Chapter Eight:
Wall Street Rules

A. The Power of the Fed and the Creditor Class

A key player in the disenfranchisement of the American people is the Federal Reserve Board, known as the Fed - the agency responsible for the creation of the nation's money. The amount of currency in circulation greatly affects the health of the economy. A reduction in the total supply tends to produce slower economic growth, whereas increasing the money supply stimulates economic activity. Congress has given this power to the Fed, which is dominated by private banks that are dominated by wealthy investors. If and when a serious conflict emerges between the self-interest of wealthy elites and the self-interest of the general population, the Fed tends to side with the wealthy and there is little that the general public can do about it.

As a source of wealth, buying and selling bonds on the world's financial markets has replaced the control of land in importance. The New York Times economics reporter Louis Uchitelle described the nation's "creditor class" as follows:

They are wealthy individuals, banks, mutual funds, pension funds, brokerage houses, insurance companies and money managers. They have out on loan over eight trillion dollars to business and to government. They make these loans by investing in Treasury securities, municipal bonds and corporate bonds.

The eight trillion dollars invested in bonds is greater even than the total invested in stocks, which is six trillion dollars. Daily trading of U.S. Treasury securities is ten times the volume of the New York Stock Exchange. Investments in bonds equal almost one-third of the nation's total net worth. These assets generate enormous profits with little effort (see Chapter Five). Personal inter-est income, $700 billion annually, now equals 15 percent of the nation's total personal income, up from 7 percent in the 1960s. Even private businesses are increasingly dependent on interest income for their own bottom lines: net interest now equals about half of total corporate profits, up from about 10 percent in the 1960s. Because bond owners are determined to protect these assets, they are obsessed with inflation.

1. The Threat of Inflation

At 7 percent annual interest and zero inflation, the eight trillion dollars invested in bonds will generate $560 billion in income annually - 10 percent of the nation's total personal income. But if prices increase by 3 percent over the year, that eight trillion dollars loses $240 billion in value, because that eight trillion dollars can buy fewer goods at the end of the year than it could at the beginning if prices are higher. And if prices increase by 7 percent, the same as the interest rate, the entire $560 billion profit is wiped out.

Interest rates, therefore, are set to compensate for expected inflation. But with eight trillion dollars invested in bonds, one percentage point of unexpected inflation means a loss of $80 billion.

It may help to consider this issue from the perspective of an individual investor. A $10,000 bond that pays 6 percent a year for ten years is a good investment if inflation is only 3 percent annually. More money is earned from interest than is lost to inflation. If inflation is zero, the bond is an even better investment, because no value is lost to inflation. At the end of 10 years, the $10,000 can buy as many goods as at the outset, and the investor still earns 6 percent interest annually. If inflation rises above 6 percent, however, the bond suddenly becomes a losing proposition: each year inflation eats away more of the bond's value than is gained by the 6 percent interest payments.

No wonder bondholders are concerned about inflation. People who invest in bonds want inflation to be as low as possible. As summarized by Uchitelle, "Lenders view inflation as dangerous because it can erode the purchasing power of their money while it is still out on loan."

2. Driving Down Inflation

The chief protector of interest income is the Fed. The Fed expands the supply of money by loaning money to private banks electronically. The simple stroke of a computer keyboard increases bank assets, which enables these banks to loan their new funds to private businesses and individual consumers and earn money on the interest.

The size of the money supply that is created in this way has a great influence on inflation. If more money is in circulation, sellers can set higher prices because consumers have more money with which to buy products and are willing to pay more for goods and services. At the same time, more money in circulation encourages manufacturers to hire more work-ers to produce more products.

In this way, the interest rate the Fed charges private banks when it loans them money (the discount rate) and the interest rate the Fed declares banks must charge each other when they borrow money from each other (the federal funds rate) have a powerful effect on the economy. If the Fed sets high interest rates, private banks must charge individuals and businesses higher interest when it loans them money. Higher interest reduce the amount of money borrowed, for borrowers have to pay more to borrow. This reduced borrowing results in less purchasing, less production, and less personal income - which in turn results in even less purchasing, in a downward spiral. On the other hand, if the Fed lowers interest rates, an upward spiral occurs: there is more borrowing and the economy expands.

