“The prophets prophesy falsely, and the priests bear rule by their means; and my people love to have it so . . . .”—Jeremiah 5:31
The beginning of the understanding of the American economy during 1966 lies in the clear perception that nothing fundamental in this economy is made what it is by the war in Vietnam. Whoever says that, but for Vietnam, the U.S. would be doing this or that great thing, speaks either without knowledge or falsely.
Morally and politically, Vietnam counts for much. The appraisal of the American role in Asia opens a great trial of minds and characters—here uncovering differences, there cementing friendships. But even morally and politically, Vietnam neither distracts strong minds nor produces anything new. The heads supposedly too concentrated on Vietnam to think also of other things were always empty. The personalities ostensibly exhausted by this one moral imperative were always sapless.
In economic policy, the cost of Vietnam changes nothing important; it merely accelerates a little. A high estimate of U.S. government expenditure attributable to Vietnam, for the calendar year 1966, might approach $12 billion. Even this amounts to no more than the increase during three or four months in the annual level of American national product. A cost of this size is not of such weight as to determine any serious person, in American public life, to desist from doing or advocating anything of great moment which he would have done or advocated had there been no Vietnam war.
Indeed, the whole of U.S. military expenditure, at the present level, constitutes only a marginal drain on the capacity of American society to be as “Great” or as good as this society otherwise has the intellectual, moral, and political resources to be. In 1965—66, hardly 8% of the Gross National Product of the U.S. will be spent for military purposes. After deducting this 8%—or even three times 8%—the United States would still be richer, per capita, than any other society in human experience. By what idiocy are Americans to be found contending that a “Great” society is unattainable without that further increment of income which no other human community has ever had?
At the turn of the years 1965—66, the Gross National Product of the U.S. was at an annual level near $705 billion. I guess that, measured in the same prices, and provided that there is meanwhile no serious additional fiscal or monetary restraint of demand, the GNP is likely to stand near $745 billion at the opening of 1967. The rise in the general price level, from the fourth quarter of 1964 to the fourth quarter of 1965, was under 2%. I find, on balance, no reason to conclude that prices will rise faster in 1966. I therefore guess that, in the prices which will actually prevail, GNP will be about $730 billion in 1966. If expansion later continued at the same rate, GNP would be in the range of $760 billion for the federal fiscal year 1967 (July 1, 1966 through June 30, 1967).
1966 is a year of sharpened conflict between those whose accent is on price stability and those whose emphasis is on full employment. Only in a limited degree is this a division of judgments concerning uncertain issues of economic fact, relationship, and probability. It is, more largely, a conflict of economic interests, of moral sympathies, and of corresponding affiliations of politics.
Price stability is of most immediate benefit to those who receive contractually fixed incomes or those whose incomes are “sticky”—hard to change. Stability therefore attracts rentiers rather than entrepreneurs, recipients of fixed interests rather than of variable profits. In this connection, it is important for the mental climate of American society that, in the past two decades, interest has been its most rapidly expanding form of earned income. While GNP tripled, personal interest income from all sources (savings, bonds, etc.) sextupled. In 1965, the interest income received by individuals, $37.1 billion, was nearly twice as great as the $18.9 billion of personal income from dividends. Indeed personal interest income was almost as great as all dividend income plus the $18.6 billion of rents received by individuals (which includes all the “imputed” rents from owner-occupied housing).
In general, the propertied and the holders of secure employments are little sympathetic to even a marginal sacrifice of price stability in exchange for expansion. They do not need those last few million jobs. And those who have property and employment security are characteristically, in our American society, also profoundly convinced that the last increments of expansion and employment are basically unhealthy—a kind of intoxicant which loosens the bonds of society. Do not the poor then get too “uppity”? And is it a stable society in which even the shiftless and improvident can have a job, for the asking?
