HOW THE NEW ECONOMICS SABOTAGED IKE’S FISCAL ACHIEVEMENTS
Needless to say, Eisenhower was the last of the fiscal Mohicans. Virtually nothing of the solid fiscal posture he left behind in 1960 survived the new economics’ crushing attack on the rule of balanced budgets.
Indeed, once the rank and file of Washington politicians became intoxicated with the sophistries of the full-employment budget and fiscal fine-tuning, they were soon unable to even accurately measure the red ink in the budgetary accounts, let alone feel impelled to relieve it.
At the end of the day, the new economics was a crucial inflection point. In the name of turbocharging the private capitalist economy, it ended up fatally impairing the essential fiscal integrity of the state.
Yet the data prove rather conclusively that after sacrificing the classical fiscal rules, the new economics generated virtually no gain in macroeconomic performance compared to the Eisenhower years. Accordingly, the Keynesian professors should be assessed heavy, everlasting blame for triggering the fiscal and monetary disasters which followed their tenure.
The necessary starting point for that indictment lies in debunking their self-justifying history of the era. The latter holds that the new economics ushered in a quantum leap in economic performance after the alleged somnolence of the Eisenhower years. The latter depiction, however, can be sustained only be measuring Ike’s record from an artificial starting point; namely, the red-hot Korean War economy he inherited in January 1953.
Truman’s war-fevered economy was not sustainable on a peacetime basis, however, and in any case, the GDP growth figures soon headed south upon the arrival of the Korean armistice a few months later. In fact, comparing what actually happened during and after the Eisenhower era illuminates an even deeper truth detailed below: virtually every period of above-normal real GDP growth since the 1930s has been accompanied by a surge in warfare state outlays.
These defense budget boomlets do not represent a true gain in national wealth, of course, since war spending destroys economic resources and diminishes consumer utility. Indeed, the reported gains in GDP are a statistical illusion, owing to the fact that the GDP accounts only measure spending, not wealth.
THE TRUE EISENHOWER ECONOMIC RECORD:
UNMATCHED ERA OF CIVILIAN ECONOMIC GROWTH
Eisenhower’s economic watch, therefore, is more honestly and accurately measured from the point that the Korean War disruption had passed through the national economy; that is, upon completion of the brief “cooling off” recession in the second quarter of 1954. During the seven-year period which followed, a fair part of this illusory defense-spending increment was stripped out of the GDP accounts.
In fact, defense spending actually made a negative contribution to reported GDP growth after mid-1954, given that real DOD spending declined by 22 percent. Consequently, when the defense ramp-down is removed from the figures, real GDP growth averaged 3.5 percent annually during the seven-year post-Korea phase of Eisenhower’s tenure. Nonfarm payrolls also grew at a healthy 1.4 percent annual rate during that seven-year period.
At the same time, the war inflation and price control machinery that Eisenhower inherited was eliminated. By the final twelve months of his term, the rate of CPI gain at 0.7 percent annually was about as close to price stability as has been achieved in the postwar world. In other words, the Eisenhower era produced the “Goldilocks economy” of strong growth and low inflation that bullish Wall Street economists only imagined in 2006–2007.
During the decade after Eisenhower, however, three successive presidents aggressively implemented Keynesian fiscal policies. The last two, Johnson and Nixon, browbeat the Fed until it monetized much of the resulting federal debt.
Yet during what might be termed the “Keynesian interlude,” which culminated in Nixon’s historic gold standard default in August 1971, there was only a modest uptick in the rate of GDP growth and employment gains. On the other hand, the breakout of inflation was so severe and uncontainable that it took the Bretton Woods monetary system down with it.
Unlike during the Eisenhower era, of course, the Kennedy-Johnson doctrine of limited war imperialism soon had the defense growth increment back in the GDP accounts. Real defense spending was 40 percent higher by fiscal 1968. So in order to measure on an apples-to-apples basis it is necessary to remove the national defense expenditure contribution from the GDP accounts.
