The Showdown Fight Over Inflation

IN other times and other places, at least one good thing could be said about inflation. It usually brought more pleasures than immediate problems. Prices rose, but paychecks and profits scooted up even faster. Few people could resist the urge to go on a buying spree to stock up on clothes, cars and all sorts of consumer goods in order to beat the next price hike. Daring entrepreneurs became instant millionaires; even penny-ante plungers built up neat nest eggs in the stock market. Inevitably, an exhilarating boom faded into sobering recession. But the letdown was usually short and sharp, followed quickly by rebound and prosperity.

Not now. Today's lingering inflation hangs on--and on and on. It is a particularly joyless affliction. Instead of expanding fast, businessmen are holding down their capital budgets and laying off workers. Instead of spending and investing, the public is saving at record rates and staying out of the stock market. For one of the rare times in U.S. history, almost everyone feels less well off than he was several years ago.

Businessmen have kicked up their prices more rapidly than at any time since the Korean War, but profits before taxes have fallen from $88 billion in 1968 to an estimated annual rate of $84 billion in this year's first half. Workers have won many extortionate wage raises--labor costs have been rising more than 7% annually--but since 1968 the real weekly earnings of the American wage earner have inched up from an average $90.67 to only $91.96. In the past 2 1/2 years alone, inflation has cut the value of the dollar by 12-c- and the once-prized greenback is now the weakest major currency in the world.

On the other side of the coin, business is improving. The nation gradually lifted out of its recession late last year; from their 1970 low points, production has risen 3.9% and personal income has advanced 8.6%. Consumers complain about being broke, but in fact they have more money than ever (though their dollars are worth less than before). They are increasing their savings at a spectacular annual rate of $64 billion. If they could be tempted to part with some of that cash, retail sales and the stock market could soar. Businessmen have trimmed the overly large payrolls that they accumulated during the 1960s, and the nation could be ready for a surge in productivity, rising from last year's abnormally low gain of .9% to 4% or 5% this year and next. Administration spokesmen insist that the U.S. is poised to enter one of history's most prosperous and productive periods.

Signs of Pessimism

What is needed to start a buoyant economic revival is a combination of decisive leadership in Washington, plus a revival of consumer confidence. And that confidence is hard to come by. Across the country, people seem to have lost faith in Washington's economic management; there is a growing feeling that the President and his advisers are making roseate promises instead of taking politically painful actions to hold down both wages and prices. The Harris poll shows that 70% of those queried believe that the President is not doing well in his handling of the economy.

In the White House, Nixon's aides are particularly worried about two recent signs of public pessimism. Corporate chiefs have been complaining that their business has softened in the past month or two. And the stock market, which is a reasonable indicator of the public mood, is weak. The Dow-Jones industrial average has declined 100 points from its April high; last week it fell 8 points, closing at 851. Almost every week consumers and businessmen are battered with bad news. Consider last week's outpouring: P: Railway workers won a 42% pay increase for 42 months, and the Administration hailed it as something of a victory because the unions agreed to do away with some featherbedding. P: Steelworkers won an inflationary contract calling for increases of about 30% over three years, and steelmakers immediately kicked up prices by 8%. That, in turn, will lead to price boosts for countless other products made of steel.* General Motors promptly announced a 3.9% increase in 1972 models --an average $176 per car. P: Industrial wholesale prices in July increased .7%, the fastest monthly rise in almost six years. P: Unemployment in July rose from 5.6% to 5.8%. The latest body count in the war against inflation: 5,330,000 jobless Americans.

P: The dollar sank in relation to the German mark, the French franc, the Belgian franc and almost every other currency in world money markets. Many European bankers figured that it was only a matter of time before the dollar would somehow have to be devalued. Another international monetary crisis could break out at any moment.

The economy has become the nation's No. 1 political issue, eclipsing Viet Nam, China, crime and civil rights. Says an official of the Republican National Committee: "The economy is literally the only thing that's hurting us, and it's hurting the hell out of us." Adds a White House aide: "The economy has been killing us all along." The key question is whether the President is doing enough to check inflation, create jobs and get the economy moving, or whether, as Democrats charge, he is running a close second to Herbert Hoover--treating the current economy as casually as Hoover treated the Depression.

Originally, Nixon hoped to stop inflation without much pain. There would be no mandatory controls, no strong-arm interference with labor negotiations, no messing with the free market. Instead, the Administration would rely on classic economic remedies, holding down its own budget spending while relying on the independent Federal Reserve Board to hold back the supply of money and credit. That kind of "Nixonomics" was supposed to slow the economy briefly and decisively brake the price spiral. After that, the Administration could again rev up business by increasing its own spending and perhaps even cutting taxes.

