What Is to Be Done?

February 6, 1961

President Kennedy’s assurance that “the dollar must be protected, the dollar can be protected in its present value” is gratifying as far as it goes, but will require courageous measures to make it effective.

The first thing we must do is to make the correct diagnosis of the disease. The prevailing diagnosis is not correct. What we are primarily suffering from is not a “balance of payments” crisis but an inflation crisis. Confidence in the dollar has not fallen because of a “deficit” in the balance of payments, but there is a “deficit” in the balance of payments because of our inflation. The cure, therefore, is not to try to tinker directly with the balance of payments but to halt the inflation. If we do this, the balance of payments will correct itself.

What would we have to do to halt the inflation?

1—We would have to raise short-term interest rates. Last June and August, the Federal Reserve did exactly the opposite of what was required when it lowered the discount rate from 4 to 3 percent. The direct effect was to cause short-term balances to go abroad for higher interest rates. The indirect effect was to cause loss of confidence in our determination to defend the dollar. We have encouraged monetary inflation to go on so uninterruptedly for 27 years that perhaps the only way we could convince the world we meant to halt inflation now would be temporarily to forbid any further increase in the total loans and investments of the banks.

2—We would have to balance the budget, convincingly and dramatically, not by another burdensome and strangling increase in tax rates but by slashing nondefense expenditures—particularly such items as foreign aid, farm price supports, public roads and housing—and by halting further increases in welfare and social-security commitments. In brief, we must do exactly the opposite of what all the Kennedy task forces have recommended. It may be sobering to recall that of our enormous Eisenhower-planned budget expenditures of $101.8 billion for the fiscal year 1962, $54.4 billion, or more than half, are for nondefense items.

3—Finally, we would have to repeal all Federal labor legislation which compels men to join unions, compels employers to bargain exclusively with specified unions, permits mass picketing or labor violence—in other words, makes it next to impossible for employers to resist unreasonable, uneconomic, and inflationary wage demands.

Merely to list these essentials shows how tremendously difficult is the political problem of getting the only real economic solution accepted. The politicians wish to take precisely the opposite measures. The assumption behind all the task-force reports is that the correct solution of the dollar problem is more inflation, not less; that the way to cure unemployment is not to restrain or correct excessive wage rates but to increase government spending, to lower interest rates, to increase the supply of paper dollars still further, to raise prices-in short, to inflate and inflate.

TRANSITIONAL STEP

In this unhealthy ideological climate, in which the real solution is so unlikely to be adopted (at least at present), one must face the question of the least harmful alternative. In fact, one must face the question of what must be done even if, after an inflation of 27 years, the real solution is now belatedly adopted. There are writers who believe that even today we could establish a full gold standard at $35 an ounce. The result of any such attempt, however, would be to drain the Federal Reserve System of gold in a few weeks, and force an intolerable deflation.

Probably the least harmful transitional measure, pending re-establishment of a full international gold standard, would be for our government to stop buying or selling gold, permit a free gold market, and compensate foreign banks for any loss of value of their present dollar reserves in terms of their own currencies. Whatever drawbacks such a course may have, they seem less than those of the alternatives being seriously considered. The real danger foreshadowed by the Allan Sproul staff report is that we will plunge into still more inflation and attempt to “repress” its consequences by exchange controls and price controls.