Editor's Note: TO Economist Stirling Newberry in this piece laments the life, death and legacy of Wall Street Journal editorialist/economist Jude Wanniski. Wanniski coined the phrase "supply side economics," which became the blueprint for Reaganomics. - ma/TO
Dear Mr. Wanniski
By Stirling Newberry
t r u t h o u t | Perspective
Wednesday 07 September 2005
I know you won't read this reply to your question, but I am writing it anyway. You were, in life, a regular reader of this space, and wrote demanding more explanations from time to time. It seems a fruitless exercise now, because your disciples will not accept it, nor will my fellow liberals. You have been increasingly isolated from the movement that brought you to prominence, because the rhetoric that runs it is at cross purposes to the society you actually want to live in. One reactionary who writes to me from time to time called you "a peacenik pansy" and an apologist for terrorism. Among his more printable accusations.
I am isolated from my fellow liberals, because I do not see the point in demonizing the past. It is the people of the present and the future that are important. I recognize that liberalism will only work when it is a supply-side theory of government. But by supply-side I don't mean tax cuts, but the real thing. Enough supply to raise the people of the world out of poverty, and to end the foolish wars over resources which we are currently engaged in.
You challenged me to talk about the "truth" of how things work, and so I will.
In 1981, a nation crazed with fear and frustration turned aside from liberal government. It was told that intellectual elites could not solve the problems of the world, and that planning would lead, inevitably, to distortion and disaster. The reality of Reaganomics is that it addressed a problem of political economy. That problem was that petro-dollars were piling up in the hands of a few nations, and they had to be enticed, or bribed, to hold those dollars. The result is that Ronald Reagan did a peculiar thing. He created a great entitlement program - namely, a monumental National Debt. That debt has upon it, interest. That interest must be paid, as surely as Social Security or Medicare. Instead of taxing the wealthy, he gave them tax breaks, and asked them to loan the money back to the government.
What is important to realize is that while liberals to this day decry this solution, it was at least a solution. The illusion of money is that governments think they can print it. This is not true, they can print currency. That is, they can print a medium of exchange, and they can require people to accept it, and they can protect those who hold it. But money is not merely the medium of exchange, it is also the store of wealth, and the unit of account. The amount of currency may be within the partial control of the government, but the amount of money is determined by the restless and relentless operation of the market. Currency may measure money, but it is not money itself.
When a government mis-measures money, either by creating too little or too much currency, the economy adjusts, and inexorably and remorselessly. The old expression "you can lead a horse to water, but you can't make him drink" applies to currency as well. You can put In God We Trust on a dollar, but only as long as people trust the government that printed it does that mean anything. And the person that matters is the last producer, who wants to store it as wealth.
Currency then, only works as long as the last producer will take it. The last producer is the individual who doesn't need to consume more, and is only interested in getting greater leverage over society. If that person is a banker who rents out gold, then the society will be on a gold standard. If that person is an Arab prince who wants American military hardware and policy concessions and is willing to rent out oil, then the society will be on an oil standard. And that is the basic recognition of Reaganomics: the world is on an oil standard. I know you support a gold standard, and I've written a good bit on it, but while the gold standard wasn't the cause of the Great Depression, it isn't coming back any time soon, because the last producer in the world isn't interested in gold, he's interested in missiles, jet fighters, and the ability to keep his restive populations in line. Perhaps someday I will write my book on the gold standard, but until then you'll have to refer to the wikipedia gold standard article; last I checked, it was primarily my work.
Reaganomics cut marginal rates on capital and raised them on labor. It did so by passing a tax increase through payroll or FICA taxes. The excuse for this was that this represented a "trust fund" to "save" Social Security. In reality, this increase ended up being general federal revenue. In essence, one part of FICA pays Social Security, but the other part pays that other great entitlement, interest on the national debt. This acted as a regressive tax, which slowed the consumption of oil. This meant that despite huge stimulus in the form of a large defense budget, inflation was restrained. Reaganomics was never going to balance the budget, and, in truth, Americans didn't really want the budget to be balanced. They might talk about it, but they were not, and are not, willing to do anything about it.