Since 1981, the Fed has kept interest rates high. Throughout the 1980s, "real interest rates," or interest rates minus inflation, were at record-high levels, averaging about 5 percent compared to an average of about 1 percent during the 1960s and 1970s. Even though the result was increased unemployment, falling wages, growing poverty, and widespread homelessness, the Fed imposed high interest rates to push down inflation, which had hovered around 8 percent in the 1970s.

From 1990 to 1993, with inflation stabilized at around 3 percent and political pressure for increased economic opportunity growing, the Fed lowered interest rates somewhat. But as the economy began to grow a bit, the Fed started pushing up interest rates again in early 1994. The Fed raised rates even though prices were stable, there was no sign of inflation on the horizon, and many voices in Congress expressed strong opposition to the Fed's policy.

The normally secretive Fed claimed in 1994 that it was raising rates to prevent an increase in inflation. The media routinely reported the matter in these terms. But the Fed apparently wanted to drive down inflation as close to zero as it could. In 1990, Fed Chairman Alan Greenspan and four Fed presidents, contrary to their normal practice of being ambiguous in their public statements, openly endorsed legislation introduced by the head of the House Banking monetary policy subcommittee that would have required the Fed to reduce inflation to between zero and 2 percent a year. It is extremely unlikely that the Chairman would have gone on record in support of this legislation without the backing of a majority of his board.

Greenspan indicated at other times that he wanted to reduce inflation to 1 or 2 percent. When the Fed increased interest rates four times in early 1994, Greenspan said that he wanted to reduce inflation even below the annual rate of 2.4 percent seen during the previous 12 months. He argued, "the lower we get under 5 percent, the more stable and growing the economy is." This language suggests "the lower, the better," or zero inflation as the ideal. The goal of eliminating inflation completely was supported by pundits like columnist George Will, who argued that "inflation can't be tolerated," and Sylvia Nasar, The New York Times economics reporter and U.S. News & World Report columnist, who argued "killing off inflation is a good idea." On the McNeil/Lehrer Newshour, conservative economist Susan Lee trumpeted the call for zero-inflation with a particularly astounding claim, totally contradicted by history: "There's no such thing as a little inflation. A little inflation leads to big inflation."

In testimony to Congress in early 1994, Alan Blinder, President Clinton's nominee to the Federal Reserve Board and a member of his Council of Economic Advisors, stated, "Growth is good for this society as long as it doesn't pass the point of tripping off inflation." He claimed that even a low 3 percent growth rate in the economy could cause inflation. In these comments, Blinder did not express concern about excessive inflation. Rather, he spoke of "inflation" itself as the danger. He thus reinforced zero-inflation propaganda and indicated his own support for zero or near-zero inflation.

A year later, after being appointed to the Board, Blinder more clearly endorsed the goal of zero inflation, when he told the Times:

Someone asked me during a recent speech, do I think we can ever achieve zero inflation. I said, 'Absolutely, yes.' We can get there in only a couple of years if we are willing to pay the price. But I think if you put the question to ordinary people - 'Would you like right now to have a recession like the one in the early 1990s to get inflation to zero by 1997?' - you would be hard put to find a single vote. You can have a more moderate strategy, arriving more slowly with less pain.
Blinder thus prefers to arrive there "more slowly" than others, but the goal is the same: zero inflation.

This rhetoric overlooks that there is a serious problem with zero or near-zero inflation, especially if achieved by maintaining high interest rates. As just discussed, high interest rates create unemployment and poverty. In 1980, Nobel prize-winner James Tobin estimated that reducing inflation to zero percent would require fifteen years of 10 percent unemployment rates.

Moreover, economist Lester Thurow has pointed out that with an average zero-inflation rate, prices on many products actually fall and

when prices fall, the smartest move is to postpone purchases. With prices lower tomorrow, only a fool buys today.... Money in the mattress becomes the only smart investment.
The same difficulty results from an average inflation rate of 1-2 percent: since many prices are increasing more than 1-2 percent, many other prices are falling to produce the low average. These falling prices suppress economic growth. But the most powerful players on the nation's economic scene rejected such considerations.

The Fed's statements about zero inflation may have been political posturing: demanding a lot in order to get as much as possible. But the militancy of their pursuit cannot be disputed. Whether or not the Fed in 1994 was genuinely trying to drive inflation down to zero is impossible to say with certainty. The Fed's secrecy, internal differences of opinion, and tendencies to change policy over time make it difficult to analyze with precision their motives in 1994. But whether the Fed truly hoped to achieve zero inflation, or merely push it down to 1 or 2 percent, the result was the same: inflation as low as possible and enormous hardship for most people.

