Western establishment will pay a political price for inflation

Easily the best part of being managing partner at a major political risk firm is the life it has given me, the fascinating places I have seen and the people I have met. One of the most interesting was the late Paul Volcker, legendary chairman of the US Federal Reserve from 1979 until 1987. It was Volcker, along with Ronald Reagan, who tamed the beast of endemically high inflation in America in the early 1980s, setting the country on a course for unprecedented prosperity in the two generations since.

While on a trip to give a keynote speech in Zurich for a Swiss bank, I found myself caught in a snowstorm, and spent a day in a glorious Swiss chalet entirely alone with the former Fed chief. It was a day I will never forget. We had a lovely lunch and talked for hours about the world, philosophy, history and our shared love-hate relationship with the Republican Party.

After some gentle prodding on my part, Volcker told me about how he came to Reagan about America’s last inflation crisis. He said he told the president that he could crush the monster, but it would take double-digit interest rates, inevitably lead to a deep recession and surely cost Reagan the midterms and possibly even his reelection. According to the Fed chief, Reagan amiably patted him on the knee and said: “You leave the politics to me, Paul; just destroy inflation.”

Of course, everything came to pass just as Volcker had predicted. The country endured the worst recession since the Great Depression and the Republican Party was punished in the 1982 midterms. But Volcker and Reagan succeeded in taming the inflationary beast. By the time the 1984 presidential campaign began, America again had the wind at its back and Reagan was overwhelmingly reelected, winning 49 of the 50 states.

What I love about this story is that neither man sidestepped the political risk that was hanging over them as they did the right thing in policy terms. Double-digit interest rates could cripple the economy and certainly do not make any political figure popular, at least in the short term. However, it is far worse in political risk terms to either actively ignore endemically high inflation or passively fail to do much about it, so scared are leaders of raising interest rates and slowing growth.

Yet, in the late 1970s, the anemic Western establishment did not do much of anything, for a combination of these two reasons. The year 1979 is instructive. Then, Valery Giscard d’Estaing’s France suffered through 10.7 percent inflation, Jim Callaghan’s Britain 13.4 percent and Jimmy Carter’s America 11.3 percent. By haplessly failing to tame the beast, all three found themselves out of power by mid-1981. In their place came a very different set of leaders (Francois Mitterrand, Margaret Thatcher and Reagan), who cemented their more successful administrations not by running away from or ignoring the inflationary problem, but by coming to grips with it.

At present, our mediocre establishment in the West looks more like Carter than Reagan. Joe Biden insisted for months (as though magical thinking did away with economic realities) that persistently higher American inflation was “transitory” — an error the American people are unlikely to forget. At the same time, he was nonsensically pushing his highly inflationary “Build Back Better” program through Congress. The neutral Congressional Budget Office said this would cost more than a gargantuan $5 trillion in real terms. In the end, Biden was saved from his folly by Democratic Sen. Joe Manchin of West Virginia, who sensibly enough was against the program as it was highly inflationary. Biden was stopped from pouring more gasoline on a roaring fire, but the damage to his status as a responsible steward of the economy has been monumental.

While Biden has been channeling his inner Carter, British Prime Minister Boris Johnson is behaving more like Callaghan than Thatcher. Instinctively, the PM’s response to almost any economic obstacle is to open the British checkbook. Although up until now somewhat restrained by his seemingly more Thatcherite Chancellor Rishi Sunak, Johnson has personally shown little interest in the cost-of-living crisis increasingly bedevilling his people, being more involved in the heroic plight of the Ukrainians. But in this week’s highly inflationary giveaway to help the British people with their out-of-control energy bills, Johnson’s spendthrift instincts have become dominant — just as the Bank of England has horrifyingly admitted that inflation will crest at more than 10 percent in the near term.

There is a political risk price to be paid for such incompetence and that is at the ballot box. Much as the inconsequential Carter and Callaghan administrations are now trivia questions, look for both Biden and Johnson to rather quickly end up on the ash heap of history. For there is one final thing Volcker told me, as my car at last came to take me away from our shared chalet to the train station. “Remember that inflation affects literally everyone, hitting the working poor hardest as a tax they just cannot bear,” he said. “They will rightly vote to save themselves from people who do not realize this.”

This post was originally published in Arab News.

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