StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

Nixon's Biggest Gamble, 40 Years Ago Today

15 Aug 2011
Posted by Bruce Bartlett

On August 15, 1971, Richard Nixon implemented the most radical economic program in American history. And it was all done over a single weekend in secrecy worthy of the atomic bomb project during World War II. While ultimately unsuccessful, the Nixon program showed what a forceful president can do to completely change the nation’s course if he is willing to push the limit of his power.

The prelude to Nixon’s actions was that inflation had become a serious problem. From 1952 to 1965, inflation rarely ever went above 2 percent. But starting in 1966, it became worse and worse, rising from 1.6 percent in 1965 to 5.7 percent in 1970.
Lyndon Johnson’s advisers convinced him to impose a 10 percent income tax surcharge in 1968 to soak up purchasing power, but this had no effect on inflation whatsoever. Nixon’s advisers knew that the Federal Reserve could stop inflation by tightening monetary policy, but that would likely bring on a recession going into an election year. Nixon desperately needed to keep inflation bottled up until after the election.
Another concern was that the international monetary system was falling apart. Established at Bretton Woods in the aftermath of World War II, its foundation was having the dollar convertible to gold at $35 per ounce, with other currencies fixed to the dollar. But inflation was putting severe pressure on the exchange rate system and for 10 years American presidents had been fending off European demands to trade their dollars for our gold.
One way out of the inflation problem was wage and price controls. But the Nixon administration was officially opposed to them. On July 28, 1971, Council of Economic Advisers Chairman Paul McCracken wrote an op-ed article for The Washington Post denouncing wage and price controls in the strongest possible terms. They would undermine personal freedom, he said, and wouldn’t even work because there were too many prices, such as those for basic commodities, that couldn’t be controlled.
In mid-August, 1971, a crisis arose when Great Britain demanded $3 billion worth of gold (worth $150 billion at today’s gold price). This led Nixon to call a special meeting of his economic advisers at Camp David on Friday, August 13.
Years later, Sid Jones, who was McCracken’s assistant at the CEA, told me he knew something big was going on because McCracken came to him just before leaving for the weekend and gave him a letter designating him as acting CEA chairman for the weekend. Not only had McCracken never done such a thing before, but it wasn’t even appropriate because Jones wasn’t a member of the CEA; just a staffer. My guess is that McCracken wanted to be able to say later that he wasn’t technically chairman of the CEA when the ensuing events transpired.
At Camp David, Treasury Secretary John Connally, former governor of Texas (as a Democrat), was very much in charge. His main argument was that Nixon needed to be bold and do as much with one dramatic action as possible.
On Sunday, August 15, Nixon announced the imposition of wage and price controls throughout the U.S. economy, making dubious use of emergency presidential authority. He also closed the gold window and set the dollar free to float, destroying in one fell swoop the international monetary system that had existed for 25 years. Additionally, Nixon announced broad cuts in government spending, a 5 percent reduction in the federal workforce, a 10 percent surcharge on all tariffs, and a variety of other measures.
By and large, reaction to Nixon’s “New Economic Policy” was positive, especially among Democrats. Senate Majority Leader Mike Mansfield said he was “delighted.” Senator George McGovern said wage and price controls were “four years overdue.” Senator William Proxmire said, “The president has not only changed his game plan, but he has also reversed his field. I support his program.” Economist Arthur Okun, who chaired the CEA under Johnson, called the Nixon plan “a leap forward into realism.” The stock market recorded one of its best days in history on the following Monday.
But just as McCracken had warned, wage and price controls began to break down almost immediately. However, in the short run they did slow inflation’s upward momentum. The Consumer Price Index only rose 4.4 percent in 1971 – 1.3 percent less than the year before – and 3.1 percent in 1972. But as the controls were phased-out, inflation caught up with its underlying trend and rose 6.2 percent in 1973 and a shocking 11 percent in 1974. A key contributor was a big increase in the price of oil that the OPEC demanded to compensate its members for the steep fall in the dollar after 1971.
Although the policies announced on August 15, 1971, undoubtedly helped Nixon politically – he won an overwhelming victory in 1972 – they also undermined his position when their long-term consequences became evident. Catch-up inflation made that problem worse, forcing the Fed to sharply tighten monetary policy, which brought on a severe recession in 1974. This weakened Nixon politically when the Watergate scandal broke. He later told journalist Jude Wanniski that he thought he would have weathered it if the economy had been stronger.
In 1980, Connally ran for the Republican presidential nomination. At the time, I was working on Capitol Hill and he came to address a Republican staff group. Inflation was still a serious problem, but Connally insisted that under no circumstances should Washington consider wage and price controls. So I asked him why he had imposed them back in 1971. His answer, basically, was that while wage and price controls never worked, there was this one unique moment in history in which economic conditions were such that they might have worked. They didn’t because blah, blah, blah, whatever. No one in the audience found his answer convincing.
Perhaps the main long-term impact of Nixon’s 1971 policy was to discourage future presidents from acting aggressively and unilaterally on domestic issues. That may be one reason why Barack Obama resisted using the 14th Amendment to counter Republican extortion on the debt limit, as I believe he should have, and seems incapable of coming up with anything remotely bold to deal with the continuing economic crisis.

