing Washington deep in
the business of dispensing “incentives,” allocating capital, and superintending the ebb
and flow of growth and jobs among industries and regions.
But this was a giant lurch onto the wrong path. It stripped American
democracy of healthy two-party competition on the matter of fiscal rectitude versus
state largesse. It opened up a destructive dynamic in which the Dem ocrats manned
the state’s ramparts of spending while the Republicans tunneled through its
foundation of income. As previously suggested, the false narrative about the
Reaganite golden age and the nation’s current fiscal incontinence are rooted in a
common source; namely, the Nixon abomination of August 1971. In jettisoning the
monetary anchor of the Bretton Woods gold exchange standard, Nixon paved the way
for the eventual deformation of central banking. There emerged in lieu of sound
money a makeshift monetary régime that spread around the globe and created a thirty-
year interregnum in which trillions of Washington’s debt emissions were warehoused
in the vaults of the world’s central banks. The economic sting of massive treasury
borrowing was thereby anesthetized.
This is the reason why post-1980 fiscal deficits did not give rise to the classic
economic dislocations. There was no enduring domestic interest rate and investment
crunch, for example, because Uncle Sam’s deficits were being monetized and
exported, not financed out of the nation’s savings pool. After the 1980s consumer
prices did not surge either because the central banks of the rapidly growing East Asian
mercantilists were more than happy to import unwanted inflationary dollars via their
currencypegging operations. So the irony was large. The Reagan era’s wild fiscal
misfire on defense, taxes, and domestic spending had been essentially sterilized by
another financial deformation; namely, the floating paper dollar monetary
arrangement that Nixon and John Connally had forced on the world after August
1971.
The story of that travesty serves as a poignant reminder that the Reagan
Revolution, often romanticized as a golden age of free market capitalism, was in
reality just a fleeting moment in the broader arc of economic history. Far from
representing the pinnacle of market efficiency and prosperity, it was merely a way
station on the winding road that ultimately led to the BlackBerry Panic of 2008, a
cataclysmic event that exposed the deep-seated flaws and contradictions of the
prevailing economic orthodoxy.
At its core, the Reagan Revolution was built on a set of ideological pillars that
extolled the virtues of deregulation, privatization, and trickle-down economics. These
principles, championed by Reagan and his conservative allies, promised to unleash
the forces of entrepreneurship and innovation, leading to unprecedented levels of
economic growth and prosperity. However, the reality fell far short of these lofty
aspirations, as the deregulatory zeal of the era laid the groundwork for a series of
financial crises and market distortions that would ultimately culminate in disaster.
One of the central tenets of Reaganomics was the belief in the self-regulating
nature of markets, which held that government intervention in the economy was not
only unnecessary but harmful. This philosophy led to a wave of deregulation across
various industries, from finance to telecommunications, as regulations were rolled
back in the name of promoting competition and efficiency. However, the unintended
consequences of this deregulatory frenzy soon became apparent, as unchecked greed
and speculation ran rampant, leading to a series of bubbles and busts that wreaked
havoc on the economy.
The financial sector, in particular, became a hotbed of reckless risk-taking and
speculation, as Wall Street titans leveraged their newfound freedoms to engage in ever
more complex and opaque financial transactions. The proliferation of exotic financial
instruments, such as mortgage-backed securities and credit default swaps, created a
false sense of security among investors and policymakers alike, as they failed to grasp
the systemic risks that were building beneath the surface.
Meanwhile, income inequality soared to levels not seen since the Gilded Age,
as the benefits of economic growth flowed disproportionately to the top echelons of
society. While the wealthy enjoyed lavish tax cuts and soaring stock market returns,
working-class families struggled to make ends meet in an increasingly precarious and
uncertain economy. The social safety net frayed under the strain of budget cuts and
austerity measures, leaving millions of Americans vulnerable to the whims of the
market.
The culmination of these trends came in the form of the BlackBerry Panic of
2008, a seismic event that shook the global economy to its core and laid bare the
fundamental flaws of the Reagan Revolution. Triggered by the collapse of the
subprime mortgage market and the subsequent implosion of the housing bubble, the
panic exposed the fragility of the financial system and the inadequacy of regulatory
oversight. As banks teetered on the brink of collapse and credit markets froze,
governments around the world were forced to intervene with massive bailouts and
stimulus packages to prevent a total meltdown.
