President Carter

by Stuart E. Eizenstat

  PHASE II

  In the fog of battle it is hard to devise a new strategy for any war, and each tactical thrust encountered its own obstacle. Labor Secretary Marshall came up with an idea for more explicit wage and price guidelines enforced by punishing government contractors that did not comply.100 But we had only limited authority over existing contracts and would need a large bureaucracy to oversee the new ones.101

  As we developed ideas for yet another anti-inflation speech, Blumenthal, who thought of himself as the inflation hawk but never liked guidelines, said that he was concerned about the certificate of compliance that government contractors would have to sign under a strengthened wage-price policy we were considering. And Strauss finally threw up his hands as inflation czar and resigned, saying, “I can’t go further with only a smile and shoeshine. I need more government help.”102

  As we were preparing the president for a nationwide television address on inflation, we did not want him to speak without having a replacement for Strauss, who had recommended Fred Kahn as his successor. A capable person can be great in one job and miscast in another. This was true for Fred Kahn, and he knew it. He had been a star in helping deregulate the airlines and abolishing his own regulatory agency, but this new challenge was very different. In mid-October 1978, returning from an Italian vacation, he was handed a message to come to the vice president’s office. He found himself surrounded by Mondale, Strauss, and Schultze, who gave him the bad news. Kahn demurred, saying he had not finished his job deregulating the airlines and had no experience in dealing with inflation. He protested that Carter did not need an inflation adviser, since he already commanded a talented economic team. In an attempt to make the job more powerful and thus more appealing, they told him he would also be the chairman of a strengthened Council on Wage and Price Stability to enforce new wage and price standards. This had the reverse effect, since he had no interest in such a “messy job” and said that Bosworth was already doing it well.

  Kahn avoided seeing the president, which elicited handwritten messages asking, “Why can’t I see Fred Kahn?” The answer was that Kahn was otherwise engaged with several eminent economists, including Nobel laureates Robert Solow and James Tobin, who warned him to avoid the job if at all possible. I met Kahn in my office, and a brighter, more able, more personable man one could never hope to meet. But he was deeply reluctant to take the job because “I am a kind of professor” who preferred a specific task backed by law, while an inflation czar must be manipulative, cajoling, and political. Indeed, he was the picture of a professor, with a balding head, heavy glasses, and a low-key manner. Moreover, he said, and we would certainly find this out, “I am very independent, and I say what I believe. I will accumulate a series of enemies.”103

  Just as we should have listened to the president on tax cuts, we should have taken Kahn’s misgivings to heart. But there was no other candidate immediately available, and when Carter saw him in the Oval Office, the president asked, “Don’t you think inflation is my most serious problem?” To which Kahn could only say yes. “And do you see anything fundamentally wrong with the inflation program I just announced?” And Kahn had to say he did not. He told the president he was not interested in enforcing wage and price standards, and Carter replied that was really Bosworth’s job, but he would be able to intervene anywhere he believed there were inflationary pressures, with full presidential support—and that the president needed him. And thus prevailed the truth of the old adage about how hard it is to say no to the president of the United States.

  Before his speech he called in the cabinet to present his anti-inflation pitch and was hardly upbeat: “I don’t approach this phase of my presidency with a lot of optimism, and we may not show short-term success. But this will be my major domestic undertaking in the next year.” When Carter addressed the nation on October 24, 1978, in what would be his fourth major speech on inflation, he declared that more than six million jobs had been created during his first twenty-one months in office, but now inflation was “our most serious domestic problem” and his “central preoccupation.” No longer would inflation receive equal billing with unemployment, it would be preeminent. The centerpiece of his anti-inflation program were new and tougher wage and price standards to break the inflation spiral, backed by federal contract authority, as Labor Secretary Marshall had recommended; tough restraints on federal spending to cut the budget deficit in half; no further tax cuts; eliminating unnecessary regulations; and deregulating the transport industries to promote competition and lower prices.104

  This would come to be known as Phase II. As Carter put it in his address, “Once it’s started, wages and prices chase each other up and up—like a crowd standing at a football stadium; no one can see any better than when everyone is sitting down, but no one is willing to be the first to sit down.”105 A neat analogy, but the mechanism for persuading the spectators to resume their seats was our embrace of Art Okun’s Real Wage Insurance, so workers who complied with the standards received a tax cut and were not disadvantaged by those who violated them. But this innovative idea was dead on arrival at Capitol Hill.

