Paper Money was published in 1981, so the readers don't know what happened next. But we do, of course, because we are living through it. I'll try and sketch in the details briefly with the help of Wikipedia and a few other sources.
The late 1970s were a time of discontent. Jimmy Carter gave his "Crisis of Confidence" speech (sometimes called the "Malaise" Speech), Britain experienced the "Winter of Discontent," and the Soviet Union entered the Era of Stagnation. It all had to do with high energy prices. Oil, having driven the boom, and now the major energy source of the industrialized world, had risen tenfold in a decade bringing down the industrialized economies. The industrial nations were also heavily polluted in the late 1970's. Confidence in nuclear power, once seen as the energy source of the space age, evaporated at Three Mile Island in 1979, and later at Chernobyl. It seemed like the post-war Keynesian consensus had let everyone down.
1974-1975 was a terrible recession. Unions, hit by the cost increases, went on strike. Garbage piled up in the streets of New York City. In 1975, New York went into debt restructuring. There was even a spike in crime and lawlessness that defied explanation. Some have convincingly argued that the introduction of lead into gasoline to stop engine knock was the cause of the crime outbreak due to lead poisoning:
Fourteen years ago, Prof Jessica Wolpaw-Reyes, an economist at Amherst College Massachusetts, was pregnant and doing what many expectant mothers do - learning about the risks to her unborn child's health. She started to read up on lead in the environment and, like Nevin before her, began pondering its link to crime.Did removing lead from petrol spark a decline in crime? (BBC)
"Everyone was trying to understand why crime was going down," she recalls. "So I wanted to test if there was a causal link between lead and violent crime and the way I did that was to look at the removal of leaded petrol from US states in the 1970s, to see if that could be linked to patterns of crime reduction in the 1990s."
Wolpaw-Reyes gathered lead data from each state, including figures for gasoline sales. She plotted the crime rates in each area and then used common statistical techniques to exclude other factors that could cause crime. Her results backed the lead-crime hypothesis.
"There is a substantial causal relationship," she says. "I can see it in the state-to-state variations. States that experienced particularly early or particularly sharp declines in lead experienced particularly early or particularly sharp declines in violent crime 20 years later."
The unions, striking to gain higher wages to cope with higher gasoline prices, came to be seen as part of the problem. Anti-union forces portrayed them as corrupt anachronisms holding back economic growth. They played up the corruption and ties to organized crime (true of a very small percentage of big city unions). I've always found this comical because it assumes that the enemies of unions - Wall Street, the corporate boardrooms, the big banks and the politicians--are somehow paragons of honesty and fairness. Give me a break. It's all corruption - it's just who benefits from it.
To some extent it was irrelevant. The opening of China (see below) led to the deindustrialization of the Industrial Heartland of America and the creation of the "Rust Belt." Entire swaths of the country became depopulated hellholes while politicians in both parties looked the other way. People were told that they had to go back to school to get more education (leading to the soaring costs of college as it became the tollbooth to what remains of the middle class), and economists touted the "service economy," i.e. low-wage McJobs as the base of the employment pyramid in place of value-added manufacturing. Automation played a role here too, despite assurances that automation always creates more jobs than it destroys.
This also accelerated the flood of migrants to the Sunbelt.The settling of the sunbelt also changed political attitudes. Because of the hot climate, the Sunbelt was a fairly undeveloped agricultural backwater. Industry was historically located near water transport, rail transport, sources of timber, coal and iron ore, and nearby farmland to feed workers. As industry left the United Sates, the geographical advantages of manufacturing cities dwindled. Most older industrial cities were built on ports, but trucking reduced the need to bring in goods by water or rail. Because the Sunbelt cities had little in the way of investment in existing infrastructure to maintain, they could offer low, low taxes to attract business, unlike the older cities of the Northeast, Upper Midwest and Ohio Valley which had infrastructure dating back to the 1800s. In addition, the lack of snow and the freeze-thaw cycle meant that infrastructure costs could be lower because roads and buildings did not decay as fast. As businesses moved, so did the people. Once air conditioning made it livable, people began to move to escape the harsh winters.
Thus Americans adopted the attitude of getting something for nothing that pervades American politics today. As long as new development was taking place, taxes could be kept low, attracting more people funding further development which kept taxes low and so on - a classic feedback loop. But this accustomed Americans to expecting to pay very low taxes no matter what. In effect, the Sunbelt was built out as a giant Ponzi scheme that voters mistook for a permanent condition. As the American population moved to these low-tax, warm weather havens, they just assumed low taxes as a birthright giving rise to the “no new taxes” attitudes we see today. With economic expansion, no aging infrastructure, and no cold winters, it was easy to adopt the minimalist government/rugged individualist ethos of the original Sunbelt farmers and ranchers, no matter how incompatible with the new reality of air-conditioned offices and globalized corporations. As the American population center of gravity began to shift south and west, these political attitudes became the dominant force in American politics. (i.e. the “Dixiefication” of American politics).
