Inside today’s Daily Journal…
Essay: Arthur Burns’ Secret 1979 Warning
Central banks running from Treasuries
UAE and Oman look to solve Iran War
Booz Allen Hamilton’s mixed earnings bag
Chart Of The Day… Hovnanian Enterprises (HOV)
Today’s Mailbag
In 1979, Belgrade, Yugoslavia, was the Dubai of the Soviet bloc.
Belgrade was the leading industrialized city in Eastern Europe. Rebuilt after World War II, it was a city shaped by the demands of the communists, which included heavy manufacturing for the military. Their plans didn’t include wastewater treatment or any regulations on air pollution. Its filth and stench were a warning of the catastrophe that would emerge a decade later in its civil war.
It was the most unlikely place in the world for the leading bankers of capitalism to gather. And it was the site of the most unlikely speech ever given by any central banker: a warning about the imminent failure of central banking.
Arthur F. Burns was chairman of the Federal Reserve from February 1970 until January 1978. He taught Milton Friedman at Rutgers. He advised four U.S. presidents. He smoked a pipe in every photograph. In the eyes of his profession, he stood at the summit of American economic thought.
He also presided over the worst peacetime inflation in American history, the rapidly escalating prices of the 1970s.
One Sunday in late September 1979 in Belgrade, Burns delivered the annual Per Jacobsson Lecture. The Per Jacobsson Foundation invites only the most senior figures in global finance – central bank governors, finance ministers, the principals of the International Monetary Fund (“IMF”) and the World Bank.
Burns’ lecture runs roughly 12,000 words. It is a moral and economic indictment of central banking. And it was a dire warning – to the entire world – of the enormous monetary reset that would begin just two months later. But this speech was kept secret for almost a decade.
It was only published after Burns’ death in 1987.
If you understand it, you have a chance of surviving what’s about to happen to America. If you don’t understand it, you have no chance.
Burns’ argument was not that the Federal Reserve botched the job of maintaining price stability in the previous decade, although he admitted plenty of error. His argument wasn’t about how central banking failed. It was about the far deeper failures, the why central banking fails.
Burns’ warning was that, in democracies, the promises of the politicians will always outpace the taxes necessary to support them. This, inevitably, creates permanent and growing fiscal deficits. Burns explained that central banks were no longer being used to support legitimate government financing, but instead, had become the bridge to spending that would otherwise be impossible. He said:
The proliferation of government programs led to progressively higher tax burdens on both individuals and corporations. Even so, the willingness of government to levy taxes fell distinctly short of its propensity to spend. Since 1950, the federal budget has been in balance in only five years. Since 1970, a deficit has occurred in every year. Not only that, but the deficits have been mounting in size. Budget deficits have thus become a chronic condition of federal finance. They have been incurred when business conditions were poor and also when business was booming. But when the government runs a budget deficit, it pumps more money into the pocketbooks of people than it withdraws from their pocketbooks – the demand for goods and services therefore tends to increase all around. That is the way the inflation that has been raging since the mid-1960s first got started and later kept being nourished.
And then Burns told the world that the only way forward was a drastic change to this accommodative policy – a global monetary reset was inevitable.
If the United States and other industrial countries are to make real headway in the fight against inflation it will first be necessary to rout inflationary psychology – that is, to make people feel that inflation can be, and probably will be, brought under control. Such a change in national psychology is not likely to be accomplished by marginal adjustments of public policy. In view of the strong and widespread expectations of inflation that prevail at present, I have therefore reluctantly come to believe that fairly drastic therapy will be needed to turn inflationary psychology around.
What did “drastic therapy” mean? A complete monetary reset. Sixty days after Burns delivered his remarks in Belgrade, Paul Volcker – Burns’ successor at the Fed – began the most violent monetary tightening in U.S. history. The federal fund rate would eventually climb to 20%. The yield on the 10-year Treasury bond would hit 15% by October 1981, causing a 50% decline in bond prices. Mortgage rates hit 18%. Unemployment touched 11%. Stocks fell until the average earnings multiple on the S&P 500 was 8x earnings. The global monetary order reset. The dollar was saved. And financial assets were virtually destroyed.
Burns knew it was coming. He tried to warn the world – and the bankers wouldn’t let him. Today, the same warning applies, but on a vastly larger scale. Will you listen…?
