The Great Deformation (26 page)

At length, Congress upped the tax cut ante to $30 billion. It also completely ignored Ford's plea to make compensating spending cuts of about $5 billion.

Then in the fall of that year (1975) the Ford White House escalated the tax stimulus battle further, proposing a tax reduction double the size of its January plan. This led to even more tax-cut largesse on Capitol Hill, a Ford veto, and then a final compromise tax bill on Christmas Eve 1975. Senate finance chairman Russell Long aptly described this final resolution as “putting Santa Claus back in his sleigh.”

And so it did, and with permanent untoward results. By the time the ornament-laden tax cut was finally signed into law, it was way too late. The deep inventory liquidation of the previous winter had long since been superseded by a vigorous economic rebound.

In fact, even as the tax relief debate was being heatedly waged on Capitol Hill during the second half of 1975, real GDP had posted a 6.1 percent annualized gain. It then leapt to a 9.4 percent rate of expansion in the first quarter of 1976, a point well before the tax bill impact could be felt in the economy.

Thus, the 1969–1972 cycle repeated itself: by the time the big Ford tax cut was enacted, the inventory liquidation had run its course and a natural rebound was under way. So the 1970s second round of fiscal stimulus was destined to fuel a renewed inflationary expansion, and this time it virtually blew the lid off the budget.

Despite Ford's resolute veto of some appropriations bills, his red pen was no match for the massive Democratic congressional majorities that had come in with the Watergate election of 1974. Their urge to spend would not be denied, as attested by the figures for budget outlays.

Federal spending grew by 23 percent in fiscal 1975 and then by more than 10 percent in each of fiscal 1976 and 1977. All told, federal outlays reached $410 billion in the Ford administration's outgoing budget, a figure nearly double the spending level in place six years earlier when Nixon hustled his advisors off to Camp David.

Federal outlays were now more than 21 percent of GDP. That marker had been breached previously by only one president, Franklin D. Roosevelt, and that was only during the total mobilization of the Second World War.

This was ironic in the extreme. Ford was a stalwart fiscal conservative who went down to defeat in 1976 in a flurry of spending bill vetoes. But the massive increase in entitlement spending enacted during the Nixon years, particularly the 1972 act which indexed Social Security for cost of living increases just as runaway inflation materialized, could not be stopped with the veto pen. In fact, the specious facade of the Nixon-Shultz full-employment budget provided the cover for a historic breakdown of fiscal discipline.

This was strikingly evident in fiscal year 1976, a year in which the budget was falling out of bed, even as the economy bounded upward. During the four quarters ending in June 1976, real GDP grew at 6.1 percent. Yet due to the huge tax cut becoming fully effective during that period, federal receipts dropped to 17.1 percent of GDP, or to pre–Korean War levels.

With spending at a record 21.4 percent, the fiscal deficit soared to 4.2 percent of GDP. Despite the best of intentions, therefore, the Ford administration left LBJ's peak deficit amounting to 2.9 percent of GDP far behind.

Thus, the nation was now on an uncharted fiscal path, one of giant deficits which were entirely gratuitous. The 1974–1975 inventory liquidation had burned out on its own and double-digit inflation had subsided to 5 percent. But with the Treasury's annual borrowing requirement now at a previously unimaginable $75 billion, a shell-shocked Arthur Burns poured monetary reserves into the banking system with almost reckless abandon.

Soon the US banking system was off to the races. Total bank loans grew by 10 percent in 1976 and then surged by a further 15 percent in 1977 and another 15 percent in 1978. In short order inflation was again accelerating.

Exactly twenty-seven months after the CPI had dipped below 5 percent in late 1976, offering some slight hope that the inflationary cycle could be subdued, it had once again exploded to a double-digit gain by March 1979. A renewed commodity price explosion was already under way, with oil prices nearly quadrupling to $40 per barrel within the next twelve months.