The rise of the US sunbelt can be understood largely as a response to the emergence of widespread air conditioning, which made places that are warm in the winter attractive despite humid, muggy summers. It’s a gradual, long-drawn-out response, because location decisions have a lot of inertia; few people would choose de novo to live in the old industrial towns of upstate New York, but the existing housing stock and the fact that people have family and social networks prevent quick abandonment. So to this day temperature is a good predictor of state population growth.Charlatans, Cranks, and Cooling (Paul Krugman)
Now, these states have several things in common besides high temperatures. They’re all very conservative. And all of them that were states before the Civil War were slave states. These commonalities are, of course, all interrelated. Hot states had slaves because they were suitable for planation agriculture; and today’s red states are, pretty much, the slave states of 150 years ago.
Now, all of this raises some interesting problems for the assessment of economic policy. Because they’re politically conservative, hot states tend to have low minimum wages and low taxes on rich people. And someone who is careless, cynical, or both, could easily take the faster growth of these states as evidence that conservative economic policies work. That is, charlatans and cranks can, all too easily, end up claiming credit for economic and demographic trends that are actually the result of air conditioning.
Beginning in the mid-1960s inflation increased rapidly. Now, inflation is of two kinds – cost push and demand pull. Demand pull is when the amount of money in circulation exceeds the amount of goods and services we can reasonably buy. This can occur from too much money or too few goods, as when rationing or a war takes goods out of production. Thus, the only result is for the things already in existence to cost more. Cost push is when a crucial input into production, such as land, labor, capital or energy, increases in cost. To keep profits steady, the producers must raise the prices of the things they sell.
It is thought that the Vietnam war began this acceleration. Taxes were not raised to pay for the war, so the money spent into existence for the war was not “umprinted” via taxes causing an increase in the amount of dollars with the economy at capacity due to the war. Military needs competed with civilian ones. The goods produced via government spending were mainly shipped to Southeast Asia and blown up. There were also some commodity shocks:
We have gotten so used to inflation now that we have forgotten what it was like to operate in an environment in which prices did not leap and sellers did not build in an extra piece for inflation. The inflation rate in the United States in the first half of the 1960s was between 1 percent and 2 percent.
So, while some elements of this story go back to 1928, and 1717, and 1913, 1965 makes a very good starting point. The economy was running at full capacity then, and the United States was escalating its presence in Vietnam. The planes and the jet fuel and the combat boots were going to cost something, and the bill had to be paid. But Lyndon Johnson chose to duck the explicit way, which would have been to raise the money in taxes.
President Johnson, as quoted by David Halberstam, said: "I don't know much about economics, but I do know the Congress. And I can get the Great Society through right now—this is a golden time. We've got a good Congress and I'm the right President and I can do it. But if I talk about the cost of the war, the Great Society won't go through. Old Wilbur Mills will sit down there and he'll thank me kindly and send me back my Great Society, and then he'll tell me that they'll be glad to spend whatever we need for the war."
When the Council of Economic Advisers began to press him for a tax increase, Johnson summoned key members of the House Ways and Means Committee to ask their advice. But the figures he gave them for Vietnam were deliberately low, and with those figures the Ways and Means Committee let him go back to the council and say that he had gone to Congress and discussed it but could not get the votes.
With the civilian economy already operating at capacity military needs competed with civilian needs, army boots with civilian shoes, military industries with civilian industries, producing a classic excess-demand inflation: not enough goods. All wars must be paid for; in this case the tax was not explicit, a special tax, but implicit: inflation. So we began with the unpaid bill of the Vietnam War.
The inflation that President Nixon faced was modest by current standards, but at roughly 5 percent it was still double its pre-Vietnam standard. Classic medicine was spooned out: tighter credit, higher taxes. The economy slowed down, but the inflation didn't. It had more momentum than the medicine spooners figured. By August 1971 Nixon had to face a decision, just as Johnson had. The polls showed that Nixon was running behind Edmund Muskie in a potential reelection fight. So Nixon adopted a twofold approach: he ordered wage and price controls, and at the same time his fiscal policies stimulated the economy. Arthur Burns, who had picked zero as a good rate of inflation, was at the helm when the money supply ballooned, which led his critics to say that his goal was all pipe smoke. Nixon's tactic worked in its timing; at election time the economy was rosy and prices, by law, relatively stable. But once the election was over, the controls had to come off. The suppressed inflation burst forth again; all the businesses that had frozen their prices marked them up as soon as they were legally able to, and demand was high because of all the excess money around.
To the political moves of Presidents Johnson and Nixon you could also add the weather and the missing anchovies. The weather helped to produce a bad wheat crop in Russia, and the Nixon administration saw an opportunity to win some points from the farmers in the election. But it sold too much wheat. Once the Russians took their purchased wheat away, Americans scrambled to buy their own grain.
There is always some out-of-place variable like the anchovies. In this case the anchovies swam away from the coast of Peru, no one knows where to, and the fish that ate the anchovies followed them, and the fishermen came back without the fish, and the European cattle feeders who normally used fish meal as feed switched to grain, and flew to Minneapolis and occupied the hotel rooms the Russians were just checking out of. The result was an explosion in grain prices.
So our overture has political decisions and industrial inflation and agricultural inflation—a nice running head start, but so far, all very classic kinds of inflation, not enough goods for the money.
And while the hotels of Minneapolis were filling with grain traders, and the money was flowing and business was good, OPEC was yawning and stretching its muscles like an aroused leopard, and that is such a major change we will come back to it in a while.
Inflation is complex, as you can see, and all the simple stories about it are too simple. There are two simple factors involved, though, which you already know.