The gamble of Reaganomics was this: give the wealthy incentives to invest in stocks, and they would pull money out of speculating in commodities, and then pass regressive taxes, and it would ease the pressure on commodities as well. Then, hope the market would find ways of doing more with less. In short, let Paul Volcker's disinflation policy and Carter's conservation policies cure the spike, use a change in tax policy to prevent the medicine from killing the patient, and hope that the economic body would heal itself.
But Reaganomics was not the only about policy, it was about people. Specifically, what kind of people would run government. The New Deal brought in a wave of people to government who believed in two things: reports from the field, and ideas. These ideas came from the social sciences, they came from history, they came from rhetoric. But to be a liberal was to be rooted in what came to be called "the technocracy."
Nixon and Reagan brought in a different kind of person. A person whose background was in business, whether franchise small business, or the large corporate hierarchy. They did not see the outside world as a thing to be analyzed but as a group of consumers to be marketed to. The Reagan Revolution was, to no small extent, the marketing department taking over from the engineering department. The nuclear submariner, Jimmy Carter, was replaced by the actor Ronald Reagan.
The basic economic policy can then be stated simply as this: in 1980 there was a dollar glut, and because of the end of the Bretton-Woods system, there was no way for those who held dollars to store wealth that guarded against inflation. So they invested in inflation itself, running up the prices of commodities such as oil, copper, iron, steel and gold. Reaganomics did three things. First, it made it more attractive to invest in stocks rather than commodities. Second, it borrowed a great deal of money, and started paying higher interest rates. Third, it imposed regressive taxation to cut demand for commodities, to slow inflation. And that is what Americans really wanted, not a balanced budget, but an end to inflation and uncertainty. Reagan's tax cuts worked, not because they would lead to a balanced budget, but because they would produce a deficit on which the government would pay interest. In short, what Reagan did was increase the demand for investment, and decrease the demand for commodities. It was a demand side policy, not in the end a supply side policy. Reagan virtually ignored the supply side of the equation.
I'm not sure whether you will be happy that a liberal will admit that Reaganomics addressed the problem it was aimed at solving, or upset at the statement that Reaganomics had a great deal of John Maynard Keynes in it. Reagan claimed the deficit would be temporary, but, well, you know there is nothing more permanent than a temporary government program.
There are two important ironies to this economic policy, coming from its nature as a demand side policy. The first is that there are liberal policies that would have solved the same problem. However, in 1980, those who led the Democratic Party could not find a way to construct and enunciate them in a form that Americans would accept and understand. This was made evident by the Republicans taking the Senate and the White House. The second irony is that the best way to meet the oil problem is not with oil supply, but by substituting something else for oil. That something else is digitality - instead of an America that binds itself together using physical transportation, an America that binds itself using digital transformation.
In the end, a nation that is based on selling assets - paper - in return for oil is going to favor the economic engines of export. And the way to produce the most value with the least oil is by symbolic manipulation and the knowledge economy. In short, the metropolitan economy - even if it moves its campuses out to the country side for the peace and quiet. That is, the Reagan economy busily set itself to creating an entire class of people who made their living being technocrats. People who saw cooperation, teamwork, infrastructure and intellectual discipline as being central to all progress. But the Republican Party's electoral success came from recruiting the white disorganized working class, particularly from outside the cities. In 1999, Newsweek spoke of this anxiety with the cover story: "Everyone's Getting Rich, But Me." While the Republican Party was filled with salesmen, it was generating the most massive wave of technocrats in history.
This irony was expressed in the Clinton Administration. When Clinton took power he faced the same problem of political economy that Reagan had faced. In fact, he was told by Robert Rubin that his economic policy as President had to be to keep the bondholders happy, lest they dump dollars. Clinton realized that that was, to borrow a phrase, "The Way the World Works." He began to do something which, if one follows rhetoric rather than actions, seems absurd: he began privatizing Reagan's great entitlement program. "Rubinomics" in the end, was the Clinton Codicil to Reaganomics. Instead of using government bonds to entice people to hold dollars, he created the conditions for a high tech boom, which sold stocks. People rushed into the dollar to buy Amazon, Yahoo, and dozens of other companies.
