The Fed Was Not Born Precise: What It Was Supposed to Do Was Still Being Figured Out in the 1970s
Before the 1970s, even Fed chairs could not say clearly what the Fed was for, and presidents simply ordered rate cuts to protect employment. Volcker pushed rates above 20% to fight inflation head-on, and in doing so set the modern template: the chair watches inflation and unemployment, nothing else.
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The Fed's mandate was only settled in the 1970s
Liu Yi stresses repeatedly that today everyone is used to treating the Fed as a precision machine, as if it had known from birth what it was supposed to manage. But before Volcker, no one could say clearly what a Fed chair was supposed to do: Keynesian economics was still new at the time, Friedman's doctrine was popular only in a small corner of Chicago, and the Bretton Woods fixed exchange rate left monetary policy little room to operate. More common was direct pressure from the president, ordering the central bank to cut rates to protect employment. Only after Volcker had rolled through decades in the Treasury and the Fed did the template take hold — the chair mainly watches inflation and unemployment, and does not manage GDP growth. The mature system on which dollar hegemony depends is in fact only a little over half a century old.
— Liu YiHad Keynes's plan passed, America would be fined every year
At Bretton Woods, Keynes proposed that the major powers crowd-fund 35 billion dollars into a very powerful IMF, with accounts kept in a virtual currency unit, the bancor: deficit countries could apply for aid, and surplus countries that refused to invest abroad would be fined, using coercion to prevent mercantilism. White rejected the plan, because he saw clearly: after the war the United States held more than half the world's export trade and a third of its industrial capacity, so under Keynes's design America would inevitably be fined every year; and Britain and France simply could not put up the crowd-funded money, so the 35 billion would basically have to come from the United States. So the IMF was designed to be very weak, and the real anchor became the dollar fixed to gold at 35 dollars an ounce. Bretton Woods was not an idealist design; it was a product of American interests.
— Liu Yi35 dollars an ounce was set in 1933
Yu Jie points out that the real foundation for writing the dollar's gold parity at 35 dollars an ounce into Bretton Woods in 1944 lay in 1933: after Roosevelt took office he declared private gold holdings illegal, nationalised the people's gold, and the gold in the Fed's hands was transferred to the Treasury; the president then, under congressional authorisation, devalued the dollar by nearly 60% to 35 dollars, and authorised the Treasury to exchange gold freely with foreign central banks. He stresses that the crux of a strict gold standard is free entry and exit across the border — once you have exchanged dollars for gold, you can load it on a ship and take it away. This 1933 exchange commitment later became the cornerstone of Bretton Woods, and it also explains why after the war countries like France flew planes to America to exchange gold: what they were cashing in was in fact Roosevelt's promise, not merely a 1944 agreement.
— Yu JieTen billion in gold cannot back forty billion in promises
Bretton Woods's fatal flaw was the Triffin dilemma: countries needed dollars, and the more dollars flowed overseas, the more everyone doubted whether they could be converted back into gold at 35 dollars, because the dollar and gold had become competitors. By around 1971, the market value of the gold reserves in American hands was only a little over 10 billion dollars, while a full 40 billion dollars circulated overseas; the London gold price was one-seventh higher than New York's, and arbitrageurs sold dollars, bought gold, and shipped it to America to demand conversion. Even without the Vietnam War and inflation, a 4-to-1 gap made "convertible at any time" arithmetically impossible long before. Nixon's suspension of convertibility in 1971 was not a sudden default but an outcome long destined to arrive.
— Liu YiVolcker's rate hikes crushed Latin American debt first
Petrodollars poured into American commercial banks, and Chase, Citibank and others lent them on to Latin American countries desperate for funds. Latin America borrowed in the era of low dollar interest rates, and when Volcker raised rates above 20% to crush inflation, Latin America was hit doubly at once: the dollar appreciated against every currency, and Latin American currencies collapsed relative to it; American rates soared, and the new debt that had to be borrowed to roll over old debt also became more expensive, forming a debt spiral outright. West German Chancellor Schmidt left behind the lament that since the birth of Jesus, he had never seen numbers with interest rates this high. American farmers drove tractors to Washington saying they would smash their heads to death under the Fed's windows — but Volcker did not stop, inflation came before everything.
