Inflation, Recession, and Crisis

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Inflation, Recession, and Crisis or Would You Buy A Used Car From This Man?

Reprinted from the Dec. 1971 issue of UPSTART

‘Science for the People’ Vol. 4, No. 1, January 1972, p. 14 – 19 & 26 – 33

This article has also been published in the December, 1971 issue of UPSTART, the journal of the University Radical Union, a group of radical socialists at Harvard. Some of the statistics in the appendix have been deleted due to lack of space. They are available in the UPSTART version. Copyright by the authors.

Since Nixon announced his new economic program, the American left has been searching for an effective response. In its reaction to the program and the underlying economic crisis, the left has not yet escaped some of its most familiar failings.

On the one hand, many radicals cling to an image of cataclysmic economic breakdown as the natural route to revolution: “Is this it?” was a common question for a few days after Nixon’s August 15 announcement of the new policies. On the other hand, since this never is it, most of the left settles down to an essentially reformist position, in this case repeating the attacks made by labor bureaucrats and liberal muckrakers on the pro-business bias of the Nixon program.

A strategy is needed which breaks out of reformism and waiting for the apocalypse. Similarly, an analysis is needed which goes beyond denunciation of the Nixon program’s short-run bias while avoiding the mirage of an “inevitable” collapse of capitalism. This article presents such an analysis. We hope that it will help others to elaborate new strategies for the radical movement.

We are not denying that Nixon’s program is a tremendous boon to big business at the expense of workers. We believe, however, that the focus on this point has obscured other important aspects of the program and the situation that brought it about. To understand the Nixon program, one must keep in mind a simple fact—one which our president has taken to dwelling upon in his recent news conferences—namely that capitalism is based on production for profit. To get the economy out of stagnation to increase production and employment, Nixon must stimulate profits. If this means a benefit to business while important social needs remain unmet, so be it.

In different circumstances—the early 1940’s or 1960’s for example—measures that stimulate profits may also be ‘ immediately beneficial to workers; but regardless of the immediate effect on workers, capitalism can only be made to grow by providing profitable opportunities for expansion.

Economic policies of a capitalist government are aimed at maintaining the stability or “smooth functioning” of the system. That is, the government works to protect and extend the operation of fundamental institutions of the system—the labor and capital markets, and private ownership and control of the means of production. It is primarily through the workings of these institutions that exploitation takes place and power is exercised in capitalist society. By insuring the smooth functioning of these institutions, rather than by favoritism to particular groups or by corruption, the state guarantees the expansion of opportunities for profit.

Nixon’s new policies, as well as the more traditional economic policies that were used throughout the Kennedy-Johnson era, are a good illustration of the government assuring profits through stabilization of the economy. The switch to new kinds of policies, involving considerable political risk, is evidence that the changed economic and political situation has rendered the traditional policies far less effective than they were in the early 1960’s.

An understanding of the current crisis and Nixon’s program requires an analysis of the economic changes which led to the present situation. In section 1 we trace the development of the economy and of government policy over the past decade. Initially, the particular circumstances of the early 1960’s allowed the success of traditional policies. But the escalation of the Vietnam War forced the economy into several years of full employment and serious inflation.

Contrary to common belief, the inflation did not mean that capitalists gained at the expense of workers. When inflation is accompanied by increased employment, the poorest groups in society—blacks, families headed by women, etc.—may gain more through employment than they lose through inflation. In fact, the low unemployment levels of the late 1960’s placed labor in an advantageous position in wage struggles: profits fell while total wages increased. This situation, clearly unacceptable to capitalist interests, led to a slow-down of business activity. In an unsuccessful attempt to end inflation, government policies precipitated the 1970-71 recession.

In section 2 we discuss the international aspects of the current crisis. Again the Vietnam War plays a particularly significant role. A decline in the U.S. trade position and a rise in U.S. government spending abroad on “costs of empire”—both resulting from the escalation of the war—were central factors in bringing about the balance of payments crisis. Short-term capital movements affected the timing of the crisis, but are not the underlying cause.

New trade agreements and changes in the international monetary system reflect the decline though not the elimination, of U.S. predominance in the “Free World”. But radicals should avoid exaggerating the extent of competition among capitalist nations, and certainly should not expect a return to anything like the situation before World War I.

In section 3 we examine the motivation and future prospects of the Nixon program. There were no major alternatives open to Nixon; waiting for inflation to subside without direct controls would have been politically impossible as well as economically difficult. The situation which required direct controls will be recurrent if not permanent. Thus direct controls will be around for some time to come. Furthermore, while there is some reason for skepticism, the controls are likely to have their intended effect: in the absence of serious political opposition, the Nixon program could succeed in short-run stabilization of the economy.

In section 4, we conclude by considering the implications of the economic crisis for the radical movement. The importance of the war, and of the war’s unpopularity, in disrupting the economy should emphasize the continuing significance of anti-war actions. The political effects of the international crisis, however, are not unambiguously positive for the left. Foreign competition with American industry could easily provide the basis for a revival of popular chauvinism.

Finally we consider the effects of the Nixon program on the organized labor movement and the consequent opportunities for radical action. We emphasize the organized labor movement not because it is a uniquely important part of the working class, but rather because its position is most drastically changed under the new policies. Traditionally, most struggles of American unions have been channelled into narrow wage struggles through the promise of ever-higher wage settlements. Wage-price controls upset this pattern of labor relations; the result could be either more radical action by workers or a more bureaucratized system of wage negotiations. The outcome is not certain, and there may well be a role for radicals in affecting the way the labor movement turns.

The international monetary system has been surrounded by a remarkable level of confusion in discussions of the current crisis. In the Appendix we provide some background information on the workings of the system of fixed exchange rates and dollar reserves.

1. The Domestic Economy

The quarter century since World War II should have taught radicals at least one important lesson: the U.S. economy is not a house of cards. By comparison with earlier periods, the economy has grown quite steadily and rapidly in the postwar years. Since 1946 real gross national product has increased at an average annual rate of more than 3.5%, and real per capita income has grown by almost 60%.1

During the 1950’s, however, recessions caused recurrent minor interruptions in growth. In 1958, for example, unemployment reached 6.8%, the highest level of the postwar period, and real national income fell by 1%. Popular resentment at the “Republican recessions” doubtless played a major part in bringing the Democrats to power in 1960.