3. How the Fed Operates

The general welfare is not the main concern of the Fed. According to law, the primary purpose of the Fed is to protect the profitability of banks, other financial institutions, and people with large amounts of capital. This mandate requires the Fed to assure that lenders are able to collect adequate interest on the eight trillion dollars they invest in bonds.

The key committee in the Federal Reserve System is the twelve-person Federal Open Market Committee (FOMC) that sets credit policy in the United States. Commercial banks dominate the boards of regional Federal Reserve Banks that appoint five members of the FOMC. Having five of the twelve votes on the FOMC thus gives private banks enormous influence from the get-go.

The remaining seven members of the FOMC are the governors of the Federal Reserve Board, who are appointed by the President to fourteen-year terms and confirmed by the Senate. These governors are themselves typically bankers and economists who move in and out of the "revolving door" of the Fed and Wall Street, creating what economics writer William Greider calls

an unofficial fraternity of industry insiders, men who [speak] the same language and [trade] gossip.... 'You almost don't have to give orders,' one former economist said. 'because the troops already know what the orders will be.'
Wayne Angell, for example, after serving a term as a Fed governor, went to work for Bear Stearns on Wall Street where he earned $100 a minute giving advice, in large part because he could more accurately predict future Fed actions based on his insider's knowledge.

The lengthy fourteen-year terms of the Fed's governors provide the Fed with considerable independence from political pressure. This allows them to more easily protect the interests of the creditor class when those interests clash with the general welfare. The Fed's independence is strengthened by the fact that Congress does not control its budget; the Fed is the only federal agency that raises its own money - from interest on loans charged to commercial banks. The fact that five of the twelve members are indirectly appointed by commercial banks further insulates the Fed from political pressure.

This fragmentation further divides the nation's political system and weakens the ability of the public to shape essential economic policy. Most countries give their elected officials power to establish all-important monetary policy. The United States Congress has given the Fed a degree of power that is almost unknown in the industrialized world. The only other country with a similar setup is Germany, where the U.S. established the Bundesbank based on the U.S. model following World War II.

This separation of power also gives Congress and the President "political cover" when constituents complain about the pain inflicted by Fed policies. The politicians can say, "It's not us. It's the Fed." This charade ignores the fact that the Fed has only the power Congress has given it.

Alan Greenspan, the current Fed Chairman, served as chair of the Council of Economic Advisors under Republican President Gerald Ford. The Republican Ronald Reagan appointed Greenspan as Chair of the Federal Reserve Board and the Republican George Bush re-appointed him. In perhaps the most significant act of his Presidency, the Democrat Bill Clinton symbolically invited Greenspan to sit next to his wife during his inauguration. Under Clinton, Greenspan steadily enhanced his power at the Fed. When the Fed reduced interest rates somewhat in July, 1995, the announcement was not made in the name of the Fed as had been traditional, but in Greenspan's name. Clinton reappointed Greenspan chair in early 1996 when his term expired.

4. The Power of the Creditor Class

Large investors make their opinions known to the Fed and throughout Washington, where they are a powerful force. Since federal deficits are covered by selling government bonds, the size and power of this creditor class has grown as the federal debt has grown in recent decades. This influence comes in part from the fact that they can refuse to buy government bonds at the interest levels that are offered, thereby forcing the government to pay higher interest to get necessary funds to cover deficits.

Despite the rhetoric about "free" markets, the creditor class exercises power in part through manipulating financial markets. With their decisions about acceptable prices for buying and selling financial instruments, traders can exercise considerable leverage on political decisions. It is difficult to prove underlying political calculations when traders determine the value of given commodities, including bonds. But mainstream reporting on Wall Street's machinations with foreign governments is revealing.

In its coverage of the 1995 Mexico currency crisis, The New Republic described a meeting with Mexican officials and a large group of Wall Street investors, known as the Weston Forum. The American investors wanted the Mexican government to take various steps to protect the Americans against losses if the value of the peso dropped considerably. According to The New Republic:

The day before the forum met with [the Mexicans] on April 20, some forum members and other investors refused to buy enough peso-denominated [bonds] to replace expiring ones, causing short-term interest rates to soar and Mexico's stock exchange to plunge. The Mexican government got the message. Soon after the meeting..., Mexico issued longer-term [bonds] as the Weston Forum had asked.... [Investors] appear to have been willing to take huge sums of money belonging to clients who may not fully understand what is at stake, and to use those sums not just to bet on emerging markets but to leverage governments into potentially disastrous policies because those policies would maximize short-term profits.
Another example of how the creditor class consciously interferes with supposedly "free markets" for political ends is the "yen crisis" of early 1995. In April 1995, economics reporters determined that United States and European bankers were secretly conspiring to force up the value of the yen as a way to pressure Japan into allowing more imports from other countries to be sold in Japan. Rather than allowing "free" currency markets to objectively determine the value of the yen through the process of open buying and selling, Western bankers were taking various steps to influence those market decisions for a blatantly political end: to increase Western exports.