On that basis, real economic growth during the Keynesian interlude (1961–1971) averaged 4.3 percent annually, or just 80 basis points more than during the Eisenhower era. Likewise, annual nonfarm payroll growth averaged 1.8 percent, or just 40 basis points more than under Ike. Those are truly meager gains when contrasted with the inflationary disorder which descended upon the American economy.
Not only did the CPI rise at a previously unheard of 6.2 percent rate during 1969, but by then the inflationary momentum was so severe that even the modest fiscal and monetary braking actions of late 1968 and 1969 were of little avail. When money market interest rates reached nearly 8 percent—levels never previously seen in the twentieth century—the economy skidded into recession. Even then, the CPI inflation rate only slowed to 5.6 percent by the end of 1970.
So in supplanting the old-time fiscal religion, the professors ushered in a devastating macroeconomic setback for the nation, not the enlightened economic science they claimed to possess. The 1960s Keynesian experiment eventually degenerated into its alter ego after August 1971: Professor Friedman’s régime of floating paper dollars. But the latter result did not come out of the blue; it had been gestating for a decade.
Way back when the new economics was first being heralded during the Democrats’ “Get America Moving Again” campaign of 1960, the warning signs of big trouble in the monetary system were already flashing. In October 1960, the first serious post–Bretton Woods run on gold flared up in the London market. Speculators were already betting against the new economics. Rightly so.
CHAPTER 12
THE AMERICAN EMPIRE AND
THE END OF SOUND MONEY
THE 1960 DEMOCRATIC CAMPAIGN PLATFORM FRONTALLY ATTACKED the “plodding” Eisenhower economy, promising to raise real GDP growth to 5 percent annually. This growth target virtually telegraphed reckless policy experimentation ahead, since it was far larger than had ever previously been imagined, let alone delivered by the modern American economy on a sustained basis. Stated more plainly, 5 percent growth was nuts.
As it became clear in the last weeks of the election that Kennedy could emerge the winner and would bring the new economics professoriate to Washington in pursuit of these aggressive fiscal and monetary policies, the London gold market went into a buying panic. Speculators began to aggressively dump dollars and stock up on gold, betting that the new administration might devalue, that is, raise the dollar price for gold above the existing $35 per ounce parity.
THE LONDON GOLD MARKET PANIC OF OCTOBER 1960: A SHOT ACROSS THE KEYNESIAN BOW
At the time, the London gold market was a genuine free market in which traders, both private parties and official institutions, could buy or sell gold at an auction price. It functioned parallel to the official Bretton Woods system under which transfers of gold among nations in settlement of payments imbalances occurred exclusively between central banks, and only at the official parities centered on $35 gold.
The rub was that this gold settlement process under the official Bretton Woods system was highly discretionary and political, not automatic and market driven as under the pre-1914 gold standard. Consequently, official gold settlements did not necessarily “clear the market” and force immediate monetary tightening and economic adjustments in the deficit countries, as occurred under the classic gold standard mechanism.
Under the dollar-based gold exchange standard, in fact, trading partners with dollar surpluses could be “persuaded” (by Washington) to forego the conversion of these dollars at the US gold window. They were instead forced to accumulate short-term dollar claims which cou
nted as monetary “reserve” assets.
As the hegemonic power during the early Cold War era, the United States self-evidently had the wherewithal to enforce a de facto policy of involuntary reserve accumulation. The overseas hoard of dollars piled up in foreign central banks was thereby steadily enlarged, even as the US balance of payments deficits grew during the 1960s and remained uncured.
The one escape valve was the ability of countries with unwanted dollars to quietly swap them for gold in the London market. Accordingly, in the early days of Bretton Woods, bureaucrats at the International Monetary Fund (IMF) made efforts to get participants to outlaw private gold markets.
