A Wary Look at Volcker’s Legacy
Paul A. Volcker’s distinguished eight-year career as chairman of the Federal Reserve Board came to an end last week. This is a time not only to praise Volcker but also to look at two major problems that he leaves behind: the mounting international debt and enormous uncertainty about inflation prospects.
First, the praise. One of Volcker’s achievements at the Fed is indeed worthy of the acclaim that is lavished on him. His policies brought annual inflation down from the 8% to 10% range to about 4% to 5% currently and contributed to the longest peacetime recovery since World War II.
These achievements can best be appreciated by comparing the accolades he receives now with the criticism and calumnies that he took during the 1981-82 recession. Then, some actually burned him in effigy. Others marched on the Fed. And still others took out full-page ads in major newspapers to denounce his anti-inflation policies. Now, all that is nearly forgotten. His courage in sticking to his anti-inflation policy during the steep 1981-82 recession is far better than we usually get from Washington. The praise is deserved.
Volcker took the lead in shaping our policy toward foreign debtors that cannot handle their interest and principal payments. Our current strategy, though called the Baker plan, is largely Volcker’s policy. The plan calls for U.S. banks and international lending agencies to continue to increase their loans in exchange for promises by the debtors to reform their economic policies. The result is that such countries as Mexico, Brazil and Argentina now owe much more than when the problem emerged in the summer of 1982. Then Mexico owed about $82 billion to its creditors. It now owes $106 billion. Much the same is the case with other debtors.
This strategy looks silly. And it is. If the debtors couldn’t pay the interest on $82 billion, how can they pay the interest on $106 billion? The supposed answer is that economic reforms help the debtor countries grow faster. If exports grow fast enough, the countries can earn enough to work their way out of trouble.
At Worst, a Writeoff
But it hasn’t happened, at least not yet. Exports have grown, but so have the countries’ debts. After five years, not one of the problem countries is close to a solution. Like the characters in “Alice in Wonderland,” they have run faster but stayed in the same place--or fallen farther behind.
Volcker’s mistake was to stay deeply involved. Perhaps it was sensible to prevent the initial problem from becoming a crisis five years ago. But crisis management helps only if followed by a program that leads to a long-term solution. Neither Volcker nor any other federal official has developed a long-term strategy to bring the international debt problem to an end.
At worst, we’ll write off most of the debt. At best, the problem will continue for an additional five years or more. Lending the debtors more now means that they have to pay more interest for years to come, perhaps forever. And more loans weaken the U.S. banking system by leading to large writeoffs.
A case in point is this year’s debt renegotiation with Mexico. The U.S. government and the International Monetary Fund loaned more money to Mexico and leaned hard on U.S. banks to do the same. The loan from the IMF will be followed sooner or later by a request to Congress and to other governments for new money for the IMF or its sister organization, the World Bank. The money will come from taxpayers here and abroad, with the largest contribution from U.S. taxpayers.
The additional $6 billion loaned by the banks comes out of the pockets of the bank’s stockholders. Mexican loans sell for about 60 cents on the dollar, so the $6 billion of new loans was worth only $3.5 billion in the marketplace as soon as the deal was made.
The lesson to be learned is that the government has made a series of costly mistakes--costly to taxpayers and costly to the banks. Volcker’s successor, Alan S. Greenspan, could show real leadership by reversing the Volcker policy on international debt. The government should get out of the way and let the borrowers and the lenders find a way out of the problem, a process that already has begun.
The Volcker Standard
Volcker’s leadership and influence were so strong that many in the financial markets refer to our current monetary policy as the Volcker standard, putting it on the same scale as the gold standard. At different times and places, the gold standard served as the basis for monetary systems that did a tolerable job of maintaining the long-term value of money and other paper claims.
At best, the gold standard was far from perfect. The exaggerated claims now made for gold should be seen as just that. But it had the virtue of restraining the power of government to cause inflation.
The Volcker standard lacks this virtue. It substitutes the decisions of one man, or a small group, for the rule of law in monetary affairs. No one has the slightest idea when or whether that group, or its successors, will choose policies that bring inflation back to 8% or 10% or higher, perhaps by chance, bad luck or error of judgment.
Volcker’s legacy includes the lower rate of inflation for which he is properly praised. But inflation at 4% or 5% is high by U.S. peacetime standards. Volcker failed to use his enormous prestige to end inflation or to put restrictions on future monetary policy that will get us back to price stability or keep inflation from going higher. That, too, is part of his legacy.
