Business: The Economy in 1968: An Expansion That Would Not Quit

When Richard Nixon becomes President next month, he will take charge of an economy that has been growing fast for years, and lately has been expanding too rapidly for its own good. Business has been on the up swing for 95 months — since February 1961, the month after John Kennedy took office at the tail end of a recession. Though the Democratic policymakers certainly cannot claim all the credit for the longest advance in the nation’s history, they have done a conspicuous amount of managing and masterminding through their Keynesian New Economics. They leave behind a remarkable record for the Republicans to try and match—as well as many difficult problems for them to try to solve.

In the past eight years, industrial production has gone up more than 50%, the gross national product has advanced more than 70%, and corporate profits after taxes have increased almost 100%.

The median income of a U.S. family of four has risen 54%, to $9,695. More than 75 million Americans are at work today in civilian jobs, and unemployment has dropped to a 15-year low of 3.3%. It is true that too many Americans remain ill-clad, ill-housed and ill-fed, but the U.S. has come close to achieving its goal of full employment.

Not the least of the economy’s strengths has been its resistance to stresses and strains. Over the past eight years, production and general prosperity have continued to grow vigorously, despite political assassinations, race riots, international monetary crises and breaks in the stock market. In the past year the economy advanced in the face of all of that, and more. Yet economic Utopia is far from the nation’s grasp. This year, the expansion has gone too far, too fast. In fact, there have been excessive increases in three vital areas: wages, prices and Government spending. During 1968, more than in any other year since the early 1950s, the joys of expansion were shaken and weakened by the jolts of inflation.

The Pangs of Prices

Though there are a few signs of a slowdown ahead, the economy so far has resisted all attempts to curb its expansive excesses. Congress belatedly passed a 10% income surtax in June, but production and demand—and prices —only kept moving higher. From November 1967 through last April, the Federal Reserve Board raised the discount rate three times, boosting it from 4% to 5½%, a 39-year high. The board later dropped the rate to 5¼% , but last week, declaring a new assault on inflation, it lifted the rate again to 5½%. Whether the rise will have any rapid effect is debatable. The causes of inflation are deep, and it will take time to root them out.

In small doses, inflation can be an economic tonic, stimulating consumers to spend and businessmen to invest. Historians sometimes define the Dark Ages as 600 years of falling prices. The trick is to limit the price rises to about 2% a year or less, as was the case from 1960 through 1965. Over the last twelve months, however, consumer prices have jumped 4.3%, the greatest annual gain since the Korean War year of 1951. During October, the latest month for which statistics have been compiled, consumer prices rose at a frantic 7.2% annual rate. While the nation’s output of goods and services climbed 8.7% to a record of $860 billion for the year, almost half of that was accounted for by price increases. Just over half represented “real growth.”

Everybody felt the pangs of inflation. The effects showed up in the form of $2-an-hour baby sitters, $3 men’s haircuts and $72-a-day hospital rooms. Housewives complained about $1.99-a-lb. sirloin, and the President-elect of the U.S. yearned to find a good 50¢ hamburger. Price increases were so pervasive that not a single component of the Government’s price index declined. Transportation rose 4.2%, food 4.5%, apparel 6.6%, medical care 7.2%. By Washington’s official reckoning, which probably understates the cost of living in many large cities, it now takes $122 to buy goods and services that a decade ago cost $100.

Deeper down, inflation caused some dangerous distortions in the U.S. economy. Consumers and businessmen rushed to borrow, spend and invest, hustling to convert their cash into goods or services before the value of the dol lar declined still further. All this only stoked inflation, and led to an abnormally steep demand that may cause an abrupt contraction on some less lucky tomorrow. As usual, some of the worst victims of inflation were the poor, who had to pay more for everything and lacked either the resources or the sophistication to invest in property or paper with a rising value to offset price increases. Clearly, one of Richard Nixon’s first priorities must be to slow the inflation without starting a recession, whose first victims would also be Amer ica’s poor. Economist Arthur Burns, one of Nixon’s most influential advisers, warns: “If inflation continues, an economic bust may become unavoidable.”