Things did not work out that way. The economy tumbled into a long, though mild recession, followed by the slowest recovery since the end of World War II. Today, pressure is building on Nixon to mount a more energetic, more direct attack on inflation. Businessmen, labor leaders and Congressmen have been telling the President that it is not enough merely to stand pat; he must "do something." Do what? The answer is: almost anything--anything that will demonstrate that he is taking bolder action to bolster the economy. The fight over economic policy is reaching a showdown, and the opposing sides are led by two men who are longtime friends, allies and Nixon loyalists.

Keep Hands Off

Chief defender of Nixon's policies is the President's most influential economic adviser, George Pratt Shultz. As head of the Office of Management and Budget, Shultz has been telling one and all that the course should remain "steady as she goes." Shultz has long and successfully argued that the President should keep hands off and let free-market forces work. A confirmed "monetarist," he believes that the ebb and flow of the money supply is of prime importance in determining the ups and downs of the economy. He gives frequent and rousing pep talks, arguing that last year's restrictive monetary policy will ultimately restrain inflation and this year's great expansion in the money supply (it has increased at an annual rate of 10%) will lead to a snappy economic recovery.

A Dangerous Rate

Oddly enough, the most effective critic of this hypothesis is the man who most controls the money supply: Federal Reserve Chairman Arthur Frank Burns. As the President's chief economic adviser during the first year of the Nixon Administration, Burns provided much of the free-market philosophy behind the anti-inflation plan. But he now feels that the plan is not working, that much more than money policy is needed. For more than a year, Burns has been calling on the President to adopt an incomes policy (TIME cover, June 1, 1970). The heart of that policy would be a presidential wage-price stabilization board that would be called on when major companies plan price increases or unions demand wage raises. The board would make strong recommendations and depend on voluntary compliance. If a company or union posted an egregious increase, the board would publicly condemn it. In theory, at least, few corporate or labor leaders then would dare to risk the wrath of Government backed by an aroused public.

When he reiterated his plea to the Congress's Joint Economic Committee two weeks ago, Burns shook up the Administration by declaring that "inflation is proceeding at both an unacceptable and a dangerous rate." Then he added: "There is little evidence as yet of any material strengthening in consumer or business confidence."

Although the quarrel over economic policy pits Burns against Shultz, the two men have much in common. Burns, a house painter's son, was born in

Galicia, and at the age of six could translate the Old Testament from Hebrew into German. He was ten when his family emigrated to America. Shultz, a schoolteacher's son, was also an early scholar; he graduated from Princeton with honors in economics, was a World War II Marine major. Both men rose in the academic world and were tapped for frequent assignments in Government. Economist Burns, 67, and Industrial Relations Expert Shultz, 50, are both close friends of Milton Friedman, the Little Giant of monetary theory. Burns was Friedman's professor at Rutgers. Shultz was his colleague at the University of Chicago, when Shultz headed the graduate school of business administration. When Burns was chairman of the President's Council of Economic Advisers in the 1950s, Shultz worked on his staff as an economist. Indeed, it was on Burns' recommendation that Nixon named Shultz Secretary of Labor in 1968, although lately Burns has been heard to question his own judgment.

Articulate Advocate

In a way, the two men have reversed roles. Before Burns became head of the Fed, he earned a reputation for being impatient, arrogant, distant. Practically nobody called him by his first name. He was intensely loyal to Nixon, remained his chief economic adviser during the dark years of the mid-1960s, ran his campaign task forces in the 1968 campaign. In policy matters, Candidate Nixon often told lieutenants: "Check it out with Arthur."

When Burns was promoted to the Fed chairmanship in January 1970, he mellowed, but he also became increasingly independent professionally. In his W.C. Fields tones, he spoke up--to the President, to Congress, to the public. Disenchanted by the Administration, Burns feels that some of the President's advisers are shallow, even deceitful men. He has no such criticism of Shultz; their differences only involve economics.

Since Shultz became the President's closest economic adviser, he seems to have taken on some of the obstinacy and edge of superiority that Burns had when he was in the same position. He is supremely self-confident and holds quietly but firmly to his ideas. With assured, professional phrases, he is an able and articulate advocate of Administration policy. Though he retains personal friendships with many Democratic economists, Shultz has launched sharp attacks on others who have questioned his policies, especially Arthur Okun, former chairman of the Council of Economic Advisers. One of Shultz's main targets is Burns' Federal Reserve, which he severely criticized for not putting out enough money during last year's General Motors strike.

