The chairman of the nation’s supposedly independent central bank thus assured Nixon: “I have done everything in my power to help you as President, your reputation and standing in American life and history…. No one has tried harder to help you.”
That was completely true. During the first two years of his tenure, Burns gunned the money supply like no Fed chairman before him had ever contemplated. Accordingly, the Fed’s balance sheet grew by nearly 11 percent two years in a row.
Nor was this an aberration. Under Burns’ direction the Fed continued to purchase government debt aggressively in the years ahead, even as inflation soared. By the end of his term in 1978 the Federal Reserve was fast becoming a warehouse for the national debt.
Needless to say, what had been considered a world of stable prices, embodied in the 1.4 percent average rise in the CPI between 1953 and 1966, was left far behind. In its place, this first chapter of printing-press money and unhinged credit growth generated a classic storm of consumer price inflation. At that point, neither floating exchange rates, nor mercantilist central banks, nor masses of cheap rural Asian labor were available to siphon-off excess domestic demand.
Accordingly, the consumer price index had first broken through 3 percent in mid-1967 and then had escalated upward to 4, 5, and 6 percent, respectively, in each of the next twelve-month periods. These were shocking rates of inflation, drastically outside the range of any peacetime experience during the twentieth century.
Through the spring of 1971, the inflationary surge was largely domestic, and there can be little doubt that the soaring growth of bank lending was the catalyst. The US economy was already on the boil owing to massive military spending on top of the booming civilian sector. Capacity utilization levels were at unsustainable all-time highs, but it was the rock-bottom unemployment rate, continuously below 4 percent for more than forty-eight months through early 1970, that best measured the US economy’s white heat.
Accordingly, with scarcely any untapped man-hours left in the US economy, let alone unused factory production lines, the Fed’s gunning of bank-lending growth, which clocked an 8 percent annual rate of growth, was inexplicable. It self-evidently amounted to pouring kerosene on the already raging fires of excess demand.
In his final months as chairman, Martin finally brushed off the White House pressures, reining in credit growth sufficiently to induce a mild recession in the fourth quarter of 1969. This move was more than warranted, even if the inflationary horse—now galloping at 6 percent—had already left the barn.
The initial hit to growth from Martin’s tightening amounted to a pinprick—with real GDP declining by only 0.4 percent during the two winter quarters of 1969–1970. But upon Burns’ appointment, Nixon hounded his new Fed chairman relentlessly—so he compliantly engineered a solid recovery during the second and third quarters of 1970. In a real economic sense that was the end of the 1970 recession. What made it appear more imposing at the time was a landmark sixty-seven-day-long strike at General Motors (GM) in the final quarter of 1970. That helped tip the economy back into a slump, but as the data show that was purely statistical—an inventory shuffle between quarters.
Needless to say, Richard Nixon did not like bad economic statistics, and most emphatically so when they coincided with an election. Moreover, back then GM still had serious economic throw-weight, as evidenced by its 50 percent share of the US auto market and its status as the world’s largest corporation.
So the strike caused 400,000 GM workers to be idled directly and pushed multiples of that number onto the unemployment rolls across the automotive supplier and dealer infrastructure. All told, the unemployment rate rose from 4 percent at the beginning of the year to nearly 6 percent by Election Day 1970.
The strike ended a few weeks later and much of the output loss proved to be temporary. Yet the strike’s blow to the economy in the final quarter of 1970 got Nixon’s full and purposeful attention.
NIXON’S POST MID-TERM ELECTION COMMAND:
THE US ECONOMY MUST BOOM BY JULY 1972
When the polls closed on the midterm elections, an even worse batch of statistics materialized: the loss of nine GOP seats in the House and negligible gains in the Senate. Ruminating over these unwelcome results, Nixon told his trusty praetorians, Chief of Staff Bob Haldeman and Domestic Affairs Advisor John Ehrlichman, exactly what he was thinking about economic policy for the coming two years.
Haldeman noted in his diary that “P still concerned about ’72. Can’t afford to risk a downtrend, no matter how much inflation.”
Ehrlichman recorded an even more precise presidential admonition: “The economy must boom beginning July 1972.”
Richard Nixon was warming up for his August 1971 demarche: the straitjacket of wage and price controls on the domestic economy and default on the nation’s international debts which emerged from Camp David. In one of the greatest paradoxes of modern history, Nixon would be advised on the formulation of that thoroughly statist plan by the largest assemblage of free market economists ever gathered under one presidential roof.
The underlying economic predicate of that weekend’s plan—infamously and hilariously christened the New Economic Plan, or NEP, which was the name Lenin had given to his partial relapse to capitalism a half century earlier—was just plain wrong. The Nixon White House was maneuvering to gun the US economy with a fresh wave of credit expansion when it wasn’t needed and could on no account be justified.
The pretext had been macroeconomic weakness, but as indicated, the 1970 recession amounted to a head fake. The dip in the winter quarters of 1969–1970 was so mild that it amounted to just $20 billion in today’s dollars. Even that momentary pause occurred after thirty-five straight quarters of red-hot GDP growth and in a context in which the economy was operating way beyond its sustainable capacity.
