Going for Broke

Whatever Herman Kahn may have intended when he and his associates compiled these “seminar notes, papers, recorded briefings and assorted dictations,” the desire to make himself intelligible cannot have been much on his mind. For example, when he wants to say that prices are a function of supply and demand as well as of interest rates and inflationary expectations, he writes, “Thus, the value of money (or the price level) is related to the availability of GNP (goods and services) and the supply of money, the price of money (i.e., the interest rate is related to the supply and demand for credit), and the likelihood of changes in the value of money.”

Such syntactical chaos throughout this book suggests more than its author’s negligence. It also suggests a mind incapable of reflecting on its own effusions, like the mind of an infant or a fanatic, or that of a man for whom it has become second nature to befuddle lecture audiences with fancy inanities. Kahn blames the reluctance of businessmen to invest for the longer term on “the absence of genuine thirty-year bonds,” by which he means bonds that pay 2 or 3 percent interest and will ultimately be redeemed in constant dollars, as if the disappearance of such bonds and the widespread reluctance to invest for the long term were cause and effect and not two ways of saying the same thing.

Kahn’s assumption of a “coming boom” is similarly tautological, for his prediction rests largely on the idea that Ronald Reagan’s economic wisdom is self-evident. “To a much greater degree than most people realize,” Kahn writes, “the strength and depth of the coming boom is [sic] dependent on the man at the top…. And we believe he will do quite well—with a little help from his friends.” Thus Kahn simultaneously patronizes his “commander in chief” and offers him his services as well as those of his colleagues at the Hudson Institute, the think tank he runs and from which his “ideas” emanate. Throughout these pages, Kahn uses the first-person-plural pronoun to indicate the collegial source of his thoughts.

Kahn says that he and his associates “created” this book late in 1981 but most of it seems to have been written much earlier and revised by patchwork. Many of its ideas, Kahn admits, were presented to new members of Congress and their staffs in the last weeks of January 1981 and some chapters, for example those on energy and defense, may have been composed earlier still, before the decline in United States petroleum consumption could be determined for 1981 and when Kahn could still imagine, as he did in his galley proofs, a Soviet nuclear attack on the United States precipitated by “another East German revolt (trying to get some of the freedoms the Poles recently achieved),” a phrase which Kahn amends in the final version of his book to read “some of the freedoms recently sought by the Poles.”

Thus readers who want fresh evidence to support an optimistic view of the economy in these troubled times, or who are looking for clues to future economic trends will be disappointed by this book, if it is a book. Except for the usual anticipation of new technologies and a prediction that the baby-boom generation will soon settle into productive middle age, along with the fact that energy prices are more or less stable, Kahn has little to say that has not already been invalidated by events, including his warning that “if Reaganomics fails, there is likely to be a spectacular backlash against all the ideas associated with it, including those which had little or nothing to do with the failure.”

The current American mood, however, seems more perplexed than vengeful, while on Wall Street the mood has been manic, even though by midsummer Secretary of the Treasury Regan, usually a sanguine man, admitted that “the recession that started in July of 1981 has gone quite a lot deeper than most thought.” If Secretary Regan is right we may be in for a much different kind of “boom” from the one Kahn predicts. According to the economist Otto Eckstein, corporate profits were so poor for the second quarter of 1982 that if they don’t recover within three years, “the American economy [will] be devastated. This [deterioration of profits] had better be temporary.”

Kahn’s choice of a title for this random collection of papers on neoconservative preoccupations (defense policy, the New Class, the Reagan coalition, etc.) is arbitrary and opportunistic, but his optimism seems genuine. “Two hundred years ago…,” he writes, “human beings were almost everywhere comparatively few, poor, and at the mercy of the forces of nature.” But in the “next two centuries…human beings should be almost everywhere numerous, rich, and largely in control of the forces of nature.” Such an expectation, for which there can be no rational or empirical basis, is actually an assertion of faith, a religious sentiment affirming the American ideology of personal success and the belief that whatever inhibits one’s eventual happiness can be overcome. It is this faith that many Americans presumably still share with Kahn, for despite the repeated political, economic, and social failures of the past thirty years, the American experience remains a miraculous exception to the poverty that preceded and still largely surrounds it.