Even at dinner parties, Shultz is completely committed. At one black-tie affair, he exhaustively tried to convince the British ambassador of the merits of the President's economic program. Burns, by contrast, has become one of Washington's inveterate fun-loving partygoers. He likes to dance so much that his wife Helen says she would like to slow him down, but she does not know how.

Nixon leans heavily on both men, but there is no doubt about whom he listens to most often. Shultz has become almost an Assistant President. He is in Nixon's office nearly every day, and his influence runs to matters beyond economics; for example, he has been active in racial integration, to which he has a deep and liberal commitment. As Federal Reserve Chairman, Burns sees the President once every four to six weeks, but he can get through to him quickly by phone whenever he wants.

So far, Shultz has completely overshadowed Nixon's other economic policymakers. When Nixon was drafting two economic messages in June and December last year, some of his aides urged him to accept Burns' idea of a wage-price review board; Shultz persuaded him to reject it openly. It was Shultz who argued, over the objections of Paul McCracken's Council of Economic Advisers, that the Administration should base its 1971 policies on the expectation that the gross national product would soar from $974 billion to $1,065 billion. He confidently forecast that the target would be hit if Burns' Federal Reserve pumped out enough money, which it certainly has. For his part, Burns forecast a more realistic $1,055 billion, and the Commerce Department now projects that the year's figure will probably come out at about $1,051 billion. With its extravagant predictions, the Administration not only hurt its own credibility but also created such great expectations that it made the economy look worse than it really is now.

Connolly's Doubts

Lately a third man has entered the power struggle: John Connally. The tall Texan does not claim to know much about economics. But he can read numbers and, as he told critics when he took office as Treasury Secretary, "I can add." Though intensely loyal to Nixon, Connally has begun to doubt whether the public has confidence in --or can even comprehend--the President's economic policy. At a meeting of top economic advisers at Camp David in June, Connally said: "Why don't you make up your minds whether you are Republicans or Democrats? You're outspending the Democrats already!" On other matters he has difficulty keeping his ideas from being shot down by the White House palace guard, but he does not get much dispute when he says, "Peace isn't going to be the issue in the election. The economy is going to be the only issue that really matters."

Shultz, for one, agrees. He argues that the Administration indeed has a comprehensive set of policies to fight inflation, but concedes that it may have failed to put them all together and properly publicize them. Shultz points out that the Administration has set up a wage board in the construction trade, which has helped bring construction labor increases down from 20% last year to about 10% in recent months. It has proposed lower minimum wages for the young to help them get jobs. It is readying measures to loosen regulation and introduce more competition in the transportation industry. Last week the President indicated that he would veto a bill to raise wages for Government blue-collar workers. Yet Nixon and his aides are openly disappointed that the rate of inflation has not come down further and faster, and they show a growing if grudging receptiveness to new ideas.

"We Need More Action"

Last week the economic debate took on new intensity. The Senate's Wednesday Club, a group of 15 liberal to moderate Republicans, called a press conference in which they urged the President to set up a wage-price commission along the lines that Burns had proposed. "I disagree with the Administration's economic policies, and I make no bones about that disagreement," said Oregon's Mark Hatfield. Connecticut's Lowell Weicker Jr. declared: "If the politics of the situation commends this action, the 10% unemployment in Connecticut shouts it." New Jersey's Clifford Case added: "The whole country has lost confidence in itself at the moment, and we need more action by the Government." Whatever other action the Wednesday Club achieved, it at least ensured that wage-price standards would be fully explored in hearings when Congress reconvenes in September.

Just an hour after the Wednesday Club had its say, President Nixon summoned a press conference. For the first time he wavered in his absolute, almost doctrinaire opposition to tinkering with the interaction of wages and prices. Nixon repeated his unalterable opposition to wage-price controls, expressed doubts that wage-price review boards would really work, and argued that "guidelines in this country have always failed." But he had an "open mind" about examining proposals, he said, although he would have to be convinced that any new tactic was almost foolproof before it would get his unqualified support. He voiced "serious doubts" that such a tactic would be found.

Nixon believes that review boards might well lead to firm, direct, Government-ordered controls on most wages and prices, a step that he thinks would sap the nation's economic vitality. He has abhorred controls ever since he had a minor role in administering them as a lawyer for the Office of Price Administration during World War II. Shultz also believes that guidelines or review boards would be of questionable value. He argues that if a wage guide were set at, say, 8%, that would actually tend to boost wages in industries where increases have been less than 8%.

