Great Wave

by Fischer, David Hackett;

  Figure 4.10 shows price movements in eight nations from 1920 to 1945. After the inflation that followed World War I, prices tended to fall from the early 1920s to the early 1930s. The nadir was reached in most nations circa 1934. Thereafter, prices resumed their upward climb, accelerating during World War II (1939–45). Hyperinflation developed in Italy after 1943, and in many European nations after 1945 (see figure 4.12); but controls were successful in Britain and the United States. Sources are B. R. Mitchell, European Historical Statistics (2d rev. ed., New York, 1981), 778–83; Historical Statistics of the United States (1976), E135.

  In the United States, President Franklin Roosevelt assembled a team of exceptionally able managers who made the American economy into the decisive weapon of the war. Productivity soared. National product per capita (in constant dollars) nearly doubled in the United States from 1938 to 1944, the strongest surge of economic growth in modern American history.14

  In the United States, a regulatory system that included rationing and price controls worked remarkably well to stabilize the booming economy. A black market developed for scarce goods, but most Americans willingly accepted a more highly regulated economy as part of the war effort. Economists such as John Kenneth Galbraith, who worked for the Office of Price Administration during the war, always remained more supportive of price controls than colleagues who had not shared that experience. The contribution of economic regulation in World War II was both material and moral. It fostered a sense of fairness and justice, and sustained collective effort in a nation that was united as never before.

  Britain also used price controls with high success during World War II. The cost of living in the United Kingdom rose only about 20 percent from 1939 to 1945, and increased scarcely at all from 1940 to 1947. The record of the Axis nations was more mixed. In Nazi Germany, prices were kept very stable, increasing 9 percent from 1939 to 1944. This was done in part by requiring citizens and corporations to freeze their liquid assets in compulsory savings accounts, which in turn were confiscated by the state. This plundering of private assets effectively reduced demand and diminished inflation, but it also contributed to the total destruction of the German economy. Fascist Italy cheerfully resorted to the printing press, and suffered severely from an inflation that continued at a rapid rate from 1934 to 1948. Through much of occupied Europe, prices rose sharply during the war. The Soviet Union also had very high inflation during World War II; official estimates put the increase of prices at 325 percent. The true number was probably higher.15

  Figure 4.11 shows the impact of price controls in the United States during World War II. Industrial prices were controlled in 1942; farm prices, in 1943. Controls were removed in 1946. The source is Historical Statistics of the United States (1976) E23–25.

  After the war, many European nations suffered severe hyperinflations, similar to the aftermath of World War I. The worst problems were in eastern and southern Europe, during the years from 1947 to 1949.

  In the United States, price controls were removed in 1945. What followed was similar in some respects to the period after World War I. In the immediate postwar years, inflation increased to double-digit levels—high by the measure of the American experience, but low by comparison with contemporary trends in Europe. Wholesale commodity prices rose 14 per cent in 1946, and 23 per cent in 1947.

  Then the American economy slipped into a short recession. National income declined, rates of unemployment increased, and in 1949 consumer prices actually fell. The decline was small and shortlived: less than 1 percent, in little more than one year. Underlying inflationary pressures were strong. By early 1950, prices were climbing again.

  Figure 4.12 shows levels reached by hyperinflations in Europe during 1947–49. The sources are consumer price indices (1929=100) in B. R. Mitchell, ed., International Historical Statistics: Europe, 1750–1988 (New York, 1992), 848–49.

  Figure 4.13 shows the effect of price controls in controlling inflation in the United States during the Korean War. When the war began in 1950, wholesale prices and consumer prices surged to double-digit levels. Controls were imposed in 1951–53. Prices immediately stabilized and did not increase when controls were lifted. The source is Historical Statistics of the United States (1976) E23, E135.

  Inflationary pressures mounted in the United States during the summer of 1950, when a Communist regime in North Korea suddenly attacked its southern neighbor, and yet another major war began. By 1951, most of the world’s great powers had men in combat on the Korean peninsula. Military forces rapidly expanded throughout the world. More Americans were in uniform during the Korean War (1950–53) than during World War I.

  In its economic impact of the Korean War was similar to the world wars that had preceded it. Once again inflationary pressures surged throughout the world. In 1950, wholesale prices jumped 12 percent in the United States, 18 percent in Germany, 21 percent in Britain, 28 percent in France, 32 percent in Sweden.

  In the United States, President Harry Truman acted decisively, and revived price controls with high success. As a short-run emergency war measure, the regulation of the American market during the Korean conflict proved to be highly effective, more so even than in World War II. After controls were imposed in 1951, prices and wages became remarkably stable. There was no inflationary surge from 1951 to 1954, and no explosion of repressed demand when controls were removed. Price-regulation kept inflation within narrow bounds. It also diminished the dangerous social instabilities that often accompany price-surges. The side effects of short-term price controls in 1942–45 and 1950–53 were much less destructive to the social fabric than neoclassical anti-inflationary policies of 1980s and 1990s. Those who believe that “price controls don’t work,” even in the short run, will find strong evidence to the contrary in the history of the American economy during World War II and the Korean War.