"A key contributor was a big

"A key contributor was a big increase in the price of oil that the OPEC demanded to compensate its members for the steep fall in the dollar after 1971."

Hah. I'll take gross oversimplifications for $100, Alex. I'm sure inflation was at the top of the minds in 1973.

Question about the VAT

Hi Bruce, I heard from Pat Choate, Ross Perot's '96 running mate, that if we replaced the personal and corporate income tax with a 22% VAT (but left everything else in place), roughly 90% of Americans would pay 4% less in taxes than they do now. Is that true or not?

I estimate

that each 1% VAT would raise about $50 billion per year in 2011 dollars. You can do the math yourself to see what taxes you want to replace. The average VA rate in Europe is 20% so you potentially have $1 trillion to play with. 

How about

Phase in a 14% VAT tax, eliminate the income tax but keep the AMT and enforce a level that makes income tax collections for those earning $50K or more are tax neutral, eliminate preferences for capital gains and dividends, expand on the existing negative income tax to make the VAT revenue neutral for incomes below the 40th percentile after accounting for reduced income taxes.

Balanced budget? Balanced trade accounts? Small shift in equity towards the high growth post-war era?

Nixon economics

The problem with Nixon's plan is simple to explain:

The federal government was meddling with prices that they had no authority to meddle with. The federal government controls just a very few things that affect the private sector - cost of pretax debt service and cost of after tax debt service.

If you want low inflation you raise the real pretax cost of debt service. If you want full employment you lower the after tax cost of debt service.

Simple as that. There is no magic wand to economics.

Obama reasoning

Obama has a Republican, Tim Geithner running his fiscal policy. Dem economic policy advisors have come and gone but Geithner remains.

Obama has a Republican, Ben Bernanke running monetary policy.

Obama was uncomfortable making the initial stimulus larger, he is uncomfortable with more spending stimulus and only wants to do tax cuts that are more favored by Republicans, but less good at job creation.

Obama has focused on deficit reduction and ignored job creation and high unemployment. Obama has allowed unemployment to languish for years at levels that were considered unacceptable in 2008.

My conclusion: Obama is not a New Deal Democrat. Obama is not overly concerned with lingering high unemployment, he is more focused on the long term deficit. Obama is not an ally of the Middle Class and traditional Democratic groups such as Labor. Obama is more comfortable with his elite Harvard colleagues and BigFinance than the working class. We have a situation where leaders of both parties, Republican and Democrat actively seek support from monied special interest (who can sponsor their political TV ads) and neither party has an interest in representing average Americans.

Go you Bruce

As per Stan and his assessment of the Commission's success, this is going to be a Diaster, plain and simple. To your point that [real] Americans think taxes should be raised as well as spending cut, we are in for a real Muck-UP, plain and simple. Perhaps one positive of all the Republicans taking the 10:1 straw poll re not raising taxes is that it it isn't what the public sees as realistic. Then again, Obama's no prize either - I'd choose Mark Warner over him in a heart beat. It's going to be a very nasty period for America and the economy, and our political leadership at the very top is the single biggest problem.