By making it so that there was something even more profitable than oil, Clinton created an incentive for those who had oil to pump it out of the ground as fast as they could. This reduced the price of oil, which allowed the government to pay less in incentives to keep people holding dollars. If anyone needs a proof that the free market is a better way to run an entitlement, Clinton's privatization of Reagan's entitlement program has to be the first header in the chapter. And all of this is good Reaganomics - lean on the oil suppliers to lower oil prices by having paper to sell that they want to buy.
In his 1994 book Peddling Prosperity, Paul Krugman pointed out that Keynes was still alive. The irony of the post-1981 world is that Reagan never really left Keynes behind, but also that Clinton did not leave behind the fundamental legacy of what is called "Supply Side Economics": taxes remained regressive, more of FICA taxes were shifted from paying for benefits to paying for interest, and marginal tax rates on corporations and on capital gains remained relatively low. Clinton tried to take on the petro-dollar directly by proposing a BTU tax, but backed off when Americans snarled that cheap gasoline is the XIth Amendment to the Bill of Rights. So he spent the rest of his presidency managing the problem.
This division is deep within the Democratic Party: there are liberals, such as Dr. Robert Reich, Minority Leader Nancy Pelosi, and Professor Paul Krugman who want to get out from underneath the problem of political economy that the 1970s left behind for us, the real legacy of the Nixonian age. There are conservatives who are willing to accept and manage this problem, such as Bill Clinton, Senator Kent Conrad, and Senator Harry Reid. I'm sure somewhere you are both smiling and frowning, because it is probably true that there are more real supply-siders on my side of the aisle than on yours. It is, in one sense, the ultimate compliment when even one's political foes adopt your rhetoric - as Daniel Patrick Moynihan admitted in 1981 that the Republican Party was "the party of ideas."
I know that you and Dr. Krugman do not get along, and have exchanged brickbats in public. He's called you "loonie," and you've called him "obsolete." But the reality is that you are both arguing so hard because you are arguing over the same thing - namely the legacy of Robert Mundell. The reason the fight is so bitter is that there is no one who understands the Mundell-Fleming model as well as Dr. Krugman does, even as there is no one who gave coinage to what Robert Mundell wanted to say as much as you have. One is tempted to put this fight in biblical terms, as the conflict between two sons for the blessing of the father.
The crowning irony is that by the time a President takes office in 2009, Reaganomics will be dead. Half of the Reaganomic program was to keep a lid on consumption demand for oil. Bush blew the doors off of this. In doing so he has created a vicious circle, similar to the Keynesian vicious circle of stagflation in the 1970s. The problem with Keynesian policies, as they were implemented by Nixon, Ford and Carter, was not that they didn't work - but that they did work. Stimulus begat jobs, which begat demand, which begat inflation, which increased the demand for jobs, and therefore the demand for stimulus.
In the present, tax cuts for those at the top beget money that needs to find someplace to park, which goes into oil, which puts more pressure on profits. Profits are propped up with tax cuts - which starts the whole cycle over again. This is why oil has marched up, even though there was, until Katrina, no shortage of crude oil. It was just that parking oil in the spot market is where the volatility was to profit from, not in stocks. Even with corporate tax rates on foreign profits being cut closer and closer to zero, it is still more profitable to park your mega-dollars in crude.
In short, in the end, you and Dr. Krugman have ended up on the same side about the foolishness of Iraq and the incompetence of the Bush executive. The reality is that Bush is killing what Reagan built, because he is breaking the triangle of a constitution. Governments must have a mandate, a mechanism to fulfill it, and a meaning that binds them together. When rhetoric tells people to do the wrong thing, the constitutional order breaks.
Let me talk about this for a moment in blunter terms than most people have been willing to do. The basic burden of political economy is that the world is on an oil standard. That means, as I stated above, that economic information is sooner or later boiled down to distance, which is crossed by oil. As I am sure you know from Mundell's work, one can have any two of: free movement of capital, a fixed exchange rate, or effective monetary policy. If oil is the ultimate standard, then political choice is reduced down to two: free capital movement, or effective monetary policy.
