Editor's note: The following essay is the third in a seven-part series of excerpts from George P. Shultz's new book Issues on My Mind: Strategies for the Future. Defining Ideas will feature these short excerpts from the book, accompanied by video interviews of Secretary Shultz.
As a teenager in the 1930s, I was acutely aware of the tough economic conditions in the United States and the government’s efforts to improve them. The New Deal, I could see, represented a massive intervention in the economy but it did not seem to help. I also recall that some of this intervention was declared unconstitutional by the Supreme Court and that President Roosevelt’s subsequent court-packing plan, through which he sought to ﬁll newly created seats with justices who shared his views, was blocked by Congress. I recognized that the strongly negative reaction to Roosevelt’s move was an affirmation of the importance citizens attach to the system of distributed power—the checks and balances produced by three independent branches of government.
While I was a Marine in the South Paciﬁc in World War II, I was conscious of the high degree to which the US economy was mobilized for the war. When I returned from active duty to study economics, a key question was how the government could disentangle itself from the war effort and reconstitute a normally functioning economy. We all hoped that lessons learned from the Great Depression—and the protectionism and competitive currency devaluations that aggravated and accompanied it—could lead us to institute more sensible policies. We wanted prosperity without inﬂation, an open-trade regime, and a workable exchange rate system. Despite periodic recessions, bouts of inﬂation, and threats of protectionism since the end of World War II, those objectives have been achieved. But wide shifts in the policy road over the years have produced obvious consequences, both positive and negative.
As I think about the tensions underlying the current economic debates, six important ideas come to mind. Paying attention to these concepts will contribute to good economic policy.
The ﬁrst involves the time horizon that governs actions. When orientation is short, intervention can be precipitous and can result in many unintended—and mostly negative—consequences. The adoption of longer time horizons is often difficult, however, particularly for political reasons.
Photo credit: U.S. Department of Treasury
Second, a sense of strategy is critical because economics is essentially a strategy science. Inputs usually produce outputs, frequently with a lag. I have learned that, all too often, an economist’s lag can become a politician’s nightmare. In my estimation, however, our economic strategy should be guided mainly by long-term consequences, not short-term ﬁxes.
Before moving on to my remaining points, I offer some stories drawn from my own experiences that highlight the importance of paying attention to time horizons and maintaining a sense of strategy.
As director of the Office of Management and Budget in the early 1970s, I worried about the growing atmosphere favoring wage and price controls. We had the budget under control and the Federal Reserve Board had a sensible monetary policy in place. Unemployment was too high and prices were rising too fast, but the rates of change in both were coming down. Long-run thinking suggested that we should stick with these policies. I set out to convince people that the proper course was “steady as you go,” an approach I advocated in a speech in April 1971:
The basic strategy of economic policy and its current tactical implementation are generally on course and economic policy can beneﬁt from application of the old nautical phrase, “Steady as you go” . . . .
A portion of the battle against inﬂation is now over; time and the guts to take the time, not additional medicine, are required for the sickness to disappear. We should now follow a noninﬂationary path back to full employment....
Those of you familiar with sailing know what a telltale is—a strip of cloth tied to a mast to show which way the wind is blowing.
A captain has the choice of steering his ship by the telltale—following the prevailing winds—or . . . by the compass.
In a democracy, you must keep your eye on the telltale, but you must set your course by the compass. That is exactly what the president of the United States is doing. The voice from the bridge says, “Steady as you go.”
Unfortunately for the economy, the voice from the bridge changed its tune and hit a different note. I lost the battle. When President Nixon imposed wage and price controls, the move proved to be wildly popular at ﬁrst. But, in the end, it produced a massive infusion of government regulation with the dire consequences that economists had predicted, including the very inﬂation the controls were intended to target. The president had violated the injunction to “think long” and the country paid the price in the form of a poor economy in the 1970s. Not until Ronald Reagan took office in 1981 did the United States get back on a sustainable economic track.
President Nixon’s decision to impose wage and price controls was triggered by the reality that he was forced to close the gold window, ending the US guarantee that it would buy gold at thirty-ﬁve dollars per ounce. There were more dollars out there than gold in Fort Knox, so it was clear that a run on the federal depository was coming. Closing the gold window was bound to lead to an overdue change in the value of the dollar compared with the currencies of other major countries, a devaluation that would make imports more expensive. As a result, it was argued, we would have signiﬁcant inﬂationary pressure. I thought these pressures were being overestimated, but the argument of others prevailed.
(When I became secretary of the treasury, I found that the wage and price control system, then in effect for over a year, was in my direct line of responsibility. In collaboration with the two men in charge, Don Rumsfeld and Dick Cheney, I was in the process of dismantling the controls. Against my strong advice, President Nixon decided to re-impose them in full. I resigned, telling him that he needed a new secretary of the treasury. I was eventually succeeded by my deputy, William Simon.) By the time I became secretary of the treasury in June 1972, the international exchange system was in disarray and there was no US plan to restore stability. I set out to create a plan that we could propose at the annual meeting held by the World Bank and the International Monetary Fund, always attended by the world’s top ﬁnance ministers and bankers. I was convinced that the United States and the world would be better off if the exchange rate system were more ﬂexible. But I knew that many throughout the world, particularly in Europe, preferred a system in which exchange rates were more ﬁxed, with par values for various currencies set and not expected to change. So, out of a conversation I had with Milton Friedman, the idea emerged of a ﬂoating exchange rate system in the clothing of par values. All countries had reserves and, in the system we devised, major changes in reserves would automatically create changes in exchange rates.
