Memo To: SSU Students
From: Jude Wanniski
Re: My Contemporary Report
In his testimony to the House Financial Services Committee on Wednesday of this last week, Fed Chairman Alan Greenspan was asked by Rep. Ron Paul of Texas why he does not consider abandoning his attempt to manage the dollar by targeting interest rates and target commodity prices directly. Greenspan knows Paul means returning to the gold standard that the US abandoned on August 15 1971 and said that once the decision was made to go to a fiat currency, he believes the Fed and other central banks are trying to "replicate" a gold standard, and that he thinks it has been a largely successful effort. For this week's summer lesson, I then decided to run the front-page report I wrote for the National Observer in its August 23, 1971 issue.
You may also read the article I wrote for Barron's on the 30th anniversary of the Nixon economic package he announced at the time, believing it would get the economy moving at a better rate and assure his re-election. He was re-elected in 1972, but had to resign the presidency in 1974, ostensibly over the Watergate scandal. More fundamentally, it was because the economy was in tatters as a result of the stagflation brought about by the floating, inflating dollar.
Please note how quaint some of the economic ideas seem now and remember I wrote this with no background in economics or finance. My discovery of supply-side economics still was ahead of me, but I’m sure there are in the piece a few anonymous quotes from Art Laffer, who was chief economist at the Office of Management and Budget at the time, and who opposed the gold decision in the private deliberations of the Nixon team.
Please note how quaint some of the 1971 economic ideas seem now and remember I wrote the Observer piece with no background in economics or finance. My discovery of supply-side economics still was ahead of me, as I searched for answers on why the Nixon program failed so badly. I’m sure there are in the piece a few anonymous quotes from Art Laffer, who was chief economist at the Office of Management and Budget at the time, and who opposed the gold decision in the private deliberations of the Nixon team.
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Richard Nixon’s Garden of Economic Delights
by Jude Wanniski
National Observer, August 23, 1971
President Nixon did not have to prepare the American people for his New Economic Policy. They were ripe. In recent weeks, the voices from the heartland had swelled to a roar: “Do something about the economy. Do anything. But do it now.”
Richard Nixon did it. In fact, he did everything, all at once. Everything his critics said he should do. Everything his supporters said he should do. Everything they were afraid he would do. He piled it on for what seemed an orgy of Presidential action, and added some more for good measure, just to be sure no one would doubt that something indeed had been done.
A 90-day freeze on wages, prices, and rents. A 10 per cent tax on imports. A suspension of the convertibility of the dollar into gold. A proposed 10 per cent investment tax credit. A proposed repeal of the 7 per cent auto excise tax. A proposed speed-up in personal income-tax exemptions. A 10 per cent cut in foreign economic aid. A 5 per cent cut in Government personnel. A six-month postponement of Government pay raises.
Relief was instantaneous; mass confusion followed. For two days the stock market soared euphorically, breaking all records for volume. Then long lines of companies, unions, foreign governments, even the Pentagon, began to form, asking exemptions from the structures of the Nixon moves. Treasury Secretary John Connally, whom Mr. Nixon made czar of the new Cost-of-Living Council, handed out rejections of these requests, with relish. The more people who ask for exemptions and are turned down, the more likely the policy would work. The Government isn’t fooling.
For the moment, most people seem pleased with the picture. Surely these were measures bold enough and sweeping enough to straighten out the economy. Surely the wage-price freeze would harness inflation. The import-tax would dam the flood of Japanese television sets and West German autos taking jobs from American working men. The speed-up in tax cuts would put more spending money in the pockets of the consumers. Tens of thousands of the unemployed would be put to work making cars. U.S. industry would have an incentive to make new investments in plant and equipment, putting more people to work building machine tools and factories. The United States would show the rest of the industrial nations. The U.S.A. is rolling up its sleeves.