— Yu JieThe Plaza Accord was not the culprit behind Japan's bubble
Yu Jie asked Toyoo Gyohten, who was present on the Japanese side at the Plaza Accord and later became vice minister of Japan's Ministry of Finance, many times: should the bursting of the bubble be blamed on the Plaza Accord. Gyohten's answer was that the dollar had long needed adjusting, and moving in 1985 was already late; Japan's real problem was a misaligned monetary policy — it failed to tighten when it should have tightened, and failed to loosen when it should have loosened. The Plaza Accord itself was neither an agreement nor a treaty, only a statement, with no binding force on any country. After the yen appreciated, Japan's fiscal discipline loosened, it went in for heavy infrastructure spending, and together with rate cuts it pushed real estate and stocks to the top; in 1991 the new central bank governor raised rates sharply, and the bubble burst at once. Pinning the lost thirty years on the Plaza Accord is to oversimplify a complex history.
— Yu JieGreenspan invented Fed-speak
After Volcker left office, the role of Fed chair switched tracks. In his first year Greenspan ran into the 1987 stock crash, and through the media he built himself into a figure whose word was decisive, bold and tough, and from then on he had enormous say at the White House; his briefcase was chased by the media, and he also invented the so-called Fed-speak — using obscure wording to make a simple question sound as suspended and uncertain as could be. Liu Yi says that from Greenspan onward, the Fed chair became a public figure who appeared on camera often. Today Kevin Warsh takes another path: saying little or even nothing, using mystery to manufacture weight with the market and the public. Mystery and Fed-speak are the same in essence: the credibility Volcker earned by holding the line has become image management in the media age.
— Liu YiIn their own words · checked verbatim
What a Fed chair is supposed to do — that was not at all clear right up to the 1970s.
美联储主席应该干什么 这件事情到1970年代为止 都是不怎么清楚的
Liu Yi6:05
The West German central bank, it really was tough... even Volcker himself, he actually did not manage it either.
西德中央银行 他是真的刚……即便是沃尔克本人 他其实也没有做到
Yu Jie13:09
Schmidt said a line that has become scripture: since the birth of Jesus, he had never seen numbers with interest rates this high.
施密特说了一个经句嘛 说自打耶稣出世以来 没有见过利率这么高的这种数字
Yu Jie48:38
These are his exact words: Japan failed to tighten when it should have tightened, and failed to loosen when it should have loosened.
这是它的原话 日本在该紧缩的时候 没有紧缩 在该宽松的时候没有宽松
Yu Jie59:45
It itself is not an agreement, nor a treaty... it is just a statement, it is a communiqué.
它本身 它并不是一个agreement 也不是一个treaty……它就是一个statement 它是一个公告
Yu Jie59:45
Greenspan invented the so-called Fed-speak, that is, how to use some very obscure wording to make a question sound as suspended and uncertain as could be.
格林斯班发明了所谓的美联储话术 就是如何用一些很晦涩的字眼 把一个问题说的悬之又悬
Liu Yi1:13:55
Figures
| The crowd-funding scale Keynes envisioned for the IMF | 35 billion dollars | 21:14 |
| Market value of US gold reserves around 1971 | a little over 10 billion dollars | 33:27 |
| Dollars circulating overseas | 40 billion dollars | 33:27 |
| London gold price premium over New York | one-seventh | 33:27 |
| Ratio of circulating dollars to gold reserves | 4 to 1 | 36:29 |
| Cut in the Fed's benchmark rate in the Nixon era | from 9% to 5% | 35:29 |
| One-day dollar issuance by the West German central bank to support the dollar | 8 billion dollars, close to a full year's issuance | 39:31 |
| The Fed's benchmark rate under the Volcker shock | above 20% | 48:38 |
| Dollar depreciation within a year and a half after the Plaza Accord took effect | about 25% | 57:44 |
Glossary
- Triffin dilemma
- The more the dollar is needed by countries and the more of it flows abroad, the less anyone believes it can still be converted into gold at a fixed price.
- Bancor
- The international unit of account Keynes proposed in 1944, used for settlement and for fining trade-surplus countries.
- Eurodollar market
- A pool of dollar funds held outside the United States, beyond American monetary supervision, into which petrodollars flowed in large volume.
- Volcker shock
- The policy shock of Volcker raising rates above 20% from 1979 to crush inflation.
How to listen
People doing cross-border investment and watching the dollar cycle, and financial journalists who still treat the Fed as a precision machine.
The first 4 minutes 55 seconds are a tour-group ad and small talk; the substance starts after that.