On an unexcited view of the prospects of the U.S. economy, there is, in my judgment, not likely to be need for additional taxes, to restrain demand, before the middle of 1967—if then. Indeed, though this judgment involves great uncertainty, I think it more likely that it will be necessary to stimulate private demand in 1967 than to restrain it. Nevertheless, I would agree that, by mid-1967, if unemployment were then down to about 2½%, a small increase in taxes might be in order. This small increase would have two purposes: first, to permit a continued expansion of federal expenditure, faster than could be financed by the already huge federal tax accrual through growth—if such expenditure were planned; second, to signal a willingness to restrain private demand further—if such restraint should later become necessary. But, at present, all of Washington's resources of intelligence and character need, I believe, to be concentrated in the opposite direction. Washington needs to strengthen its present resolve to remain unaffected by the hypertension in which many American bankers and financial editors live at all times (symptoms: constant nightmares of runaway inflation).
Of all developed countries, the U.S. has, in recent years, maintained the greatest general price stability.1 From 1958 to 1965, U.S. wholesale prices rose only 2%, export prices 6%, the cost of living 9%. Only for the single year 1965 can American preeminence in price stability be put in question. And even in 1965, such countries as the United Kingdom, West Germany, and Sweden, while achieving less economic growth than the U.S., experienced greater price advances.
For stability of consumer prices, the U.S. is clearly foremost. While U.S. consumer prices rose 9% in 1958—65, the German rise was 19%, British 21%, Swedish 27%, and Japanese 41%. True, U.S. consumer prices did rise by 2% in the single year from December 1964 through December 1965. Still, 2% is hardly an explosion.
But it is the movement of the U.S. wholesale price index which has recently been made the occasion of panic by the financial editors. From 1958 through 1964, this index hardly budged. (Meanwhile wholesale prices had risen only 3% and 4% in Japan and Germany, but 15% in Sweden and 19% in France.) Then, in the twelve months, December 1964 to December 1965, the long-desired rise in the prices of American farm products at last arrived—11.1% in one year! Farm income increased by $2.1 billion. But prices of all commodities other than farm and processed food rose only 1.4% in the year. And during the most recent months, while the financial editors have most insistently cried havoc, the index of all industrial commodities, based on 1957—59 equals 100, has moved up only from 103.2 in November 1965 to 103.5 on February 19, 1966. What an irony if, having at last managed a rise in farm prices, the U.S. were to heat itself into a panic over a supposed inflation represented by this belated success in farm price policy!
In no other developed country would the level of employment which now prevails in the United States be called “full.” Still, in the past two decades, the U.S. has had higher levels of employment than are likely in 1966 only during the Korean war years 1951—53.
For 1965, the labor force averaged 78.4 million. The unemployed were 3.5 million, and those who worked part-time though desiring full-time jobs were another 1.9 million. Civilian employment, full-time and part-time, stood at 72.2 million; it had risen 1,822,000 above 1964. The armed forces averaged a trifle smaller in 1965 than in 1964—2,722,000 instead of 2,738,000. At the turn of 1965—66, civilian employment was increasing faster than it had in 1964—65.
During 1966, the labor force will probably average over 80 million. Military employment is likely to be about 300,000 above 1965. And, unless there are new and serious restraints on demand, civilian employment may well increase by more than in 1965—say by 2,000,000, or even a bit more. Unemployment would then average about 2.8 million—3½% of the whole labor force. By the end of the year, unemployment might even get down to 3%. There is nothing in this image of 1966 that can fairly be called full employment. But it would be near enough to full employment to be mistaken for the reality by poor eyes.