Like many other Americans, Kahn now seems to take this miracle for granted, as if prosperity were an American birthright and not the result of particular efforts and circumstances. Among those who may share Kahn’s complacency are the stock traders whose response to the recent drop in interest rates was to stage a historic mid-August, rally, even though interest rates had fallen not because the economy had recovered and was generating new capital but because it had deteriorated and the demand for loans had dwindled accordingly. Ergo, the great August rally was Wall Street’s quixotic response to the worsening economy. Similarly Kahn predicts a coming boom even though median family income in the United States had increased by only 6 percent between 1970 and 1979, after having risen by 33.9 percent and 37.6 percent in each of the previous two decades respectively, while by 1979 the United States had fallen to tenth, behind the Netherlands, in per capita GNP and was tenth, as well, in average annual productivity increase.¹ Meanwhile the federal debt, according to various estimates, is growing at the rate of 10 to 15 percent a year.

One source of our recent setbacks, Kahn believes, is not economic in the ordinary sense at all. It is the defective ideology of those Americans who oppose the further pursuit of material success because they happen to be rich enough already. He means those “affluent young people [who] are instinctively aware of the deterioration in certain amenities which occurs as an economy becomes more highly developed and as all begin to share in the affluence. Beaches become more crowded, high-ways more clogged, domestic help more scarce, access to elite colleges more difficult.” These young mandarins, according to Kahn, “often turn away from the old-fashioned notion of progress and attempt to block further economic growth” to protect their own privileges. They remind him of the ruling classes that stifled economic development in ancient China, Greece, Rome, and India, “despite their technology of a relatively high order.” Most of these apostates belong to what Kahn calls “Atlantic-Protestant cultures,” cultures that are more “transcendental” than “evangelical” and that “look for inspiration and causes like environmentalism or nonproliferation of nuclear power.”

The way to outsmart these heretics and “one of the major components of the coming boom,” Kahn thinks, “is the creation of a more positive view of the future. A revised outlook is needed to reflect the more upbeat reality of changing policies, practices, and trends.” Though Kahn believes such an outlook is already “being nurtured by many both in and out of the administration” (though no longer by Secretary Regan), these high auspices may not be enough. Thus Kahn proposes a “moral revitalization in the United States [which] might begin with a more doctrinaire and systematic inculcation of ‘traditional’ American values,” presumably the pursuit of riches and the conquest of nature. “Many ‘mainstream’ children (and the country as well) would have much better prospects if they were educated more as some of our more doctrinaire/evangelical children are” and taught, Kahn seems to be saying, to pray for money and supernatural powers. Kahn boasts that his Faust is Goethe’s, not Marlowe’s.

Some readers will want a sensible account of a world in which 30 million workers in the Western countries have come to be unemployed, including 10 million in the United States; in which the Congressional Budget Office anticipates federal deficits of $140 to $160 billion over the next three years, and that next year’s GNP will fall by 1.3 percent. Such readers might turn to David Calleo’s brief, lucid, and thoughtful study of American economic and foreign policy during the Sixties and Seventies. What Calleo wants to show is “how America’s international power,” in this period, “underwrote its domestic maladjustment” or, less elegantly, how successive administrations imposed the cost of America’s recurring devaluations upon the rest of the world, principally Western Europe; how the cost of our declining industrial efficiency, combined with our full-employment policies and our global military and political ambitions, including the Vietnam War together with Nixon’s successive devaluations, became Europe’s enforced contribution to our domestic economic tranquillity, such as it was.

Calleo is especially good when he tells how America’s full-employment policies, along with high domestic wages and the low rates of productivity that resulted, encouraged American producers to shift work to countries whose workers could produce the same goods for less money, a shift further encouraged by America’s liberal trade policies. What Calleo doesn’t show, because it is not the subject of his book, is how business and labor, intent on short-term gains, neglected the long-term interests of the economy and of their own industries. Not only did they export jobs but, taking prosperity for granted, they failed to invest aggressively in new technologies and to exploit new markets, so that foreign competitors got the better of them in world markets for steel, tires, cars, shoes, watches, cameras, textile machinery, consumer electronics, and so on. As this was happening, an essentially passive government did nothing to caution them.

