completion. Whether those uncompleted networks fill out, for example, over two years or four
years significantly affects the rate of growth of productivity.
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The continuing acceleration of the flow of workers to competitive markets
during the past decade has been a potent disinflationary force. That
acceleration has depressed wage growth and held down inflation virtually
uniformly across the globe. Leaving aside Venezuela, Argentina, Iran, and
Zimbabwe, inflation during 2006 in all developed and major developing
nations was clustered between 0 and 7 percent.* Similarly narrow ranges
describe long-term interest rates. Such globally subdued price and interest-
rate pressures are exceptionally rare in my experience.
For the former centrally planned economies of Eastern Europe, the
transition is already largely complete. But that is not the case in China, by
far the largest player in the transition. There the movement of workforces
from the rural provinces to the highly competitive factories of the Pearl
River delta has been gradual and controlled. Of China's nearly 800-millionperson
labor force, approximately half are now resident in urban areas most
subject to competitive forces.1
The rate of flow of workers to competitive labor markets will eventually
slow, and as a result, disinflationary pressures should start to lift. China's
wage-rate growth should mount, as should its rate of inflation. The first
signs are likely to be a rise of export prices, best measured by the prices of
Chinese goods imported into the United States.* Falling import prices from
China have had a powerful ripple effect. They have suppressed the prices of
competing U.S.-made goods and contained the wages of the workers who
produce them—as well as the wages of any who compete against the workers
who produce the goods that vie with the Chinese imports. § Accordingly,
These rates are as measured by the consumer price index.
tin India, while call centers and a burgeoning high-tech industry garner headlines, the vast bulk
of employment remains rural. I expect the rate of migration from the rural areas to cities that
produce exportable goods and services to rise, but the numbers do not yet seem large.
^Export prices reported by China, which have been rising, appear to reflect a significant change
in the composition of exports toward higher-pried goods. U.S. import price indexes have fixed
quantity weights.
§This process is highly leveraged for imports that compete with domestically produced goods,
and especially so for those imports that have substantially different labor costs. If an importer
offers a 10 percent discount from prevailing market prices, failure to follow implies a consequent
loss of market share. If I am a domestic producer with a modest share of the market, the
loss of share could be devastating if I hold prices firm and all other domestic producers meet
the importer's price. The risks of such an outcome are often too high to contemplate. Thus,
477
THE AGE OF TURBULENCE
an easing of disinflationary pressures should foster a pickup of price inflation
and wage growth in the United States. It should be noted that import
prices from China rose markedly in spring 2007 for the first time in years.
The burden of managing this shift will fall on the Federal Reserve. The
final arbiter of inflation is monetary policy. How significant—and how
corrosive—these price pressures will become for the American economy
will depend in large part on the Fed's ability to respond. When the underlying
disinflationary pressures and excess world saving propensities begin to
ease—or what amounts to the same thing, when inflationary pressures and
real long-term interest rates rise—the degree of monetary restraint required
to contain any given rate of inflation will increase.
How the Federal Reserve responds to a reemergence of inflation and
expected falling world saving propensities will have a profound effect not
only on how the U.S. economy of 2030 turns out but also, by extension, on
our trading partners worldwide. The Federal Reserve's pre-1979 track record
in heading off inflationary pressures, as Milton Friedman often pointed
out, was not a distinguished one. In part, that earlier history was a consequence
of poor forecasting and analysis, but it also reflected pressures from
populist politicians inherently biased toward lower interest rates. (Friedman
was less critical of the Fed's post-1979 performance.) During my eighteen-
and-a-half-year tenure, I cannot remember many calls from presidents or
Capitol Hill for the Fed to raise interest rates. In fact, I believe there was
none. As recently as August 1991, Senator Paul Sarbanes, in response to
what he considered intolerably high interest rates, sought to remove voting
authority on the FOMC from what he perceived were the "inherently
hawkish" presidents of the Federal Reserve banks.* Interest rates declined
with the 1991 recession, and the proposal was shelved.
I regret to say that Federal Reserve independence is not set in stone.
FOMC discretion is granted by statute and can be withdrawn by statute. I
fear that my successors on the FOMC, as they strive to maintain price sta
small amounts of imports have often had the effect of bringing prices down for a whole domestic
U.S. market.
*Historical tabulations had indicated the bank presidents were more inclined to tighten than
were Board members. And the bank presidents are not confirmed by the Senate; Federal Reserve
governors are.
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TH E DE LPH IC FUTU RE
bility in the coming quarter century, will run into populist resistance from
Congress, if not from the White House. As Fed chairman, I was largely
spared such pressures because long-term interest rates, especially mortgage
interest rates, declined persistently throughout my tenure.
It is possible that Congress has observed the remarkable prosperity
that emerged in the United States and elsewhere as a consequence of low
inflation and has learned from this happy circumstance. But I fear that containing
inflation through higher interest rates will be as unpopular in the
future as it was when Paul Volcker did it more than twenty-five years ago.
"You're high on the hit parade for lynching," Senator Mark Andrews told
Volcker bluntly in October 1981; Senator Dennis DeConcini complained
in 1983 that Volcker had "almost single-handedly caused one of the worst
economic crises" in American history. In December 1982, more ominously,
BusinessWeek reported, "There are a number of bills in the hopper that
would severely limit the Fed's vaunted independence by giving Capitol Hill
and the Administration a more direct voice in making monetary policy."
When it became apparent that the Fed was on the right course, such criticism
disappeared virtually overnight—but sadly, so did the collective memory
that there had been such shortsighted and counterproductive criticism.
