Jimmy Carter vs. Inflation
COVER STORY
He promises budget cuts and credit curbs, but more is needed
As Jimmy Carter stepped before the television cameras in the East Room of the White House last Friday, his task was not just to proclaim another new anti-inflation program but to calm a national alarm that had begun to border on panic. Inflation and interest rates, both topping 18%, are so far beyond anything that Americans have experienced in peacetime--and so far beyond anything that U.S. financial markets are set up to handle--as to inspire a contagion of fear. Usually confident businessmen and bankers have begun talking of Latin American-style hyperinflation, financial collapse, major bankruptcies, a drastic drop in the American standard of living.
For three weeks the White House struggled to develop a plan that would restore the public's confidence that the Government could bring the economy under control. It summoned business leaders and representatives of civic groups from all over the country, consulted daily with ever widening circles of influential Congressmen. There was talk of a televised presidential address to a joint session of Congress. But the dramatized search for an anti-inflation program proved slow and frustrating. Within the Administration, economists fretted endlessly over the pros and cons of various budget-balancing proposals. The President's aides finally canceled all plans for Carter to address Congress, which was reluctant to play host to what was bound to be an unpleasant message.
But the runaway prices and the increasing national anxiety demanded that the President say something, and make it substantive, and do it quickly. So on Friday afternoon, Jimmy Carter strode into the East Room, having carefully waited until half an hour after the major financial markets had closed in the East, to outline his plans to an invited group of 175 Government officials, congressional leaders and businessmen. His program had many details to be filled in, and his speech had been written hastily in the previous 24 hours. In fact, it was clapped together so hurriedly that one page of the final draft was left out of the copy that Carter took before the cameras, and he had to skip over three missing paragraphs of the official text.
But at least Carter had some specific measures to announce. His major goal: to balance the $612 billion budget for fiscal 1981, which begins Oct. 1. That would make it the first balanced budget since 1969, and only the second in the past 21 years.* His keynote: discipline--a word he repeated nine times.
Speaking earnestly and somberly, Carter opened by stating that "persistent high inflation threatens the economic security of our country," and that "this dangerous situation calls for urgent measures." He admitted in effect that the budget he submitted in January, which called for a deficit of $15.8 billion and which he termed at the tune "prudent and responsible," had become obsolete in only seven weeks. But the troubles had been building up for more than a decade, said Carter, and they could be traced largely to "our failure in Government, as individuals and as a society to live within our means." Glossing over his own record of rapidly rising spending and huge deficits, both of which contradicted his firm campaign pledges of 1976, he proclaimed his born-again fiscal faith:
"The Federal Government must stop spending money we do not have and borrowing to make up the difference."
Only four hours later, Carter returned to the theme at a press conference in the East Room. "The Federal Government simply must accept discipline on itself as an example for others to follow," he said.
He acknowledged that his program would be "difficult politically" and, by implication, "onerous and burdensome" to some needy people, though less so than continued inflation would be. He warned that price increases would remain "very high" for several more months before his policies took effect. But his new plan would succeed, though three previous ones failed, he asserted, because "the nation is aroused now as it has never been before, at least in my lifetime, about the horrors of existing inflation and the threat of future inflation."
In follow-up press conferences Saturday morning, Federal Reserve Board Chairman Paul Volcker proclaimed that "the greatest risk beyond doubt" facing the economy is accelerating inflation. Not only do rapid price rises bring "direct pain and distortions," he said, they also prepare the way for a serious recession. Said he: "There is no way we can deal with the problems ... other than by placing restraint on people who individually would like more credit." Treasury Secretary G. William Miller similarly asserted that the Administration's first priority "is to demonstrate the political will to bring our budget under control, demonstrate to the American people and the world that we can do this."
