Still, had Shultz called it a day after taking a powder on wage and price controls at Camp David, history might have overlooked his perfidy. Nixon and Connally were going to impose them anyway. But his unforgiveable offense was in giving intellectual cover to Connally’s assault on Bretton Woods and the administration’s cowardly default on the nation’s external debts.
GEORGE SHULTZ: GODFATHER OF FLOATING MONEY
Speechwriter Bill Safire, who later in his career became a New York Times op-ed page columnist, was a faithful scribe of the proceedings, and his notes leave little doubt about how Nixon came to his decision to close the gold window. Nixon first confessed that on the gold question he had “never seen so many intelligent experts who disagree 180 degrees.”
He then went on to pin the tail of the pending US gold default exactly where it belonged: “George [Schulz] and the others like the floating idea.”
Now a crack-up boom was only a matter of time. The wage and price freeze couldn’t possibly contain the inflationary pressure in the domestic economy, but floating the dollar and then laying a 10 percent import surcharge on top brought a further gale force of rising import prices to American shores.
While the freeze and controls temporarily suppressed consumer level prices, the havoc was quickly evident in energy and raw materials, where prices were largely set in the world market and outside the reach of controls. Within twenty-four months of the Camp David meeting, the price index for crude materials was up a startling 80 percent, and with the final failure of the control apparatus in 1973, the consumer price index quickly followed.
In fact, consumer prices rose by 8.7 percent in 1973 and 12.3 percent in 1974. These were shocking hits to the American cost of living, yet they just kept coming as the decade wore on. During the thirteen years after mid-1966, the cost of living rose by 125 percent.
Nixon’s famous Sunday evening televised speech after Camp David, of course, had promised the opposite: to stop inflation in its tracks. Although that was utterly inconsistent with taxing imports and trashing the dollar, Connally had squared that circle, too.
During the fateful deliberations at Camp David, the president wondered how to justify closing the gold window. Even at that late hour, Nixon suffered from an atavistic hesitancy about being the president who “devalued the dollar.”
Connally was plagued with no such doubts and was clueless about the vast inflationary consequences of unhinging the dollar. He thus succinctly explained to the nation’s chief executive: “Our assets are going out by the bushel basket. You’re in the hands of the money changers.”
So Nixon, in turn, explained to the nation that he was responding to “an all-out war” against the dollar led by “international money speculators.” He was right about a brutal attack on the dollar, but the real truth was that it was being waged by the Nixon administration itself. In fact, even as inflation escalated and world markets dumped the dollar in response to the US default on Bretton Woods, fiscal and monetary discipline was eviscerated even further.
Once again, the executioner of sound policy was George Shultz, former professor of industrial relations at the University of Chicago. Whether Shultz had actually absorbed any “free market” principles while resident at the mecca of free market economics is an open question. Yet there can be no doubt that his affinity for its opposite, “free lunch” nostrums, slackened not one bit as he climbed the rungs of power at the White House.
The most destructive of these free lunch elixirs was the “full-employment budget.” This concept had long been embraced by the Keynesian professoriate at Harvard, but now, thanks to Shultz, it was proudly advocated by the Nixon White House, too.
The beauty of the full-employment budget was that you could spend every penny of theoretical revenue that would come into the government’s coffers under conditions of “full employment.” Never mind if the Treasury’s actual cash receipts were far lower and that the budget was bleeding red ink—that kind of borrowing didn’t matter.
Better yet, the calculation of these phantom full-employment revenues was based on an even more ethereal construct called “potential GNP.” There was a nontrivial possibility, however, that the econometricians tasked with divining this ghostly shadow, wafting above the actual economy, would arrive at a figure exactly suited to balancing the theoretical full-employment “revenue” with the actual spending needs of the White House.
In the event, the full-employment budget cover story served its purpose. Even as Nixon importuned the public to suck in its collective gut and adhere to a wage and price freeze, federal outlays jumped by 10 percent during fiscal 1972, and the actual budget deficit rose from the prior year to a near-record $23.4 billion. And in this outcome the wholly pernicious nature of the full-employment budget revealed itself.