The Kennedy administration was committed to active government regulation of the economy and took several steps to counter the 1960-61 recession. Government spending, especially military spending, was increased, thus raising the total demand for goods and services. Tax cuts in 1962 and 1964 increased the after-tax incomes, and therefore the spending, of business and consumers. Interest rates on long-term loans were kept low to encourage borrowing for industrial investment, mortgages and home construction, and installment purchases. The policies seemed effective: annual growth of GNP averaged more than 5.5% in 1962 through 1965 and unemployment dropped, though slowly, from 6.7% in 1961 to 4.5% in 1965.

Low inflation combined with persistent unemployment provided the necessary framework for the effectiveness of the government’s policy in the early 1960’s. Prices rose by less than 2% a year until 1966; unemployment, while declining, did not drop below 5% until after 1964. The low inflation removed any concern about the inflationary effects of deficit spending, and assured the stability necessary for corporate planning.

High unemployment made labor’s bargaining power in wage negotiations weak, and therefore business could respond to the government’s expansion of demand without worrying about high wage bills cutting into profits. In fact, as usual in the expansion out of a recession, profits did rise faster than wages. While the real value of total wages and salaries rose by about 25% from 1960 to 1965, the real value of corporate profits after taxes rose by over 60%.

The combination of low inflation and high unemployment that characterized the early 1960’s, as well as most earlier recessions, has not been repeated in the current period. We shall see below that the simultaneous high unemployment and high inflation of 1970-71 created contradictory pressures upon the government that could not be resolved within the framework of traditional policy.

The situation of the early 1960’s was politically as well as economically favorable to government stimulation of the economy. In the somewhat sleepy decade between the end of the Korean War and beginning of the Vietnam War buildup, immediate political and military demands on the government were at a remarkably low level. There were no strong domestic reform movements. There was no “hot” war going on. And the Cold War required an indefinite, that is an easily manipulable, level of military expenditure.

Thus the Kennedy-Johnson administration faced almost uniquely favorable economic and political circumstances for its intervention in the economy. The situation was not only unique: it was also quite brief. By 1965-66, the government was confronted with near-full employment, more rapid inflation, a war in Asia, and rising domestic opposition. In the new situation the government’s economic policies were pathetically but necessarily inept.

The War Overkills the Economy

With the expansion of the war in Indochina, the Johnson administration encountered serious difficulties in financing its military operations. In past wars, increased taxes and cutbacks in non-military government programs had provided major sources of finance. Both of these sources were largely unavailable, however, because of the unpopularity of the Vietnam War. Major tax increases or significant curtailment of popular government programs would have directly increased opposition to the war, and would have hindered Johnson’s effort to hide the whole issue. Thus the government was forced to rely on expansion of deficit spending, with unfortunate consequences for the economy.

In a period of high unemployment, deficit spending, by expanding demand, can create more jobs, lead to rising incomes, and generate more economic growth. In a period of low unemployment, however, the expansion of demand cannot readily be met by expansion of output. Thus, the government simply competes with the private sector for the available goods and services. The result is a rise in prices, that is, inflation. This is exactly what happened: beginning in 1966, war financing required increased deficit spending just as the economy was reaching near-full employment, and the result was rapid inflation.

Two miscalculations may have led the Johnson administration to believe that the inflationary effects of war deficits would not be serious. First, U.S. warmakers kept seeing the light at the end of the tunnel and imagining that they were about to win. Therefore, war expenditures were probably initially viewed as a temporary problem. Second, at the beginning of the major escalation of the war, in 1965, unemployment, though declining, was still over 4%; it may have been hoped that a short spurt of war spending would only bring the economy to a slightly lower unemployment level without creating-further inflationary pressures. This hope could conceivably have been realized if the war had ended by 1967, but the struggle of the Vietnamese people was not so easily suppressed.

Inflation, Employment and the Role of the Government

The inflation and low unemployment after 1966 posed a number of problems for the U.S. government. In general, the role of the government in the economy is to maintain the “smooth functioning” of the system. Besides the international complications, dealt with below, the economic conditions of the late 1960’s disrupted the “smooth functioning” of both corporate planning and labor supply.

Modern capitalism very much depends on large corporations being able to make long-run plans. A steady, uniform and predictable level of inflation can be compatible with planning; it is not crucial whether businesses know that prices will increase by zero, three, or ten per cent a year, as long as they know which it will be. For some Latin American countries, for instance, annual price increases of 10-15% are normal and expected; but for the U.S. in. the 1960’s, price increases as high as 5-6% a year seriously hampered corporate planning since they were quite unexpected.

The smooth functioning of capitalism also depends on business having a readily available supply of labor at its command. We. have seen how the rapid expansion of the economy in the early 1960’s was based on the availability of labor: the expansion of government demand in a time of high unemployment permitted rapidly rising profits. But in the late 1960’s unemployment rates became exceptionally low. The period 1966 through 1969 was the only four-year period since World War II in which unemployment remained below 4%.

Such conditions enhance the economic power of labor. With high employment levels workers are able to demand wage increases. Often having other family members working or having ready access to part-time and second jobs, workers hold a strong bargaining position. The bargaining power of employers is weakened, since they cannot turn to the unemployed as an alternative source of labor. They must raise wages to meet demands of those workers already employed and to attract more people into the workforce (such as housewives). Both ways they are forced to give up a growing share of revenues to wages and salaries.

