The Great Deformation (24 page)

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, was 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.

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 which 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.