In November 1964 the price was set at 24.5 cents per pound. While there were eight firms which produced aluminum, the Big Three—Alcoa, Reynolds, and Kaiser—dominated ingot output and in mid-1965 were operating at 100 percent of capacity. Fabrication was more competitive. On October 29 Ormet, a small firm, raised the ingot price half a cent. Reynolds and Kaiser followed immediately and Alcoa was studying the action. Eckstein informed the President that the increase was unjustified, that the industry should reduce prices.
If Eckstein was upset, Johnson was enraged. In fact, he was in a dreadful mood, recovering slowly from gall bladder surgery, publicly ridiculed for exposing his big scar to news photographers, on a tight diet restricting his huge appetite. Califano found him almost impossible to deal with:
What I didn’t know at the time was that this had been a terrible day for LBJ: as a result of a map-plotting error two American pilots had destroyed a friendly village of Vietnamese civilians; his daughter, Luci, who was eighteen, had told him she was going to marry Patrick Nugent and the President and Mrs. Johnson thought their youngest daughter was too young to get married and was making a serious mistake; and Johnson had seen Peter Hurd’s portrait of himself, which he hated. He called it “the ugliest thing I ever saw.” Mrs. Johnson said afterward that she didn’t expect to endure an encounter so grim if she “lived to be a thousand.”
To top it all, the New York Times reported that he was “sputtering mad.” He roared at Califano, “Do you hear me? I am not now, never in my life have been, and never will be ‘sputtering mad!’ “ Califano had to bite his hand to restrain his laughter. The poor aluminum industry did not have a chance.
When Alcoa also raised its price, McNamara on November 6 released 200,000 tons of virgin aluminum from the stockpile. It was not enough. Johnson told him to add another 100,000. On November 10 Alcoa rescinded its action and within hours the rest of the industry followed.
At that moment Anaconda, the leading copper firm, raised its price. But U.S. copper, unlike aluminum, followed the world price and Chile was the price leader. Johnson sent Averell Harriman to Santiago to demand that President Eduardo Frei roll back his price, and 200,000 tons of copper were marketed from the government stockpile. Anaconda surrendered.
Lyndon Johnson’s virtuoso performance in the metals in the latter part of 1965 made him the world’s greatest guideposter. Ackley was a witness to what he described as an “awesome” performance when he brought Roger Blough, the chairman of U.S. Steel, to the Oval Office to discuss steel prices.
Roger started to explain what it was that he wanted to do and why it was a reasonable thing to do. And the President just started working him over. … I have never seen a human being reduced to such a quivering lump of flesh. Roger was unable to speak at the end of that interview. LBJ just took him apart, spread him out on the rug, and when he left, Roger was just shaking his head.
But the massive force of the Great Inflation would soon wipe out Johnson’s role and the guideposts themselves.2
In mid-1965 the Keynesian economists at the Council of Economic Advisers could look on the nation’s economy with great satisfaction. They had guided the country, particularly with the 1964 tax cut, into an extraordinary controlled boom. This was the fifth consecutive year of economic growth. The Industrial Production Index (1957–59 = 100) had stood at 109.7 in 1961. In June 1965 it reached 143.1. The Council had persuaded Kennedy to fix an “interim” unemployment goal of 4 percent. In 1961 the rate had been 6.7. In June 1965 it had fallen to 4.7 percent. In fact, it would break the 4 percent barrier at 3.7 in February 1966. And, mirabile dictu, there was virtually no inflation. In June 1965 on the base of 1957–59 = 100 the Consumer Price Index stood at 102.8.
Walter Heller later reflected on this triumph, of which he had been the main architect. There was “very little price inflation” and that was almost entirely due to farm prices which have a “certain life of their own” unrelated to aggregate demand. “So … there was no real inflation.” He had not anticipated both full employment and stable prices. No industrial economy had ever achieved that utopia. But “the Vietnam escalation just knocked things into a cocked hat.”