In fact, during the late 1960’s the share of national income going to labor rose, and the share going to corporate profits fell. Total wages and salaries, which had been 71% of national income in 1960 and had dropped below 70% in 1965, rose above 73% in 1969. Corporate profits before taxes were 12% of national income in 1960, almost 14% in 1965, but down below 12% in 1969.2

It is well known that worker’s average real take-home pay has remained roughly constant since 1965.3 Impressive gains in money wages were quickly eroded by inflation and rising taxes. Nonetheless, the rapid expansion in the number of people employed meant that working people as a class were receiving a higher share of national income. From 1965 to 1969 the real value of total wages and salaries rose by over 23%. Average family incomes, especially those of poor families, rose rapidly with more family members working; per capita consumption continued to rise throughout the 1960’s.

Corporate profits, on the other hand, rose slightly from 1965 to 1966, and then actually declined in real value. From 1965 to 1969, the real value of corporate profits after taxes declined by 10%.4

These figures show the crisis in which American business found itself at the beginning of the 1970’s. The deteriorating state of business profits alone would certainly be enough to prompt the government to take strong actions. Also important, however, inflation meant that workers did not feel that their position was improving.

While total labor income had risen since 1965, both absolutely and as a share of national income, two factors greatly limited any positive feeling that workers might have derived from this increase in income. First, the increase had come through more work (more family members working) rather than through higher real wages. Second, workers constantly saw any gains they made eaten up by higher prices. Whether or not the price rises actually outweighed wage gains, the situation was disconcerting. Thus government action to deal with inflation had both business and popular support.

The Limitations on the Government’s Options

The Nixon administration initially tried to solve the economic problems of the late 1960’s in the traditional manner: causing a contraction of demand, by reducing the government deficit (raising taxes or lowering government spending), and by raising interest rates. Such actions were designed to curtail economic activity, raise unemployment, and thereby slow down wage increases. Eventually business, in response to the lessened wage pressures and declining consumer spending, would stop raising prices, and inflation would slow down.

It all worked according to plan except for the slowing down of inflation. Unemployment was indeed raised, ushering in the 1970-71 recession. Inflation, however, continued unabated. Rather than the “either-or” choice between inflation and unemployment which faced previous administrations—the famous “trade-off”—the Nixon government found itself enjoying the worst of both.

From the above account of the 1960’s it should be clear how the trade-off between unemployment and inflation operates. Beginning with high unemployment, as the economy expands unemployed workers can be drawn into production and no inflation occurs. But as unemployment falls the continuing rise in demand causes price and wage increases because different industries reach bottlenecks and cannot readily expand output, due to the increasing labor scarcity.

If the trade-off worked equally well in reverse, Nixon’s initial attempts to control the economy would have most likely worked. However, once inflation becomes serious, as it did in the late 1960’s, it tends to become self-perpetuating and continues after the original inflationary pressures have been eliminated. Having experienced inflation, employers and workers alike expect there to be more, raise their prices and wages accordingly, and their collective actions fulfill their expectations in spite of the government’s reduction of demand. In a more competitive economy such a process would be inhibited, because a decline in demand would quickly force price reductions. But monopolistic elements in the U.S. economy can resist the pressures and maintain their prices.

So in the summer of 1971 Nixon and U.S. capitalists found themselves in a predicament. Unemployment rates had again risen to around 6%. Traditional policies of the “new economics” would call for an expansion of government spending. But an expansion of government spending would exacerbate the inflation, already close to 6%.

Either the Nixon administration had to simply wait out the present situation–that is, live with the high level of unemployment until the inflation subsided–and then stimulate the economy, or it had to find some new means by which to intervene in the economy. If the elections had been further away and if the international monetary crisis could have been forestalled, the first alternative might have been feasible. But the elections were a fact, and, as we shall argue below, the international situation could not be forestalled because it could not be separated from the domestic events. Nixon had to act.

2. Origins of the International Crisis

As a result of the two world wars, the United States became the unchallenged, leading power among capitalist nations. In the late 1940’s and early 1950’s U.S. business rapidly spread its overseas activity. It made inroads to areas that had previously been dominated, formally or informally, by Western Europe and japan. In parts of the world where before 1914 U.S. business had been one of many competing foreign groups—Brazil or Argentina, for example—it moved to undisputed dominance by the 1950’s.

Economic expansion was accompanied by spreading military and political activity. The Pentagon extended its network of bases and advisors around the globe. U.S. diplomatic missions replaced former colonial offices as the real seats of power in much of the Third World.

But of course the extension of U.S. political and economic power was not confined to underdeveloped areas. The Marshall Plan, the suppression of rebellion in Greece, and the maintenance of the U.S. military presence in Germany provided a foundation for the rapid expansion of U.S. business activity in Europe.5

The post-war expansion of foreign trade and investment depended, among other things, on the establishment of a new set of international monetary institutions. The key factor in the new monetary arrangements, created at the 1944 Bretton Woods conference, was that the dollar became, along with gold, the basis of international transactions. The governments of countries taking part in the system (developed capitalist nations) agreed to maintain a fixed exchange rate between their currencies and the dollar. The U.S. government agreed, in turn, to maintain a fixed value of the dollar in terms of gold—$35 an ounce.

The post-war system of dollar based exchange rates provided a stable basis for trade beneficial to business in all capitalist nations. Furthermore, the system had other aspects which, by causing the accumulation of dollar reserves around the world, serve the particular interests of U.S. capitalism.

As explained in the Appendix–where more details are provided on the working of the international monetary system–other countries, increasing their reserves, have a continuing need to accumulate dollars. The U.S., providing these dollars, can therefore spend more abroad than it receives. The foreign need for dollar reserves, in effect, finances part of the U.S. balance of payments deficit. (The growth of dollar reserves around the world could finance almost all of the moderate U.S. balance of payments deficit of the 1960’s, but not the very large deficits of 1970- 18 71. See the Appendix for some more details.)

What has happened, in short, is that the total dominance of the U.S. in the international capitalist economy after World War II led to the creation of a system–partly formal and partly de facto–that further enhanced the relative position of the U.S.

Reconstruction and Competition

U.S. leadership of the capitalist world after 1945 was a natural consequence of the long-run balance of power. But the extent of U.S. predominance immediately after the war was unusually great, and clearly temporary. All the other major industrial nations had been ravaged by the war, while the U.S. economy had benefited immensely from the stimulus of war production. With the return of peace and gradual reconstruction, European and japanese competition with the U.S. was sure to reappear.

