The Fed: Lessons of 1972
Some of the best humor is found on the business page. Explaining why stocks dropped, The Washington Post reported that “the fear was twofold — that the Federal Reserve would raise rates from their historic low next month and possibly slow economic growth, and that the Fed may have been too slow to raise rates, raising the specter of inflation.” Damned if you do, Mr. Greenspan, and damned if you don’t. I find both concerns overblown, not to mention inconsistent.
There has been some speculation that the Fed’s “patience” might have something to do with the fact that Greenspan is a Republican and this is a presidential election year. And that, in turn, has invited analogies with 1972, when Fed Chairman Arthur Burns supposedly pursued an inflationary policy to help get Richard Nixon re‐elected.
In February, I wrote that during postwar presidential election years, “The Fed eased three times, in 1960, 1972 and 1992, yet the incumbent party lost two of those three.” I did not say more about the one exception, 1972. But my old friend Bruce Bartlett recently quoted historian Allen Matusow who wrote: “Burns had offered Nixon an implicit bargain. In 1971 Nixon controlled prices, and in 1972 Burns supplied money by the bushel. The policy helped re‐elect the president.” That combination of easy money and price controls boosted demand and discouraged supply, creating widespread shortages and an explosive inflation that ultimately blew the lid off controls.
Arthur Burns’ son Joseph, on the other hand, recently wrote a letter to The Wall Street Journal denying his father was politically motivated. Who’s right?
Bartlett says: “One is left with the inescapable conclusion that Burns used the Fed to help Nixon with full knowledge of the disastrous consequences for the economy. The only alternative is to believe he was incompetent, which no economist believes was the case.”
I beg to differ. On the question of inflation, Arthur Burns was only one of many high‐profile economists (Ken Galbraith was another) who actively promoted an “incomes policy” in 1971 to stop what they called “a wage‐price spiral.” That is why I submitted “The Case Against Wage and Price Controls” to National Review weeks before President Nixon announced the wage‐price freeze on Aug. 15, 1971. I regard the advocacy of price controls as definitive evidence of incompetence.
Nixon’s New Economic Policy emerged after a meeting at Camp David attended by men whose names still remain in the public spotlight, such as Peter G. Peterson and Paul Volcker. Treasury Secretary John Connally was an enthusiastic advocate of controls, as were Nixon’s infamous assistants H.R. Halderman and John Ehrlichman. Budget Director George Schultz was skeptical. Only Nixon’s honorable Council of Economic Advisors chairman, Paul McCracken, resigned in protest.
That fateful Camp David meeting was documented in Joanne Gowa’s 1983 book, “Closing the Gold Window.” Gowa noted that “tensions had emerged during the previous six months between Burns and the administration, due in part to Burns’s public advocacy of wage and price controls. The Nixon administration … objected to the Federal Reserve chairman’s outspoken campaign. … Connally and Burns had been pressing the president to implement an income policy.”
I met Burns years later, introduced to him by Friedrich Hayek at a Washington, D.C., event. Even in 1971, however, Burns’ advocacy of both easy money and wage‐price controls was no surprise to me. In his1958 book, “Prosperity Without Inflation,” Burns was skeptical about using monetary policy to restrain inflation, arguing that printing money was equivalent to printing jobs.
“Many of those who today are worried about the cost of living,” he wrote, “will be worried still more about their jobs if unemployment spreads.” He thought, “A credit policy that is sufficiently restrictive to bring down the price level … would in all likelihood bring down also the volume of employment.” Therefore, said Burns, “it would be unwise to depend on the Federal Reserve System as our sole or principal guardian of the stability of the dollar.” But who else should be held responsible for preserving the value of Federal Reserve notes?
Burns advised running a “sizable” budget surplus — as though selling fewer Treasury bills would make it safe for the Fed to buy more Treasury bills (printing money to pay for them). That loony idea — that a budget surplus could substitute for cautious Fed policy — led to the 10 percent surtax in 1968. The policy mix of high taxes and easy money doubled the inflation rate and collapsed the real economy by the end of 1969.
When his fiscal nostrum failed to fix a monetary meltdown, Burns imagined that inflation could be kept down by economic dictatorship — the government dictating to businessmen what they could charge for their products, and to workers what their time was worth. With government thus declaring inflation illegal, what harm could there be from an easy money policy? So, the Fed minutes promised to “foster financial conditions consistent with the aims of the new government program.”
By March 1, 1972, the Fed had pushed the funds rate down from 5.6 to 3.2 percent. The funds rate rose only slightly to 5 percent by the time of the election, but it was doubled to 10.4 percent nine months later. A severe 16‐month inflationary recession began one year after the election. By the end of 1974, inflation was 12.3 percent — only slightly below the peak fed funds rate of 13.6 percent in July 1974.
I am not sure Burns was primarily motivated by politics when he promoted and pursued terrible policies. He was clearly motivated by terrible economic theories, which were ubiquitous at the time.
Like Burns, Alan Greenspan is now trying to shift attention away from the Fed by lecturing about budget deficits. Unlike Burns, however, Greenspan is not known for embracing incompetent theories or policies. I do not believe the Fed has kept rates down to help President Bush, or that it will continue to keep rates down, or that raising rates from such low levels will damage the president or stock market (if earnings keep rising).
What we should have learned from 1972–74 and 1979–80 is that it can be dangerous for the Fed to try holding the fed funds rate below the inflation rate by buying Treasury bills with new money. A negative real interest rate on cash can make it profitable for people to use cheap credit to speculate in the rising prices of tangible assets such as gold and land. The fact that gold mining stocks fell nearly 30 percent this year looks like a vote of confidence that the Greenspan Fed seems less likely to risk getting into the dangerous position of playing catch‐up with inflation.