In those days, Washington was still on a June 30 fiscal year, so the path of the economy following the NEP announced in August 1971 maps almost perfectly against fiscal year 1972. Accordingly, during the first two fiscal quarters real GDP expanded at a 2.2 percent annual rate, but then picked up stunning momentum thereafter.
In the next quarter, GDP growth jumped to 7.3 percent and then closed out the June quarter and fiscal year 1972 with a surge to 9.8 percent. In only four quarters out of the 250 quarters since 1950 has the rate of GDP growth come in that high.
Likewise, during the year after Camp David the number of nonfarm payroll jobs soared by nearly 4 percent, one of the largest twelve-month gains ever recorded. In short, Nixon got his booming economy by July 1972 just as he had instructed Haldeman after the midterm elections.
What he also got was a red-hot economic bubble and a mockery of the full-employment budget theory. Fiscal policy was supposed to shift smartly toward restraint in the face of an economy hurtling toward its outer limits. Evidently, the Shultz-Nixon version included a “time-out” for election years.
HOW ARTHUR BURNS GOT OUT OF NIXON’S DOGHOUSE: THE FINAL DESTRUCTION OF SOUND MONEY
On the monetary front, the picture was even worse. Arthur Burns had been yammering for an “incomes policy” for more than a year before Camp David. Needless to say, the essential mission of the Federal Reserve is price stability, so the very fact that the Fed chairman was angling for a tripartite board to meddle with wages and prices was smoking-gun evidence that he was already failing.
Indeed, once he got the official cover of the wage and price freeze, Burns wasted no time hitting the monetary accelerator and thereby getting himself out of Nixon’s doghouse. Accordingly, outstanding bank loans grew by $100 billion during 1972, which was a blistering 17 percent rate of growth in an economy already steaming with excess demand and suffering a violent dose of imported inflation from the weak dollar.
Yet Burns was just getting started. Bank loans to businesses and households increased by another 16 percent in 1973. This meant that in the brief span of twenty-four months Burns had presided over a 36 percent expansion of bank credit.
This $200 billion blizzard of new bank lending amounted to 20 percent of GDP, a two-year spree of credit expansion never again duplicated at that rate in the United States. In fact, Burns’ record was exceeded only when the People’s Printing Press of China, in a desperate bid to keep its red capitalism alive after the collapse of global trade, opened the credit floodgates even wider in the fall of 2008.
In the face of this unprecedented bout of fiscal and monetary profligacy, the newly unshackled dollar did indeed float—and the direction was nearly straight down. During the first twenty-four months after Camp David, the dollar lost almost 20 percent of its value. Not surprisingly, the White House viewed this calamity as vindication of its policies.
This kind of perverse triumphalism was the specialty of George Shultz, who had now been promoted to secretary of the treasury. He then joined hands with the White House’s resident Keynesian economist, Herb Stein, in a circle known as the “religious floaters.”
A leading historian of the era succinctly captured the surrealism whi
ch played out during a lull in the dollar’s descent in late May 1973: “At the end of the month, Shultz ventured that floating was ‘working nicely.’ The next day the Germans raised interest rates, and the dollar began a plunge into the monetary abyss.”
So did the American economy. During the period then under way, the second quarter of 1973, real GDP clocked in at $4.9 trillion in today’s dollars. From there, real output then fell backward for the next twenty-seven months. It wasn’t until the fourth quarter of 1975 that real GDP regained its second quarter of 1973 level. And not before unemployment had soared to 9 percent in May 1975.
During that same month in the spring of 1975, the consumer price index was 21 percent higher than when Shultz had found the floating dollar to be “working nicely” two years earlier. The NEP of the Nixon White House had, in fact, generated the nightmare of stagflation.
THE GLOBAL INFLATION CATASTROPHE AFTER CAMP DAVID
In the meantime, the global currency markets had plunged into chaos. As will be seen, the free market for exchange rates turned out to be an utter illusion, as government after government jumped into the fray for the purpose of protecting domestic industries and jobs, and to safeguard their citizens against the alleged depredations of speculators and money changers.