The U.S. furthermore was caught in a situation that impelled it to hasten the decline of its relative power. First, the military and strategic imperatives of the cold war required that the U.S. build up the economies of all developed capitalist countries, including its recent enemies as well as allies. Second, the expansion of the U.S. economy was dependent on the revitalization of world trade and the reopening of opportunities for foreign investment, and this also required rebuilding the economies of Western Europe and japan.

Even though it was clear that the relative dominance of the U.S. had to decline, the timing and the extent of that decline remained unclear. Several counterforces operated to preserve the U.S. position. U.S. economic strength at the end of World War II led, as we have pointed out above, to an international financial system that continually favored U.S. interests. Also, while U.S. economic dominance could be challenged, the military might of the U.S. was less assailable. And so long as military hegemony could be maintained, the economic power of the U.S. would have a firm support.

Finally, the rise of socialism greatly affected the question of conflict and unity among capitalist nations. The military challenge and social threat of socialism would certainly force a certain solidarity among capitalists even with a decline in U.S. economic power; indeed, the situation might force the lesser powers into greater reliance on U.S. political and military leadership.

Genesis of the Current Crisis

It is tempting to identify the current U.S. balance of payments crisis as the natural result of foreign competition and declining U.S. economic predominance. Closer examination of the facts, however, suggests that more blame should be placed on direct and indirect effects of the war in Vietnam, and less on European and japanese competition, than is commonly recognized. We can trace the weakening of the U.S. international position in each of the three major long-term components of the balance of payments—trade, long-term investments, and costs of empire—and in the secondary effects of short-term investment.

Trade and Wages

Throughout the twentieth century the United States has had a trade surplus–exports have exceeded imports each year until 1971. The existence of a U.S. trade surplus may seem paradoxical. After all, wages are higher in the U.S. than in all other parts of the world. How could U.S. industry, paying such high wages. continue to compete with low wage producers elsewhere?

The answer is, of course, that U.S. industry could compete so long as its higher paid labor produced sufficiently more than other countries’ lower paid labor. Having more education (imparting both skills and discipline), better nourishment, more industrial and organizational experience, and better equipment to work with, US. labor has been the most productive labor in the world, as well as the highest paid. Although some industries–e.g. textiles and shoes–requiring large amounts of relatively unskilled labor have long been hurt by competition from low-wage foreign industry, such cases are not typical of most U.S. industry throughout the postwar period.

The high wages of U.S. labor would become a fetter on industry only when foreign capitalists were more successful than U.S. capitalists in keeping productivity increases ahead of wage increases. This might be the case, especially, in industries with strong U.S. unions but weak foreign unions. But there is little reason to believe that such a phenomenon has had general importance up to this point.

The growth of multi-national corporations may accelerate the entrance of foreign labor into effective competition with U.S. labor. A U.S.-based multi-national enterprise can use its advanced technology, organizational skills, marketing power, and highly trained skilled labor along with cheap foreign unskilled labor.

Although such forces do have long-term significance their role in precipitating the current crisis seems rather limited. As recently as the first half of the 1960’s the U.S. trade surplus was high and increasing. It is only in the later 1960’s, as the war-related inflation made U.S. goods higher priced and less competitive in world markets, that the current general deterioration in the U.S. trade position began. The average trade surplus dropped from $5.4 billion in 1960-65 to $2.0 billion in 1966-71.

It seems reasonable to attribute this decline, in view of its timing, to the inflation of the late 1960’s and thus to the war spending and the domestic struggle between U.S. capital and labor which gave rise to inflation. A decrease in the U.S. trade surplus due primarily to foreign competition and declining productivity differentials between U.S. and foreign workers would have been much slower and more gradual; there is no visible way that such long-term trends can explain the rising trade surplus before 1964 and the abruptly falling surplus during the Vietnam war years.

War and inflation are fundamental features of the present world capitalist system, no less so than rising foreign competition; thus it should be clear that the current trade deterioration results from some of the basic contradictions of contemporary capitalism.

Foreign Investment and Profits

Direct U.S. investment abroad cannot be viewed as contributing to the current balance of payments problem. While foreign investment does amount to a significant outflow of dollars, it is more than offset by the foreign profits on previous investment returning to the U.S. The total of foreign investment plus profits on past foreign investment has been a positive and rising entry in the U.S. balance of payments for more than a decade.

Direct foreign investment is carried on, of course, by multi-national corporations. The contradictory aspects of those corporations’ foreign activity are reflected in two opposing effects on the U.S. balance of payments. On the one hand, foreign investment by U.S. companies may facilitate foreign competition with U.S. industry, and thus lead towards a long-run decline in the U.S. trade balance. On the other hand, foreign investment increases the extent to which the industries of all capitalist nations are under the unified control of U.S. business. A natural expression of this control is the rising amount of foreign profits returned to the U.S.

It is not yet clear whether the competitive or the unifying aspect of multi-national corporate activity will be more important in the long-run, either in the world-wide distribution of economic power or in the effects on the U.S. balance of·payments. Returning foreign profits could not outweigh the rapid inflation-induced deterioration in U.S. trade in the late 1960’s. However, the more gradual long-run decline in the trade balance which can legitimately be attributed to rising foreign competition might well be of a magnitude comparable to the returning foreign profits. Only guesses are available on this question; Fortune magazine, a usually informed and cautious source, guesses that by the late 1970’s rapidly rising foreign profits will indeed outweigh a modest U.S. trade deficit.6

Costs of Empire

The direct and indirect effects of economic expansion on the U.S. balance of payments go well beyond trade, investment and profits. The military and diplomatic operations of the U.S. government provide a necessary support for multi-national corporate activity.

The costs of empire—military and aid spending abroad—do not result from mistaken or extravagant overseas activity; they flow directly from the requirements of the capitalist system. Economic activity cannot exist in a political vacuum; it requires the active support of the state. The significant form of this support is not graft or short-run favoritism to a particular business (though such favoritism is recurrent), but rather long-run programs designed to maintain the “smooth functioning” of the system, internationally as well as domestically.