The first is that when you pay more dollars for something, one of your fellow citizens gets those extra dollars. Obviously. Our economy is already "indexed" to some degree. If it were perfectly indexed, everything would go up at exactly the same rate—wages and prices and dividends. So one problem is that some things go up more than others, leaving unhappy those who lag in the escalation.
The second point you already know is that things used to go up and down, and they don't do that anymore. They go up and up. Or they go up, pause, look around, and go up again.Milton Friedman argued that inflation was caused by too much money floating around. “Inflation is always and everywhere a monetary phenomenon,” was his motto. Remember, this was the same guy who said OPEC would not last eighteen months. He did not believe in cost-push inflation. He believed that the ten-fold increase of the substance that came to literally underpin the entire industrial economy had no effect on inflation. It was just an excess of money. The cure was simple – get rid of the excess money. This view was called “Monetarism.”
The way economists put this is to say that wages and prices have lost their sensitivity to changes in business. Automobile sales may fall apart, but the price of automobiles doesn't go down, nor do the wages of auto workers. What do you think is going to get cheaper? Do you put off buying anything until the price comes down? Some things do get cheaper: electronic calculators, home computers, items whose technology is leapfrogging. Some things we don't notice much and don't complain about: toasters, electric alarm clocks. Everything else seems to go up: houses, shoes, doctor bills, tuition, cars, food, haircuts, lipstick, chewing gum. In a period of slack, prices are, the economists say, "sticky downward." When business improves, the prices unstick and go upward.
We don't really know why prices are sticky downward, but one probable reason is that this is the price we have paid for the prosperity and stability we have had since the Great Depression. If recessions are short and contained, sellers stand pat and wait for the upturn, to cover their costs. Unemployed workers draw their benefits; they usually don't go out and take any job at any price. But most businesses don't fire people when their sales slack off, because they think sales will pick up again and they don't want to lose good people to their competitors.
If businesses were as frightened as they were in the 1930s, they would sell at a loss and let their workers go, and workers would take any job. But we don't have that kind of fear as a motivation, and we certainly wouldn't want to have it.
In the past decade we developed not only inflation but the expectation of inflation, and that psychological force is easily the equal of all the technical economic forces. (pp.20-22)
There are two other elements in the story of paper money that sometimes carry the whole blame for inflation. Unless you're used to the terms, they can sound very abstract. The first such element is deficits in the federal budget: the government spends more than it takes in. There is one obvious way this adds to inflation. When the government doesn't take in as much money as it spends, it has to go to the marketplace and borrow the rest. In the marketplace it meets private borrowers, who might be borrowing to build new plants or new houses. When the government competes heavily with those borrowers, that competition forces interest rates up, and interest is one of the costs of doing business.
But some folks say more than that; they say all our problems would be solved if only the government balanced its budget. Before we agree to that, though, we have to see what the federal government does with its money. What if the federal government gave the money it borrowed to the cities and states? Sometimes the states are in surplus when the federal government is in deficit. So we have to take all the governments together, federal, state, and local; and match the inflation rate. Governments obviously ought not to be in deficit all the time, because then they are attempting to be the first beneficiaries of inflation: they borrow from savers and repay with cheaper dollars. If the government does not believe in the currency, who will? Lenders get more and more reluctant to lend to governments that borrow more and more. The government and its budget are indeed a problem, but not the only problem.
The second element that some folks assign all the blame to is another part of the government: the Federal Reserve. Some folks" in this case are the monetarists, who can play many tunes on one fiddle string. They say, for example, that if the Federal Reserve kept the supply of money to a low, predictable rate, all else would follow. There's no question that a supply of money growing faster than the output of goods and services contributes to inflation. The Federal Reserve says it is committed to slowing down growth in the supply of money. Yet, in the Notes of this book, you will find a simple table of two measures of the money supply; in the past five years, inflation increases even as the money supply begins to contract. So the money supply alone is not the cause of inflation. The money supply, like energy, is a subject for arguments of theological intensity, and you can find a great deal already published if you wish to pursue this.Now, the reason economists don't believe in cost-push inflation is the same reason as they don't accept the role of energy in the economy. Oil is seen as just another commodity and one that is "only" 5 percent of GDP or so.
In the 1970's as inflation increased, the Federal Reserve did not want to raise interest rates too high. It wanted to pursue what was called “full employment polices” – they did not want to cause the widespread unemployment that a recession would cause. Even in the recession of '74-'75, unemployment was relatively low.
By contrast, Volcker would pursue a “tight money” policy. Instead of pursuing full employment as a goal, the message from the Federal Reserve to the nation’s employees was the same as Persident Ford’s alleged advice to New York City, “Drop dead.” This also coincided with aggressive anti-union attitudes signified by the firing of the striking air traffic control employees in 1981.
Until the 1970s, many economists believed that there was a stable inverse relationship between inflation and unemployment. They believed that inflation was tolerable because it meant the economy was growing and unemployment would be low. Their general belief was that an increase in the demand for goods would drive up prices, which in turn would encourage firms to expand and hire additional employees. This would then create additional demand throughout the economy.
