It’s an election winning formula that’s worked in the short term for politicians of almost every party, critics note. Lots of spending. Lots of cheap money. Forget about debts.
As President Biden runs huge deficits and the Fed backs him with cheap money, some wonder if over the long term the economy could be headed for disaster.
Popular economic policies, critics say, often seem to work in the short run but eventually turn toxic. And if that repeats, it won’t be the first time that banking and political leaders destroyed the economy as documented in the Great Depression of 1929-1941 and the stagflation of the 1970s. Today, Fed officials says interest rates will stay at close to zero percent as the government runs record deficits.
Federal taxes reached a record $1.7 trillion in the October-through-March period, while federal spending climbed to $3.4 trillion, according to the U.S. Treasury’s monthly statement. That means the United States ran a deficit of some $1.7 trillion over the last six months, or a yearly red-ink pace of about $3.5 trillion. With the increasing debt, the nation’s long term red ink of some $28 trillion exceeds 100 percent of GDP. Those are numbers not seen since World War II, observers note.
Historians and economists note several presidents tried these policies before. They said they these policies shared this: They were initially popular as they seemed to work at first, but later failed.
They put money, borrowed money in peoples’ pockets; from President Nixon’s election year Social Security increase in 1972 to the Trump/Biden stimulus payments.
These included presidents and Fed chairmen who mishandled various crises in American economic history. These include the Great Depression, the misguided policies of cheap money/housing policies that led to the crash of 2008 and the great stagflation of the 1970s.
“Initially, the low interest rate policies of the Fed and the policies of the Nixon administration seemed to work in the early 1970s,” says George Selgin, an economist with the Cato Institute. President Nixon, he notes, was easily re-elected in 1972.
Disco Disaster
Popularity came in part because Nixon continued with many welfare programs and pressured the Fed to continue low interest rates, policies that appeared to lead to prosperity. That’s one reason why most incumbents were re-elected in 1972.
Later, after the election, Selgin noted, prices of basic necessities shot up. What happened to the economy, he said, was “shocking. Everything suddenly cost a lot more,” he said.
It was also unprecedented. Prices rose at an alarming double-digit rate yet the economy stopped growing. That’s something economists had previously said could never happen at the same time. So they coined a new term to describe it: stagflation.
How did stagflation happen?
Critics agree politics, not the rising price of oil, played a big part in the economic problems. In 1970, President Nixon, looking ahead to the 1972 re-election as was most of Congress, sought popular economic policies that would reverse the recession of the late 1960s just as today’s big government spending is aimed to restart the economy. These were the opposite of the Harding/Coolidge low tax policies that reversed the little-known depression of 1920-2 and generated prosperity.
Spending on Everything
Nixon needed easy money so he ended the Bretton Woods agreement. That broke the last link of the dollar to gold. The dollar had once been backed by gold.
Gutting Bretton Woods amounted to a devaluing of American dollar. That meant foreigners holding dollars lost some of the value of those dollars.
It also meant, said one observer studying the period, that “the check on the government’s ability to increase the quantity of money—the gold standard–is gone,” wrote Bruce Bartlett in the book “Reaganomics.”
Government officials, he added, now had a “powerful interest in maintaining a steady rate of inflation,” he added. That’s something that government officials, a half century later, still say is their goal, even though in the 1970s inflation became double digits and the economy blew up. Once stagflation was unleashed, it was very difficult to stop it, historians note. It required imposing a painful, protracted recession.
Bi-Partisan Disaster
Three presidents, Nixon, Ford and Carter, and their economic advisors struggled with solving the problem of stagflation, according to economist Robert Sobel. “Nothing seemed to work,” Sobel writes in “The Worldly Economists.”
These presidents combined with Democratic Congresses along a seeming politically oriented Federal Reserve chairman and Nixon ally, Arthur Burns, to push disastrous cheap money and easy spending policies. Nixon, in effect, fired Burns’ predecessor, believing his tight money policies had cost him the 1960 election. And privately he told Burns:
“I must register with you, as strongly as I can, my concern that what really determines the result of an election is not interest rates, but unemployment statistics around election time.” Nixon wrote Burns. “There is no doubt in my mind whatever that if the Fed continues to keep the lid on with regard to increases in money supply and if the economy does not expand, the blame will be put squarely on the Fed.”
Nixon adviser John Ehrlichman wrote in his memoirs that Burns understood what was wanted by the Republican administration: “Some economists are oblivious to political reality, but Arthur Burns was every bit as much a politician as he was an economist.” Another Nixon aide, H.R Haldeman, bragged they “had Arthur Burns by the balls.”