In the aftermath of the panic, the myth of the self-regulating market was
shattered, as policymakers scrambled to reassert control over an unruly and
dysfunctional financial sector. The era of deregulation and laissez-faire capitalism
came to an abrupt end, as calls for greater oversight and accountability grew louder.
However, the scars of the crisis lingered long after the dust had settled, as millions of
Americans grappled with the devastating consequences of unemployment,
foreclosure, and economic hardship.
In retrospect, the Reagan Revolution was not the golden age of free market
capitalism that its proponents had imagined, but rather a cautionary tale of the dangers
of unchecked greed and ideological extremism. It was a way station on the road to
disaster, a brief detour from which the nation has yet to fully recover. As we reflect on
the lessons of the past, it is incumbent upon us to chart a new course forward, one that
prioritizes economic stability, social equity, and environmental sustainability over the
narrow interests of the few. Only then can we hope to build a more just and
prosperous future for all.
h. The Dirty Secret of Floating Currencies
The conservative economists who advised Republicans to jettison Bretton
Woods were reflexive free marketers who suffered from monetary amnesia; that is,
they ignored the fact that the massive war inflation of 1914–1918 had ended the
classic gold standard and changed the fundamental nature of money, making it an
artifact of state policy. Failing to note that money would be heavily manipulated by
the central banking branches of the world’s sovereign states, they erroneously viewed
the floating-rate system as a good thing because the free market would purportedly set
currency exchange rates. Yet as wards of the state, the central banks were now
indentured to its policy imperatives rather than to the superintendence of sound
money. That was proven in spades by the inflationary debacle that exploded during
the very first decade of floating. Indeed, by the end of the 1970s it was evident that
there wasn’t much about the international currency exchanges which resembled the
theoretical “free market.”
The global currency markets had already become havens of “dirty float”
where state manipulation of exchange rates was the modus operandi. Likewise, the
only thing “free” about the new arrangement was that the Fed now had a fantastic new
license to freely expand its balance sheet at rates never before imagined, and with a
result that the conservative economists had not even remotely anticipated. Buying
government bills and bonds without the external discipline of redeemability, the Fed
injected massive liquidity into the Wall Street banking system—where more and more
of it ended up in speculative finance, not the real economy. So there was nothing
“progressive” about the post–Bretton Woods monetary arrangements. In closing the
gold window, Tricky Dick brought sound, redeemable money to an unceremonious
end, and not because he was a modernizing monetary reformer aiming to rid the
system of the “barbarous relic” which even Keynes had been forced to embrace in
1944.
Instead, Nixon was a crass, nationalistic politician who put his own reelection
above all other considerations, including the nation’s obligation to keep the dollar
honest and repay its external debts in a fixed weight of gold. Monetary arrangements
must last for the ages if they are to be credible, but according to the cynical Nixonian
template, no obligation was admissible which might cause an uptick in the
unemployment rate before November 1972. As will be seen, the Bretton Woods gold
exchange standard was fundamentally flawed, so it was only a matter of time before it
fell at the hand of a bombastic White House occupant like Johnson or Nixon. Still,
when it was finally jettisoned, its indispensable core function of imposing a rough
discipline on each nation to live within its means was also lost. What was not even
dimly grasped in 1971 was that the demise of Bretton Woods had unshackled the
central banks in a manner never previously experienced in modern financial history.
Given the dominant position of the US economy and the dollar at that time,
the fatal danger was that the Fed had now been positioned to emit unlimited credit
through the US banking system. The only real restraint was the willingness of the rest
of the world to accumulate and hold dollar liabilities. As it turned out, other nations
were mighty willing. The flood of dollars into the global economy did not cause its
exchange rate to collapse because mercantilist central banks bought dollars hand over
fist in order to suppress the exchange rates of their own currencies. This massive,
prolonged hoarding of dollar liabilities by foreign central banks had never been
foreseen by the conservative economists who championed floating rates.
Indeed, the willingness of statist leaders in East Asia and the Persian Gulf to
endlessly swap the resource endowments of their lands and the labor of their people
for dollar IOUs, in their pursuit of a flawed mercantilist model of growth and
prosperity, knew no historical precedent. It is one of the great deformations on which
the modern global economy rests precariously. After August 1971, this monetary
deformation gathered inexorable momentum and girth, one step at a time. Eventually,
like a hungry parasite, it would ingest US Treasury and agency debt with gluttonous
abandon.