Domestic examples of Wall Street investors consciously using the market as a political weapon are difficult to demonstrate. Traders can always say that buyers and sellers are making their decisions based on expected future economic conditions, that they are only making objective business decisions. Most reports on these issues speak of "the market" as an automatic force that is not influenced by personal bias.

But early in the Clinton administration, when officials were considering a middle-class tax cut that might increase the deficit, The New York Times reported that such action "would almost certainly lead investors to drive up already-rising interest rates," even though a $12 billion tax cut would have been "a drop in the stream of an economy rushing along at $6 trillion annually." This report forgoes the normal abstract language about "the market" and points out that real-live "investors" make the decision "to drive up" rates. Real people have personal agendas and allow their self-interest to influence their decisions.

In this case, the creditor class seemed to use the market to push a political point. As Allen Sinai, chief economist at Lehman Brothers boasted, "The bond market will sniff out any flimflam in the cuts.... [T]he result could be that Washington really will be forced to drastically cut the least productive segment of the economy - the Government itself." It is hardto believe that the creditor class would not allow their "market decisions" to be influenced by self-interested political calculations about the need "to send a message." If they did it with regard to Mexico, can anyone doubt that they would not do it with regard to the White House?

In 1994, Clinton's campaign manager, James Carville, frustrated by Clinton's economic policies, said that if he "died and went to heaven, I would like to come back as the bond market." And Bill Moyers commented, "The Democratic Party has become the party of the money-changers."

5. "Wall Street vs. Main Street"

The Fed has been allowed to protect the interests of lenders when those interests conflict with the general public, even when powerful corporate voices protest. The need for economic growth and the self-interest of lenders are inherently at odds. Economic growth tends to generate modest inflation and modest inflation tends to generate economic growth. For this reason, private businesses are less concerned about inflation than are bondholders who make money even if the total economy stagnates. High interest rates hurt the economy; but high rates enable lenders to boost their income by earning more interest income from the higher interest rates.

The importance of high interest rates is revealed by a late 1991 controversy over the interest banks charge for the use of credit cards. President George Bush sparked the fire by calling on banks to voluntarily lower credit-card interest rates in order to spur spending. A few days later, the Senate amended a bill on the floor to include a limit on card rates. The next week, as reported by Reuters, "the $100 billion market in credit card bonds ground to a halt for days. Then the stock market tumbled." On one day, the average value of stocks fell by about 3 percent. This stock market dive was attributed to the Senate vote. The House leader Thomas Foley quickly reversed position and decided not to bring the issue to a vote before the House. Consequently, credit-card interest rates remained at a national average of about 19 percent.

This conflict of interest between lenders and most sectors of the economy is revealed by the sustained, behind-the-scenes effort of the National Association of Manufacturers in the early 1980s to persuade the Fed to lower interest rates. This powerful lobbying arm of corporate America was notably unsuccessful in its campaign. The Fed pushed interest rates up to record-high levels.

In early 1994, in the midst of the controversial move by the Fed to raise interest rates for the fourth time that year, a Reuters poll found that a majority of business executives objected to the Fed's action. The Reuters poll not only found little support among executives for lower rates of inflation. A majority actually reported seeing no problem with inflation of 5 percent. In addition, 22 percent cited unemployment as the biggest problem facing the economy and only 15 percent cited inflation.

The reality of this conflict between private business and lenders is verified by a 1994 New York Times Poll that found

many executives also have a complaint: they can't get the price increases that many say are needed to keep their businesses thriving.... 56 percent expressed alarm that the rising rates could hurt their sales.
Even the National Chamber of Commerce was included among the critics of the 1994 increases. The chamber's chief economist reacted with the following comment:
With virtually all current indexes showing little or no inflation, and with many indicators showing that economic growth was already slowing from its rapid pace at the end of last year, we are becoming increasingly concerned that Federal Reserve policy may be moving too fast and too far. We are concerned that monetary policy not choke off an economy that only recently hasbegun to generate income and job growth.
This statement reinforced the clear impression that there was a serious split within the business community about national economic policy. For the Chamber of Commerce to go on record in open opposition to Fed policy is a rare phenomenon.