There are, however, sensible reasons why one may, in the United States, regard unemployment if not of 3½%, then perhaps in the range of 2½%, as approaching the “full” mark. First: there are extraordinary American patterns of job changing. In U.S. manufacturing, it is consistently necessary to engage about four workers for each hundred employed, every month, just to keep the labor force constant! Some of the 4% who have quit or been laid off will be recorded as unemployed even if they find other jobs within ten days. In January 1966, some 52% of the unemployed had been out of work less than five weeks. Second: there is much unavoidable seasonal unemployment in a country with so great a climatic range. In 1965, U.S. agriculture employed 5,626,000 people in July, and only 3,645,000 in December; construction employed 2,713,000 in February, and 3,575,000 in August. Third: the very growth in the American labor force creates transitional unemployment on a scale without parallel in countries where total employment grows very slowly (as, for example, in the United Kingdom). In the decade 1960—70, the U.S. labor force will probably grow by about 14,000,000, if high employment opportunity is sustained.
For these reasons, U.S. unemployment of 1½-to 2 million persons need not involve unconscionable hardship or great inefficiency—on two conditions. First, that the unemployed receive adequate compensation; second, that few persons remain long unemployed. In this second connection, it is encouraging that, in the fourth quarter of 1965, people unemployed for 15 weeks or longer were down to 667,000. In 1961, these long-term unemployed numbered 1,532,000; in 1953, they were only 211,000. At something close to 200,000, in a labor force of 80,000,000, long-term unemployment might perhaps be regarded as not constituting a major social problem.
As compared to the fiscal year which ended on June 3, 1965, the federal budget proposals for fiscal 1967 reflect two great changes.2 First, some $10.5 billion of prospective expenditure is specifically identified as due to Vietnam. Second, expenditure for Great Society objects (health, education, labor, welfare, housing, and community development) is to rise by $13.6 billion. These two categories add up to the whole budgeted spending increase.
During the calendar years 1964 and 1965, President Johnson carried out policies which decreased the share of the federal public sector in the national economy. Private demand was counted on for economic expansion, and this demand was stimulated by some $20 billion of annual tax reductions. The budget for the fiscal year 1967—particularly its trust account section—in part reverses this 1964—65 pattern. The sources of the reversal are Vietnam and the Great Society, taken together.
In the calendar years 1961—63, when Kennedy bore executive responsibility, federal administrative budget expenditure averaged 16.2% of GNP.
The combined share of administrative and trust expenditures, in the national product accounts, averaged 19.5%. With 16.2%, Johnson's administrative budget spending in the calendar year 1965 would have been $109.6 billion; actually it was $101.4 billion. With 19.5%, total federal participation in the national product accounts would have been $131.9 billion; actually, it was $123.3 billion. The consistent difference of about $8½ billion measures the amount by which the relative weight of the federal public sector was contracted in the shift from New Frontier to Great Society.
Under the budget for fiscal 1967, administrative budget spending would rise by $11.4 billion and total federal national product spending by $18.7 billion. These are 18-month changes—from actual calendar 1965 to proposed fiscal 1967. My calculations suggest that these 1967 spending levels would widen the gap from the Kennedy pattern regarding the administrative budget to about $10 billion, but simultaneously narrow the gap in total federal participation to about $6 billion.
The meaning of this divergence is straightforward. Vietnam (which is in the administrative budget) is less weighty than the Great Society programs (which are financed about 70% from the trust funds). In 1961—63, defense spending came to 9% of GNP; the $61.4 billion budgeted for defense in fiscal 1967 will be a little over 8%. Defense, including Vietnam, is not in a new economic dimension. On the other hand, federal expenditure for the Great Society programs is acquiring a weight of which there is no previous experience in the American economy.
In my judgment, the stimulus to economic expansion reflected in the federal budget for fiscal 1967 may well have passed its peak by the time this essay is printed—three months before that fiscal year opens. This is transparently true for the stimulus from defense spending. The calendar year 1965 total of defense spending was about $53 billion. The budgeted total for fiscal 1967 is $61.4 billion. But the revised defense budget total for fiscal 1966 is also $57.5 billion, and only about $27 billion was spent in its first six months. This means that the budgeted rate of defense spending for the six months January through June 1966 is about $30.5 billion—almost exactly half the budget of $61.4 billion of the subsequent twelve months. Moreover, defense spending provides economic stimulus not entirely when money is paid out but also, in part, earlier—when orders are placed and materials are assembled. For this reason, it seems clear that the defense stimulus to the economy, at the level provided for in the budget for fiscal 1967, will have passed its peak when the April issue of COMMENTARY is in the hands of readers.
