Nixon Showed What Not to Do in an Economic Crisis: Echoes
Head for Camp David. Convene meetings. Take advice from economists, your Cabinet, all the experts. Then put forward a giant new economic program, maybe including some dramatic form of shock therapy that will calm financial markets and create jobs.
That's the kind of response Americans are used to seeing in a president when the nation is suddenly confronted with bad news like last week's market turmoil and the U.S. credit downgrade by Standard & Poor's. But the results of such a response to economic alarm 40 Augusts ago suggest this isn't the way to go.
In 1971, President Richard Nixon convened his experts only to produce a protocol that ruined the economic prospects of the decade.
The urgent case that sent Nixon to Camp David that August was the dollar. At the time, the U.S. was on the gold-exchange standard, under which the price of gold was fixed at $35 an ounce and foreign governments could withdraw gold from American banks. The U.S. had long held the position it would maintain $10 billion in gold stock. Foreigners were concerned that U.S. growth was sluggish and began to take gold elsewhere. "Monetary Reserves of the U.S. Declined $505 Million in May," read a June headline.
By July, the reserve was officially below the $10 billion figure, and the price of gold on international markets rose to $42 an ounce. The U.S. needed a strong dollar, partly to pay the costs of the Vietnam War. Joblessness reached 6 percent. Politically, Nixon stood where President Barack Obama stands now: just 15 months away from elections.
Fearing a run on the dollar and accelerating inflation, Nixon summoned to Camp David his Cabinet and the wisest, most eminent people he knew, names many still revere today: Arthur Burns, Herbert Stein, Paul Volcker, George Shultz, Paul McCracken. Nixon closeted his advisers at Camp David, where they scribbled a plan together, emerging euphoric to be photographed by Life magazine.
On Sunday night television, Nixon presented his New Economic Policy, a cynical plan that helped his political prospects at substantial cost to the long-term economy. He immediately closed the gold window, ending the convertibility of dollars to gold. He imposed temporary wage and price controls. He asked Congress for a tax credit that was frontloaded for maximum impact pre-election, even as he slapped a surcharge on imports.
Many of the minds at Camp David, and at other advice sessions, opposed components of the plan. Shultz, then director of the Office of Management and Budget, fought the wage and price controls. But the economists eventually went along, telling themselves that concessions were the price of being policy makers.
"Ideologically, you should fall on your sword, but existentially it's great," Ben Stein, the son of Herb, told his father.
The short-term results of the New Economic Policy were as splendid as hoped. The Consumer Price Index, now manacled, dutifully declined to 1.7 percent from 4.1 percent the preceding year. Unemployment didn't rise.
By July 1972, four months before voters would choose between Nixon and Democrat George McGovern, Stein, then chairman of the Council of Economic Advisers, held a press conference at which he claimed second-quarter data was "the best combination of economic numbers to be released on one day in all of history, or at least the Christian era." (Reporters politely protected him by editing this down to "the best results in a decade.") Gross domestic product for 1972 grew more than 5 percent. McGovern didn't stand a chance.
But the long-term outcome, as Stein, an admirably honest thinker, later noted, was abominable. In the post-Nixon years, unemployment started rising again. International markets recognized that without the threat of gold withdrawals to keep officials' spending in check, the Federal Reserve, Congress and the Treasury might inflate with impunity.
Inflation therefore also accelerated, as Stein noted regretfully in his memoir, "Presidential Economics." The combination of inflation and unemployment was something so novel that Americans created a new word to describe it: stagflation. The homebuyer paid for the euphoria of Camp David with the worst mortgage interest rates in the history of Christianity, or at least the postwar period: more than 18 percent in 1981.
Only when Volcker, who became Federal Reserve chairman in 1979, started acting as a sort of human gold standard could Nixon's conceit be undone. Volcker forced interest rates up over 20 percent.
There are three takeaway messages from 1971. The first is that economists are arm candy for chief executives: Their appearance beside the president may be reassuring, but it doesn't guarantee strong policy. Economics itself is often mere window-dressing for campaign programs.
The second is that reforms dictated by crisis-intervention teams make for poor long-term policy. Short-term gimmicks, stimuli for employment and automakers -- all are pretty much useless. The best thing the Obama administration can do is to stay clear of the market, avoid election-year panic, and call on Republicans to undertake measures aimed at 2030. If this is unrealistic, then that explains why presidential and congressional approval ratings sank with the market.
Such measures might include commitments to yet smaller budgets and stronger entitlement reforms, or promulgating a new Federal Reserve law that would strip out some of the discretion that Arthur Burns enjoyed, and make the institution more accountable to taxpayers. Something closer to a gold standard would signal to markets that the U.S. is less likely to inflate away its debts in the future. In short, it would show that the debt-ceiling deal earlier this month was only the beginning of a more stable U.S. with a smaller government and a more reliable currency.
Finally: no more shock therapy. The least likely place for real improvements to be written is a self-aggrandizing presidential retreat like Camp David.
(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations, is a Bloomberg View columnist. The opinions expressed are her own.)
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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