Almost all of the death, injury, damage and destruction arising from hurricane Katrina is the result of the crimes of the Bush administration.

President Bush was criminally negligent in diverting funds that had been requested to protect the people of New Orleans for use in the criminal war of conquest in Iraq. The Bush administration did this in full knowledge of the impending danger. The highest government agency in charge of dealing with disasters, the Federal Emergency Management Agency, warned of the potential for disaster as early as 2001.

With the complete evacuation of New Orleans, tens of thousands trapped without food, water, or electricity, thousands of homes destroyed and the death toll mounting by the hour, this is a disaster of unprecedented proportion. It profoundly affects Black people, who are a major part of the population in Louisiana, Alabama, and Mississippi, and are suffering disproportionately because they are subject to racist discrimination—which leaves them in poverty and most vulnerable to such disasters. Seventy percent of New Orleans’ residents are Black and live in apartheid-like conditions.

Some politicians are calling it “our tsunami.” The tsunami last December also took an excessive toll of life because of criminal neglect. But a tsunami comes rarely. Hurricanes come to the delta region almost every year. This disaster was not only predictable but predicted. What seems like an inevitable tragedy caused by nature was foreseen long ago by scientists, engineers, government agencies, environmentalists and experts in disaster management.

The science writer for the Houston Chronicle wrote on Dec. 1, 2001:

“New Orleans is sinking.

“And its main buffer from a hurricane, the protective Missis sippi River delta, is quickly eroding away, leaving the historic city perilously close to disaster. ...

“So vulnerable, in fact, that earlier this year the Federal Emergency Management Agency ranked the potential damage to New Orleans as among the three likeliest, most catastrophic disasters facing this country.” The other two were an earthquake in San Francisco and a “terrorist attack on New York City.”

The federal, state and local governments knew of the danger. They knew what caused it and how to deal with it. But they did little or nothing. They left the people of the delta region unaware and helpless to deal with the inevitable disaster.

Why did they do nothing? An Aug. 30 dispatch of Editor and Publisher revealed that “$250 million in crucial projects” planned by the Army Corps of Engineers in the delta for shori ng up levees and building pumping stations could not be carried out. “The Corps never tried to hide the fact that the spending pressures of the war in Iraq, as well as homeland security—coming at the same time as federal tax cuts—was the reason for the strain.

“The 2004 hurricane season was the worst in decades. In spite of that, the federal government came back this spring with the steepest reduction in hurricane and flood-control funding for New Orleans in history.”

The Houston Chronicle’s 2001 report cited a study by a consortium of government agencies several years ago. This consortium recommended that between $2 billion and $3 billion dollars was needed for projects that could rectify the problem. That is less than the cost of one month of spending on the Iraq occupation, which costs $4 billion a month at the minimum! Certainly part of the $300-billion-plus spent on the war could have been used to take preventive measures.

Of course, while Bush is the immediate culprit, it must not be forgotten that the Democratic Party voted for the war and every nickel spent on it. So the Democrats are also criminally liable for both the devastation in New Orleans and the illegal war and occupation.

Now that the capitalist authorities have let this disaster happen, Bush is taking a business-as-usual approach to dealing with the disaster. Just as during the tsunami, it took him days to disrupt his vacation and step away from his Crawford ranch.

The federal government is the only authority capable of mobilizing the resources necessary for the rescue mission and the reconstruction. It is said that a million people were evacuated from New Orleans and the surrounding parishes (counties) before the hurricane. Actually, the government did not evacuate anyone. The authorities simply declared a mandatory evacuation and then left it to people to get out. Now they are saying that “at least a hundred thousand people” were left in the city itself.

People have no place to stay. Many have no food. Their personal belongings are all gone. Medical care is cut off. Schools are inaccessible. Countless are homeless. The immediate crisis requires a national mobilization of medical personnel, social workers, rescue experts, hydraulic engineers.

Food, water and medical supplies should be immediately commandeered for the emergency from agribusiness, supermarket chains, pharmaceutical companies. Wal Mart and other retail giants should be required to ship, gratis, clothing and other necessities to meet basic needs. Government food storage supplies in warehouses throughout the Midwest and other regions should be made available.

Every form of transport—planes, helicopters, buses, ambulances, small boats—should be mobilized to the region. These and other measures should be immediately implemented by the federal government based on its emergency powers and responsibilities.

In other words, all of this society’s material and human resources should be made available to the victims in this crisis. The corporations have control of these resources, but the workers who created them have every right to them.

Let the government and the bosses pay. Putting people—the suffering people of the delta—before profits should be the order of the day. The property restrictions of capitalism must be overruled in the interest of the masses.

Particularly, the oil companies should be forced to cough up billions of dollars for reconstruction out of the super-profits that they pump out of the delta region every day. Exxon Mobil refines 493,000 barrels of oil a day in Baton Rouge; Chevron, 325,000 a day in Pascgoula, Miss.; Conoco Phillips, 247 ,000 a day, to name a few. All this wealth has been taken out of the region, not to speak of the wealth spent trying to conquer Iraq and its oil. And they should not only give back the profits they gouged from the people by raising gasoline prices to over $3 a gallon—they should be forced to lower prices drastically.