Moreover, the Great Society programs will not provide a net general economic stimulus in the new fiscal year. The one-year rise in expenditure on these programs is to be $2.1 billion in the administrative budget and $3.7 billion in the trust funds. But total administrative budget expenditure, apart from Vietnam, is to rise by only $0.6 billion; in that budget, Great Society expenditure is therefore to be primarily a substitute for other spending. And, in the trust funds, Great Society spending of $3.7 billion is heavily overmatched by $5.5 billion of additional employment tax receipts. (A major increase in payroll tax rates on January 1, 1966 is to be followed by another increase on January 1, 1967.)
On balance, I suspect, by mid-year 1966, the federal budget will be affording no significant general stimulus to further economic expansion. In the federal government, both the general interest in further employment and specific desires to accomplish particular programs will have ceded priority to concern for price stability. Then the further rise in U.S. economic activity will be dependent either on additional growth of private investment and of net exports or on some autonomous increase in consumption. Fortunately, for the present, private fixed investment (other than in housing) is continuing to rise steeply—perhaps at an annual rate in the range of $10 billion. From a sanguine point of view, it is therefore still possible to regard the federal budget of fiscal 1967 as standing aside to make way for this rise in private investment.
The financial climate of opinion in the United States, at the end of February 1966, is severely agitated. The distinctly financial precipitant of this agitation was the action of the Board of Governors of the Federal Reserve System, effective in New York on December 6, 1965, raising the rediscount rate (charged by the Federal Reserve System for credit to its member banks) from 4% to 4½%. While raising its price, the Board announced that it would not curtail quantity: “The action contemplates the continued provision of additional reserves to the banking system, in amounts sufficient to meet . . . the credit needs of an expanding economy . . .”3
This action of the Board of Governors, raising its price by 12½% , constituted a signal to all commercial banks to raise the price of the service they supply—the use of money—in like proportion. The banks were quick to comply. At the same time, the Board continued to provide more reserves. It thereby permitted the volume of bank lending to expand steadily. Commercial bank credit (seasonally adjusted) rose by $2.5 billion in December and $3.0 billion in January. In the week ending February 16, 1966, the adjusted volume of loans and investments of weekly reporting member banks was 8.3% higher than a year earlier. Under Board of Governors' auspices, the banks had received official approval to do a larger volume of business, at a greatly higher price. (As bank credit is now about $300 billion, a one-half per cent rise in interest charges increases bank gross income by $1.5 billion!) Steel manufacturers and bricklayers could wish themselves similarly sponsored.
In less than three months after the Board of Governors' price increase, the yield on 90-day Treasury obligations rose by ½% and on one-year obligations by ¾%. (On February 25, 1966, these stood at 4.69% and 5.18%.) In the same short period, a representative 21-year Treasury bond lost $5 out of each $100 in capital value. The tax-exempt bond market was least disturbed; its yields (as measured by Moody's long-term composite) rose only from 3.52% to 3.80%. But even the tax-exempt market had become so jittery—because of rumors of a still higher discount rate—that the sober Moody's Investor Service found itself devoid of counsel:
We find it impossible to evaluate the attractiveness of reoffering yields due to the precipitous, continuing, downward movement in market levels that affords an insecure base upon which to make comparisons.4
At the end of February, representative yields for utility and industrial bonds were going up to the levels of 1932. Yet the volume of new corporate borrowings was greatly above 1965—and rising.