  Carter also announced the next day that Kahn, the master of airline deregulation, would work with him to provide a single voice against inflation. He closed by repeating Winston Churchill’s defiant call to his people facing the Nazi threat: “What kind of people do they think we are?” But Carter’s rhetoric was no match for Churchill’s.

  Hardly out of the box, Kahn made it clear he did not want to be the one to enforce what he openly called the “stinking guidelines,” a phrase for which he apologized by explaining to business leaders that no one wanted them anyway.106 He arrived to an empty office in the Old Executive Office Building and some resentment by Bosworth, who headed the Council on Wage and Price Stability, and had his hands full developing detailed guidelines. Kahn’s staff did not materialize as promised. He had to struggle with the president’s “Cousin Cheap,” Hugh Carter, to scrounge for assistants and finally had to intervene at a cabinet meeting on November 20, as Carter was appealing for help in the anti-inflation campaign.107 He finally was allotted five people to help him identify inflationary regulations and legislation, with particular emphasis on parts of the economy that were major contributors to the rise in the Consumer Price Index, such as health care, energy, and food.

  More generally Kahn became a pied piper, the president’s chief spokesman in his attempt to highlight his battle against inflation, an effective and credible one, perhaps too credible. When he warned that unchecked inflation might lead to a serious “depression,” the unenviable task of asking him to moderate his rhetoric fell to me. Undeterred, he piped an even more discordant note, declaring to the press that he had been told to watch his language, avoid the D-word, and henceforth would warn that the economy might turn into “a banana.” When the chairman of the United Fruit Company squawked, the irrepressible Kahn found a different euphemism without a pressure group behind it: He began warning instead of a “kumquat.”108

  But Kahn did his best to take advantage of the strengthened wage and price program. Carter laid down a presidential marker in plain numbers—a ceiling of 7 percent annual wage increases and a 5.75 percent limit for price hikes, which sounded a clearer note and was backed by stronger enforcement. All firms seeking federal contracts had to pledge they would abide by the numerical guideline. The president asserted, “We will use our buying power more effectively to make price restraint and competition a reality.”

  The program had some limited success. After Church’s Fried Chicken raised its prices above the president’s numerical ceiling, Kahn issued a stinging release that prompted a drop in the company’s walk-in business, whereupon it retreated.109 A bigger success was achieved when Sears, Roebuck reported it had violated the guidelines and rolled back prices. But this alerted major firms to hire lawyers to vet their certifications and ensure they were technically within the guidelines.110 While nonunion wages remained largely within the limit, the
unions were furious and simply dug in against them—in rare accord with the National Association of Manufacturers. And the effort to use the government’s huge purchasing power was partly foiled by the intricacies of federal regulations and especially procurement by the Pentagon, many of whose suppliers had no competition and worked on cost-plus contracts.

  There was a further division between large and concentrated industries and those dominated by small firms, over which we had no control. Bosworth explained to the president that there had been an explosion of food prices, with prices of finished goods up strongly and defensive raises by smaller and medium-size firms in the belief that our guidelines were a prelude to mandatory controls. The larger firms were generally complying. Bosworth was able to monitor firms producing just under half of the country’s output and recommended extending his oversight so his council could jump on violators of all sizes. Carter agreed and said, “It would be helpful to single out some companies and bust the hell out of them.”111 But all in all financial markets at home and abroad were not impressed by the president’s speech or its phase two follow-up.