As this barrage of resolute rhetoric might indicate, inflation is not only a frightening economic problem but is rapidly becoming Carter's most dangerous political liability as well. Campaign audiences for the President's numerous rivals are showing at least as much interest in the economy lately as in Iran or Afghanistan. In Carter's own party, Ted Kennedy has made a demand for wage and price controls his major issue, and is apt to answer any question on any other subject with an attack on inflation. On the Republican side, Front Runner Ronald Reagan has been hammering increasingly harder on economic issues. Said he, campaigning in Illinois Friday night: "It's Government that causes inflation, and Government can make it go away by cutting out deficits and stopping the printing of money." George Bush assails "Jimmy Carter's raging inflation" during almost every appearance.
For all the urgency of the issue and the careful orchestration of the Administration's response, Carter's actual program followed an all too familiar pattern of hesitant and belated steps toward a worthy goal. And a great deal of it had been too extensively leaked in advance to have much psychological effect. Its main elements:
P: "Discipline by reductions in the Federal Government"; spending will be reduced slightly.
P: "Discipline by greater conservation of energy"; a new gasoline tax will be levied.
P: "Discipline by restraints on credit"; consumer borrowing will be curbed.
Government spending. In fiscal 1981 it will be sliced, Congress willing, by $13 billion* below the amounts planned in January--though that will still be $43 billion above the likely totals for the current fiscal year. The ax will fall on a wide variety of Government activities, including, said Carter, "good, worthwhile programs--programs which I support very strongly." Exact proposals will not be submitted to Congress until the end of the month, but the activities known to be due for a slash include revenue sharing for states and cities, job-training programs, airport and highway construction, federal aid to education, health research. There will be a freeze on federal hiring, and the number of federal employees will drop 20,000 by next October. Saturday mail deliveries may well be stopped. Carter, who had pledged in his January State of the Union message to resist any Soviet move into the Persian Gulf by military force if necessary, seemed to draw back even on his plans to raise defense spending. "The Defense Department will not be immune from budget austerity," he declared, but he said that the nation will meet its financial commitment to its NATO allies. That implies an increase in spending, adjusted for inflation, of 3%--not significantly different from the official January budget figure, but well below the increase of up to 5% that Administration officials and some Congressmen had been advocating. The hope is that the difference can be made up by cutting "fat" from the Pentagon budget, rather than by hacking spending for military hardware or personnel.
Even so, the spending cuts apparently do not touch the fastest-growing portion of the budget, the major "entitlement" programs--Social Security, veterans' benefits, unemployment compensation --which are considered politically sacrosanct. Nor will the spending reductions by themselves balance the budget. If Congress and the Administration proceeded on the January plan, the $15.8 billion deficit originally estimated would swell to $25 billion or even $30 billion, according to estimates of the Congressional Budget Office. Main reason: inflation is raising the bills that the Government pays.
Revenues. They will be raised in two ways. Carter will ask Congress to institute a new withholding tax on interest and dividends. "It is intolerable for some to evade prompt payment of taxes," he said. That move alone would increase revenues by $3 billion in fiscal 1981, but much of the increase would not really be new money, merely cash that the Government would collect more speedily than now planned. Far more important, the President will slap a $4.62 per bbl. fee on imported oil, a move that he can take without any new legislative authority. Motorists will pay an extra 100 per gal. for gasoline at the pump, probably beginning in May. The President presented this mostly as a conservation measure to prompt Americans to reduce their "extravagant" use of gas. But another motive is to raise an extra $10 billion a year, to "be held in reserve" either to reduce the national debt or, if necessary, balance the budget. Translation: the extra money is needed to make sure that revenues exceed spending in the next fiscal year and produce a surplus now estimated at up to $3 billion.
Credit controls. They will be imposed, in a mild way. Said Carter: "Inflation is fed by credit-financed spending. Consumers have gone into debt too heavily. Businesses and other borrowers are tempted to use credit to finance speculative ventures." Using powers granted by Congress in 1969, the President authorized the Federal Reserve Board to control "unsecured" consumer borrowing--primarily the use of credit cards, check credit from banks, department-store charge accounts and the like. The Federal Reserve will tell banks and other lenders that, if they expand their lines of credit beyond the totals outstanding last week, they will incur a penalty: they will have to deposit a sum equal to 15% of the additional amount into a special reserve drawing no interest. How to stay within this requirement is entirely up to the lenders. They can refuse to extend additional credit to consumers, cancel the unused portion of existing credit lines, or go ahead and offer more credit, pay the penalty, and pass the cost along to the borrowers. "Secured" loans--those taken out to buy houses, cars, refrigerators and other appliances--will not be affected at all.
