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Aggregate Demand Dominance: The Lost History of the Early 1970s

Where did economics run so far off the rails, that supply-side dogma has so corrupted the field of macroeconomics?  Take one guess:

On August 15, 1971, Richard Nixon implemented the most radical economic program in American history. And it was all done over a single weekend in secrecy worthy of the atomic bomb project during World War II. While ultimately unsuccessful, the Nixon program showed what a forceful president can do to completely change the nation’s course if he is willing to push the limit of his power.

The prelude to Nixon’s actions was that inflation had become a serious problem. From 1952 to 1965, inflation rarely ever went above 2 percent. But starting in 1966, it became worse and worse, rising from 1.6 percent in 1965 to 5.7 percent in 1970.

At first, I believed I couldn’t disagree with Bruce Bartlett.  The data seems to check out:

Year

jan

feb

Mar

apr

may

jun

jul

aug

sep

oct

nov

dec

ann

1965 0.971% 0.971% 1.294% 1.618% 1.618% 1.935% 1.608% 1.935% 1.608% 1.929% 1.603% 1.923% 1.613%
1966 1.923% 2.564% 2.556% 2.866% 2.866% 2.532% 2.848% 3.481% 3.481% 3.785% 3.785% 3.459% 2.857%
1967 3.459% 2.813% 2.804% 2.477% 2.786% 2.778% 2.769% 2.446% 2.752% 2.432% 2.736% 3.04% 3.086%
1968 3.647% 3.951% 3.939% 3.927% 3.916% 4.204% 4.491% 4.478% 4.464% 4.748% 4.734% 4.72% 4.192%
1969 4.399% 4.678% 5.248% 5.523% 5.507% 5.476% 5.444% 5.714% 5.698% 5.666% 5.932% 6.197% 5.46%
1970 6.18% 6.145% 5.817% 6.061% 6.044% 6.011% 5.978% 5.405% 5.66% 5.63% 5.6% 5.57% 5.722%

But who exactly was responsible for the sharp spike in inflation rates that began in early 1969, hitting almost 6.2% in January 1970?

Mar 18, 1969:

U.S. bombs Cambodia for the first time

U.S. B-52 bombers are diverted from their targets in South Vietnam to attack suspected communist base camps and supply areas in Cambodia for the first time in the war. President Nixon approved the mission–formally designated Operation Breakfast–at a meeting of the National Security Council on March 15. This mission and subsequent B-52 strikes inside Cambodia became known as the “Menu” bombings. A total of 3,630 flights over Cambodia dropped 110,000 tons of bombs during a 14-month period through April 1970. This bombing of Cambodia and all follow up “Menu” operations were kept secret from the American public and the U.S. Congress because Cambodia was ostensibly neutral.

Nixon’s inflation problems were self-inflicted.  But Bruce Bartlett is correct, inflation was becoming a problem for the Republicans politically.  The Democrats gained 12 House seats in the 1970 midterm elections (but still managed to lose four Senate seats).  So Bartlett naturally blames Lyndon Johnson for Nixon’s predicament:

Lyndon Johnson’s advisers convinced him to impose a 10 percent income tax surcharge in 1968 to soak up purchasing power, but this had no effect on inflation whatsoever. Nixon’s advisers knew that the Federal Reserve could stop inflation by tightening monetary policy, but that would likely bring on a recession going into an election year. Nixon desperately needed to keep inflation bottled up until after the election.

I’m going to reemphasize an aspect to this story that is missed endlessly:

Immoral?  I’ll Give You Immoral!

During the time-frame Mr. Bartlett describes, the U.S. was directing an absolutely epic volume of firepower at a small corner of Asia:

The United States Air Force dropped in Indochina, from 1964 to August 15, 1973, a total of 6,162,000 tons of bombs and other ordnance. U.S. Navy and Marine Corps aircraft expended another 1,500,000 tons in Southeast Asia. This tonnage far exceeded that expended in World War II and in the Korean War. The U.S. Air Force consumed 2,150,000 tons of munitions in World War II – 1,613,000 tons in the European Theater and 537,000 tons in the Pacific Theater – and 454,000 tons in the Korean War.