The U.S. government, for instance, played a leading role in establishing international monetary institutions and negotiating trade agreements. Similarly, the U. S. provides economic aid to friendly, weak governments and employs a military strategy designed to keep the world safe for capitalist activity.

Aid and military operations can be costly. From 1960 to 1965, U.S. spending abroad on costs of empire averaged $5.5 billion a year. When major spending for the Vietnam War began, the costs of empire increased, averaging $6.9 billion a year from 1966 to 1971. Thus the direct spending on the war, as well as the war-related inflation, contributed to the current balance of payments problems.

Short-run Capital Flows: Precipitating the Crisis

While trade problems and costs of empire lie at the roots of the crisis, the international movements of short-term capital investments affected its timing. The importance of these short-term movements should not be ignored. They reflect the increasing integration of international capital markets, and the present crisis illustrates how that integration can hamper the activity of a national government attempting to regulate “its own” economy.

The balance of payments difficulties attributable to trade and costs of empire began to appear in 1966 and became substantially more serious in 1967-69. However, rising interest rates in the U.S. accompanied by economic difficulties in Europe resulted in a large inflow of short-term investments–i.e., investments in short-term bonds and securities–into the U.S. This forestalled for a few years the coming balance of payments problem.

By 1970, the increasing severity of the recession in the U.S. led the government to push down interest rates to stimulate investment in productive activity. Instead of inducing investment, the lower interest rates, along with more stable conditions and higher interest rates in Europe, resulted in a huge flight of short-term capital from the U.S. Short-term capital flows, which amounted to a $9.6 billion inflow to the U.S. in 1969. plummeted to a $5.8 billion outflow in 1970–a virtually unprecedented change of more than $15 billion in one year. Further declines in the U.S. interest rate and continuing better conditions in Europe led to a further outflow of capital: in early 1971 the balance of payments deficit from short-term investment flows was running at an annual rate of $10.7 billion. It was these dramatic shifts which brought the balance of payments crisis to a head in 1971 rather than 1969 or 1973.

Beyond the effect on the timing of the crisis, the importance of short-term capital flows is twofold. First, the increasing internationalization of capital markets, a victory for capitalist expansion, forces all major capitalist countries to maintain near-identical interest rates. Manipulation of the interest rate, one of the traditional instruments of government economic policy, can no longer be employed to counter recession or inflation.

Second, Nixon and the mass media are probably wrong in attributing these movements of short-term investment to “international speculators” More likely the culprits are not the stereotyped scheming individuals—the “gnomes of Zurich”—but rather the treasurers of U.S.— based multi-national corporations. These treasurers are responsible for the tremendous cash balances maintained by their companies; they would be remiss in their profit-maximizing duties if they failed to use their cash wherever it provided the highest quick returns. (Companies with a few million dollars of cash on hand do not keep it all in a checking account.)

Thus the internationalization of capital markets, and the use made of those markets by large corporations, limits the freedom of individual governments to regulate their economies, illustrating the contradiction that arises in advanced capitalism between international integration and nationalism.

Balance of Payments: A Summary

The forces affecting the balance of payments operate at very different speeds. Short-term investment fluctuations are the quickest and most dramatic, sometimes reversing direction within a year or less. The effects of war and inflation are somewhat slower and less volatile; in the relevant time period, they can be observed by comparing five- and six-year averages. The slowest forces, changes in foreign competition and in returning foreign profits, take decades to make themselves felt.

The shortest-term forces obviously affect the timing of any particular crisis. But a crisis caused exclusively by short-term investment flows probably would not cause serious difficulties to any major capitalist power. The current balance of payments crisis has longer-run causes. The trade deterioration of the late 1960’s, apparently resulting from war-related inflation, and the rising costs of empire during the Vietnam war, seem to be the principal factors causing the long-term balance of payments deficit. We see no evidence that the longest-term factors are significantly involved in the current crisis; important as they may become, their effects still remain limited.

3. Nixon’s Program and Where it is Leading

The seriousness of the international monetary crisis, coupled with the mounting pressure of domestic events and the impending election, left the Nixon administration little leeway. The government might have waited a month or two and it might have postponed strong action even further by some lesser regulations.

Having chosen to act, Nixon had no general alternative to the policy he has pursued. To suceed the government policy must achieve expansion without inflation, and it must at least show signs of progress in this direction before the 1972 election—sooner than inflation could have been controlled without direct price controls. The wage-price freeze is not permanent; it will be replaced by an “incomes policy” in phase II, permitting gradual, but still controlled, increases in wages and prices.7 Such controls, together with expansionary policies, were the only option Nixon possessed.

The program had to be one that would freeze everything but profits. (Only in a situation of total crisis, such as World War II, can business be expected to tolerate a “profit freeze” of any sort; and even during that war business did not do so badly.) Aside from special provisions and the difficulty of enforcing the price side of the freeze a wage-price freeze automatically favors profits. As output per worker rises, but wages remain constant, the amount of product sold can increase while costs are unchanged. Rising sales revenues with constant costs means increasing profits.

In the U.S. output per worker has been increasing at 2% to 3% annually since World War II; with increasing productivity a wage-price freeze automatically boosts profits. (Since profits are usually about 10-15% of sales, the 2-3% productivity gains would yield profit gains of 10-30% with fixed prices and wages.) The phase II incomes policy will probably tie wage and price increases to productivity increases, to eliminate this extreme bias of the total freeze.

The discussion of a “profits freeze” reflects a basic misunderstanding of capitalism. For the system to grow profits must be heated up, not frozen. That is the way capitalism works. Within the capitalist system the controls on wages and prices, but not on profits, are rational; more “humane” or “equitable” alternatives were not possible.

