At The Hill Nick Sargen reminds us of what happened the last time the federal government began implementing plans as ambitious as those of the Biden Administration:
For some observers, this predicament is similar to what occurred in the mid-late 1960s when President Lyndon B. Johnson proclaimed the “Great Society†while the Vietnam War was being ramped up. The initiatives included a “War on Poverty,†creation of Medicare and Medicaid, the launch of the Head Start program, urban renewal and passage of the Motor Vehicle Air and Pollution Control Act.
When these programs were unveiled in the mid-1960s, the federal budget was close to balance and interest rates and inflation were low. Thereafter, federal spending rose by 50 percent in the second half of the decade owing to the expansion in social programs and costs incurred in fighting the Vietnam War. Because tax rates then were substantially higher than today (with the top marginal tax rate for households at 70 percent) the increase in the federal budget deficit did not rise above 3 percent of GDP.
Nonetheless, consumer price inflation, which was only 1 percent at the beginning of the 1960s, rose steadily in the second half and approached 6 percent in 1970. The principal reason was the Fed was slow to raise interest rates and inflation expectations increased. The situation culminated with the first U.S. dollar devaluation in December 1971 that was the precursor of the breakdown of the Bretton Woods system of fixed exchange rates.
and
The main cost incurred by the “Great Societyâ€â€” added healthcare expenses associated with Medicare and Medicaid — did not show up immediately but grew exponentially over time. For example, U.S. spending on healthcare was only 5 percent of GDP when these programs were launched as compared with 18 percent today and federal programs now account for nearly one third of the total.
I share Mr. Sargen’s confidence in the ability of the Fed to manage that. There are some major differences between now and 50 years ago among them that in 1970 imports were only 5% of GDP and now they’re three times that. If Americans do, indeed, spend more as a consequence of the ARPA of 2021, we’ll be subsidizing the recovery of the rest of the world while, if bond rates rise as predicted, income inequality will be exacerbated.
As I’ve said previously I’m less concerned about consumer inflation than I am about stunting our economy’s ability to grow in the future or of catastrophic loss of confidence in U. S. credit.
Inflation is always a monetary phenomenon, and while it can affect consumer prices, it mostly manifests in asset prices. To understand the 1970’s, Bretton Woods, and increased imports, one must understand the implications of LBJ removing the Gold Cover.
Prior to 1968, dollar creation was limited by the US gold supply. It was not a gold standard, and over the years, the amount of gold per dollar had been lowered several times. This limit constrained the amount of money LJB could spend. Hence, he removed it.
One of the results was that foreign countries began exercising the Bretton Woods gold exchange provision, and the because the US gold supply exceeded the dollar supply, the gold supply was dwindling.
This is why Nixon “closed the gold window”, and this allowed unlimited US dollars to be created and used to purchase foreign goods. When Sen. Phil Graham and President Clinton repealed Glass-Steagall, it became more profitable to offshore manufacturing goods to be exchanged for domestically created dollars.
Between 1968 and 1998, there were other changes that contributed to today’s trade deficit, but removing the Gold Cover and repealing Glass-Steagall were the catalyst.
The article refers to a paper by Michael Bordo and Mickey Levy which covers 200 years. I have not read the paper, but while “two centuries” may sound impressive, it is meaningless, monetarily. The monetary system has profound effects on expansionary fiscal policies, inflation, and the relationship between the two.
Unless they have accounted for the implication of these changes, they are comparing apples to suitcases to inches to love. It might be possible to make some reasonable comparison between these, but I doubt it.
While some results of the previous decade’s spending can be reasonably deduced, we are mostly in ‘uncharted waters’, and with the US and much of the global economies shut down for a year, the most likely outcome is an unknown unknown.
In my opinion, the US is poised for an economic catastrophe, but we could have the most successful economy in all history. Without manufacturing and heavy industry returning, success is probably not possible.
I’m less concerned about consumer inflation than I am about stunting our economy’s ability to grow in the future or of catastrophic loss of confidence in U. S. credit.
If the trajectory does not change, it is becoming much, much more likely.
The Great Society is not the best analogy. WWII, WWI, the Civil War, and perhaps the Revolutionary War are better analogy to the present fiscal situation, but what the US Government is trying is best described as an experiment that’s never been tried before (in this country).
A deficit of 15%+ like 2020/2021 only occurred during those major wars. A debt to GDP ratio of 100%+ has occured only in 1945-1947. In Johnson’s day, the deficit was < 5% of GDP with a GDP/debt ratio around 40%.
What is novel is the Government is increasing its rate of borrowing coming out of the emergency. Imagine after WWII ended the Government did not demobilize and forced the public to buy more wartime bonds. Another novel factor is demographics; the baby boom post WWII was an inflationary tailwind. So far, the pandemic appears to have caused a baby bust, which is deflationary.
I'm not predicting doom, because what is happening has no historical analogues (for this country). The US could be following Japan, where extraordinary spending and monetary stimulus after the 2011 Tsunami failed the expectations of both the proponents and the detractors (i.e. no economic boom and no hyperinflation).