Unless politicians remember that events proved such criticism of Fed policy
to have been wrong, how does understanding of monetary policy by our
political leadership advance? A key question regarding the future is the political
environment that the Fed will have to confront in its quest to preserve
the low inflation rates of the past quarter century.
This brings us back to globalization. If my suppositions about the nature
of the current grip of disinflationary pressure are anywhere near accurate,
then wages and prices are being suppressed by a massive shift of
low-cost labor, which, by its nature, must come to an end. A lessening in
the degree of disinflation suggested by the upturn in prices of U.S. imports
from China in spring 2007 and the firming of real long-term interest rates
as this book goes to the press raise the possibility that the turn may be upon
us sooner rather than later. So at some point in the next few years, unless
contained, inflation will return to a higher long-term rate.
But what is that rate? Price levels, as economic historians can best estimate
them, did not materially change in the United States or much of Europe
479
THE AGE OF TURBULENCE
between the eighteenth century and World War II. Prices were defined in
terms of gold or other precious metals, and paper money was supposed to be
convertible into precious metals on demand at a fixed price. While cyclically
variable, prices of goods and services exhibited no persistent trend. During
wars, governments might print money not convertible into gold or silver, and
prices consequently temporarily spiked. Hence the phrase during our Revolutionary
War of "not worth a continental," the name of the wartime currency.
During our Civil War, the "greenbacks" met a similar fate. Fiat money—paper
money created by government decree—was in deep disrepute.
In those years, governments were perceived as unable to affect the
business cycle, and few tried. Inflation expectations, as we understand them
today, were nil. Money was backed by gold or silver, and price levels over
the long run rose or fell owing largely to changes in the supply of gold or
silver. The inflation rate over the long run was essentially zero. Moreover,
there is ample evidence that interest rates (effectively on borrowed gold)
in centuries past were not significantly different from those of the early
twentieth century* All this suggests that for centuries, inflation was quiescent,
and therefore so were inflation premiums.
The monetary landscape in the United States changed beginning in the
late nineteenth century, when stagnant prices for agricultural produce fostered
the free silver movement, which advocated the coinage of silver in
a way that would have inflated overall prices. There was deep popular concern
over the straitjacket the gold standard placed on prices, most famously
expressed in William Jennings Bryan's "Cross of Gold" speech in 1896.
The monetary orthodoxy that defined the gold standard was beginning
to crack. Fabian socialism in Britain and later the La Follette Progressive
movement in the United States were reordering the priorities of democratic
governments. Prices spiked in World War I and fell sharply in its aftermath.
But pre-1914 levels were never fully reestablished. Central banks had
*British "consols," which were the nineteenth-century equivalent of today's U.S. long-term
treasuries, yielded a steady rate of approximately 3 percent from 1840 until World War I. For
interesting background, see Sidney Homer and Richard Sylla's A History of Interest Rates.
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TH E DE LPH IC FUTU RE
found ways to circumvent gold standard rules. And after the Great Depression
of the 1930s, the gold standard was effectively abandoned virtually
worldwide.
I have always harbored a nostalgia for the gold standard's inherent
price stability—a stable currency was its primary goal. But I've long since
acquiesced in the fact that the gold standard does not readily accommodate
the widely accepted current view of the appropriate functions of government—
in particular the need for government to provide a social safety net.
The propensity of Congress to create benefits for constituents without
specifying the means by which they are to be funded has led to deficit
spending in every fiscal year since 1970, with the exception of the surpluses
of 1998 to 2001 generated by the stock-market boom. The shifting
of real resources required to perform such functions has imparted a bias
toward inflation. In the political arena, the pressure to make low-interestrate
credit generally available and to use fiscal measures to boost employment
and avoid the unpleasantness of downward adjustments in nominal
wages and prices has become nearly impossible to resist. For the most part,
the American people have tolerated the inflation bias as an acceptable cost
of the modern welfare state. There is no support for the gold standard today,
and I see no likelihood of its return.
Price levels rose sharply during World War II, and although the rate of
inflation slowed at the end of the war, it never turned sufficiently negative
to restore anything close to the price levels of 1939. The rate of inflation
has varied ever since, yet for almost every year during the past seven decades,
the rate has been positive, meaning the level of prices has continued
to rise. In 2006, consumer prices in the United States were almost fifteen
times higher than they were in 1939. In fact, the price patterns have much
in common with evidence of global warming in recent decades. Both accelerations
bear the imprint of human intervention.
We know that the average inflation rate under the gold and earlier commodity
standards was essentially zero. At the height of the gold standard between
1870 and 1913, just prior to World War I, the cost of living in the
United States, as calculated by the Federal Reserve Bank of New York, rose
by a scant 0.2 percent per annum on average. From 1939 to 1989, the year of
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THE AGE OF TURBULENCE
the fall of the Berlin Wall and before the onset of the post-cold war wage-
price disinflation, the CPI rose ninefold, or 4.5 percent per year.* This reflects
the fact that there is no inherent anchor in a fiat-money regime. What constitutes
its "normal" inflation rate is a function solely of a country's culture and
history. In the United States, modest amounts of inflation are politically tolerated,
but inflation rates close to double digits create a political storm. Indeed,
Richard Nixon felt the political need to impose wage and price controls in
1971 even though the inflation rate was below 5 percent. Thus, while political
considerations mean that the gold standard can be ruled out as a way to
suppress a forthcoming rise in inflationary pressures, ironically, politics driven
by an irate populace just might accomplish the same purpose. But that is unlikely
