Bretton Woods, Chaos, Price Stability

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After World War II, there were three major phases (outlined in colored straight lines on the graph) in First-World-wide monetary history. Rothbard, being alive through only two of them, discussed only those two. During the Bretton Woods era in the 1950s and 1960s, short-term shocks to prices were serially uncorrelated between countries and inflation was typically kept below 10%, as each First-World country’s currency was tied to the U.S. dollar, which was tied to gold at the rate of $35 per ounce. The lowest rates of inflation at the time tended to be in rapidly-growing Greece. Over the course of the 1960s, as Rothbard describes, the dollar became more and more overvalued in relation to other currencies, leading to the gradual breakdown of the Bretton Woods system as other countries proceeded to pyramid their currencies on their dollar reserves, leading to average First-World inflation gradually rising from 1968 to 1971. Nixon abolished the Bretton Woods system on August 15, 1971 by permanently taking the dollar off gold. During the era of freely floating currencies between 1973 and 1999, inflation in every first-world country at first exploded (resulting in nearly a decade of high inflation and general monetary chaos) after only a little over a year’s break from Bretton Woods. This led to and resulted from the end of the Smithsonian Agreement, a 1971 attempt to remake Bretton Woods without the backing of gold. Obviously, the recession that resulted in 1973-1975 was due to an unfortuitous and coincidental supply shock concentrated in raw commodities, which, however, led the monetary authorities of numerous countries to view sky-high inflation as perfectly normal and acceptable. This phase of stagflationary monetary chaos lasted, on average, until May 1980, when oil prices ceased rising, though some countries (e.g, Canada, Germany, Ireland, Portugal) continued to have rising inflation into later months. In some countries newly risen into the First World, however, most notably Greece and Portugal, inflation remained sky-high well into the early 1990s.

During the 1970s, a series of ideologies, ideas, policies, and other non-insane (though sometimes wrong) stuff, to be later Christened by the Far Left (esp. academic Communists) neoliberalism, emerged into publicity. This incoherent and contrived linguistic innovation did not, at the time, have the negative connotation which it universally has whenever used today. Generally, it was the trickling down of oft-diluted free-market ideas from the Ivory Tower at the University of Chicago to the leaderships of both conservative and leftish parties in the United States, Britain, Denmark, Peru, Chile, Ireland, China (though indirectly and due to different circumstances), Sweden, India, and other, less important, countries. The First-World country least affected by this trickling down of free-market thinking was Greece, which in the 1980s elected a socialist government to power which proceeded to do just the opposite of what was being done in the U.S. and Britain at the time.

The rise of neoliberalism was mostly good and resulted in Great Things (like Paul Krugman in the 1990s not being routinely wrong), as well as some Not-So-Great-After-All things. Among these Not-So-Great-After-All things was the widespread agreement that the inflation which occurred in the aftermath of the breakdown of the Smithsonian agreement was wrong and could be corrected by central banks whenever it might emerge in the future. Another Not-So-Great-After-All Thing which resulted from the rise of neoliberalism was the idea that all countries should pursue price stability, that is, gentle inflation of between 0 and 2% (absolute upper bound: 7%, absolute lower bound: -7%), even in a time of economic stagnation (which the 1970s was). The simultaneous decline in inflation and unemployment around the First World during the 1990s confirmed numerous policymakers’ and economists’ beliefs that there was nothing wrong with low and stable inflation at all times. And, indeed, per se there isn’t, provided nominal gross domestic product growth remains solid. But that insight wouldn’t be at all well-known or popular until after 2008 (see Scott Sumner’s blog on this).

The Neoliberal era resulted in the creation of the Euro, a single currency for most of Europe. Japan, Israel, Canada, and the U.K. retained monetary independence, which helped to serve them well during the aftermath of the 2008-9 recession. Though the idea of a single currency for all First-World Europe wasn’t a bad idea per se, the way it was put into practice, as well as other rules relating to it, led to the systemic overpricing of Southern European (especially Greek) sovereign and private debt (a good rule for telling the responsible countries from the irresponsible ones is how many of their currency units were equivalent to one Euro when the old currency unit was abandoned). This had to end one way (Indonesian–style) or another (depression; the way it actually happened). Though Ireland, a country well-known for its successful neoliberal reforms, suffered badly, the hardest-hit country in the aftermath of the Great Recession was undeniably the least neoliberal of the First-World countries: Greece, which suffered a somewhat more inflationary and longer version of the U.S. Great Contraction in the early 1930s. Portugal and Italy, other countries which were not known for their neoliberal reforms, also suffered, though never experienced above-20% unemployment like Greece and Spain did.

Yet, despite the huge differences in economic outcomes between the various First-World countries after the 2008-9 recession, inflation patterns in all these countries were generally very similar -low and stable, and always under 7% and above -7%. Price shocks were serially correlated, due to the great reduction in the number of First-World currencies and to the great agreement in monetary policy throughout the First World.

But, just like the high inflation of the 1970s and the Old Left economic thinking of the 1960s led to their own righteous demise in the 1980s and the 1990s, so did neoliberalism help lead to a backlash against itself. Eventually, the views espoused by Nobel-diseased Krugman and by the academic Communists became heard louder and louder on the Internet, even, sometimes, in the real world. Toxic economic policies which were refuted during the Great Depression began to be advocated for by leading First-World presidential candidates once again. Low and stable inflation, once declared optimal monetary policy, became feared. Thus, Greek voters elected a “radical left” government which immediately caused investors to run for the hills, forcing Greece into a temporary double-dip depression, which led that government to capitulate to reality and its creditors.

Unsustainable systems collapse, the apparent failures, whether coincidental or not, of one ideology lead to the rise of another, and ideas which sound great before they’re tried don’t always seem as great when they’re tried. Remember this.