According to this theory, if the economy slowed, unemployment would rise, but inflation would fall. Therefore, to promote economic growth, a country's central bank could increase the money supply to drive up demand and prices without being terribly concerned about inflation. According to this theory, the growth in money supply would increase employment and promote economic growth. These beliefs were based on the Keynesian school of economic thought, named after twentieth-century British economist John Maynard Keynes.Stagflation, 1970s Style (Investopedia) Of course, Keynesian economics, like most economic doctrines, was ignorant of the role of energy in the economy, being mainly concerned with prices and money flows.
In the 1970s, Keynesian economists had to reconsider their beliefs as the U.S. and other industrialized countries entered a period of stagflation. Stagflation is defined as slow economic growth occurring simultaneously with high rates of inflation.
When people think of the U.S. economy in the 1970s the following comes to mind:
High oil prices
Indeed, the average price of a barrel of oil reached a peak of $104.06 (as measured in 2007 dollars) in December of 1979. In the 1970s, there was a two-year period of economic contraction as measured by gross domestic product (GDP) in year 2000 dollars (i.e. Real GDP): 1974 GDP contracted 0.5%, and in 1975, GDP contracted 0.2% and unemployment reached 8.5%. In 1980, GDP contracted 0.2%.
The prevailing belief as promulgated by the media has been that high levels of inflation were the result of an oil supply shock and the resulting increase in the price of gasoline, which drove the prices of everything else higher. This is known as cost push inflation. According to the Keynesian economic theories prevalent at the time, inflation should have had an inverse relationship with unemployment, and a positive relationship with economic growth. Rising oil prices should have contributed to economic growth. In reality, the 1970s was an era of rising prices and rising unemployment; the periods of poor economic growth could all be explained as the result of the cost push inflation of high oil prices, but it was unexplainable according to Keynesian economic theory.
A now well-founded principle of economics is that excess liquidity in the money supply can lead to price inflation; monetary policy was expansive during the 1970s, which could explain the rampant inflation at the time.
Milton Friedman was an American economist who won a Nobel Prize in 1976 for his work on consumption, monetary history and theory, and for his demonstration of the complexity of stabilization policy. In a 2003 speech, the chairman of the Federal Reserve, Ben Bernanke, said, "Friedman's monetary framework has been so influential that in its broad outlines at least, it has nearly become identical with modern monetary theory … His thinking has so permeated modern macroeconomics that the worst pitfall in reading him today is to fail to appreciate the originality and even revolutionary character of his ideas in relation to the dominant views at the time that he formulated them."
Milton Friedman did not believe in cost push inflation. He believed that "inflation is always and everywhere a monetary phenomenon." In other words, he believed prices could not increase without an increase in the money supply. To get the economically devastating effects of inflation under control in the 1970s, the Federal Reserve should have followed a constrictive monetary policy. This finally happened in 1979 when Federal Reserve Chairman Paul Volcker put the monetarist theory into practice. This drove interest rates down to double-digit levels, reduced inflation down and sent the economy into a recession.
Through early 1978, the Federal Reserve had maintained a highly accommodative stance of monetary policy, hoping to combat rising unemployment. Ultimately, though, the policies showed little success in stifling the deterioration in the unemployment rate and likely fostered an environment that allowed the rising energy prices to be transmitted into more general inflation. Consumer inflation, which had already begun to accelerate in the United States, continued to rise—from below 5 percent in early 1976 to nearly 7 percent by March 1979. By that time, unease among members of the Federal Open Market Committee (FOMC) that inflation could continue to rise was growing. Records from the meeting of the FOMC on February 28, 1978, indicate that “considerable concern was expressed that the rate of inflation might accelerate significantly as the year progressed [and could] pose difficult questions concerning the appropriate role of monetary policy.” Nevertheless, the committee voted unanimously to keep the policy rate unchanged.Oil Shock of 1978–79 (Federal Reserve History)
Despite increasing concern among the public and members of the FOMC about the declining value of the dollar and rising pace of inflation, the committee remained hesitant to raise interest rates too aggressively, fearful of stifling fragile economic growth. The Fed raised the federal funds rate from 6.9 percent in April 1978 to 10 percent by the end of the year. The increase was a clear move to try to curb rising inflation. However, modern economic historians now see the increases as timid and insufficient to stem a surge in inflationary pressure, which had already become entrenched in the American psyche and economy. Twelve-month consumer price index inflation rose to 9 percent by the end of 1979.
The Carter administration’s decision to appoint Paul Volcker as Fed chairman in August 1979 was a strong endorsement of using more aggressive monetary policy to try to break inflation’s stranglehold on the US economy. As the president of the Federal Reserve Bank of New York, Volcker had been an outspoken proponent of using monetary policy to combat rising inflation. According to Volcker, “If all the difficulties growing out of inflation were going to be dealt with at all, it would have to be through monetary policy…. [No] other approach could be successful without a successful demonstration that monetary restraint would be maintained.” Volcker and the policy-setting FOMC made taming inflation their top priority, even if it came at the detriment of short-term employment. The policies ultimately proved successful in breaking the cycle of stagflation in the United States.
Volcker guided the Fed in raising the federal funds rate from 11 percent at the time he took office to a peak of 19 percent in 1981, and the policy moves successfully lowered the rate of twelve-month inflation from a peak of nearly 15 percent to 4 percent by the end of 1982. Though the Fed’s resolve under Volcker was effective in reducing inflation, the monetary contraction—combined with the impact from the oil price shock—pushed the economy into the most severe recession since the Great Depression and spurred strong popular opposition.