For most of the rest of 1965 the economists were led astray because the impact of the war was masked by two factors. The first was the duplicity of Johnson and McNamara in concealing the real cost. Ackley, depending on McNamara, assumed the maximum increase in the defense budget at $3 to $5 billion. He did not learn the actual figure until January 1966—$12.8 billion! The other factor was the lag between the letting of a defense contract and the payment for the goods when they were delivered. In the case of ammunition the delay was about six months; for a military airplane it was 18 months. Robert Warren Stevens wrote:
In the second half of 1965, companies that were already almost fully occupied with meeting the booming civilian demand for capital goods and automobiles suddenly received new high priority orders from the Pentagon. These new orders immediately set off inflationary developments in the private sector of the economy as employers began to expand their plants and to raise wages in order to attract more workers into defense production.
They also trooped to the banks for loans to finance their interim costs.
Thus, in the latter part of 1965 the economists at CEA, lovingly caressing their cheerful economic indicators, were oblivious to the gathering storm. In fact, economists generally groped in the dark. Seymour E. Harris, who was a consultant to the Treasury, set up a meeting of 20 top economists with high officials of the interested departments on November 23, 1965. They agreed that the economy would grow in 1966 at 4 percent in real terms, somewhat less than 1965. “With a few dissenters, there was no great concern that the economy was overheated and would require restrictive monetary policy.”
William McChesney Martin, the chairman of the Federal Reserve Board, invariably opened a conversation with an economist by saying, “I am not an economist,” to which the under-the-breath reply was, “Amen!” He believed that inflation of any magnitude was a variety of the bubonic plague. Lyndon Johnson, by contrast, was a Texas populist on high interest rates: He hated them. The Keynesians, preoccupied with overcoming unemployment by stimulating growth, much preferred fiscal to monetary policy. Both, therefore, looked at Martin with deep suspicion. A brawl was inevitable.
The news rose within the banking system to the Fed that businessmen were lining up at their banks for bridge loans to finance their defense orders. Martin got worried and in the early fall of 1965 began to hint that the time was approaching when interest rates must go up. Ackley, Schultze, and Treasury Secretary Henry Fowler warned the President and he called a meeting of the Quadriad—Martin, Ackley, Fowler, and Schultze—for October 6, 1965.
Fowler pointed out that Morgan Guaranty was considering a rise in rates. Johnson wondered whether he should issue a statement about keeping interest rates low. Martin wanted to know how much the government was going to spend, “particularly by McNamara on the war.” Johnson mentioned $3 to $5 billion. Martin said he was leaning toward higher rates. Johnson opposed an increase, saying it would hurt small farmers and businessmen. Ackley and Schultze agreed. Martin looked the President in the eye and said, “If we thought you were right we’d all do the same thing. But the question is, whose crystal ball is right?” Johnson had gotten nowhere. On December 3, with Martin leading the way, the Fed voted 4 to 3 to raise the discount rate from 4 to 4.5 percent.
In fact, the administration was ambivalent about the Fed’s action. Privately the President was angry and inspired congressional hearings on the independence of the central bank without consultation with the White House. But he issued a mild public statement, which opened, “The Federal Reserve Board is an independent agency.” It would have been better, he said, for the Fed to have waited till January, when the new budget would be ready and policies could have been coordinated.
Johnson called Martin and his economic advisers, including Heller, to a meeting at his ranch on December 6. �
�Sitting on the lawn in front of the ranch house,” Califano wrote, “LBJ at first probed for any way of turning Martin around. He quickly saw that there was none.” The President, moreover, recognized that the Fed’s action was not all bad because it seemed to make a tax increase unnecessary. As Kermit Gordon pointed out, there “wasn’t nearly as much of a conflict as it appeared on the surface. There was a good deal of covert support within the Executive Branch for that act.”