Also, the Federal Reserve will be empowered to extend its reserve requirements to banks that are not members of the Federal Reserve System; these banks hold 30% of all deposits. The effect will be to tighten the Fed's control of lendable funds throughout the economy. Fed Chairman Volcker will also undertake, in Carter's words, "a voluntary program, effective immediately, to restrain excessive growth in loans by larger banks." That sounds like more federal jawboning to get banks to stop making loans for unproductive purposes, such as financing mergers or speculative inventory increases.
Similar policies of moral suasion have failed resoundingly in the past.
Monetary measures. They are being tightened. The Federal Reserve announced that it will impose a 3% surcharge, on top of the 13% discount rate, on some of the loans it makes to member banks. A bank borrowing from the Fed two weeks in a row, or more than four weeks in any quarter, will thus be charged 16%. If banks want to go ahead and borrow anyway, the move would tend to raise still higher the interest rates that they in turn charge when they lend the money to customers. Federal Reserve officials hope that banks will instead reduce both their borrowing from the Reserve and their own lending. Cutting down on loans to member banks would help the Federal Reserve to lower the growth of money supply, a policy it has long pursued but found much easier to proclaim than to achieve.
Miscellaneous measures. A variety will be enacted. The supervision of the Administration's voluntary wage-price guidelines will be tightened; the Council on Wage and Price Stability will more than double its staff of the 80 people who are now watching pay and price boosts. Some major corporations will be required to give the Government advance notice of new price hikes. But the Administration has no power to order any union or company to trim a wage or a price, and Carter will not request any such power. Said the President: "Government wage and price controls have never worked in peacetime."
Immediate reaction to the program Tom politicians, businessmen and economists was cautiously reserved. Only the most partisan conservatives denounced it wholeheartedly, and even fewer people gave it warm praise. Generally, Carter got high marks for having realized the deadly seriousness of inflation and having started to attack it in the right place by focusing on a balanced budget.
The program "was very positive and broad," said C. Edward Acker, chairman of Air Florida, a small airline. "I wasn't expecting so much." Otto Eckstein, a member of TIME'S Board of Economists, declared: "I think the President has made a complete reversal of his economic policy, for the better. He has gone from three years of greatly excessive budget deficits and excessive money supply expansion to a conservative regime of budget balancing and limited credit growth." Republican Senator Bob Packwood of Oregon commented with ironic approval: "It seems that the President has learned more about inflation in the last ten days than he had in his first three years in office."
But many businessmen complained about the lack of specifics about how much Carter proposes to cut from which federal programs.
They were not alone: a spokesman for the Government's own Department of Health and Human Services (the old Department of Health, Education and Welfare, minus Education, which is now a separate department) griped that his only information was a fact sheet, handed out by the President's aides, which referred vaguely to reductions in programs to combat mental illness and alcoholism and unspecified other problems. Said the spokesman: "We are not sure what that all means. We are not sure how much these programs will be cut or which health-service programs will get the ax."
Many executives also felt that the spending reductions, which amount to only 2% of the budget, were still insufficient. "While it sounds significant, it isn't," said William Agee, chairman of Bendix Corp. "God, when the country is in almost as bad shape as it would be in time of war, it's no time for a guy to go around building a consensus."
The program is in fact open to serious objections on several counts. Balancing the budget, a move important in itself, has also become the quintessential symbol of Government resolve to fight inflation. As Carter noted, "Nothing will work until the Federal Government has demonstrated that it can discipline its own spending and its own borrowing." But a one-shot, one-year surplus would barely begin to undo the damage wreaked by years of deficits: $160 billion since 1977 By some estimates, a balanced budget in fiscal 1981 would, by itself, reduce the inflation rate only by two-tenths of 1%.