The most intense bombing strikes of the entire war, Operation Linebacker and Linebacker II, were yet to come in August 1971 (Linebacker was unleashed in response to the North Vietnamese 1972 Easter Offensive, Linebacker II was the so-called Christmas Bombing designed to bring the North Vietnamese back to the negotiating table).  Quick raise of hand who thinks Nixon could politically afford to trigger a recession while fighting a brutal war that had culminated in the largest military air campaign in history and in the process has set a small region in the world known as Southeast Asia on fire?

I’m only now beginning to understand why economists in 1971-73 couldn’t tabulate the effects of the most expensive phases of the Vietnam War—huge portions of the war were hidden away.  Even more than forty years on, wildly inaccurate information is presented as fact:

February 1969

In spite of government restrictions, President Nixon authorizes Operation Menu, the bombing of North Vietnamese and Vietcong bases within Cambodia. Over the following four years, U.S. forces will drop more than a half million tons of bombs on Cambodia.

PBS’s numbers are off only by a factor of five.  But before delving into the bombing of Cambodia, I have to acknowledge that the U.S. Air Force was ordered to secretly wage war against another noncombatant country:

As part of its efforts during the Vietnam War, the United States began a nine-year bombing campaign in Laos in 1964 that ultimately dropped 260 million cluster bombs on the country — the most heavily bombed country in history. That’s more than 2.5 million tons of munitions — more than what the U.S. dropped in World War II on Germany and Japan combined.

Sadly, the “most heavily bombed country in history” statement probably belongs to Laos’s neighbor to the south.  Cambodia seems to be the worse-hit victim of American Vietnam-era aerial warfare:

The still-incomplete database (it has several “dark” periods) reveals that from October 4, 1965, to August 15, 1973, the United States dropped far more ordnance on Cambodia than was previously believed: 2,756,941 tons’ worth, dropped in 230,516 sorties on 113,716 sites. Just over 10 percent of this bombing was indiscriminate, with 3,580 of the sites listed as having “unknown” targets and another 8,238 sites having no target listed at all. The database also shows that the bombing began four years earlier than is widely believed—not under Nixon, but under Lyndon Johnson. The impact of this bombing, the subject of much debate for the past three decades, is now clearer than ever. Civilian casualties in Cambodia drove an enraged populace into the arms of an insurgency that had enjoyed relatively little support until the bombing began, setting in motion the expansion of the Vietnam War deeper into Cambodia, a coup d’état in 1970, the rapid rise of the Khmer Rouge, and ultimately the Cambodian genocide.

This doesn’t make a lick of sense.  The Cambodians were not in any way turning against the U.S. in 1969-70:

On December 9, 1970, US President Richard Nixon telephoned his national-security adviser, Henry Kissinger, to discuss the ongoing bombing of Cambodia. This sideshow to the war in Vietnam, begun in 1965 under the Johnson administration, had already seen 475,515 tons of ordnance dropped on Cambodia, which had been a neutral kingdom until nine months before the phone call, when pro-US General Lon Nol seized power. The first intense series of bombings, the Menu campaign on targets in Cambodia’s border areas — labelled Breakfast, Lunch, Supper, Dinner, Dessert, and Snack by American commanders — had concluded in May, shortly after the coup.

Nixon has unleashed an immense aluminum jet-fueled fist otherwise known as Strategic Air Command:

A single B-52D “Big Belly” payload consists of up to 108 225-kilogram or 42 340-kilogram bombs, which are dropped on a target area of approximately 500 by 1,500 meters. In many cases, Cambodian villages were hit with dozens of payloads over the course of several hours. The result was near-total destruction. One US official stated at the time, “We had been told, as had everybody…that those carpet-bombing attacks by B-52s were totally devastating, that nothing could survive.” Previously, it was estimated that between 50,000 and 150,000 Cambodian civilians were killed by the bombing. Given the fivefold increase in tonnage revealed by the database, the number of casualties is surely higher.