The statistical tables, of course, show a second 4.2 percent annualized GDP plunge in the fourth quarter of 1970. Nearly 85 percent of that decline, however, represented inventory liquidation—a not unsurprising consequence of the sixty-seven-day auto strike which had emptied the nation’s car dealer lots and auto supply pipeline.
During the very next quarter, in fact, the rubber band snapped back. Real GDP rebounded by 11 percent in the first quarter of 1971. More than half of that gain represented the scramble to refill the very same automotive pipeline that had just been emptied.
So when the violent, strike-induced inventory swings are set aside, the underlying facts are unmistakable: real GDP on a final sales basis grew at an average rate of 2.5 percent during the four quarters ending in June 1971. There was no downturn for Nixon’s aptly named NEP to counteract.
As of mid-year 1971, however, there was ample evidence that the US economy was in the throes of a severe inflationary spiral. Consumer prices were 5 percent above year-earlier levels and wage growth in bedrock sectors of the economy was beginning to soar. Compensation costs in manufacturing were up by 7 percent from the previous year, and construction industry wages were rising by 9 percent, with first-year settlements among unionized firms reaching 18 percent.
As shown below, this intensifying inflationary spiral was bad news for the dollar, since by now large balances of unwanted dollars were accumulating in the major European central banks. But the administration made no effort to placate foreign-dollar holders, and Richard Nixon was outright bombastic on the topic.
When he learned in late 1970 that Burns had resisted too steep a decline in interest rates because of concern about the dollar, Nixon fumed to Ehrlichman that the Fed chairman should “get it right in the chops.” Prior to a meeting with him in December 1970, Nixon informed his staff that if Burns brought up the balance of payments constraints on monetary policy again, “I’ll unload on him like he’s never had.”
Punctuating the point that same week, Nixon announced that John B. Connally, who had never met an interest rate he considered low enough, would be appointed secretary of the treasury. From the perspective of history, Nixon was p
laying with monetary fire. The linchpin of the Bretton Woods system was worldwide trust in US financial discipline. Central banks in Europe and elsewhere held dollars, rather than gold, as foreign exchange reserves because they believed the dollar was as good as gold. Now he was serving them an emasculated Fed chairman and a swash-buckling financial cowboy at the Treasury.
As detailed more fully in chapter 12, foreign confidence in US fidelity to its Bretton Woods commitments had already been badly shaken by Johnson’s war deficits and his bullying of the Fed for easier money. In the eyes of traders and foreign central bankers alike, these policies—continued by Nixon—were self-evidently fueling an inflationary domestic boom that was drawing in imports at an accelerating rate, thereby sharply undermining the US balance of payments.
This was alarming to dollar holders everywhere because the United States was already sending massive amounts of greenbacks overseas to finance its Cold War imperium. If it now persisted in streaming even more dollars abroad to live high on the hog on a bloated diet of civilian imports, the stockpile of excess offshore dollars would reach the breaking point.
In fact, a crisis of historic proportion was fast approaching, but by the spring of 1971 Nixon had discarded the two advisors who actually knew something about international monetary affairs. Burns had become an object of contempt despite his furious money printing, and the White House economic advisor, Paul McCracken, was excluded from even attending crucial economic meetings.
So Nixon was listening almost exclusively to Connally, whose ignorance of economic history exceeded even Nixon’s meager grasp. And in that development lurked an extreme danger.
The United States was facing a day of reckoning. It urgently needed to restore disciplined fiscal and monetary policies if the rudiments of the crippled but serviceable Bretton Woods monetary system were to be kept intact.
In the alternative, continuing to hurtle down the road of nationalistic financial profligacy was certain to blow the postwar monetary system to smithereens. This was a baleful prospect. Bretton Woods had indisputably fostered worldwide recovery and sustained economic growth while throttling the propensities for inflation and financial speculation inherent in a fiat money system.
Richard Nixon did not recognize the stakes, nor trouble himself with the weighty implications of the decisions at hand. In fact, as revealed in the private papers of his inner circle, Nixon treated these issues with stunning insouciance.
Thus, after about a year in the Oval Office he instructed Haldeman to screen out the topic entirely: “I do not want to be bothered with international monetary matters … and will not need to see the reports on international money matters in the future.”
It is hard to fathom a more feckless gesture, since almost from the day he entered the Oval Office Nixon was being warned of severe international monetary turmoil ahead. One of the more cogent alarms came from conservative economist Henry Hazlitt, who titled his March 1969 Newsweek column “The Coming Monetary Collapse.”
Hazlitt publicly warned the White House that “one of these days the United States will be openly forced to refuse to pay out any more of its gold at $35 an ounce.” The result, Hazlitt insisted, would be a “run or crisis in the foreign exchange market” that could end convertibility entirely. “If it does … the consequence for the United States and the world will be grave.”
Hazlitt could not have been more clairvoyant. The postwar monetary order was at a crucial inflection point. It would soon lurch into a forty-year spree of global debt creation, financial speculation, and massive economic imbalance—yet Nixon refused to even read the briefing papers.