By the end of 1965 the economists had grasped reality. They now realized that McNamara’s numbers were much too low, that a big inflation was coming, and that a tax hike was necessary. The President asked CEA whether a federal budget of $115 or $110 billion would require a tax increase. Ackley replied on December 17 that a $115 billion budget would require a “significant tax increase” and $110 would “probably call for one.” Heller told Johnson, “What we really need is a surtax on the individual income tax.” He suggested 5 percent. Undersecretary of the Treasury Joseph Barr, who had been in Southeast Asia in November and had talked to many military experts, came back convinced that “we really had a bear by the tail. I recommended to Secretary Fowler … that we consider getting our taxes up and do it quickly.” Budget Director Schultze agreed. But the President would not budge.3
Robert Warren Stevens called 1966 the “year of reckoning,” a “traumatic” time for the American economy. James L. Cochrane described it as “a vintage year” when “events overran policies,” which “began badly and then deteriorated.” If one is searching for the year during which the Great Inflation began, the choice is manifest: 1966.
The Fed, deserted to face the storm, squeezed the supply of money and shoved up interest rates. Soaring interest took a toll. Savings and loans and mutual savings banks, locked into low returns on long-term mortgages, were unable to borrow. By midyear the commercial banks felt a similar pressure: their large holdings of municipal bonds could not be sold because they paid too low an interest. Bond houses were threatened with failure. The stock market, which had been falling since February 9, suffered a sharp drop in August. The reason, Ackley explained to the President, was because an investor could earn only 3.5 percent on corporate dividends, compared with 6 percent on government guaranteed federal bonds. Rising interest on mortgages severely retarded the housing industry. Imports increased sharply; exporters lost foreign markets; and the balance of payments soured. Holders of life insurance borrowed from their policies, which paid 5 percent, and received better rates elsewhere.
At the same time, manufacturing and construction boomed. Many of the firms in these industries either financed themselves or borrowed at risky high rates. On August 10, 1966, Ackley wrote Johnson, “I was told … that Morgan Guaranty’s loan demand for September and October is absolutely unbelievable.” A week later the Fed squeezed large banks, as Ackley put it, to “ration their loans to their big customers.” On September 17 he sent Johnson a three-page list of price increases on everything from eggs to electrical transformers that rose in the preceding week. November 8, he reported, “has been a bad day for prices.” Nor did corporations hesitate to raise wages either in collective bargaining or voluntarily in order to hold on to their skilled workers as unemployment held quite consistently under 4 percent.
The wage-price guideposts were swept into oblivion, carrying with them that great mediator, Lyndon Johnson. People asked, “Where did 3.2 go?” In January 1966 the new Republican mayor of New York, John V. Lindsay, settled the city’s transit wages for an increase of 6.3 percent. The construction unions vied with each other to see which could kick the guideposts farther. The unsavory Peter Weber of the Operating Engineers, Local 825, in New Jersey highway construction seems to have become champion. The most explosive case involved the Machinists and five large airlines—Eastern, National, Northwest, TWA, and United. A presidential board consisting of Wayne Morse, David Ginsburg, and Richard Neustadt recommended 3.5 percent plus a clever reopener that came into play only after a very big rise in the cost of living. But the IAM rejected the deal and struck. The President caved in and on July 29, 1966 accepted 4.3 percent. But the membership even rejected that. The union eventually got 4.9.
The White House was shaken and Califano asked CEA for comments on creation of a commission on price stability and the collapse of the guide-posts. The Council thought the commission a good idea. “I certainly agree,” Ackley wrote, “that it is useful to put the recent guidepost defeats into perspective, and I have long agreed that we will need to retreat from the 3.2 percent guidepost figure.” He opposed abandonment and urged getting something in return from labor for giving up 3.2. In August Representative Henry Reuss of Wisconsin held ceremonial hearings on the extinct guideposts.
In December 1966 the President threw in the towel on taxes. His advisers had pressed him all year. In May both Ackley and Schultze had called for a 10 percent surtax. A prominent group of Harvard and MIT economists led by Otto Eckstein met for three months and brought in Ackley, Ginsburg, Fowler, and Califano. On August 23 they made their recommendation: “A personal and corporate tax increase was absolutely essential, and the sooner the better.” Schultze, and Ackley concurred. On September 2 Fowler, McNamara, Katzenbach, O’Brien, Schultze, Ackley, Ginsburg, and Califano agreed.
