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I noticed
some interesting things regarding the end of the "bull market in
gold" (dollar devaluation episode) of the 1970s that I thought were
worth passing on.
Here's
what it looked like:
 
Here's a chart of the Fed Funds rate of that time. Remember, the Fed didn't
have a Fed Funds rate target in those days, at least in the late 1979-1982
period. They
were busy with the Monetarist Experiment.
From this, I think you can see that there was, first, some amazing
volatility, but also that a higher FF rate tended to be accompanied by a
rising dollar, and a lower FF rate would be accompanied by a falling dollar.
I suppose some people will see that and immediately become a little too
dogmatic about their "real interest rate" types of theories. I've
seen too many countries blow up trying to support their currencies with a
high interest rate target to take that very seriously. It's important to
remember that there wasn't an interest rate target at the time. Rather, the
interest rate was the consequences of open market operations within the
Monetarist framework. However, I think we can also see that they weren't
being too serious about the Monetarist thing, and were also keeping an eye on
interest rates.
One thing that the high interest rate showed was that the Fed was willing to
do something apparently economically destructive in order to support the
dollar's value. For many years, the Fed had a policy of "accomodation," which is to say that they would keep
policy relatively easy to avoid recession. The result was the gradual, and
then not-so-gradual decline of the dollar's value.
Let's look at the most dramatic 1979-1980 period a
little more closely.
We can see clearly that the dollar decline paused in October-November 1979,
when there was a big rise in the Fed Funds rate. Was the Fed finally getting
serious? I can imagine there was then a big backlash and stocks dropped a
bunch, so the Fed backed off. This was evidence that the Fed wasn't serious
after all, and the dollar's value collapsed. Then, beginning around February
1980, the Fed Funds rate climbs again to very high levels, and the dollar
rises. The Fed Funds rate falls again in May 1980, and the dollar declines
again.
This sort of thing no doubt added to the "Volcker Myth" that very
high interest rates and a recession were necessary to stop the inflation. In
practice, nothing of the sort is necessary. What if, instead of fooling
around with this sort of seat-of-the-pants Monetarism, a gold standard policy
was announced? In that case, interest rates might fall quickly, because it is
wonderful to get paid 15%+ in a gold-linked currency. The lower interest
rates and stable currency would cause the economy to boom.
Here's a look at the "real Fed Funds rate" during that time:
You can
see the big change that the Volcker move to higher rates signified. You can
also see how the Fed had a tendency to have a "negative real Fed Funds
rate" during the late 1970s. This is the "accomodation"
policy. The Fed Funds rate was rising during the time, but so was the CPI so
the "real" number came out negative.
Today, of
course, the Fed has a deeply negative "real" Fed Funds rate. But,
this compares to the official CPI, which has been so badly abused that nobody
takes it very seriously today. Shadow Government Statistics shows what the
CPI would look like today if it was computed the same way it was in 1980:
This data is why I expect the present devaluation episode of the U.S. dollar
to continue probably until a) "real interest rates" are strongly
positive; b) the Fed abandons all "accomodative"
tendencies to support the value of the currency, even if this has consequences
thought to be bad for the economy at the time; or c) we get a gold standard
system.
Obviously, we are a long way from any of these conditions today. There are
some alternative outcomes, along the lines of the Asian central banks around
1998, who supported their currencies through what
amounted to a sort of open-ended quantity framework. In that case, interest
rates fell instead of rising.
Nathan Lewis
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