They recognized that someday official parities could be threatened if the free market price of gold diverged too far from $35 per ounce. But the presence of makeshift private gold markets in places like Macau, Tangiers, and Hong Kong, along with the steady clandestine sale of gold for desperately needed hard currency by the Soviet Union, finally encouraged the Bank of England to reopen the old London gold market in March 1954.
For the next half decade, the London market operated quietly alongside the official gold window of the US Treasury. This nascent London-based free market in gold provided an outlet for Soviet bullion sales, small transactions by foreign central banks, and a venue for a corporal’s guard of private speculators to make small-time bets.
There was little reason to speculate against the gold dollar at $35 per ounce so long as the disciplined fiscal and monetary policies championed by Eisenhower and Martin, respectively, remained intact. But the combination of a modest deterioration in the US balance of payments during 1960 and the prospect that US economic policies would lurch away from orthodoxy quickly ended the quietude.
As Charles A. Coombs, then a key player at the New York Fed’s international desk, observed in his memoir of the era, “The market could smell thunder in the air…. [S]entiment shifted abruptly during the weekend of October 15, 1960.”
After years of somnolent fluctuations around parity, the gold price in the London market thus flared to $40 per ounce in late October 1960, which was an unexpected and shocking development at the time. The free market gold price came off the boil only after candidate Kennedy publicly committed to maintenance of convertibility at the official $35 price. Still, as Coombs further noted, the Fed’s earlier worry that “the London gold price would become a barometer of confidence in the dollar was being vindicated with a vengeance.”
This pre-election gold panic was the free market’s premonition of the lethal threat to Bretton Woods posed by the new economics. Yet the Keynesian professors were largely oblivious to the warning.
Notwithstanding the two full months that Professor J. M. Keynes and comrade Harry Dexter White had spent at Bretton Woods, New Hampshire, perfecting a new world monetary order during the summer of 1944, they had not expurgated the “barbarous relic” of free market gold, after all. In fact, the London gold market was a peephole back into the pre-1914 monetary order.
Under the classical gold standard régime, as previously noted, the propensity of governments and central banks to debauch the official paper money could be swiftly checked by its conversion into gold coins and bullion by private investors and speculators. On the eve of John F. Kennedy’s presidency and the arrival of the new economics in Washington, therefore, the ancient discipline of free market gold was energetically reemerging through the London market.
BRETTON WOODS AND GOLD: THE VESTIGIAL LINK TO THE ANCIENT MONETARY RÉGIME
This development was not exactly anticipated or welcomed by officialdom. In fact, the turmoil in the London gold market was a complete contradiction of the framers’ fervid intention that Bretton Woods function essentially as a hybrid form of international money that was ultimately state managed.
Indeed, there was only one reason why gold, rather than Keynes’ pure fiat script, called “bancor,” had been made the official settlement asset under Bretton Woods, and it had nothing to do with monetary theory. As of July 1944, the United States held 80 percent of the world’s stock of gold. Not surprisingly, the US delegation thought the Fort Knox hoard would provide more than enough chips for the international settlements table created by Bretton Woods.
From this signal fact the conference had leapt to the large, although unarticulated, conclusion that the United States could succeed as the reserve currency issuer under a gold exchange standard, notwithstanding the historical precedent of England’s miserable failure in the role during the 1920s. And on the surface, of course, that wager was plausible given the vastly different circumstances of the two countries.
The British Empire had emerged from the Great War deeply wounded economically, with its public accounts heavily in debt, the London money market enfeebled, and the Bank of England’s gold reserves down to a trifle. It was only British arrogance that had presumed that a gold exchange standard could be reconstituted on this wobbly foundation.
The Bretton Woods conference appropriately judged that the United States was in a far better position to function as the anchor in this attempted revival of the gold exchange system. With $20 billion of gold reserves behind it, the dollar was a far more plausible candidate to function as a reliable reserve currency; that is, the US dollar of 1944 had every appearance of being the anti-sterling of 1925.
