The Economy: Crisis of Confidence
RICHARD NIXON was probably the first President to take office vowing that he would slow down the U.S. economy. The nation's No. 1 football fan had a "game plan" that his advisers said would stop inflation without much pain to the public or danger to the politicians. No need to tackle wages and prices directly. No need to get involved in messy strikes or stop end runs by steel prices. There would be no mandatory controls, no nasty squabbles between the White House and business or labor leaders, no interference at all with the free market. Instead, Government would simply balance its budget and pump less money into the banking system. As funds became scarcer in the private economy, business would simmer down and so, too, would prices. For a few "awkward months," predicted Nixon's economists, the nation would suffer mild "slowing pains" of high interest rates, little growth in production, some drop in profits and a moderate rise in unemployment. Eventually, inflationary pressure would be wrung out of the economy and normal expansion of output and hiring could resume.
The need for a slowdown was evident. But now, to an ever-growing number of businessmen, workers, consumers -and voters -the game plan sounds like an exercise in fantasy. The awkward months have lengthened into painful seasons, and the alleviation of inflation that was supposed to be worth all the unpleasantness seems nowhere in sight. In his 16 months in office, Nixon has posted an unenviable economic box score:
>> The industrial production index has risen only .2%, and U.S. factories are operating at less than 80% of capacity.
>> Corporate profits before taxes have dropped 11%.
>> Unemployment has jumped by almost one-half, to a five-year high of 4.8% of the work force. One million more Americans than a year ago are unsuccessfully looking for work. >> Consumer prices have soared 7.5%, chopping almost 70 out of the real value of the dollar. Last week the Labor Department reported that inflation accelerated in April. The cost of living rose at a seasonally adjusted annual rate of 6%, up from 4.8% in March.
Other downbeat news darkened the gloomiest week that U.S. business has shuddered through in recent years. In Washington, embarrassed Administration officials conceded that the budget surpluses they had predicted for fiscal 1970 and 1971 will turn to deficits. On Wall Street, the most unnerving stock market reports since the Depression 1930s became daily more dismal. The Dow-Jones industrial average fell 40 points to a new seven-year low of 662; during the past 18 months, it has plunged more than 320 points.
Unquestionably, the situation is serious, but some qualifications are necessary. The economic picture appears bleaker than it really is because the market tends to overreact. It jumps extravagantly when the economy is strong, plunges precipitously when business weakens (and sometimes when it does not). Moreover, the economy has not suddenly run out of steam because of some inexplicable decline of consumer demand. Most of the drops in profits and jobs are the result of a deliberate, managed slowdown.
Still, the market is the most reliable indicator of the confidence that 26 million shareholders have in the economy and in the Government's ability to keep it healthy. Even though the economy remains essentially strong, if its financial distortions continue much longer, it could tumble into serious difficulties. Some prominent Wall Streeters worried aloud last week that the economy stands on the brink of financial crisis. They were frankly concerned that marginal corporations, which have exhausted their cash and bank credit during the long money famine, may be unable to raise necessary funds and fall into bankruptcy.
Pressures are building on Nixon to mount a new and more energetic attack on inflation without provoking a severe recession. The President, in turn, is trying to convince business and financial leaders that he is deeply concerned about the stock market and the general economy. Last week he conferred with Bernard Lasker, chairman of the New York Stock Exchange. In the next few days, National Security Adviser Henry Kissinger and Budget Director Robert Mayo will exchange ideas with other prominent businessmen.
The Rising Dissent
Political advisers are warning the President that a continuation of the current slump could be poison for Republicans in the fall congressional elections. If the economy is not "back in balance" by Election Day, says White House Political Operative Murray Chotiner, "there is no question that Republican candidates for office can be hurt." A Republican National Committee official who has traveled throughout the nation recently brought back this report: "Millions of older people who own stocks are scared to death. Lots of them have depended on stock values to take care of them in their retirement. Now the cash value is down to perhaps a fourth of what they expected it to be. At the same time, inflation keeps on. You can tell people it is being brought under control, but you cannot keep telling them that forever."
