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.