Yet this kind of dirty floating was not the ultimate problem. The world economy was now at the mercy of a “reserve currency” that was no longer anchored to anything except the self-restraint of US policy officials, the very missing ingredient that had brought Bretton Woods down.
So what transpired during the early years of floating was a massive worldwide expansion of money and credit fueled by the Fed. This, in turn, generated the greatest bout of commodity price inflation that the world had seen since the postwar fly-up in 1919.
Crude oil led the way. Having been priced on the world market at $1.40 per barrel when Nixon’s free marketers gathered at Camp David in August 1971, it rose to an interim peak of $13 per barrel four years later. And that was a way station to its eventual top of $40 per barrel by 1980.
The dramatic post-1971 escalation of worldwide oil prices was blamed by officialdom on political rather than economic forces—and in particular the alleged market rigging of the OPEC cartel. In fact, except for a brief period around the October 1973 Mideast war, there was no systematic withholding of oil from the market.
The problem was not a shortage of oil but a flood of money and inflated demand. During 1972–1974, the global economy reached a red-hot pace of expansion, which in some part was due to the locomotive pull of the Nixon boom. For example, non-oil imports to the United States rose by 15 percent in the first year after Camp David, and then accelerated to 22 percent growth the next year and 28 percent during the twelve months ending in August 1974. These giant gains in imported goods were literally off the charts.
So as blistering US demand ignited production booms around the world, factory operating rates rose and supply chain backlogs surged everywhere on the planet. Moreover, there was another entirely new, even more potent force at work. In response to the Fed’s flood of money and credit, other central banks around the world reciprocated with their own fulsome monetary expansion.
They bought dollars and sold their own currencies in foreign exchange markets in order to forestall the upward pressure on exchange rates that was inherent in the brave new world of floating currencies. In other words, the heretofore circumspect central bankers of the world became furious money printers in self-defense as they faced the flood tide of dollars being issued by Arthur F. Burns.
In fact, with exchange rates no longer fixed and visible, a more subtle process of competitive devaluation became the daily modus operandi of the system. In this manner, the Fed propagated its inflationary monetary policies outward to the balance of the world economy.
So it was a storm of money and credit expansion which generated the first commodity bubble after 1971, not the OPEC cartel alone or even primarily. For if the problem had been just the putative rigging of prices by the oil cartel, there is no way to explain the dozens of parallel commodity booms during the same two- to three-year time frame.
Quite obviously, there was no evidence of cartel arrangements in the markets for rice, copper, pork bellies, or industrial tallow, for example. Yet between 1971 and 1974, rice rose from $10 to $30 per hundredweight, while pork bellies climbed from $0.30 per pound to $1.
Likewise, the cost of a ton of scrap steel soared from $40 to $140; tin jumped from $2 to $5 per pound; and the price of coffee rocketed up nearly eightfold, from 42 cents to $3.20 per pound. Even industrial tallow caught a tailwind, rising from $0.06 to $.0.20 per pound, and pretty much the same pattern was reflected in the price of corn, copper, cotton, lead, lumber, and soybeans.
Needless to say, the first inflationary cycle of floating money came as a shock to policy officials, especially the Federal Reserve and its chairman. While Chairman Burns was a pusillanimous accommodator when it came to the game of hardball politics in Washington, as a matter of belief he had remained an anti-inflation hawk.
So when Nixon went into his terminal Watergate descent, Burns got his nerve back and threw on the monetary brakes. Accordingly, double-digit bank credit expansion came to a screeching halt, rising by only 1.2 percent in 1975.
THE 1974 RECESSION: INVENTORY LIQUIDATION AND OUTPUT COLLAPSE CAUSED BY THE CENTRAL BANK
The resulting recession was described at the time as the deepest since the 1930s, but there were really not many parallels. Housing construction did suffer a sharp retrenchment and business investment spending also declined moderately.