Indeed, in 1944 most of the world’s economies outside North America were prostrate. Accordingly, the prospect that the United States would be plagued by chronic balance of payments deficits did not stir the imagination of the conference’s leading thinkers.
So the “barbarous relic” had been reinstalled as the “reserve” or “settlement” asset at the heart of the new Bretton Woods system. Yet despite the conferees’ genuine desire to revive honest international money after the calamity of 1930s economic autarky and depreciated national currencies, the arrangement ignored the fundamental flaw of the sterling exchange system.
If America’s vast gold hoard was ever dissipated, then the danger would arise that the United States, as the issuer of the reserve currency, would find itself in the British position of the 1920s. Like the British, it could be tempted to force its trading partners to accumulate vast unwanted dollar liabilities rather than put its own domestic financial house in order.
THE LESSONS OF THE STERLING EXCHANGE STANDARD UNLEARNED
Owing to the trauma of the 1930s and the totalitarian monsters to which it had given rise, the conferees at Bretton Woods understood perfectly well that a repeat of the British gold exchange standard failure had to be avoided at all hazards. Unlike today, it was then self-evident that in the absence of global financial discipline and settlement of trade and financial accounts on a regular basis, there lurked a monetary terra incognito teeming with financial terrors.
However, in attempting to revive, for the second time, the efficiencies of a single world money and the financial disciplining mechanism of the pre–World War I gold standard, the conference succumbed to the same error as the 1920s go-round; namely, under Keynes’s tutelage it focused on accommodating economic growth and the alleged problem of a shortage of gold reserves. The real imperative, however, was resurrecting a mechanism for international financial discipline that did not depend upon the political self-control of the reserve currency issuer.
Indeed, the deeply flawed idea of “economizing” on the world’s gold stock by allowing nations to settle their current account imbalances through payments in a designated “reserve currency,” as well as gold, had been launched at a 1921 conference in Genoa. It had been convened by the League of Nations to reconstitute the international financial system from the monetary ruins left by the Great War.
The self-serving British theory at the time was that world recovery would be better nurtured by a more ample and elastic system of monetary reserve assets than would have obtained from a return to a pure gold specie system. Since Britain had exhausted all of its gold during the Great War, it amounted to a pauper’s monetary standard.
Never
theless, during the course of the 1920s this “gold plus reserve currency” arrangement became widespread, as more than thirty nations ended wartime fiat money régimes and returned to fixed exchange rates and convertibility of their currencies into either gold or sterling and dollars. As previously indicated, this jerry-built gold exchange standard appeared to be just the ticket, as the entire global economy recovered and grew at a robust pace between 1924 and 1929.
As has also been seen, however, the boom had been fueled by massive Wall Street foreign bond issuance and a temporary surge in US exports and world trade. When that daisy chain of faux prosperity came to a screeching halt, the underlying flaw of the sterling exchange system became apparent; namely, that Britain had neither the resources nor political will to perform its obligations as the reserve currency issuer.
THE BRITISH MONEY-PRINTING SPREE UNDER THE GUISE OF THE GOLD EXCHANGE STANDARD
In fact, the postwar gold exchange standard turned out to be the first great experiment in sovereign debt–based money. In this case, the money in question was the massive accumulation during the 1920s boom of pound sterling monetary reserves by France, Holland, Sweden, Italy, and the central and eastern European nations.
But these “reserves” were just a back-door form of British borrowing which permitted it to live beyond its means. The financial devastation of the Great War had depleted the British industrial economy and left the government and much of industry deeply in debt. But rather than reduce consumption, wages, and living standards in order to rebuild its economy and pay down its war debts, British policy embraced an illusion.
It attempted to return to pre-war exchange rate parity ($4.86 per pound sterling) at postwar wages and prices. Yet since the British price level had risen by 200 percent during the course of its desperate money printing during the Great War, its attempt at “resumption” on the cheap was a disaster. It resulted in an overvalued pound, chronic current account deficits, and an inflationary monetary policy that printed far too much sterling.
The Great Deformation Page 33