For the past 35 years, a financial legend has been created, and although the veracity of supply side economics has been repeatedly debunked by facts, the mainstream media have continued to print, and defend, the legacy of Reaganomics.
When Paul Volcker became Chairman of the Federal Reserve in October 1979, the US had gone through 10 years of gradually increasing inflation, and for 10 years the approach taken by the Fed was a gradual tightening of interest rates – easing them again as inflation seemed to improve.
Inflation hit 12.2 per cent the month Volcker was appointed, which was a stunning 3% higher than interest rates. Volcker immediately instituted a tight money policy, aimed at reducing the amount of money in circulation, which he correctly predicted would cause interest rates to “fluctuate over a wider range” than in the past.
Indeed, the Fed Funds rate ultimately topped 20% because with the supply of money sharply constricted, businesses and individuals who needed to borrow money were forced to pay a hefty premium for the privilege… a classic application of supply and demand.
And only five months after Volcker took charge at the Fed, inflation peaked at 14.7%. Nine months later it fell below where it had been when he was hired, and less than two years after the peak, inflation had fallen by more than half. In two years, Volcker’s policies had reversed a decade-long trend of high inflation and anaemic growth. The era people refer to as “Stagflation” was over.
This brings us to the legend. According to adherents of trickle-down economics, it was Ronald Reagan’s tax cuts that saved the day because all that extra money received by the top 10% of wage-earners filtered through the economy, creating the economic miracle of low inflation and job creation. What the proponents of Reaganomics ignore is that by 1982, a necessary and – according to economists at the time – inevitable recession had effectively “rebooted” the economy, and a 16-year bear market in stocks was about to end thanks to Paul Volcker bringing inflation under control.
You may be asking yourself: “What has this got do with me in 2015?” Well, financial uncertainty of any description is bad for stock markets, which was the case in 1979 and is the case again today. In 1982, with inflation under control, a bull market in Bonds began, which is now coming to an end, if it hasn’t ended already.
Since 1987, we have seen the policies of activist Central Banks in every major economy in the world inflating one sector of the economy after another – such as through bonds, stocks, property – and we have seen those asset bubbles pop, only to be re-inflated.
It then transpires, if you believe what you read, that the answer to every financial problem is more tax cuts for the highest wage-earners. Everyone would like to pay lower taxes, but trickle-down economics is a discredited legend which simply refuses to go out of print.
The best way to safeguard yourself is to construct a diversified portfolio of non-correlated assets, with a focus on assets classes which can profit from whatever turmoil – or growth – the markets throw at you.
An interesting side note: On July 21, 2015, another idea of Paul Volcker’s became law. The “Volcker Rule” prevents banks from using their own funds for short-term proprietary trading of securities, derivatives, commodity futures and options… that is, the very activities that helped to inflate monetary assets, and which precipitated the 2008 Financial Crisis.
It’s too soon to say if there is a correlation, but the Dow Jones Industrial Average (DJIA) – which has hovered around 18,000 for much of 2015 – began falling on July 21, and got as low as 16,000 in September. At the time of writing the Dow stands at 17,646.
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