Lessons from Overseas

The President, Shultz and Connally raise many questions about incomes policy. How effective have these policies been in other countries? What kind of organization would be set up to run the program? How would it be enforced, and how would violators be penalized? How would it affect escalator clauses in existing wage contracts? Would profits, interest rates, home prices, legal and medical fees also have to be controlled? What would happen when the program ended? Would prices soar?

Incomes policies would surely be harder to enforce in the U.S. than in smaller, more homogeneous nations. And critics contend that such policies have never worked for long even in those countries. Yet the record is by no means barren, especially over the short run. Last year Canada's Price and Incomes Commission had to abandon its short-lived wage and price guidelines because unions would not go along. Still, the commission had considerable success in persuading companies to temper the rate of price increases and was partly responsible for lowering Canada's 1970 inflation rate to 2.3% from 4.5% the year before. Britain has also had its victories. The National Board of Prices and Incomes succeeded several years ago in persuading unions to cooperate with employers in raising productivity, enabling at least some industries to grant wage increases and hold the line on prices. Eventually, dissatisfied unions began pressing for higher wages; the board's power waned, and it was all but moribund by the time the Tories abolished it last year. In The Netherlands, wage and price controls worked during the 1960s, but as inflation began to grow two years ago, they proved far from totally effective.

Fed Up with Inflation

In the U.S., guidelines and presidential jawboning held down prices for a time in the 1960s (see box, page 67). Between 1966 and 1968, for example, there were 15 jawboned industries, including autos, aluminum, copper and steel. Prices in those industries rose an average 1.7% yearly during that period, but they jumped 6% during Nixon's first year in office.

Advocates of an incomes policy say that it might well work today because the public is fed up with inflation and receptive to action. Besides, now that the steel settlement is out of the way, most major unions have caught up with inflation and are eager to preserve the purchasing power of their recently won gains. At very least, a presidential guideline for wages and prices would give company chiefs a bargaining point in labor negotiations, and would give labor leaders a talking point to temper the demands of their militant rank and file.

The Rules Are Not Working

A prime argument for experimenting with new prescriptions for inflation, says Arthur Burns, is that "the rules of economics are not working quite the way they used to." Why not? First, an inflationary bias has been built into the U.S. economy because the nation is committed to high employment and high economic growth. Once an inflation starts, no government could accept the severe recession and unemployment--well over 10%--needed to stop it cold.

Inflation is also stubborn because more and more Americans work for the Government or in service industries, where wage rises are hard to offset by rises in productivity. Public service employees have rapidly unionized and have often called illegal but successful strikes. Governments at all levels are prone to cave in to exorbitant wage demands because voters are unwilling to put up for very long without policemen, garbage collectors or teachers. In the past decade the number of municipal employees has gone up 32%; their total wages have increased 118%. And huge increases are built into current contracts.

When civil servants win such raises, workers in private industry quite naturally feel an urge to match them. Companies have given in to outrageous wage demands rather than take a strike, fearing that they might lose markets to competitors at home or abroad. U.S. labor costs have risen 38% per man-hour since 1965, but productivity has advanced only 8.2%. Result: the labor costs for each unit of goods produced have jumped 28%.

Economists, including Paul Samuelson and John Kenneth Galbraith, have noted that many unions and companies have become so big that they are virtually immune to ordinary market pressures. For example, Samuelson points out that years ago the world was dependent on natural rubber, produced by many plantations, none of which could control the price. A market glut would sometimes force prices down from a dollar to as low as a penny a pound on the docks of Malaya. "Today," says Samuelson, "when demand for synthetic rubber falls, producers close down plants to maintain the price."

Indeed, many social and political factors also keep prices rising. The drive against pollution has reduced productivity and raised prices in industries as diverse as paper, steel, autos and chemicals. By 1975 U.S. business may spend about $35 billion to control air and water pollution--and most of the cost will be passed on to customers. Abroad, rising nationalism--in Chile, Venezuela, the Middle East and Indonesia--has lately prompted price increases for the materials that those countries produce, including copper and oil.

For all that, Nixon could attack and eliminate many sources of inflation. He could ease up on import quotas on steel, meat and other products; by the estimate of a Cabinet task force, the oil quotas alone add $4.8 billion yearly to the nation's energy bills. Nixon could call for a substantial reduction of subsidies to farms, shipping companies, airlines and railroads. He could challenge the monopoly power of unions, calling for an end to the union hiring hall and an elimination of featherbedding in industries from trucking to construction. He could urge compulsory arbitration of labor disputes in municipal services and other sectors where unions dictate terms to timid or fragmented employers. "But," laments a White House aide, "whenever I tell the President that we must get tough with labor, somebody close to him says, no, you dare not touch the unions--they have too many votes."