What Calleo does show, however, is how the government mitigated the impact of this neglect by allowing the dollar to decline relative to other currencies, which made inefficiently produced American goods relatively more competitive in international markets while making it harder for foreigners to sell their goods to us. Readers interested in a detailed account of how American industry was mismanaged in these years might consult Minding America’s Business by Ira Magaziner and Robert Reich,² a useful and perhaps necessary companion to Calleo’s book, for Calleo has little to say about the decline of American industry in these years, though this decline is at the root of America’s “domestic maladjustment.”

Calleo has no better theory than anyone else to explain how an ambitious and ingenious people, living amid great natural abundance, has found itself repeatedly in its brief history confronted by economic crises and now seems in yet another. But he does show, within the setting of our international relationships, what little influence successive American presidents have had over the desires of their constituents to achieve here and now the future bliss that Kahn says awaits them, and how costly a failure this has been for us and our allies.

What interests Calleo—what seems now and then to obsess him—is how “America’s world role [and] full-employment policies to ensure smooth prosperity and endless growth” produced an inflation that “the country’s political will demanded,” because “ending inflation would mean ending the substantive policies that caused it.” Calleo’s story is not new, but his summary and synthesis, especially of Nixon’s decision to end convertibility—in effect to repudiate the promise that the dollar was as good as gold—and let the dollar float, will interest readers who want a single coherent account that does not lose its way in technicalities and continually reminds them of the underlying cultural factors. “The thirty-year trend,” he writes, “resulted not from fortuitous mistakes and coincidences but from basic economic policies and expectations now deeply rooted in the structure of American government, business and society. Perpetually unbalanced budgets, ratified by easy monetary policy, accurately reflected the broad excess of American expectations [over] American resources.”

Calleo would not argue, however, that these excessive expectations are to be regretted in all cases. “American power, whatever its abuses, has given much of the world a rare interlude of secure prosperity…. The United States, moreover, has made substantial progress toward resolving… the racial division that is the inherited curse of American history.” But the high rates of growth in the 1950s and 1960s that made these goals seem attainable engendered “social and economic expectations which develop[ed] a momentum of their own,” Calleo adds. Thus when the economy finally weakened in the 1970s, partly as a result of these costly pursuits, and “social and political unrest” seemed imminent, the government adopted the “natural expedient… inflation” as all governments “but plural democracies especially” often do.

Kahn, on the other hand, tries to show that chronic deficits don’t matter—that in fact “the United States government has not truly had many deficits,”—as long as the deficit remains roughly proportional to GNP, as it did during the 1970s, and provided interest rates are more or less the same as the rate of inflation: as long, in other words, as interest remains largely nominal. In such circumstances, Kahn argues, the sums allocated for the payment of interest barely compensate the bondholders for what their bonds have lost to inflation: therefore the sums paid out in interest amount to a repayment of principal.

Kahn’s objection to federal deficits, illusory as they may be, is not that they have become excessive in themselves as Americans have learned to live beyond their means, but that they encourage federal spending, though he himself seems undisturbed by “Secretary Weinberger [who] recently suggested we should have plans to mobilize half the GNP, i.e., $1.5 trillion,” should the Russians threaten our vital interests.

Kahn has a further objection to unbalanced budgets which is also inconsistent with his claim that deficits have not become a burden. He worries that the government may one day choose to disencumber itself of debt by printing money, though this is what it has been doing all along by means of the repeated devaluations that Calleo describes. Or that, alternatively, by borrowing to finance its deficits the government may “crowd out” other borrowers, for example, businessmen looking for development capital or consumers looking for mortgages. Despite the weak economy and unemployment rates approaching 10 percent, it is this “crowding out,” along with Federal Reserve policy and the fear among lenders of renewed inflation, that accounts for the current prime rate of 13.5 percent and bond rates that are “still unbelievably high,” according to Otto Eckstein. Kahn’s fear of inflation and “crowding out,” in response to deficits that he otherwise tries to discount has the ring of a disingenuous afterthought,³ added to prop up a hypothesis inconsistent with common sense and now discredited by events. Kahn should have known all along that the deficit was real and would have real consequences: inflation followed by monetary restraint, and a recession approximately as severe as the inflation that preceded it.