In general, the giant multinationals should be made to ante up because of all the wealth and labor they have taken from New Orleans—through which so much of the wealth of this country flows—while the majority of people are left with just enough to survive.

As for the reconstruction effort, the authorities are taking a narrow approach. They are talking about months and years to recover. People with flood insurance can stand in line once they can get back to their neighborhoods. Poor people who have no flood insurance are on their own. Perhaps FEMA will give a few handouts to tide them over for a while. All the racist hysteria being whipped up about “looters” is a cover-up for the fact that the government has made no provisions to feed the people, and that so many Black people are living in dire poverty.

But the truth is, there is a much more rapid and comprehensive solution to turning the situation around right in front of the government’s nose. There are millions of workers who can be mobilized to go to the region to help out.

Right now there is a “housing boom” where hundreds of thousands of construction workers are toiling away as real-estate developers race to make super-profits on the speculation in the housing market.

What is needed is a full-scale mobilization of the building trades, construction workers, hydraulic engineers, medical personnel, social-service workers and workers from all over the country to stop capitalist business as usual and mobilize to help the people of New Orleans, Biloxi and the delta region—fully funded by the government.

Millions of unemployed workers could be hired at union wages to pitch in. Organized labor could be in the vanguard of organizing the reconstruction effort.

With all their technology, the bosses are preoccupied with how they can collect damages from the insurance industry, how they can get their profitable refineries back on line, and how they can resume making profits in the area as soon as possible. The working class, in contrast, is concerned with the fate of the masses of people, especially the Black, Latin American poor white and the exploited who suffer the most and will get the least help.

Once the reconstruction effort begins and communications become possible, unions, community organizations, and move ment groups should set up independent channels by which they can give aid and assistance to the people of the stricken area.

Mass mobilization, putting people before property, is how reconstruction projects are handled in Cuba and under the socialist organization of society. The demand should be put forward that the government treat this as a national emergency crisis of the greatest magnitude. Measures should be taken in proportion to the extent of the crisis—measures such as giving extended unemployment insurance to everyone in the area. Personal property loss should be fully restored. And the government should subordinate all its efforts to giving effective short term and long term aid to the victims. But at the same time the working class in this country should try to find a way to get beyond the capitalist authority and bring whatever aid and assistance it can to the people of the delta.

Political aspects of the Reaganomics

Given all of these economic consequences of the 1^st Reagan administration, it would be interesting to ask why so many ordinary Americans voted again for the 2^nd Reagan administration in 1984’s presidential election. Why did so many owners of farms and middle scale manufacturing industries vote for Reagan? Why did ordinary young Americans vote for the Reaganomics?

With respect to these questions, there might be following two answers: the first is related with Republican Party’s clever political strategy during the election period. From a political perspective, Reagan’s political strategies were more brilliant than those of Jimmy Carter and later Democratic Party’s presidential candidate, Walter Mondale.

Reagan promised relief from the anxieties of inflation without mentioning the costs of recession and unemployment. “Republican Party asked Americans to enlist in a great struggle to restore the nation’s economic health. But instead of demanding sacrifices and self-denial as Jimmy Carter had, Reagan demanded only that citizens accept a reduction in their taxes.”(369)

“Republicans held the symbolic high ground that the Democratic Party had once own in national politics – the party of growth and prosperity. On the contrary, Democratic presidential candidate proposed painful remedies – a major tax increase and substantial budget reductions to restore fiscal order.” (610)

From historical perspective, the historic positions of the two dominant political parties were reversed for the first time in political history during the 1984 election. “The Democratic Party felt trapped by its past government deficit policy, still tarnished by the inflationary anxieties experienced under Jimmy Carter.” Democratic leaders decided that they must convince the public of their newly developed sense of responsibility and so they campaigned for fiscal discipline.

In the meantime, the president’s party had effectively abandoned the old Republican orthodoxy that the Democrats started to attempt to mimic. From 1984 election, Republicans started to appeal their rhetorical loyalty to the idea of a balanced budget and fiscal order.

Of course, however, the conservative party had adopted the opposite in actual policy – an economy driven by increased federal spending (mainly for military subsidies) and increased debt (mainly from tax cuts), the most serious fiscal deficit policy ever attempted in peacetime. The old Republican complaint that deficit spending ultimately led to ruinous inflation was conveniently discarded in the presence of Republican federal deficits.

Secondly, Reagan fused nationalism into his presidential campaign. “It’s morning again in America,” “America is back,” “You ain’t seen nothing yet” are common slogans he used during the election campaign. “The spirit of nationalism, the warming glow of patriotic ferver swept the country.” And the news media amplified the illusions.