Inflation never went away

Inflation never went away once the gold link was broken. In the 1970's, inflation manifested as price increases on goods (via money supply expansion). Since then, inflation has manifested as price increases on assets (via credit expansion). And the inevitable result has been the obliteration of the working/middle class - who don't have the earnings power to really stay ahead of goods price inflation and don't have the assets to benefit from asset price inflation and don't have the insider access/knowledge to know which of the two the money creators of govt are going to favor.

And the government -both parties and including both candidates for Prez - proved in 2008 that they want things to get worse. By bailing out the beneficiaries of the 30 year asset price inflation - at the direct expense of everyone who doesn't have assets.

It's a shame that Americans don't understand this. Because until they do, nothing will change and they will merely follow the partisan talking points of the DC types who have only their own self-interest at heart.

Bruce - There is no "executive" solution to the economic crisis. Central planning DOES NOT WORK.

"It's a shame that Americans

"It's a shame that Americans don't understand this."

I'm afraid you are misusing the word "understand" in this instance. There is an implication in the word "understand" that the thing understood is a fact. What you find a shame is that others don't share your belief. There is good reason to think that if the government had not taken the steps it did, the outcome in 2008 and beyond would have been far worse. If that's the case, then you are urging us to "understand" something that is false.

If "Americans" don't believe what you believe, given that there are over 300 million of them (ignoring all those Americans that are citizens of American nations other than the US), what are the odds that they are all wrong and you are right? Not high, I should think.

It is a FACT that those who

It is a FACT that those who were bailed out were precisely the beneficiaries of the previous asset bubbles. The non-housing non-financial parts of the economy were all in relatively good shape - then. Your assumption is that that bailout of the insolvent had no cost on anyone else. That in turn assumes that free lunches exist. They don't.

The "good reason to think things would have been worse" is post-facto justification for a bailout decision that was based at the time on emotive panicky fear-mongering - by people who clearly did NOT see it coming, who in many cases were causes of the bubbles, and thus can hardly be considered to have "understood" anything in any rational non-emotive non-self-interested way. And unfortunately time has proven that none of them have learned anything since then either.

The economic "value" of recessions is that they purge excess/malinvestments and reallocate whatever can be salvaged to something productive. THAT is what was short-circuited by the bailout and continuing subsidy of TBTF zombies and socialization of losses. And if most citizens don't really understand how this screwing of them works -- they most certainly understand that they are being screwed.

"It is a FACT that those who

"It is a FACT that those who were bailed out were precisely the beneficiaries of the previous asset bubbles." Yes, it is. However, the claim you made in your first statement was more expansive, and mere opinion. That was the point I made, and it stands.

There is no such thing as "post-facto", but stick an "ex" in there and you'll have something. If you mean that my claim that there is good reason to think things would have been worse was made up after the fact, you have clearly not got an argument. The claim that things could get worse was made before the bail-out was made. Not after the fact, but before. What is missing is a "counter-factual", an opportunity to know what would have happened if no bailout had been tried. We have the example of other bank runs and liquidity squeezes, though, and the record is that allowing banks to collapse is very, very bad for the real economy.

Your "purge" view, and is just that, your view. It has been repeated often enough that it has become a "just so" economic story, but there isn't much to it. Mainstream thinking - till now, anyhow - had shunned the purge view, for the reason that it had so clearly been the wrong course to take when it was tried at the beginning of the Great Depression, and again in smaller form in 1937. Feel free to keep repeating stories that you like, but don't claim they are facts. The purge view is just an Austrian bed-time story.

Oh, and you don't actually

Oh, and you don't actually know what my assumptions regarding costs are. You have simply claimed to know, in a way that is convenient to your argument. It is not a very strong argument that requires the creation of a straw man.

The War

In Vietnam was consumming a lot of demand along with the garrisioning of the West Pacific and Northern Europe.

War spending in 1969 is about what it is today in real dollars, then the US was facing huge industrial age armies, not running lamborghininis on dusty tracks occupying failed third world countries.

Wage and Price Controls

I'm old enough to remember this quite well, and often wonder whether we might try to do something similar in healthcare, which is a monster eating up our futures. Nixon wouldn't hesitate.

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