The Surge in Wages

The seeds of today’s trouble were sown three years ago. In 1965, Lyndon Johnson decided that the nation could simultaneously support the Viet Nam buildup and the Great Society. Critics insisted that such policies would push up prices unless taxes were raised. Johnson refused to propose higher taxes. Such a move would almost certainly have prompted Congress to cut back some of his favorite spending programs. Later, faced with soaring federal deficits, Johnson changed his mind and urged a tax increase. But Congress dallied for 18 months—and thus lost an opportunity to halt inflation before it took deep root.

That exposed a critical weakness in the neo-Keynesian economics, which relies primarily on delicate adjustments in taxes, government spending and monetary policy to keep the economy running close to capacity. The New Economics had served well when business needed a push. But Britain’s Keynes presumed that policymakers would always be wise enough, given knowledge of his theories, to do the right thing at the right moment. In the U.S., however, political leaders are usually unwilling to raise taxes quickly enough in overly expansive periods. The theories of the New Economics have not been found wanting; they have simply not been applied at all the crucial times.

When Congress finally got around to enacting the surtax at midyear, much of its effect was washed away by another big factor. While taxes went up, wages went up much faster. During the year’s first nine months, about 3,400,000 unionized workers won pay raises averaging 7.5% annually, the largest gain since the Labor Department started keeping track 14 years ago. For the year as a whole, wages and benefits rose about 7%, while productivity increased only 3.2%. The result was that so-called unit labor costs jumped 3.8% —and the consumer had to pay for the jump.

Psychology of Inflation

Of course, consumers had plenty of pocket money. Often during the 1960s, they have confounded economic forecasters by spending more lavishly than the experts had expected. This year, they went on something of a spree, correctly sensing that the prices of almost all goods and services were bound to rise. Such expectations become powerful economic forces, creating an inflationary psychology that is now firmly embedded in the thinking of businessmen, labor leaders and investors. Even after the tax increase, consumers rushed to buy practically everything. Their appetite for the well-styled 1969 autos was particularly keen; sales this year will reach an alltime high of about 9,600,000 cars. The U.S., with its 60 million families and 100 million cars, is fast approaching the reality of two cars in every garage.

To help finance their spending, consumers borrowed more and saved less in 1968. From the year’s second quarter to the third quarter, personal savings fell from an abnormally high 7.5% of after-tax income to 6.3%. In the third quarter, installment loans rose at a record annual rate of nearly $9 billion. And for installment buyers, as well as for businessmen, the availability of credit is far more important than its interest cost.

Credit was plentiful because the Federal Reserve Board, even while raising interest rates, allowed the supply of money in circulation to grow at a rate that proved to be inflationary. The board had to feed funds into the money market so that the Treasury could borrow to finance the federal deficit of $25.4 billion in fiscal 1968. Such great deficit financing, most economists agree, is the fundamental cause of U.S. inflation.

The money supply expanded at an annual rate of 8% during the year’s first half. Even after the midyear tax increase, the Fed’s governors continued to ease credit because, like most other experts, they misjudged how quickly the surtax would begin to brake the economy. In the last three months, the Fed has changed course, holding the increase in the money supply to a moderately constrictive rate of 3.8% a year.

Trouble in the Money Markets

By year’s end, a severe money squeeze was developing. Blue-chip businessmen had to pay 6¾% for prime loans, another alltime high, and many home buyers were paying well over 7¼% on mortgages. Bond yields rose so swiftly that scores of corporate and municipal borrowers postponed or scaled down the size of new issues.