HOW THE CARTER ADMINISTRATION TOUCHED OFF THE FINAL INFLATIONARY BLAZE

This addiction to deficit spending and pell-mell expansion of bank lending was bipartisan. The incoming Carter administration attempted to pile on further fiscal stimulus in early 1977 when it proposed a $32 billion package of tax cuts and added spending.

These measures included the infamous $50 per family tax rebate (properly derided as $0.96 per week of pocket change). The Carter package also included public works, make-work jobs, and an increase in countercyclical revenue sharing with local governments.

The very title of this latter program underscores the degree to which fiscal policy had come unhinged. These weren't emergency measures designed to prevent the economy from sliding into the abyss. To the contrary, the CBO forecast at the time projected real GDP growth of around 6 percent in both 1977 and 1978, meaning that the Carter White House was trying to stimulate an economy that its forecast showed was already red hot.

In fact, the real economic challenge was the opposite. The CBO also forecasted a 6 percent increase in consumer prices both years—a rate of gain which would reduce the dollar's purchasing power by 50 percent within the span of a decade. That this baleful prospect was the result of massive deficits and Fed money printing was lost on the reflexive Keynesian, Charles Schultze, who was Carter's top economic advisor: parroting Arthur Burns, he urged the Fed to pour kerosene on the inflationary fires and then jabbered about the need for an “incomes policy.”

In short, hopelessly immersed in countercyclical fine-tuning, Washington did not even recognize that it was attempting, unaccountably, to turbocharge an already inflation swollen economy. In the event, real GDP grew by 9.4 percent during the first quarter of 1977 and a solid 5 percent for the full year, even after most of the Carter stimulus plan was abandoned.

On the other hand, inflation was even worse than expected. It rose at a 9 percent rate by the fourth quarter of 1978 and went steadily higher from there.

Moreover, even as its fiscal policy obstinately ignored the resurgent inflationary tidal wave, the Carter White House made absolutely certain that the Fed stood ready to monetize the $50 billion per year in new Treasury debt issuance embedded in its fiscal plans. When Burns' term expired in early 1978, it appointed the clueless William G. Miller, a manufacturer of aircraft parts and golf carts, to succeed him.

Miller didn't even know how to recite the anti-inflation liturgy that Burns had made into a ritual incantation. He just followed orders from the White House Keynesians and injected even more reserves into an already wildly expanding banking system.

So Miller's brief eighteen-month tenure was essentially a final bonus round in the stunning expansion of US bank credit that had begun under Burns. Upon Martin's exit from the Fed chairmanship at the end of 1969, bank loans outstanding were less than $500 billion.

By the time Volcker shocked the financial markets with an unavoidably savage monetary tightening campaign in October 1979, bank loans outstanding had reached nearly $1.5 trillion. In a single decade, bank credit in the United States had tripled, laying the foundation for the monetary régime of bubble finance that made the Reagan-era deficits sustainable.

THE HISTORIC SIGNIFICANCE OF NIXON'S WRONG ROAD TAKEN

In August 1971, the Nixon administration put the imprimatur of the nation's conservative party on an irredeemable inflationary dollar and an activist, deficit-driven fiscal policy. The first go-round fueled a virulent commodity and wage inflation.

The practice of debt monetization on a massive scale was thereby institutionalized, while its historic bad odor was given political cover by the full employment budget scam. Statists and economic betterment merchants were thus unleashed, free from a resurgent attack by largely silenced proponents of the ancient fiscal verities. When the Asian exporters began to aggressively peg their currencies in the decades ahead, the machinery for US fiscal deficits without tears was already in place.

Yet it didn't have to be. The Nixon abomination at Camp David came only after a long twilight struggle to restore sound money and fiscal rectitude in the aftermath of the New Deal gong show, a witch's brew of primitive statist fiscal experimentation and monetary quackery that did not relieve the Great Depression, and in many respects extended it. As will be seen, the drive by Presidents Truman, Eisenhower, and Kennedy—each in their own way, to reverse the New Deal victories of crony capitalism and populist money—almost succeeded. And in no small measure this was due to the steady hand of William McChesney Martin at the helm of the Fed.