To call for a profits freeze, or to join the liberals in carping at the especially blatant aspects of the program is to encourage the idea that the economy’s problems could be solved by a liberal administration. But a liberal government, no less than a conservative one, would have to maintain the smooth functioning of the system. At most the talk about a profits freeze might lead a Democratic administration to a trivial increase in the corporation income tax rate, to create a pretense that business, also, is suffering from austerity. And beyond the profits freeze issue, most liberal politicians have only minor criticisms of Nixon’s program. It is what they would have done themselves.

The efforts to expand the economy and curb inflation were dictated by the international as well as the domestic needs of U.S. business. With wages and prices held down, the international competitiveness of U.S. goods would improve. Here again, workers pay the costs of overcoming the crisis. And here again there was little alternative within the system.

The Meaning of Direct Intervention

It is quite significant that U.S. capitalism has come to a point where there is no alternative to direct government intervention in the determination of wages and prices. Although many European capitalist governments have pursued these sorts of policies for years, U.S. government and business alike have shied away from such programs. Indeed the prerogative to make price, wage and production decisions without government interference has long been seen by U.S. business as the foundation of economic success.

When U.S. business leaders welcomed the wage-price freeze, they saw it as an escape from crisis, not necessarily as a permanent new order. They will use the freeze as best they can, but if the circumstances change they may exert pressure for a return to old, indirect forms of government policy.

But are the circumstances producing the freeze so ephermal? The current crisis, in both its international and its domestic aspects, results in large part from the war in Vietnam. While U.S. intervention in Southeast Asia is not about to end, and there will no doubt be other war in the future, military action on the scale of the late 1960’s is probably not a permanent state.

Nevertheless, our analysis has suggested that the traditional policies work well only when the economy is free of serious wage-price spirals and when the government is free of strong domestic and international political constraints on its budget. The political limitations should be stressed: the stronger the opposition facing the U.S. government at home and abroad, the greater the need for direct controls on the economy.

And even in otherwise ideal circumstances, the scope of indirect government policy is now more limited than it used to be: international movements of short-term investments force all capitalist countries to adopt nearly the same interest rates, removing one traditional policy instrument from the hands of national government.

Thus there are dim prospects for a long-lasting reversion to the old system of indirect controls. The new controls will remain a recurrent, if not quite permanent, feature of American capitalism.

Will the New Policies Work?

But the question remains, will the new policies succeed where the old ones failed? There is little doubt that the policies can initially succeed in at least one area—controlling inflation. And if we are correct in our analysis of the current inflation as a wage-price spiral set in motion by forces no longer active, breaking the spiral may reduce inflation for a considerable period of time.

As to moving the economy out of recession, the immediate prospects for the program are less favorable. As of this writing (October 20) usual economic indicators– the industrial production index, new housing starts–show little sign of an upsurge in the economy. Nixon’s intentions for Phase II and beyond remain opaque. The longer there is confusion about the program, the longer business will wait before starting new investment or expansion of production, and consequently the slower the recovery will be.

One aspect of the confusion about Nixon’s intentions has been much noted by Paul Samuelson and other liberal economists. Despite proclamations that the new policies are designed to create jobs and economic expansion, Nixon’s August 15 announcement projected no increase in the government deficit. Tax reductions were to be met by reductions in government spending, including some direct cuts in government employment. But it would require an increase of the government deficit—i.e., of the government’s demand for goods and services beyond its tax revenues—to obtain a strong and sustained expansion.

Rather than joining the liberal economists in “hoping” Nixon did not mean what he said, we may surmise that he has a fairly good public relations staff. The budget-balancing in the initial program was necessary to make the anti-inflation program seem convincing. Later, when the election is a little closer and when there will likely have been some success in controlling inflation, Nixon may well announce a reversal and advocate deficit spending to attack unemployment. This announcement would leave the liberals no leg to stand on in the final months of the campaign. Until such an announcement, however, Samuelson’s skepticism about the job-creating aspects of the program is justified.

From the point of view of business, the failure of the policies to reduce unemployment is not an unmitigated loss. Of course businesses do not advocate recession; but neither do they enjoy the very low unemployment rates (i.e., the scarcity of labor) which characterized the late 1960’s. The four-year period, 1966 to 1969, when the unemployment rate stayed below 4%, was bad for profits. Businesses can be expected to encourage government policies that, while promoting economic growth, stop short of unpleasantly full employment.

A solution to the domestic crisis would go a long way towards solving the balance of payments problem as well. Effective control on inflation would increase the competitiveness of U.S. goods in world markets, thereby increasing the U.S. trade surplus.

But there are other issues in the international situation beyond simply the competitiveness of U.S. goods. The real question is this: will the U.S. be able to establish a new set of stable political and economic relations to replace the earlier arrangements from the period of unchallenged U.S. hegemony? Obviously, the actions taken on August 15—floating the dollar, introducing the surcharge, etc.—are only a first step towards creating those new arrangements.

In fact, the extreme measures that the Nixon administration took, most notably the 10% surcharge on imports, seem to be either a bluff—perhaps an opening maneuver in negotiations—or the result of an overestimation of the continued extent of U.S. power. Most likely the surcharge will be bargained away in return for some concessions abroad, e.g., a more rapid opening up of the Japanese economy to U.S. investment.

It is possible, however, that the Nixon administration will resist compromise and the situation will spark a series of counter measures and trade wars. This alternative would work against the interests of the U.S. based multi-national enterprises; since they include many of the largest firms in the economy, we are inclined to believe their interests will prevail.

A more difficult problem arises when the U.S. attempts to reduce the costs of maintaining the empire. Both Nixon and Connally have emphasized the need for other advanced capitalist nations to share the costs of “free world defense.” But the U.S. faces a dilemma: it is difficult to share costs without sharing power. Only if other measures fail to improve the balance of payments will the U.S. government willingly cede any of its military power. Such a redistribution of power, if it occurs, will mark at least as great a step away from U.S. hegemony as does the present crisis.

4. The Economy and the American Left

The most important issue, in any case, is to determine the political implications for radical action in the United States. One point stands out as particularly important in the analysis of both domestic and international problems: the U.S. aggression in Southeast Asia lies at the heart of the current crisis of U.S. capitalism.