In Reagan's day, and even in the beginning of Clinton's day, the barriers of the Cold War acted to keep capital constrained. In 1983, one could not build a car factory in Shanghai and get cars out of it. It would have been dicey even in 1993. That meant that this has been the great era of monetary policy, with the most powerful central bankers since J.P. Morgan was the de facto central banker of the United States. Now that capital is free to move about, that era is over. As Europe, Japan and the US all show: loose monetary policy, no make that sluttish monetary policy, has failed to kick-start Japan in 17 years, likewise Europe and the US in 5 years.
Bush wanted to keep the basic economy of the US the same, which means burning lots of gasoline. This means that the world currency regime would still be pegged to oil. But he also wanted to do two other things: devalue the US dollar to get demand for US physical exports up, so that his Reagan Democrat base would vote for him, enough to keep Congress and the Presidency and have an easy monetary policy in order to encourage homebuilding, so the pickup truck NASCAR dads would get good wages.
The only way to accomplish this is the way the British did at the end of the 19th century: take control of the monetary base. In their time, gold. That's what the Boer War was about. In our time, oil. Iraq is, essentially, America's Boer War. Supported as a glorious adventure, but in fact an economic disaster which leads to a world wide conflict.
This is that "macho foreign policy" that you rejected. I'm going to say it again: if you believe in free markets and hate military Keynesianism, then the Republican Party is not where you should be. They are anti-free trade, anti-free markets and anti-peace and prosperity. Judge political parties by their track record, not by their sound track. And don't say "I'm a Libertarian," we both know that libertarianism has been code for "pot smoking Republican."
Anyway, to continue with Robert Mundell's work. Markets always adjust. Since Bush has refused to pick which two of the three points on Mundell's triangle he is going to take, the market has picked for him. Thus we have a currency that is melting down against oil. The world decided it wanted to stay pegged to the dollar, and Americans decided that they wanted free capital movement to keep importing and to hold the price of manufactured goods down. That means, as we've observed, that monetary policy is nothing more than debasing the coinage. Same fleas on a different dog; it doesn't work any more than Britain debasing silver coinage did during the Napoleonic Wars.
You know all those tirades you've written about greedy governments and the monetary base? Strike out the word "gold" and put in the world "oil" and mail them to Mssrs. Bush, Snow and Greenspan. Because that is what the dollar is, an amount of oil bandwidth, and all they have managed to do is debase it.
I didn't expect to change your mind when I started this, still less that you are now beyond all of the concerns of the dismal science. I don't expect to convince your disciples, because they are too caught up in rhetorical excess, acting as if cutting taxes is a virtuous act for which some deity will reward them in the hereafter. Nor do I really expect that liberals are going to put aside the bitter political fights - particularly when so many of your fellow Republicans are wandering about nominating people like Roberts to be the head of the Supreme Court.
But it had to be said: just as LBJ and Nixon killed the Keynesian economy, by not understanding how it worked, Bush has killed the Friedman-Mundell economy by not understanding how it worked. And that doesn't touch something I haven't mentioned to this point: there isn't enough oil on the planet to put all six billion of us in the affluent life style. You were fond of talking about obsolete ideas. Here is one: extractive economics is obsolete, and with it, conservatism.
Ah yes, the world "obsolete" that you taunted me with. Yes, we both agree that military Keynesianism is dead. If it could be made to work, Bush and his friends would have turned to it. The economics of 1960 isn't coming back any time soon. But there are new ideas in the air, ideas that place their faith in the growing sphere of the public, rather than exclusively in the power of government, ideas that answer many of the problems of information and money that have been raised over the last 50 years.
So I am going to take some time out, finish my String Quartet in E flat, and then sit down and write to you about how we should place our faith in a few radical economists and other thinkers, starting with one whose work is often thumped, but rarely read, that is to say Adam Smith. And I am going to hope that just as you had put a toe in the aisle, because you saw neo-conservatism marching towards war, repression, and a planned economy, some younger and more flexible minds will realize that it is time to stride across it and become progressives.