More immediately, Nixon could opt for one of the many varieties of incomes policy ideas. The Committee for Economic Development, a group of corporate chiefs and economists, has echoed Burns by urging that the President create a three-man Board on Prices and Incomes. It would draw up broad guide lines as to how rapidly wages and prices could rise without causing inflation. The board would denounce by name any companies or unions that flagrantly violated the guidelines. It would also issue advance reports of major wage and price decisions, outlining what a noninflationary settlement would be.

Six-Month Restraint

Economist Arthur Okun would go farther. He recommends that the President declare a six-month period of "utmost restraint." All companies would be asked to put off price increases during that time and all labor leaders would be urged to take no more than token boosts, keeping contracts open for final negotiations later. The President would appoint a board of citizens to spend those six months interviewing leaders of unions, companies and consumer groups, seeking their recommendations for equitable wage-and-price guidelines. If a company or union violated those guides, the President would point an accusing finger and rally the pressure of public opinion. He would also be prepared to penalize an offender directly--perhaps by liberalizing import quotas, selling off goods from Government stockpiles or canceling Government contracts.

In the next issue of FORTUNE, Robert Roosa, who was Treasury Under Secretary from 1961 to 1965, will propose a plan. Roosa would first have the President impose a wage freeze for six months or less. During that period, the Government would set up separate wage-price boards for each industry. The boards would be made up of people from business, labor and Government. In every labor negotiation covering a whole industry or a company with 1,000 or more employees, they would have the power to determine what the industry or company could afford to pay, depending on its costs, markets and productivity. After that, the board would set general boundaries for wage and price increases. Corporations and unions would negotiate contract details, but they would have to keep their increases roughly within the board's bounds--or else face some penalties.

According to his chief aides, Nixon is finally being forced by events to change his anti-inflation plan. Last week

Treasury Secretary Connally told TIME Economic Correspondent Lawrence Malkin: "The last thing we want to do is stay fixed in concrete. You're going to see a change in action. You're going to see the President engaged with labor-management negotiations when they're of national importance. The time has come when he is going to be more aggressive. Basic realignments and reassessments are required, and we have to explain them to the people. Even in international affairs, economic matters now have priority."

At his press conference, Nixon said that he was instructing Labor Secretary James Hodgson to keep him informed of major wage talks. Did that mean that he was going to turn his back on price increases by corporations? No, said Connally, Nixon would watch them too. What will happen if Congress approves legislation to set up an incomes board with firm powers to delay wage and price raises until they can be investigated? Replies Connally: "The President is not against that, as I read it."

Nixon's New Strategy

Indeed, the White House has a new strategy. Nixon wants to wait and see whether outsiders--businessmen, labor leaders, Congressmen--can build up enough support for an incomes policy to create the political consensus that would enable it to work. Provided that happens, he may be willing to accept it. The consensus could be built in next month's Senate hearings. While they are going on, Nixon will have a grace period of several months, during which the original anti-inflation plan may still work out as George Shultz hopes. If it appears during the hearings that Congress will approve a wage-price board and give it real powers of enforcement, then businessmen may rush to raise prices while they still can. To prevent that, the President would probably have to call a surprise, temporary wage-price freeze. Some of his aides say that for all his doubts he would just as soon have a wage-price board, simply to end all the debate. And if an incomes board is mandated by Congress but fails to halt inflation, Nixon will not bear all the blame.

The most persuasive argument in favor of more Government action against inflation is that it can hardly accomplish less than the Administration's inaction. A wage-and-incomes policy might have been more promising if adopted earlier, but it is not too late for one to have effect. Eagerness for a return to price stability and an expansive economy has made the public receptive to almost any presidential action that would decisively break with the past--the kind of bold move that Nixon made on China policy. As Arthur Burns recently told the Joint Economic Committee: "Had an incomes policy been instituted a year or two ago, it would have been more effective than it is likely to be today. But I still would try it. I would be mildly optimistic. I think it is an effort worth making."

* The day after the steel settlement, Pierre Rinfret, a windy but influential business economist who sometimes advises Nixon, told his clients by telegram not to hesitate to raise their own prices. The steel deal, he said, "locks in inflation." More important, he advised clients to give the unions what they want, and then increase prices still more to pay the bill. Says Rinfret: "There is no point in taking the heat if the Government won't stand behind you."

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