These B-52 raids backfire badly:

The Cambodian bombing campaign had two unintended side effects that ultimately combined to produce the very domino effect that the Vietnam War was supposed to prevent. First, the bombing forced the Vietnamese Communists deeper and deeper into Cambodia, bringing them into greater contact with Khmer Rouge insurgents. Second, the bombs drove ordinary Cambodians into the arms of the Khmer Rouge, a group that seemed initially to have slim prospects of revolutionary success. Pol Pot himself described the Khmer Rouge during that period as “fewer than five thousand poorly armed guerrillas scattered across the Cambodian landscape, uncertain about their strategy, tactics, loyalty, and leaders.”

The Nixon administration knew that the Khmer Rouge was winning over peasants. The CIA’s Directorate of Operations, after investigations south of Phnom Penh, reported in May 1973 that the Communists were “using damage caused by B-52 strikes as the main theme of their propaganda.” But this does not seem to have registered as a primary strategic concern.

I was always curious why the bombing continued apace in Cambodia after the Paris-mediated ceasefire in South Vietnam on January 27, 1973.  It was actually a massive escalation:

https://i2.wp.com/walrusmagazine.com/images/2006.10/l/cambodia03.jpg

The last phase of the bombing, from February to August 1973, was designed to stop the Khmer Rouge’s advance on the Cambodian capital, Phnom Penh. The United States, fearing that the first Southeast Asian domino was about to fall, began a massive escalation of the air war — an unprecedented B-52 bombardment that focused on the heavily populated area around Phnom Penh but left few regions of the country untouched. The extent of this bombardment has only now come to light.

…which failed utterly:

The Nixon administration kept the air war secret for so long that debate over its impact came far too late. It wasn’t until 1973 that Congress, angered by the destruction the campaign had caused and the systematic deception that had masked it, legislated a halt to the bombing of Cambodia. By then, the damage was already done. Having grown to more than two hundred thousand troops and militia forces by 1973, the Khmer Rouge captured Phnom Penh two years later. They went on to subject Cambodia to a Maoist agrarian revolution and a genocide in which 1.7 million people perished.

Phnom Penh falls in 1975–the same year Saigon falls despite the fact that both Cambodia and Vietnam each absorbed more bombing from the U.S. military than the total tonnage of American bombs that blasted and burned Germany and Japan during World War II.  But Nixon really wasn’t responsible for all this, was he?  In Cambodia, he was just continuing the previous administration’s foreign policy, right?

No.  If there is a temptation to blame Johnson for the Cambodian debacle, don’t.  Just don’t:

Thanks to the database, we now know that the US bombardment started three-and-a-half years earlier, in 1965, under the Johnson administration. What happened in 1969 was not the start of bombings in Cambodia but the escalation into carpet bombing. From 1965 to 1968, 2,565 sorties took place over Cambodia, with 214 tons of bombs dropped. These early strikes were likely tactical, designed to support the nearly two thousand secret ground incursions conducted by the CIA and US Special Forces during that period. B-52s—long-range bombers capable of carrying very heavy loads — were not deployed, whether out of concern for Cambodian lives or the country’s neutrality, or because carpet bombing was believed to be of limited strategic value.

214 tons of bombs.  Granted, that is 428,000 lbs of explosives–not a trivial amount.  But that is less than the fully-loaded weight of a single B-52 taking off from Andersen Air Force Base on Guam.  Moreover, 214 tons is trivial in the context of the overall campaign: 2,756,941-214= 2,756,727 tons of ordnance dropped on Cambodia after March 18, 1969.  99.992% of the bombing in Cambodia occurred due to Nixon’s orders.  He was also largely responsible for the Laotians’ misery:

http://pslarson2.files.wordpress.com/2010/12/poundts.jpeg

This doesn’t let Lyndon Johnson off the hook, of course.  Laos was frequently attacked by American combat aircraft before 1969:

http://pslarson2.files.wordpress.com/2010/12/laosbombingts.jpeg

But the operations in Laos under Johnson seem almost defensible

Initial American compliance with the 1962 Geneva agreements was better than that of the North Vietnamese.  Although we withdrew all of our 666 military advisors by the October deadline, they pulled out a mere handful, leaving somewhere between 6,000 and 10,000 North Vietnamese fighting men in Laos. 