But from the benefits of hindsight, the Reagan administration’s economic policies were anything but nationalistic. Domestic industries – manufacturing, agriculture, oil and other minerals – were being decimated by the combined effects of Washington’s fiscal and monetary policy. “Ronald Reagan’s symbol of American revival, the strong dollar, was in reality assisting America’s foreign competitors, ceding a larger and larger share of world trade to other nations.”(643)

Nonetheless, what most ordinary citizens knew from their own lives appeared to match what the President told them. “The anxiety of price inflation was gone. Most important of all real disposable income per capita was rising throughout the campaign year at an extraordinary pace. In 1980, when Jimmy Carter was up for re-election, price inflation was above 13 percent and real disposable income was shrinking slightly due to brief recession.” Thus, when the President Reagan asked, ‘Are you better off than you were four years ago?,’ “the answer seemed self-evident for the majority of Americans.”(643)

Theoretical implication of the 1980s

From theoretical perspectives, economic policies adopted under the Reagan administration in 1980s can be characterized by free market fundamentalism along with monetarist anti-inflation policy. As we already mentioned, these economic strategies was based on the negation of the previously dominant liberal Keynesian economics.

However, unlike the forward-looking expectations of “supply side economics,” it was “demand side” which pulled and induced the investment. Even under the dire circumstances, it was not capitalist or entrepreneurs but ordinary households and consumers who spent their money leading entrepreneurs to expand their production facilities. In this sense, Keynesian notion of “effective demand” has remained effective even under the dominance of “supply side economics” in economic policy area.

Furthermore, Milton Friedman’s concept of inflation turned out to be wrong during the Reagan administration’s policy experiments. Friedman ascribed the cause of inflation to the excessive quantity of money supplied by the central bank. In other words, if the government pumped out too much money relative to the quantity of money necessary for the overall operation of economic activities in a given condition, he argued, this monetary policy would lead to inflationary pressures in the near future. According to him, inflation has been and will always be a “monetary phenomenon.”

However, apart from the question related with adequate quantity of money (how can we know and to what extent is the overall quantity of money necessary in a given condition?), his explanation missed the significant role of the velocity of money. If the velocity of money changes due to various reasons, his argument that the Fed should focus on the overall quantity of money, instead of trying to regulate real interest rates, would lead us in the wrong direction.

In sum, Reagan’s 1981 tax bill failed not only to increase the average saving rates in the United States, but also to induce the investment on productive capital. The Fed’s tight monetarist money policy not only depressed manufacturing sectors but also decimated future growth potentials of the US economy.

Concluding remarks

It seems necessary for me to conclude this review essay by introducing the merits of this book. The first virtue that I would like to mention is its style and structure. It is written and organized in plain English. Even those readers with basic level of English proficiency would not find any serious difficulties in understanding the main contents of the author’s arguments. Even though it seemed to be somewhat thick compared to ordinary paperbacks at first glance (717 pages for main contents and total 798 pages including reference, appendix and index), the way of writing was easy to follow and even exciting. It took a week for me to finish reading the book.

Second, the book is well organized. The book consists of four major parts, each of which mainly deals with the Fed’s institutional characteristics (“Part one: secrets of the temple”), its history and traditional roles (“Part two: the money question”), the Fed’s monetary policies in 1980s and their repercussions (“Part three: the liquidation”) and finally evaluations of the Fed’s economic policies in socio-political perspectives (“Part four: the restoration of capital”). Every chapter is closely connected with each other.

Third, this book is based on wide range of references, data analysis and intensive interviews. As you can see, the author spent for about 5 years to gather basic data and references. He also conducted in-dept interviews with former Fed chairman and many government officials in order to represent policy debates and economic climates around the Fed and the White House at the time. The author’s honest and meticulous descriptions of the affairs offer enough information about the Fed and US contemporary economic history.

Fourth, this book contains wide range of knowledge about the US history, philosophy and sociology not to mention economics. It deals with not only domestic consequences of the Fed’s policy in the 1980s but also shows how those policies have affected on world economy. In this sense, I was tempted to conclude that the subtitle of the book should be changed into “How the Federal Reserve Runs the World Economy.”

In sum, this book will be a very helpful guide for those who want to understand the history of US economic affairs – how does it develop and where will it go. Instead of doing laborious work for myself, I would like to finish this essay by citing the following precise praises for the potential readers: “startling and revelatory as well as probing and incisive. It is not only a major journalistic achievement but a major public service, for it is an immensely valuable addition to our understanding of the hidden forces that shape our lives.” – Robert A. Caro; “I expect this book to shake up Washington and probably Wall Street too. Bill Greider’s reporting goes right to the bone and marrow of American politics – how the government really decides the largest economic questions and whose influence really counts. This book may also be the public’s best chance to understand an enormously complex subject – money – because Greider’s narrative makes it lucid and even exciting.” – David A. Stockman; “a fascinating account of Paul Volcker’s extraordinary management of the Federal Reserve Board, and through the Fed, the American economy. I don’t know of any book that has made so ambitious and effort and succeeded so brilliantly.” – Robert L. Heilbroner; “a masterly look at the Federal Reserve System, William Greider drops the other shoes and argues that much of what passes for economic policy is really about politics. This is a book that should be read and talked about from one end of the country to the other.” – Senator Edward M. Kennedy.