  We now were in a race against time before companies, investors, traders, and speculators lost faith in our economic management. At some point, and there was no way to know when, they might all vote against the dollar, and even with the more rudimentary computers of the day, their votes could move billions across borders in the click of a keystroke.

  THE DECLINING DOLLAR

  Our economic team, and the Keynesian economists upon whom we relied, had misjudged the ferocity of the underlying inflation and the difficulty of dealing with the phenomenon of stagflation. Despite all our hard work on what we thought was a comprehensive anti-inflation program, the financial markets quickly cast a final vote of no confidence. The dollar immediately dropped to an all-time low in Asia. Europe followed, and within days we faced a dollar crisis after sliding for months, in a policy that the press labeled “benign neglect.”112

  Since the start of the year, America’s currency had lost about one-quarter of its value against the world’s currency, with inflation still raging. During the weeks following the president’s October speech, billions were thrown into the currency markets to halt the dive, but it continued until it blew itself out by year’s end.113 Normally a decline in the value of a nation’s currency can stimulate its economy by encouraging sales abroad for its exports at a cheaper price to foreigners. But it can also make imports more expensive, in effect importing more inflation, which was exactly what we did not need at that moment. Blumenthal had first laid down a marker at a July 1977 cabinet meeting.114 With Carter in office for only six months, he said the dollar had declined more than 1 percent in recent weeks—nothing dramatic yet, but something to watch.

  What Blumenthal did not say was that his own ill-chosen words outside the privacy of the cabinet made it appear that he favored a lower dollar—something no Treasury secretary should ever say. His suggestion at a June 1977 meeting of G7 finance ministers in Paris,115 that the yen and mark should rise against the dollar to help correct the large U.S. trade deficits with Japan and Germany, was widely interpreted as a deliberate policy to talk down the value of the dollar. As Paul Volcker put it later, “Foreigners sensed that for the Carter Administration, a stable dollar was a much lower priority than growth and jobs.”116

  Volcker had been in the front lines during the crisis as president of the Federal Reserve Bank of New York, which operates in the foreign currency markets on behalf of the U.S. government. Blumenthal did not intend to indicate he actually wanted a cheaper dollar, but the suspicion stuck as he declined to support the dollar in the currency markets and claimed that our allies did not want us to do so.117

  His tone changed toward the end of Carter’s first year, when he called me late in December to urgently request a presidential statement, because “there is a risk of a snowballing impact on the dollar.”118 Early in the new year he called again to tell me he was working on a swap with Germany for deutschmarks. Five days later he told the cabinet that the dollar was under attack in world markets: “We are bidding with poor Jacks, and there will be a real problem if our hand is called.”119 Currencies go up and down in international trading without attracting much attention, but this was different. The dollar is the world’s reserve currency, and its stability and the policies upon which it depends have been the pillar of the postwar world’s financial system. Most international commodity transactions, most crucially the sale of crude oil, also are denominated in dollars. As our purchases of foreign oil sent more dollars abroad, foreign governments were awash with dollars they were no longer able to exchange for gold, after Nixon broke the link between the dollar and gold in 1971.

  For several months early in 1978, Blumenthal saw signs of a slow-motion crisis. The stock market was dropping, gold prices were rising, business confidence was collapsing, foreigners were pulling money out of American banks, OPEC prices were rising again, and other countries were freezing their outflows of capital. The dollar’s problems could also undercut the hard-won commitments just made at the Bonn summit by America’s allies to stimulate their economies, because we would be limited in our ability to do our share by stimulating our own. At a breakfast meeting at Treasury on August 15, Blumenthal, Schultze, Fed chairman Miller, and I reviewed possible emergency measures such as selling gold to mop up dollars and domestic measures like scrapping the tax cut, cutting Social Security taxes, delaying the increase in the minimum wage, imposing a fee on oil imports, and even wartime measures limiting the amount of money Americans could send abroad.120 None were attractive.