Businessmen are wondering whether the current slump is really necessary; within the Government last week, some powerful voices began calling publicly for the first time for changes in the game plan. Most important were the rasping W.C. Fields tones of Arthur F. Burns, Nixon's longtime economic mentor. Now, as Chairman of the Federal Reserve Board, Burns is the master of the nation's money supply. Coming from anyone else, what he said might not have seemed startling; coming from cautious Arthur Burns, it raised eyebrows around the country.
In a speech to an American Bankers Association convention at Hot Springs, Va., Burns said frankly: "We have been less successful than we would have liked in moderating the advance of prices." Then he added: "There may be a useful -albeit a very modest -role for an 'incomes policy.' "
What did he have in mind? An "incomes policy" generally requires the Government to define just what wage increases would be considered tolerable -and under what circumstances it would be justifiable for companies to raise prices. Burns was not asking for anything so drastic. He has told friends that he is thinking of several possibilities, including: 1) presidential preaching to business and labor leaders that they have a "social responsibility" to hold down wages and prices; 2) wage-price guidelines drawn up by business and labor, rather than issued by the Government; 3) federal compilation and publicizing of statistics that would point a finger at industries, such as construction, where wage and price boosts have been distressingly high. Burns would stop short of Government accusations or pressure against individual companies and unions.
Last week Housing and Urban Development Secretary George Romney made a similar proposal; earlier James J. O'Leary, an executive vice president of Manhattan's U.S. Trust Co., urged the idea on the President. Both men would have a Presidential commission look into specific wage and price increases by companies and unions, and inform the public whether they seemed justified. Their proposal, in turn, was a watered-down version of the formal wage-price guidelines that the Kennedy and Johnson Administrations promulgated, and that many Democrats and even a few Republicans have asked Nixon to reinstate.
Advocating the Immoral
The fact that conservative Arthur Burns, of all people, should speak up for anything resembling guidelines is perhaps the best indication that Washington is profoundly worried. As the President's chief economist during the election campaign, and as chief domestic policy adviser during the first year of the Nixon Administration, Burns provided much of the free-market philosophy behind the game plan, which he now feels is not working quickly enough for a nation impatient for results. Beyond that, his advocacy of an incomes policy -even as a temporary expedient -violates some of his old beliefs. Other economic policymakers are satisfied to argue that guidelines simply do not work; Burns has viewed them as immoral. Some years ago, he wrote that he could see little difference between an economy in which guidelines were observed voluntarily and one shackled by outright controls. In either case, he said, the market would not be truly free. In one of his pipe-puffing appearances before a congressional committee, Burns recently added: "I see free markets as the greatest institution this country has."
Even so, in his long career as a professor, chairman of the Council of Economic Advisers under President Eisenhower, and head of the National Bureau of Economic Research, Burns has never been what he calls "an ideological economist." He tends, in fact, to distrust all highly systematic economic theory. He has little patience with the loud quarrel between Keynesian economists, who place great importance on Government tax and spending policies, and the followers of his friend Milton Friedman,* who contends that control of the money supply is of supreme importance. Significantly, Burns wrote most of his damning comments on guidelines when he was still a professor. Now, at 66, he is in a position that requires him to accept the responsibility of making and carrying out policy. To make matters doubly difficult, says Burns, "when a nation permits its economy to become engulfed by inflation, policymakers no longer have any good choices."
Despite its legal independence from the Administration, the Federal Reserve has been given the toughest assignment in Nixon's game plan. The board was expected to hold down the growth of the nation's money supply. It did its job with what may have been an excess of zeal. Through the last half of 1969, it permitted no growth at all in money supply. By the time Burns took over last February, almost everyone was starved for cash. Corporations were forced to borrow in the bond market at alltime-high interest rates of 9% or more. Prospective home buyers frequently found mortgage money unavailable at any price. Just before Burns arrived, the Federal Reserve voted to begin expanding the money supply again. And the new chief has reinforced that policy, hinting to Congress that he aims at about a 3% to 4% annual expansion, a rate that he seems to think will be enough to prevent serious recession but not enough to keep inflation spiraling.