As will be seen, there was no stopping this great monetary deformation
because the nation’s conservative party failed to comprehend and rectify it at every
step along the way. After Nixon and Burns incited the global commodity price
explosion of the 1970s, Republicans rationalized the Fed’s continued production of
excess dollars on the feckless grounds that inflation had to be “financed” and could
only be brought down slowly.
In February 1986, a pivotal moment unfolded within the annals of U.S.
economic history, as a Republican White House made the consequential decision to
essentially remove Paul Volcker from his position as Chairman of the Federal
Reserve. Volcker, renowned for his steadfast commitment to combating inflation and
restoring stability to the nation's monetary system, had earned widespread acclaim for
his resolute leadership during a period of profound economic turbulence. However,
the decision to replace him marked a significant departure from the principles of
sound monetary policy and sent shockwaves through financial markets and political
circles alike.
Paul Volcker's tenure at the helm of the Federal Reserve was characterized by
bold and often controversial measures aimed at taming runaway inflation and
restoring confidence in the U.S. dollar. Upon assuming office in 1979, Volcker
confronted a daunting economic landscape plagued by double-digit inflation, stagnant
growth, and a crisis of confidence in the nation's currency. In response, he
implemented a series of tight monetary policies, including sharp increases in interest
rates, to rein in inflation and stabilize the economy.
The Volcker Fed's aggressive anti-inflation stance was not without its critics,
as the tight money policies imposed by the central bank exacted a heavy toll on
businesses, consumers, and financial markets. Unemployment soared, industries
contracted, and homeowners faced sky-high mortgage rates as the economy grappled
with the consequences of Volcker's austerity measures. However, the Chairman
remained steadfast in his commitment to restoring price stability and laying the
groundwork for sustainable economic growth, even in the face of mounting criticism
and political pressure.
By the mid-1980s, Volcker's efforts began to bear fruit, as inflationary
pressures eased, and the economy showed signs of recovery. The once-soaring
inflation rate began to recede, bringing relief to households and businesses alike.
Confidence in the dollar was restored, and financial markets stabilized as investors
regained faith in the Federal Reserve's ability to maintain price stability and sound
monetary policy.
However, despite his undeniable success in bringing down inflation decisively
and restoring a semblance of sound money, Volcker's tenure at the Federal Reserve
was not without controversy. His uncompromising approach to monetary policy drew
criticism from some quarters, particularly within the business community and among
conservative policymakers who favored a more laissez-faire approach to economic
management. Calls for Volcker's removal grew louder as the costs of his policies
became increasingly apparent, leading to speculation about his future at the central
bank.
In February 1986, those speculations were realized when a Republican White
House, under pressure from business interests and conservative allies, effectively
removed Volcker from his position as Chairman of the Federal Reserve. His
successor, Alan Greenspan, brought a different approach to monetary policy,
emphasizing greater flexibility and accommodation in the face of economic
challenges. While Greenspan's tenure would be marked by its own set of successes
and challenges, the decision to replace Volcker marked the end of an era in U.S.
monetary policy and signaled a shift in priorities within the nation's economic
policymaking apparatus.
In hindsight, the decision to remove Paul Volcker from his position as
Chairman of the Federal Reserve represents a missed opportunity to build on his
legacy of sound monetary policy and prudent economic management. While his
tenure was not without its flaws and controversies, Volcker's steadfast commitment to
combating inflation and restoring confidence in the nation's currency laid the
groundwork for a period of relative stability and prosperity in the years that followed.
His departure marked the end of an era of monetary discipline and ushered in a new
era of monetary policy characterized by greater accommodation and flexibility, with
far-reaching implications for the nation's economy and financial system.
After the turn of the century, still another Republican White House populated
the nation’s central bank with Wall Street–pleasing money printers who confused rank
speculation with genuine investment, and a giant debt bubble with sustainable
prosperity. When the monetary bubble finally collapsed in September 2008, a
Republican treasury secretary closed ranks with a GOP-appointed cabal at the Fed to
unleash a wave of free money so immense that it has effectively destroyed the free
market in finance. With friends like that, sound money needed no enemies.
