"What the Volcker shock entailed in policy terms, as he later admitted, was not “very fancy or very precise.” It ostensibly involved a change in procedure from announcing a target interest rate (and then selling or buying the quantities of Treasury bills through its “open market operations” to reach it) to targeting the money supply (and then forcing banks to bid against each other for the funds they needed to maintain their reserves with the Fed). The Fed’s embrace of restrictive monetary targets may have been, as Krippner puts it, a “political cover” to avoid direct responsibility for the resulting high interest rates, but the impact on the economy was clear enough: what was really significant about the conduct of monetary policy under Volcker “was not the money targeting but the austerity.” A new and increasingly invariant ethos for monetary policy, designed above all to “break inflationary expectations,” was in its formative stages during this period: “the change in objective was much more important and more durable than the change in procedures.” Volcker himself made it perfectly clear that he was prepared to embrace austerity—“and stick to it,” as he told the American Bankers Association three days after he announced the new policy in early October 1979.
And stick to it he did, sustained by the public show of unanimous support he secured from the Fed’s governors and Open Market Committee, as the federal funds rate reached previously unheard-of levels. Carter’s presidency ended with the federal funds rate at 19.1 percent; and with the interest rate still at this level six months into the Reagan presidency, the US was plunged into the deepest economic downturn since the 1930s. US inflation, aggravated by the sharp rise in oil prices at the time, had stood at over 12 percent at the end of 1979, and was still almost 10 percent at the end of 1981. The back of inflation was finally broken when unemployment (which initially rose only slowly from its 1979 level of 6 percent) reached double digits in the fall of 1982. It was at this point, exactly three years after it had been launched, that Volcker let it be understood that the “shock” was finally over: the Fed’s “policy objective” had at last changed to monetary “easing.” Even when growth finally resumed in 1983, inflation came down to just over 3 percent and more or less remained there for the rest of the century.
But the ability to stick to a policy of state-induced austerity for as long as three years was based on much more than Volcker’s personal determination. As we saw in the last chapter, previous attempts by the Fed to raise interest rates dramatically had run up against what McChesney Martin had once called the “ghost of overkill.” This was usually understood as meaning that the Fed drew back from raising rates too high to accommodate the democratic opposition to high unemployment. In fact, when the Fed drew back it was because it was itself caught up in financial capital’s own contradictory relationship to monetary discipline. Despite financial capitalists being the most vocal constituency for monetary restraint, they recoiled in horror at the instability that the imposition of high interest rates actually caused in financial markets. In 1969–70, as we have seen, once the financial system proved unable to accommodate the high-interest-rate policy that produced the commercial paper crisis and the collapse of Penn Central, the Fed had quickly pumped liquidity back into the system. US policymakers were subsequently haunted by the fear that this would happen again. Shortly before becoming head of the Council of Economic Advisors under Ford in 1974, Alan Greenspan warned in a private memo to the Treasury’s Bill Simon that a tight monetary policy would have particularly dire effects, especially since the size and range of the US mortgage market meant that the nature of “our peculiarly American thrift institutions places the crisis threshold far lower than any country in the world.” He notably added that that “the Federal Reserve’s response would be immediate and massive support for the thrift institutions”—which could, of course, only negate the initial monetary restraint.
What, then, allowed Volcker to go beyond what he himself called the earlier “hesitations and false starts”? Crucial to the change was the broadening and deepening of financial markets through the 1970s. This reflected the enormous growth in international finance that followed the removal of US exchange controls in 1974, which was further spurred by the British and Japanese liberalizations in the midst of the Volcker shock. But it also reflected the development of new derivatives markets that allowed for the spreading and hedging of risk, a more extensive commercial paper market, and the development of new securitized instruments including money-market mutual funds. The latter provided an escape hatch from the New Deal “Regulation Q” controls on how much interest banks and thrifts could pay on deposits, and so reduced the sensitivity of housing finance to high interest rates—although this meant that the Fed needed to push interest rates higher still to secure austerity. These changes would not have been enough to prevent the kind of scenario that Greenspan had feared back in 1974, if the Volcker shock had not been quickly followed by the passage of the Depositary Institutions Deregulation and Monetary Control Act (DIDMCA) in early 1980; this Act finally accomplished what Nixon had proposed in 1973: the phasing out of “Regulation Q” ceilings. It also removed state usury laws that limited the interest banks could charge on loans, and gave more flexibility to thrifts by broadening their ability to engage in consumer and commercial lending.
Although the previous deregulation in airlines, trucking, and railways appeared to suggest that “banking’s time had arrived,” the Depositary Institutions Deregulation and Monetary Control Act revealed by its very title the futility of seeing things in terms of a dichotomy between regulation and deregulation. Besides mandating greater regulatory cooperation between the Federal Reserve, the Treasury’s Office of the Controller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), the Act—“the most massive change in banking laws since the Depression”—widened the state’s regulatory remit over the whole banking system. All deposit institutions were now required to hold reserves with the Fed, and new rules were established for more uniform reporting to regulators, and for extended federal deposit insurance coverage. And it was this joint supervisory capacity that allowed the Fed, working more and more closely with the OCC and the FDIC, to sustain the Volcker shock by undertaking selective bailouts of those banks that were deemed “too big to fail.” This included the largest bailout in US history to that point, that of First Philadelphia Bank (whose roots went back two centuries to the first private bank in the US). The regulators feared that if the bank “collapsed slowly, in the manner of Franklin National [in 1973–74], it might provoke a crisis of confidence in the banking system.”