That’s the picture Mr. Nixon wanted to create in the minds of the public, and with most, he apparently succeeded. “Shock treatment,” it was called by George Shultz, director of the Office of Management and Budget. The President’s decisions “lanced the boil of pessimism,” said Gabriel Hauge of the Manufacturers Hanover Corp. Mr. Hauge, who was an economic adviser to President Eisenhower, seem to grasp quickly that the President’s new policy is primarily aimed at conditioning public psychology -- a practice sometimes called “politics.”
This was the missing ingredient in Mr. Nixon’s old economics policy, which on close inspection, is still the driving force of the new strategy. After all, economic “game plans” unlike those in football, are not adopted or discarded from one day to the next. The principal forces at work in the economy pushing it to expansion, lower unemployment, and a lessening of inflation are those set in motion by the Administration during the past year. “What we learned,” says one White House economist wearily, “is that it doesn’t do much good that our economic policies are working if the public thinks they’re not.” Something new had to be added.
It obviously did not do Mr. Nixon too much good in recent weeks to observe that the increases in the Gross National Product had set records in the first half of this year, that consumer spending was increasing rapidly, that unemployment had fallen from its highest rates, that housing starts were breaking records, and that the inflation rate for the first half of 1971 was two percentage points lower than the like period in 1970. With the highly visible wage settlements in autos, canning, steel, rails, and communications, the public could not believe inflation was abating. And with the spotlight on the discouraging deficits in the balance of trade, the public could only conclude that U.S. industry was being hurt by foreign competition and that the jobs of American workingmen were imperiled.
Not Entirely Satisfied
This doesn’t mean the Nixon economic team was entirely satisfied with the way things were going. “There are many people around who thought the economy wasn’t rising as fast as we wanted,” says Herbert Stein, a member of the President’s Council of Economic Advisers. “They thought we should push more. But there are limits to how much stimulation you can add without kicking off inflation again.” This is why the White House decided in early July to make no new moves.
“But once we got into the international monetary difficulties, we had to look at the situation at home from a different perspective,” Mr. Stein explains. “It seemed that if we took action on that front – closing the gold window – we had to protect ourselves with an anti-inflationary move. We had to do something. After all, most people aren’t sophisticated about international finance, and they had vague anxieties about what was going on. This helped precipitate the decision for a freeze. Then, once you freeze, you can add into the policy the extra stimulation you were afraid of before. The whole is like a jigsaw puzzle, each piece dependent on the others.”
By hitting the public with the whole jigsaw puzzle at once, the White House knew most people understandably would be mystified by the intricacies of the economics; it’s hard enough to explain the simplest moves, one at a time, let alone an array of complex moves all at once. The confusion over the wage-price freeze alone has been stupefying. But if the net effect was a heightening of consumer confidence in the future of the economy, it would be worth the effort.
One of the prime targets of the Nixon moves is the consumer savings rate, the millstone that economic policy has been dragging all year. Despite a 17 percent increase in spending in 1971 compared with 1970, consumers still are saving 8.4 per cent of their incomes, almost three percentage points higher than the historical norm. This amounts to about $20 billion in purchasing power that is being withheld from the economy. By comparison, the President’s proposal to add $50 to the personal income tax exemption effective on Jan. 1, 1972, a year ahead of schedule, would add but $1 billion to spending power. This would seem a puny lever for moving a trillion-dollar economy.
Besides, there’s no guarantee the $1 billion would be spent once it is distributed. Much of it also might be put into savings accounts. Mr. Nixon, though, had to make the tax-exemption speed-up part of the package he is asking Congress to pass. Of the three parts in the package, this is the most clearly identified with “the people,” as opposed to “big business.”
To eliminate the 7 percent auto excise tax would cost the Treasury $2.3 billion. But the Administration reckons the loss of revenue would be offset somewhat by directly encouraging economic expansion in the auto industry, which has high unemployment. Eliminating the tax means an average reduction of about $200 in the price of a car. Treasury Secretary Connally argues that this is a “people” move, since for every car purchased about $200 would remain in the consumer’s pocket. But liberals in Congress already are lumping the tax elimination into the “big business” bracket, since the auto industry is expected to benefit through higher sales.