[I]t was not long before we were back in Laos in several very big ways, participating in what amounted to two wars.  One was over the Ho Chi Minh trail, a network of roads, waterways, and trails in the eastern part of the Laotian panhandle that the Communists were using for the transportation and provisioning of their troops in South Vietnam and Cambodia.  This campaign was largely an adjunct of the war in Vietnam and thus an almost exclusively American show: Laotian troops rarely participated.  The other was for control of northern and central Laos, and involved a struggle between Laotian government forces supported by their American and Thai allies, and the Pathet Lao and their North Vietnamese allies.  American participation in these campaigns took several forms: (1) training anti-Communist troops (sometimes even accompanying them into battle), (2) supplying them with arms, food, and other equipment, (3) transporting them in and out of action, and (4) supporting them by heavy bombing of Communist positions.

…compared to doing this:

During the administration of US President Richard Nixon, and under the counsel of his advisor for National Security Affairs Henry Kissinger, the United States drops more than two million tons of bombs on Laos during more than 500,000 bombing missions—exceeding what it had dropped on Germany and Japan during all of World War II—in an effort to defeat the left-leaning Pathet Lao and to destroy North Vietnamese supply lines. The ordnance includes some 90 million cluster bombs, 20-30 percent of which do not detonate (see After 1973). A Senate report finds: “The United States has undertaken a large-scale air war over Laos to destroy the physical and social infrastructure of Pathet Lao held areas and to interdict North Vietnamese infiltration… throughout all this there has been a policy of subterfuge and secrecy… through such things as saturation bombing and the forced evacuation of population from enemy held or threatened areas—we have helped to create untold agony for hundreds of thousands of villagers.” And in 1970, Far Eastern Economic Review reports: “For the past two years the US has carried out one of the most sustained bombing campaigns in history against essentially civilian targets in northeastern Laos…. Operating from Thai bases and from aircraft carriers, American jets have destroyed the great majority of villages and towns in the northeast. Severe casualties have been inflicted upon the inhabitants… Refugees from the Plain of Jars report they were bombed almost daily by American jets last year. They say they spent most of the past two years living in caves or holes.”

Nixon massively intensified the aerial assault on Laos, which eventually blanketed the entire country:

http://pslarson2.files.wordpress.com/2010/12/laospoundspop.pnghttp://pslarson2.files.wordpress.com/2010/12/laospounds.png

Just as in Cambodia and Vietnam, the Laos bombing campaigns totally failed.  The Pathet Lao took control of Laos in 1975, and remain in power to this day.

This is a stark lesson proponents of strategic bombing should be forced to acknowledge–when Richard Nixon vastly increased the volume of ordnance falling on two neutral (at times allied) countries in Indochina, the indiscriminate nature of dropping millions of tons of bombs on tiny nations came back to haunt the United States.  One might posit the three dominoes in Southeast Asia fell not despite the bombing, but because the U.S. dropped 2.7 million tons on Cambodia, 2.5 million tons on Laos, and 2.4 million tons on North and South Vietnam (give or take a few hundred thousand tons of explosives).  Well, at least for the first two cases…

Of course, to Richard Nixon’s detractors this isn’t surprising.  It only adds to the fires.  But I would wager that these campaigns had massive economic effects that even today are not recognized.

War Damage to Economic History

The economic history of the early 1970s often seems to forget that the U.S. was at war.  As a student of both, I could not understand how that came to be.  In some ways, I still can’t.  Stating Nixon’s imposition of price controls on August 15, 1971 occurred during peacetime is simply false—U.S. combat involvement in Vietnam (not to mention Cambodia and Laos) did not cease until 1973.

Economists failed in the early 1970s and continue to fail now to understand that the Vietnam War became far more resource-intensive from 1969 to 1973 even as American casualty rates decreased precipitously.  Still, the source of inflation from 1965 until March 1973 seems obvious and singular to me: combat operations in Cambodia, Laos, North and South Vietnam.  I kept asking myself–why isn’t this factored into the story of the 1970s stagflation?