The Fed’s autonomy with respect to the financial system, and the detailed information it had about its precise workings that was unavailable to anyone else, was decisive in terms of the flexibility and persistence it needed to act. As Chris Rude has put it: “Contrary to the beliefs of certain populists, therefore, the Fed did not act in the interests of the banking system when it imposed austerity under Volcker because it was held captive by its member banks. The Fed was able to use austerity to promote the general interests of the larger US financial institutions because they were subject to its supervisory and regulative authority.” Yet the Fed’s autonomy could not have been sustained without support from the White House and leading members of Congress—not to mention the Treasury, which Volcker all along saw as the real “center of gravity.”
Underlying this was a broad class alignment between finance and industry. This encompassed not only Wall Street but also small savers, since high inflation had eroded support for the old New Deal ceilings on the interest paid for bank deposits, as could be seen in the American Association of Retired Persons and “Gray Panthers” lobbies, which called for the phasing-out of the “Regulation Q” ceilings. And the new class alignment also encompassed not only most industrialists, who were by now more than ready to endorse the bankers’ traditional hostility to Keynesianism, but even the AFL-CIO leadership who, as Volcker pointedly noted at the time, had in September 1979 reached a “National Accord” with the Carter administration that went so far as to give “top priority” to the “war on inflation.” All this allowed the Fed to claim in its 1979 Report that no internal opposition existed within the US to its “new approach to central banking.”
Fundamentally, the Volcker shock was not so much about finding the right monetary policy as shifting the balance of class forces in American society. Inflationary “expectations” (the economists’ buzz word at the time) could not be broken without shattering aspirations of the working class and its collective capacity to fulfill them. The defeat of the working-class militancy of the previous decade had culminated politically in the failed attempt to secure the state’s commitment to full employment in the Humphrey-Hawkins Act. A bone that labor was thrown when the Act was passed in 1978 required the chair of the Fed to make annual reports to Congress on its objectives for the year ahead. Nothing symbolized labor’s defeat more vividly in the following years than Volcker using his “Humphrey-Hawkins testimony” to make the monetarist case that low inflation was the Fed’s overriding target, even at the expense of unemployment, and that this was the principal means of ultimately reaching high employment.
But it was a Democratic Congress’s imposition on labor of what was effectively a “structural adjustment program”—in the conditions attached to the loan guarantees Congress gave Chrysler in 1979 to prevent its bankruptcy—that signaled the most important factor in sustaining the Volcker shock. Whereas there had been an explosion of labor militancy in the strike wave that erupted in the wake of the Fed’s 1969–70 “policy of extreme restraint,” a decade later the acquiescence of the UAW in the “reopening” of its collective agreement, to make wage concessions and allow for the outsourcing of production to non-union plants, now became the template for the spread of similar concessions throughout US industry. The union strategy that had informed collective bargaining in the auto industry had always been based on extending unionization in the sector, and removing wages from competition through “pattern bargaining” (in other words, negotiating agreements covering all the major firms). Against the backdrop of heightened competition from Japan (aggravated by high interest rates as well as the increases in oil prices) and the political defeat of the Democrats’ full-employment policy response to the recession of 1973–75, the threatened bankruptcy of Chrysler exposed, as Kim Moody has noted, the lack of any union plan for “dealing with large-scale business failure.” But if pattern bargaining in the auto industry was ended with Chrysler, it was soon perversely restored as similar concessions were granted to GM and Ford—and rank-and-file resistance was broken as unemployment reached 24 percent in that industry in the early 1980s.
The appeal of Ronald Reagan’s tax cuts to the Democrats’ working-class constituency, followed by the explicit class war from above undertaken by his administration after the 1980 election (through cutbacks to welfare, food stamps, Medicare, public pensions, and unemployment insurance), was a major factor in turning this initial defeat of labor in the iconic auto sector into an historic shift in the broader balance of class forces. With workers desperate to hold on to their jobs, by the end of 1982 “major concessions had been negotiated in airlines, meatpacking, agricultural implements, trucking, grocery, rubber, among smaller steel firms, and in public employment.” Anti-union appointments to the Department of Labor and the National Labor Relations Board had immediate effects in checking union organizing drives and sustaining employers’ bad-faith bargaining tactics.
But, as Alan Greenspan subsequently reflected, in discussing Reagan’s legacy, “perhaps the most important, and then highly controversial, domestic initiative was the firing of the air traffic controllers in August 1981… his action gave weight to the legal right of private employers, previously not fully exercised, to use their own discretion to both hire and discharge workers.” The strike by PATCO (the Professional Air Traffic Controllers Organization), which had actually endorsed Reagan in the 1980 election campaign) was broken not only by the permanent dismissal of 12,000 controllers, but by military personnel being brought in to run the airports, while many of the strike leaders were arrested and led away in chains. Notably, Volcker himself thought that the breaking of PATCO did “even more to break the morale of labor” than had the earlier “breaking of the pattern of wage push in the auto industry.”"
Sam Gindin and Leo Panitch, The Making of Global Capitalism
Democrats say the financial crisis was caused by the deregulation of the last 40 years. Libertarians say it was caused by the regulation of the last 40 years. Both are right. The Schmittian sovereign is one that can guarantee continuity during a crisis by suspending the Liberal system in order to restore it. The government eats up power, but only uses it during emergencies, otherwise leaving it alone. In this way, not only there is even more freedom for Capitalists in regular times, but regulation actually broadens the scope and power of the market, allowing banks to do “financial innovation” with derivatives that puts the whole system at risk. The state becomes both strong and weak, allowing a bigger government and a freer market to flourish simultaneously.