Thus the Treasury, like a ruined speculator whose assets shrivel as his debts mount, must now finance the government’s real overdrafts at intolerable rates of interest while the national income declines as the cost of borrowing discourages commerce. All that distinguishes the Treasury in these straits from an actual bankrupt or from the City of New York in 1975 is its access as a last resort to the printing press. Nor is an economically resilient and politically compliant Europe any longer at America’s disposal to share the burden of American profligacy as it had done, to its disadvantage, according to Calleo, for the past thirty years.

Though Calleo foresaw the present crisis and recognizes its roots in our national failure to find a “balance between demand that must be disciplined and supply that must be augmented,” he remains somewhat hopeful. “With bipolar parity and the rise of other powers in the world, as well as the end of cheap energy and painless inflation at home, history is finally presenting America with its bill…. Pressed by a more imperious necessity, Americans may hope to find the ideas and leadership to build a new consensus, one based on a more profound and balanced notion of welfare at home, as well as a more realistic and measured view of power abroad.”

But what if Calleo is wrong and Kahn is right? What if Americans really are a people who believe that they can defy nature and are entitled to lives of easy abundance? What if there is a lesson in the probability that Calleo will be fortunate if his worthy and troubling book is read at all while the best sellers of the season are Life Extension: Adding Years to Your Life and Life to Your Years, Thin Thighs in 30 Days, and a widely discussed book for the fall is one whose authors celebrate an exquisitely sensitive area within the vagina that human beings in all their millennia of looking had never noticed before.

Our forefathers did not, after all, uproot themselves from the settled cultures of the Old World, with their class systems, their residual despotisms, and their institutionalized inequality, so that their grandchildren should find themselves a century later once more in a world of limited means, oppressed by an aristocracy of mid-Atlantic Protestants who occupy most of the beaches, monopolize the maids, and scorn further economic development. What Calleo may have underestimated in his otherwise disenchanted view of the American character is the political and social turbulence likely to accompany America’s reintroduction to the fact of scarcity, “the fundamental fact,” Calleo calls it, “that lies at the root… of the social order itself.”

That Kahn and the majorities for whom he probably speaks would find such a definition of society excessively pessimistic, an example of fashionable Protestant transcendentalism, or perhaps even find it subversive, suggests how intense this turbulence may turn out to be. In our relatively classless society where it is permissible for anyone to ask why, if someone else succeeds, can’t I? why shouldn’t my thighs be thin, my life extended, my shares rise? the ensuing scramble for material advantage and the illusion of material possibility are cherished rights, inseparable from the American idea of democracy. Calleo’s new consensus requires first of all a willing accommodation on the part of the majority to a new and sobering definition of material limits, limits which prudent politicians are unlikely to legislate without a clear popular mandate. It is a mandate that neither Calleo nor Kahn gives much reason to anticipate.

In May of this year, former secretary of commerce Peter G. Peterson, speaking on behalf of five former secretaries of the treasury, including John Connally, William Simon, and Michael Blumenthal, warned that federal “deficits now in prospect could well exceed 5 percent of GNP year after year,” so that “federal borrowing would devour virtually every penny of household savings and divert capital from productive investment at a record rate.”⁴ This diversion, according to former Secretary Connally, represents “a day by day deterioration of the whole economic base of the country.” What we are facing, according to these former secretaries, is a federal budget of a trillion dollars by 1985, of which so-called need-related transfer payments—subsidies for the poor determined by a means test—represent less than 9 percent while “non-need-related transfer payments”—subsidies largely to the middle class, to citizens who do not have to demonstrate need—together with the military budget and interest charges, constitute about 80 percent of what the federal government spends. “The crux of the problem,” according to Paul Harman, an economist quoted by The Wall Street Journal, “is that the federal government is borrowing such a large part of total savings, and paying it right back to people who consume most of it immediately, that there is a shortage of capital for investment,” though Magaziner and Reich, among others, would argue that the problem may not be a shortage of capital as much as the inability of American business to invest capital efficiently.