The trend toward tighter and costlier money—combined with expectations of continuing inflation—portends trouble in the U.S. securities markets. Bond dealers are afraid that even the high yields on fixed-interest securities are too low, relative to the rate of inflation. These dealers figure that they may have a tough time floating the issues that industry needs to expand and modernize. With somewhat less justification, stockbrokers worry that investors will switch out of stocks and into bonds because the difference in yields is so enormous. This month, the average yield on Triple-A corporate bonds climbed to 6.47%, while the average dividend paid by the 500 stocks in the Standard & Poor’s index was down to 2.89%, the lowest since February 1962.

Speculation in Stocks

Inflation in 1968 helped to foster a contagious speculative mood in the stock market. Led by the “gogo” mutual funds, many once staid institutional investors plunged into small new issues that offered a chance for quick profit. Fried-chicken franchisers, wig makers and small computer-service firms had no trouble bringing out new—and often highly speculative—stock issues. Frequently, the prices of their stocks soared unrealistically, to 50 or even 100 times their per-share earnings.

On the New York Stock Exchange, the belwether Dow-Jones industrial aver age advanced strongly after President Johnson announced on March 31 that he would not run for re-election and that he was making new overtures to end the Viet Nam war. The average sagged in August but soon rebounded in what brokers called “Nixon rallies.” At year’s end, the index was approaching its historic peak of 995.15, set in February 1966.

Securities trading became one of the greatest growth industries. On the Big Board, the year’s volume jumped 20% to a tape-taxing record of nearly 3 billion shares. The torrent swamped securities-delivery channels, spurring belated efforts to computerize archaic clerical procedures. All the trading also lifted Wall Street profits to a level that even Big Board officials consider embarrassing. Brokerage commissions reached about $5 billion, and some top customers’ men earned as much as $500,000 each. Prodded by the Securities and Exchange Commission, the New York Stock Exchange cut commissions by 7% on orders of 1,000 shares or more. Unless the Nixon Administration forces the SEC to change course, this is only the beginning of far-reaching changes in both commissions and the privileges of the stock exchanges. They now have almost monopolistic powers to limit access to trading and to fix commissions so high that the big men in firms with exchange memberships are practically assured of making fortunes.

The Merger Rush

Another major factor in 1968 was that merger fever seized U.S. industry as never before. An estimated 4,200 mergers took place, up 41% from 1967. Instead of laying out cash, most merger-minded companies simply swapped securities through increasingly complex combinations of debentures, warrants and ordinary common shares. Such methods are enticing because stockholders avoid capital-gains taxes. More important, stock swaps give Wall Street’s favorite companies, whose shares carry a high price in relation to earnings, powerful leverage to acquire firms whose shares have a low price-earnings ratio. This fact often enables smaller cor porations to swallow concerns many times their size.

The merger pace also accelerated in Western Europe, and several large firms moved across state boundaries to form multinational giants that made competition rougher for U.S. companies. Partly because of dwindling profit margins abroad, and partly because of Washington’s restrictions on sending capital out of the country, U.S. firms have begun to level off their foreign expansion. Their capital spending abroad, which rose 7% last year, increased only 5% this year, to $9.7 billion. Meanwhile, non-American companies pressed ever deeper into world markets, including the U.S. While U.S. exports rose 8%, imports soared 22%—mostly as a result of inflation and voracious demand.

The U.S.’s traditional trade surplus, which was $4.1 billion in 1967, melted to scarcely $1 billion this year. Protectionist pressures are mounting, and Nixon may be tempted to raise further barriers to imports, even though foreign nations would retaliate with everything from quotas to border taxes.

Chances for Currency Crisis

For the eighteenth year out of the last nineteen, the U.S. ran a balance-of-payments deficit in 1968. It was comparatively small—perhaps $1.5 billion as against $3.6 billion in 1967—but the decline was due mostly to U.S. luck and other countries’ misfortunes. After the student strikes in France and the Soviet invasion of Czechoslovakia, businessmen and speculators sent billions of dollars from Europe to safer haven in the U.S. That helped to buoy the U.S. stock market and to strengthen the U.S. dollar, which early in the year fell under speculative attack but then survived the November monetary crisis without damage.

