The Great Deformation (44 page)

The federal budget did swing back to deficits when the automatic stabilizers kicked in during the short but steep recession of 1957–1958. The
notable result of this temporary setback, however, was that Eisenhower again refused to embrace countercyclical tax cuts or spending increases to combat the recession, thereby hewing to his long-term fiscal goals.

Furthermore, after the rebound got under way in mid-1958, Ike personally led a full-court press to convert the $13 billion recession deficit into a surplus the very next year. This determined presidential campaign for a balanced budget even included a threat to call a special session of Congress to raise taxes if his spending vetoes were not upheld.

Eisenhower did, in fact, achieve a small surplus in fiscal 1960. Not only was this a testament to his resolute fiscal leadership but, more importantly, it was a stunning repudiation of the Keynesian professoriate. In complete violation of their vaunted math model, Ike's deficit-cutting actions increased the alleged “full-employment surplus” by 2.5 percentage points of GDP between fiscal 1959 and 1960. This swing would have computed to $400 billion in today's economy and was supposed to unleash a bogeyman called “fiscal drag” that would send the economy plummeting back into deep recession.

Yet the bogeyman of “fiscal drag” turned out to be just that: an academic postulate not born out in the real world. During the three-year period from the recession bottom in the second quarter of 1958 through the second quarter of 1961, in fact, real GDP expanded at a 4.2 percent annual rate.

To be sure, during those twelve quarters of solid recovery, the headline rate of annualized GDP change varied widely by quarter, ranging from an 11 percent gain to a 5 percent decline. But those swings were entirely due to inventory fluctuations. With only a few brief exceptions, business investment, consumer spending, and private incomes expanded strongly quarter after quarter throughout the period.

By the time of the 1960 campaign, however, proponents of the new economics were jawing loudly against Ike's “Neanderthal” fiscal policy because reported GDP had temporarily slowed. Within months, of course, the spurious nature of these charges became evident when the US economy reaccelerated, expanding at an 8 percent annual rate by the second quarter of 1961.

And this rebound most assuredly reflected the economy's preexisting natural momentum. There simply wasn't any identifiable economic policy initiative launched by the time the Bay of Pigs invasion of Cuba ensnared the Kennedy administration during its first hundred days in office.

The truth is that the Keynesian professors had been essentially tilting at economic windmills during the 1960 campaign. Their evidence that the economy was lagging turned out to represent mainly short-term fluctuations in the inventory component of GDP.

Reported real GDP growth averaged only 0.8 percent during the four quarters of 1960, but it clocked in at a far more respectable 2.6 percent quarterly average after inventory change is backed out of the headline number. Thus, the Keynesian professoriate's full-throated attack on Eisenhower's circumspect fiscal policy implied that Washington's macroeconomic job description extended all the way to ironing out even the economy's short-run inventory oscillations. The patent absurdity of this proposition would soon be made abundantly clear by the disastrous experiments in “fiscal fine tuning” undertaken in the 1960s and 1970s.

In any event, the turning point which would usher in these calamities had clearly been reached. Kennedy, the winner of the 1960 presidential election, would install Professor Heller and his pretentious gang of Keynesian professors at the seat of power. Worse still, Nixon, who lost the election, would harbor an eternal grudge, blaming the fiscal orthodoxy of Ike and the sound money stand of William McChesney Martin for his defeat.

HOW IKE'S FISCAL RECTITUDE

REINFORCED SOUND MONEY

That Eisenhower's reign of old-fashioned fiscal discipline was crucial to the preservation of sound money cannot be gainsaid. This would become fully evident within the next decade when deficit-wielding politicians on both ends of Pennsylvania Avenue took to demanding that the Fed “accommodate” their fiscal stimulus sprees.

Indeed, when Keynesian fiscal activism became firmly entrenched in Washington, William McChesney Martin's style of resolute monetary discipline was destined to vanish. This development, in turn, doomed the rickety structure of the Bretton Woods gold standard.

Eisenhower's budgetary success, in turn, rested upon what amounts to heresy in the modern Republican Party. Owing to his unwillingness to completely dismantle Truman's war taxes until the budget was balanced first, Ike made only limited progress lowering the tax burden. From a peak level of 19 percent reached under Truman's war taxes, federal receipts were reduced to slightly under 18 percent. At the same time, Ike reduced outlays by two full percentage points of GDP by dint of the defense retrenchment and firm opposition to new or expanded domestic programs.

The nation's fiscal accounts were thus wrestled into reasonable balance at about 18 percent of GDP on both sides of the ledger during Eisenhower's final budgets. This outcome was the embodiment of the old-fashioned notion that taxes must be imposed to pay the government's bills when the avenues for spending control have been exhausted.

Indeed, this testament to fiscal orthodoxy could not have been achieved
without purposeful embrace of the inherited Truman tax régime by a Republican White House. And notwithstanding strong pressure from its own rank and file to repeal them.

Given several surplus years and limited “automatic stabilizer” deficits during the recession years, the cumulative deficit in Eisenhower's eight years was minuscule. Total deficits amounted to just $15 billion, or 0.4 percent of GDP. This salutary fiscal outcome has not been even remotely approached by any administration since then.

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

 

T
HE 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.