  It was nevertheless clear that we had entered a new phase, in which international markets were directly affecting our domestic decisions, and anything and everything had to be reconsidered. After the meeting I called the president and Ham to brief them on the need for urgent action. At a meeting of the National Security Council, Blumenthal said darkly that things had developed into a “psychological semi-panic not due to the underlying situation” and asked for a public statement by the president to calm the markets. Miller made the most dramatic statement: “There is a clear and present danger; financial markets are reacting in a more negative way than even after the assassination of JFK.” He warned that the crisis could spread to the world economy, and the administration needed to unveil a comprehensive package and not “dribble it out.” The president agreed, but we followed with a replay of our limited options.121

  Meanwhile, to his great credit, Blumenthal had secretly directed Anthony Solomon, undersecretary of the Treasury for monetary affairs, to develop a package with the Fed that would be so large it would finally exceed even the market’s expectations. It was ready when the dollar collapsed after Carter’s October speech. If there was a hero in this dollar rescue it was Tony Solomon, holding the key Treasury portfolio with international responsibilities that, in part, was held by Volcker under Nixon, and Tim Geithner under Clinton, during my tenure as deputy Treasury secretary. Aged sixty at the time, this Harvard Ph.D. in economics brought a wealth of experience in the private sector and government, having run a business in Mexico and served under Presidents Roosevelt and Johnson. A man with a slight hunchback, Solomon would at times wear an elegant silk ascot instead of a tie; he had the disposition of an undertaker, dour and crusty, with a gravelly voice and a permanent frown. Opinionated but brilliant, he was right about the link between inflation and the dollar and had little patience either for small talk or for those in the administration he told me he regarded as “Neanderthals regarding international markets.”122

  The next several days were as unnerving as anything I experienced in Washington. Blumenthal called to tell me that traders had begun dumping dollars even before the president spoke and were still doing so, prompting the Fed to increase the discount rate. Solomon called late in the evening of October 26, and asked to see me urgently. I dropped everything and quickly walked across the small path connecting the White House East Wing with the Treasury, t
hinking to myself that we were close to an economic meltdown. He warned apocalyptically that further declines in the dollar would lead to bank failures and lost prestige abroad.

  With an eye toward November’s midterm elections, he said that we would need a very large war chest to defend the dollar and simultaneously avoid the high interest rates that would guarantee a recession. He laid out a comprehensive package for coordinated action with our allies: higher bank reserves to make speculation against the dollar more expensive; increasing interest rates substantially; and most crucially, a coordinated U.S.–German–Japanese swap into the currency markets to buy dollars and thus raise their value. I told Solomon this would greatly complicate obtaining labor’s cooperation on our new, more stringent wage and price guideline program. He acknowledged that, but recommended that we tell the AFL-CIO that the program would avoid even more pain for workers from a recession. When we finished, I thought how lucky we were to have someone of Tony’s talent and experience navigating these treacherous waters, but noted in the margin of my legal pad: “Shows unseen international forces are driving domestic policy.”123

  The next morning, October 27, the president called to ask me to meet with Schultze, Kahn, and Blumenthal; he was still focused on his new anti-inflation measures. “I think there is more of a chance of success than I realized,” he said. We discussed the dollar crisis, and I told him not to make any precipitous decisions until he had heard everyone out, including Solomon. “I am very much inclined against endorsing higher interest rates,” Carter said, and it was clear in a meeting later that day that he put his hopes on enforcing the new wage and price guidelines. He told Kahn and Bosworth to sign up at least five hundred companies and unions using “maximum government and public pressure against those who don’t comply.” That included compiling a list of government penalties for noncompliance, even enlisting municipal leaders to lean on local industries. Carter was ready to throw himself into the fight. He told his economic team later in the day: “It is better to take our political lumps, but keep credibility on inflation. I want to show black leaders the unemployment consequences of high inflation. The administration’s future depends on the success of my anti-inflation program, and I am determined to make it work.”124