The Federal Reserve board led by Volcker is widely credited with ending the United States' stagflation crisis of the 1970s. Inflation, which peaked at 14.8 percent in March 1980, fell below 3 percent by 1983.Paul Volcker (Wikipedia)
The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. The prime rate rose to 21.5% in 1981 as well. Thus, the unemployment rate rose to over 10%. The economy was restored since the tight-money policy was over in 1982. According to William Silber "His policy of preemptive restraint during the economic upturn after 1983 increased real interest rates and pushed Congress and the president to adopt a plan [the 1985 Gramm-Rudman-Hollings bill] to balance the budget. The combination of sound monetary and fiscal integrity sustained the goal of price stability."
However, despite the Gramm-Rudman-Hollings bill, US debt as a percentage of GDP more than doubled between 1981 and 1993.
...What we did have was a wage-price spiral: workers demanding large wage increases (those were the days when workers actually could make demands) because they expected lots of inflation, firms raising prices because of rising costs, all exacerbated by big oil shocks. It was mainly a case of self-fulfilling expectations, and the problem was to break the cycle.The Mythical 70's (Paul Krugman)
So why did we need a terrible recession? Not to pay for our past sins, but simply as a way to cool the action. Someone — I’m pretty sure it was Martin Baily — described the inflation problem as being like what happens when everyone at a football game stands up to see the action better, and the result is that everyone is uncomfortable but nobody actually gets a better view. And the recession was, in effect, stopping the game until everyone was seated again.
The difference, of course, was that this timeout destroyed millions of jobs and wasted trillions of dollars.
Was there a better way? Ideally, we should have been able to get all the relevant parties in a room and say, look, this inflation has to stop; you workers, reduce your wage demands, you businesses, cancel your price increases, and for our part, we agree to stop printing money so the whole thing is over. That way, you’d get price stability without the recession. And in some small, cohesive countries that is more or less what happened. (Check out the Israeli stabilization of 1985).
But America wasn’t like that, and the decision was made to do it the hard, brutal way. This was not a policy triumph! It was, in a way, a confession of despair.
It worked on the inflation front, although some of the other myths about all that are just as false as the myths about the 1970s. No, America didn’t return to vigorous productivity growth — that didn’t happen until the mid-1990s. 60-year-old men should remember that a decade after the Volcker disinflation we were still very much in a national funk; remember the old joke that the Cold War was over, and Japan won?
The success of monetarism in bringing down inflation appeared to validate Friedman’s ideas, and hence those of the Neoliberal school. Economics papers began to adopt these ideas. The University of Chicago graduated more economists. Neoliberal and Austrian economists began to win Nobel Prizes (Bank of Sweden prizes).
All of these trends led led to the election of Ronald Reagan in 1980.
But Reagan had a secret weapon - the 1980's oil glut.
The proximate causes of the oil glut were that other non-OPEC oil producers, spurred by the higher cost of oil, flooded the market. This included Britain and Norway, Russia (then the Soviet Union), Mexico, Nigeria, and Canada, combined with reduced oil demand from the U.S. and Europe thanks to a combination of the poor economy and conservation measures. By lowering the amount of oil on the market, this spurred an increase in price, and this increase in price spurred the development of oil in non-OPEC countries. Not subject to artificial OPEC quotas, they began flooding the market which had been depressed by the recessions caused by high inflation and interest rates. Oil consumption did not pass its 1973 level until 1983.
Wikipedia has a good summary of the oil glut:
In April 1979, Jimmy Carter signed an executive order which was to remove market controls from petroleum products by October 1981, so that prices would be wholly determined by the free market. Ronald Reagan signed an executive order on January 28, 1981 which enacted this reform immediately, allowing the free market to adjust oil prices in the US. This ended the withdrawal of old oil from the market and artificial scarcity, encouraging increased oil production. The US Oil Windfall profits tax was lowered in August 1981 and removed in 1988, ending disincentives to US oil producers. Additionally, the Alaskan Prudhoe Bay Oil Field entered peak production, supplying the US West Coast with up to 2 million bpd of crude oil.Nonetheless, this was seen as irrelevant by the money/banking establishment who saw Volcker's "tight money" policy as the answer. This was seen to validate Milton Friedman's ideas, and hence Neoliberalism. Because of the glut, it seemed like Reagan's policies of tax cuts for the rich, deregulation of the banks, and suppression of unions was the key to prosperity, a gospel which is still believed by a majority to this day. Keynesian economics was seen to have been invalidated.
From 1980 to 1986, OPEC decreased oil production several times and nearly in half to maintain oil's high prices. However, it failed to hold on to its preeminent position, and by 1981, its production was surpassed by Non-OPEC countries. OPEC had seen its share of the world market drop to less than a third in 1985, from nearly half during the 1970s. In February 1982, the Boston Globe reported that OPEC's production, which had previously peaked in 1977, was at its lowest level since 1969. Non-OPEC nations were at that time supplying most of the West's imports.
