The Reagan Budget Debate Jude Wanniski November 25, 1997

Memo To: Richard Berke, New York Times
From: Jude Wanniski
Re: Reagan Book Review

Your review of the three new Reagan books in the November 23 "Book Review" section of the Times is on the mark, as far as I am concerned, up to its final paragraph. In that paragraph, you leave the reader with the impression that you will not approve any book on Reagan's legacy that does not blame him for the ballooning budget deficits that occurred during his eight years in the White House. I can agree that he should bear some responsibility for them, but I doubt you would agree with me that he was probably responsible for only 5% of the deficits that ballooned underneath him.

The deficits were inevitable following the decision of the Nixon administration to devalue the dollar against gold in 1971 and float the dollar completely in 1973. When Reagan was elected in 1980, the dollar price of gold was $625, up from $35. If it had stayed at that level, up eighteenfold, the deficits would have ballooned even more than they did. It was the tightening of monetary policy that began in September 1980 that brought the gold price down during the next 18 months to $300. The tightening was the result of the anticipated tax cuts bringing about an increased demand for dollar reserves. When these reserves were not supplied by the Fed, the price of gold came down. The Fed overdid it, causing a worldwide dollar deflation. The recession of 1981-82 was the result, but prices of goods, services and wages continued to rise in dollars in order to catch up with gold, oil and other commodities.

As a result of this tenfold increase in gold, the prices of things bought by the federal government also climbed tenfold. But because of the progressive tax system, revenues did not increase tenfold. Tax thresholds were not indexed to offset bracket creep in wages until 1986 and capital gains are still not indexed. Social Security benefits, remember, were indexed in 1973, so those costs climbed and had to be offset by increased payroll taxes. All the entitlement programs ballooned because of the stagnation and necessary tenfold increase in prices. The deficits occurred during the Reagan years not because tax rates were cut. The tax cuts saved the economy from hyperinflation, which would have caused the national debt to disappear in a series of zeroes. It was Reagan's appointment of Wayne Angell, Manley Johnson and finally Alan Greenspan that brought monetary policy into line with the signals being thrown by gold. At a critical point, when Volcker was still at the helm, Angell and Johnson led a revolt that lowered interest rates.

The military buildup has been blamed along with the tax cuts as the reason for the "Reagan deficits," but the defense budget's nominal rise was, like everything else, a tenfold increase that tracked with the gold inflation. The only way the deficits could have been partly avoided was if the tax cuts had taken place immediately, in 1981, and if the Fed had known what it was doing. The Bush tax increase of 1990 again caused a ballooning of the deficit through economic weakness. At least the Fed refused to offset the recession with easy money, as Treasury Secretary Nick Brady was demanding (Brady was key to talking Bush into breaking his campaign promise). Greenspan's resolute monetary policy restored confidence to the dollar as gold hovered near $350. It was this situation which Clinton inherited in 1993. The problems associated with the tenfold monetary inflation were behind him and Clinton was smart enough to allow Greenspan to run the show. When the Clinton tax increases were pushed through without a GOP vote, supply-siders sighed relief that the capgains tax had not been raised. At Polyconomics, we said the tax increase would not offset the benefits to the economy of Greenspan's monetary policies. The federal deficit has been moving toward zero not because Clinton raised taxes, but because the Reagan administration absorbed most of the shock of the Nixon/Carter inflation. As Michael Boskin once explained, prior to his tenure as chairman of the Bush Council of Economic Advisors, when there is a $3 trillion national debt and a 5% inflation, the government is taking $150 billion in wealth out of the economy (5% times $3 trillion). This means in Keynesian terms (Boskin being a Keynesian) that the government MUST run a $150 billion deficit to restore that wealth to the economy in the form of higher aggregate demand.

None of the Reagan biographers you reviewed understand any of this, and I do not believe any will in the near future. You may be surprised to know that Reagan understood it better than almost all of the political reporters who covered the White House and all of the financial writers who covered Treasury. Where I put 5% of the blame for the deficits on Reagan's shoulders is because he allowed his White House advisors, Jim Baker, Dick Darman and Budget Director Dave Stockman to (1) talk him into phasing in the tax cuts and (2) raising taxes in 1982 on the promise they would be accompanied by spending cuts. Reagan himself said he considered the 1982 tax hike his biggest mistake.