The 1990s
"...in bringing back the virtues of old-fashioned capitalism, we have brought back some of its vices..."
"key global problem of the final years of the twentieth century: unbalanced wealth and resources, unbalanced demographic trends, and the relationship between them....we are heading into the twenty-first century in a world consisting of the most part of a relatively small number of rich, satiated, demographically stagnant societies and a large number of poverty-stricken, resource-depleted nations whose populations are doubling every twenty five years or less." 

The 1980s began with the "old" international order firmly in place and the Cold War showing few signs of cooling.  The US was involved in a Nicaraguan revolution, and in response to Russia's invasion of Afghanistan, had banned agricultural exports to Russia where Breshnev appeared solidly in power despite a poorly performing economy, and by mid decade were bombing Libya.  The Middle East remained a problem with the Iranian hostage crisis and a second round of OPEC-led oil price hikes that nearly doubled the value of US  imported oil both occurring in 1979. 

There were, however, some signs of change.  Margaret Thatcher had won the election for prime minister decisively in the UK in 1979 and Ronald Reagan had been elected president the following year with a campaign pledge to rebuild the American military machine.  In Poland there were some early signs of the rising discontent in Eastern Europe.  The strikes against the Gdansk shipyard led by Polish electrician Lech Walesa finally paid off, and on August 31, 1980 an accord was reached with the Polish government who now recognized the Independent Self-Governing Trade Union, Solidarity.  But there was no indication of the momentous changes that the decade would bring.

But things changed.  Internationally it was certainly a risky time to be a national ruler. Reagan and the Pope were shot less than two months apart in 1981 followed by the assassinations of Egypt's Sadat and then India's Ghandi in November, 1984.  Brezhnev died in 1982 and after brief stints by Andropov and Chernenko, Michel Gobachev assumed power in 1985 and instituted perestroika, a program of economic and political reform designed to institute market type reforms, and glasnost, a policy of openness.  What he unleashed was a series of reforms that led to the formation of the new Soviet parliament in the spring of 1989, the Congress of People's Deputies, with Gorbachev as president. This structure allowed each republic to have its own president, which is where Boris Yeltsin got his big break, and in 1990 the Russian republic declared sovereignty and by 1992 the Soviet Union no longer existed.  Russia and ten other republics declared themselves independent and founded the Commonwealth of Independent States with Russia taking over the powers once wielded by the Soviet Union. 

The fall of the communist party in the Soviet Union was duplicated across eastern Europe.  In late 1989 the communist government of East Germany collapsed and in the following year the Berlin Wall was dismantled and East and West Germany were reunited with Berlin as the new capital.  The most dramatic power shift came in Romania where Ceausescu was overthrown in a single week in mid December of 1989 and executed on December 25th of that year.  In June of the following year the first free elections were held in Czechoslovakia, a country that was later divided into two - Slovakia and the Czech Republic.

There were also a number of significant micro and macro developments in the US economy during the 1980s.  This was the decade of the break-up of AT&T, part of an overall move away from regulation that also brought People's Air and the S&L crisis.  We also saw the mouse appear on "real" computers when Apple introduced the Macintosh and the early rise of Microsoft.  Sears made an early effort at creating a one-stop financial powerhouse, Fox made it four national networks and MTV hit the airways, Chrysler rebounded from the brink and paid off its government loan early, and the Hunt brothers lost it all in an attempt to corner the silver market.  The US Supreme Court permitted patents for forms of life, a catalyst to the bioengineering industry, and Nintendo began to gain the attention of the nation's youth.  

The macro economy at the outset of the decade was in shambles.  Inflation-adjusted earnings were at levels not seen since 1962, unemployment and inflation were on the rise again, manufacturing showed no signs of revitalization, and interest rates had reached stratospheric levels - 15 percent on three-month government securities.  International investors, aware that the US was mired in its second round of stagflation and seemed no closer to a solution than the last time, lost confidence and the price of gold, always a hedge for investors in times of uncertainty, nearly doubled in a three month period when it peaked at $835 an ounce on January 18, 1980.  

The "double dip" recession of 1980-82 turned out to be quite deep, with the unemployment rate reaching double digit levels - the highest rate since the Great Depression. But the recession did help break the rising spiral of inflation and by the first quarter of 1982 inflation was down to under 4%.