OPEC's membership began to have divided opinions over what actions to take. In September 1985, Saudi Arabia became fed up with de facto propping up prices by lowering its own production in the face of high output from elsewhere in OPEC. In 1985, daily output was around 3.5 million bpd down from around 10 million in 1981. During this period, OPEC members were supposed to meet production quotas in order to maintain price stability, however, many countries inflated their reserves to achieve higher quotas, cheated, or outright refused to accord with the quotas.In 1985, the Saudis were fed up with this behavior and decided to punish the undisciplined OPEC countries. They abandoned their role as swing producer and began producing at full capacity, which created a "huge surplus that angered many of their colleagues in OPEC". High-cost oil production facilities became less or even not profitable. Oil prices as a result fell to as low as $7 per barrel.
The corporate forces seized the opportunity to launch a counterrevolution that continues unabated to this day. The seeds had been sewn in the immediate postwar period by the establishment of the Mont Pelerin Society and the "Austrian" school, which attempted to rehabilitate unregulated markets in the aftermath of almost two decades of Depression and War caused by them. In 1971, Lewis Powell issued a memorandum calling on businesses to fight back and retake public opinion:
August 23, 2011 will bring the 40th anniversary of one of the most successful efforts to transform America. Forty years ago the most influential representatives of our largest corporations despaired. They saw themselves on the losing side of history. They did not, however, give in to that despair, but rather sought advice from the man they viewed as their best and brightest about how to reverse their losses. That man advanced a comprehensive, sophisticated strategy, but it was also a strategy that embraced a consistent tactic – attack the critics and valorize corporations!Bill Black: My Class, right or wrong – the Powell Memorandum’s 40th Anniversary (Naked Capitalism)
He issued a clarion call for corporations to mobilize their economic power to further their economic interests by ensuring that corporations dominated every influential and powerful American institution. Lewis Powell’s call was answered by the CEOs who funded the creation of Cato, Heritage, and hundreds of other movement centers.
Here's David Harvey explaining the change:
SL: The welfare state was characterized by a compact of sorts between labor and capital, the idea of a social safety net, a commitment to full employment -- you call this "embedded liberalism." Up until the 1970s it was supported by most elites. Why was there a backlash against the welfare state and the push for a new political economic order in the 1970s that gave rise to the political implementation of neoliberal thought?On Neoliberalism: An Interview with David Harvey (Monthly Review)
DH: I think there were two main reasons for the backlash. The first was that the high growth rates that had characterized the embedded liberalism of the1950s and 1960s -- we had growth rates of around 4 percent during those years -- those growth rates disappeared towards the end of the 1960s. That had a lot to do with the stresses within the US economy, where the US was trying to fight a war in Vietnam and resolve social problems at home. It was what we call a guns and butter strategy. But that led to fiscal difficulties in the United States. The United States started printing dollars, we had inflation, and then we had stagnation, and then global stagnation set in in the 1970s. It was clear that the system that had worked very well in the 1950s and much of the 1960s was coming untacked and had to be constructed along some other lines. The other issue which is not so obvious, but the data I think show it very clearly, is that the incomes and assets of the elite classes were severely stressed in the 1970s. And therefore there was a sort of class revolt on the part of the elites, who suddenly found themselves in some considerable difficulty, for economic as well as for political reasons. The 1970s was, if you like, a moment of revolutionary transformation of economies away from the embedded liberalism of the postwar period to neoliberalism, which was really set in motion in the 1970s and consolidated in the 1980s and 1990s.
Neoliberal economics, a free-market fundamentalist cult, became the world's predominant economic theory, as Keynesian economics was marginalized along with its practitioners. Rather than government being seen as a necessary force in mitigating the inherently unstable capitalist system and ensuring a relatively equitable distribution of surplus, it was recast as the problem--an impediment to the growth that would fix all problems. Unregulated markets where rational consumers could operate and "allocate capital" to wherever it was needed was the key to prosperity, the thinking went.
The Neoliberal economists, proclaiming themselves validated by the events of the 1980s, took control of the world's economic institutions . Something called the Washington Consensus took shape, and its policies were dictated by the old Bretton Woods institutions - the IMF, WTO and World Bank.
All tariffs would be abolished. Developing countries would be exposed to full competition from the heavily subsidized industries of the West. Workers in the West would now be in direct competition with workers everywhere, including in the the world's poorest countries. Even in the face of tax cuts on the rich, governments would no longer be allowed to run a deficit. Government spending, especially on vital social needs, would be curtailed. Debt crises caused selloffs of institutions to international investors who charged what the market would bear. Workers lost their pensions and were forced to invest in the unstable market for their retirement. Everyplace where these "reforms" were instituted, they were portrayed as great benefits for all. Economists proclaimed that the change was inevitable and irreverable. They pushed the idea of TINA - There Is No Alternative.
Reagan removed the solar hot water panels from the White House in 1986.
"Morning in America " unfolded alongside the 1980's oil glut.
The two largest Communist states realigned. The Soviet Union was already brittle, and the arms race with the U.S. had caused it to increase military spending. Gorbachev had begun to initiate tentative steps to reform, but was overtaken by events. When oil prices crashed due to the 1980's oil glut, the economy of the Soviet Union crashed along with it, as its exports could no longer fetch an adequate price on the world market. The Soviet Union collapsed in 1991.
The timeline of the collapse of the Soviet Union can be traced to September 13, 1985. On this date, Sheikh Ahmed Zaki Yamani, the minister of oil of Saudi Arabia, declared that the monarchy had decided to alter its oil policy radically. The Saudis stopped protecting oil prices, and Saudi Arabia quickly regained its share in the world market. During the next six months, oil production in Saudi Arabia increased fourfold, while oil prices collapsed by approximately the same amount in real terms.
