Lessons From The Past: What Paul Volcker Said In 1984

by: Tom Armistead

This is so well thought out and so germane to the current monetary situation that I have to pass it along. It's from a speech Paul Volcker gave in 1984:

Industrial nations, including our own, nowadays rely heavily - sometimes too heavily - on their central banks and on monetary policy to achieve our economic goals: to promote growth and employment, to blunt the forces of inflation, and to maintain financial stability. At times, the pursuit of those objectives requires speed and flexibility in decision-making, and that flexibility is one of the virtues of monetary and credit policy. But through the necessary process of adaptation and change runs another, more constant, threat-the need for a sense of discipline. In the broadest sense, all of economics - I am tempted to say all of life - teaches us that our collective desires always exceed the means to achieve them. And history has taught us, again and again, that the creation of money is no substitute for productivity, for savings, and for investment in enlarging our economic welfare. Yet the temptation is always there to try - with the ultimate result of destructive inflation that, in the end, only undermines those goals.

Too Heavy Reliance on Monetary Policy

Congress has steadfastly refused to make the necessary compromises and decisions to restore fiscal policy to a sustainable path. The sole piece of fiscal stimulus directed at a deep and prolonged recession was basically a set of earmarks - just send the money home. Ben Bernanke has quietly made the point, again and again, monetary policy is no substitute for fiscal policy.

Now Volcker reminds us: monetary policy is no substitute for productivity, for savings or for investment directed at enlarging our economic welfare.

Banks as Intermediaries

Savings and investment need to be linked: banks as financial intermediaries must provide a channel to move savings out into the real economy for investment in productivity enhancements, or in new means of production.

This isn't happening right now: savers receive such paltry returns from bank accounts that there is little inducement for them to save. The greatest yield available to consumers can be derived from paying down existing debt and not replacing it. The consumer who has no further debt to reduce is confronted with a problem: interest on deposits is inadequate to reward thrift.

Nor are savings being deployed into productive use in the real economy. JPMorgan's (NYSE:JPM) London Whale operation deployed them in writing naked CDS in an effort to garner outsize returns by gambling in a zero sum game against the astute manipulators of the city of London. That's $5.8 billion that won't ever be deployed in ways that enhance productivity, or increase employment. It merely adds to the arsenal of those who game the system for profit.

Obama's first State of the Union Address alluded to the proper role of banks as financial intermediaries, an insight he no doubt derived from Volcker's association with his administration. But the concept has yet to gain a central position in directing the economy and financial system.

Captains of Industry

Savvy investors are always concerned with FCF (free cash flow). Freedom here involves, not being trammeled with the cost of capital expansion. As a general rule, investors prefer FCF over capex.

This does nothing for productivity. Aging factories and obsolete machinery creak along until they are supplanted by state of the art facilities in China or other Asian nations. Some of these facilities are funded by the tax deferred income of U.S. businesses, some of them are funded by local entrepreneurs.

The CEOs of major corporations, with few exceptions, believe that buying back their shares with borrowed money or cost cutting by shipping jobs overseas are the key to the next bonus. The hard work of investing in modern facilities here in the U.S., or of moving R&D from laboratory concept to fruition and production is left undone.

The point is, U.S. savers get no return on their savings and none of it is invested in means of production.

Destructive Inflation

At this point, the pile of debt created by past profligate monetary policy and the reduced means to pay it down engendered by the resulting recession make inflation attractive as a solution: inflate it away.

The root cause of inflation is that our collective desires exceed the means to achieve them. In an effort to make things work, we increase the size of the pie by issuing promises and ultimately by diluting the value of money. Money itself is only a promise to pay.

It's hard to get the warring parties to agree on who gets what part of the pie. It's easier, somehow, if there is one hundred and ten cents in the dollar.

A Sense of Discipline

That would be nice, for a change. Don't everybody raise their hands at once.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.