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Edited on Sat Nov-19-05 10:48 AM by 1932
I've been reading Richard Parker's biography of John Kenneth Galbraith. I put it down for a few weeks, and just picked it up again. At the top of page 425, I read something that sounds familiar:
Galbraith was dismayed that fellow Keynesians such as Heller, whom he otherwise liked, were opting for the tax cut rather than holding out, as he would have preferred, for passage of substantial expenditure programs that would be as stimulative as the cuts. By mid-1965, as a major war in Southeast Asia came closer, the surrender of progressively oriented revenue-raising authority meant the loss of the government's chief tool to counter economic overheating. His years at the OPA {Office of Price Administration; during WW2} had taught Galbraith an indelible lesson about the economic and political benefits earned when governments controlled war-induced inflation pressures through means the public saw as fair. It was bad enough that the United States was now escalating its military intervention in Vietnam; worse would come when the financial costs escalated, and the administration was unable to limit war-induced inflation. It was no surprise to Galbraith that it took almost three years before Johnson and the Congress passed new tax increases with any bite to them -- long after inflation had taken hold. The only macromanagement alternative until 1968 was a blunt one: it would be up to the Federal Reserve to raise interest rates, the very action likeliest, in Galbraith's view, to derail the economy further and delegitimize both the Democrats and Keynesian theory itself. Predictably, late in 1965, the Fed began to raise rates.
War causes inflation. When the government becomes a market participant for so many materials -- for such a high percentage of industrial output and for so many resources of so many kinds -- it drives up prices. Inflation is bad because it cuts into the profits of so many business activities and because it causes misery for the majority of individuals who don't have enough wealth to effortlessly absorb higher prices. FDR's administration, because it was so concerned with the little guy, used price controls effectively to prevent inflation.
When LBJ began ramping up in Vietnam, Galbraith was worried about the inflationary pressures on the economy. They were inevitable, he thought, due to the very high cost of the war. At the same time, Congress passed and LBJ signed into law a tax bill that took a lot of progressivity out of the tax code, conferring the majority of its benefits to the very wealthy (Reagan invoked it in '81 as the model for his own help-the-wealthy tax cuts). A progressive tax code can help to reduce inflation because it takes some of the huge benefits of inflation for a few people at the top who profit from high prices, and it allows the government to redistribute them in a way that helps people on the bottom grow their economic opportunities.
So, what happens next when you have inflation caused by an expensive war, and a tax code with no progressivity left in it? You have interest rates set by the Federal Reserve as the last hedge against inflation. However, raising interest rates when they don't reflect an improving economy, but because they have to put a lid on rising prices that would hurt about 90% of the market participants (consumers and everyone but the largest businesses) is a sure-fire way to hurt even more people, because it discourages investment and reduces employment at a time when you need to make those investments to keep the economy growing in an equitable manner.
In 1968, that was the course America had set itself on, thanks to (1) an expensive war, (2) a tax code that shifted so much of the money it collected away from the wealthy, and (3) the Federal Reserve increasing interest rates.
Sound familiar? I wonder if the arguments about pulling out of Iraq right now are motivated in part by the realization that we are headed toward 1972 again. 1968-1972 were the twilight years for an era of economic history in America that was quite good for the working person, despite a lot of missed opportunity caused by an over-investment in the military in every post-war administration except Kennedy's. It looks like Parker's book places the blame for its end of this era on the Military Keynesians. Truman and Eisenhower built up the power of the military-industrial complex so much that after Kennedy died, their voices in DC -- Rostow, McNamara, and Bundy, who tried hard, but failed to get Kennedy to drop bombs on everyone -- were finally able to persuade LBJ to do their bidding. LBJ, although an incredible New Dealer on the domestic front, was a foreign policy naive and, although he struggled through decisions that were difficult for him, he ultimately made the mistake of trusting McNamara, Rostow and Bundy and all the others in the Defense and State Department who wanted to spend more money on extending American Empire throughout the globe (but phrased it to LBJ as one final push to win in Vietnam).
(Incidentally, one thing that's different now is that the same companies that make the bombs also sell you light-bulbs and cable TV, so they can get their profit out of the bombs and airplanes while they sell everything else as loss-leaders. I guess that delays the day when they have to start raising prices on their consumer goods customers, but I suspect it will still come around when the war's tremendous costs start shifting to consumers -- we already see the price of so much going up because progressive taxation can no longer help people acquire services at cheaper prices (like health care and education) and because of the destabilizing effects of war (on things like oil prices which then increases prices all down the line.)
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