Many Democrats in Congress joined in the protest. Senator Jim Sasser, for example, chair of the powerful Joint Economic Committee stated, "The Federal Reserve is once again putting the brakes on the nation's economic recovery and in doing so, hurting hard-working Americans." Referring to the modest upturn in the economy during his Administration, even President Clinton reportedly told aides "this appears to be a recovery for investors."

This widespread dissatisfaction led to moves in Congress to take away some of the Fed's nominal independence. In addition, the Fed was involved with an ongoing turf battle with the Treasury Department over authority in relation to bank regulation. Nevertheless, the Fed persisted.

The importance of this struggle led The New York Times to run a series of articles, op-ed pieces and letters challenging the Fed's policy. In May 1994, for example, Thomas Friedman commented:

But what is implicit in such moves is the following assumption: that America has decided that in the tradeoff between job growth and inflation growth, between putting people back to work and putting up prices a little, jobs are less important. Higher mortgage rates and more unemployment be damned.
Following this summary of the nation's most important economic policy, Friedman pointed to the mysterious political process that produced this policy: "But this has left a lot of people asking: 'Who decided that?' 'Was there a vote I missed?' 'Why should we be held hostage by the bond market?'"

In May, 1994, Stanley Druckenmiller, managing director of Soros Fund Management, headed by George Soros, perhaps the biggest player on Wall Street, responded to The New York Times cascade of articles with an amazing letter to the editor. With some one-third of the nation living in poverty, this voice of Wall Street complained about "the economy expanding well above its long-run potential," described the call for lower interest rates as "absurd," and said "the only real question" is whether rates should be raised even further. This rabid anti-inflation campaign, conducted with the tacit consent of Congress and the President, is thus another illustration of how wealthy elites have repeatedly manipulated public policy to their own benefit.

Among wealthy elites, certain groups are more equal than others and the creditor class is the strongest of all. In the key conflict over interest rates, those who reap their profits in the paper economy have prevailed. When asked on one occasion about the power of the Fed Chairman, former Chairman Paul Volker responded:

It's not all the Chairman.... The Federal Reserve has to work within some framework of what's acceptable and unacceptable in terms of at least informed opinion in the country generally. They don't go off half-cocked, so to speak, outside the range of what some kind of broad consensus is about the nature of policy.
The internal conflicts just described suggest that the "informed" opinion to which Volker refers does not include the National Association of Manufacturers or the National Chamber of Commerce. Rather Wall Street is where the Fed goes to find its direction - the "broad consensus" of "acceptable" public policy.

6. The Clinton Cave-In

Early on, President Clinton accepted the Fed's move toward higher interest rates. Labor Secretary Robert Reich signaled some mild resistance from within the Administration. He frequently refused to answer reporters' questions about what he contemptuously called the "paper economy" in contrast to the "real economy." And he commented:

If it is true that we have to draft seven to eight million people into unemployment in order to fight inflation, then we have a major social problem on our hands.
But even this comment was carefully qualified and avoided taking a position on whether or not high unemployment is in fact necessary to control inflation.

Early in his Administration, many of Clinton's closest advisors argued vehemently for a stronger commitment to economic growth and the creation of quality jobs. According to Bob Woodward, author of The Agenda: Inside the Clinton White House, these advisors were horrified and disgusted with Clinton's decision to persistently follow the advice of Fed Chair Greenspan.

Regardless of their personal opinions, however, the Administration as a whole spoke with a strong and clear voice in support of the Fed. As The New York Times reported in its lead story on May 8, 1994:

After a year and a half of seeking faster economic growth, the Clinton Administration has now reluctantly changed course, putting the stability of financial markets ahead of rapid economic expansion. No longer do Administration officials promote low interest rates.
The Administration let it be known that that they accepted that "interest rates are the preserve of the Fed, and the Administration is determined not to be seen as interfering with its decisions."