I now realize that the tight secrecy around the aerial operations in Cambodia and Laos didn’t really recede until the dying days of Bill Clinton’s second term in office.  Nixon managed to demobilize the U.S. Army while standing up the U.S. Air Force, the latter’s mobilization hidden due to the fact SAC air crews were used to a normal frantic pace dating from the days they served under the command of General LeMay and General Power. 

But that doesn’t change the fact that the air war over Cambodia, Laos and Vietnam was more than three times the size and intensity of World War II, and that intensity was greatest in 1972 and 1973.  Nixon’s price controls, which I previously linked with other wartime uses of price controls (WWII and Korea), likely were a mechanism to intensify the air campaigns in addition to Nixon’s desire to be reelected.  As I mentioned back in March, Nixon’s controls succeeded beyond expectation during Phases I and II:

The United States had boots on the ground, in combat, on August 16, 1971.  So, the first order of business was to anger and demoralize the troops in a warzone by freezing their pay?  Should we be surprised that the Executive Branch’s impoundment power which permitted Nixon to defy Congress to impose the pay freeze in the first place, with the enactment 23 months later of the Congressional Budget and Impoundment Control Act of 1974, would be removed?  Let me reiterate this: every time price controls have gone into effect in the United States the nation was waging war.  Richard Nixon’s price controls have a different distinction—this was the first instance during which price controls were imposed for political rather than military reasons.

But damned if Nixon’s pay freezes didn’t work at containing inflation at first:

Early in the Council’s deliberations it was decided that the freeze could not simply be lifted after 90 days without some follow-up program and the Council approved a plan to usher in a period of more flexible wage and price controls called Phase II. (Phases of the controls program, like World Wars and Super Bowls, were denominated in Roman numerals.) The Council didn’t want the administrative burden or political responsibility for actually running Phase II, so it established a Price Commission to impose price controls and a Pay Board to limit wage increases. But the Council remained in overall charge.

Phase II rules essentially allowed companies to pass through increased labor and component costs but, by establishing pre-notification requirements and profit margin limitations, they limited company eligibility for price increases. The real action was on the wage side.

The wage freeze and the follow-on Phase II wage standard, limiting wage increases to no more than 5.5%, reduced the inflationary pressure on prices. The labor leaders on the Pay Board were willing to support wage restraint in order to lower the rate of inflation so long as there was discipline on the price side.

Phase II, like the freeze, was a political ten-strike for Richard Nixon and for the U.S. economy. Inflation slowed, economic activity recovered and organized labor grudgingly agreed to moderate wage demands. The principal union chieftains had been named to the Pay Board and their cooperation was effectively marshaled by George Shultz, who was at that time Director of OMB, and by John T. Dunlop, a little-known Harvard professor who was an expert in labor-management issues and was destined to play a central role in the drama which unfolded.

John T. Dunlop was a former chairman of the Harvard University economics department and dean of the faculty of arts and sciences. He wore a bow tie, but he was no meek academic. He was robust and barrel-chested with a prickly temperament and an earthy vocabulary. No one knew labor management relations better than Dunlop. He was personally close to both labor and business leaders and, for many years, had served as an intermediary who was trusted by both sides. Since 1971, he had been head of the Construction Industry Stabilization Committee and had used his knowledge of the equilibrium among different unions in different regions to lower the pace of wage settlements sharply in the construction industry. Most nights he could be found in the bar of the Harrington Hotel in downtown Washington settling labor disputes in his own unorthodox but highly-effective manner.

A side note: the long march of steadily increasing postwar wages is almost universally acknowledged to have ended in 1973.  I’m no expert, but I believe there is reason to believe John Dunlop brought the 1943-73 era of prosperity to a close.

But inflation would not take off until March 1973.  The bombing in Cambodia was ramping up to its worst levels at the time (Laos bombing ending that March and Vietnam bombing ending in December 1972), but this time, Bruce Bartlett partly hits the history target:

Another concern was that the international monetary system was falling apart. Established at Bretton Woods in the aftermath of World War II, its foundation was having the dollar convertible to gold at $35 per ounce, with other currencies fixed to the dollar. But inflation was putting severe pressure on the exchange rate system and for 10 years American presidents had been fending off European demands to trade their dollars for our gold.