A Complaint From Mr. Muskie
This posture leaves the liberals a chance to argue that the third part of the package – the 10 per cent investment tax credit, which is clearly a “big business” benefit – weights the President’s package against “the people.” To offset some of the costs of this package, the President last week also announced that he would ask Congress to postpone his welfare-reform proposal for a year and his revenue sharing plan for three months. A number of Senate Democrats, including Maine’s Edmund Muskie, criticized these moves as being further evidence the package is weighted heavily toward business.
Most of the Democratic Presidential hopefuls don’t quite know yet how solidly the public is behind Mr. Nixon’s New Economic Policy and are being careful what they say until they find out. AFL-CIO President George Meany, however, isn’t running for anything, so he can safely lead the opposition to the Nixon policy for the time being. “We’re not going to co-operate,” Mr. Meany said after meeting two hours with Mr. Connally and Labor Secretary James D. Hodgson.
Then, to dramatize the “people” versus “big business” aspects of the three-part program the President sent to Congress, the 77-year-old labor chief urged Congress to take control of economic policy from Mr. Nixon: “Instead of extending the helping hand of the Federal Government to the poor, the unemployed, the financially strapped states and cities, and to the inflation plagued consumer, the President decided to further enrich big corporation and banks.”
Mr. Meany Does a Favor
For all this outrage, Mr. Meany slipped in a fast favor to the President by endorsing the repeal of the auto excise tax, almost guaranteeing its passage. The Democratic Presidential aspirants in the Senate would kiss off Michigan’s electoral votes by opposing this measure.
Just as Mr. Meany tried to give the Democratic hopefuls something to hang on to, Leonard Woodcock, president of the United Auto Workers, did the same. In ominous terms, Mr. Woodcock warned that if the wage-price freeze is extended beyond 90 days, thereby threatening the wage increases due auto workers under the agreement negotiated last year, he would cancel the contract. “If they want war, they can have war,” he said.
Of course, the Administration now has no intention of extending the freeze beyond Nov. 12, and would consider itself lucky if by then Americans still are abiding by the freeze.
Mr. Meany said nothing about Mr. Nixon’s moves on the international front. But as one of the nation’s leading protectionists of late and one who has inveighed against the loss of U.S. jobs to overseas competitors, he can only be pleased by the steps taken. The Nixon decisions to suspend the dollar’s convertibility into gold and to tax imports – “to make certain that American products will not be at a disadvantage because of unfair exchange rates” – may prove to be the most popular and durable of those he took last week.
Mr. Nixon’s ultimate objective is establishment of an entirely new system of handling international monetary affairs. “A reshuffling of all the cards,” is the way one official put it. The immediate aim is “fairer” rates of exchange between the dollar and other major foreign currencies, especially the Japanese yen.
Under the 27-year-old system Mr. Nixon suspended last week, the U.S. trading partners in Western Europe and Japan essentially decided by themselves how much their currencies were worth in relation to the dollar. The dollar sat stolidly at the center of the system, defined as being worth 1/35 of an ounce of gold, or $35 per ounce.
It had become increasingly obvious this year, especially to the so-called speculators, that several foreign currencies were undervalued in relation to the dollar. The most obvious were the German mark and the Japanese yen. The Bonn and Tokyo governments resisted an upward revaluation of their currencies, however. To do so would make their exports costlier to their trading partners. Export sales would drop and the workers making the export commodities would lose their jobs.
Additionally, the goods West Germany and Japan were buying from other countries would become cheaper if their currencies were revalued upward. Their consumers would benefit, but their domestic industries would meet tougher competition from the imports. Again, presumably, employment would suffer. Understandably, a politician dislikes upward revaluations of currency, for in the adjustment process some of his constituents are hurt and the politician is blamed.
But last May, the Bonn government was left with no choice. So many individuals and corporations in Europe holding dollars were turning them in for marks, to take advantage of the high interest rates being paid in West Germany, that the German central bank was swamped with dollars. Reluctantly, the Bonn government announced it would no longer buy dollars at the agreed rate. Instead, it would allow the market place – individuals and businesses who deal in dollars and marks – to decide how much one currency was worth in relation to the other. This is called “floating.” And in the market place, the mark floated upward by 8 per cent over the earlier exchange rate. At the same time, Canada floated its dollar and the Netherlands floated its guilder. They too rose in relation to the U.S. dollar.
