American Economic Steps and Missteps – Defining Us Today

 

Huge monetary and fiscal decisions in our modern era have pretty much twisted and squirmed to set our current economic stage. We’ve ignored general economic principles – perhaps no one greater than the “guns or butter” maximum (read: you can have lower taxes or widespread military conflict, but not at the same time) – and paved new economic ground. I generally look at “modern” as post-World War II.

Post WWII United States benefitted greatly by the pre-war New Deal focus on infrastructure, particularly our over-building hydro-electric generating capacity with a surfeit of dams. After the war, we were the only large, developed nation left largely unscarred by bombing and artillery damage. Our factories went into overdrive, returning GIs had “benefits” that generated affordable home ownership and college educations, and unions provided workers paid well enough to become middle class consumers. While most of the rest of the world was engaged in rebuilding, Americans were digging into consuming. In 1957, President Eisenhower (R) signed the National Highway Defense Act which began our incredibly significant economically productive Interstate Highway System.

The Korean War could have been a huge drain on our economy, but it lasted only three years. It ended in 1953, and while the Vietnam War technically began two years later, American involvement did not “escalate” into significant involvement until 1964. It did not end until the fall of Saigon eleven years later. But we began some nasty economic habits that became routine. As the cost of spending rose, government domestic entitlements and military costs rose, but taxes were cut. Nixon’s Tax Reform Act of 1969 did not pare a lot of income tax – indeed his alternative minimum tax even taxed a few rich folks more – but it still represented a cut at a time when we were still at war. Butter and guns. Vietnam began our slow march toward massive federal deficits. But Nixon also implemented a policy that changed the economic complexion of global trade forever.

We take a global economy for granted today, but… “At the end of the Second World War, there was literally no functioning global economy, so nations got together to create a new trading system and a new monetary system. That monetary system was devised in a town in New Hampshire called Bretton Woods, so it was called the Bretton Woods Agreement. One of the key elements was that the dollar would be pegged to gold at $35 an ounce. Other central banks could exchange the dollars they held for gold. In that sense, the dollar was as good as gold. Every other currency had a fixed exchange rate to the dollar.

“They established the dollar-gold standard to create some predictability and stability for global commerce. For the next 25 years, it was a tremendous success… When the Nixon administration came into office in 1969, they realize that the world economy had grown very, very big. Everybody wanted dollars, so the Federal Reserve was printing lots of dollars. As a result, there were four times as many dollars in circulation as there was gold in reserves.

“The rate of $35 for an ounce of gold was good in 1944, but it hadn’t changed, so by 1971 the dollar was really overvalued. That meant imports were very cheap, and exports were very expensive. We experienced our first trade deficit since the 19th century. We were experiencing employment problems. For the first time, the U.S. started to talk about losing competitiveness…

“On top of all that, there was the beginning of inflation. If it continued long enough, dollars would be worth less than they were before. The Nixon Administration was afraid that other countries were going to ask for gold and the U.S. wouldn’t have it. That would have been an enormous humiliation and a breaking of their commitment to exchange gold for dollars…

“In August 1971, President Nixon took his top economic advisors to Camp David. Over three days, they made the radical and momentous decision to cut the dollar loose from gold. In the process, they unilaterally changed the whole global monetary system… Nixon masterfully created a situation where suddenly countries understood that they needed coordinated policies to deal with finance, trade, energy, and food. We entered a period of enormous international cooperation on the heels of this very tough decision that Nixon made at Camp David.” Author and Yale School of Management Dean Emeritus, Jeffrey Garten in the July 19th Yale Insights. But delinking the dollar from a tangible value also enabled a new era of deficit spending.

As the Soviet Union began to crumble, President Ronald Reagan began his supply side/trickle down tax policy, a platform that would become an immutable, even when thoroughly discredited, core vector of the Republican Party for all the years that followed, well into the present day.  “In 1980 Reagan promised those cuts and over his next 2 terms, he cut taxes to the lowest since the 1920s when the top Personal Income Tax rates were lowered from 73% to 25% in the Revenue Act of 1921, the Revenue Act of 1924, and the Revenue Act of 1926. When the tax cuts were finally put into the tax code, one of the longest peacetime expansions in history began… [while t]he budget deficit increased from $74 billion in 1980 to $221 billion in 1990.” Wikipedia. The tax code needed adjusting, and efforts seemed to pay off… at first. But we were effectively living on borrowed money. America was beginning an addiction to quick fixes that would have serious repercussions for years to come.

Debates over “entitlements” and “upgrading and expanding our infrastructure” fell victim to keeping taxes low for the well-heeled. “While the average income grew 75% and the median income grew 10% from 1980-1989, this disparity shows that while top earners made huge gains, bottom earners' income grew slower than the inflation rate for the same decade… The US Federal Tax Revenue as % of the GDP decreased from 18.5 to 17.4 from 1980–1990.” Wikipedia. The long march to severe income inequality had begun. We also learned that wealthy taxpayers do not instantly create new jobs and invest in research and development when they receive a massive tax cut windfall. A rising ride definitely did not float all boats. But that notion is still the most basic Republican economic platform. Even though it has never ever worked, it just sounds so right.

But Democrats also got it wrong, very, very wrong. Passed as part of the 1933 Banking Act, the Glass-Steagall Act was originally intended to separate commercial banks, which accepted deposits, made loans, and were insured by the FDIC, and investment banks, which brought securities issues to markets, acted as brokers, and traded those securities previously issued. Responding to pressures from the financial sector, which felt that separation was not competitively advantageous, in November of 1999, President Bill Clinton led the charge to repeal those restrictions. Effectively, as commercial banks, investment banks and trading institutions merged, they now had access to absurdly inexpensive Federal Reserve bank rates, which, instead of creating more liquidity for the rest of America’s economy, generated cheap loans for investment banks and brokerage houses to invest on their own account.

Mired in a world of derivatives, including bundles of subprime mortgages, our leading financial institutions began overleveraging based on profoundly overvalued assets. The massive economic fall, as institutions like Lehman Bros. and Bear Stearns collapsed and Merrill Lynch survived only because of a forced merger, hammered well after Clinton left office: 2007-2010. Bailouts and emergency federal support squeezed “salvation” from a system that simply proved that “too big to fail” financial institutions could never be trusted to self-regulate.

I’ll end this diatribe with the US proclivity to have guns and butter, most severely illustrated by a massive corporate tax cut, one that created no major shift to more solid jobs, but simply inflated values owned by the mega-rich as the expense of the rest of us: the 2017 Trump corporate tax cut. Right in the middle of our multiple trillion dollar “longest wars ever” in the Middle East and Central Asia. Deficits soared. Income inequality went on steroids.

Deficits in times of crisis, like WWII and the recent/current pandemic, are normal. Since global crises of this kind spread the economic nasties everywhere, the deficits generated within the US to right our ship do not put us at a competitive disadvantage against the rest of the world. But whether we invest in our future or simply continue to coddle the rich will clearly define who we are for the foreseeable future. Too many Americans believe the political slogans of politicians seeking office. Economics are simply too complicated to attempt to understand. Not really!

I’m Peter Dekom, and once and a while we need to step back and understand our current economic realities and how we got here.