One way out of the inflation problem was wage and price controls. But the Nixon administration was officially opposed to them. On July 28, 1971, Council of Economic Advisers Chairman Paul McCracken wrote an op-ed article for The Washington Post denouncing wage and price controls in the strongest possible terms. They would undermine personal freedom, he said, and wouldn’t even work because there were too many prices, such as those for basic commodities, that couldn’t be controlled.

In mid-August, 1971, a crisis arose when Great Britain demanded $3 billion worth of gold (worth $150 billion at today’s gold price). This led Nixon to call a special meeting of his economic advisers at Camp David on Friday, August 13.

Why, exactly is Britain demanding 2,678.57 TONS of gold?  Other than the fact that the British could sell that massive pile for $3,662,571,428.57 on the London gold market to recapitalize after their currency crashed in November 1967? 

You’re getting closer, Mr. Bartlett:

On Sunday, August 15, Nixon announced the imposition of wage and price controls throughout the U.S. economy, making dubious use of emergency presidential authority. He also closed the gold window and set the dollar free to float, destroying in one fell swoop the international monetary system that had existed for 25 years.

Congress passed the Economic Stabilization Act to give Nixon price control authority on August 15, 1970 (one year to the day before Nixon would use that authority), hoping to score political points in the upcoming midterm elections.  That doesn’t sound like emergency authority to me, Mr. Bartlett.  As for setting the dollar to float, yes!  That signaled the start of the 1970s stagflation.  But, Mr. Bartlett, you’ve got the wrong date:

There was hope that the Smithsonian currency alignment in December 1971 would work for some time.  The U.S. dollar gained strength in the second half of 1972.  Unfortunately, after a heavy speculative attack on the dollar it was suddenly devalued on 12 February 1973 for the second time after World War Two.  This time, it was devalued by 10 percent, as the official price of gold was increased from US$38 per oz fine to US$42.22.  Soon after the second devaluation, there was another heavy speculative attack on the dollar so much so that foreign exchange markets all over the world had to be closed from 2 March for seventeen days.  When the exchange markets were reopened, the major currencies of the world including the US dollar, Deutsch Mark, Japanese Yen, Pound Sterling, French Franc, Dutch Guilder etc. were all floating.  The world was now in a floating exchange rate system as a revolt against the IMF fixed exchange rate system.

August 15, 1971 was just one more signpost on the highway to Bretton Woods’ destruction, that road ending on March 19, 1973 when the U.S. dollar was (along with the Mark, Yen, Pound, Franc and Guilder) finally floated.

I really don’t want to pick on Bruce Bartlett; after all his descriptions of monetary velocity are, in my book, brilliant.  As I’ve mentioned previously, tracking down the actual date when the dollar first floated was a trial.  But once one finds the correct date, the pieces start falling into place:

Conversation Among President Nixon, the Chairman of the Federal Reserve System Board of Governors (Burns), the Director of the Office of Management and Budget (Ash), the Chairman of the Council of Economic Advisers (Stein), Secretary of the Treasury Shultz, and the Under Secretary of the Treasury for Monetary Affairs (Volcker)1

Washington, March 3, 1973.

[Omitted here is discussion unrelated to international monetary policy.]

Shultz: I thought we might let Paul give a brief description of what has happened, and where we are, and then I can summarize some of our thinking, and then there are a couple of developments [unclear] particularly your letter to Mr. Brandt2 that I think—

Nixon: Good.

Shultz: —suggests the direction of their thinking very strongly. But Paul, why don’t you first describe the situation.

Volcker: Well, very briefly, the situation, basically, is that we made another exchange rate adjustment two weeks ago, which we thought was appropriate, which our trade department thought was appropriate, and, basically, changed the exchange rates into what everybody concedes, I think, is a better long-term realignment. But in the process, we ran into a little problem, which was not entirely unexpected; that you can’t devalue the dollar twice in two years without unsettling the psychology and creating doubts in many people’s minds about what’s going to happen next. And, why, it tipped either way for a few weeks and finally went—

Nixon: Down.

Volcker: —in the wild speculative direction.

Nixon: In other words, we were responsible for that to an extent.