Under current conditions, a rise of 12½% in the price for the use of money operates, very largely, like any other 12½% price rise. For the most part, the same economic activities go on as before the price increase. But now these activities cost more. Those weak (tested in dollars) who cannot afford the price—and have a choice—desist. Those strong who can—because they are appropriately situated—pass it on. Incomes are, in some degree, shifted and, in general, inflated. A rise in the cost of money is unique, if at all, only in the wide diffusion of its effects.
If a rise in interest rates is to have its much-advertised restraining effect, somebody important must be restrained. Some important borrower must be caused to reduce his demand for real resources—labor, materials, finished products, or plant capacity. But our major borrowers are not such people as can be brought, under present economic conditions, to reduce their demands by those rises in interest rates we have experienced or are likely to experience. I cite six groups of such relatively impervious borrowers.
First: the U.S. government. The Treasury expects to pay about $800 million more interest next year than this year. But the growth in interest payable will (rightly) be the least consideration in determining the size of any federal program—civil or military. Second: states and municipalities. Their annual budgets have now passed $80 billion. Even in the relatively cheap tax-exempt market, higher interest may cost them about $50 million this year. But their new borrowing is little influenced by changes in interest rates: they tax and pay. Third: public utilities. Their borrowing grows with their facilities. And they are not inhibited by higher interest rates: everywhere they are authorized by law to pass on their cost of money to the consumers. Fourth: profitable industrial corporations. Their internal rate of discount is greatly higher than market interest rates: they will almost never invest equity money unless it looks like earning over 10% after depreciation and after taxes. But even a 6% market interest charge—when interest is deductible as a cost and when there is a corporate income tax rate of 48%—means to them a net cost of only 3.12%. Such a cost does not restrain demand. Fifth: the speculator. He looks for a price rise of 1% in a day, a week, or a month. So long as he believes in the rise, he is not restrained by the addition of 1% or 2% per year to interest charges. Sixth: the installment buyer. Last year he added $9 billion to his debts. But he pays 1% or more per month—and does not know how much he is paying. He is not to be restrained through the cost of credit.
Where the rise in interest rates does perhaps restrain is in the largest debt projects of families of modest income. For half of our families, we have to reckon with cash resources under $140 a week. There an additional charge of $5 or $10 a week may preclude. These are the calculations involved in the purchases of simple houses. Both the Kennedy and Johnson administrations announced their concern to stimulate house construction. And both were generally successful—if that be success—in keeping interest rates on first mortgages in the range of 6%. Still the number of houses built in 1965 was less than in 1964 or 1963—or 1955. And perhaps the Board of Governors of the Federal Reserve System would not have found it dignified to say that the Board was trying to restrain inflation by discouraging the poor from buying houses.
All else failing, it used to be fashionable to assert that raising U.S. interest rates would at least help to window-dress the international balance of payments. But bankers who watch the facts (among them notably Mr. J. L. Robertson of the Board of Governors) have recently testified repeatedly that U.S. interest-rate increases merely push up foreign rates, without narrowing the differentials. Moreover, the best-disciplined part of the voluntary control over the flow of U.S. funds abroad has been precisely this sector of short-term banking credits. U.S. banks were fully as cooperative, in abstaining from increasing their foreign loans, before December 6, 1965 as after.
The Johnson executive family was aware of the unstabilizing possibilities of an officially authorized shift to higher interest prices. Before December 6, several high executive officers made a concerted effort to scare the event off. After the action, the President expressed regret. But the regret was quickly muffled. And soon observers in Washington were allowed to believe that the difference had never concerned anything but “timing.” Johnson, like Kennedy, thought unwise a direct clash with the men of money, a clash that might raise those frightening images of monetary unsoundness before which otherwise strong hearts quail. The President accordingly went along with the ideology which finds the Board of Governors an authority independent of the President. Franklin Roosevelt would never have accepted such a doctrine; Marriner Eccles would not have claimed it. And I have never known a sophisticated and independent lawyer in Washington who appraised this ideology more highly than being, at best, dubious constitutional law.