Peterson and the other former secretaries would leave subsidies to the poor intact because to cut them would be both unfair and useless in view of the small part they represent of the whole. But they would cut from the 1985 budget a total of $85 billion from defense and from middle-class entitlement programs, mainly by limiting the indexed growth of pensions, including Social Security. With $60 billion in new taxes, mainly on consumption, including taxes on alcohol, tobacco, and energy, and a consequent reduction of $30 to $35 billion in interest charges, the former secretaries propose to reduce the 1985 budget by between $175 and $200 billion, a vastly greater reduction than the one recently passed by Congress, which imposes new taxes of slightly less than $100 billion over three years.

Peterson’s plan, which emphasizes capital formation at the expense of consumption, challenges the American illusion of easy prosperity and imperial omnipotence—the overt subject of Calleo’s book and the inadvertent subject of Kahn’s—a challenge whose boldness owes something to the fact that Peterson and his fellow former secretaries are not currently responsible to the electorate. To the extent that one can imagine Peterson’s program embodied in a future Democratic or Republican platform, one can also imagine the likelihood of Calleo’s new consensus and the eventual reconstruction of the American economy.

Recent experience suggests that a more likely response to the intolerable burden of financing our growing federal deficit at high rates of interest will be the usual triumph of political expediency over economic reality, yet another in the series of devaluations that Calleo describes. It is this expedient that the Federal Reserve—having lowered its discount rate three times this summer—may be drifting toward, conceivably in return for President Reagan’s agreement to endorse the new tax bill; perhaps too in fear of precipitating a banking crisis if rates stay high and maybe because it is now clear that monetary restraint suppresses inflation at the cost of economic misery, social discontent, and political retribution.

There are few alternatives to devaluation, among them that we continue our current restrictive monetary policy and accept the high rates of unemployment and business failure that this implies; that we increase GNP by restructuring the industrial economy by some means or other, an unlikely prospect in the short term; or that the Treasury simply default, which is unthinkable. For Peterson’s proposal that we limit our entitlements and increase our taxes there seems to be hardly any constituency at all. For Kahn’s idea, on the other hand, that Americans are born to prosper as a birthright, there may still be abundant support.

Workers who want their jobs back, businessmen who want to fill their order books, bankers who want to clean up their balance sheets before it’s too late, debtors who want to pay off in cheap dollars and creditors who are happy to be paid at all in view of the highest rate of bankruptcy since 1932, debt-ridden farmers, and overextended speculators—these are the constituents, as they have been in America since before the age of Jackson, for the devaluations whose recent history Calleo writes about. If there is any substance to Kahn’s prediction of “a spectacular backlash” against Reaganomics it is more likely to be directed at Reagan’s policies of fiscal and monetary restraint than at the ramshackle Keynesianism that justifies his so-called supply-side tax cuts, no matter how little these may have benefited the average taxpayer or contributed to promised business recovery.

What Calleo’s book says repeatedly and Kahn reveals inadvertently is that our history and character do not predispose us to sacrifice. Given the “broad excess of American expectations [over] American resources” and the vast public debt that this excess has created, and the reluctance or inability of the rest of the world any longer to assume our burden, one must contemplate the future with great misgivings not to say dread if Calleo’s book turns out to describe not a disease from which we have recovered but one whose cure has yet to be found.

As for Calleo himself, he believes that such a cure requires “at the very least [that] the political system must somewhere have the capacity to formulate a long-range national economic strategy,” presumably the sort of national industrial policy that Magaziner and Reich, for example, call for in Minding America’s Business, or that Lester Thurow and Felix Rohatyn have discussed in these pages and elsewhere. But the language of Calleo’s prescription is so qualified and his commitment to the therapeutic outcome so tentative that readers may reasonably wonder how seriously he wants to be taken. They may also wonder whether he privately suspects that the process his book describes has yet to run its course, that the dollar may still go the way of the peso and the cruzeiro, leaving these and their sister currencies to go who knows where.