The Sorcerer’s Apprentice
The Tokyo government, though, refused to budge, even though leading Japanese economists argued that an upward revaluation was in order. Indeed, the yen looked highly underpriced at its pegged rate of 360 to the dollar. Fearing the adjustment process its export industry would have to go through, the Tokyo government, like the Sorcerer’s Apprentice, was unable to halt the momentum of its policies.
Japanese companies were sending high-quality manufactured goods all over the world, and accepting bits of paper – dollars and other currencies – in exchange. The paper was stacked in bank vaults where, day by day, it depreciated.
The action taken by Mr. Nixon last week was partly designed to break this spell, to force Tokyo to revalue the yen. In suspending the dollar’s link to gold, Mr. Nixon in essence “floated the dollar” in relationship to all the major currencies. It was a hazardous move, for the President could not predict how U.S. trading partners would react. He decided to reduce this risk by imposing the 10 percent surtax on all dutiable imports, about half the $45 billion in goods that the United States annually imports.
A Necessary Hedge
“We had to protect ourselves against an import explosion,” says an official. If the other nations resisted the U.S. float and continued to accumulate dollars, or even delayed action, American importers would have rushed to stockpile foreign commodities in anticipation of an eventual change in rates. The immediate imposition of the import tax contained this explosion. And it turned out to be a necessary hedge.” The European money markets closed to give the Common Market time to collect its wits. And the Japanese, still in shock, resisted the float.
They are doing so by continuing to hand out 360 yen for every dollar. But this looks like a losing game. Japanese businessmen, believing the government can’t hold out for very long, last week turned in more than $2 billion in dollars, pushing the central bank’s total holdings to more than $11 billion. Fourteen of Japan’s leading trading concerns have urged the government to revalue the yen as soon as possible.
Such a Japanese move would make it easier for a general revaluation to take place among all Western nations, either through bargained agreements or through a temporary universal floating of currencies. In other words, if Western Europe revalues and Japan does not, Japan’s exports would enjoy a greater advantage in European markets. The Europeans undoubtedly would consider direct sanctions against Japanese trade.
As it is, it now seems likely that the temporary U.S. import tax may be truly temporary and may not last more than a few weeks. Meanwhile, the Western nations are preparing to work out a new international monetary system, perhaps no longer tied to gold or keyed to the dollar, but linked to a new species of international “money.”
What Next? Phase II
At home, the question was, What next? What happens after the 90-day wage-price freeze expires in November? Will the President have to extend the freeze? Will he announce a review board with authority to roll back future inflationary wage and price increases? Or will the situation simply revert to the way it was? Treasury Secretary Connally says only that there will be a “Phase II,” some sort of tapering off.
The Nixon economic team still believes it was beating inflation before the President acted, no matter what the critics said or what the public thought. The July increase in the Consumer Price Index, announced last week after the freeze order, was two-tenths of a per cent, the smallest increase in six months.
Herbert Stein of the Council of Economic Advisers who heads the task force that’s supposed to decide what to do after 90 days, is confident there will be fairly stable prices in the future. “The hard part comes when the freeze is dropped; the public has to be reassured that we have a program to keep down the rate of inflation. We can’t do it spontaneously. We have to retain a certain amount of surveillance.” His first thoughts are of “some sort of tripartite commission,” representing labor, management, and the public.
Say Labor Secretary Hodgson: “Everything is under review – from guidelines to controls. I guess the whole subject is open. Wide open.”
The decision will come down to “what is the minimum that will sufficiently reassure the public?” As Mr. Connally points out, it is almost necessary to wait to the end of the 90-day period to see what public attitudes are then.
“A lot of our substantive problems have psychological origins,” says Mr. Stein. The missing ingredient that Mr. Nixon has added into his New Economic Policy seems to be a recognition of that fact.