But the course actually taken—Nixon's relapse into Roosevelt-style nationalism, opportunism, and electioneering with the nation's money, public purse, and free enterprise economy—had an ironic consequence. When the Nixon administration's floating-money contraption finally exploded in the financial crisis of September 2008, apologists for even more money printing and fiscal activism revived pro–New Deal narratives and FDR hagiographies that had been written in the 1950s and 1960s.

These works of postwar casuistry were dead wrong about what had given rise to the Great Depression and about what actually transpired during the American economy's long struggle to recover during the 1930s. Most especially, they ascribed recuperative powers to the New Deal's potpourri of false starts, dead ends, and surviving deformations that they never remotely possessed.

That the New Deal revivalists like Professor Paul Krugman of Princeton University are essentially telling fibs and peddling historical legends is not offensive merely because it distorts the distant past. These legends actually compound the deformations of the present by rationalizing policies that cannot succeed and which will only bury the nation deeper in debt. And worse still, they perpetuate the busted monetary system and crony capitalism that arose from the wrong road taken by Richard M. Nixon.

PART III

NEW DEAL LEGENDS AND THE
TWILIGHT OF SOUND MONEY

 

CHAPTER 8

 

T
HE NEW DEAL WAS A POLITICAL GONG SHOW, NOT A GOLDEN ERA
of enlightened economic policy. It shattered the foundation of sound money and inaugurated a régime of capricious fiscal and regulatory activism that inexorably fueled the growth of state power and the crony capitalism which thrives on it. But it did not end the Great Depression or save capitalism from the alleged shortcomings which led to the crash.

In fact, the New Deal introduced a severe dose of economic nationalism and autarky at a time when the only hope for speedy recovery was a reopening of world trade and reestablishment of a stable international monetary régime. The singular contribution of Franklin D. Roosevelt, however, was slamming the door on that possibility so decisively, unequivocally, and irreversibly as to guarantee the nation a long slog in a depression economy.

FDR and most of his so-called brain trust failed to comprehend that the United States was in a deep depression because its export markets had collapsed. Consequently, its great industries—capital goods, autos, steel, chemicals, and agriculture—had way too much capacity for the domestic market alone. During the Great War and the Roaring Twenties, these industries exported heavily based on an unsustainable artifice; namely, US vendor-financed loans to worldwide customers who ultimately could not afford to repay.

These vast vendor loans, totaling more than $3 trillion at today's economic scale, came from the US Treasury during the war and from Wall Street during the last five years of the great stock market boom. When the stock market crashed in 1929, however, the giant Wall Street market in foreign bonds cratered even more severely. Yet without fresh funding foreign borrowers soon defaulted in droves. Their purchases of US farm and industrial goods dried up almost instantly, causing output and capacity utilization to plummet during 1930 and the two years thereafter.

The United States needed to take bold action to rejuvenate its foreign customers, but the list of potential actions was short. First and foremost, a sharp reduction in import tariffs and other trade barriers was needed to enable foreign customers to earn enough foreign exchange to buy American goods without further debt extensions.

Washington also needed to cancel the war debts of England and France, so that the French especially would desist in their destructive campaign to extract crushing reparations from the faltering German economy. And the United States needed to take the lead in reestablishing stable foreign exchange markets around fixed currency rates and gold convertibility in order to revive confidence, trade, and capital flows in international commerce.

Roosevelt inherited a weak hand from his predecessor. Herbert Hoover was a stalwart proponent of free enterprise and fiscal rectitude, but unfortunately a McKinley Republican who embraced a fatal contradiction: the gold standard for money but protectionism on trade.

Striking a mortal blow at the recovery of international commerce, Hoover thus signed the infamous Smoot-Hawley tariff bill in June 1930. It caused international commodity prices and trade volumes to take another sharp leg down, further debilitating American agriculture and export-dependent industry. As is well known, it resulted in a destructive spiral of retaliation and beggar-thy-neighbor nationalism, which intensified as the decade unfolded and caused international trade and capital markets to lapse into somnolence.