According to Woodward, Clinton expressed frustration with his own economic policy, by sarcastically telling his aides, "We're Eisenhower Republicans here, and we are fighting the Reagan Republicans. We stand for lower deficits and free trade and the bond market." But when push came to shove, Clinton went along with the Fed's program. As reported by The New York Times, quoting a prominent economist in August, 1994, official policy at that time was:

Governments today have only one effective way to control inflation: restrain economic growth. In cruder terms, this means establishing and maintaining sufficient unemployment to keep labor costs under control."
The political calculations behind the Administration's policy was reported by The New York Times, based on interviews with "several top Administration officials" who acknowledged that they were
acutely aware that rising inflation forced the Fed to raise interest rates very sharply a year before the 1980 Presidential elections, a move often cited as having cost Jimmy Carter his Presidency.
Incumbent Presidents fare much better in elections if the economy is growing rapidly at the time of the election. So the Administration wanted low interest rates prior to the 1996 election, to allow enough lag time to stimulate the economy. Since the Fed was clearly committed to increasing interest rates after only a brief period of moderate growth, the Administration was willing to accept slow growth in 1995, hoping that the Fed would allow the economy to start growing in time for the election. The Fed and its allies said that there was a limit to how much the economy should grow and the Administration apparently wanted "to conserve some of that growth for 1996, rather than splurging in 1994 and 1995." The welfare of ordinary Americans was thus sacrificed to President's Clinton's desire to be re-elected.

Giving the Fed quasi-independent power has confused this entire process, leaving the impression that financial matters are beyond public control. Once again, fragmenting the government has served to divide the people and enable wealthy elites to rule more easily.

Prior to 1981, political pressures generally compelled the Fed to keep interest rates low relative to inflation. Average treasury bill rates minus changes in the Consumer Price Index were near or below zero in the 1950s and 1970s and were below 2 percent in the 1960s. In the 1980s, however, they were well above 4 percent. In the 1990s, the Fed was widely assumed to be "experimenting" with low interest rates. In fact, compared to inflation, real rates remained "high by historical standards," as reported in the minutes of the Fed's August 1997 meeting. In early October 1997, the real Fed funds rate, the interest charged on overnight loans between banks after subtracting the inflation rate for the previous year, was 3.28 percent.

Although formally independent from the Executive branch, the Fed must operate in a political manner. At any time, Congress can pass legislation to place the Federal Receive directly under the direction of the President. So the Federal Reserve Bank is normally careful not to inflame popular opinion in a manner that could interfere with its relative independence. Presidents Kennedy, Johnson, and Nixon used their power to openly pressure the Fed to keep interest rates low and were largely successful.

Given this history, the ability of the Fed to maintain high interest rates is remarkable. The Fed's determination to inflict such hardship on most Americans for the sake of already wealthy lenders, even at considerable risk to its own independence, is somewhat curious. Looking back, it seems that a series of traumatic events in the early 1970s persuaded the creditor class that drastic new measures, including record-high interest rates, were necessary to protect its wealth.

B. The Trauma of 1973-74

Following World War II, the United States stood alone as the world's greatest power, producing half the world's goods, with a monopoly on nuclear weapons. Two wars in less than thirty years had devastated Europe, the planet's most industrialized region. Never having suffered the destruction of a serious military invasion itself, the post-War United States was free to exploit most of the globe with minimal resistance.

As Benjamin Schwarz, a foreign policy analyst at the mainstream Rand Corporation think-tank, has pointed out, international capitalism experienced its greatest growth following decisive victories in two major wars: the Napoleonic wars (1815) and World War II (1945). According to Schwarz:

The key to both these episodes of peace and prosperity has been the same - the ability and will of a single state to become a hegemonic power, taking over the security problems of weaker states so they need not ... form trading blocs to improve their international positions. This suspension of power politics through hegemony [domination of one nation over others] has been the fundamental aim of American foreign policy since 1945.
Although the United States did not establish formal European-style colonies, the United States did proceed to informally dominate most third-world countries, including former European colonies that gained their technical independence. By supporting governments that allowed U.S. corporations to operate freely within their borders and by over-throwing duly-elected governments that resisted U.S. domination, the United States largely controlled most of the non-Communist world and establish economic policies that favored wealthy elites in the United States. The mere threat of military action, backed up by an occasional invasion to establish this threat as real, helped the United States to impose its will.

But eventually, as Schwarz and others argue, this strategy backfired. Europe and Japan built strong economies in part because they did not waste resources on relatively unproductive military expenditures, as the United States provided them military protection. Although public spending on the military can prop up an economy in the short run, investment in non-military areas more effectively strengthens economies in the long run. A strong military can thus help a country build a domineering economy, but this approach plants the seeds of its own destruction as other countries are better able to build up their own economies.

