FIRST, DO NO HARM:

The Fed: lessons of 1972 (Alan Reynolds, May 13, 2004, Townhall)

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 his 1958 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.

Don Rumsfeld had a great bit about this disastrous era in a speech honoring Milton Friedman:

[G]eorge Shultz came to me and asked me if I would run the wage price controls for the United States of America. (laughter) It was the country's first peacetime experiment. As I recall, it was not Milton Friedman, but H. L. Mencken who once said, "For every human problem there is a solution that is simple, neat and wrong." Richard Nixon found it.

(laughter and applause)

Early on, I figured out that the key to success was not to even try to manage wages and prices. Senator Proxmire's law, I think written on the back of an envelope, was only a paragraph or two, and it embarrassed the President because inflation was coming along and the President wasn't stopping it. So he passed a law saying that the president shall have the right to control wages and prices. I put the law on the floor in my office, next to my desk. And then every time The Wage Board, or The Price Commission, or The Health Services Board, or The Rent Board, or The Construction Stabilization Industries Board, any one of those alphabet boards that were spawned by this Economic Stabilization Act — every time they issued a regulation, we stuck on top. Before too long it started working its way up to the ceiling. As a reminder for everybody for the potential damage we were doing.

He's not here and I hate to talk behind people's back, but I think the record should show that Vice President (Richard) Cheney, of course, was part of that operation, (laughter) and I have never once seen it on his resume. (laughter) But he was there.

There was one other thing we did early on was to get agreement that any employee of the wage price controls could be fired within 30 days. The goal was to not allow a permanent bureaucracy to self-perpetuate, and it worked. So we worked and we worked we kept letting out everybody, we kept freeing up all of these categories. We had tiers and we would let this group free at wages and controls, and this group free at price controls, because it was an option or because of something else, or because it was food and the answer to (inaudible) prices is high prices.

And after a while, Milton Friedman called me up and he said, "You have got to stop doing what you are doing." And I said, "Why? Inflation used to be up at around 6 or 7, it's now down to about 4 or 5. We're freeing up all kinds of activities. We're not doing much damage the economy." He said, "I know, I know that. But you're not the reason inflation is coming down, and YOU know that! (laughter) I said "That's true." And he said the problem is that people are going to think that you're doing it, and you're not — you're letting everybody out and Inflation's coming down and they're going to learn the going to learn the wrong lesson. And it's important he did not quite go as far as to say that I should start damaging the economy, but that was right underneath what he was telling me. (laughter) And of course he was correct.

Posted by Orrin Judd at May 16, 2004 9:48 AM