What is needed is a long-range plan to bring the growth of federal spending under control. That can hardly be done without some trimming of the entitlement programs, which not only swallow 77% of the whole budget but are inexorably rising. That is because most of them are tied to the consumer price index. Social Security benefits, for example, will rise 13% this year because the CPI rose 13% in 1979. That creates a vicious circle: inflation increases federal spending, which increases deficits, which increases inflation. Several experts have proposed limiting the tie between prices and benefits to 85% of any rise in the CPI, but Carter apparently will not ask even for token cuts in the entitlement programs.
If Carter is cautious in an election year, so is Congress. Indeed, there is good reason to wonder whether the legislators who have the final say on most of Carter's plans can muster the discipline to enact even the modest spending cuts that the President proposes. On the other hand, there is the serious question of whether the President himself will have the discipline to resist the inevitable demands that he make this and that exception. "Discipline," of course, is a word that is most easily applied to other people. The Administration sought to win advance approval for its plan by consulting groups of Representatives and Senators from both parties, but the heaviest burden naturally fell on Carter's fellow Democrats, who control Congress. Meetings with them went on daily for the better part of two weeks.
There were strains on both sides.
Some Senators and Congressmen grumbled that Administration officials, principally Treasury Secretary Miller, Chief Economic Adviser Charles Schultze, and Budget Director James Mclntyre, sought their ideas on what programs to cut rather than venturing proposals of their own. Administration officials, on the other hand, complained that Senate Majority Leader Robert Byrd of West Virginia brought ever more Democratic Senators into the meetings, so that budgeteers had to go over the same ground again and again for the benefit of the newcomers.
Byrd, however, ran the meetings with a firm hand. At one point, when a group of Democratic Congressmen were meeting with Miller, the Treasury Secretary was summoned for a consultation with Carter. Byrd politely insisted that Miller would have to conclude his talk with the Congressmen first, and Miller eventually sent word to Carter that the President would just have to wait. Said Connecticut Representative Robert Giaimo admiringly: "Byrd taught me how to wield a gavel."
By midweek the Democrats had agreed on $11 billion in potential budget cuts, and there they got stuck. Liberals began arguing for tax increases--a surcharge on corporate profits, for example--to make up the remainder of the budget gap, but they were overruled. Byrd argued implacably that defense spending should be held to the 3% increase, adjusted for inflation, that would meet commitments to NATO. He won his point, but only over the strenuous objections of congressional hawks.
Conferences with the Republicans, as might be expected, were even more tense. The Republicans insisted again and again that they would not commit themselves to any budget cuts until they saw what the Democrats would agree to. At one session with Carter himself, New York Representative Jack Kemp asked twice that the President specify exactly which programs he proposed to slash and by how much; Carter politely replied that he was seeking the Republicans' ideas. When Kemp asked yet a third time, Senate Minority Leader Howard Baker somewhat testily remarked: "Look, Jack, the President told you twice he's not going to tell you." Only then did Kemp give up.
The presidential plan that finally emerged has congressional agreement only in principle. Given the national fear about inflation, says Giaimo, no Congressman or Senator wants to run for re-election as a proponent of a deficit budget. But veteran observers believe the quarrel over just which programs to cut could rival in bitterness the three-year battle over Carter's energy program. Says Democratic Representative David Obey of Wisconsin: "Everybody wants to cut Ol' Charlie's program. And nobody wants to be Ol' Charlie."
Labor leaders are vocally unhappy.
AFL-CIO President Lane Kirkland says that the proposed budget "may have psychological value for the bond market and for bankers" but "places most of the burden on those suffering worst under the present economic conditions." The Congressional Black Caucus, a group of 17 Representatives, is no less worried. Representative Parren Mitchell, of Baltimore, has advised his fellow blacks to use every parliamentary tactic available to block budget cuts that would hurt their constituents, such as reductions in job-training programs and aid to cities. Says Mitchell: "The President has got to run the risk of losing another whole block of votes. We would not vote for the Republican [presidential candidate], but the disenchantment with Carter would be so great that we would sit out the election."