The Board of Governors is not, in its central function, a judicial body, and it accordingly lacks the high claim to independence of a body which adjudicates particular rights and interests. Under the Constitution, the Congress has the power to make laws concerning money. But the Constitution does not permit any authority—even the Congress—to fragmentize the responsibility of the President for the execution of the laws. (The Supreme Court, accordingly, found that the Congress could not make the head of TVA independent of the President—and irremovable by him—even if it wished to do so.) It is at least doubtful constitutionally whether any executive Board of the U.S. government has the right, in law, to carry out persistently an economic policy in conflict with the President's policy.
I doubt that President Johnson did a service to the office of the Presidency, and to the processes of American government, when he stated, on December 5, 1965:
The Federal Reserve Board is an independent agency. Its decision was an independent decision.
But, when the President of the United States makes such a statement, he shifts the constitutional position. The statement tends to make itself true.
Early in 1966, when employment is seasonally low, the United States still has about 3¼ million people totally unemployed. Over 2 million other people are working part-time because they cannot find full-time jobs. The unemployed get little help from public authority. In the representative week of 1965, only 42 persons out of every 100 unemployed were receiving insurance compensation. Those compensated got an average of about $37 a week. Specifically to the poor, the unemployment compensation bill (HR 8282) now pending in Congress would probably mean more than any piece of legislation which the Johnson administration has actually enacted. Perhaps just for this reason, the unemployment compensation legislation does not move forward. President Johnson introduced it belatedly in 1965, and he has not pressed it. The trade-union movement failed to give it first priority. The neglected unemployed are still very much with us.
Yet the war in Vietnam and the demand management of the Great Society have brought the United States, for the first time since 1953, within sight of the threshold of the economic universe in which other developed countries have been living throughout these thirteen years. This is a universe of full employment, in which not only for private persons but also for national societies-things have real costs. Here it is no longer socially possible to have more of everything, at the sole sacrifice of involuntary idleness.
Within the limits of my acquaintance, I see this movement of the American people from one economic universe toward another as accompanied by considerable giddiness. But there are profound differences. For example, in these economic matters, as in the issues relating to Vietnam, I find Washington far more sober than New York—better informed first, but also more thoughtful, more consequential in analysis, less inclined to seek release in self-indulgent and irresponsible rhetoric. And, so far as my information extends, the contrast between Washington and New York parallels also, in some degree, a difference between Washington and the universities. (How disappointing that the dwellers in bureaucratic darkness should compare so favorably with the academic children of light!) The Sunday newspaper brings me, from the academy:
. . . the time has come for a change. President Johnson should bring in a tax program before mid-year. Congress should pass that program speedily. . . . The issue is no longer growth versus stagnation. It is maintainable long-term growth versus frenzied and self-defeating scrambling for limited resources.5
For the present, Washington is less taken by frenzy than the above, and the United States is, I believe, fortunate in the difference.
1 There is a convenient assembly of indices of wholesale and consumer prices in the Monthly Bulletin of Statistics of the United Nations, New York. A similar service for export and import prices is performed monthly by the International Financial Statistics of the International Monetary Fund, Washington.
2 The basic documents are The Budget Of The United States Government . . . 1967, together with its Appendix volume and its volume of Special Analyses. The Annual Report of the Council of Economic Advisers contains a convenient compendium of statistics, some useful analysis, and a heavy—perhaps unavoidable—component of official eyewash. All these are Government Printing Office issues of January 1966.
3 The formal statements of the Board and of President Johnson are printed textually in the New York Times of December 6, 1965, and will bear close reading.
4 Quotation from Moody's Bond Survey, issue of February 21, 1966, page 793. The identical message was repeated in the issue of February 28, page 777, in an article entitled “Tax-Exempts: A Crazy Quilt Market.”
5 Professor Paul A. Samuelson, “Boiling Economy Needs Tax Damper,” in the Washington Post of February 27, 1966.
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