The Price of Disbelief
There is, in fact, some question whether a regular 3% or 4% growth rate will be nearly enough to handle the economy's enormous need for cash and credit. From the savings of citizens, the retained earnings of corporations and other sources, the U.S. last year generated $129 billion of new capital to invest. But the demands for capital have been greater still. During the inflationary boom of the late 1960s, the Government borrowed heavily on the capital markets to cover federal deficits that ran as high as $25 billion a year, and much of the money was used for economically unproductive purposes, notably the Viet Nam War. Lyndon Johnson started the inflation by long insisting on fighting a war without asking for taxes to pay for it. Corporations meanwhile went into debt to raise money for new plant and equipment. They kept up their borrowing during the money squeeze; their executives simply did not believe that the Federal Reserve would hold down the growth of money supply as long and drastically as it did. Thus they saddled themselves with a debt that must be periodically refinanced. And now a profit pinch limits their ability to repay.
The balance sheets of major corporations have steadily deteriorated. In 1961 they held enough cash and easily marketable Government securities to cover 38.4% of their bills; at the end of last year, the figure was down to 19.3%. Big banks can hardly lend any more. Partly because they eagerly shoveled out cash to almost all comers during the boom years, they now have a high, potentially dangerous 86% of their deposits committed in loans. Says Fred Stein, chief executive of a subsidiary of Standard & Poor's Corp.: "The money markets are in a full-fledged rout, and something has to be done to check it."
As a way out, some financiers propose federal credit controls. Since there is not enough credit to go around, they argue, the Government should make sure that what is available goes to borrowers who really need it -home builders, say, or small businessmen -rather than to those with the greatest economic clout. Credit controls have strong support in some parts of official Washington, though not in the White House. Congress last December gave the President stand-by authority to allow the Federal Reserve to regulate the terms, amount and interest rates of all forms of credit. Wright Patman, chairman of the House Banking and Currency Committee, last week denounced Nixon for not using that power. Within the Nixon Cabinet, George Romney has spoken in favor of credit controls. He complains that money that should be going into housing is being diverted to borrowers who have more economic "muscle."
Nixon opposes controls as interference with a free market. Burns takes a less rigid position. In congressional testimony, he said "the markets do a better job" of allocating credit. "The fundamental answer to the housing problem," he insisted, "is the end of inflation and lower interest." But he also added: "Let's keep credit controls under observation. Don't be ideological or dogmatic."
What else can be done by Burns' Federal Reserve? It can scarcely expand the money supply much faster without risking a still greater surge of inflation. Burns is all too well aware that the Administration has failed to accomplish its prime gameplan assignment of keeping the budget in balance. And by not holding down its own spending, the Government has contributed to the demand that has been driving prices skyhigh. By not collecting enough taxes to pay its bills, it has failed to set a psychologically important example of belt tightening for business, labor and consumers. By not avoiding deficits, the Government has been forced to resort to heavy borrowing. In the middle of a cash shortage, that borrowing only diverts already scarce funds from socially desirable uses, such as housing.
Nixon has clearly let economic forces get out of hand. To keep part of an ill-advised campaign promise, he agreed to let Congress cut the 10% income tax surcharge to 5% at the start of 1970 and eliminate it entirely at midyear. He offered only feeble opposition when Congress turned a desirable tax-reform bill into a tax-cutting bill that set broad rate reductions for future years. On top of that, federal budgetmakers underestimated the severity of the economic squeeze that would be produced by their policies and those of the Federal Reserve. Interest payments on the national debt have been unexpectedly high because loan rates have not dropped as the Administration anticipated. Rising joblessness has boosted the bill for unemployment compensation. When the postal strike led to a 6% federal pay increase six months before schedule, the last hopes of a surplus vanished. Budget Director Mayo disclosed last week that the budget will show a $1.8 billion deficit this fiscal year, and a $1.3 billion deficit next year. Even those estimates may be optimistic. They are based on a January forecast that taxable corporate profits would hit $89.5 billion this year. In the year's first quarter, profits ran at a rate of only $85 billion. Unless the business upturn foreseen in the game plan starts soon, the U.S. stands to run a much deeper budget deficit.