Lobbyists of various sorts are mobilizing to guard their interests. The liberal Americans for Democratic Action claims to have organized a coalition of 50 labor, youth, civic and religious groups to block reductions in social spending. Carter's program, says the A.D.A., is "a cruel deception of the people." A coalition of 39 women's groups has warned its members to watch for any budget cuts that might be unfavorable to women.
Long and loudly as Republicans have proclaimed the necessity for a balanced mdget, the Administration already has ost its perhaps disingenuous hope for a bipartisan economic policy. A dozen Republican Senators turned out for a midweek press conference, at which they insisted that the budget must be balanced entirely through reductions in spending, with no revenue-raising measures. They want spending cuts much deeper than any that Carter will propose. Senator William Roth of Delaware has collected 46 signatures--including those of nine Democrats--on a resolution to limit federal spending to 21% of the gross national product (the dollar value of the nation's total production of goods and services). That would imply a reduction in expenditures of $26 billion for fiscal 1981, vs. Carter's $13 billion.
The Republicans want to slash spending sharply enough to leave room within a balanced budget for immediate "supply side" tax cuts, such as more generous depreciation deductions for business. This would spur savings and investment, which they contend is needed to reverse the recent drop in productivity, a major cause of inflation. Carter agrees that investment-prompting tax cuts are necessary, but he argues that they can come only after the budget is safely into surplus.
Carter's program is open to serious question on some other grounds. Controls on credit-card debt, in the opinion of many economists, will have only a marginal impact on inflation. The wage-price guidelines have been very ineffective, and there is little reason to think their impact will increase. And the Administration's fee on imported oil will immediately force up further the item that is already rising faster than anything else in the consumer price index. Gasoline prices went up 60% between early 1979 and early 1980 (see chart).
Essentially, Carter is opting for more inflation now in the hope of less inflation later. The Administration makes two arguments: 1) the extra revenues from the gas fee will shrink inflationary deficits, and 2) to the extent that a cutback in driving reduces oil imports, the U.S. will make itself less vulnerable to petroleum price increases that the OPEC cartel may decree. But the fee will not spur all that much conservation: a reduction of only 100,000 bbl. a day the first year, by Carter's estimate, in petroleum imports that now average 8 million bbl. a day. In order to prompt really significant conservation, a gasoline tax on the order of the 50-c--per-gal. bite that Republican John Anderson has been proposing might well be required.
The biggest question of all is whether Carter's plans will have enough shock value to break the inflationary psychology that has gripped the nation. The most familiar manifestation of that psychology has been the compulsion of consumers to dip into savings or to borrow in order to buy before prices go higher. That action turns the expectation of more inflation into a self-fulfilling prophecy.
In the past few weeks, however, a new side of inflationary psychology has begun to show itself among businessmen and investors: plain, old-fashioned fear. Executives talk of inflation rates going to 20% or more in the next few months, creating an environment in which reasonable planning is impossible. The jitters have unhinged the investment markets. As recently as mid-February, stocks were widely considered a hedge against inflation and thought to be grossly undervalued. The Dow Jones industrial average hit a high of 904 on Feb. 13. But since then it has tumbled 92 points, to 812; nine points of the decline came last week. The average is now lower than it was 16 years ago. Would-be investors fear that accelerating inflation is making corporate profits illusory because they are earned in cheapening currency. More generally, they fear that the uncertainties of inflation undermine every rational investment strategy. Says Arthur Levitt Jr., chairman of the American Stock Exchange: "There is no confidence whatsoever that any price has any meaning or validity."
Skyrocketing interest rates have just about destroyed the bond market, once a pillar of stability and the source of most of the cash that corporations, states and cities borrow to build factories, schools and waterworks (see box page 14). Unable to raise cash by selling bonds, businesses have been turning to short-term bank loans. That is very expensive; the bank prime rate rose twice more just last week, by a total of three-quarters of a point, to as high as 18 1/2%.