In his State of the Union message on January 10, 1967, the President said, “I recommend to the Congress a surcharge of 6 percent on both corporate and individual income taxes—to last for 2 years or for so long as the unusual expenditures associated with our efforts in Vietnam continue.”4
It would be a year and a half—all of 1967 and the first half of 1968—before Congress gave Johnson the surtax. During that period economic conditions were much as they had been in 1966: heavy price pressures and distortions with no wage-price policy and the whole burden of restraint falling upon the Federal Reserve.
Though the Fed’s governors followed interest rates very carefully and intervened frequently, their limited powers were hardly up to the task. Okun, who had succeeded Ackley as chairman of CEA, summed up the disaster for the President on May 23, 1968: “Many interest rates are now at their highest level in nearly fifty years. Rates have jumped 1 1/2 to 2 percentage points since late 1965.” Mortgages averaged 7 percent and in many areas were 8. They might soon go to 10. The annual rate of price increase was 4 percent,“the worst performance in 17 years.” The international trade deficit hit a record in March 1968. There was talk of a flight from the dollar and even of a world financial crisis.
On June 9, 1967, the President had met with his top economic advisers and Fowler said he found the money market “disturbing.” Corporations, anticipating a large federal deficit and no tax increase, were borrowing longterm funds heavily and interest rates were rising sharply. On present, not projected, facts, “Fowler urged strongly that it was necessary to go forward now on the tax surcharge.” He thought the banking and business communities would understand and back the hike. He expected a budget deficit of $23 to 28 billion. The President, shocked, said he “refused to run a deficit of the magnitude projected.” He was ready to cut spending “drastically” on domestic programs. “The country, and Democratic Congressmen in particular, would have to choose between the domestic programs and the tax increase.” He ordered Schultze to work out a curtailed budget and he suggested that the surcharge might to go 10 percent rather than 6 percent.
CEA explained the significance of a 1 percent rise in interest rates. The cost to the federal budget would be $3.6 billion annually, $29 billion to the national debt, and $4.5 billion to private, state, and local government costs. Johnson asked for a comparison of price inflation between the U.S. and the European democracies. Writing in January 1968, Ackley pointed out that the U.S. had much the best performance since 1960. But for the period of the Vietnam War, that is, since June 1965, Germany, France, and the Netherlands had a better record and the U.K. and Italy had done as well.
Private investment in plant and equipment continued to be the great engine driving the boom. Inflati
on aside, this had its attractive aspect—high output and high employment. On October 23, 1967, Ackley wrote George Christian, the White House press secretary:
On November 1, we will have gone 81 months without encountering an economic recession. This will break all records for the duration of an expansion; the previous high of 80 months was set from 1938 to 1945 (including World War II). The average length of expansions (since 1854) is 30 months, and the last three prior to the present one were 45, 35, and 25 months, respectively.
But very high employment in the absence of an incomes policy drove up wages. In the first quarter of 1967, excluding construction, union contract increases averaged 4.9 percent compared with 4.5 in 1966. The Teamsters’ national agreement in the second quarter of 1967 came to 5.5 percent plus a cost of living escalator. Ackley’s memorandum on construction was titled “The Disaster Toll.” In Chicago the carpenters and painters settled for 6.6 percent. In Cleveland the plumbers got an “incredible” 40 percent over 3 years and the carpenters and bricklayers surpassed them. In Connecticut the operating engineers received 7.4 to 9.2 percent. “Many contractors,” Ackley wrote, “seem to be offering nothing more than token resistance to this union assault.”
In September 1967 Walter Reuther negotiated a pathbreaking agreement for the UAW with Ford: 6.2 percent, a cost of living escalator, and a new guaranteed annual wage. After a strike in the spring of 1968 the telephone contract came to about 6.5 percent a year for three years.
On February 23, 1968, the President created the Cabinet Committee on Price Stability, consisting of the Secretaries of Treasury, Commerce, and Labor, the Director of the Budget, and the Chairman of the Council of Economic Advisers. The basic recommendation in its report, delivered on December 27,1968, was hardly earthshaking: “Voluntary restraint by business and labor in wage and price decisions is an essential element in the overall program to achieve full prosperity and reasonable price stability.” Amen.5
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