So as the crisis came to a head, it was up to Connally to review the reports—and the report on merchandise trade for June 1971 wasn’t good. The US trade balance had still shown a small $3 billion surplus in 1970, even though that did not begin to pay for the $10 billion spent abroad in the military and foreign aid accounts.
But now the trade accounts, too, had turned negative, making it highly probable that the United States would experience its first annual merchandise trade deficits since 1893. The cause of this southward turn after seventy-eight years of surplus was plainly evident. Malevolent foreigners had not suddenly filled their harbors with rocks and turned back ships laden with American exports.
In fact, exports were growing at double-digit rates, but even this was not sufficient to keep up with the flow of imports to domestic factories and retail shelves. The latter had rocketed upward by 65 percent during the previous thirty months, rising from a $30 billion annual rate when Nixon took office to a $50 billion run rate by the summer of 1971.
TREASURY SECRETARY CONNALLY’S MONETARY POLICY—SCREW THEM FIRST
If these facts were known to the treasury secretary, they were not much evident in his take on the mushrooming trade problem. “My basic approach is that the foreigners are out to screw us,” Connally told an audience of visitors. “Our job is to screw them first.”
In the larger scheme of history, however, Connally had it upside down. Bretton Woods was a gold exchange standard system that depended as much on the political and financial discipline of the reserve currency issuer as it did on the intrinsic value of the yellow metal.
This truth was deeply embedded in the lore of European central banking. A gold exchange standard based on the pound sterling had been tried after the First World War. Exactly fifty years earlier, in fact, the central banks of France, Netherlands, Belgium, Sweden, and others learned a hard lesson about the risks of holding their monetary assets in the reserve currency.
During the late 1920s they had accumulated large amounts of sterling exchange which they could have converted to gold. But they had kept their reserves in pounds sterling in deference to the so-called gold exchange standard that had been promoted by the British Treasury and Bank of England since the early 1920s.
On the morning of September 20, 1931, the great central banks of Europe discovered they had been betrayed, as the value of their reserves had instantly dropped by 35 percent. That occurred when the Bank of England defaulted on its obligation to convert sterling to gold—and did so without warning and notwithstanding its continuous assurances the sterling parity would be defended at all hazards.
So this time the Europeans, especially President de Gaulle of France, were not about to be screwed, either first or again. Gold outflows from the United States intensified in the spring of 1971 and reached alarming levels after the June trade deficit figures became public. Nixon and Connally now faced a run on the bank, but it was a run of their own making.
WHEN A CAMP FULL OF FREE MARKET ECONOMISTS OPTED FOR FREE MONEY
The abomination which emerged from Camp David on the weekend of August 15, 1971, was anchored to a single constant: ensuring the election year economic boom that Nixon wanted by July 1972. Yet an honest boom wasn’t possible because the US economy was already in the throes of inflationary fevers.
Under those conditions, the White House desire for an election year burst of economic stimulus measures—business investment tax credits and individual tax relief—plus open-throttle monetary expansion would have turned the heavy gold outflow then under way into a swirling torrent. Yet when the administration’s assemblage of free market wise men arrived at Camp David, they promptly checked their intellectual baggage with the marines at the gate and spent the weekend pandering to Nixon’s every wish. The heart of the scheme which ensued was a ninety-day freeze on everything—wages, prices, rents, and interest rates.
Presumably, the disciples of Milton Friedman in the room, who had been taught that inflation is “everywhere and always a monetary phenomenon,” would have resisted the illusion of bureaucratic controls. Better still, they might have insisted that Fed chairman Arthur Burns, who was also at Camp David, do something meaningful about inflation, such as putting the brakes on credit growth which was then galloping ahead at a 10 percent annual rate.
Professor Friedman’s chief disciple on hand that weekend, however, w
as George Shultz, who had already perfected his patented craft of explaining things to presidents exactly as they preferred to hear them. Referring to the ninety-day freeze, Shultz plied Nixon with a whopper: “In your statement,” Shultz advised, “you should show we will use this period to stop inflation in its tracks.”
Friedman would have flunked all day long any student who advanced the lame proposition that a roaring monetary inflation could be stopped cold by a president’s TV speech. But such hallucinatory economics was apparently contagious that weekend because it afflicted Friedman’s long ago doctoral thesis advisor, too, none other than Professor Arthur F. Burns.
In his present capacity as Fed chairman, Burns added to the Camp David madness with an even more feckless narrative: “I would have a three month freeze, which would have shock value, and give us time to work out the machinery for dealing with stabilization. I would add Congressional leaders to the [wage and price] commission to develop our plan…. And there would be the distinct threat that if labor and management can’t agree, something would be imposed upon them.”
Thus, down in its engine room, the nation’s $1 trillion economy was hissing and crackling with inflationary wage and price pressures. Yet Washington was now going to command billions of prices and wages to stand exactly still for thirteen weeks.
Then, during the standstill, an even more implausible scenario would unfold. A tripartite board of politicians would figure out new wage and price edicts, and also how to penalize any citizens who engaged in non-compliant acts of market capitalism.
Never before had there been an act of peacetime economic governance so fatuous. Nor had there been one which had such predictable, calamitous results as did the freeze and the increasingly destructive and ineffectual control “phases” which followed.
The Great Deformation Page 17