L81 IN TROUBLE - 2

The US Economy's Early Warning

From DAVID WATT

WASHINGTON

This masterly self-portrait is not of course entirely spurious. Nor indeed is it all his own work. The commentators—a month ago in the grip of inflation fever, now crying recession— have tended to add their own dramatic touches to the President's predicament. Nevertheless, it is essentially a characteristic Johnsonian concoc- tion designed to leave open as many options as P0,\Ible, to entangle as many opponents as he

in in his net, and to disguise the fact that an extremely cool and subtle mind is at work. Cer- tainly all the evidence suggests that Johnson, far from being irresolute about the economy, has decided quite calmly to run a calculated risk. The President has been told by his senior ad- visers that the economy is overheated and will probably continue to remain so unless tax in- creases or wage and price controls are imposed. But he has also been told that the boiler will not actually burst this year at the present rate. Next year is quite another matter. But by that time the Congressional elections will be over. Viet- nam may be settled one way or another, General de Gaulle may be dead—and so may Lyndon Johnson. So why introduce restrictive policies with risky political overtones before they are absolutely unavoidable?

This line of reasoning is all the easier to adopt since it has the hearty endorsement of nearly all the other interested parties. Business is ardently opposed to a rise in corporation tax and even more so to mandatory price controls; labour would explode over wage controls; the entire Democratic party would shudder at an increase in income tax so close to the elections; and the public would deeply resent cuts in welfare ex- penditure and Great Society programmes. The only dissidents are a narrow majority of academic economists, the Republican party and the Federal Reserve Bank, none of which groups is exactly prominent in the President's thought-processes and none of which is likely by next spring to be in a position where it will matter much if they say 'we told you so.'

All this raises the blood pressure of conserva- tive editorial writers, just as the brilliant personal charade put on by Johnson has helped introduce uncertainty and depression on the stock market. But the trouble is that, however strong one's sus- picions about Johnson's motives may be, it is devilishly difficult to find a watertight case for saying that he has taken the wrong course, or even to see how, having taken it, he could con- duct his public relations very differently without giving someone or other the wrong ideas.

After some wild fluctuations, the technital arguments are now, in fact, finely balanced. There was no doubt that the economic indicators for the first three months of this year all pointed to a serious inflationary situation. The consumer price index had risen a whole point to 112 (1957-59=100) and food prices two and a half points to 113.9. The Gross National Product had soared during the first quarter at an annual rate of almost 10 per cent—far above estimates. At the end of March, unemployment was at a rate of 3.8 per cent--the lowest for years—and was still falling. Consumer spending was booming and personal saving was at its lowest since the Korean war. Companies were officially admitted to be planning an increase in their expenditure on plant and equipment of at least 16 per cent, or according to some private polls as much as 19 per cent.

At this point there was a remarkable con- sensus among the academic establishment from left to right that an increase in taxes of up to $7,000 million was in order. Only a few hopeful voices in the treasury and the President's Council of Economic Advisers continued to claim that the economy was on the point of reacting to the surgery already performed on it by the govern- ment—the removal of $6,000 million of spending power through the increase in social security taxes, the reimposition of some excise taxes in March, the speed-up of corporation and income tax payments and the high interest rate induced by the Federal Reserve.

It is now beginning to look as if the optimists were right. In the last six weeks wholesale prices have subsided a trifle and unemployment has at least ceased to fall for the time being. The uncertainties and shortage of credit have started to have some effect on consumer spending— notably on large capital items like houses and motor-cars. These signs of slow-down have pre- sumably been highly gratifying to the White House and to the denizens of Capitol Hill who have badly wanted an excuse to go on sweetening their constituents by lavish federal expenditure. But unfortunately the government's dilemma was very soon exposed. For such is the volatility of Wall Street that it only needed General Motors to announce that it was sensibly cutting back production a little for the market to crash twenty-six points in a week and for everyone to start talking about recession.

From then on the administration's publicists have been busy steering a middle course between boom and bust. It has been relatively simple to rule out bust for the time being in view of the amount of federal spending in the offing and the buoyancy of private and industrial spending. But what about the boom?

Here the government is still on the defensive because it cannot or will not answer the two central questions. Firstly, it will not know until mid-June whether the President's appeals to busi- nessmen to cut down capital expenditure during the rest of this year has had any effect. Secondly, it refuses to come clean about the projected costs of the Vietnam war. The official line about busi- ness expenditure is that high interest rates, taken together with the limitations on supplies and skilled manpower brought about by the war, will reduce the rate of increase to well below the earlier projection of 16 per cent.

However, nobody is wildly confident about this; and the question of federal expenditure on the war is even more dubious. Mr Arthur Okun, a member of the Council of Economic Advisers, said the other day that the best intelligence he could get from the Pentagon is that there is no reason to mark up federal defence purchases for 1965-66 or the first half of the 1966-67 fiscal year above the estimates given last January. This implies that the existing budget will cover the build-up of American troops in Vietnam to the 350,000 or 400,000 level expected by the end of the year. Unfortunately, Mr Robert McNamara and others have frequently admitted that the whole budget is based on the unlikely assump- tion that the war will have ended by June 1967. As soon as it becomes clear, as it must before long, that the war is going to last longer than that, forward commitments will have to be made which will certainly affect the economic climate by early next year, if not sooner.

This analysis confirms the President's apolo- gists in their belief that if a tax increase is necessary at all it will not need to come until the new Congress in January—and perhaps they are right. But it emphasises the trouble the ad- ministration is laying up for itself in 1967. If defence expenditure were all, that would be

serious enough. But it is not. The cycle of union contracts in America has happened to make 1966 a quiet year on the wages front. But the first half of 1967 will see more wage negotiations than in the whole of this year, some of them very large. Considering that business profits have risen far faster than wages in recent years, it seems highly unlikely that the unions are going to pay much attention in their demands to the government's wage/productivity 'guideposts' of 3.2 per cent. But even if they did so, account would have to be taken of rises in living costs —and if these turn out to be, say, 3 per cent this year, the wage-price spiral may begin once more.

It is these future pressures rather than the present ones which are now troubling the eco- nomists. They argue, of course, that future dangers demand present remedies. But econo- mists and politicians habitually talk on totally different time-planes. To Mr Walter Heller and his colleagues eight months is no time at all. To President Johnson it is a very long time indeed.