How Inflation Ended Neoliberalism

"Inflation is remaking America -- again. It looms above all competing explanations for Donald Trump's comeback. Despite the widespread belief that the worst economic cost of curing inflation -- a steep recession -- had been avoided, it turned out the political price had yet to be paid.

The power of inflation to destroy a political establishment emerged clearly in the 1970s, when a decade of rising prices transformed American society and politics. High rates of inflation ushered in an age of neoliberal economic policies focused on free markets, free trade and globalization. Mr. Trump's election, to be sure, marks a repudiation of this consensus. But ironically, this final break from neoliberalism came because both left and right ignored its signal achievement: decades of stable prices that insulated our fractious democracy from the pressures and strains that today threaten to tear it apart.

John Maynard Keynes said the best way to overturn "the existing basis of society" was to debauch the currency -- wisdom he attributed to Vladimir Lenin. The 1970s illustrate his point. While the rest of us think of disco, wide ties and Richard Nixon, economists know this decade as "the Great Inflation" -- a steady and sustained rise in prices for nearly a decade, at a rate that in some years exceeded 10%. Not coincidentally, the decade also saw the dawning of globalization, financialization, accelerating inequality and a powerful new taxpayer politics, all of which can be traced directly to the rise in prices.

It was America's inability to control inflation that shattered Bretton Woods, the postwar currency system that bound the major trading nations together, ushering in a new era of globalization. Central to Bretton Woods were fixed exchange rates and capital controls, both of which gave governments considerable leeway over foreign investment and trade. The system couldn't hold as the U.S. dollar inflated and lost value. Under Bretton Woods, other governments could trade their dollars for gold, and they did so with increasingly frequency. Fearing the Treasury would run out of the precious metal, Nixon slammed the gold window shut, killing Bretton Woods in the process.

Instead of a managed, regulated currency system, the U.S. and the rest of the world moved to a regime of floating exchange rates, in which currencies traded against one another in global capital markets. Emerging alongside new computing technologies, this new system of fluid currencies accelerated globalization and underwrote the first serious challenges to U.S. manufacturing from abroad.

At the same time, pervasive inflation meant skyrocketing interest rates, which pushed the economy toward financialization and simultaneously deepened inequality. Because it was easier to earn interest from accumulated capital than reinvest in factories and infrastructure, major corporations turned away from manufacturing and toward financial markets. The CEO of U.S. Steel, once a linchpin of American industry, announced that it "was no longer in the business of making steel" but "in the business of making profits."

In 1980 Congress hastened this process, along with sweeping deregulation of the financial system, by passing the Depository Institutions Deregulation and Monetary Control Act. This wasn't the brainchild of free-market economists or the Reagan administration. Rather, the legislation was signed by Jimmy Carter and drafted in response to complaints from consumer advocates and commercial banks, which chafed against interest-rate caps. They pointed out, and rightly so, that the wealthy were able to benefit from high interest rates by using private banks and sophisticated investment vehicles.

Financial deregulation in this context was a move toward equality. Yet in the end, financialization mainly benefited financiers. Along with globalization, it pushed the U.S. economy toward the FIRE industries dominated by educated professionals -- finance, insurance and real estate -- and away from the stable manufacturing jobs that predated inflation's rise.

In turn, this rising inequality ignited a populist reaction: the tax revolt of the late 1970s, epitomized by California's Proposition 13 in 1978. This was a fierce new homeowner politics that, like the push for financial deregulation, stemmed from a mismatch between existing policy and the new era of inflation.

Property taxes in many states tracked assessed value, calculated annually. When prices were steady, these taxes were predictable and manageable. When this tax rose by 7%, 8% or 11% because inflation had driven up home values, the result was rage. Pensioners and retirees, among others, feared the government would tax them out of hearth and home. Shaped into ballot initiatives by conservative political entrepreneurs, this rage fueled a durable political uprising that capped property taxes at a percentage of purchase price. The resulting fall in state revenue would hit education hard, again driving inequality.