But these cheap money policies were initially popular. That is until after the 1972 elections when Americans were assaulted by high inflation rates, low or no growth and previously unheard-of 20 percent interest rates.
The latter was a rate that devastated the nation. A small businessman who owned the Sussex Spectator in Newton, New Jersey, in the early 1980s announced he was closing his publication “because of Arthur Burns.” Cars and houses were difficult to sell because financing was suddenly much more expensive owing to monetary policies.
Burns assumed leadership of the Federal Reserve in the middle of what would later become known as the “Great Inflation,” which lasted from 1965 to 1982. He speeded up money creation rates.
Monthly money growth, which had averaged 3.2 percent in the first quarter of 1971, jumped to 11 percent in the same period of 1972. Money creation was 25 percent faster in 1972 compared to 1971, according to Fed numbers. The euphoria of cheap money made people happy but the pain was coming.
“Oh, the Pain. the Pain…”
“During this period, the inflation rate, based on the year-over-year percent change in the consumer price index (CPI), rose from 1.0% in January 1965 to peak at a record high of 14.8% during March 1980,” wrote economist Ed Yardeni. Investors also felt the pain.
The stock market tanked over an 18-month period in 1973-74. It dropped some 50 percent.
It was “the greatest failure of American marco economic policy in the post-war period,” wrote Wharton professor Jeremy Siegel in his book “Stocks of the Long Run.”
Later, after stagflation’s damage was apparent, some officials insisted the problem was the result of rising oil prices. However, later “the Wall Street Journal” would write of the 1970s, “OPEC got all the credit for what the U.S. had mainly done to itself.”
Big John Eats His Cooking and Throws Up
Things were so bad, even one of the architects of the cheap money big spending policies, Nixon Treasury Secretary John Connolly, was hurt by high interest rates and sluggish growth.
A political appointee with no training in economics, Connolly bragged that he could sell almost any economic policy. “I can play it square. I can play it round,” said Connolly, a former Democrat turned Republican.
Connolly eventually filed for personal bankruptcy in the 1980s.
Stagflation Redux?
Both Selgin and economist Jeffrey M. Herbener of the Mises Institute reject the analogies to the stagflation woes of the 1970s, but agree there are dangers to these big government policies.
Is the current Fed chairman Jerome Powell another Arthur Burns?
Powell, like Burns back in the 1970s, is creating money at a vigorous pace but is it dangerous? Could it lead to another double-digit inflationary spiral?
Selgin says Powell has shown none of the political malleability of Burns. Powell, under both presidents Trump and Biden, has promised to keep interest rates at “close to zero percent.”
Money Supply Explodes
Indeed, this unprecedentedly low interest rates wouldn’t be possible without Fed’s quantative easing policies according to the True Money Supply (TMS), an Austrian economics think tank. Quantitative easing has continued over the last year at a record pace, and this is reflected in the growth of the U.S. money supply. It reached a record level in February, TMS noted.
But Powell, in a letter to Florida Senator Rick Scott, said the central bank would keep inflation manageable.
“After a decade in which inflation was too low, the Fed is now aiming for inflation moderately above 2%,” Powell wrote to Scott.
“We understand well the lessons of the high inflation experience in the 1960s and 1970s, and the burdens that experience created for all Americans,” Powell said in his letter. “We do not anticipate inflation pressures of that type, but we have the tools to address such pressures if they do arise.”
Both Selgin and Herbener reject the stagflation analogies. Still, they agree current big spending/easy money policies could lead to unique problems.
Not Stagflation But…
“The main reason for the collapse of money demand in the 1970s was breakdown of Bretton-Woods and the resulting uncertainty of the dollar continuing to serve as a world reserve currency. That kind of transformation in the international monetary system has not happened in the current situation, Herbener notes.
However, he sees the possibility of inflation rates above the Fed’s state long term goal of keeping inflation to two percent a year or less.
“The 30% rise the money stock from Feb. 2020 to Feb. 2021 is highly unlikely to continue. If it did, then sustained, rapid price inflation will follow,” Herbener says.
Selgin is worried about fiscal policy. He says huge deficits have persisted even in times of strong growth and that could lead to problems.
“If these deficits and debts continue at the same pace,” Selgin added, “it could put the government in a terrible place in just a few years.” The U.S. debt to GDP ratio reached 106.90 percent at the end of last year, according to TradingEconomics.com. The peak number was 118 percent during World War II.
Another economist and central banker who bemoaned the corrosive power of inflation on buying power as well savings and investments, would agree.
Deficit spending “becomes a source of instability when deficits persist in good times as well as bad,” wrote Arthur Burns in his “Reflections of an Economic Policy Maker.”