The war was the catalyst in the domestic crisis and has placed severe constraints on the ability of the government to deal with economic problems. Partly through inflation and partly through direct war spending, the war has also brought on the international crisis.

An international crisis might have come, even in the absence of war, as a result of slower, longer-run forces like rising foreign competition. But in explaining this particular crisis, the war is the central issue. Nixon’s talk of international speculators, or the fascination of many radicals with international monetary problems and long-run crises of capitalism must not distract the left from continued focus on the war. The analysis of the economic crisis underscores the potential of continuing anti-war action.

The usefulness of the action is twofold. First, the war would not have had nearly such serious economic consequences had the government been able to make it popular and pursue it openly. Then open taxation and direct controls (as during World War II) would have been accepted, limiting government deficits and inflation. The course followed by the economy would then have been very different.

The American left, despite its shortcomings, has played an important role in limiting the government’s ability to pursue the war. If the anti-war movement can be revitalized the war can be made a continued burden to U.S. capitalism. As the left backed up the struggle of the Vietnamese and helped force Johnson to resign and Nixon to drastically alter the nature of the war so now more action can hamper the U.S. operation even further.

A second important lesson for action derives from the importance of the war in the present crisis. The situation provides natural opportunities for relating the immediate economic circumstances of many people to the war and to the basic nature of capitalism. A basis for such political work exists in the popular hostility towards Nixon’s program, especially among organized labor. Without being unduly optimistic about the possibilities of the left creating t1es to the working class, we do see new chances both for widening the base of opposition to the war and for expanding support for a left interpretation of the crisis.

Aside from the issues relating to the war, there is another lesson to be drawn from the international situation relating to the new power relations among capitalist nation. While the relationship among capitalist powers is not likely to revert to a pre-World War I level of antagonism, it is clear that national conflicts within the developed capitalist world will become increasingly important. With those conflicts can come resurgence of popular chauvinism to supplement the waning force of anti-communism as the ideological basis for U.S. foreign policy.

There is a significant danger that the American left could become a party to the development of that chauvinism. The pre-World War I socialist parties of Europe illustrate that such has been the fate of our predecessors.

Furthermore, it is quite possible that conflict can develop alongside of integration of capitalist economies. As capital shifts the location of particular production activities, workers would see themselves losing jobs to foreign labor and would become easy prey for a chauvinist revived. Opportunism on the left could easily dictate capitulation to this chauvinism in order to gain quick popularity within the working class.

Organized Labor and the Left

The events of these months do change class relations in the United States. We noted at the beginning of this essay that the customary pattern of union activity in the U.S. channels class struggle into isolated wage struggle. Such a situation creates well known difficulties for the left. In particular, wage struggles tend to fragment the working class and to divert workers from struggles over control.8

The new circumstances created by direct controls seriously alter traditional union practices. Three possible outcomes can be suggested.

First, wage controls might transform disputes over wages from conflicts with individual employers to struggles against the government. This seems unlikely, especially since the AFL-CIO leaders have agreed to serve on the government pay boards. A confrontation with the state over wage controls could only be carried out by a more radical labor movement than exists in America in 1971.

Second, with wage demands absorbed and co-opted by the new bureaucratic apparatus, union activity might increasingly focus on local struggles over working conditions and control of the workplace. This alternative is more likely than the first one; in areas where there are strong militant groups within local unions it may well happen. But imagining that local non-wage struggles could quickly become widespread probably involves an exaggeration of the strength of labor radicalism today.

Finally, wage conflicts may be absorbed into the bureaucratic apparatus, but in a manner surrounded with legalistic confusions, conflicting jurisdictions of various commissions and councils, dozens of loopholes and escape clauses, etc. A natural tendency for labor union activity might be to convert struggles over wage demands into legal disputes, having the union lawyers try to find the right loophole in the wage controls for each union. Bureaucratized legal disputes over wages are unfortunately quite compatible with the ideology of labor leadership; it is not certain, but quite possible, that most union members will at least initially accept this new conservative pattern of union activity.

Which of these trends prevails—the tendencies toward radicalization or the tendencies toward increased bureaucratization—is ultimately a political question. There are clearly new opportunities for us to build activity within the ranks of organized labor. Without such activity the bureaucratic tendencies will surely prevail.

It would be foolish to imagine that we can have an immediate impact on the politics of organized labor. But the Nixon program of economic controls will be around for quite a while—long enough for us to develop a coherent response and perhaps become a relevant political force.

Indeed, throughout the analysis of the economic crisis political forces play a crucial role. These political forces are conditioned, but by no means mechanically determined, by the economic factors. The sucess or failure of the Nixon program, and the ultimate effects of the current crisis, depend on the reactions of many groups, in eluding the Vietnamese people, the U.S. labor movement, and other capitalist governments, as well as the American left.

Above all, the political as well as economic effects of the war in Indochina are central to an understanding of the current crisis. A socialist response to the crisis must link opposition to Nixon’s program both to the war and to the entire system of American capitalism.


Fixed Exchage Rates and Dollar Reserves

One need not have a detailed understanding of the workings of the international monetary system to comprehend the current crisis. Nonetheless, the following general remarks may serve the reader as a useful supplement to our argument, especially that at the beginning of section 3:

Fixed exchange rates are useful to trade because they allow a business to make plans based on knowledge of the future value of its trading partner’s currencies. However, maintenance of fixed exchange rates places a considerable burden on the governments involved: they must continually prevent the normal workings of supply and demand from driving the value of their currencies up or down.

For instance, suppose that Britain experiences more rapid inflation than the countries it trades with. Then British exports become higher priced, i.e., less competitive, in world markets. Other countries, buying less British exports, have less need for pounds, so the demand for pounds declines. If currency values fluctuated freely, like the prices of stocks in the stock market, the reduced demand for the pound would immediately result in a lower price for the pound (in terms of dollars or gold).

Under the fixed exchange rate system, however, the British government must use its reserves of dollars or gold to buy pounds, thus adding to the demand for the pound and eliminating the downward pressure on its price. Simultaneously, of course, the government would make efforts to halt the inflation, restore the competitiveness of British exports, and revive the normal demand for the pound. (This is a hypothetical example to illustrate the workings of the exchange rate system, not an actual explanation of recent British balance-of-payments problems.)