As a result, the Soviet Union lost approximately $20 billion per year, money without which the country simply could not survive. The Soviet leadership was confronted with a difficult decision on how to adjust. There were three options–or a combination of three options–available to the Soviet leadership.
First, dissolve the Eastern European empire and effectively stop barter trade in oil and gas with the Socialist bloc countries, and start charging hard currency for the hydrocarbons. This choice, however, involved convincing the Soviet leadership in 1985 to negate completely the results of World War II. In reality, the leader who proposed this idea at the CPSU Central Committee meeting at that time risked losing his position as general secretary.
Second, drastically reduce Soviet food imports by $20 billion, the amount the Soviet Union lost when oil prices collapsed. But in practical terms, this option meant the introduction of food rationing at rates similar to those used during World War II. The Soviet leadership understood the consequences: the Soviet system would not survive for even one month. This idea was never seriously discussed.
Third, implement radical cuts in the military-industrial complex. With this option, however, the Soviet leadership risked serious conflict with regional and industrial elites, since a large number of Soviet cities depended solely on the military-industrial complex. This choice was also never seriously considered.Why did the Soviet Union fall? (Marginal Revolution)
Unable to realize any of the above solutions, the Soviet leadership decided to adopt a policy of effectively disregarding the problem in hopes that it would somehow wither away. Instead of implementing actual reforms, the Soviet Union started to borrow money from abroad while its international credit rating was still strong. It borrowed heavily from 1985 to 1988, but in 1989 the Soviet economy stalled completely…
The money was suddenly gone. The Soviet Union tried to create a consortium of 300 banks to provide a large loan for the Soviet Union in 1989, but was informed that only five of them would participate and, as a result, the loan would be twenty times smaller than needed. The Soviet Union then received a final warning from the Deutsche Bank and from its international partners that the funds would never come from commercial sources. Instead, if the Soviet Union urgently needed the money, it would have to start negotiations directly with Western governments about so-called politically motivated credits.
In 1985 the idea that the Soviet Union would begin bargaining for money in exchange for political concessions would have sounded absolutely preposterous to the Soviet leadership. In 1989 it became a reality, and Gorbachev understood the need for at least $100 billion from the West to prop up the oil-dependent Soviet economy.
In China, by contrast, the Communist party opened up their economy to the West in a controlled experiment. They exploited their bottomless pool of cheap labor and plentiful domestic coal to become the world's factory floor. The State retained control and controlled the development of the economy. American companies, looking for greater profits, packed up America's industrial base and shipped it to China, leading the low-wage Wal-Mart economy of today. Global wage arbitrage became recast as "free trade:"
...the news from China barely made a dent in the US in 1976. The Cultural Revolution was said to be winding down. Zhou Enlai died in February; an earthquake in Tangshan in July killed as many as 650,000 persons; Mao Zedong died in September. The Mandate of Heaven, an ancient governing concept in Chinese civilization, had, it was said, perhaps been lost. Americans were preoccupied with recovery from a recession, a presidential election, the bicentennial celebration of their Declaration of Independence; Europeans with their record-breaking hot summer.“A small cloud, no bigger than a man’s hand…” (Economic Principals)
Barely two years later, the Communique of the Third Plenum of the Eleventh Central Committee announced a plan to “shift the emphasis of our party’s work and the attention of the people of the whole country to socialist modernization.” People’s material lives must be improved, it declared; bureaucratic self-indulgence would not be tolerated. A “new Long March” would make China “a great modern socialist power” by the end of the twentieth century.
Lin was one of the very first movers in the epochal events that followed the third Plenum in December 1978. Millions followed, high and low, in accordance with Deng Xiaoping’s mantra, “Let some people get rich first.” By the end of the twentieth century, China was on the verge of becoming the second largest economy in the world. Average growth of ten percent for twenty years had lifted half a billion people out of poverty and changed the lives of countless others around the world.
Entry of China into the world trading system was only one of those once-small clouds to have swiftly grown into all-encompassing developments in the ’90s and ’00s. The advent of the computer was another; financial deregulation after Mayday 1975 was a third. These are the changes we are concerned with here. Still others – gender convergence, for example – have only just begun to have their impact gauged.
The flood of cheap goods from China offset workers' falling wages, once again giving a fig leaf to Neoliberal economics. The effects on Latin America, however, were a"lost decade" in Mexico caused by falling oil prices and a debt crisis throughout Latin America. It was these crises that drove the drug wars and poverty in Latin America. The response from international institutions was the full implementation of harsh austerity measures and the "disaster capitalism" of The Shock Doctrine.
When the world economy went into recession in the 1970s and 80s, and oil prices skyrocketed, it created a breaking point for most countries in the region. Developing countries also found themselves in a desperate liquidity crunch. Petroleum exporting countries – flush with cash after the oil price increases of 1973-74 – invested their money with international banks, which 'recycled' a major portion of the capital as loans to Latin American governments. The sharp increase in oil prices caused many countries to search out more loans to cover the high prices, and even oil producing countries wanted to use the opportunity to develop further. These oil producers believed that the high prices would remain and would allow them to pay off their additional debt.