* Reference for this review

Friedman, M. 1963. A Monetary History of the United States, 1860-1960, Chicago: University of Chicago

Krugman, P. 1990. The Age of Diminished Expectations – U.S Economic Policy in the 1990s, Cambridge: The MIT Press

------------. 1994. Peddling Prosperity – Economic Sense and Nonsense in the Age of Diminished Expectations, New York: Norton & Company

* Further reading list about the history and roles of the Fed and the US economy

Greider, W. 1992. Who Will Tell the People – The Betrayal of American Democracy, New York: Simon & Schuster (focuses on the implications of the Fed for the American democracy)

Woodward, B. 2001. Maestro – Greenspan’s Fed and the American Boom, New York: Simon & Schuster (deals with the roles of the Fed in the 1990s focusing on Alan Greenspan’s leadership and personality)

Rothbard, M. 2002. A History of Money and Banking in the United States – The Colonial Era to World War Ⅱ, Alabama: Ludwig von Mises Institutes (deals with the history of the US central bank system from the perspective of Austrian school of economics)

Stiglitz, J. 2003. The Roaring Nineties – A New History of the World’s Most Prosperous Decade, New York: WW. Norton & Company (deals with the US economic affairs in 1990s under the Clinton administration based on his personal experiences as an economic advisor for the President)

Global consequences Ⅰ – in the name of ‘glory’ of the strong dollar

Until now, we focused on Reagan and Volcker’s policies and their domestic impacts. However, it would be much more interesting to see that the Fed had played a significant role in international financial market even before the term “globalization” became one of the most buzz words in our ordinary lives.

First of all, it would not be so difficult to understand that the world economy has started to enter into the same economic recession due to the Fed’s contractionary money policy. The underlying logic was simple: once the richest market in the world declined, exporters around the world started to lose their customers. When the ordinary wage earners in the North America started to suffer from their losses of jobs and reduced incomes due to higher interest rates, it was natural for export-driven “developmental economies” in the Third World to suffer from losses of their consumers. The global economy was sinking into recession too, large nations and small ones alike, due to the same economic reason.

Even in these circumstances, however, central banks of other industrial nations had no other options but to raise their interest rates too allowing the depression of their own domestic markets. If they resisted raising interest rates in their own countries whatever the reasons, huge amount of money invested on their domestic capital account would flight into the U.S financial market for the short term arbitrage causing abrupt withdrawal and financial disorder in the domestic financial market.

It is not purely theoretical; newly elected socialist president of France, Francois Mitterrand, for instance, tried for a time to boost its economy through expansionary monetary policy in early 1980s. However, as soon as the French central bank lowered the interest rates, capital fled from French enterprises in search for higher returns available overseas. Instead of investing their assets, French capitalist sought for short term interest premium. Instead of lending their financial assets to domestic entrepreneurs, French financial asset holders withdrew their money from domestic capital account and invested on the US market. Due to this capital flight, France was depreciated rapidly. Instead of faster growth and full employment, the Mitterrand government had to face stagnation.

Secondly, there was another aspect the Fed’s monetary policy had. It was more indirect process but surely exacerbated by the Fed’s high interest rate policy. The higher interest rates available in the US attracted more and more foreign wealth to dollar-denominated financial assets. The worldwide demand for dollars was increasing, but the supply of dollars was still held tight by the Fed, so naturally the international price for dollars – the foreign exchange rate at which other currencies were converted into US dollars – started to go up.

From then on, an international bank or a corporations or private investor who wished to buy dollar assets would have to pay with more francs or pounds or yen. “From July 1980 to September 1981, the dollar appreciated by 36 percent in its international exchange value with the German mark. In 1979, the yen had traded at less than 200 yen to the dollar. By 1983 the ratio was 235 yen to the dollar.”(414)

This rapid appreciation of the dollars in turn “drove away foreign buyers of American products, just as high interest rates drove away the domestic customers from goods and services. It made US exports more expensive for overseas customers proportionately, and at the same time made foreign imports cheaper in American marketplace.”

In extreme case, for example, American farmers who have previously produced their grains and corn much more cheaply in Iowa and Kansas and have sold them on overseas markets would lose their price competitiveness in foreign markets accordingly. “The machine tools produced in Germany and Japan would drive away American competitors from Cincinnati and take away customers in their own domestic market.” “American grain farmers lost more than a third of their share of the global market from 1981 to 1983 as the export price of their wheat and corn practically doubled.”(415)

In the meantime, “foreign producers of auto, steel, machine tools, computer chips and a long list of other manufactured products grabbed a larger and larger share of the American domestic market. US import of manufactured goods rose by 66 percent over four years’ time and US exports declined by 16 percent.” (593)

In a sense, this process can be described as an exploitation of producers for the interest of consumers, which every mainstream economic textbook cites as an example of the benefits of free trade. However, since American consumers are consisted of owners of farms and agricultural workers, owners of small scale of factories and industrial workers, the process of cost and benefit analysis will be highly complicated; Those who were engaged in farming and middle scale manufacture industries would lose their lands, factories and jobs due to expensive money borrowing. Those who barely succeeded in maintaining their factories and farm would now finally lose their lands and factories due to the rapid appreciation of their national currency.