The recession had been caused by the Fed's exceptionally restrictive policy stance, which can be seen in the high positive real rates in the early 1980s. In May of 1981 the Fed had raised the discount rate to 14 percent, imposed a surcharge on borrowing, and slowed the growth of money sharply.  The Fed reversed itself in late 1981, then again in early 1982, again in the summer of 1982, and then again on October 9, 1982 when Volcker announced he would suspend the Fed's policies of controlling money supply growth and end the Fed's experiment with monetarism.  

A victim of the high interest rates and the worldwide recession of the early 1980s were the Latin American countries that had borrowed heavily in the 1970s. This was the era of the Latin American debt crisis that triggered long recessions and substantial inflation throughout the region in the 1980s.  As in Germany after W.W.I, when the world presented these countries with unpaid bills, the countries responded by printing money that drove up prices across the continent.  In a decade where inflation was generally subsiding, in Latin America it was rising. 

The value of the dollar was also affected by the high interest rates.  In the early 1980s the US  government followed a policy of "benign neglect" and let the dollar, a symbol of American prosperity, rise.  High interest rates in the US attracted foreign capital and this increased demand for dollars translated into a higher price - approximately a 100 percent increase in the trade-weighted exchange rate.  By 1985 the finance ministers from France, UK, Germany, Japan and the US met at the New York Plaza Hotel and declared the dollar overvalued, but by February 22, 1987 the finance ministers were meeting again, this time at the Louvre where they agreed the dollar had fallen far enough.

The gyrations of the dollar may have contributed to Volcker's decision to step down as chair of the Fed in 1987.  He had offered resignation in 1985 over a reversal of his discount rate policy when Reagan appointees voted for a discount rate cut over his recommendation.  They reversed themselves, but rates were cut for much of the rest of the next few years.  Alan Greenspan shortly after taking office raised the discount rate in an effort to shore up the value of the dollar, but the stock market responded with a resounding crash - 508 points on one day (22.6% of value).   This was clear indicator that the Fed could not keep the dollar up.  One casualty of the rising dollar was the manufacturing industry in the US where employment, having peaked in 1979, fell approximately 10 percent through 1983 before leveling off for the remainder of the decade.  The decade closed with a net loss of 2 million manufacturing jobs in the US, despite the decade closed with a very LONG expansion.  What remains a debatable question is how deep and wide the expansion was since this was a decade of rising inequality and insecurity.  

By the end of the decade there was no question that monetary policy was powerful, but there were rising doubts about our ability to effectively harness that power.  On the fiscal side, it was the deficit that got people's attention.  This was THE story in the 1980s.  Ronald Reagan was much more successful at achieving tax cuts than spending cuts and it soon became obvious that the Laffer curve concept was the weak link in Reaganomics.  The passage of the tax cut, coupled with the defense buildup, produced massive deficits by the middle of the decade.  "Reagan had solved the short-term problems of inflation and recession, but he did so with borrowed money and without touching the deeper sources of America's economic decline. " In Reagan's second campaign, Walter Mondale, acknowledging the magnitude of the federal deficit, made the classic blunder when he announced: "Let's tell the truth. Mr. Reagan will raise taxes, and so will I.  He won't tell you.  I just did."  While this "honesty" may have contributed to the landslide Reagan victory, Monde was in fact correct and Reagan's second term opened with a tax increase that failed to eliminate the deficit.  

George Bush inherited the large deficit and watched it balloon in the recession of the early 1990s.  The deficit, which reached nearly $300 billion at the depth of the recession, caused Bush serious political harm.  First, it forced him to renege on his famous "Read my lips...NO new taxes" stand in the 1988 election against Michael Dukakis, the former governor of Massachusetts.  Once in office Bush was forced into accepting a tax increase.  The large deficit also gave Bush few fiscal policy options to deal with the recession of the early 1990s.   Government spending increases / tax cuts were traditionally proposed as "cures' for a recession, but large deficits made these proposals impossible.  The voters made Bush pay for breaking his word on taxes and for the recession.  In the 1992 election they voted Bush out and Bill Clinton into office.

To almost everyone's surprise, by the end of the 1990s the budget deficit had been eliminated after dominating macroeconomic policy debates for the decade. This was a remarkable turnaround and in this unit we will examine the issue of government finances in the section "The Visible Hand."  More specifically we will examine closely the nature of government outlays and receipts - how the government collects its money and how it spends it.  In this unit we will also look into the changing composition of federal finances with a special emphasis on two components of spending - social security and defense - and on the potential impact changing demographics and technology will have on government revenues.  We will also examine the issue of the budget deficit and federal debt's impact on the economy.