  The Discovery of Inflation, 1938–63

  Through all of these turbulent events, global prices continued to rise in peace as well as war. Even as price surges were restrained in some nations by strict controls, the secular trend moved inexorably upward. In the United States from 1938 to 1963, consumer prices rose every year but two. During the span of an entire generation, inflation was the rule in twenty-three years out of twenty-five. One result was a growth of what Americans called an “inflationary psychology.” The existence of inflation as a secular trend began to be discovered by individuals, corporations, and governments throughout the world.16

  American historian Eric Goldman lived through this period in the United States. “Inflation jabbed people wherever they turned,” he remembered. “Trolleys and subways went up two cents, then a nickel. The ten-cent Sunday newspaper was disappearing in America. Still more irritating were things that were hard to buy at any price. A public with billions of dollars stored up in war bonds and savings accounts . . . found itself queuing up in long nerve-jangling lines. Women had trouble getting furniture, nylons, a new electric iron; men found clothing, even a razor blade that would shave clean, in short supply. . . . As the summer of 1946 closed, the food shortages were reaching their climax. First came a meteoric rise in prices. . . . Gradually the store shelves began to fill; within months of the election of 1946, steaks and roasts were no longer drawing crowds. . . . Prices kept on climbing. Even the kids of Cape Cod resort towns, who for years had dived to retrieve pennies thrown in the water by vacationers, now refused to budge except for nickels. But the public was learning to live with inflation.”17

  In the years after World War II, this underlying inflationary psychology firmly established itself in North America and western Europe. People tried to make light of the problem. American humorist Max Kauffman observed, “Among the things that money can’t buy is everything it used to.” Vaudeville comedian Henny Youngman remarked, “Americans are getting stronger. Twenty years ago, it took two people to carry ten dollars’ worth of groceries. Today, a five-year-old can do it.”

  The inflation jokes of the 1950s expressed
a growing mood of fatalism about price movements. That attitude encouraged pessimism about the possibility of restraining inflation and caused people to seek other remedies. These new responses caused more inflation and increased its momentum. They also institutionalized its dynamics within entire cultural systems.

  This had happened in every other price-revolution, but during the twentieth century, the institutional machinery of modern society had grown stronger and more complex than before. Institutional responses to rising prices reinforced inflation more powerfully than in earlier waves.

  Industrial democracies began to create elaborate systems of institutional price-inflators, which economist Robert Heilbroner described as regulatory “floors without ceilings.” Price floors were constructed in many sectors of the American economy. In some industries, “administered prices” became commonplace. In others, prices were formally fixed by regulatory agencies, and by “fair trade” statutes that forbade merchants to sell below the manufacturer’s “suggested retail price.”

  The dynamic American responses to price floors were not price ceilings, but wage floors. In 1938, the Congress enacted the Fair Labor Standards Act, which set the first national minimum wage. It also briefly considered a maximum wage, but that idea was quickly forgotten. Thereafter, the minimum wage was frequently raised, and extended more broadly through the economy. Similar laws were enacted in other nations. This legislation helps to explain one of the distinctive features of the price-revolution in the twentieth century—its exceptionally high rate of advance.18

  In the period from 1938 to 1968, many inflationary floors were built into the American economy: floors under wages, pensions, and compensation for the unemployed; floors beneath farm prices, steel prices, liquor prices, and milk prices; floors for airline fares, trucking charges, doctors’ bills, and lawyers’ fees. Not all of these floors were erected by public authorities. Many were imposed by corporations, labor unions and professional associations. The creation of regulatory floors without ceilings accelerated a dynamic process called the wage-price spiral by conservatives, and the price-wage spiral by liberals.

  The institutionalization of inflation in the twentieth century was not limited to price and wage regulation itself. Systemic restraints were placed also upon supply. Many nations imposed limits on production: farm products in the United States, oil in Saudi Arabia, coffee in Colombia, gold in South Africa, and many other commodities throughout the world. International cartels pursued the same policy where they were able to do so. The classic example was the price of diamonds, which the De Beers syndicate inflated to many times their market value by restrictions on supply and other methods. From a functional perspective, it mattered not at all whether these policies were imposed by a national government, or an international cartel, or a corporate manager. The impact on prices was the same. Wherever supply was held down, prices tended to rise. The integrated international economy of the twentieth century created many opportunities, and put them in the hands of small groups who profited by their application.

  Other new structural causes of inflation began to operate in the mid-twentieth century. One of them was invented by American businessmen. Economist David Slawson called it “competitive inflation.” Two rival sellers of the same commodity, instead of competing in the classical manner by seeking to offer a better product at a lower price, learned in the twentieth century to operate in other ways. They discovered that they could increase profits and expand market-share by degrading their product, advertising relentlessly, packaging it in a different form, and raising its unit price.

