The Paul Volcker Narrative Imagines an Economy That Doesn’t Exist, and That Never Has

The Chinese government forbids foreign ownership of a broad range of Chinese businesses, including those that run websites. Despite this, despite endless rules meant to repel foreign capital migrating to China, investment inevitably finds good ideas such that China’s modern prosperity has to a high degree been financed by U.S. investors.

This truth came to mind while reading a passage by investor Jim Rickards. Writing about Paul Volcker’s time as Federal Reserve Chairman, Rickards wrote that Volcker “applied a tourniquet [on inflation] and twisted it hard. He raised the federal funds rate to 20% in June 1981, and the shock therapy worked.” Please think about what Rickards imagines Volcker did versus the happy reality that the only closed economy is the world economy. At which point, it’s worth briefly digressing, and in doing so digressing into the extraordinary fatuousness that informs a Volcker myth embraced by conservatives, libertarians, and countless other religions on the Left and Right.

The idea that Volcker’s rate machinations saved the U.S. economy first presumes that government intervention in the world’s most important price (the cost of credit) would lift the economy. Logic dictates the opposite. Credit flows signal the flow of goods, services and human capital to their highest use. To then pretend, as oh-so-many conservatives do, that Fed intervention during Volcker’s era or now has salutary effects beggars belief.

To which Volcker hagiographers will say that fiddling with rates is necessary to shrink credit, and by extension, inflation. See above on the matter of intervention to understand the extraordinary foolishness that informs the Volcker myth, after which readers need only contemplate why we borrow in the first place: to get things. To access goods, services, and labor. In other words, lending is a consequence of production, which hopefully wakes people up to the reality that soaring lending would never be a sign of inflation as much as it signals abundant production.

Of course, a loan of “money” isn’t giving away that money as much as it’s delaying consumption with an eye on attaining greater consumptive ability in the future via the interest rate. Basically an interest rate on money represents the cost of “renting” access to goods and services. And if people are renting out their money, that’s a sign of a lack of inflation. Really, why lend money that will come back in dollars that will purchase fewer and fewer goods and services?

Which brings us to interest rates. Assuming the Fed could control them, and assuming what’s even more absurd about central control of rates being a good thing, can we stop and think of the impact of higher borrowing costs? Assuming higher by Fed decree, the logical result would be more credit on offer, not less. Put another way, if Volcker had been capable of decreeing 20% borrowing costs with his funds rate (he wasn’t), this wouldn’t have choked off lending as much as it would unearthed a great deal more “money” in search of enormously high returns decreed by central banks.

The simple truth yet again is that lending is a consequence of production, at which point the very notion of Fed “tightening,” or tightening by Volcker, presumes that production is inflationary. Yes, strange. And absurd. Even if you believe the Fed capable of centrally planning prices, credit, and its cost, how odd to believe that meddling with the price of credit would fulfill the Fed’s alleged anti-inflation mission.

From there, there’s the global economy. If we accept Rickards’s odd definition of inflation and the way to combat it, we can’t ignore that the only closed economy is the world economy. For that we simply return to China. While its political leadership has long pursued policies meant to slow the flow of investment into the mainland, investors had other plans. And as the introduction to this piece makes plain, resources find the innovative and productive without regard to the wishes of governments.

Please keep this in mind with the late Paul Volcker’s time at the Fed top of mind. If the authoritarians in China can’t control the cost or amount of credit flowing there, does anyone seriously think Volcker’s rate meddling somehow acted as a tourniquet in the early 1980s? Hopefully the question answers itself. Volcker hagiography quite simply imagines a global economy that doesn’t exist, and that never has. What Rickards imagines is wholly mythological.