Even so, Richard Nixon—and the other world leaders—may face another serious monetary crisis next year. The Western world’s moneymen in 1968 earned high marks for some inspired improvisations, which kept the creaking old monetary system functioning fairly efficiently. But the basic deficiencies have been merely papered over by loans, currency swaps and temporary austerity programs in Britain and France. As the system stands, commerce is manipulated —and consumers are often hurt—to help out a country’s money. France’s franc and Britain’s pound remain weak, while Germany’s mark, Switzerland’s franc, Italy’s lira and some other currencies are stronger than their official, pegged values imply.

As for the dollar, it is still under enough suspicion that even an offhand, ill-advised remark by a high official can cause a speculative flurry. Last week David M. Kennedy, Nixon’s Secretary of the Treasury, refused to make the ritual pledge that the U.S. will maintain the official price of gold at $35 per ounce. “I want to keep every option open,” he said. Next day, the free market price of gold jumped in London to a six-month high of $41.82, and Nixon Press Aide Ron Ziegler tried to quiet the uncertainty by declaring: “We do not anticipate any change in the price of gold.”

A change in the gold price remains highly unlikely, if only because it would do nothing to solve the basic imbalances in the major nations’ currencies and economic policies. But moneymen are talking more and more about the need to revalue many currencies at once and to expand the world’s monetary reserves by quickly creating a form of “paper gold,” the so-called “Special Drawing Rights.” To do this, they may decide to hold the first monetary summit meeting since the existing system was set up in 1944 at Bretton Woods, N.H. More likely, they will take less dramatic steps—slowly and in secrecy.

The U.S. can make little real progress toward economic stability, either at home or abroad, until it ropes in inflation. So long as prices and demand rise at today’s pace, imports will continue to increase much faster than ex ports, and the integrity of the dollar will be doubted.

Prospects for 1969

There is reason to expect that next year demand will taper and the price spiral will slow. The tax increase is finally beginning to take effect: the after-tax income of the average American, which rose at an annual rate of $36 in this year’s first quarter, increased $20 in the second quarter and only $4 in the third quarter. On Jan. 1, the taxpayer will be hit with an increase in Social Security taxes; the maximum payment, for people earning $7,800 a year or more, will go up from $290 to $374. On April 15, millions of Americans will have to pay out a lot more to cover the 10% surtax on their earnings from April through June 1968, when the surtax was not withheld from paychecks. In addition, with the slowdown in Government spending and the rise in tax revenues, the federal budget may even show a small surplus in the current fiscal year ending June 30.

Even so, Walter Heller and other eminent economists maintain that inflation will continue to plague the U.S. for years to come. The task for 1969 is to gain stability without losing much of the very real progress of the past eight years. As former Eisenhower Economist Raymond J. Saulnier notes: “A stabilization program always risks recession.”

To avoid that, Nixon’s strategy is to cool the economy gradually, probably by concentrating more on monetary policy than the Democrats have done. He also aims to hold back federal spending on social programs by giving rather modest tax breaks and other incentives to private businessmen who hire and train the hard-core unemployed. Though many businessmen still doubt whether they can do more than dent the problem, the National Alliance of Businessmen this year got off to a good start by persuading 12,000 employers to hire 84,000 hard-core jobless people and to train many of them for productive work.

Nixon has quite a bit of room for some mildly deflationary measures because unemployment is so low. Encouragingly, economists of the Johnson Administration believe that the wage-price spiral eventually can be restrained by permitting unemployment to climb back to a politically acceptable rate of about 4%, and letting it hover there for a while. But, warns Arthur Okun, the outgoing chairman of the President’s Council of Economic Advisers: “If ever there is going to be a year of bliss for the American economy, it will not be 1969.”

Yet for all its imbalances, the economy seems healthy enough to continue expanding despite obvious problems and pressures. In 1969, the U.S. is likely to experience more of what it has had for the past eight years: continued monetary alarms and inflation at a somewhat lower rate—but no recession.