Volcker: Well, I, I think—

Nixon: By creating a lack of confidence in our own [unclear]—

Volcker: I think we were forced to make an exchange rate change of a sizable amount over—in the past two years, looking at both of them together. And the United States changing its exchange rate is unsettling psychologically. I don’t think we can get around that—however necessary. And we see some of the results of this. We’ve done a few things: changing the discount rate; we put out reassuring statements—they weren’t quite enough to stabilize the psychology. So, we have a peculiar situation where everybody, basically—most people think that exchange rates are basically much sounder aligned then, but the nervous speculator is out to pick out any weak spot here or there, and he runs to the traditional havens. The Swiss franc has been strong for so many years; with Swiss francs it’s the same thing; and to the mark it’s the same thing; and to gold, the same thing. So, you’re now forced to the point of decision. And I think there are two possible courses here in the most general terms: we can go—in fact, complete the transition, which is half there, toward floating rates, at least as an interim measure, at the least as an interim kind of measure. And—but the major European countries have now fixed—moving in that direction, together or separately. Or, I think, potentially, one could get together with those countries and decide to stabilize these rates and, and hope, with a concerted effort, for an indefinite period. I think this could be done, if people wanted to do it. And, the two actions have, have different implications and different risks of—and so are very difficult to judge. You can tell there’s a risk “y” in either direction, but assigning probability to—is difficult, because we’re in unknown territory; we’re in territory we haven’t been in for many, many years, anyway. But, just the pros and cons, as I see them: first of all, I think you should say in the Brandt letter—suggest the Europeans [unclear] your thoughts. The Europeans really are in a mood where they think their floating is their first option. I think this is the first time they’ve been in this mood. And, not necessarily happily, but they, for one reason or another, are inclined to think that’s the primary direction in which to go. Now, the question that arises there—I think there are two, in my judgment: whether, given the upset state of market psychology, these float—floats will be smooth and stabilizing? Or, whether the market will take it as another indication of a kind of official weakness and be out to crack every exchange rate they can; push it all over too wide a spectrum of fluctuation and kind of undermine confidence in the whole system, which is already [unclear] and the lack of domestic confidence? In one sense, it leaves all our options open, I think, for future reform. In another sense, by leaving the European options open, too, it creates opportunities for others to try to impose their view on our domestic situation. So, it’s very fluid, both in the sense of, I think, immediate market responses, and its effects on financial confidence around the world, and in its potential for long-term economic reform—monetary reform. If it worked out smoothly, if you had smooth floats, that would be fine, and [unclear] in our interest, but I think basically it would—that says this is inherently a bad action, but you can’t be sure of that, because so much depends upon market psychology. Now, we can, I think, take the alternate course and make a dramatic gesture. More than a gesture: whatever we would make, we’d have to be willing to put money behind it. I don’t think there’s any great financial risk, but we could make a dramatic show against the speculators—and maybe win, in the short run. The question is we—whether we have given kind of hostages to fortune in the future by dedicating ourselves to this particular rate structure, but in a way that will give us problems a year from now.

Volcker probably wishes the problems only started a year later:

Year

jan

feb

mar

apr

may

jun

Jul

aug

sep

oct

nov

dec

ann

1973 3.65% 3.874% 4.589% 5.06% 5.529% 5.995% 5.728% 7.381% 7.363% 7.801% 8.255% 8.706% 6.22%
1974 9.39% 10.023% 10.393% 10.092% 10.706% 10.86% 11.512% 10.865% 11.947% 12.061% 12.2% 12.338% 11.036%
1975 11.803% 11.229% 10.251% 10.208% 9.465% 9.388% 9.717% 8.6% 7.905% 7.436% 7.379% 6.936% 9.128%

The Great Inflation started right here—in March 1973.  Anyone hazard a guess why?

***Hint—the fixed exchange system was inherently unstable, and in reality acted like the price controls Mr. Bartlett is decrying.***

10 thoughts on “Aggregate Demand Dominance: The Lost History of the Early 1970s

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  3. You could definitely see yur enthusiasm in the work you write.
    The arena hopes for even more passionate writers such as you who aren’t afraid too say hhow they believe.
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