During these periods, “hundreds of thousands, perhaps millions of US jobs were extinguished by the strong dollar. The Reagan administration celebrated the stronger dollar as a sign of America’s restored vigor, but in international trade, the advantage flowed to the weakening currencies of Europe and Asia. By 1983, the estimated losses exceed 1.5 million American jobs, most of them high-wage, unionized jobs in manufacturing.”(593)

But what damaged American production was rewarding for American finance, especially for the major banks active in international markets. The rising dollars meant that the value of their overseas dollars was rising too. It also meant that market demand was growing for the commodity that American financial institutions traded – US financial assets. “As long as the Fed held interest rates high – higher than competing returns in foreign countries – capital naturally flowed across boundaries, seeking the higher returns available in American financial institutions. And as the demand for dollars increased, the dollar would naturally get harder and harder in foreign exchange. In other words, the stronger dollar was good for business – if your business was finance.”(416)

Admittedly, the Reagan administration had the power to intervene with the Fed’s policy through Treasury ministry. “The dollar’s international value was one of the few areas of monetary policy where both law and tradition gave higher authority than the Fed to the executive branch. The Treasury Secretary was responsible for US dollar policy, and if it wished he could advise the Fed to adjust its domestic interest rates accordingly. Or Treasury could coordinate interventions in foreign exchange markets – buying or selling dollars by both Treasury and the Fed to push the price of the dollar up or bring it down. But it did not use this power.” (416-417)

Given this unique balance of power controlling the international value of the dollar, it is still mysterious why the then US Treasury did not intervene with international exchange market, allowing the rapid appreciation of the dollars. The author of the book, William Greider estimated that it might be because the Reagan administration truly believed that laissez-faire policy would bring about economic recovery. But it also might be because the officials at the administration were so ignorant that they could not know their legal executive power of balancing the terms of international currency.

Global consequences Ⅱ - the Third World debt crisis

However, the most serious impacts of the Fed’s economic policy on global economy were on the less developed countries (LDCs) in the Third World, whose economies largely depended on the US market.

First of all, their economic output and real incomes fell disastrously as much as 10 percent in some instances, as their export markets dried up and the price of raw material commodity such as copper and rubber price began to fall sharply. “What was to become a severe recession for Americans was catastrophe for the citizens of these poorer countries in Africa and Latin America and Asia.”(415)

At the same time, the debt burdens of the LDCs expanded dangerously. The worldwide spike in interest rates had raised the cost of the debt, the hundreds of billions in outstanding loans previously borrowed from the banks of Europe and America. As interest rates rose, the LDCs found themselves surrounded by rising cost of interest payment. They could not even have short time to think of the payment of original loan. “Both government and businesses in the struggling nations were compelled to borrow more and more, simply to keep up the payment of interest on their old loans.” (415)

In a sense, the debt crisis had its origins in the Fed’s policy failure itself. In the late 70s and early 80s, the Fed and other US governmental regulators had failed to impose prudent limits on the money center banks and their competitive lending to the Third World. They had issued mild warnings occasionally, but they had not tried to prevent the risky lending. Then starting in 1979, Volcker launched his aggressive campaign to break inflation, rationing money tightly and imposing a stern discipline on the world currency market.

The Fed’s failures of regulation are now turning its direction to the US domestic financial market like returning boomerang. If some Latin American countries declare the default, this would result in huge amount of losses in commercial banks in the US. If this detrimental effect were not prevented from happening in advance, the whole US banking system and economic order would be collapsed.

The first challenge originated from Mexico. “The United States and Mexico were economically intertwined by trade, labor supply and finance. If Mexico declared default, it would influence most of American banks. At the early 1980s, Mexico owed $80 billion to the major American banks such as Citibank and Continental Illinois.”(485)

Paul Volcker and the Mexican finance minister agreed that Mexico should borrow money from the International Monetary Fund in the near future. However, the Fed’s chairman decided to lend huge short-term loans from the Fed reserves in order to prevent Mexico’s abrupt default declaration before the Mexican government went to the IMF. “The Fed, in addition to its other roles, was authorized to play lender of last resort to other nations. On April 30, it lent Mexico the $600 million, the first in a series of short term multimillion dollar loans called ‘currency swap.’”(485)