I spent the summer of 1972 working through the idea of a ﬂoating exchange rate system with my government colleagues. My under-secretary, Paul Volcker, pulled the laboring oar with great skill and wrote a series of memoranda supporting our plan.
On the Sunday before the Bank-Fund meeting began, I took the unprecedented step of inviting the ﬁnance ministers of the major countries to meet with me individually, review the speech I would deliver at the meeting, and offer suggestions. This process was the start of long-lasting friendships with Valéry Giscard d’Estaing of France, Helmut Schmidt of Germany, Tony Barber of the United Kingdom, and, eventually, Takeo Fukuda of Japan. None of them requested substantive changes to the basic US plan contained in my speech, but each offered valuable suggestions that probably contributed to widespread receptiveness to it.
With that, the world heaved a sigh of relief, not because every country agreed with the US plan but because the United States was now back in the game with sensible ideas. Eventually, through a series of larger meetings involving some twenty countries and extensive private discussions among the ﬁnance ministers in our little group that had gradually formed, the world found its way to the present system of loosely managed ﬂoating exchange rates. Problems have cropped up along the way, of course, but the system has worked reasonably well over the years, remaining fundamentally consistent with the recognition by the post– World War II statesmen that competitive devaluations of currencies, like protectionism in trade agreements, are a bad idea.
Lessons from this experience stood me in good stead when I was secretary of state because the process had deepened my understanding of how international agreements might be forged. It had also given me the opportunity to develop genuine personal friendships with leaders of other major countries. The experience helped me see not only what could be done but also how to make something happen.
Almost a decade after my “Steady As You Go” speech, the Reagan administration pursued a steady approach to the economy, and the results show the wisdom of that course. I chaired President Reagan’s Coordinating Committee on Economic Policy during his election campaign and through the ﬁrst eighteen months of his presidency. Before his inauguration, my committee sent the president-elect a memo containing a series of recommendations. Here are the key points from that memo, as applicable today as they were in 1980:
Sharp change in present economic policy is an absolute necessity. The problems of inﬂation and slow growth, of falling standards of living and declining productivity, of high government spending but an inadequate ﬂow of funds for defense, of an almost endless litany of economic ills, large and small, are severe. But they are not intractable. Having been produced by government policy, they can be redressed by a change in policy.
The essence of good policy is good strategy. Some strategic principles can guide your new administration as it charts its course.
—Timing and preparation are critical aspects of strategy. The fertile moment may come suddenly and evaporate as quickly. The administration that is well prepared is ready to act when the time is ripe.
—The need for a long-term point of view is essential to allow for the time, the coherence, and the predictability so necessary for success. This long-term view is as important for day-to-day problem-solving as for the making of large policy decisions. Most decisions in government are made in the process of responding to problems of the moment. The danger is that this daily ﬁre-ﬁghting can lead the policy maker farther and farther from his goals. A clear sense of guiding strategy makes it possible to move in the desired direction in the unending process of contending with issues of the day.
Many failures of government can be traced to an attempt to solve problems piecemeal.
—Consistency in policy is critical to effectiveness. Individuals and business enterprises plan on a long-range basis. They need to have an environment in which they can conduct their affairs with conﬁdence.
The fundamental areas of economic strategy concern the budget, taxation, regulation, and monetary policy. Prompt action in each of these areas is essential to establish both your resolve and your capacity to achieve your goals.
Our committee went on to comment on speciﬁc policy areas.
—Your most immediate concern upon assuming the duties of the president will be to convince the ﬁnancial markets and the public at large that your anti-inﬂation policy is more than rhetoric. Get the budget under control.
—Your tax proposal should be presented early in the new administration in tandem with other key elements of your economic program. We consider that the key ingredients should be your proposals for the Kemp-Roth cut in personal income tax rates, simpliﬁcation and liberalization of business depreciation, and a cut in effective taxes on capital gains.
—The current regulatory overburden must be removed from the economy. Equally important, the ﬂood of new and extremely burdensome regulations that the agencies are now issuing or planning to issue must be drastically curtailed.
—Many of our economic problems today stem from the large and increasing proportion of economic decisions being made through the political process rather than the market process. An important step to demonstrate your determination to rely on markets would be the prompt end of wage and price guidelines and elimination of the Council on Wage and Price Stability.
—A steady and moderate rate of monetary growth is an essential requirement both to control inﬂation and to provide a healthy environment for economic growth. We have not had such a policy.
With these fundamentals in place, the American people will respond.
As the conviction grows that the policies will be sustained in a consistent manner over an extended period, the response will quicken and a healthy US economy will restore the credibility of our dollar on world markets, contribute signiﬁcantly to smoother operation of the international economy, and enhance America’s strength in the world.
These ideas were consistent with positions President Reagan had taken during his election campaign. He followed through on implementing them and the long-run results were spectacular. President Reagan showed courage as he held a political umbrella over Paul Volcker at the Fed, despite warnings from political advisers of a recession and political losses in the midterm election. He took the view that inﬂation must be dealt with and he accepted a short-term hit in order to achieve long-term gains for the economy. By early 1983, inﬂation was under control, tax-cut incentives had kicked in, and the economy was taking off.