Our friend Steve Forbes has said that if you’re ever stuck in
the middle seat on an airplane and want to clear some elbow space,
start talking about monetary policy and your seatmates will start
fleeing for the exits. But the subject was unavoidable this past
election season, and it is precisely because President Bush had
taken his eye off the importance of defending the greenback from
its precipitous fall (perhaps he too thought the issue a yawner)
that Republicans ended up in a world of trouble. Bush has followed
a Ronald Reagan tax cutting strategy but a Jimmy Carter monetary
policy. John McCain’s loss to Barack Obama in November confirms
that the collapse of the dollar in recent years is a big
explanation for the second straight voter repudiation of Republican
economic policies.
It turns out that the direction of the dollar has a lot to do
with who wins elections, and history proves it. Since 1960, when
the dollar has remained strong the incumbent party has fared very
well on Election Day. When the dollar falls in value over a
president’s term, the voters usually throw the bums out. Why? A
weak dollar is often the trip wire for other negative economic
effects that hit Americans right smack in the pocket book: higher
inflation at the grocery store and gas pump, stagnant or declining
wages, and less international investment here, meaning fewer
jobs.
When John F. Kennedy ran against Richard Nixon in 1960, he
declared, “we can do bettah,” and as the pro-growth candidate
called for a faster economic growth rate (5 percent) and a stronger
dollar. Kennedy’s declaration on monetary policy was bullish and
unequivocal: “This nation will maintain the dollar as good as gold
at $35 an ounce, the foundation stone of the free world’s trade and
payments system.”
The economy performed well while JFK was still alive, and boomed
even more once Lyndon Johnson passed Kennedy’s tax cuts
posthumously, which helped lay the groundwork for LBJ’s landslide
victories in 1964. But as the ’60s wore on, investors increasingly
questioned America’s commitment to maintaining the dollar’s
relationship with gold. In private markets gold started to trade
far above the Bretton Woods $35/ounce fix, which translated into
inflation. By the end of 1968, consumer price inflation had risen
to 4.7 percent. One unsung reason for the implosion of his
presidency beyond the growing unpopularity of the Vietnam War was
that Americans were experiencing the cruel economic retardant of
creeping inflation.
Under Nixon the economy performed well and inflation was still
relatively tame through his first term, so he won a huge
re-election. But Nixon severed the dollar’s peg to gold in 1971,
and by mid-1973, a new and ferocious inflationary phase had been
unleashed.
With the dollar now lacking credibility, commodities, including
gold, boomed. From 1972 to ’73 oil prices rose 300 percent, meat
prices were rising at a 75 percent annual rate, and the price of a
bushel of wheat rose 240 percent. After the second dollar
devaluation in February 1973, Treasury Secretary George Shultz
said, “There is no doubt that we have achieved a major improvement
in the competitive position of American workers and American
business.” Arthur Burns assured the Federal Open Market Committee
that the inflationary impact of the dollar’s devaluation “would be
quite small.” They sounded much like Messrs. Paulson and Bernanke
today.
With the real economy weakening due to rising inflation, Nixon’s
approval ratings tanked, which allowed the relatively minor scandal
of Watergate to force his resignation. Some years after he left
office, Nixon told a group of friends and advisors that the policy
decision he regretted most was taking America off the gold
standard, and that had he not done that, he could have withstood
the Watergate scandal. Gerald Ford had no response to the massive
inflation he inherited from Nixon—except “whip inflation now”
buttons and oil price controls—and he was tossed from office as
food and energy prices continued to accelerate. His opponent in
1976, Jimmy Carter, hung the 16 percent “misery index”—the
inflation rate plus the unemployment rate—around Ford’s neck.
Carter was elected with a voter mandate to slow inflation, but
in June 1977, Treasury Secretary Michael Blumenthal communicated to
the markets his desire to see the dollar weaker. He got his wish.
The dollar price of gold rose 270 percent to $850 an ounce during
Carter’s presidency. Inflation skyrocketed to 14 percent. The
greenback fell so much in purchasing power during Carter’s reign
that in 1980 the joke was that if you found a dollar lying on the
ground, you’d pick it up to see if there was anything of value
underneath it. The dollar was at a post-World War II low at the end
of Carter’s presidency. His Keynesian economists thought a weak
dollar and inflation would create jobs. That didn’t happen.
Inflation and unemployment reached a combined 20.5 percent in
Carter’s last year.
RONALD REAGAN REVERSED THE DOLLAR’S collapse, and he often said,
sounding like JFK, that his goal was to “make the dollar as good as
gold again.” Though he never achieved his greater desire of
returning us to the gold standard, the growth wrought by tax cuts
helped soak up excess liquidity and the dollar soared. He also gave
Fed chairman Paul Volcker the green light to throw the brakes on
the money supply to choke inflation. This was one of the most
successful Reagan policies: the inflation rate fell from 14 percent
to less than 4 percent in two years. The price of gold fell by more
than half.
The dollar actually rose during George H. W. Bush’s presidency,
making him the outlier here. But the elder Bush got money right and
taxes wrong—just the opposite of W. Mr. Bush’s 1990 tax increase
created a recession. The U.S. experienced a significant credit
crunch from 1990 to ’92 and for the first time since the late 1970s
America became an exporter of capital. This led to a temporary
trade surplus, but that didn’t help the economy at all, nor did it
create jobs. Bill Clinton defeated George H. W. on a message that
“it’s the economy, stupid.”
Robert Rubin, Clinton’s economic adviser and then treasury
secretary, was an unfailing advocate of a strong greenback. The
Clinton administration’s strong-dollar policies, combined with
reduced penalties on investment through a capital gains cut in
1997, were a boon to the economy, so much so that Clinton survived
the Monica Lewinsky scandal and left office with 60 percent
approval ratings.
President George W. Bush’s dollar policy never matched his
rhetoric. Though it paid lip service to the notion that a strong
greenback is in our national interest, tariffs on steel, shrimp,
and lumber along with mercantilist stances against China and its
yuan/dollar peg strongly signaled to the markets that the
administration sought a weaker dollar. Under Alan Greenspan,
Federal Reserve Board rate cuts created negative real interest
rates in 2005, thus subsidizing credit to banks.
The dollar has fallen 40 percent versus major currencies
alongside a 240 percent rise in the price of gold since 2001.
Bush’s imitation of Jimmy Carter when it comes to dollar policy has
blunted not only some of the highly positive effects of his
investment tax cuts; unsurprisingly, Bush’s approval ratings
resemble those of Jimmy Carter.
So why is it that weak dollar policies presage bad presidential
outcomes for the incumbent party? We believe that weak dollar
policies make Americans poorer—just as tax hikes do. Inflation
erodes the earnings of the electorate and has the real effect of a
pay cut.
As the late Wall Street Journal editorial page editor
Robert Bartley wrote in The Seven Fat Years, “inflation
always creates winners and losers, redistributing wealth. When
currencies collapse, capital becomes scarce for entrepreneurs and
businesses. Workers are thus bitten twice by inflation; first
through the reduced value of their earnings, and second with
investment slowdowns that make it impossible for employers to
increase their wages commensurate with rising prices.”
With the dollar at historical lows, it’s often remarked that
fixing our inflation problem will be painful. This couldn’t be
further from the truth. A stronger dollar right now would increase
wages, lower prices at the pump and the grocery store, and drive
investment back to these shores. It is the best stimulus plan of
all and it costs nothing.