Yet on the core component of the US economy—consumer spending, which even then accounted for two-thirds of GDP—there was virtually no reduction. The peak-to-trough decline in real terms was just 0.7 percent. This was hardly the stuff of a near depression and not even in the same ballpark as the 20 percent decline in real household consumption which had occurred during the Great Depression.
Instead, the heart of the 1974–1975 downturn was a sweeping liquidation of industrial and commercial inventories, which accounted for fully two-thirds of the drop in real GDP. Moreover, that generally underappreciated fact followed exactly from the type of inflationary boom that had now been made possible by the destruction of Bretton Woods.
During 1972–1973 the drastic escalation of global commodity prices led to a scramble by businesses to buy forward and accumulate buffer stocks of raw materials, components, and finished goods before prices escalated even higher. This forward buying and accumulation of inventories was at the heart of the post–Camp David boom and bust.
When the monetary expansion was finally halted and pricing pressures subsided, businesses then violently disgorged these same inventories during the subsequent correction phase. Accordingly, what is reported as a deep 3 percent peak-to-trough decline in real GDP during the 1973–1975 recession cycle was only a 1 percent decline based on final sales. All the rest of the deep recession reflected the destocking of what had been excess inventories in the first place.
This rather persuasive evidence that inflationary monetary policy does not enhance long-term growth but only destabilizes the inventory cycle never sunk in among policy makers. In fact, when the downturn did temporarily break the commodity speculation cycle and cause the rate of CPI increase to temporarily dip under 5 percent, Burns and the Ford White House did exactly the wrong thing: they launched a new round of stimulus and soon rekindled an even more virulent inflation.
After assuming the presidency in August 1974, Gerald Ford had started off on the right foot. As a fiscally orthodox Midwestern Republican, he had been frightened by the recent runaway inflation and repulsed by the insanity of the Nixon freeze and the ever-changing wage and price control rules and phases which followed. Ford had also been just plain embarrassed by Nixon’s five straight years of large budget deficits.
So for a brief moment in the fall of 1974, he launched a campaign to get back to the basics. Ford proposed to jetti
son the notion that the budget was an economic policy tool, and demanded that Washington return to the sober business of responsibly managing the spending and revenue accounts of the federal government.
To this end, he called for drastic spending cuts to keep the current-year budget under $300 billion. He also requested a 5 percent surtax on the incomes of corporations and more affluent households to staunch the flow of budget red ink. At that point in history Ford’s proposed tax increase was applauded by fiscal conservatives, and there was no supply-side chorus around to denounce it. In fact, Art Laffer had just vacated his position as an underling at OMB.
BILL SIMON’S CRUSADE AGAINST THE FULL-EMPLOYMENT BUDGET ILLUSION
In attempting to get Washington off the fiscal stimulus drug, Ford was aided immeasurably by the fact that Shultz had vacated the Treasury Department and had been replaced by Bill Simon. The latter was from a wholly different kettle of fish.
In fact, Simon was an inflation-hating bond trader who fervently believed in free markets and smaller government, and had no patience whatever for gussied-up academic theories that justified federal meddling, spending, and borrowing. Thus, when asked at a congressional hearing whether he intended to use the full-employment budget as a fiscal guide, Simon bluntly replied, “No, sir.”
Accordingly, Simon wasted no time in summarily discarding the budget for fiscal year 1975 which the Nixon White House had submitted earlier in the year. Shultz had claimed it embodied an $8 billion full-employment “surplus,” but it actually amounted to an actual $10 billion deficit.
So from the “day Simon took over the Treasury in May,” noted historian Allen Matusow, “his goal was to get rid of this deficit by slashing $10 billion from expenditures.”
Peering through Keynesian glasses, Matusow judged Simon’s efforts to be “folly,” but from the perspective of today’s smoldering budgetary ruins, his crusade to cut federal spending looks more like a last, fleeting moment of fiscal sanity. The temporary drop in real GDP during the winter of 1974–1975 was not a valid excuse for higher spending and bigger deficits. It represented the final liquidation of the inflation-swollen inventories that had been accumulated in American factories and warehouse, not the mysterious disappearance of an economic ether called “aggregate demand.”
The Great Deformation Page 18