By 1973, these issues came to a head. America's domination of the non-Communist world had collapsed, as symbolized by America's first military defeat in Vietnam. As Richard Nixon assumed office for his second term, the most powerful nation on earth was suffering a humiliating military loss in Vietnam. Unable to win the war, after repeatedly declaring that a defeat would produce a "domino effect" that would lead to Communist governments throughout Southeast Asia if not the entire world, on January 23, 1973, peace accords ending the war were signed.

The dominos never fell, of course, but apprehensions about America's continued ability to use its military to dominate the non-Communist world proved well-founded. Despite occasional limited successes, since 1973 the American military has been severely limited in its ability to act unilaterally. Even when Iraq invaded Kuwait and threatened the West's access to Middle East oil, President Bush had to bargain relentlessly to get international support for military action and barely obtained support from his own Congress. The rapid withdrawals from Lebanon and Somalia following minimal loss of American lives reflect post-Vietnam reality: as soon as the body bags start coming home, support for military action is unlikely. The upper echelon thus had good reason in 1973-74 to worry about their position in a world that the United States was no longer able to dominate militarily. The move toward nationalizing private oil companies in countries such as Iran and Venezuela during this period reinforced an underlying uneasiness. By 1973, the need for a new economic strategy was becoming clear.

The defeat in Vietnam was only the tip of the iceberg. Another major problem was President Nixon's earlier decision to abandon the gold standard. Since World War II, global economies had been based on the American dollar. The United States promised to give gold at a fixed rate - $35 for an ounce of gold - on demand to anyone who wanted to exchange their dollars.

At the same time, the currencies of other countries were tied to the dollar at a fixed rate. This arrangement meant that owners of other currencies could at any time demand that their government give them a fixed amount of gold for each unit of currency they owned. This threat discouraged governments from rapidly increasing their money supply for short-term political purposes (e.g., re-election) if they didn't have enough gold to back it up. Since the rapid expansion of money can destabilize economies by producing hyper-inflation and speculative bubbles that create depressions when they burst, the gold standard thus helped stabilize global economies. It also communicated a political and psychological message: the United States is the strongest economy on the block.

But in the early 1970s, the United States faced a dangerous decline in its gold reserves at Fort Knox. By 1971, these reserves had fallen to only eighteen billion dollars, with outstanding claims held by foreigners totaling thirty-six billion dollars. As other economies continued to get stronger, global transactions were more likely to be conducted in the currencies of these other countries. Owners of financial assets came to be more confident about holding their assets in currencies other than U. S. dollars. In fact, as relative confidence in the American economy declined, investors were rapidly cashing in their dollars for gold.

Afraid of being subjected to a run on dollars that the United States would be unable to meet, President Nixon in 1972 unilaterally declared that the United States temporarily would no longer pay gold for dollars. Later that year and in early 1973, Nixon negotiated agreements with the other major industrialized countries to devalue the dollar - that is, to reduce the number of dollars to be exchanged for a given unit of another currency. But by March, 1973, in part due to strong resistance from other countries to reaching a new agreement, Nixon gave up on negotiating new exchange rates and unilaterally declared that the value of major currencies would permanently "float" freely on global currency markets (where currencies are bought and sold by investors and speculators). The value of the dollar would be determined by what people were willing to pay on these free markets. With floating exchange rates, the value of the dollar continued to decline.

This decline boosted the American economy because exports were cheaper abroad and imports were more expensive at home. But it hurt other economies, including oil-producing nations. As described by William Greider in Secrets of the Temple:

The immediate consequence [of Nixon's abandoning the gold standard] was dramatic and frightening. In the fall of 1973, six months after the dollar was permanently "floated," the oil-producing nations of OPEC quadrupled the price of crude oil.... The OPEC price escalation was a direct and logical response to Nixon's fateful decision. Oil traded worldwide in dollars, and if the United States was going to permit a free fall in the dollar's value, that meant the oil-producing nations would receive less and less real value for their commodity. The dollar had already lost one-third of its value in only half a dozen years and seemed headed toward even steeper decline. In substantial measure, Saudi Arabia and the other OPEC nations were grabbing back what they had already lost - and tacked extra dollars on the price to protect themselves against future U.S. inflation. The Wall Street Journal observed: "OPEC got all the credit for what the U.S. had mainly done to itself."
The OPEC price increase triggered a global increase in prices throughout the world. As a result, in the United States, for the first time since the Depression, the nation's total net wealth declined for two years in a row (1973 and 1974). The nation's total net financial wealth, in 1987 dollars, fell from $6,200 billion in at the end of 1972 to $5,000 billion at the end of 1974. Thus, on average, the wealthy saw 20 percent of their assets vanish into thin air in less than two years - a powerful shock that reinforced pre-existing uneasiness. Weakened by the loss in Vietnam, the United States was unable to act militarily to counter the OPEC price increase.