Unfair and Slow
The failure of fiscal policy has left Burns in a position he devoutly hoped to avoid. In a sense, he is being forced to try to steer the economy by monetary policy alone -or, as one economist put it, "play God." The Federal Reserve must try to gauge the exact amount of money that the economy needs, and economics is not that precise a science. Burns has other arguments against exclusive reliance on monetary policy. If money is squeezed, he says, the policy unfairly hurts particular types of borrowers. Among the victims: local governments, which often must sell bonds in order to raise the funds needed for schools, hospitals and other public works. Further, Burns argues, monetary policy moves in long lags; it takes from six to twelve months for a change in the Federal Reserve's money-supply operations to be felt throughout the economy.
Burns has recently been telling friends that "monetary policy has done about all it can. It cannot be expected to do much more." By recommending an incomes policy, he seems to be saying that the Federal Reserve has done its job and now Nixon must do his.
Will Nixon listen? He has given no indication that he will. The President has been ideologically and politically opposed to wage-price guidelines or anything similar. White House aides report that he was displeased by Burns' speech. The President's only open comment was: "Well, Arthur is independent, you know." Nixon, however, has respected Burns' advice since they served together in the Eisenhower Administration. In his book, Six Crises, Nixon relates how Burns early in 1960 urged him to propose a loosening of money and budget policies to ward off a recession. Nixon did so, but the proposal was rejected. The recession hit, and Nixon is convinced that it cost him a victory over John F. Kennedy. Burns and Nixon stayed in touch during Nixon's years in political exile in Manhattan. Shortly after Nixon was nominated in 1968, Burns informed him: "Mr. Nixon, your advisers are unanimous in finding that, unfortunately, there will be no recession in November." Well then, asked Nixon, what economic issue could he stress? Burns quickly replied: "Inflation."
Nixon's policies have failed to defeat inflation so far, but have they brought on a recession? Economists argue incessantly about whether the current slowdown qualifies for that maddeningly imprecise term. If this slump is really a recession, however, it is not like any before it. The real output of goods and services has declined for two consecutive quarters -the classic if somewhat misleading measure of a recession. But factory output so far has fallen only 2.4% from its 1969 high, compared with declines ranging from 6% to 14.2% in the four recognized recessions since World War II. Corporate profits are not down as much yet as in past slumps.
On the other hand, recession is too mild a word for the situation in the stock market. The overall market is in worse shape than indicated by the Dow-Jones average of blue chips or Standard & Poor's index of 500 Big Board issues. The decline has been more severe on the American Stock Exchange. In the over-the-counter markets, some unlisted stocks cannot be sold at any price because there are no bids to buy. On the exchange floors, many stock specialists have bought all the shares they can handle and have no money for more; if large blocks of stocks were dumped, the specialists might well be unable to keep an orderly market.
A Private Depression
As a result, brokers are in a depression of their own. Relatively light trading volume and sagging prices have cut into their commission income. "Our switchboard operator is making more money than we are," says Joe Griffith, a Dallas broker. Bache & Co. recently laid off about 500 employees, and the American Stock Exchange dropped 100. Two major firms, McDonnell & Co. and Gregory & Sons, have closed their doors; several others are reported to be in trouble because of insufficient capital. A number of them may be forced into shotgun mergers. The New York Stock Exchange last week began steps to increase the trust fund that it maintains to pay off customers of houses that fail. It intends to build up the fund from $17.3 million now to $55 million. One important balancing factor: though this has been the worst bear market since the Depression, it is not nearly so severe as the break that began in 1929. Furthermore, 1970 is quite unlike 1929. Investors are more sophisticated today, and the market has a host of safeguards.
Beyond Wall Street, the combination of slump and inflation is causing genuine pain in specific regions and industries. In the Seattle area, where layoffs in the aerospace and lumber industries are severe, unemployment has reached an alarming 8.1%. Long lines form at food-stamp headquarters, and growing numbers of the idled men are sending their wives to work. Says a laid-off Boeing engineer whose wife has taken a job as a physical therapist: "I feel a bit mean kicking her out of bed in the morning, but her working means we can stay on here, hoping for a change."