In theory at least, the debt crisis might have been avoided if the Fed had not chosen such an abrupt approach to decelerating price inflation. The LDCs were heavily dependent on credit. But the Fed had drastically raised the cost of their borrowing while simultaneously depressed their sales and incomes. “If the world economy had not been pushed down so far, if interest rates had not been forced so high, these debtor nations might have survived the contraction. As it was, they had no time to adjust and really no alternative but to keep borrowing more, just as weakened American corporations had to increase their borrowing to survive the recession.”(521)

In this respect, whether there were no alternative to the Fed’s aggressive anti-inflation policy seemed to be relevant. The Fed tightened money to curb the inflation. “The general public agreed that double-digit inflation must be curbed somehow, but if the question was examined carefully, it was not at all clear that a deep recession induced by the Fed’s monetary policy was the best way. The 1981 inflation, for instance, was driven by escalating prices in oil and agriculture. In this case, the price inflation might have been contained by temporal price controls and other aggressive government policies.”(394)

The cost and benefit analysis

The Fed imposed the most severe discipline on the US economy ever attempted in the history of the American central bank for thirty-three months. The Fed’s monetary policy had forced interest rates up to the highest levels over 20 percent. In effect, credit was rationed for two and a half years, and the scarce supply of credit was allocated by price. The high price of money effectively eliminated borrowers who were too small or underfinanced to afford the loans.

Despite various problems, however, this policy worked. “The GNP contracted in real terms by more than $82 billion from its peak, and since 1979 the country had accumulated as much as $600 billion in lost economic output. The excess supply of goods, the declining incomes, and the surplus labor had worked to force down their wages and commodity prices. Overall price inflation fell dramatically from above 13 percent to less than 4 percent by 1983.”(507)

Even though the Fed succeeded in its anti-inflation campaign, the cost was tremendously high. We can analyze this cost in its effects on the transformation of the US economy, the changes of consumption patterns, the regressive changes of income distribution.

First, the Fed’s tight money policy affect unevenly on various industrial sectors. As we already mentioned, those who borrowed huge amount of money to expand their lands and production facilities had to face dire circumstances in which their debt burdens increased substantially in a short notice. Those who borrowed money to buy house and car had to suffer from both their reduced incomes and increased interest payment at the same time. Some of farmers and small scale manufacturers went bankrupt losing everything. Some households had to lose their real estates, and suffer from credit (mortgage and loans interest) payment for a long time.

However, there was another manufacturing industry which gained the monopolist profit. Apart from financial investors, the military industry was a major winner under the Reagan-Volcker’s strategy. The production of armaments was an important special case among manufacturing sectors. “The defense companies and their allied support industries enjoyed two special advantages under Reagan administration. Firstly, the massive budget increases for defense sector expanded their market enormously. Secondly, arms manufacturers benefited from cheaper labor, as wages for skilled industrial workers were depressed generally by the slack employment.” (600-601)

Second, the Fed’s stabilization of money was also an underlying cause driving the frenzy of corporate take-over battles in the 1980s. “The Fed deplored the practice and even introduced regulations to curb the use of the junk bond used to finance many of the corporate buy outs. Nonetheless so long as monetary policy maintained such high real returns for financial investments and simultaneously depressed the return from real assets, smart investors would naturally seek ways to get their capital out of one and into the other.” (661)

Third, there is another issue related with household’s consumption patterns. In the age of inflation, it was wise decision for ordinary consumers to buy houses and cars with mortgage or credit whatever the interest rate might be. If the inflation continues, buying something today is a good deal because the credit interest rate will be undermined by high inflationary pressures. From this era on, the ordinary Americans’ consumption pattern would be a good source for boastful strong consumer power.

However, this pattern did not change even after their real incomes were reduced substantially because even under these circumstances people had to buy something to live. But the behind logic became different. While American consumers tried to buy today during the inflationary era because it was a good deal, this time they do the same thing because they could not accept the new reality of their reduced status. “By going deeper into debt, they kept spending and hoped that their prospects improved. Millions of families borrowed money to spend during and since Reagan administration. Personal debt accumulated rapidly.”(656)

From now on, previously praised strong American consumer powers now started to turn out to be a castle in the air. The US’s total outstanding debt – government and private – was $7.1 trillion at the end of 1984, nearly doubled since 1977. The alarming point was that domestic debt had increased by more than 25 percent in 1983 and 1984 alone. The outstanding debt had become more than 60 percent larger than GNP.

The Reagan and Volcker’s economic policies also revealed the changing pattern of the US consumer market structure and aggravating standards of living. First of all, since 1980s “the mass market became shrank and split apart. The auto industry, including the rising sales volume captured by foreign imports, never recovered the same market that it had enjoyed in the 1970s.”

