A bit of explanation is called for in order to understand why the crises we are facing today have roots that reach back nearly four decades. As noted in Chapter II, America was unable to keep up with the dual fiscal (spending) commitments of war (Vietnam) and welfare (the Great Society) and chose to cut the dollar loose from its gold anchor. Since all other currencies in the Bretton Woods system were pegged to the dollar, floating the dollar un-tethered the entire system from any real mooring and inflation soared like a submerged buoy freed and heading for the surface.
Conventional wisdom holds that the 1973 oil embargo after the Arab-Israeli War and the shock of the 1979 Iranian revolution were the primary drivers behind this inflation. In reality, this Middle Eastern volatility can be blamed for maybe a quarter of the inflation. The rest came from more structural causes, as indicated by the fact that the inflation trend began in the mid-1960s and helped lead to Nixon’s decision to close the gold window. The exact causes are not even clear to economists, who still argue over them, but several factors likely played a role. The beginning of the decade saw a spurt of rapid growth that fueled a brief commodity boom, inflating prices. Shortly thereafter, productivity slumped significantly, even though workers’ wages stayed high, and unemployment began to rise in the U.S. Partially in an attempt to control this after abrogating the gold standard, the Nixon Administration devalued the dollar twice; an act that tends to aggravate inflation. Facing what seemed to be a potential recession and rising unemployment, the administration attempted to counter with spending and an increased money supply, accepting rising inflation as a lesser evil.
The European Monetary System exacerbated this trend at the end of the 1970s. By lashing governments’ monetary policies to that of the relatively austere Germans, Europe’s welfare states lost the ability to manipulate their currencies in pursuit of social goals. In the stead of monetary policy, fiscal policy – government spending and taxation – became the only tool available. As their economies continued to stagnate and calls for welfare services increased, governments turned to the rapidly growing international financial markets to borrow money. The money supply soared by nearly 2000 percent in the last three decades of the twentieth century, playing no small part in the inflation of the many asset bubbles that would pop across the world around the century’s turn. The U.S., too, turned to the debt market, heavily becoming a net debtor nation in 1988. Thus, all these factors combined to yield rising prices, but did not force government austerity. The combination of rising prices and stagnant or declining economies, “stagflation,” made for hard times for many people. In response, governmental spending and the numbers of governmental employees increased markedly.