The economic troubles are exacerbating social problems. In several cities, businessmen are pledging few if any summer jobs to organizers of work programs for disadvantaged black and Puerto Rican youngsters. That will hardly help cool the nation's ghettos this year.
In Akron, School Superintendent Conrad Ott worries about how he can persuade the voters to accept a tax increase that he feels will be forced by inflation. "We honestly cannot tell them we can give them more education for their dollars," he says. "We will be hard-pressed to provide the same education that the children are getting now." He lists these price increases since 1962: a seventh-grade science textbook has gone up from $2.91 to $4.59; an algebra book from $3.30 to $4.41; a movie projector from $369 to $519.
No Reassurance
The beginnings of class tensions between blue-collar and white-collar workers are also visible. In Akron, where rubber workers have taken to the picket lines, one striker grumbles: "School officials say they got to raise pay to hold teachers, but how can we get the kind of new income to meet rising taxes and prices? Nobody is better off these days than teachers." White-collar workers voice equal anger against the unionized men on production lines. "In a way, unions are responsible for what is happening to my pay," says one office worker in a rubber company. "They have pushed labor costs so high with demands for more dough for hourly workers that there isn't anything left for guys like me on salary. We have already been told by our management not to expect the kind of increases the guys making tires are going to get."
Throughout the nation, many people have an uneasy feeling that the economy is in unprecedented trouble and that Washington does not know what to do about it. Few are cheered by Administration assurances that falling profits and rising unemployment are good news because they indicate that inflation is being brought under control. Says Alfred Seaman, president of the advertising firm of Sullivan, Stauffer, Colwell & Bayles: "It is just as though I went to my board of directors and said, The cost of money is way up, we are giving everybody a raise and our billings are way off -but don't worry.' How much confidence do you think they would have in me?"
The central problem is that inflation has proved far more stubborn than Burns and other originators of the game plan expected. A mere slump in the economy has not been enough to stop or even ameliorate it. Why not? Burns' reasoning is that the "demand-pull inflation" of earlier years has turned into more persistent "cost-push inflation." Excess demand at last has been wrung out of the economy, he believes, but prices are being pushed up now by excessive union wage demands. In a sense, this means past inflation is causing present inflation; union men are angry that past price increases have eaten up their previous pay gains, and they are pressing for extraordinary boosts to catch up and protect themselves against still more price increases in the future.
Economist Martin Gainsbrugh of the National Industrial Conference Board believes that inflation is harder to contain now than in the 1950s, partly because service industries and government at all levels employ a much larger share of the nation's work force. That makes it far more difficult for the economy to offset the impact of rising wages by achieving increases in workers' productivity. The output per man-hour of a teacher, fireman or nurse can scarcely be measured, much less increased. The wholesale price index, which does not include the cost of services, has gone up more slowly than the consumer price index.
At a meeting of TIME'S Board of Economists, Harvard's Otto Eckstein listed a number of other reasons why prices persist in rising despite the Federal Reserve's policy of money scarcity. "The rest of the world is in a very prosperous state," said he, "and demand for raw materials keeps prices rising. The present inflation is so intense that it is difficult to cure -there hasn't been a 6%-a-year inflation in modern times except for a few months after Korea. In addition, the Government is moving toward protectionism in world trade. Finally, there has been an ideological opposition to preaching."
To all that, Dr. Walter Heller, another member of TIME'S board, added a further factor. "Let's face it," he said. "There will be more inflation in our future than in our past because of our bipartisan commitment to high employment. Signs of economic weakness will get a faster Government response than in the past, and both business and consumers know it. This assurance will give an upward bias to wages and prices." In sum, businessmen and consumers will go on spending during a slide because they will take it for granted that the slump will be short-lived.
What Comes Next?
Whatever the reason, the persistence of inflation presents policymakers with excruciating choices. Inflation could be stopped dead if the Administration and the Federal Reserve were willing to push ahead with severely restrictive fiscal and monetary policies to depress the economy. But the toll would be politically intolerable and socially explosive. The Administration, for example, has been counting on rising unemployment to moderate union wage demands, but in the present environment that moderation might well require unemployment considerably higher than the current 4.8%. Economist Gainsbrugh asks worriedly: "How acceptable would such a high body count be, particularly to the militant minorities?"