Subtly but surely, the ways Americans made a living, managed their economic institutions, traded with other nations, and understood the role of government transformed. The existing basis of society, for many, was overturned.

But what happened next? After the Great Inflation came what economists call the Great Moderation -- roughly 25 years of global price stability, with no major recessions, stretching from the mid-1980s to 2007. The new economic orthodoxy that emerged, which critics called neoliberalism, took inflation as a core concern. To varying degrees, both political parties embraced a standard menu of lower taxes and reduced spending and regulation, while monetary policy took priority over fiscal policy in managing the economy. At the heart of the neoliberal order lay a commitment to low inflation and rules-based monetary policy. Unlike previous eras of American history, financial shocks and crises -- of which there were plenty -- didn't cause high inflation or deflation.

This isn't how we remember the 1980s, 1990s and early 2000s, because we often focus on the unfolding of the stories that started in the 1970s. We see the rich getting richer and the poor getting poorer, the decline of manufacturing, the birth of a new global economic order. But in the sweep of American economic history, it is a remarkably long period of stability. The disorder and divisions of the late '60s and the Watergate era subsided, the political system functioned at a level that seems enviable today, and while some economic losses persisted, others were repaired.

Yet in recent years, a new elite consensus has emerged that blames neoliberalism for all our social, economic and political problems. Since the 1970s, the story goes, Americans have traded a stable, regulated mixed economy for the Wild West of unfettered capitalism. The essence of this story is true: The 1970s did inaugurate a new economic era that rewired the existing basis of society through globalization, financialization and the rise of conservative economic populism. Yet rarely does this story grapple with inflation, the fundamental cause of neoliberalism's rise and many of the changes it wrought.

It's tempting to leave inflation out of this story because the lessons it offers often aren't ones we want to hear. For one thing, inflation can be ignited by government spending, as the Covid-19 era demonstrates. When we like the reasons we're spending or regard it as necessary, we don't want to hear about the negative consequences. Moreover, fighting inflation is painful. What broke the back of the Great Inflation was the Volcker shock -- the 1982 recession caused by Federal Reserve Chairman Paul Volcker's deliberate policy of setting interest rates high enough to reset the price level and end the cycle of inflationary expectations. Along the way, unemployment reached Depression-era levels in key industries, and many never recovered. This is the worst-case scenario today's Fed sought to avoid at all costs.

Yet in the early years of the pandemic, policymakers brushed aside concerns about emerging inflation as a relic of the past, perhaps believing they were in a new world where the old lessons didn't apply. Because neoliberalism is so often framed as a failure by both left and right, few stop to consider why new ideas and approaches to the economy emerged after the 1970s, why they lasted so long, and what they may still have to offer. With Milton Friedman vilified as an arch-neoliberal, few noticed that pandemic relief programs approximated what he called a "helicopter drop" -- a policy intended to create inflation. That isn't to say relief payments were unjustified, and Friedman would likely have supported some of them. But they were undertaken with little sense of their potential downside, economically or politically.

That inflation came down without a recession is a triumph for economic policy; that it emerged at all is a failure of both economics and politics. Although he has inflation to thank for his victory, Mr. Trump shows little understanding of its dynamics. Many of his proposed policies may reignite the price rises he promised to cure, and the rise in year-over-year consumer-price inflation to 2.6% in October is a warning sign. Yet whether inflation sparks again or recedes, leaving Mr. Trump's election as its only legacy, one thing is sure: We are standing at the precipice of another great social and political transformation -- because money matters, even when we wish it didn't.

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Ms. Burns is an associate professor of history at Stanford, a research fellow at the Hoover Institution and author of "Milton Friedman: The Last Conservative."" [1]

1. How Inflation Ended Neoliberalism. Burns, Jennifer.  Wall Street Journal, Eastern edition; New York, N.Y.. 16 Nov 2024: A.11.