At the historic Camp David meeting of Sunday, August 15, 1971, President Richard M. Nixon was persuaded by his economic advisors to default on the national debt. They didn’t quite put it that way, of course. Nixon agreed to close the gold window, which amounted to the same thing, inasmuch as the United States government had promised to pay its debt in dollars legally defined as a specified weight of gold. Closing the gold window brought a formal end to America’s full-faith debt obligations, as we had really stopped using the gold window in 1968. Prior to that year, when foreign central banks scooped up surplus dollar liquidity, they could still come to the U.S. Treasury and swap paper for gold at $35 an ounce. On March 17, 1968, President Lyndon Johnson closed the London gold pool, which meant that U.S. creditors represented by foreign central banks had little choice but to accept Treasury bonds for the dollars they accumulated. We were cheating them, something great nations or good people are not supposed to do, but our leadership decided at the time we had to do so. President Nixon assured the free world that it was in their interest as well as ours that we devalued the dollar, because we were the leaders of the free world, and devaluation would strengthen us. We paid the price, as interest rates climbed on our longterm national debt, from 3% to 4% to 5% in ‘71, then to 10% and 15% in ‘81. Monetary inflation wrecked our public finances, humbled our private banks, crushed our S&Ls, savaged capital formation, sent real wages of the work force into a 30-year net decline, and largely caused the 15-fold increase of the national debt. The far greater cost was not financial, but social, as the corruption of the national money was transmitted through the contractual obligations of the general population. The work ethic is no more easily shattered than when the linkages between effort and reward are destroyed by the manipulation of the currency.
I recount this old story, well known in our circle, as the 104th Republican Congress threatens an official default on the national debt. It does so on the grounds that it is so clearly in the national interest to balance the budget and that our creditors would not mind if we, the people of the United States, cheated them, just a little bit, temporarily, for their own good. House Speaker Newt Gingrich has developed this line of reasoning with his own cluster of Wall Street advisors, including Ken Langone, Ed Hyman, and Stanley Druckenmiller. The credit markets, they say, are so eager to see government spending decline, they might even prefer a default. The Wall Street Journal seems to have been taken in by this quackery. In its Thursday editorial last week, “The Market Bogeyman,” the Journal takes favorable note of Hyman’s reasoning: “Wall Street assumes Washington will go on behaving just like Washington. But if there were actually a default, it would mean something serious is going on. So the financial markets would respond positively.” The creditors who don’t get paid will dance in the streets.
The editorial undermines 20 years of Journal arguments against the hoary notion of crowding out in the capital markets, the idea sold to both Herbert Hoover and Franklin Roosevelt as they deepened the Great Depression with tax increases. That is, if the budget is not in balance, the government is forced to the head of the credit line in the capital markets, taking investment cash away from private capital needs. Where the Journal once laughed at this zero-sum, cash-flow, single-entry bookkeeping analysis of capital formation, it is now being dragged into its defense because of its paramount goal, which is to shrink the size of the federal government -- except for the B-1 bomber. As the voters have learned over the years, economic growth usually takes a back seat when Republicans get a shot at tearing down the dreaded New Deal and Great Society. In 1981, even Ronald Reagan was talked into deferring the deep tax cuts he promised the voters, by a GOP establishment eager to whack away at “the social pork barrel,” David Stockman’s felicitous phrase. The resultant 1981-82 recession, the deepest since the 1930s, accomplished nothing but the impoverishment and fracturing of the nation’s poorest and blackest families.
This is now again the mind set of Republicans in control of the House of Representatives for the first time in 40 years. The pendulum has finally swung far right, and Republicans are seized with the awful thought that unless it does as much damage to government as possible right now -- in the next six or eight weeks that remain to the year -- the opportunity will be lost for another generation. The pendulum will soon swing back toward statism again, or so their guiding light tells them. The hyperbole of the freshmen class in their budget-balancing pep rallies approaches kamikaze heroics. This chemistry pervades the recent conservative broadsides against Jack Kemp and Colin Powell, viewed as moderates in the pursuit of liberty, to use Barry Goldwater’s 1964 kamikaze cry.
While these passions hold, the GOP shies from talk of economic growth -- because growth produces federal revenues that can sustain federal spending. In 1978, after the historic passage of Proposition 13 in California, Howard Jarvis, its populist champion, told me at a lunch we had in NYC that he had read and enjoyed my book, but did not like the Laffer Curve. Why? Because it showed that tax cuts could produce increased revenue to feed the government!! This is the surreal attitude that now dominates the Republican Congress. When the 104th Congress began, it was the Republicans who were complaining about the “static budget analysis” of the Clinton Treasury, which was ignoring the powerful growth and revenue effects of capital gains tax reduction. Now, it is the Clinton Treasury that is producing a rosy economic scenario, which shows higher revenues than the GOP Congress wants to see. It is the same debate, but the difference is that Republicans want to score tax cuts dynamically and Democrats want to score spending dynamically. They are both right. Some tax cuts produce revenue gains and some losses. Some government spending produces a positive investment return, some a negative. The Laffer Curve, after all, is only a way of thinking about the law of diminishing returns.
The financial markets are doing as well as they are because they see a reasonable balance between the President and the Congress. This should prevent kamikaze action on debt default and enable Gingrich and Dole to find a budget reconciliation with the President. The political incentives here are all in the direction of compromise, the “inducements to moderation” in our constitutional architecture that Alexander Hamilton described in the first of the Federalist papers. If there is a casualty because of these delays, the markets must worry more about postponement of the telecommunications bill, which is perhaps why the relevant high tech stocks have been hammered so hard today. Time is running out, and if AT&T can kill telecomm this year to hold off the future, the bill may stay submerged through the election year.
Republicans who are now eager to make hay while the sun shines on them are aware of the “inducements to moderation” that characterize our political system. They can already see the Democratic Party, which has been swept off its feet, regaining its footing as the party of government service, of public goods, of the least competitive among us. If the two parties can work out their budget differences between now and Christmas, the public/private pendulum swings on taxes and spending may then return to peacetime, clockwork rhythms, narrow and regular, of a kind we haven’t seen for a while.