As interest rates increased in the United States of America and in Europe in 1979, debt payments also increased, making it harder for borrowing countries to pay back their debts. Deterioration in the exchange rate with the US dollar meant that Latin American governments ended up owing tremendous quantities of their national currencies, as well as losing purchasing power. The contraction of world trade in 1981 caused the prices of primary resources (Latin America's largest export) to fall.
While the dangerous accumulation of foreign debt occurred over a number of years, the debt crisis began when the international capital markets became aware that Latin America would not be able to pay back its loans. This occurred in August 1982 when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no longer be able to serve its debt. Mexico declared that it couldn't meet its payment due-dates, and announced unilaterally, a moratorium of 90 days; it also requested a renegotiation of payment periods and new loans in order to fulfill its prior obligations.
After the petroleum boom previous to the government of Mexican president José López Portillo (from 1976 to 1982), Mexican government began to rely heavily on export barrels to support the financial needs in the country. These exports were mainly directed towards the United States, mainly due to the petroleum crisis of 1973, taking advantage of the high prices these barrels garnered.
When the market finally settled, thus reducing the high prices per barrel, the financial stability of the country was endangered. Diversification of income would have prevented the problem, but due to the inability of other production sectors to make up for the reduced profit, Mexico had to inflate the currency to by then historic levels. The Mexican peso would then be devaluated by a 500%.Latin American Debt Crisis (Wikipedia)
In the wake of Mexico's default, most commercial banks reduced significantly or halted new lending to Latin America. As much of Latin America's loans were short-term, a crisis ensued when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced, were now due immediately.
The banks had to somehow restructure the debts to avoid financial panic; this usually involved new loans with very strict conditions, as well as the requirement that the debtor countries accept the intervention of the International Monetary Fund (IMF)...
Before the crisis, Latin American countries like Brazil and Mexico borrowed money to enhance economic stability and reduce the poverty rate. However, as their inability to pay back their foreign debts became apparent, loans ceased, stopping the flow of resources previously available for the innovations and improvements of the past few years. This rendered several half-finished projects useless, contributing to infrastructure problems in the affected countries.
During the international recession of the 1970s, many major nations and countries attempted to slow down and stop inflation in their countries by raising the interest rates of the money that they loaned, causing Latin America's already enormous debt to increase further. In between the years of 1970 to 1980, Latin America's debt levels increased by more than one-thousand percent.
The crisis caused the per capita income to drop and also increased poverty as the gap between the wealthy and poor increased dramatically. Due to the plummeting employment rate, children and young adults were forced into the drug trade and prostitution. The low employment rate also caused many problems like homicides and crime and made the affected countries undesirable places to live. Frantically trying to solve these problems, debtor countries felt pressured to constantly pay back the money that they owed, which made it hard to rebuild an economy already in ruins.
Latin America, unable to pay their debts, turned to the IMF (International Monetary Fund) who provided money for loans and unpaid debts. In return, the IMF forced Latin America to make reforms that would favor free-market capitalism. The IMF also helped Latin America utilize austerity plans and programs that will lower total spending in an effort to recover from the debt crisis. The efforts of the IMF brought Latin America's economy to become a capitalist free-trade type of economy which is a type of economy preferred by wealthy and fully developed countries.
La Década Perdida (Wikipedia)
Mexico signed onto NAFTA and Mexican farmers were exposed to competition from imports of America's heavily-subsidized corn (also cheap thanks to gasoline-powered agriculture - Mexican farms were less mechanized). The destruction of the rural Mexican economy sent millions of economic refugees from the beanfields into "El Norte" in the nineteen-nineties searching for work that Americans "wouldn't do," or rather, wouldn't do for the prices employers wanted to offer. This was another win for Neoliberalism as this drove down working class wages in the U.S.
Thus the "Neoliberal Revolution" of the 1980's and 1990's across the world was underpinned by the price of oil from expensive to cheap.
In 1981, before the brunt of the glut, Time Magazine wrote that in general, "A glut of crude causes tighter development budgets" in some oil-exporting nations.In a handful of heavily populated impoverished countries whose economies were largely dependent on oil production — including Mexico, Nigeria, Algeria, and Libya — government and business leaders failed to prepare for a market reversal.Oil would continue to be relatively cheap throughout the 1980's and through the 1990's, once again making Neoliberalism seem the key perpetual prosperity. "Between November 1985 and March 1986, the price of crude plunged by 67%. ..After the mid-1980s bust, it took nearly two decades for oil prices to rebound to pre-bust levels and remain there." (http://www.wsj.com/articles/back-to-the-future-oil-replays-1980s-bust-1421196361).
With the drop in oil prices, OPEC lost its unity. Oil exporters such as Mexico, Nigeria, and Venezuela, whose economies had expanded in the 1970s, were plunged into near-bankruptcy. Even Saudi Arabian economic power was significantly weakened.
Iraq had fought a long and costly war against Iran, and had particularly weak revenues. It was upset by Kuwait contributing to the glut and allegedly pumping oil from the Rumaila field below their common border. Iraq invaded Kuwait territory in 1990, planning to increase reserves and revenues and cancel the debt, resulting in the first Gulf War.
The USSR had become a major oil producer before the glut. The drop of oil prices contributed to the nation's final collapse.
All that would change however. Certain organizations had predicted a global peak of oil sometime abound 2006...