  As a case in point, Slawson studied the price history of American candy bars. During the late 1950s, the going price of a candy bar was five cents. By 1983, it had risen to thirty-five cents. The price was deliberately raised in a series of small five-cent increments by manufacturers. Slawson found that “each increase was disguised by making the bar larger at the same time—the size of the bar having been gradually decreased since the time of the last price rise. People generally choose candy bars on the basis of taste and size, neither of which encourages them to make close distinctions on the basis of price. Moreover, the manufacturers, one assumes deliberately, make size difficult to assess by making the wrappers larger than the bars inside, and by using a wide variety of shapes.”19

  The laws of neo-classical economics are unable to explain the price history of the American candy bar in the twentieth century. Market competition remained strong among candy-makers—in some respects, stronger than ever before. But it was no longer primarily price competition, and its effect on prices was the reverse of what neoclassical economic theory would lead us to expect. The more competitive the candy market became in America during the twentieth century, the more prices rose.20

  Economist Slawson argued that there was little difference in pricing strategies used for candy bars, automobiles, airline tickets, and other goods and services. He developed a model of a new “competitive inflation” to describe a world of growing complexity in pricing decisions by corporate sellers, and of increasing uncertainties for the individual buyer. Those trends in turn represented a shift in the distribution of knowledge and power in the marketplace. Sellers operated increasingly at an advantage over buyers. When that happened, prices went up.

  In all of these ways, the great inflation of the twentieth century differed from every price-revolution that had preceded it. Its velocity, mass, and momentum were greater than those that came before.

  The Troubles of Our Times

  In 1962, the price-revolution entered a new stage. After a period of comparatively slow increase during the late 1950s, inflation began to accelerate. This was a global movement. It appeared at about the same time in many nations: Austria (1962), Denmark (1962), Ireland (1962), Norway (1962), Sweden (1962), Belgium (1963), Italy (1963), Switzerland (1963), the Netherlands (1964), United Kingdom (1964), Yugoslavia (1964), Germany (1965), and the United States (1965).1

  The epicenter of this new movement was in western Europe, which had recovered very rapidly from the catastrophe of the second World War. After a recession in 1957–59, most European economies were flourishing. Unemployment fell to record lows in 1961: below 4 percent in Denmark and Italy; 3 percent in Austria and Norway; 2 percent in Britain and Spain; barely 1 percent in Germany and Switzerland.2

  This economic prosperity had a strong political effect. Many western nations took a turn to the left. The results included the presidencies of John Kennedy and Lyndon Johnson in the United States (1961), the “Opening to the Left” in Italy (1961), the election of a Labour government in Britain (1964), and the emergence of the “Great Coalition” in Germany (1966). European labor movements became more aggressive and more successful, winning large wage settlements in these years.3

  It was during this halcyon era of high prosperity and full employment that rates of inflation began to accelerate. Japanese consumer prices, for example, had increased less than one percent a year from 1955 to 1959. In the 1960s, they began to climb more rapidly, at more than five percent each year. Producer price increases in Japan were smaller, but still substantial.4

  Rates of gain varied from one nation and monetary system to another in the early 1960s. The pace of inflation was very low in Switzerland (2.3%), West Germany (2.4%) and the United States (2.5%). It was higher in Sweden (3.6%), Britain (3.6%), France (4.4%) and India (4.5%). The highest rates were in Latin America, and the Middle East. No nations were exempt.5

  Price rises remained comparatively moderate in the North American economy, which restrained the world inflation-rate until 1965. Then they also began to accelerate, partly because President Lyndon Johnson and his advisors made a major miscalculation. The Johnson administration decided to expand public spending for social welfare in the United States and simultaneously fight a major war in Southeast Asia, without a large increase in taxes. In the journalistic jargon of the day, they believed that the booming American economy could supply both “guns and butter” at the same time.


  The result was a large increase in public spending, on top of growing aggregate demand in the private sector. American prices began to rise more rapidly, especially prices for food and farm products. The annual rate of inflation in the United States trebled from 1961 to 1966.

  Many scholars mistakenly remember the Vietnam War as the pivotal event in the acceleration of inflation during the 1960s. In fact, the surge began a few years earlier, in another part of the world. The fiscal policies of the Johnson administration had an impact because they reinforced an existing trend and increased its momentum.6

  The roots of the price-revolution ran deep in the 20th century. As in every other great wave, the rapid increase of world population and the growth of aggregate demand were the primary cause of price increases. The world economy was more productive than ever before, and its rate of growth was the highest in history. But it could not keep up with demand. In the United States, whenever capacity-utilization rose above 80 percent, the rate of inflation accelerated. When it fell below that level, as it did from time to time, inflation subsided.

  A similar pattern appeared in the association between prices and unemployment. When the unemployment rate fell below 6 percent, the rate of inflation advanced more rapidly. When unemployment rose above that level, inflation retreated. Clearly, the price-revolution of the twentieth century was embedded in demographic trends and economic structures.

  As early as 1966, American leaders began to show concern about rising prices and acted forcefully to restrain them. The expansion of the money supply (M-I) was brought to a dead halt in the second quarter of 1966. Interest rates were raised deliberately to their highest levels in half a century, in what was called the credit crunch of 1966. An economist observes that this was “the first occasion in the post World War II period that the Fed sharply cut back monetary growth and caused rapid and, for a time, large increases in interest rates.”7