Famous Anniversary Today in Fed History

October 6, 2009

Thirty years ago, October 6th fell on a Saturday, not a typical day of the week for the Fed to be announcing important policy changes.  Paul Volcker had been Chairman of the Board just two months, and CPI inflation as of September had risen to 12.2% from 8.3% a year earlier and 5.5% two years earlier.  Inflation would crest to a post-war high of 14.8% the following March, and the rate on dollar/mark of 1.76 (equivalent to EUR 1.111) was sinking fast and just 3.4% above the November 1978 record low.  The central bank took three actions that day.

  1. The landmark decision was an announcement de-emphasizing interest rates and instead concentrating on reserves made available to the banking sector with the intent of directly slowing runaway growth in the money supply.  These days, that would be called quantitative tightening.
  2. The discount rate was increased to 12% from 11%.
  3. An 8% marginal reserve requirement was imposed on U.S. banks’ large time deposits, Euromarket borrowings, repos against Government and agency securities, and Fed funds borrowings from nonmember banks.

The Fed’ steps were recognized immediately as a potential game-changer.  A severe double-digit recession began shortly afterward, and inflation by March 1983 had shrunken to an on-year positive rate of just 2.5%.  Dollar/mark opened 2.6% higher the following Monday and gained over 12% within six months, but that first fling upward did not last.  Volcher’s moment in history came just four weekends before 50 people were taken hostage by so-called Iranian students at the American embassy in Teheran.  Credit controls undermined the Fed’s experiment and drove interest rates down temporarily and with that the dollar, which gave back all its ground won in the wake of the Fed’s actions on October 6, 1979.  The election of Conservative Republicans led by Ronald Reagan in November 1980 brought to Washington a Fed-friendly administration, and the dollar was finally off to the races in a sustaining way.  Climbing in three giant waves, the dollar reached DEM 2.5745 on August 10, 1981 at the end of the first leg and DEM 3.478 in February 1985 at the end of the final thrust.  In all it had practically doubled its value from its level at the time of that milestone in Fed policy 30 years ago.

Looking back those 30 years, one is left to conclude that while a few things have changed, much remain the same.  Consumer prices over the past 12 months have dropped 1.5%, a downward swing of 13.7 percentage points from +12.2%.  The dollar is nonetheless even weaker now than then.  The DEM-translation value of the euro is 1.3277 currently, which lies below the dollar’s weakest level against the mark (1.345 on March 8, 1995) from the era before the euro merge.  Gold was soaring in late 1979 on its way to an historic high at the time of $875 in January 1980, and gold today set a new all-time record of $1038 per ounce.  Iran created enormous problems for U.S. foreign policy then, as it is doing now.  Some eyewitnesses in fact believe that President Mahmoud Ahmadinejad is in fact one of the hostage-takers from that earlier period.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.


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