Borrowing short-term money to finance long-term needs is not only expensive but inherently risky because the loans must continually be renewed at high rates. Financial experts fear that many small and even some big corporations, unable to continue borrowing, will go bankrupt. Their demise in turn may shake some thinly capitalized banks that will be stuck with "problem" loans. Says Don Jacobs, dean of the Graduate School of Management at Northwestern University: "We are headed for a paralysis of the financial markets. We will see red ink throughout the financial industry. It could be a disaster. For the first time in my life I am really concerned."
Red ink already is a reality in parts of the auto and housing industries. Sales of U.S.-made cars have dropped 15% below a year earlier since the new model-year began in October. Automakers have slashed production 30% to guard against an excessive buildup of inventories. Some 200,000 autoworkers have been laid off. Last year 672 car dealers went out of business, and the number may rise in 1980. One reason is that dealers are being crushed by the high cost of borrowing to maintain the inventories of unsold cars that they do have. Ford Motor Co. Economist John Deaver figures that dealers have to pay more than $100 a month in interest charges for every car in their lots.
Housing starts in January fell 18% below a year earlier, to an annual rate of 1.4 million, and they appear headed much lower. Buyers cannot afford mortgage interest rates that top 16% in some areas oi the country, and savings and loan associations are running out of money to lend. In the Chicago area, new home sales in February tumbled 30% below the 1979 level. Contractors are laying off so many workers that 60% of the area's construction labor force may be unemployed in two to three months. In Houston, starts are down 50%, and John Pace, president of the Greater Houston Builders Association, speaks gloomily of "tens of thousands of homebuilders across the nation who are going broke." Builders, he points out, generally have to borrow from banks at interest charges that are two or three points above the prime rate.
To date, these troubles have not been strongly reflected in the general economy. In fact, one of the reasons for accelerating inflation is that the mild recession economists have been predicting for well over a year--and that the Administration has been counting on to hold down prices --has stubbornly refused to arrive. Panicky consumer spending has kept the overall economy expanding.
There are some signs now that consumers are running out of the cash and credit to continue the buying binge. Retail sales dropped slightly in February, and installment debt in January made only a small increase. But fear is growing that when the long-delayed recession finally does hit, it will burst with far greater virulence than policymakers have been expecting.
A severe slump, of course, would reduce U.S. standards of living--and so would inflation if it continues at anything like the current pace. "In my opinion," said Marshall McDonald, chairman of Florida Power & Light Co., at a recent business conference in Miami, "we are going to have a situation in the next five to ten years that could force us to change our entire way of life." He implied to a startled audience that Floridians would not be able to afford air conditioning and added: "We are going to have to get used to sweat. That's right, sweat."
Much of the gloom being talked today may be exaggerated. But, at the very least, the nation is in for several years of trouble.
Inflation has built up such fearful momentum that it can be brought down only slowly and with much pain.
That pain might be less if Carter had acted earlier. If he had submitted a balanced budget in January, some of the worst shudders in the financial markets might have been avoided; they occurred largely because investors saw the original budget as lax and concluded that the Administration would do nothing effective to curb inflation. Even now, the President's plan is inadequate in many respects. Like his energy program, it flourishes a rhetoric of sacrifice and national duty but actually asks relatively little. For example, Carter wants to trim only a token $2 billion from expenditures in the remaining six months of the current fiscal year, even though the deficit is estimated to be as high as $47 billion. But now that he has produced his program, the President at least has an incentive to stick to it. Cutting spending in an election year will surely lose some votes, but making a start toward lowering inflation is nothing less than a national necessity.
* Lyndon Johnson started, and Richard Nixon finished, running up a $3.2 billion surplus in fiscal 1969. Dwight Eisenhower balanced the budget three times, in 1955, 1956 and 1960; Harry Truman did it four times, in 1947, 1948, 1949 and 1951. Franklin Roosevelt, John Kennedy and Gerald Ford never did it at all.
* Carter inexplicably said $18 billion in his speech, but Administration officials admitted that this was a mistake.
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