Thus a country with substantial reserves can prevent short-run economic fluctuations from altering the fixed value of its currency. But it may turn out, of course, that the causes of pressure on the value of a currency are not short-lived factors. In the capitalist world, development necessarily proceeds unevenly among countries. As a particular country falls behind or moves ahead, the fixed rate between its currency and the dollar becomes more and more out of line with the real relationship among economies. The long-run slow- down of the British economy and its decline in efficiency relative to other nations, and the long-run relative rise in efficiency of the West German economy are cases in point. Buying or selling the currency with reserves of dollars is only a stop-gap measure. Ultimately a devaluation or revaluation—a decrease or increase in the fixed value of the currency—becomes necessary; and this is exactly what happened, respectively, in Britain and West Germany.

Such an adjustment in exchange rates can be a major disturbance to international economic activity, especially when undertaken by one of the major economic powers. If, however, it occurs only infrequently, it is not a large price for capitalism to pay for the otherwise stable conditions that fixed exchange rates provide.

The post-war system of dollar-based fixed exchange rates provided a stable basis for trade beneficial to business in all capitalist nations. However, the system had other aspects which, by causing the accumulation of dollar reserves around the world, serves the particular interest of U.S. capitalism.

The fixed exchange rate system requires that countires hold reserves in one of the stable currencies, most notably the dollar.9 (There is not enough gold, and the world supply of gold is not increasing fast enough, for it to rival the dollar as the principal reserve.) The reserves held by a government (usually by the central bank) are used in the purchase of its own currency that are necessary to maintain the fixed exchange rate.

Dollar reserves do not just fall from the sky. The number of dollars in a country increases when the country has a balance of payments surplus, i.e., when the country’s receipts from abroad (on exports, etc.) exceed its foreign expenditures (on imports, foreign investment, etc.). Then businesses and individuals will have more dollars than they need, sell them to the general bank for local currency, and thereby increase the government’s reserves.

Conversely, when a country has a balance of payments deficit, meaning that foreign expenditures exceed receipts from abroad, more dollars are leaving than entering the country. The central bank may then have to use up some of its reserve to finance the foreign expenditures. Thus in order to build up increasing reserves, a country must over the long run have a balance of payments surplus.

The system of dollar reserves—deriving from the strength of the U.S. economy and the system of fixed exchange rates—yields an important benefit for U.S. business and government. Other capitalist countries have an increasing demand for dollar reserves as their economies grow. The total world-wide demand for dollars for increasing reserves has averaged close to two billion dollars a year during the 1960’s.10 To accumulate these reserves the ‘ other capitalist countries must achieve a balance of payments surplus totalling that same amount, $2 billion, every year.

The United States, however, as the source of all these dollars, is therby able to run a balance of payments deficit of the same amount to supply the world with increasing revenues. In effect reserve holdings are supplying an important credit to U.S. business and government for international operations. The U.S. can spend several billion dollars a year on military operations abroad, foreign investment, imports, etc., in excess of its receipts from abroad without worrying about balance of payments problems or the value of the dollar.

An analogy may clarify the role of the dollar as a reserve currency. Suppose that you were a famous movie star and all your friends saved your checks and didn’t cash them in because they wanted to keep the autographs. You could then write more checks than you could afford to cash in; your friends would be financing this extra expenditure of yours by reducing their own spending in order to save up your checks.

European central banks have no sentimental attachment to the autograph on the dollar—their reasons have been explained above—but the mechanism is the same. The need for dollar reserves provides an important credit to U.S. business and government for international operations.

What has happened, in short, is that the total dominance of the U.S. in the international capitalist economy after World War II led to a system being established—partly formal and partly de facto—that further enhanced the relative position of the U.S.


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  1. Expressing amounts in “real” forms means that the figures have been corrected to eliminate the effects of inflation. For example, if income rose from $100 to $110 while there was a 5% inflation, we would say that real income increased by only 5%.
  2. The remaining roughly 15% of national income is unincorporated business income, income of farm proprietors, rental income of persons, and net interest (of financial institutions).
  3. The oft quoted average, however, obscures the real picture. First, government and agriculture workers are excluded from the figure. Second, and probably more important, since the composition of the workforce has shifted with higher employment rates to include more low paid workers — e.g., blacks and women — it is possible that everyone’s wage could rise while the average remained constant. Imagine an economy with one man working with a wage of $1 00/week and one woman working with a wage of $50/ week m 1965. The average wage would be $75. In 1969 there are two women and one man. The man gets $110/week, each woman gets $55/week, and the average is $73.33. The average goes down while everyone’s wage goes up. Something like this actually was happening in the U.S. economy during these years. The point emphasizes the fact that for political purposes it is always necessary to look beyond the simple, gross averages.
  4. This calculation uses after-tax profits, while the income share figures, above, refer to before-tax profits.
  5. See H. Magdoff, The Age of Imperialism, Monthly Review Press, 1969; and A. MacEwan, “Capitalist Expansion, Ideology and Intervention”, Upstart no.2, May 1971, for the arguments that back up this statement as well as the general basis of our analysis of U.S. imperialism.
  6. S. Rose, “U.S. Foreign Trade: There’s No Need to Panic”, Fortune, August 1971.
  7. Incomes policies are employed in several Western European countries. Under such policies an annual decision is made about how fast wages and prices should rise in the coming year, and the government then tries, with varying degrees of sucess, to hold companies and unions to that rate of increase.
  8. These problems are explored at length by Andre Gorz in Upstart no. 1 and elsewhere.
  9. The stability of the dollar, it should be emphasized, is based on the strength of the U.S. economy, not on the formal arrangements of the international monetary system.
  10. For data, see, R. Triffin, “International Reserves in 1970 and Beyond,” The Morgan Guaranty Survey, Feb. 1971, p. 8, as cited in Monthly Review, Oct. 1971, p. 8.