At the same time, the President of the United States was "twisting in the wind" while facing a trial before the Senate for high crimes and misdemeanors. In 1974, Nixon became the first President forced to resign while still in office. This controversy added to the nation's troubles and a sense of foreboding among the super-rich.

The social turbulence of the time didn't help matters any, as far as wealthy elites were concerned. The youth rebellion that overlapped with the antiwar movement and the militant Black Power movement were bothersome enough. But perhaps the most ominous sign on the horizon was the growth in labor strikes. The number of work stoppages grew from 250 in 1972 to a record-high 424 in 1974.

In combination, these events in 1973-74 shook the confidence of the nation's wealthiest individuals. The general public endured long lines at gas stations, but inflation-adjusted personal income and unemployment held steady in 1974. Wealthy elites, however, suffered traumas that continue to greatly influence public policy today. The leadership of the United States was being called into question. American military power was waning. Wealth was vanishing into thin air. From the point of view of the wealthy, something had to be done to correct this alarming decline.

Faced with these ominous conditions, a new consensus apparently formed in the corridors of power: get rich quick and to hell with the future. The wealthy increasingly shifted toward short-term profits, especially guaranteed profits on the financial markets. They de-emphasized long-term investments and paying workers enough to boost their purchasing power. Since they could play with loaded dice, computerized global financial markets offered the wealthy an opportunity to make money on the misery of those who suffer when speculative bubbles burst. As depicted so well in Martin Scorcese's film Casino, the "house" always wins in Vegas. But in High Finance, not only do the "houses" always get their commission; the game is rigged to favor the high rollers. So long as the Fed controls inflation, their money keeps growing.

Writing in The New York Times, economics writer Peter Passel offered a similar analysis of recent economic developments:

Another explanation [for increased inequality] is the breakdown of social conventions that limited extremes in compensation and deterred those with the wherewithal from simply taking the money and running [italics added]. Paul Joskow of MIT estimates that during the 1980s, a period of stagnant average wages, the pay of chief executives at 800 large corporations rose by 75 percent. And this apparent breakdown in we're-all-in-this-together civility, argues Andrei Shleifer of Harvard, could also help to explain the ruthlessness of corporate restructuring, in which divisions are liquidated or moved abroad, middle managers fired, pension plans abandoned and union strikers replaced.

C. The Carter/Reagan Revolution

The federal government, beginning with the Carter Administration from 1977-1980, soon established a set of new policies to defend the interests of the wealthy. Over the course of the next 15 years, the federal government:

In combination, these policies shifted the distribution of wealth and income toward the wealthy (see Chapter Five) and enabled them to cope with the new world order. Ordinary Americans paid the price with declining wages, higher unemployment, massive homelessness, and a declining quality of life. Since 1973, economic growth has averaged 2.3 percent a year, compared to an average annual rate of 3.4 percent for the previous 100 years.

In 1988, conservative commentator George F. Will spoke candidly about the underlying political dynamic when he acknowledged: “Politics is about who gets what, especially as a result of government action. In the Reagan years, a particular social stratum has gotten a lot.”

From this perspective, economic globalization is not the cause of the recent decline in living standards, as many claim. Nor is it the automatic result of impersonal, objective economic "forces." Rather, the growing hardship of the last thirty years is due to the fact that wealthy elites have persuaded the United States government to adopt specific economic policies that have redistributed wealth upward while damaging the well-being of most Americans. The same economic forces operate in Europe and Japan. But those countries have not experienced increasing inequality like the United States has, though American elites are trying to persuade them to follow in our example. The globalization of the economy has encouraged the wealthy to push for these changes in public policy. But elected officials could have resisted this pressure. The determining factor has been federal policy, not the supposedly new economy.

Sources for this chapter included the following, in order of appearance.
For more specific references, contact Wade Hudson at

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