Secondly, the retreat from home buying was more fundamental to the American standard of living. During the 1980s, a lot of young couples were priced out of the housing market by high mortgage interest rates or by reduced personal incomes that were too depressed to support a mortgage. For the first time in forty years, the percentage of American families that owned their own house actually decreased during the Reagan Presidency. “The rate of homeownership among Americans had increased steadily from 44 percent in 1940 to 66 percent by 1980. Starting in 1981, homeownership began to decline for the first time since World War II. By 1984, it was down to 64.5 percent. By 1986, it fell to 63.9 percent.” (654)

Finally, the Reaganomics had detrimental effects on income distributions. The 1981 tax legislation proved to be regressive in a more fundamental way. It became the pretext for a vast redistribution of incomes, flowing upward on the income ladder, through another powerful channel – interest rates. The largest benefits in reduced tax burden went to the wealthiest taxpayers, and the tax relief became proportionately smaller and smaller for families that were less well off.

According to the US Census, “only families on the top 20 percent of the economic ladder enjoyed real increases in their after-tax household incomes from 1980 to 1983. The others, the bottom 80 percent actually lost. The highest fifth, families earning $38,000 or more, gained an average of $1,480 per household in real income, and the top 5 percent, earning more than $60,000, gained an average of $3,320. Families in the middle lost about $560 and the working poor lost about $250.”(401)

Apart from these analyses, the author argues that the Fed strategy may have left larger consequences for the US economy as a whole. Once the boom was broken, “the economy never regained a normal vigor. After the second quarter of 1984, the path of expansion remained below the historic trend line for economic growth, even below the growth rate during the decade of the 1970s, which was universally considered disappointing. The economy did not go into recession. But it sputtered and started and disappointed normal expectation.” (647) From then on, the US economy has showed staggering economic growth patterns and has entered the new era which Paul Krugman once called “the age of diminished expectation.”

The Fed in action

The time when the Carter administration decided to nominate Paul Volcker as a new chairman of the Fed, the U.S economy in the late 1970s was facing up exactly the same threats as this case. The Fed led by Paul Volcker started to tight money supply in order to fight against persistent inflationary pressures.

Traditionally, the Fed had rights to regulate various financial resources including overall money supply, credit markets derived from the original money and bond market. In the early 1970s, however, the US congress already passed the law targeting the deregulation of the banking system. This bill included the abolition of market barriers which had traditionally prohibited potential financial asset holders from starting banking businesses, and the deregulation of credit markets.

Thus, when Volcker was nominated as a new chairman, he found that the only option for the regulation of the financial market was the control of the supply of money by trading government bonds. This is the determinant of the “federal fund rate.” Once the federal fund rate is determined by the Fed’s “open market operation,” this will also determine other commercial bank’s interest rates accordingly. Combined with the Fed’s right to urge bank to maintain certain range of reserve rate, this monetary policy will affect overall economy indirectly.

Paul Volcker and his committee started to fight against inflation by reducing overall supply of money. If the Fed started to sell Treasury bonds at higher interest rates, this would absorb huge amounts of money previously abundant in the real market. Furthermore, if the Fed started to raise its federal fund rates, financial asset holders would start to buy government bonds. In this way, the Fed under Volcker’s leadership tried to tighten the valve through which the blood flew into every part of a living body. The Fed and Volcker expected unprecedented economic frenzy would subside through its contractionary monetary policy.

As interest rates rose in financial markets, many potential customers would be discouraged from buying at the higher prices. Customers who still wanted to buy despite the higher interest rates would find it harder to obtain loans. Many farmers who borrowed at the higher interest rates in order to buy land and expand production facilities started to learn the hard way in the face of high pressure of repayment. Many families who borrowed at the higher interest rates in order to buy homes and cars started to realize that they were burdened with higher interest payment. They went into deeper debt to compensate for their shrinking incomes and interest payment.

However, the impact of higher credit did not fall on evenly all American people and enterprises. Some were forced to go without. The millions of American who depended on borrowing started to suffer additional distress – consumer, farmer, home builders, auto dealers, business of every type in small scale started to suffer from high interest rates without understanding the behind economic logic.

Contrast to situations of ordinary citizens, those who lend money would naturally gain from higher interest rates. At that time, “among individuals, the top 10 percent of American families owned 72 percent of corporate and federal bonds held by individuals plus 86 percent of state and local bonds. Among institutions, commercial banks owned about 20 percent of the outstanding Treasury debt and another 10 percent was owned by insurance companies and other corporations. The same people likely to hold the bonds in their personal portfolios also owned the stock of the corporations and banks that owned bonds.”(372)

At any rate, the Fed under Volcker’s leadership started to control overall quantity of money instead of regulating interest rates directly. In economics, there are only two ways to achieve certain range of interest rates. One is to control overall quantity of money, and the other is the regulation of real interest rates indirectly through the Fed’s bonds trading. Volcker and other Board members adopted officially new monetarist rule when they tried to fight against inflation.

Pendulum swung – from liberal Keynesian to conservative monetarism

We should pay a little attention here to the theoretical and ideological terrain of the time in order to understand the behind logics underlying the Fed’s monetarist rules. Since the Great Depression in the 1930s the U.S federal government and most other western industrialized countries had adopted the same in nature expansionary government’s fiscal and monetary policy under the guide of Keynesian economics.