Even if the Administration's gradual game plan ultimately works, and the Federal Reserve feeds just enough money into the economy to avoid recession, as Burns has pledged to do, the probable results seem unattractive. Eckstein thinks that "business would reach a turning point -followed by nothing in particular happening." Business, he says, would revive slowly, inflation would simmer down very gradually, and unemployment might stay uncomfortably high. It is also possible that the U.S. economy could get itself into a "stop-go" cycle such as Britain suffered through for many years. Washington would apply brakes to the economy, release them when a recession threatened, find that the business revival had set off a new burst of inflation, and slam on the brakes again.
Better Alternatives
There are, however, alternative courses of action open to the Government. Among them:
>> Institute an income policy going farther than the one Arthur Burns suggests. Anything short of actual wage and price controls, which have usually proved to be inequitable and unworkable, might tempt businessmen and labor leaders to defy presidential wrath and increase prices and wages. But there is evidence that guidelines and "jawboning" intervention by the White House held down some prices during the Kennedy-Johnson era. Arthur Okun, a member of TIME'S board, figures that prices rose 1.7% a year between 1966 and 1968 for 15 jawboned industries, including steel, copper, autos and aluminum -but that prices jumped 6% in those industries in Nixon's first year. When Nixon made the mistake of proclaiming at the start of his presidency that he would do no jawboning, businessmen and labor leaders took his announcement as a signal to go for all the increases they could get -and they did just that. A presidential guideline on just what size wage increases would be noninflationary might give company executives a bargaining point in labor negotiations, and give union leaders a talking point in dealing with their own rebellious members.
- Attack structural rigidities in the economy. U.S. business is shot through with restrictive union practices, fair-trade laws, and indefensible subsidies to farmers, shipping men and others. All such rigidities help to drive up prices. Quotas on steel and oil imports keep out low-priced foreign materials. An act passed by Congress in 1964 orders the President to impose a quota on meat imports if they seem likely to rise 10% or more above the 1959-1963 yearly average. In order to avoid triggering the quota, foreign suppliers are refraining from shipping in as much meat as they could. That restriction on the supply of one of the most important items that U.S. consumers buy helps keep up the price. A legislative drive to repeal quotas and subsidies would be in the national interest, though it would no doubt bring shrieks from every special-interest group in the country. At very least, the Nixon Administration could reverse its steps toward further protectionism, such as its campaign to force Japan to limit textile shipments to the U.S. The Government has shaped its anti-inflationary program entirely in terms of limiting demand; increasing the supply of goods and services by breaking some of the bottlenecks in the economy is an alternative that cries out to be explored.
>> Settle for less than total victory over inflation. The present 6% rate of inflation is intolerable, but the U.S. in the long run may have to learn to live with a somewhat higher rate than citizens have been accustomed to think of as acceptable. Members of TIME'S Board of Economists generally feel that the nation would do well to aim to hold price rises to an average of 3% yearly. Japan, Canada and Western Europe's major industrial nations had inflation rates of from 3.8% to 6% last year, yet still managed to do well economically. The U.S. cannot and should not reverse its commitment to prosperity and high employment.
Most of all, Washington needs to recognize that the economy is operating under new rules. The classical demand-restraint methods for curing inflation may eventually work, but social conditions no longer permit the sort of recession that might be needed to make them work as fast and as thoroughly as necessary -a point Arthur Burns well recognizes. By advocating an incomes policy, he has demonstrated a willingness to recognize changed conditions and use whatever policy tools seem appropriate. The Administration will need that flexibility in helping to shape tomorrow's economic policy.
* Burns' and Friedman's careers have been curiously intertwined. Burns was born in Eastern Galicia, then a portion of the Austro-Hungarian Empire, now part of the U.S.S.R.; Friedman, whose parents emigrated from that general area, studied under Burns at Rutgers, and they now own neighboring country homes in Ely, Vt.
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