The US federal government had invested its federal budget on public work projects such as infrastructure constructions and buildings on behalf of private corporations through its expansionary fiscal policy in order to stimulate the “aggregate demand” in the private economy. Through its monetary policy, the US Federal Reserve pumped out more money thereby leading to and maintaining lower interest rates favoring private entrepreneurs to invest on more productive capital. All of this policy mix naturally produced temporal fiscal deficits in the federal budget.

However, liberal administrations from Franklyn D. Roosvelt to John F. Kennedy argued that once the economy gained its momentum engineered by therapeutic federal government’s deficits, the increased economic activity would compensate for the budget deficit shortfall in the medium or long run. The increased demand for goods from “demand side” would lead wealth owners and corporations to invest in new factories and plants, and this in turn would result in offering much more employment opportunities. In this way, the devastated economy in the era of the Great Depression and war would recover its normal process of capital formation and secure capitalist economic growth.

This liberal Keynesian economics had really worked until it faced new economic phenomena called “stagflation” in the mid-1970s. From then on, the US economy had to deal with stagnant economic growth combined with growing threat of inflation at the same time. It was Milton Friedman who already anticipated similar economic results almost 10 years ago. In 1963, Friedman published with coauthor Anna J. Schwartz, A Monetary History of the United States, 1860-1960. In this book, Friedman argued that Keynesian economics was totally wrong. Unlike Keynesian’s wishful thinking, he argued, interventionist government’s monetary policy has devastated real economy.

With respect to the role of monetary policy, he observed that both the original collapse of 1929 and the long lasting economic contraction of the real economy in 1930s were partly caused by and surely exacerbated by the Federal Reserve’s failure to provide adequate money supply. Instead of trying to manage the overall quantity of money in accordance with the pace of economic growth, the Fed pumped out too much money and eased the credit when the actual economic situation is on the process out of recession thereby leading to fervent economic bubble and burst. On the other hand, the Fed had tightened money too much when the money for various investments was really needed the most.

In this way, Friedman argued that the Fed played a role in exacerbating the devastating effects of business cycles than otherwise might not be necessary. Thus, the Fed should revise its unique roles from trying to manage real interest rates to offering adequate quantity of money to secure ‘the overall stability’ of economic system - stable backgrounds for the overall economy.

Friedman also warned that if the Fed did not change its traditional roles, its reckless monetary policy would result in continuous inflation combined with the effects of “crowding” private investment out of the market. In the face of federal deficits combined with high inflationary pressures, his monetarist argument had gained wide recognition and acceptance from both academia and politicians.

If you remember the term “economic policy entrepreneurs” used by Paul Krugman in his book, Peddling Prosperity – Economic Sense and Nonsense in the Age of Diminished Expectations(1995) to designate those who sold profound economic ideas to politicians in the simplistic way, Friedman’s monetarism was the best selling ideas adopted by a group of conservative economic policy entrepreneurs called “supply siders” in real politics from the mid-1970s. In the end, faced with intense criticism from both monetarism of academics and supply siders of Republican Party, the Fed had to change its target of monetary policy from the management of interest rates to the management of aggregate money supply.

In the face of massive tax cuts

There was another reason why the Fed chairman tried to tighten money supply extremely. Since 1980 newly elected president Ronald Reagan adopted massive tax cuts policy, guided by supply siders who argued that US citizens had been suffered from heavy burdens of federal taxes. They maintained that reduced tax burdens would induce much more investments (saving) and this would in turn bring about economic prosperity. Aided by his economic advisors, Reagan asked the congress to approve a three-year reduction in individual income taxes rates, totaling 30 percent.

To foster business expansion, he proposed additional tax relief for corporations as well as relief from federal regulations. All together, this supply side economics would reduce the federal government’s revenue by a total of $540 billion over five years. Reagan promised that the federal government would produce a balanced budget by 1984 once the economy gained momentum through his federal tax cuts and its effects. But, considering his another agenda, federal budget increases for military defense industries, Reagan’s proposed tax reductions would lose $100 billion a year in government revenue.

Nonetheless, the US congress passed this tax legislation in 1981. Volcker and other Fed committee members considered this federal government’s fiscal deficits as another ominous source for higher inflationary pressures in the near future. Even though the components of the federal budget expenditures became different from previous fifteen years of liberal administration’s deficits (from public work projects and social security spending to military subsidies combined with massive federal tax cuts), the Fed chairman and other precautious financial investors had learned that huge federal deficits were usually predicates for continuing price inflation.

That was why Volcker warned continuously against Reagan administration’s massive budget deficits, and had adopted aggressive tight money policy throughout his tenure. “The direct cause of the higher rates was the bond market and the Fed, reacting together. Both feared the same thing – the inflationary potential of the deficits – and both moved protectively, ahead of the fact. The Fed moved short-term rates higher, expressing the same anxiety as the bond market.” (402)